================================================================================
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 March 30, 2002
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from ___________ to _________.
Commission file number: 0-23633
1-800 CONTACTS, INC.
(Exact name of registrant as specified in its charter)
Delaware 87-0571643
---------------------------------------- -------------------------------------
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
66 E. Wadsworth Park Drive, 3rd Floor
Draper, UT 84020
---------------------------------------- -------------------------------------
(Address of principal executive offices) (Zip Code)
(801) 924-9800
----------------------------------------------------
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports) and (2) has been subject to such
filing requirements for the past 90 days.
/X/ Yes / / No
As of May 7, 2002, the Registrant had 11,382,212 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 29, 2001
and March 30, 2002................................................................ 3
Condensed Consolidated Statements of Income for the Quarters Ended
March 31, 2001 and March 30, 2002................................................. 4
Condensed Consolidated Statement of Stockholders' Equity for the
Quarter Ended March 30, 2002...................................................... 5
Condensed Consolidated Statements of Cash Flows for the Quarters Ended
March 31, 2001 and March 30, 2002................................................. 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..................................................... 17
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
1-800 CONTACTS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
(IN THOUSANDS)
ASSETS
DECEMBER 29, MARCH 30,
2001 2002
------------- -----------
CURRENT ASSETS:
Cash and cash equivalents $ 36 $ 75
Inventories 43,000 44,826
Deferred income taxes 985 1,017
Other current assets 1,019 1,283
------------- -----------
Total current assets 45,040 47,201
PROPERTY AND EQUIPMENT, net 3,309 3,477
DEFERRED INCOME TAXES 439 496
INTANGIBLE ASSETS, net 1,544 1,436
OTHER ASSETS 73 88
------------- -----------
Total assets $ 50,405 $ 52,698
============= ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Line of credit $ 12,526 $ 13,628
Accounts payable 10,251 10,963
Accrued liabilities 3,313 2,787
Income taxes payable 141 1,367
Unearned revenue 421 430
------------- -----------
Total current liabilities 26,652 29,175
------------- -----------
STOCKHOLDERS' EQUITY:
Common stock 129 129
Additional paid-in capital 23,998 24,008
Retained earnings 18,276 20,216
Treasury stock at cost (18,649) (20,829)
Accumulated other comprehensive loss (1) (1)
------------- -----------
Total stockholders' equity 23,753 23,523
------------- -----------
Total liabilities and stockholders' equity $ 50,405 $ 52,698
============= ===========
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)
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
QUARTER ENDED
-----------------------------
MARCH 31, MARCH 30,
2001 2002
------------- -------------
NET SALES $ 42,817 $ 41,581
COST OF GOODS SOLD 25,534 28,894
------------- -------------
Gross profit 17,283 12,687
------------- -------------
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES:
Advertising expense 8,264 2,719
Legal and professional fees 425 1,260
Other selling, general and administrative expenses 4,542 5,391
------------- -------------
Total selling, general and administrative expenses 13,231 9,370
------------- -------------
INCOME FROM OPERATIONS 4,052 3,317
OTHER EXPENSE, net (205) (130)
------------- -------------
INCOME BEFORE PROVISION FOR INCOME TAXES 3,847 3,187
PROVISION FOR INCOME TAXES (1,517) (1,247)
------------- -------------
NET INCOME $ 2,330 $ 1,940
============= =============
PER SHARE INFORMATION:
Basic net income per common share $ 0.20 $ 0.17
============= =============
Diluted net income per common share $ 0.20 $ 0.17
============= =============
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 QUARTER ENDED MARCH 30, 2002
(UNAUDITED)
(IN THOUSANDS)
ACCUMULATED
COMMON STOCK ADDITIONAL TREASURY STOCK OTHER TOTAL
--------------- PAID-IN RETAINED ----------------- COMPREHENSIVE STOCKHOLDERS COMPREHENSIVE
SHARES AMOUNT CAPITAL EARNINGS SHARES AMOUNT LOSS EQUITY INCOME
------ ------ ---------- -------- ------ --------- ------------- ------------ -------------
BALANCE,
December 29, 2001 12,861 $ 129 $ 23,998 $ 18,276 (1,285) $ (18,649) $ (1) $ 23,753
Purchase of treasury shares - - - - (200) (2,213) - (2,213)
Exercise of common
stock options - - - - 6 33 - 33
Income tax benefit from
common stock
options exercised - - 10 - - - - 10
Net income - - - 1,940 - - - 1,940 $ 1,940
Foreign currency
translation adjustments - - - - - - - - -
------ ------ ---------- -------- ------ --------- ------------- ------------ -------------
Comprehensive income $ 1,940
=============
BALANCE,
March 30, 2002 12,861 $ 129 $ 24,008 $ 20,216 (1,479) $ (20,829) $ (1) $ 23,523
====== ====== ========== ======== ====== ========= ============= ============
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)
(IN THOUSANDS)
QUARTER ENDED
-------------------------------
MARCH 31, MARCH 30,
2001 2002
-------------- --------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 2,330 $ 1,940
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 329 422
Gain on sale of property and equipment (5) -
Loss on impairment of non-marketable securities 220 -
Deferred income taxes (174) (89)
Changes in operating assets and liabilities:
Inventories (1,152) (1,826)
Other current assets (367) (264)
Accounts payable 4,732 711
Accrued liabilities 938 (526)
Income taxes payable 691 1,236
Unearned revenue (177) 9
-------------- --------------
Net cash provided by operating activities 7,365 1,613
-------------- --------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property and equipment (517) (481)
Proceeds from sale of property and equipment 5 10
Purchase of intangible assets (61) (12)
Deposits 6 (15)
-------------- --------------
Net cash used in investing activities (567) (498)
-------------- --------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Common stock repurchases - (2,213)
Proceeds from exercise of common stock options 101 34
Net (repayments) borrowings on line of credit (3,265) 1,102
-------------- --------------
Net cash used in financing activities (3,164) (1,077)
-------------- --------------
NET INCREASE IN CASH AND CASH EQUIVALENTS 3,634 38
EFFECT OF FOREIGN EXCHANGE
RATES ON CASH AND CASH EQUIVALENTS 3 1
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 42 36
-------------- --------------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 3,679 $ 75
-------------- --------------
SUPPLEMENTAL CASH FLOW INFORMATION:
Cash paid for interest $ 32 $ 113
Cash paid for income taxes 1,000 100
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 quarters ended March 31, 2001 and March 30, 2002,
options to purchase 119,184 and 459,157 shares of common stock, respectively,
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 (in thousands, except per share amounts):
Quarter Ended March 31, 2001 Quarter Ended March 30, 2002
------------------------------------------- -------------------------------------------
Per-Share Per-Share
Net Income Shares Amount Net Income Shares Amount
------------- -------------- ------------- ------------- --------------- -------------
Basic EPS $ 2,330 11,577 $ 0.20 $ 1,940 11,521 $ 0.17
Effect of stock options 224 101
------------- -------------- ------------- ---------------
Diluted EPS $ 2,330 11,801 $ 0.20 $ 1,940 11,622 $ 0.17
============= ============== ============= ===============
NOTE 3. COMMON STOCK TRANSACTIONS
During the quarter ended March 30, 2002, the Company repurchased
200,000 shares for a total cost of approximately $2.2 million.
The Company's Board of Directors has authorized the repurchase of up to
3,000,000 shares of its common stock. 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
7
shares are retained as treasury stock to be used for corporate purposes. Through
March 30, 2002, the Company had repurchased 1,706,500 shares for a total cost of
approximately $22.1 million.
During the quarter ended March 30, 2002, employees exercised stock
options to purchase 5,506 shares of common stock for a total of approximately
$33,000.
During the quarter ended March 30, 2002 the Company granted
nonqualified stock options to purchase 119,926 shares of common stock to
employees, directors and consultants of the Company. The exercise prices of the
options range from $11.76 to $12.00. The options vest equally over a four-year
period and expire in seven to ten years.
On April 12, 2002, the Company's Board of Directors approved and
adopted, subject to stockholder approval, certain amendments to the Company's
stock option plan to provide for an increase in the number of shares of common
stock reserved for issuance under the plan from 620,000 to 1,240,000.
NOTE 4. 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 (4.5 percent at March 30, 2002)
or 2.35 percent above the lender's thirty day LIBOR. If at any time, the
Company's ratio of liabilities to net worth is more than 1.5, the floating rate
will increase by 0.25 percent. The credit facility also includes an unused
credit fee equal to one-eighth of one percent, payable quarterly. As of March
30, 2002, the Company's outstanding borrowings on the credit facility, including
bank overdrafts, were approximately $13.6 million. The credit facility is
secured by substantially all of the Company's assets and contains financial
covenants customary for this type of financing. As of March 30, 2002, the
Company was in compliance with these covenants. The credit facility expires
April 30, 2003.
NOTE 5. LEGAL MATTERS
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 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 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 Company has entered into a settlement agreement which resolves the
complaint. A cash payment of $8,500 was made in connection with the
settlement.
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,
8
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 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 & Johnson's eye care division, Vistakon, to
sell its products directly to the Company. The court finalized the MDL
settlement agreement on November 1, 2001. The agreement became effective on
December 1, 2001. To date, Vistakon has refused to open an account with the
Company. The Company filed a motion with the court alleging that Johnson &
Johnson is in violation of the settlement agreement because it has refused to
open an account for the Company. The court has granted motions for discovery and
an evidentiary hearing has been set for the summer of 2002 regarding this motion
for contempt.
On October 18, 2001, Vistakon filed an action against the Company
concerning certain of the Company's 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 granted Vistakon's preliminary injunction motion
in part. The court ruled that when the Company wishes to rely on a particular
study that the Company needs to make clear which lenses the study compares.
Also, the court found that some of the Company's statements were inconsistent
when it stated that it continues to fill virtually all orders of Vistakon
products while also stating that Vistakon has attempted to cut off the Company's
sources for Vistakon product. The Company appealed this decision and is
presently waiting for the 11th circuit federal court of appeals to hear the
case. 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.
NOTE 6. RECENTLY ISSUED ACCOUNTING STANDARDS
In June 2001, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") 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 adopted these new rules on accounting for goodwill and
other intangible assets effective in the first quarter of fiscal 2002. There was
no impact on the financial statements of the Company.
In October 2001, the FASB issued SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets," which replaces SFAS No. 121,
"Accounting for the Impairment of Long-Lived Assets to Be Disposed Of." The
accounting model for long-lived assets to be disposed of by sale applies to all
long-lived assets, including discontinued operations, and replaces the
provisions of Accounting Principles Board Opinion No. 30, "Reporting Results of
Operations--Reporting the Effects of Disposal of a Segment of a Business," for
the disposal of segments
9
of a business. This statement requires that those long-lived assets be measured
at the lower of the carrying amount or fair value less costs to sell, whether
reported in continuing operations or in discontinued operations. As a result,
discontinued operations will no longer be measured at net realizable value or
include amounts for operating losses that have not yet occurred. This statement
also broadens the reporting of discontinued operations to include all components
of an entity with operations that can be distinguished from the rest of the
entity and that will be eliminated from the ongoing operations of the entity in
a disposal transaction. This statement is effective for fiscal years beginning
after December 15, 2001. The Company adopted this statement effective in the
first quarter of fiscal 2002. There was no impact on the financial statements of
the Company.
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. Historically, the Company's net sales have grown rapidly, from $3.6
million in fiscal 1996 to $169 million in fiscal 2001. During the first
quarter of 2002, net sales declined slightly to $41.6 million from $42.8
million in the first quarter of fiscal 2001. Internet sales grew from an
insignificant amount in fiscal 1996 to $67.6 million in fiscal 2001 and from
$16.3 million in the first quarter of fiscal 2001 to $17.1 million in the
first quarter of fiscal 2002.
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 became effective on
December 1, 2001. CIBA Vision settled this lawsuit more than four years ago and
Bausch & Lomb settled in the first part of 2001. 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. 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.
Vistakon's current interpretation of the settlement agreement, and its
subsequent actions, have made its products more difficult for the Company to
obtain. As long as this restricted supply and the resulting wholesale price
increases continue, the Company's future net sales and gross profit will be
negatively impacted. As a result of this
11
restricted supply, the Company has reduced its planned advertising spending,
which will also adversely impact net sales.
The Company is also investing significant resources to ensure that the
settlement agreement will allow it to purchase contact lenses directly from
Vistakon. As a result, the Company expects to continue to incur significant
legal and related expenses during fiscal 2002.
In response to Johnson & Johnson's efforts to make its products more
difficult to obtain, the Company 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 5 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
-------------------------
MARCH 31, MARCH 30,
2001 2002
------------ ----------
Net sales 100.0% 100.0%
Cost of goods sold 59.6 69.5
------------ ----------
Gross profit 40.4 30.5
------------ ----------
Advertising expense 19.3 6.5
Legal and professional fees 1.0 3.0
Other selling, general and administrative expenses 10.6 13.0
------------ ----------
Total selling, general and administrative expenses 30.9 22.5
------------ ----------
Income from operations 9.5 8.0
Other expense, net (0.5) (0.3)
------------ ----------
Income before provision for income taxes 9.0 7.7
Provision for income taxes (3.6) (3.0)
------------ ----------
Net income 5.4% 4.7%
============ ==========
NET SALES. Net sales for the quarter ended March 30, 2002 decreased
3% to $41.6 million from $42.8 million for the quarter ended March 31, 2001.
This decrease is mainly due to a decline in new sales as a result of spending
about $5.5 million less on advertising in the first quarter of fiscal 2002
than was spent on advertising in the first quarter of fiscal 2001. The
decline in new sales was partially offset by the increase in repeat sales as
the Company continues to realize the benefits of a strong customer base.
Repeat sales for the first quarter of fiscal 2002 increased 17% to $32.9
million, or 79% of net sales, from $28.1 million, or 66% of net sales, for
the first quarter of fiscal 2001. The Company also believes that its net
sales reflect some of the benefits of the more than $100 million it has
invested in its national advertising campaign over the last several years and
its commitment to customer service. In addition, the Company continues to
refine its marketing efforts to its customer base and enhance its website.
The Company continues to highlight its website in its advertising. Internet
sales for the first quarter of fiscal 2002 were $17.1 million, or 41% of net
sales, as compared to $16.3 million, or 38% of net sales, for the first
quarter of fiscal 2001. Due to the current environment (higher prices for and
reduced supply of Vistakon products), the Company has continued its
suspension of quantity discounts on all Vistakon contact lenses
12
that was implemented in June 2001. During the first quarter of fiscal 2002,
the Company also continued with other programs implemented in September
2001 to manage its level of Vistakon inventory, including reducing the
standard quantity of Vistakon contact lenses offered to customers. Due to
such practices, the Company has been able to fill nearly all requests from
customers for Vistakon products, albeit at substantially higher costs to the
Company to aquire such product for resale.
GROSS PROFIT. Gross profit as a percentage of net sales decreased to
30.5% for the quarter ended March 30, 2002 from 40.4% for the quarter ended
March 31, 2001. 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 first quarter of fiscal 2002,
gross profit was impacted by the increase in wholesale prices paid for Vistakon
products. To offset some of the increase in wholesale prices paid for Vistakon
products, the Company raised its retail prices on Vistakon products during
December 2001. During the first quarter of fiscal 2002, Vistakon products
accounted for about 40% of the Company's net sales. If supply of Vistakon
products remains limited and wholesale prices remain at current levels, gross
profit will continue to be adversely impacted in future periods.
ADVERTISING EXPENSE. Advertising expense for the quarter ended March
30, 2002 decreased $5.5 million, or 67%, from the quarter ended March 31, 2001.
As a percentage of net sales, advertising expense decreased to 6.5% for the
first quarter of fiscal 2002 from 19.3% for the first quarter of fiscal 2001.
Until the current environment (higher prices for and reduced supply of Vistakon
products) changes, the Company plans on spending about $11 to $12 million on
advertising during the remainder of fiscal 2002. 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 March 30, 2002 increased $0.8 million, or 196%, from the quarter
ended March 31, 2001. As a percentage of net sales, legal and professional fees
increased to 3.0% for the first quarter of fiscal 2002 from 1.0% for the first
quarter of fiscal 2001. During the first quarter of fiscal 2002, 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 as it continues this proactive approach, including
investing resources to ensure that the multi-district litigation settlement
agreement with Johnson & Johnson will allow it to purchase contact lenses
directly from Vistakon.
OTHER SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Other selling,
general and administrative expenses for the quarter ended March 30, 2002
increased $0.8 million, or 19%, from the quarter ended March 31, 2001. As a
percentage of net sales, other selling, general and administrative expenses
increased to 13.0% for the first quarter of fiscal 2002 from 10.6% for the first
quarter of fiscal 2001. Operating and payroll costs increased as the Company
enhanced its operating infrastructure and its management team to meet the
demands of the business.
OTHER EXPENSE, NET. Other expense decreased to approximately $130,000
for the quarter ended March 30, 2002 from approximately $205,000 for the quarter
ended March 31, 2001. For the first quarter of fiscal 2002, other expense
consists mainly of interest expense, resulting from the increased use of the
revolving credit facility. During the first quarter of fiscal 2001, the Company
recorded a $220,000 loss related to the impairment of non-marketable securities
offset partially by interest income.
INCOME TAXES. The Company's effective tax rate for the quarter ended
March 30, 2002 was 39.1%. For the quarter ended March 31, 2001, the Company's
effective tax rate was 39.4%. As of March 30, 2002, 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 2002 effective income tax rate will be approximately 39%.
LIQUIDITY AND CAPITAL RESOURCES
For the quarters ended March 30, 2002 and March 31, 2001, net cash
provided by operating activities was approximately $1.6 million and $7.4
million, respectively. In the fiscal 2002 period, cash was provided primarily by
net income and increases in accounts payable and income taxes payable partially
offset by an increase in inventories. In the fiscal 2001 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
13
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 $498,000 and $567,000 for investing
activities in the quarters ended March 30, 2002 and March 31, 2001,
respectively. The majority of these amounts relate to capital expenditures for
infrastructure improvements. Capital expenditures for the fiscal 2002 and 2001
periods were approximately $481,000 and $517,000, respectively. The Company
anticipates additional capital expenditures for infrastructure as it continues
to expand and improve operating facilities, telecommunications systems and
management information systems in order to handle future growth.
During the quarters ended March 30, 2002 and March 31, 2001, the
Company used approximately $1.1 million and $3.2 million for financing
activities. During the fiscal 2002 period, the Company repurchased a total of
200,000 shares of its common stock for a total cost of approximately $2.2
million and had net borrowings on its credit facility of approximately $1.1
million. During the fiscal 2001 period, the Company repaid the amount owed on
its credit facility. The net repayments on the credit facility totaled
approximately $3.3 million. In both the fiscal 2002 and 2001 periods, these
amounts were offset slightly by proceeds from the exercise of common stock
options.
The Company's Board of Directors has authorized the repurchase of up to
3,000,000 shares of its common stock. 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 are
retained as treasury stock to be used for corporate purposes. Through March 30,
2002, the Company had repurchased 1,706,500 shares for a total cost of
approximately $22.1 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 (4.5 percent at March 30, 2002) or 2.35 percent
above the lender's thirty day LIBOR. If at any time, the Company's ratio of
liabilities to net worth is more than 1.5, the floating rate will increase by
0.25 percent. The credit facility also includes an unused credit fee equal to
one-eighth of one percent, payable quarterly. As of March 30, 2002, the
Company's outstanding borrowings on the credit facility, including bank
overdrafts, were approximately $13.6 million. The credit facility is secured by
substantially all of the Company's assets and contains financial covenants
customary for this type of financing. As of March 30, 2002, the Company was in
compliance with these covenants. 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 through the next year. The
Company may be required to seek additional sources of funds for accelerated
growth or continued growth beyond 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
substantial portion of the Company's customers for whom the Company is unable to
obtain or verify a prescription due to the enforcement of requirements by state
regulatory agencies.
14
CONTRACTUAL OBLIGATIONS AND COMMITMENTS
The Company has entered into additional commitments to purchase
approximately $5.7 million of inventory through December 2002, bringing the
total commitments to purchase inventory to approximately $18.1 million for 2002.
The Company has also entered into additional noncancelable commitments with
various advertising companies that will require the Company to pay approximately
$2.5 million for advertising through December 2002, bringing the total
commitments for advertising to approximately $8.8 million for 2002. See the
Company's Annual Report to Shareholders on Form 10-K for a summary of the
Company's other contractual obligations and commitments.
RECENTLY ISSUED ACCOUNTING STANDARDS
In June 2001, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") 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 adopted these new rules on accounting for goodwill and
other intangible assets effective in the first quarter of fiscal 2002. There was
no impact on the financial statements of the Company.
In October 2001, the FASB issued SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets," which replaces SFAS No. 121,
"Accounting for the Impairment of Long-Lived Assets to Be Disposed Of." The
accounting model for long-lived assets to be disposed of by sale applies to all
long-lived assets, including discontinued operations, and replaces the
provisions of Accounting Principles Board Opinion No. 30, "Reporting Results of
Operations--Reporting the Effects of Disposal of a Segment of a Business," for
the disposal of segments of a business. This statement requires that those
long-lived assets be measured at the lower of the carrying amount or fair value
less costs to sell, whether reported in continuing operations or in discontinued
operations. As a result, discontinued operations will no longer be measured at
net realizable value or include amounts for operating losses that have not yet
occurred. This statement also broadens the reporting of discontinued operations
to include all components of an entity with operations that can be distinguished
from the rest of the entity and that will be eliminated from the ongoing
operations of the entity in a disposal transaction. This statement is effective
for fiscal years beginning after December 15, 2001. The Company adopted this
statement effective in the first quarter of fiscal 2002. There was no impact on
the financial statements of the Company.
CRITICAL ACCOUNTING POLICIES
See the Company's Annual Report to Shareholders on Form 10-K for a
summary of the Company's critical accounting policies.
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.
15
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 38%, 35%
and 46% of the Company's inventory purchases in fiscal 1999, 2000 and
2001, respectively;
- Historically, Johnson & Johnson's Vistakon products have accounted for
about 40% of the Company's net sales; if supply of Vistakon products
remains limited and wholesale prices remain at current levels, the
Company's future net sales and gross profit will be negatively impacted;
- The Company may continue to incur 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'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 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;
- 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 use of the
Internet;
16
- 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 March 30, 2002, the Company's
outstanding borrowings on the credit facility, including bank overdrafts, were
approximately $13.6 million. The credit facility currently bears interest at a
variable rate. The Company is exposed to limited foreign currency risk due to
cash held by its foreign subsidiary. As of March 30, 2002, the Company's total
cash in foreign currencies was approximately $10,000. 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.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(A) Exhibits
Exhibit No. Description of Exhibit
----------- ----------------------
10.1 Employment agreement between the Company and Jonathan C. Coon.
10.2 Employment agreement between the Company and John F. Nichols.
10.3 Employment agreement between the Company and Scott S. Tanner.
10.4 Employment agreement between the Company and Robert G. Hunter.
(B) Reports on From 8-K
No reports on Form 8-K were filed by the Registrant during the quarter
ended March 30, 2002.
17
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
1-800 CONTACTS, INC.
Dated: May 14, 2002 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
18