<PAGE>
As filed with the Securities and Exchange Commission on June 9, 1999
Registration No. 333-
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
---------------
FORM S-1
REGISTRATION STATEMENT
Under
The Securities Act of 1933
---------------
1-800 CONTACTS, INC.
(Exact name of Registrant as specified in its charter)
Delaware 5960 87-0571643
(State or other (Primary Standard (I.R.S. Employer
jurisdiction of Industrial Identification No.)
Incorporation or Classification Code
organization) Number)
66 E. Wadsworth Park Drive
Draper, Utah 84020
Telephone: (801) 924-9800
(Address, including zip code, and telephone number, including area code, of
Registrant's executive offices)
Jonathan C. Coon, President and Chief Executive Officer
1-800 CONTACTS, INC.
66 E. Wadsworth Park Drive
Draper, Utah 84020
Telephone: (801) 924-9800
(Name, address, including zip code, and telephone number, including area code,
of agent for service)
Copies to:
Dennis M. Myers, Esq. David A. Zagore, Esq.
Kirkland & Ellis Squire, Sanders & Dempsey L.L.P.
200 East Randolph Drive 4900 Key Tower, 127 Public Square
Chicago, Illinois 60601 Cleveland, Ohio 44114
(312) 861-2000 (216) 479-8500
---------------
Approximate date of commencement of proposed sale to the public: As soon as
practicable after this Registration Statement becomes effective.
If any of the securities being registered on this form are to be offered on
a delayed or continuous basis pursuant to Rule 415 under the Securities Act of
1933, other than securities offered only in connection with dividend or
interest reinvestment plans, check the following box. [_]
If this Form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, please check the following
box and list the Securities Act registration statement number of the earlier
effective registration statement for the same offering. [_]
If this Form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [_]
If this Form is a post-effective amendment filed pursuant to Rule 462(d)
under the Securities Act, check the following box and list the Securities Act
registration number of the earlier effective registration statement for the
same offering. [_]
If delivery of the prospectus is expected to be made pursuant to Rule 434,
please check the following box. [_]
CALCULATION OF REGISTRATION FEE
<TABLE>
- -----------------------------------------------------------------------------------
- -----------------------------------------------------------------------------------
<CAPTION>
Proposed
Proposed Maximum
Title of Each Class of Maximum Aggregate Amount of
Securities Amount to be Offering Price Offering Registration
to be Registered Registered(1) Unit(2) Price(1)(2) Fee
- -----------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Common Stock, par value
$.01 per share........ 2,346,000 $22.53 $52,855,380 $14,694
- -----------------------------------------------------------------------------------
- -----------------------------------------------------------------------------------
</TABLE>
(1) Includes shares of common stock that the underwriters have the option to
purchase to cover over-allotments, if any.
(2) Based on the average of the high and low sales prices on the Nasdaq Stock
Market of the common stock on June 3, 1999, pursuant to Rule 457(c) under
the Securities Act of 1933, as amended.
---------------
The Registrant hereby amends this Registration Statement on such date or
dates as may be necessary to delay its effective date until the Registrant
shall file a further amendment which specifically states that this Registration
Statement shall thereafter become effective in accordance with Section 8(a) of
the Securities Act of 1933 or until this Registration Statement shall become
effective on such date as the Commission, acting pursuant to said Section 8(a),
may determine.
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- --------------------------------------------------------------------------------
<PAGE>
SUBJECT TO COMPLETION
PRELIMINARY PROSPECTUS, DATED JUNE 9, 1999
++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++
+Information contained herein is subject to completion or amendment. A +
+registration statement relating to these securities has been filed with the +
+Securities and Exchange Commission. These securities may not be sold nor may +
+offers to buy be accepted prior to the time the registration statement +
+becomes effective. This prospectus shall not constitute an offer to sell or +
+the solicitation of an offer to buy nor shall there be any sale of these +
+securities in any State in which such offer, solicitation or sale would be +
+unlawful prior to registration or qualification under the securities laws of +
+any such State. +
++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++
Prospectus
2,040,000
[1-800 CONTACTS Logo]
Common Stock
-----------
1-800 CONTACTS, INC. . We have prepared this
66 E. Wadsworth Park prospectus for use by
Drive us with respect to
Draper, Utah 84020 1,000,000 shares of
(801) 924-9800 our common stock and
by the selling
stockholders named in
this prospectus with
respect to 1,040,000
shares of our common
stock. We will not
receive any of the
proceeds from the sale
of the shares by the
selling stockholders.
<TABLE>
<CAPTION>
Per Share Total
--------- -------
<S> <C> <C>
Public Price........... $ $
Underwriting Discounts
and Commissions........
Proceeds to 1-800
CONTACTS...............
Proceeds to Selling
Stockholders...........
</TABLE>
. This offering is for
2,040,000 shares;
however, the
underwriters have an
option to purchase up
to 306,000 additional
shares from us and the
selling stockholders
to cover over-
allotments.
. We believe we are the
world's largest direct
marketer of replacement
contact lenses. We sell
our products through our
easy-to-remember, toll-
free telephone number,
"1-800 CONTACTS," and
increasingly through our
Internet addresses,
which include
"www.1800contacts.com,"
"www.contacts.com" and
"www.contactlenses.com."
. Our common stock
trades on the Nasdaq
Stock Market under the
trading symbol "CTAC."
On June 8, 1999, the
last reported sale
price of our common
stock on the Nasdaq
Stock Market was $21
1/2.
-----------
Before making an investment in 1-800 CONTACTS, you should consider carefully
the "Risk Factors" beginning on page 5.
Neither the Securities and Exchange Commission nor any state securities
commission has approved or disapproved of these securities or passed upon the
adequacy or accuracy of this prospectus. Any representation to the contrary is
a criminal offense.
-----------
McDonald Investments Inc.
The date of this prospectus is , 1999
<PAGE>
[Pictures of representative products sold by 1-800 CONTACTS,
the 1-800 CONTACTS Logo and a
customer service representative displaying contact lenses]
<PAGE>
PROSPECTUS SUMMARY
This summary highlights information contained elsewhere in this prospectus.
This summary is not complete and may not contain all of the information that
you should consider before investing in our common stock. You should read the
entire prospectus carefully. This prospectus contains forward-looking
statements, which involve risks and uncertainties. Our actual results could
differ materially from those anticipated in these forward-looking statements as
a result of certain factors, including those set forth in "Risk Factors" and
elsewhere in this prospectus. In this prospectus, references to "1-800
CONTACTS," "we," "us" or "our" each refers to 1-800 CONTACTS, INC. Unless
otherwise stated, the information contained in this prospectus assumes no
exercise of the underwriters' over-allotment option.
1-800 CONTACTS, INC.
We believe we are the world's largest direct marketer of replacement contact
lenses. Through our easy-to-remember, toll-free telephone number, "1-800
CONTACTS" (1-800-266-8228), and increasingly through our Internet addresses,
which include "www.1800contacts.com," "www.contacts.com" and
"www.contactlenses.com," we sell all of the most popular brands of contact
lenses, including those manufactured by Johnson & Johnson, CIBA Vision, Bausch
& Lomb, Wesley Jessen, Ocular Sciences and CooperVision. Our high volume, cost-
efficient operations supported by our proprietary management information
system, enable us to offer our products at competitive prices while delivering
a high level of customer service. As a result of our extensive inventory, we
generally ship approximately 90% of our orders within one business day of
receipt. We believe that we offer our customers an attractive alternative for
obtaining replacement contact lenses in terms of convenience, price and speed
of delivery. Our net sales have grown rapidly, from $3.6 million in 1996 to
$59.9 million in 1998 and from $10.4 million in the first quarter of 1998 to
$22.3 million in the first quarter of 1999.
The Internet is our fastest-growing sales channel and a more cost-effective
way for us to serve our customers. Our Internet sales have increased from just
$44,000, or 0.4% of net sales, during the first quarter of 1998 to $2.5
million, or 11.2% of net sales, during the first quarter of 1999. Selling our
products over the Internet eliminates the payroll and long distance costs
associated with telephone orders. This increased efficiency allows us to offer
Internet customers free shipping in addition to other services not possible
with telephone orders such as shipping confirmation and online order tracking.
We believe that our customers will increasingly use the Internet to order and
reorder replacement contact lenses.
We market our products through a national advertising campaign. As compared
to other direct marketers of replacement contact lenses, we believe that our
toll-free telephone number and Internet addresses afford us a significant
competitive advantage in generating consumer awareness and repeat business. We
spent approximately $22.7 million on advertising in 1998, and intend to use a
significant portion of the net proceeds from this offering to further increase
our sales and marketing activities. Our experience has been that increases in
advertising expenditures have a direct impact on the growth of net sales. We
believe that the planned increase in advertising activities will enable us to
attract significant numbers of new customers. In particular, our new marketing
campaign will be designed to continue to build brand awareness and to more
prominently feature our Internet address, www.contacts.com.
Our sales and marketing efforts, combined with our focus on delivering a
high level of customer service, have built a loyal customer base. Our customer
service representatives are trained to provide efficient and accurate order
entry, are able to provide customers with real time product availability
information and estimated delivery dates for their lenses, and are empowered to
handle all customer service issues. For the twelve month period ended May 31,
1998, each $1.00 of sales to new customers generated approximately $0.78 of
repeat sales in the succeeding 12 month period. During the first quarter of
1999, approximately $10.7 million, or 47.8% of net sales, were to repeat
customers, compared to net sales to repeat customers of approximately $3.9
million, or 37.2% of net sales, in the first quarter of 1998.
1
<PAGE>
We estimate, based on published reports, that the U.S. retail market for
contact lenses was approximately $3.0 billion in 1998 and, according to
industry analysts, is expected to grow at 4% to 6% in 1999, with the disposable
market growing at 8% to 12%. The growth in the disposable market is largely due
to the shift in the contact lens market away from traditional soft lenses,
which generally are replaced on an annual basis, to disposable lenses, which
are replaced on a daily, weekly or bi-weekly basis.
Over the last decade, there have been significant changes in the ways
contact lenses are sold to consumers. Driven primarily by the growing
commodity-like nature of contact lens products, such as disposable lenses,
direct marketers have emerged as an attractive alternative to more traditional
providers, such as eye care practitioners and retail optical chains. We
estimate that direct marketers accounted for approximately 5% of contact lens
sales in the United States during 1998. We believe that consumers are
increasingly seeking the convenience, speed and home delivery that direct
marketers of replacement contact lenses can provide.
Competitive Strengths
We believe our success in the direct marketing segment of the contact lens
industry and our significant opportunities for growth result from several
competitive strengths, which include:
. Our easy-to-remember, toll-free telephone number, 1-800 CONTACTS;
. Our Internet addresses, which include www.1800contacts.com,
www.contacts.com and www.contactlenses.com;
. Our proprietary management information system, which enables us to
process both telephone and Internet orders, continually monitor and track
substantially all of our inventory, rapidly process credit card orders
and increase the speed and accuracy of the shipping process;
. Our extensive inventory of over six million contact lenses, which enables
us to ship approximately 90% of our orders within one business day of
receipt;
. Our commitment to high quality, consistent customer service; and
. Our loyal customer base of over 800,000 customers as of April 3, 1999.
Growth Strategy
Our strategy to attract and retain new customers and increase our sales
includes:
. Increasing awareness of the 1-800 CONTACTS and www.contacts.com brand
names;
. Expanding our Internet-based advertising and sales;
. Pursuing acquisitions and strategic partnerships;
. Pursuing international expansion; and
. Enhancing our customer relationships.
1-800 CONTACTS was incorporated under the laws of the State of Utah in
February 1995 and was reincorporated under the laws of the State of Delaware in
February 1998. We completed the initial public offering of our common stock in
February 1998 (the "IPO"). Our principal executive office is located at 66 E.
Wadsworth Park Drive, Draper, Utah 84020, and our telephone number is (801)
924-9800. Our Internet address is www.contacts.com. The information contained
on our website does not constitute a part of this prospectus.
2
<PAGE>
The Offering
<TABLE>
<S> <C>
Common stock offered by 1-800
CONTACTS....................... 1,000,000 shares (1)
Common stock offered by the
selling stockholders........... 1,040,000 shares (1)
Common stock outstanding after
the offering................... 7,282,394 shares (2)
Use of proceeds................. We will use the net proceeds from the
offering to fund advertising and brand
development and for other general corporate
purposes, which may include acquisitions and
working capital. The anticipated uses of the
net proceeds are subject to change due to the
actual circumstances of operating our
business. Pending such uses, we currently
plan to invest the net proceeds in investment
grade, short-term, interest-bearing
securities. See "Use of Proceeds."
Nasdaq Stock Market Symbol...... CTAC
</TABLE>
- --------
(1) Does not include the underwriters' over-allotment option granted by us and
the selling stockholders for an aggregate of 306,000 shares of common
stock.
(2) Does not include 258,795 shares of common stock issuable upon the exercise
of outstanding options or an additional 240,519 shares of common stock
available for future issuance to employees or non-employee directors under
our stock option plan. See "Management--Incentive Stock Option Plan."
3
<PAGE>
Summary Financial Data
<TABLE>
<CAPTION>
Fiscal Year First Fiscal Quarter
------------------------------------ ------------------------
1996 1997 1998 1998 1999
---------- ----------- ----------- ----------- -----------
<S> <C> <C> <C> <C> <C>
Statement of Operations
Data:
Net sales............... $3,628,296 $21,115,314 $59,875,941 $10,429,304 $22,304,257
Gross profit............ 1,412,990 7,090,791 22,560,528 3,800,391 8,395,110
Advertising expense..... 468,146 3,485,619 24,206,857 2,003,660 5,410,276
Other selling, general
and administrative
expenses............... 573,166 2,459,602 7,334,668 1,134,266 2,589,829
Income (loss) from
operations............. 371,678 1,145,570 (8,980,997) 662,465 395,005
Net income (loss)(1).... $ 348,363 $ 1,032,408 $(7,892,608) $ (211,207) $ 297,177
Basic and diluted net
income (loss) per
common share........... $ (1.27) $ (0.04) $ 0.05
Pro Forma Statement of
Operations Data:
Income (loss) before
benefit (provision) for
income taxes........... $ 348,363 $ 1,032,408 $(8,535,287) $ 742,701 $ 479,390
Pro forma benefit
(provision) for income
taxes.................. (134,120) (397,477) 642,679 (278,337) (182,213)
---------- ----------- ----------- ----------- -----------
Pro forma net income
(loss)(2).............. $ 214,243 $ 634,931 $(7,892,608) $ 464,364 $ 297,177
========== =========== =========== =========== ===========
Pro forma basic net
income (loss) per
common share........... $ 0.14 $ (1.27) $ 0.08 $ 0.05
Pro forma diluted net
income (loss) per
common share(3)........ $ 0.13 $ (1.27) $ 0.08 $ 0.05
</TABLE>
<TABLE>
<CAPTION>
April 3, 1999
-----------------------
As
Actual Adjusted(4)
----------- -----------
<S> <C> <C>
Balance Sheet Data:
Working capital........................................ $10,372,024 $31,370,524
Total assets........................................... 22,438,188 43,436,688
Total debt (including current portion)................. 58,056 58,056
Stockholders' equity................................... 13,320,738 34,319,238
</TABLE>
- --------
(1) Prior to February 9, 1998, we were an S corporation and were not subject to
federal and certain state income taxes.
(2) Pro forma net income (loss) reflects historical net income less pro forma
income taxes. Pro forma income taxes are provided as if we had been a C
corporation rather than an S corporation for the above periods. Prior to
the closing of our IPO, our S corporation status was terminated; at that
date, we recorded a non-recurring, non-cash charge to earnings to recognize
deferred income taxes.
(3) Pro forma diluted net income (loss) per common share is based on the
weighted average shares of common stock and stock equivalents outstanding,
including actual shares outstanding and shares deemed to be outstanding
determined using the treasury stock method. The shares deemed to be
outstanding for 1997 include the number of shares sufficient to fund the
net S corporation distribution of approximately $983,000. See "Dividend
Policy."
(4) As adjusted to reflect the sale of 1,000,000 shares of common stock at an
assumed public offering price of $22.63 per share. See "Use of Proceeds."
4
<PAGE>
RISK FACTORS
In analyzing an investment in our common stock, you should carefully
consider the risk factors described below, as well as the other matters
referred to in this prospectus. If any of the following risks occur, our
business, financial condition or results of operations could be materially
adversely affected. This prospectus also contains forward-looking statements
that involve risks and uncertainties. See "Special Note Regarding Forward-
Looking Statements."
Risks Relating to Our Business
We cannot assure you that our sales growth will continue at historical rates
or that we will not encounter unforeseen difficulties in managing our future
growth.
Since our formation in February 1995, we have experienced rapid growth,
with net sales increasing from approximately $3.6 million in 1996 to
approximately $59.9 million in 1998. Although we believe that our net sales
will increase substantially in 1999 as compared to 1998, we expect the rate of
growth in net sales to decrease in future quarters of 1999. Our ability to
compete effectively and to manage future growth, if any, will require us to
continue to improve our financial and management controls and our reporting
systems and procedures on a timely basis and to expand, train and manage our
employee base. Our failure or inability to accomplish any of these goals could
have a material adverse affect on our business, financial condition and
results of operations.
A significant portion of our sales do not comply with applicable state laws
and regulations governing the delivery and sale of contact lenses.
The sale and delivery of contact lenses are generally governed by state
laws and regulations. We sell 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 laws and regulations relating to the delivery and sale of contact lenses
vary from state to state, but can generally be classified into five
categories:
(1)laws that require contact lenses to be dispensed only pursuant to a
valid prescription;
(2) laws that require the dispenser to be licensed by the state as an
optometrist, ophthalmologist or other professional authorized to
dispense lenses;
(3) laws that require lenses be dispensed only in a face-to-face
transaction;
(4) laws with requirements that are unclear or do not specifically address
the sale and delivery of contact lenses; and
(5) laws that we believe place no restrictions on the dispensing of
replacement contact lenses.
Many of the states requiring that contact lenses be dispensed in face-to-face
meetings or by a person licensed by such state to dispense lenses also require
that lenses only be dispensed pursuant to a valid prescription. Neither we nor
any of our employees is a licensed or registered dispenser of contact lenses
in any states other than California and Texas.
Our operating practice is to attempt to obtain a valid prescription from
each customer or his/her eye care practitioner. If we are unable to obtain a
copy of or verify the customer's prescription, it is our practice to ship the
lenses to the customer based on the information that the customer has
provided.
We retained legal counsel to identify and summarize the applicable laws of
each of the states in which we generate material sales. We compared our
operations to the applicable requirements of the laws contained in such
summaries. Based on such comparison, we estimate that approximately one-third
of our net sales in 1998 appeared to conform to the requirements of applicable
state laws and regulations. Any action brought against us based on our failure
to comply with applicable state laws and regulations could result in us being
subject to
5
<PAGE>
significant fines, being prohibited from making sales in a particular state
and/or being required to comply with such laws. Such required compliance could
result in:
. increased costs to us;
. the loss of a substantial portion of our customers for whom we are unable
to obtain or verify their prescription; and
. the inability to sell to customers at all in a particular state if we
cannot comply with such state's laws.
The occurrence of any of the above results could have a material adverse
effect on our ability to sell contact lenses and to operate profitably.
Furthermore, we cannot assure you that states will not enact or impose laws or
regulations that prohibit mail order dispensing of contact lenses or otherwise
impair our ability to sell contact lenses and continue to operate profitably.
We have not obtained an opinion of counsel with regard to our compliance with
applicable state laws and regulations, and information contained in this
prospectus regarding our compliance with applicable state laws and regulations
should not be construed as being based on an opinion of counsel.
From time to time, we receive notices, inquiries or other correspondence
from states or their regulatory bodies charged with overseeing the sale of
contact lenses. We are currently involved in litigation brought by two
California optometrists regarding our alleged business practices in that state
and by the Kansas Board of Examiners in Optometry regarding our alleged
business practices in that state. See "Business--Government Regulation" and "--
Legal Proceedings."
We currently purchase a substantial portion of our products from unauthorized
distributors and are not an authorized dealer for the majority of the products
that we sell.
Historically, substantially all of the major manufacturers of contact lenses
have refused to sell lenses directly to direct marketers, including us, and
have sought to prohibit their distributors from doing so. As a result, we
currently purchase a substantial portion of our products from unauthorized
distributors. We are aware that at least one large manufacturer of contact
lenses puts tracking codes on its products in an effort to identify
distributors who are selling to direct marketers. We are not an authorized
dealer for the majority of the products which we sell. In addition, the prices
we pay for certain of our products are sometimes higher than those paid by eye
care practitioners, retail chains and mass merchandisers, who are able to buy
directly from manufacturers. Furthermore, in order to help ensure adequate
supply, we generally carry a higher level of inventory than if we were able to
purchase directly from contact lens manufacturers. We cannot assure you that we
will be able to obtain sufficient quantities of contact lenses at competitive
prices in the future to meet the existing or anticipated demand for our
products. Our inability to obtain sufficient quantities of contact lenses would
have a material adverse effect on our business, financial condition and results
of operations.
We obtain a large percentage of our inventory from a limited number of
suppliers.
A single distributor supplied us with approximately 40% and 47% of our
inventory in 1997 and 1998, respectively, and our top three suppliers accounted
for approximately 72% and 70% of our inventory in 1997 and 1998, respectively.
We believe that none of these suppliers is authorized by contact lens
manufacturers to distribute their products. In the event that any of these
suppliers could no longer supply us with contact lenses, we may not be able to
secure other adequate sources of supply, or may not be able to obtain our
inventory on terms as favorable to us as our current supply. Either
circumstance could adversely affect us by increasing our costs or, in the event
adequate replacement supply cannot be secured, reducing our net sales.
6
<PAGE>
We expect to incur losses in the near-term and cannot assure you that our new
advertising strategies will prove successful. Our quarterly results are
likely to vary based upon the level of sales and marketing activity in any
particular quarter.
We expect to incur significant expenditures in order to increase awareness
of the 1-800 CONTACTS and www.contacts.com brand names through sales and
marketing and other promotional activities. Although we have been profitable
in the past, we expect to incur near-term losses as a result of these
expenditures. In addition, we cannot assure you that our new sales and
marketing activities will prove successful or will result in increases in our
net sales comparable to historical levels. Furthermore, we currently expense
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 our 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 our assessment of prevailing market
opportunities. Our operating results for any particular quarter may not be
indicative of future operating results. You should not rely on quarter-to-
quarter comparisons of our results of operations as an indication of our
future performance. It is possible that, in future periods, our results of
operations may be below the expectations of public market analysts and
investors. This could cause the trading price of our common stock to fall.
We are dependent on our telephone, Internet and management information
systems.
Our success depends, in part, on our ability to provide prompt, accurate
and complete service to our customers on a competitive basis, and our ability
to purchase and promote products, manage inventory, ship products, manage
sales and marketing activities and maintain efficient operations through our
telephone and proprietary management information systems. A significant
disruption in our telephone, Internet or management information systems could
adversely affect our relations with our customers and our ability to manage
our operations. From time to time, we have experienced temporary interruptions
in our telephone service as a result of the technical problems experienced by
our long-distance carrier. In 1998, we experienced three interruptions, which
lasted on average approximately two to three hours each. We cannot assure you
that similar interruptions will not occur in the future or that such
interruptions would not have a material adverse effect on our business,
financial condition and results of operations. Furthermore, we cannot assure
you that extended or repeated reliance on our back-up computer systems would
not have a material adverse effect on our business, financial condition and
results of operations.
We have limited operating history.
We were formed in February 1995 as the successor to the business founded by
our Vice President of Operations in March 1991. Our toll-free telephone
number, 1-800 CONTACTS, began operations in July 1995 and our website,
www.1800contacts.com, began operations in October 1995. As a result, there is
only limited financial information and operating information available for a
potential investor to evaluate an investment in our common stock. In addition,
our limited operating history and rapid growth in net sales make it difficult
to forecast future operating results and reduce the relevance of quarter-to-
quarter comparisons.
The retail sale of contact lenses is highly competitive. Certain of our
competitors are large, national optical chains that have greater resources
than we have.
The retail sale of contact lenses is a highly competitive and fragmented
industry. Our principal competitors include ophthalmologists and optometrists
in private practice and retail chain stores, which we believe collectively
accounted for approximately 70% of all contact lens sales in 1998. We also
compete with national optical chains, such as Cole Vision, LensCrafters and
National Vision Association and mass merchandisers, such as Wal-Mart, Sam's
and Costco, which we believe accounted for approximately 25% of all contact
lens sales in 1998. We also compete with other direct marketers of contact
lenses. We may face increased competition in the future from new entrants in
the direct marketing business, which may include national optical chains and
mass merchandisers, some of which may have significantly greater resources
than we have.
7
<PAGE>
In addition, many of our competitors, including most eye care practitioners,
national optical chains and mass merchandisers, have direct supply
arrangements with contact lens manufacturers, which in some cases affords such
competitors with better pricing terms and access to supply. In light of such
intense competition, we cannot assure you that we will be able to maintain our
current market position or realize our anticipated growth.
The demand for contact lenses could be substantially reduced if alternative
technologies to permanently correct vision gain in popularity.
We also encounter competition from manufacturers of eyeglasses and from
alternative technologies, such as surgical refractive procedures, including
new refractive laser procedures such as PRK, or photo refractive keratectomy,
and LASIK, or laser in situ keratomileusis. If surgical refractive procedures
become increasingly accepted as an effective and safe technique for permanent
vision correction, they could substantially reduce the demand for contact
lenses by enabling patients to avoid the ongoing cost and inconvenience of
contact lenses. Accordingly, we cannot assure you that these procedures, or
other alternative technologies that may be developed in the future, will not
cause a substantial decline in the number of contact lens wearers and thus
have a material adverse effect on our business, financial condition and
results of operations.
We are dependent to a large degree on the services of our senior management
team.
We are dependent to a large degree on the services of our senior management
team, particularly Jonathan C. Coon, our President and Chief Executive
Officer, and John F. Nichols, our Vice President, Operations. In February
1998, Messrs. Coon and Nichols each entered into three year employment
agreements with us. The loss of any of our key executives could have a
material adverse effect on us. Our ability to manage our anticipated growth
will depend on our ability to identify, hire and retain highly skilled
management and technical personnel. Competition for such personnel is intense.
As a result, we cannot assure you that we will be successful in attracting and
retaining such personnel, and the failure to attract and retain such personnel
could have a material adverse effect on our business, financial condition and
results of operations. See "Management."
Our executive officers and directors have the ability to effectively control
substantially all actions taken by our stockholders.
Upon completion of this offering, Messrs. Coon, Nichols and Yacktman will
own 2,488,504 shares of our common stock and control approximately 34% of our
aggregate voting power. Acting together, these stockholders can effectively
control substantially all actions taken by our stockholders, including the
election of directors. Such concentration of ownership could also have the
effect of delaying, deterring or preventing a change in control of 1-800
CONTACTS that might otherwise be beneficial to stockholders and may also
discourage acquisition bids for 1-800 CONTACTS and limit the amount certain
investors may be willing to pay for shares of the common stock. See
"Management" and "Principal and Selling Stockholders."
We do not have any property rights in the 1-800 CONTACTS telephone number or
the Internet addresses that we use.
We believe that a large portion of our success is attributable to the
competitive advantage we enjoy as a result of our toll-free telephone number.
While we have obtained the right to use the phone number 1-800 CONTACTS as
well as common "CONTACTS" misdials, we may not be able to obtain rights to use
the CONTACTS phone number as new toll-free prefixes are issued. Under
applicable FCC rules, we do not have and cannot acquire any property rights to
this telephone number. As a result, we cannot assure you that we will be able
to retain the use of the 1-800 CONTACTS telephone number in the future. The
loss of our ability to use the 1-800 CONTACTS number would have a material
adverse effect on our business, financial condition and results of operations.
8
<PAGE>
We also have obtained the rights to various Internet addresses, including
but not limited to www.1800contacts.com, www.contacts.com and
www.contactlenses.com. We cannot practically acquire rights to all addresses
similar to www.contacts.com. If third parties obtain rights to use similar
addresses, these third parties may confuse our customers and cause our
customers to inadvertently place orders with these third parties, which could
result in lost sales for us and could damage our brand. As with telephone
numbers, we do not have and cannot acquire any property rights in Internet
addresses. As a result, we cannot assure you that we will be able to retain the
use of our addresses. The loss of our ability to use our Internet addresses
would have a material adverse effect on our business, financial condition and
results of operations.
We may be adversely impacted by the Year 2000 issue.
We are currently performing analysis and testing of Year 2000 compliance on
our computer applications, internal technology systems and embedded technology.
After completing our analysis and testing, we believe that we will be able to
take any necessary steps to become Year 2000 compliant. If this analysis and
testing, and any necessary corrective actions, are not completed timely, the
Year 2000 issue could have a material impact on our operations.
We are currently unable to determine the effects of Year 2000 compliance by
third parties that are significant to our operations. We have received several
responses to correspondence sent to significant third parties. We are reviewing
these responses to assess the third parties' Year 2000 compliance and to
determine the extent to which our 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, our operations
will be adversely affected. To date, we have not developed a contingency plan
in the event that one or more of these third parties are not Year 2000
compliant.
Increases in the cost of shipping, postage or credit card processing could
adversely affect our business.
We ship our products to customers by United States mail and other overnight
delivery and surface services. We generally invoice the costs of delivery and
parcel shipments directly to customers as separate shipping and handling
charges. In addition, we use direct mailings to advertise our products and
receive a majority of our payments from customers using credit cards. Any
increases in shipping, postal or credit card processing rates could have an
adverse effect on our operating results as we may not be able to effectively
pass such increases on to our customers. Similarly, strikes or other service
interruptions by these shippers could adversely affect our ability to market or
deliver our products on a timely basis. See "Business--Customers and
Marketing."
Our business could be adversely affected if we are required to collect state
sales tax on the sale of products.
At present, we do not collect sales or other similar taxes in connection
with the sale of our products to consumers located outside the state of Utah.
From time to time, various states have sought to impose state sales tax
collection obligations on out-of-state direct marketing companies such as ours.
A successful assertion by one or more states that we should have collected or
should be collecting sales taxes on the sale of our products could result in
additional costs and administrative expenses to us and corresponding price
increases to our customers, which could adversely affect our business,
financial condition and results of operations.
We face an inherent risk of exposure to product liability claims in the event
that the use of the products we sell results in personal injury.
We face an inherent risk of exposure to product liability claims in the
event that the use of the products we sell results in personal injury. Although
we have not experienced any losses due to product liability claims,
9
<PAGE>
we cannot assure you that we will not experience such losses in the future. We
maintain insurance against product liability claims, but we cannot be certain
that such coverage will be adequate to cover any liabilities that we may incur,
or that such insurance will continue to be available on terms acceptable to us.
A successful claim brought against us in excess of available insurance
coverage, or any claim that results in significant adverse publicity against
us, could have a material adverse effect on our business, financial condition
and results of operations.
We conduct our operations through a single distribution facility.
All of our inventory is stored and shipped from our distribution center in
Salt Lake City. We depend in large part on the orderly operation of this
receiving and distribution process, which depends, in turn, on adherence to
shipping schedules and effective management of the distribution center. We
cannot assure you that we have anticipated all of the changing demands that our
expanding operations will impose on our receiving and distribution system or
that events beyond our control, such as disruptions in operations due to labor
disagreements, shipping problems, fires or natural disasters, will not result
in a material adverse effect on our business, financial condition and results
of operations.
Risks Relating to the Internet
Our success is dependent, in part, on continued growth in use of the Internet.
The Internet is new and rapidly evolving. A decrease in the growth of
Internet usage would adversely affect our business, results of operations and
financial condition. The following factors may inhibit growth in Internet
usage, limit visits to our Internet addresses or limit orders placed through
our website:
. inadequate Internet infrastructure;
. security and privacy concerns;
. inconsistent quality of service; and
. unavailability of low cost, high-speed service.
Our success is dependent, in part, upon the ability of the Internet
infrastructure to support increased use. The performance and reliability of the
Internet may decline as the number of users increases or the bandwidth
requirements of users increase. The Internet has experienced a variety of
outages due to damage to portions of its infrastructure. If outages or delays
occur frequently in the future, Internet usage, including usage of our website,
could grow slowly or decline. Even if the necessary infrastructure or
technologies are developed, we may have to spend considerable amounts to adapt
our solutions accordingly.
Our success is dependent on continued growth of Internet commerce.
Our ability to generate a profit in the future depends substantially upon
the widespread acceptance and use of the Internet as an effective medium of
commerce by consumers. Rapid growth in commercial online businesses is a recent
phenomenon. We cannot assure you that a sufficiently broad base of consumers
will visit, or continue to visit, our website. Demand for recently introduced
services and products over the Internet is subject to a high level of
uncertainty. The development of the Internet is subject to a high level of
uncertainty. The development of the Internet as a viable means of marketing
products directly to consumers is subject to a
10
<PAGE>
number of factors, including continued growth in the number of users of such
services, concerns about transaction security, continued development of the
necessary technological infrastructure, and the development of complementary
services and products. Failure of the Internet and online businesses to become
a viable means of marketing products directly to consumers would adversely
affect our business, results of operations and financial condition.
Online security breaches could harm our business.
The secure transmission of confidential information over the Internet is
essential to maintain consumer confidence in our website. Substantial or
ongoing security breaches of our system or other Internet-based systems could
significantly harm our business. Any penetration of our network security or
other misappropriation of our users' personal information could subject us to
liability. We may be liable for claims based on unauthorized purchases with
credit card information, impersonation or other similar fraud claims. Claims
could also be based on other misuses of personal information, such as for
unauthorized marketing purposes. These claims could result in litigation and
financial liability. Security breaches also could damage our reputation and
expose us to a risk of loss or litigation and possible liability. We rely on
licensed encryption and authentication technology to effect secure transmission
of confidential information, including credit card numbers. It is possible that
advances in computer capabilities, new discoveries or other developments could
result in a compromise or breach of the technology used by us to protect
customer transaction data.
We may incur substantial expense to protect against and remedy security
breaches and their consequences. A party that is able to circumvent our
security systems could steal proprietary information or cause interruptions in
our operations. Our insurance policies' limits may not be adequate to reimburse
us for losses caused by security breaches. We cannot guarantee that our
security measures will prevent security breaches.
Government regulation and legal uncertainties relating to the Internet and
online commerce could negatively impact our business operations.
Online commerce is new and rapidly changing, and federal and state
regulation relating to the Internet and online commerce is evolving. Currently,
there are few laws or regulations directly applicable to the Internet or online
commerce on the Internet, and the laws governing the Internet that exist remain
largely unsettled. The most recent session of the U.S. Congress resulted in
Internet laws regarding online children's privacy, copyrights and taxation.
This or similar legislation could dampen growth in use and acceptance of the
Internet. Due to the increasing popularity of the Internet, it is possible that
additional laws and regulations may be enacted with respect to the Internet,
covering issues such as user privacy, pricing, taxation, content, copyrights,
distribution, antitrust and quality of products and services. The adoption or
modification of laws or regulations applicable to the Internet could adversely
affect our business operations.
In addition, several telecommunications carriers have requested the Federal
Communications Commission to regulate telecommunications over the Internet. Due
to the increasing use of the Internet and the burden it has placed on the
current telecommunications infrastructure, telephone carriers have requested
the FCC to regulate Internet service providers and impose access fees on those
providers. If the FCC imposes access fees, the costs of using the Internet
could increase dramatically. This could result in the reduced use of the
Internet as a medium for commerce, which could adversely affect our business
operations.
Changing technology could adversely affect the operation of our website.
The Internet, online commerce and online advertising markets are
characterized by rapidly changing technologies, evolving industry standards,
frequent new product and service introductions and changing customer
preferences. Our future success will depend on our ability to adapt to rapidly
changing technologies and address our customers' changing preferences, however,
we may experience difficulties that delay or prevent our being able to do so.
11
<PAGE>
Risks Related to this Offering
The price of our common stock has been volatile and could continue to
fluctuate in the future.
The market price for shares of the common stock has been volatile and could
fluctuate substantially based on a number of factors, including quarter-to-
quarter variations in our results of operations, news announcements, changes in
general market conditions for contact lenses, regulatory actions, adverse
publicity regarding us or the industry in general, changes in financial
estimates by securities analysts and other factors. In addition, broad market
fluctuations and general economic and political conditions may adversely affect
the market price of the common stock, regardless of our actual performance.
You should be aware that we do not anticipate paying cash dividends on our
common stock.
We intend to retain all future earnings for use in our business and,
therefore, do not anticipate paying any cash dividends on the common stock in
the foreseeable future. In addition, our senior credit facility currently
prohibits us from paying any cash dividends on our common stock. See "Dividend
Policy."
Our management will have broad discretion over a portion of proceeds from this
offering.
Our management will have broad discretion to allocate the net proceeds from
this offering, including uses that stockholders may not deem desirable. We may
not be able to yield a significant return on any investment of these proceeds.
Substantially all of our proceeds from the offering will be invested in short-
term, interest-bearing, investment grade securities immediately following the
offering. See "Use of Proceeds."
Future sales of our common stock could cause the price of our shares to
decline.
Future sales of the shares of common stock could have a material adverse
effect on the price of our common stock. Upon completion of the offering, we
expect to have 7,282,394 shares of common stock outstanding. Of these shares,
4,421,826 shares of common stock (4,727,826 shares if the underwriters'
overallotment option is exercised in full) will be freely tradeable without
restriction under the Securities Act, except any such shares which may be
acquired by an "affiliate" of ours. In addition, subject to certain 180-day
"lock up" agreements described in this prospectus, approximately 2,860,568
shares of common stock will be eligible for sale in the public market, subject
to compliance with the resale volume limitations and other restrictions of Rule
144 under the Securities Act. See "Shares Eligible for Future Sale."
Certain provisions in our charter documents could delay or prevent a change in
control.
Certain provisions of our restated certificate of incorporation and our by-
laws may inhibit changes in control of us not approved by our board of
directors. These provisions include:
. a classified board of directors;
. a prohibition on stockholder action through written consents;
. a requirement that special meetings of stockholders be called only by our
board of directors or chief executive officer;
. advance notice requirements for stockholder proposals and nominations;
12
<PAGE>
. limitations on the ability of stockholders to amend, alter or repeal the
by-laws; and
. the authority of the board of directors to issue without stockholder
approval preferred stock with such terms as the board of directors may
determine.
We are also afforded the protections of Section 203 of the Delaware General
Corporation Law, which could have similar effects. See "Description of Capital
Stock."
----------------
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
This prospectus contains certain forward-looking statements within the
meaning of Section 27A of 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 our sales and marketing plans, our
growth strategy in general, expectations concerning growth in the contact lens
market, certain financial projections and the planned use of proceeds. When
used in this prospectus, the words "anticipate," "expect," "believe," "intend"
and similar expressions, as they relate to us, are intended to identify
forward-looking statements. Actual results could differ from those projected in
any forward-looking statements. The forward-looking statements are made as of
the date of this prospectus and we assume 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 factors mentioned in the "Risk Factors" section of this
prospectus, many of which are beyond the control of our management, could cause
future results to differ substantially from those contemplated in such forward-
looking statements.
USE OF PROCEEDS
Our net proceeds from this offering, after deducting applicable underwriting
discounts and our estimated expenses, are estimated to be approximately $21.0
million (assuming a public offering price of $22.63 per share). We expect to
use approximately $10.0 million to fund advertising and brand development and
to use any remaining net proceeds for general corporate purposes, including
working capital. The anticipated uses of our net proceeds are subject to change
due to the actual circumstances of operating our business. Pending such uses,
we currently plan to invest the net proceeds in investment grade, short-term,
interest-bearing securities.
We believe opportunities may exist from time to time to expand our current
business through acquisitions, strategic ventures and international expansion.
We may use a portion of the net proceeds from this offering for these purposes.
We are not currently a party to any contracts, letters of intent, commitments
or agreements, and are not currently engaged in active negotiations, with
respect to any acquisitions or strategic ventures.
We will not receive any of the proceeds from the sale of the shares by the
selling stockholders.
13
<PAGE>
MARKET PRICE FOR COMMON STOCK
Our common stock is traded on the Nasdaq Stock Market ("Nasdaq") under the
symbol "CTAC." Our common stock commenced trading on February 10, 1998. The
following table sets forth the high and low closing sale prices per share for
our common stock as reported by the Nasdaq for the periods presented:
<TABLE>
<CAPTION>
High Low
------- -------
<S> <C> <C>
1998:
First Quarter (beginning February 10, 1998)............ $20.875 $13.563
Second Quarter......................................... 19.875 13.000
Third Quarter.......................................... 16.375 5.625
Fourth Quarter......................................... 18.000 4.750
1999:
First Quarter.......................................... $17.750 $10.625
Second Quarter (through June 8, 1999).................. 22.750 17.000
</TABLE>
As of the close of business on June 8, 1999, there were approximately 63
holders of record of our common stock. We believe that we have a significantly
larger number of beneficial holders of common stock. A recently reported last
sale price of our common stock on the Nasdaq is set forth on the cover page of
this prospectus.
DIVIDEND POLICY
We anticipate that all of our future earnings will be retained to finance
the expansion of our business. Any future determination to pay dividends will
be at the discretion of our board of directors and will depend upon among other
factors, our results of operations, financial condition, capital requirements
and contractual restrictions. In addition, our credit facility prohibits us
from paying any cash dividends on our common stock.
Immediately prior to the consummation of our IPO, we entered into an
agreement to distribute to our then existing stockholders an amount equal to
our retained earnings from our formation date through the date of the
termination of our S corporation status. The distribution (net of notes
receivable from stockholders of $599,689) was in the form of promissory notes,
totaling $982,995. These promissory notes were paid in full during the first
quarter of fiscal 1998. Subsequent to this S corporation distribution, we have
not declared or paid any cash or other dividends on our common stock and do not
expect to pay dividends for the foreseeable future.
14
<PAGE>
CAPITALIZATION
The following table sets forth the actual capitalization of 1-800 CONTACTS
as of April 3, 1999 and the as adjusted capitalization of 1-800 CONTACTS to
give effect to its sale of 1,000,000 shares of common stock pursuant to this
offering, assuming a public offering price of $22.63 per share and the
application of the net proceeds to us therefrom as described under "Use of
Proceeds." This table should be read in conjunction with the financial
statements of 1-800 CONTACTS and notes thereto included elsewhere in this
prospectus.
<TABLE>
<CAPTION>
April 3, 1999
------------------------
As
Actual Adjusted(a)
----------- -----------
<S> <C> <C>
Long-term obligations:
Capital lease obligation, less current portion..... $ 20,371 $ 20,371
Stockholders' equity:
Preferred stock, $0.01 par value, 1,000,000 shares
authorized, no shares issued or outstanding....... -- --
Common stock, $0.01 par value, 20,000,000 shares
authorized; 6,430,568 shares issued on an actual
basis; 7,430,568 shares issued on an as adjusted
basis (b)........................................... 64,306 74,306
Additional paid-in capital......................... 23,009,439 43,997,939
Accumulated deficit................................ (7,891,895) (7,891,895)
Treasury stock at cost, 155,204 shares............. (1,861,112) (1,861,112)
----------- -----------
Total stockholders' equity....................... 13,320,738 34,319,238
----------- -----------
Total capitalization............................. $13,341,109 $34,339,609
=========== ===========
</TABLE>
- --------
(a) Assuming a public offering price of $22.63 per share, less the
underwriters' discounts and the estimated expenses of the offering.
(b) Does not include 258,795 shares of common stock issuable upon the exercise
of outstanding options or 240,519 additional shares of common stock
reserved for issuance under our stock option plan. See "Management--
Incentive Stock Option Plan."
15
<PAGE>
SELECTED FINANCIAL DATA
The financial data for the year ended December 31, 1994 and the one month
period ended January 1, 1995 are derived from the audited consolidated
financial statements of the Predecessor. The financial data for the eleven
month period ended December 31, 1995 and the years ended December 31, 1996 and
1997 and January 2, 1999 (Fiscal Year 1998) have been derived from our audited
financial statements. The financial data for the quarters ended April 4, 1998
and April 3, 1999 have been derived from our unaudited financial statements,
which, in the opinion of management, reflect all adjustments (consisting of
only normal recurring adjustments) necessary for fair presentation. Results for
the quarter ended April 3, 1999 are not necessarily indicative of results for
the full year. The selected financial data below should be read in conjunction
with the financial statements and the notes thereto of the Predecessor and our
financial statements and the notes thereto and "Management's Discussion and
Analysis of Results of Operations and Financial Condition." Our financial
statements for the three years ended January 2, 1999 and for the quarters ended
April 4, 1998 and April 3, 1999 are included in this prospectus.
<TABLE>
<CAPTION>
Predecessor(1) Company
------------------------ ---------------------------------------------------------------------------
One Month February 1,
Year Ended Ended 1995 to Fiscal Year First Fiscal Quarter
December 31, January 31, December 31, ------------------------------------ ------------------------
1994 1995 1995 1996 1997 1998 1998 1999
------------ ----------- ------------ ---------- ----------- ----------- ----------- -----------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Statement of
Operations Data:
Net sales.......... $212,584 $21,552 $587,918 $3,628,296 $21,115,314 $59,875,941 $10,429,304 $22,304,257
Cost of goods
sold.............. 117,326 13,069 355,466 2,215,306 14,024,523 37,315,413 6,628,913 13,909,147
-------- ------- -------- ---------- ----------- ----------- ----------- -----------
Gross profit....... 95,258 8,483 232,452 1,412,990 7,090,791 22,560,528 3,800,391 8,395,110
-------- ------- -------- ---------- ----------- ----------- ----------- -----------
Advertising
expense........... 375 -- 106,339 468,146 3,485,619 24,206,857 2,003,660 5,410,276
Other selling,
general and
administrative
expenses.......... 78,209 9,369 211,559 573,166 2,459,602 7,334,668 1,134,266 2,589,829
-------- ------- -------- ---------- ----------- ----------- ----------- -----------
Total selling,
general and
administrative
expenses.......... 78,584 9,369 317,898 1,041,312 5,945,221 31,541,525 3,137,926 8,000,105
-------- ------- -------- ---------- ----------- ----------- ----------- -----------
Income (loss) from
operations........ 16,674 (886) (85,446) 371,678 1,145,570 (8,980,997) 662,465 395,005
Other income
(expense), net.... -- -- (9,105) (23,315) (113,162) 445,710 80,236 84,385
-------- ------- -------- ---------- ----------- ----------- ----------- -----------
Income (loss)
before benefit
(provision) for
income taxes...... 16,674 (886) (94,551) 348,363 1,032,408 (8,535,287) 742,701 479,390
Benefit (provision)
for income taxes.. -- -- -- -- -- 642,679 (953,908) (182,213)
-------- ------- -------- ---------- ----------- ----------- ----------- -----------
Net income
(loss)(2)......... $ 16,674 $ (886) $(94,551) $ 348,363 $ 1,032,408 $(7,892,608) $ (211,207) $ 297,177
======== ======= ======== ========== =========== =========== =========== ===========
Basic and diluted
net income (loss)
per common share.. $ (1.27) $ (0.04) $ 0.05
=========== =========== ===========
Pro Forma Statement
of Operations
Data:
Income (loss)
before benefit
(provision) for
income taxes...... $(94,551) $ 348,363 $ 1,032,408 $(8,535,287) $ 742,701 $ 479,390
Pro forma benefit
(provision) for
income taxes...... 36,402 (134,120) (397,477) 642,679 (278,337) (182,213)
-------- ---------- ----------- ----------- ----------- -----------
Pro forma net
income (loss)(3).. $(58,149) $ 214,243 $ 634,931 $(7,892,608) $ 464,364 $ 297,177
======== ========== =========== =========== =========== ===========
Pro forma basic net
income (loss) per
common share...... $ 0.14 $ (1.27) $ 0.08 $ 0.05
=========== =========== =========== ===========
Pro forma diluted
net income (loss)
per common
share(4).......... $ 0.13 $ (1.27) $ 0.08 $ 0.05
=========== =========== =========== ===========
Balance Sheet Data
(at end of
period):
Working capital
(deficit)......... $ 13,449 $11,762 $(12,093) $ (204,080) $(1,621,522) $11,844,537 $19,224,770 $10,327,024
Total assets....... 25,574 23,687 243,845 1,156,646 7,781,064 18,016,136 28,525,698 22,438,188
Total debt
(including current
portion).......... -- -- 207,864 370,705 2,759,837 66,877 85,237 58,056
Stockholder's
equity (deficit).. 22,818 21,032 (28,412) 146,359 854,358 14,832,825 22,528,525 13,320,738
</TABLE>
16
<PAGE>
- --------
(1) The historical financial and operating data of the Predecessor was derived
from the historical financial and operating data of Discount Lens Club.
(2) Prior to February 9, 1998, we were an S corporation and were not subject to
federal and certain state income taxes.
(3) Pro forma net income (loss) reflects historical net income less pro forma
income taxes. Pro forma income taxes are provided, as if we had been a C
corporation rather than an S corporation for the above periods. Prior to
the closing of our IPO, our S corporation status was terminated; at that
date, we recorded a non-recurring, non-cash charge to earnings to recognize
deferred income taxes.
(4) Pro forma diluted net income (loss) per common share is based on the
weighted average shares of common stock and stock equivalents outstanding,
including actual shares outstanding and shares deemed to be outstanding
determined using the treasury stock method. The shares deemed to be
outstanding for 1997 include the number of shares sufficient to fund the
net S corporation distribution of approximately $983,000. See "Dividend
Policy."
17
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Overview
We believe we are the world's largest direct marketer of contact lenses. We
were formed in February 1995 and are the successor to the mail order business
founded by our Vice President of Operations in March 1991. Since our formation,
we have experienced significant growth in net sales. Our net sales have grown
rapidly, from $3.6 million in 1996 to $59.9 million in 1998 and from $10.4
million in the first quarter of 1998 to $22.3 million in the first quarter of
1999.
Prior to consummation of our IPO in February 1998, we 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, we revoked our S
Corporation status and became subject to federal and state income taxes. As a
result, we 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, we changed from a calendar year end to a 52/53
week year ending on the Saturday nearest to December 31. Due to this change,
fiscal year 1998 represents 52 weeks and 3 days, covering the period January 1,
1998 to January 2, 1999 and the first quarter of 1998 represents 13 weeks and 3
days.
During 1998, we 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, we determined that our 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, we 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 our printed
advertisements within and between quarters. The volume of mailing and other
advertising may vary in different quarters and from year to year depending on
our assessment of prevailing market opportunities.
The sale and delivery of contact lenses are generally governed by state laws
and regulations. We sell 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. Our
operating practice is to attempt to obtain a valid prescription from each of
our customers or his/her eyecare practitioner. If we are unable to obtain a
copy of or verify the customer's prescription, our practice is to ship the
lenses to the customer based on the information that the customer has provided.
We retained legal counsel to identify and summarize the applicable laws of each
of the states in which we generate material sales. We compared our operations
to the applicable requirements of the laws contained in such summaries. Based
on such comparison, we estimate that approximately one-third of our 1998 net
sales appeared to conform to the requirements of applicable state laws and
regulations.
18
<PAGE>
Results of Operations
The following table presents our results of operations expressed as a
percentage of net sales for the periods indicated:
<TABLE>
<CAPTION>
First
Fiscal
Fiscal Year Quarter
------------------- ------------
1996 1997 1998 1998 1999
----- ----- ----- ----- -----
<S> <C> <C> <C> <C> <C>
Net sales................................. 100.0% 100.0% 100.0% 100.0% 100.0%
Cost of goods sold........................ 61.1 66.4 62.3 63.6 62.4
----- ----- ----- ----- -----
Gross profit.............................. 38.9 33.6 37.7 36.4 37.6
Selling, general and administrative
expenses................................. 28.7 28.2 52.7 30.1 35.9
----- ----- ----- ----- -----
Income (loss) from operations............. 10.2 5.4 (15.0) 6.3 1.7
Other income (expense), net............... (0.6) (0.5) 0.7 0.8 0.4
----- ----- ----- ----- -----
Income (loss) before benefit (provision)
for income taxes......................... 9.6 4.9 (14.3) 7.1 2.1
Pro forma benefit (provision) for income
taxes.................................... (3.7) (1.9) 1.1 (2.6) (0.8)
----- ----- ----- ----- -----
Pro forma net income (loss)............... 5.9% 3.0% (13.2)% 4.5% 1.3%
===== ===== ===== ===== =====
</TABLE>
Quarter Ended April 3, 1999 Compared to Quarter Ended April 4, 1998
Net sales. Net sales for the quarter ended April 3, 1999 increased 114% to
$22.3 million from $10.4 million for the quarter ended April 4, 1998. We
believe that this increase in net sales reflects some of the benefits of our
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. We are 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 we believe that sales will increase substantially in 1999 as
compared to 1998, we expect the rate of growth in net sales 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, we were 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 our decision in the fourth quarter
of 1998 to begin to expense all advertising costs when the advertising first
takes place and the increase in sales and marketing activity and the related
increase in general and administrative expenditures considered necessary to
support our 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. We expect
that advertising spending as well as advertising as a percentage of sales in
fiscal year 1999 will be slightly less than in fiscal year 1998. However, if
opportunities present themselves, we may increase advertising spending above
currently planned levels.
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.
Income taxes. The pro forma provision for income taxes for the first quarter
of 1998 has been determined assuming we had been taxed as a C corporation for
federal and state income tax purposes for the quarter. Our
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future effective tax rate will depend upon future taxable income and changes in
the valuation allowance associated with the deferred tax assets. We anticipate
that our future effective income tax rate will be approximately 38%.
Year Ended January 2, 1999 Compared to Year Ended December 31, 1997
Net sales. Net sales for the year ended January 2, 1999 increased 184% to
$59.9 million from $21.1 million for the year ended December 31, 1997. We
believe that this increase in net sales reflects some of the benefits of our
increased television and Internet advertising. We are also realizing the
benefits of repeat sales from a growing customer base. Repeat sales in fiscal
1998 reached $22.6 million, exceeding total net sales for 1997 of $21.1
million.
Gross profit. Gross profit as a percentage of sales increased to 37.7% for
the year ended January 2, 1999 from 33.6% for the year ended December 31, 1997.
With the increase in sales, we were 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 year ended January 2, 1999 increased 431% to
$31.5 million from $5.9 million for the year ended December 31, 1997. As a
percentage of net sales, selling, general and administrative expenses increased
to 52.7% in fiscal 1998 from 28.2% in 1997. During fiscal 1998, we continued to
increase our sales and marketing activity. Advertising as a percentage of sales
was 40.4% in fiscal 1998 as compared to 16.5% in 1997.
During 1998, we 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, we determined that our 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, we began expensing all advertising costs, including
all direct-mail advertising costs, when the advertising first takes place. We
also determined that for previously deferred advertising costs the period
during which the future benefits were expected to be received was shortened and
accordingly is amortizing the balance at the beginning of the fourth quarter of
1998 over five months.
Other income (expense), net. The increase in other income (expense) is due
to interest income from funds received in our IPO 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 we had been taxed as a C corporation for federal and state income tax
purposes for the year.
Year Ended December 31, 1997 Compared to Year Ended December 31, 1996
Net sales. Net sales for the year ended December 31, 1997 increased 482% to
$21.1 million from $3.6 million for the year ended December 31, 1996. This
increase was primarily attributable to higher sales volumes due to additional
sales and marketing activities.
Gross profit. Gross profit as a percentage of sales decreased to 33.6% for
the year ended December 31, 1997 from 38.9% for the year ended December 31,
1996. Our gross profit margin for the year ended December 31, 1996 was
positively impacted by the sale of manufacturers' promotional products, which
generally have higher margins.
Selling, general and administrative expenses. Selling, general and
administrative expenses for the year ended December 31, 1997 increased 471% to
$5.9 million from $1.0 million for the year ended December 31, 1996 due to the
increase in sales and marketing activity and the related increase in
expenditures necessary to
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support the increased sales. As a percentage of net sales, selling, general and
administrative expenses decreased to 28.2% in 1997 from 28.7% in 1996. This
decrease was largely due to the fixed nature of many such expenses, including
rent, salaries, depreciation and certain equipment costs.
Other income (expense), net. The decrease in other income (expense) was
primarily attributable to an increase in interest expense due to increased
borrowings by us from one of our stockholders and under our credit facility.
This increase in interest expense was offset partially by an increase in other
income primarily due to an increase in interest income from stockholders' notes
receivable.
Income taxes. The pro forma provision for income taxes was determined
assuming we had been taxed as a C corporation for federal and state income tax
purposes for 1997 and 1996.
Liquidity and Capital Resources
We have historically funded our growth through a combination of funds
generated from operations and borrowings. During February 1998, we issued
2,213,750 shares of common stock in connection with our 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. We 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, we generally carry a higher level of inventory than if we
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 our growth as we significantly increased inventory
levels and advertising spending.
For 1998, 1997 and 1996, net cash provided by (used in) operating activities
was approximately $(13.8) million, $(1.0) million and $0.1 million,
respectively. For all years, cash was used primarily to fund our growth as we
increased inventory levels and advertising spending.
We 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 amounts related to capital expenditures for the 1999 and 1998 periods were
approximately $443,000 and $418,000 (including approximately $287,000 in
deposits), respectively. We began operations in our 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. We anticipate additional capital expenditures for infrastructure as we
continue to expand and improve operating facilities, telecommunications systems
and management information systems in order to handle future growth.
On May 4, 1999, we 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.
We used approximately $2.0 million, $0.9 million and $0.4 million for
investing activities in 1998, 1997 and 1996, respectively. The majority of
these amounts relate to capital expenditures for infrastructure improvements
and increases in notes receivable from shareholders. We 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 1998, 1997 and 1996 were
approximately $2,013,000, $488,000 and $175,000, respectively. We completed the
move into our new call center during July 1998. In conjunction with the move,
we acquired new telecommunications systems and enhanced our management
information systems.
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During the first quarter of 1999, we used approximately $1.8 million for
financing activities. We repurchased a total of 155,000 shares of our 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 quarter of 1998,
approximately $19.6 million was provided by financing activities, resulting
from net proceeds received from our IPO, offset by repayments of debt,
distributions to stockholders and the repurchase of stock.
For 1998, net cash of approximately $19.6 million was provided by financing
activities, resulting from net proceeds received from our IPO, offset by
repayments of debt, distributions to stockholders (S corporation distribution)
and repurchase of stock. For 1997 and 1996, net cash of approximately $1.9
million and $0.3 million, respectively, was provided by financing activities.
These amounts primarily represent borrowings from one of our stockholders and
borrowings under our credit facility.
On October 13, 1998, our board of directors authorized a repurchase of up to
500,000 shares of our 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 April 3,
1999, we have repurchased 170,000 shares for a total cost of $1,941,380. The
repurchases were funded using cash on hand.
In August 1997, we established a revolving credit facility to provide for
working capital requirements and other corporate purposes. We 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 (9.25 percent
at April 3, 1999). As of April 3, 1999, we had no outstanding borrowings under
the credit facility. The credit facility is secured by substantially all of our
assets and contains financial covenants customary for this financing.
We believe that the net proceeds from this offering, together with cash on
hand, cash generated from operations and the cash available through our credit
facility, will be sufficient to support current operations and future growth
through fiscal 2000. We 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 our planned growth, which could
adversely affect our business, financial condition and results of operations.
As a result of state regulatory requirements, our liquidity, capital
resources and results of operations may be negatively impacted in the future if
we incur increased costs or fines, are prohibited from selling our products in
a particular state(s) or experience losses of a substantial portion of our
customers for whom we are 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 our current computer applications and
internal technology systems, we believe all of our applications and internal
technology systems are substantially Year 2000 compliant. To ensure we are Year
2000 compliant, we are currently taking steps to perform a more in-depth
analysis and testing of Year 2000 compliance on our computer applications,
internal technology systems and embedded technology. We do not expect Year 2000
compliance to be a major issue since we have replaced or upgraded the majority
of our critical technology systems within the last two years. However, we
believe that after completing this in-depth analysis and testing we 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 our operations.
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We are currently unable to determine the effects of Year 2000 compliance by
third parties that are significant to our operations. We have received several
responses to correspondence sent to significant third parties. We are reviewing
these responses to assess the third parties' Year 2000 compliance and to
determine the extent to which our 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, our operations
will be adversely affected.
We have not yet incurred any significant costs related to Year 2000
compliance. Once we have completed the above steps, we will be able to
determine any significant future costs associated with Year 2000 compliance.
Although we have not yet approved a formal Year 2000 contingency plan, we have
manual processes, which can be used in the event of system disruption. We
expect to approve a formal contingency plan during 1999.
Seasonality
We do not believe that seasonality has had a material effect on our
operations for the quarter ended April 3, 1999 and for the three years ended
January 2, 1999.
Inflation
We do not believe that inflation has had a material effect on our operations
for the quarter ended April 3, 1999 and for the three years ended January 2,
1999.
Quantitative and Qualitative Disclosures About Market Risk
Based on our current operations, we believe we are not subject to
significant market risk. As of April 3, 1999, we 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 our transactions are in U.S.
dollars.
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BUSINESS
Overview
We believe that we are the world's largest direct marketer of replacement
contact lenses. Through our easy-to-remember, toll-free telephone number, "1-
800 CONTACTS" (1-800-266-8228), and increasingly through our Internet
addresses, which include "www.1800contacts.com," "www.contacts.com" and
"www.contactlenses.com," we sell all of the most popular brands of contact
lenses, including those manufactured by Johnson & Johnson, CIBA Vision, Bausch
& Lomb, Wesley Jessen, Ocular Sciences and CooperVision. Our high volume, cost-
efficient operations supported by our proprietary management information
system, enable us to offer our products at competitive prices while delivering
a high level of customer service. As a result of our extensive inventory, we
generally ship approximately 90% of our orders within one business day of
receipt. We believe that we offer our customers an attractive alternative for
obtaining replacement contact lenses in terms of convenience, price and speed
of delivery. Our net sales have grown rapidly, from $3.6 million in 1996 to
$59.9 million in 1998 and from $10.4 million in the first quarter of 1998 to
$22.3 million in the first quarter of 1999.
The Internet is our fastest-growing sales channel and a more cost-effective
way for us to serve our customers. Our Internet sales have increased from just
$44,000, or 0.4% of net sales, during the first quarter of 1998 to $2.5
million, or 11.2% of net sales, during the first quarter of 1999. Selling our
products over the Internet eliminates the payroll and long distance costs
associated with a telephone order. This increased efficiency allows us to offer
Internet customers free shipping in addition to other services not possible
with phone orders such as shipping confirmation and online order tracking. We
believe that our customers will increasingly use the Internet to order and
reorder replacement contact lenses.
We market our products through a national advertising campaign. As compared
to other direct marketers of replacement contact lenses, we believe that our
toll-free telephone number and Internet addresses afford us a significant
competitive advantage in generating consumer awareness and repeat business. We
spent approximately $22.7 million on advertising in 1998 and intend to use a
significant portion of the net proceeds from this offering to further increase
our sales and marketing activities. Our experience has been that increases in
advertising expenditures have a direct impact on the growth of net sales. We
believe that the planned increase in advertising activities will enable us to
attract significant numbers of new customers. In particular, our new marketing
campaign will be designed to continue to build brand awareness and to more
prominently feature our Internet address, www.contacts.com.
Industry Overview
Industry analysts estimate that over 50% of the United States' population
need some form of corrective eyewear. Contact lenses have become a convenient,
cost effective alternative to eyeglasses, and the number of contact lens
wearers is expected to increase as technology further improves the convenience,
comfort and fit of contact lenses. As a result, the contact lens market is
large and growing. We estimate, based on published reports, that the U.S.
retail market for contact lenses was approximately $3.0 billion in 1998 and,
according to industry analysts, is expected to grow at 4% to 6% in 1999, with
the disposable market growing at 8% to 12%. The growth in the disposable market
is largely due to the shift in the contact lens market away from traditional
soft lenses, which generally are replaced on an annual basis, to disposable
lenses, which are replaced on a daily, weekly, or bi-weekly basis.
Traditionally, contact lenses were almost exclusively sold to consumers by
either ophthalmologists or optometrists (referred to in this prospectus
collectively as "eye care practitioners"). Eye care practitioners would
typically supply a patient with his or her initial pair of contact lenses in
connection with providing the patient an eye examination and all replacement
lenses, regardless of whether the patient was given or required another eye
examination. Because the initial fitting of contact lenses requires a
prescription written by an eye care practitioner, the initial sale of contact
lenses still takes place primarily in this manner. Over the last
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decade, however, a number of alternative sellers of replacement contact lenses
have emerged, including direct marketers.
We believe that increased consumer awareness of the benefits of the direct
marketing of contact lenses will lead to further growth of direct marketing.
Purchasing replacement contact lenses from a direct marketer offers the
convenience of shopping at home, rapid home delivery, quick and easy telephone
or Internet ordering and competitive pricing. In addition, the growth in
popularity of disposable contact lenses, which require patients to purchase
replacement lenses more frequently, has contributed to the growth of the direct
marketing channel. We estimate that direct marketers accounted for
approximately 5% of contact lens sales in the United States during 1998. The
direct marketing industry continues to grow as many retail customers have
migrated towards the convenience and service offered by home shopping, and we
expect the direct marketing segment of the contact lens industry to grow in
tandem with the growth in the direct marketing industry as a whole.
The enormous growth and acceptance of the Internet as a medium of
communication and commerce presents significant opportunities for direct
marketers of contact lenses such as 1-800 CONTACTS. According to Dataquest,
more than 43 million households in America currently have Internet access and
that number is projected to grow to nearly 95 million households in 2001. The
factors driving this growth include the increasing number and decreasing cost
of personal computers in homes and offices, technological innovations providing
easier, faster and cheaper access to the Internet, the proliferation of content
and services being provided on the Internet and the increasing use of the
Internet by business and consumers as a medium for conducting business.
The Internet possesses a number of unique and commercially powerful
characteristics that differentiate it from traditional media: users communicate
or access information without geographic limitations; users access dynamic and
interactive content on a real-time basis; and users communicate and interact
instantaneously. The Internet has created a dynamic and particularly attractive
medium for commerce, empowering customers to gather more comparative purchasing
data than is feasible with traditional commerce systems, to shop in a more
convenient manner and to interact with sellers in many new ways. Forrester
Research estimates that online retail revenues will increase from approximately
$4.8 billion in 1998 to approximately $17.4 billion in 2001. We believe that
the Internet provides a convenient and efficient medium for the sale of
replacement contact lenses.
Historically, sales of contact lenses by direct marketers have been impeded
by eye care practitioners and contact lens manufacturers. Many eye care
practitioners have been reluctant to provide patients with a copy of their
prescription or to release such information to direct marketers upon request,
thereby prohibiting such patients from purchasing lenses from a direct
marketer. In addition, substantially all of the major manufacturers of contact
lenses have historically refused to sell contact lenses directly to direct
marketing companies and have sought to prohibit their distributors from doing
so. These traditional barriers to the direct marketing of contact lenses may be
reduced or eliminated in the future. The Federal Trade Commission (the "FTC")
has from time to time solicited comments regarding whether eye care
practitioners should be required to release contact lens prescriptions to their
patients. In addition, the Attorneys General for more than 30 states have
joined in a lawsuit against the major contact lens manufacturers and certain
eye care practitioners and their trade associations alleging that the
manufacturers' policy not to sell to direct marketers was adopted in conspiracy
with eye care practitioners to eliminate alternative channels of trade from the
contact lens market. See "Government Regulation," and "Purchasing and Principal
Suppliers."
Competitive Strengths
We attribute our success in the direct marketing segment of the contact lens
industry and our significant opportunities for growth to several competitive
strengths, including the following:
. 1-800 CONTACTS Telephone Number. We believe that our easy-to-remember,
toll-free telephone number, 1-800 CONTACTS, affords us a significant
competitive advantage over other direct marketers
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of contact lenses in our ability to generate consumer awareness in a cost-
effective manner. We believe, based upon an independent source, that
"vanity" numbers, like 1-800 CONTACTS, generate higher response rates than
traditional 1-800 numbers. After we first began using the 1-800 CONTACTS
number in July 1995, net sales per advertising dollar increased by over
20%. We believe that we enjoy a higher customer retention rate and higher
response rate due in large part to the top-of-mind awareness generated by
the 1-800 CONTACTS telephone number.
. Internet Addresses. We believe that our Internet addresses,
www.1800contacts.com, www.contacts.com and www.contactlenses.com, contain
the terms that are most commonly used by consumers to search the Internet
for a direct marketer of replacement contact lenses. The Internet is our
fastest-growing sales channel and represents a significant opportunity
for us to increase our net sales as the Internet grows in popularity as a
medium of commerce.
. Proprietary Management Information System. We believe that the operating
efficiency resulting from our proprietary management information system
gives us a significant competitive advantage over other direct marketers.
Our management information system enables us to process both telephone
and Internet orders, continually monitor and track our inventory levels
on substantially all of our products, rapidly process credit card orders,
increase the speed of the shipping process and increase accuracy through
the scanning of each order prior to shipment. We believe that our system
is capable of supporting our anticipated sales growth in the foreseeable
future.
. Extensive Inventory; Convenient, Rapid Delivery. We stock a large
inventory of lenses from which we can ship approximately 90% of our
orders within one business day of receipt. Customers generally receive
their lenses from us in one to five business days after shipping,
depending on whether the customer chooses standard delivery or pays an
additional charge for delivery by an overnight courier. We believe that
our extensive inventory of over six million contact lenses allows us to
deliver lenses to the customer quicker, on average, than eye care
practitioners or optical chains, which generally have smaller inventories
and place orders for lenses less frequently. In addition, lenses ordered
from us are delivered directly to the home or office of the customer, a
service which most eye care practitioners, optical chains and discount
stores do not offer.
. Customer Service. We believe that we provide better customer service to
replacement lens purchasers than traditional contact lens distributors.
Delivering high quality, consistent customer service has been a
cornerstone of our strategy since our inception. Our customer service
representatives ("CSRs") are trained to provide efficient and accurate
order entry and are able to provide each customer with real time product
availability information and the estimated delivery date for their
lenses. In addition, our CSRs are trained and authorized to handle all
customer service issues, including accepting product returns and issuing
refunds, if appropriate. We believe that consistently providing every
customer with prompt and courteous service throughout their relationship
with us increases our ability to attract and retain customers.
. Loyal Customer Base. We have built a loyal customer base due largely to
our focus on delivering a high level of customer service. As of April 3,
1999, we had a customer base of over 800,000 customers. For the twelve
month period ended May 31, 1998, each $1.00 of sales to new customers
generated $0.78 of reorder sales in the succeeding 12 month period.
Approximately $10.7 million of our net sales in the first quarter of 1999
were to repeat customers, compared to sales to repeat customers of
approximately $3.9 million in the comparable period in 1998. We expect
our sales to repeat customers to continue to grow as the contact lens
market continues to shift towards disposable lenses and consumers
increase the frequency with which they replace their lenses.
Growth Strategy
We believe that we have significant opportunities to attract and retain new
customers and increase sales through several strategic initiatives, including
the following:
. Increase Brand Awareness. We recently commissioned a study that showed
that only 13% of contact lens wearers are aware of the convenient, cost-
effective alternative available to them through
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1-800 CONTACTS. Our goal is to make the 1-800 CONTACTS brand synonymous
with obtaining replacement contact lenses. To do this, we intend to use a
significant portion of the net proceeds from this offering to increase
brand awareness for 1-800 CONTACTS and our related website,
www.contacts.com, through a nationwide advertising campaign utilizing
broadcast, print and Internet media. In addition, we intend to expand our
direct marketing campaign to our over 800,000 customers through the U.S.
mail and initiate an e-mail-based campaign.
. Expand Internet-based Advertising and Sales. To date, we have spent only
a very small percentage of our advertising budget on Internet-based
advertising. We intend to capitalize on our Internet addresses and
website by significantly increasing our advertising and other investments
in Internet-based sales.
. Pursue Acquisitions and Strategic Partnerships. We recently acquired
certain assets of Contact Lenses Online, including its customer list,
Internet addresses and telephone numbers. We believe that the highly
fragmented nature of our industry affords us significant opportunities to
make additional acquisitions. As a result, we intend to continue to
actively pursue strategic acquisitions and partnerships with companies
that will allow us to increase our customer base and enhance our brand
awareness.
. Pursue International Expansion. We derived less than 1% of our net sales
in 1998 from international sales. According to published reports, the
international market for retail contact lens sales was approximately $1.5
billion in 1998. We believe that this market is currently under-served by
direct marketing companies and are exploring options with potential
partners to penetrate the international markets in Europe and Asia.
. Enhance Customer Relationships. We intend to enhance our relationships
with customers, encouraging more frequent and more extensive use of our
website by introducing enhanced product-related content and interactive
features. For example, we are currently upgrading our website to enable
repeat customers to reorder online in a few easy steps. We believe that
the number of reorders placed on the Internet will continue to grow as
our customer base increases and the Internet becomes more widely accepted
as a medium for commerce. In addition, we are expanding our CSR training
program in order to improve customer service. We believe that the key to
retaining our customers is to provide a competitive price and convenient
delivery while providing superior customer service.
Product Offerings
Contact lenses can be divided into two categories: soft lenses and hard
lenses (primarily rigid gas permeable). There are three principal wearing
regimes for soft contact lenses: conventional, disposable and planned
replacement. Conventional lenses are designed to be worn indefinitely, but are
typically replaced after 12 to 24 months. Disposable soft contact lenses were
introduced in the late 1980s based on the concept that changing lenses on a
more regular basis was important to comfort, convenience, maintaining healthy
eyes and patient compliance. Disposable lenses are changed as often as daily
and up to every two weeks, depending on the product. Planned replacement lenses
are designed to be changed as often as every two weeks and up to every three
months and currently represent a small portion of the overall soft lens market.
We are a direct marketer of replacement contact lenses and do not
manufacture contact lenses or provide eye examinations or related services to
our customers. We offer substantially all of the soft and hard contact lenses
produced by the leading contact lens manufacturers, including Johnson &
Johnson, CIBAVision, Bausch & Lomb, Wesley Jessen, Ocular Sciences and
CooperVision. We stock a large inventory of lenses from which we can ship
approximately 90% of our orders within one business day of receipt. We believe
that our ability to maintain a large inventory of contact lenses provides us
with a competitive advantage over eye care practitioners, optical chains and
discount stores and serves as an effective barrier of entry to potential
entrants in the direct marketing of contact lenses.
In July 1997, we were approved as an authorized distributor of CIBA Vision.
We also purchase product directly from certain other manufacturers. Our
products are delivered in the same sterile, safety sealed containers in which
the lenses were packaged by the manufacturer. From time to time, we purchase
contact lenses that were labeled as "samples" by the manufacturer. Such lenses
are sometimes offered by us to customers as part of promotional programs at
reduced prices.
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Customers and Marketing
Our customers are located principally throughout the United States. The
percentage of our customers that are located in each state is approximately
equal to the percentage of the United States' population which resides in such
state, with the largest concentration of our customers residing in California.
We strive to deliver a high level of customer service in an effort to maintain
and expand our loyal customer base. We utilize a focused, closely managed and
monitored marketing strategy that is designed to enhance the awareness and
value of our brand. We continually research and analyze new ways in which to
advertise our products. After identifying an attractive potential new
advertisement or advertising medium, we commit to such advertising for an
initial test period. The response generated by such advertising is monitored
and analyzed by us and a decision to commit significant resources to a
particular advertisement or advertising medium is made only if we are
satisfied with the response rates we have generated. After the initial testing
period, we continue to closely monitor our advertising in order to identify
and react to trends in consumer response patterns and adjust our marketing
strategy accordingly.
The majority of contact lens wearers are between the ages of 18 and 39. In
addition, approximately two thirds of contact lens wearers are women and
contact lens wearers generally have higher incomes than eyeglass wearers do.
Through our national advertising campaign, we are able to target our
advertising to contact lens wearers in these key demographic groups, as well
as certain other persons based on other important demographics.
Using the proceeds from the IPO, we significantly expanded our sales and
marketing activities in 1998 to attract new customers and increase sales to
existing customers. We spent an aggregate of $22.7 million in 1998 on
advertising as compared to $4.8 million in 1997. We increased our use of
direct mailings, cooperative mailings and free standing inserts, and began
advertising in mediums not previously utilized, including television,
magazines, traditional newspaper advertisements, radio and Internet
advertising.
A brief description of the principal components of our national advertising
campaign is set forth below:
Broadcast. In July 1998, we began our first nationwide broadcast
advertising campaign with significant purchases on both cable and network
television--testing different networks, commercial lengths and broadcast
times. We believe that this investment in television advertising was primarily
responsible for the 44% increase in sales in the third quarter of 1998. Our
television ads typically focus on our ability to rapidly deliver to customers
the same contact lenses offered by eye care practitioners. We believe that our
easy-to-remember phone number makes television a particularly effective
marketing vehicle and that television advertising will continue to be the key
to building awareness for our 1-800 CONTACTS and www.contacts.com brands.
Internet. We believe that we are one of our industry's leaders in
establishing an online advertising presence. We currently maintain an
advertising presence on several leading websites, including Yahoo!, America
Online, Excite, Infoseek and Lycos. We intend to continue to seek new
opportunities to expand this presence within top-tier portal sites and highly
trafficked content sites. We intend to significantly expand our Internet
advertising and marketing efforts with a portion of the proceeds from this
offering.
Direct-Mailing. We use direct-mail to advertise our products to selected
groups of consumers. We utilize mailing lists obtained from both private and
public sources to target our advertisements specifically to contact lens
wearers.
Cooperative Mailings. We advertise our products in cooperative mail
programs sponsored by the leading cooperative mail companies in the United
States. This advertising medium permits us to target consumers in specific zip
codes according to age, income and other important demographics.
Free Standing Inserts. From time to time, we advertise our products through
free standing inserts, which are typically glossy advertisements included
inside the comic section of the Sunday paper. We use this advertising medium
due to its ability to reach a large audience in a cost-effective manner. We
utilize these inserts to supplement our direct and cooperative mailing
programs.
Magazines and Newspapers. From time to time, we also purchase
advertisements in national magazines and newspapers. We use this advertising
medium due to its ability to reach a large audience and its scheduling
flexibility.
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Management Information System
We have developed a proprietary management information system that
integrates our order entry and order fulfillment operations. We believe that
this system enables us to operate efficiently and provide enhanced customer
service. The key features of this management information system are its ability
to:
. process both telephone and Internet orders;
. continually monitor and track our inventory levels for substantially all
of our products;
. rapidly process credit card orders;
. increase the speed of the shipping process with integrated and automated
shipping functions; and
. increase accuracy through the scanning of each order prior to shipment to
ensure it contains the correct quantity and type of lenses.
The management information system provides our CSRs with real-time product
availability information for substantially all of our products through a direct
connection with our distribution center, whereupon information is immediately
updated as lenses are shipped. The management information system also has an
integrated direct connection for processing credit card payments which allows
the CSR to charge the customer's card and ensure that a valid card number and
authorization have been received in approximately five seconds while the CSR is
on the phone with the customer. CSRs also have access to records of all prior
contact with a customer, including the customer's address, prescription
information, order history and payment history and notes of any prior contact
with the customer made by phone, Internet, mail or fax. Based on product
availability provided by the management information system, the CSR provides
the customer with an estimated date of delivery of their lenses. If a
customer's order will not be shipped by the promised delivery date, the
management information system notifies the CSR who entered the order, and any
information explaining the delay, and the CSR then contacts the customer to
inform them of the delay.
After an order has been entered into the management information system by a
CSR, it is sent to our distribution center via a direct connection. After the
distribution center receives the order, the invoice for the order is printed.
The invoice for each order contains the type and quantity of the lenses, as
well as a shipping label for the order. Tracking, manifesting, billing and
other shipping functions are integrated into our management information system
so that all necessary bar codes and tracking information for shipment via
independent couriers are printed directly on our shipping label, and separate
labeling or a separate computer is not needed to ship packages via independent
couriers.
After the invoice for an order is printed at our distribution center, the
order is pulled from inventory and scanned to ensure that the prescription and
quantity of each item matches the order in our management information system.
Audible notices inform the shipping agent of any errors in the order. After the
order has been scanned for accuracy, the management information system updates
our inventory level, the order is placed in a box produced by our automated box
folder and is sent to an automatic sealer. After the package leaves the sealer,
another scanner reads the bar code on the shipping label to determine which
method of shipment is being used, adds the package to the appropriate carrier's
manifest and directs the appropriate hydraulic diverter to push the package
into the appropriate carrier's shipping bin.
We have installed a battery powered back-up system capable of supporting our
entire call center, computer room and phone switch. This system is further
supported by a generator capable of supporting our entire operation for a
period of five days. All critical data is simultaneously written to a series of
back-up drives throughout the day and at the end of the day our data is
transmitted to an offsite location. We cannot assure you that our back-up
system will be sufficient to prevent an interruption in our operations in the
event of disruption in our management information system, and an extended
disruption in the management information system could adversely affect our
business, financial condition and results of operations.
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Operations
The primary components of our operations include our teleservices, order
entry and customer service, Internet and distribution and fulfillment.
Teleservices, Order Entry and Customer Service. We provide our customers
with toll-free telephone access to our CSRs. Our call center generally operates
from 6:00 a.m. to 9:00 p.m. (MST) Monday through Friday, 7:00 a.m. to 5:00 p.m.
(MST) on Saturday and 8:00 a.m. to 4:00 p.m. (MST) on Sunday. Customers may
place orders via the Internet 24 hours a day, 7 days a week. Potential
customers may also obtain product, pricing or other information over the
Internet or through our interactive voice response system. Our orders are
received by phone, Internet, mail, facsimile and electronic mail. CSRs process
orders directly into our proprietary management information system, which
provides customer order history and information, product specifications,
product availability, expected shipping date and order number. CSRs are
provided with a sales script and are trained to provide information about
promotional items. Additionally, CSRs are trained to provide customer service
and are authorized to resolve all customer service issues, including accepting
returns and issuing refunds, as appropriate. For the first quarter of 1999, our
call center received an average of approximately 5,000 calls per day.
We believe our customers are particularly sensitive to the way merchants and
salespeople communicate with them. We strive to hire energetic, service-
oriented CSRs who can understand and relate to customers. CSRs participate in a
training program that includes a mentor system for working with more
experienced personnel. After training, CSRs are monitored to review performance
and are retrained periodically.
We completed the move into our new call center during July 1998. In
conjunction with the move, we acquired new telecommunications systems and
enhanced our management information systems. In our current facility, we
believe we have the capacity to handle up to 30,000 calls per day. We believe
that we process telephone orders on average in less time than our competitors,
which allows each CSR to handle a greater number of orders per day.
The laws in most states require that contact lenses be sold pursuant to a
valid prescription. Our operating practice is to attempt to obtain a valid
prescription from each of our customers or his/her eye care practitioner.
Customers may mail a copy of their prescription with their order or send it to
us via facsimile. Upon receipt of a prescription from a patient, the
prescription is filled by us. If we are unable to obtain a copy of or verify
the customer's prescription, it is our practice to ship the lenses to the
customer based on the information that the customer has provided.
Internet. Our website at www.contacts.com provides our customers with a
quick, efficient and cost-effective method for obtaining replacement contact
lenses. Our website allows customers to easily browse and purchase
substantially all of our products, promotes brand loyalty and encourages repeat
purchases by providing an inviting customer experience. We have designed our
website to be fast, secure and easy to use and to enable our customers to
purchase products with minimal effort. We also offer Internet purchasers with
services not available to telephone orders such as free shipping, shipping
confirmation and online order tracking.Through our call center, we offer
service and support to our customers during our call center's operating periods
over the telephone. We also provide real-time online messaging and e-mail
support to our customers. Our website allows customers to dispense with
providing personal profile and payment information after their initial order.
Our website has permitted us to expand our customer base through better service
while reducing transactional costs.
Our online service automates the processing of customer orders, interacts
with our management information system and allows us to gather, store and use
customer and transaction information in a comprehensive and cost-efficient
manner. Our website contains customized software applications that interface
with our management information system.
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We maintain a database containing information compiled from customer
profiles, shopping patterns and sales data. We analyze information in this
database to develop targeted marketing programs and provide personalized and
enhanced customer service. Our database is scaleable to permit large
transaction volumes. Our systems support automated e-mail communications with
customers to facilitate confirmations of orders, provide customer support,
obtain customer feedback and engage in targeted marketing programs.
We use a combination of proprietary and industry-standard encryption and
authentication measures designed to protect a customer's information. We
maintain an Internet firewall to protect our internal systems and all credit
card and other customer information.
Distribution and Fulfillment. Approximately 90% of our orders are shipped
within one business day of receipt. Customers generally receive orders within
one to five business days after shipping, depending upon the method of delivery
chosen by the customer. A shipping and handling fee is charged on each customer
order, except those orders received via the Internet and those received by mail
with an enclosed check. Customers have the option of having their order
delivered by overnight courier for an additional charge. Our management
information system automatically determines the anticipated delivery date for
each order.
We use an integrated packing and shipping system via a direct connection to
our management information system. This system monitors the in-stock status of
each item ordered, processes the order and generates warehouse selection
tickets and packing slips for order fulfillment operations. Our management
information system is specifically designed with a number of quality control
features to help ensure the accuracy of each order.
We began operations in our 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 airport. We believe that this new
distribution center has the capacity to support annual sales of $300 million.
Purchasing and Principal Suppliers
Historically, substantially all of the major manufacturers of contact lenses
have refused to sell lenses directly to direct marketers, including us, and
have sought to prohibit distributors from doing so. As a result, we currently
purchase a substantial portion of our products from unauthorized distributors.
We are aware that at least one large manufacturer of contact lenses puts
tracking codes on its products in an effort to identify distributors who are
selling to direct marketers. In June 1994, the Attorney General for the State
of Florida, acting on behalf of disposable contact lens consumers in that
State, filed an anti-trust action against Johnson & Johnson, CIBA Vision,
Bausch & Lomb and certain eye care practitioners and their trade associations
alleging, among other things, that, the contact lens manufacturers' policy not
to sell to mail order distributors and others was adopted in conspiracy with
eye care practitioners as the result of pressure by eye care practitioners in
order to eliminate alternative channels of trade from the disposable lens
market ("Florida Action").
In December 1996, the Attorney General for the State of New York, on behalf
of itself and the Attorney Generals for approximately 21 other States, filed a
substantially similar action naming three major manufacturers of soft contact
lenses as well as several optometrists and their trade associations as
defendants (the "New York Action"). Additional States have joined the New York
Action since it was filed, and the Florida Action and the New York Action have
been consolidated and are currently pending in the United States district Court
for the Eastern District of New York (the "Attorney General Action"). Based
upon public filings made in the Attorney General Action, we believe that one
defendant, CIBA Vision Corporation, has entered into a proposed settlement
agreement pursuant to which it has agreed to pay $5 million into a settlement
fund, agreed to provide rebates and coupons to consumers and agreed to begin to
sell soft contact lenses to direct marketers. Since this settlement agreement
was announced, we have become an authorized distributor of CIBA Vision's
contact lenses and can purchase such lenses at wholesale level prices.
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As a result of some manufacturers' refusal to sell to direct marketers, we
are not an authorized dealer for many of the products which we sell. In
addition, the price which we pay for certain of our products is sometimes
higher than those paid by eye care practitioners, retail chains and mass
merchandisers, who are able to buy directly from the manufacturers of such
lenses. Although we have been able to obtain most contact lens brands at
competitive prices in sufficient quantities on a regular basis, there can be no
assurance that we will not encounter difficulties in the future, particularly
in light of our anticipated growth. Our inability to obtain sufficient
quantities of contact lenses at competitive prices would have a material
adverse effect on our business, financial condition and results of operations.
Although we seek to reduce our reliance on any one supplier by establishing
relationships with a number of distributors and other sources, we purchased
from a single distributor 40% and 47% of our contact lens inventory in 1997 and
1998, respectively. We also purchased from another distributor approximately
40% and 21% of our contact lens inventory in 1996 and 1997, respectively. Our
top three suppliers accounted for approximately 72% and 70% of our inventory in
1997 and 1998, respectively. We believe that none of these suppliers is
authorized by contact lens manufacturers to distribute their products. We do
not have written agreements with any of these suppliers. We continually seek to
establish new relationships with potential suppliers in order to be able to
obtain adequate inventory at competitive prices.
Competition
The retail sale of contact lenses is a highly competitive and fragmented
industry. Traditionally, contact lenses were almost exclusively sold to
customers by eye care practitioners in connection with providing them an eye
examination. Competition for patients and the revenue related to providing them
contact lenses significantly increased as optical chains and large discount
retailers began providing optical services and has further intensified with the
entry of direct marketers such as us. We believe that the eye care profession
suffers from a surplus of eye care practitioners, and that the resulting
competitive pressure has been exacerbated by the increased prevalence of retail
optical chains, mass merchandisers and direct marketers. Consequently, the
competition amongst eye care practitioners to acquire customers and the
competition to provide replacement lenses to such customers has intensified.
Our principal competitors include ophthalmologists and optometrists in
private practice. We also compete with national optical chains, such as Cole
Vision, LensCrafters and National Vision Association and mass merchandisers,
such as Wal-Mart, Sam's and Costco. In addition, we compete with other direct
marketers of contact lenses. We may face increased competition in the future
from new entrants in the direct marketing business, which may include national
optical chains and mass merchandisers, some of which may have significantly
greater resources than us.
We believe that many of our competitors, including, most eye care
practitioners, national optical chains and mass merchandisers, have direct
supply arrangements with contact lens manufacturers, which in some cases
affords such competitors with better pricing terms and access to supply. In
addition, some of the competitors are significantly larger in overall revenues
and have significantly greater resources than we have. We believe that the
principal basis of competition in the industry include price, product
availability, customer service and consumer awareness.
Government Regulation
Federal Regulation. Contact lenses are regulated by the FDA as "medical
devices." The FDA classifies medical devices as Class I, Class II or Class III
and regulates them to varying degrees, with Class I medical devices subject to
the least amount of regulation and Class III medical devices subject to the
most stringent regulations. Rigid gas permeable and soft contact lenses are
classified as Class II medical devices if intended only for daily wear and as
Class III medical devices if intended for extended wear. These regulations
generally apply only to manufacturers of contact lenses, and therefore do not
directly impact us. Federal regulations also require the labels on "medical
devices" to contain adequate instructions for their safe and proper use.
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However, there is an exemption from this requirement for medical devices the
use of which is not safe except under the supervision of a practitioner
licensed by law to direct the use of such device. Devices which fall in this
exception must contain as part of their labeling the statement "Caution:
Federal law restricts this device to sale by or on the order of ," the
blank to be filled in with the word physician or other practitioner authorized
by the law of the state in which the practitioner practices to use or order the
use of the device. We believe that this exception is often misconstrued as
being a federal requirement that the device be sold only pursuant to a
prescription. The FDA considers contact lenses to qualify for this labeling
exemption; however, there is no federal law that requires that contact lenses
be sold only pursuant to a prescription.
State Regulation. Because there is no applicable federal law that regulates
the distribution of contact lenses, the sale and delivery of contact lenses to
the consumer is subject to state laws and regulations. We sell 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 laws and regulations governing the sale and
delivery of contact lenses vary from state to state, but generally can be
classified in five categories:
(1) laws that require contact lenses only be dispensed pursuant to a
prescription;
(2) laws that require the dispenser to be licensed by the state as an
optometrist, ophthalmologist or other professional authorized to
dispense lenses;
(3) laws that require lenses be dispensed only in a face-to-face
transaction;
(4) laws with requirements that are unclear or do not specifically address
the sale and delivery of contact lenses; and
(5)laws that we believe place no restrictions on the dispensing of
replacement contact lenses.
Many of the states requiring that contacts be dispensed in face-to-face
meetings or by a person licensed by such state to dispense lenses also require
that lenses only be dispensed pursuant to a valid prescription.
The laws and regulations in a significant number of states, including most
of the states wherein a large portion of our sales are concentrated, require
that contact lenses only be sold to a consumer pursuant to a valid
prescription. In some states, satisfying this prescription requirement
obligates the dispenser only to verify the customer's prescription with the
customer's prescriber, while other states specifically require that a written
prescription be obtained before providing the lenses to the customer. Our
operating practice is to attempt to obtain a valid prescription from each of
our customers or his/her eye care practitioner. If the customer does not have a
copy of his/her prescription, we attempt to contact the customer's doctor to
obtain a copy of, or verify the customer's prescription. If we are unable to
obtain a copy of or verify the customer's prescription, it is our practice to
complete the sale and ship the lenses to the customer based on the prescription
information provided by the customer. We retain copies of the written
prescriptions that we receive and maintain records of our communications with
the customer's prescriber.
Our ability to comply with state laws and regulations requiring a valid
prescription is hampered because our customers are often unable to get a copy
of their prescription. We believe that optometrists, ophthalmologists and other
contact lens prescribers have historically refused to release copies of a
patient's contact lens prescription to the patient. In addition, such providers
have refused to release or verify prescriptions at the request of mail order
companies. Federal law requires prescribers to release prescriptions for
eyeglasses to a patient, but the issue of whether or not a prescriber must
release a contact lens prescription to the patient, or at the patients request,
is currently governed by state law. There are approximately 22 states that
require contact lens prescribers to release the prescriptions for contact
lenses to the patient. However, even in states with a mandatory release law, we
believe that many prescribers continue to refuse to release prescriptions to
their patients or to mail order contact lens distributors, including us.
In addition to requiring a valid prescription, a substantial number of
states also require that contact lenses only be dispensed by a person licensed
to do so under that state's laws. A dispenser may be required to be
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licensed as an optometrist, ophthalmologist, optician, ophthalmic dispenser or
contact lens dispenser, depending on which state the customer is located in.
Neither we nor any of our employees is a licensed or registered dispenser of
contact lenses in many of the states in which we do business. The laws in a
small number of states effectively prohibit the sale of contacts through the
mail by requiring that a person licensed under that state's law to dispense
contacts be in personal attendance at the place of sale. In addition, there are
several states in which the laws and regulations do not specifically address
the issue of who may dispense contact lenses or are unclear with respect to the
requirements for dispensing lenses. Generally, these laws are older and were
written before mail order and other distributors began selling contact lenses.
Lastly, we believe that the laws in a small number of states do not require
that replacement contact lenses be dispensed pursuant to a prescription or only
by a professional licensed in such state.
We retained legal counsel to identify and summarize the applicable laws of
each of the states in which we generate material sales. We compared our
operations to the applicable requirements of the laws contained in such
summaries. Based upon such comparison, we estimate that approximately one third
of our net sales in 1997 appeared to conform to the requirements of applicable
state laws and regulations. We believe that the figure for 1998 is similar. Any
action brought against us based on our failure to comply with applicable state
laws and regulations could result in us being subject to significant fines,
being prohibited from making sales in a particular state and/or our being
required to comply with such laws. Such required compliance could result in:
. increased costs to us;
. the loss of a substantial portion of our customers for whom we are unable
to obtain or verify their prescription; and
. the inability to sell to customers at all in a particular state if we
cannot comply with such state's laws.
The occurrence of any of the above results could have a material adverse effect
on our ability to sell contact lenses and to continue to operate profitably.
Furthermore, there can be no assurance that states will not enact or impose
laws or regulations that prohibit mail order dispensing of contact lenses or
otherwise impair our ability to sell contact lenses and continue to operate
profitably. We have not obtained an opinion of counsel with regard to our
compliance with applicable state laws and regulations, and information
contained herein regarding our compliance with applicable state laws and
regulations should not be construed as being based on an opinion of counsel.
An FTC rule adopted in 1978 requires eye care practitioners to provide their
patients with a copy of their eyeglass prescription (the "Prescription Release
Rule"). The Prescription Release Rule was adopted based on a finding by the FTC
that consumers were being deterred from comparison shopping for eyeglasses
because eye care practitioners refused to release prescriptions. In April 1997,
the FTC published a request for comments regarding the Prescription Release
Rule with respect to whether the rule should be expanded to require the release
of contact lens prescriptions, whether consumers have historically been able to
get their contact lens prescriptions upon request and whether the refusal to
release contact lens prescriptions has benefits justifying such refusal. The
FTC undertook a similar review in 1985 and again in 1995, both times concluding
that the rule should not be expanded to require the release of contact lens
prescriptions.
From time to time we receive notices, inquiries or other correspondence from
states or their regulatory bodies charged with overseeing the sale of contact
lenses. Our 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 we are taking the
appropriate steps to address the various notices received. To date, no formal
complaints have been filed against us concerning our business practices, other
than discussed in this prospectus under the heading "Legal Proceedings."
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Intellectual Property
We conduct our business under the trade name and service marks "1-800
CONTACTS." We have taken steps to register and protect these marks and believe
that such marks have significant value and are an important factor in the
marketing of our products. We lease certain assets, including the right to use
the 1-800 CONTACTS telephone number, from an individual pursuant to a non-
cancelable lease. The lease expires in June 2000, at which time we have the
option to purchase such assets for $17,500. However, under applicable FCC
rules, we do not have and cannot acquire any property rights to the telephone
number. We do not expect to lose the right to use the 1-800 CONTACTS number,
however, there can be no assurance in this regard. The loss of our ability to
use the 1-800 CONTACTS number would have a material adverse effect on our
business, financial condition and results of operations. In addition, we have
obtained the rights to international equivalents for the 1-800 CONTACTS phone
number, however, like the 1-800 CONTACTS number, we do not have and cannot
acquire any property rights in these telephone numbers.
We also have obtained the rights to various Internet addresses, including
but not limited to www.1800contacts.com, www.contacts.com and
www.contactlenses.com. As with phone numbers, we do not have and cannot acquire
any property rights in Internet addresses. We do not expect to lose the ability
to use the Internet addresses, however, there can be no assurance in this
regard and such loss would have a material adverse effect on our financial
position and results of operations.
Employees
As of April 3, 1999, we employed 216 persons, of which 154 were full-time
employees and 62 were part-time employees. None of our employees are covered by
a collective bargaining agreement. We believe our relationship with our
employees to be good.
Properties
All of our management and call center operations are conducted through
approximately 32,000 square feet of leased space located in Draper, Utah, a
suburb of Salt Lake City. The lease relating to this facility expires in 2005.
In October 1998, we entered into a new lease agreement to occupy
approximately 35,000 square feet of space for our new distribution center
located near the Salt Lake City, Utah airport. The lease for the new
distribution center expires in December 2001. We began operations in this
distribution center in February of 1999. We are sub-leasing 10,000 square feet
of warehouse space that we formerly used as our distribution center to another
party for the duration of the lease term, which expires in January 2000.
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 us and our
directors in Los Angeles County Superior Court (the "Steinberg Complaint"). The
complaint alleges three separate causes of action for unfair competition: (1)
selling contact lenses to California residents without being registered, (2)
selling contact lenses to California residents without verifying the
prescription, and (3) failing to disclose in our advertising that we sell
"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 us 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, we removed the action to the United States District Court for the
Central District of California based on diversity jurisdiction.
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In response to motions by us, plaintiff and another California optometrist,
Ellis Miles (collectively, "plaintiffs") filed a First Amended Complaint
("FAC") against us and our 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 our directors as defendants rather than oppose our motion to dismiss
them, leaving us as the only remaining defendant.
On October 2, 1998, plaintiffs re-filed their motion for preliminary
injunction in federal court. We likewise filed a motion to strike plaintiffs'
claims for monetary relief. Plaintiffs withdrew their motion for preliminary
injunction on October 19, 1998, after we filed our opposition to the motion
indicating, inter alia, that we had been registered as a Nonresident Contact
Lens Seller in California. The Court denied our motion to strike plaintiffs'
claims for monetary relief on February 26, 1999. We filed our Answer to the FAC
on March 11, 1999.
On May 7, 1999, the Kansas Board of Examiners in Optometry commenced a civil
action against 1-800 CONTACTS. The action was filed in the District Court of
Shawnee County, Kansas, Division 6. The complaint alleges that on "one or more
occasions" 1-800 CONTACTS sold contact lenses in the state of Kansas without
receipt or verification of a prescription. The complaint seeks the issuance of
an order enjoining us from further engaging in the alleged activity. The
complaint does not seek monetary damages. In response to the complaint, we have
retained counsel and intend to vigorously defend ourselves in this action. An
answer to the complaint is not presently due but will be filed in a timely
manner.
From time to time we are involved in other legal matters generally
incidental to our 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
our financial condition, liquidity or results of operations.
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MANAGEMENT
The following table sets forth certain information regarding our directors,
executive officers and certain key employees as of June 4, 1999:
<TABLE>
<CAPTION>
Name Age Position
- ---- --- --------
<S> <C> <C>
Jonathan C. Coon*......... 29 President, Chief Executive Officer and Director
John F. Nichols*.......... 38 Vice President, Operations and Director
Scott S. Tanner*.......... 38 Chief Financial Officer and Director
Robert G. Hunter.......... 32 Corporate Controller
S. Todd Witzel............ 29 Manager, Information Technology
Jill A. Kocherhans........ 32 Call Center Manager
Stephen A. Yacktman
(1)(2)................... 29 Director
E. Dean Butler (1)(2)..... 54 Director
</TABLE>
- --------
(1) Member of the Compensation Committee.
(2) Member of the Audit Committee.
*Executive Officer.
Jonathan C. Coon is a co-founder of 1-800 CONTACTS and currently serves as
our President, Chief Executive Officer and a director. Mr. Coon received his
Bachelor's Degree from Brigham Young University in 1994 and has substantially
completed studies for an MBA at Brigham Young University. Mr. Coon has seven
years of experience in the contact lens distribution industry.
John F. Nichols is a co-founder of 1-800 CONTACTS and currently serves as
our Vice President, Operations and director. Mr. Nichols is a certified
optician in the State of California and was the owner of the Discount Lens Club
from 1991 until February 1995. Mr. Nichols worked with Bausch & Lomb as a
Senior Sales Representative from 1989 to 1991.
Scott S. Tanner has served as the Chief Financial Officer and a director of
1-800 CONTACTS since November 1997. Prior to joining us, Mr. Tanner served as
the Chief Financial Officer of Country Club Foods, Inc., a Utah-based snack
food manufacturer and distributor, from 1995 to 1997. Prior to that, Mr. Tanner
served in various management positions at Apple Computer, Inc. from 1988 to
1995 and worked at Peat, Marwick & Mitchell & Co. in San Francisco from 1984 to
1986. Mr. Tanner received a Bachelor's Degree from Stanford University and an
MBA from Harvard University. Mr. Tanner served as an executive officer of
Country Club Foods, Inc. at the time it filed a voluntary petition under
chapter 11 of the United States Bankruptcy Code in November 1995.
Robert G. Hunter has served as our Corporate Controller since November 1997.
Prior to joining us, Mr. Hunter served as an auditor with Hawkins, Cloward &
Simister LC from November 1993 to 1997 and with Arthur Andersen LLP from April
1992 to November 1993. Mr. Hunter is a Certified Public Accountant. Mr. Hunter
graduated summa cum laude with a Bachelor's Degree from Brigham Young
University, where he also earned a Masters of Accountancy Degree.
S. Todd Witzel has served as our Manager, Information Technology since
October 1996. Prior to joining us, Mr. Witzel worked for Access Software as a
programmer, where he helped develop Access' management information systems,
from 1994 to 1996.
Jill A. Kocherhans has served as our Call Center Manager since September
1998. From 1989 to 1998, Ms. Kocherhans held various managerial positions with
FranklinCovey Company, including Customer Service Manager and Corporate
Training Manager. Ms. Kocherhans holds a Bachelor's Degree in sociology from
the University of Utah.
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<PAGE>
Stephen A. Yacktman has served as a director of 1-800 CONTACTS since
February 1996. Mr. Yacktman is currently a Vice President at Yacktman Asset
Management Co., an investment advisory company, where he has been employed
since 1993. Mr. Yacktman's responsibilities include portfolio management, stock
analysis and trading. Mr. Yacktman holds a Bachelor's Degree in economics and
an MBA from Brigham Young University.
E. Dean Butler has served as a director of 1-800 CONTACTS since January
1998. Mr. Butler currently serves as Chairman of Winning Vision Services Ltd.,
a United Kingdom-based operator of optical superstores in the former Soviet
Union. Mr. Butler served as Vice Chairman of Grand Vision, the largest retail
optical group in Europe from late 1997 to mid-1998. In 1988, Mr. Butler founded
Vision Express in Europe, which merged with the French retail group, GPS, to
form Grand Vision in late 1997. In 1983, Mr. Butler founded LensCrafters and
served as its Chief Executive Officer until 1988. Prior to 1983, Mr. Butler was
employed by Procter & Gamble in various marketing positions since 1969.
Executive officers are elected by our board of directors on an annual basis
and serve until their successors are duly elected and qualified. There are no
family relationships between or among any of our directors or executive
officers.
Compensation of Directors
We currently do not pay a cash salary or annual retainer to our directors.
In January 1998, we granted options to purchase an aggregate of 71,979 shares
of common stock to Mr. Butler. Such options have an exercise price equal to
$11.00 per share and vest in three equal installments beginning on the first
anniversary of their grant date. In February 1999, we granted options to
purchase 2,000 shares of common stock to both Messrs. Butler and Yacktman.
These options have an exercise price of $12.5625 per share and vest in three
equal installments beginning on the first anniversary of their grant date. We
reimburse all directors for reasonable expenses incurred in attending board
meetings. The directors do not receive any additional compensation for
committee participation.
Committees of the Board of Directors
The board has two standing committees: the audit committee and the
compensation committee.
The audit committee is authorized to make recommendations to the board
regarding the independent auditors to be nominated for election by the
stockholders and to review the independence of such auditors, approve the scope
of the annual audit activities of the independent auditors, approve the audit
fee payable to the independent auditors and review such audit results. Arthur
Andersen LLP presently serves as the independent accountants of 1-800 CONTACTS.
The audit committee is currently comprised of Messrs. Stephen A. Yacktman and
E. Dean Butler. The audit committee met on three occasions in 1998.
The compensation committee is authorized to make recommendations to the full
board relating to: (1) the compensation arrangements of all of our executive
officers and (2) awards under our stock incentive plan. The compensation
committee is currently comprised of Messrs. Stephen A. Yacktman and E. Dean
Butler. The compensation committee met on three occasions in 1998.
Compensation Committee Interlocks and Insider Participation
Prior to our IPO in February 1998, we did not have a compensation committee.
The current compensation arrangements for Messrs. Coon, Nichols and Tanner were
established by the terms of their respective employment agreements with 1-800
CONTACTS. The terms of such employment agreements were approved by the full
board at the time of the IPO. The compensation committee was established in
connection with the IPO and is currently comprised of Messrs. Yacktman and
Butler, neither of whom was at any time an employee of 1-800 CONTACTS. No
executive officer of 1-800 CONTACTS serves as a member of the board of
38
<PAGE>
directors or compensation committee of any other entity which has one or more
executive officers serving as a member of 1-800 CONTACTS' board of directors or
compensation committee.
Compensation of Executive Officers
The following table sets forth information concerning the compensation
earned for the last two fiscal years by our chief executive officer and our
other two executive officers. For ease of reference, we collectively refer to
these executive officers as the "named executives" throughout this prospectus.
None of our named executives were granted options in our last fiscal year.
Summary Compensation Title
<TABLE>
<CAPTION>
Long Term
Compensation
Annual Compensation Awards
---------------------------------- ------------
Securities All Other
Name and Principal Other Annual Underlying Compensation
Position Year Salary Bonus Compensation Options (a)
- ------------------ ---- -------- ------- ------------ ------------ ------------
<S> <C> <C> <C> <C> <C> <C>
Jonathan C. Coon........ 1998 $120,000 $40,500 $49,127(b) -- $9,835
President and Chief
Executive Officer 1997 105,042 -- (d) -- 13,440
John F. Nichols......... 1998 $120,000 $40,500 (d) -- $3,432
Vice President,
Operations 1997 110,625 -- -- 10,580
Scott S. Tanner(c)...... 1998 $110,000 $47,438 (d) -- $4,638
Chief Financial Officer 1997 7,944 1,000 (d) 47,986 357
</TABLE>
- --------
(a) Reflects payments made by 1-800 CONTACTS to such named executives for
medical costs and health insurance.
(b) Includes $43,220 for domestic services paid for by 1-800 CONTACTS on behalf
of Mr. Coon.
(c) Mr. Tanner joined 1-800 CONTACTS in November 1997.
(d) None of the perquisites and other benefits paid to each of the named
executives exceeded the lesser of $50,000 or 10% of the total annual salary
and bonus received by such named executives.
Aggregated Option Exercises in Last Fiscal Year and Fiscal Year End Option
Values
The following table sets forth information for the named executives
concerning stock option exercises during 1-800 CONTACTS' last fiscal year and
options outstanding at the end of the last fiscal year:
<TABLE>
<CAPTION>
Number of Securities Value of Unexercised
Underlying Unexercised In-the-Money Options
Options at FY-End (#) at FY-End ($)(a)
Shares Acquired Value ------------------------- -------------------------
Name on Exercise (#) Realized ($) Unexercisable/Exercisable Unexercisable/Exercisable
- ---- --------------- ------------ ------------------------- -------------------------
<S> <C> <C> <C> <C>
Jonathan C. Coon........ -- -- -/- -/-
John F. Nichols......... -- -- -/- -/-
Scott S. Tanner......... -- -- 31,991/15,995 $223,937/$111,965
</TABLE>
- --------
(a) Based upon a fair market value of the common stock at January 2, 1999 of
$18.00 per share.
39
<PAGE>
Employment Agreements
Immediately prior to the completion of the IPO, Messrs. Coon, Nichols and
Tanner each entered into an employment agreement with 1-800 CONTACTS, pursuant
to which Mr. Coon agreed to serve as our President and Chief Executive Officer
for a period of three years, Mr. Nichols agreed to serve as our Vice President,
Operations for a period of three years and Mr. Tanner agreed to serve as our
Chief Financial Officer for a period of three years. Pursuant to the respective
employment agreements, Messrs. Coon, Nichols and Tanner receive:
. an annual base salary equal to at least $120,000, $120,000 and $110,000
respectively,
. an annual bonus up to 50% of their annual base salary (upon 1-800
CONTACTS achieving certain operating targets) and
. certain fringe benefits.
If the executive's employment is terminated for any reason prior to the
termination of such agreement other than for cause (as defined therein) or his
resignation, he will be entitled to receive his base salary and fringe benefits
for 12 months following such termination in addition to 50% of his bonus for
the year in which his employment was terminated if the termination is during
the first six months of the year or 100% if such termination was during the
last six months of the year. Messrs. Coon, Nichols and Tanner have each agreed
not to compete with 1-800 CONTACTS for a period of two years following his
termination of employment with 1-800 CONTACTS and not to disclose any
confidential information at any time without our prior written consent.
Incentive Stock Option Plan
Prior to the completion of the IPO, we established the 1-800 CONTACTS, INC.
Incentive Stock Option Plan (the "Stock Option Plan"). A maximum of 310,000
shares of common stock, subject to adjustment, were initially authorized for
the granting of stock options under the Stock Option Plan. As of June 3, 1999,
options to purchase an aggregate of 69,451 shares of common stock, at exercise
prices ranging from $5.625 to $15.875 per share, were outstanding under the
Stock Option Plan. All of the options granted under the Stock Option Plan vest
in three equal installments beginning on the first anniversary of the grant
date and have an exercise price equal to the fair market value of the common
stock on the grant date. Options granted under the Stock Option Plan may be
either "incentive stock options," which qualify for special tax treatment under
the Internal Revenue Code, or nonqualified stock options. The purposes of the
Stock Option Plan are to advance the interests of 1-800 CONTACTS and
stockholders by providing our employees with an additional incentive to
continue their efforts on behalf of 1-800 CONTACTS, as well as to attract
people of experience and ability. The Stock Option Plan is intended to comply
with Rule 16b-3 of the Exchange Act.
All of our officers, directors and other employees are eligible to
participate under the Stock Option Plan, as deemed appropriate by the
compensation committee of the board of directors. Eligible employees will not
pay us anything to receive options. The Stock Option Plan is administered by
the compensation committee of the board of directors. The exercise price for
incentive stock options must be no less than the fair market value of the
common stock on the date of grant. The exercise price of nonqualified stock
options is not subject to any limitation based on the then current market value
of the common stock. Options will expire not later than the tenth anniversary
of the date of grant. An option holder will be able to exercise options from
time to time, subject to vesting. Options will vest immediately upon death or
disability of a participant and upon certain change of control events. Upon
termination for cause or after 30 days of termination for any other reason by
1-800 CONTACTS, the unvested portion of the options will be forfeited. Subject
to the above conditions, the exercise price, duration of the options and
vesting provisions will be set by the compensation committee of the board of
directors in it discretion.
40
<PAGE>
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Loans to Executive Officers
At the beginning of our last fiscal year, 1-800 CONTACTS had outstanding
loans to Messrs. Coon and Nichols, each an executive officer and director of 1-
800 CONTACTS, in an aggregate of $340,615 and $231,530, respectively, evidenced
by promissory notes due on demand. The notes provided for the payment of
interest calculated at a rate equal to the prime rate (8.5% at January 1998).
These loans were repaid in February 1998 in connection with the distribution of
our retained earnings.
Loans from Significant Stockholder
Prior to our IPO, we borrowed funds from time to time for working capital
and other corporate purposes from Mr. Donald A. Yacktman, a former director and
significant stockholder. In general, these borrowings bore interest at the
prime rate plus 2% and were unsecured. We repaid all of our borrowings from Mr.
Yacktman with a portion of the net proceeds from our IPO. During years ended
January 2, 1999, December 31, 1997 and 1996, our largest outstanding
indebtedness to Mr. Donald Yacktman was approximately $1.7 million, $1.6
million and $305,000, respectively.
Repurchase of Stock from Former Director
In February 1996, we redeemed all shares of our common stock then held by
Mr. Steve Gibson, a former director of 1-800 CONTACTS, which shares represented
twenty percent of our common stock then outstanding. The purchase price of such
redeemed shares as $240,000 in cash. Mr. Gibson resigned as a director of 1-800
CONTACTS in February 1996.
Agreement for Distribution of Retained Earnings and Tax Indemnification
Immediately prior to completion of our IPO, we entered into the Agreement
for Distribution of Retained Earnings and Tax Indemnification (the
"Distribution Agreement") with each of our existing stockholders, including
Messrs. Coon, Nichols, Stephen A. Yacktman and Donald A. Yacktman
(collectively, the "Existing Stockholders"). The Distribution Agreement
provides for among other things, the indemnification of the Existing
Stockholders for any losses or liabilities with respect to any additional taxes
(including interest, penalties and legal fees) and the repayment to 1-800
CONTACTS of amounts received as refunds, resulting from 1-800 CONTACTS'
operations during the period in which it was an S corporation. In addition, the
Distribution Agreement provided for the distribution to the Existing
Stockholders of the amount of our retained earnings from our formation through
the date immediately preceding the date we terminated our S corporation status.
The following table sets forth the amounts received by our executive officers
and/or directors under the Distribution Agreement:
<TABLE>
<CAPTION>
Name Amount
---- --------
<S> <C>
Jonathan C. Coon (1)............................................ $630,962
John F. Nichols................................................. 633,075
Stephen A. Yacktman............................................. 79,064
Donald A. Yacktman (2).......................................... 237,473
</TABLE>
--------
(1) Includes $15,756 paid to each of Mr. Coon's two children.
(2) Mr. Yacktman no longer serves as a director of 1-800 CONTACTS.
Amounts reflected in the table were paid to the Yacktman Family
Trust.
41
<PAGE>
Stock Repurchase Option
Concurrently with the completion of our IPO, we repurchased from Mr. Donald
A. Yacktman 442,651 shares of our common stock for an aggregate purchase price
of $1.9 million. This repurchase was made pursuant to an option we were granted
in connection with Mr. Donald Yacktman's investment in 1-800 CONTACTS in
February 1996. In connection with entering into a promissory note with Mr.
Donald A. Yacktman in July 1997, a portion of this option was cancelled.
Indemnification Agreements
Immediately prior to the completion of our IPO, each of our directors and
executive officers entered into an indemnification agreement with 1-800
CONTACTS.
42
<PAGE>
PRINCIPAL AND SELLING STOCKHOLDERS
Except as otherwise noted, the following table sets forth certain
information as of May 31, 1999 as to the security ownership of equity
securities of 1-800 CONTACTS by: (1) each of the named executives; (2) each of
our directors; (3) all directors and executive officers as a group; and (4)
each person or entity known to us to be the beneficial owner of five percent or
more of the voting securities of 1-800 CONTACTS. All information with respect
to beneficial ownership has been furnished by the respective director,
executive officer or five percent beneficial owner, as the case may be. Unless
otherwise indicated, each person or entity named below has sole voting and
investment power with respect to the number of shares set forth opposite his
name. Beneficial ownership of the common stock listed in the table has been
determined in accordance with the applicable rules and regulations promulgated
under the Exchange Act.
<TABLE>
<CAPTION>
Prior to the
Offering After the Offering
------------------ Number ------------------
Name and Address of Beneficial Number of Percent of Shares Number Percent
Owner Shares of Class Offered of Shares of Class
- ------------------------------ --------- -------- --------- --------- --------
<S> <C> <C> <C> <C> <C>
Directors and Executive
Officers:
Jonathan C. Coon (1)(2)....... 2,366,198 37.7% 700,000 1,666,198 22.9%
John F. Nichols (1)........... 936,940 14.9 310,000 626,940 8.6
Stephen A. Yacktman (3)....... 225,366 3.6 30,000 195,366 2.7
Scott S. Tanner (4)........... 16,245 * -- 16,245 *
E. Dean Butler (5)............ 23,993 * -- 23,993 *
All directors and executive
officers as a group (5
persons)..................... 3,568,742 56.4% 1,040,000 2,528,742 34.5%
5% Stockholders:
Donald A. Yacktman (6)........ 546,000 8.7% -- 546,000 7.5%
</TABLE>
- --------
* Represents less than one percent.
(1) The address of such person is the executive offices of 1-800 CONTACTS.
(2) Includes: (i) direct beneficial ownership of 2,267,724 shares of common
stock; (ii) indirect beneficial ownership of 47,987 shares of common stock
held-by Mr. Coon as custodian under the Uniform Gift to Minors Act ("UGMA")
for and on behalf of Hannah K. Coon; (iii) indirect beneficial ownership of
an aggregate of 47,987 shares of common stock held by Mr. Coon as custodian
under the UGMA and on behalf of Abigail T. Coon; and (iv) indirect
beneficial ownership of 2,500 shares of common stock held by Mr. Coon as
custodian under the UGMA for and on behalf of Samuel Coon.
(3) The address of such person is c/o Yacktman Asset Management Co., 303 West
Madison Street, Chicago, Illinois 60606.
(4) Includes 15,995 shares of common stock that can be acquired through the
exercise of currently exercisable stock options.
(5) Includes 23,993 shares of common stock that can be acquired through the
exercise of currently exercisable stock options.
(6) Pursuant to a Schedule 13D filed with the SEC on October 13, 1998, Mr.
Donald A. Yacktman reported the sole power to vote or to direct the vote of
100,000 shares of common stock, and the sole power to dispose or to direct
the disposition of 100,000 shares of common stock. In addition, Mr.
Yacktman, in his capacity as trustee of the Arnold Trust, reported the sole
power to vote or to direct the vote of 4,000 shares of common stock, and
the sole power to dispose or to direct the disposition of 4,000 shares of
common stock. By virtue of his relationship with Carolyn Z. Yacktman (his
spouse), Mr. Yacktman reported that he may be deemed to share voting and
dispositive power with respect to the 430,000 shares of common stock held
by the Yacktman Family Trust (the "Trust") and the 12,000 shares of common
stock held by her as custodian of her three minor children. Carolyn Z.
Yacktman serves as a trustee of the Trust. Mr. Donald A. Yacktman
disclaims, for the purpose of Section 13(d) or 13(g) of the Exchange Act or
otherwise, beneficial ownership of any of the shares of common stock
beneficially owned by Mrs. Yacktman. The address for Mr. Yacktman is c/o
Yacktman Asset Management Co., 303 West Madison Street, Chicago, Illinois
60606 and the address for the Trust is c/o Citicorp Trust South Dakota, 701
East 60th Street North, Sioux Falls, South Dakota 57117.
43
<PAGE>
DESCRIPTION OF CAPITAL STOCK
General Matters
Our authorized capital stock consists of 20,000,000 shares of common stock,
par value $0.01 per share, and 1,000,000 shares of preferred stock, par value
$0.01 per share. Upon completion of this offering, 7,282,394 shares of our
common stock will be issued and outstanding and no shares of preferred stock
will be issued and outstanding. The following summary of certain provisions of
our capital stock describes all material provisions of, but does not purport to
be complete and is subject to, and qualified in our entirety by, our restated
certificate of incorporation and the by-laws that are included as exhibits to
the registration statement of which this prospectus forms a part and by the
provisions of applicable law. See "Where You Can Find More Information."
Our restated certificate of incorporation and by-laws will contain certain
provisions that are intended to enhance the likelihood of continuity and
stability in the composition of the board of directors and which may have the
effect of delaying, deferring or preventing a future takeover or change in
control of us unless such takeover or change in control is approved by the
board of directors.
Common Stock
The issued and outstanding shares of common stock are, and the shares of
common stock being offered by us will be upon payment therefor, validly issued,
fully paid and nonassessable. Subject to the prior rights of the holders of any
preferred stock, the holders of outstanding shares of common stock are entitled
to receive dividends out of assets legally available therefor at such time and
in such amounts as the board of directors may from time to time determine. See
"Dividend Policy." The shares of common stock are not convertible and the
holders thereof have no preemptive or subscription rights to purchase any of
our securities. Upon our liquidation, dissolution or winding up, the holders of
common stock are entitled to receive pro rata of our assets which are legally
available for distribution, after payment of all debts and other liabilities
and subject to the prior rights of any holders of preferred stock then
outstanding. Each outstanding share of common stock is entitled to one vote on
all matters submitted to a vote of stockholders. There is no cumulative voting.
Our common stock is included for trading on the Nasdaq Stock Market under
the symbol "CTAC."
Preferred Stock
Our board of directors may, without further action by our stockholders, from
time to time, direct the issuance of shares of preferred stock in series and
may, at the time of issuance, determine the rights, preferences and limitations
of each series. Satisfaction of any dividend preferences of outstanding shares
of preferred stock would reduce the amount of funds available for the payment
of dividends on shares of common stock. Holders of shares of preferred stock
may be entitled to receive a preference payment in the event of any
liquidation, dissolution or winding-up before any payment is made to the
holders of shares of common stock. Under certain circumstances, the issuance of
shares of preferred stock may render more difficult or tend to discourage a
merger, tender offer or proxy contest, the assumption of control by a holder of
a large block of our securities or the removal of incumbent management. Upon
the affirmative vote of a majority of the total number of directors then in
office, of our board of directors, without stockholder approval, may issue
shares of preferred stock with voting and conversion rights which could
adversely affect the holders of shares of common stock. Upon consummation of
the offering, there will be no shares of preferred stock outstanding, and we
have no present intention to issue any shares of preferred stock.
Certain Provisions of the Restated Certificate of Incorporation and By-laws
Classified Board. Our restated certificate of incorporation provides for the
board of directors to be divided into three classes, as nearly equal in number
as possible, serving staggered terms. Approximately one-third of
44
<PAGE>
the board of directors will be elected each year. See "Management." Under the
Delaware General Corporation Law, directors serving on a classified board can
only be removed for cause. The provision for a classified board could prevent a
party who acquires control of a majority of the outstanding voting stock from
obtaining control of the board of directors until the second annual
stockholders meeting following the date the acquiror obtains the controlling
stock interest. The classified board provision could have the effect of
discouraging a potential acquiror from making a tender offer or otherwise
attempting to obtain control of us and could increase the likelihood that
incumbent directors will retain their positions.
Elimination of Stockholder Action Through Written Consents. Our restated
certificate provides that stockholder action can be taken only at an annual or
special meeting of stockholders and cannot be taken by written consent in lieu
of a meeting.
Elimination of the Ability to Call Special Meetings. Our restated
certificate of incorporation and the by-laws provides that, except as otherwise
required by law, special meetings of the stockholders can only be called
pursuant to a resolution adopted by a majority of the board of directors or by
our chief executive officer. Stockholders will not be permitted to call a
special meeting or to require the board of directors to call a special meeting.
Advanced Notice Procedures. Our by-laws establish an advance notice
procedure for stockholder proposals to be brought before an annual meeting of
our stockholders, including proposed nominations of persons for election to the
board of directors. Stockholders at an annual meeting may only consider
proposals or nominations specified in the notice of meeting or brought before
the meeting by or at the direction of the board of directors or by a
stockholder who was a stockholder of record on the record date for the meeting,
who is entitled to vote at the meeting and who has given to our secretary
timely written notice, in proper form, of the stockholder's intention to bring
that business before the meeting. Although the by-laws do not give the board of
directors the power to approve or disapprove stockholder nominations of
candidates or proposals regarding other business to be conducted at a special
or annual meeting, the by-laws may have the effect of precluding the conduct of
certain business at a meeting if the proper procedures are not followed or may
discourage or defer a potential acquiror from conducting a solicitation of
proxies to elect its own slate of directors or otherwise attempting to obtain
control of us.
Amendments to the Restated Certificate and By-laws. Our restated certificate
of incorporation and by-laws provide that the affirmative vote of holders of at
least 80% of the total votes eligible to be cast in the election of directors
is required to amend, alter, change or repeal certain of their provisions. This
requirement of a super-majority vote to approve amendments to our restated
certification of incorporation and by-laws could enable a minority of our
stockholders to exercise veto power over any such amendments.
Certain Provisions of Delaware Law
We are subject to the "Business Combination" provisions of the Delaware
General Corporation Law. In general, such provisions prohibit a publicly held
Delaware corporation from engaging in various "business combination"
transactions with any "interested stockholder" for a period of three years
after the date of the transaction which the person became an "interested
stockholder," unless
. the transaction is approved by the board of directors prior to the date
the "interested stockholder" obtained such status;
. upon consummation of the transaction which resulted in the stockholder
becoming an "interested stockholder," the "interested stockholder," owned
at least 85% of the voting stock of the corporation outstanding at the
time the transaction commenced, excluding for purposes of determining the
number of shares outstanding those shares owned by (a) persons who are
directors and also officers and (b) employee stock plans in which
employee participants do not have the right to determine confidentially
whether shares held subject to the plan will be tendered in a tender or
exchange offer; or
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<PAGE>
. on or subsequent to such date the "business combination" is approved by
the board of directors and authorized at an annual or special meeting of
stockholders by the affirmative vote of at least 66 2/3% of the
outstanding voting stock which is not owned by the "interested
stockholder."
A "business combination" is defined to include mergers, asset sales and other
transactions resulting in financial benefit to a stockholder. In general, an
"interested stockholder" is a person who, together with affiliates and
associates, owns (or within three years, did own) 15% or more of a
corporation's voting stock. The statute could prohibit or delay mergers or
other takeover or change in control attempts with respect to us and,
accordingly, may discourage attempts to acquire us.
Limitations on Liability and Indemnification of Officers and Directors
Our restated certificate of incorporation limits the liability of directors
to the fullest extent permitted by the Delaware General Corporation Law. In
addition, our restated certificate of incorporation provides that we shall
indemnify our directors and officers to the fullest extent permitted by such
law. We entered into indemnification agreements with our current directors and
executive officers prior to the completion of our IPO and expect to enter into
similar agreements with any new directors or executive officers.
Transfer Agent and Registrar
The Transfer Agent and Registrar for our common stock is American Stock
Transfer & Trust Company. Its address is 40 Wall Street, New York, New York
10015 and its telephone number is (718) 921-8200.
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<PAGE>
SHARES ELIGIBLE FOR FUTURE SALE
We can make no predictions as to the effect, if any, that sales of shares or
the availability of shares for sale will have on the market price prevailing
from time to time. Nevertheless, sales of significant amounts of the common
stock in the public market, or the perception that such sales may occur, could
adversely affect prevailing market prices. See "Risk Factors--Future sales of
our common stock could cause the price of our shares to decline."
Upon completion of the offering, we expect to have 7,282,394 shares of
common stock outstanding. In addition, 258,795 shares of common stock will be
issuable upon the exercise of outstanding stock options. Of the shares
outstanding after the offering, 4,421,826 shares of common stock (4,727,826
shares if the underwriters' over-allotment is exercised in full) will be freely
tradeable without restriction under the Securities Act, except for any such
shares which may be acquired by one of our "affiliates" (an "Affiliate"), as
that term is defined in Rule 144 promulgated under the Securities Act ("Rule
144"), which shares will be subject to the volume limitations and other
restrictions of Rule 144 described below. An aggregate of 2,860,568 shares of
common stock will be "restricted securities" (as that phrase is defined in Rule
144) and may not be resold in the absence of registration under the Securities
Act or pursuant to an exemption from such registration, including among others,
the exemption provided by Rule 144 under the Securities Act.
In general, under Rule 144 as currently in effect, if a period of at least
one year has elapsed since the later of the date the "restricted securities"
were acquired from us or the date they were acquired from an Affiliate, then
the holder of such restricted securities (including an Affiliate) is entitled
to sell in the public market a number of shares within any three-month period
that does not exceed the greater of 1% of the then outstanding shares of the
common stock (approximately 72,824 shares immediately after the offering) or
the average weekly reported volume of trading of the common stock on the Nasdaq
during the four calendar weeks preceding such sale. The holder may only sell
such shares through "brokers' transactions" or in transactions directly with a
"market maker" (as such terms are defined in Rule 144). Sales under Rule 144
are also subject to certain requirements regarding providing notice of such
sales and the availability of current public information concerning us.
Affiliates may sell shares not constituting restricted shares in accordance
with the foregoing volume limitations and other requirements but without regard
to the one-year holding period. Under Rule 144(k), if a period of at least two
years has elapsed between the later of the date restricted securities were
acquired from us or the date they were acquired from an Affiliate, as
applicable, a holder of such restricted securities who is not an Affiliate at
the time of the sale and has not been an Affiliate for at least three months
prior to the sale would be entitled to sell the shares in the public market
without regard to the volume limitations and other restrictions described
above. Approximately 2,488,754 shares of our common stock are eligible for sale
in the public market pursuant to Rule 144, subject to the volume limitations
and other restrictions described above, and approximately 371,814 shares of our
common stock are eligible for sale in the public market under Rule 144(k).
Notwithstanding the foregoing, our executive officers, directors and the
selling stockholders, who own in aggregate approximately 2,528,742 shares of
our common stock (including 39,988 shares which can be acquired through
currently exercisable options), have agreed that, without the prior consent of
the representative, they will not (1) directly or indirectly, sell, offer to
sell, grant any option for the sale of or otherwise dispose of any shares of
common stock or securities or rights convertible into or exercisable or
exchangeable for common stock (except through gifts to persons who agree in
writing to be bound by such restrictions) or (2) make any demand for or
exercise any right with respect to the registration of any common stock or
other such securities, for a period of 180 days after the date of this
prospectus, other than (i) the sale to the underwriters of the shares of common
stock under the underwriting agreement or (ii) the issuance by us of shares of
common stock upon the exercise of an options sold or granted pursuant to our
existing benefit plan and outstanding on the date of this prospectus.
47
<PAGE>
UNDERWRITING
Subject to the terms and conditions contained in the underwriting agreement
among 1-800 CONTACTS, the selling stockholders and each of the underwriters
named below, 1-800 CONTACTS, and the selling stockholders have agreed to sell
to the underwriters, and each of the underwriters severally and not jointly has
agreed to purchase from 1-800 CONTACTS and the selling stockholders, the number
of shares of common stock set forth opposite their name below.
<TABLE>
<CAPTION>
Number of
Underwriter Shares
----------- ---------
<S> <C>
McDonald Investments Inc........................................
---------
Total....................................................... 2,040,000
=========
</TABLE>
McDonald Investments Inc. is acting as the representative of the several
underwriters.
The underwriting agreement provides that the obligation of the several
underwriters to pay for and accept delivery of the shares of common stock are
subject to the approval of certain legal matters by counsel and to certain
other conditions. The underwriters are obligated to take and pay for all shares
of the common stock offered hereby (other than those covered by the over-
allotment option described below) if any such shares are taken.
The underwriters propose initially to offer the shares of common stock
directly to the public at the public offering price set forth on the cover page
hereof and to certain dealers at a price that represents a concession not in
excess of $ per share of common stock under the public offering price.
The underwriters may allow, and such dealers may allow, a concession not in
excess of $ per share of common stock to the other underwriters or to
certain other dealers. The public offering price and the other selling terms
may be changed by the representatives of the public offering.
1-800 CONTACTS and the selling stockholders have granted to the underwriters
an option, exercisable at any time during the 30-day period from the date of
this prospectus, to purchase up to an aggregate of 306,000 additional shares of
common stock at the public offering price set forth on the cover page hereof
less underwriting discount. The underwriters may exercise such option to
purchase additional shares solely for the purpose of covering over-allotments,
if any, incurred in connection with the sale of the common stock offered
hereby. To the extent such option is exercised, each underwriter will become
obligated, subject to certain conditions, to purchase a number of additional
shares proportionate to such underwriter's initial amount reflected in the
preceding table.
1-800 CONTACTS and the selling stockholders have agreed to indemnify the
several underwriters against certain liabilities, including certain liabilities
under the Securities Act, or to contribute to payments the underwriters may be
required to make in respect thereof.
The underwriters may engage in over-allotment, stabilizing transactions,
syndicate covering transactions and penalty bids in accordance with Regulation
M under the Exchange Act. Over-allotment involves syndicate sales in excess of
the offering size, which creates a syndicate short position. Stabilizing
transactions permit bids to purchase the underlying security so long as the
stabilizing bids do not exceed a specified maximum. Syndicate covering
transactions involve purchases of the securities in the open market after the
distribution has been completed in order to cover syndicate short positions.
Penalty bids permit the underwriters to reclaim a selling concession from a
syndicate member when the securities originally sold by such syndicate member
are purchased in a syndicate covering transaction to cover syndicate short
positions. Such stabilizing transactions, syndicate covering transactions and
penalty bids may cause the price of the securities to be higher than it would
otherwise be in the absence of such transactions.
48
<PAGE>
Neither we nor the underwriters makes any representation or prediction as to
the direction or magnitude of any effect that the transactions described above
may have on the price of the common stock. In addition, neither we nor any of
the underwriters makes any representation that the underwriters will engage in
such transactions or that such transactions, once commenced, will not be
discontinued without notice.
1-800 CONTACTS, its executive officers, directors and each of the selling
stockholders have agreed that, without the prior consent of the representative,
they will not (1) directly or indirectly, sell, offer to sell, grant any option
for the sale of or otherwise dispose of any shares of common stock or
securities or rights convertible into or exercisable or exchangeable for common
stock (except through gifts to persons who agree in writing to be bound by such
restrictions) or (2) make any demand for or exercise any right with respect to
the registration of any common stock or other such securities, for a period of
180 days after the date of this prospectus, other than (a) the sale to the
underwriters of the shares of common stock under the underwriting agreement or
(b) the issuance by us of shares of common stock upon the exercise of an
options sold or granted pursuant to our existing benefit plan and outstanding
on the date of this prospectus.
In connection with this offering, certain underwriters and other selling
group members or their affiliates may engage in passive market making
transactions in the common stock on the Nasdaq Stock Market in accordance with
Rule 103 of Regulation M under the Exchange Act. Rule 103 permits passive
market making during the period when Regulation M would otherwise prohibit
market making activity by the participants in this offering. Passive market
making consists of displaying bids on the Nasdaq National Market limited by the
bid prices of independent market makers and making purchases limited by such
prices and effected in response to order flow. Rule 103 limits the net
purchases by a passive market maker on each day to a specified percentage of
the passive market maker's average daily trading volume in the common stock
during a specified period. The passive market maker must stop its passive
market making transactions for the rest of that day when such limit is reached.
Certain of the underwriters have, from time to time, provided investment
banking and other financial advisory services to 1-800 CONTACTS, for which they
have received customary fees.
EXPERTS
Our financial statements included in this prospectus and elsewhere in the
registration statement to the extent and for the periods indicated in their
report, have been audited by Arthur Andersen LLP, independent public
accountants, and are included herein in reliance upon the authority of said
firm as experts in giving said report.
LEGAL MATTERS
The validity of the common stock offered hereby will be passed upon for us
by Kirkland & Ellis, Chicago, Illinois (a partnership which includes
professional corporations). Certain legal matters will be passed upon for the
underwriters by Squire, Sanders & Dempsey L.L.P., Cleveland, Ohio.
49
<PAGE>
WHERE YOU CAN FIND MORE INFORMATION
We have filed with the SEC a registration statement (of which this
prospectus is a part and which term shall encompass any amendments thereto) on
Form S-1 pursuant to the Securities Act with respect to the common stock being
offered in the offering. This prospectus does not contain all the information
set forth in the registration statement and the exhibits and schedules thereto,
certain portions of which are omitted as permitted by the rules and regulations
of the SEC. Statements made in this prospectus as to the contents of any
contract, agreement or other document referred to are not necessarily complete,
with respect to any such contract, agreement or other document filed as an
exhibit to the registration statement, reference is made to the exhibit for a
more complete description of the matter involved, and each such statement shall
be deemed qualified in our entirety by such reference. For further information
about us and our securities offered hereby, reference is made to the
registration statement and to the financial statements, schedules and exhibits
filed as a part thereof.
We are subject to the informational requirements of the Exchange Act, and,
in accordance therewith, will file reports and other information with the SEC.
The registration statement, the exhibits and schedules forming a part thereof
and the reports and other information filed by us with the SEC in accordance
with the Exchange Act may be inspected and copied at the public reference
facilities maintained by the SEC at room 1024, Judiciary Plaza, 450 Fifth
Street, N.W., Washington, D.C. 20549 and at the following regional offices of
the SEC: Seven World Trade Center, 13th Floor, New York, New York 10048 and
Citicorp Center, 500 West Madison Street, Suite 1400, Chicago, Illinois 60661-
2511. Copies of such material or part thereof may also be obtained by mail from
the Public Reference Section of the SEC, 450 Fifth Street, Washington, D.C.
20549 at prescribed rates or accessed electronically by means of the SEC's home
page on the Internet at http://www.sec.gov.
50
<PAGE>
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
Page
----
<S> <C>
Report of Independent Public Accountants................................. F- 2
Balance Sheets as of January 2, 1999 and December 31, 1997............... F- 3
Statements of Operations for the years ended January 2, 1999, and
December 31, 1997 and 1996.............................................. F- 5
Statements of Stockholders' Equity for the years ended January 2, 1999,
and December 31, 1997 and 1996.......................................... F- 6
Statements of Cash Flows for the years ended January 2, 1999, and
December 31, 1997 and 1996.............................................. F- 7
Notes to Financial Statements............................................ F- 9
Unaudited Condensed Balance Sheet as of April 3, 1999.................... F-21
Unaudited Condensed Statements of Operations for the Quarters Ended April
3, 1999 and
April 4, 1998........................................................... F-22
Unaudited Condensed Statement of Stockholders' Equity for the Quarter
Ended April 3, 1999..................................................... F-23
Unaudited Condensed Statements of Cash Flows for the Quarters Ended April
3, 1999 and
April 4, 1998........................................................... F-24
Notes to Unaudited Condensed Financial Statements........................ F-26
</TABLE>
F-1
<PAGE>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To 1-800 CONTACTS, INC.:
We have audited the accompanying balance sheets of 1-800 CONTACTS, INC. (a
Delaware corporation) as of January 2, 1999 and December 31, 1997, and the
related statements of operations, stockholders' equity and cash flows for each
of the three fiscal years in the period ended January 2, 1999. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of 1-800 CONTACTS, INC. as of
January 2, 1999, and December 31, 1997, and the results of its operations and
its cash flows for each of the three fiscal years in the period ended January
2, 1999 in conformity with generally accepted accounting principles.
ARTHUR ANDERSEN LLP
Salt Lake City, Utah
February 4, 1999 (except with respect to certain matters discussed in Notes 5
and 12, as to which the date is March 26, 1999)
F-2
<PAGE>
1-800 CONTACTS, INC.
BALANCE SHEETS
ASSETS
<TABLE>
<CAPTION>
January 2, December 31,
1999 1997
----------- ------------
<S> <C> <C>
CURRENT ASSETS:
Cash and cash equivalents........................... $ 3,762,220 $ --
Inventories......................................... 10,752,324 4,811,855
Prepaid advertising................................. 294,259 127,696
Other current assets................................ 188,880 54,968
----------- ----------
Total current assets.............................. 14,997,683 4,994,519
----------- ----------
DEFERRED ADVERTISING COSTS............................ 175,631 1,705,695
----------- ----------
PROPERTY AND EQUIPMENT, at cost:
Office, computer and other equipment................ 2,078,102 630,186
Leasehold improvements.............................. 458,341 75,270
----------- ----------
2,536,443 705,456
Less - accumulated depreciation and amortization.... (487,593) (142,953)
----------- ----------
Net property and equipment........................ 2,048,850 562,503
----------- ----------
DEFERRED INCOME TAXES................................. 642,679 --
----------- ----------
OTHER ASSETS.......................................... 151,293 518,347
----------- ----------
Total assets...................................... $18,016,136 $7,781,064
=========== ==========
</TABLE>
The accompanying notes to financial statements
are an integral part of these balance sheets.
F-3
<PAGE>
1-800 CONTACTS, INC.
BALANCE SHEETS (continued)
LIABILITIES AND STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
January 2, December 31,
1999 1997
----------- ------------
<S> <C> <C>
CURRENT LIABILITIES:
Line of credit..................................... $ -- $1,055,640
Notes payable to stockholders...................... -- 1,370,000
Current portion of capital lease obligation........ 36,712 23,532
Accounts payable................................... 2,056,451 3,762,158
Accrued liabilities................................ 890,443 300,439
Unearned revenue................................... 169,540 104,272
----------- ----------
Total current liabilities........................ 3,153,146 6,616,041
----------- ----------
LONG-TERM LIABILITIES:
Notes payable to stockholders...................... -- 243,788
Capital lease obligation, less current portion..... 30,165 66,877
----------- ----------
Total long-term liabilities...................... 30,165 310,665
----------- ----------
COMMITMENTS AND CONTINGENCIES (Notes 1 and 5)
STOCKHOLDERS' EQUITY:
Common stock, $.01 par value, 20,000,000 shares
authorized,
6,430,568 and 4,659,469 shares issued,
respectively.................................... 64,306 46,595
Additional paid-in capital......................... 23,017,266 93,688
Retained earnings (deficit)........................ (8,189,072) 1,286,220
Treasury stock at cost, 11,000 shares.............. (59,675) --
Notes receivable from stockholders................. -- (572,145)
----------- ----------
Total stockholders' equity....................... 14,832,825 854,358
----------- ----------
Total liabilities and stockholders' equity....... $18,016,136 $7,781,064
=========== ==========
</TABLE>
The accompanying notes to financial statements
are an integral part of these balance sheets.
F-4
<PAGE>
1-800 CONTACTS, INC.
STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
Year Ended
---------------------------------------
January 2, December 31, December 31,
1999 1997 1996
----------- ------------ ------------
<S> <C> <C> <C>
NET SALES............................... $59,875,941 $21,115,314 $3,628,296
COST OF GOODS SOLD...................... 37,315,413 14,024,523 2,215,306
----------- ----------- ----------
Gross profit.......................... 22,560,528 7,090,791 1,412,990
SELLING, GENERAL AND ADMINISTRATIVE
EXPENSES............................... 31,541,525 5,945,221 1,041,312
----------- ----------- ----------
INCOME (LOSS) FROM OPERATIONS........... (8,980,997) 1,145,570 371,678
----------- ----------- ----------
OTHER INCOME (EXPENSE):
Interest expense...................... (104,370) (161,520) (26,175)
Interest income....................... 553,843 34,963 7,261
Other, net............................ (3,763) 13,395 (4,401)
----------- ----------- ----------
Total other, net.................... 445,710 (113,162) (23,315)
----------- ----------- ----------
INCOME (LOSS) BEFORE BENEFIT FOR INCOME
TAXES.................................. (8,535,287) 1,032,408 348,363
BENEFIT FOR INCOME TAXES................ 642,679 -- --
----------- ----------- ----------
NET INCOME (LOSS)....................... $(7,892,608) $ 1,032,408 $ 348,363
=========== =========== ==========
PER SHARE INFORMATION:
Basic and diluted net loss per common
share................................ $ (1.27)
===========
PRO FORMA INFORMATION:
Income (loss) before benefit
(provision) for income taxes......... (8,535,287) 1,032,408 348,363
Benefit (provision) for income taxes.. 642,679 (397,477) (134,120)
----------- ----------- ----------
Net income (loss)..................... $(7,892,608) $ 634,931 $ 214,243
=========== =========== ==========
Basic net income (loss) per common
share................................ $ (1.27) $ 0.14
=========== ===========
Diluted net income (loss) per common
share................................ $ (1.27) $ 0.13
=========== ===========
</TABLE>
The accompanying notes to financial statements
are an integral part of these statements.
F-5
<PAGE>
1-800 CONTACTS, INC.
STATEMENTS OF STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
Notes
Common Stock Additional Retained Treasury Stock Receivable
------------------ Paid-in Earnings ----------------- From
Shares Amount Capital (Deficit) Shares Amount Stockholders Total
--------- ------- ----------- ----------- ------- -------- ------------ -----------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
BALANCE, December 31,
1995................... 4,659,469 $46,595 $ 33,688 $ (94,551) -- $ -- $ (14,144) $ (28,412)
Repurchase of common
stock................. (931,894) (9,319) (230,681) -- -- -- -- (240,000)
Sale of common stock... 931,894 9,319 290,681 -- -- -- -- 300,000
Advances to
stockholders.......... -- -- -- -- -- -- (233,592) (233,592)
Net income............. -- -- -- 348,363 -- -- -- 348,363
--------- ------- ----------- ----------- ------- -------- --------- -----------
BALANCE, December 31,
1996................... 4,659,469 46,595 93,688 253,812 -- -- (247,736) 146,359
Advances to
stockholders.......... -- -- -- -- -- -- (324,409) (324,409)
Net income............. -- -- -- 1,032,408 -- -- -- 1,032,408
--------- ------- ----------- ----------- ------- -------- --------- -----------
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 24,827,971 -- -- -- -- 24,850,109
Repurchase and
retirement of common
stock................. (442,651) (4,427) (1,895,573) -- -- -- -- (1,900,000)
Purchase of treasury
shares................ -- -- -- -- (15,000) (81,375) -- (81,375)
Exercise of common
stock options......... -- -- (8,820) -- 4,000 21,700 -- 12,880
Net loss............... -- -- -- (7,892,608) -- -- -- (7,892,608)
--------- ------- ----------- ----------- ------- -------- --------- -----------
BALANCE, January 2,
1999................... 6,430,568 $64,306 $23,017,266 $(8,189,072) (11,000) $(59,675) $ -- $14,832,825
========= ======= =========== =========== ======= ======== ========= ===========
</TABLE>
The accompanying notes to financial statements
are an integral part of these statements.
F-6
<PAGE>
1-800 CONTACTS, INC.
STATEMENTS OF CASH FLOWS
Increase (Decrease) in Cash and Cash Equivalents
<TABLE>
<CAPTION>
Year Ended
--------------------------------------
January 2, December 31, December 31,
1999 1997 1996
----------- ------------ ------------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss)..................... $(7,892,608) $1,032,408 $ 348,363
Adjustments to reconcile net income
(loss) to net cash provided by (used
in) operating activities:
Depreciation and amortization......... 446,389 150,933 46,044
Other................................. -- 20,000 --
Loss on retirement of property and
equipment............................ 13,762 -- 1,834
Deferred income taxes................. (642,679) -- --
Changes in operating assets and
liabilities:
Inventories......................... (5,940,469) (4,336,445) (385,892)
Prepaid advertising................. (166,563) (127,696) --
Other current assets................ (133,912) (45,945) (8,423)
Deferred advertising costs.......... 1,530,064 (1,311,398) (394,297)
Accounts payable.................... (1,705,707) 3,290,864 421,228
Accrued liabilities................. 590,004 236,639 54,432
Unearned revenue.................... 65,268 68,327 30,986
----------- ---------- ---------
Net cash (used in) provided by
operating activities............. (13,836,451) (1,022,313) 114,275
----------- ---------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Net increase in notes receivable from
stockholders......................... (27,544) (324,409) (233,592)
Purchase of property and equipment.... (2,013,361) (488,244) (174,992)
Proceeds from sale of property and
equipment............................ 101,768 -- --
Purchase of intangible assets......... (5,000) (50,000) --
Deposits.............................. (38,049) (40,425) --
----------- ---------- ---------
Net cash used in investing
activities....................... $(1,982,186) $ (903,078) $(408,584)
=========== ========== =========
</TABLE>
The accompanying notes to financial statements
are an integral part of these statements.
F-7
<PAGE>
1-800 CONTACTS, INC.
STATEMENTS OF CASH FLOWS (continued)
Increase (Decrease) in Cash and Cash Equivalents
<TABLE>
<CAPTION>
Year Ended
--------------------------------------
January 2, December 31, December 31,
1999 1997 1996
----------- ------------ ------------
<S> <C> <C> <C>
CASH FLOWS FROM FINANCING ACTIVITIES:
Sale of common stock, net of
underwriting discounts and
commissions.......................... $25,734,844 $ -- $300,000
Common stock offering costs........... (509,537) (375,198) --
Common stock repurchases.............. (1,981,375) -- (240,000)
Proceeds from exercise of common stock
options.............................. 12,880 -- --
Net (repayments) borrowings on line of
credit............................... (1,055,640) 1,055,640 --
Borrowings from stockholders.......... -- 1,800,000 365,000
Principal payments on notes payable to
stockholders......................... (1,613,788) (411,212) (180,000)
Principal payments on notes payable
for distributions to stockholders,
net.................................. (982,995) -- --
Principal payments on long-term debt.. -- (55,871) (21,717)
Principal payments on capital lease
obligation........................... (23,532) (19,425) (442)
Bank overdraft........................ -- (68,543) 68,543
----------- --------- --------
Net cash provided by financing
activities......................... 19,580,857 1,925,391 291,384
----------- --------- --------
NET INCREASE (DECREASE) IN CASH AND CASH
EQUIVALENTS............................ 3,762,220 -- (2,925)
CASH AND CASH EQUIVALENTS AT BEGINNING
OF PERIOD.............................. -- -- 2,925
----------- --------- --------
CASH AND CASH EQUIVALENTS AT END OF
PERIOD................................. $ 3,762,220 $ -- $ --
=========== ========= ========
SUPPLEMENTAL CASH FLOW INFORMATION:
Cash paid for interest................ $ 228,907 $ 42,699 $ 18,984
</TABLE>
SUPPLEMENTAL DISCLOSURES OF NONCASH INVESTING AND FINANCING ACTIVITIES:
During the year ended January 2, 1999, 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
fiscal year 1998.
The accompanying notes to financial statements
are an integral part of these statements.
F-8
<PAGE>
1-800 CONTACTS, INC.
NOTES TO FINANCIAL STATEMENTS
NOTE 1. NATURE OF OPERATIONS AND ORGANIZATION OF BUSINESS
1-800 CONTACTS, INC., (the "Company") was incorporated in the state of Utah
in February 1995. The Company was reincorporated in Delaware in February 1998
in conjunction with its initial public offering of common stock. The Company is
a direct marketer of replacement contact lenses. The Company sells contact
lenses primarily through its toll-free telephone number and the Internet.
Regulatory Compliance
The sale and delivery of contact lenses is 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 laws and regulations relating to the delivery and sale of contact lenses
vary from state to state, but can generally be classified into five categories:
(i) laws that require contact lenses only be dispensed pursuant to a valid
prescription, (ii) laws that require the dispenser to be licensed by the state
as an optometrist, ophthalmologist or other professional authorized to dispense
lenses, (iii) laws that require lenses be dispensed only in a face-to-face
transaction, (iv) laws with requirements that are unclear or do not
specifically address the sale and delivery of contact lenses; and (v) laws that
the Company believes place no restrictions on the dispensing of replacement
contact lenses. The Company's operating practice is to attempt to obtain a
prescription from its customers or his/her eye care practitioner. If the
customer does not have a copy of his/her prescription, the Company attempts to
contact the customer's doctor to obtain a copy of, or verify the customer's
prescription. If the Company is unable to obtain a copy of, or verify the
customer's prescription, it is the Company's practice to complete the sale and
ship the lenses to the customer, based on the prescription information provided
by the customer. As a result, certain sales made by the Company violate the
applicable statute or regulation in the state in which the customer is located.
Any action brought against the Company based on its violation of such state
laws and regulations could result in fines to the Company and /or the required
compliance with such laws. Such required compliance could result in (i)
increased costs to the Company, (ii) the loss of a substantial portion of the
Company's customers for whom the Company is unable to obtain or verify their
prescription and (iii) the inability to sell to customers at all in a
particular state if the Company cannot comply with such state's laws. The
occurrence of any of the above could have a material adverse effect on the
Company's ability to sell contact lenses and continue to operate profitably.
Furthermore, there can be no assurance that states will not enact or impose
laws or regulations that prohibit mail order dispensing of contact lenses or
otherwise impair the Company's ability to sell contact lenses and continue to
operate profitably.
From time to time the Company receives notices, inquiries or other
correspondence from states or their 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 (see Note
5).
Sources of Supply
Historically, substantially all of the major manufacturers of contact lenses
have refused to sell lenses directly to direct marketers, including the
Company, and have sought to prohibit their distributors from doing so. As a
result, the Company currently purchases a substantial portion of its products
from unauthorized distributors. The Company is aware that at least one large
manufacturer of contact lenses puts tracking codes on its products in an effort
to identify distributors who are selling to direct marketers. The Company is
not an authorized dealer for the majority of the products which it sells. In
addition, the price the Company pays for
F-9
<PAGE>
1-800 CONTACTS, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
certain of its products is sometimes higher than that paid by eye care
practitioners, retail chains and mass merchandisers, who are able to buy
directly from the manufacturers. There can be no assurance that the Company
will be able to obtain sufficient quantities of contact lenses at competitive
prices in the future to meet the existing or anticipated demand for its
products. Any such inability would have a material adverse effect on the
Company's business, financial position and results of operations.
Although the Company seeks to reduce its reliance on any one supplier by
establishing relationships with a number of distributors and other sources, the
Company purchased from a single distributor approximately 47 percent and 40
percent of its contact lens inventory in 1998 and 1997, respectively. The
Company also purchased from another distributor 21 percent and 40 percent of
its contact lens inventory in 1997 and 1996, respectively. The Company
continually seeks to establish new relationships with potential suppliers in
order to be able to obtain adequate inventory at competitive prices. In the
event that these suppliers could no longer supply the Company with contact
lenses, there can be no assurance that the Company could secure other adequate
sources of supply, or that such supply could be obtained on terms no less
favorable to the Company than its current supply, which could adversely affect
the Company by increasing its costs or, in the event adequate replacement
supply cannot be secured, reducing its net sales.
NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
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, fiscal year 1998 represents 52 weeks and 3 days, covering the period
January 1, 1998 to January 2, 1999.
Revenue Recognition
Sales are recognized at the time of shipment to the customer. Payment for
the product is generally received prior to shipment. As a result, unearned
revenue represents amounts received from customers for which shipment has not
occurred. Shipping and handling fees are included as part of net sales. The
related freight costs associated with shipping products to customers are
included as a component of cost of goods sold.
Use of Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities as of the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
Cash Equivalents
The Company considers all highly liquid investments purchased with an
original maturity of three months or less to be cash equivalents.
Inventories
Inventories consist of contact lenses and are recorded at the lower of cost
(using the first-in, first-out method) or market.
F-10
<PAGE>
1-800 CONTACTS, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
Property and Equipment
Property and equipment are stated at cost and depreciated using the
straight-line method over their estimated useful lives ranging from three to
seven years. Leasehold improvements are amortized over the term of the lease.
Major additions and improvements are capitalized, while costs for minor
replacements, maintenance and repairs that do not increase the useful life of
an asset are expensed as incurred. Upon retirement or other disposition of
property and equipment, the cost and related accumulated depreciation or
amortization are removed from the accounts. The resulting gain or loss is
reflected in income.
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.
At each balance sheet date, the Company evaluates the realizability of
amounts reported as assets by comparing the carrying amounts of such assets to
the estimated remaining future net revenues (revenues less direct costs)
expected to result from the advertisement. To the extent the carrying amounts
exceeded the remaining future net revenues, the excess was recorded as
advertising expense in the current period.
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, is amortizing the
balance at the beginning of the fourth quarter of 1998 over 5 months.
The Company recorded total advertising expense of approximately $24,207,000,
$3,486,000 and $468,000 for the years ended January 2, 1999 and December 31,
1997 and 1996, respectively.
Other Assets
Other assets consist of the following:
<TABLE>
<CAPTION>
January December 31,
2, 1999 1997
--------- ------------
<S> <C> <C>
Intangible assets.................................. $ 175,447 $170,447
Deferred offering costs............................ -- 375,198
Deposits........................................... 78,474 40,425
--------- --------
253,921 586,070
Accumulated amortization........................... (102,628) (67,723)
--------- --------
$ 151,293 $518,347
========= ========
</TABLE>
F-11
<PAGE>
1-800 CONTACTS, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
Intangible assets consist of amounts paid to secure the rights to the
Company's telephone numbers and Internet domain names. These costs are
amortized over an estimated life of 5 years. The Company has contractual rights
customary to the industry to use its telephone numbers and Internet domain
names. However, under applicable rules and regulations of the Federal
Communications Commission, the Company does not have and cannot acquire any
property rights to the telephone numbers. In addition, the Company does not
have and cannot acquire any property rights to the Internet domain names. The
Company does not expect to lose the right to use the numbers or domain names,
however, there can be no assurance in this regard and such loss would have a
material adverse effect on the Company's financial position and results of
operations.
Fair Value of Financial Instruments
The Company's financial instruments consist mainly of cash and cash
equivalents, short-term payables and notes payable. The Company believes that
the carrying amounts approximate fair value.
Long-lived Assets
The Company reviews long-lived assets for impairment whenever events or
changes in circumstances indicate that the carrying amount of an asset may not
be recoverable. Recoverability of assets to be held and used is measured by a
comparison of the carrying amount of an asset to future net cash flows expected
to be generated by the asset. If such assets are considered to be impaired, the
impairment to be recognized is measured by the amount by which the carrying
amount of the assets exceeds the fair value of the assets.
Income Taxes
The Company recognizes deferred tax assets or liabilities for expected
future tax consequences of events that have been recognized in the financial
statements or tax returns. Under this method, deferred tax assets or
liabilities are determined based upon the difference between the financial
statement and income tax bases of assets and liabilities using enacted tax
rates expected to apply when differences are expected to be settled or
realized.
Prior to February 9, 1998, the Company had elected for federal and state
income tax purposes to include its taxable income with that of its shareholders
(an S Corporation election). For the years ended December 31, 1997 and 1996,
the unaudited 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 using an
effective income tax rate of 38.5 percent.
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 pro forma Basic and Diluted EPS for the year ended December 31, 1997
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 9).
F-12
<PAGE>
1-800 CONTACTS, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
The following is a reconciliation of the numerator and denominator used to
calculate Basic and Diluted EPS:
<TABLE>
<CAPTION>
Year Ended January 2, 1999 Year Ended December 31, 1997
-------------------------------- ----------------------------
Income Per-Share Income Per-Share
(Loss) Shares Amount (Loss) Shares Amount
----------- --------- --------- -------- --------- ---------
<S> <C> <C> <C> <C> <C> <C>
Historical:
Basic EPS.............. $(7,892,608) 6,227,640 $(1.27)
Effect of stock
options...............
----------- --------- ------
Diluted EPS............ $(7,892,608) 6,227,640 $(1.27)
=========== ========= ======
Pro Forma:
Basic EPS.............. $(7,892,608) 6,227,640 $(1.27) $634,931 4,659,469 $0.14
Effect of stock
options............... 20,782
Assumed distribution... 78,640
----------- --------- ------ -------- --------- -----
Diluted EPS............ $(7,892,608) 6,227,640 $(1.27) $634,931 4,758,891 $0.13
=========== ========= ====== ======== ========= =====
</TABLE>
At January 2, 1999, there were outstanding options to purchase 223,010
shares of common stock that were not included in the computation of Diluted EPS
because they would be antidilutive.
Reclassifications
Certain amounts in prior years' financial statements have been reclassified
to conform to the fiscal 1998 presentation.
NOTE 3. LINE OF CREDIT
Line of Credit
The Company has a revolving credit facility that 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 (9.25 percent at January 2, 1999). As of January
2, 1999, the Company had no outstanding borrowings. The credit facility is
secured by substantially all of the Company's assets and expires on July 31,
1999.
The credit facility contains various affirmative and negative covenants
which require, among other things, restrictions on additional debt, quarterly
pre-tax income, maintenance of working capital and restrictions on
distributions and changes in ownership. As of January 2, 1999, the Company was
not in compliance with the covenants regarding quarterly pre-tax income. The
bank waived these covenants for the year ended January 2, 1999.
NOTE 4. NOTES PAYABLE TO STOCKHOLDERS
Long Term
In February 1996, the Company entered into a credit agreement with a
stockholder that provides for maximum borrowings of $250,000. The borrowings
accrued interest at the prime rate plus 2 percent (9.75 percent at January 2,
1999). As of December 31, 1997, outstanding borrowings totaled $243,788. During
1998, this amount was paid in full with proceeds from the Company's initial
public offering of common stock.
Short Term
In May 1997, the Company borrowed $250,000 from a stockholder that was
repaid prior to December 31, 1997.
F-13
<PAGE>
1-800 CONTACTS, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
In May 1997, the Company borrowed $600,000 from a stockholder under a short-
term promissory note. The note accrued interest at the prime rate plus 2
percent and was due in November 1997. In July 1997, the Company repaid $100,000
on the note and refinanced the remaining $500,000 plus borrowed an additional
$600,000 from the stockholder under a new short-term promissory note. The total
$1,100,000 unsecured note payable accrued interest at prime plus 2 percent and
was due July 30, 1998. As consideration for entering into this note, the
Company agreed to modify the option it held to repurchase the stockholder's
common stock. Under the revised terms of the option, the Company had the right
to repurchase 442,651 shares of the stockholder's common stock for $1,900,000
(see Note 6).
In September 1997, the Company borrowed $250,000 from a stockholder under a
short-term, unsecured promissory note. The note accrued interest at prime plus
2 percent and was due in September 1998. In addition, for every month the note
was outstanding, a fee of $5,000 was added to the outstanding balance and
expensed as additional interest. As of December 31, 1997, $20,000 had been
added to the balance of the note.
As of December 31, 1997, accrued interest on stockholder notes payable
totaled $98,315 and is included in the caption "accrued liabilities" in the
accompanying December 31, 1997 balance sheet.
During 1998, all amounts owed to stockholders were paid in full with
proceeds from the Company's initial public offering of common stock.
NOTE 5. COMMITMENTS AND CONTINGENCIES
Legal and Regulatory 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
complain 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.
F-14
<PAGE>
1-800 CONTACTS, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
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.
See Note 1 for a discussion of regulatory matters.
Capital Lease Obligation
The Company leases the rights to use its telephone number from an individual
under a capital lease arrangement. At the end of the lease, the Company has the
option to purchase the interest in the telephone number for $17,500. The
minimum future lease payments under the capital lease as of January 2, 1999 are
as follows:
<TABLE>
<CAPTION>
Fiscal Year Amount
----------- --------
<S> <C>
1999........................................................... $ 42,000
2000........................................................... 31,500
--------
Total minimum lease payments................................... 73,500
Less amount representing interest.............................. (6,623)
--------
Present value of minimum lease payments........................ 66,877
Less current portion........................................... (36,712)
--------
Capital lease obligations, excluding current portion........... $ 30,165
========
</TABLE>
Operating Leases
The Company leases office and warehouse facilities and certain equipment
under noncancelable operating leases. Lease expense for the years ended January
2, 1999 and December 31, 1997 and 1996 totaled approximately $376,700, $88,000
and $30,900, respectively. In October 1998, the Company agreed to occupy
warehouse space in a facility then under construction. The new lease commitment
commenced in January, 1999.
Future minimum lease payments under noncancelable operating leases are as
follows (including expense under the new lease):
<TABLE>
<CAPTION>
Fiscal Year Amount
----------- ----------
<S> <C>
1999........................................................... $ 759,246
2000........................................................... 746,298
2001........................................................... 760,503
2002........................................................... 598,293
2003........................................................... 602,389
Thereafter..................................................... 658,703
----------
$4,125,432
==========
</TABLE>
Sales Tax
The Company's direct mail business is located, and all of its operations are
conducted, in the state of Utah. At January 2, 1999, the Company did not
collect sales or other similar taxes. However, various states have sought to
impose state sales tax collection obligations on out-of-state mail-order
companies, such as the
F-15
<PAGE>
1-800 CONTACTS, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
Company. The U.S. Supreme Court has held that the various states, absent
Congressional legislation, may not impose tax collection obligations on an out-
of-state mail order company whose only contacts with the taxing state are the
distribution of advertising materials through the mail, and whose subsequent
delivery of purchased goods is by mail or interstate common carriers. The
Company has not received an assessment from any state. The Company anticipates
that any legislative changes, if adopted, would be applied on a prospective
basis.
Advertising Commitments
The Company has entered into certain noncancelable commitments with
cooperative mail companies that will require the Company to pay approximately
$3.5 million for direct mail services through December 31, 1999.
NOTE 6. COMMON STOCK TRANSACTIONS
In February 1996, the Company repurchased 931,894 shares of its outstanding
common stock for $240,000 in cash. Concurrently with the purchase, the Company
sold these shares to new stockholders for $300,000 in cash. The Company
received the right to repurchase 442,651 of these shares for $1,900,000 prior
to February 1, 2001 (see Note 4). In connection with its initial public
offering, the Company exercised its rights to repurchase these shares.
In connection with the filing of an effective Form S-1 Registration
Statement and a reincorporation in the state of Delaware, the Board of
Directors and stockholders approved a 414.175 for 1 stock split and a change in
the authorized common stock to 20,000,000 shares at $0.01 par value per share.
This stock split and change in authorized common stock have been retroactively
reflected in the accompanying financial statements.
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
$24,850,000.
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 total 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. During 1998, the Company repurchased 15,000 shares for a total cost,
including commissions, of $81,375. See Note 12 for repurchases subsequent to
year end.
During December 1998, an employee exercised stock options to purchase 4,000
shares of common stock at $3.22 per share for a total of $12,880.
NOTE 7. STOCK OPTIONS AND STOCK OPTION PLAN
During fiscal 1998, the Company established a nonqualified and incentive
stock option plan. The plan provides for the issuance of a maximum of 310,000
shares of common stock to officers, directors and consultants and other key
employees. Incentive stock options and nonqualified options are granted at not
less than 100 percent of the fair market value of the underlying common stock
on the date of grant. As of January 2, 1999, 292,610 shares are available for
future granting.
F-16
<PAGE>
1-800 CONTACTS, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
Prior to the establishment of the stock option plan, the Company issued
nonqualified stock options to an employee in November 1996 to purchase 47,986
shares of common stock at an exercise price of $3.22. In addition, during the
year ended December 31, 1997, the Company issued nonqualified stock options to
an employee to purchase 4,799 shares of common stock at an exercise price of
$8.16 and nonqualified options to two employees to purchase an aggregate of
67,181 shares at $11 per share. The Company also issued stock options to a
consultant in February 1997 to purchase 19,195 shares of common stock at an
exercise price of $4.70. In January 1998, the Company granted nonqualified
stock options to purchase 71,979 shares of common stock at $11 per share to a
director of the Company. All options granted through January 2, 1999 vest
equally over a three year period and expire in ten years.
A summary of stock option activity is as follows:
<TABLE>
<CAPTION>
Weighted
Average
Exercise Price
Shares Per Share
------- --------------
<S> <C> <C>
Outstanding at January 1, 1996..................... -- --
Granted.......................................... 47,986 $ 3.22
------- ------
Outstanding at December 31, 1996................... 47,986 3.22
Granted.......................................... 91,175 9.52
------- ------
Outstanding at December 31, 1997................... 139,161 7.35
Granted.......................................... 89,369 11.22
Exercised........................................ (4,000) 3.22
Forfeited........................................ (1,520) 12.50
------- ------
Outstanding at January 2, 1999..................... 223,010 $ 8.94
======= ======
Exercisable at January 2, 1999..................... 82,378 $ 7.81
======= ======
</TABLE>
The following is additional information with respect to stock options:
<TABLE>
<CAPTION>
Outstanding Exercisable
as of Weighted-Average as of
Range of Exercise January 2, Remaining Weighted-Average January 2, Weighted-Average
Prices 1999 Contractual Life Exercise Price 1999 Exercise Price
----------------- ----------- ---------------- ---------------- ----------- ----------------
<S> <C> <C> <C> <C> <C> <C>
$ 3.18 -- $ 4.76 63,181 7.9 $ 3.67 34,390 $ 3.50
4.77 -- 6.35 3,000 9.7 5.63 0 0.00
7.94 -- 9.52 4,799 8.4 8.16 1,600 8.16
9.53 -- 11.11 139,160 8.9 11.00 46,388 11.00
11.12 -- 12.70 7,870 9.2 12.18 0 0.00
14.29 -- 15.88 5,000 9.5 15.88 0 0.00
------- --- ------ ------ ------ ---
223,010 8.7 $ 8.94 82,378 $ 7.81
======= ======
</TABLE>
The Company applies APB No. 25 and related interpretations in accounting for
its stock option grants to employees. Accordingly, no compensation expense has
been recognized for these stock option grants. Had compensation expense for the
Company's employee stock option grants been determined in accordance with SFAS
No. 123, the Company's net income (loss) for the years ended January 2, 1999
and December 31, 1997 and 1996, and diluted net income (loss) per common share
for the years ended January 2, 1999 and December 31, 1997 would have been
reduced to the pro forma amounts indicated below:
F-17
<PAGE>
1-800 CONTACTS, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
<TABLE>
<CAPTION>
1998 1997 1996
----------- -------- --------
<S> <C> <C> <C>
Net income (loss):
As reported (1)............................... $(7,892,608) $634,931 $214,243
Pro forma..................................... $(8,070,562) $617,785 $211,860
Diluted net income (loss) per common share:
As reported (1)............................... $ (1.27) $ 0.13
Pro forma..................................... $ (1.30) $ 0.13
</TABLE>
Due to the nature and timing of options grants, the resulting pro forma
compensation cost may not be indicative of future years.
- --------
(1) Includes the effect of the pro forma adjustments as described in Note 2.
The fair value of each option grant has been estimated on the grant date
using the Black-Scholes option-pricing model with the following assumptions:
weighted average risk-free interest rate of 5.6 percent for 1998 grants and 6.5
percent for 1997 and 1996 grants, expected stock price volatility of
approximately 78 percent for 1998 grants and 0 percent for 1997 and 1996
grants, an expected dividend yield of 0 for all grants and an expected life of
five years for all grants. The weighted average fair value of options granted
during fiscal years 1998, 1997 and 1996 was $7.53, $2.64 and $0.89 per share,
respectively.
NOTE 8. RELATED PARTY TRANSACTIONS
During fiscal 1998, 1997 and 1996, the Company made aggregate loans to two
stockholders totaling $22,300, $289,473 and $226,331, respectively. The loans
were unsecured, accrued interest at the prime rate and were due on demand.
Interest income on the loans totaled $5,244, $34,936 and $7,261 for the years
ended January 2, 1999, and December 31, 1997 and 1996, respectively, and is
included in the outstanding balance of the notes receivable. As of December 31,
1997 and 1996, notes receivable from stockholders totaled $572,145 and
$247,736, respectively. During 1998, the Company made equity distributions to
the stockholders sufficient to allow for their repayment on these notes. As a
result, these notes were classified as a reduction in stockholders' equity in
the accompanying 1997 financial statements. See Note 4 for a discussion of
other related party transactions.
NOTE 9. DISTRIBUTIONS TO STOCKHOLDERS
Prior to the consummation of its initial public offering, the Company
entered into an agreement for the distribution of retained earnings and tax
indemnification with the existing stockholders. Pursuant to the agreement, an S
Corporation distribution of $982,995 (net of notes receivable due from
stockholders of $599,689) was distributed in the form of promissory notes
issued by the Company. The notes were paid in full after the closing of the
offering. The agreement provided for, among other things, the indemnification
of the existing stockholders for any losses or liabilities with respect to any
additional taxes (including interest, penalties and legal fees) and the
repayment to the Company of amounts received as refunds, resulting from the
Company's operations during the period in which it was an S Corporation. No
amounts are currently payable, or anticipated to be payable, or receivable, or
anticipated to be receivable under the agreement. The existing stockholders
will be indemnified by the Company with respect to federal and state income tax
liabilities as a result of an adjustment to the Company's taxable income which
increases the tax liability to the existing stockholders for taxable periods
ending prior to the termination of the S corporation status. In addition, the
existing stockholders will indemnify the Company with respect to any federal
and state tax liabilities as a result of an adjustment which decreases the
existing stockholders' tax liability for taxable periods ending prior to the
termination of the Company's S corporation status and correspondingly increases
the tax liability of the Company for a taxable period commencing on or after
the termination of the Company's S corporation status.
F-18
<PAGE>
1-800 CONTACTS, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
NOTE 10. INCOME TAXES
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 components of the provision for income taxes for the period in fiscal
1998 since the termination of the S corporation status are as follows:
<TABLE>
<S> <C>
Current provision............................................ $ --
Deferred benefit (provision):
Federal.................................................... 2,864,270
State...................................................... 443,386
Change in valuation allowance.............................. (1,874,211)
Change from S corporation status........................... (790,766)
-----------
Total benefit for income taxes........................... $ 642,679
===========
</TABLE>
The following is a reconciliation between the statutory federal income tax
rate and the Company's effective income tax rate which is derived by dividing
the benefit for income taxes by loss before benefit for income taxes for the
fiscal year ended January 2, 1999.
<TABLE>
<S> <C>
Statutory federal income tax rate.................................. 34.0%
State income taxes, net of federal benefit......................... 3.3
Change from S corporation status................................... (8.0)
Valuation allowance................................................ (22.0)
Other.............................................................. .2
-----
7.5%
=====
</TABLE>
The components of the deferred tax assets and liabilities at January 2, 1999
are as follows:
<TABLE>
<S> <C>
Deferred income tax assets:
Operating loss carryforward............................... $ 2,357,190
Accrued reserves.......................................... 176,429
Intangibles amortization.................................. 23,741
Other..................................................... 33,645
-----------
2,591,005
Valuation allowance....................................... (1,874,211)
-----------
716,794
-----------
Deferred income tax liabilities:
Deferred advertising costs................................ (65,510)
Depreciation.............................................. (8,605)
-----------
(74,115)
-----------
Net deferred income tax asset............................... $ 642,679
===========
</TABLE>
A valuation allowance is provided when it is more likely than not that all
or some portion of the deferred tax assets will not be realized. Due to the
uncertainty with respect to the ultimate realization, the Company has
established a valuation allowance for a portion of the deferred tax assets. The
amount of the net deferred tax assets considered realizable, however, could
change in the near term based on changing conditions.
F-19
<PAGE>
1-800 CONTACTS, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
As of January 2, 1999, the Company has net operating loss carryforwards for
income tax purposes of approximately $6,320,000 which expire in fiscal year
2018 for federal income tax purposes and 2013 for state income tax purposes.
NOTE 11. PREFERRED STOCK
The Company has 1,000,000 shares authorized of $.01 par value preferred
stock. For the years ended January 2, 1999, and December 31, 1997 and 1996 no
shares were issued or outstanding.
NOTE 12. SUBSEQUENT EVENTS
Stock Options
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.
Stock Repurchases
In March 1999, the Company repurchased a total of 155,000 shares of its
common stock for a total cost, including commissions, of $1,860,005.
F-20
<PAGE>
1-800 CONTACTS, INC.
UNAUDITED CONDENSED BALANCE SHEET
<TABLE>
<CAPTION>
April 3,
1999
-----------
<S> <C>
ASSETS
CURRENT ASSETS:
Cash and cash equivalents........................................ $ 8,596,048
Inventories...................................................... 10,585,667
Other current assets............................................. 287,388
-----------
Total current assets........................................... 19,469,103
PROPERTY AND EQUIPMENT, net........................................ 2,344,296
DEFERRED INCOME TAXES.............................................. 460,466
OTHER ASSETS....................................................... 164,323
-----------
Total assets................................................... $22,438,188
===========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Current portion of capital lease obligation...................... $ 37,685
Accounts payable................................................. 7,013,140
Accrued liabilities.............................................. 1,617,283
Unearned revenue................................................. 428,971
-----------
Total current liabilities...................................... 9,097,079
-----------
CAPITAL LEASE OBLIGATION, less current portion..................... 20,371
-----------
STOCKHOLDERS' EQUITY:
Common stock..................................................... 64,306
Additional paid-in capital....................................... 23,009,439
Accumulated deficit.............................................. (7,891,895)
Treasury stock................................................... (1,861,112)
-----------
Total stockholders' equity..................................... 13,320,738
-----------
Total liabilities and stockholders' equity..................... $22,438,188
===========
</TABLE>
The accompanying notes to condensed financial statements
are an integral part of this condensed statement.
F-21
<PAGE>
1-800 CONTACTS, INC.
UNAUDITED CONDENSED STATEMENTS OF OPERATIONS
<TABLE>
<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.
F-22
<PAGE>
1-800 CONTACTS, INC.
UNAUDITED CONDENSED STATEMENT OF STOCKHOLDERS' EQUITY
For the Quarter Ended April 3, 1999
<TABLE>
<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 this condensed statement.
F-23
<PAGE>
1-800 CONTACTS, INC.
UNAUDITED CONDENSED STATEMENTS OF CASH FLOWS
Increase (Decrease) In Cash and Cash Equivalents
<TABLE>
<CAPTION>
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.
F-24
<PAGE>
1-800 CONTACTS, INC.
UNAUDITED CONDENSED STATEMENTS OF CASH FLOWS
Increase (Decrease) In Cash and Cash Equivalents
<TABLE>
<CAPTION>
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.
F-25
<PAGE>
1-800 CONTACTS, INC.
NOTES TO UNAUDITED CONDENSED FINANCIAL STATEMENTS
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 elsewhere in this prospectus.
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
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 (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.
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.
F-26
<PAGE>
1-800 CONTACTS, INC.
NOTES TO UNAUDITED CONDENSED FINANCIAL STATEMENTS--(Continued)
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 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.
NOTE 9. LEGAL MATTERS
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.
It is the opinion of management, after discussion with legal counsel, that
the ultimate dispositions of this and other matters will not have a material
impact on the financial condition, liquidity or results of operations of the
Company.
F-27
<PAGE>
[www.contacts.com]
<PAGE>
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
. We have not authorized anyone to give you any information that differs from
the information in this prospectus. If you receive any different
information, you should not rely on it.
. The delivery of this prospectus shall not under any circumstances create an
implication that 1-800 CONTACTS is operating under the same conditions that
it was operating under when this prospectus was written. Do not assume that
the information contained in this prospectus is correct at any time past the
date indicated.
. This prospectus does not constitute an offer to sell, or the solicitation of
an offer to buy, any securities other than the securities to which it
relates.
. This prospectus does not constitute an offer to sell, or the solicitation of
an offer to buy, the securities to which it relates in any circumstances in
which such offer or solicitation is unlawful.
----------------
TABLE OF CONTENTS
<TABLE>
<CAPTION>
Page
----
<S> <C>
Prospectus Summary....................................................... 1
Risk Factors............................................................. 5
Special Note Regarding Forward-Looking Statements........................ 13
Use of Proceeds.......................................................... 13
Market Price for Common Stock............................................ 14
Dividend Policy.......................................................... 14
Capitalization........................................................... 15
Selected Financial Data.................................................. 16
Management's Discussion and Analysis of Financial Condition and Results
of Operations........................................................... 18
Business................................................................. 24
Management............................................................... 37
Certain Relationships and Related Transactions........................... 41
Principal and Selling Stockholders....................................... 43
Description of Capital Stock............................................. 44
Shares Eligible for Future Sale.......................................... 47
Underwriting............................................................. 48
Experts.................................................................. 49
Legal Matters............................................................ 49
Where You Can Find More Information...................................... 50
Index to Financial Statements............................................ F-1
</TABLE>
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
2,040,000 Shares
[1-800 CONTACTS Logo]
Common Stock
----------------
PROSPECTUS
----------------
McDonald Investments Inc.
, 1999
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
<PAGE>
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
Item 13. Other Expenses of Issuance and Distribution.
The following is a statement of estimated expenses, to be paid solely by 1-
800 CONTACTS, of the issuance and distribution of the securities being
registered:
<TABLE>
<S> <C>
Securities and Exchange Commission registration fee.............. 14,694
NASD filing fee.................................................. 5,786
Nasdaq Stock Market listing fee.................................. *
Blue Sky fees and expenses (including attorneys' fees and
expenses)....................................................... *
Printing expenses................................................ *
Accounting fees and expenses..................................... *
Transfer agent's fees and expenses............................... *
Legal fees and expenses.......................................... *
Miscellaneous expenses........................................... *
------
Total........................................................ $ *
======
</TABLE>
- --------
*To be provided by amendment.
Item 14. Indemnification of Directors and Officers.
1-800 CONTACTS is incorporated under the laws of the State of Delaware.
Section 145 of the General Corporation Law of the State of Delaware ("Section
145") provides that a Delaware corporation may indemnify any persons who are,
or are threatened to be made, parties to any threatened, pending or completed
action, suit or proceeding, whether civil, criminal, administrative or
investigative (other than an action by or in the right of such corporation), by
reason of the fact that such person was an officer, director, employee or agent
of such corporation, or is or was serving at the request of such corporation as
a director, officer, employee or agent of another corporation or enterprise.
The indemnity may include expenses (including attorneys' fees), judgments,
fines and amounts paid in settlement actually and reasonably incurred by such
person in connection with such action, suit or proceeding, provided such person
acted in good faith and in a manner he reasonably believed to be in or not
opposed to the corporation's best interests and, with respect to any criminal
action or proceeding, had no reasonable cause to believe that his conduct was
illegal. A Delaware corporation may indemnify any persons who are, or are
threatened to be made, a party to any threatened, pending or completed action
or suit by or in the right of the corporation by reason of the fact that such
person was a director, officer, employee or agent of such corporation, or is or
was serving at the request of such corporation as a director, officer, employee
or agent of another corporation or enterprise. The indemnity may include
expenses (including attorneys' fees) actually and reasonably incurred by such
person in connection with the defense or settlement of such action or suit,
provided such person acted in good faith and in a manner he reasonably believed
to be in or not opposed to the corporation's best interests except that no
indemnification is permitted without judicial approval if the officer or
director is adjudged to be liable to the corporation. Where an officer or
director is successful on the merits or otherwise in the defense of any action
referred to above, the corporation must indemnify him against the expenses
which such officer or director has actually and reasonably incurred.
1-800 CONTACTS's Certificate of Incorporation and By-laws provide for the
indemnification of directors and officers of 1-800 CONTACTS to the fullest
extent permitted by Section 145.
In that regard, the By-laws provide that 1-800 CONTACTS shall indemnify any
person whom it has the power to indemnify by Section 145 from or against any
and all of the expenses, liabilities or other matters referred to or covered in
Section 145, and such indemnification is not exclusive of other rights to which
such person shall be entitled under any By-law, agreement, vote of stockholders
or disinterested directors or
<PAGE>
otherwise, both as to action in such person's official capacity for or in
behalf of 1-800 CONTACTS and/or any subsidiary of 1-800 CONTACTS and as to
action in another capacity while holding such office and shall continue as to
such person who has ceased to be a director, officer, employee, or agent of 1-
800 CONTACTS and/or subsidiary of 1-800 CONTACTS and shall inure to the benefit
of the heirs, executors, and administrators of such person.
1-800 CONTACTS has entered into indemnification agreements with each of its
executive officers and directors.
Item 15. Recent Sales of Unregistered Securities.
Within the past three years, 1-800 CONTACTS has not issued any securities
without registration under the Securities Act of 1933, as amended, except in
February 1996, 1-800 CONTACTS repurchased 2,250 shares of its outstanding
common stock and subsequently resold these shares to Donald and Stephen
Yacktman for $300,000 in cash. The above-described transaction was exempt from
registration under the Securities Act pursuant to Section 4(2) of the
Securities Act as a transaction not involving any public offering.
Item 16. Exhibits and Financial Statement Schedules.
(a) Exhibits.
<TABLE>
<CAPTION>
Number Description
------ -----------
<C> <S> <C>
*1.1 Form of Underwriting Agreement.
3.1(i) Restated Certificate of Incorporation of 1-800 CONTACTS. (1)
3.1(ii) Restated By-Laws of 1-800 CONTACTS. (1)
4.1 Form of certificate representing shares of Common Stock, $0.01
par value per share. (2)
*5.1 Opinion of Kirkland & Ellis.
10.1 Employment Agreement between 1-800 CONTACTS and Jonathan C.
Coon. (2)
10.2 Employment Agreement between 1-800 CONTACTS and John F.
Nichols. (2)
10.3 Employment Agreement between 1-800 CONTACTS and Scott S.
Tanner. (2)
10.4 Employment Agreement between 1-800 CONTACTS and Robert G.
Hunter. (2)
10.5 1-800 CONTACTS, Inc. 1998 Incentive Stock Option Plan. (2)
10.6 Lease between 1-800 CONTACTS and Draper Land Partnership II,
dated September 4, 1996, with respect to 1-800 CONTACTS's
former call center. (2)
10.7 Lease between 1-800 CONTACTS and Draper Land Partnership II,
dated November 3, 1997, with respect to 1-800 CONTACTS's call
center. (2)
10.8 Lease between 1-800 CONTACTS and Bird and Saunders, dated
January 23, 1998, with respect to 1-800 CONTACTS's warehouse.
(2)
10.9 Revolving Credit Agreement between 1-800 CONTACTS and Zions
First National Bank. (2)
10.10 Indemnification Agreement between 1-800 CONTACTS and its
officers and directors. (2)
10.11 Agreement for Distribution of Retained Earnings and Tax
Indemnification between
1-800 CONTACTS and the Existing Stockholders. (2)
10.12 Lease between 1-800 CONTACTS and Larry T. Short, dated June
27, 1995, with respect to the 1-800 CONTACTS telephone number.
(2)
10.13 Stock Option Agreement. (2)
</TABLE>
II-2
<PAGE>
<TABLE>
<CAPTION>
Number Description
------ -----------
<C> <S> <C>
10.14 First Amendment to Lease between 1-800 CONTACTS and Draper
Land Partnership II, dated May 25, 1998, with respect to 1-800
CONTACTS's call center.(3)
10.15 Second Amendment to Lease between 1-800 CONTACTS and Draper
Land Partnership II, dated August 6, 1998, with respect to 1-
800 CONTACTS's call center.(3)
10.16 Lease between 1-800 CONTACTS and ProLogis Development Services
Incorporated, dated October 13, 1998, with respect to 1-800
CONTACTS's distribution center.(3)
10.17 Revolving Credit Agreement between 1-800 CONTACTS and Zions
First National Bank, dated October 29, 1998.(3)
23.1 Consent of Independent Public Accountants.
*23.2 Consent of Kirkland & Ellis (included in Exhibit 5.1).
24.1 Power of Attorney (included in signature page).
</TABLE>
- --------
*To be filed by amendment.
(1) Incorporated by reference to 1-800 CONTACTS's Quarterly Report on Form 10-Q
for the quarterly period ended April 4, 1998 (Commission File No. 0-23633).
(2) Incorporated by reference to the same numbered exhibit to 1-800 CONTACTS's
Registration Statement on Form S-1 (Registration No. 333-41055).
(3) Incorporated by reference to the same numbered exhibit to 1-800 CONTACT's
Annual Report on Form 10-K for the year ended January 2, 1999 (Commission
File No. 0-23633).
(b) Financial Statement Schedules.
All schedules for which provision is made in the applicable accounting
regulations of the Commission are not required under the related instructions,
are inapplicable or not material, or the information called for thereby is
otherwise included in the financial statements and therefore has been omitted.
Item 17. Undertakings.
The undersigned registrant hereby undertakes:
(1) For purposes of determining any liability under the Securities Act
of 1933, the information omitted from the form of prospectus filed as part
of this registration statement in reliance upon Rule 430A and contained in
a form of prospectus filed by the registrant pursuant to Rule 424(b)(1) or
(4) or 497(h) under the Securities Act shall be deemed to be part of this
registration statement as of the time it was declared effective.
(2) For purposes of determining any liability under the Securities Act
of 1933, each post-effective amendment that contains a form of prospectus
shall be deemed to be a new registration statement relating to the
securities offered therein, and the offering of such securities at that
time shall be deemed to be the initial bona fide offering thereof.
Insofar as indemnification for liabilities arising under the Securities Act
of 1933 may be permitted to directors, officers and controlling persons of the
registrant pursuant to the foregoing provisions, or otherwise, the registrant
has been advised that in the opinion of the Securities and Exchange Commission
such indemnification is against public policy as expressed in the Securities
Act and is, therefore, unenforceable. In the event that a claim for
indemnification against such liabilities (other than the payment by the
registrant of expenses incurred or paid by a director, officer or controlling
person of the registrant in the successful defense of any action, suit or
proceeding) is asserted by such director, officer or controlling person in
connection with the securities being registered, the registrant will, unless in
the opinion of its counsel the matter has been settled by controlling
precedent, submit to a court of appropriate jurisdiction the question whether
such indemnification by it is against public policy as expressed in the
Securities Act and will be governed by the final adjudication of such issue.
II-3
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, the Registrant
has duly caused this Registration Statement to be signed on its behalf by the
undersigned, thereunto duly authorized, in the City of Draper, State of Utah,
on June 4, 1999.
1-800 Contacts, Inc.
By: _________________________________
Jonathan C. Coon
President and Chief Executive
Officer
POWER OF ATTORNEY
KNOW ALL MEN BY THESE PRESENTS, that each person whose signature appears
below constitutes and appoints Jonathan C. Coon, John F. Nichols and Scott S.
Tanner, and each of them, his true and lawful attorneys-in-fact and agents,
with full power of substitution and resubstitution, for him and in his name,
place and stead, in any and all capacities, to sign any or all amendments
(including post-effective amendments) to this registration statement (and any
registration statement filed pursuant to Rule 462(b) under the Securities Act
of 1933, as amended, for the Offering which this Registration Statement
relates), and to file the same, with all exhibits thereto, and other documents
in connection therewith, with the Securities and Exchange Commission, granting
unto said attorneys-in-fact and agents, and each of them, full power and
authority to do and perform each and every act and thing requisite and
necessary to be done in and about the premises, as fully to all intents and
purposes as he might or could do in person, hereby ratifying and confirming all
that said attorneys-in-fact and agents or any of them, or their or his
substitute or substitutes, may lawfully do or cause to be done by virtue
hereof.
* * * *
Pursuant to the requirements of the Securities Act of 1933, this
Registration Statement and power of attorney have been signed by the following
persons in the capacities and on the dates indicated:
<TABLE>
<CAPTION>
Signature Capacity Date
--------- -------- ----
<S> <C> <C>
President, Chief Executive June 4, 1999
____________________________________ Officer and Director
Jonathan C. Coon (principal executive
officer)
Chief Financial Officer and June 4, 1999
____________________________________ Director (principal
Scott S. Tanner financial officer)
Corporate Controller June 4, 1999
____________________________________ (principal accounting
Robert G. Hunter officer)
Vice President, Operations June 4, 1999
____________________________________ and Director
John F. Nichols
Director June 4, 1999
____________________________________
Stephen A. Yacktman
Director June 4, 1999
____________________________________
E. Dean Butler
</TABLE>
II-4
<PAGE>
Exhibit 23.1
CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS
As independent public accountants, we hereby consent to the use of our report
(and to all references to our firm) included in or made a part of this
registration statement.
ARTHUR ANDERSEN LLP
Salt Lake City, Utah
June 4, 1999
