| 1 800 CONTACTS INC Item 1A Risk Factors Please consider carefully the following risk factors and all other information contained in this report |
| The risks and uncertainties described below are risks that the Company currently believes to be material, but they are not the only ones the Company faces |
| Additional risks and uncertainties not presently known to the Company or that the Company currently believes are immaterial may also impair its business operations |
| Any of the following risks could harm the Company’s business, operating results and financial condition |
| This report contains forward-looking statements that involve known and unknown risks and uncertainties |
| These statements relate to the Company’s plans, objectives, expectations and intentions |
| The Company’s actual results could differ materially from those discussed in these statements |
| Factors that could contribute to these differences include those discussed below and elsewhere in this report |
| 19 ______________________________________________________________________ Risks Relating to Our Business Continued growth of “doctors only” lenses could compel contact lens manufacturers to adopt or expand a “doctors only” distribution strategy for all or some of the lenses they manufacture |
| Until a few years ago, substantially all of the major manufacturers of contact lenses refused to sell lenses to direct marketers, including the Company, and sought to prohibit their distributors from doing so |
| As a result, the Company historically purchased a substantial portion of its products from unauthorized distributors |
| Currently, the Company purchases products directly from manufacturers, including Johnson & Johnson Vision Care, CIBA Vision, Bausch & Lomb and CooperVision, as well as from distributors |
| The Company purchases the majority of its products directly from these manufacturers |
| However, the Company occasionally purchases products from two of the above manufacturers through unauthorized distributors at a lower cost and also purchases certain other products through unauthorized distributors that are marketed as “doctors only” and sold only to eye care practitioners |
| The Company can purchase some, but not all, “doctors only” lenses through unauthorized distributors |
| The Company’s current supply agreements with Johnson & Johnson Vision Care and CIBA Vision expire April 2007 and September 2006, respectively |
| Both manufacturers have stated a desire to extend the supply agreements, and the Company expects to renew these agreements prior to the expiration dates |
| The Company also purchases directly from Bausch & Lomb as a result of a five year settlement agreement that Bausch & Lomb signed in 2001 |
| That settlement agreement will expire in November 2006; however, the Company has received no indication that Bausch & Lomb will not sell to the Company after the expiration of the settlement agreement |
| The Company believes there is a risk that continued growth of “doctors only” lenses could compel one or more of these manufacturers to switch back to a “doctors only” distribution strategy for all or some of their lenses |
| 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 |
| The Company will continue to experience order cancellations due to the prescription verification requirements of the Fairness to Contact Lens Consumers Act |
| The federal Fairness to Contact Lens Consumer Act (“FCLCA”) established a national uniform standard for both eye care practitioners and direct marketers with regard to releasing and verifying consumer contact lens prescriptions as well as other requirements relating to the sale of contact lenses |
| The FCLCA requires that contact lenses only be sold to consumers based on a valid prescription |
| Satisfying this prescription requirement obligates the seller either to obtain a copy of the prescription itself or to verify the prescription by direct communication with the customer’s prescriber |
| Although the FCLCA eliminated much of the previous legal risk and uncertainty associated with numerous differing and often ambiguous or archaic state laws and regulations that had previously governed the sale of contact lenses, the Company’s adherence to the FCLCA’s requirements nationwide results in it canceling a portion of its customers’ orders due to their prescriptions being expired or otherwise invalid |
| Net sales for fiscal 2003, 2004 and 2005 were negatively impacted by canceled orders due to the Company’s prescription verification procedures |
| The Company may continue to incur significant legal and professional fees related to its legal matters and its efforts to proactively influence the industry on its behalf and on behalf of its consumers |
| The Company spent dlra6dtta4 million, dlra5dtta6 million and dlra4dtta7 million on legal and professional fees in fiscal 2003, 2004 and 2005, respectively |
| As a percentage of net sales, legal and professional fees have decreased over the last few years, representing 3dtta4prca, 2dtta6prca and 2dtta0prca of net sales in fiscal 2003, 2004 and 2005, respectively |
| During these years, the Company incurred significant legal and professional fees related to legal initiatives and increased efforts, including considerable lobbying activities, to overcome the 20 ______________________________________________________________________ anticompetitive barriers in the industry on the Company’s behalf and on behalf of consumers |
| The Company expects to continue to incur legal and professional fees as it maintains efforts to proactively change the laws, regulations and anti-competitive practices affecting the industry |
| The Company expects to increase its fiscal 2006 legal and professional fees from the fiscal 2005 amount |
| The Company obtains a large percentage of its inventory from a limited number of suppliers |
| Although the Company seeks to reduce its reliance on any one supplier by establishing relationships with a number of distributors, manufacturers and other sources, the Company acquired from a single distributor approximately 22 percent, 44 percent and 42 percent of its contact lenses purchased in fiscal 2003, 2004 and 2005, respectively |
| The Company’s top three suppliers accounted for approximately 59 percent, 83 percent and 81 percent of the Company’s inventory purchased in fiscal 2003, 2004 and 2005, respectively |
| The Company continually seeks to establish new relationships with potential suppliers in order 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 |
| The Company may incur unforeseen costs or not realize all of the anticipated benefits from its relationships with Johnson & Johnson Vision Care and CIBA Vision |
| In November 2002, the Company reached an agreement with Johnson & Johnson Vision Care to become an authorized retailer of Johnson & Johnson Vision Care contact lenses and began buying direct from Johnson & Johnson Vision Care during March 2003 |
| Prior to this, the Company became an authorized retailer of CIBA Vision contact lenses and began buying direct from CIBA Vision |
| These direct relationships have lowered the Company’s product acquisition costs and allowed it to offer rebates and other incentives not previously available to its customers who wear lenses manufactured by these companies |
| The Company has also been able to reduce its inventory investment by purchasing a more balanced mix of products at lower prices than it has historically been able to obtain through indirect sources |
| However, there is no assurance that the Company will be able to continue to realize these benefits or other anticipated benefits in the future from its relationship with these manufacturers |
| The Company currently purchases a portion of its products from unauthorized distributors and is not an authorized distributor for some of the products that 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 |
| The factors of price, availability and source of the contact lenses are all considerations in deciding which lenses to offer for sale |
| During the latter part of fiscal 2004, the Company decided to suspend sales of a specific brand of lens, as the Company is unable to obtain sufficient quantities of this lens from anyone other than the manufacturer, who refuses to sell the Company this lens |
| 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 |
| 21 ______________________________________________________________________ Because the Company does not manufacture most of the contact lenses that it sells, the Company cannot ensure that all of the contact lenses it sells meet all federal regulatory requirements |
| Contact lenses are regulated as medical devices by the FDA Under the Federal Food, Drug, and Cosmetic Act (the “FDC Act”), medical devices must meet a number of regulatory requirements, including the requirement that they be cleared or approved by the FDA, be manufactured in accordance with good manufacturing practice regulations, be labeled in compliance with federal law, and be listed with the FDA The Company attempts to ensure that the lenses it buys comply with federal laws |
| However, if it is not the manufacturer, the Company cannot ensure that the lenses it sells complies with the FDC Act |
| The distribution of medical devices that do not comply with the FDC Act is unlawful and subjects the distributor and the devices themselves to FDA regulatory action |
| The possible sanctions include warning letters from the FDA, injunction, civil penalties and criminal prosecution, as well as seizure and/or destruction of the contact lenses |
| It is possible that the FDA could consider certain of the contact lenses the Company sells to be misbranded or adulterated |
| 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 |
| These regulations generally apply only to the manufacturing of contact lenses and, therefore, do not directly impact the direct marketing operations of 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 within 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 |
| A portion of the Company’s sales may be found not to comply with state laws and regulations concerning the delivery and sale of contact lenses |
| Although the FCLCA overrides state laws or regulations that purport to impose stricter prescription verification procedures on direct marketers or that otherwise conflict with the general purposes and objectives of the FCLCA, the sale and delivery of contact lenses to consumers may also be subject to limited regulation by the state where the customer is located |
| For example, a substantial number of states require that contact lenses only be sold by persons licensed or registered to do so under that state’s laws |
| Also, the FCLCA, allows states to set the prescription length—as long as it is longer than one year |
| Such state laws or regulations may or may not run afoul of the FCLCA or other federal or constitutional requirements depending on their particular provisions |
| Neither the Company nor any of its employees is a licensed eye care professional in many of the states in which the Company does business |
| 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 or 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 inability to sell to customers at all in a particular state if the Company cannot comply with such state’s laws 22 ______________________________________________________________________ and (iii) 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 |
| The Company’s manufacturing facilities and products are subject to stringent regulation by the FDA, and the Company may not be able to develop and manufacture viable, high quality contact lenses for sale to consumers that meets all federal regulatory requirements |
| Pursuant to the FDC Act, and implementing regulations, the FDA regulates the testing, manufacturing, labeling, distribution, importation and promotion of medical devices |
| Noncompliance with applicable requirements can result in, among other things, fines, injunctions, civil penalties, recall or seizure of products, total or partial suspension of product distribution or importation, failure of the government to grant premarket clearance or approval for devices, withdrawal of marketing clearances or approvals and criminal prosecution |
| The FDA also has the authority to request the recall, repair, replacement or refund of the cost of any device manufactured or distributed by the Company |
| Under the FDC Act, clearance or approval by the FDA is required prior to the commercialization of a medical device |
| Before a new device can be introduced into the US market, it must receive from the FDA premarket notification clearance under Section 510(k) of the FDC Act or premarket approval pursuant to the more costly and time-consuming premarket approval application (PMA) procedure |
| For any devices that are cleared through the 510(k) process, modifications or enhancements that could significantly affect safety or effectiveness, or constitute a major change in the intended use of the device, will require new 510(k) submissions |
| While less expensive and time-consuming than obtaining PMA clearance, securing 510(k) clearance may involve the submission of a substantive review of six months or more |
| Any products manufactured or distributed pursuant to 510(k) clearance are subject to pervasive and continuing regulation by the FDA, including record keeping requirements and reporting of adverse experience with the use of the device |
| Most of ClearLab’s products have 510(k) clearance, and any new products under development to be marketed in the United States will undergo clinical studies to support a 510(k) or PMA There is no certainty that clinical studies involving new products will be completed in a timely manner or that the data and information obtained will be sufficient to support the filing of a PMA or 510(k) clearance |
| The Company cannot assure that it will be able to obtain necessary clearances and approvals to market new devices or any other products under development on a timely basis, if at all, and delays in receipt or failure to receive such clearances or approvals, the loss of previously received clearances, or failure to comply with existing or future regulatory requirements could have a material adverse effect on the Company’s business, financial condition and results of operations |
| As a manufacturer of medical devices for the US market, ClearLab is required to register with the FDA and comply with the FDA’s Code of Federal Regulations quality system requirements |
| These regulations require that ClearLab maintain manufacturing, testing and control activities records in a prescribed manner and maintain careful records of, and control over, device design development |
| Further, ClearLab and the Company are required to comply with FDA requirements for labeling and promoting products |
| ClearLab is subject to periodic inspections by the FDA and can be subjected to a number of regulatory actions if the FDA finds ClearLab to be not in compliance with applicable laws and regulations |
| If the FDA believes that ClearLab may not be operating in compliance with applicable laws and regulations, it can record its observations on a Form FDA 483; place ClearLab under observation and re-inspect the facilities; institute proceedings to issue a warning letter apprising of volatile conduct; detain or seize products; mandate a recall; enjoin future violations; and assess civil and criminal penalties against ClearLab, its officers or its employees |
| In addition, in appropriate circumstances, the FDA could withdraw clearances or approvals |
| 23 ______________________________________________________________________ The Company, through a wholly owned subsidiary, conducts activities as an initial importer of contact lens products which also are subject to regulation by the FDA The quality system regulations require that the subsidiary develop appropriate practices to address management responsibilities, control of documents and handling, storage and records maintenance, among other things |
| Similar to ClearLab, the FDA may periodically inspect the subsidiary |
| If the FDA finds that the subsidiary is not in compliance with the applicable laws and regulations, the FDA may institute enforcement actions, such as issuance of a Form FDA 483 or warning letter or impose the more severe penalties as described above |
| Manufacturers and importers of medical devices for marketing in the United States must also comply with medical device reporting requirements that companies report to the FDA any incident in which its product may have caused or contributed to a death or serious injury, or in which its product malfunctioned and, if the malfunction were to recur, it would be likely to cause or contribute to a death or serious injury |
| Any adverse regulatory action or the failure of ClearLab or the above mentioned subsidiary to comply with regulatory requirements could have a material adverse affect on the Company |
| The Company cannot assure that it will not incur significant costs to comply with laws and regulations in the future or that laws and regulations will not have a material adverse effect upon the Company’s business, financial condition or results of operation |
| The Company’s manufacturing facilities and products are subject to stringent regulation by various foreign jurisdictions in which its products are manufactured and/or sold |
| ClearLab’s products also are subject to regulation in other countries in which its products are sold |
| The laws and regulations of such countries range from comprehensive medical device approval procedures such as those described above to simple requests for product data or certifications |
| The number and scope of these laws and regulations are increasing |
| Under the system established by the Directive, all medical devices other than active implants and in vitro diagnostic products currently must qualify for CE marking |
| “CE marking” means the manufacturer certifies that its product bearing the CE mark satisfies all requirements essential for the product to be considered safe and fit for its intended purpose |
| Although member countries must accept for marketing medical devices bearing a CE marking without imposing further requirements related to product safety and performance, each country may require the use of its own language or labels and instructions for use |
| Member countries can impose additional requirements as long as they do not violate the Directive or constitute technical barriers to trade |
| Additional approvals from foreign regulatory authorities may be required for international sale of the Company’s products in non-EU countries |
| Failure to comply with applicable regulatory requirements can result in the loss of previously received approvals and other sanctions and could have a material adverse effect on the Company’s business, financial condition and results of operations |
| Consumer acceptance of the Company’s manufactured products may not meet the Company’s expectations |
| The Company’s wholly owned subsidiary, ClearLab, is the Company’s principal marketing organization for its wholesale manufacturing and distribution business, focusing on the marketing of its own contact lens products to major retailers and distributors, as well as providing some contract manufacturing capacity for other contact lens manufacturers |
| ClearLab’s development and manufacturing capabilities also provide the Company access to current and future contact lens products, which the Company may introduce to the US market should the Company’s access to contact lenses from the major contact lens manufacturers be disrupted, curtailed or otherwise negatively impacted, or if the manufacturers do not provide the Company with contact lenses at competitive pricing and with competitive marketing support |
| The Company intends to continue to increase its product offerings to the international 24 ______________________________________________________________________ markets |
| However, consumer acceptance of the Company’s manufactured products may not meet the Company’s expectations, and it cannot assure that the Company will be able to increase its product offerings in the international markets |
| The Company may not be able to establish a sufficient network of eye care practitioners to provide contact lens eye exams to its customers who have expired contact lens prescriptions |
| The Company is continually taking steps to minimize canceled orders, including continued development of a doctor referral network |
| The Company is currently expanding its national doctor referral network with select optical retail chains and independent practitioners and plans to have 1cmam000 locations by the end of 2006 |
| Under this referral program, when a current or potential customer needs a new contact lens prescription, the Company can facilitate the process of obtaining an eye examination through this network of providers |
| This process minimizes the interruptions in product consumption for the consumer and improves the Company’s ability to capture new customers and retain its current customers |
| If the Company is not successful in expanding its national doctor referral network, net sales could be negatively impacted by the Company’s inability to recapture orders canceled due to expired contact lens prescriptions |
| The Company’s quarterly results are likely to vary based upon the level of sales and marketing activity in any particular quarter |
| The Company currently expenses all advertising costs, including all direct-mail advertising costs, when the advertising first takes place |
| As a result, quarter-to-quarter comparisons are affected by the timing of television, radio and Internet advertisements and by the mailing of its printed advertisements within and between quarters |
| 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 Company’s operating results for any particular quarter may not be indicative of future operating results |
| For example, the Company typically decreases advertising expenditures in the fourth quarter due to the increased cost to advertise during this period |
| As a result, the Company, in the past has, and in the future expects to, generate lower revenues in the fourth quarter than in the preceding third quarter |
| You should not rely on quarter-to-quarter comparisons of the Company’s results of operations as an indication of its future performance |
| In the future the Company’s results of operations may be below the expectations of public market analysts |
| This in the past has and in the future could cause the trading price of the Company’s common stock to fall significantly |
| The retail sale of contact lenses is highly competitive and certain of the Company’s competitors are large, national optical chains that have greater resources than the Company |
| 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 contact lenses to those customers 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 practitioners to acquire customers and the competition to provide replacement lenses to such customers has intensified |
| To a lesser extent, the Company also competes with manufacturers of eyeglasses and providers of other vision correction, including refractive surgical procedures |
| 25 ______________________________________________________________________ The Company’s principal competitors include ophthalmologists and optometrists in private practice |
| The Company also competes with national optical chains, such as Pearle Vision, LensCrafters and National Vision Association, and mass merchandisers, such as Wal-Mart, Sam’s Club and Costco |
| In addition, the Company competes with other direct marketers of contact lenses, including on-line direct marketers |
| 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 all of the contact lens manufacturers which in some cases afford those 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 inability of the Company to effectively compete within the industry would have a material adverse effect on the Company’s business, financial condition and results of operations |
| The demand for contact lenses could be substantially reduced if alternative technologies to permanently correct vision gain in popularity |
| The Company also encounters competition from manufacturers of eyeglasses and from alternative technologies, such as surgical refractive procedures, including new refractive laser procedures such as PRK, or photo refractive keratectomy, and LASIK, or laser in situ keratomileusis |
| If surgical refractive procedures become increasingly accepted as an effective and safe technique for permanent vision correction, they could substantially reduce the demand for contact lenses by enabling patients to avoid the ongoing cost and inconvenience of contact lenses |
| Accordingly, these procedures or other alternative technologies may be developed in the future, which may cause a substantial decline in the number of contact lens wearers and thus harm the Company’s business |
| Increases in the cost of shipping, postage or credit card processing could harm the Company’s business |
| The Company ships its products to customers by United States mail and other overnight delivery and surface services |
| It generally invoices the costs of delivery and parcel shipments directly to customers as separate shipping and handling charges |
| In addition, the Company uses direct mailings to advertise its products and receives a majority of payments from customers using credit cards |
| Any increases in shipping, postal or credit card processing rates could harm the Company’s operating results as it may not be able to effectively pass such increases on to its customers |
| Similarly, strikes or other service interruptions by these shippers could limit the Company’s ability to market or deliver its products on a timely basis |
| The Company’s business could be harmed if it is required to collect state sales tax on the sale of all products |
| At present, the Company only collects sales or other similar taxes in connection with the sale of its products to consumers located inside the state of Utah |
| A successful assertion by one or more states that the Company should have collected or should be collecting sales taxes on the sale of its products could result in additional costs and administrative expenses to the Company and corresponding price increases to its customers, which could harm the Company’s business |
| 26 ______________________________________________________________________ The Company faces an inherent risk of exposure to product liability claims in the event that the use of the products it manufacturers or sell results in personal injury |
| The Company faces an inherent risk of exposure to product liability claims in the event that the use of the products it manufactures and/or sells results in personal injury |
| Although the Company has not experienced any significant losses due to product liability claims, it cannot assure that it will not experience such losses in the future |
| The Company maintains insurance against product liability claims, but it cannot be certain that such coverage will be adequate to cover any liabilities that it may incur, or that such insurance will continue to be available on terms acceptable to the Company |
| A successful claim brought against the Company in excess of available insurance coverage, or any claim that results in significant adverse publicity, could harm the Company’s business |
| The Company conducts its retail operations through a single distribution facility |
| Substantially all of the Company’s US retail inventory is stored and shipped from its distribution center in Salt Lake City |
| The Company depends in large part on the orderly operation of this receiving and distribution process, which depends, in turn, on adherence to shipping schedules and effective management of the distribution center |
| The Company may not be able to accurately anticipate all of the changing demands that its expanding operations will impose on its receiving and distribution system |
| In addition, events beyond the Company’s control, such as disruptions in operations due to labor disagreements, shipping problems, fires or natural disasters, may harm the Company’s business |
| The Company is subject to certain risks associated with its foreign operations that could harm its revenues and profitability |
| As a result of the ClearLab International and ClearLab UK acquisitions, the Company has significant operations in Singapore and in the United Kingdom |
| Certain risks are inherent in international operations, including the following: the Company may have difficulty enforcing agreements and collecting receivables through certain foreign legal systems; foreign customers may have longer payment cycles than customers in the United States; tax rates in certain foreign countries may exceed those in the United States, and foreign earnings may be subject to withholding requirements or the imposition of tariffs, exchange controls or other restrictions; general economic and political conditions in countries where the Company operates may have an adverse effect on its operations in those countries; the Company may find it difficult to manage a large organization spread throughout various countries; the Company may find it difficult to interpret foreign and domestic tax laws and anticipate foreign tax liabilities; and the Company may find it difficult to comply with other foreign laws and regulations |
| As the Company continues to expand its business globally, success will depend, in part, on its ability to anticipate and effectively manage these and other risks |
| The occurrence of any of the foregoing risks could have a significant effect on the Company’s international operations and, as a result, its revenues and profitability |
| Currency exchange rate fluctuations could have an adverse effect on the Company’s financial results |
| The Company faces foreign currency risks primarily as a result of its acquired Singapore and United Kingdom operations and the intercompany balances between its US and these international operations |
| Fluctuations in exchange rates between the US dollar and the Singapore dollar and the US dollar and the British pound could lead to additional currency exchange losses or gains on the intercompany balances and transactions denominated in currencies other than the functional currency |
| The Company has not entered into any foreign currency derivative financial instruments; however, it may choose to do so in the future in an effort to manage or hedge its foreign currency risk |
| 27 ______________________________________________________________________ The Company may be required to reduce the carrying value of its intangible assets if events and circumstances indicate the remaining balance of intangible assets may not be recoverable |
| The Company has a significant amount of goodwill and other intangible assets recorded on its balance sheet as a result of its acquisitions |
| SFAS Nodtta 142, “Goodwill and Other Intangible Assets,” provides that goodwill and other intangible assets with indefinite lives be tested for impairment annually using market values, or more frequently if impairment indicators arise |
| In assessing the recoverability of goodwill and other intangible assets, the Company must make assumptions regarding estimated future cash flows and other factors to determine the fair market value of the respective assets |
| If these estimates or their related assumptions change in the future, the Company may be required to record impairment charges for these assets |
| If required, these charges would be included in operating income |
| If the Company determines that significant impairment has occurred, it would be required to write off the impaired portion of intangible assets, which could have a material adverse effect on its operating results in the period in which the write-off occurs |
| The Company’s intellectual property rights may be challenged, and the Company does not have any property rights in the 1-800 CONTACTS telephone number or the Internet addresses |
| The Company conducts its direct marketing business under the various trade names and service marks, including “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 |
| To this end, the Company has secured trademark registration for the “1-800 CONTACTS” name |
| The Company has obtained the rights to various telephone numbers, including but not limited to 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 numbers |
| The Company does not expect to lose the right to use the telephone numbers; however, there can be no assurance in this regard |
| The loss of the right to use the 1-800 CONTACTS number or other specific telephone numbers 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 |
| contacts |
| contactlenses |
| 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 business, financial position and results of operations |
| The Company may not be able to complete its milestones and obligations in a timely manner under the Japanese license agreement and may not receive the amount of license fees and royalties that it presently anticipates under the agreement |
| In December 2004, the Company signed an agreement which grants Menicon, Japan’s largest independent contact lens manufacturer, exclusive rights to develop, manufacture and market certain disposable contact lenses and related intellectual property in Japan |
| Under the terms of the agreement, Menicon licenses from the Company different types of intellectual property, including contact lens material, manufacturing technology and related knowledge |
| In consideration, Menicon is expected to pay nonrefundable license fees of dlra18 million, of which dlra5 million was paid in December 2004, dlra3 million in December 2005 and dlra2 million in January 2006 |
| The remaining dlra8 million is expected to be paid over the next two to four years as the Company continues to fulfill its obligations and as corresponding milestones relating to Japanese regulatory approval and Menicon’s launch of the product in the Japanese market are 28 ______________________________________________________________________ met |
| Of the dlra10 million that has been received, dlra3 million is based on achievement of a specific milestone and the balance received represents a portion of the guaranteed license fee |
| Upon completion of this agreement, the Company will recognize the remaining milestone payments as the agreed upon milestones are achieved |
| If Menicon has not received regulatory approval on or before December 31, 2009, it may return all intellectual property covered by the agreement and in-process regulatory approvals to the Company, and the Company may pursue the Japanese market on its own and terminate the exclusive agreement |
| Under the terms of the agreement, Menicon will also pay royalties for a period of at least 15 years from the product launch date in Japan on contact lenses sold that were manufactured using the licensed technology, with a guaranteed minimum of dlra5 million per year beginning the earlier of the second year after product launch or 2012 |
| The agreement does not include the sale of any of the Company’s current equipment, facilities or capacity and is limited to the Japanese contact lens market |
| In the event that the Company is not able to complete its milestones and obligations in a timely manner, or in the event Menicon is not able to achieve regulatory approval, the Company may not receive a portion of the amount of license fees and royalties that it presently anticipates under the agreement |
| Risks Relating to the Internet The Company is dependent on its telephone, Internet and management information systems for the sale and distribution of contact lenses |
| The Company’s success depends, in part, on its ability to provide prompt, accurate and complete service to its customers on a competitive basis and its ability to purchase and promote products, manage inventory, ship products, manage sales and marketing activities and maintain efficient operations through its telephone and proprietary management information systems |
| The Company conducts all of its telephone and Internet operations from a single location |
| A significant disruption in its telephone, Internet or management information systems could harm the Company’s relations with its customers and the ability to manage its operations |
| From time to time, the Company has experienced temporary interruptions in its telephone service as a result of the technical problems experienced by its long-distance carrier |
| Similar interruptions may occur in the future and such interruptions may harm the Company’s business |
| Furthermore, extended or repeated reliance on the Company’s back-up computer systems may harm its business |
| 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 |
| The Company’s success is dependent, in part, on continued use of the Internet |
| The Internet is rapidly evolving |
| A decrease in the growth of Internet usage would harm the Company’s business |
| The following factors may inhibit growth in Internet usage, limit visits to the Company’s Internet addresses or limit orders placed through its website: inadequate Internet infrastructure; security and privacy concerns; inconsistent quality of service; and unavailability of low cost, high speed service |
| The Company’s success is dependent, in part, upon the ability of the Internet infrastructure to support increased use |
| The performance and reliability of the Internet may decline as the number of users increases or the bandwidth requirements of users increase |
| The Internet has experienced a variety of outages due to damage to portions of its infrastructure |
| If outages or delays occur frequently in the future, Internet usage, including usage of the Company’s website, could grow slowly or decline |
| Even if the 29 ______________________________________________________________________ necessary infrastructure or technologies are developed, the Company may have to spend considerable amounts to adapt its solutions accordingly |
| Online security breaches could harm the Company’s business |
| The secure transmission of confidential information over the Internet is essential to maintain consumer confidence in the Company’s website |
| Substantial or ongoing security breaches of its system or other Internet-based systems could significantly harm its business |
| Any penetration of the Company’s network security or other misappropriation of its users’ personal information could subject the Company to liability |
| The Company may be liable for claims based on unauthorized purchases with credit card information, impersonation or other similar fraud claims |
| Claims could also be based on other misuses of personal information, such as for unauthorized marketing purposes |
| These claims could result in litigation and financial liability |
| Security breaches also could damage the Company’s reputation and expose it to a risk of loss or litigation and possible liability |
| The Company relies on licensed encryption and authentication technology to effect secure transmission of confidential information, including credit card numbers |
| It is possible that advances in computer capabilities, new discoveries or other developments could result in a compromise or breach of the technology used by the Company to protect customer transaction data |
| The Company may incur substantial expense to protect against and remedy security breaches and their consequences |
| A party that is able to circumvent our security systems could steal proprietary information or cause interruptions in the Company’s operations |
| The Company’s insurance policies’ limits may not be adequate to reimburse it for losses caused by security breaches |
| The Company cannot guarantee that its security measures will prevent security breaches |
| Government regulation and legal uncertainties relating to the Internet and online commerce could negatively impact the Company’s business operations |
| Currently, there are few laws or regulations directly applicable to the Internet or online commerce on the Internet, and the laws governing the Internet that exist remain largely unsettled |
| Recently, the US Congress enacted Internet laws regarding online children’s privacy, copyrights and taxation |
| This or similar legislation could dampen growth in use and acceptance of the Internet |
| Due to the increasing popularity of the Internet, it is possible that additional laws and regulations may be enacted with respect to the Internet, covering issues such as user privacy, pricing, taxation, content, copyrights, distribution, antitrust and quality of products and services |
| The adoption or modification of laws or regulations applicable to the Internet could harm the Company’s business operations |
| In addition, several telecommunications carriers have requested that the Federal Communications Commission regulate telecommunications over the Internet |
| Due to the increasing use of the Internet and the burden it has placed on the current telecommunications infrastructure, telephone carriers have requested the FCC to regulate Internet service providers and impose access fees on those providers |
| If the FCC imposes access fees, the costs of using the Internet could increase dramatically |
| This could result in the reduced use of the Internet as a medium for commerce, which could harm the Company’s business operations |
| Changing technology could adversely affect the operation of the Company’s website |
| The Internet, online commerce and online advertising markets are characterized by rapidly changing technologies, evolving industry standards, frequent new product and service introductions and changing customer preferences |
| The Company’s future success will depend on its ability to adapt to rapidly changing 30 ______________________________________________________________________ technologies and address its customers’ changing preferences |
| However, the Company may experience difficulties that delay or prevent it being able to do so |