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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 September 29, 2001
[_] 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, 3/rd/ 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 6, 2001, the Registrant had 11,574,269 shares of Common
Stock, par value $0.01 per share outstanding.
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1-800 CONTACTS, INC.
INDEX
Page No.
--------
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Condensed Consolidated Balance Sheets as of December 30, 2000
and September 29, 2001..................................................... 3
Condensed Consolidated Statements of Income for the Quarter and
Three Quarters Ended September 30, 2000 and September 29, 2001 ............ 4
Condensed Consolidated Statement of Stockholders' Equity for the
Three Quarters Ended September 29, 2001 ................................... 5
Condensed Consolidated Statements of Cash Flows for the Three Quarters
Ended September 30, 2000 and September 29, 2001 ........................... 6
Notes to Condensed Consolidated Financial Statements ............................... 7
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations ................................................. 11
Item 3. Quantitative and Qualitative Disclosures About Market Risk ......................... 17
PART II. OTHER INFORMATION
Item 1. Legal Proceedings .................................................................. 17
Item 2. Changes in Securities and Use of Proceeds .......................................... 17
Item 3. Defaults upon Senior Securities .................................................... 17
Item 4. Submission of Matters to a Vote of Security Holders ................................ 17
Item 5. Other Information .................................................................. 17
Item 6. Exhibits and Reports on Form 8-K ................................................... 18
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
1-800 CONTACTS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
ASSETS
December 30, September 29,
2000 2001
------------------ ------------------
CURRENT ASSETS:
Cash and cash equivalents $ 42,558 $ 1,388,535
Inventories 20,402,076 29,994,723
Deferred income taxes 673,710 772,278
Other current assets 385,001 818,490
------------------ ------------------
Total current assets 21,503,345 32,974,026
PROPERTY AND EQUIPMENT, net 2,843,103 3,375,847
DEFERRED INCOME TAXES 203,620 403,368
INTANGIBLE ASSETS, net 1,261,916 1,648,358
OTHER ASSETS 295,775 69,327
------------------ ------------------
Total assets $ 26,107,759 $ 38,470,926
================== ==================
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Line of credit $ 3,264,979 $ -
Accounts payable 3,646,578 11,029,912
Accrued liabilities 3,541,463 4,041,218
Income taxes payable 1,206,523 1,435,574
Unearned revenue 483,812 423,740
------------------ ------------------
Total current liabilities 12,143,355 16,930,444
------------------ ------------------
STOCKHOLDERS' EQUITY:
Common stock 128,611 128,611
Additional paid-in capital 23,802,342 23,967,804
Retained earnings 8,412,507 16,123,027
Treasury stock at cost (18,376,111) (18,676,176)
Accumulated other comprehensive loss (2,945) (2,784)
------------------ ------------------
Total stockholders' equity 13,964,404 21,540,482
------------------ ------------------
Total liabilities and stockholders' equity $ 26,107,759 $ 38,470,926
================== ==================
The accompanying notes to condensed consolidated financial statements
are an integral part of these condensed consolidated statements.
3
1-800 CONTACTS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
Quarter Ended Three Quarters Ended
------------------------------------- -----------------------------------------
September 30, September 29, September 30, September 29,
2000 2001 2000 2001
----------------- ----------------- -------------------- -------------------
NET SALES $40,724,366 $44,374,981 $ 107,851,541 $131,389,401
COST OF GOODS SOLD 24,365,987 26,867,856 64,145,681 78,643,985
----------------- ----------------- -------------------- -------------------
Gross profit 16,358,379 17,507,125 43,705,860 52,745,416
----------------- ----------------- -------------------- -------------------
SELLING, GENERAL AND
ADMINISTRATIVE EXPENSES:
Advertising expense 7,947,936 7,786,504 20,258,398 23,317,548
Legal and professional fees 152,534 1,037,743 583,494 1,946,248
Other selling, general and
administrative expenses 4,036,859 5,289,486 11,034,794 14,664,760
----------------- ----------------- -------------------- ------------------
Total selling, general and
administrative expenses 12,137,329 14,113,733 31,876,686 39,928,556
----------------- ----------------- -------------------- ------------------
INCOME FROM OPERATIONS 4,221,050 3,393,392 11,829,174 12,816,860
OTHER INCOME (EXPENSE), net 26,475 (35,904) 259,799 (207,594)
----------------- ----------------- -------------------- ------------------
INCOME BEFORE PROVISION
FOR INCOME TAXES 4,247,525 3,357,488 12,088,973 12,609,266
PROVISION FOR INCOME TAXES (1,660,363) (1,299,709) (4,659,500) (4,898,746)
----------------- ----------------- -------------------- ------------------
NET INCOME $ 2,587,162 $ 2,057,779 $ 7,429,473 $ 7,710,520
================= ================= ==================== ==================
PER SHARE INFORMATION:
Basic net income per common share $ 0.22 $ 0.18 $ 0.62 $ 0.67
================= ================= ==================== ==================
Diluted net income per common share $ 0.22 $ 0.18 $ 0.61 $ 0.66
================= ================= ==================== ==================
The accompanying notes to condensed consolidated financial statements are
an integral part of these condensed consolidated statements.
4
1-800 CONTACTS, INC.
CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
For the Three Quarters Ended September 29, 2001
(Unaudited)
Accumulated
Common Stock Additional Treasury Stock Other
------------------------- Paid-in Retained ----------------------------- Comprehensive
Shares Amount Capital Earnings Shares Amount Loss
------------ ------------ ----------------- -------------- ------------ ---------------- --------------
BALANCE,
December 30, 2000 12,861,136 $ 128,611 $ 23,802,342 $ 8,412,507 (1,289,555) $ (18,376,111) $ (2,945)
Purchase of treasury shares - - - - (22,500) (438,125) -
Exercise of common
stock options - - 14,692 - 22,775 138,060 -
Income tax benefit from
common stock
options exercised - - 150,770 - - - -
Net income - - - 7,710,520 - - -
Foreign currency
translation adjustments - - - - - - 161
------------ ------------ ----------------- -------------- ------------ ---------------- --------------
Comprehensive income
BALANCE,
September 29, 2001 12,861,136 $ 128,611 $ 23,967,804 $16,123,027 (1,289,280) $ (18,676,176) $ (2,784)
============ ============ ================= ============== ============ ================ ==============
Total
Stockholders' Comprehensive
Equity Income
--------------- ---------------
BALANCE,
December 30, 2000 $ 13,964,404
Purchase of treasury shares (438,125)
Exercise of common
stock options 152,752
Income tax benefit from
common stock
options exercised 150,770
Net income 7,710,520 $ 7,710,520
Foreign currency
translation adjustments 161 161
-------------- ---------------
Comprehensive income $ 7,710,681
===============
BALANCE,
September 29, 2001 $ 21,540,482
==============
The accompanying notes to condensed consolidated financial statements
are an integral part of these condensed consolidated statements.
5
1-800 CONTACTS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Three Quarters Ended
--------------------------------------
September 30, September 29,
2000 2001
----------------- -----------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 7,429,473 $ 7,710,520
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 821,373 1,055,301
Gain on sale of property and equipment (2,650) (6,500)
Loss on impairment of non-marketable securities - 220,000
Deferred income taxes (360,358) (298,316)
Changes in operating assets and liabilities:
Inventories (4,027,329) (9,592,647)
Other current assets (764,657) (433,593)
Accounts payable 5,193,850 7,383,414
Accrued liabilities 1,567,635 499,793
Income taxes payable 1,131,472 379,821
Unearned revenue 211,237 (60,072)
----------------- -----------------
Net cash provided by operating activities 11,200,046 6,857,721
----------------- -----------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property and equipment (880,260) (1,298,807)
Proceeds from sale of property and equipment 2,650 6,500
Purchase of intangible assets (10,000) (676,369)
Purchase of non-marketable securities (220,000) -
Deposits 5,309 6,227
----------------- -----------------
Net cash used in investing activities (1,102,301) (1,962,449)
----------------- -----------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Common stock repurchases (16,841,448) (438,125)
Proceeds from exercise of common stock options 419,442 152,752
Net borrowings (repayments) on line of credit 2,468,544 (3,264,979)
Principal payments on capital lease obligation (30,166) -
Payment of acquisition payable (300,000) -
----------------- -----------------
Net cash used in financing activities (14,283,628) (3,550,352)
----------------- -----------------
NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS (4,185,883) 1,344,920
EFFECT OF FOREIGN EXCHANGE RATES ON CASH - 1,057
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 4,329,088 42,558
----------------- -----------------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 143,205 $ 1,388,535
================= =================
SUPPLEMENTAL CASH FLOW INFORMATION:
Cash paid for interest $ 1,999 $ 70,559
Cash paid for income taxes 4,435,984 4,817,241
The accompanying notes to condensed consolidated financial statements are
an integral part of these condensed consolidated statements.
6
1-800 CONTACTS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
NOTE 1. PRESENTATION OF CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
The accompanying condensed consolidated 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 accounting
principles generally accepted in the United States have been condensed or
omitted pursuant to such rules and regulations. These condensed consolidated
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 consolidated 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. NET INCOME PER COMMON SHARE
Basic net income per common share ("Basic EPS") excludes dilution and
is computed by dividing net income by the weighted-average number of common
shares outstanding during the period. Diluted net income 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
per common share. For the quarter ended September 29, 2001, options to purchase
168,434 shares of common stock were not included in the computation of Diluted
EPS because the exercise prices of the options were greater than the average
market price of the common shares.
The following is a reconciliation of the numerator and denominator
used to calculate Basic and Diluted EPS:
Quarter Ended September 30, 2000 Quarter Ended September 29, 2001
------------------------------------------- -------------------------------------------
Per-Share Per-Share
Net Income Shares Amount Net Income Shares Amount
------------- ---------- ------------- ----------- ---------- -----------
Basic EPS $ 2,587,162 11,584,136 $ 0.22 $2,057,779 11,571,692 $ 0.18
Effect of stock options 290,471 149,887
------------- ---------- ------------ ----------- ---------- -----------
Diluted EPS $ 2,587,162 11,874,607 $ 0.22 $2,057,779 11,721,579 $ 0.18
============= ========== ============ =========== ========== ===========
Three Quarters Ended September 30, 2000 Three Quarters Ended September 29, 2001
-------------------------------------------- ------------------------------------------
Per-Share Per-Share
Net Income Shares Amount Net Income Shares Amount
------------- ---------- ------------- ------------ ---------- -----------
Basic EPS $ 7,429,473 11,969,867 $ 0.62 $7,710,520 11,574,349 $ 0.67
Effect of stock options 231,134 193,872
------------- ---------- ------------- ----------- ---------- -----------
Diluted EPS $ 7,429,473 12,201,001 $ 0.61 $7,710,520 11,768,221 $ 0.66
============= ========== ============= =========== ========== ===========
7
NOTE 3. COMMON STOCK TRANSACTIONS
During the three quarters ended September 29, 2001, the Company repurchased
22,500 shares of its common stock for a total cost of $438,125.
On April 20, 2001, the Company's Board of Directors authorized an
additional repurchase of up to 1,000,000 shares of its common stock, bringing
the total authorization to 3,000,000 shares. A purchase of the full 3,000,000
shares would equal approximately 23.3 percent of the total shares issued. The
repurchase of common stock is subject to market conditions and is accomplished
through periodic purchases at prevailing prices on the open market, by block
purchases or in privately negotiated transactions. The repurchased shares will
be retained as treasury stock to be used for corporate purposes. Through
September 29, 2001, the Company had repurchased 1,506,500 shares for a total
cost of $19,891,234.
During the three quarters ended September 29, 2001, employees exercised
stock options to purchase 22,775 shares of common stock for a total of $152,752.
During the three quarters ended September 29, 2001, the Company granted
nonqualified stock options to purchase 111,564 shares of common stock to
employees and directors of the Company. The exercise prices of the options range
from $15.74 to $34.938. The options vest equally over a four year period and
expire in ten years.
NOTE 4. IMPAIRMENT OF INVESTMENT
During the first quarter of fiscal 2001, the Company determined that its
investment in the stock of an entity in which a member of the Company's Board of
Directors holds a significant ownership interest and serves as an officer and
director was impaired. The Company recorded a $220,000 loss to adjust the
investment to its determined net realizable value of $0.
NOTE 5. LINE OF CREDIT
The Company has a revolving credit facility that provides for borrowings
equal to the lesser of $20.0 million or 50 percent of eligible inventory. The
credit facility bears interest at a floating rate equal to the
lender's prime interest rate minus 0.25 percent (5.75 percent as of September
29, 2001). As of September 29, 2001, the Company had no outstanding borrowings
on 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, 2003.
NOTE 6. 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 California optometrists against the Company and its directors in Los Angeles
County Superior Court. In a series of rulings in late 2000 and early 2001, the
trial court struck all of Steinberg's claims for monetary relief and another
claim was dismissed. After Steinberg's appeals to the California Court of
Appeals and California Supreme Court were denied, the parties settled the action
in April 2001. The settlement did not materially impact the Company's results of
operations.
On April 7, 1999, the Kansas Board of Examiners in Optometry ("KBEO")
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 of a
prescription. The amended complaint seeks 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 and, at the request of the Court, filed
a motion for summary judgment. In November 2000, the Court issued an order
denying the summary judgment motion, finding that there were factual issues
regarding whether the KBEO can meet the
8
requirements necessary to obtain injunctive relief, and whether the Kansas law
violates the Commerce Clause of the United States Constitution. The parties are
now engaging in fact and expert discovery in preparation for trial.
On or about November 2, 1999, the Texas Optometry Board ("TOB") filed a
civil action against the Company seeking injunctive relief and civil penalties
against the Company for alleged violations of the Texas Optometry Act. The TOB
alleges that the Company (1) failed to state explicitly in its advertisements
that a written prescription is required to purchase contact lenses in Texas and
(2) dispensed contact lenses without such a prescription. The Company has filed
an answer and plans to vigorously defend this action. The Company also has filed
a counterclaim against the TOB seeking to (1) require the TOB to enforce the
Texas Optometry Act and the Contact Lens Prescription Act against optometrists
who have violated these laws, (2) prevent the TOB from conducting proceedings
regarding the dispensing of contact lenses in which the members of the TOB have
a substantial pecuniary interest; and (3) challenge the constitutionality of the
Texas Optometry Act, the Contact Lens Prescription Act, and various TOB
administrative rules. Currently, the TOB is revising its administrative rules,
which may resolve some of the issues in dispute. The Company also is engaged in
discussions with the TOB regarding this action.
The Company entered into a written settlement agreement with the Texas
Department of Health ("TDH"), the regulatory authority in Texas for sellers of
contact lenses. This settlement agreement became effective on February 29, 2000,
and relates to the Company's sales practices in Texas. The agreement began to be
implemented in November 2000 and allows for a review of and, if necessary,
changes to the Company's practices during an initial six-month period. The TDH
issued a Notice of Violation against the Company on or about February 26, 2001,
alleging that the Company failed to comply with certain provisions of the
agreement. The Company is engaged in discussions with the TDH regarding this
notice.
On May 22, 2001, the Middle District Court in Jacksonville, Florida
announced a preliminary settlement with Johnson & Johnson with respect to the
multi-district litigation ("MDL") brought by the attorneys general of 32 states
on behalf of a nationwide class of consumers. This suit alleged that consumers
overpaid for contact lenses as a result of antitrust violations by Johnson &
Johnson, CIBA Vision, Bausch & Lomb, and the American Optometric Association
("AOA"). Specifically, the attorneys general alleged that the manufacturers and
the AOA conspired to eliminate competition from alternative distribution
channels, including mail order companies, and ensure that contact lenses would
only be available from eye care professionals. On or about October 12, 2001 the
Company was granted intervener status by the court in the MDL 1030 lawsuit. This
status allows the Company to become a party to the lawsuit for the limited
purpose of enforcing the injunctive relief provisions of the MDL settlement
agreement, e.g. requiring Johnson and Johnson - Vistakon ("Vistakon") to sell
its products directly to the Company. The court finalized the MDL settlement
agreement on November 1, 2001. The agreement will be effective on December 1,
2001 provided there are no appeals to the settlement agreement.
On October 18, 2001, Vistakon filed an action against the Company
concerning certain of its communications with customers informing them of the
Company's belief that there are superior products available from other
manufacturers with less restrictive distribution policies. The action was filed
in the Middle District Court in Jacksonville, Florida. The complaint alleges
claims for false advertising, unfair trade practices, tortious interference with
prospective economic advantage and defamation and seeks both damages and
injunctive relief. Vistakon also filed a motion for preliminary injunction which
the Company opposed. The court heard the matter on November 7, 2001 but has not
yet issued a ruling. The Company believes the complaint lacks merit and plans to
vigorously defend the action.
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 all of these matters will not likely have a
material impact on the financial condition, liquidity or results of operations
of the Company. However, there can be no assurance that the Company will be
successful in its efforts to satisfactorily resolve these matters and the
ultimate outcome could result in a material negative impact on the Company's
results of operations and financial position.
9
NOTE 7. RECENTLY ISSUED ACCOUNTING STANDARDS
In June 2001, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 141, "Business Combinations," and No. 142,
"Goodwill and Other Intangible Assets," effective for fiscal years beginning
after December 15, 2001. Under the new rules, goodwill and intangible assets
deemed to have indefinite lives will no longer be amortized but will be subject
to annual impairment tests in accordance with the Statements. Other intangible
assets will continue to be amortized over their useful lives.
The Company will apply the new rules on accounting for goodwill and other
intangible assets beginning in the first quarter of fiscal 2002. Also during
fiscal 2002, the Company will perform the first of the required impairment tests
of goodwill and indefinite lived intangible assets, to the extent applicable.
The Company has not yet determined what the effect of these Statements will be
on the Company's results of operations and financial position.
NOTE 8. SOURCES OF SUPPLY
On May 22, 2001, the Middle District Court in Jacksonville, Florida
announced a preliminary settlement with Johnson & Johnson with respect to the
multi-district litigation brought by the attorneys general of 32 states on
behalf of a nationwide class of consumers. The court finalized the settlement
agreement on November 1, 2001. The agreement will be effective on December 1,
2001 provided there are no appeals to the settlement agreement. Johnson &
Johnson's current interpretation of the settlement agreement, and its subsequent
actions, have made products produced by its eye care division, Vistakon, more
difficult for the Company to obtain. This restricted supply and the resulting
wholesale price increases have reduced the Company's expectations for its
short-term net sales and gross profit. During the third quarter of fiscal 2001,
gross profit was impacted by the increase in wholesale prices paid for Vistakon
products. At the beginning of the third quarter of fiscal 2001, the Company had
approximately a three to four month supply of Vistakon lenses; therefore, the
impact of the increase in wholesale prices was less significant in the third
quarter. Gross profit in the fourth quarter of fiscal 2001 will be more
significantly impacted by this increase in wholesale prices. The Company's
wholesale prices on Vistakon products have continued to increase substantially
and Vistakon products account for more than 40% of the Company's net sales. If
supply of Vistakon products remains limited and wholesale prices remain higher
than expected, gross profit will continue to be impacted significantly in future
quarters.
10
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 Sales in March 1991. Since
its formation, the Company's net sales have grown rapidly, from $3.6 million in
fiscal 1996 to $145.0 million in fiscal 2000 and from $107.9 million in the
first three quarters of fiscal 2000 to $131.4 million in the first three
quarters of fiscal 2001. Internet sales have grown from an insignificant amount
in fiscal 1996 to approximately $53.8 million in fiscal 2000 and from $38.1
million in the first three quarters of fiscal 2000 to $51.4 million in the first
three quarters of fiscal 2001.
The Company's fiscal year consists of a 52/53 week period ending on the
Saturday nearest to December 31.
The Company expenses all 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 likely to be subject to the laws of the state where the
customer is located. In some states, the Company operates according to
agreements it has entered into with local regulatory authorities or medical
boards or agencies. The Company's general operating practice is to attempt to
obtain a valid prescription from each of its customers or his/her eye care
practitioner. If the customer does not have a copy of his/her prescription but
does have the prescription information obtained directly from the customer's eye
care practitioner, the Company attempts to contact the customer's eye care
practitioner to obtain a copy of or verify the customer's prescription. If the
Company is unable to obtain a copy of or verify the customer's prescription, it
is the Company's general practice to complete the sale and ship the lenses to
the customer based on the prescription information provided by the customer. The
Company retains copies of the written prescriptions that it receives and
maintains records of its communications with the customer's prescriber.
On May 22, 2001, the Middle District Court in Jacksonville, Florida
announced a preliminary settlement with Johnson & Johnson with respect to the
multi-district litigation brought by the attorneys general of 32 states on
behalf of a nationwide class of consumers. This suit alleged that consumers
overpaid for contact lenses as a result of antitrust violations by Johnson &
Johnson, CIBA Vision, Bausch & Lomb, and the American Optometric Association
("AOA"). Specifically, the attorneys general alleged that the manufacturers and
the AOA conspired to eliminate competition from alternative distribution
channels, including mail order companies, and ensure that contact lenses would
only be available from eye care professionals. The court finalized the
settlement agreement on November 1, 2001. The agreement will be effective on
December 1, 2001 provided there are no appeals to the settlement agreement. CIBA
Vision settled this lawsuit four years ago and Bausch & Lomb settled early this
year. The Company now purchases lenses directly from these two manufacturers.
Johnson & Johnson's press release announcing the settlement stated that it
would begin selling to alternative channels of distribution. To date, Johnson &
Johnson's eye care division, Vistakon, has refused to open an account with the
Company. The Company is not aware of any mail order company that has begun
purchasing directly from Vistakon. In October 2001, the Company was granted
intervener status to this multi-district litigation by the court. This status
allows the Company to become a party to the lawsuit for the limited purpose of
enforcing the injunctive relief provisions of the settlement agreement, e.g.
requiring Vistakon to sell its products directly to the Company.
11
Vistakon's current interpretation of the settlement agreement, and its
subsequent actions, have made its products more difficult for the Company to
obtain. This restricted supply and the resulting wholesale price increases have
reduced the Company's expectations for its short-term net sales and gross
profit.
The Company is also investing significant resources to ensure that the
settlement agreement will allow mail order companies to purchase contact lenses
directly from Vistakon. As a result, the Company expects to incur significant
legal and related expenses for the remainder of fiscal 2001.
In response to Johnson & Johnson's efforts to make its products more
difficult to obtain, the Company recently tested whether it could successfully
transition its customers into new products by assisting them in getting fitted
for a new brand of contact lenses. The Company believes that these tests
indicate that its customers are receptive to an offer from the Company to try
both a new product and a new eye care provider. The Company feels that a more
active role in the product/provider decision may help it address the policies of
manufacturers that refuse to sell their brands to the Company but seek to sell
their brands exclusively to eye doctors.
On October 18, 2001, Vistakon filed an action against the Company
concerning certain of its communications with customers informing them of the
Company's belief that there are superior products available from other
manufacturers with less restrictive distribution policies. See Note 6 to the
Company's condensed consolidated financial statements.
Results of Operations
The following table presents the Company's results of operations expressed
as a percentage of net sales for the periods indicated:
Quarter Ended Three Quarters Ended
-------------------------------- ----------------------------------
September 30, September 29, September 30, September 29,
2000 2001 2000 2001
-------------- -------------- --------------- ----------------
Net sales 100.0% 100.0% 100.0% 100.0%
Cost of goods sold 59.8 60.5 59.5 59.9
-------------- -------------- --------------- ----------------
Gross profit 40.2 39.5 40.5 40.1
-------------- -------------- --------------- ----------------
Advertising expense 19.5 17.6 18.7 17.7
Legal and professional fees 0.4 2.3 0.6 1.5
Other selling, general and
administrative expenses 9.9 11.9 10.2 11.1
-------------- -------------- --------------- ----------------
Total selling, general and
administrative expenses 29.8 31.8 29.5 30.3
-------------- -------------- --------------- ----------------
Income from operations 10.4 7.7 11.0 9.8
Other income (expense), net 0.0 (0.1) 0.2 (0.2)
-------------- -------------- --------------- ----------------
Income before provision
for income taxes 10.4 7.6 11.2 9.6
Provision for income taxes (4.1) (2.9) (4.3) (3.7)
-------------- -------------- --------------- ----------------
Net income 6.3% 4.7% 6.9% 5.9%
============== ============== =============== ================
Net sales. Net sales for the quarter ended September 29, 2001 increased 9%
to $44.4 million from $40.7 million for the quarter ended September 30, 2000.
For the three quarters ended September 29, 2001, net sales increased 22% to
$131.4 million from $107.9 million for the three quarters ended September 30,
2000. The Company added more than 450,000 new customers during the first three
quarters of fiscal 2001. In addition, the Company continues to realize the
benefits of repeat sales from a growing customer base. Repeat sales for the
third quarter of fiscal 2001 increased 25% to $31.5 million, or 71% of net
sales, from $25.3 million, or 62% of net sales, for the third quarter of fiscal
2000. Repeat sales for the first three quarters of fiscal 2001 increased 38% to
$90.4 million, or 69% of net sales, from $65.6 million, or 61% of net sales, for
the first three quarters of fiscal 2000. The Company also believes that the
increase in net sales reflects some of the benefits of the nearly $100 million
it has
12
invested in its national advertising campaign over the last several years and
its commitment to customer service. In addition to refining its marketing
efforts to its customer base, the Company has also enhanced its website and has
increased the exposure of its website in its advertising. Internet sales for the
third quarter of fiscal 2001 were $18.1 million, or 41% of net sales, as
compared to $16.2 million, or 40% of net sales, for the third quarter of fiscal
2000. For the first three quarters of fiscal 2001, Internet sales were $51.4
million, or 39% of net sales, as compared to $38.1 million, or 35% of net sales,
for same period in fiscal 2000. Due to the current environment (higher prices
for and reduced supply of Vistakon products), the Company suspended its quantity
discounts on all Vistakon contact lenses in June 2001. In September 2001, the
Company implemented other programs to manage its level of Vistakon inventory,
including reducing the standard quantity of Vistakon contact lenses offered to
customers. These steps not only impacted net sales in the third quarter of
fiscal 2001 but will also reduce expected revenues in the fourth quarter of
fiscal 2001. The Company also estimates that third quarter 2001 net sales were
reduced by more than $1.5 million by the events of September 11, 2001.
Gross profit. Gross profit as a percentage of net sales decreased to 39.5%
for the quarter ended September 29, 2001 from 40.2% for the quarter ended
September 30, 2000. For the three quarters ended September 29, 2001, gross
profit as a percentage of net sales decreased to 40.1% from 40.5% for the three
quarters ended September 30, 2000. Internet sales as a percentage of net sales
impacts gross profit as a percentage of net sales since Internet orders generate
lower gross profit due to free shipping on those orders. During the third
quarter of fiscal 2001, gross profit was impacted by the increase in wholesale
prices paid for Vistakon products. At the beginning of the third quarter of
fiscal 2001, the Company had approximately a three to four month supply of
Vistakon lenses; therefore, the impact of the increase in wholesale prices was
less significant in the third quarter. Gross profit in the fourth quarter of
fiscal 2001 will be more significantly impacted by this increase in wholesale
prices. The Company's wholesale prices on Vistakon products have continued to
increase substantially and Vistakon products account for more than 40% of the
Company's net sales. If supply of Vistakon products remains limited and
wholesale prices remain higher than expected, gross profit will continue to be
impacted significantly in future quarters.
Advertising expense. Advertising expense for the quarter ended September
29, 2001 decreased approximately $161,000, or 2%, from the quarter ended
September 30, 2000. As a percentage of net sales, advertising expense decreased
to 17.6% for the third quarter of fiscal 2001 from 19.5% for the third quarter
of fiscal 2000. For the three quarters ended September 29, 2001, advertising
expense increased $3.1 million, or 15%, from the three quarters ended September
30, 2000. As a percentage of net sales, advertising expense decreased to 17.7%
for the first three quarters of fiscal 2001 from 18.7% for the first three
quarters of fiscal 2000. Due to the current environment (higher prices for and
reduced supply of Vistakon products), the Company decreased advertising spending
below originally planned levels for the third quarter of fiscal 2001 and expects
to decrease advertising spending below originally planned levels for the
remainder of fiscal 2001. Currently, the Company believes that advertising
spending in fiscal 2001 will be approximately 6% higher than its fiscal 2000
spending. However, if opportunities present themselves, the Company may increase
advertising spending above currently planned levels.
Legal and professional fees. Legal and professional fees for the quarter
ended September 29, 2001 increased $0.9 million, or 580%, from the quarter ended
September 30, 2000. For the three quarters ended September 29, 2001, legal and
professional fees increased $1.4 million, or 234%, from the three quarters ended
September 30, 2000. As a percentage of net sales, legal and professional fees
increased to 2.3% for the third quarter of fiscal 2001 from 0.4% for the third
quarter of fiscal 2000. For the three quarters ended September 29, 2001, legal
and professional fees as a percentage of net sales increased to 1.5% from 0.6%
for the first three quarters of fiscal 2000. During the first three quarters of
fiscal 2001, the Company incurred significant legal and professional fees
related to its legal matters and its increased efforts to proactively influence
the industry on behalf of itself and consumers. The Company expects to continue
to incur significant legal and professional fees at least through the remainder
of fiscal 2001 as it continues this proactive approach, including investing
resources to ensure that the multi-district litigation settlement agreement with
Johnson & Johnson will allow mail order companies to purchase contact lenses
directly from Vistakon.
Other selling, general and administrative expenses. Other selling, general
and administrative expenses for the quarter ended September 29, 2001 increased
$1.3 million, or 31%, from the quarter ended September 30, 2000.
13
For the three quarters ended September 29, 2001, other selling, general and
administrative expenses increased $3.6 million, or 33%, from the three quarters
ended September 30, 2000. As a percentage of net sales, other selling, general
and administrative expenses increased to 11.9% for the third quarter of fiscal
2001 from 9.9% for the third quarter of fiscal 2000. For the three quarters
ended September 29, 2001, other selling, general and administrative expenses as
a percentage of net sales increased to 11.1% from 10.2% for the first three
quarters of fiscal 2000. The fixed portion of operating and payroll costs
increased as the Company continues to expand its operating infrastructure and
enhance its management team to meet the demands of current and future growth.
Other income (expense), net. Other income (expense) decreased to
approximately ($36,000) and ($208,000) for the quarter and three quarters ended
September 29, 2001, respectively, from approximately $26,000 and $260,000 for
the quarter and three quarters ended September 30, 2000, respectively. Interest
income decreased due to lower cash balances and lower interest rates. Interest
expense increased due to increased use of the revolving credit facility. In
addition, during the first quarter of fiscal 2001, the Company recorded a
$220,000 loss related to the impairment of non-marketable securities.
Income taxes. The Company's effective tax rate for the quarter and three
quarters ended September 29, 2001 was 38.7% and 38.9%, respectively. For the
quarter and three quarters ended September 30, 2000, the Company's effective tax
rate was 39.1% and 38.5% respectively. As of September 29, 2001, the Company had
not provided a valuation allowance on deferred tax assets. The Company's future
effective tax rate will depend upon future taxable income. The Company
anticipates that its fiscal 2001 effective income tax rate will be approximately
39%.
Liquidity and Capital Resources
For the three quarters ended September 29, 2001 and September 30, 2000, net
cash provided by operating activities was approximately $6.9 million and $11.2
million, respectively. In the fiscal 2001 period, cash was provided primarily by
net income and an increase in accounts payable partially offset by an increase
in inventories. In the fiscal 2000 period, cash was provided primarily by net
income and increases in accounts payable, accrued liabilities and income taxes
payable partially offset by an increase in inventories. 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.
The Company used approximately $2.0 million and $1.1 million for investing
activities in the three quarters ended September 29, 2001 and September 30,
2000, respectively. The majority of these amounts relate to capital expenditures
for infrastructure improvements. Capital expenditures for the fiscal 2001 period
were approximately $1.3 million. A portion of these expenditures relates to the
expansion of the Company's leased distribution center and leased space used for
its management and call center operations. Capital expenditures for the fiscal
2000 period were approximately $0.9 million. In addition, the Company acquired
intangible assets for approximately $0.7 million during the fiscal 2001 period.
During March 2000, the Company made a $220,000 investment in the stock of an
entity in which a member of the Company's Board of Directors holds a significant
ownership interest and serves as an officer and director. 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 current and future growth. The
Company presently anticipates that capital expenditures in fiscal 2001 will be
approximately $1.6 million.
As of September 29, 2001, the Company had certain noncancelable commitments
to purchase approximately $1.3 million of broadcast advertising through December
2001. In addition, the Company has entered into certain noncancelable
commitments with various advertising companies that will require the Company to
pay approximately $5.8 million from January 1, 2001 through December 31, 2001.
During the three quarters ended September 29, 2001 and September 30, 2000,
the Company used approximately $3.6 million and $14.3 million for financing
activities, respectively. During the fiscal 2001 period, the Company had net
repayments on its credit facility of approximately $3.3 million and repurchased
22,500 shares
14
of its common stock for a total cost of approximately $438,000. During the
fiscal 2000 period, the Company had net borrowings on its credit facility of
approximately $2.5 million and repurchased a total of 1,084,000 shares of its
common stock for a total cost of approximately $16.8 million. In both the fiscal
2001 and 2000 periods, these amounts were offset slightly by proceeds from the
exercise of common stock options. In the fiscal 2000 period, the Company also
made its final payment of $300,000 relating to the 1999 purchase of the assets
of Contact Lenses Online, Inc.
On April 20, 2001, the Company's Board of Directors authorized an
additional repurchase of up to 1,000,000 shares of its common stock, bringing
the total authorization to 3,000,000 shares. A purchase of the full 3,000,000
shares would equal approximately 23.3 percent of the total shares issued. The
repurchase of common stock is subject to market conditions and is accomplished
through periodic purchases at prevailing prices on the open market, by block
purchases or in privately negotiated transactions. The repurchased shares will
be retained as treasury stock to be used for corporate purposes. Through
September 29, 2001, the Company had repurchased 1,506,500 shares for a total
cost of approximately $19.9 million.
The Company has a revolving credit facility to provide for working capital
requirements and other corporate purposes. The credit facility provides for
borrowings equal to the lesser of $20.0 million or 50 percent of eligible
inventory and bears interest at a floating rate equal to the lender's prime
interest rate minus 0.25 percent (5.75 percent as of September 29, 2001). As of
September 29, 2001, the Company had no outstanding borrowings on 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, 2003.
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 the next
year. 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.
See "Overview" for a discussion regarding the multi-district litigation's
potential impact on the Company's results of operations.
As a result of state regulatory requirements, the Company's liquidity,
capital resources and results of operations may be negatively impacted in the
future if the Company incurs increased costs or fines, is prohibited from
selling its products in a particular state(s) or experiences losses of a 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.
Recently Issued Accounting Standards
In June 2001, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 141, "Business Combinations," and No. 142,
"Goodwill and Other Intangible Assets," effective for fiscal years beginning
after December 15, 2001. Under the new rules, goodwill and intangible assets
deemed to have indefinite lives will no longer be amortized but will be subject
to annual impairment tests in accordance with the Statements. Other intangible
assets will continue to be amortized over their useful lives.
The Company will apply the new rules on accounting for goodwill and other
intangible assets beginning in the first quarter of fiscal 2002. Also during
fiscal 2002, the Company will perform the first of the required impairment tests
of goodwill and indefinite lived intangible assets, to the extent applicable.
The Company has not yet determined what the effect of these Statements will be
on the Company's results of operations and financial position.
15
Forward-Looking Statements
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 forward-looking statements
involve risks and uncertainties and often depend on assumptions, data or methods
that may be incorrect or imprecise. 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 the other risks detailed in
the Company's other reports filed with the Securities and Exchange Commission.
The words such as "believes," "anticipates," "expects," "future," "intends,"
"would," "may" and similar expressions are intended to identify 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.
Factors That May Affect Future Results
. The Company's sales growth will not continue at historical rates and
it may encounter unforeseen difficulties in managing its future
growth;
. A significant portion of the Company's sales may not comply with
applicable state laws and regulations governing the delivery and sale
of contact lenses;
. Because the Company doesn't manufacture contact lenses, it cannot
ensure that the contact lenses it sells meet all federal regulatory
requirements;
. It is possible that the FDA will consider certain of the contact
lenses the Company sells to be misbranded;
. The Company currently purchases a substantial portion of its products
from unauthorized distributors and is not an authorized distributor
for some of the products that it sells;
. The Company obtains a large percentage of its inventory from a limited
number of suppliers, with a single distributor accounting for 47%, 38%
and 35% of the Company's inventory purchases in fiscal 1998, 1999 and
2000, respectively;
. The Company's quarterly results are likely to vary based upon the
level of sales and marketing activity in any particular quarter;
. The Company is dependent on its telephone, Internet and management
information systems for the sale and distribution of contact lenses;
. The Company has limited operating history and, as a result, there is
only limited financial information and operating information available
for a potential investor to evaluate the Company;
. The retail sale of contact lenses is highly competitive; certain of
the Company's competitors are large, national optical chains that have
greater resources than the Company has;
. The demand for contact lenses could be substantially reduced if
alternative technologies to permanently correct vision gain in
popularity;
. The Company does not have any property rights in the 1-800 CONTACTS
telephone number or the Internet addresses that it uses;
. Increases in the cost of shipping, postage or credit card processing
could harm the Company's business;
16
. The Company's business could be harmed if it is required to collect state
sales tax on the sale of products;
. The Company faces an inherent risk of exposure to product liability claims
in the event that the use of the products it sells results in personal
injury;
. The Company conducts its operations through a single distribution facility;
. The Company's success is dependent, in part, on continued growth in use of
the Internet;
. Government regulation and legal uncertainties relating to the Internet and
online commerce could negatively impact the Company's business operations;
and
. Changing technology could adversely affect the operation of the Company's
website.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
The Company is exposed to changes in interest rates primarily related to
its revolving credit facility. As of September 29, 2001, the Company had no
outstanding borrowings on the credit facility. The credit facility bears
interest at a variable rate. The Company is exposed to foreign currency risk due
to cash held by its foreign subsidiary. As of September 29, 2001, the Company's
total cash in foreign currencies was approximately $12,000. In addition, all of
the Company's revenue transactions are in U.S. dollars.
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
See notes to condensed consolidated 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.
17
Item 6. Exhibits and Reports on Form 8-K
(A) Exhibits
None.
(B) Reports on Form 8-K
No reports on Form 8-K were filed by the Registrant during the quarter
ended September 29, 2001.
18
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 13, 2001 By: /s/ Jonathan C. Coon
--------------------
Name: Jonathan C. Coon
Title: President and Chief Executive Officer
By: /s/ Scott S. Tanner
-------------------
Name: Scott S. Tanner
Title: Chief Operating Officer and Chief
Financial Officer
19