<PAGE>
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
___________________________
FORM 10-Q
(Mark one)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended October 2, 1999
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from _____________ to _____________.
Commission file number: 0-23633
1-800 CONTACTS, INC.
(Exact name of registrant as specified in its charter)
Delaware 87-0571643
- ---------------------------------------- ------------------------------------
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
66 E. Wadsworth Park Drive, 3rd Floor
Draper, UT 84020
- ---------------------------------------- ------------------------------------
(Address of principal executive offices) (Zip Code)
(801) 924-9800
----------------------------------------------------
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports) and (2) has been subject to such
filing requirements for the past 90 days.
[X] Yes [_] No
As of November 4, 1999, the Registrant has 6,262,943 shares of Common
Stock, par value $0.01 per share outstanding.
<PAGE>
1-800 CONTACTS, INC.
INDEX
Page No.
--------
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Condensed Balance Sheets as of January 2, 1999
and October 2, 1999 (unaudited)............................. 3
Condensed Statements of Operations for the Quarter and
Three Quarters Ended October 3, 1998 (unaudited) and
October 2, 1999 (unaudited)................................. 4
Condensed Statement of Stockholders' Equity for the
Three Quarters Ended October 2, 1999 (unaudited)............ 5
Condensed Statements of Cash Flows for the Three Quarters
Ended October 3, 1998 (unaudited) and October 2, 1999
(unaudited)................................................. 6
Notes to Condensed Financial Statements....................... 8
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations................................... 11
Item 3. Quantitative and Qualitative Disclosure About Market Risk..... 16
PART II. OTHER INFORMATION
Item 1. Legal Proceedings............................................. 16
Item 2. Changes in Securities and Use of Proceeds..................... 16
Item 3. Defaults upon Senior Securities............................... 16
Item 4. Submission of Matters to a Vote of Security Holders........... 16
Item 5. Other Information............................................. 16
Item 6. Exhibits and Reports on Form 8-K.............................. 16
<PAGE>
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
1-800 CONTACTS, INC.
CONDENSED BALANCE SHEETS
ASSETS
<TABLE>
<CAPTION>
January 2, October 2,
1999 1999
----------- -----------
(Unaudited)
<S> <C> <C>
CURRENT ASSETS:
Cash and cash equivalents $ 3,762,220 $ 4,588,272
Inventories 10,752,324 15,799,308
Other current assets 483,139 348,734
----------- -----------
Total current assets 14,997,683 20,736,314
DEFERRED ADVERTISING COSTS 175,631 -
PROPERTY AND EQUIPMENT, net 2,048,850 2,370,216
DEFERRED INCOME TAXES 642,679 -
INTANGIBLE ASSETS, net 72,819 1,179,425
OTHER ASSETS 78,474 71,718
----------- -----------
Total assets $18,016,136 $24,357,673
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Current portion of capital lease obligation $ 36,712 $ 39,707
Acquisition payable - 600,000
Accounts payable 2,056,451 5,616,994
Accrued liabilities 890,443 2,414,639
Unearned revenue 169,540 338,845
----------- -----------
Total current liabilities 3,153,146 9,010,185
----------- -----------
CAPITAL LEASE OBLIGATION, less current portion 30,165 -
----------- -----------
STOCKHOLDERS' EQUITY:
Common stock 64,306 64,306
Additional paid-in capital 23,017,266 23,023,564
Accumulated deficit (8,189,072) (5,483,214)
Treasury stock (59,675) (2,257,168)
----------- -----------
Total stockholders' equity 14,832,825 15,347,488
----------- -----------
Total liabilities and stockholders' equity $18,016,136 $24,357,673
=========== ===========
</TABLE>
The accompanying notes to condensed financial statements
are an integral part of these condensed statements.
3
<PAGE>
1-800 CONTACTS, INC.
CONDENSED STATEMENTS OF OPERATIONS
(Unaudited)
<TABLE>
<CAPTION>
Quarter Ended Three Quarters Ended
------------------------------- -------------------------------
October 3, October 2, October 3, October 2,
1998 1999 1998 1999
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
NET SALES $18,418,946 $26,889,818 $41,648,688 $73,154,131
COST OF GOODS SOLD 11,490,306 15,953,417 26,078,404 44,517,247
----------- ---------- ----------- -----------
Gross profit 6,928,640 10,936,401 15,570,284 28,636,884
----------- ---------- ----------- -----------
SELLING, GENERAL AND
ADMINISTRATIVE EXPENSES:
Advertising expense 8,516,652 6,493,585 14,464,503 16,292,915
Other selling, general and
administrative expenses 2,487,563 3,119,890 5,066,370 8,735,881
----------- ---------- ----------- -----------
Total selling, general and
administrative expenses 11,004,215 9,613,475 19,530,873 25,028,796
----------- ---------- ----------- -----------
INCOME (LOSS) FROM OPERATIONS (4,075,575) 1,322,926 (3,960,589) 3,608,088
----------- ---------- ----------- -----------
OTHER INCOME (EXPENSE):
Interest expense (2,051) (26,664) (77,891) (29,908)
Interest income 139,167 73,188 487,291 247,311
Cancelled offering costs - (293,059) - (293,059)
Other, net - (841) 8,202 (841)
----------- ---------- ----------- -----------
Total other, net 137,116 (247,376) 417,602 (76,497)
----------- ---------- ----------- -----------
INCOME (LOSS) BEFORE BENEFIT
(PROVISION) FOR INCOME TAXES (3,938,459) 1,075,550 (3,542,987) 3,531,591
BENEFIT (PROVISION)
FOR INCOME TAXES
(INCLUDING PRO FORMA FOR 1998) 1,468,123 (50,000) 642,679 (742,679)
----------- ---------- ----------- -----------
NET INCOME (LOSS) $(2,470,336) $1,025,550 $(2,900,308) $ 2,788,912
=========== ========== =========== ===========
PER SHARE INFORMATION:
Basic and diluted net income
(loss) per common share $ (0.38) $ 0.16 $ (0.47) $ 0.44
=========== ========== =========== ===========
</TABLE>
The accompanying notes to condensed financial statements
are an integral part of these condensed statements.
4
<PAGE>
1-800 CONTACTS, INC.
CONDENSED STATEMENT OF STOCKHOLDERS' EQUITY
For the Three Quarters Ended October 2, 1999
(Unaudited)
<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 - - - - (180,000) (2,405,911) (2,405,911)
Exercise of common stock options - - 6,298 (83,054) 23,331 208,418 131,662
Net income - - - 2,788,912 - - 2,788,912
--------- -------- ----------- ----------- -------- ----------- -----------
BALANCE, October 2, 1999 6,430,568 $ 64,306 $23,023,564 $(5,483,214) (167,669) $(2,257,168) $15,347,488
========= ======== =========== =========== ======== =========== ===========
</TABLE>
The accompanying notes to condensed financial statements
are an integral part of these condensed statements.
5
<PAGE>
1-800 CONTACTS, INC.
CONDENSED STATEMENTS OF CASH FLOWS
(Unaudited)
Increase (Decrease) In Cash and Cash Equivalents
<TABLE>
<CAPTION>
Three Quarters Ended
----------------------------------
October 3, October 2,
1998 1999
------------- ------------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) $ (2,900,308) $ 2,788,912
Adjustments to reconcile net income (loss) to net cash
provided by (used in) operating activities:
Depreciation and amortization 313,137 679,428
Loss on retirement of property and equipment 1,798 941
Deferred income taxes (642,679) 642,679
Changes in operating assets and liabilities:
Inventories (7,610,076) (5,046,984)
Other current assets (496,282) 134,405
Deferred advertising costs (4,296,054) 175,631
Accounts payable 4,042,749 3,560,543
Accrued liabilities 1,114,894 1,524,196
Unearned revenue 494,912 169,305
------------- ------------
Net cash (used in) provided by operating activities (9,977,909) 4,629,056
------------- ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Net increase in notes receivable from stockholders (27,544) -
Purchase of property and equipment (1,779,806) (869,953)
Proceeds from sale of property and equipment 22,900 -
Purchase of intangible assets (5,000) (638,388)
Deposits (14,363) 6,756
------------- ------------
Net cash used in investing activities (1,803,813) (1,501,585)
------------- ------------
</TABLE>
The accompanying notes to condensed financial statements
are an integral part of these condensed statements.
6
<PAGE>
1-800 CONTACTS, INC.
CONDENSED STATEMENTS OF CASH FLOWS
(Unaudited)
Increase (Decrease) In Cash and Cash Equivalents
<TABLE>
<CAPTION>
Three Quarters Ended
---------------------------------
October 3, October 2,
1998 1999
------------ ----------
CASH FLOWS FROM FINANCING ACTIVITIES:
<S> <C> <C>
Sale of common stock, net of underwriting discounts and commissions $ 25,734,844 $ -
Common stock offering costs (563,733) -
Common stock repurchases (1,900,000) (2,405,911)
Proceeds from exercise of common stock options - 131,662
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 (15,930) (27,170)
------------ ----------
Net cash provided by (used in) financing activities 19,602,758 (2,301,419)
------------ ----------
NET INCREASE IN CASH AND CASH EQUIVALENTS 7,821,036 826,052
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD - 3,762,220
------------ ----------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 7,821,036 $ 4,588,272
============ ===========
SUPPLEMENTAL CASH FLOW INFORMATION:
Cash paid for interest $ 203,903 $ 31,384
</TABLE>
SUPPLEMENTAL DISCLOSURES OF NONCASH INVESTING AND FINANCING ACTIVITIES:
During the period ended October 3, 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 October 3, 1998.
During the period ended October 2, 1999, the Company acquired certain intangible
assets. As of October 2, 1999, the Company had an acquisition payable of
$600,000 (see Note 8).
The accompanying notes to condensed financial statements
are an integral part of these condensed statements.
7
<PAGE>
1-800 CONTACTS, INC.
NOTES TO CONDENSED FINANCIAL STATEMENTS
(Unaudited)
NOTE 1. PRESENTATION OF CONDENSED FINANCIAL STATEMENTS
The accompanying condensed financial statements have been prepared by the
Company, without audit, pursuant to the rules and regulations of the Securities
and Exchange Commission. Certain information and disclosures normally included
in financial statements prepared in accordance with generally accepted
accounting principles have been condensed or omitted pursuant to such rules and
regulations. These condensed financial statements reflect all adjustments
(consisting only of normal recurring adjustments), which in the opinion of
management, are necessary to present fairly the results of operations of the
Company for the periods presented. It is suggested that these condensed
financial statements be read in conjunction with the audited financial
statements and the notes thereto included in the Company's Annual Report to
Shareholders on Form 10-K.
The results of operations for the interim periods presented are not
necessarily indicative of the results to be expected for the full year.
NOTE 2. CHANGE IN ACCOUNTING PERIOD
Effective January 1, 1998, the Company changed from a calendar year end to
a 52/53 week year ending on the Saturday nearest to December 31. Due to this
change, the first quarter of 1998 represents 13 weeks and 3 days, covering the
period January 1, 1998 to April 4, 1998. The other quarters for fiscal year
1998 are each 13 weeks.
NOTE 3. INCOME TAXES AND PRO FORMA INFORMATION
Effective February 9, 1998 the Company's S Corporation election was
terminated. As a result, the Company recorded a net deferred tax liability and
the related deferred tax provision of approximately $791,000 for the tax effect
of the differences between financial statement and income tax basis of assets
and liabilities that existed at the termination date of the S Corporation
election.
The benefit for income taxes for the three quarters ended October 3, 1998
is presented on a pro forma basis as if the Company had been a C Corporation for
the entire period.
NOTE 4. ADVERTISING COMMITMENTS
During the three quarters ended October 2, 1999, the Company entered into
certain commitments to purchase approximately $15 million of broadcast
advertising from October 1999 through September 2000. The Company can cancel up
to 50 percent of the total amount committed. As of October 2, 1999, the Company
has cancelled approximately $4 million of the amount committed.
NOTE 5. NET INCOME (LOSS) PER COMMON SHARE
Basic net income (loss) per common share ("Basic EPS") excludes dilution
and is computed by dividing net income (loss) by the weighted-average number of
common shares outstanding during the period. Diluted net income (loss) per
common share ("Diluted EPS") reflects the potential dilution that could occur if
stock options or other common stock equivalents were exercised or converted into
common stock. The computation of Diluted EPS does not assume exercise or
conversion of securities that would have an antidilutive effect on net income
(loss) per common share.
8
<PAGE>
The Basic and Diluted EPS for the three quarters ended October 3, 1998 give
effect to the pro forma effects on historical net income (loss) 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 (see Note 3).
The following is a reconciliation of the numerator and denominator used to
calculate Basic and Diluted EPS:
<TABLE>
<CAPTION>
Quarter Ended October 3, 1998 Quarter Ended October 2, 1999
------------------------------------- ------------------------------------
Income Per-Share Income Per-Share
(Loss) Shares Amount (Loss) Shares Amount
------------ --------- --------- ----------- --------- ---------
<S> <C> <C> <C> <C> <C> <C>
Basic EPS $ (2,470,336) 6,430,568 $ (0.38) $ 1,025,550 6,273,551 $ 0.16
Effect of stock options 84,887
------------ --------- --------- ----------- --------- ---------
Diluted EPS $ (2,470,336) 6,430,568 $ (0.38) $ 1,025,550 6,358,438 $ 0.16
============ ========= ========= =========== ========= =========
<CAPTION>
Three Quarters Ended October 3, 1998 Three Quarters Ended October 2, 1999
------------------------------------- ------------------------------------
Income Per-Share Income Per-Share
(Loss) Shares Amount (Loss) Shares Amount
------------ --------- --------- ----------- --------- ---------
<S> <C> <C> <C> <C> <C> <C>
Basic EPS $ (2,900,308) 6,164,471 $ (0.47) $ 2,788,912 6,311,924 $ 0.44
Effect of stock options 67,699
------------ --------- --------- ----------- --------- ---------
Diluted EPS $ (2,900,308) 6,164,471 $ (0.47) $ 2,788,912 6,379,623 $ 0.44
============ ========= ========= =========== ========= =========
</TABLE>
NOTE 6. COMMON STOCK TRANSACTIONS
During the three quarters ended October 2, 1999, the Company repurchased a
total of 180,000 shares of its common stock for a total cost of $2,405,911.
During the three quarters ended October 2, 1999, employees exercised stock
options to purchase 23,331 shares of common stock for a total of $131,662.
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
In May 1999, the Company acquired the assets of Contact Lenses Online, Inc.
("CLO") for $1.2 million in cash to be paid as follows: $600,000 on the closing
date, $300,000 six months after the closing date and $300,000 one year after the
closing date. The assets acquired include the web address www.contactlenses.com,
various telephone numbers and CLO's customer database which are included in
intangible assets and amortized over an estimated life of 5 years.
NOTE 9. LEGAL MATTERS
On July 14, 1998, Craig S. Steinberg, O.D., a professional corporation
d.b.a. City Eyes Optometry Center, filed a purported class action on behalf of
all optometrists licensed to practice in California against the Company and its
directors in Los Angeles County Superior Court (the "Steinberg Complaint"). The
complaint alleges three separate causes of action for unfair competition: (i)
selling contact lenses to California residents without being registered, (ii)
selling contact lenses to California residents without verifying the
prescription, and (iii) failing to disclose in its advertising that it sells
"sample" lenses not intended for sale to the public. The complaint requests
various forms of
9
<PAGE>
relief, including damages of an unspecified amount, attorney's fees and a
permanent injunction to prevent the Company from selling contact lenses to
California residents without being registered and without verifying the
prescription as well as from selling sample contact lenses to California
residents. In addition, the plaintiff has filed a motion for preliminary
injunction seeking the injunctive relief requested in the complaint. On August
11, 1998, the Company removed the action to the United States District Court for
the Central District of California based on diversity jurisdiction.
In response to motions by the Company, plaintiff and another California
optometrist, Ellis Miles (collectively "plaintiffs") filed a First Amended
Complaint ("FAC") against the Company and its directors on or about September 3,
1998 purporting to sue on behalf of the public under California's unfair
competition statute rather than as a class action on behalf of optometrists.
Although the substantive claims for unfair competition remain the same, the FAC
seeks restitutionary relief rather than damages. Plaintiffs also stipulated to
dismiss the Company's directors as defendants rather than oppose the Company's
motion to dismiss them, leaving the Company as the only remaining defendant.
On October 2, 1998, plaintiffs re-filed their motion for preliminary
injunction in federal court. The Company likewise filed a motion to strike
plaintiff's claims for monetary relief. Plaintiffs withdrew their motion for
preliminary injunction on October 19, 1998, after the Company filed its
opposition to the motion indicating, inter alia, that the Company had been
registered as a Nonresident Contact Lens Seller in California. The Court denied
the Company's motion to strike plaintiffs' claims for monetary relief on
February 26, 1999. The Company filed its Answer to the First Amended Complaint
on March 11, 1999.
On March 31, 1999, plaintiffs filed a motion to strike the Company's
affirmative defenses (1) that plaintiffs' claims are barred by the unclean hands
of plaintiffs' and those they represent, (2) that plaintiffs claims are barred
by the doctrine of primary jurisdiction because they are the responsibility of
the California Medical Board, and (3)that plaintiffs' claims for monetary relief
on behalf of non-parties absent a class action violate due process rights of the
Company and/or the non-parties plaintiffs purport to represent. The Court denied
plaintiffs' motion with respect to each of these affirmative defenses in Orders
dated June 1, 1999 and July 13, 1999.
In or about mid August 1999 the parties agreed to remand the case to Los
Angeles County Superior Court based upon plaintiffs' stipulation that they no
longer seek monetary relief on behalf of themselves or other optometrists. The
Court remanded the case to Los Angeles County Superior Court on or about August
23, 1999.
On April 7, 1999 the Kansas Board of Examiners in Optometry commenced a
civil action against the Company. The action was filed in the District Court of
Shawnee County, Kansas, Division 6. The complaint was amended on May 28, 1999.
The amended complaint alleges that on "one or more occasions" the Company sold
contact lenses in the state of Kansas without receipt or verification of a
prescription. The amended complaint seeks the issuance of an order enjoining the
Company from further engaging in the alleged activity. The amended complaint
does not seek monetary damages. In response to the amended complaint, the
Company has retained counsel and intends to vigorously defend itself in this
action. The Company has filed an answer to the amended complaint. In addition,
the Company will be filing a motion seeking summary judgment in its favor.
On or about November 2, 1999, the Company received a complaint from the
Texas Optometry Board seeking injunctive relief and civil penalties against the
Company for alleged violation of the Texas Optometry Act. Specifically, the
complaint alleges that the Company (1) failed to state explicitly in its
advertisements that an optometrist's written prescription is required to
purchase contact lenses, and (2) dispensed contact lenses without such a
prescription. Just prior to becoming aware of the complaint, the Company had
discussed and resolved these very issues with the Texas Department of Health,
the regulatory authority in Texas for sellers of contact lens like the Company.
The Company plans to vigorously defend this action should the Optometry Board
still choose to pursue it.
From time to time the Company is involved in other legal matters generally
incidental to its business.
It is the opinion of management, after discussion with legal counsel, that
the ultimate dispositions of these matters will not have a material impact on
the financial condition, liquidity or results of operations of the Company.
10
<PAGE>
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Overview
The Company is a leading direct marketer of replacement contact lenses. The
Company was formed in February 1995 and is the successor to the mail order
business founded by the Company's Vice President of Operations in March 1991.
Since its formation, the Company's net sales have grown rapidly, from $3.6
million in 1996 to $59.9 million in 1998 and from $41.6 million in the first
three quarters of 1998 to $73.2 million in the first three quarters of 1999.
Prior to consummation of its initial public offering ("IPO") in February
1998, the Company operated as an S corporation and, therefore, was not subject
to federal or certain state income taxes. In connection with the consummation
of the IPO, the Company revoked its S Corporation status and became subject to
federal and state income taxes. As a result, the Company recorded a net
deferred tax liability and the related deferred tax provision of approximately
$791,000 for the tax effect of the differences between financial statement and
income tax basis of assets and liabilities that existed at the termination date
of the S corporation election.
Effective January 1, 1998, the Company changed from a calendar year end to
a 52/53 week year ending on the Saturday nearest to December 31. Due to this
change, the first quarter of 1998 represents 13 weeks and 3 days, covering the
period January 1, 1998 to April 4, 1998. The other quarters for fiscal year 1998
are each 13 weeks.
During fiscal 1998, the Company began utilizing a variety of new
advertising vehicles, including an extensive television marketing campaign, new
print vehicles, Internet and radio spots. As direct-response information became
available during the fourth quarter of 1998, the Company determined that its
ability to track individual sales to specific advertising campaigns was
restricted as a result of the variety of new advertising vehicles utilized.
Therefore, beginning in the fourth quarter of 1998, the Company began expensing
all advertising costs, including all direct-mail advertising costs, when the
advertising first takes place. As a result, quarter-to-quarter comparisons are
impacted within and between quarters by the timing of television, radio and
Internet advertisements and by the mailing of the Company's printed
advertisements. The volume of mailings and other advertising may vary in
different quarters and from year to year depending on the Company's assessment
of prevailing market opportunities.
The sale and delivery of contact lenses are governed by both federal and
state laws and regulations. The Company sells to customers in all 50 states,
and each sale is subject to the laws of the state where the customer is located.
The Company's operating practice is to attempt to obtain a valid prescription
from each of its customers or his/her eye care practitioner. If the Company is
unable to obtain a copy of or verify the customer's prescription, the Company's
practice is to ship the lenses to the customer based on the information that the
customer has provided. The Company retained legal counsel to identify and
summarize the applicable laws of each of the states in which the Company
generates material sales. The Company compared its operations to the applicable
requirements of the laws contained in such summaries. Based on such comparison,
the Company estimates that approximately one-third of its 1998 net sales
appeared to conform to the requirements of applicable state laws and
regulations.
11
<PAGE>
Results of Operations
The following table presents the Company's results of operations expressed
as a percentage of net sales for the periods indicated:
<TABLE>
<CAPTION>
Quarter Ended Three Quarters Ended
-------------------------- --------------------------
October 3, October 2, October 3, October 2,
1998 1999 1998 1999
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
Net sales 100.0% 100.0% 100.0% 100.0%
Cost of goods sold 62.4 59.3 62.6 60.9
---------- ---------- ---------- ----------
Gross profit 37.6 40.7 37.4 39.1
---------- ---------- ---------- ----------
Advertising expense 46.2 24.2 34.7 22.3
Other selling, general and administrative expenses 13.5 11.6 12.2 11.9
---------- ---------- ---------- ----------
Total selling, general and administrative expenses 59.7 35.8 46.9 34.2
---------- ---------- ---------- ----------
Income (loss) from operations (22.1) 4.9 (9.5) 4.9
Other income (expense), net 0.7 (0.9) 1.0 (0.1)
---------- ---------- ---------- ----------
Income (loss) before benefit (provision) for
income taxes (21.4) 4.0 (8.5) 4.8
Benefit (provision) for income taxes [pro forma
for 1998] 8.0 (0.2) 1.5 (1.0)
---------- ---------- ---------- ----------
Net income (loss) [pro forma for 1998] (13.4%) 3.8% (7.0%) 3.8%
========== ========== ========== ==========
</TABLE>
Net sales. Net sales for the quarter ended October 2, 1999 increased 46%
to $26.9 million from $18.4 million for the quarter ended October 3, 1998. For
the three quarters ended October 2, 1999, net sales increased 76% to $73.2
million from $41.6 million for the three quarters ended October 3, 1998. The
Company believes the increases in net sales reflect some of the benefits of the
Company's increased television and Internet advertising. Internet sales for the
third quarter of 1999 were approximately $5.8 million, representing
approximately 21% of the net sales for the quarter, as compared to approximately
$0.9 million for the third quarter of 1998. For the first three quarters of
1999, Internet sales were approximately $12.4 million or 16.9% of net sales as
compared to approximately $1.1 million or 2.6% of net sales for the first three
quarters of 1998. The Company is also realizing the benefits of repeat sales
from a growing customer base. Repeat sales for the third quarter of 1999
increased 148% to $15.1 million or approximately 56% of net sales from $6.1
million or approximately 33% of net sales for the third quarter of 1998. Repeat
sales for the first three quarters of 1999 increased 162% to $38.5 million from
$14.7 million for the first three quarters of 1998. Although the Company
believes that sales in the fourth quarter will increase substantially in 1999 as
compared to 1998, the Company expects the rate of growth in net sales to
decrease as compared to prior quarters.
Gross profit. Gross profit as a percentage of net sales increased to 40.7%
for the quarter ended October 2, 1999 from 37.6% for the quarter ended October
3, 1998. For the three quarters ended October 2, 1999, gross profit as a
percentage of net sales increased to 39.1% from 37.4% for the three quarters
ended October 3, 1998. With the increase in sales, the Company was able to
obtain inventory at lower costs because of purchase volumes and more competitive
pricing resulting from access to more vendors.
Advertising Expense. Advertising expense for the quarter ended October 2,
1999 decreased $2.0 million, or 24%, from the quarter ended October 3, 1998. As
a percentage of net sales, advertising expense decreased to 24.2% for the third
quarter of 1999 from 46.2% for the third quarter of 1998. For the three quarters
ended October 2, 1999, advertising expense increased $1.8 million, or 13%, from
the three quarters ended October 3, 1998. Advertising expense as a percentage of
net sales decreased to 22.3% for the first three quarters of 1999 as compared to
34.7% for the first three quarters of 1998. The Company expects that advertising
spending as well as advertising as a percentage of net sales in fiscal year 1999
will be less than in fiscal year 1998. However, if opportunities present
themselves, the Company may increase advertising spending above currently
planned levels.
12
<PAGE>
During fiscal 1998, the Company began utilizing a variety of new
advertising vehicles, including an extensive television marketing campaign, new
print vehicles, Internet and radio spots. As direct-response information became
available during the fourth quarter of 1998, the Company determined that its
ability to track individual sales to specific advertising campaigns was
restricted as a result of the variety of new advertising vehicles utilized.
Therefore, beginning in the fourth quarter of 1998, the Company began expensing
all advertising costs, including all direct-mail advertising costs, when the
advertising first takes place. The Company also determined that for previously
deferred advertising costs the period during which the future benefits were
expected to be received was shortened. Accordingly, the Company amortized the
balance at the beginning of the fourth quarter of 1998 over five months.
Other selling, general and administrative expenses. Other selling, general
and administrative expenses for the quarter ended October 2, 1999 increased $0.6
million, or 25%, from the quarter ended October 3, 1998. As a percentage of net
sales, other selling, general and administrative expenses decreased to 11.6% for
the third quarter of 1999 from 13.5% for the third quarter of 1998. For the
three quarters ended October 2, 1999, other selling, general and administrative
expenses increased $3.7 million, or 72%, from the three quarters ended October
3, 1998. Other selling, general and administrative expenses as a percentage of
net sales decreased slightly to 11.9% for the first three quarters of 1999 as
compared to 12.2% for the first three quarters of 1998. With the increased
sales, the Company was able to better leverage its other selling, general and
administrative expenses.
Other income (expense), net. Other income (expense) decreased to
approximately ($247,000) for the quarter ended October 2, 1999 from
approximately $137,000 for the quarter ended October 3, 1998. For the three
quarters ended October 2, 1999, other income (expense) decreased to
approximately ($76,000) from approximately $418,000 for the three quarters ended
October 3, 1998. During the quarter ended October 2, 1999, the Company expensed
approximately $293,000 in costs related to the Company's cancelled common stock
offering. In addition, interest income decreased due to lower cash balances.
For the three quarters ended October 2, 1999, the decrease in interest income
was offset by the decrease in interest expense as the majority of debt was paid
off during the first quarter of 1998 with proceeds from the IPO.
Income taxes. The pro forma provision for income taxes for the three
quarters ended October 3, 1998 has been determined assuming the Company had been
taxed as a C Corporation for federal and state income tax purposes for the
entire period. The Company's effective tax rate for the quarter and three
quarters ended October 2, 1999 was approximately 4.6% and 21.0%, respectively,
which reflects changes in the valuation allowance as a result of utilizing some
tax operating loss carryforwards. As of October 2, 1999, the Company has
provided a valuation allowance on all deferred tax assets. The Company's future
effective tax rate will depend upon future taxable income and changes in the
valuation allowance associated with the deferred tax assets.
Liquidity and Capital Resources
The Company historically funded its growth through a combination of funds
generated from operations and borrowings. During February 1998, the Company
issued 2,213,750 shares of common stock in connection with its IPO, which
included 288,750 shares pursuant to the underwriters' over-allotment option.
The proceeds received from the IPO, net of underwriting commissions and offering
costs, totaled approximately $24.9 million. The Company used these funds to
enhance growth through increased advertising expenditures and to increase
inventory levels in anticipation of future sales. In order to help ensure
sufficient supply of inventory, the Company generally carries a higher level of
inventory than if it were able to purchase directly from all contact lens
manufacturers.
For the three quarters ended October 2, 1999 and October 3, 1998, net cash
provided by (used in) operating activities was approximately $4.6 million and
($10.0) million, respectively. In the 1999 period, cash was provided primarily
by net income and increases in accounts payable and accrued liabilities offset
by an increase in inventories. In the 1998 period, cash was used primarily to
fund the Company's growth as the Company significantly increased inventory
levels and advertising spending.
The Company used approximately $1.5 million and $1.8 million for investing
activities in the three quarters ended October 2, 1999 and October 3, 1998,
respectively. The majority of these amounts relate to capital expenditures
13
<PAGE>
for infrastructure improvements. Capital expenditures for the 1999 period were
approximately $0.9 million. The Company began operations in its new distribution
center in February 1999. This new facility is several times the size of the
prior distribution center and is strategically located near the Salt Lake City,
Utah airport. In addition, on May 4, 1999, the Company acquired the assets of
Contact Lenses Online, Inc. ("CLO") for $1.2 million in cash, of which $0.6
million was paid on the closing date. The assets acquired include the web
address, www.contactlenses.com, various telephone numbers and CLO's customer
database. Capital expenditures for the 1998 period were approximately $1.8
million. The Company completed the move into its new call center during July
1998. In conjunction with the move, the Company acquired new telecommunications
systems and enhanced it management information systems. The Company anticipates
additional capital expenditures for infrastructure as it continues to expand and
improve operating facilities, telecommunications systems and management
information systems in order to handle future growth.
As of October 2, 1999, the Company had entered into commitments to purchase
approximately $15 million of broadcast advertising from October 1999 through
September 2000. The Company can cancel up to 50% of the total amount committed.
As of October 2, 1999, the Company has cancelled approximately $4 million of the
amount committed.
During the first three quarters of 1999, the Company used approximately
$2.3 million for financing activities. The Company repurchased a total of
180,000 shares of its common stock for a total cost of $2,405,911. This was
offset slightly by proceeds from the exercise of common stock options. During
the first three quarters of 1998, approximately $19.6 million was provided by
financing activities, resulting from net proceeds received from the Company's
IPO, offset by repayments of debt, distributions to stockholders and the
repurchase of stock.
On October 13, 1998, the Company's Board of Directors authorized a
repurchase of up to 500,000 shares of its common stock. A purchase of the full
amount would equal approximately 7.8 percent of the 6,430,568 shares issued. The
repurchase of common stock is subject to market conditions and is accomplished
through periodic purchases at prevailing prices on the open market, by block
purchases or in privately negotiated transactions. The repurchased shares will
be retained as treasury stock to be used for corporate purposes. On August 13,
1999, the Company reinstated the share repurchase program, which had been
suspended as of July 26, 1999. Through October 2, 1999, the Company has
repurchased 195,000 shares for a total cost of $2,487,286. The repurchases were
funded using cash on hand.
In August 1997, the Company established a revolving credit facility, which
was most recently amended in September 1999, to provide for working capital
requirements and other corporate purposes. The credit facility, as amended,
provides for borrowings equal to the lesser of $10.0 million or 50 percent of
eligible inventory and bears interest at a floating rate equal to the lender's
prime interest rate plus 0.5 percent (8.75 percent as of October 2, 1999). As
of October 2, 1999, the Company had no outstanding borrowings under the credit
facility. The credit facility is secured by substantially all of the Company's
assets and contains financial covenants customary for this type of financing.
The credit facility expires April 30, 2001.
On June 9, 1999, the Company filed a registration statement with the
Securities and Exchange Commission to offer 2.04 million shares of common stock
to the public through an underwritten offering. On August 13, 1999, the Company
cancelled this proposed offering due to market conditions. The Company had
intended to use the proceeds from the proposed offering to help fund a 100%
increase in advertising spending in fiscal 2000. As a result of the
cancellation, the Company plans to increase advertising spending by
approximately 25% in fiscal 2000 from its anticipated fiscal 1999 spending. In
addition, the Company recorded a one-time expense of approximately $293,000 in
the third quarter of fiscal 1999 for costs related to the cancelled offering.
The Company believes that its cash on hand, together with cash generated
from operations and the cash available through the credit facility, will be
sufficient to support current operations and future growth through fiscal 2000.
The Company may be required to seek additional sources of funds for accelerated
growth or continued growth after that point, and there can be no assurance that
such funds will be available on satisfactory terms. Failure to obtain such
financing could delay or prevent the Company's planned growth, which could
adversely affect the Company's business, financial condition and results of
operations.
14
<PAGE>
As a result of state regulatory requirements, the Company's liquidity,
capital resources and results of operations may be negatively impacted in the
future if the Company incurs increased costs or fines, is prohibited from
selling its products in a particular state(s) or experiences the loss of a
substantial portion of the Company's customers for whom the Company is unable to
obtain or verify a prescription due to the enforcement of requirements by state
regulatory agencies.
Year 2000 Issue
The Company does not expect Year 2000 compliance to be a significant issue
for internal systems since the Company has replaced or upgraded the majority of
its critical technology systems within the last two years. However, the Company
is performing in-depth analysis and testing so that the Company will be able to
take any necessary steps to become Year 2000 compliant. As of the date of this
filing, the Company's Year 2000 compliance assessment is as follows:
* All of the Company's database and web site servers have been tested and
determined to be Year 2000 compliant.
* All of the Company's workstation computers have been tested and
determined to be Year 2000 compliant.
* The Company's telecommunications equipment has been certified by vendors
as Year 2000 compliant per the specifications of the manufacturer.
* The Company's accounting software system is Year 2000 compliant as
certified by the developer.
* The Company's proprietary software and web site software assessment is
scheduled to be completed by the end of November 1999. Preliminary
testing has not shown any conditions of non-compliance.
* The Company has obtained correspondence from the majority of inventory
suppliers stating Year 2000 compliance or planned compliance by the end
of the year.
* The Company has also obtained correspondence from its significant
service providers, including those providing telecommunications,
utilities and credit card processing as well as our primary provider of
expedited shipping services, stating Year 2000 compliance or planned
compliance by the end of the year.
The Company has not yet incurred any material costs related to Year 2000
compliance and does not anticipate any material costs in the future, although
the Company cannot assure that any future costs will not be material.
The Company's contingency plans include a backup electrical system and an
offsite backup web site server. The Company has manual processes for order
taking and fulfillment, which can be used in the event of system disruption.
If the Company's Year 2000 assessment fails to identify any material non-
compliant systems or if the systems of critical third parties are not compliant,
the Year 2000 issue could have a material impact on the operations of the
Company.
Forward-Looking Statements
This report contains forward-looking statements about the Company's future
business prospects. These statements are subject to risks and uncertainties that
could cause actual results to differ materially from those set forth in or
implied by such forward looking statements. Factors that may cause future
results to differ materially from the Company's current expectations include,
among others: general economic conditions, the health of the contact lens
industry, inventory acquisition and management, advertising spending and
effectiveness, year 2000 issues and regulatory considerations.
15
<PAGE>
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Based on its current operations, the Company believes it is not subject to
significant market risk. As of October 2, 1999, the Company did not hold any
market risk sensitive instruments and had no outstanding debt other than a
capital lease obligation of $39,707. In addition, all of the Company's
transactions are in U.S. dollars.
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
See notes to condensed financial statements.
Item 2. Changes in Securities and Use of Proceeds
None.
Item 3. Defaults upon Senior Securities
None.
Item 4. Submission of Matters to a Vote of Security Holders
None.
Item 5. Other Information
From time to time the Company receives notices, inquiries or other
correspondence from states or its regulatory bodies charged with overseeing the
sale of contact lenses. The Company's practice is to review such notices with
legal counsel to determine the appropriate response on a case-by-case basis. It
is the opinion of management, after discussion with legal counsel, that the
Company is taking the appropriate steps to address the various notices received.
Item 6. Exhibits and Reports on Form 8-K
(A) Exhibit Index
Exhibit No. Description of Exhibit
----------- ----------------------
27 Financial Data Schedule.
(B) No reports on Form 8-K were filed by the Registrant during the quarter
ended October 2, 1999.
16
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
1-800 CONTACTS, INC.
Dated: November __, 1999 By: ______________________________________
Name: Jonathan C. Coon
Title: President & Chief Executive Officer
By: ______________________________________
Name: Scott S. Tanner
Title: Chief Financial Officer
17
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<PERIOD-START> JAN-03-1999
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