10-Q/A 1 l00456ae10vqza.txt COLE NATIONAL CORPORATION | 10-Q/A ================================================================================ SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q/A (Amendment No. 1) (MARK ONE) X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES --- EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED AUGUST 3, 2002, OR TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES --- EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM ________________ TO _________________. COMMISSION FILE NUMBER 1-12814 COLE NATIONAL CORPORATION (Exact Name of Registrant as Specified in Its Charter) DELAWARE 34-1453189 (STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER IDENTIFICATION NO.) INCORPORATION OR ORGANIZATION) 5915 LANDERBROOK DRIVE 44124 MAYFIELD HEIGHTS, OHIO (ZIP CODE) (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (440) 449-4100 (REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE) INDICATE BY CHECK MARK WHETHER THE REGISTRANT (1) HAS FILED ALL REPORTS REQUIRED TO BE FILED BY SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 DURING THE PRECEDING 12 MONTHS (OR FOR SUCH SHORTER PERIOD THAT THE REGISTRANT WAS REQUIRED TO FILE SUCH REPORTS), AND (2) HAS BEEN SUBJECT TO SUCH FILING REQUIREMENTS FOR THE PAST 90 DAYS YES X NO --- --- INDICATE BY CHECK MARK WHETHER THE REGISTRANT IS AN ACCELERATED FILER (AS DEFINED IN RULE 12b-2 OF THE EXCHANGE ACT). YES X NO --- --- AS OF MAY 12, 2003, 16,192,769 SHARES OF THE REGISTRANT'S COMMON STOCK WERE OUTSTANDING. ================================================================================ EXPLANATORY NOTE This Amendment No. 1 to Form 10-Q is being filed by Cole National Corporation (the Company) to give effect to the restatement described in Note 8 to the accompanying Consolidated Financial Statements. See Note 8 for a summary of the effects of the restatement. Except for the certifications herein and Item 4 of Part I, all information contained herein is as of August 3, 2002, and does not reflect any events or changes in information, other than the restatement, that may have occurred subsequent to August 3, 2002. For a discussion of events and developments relating to periods subsequent to August 3, 2002, see the Company's reports filed with the Securities and Exchange Commission for such subsequent periods, including the Company's Annual Report on Form 10-K for the fiscal year ended February 1, 2003, which is being filed concurrently with this Form 10-Q. The Company makes its annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and any amendments to those reports available, free of charge, through its website, http://www.colenational.com, as soon as reasonably practicable after such material is electronically filed with, or furnished to, the Securities and Exchange Commission. COLE NATIONAL CORPORATION AND SUBSIDIARIES FORM 10-Q/A QUARTER ENDED AUGUST 3, 2002 INDEX
Page No. PART I. FINANCIAL INFORMATION Item 1. Financial Statements Consolidated Balance Sheets as of August 3, 2002 (as restated) and February 2, 2002 (as restated) ............................................................ 1 Consolidated Statements of Operations for the 13 and 26 week periods ended August 3, 2002 (as restated) and August 4, 2001 (as restated) ............................. 2 Consolidated Statements of Cash Flows for the 26 week periods ended August 3, 2002 (as restated) and August 4, 2001 (as restated) ............................. 3 Notes to Restated Consolidated Financial Statements ....................................... 4 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations ..... 18 Item 3. Quantitative and Qualitative Disclosures about Market Risk ................................ 28 Item 4. Controls and Procedures ................................................................... 28 PART II. OTHER INFORMATION Item 1. Legal Proceedings ......................................................................... 30 Item 4. Submission of Matters to a Vote of Security Holders ....................................... 31 Item 6. Exhibits and Reports on Form 8-K .......................................................... 32 Signatures ......................................................................................... 33 Certifications ..................................................................................... 34 Exhibit Index ...................................................................................... 36
PART I. - FINANCIAL INFORMATION ITEM 1. RESTATED FINANCIAL STATEMENTS COLE NATIONAL CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (Unaudited) (Dollars in thousands)
August 3, February 2, 2002 2002 (As restated, (As restated, see Note 8) see Note 8) ------------- ------------- Assets Current assets: Cash and cash equivalents $ 48,904 $ 63,418 Accounts receivable, less allowances of $3,378 and $3,228, respectively 44,613 41,365 Current portion of notes receivable 2,899 2,824 Inventories 125,970 119,203 Prepaid expenses and other 28,313 29,214 Deferred income taxes 27,326 27,252 --------- --------- Total current assets 278,025 283,276 Property and equipment, at cost 314,981 305,419 Less - accumulated depreciation and amortization (194,353) (184,985) --------- --------- Total property and equipment, net 120,628 120,434 Notes receivable, excluding current portion, less allowances of $4,217 and $5,209, respectively 21,610 20,193 Deferred income taxes 29,664 27,801 Other assets 55,078 52,201 Other intangibles, net 45,838 46,146 Goodwill, net 85,542 85,543 --------- --------- Total assets $ 636,385 $ 635,594 ========= ========= Liabilities and Stockholders' Equity Current liabilities: Current portion of long-term debt $ 267 $ 259 Accounts payable 59,541 65,124 Accrued interest 7,690 6,748 Accrued liabilities 96,159 92,577 Accrued income taxes 9,049 8,604 Deferred revenue 36,895 35,401 --------- --------- Total current liabilities 209,601 208,713 Long-term debt, net of discount and current portion 285,546 284,574 Other long-term liabilities 24,214 22,942 Deferred revenue, long-term 11,706 11,049 Stockholders' equity 105,318 108,316 --------- --------- Total liabilities and stockholders' equity $ 636,385 $ 635,594 ========= =========
The accompanying notes to consolidated financial statements are an integral part of these consolidated financial statements. 1 COLE NATIONAL CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited) (In thousands, except per share amounts)
Thirteen Week Periods Ended Twenty-Six Week Periods Ended ------------------------------- ----------------------------------- August 3, August 4, August 3, August 4, 2002 2001 2002 2001 (As restated, (As restated, (As restated, (As restated, see Note 8) see Note 8) see Note 8) see Note 8) ---------------- ------------ ---------------- ---------------- Net revenue $ 292,390 $ 275,334 $ 577,831 $ 547,108 Costs and expenses: Cost of goods sold 95,227 90,029 186,749 175,206 Operating expenses 187,293 174,224 372,834 352,160 Goodwill and tradename amortization - 1,253 - 2,506 --------- --------- --------- --------- Total costs and expenses 282,520 265,506 559,583 529,872 --------- --------- --------- --------- Operating income 9,870 9,828 18,248 17,236 Interest and other (income) expense, net: Interest expense 6,909 7,429 13,951 15,028 Interest and other (income), net (2,223) (1,038) (3,776) (2,338) --------- --------- --------- --------- Total interest and other (income) expense, net 4,686 6,391 10,175 12,690 --------- --------- --------- --------- Income before income taxes 5,184 3,437 8,073 4,546 Income tax provision 3,628 6,451 5,651 8,530 --------- --------- --------- --------- Income (loss) before extraordinary loss 1,556 (3,014) 2,422 (3,984) Extraordinary loss on early extinguishment of debt, net of $3.9 million tax benefit (7,242) - (7,242) - --------- --------- --------- --------- Net income (loss) $ (5,686) $ (3,014) $ (4,820) $ (3,984) ========= ========= ========= ========= Basic earnings (loss) per common share: Income (loss) before extraordinary loss $ 0.10 $ (0.19) $ 0.15 $ (0.25) Extraordinary loss (0.45) - (0.45) - --------- --------- --------- --------- Net income (loss) $ (0.35) $ (0.19) $ (0.30) $ (0.25) ========= ========= ========= ========= Diluted earnings (loss) per common share: Income (loss) before extraordinary loss $ 0.10 $ (0.19) $ 0.15 $ (0.25) Extraordinary loss (0.44) - (0.44) - --------- --------- --------- --------- Net income (loss) $ (0.34) $ (0.19) $ (0.29) $ (0.25) ========= ========= ========= ========= Weighted average shares: Basic 16,212 16,030 16,170 15,932 Diluted 16,672 16,030 16,630 15,932
The accompanying notes to consolidated financial statements are an integral part of these consolidated financial statements. 2 COLE NATIONAL CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) (In thousands)
Twenty-Six Week Periods Ended ------------------------------- August 3, August 4, 2002 2001 (As restated, (As restated, see Note 8) see Note 8) ------------- -------------- Cash flows from operating activities: Net income (loss) $ (4,820) $ (3,984) Adjustments to reconcile net income (loss) to net cash provided by operating activities: Depreciation and amortization 18,059 19,814 Extraordinary loss on early extinguishment of debt, net of tax 7,242 - Noncash compensation 866 1,054 Noncash interest, foreign currency exchange (gains) losses and other, net (2,346) 718 Gain on sale of building - (683) Increases (decreases) in cash resulting from changes in operating assets and liabilities: Accounts and notes receivable, prepaid expenses and other assets (2,196) 5,987 Inventories (6,774) (7,729) Accounts payable, accrued liabilities and other liabilities 7,728 3,657 Accrued interest 942 (261) Accrued and deferred income taxes 2,407 8,386 --------- -------- Net cash provided by operating activities 21,108 26,959 --------- -------- Cash flows from investing activities: Purchases of property and equipment, net (13,944) (19,226) Net proceeds from sale of fixed assets - 4,712 Systems development costs (2,330) (4,578) Investment and notes receivable in Pearle Europe, net - (6,446) Other, net (389) (569) --------- -------- Net cash used for investing activities (16,663) (26,107) --------- -------- Cash flows from financing activities: Repayment of long-term debt (158,165) (417) Proceeds from issuance of long-term debt 150,000 - Increase (decrease) overdraft balances (5,882) (3,393) Net proceeds from exercise of stock options and issuance of stock 1,149 1,186 Repayments (issuance) of notes receivable - stock options and awards, net - (340) Payment of deferred financing fees (6,003) - Other, net (58) (95) --------- -------- Net cash used for financing activities (18,959) (3,059) --------- -------- Cash and cash equivalents: Net decrease during the period (14,514) (2,207) Balance, beginning of period 63,418 37,218 --------- -------- Balance, end of period $ 48,904 $ 35,011 ========= ========
The accompanying notes to consolidated financial statements are an integral part of these consolidated financial statements. 3 COLE NATIONAL CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Basis of Presentation The consolidated financial statements include the accounts of Cole National Corporation ("the Parent"), its wholly owned subsidiary, Cole National Group, Inc. and its wholly owned subsidiaries (collectively referred to as "the Company"). The Company's 21% investment in Pearle Europe B.V. is accounted for using the cost method. All significant intercompany transactions have been eliminated in consolidation. The accompanying consolidated financial statements have been prepared without audit and certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States have been condensed or omitted, although management believes that the disclosures herein are adequate to make the information not misleading. Results for interim periods are not necessarily indicative of the results to be expected for the full year. Nature of Operations The Company is a specialty service retailer operating in both host and nonhost environments, whose primary lines of business are optical products and services and personalized gifts. The Company sells its products through 2,492 company-owned retail locations and 446 franchised locations in 50 states, Canada, and the Caribbean. In connection with its optical business, the Company is a managed vision care benefits provider and claims payment administrator whose programs provide comprehensive eyecare benefits primarily marketed directly to large employers, health maintenance organizations (HMO) and other organizations. The Company has two reportable segments: Cole Vision and Things Remembered (see Note 5). Use of Estimates The preparation of financial statements, in conformity with accounting principles generally accepted in the United States, 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. Significant estimates are required in determining the allowance for uncollectible accounts, inventory reserves, depreciation, amortization and recoverability of long-lived assets, deferred income taxes, remakes and returns allowances, managed vision underwriting results, self-insurance reserves, and retirement and post-employment benefits. Reclassifications Certain reclassifications have been made to prior year financial statements and the notes to conform to the current year presentation. Revenue Recognition and Deferred Revenue Revenues include sales of goods and services, including delivery fees, to retail customers at company-operated stores, sales of merchandise inventory to franchisees and other outside customers, other revenues from franchisees such as royalties based on sales and initial franchise fees, and capitation and other fees associated with Cole Vision's managed vision care business. Revenues from merchandise sales and services, net of estimated returns and allowances, are recognized at the time of customer receipt or when the related goods are shipped direct to the customer and all significant obligations of the Company have been satisfied. The reserve for returns and allowances is calculated as a percentage of sales based on historical return percentages. Capitation revenues are accrued when due under related contracts at the agreed upon per member, per month rates. Administrative service revenue is recognized when services are provided over the contract period and the Company's customers are obligated to pay. 4 Additionally, the Company sells discount programs which have twelve-month terms. Revenues from discount programs are deferred and amortized over the twelve-month term. Additionally, the Company sells separately priced extended warranty contracts with terms of coverage of 12 and 24 months. Revenues from the sale of these contracts are deferred and amortized over the lives of the contracts, while the costs to service the warranty claims are expensed as incurred. Incremental costs directly related to the sale of such contracts, such as sales commissions and percentage rent, are deferred in prepaid expenses and charged to expense in proportion to the revenue recognized. Franchise revenues based on sales by franchisees are accrued as earned. Initial franchise fees are recorded as revenue 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. Things Remembered sells memberships in its Rewards Club(TM) program, which allows members to earn rebates based on their accumulated purchases. The Company defers and amortizes the membership fee revenue over the life of the membership. The rebates, which can only be used to offset the price of future customer purchases, are recognized as a reduction of revenue based on the rebates earned and the estimated future redemptions. The cumulative liability for unredeemed rebates is adjusted over time based on actual experience and trends with respect to redemption. Managed Vision Underwriting Results The Company sells capitated managed vision care plans which generally have a duration of one year. Based upon its experience, the Company believes that it can predict utilization and claims experience under these plans with a high level of confidence. Underwriting results are recognized using an estimated percentage of claims revenue. Each quarter, a portion of the resulting gain is reserved for potential variances between predicted and actual results. These reserves are reconciled following the end of each plan year. Valuation of Inventories Inventories are recorded at the lower of cost or market based on the first-in, first-out (FIFO) method for the optical inventories and based on the weighted average cost method for the gift inventories. The Company records a valuation reserve for future inventory cost markdowns to be taken for inventory not expected to be part of its ongoing merchandise offering. The reserve is estimated based on historical information regarding sell through for similar products. The Company records a reserve for estimated shrinkage based on various factors including sales volume, historical shrink results and current trends. Property and Equipment Property and equipment are stated at cost. Repairs and maintenance costs that extend the life of the asset are capitalized. Depreciation is provided principally by using the straight-line method over the estimated useful life of the related assets, generally 2 to 10 years for furniture, fixtures and equipment, 2 to 25 years for leasehold improvements and 5 to 40 years for buildings and improvements. Goodwill and Other Intangible Assets Goodwill, noncompete agreements and tradename assets were amortized over their estimated useful economic life using the straight-line method and are carried at cost less accumulated amortization. Beginning with fiscal year 2002, all goodwill and tradename amortization ceased in accordance with Statement of Financial Accounting Standard (SFAS) No. 142, "Goodwill and Other Intangible Assets" (SFAS 142), and both goodwill and tradenames, are tested at least annually for impairment. The Company adopted the first day of the fourth fiscal quarter for the annual impairment review. Other intangible assets with finite lives are amortized over their estimated useful lives based on management's estimates of the period that the assets will generate revenue. Cash Flows Net cash flows from operating activities reflect cash payments for income taxes and interest of $3,074,000 and $12,596,000, respectively, for the 26 week periods ended August 3, 2002 and $51,000 and $14,691,000, respectively, for the 26 week periods ended August 4, 2001. 5 Earnings Per Common Share Basic earnings per common share is computed by dividing net income available to common shareholders by the weighted average number of common shares outstanding for the periods presented. Diluted earnings per common share also includes the dilutive effect of potential common shares (primarily dilutive stock options) outstanding for the periods presented. The following represents a reconciliation from basic earnings per share to diluted earnings per share:
Thirteen Week Periods Twenty-Six Week Periods --------------------------- --------------------------- 2002 2001 2002 2001 ------------ ------------- ------------ ------------ (In thousands, except for per share data) Determination of shares: Average common shares outstanding 16,212 16,030 16,170 15,932 Assumed conversion of dilutive stock options and awards 460 - 460 - ------------ ------------- ------------ ------------ Diluted average common shares outstanding 16,672 16,030 16,630 15,932 ------------ ------------- ------------ ------------ Basic earnings (loss) per common share before extraordinary loss 0.10 (0.19) 0.15 (0.25) Diluted earnings (loss) shares per common share before extraordinary loss 0.10 (0.19) 0.15 (0.25)
Total Other Comprehensive Income (Loss) Total other comprehensive income (loss) for the 13 and 26 week periods ended August 3, 2002 and August 4, 2001 is as follows (000's omitted):
Thirteen Week Periods Twenty-Six Week Periods ------------------------- ----------------------- 2002 2001 2002 2001 ------ ------ ------ ------ Net loss (5,686) (3,014) (4,820) (3,984) Cumulative translation income (loss) (117) (9) 5 (170) ------------ ------------- ------------- ------------ Total other comprehensive loss (5,803) (3,023) (4,815) (4,154) ============ ============= ============= ============
(2) GOODWILL AND OTHER INTANGIBLE ASSETS The Company adopted SFAS 142 in the first quarter of fiscal 2002. This statement requires that goodwill and certain intangible assets deemed to have indefinite lives will no longer be amortized, but instead, will be subject to reviews for impairment annually, or more frequently if certain indicators arise. With the adoption of this statement, the Company ceased amortization of goodwill and tradenames as of February 3, 2002. The Company completed the transitional impairment testing of goodwill and tradenames during the second quarter of fiscal 2002 as required by SFAS 142. Based on the findings of its outside valuation advisor, the Company has concluded that there was no impairment at the adoption date of the new accounting standard, effective February 3, 2002. The Company has elected to perform its annual tests for potential impairment as of the first day of the Company's fourth fiscal quarter. The following table provides the comparable effects of adopting SFAS 142 for the 13 and 26 week periods ended August 3, 2002 and August 4, 2001. 6
Thirteen Week Periods Twenty-Six Week Periods ------------------------ ------------------------ 2002 2001 2002 2001 --------- ------- --------- ------- (In thousands, except per share amounts) Income (loss): Reported income (loss) $ (5,686) $(3,014) $ (4,820) $(3,984) Goodwill amortization - Cole Vision - 707 - 1,414 Goodwill amortization - Things Remembered - 237 - 474 Tradename amortization - Cole Vision - 309 - 618 Related tax adjustment - (170) - (340) --------- ------- --------- ------- Adjusted income (loss) $ (5,686) $(1,931) $ (4,820) $(1,818) ========= ======= ========= ======= Basic earnings (loss) per share: Reported income (loss) $ (0.35) $ (0.19) $ (0.30) $ (0.25) Goodwill and tradename amortization, net of tax - 0.07 - 0.14 --------- ------- --------- ------- Adjusted income (loss) $ (0.35) $ (0.12) $ (0.30) $ (0.11) ========= ======= ========= ======= Diluted earnings (loss) per share: Reported income (loss) $ (0.34) $ (0.19) $ (0.29) $ (0.25) Goodwill and tradename amortization, net of tax - 0.07 - 0.14 --------- ------- --------- ------- Adjusted income (loss) $ (0.34) $ (0.12) $ (0.29) $ (0.11) ========= ======= ========= =======
Other intangible assets consist of (In thousands):
2002 2001 ------------ ------------ Tradename $ 49,460 $ 49,460 Noncompete agreements 840 840 Contracts 3,460 3,460 ------------ ------------ 53,760 53,760 Accumulated amortization (7,922) (7,614) ------------ ------------ Other intangibles, net $ 45,838 $ 46,146 ============ ============
The net carrying amount of goodwill at August 3, 2002, by business segment, was $64.2 million at Cole Vision and $21.4 million at Things Remembered. The decrease in the net carrying amount of $757 for goodwill and was due to a foreign currency translation of goodwill at Cole Vision. The net carrying amount of other intangibles of $45.8 million at August 3, 2002 was primarily attributable to the Cole Vision segment. Amortization of other intangibles was $308,000 for the twenty-six week periods ended August 3, 2002. (3) LONG-TERM DEBT On May 22, 2002, Cole National Group issued $150.0 million of 8-7/8% Senior Subordinated Notes that mature on May 15, 2012. Interest on the notes is payable semi-annually on each May 15 and November 15, commencing November 15, 2002. Net proceeds from the 8-7/8% note offering, together with cash on hand, were used to retire $150.0 million of 9-7/8% Senior Subordinated Notes due 2006 and pay premiums and other costs associated with retiring those notes. The Company's results for fiscal 2002 included an extraordinary loss on early extinguishment of debt of approximately $7.2 million, net of an income tax benefit of approximately $3.9 million, representing the payment of premiums and other costs of retiring the notes and the write-offs of unamortized discount and deferred financing fees. On August 22, 1997, Cole National Group issued $125.0 million of 8-5/8% Senior Subordinated Notes that mature in 2007 with no earlier scheduled redemption or sinking fund payments. Interest on the 8-5/8% notes is payable semi-annually on February 15 and August 15. 7 The 8-5/8% notes and the 8-7/8% notes are general unsecured obligations of Cole National Group, subordinated in right of payment to senior indebtedness of Cole National Group and senior in right of payment to any current or future subordinated indebtedness of Cole National Group. The indentures pursuant to which the 8-5/8% notes and the 8-7/8% notes were issued restrict dividend payments to the Company. The indentures also contain certain optional and mandatory redemption features and other financial covenants. Cole National Group was in compliance with these covenants at August 3, 2002. On April 23, 1999, the Company issued a $10.0 million promissory note bearing interest at 5.0% per annum in recognition of a commitment to contribute $10.0 million to a leading medical institution, supporting the development of a premier eye care research and surgical facility. The note requires a $5.0 million principal payment to be made on April 23, 2004, and principal payments in the amount of $1.0 million to be made on the anniversary date of the note each successive year through 2009. Interest only is payable annually for the first 5 years, and thereafter with each payment of principal. The Company has no significant principal payment obligations under its outstanding indebtedness until the $5.0 million principal payment due in 2004 under the 5.0% promissory note and until 2007, when the $125.0 million Senior Subordinated debt is due. Subsequent to August 3, 2002, the Company entered into interest rate swap agreements to take advantage of favorable market interest rates. These agreements require the Company to pay an average floating interest rate based on six-month LIBOR plus 4.5375% to a counter party while receiving a fixed interest rate on a portion of the Company's $125.0 million 8-5/8% Senior Subordinated Notes due 2007. The counter party is a major commercial bank. The agreements mature August 15, 2007 and qualify as fair value hedges. The aggregate notional amount of the interest rate swap agreements is $50.0 million. (4) CREDIT FACILITY The operating subsidiaries of Cole National Group, Inc. have a working capital commitment of $75.0 million that extends until May 31, 2006. Borrowings under the credit facility presently bear interest based on leverage ratios of Cole National Group at a rate equal to either (a) the Eurodollar Rate plus 2.25% or (b) 1.25% plus the highest of (i) the CIBC prime rate, (ii) the three-week moving average of the secondary market rates for three-month certificates of deposit plus 1.0% or (iii) the federal funds rate plus 0.5%. Cole National Group pays a commitment fee of between 0.50% and 0.75% per annum on the total unused portion of the facility based on the percentage of revolving credit commitments used. The Company and Cole National Group guarantee this credit facility. The credit facility is secured by the assets of the operating subsidiaries of Cole National Group, Inc. The credit facility requires the principal operating subsidiaries of Cole National Group to comply with various operating covenants that restrict corporate activities, including covenants restricting the ability of the subsidiaries to incur additional indebtedness, pay dividends, prepay subordinated indebtedness, dispose of certain investments or make acquisitions. The credit facility also requires the subsidiaries of Cole National Group to comply with certain financial covenants, including covenants regarding minimum interest coverage and maximum leverage. The credit facility restricts dividend payments to Cole National Group from its subsidiaries to amounts needed to pay interest on the 8-7/8% notes and the 8-5/8% notes, and certain amounts related to taxes, along with up to 0.25% of Cole National Group's consolidated net revenue annually for other direct expenses of the Company or Cole National Group. The credit facility restricts dividend payments to Cole National Group in an aggregate amount not to exceed $50.0 million to allow for the repurchase of Senior Subordinated Notes. No borrowings under the credit facility were outstanding as of August 3, 2002 and August 4, 2001. There were no borrowings during the second quarter of fiscal 2002 and fiscal 2001. 8 (5) SEGMENT INFORMATION Information on the Company's reportable segments is as follows (dollars in thousands):
Thirteen Week Periods Twenty-Six Week Periods ------------------------ ------------------------ 2002 2001 2002 2001 -------- -------- -------- -------- Net revenue: Cole Vision $218,079 $201,431 $451,049 $420,260 Things Remembered 74,311 73,903 126,782 126,848 -------- -------- -------- -------- Total net revenue $292,390 $275,334 $577,831 $547,108 ======== ======== ======== ======== Operating income: Cole Vision $ 2,906 $ 1,673 $ 16,197 $ 12,973 Things Remembered 9,795 10,922 7,956 9,690 -------- -------- -------- -------- Total segment operating income 12,701 12,595 24,153 22,663 Unallocated amounts: Corporate expenses $ 2,831 $ 2,767 $ 5,905 $ 5,427 -------- -------- -------- -------- Total operating income 9,870 9,828 18,248 17,236 Interest and other (income) expense, net 4,686 6,391 10,175 12,690 -------- -------- -------- -------- Income before income taxes $ 5,184 $ 3,437 $ 8,073 $ 4,546 ======== ======== ======== ========
(6) COMMITMENTS AND CONTINGENCIES The Company leases a substantial portion of its computers, equipment and 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 or purchase options. Operating and capital lease obligations are based upon contractual minimum rates and, in most leases covering retail store locations, additional rents are payable based on store sales. In addition, Cole Vision 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 Company guarantees future minimum lease payments for certain store locations leased directly by franchisees. These guarantees totaled approximately $13.7 million and $14.0 million as of February 2, 2002 and August 3, 2002. Performance under a guarantee by the Company is triggered by default of a franchisee in their lease commitment. Generally, these guarantees also extend to payments of taxes and other normal expenses payable under these leases, the amounts of which are not readily quantifiable. Many of the guarantees are limited to periods that are less than the full term of the leases involved. Agreements between HAL, the Company and members of Pearle Europe management require HAL and the Company to periodically offer to purchase Pearle Europe shares held by the members of Pearle Europe Management. These offers are required to be made (1) not later than September 3, 2003, (2) in May 2005, and (3) biannually in May commencing in 2007. The obligations to fund the purchase of any shares as to which the offer to purchase is accepted are pro rata to HAL and to the Company based on their respective ownership interests on the date of the offer. HAL and the Company have not yet agreed on the price to offer this year or on the process to agree to the price or on the source of funding for any purchases. Funds could be derived from payments by Pearle Europe, from the separate resources of HAL and the Company, or from financings. In the event that all of Pearle Europe's managers who are entitled to receive an offer to purchase their shares were to accept that offer, the resulting obligation to the Company could be material. The Company believes that it will have sufficient liquidity to meet the obligation, if any, that may result from their commitment in fiscal 2003. (7) LEGAL PROCEEDINGS The State of California has obtained a preliminary injunction in July 2002 in a case brought against the Company, Pearle Vision and other subsidiaries regarding Pearle Vision Centers and Pearle Vision Care, Inc. The terms of the injunction are not expected to have any material effect on the Company's operations. Although we believe we are in compliance with California law and intend to continue to defend the case vigorously, we may be required to further modify our activities or might be required to pay damages and/or restitution in currently undeterminable amounts if we are not successful, the cost of which, as well as continuing defense costs, might have a material adverse effect on our operating results in one or more periods. A class action complaint was filed in a case brought against the Company's subsidiary, Things Remembered, Inc., alleging violation of California's wage and hour laws. The case is in its early stages and the Company intends to vigorously defend the suit. We may be required to modify our activities and pay damages and/or restitution in currently undeterminable amounts if the plaintiffs prevail, the cost of which, as well as continuing defense costs, might have a material adverse impact on our operating results in one or more periods. 9 In the ordinary course of business, the Company is involved in various other legal proceedings. The Company is of the opinion that the ultimate resolution of these matters will not have a material adverse effect on the results of operations, liquidity or financial position of the Company. (8) RESTATEMENT Subsequent to the issuance of the Company's consolidated financial statements for the second quarter of fiscal 2002, the Company determined it needed to restate its previously issued financial statements for numerous items, each of which was an "error" within the meaning of Accounting Principles Board (APB) Opinion No. 20, "Accounting Changes". In addition to the restatement of its annual financial statements, the Company has also restated its previously issued quarterly financial statements for fiscal years 2002 and 2001. Recognition of Revenues Earned on the Sale of Extended Warranty Contracts. Customers purchasing eyeglasses from the Company's retail stores are offered the option of buying a warranty for up to two years, paying in full for the warranty at the time of sale. The Company historically recognized the revenue at the time of the sale. The Company has made restatement adjustments to record the warranty payment received at the time of the sale as deferred revenue and recognizes the revenue on a straight-line basis over the warranty period. Other Revenue Recognition Adjustments. Previously, the Company recognized certain sales transactions as revenue when the customer placed the order and a deposit was taken. Restatement adjustments were made to defer such revenue until customer receipt or when the related goods were shipped direct to the customer and all significant obligations of the Company were satisfied. In addition, revenue adjustments have been made to establish adequate allowances for returns and remakes. Historically, the Company had recorded returns and remakes based on actual product returned during the period. Valuation of Long-lived Assets. Historically, the Company did not consider certain mature stores with negative cash flows in its asset impairment tests. In addition, in testing for SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of" (SFAS 121) impairment, the Company did not allocate goodwill to the respective stores. As part of the restatement, the Company applied a methodology which includes all mature stores in its asset impairment tests and includes an allocation of goodwill for years prior to fiscal 2002. The restated financial statements also reflect the recognition of losses on the disposal of fixed assets in the appropriate periods. Additional adjustments were made to record depreciation expense for certain depreciable fixed assets which were not previously being depreciated. Also included is an adjustment to record capital lease assets and the corresponding lease obligation for leases that had previously been accounted for as operating leases. Inventories and Cost of Goods Sold. The Company's restated financial statements reflect adjustments relating to inventories and cost of goods sold primarily to (i) recognize obsolescence reserves in appropriate periods and amounts, correct calculation errors and recognize certain inventory costs in appropriate periods and (ii) reflect certain vendor allowances previously recorded in operations but not yet earned as a reduction in the inventory balances. Accruals for Operating Expenses. Historically, the Company did not always record changes in estimates in the period of change, and established accruals for certain expenses that had not yet been incurred. The restated financial statements reflect adjustments to recognize certain operating expenses in the period in which they were incurred and to record the corresponding liability for those items not paid at the end of the period. Such operating expenses primarily consist of advertising, self-insurance, IBNR claims, retirement and post employment benefits, vacation, allowance for uncollectible accounts and miscellaneous operating expenses. 1998 Settlement from Former Owner of Pearle. The Company's 1998 financial statements included the recognition of $6.0 million of income from a $13.0 million cash settlement with the former owner of Pearle. The terms of the related agreement included the settlement of certain claims and indemnifications associated with the purchase agreement. In addition, as part of the settlement, the Company agreed to assume certain contingent liabilities from the former owner. The restated financial statements reflect the treatment of this $6.0 million from the settlement as an adjustment to the purchase price of Pearle, thereby reducing the goodwill that was established in connection with the Pearle acquisition and associated amortization expense. 10 Investment in Pearle Europe. The Company owns a 21% equity interest in Pearle Europe, B.V. ("Pearle Europe") which operates a retail optical business in Europe. HAL Holding N.V. ("HAL"), a Dutch investment Company, owns 68% of Pearle Europe and individual members of Pearle Europe's management own the remaining 11%. The Company has owned its interest in Pearle Europe and predecessor companies since 1996. The Company has historically accounted for its investment in Pearle Europe under the equity method, pursuant to which the Company's net income has included its equity share in Pearle Europe's earnings. Under APB Opinion 18 "The Equity Method of Accounting for Investments in Common Stock," use of the equity method is appropriate when an investor has the ability to exercise significant influence over the operating and financial policies of the investee. The Company has one of five seats on Pearle Europe's Supervisory Board, and the Pearle Europe management shareholders control one seat. HAL controls two seats, and appoints the President of the Supervisory Board, with the consent of the Company. Between 1996 and June 2000, the contractual arrangements between the parties gave the Company the ability to exercise significant influence over the operating and financial policies of Pearle Europe. In Pearle Europe's early years, the Company provided management advice and support. The contractual relationships between the parties changed significantly in June 2000, so that the Company no longer had the ability to exercise significant influence over the operating and financial policies of Pearle Europe. The restated financial statements reflect a change in the Company's method of accounting for its investment in Pearle Europe from the equity method of accounting to the cost method of accounting beginning with the third quarter of 2000. Under the cost method, the Company has recorded its investment in the Pearle Europe shares at the carrying values as of the end of second quarter fiscal 2000. Starting at the same time, the Company included foreign currency gains and losses related to the Pearle Europe notes in net income. The Company will recognize as income any dividends received from Pearle Europe that are distributed from Pearle Europe's net accumulated earnings. Deferred Income Taxes and Income Tax Liabilities. The Company reviewed all of its temporary differences and loss and tax credit carryforwards, and made adjustments to its deferred tax assets and liabilities. Adjustments were made to provide for state and local income tax deferred tax assets and liabilities, which were previously not recorded. The Company evaluated the adequacy of the tax liabilities established for the current and open tax years and adjusted the amounts maintained in the tax liability accounts. Also included is the tax effect of the restatement items. Summary. This Form 10-Q for the quarterly period ended August 3, 2002 is being filed at the completion of the restatement process, and at the same time as the filing of the Company's Form 10-K for the fiscal year ended February 1, 2003. The comparative financial information for the prior year set forth in the financial statements of this Form 10-Q have been restated. 11 CONSOLIDATED BALANCE SHEET AS OF AUGUST 3, 2002
As Previously Reported Adjustments As Restated ---------- ----------- ----------- (Dollars in thousands) ASSETS Current assets: Cash and cash equivalents $ 48,931 $ (27) $ 48,904 Accounts receivable, net of allowances 44,574 39 44,613 Current portion of notes receivable 2,899 -- 2,899 Inventories 118,318 7,652 125,970 Refundable income taxes 458 (458) -- Prepaid expenses and other 22,088 6,225 28,313 Deferred income taxes 547 26,779 27,326 --------- --------- --------- Total current assets 237,815 40,210 278,025 Property and equipment, at cost 303,851 11,130 314,981 Less - accumulated depreciation and amortization (182,391) (11,962) (194,353) --------- --------- --------- Total property and equipment, net 121,460 (832) 120,628 Notes receivable, excluding current portion, less allowances 20,706 904 21,610 Deferred income taxes and other assets 80,509 4,233 84,742 Other intangibles, net -- 2,846 2,846 Tradenames, net 42,992 -- 42,992 Goodwill, net 103,551 (18,009) 85,542 --------- --------- --------- Total assets $ 607,033 $ 29,352 $ 636,385 ========= ========= ========= LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Current portion of long-term debt $ 50 $ 217 $ 267 Accounts payable 53,590 5,951 59,541 Accrued interest 7,970 (280) 7,690 Accrued liabilities and deferred revenues 83,358 49,696 133,054 Accrued income taxes 743 8,306 9,049 --------- --------- --------- Total current liabilities 145,711 63,890 209,601 Long term debt, net of discount and current portion 285,000 546 285,546 Other long term liabilities 17,073 18,847 35,920 Stockholders' equity 159,249 (53,931) 105,318 --------- --------- --------- Total liabilities and stockholders' equity $ 607,033 $ 29,352 $ 636,385 ========= ========= =========
12 CONSOLIDATED BALANCE SHEET AS OF FEBRUARY 2, 2002
As Previously Reported Adjustments As Restated ---------- ----------- ----------- (Dollars in thousands) ASSETS Current assets: Cash and cash equivalents $ 63,656 $ (238) $ 63,418 Accounts receivable, net of allowances 39,609 1,756 41,365 Current portion of notes receivable 2,926 (102) 2,824 Inventories 111,098 8,105 119,203 Refundable income taxes 502 (502) - Prepaid expenses and other 22,757 6,457 29,214 Deferred income taxes 477 26,775 27,252 --------- --------- --------- Total current assets 241,025 42,251 283,276 Property and equipment, at cost 297,649 7,770 305,419 Less - accumulated depreciation and amortization (174,300) (10,685) (184,985) --------- --------- --------- Total property and equipment, net 123,349 (2,915) 120,434 Notes receivable, excluding current portion, less allowances 19,056 1,137 20,193 Deferred income taxes and other assets 74,220 5,782 80,002 Other intangibles, net - 3,154 3,154 Tradenames, net 42,992 - 42,992 Goodwill, net 103,552 (18,009) 85,543 --------- --------- --------- Total assets $ 604,194 $ 31,400 $ 635,594 ========= ========= ========= LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Current portion of long-term debt $ 85 $ 174 $ 259 Accounts payable 57,647 7,477 65,124 Accrued interest 6,539 209 6,748 Accrued liabilities and deferred revenues 79,722 48,256 127,978 Accrued income taxes 3,501 5,103 8,604 --------- --------- --------- Total current liabilities 147,494 61,219 208,713 Long term debt, net of discount and current portion 284,318 256 284,574 Other long term liabilities 16,775 17,216 33,991 Stockholders' equity 155,607 (47,291) 108,316 --------- --------- --------- Total liabilities and stockholders' equity $ 604,194 $ 31,400 $ 635,594 ========= ========= =========
13 FOR THE QUARTER ENDED AUGUST 3, 2002
As Previously Reported Adjustments As Restated ------------- ------------- ------------- (In thousands, except per share amounts) Net revenue $ 288,857 $ 3,533 $ 292,390 Cost and expenses: Cost of goods sold 94,520 707 95,227 Operating expenses 185,234 2,059 187,293 Goodwill and tradename amortization - - - --------- ------- --------- Total costs and expenses 279,754 2,766 282,520 --------- ------- --------- Operating income 9,103 767 9,870 Interest and other (income) expense: Interest expense 6,947 (38) 6,909 Interest and other (income) (613) (1,610) (2,223) --------- ------- --------- Total interest and other (income) expense, net 6,334 (1,648) 4,686 --------- ------- --------- Income before income taxes 2,769 2,415 5,184 Income tax provision (benefit) 1,108 2,520 3,628 --------- ------- --------- Income (loss) after taxes 1,661 (105) 1,556 Equity in net income of Pearle Europe 1,030 (1,030) - --------- ------- --------- Income (loss) before extraordinary loss 2,691 (1,135) 1,556 Extraordinary loss on early extinguishment of debt (7,634) 392 (7,242) --------- ------- --------- Net income (loss) $ (4,943) $ (743) $ (5,686) ========= ======= ========= Basic earnings (loss) per common share: Income before extraordinary loss $ 0.16 $ (0.06) $ 0.10 Extraordinary loss (0.47) 0.02 (0.45) --------- ------- --------- Net income (loss) $ (0.31) $ (0.04) $ (0.35) ========= ======= ========= Diluted earnings (loss) per common share: Income before extraordinary loss $ 0.16 $ (0.06) $ 0.10 Extraordinary loss (0.46) 0.02 (0.44) --------- ------- --------- Net income (loss) $ (0.30) $ (0.04) $ (0.34) ========= ======= =========
14 FOR THE QUARTER ENDED AUGUST 4, 2001
As Previously Reported Adjustments As Restated ------------- ------------ ------------- (In thousands, except per share amounts) Net revenue $ 273,348 $ 1,986 $ 275,334 Cost and expenses: Cost of goods sold 91,307 (1,278) 90,029 Operating expenses 171,374 2,850 174,224 Goodwill and tradename amortization 1,436 (183) 1,253 --------- ------- --------- Total costs and expenses 264,117 1,389 265,506 --------- ------- --------- Operating income 9,231 597 9,828 Interest and other (income) expense: Interest expense 7,010 419 7,429 Interest and other (income) (787) (251) (1,038) --------- ------- --------- Total interest and other (income) expense, net 6,223 168 6,391 --------- ------- --------- Income before income taxes 3,008 429 3,437 Income tax provision 1,786 4,665 6,451 --------- ------- --------- Income (loss) after taxes 1,222 (4,236) (3,014) Equity in net income of Pearle Europe 237 (237) - --------- ------- --------- Net income (loss) $ 1,459 $(4,473) $ (3,014) ========= ======= ========= Earnings (loss) per common share: Basic $ 0.09 $ (0.28) $ (0.19) Diluted $ 0.09 $ (0.28) $ (0.19)
15 FOR THE TWENTY-SIX WEEKS ENDED AUGUST 3, 2002
As Previously Reported Adjustments As Restated ------------- ------------ ------------- (In thousands, except per share amounts) Net revenue $ 578,966 $(1,135) $ 577,831 Cost and expenses: Cost of goods sold 190,168 (3,419) 186,749 Operating expenses 368,621 4,213 372,834 Goodwill and tradename amortization - - - --------- ------- --------- Total costs and expenses 558,789 794 559,583 --------- ------- --------- Operating income (loss) 20,177 (1,929) 18,248 Interest and other (income) expense: Interest expense 14,076 (125) 13,951 Interest and other (income) (1,246) (2,530) (3,776) --------- ------- --------- Total interest and other (income) expense, net 12,830 (2,655) 10,175 --------- ------- --------- Income before income taxes 7,347 726 8,073 Income tax provision 2,939 2,712 5,651 --------- ------- --------- Income after taxes 4,408 (1,986) 2,422 Equity in net income of Pearle Europe 1,826 (1,826) - --------- ------- --------- Income before extraordinary loss 6,234 (3,812) 2,422 Extraordinary loss on early extinguishment of debt (7,634) 392 (7,242) --------- ------- --------- Net income (loss) $ (1,400) $(3,420) (4,820) ========= ======= ========= Basic earnings (loss) per common share: Income before extraordinary loss $ 0.39 $ (0.24) $ 0.15 Extraordinary loss (0.48) 0.03 (0.45) --------- ------- --------- Net income (loss) $ (0.09) $ (0.21) $ (0.30) ========= ======= ========= Diluted earnings (loss) per common share: Income before extraordinary loss $ 0.38 $ (0.23) $ 0.15 Extraordinary loss (0.46) 0.02 (0.44) --------- ------- --------- Net income (loss) $ (0.08) $ (0.21) $ (0.29) ========= ======= =========
16 FOR THE TWENTY-SIX WEEKS ENDED AUGUST 4, 2001
As Previously Reported Adjustments As Restated ------------- ------------ ------------- (In thousands, except per share amounts) Net revenue $ 543,639 $ 3,469 $ 547,108 Cost and expenses: Cost of goods sold 179,029 (3,823) 175,206 Operating expenses 345,277 6,883 352,160 Goodwill and tradename amortization 2,898 (392) 2,506 --------- ------- --------- Total costs and expenses 527,204 2,668 529,872 --------- ------- --------- Operating income 16,435 801 17,236 Interest and other (income) expense: Interest expense 14,068 960 15,028 Interest and other (income) (2,126) (212) (2,338) --------- ------- --------- Total interest and other (income) expense, net 11,942 748 12,690 --------- ------- --------- Income before income taxes 4,493 53 4,546 Income tax provision 2,574 5,956 8,530 --------- ------- --------- Income (loss) after taxes 1,919 (5,903) (3,984) Equity in net income of Pearle Europe 185 (185) - --------- ------- --------- Net income (loss) $ 2,104 $(6,088) $ (3,984) ========= ======= ========= Earning (loss) per common share: Basic $ 0.13 $ (0.38) $ (0.25) Diluted $ 0.13 $ (0.38) $ (0.25)
17 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS As discussed in Note 8 to the Consolidated Financial Statements the Company's financial statements have been restated. See Note 8 to the Notes to Consolidated Financial Statements, for a summary of the significant effects of the restatement. The following discussion of the Company's financial condition and results of operations gives effects to the restatement and should be read in conjunction with the Consolidated Financial Statements and related notes. OVERVIEW Cole National, primarily through the subsidiaries owned by its direct subsidiary, Cole National Group, Inc., is a leading provider of optical products and services and personalized gifts. The Company sells its products and services through 2,492 company-owned retail locations and 446 franchised locations in 50 states, Canada and the Caribbean. Fiscal years end on the Saturday closest to January 31 and are identified according to the calendar year in which they begin. For example, the fiscal year ended February 2, 2002 is referred to as "fiscal 2001." The current fiscal year, which ends February 1, 2003, is referred to as "fiscal 2002." Fiscal 2002 and fiscal 2001 each consisted of 52 weeks. The Company has two reportable segments, Cole Vision and Things Remembered. Most of Cole Vision's revenue represents sales of prescription eyewear, accessories and services through its Cole Licensed Brands and Pearle Vision retail locations. Cole Vision revenue also includes sales of merchandise to franchisees, royalties based on franchise sales, initial franchise fees for Pearle Vision and capitation revenue, administrative service fee revenue and discount program service fees from its Cole Managed Vision business. Things Remembered's revenue represents sales of engraveable gift merchandise, personalization and other services primarily through retail in-line stores and kiosks. Things Remembered revenue also includes direct sales through its e-commerce site, http://www.ThingsRemembered.com, sales through Things Remembered catalogs and through affiliate programs direct to businesses. 18 RESULTS OF OPERATIONS The following table sets forth certain operating information for the second quarter and first six months of fiscal 2002 and fiscal 2001. This schedule and subsequent discussions should be read in conjunction with the consolidated financial statements included in this Form 10-Q/A.
Second Quarter First Six Months ------------------------ ------------------------ 2002 2001 Change 2002 2001 Change ---------- ----------- ---------- ---------- ---------- --------- (Dollars in millions) (Dollars in millions) Net revenue: Cole Vision $ 218.1 $ 201.4 8.3 % $ 451.0 $ 420.2 7.3 % Things Remembered 74.3 73.9 0.5 126.8 126.9 (0.1) ---------- ----------- ---------- ---------- Total net revenue $ 292.4 $ 275.3 6.2 % $ 577.8 $ 547.1 5.6 % Gross margin: Cole Vision $ 143.4 $ 132.7 8.1 % $ 298.6 $ 280.9 6.3 % Things Remembered 53.8 52.6 2.3 92.5 91.0 1.6 ---------- ----------- ---------- ---------- Total gross margin $ 197.2 $ 185.3 6.4 % $ 391.1 $ 371.9 5.2 % Operating expenses: Cole Vision $ 140.5 $ 130.0 8.1 % $ 282.4 $ 265.9 6.2 % Things Remembered 44.0 41.5 6.0 84.5 80.8 4.6 Unallocated corporate 2.9 2.8 3.6 6.0 5.5 9.1 ---------- ----------- ---------- ---------- Total operating expense $ 187.4 $ 174.3 7.5 % $ 372.9 $ 352.2 5.9 % Goodwill and tradename amortization Cole Vision $ - $ 1.0 (100.0)% $ - $ 2.0 (100.0)% Things Remembered - 0.2 (100.0) - 0.5 (100.0) ---------- ----------- ---------- ---------- Total goodwill and tradename amortization $ - $ 1.2 (100.0)% $ - $ 2.5 (100.0)% Operating income (loss): Cole Vision $ 2.9 $ 1.7 70.6 % $ 16.2 $ 13.0 24.6 % Things Remembered 9.8 10.9 (10.1) 8.0 9.7 (17.5) Unallocated corporate expenses (2.9) (2.8) 3.6 (6.0) (5.5) 9.1 ---------- ----------- ---------- ---------- Total operating income $ 9.8 $ 9.8 - $ 18.2 $ 17.2 5.8 % ========== =========== ========== ========== Percentage of net revenue: Gross margin 67.4 % 67.3 % 0.1 67.7 % 68.0 % (0.3) Operating expenses 64.1 63.3 0.8 64.5 64.4 0.1 Goodwill and tradename amortization - 0.4 (0.4) - 0.5 (0.5) ---------- ----------- ---------- ---------- Operating income 3.4 % 3.6 % (0.2) 3.1 % 3.1 % 0.0 ========== =========== ========== ========== Number of retail locations at the end of the period Cole Licensed Brands 1,296 1,225 Pearle company-owned 420 435 Pearle franchised 446 416 ---------- ----------- Total Cole Vision 2,162 2,076 Things Remembered 776 780 ---------- ----------- Total Cole National 2,938 2,856 ========== ===========
19 As used in Item 2 of this Form 10-Q, same-store sales growth is a non-GAAP financial measure, which includes deferred warranty sales on a cash basis and does not reflect provisions for returns and remakes and certain other items. The Company's current systems do not gather data on these items on an individual store basis. Adjustments to the cash basis sales information accumulated at the store level are made for these items on an aggregate basis. As a retailer, the Company believes that a measure of same-store sales performance is important for understanding its operations. The Company calculates same-store sales for stores opened for at least twelve months. A reconciliation of same-store sales to revenue is presented below in the section "Reconciliation of Same-Store Sales Growth". Same-store sales growth follows: 2002 -------------------------------------- Second Quarter First Six Months ----------------- ----------------- Cole Licensed Brands (U.S.) 5.8% 4.6% Pearle Company-owned (U.S.) 1.5% 6.2% Total Cole Vision 3.5% 4.7% Things Remembered (1.6%) (2.2%) Total Cole National 2.1% 3.0% Pearle franchise stores (U.S.) 0.6% 1.0% Same-store sales for Pearle U.S. franchise stores is a non-GAAP financial measure that is provided for comparative purposes only. The Company believes that its franchisees' method of reporting sales is consistent on a year-to-year basis. SECOND QUARTER FISCAL 2002 COMPARED TO SECOND QUARTER FISCAL 2001 CONSOLIDATED OPERATIONS Total revenues were $292.4 million in the second quarter of fiscal 2002, compared with $275.3 million in the same period of fiscal 2001. Total revenues increased 6.2% in the second quarter, primarily attributable to a 2.1% increase in same-store sales and an increase in the number of Target Optical stores open. Gross margin was $197.2 million in the second quarter of fiscal 2002, compared with $185.3 million in the same period of fiscal 2001, an increase of 6.4%. The gross margin dollar increase was primarily attributable to improvements in net revenue at Cole Vision. The gross margin rate for the second quarter was 67.4%, compared to 67.3% for the second quarter 2001. The increase in gross margin rate for the second quarter was attributable to improvements in gross margin rate at Things Remembered, offset by a slight decline in Cole Vision. At Things Remembered, the gross margin rate improved from 71.2% to 72.4%. The improvement was due primarily to increases in the average dollar sale. Operating expenses were $187.4 million in the second quarter of fiscal 2002, compared with $174.3 million in the same period of fiscal 2001, an increase of 7.5%. The increase in operating expenses was primarily due to costs incurred to support the increases in net revenue and the number of Target Optical stores opened in the past twelve months. As a percentage of net revenue, operating expenses were 64.1% compared to 63.3% for the second quarter 2001. The increase in operating expense percent was primarily a result of higher operating costs at Things Remembered. Operating expenses at Things Remembered increased 6.0% on a 0.5% increase in sales. Higher costs of store rent and occupancy and increases in marketing were the primary reasons for the increase in operating expense percent. The Company adopted SFAS 142 "Goodwill and Other Intangible Assets", (SFAS 142), in the first quarter of fiscal 2002. SFAS 142 requires that goodwill and certain intangibles deemed to have indefinite lives no longer be amortized, but instead, will be subject to annual reviews for impairment. With the adoption of this statement, the Company ceased amortization of goodwill and tradenames as of February 3, 2002. The Company recorded a $1.2 million goodwill and tradename amortization charge in the second quarter of fiscal 2001. Operating income was $9.8 million in the second quarter of fiscal 2002, compared to $9.8 million in the same period of fiscal 2001. Improvements at Cole Vision were offset by a decline in operating income at Things Remembered. 20 Interest and other (income) expense, net, decreased $1.7 million in the second quarter of fiscal 2002, compared to the comparable period of fiscal 2001. The Company recorded a transaction gain of $1.3 million related to its investment in notes and interest receivable from Pearle Europe in the second quarter of fiscal 2002. This compared to a transaction loss of $0.1 million for the comparable period of fiscal 2001. In addition, the Company recorded lower interest expense in the second quarter of fiscal 2002, due to the replacement of the $150.0 million 9-7/8% Senior Subordinated Notes with the issuance of 8-7/8% Senior Subordinated Notes in May 2002. See Note 3 of the Notes to Consolidated Financial Statement for further information regarding this transaction. The lower effective tax rate in 2002 was primarily due to the elimination of goodwill amortization pursuant to the new accounting standard and a reduction in the provision for valuation allowances related to deferred tax assets for charitable contribution carryforwards. COLE VISION SEGMENT Cole Vision revenues were $218.1 million in the second quarter of fiscal 2002, compared with $201.4 million in the comparable period of fiscal 2001, an increase of 8.3%. Same-store sales for the second quarter of fiscal 2002 increased 5.8% at Cole Licensed Brands and 1.5% at Pearle Vision company-owned stores, despite the difficult retail environment and a slowdown in business in July. Same-store sales reflected an increase in the average spectacle selling price and an increase in transactions at Target Optical. Same-store sales increased 41.1% at Target Optical in the second quarter. The gross margin rate decreased slightly, 0.1%, from the prior year. Operating expenses as a percent of sales were slightly lower than the prior year. Higher costs of advertising and store payroll at Cole Licensed Brands to support the increase in net revenue and the number of Target Optical locations opened in the past twelve months were offset by improvements at Cole Managed Vision and Pearle Vision. The processing cost per claim was reduced as the Company converted MetLife claims to its internal systems. At Pearle, operating expense as a percent of revenues was lower due to improvements in store payroll, as both hours worked per store week and average wage rate grew at a lower rate than sales. In addition, a demutualization insurance credit was recorded in the second quarter totaling $0.4 million at Cole Vision. The Prudential Insurance company demutualized, converting from a mutual insurance company to a publicly traded company and issued a dividend to its shareholders. Operating income at Cole Vision improved to $2.9 million in the second quarter of fiscal 2002, compared to $1.7 million in the comparable period of fiscal 2001. The cessation of goodwill and tradename amortization, which totaled $1.0 million at Cole Vision during the second quarter of fiscal 2001, was the primary reason for the improvement in operating income. THINGS REMEMBERED SEGMENT Things Remembered sales were $74.3 million in the second quarter of fiscal 2002, compared with $73.9 million in the comparable period of fiscal 2001, a 0.5% increase. Same-store sales declined 1.6% as fewer transactions offset the increase in average selling price resulting from sales of new merchandise at higher average unit prices, higher revenue from merchandise personalization, and less merchandise sold at clearance prices. Gross margin as a percent of sales increased 1.2% in the second quarter of fiscal 2002 compared to the comparable period of fiscal 2001, due primarily to an increase in the average dollar sale. At Things Remembered, operating expenses grew 6.0% on a 0.5% increase in sales. Store rent and occupancy charges increased in the second quarter due to increases in insurance, taxes and other common area charges. In addition, marketing expenses increased by $0.8 million due primarily to increased direct mail marketing efforts to increase sales in the difficult retail environment. Operating income for the second quarter of 2002 was $9.8 million compared to an operating income of $10.9 million in the comparable period of 2001. Higher store rent and occupancy charges and increases in marketing offset the sales increase. 21 FIRST SIX MONTHS FISCAL 2002 COMPARED TO FIRST SIX MONTHS FISCAL 2001 CONSOLIDATED OPERATIONS Total revenue was $577.8 million for the first six months of fiscal 2002, compared to $547.1 million for the comparable period of fiscal 2001. Total revenue increased 5.6% during this period, primarily attributable to a 3.0% increase in same-store sales, an increase in the number of Target Optical stores open, and an increase in revenues from managed vision care programs. Gross margin increased $19.2 million, or 5.2% in the first six months of fiscal year 2002 compared to the same period a year ago. The gross margin dollar increase was primarily attributable to improvements in net revenue at Cole Vision. The gross margin rate decreased to 67.7% for the first six months of fiscal 2002 from 68.0% in fiscal 2001 due to a 0.6 percentage point decrease at Cole Vision offset by a 1.2 percentage point margin improvement at Things Remembered. The gross margin rate at Cole Vision decreased at both Vision retail businesses (further discussion is included in the Cole Vision segment). The increase in gross margin rate at Things Remembered was due to increases in the average dollar sale. Operating expenses increased $20.7 million, or 5.9% for the first six months of fiscal 2002 compared to the same period in fiscal 2001. The increase in operating expenses was primarily due to costs incurred to support the increases in net revenue and the number of Target Optical stores opened in the past twelve months. For the first six months, operating expenses as a percentage of net revenue increased to 64.5% from 64.4% for the comparable period of fiscal 2001. The increase in operating expense percent was primarily a result of Things Remembered's negative same-store sales and higher occupancy and advertising expenses. The Company adopted SFAS 142 in the first quarter of fiscal 2002. SFAS 142 requires that goodwill and certain intangibles deemed to have indefinite lives no longer be amortized, but instead, will be subject to annual reviews for impairment. With the adoption of this statement, the Company ceased amortization of goodwill and tradenames as of February 3, 2002. The Company recorded a $2.5 million goodwill and tradename amortization charge for the first six months of fiscal 2001. Operating income for the first six months of fiscal 2002 was $18.2 million, compared with $17.2 million for the comparable period of fiscal 2001, a 5.8% improvement. The improvement in operating income for the first six months reflected the elimination of goodwill and tradename amortization from adopting SFAS 142 and improved operating earnings at Cole Vision. These were offset by lower operating earnings at Things Remembered. Interest and other (income) expense, net, decreased to $10.2 million for the first six months of fiscal 2002, compared to $12.7 million for the comparable period of fiscal 2001. The Company recorded a transaction gain of $2.0 million for the first six months of fiscal 2002, compared to a transaction loss of $0.7 million for the comparable period of fiscal 2001. Interest expense was also lower than the prior year, reflecting the refinancing of Cole National Group's Senior Subordinated Note. (See Note 3 of the Notes to Consolidated Financial Statements for further information regarding this transaction). These improvements were partially offset by a $0.7 million gain from the sale of a Dallas, Texas office facility in the first quarter of fiscal 2001. The lower effective tax rate in 2002 was primarily due to the elimination of goodwill amortization pursuant to the new accounting standard and a reduction in the provision for valuation allowances related to deferred tax assets for charitable contribution carryforwards. The results for the first six months of fiscal 2002 include an extraordinary loss on early extinguishment of debt of $7.2 million, net of an income tax benefit of $3.9 million. The extraordinary charge represents payment of premiums and other costs of retiring Cole National Group's 9-7/8% Senior Subordinated Notes due 2006 and the write-offs of unamortized discount and deferred financing fees. See the section below entitled "Liquidity and Capital Resources" and Note 3 of the Notes To Consolidated Financial Statements for more information regarding the early extinguishment of debt. 22 COLE VISION SEGMENT Cole Vision revenues were $451.0 million for the first nine months of fiscal 2002, compared with $420.2 million for the comparable period of fiscal 2001. Same-store sales for the first six months of fiscal 2002 increased in all retail vision brands, despite the difficult retail environment and a slowdown in business in July. Cole Licensed Brands and Pearle Vision company-owned locations increased same-store sales by 4.6% and 6.2%, respectively. Same-store sales reflected an increase in the average spectacle selling price and strong transaction increases at Target Optical. Same-stores sales increased 35.0% at Target Optical for the first six months of fiscal 2002. Same-store sales increases also reflected strong first quarter transaction increases at Pearle Vision. Gross margin percent declined 0.6% for the first six months of fiscal 2002, compared to the comparable period in fiscal 2001. The decrease in vision gross margin percent was due to more competitive pricing on contact lenses and an increase in product sold to Pearle franchisees. Sales to franchisees, which carry a lower margin rate, offer other benefits, including helping franchise comparable store sales and producing a more uniform merchandise assortment and consistent brand look across all stores. Operating expenses as a percent of sales declined at Cole Vision by 0.7% for the first six months of fiscal 2002, compared to the comparable period of fiscal 2001. The reduction in operating expense percent was due primarily to a reduction in the processing cost per claim at Cole Managed Vision and to lower operating costs at Pearle Vision, primarily due to advertising costs which were lower in the first six months of fiscal 2002 compared to the comparable period in fiscal 2001. Operating income at Cole Vision improved to $16.2 million for the first six months of fiscal 2002, compared to $13.0 million for the comparable period of fiscal 2001. Improved operating earnings at Pearle Vision resulting from higher revenues and lower advertising and nonstore expenses, the lower cost of claims processing at Cole Managed Vision and the cessation of goodwill and tradename amortization were the primary reasons for the increase. Goodwill and tradename amortization at Cole Vision totaled $2.0 million during the first six months of fiscal 2001. These improvements were offset by higher costs of payroll and advertising at Target Optical to support the increase in revenues. THINGS REMEMBERED SEGMENT Things Remembered sales were $126.8 million for the first six months of fiscal 2002, slightly lower than the comparable period of fiscal 2001. Same-store sales declined 2.2% as fewer transactions offset the increase in average selling price resulting from sales of new merchandise at higher average unit prices, higher revenue from merchandise personalization, and less merchandise sold at clearance prices. Gross margin percent increased 1.2% at Things Remembered for the first six months of fiscal 2002 compared to the comparable period of fiscal 2001. The increase in margin rate was primarily attributable to a change in sales mix to higher end product. At Things Remembered, operating expenses grew 4.6% on a slight decline in sales. Store rent and occupancy charges increased for the first six months due to increases in insurance, taxes and other common area charges. In addition, marketing expenses increased by $0.9 million due primarily to increased direct mail marketing efforts to increase sales in a difficult retail environment. Operating income decreased to $8.0 million for the first six months of fiscal 2002, compared to $9.7 million in the comparable period of fiscal 2001. Costs of rent, occupancy and advertising increased despite a slight decrease in sales, resulting in the lower operating income. RECONCILIATION OF SAME-STORE GROWTH Same-store sales growth is a non-GAAP financial measure, which includes deferred warranty sales on a cash basis and does not reflect provisions for returns and remakes and certain other items. The Company's current systems do not gather data on these items on an individual store basis. Adjustments to the cash basis sales information accumulated at the store level are made for these items on an aggregate basis. As a retailer, the Company believes that a measure of same-store performance is important for understanding its operations. 23 The Company calculates same-store sales for stores opened for at least twelve months. A reconciliation of same-store sales to revenue reported on a GAAP basis follows:
2002 ------------------------------------ Thirteen Twenty-Six Week Period Week Period -------------- -------------- (In thousands) Current year same-store sales $ 249,172 $ 498,966 Prior year same-store sales 244,136 484,477 Percent Change 2.1% 3.0% Current year same-store sales 249,172 498,966 Adjustment for: Sales at new and closed stores 8,365 16,928 Extended warranties (9) (2,150) Order vs. customer receipt 2,605 (362) Returns, remakes and refunds 862 (305) Other (48) (9) -------------- -------------- Store sales 260,947 513,068 Nonstore revenues 38,453 79,693 Intercompany eliminations (7,010) (14,930) -------------- -------------- GAAP Basis Net Revenue $ 292,390 $ 577,831 ============== ==============
LIQUIDITY AND CAPITAL RESOURCES Cole National Corporation's primary source of liquidity is funds provided from operations of its operating subsidiaries. In addition, its wholly owned subsidiary, Cole National Group, Inc., and its operating subsidiaries have a working capital line of credit. As of August 3, 2002, the total commitment was $75.0 million and availability under the credit facility totaled $60.3 million after reduction for commitments under outstanding letters of credit. There were no working capital borrowings outstanding at any time during the first six months of fiscal 2002 or fiscal 2001. The credit facility, which is guaranteed by Cole National Corporation and Cole National Group, requires Cole National Group and its principal operating subsidiaries to comply with various operating covenants that restrict corporate activities, including covenants restricting the ability of the subsidiaries to incur additional indebtedness, pay dividends, prepay subordinated indebtedness, dispose of certain investments or make acquisitions. The credit facility also requires Cole National Group to comply with certain financial covenants, including covenants regarding minimum interest coverage and maximum leverage. On May 22, 2002, the Company issued $150.0 million of 8-7/8% Senior Subordinated Notes due 2012. The notes are unsecured and mature on May 15, 2012. Net proceeds from the notes offering, together with cash on hand, were used to retire $150.0 million of 9-7/8% Senior Subordinated Notes due 2006 and pay premium and other costs associated with retiring those notes. An extraordinary loss on early extinguishment of debt of $7.2 million, net of an income tax benefit of $3.9 million, representing the payment of premiums and other costs of retiring the notes and write-offs of unamortized discount and deferred financing fees, was recorded in the second quarter of fiscal 2002. The indentures pursuant to which the 8-5/8% notes and the 8-7/8% notes were issued contain certain optional and mandatory redemption features and other financial covenants, including restrictions on the ability of Cole National Group to incur additional indebtedness, pay dividends or make other restricted payments to Cole National Corporation. 24 The indentures permit dividend payments to Cole National Corporation for certain tax obligations and for administrative expenses not to exceed 0.25% of net sales. See Note 3 of the Notes to Consolidated Financial Statements. The Company may from time to time purchase its outstanding notes in the open market or refinance them depending on capital market conditions. No significant principal payment obligations are due under the Company's outstanding indebtedness until April 2004, when a $5.0 million principal payment is due under a 5.0% promissory note and until 2007, when the $125.0 million Senior Subordinated debt is due. The ability of Cole National Corporation and its subsidiaries to satisfy their obligations will be primarily dependent upon the future financial and operating performance of the subsidiaries and upon the Company's ability to renew or refinance borrowings or raise additional capital through equity financing or sales of assets. Operations for the first six months provided $21.1 million of cash in fiscal 2002 compared with $27.0 million in fiscal 2001. The primary reason for the $5.9 million decrease in cash provided by operations was a change in working capital. Changes in working capital resulted in a source of funds of $2.1 million in fiscal 2002, compared to a source of funds of $10.0 million in fiscal 2001. Changes in accounts payable and other liabilities resulted in a source of cash of $7.7 million in fiscal 2002 compared to a source of cash of $3.7 million in fiscal 2001. The increase in payables and other liabilities was due to timing of purchases and payments. Changes in receivables and other assets resulted in a use of funds of $2.2 million compared to a source of funds of $6.0 million in fiscal 2001. The increase in receivables was primarily due to increases in sales and corresponding receivables at Cole Vision. Changes in accrued and deferred taxes resulted in a source of cash of $2.4 million in fiscal 2002, compared to a source of cash totaling $8.4 million in fiscal 2001. The change was due to a lower effective tax rate in fiscal 2002 compared to fiscal 2001. In addition, the Company made a cash payment for income taxes of $3.1 million in fiscal 2002 compared with a payment of $0.1 million in fiscal 2001. Net cash from investing activities resulted in a use of funds of $16.7 million for the first six months of fiscal 2002 compared to a use of funds totaling $26.1 million in the comparable period of fiscal 2001. Capital expenditures, which accounted for most of the cash used for investing, were $13.9 million and $19.2 million in fiscal 2002 and fiscal 2001, respectively. The majority of capital expenditures were for store fixtures, equipment and leasehold improvements for new stores and remodeling of existing stores. Expenditures for systems development costs totaled $2.3 million and $4.6 million for the first six months of fiscal 2002 and fiscal 2001, respectively. In fiscal 2001, net proceeds of $4.7 million were received from the sale of a Dallas office facility. In fiscal 2001, the Company made a net investment in Pearle Europe of $6.4 million in connection with Pearle Europe's acquisition of a leading optical retail chain in Portugal. Of this amount, $4.7 million is accounted for as notes receivable and $1.7 million as equity investment. Net cash used for financing activities totaled $19.0 million for the first six months of fiscal 2002, compared to $3.1 million for the comparable period of fiscal 2001. In May 2002, Cole National Group, Inc., issued $150.0 million of 8-7/8% Senior Subordinated Notes due May 2012. The net proceeds of this issuance and cash on hand were used to retire all of Cole National Group's $150.0 million 9-7/8% Senior Subordinated Notes due 2006. Finance fees and early repayment premium of the 9-7/8% notes resulted in a net cash usage of $14.2 million. See Note 3 for further information regarding this transaction. Changes in overdraft balances resulted in a use of cash of $5.9 million in fiscal 2002 compared to $3.4 million in fiscal 2001. The change was due to the timing of payments. The Company believes that funds provided from operations, including cash on hand, along with funds available under the credit facility will provide adequate sources of liquidity to allow its operating subsidiaries to continue to expand the number of stores and to fund capital expenditures and system development costs. OFF BALANCE SHEET ARRANGEMENTS AND CONTRACTUAL COMMITMENTS The Company leases a substantial portion of its equipment and facilities including laboratories, office and warehouse space, and retail locations. In addition, Cole Vision operates departments in various host stores and pays occupancy costs solely as a percentage of sales. A more complete discussion of the Company's lease and license commitments is included in Note 6 of the Notes to Consolidated Financial Statements. The Company guarantees future minimum lease payments for certain store locations leased directly by Pearle franchisees. The term of these guarantees range from one to ten years of which many are limited to periods that are less than the full term of the leases involved. A more complete discussion of the Company's guarantees is included in Note 6 of the Notes to Consolidated Financial Statements. 25 In the second quarter, Cole National Group issued $150.0 million of Senior Subordinated Notes due 2012 and retired all of its $150.0 million Senior Subordinated Notes due 2006 as discussed above and in Note 3 of the Notes to Consolidated Financial Statements. As a result, $150.0 million of the Company's scheduled payments for contractual obligations as reported in its latest annual report on Form 10-K have been shifted from due in the period "4-5 years" to due in the period "after 5 years". The Company's primary source of liquidity, other than cash on hand, is the working capital line of credit discussed above and in Note 4 of the Notes to Consolidated Financial Statements. This facility has been extended until May 31, 2006 and supports $14.7 million of standby letters of credit that are renewable annually. RECENTLY ISSUED ACCOUNTING STANDARDS The Company adopted SFAS 142, "Goodwill and Other Intangible Assets" (SFAS 142) in the first quarter of fiscal 2002. This statement requires that goodwill and certain intangible assets deemed to have indefinite useful lives no longer be amortized, but instead be subject to at least an annual review for impairment. With the adoption of this statement, the Company ceased amortization of goodwill and tradenames as of February 3, 2002. Amortization of goodwill and tradenames totaled $5.0 million in fiscal 2001. During the second quarter of fiscal 2002, the Company completed the transitional impairment testing of goodwill as required by SFAS 142. Based on the findings of its outside valuation advisor, the Company has concluded that there was no impairment of its goodwill or tradenames at the adoption date of the new accounting standard, effective February 3, 2002. The Company has elected to perform its annual tests for potential impairment as of the first day of the Company's fourth quarter. The Financial Accounting Standards Board (FASB) has issued SFAS No. 145, "Rescission of FASB Statements No. 4, 44, and 64, Amendment of SFAS Statement No. 13, and Technical Corrections" (SFAS 145). SFAS 145 states that the rescission of SFAS No. 4 shall be applied in fiscal years beginning after May 15, 2002. Any gain or loss on extinguishment of debt that was classified as an extraordinary item in prior periods presented that does not meet the criteria in APB Opinion 30, "Reporting the Results of Operations - Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions", for classification as an extraordinary item shall be reclassified as an operating expense. The Company will adopt SFAS 145 as of the beginning of fiscal 2003. As a result, the loss on early extinguishment of debt reported as an extraordinary item for the year ended February 1, 2003 will be reclassified at that time. The pretax loss from the early extinguishment of debt will be presented as a separate line within interest and other (income) expenses and the related income tax benefit will reduce the reported income tax provision. In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal Activities" (SFAS 146). This statement requires that a liability for a cost associated with an exit or disposal activity be recognized when the liability is incurred. The provisions of this statement were effective for exit or disposal activities initiated after December 31, 2002. The Company will adopt SFAS 146 on January 1, 2003. The adoption will have no effect on the Company's financial position or operations. The FASB has also issued SFAS No. 143, "Accounting for Asset Retirement Obligations" (SFAS 143), and SFAS No. 144, "Accounting for Impairment or Disposal of Long-Lived Assets" (SFAS 144). SFAS 143 provides guidance for legal obligations arising from the retirement of long-lived assets. SFAS 144 addresses financial accounting and reporting for the impairment or disposal of long-lived assets. SFAS 144 was adopted during fiscal 2002 and had no effect on the Company's financial position or operations. SFAS 143 will be adopted during fiscal 2003 and is not expected to have a material effect on the Company's financial position or operations. CONTINGENCIES A complaint was filed in the Superior Court of California, county of San Diego against Cole National Corporation, its affiliates and certain of its officers by the Attorney General of the State of California on February 14, 2002 and amended on February 22, 2002. The case, State of California v. Cole National Corporation, et. al., alleges claims for various statutory violations related to the operation of 24 Pearle Vision Centers in California. The claims include untrue or misleading advertising, illegal dilation fees, unlawful advertising of eye exams, maintaining an optometrist on or near the premises of a registered dispensing optician, unlawful advertising of an optometrist, unlicensed practice of optometry, and illegal relationships between dispensing opticians, optical retailers and optometrists. The action seeks unspecified damages, restitution and injunctive relief. Although the State of California obtained a preliminary injunction to enjoin certain advertising practices and the charging of dilation fees in July 2002, the terms of the injunction have not had and are not expected to have a material effect on the Company operations. In addition, both the State and the Company have appealed the preliminary injunction. Although we believe we are in compliance with California law and intend to continue to defend the issues raised in the case vigorously, the case is in its early stages and we cannot predict with certainty its outcome or costs. 26 FORWARD LOOKING STATEMENTS The Company's expectations and beliefs concerning the future contained in this document are forward looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Actual results may differ materially from those forecasted due to a variety of factors that can adversely affect the Company's operating results, liquidity and financial condition such as risks associated with potential adverse consequences of the restatement of the Company's financial statements, including those resulting from litigation or government investigations, restrictions or curtailment of the Company's credit facility and other credit situations, costs and other effects associated with the California litigation, the timing and achievement of improvements in the operations of the optical business, the results of Things Remembered, which is highly dependent on the fourth quarter holiday season, the nature and extent of disruptions of the economy from terrorist activities or major health concerns, and from governmental and consumer responses to such situations, the actual utilization of Cole Managed Vision funded eyewear programs, the success of new store openings and the rate at which new stores achieve profitability, the Company's ability to select, stock and price merchandise attractive to customers, success of systems development and integration, competition in the optical industry, integration of acquired businesses, economic and weather factors affecting consumer spending, operating factors affecting customer satisfaction, including manufacturing quality of optical and engraved goods, the Company's relationships with host stores and franchisees, the mix of goods sold, pricing and other competitive factors, and the seasonality of the Company's business. 27 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The Company's major market risk exposure is to changes in foreign currency exchange rates in Canada and in Euros, which could impact its results of operations and financial condition. Foreign exchange risk arises from the Company's exposure to fluctuations in foreign currency exchange rates because the Company's reporting currency is the United States dollar. Management seeks to minimize the exposure to foreign currency fluctuations through natural internal offsets to the fullest extent possible. ITEM 4. CONTROLS AND PROCEDURES (a) Immediately following the Signature section of this Quarterly Report are certifications of the Company's Chief Executive Officer and Chief Financial Officer required in accordance with Section 302 of the Sarbanes-Oxley Act of 2002 (the "Section 302 Certification"). This portion of our Quarterly Report on Form 10-Q is our disclosure of the results of our control evaluation referred to in paragraphs (4), (5) and (6) of the Section 302 Certification and should be read in conjunction with the Section 302 Certification for a more complete understanding of the topics presented. In November 2002, the Company determined it needed to restate its previously issued financial statements for the timing of the recognition of revenues earned on the sale of extended warranty contracts. The Company issued a press release on November 26, 2002 announcing the restatement of its historical consolidated financial statements beginning with its 1998 fiscal year. The Company subsequently determined that it needed to make other changes to previously issued financial statements in addition to the timing of the recognition of warranty revenues. The adjustments have a significant negative impact on the Company's previously reported revenue, net income, and earnings per share. See Note 8 to the Notes to Consolidated Financial Statements for further discussion of the restatement. In March 2003, the Audit Committee engaged outside counsel to conduct an inquiry into the issues surrounding the restatement. The results and conclusions of that inquiry have been considered in the preparation of the accompanying financial statements. Within 90 days prior to the filing date of this Form 10-Q, the Company carried out an evaluation, under the supervision and with the participation of its Chief Executive Officer and Chief Financial Officer, pursuant to Rule 13a-15 promulgated under the Securities Exchange Act of 1934 (the "Exchange Act"), as amended, of the effectiveness of the design and operation of its disclosure controls and procedures. In making this evaluation, the Company has considered matters relating to its restatement of previously issued financial statements, including the substantial process that was undertaken to ensure that all material adjustments necessary to restate the previously issued financial statements were recorded. The Company believes that certain of the restatement adjustments occurred because certain of the Company's control processes and procedures related to the matters underlying such adjustments were not effective. In connection with the audit of the Company's financial statements for the 2002 fiscal year and the restated financial statements for the 2001 and 2000 fiscal years, Deloitte & Touche reported to management and the Board of Directors on April 30, 2003 that certain deficiencies existed during the audit period in the design or operation of the Company's internal accounting controls which, constituted material weaknesses pursuant to standards established by the American Institute of Certified Public Accountants. Such deficiencies related to the application or selection of accounting principles, the use of management judgment and estimates, and the adequacy of account details and reconciliations. In order to improve the effectiveness of its control processes and procedures, the Company has taken a number of actions within the past year. The Company searched for and hired a new Chief Financial Officer from outside the Company, and filled the position of Corporate Controller. The Audit Committee approved a charter for the Internal Audit function; the Internal Audit staff was strengthened and its role was expanded. The Company established an internal representation requirement, whereby the operating executive and financial officer of each business unit and major staff area are required to certify on a quarterly basis the accuracy of the financial statements and the adequacy of the control processes and procedures within that business unit or staff area. With the approval of the Board of Directors, the Company amended its Business Code of Conduct, and required that all management employees certify in 28 writing that they will comply with it. The Business Code of Conduct includes procedures for the receipt, retention and treatment of complaints received from employees regarding among, other things, accounting and internal accounting control matters. The Company is currently revising its Finance and Accounting Policies and Procedures Manual. Based in part upon these changes, the Company's Chief Executive Officer and Chief Financial Officer concluded that as of the evaluation date, the Company's disclosure controls and procedures were reasonably designed to ensure that information required to be disclosed by the Company in the reports it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission. (b) Other than as described above, since the evaluation date by the Company's management of its internal controls, there have not been any significant changes in the internal controls or in other factors that could significantly affect the internal controls. 29 PART II - OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS From time to time during the ordinary course of business, the Company is threatened with, or may become a party to a variety of legal actions and other proceedings incidental to its business. A complaint was filed in the Superior Court of California, County of San Diego against Cole National Corporation, its affiliates and certain of its officers by the Attorney General of the State of California on February 14, 2002 and amended on February 22, 2002. The case, State of California v. Cole National Corporation, et al., Case No. G1C783135, alleges claims for various statutory violations related to the operation of 24 Pearle Vision Centers in California. The claims include alleged untrue or misleading advertising, illegal dilation fees, unlawful advertising of eye exams, maintaining an optometrist on or near the premises by a registered dispensing optician, unlawful advertising of an optometrist, unlicensed practice of optometry, and illegal relationships among dispensing opticians, optical retailers and optometrists. The action seeks unspecified damages, restitution and injunctive relief. The case is in its early stages and we cannot predict with certainty its outcome or costs. In May 2002, all of the individual officer defendants were dismissed and their dismissal has been appealed by the State. The State of California moved for a preliminary injunction to enjoin certain advertising practices and from charging dilation fees. Though the State obtained a preliminary injunction in July 2002, the terms of the injunction are not expected to have any material effect on the Company's operations. In addition, both the State and the Company have appealed the preliminary injunction. We believe we are in compliance with California law and intend to continue to defend the issues raised in the case vigorously. On August 14, 2002, two former store managers employed in the San Francisco area by our subsidiary, Things Remembered, Inc., filed a class action complaint in San Francisco Superior Court. The complaint alleges that the plaintiffs and the other members of the putative class (alleged to include 250 members) were improperly denied overtime compensation for more than eight hours of work per day and/or more than 40 hours of work per week in violation of California law. The action seeks unspecified damages, interest, restitution, as well as, declaratory and injunctive relief and attorneys' fees. 30 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS On June 13, 2002 the Company held its annual meeting of stockholders. At that meeting, the stockholders elected eight directors to serve until the next annual meeting of stockholders. Of the total eligible votes 16,009,403, stockholders cast votes of 13,983,576 or 87.3% of the total eligible votes. The votes cast for the election of directors were as follows: For Withheld Non-votes -------------- ---------- ----------- Jeffrey A. Cole 13,792,217 191,359 0 Larry Pollock 13,792,945 190,631 0 Timothy F. Finley 13,799,333 184,243 0 Irwin N. Gold 13,801,455 182,121 0 Melchert F. Groot 13,801,380 182,196 0 Peter V. Handal 13,799,380 184,196 0 Charles A. Ratner 13,792,680 190,896 0 Walter J. Salmon 13,794,408 189,168 0 ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits. The following Exhibits are filed herewith and made a part hereof: 10.1* Letter dated April 14, 2002 from Cole National Corporation to Lawrence Hyatt. 10.2* Letter Agreement dated April 19, 2002 between Cole National Corporation and Lawrence Hyatt regarding termination of employment. 10.3* Restricted Stock Agreement between Cole National Corporation and Lawrence Hyatt dated as of July 15, 2002. 10.4* Nonqualified Stock Option Agreement between Cole National Corporation and Lawrence Hyatt dated as of July 15, 2002. 10.5* First Amendment to Credit Agreement, dated as of August 23, 2002, among Cole Vision Corporation, Things Remembered, Inc., and Pearle, Inc. and Canadian Imperial Bank of Commerce. 10.6* Second Amendment to Credit Agreement, dated as of September 13, 2002, among Cole Vision Corporation, Things Remembered, Inc., and Pearle, Inc. and Canadian Imperial Bank of Commerce. 10.7* Amendment No. 1 to the Cole National Group, Inc. Retirement Plan (Amended and Restated as of January 1, 2001), effective March 31, 2002. 10.8* Nonqualified Stock Option Agreement (1998 Plan/Time Vesting/Senior Executive) between Cole National Corporation and Jeffrey A. Cole dated as of January 25, 2002. 99.1+ Certification of Chief Executive Officer and Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 31 (b) Reports on Form 8-K The Company filed a report on Form 8-K (Items 4 and 7) on June 18, 2002 disclosing the Company was replacing Arthur Andersen LLP as its independent public accountants and appointing Deloitte & Touche LLP to serve as its independent public accountants for the fiscal year 2002. The Company filed a report on Form 8-K (Items 4 and 7) on June 19, 2002 disclosing the Company was replacing Arthur Andersen LLP for the Cole National Corporation 401(K) Savings Plan for Employees at Pearle Vision Centers and appointing Grant Thornton LLP to serve as its independent public accountants for the Plan for the year ending December 31, 2001. The Company filed a report on Form 8-K (Items 4 and 7) on June 19, 2002 disclosing the Company was replacing Arthur Andersen LLP for the Cole National Corporation 401(K) Savings Plan and appointing Grant Thornton LLP to serve as its independent public accountants for the Plan for the year ending December 31, 2001. The Company filed a report on Form 8-K (Items 4 and 7) on June 19, 2002 disclosing the Company was replacing Arthur Andersen LLP for the Cole National Corporation 401(K) Savings Plan for Employees at Former NuVision Locations and appointing Grant Thornton LLP to serve as its independent public accountants for the Plan for the year ending December 31, 2001. The Company filed a report on Form 8-K (Item 5) on August 27, 2002, which attached a press release dated August 27, 2002. * Filed with the original Form 10-Q filed September 17, 2002. + Filed herewith. 32 SIGNATURES Pursuant to the requirements 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 By: /s/ Lawrence E. Hyatt ------------------------------------------------ Lawrence E. Hyatt Executive Vice President and Chief Financial Officer (Duly Authorized Officer) By: /s/ Ann M. Holt ------------------------------------------------ Ann M. Holt Senior Vice President and Corporate Controller (Principal Accounting Officer) Date: May 16, 2003 33 CERTIFICATION I, Jeffrey A. Cole, certify that: 1. I have reviewed this quarterly report on Form 10-Q/A of Cole National Corporation; 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report. 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act rules 13a-14 and 15d-14) for the registrant and we have: a) Designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; b) Evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and c) Presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function): a) All significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officer and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: May 16, 2003 /s/ Jeffrey A. Cole ----------------------------------- Jeffrey A. Cole Chairman and CEO 34 CERTIFICATION I, Lawrence E. Hyatt, certify that: 1. I have reviewed this quarterly report on Form 10-Q/A of Cole National Corporation; 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act rules 13a-14 and 15d-14) for the registrant and we have: a) Designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; b) Evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and c) Presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function): a) All significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officer and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: May 16, 2003 /s/ Lawrence E. Hyatt ----------------------------------------------------- Lawrence E. Hyatt Executive Vice President and Chief Financial Officer 35 COLE NATIONAL CORPORATION FORM 10-Q/A QUARTER ENDED AUGUST 3, 2002 EXHIBIT INDEX Exhibit Number Description ------ ----------- 10.1* Letter dated April 14, 2002 from Cole National Corporation to Lawrence Hyatt. 10.2* Letter Agreement dated April 19, 2002 between Cole National Corporation and Lawrence Hyatt regarding termination of employment. 10.3* Restricted Stock Agreement between Cole National Corporation and Lawrence Hyatt dated as of July 15, 2002. 10.4* Nonqualified Stock Option Agreement between Cole National Corporation and Lawrence Hyatt dated as of July 15, 2002. 10.5* First Amendment to Credit Agreement, dated as of August 23, 2002, among Cole Vision Corporation, Things Remembered, Inc., and Pearle, Inc. and Canadian Imperial Bank of Commerce. 10.6* Second Amendment to Credit Agreement, dated as of September 13, 2002, among Cole Vision Corporation, Things Remembered, Inc., and Pearle, Inc. and Canadian Imperial Bank of Commerce. 10.7* Amendment No. 1 to the Cole National Group, Inc. Retirement Plan (Amended and Restated as of January 1, 2001), effective March 31, 2002. 10.8* Nonqualified Stock Option Agreement (1998 Plan/Time Vesting/Senior Executive) between Cole National Corporation and Jeffrey A. Cole dated as of January 25, 2002. 99.1+ Certification of Chief Executive Officer and Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. * Filed with the original Form 10-Q filed September 17, 2002. + Filed herewith. 36