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UNITED STATES
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 December 27, 2003.
Transition report pursuant to Section 13 or 15(d) of the Securities
- -- Exchange Act of 1934.
Commission file number 33-70572
EYE CARE CENTERS OF AMERICA, INC.
(Exact name of registrant as specified in its charter)
TEXAS 74-2337775
(State or other jurisdiction (IRS Employer Identification No.)
of incorporation or organization)
11103 West Avenue
San Antonio, Texas 78213-1392
(Address of principal executive offices, including Zip Code)
(210) 340-3531
(Registrant's telephone number, including area code)
SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT: NONE
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. N/A
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). Yes __ No X
Aggregate market value of common stock held by non-affiliates of the
registrant is $6,325,550. As the registrant's common stock is not traded
publicly, the per share price used in this calculation is based on the per share
price as designated by the Board of Directors as of the last business day of the
registrant's most recently completed second fiscal quarter ($15.13 per share).
Indicate the number of shares outstanding of each of the registrant's
classes of common stock as of the latest practicable date: 7,397,689 shares of
common stock as of March 15, 2004.
Documents incorporated by reference: None
1
FORM 10-K INDEX
PART I
ITEM 1. BUSINESS 4
ITEM 2. PROPERTIES 19
ITEM 3. LEGAL PROCEEDINGS 20
ITEM 4.. . . . . . . . . . . . . . .. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS 20
PART II
ITEM 5.. . . . . . . . . . . . . . .. MARKET FOR REGISTRANT COMMON STOCK AND RELATED
. . . . . . . . SHAREHOLDER MATTERS 21
ITEM 6.. . . . . . . . . . . . . . .. SELECTED CONSOLIDATED FINANCIAL DATA. 22
ITEM 7.. . . . . . . . . . . . . . .. MANAGEMENT DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS 24
ITEM 7A. . . . . . . . . . . . . . .. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT
. . . . . . . . . . . . MARKET RISK 42
ITEM 8.. . . . . . . . . . . . . . .. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA. 42
ITEM 9.. . . . . . . . . . . . . . .. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE 44
ITEM 9A. CONTROLS AND PROCEDURES 44
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT 45
ITEM 11. EXECUTIVE COMPENSATION 49
ITEM 12. . . . . . . . . . . . . . .. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
. . . . . . . . . . . . . MANAGEMENT 53
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS 55
ITEM 14. . . . . . . . . . . . . . .. PRINCIPAL ACCOUNTANT FEES AND SERVICES 56
PART IV
ITEM 15. . . . . . . . . . . . . . .. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS
. . . . . . . . . . . . ON FORM 8-K 57
2
FORWARD-LOOKING STATEMENTS
Certain statements contained herein constitute "forward-looking statements"
within the meaning of Section 27A of the Securities Act of 1933, as amended, and
Section 21E of the Securities Exchange Act of 1934, as amended. All statements
other than statements of historical facts included in this report regarding the
Company's financial position, business strategy, budgets and plans and
objectives of management for future operations are forward-looking statements.
Whenever the Company makes a statement that is not a statement of historical
fact (such as when the Company describes what it "believes," "expects,"
"anticipates," or "intends" to do or what "should" occur in the future, and
other similar statements), the Company is making a forward looking statement.
Although the management of the Company believes that the expectations reflected
in such forward-looking statements are reasonable, it can give no assurance that
such expectations will prove to have been correct. Such forward-looking
statements involve known and unknown risks, uncertainties and other factors that
may cause the actual results, performance or achievements of the Company, or
industry results, to be materially different from those contemplated or
projected, forecasted, estimated or budgeted in or expressed or implied by such
forward-looking statements. Such factors include, among others, the risk and
other factors set forth under "Risk Factors" herein and under the heading
"Government Regulation" herein as well as the following: general economic and
business conditions; industry trends; the loss of major customers or suppliers;
cost and availability of raw materials; changes in business strategy or
development plans; availability and quality of management; and availability,
terms and deployment of capital. SPECIAL ATTENTION SHOULD BE PAID TO THE FACT
THAT CERTAIN STATEMENTS CONTAINED HEREIN ARE FORWARD-LOOKING INCLUDING, BUT NOT
LIMITED TO, STATEMENTS RELATING TO (I) THE COMPANY'S ABILITY TO EXECUTE ITS
BUSINESS STRATEGY (INCLUDING, WITHOUT LIMITATION, WITH RESPECT TO NEW STORE
OPENINGS AND INCREASING THE COMPANY'S PARTICIPATION IN MANAGED VISION CARE
PROGRAMS); (II) THE COMPANY'S ABILITY TO OBTAIN SUFFICIENT RESOURCES TO FINANCE
ITS WORKING CAPITAL AND CAPITAL EXPENDITURE NEEDS AND PROVIDE FOR ITS
OBLIGATIONS; (III) THE CONTINUING SHIFT IN THE OPTICAL RETAIL INDUSTRY OF MARKET
SHARE FROM INDEPENDENT PRACTITIONERS AND SMALL REGIONAL CHAINS TO LARGER OPTICAL
RETAIL CHAINS; (IV) INDUSTRY SALES GROWTH; (V) IMPACT OF REFRACTIVE SURGERY AND
OTHER CORRECTIVE VISION TECHNIQUES; (VI) DEMOGRAPHIC TRENDS; (VII) THE COMPANY'S
MANAGEMENT ARRANGEMENTS WITH PROFESSIONAL CORPORATIONS; (VIII) THE COMPANY'S
ABILITY TO OBTAIN ADDITIONAL FINANCING TO REPAY THE CREDIT FACILITY OR NOTES AT
MATURITY; AND (IX) THE CONTINUED MEDICAL INDUSTRY EFFORT TO REDUCE MEDICAL COSTS
AND THIRD PARTY REIMBURSEMENTS.
3
PART I
ITEM 1. BUSINESS
- ------------------
GENERAL
Eye Care Centers of America, Inc. (the "Company") is the third largest
retail optical chain in the United States as measured by net revenues, operating
or managing 373 stores, of which 304 are optical superstores with in-house lens
processing capabilities. The Company directly owns 309 optical stores with the
remaining 64 stores being owned by an optometrist's professional entity and
managed by a subsidiary of the Company under management agreements. For purposes
of this Report, all of such optical stores, whether owned or managed by the
Company (and its subsidiaries) are referred to herein as the Company's stores.
The Company utilizes a strategy of clustering its stores within its targeted
markets in order to build local market leadership and strong consumer brand
awareness, as well as to achieve economies of scale in advertising, management
and field overhead. Management believes that the Company has either the number
one or two superstore market share position in twelve of its top fifteen
markets, including Washington, D.C., Minneapolis, Dallas, Houston, Tampa/St.
Petersburg, Phoenix, Miami/Ft. Lauderdale, Portland and San Antonio. The Company
generated net revenues and EBITDA (as defined under the heading "Item 6.
Selected Consolidated Financial Data") of $369.9 million and $53.7 million,
respectively, for the fiscal year ended December 27, 2003 ("fiscal 2003") and
anticipates net revenues and EBITDA of $398.1 million and $61.7 million,
respectively, for the fiscal year ended January 1, 2005 ("fiscal 2004").
The Company's stores, which average approximately 4,100 square feet, carry
a broad selection of branded frames at competitive prices, including designer
eyewear, as well as the Company's own proprietary brands and non-branded
products. Non-branded product constituted approximately 75% of frame units sold
in both 2003 and 2002, respectively. The Company's superstores offer customers
"one-hour service" on most prescriptions by utilizing on-site processing
laboratories to grind, coat and edge lenses. Moreover, optometrists ("ODs")
located within or adjacent to all of the Company's stores offer customers
convenient eye exams and provide a consistent source of optical retail
customers. In the Company's experience, over 72% of such ODs' regular eye exam
patients purchase eyewear from the Company's adjacent optical retail stores.
The Company's management team has focused on improving operating
efficiencies and growing the business through both strategic acquisitions and
new store openings. The Company's net revenues increased from $140.2 million in
fiscal 1995 to $369.9 million in fiscal 2003, while the Company's store base
increased from 152 to 373 over the same period, primarily as a result of four
acquisitions. The Company's management team owns or has the right to acquire
approximately 15.1% of the Company's common stock on a fully diluted basis,
through direct ownership and stock options.
4
BUSINESS STRATEGY
Management believes that key drivers of growth for the Company include (i)
the success of the Company's promotional activities, (ii) the continuing role of
managed vision care and (iii) new product innovations. The Company plans to
focus on these key drivers by building local market leadership through the
implementation of the following key elements of its business strategy:
MAXIMIZE STORE PROFITABILITY. Management continues to improve the Company's
operating margins through enhanced day-to-day store execution, customer service
and inventory asset management. The Company has implemented various programs
focused on (i) increasing sales of higher margin, value-added and non-branded
products, (ii) continuing store expense reductions and (iii) offering extensive
productivity-enhancing employee training. Management believes its store
clustering strategy will enable the Company to continue to leverage local
advertising and field management costs to improve its operating margins. In the
fourth quarter of 2001, management implemented a value-oriented format in
certain markets based upon local market demographics. This value format
involves featuring lower retail price, higher margin products and increasing the
selection of value frames. The Company continues to improve the value offering
by increasing the number of frames in additional stores and making multiple pair
purchases available to several prescription wearers. In addition to the two
complete pair of single vision eyeglasses for $99 value promotion, the Company
continued to increase the availability of its promotional discount offers.
REDUCTION OF DEBT. In order to improve the Company's EBITDA to total debt
ratio and reduce the amount of outstanding debt, management has initiated
strategies to generate cash. During 2001, 2002, and 2003 the new store opening
program was reduced to approximately seven to ten stores each year and the
Company plans to continue this trend with eight new store openings anticipated
for 2004. Management has also continued its focus on process improvement
initiatives that result in the reduction in head counts and corporate overhead
expenses. Management is continually evaluating methods to increase store
profitability and increase cash flow. Total debt has been reduced from $291.4
million at the end of fiscal 2000 to $238.8 million at the end of fiscal 2003
with further reductions to $221.6 million anticipated by the end of fiscal 2004.
CAPITALIZE ON MANAGED VISION CARE. While management continues to pursue
managed vision care relationships, revenues from managed vision care remained
consistent from fiscal 2002 to fiscal 2003 (and decreased as a percentage of
revenues), mostly due to the Company's aggressive in-store promotional offers.
As of December 27, 2003, retail sales arising from managed vision care plans
totaled 31.6% of optical sales for fiscal 2003. Management has made a strategic
decision to pursue funded managed vision care relationships in order to help the
Company's retail business grow. Funded managed vision care relationships
include capitated and fee-for-service insurance contracts. Discount insurance
programs consist of relationships where the customer receives an agreed upon
discount on product. Funded managed vision care plans grew at the rate of 7% in
2003. Management believes that discount managed care programs will play a less
significant role as the value retail offer becomes more developed
5
throughout the Company's stores. The percent of penetration should normalize at
30% as the transition to the funded programs materializes and the retail offer
displaces discount managed care activity. As part of its ongoing effort to
develop its managed vision care business, the Company has (i) implemented direct
marketing programs and information systems necessary to compete for managed
vision care relationships primarily with funded plans and other third party
payors, (ii) developed significant relationships with insurance companies, which
have strengthened the Company's ability to secure managed vision care
relationships, and (iii) been asked to participate on numerous regional and
national managed vision care panels. While the average ticket price on products
purchased under managed vision care reimbursement plans is typically lower,
managed vision care transactions generally earn comparable operating profit
margins as they require less promotional spending and advertising support. The
Company believes that the increased volume resulting from managed vision care
relationships also compensates for the lower average ticket price. Management
believes that the role of managed vision care will continue to benefit the
Company and other large retail optical chains with strong local market shares,
broad geographic coverage and sophisticated information management and billing
systems.
EXPAND STORE BASE. In order to continue to build leadership in its targeted
markets, the Company plans to take advantage of "fill-in" opportunities in its
existing markets, as well as to enter attractive new markets where it believes
it can achieve a number one or two market share position. Consequently, the
Company opened one store in an existing market and nine stores in Atlanta,
Georgia during 2003. The Company aggressively introduced its stores to the
Atlanta market in 2003 with eight stores planned in 2004, five of which will be
in the Atlanta market. Management believes that the Company has in place the
systems and infrastructure to execute its new store opening plan and has devoted
significant management resources to the continued development of the Atlanta
market. The Company uses a site selection model utilizing proprietary software
which incorporates industry and internally generated data (such as competitive
market factors, demographics and customer specific information) to evaluate the
attractiveness of new store openings. In 2003, the Company utilized a smaller
and more efficient format, spending approximately $350,000 per new store, using
a store format averaging approximately 2,800 square feet, equipping each new
store with standardized fixtures and equipment. Initial inventory requirements
for new stores averaged $49,000 and pre-opening costs averaged $34,000 per
store, primarily for payroll and training expenditures incurred before the store
opens.
6
WHILE ALL STORES SELL FRAMES AND SPECTACLE LENSES, THE COMPANY OPERATES VARIOUS
STORE FORMATS. THE FOLLOWING TABLE SETS FORTH A SUMMARY OF THE COMPANY'S STORES
OPERATING UNDER EACH TRADE NAME, AS OF MARCH 15, 2004, RANKED BY NUMBER OF
STORES:
NUMBER OF GEOGRAPHIC TYPICAL STORE
TRADE NAME. . . . . . . . . . . . . . . . . . . . STORES FOCUS FORMAT
- ------------------------------------------------- ------------- ------------------ --------------
EyeMasters. . . . . . . . . . . . . . . . . . . . 163 Southwest, Superstores
. . . . . . . . . . . . . . . . . . . . . . . Midwest, Sq. Ft. 4,000
. . . . . . . . . . . . . . . . . . . . . . . Southeast Lab
Contact Lenses
(124 of 163 locations)
Visionworks . . . . . . . . . . . . . . . . . . . 53 Southeast Superstores
. . . . . . . . . . . . . . . . . . . . . . . . Sq. Ft. 6,100
. . . . . . . . . . . . . . . . . . . . . . . . Lab
Contact Lenses
Vision World. . . . . . . . . . . . . . . . . . . 36 Primarily Conventional
. . . . . . . . . . . . . . . . . . . . . . . Minnesota Sq. Ft. 2,300
Contact Lenses
Doctor VisionWorks . . . . . . . . . . . . . . . 31 Maryland, Superstores
. . . . . . . . . . . . . . . . . . . . . . . Colorado Sq. Ft. 3,500
. . . . . . . . . . . . . . . . . . . . . . . . and Atlanta Lab
Contact Lenses
Dr. Bizer's VisionWorld, Dr. Bizer's. . . . . . . 24 Southeast & Superstores
ValuVision, Doctor's ValuVision . .. . . . . . . Central Sq. Ft. 5,800
Lab
Contact Lenses
Hour Eyes . . . . . . . . . . . . . . . . . . . . 22 Mid Atlantic Conventional
. . . . . . . . . . . . . . . . . . . . . . . . Sq. Ft. 2,600
. . . . . . . . . . . . . . . . . . . . . . . . Lab
Contact Lenses
Stein Optical . . . . . . . . . . . . . . . . . . 15 Primarily Superstores
. . . . . . . . . . . . . . . . . . . . . . . Wisconsin Sq. Ft. 3,400
. . . . . . . . . . . . . . . . . . . . . . . . Lab
Contact Lenses
Eye DRx . . . . . . . . . . . . . . . . . . . . 15 Primarily Conventional
. . . . . . . . . . . . . . . . . . . . . . . New Jersey Sq. Ft. 3,200
Contact Lenses
Binyon's. . . . . . . . . . . . . . . . . . . . . . 14 Primarily Superstores
Oregon. . . . . . . Sq. Ft. 4,600
. . . . . . . . . . . . . . . . . . . . . . . . Lab
-------------
Total . . . . . . . . . . . . . . . . . . 373
=============
7
STORE OPERATIONS
OVERVIEW. The Company believes that the location of its stores is an
essential element of its strategy to compete effectively in the optical retail
market. The Company emphasizes locations within regional shopping malls, power
centers, strip shopping centers and freestanding locations. The Company
generally targets retail space that is close to high volume retail anchor stores
frequented by middle to high-income clientele. In order to generate economies of
scale in advertising, management and field overhead expenses, the Company
attempts to cluster its stores within a direct marketing area.
The following table sets forth as of December 27, 2003 the Company's top
fifteen markets as measured by the Company's sales. Management's estimate of the
Company's superstore market share ranking is number one or two in the twelve
markets noted.
DESIGNATED NUMBER OF
MARKET AREA . . . SUPERSTORES
- ----------------- -------------
Washington, D.C *. . . . . . 21
Houston *. . . . . . . . . . 19
Dallas * . . . . . . . . . . 22
Louisville * . . . . . . . . 7
Tampa/St. Petersburg * . . . 13
Minneapolis/St. Paul * . . . 21
Phoenix *. . . . . . . . . . 13
Nashville *. . . . . . . . . 11
Milwaukee *. . . . . . . . . 15
Miami/Ft. Lauderdale * . . . 9
Portland * . . . . . . . . . 12
Eastern New Jersey . . . . . 14
San Antonio *. . . . . . . . 8
Denver . . . . . . . . . . . 9
Baltimore. . . . . . . . . . 9
---------------
Total of Top Fifteen Markets 203
===============
LOCATIONS. The Company operates or manages 373 stores, 304 of which are
superstores, located primarily in the Southwest, Midwest and Southeast, along
the Gulf Coast and Atlantic Coast and in the Pacific Northwest regions of the
United States. Of the Company's stores, 186 are located in enclosed regional
malls, 126 are in strip shopping centers and 61 are freestanding locations.
8
The following table sets forth by location, ranked by number of stores, the
Company's store base as of March 15, 2004.
LOCATION. . . . EYEMASTERS VISIONWORKS VISION WORLD DR. VISIONWORKS BIZER HOUR EYES STEIN EYE DRX BINYONS TOTAL
- ---------------- ---------- ----------- ------------ --------------- ----- --------- ----- ------- ------ -----
Texas . . . . . 78 - - - - - - - - 78
Florida . . . . 3 38 - - - - - - - 41
Minnesota . . . - - 30 - - - - - - 30
Tennessee . . . 7 - - - 12 - - - - 19
Wisconsin . . . - - 2 - - - 15 - - 17
Arizona . . . . 15 - - - - - - - - 15
New Jersey. . . - - - - - - - 15 - 15
Virginia. . . . - 1 - - - 13 - - - 14
Maryland. . . . - - - 8 - 6 - - - 14
Oregon. . . . . - - - - - - - - 13 13
Colorado. . . . - - - 12 - - - - - 12
Louisiana . . . 12 - - - - - - - - 12
North Carolina. - 12 - - - - - - - 12
Georgia. . . . - - - 11 - - - - - 11
Kentucky. . . . - - - - 10 - - - - 10
Ohio. . . . . . 9 - - - - - - - - 9
Missouri. . . . 5 - - - 1 - - - - 6
Oklahoma. . . . 5 - - - - - - - - 5
Kansas. . . . . 4 - - - - - - - - 4
Nebraska. . . . 4 - - - - - - - - 4
Nevada. . . . . 4 - - - - - - - - 4
New Mexico. . . 4 - - - - - - - - 4
Utah. . . . . . 4 - - - - - - - - 4
Iowa. . . . . . 1 - 2 - - - - - - 3
Mississippi . . 3 - - - - - - - - 3
Washington, D.C - - - - - 3 - - - 3
Alabama . . . . 2 - - - - - - - - 2
Idaho . . . . . 2 - - - - - - - - 2
South Carolina. - 2 - - - - - - - 2
Washington. . . 1 - - - - - - - 1 2
Indiana . . . . - - - - 1 - - - - 1
North Dakota. . - - 1 - - - - - - 1
South Dakota. . - - 1 - - - - - - 1
---------- --------- ------------ --------------- ----- --------- ----- ------- ------ -----
Total . . . . . 163 53 36 31 24 22 15 15 14 373
========== =========== ============ =============== ===== ========= ===== ======= ====== =====
STORE LAYOUT AND DESIGN. The average size of the Company's stores is
approximately 4,100 square feet. The Company has developed and implemented a
smaller and more efficient new store prototype, which ranges in size from
approximately 2,800 square feet to 3,500 square feet depending upon the on-site
optometrist's location within the store or in an adjacent location. This new
store prototype typically has approximately 450 square feet dedicated to the
in-house lens processing area and 1,750 square feet devoted to product display
and fitting areas. If adjacent to the store location, the OD's office is
generally 1,300 square feet and if within the store is generally 600 square
feet. Each store follows a uniform merchandise layout plan, which is designed to
emphasize fashion, invite customer browsing and enhance the customer's shopping
9
experience. Frames are displayed in self-serve cases along the walls and on
tabletops located throughout the store and are organized by gender suitability
and frame style. The Company believes its self-serve displays are more effective
and more customer friendly than the locked glass cases or "under the shelf"
trays used by some of its competitors. Above the display racks are photographs
of men and women which are designed to help customers coordinate frame shape and
color with their facial features. In-store displays and signs are rotated
periodically to emphasize key vendors and new styles.
IN-HOUSE LENS PROCESSING. The Company's superstores have an on-site
lens-processing laboratory of approximately 450 square feet in which most
prescriptions can be prepared in one hour or less. Lens processing involves
grinding, coating and edging lenses. Some stores utilize the Company's main
laboratory in San Antonio, Texas, which has a typical turnaround of two to four
days and also handles unusual or difficult prescriptions.
ON-SITE OPTOMETRIST. Adjacent to or within most of the stores is an OD who
performs eye examinations and in some cases dispenses contact lenses. The ODs
generally have the same operating hours as the Company's adjacent stores. The
ODs offer customers convenient eye exams and provide a consistent source of
optical retail customers. In the Company's experience, over 72% of such ODs'
regular eye exam patients purchase eyewear from the adjacent optical retail
store. In addition, the Company believes proficient ODs help to generate repeat
customers and reinforce the quality and professionalism of each store. Due to
various applicable state regulations, the Company has a variety of operating
structures.
- - At 227 of the Company's stores, the ODs are independent optometrists (the
"Independent ODs"), who lease space within or adjacent to each store. At 36
of the Company's stores, the Independent OD owns the professional eye exam
practice and the Company provides management services to the practices
under business management agreements. These Independent ODs are independent
and the Company cannot exercise any control over such Independent ODs. Most
of these ODs pay the Company monthly rent consisting of a percentage of
gross receipts, base rental or a combination of both.
- - At 46 of the Company's stores, the ODs are employees of the Company.
- - Sixty-four of the Company's stores are owned by a professional corporation
or other entity controlled by an OD (the "OD PC"). The OD PC owns both the
optical dispensary and the professional eye examination practice. The OD PC
employs the ODs and the Company (through its subsidiaries) provides
management services to these stores (including the dispensary and the
professional practice) under business management agreements. At most of
these locations, the Company (through its subsidiaries) provides a turnkey
operation, providing the leased premises, employees (other than the ODs),
furniture, fixtures and equipment. In addition, the Company has an option
to designate another OD to purchase the OD PC (or its assets) at an agreed
upon calculation to determine the purchase price. At December 27, 2003,
these prices in the aggregate are approximately $10.0 million. Under the
applicable optometric and other laws and regulations, the Company is not
permitted to control the professional practice of the OD PC (e.g.,
scheduling, employment of optometrists,
10
protocols, examination fees and other matters requiring the professional
judgment of the OD). The management agreements specifically prohibit the
Company from engaging in activities that would constitute controlling the
OD PC's practice and reserve such rights and duties for the OD PC.
STORE MANAGEMENT. Each store has an operating plan, which maps out
appropriate staffing levels to maximize store profitability. In addition, a
general manager is responsible for the day-to-day operations of each store. In
higher volume locations, a retail manager supervises the merchandising area and
the eyewear specialists. Customer service is highly valued by the Company and is
monitored by location and associate. A lab manager trains the lab technicians
and supervises eyewear manufacturing. Sales personnel are trained to assist
customers effectively in making purchase decisions. A portion of store managers'
and territory directors' compensation is based on sales, profitability and
customer service scores at their particular stores. The stores are open during
normal retail hours, typically 10 a.m. to 9 p.m., six days a week, and typically
12:00 p.m. to 6:00 p.m. on Sundays.
MERCHANDISING
The Company's merchandising strategy is to offer its customers a wide
selection of high quality and fashionable frames at various price points, with
particular emphasis on offering a broad selection of competitively priced
designer and proprietary branded frames. The Company's product offering is
supported by strong customer service and advertising. The key elements of the
Company's merchandising strategy are described below.
BREADTH AND DEPTH OF SELECTION. The Company's stores offer the customers
high quality frames, lenses, accessories and sunglasses, including designer and
proprietary brand frames. Frame assortments are tailored to match the
demographic composition of each store's market area. On average, each store
features between 1,500 and 2,000 frame stock keeping units in 350 to 400
different styles of frames, representing two to three times the assortment
provided by conventional optical retail chains or independent optical retailers.
Approximately 25% of the frames carry designer names such as Nine West,
Polo/Ralph Lauren, Guess, Tommy Hilfiger and Chaps. In fiscal 2003, other
well-known frame manufacturers supplied over 10% of the Company's frames and
about 30% of the Company's frames were manufactured specifically for the Company
under proprietary brands. The Company believes that a broader selection of
high-quality, lower-priced proprietary brand frames allow it to offer more value
to customers while improving the Company's gross margin. In 2003, management
implemented a value-oriented format in seven markets based upon local market
demographics. This value format involves featuring lower retail price, higher
margin products and increasing the selection of value frames. In addition, the
Company also offers customers a wide variety of value-added eyewear features and
services on which it realizes a higher gross margin. These include thinner and
lighter lenses, progressive lenses and custom lens features, such as tinting,
anti-reflecting coatings, scratch-resistant coatings, ultra-violet protection
and edge polishing.
PROMOTIONAL STRATEGY. The Company's frames and lenses are generally
comparably priced or priced lower than its direct superstore competitors, with
prices varying based on geographic
11
region. The Company employs a comprehensive promotional strategy on a wide
selection of frames and/or lenses, offering discounts and "two for one"
promotions. While the promotional strategy is fairly common for optical retail
chains, independent optometric practitioners tend to offer fewer promotions in
order to guard their margins, and mass merchandisers tend to generally adhere to
an "Every Day Low Pricing" strategy.
PRODUCT DISPLAY. The Company employs an "easy-to-shop" store layout.
Merchandise in each store is organized by gender suitability, frame style and
brand. Sales personnel are trained to assist customers in selecting frames which
complement an individual's attributes such as facial features, face shape and
skin tone. See "Store Layout and Design." In-store displays focus customer
attention on premium priced products, such as designer frames and thinner and
lighter lenses.
MARKETING
The Company actively supports its stores by aggressive local advertising in
individual geographical markets. Advertising expenditures totaled $31.6 million,
or 8.5% of net revenues, in fiscal 2003. Advertising expenditures for fiscal
2004 are expected to be $34.1 million, or 8.6% of anticipated net revenues. The
Company utilizes a variety of advertising media and promotions in order to
establish the Company's image as a high quality, cost competitive eyewear
provider with a broad product offering. The Company's brand positioning is
supported by a marketing campaign which features the phrase "Why Pay More." In
addition, the Company believes that its strategy of clustering stores in each
targeted market area maximizes the benefit of its advertising expenditures. As
managed vision care becomes a larger part of the Company's business in certain
local markets, advertising expenditures as a percentage of sales are likely to
decrease in those markets, since managed vision care programs tend to reduce the
need for marketing expenditures to attract customers to the Company's stores.
COMPETITION
The retail optical industry is fragmented and highly competitive. The
Company competes with (i) independent practitioners (including opticians,
optometrists and ophthalmologists who operate an optical dispensary within their
practice), (ii) optical retail chains (including superstores) and (iii) mass
merchandisers and warehouse clubs. The Company's largest optical retail chain
competitors are LensCrafters and Cole National Corporation (Pearle and Cole
Vision licensed brands). In January 2004, the parent of LensCrafters announced
that it had agreed to acquire Cole National Corporation. This transaction has
not yet been consummated. Some of the Company's competitors are larger, have
longer operating histories, greater financial resources and greater market
recognition than the Company.
VENDORS
The Company purchases a majority of its lenses from three principal vendors
and purchases frames from over ten different vendors. In fiscal 2003, four
vendors collectively supplied approximately 63.4% of the frames purchased by the
Company. One vendor supplied over
12
42.8% of the Company's lens materials during the same period. The Company has
consolidated its vendors to develop strategic relationships resulting in
improved service and payment terms. While such vendors supplied a significant
share of the lenses used by the Company, lenses are a generic product and can be
purchased from a number of other vendors on comparable terms. Management of the
Company therefore does not believe that it is dependent on such vendors or any
other single vendor for frames or lenses. Management of the Company believes
that the Company's relationships with its existing vendors are satisfactory and
that significant disruption in the delivery of merchandise from one or more of
its current principal vendors would not have a material adverse effect on the
Company's operations because multiple vendors exist for all of the Company's
products.
MANAGED VISION CARE
Managed vision care has grown in importance in the optical retail industry.
Health insurers have sought a competitive advantage by offering a full range of
health insurance options, including coverage of primary eye care. Managed vision
care, including the benefits of routine annual eye examinations and eyewear
(i.e., funded plans) or discounts on eyewear (i.e., discount plans), is being
utilized by a growing number of managed vision care participants. Since regular
eye examinations may assist in the identification and prevention of more serious
conditions, managed vision care programs encourage members to have their eyes
examined more regularly, which in turn typically results in more frequent
eyewear replacement.
While the average ticket price on products purchased under managed vision
care reimbursement plans is typically lower, managed vision care transactions
generally earn comparable operating profit margins as they require less
promotional spending and advertising support. Management of the Company believes
that the increased volume resulting from managed vision care relationships also
compensates for the lower average ticket price.
While managed vision care encompasses many of the conventional attributes
of managed care, there are significant differences. For example, the typical
managed vision care benefit covers an annual wellness exam and eyeglasses (or
discounts for eyeglasses) and treatment of eye diseases would not be covered.
Even though managed vision care programs typically limit coverage to a certain
dollar amount or discount for an eyewear purchase, the member's eyewear benefit
generally allows the member to "trade up." Management believes that the growing
consumer perception of eyewear as a fashion accessory as well as the consumer's
historical practice of paying for eyewear purchases out-of-pocket contributes to
the frequency of "trading-up." The Company has historically found that managed
vision care participants who take advantage of the eye exam benefit under the
managed vision care program in turn have typically had their prescriptions
filled at adjacent optical stores and are a strong source of repeat business.
While management continues to pursue managed vision care relationships in
order to help the Company's retail business grow, revenues from managed vision
care remained constant from fiscal 2001 to fiscal 2002 (and decreased as a
percentage of revenues), mostly due to the Company's aggressive in-store
promotional offers displacing discount managed vision care activity. As of
December 27, 2003, retail sales arising from managed vision care plans totaled
13
31.6% of optical sales for fiscal 2003. Management has made a strategic decision
to pursue funded managed vision care relationships in order to help the
Company's retail business grow. Funded managed vision care relationships include
capitated and fee-for-service insurance contracts. Discount insurance programs
consist of relationships where the customer receives an agreed upon discount on
product. Funded managed vision care plans grew at the rate of 7% in 2003.
Management believes that discount managed vision care programs will play a less
significant role as the value retail offer becomes more developed throughout the
Company's stores. The percent of penetration should normalize at 30% as the
transition to funded programs materializes and the retail offer displaces
discount managed vision care activity. As part of its ongoing effort to develop
its managed vision care business, the Company has (i) implemented direct
marketing programs and information systems necessary to compete for managed
vision care relationships with large employers, groups of employers and other
third party payors, (ii) developed significant relationships with insurance
companies, which have strengthened the Company's ability to secure managed
vision care relationships, and (iii) been asked to participate on numerous
regional and national managed vision care panels.
Management believes that the role of managed vision care will continue to
benefit the Company and other large retail optical chains. Managed vision care
is likely to accelerate industry consolidation as payors look to contract with
large retail optical chains that have brand awareness, offer competitive prices,
provide multiple convenient locations and convenient hours of operation, and
possess sophisticated information management and billing systems. Large optical
retail chains are likely to be the greatest beneficiaries of this trend as
independent practitioners do not satisfy the scale requirements of managed
vision care programs and mass merchandisers' "Every Day Low Price" strategy is
generally incompatible with the discount price structure required by the managed
vision care model. Most managed vision care contracts renew annually, have
eligibility requirements reviewed annually and certain relationships are not
evidenced by contracts. The non-renewal or termination of a material contract or
relationship could have a material adverse effect on the Company.
GOVERNMENT REGULATION
The Company has several operating structures to address regulatory issues.
At 263 of the Company's stores, the Company or its landlord leases a portion of
the store or adjacent space to Independent ODs. At 46 of the stores, the Company
employs the optometrist. The availability of such professional services inside
or adjacent to the Company's stores is critical to the Company's marketing
strategy. At 64 of the stores, to address and comply with certain regulatory
restrictions, the OD PCs own the stores (including the practice and the optical
dispensary) and the Company (through its subsidiaries) provides certain
management services such as accounting, human resources, marketing and
information services for an agreed upon fee pursuant to long-term management
agreements. The OD PCs employ the ODs. See "-General - On-Site Optometrist."
The delivery of health care, including the relationships among health care
providers such as optometrists and suppliers (e.g., providers of eyewear), is
subject to extensive federal and state regulation. The laws of most states
prohibit business corporations such as the Company from practicing optometry or
exercising control over the medical judgments or decisions of
14
optometrists and from engaging in certain financial arrangements, such as
referral fees or fee-splitting with optometrists.
Management of the Company believes the operations of the Company are in
material compliance with federal and state laws and regulations; however, these
laws and regulations are subject to interpretation, and a finding that the
Company is not in such compliance could have a material adverse effect upon the
Company.
The fraud and abuse provisions of the Social Security Act and anti-kickback
laws and regulations adopted in many states prohibit the solicitation, payment,
receipt, or offering of any direct or indirect remuneration in return for, or as
an inducement to, certain referrals of patients, items or services. Provisions
of the Social Security Act also impose significant penalties for false or
improper billings to Medicare and Medicaid, and many states have adopted similar
laws applicable to any payor of health care services. In addition, the Stark
Self-Referral Law imposes restrictions on physicians' referrals for designated
health services reimbursable by Medicare or Medicaid to entities with which the
physicians have financial relationships, including the rental of space if
certain requirements have not been satisfied. Many states have adopted similar
self-referral laws which are not limited to Medicare or Medicaid reimbursed
services. Violations of any of these laws may result in substantial civil or
criminal penalties, including double and treble civil monetary penalties, and,
in the case of violations of federal laws, exclusion from participation in the
Medicare and Medicaid programs.
The Health Insurance Portability and Accountability Act of 1996 ("HIPAA")
covers a variety of subjects which impacts the Company's businesses and the
business of the ODs. Some of those areas include the privacy of patient health
care information, the security of such information and the standardization of
electronic data transactions for purposes of medical billing. The Department of
Health and Human Services promulgated HIPAA regulations which became effective
during 2003. The Company has devoted, and continues to devote, resources to
implement operating procedures within the stores and the corporate office to
ensure compliance with the HIPAA regulations.
Management of the Company believes the Company is currently in material
compliance with all of the foregoing laws and no determination of any violation
in any state has been made with respect to the foregoing laws. Such exclusions
and penalties, if applied to the Company, or a determination that the Company or
any of the ODs or the OD PCs is not in compliance with such laws, could have a
material adverse effect on the Company.
TRADEMARK AND TRADE NAMES
The Company's stores operate under the trade names "EyeMasters,"
"Binyon's," "Visionworks," "Hour Eyes," "Dr. Bizer's VisionWorld", "Dr. Bizer's
ValuVision," "Doctor's ValuVision," "Stein Optical," "Vision World," "Doctor's
VisionWorks" and "Eye DRx." In addition the Company has several product related
trademarks such as "SlimLite", "Aztec", "ProVsport", "Chelsea Morgan",
"Boardroom Classics", "Splendor", "South Hampton", "Robert Mitchel",
"Technolite", "Blue Moon", "Provision Premium" and "See Better Look Better".
15
EMPLOYEES
As of December 27, 2003, the Company employed approximately 4,200
employees. Approximately 59 hourly paid workers in the Eye DRx stores are
affiliated with the International Union, United Automobile, Aerospace and
Agricultural Implement Workers of America, with which the Company has a contract
extending through November 30, 2004. The Company considers its relations with
its employees to be good.
INDUSTRY
OVERVIEW. Jobson Publishing LLC ("Jobson"), a leading industry publication,
predicts optical retail sales in the United States totaled $16.3 billion in
2003. The optical retail market has grown each year at an average annual rate of
approximately 5% from 1991 to 1997. During 1998 through 2000, the average
annual growth rate decreased to approximately 2%. In 2001, the optical retail
market declined 4%, the 2% growth rate returned in 2002 and slowed to 0.6%
growth in 2003. Jobson projects optical retail chains will have a 1.7% increase
in growth in 2004.
The following chart sets forth expenditures (based upon products sold) in
the optical retail market over the past nine years according to Jobson.
U.S. OPTICAL RETAIL SALES BY SECTOR 1993 2003
(DOLLARS IN BILLIONS)
2003
1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 SHARE
----- ----- ----- ----- ----- ----- ----- ----- ----- ----- ----- ------
Lenses/treatments $ 6.0 $ 6.5 $ 6.8 $ 7.2 $ 7.6 $ 7.9 $ 8.0 $ 8.3 $ 8.1 $ 8.5 $ 8.6 53.0%
Frames. . . . . . 4.1 4.1 4.4 4.6 5.0 5.2 5.3 5.5 5.2 5.2 5.1 31.5%
Sunglasses. . . . 0.5 0.5 0.7 0.8 0.9 0.8 0.7 0.7 0.6 0.6 0.6 3.7%
Contact lenses. . 1.7 1.8 1.9 1.9 1.9 1.9 2.0 2.0 2.0 1.9 1.9 11.8%
----- ----- ----- ----- ----- ----- ----- ----- ----- ----- ----- ------
$12.3 $12.9 $13.8 $14.5 $15.4 $15.8 $16.0 $16.5 $15.9 $16.2 $16.3 100.0%
===== ===== ===== ===== ===== ===== ===== ===== ===== ===== ===== ======
DISTRIBUTION. The optical retail industry in the United States is highly
fragmented and consists of (i) independent practitioners (including opticians,
optometrists and ophthalmologists) who operate an optical dispensary within
their practice, (ii) optical retail chains and (iii) warehouse clubs and mass
merchandisers. In 2003, optical retail chains, warehouse clubs and mass
merchandisers accounted for approximately 37.7% of the total market, while
independent practitioners comprised approximately 59.9% and other distribution
channels represented approximately 2.4%. Optical retail chains have begun
consolidating the optical retail market, resulting in a decreased market share
for independent practitioners. Independent practitioners' market share dropped
from 63.0% to 59.9% between 1996 and 2003, while optical retail chains' market
share increased over the same period from 31.3% to 37.7%.
16
INDEPENDENT PRACTITIONERS. In 2003, independent practitioners represented
$9.8 billion of eyewear retail sales, or 59.9% of the industry's total optical
retail sales volume of $16.3 billion. Independent practitioners typically cannot
provide quick turnaround of eyeglasses because they do not have laboratories on
site and generally charge higher prices than other competitors. Moreover, their
eyewear product assortment is usually narrow, although a growing portion include
some designer or branded products. Prior to 1974, independent practitioners
benefited from regulatory and other factors which inhibited commercial retailing
of prescription eyewear. In 1974, the Federal Trade Commission began requiring
doctors to provide their patients with copies of their prescriptions, enabling
sophisticated retailers to implement retail marketing concepts which resulted in
a more competitive marketplace. Independent practitioners' market share has
declined from approximately 100% in 1974 to 59.9% in 2003, dropping 8% from 1996
to 2003. For the reasons set forth above, management believes that independent
practitioners will continue to lose market share over the next several years.
CHAINS. Optical retail chains, warehouse clubs and mass merchandisers
represented 37.7% of the total optical retail market in 2003.
Optical Retail Chains. Over the past four years, the top 10 optical retail
chains (in terms of net revenues) have grown at a rate faster than the overall
market. Optical retail chains include both superstores and conventional optical
stores. Optical retail chains offer quality service provided by on-site
optometrists and also carry a wide product line, emphasizing the fashion element
of eyewear, although lower-priced lenses and frames are also available. In
addition, the optical retail chains, particularly the superstores, are generally
able to offer better value and service through a reduced cost structure,
sophisticated merchandising and displays, economies of scale and greater volume.
Furthermore, they can generate greater market awareness than the fragmented
independent practitioners because optical retail chains usually invest more in
advertising and promotions. Management believes that large optical chains are
best positioned to benefit from industry consolidation trends including the
growth in managed vision care. See discussion under "Managed Vision Care."
Warehouse Clubs and Mass Merchandisers. Warehouse clubs and mass
merchandisers usually provide eyewear in a host environment which is typically a
larger general merchandise store. This segment typically provides some of the
service elements of retail optical chains, but competes primarily on price. As a
result, its eyewear selection tends to focus on lower-priced optical products.
Moreover, this segment's low margin pricing strategy is generally incompatible
with the pricing structure required by the managed vision care model.
OTHER. Other participants in the optical retail market include HMOs and
school-controlled dispensaries. In 2003, other participants represented
approximately 2.4% of the total optical retail market.
TRENDS. Management believes that the optical retail market is being driven
by the following trends:
- - Demographics. Approximately 73% of the U.S. adult population, or 150
million individuals, and nearly 88% of people over the age of fifty-five,
require some form of corrective eyewear. In addition to their higher
utilization of
17
corrective eyewear, the over fifty-five segment spends more per pair of glasses
purchased due to their need for premium priced products like bifocals and
progressive lenses and their generally higher levels of discretionary income. As
the "baby boom" generation ages and life expectancies increase, management
believes that this demographic trend is likely to increase the number of eyewear
customers and the average price per purchase.
- - Increasing Role of Managed Vision Care. Management believes that optical
retail sales through managed vision care programs, which were approximately 35%
to 40% of the market in 2002, will continue to increase over the next several
years. Managed vision care, including the benefits of routine annual eye
examinations and eyewear discounts, is being utilized by a growing number of
managed vision care participants. Since regular eye examinations may assist in
the identification and prevention of more serious conditions, managed vision
care programs encourage members to have their eyes examined more regularly,
which in turn typically results in more frequent eyewear replacement. Management
believes that large optical retail chains are likely to be the greatest
beneficiaries of this trend as payors look to contract with chains that deliver
superior customer service, have strong local brand awareness, offer competitive
prices, provide multiple convenient locations and flexible hours of operation,
and possess sophisticated information management and billing systems.
- - Consolidation. Although the optical retail market in the United States is
highly fragmented, the industry has experienced consolidation through mergers
and acquisitions as well as shifting market share. In 2002, the top ten optical
retail chains represented approximately 29.1% of the total optical market as
compared to 17.7% in 1997. The remainder of the market included independent
practitioners, smaller chains, warehouse clubs and mass merchandisers.
Independent practitioners' market share dropped from 63.0% to 59.9% between 1996
and 2003, while the market share of optical retail chains, warehouse clubs and
mass merchandisers increased over the same period from 31.3% to 37.7%.
Management believes that the large optical retail chains are better positioned
than mass merchandisers and warehouse clubs to benefit from this consolidation
trend and that such chains will continue to gain market share from the
independent practitioners over the next several years.
- - New Product Innovations. Since the late 1980's, several technological
innovations have led to the introduction of new optical lenses and lens
treatments, including progressive addition lenses (no-line bifocals), high-index
and aspheric lenses (thinner and lighter lenses), polycarbonate lenses (shatter
resistant) and anti-reflective coatings. These innovative products are popular
among consumers, generally command premium prices, and yield higher margins than
traditional lenses. The average retail price for all lenses and lens treatments
has increased from $88 to $109 between 1995 and 2003, reflecting, in part, the
rising popularity of these products. Similarly, during the same period, the
average retail price for eyeglass frames has increased from $57 to $79, due in
large part to both technological innovation and an evolving customer preference
for higher priced, branded frames. The 1995 to 2000
18
historical average growth rates for lenses and frames were 5% and 12%,
respectively, while the 2001 average growth rates were 1%. The 2002 and 2003
average growth rate for lenses returned to 5% and 3%, respectively, while frames
experienced no growth in 2002 and declined 4% in 2003. Management believes this
decline in the growth rate is more related to the state of the economy than
changes in consumer purchasing habits.
- - Lasik Surgery. Laser In-Situ Keratomileusis, or LASIK, was introduced in
1996, leading to a dramatic increase in the popularity of laser vision
correction surgery. In 2000, eye care professionals performed an estimated 1.4
million laser vision correction surgery procedures in the U.S., representing an
increase of 50% over the approximately 950,000 procedures performed in 1999.
Industry forecasts estimate 1.2 million laser vision correction surgery
procedures being performed in 2003. Despite this rapid growth, the number of
vision correction surgery patients in 1999 represented 0.8% of the 150 million
people with refractive vision conditions in the U.S. The consumer's evaluation
process of LASIK surgery creates options other than eyeglasses and contacts.
Management believes that the increase in LASIK procedures, and the evaluation
process by potential customers (including both individuals who undergo LASIK
surgery and those who decide not to undergo LASIK surgery) has contributed to
the slower growth rates in the optical industry since 1998.
THE RECAPITALIZATION
On March 6, 1998, ECCA Merger Corp. ("Merger Corp."), a Delaware
corporation formed by Thomas H. Lee Company ("THL Co."), and the Company entered
into a recapitalization agreement (the "Recapitalization Agreement") providing
for, among other things, the merger of such corporation with and into the
Company (the "Merger" and, together with the financing of the recapitalization
and related transactions, the "Recapitalization"). Upon consummation of the
Recapitalization on April 24, 1998, Thomas H. Lee Equity Fund IV, L.P. ("THL
Fund IV") and other affiliates of THL Co. (collectively with THL Fund IV and THL
Co., "THL") owned approximately 89.7% of the issued and outstanding shares of
common stock of the Company ("Common Stock"), existing shareholders (including
management) of the Company retained approximately 7.3% of the issued and
outstanding Common Stock and management purchased additional shares representing
approximately 3.0% of the issued and outstanding Common Stock. The total
transaction value of the Recapitalization was approximately $323.8 million,
including related fees and expenses, and the implied total equity value of the
Company following the Recapitalization was approximately $107.3 million.
ITEM 2. PROPERTIES
As of March 15, 2004, the Company operated or managed 373 retail locations
in the United States. The Company believes its properties are adequate and
suitable for its purposes. The Company leases all of its retail locations, the
majority of which are under triple net leases that require payment by the
Company of its pro rata share of real estate taxes, utilities, and common area
maintenance charges. These leases range in terms of up to 15 years. Certain
leases require
19
percentage rent based on gross receipts in excess of a base rent. In
substantially all of the stores that it owns, the Company subleases (or the
landlord leases) a portion of such stores or an adjacent space to an Independent
OD (or its wholly-owned operating entity). With respect to the OD PCs, the
Company subleases the entire premises of the store to the OD PC. The terms of
these leases or subleases range from one to fifteen years, with rentals
consisting of a percentage of gross receipts, a base rental, or a combination of
both. The general location and character of the Company's stores are described
in Item 1 of this Annual Report.
The Company leases combined corporate offices and a retail location in San
Antonio, Texas, pursuant to a fifteen-year lease starting in August 1997. In
addition, the Company leases a combined distribution center and central
laboratory in San Antonio, pursuant to a five-year lease expiring in June 2009.
The Company believes central distribution improves efficiency through better
inventory management and streamlined purchasing.
ITEM 3. LEGAL PROCEEDINGS
The Company is a party to routine litigation in the ordinary course of its
business. No such pending matters, individually or in the aggregate, are deemed
to be material to the business or financial condition of the Company.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
On December 16, 2003, the Company held its Annual Meeting of Shareholders
in San Antonio, Texas. The following seven directors were elected by the
shareholders to serve a one year term to conclude at the next Annual Meeting of
Shareholders:
Bernard W. Andrews
Charles A. Brizius
Anthony J. DiNovi
Norman S. Matthews
David E. McComas
Warren C. Smith, Jr.
Antoine G. Treuille
20
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
The Common Stock, par value $.01 per share, of the Company is not traded on
any established public trading market. There are 48 holders of the Common Stock.
All holders are parties to a shareholders agreement. See the discussion under
the heading "Stockholders' Agreement" within "ITEM 13. CERTAIN RELATIONSHIPS AND
RELATED TRANSACTIONS." No dividends were paid in fiscal 2002 or 2003 and payment
of dividends is restricted by the Indenture governing the Exchange Notes (as
defined in Management Discussion and Analysis - Liquidity and Capital
Resources).
21
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
The following table sets forth selected financial data and other operating
information of the Company. The selected financial data in the table are derived
from the consolidated financial statements of the Company. The following
selected financial data should be read in conjunction with the Consolidated
Financial Statements, the related notes thereto and other financial information
included elsewhere in this Annual Report on Form 10-K. All references in this
Annual Report on Form 10-K to 1999 or fiscal 1999, 2000 or fiscal 2000, 2001 or
fiscal 2001, 2002 or fiscal 2002 and 2003 or fiscal 2003 relate to the fiscal
years ended January 1, 2000, December 30, 2000, December 29, 2001, December 28,
2002 and December 27, 2003 respectively.
January 1, December 30, December 29, December 28, December 27,
2000 2000 2001 2002 2003
------------ -------------- -------------- -------------- --------------
STATEMENT OF OPERATIONS DATA:
Net revenues . . . . . . . . . . . . . . . . . $ 293,795 $ 338,457 $ 336,034 $ 363,667 $ 369,852
Operating costs and expenses:
Cost of goods sold. . . . . . . . . . . . . 98,184 107,449 104,446 112,471 114,578
Selling, general and administrative . . . . 170,146 204,365 203,187 212,472 218,702
Store closure expense . . . . . . . . . . . - 3,580 - - -
Amortization of intangible assets . . . . . 5,653 9,137 8,697 1,865 165
------------ -------------- -------------- -------------- --------------
Total costs and expenses. . . . . . . . . . 273,983 324,531 316,330 326,808 333,445
------------ -------------- -------------- -------------- --------------
Operating income . . . . . . . . . . . . . . . 19,812 13,926 19,704 36,859 36,407
Interest expense, net. . . . . . . . . . . . . 24,685 28,694 27,537 21,051 20,200
------------ -------------- -------------- -------------- --------------
Income (loss) before income taxes. . . . . . . (4,873) (14,768) (7,833) 15,808 16,207
Income tax expense (benefit) . . . . . . . . . 384 766 1,239 1,565 (9,600)
------------ -------------- -------------- -------------- --------------
Net income (loss) before cumulative effect . . (5,257) (15,534) (9,072) 14,243 25,807
of change in acct principle
Cumulative effect of change in acct principle. 491 - - - -
------------ -------------- -------------- -------------- --------------
Net income (loss). . . . . . . . . . . . . . . $ (5,748) $ (15,534) $ (9,072) $ 14,243 $ 25,807
============ ============== ============== ============== ==============
OTHER FINANCIAL DATA:
Depreciation and amortization. . . . . . . . . $ 22,754 $ 29,600 $ 29,047 $ 20,626 $ 16,818
Capital expenditures . . . . . . . . . . . . . 19,920 18,932 10,559 10,668 10,971
Gross margin % . . . . . . . . . . . . . . . . 66.6% 68.3% 68.9% 69.1% 69.0%
Total assets . . . . . . . . . . . . . . . . . $ 261,678 $ 250,920 $ 223,676 $ 217,056 $ 225,526
Long term obligations. . . . . . . . . . . . . $ 279,480 $ 285,607 $ 267,903 $ 254,633 $ 238,825
Ratio of earnings to fixed charges(b). . . . . 0.85x 0.62x 0.79x 1.49x 1.52x
MISCELLANEOUS DATA:
EBITDA - see below . . . . . . . . . . . . . . $ 42,386 $ 47,107 $ 48,751 $ 57,985 $ 53,725
EBITDA margin %. . . . . . . . . . . . . . . . 14.40% 13.90% 14.51% 15.94% 14.53%
Comparable store sales growth (c). . . . . . . 1.10% 0.90% -1.40% 5.60% -0.30%
End of period stores . . . . . . . . . . . . . 361 361 359 363 371
Sales per store (d). . . . . . . . . . . . . . $ 987 $ 940 $ 935 $ 1,009 $ 1,010
(a) All dollars are in thousands.
(b) In computing the ratio of earnings to fixed charges, "earnings" represents
income (loss) before income tax expense plus fixed charges. "Fixed charges"
consists of interest, amortization of debt issuance costs and a portion of
rent, which is representative of interest factor (approximately one-third
of rent expense).
(c) Comparable store sales growth increase is calculated comparing net revenues
for the period to net revenues of the prior period for all stores open at
least twelve months prior to each such period.
(d) Sales per store is calculated on a monthly basis by dividing total net
revenues by the total number of stores open during the period. Annual sales
per store is the sum of the monthly calculations.
22
EBITDA The Company's operating performance is evaluated using several
measures. One of those measures, EBITDA, is derived from the Operating Income
GAAP measurement. EBITDA has historically been used by the Company's credit
facility lenders to measure compliance with certain financial debt covenants and
by certain investors as one measure of the Company's historical ability to fund
operations and meet its financial obligations. The Company's credit facility
agreement defines EBITDA as consolidated net income (loss) before interest
expense, income taxes, depreciation and amortization (other than amortization of
store pre-opening costs), recapitalization and other expenses, extraordinary
loss (gain) and store closure expense. EBITDA should not be considered as an
alternative to, or more meaningful than, operating income or net income (loss)
in accordance with generally accepted accounting principles as an indicator of
the Company's operating performance or cash flow as a measure of liquidity.
Additionally, EBITDA presented may not be comparable to similarly titled
measures reported by other companies. The following table is a reconciliation of
operating income to EBITDA for each of the fiscal periods presented:
January 1, December 30, December 29, December 28, December 27,
2000 2000 2001 2002 2003
------------ ------------- ------------- -------------- -------------
RECONCILIATION OF EBITDA TO OPERATING INCOME:
Operating income. . . . . . . . . . . . . . . $ 19,812 $ 13,926 $ 19,704 $ 36,859 $ 36,407
Reconciling items:
Depreciation and amortization. . . . . . . 22,754 29,600 29,047 20,626 16,818
Store closure expense. . . . . . . . . . . - 3,580 - - -
Gain on extinguishment of debt . . . . . . - - - (904) -
Other. . . . . . . . . . . . . . . . . . . (180) - - 500 500
------------ ------------- ------------- -------------- -------------
EBITDA . . . . . . . . . . . . . . . . . . $ 42,386 $ 47,106 $ 48,751 $ 57,081 $ 53,725
============ ============= ============= ============== =============
23
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
INTRODUCTION
The Company is the third largest retail optical chain in the United States
as measured by net revenues, operating or managing 373 stores, 304 of which are
optical superstores. The Company operates in the $6.1 billion retail optical
chain sector of the $16.3 billion optical retail market. Management believes
that key drivers of growth for the Company include (i) the success of the
Company's promotional activities, (ii) the continuing role of managed vision
care and (iii) new product innovations.
The Company's management team has focused on improving operating
efficiencies and growing the business through new store openings. During fiscal
2003, the Company continued to focus on its value retail promotion of two
complete pair of single vision eyewear for $99. Management believes this
promotion has been successful because it leverages the Company's strength as the
leader in its markets and also differentiates the Company's stores from
independent optometric practitioners who tend to offer fewer promotions in order
to protect their margins. Because the average ticket price is typically less for
glasses sold under the promotion, in order for the Company to continue to be
successful using this strategy, the Company must continue to increase the number
of transactions and must also be successful in controlling costs. In addition,
it will be incumbent upon the Company to be able to maintain its broad selection
of high quality, lower priced non-branded frames so that it can continue to
offer more value to customers while improving gross margins. For fiscal 2003,
the Company experienced a 1.7% increase in optical sales compared to fiscal
2002, which was largely the result of opening ten new stores during fiscal 2003.
Fiscal 2003 transaction volume declined .4% when compared to fiscal 2002 and
management believes this relatively flat transaction volume was largely the
result of mediocre consumer demand and a sluggish economy for the majority of
fiscal 2003. The Company believes that it will experience an 8% increase in
optical sales in fiscal 2004, the result of opening eight new stores,
anticipated comparable store sales of 2.0% and a 53 week year compared to the 52
week fiscal 2003.
Management believes that optical retail sales through funded managed vision care
programs will continue to increase over the next several years. Funded managed
vision care relationships include capitated and fee-for-service insurance
contracts. As a result, management has made a strategic decision to pursue
funded managed vision care relationships in order to help the Company's retail
business grow. Funded managed vision care plans grew at the rate of 7% in
2003. Discount managed care programs will play a less significant role in the
Company's sales as the value retail offer becomes more developed throughout the
Company's stores. Discount insurance programs consist of relationships where
the customer receives an agreed upon discount on product. While the average
ticket price on products purchased under managed vision care reimbursement plans
is typically lower, managed vision care transactions generally require less
promotional spending and advertising support. The Company believes that the
increased volume resulting from managed vision care relationships also
compensates for the lower average ticket price. During fiscal 2003,
approximately 31.6% of the Company's optical revenues were derived
24
from managed vision care programs, although the percent of penetration should
normalize at 30% as the transition to funded programs materializes and the
retail offer displaces activity under discount managed vision care plans.
Management believes that the role of managed vision care will continue to
benefit the Company and other large retail optical chains with strong local
market shares, broad geographic coverage and sophisticated information
management and billing systems. Most managed vision care contracts renew
annually and certain relationships are not evidenced by contracts. The
non-renewal or termination of a material contract or relationship could have a
material adverse effect on the Company.
RESULTS OF OPERATIONS
The following table sets forth the percentage relationship to net revenues of
certain income statement data.
Fiscal Year Ended
---------------------
2001 2002 2003
------- ------ ------
Net revenues:
Optical sales. . . . . . . . . . . . . . . . . . 99.0% 99.1% 99.1%
Management fee . . . . . . . . . . . . . . . . . 1.0 0.9 0.9
------------------ ------ ------
Total net revenues . . . . . . . . . . . . . . . 100.0 100.0 100.0
Operating costs and expenses:
Cost of goods sold (a) . . . . . . . . . . . . . 31.4 31.2 31.3
Selling, general and administrative expenses (a) 61.1 59.0 59.7
Amortization of intangibles. . . . . . . . . . . 2.6 0.5 -
------------------ ------ ------
Total operating costs and expenses . . . . . . . 94.1 89.9 90.2
------------------ ------ ------
Income from operations . . . . . . . . . . . . . 5.9 10.1 9.8
Interest expense, net. . . . . . . . . . . . . . 8.2 5.8 5.4
------------------ ------ ------
Income/(loss) before income taxes. . . . . . . . (2.3) 4.3 4.4
Income tax expense/(benefit) . . . . . . . . . . 0.4 0.4 (2.6)
------------------ ------ ------
Net income/(loss). . . . . . . . . . . . . . . . (2.7) 3.9 7.0
================== ====== ======
(a) Percentages based on optical sales only
The following is a discussion of certain factors affecting the Company's
results of operations from fiscal 2001 to fiscal 2003 and its liquidity and
capital resources. This discussion should be read in conjunction with the
consolidated financial statements and notes thereto included elsewhere in this
document.
FISCAL 2003 COMPARED TO FISCAL 2002
Net Revenues. The increase in net revenues to $369.9 million in 2003 from
$363.7 million in fiscal 2002 was largely the result of the addition of ten
stores, nine of which were in the Atlanta market. Comparable store sales
decreased by .3% compared to fiscal 2002. Comparable transaction volume
decreased by .4% compared to fiscal 2002 and average ticket prices increased by
..2% compared to fiscal 2002. This relatively flat performance in comparable
store sales, average ticket and comparable transactions is the result of a soft
optical retail environment driven
25
by mediocre consumer demand and comparisons to a strong comparable sales result
of 5.6% for fiscal 2002. The Company closed two stores during fiscal 2003.
Gross Profit. Gross profit increased to $255.3 million in fiscal 2003 from
$251.2 million in fiscal 2002, primarily as a result of an increase in the sales
of higher margin products. Gross profit as a percentage of optical sales
decreased to 68.7% ($252.0 million) in fiscal 2003 as compared to 68.8% ($247.8
million) in fiscal 2002. This relatively flat trend was largely due to the
Company's maintaining its favorable mix of non-branded frames with higher
margins than branded frames. Non-branded frames have lower acquisition costs
than branded frames resulting in higher margins.
Selling General & Administrative Expenses (SG&A). SG&A increased to $218.7
million in fiscal 2003 from $212.5 million in fiscal 2002. SG&A as a percentage
of optical sales increased to 59.7% in fiscal 2003 from 59.0% in fiscal 2002.
This increase was primarily due to the addition of noncomparable doctor
practices in eight of the Company's markets, which has resulted in increased
doctor payroll expenditures. In addition, the Company closed two stores and
opened ten new stores during fiscal 2003, which has resulted in increased
occupancy expenditures.
Amortization Expense. Amortization expense decreased to $0.2 million for
fiscal 2003 from $1.9 million in fiscal 2002 as the related intangible asset was
fully amortized.
Income Tax Benefit. Income tax benefit increased for fiscal 2003 due to
the increase in the related deferred tax asset of $17.6 million. The
recognition of the deferred tax asset is the result of the removal of the
valuation allowance on deferred tax assets because of the Company's history of
taxable income and high probability of future taxable income.
Net Interest Expense. Net interest expense decreased to $20.2 million for
fiscal 2003 from $21.1 million for fiscal 2002. This decrease was primarily due
to lower outstanding debt balances during 2003.
FISCAL 2002 COMPARED TO FISCAL 2001
Net Revenues. The increase in net revenues to $363.7 million in 2002 from
$336.0 million in fiscal 2001 was largely the result of an increase in
comparable store sales of 5.6% primarily due to the continuation of the two
complete pair of single vision eyeglasses for $99 value promotion started in the
fourth quarter of 2001. Additionally, the improvement of product depth and
selection, improved in-stock positions and overall optical market improvement
contributed to the increase in sales. The number of transactions increased by
13.7% compared to fiscal 2001, which was offset by a decrease in average ticket
prices of 4.7% compared to fiscal 2001. Both the increase in transactions and
decrease in average ticket prices were due primarily to the two complete pair of
single vision eyeglasses for $99 value promotion. Managed vision care sales
decreased 1.5% for fiscal 2002 as compared to fiscal 2001. The Company opened
eight stores and closed four stores in fiscal 2002.
Gross Profit. Gross profit increased to $251.2 million in fiscal 2002 from
$231.6 million in
26
fiscal 2001, primarily as a result of an increase in comparable store sales and
an increase in the sales of higher margin products. Gross profit as a percentage
of optical sales increased to 68.8% ($247.8 million) in fiscal 2002 as compared
to 68.6% ($228.1 million) in fiscal 2001. This percentage increase was largely
due to an increase as a percentage of sales in fiscal 2002 versus fiscal 2001 of
non-branded frames with higher margins than branded frames. Non-branded frames
have lower acquisition costs than branded frames resulting in higher margins.
Selling General & Administrative Expenses (SG&A). SG&A increased to $212.5
million in fiscal 2002 from $203.2 million in fiscal 2001. SG&A as a percentage
of optical sales decreased to 59.0% in fiscal 2002 from 61.1% in fiscal 2001.
This percentage decrease was primarily due to increased sales from more
effective advertising promotions in fiscal 2002 versus fiscal 2001 with
advertising expenditures rising slightly over the two years but declining as a
percentage of sales. In addition, while depreciation declined slightly and
occupancy expenses rose slightly in fiscal 2002 versus fiscal 2001, they
declined as a percentage of sales which was offset by increases in retail and
doctor payroll.
Amortization Expense. Amortization expense decreased to $1.9 million for
fiscal 2002 from $8.7 million in fiscal 2001 due to the adoption of FAS 142
which disallows the amortization of goodwill over its useful life and instead
requires an annual assessment for impairment.
Net Interest Expense. Net interest expense decreased to $21.1 million for
fiscal 2002 from $27.5 million for fiscal 2001. This decrease was primarily due
to the overall decline in market interest rates in 2002 and re-payment of debt
during 2002.
LIQUIDITY AND CAPITAL RESOURCES
The Company's capital requirements are driven principally by its
obligations to service debt and to fund the following costs:
- - Construction of new stores
- - Repositioning of existing stores
- - Purchasing inventory and equipment
- - Leasehold improvements
The amount of capital available to the Company will affect its ability to
service its debt obligations and to continue to grow its business through
expanding the number of stores and increasing comparable store sales.
SOURCES OF CAPITAL
The Company's principal sources of capital are from cash on hand, cash flow
from operating activities and funding from its credit facility. Cash flows from
operating activities provided net cash for 2003, 2002 and 2001 of $27.4 million,
$34.4 million and $27.4 million, respectively. As
27
of December 27, 2003, the Company had $3.8 million of cash available to meet the
Company's obligations.
Payments on debt and issuance of debt have been the Company's principal
financing activities. Cash flows used in financing activities for 2003, 2002
and 2001 were $16.1 million, $23.6 million and $17.5 million, respectively.
Working capital of the Company primarily consists of cash and cash
equivalents, accounts receivable, inventory, accounts payable and accrued
expenses and is a deficit of $19.3 million at December 27, 2003. The level of
working capital has remained relatively consistent to the period ended December
2002. The largest working capital usage occurs on May 1 and November 1 of each
year when the Company's interest payments under its Notes ranging from $5.0 to
$6.0 million are paid.
Capital expenditures for 2003, 2002 and 2001 were $11.0 million, $10.7
million and $10.5 million, respectively, and are the Company's principal uses of
cash for investing activities. The table below sets forth the components of
these capital expenditures for 2003, 2002 and 2001.
Fiscal Year Ended
----------------------
2001 2002 2003
------ ------- -------
Expenditure Category:
New Stores. . . . . . . . . $ 3,800 $ 2,900 $ 3,700
Information Systems . . . . 1,500 1,800 1,400
Lab Equipment . . . . . . . 1,000 1,400 2,400
Store Maintenance . . . . . 2,900 4,400 3,300
Other . . . . . . . . . . . 1,300 200 200
Total Capital Expenditures $ 10,500 $10,700 $11,000
================== ======= =======
Capital expenditures for 2004 are projected to be approximately $11.0
million.
LONG-TERM DEBT
CREDIT FACILITY. On December 23, 2002, the Company entered into a credit
agreement with Fleet National Bank, as administrative agent, and Bank of
America, N.A., acting as syndication agent, which consists of (i) a $55.0
million term loan facility (the "Term Loan A"); (ii) a $62.0 million term loan
facility (the "Term Loan B"); and (iii) a $25.0 million revolving credit
facility (the "Revolver" and, together with Term Loan A and Term Loan B, the
"New Facilities"). The proceeds of the New Facilities were used to (i) pay
long-term debt outstanding under the Company's previous credit facility, (ii)
redeem $20.0 million face value of the Notes at a cost of $17.0 million, and
(iii) pay fees and expenses incurred in connection with the New Facilities. The
New Facilities are available to finance working capital requirements and general
corporate purposes. At December 27, 2003, the Company had approximately $23.0
million available under the Revolver.
Borrowings made under the New Facilities accrue interest at the Company's
option at the Base
28
Rate or the LIBOR rate, plus the applicable margin. The Base Rate is a floating
rate equal to the higher of Fleet Bank's prime rate or the overnight Federal
Funds Rate plus 1/2%.
NEW FACILITY BASE RATE MARGIN LIBOR MARGIN
- ------------ ----------------- -------------
Term Loan A 3.25% 4.25%
- ------------ ----------------- -------------
Term Loan B 3.75% 4.75%
- ------------ ----------------- -------------
Revolver 3.50% 4.50%
- ------------ ----------------- -------------
Principal under Term Loan A shall amortize in quarterly payments commencing on
March 31, 2003 in annual amounts of $18.8 million and $20.0 million,
respectively, for fiscal years 2004 and 2005. Term Loan B has no principal
payments until 2006 when quarterly payments will commence in annual amounts of
$20.0 million and $42.0 million, respectively, for fiscal years 2006 and 2007.
In connection with the borrowings made under the New Facilities, the
Company incurred approximately $4.8 million in debt issuance costs. These
amounts are classified within other assets in the accompanying balance sheets
and are being amortized over the life of the New Facilities. The unamortized
amount of debt issuance costs as of December 27, 2003 related to the New
Facilities was $3.5 million.
At December 27, 2003, the Company had $238.8 million of outstanding debt
consisting of $129.8 million of the Notes (as hereinafter defined) outstanding,
$43.8 million and $62.0 million in term loans outstanding under the Term Loan A
and Term Loan B, respectively, $1.0 million under the Revolver and $2.2 million
in capital lease and equipment obligations. The Company anticipates debt
payments of approximately $17.2 million during fiscal 2004, reducing the total
outstanding debt balance to $221.6 million.
The New Facilities are collateralized by all tangible and intangible
assets, including the stock of the Company's subsidiaries. In addition, the
Company must meet certain financial covenants including minimum EBITDA, interest
coverage, leverage ratio and capital expenditures. As of December 27, 2003, the
Company was in compliance with the financial reporting covenants.
NOTES. In 1998, the Company issued $100.0 million aggregate principal
amount of its 9 1/8% senior Subordinated Notes due 2008 (the "Fixed Rate Notes")
and $50.0 million aggregate principal amount of its Floating Interest Rate
Subordinated Term Securities due 2008 (the "Floating Rate Notes" and, together
with the Fixed Rate Notes the "Notes"). In connection with the New Facilities,
the Company redeemed $20.0 million of the Floating Rate Notes on December 23,
2002. Interest on the Notes is payable semiannually on each May 1 and November
1 until maturity. Interest on the Fixed Rate Notes accrues at the rate of 9 1/8%
per annum. The Floating Rate Notes bear interest at a rate per annum, reset
semiannually, equal to LIBOR plus 3.98%. The Notes are not entitled to the
benefit of any mandatory sinking fund.
29
The Notes are guaranteed on a senior subordinated basis by all of the
Company's subsidiaries. The Notes and related guarantees:
- - Are general unsecured obligations of the Company and the guarantors;
- - Are subordinated in right of payment to all current and future senior
indebtedness including indebtedness under the New Facilities; and
- - Rank pari passu in right of payment with any future senior subordinated
indebtedness of the Company and the guarantors and senior in right of
payment with any future subordinated obligations of the Company and the
guarantors.
The Company may redeem the Notes, at its option, in whole at any time or in
part from time to time. The redemption prices for the Fixed Rate Notes are set
forth below for the 12-month periods beginning May 1 of the year set forth
below, plus in each case, accrued interest to the date of redemption:
YEAR. . . . . . . . REDEMPTION PRICE
- ----------------------------------------
2004. . . . . . . . 103.042%
2005. . . . . . . . 101.521%
2006 and thereafter 100.000%
Beginning on May 1, 2003, the Floating Rate Notes may be redeemed at 100% of the
principal amount thereof plus accrued and unpaid interest to the date of
redemption.
The indenture governing the Notes contains certain covenants that, among
other things, limit the Company and the guarantors' ability to:
- - Incur additional indebtedness;
- - Pay dividends or make other distributions in respect of its capital stock;
- - Purchase equity interests or subordinated indebtedness;
- - Create certain liens;
- - Enter into certain transactions with affiliates;
- - Consummate certain asset sales; and
- - Merge or consolidate.
PREFERRED STOCK. During 1998, the Company issued 300,000 shares of a new
series of preferred stock (the "Preferred Stock"), par value $.01 per share.
Dividends on shares of the Preferred Stock are cumulative from the date of issue
(whether or not declared) and will be payable when and as may be declared from
time to time by the Board of Directors of the Company. Such dividends accrue on
a daily basis from the original date of issue at an annual rate per share equal
to 13% of the original purchase price per share, with such amount to be
compounded quarterly. The Preferred Stock will be redeemable at the option of
the Company, in whole or in part, at $100 per share plus (i) the per share
dividend rate and (ii) all accumulated and unpaid dividends, if any, to the date
of redemption, upon occurrence of an offering of equity securities, a change of
control or certain sales of assets.
30
CONTRACTUAL OBLIGATIONS. The Company is committed to make cash payments in
the future on the following types of agreements:
- - Long-term debt
- - Operating leases for stores and office facilities
The following table reflects a summary of its contractual cash obligations
as of December 27, 2003:
Payments due by period
----------------------------------------------------------------------------
Total . Less than 1 yr 1 to 3 yrs 3 to 5 yrs More than 5 yrs
------ --------------- ----------- ----------- ------------
Long-Term Debt. . . . . . . . . . . . . $ 236,538 $ 18,750 $ 45,000 $ 172,788 $ -
Capital Lease Obligations . . . . . . . 2,287 230 659 1,039 359
Operating Leases. . . . . . . . . . . . 155,540 30,192 52,028 38,606 34,714
Purchase Obligations. . . . . . . . . . - - - - -
-------------- ---------- ----------- --------------- ------
Total future principal payments on debt $ 394,365 $ 49,172 $ 97,687 $ 212,433 $35,073
============= =========== =========== ================ =======
Material Off-Balance Sheet Arrangements. The Company has no material
off-balance sheet debt or unrecorded obligations and has not guaranteed the debt
of any other party.
FUTURE CAPITAL RESOURCES. Based upon current operations, anticipated cost
savings and future growth, the Company believes that its cash flow from
operations, together with borrowings currently available under the Revolver, are
adequate to meet its anticipated requirements for working capital, capital
expenditures and scheduled principal and interest payments through the next
twelve months. The ability of the Company to satisfy its financial covenants
within its New Facilities, meet its debt service obligations and reduce its debt
will be dependent on the future performance of the Company, which in turn, will
be subject to general economic conditions and to financial, business, and other
factors, including factors beyond the Company's control. The Company believes
that its ability to repay the Notes and amounts outstanding under the New
Facilities at maturity will likely require additional financing. The Company
cannot provide assurance that additional financing will be available to it. A
portion of the Company's debt bears interest at floating rates; therefore, its
financial condition is and will continue to be affected by changes in prevailing
interest rates.
CRITICAL ACCOUNTING POLICIES
Critical accounting policies are those that require management to make
assumptions that are difficult or complex about matters that are uncertain and
may change in subsequent periods, resulting in changes to reported results.
The Company's significant accounting policies are described in Note 2 in
the Notes to Consolidated Financials Statements. The majority of these
accounting policies do not require
31
management to make difficult, subjective or complex judgments or estimates or
the variability of the estimates is not material. However, the following
policies could be deemed critical. The Company's management has discussed these
critical accounting policies with the Audit Committee of the Board of Directors.
- - Accounts receivable are primarily from third party payors related to the
sale of eyewear and include receivables from insurance reimbursements, OD
management fees, credit card companies, merchandise, rent and license fee
receivables. The Company's allowance for doubtful accounts requires
significant estimation and primarily consists of amounts owed to the
Company by third party insurance payors. This estimate is based on the
historical ratio of collections to billings. The Company's allowance for
doubtful accounts was $4.1 million at December 27, 2003.
- - Inventory consists principally of eyeglass frames, ophthalmic lenses and
contact lenses and is stated at the lower of cost or market. Cost is
determined using the weighted average method which approximates the
first-in, first-out (FIFO) method. The Company's inventory reserves require
significant estimation and are based on product with low turnover or deemed
by management to be unsaleable. The Company's inventory reserve was $0.6
million at December 27, 2003.
- - Intangible assets represent approximately 47% of the Company's assets and
consist of the amounts by which the purchase price exceeds the market value
of acquired net assets ("goodwill"), management agreements and noncompete
agreements. Goodwill must be tested for impairment at least annually using
a "two-step" approach that involves the identification of reporting units
and the estimation of fair values. This fair value estimation requires
significant judgment by the Company's management.
- - Valuation allowances for deferred tax assets reduce deferred tax assets
when it is deemed more likely than not that some portion or all of the
deferred tax assets will expire before realization of the benefit or that
future deductibility is not probable due to taxable losses. Although
realization is not assured due to historical taxable income and the
probability of future taxable income, Management believes it is more likely
than not that all of the deferred tax asset will be realized.
INFLATION
The impact of inflation on the Company's operations has not been
significant to date. While the Company does not believe its business is highly
sensitive to inflation, there can be no assurance that a high rate of inflation
would not have an adverse impact on the Company's operations.
SEASONALITY AND ANNUAL RESULTS
The Company's sales fluctuate seasonally. Historically, the Company's
highest sales and earnings occur in the first and third quarters. In addition,
annual results are affected by the Company's growth.
32
RISK FACTORS
THE COMPANY OFTEN OFFERS INCENTIVES TO CUSTOMERS WHICH LOWER PROFIT MARGINS. At
times when the Company's major competitors offer significantly lower prices for
their products, the Company is often required to do the same. Certain of its
major competitors offer promotional incentives to their customers including free
eye exams, "50% Off" on designer frames and "Buy One, Get One Free" eye care
promotions. In response to these promotions, the Company has offered the same
or similar incentives to its customers. This practice has resulted in lower
profit margins and these competitive promotional incentives may further reduce
revenues, gross margins and cash flows. Although the Company believes that it
provides quality service and products at competitive prices, several of the
other large retail optical chains have greater financial resources than the
Company. Therefore, the Company may not be able to continue to deliver cost
efficient products in the event of aggressive pricing by its competitors, which
would reduce profit margins, net income and cash flow.
AS REFRACTIVE LASER SURGERY AND OTHER ADVANCES IN MEDICAL TECHNOLOGY GAIN MARKET
ACCEPTANCE, THE COMPANY MAY LOSE REVENUE FROM TRADITIONAL EYEWEAR CUSTOMERS.
Corneal refractive surgery procedures such as radial-keratotomy,
photo-refractive keratectomy, Laser In-Situ Keratomileusis or LASIK and future
drug development, may change the demand for the Company's products. As
traditional eyewear users undergo laser vision correction procedures or other
vision correction techniques, the demand for certain contact lenses and
eyeglasses will decrease. Technological developments such as wafer technology
and lens casting may render the Company's current lens manufacturing method
uncompetitive or obsolete. Due to the fact that the marketing and sale of
eyeglasses and contact lenses is a significant part of the Company's business, a
decrease in customer demand for these products could have a material adverse
effect on sales of prescription eyewear. There can be no assurance that medical
advances and technological developments will not have a material adverse effect
on the Company's operations.
THE COMPANY MAY BE UNABLE TO SERVICE ITS INDEBTEDNESS. The Company is highly
leveraged, with indebtedness that is substantial in relation to its
shareholders' equity. As of December 27, 2003, the Company's aggregate
outstanding indebtedness was approximately $238.8 million and the Company's
shareholders' equity was a deficit of $63.6 million. In addition, subject to
certain limitations, the New Facilities and the indenture governing the Exchange
Notes (the "Indenture") permit the Company to incur or guarantee certain
additional indebtedness. See "Consolidated Financial Statements" and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations - Liquidity and Capital Resources."
The Company's high degree of leverage could have important consequences to
holders of the Exchange Notes, including, but not limited to, the following: (i)
the Company's ability to obtain additional financing for working capital,
capital expenditures, acquisitions or general corporate purposes may be impaired
in the future; (ii) a substantial portion of the Company's cash flow from
operations must be dedicated to the payment of principal and interest on its
indebtedness (including the Exchange Notes), thereby reducing the funds
available to the Company for its operations and other purposes including
acquisitions and new store openings; (iii) the Company may be substantially more
leveraged than certain of its competitors, which may place the
33
Company at a competitive disadvantage; (iv) the Company may be hindered in its
ability to adjust rapidly to changing market conditions; (v) the Company's high
degree of leverage could make it more vulnerable in the event of a downturn in
general economic conditions or its business or changing market conditions and
regulations; and (vi) to the extent that the Company's obligations under the
Floating Rate Notes and the New Facilities bear interest at floating rates, an
increase in interest rates could adversely affect, among other things, the
Company's ability to meet its financing obligations.
The Company's ability to repay or to refinance its obligations with respect
to its indebtedness (including the Exchange Notes) will depend on its future
financial and operating performance, which, in turn, will be subject to
prevailing economic and competitive conditions and to certain financial,
business, legislative, regulatory and other factors, many of which are beyond
the Company's control, as well as the availability of borrowings under the New
Facilities. These factors could include operating difficulties, difficulties in
identifying and integrating acquisitions, increased operating costs, product
pricing pressures, the response of competitors, regulatory developments and
delays in implementing strategic projects, including store openings. The
Company's ability to meet its debt service and other obligations may depend in
significant part on the extent to which the Company can implement successfully
its business strategy. There can be no assurance that the Company will be able
to implement its strategy fully or that the anticipated results of its strategy
will be realized.
If the Company is unable to fund its debt service obligations, the Company
may be forced to reduce or delay capital expenditures, sell assets, or seek to
obtain additional debt or equity capital, or to refinance or restructure its
debt (including the Exchange Notes). The Company may need additional financing
to repay the Exchange Notes at maturity. There can be no assurance that any of
these remedies can be affected on satisfactory terms, if at all. Factors which
could affect the Company's or its subsidiaries' access to the capital markets,
or the cost of such capital, include changes in interest rates, general economic
conditions and the perception in the capital markets of the Company's business,
results of operations, leverage, financial condition and business prospects.
THE EXCHANGE NOTES ARE SUBORDINATED IN RIGHT OF PAYMENT TO ALL FUTURE AND
EXISTING SENIOR INDEBTEDNESS OF THE COMPANY. The Exchange Notes and the
Guarantees are subordinated in right of payment to all existing and future
Senior Indebtedness of the Company, including indebtedness of the Company under
the New Facilities, and to all existing and future Guarantor Senior Indebtedness
of the guarantors, including the guarantees of the guarantors under the New
Facilities, respectively, and the Exchange Notes are also effectively
subordinated to all secured indebtedness of the Company and the guarantors,
respectively, to the extent of the value of the assets securing such
indebtedness. The obligations under the New Facilities are guaranteed by the
guarantors and are secured by substantially all of the assets of the Company and
all direct and indirect subsidiaries of the Company and a pledge of the capital
stock of each such subsidiary (but not to exceed 65% of the voting stock of
foreign subsidiaries). As of December 27, 2003, the aggregate amount of Senior
Indebtedness of the Company was approximately $236.5 million (exclusive of
unused commitments under the New Facilities of approximately $23.0 million),
$130.0 million of which is guaranteed by the guarantors under the New
Facilities.
34
In the event of bankruptcy, liquidation, reorganization or any similar
proceeding regarding the Company, or any Guarantor, or any default in payment,
the assets of the Company or such Guarantor, as applicable, will be available to
pay obligations on the Exchange Notes only after the senior indebtedness of the
Company or the Guarantor Senior Indebtedness of such Guarantor, as applicable,
has been paid in full, and there may not be sufficient assets remaining to pay
amounts due on all or any of the Exchange Notes. Moreover, under certain
circumstances, if any nonpayment default exists with respect to designated
senior indebtedness which would permit the holders of such designated senior
indebtedness to accelerate the maturity thereof, the Company may not make any
payments on the Exchange Notes for a specific time, unless such default is cured
or waived, or such designated senior indebtedness is paid in full. The holders
of the Exchange Notes will have no direct claim against the guarantors other
than the claim created by the Guarantees. The rights of holders of the Exchange
Notes to participate in any distribution of assets of any Guarantor upon
liquidation, bankruptcy or reorganization may, as is the case with other
unsecured creditors of the Company, be subject to prior claims against such
Guarantor. The Guarantees may themselves be subject to legal challenge in the
event of the bankruptcy or insolvency of a Guarantor, or in certain other
circumstances. If such a challenge were upheld, the Guarantees would be
invalidated and unenforceable.
THE COMPANY IS RESTRICTED BY THE TERMS OF ITS INDEBTEDNESS FROM TAKING MANY
CORPORATE ACTIONS THAT MAY BE IMPORTANT TO ITS FUTURE SUCCESS. The Indenture
restricts, among other things, the Company's and its subsidiaries' ability to:
incur additional indebtedness; incur liens; pay dividends or make certain other
restricted payments; consummate certain asset sales; enter into certain
transactions with affiliates; incur indebtedness that is subordinate in right of
payment to any Senior Indebtedness and senior in right of payment to the
Exchange Notes; create or cause to exist restrictions on the ability of a
subsidiary to pay dividends or make certain payments to the Company; merge or
consolidate with any other person or sell, assign, transfer, lease, convey or
otherwise dispose of all or substantially all of the assets of the Company. In
addition, the New Facilities contain other and more restrictive covenants and
prohibits the Company in all circumstances from prepaying certain of its
indebtedness (including the Exchange Notes). The New Facilities also require the
Company to maintain specified financial ratios. The Company's ability to meet
those financial ratios can be affected by events beyond its control, and there
can be no assurance that the Company will meet those tests. A breach of any of
these covenants could result in a default under the New Facilities and/or the
Indenture. Upon the occurrence of an event of default under the New Facilities,
the lenders could also elect to declare all amounts outstanding under the New
Facilities, together with accrued interest, to be immediately due and payable.
If the Company were unable to repay those amounts, the lenders could proceed
against the collateral granted to them to secure that indebtedness or against
the guarantees of the guarantors of the New Facilities. If the debt outstanding
under the New Facilities were to be accelerated, there can be no assurance that
the assets of the Company and its subsidiaries would be sufficient to repay the
obligations under the New Facilities, other Senior Indebtedness, Guarantor
Senior Indebtedness or the Exchange Notes. Substantially all the assets of the
Company and its subsidiaries secure the New Facilities. See "Liquidity and
Capital Resources."
THE COMPANY IS SUBJECT TO A VARIETY OF STATE, LOCAL AND FEDERAL REGULATIONS THAT
AFFECT THE HEALTH CARE INDUSTRY, WHICH MAY AFFECT ITS ABILITY TO GENERATE
REVENUE OR SUBJECT IT TO ADDITIONAL
35
EXPENSES. The Company or its landlord leases a portion of each of the Company's
stores or adjacent space to an independent optometrist. The availability of such
professional services within or adjacent to the Company's stores is critical to
the Company's marketing strategy. The delivery of health care, including the
relationships among health care providers such as optometrists and suppliers
(e.g., providers of eyewear), is subject to extensive federal and state
regulation. The laws of many states prohibit business corporations such as the
Company from practicing medicine or exercising control over the medical
judgments or decisions of physicians and from engaging in certain financial
arrangements, such as splitting fees with physicians. These laws and their
interpretations vary from state to state and are enforced by both courts and
regulatory authorities, each with broad discretion. The Company has addressed
these prohibitions with three distinct operating structures. With respect to 191
of its stores, the Company subleases a portion of the space within or adjacent
to its store to an Independent OD. In forty-six of the stores, the Company
directly employs the optometrist. In sixty-four of the Company's stores, the
Company has structured its business relationships with independent optometrists
by subleasing the entire premises to the OD PC and entering into a long-term
management agreement to manage the optometrist's entire practice (which includes
the optical dispensary as well as the professional eye examination practice).
Violations of these laws could result in censure or delicensing of optometrists,
civil or criminal penalties, including large civil monetary penalties, or other
sanctions. In addition, a determination in any state that the Company is engaged
in the corporate practice of medicine or any unlawful fee-splitting arrangement
could render any service agreement between the Company and optometrists located
in such state unenforceable or subject to modification, which could have a
material adverse effect on the Company. The Company believes it is currently in
material compliance with each of these laws; however, courts and regulatory
authorities will determine that these operating structures comply with
applicable laws and regulations. See "Business - Government Regulation."
The fraud and abuse provisions of the Social Security Act and anti-kickback
laws and regulations adopted in many states prohibit the solicitation, payment,
receipt, or offering of any direct or indirect remuneration in return for, or as
an inducement to, certain referrals of patients, items or services. Provisions
of the Social Security Act also impose significant penalties for false or
improper billings to Medicare and Medicaid, and many states have adopted similar
laws applicable to any payor of health care services. In addition, the Stark
Self-Referral Law imposes restrictions on physicians' referrals for designated
health services reimbursable by Medicare or Medicaid to entities with which the
physicians have financial relationships, including the rental of space if
certain requirements have not been satisfied. Many states have adopted similar
self-referral laws which are not limited to Medicare or Medicaid reimbursed
services. Violations of any of these laws may result in substantial civil or
criminal penalties, including double and treble civil monetary penalties, and,
in the case of violations of federal laws, exclusion from participation in the
Medicare and Medicaid programs. Such exclusions and penalties, if applied to the
Company, could have a material adverse effect on the Company. The Company is
currently in material compliance with all of the foregoing laws and no
determination of any violation in any state has been made with respect to the
foregoing laws.
THE COMPANY'S FUTURE SUCCESS WILL DEPEND ON ITS ABILITY TO ENTER INTO MANAGED
CARE CONTRACTS. As an increasing percentage of patients enter into health care
coverage arrangements
36
with managed care payors, the Company believes that its success will be, in
part, dependent upon the Company's ability to negotiate contracts with employer
groups and other private third party payors. Many of the existing managed care
contracts may be terminated with little or no notice. Currently, the Company
participates in a managed care network that it anticipates being removed from in
fiscal 2004 representing approximately $4.0 million in annual revenues. There is
no certainty that the Company will be able to establish or maintain satisfactory
relationships with managed care and other third party payors, many of which
already have existing provider structures in place and may not be able or
willing to change their provider networks. The inability of the Company to
maintain its current relationships or enter into such arrangements in the future
could have a material adverse effect on the Company.
The Company's contractual arrangements with managed care companies on the
one hand, and the networks of optometrists and other providers on the other, are
subject to federal and state regulations, including but not limited to the
following:
Insurance Licensure. Most states impose strict licensure requirements on health
insurance companies, HMOs and other companies that engage in the business of
insurance. In most states, these laws do not apply to networks paid on a
discounted fee-for-service arrangements or on a capitated basis. In the event
that the Company is required to become licensed under these laws, the licensure
process can be lengthy and time consuming. In addition, many of the licensing
requirements mandate strict financial and other requirements which the Company
may not be able to meet.
Any Willing Provider Laws. Some states have adopted, and others are
considering, legislation that requires managed care payors to include any
provider who is willing to abide by the terms of the managed care payor's
contracts and/or prohibit termination of providers without cause. Such laws
would limit the ability of the Company to develop effective managed care
provider networks in such states.
Antitrust Laws. The Company and its networks of providers are subject to a
range of antitrust laws that prohibit anti-competitive conduct, including
price-fixing, concerted refusals to deal and divisions of markets. There can be
no assurance that there will not be a challenge to the Company's operations on
the basis of an antitrust violation in the future.
ANY TERMINATION OF THE COMPANY'S LONG TERM PROFESSIONAL CORPORATION MANAGEMENT
AGREEMENTS OR A DISPUTE WITH THE OD PCS WOULD HARM ITS BUSINESS. Sixty-four of
the stores are subleased to an OD PC that employs the ODs, and the Company
(through its subsidiaries) operates the store through the provision of
management services to the OD PC (including management of the professional
practice and optical retail business). Each of the OD PCs own between twelve
and twenty-four stores. Each of these relationships is material to the Company.
In addition, the Company has a right to, and with respect to the Hour Eye's
locations the OD PC has the right to cause the Company to, designate another
optometrist to purchase the stock or assets of the OD PC at an agreed upon
calculation to determine the purchase price. At December 27, 2003, these prices
in the aggregate are approximately $10.0 million. While these contracts are
long-term commitments, no assurances can be given as to the likelihood of an
agreement
37
being terminated by an OD or a dispute arising between the Company and the OD
and to the resulting impact on the Company's revenues and cashflows. A finding
that the OD PC does not comply with applicable laws, a dispute with an OD PC or
the termination of a management relationship could have a material adverse
effect on the Company.
PROPOSED AND FUTURE HEALTH CARE REFORM INITIATIVES COULD HARM THE COMPANY.
There have been numerous initiatives at the federal and state levels for
comprehensive reforms affecting the payment for and availability of healthcare
services. The Company believes that such initiatives will continue during the
foreseeable future. Aspects of certain of these reforms as proposed in the past
or others that may be introduced could, if adopted, adversely affect the
Company.
The following, among others, are potential governmental initiatives which
may have an adverse effect on the Company.
Licensure. The Company must obtain licenses or certifications to operate
its business in certain states. To obtain and maintain such licenses, the
Company must satisfy certain licensure standards. Changes in licensure standards
could increase the Company's costs or prevent the Company from providing certain
services, both of which could have a material adverse effect on the Company. See
"Business."
Fraud and Abuse and Stark Laws. There are a variety of federal and state
laws that affect financial and service arrangements between health care
providers. The Medicare and Medicaid anti-fraud and abuse laws, as well as the
laws of certain states, prohibit health care providers from offering, paying,
soliciting or receiving any payments, directly or indirectly, in cash or in
kind, which are designed to induce or encourage the referral of patients to, or
the recommendation of, a particular provider for medical products and services.
In addition, federal law, as well as the laws of certain states, prohibit a
physician, including an optometrist or ophthalmologist, who has a financial
relationship through an investment interest or compensation arrangement (or
whose immediate family member has such a financial relationship) with a provider
of designated health services from making referrals to that provider for such
services, unless the financial relationship qualifies for an exception under the
applicable law. The federal law, as well as the laws of certain states, also
prohibits the provider of such services from billing for services provided as
the result of a prohibited referral. Under the federal law, designated health
services in certain instances include eye glasses and lenses. The federal
government has issued proposed regulations which further describe prohibited
referrals, the nature of financial relationships and permitted exceptions. The
Company believes that it is in material compliance with these regulations as
proposed. The federal government has not yet issued final regulations.
The Company has financial relationships with numerous physicians to which
these laws and regulations apply. While the Company reviews such arrangements
for compliance with applicable laws and regulations, the Company has not
requested, and has not received, from any governmental agency an advisory
opinion finding that such relationships are in compliance with applicable laws
and regulations, and all such financial relationships may not be found to comply
38
with such laws and regulations. It is also possible that future interpretations
of such laws and regulations will require modifications to the Company's
business arrangements.
Violations of these laws and regulations may result in substantial civil or
criminal penalties, including double and treble monetary penalties, and, in the
case of violations of federal laws and regulations, exclusion from the Medicare
and Medicaid programs. Such exclusions and penalties, if applied to the Company,
could have a material adverse effect on the Company.
Changes in Reimbursement. Government revenue sources are subject to statutory
and regulatory changes, administrative rulings, interpretations of policy,
determinations by fiscal intermediaries and carriers, and government funding
limitations, all of which may materially increase or decrease the rates of
payment and cash flow to the Company. There is no assurance that payments made
under such programs will remain at levels comparable to the present levels or be
sufficient to cover all operating and fixed costs. Government or third party
payors may retrospectively and/or prospectively adjust previous payments to the
Company in amounts which would have a material adverse effect on the Company.
THE COMPANY IS VULNERABLE TO POSSIBLE FRANCHISE CLAIMS. Two optometrists
asserted claims arising out of the nonrenewal of their subleases of office space
with the Company and their Trademark License Agreements with Enclave Advancement
Group, Inc., a subsidiary of the Company ("Enclave"). Such optometrists
contended that the leasing of space from the Company, coupled with the license
from Enclave of certain trademarks, constituted a franchise, and such
optometrists have alleged various claims arising out of this contention. This
claim was settled in May, 1998. While the Company believes that the structure of
the relationships among the Company, Enclave and the optometrists were operating
near the Company's retail stores does not constitute a franchise, no assurance
can be given that a claim, action or proceeding will not be brought against the
Company or Enclave asserting that a franchise exists.
THE COMPANY RELIES ON THIRD-PARTY REIMBURSEMENT, THE FUTURE REDUCTION OF WHICH
WOULD HARM ITS BUSINESS. The cost of a significant portion of medical care in
the United States is funded by government and private insurance programs, such
as Medicare, Medicaid and corporate health insurance plans. According to
governmental projections, it is expected that more medical beneficiaries who are
significant consumers of eye care services will enroll in management care
organizations. The health care industry is experiencing a trend toward
cost-containment with governmental and private third party payors seeking to
impose lower reimbursement, utilization restrictions and risk-based compensation
arrangements. Private third-party reimbursement plans are also developing
increasingly sophisticated methods of controlling health care costs through
redesign of benefits and explorations of more cost-effective methods of
delivering health care. Accordingly, there can be no assurance that
reimbursement for purchase and use of eye care services will not be limited or
reduced and thereby adversely affect future sales by the Company.
THE COMPANY MAY BE EXPOSED TO A SIGNIFICANT RISK FROM LIABILITY CLAIMS IF IT IS
UNABLE TO OBTAIN INSURANCE, AT ACCEPTABLE COSTS, TO PROTECT IT AGAINST POTENTIAL
LIABILITY CLAIMS. The provision of professional eye care services entails an
inherent risk of professional malpractice and other similar claims. The Company
does not influence or control the practice of optometry by the
39
optometrists that it employs or affiliates with, nor does it have responsibility
for their compliance with certain regulatory and other requirements directly
applicable to these individual professionals. As a result of the relationship
between the employed and affiliated optometrists and the Company, however, the
Company may become subject to professional malpractice actions or claims under
various theories relating to the professional services provided by these
individuals. The Company may not be able to continue to obtain adequate
liability insurance at reasonable rates, in which event, its insurance may not
be adequate to cover claims asserted against it, in which event, its future cash
position could be reduced and its ability to continue operations could be
jeopardized.
IF THE COMPANY IS UNABLE TO MAKE A CHANGE OF CONTROL PAYMENT, IT WILL BE IN
DEFAULT UNDER THE INDENTURE. Upon the occurrence of a Change of Control,
subject to certain conditions, the Company will be required to make an offer to
purchase all of the outstanding Exchange Notes at a price equal to 101% of the
principal amount thereof at the date of purchase plus accrued and unpaid
interest, if any, to the date of purchase. If a Change of Control were to occur,
there can be no assurance that the Company would have sufficient funds to pay
the repurchase price for all Exchange Notes tendered by the holders thereof;
such failure would result in an event of default under the Indenture. The
occurrence of a Change of Control would constitute a default under the New
Facilities and might constitute a default under the other agreements governing
indebtedness that the Company or its subsidiaries may enter into from time to
time. In addition, the New Facilities prohibits the purchase of the Notes by the
Company in the event of a Change of Control, unless and until such time as the
indebtedness under the New Facilities is repaid in full. The Company's failure
to purchase the Notes in such instance would result in a default under each of
the Indenture and the New Facilities. The inability to repay the indebtedness
under the New Facilities, if accelerated, could have a material adverse
consequence to the Company and to holders of the Exchange Notes. Future
indebtedness of the Company may also contain prohibitions of certain events or
transactions that could constitute a Change of Control or require such
indebtedness to be repurchased upon a Change of Control. See "Liquidity and
Capital Resources."
IF THE COMPANY FAILS TO MAKE TIMELY PAYMENTS ON ANY OF ITS INDEBTEDNESS, AN
EVENT OF DEFAULT UNDER THE INDENTURE WOULD BE TRIGGERED. The failure to pay
principal at maturity under the terms of any Indebtedness, after giving effect
to any applicable grace period or extensions thereof, by the Company, resulting
in a default under such Indebtedness, would result in an Event of Default under
the Exchange Notes. If such an Event of Default were to occur, there can be no
assurance that the Company would have sufficient funds to pay the repurchase
price for all Exchange Notes tendered by the holders thereof. Future
indebtedness of the Company may also contain prohibitions of certain events or
transactions that would constitute a Change of Control or require such
indebtedness to be repurchased upon a Change of Control.
IN BANKRUPTCY, THE EXCHANGE NOTES MAY BE INVALIDATED OR SUBORDINATED TO OTHER
DEBTS OF THE COMPANY. Under applicable provisions of federal bankruptcy law or
comparable provisions of state fraudulent conveyance law, if, among other
things, the Company or the guarantors, at the time it incurred the indebtedness
evidence by the Exchange Notes or the Guarantees, as the case may be, (i) (a)
was or is insolvent or rendered insolvent by reason of such occurrence of (b)
was
40
or is engaged in a business or transaction of which the assets remaining with
the Company or the guarantors were unreasonably small or constitute unreasonably
small capital or (c) intended or intends to incur, or believed, believes or
should have believed that it would incur, debts beyond its ability to repay such
debts as they mature and (ii) the Company or the Guarantor received or receives
less than the reasonably equivalent value or fair consideration for the
incurrence of such indebtedness, the Exchange Notes and the Guarantees could be
invalidated or subordinated to all other debts of the Company or the guarantors,
as the case may be. The Exchange Notes or Guarantees could also be invalidated
or subordinated if it were found that the Company or the Guarantor, as the case
may be, incurred indebtedness in connection with the Exchange Notes or the
Guarantees with the intent of hindering, delaying or defrauding current or
future creditors of the Company or the guarantors, as the case may be. In
addition, the payment of interest and principal by the Company pursuant to the
Exchange Notes or the payment of amounts by the guarantors pursuant to the
Guarantees could be voided and required to be returned to the person making such
payment, or to a fund for the benefit of the creditors of the Company or the
guarantors, as the case may be.
The measures of insolvency for purposes of the foregoing considerations
will vary depending upon the law applied in any proceeding with respect to the
foregoing. Generally, however, the Company or the guarantors would be considered
insolvent if (i) the sum of its debts, including contingent liabilities, were
greater than the sum of all of its assets at a fair valuation or if the present
fair saleable value of its assets were less than the amount that would be
required to pay its probable liability on its existing debts, including
contingent liabilities, as they become absolute and mature or (ii) it could not
pay its debts as they become due.
To the extent the Guarantees were voided as a fraudulent conveyance or held
unenforceable for any other reason, holders of Exchange Notes would cease to
have any claim in respect of the guarantors and would be creditors solely of the
Company. In such event, the claims of holders of Exchange Notes against the
guarantors would be subject to the prior payment of all liabilities and
preferred stock claims of the guarantors. There can be no assurance that, after
providing for all prior claims and preferred stock interests, if any, there
would be sufficient assets to satisfy the claims of holders of Exchange Notes
relating to any voided portions of the Guarantees.
THL CONTROLS THE COMPANY AND MAY HAVE INTERESTS THAT DIVERGE FROM THOSE OF THE
HOLDERS OF THE EXCHANGE NOTES. THL owns approximately 90.1% of the issued and
outstanding Common Stock. Accordingly, THL controls the Company and has elected
a majority of its directors, appointed new management and approved any action
requiring the approval of the holders of Common Stock, including adopting
amendments to the Company's charter and approving mergers or sales of
substantially all of the Company's assets. The directors elected by THL have the
authority to make decisions affecting the capital structure of the Company,
including the issuance of additional capital stock, the implementation of stock
repurchase programs and the declaration of dividends. There can be no assurance
that the interests of THL does or will not conflict with the interests of the
holders of the Exchange Notes. See "Certain Relationships and Related
Transactions."
41
THE COMPANY DEPENDS ON THE ABILITY AND EXPERIENCE OF CERTAIN MEMBERS OF ITS
MANAGEMENT TEAM AND THEIR DEPARTURE MAY HURT ITS FINANCIAL PERFORMANCE. The
Company relies on the skills of certain members of its senior management team to
guide operations, the loss of which could have an adverse effect on its
operations. Furthermore, the members of its senior management team, other than
Mr. McComas, have annual employment agreements with the Company that
automatically renew unless either party gives thirty day notice. Accordingly,
key executives may not continue to work for the Company, and it may not have
adequate time to hire qualified replacements which could have a material adverse
effect on the Company.
THE EXCHANGE NOTES ARE NOT PUBLICLY TRADED AND THEREFORE MAY NOT BE A LIQUID
INVESTMENT. There is no existing market for the Exchange Notes and there can be
no assurances as to the liquidity of any markets that may develop for the
Exchange Notes, the ability of holders of the Exchange Notes to sell their
Exchange Notes, or the price at which holders would be able to sell their
Exchange Notes. Future trading prices of the Exchange Notes will depend on many
factors, including among other things, prevailing interest rates, the Company's
operating results and the market for similar securities.
ADVERSE CHANGES IN ECONOMIC CONDITIONS GENERALLY OR IN THE COMPANY'S MARKETS
COULD REDUCE DEMAND FOR ITS PRODUCTS AND SERVICES WHICH WOULD ADVERSELY AFFECT
ITS RESULTS OF OPERATIONS. The optical retail industry is cyclical. Downturns
in general economic conditions or uncertainties regarding future economic
prospects, which affect consumer disposable income, have historically adversely
affected consumer spending habits in the company's principal markets.
Therefore, future economic downturns or uncertainties could have a material
adverse effect on the company's business, results of operations and financial
condition.
The optical retail industry is also subject to rapidly changing consumer
preferences. While eyewear has achieved widespread acceptance as a fashion
accessory, leading to overall growth in the company's sales, there can be no
assurance that this growth will continue or that consumer preferences will
change in a manner which will adversely affect the Company or the optical retail
industry as a whole.
IF THE COMPANY DOES NOT COMPETE SUCCESSFULLY IN THE COMPETITIVE OPTICAL RETAIL
INDUSTRY, ITS BUSINESS AND REVENUES MAY BE ADVERSELY AFFECTED. The optical
retail market is highly competitive and is continuing to undergo consolidation.
The Company competes directly with national, regional and local retailers
located in its markets within the U.S. Many potential competitors for the
company's products and services have, and some potential competitors are likely
to enjoy, substantial competitive advantages, including the following:
- - greater name recognition;
- - greater financial, technical, marketing and other resources;
- - more extensive knowledge of the optical retail business and industry; and
- - well-established relationships with a larger base of current and potential
customers and suppliers.
42
For example, at times when the Company's major competitors offer
significantly lower prices for their products, the Company is often required to
do the same. Certain of its major competitors offer promotional incentives to
their customers including free eye exams, "50% Off" on designer frames and "Buy
One, Get One Free" eye care promotions. In response to these promotions, the
Company has offered the same or similar incentives to its customers. This
practice has resulted in lower profit margins and these competitive promotional
incentives may further reduce revenues, gross margins and cash flows. Although
the Company believes that it provides quality service and products at
competitive prices, several of the other large retail optical chains have
greater financial resources than the Company. Therefore, the Company may not be
able to continue to deliver cost efficient products in the event of aggressive
pricing by its competitors, which would adversely affect profit margins, net
income and cash flow.
The Company may also encounter increased competition in the future from
industry consolidation and from new competitors that enter its market. Increased
competition could result in lower sales or downward price pressure on its
products and services, which may adversely affect the company's results of
operations.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company is exposed to various market risks. Market risk is the
potential loss arising from adverse changes in market prices and rates. The
Company does not enter into derivative or other financial instruments for
trading or speculative purposes.
INTEREST RATE RISK
The Company's primary market risk exposure is interest rate risk, with
specific vulnerability to changes in LIBOR. As of December 27, 2003, $136.5
million of the Company's long-term debt bore interest at variable rates.
Accordingly, the Company's net income is affected by changes in interest rates.
Assuming a two hundred basis point change in the 2003 average interest rate
under the $136.5 million in borrowings, the Company's 2003 interest expense
would have changed approximately $2.7 million.
In the event of an adverse change in interest rates, management could take
actions to mitigate its exposure. However, due to the uncertainty of the actions
that would be taken and their possible effects, this analysis assumes no such
actions. Further, this analysis does not consider the effects of the change in
the level of overall economic activity that could exist in such an environment.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The financial statements and supplementary data are set forth in this
annual report on Form 10-K commencing on page F-1.
43
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
ITEM 9A. CONTROLS AND PROCEDURES
The Company has established and maintains disclosure controls and
procedures that are designed to ensure that material information relating to the
Company and its subsidiaries required to be disclosed in the reports that it
files or submits under the Securities and Exchange Act of 1934 is recorded,
processed, summarized, and reported within the time periods specified in the
Securities and Exchange Commission's rules and forms, and that such information
is accumulated and communicated to the Company's management, including its Chief
Executive Officer and Chief Financial Officer, as appropriate to allow timely
decisions regarding required disclosure. As of the end of the period covered by
this annual report, the Company carried out an evaluation, under the supervision
and with the participation of management, including the Chief Executive Officer
and Chief Financial Officer, of the effectiveness of the design and operation of
disclosure controls and procedures. Based on that evaluation of these disclosure
controls and procedures, the Chief Executive Officer and Chief Financial Officer
concluded that the Company's disclosure controls and procedures were effective
as of the date of such evaluation.
The Chief Executive Officer and Chief Financial Officer have also concluded
that there were no significant changes in the Company's internal controls or in
other factors that could significantly affect the internal controls subsequent
to the date that the Company completed its evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
44
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The table below sets forth the names, ages and positions of the executive
officers and directors of the Company.
NAME . . . . . . . . . . . . . . . . . . . AGE POSITION
- ------ --- --------
David E. McComas . . . . . . . . . . . . . 61 President, Chief Executive Officer and Chairman
George E. Gebhardt . . . . . . . . . . . . 53 Executive Vice President of Merchandising, Marketing and
Real Estate/Construction
Alan E. Wiley. . . . . . . . . . . . . . . 56 Executive Vice President, Chief Financial Officer, President of Managed
Vision Care, Secretary and Treasurer
Diana Beaufils . . . . . . . . . . . . . . 50 Senior Vice President of Store Operations
Raymond D. Carrig, Jr. . . . . . . . . . . 50 Senior Vice President of Store Operations
James J. Denny . . . . . . . . . . . . . . 59 Senior Vice President of Store Operations
Daniel C. Walker, III. . . . . . . . . . . 46 Senior Vice President of Store Operations
Robert T. Cox. . . . . . . . . . . . . . . 38 Vice President of Human Resources
Bernard W. Andrews . . . . . . . . . . . . 62 Director
Charles A. Brizius . . . . . . . . . . . . 35 Director
Anthony J. DiNovi. . . . . . . . . . . . . 41 Director
Norman S. Matthews . . . . . . . . . . . . 70 Director
Warren C. Smith, Jr. . . . . . . . . . . . 47 Director
Antoine G. Treuille. . . . . . . . . . . . 54 Director
Directors of the Company are elected at the annual shareholders' meeting
and hold office until their successors have been elected and qualified. The
officers of the Company are chosen by the Board of Directors and hold office
until they resign or are removed by the Board of Directors.
David E. McComas has served as the President and Chief Executive Officer of
the Company since July 2001 and as Chairman since January 2004. From July 1998
to July 2001, Mr. McComas served as the President and Chief Operating Officer of
the Company. Prior to joining the Company in July 1998, Mr. McComas was Western
Region President and Corporate Vice President, Circuit City Stores, Inc., and
was responsible for ten Western States and Hawaii since 1994. Prior to 1994, Mr.
McComas was General Manager of Circuit City Stores, Inc. Mr. McComas has over
thirty years of store management experience including positions with Montgomery
Ward Holding Corporation and Sears, Roebuck & Co. Since 1996, Mr. McComas has
served as a Director of West Marine, Inc.
George E. Gebhardt has served as the Company's Executive Vice President of
Merchandising, since September 1996 when the Company acquired his former
employer, Visionworks, Inc. He assumed the responsibilities of the Company's
Marketing in June 1998 and Real Estate/Construction in April 2002. Mr. Gebhardt
was with Visionworks from February 1994 to September 1996 serving in various
positions, most recently Senior Vice
45
President of Merchandising and Marketing. Prior to that, Mr. Gebhardt spent over
thirteen years with Eckerd Corporation in various operational positions
including Senior Vice President, General Manager of Eckerd Vision Group. Mr.
Gebhardt also spent seven years working for Procter & Gamble serving in various
positions including Unit Sales Manager of Procter & Gamble's Health and Beauty
Care Division.
Alan E. Wiley has served as Executive Vice President and Chief Financial
Officer of the Company since November 1998 and as President of Managed Vision
Care, Inc. since July 2001. From 1992 until November 1998, Mr. Wiley served as
the Senior Executive Vice President, Secretary, Chief Financial and
Administrative Officer and a Director of The Cato Corporation. From 1981 through
1990, Mr. Wiley held senior administrative and financial positions with British
American Tobacco, U.S., in various companies of the specialty retail division.
Diana Beaufils has served as a Senior Vice President of Store Operations
since September 1998, overseeing the management of approximately one-quarter of
the Company's stores. From October 1993 to September 1998, Ms. Beaufils held
various progressive operations positions culminating in Assistant Vice President
with Circuit City Stores, Inc. Prior to October 1993, Ms. Beaufils held several
operations positions with Montgomery Ward Holding Corporation.
Raymond D. Carrig, Jr. has served as a Senior Vice President of Store
Operations since October 1998 when the Company acquired the assets of his former
employer, Dr. Bizer's VisionWorld, PLLC ("VisionWorld"). He oversees the
management of approximately one-quarter of the Company's stores. From January
1985 to the Company's acquisition of VisionWorld in October 1998, Mr. Carrig
held various progressive operations positions and obtained his Master Optician
certification.
James J. Denny has served as a Senior Vice President of Store Operations
since August 2003 overseeing the management of approximately one-quarter of the
Company's stores. From June 1967 to March 1992 and again from January 1994 to
December 2002, Mr. Denny held various progressive operations positions
culminating in President of Sears Puerto Rico with Sears Roebuck & Co. From
March 1993 to January 1994 Mr. Denny served as Region Manager with Circuit City
Stores, Inc.
Daniel C. Walker, III has served as a Senior Vice President of Store
Operations since June 2000, overseeing the management of approximately
one-quarter of the Company's stores. From July 1998 to June 2000, he served as
Vice President of Store Operations, overseeing the corporate office management
of field operations. From 1992 to June 2000, Mr. Walker served in progressive
operations positions culminating in Division General Operations Manager with
Circuit City Stores, Inc.
Robert T. Cox has served as the Vice President of Human Resources since
April 2002. From January 1999 through April 2002, Mr. Cox served as the
Division Human Resource Manager for The Home Depot in the Phoenix, Arizona and
surrounding markets. From December 1987 through December 1998, Mr. Cox held
several human resources positions to include Regional
46
Human Resource Manager with Western Auto Supply Co. (a division of Sears Roebuck
& Co.). Mr. Cox has over twenty years of retail experience.
Bernard W. Andrews retired as Chief Executive Officer in July 2001, served
as the Company's Chairman of the Board until January 2004, a position he had
held since the consummation of the Recapitalization, and now serves as a
Director of the Company. Mr. Andrews joined the Company as Director and Chief
Executive Officer in March 1996. From January 1994 to April 1995, Mr. Andrews
was President and Chief Operating Officer as well as a Director of Montgomery
Ward-Retail. He was an Executive Vice President and a Director of Circuit City
Stores, Inc., from October 1990 to January 1994. Mr. Andrews was with
Montgomery Ward-Retail from October 1983 to May 1990, serving as
President-Hardlines, Executive Vice President-Marketing and Vice President-Home
Fashions. Prior to 1983, Mr. Andrews spent twenty years with Sears, Roebuck &
Co. in a number of merchandising, marketing and operating positions.
Charles A. Brizius has served as a Director of the Company since the
consummation of the Recapitalization. Mr. Brizius worked at Thomas H. Lee
Company from 1993 to 1995, rejoined in 1997 and currently serves as a Managing
Director. Mr. Brizius is a Member of THL Equity Advisors IV, LLC, the general
partner of Thomas H. Lee Equity Fund IV, LP. From 1991 to 1993, Mr. Brizius
worked at Morgan Stanley & Co. Incorporated in the Corporate Finance Department.
Mr. Brizius is a member of the Board of Directors of TransWestern Publishing,
L.P., United Industries Corporation and Big V Supermarkets, Inc.
Anthony J. DiNovi has served as a Director of the Company since the
consummation of the Recapitalization. Mr. DiNovi has been employed by Thomas H.
Lee Company since 1988 and currently serves as a Managing Director. Mr. DiNovi
is a Managing Director and Member of THL Equity Advisors IV, LLC, the general
partner of Thomas H. Lee Equity Fund IV, LP. Mr. DiNovi is a member of the Board
of Directors of Fisher Scientific International, Inc., Fair Point
Communications, Inc., US LEC Corporation, Vertis, Inc. and various private
companies.
Norman S. Matthews has served as a Director of the Company since October
1993 and served as Chairman from December 1996 to April 1998. Mr. Matthews is
Chairman of the Executive Committee of the Company's Board of Directors. From
1988 to the present, Mr. Matthews has been an independent retail consultant and
venture capitalist. Mr. Matthews was President of Federated Department Stores
from 1987 to 1988, and served as Vice Chairman from 1983 to 1987. He is the
Chairman of Galyan's Trading Company and a member of the Board of Directors of
Finlay Enterprises, Inc., Toys "R" Us, Inc., Henry Schein, Inc, The Progressive
Corporation and Sunoco, Inc.
Warren C. Smith, Jr., has served as a Director of the Company since the
consummation of the Recapitalization. Mr. Smith has been employed by Thomas H.
Lee Company since 1990 and currently serves as a Managing Director. Mr. Smith is
a Managing Director and Member of THL Equity Advisors IV, LLC, the general
partner of Thomas H. Lee Equity Fund IV, LP. Mr. Smith is also a member of the
Board of Directors of Rayovac Corporation and Finlay Enterprises, Inc.
47
Antoine G. Treuille has served as a Director of the Company since October
1993. In 1999, Mr. Treuille became Managing Director of Mercantile Capital
Partners, a private equity investment fund. Mr. Treuille has served as
President of Charter Pacific Corp. since May 1996. He was previously Managing
Director of Financo, Inc., an investment bank, from March 1998 until 1999.
Prior to his current position, Mr. Treuille served as Senior Vice President of
Desai Capital Management Inc. From September 1985 to April 1992, he served as
Executive Vice President with the investment firm of Entrecanales, Inc. Mr.
Treuille is also a member of the Board of Directors of ERAMET and Harris
Interactive.
CODE OF ETHICS
The Company has adopted a Business Conduct and Ethics Policy which covers
its directors, officers (including its principal executive officer, principal
financial officer and principal accounting officer) and employees.
Security holders may request a free copy of the Business Conduct and Ethics
Policy from:
Eye Care Centers of America, Inc.
11103 West Avenue
San Antonio, TX 78213
48
ITEM 11. EXECUTIVE COMPENSATION
The following table sets forth certain information concerning the
compensation paid during the last three years to the Company's Chief Executive
Officer and the four other most highly compensated executive officers serving as
executive officers at the end of fiscal 2003 (the "Named Executive Officers").
SUMMARY COMPENSATION TABLE
LONG-TERM
COMPENSATION
ANNUAL -------------
COMPENSATION AWARDS
-------------------------------------------------------------
OTHER ANNUAL SECURITIES ALL OTHER
COMPENSATION UNDERLYING COMPENSATION
NAME AND PRINCIPAL POSITION. . . . . YEAR SALARY($)(A) BONUS($)(B) ($)(C) OPTIONS(#) ($)
- ------------------------------------ --------- ------------- ------------- ------ ---------- ---
David E. McComas . . . . . . . . . . 2003 549,039 144,000 - - -
President and Chief . . . . . . . 2002 474,038 650,000 - 233,000 -
Executive Officer . . . . . . . . 2001 399,109 112,500 - - -
Alan E. Wiley. . . . . . . . . . . . 2003 297,362 50,000 - - -
Executive Vice President, . . . . 2002 287,692 319,000 - 71,500 -
Chief Financial Officer,. . . . . 2001 258,038 68,750 - - -
President of Managed Vision Care,
Secretary and Treasurer
George E. Gebhardt . . . . . . . . . 2003 280,615 60,000 - - -
Executive Vice President of . . . 2002 237,692 264,000 - 56,500 -
Merchandising, Marketing and. . . 2001 223,692 25,000 - - -
Construction/Real Estate
Diana Beaufils . . . . . . . . . . . 2003 210,204 - - - -
Senior Vice President of. . . . . 2002 203,769 118,900 - 28,000 -
Store Operations. . . . . . . . . 2001 195,923 25,000 - - -
Daniel C. Walker, III. . . . . . . . 2003 206,346 50,000 - - -
Senior Vice President of. . . . . 2002 199,539 260,000 - 29,000 -
Store Operations. . . . . . . . . 2001 170,923 25,000 - - -
(a) Represents annual salary, including any compensation deferred by the Named
Executive Officer pursuant to the Company's 401(k) defined contribution
plan.
(b) Represents annual bonus earned by the Named Executive Officer for the
relevant fiscal year.
(c) The dollar value of the perquisites and other personal benefits, securities
or property paid to each Named Executive Officer did not exceed the lesser
of $50,000 or 10% of reported annual salary and bonus received by the Named
Executive Officer.
49
STOCK OPTION GRANTS. The Named Executive Officers have not been granted
any options or SARs in fiscal 2003.
STOCK OPTION EXERCISES AND HOLDINGS TABLE. The following table sets forth
information with respect to the Named Executive Officers concerning unexercised
options held as of December 27, 2003. The Named Executive Officers have not been
granted any SARs.
AGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR AND FY-END OPTION VALUES
... . . . . . . . . . . . NUMBER OF
... . . . . . . . . . . . SECURITIES VALUE OF
... . . . . . . . . . . . UNDERLYING UNEXERCISED
... . . . . . . . . . . . UNEXERCISED IN-THE-MONEY
... . . . . . . . . . . . OPTIONS AT OPTIONS AT
... . . . . . . . . . FY-END (#) FY-END ($)
SHARES VALUE ----------------- ---------------------
... . . . . . . . . . ACQUIRED ON REALIZED EXERCISABLE/ EXERCISABLE/
NAME . . . . . . . . EXERCISE (#) ($) UNEXERCISABLE UNEXERCISABLE
- -------------------- ------------ --------- ----------------- ---------------------
David E. McComas . . . . 133,300 / 99,700 $ 1,349,157/ $900,413
Alan E. Wiley. . . . . . 39,650 / 31,850 $ 398,639 / $266,247
George E. Gebhardt . . . 23,150 / 33,350 $ 230,009 / $281,577
Diana Beaufils . . . . . 15,300 / 12,700 $ 153,327 / $102,443
Daniel C. Walker III . . 15,400 / 13,600 $ 153,336 / $102,524
There is currently no market for the Company's Common Stock. A value of $15.13
per share was determined by the Board of Directors.
COMMITTEES OF THE BOARD OF DIRECTORS
The Board of Directors has an Executive Committee of which Norman S.
Matthews is chairman and Anthony DiNovi and Warren Smith are members.
The Board of Directors has a Compensation Committee currently consisting of
Messrs. Matthews, DiNovi and Smith. The Compensation Committee makes
recommendations concerning the salaries and incentive compensation of employees
and consultants to the Company.
The Board of Directors has an Audit Committee currently consisting of
Messrs. DiNovi, Smith, Treuille and Brizius. The Audit Committee is responsible
for reviewing the results and scope of audits and other services provided by the
Company's independent auditors. The Company's Audit Committee does not have an
audit committee financial expert, however the Company feels the committee
members' combined financial and retail industry knowledge is adequate. See
"Item 14. Principal Accounting Fees and Services" for discussion of audit
committee oversight of independent auditors.
50
DIRECTOR COMPENSATION
In connection with the Recapitalization, the Company and THL Co. entered
into a management agreement as of the closing date of the Recapitalization
pursuant to which THL Co. receives, among other things, $500,000 per year, plus
expenses for management and other consulting services provided to the Company.
The management agreement has been amended to reduce the fee to $250,000, subject
to certain increases depending upon the Company achieving certain leverage
ratios. See "Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS."
The Company has entered into a consulting agreement with Norman S.
Matthews, which provides for the payment of an annual consulting fee of $50,000.
Concurrently with the closing of the Recapitalization, Mr. Matthews was also
granted an option to purchase 110,000 shares of the Company's Common Stock,
subject to a vesting schedule which will be one-half time based and one-half
performance based, at an exercise price equal to approximately $10.41 per share,
the same price paid by THL in connection with the Recapitalization. These
options were cancelled in connection with the Cancellation Agreements in 2001
and 111,412 replacement options were issued on January 8, 2002. The replacement
options are at an exercise price of $5.00 per share and vest 50% on the date of
grant, and an additional 25% will vest on each of the first and second
anniversary of the date of grant.
Antoine Treuille receives $10,000 per year for his services. Mr. Treuille
received 5,000 options in 1998, 1999 and 2000, respectively, at an exercise
price of $10.41, $10.41 and $12.85 per share, respectively, subject to a vesting
schedule of equal amounts over four years. These options were cancelled in
connection with the Cancellation Agreements in 2001 and 15,000 replacement
options were issued in January 2002. The replacement options are at an exercise
price of $5.00 per share and vest 50% on the date of grant, and an additional
25% will vest on each of the first and second anniversary of the date of grant.
Subsequent to the January 8, 2002 reissuance, Mr. Treuille received two
additional grants of 5,000 options that are subject to a four year vesting
schedule and are at an exercise price of $15.13 per share.
As of the closing of the Recapitalization, Bernard Andrews purchased $1.0
million of Common Stock at the same price that THL paid in connection with the
Recapitalization. Mr. Andrews paid for these shares by delivering a promissory
note with an original purchase amount of $1.0 million, which shall accrue
interest at a fixed rate equal to the Company's initial borrowing rate. The
repayment of such note is secured by Mr. Andrews' shares of Common Stock. Mr.
Andrews received 281,275 options with the January 8, 2002 option reissuance. The
options are subject to a three year vesting schedule and are at an exercise
price of $5.00 per share. Mr. Andrews' employment contract was terminated in
July 2002 and under the termination contract he continues to receive annual
employment compensation of $100,000.
Except with respect to the consulting fee paid to Mr. Matthews, the annual
payments paid to Mr. Treuille and Mr. Andrews, and the management fee paid to
THL Co., during fiscal 2003 none of the directors of the Company received any
compensation for their services as directors of the Company.
51
EMPLOYMENT AGREEMENTS
Mr. McComas entered into an employment agreement with the Company,
effective July 2, 2001, which provides for his employment with the Company for
an initial term of two years and thereafter renewing for consecutive one year
terms unless terminated by either party. Mr. McComas is entitled to a base
salary of $550,000 during fiscal 2003 and $600,000 in fiscal 2004. Mr. McComas
will be eligible to receive an annual performance bonus upon the achievement by
the Company of certain EBITDA targets as determined from year to year by the
Board of Directors.
Mr. McComas is entitled to receive severance of his base salary upon
termination by the Company without cause, as defined within the employment
agreement. Severance shall be paid over twenty-four months. Mr. McComas is also
subject to a standard restrictive covenants agreement (including
non-competition, non-solicitation, and non-disclosure covenants) during the term
of his employment and for a period of one year following termination for any
reason.
Mr. McComas received non-qualified options to purchase 220,000 shares of
Common Stock at an exercise price of $5.00 per share on January 8, 2002. These
options vest over a three year period. Subsequent to the January 8, 2002
reissuance, Mr. McComas received additional options to purchase 43,000 shares
that are subject to a four year vesting schedule and are at an exercise price of
$15.13 per share.
The remaining executive officers are each subject to annual employment
agreements that automatically renew unless either party gives thirty days
notice. Each executive officer is eligible to participate in the Company's
Incentive Plan for Key Management, whereby they may receive a certain percentage
of their base compensation upon the achievement of certain EBITDA levels as
determined by the Board of Directors.
Upon termination by the Company without cause, as defined in the employment
agreement, the executive officers are eligible for a range of nine to twelve
months of severance. The employment agreements also contain standard
restrictive covenants such as non-competition, non-solicitation and
non-disclosure during the term of employment and for a period of two years
following termination for any reason.
STOCK OPTION PLAN
The Company has granted stock options to certain officers under the
Company's 1998 stock option plan. On June 15, 2001, the Company entered into
Option Cancellation Agreements (the "Cancellation Agreements") with certain
employees and directors (the "Optionees") to cancel all outstanding options
which were granted under the Company's 1998 Stock Option Plan (the "Plan") due
to changes in the fair market value of the Company's common stock. The
Cancellation Agreements provided that a new grant would be made no earlier than
six months and a day after the cancellation of the options and such grant was
made on January 8, 2002. As of March 15, 2004, options to purchase 1,025,775
shares of Common Stock were outstanding. Of the outstanding options, 775,775
were options issued in relation to the Cancellation Agreements.
52
Subject to acceleration under certain circumstances, these options vest over a
three-year period with 40% vesting on the date of grant and an additional 20%
vesting on each of the first, second and third anniversaries of the date of
grant. The remaining 250,000 outstanding options were granted in the normal
course of business under the Company's 1998 stock option plan. Subject to
acceleration under certain circumstances, these options vest over a four-year
period with 10%, 15%, 25% and 50% vesting on each of the anniversaries of the
date of grant. The per option exercise price ranges from $5.00 to $15.13.
Generally, all unvested options will be forfeited upon termination of
employment.
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION. During 2003,
the Compensation Committee consisted of Messrs. Matthews, DiNovi and Smith, none
of whom were an officer or employee of the Company. See discussion under "ITEM
13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS."
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth information with respect to the anticipated
beneficial ownership of shares of the Common Stock as of March 15, 2004 by
persons who are beneficial owners of more than 5% of the Common Stock, by each
director, by each executive officer of the Company and by all directors and
executive officers as a group, as determined in accordance with Rule 13d-3 under
the Securities Exchange Act of 1934, as amended (the "Exchange Act"). All shares
of the Common Stock are voting stock.
53
SHARES OF PERCENTAGE
NAME OF BENEFICIAL OWNER(A) . . . . . . . . . . . . . . . . . . . . . . COMMON STOCK OF CLASS
- ------------------------------------------------------------------------- ------------ -----------
Affiliates of THL Co.(b). . . . . . . . . . . . . . . . . . . . . . . . . 6,664,800 90.1%
Equity-Linked Investors-II (c). . . . . . . . . . . . . . . . . . . . . . 383,616 5.2
David E. McComas (f). . . . . . . . . . . . . . . . . . . . . . . . . . . 201,315 *
George E. Gebhardt (i). . . . . . . . . . . . . . . . . . . . . . . . . . 67,399 *
Alan E. Wiley (j) . . . . . . . . . . . . . . . . . . . . . . . . . . . . 62,256 *
Diana Beaufils (k). . . . . . . . . . . . . . . . . . . . . . . . . . . . 20,300 *
Raymond D. Carrig, Jr. (l). . . . . . . . . . . . . . . . . . . . . . . . 20,300 *
James J. Denny (m). . . . . . . . . . . . . . . . . . . . . . . . . . . . - *
Daniel C. Walker, III (n) . . . . . . . . . . . . . . . . . . . . . . . . 20,400 *
Robert T. Cox (o) . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,700 *
Bernard W. Andrews (e). . . . . . . . . . . . . . . . . . . . . . . . . . 417,140 5.5
Charles A. Brizius (b). . . . . . . . . . . . . . . . . . . . . . . . . . 6,664,800 90.1
Anthony J. DiNovi (b) . . . . . . . . . . . . . . . . . . . . . . . . . . 6,664,800 90.1
Norman S. Matthews (g). . . . . . . . . . . . . . . . . . . . . . . . . . 131,104 *
Warren C. Smith (b) . . . . . . . . . . . . . . . . . . . . . . . . . . . 6,664,800 90.1
Antoine G. Treuille (h) . . . . . . . . . . . . . . . . . . . . . . . . . 22,778 *
All directors and executive officers of the Company as a group (11)(b)(d) 7,566,792 94.4
* Less than 1%.
(a) Beneficial ownership is determined in accordance with the rules of the
Securities and Exchange Commission and reflects general voting power and/or
investment power with respect to securities.
(b) The business address for such person(s) is c/o Thomas H. Lee Company, 75
State Street, Suite 2600, Boston, Massachusetts 02109. Of the securities
held by affiliates of Thomas H. Lee Company, 5,664,330 are held by the
Thomas H. Lee Equity Fund IV, L.P., 195,133 are held by the Thomas H. Lee
Foreign Fund IV, L.P., 551,323 are held by Thomas H. Lee Foreign Fund IV-B,
L.P. and 254,014 are held by others. All such voting securities may be
deemed to be beneficially owned by THL Equity Advisors IV, LLC ("Advisors")
the general partner of THL Fund IV, Thomas H. Lee, Messrs. DiNovi, Smith
and the other managing directors and by Mr. Brizius and the other officers
of THL Co., in each case pursuant to the definition of beneficial ownership
provided in footnote (a). Each of such persons disclaims beneficial
ownership of such shares.
(c) Equity-Linked Investors-II is an investment partnership managed by Desai
Capital Management Incorporated. The business address for such person is
c/o Desai Capital Management, Incorporated, 540 Madison Avenue, New York,
New York 10022.
(d) Includes 615,032 shares issuable pursuant to presently exercisable options
(or those exercisable prior to May 1, 2004).
(e) Includes 225,020 shares issuable pursuant to presently exercisable options
(or those exercisable prior to May 1, 2004). Excludes 56,255 shares
issuable pursuant to options which are not currently exercisable (or
exercisable prior to May 1, 2004).
(f) Includes 177,300 shares issuable pursuant to presently exercisable options
(or those exercisable prior to May 1, 2004). Excludes 85,700 shares
issuable pursuant to options which are not currently exercisable (or
exercisable prior to May 1, 2004).
(g) Includes 111,412 shares issuable pursuant to presently exercisable options
(or those exercisable prior to May 1, 2004).
(h) Includes 16,250 shares issuable pursuant to presently exercisable options
(or those exercisable prior to May 1, 2004). Excludes 8,750 shares issuable
pursuant to options which are not currently exercisable (or exercisable
prior to May 1, 2004).
(i) Includes 32,400 shares issuable pursuant to presently exercisable options
(or those exercisable prior to May 1, 2004). Excludes 40,100 shares
issuable pursuant to options which are not currently exercisable (or
exercisable prior to May 1, 2004).
(j) Includes 52,650 shares issuable pursuant to presently exercisable options
or those exercisable prior to May 1, 2004). Excludes 28,850 shares issuable
pursuant to options which are not currently exercisable (or exercisable
prior to May 1, 2004).
(k) Includes 20,300 shares issuable pursuant to presently exercisable options
(or those exercisable prior to May 1, 2004). Excludes 12,700 shares
issuable pursuant to options which are not currently exercisable (or
exercisable prior to May 1, 2004).
(l) Includes 20,300 shares issuable pursuant to presently exercisable options
(or those exercisable prior to May 1, 2004). Excludes 12,700 shares
issuable pursuant to options which are not currently exercisable (or
exercisable prior to May 1, 2004).
(m) Excludes 30,000 shares issuable pursuant to options which are not currently
exercisable (or exercisable prior to May 1, 2004).
(n) Includes 20,400 shares issuable pursuant to presently exercisable options
(or those exercisable prior to May 1, 2004). Excludes 13,600 shares
issuable pursuant to options which are not currently exercisable (or
exercisable prior to May 1, 2004).
(o) Includes 1,700 shares issuable pursuant to presently exercisable options
(or those exercisable prior to May 1, 2004). Excludes 19,300 shares
issuable pursuant to options which are not currently exercisable (or
exercisable prior to May 1, 2004).
54
The following table summarizes information, as of December 27, 2003,
relating to the Company's equity compensation plan pursuant to which grants of
options, restricted stock, or other rights to acquire shares may be granted from
time to time.
(a) (b) (c)
... . . . . . . . . . . . . . . . . . Number of
... . . . . . . . . . . . . . . . . . securities remaining
... . . . . . . . . . . . . . . . Number of . available for
... . . . . . . . . . . . . . . . securities to be Weighted- future issuance
... . . . . . . . . . . . . . . . issued upon average exercise under equity
... . . . . . . . . . . . . . . . exercise of price of compensation
... . . . . . . . . . . . . . . . outstanding outstanding plans (excluding
... . . . . . . . . . . . . . . . options, warrants options, warrants securities reflected
... . . . . . . . . . . . . . . . and rights and rights in column (a))
------------------ ------------------- ---------------------
PLAN CATEGORY
Equity compensation plans
approved by security holders . . 925,775 $ 6.19 87,065
Equity compensation plans
not approved by security holders - $ - -
------------------ ------------------- ---------------------
Total. . . . . . . . . . . . . . 925,775 $ 6.19 87,065
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
MANAGEMENT AGREEMENT
The Company and THL Co. entered into a management agreement as of the
closing date of the Recapitalization (the "Management Agreement"), pursuant to
which (i) THL Co. received a financial advisory fee of $6.0 million in
connection with structuring, negotiating and arranging the Recapitalization and
structuring, negotiating and arranging the debt financing and (ii) THL Co. would
receive $500,000 per year plus expenses for management and other consulting
services provided to the Company, including one percent (1%) of the gross
purchase price for acquisitions for its participation in the negotiation and
consummation of any such acquisition. As of December 31, 2000, the Management
Agreement was amended to reduce the fees to $250,000 per year plus expenses for
management and other consulting services provided to the Company. However, such
fee may be increased dependent upon the Company attaining certain leverage
ratios. The Management Agreement continues unless and until terminated by
mutual consent of the parties in writing, for so long as THL Co. provides
management and other consulting services to the Company. The Company believes
that the terms of the Management Agreement are comparable to those that would
have been obtained from unaffiliated sources.
STOCKHOLDERS' AGREEMENT
The Company entered into a Stockholders' Agreement (the "Stockholders'
Agreement") among THL Co. and the other shareholders of the Company upon the
consummation of the Recapitalization. Pursuant to the Stockholders' Agreement,
the shareholders are required to vote
55
their shares of capital stock of the Company to elect a Board of Directors of
the Company consisting of directors designated by THL Co. The Stockholders'
Agreement also grants THL Co. the right to require the Company to effect the
registration of shares of Common Stock it (or its affiliates) holds for sale to
the public, subject to certain conditions and limitations. If the Company
proposes to register any of its securities under the Securities Act of 1933, as
amended, whether for its own account or otherwise, the shareholders are entitled
to notice of such registration and are entitled to include their shares in such
registration, subject to certain conditions and limitations. All fees, costs and
expenses of any registration effected on behalf of such shareholders under the
Stockholders' Agreement (other than underwriting discounts and commissions) will
be paid by the Company.
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES
Ernst & Young LLP acts as the principal auditor for the Company and also
provides certain audit-related, tax and other services. Before Ernst & Young
and all other outside accounting firms are engaged to render audit or non-audit
services to the Company, the engagement is approved by the Audit Committee. The
fees for the services provided by Ernst & Young to the Company in 2003 and 2002
were as follows:
- - Audit Fees were $203,250 and $191,350 for 2003 and 2002, respectively.
Included in this category are fees for the annual financial statement audit
and quarterly financial statement reviews.
- - Audit-Related Fees were $16,200 and $16,100 for 2003 and 2002,
respectively. The fees, which are for assurance and related services other
than those included in Audit Fees, include charges for audits of employee
benefit plans and due diligence.
- - Tax Fees were $3,000 and $11,688 for 2003 and 2002, respectively. These
fees include charges for tax return preparation and various federal and
state tax research projects.
- - There were no other fees paid during either 2003 or 2002.
56
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) The following documents are filed as part of this report.
Page
of 10-K
-------
1. FINANCIAL STATEMENTS
Report of Independent Auditors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . F-2
Consolidated Balance Sheets at December 28, 2002 and December 27, 2003 . . . . . . . . . F-3
Consolidated Statements of Operations for the Years Ended December 29, 2001,
December 28, 2002 and December 27, 2003. . . . . . . . . . . . . . . . . . . . . . . . . F-4
Consolidated Statements of Shareholders' Deficit as of December 29, 2001,
December 28, 2002 and December 27, 2003. . . . . . . . . . . . . . . . . . . . . . . . . F-5
Consolidated Statements of Cash Flows for the Years ended December 29, 2001,
December 28, 2002 and December 27, 2003. . . . . . . . . . . . . . . . . . . . . . . . . F-6
Notes to the Consolidated Financial Statements . . . . . . . . . . . . . . . . . . . . . F-7
2. FINANCIAL STATEMENT SCHEDULES
Schedule II Consolidated Valuation and Qualifying Accounts For the Years Ended
December 29, 2001, December 28, 2002 and December 27, 2003 . . . . . . . . . . . . . . . F-34
3. EXHIBITS
2.1 Stock Purchase Agreement dated August 15, 1996 by and between Eye Care
Centers of America, Inc., Visionworks Holdings, Inc. and the Sellers listed
therein. (a)
2.2 Stock Purchase Agreement, dated September 30, 1997, by and among Eye Care
Centers of America, Inc., a Texas corporation, Robert A. Samit, O. D. and
Michael Davidson, O. D. (a)
2.3 Recapitalization Agreement dated as of March 6, 1998 among ECCA Merger
Corp., Eye Care Centers of America, Inc. and the sellers listed therein.
(a)
2.4 Amendment No. 1 to the Recapitalization Agreement dated as of April 23, 1998
among ECCA Merger Corp., Eye Care Centers of America, Inc, and the sellers
listed therein. (a)
2.5 Amendment No. 2 to the Recapitalization Agreement dated as of April 24, 1998
among ECCA Merger Corp., Eye Care Centers of America, Inc. and the sellers
listed therein. (a)
57
2.6 Articles of Merger of ECCA Merger Corp. with and into Eye Care Centers of
America, Inc. dated April 24, 1998. (a)
2.7 Master Asset Purchase Agreement, dated as of August 22, 1998, by and among
Eye Care Centers of America, Inc., Mark E. Lynn, Dr. Mark Lynn &
Associates, PLLC, Dr. Bizer's Vision World, PLLC and its affiliates. (a)
2.8 Letter Agreement, dated October 1, 1998, amending and modifying that
certain Master Asset Purchase Agreement, dated as of August 22, 1998, by
and among Eye Care Centers of America, Inc.; Mark E. Lynn; Dr. Mark Lynn &
Associates, PLLC, Dr. Bizer's VisionWorld, PLLC and its affiliates. (a)
2.9 Asset Purchase Agreement, dated July 7, 1999, by and among Eye Care Centers
of America, Inc., Vision Twenty-One, Inc., and The Complete Optical
Laboratory, Ltd., Corp. ! (c)
2.10 Letter Agreement, dated August 31, 1999, amending and modifying that
certain Asset Purchase Agreement, dated July 7, 1999 by and among Eye Care
Centers of America, Inc., Vision Twenty-One, Inc., and The Complete Optical
Laboratory, Inc., Corp. (d)
2.11 Agreement Regarding Strategic Alliance. (d)
2.12 Fiscal 2002 Incentive Plan for Key Management. (n) *
2.13 Fiscal 2003 Incentive Plan for Key Management. (p) *
2.14 Fiscal 2004 Incentive Plan for Key Management. (t) *
3.1 Restated Articles of Incorporation of Eye Care Centers of America Inc. (a)
3.2 Statement of Resolution of the Board of Directors of Eye Care Centers of
America, Inc. designating a series of Preferred Stock. (a)
3.3 Amended and Restated By-laws of Eye Care Centers of America, Inc. (a)
4.1 Indenture dated as of April 24, 1998 among Eye Care Centers of America,
Inc., the Guarantors named therein and United States Trust Company of New
York, as Trustee for the 9 1/8% Senior Subordinated Notes Due 2008 and
Floating Interest Rate Subordinated Term Securities. (n)
4.2 Form of Fixed Rate Exchange Note (included in Exhibit 4.1 hereto). (a)
4.3 Form of Floating Rate Exchange Note (included in Exhibit 4.1 hereto). (a)
4.4 Form of Guarantee (included in Exhibit 4.1 hereto). (a)
4.5 Registration Rights Agreement dated April 24, 1998 between Eye Care Centers
of America, Inc., the subsidiaries of the Company named as guarantors
therein, BT Alex. Brown Incorporated and Merrill Lynch, Pierce, Fenner &
Smith Incorporated. (a)
10.1 Form of Stockholders's Agreement dated as of April 24, 1998 by and among
Eye Care Center's of America, Inc. and the shareholders listed therein. (a)
10.2 1998 Stock Option Plan. (a) *
58
10.3 Employment Agreement dated July 2, 2001 by and between Eye Care Centers of
America, Inc. and David E. McComas. (k) *
10.4 Stock Option Agreement dated July 2, 2001 by and between Eye Care Centers
of America, Inc. and Alan E. Wiley. (k) *
10.5 Employment Agreement dated January 1, 2003 between Eye Care Centers of
America, Inc. and George Gebhardt. (p) *
10.6 Management Agreement, dated as of April 24, 1998, by and between Thomas H.
Lee Company and Eye Care Centers of America, Inc. (a)
10.7 Retail Business Management Agreement, dated September 30, 1997, by and
between Dr. Samit's Hour Eyes Optometrist, P.C., a Virginia professional
corporation, and Visionary Retail Management, Inc., a Delaware corporation.
! (a) Amendment No. 1 to the Retail Business Management Agreement, dated
June 2000, by and between Hour Eyes Doctors of Optometry, P.C., formerly
known as Dr. Samit's Hour Eyes Optometrist, P.C., and Visionary Retail
Management, Inc. (j)
10.8 Professional Business Management Agreement dated September 30, 1997, by and
between Dr. Samit's Hour Eyes Optometrists, P.C., a Virginia professional
corporation, and Visionary MSO, Inc., a Delaware corporation. ! (a)
Amendment No. 1 to the Professional Business Management Agreement, dated
June 2000, by and between Hour Eyes Doctors of Optometry, P.C., formerly
known as Dr. Samit's Hour Eyes Optometrist, P.C., and Visionary MSO, Inc.
(j)
10.9 Contract for Purchase and Sale dated May 29, 1997 by and between Eye Care
Centers of America, Inc. and JDB Real Properties, Inc. (a)
10.10 Contract for Purchase and Sale dated May 29, 1997 by and between Eye Care
Centers of America, Inc. and JDB Real Properties, Inc. (a)
10.11 Amendment to Contract for Purchase and Sale dated July3, 1997 by and
between Eye Care Centers of America, Inc. and JDB Real Properties, Inc. (a)
10.12 Second Amendment to Contract for Purchase and Sale dated July10, 1997 by
and between Eye Care Centers of America, Inc. and JDB Real Properties, Inc.
(a)
10.13 Third Amendment to Contract for Purchase and Sale by and between Eye Care
Centers of America, Inc., John D. Byram, Dallas Mini #262. Ltd. and Dallas
Mini #343, Ltd. (a)
10.14 Commercial Lease Agreement dated August19, 1997 by and between John D.
Byram, Dallas Mini #262, Ltd. and Dallas Mini #343, Ltd. and Eye Care
Centers of America, Inc. (a)
59
10.15 Master Lease Agreement, dated August 12, 1997, by and between Pacific
Financial Company and Eye Care Centers of America, Inc., together with all
amendments, riders and schedules thereto. (a)
10.16 Credit Agreement, dated as of April 23, 1998, among Eye Care Centers of
America, Inc., Various Lenders, Bankers Trust Company, as Administrative
Agent, and Merrill Lynch Capital Corporation, as Syndication Agent. (a)
10.17 First Amendment to Credit Agreement, dated as of December 27, 2000, among
Eye Care Centers of America, Inc., Various Lenders, Bankers Trust Company,
as Administrative Agent, and Merrill Lynch Capital Corporation, as
Syndication Agent. (i)
10.18 Purchase Agreement, dated as of April 24, 1998, by and among Eye Care
Centers of America, Inc., the subsidiaries of Eye Care Centers of America,
Inc. named therein, BT Alex. Brown Incorporated and Merrill Lynch, Pierce,
Fenner & Smith Incorporated. (a)
10.19 Secured Promissory Note, dated April 24, 1998, issued by Bernard W.
Andrews in favor of Eye Care Centers of America, Inc. (a)
10.20 Form of Stock Option Cancellation Agreement dated June 15, 2001 by and
between Eye Care Centers of America, Inc., and the employees granted
options under the Company's 1998 Stock Option Plan. (k)
10.21 Form of Stock Option Cancellation Agreement dated June 15, 2001 by and
between Eye Care Centers of America, Inc., and the board of directors
granted options under the Company's 1998 Stock Option Plan. (k)
10.22 Retail Business Management Agreement, dated October 1, 1998 by and between
Visionary Retail Management, Inc., a Delaware corporation, and Dr. Mark
Lynn & Associates, PLLC, a Kentucky professional limited liability company.
! (b) Amendment to Retail Business Management Agreement by and between
Visionary Retail Management, Inc. and Dr. Mark Lynn & Associates, PLLC
dated June 1, 1999. (j) Amendment to Retail Business Management Agreement
by and between Visionary Retail Management, Inc. and Dr. Mark Lynn &
Associates, PLLC dated August 31, 2000. (j)
10.23 Professional Business Management Agreement, dated October 1, 1998, by and
between Visionary MSO, Inc., a Delaware Corporation, and Dr. Mark Lynn &
Associates, PLLC, a Kentucky professional limited liability company. ! (b)
Amendment to Professional Business Management Agreement by and between
Visionary MSO, Inc. and Dr. Mark Lynn & Associates, PLLC dated June 1,
1999. (j) Amendment Professional Business Management Agreement by and
between Visionary MSO, Inc. and Dr. Mark Lynn & Associates, PLLC dated
August 1, 2000. (j)
60
10.24 Form of Stock Option Agreement. (l)
10.25 Professional Business Management Agreement dated February 27, 2000, by and
between Eye Care Centers of America, Inc., a Texas corporation and S.L.
Christensen, O.D. and Associates, P.C., an Arizona professional
corporation. (f)
10.26 Professional Business Management Agreement dated June 19, 2000, by and
between Visionary Retail Management, Inc., a Delaware corporation, and Dr.
Tom Sowash, O.D. and Associates, LLC, a Colorado limited liability company.
(g)
10.27 Settlement Agreement dated September 21, 2000 between Eye Care Centers of
America, Inc., a Texas corporation, and Vision Twenty-One, Inc. (h)
10.28 Stock Option Agreement dated January 8, 2002 by and between Eye Care
Centers of America, Inc and Norman Matthews. (l)
10.29 Stock Option Agreement dated January 8, 2002 by and between Eye Care
Centers of America, Inc and Antoine Treuille. (l)
10.30 Amended and Restated Credit Agreement among Eye Care Centers of America,
Inc., Various Lenders, Fleet National Bank, as Administrative Agent, Bank
of America, N.A., as Syndication Agent and Fleet Securities, Inc., Bank of
America Securities, LLC, as Co-Lead Arrangers Dated as of December 23,
2002. (o)
10.31 Stock Option Agreement dated October 31, 2002 by and between Eye Care
Centers of America, Inc and Antoine Treuille. (p)
10.32 Termination Agreement, dated as of July 1, 2002 between Eye Care Centers
of America, Inc. and Bernard W. Andrews. (m)
10.33 Business Management Agreement by and between Vision Twenty-One, Inc. and
Charles M. Cummins, O.D. and Elliot L. Shack, O.D., P.A. dated January 1,
1998. (p)Amendment No. 1 to Business Management Agreement by and between
Charles M. Cummins, O.D., P.A., and Eye Drx Retail Management, Inc. dated
August 31, 1999. (p) Amendment No. 2 to Business Management Agreement by
and between Charles M. Cummins, O.D., P.A. and Eye Drx Retail Management,
Inc. dated February 29, 2000. (j) Amendment No. 3 to Business Management
Agreement by and between Charles M. Cummins, O.D., P.A. and Eye Drx Retail
Management, Inc. dated May 1, 2000. (j) Amendment No. 4 to Business
Management Agreement by and between Charles M. Cummins, O.D., P.A. and Eye
Drx Retail Management, Inc. dated February 1, 2001. (j) Amendment No. 5 to
Business Management Agreement by and between Charles M. Cummins, O.D. P.A.
and Eye Drx Retail Management, Inc. dated February 28, 2002. (p) Amendment
No. 6 to Business Management Agreement by and between Charles M. Cummins
O.D., P.A and Eye Drx Retail Management, Inc. dated February 28, 2003. (p)
61
10.34 Employment Agreement dated April 15, 2002 between Eye Care Centers of
America, Inc. and Robert Cox. (p) *
10.35 Promissory note dated as of April 24, 2003 among Eye Care Centers of
America, Inc. and Daniel Poth, O.D. (q)
10.36 Professional Business Management Agreement dated May 25, 2003, by and
between EyeMasters, Inc., a Delaware corporation, and S.L. Christensen,
O.D. and Associates, P.C., an Arizona professional corporation. (r)
10.37 Professional Business Management Agreement dated May 12, 2003, by and
between EyeMasters, Inc., a Delaware corporation, and Michael J. Martin,
O.D. and Associates, P.C., P.C., a Georgia professional corporation. (r)
10.38 Professional Business Management Agreement dated August 3, 2003, by and
between EyeMasters, Inc., a Delaware corporation, and Jason Wonch, O.D. and
Associates, P.C., a Louisiana professional optometry corporation. (s)
10.39 Employment Agreement dated September 7, 1998 between Eye Care Centers of
America, Inc. and Diana Beaufils. (t) *
10.40 Employment Agreement dated July 29, 1998 between Eye Care Centers of
America, Inc. and Dan Walker. (t) *
10.41 Employment Agreement dated October 1, 1998 between Eye Care Centers of
America, Inc. and David Carrig. (t) *
10.42 Employment Agreement dated August 11, 2003 between Eye Care Centers of
America, Inc. and James J. Denny. (t) *
12.1 Statement re Computation of Ratios (t)
21.1 List of subsidiaries of Eye Care Centers of America, Inc. (t)
14.1 Business Conduct and Ethics Policy. (p)
14.2 Ethics for Financial Management. (p)
24.1 Powers of Attorney (contained on the signature pages of this report). (t)
31.1 Certification of Chief Executive Officer (t)
31.2 Certification of Chief Financial Officer (t)
! Portions of this Exhibit have been omitted pursuant to an application for
an order declaring confidential treatment filed with the Securities and
Exchange Commission.
* Represents a management contract or compensatory plan.
(a) Incorporated by reference from the Registration Statement on Form S-4 (File
No. 333 - 56551).
(b) Previously provided with, and incorporated by reference from, the Company's
annual Report on Form 10-K for the year ended January 2, 1999.
(c) Previously provided with, and incorporated by reference from, the Company's
quarterly Report on Form 10-Q for the quarter ended July 3, 1999.
(d) Previously provided with, and incorporated by reference from, the Company's
quarterly Report on Form 10-Q for the quarter ended October 2, 1999.
(e) Previously provided with, and incorporated by reference from, the Company's
annual Report on Form 10-K for the year ended January 1, 2000.
62
(f) Previously provided with, and incorporated by reference from, the Company's
quarterly Report on Form 10-Q for the quarter ended April 1, 2000.
(g) Previously provided with, and incorporated by reference from, the Company's
quarterly Report on Form 10-Q for the quarter ended July 1, 2000.
(h) Previously provided with, and incorporated by reference from, the Company's
quarterly Report on Form 10-Q for the quarter ended September 30, 2000.
(i) Previously provided with, and incorporated by reference from, the Company's
Report on Form 8-K as of December 27, 2000.
(j) Previously provided with, and incorporated by reference from, the Company's
annual Report on Form 10- K for the year ended December 30, 2000.
(k) Previously provided with, and incorporated by reference from, the Company's
quarterly Report on Form 10-Q for the quarter ended June 30, 2001.
(l) Previously provided with, and incorporated by reference from, the Company's
annual Report on Form 10-K for the year ended December 29, 2001.
(m) Previously provided with, and incorporated by reference from, the Company's
quarterly Report on Form 10-Q for the quarter ended June 29, 2002.
(n) Previously provided with, and incorporated by reference from, the Company's
quarterly Report on Form 10-Q for the quarter ended September 28, 2002.
(o) Previously provided with, and incorporated by reference from, the Company's
Report on Form 8-K as of December 31, 2002.
(p) Previously provided with, and incorporated by reference from, the Company's
annual Report on Form 10-K for the year ended December 28, 2002.
(q) Previously provided with, and incorporated by reference from, the Company's
quarterly Report on Form 10-Q for the quarter ended March 29, 2003.
(r) Previously provided with, and incorporated by reference from, the Company's
quarterly Report on Form 10-Q for the quarter ended June 28, 2003.
(s) Previously provided with, and incorporated by reference from, the Company's
quarterly Report on Form 10-Q for the quarter ended September 27, 2003.
(t) Filed herewith.
The Company filed no current reports on Form 8-K with the Securities and
Exchange Commission during the thirteen weeks ended December 27, 2003.
SUPPLEMENTAL INFORMATION TO BE FURNISHED WITH REPORTS FILED PURSUANT TO SECTION
15 (D) OF THE ACT BY REGISTRANTS WHICH HAVE NOT REGISTERED SECURITIES PURSUANT
TO SECTION 12 OF THE ACT.
No annual report or proxy materials have been sent to security holders of the
Company.
63
SIGNATURES
PURSUANT TO THE REQUIREMENTS OF SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934, THE REGISTRANT HAS DULY CAUSED THIS REPORT TO BE SIGNED ON
ITS BEHALF BY THE UNDERSIGNED, THEREUNTO DULY AUTHORIZED, IN THE CITY OF SAN
ANTONIO, STATE OF TEXAS, ON MARCH 24, 2004.
EYE CARE CENTERS OF AMERICA, INC.
By: /S/ DAVID E. MCCOMAS
DAVID E. MCCOMAS
CHAIRMAN OF THE BOARD, CHIEF EXECUTIVE OFFICER AND PRESIDENT
------------------------------------------------------------
POWER OF ATTORNEY
KNOW ALL MEN BY THESE PRESENTS that each person whose signature appears
below constitutes and appoints Bernard W. Andrews and Alan E. Wiley and each of
them, with the power to act without the other, his true and lawful
attorney-in-fact and agent, with full power of substitution and resubstitution,
for him or in his name, place and stead, in any and all capacities to sign any
and all amendments to this report, and to file the same, with all exhibits
thereto, and other documents in connection therewith, with the Securities and
Exchange Commission, granting unto said attorneys-in-fact and agents, and each
of them, full power and authority to do and perform each and every Act and thing
requisite or necessary to be done in and about the premises, as fully to all
intents and purposes as he might or could do in person, hereby ratifying and
confirming all that said attorneys-in-fact and agents or any of them, or their
or his substitutes, may lawfully do or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
SIGNATURE . . . . . . . . . . . TITLE DATE
Chairman of the Board, Chief
/S/ David E. McComas. . . . Executive Officer and President March 24, 2004
- ------------------------------- (Principal Executive Officer)
DAVID E. MCCOMAS. . . . . . . .
Executive Vice President and
/S/ Alan E. Wiley . . . . . Chief Financial Officer March 24, 2004
- ------------------------------- (Principal Financial and
ALAN E. WILEY . . . . . . . . . Accounting Officer)
/S/ Bernard W. Andrews. . . Director March 24, 2004
- -------------------------------
BERNARD W. ANDREWS
/S/ Norman S. Matthews. . . Director March 24, 2004
- -------------------------------
NORMAN S. MATTHEWS
/S/ Antoine G. Treuille . . Director March 24, 2004
- -------------------------------
ANTOINE G. TREUILLE
/S/ Anthony J. DiNovi . . . Director March 24, 2004
- -------------------------------
ANTHONY J. DINOVI
/S/ Warren C. Smith, Jr.. . Director March 24, 2004
- -------------------------------
WARREN C. SMITH, JR.
/S/ Charles A. Brizius. . . Director March 24, 2004
- -------------------------------
CHARLES A. BRIZIUS
64
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
EYE CARE CENTERS OF AMERICA, INC. AND SUBSIDIARIES
Report of Independent Auditors . . . . . . . . . . . . . . . . . . . . . . . F-2
Consolidated Balance Sheets at December 28, 2002 and December 27, 2003 . . . F-3
Consolidated Statements of Operations for the Years Ended December 29, 2001,
December 28, 2002 and December 27, 2003. . . . . . . . . . . . . . . . . . . F-4
Consolidated Statements of Shareholders' Deficit as of
December 29, 2001, December 28, 2002 and December 27, 2003 . . . . . . . . . F-5
Consolidated Statements of Cash Flows for the Years Ended December 29, 2001,
December 28, 2002 and December 27, 2003. . . . . . . . . . . . . . . . . . . F-6
Notes to the Consolidated Financial Statements . . . . . . . . . . . . . . . F-7
Schedule II Consolidated Valuation and Qualifying Accounts For the
Years Ended December 29, 2001, December 28, 2002 and December 27, 2003 . . . F-34
REPORT OF INDEPENDENT AUDITORS
Board of Directors and Shareholders
Eye Care Centers of America, Inc.
San Antonio, Texas
We have audited the accompanying consolidated balance sheets of Eye Care Centers
of America, Inc. and Subsidiaries as of December 27, 2003 and December 28, 2002,
and the related consolidated statements of operations, shareholders' deficit,
and cash flows for each of the fiscal years ended December 27, 2003, December
28, 2002, and December 29, 2001. Our audits also included the financial
statement schedule listed in the index at Item 15. These financial statements
and schedule are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements and
schedule based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States. Those standards require that we plan and perform the
audit to obtain reasonable assurance about whether the financial statements are
free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements. An
audit also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of Eye
Care Centers of America, Inc. and Subsidiaries at December 27, 2003 and December
28, 2002, and the consolidated results of their operations and their cash flows
for the fiscal years ended December 27, 2003, December 28, 2002, and December
29, 2001, in conformity with accounting principles generally accepted in the
United States. Also, in our opinion, the related financial statement schedule,
when considered in relation to the basic financial statements taken as a whole,
presents fairly in all material respects the information set forth therein.
As discussed in Note 2 to the consolidated financial statements, effective
December 30, 2001, the Company adopted Statement of Financial Accounting
Standards No. 142, "Goodwill and Other Intangible Assets."
San Antonio, Texas
March 2, 2004
F-2
EYE CARE CENTERS OF AMERICA, INC.
CONSOLIDATED BALANCE SHEETS
(DOLLAR AMOUNTS IN THOUSANDS UNLESS INDICATED OTHERWISE)
DECEMBER 28, DECEMBER 27,
2002 2003
-------------- --------------
ASSETS
Current assets:
Cash and cash equivalents. . . . . . . . . . . . . . . . . . . . . . . . $ 3,450 $ 3,809
Accounts receivable, less allowance for doubtful accounts of
$4,291 in fiscal 2002 and $4,076 in fiscal 2003 . . . . . . . . . . . 12,084 11,117
Inventory, less reserves of $677 in fiscal 2002 and $596 in fiscal 2003. 24,060 25,120
Deferred income taxes, net . . . . . . . . . . . . . . . . . . . . . . . - 570
Prepaid expenses and other . . . . . . . . . . . . . . . . . . . . . . . 3,573 3,696
-------------- --------------
Total current assets . . . . . . . . . . . . . . . . . . . . . . . . . 43,167 44,312
Property and equipment, net of accumulated depreciation and amortization of
$125,225 in fiscal 2002 and $141,351 in fiscal 2003. . . . . . . . . . . 57,439 51,715
Intangibles, net. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 107,588 107,423
Other assets. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8,862 8,631
Deferred income taxes, net. . . . . . . . . . . . . . . . . . . . . . . . . - 13,445
-------------- --------------
Total assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 217,056 $ 225,526
============== ==============
LIABILITIES AND SHAREHOLDERS' DEFICIT
Current liabilities:
Accounts payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 20,256 $ 21,360
Current portion of long-term debt. . . . . . . . . . . . . . . . . . . . 15,524 18,980
Deferred revenue . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6,334 5,743
Accrued payroll expense. . . . . . . . . . . . . . . . . . . . . . . . . 7,776 5,429
Accrued interest . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,318 3,213
Other accrued expenses . . . . . . . . . . . . . . . . . . . . . . . . . 8,523 8,334
-------------- --------------
Total current liabilities. . . . . . . . . . . . . . . . . . . . . . . 60,731 63,059
Long-term debt, less current maturities . . . . . . . . . . . . . . . . . . 239,109 219,845
Deferred rent . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4,571 4,719
Deferred gain . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,766 1,532
-------------- --------------
Total liabilities. . . . . . . . . . . . . . . . . . . . . . . . . . . 306,177 289,155
-------------- --------------
Commitments and contingencies
Shareholders' deficit:
Common stock, par value $.01 per share; 20,000,000 shares authorized,
7,397,689 shares issued and outstanding in fiscal 2002 and fiscal 2003. 74 74
Preferred stock, par value $.01 per share, 300,000 shares authorized,
issued and outstanding in fiscal 2002 and fiscal 2003. . . . . . . . . 54,703 62,169
Additional paid-in capital . . . . . . . . . . . . . . . . . . . . . . . 36,040 28,259
Accumulated deficit. . . . . . . . . . . . . . . . . . . . . . . . . . . (179,938) (154,131)
-------------- --------------
Total shareholders' deficit. . . . . . . . . . . . . . . . . . . . . . (89,121) (63,629)
-------------- --------------
$ 217,056 $ 225,526
============== ==============
The accompanying notes are an integral part of these consolidated financial statements.
F-3
EYE CARE CENTERS OF AMERICA, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(DOLLAR AMOUNTS IN THOUSANDS UNLESS INDICATED OTHERWISE)
FISCAL YEAR ENDED
-------------------
DECEMBER 29, DECEMBER 28, DECEMBER 27,
2001 2002 2003
------------------- ------------- --------------
Revenues:
Optical sales . . . . . . . . . . . . . . . . $ 332,550 $ 360,266 $ 366,531
Management fees . . . . . . . . . . . . . . . 3,484 3,401 3,321
------------------- ------------- --------------
Net revenues. . . . . . . . . . . . . . . . 336,034 363,667 369,852
Operating costs and expenses:
Cost of goods sold. . . . . . . . . . . . . . 104,446 112,471 114,578
Selling, general and administrative expenses. 203,187 212,472 218,702
Amortization of intangibles:
Goodwill . . . . . . . . . . . . . . . . . 5,319 - -
Noncompete and other intangibles . . . . . 3,378 1,865 165
------------------- ------------- --------------
Total operating costs and expenses . . . 316,330 326,808 333,445
------------------- ------------- --------------
Income from operations . . . . . . . . . . . . . 19,704 36,859 36,407
Interest expense, net. . . . . . . . . . . . . . 27,537 21,051 20,200
------------------- ------------- --------------
Net income (loss) before income taxes. . . . . . (7,833) 15,808 16,207
Income tax expense (benefit) . . . . . . . . . . 1,239 1,565 (9,600)
------------------- ------------- --------------
Net income (loss). . . . . . . . . . . . . . . . $ (9,072) $ 14,243 $ 25,807
=================== ============= ==============
The accompanying notes are an integral part of these consolidated financial statements.
F-4
EYE CARE CENTERS OF AMERICA, INC.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' DEFICIT
(DOLLAR AMOUNTS IN THOUSANDS UNLESS INDICATED OTHERWISE)
Additional Total
Common Stock Paid-In Preferred Accumulated Shareholders'
Shares Amount Capital Stock Deficit Deficit
-------------- -------- ----------- ------------ --------------- ----------
Balance at December 30, 2000 . . . . . . . 7,410,133 $ 74 $ 49,963 $ 42,354 $ (185,109) $ (92,718)
Dividends accrued on preferred stock . . . - - (5,780) 5,780 - -
Interest receivable on loan to shareholder - - (90) - - (90)
Distribution to affiliated OD. . . . . . . - - (603) - - (603)
Stock buyback. . . . . . . . . . . . . . . (2,844) - (16) - - (16)
Net loss . . . . . . . . . . . . . . . . . - - - - (9,072) (9,072)
-------------- -------- ----------- ------------ --------------- ----------
Balance at December 29, 2001 . . . . . . . 7,407,289 $ 74 $ 43,474 $ 48,134 $ (194,181) $(102,499)
Dividends accrued on preferred stock . . . - - (6,569) 6,569 - -
Interest receivable on loan to shareholder - - (90) - - (90)
Distribution to affiliated OD. . . . . . . - - (675) - - (675)
Stock buyback. . . . . . . . . . . . . . . (9,600) - (100) - - (100)
Net income . . . . . . . . . . . . . . . . - - - - 14,243 14,243
-------------- -------- ----------- ------------ --------------- ----------
Balance at December 28, 2002 . . . . . . . 7,397,689 $ 74 $ 36,040 $ 54,703 $ (179,938) $ (89,121)
-------------- -------- ----------- ------------ --------------- ----------
Dividends accrued on preferred stock . . . - - (7,466) 7,466 - -
Interest receivable on loan to shareholder - - (90) - - (90)
Distribution to affiliated OD. . . . . . . - - (225) - - (225)
Net income . . . . . . . . . . . . . . . . - - - - 25,807 25,807
-------------- -------- ----------- ------------ --------------- ----------
Balance at December 27, 2003 . . . . . . . 7,397,689 $ 74 $ 28,259 $ 62,169 $ (154,131) $ (63,629)
============== ======== =========== ============ =============== ==========
The accompanying notes are an integral part of these consolidated financial statements.
F-5
EYE CARE CENTERS OF AMERICA, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(DOLLAR AMOUNTS IN THOUSANDS UNLESS INDICATED OTHERWISE)
FISCAL YEAR ENDED
-------------------
DECEMBER 29, DECEMBER 28, DECEMBER 27,
2001 2002 2003
------------------- -------------- --------------
Cash flows from operating activities:
Net income (loss). . . . . . . . . . . . . . . . . . . . . . . . $ (9,072) $ 14,243 $ 25,807
Adjustments to reconcile net income (loss) to net cash provided
by operating activities:
Depreciation. . . . . . . . . . . . . . . . . . . . . . . . 20,350 18,761 16,653
Amortization of intangibles . . . . . . . . . . . . . . . . 8,697 1,865 165
Amortization of debt issue costs. . . . . . . . . . . . . . 1,956 1,901 2,007
Deferrals and other . . . . . . . . . . . . . . . . . . . . (48) 387 (635)
Gain on extinguishment of debt. . . . . . . . . . . . . . . - (904) -
Benefit for deferred taxes. . . . . . . . . . . . . . . . . - - (14,015)
Changes in operating assets and liabilities:
Accounts and notes receivable . . . . . . . . . . . . . . . 3,070 (1,899) 877
Inventory . . . . . . . . . . . . . . . . . . . . . . . . . 1,025 605 (1,060)
Prepaid expenses and other. . . . . . . . . . . . . . . . . (337) (203) (1,143)
Deposits and other. . . . . . . . . . . . . . . . . . . . . 3 - (646)
Accounts payable and accrued liabilities. . . . . . . . . . 1,729 (393) (598)
------------------- -------------- --------------
Net cash provided by operating activities. . . . . . . . . . . . 27,373 34,363 27,412
------------------- -------------- --------------
Cash flows from investing activities:
Acquisition of property and equipment, (net of proceeds). . . (10,491) (10,668) (10,971)
------------------- -------------- --------------
Net cash used in investing activities. . . . . . . . . . . . . . (10,491) (10,668) (10,971)
------------------- -------------- --------------
Cash flows from financing activities:
Payments on debt related to refinancing . . . . . . . . . . . - (118,346) -
Proceeds from issuance of long-term debt. . . . . . . . . . . 66 124,000 -
Payments on debt and capital leases . . . . . . . . . . . . . (16,928) (23,708) (15,857)
Payments for refinancing fees . . . . . . . . . . . . . . . . - (4,788) -
Distribution to affiliated OD and other . . . . . . . . . . . (619) (775) (225)
------------------- -------------- --------------
Net cash used in financing activities. . . . . . . . . . . . . . (17,481) (23,617) (16,082)
------------------- -------------- --------------
Net (decrease) increase in cash and cash equivalents . . . . . . (599) 78 359
Cash and cash equivalents at beginning of period . . . . . . . . 3,971 3,372 3,450
------------------- -------------- --------------
Cash and cash equivalents at end of period . . . . . . . . . . . $ 3,372 $ 3,450 $ 3,809
=================== ============== ==============
Supplemental cash flow disclosures:
Cash paid during the period for:
Interest $ 26,150 $ 19,401 $ 17,232
Taxes 358 687 4,294
Noncash investing and financing activities:
Dividends accrued on preferred stock 5,780 6,569 7,466
Additions of property and equipment - 1,076 -
The accompanying notes are an integral part of these consolidated financial statements.
F-6
EYE CARE CENTERS OF AMERICA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollar amounts in thousands unless indicated otherwise)
1. DESCRIPTION OF BUSINESS AND ORGANIZATION
Description of Business. Eye Care Centers of America, Inc. (the "Company")
operates optical retail stores that sell prescription eyewear, contact lenses,
sunglasses and ancillary optical products, and feature on-site laboratories.
The Company's operations are located in 33 states, primarily in the Pacific
Northwest, Southwest, Midwest and Southeast, in the Mid-Atlantic States and
along the Gulf and East Coasts.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation. The financial statements include the accounts of
the Company, its wholly owned subsidiaries and certain private optometrists with
practices managed by subsidiaries of the Company (the "ODs"). All significant
intercompany accounts and transactions have been eliminated in consolidation.
Certain reclassifications have been made to the prior period statements to
conform to the current period presentation.
Use of Estimates. In preparing financial statements in conformity with
generally accepted accounting principles, management is required to make
estimates and assumptions. These estimates and assumptions affect the reported
amount of assets and liabilities, the disclosure of contingent assets and
liabilities at the date of the financial statements and revenues and expenses
during the reporting period. Actual results could differ from these estimates.
Reporting Periods. The Company uses a 52/53-week reporting format. The
fiscal years ended 2001, 2002 and 2003 consisted of 52 weeks. Fiscal year 2001
ended December 29, 2001 ("fiscal 2001"), fiscal year 2002 ended December 28,
2002 ("fiscal 2002") and fiscal year 2003 ended December 27, 2003 ("fiscal
2003").
Cash and Cash Equivalents. All short-term investments that mature in less
than 90 days when purchased are considered cash equivalents for purposes of
disclosure in the consolidated balance sheets and consolidated statements of
cash flows. Cash equivalents are stated at cost, which approximates market
value.
Accounts Receivable. Accounts receivable are primarily from third party
payors related to the sale of eyewear and include receivables from insurance
reimbursements, OD management fees, credit card companies, merchandise, rent and
license fee receivables. The Company's allowance for doubtful accounts requires
significant estimation and primarily consists of amounts owed to the Company by
third party insurance payors. This estimate is based on the historical ratio of
collections to billings. The Company's allowance for doubtful accounts was $4.1
million at December 27, 2003.
Inventory. Inventory consists principally of eyeglass frames, ophthalmic
lenses and contact lenses and is stated at the lower of cost or market. Cost is
determined using the
F-7
EYE CARE CENTERS OF AMERICA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollar amounts in thousands unless indicated otherwise)
weighted average method, which approximates the first-in, first-out (FIFO)
method. The Company's inventory reserves require significant estimation and are
based on product with low turnover or deemed by management to be unsaleable. The
Company's inventory reserve was $0.6 million at December 27, 2003.
The Company uses several vendors to supply its lens and frame inventory. In
fiscal 2003, one of the principal lens vendors supplied approximately 42.8% of
the Company's lens materials while four frame vendors collectively supplied
approximately 63.4% of the frames purchased by the Company during the same
period. While such vendors supplied a significant share of the inventory used by
the Company, lenses and frames are a generic product and can be purchased from a
number of other vendors on comparable terms. The Company therefore does not
believe that it is dependent on such vendors or any other single vendor for
lenses or frames. The Company believes that its relationships with its existing
vendors are satisfactory. The Company believes that significant disruption in
the delivery of merchandise from one or more of its current principal vendors
would not have a material adverse effect on the Company's operations because
multiple vendors exist for all of the Company's products.
Property and Equipment. Property and equipment is recorded at cost. For
financial statement purposes, depreciation of building, furniture and equipment
is calculated using the straight-line method over the estimated useful lives of
the assets. Leasehold improvements are amortized on a straight-line method over
the shorter of the life of the lease or the estimated useful lives of the
assets. Depreciation of capital leased assets is included in depreciation
expense and is calculated using the straight-line method over the term of the
lease.
Estimated useful lives are as follows:
Building 20 years
Furniture and equipment 3 to 10 years
Leasehold improvements 5 to 10 years
Maintenance and repair costs are charged to expense as incurred.
Expenditures for significant betterments are capitalized.
Intangibles. Intangibles consist of the amounts of excess purchase price
over the market value of acquired net assets ("goodwill"). Goodwill is subject
to an annual assessment for impairment applying a fair-value based test.
Additionally, an acquired intangible asset should be separately recognized if
the benefit of the intangible asset is obtained through contractual or other
legal rights, or if the intangible asset can be sold, transferred, licensed,
rented, or exchanged, regardless of the acquirer's intent to do so. The Company
performed its annual assessment of goodwill on a consolidated basis as of
December 27, 2003, and based upon its analysis, the Company believes that no
impairment of goodwill exists. The Company's pro forma net loss with
amortization of goodwill excluded for fiscal year 2001 was $3,753.
F-8
EYE CARE CENTERS OF AMERICA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollar amounts in thousands unless indicated otherwise)
Other Assets. Other assets consist primarily of deferred debt financing
costs and a note receivable. The deferred debt financing costs are amortized
into expense over the life of the associated debt. The note receivable consists
of a $1.0 million loan made during fiscal 2003 to an optometrist owning the
optometric practice Hour Eyes. Previously, the Company guaranteed a bank loan in
connection with the Company's acquisition of certain assets used at the Hour
Eyes locations in Virginia and the related long-term business management
agreement. On April 24, 2003, the bank loan was paid off with proceeds from the
loan directly from the Company to the optometrist owning the optometric
practice.
Long-Lived Assets. Long-lived assets consist primarily of store furnishings
and lab equipment. Long-lived assets to be held and used and long-lived assets
to be disposed of by sale are subject to an annual assessment for impairment.
The Company performed its annual assessment of long-lived assets as of December
27, 2003, and based upon its analysis, the Company believes no impairment of
long-lived assets exists.
Deferred Revenue - Replacement Certificates and Warranty Contracts. At the
time of a frame sale, some customers purchase a warranty contract covering
eyewear defects or damage during the 12-month period subsequent to the date of
the sale. Revenue relating to these contracts is deferred and recognized over
the life of the warranty contract (one year). Costs incurred to fulfill the
warranty are expensed when incurred.
Prior to July 2003, certain frames purchased included a one-year warranty
period without requiring the separate purchase of a warranty contract. Reserves
are established for the expected cost of repair related to these frame sales. At
the end of fiscal 2002 and 2003 the Company had established a reserve based on
historical experience of approximately $861 and $386, respectively, related to
these warranties, which is included in other accrued expenses on the
accompanying balance sheet.
Income Taxes. The Company records income taxes under SFAS No. 109 using the
liability method. Under this method, deferred tax assets and liabilities are
determined based on differences between financial reporting and tax bases of
assets and liabilities and are measured using the enacted tax rates and laws
that will be in effect when the differences are expected to reverse.
Revenue Recognition. Sales and related costs are recognized by the Company
upon the sale of products at company-owned retail locations. Licensing fees
collected from independent optometrists for using the Company's trade name
"Master Eye Associates," insurance premiums and management fees are recognized
when earned. Historically, the Company's highest sales occur in the first and
third quarters.
Advertising Costs. Advertising costs of the Company include costs related
to broadcast and print media advertising expenses. The Company expenses
production
F-9
EYE CARE CENTERS OF AMERICA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollar amounts in thousands unless indicated otherwise)
costs and media advertising costs when incurred. For the fiscal years ended
2001, 2002 and 2003 advertising costs amounted to approximately $28,988, $30,629
and $31,587, respectively.
New Accounting Pronouncements. On April 30, 2002, SFAS 145, "Rescission of
FASB Statements No. 4, 44 and 64, Amendment of FASB Statement No. 13, and
Technical Corrections" was approved by the FASB. As a result, gains and losses
from extinguishment of debt are classified as extraordinary items only if they
meet the criteria in Accounting Principles Board Opinion 30. The Company
adopted the statement on December 29, 2002. While the adoption of SFAS 145
resulted in the reclassification of extraordinary gain to ordinary gain, the
adoption of SFAS 145 did not have a significant impact on the Company's results
of operations or financial position. Refer to the discussion under "Gain" in
footnote 9 of these financial statements.
In December 2002, SFAS 148, "Accounting for Stock-Based Compensation -
Transition and Disclosure" was issued by the FASB. This statement amends SFAS
123 to provide alternative methods of transition for a voluntary change to the
fair value method of accounting for stock-based employee compensation. In
addition, this statement amends the disclosure requirements of SFAS 123 to
require prominent disclosures in both annual and interim financial statements
about the method of accounting for stock-based employee compensation and the
effect of the method used on reported results. The Company adopted the
statement on December 29, 2002 and continues to account for stock-based employee
compensation under the intrinsic value method. As all options are granted at
fair market value, the Company recorded no compensation expense for options
granted in fiscal years 2001, 2002 or 2003. As there were no options
outstanding as of December 29, 2001, pro forma disclosures are only applicable
to fiscal years 2002 and 2003. For purposes of pro forma disclosures, the
estimated fair value of the options is amortized to expense over the options'
vesting period. The pro forma calculations include only the effects of 2002 and
2003 grants as all grants previous to 2002 were exercised or cancelled. As
such, the impacts are not necessarily indicative of the effects on reported net
income of future years. The Company's pro forma net income for fiscal years
2002 and 2003 are as follows:
FISCAL FISCAL
2002 2003
-------- --------
Net income . . . . . . . . . . . . . . . . . $14,243 $25,807
Fair value based method compensation expense (121) (115)
-------- --------
Pro forma net income . . . . . . . . . . . . $14,122 $25,692
In January 2003, the FASB issued Interpretation No. 46, Consolidation of
Variable Interest Entities, an interpretation of ARB No. 51 ("FIN 46"). As a
result, a variable interest entity is to be consolidated by a company if that
company is subject to a majority
F-10
EYE CARE CENTERS OF AMERICA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollar amounts in thousands unless indicated otherwise)
of the risk of loss from the variable interest entity's activities or is
entitled to receive a majority of the entity's residual returns or both. The
interpretation also requires disclosures about variable interest entities that
the company is not required to consolidate but in which it has a significant
variable interest. On December 24, 2003, the FASB issued a revision to FIN 46,
Revised Interpretation 46 ("FIN 46R"). FIN 46R codifies both the proposed
modifications and other decisions previously issued through certain FASB Staff
Positions and supercedes FIN 46 to include (1) deferring the effective date of
the Interpretation's provisions for certain variable interests, (2) providing
additional scope exceptions for certain other variable interests, (3) clarifying
the impact of troubled debt restructurings on the requirement to reconsider (a)
whether an entity is a variable interest entity or (b) which party is the
primary beneficiary of a variable interest entity, and (4) revising Appendix B
of FIN 46 to provide additional guidance on what constitutes a variable
interest. The Company adopted FIN 46R on December 27, 2003 and the adoption did
not have a significant impact on the Company's results of operations or
financial position.
Stock Based Compensation. The Company grants stock options for a fixed
number of shares to employees with an exercise price equal to the fair value of
the shares at the date of grant. In accordance with SFAS No. 123, "Accounting
for Stock-Based Compensation," the Company has continued to account for stock
option grants in accordance with APB Opinion No. 25, "Accounting for Stock
Issues to Employees," and, accordingly, recognized no compensation expense for
the stock option grants.
Interest Expense, Net. Interest expense, net consists of the following:
YEAR-ENDED
-------------
DECEMBER 29, DECEMBER 28, DECEMBER 27,
2001 2002 2003
------------- ------------- -------------
Interest expense. . . $ 28,125 $ 21,481 $ 20,518
Interest income . . . (268) (178) (164)
Interest capitalized. (320) (252) (154)
------------- ------------- -------------
Interest expense, net $ 27,537 $ 21,051 $ 20,200
============= ============= =============
3. SELF-INSURANCE
The Company maintains its own self-insurance group health plan. The plan
provides medical benefits for participating employees. The Company has an
employers' stop loss insurance policy to cover individual claims in excess of
$150 per employee. The amount charged to health insurance expense is based on
estimates obtained from an actuarial firm. Management believes the accrued
liability of approximately $1.3 million, which is
F-11
EYE CARE CENTERS OF AMERICA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollar amounts in thousands unless indicated otherwise)
included in accrued other, as of December 27, 2003 is adequate to cover future
benefit payments for claims that occurred prior to fiscal year end.
4. RELATED PARTY TRANSACTIONS
The Company and Thomas H. Lee Company ("THL Co.") entered into a management
agreement as of April 24, 1998 (as amended, the "Management Agreement"),
pursuant to which (i) THL Co. received a financial advisory fee of $6.0 million
in connection with structuring, negotiating and arranging the recapitalization
and structuring, negotiating and arranging the debt financing and (ii) THL Co.
would receive $500 per year plus expenses for management and other consulting
services provided to the Company, including one percent (1%) of the gross
purchase price for acquisitions for its participation in the negotiation and
consummation of any such acquisition. As of December 31, 2000, the Management
Agreement was amended to reduce the fees payable thereunder to $250 per year
plus expenses for management and other consulting services provided to the
Company. However, the fees payable under the Management Agreement may be
increased by an additional $250 annually depending upon the Company attaining
certain leverage ratios. The Management Agreement continues unless and until
terminated by mutual consent of the parties in writing, for so long as THL Co.
provides management and other consulting services to the Company. The Company
believes that the terms of the Management Agreement are comparable to those that
would have been obtained from unaffiliated sources. For the fiscal years ended
2001, 2002 and 2003 the Company incurred $250, $500 and $500, respectively,
related to the Management Agreement.
During fiscal 1998, Bernard Andrews, CEO at the time of the transaction,
purchased $1.0 million of the Company's Common Stock. Mr. Andrews paid for these
shares by delivering a promissory note with an original purchase amount of $1.0
million, which is accruing interest at a fixed rate equal to the Company's
initial borrowing rate. The repayment of such note is secured by Mr. Andrews'
shares of Common Stock.
F-12
EYE CARE CENTERS OF AMERICA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollar amounts in thousands unless indicated otherwise)
5. PREPAID EXPENSES AND OTHER
Prepaid expenses and other consists of the following:
DECEMBER 28, DECEMBER 27,
2002 2003
------------ ------------
Prepaid insurance. . . $ 568 $ 780
Prepaid store supplies 843 943
Prepaid advertising. . 1,861 1,477
Other. . . . . . . . . 301 496
------------ ------------
$ 3,573 $ 3,696
============ ============
6. PROPERTY AND EQUIPMENT
Property and equipment, net, consists of the following:
DECEMBER 28, DECEMBER 27,
2002 2003
------------- -------------
Land . . . . . . . . . . . . . . . . . . . . . $ 638 $ -
Building . . . . . . . . . . . . . . . . . . . 2,240 2,240
Furniture and equipment. . . . . . . . . . . . 116,126 123,672
Leasehold improvements . . . . . . . . . . . . 63,660 67,154
------------- -------------
182,664 193,066
Less accumulated depreciation and amortization (125,225) (141,351)
------------- -------------
Property and equipment, net. . . . . . . . . . $ 57,439 $ 51,715
============= =============
F-13
EYE CARE CENTERS OF AMERICA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollar amounts in thousands unless indicated otherwise)
7. INTANGIBLE ASSETS
The following is a summary of the components of intangible assets
along with the related accumulated amortization for the fiscal years
then ended.
DECEMBER 28, DECEMBER 27,
2002 2003
------------- -------------
Noncompete and management agreements $ 10,187 $ 10,187
Less accumulated amortization. . . . (10,022) (10,187)
------------- -------------
Net . . . . . . . . . . . . . . . 165 -
Goodwill . . . . . . . . . . . . . . 107,423 107,423
------------- -------------
Intangibles, net . . . . . . . . . . $ 107,588 $ 107,423
============= =============
8. OTHER ACCRUED EXPENSES
Other accrued expenses consists of the following:
DECEMBER 28, DECEMBER 27,
2002 2003
------------ ------------
Construction. . . . . . $ - $ 1,319
Insurance . . . . . . . 1,654 1,312
Payroll & sales/use tax 829 1,211
Store expenses. . . . . 930 1,194
Other . . . . . . . . . 752 943
Income tax payable. . . 1,175 669
Property taxes. . . . . 441 549
Warranties. . . . . . . 861 386
Advertising . . . . . . 839 328
Third party liability . 196 225
Professional fees . . . 746 198
Severance & legal fees. 100 -
------------ ------------
$ 8,523 $ 8,334
============ ============
F-14
EYE CARE CENTERS OF AMERICA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollar amounts in thousands unless indicated otherwise)
9. LONG-TERM DEBT
Credit Facilities. In April 1998, the Company entered into a credit
agreement which provided for $55.0 million in term loans, $100.0 million in
acquisition facilities, and $35.0 million in revolving credit facilities ("Old
Credit Facility"). On December 23, 2002, the Company entered into a credit
agreement which consists of (i) the $55.0 million term loan facility (the "Term
Loan A"); (ii) the $62.0 million term loan facility (the "Term Loan B"); and
(iii) the $25.0 million revolving credit facility (the "Revolver" and together
with the Term Loan A and Term Loan B, the "New Facilities"). The proceeds of
the New Facilities were used to (i) pay long-term debt outstanding under the Old
Credit Facility, (ii) redeem $20.0 million face value of subordinated debt at a
cost of $17.0 million, and (iii) pay fees and expenses incurred in connection
with the New Facilities. Thereafter, the New Facilities are available to
finance working capital requirements and general corporate purposes.
Borrowings made under the New Facilities shall accrue interest at the
Company's option at the Base Rate or the LIBOR rate, plus the applicable margin.
Base Rate shall mean a floating rate equal to the higher of (i) the Fleet prime
rate and (ii) the overnight Federal Funds Rate plus 1/2%. Pricing for the
Revolver will be at LIBOR plus 4.50% (Base Rate plus 3.50%), Term Loan A will be
at LIBOR plus 4.25% (Base Rate plus 3.25%), and Term Loan B will be at LIBOR
plus 4.75% (Base Rate plus 3.75%). The Term Loan A amortizes in quarterly
payments which began on March 31, 2003. $15.0 million of the principal amount
amortized during fiscal 2003 and $18.8 and 25.0 million will amortize in annual
principal amounts for fiscal years 2004 and 2005, respectively. The Term Loan B
shall have no payments until 2006 when quarterly payments will commence in
annual principal amounts of $20.0 million and $42.0 million, respectively, for
fiscal years 2006 and 2007.
In connection with the borrowings made under the New Facilities, the
Company incurred approximately $4.8 million in debt issuance costs. These
amounts are classified within other assets in the accompanying balance sheets
and are being amortized over the life of the New Facilities. The unamortized
amount of debt issuance costs as of December 27, 2003 related to the New
Facilities was $3.5 million.
At December 27, 2003, the Company had $43.8 million and $62.0 million in
term loans outstanding under the Term Loan A and Term Loan B, respectively, $1.0
million outstanding under the Revolver, $129.8 million in notes payable
outstanding evidenced by the Exchange Notes and $2.2 million in capital lease
and equipment obligations.
The New Facilities are collateralized by all tangible and intangible
assets, including the stock of the Company's subsidiaries. In addition, the
Company must meet certain financial covenants including minimum EBITDA, interest
coverage, leverage ratio and capital expenditures. As of December 27, 2003, the
Company was in compliance with the financial covenants.
F-15
EYE CARE CENTERS OF AMERICA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollar amounts in thousands unless indicated otherwise)
On April 24, 1998, the Company completed a debt offering consisting of
$100.0 million aggregate principal amount of its 9 1/8% Senior Subordinated
Notes due 2008 (the "Fixed Rate Notes") and $50.0 million aggregate principal
amount of its Floating Interest Rate Subordinated Term Securities due 2008 (the
"Floating Rate Notes" and, together with the Fixed Rate Notes, the "Initial
Notes"). The Floating Rate Notes bear interest at a rate per annum, reset
semiannually, and equal to LIBOR plus 3.98%. In connection with the New
Facilities, the Company redeemed $20.0 million of the Floating Rate Notes on
December 23, 2002. The Company filed a registration statement with the
Securities and Exchange Commission with respect to an offer to exchange the
Initial Notes for notes which have terms substantially identical in all material
respects to the Initial Notes, except such notes are freely transferable by the
holders thereof and are issued without any covenant regarding registration (the
"Exchange Notes"). The registration statement was declared effective on January
28, 1999. The exchange period ended March 4, 1999. The Exchange Notes are the
only notes of the Company which are currently outstanding.
The Exchange Notes are senior uncollateralized obligations of the Company
and rank pari passu with all other indebtedness of the Company that by its terms
other indebtedness is not subordinate to the Exchange Notes. In connection with
the issuance of the Exchange Notes, the Company incurred approximately $11.2
million in debt issuance costs. These amounts are classified within other assets
in the accompanying balance sheets and are being amortized over the life of the
Exchange Notes. The unamortized amount of debt issuance costs as of December 27,
2003 related to the Exchange Notes was $2.9 million.
The Exchange Notes contain various restrictive covenants which apply to
both the Company and the Guarantor Subsidiaries (defined herein), including
limitations on additional indebtedness, restriction on dividends and sale of
assets other than in the normal course of business.
Gain. On December 23, 2002, the Company retired $20.0 million face value of
subordinated debt at a cost of $17.0 million and $0.5 million of related
capitalized loan costs resulting in a gain of $2.5 million. In addition, the
Company wrote-off $1.6 million of capitalized loan costs related to the Old
Credit Facility resulting in a loss of $1.6 million. As a result, the Company
recognized a gain net of tax of $0.9 million in its financial statements.
Capital Leases. The Company has an agreement whereby it leases equipment
and buildings at various operating locations. The Company has accounted for the
equipment and property leases as capital leases and has recorded the assets and
the future obligations on the balance sheet as follows:
F-16
EYE CARE CENTERS OF AMERICA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollar amounts in thousands unless indicated otherwise)
DECEMBER 28, DECEMBER 27,
2002 2003
------------ ------------
Buildings and equipment-assets . . . . . . $ 3,447 $ 3,445
Buildings and equipment-future obligations $ 2,501 $ 2,287
The Company's scheduled future minimum lease payments for the next five fiscal
years under the property and equipment capital leases are as follows:
2004. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 803
2005. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 829
2006. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 833
2007. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 833
2008. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 833
Beyond 2008 . . . . . . . . . . . . . . . . . . . . . . . . . . . 398
------
Total minimum lease payments. . . . . . . . . . . . . . . . . . . 4,529
Amounts representing interest . . . . . . . . . . . . . . . . . . 2,467
------
Present value of minimum lease payments . . . . . . . . . . . . . $2,062
======
Long-term debt outstanding, including capital lease obligations,
consists of the following:
DECEMBER 28, DECEMBER 27,
2002 2003
-------------- --------------
Exchange Notes, face amount of $130,000
net of unamortized debt discount of
$261 and $212, respectively . . . . . $ 129,739 $ 129,788
New Facilities. . . . . . . . . . . . . 117,000 105,750
Capital lease and other obligations . . 2,894 2,287
Revolver. . . . . . . . . . . . . . . . 5,000 1,000
-------------- --------------
254,633 238,825
Less current portion. . . . . . . . . . (15,524) (18,980)
-------------- --------------
$ 239,109 $ 219,845
============== ==============
F-17
EYE CARE CENTERS OF AMERICA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollar amounts in thousands unless indicated otherwise)
Future principal maturities for long-term debt and capital lease obligations
are as follows:
2004. . . . . . . . . . . . . . . . . . $ 18,980
2005. . . . . . . . . . . . . . . . . . 25,329
2006. . . . . . . . . . . . . . . . . . 20,330
2007. . . . . . . . . . . . . . . . . . 42,431
2008. . . . . . . . . . . . . . . . . . 131,755
--------
Total future principal payments on debt $238,825
========
As of the end of fiscal 2003, the fair value of the Company's Exchange
Notes was approximately $130.0 million and the fair value of the capital lease
obligations was approximately $2.1 million. The estimated fair value of
long-term debt is based primarily on quoted market prices for the same or
similar issues and the estimated fair value of the capital lease obligation is
based on the present value of estimated future cash flows. The carrying amount
of the variable rate credit facility approximates its fair value.
10. CONDENSED CONSOLIDATING INFORMATION (UNAUDITED)
The Exchange Notes described in Note 9 were issued by Eye Care Centers of
America, Inc. ("ECCA") and are guaranteed by all of the subsidiaries of the
Company (the "Guarantor Subsidiaries") but are not guaranteed by the ODs. The
Guarantor Subsidiaries are wholly owned by the Company and the guarantees are
full, unconditional and joint and several. The following condensed
consolidating financial information presents the financial position, results of
operations and cash flows of (i) ECCA, as parent, as if it accounted for its
subsidiaries on the equity method, (ii) the Guarantor Subsidiaries, and (iii)
ODs. Separate financial statements of the Guarantor Subsidiaries are not
presented herein as management does not believe that such statements would be
material to investors.
F-18
EYE CARE CENTERS OF AMERICA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollar amounts in thousands unless indicated otherwise)
CONSOLIDATING STATEMENTS OF OPERATIONS
FOR THE YEAR ENDED DECEMBER 29, 2001
Guarantor Consolidated
Parent Subsidiaries ODs Eliminations Company
----------- -------------- -------- -------------- ---------
Revenues:
Optical sales. . . . . . . . . . . . . . . . $ 163,733 $ 109,196 $59,621 $ - $332,550
Management fees. . . . . . . . . . . . . . . 758 20,714 - (17,988) 3,484
Investment earnings in subsidiaries. . . . . (9,844) - - 9,844 -
----------- -------------- -------- -------------- ---------
Net revenues. . . . . . . . . . . . . . . . . . 154,647 129,910 59,621 (8,144) 336,034
Operating costs and expenses:
Cost of goods sold . . . . . . . . . . . . . 54,311 38,275 11,860 - 104,446
Selling, general and administrative expenses 91,855 80,706 48,614 (17,988) 203,187
Amortization of intangibles:
Goodwill. . . . . . . . . . . . . . . . . . 1,056 4,259 4 - 5,319
Noncompete and other intangibles. . . . . . - 3,378 - - 3,378
----------- -------------- -------- -------------- ---------
Total operating costs and expenses. . . . . . . 147,222 126,618 60,478 (17,988) 316,330
----------- -------------- -------- -------------- ---------
Income (loss) from operations . . . . . . . . . 7,425 3,292 (857) 9,844 19,704
Interest expense, net . . . . . . . . . . . . . 15,857 11,672 8 - 27,537
----------- -------------- -------- -------------- ---------
Loss before income taxes. . . . . . . . . . . . (8,432) (8,380) (865) 9,844 (7,833)
Income tax expense. . . . . . . . . . . . . . . 640 199 400 - 1,239
----------- -------------- -------- -------------- ---------
Net loss. . . . . . . . . . . . . . . . . . . . $ (9,072) $ (8,579) $(1,265) $ 9,844 $ (9,072)
=========== ============== ======== ============== =========
F-19
EYE CARE CENTERS OF AMERICA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollar amounts in thousands unless indicated otherwise)
CONSOLIDATING STATEMENT OF CASH FLOWS
FOR THE YEAR ENDED DECEMBER 29, 2001
Guarantor Consolidated
Parent Subsidiaries ODs Eliminations Company
----------- -------------- -------- -------------- ---------
Cash flows from operating activities:
Net loss . . . . . . . . . . . . . . . . . . . . . . . . . $ (9,072) $ (8,579) $(1,265) $ 9,844 $ (9,072)
Adjustments to reconcile net loss to net
cash provided by operating activities:
Depreciation. . . . . . . . . . . . . . . . . . . . . . 12,532 7,818 - - 20,350
Amortization of intangibles . . . . . . . . . . . . . . 1,056 7,636 5 - 8,697
Other amortization. . . . . . . . . . . . . . . . . . . 1,956 - - - 1,956
Amortization of deferred gain . . . . . . . . . . . . . (160) (74) - - (234)
Deferred revenue. . . . . . . . . . . . . . . . . . . . (356) 261 (6) - (101)
Deferred rent . . . . . . . . . . . . . . . . . . . . . (51) 70 - - 19
Loss on disposition of property and equipment . . . . . 137 131 - - 268
Changes in operating assets and liabilities:
Accounts and notes receivable . . . . . . . . . . . . . 4,866 (3,370) 1,968 (394) 3,070
Inventory . . . . . . . . . . . . . . . . . . . . . . . (589) 1,495 119 - 1,025
Prepaid expenses and other. . . . . . . . . . . . . . . (290) (47) - - (337)
Accounts payable and accrued liabilities. . . . . . . . 1,057 657 (379) 394 1,729
----------- -------------- -------- -------------- ---------
Net cash provided by operating activities. . . . . . . . . 11,086 5,998 442 9,844 27,370
----------- -------------- -------- -------------- ---------
Cash flows from investing activities:
Acquisition of property and equipment (net of proceeds) (6,034) (4,457) - - (10,491)
Payment received on notes receivable. . . . . . . . . . - 3 - - 3
Investment in subsidiaries. . . . . . . . . . . . . . . 9,844 - - (9,844) -
----------- -------------- -------- -------------- ---------
Net cash provided by ( used in) investing activities . . . 3,810 (4,454) - (9,844) (10,488)
----------- -------------- -------- -------------- ---------
Cash flows from financing activities:
Proceeds from issuance of long-term debt. . . . . . . . - 66 - - 66
Distribution to affiliated OD . . . . . . . . . . . . . - - (603) - (603)
Redemption of common stock. . . . . . . . . . . . . . . (15) (1) - - (16)
Payments on debt and capital leases . . . . . . . . . . (16,341) (587) - - (16,928)
----------- -------------- -------- -------------- ---------
Net cash used in financing activities. . . . . . . . . . . (16,356) (522) (603) - (17,481)
----------- -------------- -------- -------------- ---------
Net increase (decrease) in cash and cash equivalents . . . (1,460) 1,022 (161) - (599)
Cash and cash equivalents at beginning of period . . . . . 2,215 1,187 569 - 3,971
----------- -------------- -------- -------------- ---------
Cash and cash equivalents at end of period . . . . . . . . $ 755 $ 2,209 $ 408 $ - $ 3,372
=========== ============== ======== ============== =========
F-20
EYE CARE CENTERS OF AMERICA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollar amounts in thousands unless indicated otherwise)
CONSOLIDATING BALANCE SHEET
FOR THE YEAR ENDED DECEMBER 28, 2002
Guarantor Consolidated
Parent Subsidiaries ODs Eliminations Company
----------- -------------- -------- -------------- ----------
ASSETS
Current assets:
Cash and cash equivalents. . . . . . $ 554 $ 2,532 $ 364 $ - $ 3,450
Accounts and notes receivable. . . . 134,896 42,366 3,245 (168,423) 12,084
Inventory. . . . . . . . . . . . . . 14,715 7,491 1,854 - 24,060
Prepaid expenses and other . . . . . 2,289 1,236 48 - 3,573
----------- -------------- -------- -------------- ----------
Total current assets. . . . . . . . . . 152,454 53,625 5,511 (168,423) 43,167
Property and equipment. . . . . . . . . 35,016 22,423 - - $ 57,439
Intangibles . . . . . . . . . . . . . . 16,693 90,808 87 - 107,588
Other assets. . . . . . . . . . . . . . 8,552 310 - - 8,862
Investment in subsidiaries. . . . . . . (19,578) - - 19,578 -
----------- -------------- -------- -------------- ----------
Total Assets. . . . . . . . . . . . . . $ 193,137 $ 167,166 $ 5,598 $ (148,845) $ 217,056
=========== ============== ======== ============== ==========
LIABILITIES AND SHAREHOLDERS' DEFICIT
Current liabilities:
Accounts payable . . . . . . . . . . $ 9,696 $ 170,349 $ 8,634 $ (168,423) $ 20,256
Current portion of long-term debt. . 15,374 83 - - 15,524
Deferred revenue . . . . . . . . . . 3,511 2,629 194 - 6,334
Accrued payroll expense. . . . . . . 4,956 2,792 28 - 7,776
Accrued interest . . . . . . . . . . 1,798 520 - - 2,318
Other accrued expenses . . . . . . . 4,878 2,632 1,013 - 8,523
----------- -------------- -------- -------------- ----------
Total current liabilities . . . . . . . 40,213 179,005 9,869 (168,423) 60,731
Long-term debt, less current maturities 237,028 2,048 100 - 239,109
Deferred rent . . . . . . . . . . . . . 2,763 1,808 - - 4,571
Deferred gain . . . . . . . . . . . . . 1,372 394 - - 1,766
----------- -------------- -------- -------------- ----------
Total liabilities . . . . . . . . . . . 281,376 183,255 9,969 (168,423) 306,177
----------- -------------- -------- -------------- ----------
Shareholders' deficit:
Common stock . . . . . . . . . . . . 74 - - - 74
Preferred stock. . . . . . . . . . . 54,703 - - - 54,703
Additional paid-in capital . . . . . 36,922 1,092 (1,974) - 36,040
Accumulated deficit. . . . . . . . . (179,938) (17,181) (2,397) 19,578 (179,938)
----------- -------------- -------- -------------- ----------
Total shareholders' deficit . . . . . . (88,239) (16,089) (4,371) 19,578 (89,121)
----------- -------------- -------- -------------- ----------
$ 193,137 $ 167,166 $ 5,598 $ (148,845) $ 217,056
=========== ============== ======== ============== ==========
F-21
EYE CARE CENTERS OF AMERICA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollar amounts in thousands unless indicated otherwise)
CONSOLIDATING STATEMENTS OF OPERATIONS
FOR THE YEAR ENDED DECEMBER 28, 2002
Guarantor Consolidated
Parent Subsidiaries ODs Eliminations Company
---------- ------------- ------- -------------- --------
Revenues:
Optical sales. . . . . . . . . . . . . . . . . . $ 175,733 $ 114,834 $69,699 $ - $360,266
Management fees. . . . . . . . . . . . . . . . . 554 22,319 - (19,472) 3,401
Investment earnings in subsidiaries. . . . . . . 6,251 - - (6,251) -
---------- ------------- ------- -------------- --------
Net revenues. . . . . . . . . . . . . . . . . . . . 182,538 137,153 69,699 (25,723) 363,667
Operating costs and expenses:
Cost of goods sold . . . . . . . . . . . . . . . 58,914 39,535 14,022 - 112,471
Selling, general and administrative expenses . . 96,547 81,138 54,566 (19,472) 212,472
Amortization of noncompete and other intangibles - 1,865 - - 1,865
---------- ------------- ------- -------------- --------
Total operating costs and expenses. . . . . . . . . 155,461 122,538 68,588 (19,472) 326,808
---------- ------------- ------- -------------- --------
Income from operations. . . . . . . . . . . . . . . 27,077 14,615 1,111 (6,251) 36,859
Interest expense, net . . . . . . . . . . . . . . . 12,495 8,548 8 - 21,051
---------- ------------- ------- -------------- --------
Income before income taxes. . . . . . . . . . . . . 14,582 6,067 1,103 (6,251) 15,808
Income tax expense. . . . . . . . . . . . . . . . . 339 419 500 - 1,565
---------- ------------- ------- -------------- --------
Net income. . . . . . . . . . . . . . . . . . . . . $ 14,243 $ 5,648 $ 603 $ (6,251) $ 14,243
========== ============= ======= ============== ========
F-22
EYE CARE CENTERS OF AMERICA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollar amounts in thousands unless indicated otherwise)
CONSOLIDATING STATEMENT OF CASH FLOWS
FOR THE YEAR ENDED DECEMBER 28, 2002
Guarantor Consolidated
Parent Subsidiaries ODs Eliminations Company
----------- -------------- ------ -------------- ----------
Cash flows from operating activities:
Net income . . . . . . . . . . . . . . . . . . . . . . . . $ 14,243 $ 12,234 $ 603 $ (12,837) $ 14,243
Adjustments to reconcile net income to net
cash provided by operating activities:
Depreciation. . . . . . . . . . . . . . . . . . . . . . 11,363 7,398 - - 18,761
Amortization of intangibles . . . . . . . . . . . . . . - 1,865 - - 1,865
Amortization of debt issue costs. . . . . . . . . . . . 1,901 - - - 1,901
Amortization of deferred gain . . . . . . . . . . . . . (158) (75) - - (233)
Deferred revenue. . . . . . . . . . . . . . . . . . . . (109) (308) 194 - (223)
Deferred rent . . . . . . . . . . . . . . . . . . . . . 281 500 - - 781
Loss on disposition of property and equipment . . . . . 30 32 - - 62
(Gain) loss on extinguishment of debt . . . . . . . . . (1,290) 386 - - (904)
Changes in operating assets and liabilities:
Accounts and notes receivable . . . . . . . . . . . . . (13,311) (6,932) (811) 19,155 (1,899)
Inventory . . . . . . . . . . . . . . . . . . . . . . . 656 256 (307) - 605
Prepaid expenses and other. . . . . . . . . . . . . . . (166) (35) (2) - (203)
Accounts payable and accrued liabilities. . . . . . . . (459) 18,268 954 (19,156) (393)
----------- -------------- ------ -------------- ----------
Net cash provided by operating activities. . . . . . . . . 12,981 33,589 631 (12,838) 34,363
----------- -------------- ------ -------------- ----------
Cash flows from investing activities:
Acquisition of property and equipment (net of proceeds) (7,765) (2,903) - - (10,668)
Investment in subsidiaries. . . . . . . . . . . . . . . (12,838) - - 12,838 -
----------- -------------- ------ -------------- ----------
Net cash used in investing activities. . . . . . . . . . . (20,603) (2,903) - 12,838 (10,668)
----------- -------------- ------ -------------- ----------
Cash flows from financing activities:
Payments on debt related to refinancing . . . . . . . . (88,346) (30,000) - - (118,346)
Proceeds from issuance of long-term debt. . . . . . . . 124,000 - - - 124,000
Payments on debt and capital leases . . . . . . . . . . (23,345) (363) - - (23,708)
Payments for refinancing fees . . . . . . . . . . . . . (4,788) - - - (4,788)
Distribution to affiliated OD . . . . . . . . . . . . . - - (675) - (675)
Stock buyback . . . . . . . . . . . . . . . . . . . . . (100) - - - (100)
----------- -------------- ------ -------------- ----------
Net cash provided by (used in) financing activities. . . . 7,421 (30,363) (675) - (23,617)
----------- -------------- ------ -------------- ----------
Net increase (decrease) in cash and cash equivalents . . . (201) 323 (44) - 78
Cash and cash equivalents at beginning of period . . . . . 755 2,209 408 - 3,372
----------- -------------- ------ -------------- ----------
Cash and cash equivalents at end of period . . . . . . . . $ 554 $ 2,532 $ 364 $ - $ 3,450
=========== ============== ====== ============== ==========
F-23
EYE CARE CENTERS OF AMERICA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollar amounts in thousands unless indicated otherwise)
CONSOLIDATING BALANCE SHEET
FOR THE YEAR ENDED DECEMBER 27, 2003
Guarantor Consolidated
Parent Subsidiaries ODs Eliminations Company
----------- -------------- -------- -------------- ----------
ASSETS
Current assets:
Cash and cash equivalents. . . . . . $ 67 $ 3,501 $ 241 $ - $ 3,809
Accounts and notes receivable. . . . 166,924 48,875 2,847 (207,529) 11,117
Inventory. . . . . . . . . . . . . . - 22,941 2,179 - 25,120
Deferred income taxes, net . . . . . 570 - - 570
Prepaid expenses and other . . . . . - 3,648 48 - 3,696
----------- -------------- -------- -------------- ----------
Total current assets. . . . . . . . . . 167,561 78,965 5,315 (207,529) 44,312
Property and equipment. . . . . . . . . - 51,715 - - 51,715
Intangibles . . . . . . . . . . . . . . 166 107,195 87 (25) 107,423
Other assets. . . . . . . . . . . . . . 6,414 2,217 - - 8,631
Deferred income taxes, net. . . . . . . 13,445 - - - 13,445
Investment in subsidiaries. . . . . . . (6,952) - - 6,952 -
----------- -------------- -------- -------------- ----------
Total Assets. . . . . . . . . . . . . . $ 180,634 $ 240,092 $ 5,402 $ (200,602) $ 225,526
=========== ============== ======== ============== ==========
LIABILITIES AND SHAREHOLDERS' DEFICIT
Current liabilities:
Accounts payable . . . . . . . . . . $ 341 $ 221,829 $ 6,719 $ (207,529) $ 21,360
Current portion of long-term debt. . 18,750 230 - - 18,980
Deferred revenue . . . . . . . . . . 512 4,785 446 - 5,743
Accrued payroll expense. . . . . . . - 5,027 402 - 5,429
Accrued interest . . . . . . . . . . 3,213 - - - 3,213
Other accrued expenses . . . . . . . 246 6,889 1,199 - 8,334
----------- -------------- -------- -------------- ----------
Total current liabilities . . . . . . . 23,062 238,760 8,766 (207,529) 63,059
Long-term debt, less current maturities 217,789 2,056 - - 219,845
Deferred rent . . . . . . . . . . . . . - 4,570 149 - 4,719
Deferred gain . . . . . . . . . . . . . 1,213 319 - - 1,532
----------- -------------- -------- -------------- ----------
Total liabilities . . . . . . . . . . . 242,064 245,705 8,915 (207,529) 289,155
----------- -------------- -------- -------------- ----------
Shareholders' deficit:
Common stock . . . . . . . . . . . . 74 - - - 74
Preferred stock. . . . . . . . . . . 62,169 - - - 62,169
Additional paid-in capital . . . . . 30,458 25 (2,199) (25) 28,259
Accumulated deficit. . . . . . . . . (154,131) (5,638) (1,314) 6,952 (154,131)
----------- -------------- -------- -------------- ----------
Total shareholders' deficit . . . . . . (61,430) (5,613) (3,513) 6,927 (63,629)
----------- -------------- -------- -------------- ----------
$ 180,634 $ 240,092 $ 5,402 $ (200,602) $ 225,526
=========== ============== ======== ============== ==========
F-24
EYE CARE CENTERS OF AMERICA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollar amounts in thousands unless indicated otherwise)
CONSOLIDATING STATEMENTS OF OPERATIONS
FOR THE YEAR ENDED DECEMBER 27, 2003
Guarantor Consolidated
Parent Subsidiaries ODs Eliminations Company
----------- ------------- ------- -------------- ---------
Revenues:
Optical sales . . . . . . . . . . . . . . . . . . $ 62,864 $ 228,982 $74,685 $ - $366,531
Management fees . . . . . . . . . . . . . . . . . 480 23,711 - (20,870) 3,321
Investment earnings in subsidiaries . . . . . . . 12,242 - - (12,242) -
----------- ------------- ------- -------------- ---------
Net revenues . . . . . . . . . . . . . . . . . . . . 75,586 252,693 74,685 (33,112) 369,852
Operating costs and expenses:
Cost of goods sold. . . . . . . . . . . . . . . . 22,204 77,509 14,865 - 114,578
Selling, general and administrative expenses. . . 36,414 145,691 57,467 (20,870) 218,702
Amortization of noncompete and other intangibles. - 165 - - 165
----------- ------------- ------- -------------- ---------
Total operating costs and expenses . . . . . . . . . 58,618 223,365 72,332 (20,870) 333,445
----------- ------------- ------- -------------- ---------
Income from operations . . . . . . . . . . . . . . . 16,968 29,328 2,353 (12,242) 36,407
Interest expense, net. . . . . . . . . . . . . . . . 2,019 18,169 12 - 20,200
----------- ------------- ------- -------------- ---------
Income before income taxes . . . . . . . . . . . . . 14,949 11,159 2,341 (12,242) 16,207
Income tax expense (benefit) . . . . . . . . . . . . (10,858) - 1,258 - (9,600)
----------- ------------- ------- -------------- ---------
Net income . . . . . . . . . . . . . . . . . . . . . $ 25,807 $ 11,159 $ 1,083 $ (12,242) $ 25,807
=========== ============= ======= ============== =========
F-25
EYE CARE CENTERS OF AMERICA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollar amounts in thousands unless indicated otherwise)
CONSOLIDATING STATEMENT OF CASH FLOWS
FOR THE YEAR ENDED DECEMBER 27, 2003
Guarantor Consolidated
Parent Subsidiaries ODs Eliminations Company
----------- -------------- -------- -------------- ---------
Cash flows from operating activities:
Net income. . . . . . . . . . . . . . . . . . . . . . . . . $ 25,807 $ 11,159 $ 1,083 $ (12,242) $ 25,807
Adjustments to reconcile net income to net
cash provided by operating activities:
Depreciation . . . . . . . . . . . . . . . . . . . . . . 3,485 13,168 - - 16,653
Amortization of intangibles. . . . . . . . . . . . . . . - 165 - - 165
Amortization of debt issue costs . . . . . . . . . . . . 687 1,320 - - 2,007
Deferrals and other. . . . . . . . . . . . . . . . . . . (5,933) 4,897 401 - (635)
Benefit for deferred taxes . . . . . . . . . . . . . . . (14,015) - - - (14,015)
Changes in operating assets and liabilities:
Accounts and notes receivable. . . . . . . . . . . . . . (32,120) (6,123) 398 38,722 877
Inventory. . . . . . . . . . . . . . . . . . . . . . . . 14,715 (15,450) (325) - (1,060)
Prepaid expenses and other . . . . . . . . . . . . . . . 3,789 (4,932) - - (1,143)
Deposits and other . . . . . . . . . . . . . . . . . . . - (646) - - (646)
Accounts payable and accrued liabilities . . . . . . . . 34,682 5,181 (1,355) (39,106) (598)
----------- -------------- -------- -------------- ---------
Net cash provided by operating activities . . . . . . . . . 31,097 8,739 202 (12,626) 27,412
----------- -------------- -------- -------------- ---------
Cash flows from investing activities:
Acquisition of property and equipment, (net of proceeds) (3,046) (7,925) - - (10,971)
Investment in subsidiaries . . . . . . . . . . . . . . . (12,626) - - 12,626 -
----------- -------------- -------- -------------- ---------
Net cash used in investing activities . . . . . . . . . . . (15,672) (7,925) - 12,626 (10,971)
----------- -------------- -------- -------------- ---------
Cash flows from financing activities:
Payments on debt and capital leases. . . . . . . . . . . (15,912) 155 (100) - (15,857)
Distribution to affiliated OD. . . . . . . . . . . . . . - - (225) - (225)
----------- -------------- -------- -------------- ---------
Net cash provided by (used in) financing activities . . . . (15,912) 155 (325) - (16,082)
----------- -------------- -------- -------------- ---------
Net increase (decrease) in cash and cash equivalents. . . . (487) 969 (123) - 359
Cash and cash equivalents at beginning of period. . . . . . 554 2,532 364 - 3,450
----------- -------------- -------- -------------- ---------
Cash and cash equivalents at end of period. . . . . . . . . $ 67 $ 3,501 $ 241 $ - $ 3,809
=========== ============== ======== ============== =========
F-26
EYE CARE CENTERS OF AMERICA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollar amounts in thousands unless indicated otherwise)
11. PREFERRED STOCK
During 1998, the Company issued 300,000 shares of Preferred Stock, par
value $ .01 per share. Dividends on shares of Preferred Stock are cumulative
from the date of issue (whether or not declared) and will be payable when and as
may be declared from time to time by the Board of Directors of the Company.
Such dividends accrue on a daily basis from the original date of issue at an
annual rate per share equal to 13% of the original purchase price per share,
with such amount to be compounded quarterly. Cumulative preferred dividends in
arrears were $24.8 and $32.3 million as of December 28, 2002 and December 27,
2003, respectively. The Preferred Stock will be redeemable at the option of the
Company, in whole or in part, at $100 per share plus (i) the per share dividend
rate and (ii) all accumulated and unpaid dividends, if any, to the date of
redemption, upon occurrence of an offering of equity securities, a change of
control or certain sales of assets. The Preferred Stock has no voting rights.
12. SHAREHOLDERS' DEFICIT
1998 Executive Stock Option Plan. On April 25, 1998, the Company authorized
a non-qualified stock option plan whereby key executives and senior officers may
be offered options to purchase the Company's Common Stock. Under the plan, the
exercise price set by the Board of Directors of the Company must at least equal
the fair market value of the Company's Common Stock at the date of grant. The
options begin vesting one year after the date of grant in four installments of
10%, 15%, 25% and 50% provided the optionee is an employee of the Company on the
anniversary date and shall expire 10 years after the date of grant. Under
certain specified conditions the vesting schedule may be altered. During fiscal
2001, the Company entered into Option Cancellation Agreements (the "Cancellation
Agreements") with certain employees and directors (the "Optionees") to cancel
all outstanding options which were granted through the cancellation date under
the Company's 1998 Stock Option Plan (the "Plan") due to changes in the fair
market value of the Company's common stock. The Company provided all of the
Optionees with an option cancellation notice detailing the Company's offer for
the Optionees to cancel and terminate their respective options in exchange for
the commitment of the Company to grant new options under the Plan (the "New
Options"), such new grant to be made no earlier than six months and a day after
the effective date of the cancellation of the options and at an exercise price
equal to the fair market value of the common stock as of the effective date of
the grant of the New Options. The Cancellation Agreements provided that, in
January 2002 (the "Grant Date"), the Company granted to each of the Optionees a
New Option to purchase the number of shares of common stock subject to the
options being terminated and cancelled and that such New Option will have an
exercise price equal to the fair market value of the common stock as of the
Grant Date. The vesting period for the New Options granted to employees was 40%
on the Grant Date with an additional 20% to vest on each of the first, second
and third anniversaries of the Grant Date. The exercise price at the Grant Date
was $5.00 per share. Subsequent grants of 131,000 options were made throughout
the
F-27
EYE CARE CENTERS OF AMERICA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollar amounts in thousands unless indicated otherwise)
remainder of fiscal 2002. Such grants begin vesting one year after the
date of the grant in four installments of 10%, 15%, 25% and 50% and have an
exercise price of $5.00 to $15.13 per share, based on the fair market value at
the Grant Date. The weighted-average fair value per share for option grants was
$2.33, $0.63 and $1.72 for fiscal years 2001, 2002 and 2003, respectively. The
weighted-average remaining contractual life as of December 27, 2003 was 8.5
years.
Following is a summary of activity in the plan for fiscal years 2001, 2002 and 2003.
WEIGHTED WEIGHTED
AVERAGE OPTION AVERAGE OPTION
EXERCISE PRICE OPTIONS EXERCISE PRICE OPTIONS
PER SHARE($) OUTSTANDING PER SHARE($) EXERCISABLE
--------------- --------------- ----------------- ------------
Outstanding December 30, 2000 10.60 483,000 10.41 94,450
Granted . . . . . . . . . . . 12.85 11,000 - -
Became exercisable. . . . . . - - 10.49 4,650
Canceled or expired . . . . . 10.63 (494,000) 10.43 (99,100)
--------------- ------------
Outstanding December 29, 2001 - - - -
Granted . . . . . . . . . . . 5.76 988,775 - -
Became exercisable. . . . . . - - 5.27 341,710
Canceled or expired . . . . . 5.00 (41,000) 5.00 (17,200)
--------------- ------------
Outstanding December 28, 2002 5.54 947,775 5.00 324,510
Granted . . . . . . . . . . . 15.13 48,000 - -
Became exercisable. . . . . . - - 5.30 173,355
Canceled or expired . . . . . 5.29 (70,000) 5.00 (8,000)
--------------- ------------
Outstanding December 27, 2003 6.06 925,775 5.10 489,865
=============== ============
The Company grants certain directors options to purchase the Company's
Common Stock from time to time. Options granted during fiscal 2001 begin
vesting on the date of grant in three installments of 50%, 25% and 25%, with
such options expiring 10 years from the date of grant. All subsequent options
granted begin vesting one year after the date of the grant in four installments
of 25% each installment, with such options expiring 10 years from the date of
grant. The weighted-average fair value per share for option grants was $2.33,
$0.63 and $1.72 for fiscal years 2001, 2002 and 2003, respectively. The
weighted-average remaining contractual life as of December 27, 2003 was 8.7
years.
F-28
EYE CARE CENTERS OF AMERICA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollar amounts in thousands unless indicated otherwise)
Following is a summary of director option activity for fiscal years 2001, 2002 and 2003.
WEIGHTED WEIGHTED
AVERAGE OPTION AVERAGE OPTION
EXERCISE PRICE OPTIONS EXERCISE PRICE OPTIONS
PER SHARE($) OUTSTANDING PER SHARE($) EXERCISABLE
--------------- --------------- ----------------- ------------
Outstanding December 30, 2000 10.51 126,412 10.41 59,456
Granted . . . . . . . . . . . - - - -
Became exercisable. . . . . . - - 11.63 2,500
Canceled or expired . . . . . 10.51 (126,412) 10.46 (61,956)
--------------- ------------
Outstanding December 29, 2001 - - - -
Granted . . . . . . . . . . . 5.39 131,412 - -
Became exercisable. . . . . . - - 5.00 63,206
Canceled or expired . . . . . - - - -
--------------- ------------
Outstanding December 28, 2002 5.39 131,412 5.00 63,206
Granted . . . . . . . . . . . 15.13 5,000 - -
Became exercisable. . . . . . - - 5.39 32,853
Canceled or expired . . . . . - - - -
--------------- ------------
Outstanding December 27, 2003 5.74 136,412 5.13 96,059
=============== ============
The Company has elected to follow Accounting Principles Board Opinion No.
25 "Accounting for Stock Issued to Employees" ("APB 25") and related
interpretations in accounting for its employee stock options because, as
discussed below, the alternative fair value accounting provided for under FASB
Statement No. 123 "Accounting for Stock-Based Compensation," requires use of
option valuation models that were not developed for use in valuing employee
stock options of privately held companies. Under APB 25, because the exercise
price of the Company's employee stock options equals the estimated fair value of
the underlying stock on the date of grant, no compensation expense is
recognized.
The fair value for these options was estimated at the date of the grant
using the minimum value method with the following assumptions for 2002 and 2003:
risk-free interest rate of 3%, no dividend yield and a weighted-average expected
life of the options of 4 years.
Option valuation models require the input of highly subjective assumptions.
Because the Company's employee stock options have characteristics significantly
different from those of traded options, and because changes in the subjective
input assumptions can
F-29
EYE CARE CENTERS OF AMERICA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollar amounts in thousands unless indicated otherwise)
materially affect the fair value estimate, in management's opinion, the existing
models do not necessarily provide a reliable single measure of the fair value of
its employee stock options.
13. INCOME TAXES
The provision (benefit) for income taxes is comprised of the following:
YEAR ENDED
--------------------------------------------
DECEMBER 29, DECEMBER 28, DECEMBER 27,
2001 2002 2003
------------- ------------- --------------
Current. $ 1,239 $ 1,258 $ 4,415
Deferred - - (14,015)
------------- ------------- --------------
$ 1,239 $ 1,258 $ (9,600)
============= ============= ==============
The reconciliation between the federal statutory tax rate at 34% and the
Company's effective tax rate is as follows:
YEAR ENDED
----------------------------------------------
DECEMBER 29, DECEMBER 28, DECEMBER 27,
2001 2002 2003
-------------- -------------- --------------
Expected tax expense (benefit). $ (2,663) $ 5,166 $ 5,510
Provision to return adjustment. - - 2,087
State taxes . . . . . . . . . . - - 1,320
Goodwill. . . . . . . . . . . . 1,483 - -
Other . . . . . . . . . . . . . 680 2,473 2,351
Change in valuation allowance . 1,739 (6,074) (20,868)
-------------- -------------- --------------
$ 1,239 $ 1,565 $ (9,600)
============== ============== ==============
The above reconciliation takes into account certain entities that are
consolidated for financial accounting purposes but are not consolidated for tax
purposes, therefore, the net operating loss carryforward cannot offset the
income from the non-consolidated entities.
F-30
EYE CARE CENTERS OF AMERICA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollar amounts in thousands unless indicated otherwise)
The components of the net deferred tax assets are as follows:
DECEMBER 28, DECEMBER 27,
2002 2003
-------------- --------------
Total deferred tax assets, current. . . . . $ 2,117 $ 844
Total deferred tax liabilities, current . . (705) (274)
Valuation allowance . . . . . . . . . . . . (1,412) -
-------------- --------------
Net deferred tax asset, current. . - 570
============== ==============
Total deferred tax assets, long-term. . . . 21,439 16,713
Total deferred tax liabilities, long-term . (1,983) (3,268)
Valuation allowance . . . . . . . . . . . . (19,456) -
-------------- --------------
Net deferred tax assets, long term $ - $ 13,445
============== ==============
The sources of the differences between the financial accounting and tax
assets and liabilities which give rise to the deferred tax assets and deferred
tax liabilities are as follows:
DECEMBER 28, DECEMBER 27,
2002 2003
-------------- -------------
Deferred tax assets:
Fixed asset depreciation differences . . . $ 9,791 $ 10,976
Net operating loss and credit carryforward 5,769 1,841
Gain on debt purchase. . . . . . . . . . . 2,315 1,881
Allowance for bad debts. . . . . . . . . . 1,121 563
Other. . . . . . . . . . . . . . . . . . . 1,417 869
Gain on asset disposals. . . . . . . . . . - 465
Inventory basis differences. . . . . . . . 482 438
Accrued salaries . . . . . . . . . . . . . 611 256
Deferred rent. . . . . . . . . . . . . . . 1,138 187
Deferred revenue . . . . . . . . . . . . . 921 81
-------------- -------------
Total deferred tax assets. . . . . . . . . . . . . 23,565 17,557
Deferred tax liabilities:
Goodwill . . . . . . . . . . . . . . . . . 811 2,197
Deferred financing costs . . . . . . . . . 612 731
Other. . . . . . . . . . . . . . . . . . . 300 320
Prepaid expense. . . . . . . . . . . . . . 705 273
Store pre-opening costs. . . . . . . . . . 269 21
-------------- -------------
Total deferred tax liability . . . . . . . . . . . 2,697 3,542
-------------- -------------
Net deferred tax assets. . . . . . . . . . 20,868 14,015
Valuation allowance. . . . . . . . . . . . (20,868) -
-------------- -------------
Net deferred tax assets. . . . . . . . . . . . . . $ - $ 14,015
============== =============
F-31
EYE CARE CENTERS OF AMERICA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollar amounts in thousands unless indicated otherwise)
At December 28, 2002 and December 27, 2003, the Company had net operating loss
carryforward for tax purposes of $16,967 and $5,413, respectively. These loss
carryforwards will expire from 2008 through 2018 if not utilized. Although
realization is not assured due to historical taxable income and the probability
of future taxable income, management believes it is more likely than not that
all of the deferred tax asset will be realized. Accordingly the Company's
valuation allowance was fully released in 2003.
14. EMPLOYEE BENEFITS
401(k) Plan. The Company maintains a defined contribution plan whereby
substantially all employees who have been employed for at least six consecutive
months are eligible to participate. Contributions are made by the Company as a
percentage of employee contributions. In addition, discretionary contributions
may be made at the direction of the Company's Board of Directors. Total Company
contributions were approximately $220, $214 and $235 for fiscal years 2001, 2002
and 2003, respectively.
15. LEASES
The Company is obligated as lessee under operating leases for substantially
all of the Company's retail facilities as well as certain warehouse space. In
addition to rental payments, the leases generally provide for payment by the
Company of property taxes, insurance, maintenance and its pro rata share of
common area maintenance. These leases range in terms of up to 15 years. Certain
leases also provide for additional rent in excess of the base rentals calculated
as a percentage of sales.
The Company subleases a portion of substantially all of the stores to an
independent optometrist or a corporation controlled by an independent
optometrist. The terms of these leases or subleases are principally one to seven
years with rentals consisting of a percentage of gross receipts, base rentals,
or a combination of both. Certain of these leases contain renewal options.
Certain of the Company's lease agreements contain provisions for scheduled
rent increases or provide for occupancy periods during which no rent payment is
required. For financial statement purposes, rent expense is recorded based on
the total rentals due over the entire lease term and charged to rent expense on
a straight-line basis. The difference between the actual cash rentals paid and
rent expenses recorded for financial statement purposes is recorded as a
deferred rent obligation. At the end of fiscal years 2002 and 2003, deferred
rent obligations aggregated approximately $4.6 million and $4.7 million,
respectively.
Rent expense for all locations, net of lease and sublease income, is as
follows. For the purposes of this table, base rent expense includes common area
maintenance costs. Common area maintenance costs were approximately 21%, 21% and
22% of base rent expense for fiscal years 2001, 2002 and 2003, respectively.
F-32
EYE CARE CENTERS OF AMERICA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollar amounts in thousands unless indicated otherwise)
DECEMBER 29, DECEMBER 28, DECEMBER 27,
2001 2002 2003
-------------- -------------- --------------
Base rent expense. . . . . $ 38,666 $ 40,364 $ 41,483
Rent as a percent of sales 266 436 478
Lease and sublease income. (4,259) (4,435) (3,326)
-------------- -------------- --------------
Rent expense, net. . . . . $ 34,673 $ 36,365 $ 38,635
============== ============== ==============
Future minimum lease payments, excluding common area maintenance costs, net
of future minimum lease and sublease income under irrevocable operating leases
for the next five years and beyond are as follows:
OPERATING LEASE AND OPERATING
RENTAL SUBLEASE LEASE,
PAYMENTS INCOME NET
---------- ----------- ----------
2004. . . . . . . . . . . . . . . . . . $ 31,941 $ (1,749) $ 30,192
2005. . . . . . . . . . . . . . . . . . 28,846 (914) 27,932
2006. . . . . . . . . . . . . . . . . . 24,720 (624) 24,096
2007. . . . . . . . . . . . . . . . . . 21,035 (414) 20,621
2008. . . . . . . . . . . . . . . . . . 18,210 (225) 17,985
Beyond 2008 . . . . . . . . . . . . . . 34,946 (232) 34,714
---------- ----------- ----------
Total minimum lease payments/(receipts) $ 159,698 $ (4,158) $ 155,540
========== =========== ==========
16. COMMITMENTS AND CONTINGENCIES
The Company is involved in various claims and legal actions arising in the
ordinary course of business. In the opinion of management, the ultimate
disposition of these matters will not have a material adverse effect on the
Company's consolidated financial position or consolidated results of operations.
F-33
SCHEDULE II
EYE CARE CENTERS OF AMERICA, INC.
CONSOLIDATED VALUATION AND QUALIFYING ACCOUNTS
(Dollar amounts in thousands unless indicated otherwise)
ADDITIONS
--------------------------
CHARGED TO CHARGED TO
BALANCE AT CREDITED CREDITED DEDUCTIONS BALANCE
BEGINNING OF FROM COST FROM OTHER FROM AT CLOSE
PERIOD AND EXPENSES ACCOUNTS RESERVE OF PERIOD
------------- ------------- ----------- ------------ ----------
Allowance for doubtful accounts of
current receivables:
Year ended December 29, 2001 . . . . . . . . . . . $ 3,937 $ 919 $ - $ - $ 4,856
Year ended December 28, 2002 . . . . . . . . . . . 4,856 - - (565) 4,291
Year ended December 27, 2003 . . . . . . . . . . . 4,291 - - (315) 3,976
Inventory obsolescence reserves:
Year ended December 29, 2001 . . . . . . . . . . . 1,004 95 - - 1,099
Year ended December 28, 2002 . . . . . . . . . . . 1,099 - - (422) 677
Year ended December 27, 2003 . . . . . . . . . . . $ 677 $ - $ - $ (81) $ 596
F-34