UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-K

 

ý ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934

 

For the fiscal year ended January 1, 2005

 

or

 

o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934

 

Commission file number 001-16635

 

National Vision, Inc.

(Exact name of registrant as specified in its charter)

 

Georgia		58-1910859
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)
296 Grayson Highway Lawrenceville, Georgia		30045
(Address of principal executive offices)		(Zip Code)
Registrant’s telephone number, including area code:  (770) 822-3600
Securities registered pursuant to Section 12(b) of the Act:
Common Stock, par value $0.01 per share, with attached Common Stock Purchase Rights
12% Senior Secured Notes due 2009
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 ý No o

 

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. o

 

Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2).

Yes o No ý

 

The aggregate market value of shares of Common Stock held by non-affiliates of the registrant as of July 2, 2004, was approximately $11.0 million based on a closing price of $2.20 per share on the American Stock Exchange on such date.  We have deemed all of our executive officers and directors to be affiliates in computing this amount.

 

The number of shares of Common Stock of the registrant outstanding as of February 28, 2005, was 5,390,929.

 

Indicate by check mark whether the registrant has filed all documents and reports required to be filed by Section 12, 13 or 15(d) of the Securities and Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court. Yes  ýNo o

 

DOCUMENTS INCORPORATED BY REFERENCE

 

None

 

 

 

TABLE OF CONTENTS

 

PART I
Item	1.		Business
Item	2.		Properties
Item	3.		Legal Proceedings
Item	4.		Submission of Matters to a Vote of Security Holders
PART II
Item	5.		Market for Registrant’s Common Stock and Related Stockholder Matters
Item	6.		Selected Financial Data
Item	7.		Management’s Discussion and Analysis of Financial Condition and Results of Operations
Item	7a.		Quantitative and Qualitative Disclosures About Market Risk
Item	8.		Financial Statements and Supplementary Data
Item	9.		Disagreements on Accounting and Financial Disclosure
Item	9a.		Controls and Procedures
Item	9b.		Other Information
PART III
Item	10.		Directors and Executive Officers of the Registrant
Item	11.		Executive Compensation
Item	12.		Security Ownership of Certain Beneficial Owners and Management
Item	13.		Certain Relationships and Related Transactions
Item	14.		Principal Accountant Fees and Services
PART IV
Item	15.		Exhibits and Financial Statement Schedules
			Index to Consolidated Financial Statements and Schedule
			Notes to Consolidated Financial Statements
			Signatures
Ex-10.23			Letter Agreement between the Company and Fleet Retail Group, Inc.
Ex-10.26			Form Performance Unit Award
Ex-21			Subsidiaries of the Registrant
Ex-23.1			Consent of Deloitte & Touche LLP
Ex-31.1			Section 302 Certification of the CEO
Ex-31.2			Section 302 Certification of the CFO
Ex-32.1			Section 906 Certifications of the CEO & CFO

 

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PART I

 

In this Annual Report on Form 10-K, “National Vision,” the “Company,” “we,” “us” and “our” mean National Vision, Inc. and its subsidiaries.

 

Our fiscal year ends on the Saturday closest to December 31.  Throughout this Annual Report on Form 10-K, depending on the context in which used, “2004” refers either to January 1, 2005 or the 52-week fiscal year then ended, “2003” refers either to January 3, 2004 or the 53-week fiscal year then ended, “2002” refers either to December 28, 2002 or the 52-week fiscal year then ended, “2001” refers either to December 29, 2001 or the 52-week fiscal year then ended and “2000” refers either to December 30, 2000 or the 52-week fiscal year then ended.

 

This Form 10-K contains forward-looking statements regarding our plans, strategies, objectives, beliefs and intentions.  The words “believe”, “anticipate”, “plan”, “expect” and similar expressions are intended to identify forward-looking statements.  Forward-looking statements represent our expectations concerning future events.  The actual outcome of the events described in these forward-looking statements could differ materially from our expectations.  See “Management’s Discussion and Analysis of Financial Condition and Results of Operations - Risk Factors” for a discussion of the factors and risks that could contribute to such potentially material differences.

 

Item 1.  Business

 

Unless otherwise expressly stated, all information in Item 1 of this annual Report on Form 10-K is as of January 1, 2005.

 

Overview

 

Our primary business is the operation of 416 retail vision centers in the United States and Mexico.  Approximately 96% of our 2004 net revenue from continuing operations was derived from these retail vision centers.  Based on information available to us through industry publications, we believe we are the fifth largest operator of retail vision centers in the United States.  However, as described below, our store count began declining during the last half of 2002.

 

Our vision centers are located inside 339 Wal-Mart stores (including 35 in Mexico), 47 Fred Meyer stores and on 28 U.S. military bases located in the United States or one of its possessions.  We also operate two freestanding stores in the United States.

 

Our vision centers sell a wide range of optical products including eyeglasses, contact lenses, sunglasses and a variety of optical accessories.  Independent optometrists operate their own practices adjacent to or within substantially all of our vision centers, providing our customers with convenient access to eye examinations and contact lens fittings.  We also operate two centralized optical labs and distribution centers.

 

As described in the remainder of this “Overview” section and elsewhere in this Annual Report on Form 10-K, we face two significant challenges.  The first of these is an annual contraction of our store count in domestic Wal-Mart stores.  The second is the restrictive nature of our Senior Subordinated Notes, the mandatory redemption provisions of which periodically reduce the cash we might otherwise have available to invest in new optical ventures and certain other provisions of which may limit our spending on non-optical business ventures.

 

Leases with Wal-Mart.  We depend on our domestic Wal-Mart vision centers for the bulk of our revenues and cash flow.  Our domestic Wal-Mart vision centers account for 73% of our total store count at January 1, 2005, and 82% of our net revenue from continuing operations for the year then ended.  Our leases with Wal-Mart for domestic locations have begun to expire in significant numbers.  The lease on each domestic Wal-Mart store provides for a nine-year initial term and a three-year renewal term.  No additional renewal options are available to us.  However, our tenure in any particular location will be extended if our vision center is relocated because Wal-Mart converts such host location to a Supercenter, in which case our lease term starts anew from the relocation date.  To our knowledge, Wal-Mart is the only other entity operating vision centers within its domestic stores, and we believe that Wal-Mart typically opens its own vision centers in the spaces we vacate.  We believe that Wal-Mart is the second largest operator of retail vision centers in the United States.  Wal-Mart has not offered us leases for additional optical stores or renewals of expiring leases in the United States.  Since opening our 400th store inside a domestic Wal-Mart location in 2001, we have, through January 1, 2005, closed 96 such stores.  We expect to close 33 domestic Wal-Mart locations in 2005 as a result of lease expirations.

 

As a result of our declining number of vision centers in Wal-Mart stores, we devote substantial attention to developing new businesses.  We have begun to open freestanding vision centers and we are seeking to expand our presence on military bases.  We may also seek to acquire vision center locations.  During 2004 we also tested the viability of a retail home medical equipment concept by opening two locations inside

 

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domestic Wal-Mart stores.  We expect to terminate this test during 2005.

 

Senior Subordinated Notes.  Our 12% Senior Subordinated Notes, which were issued when we emerged from bankruptcy in 2001, result in substantial payments of principal and interest.  The associated Note Indenture provides that we make, subject to the terms of the Indenture, mandatory redemptions at par every six months.  The redemptions are based upon a contractual computation of cash generated during the period and are subject to our maintaining a minimum $3.0 million consolidated cash balance.  These mandatory redemption requirements may limit our ability to invest in new optical ventures.  Through February 28, 2005, we have redeemed approximately $21.4 million of Notes at par.  Additionally, we have repurchased, in negotiated or open market transactions, Notes with a par value of $25.7 million at an aggregate cost of approximately $18.6 million.  We hope to continue to repurchase Notes from time to time in negotiated or open market transactions; however, we were able to purchase only small amounts of Notes at discounted prices during the fourth quarter of 2004 and do not expect to be able to purchase any significant amount of Notes at a discount to par in the foreseeable future.  As a result of both mandatory redemption payments and discounted repurchases, we have reduced this indebtedness by $47.1 million through February 28, 2005.  The Notes mature on March 30, 2009.

 

Certain provisions of the Indenture may also limit our ability to invest in non-optical new business ventures.  One such provision provides that we may not spend more than $1.0 million in businesses “…which are not the same, similar or reasonably related to the businesses in which the Company…” was engaged on May 31, 2001.  Through February 28, 2005, we made expenditures of $735,000 in connection with our test of the aforementioned retail home medical equipment  (“HME”) concept.  See “Risk Factors - Our pursuit of other lines of business could be constrained by the terms of our indenture.”

 

Review of Strategic Alternatives.  To help address the challenges described above, in May 2004 our Board of Directors engaged TM Capital Corp. as financial advisors to review our strategic alternatives.  Such strategic alternatives could possibly include a refinancing of the 12% Notes or a more extensive recapitalization, a sale of the Company or a controlling interest therein, or a merger with or acquisition of another entity or other entities.  This strategic review is continuing and we have engaged in extensive discussions and investigation of several of these alternatives.  There is no assurance that any transaction will be pursued or, if pursued, consummated.

 

History of the Company

 

The Company was incorporated as a Georgia corporation in 1990 under the name National Vision Associates, Ltd., when we entered into a master license agreement with Wal-Mart Stores, Inc.  As subsequently amended through 1994, the agreement gave us the right to open 400 vision centers in Wal-Mart stores in the United States.  We opened the 400th such store in 2001.

 

In late 1997, the Company made a strategic decision to diversify our revenue base through acquisitions in the freestanding optical market.  In October 1997, we acquired Midwest Vision, Inc. with 51 freestanding retail optical centers in four midwestern states.  In July 1998, we acquired Frame-n-Lens Optical, Inc. with 150 freestanding vision centers in California and 120 vision centers located within Sam’s Clubs.  In October 1998, we acquired New West Eyeworks, Inc. with 175 retail optical centers in 13 states, including approximately 120 vision centers in freestanding locations and more than 50 host vision centers in Fred Meyer stores.  Following the acquisitions, we changed our name to Vista Eyecare, Inc.  To fund the acquisitions, we issued $125 million of Senior Subordinated Notes due 2005 bearing interest at 12.75% per annum.

 

Sales shortfalls in the freestanding stores caused adverse pressure on cash flow and liquidity.  After failing to negotiate an out-of-court restructuring with the holders of the then-outstanding Senior Subordinated Notes, we filed for reorganization under Chapter 11 of the bankruptcy code on April 5, 2000.

 

During the bankruptcy process, we closed or disposed of all of our freestanding stores and closed all of our host vision centers operating in Sam’s Clubs and in Meijer Thrifty Acres stores.  We emerged from the bankruptcy reorganization process on May 31, 2001, as an operator of 503 vision centers located in host environments and on military bases.  At that time, we changed our name to National Vision, Inc.

 

Since the date we emerged from bankruptcy, we have opened 28 vision centers (including two freestanding stores that were relocated from nearby Wal-Mart locations at the time our leases therein expired), and two home medical equipment stores, and we have closed 115 vision centers, as follows:

 

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		Retail Vision Centers												Retail
		Inside U.S. Wal-Mart Stores		Inside Wal-Mart Stores in Mexico		Inside Fred Meyer Stores		On U.S. Military Bases		Free- Standing Stores		Total No. of Vision Centers		Home Medical Equipment Stores
Store count, May 31, 2001		398		30		55		20		0		503		0
Store openings		2		7		4		13		2		28		2
Store closings		(96	)	(2	)	(12	)	(5	)	0		(115	)	0
Store count, January 1, 2005		304		35		47		28		2		416		2
Net change during period		(94	)	5		(8	)	8		2		(87	)

 

Of our 96 Wal-Mart locations that have closed since we emerged from bankruptcy, 13 were underperforming stores that we closed prior to lease expiration and eight were stores for which we did not exercise the 3-year renewal option because store economics were not attractive under the higher minimum rent structure in effect during the renewal period.  All remaining domestic Wal-Mart store closings were the result of final expiration of the lease and all available extensions or renewal options.

 

All closings of Wal-Mart Mexico and Fred Meyer stores since May 29, 2001, have been the result of our early termination of leases due to poor operating performance at the locations.

 

All military store closings have been the result of lease expirations.

 

We closed 60 stores in 2004 and these are included in the activity reported in the preceding table.  Store opening and closing activity for 2004 only is presented in the following table:

 

		Retail Vision Centers												Retail
		Inside U.S. Wal-Mart Stores		Inside Wal-Mart Stores in Mexico		Inside Fred Meyer Stores		On U.S. Military Bases		Free- Standing Stores		Total No. of Vision Centers		Home Medical Equipment Stores
Store count, January 4, 2004		359		37		47		25		0		468		0
Store openings		0		0		0		6		2		8		2
Store closings		(55	)	(2	)	0		(3	)	0		(60	)	0
Store count, January 1, 2005		304		35		47		28		2		416		2
Net change during fiscal 2004		(55	)	(2	)	0		3		2		(52	)

 

Of our 55 Wal-Mart domestic locations that closed during 2004, 13 were underperforming stores that we closed prior to lease expiration, eight were stores for which we did not exercise the 3-year renewal option and 34 were closed at lease expiration.  We relocated two of the closed Wal-Mart vision centers to freestanding locations.

 

We expect to close our two Home Medical Equipment stores during 2005.

 

See “Management’s Discussion and Analysis of Financial Condition and Results of Operations - Lease Agreements” for additional information regarding our lease agreements and a schedule of lease expiration dates.

 

Dependence on Domestic Wal-Mart Vision Centers

 

As of January 1, 2005, we operated 304 vision centers in domestic Wal-Mart stores, all of which operate pursuant to a master license agreement (see “Management’s Discussion and Analysis of Financial Condition and Results of Operations - Lease

 

5

 

Agreements”).  These units generated approximately 82% of our net revenue in 2004.  Further, the average profitability of our domestic Wal-Mart vision centers, measured as a percent of sales, is the highest of any of our retail operations.  We therefore depend on Wal-Mart and on our agreement with them for our continued viability unless and until we develop a replacement business.

 

Retail Vision Center Operations

 

Our retail vision centers occupy between 500 and 3,000 square feet, including areas for merchandise display, customer service, and contact lens fitting.  Each vision center maintains inventory of approximately 900 eyeglass frames and 450 pairs of contact lenses, along with sunglasses and other optical accessories.  Our two optical laboratories deliver prescription eyewear to our vision centers.  Approximately 63% of our vision centers have a finishing laboratory, which allows the vision center to provide one-hour service for most single vision prescription lenses.  These vision centers carry inventory of approximately 850 pairs of spectacle lenses.

 

Optometrists are important to the success of our vision centers.  We strive to have an optometrist locate a practice adjacent to or within most of our locations.  These optometrists are typically independent from us and, except in California, lease their premises from us.  The rent we typically charge to these optometrists covers both the premises and the equipment which we provide.  Our agreement with Wal-Mart contemplates that we generally will have an optometrist on duty at least 48 hours each week.  Our relationships with optometrists are subject to extensive regulation.  (See “Government Regulation” below.)

 

Our Test of Freestanding Retail Locations

 

We operate two freestanding stores which were opened in August 2004 and November 2004.  In both instances, our managers and other store associates moved to the new locations from our closed vision centers in the nearby Wal-Mart, and the independent optometrists that practiced adjacent to the closed vision centers also elected to move their practices to our new locations.

 

Our two freestanding vision centers have a larger retail selling area than is typical of our locations in host environments, and offer a larger selection of spectacle frames, including more branded merchandise.

 

These two freestanding stores were opened as a test.  We intend to expand the test by opening between 12 and 18 additional freestanding stores in 2005.  Our historical strength has been operating stores within host environments.  Operating within a host such as Wal-Mart provides high visibility and customer traffic with below average advertising and promotional costs.  Our new freestanding locations were not expected to generate, and have not generated, revenues at the same level that had been achieved when we operated in the Wal-Mart nearby.  We also planned to spend, and are spending, more on advertising and promotion for these stores than has been typical in our host locations.  Our plans to expand this test are contingent upon, among other factors, finding appropriate store locations and retaining our store managers and other associates.  Further, we may discontinue expansion of this test at any time if we are unable to maintain targeted revenue and profitability levels at new locations as we continue to expand the concept.

 

During the period from January 1, 2005 through March 21, 2005, we have opened two additional freestanding locations and executed leases for two others.

 

Managed Vision Care

 

We believe that managed care sales are and will remain a significant percent of total optical industry sales.  Under managed vision care plans, members fulfill their eyecare and eyewear needs at either 1) specific locations designated by the plan sponsor or 2) locations outside of the plan’s network where the provider can accept assignment of benefits as an “out-of-network” provider.  Our declining base of vision centers may adversely affect our ability to compete for managed care contracts. (See “Risk Factors - Our declining base of vision centers in Wal-Mart stores could make it more difficult for us to compete.”) Managed care sales accounted for approximately 11%, 12% and 11% of our retail sales in 2004, 2003 and 2002, respectively.  We believe that our managed care sales as a percent of our total sales are significantly lower than industry averages.

 

Intellectual Property

 

Our vision centers in Wal-Mart are identified as the “Vision Center located in Wal-Mart” in the United States and as “Opticas Centro de Vision” in Mexico.  Our vision centers on U.S. military bases are identified by a variety of names such as “National Vision Optical,” “Vision Center,” and “Optical Shop.”  Our vision centers within Fred Meyer operate as “The

 

6

 

Optical Shoppe.”  These names reflect our belief that we benefit more from the customer traffic generated by our hosts than we do from consumer recognition of our trade names, and that our customers will return for future purchases based on their positive impression of our operations and store associates.  We therefore do not engage in significant promotional activity pertaining to our host store names.

 

We operate our two new freestanding vision centers under the name “Vision Center II.”  We are promoting this brand name to emphasize the continuity between our closed Wal-Mart locations and our nearby locations outside of the Wal-Mart environment.

 

Lease Agreements

 

We have agreements governing our operations in host environments that typically provide for payments of minimum and percentage rent.  See “Management’s Discussion and Analysis of Financial Condition and Results of Operations - Lease Agreements”.

 

Purchasing

 

To improve purchasing efficiencies, we generally attempt to purchase from a limited number of suppliers the merchandise, supplies and component parts (spectacle lenses and frames) required for the various products we sell.  We believe, however, that all merchandise, supplies and component parts are available from a large number of suppliers and manufacturers, and are generally readily available.  Our purchases are generally not made under long-term contracts.  We believe that the loss of any one supplier or manufacturer would not have a material adverse effect on our operations.

 

Manufacturing and Distribution

 

We operate two central lab and distribution facilities that supply substantially all merchandise requirements of our domestic vision centers.  The facilities are located in Lawrenceville, Georgia and St. Cloud, Minnesota.  Our Lawrenceville facility also includes our central administrative offices.

 

Our lab and distribution facilities provide spectacle lenses, frames, finished spectacles, contact lenses, sunglasses, optical supplies and eyewear accessories to our retail locations.  We use an overnight delivery service to ship completed orders and replenishment items to the vision centers.  The manufacturing and distribution facilities are interfaced with our management information system.  Raw materials consist of frames and lenses which are readily available from multiple vendors.

 

Government Regulation

 

Our business is heavily regulated by federal, state and local law.

 

We must comply with federal laws such as the Social Security Act (which applies to our participation in Medicare programs), the Health Insurance Portability and Accountability Act of 1996 (“HIPAA”) (which governs our participation in managed care programs), and the Food and Drug Administration Act (which regulates medical devices such as contact lenses).  We also must comply with the privacy and security regulations under HIPAA.

 

Many states also have adopted laws that mirror the federal laws described above.  In addition, all states have passed laws that govern or affect our arrangements with the optometrists who practice in or adjacent to our vision centers and many states require the presence of licensed opticians during hours when prescription eyewear is being dispensed.  Some states, such as California, Texas, North Carolina and Kansas, have particularly extensive and burdensome requirements that affect the way we do business.  In California, optometrists who practice adjacent to our retail locations are sublicensees and contract providers to a subsidiary, which is licensed as a specialized health care service plan.  (See “HMO Operations” below.)  Local ordinances (such as zoning requirements) can also impose significant burdens and costs of compliance.  Frequently, our competitors sit on state and local boards.  Our risks and costs of compliance are often increased as a result.

 

We believe that we substantially comply with material regulations that apply to our business.

 

Competition

 

The retail eye care industry is highly competitive.  We compete with large national retailers such as LensCrafters and Pearle.  We also compete with numerous regional and local optical chains.  Independent optometrists, ophthalmologists and opticians often provide many of the same goods and services we provide.  In addition to benefiting from the customer traffic generated

 

7

 

by our hosts, we compete on the basis of our competitive pricing policies, product selection, training programs, quality of products and service, and consistency of service.

 

We also compete for managed care contracts, which can allow us to provide better service to our managed care customers by filing claims directly with the payor and collecting only the applicable co-pay amount from the customer.  Our declining base of vision centers may adversely affect our ability to compete for managed care contracts. (See “Risk Factors - Our declining base of vision centers in Wal-Mart stores could make it more difficult for us to compete.”)

 

Several of our competitors have significantly greater financial resources than we do.  As a result, they are able to advertise extensively and may be able to engage in extensive and prolonged price promotions that may adversely affect our business.    In 2004, our two largest competitors merged.  The merger could adversely affect our business.  (See “Risk Factors - - The retail eyecare industry is extremely competitive.”)

 

Seasonality

 

Our vision centers’ business is moderately seasonal in a pattern that we believe is also experienced by others in the industry.  Generally, our lowest sales volume occurs during our fourth fiscal quarter, when we believe consumers concentrate much of their spending on general and holiday merchandise.  Our highest sales volume occurs during our first fiscal quarter, perhaps as the natural and opposing result of some consumers’ decisions to defer their eye-care expenditures until after the holiday season.  Additionally, individuals who participate in employer-sponsored healthcare plans may have new funds available for medical expenditures at the start of each new year.

 

HMO Operations

 

In California, we sell memberships in an eye examination benefit plan and provide eye examination services through a wholly owned subsidiary (the “HMO”) that is licensed to operate as a specialized health care service plan.  This subsidiary’s optometric offices are generally located adjacent to retail optical centers inside host retail stores.

 

Prior to 2004, the HMO’s optometric offices were located only in California Wal-Mart stores in which we operated a vision center.  The HMO’s leases with Wal-Mart for its offices were co-terminus with our leases for the vision center.  Therefore, as each of our vision center leases expired, the HMO would close its office in that location.  The HMO operated 93 such offices at the end of 2002 and 83 such offices at the end of 2003.

 

During 2004, the HMO began expanding its business by opening and operating offices within certain California Wal-Mart and Sam’s Club locations in which the vision center was operated by Wal-Mart.  In some instances and contrary to its prior practice, Wal-Mart offered the HMO an opportunity to continue operating its office in a particular location after we had closed our vision center in that location.  In other instances, the HMO was offered the opportunity to open an office in a Wal-Mart or Sam’s Club location in which we had not previously operated a vision center.  This change allowed the HMO to grow in California in 2004, even as we closed another 13 vision center locations due to lease expiration.  At the end of 2004, the HMO operated 95 optometric examination offices in California Wal-Mart and Sam’s locations, a net increase of 12 offices during the year.  Of these 95 offices, 70 are adjacent to vision centers that we operate and 25 are in California Wal-Mart or Sam’s locations in which Wal-Mart operates the vision center.

 

Prior to 2004, the HMO sublet each of its offices to independent optometrists who conducted eye examinations in these offices.  The HMO collected sublicense payments from these doctors in exchange for their use of the HMO’s space and examination equipment.  During 2004, the HMO began to contract with licensed optometrists to conduct patient eye examinations in some of its offices.  Under this approach the optometrists are contract employees of the HMO rather than sublicensees.

 

Subsequent to January 1, 2005, and through February 28, 2005, the HMO opened ten additional California offices adjacent to vision centers operated by Wal-Mart, increasing its office total to 105, the most it has ever operated.  The HMO expects to open between 18 and 28 additional new locations during the remainder of 2005.

 

Home Medical Equipment Stores

 

In 2004, we opened, as a test, home medical equipment (“HME”) stores inside two domestic Wal-Mart locations.  Neither HME store replaced an existing vision center.  In these stores, we sell products such as wheelchairs, scooters, walkers, lift chairs, diabetic shoes and hosiery, bathroom safety equipment and various orthopedic products.

 

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The industry research we conducted prior to opening these two stores indicated that new medical equipment stores require three years to ramp up to stable sales volumes.  Our operating projections assumed net losses for the first twelve months each store operates.  The stores’ results have fallen short of revenue projections and operating losses have exceeded projected levels.  We expect to terminate this test during 2005 and either close the stores or transfer them to an independent operator.  As a result, we recorded a non-cash impairment charge of $125,000 in 2004 to write down the value of the long-lived assets at these stores to their fair market value.

 

Operations in Mexico

 

Through a wholly owned subsidiary, we operate 35 vision centers in Mexico under a master license agreement with Wal-Mart de Mexico (see “Management’s Discussion and Analysis of Financial Condition and Results of Operations - Lease Agreements”).  Our operations in Mexico face unique risks, such as currency devaluations, inflation and difficulties in cross-cultural marketing.

 

Information relative to sales and long-lived assets for the United States and Mexico for each of our three most recent fiscal years is summarized as follows (amounts in thousands):

 

		United States			Mexico			Consolidated
2004:
Sales from continuing operations during year		$	224,455		$	4,397		$	228,852
Long-lived assets at end of year		$	97,471		$	571		$	98,042
2003:
Sales from continuing operations during year		$	212,439		$	4,275		$	216,714
Long-lived assets at end of year		$	106,065		$	833		$	106,898
2002:
Sales from continuing operations during year		$	192,912		$	4,910		$	197,822
Long-lived assets at end of year		$	118,177		$	1,204		$	119,381

 

Subsequent to January 1, 2005, we closed four of our vision centers in Mexico.  We expect to open one new vision center in Mexico in April 2005.

 

Employees

 

We employ a total of 2,547 associates, 1,913 on a full-time basis and 634 on a part-time basis.  We have 2,062 associates engaged in retail sales, 245 in laboratory and distribution operations, and 240 in management and administration.  Apart from our retail associates in Mexico, none of our associates is governed by any collective bargaining agreements.  We believe our labor relations to be satisfactory.

 

Our Web Site and Availability of SEC Reports

 

Our corporate web site is located at www.nationalvision.com.  We make available on our web site, free of charge and as soon as reasonably practicable after we file them with the Securities and Exchange Commission (“SEC”), copies of our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and any amendments to those reports.

 

These reports may also be obtained from the SEC’s web site, www.sec.gov, or directly from us (without charge) upon written request to National Vision, Inc., 296 Grayson Highway, Lawrenceville, GA 30045, Attn: Investor Relations.

 

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Item 2.  Properties

 

We own no real estate and operate solely from leased facilities.  The following table presents the number and location of retail vision centers we operated at the end of each of the last three fiscal years:

 

		2002				2003				2004
		Inside				Inside				Inside
		Wal-Mart				Wal-Mart				Wal-Mart
		Stores		Total		Stores		Total		Stores		Total
Domestic:
Alabama		7		8		6		8		4		6
Alaska		3		13		3		11		3		11
Arizona		14		14		11		11		10		10
California		94		97		83		86		70		72
Colorado		8		8		8		8		8		8
Connecticut		9		10		9		10		9		9
Florida		2		5		2		5		2		5
Georgia		36		37		34		36		28		30
Hawaii		4		4		4		4		4		4
Idaho		0		3		0		3		0		3
Kansas		10		10		9		9		8		8
Kentucky		1		1		1		1		0		0
Louisiana		1		1		1		1		1		1
Maine		0		1		0		1		0		1
Maryland		1		3		1		3		1		3
Massachusetts		5		5		5		5		4		4
Minnesota		1		1		0		0		0		0
Montana		2		2		2		2		2		2
Nevada		7		7		5		5		4		5
New Hampshire		4		4		3		3		3		3
New Jersey		13		13		13		13		12		15
New Mexico		10		10		10		10		9		9
New York		26		26		24		24		18		19
North Carolina		60		60		53		53		43		44
North Dakota		4		4		0		0		0		0
Oregon		9		34		9		30		6		27
Pennsylvania		18		18		17		17		14		14
Puerto Rico		0		1		0		1		0		1
South Carolina		11		11		10		10		8		8
South Dakota		1		1		1		1		1		1
Tennessee		1		2		0		1		0		1
Texas		6		7		4		6		3		7
Virginia		20		23		20		23		18		20
Washington		3		29		3		22		3		22
West Virginia		7		7		7		7		7		7
Wyoming		1		1		1		1		1		1
Total Domestic		399		481		359		431		304		381
International - Mexico		37		37		37		37		35		35
Total		436		518		396		468		339		416

 

At January 1, 2005, our wholly owned HMO subsidiary leased space within 95 California Wal-Mart stores, including the 70 stores within which we operated a vision center.  Leases for HMO offices that are adjacent to our vision centers expire on the same date the lease for the vision center expires, unless extended by agreement with Wal-Mart.  Leases for HMO offices located adjacent to vision centers operated by Wal-Mart expire at various dates.

 

At January 1, 2005, we operate two leased home medical equipment stores, one in Tennessee and the other in Pennsylvania.

 

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The leases for these two locations are for a five-year term commencing in May 2004.  Because the stores were opened as a test, the leases also provided for an early termination, at our option, after twelve months and prior to the end of the eighteenth month.  On February 28, 2005, we notified Wal-Mart of our intent to terminate the leases during the early termination period.  See “Management’s Discussion and Analysis of Financial Condition and Results of Operations - Lease Agreements.”

 

Our corporate offices, retail support center and one of our labs and distribution centers are all located in a 66,000 square foot leased facility located in Lawrenceville, Georgia.  This building is leased through January 2009.

 

A second optical laboratory and distribution center is located in a 20,000 square foot leased facility located in St. Cloud, Minnesota.   This lease expires in October 2007.

 

Item 3.  Legal Proceedings

 

Litigation in Oklahoma.  On October 5, 2004, we filed a lawsuit in the District Court of Oklahoma County, Oklahoma (Case No. CJ-2004-8170) against the District Attorney for Oklahoma County.  Our lawsuit seeks a declaratory judgment that we may operate vision centers in Oklahoma in space subleased from Wal-Mart.  To date, certain Oklahoma statutes have been broadly interpreted as preventing any optical chain from operating vision centers in space leased from retailers such as Wal-Mart.  We have developed a business model for our proposed operations in that state that we believe complies with the applicable legal requirements. On February 19, 2005, a state court judge held that our proposed business model does not comply with applicable legal requirements.  We intend to appeal this decision.  There are no assurances that we will obtain a favorable and final judgement from the Oklahoma courts.

 

Litigation in California.  On September 3, 2003, the Second Appellate District of the California Court of Appeal affirmed a prior judgment of the Los Angeles County Superior Court (Case No. BC 274257) dismissing litigation that had been instituted against us on May 20, 2002 by Consumer Cause, Inc. alleging that our business model in California failed to comply with applicable legal requirements.  The complaint sought attorney fees and an injunction prohibiting us from continuing the alleged violations.  The case brought by Consumer Cause, Inc. against us was similar to a case previously brought by the California Attorney General against one of our competitors, alleging, among other things, that their business model fails to comply with applicable legal requirements. See “Risk Factors - We are subject to state and local regulation of the vision care industry”.

 

Other Litigation.  We are from time to time involved in litigation in the ordinary course of our business, none of which has had or is expected to have a material adverse impact on our financial position or results of operations.

 

Item 4.  Submission of Matters to a Vote of Security Holders

 

No matters were submitted to a vote of security holders during the last quarter of fiscal 2004.

 

11

 

PART II

 

Item 5.  Market for Registrant’s Common Stock and Related Stockholder Matters

 

Our Common Stock is listed on the American Stock Exchange under the symbol “NVI”.  The following table sets forth for the periods indicated the high and low prices of our Common Stock.

 

		Fiscal Quarter Ended		High			Low
Fiscal 2003		March 29, 2003		$	0.47		$	0.32
		June 28, 2003		$	0.69		$	0.25
		September 27, 2003		$	0.90		$	0.55
		January 3, 2004		$	2.75		$	0.67
Fiscal 2004		April 3, 2004		$	2.56		$	1.51
		July 3, 2004		$	2.62		$	1.54
		October 2, 2004		$	6.20		$	2.06
		January 1, 2005		$	9.25		$	4.76

 

As of February 28, 2005, there were approximately 677 holders of record of our Common Stock.

 

We have never paid dividends on our common stock.  In addition, both our indenture and our credit facility prohibit us from paying cash dividends.

 

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Item 6.  Selected Financial Data

 

We emerged from bankruptcy on May 31, 2001.  Effective as of June 2, 2001, we implemented “fresh start” accounting.  As a result, all assets and liabilities were restated to reflect their respective fair values at that date.  The consolidated financial statements after that date are identified as “Successor” financial statements in the table below and represent those of a new reporting entity.  The Successor financial statements are not comparable to the financial statements of the pre-confirmation company, which are identified as “Predecessor” financial statements in the table below.

 

At the beginning of 2002, we adopted Financial Accounting Standard No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets” (“FAS No. 144”) which includes a requirement that discontinued operations be evaluated at the lowest level to which cash flow is attributed.  Accordingly, except for two of our closed Wal-Mart vision centers that we relocated as freestanding stores in 2004, we classify closed stores as “Discontinued Operations.”  Revenues and expenses attributable to closed HMO offices are also classified as Discontinued Operations, whereas we report within results of continuing operations the operating results of HMO offices that remain open in a Wal-Mart location after our vision center closes.  Locations that were closed or disposed of prior to the adoption of FAS No. 144 did not qualify for Discontinued Operations presentation and are included in Continuing Operations for the periods during which they operated.

 

This summary should be read in conjunction with the consolidated financial statements and related notes included in this Annual Report on Form 10-K as well as the sections of this report entitled Business (Item 1) and Management’s Discussion and Analysis of Financial Condition and Results of Operations (Item 7).

 

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											2001
		2004			2003			2002			Seven months ended December 29, 2001			Five months ended June 2, 2001				2000
		Successor												Predecessor
Continuing Operations:
Total net revenue		$	228,852		$	216,714		$	197,822		$	108,134		$		99,346		$		257,852
Gross profit		$	127,685		$	119,182		$	110,284		$	60,232		$		52,183		$		138,004
Gross profit percentage		55.9		%	55.0		%	55.6		%	55.7		%	52.5			%	53.5			%
Operating income (loss) from continuing operations		$	16,566		$	5,378		$	1,295		$	(8	)	$		(7,409	)	$		(13,301	)
Discontinued Operations:
Income from discontinued operations, net of taxes		$	2,252		$	1,996		$	4,564		$	2,537		$		2,185		$	6,888
All Operations:
Interest expense		$	10,595		$	12,913		$	14,099		$	8,459		$		1,154		$	7,783
Cumulative effect of change in accounting principle		—			$	(564	)	—			—			—				—
Net earnings (loss)		$	12,375		$	(3,868	)	$	(6,204	)	$	(5,860	)	$	113,323			$	(139,880		)
														(See Note)				(See Note)
Net earnings (loss) per basic share:
Earnings (loss) from continuing operations		$	1.99		$	(1.05	)	$	(2.15	)	$	(1.68	)	$	4.44			$	(6.73		)
Net earnings (loss)		$	2.43		$	(0.77	)	$	(1.24	)	$	(1.17	)	$	5.35			$	(6.61		)
Net earnings (loss) per diluted share:
Earnings (loss) from continuing operations		$	1.81		$	(1.05	)	$	(2.15	)	$	(1.68	)	$	4.44			$	(6.73		)
Net earnings (loss)		$	2.21		$	(0.77	)	$	(1.24	)	$	(1.17	)	$	5.35			$	(6.61		)
Balance Sheet Data:
Total assets		$	135,110		$	140,297		$	153,801		$	171,217		$	186,688			$	90,888
Long-term debt		$	72,930		$	94,939		$	105,882		$	118,403		$	120,000			$	139,109
Shareholders’ equity (deficit)		$	21,422		$	8,870		$	12,829		$	19,274		$	25,000			$	(113,323		)
Cash Flow Data:
Net cash provided by operating activities		$	23,725		$	10,802		$	13,124		$	4,813		$	9,564			$	18,589
Depreciation and amortization		$	13,542		$	15,962		$	18,999		$	11,425		$		4,808		$		17,526
Capital expenditures		$	5,137		$	4,517		$	5,209		$	2,750		$		2,084		$		5,379
Statistical Data:
Vision centers open at end of period: Leased department vision centers		414			468			518			514			503				499
Freestanding vision centers		2			—			—			—			—				226
Number of closed retail optical locations: Included in continuing operations		—			—			—			—			226				322
Included in discontinued operations		58			112			113			113			109				91

 

Note:                   The net loss for 2000 includes reorganization expenses of $121.5 million, of which $100.8 million represented impairment of goodwill.  Net earnings for the five months ended June 2, 2001, include net reorganization gains of $96.5 million, with more than 100% of such net gains arising from our implementation of  fresh-start accounting.

 

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Item 7.  Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

Overview

 

We are primarily an optical retailer.  More than 96% of our 2004 net revenue from continuing operations was derived from sales of prescription eyewear (spectacles and contact lenses) and other optical merchandise we sell in the 414 vision centers we operated as of January 1, 2005 within host environments and from our two recently opened freestanding stores.

 

Wal-Mart is our most important vision center host. Our locations inside domestic Wal-Mart stores account for 73% of our total store count at January 1, 2005, and 82% of our net revenue from continuing operations for the year then ended.  We have closed 96 of our domestic Wal-Mart locations in the last three fiscal years, primarily because our contractual right to continue to occupy the space expired, and we expect another 33 leases to expire in 2005.  Although we believe that we maintain an excellent tenant relationship with Wal-Mart, we nonetheless believe that Wal-Mart will continue its practice of opening its own domestic corporate vision centers in the spaces we vacate.  Accordingly, we do not believe that Wal-Mart will offer to extend any of our expiring leases in the United States.

 

We seek to be a growth retailer.  The domestic Wal-Mart store closings represent a significant challenge to overcome if we are to achieve our objective.  Our primary strategies as we entered 2004 were to:

 

•                  optimize the profitability of our existing store base to maximize the time we have to develop sustainable growth vehicles,

 

•                  develop growth opportunities within optics but outside of Wal-Mart, and

 

•                  drawing upon our strong relationship with Wal-Mart, test non-optics retail opportunities inside Wal-Mart stores.

 

The following discussion provides information regarding our progress against these three primary strategies, our primary objectives for 2005, changes in certain key operating measures over the last three years, how certain accounting principles affect our financial statements, our arrangements for leased retail space and our liquidity.  This discussion should be read in conjunction with our financial statements and notes included herein.

 

Summary of 2004 Results

 

During 2004, we made great progress towards optimizing the profitability of our existing store base, we tested a non-optics retail opportunity inside Wal-Mart and we continued to attempt to develop other growth opportunities within optics.  The year’s highlights were:

 

•                  Our domestic comparable store sales growth, a key internal measure of operating success used by retailers, was +6.5%.  This was on top of domestic comparable store sales growth of +6.1% in the prior year.

 

•                  Gross margins achieved on our continuing operations sales of optical products and services grew 110 basis points to 56.6%.

 

•                  Net cash provided by operating activities grew to $23.7 million, a 120% increase from net cash provided by operating activities in 2003 and the highest such measure in the Company’s history.

 

•                  Net income of $12.4 million represented a profit turnaround of $16.2 million versus the prior year.

 

•                  We realized gains of $3.2 million on repurchases of our Senior Subordinated Notes.

 

•                  We reduced the outstanding balance of our Senior Subordinated Notes by 18.5%, from $95.5 million at January 3, 2004, to $77.8 million at January 1, 2005.  Subsequently, we made an additional payment of principal of $4.9 million in February 2005, reducing the Note balance to $72.9 million.

 

•                  We relocated two of our Wal-Mart vision centers, in West Berlin, New Jersey, and Watertown, New York, to freestanding locations.  These are the first two locations in what we expect to be an expanding test of our ability to operate outside of host environments.

 

•                  We continued to grow our military business, with a net gain of three stores during the year and successful bids for

 

15

 

three more locations that will open during the first half of 2005.  Through March 21, 2005, we have opened two of these locations and been awarded a contract for one additional location.

 

•                  We filed a lawsuit in Oklahoma that, if successful, could potentially enable us to open vision centers leased from Wal-Mart in that state.  We can provide no assurance of a favorable outcome.  If the legal outcome is favorable, we can provide no assurance that Wal-Mart would lease space to us in Oklahoma. See “Legal Proceedings”.

 

•                  We expanded our California HMO into new Wal-Mart and Sam’s Club locations in which Wal-Mart operates a vision center.

 

Additionally, in May 2004 our Board of Directors engaged TM Capital Corp. as financial advisors to review our strategic alternatives and we have engaged in extensive discussions and investigation of several of these alternatives.

 

The foundation for the operational improvements we achieved in 2004 had, in fact, been put into place in the last half of 2002 and throughout, but particularly in the first half of 2003.  Changes made during that period affected almost every aspect of our base business, including:

 

•                  our frame and lens selection and the number of suppliers from which we purchased these components,

 

•                  the materials used to help consumers better understand the spectacle lens choices available to them,

 

•                  pricing and organization of in-store spectacle frame displays,

 

•                  store staffing levels,

 

•                  incentive programs for store managers and other store associates, and

 

•                  store manager and associate training and evaluation measurements.

 

In addition to these changes in store operations, during August 2003 we reduced home office and field supervision staffing levels.

 

During 2004 we made fewer changes, but continued to enhance our training programs and refine our product procurement activities with initiatives that included the direct importation of a limited number of spectacle frames.

 

Primary Objectives for 2005

 

The TM Capital review of our strategic alternatives is continuing.  Such strategic alternatives could possibly include a refinancing of the 12% Notes or a more extensive recapitalization, a sale of the Company or a controlling interest therein, or a merger with or acquisition of another entity or other entities.  We have engaged in extensive discussions and investigation of several of these alternatives.  Because there is no assurance that any such transaction will be pursued or, if pursued, consummated, the discussion that follows does not take into consideration the potential effects of alternatives that could arise as a result of this strategic review.

 

Our primary objective remains as it has been - to develop ways to overcome the projected annual reduction of our vision centers inside Wal-Mart and become a growth retailer.  To this end, in 2005 our objectives are to:

 

•                  maintain or improve upon the per-store profitability levels we achieved in our base business in 2004,

 

•                  expand by 12 to 18 stores our test of relocating vision centers to freestanding store locations as their leases in Wal-Mart expire,

 

•                  develop other avenues for growth in optical retailing, and

 

•                  continue to grow the number of optometric offices operated in California by our HMO subsidiary.

 

We believe that we will continue to achieve strong operating results in 2005, but that our net income will decline from its 2004 level for the following reasons:

 

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•                  we expect to lose another 33 of our vision center leases inside domestic Wal-Mart stores and our Wal-Mart vision centers are, on average, our most profitable locations,

 

•                  we expect that the planned 12 to 18 relocated freestanding locations will not achieve profitable operating levels during 2005 due to the timing of their openings throughout the year, heavy initial promotional spending and as their sales levels ramp up,

 

•                  we are likely to incur costs and possibly initial operating losses associated with other new optical retail opportunities,

 

•                  we do not expect to be able to duplicate the $3.2 million in pre-tax gains included in 2004 results from repurchases of our Notes at discounted prices, and

 

•                  2004 net income benefited from the reversal of our deferred income tax valuation allowance.  While the amount of income taxes we pay should remain relatively low in 2005, at approximately 5% of consolidated pre-tax income, we expect to record an income tax provision of between 36% and 40% of pre-tax income (see “Critical Accounting Policies and Estimates - Accounting for Income Taxes” below).

 

Results of Operations

 

Total Net Revenue.  Total net revenue from continuing operations consists of sales of optical products and services fees from managed vision care services and sales of home medical products and services.  We operate on a 52/53 week fiscal year.  Fiscal 2003 contained 53 weeks whereas fiscal 2004 and fiscal 2002 each contained 52 weeks.

 

Sales of optical products and services increased 4.9% in 2004 compared to 2003 and 7.3% in 2003 compared to 2002, whereas comparable store sales increased 6.5% in 2004 and 5.7% in 2003.  Comparable store sales are computed based upon stores that were open in the same month of each year within the comparison periods and exclude 2003’s extra week.  During 2003 we made several operational changes designed to improve our sales performance.  These changes positively impacted 2003 sales and had a continuing positive impact on 2004 sales.  While it is difficult to quantify the effect of each of these changes, we believe the following initiatives had the most significant impact on retail sales in 2004 and 2003.

 

1.               In May 2003, we began offering a twelve-month extended warranty plan to provide for repair and replacement of eyeglasses during the first year after purchase.  Revenue recognized from the sales of the warranty plan was approximately $5.4 million in 2004 compared to $1.2 million in 2003.  Amounts collected from the sale of these warranties are recognized as revenues over the twelve-month warranty period on a straight-line basis.  Thus, the year-over-year increase in warranty plan revenue is the result of both (a) selling the plan for all twelve months in 2004 and (b) reaching the point, in May 2004, where monthly revenues recognized approximated one month’s sales of the plan.  Incremental revenues from sales of this warranty plan are, therefore, expected to slow in 2005, particularly beginning in May.

 

2.               We implemented significant merchandising changes in every major product category (frames, spectacle lenses, contact lenses and accessories).  The most significant category changes were as follows:

 

a.         In the first quarter of 2003, we updated our frame collection to modernize and simplify our presentation.  As part of this process, we substantially reduced the number of frame vendors, consolidated price points and enhanced the presentation of frames to make them more brand focused for the customer and easier to manage for our associates.

 

b.        In the fourth quarter of 2003, we consolidated our lens offering to simplify the sales process for our associates and make it easier for the customer to select the lenses that best fit their needs.

 

c.               During the first half of 2003, we aligned our contact lens selection with the products most frequently prescribed by our independent doctors.  This favorably impacted our contact lens sales, which were up approximately 8% in 2004 over 2003 and increased approximately 9% in 2003 compared to 2002.

 

d.              We also updated our accessory collection to complement our spectacle offering, increasing 2003 accessory sales by approximately 19% over 2002.

 

3.               We restructured our personnel scheduling at the store-level to provide for consistent coverage based on operating

 

17

 

needs by sales volume levels.

 

4.               We amended our incentive programs to increase potential participation by, and therefore the productivity of, our associates.

 

5.               In January 2003, we began manufacturing eyeglasses for a small retail optical company.  Total revenue from this line of business was approximately $966,000 and $877,000 in 2004 and 2003, respectively.

 

Managed care sales accounted for approximately 11%, 12% and 11% of our sales of optical products in 2004, 2003 and 2002, respectively.  We work with large and small managed care payors to provide vision benefits to their members.  We expect that sales through managed vision care programs will continue to represent a significant percentage of total retail industry optical sales.  (See “Risk Factors - Our declining base of vision centers in Wal-Mart stores could make it more difficult for us to compete.”)  Changes in the managed vision care industry can significantly impact our sales.  Effective October 1, 2003, a large national managed care payor changed its policy regarding out-of-network providers.  These changes limited our ability to verify benefit coverage and to accept assignment of the payor’s benefits on behalf of certain of our customers.  In 2003, we generated sales of approximately $3.2 million as an out-of-network provider for this payor.  In 2004, sales from this source declined to $186,000.  We are working aggressively to mitigate the decreases in lost sales.  We will continue to work toward adding third party plans and payors as part of our ongoing managed care growth strategy.

 

During the second quarter of 2002, a wholly owned subsidiary (the “HMO”) began aggressively marketing eye examination products and services as a specialized health care service plan in California.  Until January 2004, the HMO operated optometric examination offices only in California Wal-Mart stores in which we operated the vision center.  In January 2004, we also began operating optometric examination offices in certain California Wal-Mart stores in which Wal-Mart operates the vision center.  Fees from managed care vision services include premiums from the HMO’s managed care insurance product and, commencing in 2004,  patient co-payments for exam fees.

 

The increases in fees from managed care vision services in 2004 and 2003 are largely attributable to increased enrollments in our HMO.  The HMO had approximately 168,000, 150,000 and 48,000 members at the end of 2004, 2003 and 2002, respectively.  In 2004 we also generated revenue from patient co-payments of approximately $472,000.

 

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Gross Profit.  The components of sales and gross profit from continuing operations are detailed below (dollars in thousands):

 

		2004								2003							2002
Optical Products and Services:
Sales, net		$				220,759		100.0	%	$			210,368		100.0	%	$	196,123		100.0	%
Cost of goods sold		95,909						43.4	%	93,685					44.5	%	86,139			43.9	%
Gross profit		$			124,850			56.6	%	$			116,683		55.5	%	$	109,984		56.1	%
Managed Care Vision Services:
Revenue		$			7,835			100.0	%	$	6,346				100.0	%	$	1,699		100.0	%
Claims expense		5,066						64.7	%	3,847					60.6	%	1,399			82.3	%
Gross profit		$				2,769		35.3	%	$	2,499				39.4	%	$	300		17.7	%
Home Medical Products:
Sales		$				258		100.0	%
Cost of sales		192						74.4	%
Gross profit		$				66		25.6	%
Total net revenue		$		228,852				100.0	%	$	216,714				100.0	%	$	197,822		100.0	%
Total cost of goods sold		101,167						44.2	%	97,532					45.0	%	87,538			44.3	%
Total gross profit		$	127,685					55.8	%	$		119,182			55.0	%	$	110,284		55.7	%

 

The improvement in gross margin on sales of optical products and services to 56.6 % in 2004 compared to 55.5 % in 2003 was attributable to several factors:

 

1.               Eyeglass margins improved 50 basis points in 2004 compared to 2003.  The improvement in margins was attributable in part to an increase in revenue recognized from the sale of our twelve-month extended warranty plan to approximately $5.4 million in 2004 compared to $1.2 million in 2003.  Eyeglass margins in 2004 were also favorably impacted by a change in our single vision lens offering made in the fourth quarter of 2003, changes made to our multifocal lens offering in 2004 and a reduction in remake and warranty claims in 2004.  These factors were partially offset by lower margins on an increased level of promotional sales, such as the free frames promotion for the purchase of a second pair of eyeglasses which resulted in increased sales and a reduction in inactive inventory, but at reduced margins.

 

2.               A revision in the lease agreement covering all of our Fred Meyer locations became effective in January 2004 resulting in a decrease in rent (a component of cost of sales) for these stores.  We experienced savings in rent expense of approximately $1.2 million in 2004 compared to 2003 which favorably impacted margins as a percent of sales by approximately 0.5%.

 

3.               Margin on contact lens sales improved in 2004 compared to 2003 due to a change to new extended wear contact lens products with higher gross margins.

 

Partially offsetting these improvements in the retail gross margin percentage was a shift in product mix to a higher percentage of contact lens sales and a lower percentage of eyeglass sales.  Contact lens sales, which yield a lower margin than do eyeglass sales, increased by $3.4 million to $45.8 million or 20.8% of total sales of optical products and services in 2004 from $42.4 million or 20.1% of total sales of optical products and services in 2003.  Our eyeglass sales, which include revenue recognized from the sale of our twelve-month extended warranty plan, increased $7.3 million to $165.6 million in 2004 from $158.3 million in 2003, but as a percent of total sales of optical products and services they declined to 75.0% in 2004 from 75.2% in 2003.  A continuation of this trend of declining eyeglass sales as a percent of total sales would have a negative impact on our gross margins.

 

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