ITEM 1. BUSINESS.
THE COMPANY
U.S. Vision, Inc. was formed in March 1990 when the company completed a leveraged buyout of Royal International Optical Corporation and became a publicly traded retail optical company. Royal also owned Styl-Rite Optical Mfg. Co., Inc., which currently manufactures, imports and distributes optical frames and sunglasses principally for sale in the company's retail optical stores, as well as for sale to third party optical retailers.
The majority of the company's outstanding stock was acquired by Royal Associates Acquisition Partnership in December 1994 and, in May 1995, the company effected a one-for-one thousand reverse stock split and deregistered its stock from the Nasdaq SmallCap Market. In March 1997, the company changed its state of incorporation from Pennsylvania to Delaware. In December 1997, the company completed its initial public offering of 2,500,000 shares of stock. The company's stock is listed on the Nasdaq National Market under the symbol "USVI".
Prior to January 31, 1996, the company's fiscal year ended on March 31. Effective January 31, 1996, the company changed its fiscal year end to January 31. References herein to "fiscal 1995," "fiscal 1996," "fiscal 1997" and "fiscal 1998" refer to the ten months ended January 31, 1996, the fiscal year ended January 31, 1997, the fiscal year ended January 31, 1998, and the fiscal year ended January 31, 1999, respectively. The differences in period durations must be considered in making period-to-period comparisons.
U.S. Vision maintains its corporate headquarters at 1 Harmon Drive, Glen Oaks Industrial Blvd., Glendora, New Jersey, 08029. The company's telephone number is (609) 228-1000.
GENERAL
U.S. Vision is a retailer of optical products and services through retail optical departments licensed to operate within national and regional department host stores and through a limited number of freestanding retail locations. As of January 31, 1999, the company operated 614 locations in 48 states, consisting of 557 licensed departments and 57 freestanding stores. The company currently operates 403 J.C. Penney Company, Inc. retail optical departments and is J.C. Penney's primary optical licensee. In addition, the company operates 69 Sears retail optical departments and 85 retail optical departments in regional department stores. The company's freestanding stores are generally located in malls and shopping centers.
U.S. Vision's retail optical departments are generally full-service retail vision care stores that offer an extensive selection of designer brands and private label prescription eyewear, contact lenses, sunglasses and accessories with an on-premises, independent optometrist who performs complete eye examinations and prescribes eyeglasses and contact lenses. The company's extensive selection of designer and private label branded eyewear allows the company to tailor its merchandise selection to meet the needs of the company's host store customers. See "Business -- Products and Services --Merchandise Selection" and "Store Operations."
U.S. Vision operates a single, modern optical laboratory, distribution and lens grinding facility where it fills customer orders for prescription eyewear and maintains a central inventory of frames. Customer orders are placed at the retail stores and are phoned into the central optical laboratory daily, where the lenses are ground, cut, finished and custom fitted to optical frames in the size and style selected by the customer. The finished eyewear is then shipped to the retail store for delivery to the customer within one day upon request, otherwise generally within approximately three to four days. See "Business -- Optical Laboratory and Distribution." Through Styl-Rite, the company manufactures, imports and distributes optical frames and sunglasses principally for sale in its optical stores and to a lesser extent for sale to third party retailers.
Since 1991, the company has been a national provider of managed vision care benefits through its participation in managed vision care programs which offer comprehensive eyewear benefits to managed care participants. Approximately 34% of the company's revenues are attributable to purchases by participants in managed vision care programs. See "Business -- Managed Vision Care."
PRODUCTS AND SERVICES
Merchandise Selection. U.S. Vision carries a full selection of men's, women's and children's eyeglass frames, a complete line of contact lenses, sunglasses and ancillary products for eyeglasses and contact lenses. Prescription eyewear and accessories accounted for 87% of the company's sales during fiscal 1998. The company offers an extensive selection of designer and private label branded eyewear. Designer eyeglass frames offered include Guess, Nautica, Halston and Eddie Bauer, among others and, at certain stores, Giorgio Armani, Calvin Klein and Polo by Ralph Lauren. The company also offers private label branded eyeglass frames such as Hunt Club, Arizona, Ashley Stewart, Oliver Winston, City Slickers and Rascals, among others. U.S. Vision offers a wide variety of value-added eyewear features and services on which it realizes a higher gross margin such as lightweight, virtually unbreakable polycarbonate lenses, including Kodak progressive lenses and plastic photochromic lenses, as well as scratch resistant and anti-reflective coatings. The company carries a complete line of contact lenses by major contact lens manufacturers such as Bausch & Lomb, Wesley Jessen, and Johnson & Johnson, including daily wear and extended wear soft contact lenses and cosmetic tinted lenses. During fiscal 1998, contact lenses accounted for approximately 13% of the company's sales.
Pricing. U.S. Vision maintains a promotional pricing strategy which stresses a quality product delivered at a competitive price. The company's frames and lenses are generally competitively priced, with prices varying based on geographic region. While the company earns a higher gross margin on its private-label lines, designer frames generally command premium prices, resulting in higher gross profit dollars per transaction.
Full Customer Service. U.S. Vision strives to provide its customers with exceptional care and value by combining the personal service typically associated with a private optometrist with the broad product selection and competitive prices of a large optical retailer. Management believes that providing superior customer service from knowledgeable and courteous employees complements the customer-oriented policies of its department store hosts.
MANAGED VISION CARE
Since 1991, U.S. Vision has been a participating provider of managed vision care benefits primarily through Vision One, a national vision care program which offers comprehensive eyewear benefits to over 50 million covered lives through a network of over 2,500 optical locations. Managed care programs are marketed directly to employers, employee benefit plan sponsors and insurance companies such as General Motors, Metropolitan Life, Aetna, Cigna, PruCare HMO and Blue Cross/Blue Shield. Managed care programs give employers the opportunity to offer their employees a group discount at retail optical locations of participating providers with minimal direct cost to the employer. The discounts vary under the plans from fixed percentage discounts to fixed dollar amounts with the balance paid by the subscriber. As a result of these benefits, management believes that many managed care participants have vision examinations on a regular basis and may become more frequent customers of U.S. Vision. In addition, managed care participants frequently apply their discounts and allowances toward the purchase of premium eyeglass products and related accessories. Under the terms of the company's contract with Cole National, a competitor of the company and the owner of the Vision One program, the company pays an administrative fee for each Vision One member transaction. The company's contract with Cole National expires in 2002. The company retains the right, though it has not exercised it in the past, to refuse to participate in particular Vision One programs under which it cannot profitably provide goods and services, and to participate in other managed care vision plans under certain conditions. Approximately 34% of the company's revenues are generated from its participation in various managed vision care programs.
STORE OPERATIONS
Location and Layout. U.S. Vision operates most of its stores on the premises of national and regional host department stores. These stores generally operate under names such as "J.C. Penney Optical Center" and "Sears Optical," which associate the departments with the host store. The company's retail optical departments generally operate under a lease or license arrangement through which the host store collects the sales receipts, retains an agreed upon percentage of sales, which is recorded as rent expense by the company, and remits the remainder to the company on a regular basis. The company's leased retail optical departments typically average in size from 500 to 800 square feet. The company's retail optical departments are often located within the host department store near the host store's other licensed departments such as the beauty salon and photography studio. Management believes that the location of its retail optical departments within a host store influences the company's ability to take full advantage of the host store's customer traffic.
Each store follows a standard merchandise layout plan which is designed to emphasize fashion, invite customer browsing and enhance the customer's shopping experience. All of the company's stores are similar in appearance and are operated under certain uniform standards and procedures. The company has developed a new store prototype design and all of the company's new and remodeled retail optical departments are designed in accordance with this prototype.
U.S. Vision's freestanding stores operate under various trade names such as Royal Optical, Service Optical and Wall & Ochs and are located in malls and shopping centers. A limited number of these stores are housed in freestanding buildings with adjacent parking facilities. The company's freestanding stores generally range in size from 900 to 1,400 square feet.
Store Management. The company's store management structure consists of field managers and store managers. The store managers, along with two to three associates known as Optechs, are responsible for the day-to-day operations of each of the company's retail optical departments. Optechs undertake a comprehensive training program that familiarizes them with the company's product lines, customer services, store procedures and automated systems. The company's national Director of Training is responsible for overseeing the training of the Optechs and updating the company's training materials. Management believes that providing knowledgeable and responsive customer service is an important element of its success and, accordingly, has developed and implemented a variety of employee training and incentive programs.
On-Site Independent Optometrist. The company has made arrangements with licensed optometrists to provide eye examination services at or adjacent to its retail locations in those states where it is permitted. See "Government Regulations." The independent optometrists sublease space and equipment from the company or from the host store. The company and the optometrists do not share in each other's revenues. Management believes the presence of the optometrists at the stores leads to repeat customers and reinforces the quality and professionalism of each store.
RELATIONSHIP WITH HOST STORES
Most of the company's stores operate as licensed optical departments within a host department store such as J.C. Penney, Sears, Federated (Rich's, Burdines and Lazarus), May (Strawbridge's, Famous Barr and L.S. Ayres), Marshall Field's, Dayton's, Hudson's and Carson Pirie Scott, among others. Management believes that the company's relationships with its host stores provide several competitive advantages such as: (a) lower operating expenses; (b) lower initial capital investment; (c) loyal host store customer base; (d) established host store advertising and marketing programs; (e) one-stop shopping convenience; and (f) access to the host store's private label credit card. Management believes its hosts' reputation of quality, trust and value further enhances the company's customer relations.
Management believes it has developed excellent relationships with the host stores in which it operates. Management strives to continue to enhance these relationships. The company routinely consults with the host stores about the size and placement of the company's optical departments within newly opened or remodeled host stores.
The company's retail optical departments within J.C. Penney stores are subject to a master lease that expires in December 2003. Since 1992, the company has opened 168 retail optical departments within J.C. Penney and currently has 403 locations within J.C. Penney. The company's master lease with J.C. Penney provides that only a limited number of the company's J.C. Penney optical centers may be closed by J.C. Penney in any calendar year without cause. This limitation, however, does not apply if J.C. Penney closes an entire J.C. Penney department store, either temporarily or permanently. The lease also provides that J.C. Penney will reimburse the company for certain costs relating to the closed department. The company's optical departments within Sears stores are each subject to a lease which provides for a year-to-year term, subject to early termination by either party, without cause, on thirty-days prior written notice. The company's retail optical departments located within other department stores are subject to lease arrangements which contain short notice lease termination provisions. These leases provide for monthly lease payments based upon a percentage of the company's sales at each location.
In January 1999, as part of the company's growth objectives to diversify its host store base, the company signed master lease agreements with Hudson's Bay Company, which operates over 450 retail locations in Canada In March 1999, the company opened 15 retail optical departments within The Bay, a traditional department store division of Hudson's Bay. In April 1999, the company opened its first location in Zellers, the upscale discount retail division of Hudson's Bay.
MARKETING AND ADVERTISING
U.S. Vision engages in a variety of marketing and promotional efforts to maintain and strengthen its customer base. The company's advertising program is targeted at the department store consumer and is designed to convey a message of value, fashion, convenience and trust to its customer base. The company works with each of its host stores to design advertising programs that convey this message in a manner consistent with that of the host store and are targeted at the specific customer base. For example, the company works with J.C. Penney to develop targeted catalog inserts which advertise the company's J.C. Penney optical departments. These advertising promotions generally mention the availability of on-site professional eye examinations and the company's acceptance, as a participating provider of managed vision care benefits, of the discounts and allowances offered by managed vision care plans. These targeted inserts are mailed to selected customers based on previous spending patterns at the host store. The company actively supports its stores by providing local advertising in individual geographic markets. U.S. Vision has an in-house advertising department which permits it to respond quickly to fashion trends, competitor advertising and promotional initiatives.
OPTICAL LABORATORY AND DISTRIBUTION
U.S. Vision operates a 60,000 square foot modern optical laboratory, distribution and lens grinding facility adjacent to its headquarters in Glendora, New Jersey. Customer orders for prescription eyewear, sunglasses and contact lenses are phoned or faxed in from each of the company's store locations to its central laboratory. Customer orders generally are processed and shipped to stores within three to four working days and many can often be completed overnight if requested by the customer. Most prescription lenses are completed from semi-finished polycarbonate or plastic lenses obtained from third-party suppliers. These lenses are finished in a highly technical process that grinds the surface of the lens to fit the prescription utilizing modern grinding equipment, much of it computer-guided. The lenses are then custom fitted to optical frames in the size and style selected by the customer. Other
prescriptions, including many standard prescriptions, can be manufactured by cutting and edging a prefinished lens, also purchased from a third-party supplier, to fit the frames selected. Contact lenses, accessories and non-prescription sunglass orders are filled from available stock and shipped to the company's retail optical departments.
The company's laboratory is furnished with machinery capable of custom grinding, polishing, cutting, edging, tinting and coating prescription lenses. Management believes it has the manufacturing capacity in its laboratory to accommodate all of the company's projected growth for the foreseeable future.
PURCHASING
The company's relationships with its vendors and Styl-Rite's manufacturing and importing capability have enabled the company to gain access to a wide array of brand name product offerings. As a leading retailer of eyewear in the United States, U.S. Vision purchases significant quantities of frames, lenses and contact lenses from its suppliers. No purchases are made under long-term contracts. In fiscal 1998, Bausch & Lomb, Signet Armorlite and Vistakon, the company's largest suppliers, accounted for approximately 14%, 20% and 11% of the company's total merchandise purchases, respectively. All raw materials for products manufactured by the company are available from numerous suppliers.
Through Styl-Rite, the company manufactures, imports, and distributes optical frames and sunglasses for sale primarily in its own stores, and for sale to third party optical retailers. Through various licenses and sublicenses, Styl-Rite imports metal frames and manufactures plastic frames which bear the designer, brand name and private label names sold by the company.
MANAGEMENT INFORMATION SYSTEMS
Currently, customer prescription orders for the company's optical products are prepared by the stores on order forms and the details of each order are phoned in daily to the company's centralized laboratory. These orders are then entered into the laboratory's order entry system which, for lenses, also makes the necessary optical calculations to grind and finish the lenses to the correct prescription and shape them to the dimensions of the frame selected by the customer. The present laboratory order entry system also tracks each order through every step of the manufacturing process until the finished product is shipped to the retail optical department.
In fiscal 1998, the company continued its efforts to design an integrated management information system, which includes an automated order entry system at each of its optical stores, and new manufacturing and financial systems in the company's corporate headquarters. This new integrated system is designed to facilitate the transmission of the order to the laboratory and provide the company with improved order pricing and costing capability. This new system is also designed to provide the stores with the capability to capture sales and customer information, including prescription data, enhancing the company's ability to monitor sales and merchandise trends and to improve customer service after the sale. In addition, the automated order entry system is designed to enable the stores to validate, at the time of sale, whether a particular frame selected by the customer is in stock and whether the combination of the customer's prescription, selected lenses and frame is within manufacturing tolerances. The integrated information system is expected to enhance the company's operating efficiencies by permitting all orders to be electronically transmitted from the stores to the laboratory. The company has completed its
implementation of the new financial accounting and reporting systems in its corporate headquarters and commenced the implementation of the integrated manufacturing systems in its laboratory. The company is currently in the design and testing phase of the automated order entry portion of the system. There can be no assurance that the company will be able to implement and operate this information system effectively or that the system will produce the expected benefits.
COMPETITION
The company competes with other national, regional, and local retail optical chains and independent optical retailers. Optical retailers generally serve individual or local markets, and, as a result, competition is fragmented and varies substantially among locations and geographic areas. Although the retail optical industry is highly competitive, management believes none of the company's competitors has more than a 7% market share based on revenue. The principal competitive factors affecting the company's retail operations are merchandise selection, quality and consistency of products and services, price, location within the host store, convenience, availability of on-site professional eye examinations and access to a host store's private label credit card. The retail optical industry engages in price-related promotions as a standard marketing practice. Several of the company's competitors have greater financial and other resources than the company, which may enable competitors to pursue more aggressive pricing and promotional strategies at the expense of profits for longer periods of time than the company.
The ability of the company to achieve its growth strategy by opening new retail optical departments in existing and new host stores is dependent on the company's ability to obtain suitable optical locations within existing and new host stores. Management does not believe that the company's growth strategy will be adversely effected by the fact that some competitors operate more retail optical departments in host stores than the company. In addition, the company's ability to obtain locations within host stores is dependent on whether or not the host store's management decides to include an optical department within a particular host store.
Additionally, the company faces competition from advances in vision correction technologies, including laser surgery and other surgical vision correction procedures. This could result in decreased demand for eyeglasses and contact lenses.
To the extent U.S. Vision's customers may not be covered by its eye care benefit plans, the company may compete with other vision care benefit plans and retailers who provide alternative vision care plans. As the number of national and regional managed vision care programs increase, competition for customers will intensify among the various vision care programs.
EMPLOYEES
As of January 31, 1999, the company had approximately 2,700 full-time and part-time employees, of which: (a) approximately 2,100 were employed in the company's retail outlets; (b) 400 were employed in manufacturing and distribution in the company's laboratory in Glendora, New Jersey; (c) 100 were employed at the company's Styl-Rite manufacturing facility in Miami; and (d) 100 were employed in administrative, marketing and managerial positions at the company's headquarters in Glendora.
Approximately 60 of the company's employees at the Styl-Rite facility are subject to a collective bargaining agreement with the United Optical Workers that expires in 2000. The company has never experienced a work stoppage or other organized labor dispute and considers its labor relations to be good.
GOVERNMENT REGULATION
The company is subject to a variety of federal, state and local laws, rules and regulations affecting the health care industry and the delivery of health care services. State and local legal requirements vary widely among jurisdictions and are subject to frequent change. Federal legal requirements are also subject to change.
Relationships between the company and independent optometrists and ophthalmologists are subject to federal, state and local laws and regulations. State laws generally prohibit the practice of medicine and optometry by unlicensed practitioners. In addition, many states prohibit medical practitioners and optometrists from splitting fees with business corporations such as the company and prohibit the practice of medicine and optometry by corporate entities. Some states have enacted laws governing the ability of ophthalmologists and optometrists to enter into contracts to provide professional services with business corporations or lay persons. Some states prohibit the company from computing its fee for rent, equipment leases and management services provided by the company based on a percentage of the gross revenue of the ophthalmologists and the optometrists. Such requirements are particularly comprehensive in California and Texas, where the company operates a significant number of stores. Further, some states restrict the location of optometric offices in relation to optical stores, such as the company's, and regulate advertising and the solicitation of prospective patients.
Relationships between the company and independent ophthalmologists and optometrists are also subject to the fraud and abuse provisions of the federal Social Security Act which include the "anti-kickback" laws. The anti-kickback laws prohibit the offering, payment, solicitation or receipt of any direct or indirect remuneration for the referral of Medicare or Medicaid patients or for the ordering or providing of Medicare or Medicaid covered services, items or equipment. Violations of these laws may result in substantial civil or criminal penalties for individuals or entities and exclusion from participation in the Medicare and Medicaid programs. Several states, including states in which the company operates, have adopted similar laws that cover patients with private health insurance coverage as well as those covered by government programs. Although management believes it is not in violation of the anti-kickback laws, the applicability of these provisions has been subject to only limited judicial and regulatory interpretation. In addition, certain of the company's products, specifically frames manufactured by Styl-Rite, must comply with standards set by the United States Food and Drug Administration.
The company, as well as the independent optometrists providing services in or adjacent to the company's stores, from time to time receive inquiries from regulatory bodies regarding its compliance with applicable state and local regulations. If the company's relationships with ophthalmologists and optometrists are challenged, the company may be required to alter the manner in which it conducts its business. There can be no assurance that a review of the company's business by courts or regulatory authorities will not result in determinations that could adversely affect the operations of the company or that new laws, regulations or interpretations of current laws and regulations will not have a material adverse effect on the company's business, financial condition or results of operations.
ITEM 2.
ITEM 2. PROPERTIES
The company owns a 20,000 square foot facility in Glendora, New Jersey, which serves as the company's corporate headquarters and a neighboring 60,000 square foot optical laboratory and distribution facility. The real property on which these facilities are located, as well as the buildings and certain equipment located therein, secure the company's obligations under the DRPA Term Loans. See "Management's Discussion and Analysis of Financial Conditions and Results of Operations--Liquidity and Capital Resources." Styl-Rite, the company's frame manufacturing and importing operation, owns and operates a 40,000 square foot facility in Miami, Florida. The real property on which this facility is located, as well as the building, secure the company's obligations under the revolving line of credit and term loan. See "Management's Discussion and Analysis of Financial Conditions and Results of Operations--Liquidity and Capital Resources."
In fiscal 1997, the company leased a 24,000 square foot warehouse adjacent to its corporate headquarters in Glendora, New Jersey. The lease has a three-year term and expires in 2000. The company has an option to purchase this facility.
U.S. Vision's freestanding store locations are subject to lease arrangements which contain varying terms and are not subject to short notice lease termination provisions. The leases provide for monthly base lease payments plus, under certain circumstances, include an additional rent provision based on a percentage of the company's sales at each location.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS.
The company is subject to various pending and threatened litigation from time to time in the ordinary course of business. Although all litigation involves some degree of uncertainty, in the opinion of management, liabilities, if any, arising from such litigation or threat thereof are not expected to have a material adverse effect on the company.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
None.
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
The company's stock is traded on Nasdaq under the symbol "USVI." The company completed its initial public offering of 2,500,000 shares of stock on December 5, 1997 and the first day of trading in the stock was December 1, 1997.
For the period indicated below, the following table sets forth the high and low bid information of the stock as reported on Nasdaq, rounded to the nearest eighth of a dollar.
As of April 20, 1999, there were 66 record holders of the company's stock. The company has not declared or paid any cash dividends on the stock since its organization. Under the terms of the company's revolving bank line of credit, the company's ability to pay cash dividends to its stockholders is restricted.
- ------ (1) December 1, 1997 - January 31, 1998
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA.
The selected consolidated financial information regarding the company's financial position and operating results set forth below for the years ended January 31, 1999, 1998 and 1997, the ten months ended January 31, 1996, and the year ended March 31, 1995 have been derived from the audited consolidated financial statements of the company. The selected consolidated financial data set forth below should be read in conjunction with the consolidated financial statements of the company and related notes thereto and "Management's Discussion and Analysis of Financial Condition and Results of Operations" included elsewhere in this report.
Footnotes on following page.
- -------------------------- (1) The difference in duration of this period must be considered in making period-to-period comparisons.
(2) Represents write-off of goodwill related to the 1990 acquisition of Royal. The goodwill was attributed to the closing of the Dallas facility and closed or otherwise liquidated stores described in notes (3) and (4) below, respectively. The write-off was determined based upon a measurement of the remaining undiscounted operating cash flows of the company.
(3) Represents the writedown of the Dallas facility, which was closed by the company in connection with its plan to consolidate its laboratories into a single facility.
(4) Represents lease termination costs, write-off of leasehold improvements and other related costs associated with the closing and disposal of stores during fiscal 1992 through 1995. As a result of favorable settlements on the terminated leases, the company realized a gain in fiscal 1997.
(5) Net income per share has been computed using the weighted average number of shares outstanding after giving effect for all periods presented to the 64-for-1 stock dividend and the conversion of all outstanding Series A Preferred Stock and Series C Preferred Stock into stock upon the closing of the company's initial public offering as described in Note 1 to Notes to Consolidated Financial Statements. Cash dividends on preferred stock of $217,000 were deducted from net income in computing net income per share for the fiscal year ended January 31, 1998.
(6) Net income per share -- assuming dilution has been computed using the weighted average number of shares outstanding after giving effect to the 64-for-1 stock dividend and the conversion of all outstanding Series A Preferred Stock and Series C Preferred Stock into stock upon the closing of the company's initial public offering as described in Note 1 to Notes to Consolidated Financial Statements. In addition, common share equivalents such as warrants and options are included in the computation for the years ended January 31, 1999, 1998 and 1997, respectively. Cash dividends on preferred stock of $217,000 were deducted from net income in computing net income per share - assuming dilution for the fiscal year ended January 31, 1998.
(7) Net income per share -- pro forma is calculated by dividing net income after adjustment for applicable interest expense, net of tax ($2,208,000) by the adjusted number of weighted average shares outstanding after giving effect to the 2,500,000 shares that were sold at the initial public offering price to repay $20,375,000 of debt.
(8) Comparable store sales reflect existing stores that have been open over twelve months.
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
GENERAL OVERVIEW
The company's net sales consist primarily of retail sales of prescription eyewear and contact lenses, net of refunds and allowances for customer returns. The company's sales are influenced by customer traffic in its host department stores, the successful implementation of its promotional programs and its participation in various managed vision care plans. The principal components of the company's cost of sales include the cost of materials, including eyeglass frames and lenses, as well as manufacturing, assembly, labor and overhead costs associated with operating the company's centralized optical laboratory. Prices of frames vary widely, from inexpensive to high-end designer brands.
The company's selling, general and administrative expenses include primarily labor-related expenses at the store level, rent and occupancy costs, managed vision care costs, advertising and administrative expenses. The company's rent paid to the host store is calculated as a percentage of net sales within each retail optical department. Freestanding store rent is generally a fixed monthly payment plus, in many cases, a percentage of net sales above certain revenue levels. Flat fees per transaction are paid by the company to vision care plans in which the company participates.
RESULTS OF OPERATIONS
The following table sets forth selected statement of operations items expressed as a percentage of net sales for the periods indicated:
FISCAL 1998 COMPARED TO FISCAL 1997
Net sales increased $8.7 million, or 7.1%, from $122.8 million for fiscal 1997 to $131.5 million for fiscal 1998. A 4.2% increase in comparable store sales accounted for $5.0 million of the increase in net sales. New store openings, net of store closings, accounted for the remaining $3.7 million of the increase. The increase in comparable store sales was the result of an increase in the number of eyeglasses sold, as well as an increase in value added eyewear features, such as anti-reflective coating and accessory kits.
Cost of sales increased by $2.0 million, or 5.2%, from $38.6 million in fiscal 1997 to $40.6 million in fiscal 1998. The increase was due principally to the $8.7 million increase in net sales. As a percentage of net sales, cost of sales decreased from 31.4% in fiscal 1997 to 30.9% in fiscal 1998. The
decrease was due principally to sales of higher margin merchandise, as discussed above, and the benefit of additional discounts on inventory bulk purchases.
Selling, general and administrative expenses increased by $5.7 million, or 7.8%, from $73.4 million in fiscal 1997 to $79.1 million in fiscal 1998. The increase was principally due to an increase in retail salaries associated with new store openings and greater department store rents which are tied directly to sales volume. As a percentage of net sales, selling, general and administrative expenses increased slightly for fiscal 1998 compared to fiscal 1997 due principally to the opening of 63 new locations as well as an overall increase in base salary rates as a result of the competitive labor market and the low unemployment factor.
Depreciation and amortization increased by $0.5 million, or 14.7%, from $3.4 million in fiscal 1997 to $3.9 million in fiscal 1998 due principally to the increase in capital expenditures associated with new store openings and acquisitions.
Interest expense, net decreased by $2.5 million, or 100.0%, from $2.5 million in fiscal 1997 to $0.0 million in fiscal 1998. The decrease was due to: (a) the repayment of debt in connection with the completion of the initial public offering in December 1997 and (b) the capitalization of interest expense incurred during the development of the company's integrated management information system. See "Liquidity and Capital Resources."
FISCAL 1997 COMPARED TO FISCAL 1996
Net sales increased by $11.3 million, or 10.1%, from $111.5 million for fiscal 1996 to $122.8 million for fiscal 1997. A 9.2% increase in comparable store sales accounted for $9.5 million of the increase in net sales and new store openings accounted for the remaining $1.7 million of the increase. The increase in comparable store sales was the result of an increase in the number of eyeglasses sold, as well as an increase in value added eyewear features, such as anti-reflective coating and accessory kits.
Cost of sales increased by $4.3 million, or 12.5%, from $34.3 million in fiscal 1996 to $38.6 million in fiscal 1997. The increase was due principally to the $11.2 million increase in net sales. As a percentage of net sales, cost of sales increased from 30.7% in fiscal 1996 to 31.4% in fiscal 1997. The increase was attributable to increased sales of designer and branded frames and lenses. Although the company realizes a lower gross margin on the sale of these products, designer and branded frames and lenses provide the company with higher gross profit dollars per transaction.
Selling, general and administrative expenses increased by $5.0 million, or 7.3%, from $68.4 million in fiscal 1996 to $73.4 million for fiscal 1997. The increase was principally due to an increase in retail salaries associated with new store openings and greater department store rents which are tied directly to sales volume. As a percentage of net sales, selling, general and administrative expenses decreased from 61.3% for fiscal 1996 to 59.8% for fiscal 1997 as increases in revenue enabled the company to leverage its fixed expenses and take advantage of operating efficiencies.
Depreciation and amortization increased slightly by $0.1 million, or 3.0%, from $3.3 million in fiscal 1996 to $3.4 million in fiscal 1997.
Unusual gains for fiscal 1997 of $0.4 million consisted of $0.7 million income resulting from favorable settlements of lease liabilities that were established in connection with the closing and disposal of freestanding stores in fiscal 1995, net of a $0.3 million loss recognized on the sale of the Dallas facility.
Interest expense, net decreased by $1.0 million, or 28.6 %, from $3.5 million for fiscal 1996 to $2.5 million for fiscal 1997. The decrease was due to: (a) a reduction of the interest rate on the company's subordinated debentures from an accrual rate of 20% in fiscal 1996 to 12% in fiscal 1997
when the company agreed to make cash interest payments and (b) the repayment of debt in connection with the completion of the initial public offering in December 1997. See "Liquidity and Capital Resources."
QUARTERLY FLUCTUATIONS
The company's financial position and results of operations are affected by seasonal fluctuations in sales and operating profits. The company's sales and operating profits are generally lower in the fourth quarter, due to the Christmas season, which has historically been a period of reduced sales of prescription optical products. This trend has been mitigated somewhat by the increase in vision care sales under plans which are on a calendar year basis and require participants to use or lose their benefits annually. Quarterly sales can also be affected by the timing and amount of sales contributed by new stores. Accordingly, the results of operations for interim periods are not necessarily indicative of results for the entire fiscal year.
The following tables set forth certain unaudited financial data for the quarters indicated:
The decrease in operating income in the fourth quarter of fiscal 1998 was due to lower than anticipated net sales as well as an overall increase in base salary rates as a result of the competitive labor market.
INCOME TAXES
As of January 31, 1999, the company had net operating loss carryforwards of approximately $16,000,000 which will begin to expire in the year 2006. Approximately $6,300,000 of these carryforwards are available to offset future taxable income without limitation and approximately $9,700,000 of these carryforwards (the "Restricted NOLs") are significantly limited due to ownership changes experienced by the company prior to 1999. As a result of these limitations, approximately $780,000 of the Restricted NOLs will become available for use each year through the year 2008. The remaining Restricted NOLs are expected to expire unutilized. A valuation allowance has been established to fully reserve the future benefit of all the net operating loss carryforwards.
LIQUIDITY AND CAPITAL RESOURCES
The company's primary cash sources for fiscal 1998 were from operations and a new line of credit established in the second quarter of 1998. The company used proceeds from the new line of credit to pay the entire outstanding balance on its prior line of credit and an outstanding term loan. The company's working capital requirements are seasonal and traditionally peak at the end of the fourth quarter and the beginning of the first quarter. Cash and working capital at January 31, 1999 were $693,000 and $23.2 million, respectively, compared to $365,000 and $18.0 million, respectively, at January 31, 1998.
For the year ended January 31, 1999, cash provided by operating activities was $6.4 million compared to cash provided by operating activities of $1.8 million for the year ended January 31, 1998. The $4.6 million increase resulted from an increase in net income and favorable changes in: (a) the collection of accounts receivable, principally the result of one of the company's host department stores centralizing its accounts payable department; (b) the accrued interest expense payable by the company after the repayment of outstanding debt from proceeds of the December 1997 initial public offering; (c) the timing of payments for compensation and benefits; and (d) the reduction of lease termination liabilities in fiscal 1997 as a result of the settlement of leases on freestanding stores closed in fiscal 1995. These favorable increases in cash provided by operating activities were offset by an increase in inventory as a result of $3.4 million in bulk purchases during the third and fourth quarters of fiscal 1998.
Cash used in investing activities in fiscal 1998 was $10.8 million compared to $5.2 million in fiscal 1997 and $4.5 million in fiscal 1996. Capital expenditures in fiscal 1998 of $10.8 million were primarily for new store openings, development work on the company's integrated management information system and the acquisition of twenty-five licensed optical retail stores and two medical center locations. See Note 10 to Notes to Consolidated Financial Statements. In fiscal 1999, the company expects to spend approximately $12.0 million on capital expenditures for new store openings, new laboratory equipment, the integrated management information system, and other capital expenditures. Historically, the company has funded capital expenditures through a revolving line of credit, debt financing activities, including capital leases, and operating cash flow.
The company's principal external source of liquidity is its $20.0 million revolving line of credit with Commerce Bank, N.A. The revolving line of credit facility bears interest at the lower of the prime rate as published in the Wall Street Journal or the thirty (30) day rate for United States Treasury Bills plus 250 basis points, matures in June 2000 and renews automatically for a one-year period, subject to either party's right to terminate by notice of non-renewal. As of January 31, 1999, the company had $8,324,000 outstanding under its revolving line of credit and $11,676,000 of availability. The loan agreement prohibits the payment of dividends to stockholders and contains customary covenants. The company must also maintain certain financial ratios pertaining to its net worth, current ratio, and ratio of cash to fixed charges. See Note 5 to Notes to Consolidated Financial Statements. The company is currently in compliance with all financial covenants and management does not believe that the financial covenants set forth in its revolving line of credit will have an adverse impact on its operations or future plans.
The company received a commitment from Commerce BankLease, a unit of Commerce Bank, N.A., for a $1,000,000 five-year equipment lease financing facility. The lease financing facility is subject to the completion of all required documentation.
In addition, in fiscal 1994 and 1995, the company invested $5.6 million in capital expenditures related to the consolidation of the company's laboratory operations and the purchase of its current corporate headquarters in New Jersey. These expenditures were partially financed with a 2% term loan provided by the Delaware River Port Authority ("DRPA"). The first DRPA term loan, which had a balance of $1,078,000 as of January 31, 1999, is due in February 2010 and is secured by the real property and building in which the company maintains its corporate headquarters. The second DRPA term loan, which had a balance of $2,049,000 as of January 31, 1999, is due in February 2010 and is secured by the real property and building in which the company maintains its optical laboratory and distribution facility. The third DRPA term loan, which had a balance of $778,000 as of January 31, 1999, is due in June 2005 and is secured by certain equipment located in the company's optical laboratory and distribution facility. See Note 5 to Notes to Consolidated Financial Statements.
Based upon its current operating and new store opening plans, the company believes that it can fund its working capital and capital expenditure needs for the foreseeable future through borrowings under the revolving line of credit and cash generated from operations.
EFFECTS OF INFLATION
The company believes that the effects of inflation on its operations have not been material during the past three years.
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
In March 1998, the AICPA issued Statement of Position (SOP) 98-1 "Accounting for the Costs of Computer Software Developed or Obtained for Internal Use." The SOP, which has been adopted as of February 1, 1998, requires the capitalization of certain costs incurred in connection with developing or obtaining internal use software. Prior to the adoption of SOP 98-1, the company capitalized all internal use software related costs except for interest which was expensed as incurred. The effect of adopting the SOP was to increase net income for the year ended January 31, 1999 by $528,000 or $0.07 per share.
YEAR 2000 COMPLIANCE
The company's management recognizes the need to ensure that its operations and relationships with host stores and other third parties will not be adversely impacted by the Year 2000 issue. The Year 2000 problem is a result of computer programs being written using two digits rather than four to define the applicable year. Any of the company's programs that recognize a date using "00" as the year 1900 rather than the Year 2000 could result in system failures or miscalculations.
During the third quarter of fiscal 1998, the company completed the assessment of its internal critical and non-critical hardware and software. Included in the company's assessment was the identification of all critical and non-critical computer programs and hardware, including environmental systems that are dependent on embedded microchips, such as security systems and VAC systems. Based on its assessment, the company determined a portion of its software and certain hardware will require modification or replacement so that those systems will properly utilize dates beyond December 31, 1999. The company anticipates that the total cost of the modifications will be less than $200,000. The company's assessment indicated that its significant information technology systems would not be affected. In addition, the company is currently developing a Year 2000 compliant point of sale and order entry system in its retail locations and, therefore, does not anticipate having any Year 2000 compliance issues with respect to the information technology systems to be utilized by its retail stores.
The company also depends on the systems of its suppliers and host stores. Consequently, the company is in the process of receiving adequate assurances from its host stores that those systems on which the company relies are or will be Year 2000 compliant before the end of 1999.
To the extent possible, the company has developed and will implement contingency plans designed to allow continued operations in the event of failure of the company's or third party systems to be Year 2000 compliant.
Management of the company believes it has an effective program in place to resolve the Year 2000 issue in a timely manner. As noted above, the company has not yet completed all necessary phases of the Year 2000 program. Further, the failure of the company or third parties upon which the company relies, to identify Year 2000 issues and successfully and timely resolve them could have a material adverse impact on the operations of the company.
CAUTION REGARDING FORWARD-LOOKING STATEMENTS
The company occasionally makes forward-looking statements concerning its plans, goals, product and service offerings, store openings and closings and anticipated financial performance. These forward-looking statements may generally be identified by introductions such as "outlook" for an upcoming period of time, or words and phrases such as "should", "expect", "hope", "plans", "projected",
"believes", "forward-looking" (or variants of those words and phrases) or similar language indicating the expression of an opinion or view concerning the future.
These forward-looking statements are subject to risks and uncertainties based on a number of factors and actual results or events may differ materially from those anticipated by such forward-looking statements. These factors include, but are not limited to: the company's ability to maintain its relationship with its host stores such as J.C. Penney and Sears, as well as with Cole National Corporation, a competitor of the company and the owner of the Vision One managed vision care plan in which the company participates; the growth rate of the company's revenue and market share; the company's ability to effectively manage its business functions while growing the company's business in a rapidly changing environment; and the quality of the company's plans and strategies, and the ability of the company to execute such plans and strategies.
In addition, forward-looking statements concerning the company's expected revenue or earnings levels are subject to many additional uncertainties applicable to competitors generally and to general economic conditions over which the company has no control, such as the performance of its host stores. The company does not plan to generally publicly update prior forward-looking statements for unanticipated events or otherwise and, accordingly, prior forward-looking statements should not be considered to be "fresh" simply because the company has not made additional comments on those forward-looking statements.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The company's earnings are affected by changes in interest rates due to the impact those changes have on the interest expense payable by the company under its variable rate debt revolving line of credit, for which the outstanding balance was $8,324,000 as of January 31, 1999. A 1.0% change in the underlying prime rate or the thirty (30) day rate for United States Treasury Bills would result in a $83,000 change in the annual amount of interest on such debt. This amount is determined by considering the impact of the hypothetical interest rates on the company's revolving line of credit outstanding as of January 31, 1999.
ITEM 8.
ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
The Financial Statements together with the report thereon of Ernst & Young LLP, independent auditors, are included in this report commencing at Page.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.
None.
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
The information set forth under the heading "Election of Directors" and "Management of the Company" definitive proxy statement for the company's 1999 Annual Meeting of Stockholders is incorporated by reference in this Form 10-K Annual Report.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION.
The information set forth under the heading "Executive Compensation" of the definitive proxy statement for the company's 1999 Annual Meeting of Stockholders is incorporated by reference in this Form 10-K Annual Report.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
The information set forth under the heading "Ownership of Common Stock by Certain Beneficial Owners and Management" of the definitive proxy statement for the company's 1999 Annual Meeting of Stockholders is incorporated by reference in this Form 10-K Annual Report.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
The information set forth under the headings "Management of the Company -- Compensation of the Company's Directors" and "Executive Compensation - -- Transactions with Management and Related Parties" of the definitive proxy statement for the company's 1999 Annual Meeting of Stockholders is incorporated by reference in this Form 10-K Annual Report.
PART IV
ITEM 14.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.
FINANCIAL STATEMENTS
The following financial statements of the company are filed as a part of this report:
All financial statement schedules have been omitted because they are not applicable or the required information is shown in the consolidated financial statements and notes thereto.
REPORTS ON FORM 8-K
No reports on Form 8-K have been filed by the company during the last quarter of fiscal 1998.
EXHIBITS
The following exhibits are filed as a part of this report:
Exhibit Number Exhibit
3.1* Restated Certificate of Incorporation of the Company 3.2* Bylaws of the Company 10.1* Loan and Security Agreement between the Company and Commerce Bank, as amended 10.2* Stock Option Plan, including form of Stock Option Agreement 10.3** Subordinated Note Purchase Agreement 10.4** Amendment to Subordinated Note Purchase Agreement 10.5** J.C. Penney License Agreement 10.6** Vision Care Agreement 10.7+ Employment Agreement for William A. Schwartz, Jr. 10.8+ Form of Employment Severance Agreement 10.9** Form of Non-Statutory Option Agreement 10.10** Form of Indemnification Agreement 10.11** Stockholders' Agreement 10.12** Form of Sears Lease 10.13** Commerce Bank Mortgages and Schedules 10.14** DRPA Loan Documentation 21+ Subsidiaries of the Company 23+ Consent of Independent Auditors 27+ Financial Data Schedule
- ---------- * Previously filed as an exhibit to the Form S-1 (Reg. No. 333-35819) filed with the Commission on September 17, 1997.
** Previously filed as an exhibit to Amendment No. 1 to the Form S-1 (Reg. No. 333-35819) filed with the Commission on October 29, 1997.
+ Filed herewith.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
U. S. VISION, INC.
April 30, 1999 By: /s/ William A. Schwartz, Jr. ------------------------------------ William A. Schwartz, Jr., President and Chief Executive Officer
Pursuant to the requirements of the Securities Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities indicated on April 30, 1999.
Report of Independent Auditors
Board of Directors and Stockholders U.S. Vision, Inc.
We have audited the accompanying consolidated balance sheets of U.S. Vision, Inc. as of January 31, 1999 and 1998, and the related consolidated statements of income, changes in stockholders' equity, and cash flows for each of the three years in the period ended January 31, 1999. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of U.S. Vision, Inc. at January 31, 1999 and 1998, and the consolidated results of its operations and its cash flows for each of the three years in the period ended January 31, 1999, in conformity with generally accepted accounting principles.
As discussed in Note 2 to the financial statements, in the year ended January 31, 1999, the Company changed its method of accounting for costs of computer software developed or obtained for internal use.
/s/Ernst & Young LLP
Philadelphia, Pennsylvania March 17, 1999
U.S. Vision, Inc.
Consolidated Balance Sheets
(Dollars in thousands, except per share amounts)
See accompanying notes to consolidated financial statements.
U.S. Vision, Inc.
Consolidated Statements of Income
(Dollars in thousands, except per share amounts)
See accompanying notes to consolidated financial statements.
U.S. Vision, Inc.
Consolidated Statements of Changes in Stockholders' Equity
(In thousands, except share data)
U.S. Vision, Inc.
Consolidated Statements of Changes in Stockholders' Equity (continued)
(In thousands, except share data)
See accompanying notes to consolidated financial statements.
U.S. Vision, Inc.
Consolidated Statements of Cash Flows
(In thousands)
See accompanying notes to consolidated financial statements.
U.S. Vision, Inc.
Notes to Consolidated Financial Statements
January 31, 1999
1. ORGANIZATION
U.S. Vision, Inc. (the "Company") was formed in March 1990 and incorporated in the Commonwealth of Pennsylvania. In March 1997, the Company reincorporated in the State of Delaware. The Company's principal business activity is the retail sale and manufacturing of prescription eyewear through approximately 614 stores located throughout the United States.
On May 12, 1995, the Board of Directors of the Company effected a 1-for-1,000 reverse stock split. All shareholders who had fractional shares after the reverse split received cash at the rate of $1.25 per pre-split share. The Company paid $407,000 in total for the fractional shares. Subsequent to the reverse split, the Company deregistered its common stock under the Securities and Exchange Act of 1934, as amended, and delisted its common stock for trading on the Small Cap-Tier of the Nasdaq Stock Market. All share data for all periods presented herein reflects the reverse stock split.
In December 1997, the Company completed an initial public offering of 2,500,000 shares of the Company's common stock. The initial public offering price was $9.00 per share. The net proceeds to the Company were used to retire the $8,837,000 outstanding balance of its 12% subordinated debentures which was payable on March 1998 (See Note 5), to repay $6,600,000 on its bank term loan due 2001 (see Note 5), and to repay $4,938,000 on its revolving line of credit which would have expired on December 31, 1999 (see Note 5). In conjunction with the sale of common stock, the Company recapitalized its common stock and authorized a 64-for-1 stock dividend. Additionally, in conjunction with the initial public offering described above, the holders of the Series A cumulative preferred stock and Series C cumulative preferred stock converted all the outstanding shares of preferred stock into common stock at the public offering price. The liquidation values of the Series A and the Series C preferred stock plus accumulated dividends at the date of the conversion of $16,853,000 and $7,969,000, respectively, were converted for 1,872,592 and 885,412 shares of common stock, respectively. All references to net income per share data in the financial statements have been restated to give effect to the stock dividend and conversion of the preferred stock.
2. SIGNIFICANT ACCOUNTING POLICIES
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of the Company and all of its wholly owned subsidiaries. All significant intercompany transactions and balances have been eliminated.
U.S. Vision, Inc.
Notes to Consolidated Financial Statements (continued)
2. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
USE OF ESTIMATES
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates.
INVENTORY
Inventory, consisting principally of frames and lenses, is valued at the lower of cost or market, determined by the first-in, first-out method.
PROPERTY, PLANT, AND EQUIPMENT
Property, plant, and equipment are stated at cost. Depreciation, which includes assets under capital leases, is computed using the straight-line method. The general range of useful lives is 10 to 30 years for buildings and improvements, and 3 to 10 years for automobiles, machinery and equipment, computer equipment, and furniture and fixtures. Depreciation expense totaled $3,703,000, $3,297,000, and $3,178,000 in fiscal 1998, 1997, and 1996, respectively.
LONG-LIVED ASSETS
Long-lived assets, which principally includes property, plant, and equipment, and goodwill arising from business acquisitions, are amortized on a straight-line basis over the expected period to be benefited from 15 to 40 years. In accordance with FASB Statement No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of," the Company periodically evaluates the realizability of long-lived assets as events or circumstances indicate a possible inability to recover their carrying amounts. Long-lived assets are grouped and evaluated on a per store basis by applying various analyses, including undiscounted cash flows and profitability projections.
U.S. Vision, Inc.
Notes to Consolidated Financial Statements (continued)
2. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
ADVERTISING
The Company expenses advertising costs as incurred. Advertising expense was $8,035,000, $7,594,000, and $6,766,000 in fiscal 1998, 1997, and 1996, respectively.
STORE OPENINGS AND CLOSINGS
The noncapital expenditures incurred in opening new stores or remodeling existing stores are expensed as incurred. When a store is closed, the remaining investment in leasehold improvements and the amount estimated to terminate the lease are expensed.
REVENUE RECOGNITION
Revenue is generally recognized when merchandise is delivered or shipped to the customer.
RECLASSIFICATION
Certain prior-year amounts have been reclassified to conform with the current-year presentation.
RECENT ACCOUNTING PRONOUNCEMENTS
In March 1998, the AICPA issued Statement of Position (SOP) 98-1 "Accounting for the Costs of Computer Software Developed or Obtained for Internal Use". The SOP, which has been adopted as of February 1, 1998, requires the capitalization of certain costs incurred in connection with developing or obtaining internal use software. Prior to the adoption of SOP 98-1, the Company capitalized all internal use software related costs except for interest which was expensed as incurred. The effect of adopting the SOP was to increase net income for the year ended January 31, 1999 by $528,000 or $0.07 per share on a diluted basis.
U.S. Vision, Inc.
Notes to Consolidated Financial Statements (continued)
3. INVENTORY
Inventory is as follows (In thousands):
4. PROPERTY, PLANT, AND EQUIPMENT
Property, plant, and equipment is as follows (In thousands):
U.S. Vision, Inc.
Notes to Consolidated Financial Statements (continued)
5. LONG-TERM DEBT
Long-term debt is as follows (In thousands):
U.S. Vision, Inc.
Notes to Consolidated Financial Statements (continued)
5. LONG-TERM DEBT (CONTINUED)
The revolving credit agreement contains various financial covenants pertaining to net worth, current ratio, and ratio of cash flow to fixed charges. The revolving credit agreement also prohibits the payment of dividends to common stockholders. At January 31, 1999, the Company was in compliance with all financial covenants.
The carrying amounts of the Company's borrowings approximate their fair values.
Maturities of long-term debt for each of the next five years and thereafter are as follows (In thousands):
6. LEASE COMMITMENTS
Capital lease obligations are machinery and equipment leases which expire on various dates through 2003. Assets under capital leases at January 31, 1999 and 1998, were $3,381,000 and $3,718,000, net of accumulated amortization of $576,000 and $287,000, respectively, and are included as a component of property, plant, and equipment in the consolidated balance sheets.
U.S. Vision, Inc.
Notes to Consolidated Financial Statements (continued)
6. LEASE COMMITMENTS (CONTINUED)
Future minimum payments required under noncancelable capital leases and operating leases with lease terms in excess of one year as of January 31, 1999, are as follows (In thousands):
At January 31, 1999, the Company operated 57 of its retail stores under operating leases with varying terms. The leases expire at various dates from fiscal 1999 to fiscal 2006, and many have renewal options for up to five additional years. The leases provide for minimum lease payments and, in many cases, require payment of additional rents if sales exceed stipulated levels. These additional rents are not significant. The leases also require, in most cases, payment of taxes and common area expenses such as maintenance, security, and other expenses.
The Company also operated 557 licensed optical departments under leases with expiration dates ranging from 60-days to 5-years. These leases provide for monthly lease payments calculated as a percentage of sales. Rent expense under these leases was $15,537,000, $14,212,000, and $12,580,000 in fiscal 1998, 1997, and 1996, respectively. Approximately 70% of these leases are with one large national retailer. The Company's master lease provides that only a limited number of the Company's optical centers with this retailer may be closed in any calendar year without cause.
U.S. Vision, Inc.
Notes to Consolidated Financial Statements (continued)
6. LEASE COMMITMENTS (CONTINUED)
The Company also operates other facilities under operating leases. Rent expense for all operating leases, including those on its retail stores and licensed optical departments described above, was $18,270,000, $17,010,000, and $15,519,000 in fiscal 1998, 1997, and 1996, respectively.
7. INCOME TAXES
The components of the income tax provision are as follows (In thousands):
Deferred income tax liabilities and assets result from differences in the tax basis of assets and liabilities and their reported amounts in the consolidated financial statements. Significant components of the Company's deferred income taxes are as follows (In thousands):
U.S. Vision, Inc.
Notes to Consolidated Financial Statements (continued)
7. INCOME TAXES (CONTINUED)
The deferred tax valuation reserve decreased $3,483,000 and $2,030,000 for fiscal 1998 and 1997, respectively. The valuation reserve has been established to eliminate the benefit of all net deferred tax assets except for the credit on the Alternative Minimum Tax.
A reconciliation of the income tax provision with amounts determined by applying the U.S. Statutory rate to income before income tax is as follows (in thousands):
As of January 31, 1999, the Company had net operating loss carry forwards of approximately $16,000,000 which will begin to expire in the year 2006. Approximately $6,300,000 of these carry forwards are available to offset future taxable income without limitation and approximately $9,700,000 of these carry forwards (the "Restricted NOLs") are significantly limited due to ownership changes experienced by the Company. As a result of these limitations, approximately $780,000 of the Restricted NOLs will become available for use each year through the year 2008. The remaining Restricted NOLs are expected to expire unutilized. A valuation allowance has been established to fully reserve the future benefit of all the net operating loss carry forwards.
U.S. Vision, Inc.
Notes to Consolidated Financial Statements (continued)
8. NET INCOME PER SHARE
The following table (in thousands except per share data) presents the calculation of earnings per share for the periods indicated.
Pro forma net income per share-basic and pro forma net income per share-assuming dilution for the year ended January 31, 1998 was $0.96. Pro forma net income gives effect to the initial public offering and the related pay down of the debt as of the beginning of fiscal 1997. Pro forma net income per share-basic is calculated by dividing net income after adjustment for applicable interest expense, net of tax ($2,208,000) by the adjusted number of weighted average shares outstanding (7,761,544) after giving effect to the 2,500,000 shares sold to repay $20,375,000 of debt. Pro forma net income per share-assuming dilution is calculated by dividing net income after adjustment for applicable interest expense, net of tax by the adjusted number of weighted average shares outstanding during the period plus the dilutive effect of stock options (107,157).
9. COMMITMENTS AND CONTINGENCIES
The Company, in the normal course of business, is involved in various legal proceedings. Management of the Company believes that, in all cases, the outcome of such legal proceedings will not have a material effect on the Company's results of operations or financial condition.
U.S. Vision, Inc.
Notes to Consolidated Financial Statements (continued)
10. ACQUISITIONS
On July 7, 1998, the Company acquired nine licensed optical retail stores located within Sears full line stores and two medical center locations. On October 4, 1998, the Company acquired all of the assets and inventory of sixteen licensed optical departments from a department store division of a national retailer. Both acquisitions were accounted for under the purchase method of accounting. The operating results of these acquisitions are included in the consolidated financial statements since the date of the acquisitions. The total cost of these acquisitions was $3.2 million, and the excess of the purchase price over the fair market value of the acquired assets and liabilities assumed has been recorded as goodwill. The total goodwill recorded on these acquisitions was $2.8 million which is being amortized on a straight line basis over 15 years from the respective date of each acquisition.
11. SEGMENT INFORMATION
The Company operates in one segment: the marketing, distribution, and production of optical products through retail optical stores. On January 31, 1999, the Company operated in 48 states.
Approximately 66% of the Company's sales were in licensed departments of one retailer for fiscal 1998 and 1997. Sales in licensed departments of another retailer were approximately 12% and 10% for fiscal 1998 and 1997. A termination of the licensed departments could cause a loss of sales, which would affect operating results adversely.
12. STOCK BASED COMPENSATION PLANS
In February 1996, the Board of Directors authorized the formation of an incentive stock option plan. The total amount of Common Stock for which options may be granted under this plan may not exceed in the aggregate 1,300,000 shares. The price at which shares may be purchased pursuant to options granted under the plan may not be less than the fair market value of the shares of Common Stock on the date the option is granted. In March 1996, 639,665 options were issued to various members of management. The majority of these options vested immediately, are exercisable at $7.69 per share (fair market value on date of grant), and expire on October 1, 2004.
In May 1998, 317,000 options were issued to various members of management with an exercise price of $12.00 per share (estimated fair market value on date of grant). Twenty-five percent of these options vested immediately upon grant, and the remaining options vest twenty-five percent per year for the next three years from the date of grant. These options expire in May 2008.
U.S. Vision, Inc.
Notes to Consolidated Financial Statements (continued)
12. STOCK BASED COMPENSATION PLANS (CONTINUED)
In December 1997, 33,333 non-qualified options were issued to various directors with an exercise price of $9.00 per share (fair market value on date of grant). One third of these options vested immediately upon grant, and the remaining options vest one third per year for the next two years from the date of grant. These options expire in December 2007.
The following table summarizes the Company's stock option activity:
The Company has elected to follow Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" (APB 25) and related interpretations in accounting for its employee stock options because the alternative fair value accounting provided for under FASB Statement No. 123, "Accounting for Stock-Based Compensation," requires use of option valuation models that were not developed for use in valuing employee stock options. If the Company had recognized compensation costs based upon the fair value of the stock options at the date of the grant, as prescribed by FAS 123, the Company's pro forma net income and pro forma net income per share would have been $6.7 million and $0.85, respectively, for the fiscal year ended January 31, 1999. The effect of applying Statement 123's fair value method to the Company's stock-based awards results in pro forma net income per share that are not different from amounts reported for fiscal years ended January 31, 1998 and January 31, 1997.
U.S. Vision, Inc.
Notes to Consolidated Financial Statements (continued)
12. STOCK BASED COMPENSATION PLANS (CONTINUED)
The fair value of options granted in fiscal 1998 was $5.54 per share. The fair value of the options was estimated at the date of the grant using a Black-Scholes option pricing model with the following assumptions: risk-free interest rate of 5.75%, dividend yield of 0%, expected volatility of the market price of the common stock of 43.5%, and weighted average expected life of the options of 5 years. The estimated fair value of the options was amortized to expense over the vesting period of the options for the purposes of determining pro forma net income and pro forma net income per share. The effects of applying FAS 123 for purposes of providing pro forma disclosures are not likely to be representative of the effects on reported net income in future years.
During 1998, the Company issued 15,563 shares of common stock to directors. Compensation expense, based on the fair market value of the stock at the date of grant, of $158,000 has been included in the statement of income for fiscal 1998.
13. EMPLOYEE BENEFIT PLAN
The Company implemented an employee savings plan (the "plan") during fiscal 1995 pursuant to Section 401(k) of the Internal Revenue Code. All employees who have been credited with at least 250 hours of service within three consecutive months are eligible to participate in the plan. Employees may elect to contribute to the plan through payroll deductions in an amount not to exceed the amount permitted under the Internal Revenue Code. The Company has the discretion to make matching contributions on behalf of the participants. Employees are fully vested in their contributions. Company contributions vest at a rate of 20% on each participant's anniversary date in the plan provided that the participant has completed 1,000 hours of service with the Company as of such date. During fiscal 1998, 1997 and 1996, the Company contributed $104,000, $98,000 and $90,000, respectively to the plan.
EXHIBIT INDEX
EXHIBIT NUMBER EXHIBIT
3.1* Restated Certificate of Incorporation of the Company 3.2* Bylaws of the Company 10.1* Loan and Security Agreement between the Company and Commerce Bank, as amended 10.2* Stock Option Plan, including form of Stock Option Agreement 10.3** Subordinated Note Purchase Agreement 10.4** Amendment to Subordinated Note Purchase Agreement 10.5** J.C. Penney License Agreement 10.6** Vision Care Agreement 10.7+ Employment Agreement for William A. Schwartz, Jr. 10.8+ Form of Employment Severance Agreement 10.9** Form of Non-Statutory Option Agreement 10.10** Form of Indemnification Agreement 10.11** Stockholders' Agreement 10.12** Form of Sears Lease 10.13** Commerce Bank Mortgages and Schedules 10.14** DRPA Loan Documentation 21+ Subsidiaries of the Company 23+ Consent of Independent Auditors 27+ Financial Data Schedule - ----------- * Previously filed as an exhibit to the Form S-1 (Reg. No. 333-35819) filed with the Commission on September 17, 1997.
** Previously filed as an exhibit to Amendment No. 1 to the Form S-1 (Reg. No. 333-35819) filed with the Commission on October 29, 1997.
+ Filed herewith.