- --------------------------------------------------------------------------------
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 April 3, 1999
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
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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 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 May 18, 1999, the Registrant has 6,282,364 shares of Common
Stock, par value $0.01 per share outstanding.
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<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 April 3, 1999 (unaudited)
and January 2, 1999. . . . . . . . . . . . . . . . . . . . . . . . . . . . . .3
Condensed Statements of Operations for the Quarters Ended
April 3, 1999 and April 4, 1998 (unaudited). . . . . . . . . . . . . . . . . .4
Condensed Statement of Stockholders' Equity for the Quarter Ended
April 3, 1999 (unaudited) . . . . . . . . . . . . . . . . . . . . . . . . . .5
Condensed Statements of Cash Flows for the Quarters Ended
April 3, 1999 and April 4, 1998 (unaudited). . . . . . . . . . . . . . . . . .6
Notes to Condensed Financial Statements . . . . . . . . . . . . . . . . . . . . . .8
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operation. . . . . . . . . . . . . . . . . . . . . . . . . . .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 . . . . . . .. . . . . . . . . . . . . .16
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>
1-800 CONTACTS, INC.
CONDENSED BALANCE SHEETS
ASSETS
<CAPTION>
April 3, January 2,
1999 1999
------------------ ------------------
(Unaudited)
<S> <C> <C>
CURRENT ASSETS:
Cash and cash equivalents $ 8,596,048 $ 3,762,220
Inventories 10,585,667 10,752,324
Other current assets 287,388 483,139
------------------ ------------------
Total current assets 19,469,103 14,997,683
DEFERRED ADVERTISING COSTS - 175,631
PROPERTY AND EQUIPMENT, net 2,344,296 2,048,850
DEFERRED INCOME TAXES 460,466 642,679
OTHER ASSETS 164,323 151,293
------------------ ------------------
Total assets $ 22,438,188 $ 18,016,136
================== ==================
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Current portion of capital lease obligation $ 37,685 $ 36,712
Accounts payable 7,013,140 2,056,451
Accrued liabilities 1,617,283 890,443
Unearned revenue 428,971 169,540
------------------ ------------------
Total current liabilities 9,097,079 3,153,146
------------------ ------------------
CAPITAL LEASE OBLIGATION, less current portion 20,371 30,165
------------------ ------------------
STOCKHOLDERS' EQUITY:
Common stock 64,306 64,306
Additional paid-in capital 23,009,439 23,017,266
Accumulated deficit (7,891,895) (8,189,072)
Treasury stock (1,861,112) (59,675)
------------------ ------------------
Total stockholders' equity 13,320,738 14,832,825
------------------ ------------------
Total liabilities and stockholders' equity $ 22,438,188 $ 18,016,136
================== ==================
</TABLE>
The accompanying notes to condensed financial statements
are an integral part of these condensed statements.
3
<PAGE>
<TABLE>
1-800 CONTACTS, INC.
CONDENSED STATEMENTS OF OPERATIONS
(Unaudited)
<CAPTION>
Quarter Ended
--------------------------------------
April 3, April 4,
1999 1998
----------------- -----------------
<S> <C> <C>
NET SALES $ 22,304,257 $ 10,429,304
COST OF GOODS SOLD 13,909,147 6,628,913
----------------- -----------------
Gross profit 8,395,110 3,800,391
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES 8,000,105 3,137,926
----------------- -----------------
INCOME FROM OPERATIONS 395,005 662,465
----------------- -----------------
OTHER INCOME (EXPENSE):
Interest expense (1,844) (73,633)
Interest income 86,229 143,869
Other, net - 10,000
----------------- -----------------
Total other, net 84,385 80,236
----------------- -----------------
INCOME BEFORE PROVISION FOR INCOME TAXES 479,390 742,701
PROVISION FOR INCOME TAXES (182,213) (953,908)
----------------- -----------------
NET INCOME (LOSS) $ 297,177 $ (211,207)
================= =================
PER SHARE INFORMATION:
Basic and diluted net income (loss) per common share $ 0.05 $ (0.04)
================= =================
PRO FORMA INFORMATION:
Income before provision for income taxes 479,390 742,701
Provision for income taxes (182,213) (278,337)
----------------- -----------------
Net income $ 297,177 $ 464,364
================= =================
Basic and diluted net income per common share $ 0.05 $ 0.08
================= =================
</TABLE>
The accompanying notes to condensed financial statements
are an integral part of these condensed statements.
4
<PAGE>
<TABLE>
1-800 CONTACTS, INC.
CONDENSED STATEMENT OF STOCKHOLDERS' EQUITY
For the Quarter Ended April 3, 1999
(Unaudited)
<CAPTION>
Common Stock Additional Treasury Stock
---------------------- Paid-In Accumulated -------------------------
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 - - (7,827) - 10,796 58,568 50,741
Net income - - - 297,177 - - 297,177
--------- --------- ------------ ------------ ------------ ------------ -----------
BALANCE, April 3, 1999 6,430,568 $ 64,306 $ 23,009,439 $ (7,891,895) (155,204) $ (1,861,112) $ 13,320,738
========= ========= ============ ============ ============ ============ ===========
</TABLE>
The accompanying notes to condensed financial statements
are an integral part of these condensed statements.
5
<PAGE>
<TABLE>
1-800 CONTACTS, INC.
CONDENSED STATEMENTS OF CASH FLOWS
(Unaudited)
<CAPTION>
Increase (Decrease) In Cash and Cash Equivalents
Quarter Ended
---------------------------------------
April 3, April 4,
1999 1998
----------------- ------------------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) $ 297,177 $ (211,207)
Adjustments to reconcile net income (loss) to net cash
provided by (used in) operating activities:
Depreciation and amortization 156,905 63,536
Deferred income taxes 182,213 953,908
Changes in operating assets and liabilities:
Inventories 166,657 (663,251)
Other current assets 195,751 (1,261,233)
Deferred advertising costs 175,631 (1,562,536)
Accounts payable 4,956,689 465,959
Accrued liabilities 726,840 255,520
Unearned revenue 259,431 56,625
----------------- ------------------
Net cash provided by (used in) operating activities 7,117,294 (1,902,679)
----------------- ------------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Net increase in notes receivable from stockholders - (27,544)
Purchase of property and equipment (443,202) (131,030)
Purchase of intangible assets (19,600) -
Deposits (2,579) (287,396)
----------------- ------------------
Net cash used in investing activities (465,381) (445,970)
----------------- ------------------
</TABLE>
The accompanying notes to condensed financial statements
are an integral part of these condensed statements.
6
<PAGE>
<TABLE>
1-800 CONTACTS, INC.
CONDENSED STATEMENTS OF CASH FLOWS
(Unaudited)
<CAPTION>
Increase (Decrease) In Cash and Cash Equivalents
Quarter Ended
---------------------------------------
April 3, April 4,
1999 1998
----------------- ------------------
<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)
Common stock repurchases (1,860,005) (1,900,000)
Proceeds from exercise of common stock options 50,741 -
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 (8,821) (5,172)
----------------- ------------------
Net cash (used in) provided by financing activities (1,818,085) 19,613,516
----------------- ------------------
NET INCREASE IN CASH AND CASH EQUIVALENTS 4,833,828 17,264,867
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 3,762,220 -
----------------- ------------------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 8,596,048 $ 17,264,867
================= ==================
SUPPLEMENTAL CASH FLOW INFORMATION:
Cash paid for interest $ 3,320 $ 199,645
</TABLE>
SUPPLEMENTAL DISCLOSURES OF NONCASH INVESTING AND FINANCING ACTIVITIES:
During the period ended April 4, 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 period ended April 4, 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 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 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 period ended April 3, 1999 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.
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 COSTS
Prior to the fourth quarter of fiscal 1998, the Company capitalized
certain direct-mail advertising costs and amortized those costs over the period
for which the revenues were generated in accordance with Statement of Position
("SOP") 93-7. Based upon the Company's past direct-response information, the
Company capitalized direct-mail advertising costs on a cost-pool-by-cost-pool
approach and amortized those costs over a 12 month period, which was the period
during which the future benefits were expected to be received. Approximately 73
percent of capitalized costs were amortized over the first six months after the
advertisement. Accordingly, deferred advertising costs were amortized in
proportion to the expected future benefits to be received. The Company expensed
all other advertising costs when the advertising first occurred.
During 1998, the Company began utilizing a variety of new advertising
vehicles, including new print vehicles, Internet and radio spots, and an
extensive television marketing campaign. 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. The Company also determined that for previously
8
<PAGE>
deferred advertising costs the period during which the future benefits were
expected to be received was shortened and accordingly amortized the balance at
the beginning of the fourth quarter of 1998 over 5 months.
The Company recorded total advertising expense of approximately
$5,410,000 and $2,003,000 for the quarters ended April 3, 1999 and April 4,
1998, respectively.
NOTE 5. NET INCOME PER COMMON SHARE
Basic net income 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.
The pro forma Basic and Diluted EPS for the quarter ended April 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 April 3, 1999 Quarter Ended April 4, 1998
------------------------------------ ---------------------------------------
Income Per-Share Income Per-Share
(Loss) Shares Amount (Loss) Shares Amount
------------- ------------ ------------- ------------- ------------ -------------
<S> <C> <C> <C> <C> <C> <C>
Historical:
Basic EPS $ 297,177 6,381,547 $ 0.05 $ (211,207) 5,649,263 $ (0.04)
Effect of stock options 37,995
------------- ------------ ------------- ------------- ------------ -------------
Diluted EPS $ 297,177 6,419,542 $ 0.05 $ (211,207) 5,649,263 $ (0.04)
============= ============ ============= ============= ============ =============
Pro Forma:
Basic EPS $ 297,177 6,381,547 $ 0.05 $ 464,364 5,649,263 $ 0.08
Effect of stock options 37,995 59,422
------------- ------------ ------------- ------------- ------------ -------------
Diluted EPS $ 297,177 6,419,542 $ 0.05 $ 464,364 5,708,685 $ 0.08
============= ============ ============= ============= ============ =============
</TABLE>
NOTE 6. COMMON STOCK TRANSACTIONS
During the quarter ended April 3, 1999, the Company repurchased a total
of 155,000 shares of its common stock for a total cost, including commissions,
of $1,860,005.
During the quarter ended April 3, 1999, an employee exercised stock
options to purchase 10,796 shares of common stock at $4.70 per share for a total
of $50,741.
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.
NOTE 8. ASSET ACQUISITION
Subsequent to the first quarter of 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.
9
<PAGE>
NOTE 9. 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
plaintiff's 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 Court denied
the Company's motion to strike plaintiffs' claims for monetary relief on
February 26, 1999. The Company filed its Answer to the First Amended Complaint
on March 11, 1999.
On May 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 alleges that on "one or more
occasions" the Company sold contact lenses without receipt or verification of a
prescription. The relief requested is the issuance of an order enjoining the
company from further engaging in the alleged activity. The complaint does not
seek monetary damage.
The Company, in response to the complaint, has retained counsel and
intends to vigorously defend itself in this action. An answer to the complaint
is not presently due but will be filed in a timely manner.
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. Net sales for the first quarter of 1999 increased 114% to $22.3
million from $10.4 million in the first quarter 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 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.
During 1998, the Company began utilizing a variety of new advertising
vehicles, including new print vehicles, Internet and radio spots, and an
extensive television marketing campaign. 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 generally governed by state
laws and regulations. The Company sells to customers in 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
-------------------------------------
April 3, April 4,
1999 1998
----------------- -----------------
<S> <C> <C>
Net sales 100.0% 100.0%
Cost of goods sold 62.4 63.6
----------------- -----------------
Gross profit 37.6 36.4
Selling, general and administrative expenses 35.9 30.1
----------------- -----------------
Income from operations 1.7 6.3
Other income (expense), net 0.4 0.8
----------------- -----------------
Income before provision for income taxes 2.1 7.1
Provision for income taxes (pro forma for 1998) (0.8) (2.6)
----------------- -----------------
Pro forma net income 1.3% 4.5%
================= =================
</TABLE>
Net sales. Net sales for the quarter ended April 3, 1999 increased 114%
from the quarter ended April 4, 1998. The Company believes that this increase in
net sales reflects some of the benefits of the Company's increased television
and Internet advertising. Internet sales for the first quarter of 1999 were
approximately $2.5 million as compared to an insignificant amount for the first
quarter of 1998. The Company is also realizing the benefits of repeat sales from
a growing customer base. Repeat sales for the first quarter of 1999 increased
174% to $10.7 million from $3.9 million for the first quarter of 1998. Although
the Company believes that sales will increase substantially in 1999 as compared
to 1998, the Company expects the rate of growth to decrease in future quarters
of 1999.
Gross profit. Gross profit as a percentage of sales increased to 37.6%
for the quarter ended April 3, 1999 from 36.4% for the quarter ended April 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.
Selling, general and administrative expenses. Selling, general and
administrative expenses for the quarter ended April 3, 1999 increased $4.9
million, or 155%, from the quarter ended April 4, 1998. As a percentage of net
sales, selling, general and administrative expenses increased to 35.9% in the
first quarter of 1999 from 30.1% in the 1998 period. The increases in expense
and as a percentage of net sales are due to the increase in sales and marketing
activity and the related increase in general and administrative expenditures
considered necessary to support the growth. Advertising as a percentage of sales
was 24.3% in the first quarter of 1999 as compared to 19.2% for the first
quarter of 1998. The Company expects that advertising spending as well as
advertising as a percentage of sales in fiscal year 1999 will be less than in
fiscal year 1998. However, if opportunities present themselves, the Company may
increase advertising spending above currently planned levels.
During 1998, the Company began utilizing a variety of new advertising
vehicles, including new print vehicles, Internet and radio spots, and an
extensive television marketing campaign. 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. The Company also determined that for previously
deferred advertising costs the period during which the future benefits were
expected to be received was shortened and accordingly amortized the balance at
the beginning of the fourth quarter of 1998 over 5 months.
Other income (expense), net. Other income (expense) increased slightly
to approximately $84,000 in the first quarter of 1999 from approximately $80,000
in the first quarter of 1998. The decrease in interest income due to lower cash
balances 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.
12
<PAGE>
Income taxes. The pro forma provision for income taxes for the first
quarter of 1998 has been determined assuming the Company had been taxed as a C
Corporation for federal and state income tax purposes for the quarter. 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. 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 $24.9 million. The Company uses 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, the
Company generally carries a higher level of inventory than if it were able to
purchase directly from all contact lens manufacturers.
For the quarters ended April 3, 1999 and April 4, 1998, net cash
provided by (used in) operating activities was approximately $7.1 million and
$(1.9) million, respectively. In the 1999 period, cash was provided primarily by
increases in accounts payable and accrued liabilities. 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 $465,000 and $446,000 for investing
activities for the quarters ended April 3, 1999 and April 4, 1998, respectively.
The majority of these amounts relate to capital expenditures for infrastructure
improvements. The amount related to capital expenditures for the 1999 and 1998
periods were approximately $443,000 and $418,000 (including approximately
$287,000 in deposits), respectively. The Company began operations in its new
distribution center in February of 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. 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.
Subsequent to the first quarter of 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.
For the 1999 period, the Company used approximately $1.8 million for
financing activities. During the first quarter of 1999, the Company repurchased
a total of 155,000 shares of its common stock for a total cost, including
commissions, of $1,860,005. This was offset slightly by proceeds from the
exercise of common stock options. For the 1998 period, 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. The repurchase
program will be effected in accordance with the safe harbor provisions of Rule
10b-18. Through April 3, 1999, the Company has repurchased 170,000 shares for a
total cost, including commissions, of $1,941,380. 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
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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 (9.25 percent at April 3, 1999). As of April 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 type of financing. The Credit Facility is
set to mature on July 31, 1999.
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.
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. The Company expects to approve a formal contingency
plan during 1999.
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.
14
<PAGE>
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 April 3, 1999, the Company did not hold any
market risk-sensitive instruments and had no outstanding debt other than a
capital lease obligation of $58,056. In addition, all of the Company's
transactions are in U.S. dollars.
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
plaintiff's 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 Court denied
the Company's motion to strike plaintiffs' claims for monetary relief on
February 26, 1999. The Company filed its Answer to the First Amended Complaint
on March 11, 1999.
On May 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 alleges that on "one or more
occasions" the Company sold contact lenses without receipt or verification of a
prescription. The relief requested is the issuance of an order enjoining the
company from further engaging in the alleged activity. The complaint does not
seek monetary damage.
The Company, in response to the complaint, has retained counsel and
intends to vigorously defend itself in this action. An answer to the complaint
is not presently due but will be filed in a timely manner.
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.
15
<PAGE>
Item 2. Changes in Securities and Use of Proceeds
None.
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.
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 April 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: May 18, 1999 By: /s/Jonathan C. Coon
------------------------------------------
Name: Jonathan C. Coon
Title: President & Chief Executive Officer
By: /s/Scott S. Tanner
------------------------------------------
Name: Scott S. Tanner
Title: Chief Financial Officer
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