<PAGE>
================================================================================
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 July 3, 1999
[ ] 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 charter)
Delaware 87-0571643
- ----------------------------------------- --------------------------------------
(State or other jurisdiction of (I.R.S. 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)
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 13, 1999, the Registrant has 6,282,458 shares of Common Stock,
par value $0.01 per share outstanding.
================================================================================
<PAGE>
1-800-CONTRACTS, INC.
INDEX
<TABLE>
<CAPTION>
Page No.
--------
<S> <C>
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Condensed Balance Sheets as of January 2, 1999
and July 3, 1999 (unaudited) ................................................... 3
Condensed Statements of Operations for the Quarter and Two Quarters Ended
July 4, 1998 (unaudited) and July 3, 1999 (unaudited) ......................... 4
Condensed Statement of Stockholders' Equity for the Two Quarters Ended
July 3, 1999 (unaudited) ...................................................... 5
Condensed Statements of Cash Flows for the Two Quarters Ended
July 4, 1998 (unaudited) and July 3, 1999 (unaudited) .......................... 6
Notes to Condensed Financial Statements ............................................ 8
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations ...................................................... 11
Item 3. Quantitative and Qualitative Disclosure About Market Risk ........................... 15
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
1-800 CONTACTS, INC.
CONDENSED BALANCE SHEETS
<TABLE>
<CAPTION>
ASSETS
January 2, July 3,
1999 1999
------------- -------------
(Unaudited)
<S> <C> <C>
CURRENT ASSETS:
Cash and cash equivalents $ 3,762,220 $ 6,324,180
Inventories 10,752,324 14,759,008
Other current assets 483,139 516,894
------------- -------------
Total current assets 14,997,683 21,600,082
DEFERRED ADVERTISING COSTS 175,631 -
PROPERTY AND EQUIPMENT, net 2,048,850 2,330,792
DEFERRED INCOME TAXES 642,679 -
INTANGIBLE ASSETS, net 72,819 1,250,117
OTHER ASSETS 78,474 118,759
------------- -------------
Total assets $ 18,016,136 $ 25,299,750
============= =============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Current portion of capital lease obligation $ 36,712 $ 38,682
Acquisition payable - 600,000
Accounts payable 2,056,451 7,007,627
Accrued liabilities 890,443 2,364,026
Unearned revenue 169,540 465,710
------------- -------------
Total current liabilities 3,153,146 10,476,045
------------- -------------
CAPITAL LEASE OBLIGATION, less current portion 30,165 10,319
------------- -------------
STOCKHOLDERS' EQUITY:
Common stock 64,306 64,306
Additional paid-in capital 23,017,266 23,017,266
Accumulated deficit (8,189,072) (6,491,087)
Treasury stock (59,675) (1,777,099)
------------- -------------
Total stockholders' equity 14,832,825 14,813,386
------------- -------------
Total liabilities and stockholders' equity $ 18,016,136 $ 25,299,750
============= =============
</TABLE>
The accompanying notes to condensed financial statements
are an integral part of these condensed statements.
3
<PAGE>
1-800 CONTACTS, INC.
CONDENSED STATEMENTS OF OPERATIONS
(Unaudited)
<TABLE>
<CAPTION>
Quarter Ended Two Quarters Ended
-------------------------------- -------------------------------
July 4, July 3, July 4, July 3,
1998 1999 1998 1999
------------ ------------ ------------ -----------
<S> <C> <C> <C> <C>
NET SALES $ 12,800,438 $ 23,960,056 $ 23,229,742 $ 46,264,313
COST OF GOODS SOLD 7,959,185 14,654,683 14,588,098 28,563,830
------------ ------------ ------------ -------------
Gross profit 4,841,253 9,305,373 8,641,644 17,700,483
------------ ------------ ------------ -------------
SELLING, GENERAL AND
ADMINISTRATIVE EXPENSES:
Advertising expense 3,944,191 4,389,054 5,947,851 9,799,330
Other selling, general and
administrative expenses 1,444,541 3,026,162 2,578,807 5,615,991
------------ ------------ ------------ -------------
Total selling, general and
administrative expenses 5,388,732 7,415,216 8,526,658 15,415,321
------------ ------------ ------------ -------------
INCOME (LOSS) FROM OPERATIONS (547,479) 1,890,157 114,986 2,285,162
------------ ------------ ------------ -------------
OTHER INCOME (EXPENSE):
Interest expense (2,207) (1,400) (75,840) (3,244)
Interest income 204,255 87,894 348,124 174,123
Other, net (1,798) - 8,202 -
------------ ------------ ------------ -------------
Total other, net 200,250 86,494 280,486 170,879
------------ ------------ ------------ -------------
INCOME (LOSS) BEFORE BENEFIT
(PROVISION) FOR INCOME TAXES (347,229) 1,976,651 395,472 2,456,041
BENEFIT (PROVISION)
FOR INCOME TAXES 128,464 (510,466) (825,444) (692,679)
------------ ------------ ------------ -------------
NET INCOME (LOSS) $ (218,765) $ 1,466,185 $ (429,972) $ 1,763,362
============ ============ ============ =============
PER SHARE INFORMATION:
Basic and diluted net income
(loss) per common share $ (0.03) $ 0.23 $ (0.07) $ 0.28
============ ============ ============ =============
PRO FORMA INFORMATION:
Income (loss) before benefit
(provision) for income taxes (347,229) 1,976,651 395,472 2,456,041
Benefit (provision) for income taxes 128,464 (510,466) (149,873) (692,679)
------------ ------------ ------------ -------------
Net income (loss) $ (218,765) $ 1,466,185 $ 245,599 $ 1,763,362
============ ============ ============ =============
Basic and diluted net income
(loss) per common share $ (0.03) $ 0.23 $ 0.04 $ 0.28
============ ============ ============ =============
</TABLE>
The accompanying notes to condensed financial statements
are an integral part of these condensed statements.
4
<PAGE>
1-800 CONTACTS, INC.
CONDENSED STATEMENT OF STOCKHOLDERS' EQUITY
For the Two Quarters Ended July 3, 1999
(Unaudited)
<TABLE>
<CAPTION>
Additional
Common Stock Paid-in Accumulated Treasury Stock
-------------------- ----------------------
Shares Amount Capital Deficit Shares Amount Total
-------- -------- ----------- ------------- ----------- --------- -----------
<S> <C> <C> <C> <C> <C> <C> <C>
BALANCE, January 2, 1999 6,430,568 $ 64,306 $ 23,017,266 $ (8,189,072) (11,000) (59,675) $ 14,832,825
Purchase of treasury shares - - - - (155,000) (1,860,005) (1,860,005)
Exercise of common stock options - - - (65,377) 17,873 142,581 77,204
Net income - - 1,763,362 - - 1,763,362
---------- -------- ------------ ------------- ----------- ----------- -------------
BALANCE, July 3, 1999 6,430,568 $ 64,306 $ 23,017,266 $ (6,491,087) (148,127) $(1,777,099) $ 14,813,386
========== ======== ============ ============= =========== =========== =============
</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)
Increase (Decrease) In Cash and Cash Equivalents
<TABLE>
<CAPTION>
Two Quarters Ended
-------------------------------
July 4, July 3,
1998 1999
------------ ------------
1998 1999
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) $ (429,972) $ 1,763,362
Adjustments to reconcile net income (loss) to net cash
provided by (used in) operating activities:
Depreciation and amortization 198,821 434,546
Loss on retirement of property and equipment 1,798 -
Deferred income taxes 825,444 642,679
Changes in operating assets and liabilities:
Inventories (5,009,791) (4,006,684)
Other current assets (714,790) (33,755)
Deferred advertising costs (4,217,349) 175,631
Accounts payable 2,112,938 4,951,176
Accrued liabilities 635,581 1,473,583
Unearned revenue 164,600 296,170
------------ --------------
Net cash (used in) provided by operating activities (6,432,720) 5,696,708
------------ --------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Net increase in notes receivable from stockholders (27,544) -
Purchase of property and equipment (1,150,327) (655,398)
Purchase of intangible assets (5,000) (638,388)
Deposits (21,802) 5,236
------------ --------------
Net cash used in investing activities (1,204,673) (1,288,550)
============ ==============
</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
(Unaudited)
Increase (Decrease) In Cash and Cash Equivalents
<TABLE>
<CAPTION>
Two Quarters Ended
---------------------------------
July 4, July 3,
1998 1999
------------ ------------
<S> <C> <C>
CASH FLOWS FROM FINANCING ACTIVITIES:
Sale of common stock, net of underwriting discounts and commissions $ 25,734,844 $ -
Common stock offering costs (563,733) (45,521)
Common stock repurchases (1,900,000) (1,860,005)
Proceeds from exercise of common stock options - 77,204
Net repayments on line of credit (1,055,640) -
Principal payments on notes payable to stockholders (1,613,788) -
Principal payments on notes payable for distributions to stockholders, net (982,995) -
Principal payments on capital lease obligation (10,481) (17,876)
------------ ------------
Net cash provided by (used in) financing activities 19,608,207 (1,846,198)
------------ ------------
NET INCREASE IN CASH AND CASH EQUIVALENTS 11,970,814 2,561,960
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD - 3,762,220
------------ ------------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 11,970,814 $ 6,324,180
============ ============
SUPPLEMENTAL CASH FLOW INFORMATION:
Cash paid for interest $ 201,852 $ 4,720
</TABLE>
SUPPLEMENTAL DISCLOSURES OF NONCASH INVESTING AND FINANCING ACTIVITIES:
During the period ended July 4, 1998 the Company distributed $1,582,684 to its S
Corporation stockholders. This distribution (net of notes receivables 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 period ended July 4, 1998.
During the period ended July 3, 1999, the Company acquired certain intangible
assets. As of July 3, 1999, the Company had an aquisition payable of $600,000
(see Note 8).
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 STATEMENTS
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 audited financial
statements and the notes thereto included in the Company's Annual Report to
Shareholders on Form 10-K.
The results of operations for the interim periods presented 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. 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.
NOTE 4. ADVERTISING COMMITMENTS
During the two quarters ended July 3, 1999, the Company entered into
certain commitments to purchase approximately $15 million of broadcast
advertising from October 1999 through September 2000. The Company can cancel up
to 50 percent of the total amount committed.
NOTE 5. NET INCOME (LOSS) PER COMMON SHARE
Basic net income (loss) per common share ("Basic EPS") excludes dilution
and is computed by dividing net income (loss) by the weighted-average number of
common shares outstanding during the period. Diluted net income (loss) 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 computation of Diluted EPS does not assume exercise or
conversion of securities that would have an antidilutive effect on net income
(loss) per common share.
8
<PAGE>
The pro forma Basic and Diluted EPS for the two quarters ended July 4, 1998
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.
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 July 3, 1999
----------------------------------------- ---------------------------------------
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) $ 1,466,185 6,280,674 $ 0.23
Effect of stock options 80,216
----------- ------------ ---------- ------------ ---------- ---------
Diluted EPS $ (218,765) 6,430,568 $ (0.03) $ 1,466,185 6,360,890 $ 0.23
=========== ============ ========== ============ ========== =========
Pro Forma:
Basic EPS $ (218,765) 6,430,568 $ (0.03) $ 1,466,185 6,280,674 $ 0.23
Effect of stock options 80,216
----------- ------------ ---------- ------------ ---------- ---------
Diluted EPS $ (218,765) 6,430,568 $ (0.03) $ 1,466,185 6,360,890 $ 0.23
=========== ============ ========== ============ ========== =========
</TABLE>
<TABLE>
<CAPTION>
Two Quarters Ended July 4, 1998 Two Quarters Ended July 3, 1999
----------------------------------------- -----------------------------------------
Income Per-Share Income Per-Share
(Loss) Shares Amount (Loss) Shares Amount
------------- ------------ -------------- ------------- ------------ --------------
<S> <C> <C> <C> <C> <C> <C>
Historical:
Basic EPS $ (429,972) 6,033,580 $ (0.07) $ 1,763,362 6,331,111 $ 0.28
Effect of stock options 59,106
----------- ------------ ---------- ------------ ---------- ---------
Diluted EPS $ (429,972) 6,033,580 $ (0.07) $ 1,763,362 6,390,217 $ 0.28
=========== ============ ========== ============ ========== =========
Pro Forma:
Basic EPS $ 245,599 6,033,580 $ 0.04 $ 1,763,362 6,331,111 $ 0.28
Effect of stock options 61,437 59,106
----------- ------------ ---------- ------------ ---------- ---------
Diluted EPS $ 245,599 6,095,017 $ 0.04 $ 1,763,362 6,390,217 $ 0.28
=========== ============ ========== ============ ========== =========
</TABLE>
NOTE 6. COMMON STOCK TRANSACTIONS
During the two quarters ended July 3, 1999, the Company repurchased a total
of 155,000 shares of its common stock for a total cost of $1,860,005.
During the two quarters ended July 3, 1999, employees exercised stock
options to purchase 17,873 shares of common stock for a total of $77,204.
NOTE 7. STOCK OPTION GRANTS
In February 1999, the Company granted nonqualified stock options to
purchase 54,700 shares of common stock at $12.5625 per share to employees and
Directors of the Company. The options vest over a three year period and expire
in ten years.
9
<PAGE>
NOTE 8. ASSET ACQUISITION
In May 1999, the Company acquired the assets of Contact Lenses Online, Inc.
("CLO") for $1.2 million in cash to be paid as follows: $600,000 on the closing
date, $300,000 six months after the closing date and $300,000 one year after the
closing date. The assets acquired include the web address www.contactlenses.com,
various telephone numbers and CLO's customer database which are included in
intangible assets and amortized over an estimated life of 5 years.
NOTE 9. LEGAL MATTERS
On April 7, 1999 the Kansas Board of Examiners in Optometry commenced a
civil action against the Company. The action was filed in the District Court of
Shawnee County, Kansas, Division 6. The complaint was amended on May 28, 1999.
The amended complaint alleges that on "one or more occasions" the Company sold
contact lenses in the state of Kansas without receipt or verification of a
prescription. The amended complaint seeks the issuance of an order enjoining the
Company from further engaging in the alleged activity. The amended complaint
does not seek monetary damages. In response to the amended complaint, the
Company has retained counsel and intends to vigorously defend itself in this
action. The Company has filed an answer to the amended complaint.
For legal proceedings previously reported in fiscal 1999, see the Company's
Quarterly Report on Form 10-Q for the quarterly period ended April 3, 1999.
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 leading 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's net sales have grown rapidly, from $3.6
million in 1996 to $59.9 million in 1998 and from $23.2 million in the first two
quarters of 1998 to $46.3 million in the first two quarters of 1999.
Prior to consummation of its initial public offering ("IPO") in
February 1998, the Company operated as an S corporation and, therefore, was not
subject to federal or certain state income taxes. In connection with the
consummation of the IPO, the Company revoked its S Corporation status and became
subject to federal and state income taxes. 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.
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.
During fiscal 1998, the Company began utilizing a variety of new
advertising vehicles, including an extensive television marketing campaign, new
print vehicles, Internet and radio spots. As direct-response information became
available during the fourth quarter of 1998, the Company determined that its
ability to track individual sales to specific advertising campaigns was
restricted as a result of the variety of new advertising vehicles utilized.
Therefore, beginning in the fourth quarter of 1998, the Company began expensing
all advertising costs, including all direct-mail advertising costs, when the
advertising first takes place. As a result, quarter-to-quarter comparisons are
impacted by the timing of television, radio and Internet advertisements and by
the mailing of the Company's printed advertisements within and between quarters.
The volume of mailings and other advertising may vary in different quarters and
from year to year depending on the Company's assessment of prevailing market
opportunities.
The sale and delivery of contact lenses are governed by both federal
and state laws and regulations. The Company sells to customers in all 50 states,
and each sale is 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 1998 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 for the periods indicated:
<TABLE>
<CAPTION>
Quarter Ended Two Quarters Ended
---------------------------- ----------------------------
July 4, July 3, July 4, July 3,
1998 1999 1998 1999
------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
Net sales 100.0% 100.0% 100.0% 100.0%
Cost of goods sold 62.2 61.2 62.8 61.7
------------- ------------- ------------- -------------
Gross profit 37.8 38.8 37.2 38.3
------------- ------------- ------------- -------------
Advertising expense 30.8 18.3 25.6 21.2
Other selling, general and administrative expenses 11.3 12.6 11.1 12.1
------------- ------------- ------------- -------------
Total selling, general and administrative expenses 42.1 30.9 36.7 33.3
------------- ------------- ------------- -------------
Income (loss) from operations (4.3) 7.9 0.5 5.0
Other income (expense), net 1.6 0.3 1.2 0.3
------------- ------------- ------------- -------------
Income (loss) before benefit (provision) for
income taxes (2.7) 8.2 1.7 5.3
Benefit (provision) for income taxes [pro forma
for 1998] 1.0 (2.1) (0.6) (1.5)
------------- ------------- ------------- -------------
Net income (loss) [pro forma for 1998] (1.7%) 6.1% 1.1% 3.8%
============= ============= ============= =============
</TABLE>
Net sales. Net sales for the quarter ended July 3, 1999 increased 87%
to $24.0 million from $12.8 million for the quarter ended July 4, 1998. For the
two quarters ended July 3, 1999, net sales increased 100% to $46.3 million from
$23.2 million for the two quarters ended July 4, 1998. The Company believes the
increases in net sales reflect some of the benefits of the Company's increased
television and Internet advertising. Internet sales for the second quarter of
1999 were approximately $4.0 million as compared to $0.1 million for the second
quarter of 1998. For the first two quarters of 1999, Internet sales were
approximately $6.5 million as compared to approximately $0.1 million for the
first two quarters of 1998. The Company is also realizing the benefits of repeat
sales from a growing customer base. Repeat sales for the second quarter of 1999
increased 170% to $12.7 million from $4.7 million for the second quarter of
1998. Repeat sales for the first two quarters of 1999 increased 172% to $23.4
million from $8.6 million for the first two quarters of 1998. Although the
Company believes that sales will increase substantially in 1999 as compared to
1998, the Company expects the rate of growth in net sales to decrease in future
quarters of 1999.
Gross profit. Gross profit as a percentage of net sales increased to
38.8% for the quarter ended July 3, 1999 from 37.8% for the quarter ended July
4, 1998. For the two quarters ended July 3, 1999, gross profit as a percentage
of net sales increased to 38.3% from 37.2% for the two quarters ended July 4,
1998. With the increase in sales, the Company was able to obtain inventory at
lower costs because of purchase volumes and more competitive pricing resulting
from access to more vendors.
Advertising Expense. Advertising expense for the quarter ended July 3,
1999 increased $0.4 million, or 11%, from the quarter ended July 4, 1998. As a
percentage of net sales, advertising expense decreased to 18.3% for the second
quarter of 1999 from 30.8% for the second quarter of 1998. For the two quarters
ended July 3, 1999, advertising expense increased $3.9 million, or 65%, from the
two quarters ended July 4, 1998. Advertising expense as a percentage of net
sales decreased to 21.2% for the first two quarters of 1999 as compared to 25.6%
for the first two quarters of 1998. The Company expects that advertising
spending as well as advertising as a percentage of net sales in fiscal year 1999
will be slightly less than in fiscal year 1998. However, if opportunities
present themselves, the Company may increase advertising spending above
currently planned levels.
During fiscal 1998, the Company began utilizing a variety of new
advertising vehicles, including an extensive television marketing campaign, new
print vehicles, Internet and radio spots. As direct-response information became
12
<PAGE>
available during the fourth quarter of 1998, the Company determined that its
ability to track individual sales to specific advertising campaigns was
restricted as a result of the variety of new advertising vehicles utilized.
Therefore, beginning in the fourth quarter of 1998, the Company began expensing
all advertising costs, including all direct-mail advertising costs, when the
advertising first takes place. The Company also determined that for previously
deferred advertising costs the period during which the future benefits were
expected to be received was shortened. Accordingly, the Company amortized the
balance at the beginning of the fourth quarter of 1998 over five months.
Other selling, general and administrative expenses. Other selling,
general and administrative expenses for the quarter ended July 3, 1999 increased
$1.6 million, or 109%, from the quarter ended July 4, 1998. As a percentage of
net sales, other selling, general and administrative expenses increased to 12.6%
for the second quarter of 1999 from 11.3% for the second quarter of 1998. For
the two quarters ended July 3, 1999, other selling, general and administrative
expenses increased $3.0 million, or 118%, from the two quarters ended July 4,
1998. Other selling, general and administrative expenses as a percentage of net
sales increased to 12.1% for the first two quarters of 1999 as compared to 11.1%
for the first two quarters of 1998. The increases in expense and as a percentage
of net sales are due to the increase in general and administrative expenditures
considered necessary to support the growth in net sales.
Other income (expense), net. Other income (expense) decreased to
approximately $86,000 for the quarter ended July 3, 1999 from approximately
$200,000 for the quarter ended July 4, 1998. For the two quarters ended July 3,
1999, other income (expense) decreased to approximately $171,000 from
approximately $280,000 for the two quarters ended July 4, 1998. These decreases
are the result of decreases in interest income due to lower cash balances. For
the two quarters ended July 3, 1999, the decrease in interest income was offset
by the decrease in interest expense as the majority of debt was paid off during
the first quarter of 1998 with proceeds from the IPO.
Income taxes. The pro forma provision for income taxes for the two
quarters ended July 4, 1998 has been determined assuming the Company had been
taxed as a C Corporation for federal and state income tax purposes for the
entire period. The Company's effective tax rate for the quarter and two quarters
ended July 3, 1999 was approximately 25.8% and 28.2%, respectively, which
reflects changes in the valuation allowance as a result of utilizing some tax
operating loss carryforwards. As of July 3, 1999, the Company has provided a
valuation allowance on all deferred tax assets. The Company's future effective
tax rate will depend upon future taxable income and changes in the valuation
allowance associated with the deferred tax assets.
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 issued 2,213,750 shares of common stock in connection with its IPO,
which included 288,750 shares pursuant to the underwriters' over-allotment
option. The proceeds received from the IPO, net of underwriting commissions and
offering costs, totaled approximately $24.9 million. The Company used these
funds to enhance growth through increased advertising expenditures and to
increase inventory levels in anticipation of future sales. In order to help
ensure sufficient supply of inventory, the Company generally carries a higher
level of inventory than if it were able to purchase directly from all contact
lens manufacturers.
For the two quarters ended July 3, 1999 and July 4, 1998, net cash
provided by (used in) operating activities was approximately $5.7 million and
$(6.4) million, respectively. In the 1999 period, cash was provided primarily by
net income and increases in accounts payable and accrued liabilities offset by
an increase in inventories. In the 1998 period, cash was used primarily to fund
the Company's growth as the Company significantly increased inventory levels and
advertising spending.
The Company used approximately $1.3 million and $1.2 million for
investing activities in the two quarters ended July 3, 1999 and July 4, 1998,
respectively. The majority of these amounts relate to capital expenditures for
infrastructure improvements. Capital expenditures for the 1999 period were
approximately $0.7 million. The Company began operations in its new distribution
center in February 1999. This new facility is several times the size of the
prior distribution center and is strategically located near the Salt Lake City,
Utah airport. In addition, on May 4, 1999, the Company acquired the assets of
Contact Lenses Online, Inc. ("CLO") for $1.2 million in cash, of which $0.6
million was
13
<PAGE>
paid on the closing date. The assets acquired include the web address,
www.contactlenses.com, various telephone numbers and CLO's customer database.
Capital expenditures for the 1998 period were approximately $1.2 million. 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.
As of July 3, 1999, the Company had entered in commitments to purchase
approximately $15 million of broadcast advertising from October 1999 through
September 2000. The Company can cancel up to 50% of the total amount committed.
During the first two quarters of 1999, the Company used approximately
$1.8 million for financing activities. The Company repurchased a total of
155,000 shares of its common stock for a total cost of $1,860,005. This was
offset slightly by proceeds from the exercise of common stock options. During
the first two quarters of 1998, approximately $19.6 million was provided by
financing activities, resulting from net proceeds received from the Company's
IPO, offset by repayments of debt, distributions to stockholders and the
repurchase of stock.
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 common stock is subject to market conditions and is 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 to be used for corporate purposes. Through July 3,
1999, the Company has repurchased 170,000 shares for a total cost of $1,941,380.
The repurchases were funded using cash on hand. On August 13, 1999, the Company
reinstated the share repurchase program, which had been suspended as of July 26,
1999.
In August 1997, the Company established a revolving credit facility to
provide for working capital requirements and other corporate purposes. 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 percent of eligible inventory. The credit facility bears interest
at a floating rate equal to the lender's prime interest rate plus 1.5 percent
(9.5 percent as of July 3, 1999). As of July 3, 1999, 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 financing. The credit facility was to expire at the end of
July 1999 but has been extended until September 15, 1999. The Company is in the
process of replacing the facility.
On June 9, 1999, the Company filed a registration statement with the
Securities and Exchange Commission to offer 2.04 million shares of common stock
to the public through an underwritten offering. On August 13, 1999, the Company
cancelled this proposed offering due to market conditions. The Company had
intended to use the proceeds from the proposed offering to help fund a 100%
increase in advertising spending in fiscal 2000. As a result of the
cancellation, the Company plans to increase advertising spending by
approximately 25% in fiscal 2000 from its anticipated spending of approximately
$20 million in fiscal 1999. In addition, the Company expects to record a
one-time expense of approximately $500,000 in the third quarter of fiscal 1999
for costs related to the cancelled offering.
The Company believes that its cash on hand, 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 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 the loss 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.
14
<PAGE>
Year 2000 Issue
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
has received several responses to correspondence sent to significant third
parties. The Company is currently reviewing these responses to assess the third
parties' Year 2000 compliance and to determine the extent to which the Company's
operations will be impacted by those third parties' failure, if any, to
adequately address their own Year 2000 issues. If the systems of critical third
parties are not in compliance, the Company's operations will be adversely
affected.
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.
Forward-Looking Statements
This report contains forward-looking statements about the Company's
future business prospects. These statements are subject to risks and
uncertainties that could cause actual results to differ materially from those
set forth in or implied by such forward looking statements. Factors that may
cause future results to differ materially from the Company's current
expectations include, among others: general economic conditions, the health of
the contact lens industry, inventory acquisition and management, advertising
spending and effectiveness, year 2000 issues and regulatory considerations.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Based on its current operations, the Company believes it is not subject
to significant market risk. As of July 3, 1999, the Company did not hold any
market risk sensitive instruments and had no outstanding debt other than a
capital lease obligation of $49,001. In addition, all of the Company's
transactions are in U.S. dollars.
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
See notes to condensed financial statements.
Item 2. Changes in Securities and Use of Proceeds
None.
15
<PAGE>
Item 3. Defaults upon Senior Securities
None.
Item 4. Submission of Matters to a Vote of Security Holders
The annual meeting of the stockholders of the Company was held on May
21, 1999. The stockholders approved the following matters:
. The election as directors of Scott S. Tanner and John F. Nichols to
serve until the annual meeting of stockholders in 2002 and until
their respective successors are duly elected and qualified.
Votes cast for the above matter: 5,893,219 withheld: 705
The other directors of the Company include the following persons:
(i) E. Dean Butler and Stephen A. Yacktman, who are to serve until
the annual meeting of stockholders in 2000 and (ii) Jonathan C.
Coon, who is to serve until the annual meeting of stockholders in
2001.
. The appointment of Arthur Andersen LLP to serve as the Company's
independent public accountants for the Company's 1999 fiscal year.
<TABLE>
<S> <C> <C>
Votes cast for the above matter: 5,893,589 against: 10 abstaining: 325
</TABLE>
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.
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 July 3, 1999.
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 16, 1999 By: /s/ Jonathan C. Con
---------------------------------------
Name: Jonathan C. Coon
Title: President & Chief Executive Officer
By: /s/ Scott S. Tanner
---------------------------------------
Name: Scott S. Tanner
Title: Chief Financial Officer
17
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<PAGE>
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<FISCAL-YEAR-END> JAN-01-2000
<PERIOD-START> JAN-03-1999
<PERIOD-END> JUL-03-1999
<CASH> 6,324,180
<SECURITIES> 0
<RECEIVABLES> 0
<ALLOWANCES> 0
<INVENTORY> 14,759,008
<CURRENT-ASSETS> 21,600,082
<PP&E> 3,191,841
<DEPRECIATION> 861,049
<TOTAL-ASSETS> 25,299,750
<CURRENT-LIABILITIES> 10,476,045
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<COMMON> 64,306
<OTHER-SE> 14,749,080
<TOTAL-LIABILITY-AND-EQUITY> 25,299,750
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