- --------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
---------------------------
FORM 10-Q
(Mark one)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended July 4, 1998
[ ] 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: 0-23633
--------
1-800 CONTACTS, INC.
(Exact name of registrant as specified in its certificate)
Delaware 87-0571643
- ------------------------------------------- -------------------------------
(State or other jurisdiction of (IRS Employer Identification No.)
incorporation or organization)
66 E. Wadsworth Park Drive, 3rd Floor
Draper, UT 84020
- ------------------------------------------- -------------------------------
(Address of principal executive offices) (Zip Code)
(801) 924-9800
------------------------------------------------------
(Registrant's telephone number, including area code)
13751 S. Wadsworth Park Drive, Suite D-140
Draper, UT 84020
--------------------------------------------------------
(Former address since last report)
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.
[X] Yes [ ] No
As of August 18, 1998, the Registrant has 6,430,568 shares of Common Stock, par
value $0.01 per share outstanding.
- --------------------------------------------------------------------------------
<PAGE>
7
1-800 CONTACTS, INC.
INDEX
<TABLE>
<CAPTION>
Page No.
--------
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Condensed Balance Sheets as of July 4, 1998 (unaudited)
<S> <C>
and December 31, 1997. . . . . . . . . . . . . . . . . . . . . . . . . . . . 3
Condensed Statements of Operations for the Quarter and Two Quarters
Ended July 4, 1998 (unaudited) and June 30, 1997 (unaudited). . . . . . . . .4
Condensed Statement of Stockholders' Equity for the Two Quarters Ended
July 4, 1998 (unaudited) . . . . . . . . . . . . . . . . . . . . . . . . .. 5
Condensed Statements of Cash Flows for the Two Quarters Ended
July 4, 1998 (unaudited) and June 30, 1997 (unaudited) . . . . . . . . . . 6
Notes to Condensed Financial Statements. . . . . . . . . . . . . . . . . . . . . .8
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations . . . . . . . . . . . . . . . . . . . . . . . . .. 11
PART II. OTHER INFORMATION
Item 1. Legal Proceedings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15
Item 2. Changes in Securities and Use of Proceeds. . . . . . . . . . . . . . . . . . . . 15
Item 3. Defaults upon Senior Securities . . . . . . . . . . . . . . . . . . . . . . . . . 16
Item 4. Submission of Matters to a Vote of Security Holders . . . . . . . . . . . . . . . 16
Item 5. Other Information . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16
Item 6. Exhibits and Reports on Form 8-K. . . . . . . . . . . . . . . . . . . . . . . . . 16
</TABLE>
<PAGE>
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
<TABLE>
<CAPTION>
1-800 CONTACTS, INC.
CONDENSED BALANCE SHEETS
ASSETS
July 4, December 31,
1998 1997
------------ -----------
(Unaudited)
<S> <C> <C>
CURRENT ASSETS:
Cash and cash equivalents $ 11,970,814 $ -
Inventories 9,821,646 4,811,855
Prepaid advertising 742,438 127,696
Deferred income tax asset 35,435 -
Other current assets 155,016 54,968
------------ -----------
Total current assets 22,725,349 4,994,519
DEFERRED ADVERTISING COSTS 5,923,044 1,705,695
PROPERTY AND EQUIPMENT, net: 1,529,571 562,503
OTHER ASSETS 152,591 518,347
------------ -----------
Total assets $ 30,330,555 $ 7,781,064
============ ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Line of credit $ - $ 1,055,640
Notes payable to stockholders - 1,370,000
Current portion of capital lease obligation 30,928 23,532
Accounts payable 5,875,096 3,762,158
Accrued liabilities 936,020 300,439
Unearned revenue 268,872 104,272
------------ -----------
Total current liabilities 7,110,916 6,616,041
------------ -----------
LONG-TERM LIABILITIES:
Notes payable to stockholders - 243,788
Capital lease obligation, less current portion 49,000 66,877
Deferred income tax liability 860,879 -
------------ -----------
Total long-term liabilities 909,879 310,665
------------ -----------
STOCKHOLDERS' EQUITY:
Common stock 64,306 46,595
Additional paid-in capital 22,971,890 93,688
Retained earnings (deficit) (726,436) 1,286,220
Notes receivable from stockholders - (572,145)
------------ -----------
Total stockholders' equity 22,309,760 854,358
------------ -----------
Total liabilities and stockholders' equity $ 30,330,555 $ 7,781,064
============ ===========
</TABLE>
The accompanying notes to condensed financial statements
are an integral part of these condensed statements.
3
<PAGE>
<TABLE>
<CAPTION>
1-800 CONTACTS, INC.
CONDENSED STATEMENTS OF OPERATIONS
(Unaudited)
Quarter Ended Two Quarters Ended
------------------------------ ------------------------------
July 4, June 30, July 4, June 30,
1998 1997 1998 1997
----------- ------------ ----------- -----------
<S> <C> <C> <C> <C>
NET SALES $12,800,438 $ 4,870,394 $23,229,742 $ 7,716,383
COST OF GOODS SOLD 7,959,185 3,253,544 14,588,098 5,111,884
----------- ------------ ----------- -----------
Gross profit 4,841,253 1,616,850 8,641,644 2,604,499
SELLING, GENERAL AND
ADMINISTRATIVE EXPENSES 5,388,732 1,315,779 8,526,658 2,093,318
----------- ------------ ----------- -----------
INCOME (LOSS) FROM OPERATIONS (547,479) 301,071 114,986 511,181
----------- ------------ ----------- -----------
OTHER INCOME (EXPENSE):
Interest expense (2,207) (28,153) (75,840) (32,256)
Interest income 204,255 14,445 348,124 14,445
Other, net (1,798) 10,248 8,202 10,248
----------- ------------ ----------- -----------
Total other, net 200,250 (3,460) 280,486 (7,563)
----------- ------------ ----------- -----------
INCOME (LOSS) BEFORE BENEFIT
(PROVISION) FOR INCOME TAXES (347,229) 297,611 395,472 503,618
BENEFIT (PROVISION)
FOR INCOME TAXES 128,464 - (825,444) -
----------- ------------ ----------- -----------
NET INCOME (LOSS) $ (218,765) $ 297,611 $ (429,972) $ 503,618
============= ============ =========== ===========
PER SHARE INFORMATION:
Basic and diluted net income
(loss) per common share $ (0.03) $ 0.06 $ (0.07) $ 0.11
============= ============ =========== ===========
PRO FORMA INFORMATION:
Income before benefit
(provision) for income taxes (347,229) 297,611 395,472 503,618
Benefit (provision) for income taxes 128,464 (114,580) (149,873) (193,893)
----------- ------------ ----------- -----------
Net income (loss) $ (218,765) $ 183,031 $ 245,599 $ 309,725
============= ============ =========== ===========
Basic and diluted net income
(loss) per common share $ (0.03) $ 0.04 $ 0.04 $ 0.07
============= ============ =========== ===========
</TABLE>
The accompanying notes to condensed financial statements
are an integeral part of these condensed statements
4
<PAGE>
1-800 CONTACTS, INC.
CONDENSED STATEMENT OF STOCKHOLDERS' EQUITY
For the Two Quarters Ended July 4, 1998
(Unaudited)
<TABLE>
<CAPTION>
Notes
Additional Retained Receivable
Common Stock Paid-in Earnings From
Shares Amount Capital (Deficit) Stockholders Total
--------- -------- ----------- ------------ ------------ ------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
BALANCE, December 31, 1997 4,659,469 $ 46,595 $ 93,688 $ 1,286,220 $ (572,145) $ 854,358
Advances to stockholder - - - - (27,544) (27,544)
Distributions to stockholders,net - - - (1,582,684) 599,689 (982,995)
Sale of common stock,
net of offering costs 2,213,750 22,138 24,773,775 - - 24,795,913
Repurchase of common stock (442,651) (4,427) (1,895,573) - - (1,900,000)
Net loss - - - (429,972) - (429,972)
--------- -------- ----------- ------------ ------------ ------------
BALANCE, July 4, 1998 6,430,568 $ 64,306 $22,971,890 $ (726,436) $ - $ 22,309,760
========= ======== =========== ============ ============ ============
</TABLE>
The accompanying notes to condensed financial statements
are an integral part of these condensed statements.
5
<PAGE>
1-800 CONTACTS, INC.
CONDENSED STATEMENTS OF CASH FLOWS
(Unaudited)
<TABLE>
<CAPTION>
Increase (Decrease) In Cash And Cash Equivalents
Two Quarters Ended
------------------------------------
July 4, June 30,
1998 1997
--------------- --------------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) $ (429,972) $ 503,618
Adjustments to reconcile net income (loss) to net cash
provided by (used in) operating activities:
Depreciation and amortization 198,821 69,512
Loss on retirement of property and equipment 1,798 -
Deferred income taxes 825,444 -
Changes in operating assets and liabilities:
Inventories (5,009,791) (854,644)
Prepaid advertising (614,742) (54,900)
Other current assets (100,048) (132,436)
Deferred advertising costs (4,217,349) (764,154)
Accounts payable 2,112,938 1,029,525
Accrued liabilities 635,581 121,044
Unearned revenue 164,600 109,772
--------------- --------------
Net cash provided by (used in) operating activities (6,432,720) 27,337
--------------- --------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Net increase in notes receivable from stockholders (27,544) (181,612)
Purchase of property and equipment (1,150,327) (225,725)
Purchase of intangible assets (5,000) (50,000)
Deposits (21,802) -
--------------- --------------
Net cash used in investing activities (1,204,673) (457,337)
--------------- --------------
</TABLE>
The accompanying notes to condensed financial statements
are an integral part of these condensed statements.
6
<PAGE>
1-800 CONTACTS, INC.
CONDENSED STATEMENTS OF CASH FLOWS (continued)
(Unaudited)
<TABLE>
<CAPTION>
Increase (Decrease) In Cash And Cash Equivalents
Two Quarters Ended
-----------------------------------
July 4, June 30,
1998 1997
------------- ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
<S> <C> <C>
Sale of common stock, net of underwriting discounts and commissions 25,734,844 -
Stock offering costs (563,733) (18,664)
Stock repurchase (1,900,000) -
Net repayments on line of credit (1,055,640) -
Borrowings from stockholders - 950,000
Principal payments on notes payable to stockholders (1,613,788) (311,212)
Principal payments on notes payable for distributions to stockholders, net (982,995) -
Principal payments on long-term debt - (28,682)
Principal payments on capital lease (10,481) (7,871)
Repayment of bank overdraft - (68,543)
------------- ------------
Net cash provided by financing activities 19,608,207 515,028
------------- ------------
NET INCREASE IN CASH AND CASH EQUIVALENTS 11,970,814 85,028
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD - -
------------- ------------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 11,970,814 $ 85,028
SUPPLEMENTAL CASH FLOW INFORMATION:
Cash paid for interest $ 201,852 $ 14,892
</TABLE>
SUPPLEMENTAL DISCLOSURES OF NONCASH INVESTING AND FINANCING ACTIVITIES:
During the first quarter of 1998, the Company distributed $1,582,684 to its S
Corporation stockholders. This distribution (net of notes receivable from
stockholders of $599,689) was in the form of promissory notes, totaling
$982,995, issued by the Company. The promissory notes were paid in full during
the first quarter of 1998.
The accompanying notes to condensed financial statements
are an integral part of these condensed statements.
7
<PAGE>
1-800 CONTACTS, INC.
NOTES TO CONDENSED FINANCIAL STATEMENTS
(Unaudited)
NOTE 1. PRESENTATION OF CONDENSED FINANCIAL STATMENTS
The accompanying condensed financial statements have been prepared by
the Company, without audit, pursuant to the rules and regulations of the
Securities and Exchange Commission. Certain information and disclosures normally
included in financial statements prepared in accordance with generally accepted
accounting principles have been condensed or omitted pursuant to such rules and
regulations. These condensed financial statements reflect all adjustments
(consisting only of normal recurring adjustments), which in the opinion of
management, are necessary to present fairly the results of operations of the
Company for the periods presented. It is suggested that these condensed
financial statements be read in conjunction with the financial statements and
the notes thereto included in the Company's Registration Statement on Form S-1
(registration number is 333-41055).
The results of operations for the quarter and two quarters ended July
4, 1998 are not necessarily indicative of the results to be expected for the
full year.
NOTE 2. CHANGE IN ACCOUNTING PERIOD
Effective January 1, 1998, the Company changed from a calendar year end
to a 52/53 week year ending on the Saturday nearest to December 31. Due to this
change, the first quarter of 1998 represents 13 weeks and 3 days, covering the
period January 1, 1998 to April 4, 1998. The other quarters for fiscal year 1998
are each 13 weeks.
NOTE 3. INITIAL PUBLIC OFFERING
During February 1998, the Company completed its initial public offering
of common stock. In connection therewith, the Company issued 2,213,750 shares of
common stock, which included 288,750 shares issued pursuant to the underwriters'
over-allotment option. The proceeds received from the offering, net of
underwriting commissions and offering costs, totaled approximately $24,796,000.
NOTE 4. S CORPORATION DISTRIBUTIONS
Immediately prior to the consummation of its initial public offering,
the Company entered into an agreement to distribute to its existing stockholders
an amount equal to the Company's retained earnings from its formation date
through the date of the termination of the Company's S Corporation status. The
distribution (net of notes receivable from stockholders of $599,689) was in the
form of promissory notes, totaling $982,995, issued by the Company. These
promissory notes were paid in full during the first quarter of 1998.
NOTE 5. INCOME TAXES AND PRO FORMA INFORMATION
Effective February 9, 1998 the Company's S Corporation election was
terminated. As a result, the Company recorded a net deferred tax liability and
the related deferred tax provision of approximately $791,000 for the tax effect
of the differences between financial statement and income tax basis of assets
and liabilities that existed at the termination date of the S Corporation
election.
The pro forma net income presents the pro forma effects on historical
net income adjusted for a pro forma provision for income taxes. The pro forma
provision for income taxes has been determined assuming the Company had been
taxed as a C Corporation for federal and state income tax purposes.
8
<PAGE>
NOTE 6. NET INCOME PER COMMON SHARE
Basic net income per common share ("Basic EPS") excludes dilution and
is computed by dividing net income by the weighted-average number of common
shares outstanding during the period. Diluted net income per common share
("Diluted EPS") reflects the potential dilution that could occur if stock
options or other common stock equivalents were exercised or converted into
common stock.
The pro forma Basic and Diluted EPS gives effect to the pro forma
effects on historical net income adjusted for a pro forma provision for income
taxes assuming the Company had been taxed as a C Corporation for federal and
state income tax purposes. In addition, it takes into consideration the shares
deemed to be outstanding at the initial public offering price of $12.50 per
share, sufficient to fund the S Corporation distribution of approximately
$983,000 (see Note 4).
The following is a reconciliation of the numerator and denominator used
to calculate Basic and Diluted EPS:
<TABLE>
<CAPTION>
Quarter Ended July 4, 1998 Quarter Ended June 30, 1997
------------------------------------ --------------------------------
Income Per-Share Income Per-Share
(Loss) Shares Amount (Loss) Shares Amount
------------- ------------ ------------- ------------- ------------ -------------
<S> <C> <C> <C> <C> <C> <C>
Historical:
Basic EPS $ (218,765) 6,430,568 $ (0.03) $ 297,611 4,659,469 $ 0.06
Effect of stock options 18,258
---------- --------- ---------- ---------- --------- ---------
Diluted EPS $ (218,765) 6,430,568 $ (0.03) $ 297,611 4,677,727 $ 0.06
========== ========= ========== ========== ========= =========
Pro Forma:
Basic EPS $ (218,765) 6,430,568 $ (0.03) $ 183,031 4,659,469 $ 0.04
Effect of stock options 18,258
Assumed distribution 78,640
------------- ------------ ------------- ------------- ------------ -------------
Diluted EPS $ (218,765) 6,430,568 $ (0.03) $ 183,031 4,756,367 $ 0.04
============= ============ ============= ========== ========= =========
Two Quarters Ended July 4, 1998 Two Quarters Ended June 30, 1997
------------------------------------ --------------------------------------
Income Per-Share Income Per-Share
(Loss) Shares Amount (Loss) Shares Amount
------------- ------------ ------------- ---------- ------------ -------------
Historical:
Basic EPS $ (429,972) 6,033,580 $ (0.07) $ 503,618 4,659,469 $ 0.11
Effect of stock options 13,814
------------- ------------ ------------- ------------- ------------ -------------
Diluted EPS $ (429,972) 6,033,580 (0.07) 503,618 4,673,283 $ 0.11
============= ============ ============= ========== ========= =========
Pro Forma:
Basic EPS $ 245,599 6,033,580 $ 0.04 $ 309,725 4,659,469 $ 0.07
Effect of stock options 61,437 13,814
Assumed distribution 78,640
------------- ------------ ------------- ------------- ------------ -------------
Diluted EPS $ 245,599 6,095,017 $ 0.04 $ 309,725 4,751,923 $ 0.07
============= ============ ============= ========== ========= =========
</TABLE>
9
<PAGE>
NOTE 7. ADVERTISING COSTS
The Company capitalizes certain direct-mail advertising costs and
amortizes those costs over the period for which the revenues are generated in
accordance with Statement of Position ("SOP") 93-7. Based upon the Company's
past direct-response information, the Company amortizes those costs over a 12
month period. The Company recorded direct-response advertising expense of
approximately $3,379,000 and $5,256,000, respectively, for the quarter and two
quarters ended July 4, 1998 and $748,000 and $1,110,000, respectively for the
quarter and two quarters ended June 30, 1997. The Company expenses all other
advertising costs when the advertising takes place. These advertising costs
totaled approximately $565,000 and $692,000, respectively, for the quarter and
two quarters ended July 4, 1998 and $14,000 and $17,000, respectively for the
quarter and two quarters ended June 30, 1997.
NOTE 8. LEGAL MATTERS
On July 14, 1998, Craig S. Steinberg, O.D., a professional corporation
d.b.a. City Eyes Optometry Center, filed a purported class action on behalf of
all optometrists licensed to practice in California against the Company and its
directors in Los Angeles County Superior Court (the "Steinberg Complaint"). The
complaint alleges three separate causes of action for unfair competition: (i)
selling contact lenses to California residents without being registered, (ii)
selling contact lenses to California residents without verifying the
prescription, and (iii) failing to disclose in its advertising that it sells
"sample" lenses not intended for sale to the public. The complaint requests
various forms of relief, including damages of an unspecified amount, attorney's
fees and a permanent injunction to prevent the Company from selling contact
lenses to California residents without being registered and without verifying
the prescription as well as from selling sample contact lenses to California
residents. In addition, the plaintiff has filed a motion for preliminary
injunction seeking the injunctive relief requested in the complaint. On August
11, 1998, the Company removed the action to the United States District Court for
the Central District of California based on diversity jurisdiction.
The Company is in the preliminary stages of investigating this matter.
Based upon the limited information available to the Company at the present time,
the Company is unable to express an opinion as to the actual exposure of the
Company for this matter. The Company intends to vigorously defend this matter.
From time to time the Company is involved in other legal matters
generally incidental to its business. It is the opinion of management, after
discussion with legal counsel, that the ultimate dispositions of these matters
will not have a material impact on the financial condition, liquidity or results
of operations of the Company.
10
<PAGE>
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations.
Overview
The Company is a rapidly growing direct marketer of replacement contact
lenses. The Company was formed in February 1995 and is the successor to the mail
order business founded by the Company's Vice President of Operations in March
1991. Since its formation, the Company has experienced significant growth in
revenues. The Company's net sales have grown rapidly from $7.7 million in the
first two quarters of 1997 to $23.2 million in the first two quarters of 1998.
Prior to consummation of its initial public offering ("IPO") in
February 1998, the Company operated as an S corporation and, as a result, had
not been subject to federal or certain state income taxes. In connection with
the consummation of the IPO, the Company revoked its S Corporation status,
became subject to federal and state income taxes, and recognized a
non-recurring, non-cash charge to earnings of approximately $791,000 to record
deferred income taxes for the tax effect of cumulative temporary differences
between financial and tax reporting.
Effective January 1, 1998, the Company changed from a calendar year end
to a 52/53 week year ending on the Saturday nearest to December 31. Due to this
change, the first quarter of 1998 represents 13 weeks and 3 days, covering the
period January 1, 1998 to April 4, 1998. The other quarters for fiscal year 1998
are each 13 weeks.
Quarter-to-quarter comparisons are impacted by the timing of the
mailing of the Company's printed advertisements within and between quarters.
Approximately 40% of the revenue related to a particular mailing is generated
within 60 to 90 days after such mailing. The Company engages in an ongoing
mailing campaign. The volume of mailings may vary in different quarters and from
year-to-year depending on the Company's assessment of prevailing market
opportunities. The Company began advertising through television and the Internet
in the second quarter of 1998. In addition, the Company expects to begin
advertising through radio during the third quarter of 1998. The costs of
television, radio and Internet advertising are expensed as incurred and are not
capitalized like direct-mailing advertising costs. As a result,
quarter-to-quarter comparisons are impacted by the timing of such television,
radio and Internet advertisements.
The sale and delivery of contact lenses are generally governed by state
laws and regulations. The Company sells to customers in nearly all 50 states and
each sale is likely to be subject to the laws of the state where the customer is
located. The Company's operating practice is to attempt to obtain a valid
prescription from each of its customers or his/her eye care practitioner. If the
Company is unable to obtain a copy of or verify the customer's prescription, the
Company's practice is to ship the lenses to the customer, based on the
information that the customer has provided. The Company retained legal counsel
to identify and summarize the applicable laws of each of the states in which the
Company generates material sales. The Company compared its operations to the
applicable requirements of the laws contained in such summaries. Based on such
comparison, the Company estimates that approximately one-third of its net sales
appeared to conform to the requirements of applicable state laws and
regulations.
11
<PAGE>
Results of Operations
The following table presents the Company's results of operations
expressed as a percentage of net sales:
<TABLE>
<CAPTION>
Quarter Ended Two Quarters Ended
------------------------ -------------------------
July 4, June 30, July 4, June 30,
1998 1997 1998 1997
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Net sales 100.0% 100.0% 100.0% 100.0%
Cost of sales 62.2% 66.8% 62.8% 66.2%
----------- ----------- ----------- -----------
Gross profit 37.8% 33.2% 37.2% 33.8%
Selling, general and administrative expenses 42.1% 27.0% 36.7% 27.2%
----------- ----------- ----------- -----------
Income (loss) from operations (4.3%) 6.2% 0.5% 6.6%
Other income (expense), net 1.6% (0.1%) 1.2% (0.1%)
----------- ----------- ----------- -----------
Income (loss) before benefit
(provision) for income taxes (2.7%) 6.1% 1.7% 6.5%
Pro forma benefit (provision) for income taxes 1.0% (2.3%) (0.6%) (2.5%)
----------- ----------- ----------- -----------
Pro forma net income (loss) (1.7%) 3.8% 1.1% 4.0%
=========== =========== =========== ===========
</TABLE>
Net sales. Net sales for the quarter ended July 4, 1998 increased $7.93
million, or 163%, to $12.80 million from $4.87 million for the quarter ended
June 30, 1997. For the two quarters ended July 4, 1998, net sales increased
$15.51 million, or 201%, to $23.23 million from $7.72 million for the two
quarters ended June 30, 1997. These increases are primarily attributable to
higher sales volumes resulting from the acquisition of new customers through
additional sales and marketing efforts and from reorders from a growing customer
base.
Gross profit. Gross profit as a percentage of sales increased to 37.8%
for the quarter ended July 4, 1998 from 33.2% for the quarter ended June 30,
1997. For the two quarters ended July 4, 1998, gross profit as a percentage of
sales increased to 37.2% from 33.8% for the two quarters ended June 30, 1997.
These increases are largely due to decreases in inventory procurement costs.
Selling, general and administrative expenses. Selling, general and
administrative expenses for the quarter ended July 4, 1998 increased $4.07
million, or 308%, from the quarter ended June 30, 1997. As a percentage of net
sales, selling, general and administrative expenses increased to 42.1% in the
second quarter of 1998 from 27.0% in the comparable 1997 period. For the two
quarters ended July 4, 1998, selling, general and administrative expenses
increased $6.43 million, or 307%, from the two quarters ended June 30, 1997. As
a percentage of net sales, selling, general and administrative expenses
increased to 36.7% in the first two quarters of 1998 from 27.2% in the
comparable 1997 period. These increases in expense and as a percentage of net
sales are primarily due to the increase in sales and marketing activity and the
related increase in expenditures necessary to support the increased sales.
Advertising as a percentage of sales was 30.8% in the second quarter of 1998 as
compared to 15.6% in the second quarter of 1997. For the first two quarters of
1998, advertising as a percentage of sales was 25.6% as compared to 14.6% for
the first two quarters of 1997. During the second quarter of 1998, the Company
tested new forms of advertising, including television and Internet advertising.
As a result of this testing, the Company has decided to change the business
advertising model from mainly print advertising, which is capitalized, to a
majority of fully-expensed broadcast advertising (television, radio, and
Internet).
Other (expense) income, net. For the quarter ended July 4, 1998, other
(expense) income increased to $200,250 from $(3,460) for the quarter ended June
30, 1997. For the two quarters ended July 4, 1998, other (expense) income
increased to $280,486 from $(7,563) for the two quarters ended June 30, 1997.
These increases are due to interest income from funds received in the initial
public offering of common stock in excess of the interest expense incurred prior
to the initial public offering.
12
<PAGE>
Income taxes. The pro forma provision for income taxes has been
determined assuming the Company had been taxed as a C Corporation for federal
and state income tax purposes for the periods shown. For the quarter ended July
4, 1998, the pro forma provision for income taxes is the same as the provision
for income taxes as the Company was a C Corporation for the entire period. The
Company anticipates that its future effective income tax rate will be
approximately 38%.
Liquidity and Capital Resources
The Company has historically funded its growth through a combination of
funds generated from operations and borrowings. During February 1998, the
Company completed its initial public offering of common stock. In connection
therewith, the Company issued 2,213,750 shares of common stock, which included
288,750 shares pursuant to the underwriters' over-allotment option. The proceeds
received from the offering, net of underwriting commissions and offering costs,
totaled approximately $24.8 million. The Company uses funds to enhance growth
through increased advertising expenditures and to increase inventory levels in
anticipation of future sales.
For the two quarters ended July 4, 1998 and June 30, 1997, net cash
provided by (used in) operations was approximately $(6,433,000) and $27,000,
respectively. In both 1998 and 1997, cash was used primarily to fund increases
in inventory and advertising assets (prepaid advertising and deferred
advertising). In 1998, these increases were partially offset by deferred income
taxes and by increases in accounts payable and accrued liabilities. In 1997,
cash used to fund the increases in inventory and advertising assets mostly
offset by net income and the increases in accounts payable and accrued
liabilities.
The Company used approximately $1,205,000 and $457,000 for investing
activities for the two quarters ended July 4, 1998 and June 30, 1997,
respectively. The majority of these amounts relate to capital expenditures and
increases in notes receivable from shareholders. The Company received payment in
full on the notes receivable during the first quarter of 1998, as the notes were
netted with the S Corporation distribution paid during the period. The amounts
related to capital expenditures for the 1998 and 1997 periods were approximately
$1,150,000 and $226,000, respectively. The Company moved into its new call
center during June and July of 1998. In conjunction with the move, the Company
acquired new telecommunications systems and enhanced its management information
systems. The Company anticipates additional capital expenditures for
infrastructure as it continues to expand and improve operating facilities,
telecommunications systems and management information systems in order to handle
future growth.
For the 1998 period, the Company had approximately $19.61 million
provided by financing activities, resulting from net proceeds received from its
initial public offering, offset by repayments of debt, distributions to
stockholders and repurchase of stock. For the 1997 period, the Company had
approximately $515,000 provided by financing activities, resulting from net
borrowings from stockholders, offset by debt payments and repayment of a bank
overdraft.
In August 1997, the Company established a revolving credit facility to
provide for working capital requirements and other corporate purposes (the
"Credit Facility"). The Company amended the Credit Facility in January 1998. As
a result, the Credit Facility provided for borrowings equal to the lesser of
$3.0 million or 50% of eligible inventory, declining to the lesser of $1.5
million or 50% of eligible inventory upon completion of a successful initial
public offering of $10 million or more. The Credit Facility bears interest at a
floating rate equal to the lender's prime interest rate plus 1.5% (10% at July
4, 1998). As of July 4, 1998, the Company had no outstanding borrowings under
the Credit Facility. The Credit Facility is secured by substantially all of the
Company's assets and contains financial covenants customary for this type of
financing. The term of the Credit Facility was originally set to mature on July
31, 1998; however, the Credit Facility term has been extended to August 31,
1998. The Company has applied for a renewal of the Credit Facility.
13
<PAGE>
The Company believes that its cash on hand after the IPO, together with
cash generated from operations, will be sufficient to support current operations
and future growth through fiscal 1998. The Company may be required to seek
additional sources of funds for accelerated growth or continued growth after
that point, and there can be no assurance that such funds will be available on
satisfactory terms. Failure to obtain such financing could delay or prevent the
Company's planned growth, which could adversely affect the Company's business,
financial condition and results of operations.
As a result of state regulatory requirements, the Company's liquidity,
capital resources and results of operations may be negatively impacted in the
future if the Company incurs increased costs or fines, is prohibited from
selling its products in a particular state(s) or experiences losses of a
substantial portion of the Company's customers for whom the Company is unable to
obtain or verify a prescription due to the enforcement of requirements by state
regulatory agencies.
During the second quarter of 1998, the Company tested new forms of
advertising, including television and Internet advertising. As a result of this
testing, the Company has decided to change the business advertising model from
mainly print advertising, which is capitalized, to a majority of fully-expensed
broadcast advertising (television, radio, and Internet). This shift from print
advertising to a majority of broadcast advertising will result in reported
losses in the remainder of the year. The Company expects losses during this
transition period to range from ($0.35) to ($0.40) per share in the third
quarter and from ($0.03) to ($0.05) per share in the fourth quarter of 1998.
These expected losses are mainly the result of a shift to a business model with
more immediately expensed advertising.
The Company has reviewed all of its current computer applications with
respect to the year 2000 issue. The Company believes all of its applications are
substantially year 2000 compliant and that any additional costs with respect to
year 2000 compliance will not be material to the Company. The Company is
currently unable to determine the effects of year 2000 compliance by its
vendors.
Forward Looking Statements
This document contains certain forward-looking statements within the
meaning of Section 27A of the Securities Act of 1933 (the "Securities Act") and
Section 21E of the Securities Exchange Act of 1934, as amended (the "Exchange
Act"). Such forward-looking statements include statements regarding the
Company's marketing plans, expectations concerning growth in the market, certain
financial projections and the planned use of capital. Actual results could
differ from those projected in any forward-looking statements. The
forward-looking statements are made as of this document and the Company assumes
no obligation to update such forward-looking statements, or to update the
reasons why actual results may differ from those projected in the
forward-looking statements. Numerous factors, including without limitation
general economic conditions, the health of the contact lens industry, the
effectiveness of advertising, inventory acquisition and management, and legal
and regulatory considerations, many of which are beyond the control of
management of the Company, could cause future results to differ substantially
from those contemplated in such forward-looking statements.
14
<PAGE>
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
During the quarter ended July 4, 1998, a claim against the Company by a
former applicant was settled. The settlement amount was recorded in the quarter
ended April 4, 1998.
On July 14, 1998, Craig S. Steinberg, O.D., a professional corporation
d.b.a. City Eyes Optometry Center, filed a purported class action on behalf of
all optometrists licensed to practice in California against the Company and its
directors in Los Angeles County Superior Court (the "Steinberg Complaint"). The
complaint alleges three separate causes of action for unfair competition: (i)
selling contact lenses to California residents without being registered, (ii)
selling contact lenses to California residents without verifying the
prescription, and (iii) failing to disclose in its advertising that it sells
"sample" lenses not intended for sale to the public. The complaint requests
various forms of relief, including damages of an unspecified amount, attorney's
fees and a permanent injunction to prevent the Company from selling contact
lenses to California residents without being registered and without verifying
the prescription as well as from selling sample contact lenses to California
residents. In addition, the plaintiff has filed a motion for preliminary
injunction seeking the injunctive relief requested in the complaint. On August
11, 1998, the Company removed the action to the United States District Court for
the Central District of California based on diversity jurisdiction.
The Company is in the preliminary stages of investigating this matter.
Based upon the limited information available to the Company at the present time,
the Company is unable to express an opinion as to the actual exposure of the
Company for this matter. The Company intends to vigorously defend this matter.
From time to time the Company is involved in other legal matters
generally incidental to its business. It is the opinion of management, after
discussion with legal counsel, that the ultimate dispositions of these matters
will not have a material impact on the financial condition, liquidity or results
of operations of the Company.
Item 2. Changes in Securities and Use of Proceeds
(b) Use of Proceeds from Registered Securities.
A Registration Statement on Form S-1 (File No. 333-41055) (the
"Registration Statement") registering shares of the Company's Common Stock, par
value $0.01 per share, filed in connection with the Company's IPO, was declared
effective by the Securities and Exchange Commission on February 9, 1998. The IPO
commenced on the effective date and terminated after all the securities
registered under such Registration Statement were sold.
Pursuant to the Registration Statement, the Company sold 2,213,750
shares of Common Stock (including 288,750 shares sold pursuant to the
underwriter's over-allotment option) for its own account, for an aggregate
offering price of $27,671,875, and 316,250 shares of Common Stock (including
41,250 shares sold pursuant to the underwriter's over-allotment option) for the
account of the selling stockholder for an aggregate offering price of
$3,953,125. The managing underwriters of the IPO were McDonald & Company
Securities, Inc. and Morgan Keegen & Company, Inc.
In connection with the IPO, the Company incurred expenses of
$2,875,962, including underwriting discounts and commissions of $1,937,031 and
other expenses of $938,931. After such expenses, the Company's net proceeds from
the IPO were approximately $24.8 million. Since completion of the IPO, through
July 4, 1998, the approximate amounts of net offering proceeds used by the
Company were as follows: (i) $1.0 million for the payment of the S Corporation
distribution, net of notes receivable from stockholders, (which was paid to the
shareholders who were shareholders of the Company prior to the IPO, some of whom
15
<PAGE>
are directors and officers of the Company); (ii) $3.0 million for the repayment
of debt (a portion of which was repaid to a director of the Company); (iii) $1.9
million to exercise an option to purchase 442,651 shares of Common Stock from a
director of the Company (iv) $1.1 million for capital expenditures and (v) $5.8
million for working capital. The $12.0 million remaining proceeds are held in a
money market fund.
Item 3. Defaults upon Senior Securities
None.
Item 4. Submission of Matters to a Vote of Security Holders
None.
Item 5. Other Information
From time to time the Company receives notices, inquiries or other
correspondence from states or its regulatory bodies charged with overseeing the
sale of contact lenses. The Company's practice is to review such notices with
legal counsel to determine the appropriate response on a case-by-case basis. It
is the opinion of management, after discussion with legal counsel, that the
Company is taking the appropriate steps to address the various notices received.
To date, no formal complaints have been filed against the Company concerning its
business practices, other than the Steinberg Complaint referenced above.
Item 6. Exhibits and Reports on Form 8-K
(A) Exhibit Index
Exhibit No. Description of Exhibit
----------- ----------------------
27.1 Financial Data Schedule.
(B) No reports on Form 8-K were filed by the Registrant during the
quarter ended July 4, 1998.
16
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of
1934, the Registrant has duly caused this report to be signed on its behalf by
the undersigned thereunto duly authorized.
1-800 CONTACTS, INC.
Dated: August __, 1998 By:-----------------------------------------
Name: Jonathan C. Coon
Title: President & Chief Executive Officer
By:-----------------------------------------
Name: Scott S. Tanner
Title: Chief Financial Officer
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