Edgar Filing: EMERGING VISION INC

(State of incorporation)

(I.R.S. Employer Identification Number)

U.S. Securities and Exchange Commission
Washington, D.C. 20549

FORM 10-K

Annual Report Pursuant to Section 13 or 15 (d) of the Securities and Exchange Act of 1934

For the fiscal year ended December 31, 2004

Commission File Number 1-14128

EMERGING VISION, INC.

(Exact name of Registrant as specified in its Charter)

100 Quentin Roosevelt Boulevard
Garden City, NY 11530
Telephone Number: (516) 390-2100
(Address and Telephone Number of
Principal Executive Offices)

Securities registered pursuant to Section 12(b) of the Act: None

Securities registered pursuant to Section 12(g) of the Act: Common Stock, par value $0.01 per share

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 No

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant's knowledge, in the definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.

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

Yes No

The aggregate market value of the voting and non-voting common equity held by non-affiliates computed by reference to the price at which the common equity was last sold, as of June 30, 2004, was $10,081,337.

Number of shares outstanding as of March 29, 2005:

70,323,698 shares of Common Stock, par value $0.01 per share

Documents incorporated by reference: None

Part I

Item 1. Business

GENERAL

Emerging Vision, Inc. (the "Registrant" and, together with its subsidiaries, hereinafter the "Company" or "Emerging") is one of the largest chains of retail optical stores and one of the largest franchise optical chains in the United States, based upon management's beliefs, domestic sales and the number of locations of Company-owned and franchised stores (collectively referred to hereinafter as "Sterling Stores"). The Registrant was incorporated under the laws of the State of New York in January 1992 and, in July 1992, purchased substantially all of the assets of Sterling Optical Corp., a New York corporation then a debtor-in-possession under Chapter 11 of the U.S. Bankruptcy Code.

STORE OPERATIONS

The Company and its franchisees operate retail optical stores under the trade names "Sterling Optical," "Site For Sore Eyes," "Duling Optical" and "Singer Specs," although most stores (other than the Company's Site for Sore Eyes stores located in Northern California) operate under the name "Sterling Optical." The Company also operates VisionCare of California, Inc. ("VCC"), a specialized health care maintenance organization licensed by the State of California, Department of Managed Health Care, which employs licensed optometrists who render services in offices located immediately adjacent to, or within, most Sterling Stores located in California.

Most Sterling Stores offer eye care products and services such as prescription and non-prescription eyeglasses, eyeglass frames, ophthalmic lenses, contact lenses, sunglasses and a broad range of ancillary items. To the extent permitted by individual state regulations, an optometrist is employed by, or affiliated with, most Sterling Stores to provide professional eye examinations to the public. The Company fills prescriptions from these employed or affiliated optometrists, as well as from unaffiliated optometrists and ophthalmologists. Most Sterling Stores have an inventory of ophthalmic and contact lenses, as well as on-site lab equipment for cutting and edging ophthalmic lenses to fit into eyeglass frames, which, in many cases, allows Sterling Stores to offer same-day service.

Occasionally, the Company sells the assets of certain of its Company-owned stores to qualified franchisees and, in certain instances, realizes a profit on the conveyance of the assets of such stores. Through these sales, along with the opening of new stores by qualified franchisees, the Company seeks to create a stream of royalty payments based upon a percentage of the gross revenues of the franchised locations, and grow both the Sterling Optical and Site For Sore Eyes brand names. The Company currently derives its revenues from the sale of eye care products and services at Company-owned stores, membership fees paid to VCC, and ongoing royalty fees based upon a percentage of the gross revenues of its franchised stores.

As of December 31, 2004, there were 165 Sterling Stores in operation, consisting of 11 Company-owned stores (two of which were being managed by franchisees) and 154 franchised stores. Sterling Stores are located in 17 states, the District of Columbia, Canada and the U.S. Virgin Islands.

The following chart sets forth the breakdown of Sterling Stores in operation as of December 31, 2004 and 2003:


	December 31,
	2004^(*)		2003
I. COMPANY-OWNED STORES:
Company-owned stores		9		9
Company-owned stores managed by franchisees		2		5
Total		11		14


^(*)	Existing store locations: California (1), New York (7), North Dakota (1), and Wisconsin (2).


II. FRANCHISED STORES:
Franchised stores	154	158


^(*)	Existing store locations: California (40), Delaware (6), Florida (1), Illinois (1), Maryland (14), Massachusetts (1), Montana (1), Nevada (1), New Jersey (7), New York (41), North Dakota (3), Ontario, Canada (2), Pennsylvania (13), South Dakota (1), Texas (1),Virginia (8), Washington, D.C. (2), West Virginia (1), Wisconsin (8) and the U.S. Virgin Islands (2).

Sterling Stores generally range in size from approximately 1,000 square feet to 2,000 square feet, are similar in appearance and are operated under certain uniform standards and operating procedures. Many Sterling Stores are located in enclosed regional shopping malls and smaller strip centers, with a limited number of Sterling Stores being housed in freestanding buildings with adjacent parking facilities. Sterling Stores are generally clustered within geographic market areas to maximize the benefit of advertising strategies and minimize the cost of supervising operations.

In response to the eyewear market becoming increasingly fashion-oriented during the past decade, most Sterling Stores carry a large selection of ophthalmic eyeglass frames. The Company frequently test-markets various brands of sunglasses, ophthalmic lenses, contact lenses and designer frames. Small quantities of these items are usually purchased for selected stores that test customer response and interest. If a product test is successful, the Company attempts to negotiate a system-wide preferred vendor discount for the product in an effort to maximize system-wide sales and profits.

FRANCHISE SYSTEM

An integral part of the Company's franchise system includes providing a high level of marketing, financial, training and administrative support to its franchisees. The Company provides "grand opening" assistance for each new franchised location by consulting with its franchisees with respect to store design, fixture and equipment requirements and sources, inventory selection and sources, and marketing and promotional programs, as well as assistance in obtaining managed care contracts. Specifically, the Company's grand opening assistance helps to establish business plans and budgets, provides preliminary store design and plan approval prior to construction of a franchised store, and provides training, an operations manual and a comprehensive business review to aid the franchisee in attempting to maximize its sales and profitability. Further, on an ongoing basis, the Company provides training through regional and national seminars, offers assistance in marketing and advertising programs and promotions, offers online communication, franchisee group discussion as well as updated training modules and product information through its interactive Franchisee Intranet, and consults with its franchisees as to their management and operational strategies and business plans.

Preferred Vendor Network. With the collective buying power of Company-owned and franchised Sterling Stores, the Company has established a network of preferred vendors (the "Preferred Vendors") whose products may be purchased directly by franchisees at group discount prices, thereby providing such franchisees with the opportunity for higher gross margins. Additionally, the Company negotiates and executes cooperative advertising programs with its Preferred Vendors for the benefit of all Company-owned and franchised stores.

Franchise Agreements. Each franchisee enters into a franchise agreement (the "Franchise Agreement") with the Company, the material terms of which are as follows:


a.	Term. Generally, the term of each Franchise Agreement is ten years and, subject to certain conditions, is renewable at the option of the franchisee.

Initial Fees. Generally, franchisees (except for any franchisees converting their existing retail optical store to a Sterling Store (a "Converted Store"), and those entering into agreements for more than one location) must pay the Company a non-recurring, initial franchise fee of $20,000. The Company charges each franchisee of a Converted Store a non-recurring, initial franchise fee of $10,000 per location. For each franchisee entering into agreements for more than one location, the Company charges a non-recurring, initial franchise fee of $15,000 for the second location, and $10,000 for each location in excess of two.

Ongoing Royalties. Franchisees are obligated to pay the Company ongoing royalties in an amount equal to a percentage (generally 8%) of the gross revenues generated by their Sterling Store. Franchisees of Converted Stores, however, pay ongoing royalties, on their store's historical average base sales, at reduced rates increasing (in most cases) from 2% to 6% for the first three years of the term of the Franchise Agreement. In addition, most of the Franchise Agreements acquired by the Company from Singer Specs, Inc. (the "Singer Franchise Agreements") provide for ongoing royalties calculated at 7% of gross revenues. Franchise Agreements entered into prior to January 1994 provide for the payment of ongoing royalties on a monthly basis, while those entered into after January 1994 provide for their payment on a weekly basis, in each case, based upon the gross revenues for the preceding period. Gross revenues generally include all revenues generated from the operation of the Sterling Store in question, excluding refunds to customers, sales taxes, a limited amount of bad debts and, to the extent required by state law, fees charged by independent optometrists.

Advertising Fund Contributions. Most franchisees must make ongoing contributions to an advertising fund (the "Advertising Fund") equal to a percentage of their store's gross revenues. Except for the Singer Franchise Agreements, which generally provide for contributions equal to 7% of gross revenues, for Franchise Agreements entered into prior to August 1993, the rate of contribution is generally 4% of the store's gross revenues, while Franchise Agreements entered into after August 1993 generally provide for contributions equal to 6% of the store's gross revenues. Generally, 50% of these funds are expended at the direction of each individual franchisee (for the particular Sterling Store in question), with the balance being expended on joint advertising campaigns for all franchisees located within specific geographic areas.

Termination. Franchise Agreements may be terminated if a franchisee has defaulted on its payment of monies due to the Company, or in its performance of the other terms and conditions of the Franchise Agreement. During 2004, the assets of (as well as possession of) two franchised stores were reacquired by the Company. Substantially all of the assets located in such stores were voluntarily surrendered and transferred back to the Company in connection with the termination of the related Franchise Agreements. In such instances, it is generally the Company's intention to re-convey the assets of such a store to a new franchisee, requiring the new franchisee to enter into the Company's then current form of Franchise Agreement.

MARKETING AND ADVERTISING

The Company's marketing strategy emphasizes professional eye examinations, competitive pricing (primarily through product promotions), convenient locations, excellent customer service, customer-oriented store design and product displays, knowledgeable sales associates, and a broad range of quality products, including privately-labeled contact lenses presently being offered by the Company and certain of its franchisees. Examinations by licensed optometrists are generally available on the premises of, or directly adjacent to, substantially all Sterling Stores.

The Company continually prepares and revises its in-store, point-of-purchase displays, which provide various promotional messages to customers. Both Company-owned and franchised Sterling Stores participate in advertising and in-store promotions, which include visual merchandising techniques to draw attention to the products displayed in the Sterling Store in question. The Company is also continually refining its interactive web site, which further markets the "Sterling Optical" and "Site for Sore Eyes" brands in an effort to increase traffic to its stores and, in many instances, also uses direct mail advertising as well as opt-in email advertising to reach prospective, as well as existing, consumers.

The Company annually budgets approximately 4% to 6% of system-wide sales for advertising and promotional expenditures. Generally, franchisees are obligated to contribute a percentage of their Sterling Store's gross revenues to the Company's segregated advertising fund accounts, which the Company maintains for advertising, promotional and public relations programs. In most cases, the Company permits each franchisee to direct the expenditure of approximately 50% of such

contributions, with the balance being expended to advertise and promote all Sterling Stores located within the geographic area of the Sterling Store in question, and/or on national promotions and campaigns.

INSIGHT MANAGED VISION CARE

Managed care is a substantial and growing segment of the retail optical business. The Company, under the trade name "Insight Managed Vision Care," contracts with payors (i.e. health maintenance organizations, preferred provider organizations, insurance companies, Taft-Hartley unions, and mid-sized to large companies) that offer eye care benefits to their covered participants. When Sterling Stores provide services or products to a covered participant, it is generally at a discount from the everyday advertised retail price. Typically, participants will be eligible for greater eye care benefits at Sterling Stores than those offered at eye care providers that are not participating in a managed care program. The Company believes that the additional customer traffic generated by covered participants, along with purchases by covered participants above and beyond their eye care benefits, more than offsets the reduced gross margins being realized on these sales. The Company believes that convenience of store locations and hours of operation are key factors in attracting managed care business. As the Company increases its presence within markets it has already entered, as well as expands into new markets, it believes it will be more attractive to managed care payors due to the additional Sterling Stores being operated by the Company and its franchisees.

COMPETITION

The optical business is highly competitive and includes chains of retail optical stores, superstores, individual retail outlets, the operators of web sites and a large number of independent opticians, optometrists and ophthalmologists who provide professional services and may, in connection therewith, dispense prescription eyewear. As retailers of prescription eyewear generally service local markets, competition varies substantially from one location or geographic area to another. Since 1994, certain major competitors of the Company have been offering promotional incentives to their customers and, in response thereto, the Company generally offers the same or similar incentives to its customers.

The Company believes that the principal competitive factors in the retail optical business are convenience of location, on-site availability of professional eye examinations, rapid service, quality and consistency of product and service, price, product warranties, a broad selection of merchandise, the participation in third-party managed care provider programs and the general consumer acceptance of refractive laser surgery. The Company believes that it competes favorably in each of these areas, except in regards to laser surgery as the Company discontinued the operations of its laser vision correction centers.

GOVERNMENT REGULATION

The Company and its operations are subject to extensive federal, state and local laws, rules and regulations affecting the health care industry and the delivery of health care, including laws and regulations prohibiting the practice of medicine and optometry by persons not licensed to practice medicine or optometry, prohibiting the unlawful rebate or unlawful division of fees, and limiting the manner in which prospective patients may be solicited. The regulatory requirements that the Company must satisfy to conduct its business vary from state to state. In particular, some states have enacted laws governing the ability of ophthalmologists and optometrists to enter into contracts to provide professional services with business corporations or lay persons, and some states prohibit the Company from computing its continuing royalty fees based upon a percentage of the gross revenues of the fees collected by affiliated optometrists. Various federal and state regulations limit the financial and non-financial terms of agreements with these health care providers; and the revenues potentially generated by the Company differ among its various health care provider affiliations.

The Company is also subject to certain regulations adopted under the Federal Occupational Safety and Health Act with respect to its in-store laboratory operations. The Company believes that it is in material compliance with all such applicable laws and regulations.

As a franchisor, the Company is subject to various registration and disclosure requirements imposed by the Federal Trade Commission and by many states in which the Company conducts franchising operations. The Company believes that it is in material compliance with all such applicable laws and regulations.

The Company must comply with the Health Insurance Portability and Accountability Act of 1996 ("HIPAA"), which governs our participation in managed care programs. We also must comply with the privacy regulations under HIPAA, which went into effect in April 2003. In addition, all states have passed laws that govern or affect our arrangements with the optometrists who practice in our vision centers. Some states, such as California, have particularly extensive and burdensome requirements that affect the way we do business. In California, optometrists who practice adjacent to our retail locations are providers to, and subtenants of, a subsidiary, which is licensed as a single-service HMO.

ENVIRONMENTAL REGULATION

The Company's business activities are not significantly affected by environmental regulations, and no material expenditures are anticipated in order for the Company to comply with any such environmental regulations. However, the Company is subject to certain regulations promulgated under the Federal Environmental Protection Act with respect to the grinding, tinting, edging and disposal of ophthalmic lenses and solutions, with which the Company believes it is in material compliance.

EMPLOYEES

As of March 29, 2005, the Company employed approximately 124 individuals, of which approximately 80% were employed on a full-time basis. No employees are covered by any collective bargaining agreement. The Company considers its labor relations with its associates to be in good standing and has not experienced any interruption of its operations due to disagreements. The Company is in the process of negotiating employment agreements with its key executives.

Item 2. Properties

The Company's headquarters, consisting of approximately 7,000 square feet, are located in an office building situated at 100 Quentin Roosevelt Boulevard, Garden City, New York 11530, under a sublease that expires in November 2006. This facility houses the Company's principal executive and administrative offices.

VCC's headquarters, consisting of approximately 1,200 square feet, are located in an office building situated at 9663 Tierre Grande Street, Suite 203, San Diego, CA 92126, under a lease that expires on March 31, 2005. VCC is currently negotiating the terms of a one-year lease extension.

The Company leases the space occupied by all of its Company-owned Sterling Stores and certain of its franchised Sterling Stores. The remaining leases for its franchised Sterling Stores are held in the names of the respective franchisees, of which the Company holds a collateral assignment on certain of those leases.

Sterling Stores are generally located in commercial areas, including major shopping malls, strip centers, freestanding buildings and other areas conducive to retail trade. Generally, Sterling Stores range in size from 1,000 to 2,000 square feet.

Item 3. Legal Proceedings

Information with respect to the Company's legal proceedings required by Item 103 of Regulation S-K is set forth in Note 11 to the Consolidated Financial Statements included in Item 8 of this Report, and is incorporated by reference herein.

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

There were no matters submitted to a vote by the Company's shareholders during the fourth quarter ended December 31, 2004.

PART II

Item 5. Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

The Registrant's Common Stock is traded in the over-the-counter market and quoted on the OTC Bulletin Board under the trading symbol "ISEE". Over-the-counter market quotations reflect inter-dealer prices, without retail mark-up, mark-down or commission and may not necessarily represent actual transactions. The range of the high and low closing bid prices for the Registrant's Common Stock for each quarterly period of the last two years, is as follows:


	2004				2003
Quarter Ended:	High		Low		High		Low
March 31	$	0.19	$	0.09	$	0.13	$	0.04
June 30	$	0.17	$	0.08	$	0.09	$	0.04
September 30	$	0.20	$	0.13	$	0.17	$	0.06
December 31	$	0.19	$	0.13	$	0.25	$	0.09

The approximate number of shareholders of record of the Company's Common Stock as of March 11, 2005 was 302.

There was one shareholder of record of the Company's Senior Convertible Preferred Stock as of March 29, 2005.

Historically, the Company has not paid dividends on its Common Stock, and has no intention to pay dividends on its Common Stock in the foreseeable future. It is the present policy of the Registrant's Board of Directors to retain earnings, if any, to finance the Company's future operations and growth.

Item 6. Selected Financial Data

USE OF NON-GAAP FINANCIAL MEASURE

In this document, at times we refer to EBITDA. EBITDA is calculated as net earnings before interest, taxes, depreciation and amortization, and extraordinary items, and excludes non-cash charges related to equity securities. We refer to EBITDA because it is a widely accepted financial indicator of a company's ability to service or incur indebtedness.

EBITDA does not represent cash flow from operations as defined by generally accepted accounting principles, is not necessarily indicative of cash available to fund all cash flow needs, should not be considered an alternative to net income or to cash flow from operations (as determined in accordance with GAAP) and should not be considered an indication of our operating performance or as a measure of liquidity. EBITDA is not necessarily comparable to similarly titled measures for other companies.

SELECTED CONSOLIDATED FINANCIAL AND OPERATING DATA

The following Selected Financial Data has been derived from the audited consolidated financial statements of the Company and should be read in conjunction with those statements, which are included in this Report. The consolidated financial statements were audited by Arthur Andersen LLP, independent public accountants, with respect to the years ended December 31, 2001 and 2000. The consolidated financial statements for the years ended December 31, 2004, 2003 and 2002 were audited by Miller Ellin & Company LLP, independent public accountants.


	(In thousands, except for per share data)
	Year Ended December 31,
Statement of Operations Data:	2004			2003			2002			2001			2000
System-wide sales (1)	$	92,534		$	93,731		$	105,726		$	126,277		$	130,382
Total revenues	$	14,484		$	14,546		$	18,703		$	22,341		$	24,665
Income (loss) from continuing operations	$	884		$	(2,948	)	$	(4,721	)	$	(5,088	)	$	(14,628	)
(Loss) income from discontinued operations	$	—		$	(19	)	$	74		$	1,312		$	(15,533	)
Loss on disposal of discontinued operations	$	—		$	—		$	—		$	—		$	(8,831	)
Net income (loss)	$	884		$	(2,967	)	$	(4,647	)	$	(3,776	)	$	(38,992	)
Per Share Information – basic and diluted
Income (loss) from continuing operations	$	0.01		$	(0.05	)	$	(0.17	)	$	(0.19	)	$	(2.04	)
(Loss) income from discontinued operations	$	—		$	—		$	0.01		$	0.05		$	(0.66	)
Loss on disposal of discontinued operations	$	—		$	—		$	—		$	—		$	(0.37	)
Net income (loss) per share	$	0.01		$	(0.05	)	$	(0.16	)	$	(0.14	)	$	(3.07	)
Weighted-average common shares outstanding:
Basic		69,475			56,507			28,641			26,409			23,627
Diluted		113,696			56,507			28,641			26,409			23,627
Balance Sheet Data:
Working capital deficit	$	(603	)	$	(1,590	)	$	(4,632	)	$	(1,011	)	$	(3,987	)
Total assets		5,989			6,639			6,650			11,057			22,531
Total debt		658			931			1,494			1,299			754
Other Data:
EBITDA (2)		1,388	(a)		2,220			(3,897	)		(3,400	)		(12,592	)

Quarterly Data:


	First Quarter					Second Quarter				Third Quarter				Fourth Quarter
	2004		2003			2004		2003		2004		2003		2004			2003
Net revenues	$	3,768	$	3,894		$	3,619	$	3,530	$	3,627	$	3,628	$	3,470		$	3,494
Net income (loss) from continuing operations	$	648	$	581		$	35	$	511	$	229	$	543	$	(28	)	$	(4,583	)
(Loss) income from discontinued operations	$	—	$	(222	)	$	—	$	2	$	—	$	56	$	—		$	145
Net income (loss)	$	648	$	359		$	35	$	513	$	229	$	599	$	(28	)	$	(4,438	)
EBITDA (2)	$	717	$	718		$	112	$	722	$	319	$	588	$	240		$	192

Sterling Store Data:


	(In thousands, except for number of stores) Year Ended December 31,
	2004			2003			2002			2001			2000
Company-owned stores bought, opened or reacquired		2			3			4			15			3
Company-owned stores sold or closed		(2	)		(9	)		(14	)		(10	)		(13	)
Company-owned stores at end of period		9			9			15			25			20
Company-owned stores being managed by Franchisees at end of period		2			5			8			9			12
Franchised stores being managed by Company at end of period		—			—			—			1			3
Franchised stores at end of period		154			158			159			169			201
Average sales per store (3):
Company-owned stores	$	467		$	408		$	394		$	434		$	453
Franchised stores	$	545		$	545		$	591		$	564		$	546
Average franchise royalties per franchised store (3)	$	42		$	40		$	47		$	43		$	42


(1)	System-wide sales represent combined retail sales generated by Company-owned and franchised stores, as well as revenues generated by VCC.


(2)	EBITDA is calculated as net earnings before interest, taxes, depreciation and amortization, and extraordinary items, and excludes non-cash charges related to equity securities (see "Management's Discussion and Analysis of Financial Condition and Results of Operations — Use of Non-GAAP Financial Measures"). The following is a reconciliation of net income to EBITDA (amounts in thousands):


a)	The 2004 calculation of EBITDA does not include an add-back of $581,000 of costs incurred in connection with the proxy contest and related litigation. Had these costs not been incurred, the Company would have had an adjusted EBITDA of $1,970,000.

Reconciliation of Non-GAAP Financial Measure

This table includes the reconciliation of net income (loss) from continuing operations to EBITDA for the years ended December 31, 2004, 2003 and 2002.


	2004		2003			2002
Net income (loss) from continuing operations	$	884	$	(2,948	)	$	(4,647	)
Add back:
Interest expense		59		197			207
Taxes		75		57			54
Non-cash equity charges		143		4,636			—
Depreciation and amortization		227		278			489
EBITDA	$	1,388	$	2,220		$	(3,897	)


(3)	Average sales per store and average franchise royalties per franchised store are computed based upon the weighted-average number of Company-owned and franchised stores in operation, respectively, for each of the specified periods. For periods of less than a year, the averages have been annualized.

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

This Report contains certain forward-looking statements and information relating to the Company that is based on the beliefs of the Company's management, as well as assumptions made by, and

information currently available to, the Company's management. When used in this Report, the words "anticipate", "believe", "estimate", "expect", "there can be no assurance", "may", "could", "would", "might", "intends" and similar expressions, as they relate to the Company or the Company's management, are intended to identify forward-looking statements. Such statements reflect the view of the Company at the date they are made with respect to future events, are not guarantees of future performance and are subject to various risks and uncertainties. These risks and uncertainties may include, among other items: potential conflicts of interest that could occur with certain of our directors; the retention of certain members of our management team; our inability to control the management of our franchised stores; the effects of new federal, state and local regulations that affect the health care industry; insured health plan reimbursement policies and practices with respect to our products and services; our ability to continue to enter favorable arrangements with health care providers; increased competition from other eyewear providers; the general consumer acceptance of refractive laser surgery; product demand and market acceptance risks; the effect of general economic conditions; the impact of competitive products, services and pricing; product development, commercialization and technological difficulties; our ability, or lack thereof, to secure additional equity or debt financing in the future, if necessary, due to the potential lack of liquidity of our common stock; the potential limitation on the use of our net operating loss carry-forwards in accordance with Section 382 of the Internal Revenue Code of 1986, as amended, based on certain changes in ownership that have occurred or could in the future occur; the possibility that we will be unable to successfully execute our business plan; and the outcome of pending and future litigation. Should one or more of these risks or uncertainties materialize, or should underlying assumptions prove incorrect, actual results may vary materially from those described herein with the forward-looking statements referred to above. The Company does not intend to update these forward-looking statements for the occurrence of events or developments not within the Company's control.

COMPARISON OF OPERATING RESULTS FOR THE YEARS ENDED DECEMBER 31, 2004 AND 2003

Net sales for Company-owned stores, including revenues generated by VCC decreased by $88,000, or 1.2%, to $7,525,000 for the year ended December 31, 2004, as compared to $7,613,000 for the comparable period in 2003. The decrease in net sales was a direct result of a decrease in Company-owned store sales primarily due to a lower average number of stores over the course of the full fiscal year during the comparable periods, offset by an increase in membership fees generated by VCC. On a same store basis (for stores that operated as a Company-owned store during the entirety of both of the years ended December 31, 2004 and 2003), comparative net sales decreased by $99,000, or 2.8%, to $3,437,000 for the year ended December 31, 2004, as compared to $3,536,000 for the comparable period in 2003. Management believes that this decrease was a direct result of generally weak sales levels experienced in the upstate New York market, where the majority of the Company-owned stores are located, combined with the effects of employee turnover in certain of the stores.

Franchise royalties increased by $163,000, or 2.5%, to $6,588,000 for the year ended December 31, 2004, as compared to $6,425,000 for the comparable period in 2003. Management believes this increase was a result of a slight increase in franchise sales for the stores that were open during both of the comparable periods, increased levels of field support to franchisees and the success of the Company's audits of franchise locations, which generated additional revenues.

Other franchise related fees (which includes initial franchise fees, renewal fees and fees related to the transfer of store ownership from one franchisee to another) decreased by $86,000, or 30.0%, to $201,000 for the year ended December 31, 2004, as compared to $287,000 for the comparable period in 2003. This decrease was primarily attributable to the Company entering into fourteen new franchise agreements during the year ended December 31, 2003, as opposed to five new franchise agreements during the comparable period in 2004.

Interest on franchise notes receivable decreased by $63,000, or 41.7%, to $88,000 for the year ended December 31, 2004, as compared to $151,000 for the comparable period in 2003. This decrease was primarily due to numerous franchise notes maturing during the past 12 months, offset, in part, by three new interest-bearing notes being generated during 2004.

Excluding revenues generated by VCC and exam fee income generated by the Company stores, the Company's gross profit margin decreased by 5.5%, to 71.1% for the year ended December 31, 2004, as compared to 76.6% for the comparable period in 2003. This decrease was mainly a result of the fact that, in 2003, the Company settled liabilities with certain of its vendors at lower amounts than originally anticipated, which had a positive effect on its gross profit margin during the year ended December 31, 2003. No such settlements occurred in 2004. In the future, the Company's gross profit margin may fluctuate depending upon the extent and timing of changes in the product mix in Company-owned stores, competitive pricing, and promotional incentives, among other things.

Selling, general and administrative expenses increased by $46,000, or 0.4%, to $11,853,000 for the year ended December 31, 2004, as compared to $11,807,000 for the comparable period in 2003. This increase was a result of increases in facility and other overhead charges of $121,000 and increases in professional fees of $46,000, offset, in part, by decreases in salaries and related expenses of $61,000. Additionally, during 2003, the Company incurred approximately $140,000 of costs related to an unsolicited offer to acquire all the outstanding Capital Stock of the Company. No such costs were incurred during 2004.

Interest expense decreased by $138,000, or 70.1%, to $59,000, for the year ended December 31, 2004, as compared to $197,000 for the comparable period in 2003. The decrease was primarily due to the amortization of the discount associated with certain financing during 2003.

COMPARISON OF OPERATING RESULTS FOR THE YEARS ENDED DECEMBER 31, 2003 AND 2002

Net sales for Company-owned stores, including revenues generated by VCC, a specialized health care maintenance organization licensed by the State of California Department of Managed Health Care, decreased by $3,571,000, or 31.9%, to $7,613,000 for the year ended December 31, 2003, as compared to $11,184,000 for the comparable period in 2002. The decrease in net sales was a direct result of management's commitment to continue to close non-profitable Company-owned stores. There were 9 stores being operated by the Company as of December 31, 2003 compared to 15 stores as of December 31, 2002. On a same store basis (for stores that operated as a Company-owned store during the entirety of both of the years ended December 31, 2003 and 2002), comparative net sales decreased by $179,000, or 4.8%, to $3,536,000 for the year ended December 31, 2003, as compared to $3,715,000 for the comparable period in 2002. Management believes this decrease was primarily a result of the struggling U.S. economy.

Franchise royalties decreased by $391,000, or 5.7%, to $6,425,000 for the year ended December 31, 2003, as compared to $6,816,000 for the comparable period in 2002. Management believes this decrease was primarily a result of the struggling U.S. economy, particularly the weak retail sales experienced during the months of the War in Iraq, combined with increased competition in capturing customers on certain managed care programs.

Other franchise related fees (which includes initial franchise fees, renewal fees and fees related to the transfer of store ownership from one franchisee to another) increased by $216,000, or 304.2%, to $287,000 for the year ended December 31, 2003, as compared to $71,000 for the comparable period in 2002. This increase was a direct result of the Company entering into 14 new franchise agreements for the year ended December 31, 2003.

Interest on franchise notes receivable decreased by $161,000, or 51.6%, to $151,000 for the year ended December 31, 2003, as compared to $312,000 for the comparable period in 2002. This decrease was primarily due to numerous franchise notes maturing during the past 12 months and only two new notes being generated during 2003.

Other income decreased by $250,000, to $70,000, for the year ended December 31, 2003, as compared to $320,000 for the comparable period in 2002. This decrease was primarily a result of one-time sales of certain assets of the Company to third parties during 2002 that did not occur during 2003.

Excluding revenues generated by VCC, the Company's gross profit margin decreased by 0.4%, to 76.6% for the year ended December 31, 2003, as compared to 77.0% for the comparable period in

2002. The gross profit margin remained consistent with prior year. The Company continued to effectively manage and control its inventory, continued purchasing at lower average product costs, and continued receiving strong discounts from certain of the Company's key vendors. In the future, the Company's gross profit margin may fluctuate depending upon the extent and timing of changes in the product mix in Company-owned stores, competitive pricing, and promotional incentives.

Selling, general and administrative expenses decreased by $8,035,000, or 40.5%, to $11,807,000 for the year ended December 31, 2003, as compared to $19,842,000 for the comparable period in 2002. This decrease was primarily due to management's continuing plans to reduce administrative expenses and to close non-profitable Company-owned stores. Included were reductions in salaries and related expenses of $2,446,000, facility and other overhead charges of $3,117,000 and professional fees of $684,000. Additionally, the provision for doubtful accounts decreased by $1,651,000 as certain large notes receivable were deemed uncollectible in 2002. The Company did not experience a similar situation in 2003.

Provision for store closings decreased by $920,000, or 100.0%, to $0 for the year ended December 31, 2003, as compared to $920,000 for the comparable period in 2002. In 2002, management made the decision to close 15 of its Company-owned stores. In connection therewith, the Company recorded a provision based on the estimated costs (including lease termination costs and other expenses) that would be incurred in the closing of the stores. The Company did not incur any additional costs related to these store closures during 2003, nor did management make the decision to close any additional stores.

Charges related to long-lived assets decreased by $163,000, or 94.2%, to $10,000 for the year ended December 31, 2003, as compared to $173,000 for the comparable period in 2002. In connection with management's decision to close non-profitable Company-owned stores, the Company impaired assets related to those stores during 2002. No such assets were deemed impaired during 2003.

Interest expense decreased by $10,000, or 4.8%, to $197,000, for the year ended December 31, 2003, as compared to $207,000 for the comparable period in 2002. The decrease was a result of the Company paying off certain of its debt obligations in April 2003 with the proceeds received from its shareholder rights offering, offset by the amortization of the remaining debt discount resulting from the aforementioned debt payment in April 2003.

USE OF NON-GAAP FINANCIAL MEASURE

Reconciliation of Non-GAAP Financial Measure

This table includes the reconciliation of net income (loss) from continuing operations to EBITDA for the years ended December 31, 2004, 2003 and 2002.


	2004		2003			2002
Net income (loss) from continuing operations	$	884	$	(2,948	)	$	(4,647	)
Add back:
Interest expense		59		197			207
Taxes		75		57			54
Non-cash equity charges		143		4,636			—
Depreciation and amortization		227		278			489
EBITDA (1)	$	1,388	$	2,220		$	(3,897	)


(1)	The 2004 calculation of EBITDA does not include an add-back of $581,000 of costs incurred in connection with the proxy contest and related litigation. Had these costs not been incurred, the Company would have had an adjusted EBITDA of $1,970,000.

LIQUIDITY AND CAPITAL RESOURCES

For the year ended December 31, 2004, cash flows used in investing activities were $266,000, primarily due to the issuance of franchise promissory notes and by capital expenditures made by the Company during 2004, offset, in part, by proceeds received on certain franchise notes.

For the year ended December 31, 2004, cash flows used in financing activities were $140,000, principally due to the repayment of the Company's debt and related party borrowings, offset by the proceeds from the exercise of stock options and warrants.

As of December 31, 2004, the Company had negative working capital of $603,000 (compared to $1,590,000 as of December 31, 2003) and cash on hand of $880,000. During 2004, the Company used $97,000 of cash in its operating activities. This usage was principally a result of a net decrease of $1,227,000 in accounts payable and accrued liabilities that existed as of December 31, 2003, offset by EBITDA of $1,388,000 for the year ended December 31, 2004. Additionally, the Company incurred $581,000 of costs related to the proxy contest and related litigation during 2004. If the proxy contest hadn't occurred, the Company would have had an adjusted EBITDA of $1,970,000.

The Company plans to increase its cash flows during 2005 by improving store profitability through increased monitoring of store-by-store operations, continuing to reduce administrative overhead expenses where necessary and feasible, actively supporting development programs for franchisees, and adding new franchised stores to the system. Management believes that with the successful execution of the aforementioned plans to improve cash flows, its existing cash and the collection of outstanding receivables, there will be sufficient liquidity available for the Company to continue in operation through the first quarter of 2006. However, there can be no assurance that the Company will be able to successfully execute the aforementioned plans.

CONTRACTUAL OBLIGATIONS

Payments due under contractual obligations as of December 31, 2004 were as follows (in thousands):


	Within 1 year		1-3 years		After 3 years		Total
Long-term debt (a)	$	39	$	619	$	—	$	658
Interest on long-term debt (a)		—		125		—		125
Employment agreements		21		—		—		21
Operating leases		5,007		5,789		3,046		13,842
		5,067		6,533		3,046		14,646

Effective April 14, 2003, in connection with certain Rescission Transactions consummated by the Company on December 31, 2003, the Company signed numerous promissory notes with certain of its shareholders, two of whom are also directors of the Company. The notes, which aggregate $520,000, bear interest at a rate of 6% per annum, and all sums (principal and interest) under the notes are due and payable in April 2007. Information with respect to the Company's contractual obligations is set forth in the Notes to the Consolidated Financial Statements included in Item 8 of this Report.

OFF-BALANCE SHEET ARRANGEMENTS

An off-balance sheet arrangement is any contractual arrangement involving an unconsolidated entity under which a company has (a) made guarantees, (b) a retained or a contingent interest in transferred assets, (c) any obligation under certain derivative instruments or (d) any obligation under a material variable interest in an unconsolidated entity that provides financing, liquidity, market risk, or credit risk support to the company, or engages in leasing, hedging, or research and development services within the company.

The Company does not have any off-balance sheet financing or unconsolidated variable interest entities, with the exception of certain guarantees on leases. We refer the reader to the Notes of the Consolidated Financial Statements included in Item 8 of this Report for information regarding the Company's lease guarantees.

MANAGEMENT'S DISCUSSION OF CRITICAL ACCOUNTING POLICIES AND ESTIMATES

High-quality financial statements require rigorous application of high-quality accounting policies. Management believes that its policies related to revenue recognition, legal contingencies and allowances on franchise, notes and other receivables are critical to an understanding of the Company's consolidated financial statements because their application places the most significant demands on management's judgment, with financial reporting results relying on estimation about the effect of matters that are inherently uncertain.

Management's estimate of the allowances on receivables is based on historical sales, historical loss levels, and an analysis of the collectibility of individual accounts. To the extent that actual bad debts differed from management's estimates by 10 percent, consolidated net income would be an estimated $24,000 higher/lower, based upon 2004 results, depending upon whether the actual write-offs are greater or lesser than estimated.

Management's estimate of the valuation allowance on deferred tax assets is based on whether it is more likely than not that the Company's net operating loss carry-forwards will be utilized. Factors that could impact estimated utilization of the Company's net operating loss carry-forwards are the success of its stores and franchisees, as well as the Company's operating efficiencies, which would allow it to generate taxable income in the future. To the extent that management lowered its valuation allowance on deferred tax assets by 10 percent, consolidated net income would be an estimated $2,000,000 higher, based on 2004 results.

The Company recognizes revenues in accordance with SEC Staff Accounting Bulletin ("SAB") No. 103. Accordingly, revenues are recorded when persuasive evidence of an arrangement exists, delivery

has occurred or services have been rendered, the Company's price to the buyer is fixed or determinable, and collectibility is reasonably assured. To the extent that collectibility of royalties and/or interest on franchise notes is not reasonably assured, the Company recognizes such revenues when the cash is received. To the extent that revenues that were recognized on a cash basis were recognized on an accrual basis, consolidated net income would be an estimated $399,000 higher, based upon 2004 results.

RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS

Inventory Costs

In November 2004, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 151, "Inventory Costs," as amendment to Accounting Principles Board ("APB") No. 43, Chapter 4, which clarifies the accounting for abnormal amounts of idle facility expenses, freight, handling costs, and wasted material. This Statement requires that those items be recognized as current-period charges regardless of whether they meet the criterion "so abnormal," as that term is used in paragraph 5 of APB No. 43, Chapter 4. The adoption of this Statement did not have, nor is it expected to have, a material impact on the Company's financial position or results of operations.

Stock Based Compensation

In December 2004, the FASB revised SFAS No. 123. This revision establishes standards for accounting for transactions in which an entity exchanges its equity instruments for goods or services, including those granted to employees. The Company adopted the revision of SFAS No. 123, SFAS No. 123R, "Share-Based Payment," which revises the fair value method of accounting recommended by SFAS No. 123 for stock-based employee compensation. The Company now accounts for stock-based compensation in accordance with the provisions of SFAS No. 123R to apply a modified retroactive application of fair value based accounting to prior periods. SFAS No. 123R supercedes SFAS No. 148. All such transactions are accounted for accordingly in the Company's results of operations.

Real Estate Time-Sharing

In December 2004, the FASB issued SFAS No. 152, "Accounting for Real Estate Time-Sharing Transactions," which amends FASB SFAS 66 and SFAS 67. This Statement establishes standards for accounting and reporting on real estate time-sharing transactions. This Statement is effective for financial statements for fiscal years beginning after June 15, 2005. As the Company is not involved in any real estate time-sharing transactions, the Company has determined the Statement does not have a material impact on its financial position or results of operations.

Exchanges of Nonmonetary Assets

In December 2004, the FASB issued SFAS No. 153, "Exchanges of Nonmonetary Assets," which amends APB Opinion No. 29, "Accounting for Nonmonetary Transactions". This Statement eliminates the exception for nonmonetary exchanges of similar productive assets and replaces it with a general exception for exchanges of nonmonetary assets that do not have commercial substance. The Company is not currently involved in exchanges of nonmonetary assets; thus, the Company has determined the Statement does not have a material impact on its financial position or results of operations.

Item 7A. Quantitative and Qualitative Disclosures about Market Risk

The Company presently has outstanding certain equity instruments with beneficial conversion terms. Accordingly, the Company, in the future, could incur non-cash charges to equity (as a result of the exercise of such beneficial conversion terms), which would have a negative impact on future per share calculations.

The Company believes that the level of risk related to its cash equivalents is not material to the Company's financial condition or results of operations.

Item 8. Financial Statements and Supplementary Data

TABLE OF CONTENTS


	PAGE
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM		17

CONSOLIDATED FINANCIAL STATEMENTS

Consolidated Balance Sheets as of December 31, 2004 and 2003		18

Consolidated Statements of Operations for the Years Ended December 31, 2004, 2003 and 2002		19

Consolidated Statements of Shareholders' Equity (Deficit) for the Years Ended December 31, 2004, 2003 and 2002		20

Consolidated Statements of Cash Flows for the Years Ended December 31, 2004, 2003 and 2002		21

Notes to Consolidated Financial Statements		22

Information required by schedules called for under Regulation S-X is either not applicable or is included in the consolidated financial statements or notes thereto.

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Shareholders of Emerging Vision, Inc. and Subsidiaries:

We have audited the accompanying consolidated balance sheets of Emerging Vision, Inc. (a New York corporation) and subsidiaries (the "Company") as of December 31, 2004 and 2003, and the related consolidated statements of operations, shareholders' equity (deficit) and cash flows for each of the three years ended December 31, 2004. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Emerging Vision, Inc. and subsidiaries as of December 31, 2004 and 2003, and the results of their operations and their cash flows for each of the three years ended December 31, 2004 in conformity with accounting principles generally accepted in the United States.

/S/ MILLER, ELLIN & COMPANY LLP

New York, New York
March 21, 2005

EMERGING VISION, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In Thousands, Except Share Data)


	December 31,
	2004			2003
ASSETS
Current assets:
Cash and cash equivalents	$	880		$	1,383
Franchise receivables, net of allowance of $114 and $844, respectively		1,512			1,281
Other receivables, net of allowance of $47 and $118, respectively		113			291
Current portion of franchise notes receivable, net of allowance of $58 and $241, respectively		379			449
Inventories, net		396			392
Prepaid expenses and other current assets		452			389
Total current assets		3,732			4,185

Property and equipment, net		487			481
Franchise notes receivable, net of allowance of $22 and $541, respectively		295			470
Goodwill		1,266			1,266
Other assets		209			237
Total assets	$	5,989		$	6,639

LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Current portion of long-term debt	$	—		$	207
Accounts payable and accrued liabilities		4,162			5,389
Payables associated with proxy contest and related litigation		92			—
Accrual for store closings		42			144
Related party borrowings		39			35
Total current liabilities		4,335			5,775

Long-term debt		385			143
Related party borrowings		234			546
Franchise deposits and other liabilities		659			937

Commitments and contingencies

Shareholders' equity (deficit):
Preferred stock, $0.01 par value per share; 5,000,000 shares authorized: Senior Convertible Preferred Stock, $100,000 liquidation preference per share; 0.74 shares issued and outstanding		74			74
Common stock, $0.01 par value per share; 150,000,000 shares authorized; 70,506,035 and 67,682,087 shares issued, respectively, and 70,323,698 and 67,499,750 shares outstanding, respectively		705			677
Treasury stock, at cost, 182,337 shares		(204	)		(204	)
Additional paid-in capital		126,213			125,987
Accumulated deficit		(126,412	)		(127,296	)
Total shareholders' equity (deficit)		376			(762	)
Total liabilities and shareholders' equity (deficit)	$	5,989		$	6,639

The accompanying notes are an integral part of these consolidated balance sheets.

EMERGING VISION, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(In Thousands, Except Per Share Data)


	For the Year Ended December 31,
	2004		2003			2002

Revenues:
Net sales	$	7,525	$	7,613		$	11,184
Franchise royalties		6,588		6,425			6,816
Other franchise related fees		201		287			71
Interest on franchise notes receivable		88		151			312
Other income		82		70			320
		14,484		14,546			18,703
Costs and expenses:

Cost of sales		964		844			2,282
Selling, general and administrative expenses		11,853		11,807			19,842
Costs for proxy contest and related litigation		581		—			—
Provision for store closings		—		—			920
Charges related to long-lived assets		—		10			173
Non-cash charge for issuance of options and warrants		143		92			—
Non-cash charge for issuance of warrants as a result of Rescission Transactions		—		4,544			—
Interest expense		59		197			207
		13,600		17,494			23,424

Income (loss) from continuing operations before provision for income taxes		884		(2,948	)		(4,721	)
Provision for income taxes		—		—			—
Income (loss) from continuing operations		884		(2,948	)		(4,721	)

(Loss) income from discontinued operations		—		(19	)		74

Net income (loss)	$	884	$	(2,967	)	$	(4,647	)

Per share information — basic:
Income (loss) from continuing operations	$	0.01	$	(0.05	)	$	(0.17	)
Income from discontinued operations		—		—			0.01
Net income (loss) per share	$	0.01	$	(0.05	)	$	(0.16	)

Weighted-average number of common shares outstanding —
Basic		69,475		56,507			28,641
Diluted		113,696		56,507			28,641

The accompanying notes are an integral part of these consolidated statements.

EMERGING VISION, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (DEFICIT)
FOR THE YEARS ENDED DECEMBER 31, 2004, 2003 AND 2002
(In Thousands, Except Share Data)


	Senior Convertible Preferred Stock						Common Stock						Treasury Stock, at cost
	Shares			Amount			Shares			Amount			Shares		Amount			Additional Paid-In Capital			Accumulated Deficit			Total Shareholders' Equity (Deficit)

Balance — December 31, 2001		3		$	287			27,187,309		$	272			182,337	$	(204	)	$	119,926		$	(119,664	)	$	617
Issuance of warrants in connection with financing arrangements		—			—			—			—			—		—			190			—			190
Exercise of stock warrants		—			—			2,500,000			25			—		—			—			—			25
Issuance of common shares upon conversion of Senior Convertible Preferred Stock		(2	)		(213	)		235,648			2			—		—			229			(18	)		—
Net loss		—			—			—			—			—		—			—			(4,647	)		(4,647	)
Balance — December 31, 2002		1		$	74			29,922,957		$	299			182,337	$	(204	)	$	120,345		$	(124,329	)	$	(3,815	)
Exercise of stock options and warrants		—			—			759,130			8			—		—			37			—			45
Issuance of common shares in connection with Rights Offering		—			—			50,000,000			500			—		—			838			—			1,338
Issuance of warrants in connection with Rights Offering		—			—			—			—			—		—			521			—			521
Issuance of stock options to Officers and Directors		—			—			—			—			—		—			13			—			13
Rescission of common shares and warrants issued in Rights Offering		—			—			(13,000,000	)		(130	)		—		—			(390	)		—			(520	)
Issuance of warrants as a result of Rescission Transactions		—			—			—			—			—		—			4,544			—			4,544
Vesting of warrants issued to Balfour & Goldin		—			—			—			—			—		—			79			—			79
Net loss		—			—			—			—			—		—			—			(2,967	)		(2,967	)
Balance — December 31, 2003		1		$	74			67,682,087		$	677			182,337	$	(204	)	$	125,987		$	(127,296	)	$	(762	)
Exercise of stock options and warrants		—			—			2,823,948			28			—		—			78			—			106
Issuance of warrants for services rendered in connection with Proxy Contest		—			—			—			—			—		—			5			—			5
Issuance of stock options and warrants		—			—			—			—			—		—			143			—			143
Net income		—			—			—			—			—		—			—			884			884
Balance — December 31, 2004		1		$	74			70,506,035		$	705			182,337	$	(204	)	$	126,213		$	(126,412	)	$	376

The accompanying notes are an integral part of these consolidated statements.

EMERGING VISION, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in Thousands)


	For the Year Ended December 31,
	2004			2003			2002
Cash flows from operating activities:
Net income (loss) from continuing operations	$	884		$	(2,948	)	$	(4,721	)
Adjustments to reconcile net income (loss) from continuing operations to net cash used in operating activities:
Depreciation and amortization		227			278			489
Provision for doubtful accounts		353			179			1,829
Provision for store closings		—			—			920
Non-cash compensation charges related to options and warrants		148			4,739			87
Charges related to long-lived assets		—			10			173
Changes in operating assets and liabilities:
Franchise and other receivables		(128	)		(234	)		328
Inventories		(4	)		64			290
Prepaid expenses and other current assets		(63	)		(68	)		(227	)
Other assets		28			32			78
Accounts payable and accrued liabilities		(1,254	)		(556	)		(430	)
Payables associated with proxy contest and related litigation		92			—			—
Franchise deposits and other liabilities		(278	)		(980	)		142
Accrual for store closings		(102	)		(965	)		(775	)
Net cash used in operating activities		(97	)		(449	)		(1,817	)

Cash flows from investing activities:
Franchise notes receivable issued		(377	)		(21	)		(71	)
Proceeds from franchise and other notes receivable		344			558			1,409
Purchases of property and equipment		(233	)		(68	)		(280	)
Net cash (used in) provided by investing activities		(266	)		469			1,058

Cash flows from financing activities:
Proceeds from the issuance of common stock upon the exercise of stock options and warrants		106			45			25
Proceeds from borrowings		—			769			2,141
Payments on borrowings		(246	)		(1,435	)		(1,843	)
Net proceeds from Rights Offering		—			1,339			—
Net cash (used in) provided by financing activities		(140	)		718			323
Net cash (used in) provided by continuing operations		(503	)		738			(436	)
Net cash (used in) provided by discontinued operations		—			(19	)		47
Net (decrease) increase in cash and cash equivalents		(503	)		719			(389	)
Cash and cash equivalents — beginning of year		1,383			664			1,053
Cash and cash equivalents — end of year	$	880		$	1,383		$	664

Supplemental disclosures of cash flow information:
Cash paid during the year for:
Interest	$	25		$	71		$	118
Taxes	$	93		$	72		$	75

Non-cash investing and financing activities:
Issuance of promissory notes in exchange for rescission of units	$	—		$	520		$	—

The accompanying notes are an integral part of these consolidated statements.

EMERGING VISION, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1 – ORGANIZATION AND BUSINESS:

Business

As of December 31, 2004, there were 165 Sterling Stores in operation, consisting of 11 Company-owned stores (two of which were being managed by franchisees) and 154 franchised stores.

Basis of Presentation

The Consolidated Financial Statements reflect the operations of the Company's retail optical store operation as continuing operations. The results of operations and cash flows of Insight Laser Centers, Inc. ("Insight Laser") – which operated three laser vision correction centers in the New York metropolitan area, Insight Laser Centers N.Y.I, Inc. (the "Ambulatory Center") – the owner of the assets of an ambulatory surgery center located in Garden City, New York, and its Internet Division – which was to provide a web-based portal designed to take advantage of business-to-business opportunities in the optical industry, are reflected as discontinued operations in accordance with Accounting Principles Board ("APB") Opinion No. 30, "Reporting the Results of Operations – Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions."

NOTE 2 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:

Use of Estimates

The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amount of assets and liabilities and the disclosure of contingent assets and liabilities as of the dates of such financial statements, and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from those estimates. Significant estimates made by management include, but are not limited to, allowances on franchise, notes and other receivables, accruals for store closings, and costs of current and potential litigation.

Principles of Consolidation

The Consolidated Financial Statements include the accounts of Emerging Vision, Inc. and its operating subsidiaries, all of which are wholly-owned. All intercompany balances and transactions have been eliminated in consolidation.

Revenue Recognition

The Company charges franchisees a nonrefundable initial franchise fee. Initial franchise fees are recognized at the time all material services required to be provided by the Company have been substantially performed. Continuing franchise royalty fees are based upon a percentage of the gross revenues generated by each franchised location and are recorded as earned, subject to meeting all of the requirements of SEC Staff Accounting Bulletin ("SAB") No. 103, "Update of Codification of Staff Accounting Bulletins," and SAB 104, "Revenue Recognition." SAB 103 superceded SAB 101, "Revenue Recognition in Financial Statements," and replaced it, as well as other previously issued bulletins, with a codified format for the updated information. SAB 104 revised or rescinded portions of the interpretative guidance included in SAB 103.

The Company derives its revenues from the following three principal sources:

Net sales – Represents sales from eye care products and related services;

Franchise royalties – Represents continuing franchise royalty fees based upon a percentage of the gross revenues generated by each franchised location;

Other franchise related fees – Represents the net gains from the sale of Company-owned store assets to franchisees; and certain fees collected by the Company under the terms of franchise agreements (including, but not limited to, initial franchise fees, transfer fees and renewal fees).

The Company recognizes revenues in accordance with SAB 103 and SAB 104. Accordingly, revenues are recorded when persuasive evidence of an arrangement exists, delivery has occurred or services have been rendered, the Company's price to the buyer is fixed or determinable, and collectibility is reasonably assured. To the extent that collectibility of royalties and/or interest on franchise notes is not reasonably assured, the Company recognizes such revenue when the cash is received.

The Company also follows the provisions of Emerging Issue Task Force ("EITF") Issue 01-09, "Accounting for Consideration Given by a Vendor to a Customer (Including a Reseller of the Vendor's Products)," and accordingly, accounts for discounts, coupons and promotions (that are offered to its customers) as a direct reduction of sales.

Cash and Cash Equivalents

Cash represents cash on hand at Company-owned stores and cash on deposit with financial institutions. All highly liquid investments with an original maturity (from date of purchase) of three months or less are considered to be cash equivalents. The Company's cash equivalents are invested in various investment-grade money market accounts.

Fair Value of Financial Instruments

In determining the fair value of its financial instruments, the Company uses a variety of methods and assumptions that are based on market conditions and risks existing as of each balance sheet date. For the majority of financial instruments, including receivables, long-term debt, and stock options and warrants, standard market conventions and techniques, such as discounted cash flow analysis, option pricing models, replacement cost and termination cost, are used to determine fair value. All methods of assessing fair value result in a general approximation of value, and such value may never actually be realized.

Inventories, net

Inventories, net, are stated at the lower of cost or market value, and consist primarily of contact lenses, ophthalmic lenses, eyeglass frames and sunglasses.

Property and Equipment, net

Property and equipment, net, are recorded at cost, less accumulated depreciation and amortization. Depreciation is recorded on a straight-line basis over the estimated useful lives of the respective classes of assets.

Goodwill

Through December 31, 2001, goodwill was being amortized, on a straight-line basis, over its estimated useful life of 20 years, and, as of December 31, 2001, accumulated amortization of the goodwill was approximately $1,297,000.

In 2001, the Financial Accounting Standards Board ("FASB") issued SFAS No. 142, "Goodwill and Other Intangible Assets." This Statement provided that goodwill and intangible assets with indefinite lives should no longer be amortized, but should be reviewed, at least annually, for impairment. In accordance with the adoption of SFAS No. 142, beginning January 1, 2002, the Company ceased amortizing its existing net goodwill of $1,266,000, resulting in the exclusion of approximately $268,000 of amortization expense for each of the years ended December 31, 2004, 2003 and 2002. Management performed a review of its existing goodwill and determined that it is not impaired as of December 31, 2004.

Impairment of Long-Lived Assets

The Company follows the provisions of SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets." This Statement requires that long-lived assets and certain identifiable intangibles be reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of the assets may not be recoverable, but amends the prior accounting and reporting standards for segments of a business to be disposed of. The Company periodically evaluates its long-lived assets (on a store-by-store basis) based on, among other factors, the estimated, undiscounted future cash flows expected to be generated from such assets in order to determine if an impairment exists. For the years ended December 31, 2004, 2003 and 2002, the Company did not record any impairment charges for stores it will continue to operate, and wrote off $0, $0 and $173,000, respectively, of long-lived assets related to stores that management has made the decision to close (Note 7). All of the aforementioned amounts are reflected in the Consolidated Statements of Operations for the years ended December 31, 2004, 2003 and 2002, respectively, and a new basis, if any, for the impaired assets was established.

Advertising Costs

The Company expenses advertising costs as incurred. Advertising costs for Company-owned stores aggregated approximately $185,000, $177,000 and $364,000 for the years ended December 31, 2004, 2003 and 2002, respectively.

Comprehensive Income

The Company follows the provisions of SFAS No. 130, "Reporting Comprehensive Income," which establishes rules for the reporting of comprehensive income (loss) and its components. For the years ended December 31, 2004, 2003 and 2002, the Company's operations did not give rise to items includible in comprehensive income (loss) that were not already included in net income (loss). Therefore, the Company's comprehensive income (loss) is the same as its net income (loss) for all periods presented.

Income Taxes

The Company accounts for income taxes in accordance with SFAS No. 109, "Accounting for Income Taxes." Under the asset and liability method specified by SFAS No. 109, the deferred income tax amounts included in the Consolidated Balance Sheets are determined based on the differences between the financial statement and tax basis of assets and liabilities, as measured by the enacted tax rates, that will be in effect when these differences reverse. Differences between assets and liabilities for financial statement and tax return purposes are principally related to accrued expenses, the allowances for receivable, equity-based awards and net operating loss carry-forwards.

Guarantee Disclosures

The Company follows the provision of FASB Interpretation ("FIN") No. 45, "Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others," which clarifies the required disclosures to be made by a guarantor in their interim and annual financial statements about its obligations under certain guarantees that it has issued. FIN No. 45 also requires a guarantor to recognize, at the inception of the guarantee, a liability for the fair value of the obligation undertaken. The provisions of this Interpretation did not have a material impact on the Company's financial position or results of operations.

Stock-Based Compensation

Since January 1, 2003, the Company has accounted for stock-based compensation in accordance with the provisions of SFAS No. 123, "Accounting for Stock-Based Compensation," which provided guidance for the recognition of compensation expense as it related to the issuance of stock options and warrants. In addition, the Company adopted the provisions of SFAS No. 148, "Accounting for Stock-Based Compensation – Transition and Disclosure – an amendment of SFAS No. 123." SFAS No. 148 amended SFAS No. 123 to provide alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation provided by SFAS No.

123. In addition, SFAS No. 148 amended the disclosure requirements of SFAS No. 123 to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. SFAS No. 148 also amended the manner by which a company accounts for the transition to the fair value based method recommended by SFAS No. 123. As permitted by SFAS No. 148, the Company has adopted the fair value method recommended by SFAS No. 123 to effect a change in accounting for stock-based employee compensation. Prior to 2003, the Company accounted for stock-based employee compensation under the recognition and measurement provisions of Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees," and related Interpretations.

Stock-based compensation cost of approximately $129,000, $13,000 and $0 is reflected in the accompanying Statement of Operations for the years ended December 31, 2004, 2003 and 2002, respectively. The following table illustrates the effect on net income (loss) and net income (loss) per share as if the fair value method had been applied to all outstanding and unvested awards granted prior to January 1, 2003 in each year presented:


	2004			2003			2002
Net income (loss), as reported	$	884		$	(2,967	)	$	(4,647	)
Add: Stock-based compensation expense included in reported net income (loss)		148			13			—
Deduct: Stock-based compensation expense determined under the fair value method		(190	)		(917	)		(3,653	)
Pro forma	$	842		$	(3,871	)	$	(8,300	)
Net income (loss) per share – basic and diluted, as reported	$	0.01		$	(0.05	)	$	(0.16	)
Pro forma	$	0.01		$	(0.07	)	$	(0.29	)

The Company recognized $19,000, $0, and $0 of expenses related to its issuance of stock options and warrants to certain non-employee consultants to the Company in 2004, 2003 or 2002, respectively.

Concentration of Credit Risk

Cash

The Company maintains cash balances with various financial institutions, which, at times, may exceed the Federal Deposit Insurance Corporation limit. The Company has not experienced any losses to date as a result of this policy, and management believes there is little risk of loss.

Receivables

The Company operates retail optical stores in North America, predominantly in the United States, and its receivables are primarily from franchisees that also operate retail optical stores in the United States. The Company estimates allowances for doubtful accounts based on its franchisees' financial condition and collection history. Management believes the Company's allowances are sufficient to cover any losses related to its inability to collect its accounts and notes receivables. Accounts are written-off when significantly past due and deemed uncollectible by management. At times, the Company experiences difficulties with the collection of amounts due from certain franchisees and with certain franchisees' reporting of revenues subject to royalties. This is a common problem for franchisors, and the Company has taken steps designed to improve the reporting by, and collection from, its franchisees.

Segment Information

SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information," establishes annual and interim reporting standards for an enterprise's operating segments, and related disclosures about its products, services, geographic areas and major customers. For the years ended December 31, 2004, 2003 and 2002, the Company's continuing operations were classified into one principal industry segment – retail optical (Note 1). Accordingly, the disclosures required by SFAS No. 131 have not been provided.

Reclassifications

Certain reclassifications have been made to prior years' consolidated financial statements to conform to the current year presentation.

New Accounting Pronouncements

In November 2004, the FASB issued SFAS No. 151, "Inventory Costs," as amendment to Accounting Principles Board ("APB") No. 43, Chapter 4, which clarifies the accounting for abnormal amounts of idle facility expenses, freight, handling costs, and wasted material. This Statement requires that those items be recognized as current-period charges regardless of whether they meet the criterion "so abnormal," as that term is used in paragraph 5 of APB No. 43, Chapter 4. The adoption of this Statement did not have, nor is it expected to have, a material impact on the Company's financial position or results of operations.

In December 2004, the FASB issued SFAS No. 152, "Accounting for Real Estate Time-Sharing Transactions," which amends FASB SFAS 66 and SFAS 67. This Statement establishes standards for accounting and reporting on real estate time-sharing transactions. This Statement is effective for financial statements for fiscal years beginning after June 15, 2005. As the Company is not involved in any real estate time-sharing transactions, the Company has determined the Statement will not have a material impact on its financial position or results of operations.

NOTE 3 – PER SHARE INFORMATION:

In accordance with SFAS No. 128, "Earnings Per Share", basic net income (loss) per common share ("Basic EPS") is computed by dividing the net income (loss) attributable to common shareholders by the weighted-average number of common shares outstanding. Diluted net income (loss) per common share ("Diluted EPS") is computed by dividing the net income (loss) attributable to common shareholders by the weighted-average number of common shares and dilutive common share equivalents and convertible securities then outstanding. SFAS No. 128 requires the presentation of both Basic EPS and Diluted EPS on the face of the Company's Consolidated Statements of Operations. There were 5,340,153, 9,223,227 and 7,783,205, and stock options and warrants excluded from the computation of Diluted EPS for the years ended December 31, 2004, 2003 and 2002, respectively, as their effect on the computation of Diluted EPS would have been anti-dilutive. Additionally, for the years ended December 31, 2004, 2003 and 2002, respectively, there were 0.74 shares of our Senior Convertible Preferred Stock outstanding, convertible into 98,519 shares of the Company's Common Stock. Similarly, these preferred shares were not "assumed converted" as the effect on the computation of Diluted EPS would also have been anti-dilutive.

The following table sets forth the computation of basic and diluted per share information:


	(In thousands)
	2004		2003			2002
Numerator:
Income (loss) from continuing operations	$	884	$	(2,948	)	$	(4,721	)
Induced conversion of Senior Convertible Preferred Stock		—		—			(18	)
Numerator for basic and diluted income (loss) per share – Income (loss) attributable to common shareholders		884		(2,948	)		(4,739	)

Basic and Diluted:
Income (loss) attributable to common shareholders		884		(2,948	)		(4,739	)
Income (loss) from discontinued operations		—		(19	)		74
Net income (loss) attributable to common shareholders	$	884	$	(2,967	)	$	(4,665	)

Denominator:
Weighted average common shares outstanding		69,475		56,507			28,641
Dilutive effect of stock options and warrants		44,221		—			—
Weighted average common shares outstanding, assuming dilution		113,696		56,507			28,641

Basic and Diluted Per Share Information:
Income (loss) attributable to common shareholders	$	0.01	$	(0.05	)	$	(0.17	)
Income from discontinued operations		—		—			0.01
Net income (loss) attributable to common shareholders	$	0.01	$	(0.05	)	$	(0.16	)

NOTE 4 – FRANCHISE NOTES RECEIVABLE:

Franchise notes held by the Company consist primarily of purchase money notes related to Company-financed conveyances of Company-owned store assets to franchisees, and certain franchise notes receivable obtained by the Company in connection with acquisitions in prior years. Substantially all notes are secured by the underlying assets of the related franchised store, as well as the personal guarantee of the principal owners of the franchise. As of December 31, 2004, these notes generally provided for interest at 12%.

Scheduled maturities of notes receivable as of December 31, 2004, are as follows (in thousands):


2005	$	437
2006		109
2007		42
2008		164
2009		2
		754
Less: allowance for doubtful accounts		(80	)
	$	674

NOTE 5 – VALUATION AND QUALIFYING ACCOUNTS:

Franchise receivables, franchise notes receivable, and other Company receivables, are shown on the Consolidated Balance Sheets net of allowances for doubtful accounts. The following is a breakdown, by major component, of the change in those allowances, along with the accruals for store closings:


	(In thousands) As of December 31,
	2004			2003			2002
Franchise Receivables:
Balance, beginning of year	$	844		$	1,063		$	3,095
Charged to expense		206			84			484
Reductions, including write-offs		(975	)		(303	)		(4,293	)
Additions		39			—			1,777
Balance, end of year	$	114		$	844		$	1,063
Franchise Notes Receivables:
Balance, beginning of year	$	782		$	1,928		$	3,326
Charged to expense		37			20			1,195
Reductions, including write-offs		(739	)		(1,173	)		(2,788	)
Additions		—			7			195
Balance, end of year	$	80		$	782		$	1,928
Other Company Receivables:
Balance, beginning of year	$	118		$	101		$	171
Charged to expense		109			75			150
Reductions, including write-offs		(180	)		(117	)		(249	)