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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

FORM 10-Q

For the Quarterly Period Ended September 30, 2003

OR

For the Transition Period from ____________________ to ______________________

Commission File No. 0-22623

OCULAR SCIENCES, INC.

(925) 969-7000
(Registrant’s telephone number, including area code)

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 o.

Indicate by check mark whether the Registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2). YES x NO o.

As of October 23, 2003, there were outstanding 24,012,662 shares of the registrant’s Common Stock, par value $0.001 per share.

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OCULAR SCIENCES, INC.

INDEX

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PART I — FINANCIAL INFORMATION

ITEM 1. Financial Statements

OCULAR SCIENCES, INC.
Condensed Consolidated Balance Sheets
(In thousands, except share and per share data)

•

The consolidated balance sheet at December 31, 2002 has been derived from the Company’s audited consolidated financial statements at that date, but does not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements.

See accompanying notes to condensed consolidated financial statements.

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OCULAR SCIENCES, INC.
Condensed Consolidated Statements of Income — (unaudited)
(In thousands, except share and per share data)

See accompanying notes to condensed consolidated financial statements.

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OCULAR SCIENCES, INC.
Condensed Consolidated Statements of Cash Flows — (unaudited)
(In thousands)

See accompanying notes to condensed consolidated financial statements.

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OCULAR SCIENCES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Note 1 — Basis of Preparation

     The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not contain all of the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements. The accompanying unaudited condensed consolidated financial statements have been prepared on the same basis as the audited consolidated financial statements at and for the year ended December 31, 2002 and, in the opinion of management, include all adjustments, consisting only of normal recurring adjustments, necessary for the fair presentation of the company’s financial condition as of September 30, 2003, the results of the company’s operations for the three and nine-month periods ended September 30, 2003 and 2002, and its cash flows for the nine months ended September 30, 2003 and 2002. These unaudited condensed consolidated financial statements should be read in conjunction with the company’s audited consolidated financial statements as of December 31, 2002 and 2001 and for each of the three years ended December 31, 2002, including notes thereto, included in the company’s Annual Report on Form 10-K for the year ended December 31, 2002. Operating results for the nine months ended September 30, 2003 are not necessarily indicative of the results that may be expected for the year ending December 31, 2003.

Certain prior year amounts have been changed to conform to current year presentation.

All amounts, unless otherwise indicated are in U.S. dollars.

Note 2 — New Accounting Standards

     The Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 146, “Accounting for Costs Associated with Exit or Disposal Activities” in June 2002. SFAS No. 146 addresses accounting and reporting for costs associated with exit and disposal activities and supercedes EITF No. 94-3, “Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring).” SFAS No. 146 requires that a liability for a cost associated with an exit or disposal activity be recognized when the liability is incurred, as defined by the Statement. Under EITF 94-3, an exit cost was recognized at the date an entity committed to an exit plan. Additionally, SFAS No. 146 provides that exit and disposal costs should be measured at fair value and that the associated liability be adjusted for changes in estimated cash flows. The company adopted SFAS No. 146 effective January 1, 2003 on a prospective basis.

     In November 2002, the FASB issued Interpretation No. 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness to Others,” an interpretation of FASB Statements No. 5, 57 and 107 and a rescission of FASB Interpretation No. 34. This interpretation elaborates on the disclosures to be made by guarantor in its interim and annual financial statements about its obligations under guarantees issued. The interpretation also clarifies that a guarantor is required to recognize, at inception of a guarantee, a liability for the fair value of the obligation undertaken. The initial recognition and measurement provisions of the interpretation are applicable to guarantees issued or modified after December 31, 2002 and have not had a material effect on the company’s financial statements.

     In December 2002, the FASB issued SFAS No. 148 “Accounting for Stock-Based Compensation — Transition and Disclosure,” which amends SFAS No. 123, “Accounting for Stock-Based Compensation.” SFAS 148 provides alternative methods of transition for a voluntary change to the fair value method of accounting for stock-based compensation. In addition, SFAS No. 148 amends the disclosure requirements of SFAS No. 123 to require prominent disclosure 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 has adopted SFAS No. 148 effective January 1, 2003 and the company has made the disclosure requirements under Critical Accounting Policies of the “Management discussion and analysis of financial conditions and results of operations” section of

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this Form 10-Q.

     In April 2003, the FASB issued SFAS No. 149, “Amendments of Statement 133 on Derivative Instruments and Hedging Activities,” which amends and clarifies financial accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts and for hedging activities under SFAS No. 133. This statement is effective for contracts entered into or modified after September 30, 2003, with certain exceptions, and for hedging relationships designated after September 30, 2003. The Company does not expect adoption of SFAS No. 149 to have a material impact on its consolidated financial statements.

     In May 2003, the FASB issued SFAS No. 150, “Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity,” which establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. Financial instruments that are within the scope of the statement, which previously were often classified as equity, must now be classified as liabilities. This statement is effective for financial instruments entered into or modified after May 31, 2003, and otherwise shall be effective at the beginning of the first interim period beginning after June 15, 2003. The company adopted SFAS No. 150 effective July 1, 2003. The statement has not had a material impact on the company’s consolidated financial statements.

Note 3 — Balance Sheet Items

     Inventories consisted of the following (in thousands):

     Prepaid expenses and other current assets consisted of the following (in thousands):

     Accrued liabilities consisted of the following (in thousands):

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Other long-term liabilities consisted of the following (in thousands):

Note 4 — Comprehensive Income

Comprehensive income consisted of (in thousands):

     *     net of taxes

Note 5 — Goodwill and Other Intangible Assets

Goodwill and other intangible assets (gross) consisted of the following (in thousands):

     Accumulated amortization consisted of the following (in thousands):

     Goodwill and other intangible assets, net of accumulated amortization, consisted of the following (in thousands):

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The total weighted average amortization period of intangible assets subject to amortization is approximately 11 years.

     Intangible assets subject to amortization consist primarily of marketing rights, patents, customer lists, core technology and trade names. Amortization expense for intangible assets subject to amortization amounted to approximately $0.5 million and $1.6 million for the three and nine months ended September 30, 2003, respectively and approximately $0.6 million and $1.4 million for the three and nine months ended September 30, 2002, respectively.

     Amortization expense for each of the five succeeding fiscal years will amount to approximately (in thousands):

Note 6 — Net Income Per Share

     In accordance with SFAS No. 128, “Earnings Per Share,” basic earnings per share is calculated using the weighted average number of common shares outstanding during the period. Diluted earnings per share is calculated using the weighted average number of common shares and dilutive potential common shares outstanding during the period. Dilutive potential common shares represent shares issuable upon the exercise of outstanding options and are calculated using the treasury stock method.

     Options to purchase 1,294,755 and 2,304,680 shares of the company’s common stock were not included in the computation of diluted earnings per share because their exercise prices were greater than the average market price of the company’s common stock of $21.38 and $17.48 per share for the three and nine months ended September 30, 2003 respectively. Options to purchase 971,720 and 813,270 shares of the company’s common stock for the three and nine months ended September 30, 2002, respectively, were not included in the computation of diluted earnings per share because their exercise prices were greater than the average market price of our common stock of $24.05 and $25.89 per share, respectively.

Note 7 — Acquisitions

Acquisition of the Contact Lens Business of Essilor

     On February 12, 2001, the company acquired the contact lens business of Essilor International (Compagnie Generale d’Optique) S. A. (“Essilor”). The company acquired Essilor’s sales and distribution assets of the contact lens business in Europe and the United States and manufacturing facilities in France, the United Kingdom and the United States. The primary reasons for this acquisition were to expand the company’s presence in Europe and to increase its breadth of product offerings.

     Included in the liabilities assumed are accruals for costs associated with exiting certain activities and facilities of the acquired Essilor operations that were considered duplicative. This includes accruals for severance costs related to workforce reductions across all functions and exit costs associated with exiting certain facilities, dismantling equipment and other miscellaneous exit costs. Details of the exit costs and severance costs paid and charged against the accrual are presented in the following table (in thousands):

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Acquisition of Assets of Seiko Contactlens, Inc.

     On March 11, 2002, the company entered into an agreement to acquire certain assets of Seiko Contactlens, Inc. (“Seiko”). The purchase was completed on April 1, 2002. The primary reasons for this acquisition were to strengthen the company’s presence and enhance its competitive positioning in Japan.

     Included in the liabilities assumed are accruals for costs associated with exiting certain activities and facilities of the acquired Seiko operations that were considered duplicative. This includes accruals for severance costs related to workforce reductions across all functions and exit costs associated with exiting certain activities and facilities. Details of the severance and exit costs paid and charged against the accrual are presented in the following table (in thousands):

     Management began formulating the plans to exit certain activities and facilities of the acquired Seiko operations at the time of the acquisition and expects to complete all actions under such plans by December 31, 2003.

Note 8 — Restructuring and related expenses

     During the fourth quarter of 2002, the company accelerated the implementation of its second-generation manufacturing process throughout its high volume product lines. Given the lower labor and space requirements of these processes, the company will consolidate its manufacturing operations into a smaller total plant structure. The initiative will allow the company to meet volume production goals in substantially less space with lower manufacturing overhead. The company believes that this initiative will result in an annual cost savings of $40 million beginning in 2005. The company expects the initiative to be completed by 2004. The company expects to incur total restructuring and related expenses of $50 - $55 million in connection with this initiative. Approximately $25 million of these expenses are expected to be non-cash.

     As a result of this initiative, the company recorded a restructuring charge of approximately $34.5 million in the fourth quarter of 2002. Of the $34.5 million, approximately $24.7 million related to impairment of property and equipment, $4.7 million related to employee severance and benefit costs, $4.4 million related to leased facilities that will be abandoned within one year and the remaining $0.7 million relates to miscellaneous costs, such as professional fees related to the initiative.

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     The company recorded additional charges of approximately $2.4 million and $7.4 million during the three and nine months ended September 30, 2003, respectively. Of the $2.4 million charged during the three months ended September 30, 2003, approximately $1.2 million related to severance and other salary related and benefit costs, and $1.2 million related to other costs. Of the $7.4 million charged during the nine months ended September 30, 2003, approximately $4.9 million related to severance and other salary related and benefit costs, and $2.5 million related to other costs.

     Of the $41.9 million of restructuring charges incurred since the inception of the restructuring initiative, $7.2 million of cash has been spent.

     For leased facilities that will be abandoned and subleased, the lease costs represent future lease payments subsequent to abandonment less estimated sublease income. For owned property and equipment, the impairment loss recognized was based on the estimated fair value of the equipment.

     The following table summarizes the restructuring and related expense accrual activity from the initiation of the company’s activities (in thousands):

Note 9 — Credit Facility

     On April 16, 2002, the company completed a new $50 million credit facility with two banks. Revolving loans under this facility mature on April 16, 2005, and bear interest at 0.50% below one of the bank’s prime rate or 1.00% to 1.50% above the eurodollar rate depending on the company’s ratio of total funded debt to earnings before interest and taxes plus non-cash charges. The facility provides an option to convert any outstanding revolving loans (not to exceed $40 million) at the maturity date to a four-year term loan. The term loan, once repaid, may not be reborrowed. This credit agreement contains covenants, which, among other things, require the company to maintain certain financial ratios. As of September 30, 2003, there was $17.5 million of revolving loans outstanding under this credit agreement and the interest rates were 2.12% and 3.5% on loan balances of $14.5 million and $3.0 million respectively. This revolving loan is included in long-term liabilities in the accompanying balance sheet as of September 30, 2003 based on the company’s ability and intent to defer payment beyond September 30, 2004. Borrowings under this agreement are secured by a pledge of 100% of the outstanding common stock of Ocular Sciences Puerto Rico and Sunsoft, Inc. and 65% of the outstanding common stock of its Barbados and Canadian subsidiaries. As of September 30, 2003, the company was in compliance with its covenants.

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

     The following discussion should be read in conjunction with the unaudited condensed consolidated financial statements and notes thereto included in Part I — Item 1 of this Quarterly Report and the audited consolidated financial statements and notes thereto and Management’s Discussion and Analysis of Financial Condition and Results of Operations contained in our Annual Report on Form 10-K for the year ended December 31, 2002.

     This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended, and Section 27A of the Securities Act of 1933, as amended. Such

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statements relate to our future performance and plans, results of operations, capital expenditures, acquisitions and operating improvements and costs. You can identify forward-looking statements by the use of forward-looking terminology such as “believes,” “expects,” “may,” “will,” “should,” “seeks,” “approximately,” “intends,” “plans,” “pro forma,” “estimates” or “anticipates” or the negative of these words and phrases or similar words or phrases. You can also identify forward-looking statements by discussions of strategy, plans or intentions. Forward-looking statements involve numerous risks and uncertainties and you should not rely upon them as predictions of future events. There is no assurance that the events or circumstances reflected in forward-looking statements will be achieved or will occur.

Forward-looking statements are necessarily dependent on assumptions, data, or methods that may be incorrect or imprecise and we may not be able to realize them. Factors that could cause actual results and future events to differ materially from those set forth or contemplated in the forward-looking statements include risks associated with the overall economic environment, the integration of the Essilor and Seiko Contactlens businesses, the impact of competitive products and pricing, product demand both domestically and overseas, market receptiveness to various product launches, higher than expected employee turnover, potential difficulties in implementing second generation manufacturing processes or in obtaining anticipated cost reductions, customer bad debts, currency fluctuations, other risks of doing business internationally and the other risks detailed in the sections entitled “Item 1, Business — Risk Factors,” and “Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations” and elsewhere in our Annual Report on Form 10-K for the year ended December 31, 2002, and from time to time our other reports filed with the Securities and Exchange Commission. We caution you not to place undue reliance on forward-looking statements, which reflect our analysis only and speak as of the date of this report or as of the dates indicated in the statements. Unless the context otherwise requires, the terms “we”, “us”, and “our” refer to Ocular Sciences, Inc. and its subsidiaries.

Acquisition

     On April 1, 2002, we acquired certain assets of Seiko Contactlens, Inc. (“Seiko”). The purchase price was $21.6 million. Seiko had been our distributor in Japan. We have accounted for the acquisition under the purchase method. Accordingly, the operating results of Seiko have been included in our operating results from April 1, 2002. The $21.6 million purchase price was comprised of an exchange of accounts receivable of $11.2 million, cash of $8.8 million and acquisition costs of $1.6 million. There were no contingent payments, pre-acquisition contingencies or other commitments specified in the acquisition agreement.

Critical Accounting Policies

     Our critical accounting policies are as follows:

	•		revenue recognition;
	•		estimating valuation allowances;
	•		accounting for income taxes;
	•		valuation of long-lived and intangible assets and goodwill;
	•		estimates inherent in purchase accounting; and
	•		stock-based compensation

Revenue Recognition

     Revenue is recognized based on the terms of sale with the customer, generally upon product shipment. We have established programs that, under specified conditions, enable our customers to return product. We establish reserves for estimated returns and allowances at the time revenues are recognized. In addition, accruals for customer discounts and rebates are recorded when revenues are recognized. Amounts billed to customers in sale transactions related to shipping and handling are classified as revenue. The process of establishing reserves requires significant

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management judgment. In the event that actual results differ from these estimates or we adjust these estimates in future periods, our financial position and results of operations could be materially impacted.

Estimating Valuation Allowances

     The preparation of financial statements requires management to make estimates and assumptions that affect the reported amount of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period.

     We specifically analyze the aging of accounts receivable and historical bad debts, customer concentrations, customer credit-worthiness, current economic trends and changes in customer payment terms and sales returns when evaluating the adequacy of the allowance for doubtful accounts and sales returns in any accounting period. We sell our products to a diverse group of optometrists, optical retailers, optical product distributors and ophthalmologists, and therefore the concentration of credit risk with respect to accounts receivable is limited due to the large number and diversity of customers across broad geographic areas. Accounts receivable from customers are uncollateralized. To reduce credit risk, we perform ongoing credit evaluations of significant customers’ respective financial conditions. We establish an allowance for doubtful accounts based upon factors surrounding the credit risk of specific customers, historical trends and other information.

     We assess the need for reserves on inventory generally based on monthly forward projections of sales of products that are updated periodically. Inventories are recorded at the lower of cost (first-in, first-out method) or market. Cost includes material, labor and applicable factory overhead. The reported value of our inventory includes saleable products, promotional products, raw materials and componentry that will be sold or used in future periods. Provision for potentially obsolete or slow moving inventory is made based upon our analysis of inventory levels and forecasted sales. Once inventory is reserved, the reserve can only be relieved by the subsequent sale or disposal of the inventory.

     Material differences may result in the amount and timing of revenue and/or expenses for any period if different judgments had been made or different estimates utilized.

Accounting for Income Taxes

     Income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax effects attributable to differences between financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.

     In preparing our consolidated financial statements, we are required to estimate our income taxes in each of the jurisdictions in which we operate. This process involves estimating actual current tax liability together with assessing temporary differences resulting from differing treatment of items for tax and accounting purposes. These differences result in deferred tax assets and liabilities, which are included within the consolidated balance sheet. Significant management judgment is required in determining the provision for income taxes and deferred tax assets and liabilities. In the event that actual results differ from these estimates or we adjust these estimates in future periods, our financial position and results of operations could be materially impacted.

Valuation of Long-Lived and Intangible Assets and Goodwill

     We periodically review long-lived assets and certain identifiable intangible assets for impairment in accordance with Statement of Financial Accounting Standards (SFAS) No. 144, “Accounting for the Impairment or Disposal of Long-lived Assets”. Goodwill and certain intangible assets, which are not subject to amortization, are periodically reviewed for impairment in accordance with SFAS No. 142, “Goodwill and Other Intangible Assets.”

     For assets to be held and used, including acquired intangibles, we initiate our review whenever events or changes in circumstances indicate that the carrying amount of goodwill and intangible assets may not be recoverable.

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Recoverability of an asset is measured by comparison of its carrying amount to the expected future undiscounted cash flows (without interest charges) that the asset is expected to generate. Any impairment to be recognized is measured by the amount by which the carrying amount of the asset exceeds its fair market value. Significant management judgment is required in this process.

     In January 2002, SFAS No. 142 became effective and as a result, we have ceased to amortize goodwill and assembled workforce beginning January 1, 2002. As of September 30, 2003, unamortized goodwill and assembled workforce was approximately $44 million. In lieu of amortization, we were required to perform an initial impairment review of goodwill in 2002 and an annual impairment review thereafter. We completed the first step of SFAS No. 142 transitional goodwill impairment test and determined that as of January 1, 2002 our goodwill had not been impaired. During the fourth quarter of 2002, we performed our annual impairment test and concluded that there is no impairment of our goodwill. In the future, we will perform the annual impairment test required by SFAS No. 142 in the fourth quarter of each year. We cannot assure you that a material impairment charge will not be recorded in the future.

Estimates Inherent in Purchase Accounting

     Purchase accounting requires extensive use of accounting estimates and judgments to allocate the purchase price to the fair value of the assets purchased and liabilities assumed. In our recording of the acquisitions of the assets of Essilor and Seiko Contactlens, values were assigned to identifiable intangible assets based on management’s forecasts and projections that include assumptions related to future revenues and cash flows generated from the acquired assets.

Stock-Based Compensation

     We account for stock-based compensation using methods prescribed in Accounting Principles Board (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees,” and related Interpretations. We have adopted the disclosure-only provisions of SFAS No. 123 “Accounting for Stock-Based Compensation”.

     In accordance with SFAS No. 123, as amended by SFAS No. 148, “Accounting for Stock-Based Compensation-Transition and Disclosure,” we have provided, below, the pro forma disclosures of the effect on net income and earnings per share as if SFAS No. 123 had been applied in measuring compensation expense for all periods presented.

     The following table illustrates, pursuant to SFAS No. 123, as amended by SFAS No. 148, the effect on net income and related net income per share for the three and nine months ended September 30, 2003 and 2002, had compensation cost for stock-based compensation plans been determined based upon the fair value method prescribed under SFAS No. 123:

New Accounting Pronouncements Adopted

     See Note 2 to Notes to Condensed Consolidated Financial Statements which are incorporated herein by

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reference.

Results of Operations

     The following table summarizes certain items on the consolidated statements of income as a percentage of net sales:

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