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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended December 30, 2000 or
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ______________ to ______________
Commission file number: 0-23633
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1-800 CONTACTS, INC.
(Exact name of registrant as specified in its charter)
Delaware 87-0571643
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(State or other jurisdiction of incorporation or organization) (I.R.S. Employer Identification No.)
66 E. Wadsworth Park Drive 3rd Floor, Draper, UT 84020
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (801) 924-9800
Securities registered pursuant to Section 12(b) of the Act: Not applicable
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, par value $.01 per share
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(Title of Class)
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
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [_]
The aggregate market value of voting common equity held by non-affiliates
of the registrant as of March 19, 2001 at a closing sale price of $21.938 as
reported by the Nasdaq National Market ("Nasdaq") was approximately $150
million. Shares held by each officer and director and by each person who owns
or may be deemed to own 10% or more of the outstanding Common Stock have been
excluded since such persons may be deemed to be affiliates. This determination
of affiliate status is not necessarily a conclusive determination for other
purposes.
As of March 19, 2001, the Registrant had 11,588,125 shares of Common Stock,
par value $0.01 per share, outstanding.
Documents Incorporated by Reference
Portions of the Registrant's Proxy Statement to be used in connection with
the solicitation of proxies for the Annual Meeting of Stockholders to be held on
May 18, 2001 (the "Proxy Statement") are incorporated by reference in Part III
of this Annual Report on Form 10-K (the "Form 10-K").
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1-800 CONTACTS, INC.
INDEX TO ANNUAL REPORT ON FORM 10-K
Page No.
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PART I
Item 1. Business................................................................ 3
Item 2. Properties.............................................................. 12
Item 3. Legal Proceedings....................................................... 13
Item 4. Submission of Matters to a Vote of Security Holders..................... 14
Item 4A. Executive Officers of the Registrant.................................... 14
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters... 15
Item 6. Selected Financial Data................................................. 16
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations................................................. 17
Item 7A. Quantitative and Qualitative Disclosures About Market Risk.............. 23
Item 8. Financial Statements and Supplementary Data............................. 23
Item 9. Changes in and Disagreements With Accountants on Accounting and
Financial Disclosure.................................................. 24
PART III
Item 10. Directors and Executive Officers of the Registrant...................... 24
Item 11. Executive Compensation.................................................. 24
Item 12. Security Ownership of Certain Beneficial Owners and Management.......... 24
Item 13. Certain Relationships and Related Transactions.......................... 24
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K........ 24
PART I
Item 1. Business.
Overview
1-800 CONTACTS, INC. (the "Company") was incorporated under the laws of the
State of Utah in February 1995 and was reincorporated under the laws of the
State of Delaware in February 1998 in conjunction with its initial public
offering of common stock. The Company is the successor to the business founded
by the Company's Vice President of Sales in March 1991. The Company's principal
executive office is located at 66 E. Wadsworth Park Drive 3rd Floor, Draper,
Utah 84020, and its telephone number is (801) 924-9800. The Company maintains a
website on the Internet at www.1800contacts.com.
The Company is a leading direct marketer of replacement contact lenses. As
of December 30, 2000, the Company had shipped more than 3.7 million orders to
approximately 1.8 million customers since inception. Through its easy-to-
remember, toll-free telephone number, "1-800 CONTACTS" (1-800-266-8228), and
through its Internet addresses, which include "www.1800contacts.com,"
"www.contacts.com" and "www.contactlenses.com," the Company sells all of the
popular brands of contact lenses, including those manufactured by Johnson &
Johnson, CIBA Vision, Wesley Jessen (recently acquired by CIBA Vision), Bausch &
Lomb, Ocular Sciences and CooperVision. The Company's high volume, cost-
efficient operations, supported by its proprietary management information
systems, enable it to offer consumers an attractive alternative for obtaining
replacement contact lenses in terms of convenience, price, speed of delivery and
customer service. As a result of its extensive inventory of more than 30,000
SKUs, the Company generally ships approximately 90% of its orders within one
business day of receipt. The Company believes that it offers its customers an
attractive alternative for obtaining replacement contact lenses in terms of
convenience, price, speed of delivery and customer service. The Company's net
sales have grown rapidly, from $3.6 million in fiscal 1996 to $145 million in
fiscal 2000.
The Internet is the Company's fastest-growing sales channel and a more
cost-effective way for the Company to serve its customers. The Company's
Internet sales for fiscal 2000 were $53.8 million compared to $18.7 million in
the previous fiscal year. During the fourth quarter of fiscal 2000, new Internet
orders represented approximately 47% of the Company's total new orders. Its
online presence enables the Company to operate more efficiently by substantially
eliminating the payroll and long distance costs associated with telephone
orders. This increased efficiency allows the Company to offer Internet customers
free shipping in addition to other services such as e-mail shipping
confirmation, online order tracking and e-mail correspondence. The Company
believes that its customers will increasingly use the Internet to order and
reorder replacement contact lenses.
The Company markets its products through a national advertising campaign
that aims to increase recognition of the 1-800 CONTACTS brand name, increase
traffic on its website, add new customers, continue to build strong customer
loyalty and maximize repeat purchases. As compared to other direct marketers of
replacement contact lenses, the Company believes that its toll-free telephone
number and Internet addresses afford it a significant competitive advantage in
generating consumer awareness and repeat business. The Company spent
approximately $25.6 million on advertising in fiscal 2000 and has invested more
than $74 million in its national advertising campaign over the last several
years. The Company's experience has been that increases in advertising
expenditures have a direct impact on the growth of net sales.
Industry Overview
Industry analysts estimate that over 50% of the United States' population
need some form of corrective eyewear. Contact lenses are a convenient, cost-
effective alternative to eyeglasses, and the number of contact lens wearers is
expected to increase as technology further improves the convenience, comfort and
fit of contact lenses. As a result, the contact lens market is large and
growing. The growth in the disposable market is largely due to the shift in the
contact lens market away from traditional soft lenses, which generally are
replaced on an annual basis, to disposable lenses, which are replaced on a
daily, weekly, or bi-weekly basis.
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Traditionally, contact lenses were sold to consumers almost exclusively by
either ophthalmologists or optometrists (referred to herein collectively as "eye
care practitioners"). Eye care practitioners would typically supply a patient
with his or her initial pair of contact lenses in connection with providing the
patient an eye examination and subsequently provide all replacement lenses,
regardless of whether the patient was given or required another eye examination.
Because the initial fitting of contact lenses requires a prescription written by
an eye care practitioner, the initial sale of contact lenses still takes place
primarily in this manner. Over the last decade, however, a number of alternative
sellers of replacement contact lenses have emerged, including direct marketers.
The Company believes that increased consumer awareness of the benefits of
the direct marketing of contact lenses will lead to further growth of this
method of buying and selling contact lenses. Purchasing replacement contact
lenses from a direct marketer offers the convenience of shopping at home, rapid
home delivery, quick and easy telephone or Internet ordering and competitive
pricing. In addition, the growth in popularity of disposable contact lenses,
which require patients to purchase replacement lenses more frequently, has
contributed to the growth of the direct marketing channel. The direct marketing
industry continues to grow as many retail customers have migrated towards the
convenience and service offered by home shopping, and the Company expects the
direct marketing segment of the contact lens industry to grow in tandem with the
growth in the direct marketing industry as a whole.
The Company believes that the growth and acceptance of the Internet
presents significant opportunities for direct marketers of contact lenses such
as the Company. The factors driving this growth include the increasing number
and decreasing cost of personal computers in homes and offices, technological
innovations providing easier, faster and cheaper access to the Internet, the
proliferation of content and services being provided on the Internet and the
increasing use of the Internet by business and consumers as a medium for
conducting business.
The Internet possesses a number of unique and commercially powerful
characteristics that differentiate it from traditional media: users communicate
or access information without geographic limitations; users access dynamic and
interactive content on a real-time basis; and users communicate and interact
instantaneously. The Internet has created a dynamic and particularly attractive
medium for commerce, empowering customers to gather more comparative purchasing
data than is feasible with traditional commerce systems, to shop in a more
convenient manner and to interact with sellers in many new ways. The Company
believes that the Internet provides a convenient and efficient medium for the
sale of replacement contact lenses.
Historically, sales of contact lenses by direct marketers have been impeded
by eye care practitioners and contact lens manufacturers. Many eye care
practitioners have been reluctant to provide patients with a copy of their
prescription or to release such information to direct marketers upon request,
thereby impeding patients from purchasing lenses from a direct marketer. In
addition, until recently substantially all of the major manufacturers of contact
lenses had refused to sell contact lenses directly to direct marketing companies
and had sought to prohibit their distributors from doing so. These traditional
barriers to the direct marketing of contact lenses have been reduced and may be
completely eliminated in the future. The Federal Trade Commission (the "FTC")
has from time to time solicited comments regarding whether eye care
practitioners should be required to release contact lens prescriptions to their
patients. In addition, the Attorneys General for more than 30 states have joined
in a lawsuit against the major contact lens manufacturers and certain eye care
practitioners and their trade associations alleging that the manufacturers'
policy not to sell to direct marketers was adopted in conspiracy with eye care
practitioners to eliminate alternative channels of trade from the contact lens
market. See "Purchasing and Principal Suppliers" and "Government Regulation."
Product Offerings
Contact lenses can be divided into two categories: soft lenses and hard
lenses (primarily rigid gas permeable). There are three principal wearing
regimes for soft contact lenses: conventional, disposable and planned
replacement. Conventional lenses are designed to be worn indefinitely but are
typically replaced after 12 to 24 months. Disposable soft contact lenses were
introduced in the late 1980s based on the concept that changing lenses on a more
regular basis was important to comfort, convenience, maintaining healthy eyes
and patient compliance. Disposable lenses are changed as often as daily and up
to every two weeks, depending on the product. Planned replacement lenses are
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designed to be changed as often as every two weeks and up to every three months
and currently represent a small portion of the overall soft lens market.
The Company is a direct marketer of replacement contact lenses and does not
manufacture contact lenses or provide eye examinations or related services to
its customers. The Company offers substantially all of the soft and hard contact
lenses produced by the leading contact lens manufacturers, including Johnson &
Johnson, CIBA Vision, Wesley Jessen (recently acquired by CIBA Vision), Bausch &
Lomb, Ocular Sciences and CooperVision. The Company stocks a large inventory of
lenses from which it can ship approximately 90% of its orders within one
business day of receipt. The Company believes that its ability to maintain a
large inventory of contact lenses provides it with a competitive advantage over
eye care practitioners, optical chains and discount stores and serves as an
effective barrier to entry to potential entrants in the direct marketing of
contact lenses.
In July 1997, the Company was approved as an authorized distributor of CIBA
Vision. The Company also purchases product directly from certain other
manufacturers. See "Purchasing and Principal Suppliers." The Company's products
are delivered in the same sterile, safety sealed containers in which the lenses
were packaged by the manufacturer. From time to time, the Company purchases
contact lenses that were labeled as "samples" by the manufacturer. Such lenses
are sometimes offered by the Company to customers as part of promotional
programs at reduced prices.
Customers and Marketing
The Company's customers are located principally throughout the United
States. The percentage of the Company's customers that are located in each state
is approximately equal to the percentage of the United States' population which
resides in such state, with the largest concentration of the Company's customers
residing in California. The Company strives to deliver a high level of customer
service in an effort to maintain and expand its loyal customer base. The Company
utilizes a focused, closely managed and monitored marketing strategy that is
designed to enhance the awareness and value of its brand. The Company
continually researches and analyzes new ways in which to advertise its products.
After identifying an attractive potential new advertisement or advertising
medium, the Company commits to such advertising for an initial test period. The
response generated by such advertising is monitored and analyzed by the Company
and a decision to commit significant resources to a particular advertisement or
advertising medium is made only if the Company is satisfied with the response
rates it has generated. After the initial testing period, the Company continues
to closely monitor its advertising in order to identify and react to trends in
consumer response patterns and adjust its marketing strategy accordingly.
The majority of contact lens wearers are between the ages of 18 and 49. In
addition, approximately two-thirds of contact lens wearers are women and contact
lens wearers generally have higher incomes than eyeglass wearers do. Through its
national advertising campaign, the Company is able to target its advertising to
contact lens wearers in these key demographic groups, as well as certain other
persons based on other important demographics.
The Company spent approximately $25.6 million on advertising in fiscal 2000
and intends to increase advertising spending in fiscal 2001 to continue its
nationwide advertising campaign that aims to increase recognition of the 1-800
CONTACTS brand name, increase traffic on its website, add new customers,
continue to build strong customer loyalty and maximize repeat purchases. The
Company's advertising campaign targets both its traditional telephone customers
and its online customers and is designed to drive new and repeat purchases. In
addition, the Company intends to continue expanding its direct marketing
campaign to its more than 1.8 million customers through the U.S. mail and
e-mail.
A brief description of the principal components of the Company's national
advertising campaign is set forth below:
Broadcast. The Company utilizes a nationwide broadcast advertising campaign
with significant purchases on both cable and network television. The Company's
television ads typically focus on its ability to rapidly deliver to customers
the same contact lenses offered by eye care practitioners. The Company believes
that its easy-to-remember
5
phone number and Internet address make television a particularly effective
marketing vehicle and that television advertising will continue to be the key
to building awareness for its 1-800 CONTACTS brand name.
Internet. The Company uses the unique resources of the Internet as a means
of marketing in an effort to drive new and repeat traffic. The Company continues
to seek opportunities to expand its presence within highly trafficked content
sites.
Direct-Mailing. The Company uses direct-mail to advertise its products to
selected groups of consumers. The Company utilizes mailing lists obtained from
both private and public sources to target its advertisements specifically to
contact lens wearers.
Cooperative Mailings. The Company advertises its products in cooperative
mail programs sponsored by the leading cooperative mail companies in the United
States. This advertising medium permits the Company to target consumers in
specific zip codes according to age, income and other important demographics.
Management Information Systems
The Company has developed proprietary management information systems that
integrate the Company's order entry and order fulfillment operations. The
Company is continually upgrading and enhancing these systems and believes that
these systems enable it to operate efficiently and provide enhanced customer
service. The key features of these management information systems are their
ability to: (i) process numerous types of orders, including telephone, Internet
and others; (ii) continually monitor and track the Company's inventory levels
for substantially all of its products; (iii) rapidly process credit card orders;
(iv) increase the speed of the shipping process with integrated and automated
shipping functions and (v) increase accuracy through the scanning of each order
prior to shipment to ensure it contains the correct quantity and type of lenses.
The management information systems provide the Company's customer service
representatives ("CSRs") with real-time product availability information for
substantially all of its products through a direct connection with the Company's
distribution center, whereupon information is immediately updated as lenses are
shipped. In addition, Internet customers can obtain real-time product
availability information for many products. The management information systems
also have an integrated direct connection for processing credit card payments
which allows the CSR to charge the customer's card and ensure that a valid card
number and authorization have been received in approximately five seconds while
the CSR is on the phone with the customer. CSRs also have access to records of
all prior contact with a customer, including the customer's address,
prescription information, order history and payment history and notes of any
prior contact with the customer made by phone, Internet, e-mail, mail or fax.
Based on product availability provided by the management information systems,
the CSR provides the customer with an estimated date of delivery of their
lenses. If a customer's order will not be shipped by the promised delivery date,
the management information systems notify the CSR who entered the order and
provide any information explaining the delay, and the CSR then contacts the
customer to inform them of the delay.
After an order has been entered into the management information systems by
a CSR, it is sent to the Company's distribution center via a direct connection.
After the distribution center receives the order, the invoice for the order is
printed. The invoice for each order contains the type and quantity of the
lenses, as well as a shipping label for the order. Tracking, manifesting,
billing and other shipping functions are integrated into the Company's
management information systems so that all necessary bar codes and tracking
information for shipment via independent couriers are printed directly on the
Company's shipping label, and separate labeling or a separate computer is not
needed to ship packages via independent couriers.
After the invoice for an order is printed at the Company's distribution
center, the order is pulled from inventory and scanned to ensure that the
prescription and quantity of each item matches the order in the Company's
management information systems. Audible notices inform the shipping agent of any
errors in the order. After the order has been scanned for accuracy, the
management information systems update the Company's inventory level. Then the
order is placed in a box produced by the Company's automated box folder and is
sent to an automatic sealer. After the package leaves the sealer,
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another scanner reads the bar code on the shipping label to determine which
method of shipment is being used, adds the package to the appropriate carrier's
manifest and directs the appropriate hydraulic diverter to push the package into
the appropriate carrier's shipping bin.
The Company has installed a battery powered back-up system capable of
supporting its entire call center, computer room and phone switch. This system
is further supported by a generator capable of supporting the Company's call
center operations for a period of five days. All critical data is simultaneously
written to a series of back-up drives throughout the day and at the end of the
day the Company's data is transmitted to an offsite location. There can be no
assurance that the Company's back-up system will be sufficient to prevent an
interruption in the Company's operations in the event of disruption in the
Company's management information systems, and an extended disruption in the
management information systems could adversely affect the Company's business,
financial condition and results of operations.
Operations
The primary components of the Company's operations include its
teleservices, order entry and customer service, Internet and distribution and
fulfillment.
Teleservices, Order Entry and Customer Service. The Company provides its
customers with toll-free telephone access to its CSRs. Currently, the Company's
call center generally operates from 6:00 a.m. to 10:00 p.m. (MST) Monday through
Friday, 7:00 a.m. to 9:00 p.m. (MST) on Saturday and 8:00 a.m. to 4:00 p.m.
(MST) on Sunday. Customers may place orders via the Internet 24 hours a day,
7 days a week. Potential customers may also obtain product, pricing or other
information over the Internet or through an interactive voice response system.
The Company's orders are received by phone, Internet, mail, facsimile and
electronic mail. CSRs process orders directly into the Company's proprietary
management information systems, which provide customer order history and
information, product specifications, product availability, expected shipping
date and order number. CSRs are provided with a sales script and are trained to
provide information about promotional items. Additionally, CSRs are trained to
provide customer service and are authorized to resolve all customer service
issues, including accepting returns and issuing refunds, as appropriate.
The Company believes its customers are particularly sensitive to the way
merchants and salespeople communicate with them. The Company strives to hire
energetic, service-oriented CSRs who can understand and relate to customers.
CSRs participate in an extensive training program. The Company also has a
quality assurance department. This department monitors and reviews the CSRs'
performance and coaches the CSRs as necessary.
The Company completed the move into its new call center during July 1998.
In conjunction with the move, the Company acquired new telecommunications
systems and enhanced its management information systems. Since the move, the
Company has further upgraded and enhanced its management information systems, as
this is a continual process. In its current facility, the Company believes it
has the capacity to handle up to 30,000 calls per day. The Company believes that
it processes telephone orders on average in less time than its competitors,
which allows each CSR to handle a greater number of orders per day.
The laws in most states require that contact lenses be sold pursuant to a
valid prescription. 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.
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Internet. The Company's website, contacts.com, provides customers with a
quick, efficient and cost-effective method for obtaining replacement contact
lenses 24 hours a day, 7 days a week. The Company is continually upgrading the
content and functionality of its website. The website allows customers to easily
browse and purchase substantially all of the Company's products, promotes brand
loyalty and encourages repeat purchases by providing an inviting customer
experience. The Company has designed its website to be fast, secure and easy to
use and to enable its customers to purchase products with minimal effort. The
Company also offers Internet customers services such as free shipping, shipping
confirmation and online order tracking. During the call center's operating
periods, the Company offers service and support to its Internet customers over
the telephone. The Company also provides real-time online messaging and e-mail
support to customers 24 hours a day, 7 days a week. The Company's website allows
customers to dispense with providing personal profile information after their
initial order. The website has permitted the Company to expand its customer base
through better service while reducing transactional costs.
The Company's online service automates the processing of customer orders,
interacts with the management information systems and allows the Company to
gather, store and use customer and transaction information in a comprehensive
and cost-efficient manner. The Company's website contains customized software
applications that interface with the Company's management information systems.
The Company maintains a database containing information compiled from
customer profiles, shopping patterns and sales data. The Company analyzes
information in this database to develop targeted marketing programs and provide
personalized and enhanced customer service. This database is scaleable to permit
large transaction volumes. The Company's systems support automated e-mail
communications with customers to facilitate confirmations of orders, provide
customer support, obtain customer feedback and engage in targeted marketing
programs.
The Company uses a combination of proprietary and industry-standard
encryption and authentication measures designed to protect a customer's
information. The Company maintains an Internet firewall to protect its internal
systems and all credit card and other customer information.
Distribution and Fulfillment. Approximately 90% of the Company's orders are
shipped within one business day of receipt. Customers generally receive orders
within one to five business days after shipping, depending upon the method of
delivery chosen by the customer. A shipping and handling fee is charged on each
customer order, except those orders received via the Internet and those received
by mail with an enclosed check. Customers have the option of having their order
delivered by overnight courier for an additional charge. The Company's
management information systems automatically determine the anticipated delivery
date for each order.
The Company uses an integrated packing and shipping system via a direct
connection to the Company's management information systems. This system monitors
the in-stock status of each item ordered, processes the order and generates
warehouse selection tickets and packing slips for order fulfillment operations.
The Company's management information systems are specifically designed with a
number of quality control features to help ensure the accuracy of each order.
The Company began operations in its new distribution center in February
1999. This new facility is strategically located near the Salt Lake City, Utah
airport. In the fourth quarter of fiscal 2000, the Company nearly doubled the
size of its distribution center, increasing the total space to approximately
66,000 square feet.
Purchasing and Principal Suppliers
Until recently, substantially all of the major manufacturers of contact
lenses had refused to sell lenses directly to direct marketers, including the
Company, and had sought to prohibit their distributors from doing so. As a
result, the Company currently purchases a substantial portion of its products
from unauthorized distributors. The Company is aware that at least one large
manufacturer of contact lenses puts tracking codes on its products in an effort
to identify distributors who are selling to direct marketers. In June 1994, the
Attorney General for the State of Florida, acting on behalf of disposable
contact lens consumers in that state, filed an anti-trust action against
Johnson &
8
Johnson, CIBA Vision, Bausch & Lomb and certain eye care practitioners and their
trade associations alleging, among other things, that the contact lens
manufacturers' policy not to sell to mail order distributors and others was
adopted in conspiracy with eye care practitioners, as the result of pressure by
eye care practitioners, in order to eliminate alternative channels of trade from
the disposable lens market (the "Florida Action").
In December 1996, the Attorney General for the State of New York, on behalf
of itself and the Attorney Generals for approximately 21 other States, filed a
substantially similar action naming three major manufacturers of soft contact
lenses as well as several optometrists and their trade associations as
defendants (the "New York Action"). Additional states have joined the New York
Action since it was filed, and the Florida Action and the New York Action have
been consolidated (the "Attorney General Action"). The Attorney General Action
entered into the trial phase in March 2001 in Jacksonville, Florida. Based upon
public filings made in the Attorney General Action, the Company believes that
one defendant, CIBA Vision Corporation, has entered into a proposed settlement
agreement pursuant to which it has agreed to pay $5 million into a settlement
fund, agreed to provide rebates and coupons to consumers and agreed to begin to
sell soft contact lenses to direct marketers. Since this settlement agreement
was announced, the Company has become an authorized distributor of CIBA Vision's
contact lenses and can purchase such lenses at wholesale level prices. Based
upon a press release issued by Bausch & Lomb in February 2001, the Company
believes that Bausch & Lomb has entered into a proposed settlement agreement
pursuant to which it has agreed to pay $8 million into a settlement fund, agreed
to provide rebates and coupons to consumers and agreed to begin to sell its
contact lenses to direct marketers.
As of the date of this filing, Johnson & Johnson and Ocular Sciences are
the only major manufacturers who refuse to sell directly to the Company.
As a result of some manufacturers' refusal to sell to direct marketers, the
Company is not an authorized dealer for some of the products which it sells. In
addition, the Company believes that the price which it pays for certain products
is sometimes higher than those paid by eye care practitioners, retail chains and
mass merchandisers, who are able to buy directly from the manufacturers of such
lenses and who benefit from being allowed to participate in cooperative
advertising funds, coupon, sample, rebate and other marketing and promotional
programs. Although the Company has been able to obtain most contact lens brands
at competitive prices in sufficient quantities on a regular basis, there can be
no assurance that the Company will not encounter difficulties in the future,
particularly in light of the Company's anticipated growth. The inability of the
Company to obtain sufficient quantities of contact lenses at competitive prices
would have a material adverse effect on the Company's business, financial
condition and results of operations.
Although the Company seeks to reduce its reliance on any one supplier by
establishing relationships with a number of distributors and other sources, the
Company purchased from a single distributor approximately 47%, 38% and 35% of
its contact lens inventory in fiscal 1998, 1999 and 2000, respectively. The
Company's top three suppliers accounted for approximately 70%, 68% and 62% of
the Company's inventory purchases in fiscal 1998, 1999 and 2000, respectively.
The Company believes that a substantial number of its suppliers are not
authorized by contact lens manufacturers to distribute their products. The
Company does not have written agreements with substantially all of its
suppliers. The Company continually seeks to establish new relationships with
potential suppliers in order to be able to obtain adequate inventory at
competitive prices.
Competition
The retail sale of contact lenses is a highly competitive and fragmented
industry. Traditionally, contact lenses were sold to customers almost
exclusively by eye care practitioners in connection with providing them an eye
examination. Competition for patients and the revenue related to providing them
contact lenses significantly increased as optical chains and large discount
retailers began providing optical services and has further intensified with the
entry of direct marketers such as the Company. The Company believes that the eye
care profession suffers from a surplus of eye care practitioners, and that the
resulting competitive pressure has been exacerbated by the increased prevalence
of retail optical chains, mass merchandisers and direct marketers. Consequently,
the competition amongst eye care
9
practitioners to acquire customers and the competition to provide replacement
lenses to such customers has intensified.
The Company's principal competitors include ophthalmologists and
optometrists in private practice. The Company also competes with national
optical chains, such as Cole Vision, LensCrafters and National Vision
Association and mass merchandisers, such as Wal-Mart, Sam's and Costco. In
addition, the Company competes with other direct marketers of contact lenses.
The Company may face increased competition in the future from new entrants in
the direct marketing business, which may include national optical chains and
mass merchandisers, some of which may have significantly greater resources than
the Company.
The Company believes that many of its competitors, including most eye care
practitioners, national optical chains and mass merchandisers, have direct
supply arrangements with contact lens manufacturers, which in some cases affords
such competitors with better pricing terms, access to supply and other sales and
marketing programs. In addition, some of the competitors are significantly
larger in overall revenues and have significantly greater resources than the
Company. The Company believes that the principal basis of competition in the
industry include price, product availability, customer service and consumer
awareness.
Government Regulation
Federal Regulation. Contact lenses are regulated by the FDA as "medical
devices." The FDA classifies medical devices as Class I, Class II or Class III
and regulates them to varying degrees, with Class I medical devices subject to
the least amount of regulation and Class III medical devices subject to the most
stringent regulations. Rigid gas permeable and soft contact lenses are
classified as Class II medical devices if intended only for daily wear and as
Class III medical devices if intended for extended wear. These regulations
generally apply only to manufacturers of contact lenses, and therefore do not
directly impact the Company. Federal regulations also require the labels on
"medical devices" to contain adequate instructions for their safe and proper
use. However, there is an exemption from this requirement for medical devices
the use of which is not safe except under the supervision of a practitioner
licensed by law to direct the use of such device. Devices which fall in this
exception must contain as part of their labeling the statement "Caution: Federal
law restricts this device to sale by or on the order of ________ (physician or
other licensed practitioner)," the blank to be filled in with the word physician
or other practitioner authorized by the law of the state in which the
practitioner practices to use or order the use of the device. The FDA considers
contact lenses to qualify for this labeling exemption; however, a device bearing
this legend that is dispensed without a prescription may be considered
misbranded by the FDA. Potential penalties for misbranding include warning
letters from the FDA, seizure, injunction, civil penalties, or prosecution. To
date, the FDA has not taken any such action against the Company.
State Regulation. The sale and delivery of contact lenses to the consumer
is subject to 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. The laws and regulations governing the sale and
delivery of contact lenses vary from state to state, but generally can be
classified into six categories: (i) laws that require contact lenses only be
dispensed pursuant to a prescription; (ii) laws that require the dispenser to be
licensed by the state as an optometrist, ophthalmologist or other professional
authorized to dispense lenses; (iii) laws that require lenses be dispensed only
in a face-to-face transaction; (iv) laws with requirements that are unclear or
do not specifically address the sale and delivery of contact lenses; (v)
agreements with regulatory authorities which regulate the dispensing of contact
lenses and (vi) laws that the Company believes place no restrictions on the
dispensing of replacement contact lenses. Many of the states requiring that
contacts be dispensed in face-to-face meetings or by a person licensed by such
state to dispense lenses also require that lenses only be dispensed pursuant to
a valid prescription.
The laws and regulations in a significant number of states, including most
of the states wherein a large portion of the Company's sales are concentrated,
require that contact lenses only be sold to a consumer pursuant to a valid
prescription. In some states, satisfying this prescription requirement obligates
the dispenser only to verify the customer's prescription with the customer's
prescriber, while other states specifically require that a written prescription
be obtained before providing the lenses to the customer. In some states, the
Company operates according to
10
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.
The Company's ability to comply with state laws and regulations requiring a
valid prescription is hampered because the Company's customers are often unable
to get a copy of their prescription. The Company believes that optometrists,
ophthalmologists and other contact lens prescribers have historically refused to
release copies of a patient's contact lens prescription to the patient. In
addition, such providers have refused to release or verify prescriptions at the
request of direct marketers. Federal law requires prescribers to release
prescriptions for eyeglasses to a patient, but the issue of whether or not a
prescriber must release a contact lens prescription to the patient, or at the
patient's request, is under review by the FTC. In the absence of federal law on
the matter, contact lens prescription release is currently governed by state
law. The Company believes there are approximately 22 states that require contact
lens prescribers to release the prescriptions for contact lenses to the patient.
However, even in states with a mandatory release law, the Company believes that
many prescribers continue to refuse to release prescriptions to their patients
or to direct marketers of contact lenses, including the Company.
In addition to requiring a valid prescription, a substantial number of
states also require that contact lenses only be dispensed by a person licensed
to do so under that state's laws. A dispenser may be required to be licensed as
an optometrist, ophthalmologist, optician, ophthalmic dispenser or contact lens
dispenser, depending on the state in which the customer is located. Neither the
Company nor any of its employees is a licensed or registered dispenser of
contact lenses in many of the states in which the Company does business. The
laws in a small number of states effectively prohibit the sale of contacts
through the mail by requiring that a person licensed under that state's law to
dispense contacts be in personal attendance at the place of sale. In addition,
there are several states in which the laws and regulations do not specifically
address the issue of who may dispense contact lenses or are unclear with respect
to the requirements for dispensing lenses. Generally, these laws are older and
were written before mail order and other distributors began selling contact
lenses. Lastly, the Company believes that the laws in a small number of states
do not require that replacement contact lenses be dispensed pursuant to a
prescription or only by a professional licensed in such state.
Any action brought against the Company based on its failure to comply with
applicable state laws and regulations could result in significant fines to the
Company, the Company being prohibited from making sales in a particular state,
the Company being required to comply with such laws or could constitute a
misdemeanor. Such required compliance could result in: (i) increased costs to
the Company; (ii) the loss of a substantial portion of the Company's customers
for whom the Company is unable to obtain or verify their prescription; (iii) the
inability to sell to customers at all in a particular state if the Company
cannot comply with such state's laws and (iv) misdemeanor penalties and civil
fines. The occurrence of any of the above results could have a material adverse
effect on the Company's ability to sell contact lenses and to continue to
operate profitably. Furthermore, there can be no assurance that states will not
enact or impose laws or regulations that prohibit mail order dispensing of
contact lenses or otherwise impair the Company's ability to sell contact lenses
and continue to operate profitably. The Company has not obtained an opinion of
counsel with regard to its compliance with all applicable state laws and
regulations or the enforceability of such state laws and regulations, and
information contained herein regarding the Company's compliance with applicable
state laws and regulations should not be construed as being based on an opinion
of counsel. The Company has in the past, and intends in the future, to
vigorously defend any actions brought against it.
An FTC rule adopted in 1978 requires eye care practitioners to provide
their patients with a copy of their eyeglass prescription (the "Prescription
Release Rule"). The Prescription Release Rule was adopted based on a finding by
the FTC that consumers were being deterred from comparison shopping for
eyeglasses because eye care practitioners refused to release prescriptions. In
April 1997, the FTC published a request for comments regarding the
11
Prescription Release Rule with respect to whether the rule should be expanded to
require the release of contact lens prescriptions, whether consumers have
historically been able to get their contact lens prescriptions upon request and
whether the refusal to release contact lens prescriptions has benefits
justifying such refusal. The April 1997 request for comment is still open. The
Attorneys General of 17 states have provided comment to the FTC in support of
extending the Prescription Release Rule to contact lenses. The FTC undertook a
similar review in 1985 and again in 1995, both times concluding that the rule
should not be expanded to require the release of contact lens prescriptions.
From time to time the Company receives notices, inquiries or other
correspondence from states or their 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. See "Legal Proceedings" for formal complaints filed against the
Company concerning its business practices.
Intellectual Property
The Company conducts its business under the trade name and service marks
"1-800 CONTACTS." The Company has taken steps to register and protect these
marks and believes that such marks have significant value and are an important
factor in the marketing of its products. The Company owns the right to use the
1-800 CONTACTS telephone number. However, under applicable FCC rules and
regulations, the Company does not have and cannot acquire any property rights to
the telephone number. The Company does not expect to lose the right to use the
1-800 CONTACTS number; however, there can be no assurance in this regard. The
loss of the right to use the 1-800 CONTACTS number would have a material adverse
effect on the Company's business, financial condition and results of operations.
In addition, the Company has obtained the rights to international equivalents
for the 1-800 CONTACTS phone number; however, like the 1-800 CONTACTS number,
the Company does not have and cannot acquire any property rights in these
telephone numbers.
The Company also has obtained the rights to various Internet addresses,
including but not limited to www.1800contacts.com, www.contacts.com and
www.contactlenses.com. As with phone numbers, the Company does not have and
cannot acquire any property rights in Internet addresses. The Company does not
expect to lose the ability to use the Internet addresses; however, there can be
no assurance in this regard and such loss would have a material adverse effect
on the Company's financial position and results of operations.
Employees
As of December 30, 2000 the Company employed 368 persons, of which 246 were
full-time employees and 122 were part-time employees. None of the Company's
employees is covered by a collective bargaining agreement. The Company believes
its relationship with its employees to be good.
Item 2. Properties.
The Company's management and call center operations are located in Draper,
Utah, a suburb of Salt Lake City. In January 2001, the Company amended its lease
agreement to increase the space by approximately 7,000 square feet, bringing the
total leased space to approximately 39,000 square feet. The lease term was
extended to 2006.
The Company's distribution center is located near the Salt Lake City, Utah
airport. In October 2000, the Company amended its lease agreement to increase
the space by approximately 31,000 square feet, bringing the total leased space
to approximately 66,000 square feet. The lease term for the distribution center
was extended through December 2002.
12
Item 3. Legal Proceedings.
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. The complaint alleged three separate causes of action for
unfair competition: (i) selling contact lenses to California residents without
being registered, (ii) selling contact lenses to California residents without
verifying the prescription and (iii) failing to disclose in its advertising that
it sells "sample" lenses not intended for sale to the public. The complaint
requested various forms of relief, including damages of an unspecified amount,
attorney's fees and a permanent injunction. The Company removed the action to
the United States District Court for the Central District of California.
Plaintiff and another California optometrist, Ellis Miles, (collectively
"plaintiffs") filed a First Amended Complaint ("FAC") against the Company and
its directors on or about September 3, 1998 purporting to sue on behalf of the
public under California's unfair competition statute rather than as a class
action on behalf of optometrists. Although the substantive claims for unfair
competition remain the same, the FAC seeks injunctive relief and restitution
rather than damages. Plaintiffs also dismissed the Company's directors as
defendants, leaving the Company as the only remaining defendant. Upon agreement
among the parties, the case was remanded to Los Angeles County Superior Court
based upon plaintiffs' stipulation that they no longer seek monetary relief on
behalf of themselves or other optometrists. In response to a series of motions
filed by the Company, plaintiffs abandoned their claim for selling lenses
without being registered. In addition, by Order dated January 12, 2001, the
Court granted the Company's motion to strike all claims for monetary relief
without leave to amend. Plaintiffs filed a Petition for Writ of Mandate with the
California Court of Appeals on or about January 21, 2001, seeking to overturn
the trial court's ruling. The Court of Appeals denied plaintiffs petition on
February 15, 2001. Plaintiff filed a Petition for Review with the California
Supreme Court on or about February 21, 2001. The Supreme Court has not yet ruled
on this petition.
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 Company received a complaint from the
Texas Optometry Board seeking injunctive relief and civil penalties against the
Company for alleged violation of the Texas Optometry Act. The complaint alleges
that the Company (1) failed to state explicitly in its advertisements that a
written prescription is required to purchase contact lenses and (2) dispensed
contact lenses without such a prescription. The Company has filed an answer to
the complaint and plans to vigorously defend 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, which became effective February 29, 2000, relating to the
Company's sales practices in Texas. The implementation of this agreement began
November 2000. The agreement allows for a review of and, if necessary, changes
to the Company's practices during a 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
will be engaging 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
13
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.
Item 4. Submission of Matters to a Vote of Security Holders.
No matters were submitted to a vote of the Company's scurity holders in the
fourth quarter of fiscal 2000.
Item 4A. Executive Officers of the Registrant
The information under this Item is furnished pursuant to Instruction 3 to
Item 401(b) of Regulation S-K. Executive officers of the Company are elected by
and serve at the discretion of the Board of Directors.
Name Age Position
- -----------------------------------------------------------------------------------------------------
Jonathan C. Coon.............. 31 President, Chief Executive Officer and Director
John F. Nichols............... 40 Vice President, Sales and Director
Scott S. Tanner............... 40 Chief Operating Officer, Chief Financial Officer and Director
Kevin K. McCallum............. 39 Vice President, Marketing
Robert G. Hunter.............. 34 Vice President, Finance
Jonathan C. Coon is a co-founder of the Company and currently serves as
President and Chief Executive Officer and Director. Mr. Coon received his
Bachelor's Degree from Brigham Young University in 1994. Mr. Coon has eight
years of experience in the contact lens distribution industry.
John F. Nichols is a co-founder of the Company and currently serves as Vice
President, Sales and Director. Mr. Nichols is a certified optician in the State
of California and was the owner of the Discount Lens Club from 1991 until
February 1995. Mr. Nichols worked with Bausch & Lomb as a Senior Sales
Representative from 1989 to 1991.
Scott S. Tanner has served as the Chief Operating Officer of the Company
since November 1999 and as the Chief Financial Officer and Director since
November 1997. Prior to joining the Company, Mr. Tanner served as the Chief
Financial Officer of Country Club Foods, Inc., a Utah-based snack food
manufacturer and distributor, from 1995 to 1997. Prior thereto, Mr. Tanner
served in various management positions at Apple Computer, Inc. from 1988 to 1995
and worked at Peat, Marwick & Mitchell & Co. in San Francisco from 1984 to 1986.
Mr. Tanner received a Bachelor's Degree from Stanford University and an MBA from
Harvard University.
Kevin K. McCallum has served as Vice President, Marketing of the Company
since March 2000. Prior to joining the Company, Mr. McCallum, a 9-year veteran
of Procter & Gamble from 1991 to 2000, served as a Director of Marketing for
several of Proctor & Gamble's global laundry and cleaning brands. Prior thereto,
Mr. McCallum served as a line officer in the U.S. Navy from 1984 to 1989. Mr.
McCallum received a Bachelor's Degree from the United States Naval Academy and
an MBA from the Georgia Institute of Technology.
Robert G. Hunter has served as Vice President, Finance of the Company since
August 2000. Prior to his current position, Mr. Hunter served as the Corporate
Controller since November 1997. Before joining the Company, Mr. Hunter served as
an auditor with Hawkins, Cloward & Simister LC from November 1993 to 1997 and
with Arthur Andersen LLP from April 1992 to November 1993. Mr. Hunter is a
Certified Public Accountant. Mr. Hunter graduated summa cum laude with a
Bachelor's Degree from Brigham Young University, where he also earned a Masters
of Accountancy Degree.
14
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters.
Market Information
The Common Stock is traded on the Nasdaq National Market ("Nasdaq") under
the symbol "CTAC." The Common Stock commenced trading on February 10, 1998. On
July 24, 2000, the Company effected a two-for-one stock split. This stock split
has been retroactively reflected in the following table which sets forth the
high and low closing sale prices per share for the Common Stock as reported by
the Nasdaq for the periods presented:
High Low
--------- ------
Year ended January 2, 1999:
First Quarter (beginning February 10, 1998).... $10.44 $ 6.78
Second Quarter................................. 9.94 6.50
Third Quarter.................................. 8.19 2.81
Fourth Quarter................................. 9.00 2.38
Year ended January 1, 2000:
First Quarter.................................. 8.88 5.31
Second Quarter................................. 11.38 8.38
Third Quarter.................................. 14.25 8.19
Fourth Quarter................................. 15.44 11.50
Year ended December 30, 2000:
First Quarter.................................. 17.31 12.97
Second Quarter................................. 24.00 12.50
Third Quarter.................................. 62.50 22.72
Fourth Quarter................................. 47.75 25.19
Holders
As of March 16, 2001, there were approximately 80 holders of record of
Common Stock. The Company believes that it has a significantly larger number of
beneficial holders of Common Stock. A recently reported last sale price of the
Common Stock on the Nasdaq is set forth on the cover page of this report.
Dividends
The Company anticipates that all of its future earnings will be retained to
finance the expansion of its business. Any future determination to pay dividends
will be at the discretion of the Company's Board of Directors and will depend
upon among other factors, the Company's results of operations, financial
condition, capital requirements and contractual restrictions. In addition, the
Company's revolving credit facility prohibits the Company from paying any cash
dividends on the Common Stock.
Recent Sales of Unregistered Securities
No securities of the Company that were not registered under the Securities
Act have been issued or sold by the Company within the period covered by this
report.
15
Item 6. Selected Financial Data.
The financial data as of and for the years ended December 31, 1996 and
1997, January 2, 1999 ("fiscal 1998"), January 1, 2000 ("fiscal 1999") and
December 30, 2000 ("fiscal 2000") have been derived from the audited financial
statements of the Company. The selected financial data below should be read in
conjunction with the financial statements and the notes thereto of the Company
and "Management's Discussion and Analysis of Financial Condition and Results of
Operations." Such information for the three years ended December 30, 2000 is
included as part of this Form 10-K.
Year Year Year Year Year
Ended Ended Ended Ended Ended
December 31, December 31, January 2, January 1, December 30,
1996 1997 1999 2000 2000
------------ ------------ ----------- ----------- ------------
Statement of Operations Data:
Net sales $3,628,296 $21,115,314 $59,875,941 $98,524,906 $144,970,717
Cost of goods sold 2,215,306 14,024,523 37,315,413 59,415,723 86,367,149
---------- ----------- ----------- ----------- ------------
Gross profit 1,412,990 7,090,791 22,560,528 39,109,183 58,603,568
---------- ----------- ----------- ----------- ------------
Advertising expense 468,146 3,485,619 24,206,857 20,238,267 25,603,365
Other selling, general and
administrative expenses 573,166 2,459,602 7,334,668 12,001,536 16,120,718
---------- ----------- ----------- ----------- ------------
Total selling, general and
administrative expenses 1,041,312 5,945,221 31,541,525 32,239,803 41,724,083
---------- ----------- ----------- ----------- ------------
Income (loss) from operations 371,678 1,145,570 (8,980,997) 6,869,380 16,879,485
Other income (expense), net (23,315) (113,162) 445,710 (40,552) 198,433
---------- ----------- ----------- ----------- ------------
Income (loss) before benefit
(provision) for income taxes 348,363 1,032,408 (8,535,287) 6,828,828 17,077,918
Benefit (provision)
for income taxes(1) (134,120) (397,477) 642,679 (701,250) (6,603,917)
---------- ----------- ----------- ----------- ------------
Net income (loss)(1) $ 214,243 $ 634,931 $(7,892,608) $ 6,127,578 $ 10,474,001
========== =========== =========== =========== ============
Basic net income (loss)
per common share $ 0.07 $ (0.63) $ 0.49 $ 0.88
=========== =========== =========== ============
Diluted net income (loss)
per common share(2) $ 0.07 $ (0.63) $ 0.48 $ 0.86
=========== =========== =========== ============
Balance Sheet Data (at the
end of period):
Working capital (deficit) $ (204,080) $(1,621,522) $11,844,537 $14,837,002 $ 9,359,990
Total assets 1,156,646 7,781,064 18,016,136 25,053,572 26,107,759
Total debt (including
current portion) 370,705 2,759,837 66,877 30,166 3,264,979
Stockholders' equity 146,359 854,358 14,832,825 18,700,709 13,964,404
- ---------------------------
(1) Prior to February 9, 1998, the Company operated as an S corporation and was
not subject to federal and certain state income taxes. The benefit
(provision) for income taxes and net income (loss) for the periods prior to
February 9, 1998 reflect income taxes on a pro forma basis as if the
Company had been a C corporation.
(2) Diluted net income (loss) per common share is based on the weighted average
shares of Common Stock and Common Stock equivalents outstanding, including
actual shares outstanding and shares deemed to be outstanding using the
treasury stock method. The shares deemed to be outstanding for 1997 include
the number of shares sufficient to fund the S corporation distribution of
approximately $983,000.
16
Item 7. 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 million in fiscal 2000, with Internet sales having grown
from an insignificant amount in fiscal 1996 to approximately $53.8 million in
fiscal 2000.
On July 24, 2000, the Company effected a two-for-one stock split. All share
and per share information in this Form 10-K has been adjusted retroactively to
give effect to this stock split.
Effective January 1, 1998, the Company changed from a calendar year end to
a 52/53 week year ending on the Saturday nearest to December 31. Due to this
change, fiscal year 1998 represents 52 weeks and 3 days, covering the period
January 1, 1998 to January 2, 1999. Fiscal year 1999, ended January 1, 2000, and
fiscal year 2000, ended December 30, 2000, are 52 week years.
During fiscal 1998, the Company began utilizing a variety of new
advertising vehicles, including an extensive television marketing campaign, new
print vehicles, Internet and radio spots. As direct-response information became
available during the fourth quarter of fiscal 1998, the Company determined that
its ability to track individual sales to specific advertising campaigns was
restricted as a result of the variety of new advertising vehicles utilized.
Therefore, beginning in the fourth quarter of fiscal 1998, the Company began
expensing all advertising costs, including all direct-mail advertising costs,
when the advertising first takes place. As a result, quarter-to-quarter
comparisons are impacted within and between quarters by the timing of
television, radio and Internet advertisements and by the mailing of the
Company's printed advertisements. The volume of mailings and other advertising
may vary in different quarters and from year to year depending on the Company's
assessment of prevailing market opportunities.
The sale and delivery of contact lenses are governed by both federal and
state laws and regulations. The Company sells to customers in all 50 states, and
each sale is 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. See
"Government Regulation" under Item 1 of Part I of this Form 10-K.
17
Results of Operations
The following table presents the Company's results of operations expressed
as a percentage of net sales for the periods indicated:
Fiscal Year
------------------------------------------------
1998 1999 2000
------ ------ ------
Net sales 100.0% 100.0% 100.0%
Cost of goods sold 62.3 60.3 59.6
----- ----- -----
Gross profit 37.7 39.7 40.4
----- ----- -----
Advertising expense 40.4 20.5 17.7
Other selling, general and administrative expenses 12.3 12.2 11.1
----- ----- -----
Total selling, general and administrative expenses 52.7 32.7 28.8
----- ----- -----
Income (loss) from operations (15.0) 7.0 11.6
Other income (expense), net 0.7 (0.1) 0.2
----- ----- -----
Income (loss) before benefit (provision) for income taxes (14.3) 6.9 11.8
Benefit (provision) for income taxes 1.1 (0.7) (4.6)
----- ----- -----
Net income (loss) (13.2)% 6.2% 7.2%
===== ===== =====
Fiscal Year 2000 Compared to Fiscal Year 1999
Net sales. Net sales for fiscal 2000 increased 47% to $145 million from
$98.5 million for fiscal 1999. The Company added more than 610,000 new customers
during fiscal 2000. The Company is realizing the benefits of repeat sales from a
growing customer base. Repeat sales for fiscal 2000 increased 67% to $90.1
million, or 62% of net sales, from $53.8 million, or 55% of net sales, for
fiscal 1999. The Company also believes that this increase in net sales reflects
some of the benefits of the more than $74 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 fiscal 2000 were $53.8
million, or 37% of net sales, as compared to $18.7 million, or 19% of net sales,
for fiscal 1999. Although the Company believes that sales will increase
substantially in fiscal 2001 as compared to fiscal 2000, the Company expects the
rate of growth in net sales to decrease.
Gross profit. Gross profit as a percentage of net sales increased to 40.4%
for fiscal 2000 from 39.7% for fiscal 1999. Although gross profit as a
percentage of net sales increased as compared to the prior year, it has
decreased slightly each quarter during fiscal 2000 from 41.0% in the first
quarter of fiscal 2000 to 40.1% by the fourth quarter of fiscal 2000. With the
increase in sales, the Company continues to obtain inventory at lower costs
because of purchase volumes and more competitive pricing resulting from access
to more vendors. The Company also believes that enhanced inventory management
techniques have had a positive impact on gross profit. These factors are offset
by the increase in Internet sales as a percentage of net sales since Internet
orders generate lower gross profit because the Company offers free shipping on
those orders. The Company believes gross profit as a percentage of net sales may
continue to decrease slightly as Internet sales as a percentage of net sales
continues to increase.
Advertising expense. Advertising expense for fiscal 2000 increased $5.4
million, or 27%, from fiscal 1999. As a percentage of net sales, advertising
expense decreased to 17.7% for fiscal 2000 from 20.5% for fiscal 1999. The
Company plans to increase advertising spending in fiscal 2001 by approximately
18% 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 fiscal 2000 increased $4.1 million, or 34%, from
fiscal 1999. As a percentage of net sales, other selling, general and
18
administrative expenses decreased to 11.1% for fiscal 2000 from 12.2% for fiscal
1999. With the continued growth in net sales, the Company has been able to
leverage the fixed portion of these expenses. In addition, some variable
expenses such as wages and telephone expenses have decreased as a percentage of
net sales largely due to the increase in the percentage of net sales via the
Internet, which requires less employee interaction, and a decrease in telephone
rates.
Other income (expense), net. Other income (expense) increased to
approximately $198,000 for fiscal 2000 from approximately ($41,000) for fiscal
1999. Interest income decreased due to lower cash balances throughout the year,
and interest expense increased because of increased utilization of the credit
facility during fiscal 2000. However, during fiscal 1999, the Company expensed
approximately $293,000 in costs related to the Company's cancelled common stock
offering.
Income taxes. The Company's effective tax rate for fiscal 2000 was
approximately 38.7%. For fiscal 1999, the Company's effective tax rate was
approximately 10.3%, which reflects a reduction in the valuation allowance as a
result of utilizing all of its tax operating loss carryforwards. The Company
anticipates that its fiscal 2001 effective income tax rate will be approximately
39%.
Fiscal Year 1999 Compared to Fiscal Year 1998
Net sales. Net sales for fiscal 1999 increased 64% to $98.5 million from
$59.9 million for fiscal 1998. The Company believes that this increase in net
sales reflects some of the benefits of its increased television and Internet
advertising. Internet sales for fiscal 1999 were approximately $18.7 million, or
19% of net sales, as compared to approximately $2.3 million, or 3.8% of net
sales, for fiscal 1998. The Company also realized the benefits of repeat sales
from a growing customer base. Repeat sales for fiscal 1999 increased 138% to
$53.8 million, or 54.6% of net sales, from $22.6 million, or 37.7% of net sales,
for fiscal 1998.
Gross profit. Gross profit as a percentage of net sales increased to 39.7%
for fiscal 1999 from 37.7% for fiscal 1998. With the increase in sales, the
Company obtained inventory at lower costs because of purchase volumes and more
competitive pricing resulting from access to more vendors. In addition, the
Company believes that enhanced inventory management techniques also had a
positive impact on gross profit.
Advertising expense. Advertising expense for fiscal 1999 decreased $4.0
million, or 16%, from fiscal 1998. As a percentage of net sales, advertising
expense decreased to 20.5% for fiscal 1999 from 40.4% for fiscal 1998.
Beginning in the fourth quarter of fiscal 1998, the Company began expensing
all advertising costs, including all direct-mail advertising costs, when the
advertising first takes place. The Company also determined that for previously
deferred advertising costs the period during which the future benefits were
expected to be received was shortened. Accordingly, the Company amortized the
balance of deferred advertising costs at the beginning of the fourth quarter of
fiscal 1998 over five months.
Other selling, general and administrative expenses. Other selling, general
and administrative expenses for fiscal 1999 increased $4.7 million, or 64%, from
fiscal 1998. As a percentage of net sales, other selling, general and
administrative expenses decreased slightly to 12.2% for fiscal 1999 from 12.3%
for fiscal 1998.
Other income (expense), net. Other income (expense) decreased to
approximately ($41,000) for fiscal 1999 from approximately $446,000 for fiscal
1998. During fiscal 1999, the Company expensed approximately $293,000 in costs
related to the Company's cancelled common stock offering. In addition, interest
income decreased due to lower cash balances throughout the year. For fiscal
1999, the decrease in interest income was offset by the decrease in interest
expense as the majority of the Company's debt was paid off during the first
quarter of fiscal 1998 with proceeds from its initial public offering of common
stock ("IPO").
19
Income taxes. For fiscal 1998, the Company had a net benefit for income
taxes. This resulted from losses offset by a partial valuation allowance
against these deferred tax assets. The Company's effective tax rate for fiscal
1999 was approximately 10.3%, which reflects a reduction in the valuation
allowance as a result of utilizing all of its tax operating loss carryforwards.
Liquidity and Capital Resources
The Company historically funded its growth through a combination of funds
generated from operations and borrowings. During February 1998, the Company
issued 4,427,500 shares of common stock in connection with its IPO, which
included 577,500 shares pursuant to the underwriters' over-allotment option.
The proceeds received from the IPO, net of underwriting commissions and offering
costs, totaled approximately $24.9 million. The Company used these funds to
enhance growth through increased advertising expenditures and to increase
inventory levels in anticipation of future sales. In order to help ensure
sufficient supply of inventory, the Company generally carries a higher level of
inventory than it would if it were able to purchase directly from all contact
lens manufacturers.
For fiscal 2000, 1999 and 1998, net cash provided by (used in) operating
activities was approximately $11.0 million, $5.3 million and $(13.8) million,
respectively. For fiscal 2000 and 1999, cash was provided primarily by net
income and increases in accounts payable, accrued liabilities and income taxes
payable offset by an increase in inventories. During fiscal 1998, cash was used
primarily to fund the Company's growth as the Company increased inventory levels
and advertising spending.
The Company used approximately $1.8 million, $2.3 million and $2.0 million
for investing activities in fiscal 2000, 1999 and 1998, respectively. The
majority of these amounts relate to capital expenditures for infrastructure
improvements. Capital expenditures for fiscal 2000 were approximately $1.4
million. 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.
Capital expenditures for fiscal 1999 were approximately $1.0 million. The
Company began operations in its new distribution center in February 1999.
During the fourth quarter of fiscal 2000, the Company nearly doubled the size of
its distribution center by leasing additional space of approximately 31,000
square feet, bringing the total to approximately 66,000 square feet. The
Company also increased its leased space used for its management and call center
operations by approximately 7,000 additional square feet during the fourth
quarter of fiscal 2000 and the first quarter of fiscal 2001. On May 4, 1999,
the Company acquired certain assets of Contact Lenses Online, Inc. ("CLO") for
$1.2 million in cash, of which $0.9 million was paid during fiscal 1999. The
assets acquired include the Internet address, www.contactlenses.com, various
telephone numbers and CLO's customer database. The Company also acquired
additional Internet addresses for approximately $0.2 million and $0.3 million
during fiscal 2000 and 1999, respectively. Capital expenditures for fiscal 1998
were approximately $2.0 million. The Company completed the move into its new
call center during July 1998. In conjunction with the move, the Company
acquired new telecommunications systems and enhanced its management information
systems. The Company received payment in full on the notes receivable from
stockholders during the first quarter of fiscal 1998, as the notes were netted
with the S Corporation distribution paid during the period. 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. The Company
presently anticipates that capital expenditures in fiscal 2001 will be
approximately $1.6 million.
As of December 30, 2000, the Company had certain commitments to purchase
approximately $11.5 million of broadcast advertising through September 2001.
The Company had options to cancel approximately $2 million of the amount
committed. In addition, the Company has entered into certain noncancelable
commitments with various advertising companies that will require the Company to
pay approximately $6.4 million through December 31, 2001.
The Company considers opportunities to expand its business operations to
international markets. During fiscal 2000, the Company established a subsidiary
in Japan and incurred expenses relating to market research in
20
Japan. Currently, the Company has not established operations in Japan and does
not expect to establish operations there during fiscal 2001.
During fiscal 2000 and 1999, the Company used approximately $13.5 million
and $2.4 million for financing activities. During fiscal 2000, the Company
repurchased 1,084,000 shares of its common stock for a total cost of
approximately $16.8 million. During fiscal 1999, the Company repurchased
370,000 shares of its common stock for a total cost of approximately $2.5
million. In both fiscal 2000 and 1999, these repurchases were offset slightly
by proceeds from the exercise of common stock options. In fiscal 2000, the
Company also made its final payment relating to the 1999 purchase of CLO's
assets and had net borrowings on its revolving credit facility of approximately
$3.3 million. For fiscal 1998, net cash of approximately $19.6 million was
provided by financing activities, resulting from net proceeds received from the
IPO, offset by repayments of debt, distributions to stockholders (S corporation
distribution) and repurchase of stock.
On October 13, 1998, the Company's Board of Directors authorized a
repurchase of up to 1,000,000 shares of its common stock. On February 17, 2000,
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
2,000,000 shares. A purchase of the full 2,000,000 shares would equal
approximately 15.6 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 December 30, 2000,
the Company had repurchased 1,484,000 shares for a total cost of approximately
$19.5 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 $10.0 million or 50 percent of eligible
inventory and bears interest at a floating rate equal to the lender's prime
interest rate (9.5 percent as of December 30, 2000). As of December 30, 2000,
the Company's outstanding borrowings on the credit facility were approximately
$3.3 million. The credit facility is secured by substantially all of the
Company's assets and contains financial covenants customary for this type of
financing. The credit facility expires April 30, 2001. Subsequent to December
30, 2000, the Company has repaid the amount owed on the credit facility.
Management is currently in negotiations to renew the credit facility.
The Company believes that its cash on hand, together with cash generated
from operations and the cash available through the credit facility, will be
sufficient to support current operations and future growth through fiscal 2001.
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
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.
Forward-Looking Statements
Except for the historical information contained herein, the matters
discussed in this Form 10-K 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
21
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 do not comply with applicable
state laws and regulations governing the delivery and sale of contact
lenses;
. Because the Company doesn't manufacture contact lenses, it cannot ensure
that the contact lenses it sells meet all federal regulatory requirements;
. It is possible that the FDA will consider certain of the contact lenses the
Company sells to be misbranded;
. The Company currently purchases a substantial portion of its products from
unauthorized distributors and is not an authorized distributor for some of
the products that it sells;
. The Company obtains a large percentage of its inventory from a limited
number of suppliers, with a single distributor accounting for 47%, 38% and
35% of the Company's inventory purchases in fiscal 1998, 1999 and 2000,
respectively;
. The Company's quarterly results are likely to vary based upon the level of
sales and marketing activity in any particular quarter;
. The Company is dependent on its telephone, Internet and management
information systems for the sale and distribution of contact lenses;
. The Company has limited operating history and, as a result, there is only
limited financial information and operating information available for a
potential investor to evaluate the Company;
. The retail sale of contact lenses is highly competitive; certain of the
Company's competitors are large, national optical chains that have greater
resources than the Company has;
. The demand for contact lenses could be substantially reduced if alternative
technologies to permanently correct vision gain in popularity;
. The Company does not have any property rights in the 1-800 CONTACTS
telephone number or the Internet addresses that it uses;
. Increases in the cost of shipping, postage or credit card processing could
harm the Company's business;
. 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;
22
. 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.
Seasonality
The Company does not believe that seasonality has had a material effect
on its operations.
Inflation
The Company does not believe that inflation has had a material effect on
its operations.
Item 7A. 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 December 30, 2000, the Company's
outstanding borrowings on the credit facility were approximately $3.3 million.
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
December 30, 2000, the Company's total cash in foreign currencies was
approximately $17,000. In addition, all of the Company's revenue transactions
are in U.S. dollars.
Item 8. Financial Statements and Supplementary Data.
The audited financial statements required by Item 8 are set forth on pages
F-1 through F-21 of this Form 10-K.
Selected Quarterly Results of Operations
The following unaudited selected quarterly results of operations data for
the last eight quarters have been derived from the Company's unaudited
consolidated financial statements, which in the opinion of management, have been
prepared on the same basis as the audited financial statements and reflect all
adjustments (consisting of normal recurring adjustments) necessary to present
fairly the information for the quarters presented. This information should be
read in conjunction with the financial statements and the related notes and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" included as part of this Form 10-K. The operating results for the
quarters presented are not necessarily indicative of the operating results for
any future period.
First Quarter Second Quarter Third Quarter Fourth Quarter
------------- -------------- ------------- --------------
Year ended January 1, 2000:
Net sales $22,304,257 $23,960,056 $26,889,818 $25,370,775
Gross profit 8,395,110 9,305,373 10,936,401 10,472,299
Net income 297,177 1,466,185 1,025,550 3,338,666
Basic net income
per common share 0.02 0.12 0.08 0.27
Diluted net income
per common share 0.02 0.12 0.08 0.26
Year ended December 30, 2000:
Net sales $31,419,004 $35,708,171 $40,724,366 $37,119,176
Gross profit 12,886,407 14,461,074 16,358,379 14,897,708
Net income 1,812,549 3,029,762 2,587,162 3,044,528
Basic net income
per common share 0.15 0.25 0.22 0.26
Diluted net income
per common share 0.14 0.25 0.22 0.26
23
Item 9. Changes in and Disagreements With Accountants on Accounting and
Financial Disclosure.
None.
PART III
Item 10. Directors and Executive Officers of the Registrant.
Information with respect to Directors of the Company is set forth in the
Proxy Statement under the heading "Proposal No. 1 -- Election of Directors,"
which information is incorporated herein by reference. Information regarding the
executive officers of the Company is included as Item 4A of Part I of this Form
10-K as permitted by Instruction 3 to Item 401(b) of Regulation S-K. Information
required by Item 405 of Regulation S-K is set forth in the Proxy Statement under
the heading "Section 16(a) Beneficial Ownership Reporting Compliance," which
information is incorporated herein by reference.
Item 11. Executive Compensation.
Information with respect to executive compensation is set forth in the
Proxy Statement under the heading "Executive Compensation and Other Matters,"
which information is incorporated herein by reference (except for the
Compensation Committee Report on Executive Compensation, the Performance Graph
and Report of the Audit Committee of the Board of Directors).
Item 12. Security Ownership of Certain Beneficial Owners and Management.
Information with respect to security ownership of certain beneficial owners
and management is set forth in the Proxy Statement under the heading "Security
Ownership of Certain Beneficial Owners and Management," which information is
incorporated herein by reference.
Item 13. Certain Relationships and Related Transactions.
Information with respect to certain relationships and related transactions
is set forth in the Proxy Statement under the headings "Compensation Committee
Interlocks and Insider Participation" and "Certain Relationships and Related
Transactions," which information is incorporated herein by reference.
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K.
(a) The following documents are filed as a part of this report:
1. Financial Statements. The following financial statements of the
Company and the report of the independent public accountants
thereon, are included in this Form 10-K on pages F-1 through F-
21:
Report of Independent Public Accountants
Consolidated Balance Sheets as of January 1, 2000 and
December 30, 2000
Consolidated Statements of Operations for the fiscal
years ended January 2, 1999, January 1, 2000 and
December 30, 2000
Consolidated Statements of Stockholders' Equity for the
fiscal years ended January 2, 1999, January 1, 2000 and
December 30, 2000
24
Consolidated Statements of Cash Flows for the fiscal years
ended January 2, 1999, January 1, 2000 and December 30,
2000
Notes to Consolidated Financial Statements
2. Financial Statement Schedules. All financial statement schedules
have been omitted because they are inapplicable or the required
information is included elsewhere herein.
3. Exhibits. The Company will furnish to any eligible stockholder,
upon written request of such stockholder, a copy of any exhibit
listed below upon the payment of a reasonable fee equal to the
Company's expenses in furnishing such exhibit.
Exhibit
No. Exhibit
------- ------------------------------------------------------------------------
3.1(i) Restated Certificate of Incorporation of the Company. (1)
3.1(ii) Restated By-Laws of the Company. (1)
4.1 Form of certificate representing shares of Common Stock, $0.01 par value
per share. (2)
10.1 Employment Agreement between the Company and Jonathan C. Coon. (2) *
10.2 Employment Agreement between the Company and John F. Nichols. (2) *
10.3 Employment Agreement between the Company and Scott S. Tanner. (2) *
10.4 Employment Agreement between the Company and Robert G. Hunter. (2) *
10.5 1-800 CONTACTS, INC. 1998 Incentive Stock Option Plan. (2) *
10.6 Employment Agreement between the Company and Kevin K. McCallum. *
10.7 Lease between the Company and Draper Land Limited Partnership No. 2,
dated November 3, 1997, with respect to the Company's call center. (2)
10.8 Lease between the Company and Bird and Saunders, dated January 23, 1998,
with respect to the Company's former warehouse. (2)
10.9 Change in Terms Agreement to First Amendment to Revolving Credit
Agreement between the Company and Zions First National Bank, dated
November 22, 2000.
10.10 Indemnification Agreement between the Company and its officers and
directors. (2)
10.11 Agreement for Distribution of Retained Earnings and Tax Indemnification
between the Company and the Existing Stockholders. (2)
10.12 First Amendment to Lease between the Company and ProLogis North American
Properties Fund I LLC, dated October 9, 2000, with respect to the
Company's distribution center.
10.13 Stock Option Agreement. (2) *
10.14 First Amendment to Lease between the Company and Draper Land Limited
Partnership No. 2, dated May 25, 1998, with respect to the Company's
call center. (3)
10.15 Second Amendment to Lease between the Company and Draper Land Limited
Partnership No. 2, dated August 6, 1998, with respect to the Company's
call center. (3)
25
Exhibit
No. Exhibit
------- ------------------------------------------------------------------------
10.16 Lease between the Company and ProLogis Development Services
Incorporated, dated October 13, 1998, with respect to the Company's
distribution center. (3)
10.17 Revolving Credit Agreement between the Company and Zions First National
Bank, dated October 29, 1998. (3)
10.18 First Amendment to Revolving Credit Agreement between the Company and
Zions First National Bank, dated September 17, 1999. (4)
10.19 Third Amendment to Lease between the Company and Draper Land Limited
Partnership No. 2, dated January 17, 2001, with respect to the Company's
call center.
10.20 Fourth Amendment to Lease between the Company and Draper Land Limited
Partnership No. 2, dated January 17, 2001, with respect to the Company's
call center.
10.21 Fifth Amendment to Lease between the Company and Draper Land Limited
Partnership No. 2, dated January 17, 2001, with respect to the Company's
call center.
10.22 Sixth Amendment to Lease between the Company and Draper Land Limited
Partnership No. 2, dated January 17, 2001, with respect to the Company's
call center.
21.1 Subsidiaries of the Registrant
23.1 Consent of Independent Public Accountants.
--------------------
(1) Incorporated by reference to the Company's Quarterly Report on Form 10-Q
for the quarterly period ended April 4, 1998 (Commission File No. 0-23633).
(2) Incorporated by reference to the same numbered exhibit to the Company's
Registration Statement on Form S-1 (Registration No. 333-41055).
(3) Incorporated by reference to the same numbered exhibit to the Company's
Annual Report on Form 10-K for the year ended January 2, 1999 (Commission
File No. 0-23633).
(4) Incorporated by reference to the same numbered exhibit to the Company's
Annual Report on Form 10-K for the year ended January 1, 2000 (Commission
File No. 0-23633).
* Management contract, compensatory plan or arrangement required to be
filed as an exhibit pursuant to Item 14(c) of this report.
(b) Reports on Form 8-K.
None.
26
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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, on March 30, 2001.
1-800 CONTACTS, INC.
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
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant in the capacities indicated on March 30, 2001.
Signature Capacity
--------- --------
/s/ Jonathan C. Coon President, Chief Executive Officer and Director
- ----------------------- (principal executive officer)
Jonathan C. Coon
/s/ Scott S. Tanner Chief Operating Officer, Chief Financial Officer
- ----------------------- and Director (principal financial officer)
Scott S. Tanner
/s/ Robert G. Hunter Vice President, Finance (principal accounting
- ----------------------- officer)
Robert G. Hunter
/s/ John F. Nichols Director
- -----------------------
John F. Nichols
/s/ Stephen A. Yacktman Director
- -----------------------
Stephen A. Yacktman
/s/ E. Dean Butler Director
- -----------------------
E. Dean Butler
/s/ Jason S. Subotky Director
- -----------------------
Jason S. Subotky
/s/ Brad Knight Director
- -----------------------
Brad Knight
27
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Page
----
Report of Independent Public Accountants........................................... F-2
Consolidated Balance Sheets as of January 1, 2000 and December 30, 2000............ F-3
Consolidated Statements of Operations for the fiscal years ended January 2, 1999,
January 1, 2000 and December 30, 2000............................................ F-5
Consolidated Statements of Stockholders' Equity for the fiscal years ended
January 2, 1999, January 1, 2000 and December 30, 2000........................... F-6
Consolidated Statements of Cash Flows for the fiscal years ended
January 2, 1999, January 1, 2000 and December 30, 2000........................... F-7
Notes to Consolidated Financial Statements......................................... F-9
F-1
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To 1-800 CONTACTS, INC.:
We have audited the accompanying consolidated balance sheets of 1-800
CONTACTS, INC. and subsidiaries as of January 1, 2000 and December 30, 2000, and
the related consolidated statements of operations, stockholders' equity and cash
flows for each of the three fiscal years in the period ended December 30, 2000.
These financial statements are the responsibility of the Company's management.
Our responsibility is to express an opinion on these consolidated financial
statements based on our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States. Those standards require that we plan and perform
the audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements. An
audit also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the consolidated financial position of 1-800 CONTACTS,
INC. and subsidiaries as of January 1, 2000 and December 30, 2000, and the
results of their operations and their cash flows for each of the three fiscal
years in the period ended December 30, 2000 in conformity with accounting
principles generally accepted in the United States.
ARTHUR ANDERSEN LLP
Salt Lake City, Utah
March 2, 2001
F-2
1-800 CONTACTS, INC.
CONSOLIDATED BALANCE SHEETS
ASSETS
January 1, December 30,
2000 2000
------------ ------------
CURRENT ASSETS:
Cash and cash equivalents $ 4,329,088 $ 42,558
Inventories 15,980,169 20,402,076
Deferred income taxes 405,021 673,710
Other current assets 475,587 385,001
------------ ------------
Total current assets 21,189,865 21,503,345
------------ ------------
PROPERTY AND EQUIPMENT, at cost:
Office, computer and other equipment 2,869,263 3,800,122
Leasehold improvements 649,447 1,031,330
------------ ------------
3,518,710 4,831,452
Less - accumulated depreciation and
amortization (1,252,404) (1,988,349)
------------ ------------
Net property and equipment 2,266,306 2,843,103
------------ ------------
DEFERRED INCOME TAXES 116,136 203,620
------------ ------------
INTANGIBLE ASSETS, net of accumulated
amortization of $313,890 and $651,899,
respectively 1,394,945 1,261,916
------------ ------------
OTHER ASSETS 86,320 295,775
------------ ------------
Total assets $25,053,572 $26,107,759
============ ============
The accompanying notes to consolidated financial statements
are an integral part of these consolidated balance sheets.
F-3
1-800 CONTACTS, INC.
CONSOLIDATED BALANCE SHEETS (continued)
LIABILITIES AND STOCKHOLDERS' EQUITY
January 1, December 30,
2000 2000
------------ ------------
CURRENT LIABILITIES:
Line of credit $ - $ 3,264,979
Capital lease obligation 30,166 -
Acquisition payable 300,000 -
Accounts payable 3,059,993 3,646,578
Accrued liabilities 1,856,756 2,564,463
Accrued shipping costs 336,000 977,000
Income taxes payable 447,143 1,206,523
Unearned revenue 322,805 483,812
------------ ------------
Total current liabilities 6,352,863 12,143,355
------------ ------------
COMMITMENTS AND CONTINGENCIES (Notes 1 and 4)
STOCKHOLDERS' EQUITY:
Common stock, $.01 par value, 20,000,000
shares authorized, 12,861,136 shares issued 128,611 128,611
Additional paid-in capital 22,992,892 23,802,342
Retained earnings (accumulated deficit) (2,061,494) 8,412,507
Treasury stock at cost, 341,650 and
1,289,555 shares, respectively (2,359,300) (18,376,111)
Accumulated other comprehensive loss - (2,945)
------------ ------------
Total stockholders' equity 18,700,709 13,964,404
------------ ------------
Total liabilities and stockholders'
equity $ 25,053,572 $ 26,107,759
============ ============
The accompanying notes to consolidated financial statements
are an integral part of these consolidated balance sheets.
F-4
1-800 CONTACTS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
Fiscal Year Ended
--------------------------------------------------
January 2, January 1, December 30,
1999 2000 2000
-------------- -------------- --------------
NET SALES $ 59,875,941 $ 98,524,906 $144,970,717
COST OF GOODS SOLD 37,315,413 59,415,723 86,367,149
-------------- -------------- --------------
Gross profit 22,560,528 39,109,183 58,603,568
-------------- -------------- --------------
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES:
Advertising expense 24,206,857 20,238,267 25,603,365
Other selling, general and administrative expenses 7,334,668 12,001,536 16,120,718
-------------- -------------- --------------
Total selling, general and administrative expenses 31,541,525 32,239,803 41,724,083
-------------- -------------- --------------
INCOME (LOSS) FROM OPERATIONS (8,980,997) 6,869,380 16,879,485
-------------- -------------- --------------
OTHER INCOME (EXPENSE):
Interest expense (104,370) (31,860) (68,741)
Interest income 553,843 310,185 238,854
Cancelled offering costs - (293,059) -
Other, net (3,763) (25,818) 28,320
-------------- -------------- --------------
Total other, net 445,710 (40,552) 198,433
-------------- -------------- --------------
INCOME (LOSS) BEFORE BENEFIT
(PROVISION) FOR INCOME TAXES (8,535,287) 6,828,828 17,077,918
BENEFIT (PROVISION) FOR INCOME TAXES 642,679 (701,250) (6,603,917)
-------------- -------------- --------------
NET INCOME (LOSS) $ (7,892,608) $ 6,127,578 $ 10,474,001
============== ============== ==============
PER SHARE INFORMATION:
Basic net income (loss) per common share $ (0.63) $ 0.49 $ 0.88
============== ============== ==============
Diluted net income (loss) per common share $ (0.63) $ 0.48 $ 0.86
============== ============== ==============
The accompanying notes to consolidated financial statements
are an integral part of these consolidated statements.
F-5
1-800 CONTACTS, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
Retained Notes
Common Stock Additional Earnings Treasury Stock Receivable
------------------------- Paid-in (Accumulated) ------------------------- From
Shares Amount Capital (Deficit) Shares Amount Stockholders
----------- ----------- ----------- ------------- ----------- ------------ ------------
BALANCE,
December 31, 1997 9,318,938 $ 93,189 $ 47,094 $ 1,286,220 - $ - $ (572,145)
Advances to stockholders - - - - - - (27,544)
Distributions to
stockholders, net - - - (1,582,684) - - 599,689
Sale of common stock,
net of offering costs 4,427,500 44,275 24,805,834 - - - -
Repurchase and retirement
of common stock (885,302) (8,853) (1,891,147) - - - -
Purchase of treasury shares - - - - (30,000) (81,375) -
Exercise of common
stock options - - (8,820) - 8,000 21,700 -
Net loss - - - (7,892,608) - - -
----------- ----------- ----------- ------------- ----------- ------------ ------------
Comprehensive loss
BALANCE,
January 2, 1999 12,861,136 128,611 22,952,961 (8,189,072) (22,000) (59,675) -
Purchase of treasury shares - - - - (370,000) (2,530,286) -
Exercise of common
stock options - - (92,654) - 50,350 230,661 -
Income tax benefit from
common stock
options exercised - - 132,585 - - - -
Net income - - - 6,127,578 - - -
----------- ----------- ----------- ------------- ----------- ------------ ------------
Comprehensive income
BALANCE,
January 1, 2000 12,861,136 128,611 22,992,892 (2,061,494) (341,650) (2,359,300) -
Purchase of treasury shares - - - - (1,084,000) (16,841,448) -
Exercise of common
stock options - - (386,680) - 136,095 824,637 -
Income tax benefit from
common stock
options exercised - - 1,196,130 - - - -
Net income - - - 10,474,001 - - -
Foreign currency
translation adjustments - - - - - - -
----------- ----------- ----------- ------------- ----------- ------------ ------------
Comprehensive income
BALANCE,
December 30, 2000 12,861,136 $ 128,611 $23,802,342 $ 8,412,507 (1,289,555) $(18,376,111) $ -
=========== =========== =========== ============= =========== ============ ============
Accumulated
Other Total Comprehensive
Comprehensive Stockholders' Income
Loss Equity (Loss)
------------- ------------- -------------
BALANCE,
December 31, 1997 $ - $ 854,358 $ -
Advances to stockholders - (27,544) -
Distributions to
stockholders, net - (982,995) -
Sale of common stock,
net of offering costs - 24,850,109 -
Repurchase and retirement
of common stock - (1,900,000) -
Purchase of treasury shares - (81,375) -
Exercise of common
stock options - 12,880 -
Net loss - (7,892,608) (7,892,608)
------------- ------------- -------------
Comprehensive loss $ (7,892,608)
=============
BALANCE,
January 2, 1999 - 14,832,825 -
Purchase of treasury shares - (2,530,286) -
Exercise of common
stock options - 138,007 -
Income tax benefit from
common stock
options exercised - 132,585 -
Net income - 6,127,578 6,127,578
------------- ------------- -------------
Comprehensive income $ 6,127,578
=============
BALANCE,
January 1, 2000 - 18,700,709 -
Purchase of treasury shares - (16,841,448) -
Exercise of common
stock options - 437,957 -
Income tax benefit from
common stock
options exercised - 1,196,130 -
Net income - 10,474,001 10,474,001
Foreign currency
translation adjustments (2,945) (2,945) (2,945)
------------- ------------- -------------
Comprehensive income $ 10,471,056
=============
BALANCE,
December 30, 2000 $ (2,945) $ 13,964,404
============= =============
The accompanying notes to consolidated financial statements
are an integral part of these consolidated statements.
F-6
1-800 CONTACTS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
Fiscal Year Ended
--------------------------------------------------
January 2, January 1, December 30,
1999 2000 2000
-------------- -------------- --------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) $ (7,892,608) $ 6,127,578 $ 10,474,001
Adjustments to reconcile net income (loss) to net cash
provided by (used in) operating activities:
Depreciation and amortization 446,389 992,184 1,126,162
Other 13,762 26,218 (2,650)
Deferred income taxes (642,679) 254,107 (356,173)
Changes in operating assets and liabilities:
Inventories (5,940,469) (5,227,845) (4,421,907)
Other current assets (300,475) 7,552 90,448
Deferred advertising costs 1,530,064 175,631 -
Accounts payable (1,705,707) 1,003,542 586,703
Accrued liabilities 518,500 1,106,883 707,727
Accrued shipping costs 71,504 195,430 641,000
Income taxes payable - 447,143 1,955,510
Unearned revenue 65,268 153,265 161,007
-------------- -------------- --------------
Net cash (used in) provided by operating activities (13,836,451) 5,261,688 10,961,828
-------------- -------------- --------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Net increase in notes receivable from stockholders (27,544) - -
Purchase of property and equipment (2,013,361) (1,019,596) (1,365,649)
Proceeds from sale of property and equipment 101,768 - 2,650
Purchase of intangible assets (5,000) (1,238,388) (204,980)
Purchase of non-marketable securities - - (220,000)
Deposits (38,049) (7,846) 10,230
-------------- -------------- --------------
Net cash used in investing activities $ (1,982,186) $ (2,265,830) $ (1,777,749)
-------------- -------------- --------------
The accompanying notes to consolidated financial statements
are an integral part of these consolidated statements.
F-7
1-800 CONTACTS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (continued)
Fiscal Year Ended
--------------------------------------------------
January 2, January 1, December 30,
1999 2000 2000
-------------- -------------- --------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Sale of common stock, net of underwriting discounts
and commissions $ 25,734,844 $ - $ -
Common stock offering costs (509,537) - -
Common stock repurchases (1,981,375) (2,530,286) (16,841,448)
Proceeds from exercise of common stock options 12,880 138,007 437,957
Net (repayments) borrowings on line of credit (1,055,640) - 3,264,979
Principal payments on notes payable to stockholders (1,613,788) - -
Principal payments on notes payable for distributions
to stockholders, net (982,995) - -
Principal payments on capital lease obligation (23,532) (36,711) (30,166)
Payment of acquisition payable - - (300,000)
-------------- -------------- --------------
Net cash provided by (used in) financing activities 19,580,857 (2,428,990) (13,468,678)
-------------- -------------- --------------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 3,762,220 566,868 (4,284,599)
EFFECT OF FOREIGN EXCHANGE RATES ON CASH - - (1,931)
CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR - 3,762,220 4,329,088
-------------- -------------- --------------
CASH AND CASH EQUIVALENTS AT END OF YEAR $ 3,762,220 $ 4,329,088 $ 42,558
============== ============== ==============
SUPPLEMENTAL CASH FLOW INFORMATION:
Cash paid for interest $ 228,907 $ 33,335 $ 47,425
Cash paid for income taxes - 100,000 4,904,580
SUPPLEMENTAL DISCLOSURES OF NONCASH INVESTING AND FINANCING ACTIVITIES:
During the year ended January 2, 1999, the Company distributed $1,582,684 to its
S Corporation stockholders. This distribution (net of notes receivable from
stockholders of $599,689) was in the form of promissory notes, totaling
$982,995, issued by the Company. The promissory notes were paid in full during
the year ended January 2, 1999.
During the year ended January 1, 2000, the Company acquired $300,000 of certain
intangible assets under a short-term acquisition payable (see Note 11).
The accompanying notes to consolidated financial statements
are an integral part of these consolidated statements.
F-8
1-800 CONTACTS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1. NATURE OF OPERATIONS AND ORGANIZATION OF BUSINESS
1-800 CONTACTS, INC. (the "Company") was incorporated in the state of Utah
in February 1995. The Company was reincorporated in Delaware in February 1998 in
conjunction with its initial public offering of common stock. The Company is a
direct marketer of replacement contact lenses. The Company sells contact lenses
primarily through its toll-free telephone number and the Internet.
Regulatory Compliance
The Company sells contact lenses 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. The laws and regulations governing the sale and delivery of contact
lenses vary from state to state, but generally can be classified into six
categories: (i) laws that require contact lenses only be dispensed pursuant to a
prescription; (ii) laws that require the dispenser to be licensed by the state
as an optometrist, ophthalmologist or other professional authorized to dispense
lenses; (iii) laws that require lenses be dispensed only in a face-to-face
transaction; (iv) laws with requirements that are unclear or do not specifically
address the sale and delivery of contact lenses; (v) agreements with regulatory
authorities which regulate the dispensing of contact lenses and (vi) laws that
the Company believes place no restrictions on the dispensing of replacement
contact lenses. 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. As a
result of this operating practice, certain sales made by the Company fail to
comply with the applicable statute or regulation in the state in which the
customer is located. Any action brought against the Company based on its failure
to comply with applicable state laws and regulations could result in significant
fines to the Company, the Company being prohibited from making sales in a
particular state, the Company being required to comply with such laws or could
constitute a misdemeanor. Such required compliance could result in (i) increased
costs to the Company; (ii) the loss of a substantial portion of the Company's
customers for whom the Company is unable to obtain or verify their prescription;
(iii) the inability to sell to customers at all in a particular state if the
Company cannot comply with such state's laws and (iv) misdemeanor penalties and
civil fines. The occurrence of any of the above results could have a material
adverse effect on the Company's ability to sell contact lenses and continue to
operate profitably. Furthermore, there can be no assurance that states will not
enact or impose laws or regulations that prohibit mail order dispensing of
contact lenses or otherwise impair the Company's ability to sell contact lenses
and continue to operate profitably.
From time to time the Company receives notices, inquiries or other
correspondence from states or their 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. See Note 4 for formal complaints filed against the Company concerning
its business practices.
The FDA regulates the labeling of medical devices. The contact lenses that
the Company sells are prescription devices, and therefore contain the statement
required by FDA regulations: "Caution: Federal law restricts this device to sale
by or on the order of a _________ (physician or other licensed practitioner)."
However, because of the difficulty the Company has encountered in obtaining the
cooperation of eye care practitioners, the Company sometimes sells lenses based
solely on the prescription information provided by the customer without a
written
F-9
1-800 CONTACTS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
prescription or other order by the customer's eye care practitioner. Although
the FDA has not objected to the sale of contacts lenses without a written
prescription or other order directly from the customer's eye care practitioner,
it is possible that the FDA will consider contact lenses that are sold in such a
fashion to be misbranded. The sale of misbranded devices is unlawful under the
Federal Food, Drug, and Cosmetic Act, and can result in a warning letter,
seizure, injunction, civil penalties, or prosecution. To date, the FDA has not
taken any such action against the Company.
Sources of Supply
Historically, substantially all of the major manufacturers of contact
lenses have refused to sell lenses directly to direct marketers, including the
Company, and have sought to prohibit their distributors from doing so. As a
result, the Company currently purchases a substantial portion of its products
from unauthorized distributors. The Company is aware that at least one large
manufacturer of contact lenses puts tracking codes on its products in an effort
to identify distributors who are selling to direct marketers. The Company is not
an authorized dealer for some of the products which it sells. In addition, the
Company believes that the price which it pays for certain products is sometimes
higher than those paid by eye care practitioners, retail chains and mass
merchandisers, who are able to buy directly from the manufacturers of such
lenses and who benefit from being allowed to participate in cooperative
advertising funds, coupon, sample, rebate and other marketing and promotional
programs. There can be no assurance that the Company will be able to obtain
sufficient quantities of contact lenses at competitive prices in the future to
meet the existing or anticipated demand for its products. Any such inability
would have a material adverse effect on the Company's business, financial
position and results of operations.
Although the Company seeks to reduce its reliance on any one supplier by
establishing relationships with a number of distributors and other sources, the
Company purchased from a single distributor approximately 47 percent, 38 percent
and 35 percent of its contact lens inventory in fiscal 1998, 1999 and 2000,
respectively. The Company's top three suppliers accounted for approximately 70
percent, 68 percent and 62 percent of the Company's inventory purchases in
fiscal 1998, 1999 and 2000, respectively. The Company continually seeks to
establish new relationships with potential suppliers in order to be able to
obtain adequate inventory at competitive prices. In the event that these
suppliers could no longer supply the Company with contact lenses, there can be
no assurance that the Company could secure other adequate sources of supply, or
that such supply could be obtained on terms no less favorable to the Company
than its current supply, which could adversely affect the Company by increasing
its costs or, in the event adequate replacement supply cannot be secured,
reducing its net sales.
NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Change in Accounting Period
Effective January 1, 1998, the Company changed from a calendar year end to
a 52/53 week year, ending on the Saturday nearest to December 31. Due to this
change, fiscal year 1998 represents 52 weeks and 3 days, covering the period
January 1, 1998 to January 2, 1999. Fiscal year 1999, ended January 1, 2000, and
fiscal year 2000, ended December 30, 2000, are 52 week years.
Revenue Recognition
Sales are recognized at the time of shipment to the customer. Payment for
the product is generally received prior to shipment. As a result, unearned
revenue represents amounts received from customers for which shipment has not
occurred. Shipping and handling fees are included as part of net sales. The
related freight costs and supplies directly associated with shipping products to
customers are included as a component of cost of goods sold. Other indirect
shipping and handling costs, consisting mainly of labor and facilities costs,
are included as a component of other selling, general and administrative
expenses.
F-10
1-800 CONTACTS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Use of Estimates
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities as of the date
of the financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those estimates.
Principles of Consolidation
The consolidated financial statements include the accounts of 1-800
CONTACTS, INC. and its wholly owned subsidiaries, 1-800 CONTACTS Japan, KK and
CL4, L.L.C. All significant inter-company accounts and transactions have been
eliminated in consolidation.
Cash Equivalents
The Company considers all highly liquid investments purchased with an
original maturity of three months or less to be cash equivalents.
Inventories
Inventories consist of contact lenses and are recorded at the lower of cost
(using the first-in, first-out method) or market.
Property and Equipment
Property and equipment are stated at cost and depreciated using the
straight-line method over their estimated useful lives ranging from three to
seven years. Leasehold improvements are amortized over the lesser of the useful
life or the term of the lease. Major additions and improvements are capitalized,
while costs for minor replacements, maintenance and repairs that do not increase
the useful life of an asset are expensed as incurred. Upon retirement or other
disposition of property and equipment, the cost and related accumulated
depreciation or amortization are removed from the accounts. The resulting gain
or loss is reflected in income.
Advertising Costs
The Company currently expenses all advertising costs when the advertising
first takes place.
Prior to the fourth quarter of fiscal 1998, the Company capitalized certain
direct-mail advertising costs and amortized those costs over the period for
which the revenues were generated in accordance with Statement of Position
("SOP") 93-7, "Reporting on Advertising Costs." During fiscal 1998, the Company
began utilizing a variety of new advertising vehicles, including new print
vehicles, Internet and radio spots, and an extensive television marketing
campaign. As direct-response information became available during the fourth
quarter of fiscal 1998, the Company determined that its ability to track
individual sales to specific advertising campaigns was restricted as a result of
the variety of new advertising vehicles utilized. Therefore, beginning in the
fourth quarter of fiscal 1998, the Company began expensing all advertising
costs, including all direct-mail advertising costs, when the advertising first
takes place. The Company also determined that for previously deferred
advertising costs the period during which the future benefits were expected to
be received was shortened and accordingly amortized the balance of deferred
advertising costs at the beginning of the fourth quarter of fiscal 1998 over 5
months.
F-11
1-800 CONTACTS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Intangible Assets
Intangible assets mainly consist of amounts paid to secure the rights to
the Company's telephone numbers and Internet addresses. These costs are
amortized over an estimated life of 5 years. The Company has contractual rights
customary to the industry to use its telephone numbers and Internet addresses.
However, under applicable rules and regulations of the Federal Communications
Commission, the Company does not have and cannot acquire any property rights to
the telephone numbers. In addition, the Company does not have and cannot
acquire any property rights to the Internet addresses. The Company does not
expect to lose the right to use the telephone numbers or Internet addresses;
however, there can be no assurance in this regard and such loss would have a
material adverse effect on the Company's financial position and results of
operations.
Fair Value of Financial Instruments
The Company's financial instruments consist mainly of cash and cash
equivalents, a line of credit, and short-term payables. The Company believes
that the carrying amounts approximate fair value.
Foreign Currency Translation
The accounts of 1-800 CONTACTS Japan, KK are translated into U.S. dollars
using the exchange rate at the balance sheet date for assets and liabilities and
the weighted average exchange rate for the period for revenues, expenses, gains
and losses. Foreign currency translation adjustments are recorded as a separate
component of comprehensive income (loss) in stockholders' equity.
Long-lived Assets
The Company reviews long-lived assets for impairment whenever events or
changes in circumstances indicate that the carrying amount of an asset may not
be recoverable. Recoverability of assets to be held and used is measured by a
comparison of the carrying amount of an asset to future net cash flows expected
to be generated by the asset. If such assets are considered to be impaired, the
impairment to be recognized is measured by the amount by which the carrying
amount of the assets exceeds the fair value of the assets.
Income Taxes
The Company recognizes deferred tax assets or liabilities for expected
future tax consequences of events that have been recognized in the financial
statements or tax returns. Under this method, deferred tax assets or liabilities
are determined based upon the difference between the financial statement and
income tax bases of assets and liabilities using enacted tax rates expected to
apply when differences are expected to be settled or realized.
Net Income (Loss) Per Common Share
Basic net income (loss) per common share ("Basic EPS") excludes dilution
and is computed by dividing net income (loss) by the weighted-average number of
common shares outstanding during the period. Diluted net income (loss) per
common share ("Diluted EPS") reflects the potential dilution that could occur if
stock options or other common stock equivalents were exercised or converted into
common stock. The computation of Diluted EPS does not assume exercise or
conversion of securities that would have an antidilutive effect on net income
(loss) per common share.
F-12
1-800 CONTACTS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following is a reconciliation of the numerator and denominator used to
calculate Basic and Diluted EPS:
Net Income Per-Share
(Loss) Shares Amount
------------ ---------- ---------
Year Ended January 2, 1999:
Basic EPS $(7,892,608) 12,455,280 $(0.63)
Effect of stock options
----------- ---------- ------
Diluted EPS $(7,892,608) 12,455,280 $(0.63)
=========== ========== ======
Year Ended January 1, 2000:
Basic EPS $ 6,127,578 12,596,528 $ 0.49
Effect of stock options 161,996
----------- ---------- ------
Diluted EPS $ 6,127,578 12,758,524 $ 0.48
=========== ========== ======
Year Ended December 30, 2000:
Basic EPS $10,474,001 11,871,779 $ 0.88
Effect of stock options 238,268
----------- ---------- ------
Diluted EPS $10,474,001 12,110,047 $ 0.86
=========== ========== ======
At January 2, 1999, there were outstanding options to purchase 446,020
shares of common stock that were not included in the computation of Diluted EPS
because they would be antidilutive.
Reclassifications
Certain amounts in prior years' financial statements have been reclassified
to conform to the fiscal 2000 presentation.
NOTE 3. LINE OF CREDIT
Line of Credit
The Company has a revolving credit facility that provides for borrowings
equal to the lesser of $10.0 million or 50 percent of eligible inventory. The
credit facility bears interest at a floating rate equal to the lender's prime
interest rate (9.5 percent at December 30, 2000). As of December 30, 2000, the
Company's outstanding borrowings on the credit facility were $3,264,979. The
credit facility is secured by substantially all of the Company's assets and
expires April 30, 2001.
The credit facility contains various affirmative and negative covenants
which require, among other things, restrictions on additional debt, minimum
levels for net income, maintenance of certain working capital levels and
restrictions on distributions and changes in ownership. As of December 30, 2000,
the Company was in compliance with these covenants.
F-13
1-800 CONTACTS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 4. COMMITMENTS AND CONTINGENCIES
Legal and Regulatory 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. The complaint alleged three separate causes of action for
unfair competition: (i) selling contact lenses to California residents without
being registered, (ii) selling contact lenses to California residents without
verifying the prescription and (iii) failing to disclose in its advertising that
it sells "sample" lenses not intended for sale to the public. The complaint
requested various forms of relief, including damages of an unspecified amount,
attorney's fees and a permanent injunction. The Company removed the action to
the United States District Court for the Central District of California.
Plaintiff and another California optometrist, Ellis Miles, (collectively
"plaintiffs") filed a First Amended Complaint ("FAC") against the Company and
its directors on or about September 3, 1998 purporting to sue on behalf of the
public under California's unfair competition statute rather than as a class
action on behalf of optometrists. Although the substantive claims for unfair
competition remain the same, the FAC seeks injunctive relief and restitution
rather than damages. Plaintiffs also dismissed the Company's directors as
defendants, leaving the Company as the only remaining defendant. Upon agreement
among the parties, the case was remanded to Los Angeles County Superior Court
based upon plaintiffs' stipulation that they no longer seek monetary relief on
behalf of themselves or other optometrists. In response to a series of motions
filed by the Company, plaintiffs abandoned their claim for selling lenses
without being registered. In addition, by Order dated January 12, 2001, the
Court granted the Company's motion to strike all claims for monetary relief
without leave to amend. Plaintiffs filed a Petition for Writ of Mandate with the
California Court of Appeals on or about January 21, 2001, seeking to overturn
the trial court's ruling. The Court of Appeals denied plaintiffs petition on
February 15, 2001. Plaintiff filed a Petition for Review with the California
Supreme Court on or about February 21, 2001. The Supreme Court has not yet ruled
on this petition.
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 Company received a complaint from the
Texas Optometry Board seeking injunctive relief and civil penalties against the
Company for alleged violation of the Texas Optometry Act. The complaint alleges
that the Company (1) failed to state explicitly in its advertisements that a
written prescription is required to purchase contact lenses and (2) dispensed
contact lenses without such a prescription. The Company has filed an answer to
the complaint and plans to vigorously defend 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, which became effective February 29, 2000, relating to the
Company's Sales practices in Texas. The implementation of this agreement began
November 2000. The agreement allows for a review of and, if necessary, changes
to the Company's practices during a 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
will be engaging in discussions with the TDH regarding this notice.
F-14
1-800 CONTACTS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
See Note 1 for a discussion of regulatory matters.
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.
Capital Lease Obligation
The Company leased the rights to use its toll-free telephone number from an
individual under a capital lease arrangement. At the end of the lease in fiscal
year 2000, the Company exercised its option to purchase the interest in the
telephone number for $17,500.
Operating Leases
The Company leases office and warehouse facilities and certain equipment
under noncancelable operating leases. Lease expense for the years ended January
2, 1999, January 1, 2000 and December 30, 2000 totaled approximately $377,000,
$784,000 and $797,000, respectively.
Future minimum lease payments under noncancelable operating leases as of
December 30, 2000 are as follows:
Fiscal Year Amount
----------- ----------
2001 $1,054,694
2002 1,074,252
2003 749,375
2004 772,805
2005 797,475
Thereafter 105,492
----------
$4,554,093
==========
Sales Tax
The Company's direct mail business is located, and all of its operations
are conducted, in the state of Utah. At December 30, 2000, the Company did not
collect sales or other similar taxes for any out-of-state sales. However,
various states have sought to impose state sales tax collection obligations on
out-of-state mail-order companies, such as the Company. The U.S. Supreme Court
has held that the various states, absent Congressional legislation, may not
impose tax collection obligations on an out-of-state mail order company whose
only contacts with the taxing state are the distribution of advertising
materials through the mail, and whose subsequent delivery of purchased goods is
by mail or interstate common carriers. The Company has not received an
assessment from any state. The Company anticipates that any legislative changes,
if adopted, would be applied on a prospective basis.
Advertising Commitments
As of December 30, 2000, the Company had certain commitments to purchase
approximately $11.5 million of broadcast advertising through September 2001. The
Company had options to cancel approximately $2 million of the amount committed.
F-15
1-800 CONTACTS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
In addition, the Company has entered into certain noncancelable commitments
with various advertising companies that will require the Company to pay
approximately $6.4 million through December 31, 2001.
NOTE 5. COMMON STOCK TRANSACTIONS
On July 7, 2000, the Company's Board of Directors approved a two-for-one
common stock split, effected in the form of a stock dividend. The record date
for the stock split was July 24, 2000, and the payment date was August 1, 2000.
In fiscal 1998, in connection with the filing of an effective Form S-1
Registration Statement and a reincorporation in the state of Delaware, the Board
of Directors and stockholders approved a 414.175 for 1 stock split and a change
in the authorized common stock to 20,000,000 shares at $0.01 par value per
share. These stock splits have been retroactively reflected in the accompanying
financial statements for all periods presented.
During February 1998, the Company completed its initial public offering of
common stock. In connection therewith, the Company issued 4,427,500 shares of
common stock, which included 577,500 shares issued pursuant to the underwriters'
over-allotment option. The proceeds received from the offering, net of
underwriting commissions and offering costs, totaled $24,850,109.
In fiscal 1998, the Company exercised its rights to repurchase 885,302
shares of its outstanding common stock for $1,900,000 (see Note 7).
On October 13, 1998, the Company's Board of Directors authorized a
repurchase of up to 1,000,000 shares of its common stock. On February 17, 2000,
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
2,000,000 shares. A purchase of the full 2,000,000 shares would equal
approximately 15.6 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 December 30, 2000, the
Company had repurchased 1,484,000 shares for a total cost of $19,453,109.
NOTE 6. STOCK OPTIONS AND STOCK OPTION PLAN
During fiscal 1998, the Company established a nonqualified and incentive
stock option plan. The plan provides for the issuance of a maximum of 620,000
shares of common stock to officers, directors and consultants and other key
employees. Incentive stock options and nonqualified options are granted at not
less than 100 percent of the fair market value of the underlying common stock on
the date of grant. As of December 30, 2000, 231,912 shares are available for
future granting.
Prior to the establishment of the stock option plan, the Company issued
nonqualified stock options to various key employees, a consultant and a director
of the Company. During fiscal 1998, the Company granted nonqualified stock
options to purchase 143,958 shares of common stock at $5.50 per share to a
director of the Company.
All options granted through January 1, 2000 vest equally over a three year
period and expire in ten years. All options granted during the year ended
December 30, 2000, vest equally over a four year period and expire in ten years.
F-16
1-800 CONTACTS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
A summary of stock option activity is as follows:
Weighted
Average
Exercise
Price Per
Shares Share
-------- ---------
Outstanding at December 31, 1997 278,322 $ 3.68
Granted 178,738 5.61
Exercised (8,000) 1.61
Forfeited (3,040) 6.25
--------
Outstanding at January 2, 1999 446,020 4.47
Granted 113,360 6.25
Exercised (50,350) 2.74
Forfeited (14,938) 6.28
--------
Outstanding at January 1, 2000 494,092 5.00
Granted 306,000 18.59
Exercised (136,095) 3.22
Forfeited (48,074) 13.66
--------
Outstanding at December 30, 2000 615,923 $11.45
========
Exercisable at December 30, 2000 233,663 $ 5.54
========
The following is additional information with respect to stock options:
Outstanding Weighted-Average Exercisable
Range of as of Remaining Weighted-Average as of Weighted-Average
Exercise Prices 12/30/00 Contractual Life Exercise Price 12/30/00 Exercise Price
- --------------- ----------- ---------------- ---------------- ----------- ----------------
$ 1.61 - $ 4.37 7,970 6.7 $ 3.65 5,970 $ 3.93
4.38 - 8.75 346,161 7.2 5.72 227,693 5.58
13.13 - 17.50 186,192 9.1 14.01 - -
21.88 - 26.25 38,000 9.5 24.00 - -
35.00 - 39.37 17,600 9.9 36.95 - -
39.38 - 43.75 20,000 9.7 43.75 - -
-------- -------
615,923 8.1 11.45 233,663 5.54
======== =======
F-17
1-800 CONTACTS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The Company applies Accounting Principles Board Opinion No. 25, "Accounting
for Stock Issued to Employees," and related interpretations in accounting for
its stock option grants to employees. Accordingly, no compensation expense has
been recognized for these stock option grants. Had compensation expense for the
Company's employee stock option grants been determined in accordance with
Statement of Financial Accounting Standards ("SFAS") No. 123, "Accounting for
Stock-Based Compensation," the Company's net income (loss) and diluted net
income (loss) per common share for the years ended January 2, 1999, January 1,
2000 and December 30, 2000 would have been reduced to the pro forma amounts
indicated below:
Fiscal Year
-------------------------------------------
1998 1999 2000
---- ---- ----
Net income (loss):
As reported............................... $(7,892,608) $6,127,578 $10,474,001
Pro forma................................. $(8,070,562) $5,864,847 $ 9,981,548
Diluted net income (loss) per common share:
As reported............................... $ (0.63) $ 0.48 $ 0.86
Pro forma................................. $ (0.65) $ 0.46 $ 0.82
Due to the nature and timing of options grants, the resulting pro forma
compensation cost may not be indicative of future years.
The fair value of each option grant has been estimated on the grant date
using the Black-Scholes option-pricing model with the following assumptions:
weighted average risk-free interest rate of 5.6 percent for fiscal 1998 grants,
5.4 percent for fiscal 1999 grants and 6.6 percent for fiscal 2000 grants;
expected stock price volatility of approximately 78 percent for fiscal 1998
grants, 75 percent for fiscal 1999 grants and 80 percent for fiscal 2000 grants;
an expected dividend yield of 0 percent for all grants and an expected life of
five years for all grants. The weighted average fair value of options granted
during fiscal years 1998, 1999 and 2000 was $3.77, $4.07 and $12.91 per share,
respectively.
NOTE 7. RELATED PARTY TRANSACTIONS
As of December 31, 1997, notes receivable from stockholders totaled
$572,145. During fiscal 1998, the Company made aggregate loans on the notes to
two stockholders totaling $22,300. The notes were unsecured, accrued interest at
the prime rate and were due on demand. Interest income on the notes totaled
$5,244 during fiscal 1998. During fiscal 1998, the Company made equity
distributions to the stockholders sufficient to allow for their repayment on
these notes.
During fiscal 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. This
investment is being accounted for under the cost method.
In February 1996, the Company entered into a credit agreement with a
stockholder that provided for maximum borrowings of $250,000 of which $243,788
was outstanding at December 31, 1997 and was repaid in fiscal 1998 with proceeds
from the Company's initial public offering of common stock. The borrowings
accrued interest at the prime rate plus 2 percent.
During fiscal 1997, the Company borrowed $1,100,000 from a stockholder
under a short-term promissory note which was repaid in fiscal 1998 with proceeds
from the Company's initial public offering of common stock. The note accrued
interest at prime plus 2 percent and was due July 30, 1998. As consideration for
entering into this note, the Company agreed to modify the option it held to
repurchase the stockholder's common stock. Under the revised
F-18
1-800 CONTACTS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
terms of the option, the Company had the right to repurchase 885,302 shares of
the stockholder's common stock for $1,900,000, which occurred in fiscal 1998
(see Note 5).
In September 1997, the Company borrowed $250,000 from a stockholder under a
short-term, unsecured promissory note which was repaid in fiscal 1998 with
proceeds from the Company's initial public offering of common stock. The note
accrued interest at prime plus 2 percent and was due in September 1998. In
addition, for every month the note was outstanding, a fee of $5,000 was added to
the outstanding balance and expensed as additional interest.
Interest expense under these related party notes was $26,838 in fiscal
1998.
NOTE 8. DISTRIBUTIONS TO STOCKHOLDERS
Prior to the consummation of its initial public offering in February 1998,
the Company entered into an agreement for the distribution of retained earnings
and tax indemnification with the existing stockholders. Pursuant to the
agreement, an S Corporation distribution of $982,995 (net of notes receivable
due from stockholders of $599,689) was distributed in the form of promissory
notes issued by the Company. The notes were paid in full after the closing of
the offering. The agreement provided for, among other things, the
indemnification of the existing stockholders for any losses or liabilities with
respect to any additional taxes (including interest, penalties and legal fees)
and the repayment to the Company of amounts received as refunds, resulting from
the Company's operations during the period in which it was an S Corporation. No
amounts are currently payable, or anticipated to be payable, or receivable, or
anticipated to be receivable under the agreement. The existing stockholders were
indemnified by the Company with respect to federal and state income tax
liabilities as a result of an adjustment to the Company's taxable income which
increases the tax liability to the existing stockholders for taxable periods
ending prior to the termination of the S corporation status. In addition, the
existing stockholders indemnified the Company with respect to any federal and
state tax liabilities as a result of an adjustment which decreases the existing
stockholders' tax liability for taxable periods ending prior to the termination
of the Company's S corporation status and correspondingly increases the tax
liability of the Company for a taxable period commencing on or after the
termination of the Company's S corporation status.
NOTE 9. INCOME TAXES
Prior to February 9, 1998, the Company had elected for federal and state
income tax purposes to include its taxable income with that of its stockholders
(an S Corporation election). Effective February 9, 1998 the Company's S
corporation election was terminated. As a result, the Company recorded a net
deferred tax liability and the related deferred tax provision of approximately
$791,000 for the tax effect of the differences between financial statement and
income tax basis of assets and liabilities that existed at the termination date
of the S corporation election.
Income (loss) before income taxes consists of the following components for
the years ended January 2, 1999, January 1, 2000 and December 30, 2000:
Fiscal Year
---------------------------------------------
1998 1999 2000
---- ---- ----
Domestic U.S. operations.......... $(8,535,287) $6,828,828 $17,175,644
Operations of foreign subsidiary.. - - (97,726)
----------- ---------- -----------
$(8,535,287) $6,828,828 $17,077,918
=========== ========== ===========
F-19
1-800 CONTACTS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The components of the provision for income taxes for the year ended January
2, 1999 since the termination of the S corporation status and for the years
ended January 1, 2000 and December 30, 2000 are as follows:
Fiscal Year
-------------------------------------------
1998 1999 2000
---- ---- ----
Current provision:
Federal................................................. $ - $ (387,204) $(6,053,222)
State................................................... - (59,939) (906,868)
----------- ----------- -----------
Total current provision for income taxes........... - (447,143) (6,960,090)
----------- ----------- -----------
Deferred benefit (provision):
Federal................................................. 2,864,270 (1,728,208) 311,349
State................................................... 443,386 (267,525) 44,824
Change in valuation allowance........................... (1,874,211) 1,741,626 -
Change from S corporation status........................ (790,766) - -
----------- ----------- -----------
Total deferred benefit (provision) for
income taxes..................................... 642,679 (254,107) 356,173
----------- ----------- -----------
Total benefit (provision) for income taxes................... $ 642,679 $ (701,250) $(6,603,917)
=========== =========== ===========
During fiscal year 1999, the Company reduced the valuation allowance an
additional $132,585 and increased additional paid-in capital from common stock
to recognize the tax benefit from common stock options exercised.
The following is a reconciliation between the statutory federal income tax
rate and the Company's effective income tax rate which is derived by dividing
the benefit (provision) for income taxes by income (loss) before benefit
(provision) for income taxes for the years ended January 2, 1999, January 1,
2000 and December 30, 2000:
Fiscal Year
-------------------------------------------
1998 1999 2000
---- ---- ----
Statutory federal income tax rate.......................... 34.0% (34.0)% (34.0)%
State income taxes, net of federal benefit................. 3.3 (3.3) (3.3)
Change from S corporation status........................... (8.0) - -
Valuation allowance........................................ (22.0) 27.3 -
Other...................................................... 0.2 (0.3) (0.4)
----- ----- -----
7.5% (10.3)% (38.7)%
===== ===== =====
The components of the deferred tax assets and liabilities at January 1,
2000 and December 30, 2000 are as follows:
January 1, December 30,
2000 2000
---------- ------------
Deferred income tax assets:
Accrued reserves................................... $346,890 $476,595
Depreciation....................................... 39,615 39,254
Intangibles amortization........................... 76,521 164,366
Other.............................................. 58,131 197,115
-------- --------
$521,157 $877,330
======== ========
A valuation allowance is provided when it is more likely than not that all
or some portion of the deferred tax assets will not be realized. The Company did
not have a valuation allowance at January 1, 2000 or December 30, 2000. During
fiscal 1999, the Company reversed its valuation allowance due to the
profitability of the Company and utilization of its net operating loss
carryforwards. The amount of the net deferred tax assets considered realizable,
however, could change in the near term based on changing conditions.
F-20
1-800 CONTACTS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 10. PREFERRED STOCK
The Company has 1,000,000 shares authorized of $.01 par value preferred
stock. For the years ended January 2, 1999, January 1, 2000 and December 30,
2000, no shares were issued or outstanding. The Company's board of directors
may, without further action by its stockholders, from time to time, direct the
issuance of shares of preferred stock in series and may, at the time of
issuance, determine the rights, preferences and limitations of each series.
NOTE 11. ASSET ACQUISITION
In May 1999, the Company acquired certain assets of Contact Lenses Online,
Inc. ("CLO") for $1.2 million in cash to be paid as follows: $600,000 on the
closing date, $300,000 six months after the closing date and $300,000 one year
after the closing date. As of December 30, 2000, these amounts had been paid in
full. The assets acquired include the Internet address www.contactlenses.com,
various telephone numbers and CLO's customer database which are included in
intangible assets and amortized over an estimated life of 5 years.
NOTE 12. RETIREMENT AND SAVINGS PLAN
Effective January 1, 2000, the Company established a 401(k) plan covering
substantially all of its employees. Eligible employees may contribute, through
payroll deductions, up to 15 percent of their eligible compensation, but not
more than the statutory limits. The Company contributes fifty cents for each
dollar a participant contributes, with a maximum Company contribution of three
percent of a participant's eligible compensation. No Company contributions were
made during the year ended January 1, 2000. The Company contributed $67,006 to
the plan during the year ended December 30, 2000.
F-21