ITEM 1. BUSINESS
GENERAL
Cole National Corporation ("CNC") was incorporated as a Delaware corporation in 1984. CNC, primarily through the subsidiaries owned by its direct subsidiary, Cole National Group, Inc. ("CNG"), is a leading provider of eyewear products, optometric services and personalized gifts with over 2,800 retail locations in 49 states, Canada and the Caribbean. References herein to the "Company" include CNC, its direct and indirect subsidiaries, and its predecessor companies, which have operated for more than 50 years, where applicable. The Company's businesses are conducted through two principal operating units: (i) Cole Optical, consisting of Cole Vision Corporation ("Cole Vision") and Pearle, Inc. ("Pearle"), which was acquired on November 15, 1996; and (ii) Things Remembered Inc. ("Things Remembered"). The Company believes that, based on industry data and after the acquisition of American Vision Centers, Inc. ("AVC") in August 1997, Cole Optical is the largest optical retail company in North America. Things Remembered operates the only nationwide chain of gift stores offering "while you shop" gift personalization, key duplicating, and related merchandise. The Company differentiates itself from other specialty retailers by providing value-added services at the point of sale at all of its retail locations.
In January, 1998, the Company announced the closing of its Cole Gift Centers ("CGC") operations which included 445 key duplicating, greeting card and gift departments on the premises of hosts' stores. The closings were completed by February 28, 1998. CGC has been accounted for as a discontinued operation in the accompanying financial statements.
COLE OPTICAL
Cole Optical contributed 77.4% of the Company's net revenue in fiscal 1997 with over 2,000 company-owned and franchised locations throughout the United States, Canada and the Caribbean as of January 31, 1998. Cole Vision and Pearle share management leadership, purchasing power and corporate support functions. Cole Vision's managed vision care programs give participants access to a network of company-owned, franchised and third-party optical locations.
COLE VISION
Cole Vision operates principally under the "Sears Optical", "Ward's Optical" and "BJ's Optical Department" names. As of January 31, 1998, Cole Vision operated 1,157 locations in 46 states and Canada, including 767 departments on the premises of Sears department stores, 192 departments in Montgomery Ward stores, 79 departments in BJ's Wholesale Club stores, 11 departments in Target stores, 104 freestanding stores operated under the name "Sears Optical" and four other locations. Cole Vision departments are generally operated under a lease or license arrangement through which the host store collects the sales receipts, retains an agreed upon percentage of sales and remits the remainder to Cole Vision on a weekly basis.
Cole Vision locations are, in most cases, full-service retail eyecare stores offering brand name and private label prescription eyeglasses, contact lenses and accessories, with an on-premises doctor of optometry who performs complete eye examinations and prescribes eyeglasses and contact lenses. Most Cole Vision optical departments, which are typically 1,000 square feet in size, operate with a doctor of optometry, a department manager, and from one to seven opticians depending on store sales volume. A majority of the doctors of optometry are independent, as is often required by state law, with the remainder being employed by Cole Vision. The independent doctors sublease space and equipment from Cole Vision where permitted by law, or from the host, and retain their examination fees.
Each of Cole Vision's locations is computer linked to Cole Vision's five centralized manufacturing laboratories, which grind, cut and fit lenses to order and ship them to the stores. Cole Vision provides next day delivery on most of the eyewear it offers when requested by its customers. Cole Vision purchases all of the frames and lenses used in its eyeglasses from outside suppliers, both in the United States and several foreign countries.
Cole Vision conducts a variety of marketing and promotional efforts to build and maintain its customer base. Cole Vision primarily uses newspaper, direct mail, yellow pages and host advertising. Host advertising includes the placement of promotional material within sales circulars or credit card billings sent out by the host store to its customers. Cole Vision also promotes its next day service as "Eyewear Express."
MANAGED VISION CARE
In the last several years, Cole Vision has expanded its managed vision care program that provides low cost, comprehensive eyecare benefits marketed directly to employers, other employee benefit plan sponsors and insurance companies, primarily under the name "Vision One." Vision One's basic program gives employers the opportunity to offer their employees a group discount at locations within the managed vision care network with minimal direct cost to the employer. An enhanced Vision One program allows employers to provide their employees with prepaid eye examinations, as well as pricing discounts or reimbursements. Cole Vision added the Pearle company-owned and a majority of franchised locations to its managed vision care programs in fiscal 1997.
PEARLE
At January 31, 1998, Pearle's operations, including AVC's locations, consisted of 444 company-owned and 401 franchised stores located in 43 states, Canada, and the Caribbean. All Pearle stores operate in either an "Express" or "Mainline" store format. Express stores contain a full surfacing lab that can manufacture most glasses in approximately one hour. Mainline stores can manufacture over 50% of prescriptions on-site in approximately one hour. Other prescriptions are sent to a nearby Express location or to the main laboratory in Dallas. The main laboratory generally is able to complete orders for next day delivery if requested. At January 31, 1998, 325 of the company-owned stores and 128 of the franchised stores were Express, with the balance being Mainline. Most of the AVC locations, which included 80 company-owned and 75 franchised stores at January 31, 1998, have been integrated into the Pearle system.
The Express stores typically are located in high traffic freestanding, strip center and mall locations with most stores averaging 3,000 square feet. The Express stores are usually staffed with two managers and a support staff of four to eight people. Mainline stores have an average size of 1,700 square feet and are also located in freestanding buildings, or in smaller strip or regional centers. Mainline stores generally carry a smaller assortment of inventory than Express stores and are usually staffed with one manager and two to three associates. Most Pearle stores have a doctor of optometry on site with approximately 80% leasing space from Pearle on an independent basis and the remaining being direct employees of Pearle.
Pearle's marketing strategy employs a wide range of media at both the national and local levels. The franchised and company-owned stores each contribute a percentage of revenues to Pearle's marketing budget with approximately half of Pearle's marketing expenditures devoted to television. Pearle's brand positioning of high quality eyecare products and services has been reinforced by an advertising and promotions program, which includes Pearle's advertising slogans, Nobody Cares for Eyes More Than Pearle and Put your Pearle's on.
Pearle operates a warehouse facility in Dallas that inventories and distributes a comprehensive product line, including frames, eyeglass lenses, contact lenses, optical supplies and eyewear accessories to company-owned and franchised locations.
In fiscal 1997 and early 1998, the Company increased its equity interest in Pearle Europe B.V., which operates 490 owned and franchised retail optical locations in the Netherlands, Belgium, Germany and Austria, to 24%.
FRANCHISE OPERATIONS
Pearle has maintained a franchise program since 1980. Most of the franchised stores are single franchise operations, with no franchisee operating more than eight stores. With the proper financial approvals, a franchise purchase can be financed through Pearle. Currently, Pearle offers financing over periods up to ten years at variable interest rates ranging from prime plus one point to prime plus three points adjusted periodically.
Each franchisee is required to enter into a Franchise Agreement requiring payment of an initial franchise fee. The term of the typical franchise agreement is equal to the earlier of ten years or the expiration or termination of the underlying base lease. Royalty and advertising contributions typically are based on a percentage of the franchisee's gross revenues from the retail operation and/or non-surgical professional fee revenues. The total monthly advertising contribution is distributed between Pearle's system-wide advertising fund and the local co-op market advertising fund.
During 1997 Pearle modified its Franchise Agreement to reduce the royalty and advertising fees the franchisees pay and, among other things, provide for the franchisees' participation in Cole Vision's managed vision care programs. Approximately 75% of existing franchisees have accepted the modified agreement.
THINGS REMEMBERED
Things Remembered contributed 22.6% of the Company's net revenue in fiscal 1997. As of January 31, 1998, Things Remembered operated 831 stores and kiosks generally located in large, enclosed shopping malls located in 45 states. Each location carries a wide assortment of engravable items and provides "while you shop" personalization and engraving services for any occasion including holiday, business and special occasion gift events. Things Remembered offers engraving for items purchased at the store as well as for items purchased elsewhere.
Merchandise sold at Things Remembered stores consists of a broad assortment of gift categories and items at prices generally ranging from $10 to $75. Things Remembered's offering of gifts includes writing instruments, clocks, music boxes, picture frames and albums, executive desk sets and accessories, ID bracelets, glassware, lighters, keys and key rings, door knockers and Christmas ornaments. Things Remembered features brand name merchandise as well as higher margin private label merchandise. At some locations, the Company utilizes computer-controlled embroidery equipment for the personalization of merchandise such as throws, sweaters, bathrobes, jackets, baseball caps, towels and baby blankets. These softgoods were added to most of Things Remembered's other locations in 1996 with personalization services provided from a central fulfillment facility.
At January 31, 1998, Things Remembered locations consisted of 456 stores and 375 kiosks. The typical store consists of about 1,000 square feet, while kiosks, which are units generally located in the center of the common mall area, are typically 200 square feet in size.
Things Remembered locations are usually operated by one or two employees during non-peak periods and up to 15 employees during the peak Christmas season. Locations typically employ a store manager on a full-time basis and a full or part-time assistant manager, while the balance of the employees is part-time sales associates.
Nearly all locations are equipped with computerized gift engravers and key duplicating machines. Many stores also have equipment for etching glassware items. All locations are equipped with point-of-sale terminals.
The Company ships most of Things Remembered's store merchandise through its centralized warehouse and distribution facility located near Youngstown, Ohio. Completed in July 1997, this facility is expected to improve distribution efficiencies. The warehouse utilizes a computerized carousel system to automate the process of locating merchandise needed to fill a store order.
HOST RELATIONSHIPS
The Company believes it has developed excellent relationships with the host stores in which Cole Vision operates. The Company has maintained its relationships with Sears and Montgomery Ward over 35 years in the optical business. Of the Sears and Montgomery Ward stores that offer optometric services, the vast majority are operated by Cole Vision. Although leases with major hosts are terminable by either party upon relatively short notice, Cole Vision has never had a lease terminated other than in connection with a store closing, relocation or major remodeling.
PURCHASING
The merchandise, supplies and component parts required for the various products sold by the Company are purchased from a large number of suppliers and manufacturers and are generally readily available. In most cases, such purchases are not made under long-term contracts. In fiscal 1997, no single supplier or manufacturer accounted for as much as 10% of total purchases.
COMPETITION
The Company operates in highly competitive businesses. Cole Optical competes with other optical companies, private ophthalmologists, optometrists and opticians and a growing number of HMOs in a highly fragmented marketplace. Pearle competes on the basis of its highly recognized brand name, one-hour express service and by offering quality eyecare products. Cole Vision competes primarily on the basis of the patient service it provides, as well as price and product quality and the reputation of its host stores. The Company believes that, based on industry data and after the acquisition of AVC in August 1997, Cole Optical is the largest optical retail company in North America. Although Things Remembered operates the only nation-wide chain of gift stores offering "while you shop" gift engraving, key duplicating, glass etching and monogramming, as well as related merchandise, it competes with many other retailers that sell gift items. Things Remembered competes with such other retailers primarily on the basis of the value-added point of sale services that it provides, as well as price and product quality. Some of the Company's competitors have greater financial resources than the Company.
EMPLOYEES
As of January 31, 1998, the Company and its subsidiaries had approximately 9,200 full-time and 5,200 part-time employees. During October, November and December, the Company employs additional full- and part-time employees. In fiscal 1997, approximately 5,000 additional employees were employed during such period. Approximately 190 employees at certain Pearle locations are represented by labor unions. The Company considers its present labor relations to be satisfactory.
ITEM 2.
ITEM 2. PROPERTIES
The Company owns an office in Highland Heights, Ohio that is subject to a mortgage, leases another office in Highland Heights, Ohio and leases its executive offices and an office in Cleveland, Ohio. All of Cole Vision's retail locations are leased or operated under a license with the host store, and none of the individual retail locations is material to the Company's operations. Leases for departments operated in Sears stores and freestanding stores operated under the name "Sears Optical" are generally for terms of 90 days and five years, respectively. Leases for Things Remembered stores and kiosks are generally for terms of ten and five years, respectively. The Company believes that its relationships with its lessors are generally good. The Company leases its five Cole Vision optical laboratories, located in Knoxville, Tennessee (two labs); Memphis, Tennessee; Salt Lake City, Utah; and Richmond, Virginia, pursuant to leases expiring (including renewals at the option of the Company) in 1999, 2005, 2002, 2006 and 2002, respectively.
Pearle and AVC have 401 stores based in 39 states. Pearle also has 18 stores in Canada and 25 stores in the Caribbean. Stores are located in malls, strip centers and freestanding locations. Pearle and AVC lease most of their retail stores under non-cancelable operating leases with terms generally ranging from five to ten years and which generally contain renewal options for additional periods. Pearle or AVC is the principal lessee on a majority of stores operated by franchisees who sublease the facilities from Pearle or AVC. Pearle owns its Dallas Support Center, which comprises approximately 88,721 square feet of office space and 147,336 square feet of laboratory and distribution facilities. Pearle also owns a small headquarters and laboratory in Puerto Rico. AVC leases its Flint laboratory and distribution facility pursuant to a lease expiring in 2000.
In fiscal 1997, the Company completed construction of a 210,000 square foot warehouse and distribution facility for Things Remembered near Youngstown, Ohio. The Company currently owns this facility but is evaluating financing alternatives.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
The Company is subject to a variety of routine legal proceedings.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY-HOLDERS
There were no matters submitted to a vote of security holders through the solicitation of proxies or otherwise during the fourth quarter of the fiscal year ended January 31, 1998.
ITEM 4A. EXECUTIVE OFFICERS OF THE COMPANY
(a) The following persons are the executive officers of the Company who are not members of the Company's Board of Directors, having been elected to their respective offices by the Board of Directors of the Company to serve until the election and qualification of their respective successors:
NAME AGE OFFICE --------------- --- ------------------------------
Leslie D. Dunn 52 Senior Vice President - Business Development, General Counsel and Secretary
Joseph Gaglioti 52 Vice President and Treasurer
Wayne L. Mosley 44 Vice President and Controller
(b) The following is a brief account of the positions held with the Company during the past five years by each of the above named executive officers of the Company:
Ms. Dunn has been Senior Vice President - Business Development, General Counsel and Secretary of the Company since September 1997. Prior to joining the Company, she was a partner in the law firm of Jones Day Reavis & Pogue for more than five years.
Mr. Gaglioti has been Vice President of the Company since 1992 and Treasurer of the Company since 1991. Mr. Gaglioti joined the Company in 1981.
Mr. Mosley has been Vice President and Controller, Assistant Secretary and Assistant Treasurer of the Company since 1992. Mr. Mosley joined the Company in 1986.
Information concerning Jeffrey A. Cole and Brian B. Smith, the Company's executive officers who are also Directors, will be included in the Company's Proxy Statement for the 1998 Annual Meeting of Stockholders (the "Proxy Statement").
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company's Common Stock is traded on the New York Stock Exchange (NYSE) under the symbol "CNJ". The following table sets forth, for the fiscal periods indicated, the high and low sales prices per share.
The Company's dividend policy for the foreseeable future is to retain earnings to support its growth strategy. The Company did not pay dividends on its Common Stock during the last two fiscal years.
As of March 25, 1998, there were 194 shareholders of record.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
The selected financial data set forth below have been restated to reflect continuing operations only and should be read in conjunction with the Consolidated Financial Statements and the notes thereto and other information contained elsewhere in this report (dollars in thousands, except per share amounts).
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The Company's fiscal year ends on the Saturday closest to January 31. Fiscal years are identified according to the calendar year in which they begin. For example, the fiscal year ended January 31, 1998 is referred to as "fiscal 1997." Fiscal 1997 and 1996 consisted of 52-week periods while fiscal 1995 consisted of a 53-week period.
RESULTS OF OPERATIONS
On January 13, 1998, the Company announced the closing of its Cole Gift Centers ("CGC") business which included 445 key duplicating, greeting card and gift departments on the premises of hosts' stores. CGC has been accounted for as a discontinued operation in the accompanying financial statements. Accordingly, the results of operations and loss on disposition of CGC have been excluded from the results of continuing operations.
The following is a discussion of the results of the Company's continuing operations for the three fiscal years ended January 31, 1998.
FISCAL 1997 COMPARED TO FISCAL 1996
On August 5, 1997, the Company acquired all of the issued and outstanding common stock of American Vision Centers, Inc. ("AVC") for approximately $28.9 million in cash, including debt assumed. The acquisition was accounted for using the purchase method of accounting. Accordingly, AVC's results of operations, which included 80 company-owned optical stores and 75 franchised locations at January 31, 1998, have been included in the Company's consolidated statement of income for fiscal 1997 since the date of acquisition. For the six-month period, AVC's net revenue was approximately $25.0 million.
Net revenue increased 59.1% to $1.0 billion in fiscal 1997 from $628.5 million in fiscal 1996. The increase in revenue was primarily attributable to the acquisitions of Pearle, Inc. ("Pearle") and AOCO Limited ("Sears Optical of Canada") in November 1996 and AVC in August 1997 (collectively "the Acquired Companies"), which accounted for $290.7 million of the increase for the fiscal year. See Notes 2 and 3 of the Notes to Consolidated Financial Statements for further discussion of the Acquired Companies. The Company's consolidated comparable store sales increased 3.6% in fiscal 1997 with a 5.9% comparable store growth at Cole Optical and a 0.5% comparable store sales decline at Things Remembered. The increase at Cole Optical was primarily a result of successful eyewear promotions and growth in managed vision care sales. The net revenue increase was also attributable to the Company's classification of capitation and other fees associated with its growing managed vision care business as revenue. Until the first quarter of fiscal 1997, such fees were netted with operating expenses in the Company's financial statements. For fiscal 1997, these fees were approximately $44.7 million. The opening of additional Cole Optical and Things Remembered units also contributed to the revenue increase. At January 31, 1998, the Company had 2,833 specialty service retail locations, including 401 franchised locations, compared to 2,657 at February 1, 1997.
Gross profit increased to $659.3 million in fiscal 1997 from $427.3 million in fiscal 1996. The gross profit increase was primarily attributable to the Acquired Companies and classification of managed vision care fees as revenue. Gross margins for fiscal 1997 and fiscal 1996 were 65.9% and 68.0%, respectively. The lower gross margin percentage in fiscal 1997 resulted primarily from the addition of Pearle which operates at a lower gross margin than the Company has historically experienced due to the higher costs of in-store laboratories and lower margin wholesale sales to franchised stores. This was partially offset by revenue generated by Pearle's franchise royalties and fees, interest income on Pearle's franchise notes receivable and the managed vision care fees, each of which has no corresponding cost of goods sold.
Operating expenses increased 55.5% to $558.5 million in fiscal 1997 from $359.1 million in fiscal 1996. As a percentage of revenue, operating expenses decreased to 55.8% in fiscal 1997 from 57.1% in fiscal 1996. The leverage improvement was primarily a result of the addition of Pearle, which has lower operating expenses as a percentage of revenue than the rest of the Company, along with leverage gains achieved by Cole Optical's comparable store sales increase. This was offset in part by leverage losses at Things Remembered resulting from the decline in comparable store sales. Operating expenses increased primarily because of the Acquired Companies and the classification of capitation and other fees as revenue. The expense increase reflected higher advertising expenditures, payroll costs, and store occupancy expenses, as well as expenses related to the growth of managed vision care. Advertising expenditures at Cole Optical were increased for optical promotions and Pearle name awareness. Payroll costs increased because of more higher-volume retail units open in 1997 and additional payroll to support increased sales. Store occupancy expenses increased primarily as a result of more locations and higher percentage rents caused by increased comparable store sales. Fiscal 1997 depreciation and amortization expense of $30.0 million was $11.4 million more than fiscal 1996 reflecting the addition of the Acquired Companies and an increase in capital expenditures.
The third and fourth quarter of fiscal 1997 included a total of $8.0 million of charges for non-recurring items related to integration of AVC into the Company's operations. In the fourth quarter of fiscal 1996, the Company recorded a $61.1 million pre-tax charge for certain unusual non-recurring items primarily related to the integration
and consolidation of Pearle. See Note 3 of the Notes to Consolidated Financial Statements for further discussion of the Business Integration and Other Non-Recurring Charges.
Operating income, excluding charges for business integration and other non-recurring items from each year, increased 42.9% to $70.9 million in fiscal 1997 from $49.6 million the prior year, primarily the result of the Acquired Companies and comparable store sales growth at Cole Optical, offset in part by soft sales performance at Things Remembered.
Net interest expense for fiscal 1997 of $27.9 million increased $7.7 million compared to fiscal 1996. The increase was primarily attributable to the additional interest on $150.0 million of 9-7/8% Senior Subordinated Notes due 2006 (the "9-7/8% Notes") issued in connection with financing the Pearle acquisition and $125.0 million of 8-5/8% Senior Subordinated Notes due 2007 (the "8-5/8% Notes") issued in August 1997. This was partially offset by a decrease in interest expense due to the purchase and subsequent retirement of $15.1 million of 11-1/4% Senior Notes due 2001 (the "Senior Notes") in the second quarter of fiscal 1996 and the purchase and retirement of $150.9 million of Senior Notes in conjunction with a tender offer in September 1997. The issuance of the 8-5/8% Notes, combined with the redemption of the Senior Notes, is expected to reduce fiscal 1998 interest expense by more than $3.0 million compared to fiscal 1997.
The income tax provisions for fiscal 1997 and 1996 include $3.4 million and $20.0 million, respectively, of income tax benefits related to the charges for business integration and other non-recurring items. The effective tax rate on income excluding the charge for business integration and other non-recurring items was 43.0% in fiscal 1997 and 44.3% in fiscal 1996. This rate reflects the significant impact of non-deductible amortization of goodwill in both years. A more complete discussion of income taxes is included in Note 10 of Notes to Consolidated Financial Statements.
The net loss in fiscal 1997 of $6.2 million included a $14.0 million loss, net of an income tax benefit of $8.5 million, related to the operations and closing of CGC and a $12.2 million extraordinary loss, net of an income tax benefit of $7.5 million, recorded in the third quarter of fiscal 1997 in connection with the early extinguishment of debt. The loss represented the tender premium, write-off of related unamortized debt discount and other costs associated with redemption of the Senior Notes. A similar charge for $0.7 million, net of an income tax benefit of $0.5 million, was recorded in the second quarter of fiscal 1996.
FISCAL 1996 COMPARED TO FISCAL 1995
On November 15, 1996, the Company acquired the North American and Caribbean operations of Pearle and a 20% interest in Pearle Trust B.V., a company formed to purchase Pearle's European business. The acquisition of Pearle has been accounted for under the purchase method of accounting. Accordingly, Pearle's results of operations since the date of acquisition have been included in the Company's consolidated statement of income for fiscal 1996. For the eleven-week period, Pearle operated at approximately a break-even level with net revenue of $58.3 million reflecting the relatively lower level of optical retail sales during the holiday season. At February 1, 1997, the Pearle system included 348 company operated optical stores and 338 franchised locations in the United States, Canada and the Caribbean. Except as otherwise indicated, the following discussion of net revenue, gross profit and operating expenses relates to the Company on an historical basis without giving effect to the Pearle acquisition.
Net revenue increased 9.8% to $566.3 million in fiscal 1996 from $515.9 million in fiscal 1995. The increase in consolidated revenue was due to a comparable store sales increase of 7.2% and to the opening of additional Things Remembered and Cole Vision units including 75 optical locations in Canada as a result of the acquisition of Sears Optical of Canada in November 1996. This was partially offset by one less week of revenue in fiscal 1996 compared to fiscal 1995. Comparable store sales increased 10.7% at Cole Vision primarily as a result of successful eyewear promotions and growth in the managed vision care program. Comparable store sales increased 2.3% at Things Remembered benefiting from the roll-out of monogrammed softgoods and the introduction of new merchandise. At February 1, 1997, the Company operated 1,971 specialty service retail locations, excluding the Pearle system, versus 1,834 at the end of the prior year.
Gross profit increased to $391.4 million in fiscal 1996 from $354.2 million in fiscal 1995. Gross margins for fiscal 1996 and fiscal 1995 were 69.1% and 68.7%, respectively. The increase in gross margin percentage was the result of lower product costs, improved optical lab productivity and a higher level of personalization in the sales mix at Things Remembered.
Operating expenses increased 10.1% to $326.0 million in fiscal 1996 from $296.0 million the prior year. As a percentage of revenue, operating expenses increased slightly to 57.6% in fiscal 1996 from 57.4% in fiscal 1995. Operating expenses increased primarily due to higher advertising expenditures, payroll costs and store occupancy expenses, partly offset by one less week in fiscal 1996. Advertising expenditures at Cole Vision were increased for optical promotions to encourage continued sales growth above last year's successful promotions. Payroll costs increased because of more higher-volume retail units open in 1996, including an increased number of Things Remembered personalization superstores, and additional payroll to support increased sales. Store occupancy expenses increased primarily as a result of the increased number of Things Remembered personalization superstores and higher percentage rents caused by increased comparable store sales. Fiscal 1996 depreciation and amortization expense of $16.0 million was $1.4 million more than fiscal 1995 reflecting an increase in capital expenditures.
In the fourth quarter of fiscal 1996, the Company recorded a $61.1 million pre-tax charge for certain unusual non-recurring items. Such charge was primarily related to the acquisition of Pearle and included costs incurred related to the integration and consolidation of Pearle into the Company's operations, as well as certain other non-recurring charges. See Note 3 of the Notes to Consolidated Financial Statements for further discussion of the Business Integration and Other Non-recurring Charges.
Operating income, excluding the charge for non-recurring items, increased 13.2% to $49.4 million in fiscal 1996 from $43.7 million the prior year. The increase was primarily attributable to increased revenue and improved gross margin.
Net interest expense for fiscal 1996 of $20.2 million was $1.0 million more than that of the prior year. This increase was primarily due to $3.4 million of additional interest expense related to the financing of the Pearle acquisition offset by decreases in interest expense due to the retirement of $5.0 million of the Senior Notes in November 1995, the purchase and subsequent retirement of $15.1 million of Senior Notes in the second quarter of fiscal 1996, the elimination of working capital borrowings and increased interest income from an increase in temporary cash investments.
The income tax benefit of $6.9 million for fiscal 1996 includes a $20.0 million income tax benefit related to the charge for integration and other non-recurring items. The effective income tax rate on income excluding the charge for integration and other non-recurring items was 44.3% in fiscal 1996 and 43.7% in fiscal 1995. This rate reflects the significant impact of non-deductible amortization of goodwill in both years.
The net loss in fiscal 1996 of $28.3 million included a $2.9 million loss, net of an income tax provision of $0.2 million, from CGC's discontinued operations, which included a write-off of CGC's goodwill of $3.3 million, and a $0.7 million extraordinary loss, net of an income tax benefit of $0.5 million, recorded in the second quarter in connection with the early extinguishment of debt. The extraordinary loss represented the payment of premiums, the write-off of unamortized discount and other costs associated with purchasing the debt.
LIQUIDITY AND CAPITAL RESOURCES
The Company's primary source of liquidity is funds provided from operations of its operating subsidiaries. In addition, the Company's wholly-owned subsidiary, Cole National Group, Inc. (CNG) and its operating subsidiaries have available to them working capital commitments of $75.0 million, reduced by commitments under letters of credit, under a credit facility put in place at the time of the Pearle acquisition (the "Credit Facility").
There were no working capital borrowings outstanding during fiscal 1997 and 1996.
The Credit Facility contains covenants restricting the ability of the Company's operating subsidiaries to, among other things, pay dividends or make other restricted payments to the Company or CNG. The Credit Facility permits CNG's subsidiaries to pay dividends to CNG to the extent necessary to permit CNG to pay all interest and principal on the Senior Notes, the 9-7/8% Notes and the 8-5/8% Notes when due.
During the second quarter of fiscal 1997, the Company completed a public offering of 2,587,500 shares of its Common Stock at an offering price of $47.00 per share. The net proceeds of approximately $116.0 million were used for general corporate purposes including reducing outstanding indebtedness and financing acquisitions, including the purchase of AVC.
In August 1997, CNG issued $125.0 million of 8-5/8% Notes. The net proceeds of the issuance were $121.8 million. CNG also commenced a tender offer which expired on September 12, 1997, to purchase up to all of its $165.8 million outstanding Senior Notes at $1,105.61 per $1,000 principal amount, plus accrued interest thereon, using the net proceeds of the 8-5/8% Notes issuance and cash on hand. A total of $151.3 million of Senior Notes was tendered resulting in the extraordinary charge discussed above. The Company plans to redeem the remaining $14.5 million of Senior Notes in October 1998, the first call date, and accordingly, has reflected them as current liabilities in the accompanying consolidated balance sheet.
In November 1997, the Company's Board of Directors authorized the repurchase from time to time of up to 500,000 shares of common stock, or approximately 3.5% of the Company's outstanding shares, through open market or block transactions. It is expected that the shares will be purchased using internally generated funds and will be used in part to offset dilution from stock options and in connection with other benefit plans. As of January 31, 1998, a total of 20,000 shares had been purchased.
At year end, the Company had outstanding $14.5 million of Senior Notes, $150.0 million of 9-7/8% Notes and $125.0 million of 8-5/8% Notes. The Senior Notes, the 9-7/8% Notes and the 8-5/8% Notes are unsecured and mature October 1, 2001, December 31, 2006 and August 15, 2007, respectively, with no earlier scheduled redemption or sinking fund payment. The Senior Notes bear interest at a rate of 11-1/4% per annum, payable semi-annually on each April 1 and October 1. The 9-7/8% Notes interest is payable semi-annually on each June 30 and December 31, while the 8-5/8% Notes interest is payable semi-annually on each February 15 and August 15. The indentures pursuant to which the Senior Notes, the 9/7/8% Notes and the 8-5/8% Notes were issued contain certain optional and mandatory redemption features and other financial covenants, including restrictions on the ability of CNG to pay dividends or make other restricted payments to the Company. The indentures permit dividend payments to the Company of one-half of CNG's consolidated net income, provided that no default or event of default has occurred under the indentures and that CNG has met a specified fixed charge coverage ratio test. The indentures also permit payments to the Company for certain tax obligations and for administrative expenses of the Company not to exceed .25% of net sales. See Note 6 of Notes to Consolidated Financial Statements.
The Company plans to redeem the remaining Senior Notes in 1998. As a result, the Company will have no significant principal payment obligations under its outstanding indebtedness until the 9-7/8% Notes mature in 2006. The ability of the Company and its subsidiaries to satisfy these obligations will be primarily dependent upon future financial and operating performance of the subsidiaries and upon the Company's ability to renew or refinance borrowings or to raise additional equity capital.
Cash balances at year end were $68.1 million compared to $73.1 million at February 1, 1997. Operations generated net cash of $8.0 million in fiscal 1997, $82.8 million in fiscal 1996 and $34.8 million in fiscal 1995. The $74.8 million decrease in cash provided by operations in fiscal 1997 compared to fiscal 1996 was primarily attributable to a decrease in accounts payable and accrued liabilities of $11.8 million due in part to the payment of non-recurring charges, an increase in inventories of $11.2 million versus $3.9 million in fiscal 1996, and a decrease in accrued and deferred income taxes of $25.8 million versus an increase of $16.3 million in fiscal 1996. These cashflow decreases were partly offset by a $15.9 million decrease in the net assets of discontinued operations, increased income from operations of $13.5 million, excluding the charge for integration and other non-recurring items, and increased depreciation and amortization expense of $11.4 million. The $48.0 million increase in cash provided by operations in fiscal 1996 compared to fiscal 1995 was primarily attributable to an increase in accounts payable and accrued
liabilities of $34.9 million, excluding amounts related to integration and other non-recurring items, increased accrued income taxes of $14.9 million primarily related to the sale of Pearle's European business for which the Company was reimbursed, increased income from operations of $5.0 million excluding the charge for integration and other non-recurring items, and increased depreciation and amortization expense of $4.0 million. These cash flow increases were partly offset by an increase in inventories of $3.9 million versus a $2.4 million reduction in fiscal 1995.
In fiscal 1997 and fiscal 1996, the Company recorded $8.0 and $61.1 million, respectively, of pre-tax charges for business integration and other non-recurring items. The total cash outlay related to these charges is expected to be approximately $48.6 million, of which $23.1 million has been paid as of January 31, 1998. The remaining amount is expected to be incurred within the next 12 to 18 months, except for lease obligations which may be incurred over the life of the leases.
Net capital additions were $32.6 million, $25.1 million, and $18.1 million in fiscal 1997, 1996 and 1995, respectively. The majority of the capital additions was for store fixtures, equipment and leasehold improvements for new stores and the remodeling of existing stores. The Company also acquired land and constructed a new warehouse and distribution facility for Things Remembered at a cost of approximately $9.3 million (of which $6.6 million is included in capital expenditures in fiscal 1997) to improve distribution efficiencies. In addition, the Company used $27.8 million for the purchase of AVC and $2.8 million for additional investment in Pearle Europe in fiscal 1997, $157.4 million for the purchases of Pearle and AOCO Limited and $6.1 million for the investment in Pearle Europe in fiscal 1996, and $0.8 million for the purchase of the BJ's Wholesale Club optical departments in fiscal 1995.
For fiscal 1998, the Company plans to expand the number of stores as well as remodel and relocate stores. The Company currently estimates that capital expenditures in fiscal 1998 will be approximately $35.0 million, excluding acquisitions. In February 1998, the Company increased its investment in Pearle Europe by $10.4 million in connection with Pearle Europe's acquisition of two of the largest optical retailers in Germany and Austria.
The Company paid approximately $17.9 million for systems development costs in 1997. Such costs have been capitalized and are being amortized over their estimated useful lives. The Company estimates that it will incur an additional $15 to $20 million of systems development costs in 1998 that will also be capitalized and amortized.
The Company believes that funds provided from operations along with funds available under the Revolving Credit Facility will provide adequate sources of liquidity to allow the Company's operating subsidiaries to continue to expand the number of stores and to fund capital expenditures and systems development costs.
YEAR 2000
In connection with the significant investment in the development of new data processing systems, the Company has begun to evaluate the impact of issues regarding the year 2000. The Company is developing an action plan, including identifying required resources, to modify any computer systems and software applications not already modified, to be year 2000 compliant. At the present time, the Company anticipates completion of any modifications to critical systems by the end of fiscal 1998. However, there can be no assurance that such schedule will be met or that any similar failure to convert by the Company's vendors and suppliers or consumer credit providers such as banks or credit card companies would not have an adverse effect on the Company's business. Although the Company does not anticipate the cost of any modifications, which will be expensed, to have a material effect on its results of operations, financial position or cash flows, the ultimate impact is unknown at this time.
NEW ACCOUNTING PRONOUNCEMENTS
In fiscal 1998, the Company will adopt Statement of Financial Accounting Standards (SFAS) No. 130 "Reporting Comprehensive Income" and No. 131 "Disclosures about Segments of an Enterprise and Related Information".
SFAS No. 130 establishes standards for reporting comprehensive income and its components in a full set of financial statements. Comprehensive income is defined as "the change in equity of a business enterprise during a period from transactions and other events and circumstances from non-owner sources". Comprehensive income is the
total of net income and all other non-owner changes in equity. SFAS No. 130 will require the Company to report comprehensive income in a financial statement that is displayed with the same prominence as other financial statements.
SFAS No. 131 requires that the Company report certain information about operating segments in its financial statements. Operating segments are components of an enterprise whose results are regularly reviewed by the Company's chief operating decision maker to make decisions about resources to be allocated to the segment and assess its performance, and for which discrete financial information is available. The Company is currently evaluating which parts of its business meet the definition of an operating segment.
Adoption of the aforementioned standards is not expected to have a material impact on the Company's results of operations, financial position or cash flows.
FORWARD-LOOKING INFORMATION
Certain sections of this report contain forward-looking statements. Forward-looking statements are made based upon management's expectations and beliefs concerning future events impacting the Company. All forward-looking statements involve risk and uncertainty.
The Company operates in a highly competitive environment, and its future liquidity, financial condition and operating results may be materially affected by a variety of factors, some of which may be beyond the control of the Company, including risks associated with the integration of Pearle and AVC, the Company's ability to select and stock merchandise attractive to customers, economic and weather factors affecting consumer spending, operating factors, including manufacturing quality of optical and engraved goods, affecting customer satisfaction, the Company's relationships with host stores, the mix of goods sold, pricing and other competitive factors.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Information required by this item appears on pages through of this Form 10-K and is incorporated herein by reference. Other financial statements and schedules are filed herewith as "Financial Statement Schedules" pursuant to Item 14.
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 required by this item as to Directors will be included in the Company's Proxy Statement under the caption "Election of Directors" and is incorporated herein by reference. The information required by this item as to executive officers who are not Directors is included in Item 4A in Part I of this report.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this item will be included in the Company's Proxy Statement under the caption "Compensation of Executive Officers" and is incorporated herein by reference.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this item will be included in the Company's Proxy Statement under the caption "Security Ownership of Management and Certain Beneficial Owners" and is incorporated herein by reference.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this item will be included in the Company's Proxy Statement under the caption "Compensation Committee Interlocks, Insider Participation and Certain Transactions" and is incorporated herein by reference.
PART IV
ITEM 14.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a)(1) and (2) FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES
The consolidated financial statements and the related financial statement schedules filed as part of this Form 10-K are located as set forth in the index on page of this report.
(a)(3) EXHIBITS
See Exhibit Index on pages X-1 through X-6.
(b) REPORTS ON FORM 8-K
The Company did not file any reports on Form 8-K during the last quarter of the fiscal year ended January 31, 1998.
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.
COLE NATIONAL CORPORATION
April 30, 1998 By: /s/ Wayne L. Mosley --------------------------------- Wayne L. Mosley Vice President and Controller
PURSUANT TO THE REQUIREMENTS OF THE SECURITIES EXCHANGE ACT OF 1934, THIS REPORT HAS BEEN SIGNED BY THE FOLLOWING PERSONS ON BEHALF OF THE REGISTRANT AND IN THE CAPACITIES AND ON THE DATES INDICATED.
* Chairman and Chief April 30, 1998 - ------------------------ Executive Officer and Jeffrey A. Cole Director (Principal Executive Officer and Principal Financial Officer)
* President and Director April 30, 1998 - ------------------------ Brian B. Smith
/s/ Wayne L. Mosley Vice President and Controller April 30, 1998 - ------------------------ (Principal Accounting Officer) Wayne L. Mosley
* Director April 30, 1998 - ---------------------- Timothy F. Finley
* Director April 30, 1998 - ---------------------- Irwin N. Gold
* Director April 30, 1998 - ---------------------- Peter V. Handal
* Director April 30, 1998 - ---------------------- Charles A. Ratner
* Director April 30, 1998 - ---------------------- Walter J. Salmon
* The undersigned, by signing his name hereto, does sign and execute this report on Form 10-K pursuant to the Powers of Attorney executed by the above-named officers and directors of the Company and which are being filed herewith with the Securities and Exchange Commission on behalf of such officers and directors.
/s/ Wayne L. Mosley - --------------------------------- Wayne L. Mosley, Attorney-in-Fact
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND SCHEDULES
PAGE
Report of Independent Public Accountants F - 2
Consolidated Balance Sheets as of January 31, 1998 and February 1, 1997 F - 3
Consolidated Statements of Operations for the 52 weeks ended January 31, 1998, the 52 weeks ended February 1, 1997 and the 53 weeks ended February 3, 1996 F - 4
Consolidated Statements of Cash Flows for the 52 weeks ended January 31, 1998, the 52 weeks ended February 1, 1997 and the 53 weeks ended February 3, 1996 F - 5
Consolidated Statements of Stockholders' Equity for the 52 weeks ended January 31, 1998, the 52 weeks ended February 1, 1997 and the 53 weeks ended February 3, 1996 F - 6
Notes to Consolidated Financial Statements F - 7
Schedules included herein:
Report of Independent Public Accountants on the Financial Statement Schedule F - 22
Schedule I - Condensed Financial Information of Registrant F - 23
All financial statement schedules not included have been omitted because they are not applicable or because the required information is otherwise furnished.
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS ----------------------------------------
TO THE BOARD OF DIRECTORS OF COLE NATIONAL CORPORATION:
We have audited the accompanying consolidated balance sheets of Cole National Corporation (a Delaware corporation) and Subsidiaries (the Company) as of January 31, 1998 and February 1, 1997, and the related consolidated statements of operations, stockholders' equity and cash flows for each of the three years in the period ended January 31, 1998. 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 consolidated financial statements referred to above present fairly, in all material respects, the financial position of Cole National Corporation and Subsidiaries as of January 31, 1998 and February 1, 1997 and the results of their operations and their cash flows for each of the three years in the period ended January 31, 1998 in conformity with generally accepted accounting principles.
ARTHUR ANDERSEN LLP
Cleveland, Ohio, March 18, 1998.
COLE NATIONAL CORPORATION AND SUBSIDIARIES ------------------------------------------ CONSOLIDATED BALANCE SHEETS --------------------------- (DOLLARS IN THOUSANDS) ----------------------
The accompanying notes to consolidated financial statements are an integral part of these consolidated balance sheets.
COLE NATIONAL CORPORATION AND SUBSIDIARIES ------------------------------------------ CONSOLIDATED STATEMENTS OF OPERATIONS ------------------------------------- (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) ------------------------------------------------
The accompanying notes to consolidated financial statements are an integral part of these consolidated statements.
COLE NATIONAL CORPORATION AND SUBSIDIARIES ------------------------------------------ CONSOLIDATED STATEMENTS OF CASH FLOWS ------------------------------------- (DOLLARS IN THOUSANDS) ----------------------
The accompanying notes to consolidated financial statements are an integral part of these consolidated statements.
COLE NATIONAL CORPORATION AND SUBSIDIARIES ------------------------------------------ CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY ----------------------------------------------- (DOLLARS IN THOUSANDS) ----------------------
The accompanying notes to consolidated financial statements are an integral part of these consolidated statements.
COLE NATIONAL CORPORATION AND SUBSIDIARIES ------------------------------------------ NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ------------------------------------------
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION -
The consolidated financial statements include the accounts of Cole National Corporation (CNC), its wholly owned Subsidiaries, including Cole National Group, Inc. (CNG), and CNG's wholly owned subsidiaries (collectively, the Company). CNG's subsidiaries include Pearle, Inc. (Pearle) which was acquired on November 15, 1996 (see Note 2). All significant intercompany transactions have been eliminated in consolidation.
The Company is a specialty service retailer operating in both host and non-host environments. The Company's primary lines of business are eyewear products and services, and personalized gifts. Eyewear products and services represented approximately 77.4%, 64.8% and 59.3% of consolidated net revenue in 1997, 1996, and 1995, respectively.
The Company sells its products through over 2,400 company-owned retail locations and 400 franchised locations in 49 states, Canada, and the Caribbean, and differentiates itself from other specialty retailers by providing value-added services at the point of sale at all of its retail locations. The Company considers its operations to be in one business segment.
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
The Company's fiscal year ends on the Saturday closest to January 31. Fiscal years are identified according to the calendar year in which they begin. Fiscal years 1997 and 1996 consisted of 52 weeks while fiscal year 1995 consisted of 53 weeks.
INVENTORIES -
The Company's inventories are valued at the lower of first-in, first-out (FIFO) cost or market.
PROPERTY AND DEPRECIATION -
The Company's policy is to provide depreciation using the straight-line method over a period which is sufficient to amortize the cost of the asset over its useful life or lease term.
The estimated useful lives for depreciation purposes are:
Buildings and improvements 5 to 40 years Equipment 3 to 10 years Furniture and fixtures 2 to 10 years Leasehold improvements 2 to 20 years
Property and equipment, at cost, consist of the following as of January 31, 1998 and February 1, 1997 (000's omitted):
STORE OPENING EXPENSES -
Store opening expenses are charged to operations in the year the store is opened, which is generally the year the expense is incurred.
NOTES RECEIVABLE -
The Company's notes receivable are primarily from Pearle's franchisees throughout the U.S. and are collateralized by inventory, equipment, and leasehold improvements at each location. The notes generally bear interest at the prime rate plus 3% and require monthly payments of principal and interest over periods of up to ten years.
INTANGIBLE ASSETS -
Intangible assets, net, consist of the following at January 31, 1998 and February 1, 1997 (000's omitted):
Tradenames acquired in connection with the Pearle acquisition are being amortized on a straight-line basis over 40 years and are presented net of accumulated amortization of $1,498,500 and $262,000 at January 31, 1998 and February 1, 1997, respectively.
Goodwill is being amortized on a straight-line basis over 40 years and is presented net of accumulated amortization of $34,008,000 and $30,609,000 at January 31, 1998 and February 1, 1997, respectively. Management regularly evaluates its accounting for goodwill considering primarily such factors as historical profitability, current operating profits and cash flows. The Company believes that, at January 31, 1998, the asset is realizable and the amortization period is still appropriate.
INVESTMENT IN PEARLE EUROPE B.V. -
Included in other assets is the Company's investment in Pearle Europe B.V. (Pearle Europe), which conducts Pearle's European operations and is the parent company of Pearle Trust B.V. The Company's common equity investment of $2.2 million at January 31, 1998, (representing an approximate 24% ownership interest) is accounted for using the equity method.
Included in notes receivable is $6.2 million and $3.6 million of net shareholder loans receivable from Pearle Europe and its subsidiaries at January 31, 1998 and February 1, 1997, respectively. The shareholder loans provide for interest at rates ranging from 10% to 12.7%. In February 1998, the Company repaid a $3.2 million note payable to a subsidiary of Pearle Europe and invested an additional $7.2 million in the form of 8% shareholder loans to Pearle Europe in connection with Pearle Europe's acquisition of optical operations in Germany and Austria.
OTHER ASSETS -
Financing costs incurred in connection with obtaining long-term debt are capitalized in other assets and amortized over the life of the related debt using the effective interest method.
In March 1998 the Accounting Standards Executive Committee issued Statement of Position (SOP) 98-1, "Accounting for the Costs of Computer Software Developed or Obtained for Internal Use." This SOP, which was issued as an exposure draft in December 1996, provides guidance on accounting for the costs of computer software developed or obtained for internal use. SOP 98-1 provides that direct costs to develop or obtain internal use software, including internal costs, should be capitalized and amortized over the estimated useful life of the software.
Such costs incurred by the Company have been capitalized and are included in other assets. These costs are being amortized on a straight-line basis over periods ranging from two to seven years, beginning when the software is placed in service. At January 31, 1998 and February 1, 1997, these costs, net of accumulated amortization, were $23,963,000 and $3,102,000, respectively.
OTHER LONG-TERM LIABILITIES -
Other long-term liabilities consist primarily of certain employee benefit obligations, deferred lease credits and other lease-related obligations not expected to be paid within 12 months, and deferred income taxes. Deferred lease credits are amortized on a straight-line basis over the life of the applicable lease.
CASH FLOWS -
For purposes of reporting cash flows, the Company considers all temporary cash investments, which have original maturities of three months or less, to be cash equivalents. The carrying amounts of cash and cash equivalents approximate fair value due to the short maturity of those instruments.
Net cash flows from operating activities reflect cash payments for income taxes and interest as follows (000's omitted):
During 1997, 1996 and 1995, non-cash financing activities included incurring $799,000, $2,504,000 and $3,192,000, respectively, in capital lease obligations.
REVENUES -
Revenues include sales of goods and services to retail customers at company-operated stores, sales of merchandise inventory to franchisees and other outside customers, and other revenues from franchisees such as royalties based on sales, interest income on notes receivable and initial franchise fees. Other revenues from franchisees totaled $19.8 million and $4.0 million in fiscal 1997 and 1996, respectively.
Franchise revenues based on sales by franchisees are accrued as earned. Initial franchise fees are recorded as income when all material services or conditions relating to the sale of the franchises have been substantially performed or satisfied by the Company and when the related store begins operations.
In fiscal 1997, the Company began classifying capitation and other fees associated with its growing managed vision care business, totaling $44.7 million for fiscal 1997, as revenues, which in prior years has been netted with operating expenses.
ADVERTISING -
The Company expenses advertising production costs and advertising costs as incurred and is reimbursed by franchisees for certain advertising expenses based on a percentage of sales. Advertising expense is summarized as follows (000's omitted):
FOREIGN CURRENCY TRANSLATION -
The assets and liabilities of the Company's foreign subsidiaries and its investment in Pearle Europe are translated to United States dollars at the rates of exchange on the balance sheet date. Income and expense items are translated at average monthly rates of exchange. Translation gains or losses are included in the foreign currency translation adjustment component of stockholders' equity.
CAPITAL STOCK -
At January 31, 1998 and February 1, 1997, there were 14,727,325 and 11,965,473, respectively, shares of common stock, par value $.001 per share (the Common Stock), outstanding. At January 31, 1998, there were 40,000,000 and 5,000,000 authorized shares of Common Stock and undesignated preferred stock, respectively.
EARNINGS PER SHARE -
In the fourth quarter of fiscal 1997, the Company adopted Statement of Financial Accounting Standards (SFAS) No. 128, "Earnings Per Share," and accordingly, has restated all prior period data presented.
SFAS No. 128 requires that earnings per share be presented as two calculations: basic and diluted. Basic earnings per share for 1997, 1996 and 1995 have been based on 13,480,792; 11,333,453 and 10,415,047, respectively, weighted average number of common shares outstanding. The Company has stock options and warrants outstanding which are considered to be potentially dilutive common stock. Diluted earnings per share for 1997, 1996 and 1995, have been based on 13,980,727; 11,333,453 and 10,565,068, respectively, weighted average number of common shares outstanding after consideration of the dilutive effect, if any, for these common share equivalents.
ASSET IMPAIRMENT -
In the first quarter of 1996 the Company adopted SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of." Adoption of this standard did not have a material impact on the Company's results of operations, financial position or cash flows for the fiscal year-ended February 1, 1997. Management regularly evaluates its long-lived assets for impairment considering primarily such factors as store level profitability and cash flows. The Company believes that, at January 31, 1998, no asset impairment exists.
NEW ACCOUNTING PRONOUNCEMENTS -
In fiscal 1998, the Company will adopt Statement of Financial Accounting Standards (SFAS) No. 130 "Reporting Comprehensive Income" and No. 131 "Disclosures about Segments of an Enterprise and Related Information".
SFAS No. 130 establishes standards for reporting comprehensive income and its components in a full set of financial statements. Comprehensive income is defined as "the change in equity of a business enterprise
during a period from transactions and other events and circumstances from non-owner sources". Comprehensive income is the total of net income and all other non-owner changes in equity. SFAS No. 130 will require the Company to report comprehensive income in a financial statement that is displayed with the same prominence as other financial statements.
SFAS No. 131 requires that the Company report certain information about operating segments in its financial statements. Operating segments are components of an enterprise whose results are regularly reviewed by the Company's chief operating decision maker to make decisions about resources to be allocated to the segment and assess its performance, and for which discrete financial information is available. The Company is currently evaluating which parts of its business meet the definition of an operating segment.
Adoption of the aforementioned standards is not expected to have a material impact on the Company's results of operations, financial position or cash flows.
RECLASSIFICATIONS -
Certain 1996 and 1995 amounts have been reclassified to conform with the 1997 presentation.
(2) ACQUISITIONS OF BUSINESSES
On November 15, 1996, the Company purchased, for an aggregate purchase price of $219.7 million, including the costs of acquisition, certain assets and all of the issued and outstanding common stock of Pearle. Pearle consisted of 346 company-operated optical stores and 340 franchised locations in the United States, Canada and the Caribbean and 193 locations in the Netherlands and Belgium. Immediately following the acquisition, the Company sold Pearle Holdings B.V., Pearle's European operations, to Pearle Trust B.V. for approximately $62 million. No gain or loss was recorded on this transaction. As more fully described in Note 1, the Company has retained an ownership interest in Pearle Europe, the parent company of Pearle Trust B.V.
The Pearle acquisition was accounted for under the purchase method of accounting. The results of operations of Pearle have been included in the consolidated financial statements since the date of acquisition. The purchase price was allocated to the assets acquired and liabilities assumed based upon their relative fair values as of the closing date. This resulted in an excess of purchase price over net assets acquired of $24.5 million, including final adjustments of $4.3 million. The relative fair values of the assets acquired and liabilities assumed were based upon valuations and other studies and included tradenames of $49.5 million, unfavorable leasehold interests of $7.5 million, accruals for involuntary severance and termination benefits of $4.4 million and deferred tax assets of $16.7 million.
On a pro forma basis, if the Pearle acquisition had taken place at the beginning of the respective periods, the unaudited consolidated net revenues would have been $878.3 million for fiscal 1996 and $812.5 million for fiscal 1995. After giving effect to certain pro forma adjustments, including adjustments to reflect the amortization of tradenames and goodwill, the elimination of transactions between Pearle and its former parent, the elimination of Pearle's provision for impairment of intangible assets and related costs which resulted from the acquisition, increased interest expense and reduced interest income associated with acquisition funding and the estimated related income tax effects, pro forma net loss in fiscal 1996 would have improved by $1.7 million or $0.15 per share and pro forma net income in 1995 would have decreased by $11.7 million or $1.10 per share from the amounts reported. Anticipated efficiencies from the consolidation of the Company and Pearle have not been reflected in these amounts because their realization cannot be assured.
The unaudited pro forma results have been prepared for informational purposes only and should not be considered indicative of the actual results of operations which would have occurred had the acquisition been in effect at the beginning of the periods indicated, and do not purport to be indicative of results of operations which may occur in the future.
The Company also made the following acquisitions, each of which has been accounted for under the purchase method of accounting. On August 5, 1997, the Company acquired all of the issued and outstanding
common stock of American Vision Centers, Inc. (AVC), whose operations consisted of 79 company-owned and 85 franchised optical stores, for an aggregate purchase price of approximately $28.9 million, including debt assumed. The purchase price was allocated to the assets acquired and liabilities assumed based upon their relative fair values as of the closing date. This resulted in an excess of purchase price over net assets acquired of $20.0 million. The relative fair values of the assets acquired and liabilities assumed included unfavorable leasehold interests of $3.4 million, accruals for involuntary severance and termination benefits of $0.5 million, write-off of deferred assets of $1.4 million and deferred tax assets of $7.5 million. The purchase price allocation for AVC is substantially complete but is subject to adjustment, should actual costs differ from the recorded amounts. Such adjustments, if made within one year from the date of acquisition, will be recorded as adjustments to goodwill. Thereafter, any cost incurred in excess of the liability recorded will be included in the determination of net income.
In November 1996, the Company acquired all of the issued and outstanding stock of AOCO Limited, which operated 73 Sears Optical Departments and two freestanding Vision Club stores in Canada, for a purchase price of $2.6 million. In May 1995, the Company acquired the assets of 59 optical departments located in BJ's Wholesale Clubs for a purchase price of $1.1 million. Pro forma financial results have not been presented for these acquisitions, including AVC, as they did not have a material effect on the Company's results of operations.
(3) BUSINESS INTEGRATION AND OTHER NON-RECURRING CHARGES
During fiscal 1997, the Company recorded an $8.0 million pre-tax business integration charge associated with the AVC acquisition. Such charge included costs incurred related to the integration and consolidation of AVC into the Company's operations, including costs of store and other facility closings, transitional costs incurred to change the brand identity to Pearle and duplicate costs incurred through fiscal year end in connection with the consolidation of the AVC home office functions. The total pretax cash outlay for these charges is estimated to be $7.5 million, with approximately $3.1 million having been paid as of January 31, 1998. The remaining amount is expected to be incurred over the next 12 to 18 months, except for certain lease costs which may be incurred over the remaining life of the leases.
In the fourth quarter of fiscal 1996, the Company recorded a $61.1 million pre-tax charge for certain unusual and non-recurring items. Such charge was primarily related to the acquisition of Pearle and included costs incurred related to the integration and consolidation of Pearle into the Company's operations, as well as certain other non-recurring charges. The charge included $17.6 million for store and other facility closings, $21.6 million related to computer systems, $6.1 million for asset impairment and $15.8 million of other charges. The total pretax cash outlay related to these charges is expected to be approximately $41.1 million, of which approximately $20.0 million has been paid as of January 31, 1998. The remaining amount is expected to be incurred within the next 12 to 18 months, except for certain lease costs which may be incurred over the remaining life of the leases.
Subsequent to the effective date of the Pearle acquisition, the Company identified certain unprofitable Pearle stores which it intends to close. The Company also identified certain other on-going retail locations at which it intends to close the in-store labs and supply these locations from other facilities. In addition, the Company decided to retain Pearle's distribution and central lab facilities, but to close Pearle's home office facility in Dallas, Texas. The charge in fiscal 1996 for store and other facility closings consists primarily of the remaining noncancellable term of operating leases and other obligations remaining on these facilities subsequent to their estimated date of closing along with the loss on fixed assets.
In fiscal 1995, the Company entered into a ten-year agreement to outsource its systems integration needs and data processing operations. Due to the Pearle acquisition, the Company reassessed its system requirements and decided to terminate its outsourcing agreement and install new systems utilizing the resources of internal and external systems integrators. The settlement cost of terminating the outsourcing agreement, as well as other related costs, were accrued as of February 1, 1997.
Following the Pearle acquisition and in light of operating results in fiscal 1996, the Company reviewed the strategic direction of certain other operations. In accordance with SFAS No. 121, the Company determined that the goodwill associated with portions of its optical business would not be recoverable as the carrying values of these businesses exceeded fair value, as measured by projected future discounted cash flows.
The other charges in fiscal 1996 include costs related to employee matters, including duplicate costs incurred through the end of fiscal 1996 and costs related to hiring employees in connection with the consolidation of the Pearle home office functions, and other costs of management realignment. In addition, the other charges include incremental travel and professional fees incurred in connection with the integration of Pearle, along with costs of developing and implementing a new franchise agreement. Also, in February 1996, the Board of Directors granted stock options to executive officers at a share price equal to the market price of the common stock on the date of grant, which were subject to stockholder approval. The increase in the price of the common stock between the grant date and the date of stockholder approval resulted in $4.2 million of compensation expense. The options as approved contained accelerated vesting provisions if the common stock price rose to certain levels, which were reached in the fourth quarter of fiscal 1996. Because future periods will not benefit by this plan, the Company recognized the full costs of the plan as expense.
(4) DISCONTINUED OPERATIONS
On January 13, 1998 the Company announced the closing of its Cole Gift Centers ("CGC") chain of personalized gift and greeting card departments located in host stores. For financial statement purposes, the assets, liabilities, results of operations and cash flows of CGC are included in the Company's consolidated financial statements as discontinued operations. Prior year financial statements have been restated to reflect discontinued operations. The estimated loss on disposal of $13.9 million (net of an applicable income tax benefit of $8.5 million) includes provisions for severance and other closing costs, inventory and other asset write-offs and estimated operating losses for the period from January 13, 1998 through February 1998 when all locations were closed.
CGC's net revenue was $50.9, $55.5 and $61.2 million in 1997, 1996 and 1995, respectively. The Company's consolidated interest expense that was not directly attributable to other operations of the Company was allocated to discontinued operations based on the ratio of the net assets of discontinued operations to total net assets of the Company plus consolidated debt of the Company not directly attributable to other operations. As a result, the operating loss from discontinued operations includes allocated interest expense of $1.3 million, $1.9 million and $2.2 million in fiscal 1997, 1996 and 1995, respectively. The net loss of discontinued operations also includes a non-recurring charge of $3.3 million in fiscal 1996, primarily related to the write-off of goodwill at CGC, in accordance with FAS No. 121.
The net assets (liabilities) of discontinued operations, after recognition of the estimated loss on disposal included in the accompanying consolidated balance sheets consist of the following (000's omitted):
(5) PUBLIC OFFERINGS
On July 18, 1997, the Company completed a public offering of 2,587,500 shares of its Common Stock at a price of $47.00 per share. Net proceeds from the offering were approximately $116 million. A portion of the net proceeds from the offering were used for the purchase of AVC and CNG's tender offer to purchase up to all of its $165.8 million outstanding 11-1/4% Senior Notes due 2001 (the Senior Notes) (see Note 6). The Company intends to use the remaining net proceeds from the offering for general corporate purposes, including reducing outstanding indebtedness and financing possible future acquisitions.
In 1996, the Company completed a public offering of 1,437,500 shares of Common Stock at a price of $19.25 per share. The net proceeds from the offering were $26.2 million. A portion of the proceeds was used to purchase $15.1 million of the Senior Notes, plus accrued interest thereon (see Note 6).
(6) LONG-TERM DEBT
Long-term debt at January 31, 1998 and February 1, 1997 is summarized as follows (000's omitted):
The Senior Notes mature October 1, 2001 with no earlier scheduled redemption or sinking fund payments. Interest on the Senior Notes is payable semi-annually on April 1 and October 1.
On August 15, 1997, CNG announced a tender offer to purchase up to all of its Senior Notes at a price of $1,105.61 per $1,000 of principal, plus accrued interest. The tender offer expired on September 12, 1997, at which time a total of $151.3 million principal amount of the Senior Notes were tendered, leaving $14.5 million outstanding. The Company plans to call the remaining Senior Notes in October 1998, the first call date, and accordingly, has reflected them as current liabilities in the accompanying consolidated balance sheet. As a result of the tender offer, in the third quarter of fiscal 1997 the Company recorded an extraordinary charge of $12.2 million, net of an income tax benefit of $7.5 million, representing the tender premium, the write-off of the related unamortized debt discount and other costs associated with redeeming the debt.
On August 22, 1997, CNG issued $125.0 million of 8-5/8% Senior Subordinated Notes (the 8-5/8% Notes) that mature in 2007 with no earlier scheduled redemption or sinking fund payments. Proceeds from this debt issuance of approximately $121.8 million, along with cash on hand, were used to fund the above-described tender offer. Interest on the 8-5/8% Notes is payable semi-annually on February 15 and August 15.
On November 15, 1996, CNG issued $150 million of 9-7/8% Senior Subordinated Notes (the 9-7/8% Notes) that mature in 2006 with no earlier scheduled redemption or sinking fund payments. The Notes were used by the Company to finance a portion of the Pearle acquisition (see Note 2). Interest on the 9-7/8% Notes is payable semi-annually on June 30 and December 31.
The Senior Notes, the 8-5/8% Notes and the 9-7/8% Notes are general unsecured obligations of CNG, subordinated in right of payment to senior indebtedness of CNG and senior in right of payment to any current or future subordinated indebtedness of CNG.
The indentures pursuant to which the Senior Notes, the 8-5/8% Notes and the 9-7/8% Notes were issued restrict dividend payments to the Company to 50% of CNG's net income after October 31, 1993, plus amounts due to the Company under a tax sharing agreement and for administrative expenses of the Company not to exceed 0.25% of CNG's net revenue. The indentures also contain certain optional and mandatory redemption features and other financial covenants. The Company was in compliance with these covenants at January 31, 1998.
The Company recorded an extraordinary loss of $0.7 million in 1996, net of an income tax benefit of $0.5 million, representing the payment of premiums, the write-off of unamortized discount and other costs associated with retiring $15.1 million of the Senior Notes.
The agreement in connection with the Industrial Revenue Bonds provides for repayment of the final annual installment of $168,750 in 1998. The Industrial Revenue Bonds are secured by an office facility with a net book value of $1,516,000 at January 31, 1998.
The Company plans to redeem the remaining Senior Notes in 1998. As a result, the Company will have no significant principal payment obligations under its outstanding indebtedness until the 9-7/8% Notes mature in 2006.
At January 31, 1998, the fair value of the Company's long-term debt was approximately $307.3 million compared to a carrying value of $293.4 million. The fair value was estimated primarily by using quoted market prices.
(7) CREDIT FACILITY
Concurrent with the Pearle acquisition, the principal operating subsidiaries of CNG (the Borrowers) entered into a Credit Facility. The Credit Facility replaced the existing revolving credit facility.
The Credit Facility provides the Borrowers with a four-year revolving line of credit of up to the lesser of a "borrowing base" or $75 million. Up to $30 million of the Credit Facility is available for the issuance of letters of credit. Borrowings under the Credit Facility initially bear interest at a rate equal to, at the option of the Borrowers, either (a) the Eurodollar Rate plus 1.25% or (b) 0.25% plus the highest of (i) the prime rate, (ii) the three-week moving average of the secondary market rates for three-month certificates of deposit plus 1% and (iii) the federal funds rate plus 0.5%. The Company pays a commitment fee of 0.375% per annum on the total unused portion of the facility. Additionally, the Credit Facility requires the Borrowers to comply with various operating covenants that restrict corporate activities, including covenants restricting the Borrowers' ability to incur additional indebtedness, pay dividends, prepay subordinated indebtedness, dispose of certain investments or make acquisitions. The Credit Facility also requires the Borrowers to comply with certain financial covenants, including covenants regarding minimum interest coverage, maximum leverage and consolidated net worth. The Borrowers were in compliance with these covenants at January 31, 1998.
The Credit Facility restricts dividend payments to CNG to amounts needed to pay interest on the Senior Notes, the 9-7/8% Notes and the 8-5/8% Notes, and certain amounts related to taxes, along with up to $8.0 million plus 0.25% of the CNG's consolidated net revenue annually for other direct expenses of CNC or CNG. In addition, dividends of up to $20.0 million are permitted to repurchase the Senior Notes, the 8-5/8% Notes and/or the 9-7/8% Notes.
No borrowings under the Credit Facility were outstanding as of January 31, 1998 or February 1, 1997 or at any time during fiscal 1997 or 1996.
(8) STOCK OPTIONS AND WARRANTS
The Company had stock options outstanding at January 31, 1998 under the 1992, the 1993 and the 1996 Management Stock Option Plans (the 1992, 1993 and 1996 Plans), the 1993 Option Agreements granting options to non-employee Directors (the 1993 Option Agreements) and the 1994 non-qualified Stock Option
Plan for non-employee Directors (the 1994 Plan). The Company is authorized to issue to key employees up to 555,556; 600,000 and 884,000 shares of Common Stock under the 1992, 1993 and 1996 Plans, respectively. The Company is also authorized to issue to non-employee Directors of the Company up to 22,500 and 100,000 shares of Common Stock under the 1993 Option Agreements and the 1994 Plan, respectively. Options generally become exercisable over a three-, four- or five-year period from the date of grant and expire ten years from the date of grant.
A summary of the status of the Company's stock option plans as of the end of fiscal 1997, 1996 and 1995, and changes during each of the fiscal years is presented below:
A summary of information about stock options outstanding at January 31, 1998 is presented below:
Payment for certain options exercised between 1993 and 1996 has been made by executing promissory notes, of which $926,000 were outstanding at January 31, 1998. The promissory notes are secured by the shares of common stock acquired and are payable on various dates through April 2001 at interest rates ranging from 5.33% to 6.37%.
At January 31, 1998, there were warrants outstanding to purchase 81,574 shares of common stock. Of these, warrants to purchase 2,625 shares are exercisable at $1.00 per share and expire in 2000. Warrants to purchase 78,949 shares are exercisable at $49.40 per share and expire on March 6, 1999. During 1997, warrants to purchase 90,389 shares at $24.70 per share were exercised and a warrant to purchase 1,715 shares at $24.70 per share was canceled.
The Company applies APB Opinion 25 and related Interpretations in accounting for its stock-based compensation plans. Accordingly, no compensation cost has been recognized for its stock option plans in fiscal 1995 and fiscal 1997. Compensation cost that has been charged against income for its stock-based plans in fiscal 1996 was $4.2 million as discussed in Note 3. Had compensation cost for the Company's stock-based compensation plans been determined based on the fair value at the dates of awards under those plans consistent with the method of SFAS No. 123, the Company's net loss and diluted loss per share would have been increased to $6,731,000 and $.48 in fiscal 1997 and $30,234,000 and $2.67 in fiscal 1996, respectively,
and its net income and diluted earnings per share in fiscal 1995 would have been reduced to $13,617,000 and $1.29, respectively.
The fair value of each option granted was estimated on the date of grant using the Black-Scholes option-pricing model with the following assumptions: risk-free interest rates of 5.7%, 6.2% and 6.4% for grants in fiscal 1997, 1996 and 1995, respectively, volatility of 35% in fiscal 1997 and 33% in fiscal 1996 and 1995, and expected lives of six years for options granted in all fiscal years. Because the SFAS No. 123 method of accounting has not been applied to options granted prior to January 29, 1995, the resulting pro forma expense may not be representative of that to be expected in the future.
(9) STOCKHOLDERS' EQUITY
In August 1995, the Company's Board of Directors approved a Stockholders' Rights Plan. The Rights Plan provides for the distribution of one Right for each outstanding share of the Company's Common Stock held of record as of the close of business on September 1, 1995 or that thereafter become outstanding prior to the earlier of the Final Expiration Date of the Rights or the first date upon which the Rights become exercisable. Each Right entitles the registered holder to purchase from the Company one one-hundredth of a share of Series A Junior Participating Preferred Stock, without par value, at a price of $180, subject to adjustment. The Rights are only exercisable if a person or group buys or announces a tender offer for 15% or more of the Company's Common Stock. In the event such a transaction occurs, Rights that are beneficially owned by all other persons would be adjusted and such holders would thereafter have the right to receive, upon exercise thereof at the then current exercise price of the Right, that number of shares of Common Stock (or, under certain circumstances, an economically equivalent security of the Company) having a market value of two times the exercise price of the Right. The Rights will expire on August 31, 2005, unless extended or unless the Rights are earlier redeemed by the Company in whole, but not in part, at a price of $0.01 per Right, or exchanged.
(10) INCOME TAXES
The income tax provision (benefit) for continuing operations reflected in the accompanying consolidated statements of operations for fiscal 1997, 1996 and 1995 is detailed below (000's omitted):
The income tax provision (benefit) for continuing operations differs from the federal statutory rate as follows (000's omitted):
The tax effects of temporary differences that give rise to significant portions of the Company's deferred tax assets and deferred tax liabilities at January 31, 1998 and February 1, 1997 are as follows (000's omitted):
At January 31, 1998, the Company has approximately $8.3 million of tax net operating loss (NOL) carryforwards acquired in connection with the acquisition of AVC, which expire between 2005 and 2010. Due to the change in ownership requirements of the Internal Revenue Code, utilization of the AVC NOL is limited to approximately $338,000 per year. A valuation allowance of $1.1 million has been established to reduce the deferred tax asset related to the NOL to the amount that will likely be realized.
Accrued income taxes at February 1, 1997 includes $15.0 million of taxes due on the sale of Pearle Holdings B.V. that were reimbursed to the Company by the seller in connection with the Pearle acquisition in fiscal 1996 and paid by the Company in fiscal 1997.
(11) RETIREMENT PLANS
The Company maintains a noncontributory defined benefit pension plan (the Retirement Plan) that covers employees who have met eligibility service requirements and are not members of certain collective bargaining units. The Retirement Plan calls for benefits to be paid to eligible employees at retirement based primarily upon years of service with the Company and their compensation levels near retirement.
The Company's policy is to fund amounts necessary to keep the Retirement Plan in full force and effect, in accordance with the Internal Revenue Code and the Employee Retirement Income Security Act of 1974. Actuarial present values of benefit obligations are determined using the projected unit credit method.
Pension expense for fiscal 1997, 1996 and 1995 includes the following components (000's omitted):
The following sets forth the funded status of the Retirement Plan at December 31, 1997 and 1996 based upon the actuarial present values of benefit obligations (000's omitted):
The weighted average discount rate used to measure the projected benefit obligation was 7.5% in 1997 and 8.0% in 1996. For both years, the rate of increase in future compensation levels was 5.0% and the expected long-term rate of return on plan assets was 9.5%.
The Company has a defined contribution plan, including features under Section 401(k) of the Internal Revenue Code, which provides retirement benefits to its employees. Eligible employees may contribute up to 17% of their compensation to the plan. Prior to January 1, 1998, there was no mandatory matching of employee contributions by the Company, but discretionary matches of $374,000, $327,000, and $164,000 were recorded for 1997, 1996 and 1995, respectively. Effective January 1, 1998, the plan was amended to, among other things, provide for a mandatory company match of 10% of employee contributions.
Prior to January 1, 1998, the Company had separate contributory profit-sharing plans for Pearle and AVC employees meeting certain service requirements as defined in the plans. The Company's contribution to the Pearle plan consisted of a minimum matching contribution of $861,000 in 1997 and $229,000 in 1996. There were no Company contributions required or made in connection with the AVC plan in 1997. Effective January 1, 1998, eligible employees of Pearle and AVC became eligible to participate in the Company's defined contribution plan. The Pearle and AVC plans will be merged into the Company's plan.
The Company has two Supplemental Executive Retirement Plans that provide for the payment of retirement benefits to participating executives supplementing amounts payable under the Company's Retirement Plan. The first plan is an excess benefit plan designed to replace benefits that would otherwise have been payable under the Retirement Plan but that were limited as a result of certain tax law changes. The second plan is a defined contribution plan under which participants receive an annual credit based on a percentage of base salary, subject to vesting requirements. Expense for these plans for fiscal 1997, 1996 and 1995 was $541,000, $468,000, and $447,000, respectively.
(12) COMMITMENTS
The Company leases a substantial portion of its facilities including laboratories, office and warehouse space, and retail store locations. These leases generally have initial terms of up to 10 years and often contain renewal options. Certain of the store locations have been sublet to franchisees. In most leases covering retail store locations, additional rents are payable based on store sales. In addition, the Company operates departments in various host stores paying occupancy costs solely as a percentage of sales under agreements containing short-term cancellation clauses. Generally, the Company is required to pay taxes and normal
expenses of operating the premises for laboratory, office, warehouse and retail store leases; the host stores pay these expenses for departments operated on a percentage-of-sales basis. The following amounts represent rental expense for fiscal 1997, 1996 and 1995 (000's omitted):
The Company has entered into leases for equipment which have been accounted for as capital leases. At January 31, 1998 and February 1, 1997, property under capital leases consisted of $7,113,000 and $5,696,000 in equipment with accumulated amortization of $1,610,000 and $397,000, respectively.
At January 31,1998, future minimum lease payments and sublease income receipts under noncancellable leases, and the present value of future minimum lease payments for capital leases are as follows (000's omitted):
(13) QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)
The following is a summary of quarterly financial data for the 52 weeks ended January 31, 1998 and February 1, 1997. The third and fourth quarters of fiscal 1997 include pre-tax charges of $1.1 million and $6.9 million, respectively, for business integration charges related to AVC. The fourth quarter of fiscal 1996 includes a $61.1 million pre-tax charge for business integration and other non-recurring charges primarily related to Pearle.
FISCAL 1997 ---------------------------------------------------------------------- ($ in thousands, except per share amounts)
FISCAL 1996 ---------------------------------------------------------------------- ($ in thousands, except per share amounts)
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS ON THE FINANCIAL STATEMENT SCHEDULE
To Cole National Corporation:
We have audited in accordance with generally accepted auditing standards, the consolidated financial statements included in this Form 10-K and have issued our report thereon dated March 18, 1998. Our audit was made for the purpose of forming an opinion on those statements taken as a whole. The financial statement schedule is the responsibility of the Company's management and is presented for purposes of complying with the Securities and Exchange Commission's rules and is not part of the consolidated financial statements. This schedule has been subjected to the auditing procedures applied in the audit of the consolidated financial statements and, in our opinion, fairly states in all material respects the financial data required to be set forth therein in relation to the consolidated financial statements taken as a whole.
ARTHUR ANDERSEN LLP
Cleveland, Ohio, March 18, 1998.
SCHEDULE I
COLE NATIONAL CORPORATION AND SUBSIDIARIES CONDENSED FINANCIAL INFORMATION OF REGISTRANT
COLE NATIONAL CORPORATION CONDENSED BALANCE SHEETS JANUARY 31, 1998 AND FEBRUARY 1, 1997 (Dollars in millions)
SCHEDULE I (CONTINUED) COLE NATIONAL CORPORATION CONDENSED STATEMENTS OF OPERATIONS AND CASH FLOWS 52 WEEKS ENDED JANUARY 31, 1998, 52 WEEKS ENDED FEBRUARY 1, 1997 AND 53 WEEKS ENDED FEBRUARY 3, 1996 (Dollars in millions)
SCHEDULE I (CONTINUED)
NOTE TO CONDENSED FINANCIAL INFORMATION OF REGISTRANT
The accompanying financial information of Cole National Corporation (CNC) is as of January 31, 1998 and February 1, 1997 and for the 52 weeks ended January 31, 1998, the 52 weeks ended February 1, 1997 and the 53 weeks ended February 3, 1996. CNC is a holding company for its wholly-owned subsidiaries, including Cole National Group, Inc. (CNG) and consisted of no other operations.
This financial information should be read in connection with the Consolidated Financial Statements and notes thereto of Cole National Corporation and Subsidiaries, contained on pages elsewhere in this Form 10-K.
EXHIBIT INDEX
EXHIBIT NUMBER DESCRIPTION - ------ -----------
3.1(i) Restated Certificate of Incorporation of the Company, incorporated by reference to Exhibit 3.1 (i) of Cole National Corporation's Annual Report on Form 10-K for the year ended February 3, 1996 (File No. 1-12814).
3.1(ii) Certificate of Amendment of the Restated Certificate of Incorporation.
3.2(ii) Amended and Restated By-Laws of the Company, incorporated by reference to Exhibit 3.2(ii) of Cole National Corporation's Annual Report on Form 10-K for the year ended February 3, 1996 (File No. 1-12814).
3.3 Certificate of Designations of Series A Junior Participating Preferred Stock, incorporated by reference to Exhibit 3.3 of Cole National Corporation's Annual Report on Form 10-K for the year ended February 3, 1996 (File No. 1-12814).
4.1 Indenture dated as of September 30, 1993 between CNG and Norwest Bank Minnesota, N.A., as trustee, relating to the 11 1/4% Senior Notes due 2001 (the form of which Senior Note is included in such Indenture), incorporated by reference to Exhibit 4.1 of Cole National Corporation's Annual Report on Form 10-K for the year ended February 3, 1996 (File No. 1-12814).
4.2 First Supplemental Indenture, dated August 14, 1997, between Cole National Group, Inc. and Norwest Bank Minnesota, National Association, as Trustee, relating to the 11-1/4% Senior Notes Due 2001, incorporated by reference to Exhibit 4.6 of Cole National Group, Inc.'s Registration Statement on Form S-1 (Registration No. 333-34963).
4.3 Second Supplemental Indenture dated September 15, 1997, between Cole National Group, Inc. and Norwest Bank Minnesota, National Association, as Trustee, relating to the 11-1/4% Senior Notes Due 2001, incorporated by reference to Exhibit 4.7 of Cole National Group, Inc.'s Registration Statement on Form S-1, Amendment No. 3, filed with the Commission on December 5, 1997 (Registration No. 333-34963).
4.4 Indenture dated November 15, 1996, by and among Cole National Group, Inc. and Norwest Bank Minnesota, National Association, as trustee, relating to the 9 7/8% Senior Subordinated Notes due 2006 (the form of which Senior Subordinated Note is included in such Indenture), incorporated by reference to Exhibit 4.1 of Cole National Corporation's Report on Form 8-K, filed with the Commission on December 2, 1996 (File No. 1-12814).
4.5 Indenture, dated August 22, 1997, between Cole National Group, Inc. and Norwest Bank Minnesota, National Association, as Trustee, relating to the 8-5/8% Senior Subordinated Notes Due 2007, incorporated by reference to Exhibit 4.4 of Cole National Group, Inc.'s Registration Statement on Form S-1 (Registration No. 333-34963).
4.6 Rights Agreement dated as of August 22, 1995 by and between the Company and National City Bank as Rights Agent, incorporated by reference to Exhibit 4.3 of Cole National Corporation's Annual Report on Form 10-K for the year ended February 3, 1996 (File No. 1-12814).
X-1
EXHIBIT NUMBER DESCRIPTION - ------ -----------
4.7 Amendment No. 1, dated as of August 21, 1997, to the Rights Agreement, dated as of August 22, 1995, between the Company and National City Bank, as Rights Agent, incorporated by reference to Exhibit 4.1 of the Company's current report on Form 8-K, filed with the Securities and Exchange Commission on August 22, 1997 (File No. 1-12814).
4.8 The Company by this filing agrees, upon request, to file with the Commission the instruments defining the rights of holders of long-term debt of the Company and its subsidiaries where the total amount of securities authorized thereunder does not exceed 10% of the total assets of the Company and its subsidiaries on a consolidated basis.
10.1* Employment Agreement entered into as of April 1, 1996 by and among the Company, Cole National Group, Inc., Cole Gift Centers, Inc., Cole Vision Corporation, Things Remembered, Inc. and Jeffrey A. Cole, incorporated by reference to Exhibit 10.1 of Cole National Corporation's Annual Report on Form 10-K for the year ended February 3, 1996 (File No. 1-12814).
10.2* Employment Agreement entered into as of April 1, 1996 by and among the Company, Cole National Group, Cole Gift Centers, Inc., Cole Vision Corporation, Things Remembered, Inc. and Brian B. Smith, incorporated by reference to Exhibit 10.2 of Cole National Corporation's Annual Report on Form 10-K for the year ended February 3, 1996 (File No. 1-12814).
10.3* Agreement dated March 27, 1993 between the Company and Joseph Gaglioti regarding termination of employment, incorporated by reference to Exhibit 10.8 to CNG's Registration Statement on Form S-1 (Registration No. 33-66342).
10.4* Agreement dated April 9, 1993 between the Company and Wayne L. Mosley regarding termination of employment, incorporated by reference to Exhibit 10.9 to CNG's Registration Statement on Form S-1 (Registration No. 33-66342).
10.5* 1992 Management Stock Option Plan, including forms of Nonqualified Stock Option Agreement (Time Vesting) and Nonqualified Stock Option Agreement (Performance Option), as amended, and forms of promissory notes and pledge agreements, incorporated by reference to Exhibit 10.11 to CNG's Registration Statement on Form S-1 (Registration No. 33-66342).
10.6* Cole National Corporation 1993 Management Stock Option Plan, including forms of Nonqualified Stock Option Agreement (1993 Time Vesting) and form of secured promissory notes and stock pledge agreement, incorporated by reference to Exhibit 10.29 to CNG's Registration Statement on Form S-1 (Registration No. 33-66342).
10.7* Form of Option Agreement for Directors of the Company, incorporated by reference to Exhibit 10.41 to the Company's Registration Statement on Form S-1 (Registration No. 33-74228).
X-2
EXHIBIT NUMBER DESCRIPTION - ------ -----------
10.8* Amended and Restated Nonqualified Stock Option Plan for Non-employee Directors, incorporated by reference to Exhibit A to the Company's Proxy Statement for the 1997 Annual Meeting (File No. 1-12814).
10.9* Form of Nonqualified Stock Option Agreement for Non-employee Directors, incorporated by reference to Exhibit 10.9 of Cole National Corporation's Annual Report on Form 10-K for the year ended February 3, 1996 (File No. 1-12814).
10.10* Cole National Corporation 1996 Management Stock Option Plan, including forms of Nonqualified Stock Option Agreement (1996 Time Vesting), incorporated by reference to Exhibit 10.10 of Cole National Corporation's Annual Report on Form 10-K for the year ended February 3, 1996 (File No. 1-12814).
10.11* Management Incentive Bonus Program.
10.12* Form of Nonqualified Stock Option Agreement (1997 Time Vesting).
10.21* Executive Life Insurance Plan of the Company, incorporated by reference to Exhibit 10.12 to CNG's Registration Statement on Form S-1 (Registration No. 33-66342).
10.22* Medical Expense Reimbursement Plan of the Company effective as of February 1, 1992, incorporated by reference to Exhibit 10.13 to CNG's Registration Statement on Form S-1 (Registration No. 33-66342).
10.23 Agreement for the Allocation of Federal Income Tax Liability and Benefits among Members of the Parent Group dated August 23, 1985, as amended, incorporated by reference to Exhibit 10.26 to CNG's Registration Statement on Form S-1 (Registration No. 33-66342).
10.24 Assignment and Assumption Agreement dated as of September 30, 1993 between the Company and CNG, incorporated by reference to Exhibit 10.24 of Cole National Corporation's Annual Report on Form 10-K for the year ended February 3, 1996 (File No. 1-12814).
10.25 Lease Agreement (Knoxville) dated as of November 28, 1979 by and between Tommy Hensley, as agent for the real property of Mrs. Don Siegel and Cole Vision Corporation, as amended and supplemented, incorporated by reference to Exhibit 10.15 to CNG's Registration Statement on Form S-1 (Registration No. 33-66342).
10.26 Lease Agreement (Memphis) dated as of October 2, 1991 by and between Shelby Distribution Park and Cole Vision Corporation, incorporated by reference to Exhibit 10.16 to CNG's Registration Statement on Form S-1 (Registration No. 33-66342).
10.27 Lease Agreement (Richmond) dated as of April 23, 1982 by and between Daniel, Daniel & Daniel and Cole Vision Corporation, as amended and supplemented, incorporated by reference to Exhibit 10.17 to CNG's Registration Statement on Form S-1 (Registration No. 33-66342).
X-3
EXHIBIT NUMBER DESCRIPTION - ------ -----------
10.28 Lease for Multi-Tenancy Space (Salt Lake) dated as of October 30, 1981 by and between East Centennial Joint Venture and Cole Vision Corporation, as amended and supplemented, incorporated by reference to Exhibit 10.18 to CNG's Registration Statement on Form S-1 (Registration No. 33-66342).
10.29 Lease Agreement (Knoxville) dated as of April 11, 1995 by and between Richard T. Fox and Cole Vision Corporation, incorporated by reference to Exhibit 10.29 of Cole National Corporation's Annual Report on Form 10-K for the year ended February 3, 1996 (File No. 1-12814).
10.30 Form of Lease Agreement Finite 19518 dated as of December 29, 1988 between Sears, Roebuck and Co. and Cole Vision Corporation, incorporated by reference to Exhibit 10.23 to CNG's Registration Statement on Form S-1 (Registration No. 33-66342).
10.31 Master License Agreement dated as of October 2, 1986, between Montgomery Ward & Co., Incorporated and Cole Vision Corporation, as amended, incorporated by reference to Exhibit 10.21 to CNG's Registration Statement on Form S-1 (Registration No. 33-66342).
10.32 Master License Agreement dated as of June 12, 1986, between Montgomery Ward & Co., Incorporated and Bay Cities Optical Company, as amended, incorporated by reference to Exhibit 10.22 to CNG's Registration Statement on Form S-1 (Registration No. 33-66342).
10.33 Form of License Agreement (Optical), incorporated by reference to Exhibit 10.24 to CNG's Registration Statement on Form S-1 (Registration No. 33-66342).
10.34 Form of License/Lease Agreement (Optical), incorporated by reference to Exhibit 10.25 to CNG's Registration Statement on Form S-1 (Registration No. 33-66342).
10.37 Form of Indemnification Agreement for Directors of the Company, incorporated by reference to Exhibit 10.19 to CNG's Registration Statement on Form S-1 (Registration No. 33-66342).
10.38 Form of Indemnification Agreement for Officers of the Company, incorporated by reference to Exhibit 10.20 to CNG's Registration Statement on Form S-1 (Registration No. 33-66342).
10.39* Supplemental Retirement Benefit Plan of the Company, incorporated by reference to Exhibit 10.38 to the Company's Registration Statement on Form S-1 (Registration No. 33-74228).
X-4
EXHIBIT NUMBER DESCRIPTION ------ -----------
10.40* Supplemental Pension Plan of the Company, incorporated by reference to Exhibit 10.48 to the Company's Registration Statement on Form S-1 (Registration No. 33-74228).
10.41 Warrant Agreement dated as of March 6, 1992 between the Company and the purchasers named therein, incorporated by reference to Exhibit 10.35 to the Company's Registration Statement on Form S-1 (Registration No. 33-74228).
10.42 Warrant Agreement dated as of September 25, 1990 between the Company and the purchasers named therein, incorporated by reference to Exhibit 10.36 to the Company's Registration Statement on Form S-1 (Registration No. 33-74228).
10.45 Lease agreement (Salt Lake) dated as of November 1, 1996 by and between Gibbons Realty Company and Cole Vision Corporation, incorporated by reference to Exhibit 10.01 of Cole National Corporations Quarterly Report on Form 10-Q for the period ended November 2, 1996 (File No. 1-12814).
10.46 Credit Agreement, dated as of November 15, 1996, among Cole Vision Corporation, Things Remembered, Inc., Cole Gift Centers, Inc., Pearle, Inc. and Pearle Service Corporation and Canadian Imperial Bank of Commerce, incorporated by reference to Exhibit 99.1 of Cole National Corporation's Report on Form 8-K, filed with the Commission on December 2, 1996 (File No. 1-12814).
10.47 First Amendment to the Credit Agreement, dated as of January 13, 1997, among Cole Vision Corporation, Things Remembered, Inc., Cole Gift Centers, Inc., Pearle, Inc., and Pearle Service Corporation and Canadian Imperial Bank of Commerce, incorporated by reference to Exhibit 10.33 of Cole National Group, Inc.'s Registration Statement on Form S-1 (Registration No. 333-34963).
10.48 Second Amendment to Credit Agreement, dated as of August 8, 1997, among Cole Vision Corporation, Things Remembered, Inc., Cole Gift Centers, Inc., Pearle, Inc. and Pearle Service Corporation and Canadian Imperial Bank of Commerce, incorporated by reference to Exhibit 10.34 of the Cole National Group, Inc.'s Registration Statement on Form S-1 (Registration No. 333-34963).
10.49 CNG Guarantee and Cash Collateral Agreement, dated as of November 15, 1996, by the Company and Cole National Corporation, incorporated by reference to Exhibit 99.3 of Cole National Corporation's Report on Form 8-K, filed with the Commission on December 2, 1996 (File No. 1-12814).
10.50 Guarantee and Collateral Agreement dated as of November 15, 1996, by Cole Vision Corporation, Things Remembered, Inc., Cole Gift Centers, Inc., Pearle, Inc. and Pearle Service Corporation and Canadian Imperial Bank of Commerce, Incorporated by reference to Exhibit 99.4 of Cole National Corporation's Report on Form 8-K, filed with the Commission on December 2, 1996 (File No. 1-12814).
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EXHIBIT NUMBER DESCRIPTION ------ -----------
10.51 Form of Cole National Corporation 401(k) Savings Plan, incorporated by reference to Exhibit 4.1 of Cole National Corporation's Registration Statement on Form S-8, filed with the Commission on November 20, 1997 (Registration No. 333-40609).
10.52* Agreement, dated August 4, 1997, between the Company and Leslie D. Dunn regarding termination of employment, incorporated by reference to Exhibit 10.37 of Cole National Group, Inc.'s Registration Statement on Form S-1 (Registration No. 333-34963).
10.53* Form of Cole National Corporation Non Qualified Stock Option Agreement (Non employee Directors), incorporated by reference to Exhibit 10.5 of Cole National Corporation's Quarterly Report on Form 10-Q for the period ended August 2, 1997 (File No. 1-12814).
10.54* Form of Cole National Corporation Non Employee Director Equity and Deferred Compensation Plan, incorporated by reference to Exhibit B to Cole National Corporation's definitive Proxy Statement dated May 6, 1997 (File No. 1-12814).
10.55* Form of Cole National Corporation Non Employee Director Equity and Deferred Compensation Plan Participation Agreement Plan Year 1997, incorporated by reference to Exhibit 10.7 of Cole National Corporation's Quarterly Report on Form 10-Q for the period ended August 2, 1997 (File No. 1-2814).
21 Subsidiaries of the Company.
23 Consent of Arthur Andersen LLP.
24 Power(s) of Attorney.
27 Financial Data Schedule.
* Reflects management contract or other compensatory arrangement required to be filed as an exhibit pursuant to Item 14(c) of this Form 10-K.
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