<PAGE> 1
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the Transition Period from _____ to _____
COMMISSION FILE NO. 0-22623
OCULAR SCIENCES, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 94-2985696
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
475 ECCLES AVENUE
SOUTH SAN FRANCISCO, CALIFORNIA 94080
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES, INCLUDING ZIP CODE)
(650) 583-1400
(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. YES [X] NO [ ] .
As of October 31, 1998, there were 22,438,621 outstanding shares of the
Registrant's Common Stock, par value $0.001 per share.
<PAGE> 2
OCULAR SCIENCES, INC.
INDEX
<TABLE>
<CAPTION>
PART I - FINANCIAL INFORMATION Page
----
<S> <C>
ITEM 1. FINANCIAL STATEMENTS
Consolidated Balance Sheets -
September 30, 1998 and December 31, 1997 3
Consolidated Statements of Income -
Three and Nine Months Ended September 30, 1998 and 1997 4
Consolidated Statements of Comprehensive Income -
Three and Nine Months Ended September 30, 1998 and 1997 5
Consolidated Statements of Cash Flows -
Nine Months Ended September 30, 1998 and 1997 6
Notes to Consolidated Financial Statements 7
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS 10
PART II - OTHER INFORMATION
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS 25
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K 26
SIGNATURES 27
</TABLE>
2
<PAGE> 3
PART I - FINANCIAL INFORMATION
ITEM I. FINANCIAL STATEMENTS
OCULAR SCIENCES, INC.
CONSOLIDATED BALANCE SHEETS
(In thousands, except share data)
<TABLE>
<CAPTION>
September 30, December 31,
1998 1997
(unaudited) (audited)
----------- ------------
<S> <C> <C>
ASSETS
Current Assets:
Cash and cash equivalents $ 32,389 $ 27,895
Restricted cash 489 464
Short-term investments 18,656 10,000
Accounts receivable, less allowance for sales returns and doubtful
accounts of $2,255 and $1,655 for 1998 and 1997, respectively 21,316 18,785
Inventories 12,014 12,941
Loans to officers and employees 300 927
Other current assets 5,326 5,173
--------- ---------
Total Current Assets 90,490 76,185
Property and equipment, net 53,360 36,248
Intangible assets, net 7,446 8,137
Long-term investments 10,173 9,070
Other assets 158 95
========= =========
Total Assets $ 161,627 $ 129,735
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Accounts payable $ 5,233 $ 3,723
Accrued liabilities 10,303 9,354
Accrued cooperative merchandise allowances 6,169 4,238
Current portion of long-term debt 480 445
Current deferred taxes 2,203 2,159
Income and other taxes payable 4,409 278
--------- ---------
Total Current Liabilities 28,797 20,197
Long-term debt, less current portion 3,086 3,434
--------- ---------
Total Liabilities 31,883 23,631
Stockholders' Equity:
Common stock, $0.001 par value; 80,000,000
shares authorized; 22,437,901 and 21,738,166 shares
issued and outstanding for 1998 and 1997, respectively 22 22
Additional paid-in capital 71,950 70,438
Retained earnings 58,223 36,164
Accumulated other comprehensive income (451) (520)
--------- ---------
Total Stockholders' Equity 129,744 106,104
--------- ---------
Total Liabilities and Stockholders' Equity $ 161,627 $ 129,735
========= =========
</TABLE>
See accompanying notes to consolidated financial statements.
3
<PAGE> 4
OCULAR SCIENCES, INC.
CONSOLIDATED STATEMENTS OF INCOME - (UNAUDITED)
(In thousands, except share and per share data)
<TABLE>
<CAPTION>
Three months ended Nine months ended
September 30, September 30,
------------------------------- -------------------------------
1998 1997 1998 1997
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Net sales $ 41,701 $ 33,095 $ 111,891 $ 86,064
Cost of sales 13,053 10,391 34,879 30,811
------------ ------------ ------------ ------------
Gross profit 28,648 22,704 77,012 55,253
Selling and marketing expenses 11,124 7,410 30,370 19,382
General and administrative expenses 5,057 4,602 14,602 13,589
Research and development expenses 386 622 1,847 1,710
------------ ------------ ------------ ------------
Income from operations 12,081 10,070 30,193 20,572
Interest expense (76) (309) (240) (1,258)
Interest income 827 319 2,092 386
Other (expense) income (225) (453) (532) (416)
------------ ------------ ------------ ------------
Income before taxes 12,607 9,627 31,513 19,284
Income taxes (3,782) (2,889) (9,454) (5,786)
------------ ------------ ------------ ------------
Net income 8,825 6,738 22,059 13,498
Preferred stock dividends -- (8) -- (49)
------------ ------------ ------------ ------------
Net income applicable
to common stockholders $ 8,825 $ 6,730 $ 22,059 $ 13,449
============ ============ ============ ============
Net income per share data:
Basic $ 0.39 $ 0.34 $ 0.99 $ 0.76
============ ============ ============ ============
Diluted $ 0.38 $ 0.31 $ 0.95 $ 0.66
============ ============ ============ ============
Weighted average common
shares outstanding:
Basic 22,413,359 20,008,761 22,213,744 17,716,174
============ ============ ============ ============
Diluted 23,304,495 22,019,450 23,311,944 20,387,596
============ ============ ============ ============
</TABLE>
See accompanying notes to consolidated financial statements.
4
<PAGE> 5
OCULAR SCIENCES, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME - (UNAUDITED)
(In thousands)
<TABLE>
<CAPTION>
Three months ended Nine months ended
September 30, September 30,
-------------------- --------------------
1998 1997 1998 1997
------- ------- ------- -------
<S> <C> <C> <C> <C>
Net income $ 8,825 $ 6,738 $22,059 $13,498
Other comprehensive income
Foreign currency translation
adjustment 27 293 29 75
Unrealized holding gain on
securities arising during
the period 36 -- 40 --
------- ------- ------- -------
Other comprehensive net income 63 293 69 75
------- ------- ------- -------
Comprehensive income $ 8,888 $ 7,031 $22,128 $13,573
======= ======= ======= =======
</TABLE>
See accompanying notes to consolidated financial statements.
5
<PAGE> 6
OCULAR SCIENCES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS - (UNAUDITED)
(In thousands)
<TABLE>
<CAPTION>
Nine months ended
September 30,
-----------------------
1998 1997
-------- --------
<S> <C> <C>
Cash flows from operating activities:
Net income $ 22,059 $ 13,498
Adjustments to reconcile net income to net cash provided
by operating activities:
Depreciation and amortization 4,366 5,238
Tax benefit from employee stock option exercise -- 7,869
Allowances for sales returns and doubtful accounts 922 795
Provision for excess and obsolete inventory 823 754
Provision for damaged and scrap products 567 584
Provision for property and equipment 586 --
Exchange loss (gain) 384 326
Deferred income taxes (156) (933)
Changes in operating assets and liabilities:
Accounts receivable (3,420) (1,030)
Inventories (409) (1,684)
Other current and non-current assets 567 (5,817)
Accounts payable 1,463 (274)
Accrued liabilities 2,204 4,163
Income and other taxes payable 4,134 (928)
-------- --------
Net cash provided by operating activities 34,090 22,561
-------- --------
Cash flows from investing activities:
Purchase of property and equipment (20,717) (9,871)
Purchase of available-for-sale short-term and long-term
Investments (23,993) (10,190)
Sales and maturities of available-for-sale short-term
and long-term investments 14,274 --
Purchase of marketing rights and license agreement -- (8,817)
Payments from (deposits to) restricted cash (10) 1,228
-------- --------
Net cash used in investing activities (30,446) (27,650)
-------- --------
Cash flows from financing activities:
Proceeds from issuance of long-term debt -- 5,929
Repayment of long-term debt (288) (24,744)
Proceeds from public offering of common stock, net 133 53,629
Preferred stock dividends -- (63)
Proceeds from issuance of common stock 1,378 504
-------- --------
Net cash provided by financing activities 1,223 35,255
Effect of exchange rate changes on cash and cash equivalents (373) (38)
-------- --------
Net increase in cash and cash
equivalents 4,494 30,128
Cash and cash equivalents at beginning of period 27,895 3,795
-------- --------
Cash and cash equivalents at end of period $ 32,389 $ 33,923
======== ========
Supplemental cash flow disclosures:
Cash paid during the year for:
Interest $ 245 $ 1,320
======== ========
Income taxes $ 5,772 $ 2,775
======== ========
</TABLE>
See accompanying notes to consolidated financial statements.
6
<PAGE> 7
OCULAR SCIENCES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - BASIS OF PREPARATION
The accompanying unaudited consolidated financial statements have been
prepared in accordance with generally accepted accounting principles for interim
financial information and with the instructions to Form 10-Q and Rule 10-01 of
Regulation S-X. Accordingly, they do not contain all of the information and
footnotes required by generally accepted accounting principles for complete
financial statements. In the opinion of management, the accompanying unaudited
consolidated financial statements have been prepared on the same basis as the
audited consolidated financial statements and include all adjustments,
consisting only of normal recurring adjustments, necessary for the fair
statement of the Company's financial condition as of September 30, 1998 and the
results of its operations, and its cash flows for the three and nine month
periods ended September 30, 1998 and 1997. These financial statements should be
read in conjunction with the Company's audited financial statements as of
December 31, 1997 and 1996 and for each of the years in the three-year period
ended December 31, 1997, including notes thereto, included in the Company's
Annual Report on Form 10-K. Operating results for the three and nine month
periods ended September 30, 1998 are not necessarily indicative of the results
that may be expected for the year ending December 31, 1998.
NOTE 2 - NEW ACCOUNTING POLICIES
The Company has adopted Statement of Financial Accounting Standards
("SFAS") Nos. 130 and 131, "Reporting Comprehensive Income" ("SFAS No. 130") and
"Disclosures about Segments of an Enterprise and Related Information" ("SFAS No.
131"), respectively (collectively, the "Statements") effective in the year
ending December 31, 1998. SFAS No. 130 establishes standards for the reporting
of comprehensive income and its components in annual financial statements. The
Company has included a statement of comprehensive income that begins with net
income and reconciles to comprehensive income. SFAS No. 131 establishes
standards for reporting financial and descriptive information about an
enterprise's operating segments in its annual financial statements and selected
segment information in interim financial reports. The Company operates in a
single industry segment and will disclose the enterprise-wide disclosures in its
annual financial statements as of and for the year ended December 31, 1998.
Application of the Statements' disclosure requirements did not have an impact on
the Company's consolidated financial position, results of operations or net
income per share data as currently reported.
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities" ("SFAS No. 133") which will be effective for
all fiscal quarters of fiscal years beginning after June 15, 1999. SFAS No. 133
establishes accounting and reporting standards for derivatives instruments and
for hedging activities. The statement requires that an entity recognize all
derivatives as either assets or liabilities in the statement of financial
position and measure those instruments at fair value. The statement generally
provides for matching the timing of gain or loss recognition on the hedging
instrument with the recognition of (a) the changes in the fair value of the
hedged asset or liability that are attributable to the hedged risk or (b) the
earnings effect of the hedged forecasted transaction. The Company anticipates
that adoption of this Statement will not have a material effect on the
consolidated financial statements.
7
<PAGE> 8
NOTE 3 - SIGNIFICANT EVENTS
The Secondary Public Offering
In March 1998, the Company completed a secondary offering in which
5,343,381 shares of its Common Stock were sold to the public at a price of
$27.50 per share (including shares sold pursuant to the underwriters'
over-allotment option). The shares sold consisted of 30,000 shares sold by the
Company and 5,313,381 shares sold by selling stockholders. The Company incurred
aggregate expenses of $650,000 in connection with the secondary offering
(excluding underwriting discounts and commissions paid by the Company and the
selling stockholders).
Financing
Ocular Sciences Puerto Rico has entered into a letter of intent and is
negotiating the final terms of an agreement with the Puerto Rico Industrial
Development Company ("PRIDCO") to manage on PRIDCO's behalf the construction of
a new building in Puerto Rico that will be leased by Ocular Sciences Puerto Rico
as its manufacturing facility, upon completion of construction. Ocular Sciences
Puerto Rico plans to initially finance the building construction as well as the
leasehold improvements with existing cash and then borrow against the remaining
balance available under its term loan with Comerica Bank - California upon
completion of construction. Under the anticipated agreement, PRIDCO would
reimburse Ocular Sciences Puerto Rico for up to a maximum of $3,470,000 for
certain structural construction costs of the facility at the end of the
construction project, as specified in the agreement. Annual rental payments of
approximately $489,000 per year would be due to PRIDCO to commence four months
after completion of the project, for a period of ten years. No assurance can be
given as to the terms of the final agreement between PRIDCO and Ocular Sciences
Puerto Rico. This transaction will be accounted for in accordance with Emerging
Issues Task Force 97-10 and SFAS Nos. 13 and 98.
Incorporation
The Company incorporated a new 100% owned subsidiary, Precision Lens
Manufacturing & Technology, Inc. in Barbados, in September, 1998. The Company
has not yet commenced activity at this subsidiary.
NOTE 4 - INVENTORIES
Inventories consisted of the following (in thousands):
<TABLE>
<CAPTION>
September 30, December 31,
1998 1997
------- -------
<S> <C> <C>
Raw materials $ 1,814 $ 2,767
Work in process 1,005 812
Finished goods 9,195 9,362
------- -------
$12,014 $12,941
======= =======
</TABLE>
NOTE 5- PROPERTY AND EQUIPMENT, NET
In the second quarter of 1998, the Company recorded a charge of $586,000
related to a custom-built packaging machine that failed the factory acceptance
test and Company specifications.
8
<PAGE> 9
NOTE 6- ACCUMULATED OTHER COMPREHENSIVE INCOME BALANCES
Accumulated other comprehensive income consists of the following (in
thousands):
<TABLE>
<CAPTION>
FOREIGN ACCUMULATED
CURRENCY UNREALIZED OTHER
TRANSLATION GAINS ON COMPREHENSIVE
ADJUSTMENT SECURITIES INCOME
----------- ---------- -------------
<S> <C> <C> <C>
Balances at December 31, 1997 (531) 11 (520)
Current-period change 29 40 69
------ ------ ------
Balances at September 30, 1998 (502) 51 (451)
====== ====== ======
</TABLE>
9
<PAGE> 10
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion should be read in conjunction with the
unaudited Consolidated Financial Statements and notes thereto included in Part I
- - Item 1 of this Quarterly Report and the audited Consolidated Financial
Statements and notes thereto and Management's Discussion and Analysis of
Financial Condition and Results of Operations contained in the Company's Annual
Report on Form 10-K for the year ended December 31, 1997.
Except for the historical information contained herein, the matters
discussed in this Form 10-Q are forward-looking statements within the meaning of
Section 21E of the Securities Exchange Act of 1934, as amended, and Section 27A
of the Securities Act of 1933, as amended. These statements involve risks and
uncertainties that could cause actual results to differ materially from those
anticipated. Such risks and uncertainties include, but are not limited to, the
impact of intense competition, uncertainties in demand for and market acceptance
of the Company's products; changes in trade practices and the risk of trade
practice litigation; and the risks of developing new automated production
technology and manufacturing facilities. These and other risks are described in
the section labeled "Factors That May Affect Future Results," and in the
Company's SEC reports and filings, including its annual report on Form 10-K for
the fiscal year ended December 31, 1997 and its quarterly report on Form 10-Q
for the quarterly periods ended June 30, 1998 and March 31, 1998. The Company
has identified with a preceding asterisk ("*"), various sentences within this
Form 10-Q which contain such forward-looking statements, and words such as
"believes", "anticipates", "expects", "future", "intends", "would", "may" and
similar expressions are also intended to identify forward-looking statements.
However, the asterisk and these words are not the exclusive means of identifying
such statements. In addition, the section labeled "Factors That May Affect
Future Results", which has no asterisks for improved readability, consists
primarily of forward-looking statements. The Company undertakes no obligation to
revise any of these forward-looking statements to reflect events or
circumstances after the date hereof.
RESULTS OF OPERATIONS
Net Sales
<TABLE>
<CAPTION>
Three Months Ended September 30,
-------------------------------
1998 1997 % Change
----------- ----------- --------
<S> <C> <C> <C>
U.S. $33,164,000 $26,341,000 25.9%
As a percentage of net sales 79.5% 79.6%
International $ 8,537,000 $ 6,754,000 26.4%
As a percentage of net sales 20.5% 20.4%
----------- -----------
Net sales $41,701,000 $33,095,000 26.0%
</TABLE>
<TABLE>
<CAPTION>
Nine Months Ended September 30,
---------------------------------
1998 1997 % Change
------------ ------------ --------
<S> <C> <C> <C>
U.S. $ 88,836,000 $ 68,292,000 30.1%
As a percentage of net sales 79.4% 79.4%
International $ 23,055,000 $ 17,772,000 29.7%
As a percentage of net sales 20.6% 20.6%
------------ ------------
Net sales $111,891,000 $ 86,064,000 30.0%
</TABLE>
10
<PAGE> 11
Net sales represents gross sales less volume discounts, trial set
discounts, prompt payment discounts and allowances for sales returns. The
Company recognizes sales upon shipment of products to its customers. Discounts
and allowances for sales returns are accrued at the time sales are recognized.
During the quarter and nine months ended September 30, 1998, 90.3% and 89.3%,
respectively, of all lenses sold were for use in the weekly disposable
replacement regimen, compared to 85.5% and 84.1% during the quarter and nine
months ended September 30, 1997, respectively. Substantially all of the growth
in net sales from the quarter and nine months ended September 30, 1997 to the
quarter and nine months ended September 30, 1998 resulted from increased sales
of the Company's lenses marketed for weekly disposable replacement regimens.
Unit sales of the Company's lenses marketed for weekly disposable replacement
regimens increased 50.2% from the third quarter of 1997 to the third quarter of
1998 and 58.1% from the nine months ended September 30, 1997 to the nine months
ended September 30, 1998. This unit growth rate while much higher than the
industry average is somewhat reduced from previous quarters. The Company
believes such slower growth is due to reduced growth in U.S. market demand for
contact lenses in general, over the past several quarters. Unit sales of the
Company's lenses marketed for monthly replacement regimens increased 20.9% and
lenses for annual replacement regimens declined 13.9% from the third quarter of
1997 to the third quarter of 1998. *The Company plans to introduce a lens for
the daily disposable replacement regimen at a price substantially less than the
current price for lenses marketed for the weekly disposable replacement regimen
in Japan by first quarter of 1999 and in Europe and in the U.S. later in 1999.
*The Company expects that introduction of the new lenses marketed for daily
disposable regime will result in increased unit growth due to the more frequent
replacement of such lenses. The Company's overall average selling price declined
approximately 11.3% and 12.4% from the quarter and nine months ended September
30, 1997 to the quarter and nine months ended September 30, 1998, respectively,
as a result of the price reductions on the weekly disposable products in the
U.S., a continued shift in product mix towards sales of lower priced products
for weekly disposable replacement regimens, and geographic mix towards lower
priced international distributors. *The Company expects that the overall average
selling price that it realizes across its products will continue to decline over
time, and may decline at a greater rate than in the past, because of (i) further
decreases in the average per unit selling prices of lenses marketed for
disposable replacement regimens (ii) shifts in the Company's product mix from
lenses marketed for annual replacement regimens to lenses marketed for weekly
disposable replacement regimens and, in the future, to lenses marketed for daily
disposable replacement regimens, and (iii) increases in products sold
internationally to distributors at prices lower than direct sales prices in the
United States. *The Company does not expect there to be significant growth, if
any, in its sales of lenses for annual replacement as a result of the continuing
shift in consumer demand towards more frequent replacement regimens. *The
Company had planned to ship lenses marketed for daily disposable regimen to
Japan in the fourth quarter of 1998, but may be delayed due to regulatory
approval. This delay may result in a reduction in revenue growth rate in the
fourth quarter of 1998, however will not affect the Company's net income as
these sales are at very low gross profit.
Gross Profit
<TABLE>
<CAPTION>
Three Months Ended September 30,
-----------------------------------
1998 1997 % Change
------------- ------------- -------------
<S> <C> <C> <C>
Gross profit $ 28,648,000 $ 22,704,000 26.2%
As a percentage of net sales 68.7% 68.6%
</TABLE>
<TABLE>
<CAPTION>
Nine Months Ended September 30,
-----------------------------------
1998 1997 % Change
------------- ------------- -------------
<S> <C> <C> <C>
Gross profit $ 77,012,000 $ 55,253,000 39.4%
As a percentage of net sales 68.8% 64.2%
</TABLE>
11
<PAGE> 12
Cost of sales is comprised primarily of the labor, overhead and material
costs of production and packaging, freight and duty, inventory reserves,
royalties to third parties and amortization of certain intangible assets. A
substantial portion of the Company's cost of sales is fixed and therefore
declines as a percentage of net sales as volume increases. The increase in gross
profit from the quarter and nine months ended September 30, 1997 to the quarter
and nine months ended September 30, 1998 was due primarily to increased net
sales, and to decreases in per unit production costs resulting from the
implementation of certain process improvements and increases in manufacturing
volume. *The Company expects cost reductions resulting from improvements in the
Company's current production process to be less significant in the future. *The
Company intends to add new, automated production technology at its United
Kingdom and Puerto Rico facilities, and is currently validating the first of
these automated production lines, and anticipates commencing production on these
new lines in the first half of 1999. *The new manufacturing technology is
designed to further reduce the Company's per unit cost of production over time,
although such cost reductions may not be seen until future periods and are
dependent in part on increases in production volume to offset the higher
depreciation costs (which are a component of cost of goods sold) associated with
the new production lines. *In addition, as described above in "Net Sales", the
Company expects that its overall average selling price on its current products
will continue to decline over time, and that accordingly the Company will need
to continue to reduce its per unit production costs through increased
automation, increased volume and reduced packaging costs in order to improve, or
even maintain, its gross margins on such products. See "Factors That May Affect
Future Results - Manufacturing Capacity Constraints; Risks Associated With
Expansion and Automation of Manufacturing Operations." *The Company expects that
the introduction of a lower priced lens marketed for the daily disposable
replacement regimen will result in a decline in the average selling price of the
Company's products, while reductions in costs of sales will likely not reach
comparable levels until subsequent periods, if at all. *Accordingly, the Company
expects its gross margins to decrease, at least in the first several quarters
following the introduction of lenses marketed for daily replacement regimens and
also expects that gross margins may fluctuate more significantly than in the
past. See "Factors That May Affect Future Results - Fluctuations in Operating
Results; Seasonality; Decreasing Average Sales Prices."
Selling and Marketing Expenses
<TABLE>
<CAPTION>
Three Months Ended September 30,
-----------------------------------
1998 1997 % Change
------------- ------------- --------
<S> <C> <C> <C>
Selling and marketing expenses $ 11,124,000 $ 7,410,000 50.1%
As a percentage of net sales 26.7% 22.4%
</TABLE>
<TABLE>
<CAPTION>
Nine Months Ended September 30,
-----------------------------------
1998 1997 % Change
------------- ------------- --------
<S> <C> <C> <C>
Selling and marketing expenses $ 30,370,000 $ 19,382,000 56.7%
As a percentage of net sales 27.1% 22.5%
</TABLE>
Selling and marketing expenses are comprised primarily of cooperative
merchandising allowances, sample diagnostic products provided to eyecare
practitioners without charge, salaries, commissions and benefits for selling and
marketing personnel and postage and freight charges not billed to customers.
Cooperative merchandising allowances are reimbursements made principally to
chain stores and mass merchants to encourage the fitting and wearing of the
Company's lenses marketed for disposable replacement regimens. Such activities
may include but are not limited to advertising, in-house promotion, displays and
mailings. These allowances are limited to a percentage of purchases of lenses
marketed for disposable replacement regimens from the
12
<PAGE> 13
Company. The increase, both in dollars and as a percentage of net sales, from
the quarter and nine months ended September 30, 1997 to the quarter and nine
months ended September 30, 1998 resulted primarily from increases in cooperative
merchandising allowances and, to a lesser extent, from increased shipments of
diagnostic lenses, increases in the size of the U.S. sales force and increases
in royalties which are due on certain U.K. sales. The increase in cooperative
merchandising allowances was primarily attributable to the 50.2% unit growth in
lenses marketed for weekly disposable replacement regimens as well as the growth
in sales to the optical retail channel which tends to carry a higher level of
these allowances. *The Company anticipates that its recent price reductions will
lead to a reduction in the rate of growth of cooperative merchandising
allowances starting in the fourth quarter of 1998. *Because of this, the Company
believes selling and marketing expenses, are likely to continue to grow, but at
a slower rate than in previous quarters. *If the Company is required to respond
to pricing and promotional pressures from competitors, its rate of spending on
cooperative merchandising allowances may increase in the future.
General and Administrative Expenses
<TABLE>
<CAPTION>
Three Months Ended September 30,
---------------------------------
1998 1997 % Change
------------ ------------ --------
<S> <C> <C> <C>
General and administrative expenses $ 5,057,000 $ 4,602,000 9.9%
As a percentage of net sales 12.1% 13.9%
</TABLE>
<TABLE>
<CAPTION>
Nine Months Ended September 30,
-----------------------------------
1998 1997 % Change
------------- ------------- --------
<S> <C> <C> <C>
General and administrative expenses $ 14,602,000 $ 13,589,000 7.5%
As a percentage of net sales 13.1% 15.8%
</TABLE>
General and administrative expenses are comprised primarily of
salaries and benefits for general and administrative, distribution,
non-manufacturing facilities costs, professional services, and consultants'
fees. General and administrative expenses increased in dollars but decreased as
a percentage of net sales from both the quarter and nine months ended September
30, 1997 to the quarter and nine months ended September 30, 1998. Included in
the expense for the second quarter of 1998 is a charge of $586,000 related to a
custom-built packaging machine which failed factory acceptance tests and Company
specifications. Without this one-time expense, general and administrative
expenses would have increased 3.1% from the nine months ended September 30, 1997
to the nine months ended September 30, 1998. The increase in absolute dollars
was due primarily to the additional infrastructure related to the requirements
of being a publicly held company. The increase in general and administrative
expenses was substantially less than the increases in net sales of 26.0% and
30.0% for the same periods due primarily to the automation of the Company's
distribution centers and the leverage from utilizing the infrastructures of the
Company's international partners rather than establishing direct operations
overseas. *The Company believes that as net sales grow, its general and
administrative expenses will increase in absolute dollars, but decrease as a
percentage of net sales.
13
<PAGE> 14
Research and Development Expenses
<TABLE>
<CAPTION>
Three Months Ended
September 30,
-----------------------------
1998 1997 % Change
---------- ---------- ---------
<S> <C> <C> <C>
Research and development expenses $ 386,000 $ 622,000 (37.9%)
As a percentage of net sales 0.9% 1.9%
</TABLE>
<TABLE>
<CAPTION>
Nine Months Ended September 30,
---------------------------------
1998 1997 % Change
------------ ------------ --------
<S> <C> <C> <C>
Research and development expenses $ 1,847,000 $ 1,710,000 8.0%
As a percentage of net sales 1.7% 2.0%
</TABLE>
Research and development expenses are comprised primarily of consulting
costs for research and development personnel and in-house labor related to
process development. The decrease from the quarter ended September 30, 1997 to
the quarter ended September 30, 1998, both in dollars and as a percentage of
revenue, was primarily due to the fact that the Company finished the research
and development phase related to its new automated production technology during
the third quarter of 1998. The increase in dollars and decrease as a percentage
of revenue from the nine months ended September 30, 1997 to the nine months
ended September 30, 1998 related primarily to significant consulting costs in
1998 for ongoing process and engineering improvements. This increase, however,
was less than the increase in sales. *The Company does not believe that its
research and development expense growth rate from the quarter and nine months
ended September 30, 1997 to the quarter and nine months ended September 30,
1998, respectively, is indicative of the Company's long-term expense growth
rate. *Research and development expenses may fluctuate as the Company undertakes
new engineering projects and new products.
Income from operations
<TABLE>
<CAPTION>
Three Months Ended September 30,
-----------------------------------
1998 1997 % Change
------------- ------------- --------
<S> <C> <C> <C>
Income from operations $ 12,081,000 $ 10,070,000 20.0%
As a percentage of net sales 29.0% 30.4%
</TABLE>
<TABLE>
<CAPTION>
Nine Months Ended September 30,
-----------------------------------
1998 1997 % Change
------------- ------------- --------
<S> <C> <C> <C>
Income from operations $ 30,193,000 $ 20,572,000 46.8%
As a percentage of net sales 27.0% 23.9%
</TABLE>
The increase in income from operations , in dollars, and as a percentage
of net sales from the nine months ended September 30, 1997 to September 30,
1998, is due primarily to increased sales and improved gross margins. The
decrease in net income from operations as a percentage of net sales from the
quarter ended September 30, 1997 to the quarter ended September 30, 1998 is due
primarily to an increase in overall operating expenses as a percentage of net
sales. Income growth slowed as a result of slower revenue growth and product
price reductions.
14
<PAGE> 15
Interest and Other Income (Expense), Net
<TABLE>
<CAPTION>
Three Months Ended
September 30,
-----------------------------
1998 1997 % Change
---------- ---------- --------
<S> <C> <C> <C>
Interest and other income (expense), net $ 526,000 $ (443,000) NA
As a percentage of net sales 1.3% (1.3%)
</TABLE>
<TABLE>
<CAPTION>
Nine Months Ended September 30,
---------------------------------
1998 1997 % Change
------------ ------------ ---------
<S> <C> <C> <C>
Interest and other income (expense), net $ 1,320,000 $ (1,288,000) NA
As a percentage of net sales 1.2% (1.5%)
</TABLE>
The increase in interest and other income (expense), net from the
quarter and nine months ended September 30, 1997 to the quarter and nine months
ended September 30, 1998 resulted primarily from a reduction in interest expense
as the aggregate amount of the Company's borrowings was reduced following its
initial public offering in August 1997 and an increase in interest earned as a
result of the investment of a portion of the net proceeds from the Company's
initial public offering.
Income Taxes
<TABLE>
<CAPTION>
Three Months Ended September 30,
---------------------------------
1998 1997 % Change
------------ ------------ ---------
<S> <C> <C> <C>
Income taxes $ 3,782,000 $ 2,889,000 30.9%
Effective tax rate 30.0% 30.0%
</TABLE>
<TABLE>
<CAPTION>
Nine Months Ended September 30,
---------------------------------
1998 1997 % Change
------------ ------------ ---------
<S> <C> <C> <C>
Income taxes $ 9,454,000 $ 5,786,000 63.4%
Effective tax rate 30.0% 30.0%
</TABLE>
The Company's effective tax rate remained constant at 30.0% from the
quarter and nine months ended September 30, 1997 to the quarter and nine months
ended September 30, 1998. Earnings attributable to the Company's Puerto Rican
operations are partially exempt from U.S. taxation. *The Company anticipates
that it will continue to benefit from the favorable effect of this partial
exemption through 2001, with limited exemption during the transition period from
2002 through 2006, when the benefit will expire under the current provisions of
the Internal Revenue Code. *The Company continues to evaluate various tax
planning strategies to maintain or reduce its effective tax rate. *In addition,
the Company's planned installation of the automated production technology in
Puerto Rico could cause an increase in the Company's tax rate if the automation
results in a reduction in the Company's labor costs in Puerto Rico relative to
its Puerto Rican earnings.
15
<PAGE> 16
LIQUIDITY AND CAPITAL RESOURCES
At September 30, 1998, the Company had a cash and cash equivalents
balance of $32.4 million, compared to a cash and cash equivalents balance of
$27.9 million at December 31, 1997. The increase in cash and cash equivalents
was due primarily to cash generated from operations substantially offset by net
purchases of short-term and long-term investments and purchases of property and
equipment. Working capital increased from $56.0 million at December 31, 1997 to
$61.7 million at September 30, 1998. The increase in working capital was due
primarily to the increase in short-term investments. The Company had $28.8
million in short-term and long-term investments as of September 30, 1998,
compared to $19.1 million as of December 31, 1997. The Company's short-term and
long-term investments may be easily liquidated at minimal cost.
In the first nine months of 1998, net cash provided by operating
activities of $34.1 million, was derived principally from net income of $22.1
million, adjusted primarily for depreciation and amortization of $4.4 million
and a $4.1 million increase in income and other taxes payable due to differences
between the timing of estimated tax payments and the accrual of the related tax
expense, offset by a $3.4 million increase in accounts receivable due to timing
differences between the recording of sales and the payments of the related
invoices. Net cash provided by operating activities in the nine months ended
September 30, 1998 increased $11.5 million compared to the nine months ended
September 30, 1997, due primarily to the increase in net income and changes in
operating assets and liabilities.
Net cash used in investing activities in the first nine months of 1998
was $30.4 million. During this period, the Company used $20.7 million to
purchase property and equipment, and $9.7 million for net purchases of
short-term and long-term investments. Net cash used in investing activities in
the nine months ended September 30, 1998 increased $2.8 million compared to the
nine months ended September 30, 1997 due primarily to increased purchases of
property and equipment and short-term and long-term investments, partially
offset by the effect of the purchase of marketing rights and a license in the
first quarter of 1997 as part of the settlement of certain United Kingdom
litigation. *The Company anticipates that capital expenditures will be
approximately $13 million for the remainder of 1998 as the Company continues to
invest in the development and implementation of automated production technology
at its manufacturing facilities and the development and construction of a new
Puerto Rican manufacturing facility. *However, the amount of capital
expenditures may increase or decrease, as the Company may accelerate or delay
the implementation of the automated production lines based on market conditions
and demand for its products. *The Company expects to finance the acquisition of
property, plant and equipment using cash from operations and currently available
bank lines for the foreseeable future without the need for additional debt or
equity financing. See "Factors That May Affect Future Results Manufacturing
Capacity Constraints; Risks Associated With Expansion and Automation of
Manufacturing Operations."
Net cash provided by financing activities in the first nine months of
1998 was $1.2 million. The decrease of $34.0 million from the first nine months
of 1997 to the first nine months of 1998 was due primarily to net proceeds from
the Company's 1997 initial public offering of $53.6 million, partially offset by
net repayments of long-term debt of $18.8 million. The Company repaid all debt
outstanding under its previous credit facility with Comerica Bank-California
with proceeds from the initial public offering.
In addition to cash, cash equivalents, short-term investments and
long-term investments, the Company has a credit facility with Comerica Bank -
California. Under the Comerica Credit Agreement, the Company and its subsidiary
Ocular Sciences Puerto Rico, Inc. ("Ocular Sciences Puerto Rico") can borrow up
to an aggregate of $30.0 million. The Comerica Credit Agreement provides for up
to $20.0 million of revolving credit loans to the Company and up to $10.0
million of term loans to Ocular Sciences Puerto Rico. Revolving credit
borrowings under the Comerica Credit Agreement bear interest at the bank's base
rate
16
<PAGE> 17
or at 1.00% to 1.50% above the eurodollar rate, and term loans bear interest at
the bank's base or at 1.25% to 1.75% above the eurodollar rate, in each case
with the applicable margin over the eurodollar rate depending on the Company's
ratio of debt to tangible net worth. As of September 30, 1998, there were no
revolving credit loans outstanding under the Comerica Credit Agreement. $2.4
million of term loans were borrowed on November 7, 1997 and used to repay
outstanding loans from the Banco Bilbao de Vizcaya, and the remaining $7.6
million of term loans are available to finance the construction and development
of the Company's planned new Puerto Rican manufacturing facility. The revolving
credit loans will be available through June 30, 2000 and the term loan facility
provides for advances through April 30, 1999, at which time the principal amount
outstanding will become payable over twenty-two quarterly principal
installments, with a final maturity date of October 31, 2004. The Company is
required to maintain minimum ratios of debt to tangible net worth and of current
assets to current liabilities, and a minimum tangible net worth. Borrowings
under the Comerica Credit Agreement are secured by a pledge of 100% of the
outstanding common stock of Ocular Sciences Puerto Rico and 65% of the
outstanding capital stock of the Company's United Kingdom and Canadian
subsidiaries. In addition, the Company and Ocular Sciences Puerto Rico have each
guaranteed the other's borrowings under the Comerica Credit Agreement.
*The Company believes that its current cash and cash equivalents,
further borrowings available under its credit facilities and its anticipated net
cash flow from operations, will be sufficient to meet its anticipated cash needs
for working capital, contractual commitments and capital expenditures for at
least the next 12 months. *If cash generated from operations proves insufficient
to satisfy the Company's liquidity requirements, the Company may seek to sell
additional equity or debt securities or obtain further credit facilities. *The
sale of additional equity or convertible debt securities could result in
additional dilution to the Company's stockholders *The sale of additional debt
or further bank borrowings could subject the Company to additional restrictive
financial covenants and restrictions on the payment of dividends. There can be
no assurance that financing will be available to the Company in amounts or on
terms acceptable to the Company, if at all.
YEAR 2000
Many currently installed computer systems and software products are
unable to distinguish between twentieth century dates and twenty-first century
dates because such systems may have been developed using two digits rather than
four to determine the applicable year. For example, computer programs that have
date-sensitive software may recognize a date using "00" as the year 1900 rather
than the year 2000. This error could result in system failures or
miscalculations causing disruptions of operations, including among other things,
a temporary inability to process transactions, send invoices or engage in
similar normal business activities. As a result, many companies' software and
computer systems may need to be upgraded or replaced to comply with such "Year
2000" requirements.
The Company's business is dependent on the operation of numerous systems
that could potentially be impacted by Year 2000 related problems. Those systems
include, among others: hardware and software systems used by the Company to
manufacture and deliver products and services to its customers; the internal
systems of the Company's customers and suppliers; the hardware and software
systems used internally by the Company in the management of its business; and
non-information technology systems and services used by the Company in the
management of its business, such as telephone systems and building systems.
In early 1998, the Company's Board of Directors named it's Chief
Information Officer ("CIO") to head up a compliance project to identify all
information technology ("IT"), non-IT systems and third party related issues.
The CIO will make presentations on the Company's compliance program at each
Board of Directors meeting until the year 2000.
17
<PAGE> 18
At present, the Company has completed an inventory of all IT and non-IT systems
and is assessing the requirements for modifications if necessary. *The
assessment phase is due to be completed by the end of 1998, correction and
testing by the third quarter of 1999 and implementation by the fourth quarter
1999.
Within that overall program Company is in the process of replacing its
business control information systems with new systems that function properly
with respect to dates in the Year 2000 and thereafter. *The Company has
implemented several of these applications and anticipates implementing the other
planned applications by the middle of 1999. *The Company expects that, with the
new information system, the Year 2000 issue will not pose significant
operational problems for the Company's computer system, however, there can be no
assurance there will not be a delay in, or increased costs associated with, the
implementation of the new information system and the Company's inability to
install such a system could have an adverse effect on future results of
operations. *If this project is delayed, the Company will modify its current
systems at a cost of approximately $750,000 to handle Year 2000 dates.
The Company has not fully determined the extent to which it may be
impacted by third parties' systems, which may not be Year 2000-compliant. The
Year 2000 computer issue creates risk for the Company from third parties with
whom the Company works on business transactions worldwide. *While the Company
has begun efforts to seek reassurance from its suppliers and service providers,
there can be no assurance that the systems of other companies that the Company
works with or on which the Company's systems rely will be timely converted, or
that any such failure to convert by another company could not have an adverse
effect on the Company. See "Factors That May Affect Future Results - Uncertain
Ability to Manage Growth: Risks Associated with Implementation of New Management
Information Systems.
FACTORS THAT MAY AFFECT FUTURE RESULTS
The Company's future operating results may differ materially from the
results discussed in, or implied by, forward-looking statements made by the
Company. Factors that may cause such differences include, but are not limited
to, those discussed below and elsewhere in this Report.
As referenced in the first paragraph of Part 1 - Item 2, this section
consists primarily of forward-looking statements and associated risks but, for
improved readability, does not include asterisks.
Intense Competition. The market for soft contact lenses is intensely
competitive and is characterized by decreasing prices for many products. The
Company's products compete with products offered by a number of larger companies
including the Vistakon division of Johnson & Johnson ("Johnson & Johnson"), the
CIBA Vision division of Novartis ("CIBA"), Bausch & Lomb, Inc. ("Bausch &
Lomb"), Wesley Jessen VisionCare, Inc. ("Wesley Jessen") and The Cooper
Companies, Inc. ("Cooper"), which recently acquired Aspect Vision Care Ltd. Many
of the Company's competitors have substantially greater financial,
manufacturing, marketing and technical resources, greater market penetration and
larger manufacturing volumes than the Company. Among other things, these
advantages may afford the Company's competitors greater ability to manufacture
large volumes of lenses, reduce product prices and influence customer buying
decisions. The Company believes that certain of its competitors are expanding,
or are planning to expand their manufacturing capacity, and are implementing
new, more automated manufacturing processes, in order to support anticipated
increases in volume. As many of the costs involved in producing contact lenses
are relatively fixed, if a manufacturer can increase its volume, it can
generally reduce its per unit costs and thereby increase its flexibility to
reduce prices. In addition, the Company's largest competitor reduced its U.S.
prices, during the second quarter of 1998 and further restructured its pricing
plan in the fourth quarter of 1998. The Company matched the second quarter
adjustment in most respects starting in the third quarter of 1998 and expects to
18
<PAGE> 19
match the fourth quarter adjustments during the fourth quarter of 1998. The
Company's competitors may continue to reduce prices to achieve the sales volumes
necessary to utilize their increased capacity, or for other reasons. Future
price reductions by competitors could make the Company's products less
competitive, and there can be no assurance that the Company would be able to
either match the competitor's pricing plan or reduce its prices in response. The
Company's ability to respond to competitive pressures by decreasing its prices
without adversely affecting its gross margins and operating results will depend
on its ability to decrease its costs per lens. Any significant decrease in the
Company's costs per lens will depend, in part, on the Company's ability to
increase its sales volume and production capacity. There can be no assurance
that the Company will be able to continue to increase its sales volume or reduce
its per unit production costs. In response to competition, the Company may also
increase cooperative merchandising allowances or otherwise increase spending,
which may adversely affect its business, financial condition and results of
operations. The failure of the Company to respond to competitive pressures, and
particularly price competition, in a timely manner would have a material adverse
effect on the Company's business, financial condition and results of operations.
See "- Manufacturing Capacity Constraints; Risks Associated with Expansion and
Automation of Manufacturing Operations."
The market for contact lenses is shifting from lenses marketed for
annual replacement regimens, where the Company has significant experience and a
leading market position, to lenses marketed for weekly and daily disposable
replacement regimens, where the Company is less experienced and has a
significantly smaller market share. The weekly disposable replacement market is
particularly competitive and price-sensitive and is currently dominated by the
Acuvue product produced by Johnson & Johnson. The Company believes that the per
unit production costs of Johnson & Johnson and certain of the Company's other
competitors are currently lower than those of the Company. Further price
reductions by Johnson & Johnson or certain of the Company's other competitors
could limit or reduce the Company's market share in the weekly disposable
replacement segment and, as a result, could materially adversely affect the
Company's business, financial condition and results of operations. The Company
plans to introduce a lens marketed for the daily disposal regimen in Japan,
Europe and the U.S. The Company's ability to enter and to compete effectively in
the daily market will depend in large part upon the Company's ability to expand
its production capacity and reduce its per unit production costs. Additionally,
over the past few quarters, the rate of U.S. market demand has slowed. Should
such trend continue, it could have a material adverse effect on the Company's
business, financial condition and results of operations.
The Company believes that its manufacturing process technology, lens
designs and marketing strategies differentiate it from its leading competitors.
However, there can be no assurance that competitors will not adopt technologies,
lens designs or marketing strategies that are similar to those used by the
Company. Any such action by competitors could have a material adverse effect on
the Company's business, results of operations and financial condition. In this
regard, Cooper's acquisition of Aspect Vision Care Ltd. in December 1997, has
given them the ability to market in the U.S. a new line of contact lenses for
weekly and monthly replacement regimens that utilize a manufacturing process
technology that is based in significant part on technology also licensed to and
used by the Company.
The Company also encounters competition from manufacturers of eyeglasses
and from alternative technologies, such as surgical refractive procedures
(including new refractive laser procedures such as PRK, or photorefractive
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, there can be no assurance 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 the Company's business, financial condition and
results of operations.
19
<PAGE> 20
Manufacturing Capacity Constraints; Risks Associated with Expansion and
Automation of Manufacturing Operations. The Company's success will depend upon
its ability to increase its production volume on a timely basis while
maintaining product quality and lowering per unit production costs.
Manufacturers often encounter difficulties in increasing production volumes,
including problems involving delays, quality control and shortages of qualified
personnel. Any significant increase in production volume will require that the
Company increase its manufacturing capacity.
The Company intends to add new, highly automated production technology
at its facilities in the United Kingdom and Puerto Rico to increase its
manufacturing capacity and reduce its per unit manufacturing costs. However,
there can be no assurance that the Company will be able to implement this
automated technology on a timely basis or that the automated technology will
operate as efficiently as expected. The Company has encountered a delay in
implementing the first line of this automated technology, has had to write off
the cost of a custom made piece of equipment, and there can be no assurance that
it will not encounter significant delays and difficulties in the future. For
example, suppliers could miss their equipment delivery schedules, the efficiency
of the new production lines and facility could improve less rapidly than
expected, if at all, or the equipment or processes could require longer design
time than anticipated, or redesigning after installation. In addition, the new
production technology will involve processes and equipment with which the
Company and its personnel are not experienced. Difficulties experienced by the
Company in automating its manufacturing process could impair the Company's
ability to reduce its per unit production costs and to compete in the weekly and
daily disposable replacement market and, accordingly, could have a material
adverse effect on the Company's business, financial condition and results of
operations. In addition, the installation of this automated production
technology in Puerto Rico could increase the Company's tax rate if it results in
a significant reduction in the Company's labor costs in Puerto Rico in relation
to its Puerto Rican earnings.
The Company currently expects that from 1998 through the end of 2000, it
will invest approximately $75.0 million in capital expenditures on automated
production lines in the United Kingdom and Puerto Rico and expects to continue
to invest in additional automated production lines after this period. The
Company intends to finance these capital expenditures with net cash provided by
operating activities, existing cash balances and borrowings under its credit
facilities. No assurances can be given as to the availability of such net cash
from operations or borrowings, and if such funds are not available, the Company
could be required to curtail the installation of the automated lines.
The Company is currently experiencing space constraints at its Puerto
Rican facility. As a result, the Company intends to relocate its Puerto Rican
manufacturing operations to a substantially larger new facility being
constructed to the Company's specifications and leased to the Company by the
Puerto Rico Industrial Development Company. The development and construction of
a new manufacturing facility is subject to significant risks and uncertainties,
including cost estimation errors and overruns, construction delays, weather
problems, equipment delays or shortages, production start-up problems and other
factors. As many of such factors are beyond the Company's control, the Company
cannot predict the length of any such delays, which could be substantial.
Construction of the new facility began during the fourth quarter of 1997 and is
expected to be completed during the first quarter of 1999. There can be no
assurances as to when the Company will complete construction and begin
production. Before this new facility begins production, it must be inspected by
the U.S. Food and Drug Administration (the "FDA") for compliance with current
good manufacturing practices ("GMP"), and the inspection and approval process
could significantly delay the Company's ability to begin production in this new
facility.
The Company's development of a new facility and implementation of the
new automated production technology will result in new fixed and operating
expenses, including substantial increases in depreciation expense that will
increase the Company's cost of sales. If revenue levels do not increase
sufficiently to offset these new expenses, the Company's
20
<PAGE> 21
operating results could be materially adversely affected. There can be no
assurance that the Company will not encounter unforeseen difficulties, costs or
delays in automating its production process, in constructing and equipping the
new manufacturing facility in Puerto Rico or in commencing production on the new
lines and at the new facility. Any such difficulties or delays would limit the
Company's ability to increase production volume and lower per unit costs (and
consequently prices), would limit the Company's ability to compete in the weekly
and daily disposable replacement regimen markets and, accordingly, could have a
material adverse effect on the Company's business, financial condition and
results of operations.
Risk of Trade Practice Litigation; Changes in Trade Practices. The
contact lens industry has been the subject of a number of class action and
government lawsuits and government investigations in recent years. In December
1996, over twenty states sued three of the Company's largest competitors, as
well as certain eyecare practitioners and trade organizations. The lawsuit
alleges, among other things, a conspiracy among such persons to violate
antitrust laws by refusing to sell contact lenses to mail order and other
non-practitioner contact lens providers, so as to reduce competition in the
contact lens industry. A similar lawsuit was filed by the State of Florida in
1994 and several similar class action lawsuits were also filed in 1994. One of
the defendants has agreed to settle the lawsuits as to itself by agreeing to
sell contact lenses to mail-order and other alternative distribution channels,
and to make substantial cash and product rebates available to consumers.
In an unrelated matter, one of the Company's largest competitors was
sued in a national class action lawsuit brought in the Federal District Court in
the Northern District of Alabama in 1994 (the "Alabama Lawsuit"). This suit
alleged that the defendant engaged in fraudulent and deceptive practices in the
marketing and sale of contact lenses by selling identical contact lenses, under
different brand names and for different replacement regimens, at different
prices. The defendant subsequently modified certain of its marketing practices
and ultimately settled the lawsuit in August 1996 by making substantial cash and
product payments available to consumers. In August 1997, such competitor also
settled an investigation by 17 states into similar matters by agreeing to
certain restrictions on its future contact lens marketing practices and making
certain payments to each of the states. In October 1996, a class action lawsuit
was brought against another of the Company's largest competitors in the Superior
Court of New Jersey-Camden (the "New Jersey Lawsuit"). This suit alleges that
the defendant engaged in fraudulent and deceptive practices in the marketing and
sale of contact lenses by selling interchangeable contact lenses, under
different brand names and for different replacement regimens, at different
prices. The suit was certified as a national class action in December 1997.
Although the Company has not been named in any of the foregoing
lawsuits, the Company from time to time receives claims or threats similar to
those brought against its competitors, and in one circumstance a suit was filed
against the Company making allegations similar to those made in the Alabama and
New Jersey Lawsuits, which suit was dismissed without prejudice for
non-substantive reasons. There can be no assurance that the Company will not
face similar actions relating to its marketing and pricing practices or other
claims or lawsuits in the future. The defense of any such action, lawsuit or
claim could result in substantial expense to the Company and significant
diversion of attention and effort by the Company's management personnel. There
can be no assurance that any such lawsuit would be settled or decided in a
manner favorable to the Company, and a settlement or adverse decision in any
such action, lawsuit or claim could have a material adverse effect on the
Company's business, financial condition and results of operations.
In addition to the foregoing lawsuits, there is substantial federal and
state governmental regulation related to the prescribing of contact lenses.
These regulations relate to who is permitted to prescribe and fit contact
lenses, the prescriber's obligation to provide prescriptions to its patients,
the length of time a prescription is valid, the ability or obligation of
prescribers to prescribe lenses by brand rather than by generic equivalent or
specification, and other matters. Although these regulations primarily affect
contact lens prescribers, and
21
<PAGE> 22
not manufacturers or distributors of lenses such as the Company, changes in
these regulations, or their interpretation or enforcement, could adversely
affect the effectiveness of the Company's marketing strategy to eyecare
practitioners, most notably the effectiveness of the Company's channel-specific
and private label branding strategies. Additionally, given the Company's
strategic emphasis on focusing its marketing efforts on eyecare practitioners,
the Company may be more vulnerable than its competitors to changes in current
trade practices. Finally, although cost controls or other requirements imposed
by third party health-care payors such as insurers and health maintenance
organizations have not historically had a significant effect on contact lens
prices or distribution practices, this could change in the future, and could
adversely affect the Company's business, financial condition and results of
operations. Adverse regulatory or other decisions affecting eyecare
practitioners, or material changes in the selling and prescribing practices for
contact lenses, could have a material adverse effect on the Company's business,
financial condition and results of operations.
Fluctuations in Operating Results; Seasonality; Decreasing Average Sales
Prices. The Company's quarterly operating results have varied significantly in
the past and are likely to vary significantly in the future based upon a number
of factors. The Company's quarterly results can be affected significantly by
pricing changes by the Company or its competitors, the Company's ability to
increase manufacturing capacity efficiently and to reduce per unit manufacturing
costs, the time and costs involved in expanding existing distribution channels
and establishing new distribution channels, discretionary marketing and
promotional expenditures such as cooperative merchandising allowances paid to
the Company's customers, timing of the introduction of new products by the
Company or its competitors, inventory shortages, timing of regulatory approvals
and other factors. The Company's customers generally do not have long-term
commitments to purchase products and products are generally shipped as orders
are received. Consequently, quarterly sales and operating results depend
primarily on the volume and timing of orders received during the quarter, which
are difficult to forecast. A significant portion of the Company's operating
expenses is relatively fixed, and planned expenditures are based on sales
forecasts. If sales levels fall below expectations, operating results are likely
to be materially adversely affected. In particular, net income may be
disproportionately affected because only a small portion of the Company's
expenses varies with net sales in the short term. In response to competition,
the Company may reduce prices, increase cooperative merchandising allowances or
otherwise increase marketing expenditures, and such responses may adversely
affect the Company's business, financial condition and results of operations.
Due to the foregoing factors, the Company believes that period-to-period
comparisons of its results of operations are not necessarily meaningful and
should not be relied upon as indications of future performance. Further, it is
likely that in some future quarter the Company's net sales or operating results
will be below the expectations of public market analysts and investors. In such
event, the price of the Company's Common Stock would likely be materially
adversely affected.
The Company expects that the overall average selling price that it
realizes across its products will decline over time because of (i) further
decreases in the prices of lenses marketed for disposable replacement regimens,
(ii) shifts in the Company's product mix from lenses marketed for annual
replacement regimens to lenses marketed for weekly disposable replacement
regimens and, in the future, to lenses marketed for daily disposability, and
(iii) increases in products sold internationally through distributors at prices
lower than direct sales prices in the United States. The Company does not expect
there to be significant growth in its sales of lenses marketed for annual or
monthly replacement. Accordingly, the Company will need to continue to reduce
its per unit production costs through increased automation, increased volume and
reduced packaging costs in order to improve, or even to maintain, its gross
margins. The Company does not believe that its recent net sales and operating
income growth rates are indicative of the Company's long-term growth rates.
Need to Increase Sales of Lenses Marketed for Weekly and Daily
Disposable Replacement Regimens. The market for contact lenses is shifting from
lenses marketed for annual replacement regimens, where the Company has
significant experience and a leading
22
<PAGE> 23
market position, to lenses marketed for weekly and daily disposable replacement
regimens, where the Company is less experienced and has a significantly smaller
market share. The Company's success depends on both continued growth of the
weekly disposable replacement market and increased penetration of this market by
the Company's products. The Company anticipates that prices for its products
targeted for weekly disposable replacement regimens will decline in the future.
In addition, the lenses currently offered in the United States by the Company in
the disposable segment are marketed for weekly and monthly replacement regimens.
Certain of the Company's competitors have introduced lenses for daily
replacement at lower prices than their current weekly and monthly disposable
lenses. The Company plans to introduce a lens marketed for daily disposability
within the next six months. The Company's ability to enter and to compete
effectively in the market for lenses marketed for daily disposal will depend in
large part upon the Company's ability to expand its production capacity and
reduce its per unit production costs. The Company's ability to increase volume
and reduce costs is also dependent upon the success of the market for daily
disposability, which is currently relatively small. If the Company's
introduction of lenses marketed for daily disposal is not successful, the
Company's financial performance could be adversely affected.
Risks Relating to International Operations; Need to Increase Sales in
International Markets. In 1996, 1997 and the first nine months of 1998, the
Company's international sales represented 18.2%, 21.0% and 20.6%, respectively,
of the Company's net sales. In addition, a substantial portion of the Company's
products is manufactured in the United Kingdom. As a result, the Company's
business is subject to the risks generally associated with doing business
abroad, such as foreign consumer preferences, disruptions or delays in
shipments, changes in currency exchange rates, longer accounts receivable
payment cycles and greater difficulties in collecting accounts receivable,
foreign tax laws or tariffs, political unrest and changing economic conditions
in countries in which the Company's products are sold or manufacturing
facilities are located. These factors, among others, could adversely affect the
Company's ability to sell its products in international markets, as well as its
ability to manufacture its products. If any such factors were to render the
conduct of business in a particular country undesirable or impractical, there
could be a material adverse effect on the Company's business, financial
condition and results of operations. The Company and its representatives, agents
and distributors are also subject to the laws and regulations of foreign
jurisdictions in which they operate or in which the Company's products are sold,
and there can be no assurance that new laws or regulations will not have a
material adverse effect on the Company's business, financial condition and
results of operations.
A substantial portion of the Company's sales and expenditures are
collected or paid in currencies other than the U.S. dollar. Therefore, the
Company's operating results are affected by fluctuations in foreign currency
exchange rates. In the three and nine months ended September 30, 1998, the
Company had an exchange loss of $159,000 and $384,000, respectively, primarily
relating to changes in exchange rate between the U.S. dollar and the Canadian
dollar. There can be no assurance that in the future exchange rate movements
will not have a material adverse effect on the Company's sales, gross profit,
operating expenses or foreign currency exchange gains and losses.
The Company's continued growth is dependent on the expansion of
international sales of its products. This expansion will involve operations in
markets with which the Company is not experienced and there can be no assurance
that the Company will be successful in capturing a significant portion of these
markets for contact lenses. In addition, the Company will not be able to market
and sell its products in certain international markets, such as Japan, until it
obtains regulatory approval and the Company has experienced some delays in
obtaining such approval in Japan. The failure of the Company to increase its
international sales substantially could have a material adverse effect on the
Company's business, financial condition and results of operations.
Uncertain Ability to Manage Growth; Risks Associated with Implementation
of New Management Information Systems. The Company has experienced rapid growth
in recent
23
<PAGE> 24
years. Continued rapid growth may place a significant strain on management,
operational infrastructure, working capital and financial and management control
systems. Growth in the Company's business has required, and is expected to
continue to require, significant personnel management and other infrastructure
resources. The Company's ability to manage any future growth effectively will
require it to attract, train, motivate and manage new employees successfully, to
integrate new employees into its overall operations and to continue to improve
its operational, financial and management information systems.
The Company's business is dependent on the operation of numerous systems
that could potentially be impacted by Year 2000 related problems. Those systems
include, among others: hardware and software systems used by the Company to
manufacture and deliver products and services to its customers; the internal
systems of the Company's customers and suppliers; the hardware and software
systems used internally by the Company in the management of its business; and
non-information technology systems and services used by the Company in the
management of its business, such as telephone systems and building systems.
In early 1998, the Company's Board of Directors named it's Chief
Information Officer ("CIO") to head up a compliance project to identify all
information technology ("IT"), non-IT systems and third party related issues.
The CIO will make presentations on the Company's compliance program at each
Board of Directors meeting until the year 2000. At present, the Company has
completed an inventory of all IT and non-IT systems and is assessing the
requirements for modifications if necessary. The assessment phase is due to be
completed by the end of 1998, correction and testing by the third quarter of
1999 and implementation by the fourth quarter 1999.
The Company is in the process of replacing its information systems with
new systems that are expected to include a number of integrated applications,
including order entry, billing and labeling. The new systems will significantly
affect many aspects of the Company's business, including its manufacturing,
sales and marketing and accounting functions, and the successful implementation
and integration of these applications will be important to facilitate future
growth. The Company has implemented several of these applications, and
anticipates implementing the other planned applications by the middle of 1999.
However, the Company could experience unanticipated delays in the implementation
of the new systems and implementation of the new information systems could cause
significant disruption in operations. If the Company is not successful in
implementing its new systems or if the Company experiences difficulties in such
implementation, the Company could experience problems with the delivery of its
products or an adverse impact on its ability to access timely and accurate
financial and operating information. In addition, delays in implementing the new
systems could require additional expenditures by the Company to modify or
replace portions of its existing information systems so that they will function
properly with respect to dates in the Year 2000 at a cost of approximately
$750,000 and thereafter there can be no assurance that the Company will be able
to correct any problems with respect to such dates in a timely manner.
Additionally, the Year 2000 computer issue creates risk for the Company
from third parties with whom the Company works on business transactions
worldwide. While the Company has begun efforts to seek reassurance from its
suppliers and service providers, there can be no assurance that the systems of
other companies that the Company works with or on which the Company's systems
rely will be timely converted, or that any such failure to convert by another
company will not have an adverse effect on the Company.
24
<PAGE> 25
PART II - OTHER INFORMATION
ITEM 2: CHANGES IN SECURITIES AND USE OF PROCEEDS
Initial Public Offering
The Company's registration statement (the "Registration Statement") on
Form S-1, registering the offer and sale of an aggregate of 8,280,000 shares of
the Company's common stock in connection with the Company's initial public
offering (Securities and Exchange Commission File No. 333-27421) was declared
effective by the Securities and Exchange Commission on August 4, 1997, the
offering date for the initial public offering. The managing underwriters for the
offering were Morgan Stanley Dean Witter Incorporated, Bear, Stearns & Co. Inc.
and Cowen and Company.
In August 1997, the Company completed its initial public offering in
which 8,280,000 shares of its Common Stock were sold to the public at a price of
$16.50 per share (including shares sold pursuant to the underwriters'
over-allotment option). The shares sold consisted of 3,600,000 shares sold by
the Company at an aggregate public offering price of $59.4 million and 4,680,000
shares sold by selling stockholders at an aggregate public offering price of
$77.2 million. Effective immediately prior to the closing of the initial public
offering, all outstanding shares of the Company's then outstanding preferred
stock were automatically converted into shares of common stock.
The aggregate net offering proceeds to the Company from the initial
public offering after deducting the total expenses described above was $53.7
million. From the effective date of the Registration Statement through September
30, 1998, such proceeds were used for the following purposes:
<TABLE>
<S> <C>
Construction of plant, building and facilities ..... $ 4,582,000
Purchase and installation of machinery and equipment 23,486,000
Repayment of indebtedness .......................... 14,728,000
Working capital .................................... 4,216,000
Cash equivalents ................................... 0
Final payment pursuant to UK settlement agreement .. 6,685,000
</TABLE>
None of such payments were direct or indirect payments to directors or
officers of the Company or any of their associates, to persons holding ten
percent or more of any class of equity securities of the Company or to
affiliates of the Company, except that $2,895,000 of the net proceeds were used
to repay indebtedness owed to John Fruth, the Company's Chief Executive Officer
and a Director and holder of in excess of ten percent of the Company's common
stock.
25
<PAGE> 26
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
The following exhibits are filed herewith:
<TABLE>
<CAPTION>
Exhibit
Number Exhibit Title
- ------ -------------
<S> <C>
11.01 - Statement regarding computation of net income per share (basic and
diluted)
27.01 - Financial Data Schedule
</TABLE>
(b) Reports on Form 8-K
The Company did not file a report on Form 8-K during the period ended
September 30, 1998.
26
<PAGE> 27
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.
OCULAR SCIENCES, INC.
(Registrant)
Date: November 12, 1998 /s/ Gregory E. Lichtwardt
----------------------------------------
Gregory E. Lichtwardt
Vice President, Finance,
Chief Financial Officer, and Treasurer
(Duly Authorized Officer and Chief
Accounting Officer)
27
<PAGE> 28
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION PAGE
------ ----------- ----
<S> <C> <C>
11.01 Statement Regarding Computation of Net Income Per Share (Basic 29
and Diluted)
27.01 Financial Data Schedule 31
</TABLE>
28
<PAGE> 1
EXHIBIT 11.01
OCULAR SCIENCES, INC.
STATEMENT REGARDING COMPUTATION OF NET INCOME PER SHARE (BASIC AND DILUTED)
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
-------------------------- --------------------------
1998 1997 1998 1997
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Net income per share (basic):
Net income applicable to common stockholders $ 8,825,000 $ 6,730,000 $22,059,000 $13,449,000
=========== =========== =========== ===========
Weighted average common shares outstanding 22,413,359 20,008,761 22,213,744 17,716,174
=========== =========== =========== ===========
Net income per share (basic) $ 0.39 $ 0.34 $ 0.99 $ 0.76
=========== =========== =========== ===========
Net income per share (diluted):
Net income $ 8,825,000 $ 6,738,000 $22,059,000 $13,498,000
=========== =========== =========== ===========
Weighted average common shares outstanding 22,413,359 20,008,761 22,213,744 17,716,174
Weighted average shares of stock options
under the treasury stock method 891,136 1,931,910 1,098,200 2,487,605
Weighted average shares issuable upon conversion
of the Series A Preferred Stock 0 78,779 0 183,817
----------- ----------- ----------- -----------
Weighted average common and dilutive
potential common shares outstanding 23,304,495 22,019,450 23,311,944 20,387,596
=========== =========== =========== ===========
Net income per share (diluted) $ 0.38 $ 0.31 $ 0.95 $ 0.66
=========== =========== =========== ===========
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
This schedule contains summary financial information extracted from the
consolidated balance sheet, consolidated statement of income and consolidated
statement of cash flows included in the Company's Form 10-Q for the period ended
September 30, 1998, and is qualified in its entirety by reference to such
financial statements.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-1-1998
<PERIOD-END> SEP-30-1998
<CASH> 32,878
<SECURITIES> 18,656
<RECEIVABLES> 23,571
<ALLOWANCES> 2,255
<INVENTORY> 12,014
<CURRENT-ASSETS> 90,490
<PP&E> 70,984
<DEPRECIATION> 17,624
<TOTAL-ASSETS> 161,627
<CURRENT-LIABILITIES> 28,797
<BONDS> 0
0
0
<COMMON> 22
<OTHER-SE> 129,722
<TOTAL-LIABILITY-AND-EQUITY> 161,627
<SALES> 111,891
<TOTAL-REVENUES> 111,891
<CGS> 34,879
<TOTAL-COSTS> 46,819
<OTHER-EXPENSES> 532
<LOSS-PROVISION> 922
<INTEREST-EXPENSE> 240
<INCOME-PRETAX> 31,513
<INCOME-TAX> 9,454
<INCOME-CONTINUING> 22,059
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 22,059
<EPS-PRIMARY> 0.99<F1>
<EPS-DILUTED> 0.95
<FN>
<F1>FOR PURPOSES OF THIS EXHIBIT, PRIMARY MEANS BASIC.
</FN>
</TABLE>
