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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549
 FORM 10-K/A (Amendment No. 1)
 (Mark One) þ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934
 For the fiscal year ended January 31, 2004,
 OR o 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 33-66342 COLE NATIONAL GROUP, INC.  Delaware
(State or other jurisdiction
of incorporation or organization)
    
    34-1744334
(I.R.S. Employer
Identification No.)1925 Enterprise Parkway, Twinsburg, Ohio
(Address of principal executive offices)
    
    44087
(Zip Code)
 Registrants telephone number, including area code: (330) 486-3100 Securities registered pursuant to section 12(b) of the act: None Securities registered pursuant to section 12(g) of the act: None The registrant meets the conditions set forth in general instruction
I(1)(a) and (b) of Form 10-K and is therefore filing this form in the reduced
disclosure format. Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days YES x NO o. Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K (§ 229.405 of this chapter) is not contained
herein, and will not be contained, to the best of registrants knowledge, in
definitive proxy or information statements incorporated by reference to in
Part III of this Form 10-K/A OR any amendment to this Form 10-K/A. x Indicate by check mark whether the registrant is an accelerated filer
(as defined in Rule 12b-2 of the Act). YES x NO o. All of the outstanding capital stock of the registrant is held by Cole
National Corporation. As of March 31, 2004, 1,100 shares of the registrants common stock,
$.01 par value, were outstanding. DOCUMENTS INCORPORATED BY REFERENCE: NONE




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EXPLANATORY NOTE This
amendment No. 1 on Form 10-K/A amends and restates Items 7
and 8 of Part II contained in the Companys report on
Form 10-K for the fiscal year ended January 31, 2004 to
give effect to the restatement of the Companys consolidated
statements of cash flows for the fiscal years 2003, 2002 and 2001, as
discussed in Note 11 of the Notes to Consolidated Financial
Statements. Except as set forth in Items 7 and 8 of Part II
below, the Company has not made any changes to, nor updated any
disclosures contained in its Form 10-K filed April 12, 2004.  
 TABLE OF CONTENTS PagePart IItem
    
    1.
    
    Business
    
    
    12.
    
    Properties
    
    
    43.
    
    Legal Proceedings
    
    
    54.
    
    Submission of Matters to a Vote of Security Holders
    
    
    6Part IIItem
    
    5.
    
    Market for
Registrants Common Equity and Related Stockholder Matters
    
    
    66.
    
    Selected Financial Data
    
    
    67.
    
    Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    77A.
    
    Quantitative and Qualitative Disclosures About Market Risk
    
    
    248.
    
    Financial Statements and Supplementary Data
    
    
    259.
    
    Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
    
    
    259A.
    
    Controls and Procedures
    
    
    25Part IIIItem
    
    10.
    
    Directors and Executive Officers of the Registrant
    
    
    2511.
    
    Executive Compensation
    
    
    2512.
    
    Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
    
    
    2613.
    
    Certain Relationships and Related Transactions
    
    
    2614.
    
    Principal Accounting Fees and Services
    
    
    26Part IVItem
    
    15.
    
    Exhibits, Financial Statement Schedules, and Reports on Form 8-K
    
    
    26Signatures
    
    
    27Exhibit Index
    
    
    X-1CERTIFICATION OF CEOCERTIFICATION OF CFO906 CERTIFICATIONS




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Forward Looking Statements Cole National Group Inc.s (including its direct and indirect subsidiaries
and predecessor companies, the Company) 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, risks that the contemplated
merger between Cole National Corporation and Luxottica Group S.p.A. will not be
completed, uncertainty as to the timing of obtaining regulatory approvals and
clearance for the Merger, 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, costs and other
effects associated with litigation, 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, franchisees and managed care clients, the mix
of goods sold, pricing and other competitive factors, and the seasonality of
the Companys business. 
 PART I 
 Item 1. Business General On January 26, 2004, Cole National Corporation (the Parent) announced
that it entered into a definitive merger agreement with the Luxottica Group
S.p.A (the Merger). Under the agreement, Luxottica Group will acquire all of
the outstanding shares of the Parent for a cash purchase price of $22.50 per
share, together with the purchase of all outstanding options and similar equity
rights at the same price per share, less their respective exercise prices, for
a total price of approximately $400 million. The Merger is subject to the
approval of the Parents stockholders and the satisfaction of other customary
conditions, including compliance with applicable antitrust clearance
requirements. On February 27, 2004 the Parent and Luxottica Group filed
pre-merger notifications with the U.S. antitrust authorities pursuant to the
Hart-Scott-Rodino Antitrust Improvements Act of 1976 (the HSR Act). On March
30, 2004 the Parent and Luxottica Group jointly announced that they had
received a request from the Federal Trade Commission (FTC) for additional
information and documentary material with respect to the Merger. Accordingly,
the waiting period under the HSR Act has been extended until the 30th day after
the date of substantial compliance with the request by both parties, unless
earlier terminated by the FTC. A special meeting of the Parents stockholders
to consider and vote upon the Merger is scheduled for April 20, 2004. The
transaction is currently expected to close in the second half of 2004. Cole National Group, Inc., a wholly owned subsidiary of Cole National
Corporation, was incorporated as a Delaware corporation in 1984 as a successor
to companies that began operations approximately 60 years ago. Cole National
Group, Inc., is a leading provider of vision care products and services,
including managed vision care programs, and personalized gifts with 2,925
retail locations in 50 states, Canada and the Caribbean. Unless the context
otherwise requires, references herein to the Company include Cole National
Group, its direct and indirect subsidiaries, and its predecessor companies. The
Companys retail vision locations do business primarily under the names Pearle
Vision, Sears Optical, Target Optical and BJs Optical and its managed
vision care programs are offered primarily through Cole Managed Vision.
Collectively these businesses are referred to herein as Cole Vision.
Personalized gifts are offered through retail locations, e-commerce and
catalogs by Things Remembered. The Company believes that, based on industry
data, it is the third largest retail optical company in the United States and
operates the only nationwide chain of personalized gift stores. The Company
differentiates itself from other specialty retailers by providing value-added
services at the point of sale at all of its retail locations. The Company electronically files 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 with the Securities and Exchange Commission. 1




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Cole Vision The Companys Cole Vision segment contributed 77% of the Companys net
revenue in fiscal 2003 through the operations of 2,197 Company-owned and
franchised retail locations throughout the United States, Canada, and the
Caribbean as of January 31, 2004 and through Cole Managed Vision programs that
provide vision care benefits to participants through access to networks of
Company-owned, franchised and third-party optical locations. Cole Licensed Brands Cole Licensed Brands operates principally under the Sears Optical,
Target Optical and BJs Optical names. As of January 31, 2004, Cole
Licensed Brands operated 1,337 retail locations in 47 states and Canada,
including 831 departments on the premises of Sears department stores, 108
freestanding Sears Optical stores, 265 departments in Target stores and 133
departments in BJs Wholesale Club stores. Retail locations are generally
operated under a lease or license arrangement through which the host store
collects the sales receipts, retains an agreed upon percentage of sales and
remits the remainder on a weekly or monthly basis. Locations are, in most cases, retail eyecare stores offering brand name
and private label prescription eyeglasses, contact lenses and accessories,
which make available services of a doctor of optometry who performs complete
eye examinations and prescribes eyeglasses and contact lenses. Most optical
departments, which are typically 1,000 square feet in size, operate with a
department manager and support staff of one to seven associates depending on
store sales volume. In a majority of the stores, eye examination services are
available from independent doctors of optometry, as is often required by state
law, and from doctors of optometry employed by Cole Licensed Brands. Each of the United States and Canadian retail locations is computer-linked
to six centralized laboratory facilities, which grind, cut and fit lenses to
order and ship them to the stores. Next-day delivery can be provided on most
eyewear when requested by customers. All of the frames and most lenses used in
eyeglasses are purchased from outside suppliers, both in the United States and
several foreign countries. A variety of marketing and promotional efforts, primarily television,
newspaper, host advertising, direct mail, and yellow pages are used to build
and maintain the customer base for each of the Cole Licensed Brands stores.
Host advertising includes the placement of promotional material within sales
circulars or credit card billings sent out by the host store to its customers. The Company believes it has developed excellent relationships with the
host stores in which Cole Licensed Brands operates. The Company has maintained
its relationships in the optical business with Sears for over 40 years.
Although leases and licenses with Sears are terminable upon relatively short
notice, Cole Licensed Brands has never had a lease terminated other than in
connection with a store closing, relocation or major remodeling. Pearle Pearle Vision (Pearle) operates 379 Company-owned and 481 franchised
stores located in 45 states, Canada, and the Caribbean. Most Pearle stores
operate in either an Express or Mainline store format. Express stores
contain a full surfacing lab that can produce most glasses in approximately one
hour. Mainline stores can produce over 40% of prescriptions on-site in
approximately one hour. At January 31, 2004, 235 of the Company-owned stores
and 154 of the franchised stores were Express, with most of the balance being
Mainline. Although the Express and Mainline stores are capable of producing glasses
in approximately one hour, the Company does not believe that this capability is
important to most Pearle customers. During 2003, approximately 18% of the
prescription eyeglasses sold by Company-owned Pearle stores were produced in
the stores and available the same day as ordered, of which less than half were
available within one hour. The remaining 82% of prescriptions were not
available for the customer the same day as ordered, and were either produced in
the store, or at Pearles central laboratory in Dallas, Texas. The Express stores typically are located in high-traffic freestanding
strip centers or mall locations with most stores averaging 3,500 square feet.
The Express stores are usually staffed with a manager and a support staff of
four to eight associates. Mainline stores have an average size of 2,400 square
feet and are also located in freestanding buildings, or in smaller strip or
regional centers. Mainline stores are usually staffed with a manager and two or
three associates. Exams are available in or next to most Pearle stores by
on-site doctors of optometry with approximately 70% of doctors in Company-owned
stores leasing space from Pearle on an independent 2




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basis. Most of the remaining doctors are direct employees of Pearle. In
California, eye exams are provided by doctors of optometry employed by Pearle
Vision Care, Inc., a licensed health care service plan. Pearles marketing strategy employs a wide range of media at both the
national and local levels. The franchised and Company-owned stores each
contribute a percentage of revenues to Pearles marketing budget with a
significant amount of Pearles marketing expenditures devoted to print,
television and direct mail. Pearles brand positioning of high quality eyecare
products and services has been reinforced by an advertising and promotions
program, which includes Pearles long-standing advertising slogan: Nobody
Cares for Eyes More Than Pearle. Pearle operates a central lab and distribution center in Dallas, Texas
that inventories and distributes a comprehensive product line, including
frames, eyeglass lenses, contact lenses, optical supplies and eyewear
accessories, to Company-owned and franchised locations. Pearle has maintained a franchise program since 1980. Most of the
franchised stores are single store franchise operations, with no franchisee
operating more than ten stores. Each franchisee must enter into a franchise
agreement requiring payment of an initial franchise fee. The term of the
typical franchise agreement is equal to the lesser of ten years or the term of
the underlying base lease. Royalty and advertising contributions typically have
been based on a percentage of the franchisees gross revenues from the retail
operation, excluding nonsurgical professional fees. The total monthly
advertising contribution is distributed to Pearles system-wide advertising
fund and the local co-op market advertising fund. Franchisees are generally
eligible to participate in Cole Visions managed vision care programs. In
fiscal 2003, 14 new franchise locations were opened, 11 Company-operated
locations were sold to franchisees, one franchise location was converted to a
Company-operated location and seven franchise locations closed. Cole Managed Vision Recognizing the role that managed health care would play in the coming
years, in 1988 Cole Vision Corporation created Cole Managed Vision (CMV) to
bring its own unique capabilities to the vision benefit marketplace, and to
provide an additional source of customers for the Companys owned and
franchised retail locations. Since then, CMV has been developing, marketing,
and administering group vision benefit programs for employers, health plans and
associations nationwide. Today, CMV manages funded benefits for approximately
13 million participants, and discount benefits for more than 80 million
participants. Managed vision care participants comprise over a third of Cole
Visions retail customers. Things Remembered Things Remembered contributed 23% of the Companys net revenue in fiscal
2003. As of January 31, 2004, Things Remembered operated 728 inline stores and
kiosks located in large, enclosed shopping malls located in 47 states. Each
location carries a wide assortment of engraveable items and provides while you
shop personalization services for any occasion including holiday, wedding,
business recognition and other special occasion gift events. Engraving is
offered for items purchased at the store as well as for items purchased
elsewhere. Customers can also purchase Things Remembereds broad gift
assortment through its catalogs (1-800-274-7367) and its e-commerce site,
http://www.thingsremembered.com. Merchandise sold at Things Remembered stores and through the catalog and
internet consists of a broad selection of moderately priced gift categories and
items at prices generally ranging from $15 to $150. The gift offerings include
writing instruments, desk accessories such as desk sets, recognition plaques
and awards; womens gifts which include sterling jewelry, jewelry boxes, and
keepsake boxes; mens gifts which include barware, valet boxes, and leather
goods; gifts for newborns and children including baby cups, rattles and jewelry
as well as apparel and quilts. Gifts for the home include glassware, clocks,
frames, albums and a special assortment of holiday gifts such as ornaments and
other collectible items. Gifts for pets include food bowls, treat jars and pet
throws. Things Remembered features brand name merchandise as well as higher
margin private label merchandise. Engraving for all hardline merchandise is
offered at all locations. Personalization of softline merchandise, such as
throws, pillows, polo shirts, bathrobes, canvas totes and baby blankets are
available from all locations with personalization provided from a central
fulfillment facility. At January 31, 2004, Things Remembered locations consisted of 464 inline
stores and 264 kiosks. The typical inline store consists of about 1,300 square
feet, while kiosks, which are units generally located in the center of the
common mall area, are typically 200 square feet. 3




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Things Remembered locations are usually operated by one or two employees
during nonpeak periods and up to 15 employees during the peak fourth quarter
holiday season. Locations typically employ a store manager on a full-time
basis, an assistant store manager on a full-time or part-time basis, and the

balance of employees as part-time sales associates. All locations are equipped with computerized engravers and some locations
have key duplicating machines. Most stores also have equipment for etching
glassware items. All locations are equipped with point-of-sale terminals. Most of the Things Remembereds store merchandise is shipped through its
centralized warehouse and distribution facility located near Youngstown, Ohio.
The warehouse utilizes a computerized carousel system to automate the process
of locating merchandise needed to fulfill store orders. The warehouse also has
systems and support capabilities to fulfill e-commerce and catalog orders
within 72 hours. Purchasing The merchandise, supplies and component parts required for the various
products sold by the Company are purchased from a large number of suppliers and
manufacturers and are generally readily available. In most cases, such
purchases are not made under long-term contracts. The Company believes that the
loss of any one supplier or manufacturer would not have a material adverse
effect on its operations. Competition The Company operates in highly competitive businesses. Cole Vision
competes with other optical companies, private ophthalmologists, optometrists
and opticians and health maintenance organizations (HMOs) and other managed
vision care companies in a highly fragmented marketplace on the basis of the
services it provides, as well as price and product quality. In addition, Pearle
competes on the basis of its highly recognized brand name, superior customer
service and large merchandise assortment. The Company believes that, based on
industry data, Cole Vision is the third largest optical retail company in the
United States. Although Things Remembered operates the only nationwide chain of
gift stores offering while you shop gift engraving, key duplicating, glass
etching and monogramming, as well as related merchandise, it competes with many
other retailers that sell gift items. Things Remembered competes with such
other retailers primarily on the basis of the value-added point of sale
services, as well as price and product quality. Some competitors have greater
financial resources than the Company. Employees As of January 31, 2004, the Company and its subsidiaries had approximately
9,330 full-time employees. This full-time work force is supplemented by 4,379
part-time and seasonal employees. Approximately 116 Pearle employees are
represented by labor unions. The Company considers its present labor relations
to be satisfactory. Segment Information Information for the Companys two reportable segments and geographical
information are contained in Note 7 of the Notes to Consolidated Financial
Statements. 
 Item 2. Properties All Cole Licensed Brands retail locations are leased or operated under a
license with the host store, and none of the individual retail locations are
material to operations. Leases for departments operated in Sears stores are
terminable upon relatively short notice. Freestanding stores operated under the
name Sears Optical are leased for terms which average five years. The leases
for departments operated in BJs Wholesale Club stores expire in April 2006.
The licenses for departments operated in Target stores expire in May 2007, and
under certain circumstances may be extended at the Companys option. Cole Licensed Brands leases six optical laboratory facilities, located in
Columbus, Ohio; Knoxville, Tennessee (two); Memphis, Tennessee; Salt Lake City,
Utah; and Richmond, Virginia, pursuant to leases expiring (including renewal
options) between 2006 and 2017. 4




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Pearle leases most of its retail stores under noncancelable operating
leases with terms generally ranging from five to ten years and which generally
contain renewal options for additional periods. Pearle is the principal lessee
on a majority of stores operated by franchisees who sublease the facilities
from Pearle. In January 2002, Pearle completed a sale and leaseback of its Dallas,
Texas Support Center, which comprises approximately 129,000 square feet of
laboratory and distribution facilities. The lease expires in 2017 and includes
four options to renew for five-year terms. An adjoining office facility, no
longer used for operations, was sold in April 2001. Pearle also owns a small
headquarters and a laboratory facility in Puerto Rico. In the second quarter of fiscal 2003 the Company closed its manufacturing
and distribution facility in Toronto, Canada. The operations of this facility
were absorbed by the Companys facility in Knoxville, TN. A small headquarters
and distribution facility is leased in Canada. Leases for Things Remembered inline stores and kiosks are generally for
terms of ten and five years, respectively. Things Remembereds home office
functions are located in a 50,000 square foot leased facility in Highland
Heights, Ohio. The lease expires (including renewal options) in 2007. Things
Remembered leases its 210,000 square foot warehouse and distribution facility
located near Youngstown, Ohio. The lease expires in 2013 and includes three
options to renew for five-year terms. 
 Item 3. Legal Proceedings From time to time during the ordinary course of business, the Company may
be threatened with, or may become a party to, a variety of legal actions and
other proceedings incidental to its business. The Company and its optical subsidiaries have been sued by the State of
California, which alleges claims for various statutory violations related to
the operation of 23 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. In July 2002, the State of
California obtained a preliminary injunction to enjoin certain advertising
practices and from charging dilation fees. The trial courts decision was
appealed by both the Company and the State. On November 26, 2003, the appellate
court ruled on the appeal in a manner adverse to the Company with respect to
continued advertising in California by Pearle Vision that expressly or
implicitly advertises the furnishing of optometric services, disallowing
continued advertising of the availability of optometric services with a
disclaimer that had been previously approved by the trial court. The appellate
court ruled in the Companys favor with respect to charging dilation fees. On
March 3, 2004, the California Supreme Court granted the Companys petition for
review of the Appellate Courts decision. Although the Company believes that
its advertising and operational practices in California complied with
California law, the appellate ruling may, if unmodified by the Supreme Court,
compel the Company to modify or close its activities in California. Further,
the Company might be required to pay damages and or restitution in a currently
undeterminable amount, the cost of which might have a material adverse effect
on the Companys operating results and cash flow in one or more periods. Things Remembered, Inc. settled a class action complaint in California
alleging that the putative class (alleged to include 200 members) were
improperly denied overtime compensation in violation of California law. The
action sought unspecified damages, interest, restitution, as well as
declaratory and injunctive relief and attorneys fees. On February 3, 2003,
Things Remembered and the plaintiffs reached an agreement to resolve the
lawsuit for $562,500. Preliminary approval was received from the Court on
August 1, 2003. On December 3, 2003, the Court approved final settlement of the
lawsuit. A liability of $562,500 was recorded in the fourth quarter of fiscal
2002 and paid in the first quarter of fiscal 2004. Following the Companys announcement in November 2002 of the restatement
of the Companys financial statements, the Securities and Exchange Commission
began an investigation into the Companys previous accounting. The course of
this investigation or other litigation or investigations arising out of the
restatement of the Companys financial statements cannot be predicted. In
addition, under certain circumstances the Company would be obliged to indemnify
the individual current and former directors and officers who are named as
defendants in litigation or who are or become involved in an investigation. The
Company believes it has insurance that should be available with respect to a
portion of its indemnification obligations. If the Company is unsuccessful in
defending against the current investigation or any litigation, there may be a
material adverse effect on the Companys financial condition, cash flow and
results of operations. 5




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The Company has been named as a defendant along with numerous other
retailers, in patent infringement litigation challenging the defendants use of
bar code technology in the United States District Court of Arizona, known as
Lemelson Medical, Education & Research Foundation, Limited Partnerships v.
CompUSA, Inc. et. al., No. Civ. 00-0663. A stay of the proceeding has been
sought and was granted, in deference to prior pending declaratory judgment
suits brought by the manufacturers and suppliers of the implicated technology
seeking to declare the patents in suit not infringed. On January 23, 2004, a
court in Nevada entered a memorandum of decision in favor of a manufacturer
declaring the Lemelson patents not infringed. This judgment is expected to be
appealed by the Lemelson Partnership, and the Arizona infringement litigation
against the Company will remain stayed pending the final resolution any such
appeal; however, this trial court decision favors the Company and its defenses.
The Company believes it has available defenses and does not expect any
liability. However, if the Company were to be found liable for an infringement,
it might have a material adverse effect on the Companys operating results and
cash flow in the period incurred. See Note 9 of Notes to Consolidated Financial Statements for further
discussion of these legal proceedings. 
 Item 4. Submission of Matters to a Vote of Security Holders Information required by this item has been omitted pursuant to General
Instruction I of Form 10-K. 
 PART II 
 Item 5. Market for Registrants Common Equity and Related Stockholder Matters The Registrant is a wholly owned subsidiary of Cole National Corporation
and has no equity securities that are traded in an established public trading
market or otherwise. The indentures pursuant to which the 8-5/8% Senior Subordinated Notes due
2007 and the 8-7/8% Senior Subordinated Notes due 2012 were issued contain
certain optional and mandatory redemption features and other financial
covenants, including restrictions on the ability of the Company to incur
additional indebtedness, pay dividends or make other restricted payments to
Cole National Corporation. The indentures also permit payments to Cole National
Corporation for certain tax obligations and for administrative expenses not to
exceed 0.25% of the Companys net sales. The Company has no equity compensation plans under which securities of the
Company are authorized for issuance. 
 Item 6. Selected Financial Data Information required by this item has been omitted pursuant to General
Instruction I of Form 10-K. 6




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Item 7. Managements Discussion and Analysis of Financial Condition and Results of Operations Subsequent
to the issuance of the Companys consolidated financial statements for
the year ended January 31, 2004, the Company determined that certain
components in its consolidated statements of cash flows for fiscal
2003, 2002 and 2001 were incorrectly classified. As a result, the
accompanying consolidated statements of cash flows for the fiscal
years 2003, 2002 and 2001 have been restated from the amounts
previously reported. See Note 11 of the Notes to the
Consolidated Financial Statements for a summary of the significant
effects of the restatement. This managements discussion and
analysis of financial condition and results of operations reflect
the effect of the restatement. On January 26, 2004, Cole National Corporation announced that it entered
into a definitive merger agreement with the Luxottica Group S.p.A. Under the
agreement, Luxottica Group will acquire all of the outstanding shares of the
Parent for a cash purchase price of $22.50 per share, together with the
purchase of all outstanding options and similar equity rights at the same price
per share, less their respective exercise prices, for a total price of
approximately $400 million. The merger is subject to the approval of the
Parents stockholders and the satisfaction of other customary conditions,
including compliance with applicable antitrust clearance requirements. On
February 27, 2004 the Parent and Luxottica Group filed pre-merger notifications
with the U.S. antitrust authorities pursuant to the Hart-Scott-Rodino Antitrust
Improvements Act of 1976 (the HSR Act). On March 30, 2004 the Parent and
Luxottica Group jointly announced that they had received a request from the
Federal Trade Commission (FTC) for additional information and documentary
material with respect to the Merger. Accordingly, the waiting period under the
HSR Act has been extended until the 30th day after the date of substantial
compliance with the request by both parties, unless earlier terminated by the
FTC. A special meeting of Parents stockholders to consider and vote upon the
merger is scheduled for April 20, 2004. The transaction is currently expected
to close in the second half of 2004. Overview Cole National Group, Inc., a wholly owned subsidiary of Cole National
Corporation, is a leading provider of optical products and services and
personalized gifts. The Company sells its products and services through 2,444
Company-owned retail locations and 481 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 January 31, 2004 is referred to as fiscal 2003. Fiscal 2003,
fiscal 2002 and fiscal 2001 each consisted of a 52-week period. 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 and 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 third party partner programs. Beginning in early 2000, management of the Company initiated a
comprehensive effort to improve financial performance by rethinking all aspects
of how the Company conducts its business. The strategies implemented by
management since that time are based upon the following fundamental building
blocks:  
    
    Developing business units that give clear focus to its different businesses;  
    
    Getting the right people in the right positions so that they can do the best job possible;  
    
    Developing and executing plans that are both strategic and tactical;  
    
    Staying focused on the customer  who they are and why, when, where, and how they buy, and;  
    
    Changing the corporate culture to one of greater accountability Since adopting this approach, the Company has fine-tuned its plans on many
occasions, making adjustments in response to market conditions and the external
environment. However, the overall direction has remained constant, and the
Company believes that its strategies have generally been successful. One way
that the Company measures its progress in the vision segment is by comparing
its same store sales growth with the sales growth in the overall optical retail
industry as reported by Jobson Optical Research Group. As indicated by the
table below, the Companys vision segment same store sales grew faster than the
industry in fiscal 2003, 2002 and 2001. Percentage Growth in Sales Cole Vision Segment
    
    Optical Retail Industry(1)
    
    Difference2001
    
    
    2.6
    %
    
    
    (3.7
    )%
    
    6.3 pts2002
    
    
    3.3
    %
    
    
    1.5
    %
    
    1.8 pts2003
    
    
    3.8
    %
    
    
    0.6
    %
    
    3.2 pts
 7




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##### Table of Contents



(1) As reported by Jobson Optical Research Group Things Remembered also grew same store sales in fiscal 2003, despite a
difficult retail environment by developing new product lines, including
childrens, pet accessories, sterling silver jewelry, gift bags and spa/resort.
Their direct channel business grew at 44% and 36%, in fiscal 2003 and 2002,
respectively as Things Remembered continues to tap into new avenues of selling
to its customers. The Company has faced many challenges over the past two years. On October
8, 2003 Cole National Corporation announced that it had received an unsolicited
offer to acquire the Parent, and that its Board of Directors had formed a
Special Committee of independent directors on July 28, 2003 to evaluate the
Companys strategic alternatives. The work of this committee resulted in the
definitive merger agreement between the Parent and Luxottica Group S.p.A.
Further information regarding this agreement can be found in Note 10 of the
Notes to Consolidated Financial Statements included in this Form
10-K/A and in
the definitive proxy statement filed by the Parent on March 15, 2004. The
Companys former Chairman and Chief Executive Officer retired at the annual
meeting of shareholders on June 25, 2003. With the filing of its Form 10-K for
the 2002 fiscal year on May 16, 2003, the Company completed a restatement of
its financial results beginning in 1998, which also required re-audits of
fiscal years 2000 and 2001. As a result of the restatement, the Parent was
named as a defendant in a class action lawsuit, and the Company is the subject
of an SEC investigation. The class action lawsuit was resolved and the Court
approved final settlement on September 29, 2003. The SEC investigation is
ongoing. Despite these challenges and potential distractions, the Company has
continued to grow the business by focusing on the fundamental building blocks
discussed above. Further information about these matters and the Companys
performance is included below. Results of Operations The following schedule sets forth the results from continuing operations
for the fiscal years ended January 31, 2004, February 1, 2003, and February 2,
2002. This schedule and subsequent discussions should be read in conjunction
with the consolidated financial statements and notes thereto included in Item 8
of this Form 10-K/A. Fiscal Year
    
    % Change Fav/(Unfav)2003 vs.
    
    2002 vs.(Dollars in millions)
    
    2003
    
    2002
    
    2001
    
    2002
    
    2001Net revenue:Cole Vision
    
    $
    919.5
    
    
    $
    877.5
    
    
    $
    836.8
    
    
    
    4.8
    %
    
    
    4.9
    %Things Remembered
    
    
    282.3
    
    
    
    270.6
    
    
    
    272.3
    
    
    
    4.3
    
    
    
    (0.6
    )Total net revenue
    
    $
    1,201.8
    
    
    $
    1,148.1
    
    
    $
    1,109.1
    
    
    
    4.7
    %
    
    
    3.5
    %Gross margin:Cole Vision
    
    $
    553.3
    
    
    $
    543.8
    
    
    $
    519.9
    
    
    
    1.7
    %
    
    
    4.6
    %Things Remembered
    
    
    199.7
    
    
    
    192.1
    
    
    
    193.8
    
    
    
    4.0
    
    
    
    (0.9
    )Total gross margin
    
    $
    753.0
    
    
    $
    735.9
    
    
    $
    713.7
    
    
    
    2.3
    %
    
    
    3.1
    %Operating expenses:Cole Vision
    
    $
    528.4
    
    
    $
    513.2
    
    
    $
    500.7
    
    
    
    (3.0
    )%
    
    
    (2.5
    )%Things Remembered
    
    
    178.3
    
    
    
    177.0
    
    
    
    168.8
    
    
    
    (0.7
    )
    
    
    (4.9
    )Unallocated corporate expense
    
    
    34.3
    
    
    
    17.4
    
    
    
    9.5
    
    
    
    (97.4
    )
    
    
    (81.0
    )Total operating expenses
    
    $
    741.0
    
    
    $
    707.6
    
    
    $
    679.0
    
    
    
    (4.7
    )%
    
    
    (4.2
    )%Goodwill and tradename amortization:Cole Vision
    
    $
    
    
    
    $
    
    
    
    $
    4.1
    
    
    
    
    %
    
    
    (100.0
    )%Things Remembered
    
    
    
    
    
    
    
    
    
    
    0.9
    
    
    
    
    
    
    
    (100.0
    )Total goodwill and tradename amortization
    
    $
    
    
    
    $
    
    
    
    $
    5.0
    
    
    
    
    %
    
    
    (100.0
    )%Operating income:Cole Vision
    
    $
    24.9
    
    
    $
    30.6
    
    
    $
    15.1
    
    
    
    (18.7
    )%
    
    
    102.4
    %Things Remembered
    
    
    21.4
    
    
    
    15.1
    
    
    
    24.1
    
    
    
    42.3
    
    
    
    (37.6
    )Unallocated corporate expense
    
    
    (34.3
    )
    
    
    (17.4
    )
    
    
    (9.5
    )
    
    
    (97.4
    )
    
    
    (81.0
    )Total operating income
    
    $
    12.0
    
    
    $
    28.3
    
    
    $
    29.7
    
    
    
    (57.5
    )%
    
    
    (4.7
    )%
 8




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##### Table of Contents



Information on the number of the Companys retail locations by business
open at January 31, 2004, February 1, 2003 and February 2, 2002 is presented
below: Fiscal Year2003
    
    2002
    
    2001Number of retail locations at the end of the periodSears Optical
    
    
    939
    
    
    
    943
    
    
    
    942Target Optical
    
    
    265
    
    
    
    241
    
    
    
    224BJs Optical
    
    
    133
    
    
    
    126
    
    
    
    116Total Cole Licensed Brands
    
    
    1,337
    
    
    
    1,310
    
    
    
    1,282Pearle Company-owned
    
    
    379
    
    
    
    400
    
    
    
    423Pearle franchised
    
    
    481
    
    
    
    464
    
    
    
    440Total Cole Vision
    
    
    2,197
    
    
    
    2,174
    
    
    
    2,145Things Remembered
    
    
    728
    
    
    
    770
    
    
    
    774Total Cole National
    
    
    2,925
    
    
    
    2,944
    
    
    
    2,919
 Results of operations below are reflected as a percentage of net revenues.
Data for the Cole Vision and Things Remembered segments are shown as a
percentage of their respective net revenues. Unallocated corporate expenses and
classification totals are shown as a percentage of total net revenues. Fiscal Year2003
    
    2002
    
    2001Gross margin:Cole Vision
    
    
    60.2
    %
    
    
    62.0
    %
    
    
    62.1
    %Things Remembered
    
    
    70.8
    %
    
    
    71.0
    %
    
    
    71.2
    %Total gross margin
    
    
    62.7
    %
    
    
    64.1
    %
    
    
    64.3
    %Operating expenses:Cole Vision
    
    
    57.5
    %
    
    
    58.5
    %
    
    
    59.8
    %Things Remembered
    
    
    63.2
    %
    
    
    65.4
    %
    
    
    62.0
    %Unallocated corporate expense
    
    
    2.9
    %
    
    
    1.5
    %
    
    
    0.9
    %Total operating expenses
    
    
    61.7
    %
    
    
    61.6
    %
    
    
    61.2
    %Goodwill and tradename amortization:Cole Vision
    
    
    0.0
    %
    
    
    0.0
    %
    
    
    0.5
    %Things Remembered
    
    
    0.0
    %
    
    
    0.0
    %
    
    
    0.3
    %Total goodwill and tradename amortization
    
    
    0.0
    %
    
    
    0.0
    %
    
    
    0.5
    %Operating income:Cole Vision
    
    
    2.7
    %
    
    
    3.5
    %
    
    
    1.8
    %Things Remembered
    
    
    7.6
    %
    
    
    5.6
    %
    
    
    8.9
    %Unallocated corporate expense
    
    
    -2.9
    %
    
    
    -1.5
    %
    
    
    -0.9
    %Total operating income
    
    
    1.0
    %
    
    
    2.5
    %
    
    
    2.7
    %
 As
used in Item 7 of this Form 10-K/A, same store sales growth is a non-GAAP
financial measure, which includes deferred warranty sales on a cash basis and
undelivered customer orders, and does not reflect provisions for returns,
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 to investors and management 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 net revenue is presented below in the section Reconciliation of Same Store
Sales Growth. Same store sales growth follows: 9




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##### Table of Contents



Fiscal Year2003
    
    2002
    
    2001Sears Optical (U.S.)
    
    
    3.8
    %
    
    
    2.0
    %
    
    
    3.2
    %Target Optical
    
    
    18.5
    %
    
    
    27.8
    %
    
    
    19.3
    %BJs Optical
    
    
    11.8
    %
    
    

    1.9
    %
    
    
    4.3
    %Cole Licensed Brands (U.S.)
    
    
    5.7
    %
    
    
    3.7
    %
    
    
    3.8
    %Pearle Vision Company-owned (U.S.)
    
    
    0.8
    %
    
    
    4.0
    %
    
    
    2.6
    %Total Cole Vision
    
    
    3.8
    %
    
    
    3.3
    %
    
    
    2.6
    %Things Remembered
    
    
    3.7
    %
    
    
    (2.5
    )%
    
    
    (1.8
    )%Total Cole National
    
    
    3.7
    %
    
    
    1.8
    %
    
    
    1.4
    %Pearle Vision U.S. franchise stores
    
    
    (0.3
    )%
    
    
    1.1
    %
    
    
    0.0
    %
 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. Net Revenues Consolidated Operations Net revenues were $1,201.8 million in fiscal 2003, compared with $1,148.1
million in fiscal 2002 and $1,109.1 million in fiscal 2001. Compared to the
same period the previous year, net revenues increased 4.7% in fiscal 2003 and
3.5% in fiscal 2002, primarily attributable to a 3.7% and 1.8% increase in same
store sales in fiscal 2003 and fiscal 2002, respectively and an increase in
revenues from managed vision care programs in both years. Also impacting the
change in net revenues is the number of stores open. There were 2,925 locations
open at the end of fiscal 2003, compared to 2,944 and 2,919 open at the end of
fiscal 2002 and fiscal 2001, respectively. Cole Vision Segment Cole Vision revenues were $919.5 million in fiscal 2003, compared with
$877.5 million and $836.8 million in fiscal 2002 and fiscal 2001, respectively,
an increase compared to the same period the previous year of 4.8% and 4.9%,
respectively. In fiscal 2003 compared to fiscal 2002, the revenue increase of 4.8% was
primarily due to increased revenues at Cole Licensed Brands and from managed
vision care programs, partially offset by revenue decreases at Pearle Vision
U.S. The increase in Cole Licensed Brands revenues was attributable to same
store sales increases at all brands and an increase in the number of store
locations, primarily at Target Optical. Same store sales at Cole Licensed
Brands were driven by increases in the average transaction size and an increase
in the number of transactions. A continuing focus on selling premium products
and additional features were the key factors in the average transaction size
increase. The increase in the number of transactions was due to increases at
Target Optical and BJs Optical, partially offset by a transaction decrease at
Sears Optical. Revenues from managed vision care programs were higher than last
year primarily due to an increase in the number of capitated plans sold to
employers, health plans and associations, and increased laser procedure volume.
Although revenues decreased at Pearle Vision Company-owned stores, same store
sales in fiscal 2003 increased 0.8% due to an increase in the average
transaction size partially offset by a decrease in the number of transactions.
Improved merchandise assortment and selling skills at the store level and
rollout of a new Pearle Preferred Credit Card are the primary drivers of the
increase in average transaction size. The Company believes that the decrease in
the number of transactions is due primarily to the increasingly competitive and
promotional nature of the optical retail industry. Offsetting the same store
sales increases at Pearle Vision were a lower number of Company-owned stores.
Pearle Vision operated 21 fewer Company-owned stores at the end of fiscal 2003
than it did at the end of fiscal 2002, due to the net sale of 11 Company stores
to franchisees, the closure of 15 stores and the opening of 5 new stores. The
Company is continuing to divest Company-owned stores in markets that are
predominantly franchised in order to lower its store supervision costs, and
provide growth opportunities for franchisees already operating in those
markets. In fiscal 2002 compared to fiscal 2001, the revenue increase of 4.9% was
due to increased revenues at Cole Licensed Brands, Pearle Vision U.S. and
increased revenues from managed vision care programs. The increase in Cole
Licensed Brands revenues was attributable to same store sales increases at
Sears Optical and Target Optical and an increase in the number of store
locations, primarily at Target Optical. These same store sales increases were
driven by increased average transaction size and sales of accessories. New
premium product introductions at both Sears Optical and Target Optical,
partially offset by increased sales of contact 10




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##### Table of Contents



lenses, were a key factor in the
average selling price increase. Same store sales increased 4.0% at Pearle
Vision Company-owned U.S. stores, primarily reflecting an increase in average
transaction size. Improved merchandise assortment and selling skills at the
store level have resulted in a higher rate of multi-pair purchases and
increased sales of additional features. Cole Managed Vision revenues also
increased from the prior year, due to increases in claims revenue and
administrative service only (ASO) fees and the addition of laser procedure
revenue. Things Remembered Segment Things Remembered revenues were $282.3 million in fiscal 2003, compared
with $270.6 million and $272.3 million in fiscal 2002 and fiscal 2001,
respectively, a 4.3% increase and 0.6% decrease compared to the same period the
previous year, respectively. In fiscal 2003 compared to fiscal 2002, a same store sales increase of
3.7% and a 44% increase in direct channel revenues were the primary reason for
the increase in revenues. Direct channel revenues include revenues from its
e-commerce site, www.ThingsRemembered.com, revenues from Things Remembered
catalogs, and revenues generated through third party partner programs.
Improvements in the average transaction size were partially offset by a lower
number of transactions and from a reduction in the number of stores operating.
There were 728 Things Remembered store locations operating at the end of fiscal
2003, compared to 770 at the end of fiscal 2002. The reduction was due
primarily to the Companys decision to allow the leases at under- performing
stores to expire. In fiscal 2002 compared to fiscal 2001, the decrease in net revenues of
0.6% was primarily due to a same store sales decrease of 2.5% and a lower
number of stores operating than the prior year. Store count at fiscal year end
decreased from 774 to 770. The same store sales decrease was primarily
attributable to a slowdown in mall traffic during fiscal 2002. Demand for
business award and recognition gifts also decreased during the year due to
changes in general economic conditions. Decreases in customer count were
partially offset by increases in average transaction size and a 36% growth in
the still relatively small direct channel business. Gross Margin Consolidated Operations Gross margin was $753.0 million in fiscal 2003, compared with $735.9
million in fiscal 2002 and $713.7 million in fiscal 2001. Compared to the same
period the previous year, gross margin dollars increased 2.3% in fiscal 2003
and 3.1% in fiscal 2002, primarily attributable to an increase in net revenues,
partially offset by a decrease in the gross margin rate. The gross margin rate
was 62.7% in fiscal 2003, compared with 64.1% in fiscal 2002 and 64.3% in
fiscal 2001. Cole Vision Segment Gross margin was $553.3 million in fiscal 2003, compared to $543.8 million
in fiscal 2002 and $519.9 million in fiscal 2001, an increase of gross margin
dollars of 1.7% and 4.6% compared to the same period the previous year,
respectively, due to increased revenues, partially offset by a decrease in the
gross margin rate. Gross margin, as a percent of net revenues, was 60.2%, 62.0%
and 62.1% in fiscal 2003, fiscal 2002 and fiscal 2001, respectively. In fiscal 2003 compared to fiscal 2002, the Cole Vision gross margin rate
decreased by 1.8 percentage points due to decreases in the gross margin rate in
all businesses. Cole Managed Vision gross margin rate decreased due to a shift
in revenue mix toward more funded programs from fee-for-service programs and
higher benefit utilization by plan members within funded programs, which
decreases the gross margin rate. In the Canadian operations, the Company
closed its manufacturing and distribution facility in Toronto, Canada in the
second quarter of fiscal 2003. The operations of this facility have been
absorbed by the Companys facility in Knoxville, TN. As part of the integration
of the Canadian operations in the Knoxville lab, the Company changed the
Canadian product assortment. As a result, the Company recorded a $0.3 million
charge for obsolescence of inventory. The obsolescence charge, in addition to
more aggressive promotions, unfavorable exchange rates and change in product
assortment toward more premium products, which carry a lower gross margin rate,
resulted in a $1.3 million lower gross margin from the Companys Canadian
operations. Cole Licensed Brands gross margin rate decreased and was impacted
by higher obsolescence costs, higher costs associated with a shift toward lower
gross margin rate premium product, a lower contact lens gross margin rate and
an increase in discounts and other pricing promotions. The increase in
obsolescence was due to a larger quantity of new product introductions in
fiscal 2003, compared to previous years. The decrease in the contact lens gross
margin rate was due primarily to increased selling of annual supplies to
customers, which is a lower gross margin rate transaction and pricing actions
taken in response to competition. Pearle Vision gross margin, as a percent of
net revenues, decreased slightly due to an increased mix of sales of products
to franchisees 11




---



##### Table of Contents



compared to revenues from Company-owned stores, compared to the
prior year. Sales to franchisees carry a lower gross margin rate than revenues
from Company-owned stores, but offer benefits to the Company, including
producing a more uniform merchandise assortment and a consistent brand look
across all stores. Partially offsetting this gross margin rate decrease at
Pearle Vision was higher product gross margin at Company-owned stores and lower
manufacturing costs compared to the prior year. Lower manufacturing costs were
achieved through in-store lab cost reductions and reduced costs of insurance
and workers compensation. In fiscal 2002 compared to fiscal 2001, the decrease in gross margin rate
was attributable to a change in sales mix at both Pearle Vision and Cole
Licensed Brands. At Pearle Vision, the decrease in gross margin rate was
attributable to an increased mix of sales of product to franchisees, compared
to sales at Company-owned stores. Additionally, Pearle Visions mix of contact
lens sales increased, which also contributed to a decrease in the gross margin
rate. At Cole Licensed Brands, the decrease in gross margin rate was
attributable to the increased sales of premium product and saleable
accessories. Accessories, which include lens cleaner, lens cloth, clips and
other products designed to care for optical purchases, and premium products,
generally are sold at lower gross margin rates. In addition, Cole Licensed
Brands made a strategic decision to lower retail prices of contact lenses in
fiscal 2002 to become more competitive. The price decrease was a key factor in
the gross margin rate decrease at Cole Licensed Brands. Partially offsetting
the decrease in gross margin rate were improvements at Cole Managed Vision,
where underwriting gain as a percentage of sales improved due to pricing
initiatives on new and existing business and lower benefit utilization by plan
members. Things Remembered Segment Gross margin was $199.7 million in fiscal 2003, $192.1 million in fiscal
2002 and $193.8 million in fiscal 2001. Compared to the same period the
previous year, fiscal 2003 had an increase of 4.0% and fiscal 2002 had a
decrease of 0.9% primarily driven by the same store sales performance and
changes in the gross margin rate. Gross margin as a percent of net revenues was
70.8% in fiscal 2003, 71.0% in fiscal 2002 and 71.2% in fiscal 2001. The gross
margin rate decrease in fiscal 2003, compared to the prior year, was due
primarily to reduced revenues from gift personalization. The gross margin rate
decrease in fiscal 2002, compared to the prior year, was due primarily to an
increased mix in direct channel revenues, including shipping revenue, which has
a lower gross margin rate than revenues from stores. Operating Expenses Consolidated Operations Operating
expenses were $741.0 million in fiscal 2003, compared with
$707.6 million in fiscal 2002, and $679.0 million in fiscal 2001. Compared to
the prior year, the increase in fiscal 2003 was 4.7% and the increase in fiscal
2002 was 4.2%. Of the increase in fiscal 2003, $16.5 million is attributable to
the operating segments and $16.9 million is attributable to unallocated
corporate expenses. Of the increase in fiscal 2002, $20.7 million is
attributable to the operating segments and $7.9 million is attributable to
unallocated corporate expenses. As discussed in detail below, certain unusual
items affected the Companys operating expenses during these periods. The
Company defines unusual items as transactions that are non-comparable or
infrequent in nature, including significant one time transactions unrelated to
core operations and special charges and impairments. Management believes that
operating expenses excluding unusual items is a useful measure for
understanding trends in core operations and excludes some of these items in the
management bonus plans. Operating expenses excluding unusual items is a
non-GAAP financial measure and should not be used as a substitute for the
directly comparable GAAP financial measure. In order to facilitate an
understanding of such unusual items and their effect on the results of the
operations, the following table is provided as a reconciliation of reported
operating expense to operating expense excluding certain unusual items. 12




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##### Table of Contents



Fiscal Year
    
    Change Fav/(Unfav)2003 vs.
    
    2002 vs.(Dollars in millions)
    
    2003
    
    2002
    
    2001
    
    2002
    
    2001Operating expenses, as reported
    
    $
    741.0
    
    
    $
    707.6
    
    
    $
    679.0
    
    
    $
    (33.4
    )
    
    $
    (28.6
    )Unusual items:CEO Retirement
    
    
    9.2
    
    
    
    
    
    
    
    Legal & professional fees for
restatement & SEC investigation
    
    
    2.2
    
    
    
    
    
    
    
    Shareholder litigation settlement
    
    
    2.7
    
    
    
    
    
    
    
    Audit fees for restatement
    
    
    1.8
    
    
    
    3.4
    
    
    
    Legal fees for California litigation
    
    
    4.6
    
    
    
    3.5
    
    
    
    POS software impairment
    
    
    2.5
    
    
    
    
    
    
    
    Gain on sale of aircraft
    
    
    (1.0
    )
    
    
    
    
    
    
    Restructuring charge
    
    
    
    
    
    
    1.1
    
    
    
    Closure of corporate office
    
    
    
    
    
    
    0.3
    
    
    
    Things Remembered class action settlement
    
    
    
    
    
    
    1.1
    
    
    
    Total unusual items
    
    
    22.0
    
    
    
    9.4
    
    
    
    Operating expenses, excluding unusual items
    
    $
    719.0
    
    
    $
    698.2
    
    
    $
    679.0
    
    
    $
    (20.8
    )
    
    $
    (19.2
    )Operating expenses, excluding unusual items,
as a percent of total net revenues
    
    
    59.8
    %
    
    
    60.8
    %
    
    
    61.2
    %
    
    
    1.0
    %
    
    
    0.4
    %Operating expense, as reported, as a percent
of total net revenues
    
    
    61.7
    %
    
    
    61.6
    %
    
    
    61.2
    %
    
    
    (0.1
    )%
    
    
    (0.4
    )%
 Unusual Items The Companys former Chairman and Chief Executive Officer retired at the
annual meeting of shareholders on June 25, 2003 and the Company fulfilled its
obligations, including certain contingent obligations, under his employment
agreement and for retirement and life insurance benefits. These obligations
required a one-time cash payment of $11.9 million with a charge to operating
expenses in the second quarter of fiscal 2003 of $9.2 million. Cole National Corporation announced on October 8, 2003 that its Board of
Directors had formed a Special Committee of independent directors on July 28,
2003 to evaluate the Companys strategic alternatives, including a possible
merger or sale of the Company, a corporate restructuring or other alternatives.
The Parent and Luxottica Group S.p.A. entered into a definitive merger
agreement on January 23, 2004 with the unanimous approval of the Boards of
Directors of both companies. (See Note 10 of the Notes to Consolidated
Financial Statements.) Costs related to legal, advisory and other professional
expenses related to the evaluation of strategic alternatives and the
negotiation of the definitive merger agreement are recorded at the Parent. In fiscal 2003, the Company incurred incremental charges of $2.2 million
for legal and professional fees related to the reaudit and restatement of its
financial statements and the resulting SEC investigation, net of reimbursements
received from insurance. Settlement costs related to the class action
shareholder lawsuit, alleging claims of various violations of federal
securities laws related to the Companys publicly reported revenues and
earnings totaled $2.7 million. Audit fees attributable to the restatement and
reaudit were $1.8 million in fiscal 2003 and $3.4 million in fiscal 2002. The Company and its optical subsidiaries have been sued by the State of
California. (See Note 9 of the Notes to Consolidated Financial
Statements). Legal costs associated with the defense of this matter totaled $4.6 million in
fiscal 2003, and $3.5 million in fiscal 2002. Other charges incurred in fiscal 2003 include a $2.5 million charge
related to the impairment of point of sale (POS) software purchased by the
Company in 1999 and never deployed. During the fourth quarter of 2003, the
Company decided to indefinitely delay further development. The Company sold its
aircraft in the fourth quarter of fiscal 2003 and recorded a $1.0 million gain. 13




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The Company recorded $1.1 million for severance costs for a restructuring
in the fourth quarter of fiscal 2002. The restructuring charge was related to a
reduction in workforce of 60 individuals in the corporate office and field
management. The Company also recorded a charge of $0.3 million in the third
quarter of fiscal 2002 related to the closing of the corporate office and
relocating it to the Companys facility in Twinsburg, Ohio. Things Remembered incurred legal and settlement costs of $1.1 million
related to the settlement of a class action complaint in California involving
overtime compensation in fiscal 2002. (See Note 9 of the Notes to Consolidated
Financial Statements). Unallocated Corporate Expenses Unallocated corporate expenses were $34.3 million in fiscal 2003, compared
to $17.4 million for fiscal 2002 and $9.5 million for fiscal 2001. Included in
unallocated corporate expense are all of the unusual items listed above except
for the California litigation charges, which is recorded in the Cole Vision
segment and the Things Remembered class action settlement. The unusual items
included in unallocated corporate expenses totaled $17.4 million and $4.8
million in fiscal 2003 and fiscal 2002, respectively. In
fiscal 2003 unallocated corporate expenses included compensation expense of $3.2 million for variable stock options having a feature permitting the use of vested options in payment of the exercise price. In fiscal 2003, certain stock options were exercised by using this feature. Previous to fiscal 2003, such options had been accounted for as fixed
grants based on the presumption that this feature would not be
utilized as evidence by the Companys historical experience of this
feature not being used, therefore no compensation expense was
recorded. The utilization of this feature in fiscal year 2003 created
an arrangement that requires variable accounting, beginning with the third quarter of fiscal 2003. The Company incurred in fiscal 2003 compared to fiscal 2002 incremental management bonus expense of $1.5 million and professional
and legal fees of $1.1 million related to management changes and management
initiatives. The Company incurred incremental audit and professional fees of
$0.8 million compared to the same period last year due to higher audit costs
and higher expenses incurred to comply with Section 404 of the Sarbanes-Oxley
Act of 2002. Partially offsetting these increased expenses were $1.0 million
lower expenses for continuing group medical and basic life insurance for a
group of former employees covered under a postemployment benefit agreement, due
to a lower number of participants covered under the agreement and lower
overhead costs from the reduction in workforce. In fiscal 2002 compared to fiscal 2001, the Company recorded incremental
costs of $1.2 million for continuing group medical and basic life insurance
coverage for a group of employees covered under a postemployment benefits
agreement. The Company recorded incremental legal fees of $0.9 million for
general matters. Cole Vision Segment Operating expenses were $528.4 million in fiscal 2003, compared to $513.2
million for fiscal 2002 and $500.7 million for fiscal 2001. Compared to the
same period the previous year, fiscal 2003 had an increase of 3.0% and fiscal
2002 had an increase of 2.5%. Operating expenses as a percent of net revenues
decreased at Cole Vision by 1.0 points in fiscal 2003 and 1.3 points in fiscal
2002, compared to prior years. Included in operating expenses is the unusual
item of California litigation charges described above which totaled $4.6
million and $3.5 million in fiscal 2003 and fiscal 2002, respectively. In applying Statements of Accounting Standards (SFAS) No. 144, Accounting
for Impairment or Disposal of Long-Lived Assets, (SFAS 144), which addresses
financial accounting and reporting for the impairment or disposal of long-lived
assets, the Company evaluates the operating performance of each of its
locations at least once per year or whenever there is a change in events or
circumstances. Cole Vision recorded impairment charges of $1.7 million in
fiscal 2003, compared to $0.4 million in fiscal 2002 and $2.8 million in fiscal
2001. The impairment charges are due to declining revenues primarily at certain
Pearle Vision stores. Since the evaluation is made annually it is not
considered by the Company to be an unusual item. In fiscal 2003 compared to fiscal 2002, store payroll and rent and
occupancy costs at Cole Vision were $8.3 million and $3.6 million higher,
respectively, to support increases in net revenues. Store payroll and rent and
occupancy costs, as a percent of net revenues, were lower in fiscal 2003
compared to the same period last year. Operating expenses from the Companys
Canadian operations were $3.2 million higher in fiscal 2003 compared to the
same period last year. The increase in operating expense was due primarily to
costs associated with the closure of its manufacturing and distribution
facility in Toronto, Canada, higher store payroll, depreciation, and
unfavorable exchange rates. At Cole Managed Vision, claims processing costs
were $2.5 million higher than the previous year. Included in claims processing
costs were $1.6 million of incremental costs related to the Companys
compliance with the Health Insurance Portability and Accountability Act
(HIPAA), $1.3 million of incremental systems amortization and higher costs due
to an increase in claim volume. These increases were partially offset by lower
bad debt expense and printed material costs compared to the same period last
year. In addition, savings were realized from lower bonus expense and reduction
of processing fees paid to MetLife. Pearle Vision recorded a $0.6 million
charge for assets disposed in a prior period. Partially offsetting the expense
increases in fiscal 2003 were savings from lower store advertising and field
supervision expenses. Fiscal 2002 results included charges of $1.0 million for
the closure of 12 Target Optical stores. Pearle Vision recorded $2.5 million in
fiscal 2003 related to gains on the sale of 15 Company-owned locations to
franchisees. This compared to a $0.7 million gain on the sale of 8 stores in
fiscal 2002. 14




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In fiscal 2002 compared to fiscal 2001, store payroll and rent and
occupancy charges at Cole Vision were $7.3 million and $1.6 million higher,
respectively, supporting increases in net revenues and increases in the number
of Target Optical stores open. Store payroll and rent and occupancy costs, as a
percent of net revenues, were lower in fiscal 2002 compared to the prior year.
Operating expenses at Cole Licensed Brands decreased as a percent to sales
compared to the prior year due primarily to improvements at Target Optical.
Fiscal 2002 results included a charge of $1.0 million for the closure of 12
Target Optical stores. Pension expense was $1.0 million lower than the prior
year at Cole Vision due to the Companys decision to freeze the defined benefit
pension plan. (See Note 6 of the Notes to Consolidated Financial
Statements).
Operating expenses at Cole Managed Vision decreased as a percent of sales
compared to prior year primarily due to the reduction of processing fees paid
to MetLife as claims processing was converted to the Companys internal systems
at a lower cost per claim. Things Remembered Segment Operating expenses were $178.3 million in fiscal 2003, compared to $177.0
million for the same period last year and $168.8 million in fiscal 2001.
Compared to the same period the previous year, fiscal 2003 had an increase of
0.7% and fiscal 2002 had an increase of 4.9%. Operating expenses as a percent
of net revenues decreased 2.2 points in fiscal 2003 and increased 3.4 points in
fiscal 2002, compared to prior years. Included in operating expenses is the
unusual item of the class action settlement described above which totaled $1.1
million in fiscal 2002. Applying SFAS 144, Things Remembered recorded impairment charges of $0.2
million in fiscal 2003, compared to $0.5 million in fiscal 2002 and $0.9
million in fiscal 2001. The impairment charges are due to declining revenues
and operating performance at certain Things Remembered stores. Since the
evaluation is made annually it is not considered by the Company to be an
unusual item. In fiscal 2003 compared to fiscal 2002, store rent and occupancy charges
increased $1.5 million primarily due to a higher mix of inline mall locations
than kiosks. Inline mall locations generally incur higher rent and occupancy
costs than kiosks due to greater square footage requirements. Rent and
occupancy costs, as a percent of net revenues, were lower by 0.3 points in
fiscal 2003 than the same period last year. Things Remembered accrued higher
management bonuses, totaling $1.7 million and incurred incremental advertising
costs in support of higher net revenues, totaling $1.7 million in fiscal 2003,
compared to the same period last year. Things Remembered recorded lower store
payroll costs in fiscal 2003, compared to the same period last year due to
fewer stores operating and lower workers compensation costs. Store payroll
costs, as a percent of net revenues, were lower in fiscal 2003 than the same
period last year due to improvements in productivity. Things Remembered
realized savings totaling $1.4 million from lower non-store payroll, due
primarily to workforce reductions taken in fiscal 2002. Things Remembered also
realized savings from lower travel, meetings, store depreciation, field
supervision and systems development expenses. In fiscal 2002 compared to fiscal 2001, store rent and occupancy charges
increased $3.1 million primarily due to a higher mix of inline mall locations
than kiosks and increases in insurance, taxes and other common areas charges.
Store wage costs at Things Remembered increased $2.3 million due to higher
average hourly wage rates and increases in benefits and workers compensation.
Non-store overhead also included costs of $0.5 million for a new store point of
sales system, the implementation of which was subsequently delayed
indefinitely. Severance costs related to a senior Things Remembered executive
totaled $0.3 million. Goodwill and Tradename Amortization The Company adopted SFAS No. 142, Goodwill and Other Intangible Assets
(SFAS 142), in the first quarter of fiscal 2002. SFAS 142 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. The Company
recorded a $5.0 million goodwill and tradename amortization charge in fiscal
2001. Of this amount, $4.1 million was attributable to Cole Vision and $0.9
million to Things Remembered. Operating Income Consolidated Operations Operating income was $12.0 million, $28.3 million and $29.7 million in
fiscal 2003, 2002 and 2001, respectively. In fiscal 2003 compared to fiscal
2002, increases in unallocated corporate expenses totaling $16.9 million and
lower gross margin rate from the Cole Vision segment were the primary reason
for the decrease in operating results, offsetting improvements at Things
Remembered. In fiscal 2002 compared to fiscal 2001, a decline in operating
income at Things Remembered, increases in unallocated corporate 15




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expenses
totaling $7.9 million and legal costs associated with the California Attorney
Generals action offset improvements at Cole Vision. Cole Vision Segment Operating income at Cole Vision was $24.9 million, $30.6 million and $15.1
million in fiscal 2003, 2002 and 2001, respectively. The decrease in operating
income at Cole Vision in fiscal 2003 compared to fiscal 2002, was due
to a lower
gross margin rate, the costs associated with the closure of the Companys
Canadian lab and manufacturing facility, the increase in impairment costs, the
decrease in net revenues at Pearle Vision and increased costs of legal fees
related to the California lawsuit. These items were partially offset by
improved net revenues at Cole Licensed Brands and Cole Managed Vision and
improvements in operating expenses as a percentage of net revenues. The increase in operating income in fiscal 2002 compared to fiscal 2001
was due to the revenue increase and lower expenses as a percent of net
revenues. Results at Target Optical improved as the focus changed from
aggressive growth to measured growth and improved operations. The cessation of
goodwill and tradename amortization resulted in $4.1 million lower expense in
fiscal 2002 compared to fiscal 2001. In addition, the growth in revenue and
improved claims management efficiencies resulted in higher operating income at
Cole Managed Vision. These improvements were partially offset by the
incremental $3.5 million in legal costs associated with the California
litigation. Things Remembered Segment Operating income at Things Remembered was $21.4 million, $15.1 million and
$24.1 million in fiscal 2003, 2002 and 2001, respectively. The increase in
operating income at Things Remembered in fiscal 2003 compared to fiscal 2002
was due to increases in net revenues, improvements in store operating expenses
as a percent of net revenues, and savings from workforce reductions,
non-recurring legal costs, travel, meetings, field supervision and systems
development expenses. These improvements were partially offset by the lower
gross margin rate, and higher advertising, management bonus, and store rent and
occupancy cost increases. The decrease in operating income in fiscal 2002 compared to fiscal 2001
was due to reductions in revenue, higher store rent and occupancy costs, higher
store payroll and non-store expenses. Interest and Other (Income) Expense Interest and other (income) expense, net was $23.5 million, $36.4 million
and $24.9 million in fiscal 2003, 2002 and 2001, respectively. Fiscal 2002
results include a loss of $11.1 million on early extinguishment of debt. The
charge represents the 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. The Company recorded interest expense of $25.0 million, $26.3 million and
$27.8 million in fiscal 2003, 2002 and 2001, respectively. The reduction in
interest expense was primarily 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 and the favorable impact of the interest rate
swap agreements. See Note 3 of the Notes to Consolidated Financial Statements
for further discussion. Interest and other income, net was $1.5 million, $1.1 million and $3.0
million in fiscal 2003, 2002 and 2001, respectively. The Company recorded
interest income, primarily from temporary investments and franchise interest
income, totaling $1.4 million, $1.2 million and $2.3 million in fiscal 2003,
fiscal 2002 and fiscal 2001, respectively. The Company recognized a gain of
$0.8 million from the sale of a Dallas, Texas facility in the first quarter of
fiscal 2001. Income Tax Rate The effective income tax rate was 31.7% in fiscal 2003 compared with
103.1%, excluding the impact of the early extinguishment of debt in fiscal
2002, and 110.6% in fiscal 2001. The lower effective tax rate in fiscal 2003,
compared to fiscal 2002 was primarily due to the impact of certain
non-deductible expenses. The lower effective tax rate in fiscal 2002, compared
to fiscal 2001 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. See Note 5 of Notes to Consolidated Financial Statements for
further discussion. 16




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Reconciliation of Same Store Sales Growth Same store sales growth is a non-GAAP financial measure, which includes
deferred warranty sales on a cash basis and undelivered customer orders, and
does not reflect provisions for returns, 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 to
investors and management 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 reported on a GAAP basis follows: 2003
    
    2002
    
    2001(Dollars in thousands)Current year same store sales
    
    $
    1,041,574
    
    
    $
    993,776
    
    
    $
    961,240Prior year same store
sales(1)
    
    
    1,004,133
    
    
    
    976,291
    
    
    
    948,060Percent change
    
    
    3.7
    %
    
    
    1.8
    %
    
    
    1.4
    %Current year same store sales
    
    $
    1,041,574
    
    
    $
    993,776
    
    
    $
    961,240Adjustment for:Sales at new and closed stores
    
    
    15,261
    
    
    
    30,185
    
    
    
    25,510Deferred revenue
    
    
    (3,678
    )
    
    
    (2,701
    )
    
    
    (1,846
    )Order vs. customer receipt
    
    
    24
    
    
    
    (478
    )
    
    
    4,341Returns, remakes and refunds
    
    
    46
    
    
    
    (1,183
    )
    
    
    (751
    )Other
    
    
    325
    
    
    
    (37
    )
    
    
    188Store sales
    
    
    1,053,552
    
    
    
    1,019,562
    
    
    
    988,682Nonstore revenues
    
    
    178,517
    
    
    
    157,042
    
    
    
    146,631Intercompany eliminations
    
    
    (30,296
    )
    
    
    (28,485
    )
    
    
    (26,190
    )GAAP Basis Net revenue
    
    $
    1,201,773
    
    
    $
    1,148,119
    
    
    $
    1,109,123
 (1) Prior year same store sales differ from current year same store
sales in the prior year due to store openings and closings. Liquidity and Capital Resources The Companys primary source of liquidity is funds provided from
operations of its operating subsidiaries. On June 27, 2003, the Companys
operating subsidiaries amended, restated and extended their working capital
line of credit. The maturity date of the credit facility was extended to
February 1, 2007 from May 31, 2006. The size of the facility was adjusted to
$60.0 million from $75.0 million. In addition, certain financial covenants were
amended. As of fiscal year end 2003, the total commitment was $60.0 million and
availability under the credit facility totaled $46.1 million after reduction
for $13.9 million under letters of credit. There are no working capital
borrowings outstanding as of January 31, 2004. The maximum amount outstanding
was $11.5 million and the daily average borrowing during fiscal 2003 was
approximately $848,000. The credit facility, which is guaranteed by Cole National Corporation and
the Company, requires the Company 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 the Company to comply with certain financial covenants, including
covenants regarding minimum interest coverage and maximum leverage. The Company
is currently in compliance with the covenants in the credit agreement. On November 3, 2003, Things Remembered, Inc. and the Parent entered into
an agreement with a bank to provide documentary letters of credit for import
inventory purchases not to exceed $7.0 million. The letters of credit are
secured by the inventory purchased. As of January 31, 2004, the Company has
$3.9 million outstanding under this facility. 17




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On August 22, 1997, the Company issued $125.0 million of 8-5/8% Senior
Subordinated Notes that mature in 2007 with no earlier scheduled redemption or
sinking fund payments. 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. A loss on
early extinguishment of debt of $11.1 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 the Company
to incur additional indebtedness, pay dividends or make other restricted
payments to the Parent. The indentures also permit payments to the Parent 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. Following
consummation of the Merger the holders of the 8-5/8% notes and the 8-7/8% notes
will have the right to put the notes to the Company at a price of 101% of par
plus accrued interest. If the holders exercise such right, the Company may be
required to obtain financing from its parent or a third party to satisfy such
obligation. No significant principal payment obligations are due under the Companys
outstanding indebtedness until 2007, when the $125.0 million of 8-5/8% senior
subordinated debt is due. The ability of the Company and its subsidiaries to
satisfy their obligations will be primarily dependent upon the future financial
and operating performance of the subsidiaries and upon the Parents ability to
renew or refinance borrowings or raise additional capital through equity
financing or sales of assets. The Company maintains a noncontributory defined benefit pension plan that
covers employees who have met eligibility service requirements and are not
members of certain collective bargaining units. The pension plan calls for
benefits to be paid to eligible employees at retirement, based primarily upon
years of service and their compensation levels near retirement. In January
2002, the Company approved a plan freeze for all participants except for
participants who are at least age 50 or older with 10 years of benefit service
as of March 31, 2002. These participants had their average pay frozen as of
March 31, 2002, and covered compensation frozen
as of December 31, 2001, but their benefit service will continue to grow.
The Companys policy is to fund amounts necessary to keep the pension plan in
full force and effect, in accordance with the Internal Revenue Code and the
Employee Retirement Income Security Act of 1974. During fiscal 2003, the Company changed the discount rate used to
calculate its projected benefit obligation from 6.5% to 6.0%. The change in the
discount rate reflects the overall decline in market interest rates and has led
to an increase in the projected benefit obligation at January 31, 2004. The
increase in the obligation was partially offset by improvements in stock market
performance, which increased the fair value of the pension plans assets. As a
result of these factors, the pension plan was underfunded by $20.5 million as
of January 31, 2004. The Company has recorded the increase in the minimum
pension liability by charging $2.8 million to accumulated other comprehensive
income (loss) in stockholders equity. This charge will not impact the actual
funding requirements of the plan or the Companys compliance with debt
covenants. The expected future funding requirement for fiscal 2004 is $7.5
million. Cash Flows from Operating Activities Cash and cash equivalents were $59.2 million at January 31, 2004 compared
to $42.0 million at February 1, 2003 and $63.3 million at February 2, 2002.
Operations generated net cash of $30.8 million,
$43.8 million, and $56.2
million in fiscal 2003, fiscal 2002, and fiscal 2001, respectively. The Company
incurred a net loss in fiscal 2003, 2002 and 2001, which is described above in
the Results of Operations section of this report. Depreciation and amortization
was $39.8 million, $35.6 million and $38.9 million for fiscal 2003, fiscal 2002
and fiscal 2001, respectively. The increase in fiscal 2003, compared to fiscal
2002, was due primarily to higher systems development and capitalized software
amortization, primarily for the Patriot Claims Management System. The decrease
in fiscal 2002 compared to fiscal 2001 was due primarily to the cessation of
goodwill and tradename amortization. Gains from sales of assets were $1.0
million in fiscal 2003 and $0.8 million in fiscal 2001. These gains were
attributable to the sale of the aircraft in fiscal 2003 and the gain on the
sale of a Dallas, TX facility in the first quarter of fiscal 2001. Noncash
impairment charges were $4.4 million, $0.9 million and $3.7 million in fiscal
2003, fiscal 2002 and fiscal 2001, respectively. Fiscal 2003 impairment charges
included $2.5 million for point of sale software purchased in 1999, but never
deployed. The remaining impairment charges resulted from the Companys
application of SFAS 144, which was described above in the Results of Operations
section of this report. Noncash compensation totaled $3.7 million,
($0.4) million and $0.2 million in fiscal 2003, 2002 and 2001,
respectively. The change was due primarily for compensation expense
for variable stock options. The change in the deferred income tax provision
(benefit) was ($3.5) million in fiscal 2003, compared to ($2.5) million and
$2.9 million in 18




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fiscal 2002 and fiscal 2001, respectively. Further information regarding
deferred taxes is provided in Note 5 of the Notes to Consolidated Financial
Statements. Fiscal 2002 results included a loss of $11.1 million on early
extinguishment of debt, described earlier in the Results of Operations. Noncash
interest was $0.0 million, $1.2 million and $1.3 million in fiscal 2003, 2002
and 2001, respectively. The change was due primarily to the return on deferred
compensation plan assets. Changes
in working capital resulted in a use of funds totaling $4.7
million in fiscal 2003 compared to a source of funds of $5.2 million in fiscal
2002 and $10.5 million in fiscal 2001. Changes in
accounts and notes receivable and other assets resulted in a use of funds of
$4.0 million in fiscal 2003, compared to a use of funds of $11.5 million in
fiscal 2002 and $1.4 million in fiscal 2001. Increases in receivables at Cole
Licensed Brands and receivables generated from the sale of franchise locations
at Pearle Vision accounted for the majority of the use of cash in fiscal 2003,
partially offset by lower receivables at Cole Managed Vision due to improved
receivables collection. The $11.5 million use of cash in fiscal 2002 was due
primarily to increased revenues and corresponding receivables at Cole Vision.
Changes in inventories resulted in a source of cash totaling $1.0 million in
fiscal 2002 and $9.6 million in fiscal 2001. During fiscal 2001, the Company
undertook an extensive re-merchandising program at Pearle Vision, which
contributed to the inventory reduction of $9.6 million. Changes in accounts
payables and liabilities resulted in a use of cash totaling $0.2 million in
fiscal 2003 compared to a source of cash totaling
$13.6 million and $2.1 million in fiscal 2002 and fiscal
2001, respectively. The source
of cash in fiscal 2002 was due primarily to the increase in deferred revenues
and to increases in liabilities for audit fees, retirement plans, benefit
obligations and bonus accruals. Accrued and refundable income taxes used $0.4
million in fiscal 2003, compared to a source of funds of $0.7 million and $0.3
million in fiscal 2002 and 2001, respectively. Further information regarding
income taxes is provided in Note 5 of the Notes to Consolidated Financial
Statements. Cash Flows from Investing Activities Net cash from investing activities resulted in a use of funds of $33.5
million in fiscal 2003, compared to $46.6 million in fiscal 2002 and $28.9
million in fiscal 2001. Capital expenditures, which accounted for most of the
cash used for investing, were $26.8 million, $39.4 million and $33.6 million in
fiscal 2003, 2002 and 2001, respectively. The majority of capital expenditures
were for remodeling of existing stores and store fixtures, equipment and
leasehold improvements for new stores, including the Target Optical expansion.
The reduction in capital expenditures in fiscal 2003 was primarily at Cole
Licensed Brands and Things Remembered, as the Company reduced its investment in
new stores and remodeling. The increase in capital expenditures in fiscal 2002
compared to fiscal 2001 was due to increased investment in Cole Licensed Brands
for the Target Optical expansion and central lab investments, partially offset
by lower capital expenditures at Pearle Vision as the Company reduced
expenditures for new Pearle Vision stores. Proceeds from the sale of fixed
assets totaled $2.6 million in fiscal 2003, $12.5 million in fiscal 2001 and $0
in fiscal 2002. The fiscal 2003 proceeds were due to the sale of the Companys
aircraft. In fiscal 2001, net proceeds of $12.5 million were received from the
sale of two facilities no longer required for operations and from the sale and
leaseback of Pearle Visions former headquarters office building in Dallas,
Texas and a portion of the land. The Company paid $5.3 million, $5.6 million
and $6.9 million for systems development costs in fiscal 2003, 2002 and 2001,
respectively. Such costs have been capitalized and are being amortized over the
systems estimated useful lives. The Company used $3.8 million, $1.6 million
and $0.8 million in fiscal 2003, 2002 and 2001, respectively, for contingent
payments in connection with the prior acquisition of MetLifes managed vision
business. Cash Flows from Financing Activities Net
cash provided by financing activities totaled $19.9 million in fiscal
2003. Net cash used for financing totaled
$18.5 million and $1.2 million in fiscal 2002 and fiscal
2001, respectively. In May 2002, the Company issued $150.0 million of
8-7/8% Senior Subordinated Notes due May 2012. The net proceeds of the issuance
and cash on hand were used to retire all of the Companys $150.0 million 9-7/8%
Senior Subordinated Notes due 2006. Finance fees and early repayment of the
9-7/8% notes resulted in a net cash usage of $14.2 million. Changes in
overdraft balances used $2.4 million in funds in fiscal 2003, compared to a
source from financing of $1.7 million and $3.5 million in fiscal 2002 and 2001,
respectively. The change in overdraft balances was due to the timing of
payments. Advances from affiliates totaled $21.4 million in fiscal 2003,
compared with advances to affiliates of $6.4 million and $4.3 million in fiscal
2002 and 2001, respectively. 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 systems
development costs. These expenditures are expected to be in the range of $35.0
to $40.0 million in fiscal 2004. 19




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##### Table of Contents



Off-Balance Sheet Arrangements and Contractual Obligations 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 revenues. A more complete discussion
of the Companys lease and license commitments is included in Note 8 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 and 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 8 of the Notes to Consolidated
Financial Statements. The Company also subleases an office and general operating facility in
Highland Heights, Ohio from the Parent who leases the property from a special
purpose entity (the Trust), which was created in 1997 specifically for the
purpose of structuring a four-year operating lease with annual renewal options
up to six years. The lease provides for regular payments based on LIBOR plus
1.50%. In accordance with this agreement, the Parent must maintain compliance
with a minimum net worth covenant. At the end of this lease in 2007, the Parent
has the option to purchase the property or arrange for the sale of the
property. If the Parent does not exercise its purchase option at the end of the
lease, it is contingently liable to the Trust for up to $1.7 million. The
Parent does not believe it will have any payment obligation at the end of the
lease because either the Parent will exercise the purchase option, or the net
proceeds from the sale of the property will exceed the amount payable to the
Trust. Under FASB Interpretation No. 46, Consolidation of Variable Interest
Entities (FIN 46) and revised FIN 46 (FIN 46R), certain special purpose
entities are required to be consolidated if it is determined that an enterprise
is the primary beneficiary because it is deemed to have controlling financial
interest in the entity. The Company has determined that it has controlling
financial interest in the Trust since the Company is required to absorb any
expected losses, will receive the majority of expected residual returns and is
the primary beneficiary. Therefore, the Trust assets of $2.2 million and
liabilities of $2.2 million have been consolidated into the financial
statements of the Company as of January 31, 2004. Future operating results of
the Trust will be consolidated in the financial statements of the Company and
is not expected to have a material effect on the Companys financial position
or operations. In fiscal 2000, the Company guaranteed certain borrowings of a franchisee
with a bank in connection with the operations of two franchised stores. The
maximum exposure under the agreement is $333,000 and expires upon full payment
of the term loan borrowings by the franchisee. The term of the loan is until
2010. In fiscal 2003, the Company entered into an agreement to guarantee a
portion of the amount owed to a bank by a franchisee as a result of a loan
granted in connection with the purchase of five stores. The guaranteed amount
equals the cumulative value of the store assets. The Company is released from
its obligation once the landlords of the store locations execute subordination
agreements or the bank is granted access to the store assets in the event of
the default by the franchisee. The maximum exposure under the agreement is
$464,000 as of January 31, 2004. The following table summarizes certain payments due by period for
contractual obligations including operating leases: Payments Due by Period (dollars in thousands)Less Than
    
    
    
    
    
    
    
    
    
    AfterContractual Obligations
    
    Total
    
    1 Year
    
    1-3 Years
    
    4-5 Years
    
    5 YearsLong-term debt
    
    $
    275,000
    
    
    $
    
    
    
    $
    125,000
    
    
    $
    
    
    
    $
    150,000Capital lease obligations, including interest
    
    
    2,614
    
    
    
    643
    
    
    
    1,156
    
    
    
    713
    
    
    
    102Debt of variable interest entity
    
    
    2,452
    
    
    
    196
    
    
    
    410
    
    
    
    1,846
    
    
    
    Operating leases
    
    
    346,628
    
    
    
    77,244
    
    
    
    117,465
    
    
    
    74,913
    
    
    
    77,006Sublease agreements
    
    
    (38,827
    )
    
    
    (10,456
    )
    
    
    (14,592
    )
    
    
    (7,904
    )
    
    
    (5,875
    )Long-term employee contract
    
    
    3,035
    
    
    
    865
    
    
    
    1,805
    
    
    
    365
    
    
    
    Total contractual obligations
    
    $
    590,902
    
    
    $
    68,492
    
    
    $
    231,244
    
    
    $
    69,933
    
    
    $
    221,233
 20




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Recently Issued Accounting Standards The Financial Accounting Standards Board (FASB) 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 for classification as an extraordinary item shall be
reclassified as operating expenses. The Company adopted 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 has been
reclassified. The pretax loss from the early extinguishment of debt has been
presented as a separate line within interest and other (income) expenses and
the related income tax benefit reduced the reported income tax provision. Other
portions of the statement are not applicable to the Company. The FASB has also issued SFAS No. 143, Accounting for Asset Retirement
Obligations (SFAS 143). SFAS 143 provides guidance for legal obligations
arising from the retirement of long-lived assets. SFAS 143 was adopted in
fiscal 2003 and did not have a material effect on the Companys financial
position or operations. In January 2003, the FASB issued FASB Interpretation No. 46,
Consolidation of Variable Interest Entities (FIN 46) and revised FIN 46 (FIN
46R) in December 2003. The Interpretations requires certain variable interest
entities, including certain special purpose entities, to be consolidated by the
primary beneficiary if the equity investors in the entity do not have all the
essential characteristics of a controlling financial interest or do not have
sufficient equity at risk. The Interpretations immediately apply to entities
created after January 31, 2003, are effective for the fourth quarter of fiscal
2003 for certain special purpose entities and are effective for the first
quarter of fiscal 2004 for other existing variable interest entities. The
synthetic operating lease for the Highland Heights, Ohio facility required
consolidation under this Interpretation. The consolidation resulted in an
additional $2.2 million in assets and liabilities on the consolidated balance
sheet. Management is still assessing the impacts of this Interpretation on its
consolidated financial statements regarding existing variable interest entities
within its franchise operations. In November 2002, the Emerging Issues Task Force of the FASB (EITF)
reached a consensus on Issue 02-16, Accounting by a Reseller for Cash
Consideration Received from a Vendor (Issue 02-16), which addresses the
accounting by a customer for consideration received from a vendor, including
a reseller of the vendors products. Certain aspects of the issue were
effective immediately, which were adopted and did not have a significant impact
on results of operations in fiscal 2002. The remaining portion of Issue 02-16
was adopted during fiscal 2003 and did not have a material effect on the
Companys financial position or results of operations. In December 2003, the FASB issued SFAS No. 132 (Revised 2003), Employers
Disclosures about Pensions and Other Postretirement Benefits (SFAS 132). This
statement revises employers disclosures about pension plans and other
postretirement benefit plans to require more information about the economic
resources and obligations of such plans. Certain disclosure provisions were
effective for fiscal 2003, which were adopted. The remaining disclosure
provisions of SFAS 132 will be adopted during fiscal 2004. In April 2003, the FASB issued SFAS No. 149, Amendment of Statement 133
on Derivative Instruments and Hedging Activities SFAS 149, which amends and
clarifies accounting and reporting for derivative instruments, including
certain embedded derivatives and for hedging activities under SFAS 133. SFAS
149 was adopted in fiscal 2003 and had no effect on the Companys financial
position or results of operations. On December 8, 2003, the Medicare Prescription Drug, Improvement and
Modernization Act of 2003 (the Act) was signed into law. In accordance with
FASB Staff Position 106-1, the Companys measures of the accumulated
postretirement benefit obligation and net periodic benefit cost in the
consolidated financial statements and accompanying notes do not reflect the
effects of the Act on the Companys postretirement benefit plan. Specific
authoritative guidance on the accounting for the federal subsidy is pending
and, when issued, could require the Company to change previously reported
information. Contingencies The Company and its optical subsidiaries have been sued by the State of
California, which alleges claims for various statutory violations related to
the operation of 23 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. In July 2002, the 21




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State of California obtained a preliminary injunction to enjoin certain advertising
practices and from charging dilation fees. The trial courts decision was
appealed by both the Company and the State. On November 26, 2003, the appellate
court ruled on the appeal in a manner adverse to the Company with respect to
continued advertising in California by Pearle Vision that expressly or
implicitly advertises the furnishing of optometric services, disallowing
continued advertising of the availability of optometric services with a
disclaimer that had been previously approved by the trial court. The appellate
court ruled in the Companys favor with respect to charging dilation fees. On
March 3, 2004, the California Supreme Court granted the Companys petition for
review of the Appellate Courts decision. Although the Company believes that
its advertising and operational practices in California complied with
California law, the appellate ruling may, if unmodified, compel the Company to
modify or close its activities in California. Further, the Company might be
required to pay damages and or restitution in a currently undeterminable
amount, the cost of which might have a material adverse effect on the Companys
operating results and cash flow in one or more periods. Following the Companys announcement in November 2002 of the restatement
of the Companys financial statements, the Securities and Exchange Commission
began an investigation into the Companys previous accounting. The course of
this investigation or other litigation or investigations arising out of the
restatement of the Companys financial statements cannot be predicted. In
addition, under certain circumstances the Company would be obliged to indemnify
the individual current and former directors and officers who are named as
defendants in litigation or who are or become involved in an investigation. The
Company believes it has insurance that should be available with respect to a
portion of its indemnification obligations. If the Company is unsuccessful in
defending against the current investigation or any litigation,there may be a
material adverse effect on the Companys financial condition, cash flow and
results of operations. As described in Part I, Item 3, Legal Proceedings, the Company has been
named as a defendant along with numerous other retailers, in patent
infringement litigation challenging the defendants use of bar code technology.
The Company believes it has available defenses and does not expect any
liability. However, if the Company were to be found liable for an infringement,
it might have a material adverse effect on the Companys operating results and
cash flow in the period incurred. 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. The Company and Target Corporation have reached an agreement to renew the
agreement under which the Company operates licensed optical departments in
Target stores with modified terms. As a result of the new agreement, the
Company closed 25 Target Optical stores in the first quarter of fiscal 2004 and
will incur a charge of approximately $2.2 million related to store closing
costs. Significant Accounting Policies The preparation of financial statements requires the Company to estimate
the effect of various matters that are inherently uncertain as of the date of
the financial statements. Each of these required estimates varies in regard to
the level of judgment involved and its potential impact on the Companys
reported financial results. Estimates are deemed significant when a different
estimate could have reasonably been used or where changes in the estimate are
reasonably likely to occur from period to period, and would materially impact
the Companys financial condition, changes in financial condition or results of
operations. The Companys significant accounting policies are discussed in Note
1 of the Notes to Consolidated Financial Statements. Critical estimates
inherent in these accounting policies are discussed in the following
paragraphs. Allowance for Uncollectible Accounts The Company records an allowance for uncollectible accounts to reflect
managements best estimate of losses inherent in its portfolio of receivables
from Cole Licensed Brands host stores, Pearle Vision franchisees and managed
vision care accounts. The allowance is established through a charge to the
provision and represents amounts of current and past due receivable balances
which management estimates will not be collectible. The Company calculates the
allowance for uncollectible accounts using historical experience, current
trends, credit policy and aging reports. An analysis, including historical
performance, break-even analysis and payment arrangements is performed on
delinquent accounts. The Companys calculation is reviewed by management to
assess whether additional consideration is required to appropriately estimate
losses in the receivable portfolio. Management believes its receivables are
adequately reserved under current conditions. Any significant deterioration in
the economic environment could materially affect these expectations. 22




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Valuation of Inventories Inventories are recorded at the lower of cost, or market, with cost 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 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. Management believes its inventories are appropriately valued. Valuation of Long-Lived Assets Property and equipment, systems development, and other finite intangibles
are amortized over their estimated useful lives. Useful lives are based on
managements estimates of the period that the assets will generate revenue.
These assets are reviewed for impairment whenever events or changes in
circumstances indicate that the carrying amount may not be recoverable. An
initial screening is performed on all long-lived assets. Store locations less
than three years old and stores relocated within three years of fiscal year-end
are excluded from testing. If the undiscounted future cash flows from the
long-lived asset are less than the carrying value, the Company recognizes a
loss equal to the difference between the discounted future cash flow and the
carrying value. Managements estimate of future cash flow is based on its
experience, knowledge and market data. However, these estimates can be affected
by factors such as future store profitability, real estate demand and economic
conditions that can be difficult to predict. 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). 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. The Company uses, amongst other things, the
findings of an outside valuation advisor to assist with its impairment testing. Valuation of Deferred Income Taxes Deferred tax assets and liabilities are recognized based on the
differences between the financial statement carrying amounts and the tax bases
of assets and liabilities. Management regularly reviews its deferred tax assets
for recoverability and establishes a valuation allowance for tax assets based
on historical taxable income, projected future taxable income and the expected
timing of the reversals of existing temporary differences. In determining the
valuation allowance related to deferred tax assets, management estimates
taxable income into the future. The assessment of whether or not a valuation
allowance is required often requires significant judgment including the
forecast of future taxable income and the evaluation of tax planning
initiatives. Adjustments to the deferred tax valuation allowance are made to
earnings in the period when such assessment is made. Allowance for Remakes and Returns Sales are recorded in accordance with the Companys policy for revenue
recognition and deferred revenue discussed in the summary of Significant
Accounting Policies. Revenues have been reduced by allowances for remakes of
product and returns. The estimated allowances are calculated as a percentage of
sales and based upon historical return percentages. Managed Vision Underwriting Results The Company sells capitated managed vision care plans, which generally
have duration of one year. Based upon its experience, the Company believes that
it can predict utilization and claims experience, including estimates for
claims incurred but not reported, 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. The reserves are
reconciled following the end of each plan year. Self-Insurance Reserves Due to the significant deductible under its insurance policies, the
Company is primarily self-insured for property loss, workers compensation,
automobile and general liability costs. The liabilities are determined
actuarially based on claims filed and estimates for
claims incurred but not reported. These liabilities are not discounted. In
estimating the obligation associated with incurred losses, the 23




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##### Table of Contents



Company utilizes
loss development factors prepared by independent third party actuaries. These
development factors utilize historical data to project the future development
of incurred losses. Loss estimates are adjusted based upon actual claims
settlements and reported claims. Defined Benefit Retirement Plans The plan obligations and related assets of defined benefit retirement
plans are presented in Note 6 of the Notes to Consolidated Financial
Statements. Plan assets, which consist primarily of marketable equity and debt
instruments, are valued using market quotations. Plan obligations and annual
pension expense are determined by independent actuaries and through the use of
a number of assumptions. Key assumptions in measuring the plan obligations
include the discount rate and the estimated future return on plan assets. In
determining the discount rate, the Company utilizes the yield on high-quality,
fixed income investments currently available with maturities corresponding to
the anticipated timing of the benefit payments. Asset returns are based upon
the anticipated average rate of earnings expected on the invested funds of the
plans. At January 31, 2004, the weighted average actuarial assumptions of the
Companys plans were discount rate 6.0% and long-term rate of return on plan
assets 9.0%. Certain Operating and Expense Trends Same store sales in the Companys vision segment experienced strong
double-digit increases during the first two months of the 2004 fiscal year
compared to the same period in fiscal 2003. The performance within the segment
was varied, with Cole Licensed Brands posting strong double digit results and
Pearle Visions Company-owned stores posting low single digit increases. Things
Remembered generated same store sales increases in the high single digits.
There is no assurance that these same store sales trends will continue for the
remainder of the first quarter of fiscal 2004. Costs associated with the California litigation and the SEC investigation
are expected to continue in 2004. However, many of the unallocated corporate
expenses, such as the costs related to the management change, shareholder
settlement and restatement audit fees are not expected to recur. The Company
expects its profit performance to improve in fiscal 2004 as a result of revenue
growth, expense controls and the non-recurrence of the aforementioned
unallocated corporate expenses. As a result of the Companys new agreement with
Target Corporation, the Company closed 25 Target Optical stores on April 10,
2004 and expects to incur a charge of approximately $2.2 million related to
store closing costs. 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, risks that the contemplated merger between the
Parent and Luxottica Group S.p.A. will not be completed, uncertainty as to the
timing of obtaining regulatory approvals and clearance for the Merger, 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, costs and other effects associated with
litigation, 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,
franchisees and managed care clients, the mix of goods sold, pricing and other
competitive factors, and the seasonality of the Companys business. 
 Item 7A. Quantitative and Qualitative Disclosures About Market Risk The Companys major market risk is to changes in foreign currency exchange
rates in Canada 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 24




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##### Table of Contents



foreign currency fluctuations through natural internal offsets to the
fullest extent possible. A 10% adverse movement in quoted foreign currency
exchange rates could result in a loss of fair value of investments and notes
and interest receivables of $0.1 million. In addition, the Company is exposed to changes in the fair value of its
debt portfolio, primarily resulting from the effects of changes in interest
rates. The Company utilizes interest rate swaps to manage its exposure.
Management believes that its use of these financial instruments is in the
Companys best interest. 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 rate on $50.0 million of the Companys $125.0 million
8-5/8% Senior Subordinated Notes due 2007. The agreements mature August 15,
2007 and qualify as fair value hedges. The LIBOR rate is reset in arrears in
February and August of each year. The reset effective on February 17, 2004 for
six month LIBOR was 1.175% and resulted in a rate of 5.7125% applied from
August 16, 2003 through February 17, 2004. At January 31, 2004 the fair value
of the swap agreements was an unrealized gain of approximately $0.8 million. A change in six month LIBOR would effect the interest cost associated with
the $50.0 million notional value of the swap agreements. A 50% change
(approximately 59 basis points) in the market rates of interest for six month
LIBOR as compared to the rate in effect for fiscal 2003 would increase the
Companys annual interest cost by $0.3 million. The Company does not enter into
financial instruments for trading purposes. 
 Item 8. Financial Statements and Supplementary Data Information
required by this item appears on pages F-1 through F-32 of
this Form 10-K/A and is incorporated herein by this reference. Other financial
statements and schedules are filed herewith as Financial Statement Schedules
pursuant to Item 15. 
 Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure None. 
 Item 9A. Controls and Procedures (a) Immediately following the Signature section of this Annual 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 Annual Report on
Form 10-K is our disclosure of the results of our control evaluation referred
to in paragraphs (4) and (5) 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. 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 design, operation and effectiveness of
the Companys disclosure controls and procedures. The Companys Chief Executive
Officer and Chief Financial Officer concluded that based on such evaluation, as
of January 31, 2004, the Companys disclosure controls and procedures were
effective and 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) Based on evaluation, there have not been any changes in the Companys
internal control over financial reporting or in other factors during the
fourth quarter of fiscal year ended January 31, 2004 that have materially
affected, or are reasonably likely to materially affect, the Companys internal
controls over financial reporting. 
 PART III 
 Item 10. Directors and Executive Officers of the Registrant Information required by this item has been omitted pursuant to General
Instruction I of Form 10-K. 
 Item 11. Executive Compensation Information required by this item has been omitted pursuant to General
Instruction I of Form 10-K. 25




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##### Table of Contents



Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters Information required by this item has been omitted pursuant to General
Instruction I of Form 10-K. 
 Item 13. Certain Relationships and Related Transactions Information required by this item has been omitted pursuant to General
Instruction I of Form 10-K. 
 Item 14. Principal Accountant Fees and Services. Information required by this item has been omitted pursuant to General
Instruction I of Form 10-K. 
 PART IV 
 Item 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K (a)(1) and (2) Financial Statements and Financial Statement Schedules The consolidated financial statements and the related financial
statement schedules filed as part of this Form 10-K/A for Cole National Group,
Inc. and its consolidated subsidiaries are located as set forth in the index
on page F-1 of this report. (a)(3) Exhibits See Exhibit Index on pages X-1 through X-4. (b) Reports on Form 8-K The Company filed a Form 8-K (Item 7 and 12) on December 16, 2003, which
attached a press release announcing financial results for third fiscal quarter
of 2003. The Company filed a Form 8-K (Item 5 and 7) on January 27, 2004 announcing
that the Parent entered into a definitive Agreement and Plan of Merger with
Luxottica Group S.P.A. and Colorado Acquisition Corp, to acquire all of the
outstanding shares of Cole National Corporation for a cash purchase price of
$22.50 per share. The Company filed a Form 8-K (Item 5 and 7) on January 30, 2004,
announcing that it had extended its agreement with Target Corporation. Supplemental information to be furnished with reports filed pursuant to Section
15(d) of the Act by Registrants which have not registered securities pursuant
to Section 12 of the Act. No annual report or proxy statement covering Cole National Groups last fiscal
year has been or will be circulated to security holders. 26




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##### Table of Contents



SIGNATURES Pursuant to the requirements of section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed
on its behalf by the undersigned, thereunto duly authorized. COLE NATIONAL GROUP, INC.
 June 1, 2004
    
    By:
    
    /s/ Ann M. HoltAnn M. HoltSenior Vice President and Corporate Controller
 Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed by the following persons on behalf of the Registrant and
in the capacities and on the dates indicated. /s/ Larry Pollock
    
    President and Chief Executive Officer
    
    June 1, 2004and DirectorLarry Pollock/s/ Lawrence E. Hyatt
    
    Executive Vice President and
    
    June 1, 2004Chief Financial OfficerLawrence E. Hyatt
    
    (Principal Financial Officer)s/ Ann M. Holt
    
    Senior Vice President and Corporate Controller
    
    June 1, 2004(Principal Accounting Officer)Ann M. Holt*
    
    Chairman
    
    June 1, 2004Walter J. Salmon*
    
    Director
    
    June 1, 2004Jeffrey A. Cole*
    
    Director
    
    June 1, 2004Ronald E. Eilers*
    
    Director
    
    June 1, 2004Timothy F. Finley*
    
    Director
    
    June 1, 2004Irwin N. Gold*
    
    Director
    
    June 1, 2004Peter V. Handal*
    
    Director
    
    June 1, 2004Charles A. Ratner
  *
    
    The undersigned, by signing her name hereto, does sign and execute
this report on Form 10-K/A pursuant to the Powers of Attorney executed by
the above-named officers and directors of Cole National Group, Inc. and
which are being filed herewith with the Securities and Exchange Commission
on behalf of such officers and directors. /s/
Ann M. HoltAnn M. Holt, Attorney-in-Fact
 27




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##### Table of Contents



INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND SCHEDULES PageReport of
Independent Registered Public Accounting Firm
    
    
    F - 2Consolidated Balance Sheets as of January 31, 2004 and February 1, 2003
    
    
    F - 3Consolidated Statements of Operations for the 52 weeks ended January 31, 2004, February 1, 2003
and February 2, 2002
    
    
    F - 4Consolidated Statements of Cash Flows for the 52 weeks ended January 31, 2004, February 1, 2003
and February 2, 2002 (as restated)
    
    
    F - 5Consolidated
Statements of Stockholders Equity and Comprehensive Income (Loss)
for the 52 weeks ended January 31, 2004, February 1, 2003 and February 2, 2002
    
    
    F - 6Notes to Consolidated Financial Statements
    
    
    F - 7Financial Statement Schedules:Schedule I  Condensed Financial Information of Registrant
    
    
    F - 29Schedule II  Valuation and Qualifying Accounts
    
    
    F - 32
 All financial statement schedules not included have been omitted because they
are not applicable or because the required information is otherwise
furnished. F-1




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##### Table of Contents



Report of Independent
Registered Public Accounting Firm To the Board of Directors of Cole National Group, Inc.: We have audited the accompanying consolidated balance sheets of Cole
National Group, Inc. and subsidiaries (the Company) as of January 31, 2004
and February 1, 2003, and the related consolidated statements of operations,
stockholders equity and comprehensive income (loss), and cash flows for each
of the three fiscal years in the period ended January 31, 2004. Our audits also
included the financial statement schedules listed in Item 15(a)(2) . These
financial statements and financial statement schedules are the responsibility
of the Companys management. Our responsibility is to express an opinion on
these financial statements and financial statement schedules based on our
audits. We
conducted our audits in accordance with standards of the Public
Company Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion. In our opinion, such consolidated financial statements present fairly, in
all material respects, the financial position of Cole National Group, Inc. and
subsidiaries as of January 31, 2004 and February 1, 2003, and the results of
their operations and their cash flows for each of the three fiscal years in the
period ended January 31, 2004, in conformity with accounting principles
generally accepted in the United States of America. Also, in our opinion, such
financial statement schedules, when considered in relation to the basic
consolidated financial statements taken as a whole, present fairly in all
material respects the information set forth therein. As discussed in Note 1 to the consolidated financial statements, the
Company changed its presentation and classification of the (gain) loss on early
extinguishment of debt, effective February 2, 2003. As discussed in Notes 1 and 2 to the consolidated financial statements,
the Company changed its method of accounting for goodwill and other intangible
assets, effective February 3, 2002. As
discussed in Note 11 to the consolidated financial statements,
the accompanying consolidated statements of cash flows have been
restated. /s/Deloitte & Touche LLP Cleveland, Ohio
April 12, 2004
(May 28, 2004 as to Note 11) F-2




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##### Table of Contents



COLE NATIONAL GROUP, INC AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Dollars in thousands) January 31,
    
    February 1,2004
    

    2003AssetsCurrent assets:Cash and cash equivalents
    
    $
    59,184
    
    
    $
    42,001Accounts receivable, less allowances of $3,449
in 2003 and $3,063 in 2002
    
    
    55,238
    
    
    
    50,954Current portion of notes receivable
    
    
    2,501
    
    
    
    4,517Inventories
    
    
    120,927
    
    
    
    120,642Prepaid expenses and other
    
    
    25,610
    
    
    
    24,210Deferred income taxes
    
    
    31,612
    
    
    
    32,116Total current assets
    
    
    295,072
    
    
    
    274,440Property and equipment, at cost
    
    
    311,890
    
    
    
    312,413Less  accumulated depreciation and amortization
    
    
    (194,886
    )
    
    
    (192,805
    )Total property and equipment, net
    
    
    117,004
    
    
    
    119,608Notes receivable, excluding current portion, less allowances
of $2,858 in 2003 and $3,049 in 2002
    
    
    4,928
    
    
    
    2,180Deferred income taxes
    
    
    31,375
    
    
    
    26,026Other assets
    
    
    36,959
    
    
    
    45,449Other intangibles, net
    
    
    49,773
    
    
    
    50,903Goodwill, net
    
    
    85,734
    
    
    
    85,557Total assets
    
    $
    620,845
    
    
    $
    604,163Liabilities and Stockholders EquityCurrent liabilities:Current portion of long-term debt
    
    $
    608
    
    
    $
    232Accounts payable
    
    
    61,180
    
    
    
    67,581Payable to affiliates, net
    
    
    97,512
    
    
    
    75,764Accrued interest
    
    
    7,715
    
    
    
    7,805Accrued liabilities
    
    
    95,041
    
    
    
    92,289Accrued income taxes
    
    
    2,789
    
    
    
    3,309Deferred revenue
    
    
    41,122
    
    
    
    38,014Total current liabilities
    
    
    305,967
    
    
    
    284,994Long-term debt, net of discount and current portion
    
    
    279,229
    
    
    
    276,553Other long-term liabilities
    
    
    32,726
    
    
    
    36,498Deferred revenue, long-term
    
    
    12,129
    

    
    
    11,559Stockholders equity:Common stock
    
    
    
    
    
    
    Paid in-capital
    
    
    200,299
    
    
    
    195,326Accumulated other comprehensive loss
    
    
    (15,303
    )
    
    
    (14,393
    )Accumulated deficit
    
    
    (194,202
    )
    
    
    (186,374
    )Total stockholders equity (deficit)
    
    
    (9,206
    )
    
    
    (5,441
    )Total liabilities and stockholders equity
    
    $
    620,845
    
    
    $
    604,163
 The accompanying notes to consolidated financial statements are an integral part of these consolidated financial statements. F-3




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COLE NATIONAL GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(Dollars in thousands) Fifty-Two Weeks EndedJanuary 31,
    
    February 1,
    
    February 2,2004
    
    2003
    
    2002Net revenues
    
    $
    1,201,773
    
    
    $
    1,148,119
    
    
    $
    1,109,123Cost and expenses:Cost of revenues
    
    
    448,813
    
    
    
    412,253
    
    
    
    395,407Operating expenses
    
    
    740,950
    
    
    
    707,596
    
    
    
    679,040Goodwill and tradename amortization
    
    
    
    
    
    
    
    
    
    
    5,010Total costs and expenses
    
    
    1,189,763
    
    
    
    1,119,849
    
    
    
    1,079,457Operating income
    
    
    12,010
    
    
    
    28,270
    
    
    
    29,666Interest and other (income) expense:Interest expense
    
    
    24,989
    
    
    
    26,320
    
    
    
    27,829Interest and other (income), net
    
    
    (1,498
    )
    
    
    (1,059
    )
    
    
    (2,962
    )(Gains) loss on early extinguishment of debt
    
    
    (15
    )
    
    
    11,141
    
    
    
    Total interest and other (income) expense, net
    
    
    23,476
    
    
    
    36,402
    
    
    
    24,867Income (loss) before income taxes
    
    
    (11,466
    )
    
    
    (8,132
    )
    
    
    4,799Income tax provision (benefit)
    
    
    (3,638
    )
    
    
    (795
    )
    
    
    5,309Net income (loss)
    
    $
    (7,828
    )
    
    $
    (7,337
    )
    
    $
    (510
    )
 The accompanying notes to consolidated financial statements are an integral part of these consolidated financial statements. F-4




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##### Table of Contents



COLE NATIONAL GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in thousands) Fifty-Two Weeks EndedJanuary 31,
    
    February 1,
    
    February 2,2004
    
    2003
    
    2002(As restated, see
Note 11)Cash flows from operating activities:Net income (loss)
    
    $
    (7,828
    )
    
    $
    (7,337
    )
    
    $
    (510
    )Adjustments to reconcile net income (loss) to net cash
provided by operating activities:Depreciation and amortization
    
    
    39,787
    
    
    
    35,630
    
    
    
    38,905Gain on sale of assets
    
    
    (1,019
    )
    
    
    
    
    
    
    (840
    )Impairment losses
    
    
    4,406
    
    
    
    899
    
    
    
    3,738Noncash compensation
    
    
    3,690
    
    
    
    (399
    )
    
    
    218Deferred income tax provision (benefit)
    
    
    (3,450
    )
    
    
    (2,488
    )
    
    
    2,929(Gain) loss on early extinguishment of debt
    
    
    (15
    )
    
    
    11,141
    
    
    
    Noncash interest and other, net
    
    
    (12
    )
    
    
    1,165
    
    
    
    1,253Increases (decreases) in cash resulting from changes
in operating assets and liabilities:Accounts and notes receivable, prepaid expenses and other assets
    
    
    (3,999
    )
    
    
    (11,453
    )
    
    
    (1,385
    )Inventories
    
    
    (49
    )
    
    
    958
    
    
    
    9,566Accounts payable, accrued liabilities and other liabilities
    
    
    (237)
    
    
    
    13,572
    
    
    
    2,131Accrued interest
    
    
    (90
    )
    
    
    1,465
    
    
    
    (70
    )Accrued and refundable income taxes
    
    
    (359
    )
    
    
    685
    
    
    
    276Net cash provided by operating activities
    
    
    30,825
    
    
    
    43,838
    
    
    
    56,211Cash flows from investing activities:Purchases of property and equipment
    
    
    (26,828
    )
    
    
    (39,360
    )
    
    
    (33,628
    )Net proceeds from sales and sale/leasebacks of fixed assets
    
    
    2,605
    
    
    
    
    
    
    
    12,481Systems development costs
    
    
    (5,261
    )
    
    
    (5,626
    )
    
    
    (6,912
    )Contingent payments for and acquisition of businesses
    
    
    (4,051
    )
    
    
    (1,645
    )
    
    
    (847
    )Other, net
    
    
    11
    
    
    
    9
    
    
    
    Net cash used for investing activities
    
    
    (33,524
    )
    
    
    (46,622
    )
    
    
    (28,906
    )Cash flows from financing activities:Repayment of long-term debt
    
    
    (444
    )
    
    
    (158,288
    )
    
    
    (135
    )Proceeds from issuance of long-term debt
    
    
    
    
    
    
    150,000
    
    
    
    Payment of deferred financing fees
    
    
    (238
    )
    
    
    (6,058
    )
    
    
    Advances from (to) affiliates, net
    
    
    21,379
    
    
    
    (6,395
    )
    
    
    (4,329
    )Increase (decrease) in overdraft balances
    
    
    (2,362
    )
    
    
    1,705
    
    
    
    3,515Other, net
    
    
    1,547
    
    
    
    522
    
    
    
    (275
    )Net cash provided by (used for) financing activities
    
    
    19,882
    
    
    
    (18,514
    )
    
    
    (1,224
    )Cash and cash equivalents:Net increase (decrease) during the period
    
    
    17,183
    
    
    
    (21,298
    )
    
    
    26,081Balance, beginning of period
    
    
    42,001
    
    
    
    63,299
    
    
    
    37,218Balance, end of period
    
    $
    59,184
    
    
    $
    42,001
    
    
    $
    63,299Supplemental disclosures:Interest paid
    
    $
    23,887
    
    
    $
    23,690
    
    
    $
    26,646Income taxes paid
    

    $
    1,094
    
    
    $
    1,268
    
    
    $
    1,049
 The accompanying notes to consolidated financial statements are an integral part of these consolidated financial statements. F-5




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COLE NATIONAL GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS
EQUITY AND COMPREHENSIVE INCOME (LOSS)
(Dollars in thousands) January 31,
    
    February 1,
    
    February 2,2004
    
    2003
    
    2002Common Stock:Balance at beginning of period
    
    $
    
    
    
    $
    
    
    
    $
    Issuance of stock
    
    
    
    
    
    
    
    
    
    
    Balance at end of period
    
    
    
    
    
    
    
    
    
    
    Paid-in Capital:Balance at beginning of period
    
    
    195,326
    
    
    
    194,886
    
    
    
    195,066Capital contribution
    
    
    3,564
    
    
    
    
    
    
    
    Shares of parent held in deferred compensation plan
    
    
    162
    
    
    
    (58
    )
    
    
    (34
    )Tax benefits of exercised stock options
    
    
    1,247
    
    
    
    498
    
    
    
    (146
    )Balance at end of period
    
    
    200,299
    
    
    
    195,326
    
    
    
    194,886Accumulated Other Comprehensive Income (Loss), net of tax:Balance at beginning of period
    
    
    (14,393
    )
    
    
    (1,105
    )
    
    
    (664
    )Minimum pension liability, net of tax of $1,253 and $6,987
and $0, respectively
    
    
    (1,638
    )
    
    
    (13,665
    )
    
    
    Foreign currency translation adjustment
    
    
    728
    
    
    
    377
    
    
    
    (441
    )Other comprehensive loss
    
    
    (910
    )
    
    
    (13,288
    )
    
    
    (441
    )Balance at end of period
    
    
    (15,303
    )
    
    
    (14,393
    )
    
    
    (1,105
    )Accumulated Deficit:Balance at beginning of period
    
    
    (186,374
    )
    
    
    (179,037
    )
    
    
    (178,527
    )Net income (loss)
    
    
    (7,828
    )
    
    
    (7,337
    )
    
    
    (510
    )Balance at end of period
    
    
    (194,202
    )
    
    
    (186,374
    )
    
    
    (179,037
    )Total Stockholders Equity
    
    $
    (9,206
    )
    
    $
    (5,441
    )
    
    $
    14,744Total Comprehensive Income (Loss):Net income (loss)
    
    $
    (7,828
    )
    
    $
    (7,337
    )
    
    $
    (510
    )Other comprehensive income (loss) per above
    
    
    (910
    )
    
    
    (13,288
    )
    
    
    (441
    )Total comprehensive income (loss)
    
    $
    (8,738
    )
    
    $
    (20,625
    )
    
    $
    (951
    )
 The accompanying notes to consolidated financial statements are an integral part of these consolidated financial statements. F-6




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Cole National Group, Inc. and Subsidiaries
Notes to Consolidated Financial Statements  (1)
    
    Summary of Significant Accounting PoliciesBasis of Presentation Cole National Group, Inc., is a wholly owned subsidiary of Cole National
Corporation. The consolidated financial statements include the accounts of
Cole National Group and its wholly owned subsidiaries (collectively, the
Company). All significant intercompany transactions have been eliminated in
consolidation. 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 January 31, 2004 is referred to as fiscal 2003.
Fiscal 2003, fiscal 2002 and fiscal 2001 each consisted of 52-week periods.  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
2,444 company-owned retail locations and 481 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 7).  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 valuation, 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. Managed care claims expense, certain store lab leased equipment, and
workers compensation and property insurance expense related to the companys
manufacturing activities have been reclassified to cost of revenues from
operating expenses to more appropriately reflect the nature of the costs and
to provide an improved measure of gross margin.  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 revenues 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. Additionally, the
Company sells discount programs which have twelve-month terms. Revenues from
discount programs are deferred and amortized over the 12-month term. F-7




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The Company also 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. A reconciliation of the changes in deferred revenue from the sale of
warranty contracts and other deferred items follows (dollars in thousands): 2003
    
    2002Deferred revenues:Beginning balance
    
    $
    49,573
    
    
    $
    46,511Warranty contracts sold
    
    
    56,479
    
    
    
    53,023Other deferred revenue
    
    
    3,264
    
    
    
    1,080Amortization of deferred revenue
    
    
    (56,065
    )
    
    
    (51,041
    )Ending balance
    
    $
    53,251
    
    
    $
    49,573
 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 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.  Consideration Received from Vendors The Company receives consideration from vendors as either rebates on the
purchase of the inventory or as reimbursement of costs incurred to sell the
vendors products. Rebates received for purchases are deferred and recorded
as a reduction of cost of revenues when the product is sold or based upon
estimated inventory turns. Reimbursement for specific, incremental and identifiable advertising
costs incurred by the Company to sell the vendors products are recorded as a
reduction of those costs at the time the expense is recognized in the
statement of operations. Co-op funds calculated as a percentage of inventory
purchases are offset against the related expense at the time the inventory is
sold.  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, including estimates
for claims incurred but not reported, under these plans with a high level of
confidence. Underwriting results are recognized using an estimated percentage
of claims revenue. A portion of the resulting gain is reserved for potential
variances between predicted and actual results. The reserves are reconciled
following the end of each plan year.  Other Managed Vision Expenses Cost of printing member cards, program descriptions and related
distribution costs for capitation and administrative service contracts are
expensed when incurred. Expenses for discount programs are recognized over
the 12-month contract period.  Advertising and Direct Response Marketing Cost for newspaper, television, radio and other media advertising are
expensed when incurred and production costs are expensed the first time
the advertising occurs or when the service is performed, if later. Costs
for certain direct response advertising are capitalized if such direct
response advertising costs result in future economic benefit. Such costs
related to direct F-8




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response advertising are amortized in proportion to when the revenues are
recognized, not to exceed 90 days. Generally, other direct response program
costs that do not meet the capitalization criteria are expensed the first
time advertising occurs.

The total cost of advertising charged to operating expense is net of
amounts reimbursed by franchisees based on a percentage of their sales.
Advertising expense is summarized as follows (dollars in thousands):

2003
    
    2002
    
    2001Gross advertising expense
    
    $
    87,572
    
    
    $
    85,215
    
    
    $
    84,191Less: Franchise contribution
    
    
    (23,828
    )
    
    
    (21,303
    )
    
    
    (20,486
    )Net advertising expense
    
    $
    63,744
    
    
    $
    63,912
    
    
    $
    63,705




| |  | Gains (Losses) from the Sale and Franchising of Company Operated Stores
| |  | -----------------------------------------------------------------------

Gains (losses) from the sale and franchising of company operated stores
include the gains or losses from the sale of existing Pearle operated stores
to new and existing franchisees, reduced by transaction costs and direct
administrative costs of franchising. The Company recognizes these gains
(losses) when the sale transaction closes, the franchisee has a minimum
amount of the purchase at-risk and the Company is satisfied that the
franchisee can meet its financial obligations. If the criteria for gain
recognition are not met, the gain is deferred to the extent a remaining
financial obligation in connection with the sales transaction exists.
Deferred gains are recognized when these criteria are met or as the Companys
financial obligation is reduced. Gains (losses) are recorded as decreases
(increases) to operating expenses and were $2,487,000, $711,000 and $44,000
in fiscal 2003, 2002 and 2001, respectively.



| |  | Store Opening Expenses
| |  | ----------------------

Store opening expenses are charged to operations in the period the
expenses are incurred.



| |  | Cash and Cash Equivalents
| |  | -------------------------

Cash and cash equivalents consist of cash in banks, investments in money
market accounts, treasury bills, commercial paper, and marketable securities
with maturities of three months or less and credit card receivables recorded
at the time of sale. Credit card receivables were $4.5 million and $4.4
million as of January 31, 2004 and February 1, 2003, respectively.

In addition, overdrafts resulting from outstanding checks at the end of
each reporting period are reclassified as current liabilities in either
accounts payable or accrued expenses. This reclassification to accounts
payable amounted to $21.1 million and $24.0 million at January 31, 2004 and
February 1, 2003, respectively, and to accrued expenses amounted to $3.8
million and $3.2 million at January 31, 2004 and February 1, 2003,
respectively.



| |  | Valuation of Inventories
| |  | ------------------------

Inventories are recorded at the lower of cost, or market, with cost
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.



| |  | Notes Receivable
| |  | ----------------

Notes from Pearles franchisees are included in notes receivable. The
franchise notes are collateralized by inventory, equipment, and leasehold
improvements at each location, generally bear interest at the prime rate plus
3.0%, and require monthly payments of principal and interest over periods of
up to ten years.

F-9



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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. Property and equipment at cost, consist of the following at January 31,
2004 and February 1, 2003 (dollars in thousands): 2003
    
    2002Land and building
    
    $
    5,251
    
    
    $
    2,414Furniture, fixtures and equipment
    
    
    194,946
    
    
    
    196,384Leasehold improvements
    
    
    109,609
    
    
    
    111,138Construction-in-progress
    
    
    2,084
    
    
    
    2,477Total property and equipment
    
    $
    311,890
    
    
    $
    312,413
  Capitalized Lease Property Capitalized lease assets are amortized using the straight-line method
over the term of the lease, or in accordance with practices established for
similar owned assets if ownership transfers to the Company at the end of the
lease term. Capital lease assets are included in property and equipment and
are $5.5 million and $3.9 million in fiscal 2003 and 2002, respectively and
accumulated amortization is $3.2 million and $2.6 million in fiscal 2003 and
2002, respectively. Amortization is included with depreciation expense and
was $0.6 million, $0.3 million and $0.2 million in fiscal 2003, 2002 and
2001, respectively.  Software and Development Costs Software development and implementation costs are expensed until the
Company has determined that the software will result in probable future
economic benefits and management has committed to funding the project.
Thereafter, all direct costs to develop or obtain internal use software,
including internal costs, are capitalized in other assets and amortized over
the estimated useful life of the software using the straight-line method.
Amortization periods range from two to seven years and begin when the
software is placed in service. At January 31, 2004 and February 1, 2003,
these costs were $71.0 million and $65.8 million, respectively and
accumulated amortization was $46.2 million and $34.1 million, respectively.
Amortization of software development costs in fiscal 2003, 2002 and 2001 was
$9.6 million, $7.9 million and $7.7 million, respectively.  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.  Long-Lived Asset Recoverability Long-lived assets, including finite lived intangible assets, are
reviewed for impairment when facts and circumstances indicate that the
carrying value of the asset may not be recoverable. When necessary, impaired
assets are written down to estimated fair value based on the best information
available. Estimated fair value is generally based on either appraised value
or measured by discounting estimated future cash flows. Considerable
management judgment is necessary to estimate discounted future cash flows.
Accordingly, actual results could vary significantly from such estimates.
Impairment charges include the write-down of long-lived assets at stores
(Cole Vision and Things Remembered) and purchased software (unallocated
corporate expense) that were assessed for impairment because changes in circumstances indicate
the carrying value of an asset may not be recoverable. Impairment charges
recorded to operating expenses by segment follows (dollars in thousands): F-10




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##### Table of Contents



2003
    
    2002
    
    2001Cole Vision
    
    $
    1,671
    
    
    $
    444
    
    
    $
    2,848Things Remembered
    
    
    185
    
    
    
    455
    
    
    
    890Purchased software
    
    
    2,550
    
    
    
    
    
    
    
    Total impairment charges
    
    $
    4,406
    
    
    $
    899
    
    
    $
    3,738
  Unamortized Debt Issuance Cost Financing costs incurred in connection with obtaining long-term debt are
capitalized in other assets and amortized over the life of the related debt
using the effective interest method. At January 31, 2004 and February 1,
2003, deferred financing costs net of accumulated amortization were
$6,023,000 and $6,976,000, respectively. Amortization of financing costs
included in interest expense in fiscal 2003, 2002 and 2001 was $1,192,000,
$1,128,000 and $1,150,000, respectively.  Income Taxes The Company is included in the consolidated federal income tax returns
of Cole National Corporation and has been charged (credited) an amount equal
to the taxes that would have been payable by it if it were a corporation
filing a separate return. Income taxes are accounted for under the asset and
liability method. Under the asset and liability method, deferred tax assets
and liabilities are recognized for the estimated future tax consequences
attributable to differences between the financial statement carrying amount
of existing assets and liabilities and their respective tax bases. This
method also requires the recognition of future tax benefits such as net
operating loss carryforwards, to the extent that realization of such benefits
is more likely than not. Deferred tax assets and liabilities are measured
using enacted tax rates expected to apply to taxable income in the years in
which those temporary differences are expected to be recovered or settled.
The effect on deferred tax assets and liabilities from a change in tax rates
is recognized in income in the period that includes the enactment date. The
Company includes interest on prior year taxes in income tax expense.  Derivatives and Hedging Activity The interest rate swap agreements utilized by the Company are designated
as fair value hedges of the underlying fixed rate debt obligations and are
recorded at fair value as an increase in noncurrent assets or liabilities and
an increase or decrease in long-term debt. These interest rate swaps qualify
for the short-cut method for assessing hedge effectiveness under the
provisions of SFAS No. 133, Accounting for Derivative Instruments and
Hedging Activities (SFAS 133) and as amended by SFAS No. 149, Amendment of
Statement 133 on Derivative Instruments and Hedging Activities. Changes in
fair value of the interest rate swaps are offset by the changes in fair value
of the underlying debt.  Self Insurance Due to the significant deductible under its insurance policies, the
Company is primarily self-insured for property loss, workers compensation,
automobile and general liability costs. The liabilities are determined
actuarially based on claims filed and estimates for claims incurred but not
reported. These liabilities are not discounted.  Accrued Liabilities Accrued liabilities consist of the following (dollars in thousands): 2003
    
    2002Accrued payroll liabilities and
related liabilities
    
    $
    32,438
    
    
    $
    23,507Customer deposits
    
    
    19,291
    
    
    
    17,479Insurance reserve
    
    
    11,904
    
    
    
    10,513Other
    
    
    31,408
    
    
    
    40,790$
    95,041
    
    
    $
    92,289
 F-11




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##### Table of Contents



Other Long-Term Liabilities Other long-term liabilities consist primarily of certain employee
benefit obligations, deferred lease credits and other lease-related
obligations, and other obligations not expected to be paid within 12 months.
Deferred lease credits are amortized on a straight-line basis over the life
of the applicable lease.  Foreign Currency Translation The assets and liabilities of the Companys foreign subsidiary are
translated to United States dollars at the rates of exchange on the balance
sheet date. Income and expense items are translated at average rates of
exchange for the foreign subsidiary. Translation adjustments are presented as
a component of accumulated other comprehensive income within stockholders
equity.  Fair Value of Financial Instruments Due to their short-term nature, the carrying value of the Companys cash
and cash equivalents, credit card and other receivables, and short-term
borrowings approximate fair value. The fair value of the notes receivables
has not been determined due to nonmarketability and related party nature of
the notes. Fair value estimates for the Companys derivative and debt
instruments are based on market prices when available or are derived from
financial valuation methodologies such as discounted cash flow analyses.  Capital Stock At February 2, 2002 and February 3, 2001, there were 1,100 shares of
common stock, par value $.01 per share, authorized, issued and outstanding.  Earnings Per Common Share Earnings per common share and weighted average number of common shares
outstanding data for 2003, 2002 and 2001 have been omitted as the
presentation of such information, considering the Company is a wholly owned
subsidiary of Cole National Corporation, is not meaningful.  Related Party Transactions Cole National Corporation allocates certain expenses to the Company for
Director fees, certain public company expenses and professional fees. Amounts
allocated to the Company were $3.5 million, $0.5 million and $0.6 million in
fiscal 2003, 2002 and 2001, respectively. The amount in fiscal 2003 includes
the shareholder litigation settlement. The balance of payable to affiliates
is due on demand.  Comprehensive Income The following table presents the beginning balance, annual activity and
ending balance of each component of accumulated other comprehensive
income (loss) (dollars in thousands): F-12




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##### Table of Contents



Foreign
    
    Minimum
    
    AccumulatedCurrency
    
    Pension
    
    OtherTranslation
    
    Liability
    
    ComprehensiveAdjustment
    
    Adjustment
    
    Income (Loss)Balance at February 3, 2001
    
    $
    (664
    )
    
    $
    
    
    
    $
    (664
    )Activity in fiscal 2001
    
    
    (441
    )
    
    
    
    
    
    
    (441
    )Balance at February 2, 2002
    
    
    (1,105
    )
    
    
    
    
    
    
    (1,105
    )Activity in fiscal 2002
    
    
    377
    
    
    
    (20,652
    )
    
    
    (20,275
    )Tax benefit (expense)
    
    
    
    
    
    
    6,987
    
    
    
    6,987Balance at February 1, 2003
    
    
    (728
    )
    
    
    (13,665
    )
    
    
    (14,393
    )Activity in fiscal 2003
    
    
    728
    
    
    
    (2,891
    )
    
    
    (2,163
    )Tax benefit (expense)
    
    
    
    
    
    
    1,253
    
    
    
    1,253Balance at January 31, 2004
    
    $
    
    
    
    $
    (15,303
    )
    
    $
    (15,303
    )
  Stock-Based Compensation Cole National Corporation has various stock-based compensation plans in
which key employees of the Company are eligible to participate. The Company
applies APB Opinion No. 25 Accounting for Stock Issued to Employees, for
Cole National Corporations stock-based compensation plans. The Company
measures compensation expense for employee stock options as the aggregate
difference between the market value of Cole National Corporations common
stock and the exercise price of the options on the date that both the number
of shares the grantee is entitled to receive and the exercise price are
known. In fiscal 2003, certain stock options were exercised by using a feature permitting a cashless exercise of options through the use of vested options in payment of the exercise price. This feature creates an arrangement that requires variable accounting, beginning with the third quarter of fiscal 2003. Previous to the fiscal 2003 transactions, such options had been accounted for as fixed grants based on the presumption that this feature would not be utilized as evidenced
by Cole National Corporations's historical experience of this feature not being used. For the stock option agreements that have this cashless exercise feature, compensation expense is measured as the amount by which the quoted market value of the shares exceeds the option price at the end of each period. All stock options requiring variable accounting are fully vested. Compensation expense associated with stock options requiring variable accounting was $3.2 million in the third
quarter of fiscal 2003. Compensation expense associated with Cole
National Corporations restricted stock grants are not
allocated to the Company. For SFAS No. 123,
Accounting for Stock Based Compensation (SFAS 123) purposes, the fair value
of each option granted was estimated on the date of grant using the
Black-Scholes option pricing model with the following assumptions: risk-free
interest rates of 2.8%, 4.6% and 4.8% for grants in fiscal 2003, 2002 and
2001, respectively, volatility of 50%, 49-50% and 47-49% in fiscal 2003,
2002 and 2001, respectively, and expected lives of six years for options
granted in all fiscal years. The weighted average fair value of options
granted during fiscal 2003, 2002 and 2001 at the date of grant was $5.39,
$9.50 and $6.31, respectively. Tax benefits from stock-based compensation
activity are allocated to the Company. Per the disclosure provisions of SFAS
No. 148, Accounting for Stock-Based Compensation  Transition and
Disclosures (SFAS 148), pro forma information relating to the fair value of
stock-based compensation is summarized as follows: F-13




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##### Table of Contents



2003
    
    2002
    
    2001(In thousands)Net income (loss), as reported
    
    $
    (7,828
    )
    
    $
    (7,337
    )
    
    $
    (510
    )Additions for stock-based employee compensation
expense included in reported net income, net of
related taxes
    
    
    2,066
    
    
    
    
    
    
    
    Deductions for total stock-based compensation
expense determined under fair value based method
for all awards, net of related taxes
    
    
    (1,117
    )
    
    
    (2,200
    )
    
    
    (1,208
    )Net income (loss), pro forma
    
    $
    (6,879
    )
    
    $
    (9,537
    )
    
    $
    (1,718
    )
  Retirement Plans The Company accounts for its defined benefit pension plans and its
nonpension postretirement benefit plans using actuarial models required by
SFAS No. 87, Employers Accounting for Pensions (SFAS 87) and SFAS No. 106,
Employers Accounting for Postretirement Benefits Other Than Pensions (SFAS
106), respectively. These models use an attribution approach that generally
spreads individual events over the service lives of the employees in the
plan. The Company accounts for other post-employment benefits under SFAS No.
112, Employers Accounting for Postemployment Benefits (SFAS 112), which
requires the recognition of the obligation to provide benefits awarded to
certain individuals.  Recently Issued Accounting Standards The Financial Accounting Standards Board (FASB) 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 for classification as an extraordinary item shall
be reclassified as an item of continuing operations. The Company adopted 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 has been reclassified. The pretax loss from the early
extinguishment of debt has been presented as a separate line within interest
and other (income) expenses and the related income tax benefit reduced the
reported income tax provision. Other portions of the statement are not
applicable to the Company. The FASB has also issued SFAS No. 143, Accounting for Asset Retirement
Obligations (SFAS 143). SFAS 143 provides guidance for legal obligations
arising from the retirement of long-lived assets. SFAS 143 was adopted in
fiscal 2003 and did not have a material effect on the Companys financial
position or results of operations. In January 2003, the FASB issued FASB Interpretation No. 46,
Consolidation of Variable Interest Entities (FIN 46) and revised FIN 46
(FIN 46R) in December 2003. The Interpretations require certain variable
interest entities, including certain special purpose entities, to be
consolidated by the primary beneficiary if the equity investors in the entity
do not have all the essential characteristics of a controlling financial
interest or do not have sufficient equity at risk. The Interpretations
immediately apply to entities created after January 31, 2003, are effective
at the end of the fourth quarter of fiscal 2003 for certain special purpose
entities and are effective for the first quarter of fiscal 2004 for other
existing variable interest entities. The synthetic operating lease for the
Highland Heights, Ohio facility required consolidation under this
Interpretation. The consolidation resulted in an additional $2.2 million in
assets and liabilities on the consolidated balance sheet. Management is still
assessing the impacts of this Interpretation on its consolidated financial
statements regarding existing variable interest entities within its franchise
operations. In November 2002, the Emerging Issues Task Force of the FASB (EITF)
reached a consensus on Issue 02-16, Accounting by a Reseller for Cash
Consideration Received from a Vendor (Issue 02-16), which addresses the
accounting by a customer for consideration received from a vendor, including
a reseller of the vendors products. Certain aspects of the issue were
effective immediately, which were adopted and did not have a significant
impact on results of operations in fiscal 2002. The remaining portion of
Issue 02-16 was adopted during fiscal 2003 and did not have a material effect
on the Companys financial position or results of operations. F-14




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##### Table of Contents



In December 2003, the FASB issued SFAS No. 132 (Revised 2003),
Employers Disclosures about Pensions and Other Postretirement Benefits
(SFAS 132). This statement revises employers disclosures about pension
plans and other postretirement benefit plans to require more information
about the economic resources and obligations of such plans. Certain
disclosure provisions were effective for fiscal 2003 and were adopted. The
remaining disclosure provisions of SFAS 132 will be adopted during fiscal
2004. In April 2003, the FASB issued SFAS No. 149, Amendment of Statement 133
on Derivative Instruments and Hedging Activities (SFAS 149), which amends
and clarifies accounting and reporting for derivative instruments, including
certain embedded derivatives and for hedging activities under SFAS 133. SFAS
149 was adopted in fiscal 2003 and had no effect on the Companys financial
position or results of operations. On December 8, 2003, the Medicare Prescription Drug, Improvement and
Modernization Act of 2003 (the Act) was signed into law. In accordance with
FASB Staff Position 106-1, the Companys measures of the accumulated
postretirement benefit obligation and net periodic benefit cost in the
consolidated financial statements and in Note 6 do not reflect the effects of
the Act on the Companys postretirement benefit plan. Specific authoritative
guidance on the accounting for the federal subsidy is pending and, when
issued, could require the Company to change previously reported information.  (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
review 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 and other things,
the Company concluded that there was no impairment at the adoption date of
the new accounting standard, effective February 3, 2002. The Company elected
to perform its annual tests for potential impairment as of the first day of
the Companys fourth fiscal quarter. Based on its annual tests, the Company
has concluded that there was no impairment of its goodwill or tradenames for
fiscal 2003 and fiscal 2002. The following table provides the comparable effects of adopting SFAS 142
for the three years ended January 31, 2004, February 1, 2003 and February 2,
2002. 2003
    
    2002
    
    2001(In thousands)Net income (loss):Reported net income (loss)
    
    $
    (7,828
    )
    
    $
    (7,337
    )
    
    $
    (510
    )Goodwill amortization  Cole Vision
    
    
    
    
    
    
    
    
    
    
    2,825Goodwill amortization  Things Remembered
    
    
    
    
    
    
    
    
    
    
    948Tradename amortization  Cole Vision
    
    
    
    
    
    
    
    
    
    
    1,237Related tax adjustment
    
    
    
    
    
    
    
    
    
    
    (680
    )Adjusted net income (loss)
    
    $
    (7,828
    )
    
    $
    (7,337
    )
    
    $
    3,820
 Other intangible assets consist of (dollars in thousands): F-15




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##### Table of Contents



2003
    
    2002Non-amortizable:Tradename
    
    $
    49,460
    
    
    $
    49,460Amortizable:Noncompete agreements
    
    
    320
    
    
    
    240Contracts
    
    
    8,947
    
    
    
    8,847Customer records
    
    
    9
    
    
    
    Total amortizable
    
    
    9,276
    
    
    
    9,087Accumulated amortization
    
    
    (8,963
    )
    
    
    (7,644
    )$
    49,773
    
    
    $
    50,903
 During the first quarter of fiscal 2003, the Company purchased the
operations of three Sears Optical departments in California for a total
purchase price of $242,500. The amount allocated to the tangible fixed assets
acquired including exam equipment and inventory was $29,500. The remainder of
the purchase price was allocated to intangible assets under the provisions of
Statement of Financial Accounting Standards No. 141, Business Combinations.
Goodwill related to this transaction was $124,000 and noncompete agreements and
customer records totaled $89,000. The change in the carrying amount of
contracts for fiscal 2003 resulted primarily from a contingent payment for a
previously acquired provider network. The additional change in the carrying
amount of goodwill was due to foreign currency translation at Cole Vision. The net carrying amount of goodwill at January 31, 2004, by business
segment was $64.3 million at Cole Vision and $21.4 million at Things
Remembered.  (3)
    
    Long-Term Debt Long-term debt at January 31, 2004 and February 1, 2003 is summarized as
follows (dollars in thousands): F-16




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##### Table of Contents



2003
    
    20028-7/8% Senior Subordinated Notes
    
    $
    150,000
    
    
    $
    150,0008-5/8% Senior Subordinated Notes, including fair market value
adjustments related to interest rate swap
    
    
    125,459
    
    
    
    125,807Capital lease obligations
    
    
    2,134
    
    
    
    978Debt of variable interest entity
    
    
    2,244
    
    
    
    279,837
    
    
    
    276,785Less current portion
    
    
    (608
    )
    
    
    (232
    )Net long-term debt
    
    $
    279,229
    
    
    $
    276,553
 On August 15, 2003, the Company retired $385,000 of 8-5/8% Senior
Subordinated Notes due December 31, 2006 that the Company had received as
part of the full repayment for a note receivable from the Companys former
Chairman and Chief Executive Officer (CEO). A $15,400 gain on early
extinguishment of debt and $15,400 of compensation expense were recorded in
connection with the transaction. On May 22, 2002, the Company issued $150.0 million of 8-7/8% Senior
Subordinated Notes that mature in 2012. Interest on the notes is payable
semi-annually on each May 15 and November 15. 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 a loss on early extinguishment of debt of $11.1 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, the Company 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. The 8-5/8% notes and the 8-7/8% notes are general unsecured obligations
of the Company, subordinated in right of payment to senior indebtedness of
the Company and senior in right of payment to any current or future
subordinated indebtedness of the Company. The indentures pursuant to which
the 8-5/8% notes and the 8-7/8% notes were issued restrict dividend payments
to Cole National Corporation. The indentures also contain certain optional
and mandatory redemption features and other financial covenants. At January 31, 2004, the fair value of long-term debt was approximately
$305.0 million compared to a carrying value of $279.2 million. The fair value
was estimated primarily by using quoted market prices. The Company has no
significant principal payment obligations under its outstanding indebtedness
until 2007, when the $125.0 million 8-5/8% Senior Subordinated Notes are due.
Following the consummation of the Merger with Luxottica, the holders of the
8-5/8% notes and the 8-7/8% notes will have the right to put the notes to the
Company at a price of 101% of par plus accrued interest. During the third quarter of fiscal 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
of 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. At January 31, 2004, the floating rate of the
swaps was approximately 5.8% and the fair value of the swap agreements was an
unrealized gain of approximately $0.8 million. There was no impact to
earnings in fiscal 2003 due to hedge ineffectiveness. The Company subleases an office and general operating facility in
Highland Heights, Ohio from the Parent who leases the property from a special
purpose entity (the Trust), which was created in 1997 specifically for the
purpose of structuring a four-year operating lease with annual renewal
options up to six years. The lease provides for regular payments based on
LIBOR plus 1.50%. In accordance with this agreement, the Parent must
maintain compliance with a minimum net worth covenant. At the end F-17




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##### Table of Contents



of this lease in 2007, the Parent has the option to purchase the
property or arrange for the sale of the property. If the Parent does not
exercise its purchase option at the end of the lease, it is contingently
liable to the Trust for up to $1.7 million. The Parent does not believe it
will have any payment obligation at the end of the lease because either the
Parent will exercise the purchase option, or the net proceeds from the sale
of the property will exceed the amount payable to the Trust. Under FIN 46R, certain special purpose entities are required to be
consolidated if it is determined that an enterprise is the primary
beneficiary because it is deemed to have controlling financial interest in
the entity. The Company has determined that it has controlling financial
interest in the Trust since the Company is required to absorb any expected
losses, will receive the majority of expected residual returns and is the
primary beneficiary. Therefore, the Trust assets of $2.2 million and
liabilities of $2.2 million have been consolidated into the financial
statements of the Company as of January 31, 2004. Future operating results
of the Trust will be consolidated in the financial statements of the Company
and is not expected to have a material effect on the Companys results of
operations.  (4)
    
    Credit Facility On June 27, 2003, the operating subsidiaries of the Company amended,
restated and extended their working capital credit facility with their bank
lenders. The maturity date of the credit facility was extended to February 1,
2007 from May 31, 2006. The size of the facility was adjusted to $60.0
million from $75.0 million. In addition, certain financial covenants were
amended. Borrowings under the credit facility presently bear interest based
on leverage ratios of the Company at a rate equal to either (a) the
Eurodollar Rate plus 2.50% or (b) 1.50% 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%. The Company pays a commitment fee of 0.75% per annum on the
total unused portion of the facility based on the percentage of revolving
credit commitments used. Cole National Corporation and the Company guarantee
this credit facility. The credit facility is secured by the assets of the
operating subsidiaries of the Company. On October 30, 2003, the credit
facility was amended to permit indebtedness of up to $10.0 million of
documentary letters of credit from sources other than the lenders and liens
on inventory pursuant to documentary letters of credit issued under such
financing. The credit facility requires the principal operating subsidiaries of the
Company 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 Company to comply with certain financial
covenants, including covenants regarding interest coverage and maximum
leverage. The Company is in compliance with the covenants in the credit
agreement as of January 31, 2004 and the date of the Form 10-K
as originally filed. The credit facility restricts dividend payments to the Company from its
subsidiaries to amounts needed to pay interest on the 8-7/8% notes and the
8-5/8% notes, certain amounts related to taxes and $7.5 million for direct
expenses of the Company, along with up to 0.25% of the Companys consolidated
net revenue annually for other direct expenses of Cole National Corporation.
If certain maximum leverage targets are met, the credit facility restricts
dividend payments to the Company in an aggregate amount not to exceed $25.0
million to allow for the repurchase of Senior Subordinated Notes. As of January 31, 2004, the total availability under the credit facility
totaled $46.1 million after reduction for commitments outstanding of $13.9
million under letters of credit. There were no working capital borrowings
under the credit facility outstanding as of January 31, 2004 and February 1,
2003. The maximum amount of borrowings outstanding was $11.5 million during
fiscal 2003 and $2.3 million during fiscal 2002. The weighted average
interest rate was 5.5% for both fiscal 2003 and 2002. On November 3, 2003, Things Remembered, Inc. and the Parent entered into
an agreement with a bank to provide documentary letters of credit for import
inventory purchases not to exceed $7.0 million. The letters of credit are
secured by the inventory purchased. As of January 31, 2004, the Company had
$3.9 million outstanding under this facility.  (5)
    
    Income Taxes The income tax provision reflected in the accompanying consolidated
statements of operations for fiscal 2003, 2002 and 2001 are detailed below
(dollars in thousands): F-18




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##### Table of Contents



2003
    
    2002
    
    2001Current payable -Federal
    
    $
    (567
    )
    
    $
    522
    
    
    $
    750State and local
    
    
    551
    
    
    
    538
    
    
    
    1,335Foreign
    
    
    (172
    )
    
    
    633
    
    
    
    295(188
    )
    
    
    1,693
    
    
    
    2,380Deferred -Federal
    
    
    (1,978
    )
    
    
    (2,670
    )
    
    
    2,854State and local
    
    
    (639
    )
    
    
    183
    
    
    
    32Foreign
    
    
    (833
    )
    
    
    (1
    )
    
    
    43(3,450
    )
    
    
    (2,488
    )
    
    
    2,929Income tax provision (benefit)
    
    $
    (3,638
    )
    
    $
    (795
    )
    
    $
    5,309
 The exercise of nonqualified stock options during fiscal 2003 and fiscal
2002 resulted in $1.3 million and $0.5 million, respectively of income tax
benefits to the Company derived from the difference between the market price
at the date of exercise and the option price. These tax benefits were
recorded in additional paid-in capital. Tax benefits from option exercises in
fiscal 2001 were not significant. The income tax provision differs from the federal statutory rate as
follows (dollars in thousands): 2003
    
    2002
    
    2001Income tax provision (benefit) at statutory rate
    
    $
    (4,014
    )
    
    $
    (2,846
    )
    
    $
    1,680Tax effect of -Goodwill
    
    
    
    
    
    
    
    
    
    
    1,451State income taxes, net of federal tax benefit
    
    
    (422
    )
    
    
    533
    
    
    
    900Foreign income
    
    
    20
    
    
    
    199
    
    
    
    59Valuation allowance
    
    
    89
    
    
    
    484
    
    
    
    988Nondeductible expenses
    
    
    277
    
    
    
    296
    
    
    
    331Adjustment to prior year federal taxes
    
    
    389
    
    
    
    522
    
    
    
    354Research and development credit
    
    
    (235
    )
    
    
    
    
    
    
    (265
    )Other, net
    
    
    258
    
    
    
    17
    
    
    
    (189
    )Income tax provision (benefit)
    
    $
    (3,638
    )
    
    $
    (795
    )
    
    $
    5,309
 The tax effects of temporary differences that give rise to significant
portions of the Companys deferred tax assets and deferred tax liabilities
at January 31, 2004 and February 1, 2003 are as follows (dollars in
thousands): F-19




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##### Table of Contents



2003
    
    2002Deferred tax assets:Accrued compensation and benefits
    
    $
    14,343
    
    
    $
    11,420Deferred revenue
    
    
    18,816
    
    
    
    22,659Other non-deductible accruals
    
    
    11,732
    
    
    
    8,432Net operating loss carryforwards
    
    
    5,250
    
    
    
    8,961Depreciation and amortization
    
    
    4,692
    
    
    
    Intangibles
    
    
    3,976
    
    
    
    4,373Inventory basis differences
    
    
    2,548
    
    
    
    2,047Leases
    
    
    3,155
    
    
    
    5,106Contribution carryforward
    
    
    1,179
    
    
    
    1,223Foreign tax credit carryforward
    
    
    155
    
    
    
    Other
    
    
    1,261
    
    
    
    2,005Total deferred tax assets
    
    
    67,107
    
    
    
    66,226Valuation allowance
    
    
    (4,120
    )
    
    
    (4,371
    )Net deferred tax assets
    
    
    62,987
    
    
    
    61,855Deferred tax liabilities:Depreciation and amortization
    
    
    
    
    
    
    (3,713
    )Net deferred tax assets
    
    $
    62,987
    
    
    $
    58,142
 At January 31, 2004, the Company had approximately $8.7 million of
federal tax net operating loss carryforwards in the United States that expire
in years 2004 through 2022. Of that amount, $7.7 million resulted from the
Companys acquisition of American Vision Centers (AVC). Due to the change
in ownership requirements of the Internal Revenue Code, utilization of the
AVC net operating loss is limited to approximately $0.3 million per year.
Valuation allowances of $3.4 million, $0.5 million and $0.2 million at
January 31, 2004 have been established against net operating losses,
charitable contribution carryforwards and tax credit carryforwards,
respectively to reduce the corresponding deferred tax assets to the amount
that will likely be realized. The decrease in the valuation allowance in
fiscal 2003 is primarily due to the operating loss tax carryforwards. No provision of United States federal and state income taxes has been
provided for the undistributed earnings of the Companys foreign subsidiaries
because those earnings are considered to be indefinitely reinvested. Upon
distribution of those earnings in the form of dividends or otherwise, the
Company would be subject to both United States income taxes (subject to an
adjustment of foreign tax credits) and withholding taxes payable.
Determination of the net amount of unrecognized U. S. income tax with respect
to these earnings is not practicable.  (6)
    
    Retirement Plans The Company maintains a noncontributory defined benefit pension plan
that covers employees who have met eligibility service requirements and are
not members of certain collective bargaining units. The pension plan calls
for benefits to be paid to eligible employees at retirement based primarily
upon years of service and their compensation levels near retirement. In
January 2002, the Company approved a plan freeze for all participants except
for participants who are age 50 with 10 years of benefit service as of March
31, 2002. These participants had their average pay frozen as of March 31,
2002, and covered compensation frozen as of December 31, 2001, but their
benefit service will continue to grow. The Companys policy is to fund
amounts necessary to keep the pension plan in full force and effect, in
accordance with the Internal Revenue Code and the Employee Retirement Income
Security Act of 1974. The Company also maintains a postretirement benefit plan in connection
with the acquisition of Pearle in 1996. This plan was closed to new
participants at the time of acquisition. Under this plan, the eligible former
employees are provided life insurance and certain health care benefits
through insurance premiums based on expected benefits to be paid during the
year. Substantial portions of the health care benefits are not insured and
are paid by the Company. For measurement purposes, a 13% annual rate of
increase for health care benefits was assumed for fiscal 2004. The rate was
assumed to decrease gradually to 8% over ten years and level thereafter.
Assumed health care cost trend rates have a significant effect on the amounts
reported for health care plans. A one percentage point change in the assumed
health care cost trend rate would have the following effects: F-20




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##### Table of Contents



1 Percentage
    
    1 PercentagePoint Increase
    
    Point DecreaseEffect on total of service and interest cost components
    
    $
    33,500
    
    
    $
    (28,100
    )Effect on postretirement benefit obligation
    
    
    557,800
    
    
    
    (468,500
    )
 On December 8, 2003 the Medicare Prescription Drug, Improvement and
Modernization Act of 2003 (the Act) was signed into law. In accordance with
FASB Staff Position 106-1, the Companys measures of the accumulated
postretirement benefit obligation and net periodic benefit cost in the
consolidated financial statements and disclosures herein do not reflect the
effects of the Act on the Companys postretirement benefit plan. Specific
authoritative guidance on the accounting for the federal subsidy is pending
and, when issued, could require the Company to change previously reported
information. The Company uses a December 31 measurement date for its plans. The
following provides a reconciliation of benefit obligations, plan assets and
funded status of the pension plan and postretirement benefits. Pension Benefits
    
    Postretirement Benefits2003
    
    2002
    
    2003
    
    2002(Dollars in thousands)Change in benefit obligation:Benefit obligation at beginning of period
    
    $
    40,122
    
    
    $
    28,825
    
    
    $
    4,109
    
    
    $
    2,879Service cost
    
    
    273
    
    
    
    238
    
    
    
    
    
    
    
    Interest cost
    
    
    2,647
    
    
    
    2,423
    
    
    
    261
    
    
    
    203Actuarial loss
    
    
    5,767
    
    
    
    10,203
    
    
    
    62
    
    
    
    1,149Benefits paid
    
    
    (1,839
    )
    
    
    (1,147
    )
    
    
    (179
    )
    
    
    (159
    )Participants contributions
    
    
    
    
    
    
    
    
    
    
    36
    
    
    
    37Administrative expenses paid
    
    
    (433
    )
    
    
    (420
    )
    
    
    
    
    
    
    Benefit obligation at the end of the period
    
    
    46,537
    
    
    
    40,122
    
    
    
    4,289
    
    
    
    4,109Change in plan assets:Fair value of plan assets at beginning of year
    
    
    24,107
    
    
    
    28,861
    
    
    
    
    
    
    
    Actual return of plan assets
    
    
    4,240
    
    
    
    (3,709
    )
    
    
    
    
    
    
    Employer contributions
    
    
    
    
    
    
    522
    
    
    
    143
    
    
    
    122Participants contributions
    
    
    
    
    
    
    
    
    
    
    36
    
    
    
    37Benefits paid
    
    
    (1,839
    )
    
    
    (1,147
    )
    
    
    (179
    )
    
    
    (159
    )Administrative expenses paid
    
    
    (433
    )
    
    
    (420
    )
    
    
    
    
    
    
    Fair value of plan assets at end of year
    
    
    26,075
    
    
    
    24,107
    
    
    
    
    
    
    
    Funded status
    
    
    (20,462
    )
    
    
    (16,015
    )
    
    
    (4,289
    )
    
    
    (4,109
    )Employer contributions after measurement date
    
    
    
    
    
    
    
    
    
    
    12
    
    
    
    10Unrecognized net actuarial loss
    
    
    23,622
    
    
    
    20,992
    
    
    
    2,527
    
    
    
    2,614Unrecognized prior service cost
    
    
    
    
    
    
    
    
    
    
    94
    
    
    
    103Unrecognized initial asset
    
    
    (160
    )
    
    
    (340
    )
    
    
    
    
    
    
    Net amount recognized
    
    $
    3,000
    
    
    $
    4,637
    
    
    $
    (1,656
    )
    
    $
    (1,382
    )
 Amounts recognized in the statements of financial position consist of: Pension Benefits
    
    Postretirement Benefits2003
    
    2002
    
    2003
    
    2002Accrued benefit cost:Accrued liabilities
    
    $
    (7,475
    )
    
    $
    
    
    
    $
    (151
    )
    
    $
    (152
    )Other long-term liabilities
    
    
    (12,987
    )
    
    
    (16,015
    )
    
    
    (1,505
    )
    
    
    (1,230
    )Accumulated other comprehensive loss
    
    
    23,462
    
    
    
    20,652
    
    
    
    
    
    
    
    $
    3,000
    
    
    $
    4,637
    
    
    $
    (1,656
    )
    
    $
    (1,382
    )
 F-21




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##### Table of Contents



The current employer contribution for fiscal 2004 of $7,475,000 included
in accrued liabilities was determined with the assumption that Congress will
not grant further pension relief for the 2004 plan year. The accumulated benefit obligation for the defined benefit pension plan
was $46,537,000 and $40,122,000 at December 31, 2003 and December 31, 2002,
respectively. Net pension expense and postretirement expense for fiscal 2003, 2002 and
2001 includes the following components (dollars in thousands): Pension Benefits
    
    Postretirement Benefits2003
    
    2002
    
    2001
    
    2003
    
    2002
    
    2001Service cost  benefits earned during the period
    
    $
    273
    
    
    $
    238
    
    
    $
    1,868
    
    
    $
    
    
    
    $
    
    
    
    $
    Interest cost on the projected benefit obligation
    
    
    2,647
    
    
    
    2,423
    
    
    
    2,156
    
    
    
    261
    
    
    
    203
    
    
    
    174Expected return on plan assets
    
    
    (2,594
    )
    
    
    (2,810
    )
    
    
    (2,720
    )
    
    
    
    
    
    
    
    
    
    
    Recognized net actuarial loss
    
    
    1,491
    
    
    
    284
    
    
    
    
    
    
    
    149
    
    
    
    83
    
    
    
    76Amortization of initial asset
    
    
    (179
    )
    
    
    (179
    )
    
    
    (179
    )
    
    
    
    
    
    
    
    
    
    
    Amortization of prior service cost
    
    
    
    
    
    
    
    
    
    
    25
    
    
    
    9
    
    
    
    9
    
    
    
    9Net expense (income)
    
    $
    1,638
    
    
    $
    (44
    )
    
    $
    1,150
    
    
    $
    419
    
    
    $
    295
    
    
    $
    259Increase in minimum liability included in other
comprehensive income
    
    $
    2,810
    
    
    $
    20,652
    
    
    $
    
    
    
    
    N/A
    
    
    
    N/A
    
    
    
    N/AWeighted average assumptions used to determine
obligations at fiscal year end:Discount rate
    
    
    6.0
    %
    
    
    6.5
    %
    
    
    7.5
    %
    
    
    6.0
    %
    
    
    6.5
    %
    
    
    7.3
    %Rate of compensation increase
    
    
    N/A
    
    
    
    N/A
    
    
    
    N/A
    
    
    
    N/A
    
    
    
    N/A
    
    
    
    N/AWeighted average assumptions used to determine
net costs for the fiscal year:Discount rate
    
    
    6.5
    %
    
    
    7.5
    %
    
    
    7.8
    %
    
    
    6.5
    %
    
    
    7.3
    %
    
    
    7.8
    %Expected return on plan assets
    
    
    9.0
    %
    
    
    9.0
    %
    
    
    9.5
    %
    
    
    N/A
    
    
    
    N/A
    
    
    
    N/ARate of compensation increase
    
    
    N/A
    
    
    
    N/A
    
    
    
    3 to 7
    %
    
    
    N/A
    
    
    
    N/A
    
    
    
    N/A
 The change in the discount rate reflects the overall decline in market
interest rates and has led to an increase in the projected benefit obligation
at December 31, 2003 and December 31, 2002. In addition, stock market declines
in fiscal 2002 reduced the fair value of the pension plans assets at December
31, 2002. As a result of these factors, the pension benefit plan was
underfunded by $20.5 million and $16.0 million at December 31, 2003 and
December 31, 2002, respectively. In fiscal 2002, the Company wrote off its
prepaid pension expense of $4.6 million and recorded the minimum pension
liability by charging $20.7 million to accumulated other comprehensive income
(loss) in stockholders equity. In fiscal 2003, the Company recorded an
increase in the minimum pension liability by charging $2.8 million to
accumulated other comprehensive income (loss). The expected long-term rate of return on plan assets is established based
upon our expectations of asset returns over the expected period to fund
participant benefits considering the plans current target asset allocation.
We further validated this assumption with an independent expert using our
target asset mix in an asset return generation model which projected future
asset returns using simulation and asset class correlation. The Companys pension benefit plan weighted-average asset allocation at
December 31, 2003 and 2002, and target allocation for 2004 are as follows: F-22




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##### Table of Contents



Plan AssetsAsset Allocation 2004
    
    at December 31,Target
    
    Range
    
    2003
    
    2002Large-Cap U.S. Equity
    
    
    45.0
    %
    
    
    30% - 50
    %
    
    
    51
    %
    
    
    40
    %Small/Mid-Cap U.S. Equity
    
    
    10.0
    %
    
    
    5% - 15
    %
    
    
    10
    %
    
    
    7
    %International Equity
    
    
    10.0
    %
    
    
    5% - 15
    %
    
    
    8
    %
    
    
    7
    %Total Equity
    
    
    65.0
    %
    
    
    60% - 75
    %
    
    
    69
    %
    
    
    54
    %Tactical Asset Allocation
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    19
    %Fixed Income
    
    
    35.0
    %
    
    
    25% - 40
    %
    
    
    31
    %
    
    
    27
    %100
    %
    
    
    100
    %
 The pension benefit plan investment policy provides the framework within
which investment decisions are made, establishes standards to measure
investment manager performance, outlines roles and responsibilities and
describes the ongoing review process. The plans investment strategies
include established asset allocation targets and ranges as set forth above to
maximize the advantages of diversification and to minimize risk. The asset
allocation targets disclosed above were implemented during 2003 and the
tactical asset allocation category included in the previous target strategy
was eliminated. The tactical asset allocation category in place at December
31, 2003 provided for investment in any mix of debt and/or equity at the
discretion of the fund manager. At December 31, 2002, the 19% invested in
tactical asset allocation was fully invested in equities. Small/Mid-Cap Equity investments include the Parents common stock in
the amounts of $160,000 (0.6% of total plan assets) and $91,000 (0.4% of
total plan assets) at December 31, 2003 and 2002, respectively. The Company has a defined contribution plan, including features under
Section 401(k) of the Internal Revenue Code, which provides retirement
benefits to its employees. Eligible employees may contribute up to 17% of
their compensation to the plan. In the United States, the Company changed the
plan beginning with the 2003 fiscal year to provide for a mandatory company
match in cash of 25% of the first 4% of employee contributions. During prior
fiscal years, the plan provided a mandatory company match of 10% of employee
contributions. The Company may also make a discretionary matching
contribution for each plan year equal to such dollar amount or percentage of
employee contributions as determined by the Companys Board of Directors. In
Puerto Rico, the Company provides for a mandatory match of 50% of the first
6% of employee contributions. The plan provides for the investment of
employer and employee contributions in the Parents common stock and other
investment alternatives. The Companys matching contributions, net of
forfeitures, of $1.0 million, $1.0 million and $0.6 million were recorded as
expense for fiscal years 2003, 2002 and 2001, respectively. The Company has a Supplemental Executive Retirement Plan (SERP), which
provides for the payment of retirement benefits for certain management and
highly compensated employees supplementing amounts payable under the
Companys non-contributory defined contribution plan. The benefits are
unfunded and each participants SERP account is credited with a percentage of
their base salary and interest earned for the year. Expenses for this plan
for fiscal 2003, 2002 and 2001 were $0.4 million, $0.3 million and $0.5
million, respectively. The plan liability recorded primarily in other
long-term liabilities was $2.6 million and $2.3 million at January 31, 2004
and February 1, 2003, respectively. The Company has a deferred compensation plan for executives and other
senior management which allows deferral of income without regard to
limitations imposed by the Companys 401(k) plan. The Company has generally
made a contribution of the Parents common stock equal to 10% of the
participants deferrals, however, in fiscal 2003 and 2002 the Company made
cash contributions. The deferred compensation together with the Companys
contributions is funded through various marketable securities based on the
election of the participant. As of fiscal year end 2003 and 2002, the Company
had accrued $2.9 million and $2.1 million, respectively for its obligations
under these plans in other long-term liabilities. The Companys net expense,
which includes the participants deferral, investment earnings and Company
contributions was $1.3 million, $0.9 million and $1.3 million for fiscal
2003, 2002 and 2001, respectively. The investments made on behalf of the
participants, other than purchase of the Parents common stock, are included
in other noncurrent assets and were $2.5 million and $1.8 million at December
31, 2003 and 2002, respectively. Investments in the Parents common stock are
recorded as paid in capital in stockholders equity. The Company provides under certain conditions postemployment benefits for
continuation of health care benefits and life insurance coverage to former
employees after employment but before retirement. Pursuant to SFAS 112, the
accrued cost for postemployment benefits was $2.5 million and $2.6 million at
January 31, 2004 and February 1, 2003, respectively. The net F-23




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##### Table of Contents



postemployment benefits (income) expense was $(0.1) million, $1.0 million and
$0.1 million in 2003, 2002 and 2001, respectively. The Company has certain individual deferred compensation agreements,
which provide guaranteed retirement benefits each year for life. The benefits
are accrued over the estimated period in which the employee is to render
service and becomes eligible for the benefit. The benefits are unfunded and a
minimum pension liability of $81,000 was charged to accumulated other
comprehensive income (loss) in stockholders equity in fiscal 2003. Expenses
for these agreements for fiscal 2003, 2002 and 2001 were $2.2 million, $0.5
million and $0.4 million, respectively. At January 31, 2004 and February 1,
2003, the liability, which was recorded in other long-term liabilities, was
$1.1 million and $3.4 million, respectively. In fiscal 2003, a lump sum
payment of $4.6 million was made to the Companys former Chairman and CEO
under the terms of his separation agreement.  (7)
    
    Segment Information The Company has two reportable segments: Cole Vision and Things
Remembered. Most of Cole Visions revenue is provided primarily by sales of
prescription eyewear, accessories and services through its Cole Licensed
Brands and Pearle retail locations. Cole Visions revenue is also provided by
sales of merchandise to franchisees and other outside customers, by royalties
based on sales and initial franchise fees from franchisees and by fees from
managed vision care programs. Cole Vision is subject to various state
regulations related to the dispensing of prescription eyewear, its
relationship with the doctors of optometry and other matters. The Cole
Licensed Brands, Pearle Vision and Cole Managed Vision business units have
been aggregated in accordance with SFAS No. 131, Disclosures About Segments
of an Enterprise and Related Information (SFAS 131), based on the similarity
of their economic characteristics, nature of products, services and
production processes, types of customers, distribution methods and regulatory
environment. Things Remembereds revenue is provided by sales of engraveable
gift merchandise, personalization and other services primarily through retail
stores and kiosks. The accounting policies of the segments are the same as
those described in the Summary of Significant Accounting Policies (see Note
1). The reportable segments are strategic business units that offer
different products and services. They are managed separately as each business
requires different technology and marketing strategies. Performance is
evaluated based on operating income. Reported segment revenue, depreciation
and amortization, and income or loss, with reconciliations to consolidated
amounts are as follows (dollars in thousands): 2003
    
    2002
    
    2001Net revenues:Cole Vision
    
    $
    919,512
    
    
    $
    877,550
    
    
    $
    836,869Things Remembered
    
    
    282,261
    
    
    
    270,569
    
    
    
    272,254Total net revenues
    
    $
    1,201,773
    
    
    $
    1,148,119
    
    
    $
    1,109,123Depreciation and amortization:Cole Vision
    
    $
    27,047
    
    
    $
    22,554
    
    
    $
    25,508Things Remembered
    
    
    9,904
    
    
    
    10,297
    
    
    
    10,520Total segment depreciation and amortization
    
    
    36,951
    
    
    
    32,851
    
    
    
    36,028Unallocated corporate depreciation
    
    
    2,836
    
    
    
    2,779
    
    
    
    2,877Total depreciation and amortization
    
    $
    39,787
    
    
    $
    35,630
    
    
    $
    38,905Income:Cole Vision
    
    $
    24,863
    
    
    $
    30,583
    
    
    $
    15,113Things Remembered
    
    
    21,433
    
    
    
    15,060
    
    
    
    24,149Total segment operating income
    
    
    46,296
    
    
    
    45,643
    
    
    
    39,262Unallocated corporate expense
    
    
    (34,286
    )
    
    
    (17,373
    )
    
    
    (9,596
    )Total operating income
    
    
    12,010
    
    
    
    28,270
    
    
    
    29,666Interest and other (income) expense, net
    
    
    23,476
    
    
    
    36,402
    
    
    
    24,867Income (loss) before income taxes
    
    $
    (11,466
    )
    
    $
    (8,132
    )
    
    $
    4,799
 F-24




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##### Table of Contents



Reported segment assets, expenditures for capital additions and systems
development costs and acquisitions of businesses, with reconciliations to
consolidated amounts, are as follows (dollars in thousands): 2003
    
    2002
    
    2001Segment assets:Cole Vision
    
    $
    424,385
    
    
    $
    421,661Things Remembered
    
    
    117,223
    
    
    
    119,105Total segment assets
    
    
    541,608
    
    
    
    540,766Corporate cash and temporary cash investments
    
    
    43,479
    
    
    
    28,435Other corporate assets
    
    
    35,758
    
    
    
    34,962Consolidated assets
    
    $
    620,845
    
    
    $
    604,163Expenditures for capital additions and
systems development costs:Cole Vision
    
    $
    23,300
    
    
    $
    31,502
    
    
    $
    26,288Things Remembered
    
    
    6,454
    
    
    
    10,342
    
    
    
    12,582Total segment expenditures
    
    
    29,754
    
    
    
    41,844
    
    
    
    38,870Corporate
    
    
    2,335
    
    
    
    3,142
    
    
    
    1,670Consolidated expenditures
    
    $
    32,089
    
    
    $
    44,986
    
    
    $
    40,540Contingent payments for and acquisition of businessCole Vision
    
    $
    4,051
    
    
    $
    1,645
    
    
    $
    847
 Revenues from external customers of each group of similar products and
services is as follows (dollars in thousands): 2003
    
    2002
    
    2001Sales of optical products and services
    
    $
    810,290
    
    
    $
    783,765
    
    
    $
    751,680Royalties and initial franchise fees
    
    
    20,136
    
    
    
    19,450
    
    
    
    18,744Fees from managed vision care programs
    
    
    89,086
    
    
    
    74,335
    
    
    
    66,445Total Cole Vision net revenue
    
    
    919,512
    
    
    
    877,550
    
    
    
    836,869Retail sales of gift merchandise and services
    
    
    282,261
    
    
    
    270,569
    
    
    
    272,254Consolidated net revenue
    
    $
    1,201,773
    
    
    $
    1,148,119
    
    
    $
    1,109,123
 The Company operates primarily in the United States. Net revenues
attributable to Cole Visions Canadian operations were $29.2 million, $28.6
million and $30.0 million in fiscal 2003, 2002 and 2001, respectively.
Long-lived assets located in Canada at January 31, 2004 and February 1, 2003
totaled $2.2 million and $2.9 million, respectively.  (8)
    
    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. The Sears agreement
contains a short-term cancellation clause. Generally, the Company is required
to pay taxes and normal expenses of operating the premises for laboratory,
office, warehouse and retail store leases; the host stores pay these expenses
for departments operated on a percentage-of-sales basis. The following
amounts represent rental expense for fiscal 2003, 2002 and 2001 (dollars in
thousands): F-25




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##### Table of Contents



2003
    
    2002
    
    2001Occupancy costs based on sales
    
    $
    63,182
    
    
    $
    58,966
    
    
    $
    56,923All other rental expense
    
    
    91,494
    
    
    
    91,736
    
    
    
    89,940Sublease rental income
    
    
    (14,638
    )
    
    
    (14,525
    )
    
    
    (16,270
    )Total rental expense, net
    
    $
    140,038
    
    
    $
    136,177
    
    
    $
    130,593
 At January 31, 2004, future minimum lease payments and sublease income
receipts under noncancelable leases and the present value of future minimum
lease payments for capital leases are as follows (dollars in thousands): Capital
    
    Operating LeasesLeases
    
    Payments
    
    Receipts2004
    
    $
    643
    
    
    $
    77,244
    
    
    $
    (10,456
    )2005
    
    
    599
    
    
    
    64,647
    
    
    
    (8,060
    )2006
    
    
    557
    
    
    
    52,818
    
    
    
    (6,532
    )2007
    
    
    417
    
    
    
    41,772
    
    
    
    (4,895
    )2008
    
    
    296
    
    
    
    33,141
    
    
    
    (3,009
    )2009 and thereafter
    
    
    102
    
    
    
    77,006
    
    
    
    (5,875
    )Total future minimum lease payments
    
    
    2,614
    
    
    $
    346,628
    
    
    $
    (38,827
    )Amount representing interest
    
    
    (480
    )Present value of future minimum lease payments
    
    $
    2,134
 In fiscal 2001, under a sale and leaseback agreement, the Company
received approximately $5.7 million, net of related costs, from the sale of
its Pearle Vision lab and distribution facility in Dallas, Texas and leased
it back under a fifteen-year operating lease agreement with four five-year
renewal options. The transaction produced a gain of approximately $0.6
million that was deferred and is being amortized over the fifteen year lease
period. The Company guarantees future minimum lease payments for certain store
locations leased directly by franchisees. These guarantees totaled
approximately $13.4 and $13.8 million as of January 31, 2004 and February 1,
2003. 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. The term of the
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. Under the terms of
the guarantees, the Company has the right to assume the primary obligation
and begin operating as a company-owned store. In addition, as part of many
franchise agreements, the Company may recover any amounts paid under a
guarantee from the defaulting franchisee. The Company has recorded a
liability of $23,500, which represents the estimated fair value of the
Companys obligations from guarantees entered into or modified after December
31, 2002 using an expected present value calculation. In fiscal 2000, the Company guaranteed certain borrowings of a
franchisee with a bank in connection with operations of two franchised
stores. The maximum exposure under the agreement is $333,000 and expires upon
full payment of the term loan borrowings by the franchisee. The loan matures
in 2010. In fiscal 2003, the Company entered into an agreement to guarantee a
portion of the amount owed to a bank by a franchisee as a result of a loan
granted in connection with the purchase of five stores. The guaranteed amount
equals the cumulative value of the store assets. The Company is released from
its obligation once the landlords of the store locations execute
subordination agreements or the bank is granted access to the store assets in
the event of the default by the franchisee. The maximum exposure under the
agreement is $464,000 as of January 31, 2004.  (9)
    
    Legal Proceedings The Company and its optical subsidiaries have been sued by the State of
California, which alleges claims for various statutory violations related to
the operation of 23 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 F-26




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##### Table of Contents



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. In July 2002, the State of
California obtained a preliminary injunction to enjoin certain advertising
practices and from charging dilation fees. The trial courts decision was
appealed by both the Company and the State. On November 26, 2003, the
appellate court ruled on the appeal in a manner adverse to the Company with
respect to continued advertising in California by Pearle Vision that
expressly or implicitly advertises the furnishing of optometric services,
disallowing continued advertising of the availability of optometric services
with a disclaimer that had been previously approved by the trial court. The
appellate court ruled in the Companys favor with respect to charging
dilation fees. On March 3, 2004, the California Supreme Court granted the
Companys petition for review of the Appellate Courts decision. Although the
Company believes that its advertising and operational practices in California
complied with California law, the appellate ruling may, if unmodified by the
Supreme Court, compel the Company to modify or close its activities in
California. Further, the Company might be required to pay damages and or
restitution in a currently undeterminable amount, the cost of which might
have a material adverse effect on the Companys operating results and cash
flow in one or more periods. Things Remembered, Inc. settled a class action complaint in California
alleging that the putative class (alleged to include 200 members) were
improperly denied overtime compensation in violation of a California law. The
action sought unspecified damages, interest, restitution, as well as
declaratory and injunctive relief and attorneys fees. On February 3, 2003,
Things Remembered and the plaintiffs reached an agreement to resolve the
lawsuit for $562,500. Preliminary approval was received from the Court on
August 1, 2003. On December 3, 2003, the Court approved final settlement of
the lawsuit. A liability of $562,500 was recorded in the fourth quarter of
fiscal 2002 and paid in the first quarter of fiscal 2004. Cole National Corporation settled a class action lawsuit alleging claims
for various violations of federal securities laws related to the Companys
publicly reported revenues and earnings. The action, which pleaded claims
under Section 10(b) and 20(a) of the Securities Exchange Act of 1934, and
named the Parent and certain present and former officers and directors as
defendants, sought unspecified compensatory damages, punitive damages where
appropriate, costs, expenses and attorneys fees. On May 30, 2003, the
Parent and the plaintiffs reached an agreement to resolve the lawsuit. On
September 29, 2003, the Court approved final settlement of the lawsuit. A
charge of $2,687,500 was recorded in the first quarter of fiscal 2003 with
respect to the Companys portion of the settlement. Following the Companys announcement in November 2002 of the restatement
of the Companys financial statements, the Securities and Exchange Commission
began an investigation into the Companys previous accounting. The course of
this investigation or other litigation or investigations arising out of the
restatement of the Companys financial statements cannot be predicted. In
addition, under certain circumstances the Company would be obliged to
indemnify the individual current and former directors and officers who
are named as defendants in litigation or who are or become involved in an
investigation. The Company believes it has insurance that should be available
with respect to a portion of its indemnification obligations. If the Company
is unsuccessful in defending against the current investigation or any
litigation, there may be a material adverse effect on the Companys financial
condition, cash flow and results of operations. The Company has been named as a defendant along with numerous other
retailers, in patent infringement litigation challenging the defendants use
of bar code technology. A stay of the proceeding has been sought and was
granted, in deference to prior pending declaratory judgment suits brought by
the manufacturers and suppliers of the implicated technology seeking to
declare the patents in suit not infringed. On January 23, 2004, a court in
Nevada entered a memorandum of decision in favor of a manufacturer declaring
the patents not infringed. This judgment is expected to be appealed, and the
infringement litigation against the Company will remain stayed pending the
final resolution any such appeal. The Company believes it has available
defenses and does not expect any liability. If the Company were to be found
liable for an infringement, it might have a material adverse effect on its
operating results and cash flow in the period incurred. 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.  (10)
    
    Merger Agreement On January 26, 2004, Cole National Corporation and Luxottica Group
S.p.A. entered into a merger agreement pursuant to which the Parent would
become a subsidiary of Luxottica Group. Under the agreement, Luxottica Group
will acquire all of the F-27




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##### Table of Contents



outstanding shares of the Parent for a cash purchase price of $22.50 per
share, together with the purchase of all outstanding options and similar
equity rights at the same price per share, less their respective exercise
price. The merger is subject to approval by the holders of a majority of the
outstanding shares of the Parents common stock and the satisfaction of other
customary conditions, including compliance with applicable antitrust
clearance requirements. On February 27, 2004, the Parent and Luxottica Group
filed pre-merger notifications with the U.S. antitrust authorities pursuant
to the Hart-Scott-Rodino Antitrust Improvements Act of 1976 (the HSR Act).
On March 30, 2004 the Parent and Luxottica Group jointly announced that they
had received a request from the Federal Trade Commission (FTC) for additional
information and documentary material with respect to the Merger. Accordingly,
the waiting period under the HSR Act has been extended until the 30th day
after the date of substantial compliance with the request by both parties,
unless earlier terminated by the FTC. On March 2, 2004, the Parent announced
that it has scheduled a special meeting of stockholders for April 20, 2004 to
consider and vote on the approval of the merger agreement with Luxottica
Group. Stockholders of record of the Parent as of March 12, 2004 will be
entitled to vote on the transaction. On March 15, 2004, the Parent filed its
definitive proxy statement. (11) Restatement of
Consolidated Statements of Cash Flows Subsequent to the issuance
of the fiscal 2003 consolidated financial statements, the Company determined that
certain components in its consolidated statements of cash flows for
fiscal 2003, 2002, and 2001 were incorrectly classified. Mistakes were discovered in the calculation of the fiscal
2002, 2001 and 2000 overdraft balances resulting in misstatements of
changes in account payable, accrued liabilities and other liabilities
within cash flows from operating activities with corresponding
misstatements of changes in overdraft balances within cash flows
from financing activities. Certain other individually insignificant
items for fiscal 2003 were also incorrectly classified. As a result,
the accompanying consolidated statements of cash flows for the fiscal
years 2003, 2002 and 2001 have been restated from the amounts
previously reported to increase (decrease) cash flows from operating
activities by ($4.3) million, $4.5 million and
$4.4 million for fiscal 2003, 2002 and 2001, respectively and
increase (decrease) cash flows from financing activities by
$4.3 million, ($4.5) million and ($4.4) million for
fiscal 2003, 2002 and 2001, respectively. In addition, the overdraft
balance at February 1, 2003 disclosed in Note 1 have been
decreased by $4.4 million. F-28




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##### Table of Contents



Schedule I COLE NATIONAL GROUP, INC. AND SUBSIDIARIES
CONDENSED FINANCIAL INFORMATION OF REGISTRANT Cole National Group, Inc.
Condensed Balance Sheets
January 31, 2004 and February 1, 2003
(Dollars in millions) 2003
    
    2002Assets:Cash
    
    $
    43.5
    
    
    $
    28.4Investment in subsidiaries
    
    
    291.4
    
    
    
    313.8Property and equipment, net
    
    
    2.6
    
    
    
    4.4Deferred income tax and other
    
    
    26.3
    
    
    
    23.6Total assets
    
    $
    363.8
    
    
    $
    370.2Liabilities and stockholders equity:Accounts payable and accrued expenses
    
    
    25.6
    
    
    
    21.1Payable to affiliates
    
    
    50.0
    
    
    
    52.5Long-term debt
    
    
    275.5
    
    
    
    275.8Other long-term liabilities
    
    
    21.9
    
    
    
    26.2Stockholders equity (deficit)
    
    
    (9.2
    )
    
    
    (5.4
    )Total liabilities and stockholders equity
    
    $
    363.8
    
    
    $
    370.2
 F-29




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##### Table of Contents



Schedule I
(Continued) Cole National Group, Inc.
Condensed Statements of Operations and Cash Flows
52 Weeks Ended January 31, 2004, February 1, 2003 and
February 2, 2002
(Dollars in millions) January 31,
    
    February 1,
    
    February 2,Condensed Statements of Operations
    
    2004
    
    2003
    
    2002Revenue  services to affiliates
    
    $
    45.8
    
    
    $
    32.9
    
    
    $
    29.7Operating expenses
    
    
    47.2
    
    
    
    35.7
    
    
    
    29.2Interest and other (income) expenses, net
    
    
    (7.8
    )
    
    
    3.2
    
    
    
    (8.1
    )Income (loss) before taxes
    
    
    6.4
    
    
    
    (6.0
    )
    
    
    8.6Income tax provision (benefit)
    
    
    (8.8
    )
    
    
    (12.6
    )
    
    
    (17.6
    )Income (loss) before equity in undistributed earnings (loss)
of subsidiaries
    
    
    15.2
    
    
    
    6.6
    
    
    
    26.2Equity in undistributed earnings (loss) of subsidiaries
    
    
    (23.0
    )
    
    
    (13.9
    )
    
    
    (26.7
    )Net income (loss)
    
    $
    (7.8
    )
    
    $
    (7.3
    )
    
    $
    (0.5
    )Condensed Statements of Cash FlowsNet cash (used for) provided by operating activities
    
    $
    14.2
    
    
    $
    29.0
    
    
    $
    28.0Investing activities:Purchase of property and equipment
    
    
    (0.5
    )
    
    
    (0.5
    )
    
    
    (3.4
    )Proceeds from sale of asset
    
    
    2.6
    
    
    
    
    
    
    
    Systems development costs
    
    
    
    
    
    
    (1.0
    )
    
    
    (1.0
    )Other, net
    
    
    
    
    
    
    (0.2
    )
    
    
    0.1Net cash used for investing activities
    
    
    2.1
    
    
    
    (1.7
    )
    
    
    (4.3
    )Financing activities:Repayment of long-term debt
    
    
    
    
    
    
    (158.1
    )
    
    
    (0.1
    )Advances from (to) affiliates
    
    
    (2.4
    )
    
    
    (35.7
    )
    
    
    2.4Proceeds from issuance of long-term debt
    
    
    
    
    
    
    150.0
    
    
    
    Payment of financing fees
    
    
    (0.2
    )
    
    
    (6.1
    )
    
    
    Other, net
    
    
    1.4
    
    
    
    0.7
    
    
    
    (2.0
    )Net cash provided by (used for) financing activities
    
    
    (1.2
    )
    
    
    (49.2
    )
    
    
    0.3Net change in cash
    
    
    15.1
    
    
    
    (21.9
    )
    
    
    24.0Cash, beginning of period
    
    
    28.4
    
    
    
    50.3
    
    
    
    26.3Cash, end of period
    
    $
    43.5
    
    
    $
    28.4
    
    
    $
    50.3
 F-30




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##### Table of Contents



Schedule I
(Continued) Note to Condensed Financial Information of Registrant The accompanying financial information of Cole National Group, Inc. is as
of January 31, 2004 and February 1, 2003, and for the 52 weeks ended January
31, 2004, February 1, 2003 and February 2, 2002. Cole National Group, Inc. is a
holding company for its wholly owned subsidiaries, Things Remembered, Inc.,
Cole Vision Corporation and Pearle, Inc., except for expenses associated with
Cole National Groups corporate offices, consisted of no other operations. This financial information should be read in connection with the
Consolidated Financial Statements and notes thereto of Cole National Group,
Inc. and Subsidiaries, contained elsewhere in this Form 10-K/A. F-31




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Schedule II Cole National Group, Inc. and Subsidiaries 
Valuation and Qualifying Accounts
52 Weeks Ended January 31, 2004, February 1, 2003
and February 2, 2002
(Dollars in millions) ChargesBalance at
    
    (Reversals)
    
    
    
    
    
    
    
    
    
    BalanceBeginning
    
    to Cost and
    
    
    
    
    
    
    
    
    
    End ofDescription
    
    of Period
    
    Expenses
    
    Transfers(B)
    
    Deductions(A)
    
    PeriodJanuary 31, 2004Allowance for uncollectible accounts
    
    $
    3.1
    
    
    $
    2.2
    
    
    $
    
    
    
    $
    (1.9
    )
    
    $
    3.4Franchise note allowance for uncollectible accounts
    
    
    3.0
    
    
    
    
    
    
    
    
    
    
    
    (0.1
    )
    
    $
    2.9February 1, 2003Allowance for uncollectible accounts
    
    $
    3.2
    
    
    $
    2.0
    
    
    $
    
    
    
    $
    (2.1
    )
    
    $
    3.1Franchise note allowance for uncollectible accounts
    
    
    5.2
    
    
    
    (0.7
    )
    
    
    
    
    
    
    (1.5
    )
    
    $
    3.0February 2, 2002Allowance for uncollectible accounts
    
    $
    6.3
    
    
    $
    1.1
    
    
    $
    (1.2
    )
    
    $
    (3.0
    )
    
    $
    3.2Franchise note allowance for uncollectible accounts
    
    
    4.7
    
    
    
    0.3
    
    
    
    1.2
    
    
    
    (1.0
    )
    
    $
    5.2
  (A)
    
    Receivable balances written off, net of recoveries(B)
    
    Transfers resulted from conversions of accounts receivables
to notes receivables.Allowance balances presented in the Notes to Consolidated Financial Statements
are represented on this schedule. F-32




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##### Table of Contents



CNG EXHIBIT INDEX ExhibitNumber
    
    Description3.1(i)
    
    Certificate of Incorporation of Cole National Group, incorporated
by reference to Exhibit 3.1(i) to Cole National Groups
Registration Statement on Form S-1 (Registration No. 33-66342).3.2(ii)
    
    Amended and Restated By-Laws of Cole National Group, dated July
28, 2003, incorporated by reference to Exhibit 3.2(ii) to Cole
National Group Inc.s Quarterly Report on Form 10-Q for period
ended August 2, 2003 (File No. 33-66342).4.1
    
    Indenture dated May 22, 2002, by and among Cole National Group,
Inc. and Wells Fargo Bank Minnesota, National Association, as
trustee, relating to the 8-7/8% Senior Subordinated Notes due 2012
(the form of which Senior Subordinated Note is included in such
Indenture), incorporated by reference to Exhibit 10.2 of Cole
National Group Inc.s Quarterly Report on Form 10-Q for the period
ending August 3, 2002 (File No. 33-66342).4.2
    
    Indenture dated August 22, 1997, between Cole National Group, Inc.
and Norwest Bank Minnesota, National Association, as Trustee,
relating to the 8-5/8% Senior Subordinated Notes Due 2007,
incorporated by reference to Exhibit 4.4 of Cole National Group,
Inc.s Registration Statement on Form S-1 (Registration No.
333-34963).10.1
    
    Form of Indemnification Agreement for Directors of Cole National
Group, incorporated by Reference to Exhibit 10.19 to Cole National
Groups Registration Statement on Form S-1 (Registration No.
33-66342).10.2
    
    Form of Indemnification Agreement for Officers of Cole National
Group, incorporated by reference to Exhibit 10.20 to Cole National
Groups Registration Statement on Form S-1 (Registration No.
33-66342).10.3
    
    Agreement for the Allocation of Federal Income Tax Liability and
Benefits among Members of the Parent Group dated August 23, 1985,
as amended, incorporated by reference to Exhibit 10.26 to Cole
National Groups Registration Statement on Form S-1 (Registration
No. 33-66342).10.4
    
    Assignment and Assumption Agreement dated as of September 30, 1993
between Cole National Corporation and Cole National Group,
incorporated by reference to Exhibit 10.24 to Cole National
Corporations Annual Report on Form 10-K for the period ended
February 3, 1996 (File No. 1-12814).10.5
    
    Cole National Group Guarantee and Cash Collateral Agreement, dated
as of November 15, 1996, by Cole National Group and Cole National
Corporation, incorporated by reference to Exhibit 99.3 of Cole
National Corporations Report on Form 8-K, filed on December 2,
1996 (File No. 1-12814).10.6
    
    Guarantee and Collateral Agreement, dated as of November 15, 1996,
by Cole Vision Corporation, Things Remembered, Inc., Cole Gift
Centers, Inc., Pearle, Inc. and Pearle Service Corporation and
Canadian Imperial Bank of Commerce, incorporated by reference to
Exhibit 99.4 of Cole National Corporations Report on Form 8-K,
field on December 2, 1996 (File No. 1-12814).10.7*
    
    Cole National Group, Inc. 1999 Supplemental Retirement Benefit
Plan dated as of December 17, 1998, incorporated by reference to
Exhibit 10.51 to Cole National Corporations Annual Report on Form
10-K for the period ended January 30, 1999 (File No. 1-12814)10.8*
    
    Cole National Group, Inc. Deferred Compensation Plan effective as
of February 1, 1999, incorporated by reference to Exhibit 10.53 to
Cole National Corporations Annual Report on Form 10-K for the
period ended January 30, 1999 (File No. 1-12814).
 X-1




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##### Table of Contents



ExhibitNumber
    
    Description10.9*
    
    Amendment No. 1, dated as of December 17, 1998, to the Cole
National Group, Inc. Supplemental Pension Plan, incorporated by
reference to Exhibit 10.54 to Cole National Corporations Annual
Report on Form 10-K for the period ended January 30, 1999 (File
No. 1-12814).10.10*
    
    Amendment No. 1 to the Cole National Group, Inc. Deferred
Compensation Plan for Senior Executives and other Senior
Management, dated January 25, 2002 incorporated by reference to
Exhibit 10.32 to Cole National Group Inc.s Annual Report on Form
10-K for the period ended February 2, 2002 (File No. 33-66342).10.11*
    
    Amendment No. 2 to the Cole National Group, Inc. Supplemental
Pension Plan, dated January 25, 2002 incorporated by reference to
Exhibit 10.33 to Cole National Group Inc.s Annual Report on Form
10-K for the period ended February 2, 2002 (File No. 33-66342).10.12*
    
    Amendment No. 2 to the Cole National Group, Inc. Supplemental
Retirement Benefit Plan, dated January 25, 2002 incorporated by
reference to Exhibit 10.34 to Cole National Group Inc.s Annual
Report on Form 10-K for the period ended February 2, 2002 (File
No. 33-66342).10.13*
    
    Amendment No. 1 to the Cole National Group, Inc. 1999 Supplemental
Retirement Benefit Plan, dated January 5, 2002 incorporated by
reference to Exhibit 10.35 to Cole National Group Inc.s Annual
Report on Form 10-K for the period ended February 2, 2002 (File
No. 33-66342).10.14
    
    Amended and Restated Credit Agreement, dated as of May 23, 2002,
among Cole Vision Corporation, Things Remembered, Inc., Cole Gift
Centers, Inc., Pearle, Inc. and Canadian Imperial Bank of
Commerce, incorporated by reference to Exhibit 10.1 of Cole
National Group Inc.s Quarterly Report on Form 10-Q for the period
ended May 4, 2002 (File No. 33-66342).10.15
    
    Amendment No. 1 to the Cole National Group, Inc. Retirement Plan
(Amended and Restated as of January 1, 2001), effective March 31,
2002, incorporated by reference to Exhibit 10.3 of Cole National
Group Inc.s Quarterly Report on Form 10-Q for the period ended
August 2, 2002 (File No. 33-66342).10.16
    
    Third Amendment to Credit Agreement, dated December 16, 2002,
among Cole Vision Corporation, Things Remembered, Inc. and Pearle,
Inc. and Canadian Imperial Bank of Commerce, incorporated by
reference to Exhibit 10.26 of Cole National Group Inc.s Annual
Report on Form 10-K for the year ended February 1, 2003 (File No.
33-66342).10.17
    
    Amended and Restated Instrument Designating Participants of the
Cole National Group, Inc. 1999 Supplemental Retirement Benefit
Plan dated January 25, 2002, incorporated by reference to Exhibit
10.27 of Cole National Group Inc.s Annual Report on Form 10-K for
the year ended February 1, 2003 (File No. 33-66342).10.18
    
    Form of License/Lease Agreement for Sears Optical, incorporated by
reference to Exhibit 10.28 of Cole National Group Inc.s Annual
Report on Form 10-K for the year ended February 1, 2003 (File No.
33-66342).10.19
    
    Bank Waiver to the Credit Agreement, dated May 9, 2003, among Cole
Vision Corporation, Things Remembered, Inc. and Pearle, Inc. and
Canadian Imperial Bank of Commerce, incorporated by reference to
Exhibit 10.29 of Cole National Group Inc.s Annual Report on Form
10-K for the year ended February 1, 2003 (File No. 33-66342).10.20*
    
    Employment Agreement entered into as of June 2, 2003 by and among
Cole National Corporation and Larry Pollock, incorporated by
reference to Exhibit 10.1 of Cole National Corporations Form 10-Q
for the period ended May 3, 2003 (File No. 1-12814).
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##### Table of Contents



ExhibitNumber
    
    Description10.21*
    
    Amended, restated and extended Credit Agreement, dated June 27,
2003, among Cole Vision, Things Remembered and Pearle, Inc. and
Canadian Imperial Bank of Commerce, incorporated by reference to
Exhibit 10.1 of Cole National Group Inc.s Quarterly Report on
Form 10-Q for the period ended August 2, 2003 (File No. 33-66342).10.22
    
    Separation Agreement entered into as of July 16, 2003 by and among
Cole National Corporation and Jeffrey A. Cole, incorporated by
reference to Exhibit 10.2 of Cole National Group Inc. s Form 10-Q
for the period ended August 2, 2003 (File No. 1-12814).10.23*
    
    Assignment of Life Insurance Policy, Termination of Split-Dollar
Agreement and Satisfaction of Collateral Assignment by and among
Cole National Corporation and Jeffrey A. Cole, incorporated by
reference to Exhibit 10.3 of Cole National Group Inc.s Quarterly
Report on Form 10-Q for the period ended August 2, 2003 (File No.
33-66342).10.24*
    
    Employment Agreement dated September 3, 2003 between Cole National
Corporation and Lawrence E. Hyatt, incorporated by reference to
Exhibit 10.1 of Cole National Group Inc.s Quarterly Report on
Form 10-Q for the period ended November 1, 2003 (File No.
33-66342).10.25*
    
    Employment Agreement dated September 3, 2003 between Cole National
Corporation and Leslie D. Dunn, incorporated by reference to
Exhibit 10.2 of Cole National Group Inc.s Quarterly Report on
Form 10-Q for the period ended November 1, 2003 (File No.
33-66342).10.26*
    
    Employment Agreement dated September 3, 2003 between Cole National
Corporation and Patricia M. Luzier, incorporated by reference to
Exhibit 10.3 of Cole National Group Inc.s Quarterly Report on
Form 10-Q for the period ended November 1, 2003 (File No.
33-66342).10.27*
    
    Multi-Year Performance Incentive Bonus Addendum between Cole
National Corporation and Larry Pollock, dated November 26, 2003,
incorporated by reference to Exhibit 10.4 of Cole National Group
Inc.s Quarterly Report on Form 10-Q for the period ended November
1, 2003 (File No. 33-66342).10.28
    
    Letter of Credit Reimbursement and Security agreement among Cole
National Corporation, Things Remembered, Inc. and Key Bank
National Association, dated November 3, 2003, incorporated by
reference to Exhibit 10.6 of Cole National Group Inc.s Quarterly
Report on Form 10-Q for the period ended November 1, 2003 (File
No. 33-66342).10.29*
    
    Addendum to Letter Agreement dated May 15, 2000 between Cole
National Corporation and Ann M. Holt, incorporated by reference to
Exhibit 10.7 of Cole National Group Inc.s Quarterly Report on
Form 10-Q for the period ended November 1, 2003 (File No.
33-66342).10.30*
    
    Addendum to Letter Agreement dated March 27, 1993 between Cole
National Corporation and Joseph Gaglioti, incorporated by
reference to Exhibit 10.8 of Cole National Group Inc.s Quarterly
Report on Form 10-Q for the period ended November 1, 2003 (File
No. 33-66342).10.31*+
    
    Amendment No. 2 to the Cole National Group, Inc. 1999 Supplemental
Retirement Benefit Plan, dated January 23, 2004.10.32*+
    
    Instrument Designating Participant of the Cole National Group,
Inc. 1999 Supplemental Retirement Benefit Plan dated January 23,
2004 between Cole National Corporation and Larry Pollock.10.33*+
    
    Cole National Group, Inc. 1999
Supplemental Retirement Benefit Plan, Payment Election Agreement,
dated January 30, 2004 between Cole National Group, Inc. and
Larry Pollock.24+
    
    Power of Attorney.
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##### Table of Contents



ExhibitNumber
    
    Description31.1
    
    Certification of Chief Executive Officer Pursuant to Rule 13a-14(a)/15d-14(a) of the Exchange Act.31.2
    
    Certification of Chief Executive Officer Pursuant to Rule 13a-14(a)/15d-14(a) of the Exchange Act.32#
    
    Certification of Chief Executive Officer and Chief Financial Officer Pursuant to 18 U.S.C.
Section 1350, as adopted to Section 906 of the Sarbanes-Oxley Act of 2002.99.1
    
    Agreement and Plan of Merger among Cole National Corporation, Luxottica Group S.p.A. and Colorado
Acquisition Corp., dated January 23, 2004, incorporated by reference to Exhibit 99.1 of Cole
National Group Inc.s Form 8-K filed on January 27, 2004 (File No. 33-66342).99.2
    
    Amendment No. 1, dated January 23 2004, to 199 Rights Agreement, dated November 22, 1999, between
Cole National Corporation and National City Bank, as Rights Agent, incorporated by reference to
Exhibit 99.2 of Cole National Group Inc.s Form 8-K filed on January 27, 2004 (File No.
33-66342).
  *
    
    Reflects management contract or other compensatory arrangement required to be filed as an exhibit pursuant to
Item 14(c) of this Form 10-K/A.#
    
    In accordance with Item 601(b)(32)(ii) of Regulation S-K, this exhibit shall not be deemed filed for the
purposes of Section 18 of the Securities and Exchange Act of 1934 or otherwise subject to the liability of that
section, nor shall it be deemed incorporated by reference in any filing under the Securities Act of 1933 or the
Securities Exchange Act of 1934.+
    
    Filed with the original Form 10-K filed on April 12, 2004.
    
    Filed herewith. X-4