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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 June 30, 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
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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 August 8, 2001, the Registrant had 11,571,743 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 June 30, 2001 ...................................................... 3
Condensed Consolidated Statements of Income for the Quarter and
Two Quarters Ended July 1, 2000 and June 30, 2001 ...................... 4
Condensed Consolidated Statement of Stockholders' Equity for the
Two Quarters Ended June 30, 2001 ....................................... 5
Condensed Consolidated Statements of Cash Flows for the Two Quarters
Ended July 1, 2000 and June 30, 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................... 16
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, June 30,
2000 2001
------------------ -----------------
CURRENT ASSETS:
Cash and cash equivalents $ 42,558 $ 77,261
Inventories 20,402,076 30,369,113
Deferred income taxes 673,710 767,590
Other current assets 385,001 790,546
------------------ -----------------
Total current assets 21,503,345 32,004,510
PROPERTY AND EQUIPMENT, net 2,843,103 3,276,803
DEFERRED INCOME TAXES 203,620 373,851
INTANGIBLE ASSETS, net 1,261,916 1,154,545
OTHER ASSETS 295,775 69,301
------------------ -----------------
Total assets $ 26,107,759 $ 36,879,010
================== =================
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Line of credit $ 3,264,979 $ 226,026
Accounts payable 3,646,578 13,322,797
Accrued liabilities 3,541,463 3,335,792
Income taxes payable 1,206,523 230,407
Unearned revenue 483,812 285,911
------------------ -----------------
Total current liabilities 12,143,355 17,400,933
------------------ -----------------
STOCKHOLDERS' EQUITY:
Common stock 128,611 128,611
Additional paid-in capital 23,802,342 23,965,162
Retained earnings 8,412,507 14,065,248
Treasury stock at cost (18,376,111) (18,678,807)
Accumulated other comprehensive loss (2,945) (2,137)
------------------ -----------------
Total stockholders' equity 13,964,404 19,478,077
------------------ -----------------
Total liabilities and stockholders' equity $ 26,107,759 $ 36,879,010
================== =================
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 Two Quarters Ended
----------------------------------- -------------------------------------
July 1, June 30, July 1, June 30,
2000 2001 2000 2001
---------------- ---------------- ----------------- -----------------
NET SALES $ 35,708,171 $ 44,197,114 $ 67,127,175 $ 87,014,420
COST OF GOODS SOLD 21,247,097 26,241,743 39,779,694 51,776,129
---------------- ---------------- ----------------- -----------------
Gross profit 14,461,074 17,955,371 27,347,481 35,238,291
---------------- ---------------- ----------------- -----------------
SELLING, GENERAL AND
ADMINISTRATIVE EXPENSES:
Advertising expense 5,808,266 7,267,221 12,310,462 15,531,044
Other selling, general and
administrative expenses 3,824,131 5,316,300 7,428,895 10,283,779
---------------- ---------------- ----------------- -----------------
Total selling, general and
administrative expenses 9,632,397 12,583,521 19,739,357 25,814,823
---------------- ---------------- ----------------- -----------------
INCOME FROM OPERATIONS 4,828,677 5,371,850 7,608,124 9,423,468
OTHER INCOME (EXPENSE), net 117,495 32,826 233,324 (171,690)
---------------- ---------------- ----------------- -----------------
INCOME BEFORE PROVISION
FOR INCOME TAXES 4,946,172 5,404,676 7,841,448 9,251,778
PROVISION FOR INCOME TAXES (1,916,410) (2,081,919) (2,999,137) (3,599,037)
---------------- ---------------- ----------------- -----------------
NET INCOME $ 3,029,762 $ 3,322,757 $ 4,842,311 $ 5,652,741
================ ================ ================= =================
PER SHARE INFORMATION:
Basic net income per common share $ 0.25 $ 0.29 $ 0.40 $ 0.49
================ ================ ================= =================
Diluted net income per common share $ 0.25 $ 0.28 $ 0.39 $ 0.48
================ ================ ================= =================
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 Two Quarters Ended June 30, 2001
(Unaudited)
Common Stock Additional Treasury Stock
---------------------- Paid-in Retained ----------------------------
Shares Amount Capital Earnings Shares Amount
---------- --------- ------------ ------------ ----------- -------------
BALANCE,
December 30, 2000 12,861,136 $ 128,611 $ 23,802,342 $ 8,412,507 (1,289,555) $ (18,376,111)
Purchase of treasury
shares - - - - (22,500) (438,125)
Exercise of common
stock options - - 13,556 - 22,341 135,429
Income tax benefit
from common stock
options exercised - - 149,264 - - -
Net income - - - 5,652,741 - -
Foreign currency
translation
adjustments - - - - - -
---------- --------- ------------ ------------ ----------- -------------
Comprehensive income
BALANCE,
June 30, 2001 12,861,136 $ 128,611 $ 23,965,162 $ 14,065,248 (1,289,714) $ (18,678,807)
========== ========= ============ ============ =========== =============
Accumulated
Other Total
Comprehensive Stockholders' Comprehensive
Loss Equity Income
------------- ------------- -------------
BALANCE,
December 30, 2000 $ (2,945) $ 13,964,404
Purchase of treasury
shares - (438,125)
Exercise of common
stock options - 148,985
Income tax benefit
from common stock
options exercised - 149,264
Net income - 5,652,741 $ 5,652,741
Foreign currency
translation
adjustments 808 808 808
------------ ------------ -------------
Comprehensive income $ 5,653,549
=============
BALANCE,
June 30, 2001 $ (2,137) $ 19,478,077
============ ============
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)
Two Quarters Ended
----------------------------
July 1, June 30,
2000 2001
------------ ------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 4,842,311 $ 5,652,741
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 525,375 665,699
Gain on sale of property and equipment (2,650) (6,500)
Loss on impairment of non-marketable securities -- 220,000
Deferred income taxes (123,663) (264,111)
Changes in operating assets and liabilities:
Inventories (870,422) (9,967,037)
Other current assets 12,658 (405,675)
Accounts payable 4,274,909 9,676,299
Accrued liabilities 1,372,246 (205,607)
Income taxes payable 925,300 (826,852)
Unearned revenue 302,031 (197,901)
------------ ------------
Net cash provided by operating activities 11,258,095 4,341,056
------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property and equipment (513,759) (921,312)
Proceeds from sale of property and equipment 2,650 6,500
Purchase of intangible assets (10,000) (71,967)
Purchase of non-marketable securities (220,000) --
Deposits (5,898) 6,227
------------ ------------
Net cash used in investing activities (747,007) (980,552)
------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Common stock repurchases (14,323,948) (438,125)
Proceeds from exercise of common stock options 210,275 148,985
Net repayments on line of credit -- (3,038,953)
Principal payments on capital lease obligation (19,848) --
Payment of acquisition payable (300,000) --
------------ ------------
Net cash used in financing activities (14,433,521) (3,328,093)
------------ ------------
NET INCREASE IN CASH AND CASH EQUIVALENTS (3,922,433) 32,411
EFFECT OF FOREIGN EXCHANGE RATES ON CASH -- 2,292
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 4,329,088 42,558
------------ ------------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 406,655 $ 77,261
============ ============
SUPPLEMENTAL CASH FLOW INFORMATION:
Cash paid for interest $ 1,152 $ 31,701
Cash paid for income taxes 2,097,500 4,690,000
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 generally
accepted accounting principles 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 June 30, 2001, options to purchase
125,138 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 July 1, 2000 Quarter Ended June 30, 2001
---------------------------------------- ------------------------------------------
Per-Share Per-Share
Net Income Shares Amount Net Income Shares Amount
---------- ----------- --------- ----------- ---------- ---------
Basic EPS $3,029,762 11,963,053 $ 0.25 $ 3,322,757 11,574,520 $ 0.29
Effect of stock options 208,230 207,800
---------- ----------- --------- ----------- ---------- ---------
Diluted EPS $3,029,762 12,171,283 $ 0.25 $ 3,322,757 11,782,320 $ 0.28
========== =========== ========= =========== ========== =========
Two Quarters Ended July 1, 2000 Two Quarters Ended June 30, 2001
--------------------------------------- ------------------------------------------
Per-Share Per-Share
Net Income Shares Amount Net Income Shares Amount
---------- ----------- --------- ----------- ---------- ---------
Basic EPS $4,842,311 12,162,733 $ 0.40 $ 5,652,741 11,575,678 $ 0.49
Effect of stock options 201,266 215,864
---------- ----------- --------- ----------- ---------- ---------
Diluted EPS $4,842,311 12,363,999 $ 0.39 $ 5,652,741 11,791,542 $ 0.48
========== =========== ========= =========== ========== =========
7
NOTE 3. COMMON STOCK TRANSACTIONS
During the two quarters ended June 30, 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 June
30, 2001, the Company had repurchased 1,506,500 shares for a total cost of
$19,891,234.
During the two quarters ended June 30, 2001, employees exercised stock
options to purchase 22,341 shares of common stock for a total of $148,985.
During February and March 2001, the Company granted nonqualified stock
options to purchase 93,564 shares of common stock to employees and directors of
the Company. The exercise prices of the options range from $21.25 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 (6.5 percent as of June 30,
2001). As of June 30, 2001, the Company's outstanding borrowings on the credit
facility were $226,026. 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.
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 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. 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
9
expectations for its short-term net sales and gross margin. If supply of
Vistakon products remains limited and wholesale prices remain higher than
expected, gross margins will be impacted significantly at the end of the third
quarter and in the fourth quarter of fiscal 2001. As of June 30, 2001, the
Company had approximately a three to four month supply of Vistakon lenses;
therefore, the impact should be less significant in the third quarter of fiscal
2001. The Company's wholesale prices on Vistakon products have increased
approximately 10% to 20%, and Vistakon products account for more than 40% of the
Company's net sales.
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 $67.1 million in the first
two quarters of fiscal 2000 to $87.0 million in the first two 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 $21.9 million in the first
two quarters of fiscal 2000 to $33.3 million in the first two 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. A fairness hearing on the
settlement is scheduled for September 7, 2001. 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 and has recently informed the Company that Vistakon will not be
processing the Company's application until September at the earliest. The
Company is not aware of any mail order company that has begun purchasing
directly from Vistakon. The Company expects the fairness hearing in September to
address Vistakon's obligations under the settlement in more detail.
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
margin. Due to the current
11
environment (higher prices for and reduced supply of Vistakon products), the
Company has suspended its quantity discounts on all Vistakon contact lenses.
This will reduce expected revenues in the third quarter of fiscal 2001, as
customers who had previously benefited by purchasing a one-year supply of lenses
at a discounted price may now shift to purchasing a six-month supply of lenses.
However, sales in the first quarter of fiscal 2002 should be positively
impacted, as these customers will need replacements sooner.
If supply of Vistakon products remains limited and wholesale prices
remain higher than expected, gross margins will be impacted significantly at the
end of the third quarter and in the fourth quarter of fiscal 2001. As of June
30, 2001, the Company had approximately a three to four month supply of Vistakon
lenses; therefore, the impact should be less significant in the third quarter of
fiscal 2001.
The Company is also investing significant resources to ensure that the
settlement agreement, if finalized, 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.
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 Two Quarters Ended
------------------------------ ------------------------------
July 1, June 30, July 1, June 30,
2000 2001 2000 2001
--------------- -------------- --------------- --------------
Net sales 100.0% 100.0% 100.0% 100.0%
Cost of goods sold 59.5 59.4 59.3 59.5
--------------- -------------- --------------- --------------
Gross profit 40.5 40.6 40.7 40.5
--------------- -------------- --------------- --------------
Advertising expense 16.3 16.5 18.3 17.9
Other selling, general and administrative expenses 10.7 12.0 11.1 11.8
--------------- -------------- --------------- --------------
Total selling, general and administrative expenses 27.0 28.5 29.4 29.7
--------------- -------------- --------------- --------------
Income from operations 13.5 12.1 11.3 10.8
Other income (expense), net 0.3 0.1 0.4 (0.2)
--------------- -------------- --------------- --------------
Income before provision for income taxes 13.8 12.2 11.7 10.6
Provision for income taxes (5.3) (4.7) (4.5) (4.1)
--------------- -------------- --------------- --------------
Net income 8.5% 7.5% 7.2% 6.5%
=============== ============== =============== ==============
Net sales. Net sales for the quarter ended June 30, 2001 increased 24%
to $44.2 million from $35.7 million for the quarter ended July 1, 2000. For the
two quarters ended June 30, 2001, net sales increased 30% to $87.0 million from
$67.1 million for the two quarters ended July 1, 2000. The Company added more
than 310,000 new customers during the first two quarters of fiscal 2001. The
Company is realizing the benefits of repeat sales from a growing customer base.
Repeat sales for the second quarter of fiscal 2001 increased 39% to $30.8
million, or 70% of net sales, from $22.1 million, or 62% of net sales, for the
second quarter of fiscal 2000. Repeat sales for the first two quarters of fiscal
2001 increased 46% to $58.9 million, or 68% of net sales, from $40.3 million, or
60% of net sales, for the first two quarters of fiscal 2000. The Company also
believes that the increase in net sales reflects some of the benefits of the
approximately $90 million it has 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 second quarter of fiscal 2001 were $17.1
million, or 39% of net sales, as compared to $12.6 million, or 35% of net sales,
for the second quarter of fiscal 2000. For the first two quarters of fiscal
2001, Internet sales were $33.3 million, or 38% of net sales, as compared to
$21.9 million, or 33% 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 has suspended its quantity discounts on all Vistakon contact lenses.
This will reduce expected revenues in the third quarter of fiscal 2001, as
customers who had previously benefited by purchasing a one-year supply of lenses
at a
12
discounted price may now shift to purchasing a six-month supply of lenses.
However, sales in the first quarter of fiscal 2002 should be positively
impacted, as these customers will need replacements sooner. The Company believes
that sales will increase substantially in fiscal 2001 as compared to fiscal
2000, although the Company expects the rate of growth in net sales to decrease.
Gross profit. Gross profit as a percentage of net sales increased
slightly to 40.6% for the quarter ended June 30, 2001 from 40.5% for the quarter
ended July 1, 2000. For the two quarters ended June 30, 2001, gross profit as a
percentage of net sales decreased slightly to 40.5% from 40.7% for the two
quarters ended July 1, 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 second quarter of
fiscal 2001, the Company realized the benefits of temporary favorable pricing on
some specific inventory purchases. If supply of Vistakon products remains
limited and wholesale prices remain higher than expected, gross margins will be
impacted significantly at the end of the third quarter and in the fourth quarter
of fiscal 2001. As of June 30, 2001, the Company had approximately a three to
four month supply of Vistakon lenses; therefore, the impact should be less
significant in the third quarter of fiscal 2001. The Company's wholesale prices
on Vistakon products have increased approximately 10% to 20%, and Vistakon
products account for more than 40% of the Company's net sales.
Advertising expense. Advertising expense for the quarter ended June 30,
2001 increased $1.5 million, or 25%, from the quarter ended July 1, 2000. As a
percentage of net sales, advertising expense increased slightly to 16.5% for the
second quarter of fiscal 2001 from 16.3% for the second quarter of fiscal 2000.
For the two quarters ended June 30, 2001, advertising expense increased $3.2
million, or 26%, from the two quarters ended July 1, 2000. As a percentage of
net sales, advertising expense decreased slightly to 17.9% for the first two
quarters of fiscal 2001 from 18.3% for the first two quarters of fiscal 2000.
Due to the current environment (higher prices for and reduced supply of Vistakon
products), the Company expects to decrease advertising spending below originally
planned levels for the remainder of fiscal 2001. Currently the Company plans to
increase advertising spending in fiscal 2001 by approximately 15% from its
fiscal 2000 spending. However, if opportunities present themselves, the Company
may increase advertising spending above currently planned levels.
Other selling, general and administrative expenses. Other selling,
general and administrative expenses for the quarter ended June 30, 2001
increased $1.5 million, or 39%, from the quarter ended July 1, 2000. For the two
quarters ended June 30, 2001, other selling, general and administrative expenses
increased $2.9 million, or 38%, from the two quarters ended July 1, 2000. As a
percentage of net sales, other selling, general and administrative expenses
increased to 12.0% for the second quarter of fiscal 2001 from 10.7% for the
second quarter of fiscal 2000. For the two quarters ended June 30, 2001, other
selling, general and administrative expenses as a percentage of net sales
increased to 11.8% from 11.1% for the first two quarters of fiscal 2000. The
fixed portion of payroll costs increased as the Company continues to enhance its
management team to meet the demands of current and future growth. In addition
the Company's legal and related expenses have increased. The Company expects to
continue to incur significant legal and related expenses for the remainder of
fiscal 2001 as the Company invests resources to ensure that the multi-district
litigation settlement agreement with Johnson & Johnson, if finalized, will allow
mail order companies to purchase contact lenses directly from Vistakon.
Other income (expense), net. Other income (expense) decreased to
approximately $33,000 and ($172,000) for the quarter and two quarters ended June
30, 2001, respectively, from approximately $117,000 and $233,000 for the quarter
and two quarters ended July 1, 2000, respectively. Interest income decreased due
to lower cash balances and lower interest rates. 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 two
quarters ended June 30, 2001 was 38.5% and 38.9%, respectively. For the quarter
and two quarters ended July 1, 2000, the Company's effective tax rate was 38.7%
and 38.2% respectively. As of June 30, 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%.
13
Liquidity and Capital Resources
For the two quarters ended June 30, 2001 and July 1, 2000, net cash
provided by operating activities was approximately $4.3 million and $11.3
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. Due to the recent limited availability of Vistakon products, the
Company increased the level of Vistakon inventory that it carries.
The Company used approximately $981,000 and $747,000 for investing
activities in the two quarters ended June 30, 2001 and July 1, 2000,
respectively. The majority of these amounts relate to capital expenditures for
infrastructure improvements. Capital expenditures for the fiscal 2001 period
were approximately $921,000. A significant portion of these expenditures relate
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 $514,000. In addition, in 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 June 30, 2001, the Company had certain noncancelable commitments
to purchase approximately $4.8 million of broadcast advertising through
September 2001. In addition, the Company has entered into certain noncancelable
commitments with various advertising companies that will require the Company to
pay approximately $5.6 million from January 1, 2001 through December 31, 2001.
During the two quarters ended June 30, 2001 and July 1, 2000, the
Company used approximately $3.3 million and $14.4 million for financing
activities. During the fiscal 2001 period, the Company had net repayments on its
credit facility of approximately $3.0 million and repurchased 22,500 shares of
its common stock for a total cost of approximately $438,000. During the fiscal
2000 period, the Company repurchased a total of 984,000 shares of its common
stock for a total cost of approximately $14.3 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 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 June
30, 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 (6.5 percent as of June 30, 2001). As of June
30, 2001, the Company's outstanding borrowings on the credit facility were
approximately $226,000. 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
14
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.
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.
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;
15
. 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;
. 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 June 30, 2001, the Company's outstanding
borrowings on the credit facility were approximately $226,000. 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 June 30, 2001,
the Company's total cash in foreign currencies was approximately $13,000. In
addition, all of the Company's revenue transactions are in U.S. dollars.
16
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
The annual meeting of the stockholders of the Company was held on May
18, 2001. The stockholders approved the following matters:
. The election as directors of Jonathan C. Coon, Jason S. Subotky and
Bradley T. Knight to serve until the annual meeting of stockholders
in 2004 and until their respective successors are duly elected and
qualified.
Votes cast
------------------------
For Against
------------ ----------
Jonathan C. Coon 8,808,938 368,900
Jason S. Subotky 9,160,008 17,830
Bradley T. Knight 9,160,778 17,060
The other directors of the Company include the following persons:
(i) John F. Nichols and Scott S. Tanner, who are to serve until the
annual meeting of stockholders in 2002 and (ii) Stephen A. Yacktman
and E. Dean Butler, who are to serve until the annual meeting of
stockholders in 2003.
. The appointment of Arthur Andersen LLP to serve as the Company's
independent public accountants for the Company's 2001 fiscal year.
Votes cast:
For 9,176,431
Against 327
Abstained 1,080
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
Exhibit No. Description of Exhibit
----------- --------------------------------------------------
10.1 Revolving Credit Agreement between the Company and
Zions First National Bank, dated June 26, 2001.
(B) Reports on Form 8-K
No reports on Form 8-K were filed by the Registrant during the
quarter ended June 30, 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: August 14, 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