UNITED STATES
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 October 3, 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
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1-800 CONTACTS, INC.
(Exact name of registrant as specified in its charter)
Delaware 87-0571643
----------------- -------------------------
(State or other jurisdiction (I.R.S. Employer Identification No.)
of 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)
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 November 17, 1998, the Registrant has 6,415,568 shares of Common Stock,
par value $0.01 per share, outstanding.
<PAGE>
1-800 CONTACTS, INC.
INDEX
<TABLE>
<CAPTION>
Page No.
--------
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
<S> <C>
Condensed Balance Sheets as of October 3, 1998 (unaudited)
and December 31, 1997. . . . . . . . . . . . . . . . . . . . . . . . . . . . .3
Condensed Statements of Operations for the Quarter and Three Quarters Ended
October 3, 1998 (unaudited) and September 30, 1997 (unaudited) 4
Condensed Statement of Stockholders' Equity for the Three Quarters Ended
October 3, 1998 (unaudited) . . . . . . . . . . . . . . . . . . . . . . . . 5
Condensed Statements of Cash Flows for the Three Quarters Ended
October 3, 1998 (unaudited) and September 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
October 3, December 31,
1998 1997
------------ ------------
(Unaudited)
<S> <C> <C>
CURRENT ASSETS:
Cash and cash equivalents $ 7,821,036 $ -
Inventories 12,421,931 4,811,855
Prepaid advertising 476,832 127,696
Deferred income tax asset 71,989 -
Other current assets 202,114 54,968
------------ ------------
Total current assets 20,993,902 4,994,519
DEFERRED ADVERTISING COSTS 6,001,749 1,705,695
PROPERTY AND EQUIPMENT, net: 2,030,606 562,503
DEFERRED INCOME TAX ASSET 570,690 -
OTHER ASSETS 136,380 518,347
------------ ------------
Total assets $ 29,733,327 $ 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 34,773 23,532
Accounts payable 7,804,907 3,762,158
Accrued liabilities 1,415,333 300,439
Unearned revenue 599,184 104,272
------------ ------------
Total current liabilities 9,854,197 6,616,041
------------ ------------
LONG-TERM LIABILITIES:
Notes payable to stockholders - 243,788
Capital lease obligation, less current portion 39,706 66,877
------------ ------------
Total long-term liabilities 39,706 310,665
------------ ------------
STOCKHOLDERS' EQUITY:
Common stock 64,306 46,595
Additional paid-in capital 22,971,890 93,688
Retained earnings (deficit) (3,196,772) 1,286,220
Notes receivable from stockholders - (572,145)
------------ ------------
Total stockholders' equity 19,839,424 854,358
------------ ------------
Total liabilities and stockholders' equity $ 29,733,327 $ 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 Three Quarters Ended
-------------------------------- -------------------------------
October 3, September 30, October 3, September 30,
1998 1997 1998 1997
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
NET SALES $ 18,418,946 $ 6,428,452 $ 41,648,688 $ 14,144,835
COST OF GOODS SOLD 11,490,306 4,340,929 26,078,404 9,452,813
------------ ------------ ------------ ------------
Gross profit 6,928,640 2,087,523 15,570,284 4,692,022
SELLING, GENERAL AND
ADMINISTRATIVE EXPENSES 11,004,215 1,765,538 19,530,873 3,858,856
------------ ------------ ------------ ------------
INCOME (LOSS) FROM OPERATIONS (4,075,575) 321,985 (3,960,589) 833,166
------------ ------------ ------------ ------------
OTHER INCOME (EXPENSE):
Interest expense (2,051) (46,230) (77,891) (78,486)
Interest income 139,167 9,622 487,291 24,067
Other, net - 3,147 8,202 13,395
------------ ------------ ------------ ------------
Total other, net 137,116 (33,461) 417,602 (41,024)
------------ ------------ ------------ ------------
INCOME (LOSS) BEFORE BENEFIT
FOR INCOME TAXES (3,938,459) 288,524 (3,542,987) 792,142
BENEFIT FOR INCOME TAXES 1,468,123 - 642,679 -
------------ ------------ ------------ ------------
NET INCOME (LOSS) $ (2,470,336) $ 288,524 $ (2,900,308) $ 792,142
============ ============ ============ ============
PER SHARE INFORMATION:
Basic and diluted net income
(loss) per common share $ (0.38) $ 0.06 $ (0.47) $ 0.17
============ ============ ============ ============
PRO FORMA INFORMATION:
Income before benefit
(provision) for income taxes (3,938,459) 288,524 (3,542,987) 792,142
Benefit (provision) for income taxes 1,468,123 (111,082) 642,679 (304,975)
------------ ------------ ------------ ------------
Net income (loss) $ (2,470,336) $ 177,442 $ (2,900,308) $ 487,167
============ ============ ============ ============
Basic and diluted net income
(loss) per common share $ (0.38) $ 0.04 $ (0.47) $ 0.10
============ ============ ============ ============
</TABLE>
The accompanying notes to condensed financial statements are an
integral part of these condensed statements.
4
<PAGE>
<TABLE>
<CAPTION>
1-800 CONTACTS, INC.
CONDENSED STATEMENT OF STOCKHOLDERS' EQUITY
For the Three Quarters Ended October 3, 1998
(Unaudited)
Notes
Common Stock Additional Retained Receivable
------------ Paid-in Earnings From
Shares Amount Capital (Deficit) Stockholders Total
------------ ------------ ------------ ------------ ------------ ----------
<S> <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 stockholders - - - - (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 - - - (2,900,308) - (2,900,308)
------------ ------------ ------------ ------------ ------------- ------------
BALANCE, October 3, 1998 6,430,568 $ 64,306 $ 22,971,890 $ (3,196,772) $ - $19,839,424
============ ============ ============ ============= ============= ===========
</TABLE>
The accompanying notes to condensed financial
statements are an integral part of these condensed
statements.
5
<PAGE>
<TABLE>
<CAPTION>
1-800 CONTACTS, INC.
CONDENSED STATEMENTS OF CASH FLOWS
(Unaudited)
Increase (Decrease) In Cash And Cash Equivalents
Three Quarters Ended
------------------------------------
October 3, September 30,
1998 1997
------------- -------------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) $ (2,900,308) $ 792,142
Adjustments to reconcile net income (loss) to net cash
provided by (used in) operating activities:
Depreciation and amortization 313,137 97,213
Loss on retirement of property and equipment 1,798 -
Deferred income taxes (642,679) -
Changes in operating assets and liabilities:
Inventories (7,610,076) (2,737,270)
Prepaid advertising (349,136) (77,272)
Other current assets (147,146) (40,677)
Deferred advertising costs (4,296,054) (1,231,666)
Accounts payable 4,042,749 1,869,978
Accrued liabilities 1,114,894 178,386
Unearned revenue 494,912 123,615
------------- -------------
Net cash used in operating activities (9,977,909) (1,025,551)
------------- -------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Net increase in notes receivable from stockholders (27,544) (262,739)
Purchase of property and equipment (1,779,806) (344,432)
Proceeds from sale of property and equipment 22,900 -
Purchase of intangible assets (5,000) (50,000)
Deposits (14,363) (32,563)
------------- -------------
Net cash used in investing activities (1,803,813) (689,734)
------------- -------------
</TABLE>
The accompanying notes to condensed financial statements are an
integral part of these condensed statements.
6
<PAGE>
<TABLE>
<CAPTION>
1-800 CONTACTS, INC.
CONDENSED STATEMENTS OF CASH FLOWS (continued)
(Unaudited)
Increase (Decrease) In Cash And Cash Equivalents
Three Quarters Ended
------------------------------------
October 3, September 30,
1998 1997
------------ ------------
<S> <C> <C>
CASH FLOWS FROM FINANCING ACTIVITIES:
Sale of common stock, net of underwriting discounts and commissions 25,734,844 -
Stock offering costs (563,733) (187,459)
Stock repurchase (1,900,000) -
Net (repayments) borrowings on line of credit (1,055,640) 651,107
Borrowings from stockholders - 1,800,000
Principal payments on notes payable to stockholders (1,613,788) (411,212)
Principal payments on notes payable for distributions to stockholders, net (982,995) -
Principal payments on long-term debt - (55,871)
Principal payments on capital lease obligation (15,930) (12,737)
Repayment of bank overdraft - (68,543)
------------ ------------
Net cash provided by financing activities 19,602,758 1,715,285
------------ ------------
NET INCREASE IN CASH AND CASH EQUIVALENTS 7,821,036 -
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD - -
------------ ------------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 7,821,036 $ -
=========== ============
SUPPLEMENTAL CASH FLOW INFORMATION:
Cash paid for interest $ 203,903 $ 22,552
</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 three quarters ended
October 3, 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 became subject to income taxation; and in
accordance with SFAS 109, recorded deferred tax assets and liabilities and the
corresponding income tax provision.
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 October 3, 1998 Quarter Ended September 30, 1997
-------------------------------------------------- --------------------------------------------------
Income Per-Share Income Per-Share
(Loss) Shares Amount (Loss) Shares Amount
---------------- --------------- -------------- ---------------- --------------- ---------------
<S> <C> <C> <C> <C> <C> <C>
Historical:
Basic EPS $(2,470,336) 6,430,568 $ (0.38) $ 288,524 4,659,469 $ 0.06
Effect of stock options 26,551
---------------- --------------- -------------- ---------------- --------------- ---------------
Diluted EPS $(2,470,336) 6,430,568 $ (0.38) $ 288,524 4,686,020 $ 0.06
================ =============== ============== ================ =============== ===============
Pro Forma:
Basic EPS $(2,470,336) 6,430,568 $ (0.38) $ 177,442 4,659,469 $ 0.04
Effect of stock options 26,551
Assumed distribution 78,640
---------------- --------------- -------------- ---------------- --------------- ---------------
Diluted EPS $(2,470,336) 6,430,568 $ (0.38) $ 177,442 4,764,660 $ 0.04
================ =============== ============== ================ =============== ===============
Three Quarters Ended October 3, 1998 Three Quarters Ended September 30, 1997
-------------------------------------------------- --------------------------------------------------
Income Per-Share Income Per-Share
(Loss) Shares Amount (Loss) Shares Amount
---------------- --------------- -------------- ---------------- --------------- ---------------
Historical:
Basic EPS $(2,900,308) 6,164,471 $ (0.47) $ 792,142 4,659,469 $ 0.17
Effect of stock options 18,059
---------------- --------------- -------------- ---------------- --------------- ---------------
Diluted EPS $(2,900,308) 6,164,471 $ (0.47) $ 792,142 4,677,528 $ 0.17
================ =============== ============== ================ =============== ===============
Pro Forma:
Basic EPS $(2,900,308) 6,164,471 $ (0.47) $ 487,167 4,659,469 $ 0.10
Effect of stock options 18,059
Assumed distribution 78,640
---------------- --------------- -------------- ---------------- --------------- ---------------
Diluted EPS $(2,900,308) 6,164,471 $ (0.47) $ 487,167 4,756,168 $ 0.10
================ =============== ============== ================ =============== ===============
</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 $4,136,000 and $9,392,000, respectively, for the quarter and three
quarters ended October 3, 1998 and $1,004,000 and $2,114,000, respectively for
the quarter and three quarters ended September 30, 1997. The Company expenses
all other advertising costs when the advertising takes place. These advertising
costs totaled approximately $4,380,000 and $5,072,000, respectively, for the
quarter and three quarters ended October 3, 1998 and $28,000 and $45,000,
respectively for the quarter and three quarters ended September 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.
In response to motions by the Company, plaintiff and another California
optometrist, Ellis Miles (collectively, "plaintiffs") filed a First Amended
Complaint ("FAC") against the Company and its directors on or about September 3,
1998 purporting to sue on behalf of the public under California's unfair
competition statute rather than as a class action on behalf of optometrists.
Although the substantive claims for unfair competition remain the same, the FAC
seeks restitutionary relief rather than damages. Plaintiffs also stipulated to
dismiss the Company's directors as defendants rather than oppose the Company's
motion to dismiss them, leaving the Company as the only remaining defendant.
On October 2, 1998, plaintiffs re-filed their motion for preliminary
injunction in federal court. The Company likewise filed a motion to strike
plaintiffs' claims for monetary relief. Plaintiffs withdrew their motion for
preliminary injunction on October 19, 1998, after the Company filed its
opposition to the motion indicating, inter alia, that the Company had been
registered as a Nonresident Contact Lens Seller in California. The parties are
still waiting for the Court's ruling on the Company's motion to strike
plaintiffs' claims for monetary relief.
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.
NOTE 9. SUBSEQUENT EVENT
On October 13, 1998, the Company's Board of Directors authorized a
repurchase of up to 500,000 shares of its common stock. A purchase of the full
amount would equal approximately 7.8 percent of the 6,430,568 shares issued. The
repurchase of 1-800 CONTACTS, INC. common stock will be subject to market
conditions and will be accomplished through periodic purchases at prevailing
prices on the open market, by block purchases or in privately negotiated
transactions. The repurchased shares will be retained as treasury stock for use
for corporate purposes. The repurchase program will be effected in accordance
10
<PAGE>
with the safe harbor provisions of Rule 10b-18. As of November 17, 1998, the
Company has repurchased 15,000 shares at $5.375 per share plus commissions for a
total cost of $81,375. The repurchases were funded using cash on hand.
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. Net sales for the third quarter of 1998 increased 187% to a record
$18.4 million from $6.4 million in the same quarter in 1997 and from $12.8
million in the second quarter of 1998. Net sales for the three quarters ended
October 3, 1998 increased 194% to $41.6 million from the comparable three
quarters in 1997.
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 recorded 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 began 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 Three Quarters Ended
------------------------------------ -----------------------------------
October 3, September 30, October 3, September 30,
1998 1997 1998 1997
----------------- ----------------- ----------------- -----------------
<S> <C> <C> <C> <C>
Net sales 100.0% 100.0% 100.0% 100.0%
Cost of goods sold 62.4% 67.5% 62.6% 66.8%
----------------- ----------------- ----------------- -----------------
Gross profit 37.6% 32.5% 37.4% 33.2%
Selling, general and administrative expenses 59.7% 27.5% 46.9% 27.3%
----------------- ----------------- ----------------- -----------------
Income (loss) from operations (22.1%) 5.0% (9.5%) 5.9%
Other income (expense), net 0.7% (0.5%) 1.0% (0.3%)
----------------- ----------------- ----------------- -----------------
Income (loss) before benefit
(provision) for income taxes (21.4%) 4.5% (8.5%) 5.6%
Pro forma benefit (provision) for income taxes 8.0% (1.7%) 1.5% (2.2%)
----------------- ----------------- ----------------- -----------------
Pro forma net income (loss) (13.4%) 2.8% (7.0%) 3.4%
================= ================= ================= =================
</TABLE>
Net sales. Net sales for the quarter ended October 3, 1998 increased
187% from the quarter ended September 30, 1997. For the three quarters ended
October 3, 1998, net sales increased 194% from the three quarters ended
September 30, 1997. The Company believes that these increases in net sales
reflect some of the benefits of the Company's increased television and Internet
advertising. The Company expects net sales for the fourth quarter of 1998 to be
relatively constant with the third quarter net sales.
Gross profit. Gross profit as a percentage of sales increased to 37.6%
for the quarter ended October 3, 1998 from 32.5% for the quarter ended September
30, 1997. For the three quarters ended October 3, 1998, gross profit as a
percentage of sales increased to 37.4% from 33.2% for the three quarters ended
September 30, 1997. With the increase in sales, the Company has been able to
obtain inventory at lower costs because of purchase volumes and more competitive
pricing resulting from the access to more vendors.
Selling, general and administrative expenses. Selling, general and
administrative expenses for the quarter ended October 3, 1998 increased 523%
from the quarter ended September 30, 1997. As a percentage of net sales,
selling, general and administrative expenses increased to 59.7% in the third
quarter of 1998 from 27.5% in the comparable 1997 period. For the three quarters
ended October 3, 1998, selling, general and administrative expenses increased
406% from the three quarters ended September 30, 1997. As a percentage of net
sales, selling, general and administrative expenses increased to 46.9% in the
first three quarters of 1998 from 27.3% in the comparable 1997 period. During
1998, the Company has continued to increase its sales and marketing activity. In
addition, during the third quarter of 1998, the Company changed the business
advertising model from mainly print advertising, which is capitalized, to a
model with a significant amount of fully-expensed broadcast advertising
(television, radio, and Internet). Advertising as a percentage of sales was
46.2% in the third quarter of 1998 as compared to 16.1% in the third quarter of
1997. For the first three quarters of 1998, advertising as a percentage of sales
was 34.7% as compared to 15.3% for the first three quarters of 1997.
Other (expense) income, net. The quarterly and year-to-date increases
in other (expense) income 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.
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. The Company anticipates
that its future effective income tax rate will be approximately 38%.
12
<PAGE>
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 three quarters ended October 3, 1998 and September 30, 1997,
net cash used in operations was approximately $10.0 million and 1.0 million,
respectively. In both 1998 and 1997, cash was used primarily to fund the
Company's growth as the Company increased inventory levels and advertising
spending.
The Company used approximately $1,804,000 and $690,000 for investing
activities for the three quarters ended October 3, 1998 and September 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 first three quarters of 1998 and 1997
were approximately $1,780,000 and $344,000, 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. To support the inventory levels and to improve fulfillment
capabilities, the Company has executed a lease agreement for an expanded
distribution center. This new facility is several times the size of the current
distribution center and is strategically located close the Salt Lake City
airport. The Company expects to be in the new facility by early 1999. The
Company made and 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 $19.6 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 $1.7 million provided by financing activities, resulting from net
borrowings on a line of credit and from stockholders, offset by debt payments
and repayment of a bank overdraft.
On October 13, 1998, the Company's Board of Directors authorized a
repurchase of up to 500,000 shares of its common stock. A purchase of the full
amount would equal approximately 7.8 percent of the 6,430,568 shares issued. The
repurchase of 1-800 CONTACTS, INC. common stock will be subject to market
conditions and will be accomplished through periodic purchases at prevailing
prices on the open market, by block purchases or in privately negotiated
transactions. The repurchased shares will be retained as treasury stock for use
for corporate purposes. The repurchase program will be effected in accordance
with the safe harbor provisions of Rule 10b-18. As of November 17, 1998, the
Company has repurchased 15,000 shares at $5.375 per share plus commissions for a
total cost of $81,375. The repurchases were funded using cash on hand.
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 and
October 1998. As a result, the Credit Facility provides for borrowings equal to
the lesser of $5.0 million or 50% of eligible inventory. The Credit Facility
bears interest at a floating rate equal to the lender's prime interest rate plus
1.5% (9.75% at October 3, 1998). As of October 3, 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 Credit Facility is set to mature on
July 31, 1999.
The Company believes that its cash on hand after the IPO, together with
cash generated from operations and the cash available through the Credit
Facility, will be sufficient to support current operations and future growth
through fiscal 1999. The Company may be required to seek additional sources of
13
<PAGE>
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.
Based on a preliminary review of its current computer applications and
internal technology systems, the Company believes all of its applications and
internal technology systems are substantially Year 2000 compliant. To ensure the
Company is Year 2000 compliant, the Company is currently taking steps to perform
a more in-depth analysis and testing of Year 2000 compliance on its computer
applications, internal technology systems and embedded technology. The Company
does not expect Year 2000 compliance to be a major issue since the Company has
replaced or upgraded the majority of its critical technology systems within the
last two years. However, the Company believes that by completing this in-depth
analysis and testing that the Company will be able to take any necessary steps
to become Year 2000 compliant. If this analysis and any necessary corrective
actions are not completed timely, the Year 2000 issue could have a material
impact on the operations of the Company.
The Company is currently unable to determine the effects of Year 2000
compliance by third parties that are significant to its operations. The Company
is in the process of contacting significant third parties to assess the parties'
Year 2000 compliance and to determine the extent to which the Company's
operations will be impacted by those third parties' failure to fix their own
Year 2000 issues. If the systems of critical third parties are not in
compliance, the Company's operations will be adversely effected.
The Company has not yet incurred any significant costs related to Year
2000 compliance. Once the Company has completed the above steps, the Company
will be able to determine any significant future costs associated with Year 2000
compliance. Although the Company has not yet approved a formal Year 2000
contingency plan, the Company has manual processes which can be used in the
event of system disruption. The Company expects to approve a formal contingency
plan during 1999.
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
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.
In response to motions by the Company, plaintiff and another California
optometrist, Ellis Miles (collectively, "plaintiffs") filed a First Amended
Complaint ("FAC") against the Company and its directors on or about September 3,
1998 purporting to sue on behalf of the public under California's unfair
competition statute rather than as a class action on behalf of optometrists.
Although the substantive claims for unfair competition remain the same, the FAC
seeks restitutionary relief rather than damages. Plaintiffs also stipulated to
dismiss the Company's directors as defendants rather than oppose the Company's
motion to dismiss them, leaving the Company as the only remaining defendant.
On October 2, 1998, plaintiffs re-filed their motion for preliminary
injunction in federal court. The Company likewise filed a motion to strike
plaintiffs' claims for monetary relief. Plaintiffs withdrew their motion for
preliminary injunction on October 19, 1998, after the Company filed its
opposition to the motion indicating, inter alia, that the Company had been
registered as a Nonresident Contact Lens Seller in California. The parties are
still waiting for the Court's ruling on the Company's motion to strike
plaintiffs' claims for monetary relief.
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
(d) 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
15
<PAGE>
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
October 3, 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
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) $1.8 million for capital expenditures and (v) $9.3
million for general corporate purposes, including advertising, inventory and
other working capital. The $7.8 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
On November 4, 1998, Donald Yacktman resigned from the Company's Board
of Directors for personal reasons. Mr. Yacktman has been a member of the Board
since February 1996.
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 Financial Data Schedule.
(B) No reports on Form 8-K were filed by the Registrant during the
quarter ended October 3, 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: November __, 1998 By:
--------------------------------------------
Name: Jonathan C. Coon
Title: President & Chief Executive Officer
By:
--------------------------------------------
Name: Scott S. Tanner
Title: Chief Financial Officer
17
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