** **

**UNITED STATES**

**SECURITIES AND EXCHANGECOMMISSION**

**Washington,DC  20549**

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**FORM 10-Q**
| **(Mark one)** |
|----------------|
| **x**          | ** ** | **QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)  OF THE SECURITIES EXCHANGE ACT OF 1934** |
| ** **     | ** ** | ** ** |
| ** **     | ** ** | **For the quarterly period ended July 1, 2006** |
| ** **     | ** ** | ** ** |
| ** **     | **or** | ** ** |
| ** **     | ** ** | ** ** |
| **o**          | ** ** | **TRANSITION REPORT PURSUANT TO SECTION 13 OR  15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
| ** **     | ** ** | ** ** |
| ** **     | ** ** | **For the transition period from                     to                     .** |
| ** **     | ** ** | ** ** |
| ** **     | ** ** | **Commission file number:         0-23633** |
|                |  |  |  |  |

 

**1-800 CONTACTS, INC.**

(Exact name ofregistrant as specified in its charter)

| **Delaware**                                                     | ** ** | **87-0571643**                        |
|------------------------------------------------------------------|------------|---------------------------------------|
| (State or other  jurisdiction of  incorporation or organization) |       | (I.R.S. Employer  Identification No.) |
|                                                             |       |                                  |
| **66 E.  Wadsworth Park Drive,  Draper, UT**                     | ** ** | **84020**                             |
| (Address of  principal executive offices)                        |       | (Zip Code)                            |

 

**(801) 316-5000**

(Registrant’stelephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reportsrequired to be filed by Section 13 or 15(d) of the Securities Exchange Act of1934 during the preceding 12 months (or for such shorter period that theregistrant was required to file such reports) and (2) has been subject to suchfiling requirements for the past 90 days.

x  Yes             o  No

Indicateby check mark whether the registrant is a large accelerated filer, anaccelerated filer or a non-accelerated filer (as defined in Rule 12b-2 of theExchange Act).

| Large accelerated filer  o |   | Accelerated  filer  x |   | Non-accelerated  filer  o |
|--------------------------------------|--------|---------------------------------|--------|-------------------------------------|

 

Indicateby check mark whether the registrant is a shell company (as defined in Rule12b-2 of the Exchange Act).

o  Yes             x  No

As of August 4, 2006, the Registrant had 14,012,169shares of Common Stock, par value $0.01 per share, outstanding.

 

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**1-800CONTACTS, INC.**

**INDEX**
| **PART  I.    FINANCIAL INFORMATION**  |   |                                                                                                                  |
|------------------------------------------------------------|--------|-----------------------------------------------------------------------------------------------------------------------|
| Item 1.   Financial Statements  (unaudited) |   |                                                                                                                  |
|                                                       |   | Condensed Consolidated Balance Sheets as of December  31, 2005 and July 1, 2006                                       |   |   |
|                                                       |   | Condensed Consolidated Statements of Operations for  the Quarter and Two Quarters ended July 2, 2005 and July 1, 2006 |   |   |
|                                                       |   | Condensed Consolidated Statements of Cash Flows for  the Two Quarters ended July 2, 2005 and July 1, 2006             |   |   |
|                                                       |   | Notes to  Condensed Consolidated Financial Statements                                                                 |   |   |
| Item 2.                                                    |   | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                           |   |   |
| Item 3.                                                    |   | Quantitative  and Qualitative Disclosures About Market Risk                                                      |   |   |
| Item 4.                                                    |   | Controls and  Procedures                                                                                              |   |   |
|                                                       |   |                                                                                                                  |   |   |
| **PART II.   OTHER  INFORMATION**           |   |                                                                                                                  |
| Item 1.                                                    |   | Legal Proceedings                                                                                                     |   |   |
| Item  1A.                                                  |   | Risk  Factors                                                                                                         |   |   |
| Item 2.                                                    |   | Unregistered  Sales of Equity Securities and Use of Proceeds                                                     |   |   |
| Item 3.                                                    |   | Defaults  Upon Senior Securities                                                                                      |   |   |
| Item 4.                                                    |   | Submission  of Matters to a Vote of Security Holders                                                                  |   |   |
| Item 5.                                                    |   | Other Information                                                                                                     |   |   |
| Item  6.                                                   |   | Exhibits                                                                                                              |   |   |

 

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**PART1. FINANCIAL INFORMATION**

**Item1.  Financial Statements**

 

 

**1-800CONTACTS, INC.**

**CONDENSED CONSOLIDATED BALANCE SHEETS**

**(inthousands)**

**(unaudited)**

 
| ** **                                                            | ** ** | **December 31,** | ** ** | **July 1,** | ** ** |
|-----------------------------------------------------------------------|------------|-----------------------|------------|------------------|------------|
| ** **                                                            | ** ** | **2005**              | ** ** | **2006**         | ** ** |
| **ASSETS**                                                            |       |                  |       |             |       |
| CURRENT ASSETS:                                                       |       |                  |       |             |       |
| Cash                                                                  |       | $                     | 1,481      |             | $          | 89 |   |
| Accounts  receivable, net                                             |       | 3,451                 |       | 3,471            |       |
| Other  receivables                                                    |       | 1,738                 |       | 2,156            |       |
| Inventories, net                                                      |       | 21,458                |       | 20,419           |       |
| Deferred income  taxes                                                |       | 1,624                 |       | 1,817            |       |
| Other current  assets                                                 |       | 3,792                 |       | 2,494            |       |
| Total current  assets                                                 |       | 33,544                |       | 30,446           |       |
| PROPERTY AND EQUIPMENT,  net                                          |       | 29,705                |       | 31,223           |       |
| DEFERRED INCOME TAXES                                                 |       | 1,087                 |       | 1,006            |       |
| GOODWILL                                                              |       | 35,405                |       | 35,963           |       |
| DEFINITE-LIVED  INTANGIBLES, net                                      |       | 13,847                |       | 12,639           |       |
| OTHER ASSETS                                                          |       | 1,357                 |       | 1,726            |       |
| Total assets                                                          |       | $                     | 114,945    |             | $          | 113,003 |   |
|                                                                  |       |                  |       |             |       |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY**                        | ** ** | ** **            | ** ** | ** **       | ** ** |
| CURRENT LIABILITIES:                                                  |       |                  |       |             |       |
| Line of credit                                                        |       | $                     | —     |             | $          | 19,479 |   |
| Current portion  of long-term debt                                    |       | 1,633                 |       | 2,221            |       |
| Current portion  of capital lease obligations                         |       | 58                    |       | 25               |       |
| Income taxes  payable                                                 |       | 567                   |       | 1,747            |       |
| Accounts payable                                                      |       | 12,063                |       | 11,487           |       |
| Accrued  liabilities                                                  |       | 8,197                 |       | 11,131           |       |
| Unearned revenue                                                      |       | 3,299                 |       | 3,219            |       |
| Total current  liabilities                                            |       | 25,817                |       | 49,309           |       |
| LONG-TERM LIABILITIES:                                                |       |                  |       |             |       |
| Line of credit                                                        |       | 23,746                |       | —           |       |
| Long-term debt,  net of current portion                               |       | 6,440                 |       | 5,377            |       |
| Capital lease  obligations, net of current portion                    |       | 83                    |       | 59               |       |
| Unearned  revenue, net of current portion                             |       | 973                   |       | —           |       |
| Other long-term  liabilities                                          |       | 669                   |       | 643              |       |
| Total long-term  liabilities                                          |       | 31,911                |       | 6,079            |       |
| STOCKHOLDERS’ EQUITY                                             |       |                  |       |             |       |
| Common stock,  13,340 and 13,360 issued and outstanding, respectively |       | 133                   |       | 134              |       |
| Additional  paid-in capital                                           |       | 47,876                |       | 49,019           |       |
| Retained  earnings                                                    |       | 9,613                 |       | 8,756            |       |
| Accumulated  other comprehensive loss                                 |       | (405                  | )          | (294             | )          |
| Total  stockholders’ equity                                      |       | 57,217                |       | 57,615           |       |
| Total  liabilities and stockholders’ equity                      |       | $                     | 114,945    |             | $          | 113,003 |   |

 

See accompanyingnotes to condensed consolidated financial statements.

3

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**1-800CONTACTS, INC.**

**CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS**

**(inthousands, except per share amounts)**

**(unaudited)**

 
| ** **                                            | ** ** | **Quarter Ended** | ** ** | **Two Quarters Ended** | ** ** |
|-------------------------------------------------------|------------|------------------------|------------|----------------------------------|------------|
| ** **                                            | ** ** | **July 2,**       | ** ** | **July 1,**                 | ** ** | **July 2,** | ** ** | **July 1,** | ** ** |
| ** **                                            | ** ** | **2005**               | ** ** | **2006**                         | ** ** | **2005** | ** ** | **2006** | ** ** |
| NET SALES                                             |       | $                      | 61,365     |                             | $          | 63,155 |   | $ | 121,648 |   | $ | 126,646 |   |
| COST OF GOODS  SOLD                                   |       | 37,697                 |       | 40,523                           |       | 75,472 |   | 79,536 |   |
| Gross profit                                          |       | 23,668                 |       | 22,632                           |       | 46,176 |   | 47,110 |   |
| SELLING, GENERAL  AND ADMINISTRATIVE EXPENSES:        |       |                   |       |                             |       |   |   |   |   |
| Advertising                                           |       | 7,120                  |       | 3,703                            |       | 13,658 |   | 7,686 |   |
| Legal and professional                                |       | 906                    |       | 1,123                            |       | 2,190 |   | 2,248 |   |
| Research and development                              |       | 811                    |       | 1,637                            |       | 1,866 |   | 2,965 |   |
| Other selling, general and administrative             |       | 12,304                 |       | 15,922                           |       | 23,821 |   | 29,601 |   |
| Total selling, general and administrative expenses    |       | 21,141                 |       | 22,385                           |       | 41,535 |   | 42,500 |   |
| INCOME FROM  OPERATIONS                               |       | 2,527                  |       | 247                              |       | 4,641 |   | 4,610 |   |
| OTHER INCOME  (EXPENSE), net                          |       | (1,166                 | )          | 352                              |       | (1,807 | ) | 665 |   |
| INCOME BEFORE  PROVISION FOR INCOME TAXES             |       | 1,361                  |       | 599                              |       | 2,834 |   | 5,275 |   |
| PROVISION FOR  INCOME TAXES                           |       | (1,320                 | )          | (2,637                           | )          | (2,610 | ) | (6,132 | ) |
| NET INCOME  (LOSS)                                    |       | $                      | 41         |                             | $          | (2,038 | ) | $ | 224 |   | $ | (857 | ) |
|                                                  |       |                   |       |                             |       |   |   |   |   |
| PER SHARE  INFORMATION:                               |       |                   |       |                             |       |   |   |   |   |
| Basic and  diluted net income (loss) per common share |       | $                      | 0.00       |                             | $          | (0.15 | ) | $ | 0.02 |   | $ | (0.06 | ) |

 

See accompanying notes tocondensed consolidated financial statements.

4

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**1-800CONTACTS, INC.**

**CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS**

**(inthousands)**

**(unaudited)**

** **
| ** **                                                                                | ** ** | **Two Quarters Ended** | ** ** |
|-------------------------------------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                                                | ** ** | **July 2,**                 | ** ** | **July 1,** | ** ** |
| ** **                                                                                | ** ** | **2005**                         | ** ** | **2006** | ** ** |
| CASH FLOWS FROM  OPERATING ACTIVITIES:                                                    |       |                             |       |   |   |
| Net income (loss)                                                                         |       | $                                | 224        |   | $ | (857 | ) |
| Adjustments to reconcile net income (loss) to net  cash provided by operating activities: |       |                             |       |   |   |
| Depreciation and amortization                                                             |       | 4,291                            |       | 4,892 |   |
| Amortization of debt issuance costs and discounts                                         |       | 96                               |       | 158 |   |
| Foreign currency exchange loss (gain)                                                     |       | 1,060                            |       | (1,519 | ) |
| Stock-based compensation                                                                  |       | 44                               |       | 1,028 |   |
| Tax benefits from share-based payment exercises                                           |       | —                           |       | (28 | ) |
| Loss on sale of property and equipment                                                    |       | 107                              |       | 164 |   |
| Deferred income taxes                                                                     |       | (1,157                           | )          | (112 | ) |
| Changes in operating assets and liabilities:                                              |       |                             |       |   |   |
| Accounts receivable, net                                                                  |       | (749                             | )          | 469 |   |
| Inventories, net                                                                          |       | 399                              |       | 1,487 |   |
| Other receivables                                                                         |       | (924                             | )          | (418 | ) |
| Other current assets                                                                      |       | (651                             | )          | 1,340 |   |
| Income taxes payable                                                                      |       | (1,008                           | )          | 1,190 |   |
| Accounts payable                                                                          |       | 2,412                            |       | (1,025 | ) |
| Accrued liabilities                                                                       |       | 2,534                            |       | 2,863 |   |
| Unearned revenue                                                                          |       | (1,968                           | )          | (1,193 | ) |
| Net cash provided by operating activities                                                 |       | 4,710                            |       | 8,439 |   |
| CASH FLOWS FROM  INVESTING ACTIVITIES:                                                    |       |                             |       |   |   |
| Purchase of property and equipment                                                        |       | (3,473                           | )          | (3,744 | ) |
| Proceeds from sale of property and equipment                                              |       | 27                               |       | — |   |
| Purchase of definite-lived intangible assets                                              |       | (610                             | )          | — |   |
| Deposits and other                                                                        |       | (1,610                           | )          | (605 | ) |
| Net cash used in  investing activities                                                    |       | $                                | (5,666     | ) | $ | (4,349 | ) |

 

5

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**1-800CONTACTS, INC.**

**CONDENSEDCONSOLIDATED STATEMENTS OF CASH FLOWS (continued)**

**(inthousands)**

**(unaudited)**

 
| ** **                                              | ** ** | **Two Quarters Ended** | ** ** |
|---------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                              | ** ** | **July 2,**                 | ** ** | **July 1,** | ** ** |
| ** **                                              | ** ** | **2005**                         | ** ** | **2006** | ** ** |
| CASH FLOWS FROM  FINANCING ACTIVITIES:                  |       |                             |       |   |   |
| Proceeds from exercise of stock options                 |       | $                                | 162        |   | $ | 107 |   |
| Excess tax benefits from share-based payment  exercises |       | —                           |       | 28 |   |
| Net repayments on line of credit                        |       | (911                             | )          | (4,267 | ) |
| Principal payments on capital lease obligations         |       | (20                              | )          | (62 | ) |
| Principal payments on long-term debt                    |       | (835                             | )          | (961 | ) |
| Net cash used in financing activities                   |       | (1,604                           | )          | (5,155 | ) |
| EFFECT OF  FOREIGN EXCHANGE RATES ON CASH               |       | 101                              |       | (327 | ) |
|                                                    |       |                             |       |   |   |
| NET DECREASE IN  CASH                                   |       | (2,459                           | )          | (1,392 | ) |
| CASH AT  BEGINNING OF PERIOD                            |       | 3,105                            |       | 1,481 |   |
| CASH AT END OF  PERIOD                                  |       | $                                | 646        |   | $ | 89 |   |
|                                                    |       |                             |       |   |   |
| SUPPLEMENTAL  CASH FLOW INFORMATION:                    |       |                             |       |   |   |
| Cash paid for interest                                  |       | $                                | 509        |   | $ | 815 |   |
| Cash paid for income taxes                              |       | 4,775                            |       | 5,045 |   |
|                                                    |       |                             |       |   |   |

 

See accompanying notes tocondensed consolidated financial statements.

 

6

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**1-800CONTACTS, INC.**

**NOTES TO CONDENSED CONSOLIDATEDFINANCIAL STATEMENTS**

**(Unaudited)**

# **NOTE1.  PRESENTATION OF CONDENSEDCONSOLIDATED FINANCIAL STATEMENTS**

Theaccompanying condensed consolidated financial statements have been prepared by1-800 CONTACTS, INC. (“the Company”), without audit, pursuant to the rules andregulations of the Securities and Exchange Commission.  Certain information and disclosures normallyincluded in financial statements prepared in accordance with U.S. generallyaccepted accounting principles have been condensed or omitted pursuant to suchrules and regulations.  These condensedconsolidated financial statements reflect all adjustments (consisting only ofnormal recurring adjustments), which in the opinion of management, are necessaryto present fairly the results of operations of the Company for the periodspresented.  It is suggested that thesecondensed consolidated financial statements be read in conjunction with theaudited financial statements and the notes thereto included in the Company’sAnnual Report on Form 10-K for the year ended December 31, 2005.

Thepreparation of financial statements in conformity with U.S. generally acceptedaccounting principles requires management to make estimates and assumptionsthat affect the reported amounts of assets and liabilities and disclosure ofcontingent assets and liabilities at the date of the financial statements andthe reported amounts of revenue and expenses during the reporting period.  Actual results could differ from these estimates.

# **NOTE2.  INVENTORIES**

Inventories arerecorded at the lower of cost (using the first-in, first-out method) or marketvalue.  Elements of cost in the Company’smanufactured inventories generally include raw materials, direct labor,manufacturing overhead and freight-in.  Inventoriesconsisted of the following (in thousands):
|                                          | ** ** | **December 31,** | ** ** | **July 1,** | ** ** |
|------------------------------------------|------------|-----------------------|------------|------------------|------------|
| ** **                               | ** ** | **2005**              | ** ** | **2006**         | ** ** |
| Purchased contact lenses and accessories |       | $                     | 13,554     |             | $          | 10,768 |   |
| Manufactured inventories:                |       |                  |       |             |       |
| Raw materials                            |       | 1,322                 |       | 1,004            |       |
| Work in process                          |       | 1,894                 |       | 1,422            |       |
| Finished goods contact lenses            |       | 4,688                 |       | 7,225            |       |
| Total                                    |       | $                     | 21,458     |             | $          | 20,419 |   |

 

Provision is madeto reduce excess and obsolete inventories to their estimated net realizablevalues.  As of December 31, 2005 and July1, 2006, reserves for excess and obsolete inventories were approximately $2.2million and $2.1 million, respectively. 

**NOTE 3.  NETINCOME (LOSS) PER COMMON SHARE**

Basic net income (loss)per common share (“Basic EPS”) excludes dilution and is computed by dividingnet income (loss) by the weighted-average number of common shares outstandingduring the period.  Diluted net income(loss) per common share (“Diluted EPS”) reflects the potential dilution thatcould occur if stock options or other common stock equivalents were exercisedor converted into common stock using the treasury stock method.  The computation of Diluted EPS does notassume exercise or conversion of securities that would have an antidilutiveeffect on net income (loss) per common share. Additionally, the Company has not reflected performance based unvestedstock awards in Diluted EPS since the performance conditions were not satisfiedas of July 1, 2006.  For the quarter and two quarters ended July 2, 2005,options to purchase 814,325 and 822,225 shares of common stock, respectively,were not included in the computation of Diluted EPS because the effect would beantidilutive.  For the

7

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quarter and two quarters ended July 1, 2006, optionsto purchase 1,185,090 shares of common stock, as well as 680,878 shares ofunvested common stock, were not included in the computation of Diluted EPSbecause the effect would be antidilutive.

The following is areconciliation of the numerator and denominator used to calculate Basic andDiluted EPS (in thousands, except per share amounts):
| ** **                       | ** ** | **Quarter Ended July 2, 2005** | ** ** | **Quarter Ended July 1, 2006** | ** ** |
|----------------------------------|------------|----------------------------------------------------|------------|----------------------------------------------------|------------|
| ** **                       | ** ** | **Net  Income**                                    | ** ** | **Shares**                                         | ** ** | **Per-Share  Amount** | ** ** | **Net  Loss** | ** ** | **Shares** | ** ** | **Per-Share  Amount** | ** ** |
|                             |       |                                               |       |                                               |       |   |   |   |   |   |   |   |   |
| Basic  EPS                       |       | $                                                  | 41         |                                               | 13,312     |   | $ | 0.00 |   | $ | (2,038 | ) | 13,360 |   | $ | (0.15 | ) |
| Effect  of stock options         |       |                                               |       | 151                                                |       |   |   |   |   | — |   |   |   |
| Effect  of unvested stock awards |       |                                               |       | —                                             |       |   |   |   |   | — |   |   |   |
| Diluted  EPS                     |       | $                                                  | 41         |                                               | 13,463     |   | $ | 0.00 |   | $ | (2,038 | ) | 13,360 |   | $ | (0.15 | ) |

 
| ** **                       | ** ** | **Two  Quarters Ended July 2, 2005** | ** ** | **Two  Quarters Ended July 1, 2006** | ** ** |
|----------------------------------|------------|--------------------------------------|------------|--------------------------------------|------------|
| ** **                       | ** ** | **Net  Income**                      | ** ** | **Shares**                           | ** ** | **Per-Share  Amount** | ** ** | **Net  Loss** | ** ** | **Shares** | ** ** | **Per-Share  Amount** | ** ** |
|                             |       |                                 |       |                                 |       |   |   |   |   |   |   |   |   |
| Basic  EPS                       |       | $                                    | 224        |                                 | 13,307     |   | $ | 0.02 |   | $ | (857 | ) | 13,352 |   | $ | (0.06 | ) |
| Effect  of stock options         |       |                                 |       | 169                                  |       |   |   |   |   | — |   |   |   |
| Effect  of unvested stock awards |       |                                 |       | —                               |       |   |   |   |   | — |   |   |   |
| Diluted EPS                      |       | $                                    | 224        |                                 | 13,476     |   | $ | 0.02 |   | $ | (857 | ) | 13,352 |   | $ | (0.06 | ) |

 

**NOTE4.  COMPREHENSIVE LOSS**

Comprehensive loss forthe quarter and two quarters ended July 2, 2005 and July 1, 2006 consisted ofthe following components (in thousands): 
| ** **                                | ** ** | **Quarter Ended**          | ** ** | **Two Quarters Ended**     | ** ** |
|-------------------------------------------|------------|----------------------------|------------|----------------------------|------------|
| ** **                                | ** ** | **July 2, 2005** | ** ** | **July 1, 2006** | ** ** | **July 2, 2005** | ** ** | **July 1, 2006** | ** ** |
| Net income (loss)                         |       | $                          | 41         |                       | $          | (2,038 | ) | $ | 224 |   | $ | (857 | ) |
| Foreign currency  translation gain (loss) |       | (242                       | )          | 112                        |       | (360 | ) | 111 |   |
| Comprehensive loss                        |       | $                          | (201       | )                          | $          | (1,926 | ) | $ | (136 | ) | $ | (746 | ) |

 

The foreigncurrency translation gain (loss) resulted primarily from changes in exchangerates relative to the U.S. dollar from the translation of the Company’sSingapore and United Kingdom subsidiaries’ financial statements. 

**NOTE 5. STOCK-BASED COMPENSATION**

Effective January 1, 2006, the Company adopted Statementof Financial Accounting Standards (“SFAS”) No. 123 (Revised 2004), “Share-BasedPayment,” (“SFAS No. 123R”), which requires stock-based compensation to bemeasured based on the fair value of the award on the date of grant andrecognized over the period during which service is required in exchange for theaward.  In March 2005, the SEC issuedStaff Accounting Bulletin No. 107 (“SAB No. 107”) relating to SFAS No.123R.  The Company has applied theprovisions of SAB No. 107 in its adoption of SFAS No. 123R.

8

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Prior to January 1, 2006,the Company applied Accounting Principles Board Opinion No. 25, “Accountingfor Stock Issued to Employees,” and related interpretations (“APB 25”), andadopted the disclosure-only provisions of Statement of Financial AccountingStandards No. 123 (“SFAS No. 123”), “Accounting for Stock-Based Compensation.”  Under APB 25, no compensation expense wasrecognized in net income for grants of employee stock options prior to 2006.

SFAS No. 123R applies to all of theCompany’s outstanding unvested share-based payment awards as of January 1, 2006and all prospective awards.  All of theCompany’s stock-based awards, which are stock options and restricted stockawards, are classified as equity instruments. In accordance with SFAS No. 123R, the Company elected to use themodified prospective transition method and therefore, financial statementsprior to adoption remain unchanged. Under this transition method, compensationcost for the quarter and two quarters ended July 1, 2006 includes amountsassociated with (i) unvested stock options granted prior to January 1, 2006,(ii) restricted stock awards granted prior to January 1, 2006 and (iii)restricted stock awards granted during the current fiscal year.  Compensation cost recognized in fiscal 2006for unvested options as of January 1, 2006 was based on the grant-date fairvalue estimated in accordance with the original provisions of SFAS No.123.  The following discusses certainother elections and assumptions the Company made as a result of adoptingSFAS No. 123R:

·                  *Black-Scholes Model. *Forthe Company’s pro forma disclosures under SFAS No. 123, it used theBlack-Scholes option pricing model. Upon the adoption of SFAS No. 123R,the Company has elected to continue to use the Black-Scholes option pricingmodel to compute the fair value of options granted on or after January 1,2006.

·                  *Forfeitures.*Forfeitures under SFAS No. 123 were recognized whenthey occurred. SFAS No. 123R, however, requires forfeitures to beestimated at the grant date. Accordingly, compensation cost is recognized basedon the number of awards expected to vest. There may be adjustments in futureperiods if actual forfeitures differ from the Company’s estimates.  The Company’s forfeiture rates are based uponhistorical experience.

·                  *Short-cut Method.*The Company has elected to use the short-cut method inaccordance with FSP 123R-3 in measuring its APIC pool available to absorb taxdeficiencies recognized in subsequent periods from the exercise of unqualifiedstock options and vesting of restricted stock awards.  Under the short-cut method, the Company hasdetermined that it has no APIC pool as of January 1, 2006.  Accordingly, realized tax deficiencies inexcess of tax benefits related to fully vested awards as of January 1, 2006will be recorded as additional income tax expense in the period determined.

Prior to the adoption ofSFAS No. 123R, the Company presented tax benefits resulting fromshare-based compensation as operating cash flows in the consolidated statementsof cash flows.  SFAS 123R requires thatcash flows resulting from tax deductions in excess of compensation costrecognized in the financial statements be classified as financing cash flows.However, under the short-cut method, for all vested awards as of January 1,2006, any realized tax benefits are recorded as financing cash flows and anincrease to additional paid in capital.  Forthe quarter and the two quarters ended July 1, 2006, approximately $1,000 and$28,000 of excess tax benefits, respectively, were generated.

Stock-based expenserecorded during fiscal 2006 includes expense, recognized over the applicablevesting periods, for new restricted stock share-based awards and for restrictedstock and stock option share-based awards granted prior to, but not yet vested,as of January 1, 2006.  As a result of adopting SFAS No. 123R, thestock-based compensation expense for employees and non-employee directors forthe quarter and two quarters ended July 1, 2006 totaled approximately $0.7million and $1.0 million, respectively.  The total income tax benefitrelated to stock-based expense during the quarter and two quarters ended July1, 2006 were approximately $0.3 million and $0.4 million, respectively.  The impact on Basic and Diluted EPS for thequarter and two quarters ended July 1, 2006 was a decrease of approximately$0.03 and $0.04 per share, respectively. In addition, prior to the adoption ofSFAS No. 123R, the Company presented the tax benefit from the exercise ofcommon stock option exercises as a component of cash flows from operatingactivities.  Upon the adoption of SFAS No. 123R, tax benefitsresulting from tax deductions in excess of the compensation cost recognized forthose options are classified as a component of cash flows from financing activities. For the quarter and two quarters ended July 1, 2006, this resulted in adecrease of $1,000 and $28,000, respectively, in cash flows from operatingactivities and an increase of $1,000 and $28,000, respectively, in cash flowsfrom financing activities compared to cash

9

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flows from stock-based compensation presented underAPB 25.

***Stock –Based Award Plans***

***Stock Options.***The Company has established astock incentive plan that provides for the issuance of a maximum 1,940,000shares of common stock to officers, employees, directors and consultants. Theplan allows for the issuance of incentive stock options, nonqualified stockoptions and restricted stock. Incentive and nonqualified stock options aregranted at not less than 100 percent of the fair market value of theunderlying common stock on the date of grant. As of July 1, 2006, 45,428 shareswere available for future granting.

Prior to theestablishment of the stock incentive plan, the Company issued nonqualifiedstock options to various key employees, a consultant and a director of theCompany.

All options grantedthrough January 1, 2000 vest equally over a three-year period and expirein ten years. The stock options issued as a portion of the consideration forthe assignment of certain technologies and intellectual property in conjunctionwith the acquisition of ClearLab International and other options issued to thechief technology officer of ClearLab International vest equally at the end ofthe third, fourth and fifth years and expire in ten years. All other optionsgranted subsequent to January 1, 2000, vest equally over a four-yearperiod and expire in five to ten years.

Stockoptions remained outstanding under these various plans as of January 1, 2006.******There have been no optionsgranted from these plans during fiscal 2006, and the Company does not currentlyplan to grant any stock options during the remainder of fiscal 2006.  Under SFAS No. 123, pro-forma expensefor stock options was calculated using a straight-line vesting schedule overthe vesting period of approximately four years.  Had the Company used thefair value based accounting method for stock option expense prescribed by SFASNo. 123, the Company’s net income and earnings per share for the quarter andtwo quarters ended July 1, 2005 would have been reduced to the pro-formaamounts illustrated as follows (in thousands, except per share amounts):
| ** **                                                                         | ** ** | **Quarter Ended**     | ** ** | **Two Quarters Ended** | ** ** |
|------------------------------------------------------------------------------------|------------|----------------------------|------------|----------------------------------|------------|
| ** **                                                                         | ** ** | **July 2, 2005** | ** ** | **July 2, 2005**       | ** ** |
| Net income (loss):                                                                 |       |                       |       |                             |       |
| As reported                                                                        |       | $                          | 41         |                             | $          | 224 |   |
| Add: Stock-based  compensation expense included in reported net income, net of tax |       | 24                         |       | 27                               |       |
| Deduct:  Fair-value based compensation, net of tax                                 |       | (262                       | )          | (572                             | )          |
| Pro forma                                                                          |       | $                          | (197       | )                                | $          | (321 | ) |
|                                                                               |       |                       |       |                             |       |
| Basic and diluted net  income (loss) per common share:                             |       |                       |       |                             |       |
| As reported                                                                        |       | $                          | 0.00       |                             | $          | 0.02 |   |
| Pro forma                                                                          |       | $                          | (0.01      | )                                | $          | (0.02 | ) |

 

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The Company’s stock option activity during the firsttwo quarters of fiscal 2006 is as follows (in thousands, except option pricesand years):
| ** **                                           | ** ** | ** **         | ** ** | ** **   | ** ** | **Weighted**          | ** ** | ** **    | ** ** |
|------------------------------------------------------|------------|--------------------|------------|--------------|------------|-----------------------|------------|---------------|------------|
| ** **                                           | ** ** | ** **         | ** ** | **Weighted** | ** ** | **Average**           | ** ** | ** **    | ** ** |
| ** **                                           | ** ** | ** **         | ** ** | **Average**  | ** ** | **Remaining**         | ** ** | **Aggregate** | ** ** |
| ** **                                           | ** ** | **Number of** | ** ** | **Exercise** | ** ** | **Contractual**       | ** ** | **Intrinsic** | ** ** |
| ** **                                           | ** ** | **Options**        | ** ** | **Price**    | ** ** | **Life (Years)** | ** ** | **Value**     | ** ** |
|                                                 |       |               |       |         |       |                  |       |          |       |
| Options  outstanding at December 31, 2005            |       | 1,243              |       | $            | 20.90      |                  |       |          |       |   |
| Exercised                                            |       | (14                | )          | 7.45         |       |                  |       |          |       |
| Forfeited                                            |       | (35                | )          | 23.59        |       |                  |       |          |       |
| Expired                                              |       | (9                 | )          | 24.26        |       |                  |       |          |       |
| Options  outstanding at July 1, 2006                 |       | 1,185              |       | $            | 20.96      |                  | 3.95       |          | $          | 1,943 |   |
|                                                 |       |               |       |         |       |                  |       |          |       |
| Options  vested and expected to vest at July 1, 2006 |       | 1,152              |       | 20.78        |       | 3.96                  |       | $             | 1,943      |   |
|                                                 |       |               |       |         |       |                  |       |          |       |
| Options exercisable at July 1, 2006                  |       | 967                |       | $            | 19.53      |                  | 3.97       |          | $          | 1,943 |   |

 

The total intrinsic value of options exercised duringthe two quarters ended July 1, 2006 totaled approximately $0.1 million.  The total intrinsic value of optionsexercised during the two quarters ended July 2, 2005 totaled approximately $0.1million.  The weighted average fair valueof stock option grants was $11.30 for the first two quarters of fiscal2005.  No stock options were granted inthe first two quarters of fiscal 2006.

The fair value of optionsgranted in the two quarters of fiscal 2005 was estimated using the Black-Scholesoption valuation model that used the assumptions noted in the table below.Expected volatility and expected dividend yield are based on actual historicalexperience of the Company’s stock. The expected life represents the period oftime that options granted are expected to be outstanding. The risk-free rate isbased on the U.S. Treasury security with terms equal to the expected time ofexercise as of the grant date.
|                         | ** ** | **Two Quarters Ended** |
|-------------------------|------------|------------------------|
| ** **              | ** ** | **July 2, 2005**       |
| Risk-free interest rate |       | 3.7%                   |
| Expected dividend yield |       | 0.0%                   |
| Volatility              |       | 65.5%                  |
| Expected life           |       | 5 years                |

 

For the quarter and twoquarters ended July 1, 2006, stock option expense was recognized on astraight-line basis over the four year vesting period.  Approximately $0.3 million and $0.6 million,respectively, was charged to expense in the quarter and two quarters ended July1, 2006 related to stock options. The Company has applied a weighted averageforfeiture assumption of 15.03% in the calculation of such expense.

As of July 1, 2006, therewas approximately $1.1 million of unrecognized compensation cost related tonon-vested stock options, which is expected to be recognized over aweighted-average period of approximately one year. 

Cash received from optionexercises during the two quarters ended July 1, 2006 was approximately $0.1million. The total tax benefit generated from options granted prior to December31, 2005, which were exercised during the two quarters ended July 1, 2006, wasapproximately $28,000, which was credited to additional paid-in capital.

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***Restricted Share Awards****. *During the firstfiscal quarter of 2006, the Company’s Board of Directors approved a grant of599,096 shares of restricted common stock to various employees and executivesof the Company.  The restricted sharegrants were valued at the closing stock price on the date of the grant, March27, 2006, which was $13.14.  Therestricted share grants include both time-vesting and performance-vestingrestricted shares.  The time-vestingshares (273,451 awards) vest 20% per year beginning November 30, 2006 andending November 30, 2010.  Theperformance-vesting shares (325,645 awards) vest upon achievement of certainoperational milestones - such as obtaining sources for “doctors only” lenses oncompetitive terms, development of certain contact lens products and theachievement of an eight quarter cumulative financial target of at least $81million consolidated earnings before taxes by or before the end of fiscal 2010.  Both the time-vesting and the performance-vestingshares are subject to various change in control provisions involving theCompany and its subsidiaries that may result in the accelerated vesting ofunvested shares as well as conversion of unvested shares into a cash amount atthe time of a change in control.

The Company also granted 50,000 shares of restrictedcommon stock to its five non-employee directors.  These grants vest equally over a three-yearperiod ending March 27, 2009; the vesting of these awards will be acceleratedupon a change in control of the Company. The restricted share grants were also valued at the closing stock priceon the date of the grant, March 27, 2006, which was $13.14.  An additional 2,500 shares of restrictedcommon stock were granted to one non-employee director.  This restricted share grant was valued at theclosing stock price on the date of the grant, March 29, 2006, which was $13.28and vests on July 28, 2006. 

The Company’s activity relating to restricted shareawards during the first two quarters of fiscal 2006 was as follows (inthousands, except fair values):
| ** **                     | ** ** | **Number of Restricted** | ** ** | **Weighted Average  Grant Date Fair** | ** ** |
|--------------------------------|------------|------------------------------------|------------|------------------------------------------------------|------------|
| ** **                     | ** ** | **Share Awards**              | ** ** | **Value Per Award**                        | ** ** |
| Unvested at December  31, 2005 |       | 36                                 |       | $                                                    | 17.82      |   |
| Granted                        |       | 652                                |       | 13.14                                                |       |
| Vested                         |       | (4                                 | )          | 22.69                                                |       |
| Forfeited and expired          |       | —                             |       | —                                               |       |
| Unvested at April 1,  2006     |       | 684                                |       | $                                                    | 13.51      |   |
| Vested                         |       | (2                                 | )          | 18.84                                                |       |
| Forfeited and expired          |       | (1                                 | )          | 13.14                                                |       |
| Unvested at July 1, 2006       |       | 681                                |       | $                                                    | 13.49      |   |

 

For the two quarters ended July 1, 2006, approximately$0.4 million was charged to expense relating to the amortization of thetime-vested restricted share awards.  AtJuly 1, 2006, unrecognized compensation expense, including estimatedforfeitures related to time-vested restricted share awards totaled approximately$4.1 million and will be recognized over a weighted average period of 4.13years.  No restricted share awards vestedduring the quarter and two quarters ended July 2, 2005.  The fair value of restricted share awardsthat vested during the quarter and two quarters ended July 1, 2006 totaled approximately$26,000 and $82,000, respectively. 

Expense related to performance-vesting shares will berecognized once it is determined “probable” that the operational milestoneswill be met.  At the time the achievementof these operational milestones are considered “probable”, the Company willrecord a cumulative catch-up for the amount of expense that should have beenrecognized from the date of the grant to the date it was determined achievementwas probable and recognize the remaining expense on a straight-line basisthrough the estimated date of achievement. Currently the Company believes it is not probable that the milestoneswill be met. Total gross compensation expense, excluding any estimate offorfeitures related to the performance-vesting shares, will be approximately$4.3 million.

**NOTE 6. DEBT OBLIGATIONS**

The Company has a loan agreement with a U.S. bankproviding for a revolving credit facility. On January 13, 2006, theCompany entered into a modified agreement which modified this loan agreementeffective as of

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December 30,2005. The modified loan agreement provides for borrowings of up to$30 million, $35 million, or $40 million, depending on the Company’sminimum fixed coverage ratio assessed on a quarterly basis, as defined in theagreement. As of July 1, 2006, the Company could borrow up to $40 million.  Subsequent to the second quarter of fiscal2006, the Company could borrow up to $30 million.  Additionally, the agreement provides forletters of credit up to a maximum of $15 million outstanding or payable atany time. The amount of any letters of credit outstanding is deducted from theamount available for borrowing. The maturity date of the loan agreement remainsFebruary 27, 2007, as such, the amounts due under the line of credit arereported as current liabilities in the condensed consolidated balance sheet asof July 1, 2006.  The Company intends torenew or refinance this line of credit prior to the maturity date.  Outstanding borrowings on the revolvingcredit facility bear interest at a floating rate equal to the lender’s primeinterest rate plus a margin or the lender’s LIBOR rate plus a margin. Theinterest rate is adjusted quarterly and ranges between prime minus0.25 percent and prime plus 0.25 percent or between the applicable LIBORrate plus 1.75 percent and the applicable LIBOR rate plus2.25 percent, depending on the Company’s maximum leverage ratio, asdefined in the agreement. As of July 1, 2006, the prime rate margin is 0percent and the LIBOR rate margin is 2.00 percent. Interest is payablemonthly. As of July 1, 2006, the Company’s outstanding borrowings on the creditfacility, including bank overdrafts, were $19.5 million. Of this amount,$9.0 million bore interest at the lender’s LIBOR rate plus2.00 percent (7.32% at July 1, 2006) and the remaining $10.5 million boreinterest at the lender’s prime rate plus 0 percent (8.25% at July 1,2006). The facility requires the quarterly payment of an unused credit feewhich ranges from 0.25 percent to 0.38 percent, depending on theCompany’s maximum leverage ratio.

Outstanding balances onthe credit facility are secured by substantially all of the Company’s U.S.assets, subsidiary debt instruments, 100 percent ownership interests inall domestic subsidiaries and 65 percent ownership interests in foreignsubsidiaries directly owned by the Company. The modified loan agreementincludes various financial covenants including a capital expenditure limit, amaximum leverage ratio and a minimum fixed charge coverage ratio. The modifiedloan agreement does not permit the Company or its subsidiaries to dissolve,sell, dispose or merge all of their assets or acquire all of the assets of anyentity without the written consent of the U.S. bank, unless the transactionmeets the definition of a “Permitted Acquisition Basket”, as defined in theagreement. The modified loan agreement also places a limit on the amount theCompany can loan to any entity, outside the normal course of business.Additionally, the modified agreement allows the Company to declare or pay cashdividends, to repurchase its stock or to perform other similar equitytransactions if such transactions would not exceed $15 million in any fiscalyear and subject to other terms. This agreement defines several customaryevents of default including any material adverse change or any event thatoccurs which may cause a material adverse change in the Company’s or itssubsidiaries’ condition.

The Company’s Singaporebank term loan contains various financial covenants including minimums on networth and shareholders’ funds of the Singapore operations. 1-800CONTACTS, INC. has guaranteed this term loan.

Cross default clausesexist such that if the Company were in default on its U.S. debt, the Companywould also be in default on its Singapore debt. If the Company were in defaulton its Singapore bank term loan, the Company would also be in default on itsnote payable to the former parent of ClearLab International and its loanagreement with its U.S. bank.

**NOTE 7. COMMITMENTS AND CONTINGENCIES**

***Legal and Regulatory Matters***

The sale and delivery of contact lenses are governedby both federal and state laws and regulations, including the federal Fairnessto Contact Lens Consumer Act (“FCLCA”). The FCLCA requires that contact lensesonly be sold to customers based on the seller obtaining a copy of theprescription itself or verifying the prescription by direct communication withthe customer’s prescriber. Consistent with this requirement, the Company’scurrent operating practice is to require all customers to provide either avalid copy of their prescription or the contact information for theirprescriber so that the Company can verify their prescription by directcommunication with their prescriber. If the Company does not have a valid copyof the customer’s prescription, the Company directly communicates to thecustomer’s prescriber the precise prescription information received from thecustomer and, in accordance with the FCLCA, informs the prescriber that it willproceed with the sale based on this prescription information unless theprescriber advises it within eight business hours that such prescriptioninformation is expired

13

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orotherwise invalid. If the prescriber properly advises the Company within thistime period that the customer’s prescription is expired or otherwise invalid,the Company’s practice is to cancel the customer’s order. On the other hand, ifthe prescriber either advises the Company that the prescription is valid orfails to respond properly within the required time period, the Company’spractice is to complete the sale based on the prescription informationcommunicated to the prescriber, as expressly permitted by the FCLCA. TheCompany retains copies of the written prescriptions that it receives andmaintains records of its communications with the customer’s prescriber. TheFCLCA provides for several means of direct communication with eye carepractitioners, and the Company may alter its prescription verificationprocedures from time to time in keeping with the FCLCA and FTC guidelines.

From time to time, theCompany is involved in legal matters generally incidental to its business. Itis the opinion of management, after discussion with legal counsel that, exceptfor legal and professional fees that the Company incurs from time to time, theultimate dispositions of all of these matters will not have a material impacton the financial position, liquidity or results of operations of the Company.However, there can be no assurance that the Company will be successful in itsefforts to satisfactorily resolve these matters, and the ultimate outcome couldresult in a material negative impact on the Company’s financial position,liquidity or results of operations.

***AdvertisingCommitments***

As of July 1, 2006, the Company had entered intocertain noncancelable commitments with various advertising companies that willrequire the Company to pay approximately $3.2 million during the remainder of2006.

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**NOTE 8.  SEGMENTINFORMATION**

The Company has two operating segments. These operatingsegments represent components of the Company for which separate financialinformation is available and are evaluated regularly by management indetermination of resource allocation and performance assessment. The Company’sU.S. Retail segment includes the operations of 1-800 CONTACTS, a directmarketer of replacement contact lenses. The Company’s International segmentincludes the operations of ClearLab International and ClearLab UK, developers,marketers, manufacturers and distributors of contact lenses.  The U.S.Retail segment includes revenue from the optical retail store agreement and theInternational segment includes revenue from the Japanese license and royaltyagreement.  Operating segment informationfor the quarter and two quarters ended July 2, 2005 and July 1, 2006 is asfollows (in thousands):
| **Quarter Ended July 2, 2005**                   | ** ** | **U.S. Retail** | ** ** | **International** | ** ** | **Eliminations** | ** ** | **Total** | ** ** |
|----------------------------------------------------------------------|------------|----------------------|------------|-------------------|------------|------------------|------------|-----------|------------|
|                                                                 |       |                 |       |              |       |             |       |      |       |
| Net sales (International segment includes intersegment  sales of $3) |       | $                    | 56,767     |              | $          | 4,601            |       | $         | (3         | ) | $ | 61,365 |   |
| Gross  profit                                                        |       | 22,857               |       | 703               |       | 108              |       | 23,668    |       |
| Research  and development                                            |       | —               |       | 811               |       | —           |       | 811       |       |
| Other  selling, general and administrative expense                   |       | 10,794               |       | 1,510             |       | —           |       | 12,304    |       |
| Income  (loss) from operations                                       |       | $                    | 4,389      |              | $          | (1,970           | )          | $         | 108        |   | $ | 2,527 |   |

 
| **Quarter Ended July 1, 2006**                     | ** ** | **U.S. Retail** | ** ** | **International** | ** ** | **Eliminations** | ** ** | **Total** | ** ** |
|----------------------------------------------------|------------|-----------------|------------|-------------------|------------|------------------|------------|-----------|------------|
|                                               |       |            |       |              |       |             |       |      |       |
| Net  sales                                         |       | $               | 57,734     |              | $          | 5,421            |       | $         | —     |   | $ | 63,155 |   |
| Gross  profit (loss)                               |       | 22,774          |       | (180              | )          | 38               |       | 22,632    |       |
| Research  and development                          |       | —          |       | 1,637             |       | —           |       | 1,637     |       |
| Other  selling, general and administrative expense |       | 12,569          |       | 3,353             |       | —           |       | 15,922    |       |
| Income  (loss) from operations                     |       | $               | 5,755      |              | $          | (5,546           | )          | $         | 38         |   | $ | 247 |   |

 
| **Two Quarters Ended July 2,   2005**                                  | ** ** | **U.S. Retail** | ** ** | **International** | ** ** | **Eliminations** | ** ** | **Total** | ** ** |
|------------------------------------------------------------------------|------------|-----------------|------------|-------------------|------------|------------------|------------|-----------|------------|
|                                                                   |       |            |       |              |       |             |       |      |       |
| Net sales (International segment includes intersegment  sales of $374) |       | $               | 113,133    |              | $          | 8,889            |       | $         | (374       | ) | $ | 121,648 |   |
| Gross  profit                                                          |       | 45,044          |       | 1,306             |       | (174             | )          | 46,176    |       |
| Research  and development                                              |       | —          |       | 1,866             |       | —           |       | 1,866     |       |
| Other  selling, general and administrative expense                     |       | 20,872          |       | 2,949             |       | —           |       | 23,821    |       |
| Income  (loss) from operations                                         |       | $               | 8,792      |              | $          | (3,977           | )          | $         | (174       | ) | $ | 4,641 |   |

 

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| **Two Quarters Ended July 1,   2006**              | ** ** | **U.S. Retail** | ** ** | **International** | ** ** | **Eliminations** | ** ** | **Total** | ** ** |
|----------------------------------------------------|------------|-----------------|------------|-------------------|------------|------------------|------------|-----------|------------|
|                                               |       |            |       |              |       |             |       |      |       |
| Net  sales                                         |       | $               | 116,907    |              | $          | 9,739            |       | $         | —     |   | $ | 126,646 |   |
| Gross  profit                                      |       | 46,398          |       | 458               |       | 254              |       | 47,110    |       |
| Research  and development                          |       | 10              |       | 2,955             |       | —           |       | 2,965     |       |
| Other  selling, general and administrative expense |       | 24,282          |       | 5,319             |       | —           |       | 29,601    |       |
| Income (loss) from operations                      |       | $               | 12,761     |              | $          | (8,405           | )          | $         | 254        |   | $ | 4,610 |   |

 

The following reconciles total segment income fromoperations to income before provision for income taxes for the quarter and twoquarters ended July 2, 2005 and July 1, 2006 as follows (in thousands):
| ** **                                              | ** ** | **Quarter Ended**     | ** ** |
|---------------------------------------------------------|------------|----------------------------|------------|
| ** **                                              | ** ** | **July 2, 2005** | ** ** | **July 1, 2006** | ** ** |
| Income  from operations                                 |       | $                          | 2,527      |   | $ | 247 |   |
| Interest  expense, net                                  |       | (347                       | )          | (433 | ) |
| Foreign  currency exchange transaction gain (loss), net |       | (748                       | )          | 789 |   |
| Other,  net                                             |       | (71                        | )          | (4 | ) |
| Income before provision for income taxes                |       | $                          | 1,361      |   | $ | 599 |   |

 
| ** **                                              | ** ** | **Two Quarters Ended** | ** ** |
|---------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                              | ** ** | **July 2, 2005**       | ** ** | **July 1, 2006** | ** ** |
| Income  from operations                                 |       | $                                | 4,641      |   | $ | 4,610 |   |
| Interest  expense, net                                  |       | (648                             | )          | (846 | ) |
| Foreign  currency exchange transaction gain (loss), net |       | (1,060                           | )          | 1,519 |   |
| Other,  net                                             |       | (99                              | )          | (8 | ) |
| Income before provision for income taxes                |       | $                                | 2,834      |   | $ | 5,275 |   |

 

Identifiablesegment assets are as follows (in thousands):

| Fiscal Year Ended December 31,   2005 | ** ** | **U.S. Retail** | ** ** | **International** | ** ** | **Total** | ** ** |
|----------------------------------------------------------------|------------|----------------------|------------|-------------------|------------|-----------|------------|
|                                                           |       |                 |       |              |       |      |       |
| Long-lived assets, net                                         |       | $                    | 35,130     |              | $          | 43,827    |       | $ | 78,957 |   |
| Total assets                                                   |       | 54,758               |       | 60,187            |       | 114,945   |       |
|                                                                |            |                      |            |                   |            |           |            |  |  |  |

 

| Quarter Ended July 1, 2006 | ** ** | **U.S. Retail** | ** ** | **International** | ** ** | **Total** | ** ** |
|----------------------------|------------|-----------------|------------|-------------------|------------|-----------|------------|
|                       |       |            |       |              |       |      |       |
| Long-lived assets, net     |       | $               | 33,828     |              | $          | 45,997    |       | $ | 79,825 |   |
| Total  assets              |       | 51,643          |       | 61,360            |       | 113,003   |       |
|                            |            |                 |            |                   |            |           |            |  |  |  |

 

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**Item 2.**    ***Management’s Discussion and Analysis of FinancialCondition and Results of Operations***

**Overview**

The Company is a direct marketer of replacementcontact lenses and is also a manufacturer, developer and distributor of its ownbranded and private label contact lenses through its operations in Singaporeand the United Kingdom.  The Company’sU.S. Retail operations sell almost all of the popular brands of contactslenses, including those manufactured by Johnson & Johnson Vision Care, CIBAVision, Bausch & Lomb and CooperVision. ClearLab is the Company’s international contact lens development,manufacturing and distribution business. On July 26, 2006 ClearLab introduced its AquaSoft Singles product whichis still currently under development. The Company has recently engaged an investment banking firm to evaluatea broad range of strategic alternatives in an effort to capitalize on the valueof ClearLab and this new product. Among the options being considered tomaximize the value for the Company’s shareholders is the possible separation ofClearLab from the Company.

***Japanese License and RoyaltyAgreement.***  InDecember 2004, the Company signed an agreement which grants Menicon Co., LTD(Menicon), Japan’s largest independent contact lens manufacturer, exclusiverights to develop, manufacture and market certain disposable contact lenses andrelated intellectual property in Japan. Under the terms of the agreement, Menicon licenses from the Companydifferent types of intellectual property, including contact lens material,manufacturing technology and related knowledge. As of the second quarter of fiscal 2006, the Company has received atotal of $10 million under the agreement; the Company will receive anadditional $3 million of guaranteed payments under this agreement throughDecember 31, 2007.

***Optical Retail Store Agreement.******  ***Duringthe latter part of 2004, the Company entered into an agreement with a regionaloptical retail chain in Utah. Under the terms of the agreement, the companieseffectively combined their contact lens business in Utah and began jointlyserving these customers in December 2004. The objective of this agreementis to partner with an optical retailer to create a seamless experience forconsumers that will include exams as well as in-store, phone and onlineservice.

Under the agreement, theCompany fulfills substantially all orders taken at the retail optical chain forcontact lenses and both parties share in the operating results of the combinedcontact lens business based on a certain allocation percentage. However, duringthe term of the agreement, the Company guaranteed that the retail chain wouldreceive at least $0.5 million of annual earnings under the arrangement.Additionally, the Company committed to purchase approximately $0.3 million peryear in inventory from the retail chain’s source of supply. Under thearrangement, the Company records gross revenues for all orders fulfilled andrecords selling, general and administrative expense for the retail chain’sshare of the net operating results.

This agreement expired inJanuary 2006; however, both parties continue to operate their contact lensbusinesses jointly as they work towards confirming the terms of a newarrangement.  The Company is deferringany decision to launch a national network with optical retail stores until aresolution can be found to industry practices relating to “doctors only” lensesand after a review of the Company’s progress with the doctor referral network.

***Doctor Referral Network.******  ***The Company iscurrently expanding its national doctor referral network with select opticalretail chains and independent practitioners and plans to have approximately1,000 locations for referrals in its network by the end of the third quarter offiscal 2006. Under this referral program, when a current or potential customerneeds a new contact lens prescription, the Company can facilitate the processof obtaining an eye examination through this network of providers. This processminimizes the interruptions in product consumption for the consumer andimproves the Company’s ability to capture new customers and retain its currentcustomers.

The Company is developingthis referral program under the brand name ProNet. ProNet will serve as thedivision of the Company dedicated to the national doctor referral network. TheCompany launched a website in support of the ProNet brand duringMarch 2006. This website serves as a tool to assist ProNet in recruitingproviders and communicating with the optical community.

***Supplier Agreements.******  ***TheCompany has agreements with its top two vendors for improved pricing andmarketing support. This support comes in the form of cooperative marketing andrebate programs designed to promote the manufacturer’s products and buildsales. As part of its ongoing relationship with its suppliers, the

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Companyperiodically reviews its specific marketing plans and negotiates cooperativemarketing programs and product pricing.

# **RegulatoryConsiderations**

***Fairness to Contact Lens Consumer Act. ***In November2003, Congress passed the Fairness to Contact Lens Consumer Act (“FCLCA”),which establishes a national uniform standard for both eye care practitionersand direct marketers with regard to releasing and verifying consumer contactlens prescriptions as well as other requirements relating to the sale ofcontact lenses.  The FCLCA becameeffective February 4, 2004, and now requires all eye care practitioners to givepatients a copy of their prescription as soon as they have been fitted forcontact lenses, whether the patients ask for it or not.  It also directs contact lens sellers tocontact eye care practitioners to request verification of consumerprescriptions before shipping all orders (if the prescription is not already onfile), and it provides that failure to respond within eight business hoursshall result in the prescription being presumed valid, thereby eliminating theability of eye care practitioners to impede sales by direct marketers simply byignoring or refusing to respond to their requests to verify prescriptions.  The FCLCA also provides that prescriptionswill be valid for a minimum of at least one year (absent some special medicalreason justifying a shorter period).  Italso directed the Federal Trade Commission (“FTC”) to conduct a studyexamining the strength of competition in the market for contact lenses and tosubmit a report to Congress within twelve months of the FCLCA effective date.This FTC completed and published this study on February 15, 2005, with norecommendations for further changes in federal law.

Satisfyingthe prescription verification requirement of the FCLCA obligates a contact lensseller either to obtain a copy of the prescription itself or to verify theprescription by direct communication with the customer’s prescriber.  Consistent with this requirement, the Company’scurrent operating practice is to require all customers to provide either avalid copy of their prescription or the contact information for theirprescriber so that the Company can verify their prescription by directcommunication with their prescriber.  Ifthe Company does not have a valid copy of the customer’s prescription, theCompany directly communicates to the customer’s prescriber the preciseprescription information received from the customer and informs the prescriberthat it will proceed with the sale based on this prescription informationunless the prescriber advises it within eight business hours that suchprescription information is expired or otherwise invalid.  If the prescriber properly advises the Companywithin this time period that the customer’s prescription is expired orotherwise invalid, the Company’s practice is to cancel the customer’sorder.  On the other hand, if theprescriber either advises the Company that the prescription is valid or failsto respond properly within the required time period, the Company’s practice isto complete the sale based on the prescription information communicated to theprescriber, as expressly permitted by the FCLCA.  The Company retains copies of the written prescriptionsthat it receives and maintains records of its communications with the customer’sprescriber.  The FCLCA provides forseveral means of direct communication with eye care practitioners, and theCompany may alter its prescription verification procedures from time to time inkeeping with the FCLCA and FTC guidelines.

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**Resultsof Operations**

The Company’s fiscal year consists of a 52/53-weekperiod ending on the Saturday nearest to December 31. The Company’s 2006 fiscalyear is a 52-week year and will end on December 30, 2006.

The Company has two operating segments referred tobelow.  The Company’s domestic segment isrepresented by operations within the U.S. and is referred to as “U.S. Retail”by the Company, whereas the Company’s international segment is represented byoperations in both Singapore and the U.K. and is referred to as “ClearLab” bythe Company.

The following table presents the Company’s results ofoperations expressed as a percentage of net sales for the periods indicated:
| ** **                                            | ** ** | **Quarter Ended** | ** ** | **Two Quarters Ended** | ** ** |
|-------------------------------------------------------|------------|------------------------|------------|----------------------------------|------------|
| ** **                                            | ** ** | **July 2,**       | ** ** | **July 1,**                 | ** ** | **July 2,** | ** ** | **July 1,** | ** ** |
| ** **                                            | ** ** | **2005**               | ** ** | **2006**                         | ** ** | **2005** | ** ** | **2006** | ** ** |
| NET SALES                                             |       | 100.0                  | %          | 100.0                            | %          | 100.0 | % | 100.0 | % |
| COST OF GOODS  SOLD                                   |       | 61.4                   |       | 64.2                             |       | 62.0 |   | 62.8 |   |
| Gross profit                                          |       | 38.6                   |       | 35.8                             |       | 38.0 |   | 37.2 |   |
|                                                  |       |                   |       |                             |       |   |   |   |   |
| SELLING, GENERAL  & ADMINISTRATIVE EXPENSES:      |       |                   |       |                             |       |   |   |   |   |
| Advertising                                           |       | 11.6                   |       | 5.9                              |       | 11.2 |   | 6.1 |   |
| Legal and professional                                |       | 1.5                    |       | 1.8                              |       | 1.8 |   | 1.8 |   |
| Research and development                              |       | 1.3                    |       | 2.6                              |       | 1.5 |   | 2.3 |   |
| Other selling, general & administrative           |       | 20.1                   |       | 25.1                             |       | 19.7 |   | 23.4 |   |
| Total selling,  general & administrative expenses |       | 34.5                   |       | 35.4                             |       | 34.2 |   | 33.6 |   |
| INCOME FROM  OPERATIONS                               |       | 4.1                    |       | 0.4                              |       | 3.8 |   | 3.6 |   |
| OTHER INCOME  (EXPENSE), net                          |       | (1.9                   | )          | 0.6                              |       | (1.5 | ) | 0.5 |   |
| INCOME BEFORE  PROVISION FOR INCOME TAXES             |       | 2.2                    |       | 1.0                              |       | 2.3 |   | 4.1 |   |
| PROVISION FOR  INCOME TAXES                           |       | (2.1                   | )          | (4.2                             | )          | (2.1 | ) | (4.8 | ) |
| NET INCOME (LOSS)                                     |       | 0.1                    | %          | (3.2                             | )%         | 0.2 | % | (0.7 | )% |

 

***Net sales***.  Net sales for the quarter ended July 1, 2006increased 2.9% to $63.2 million from $61.4 million for the quarter ended July2, 2005.  For the two quarters ended July1, 2006, net sales increased 4.1% to $126.6 million from $121.6 million for thetwo quarters ended July 2, 2005.  Netsales for the Company’s U.S. Retail operations, for the second quarter offiscal 2006 and the first two quarters of fiscal 2006, were $57.7 million and$116.9 million, respectively, an increase from the prior year periods of 1.7%and 3.3%, respectively.  U.S. Retail netsales increased primarily from an increase in sales on the Internet due mainlyto upgrades the Company made to its website during fiscal 2005 and fromtargeted online marketing programs.

During the quarter and two quarters ended July 1, 2006the Company spent approximately $3.7 million and $7.7 million, respectively, onadvertising.  During the quarter and twoquarters ended July 2, 2005 the Company spent approximately $7.1 million and$13.7 million, respectively, on advertising . The Company’s reduction in advertising spending during the first twoquarters from the first two quarters of fiscal 2005 is consistent with theCompany’s strategy to spend less on advertising in fiscal 2006 as the Companyfocuses on addressing the threat of ‘doctors only’ lenses.  The Company expects that U.S. Retail netsales will continue to be impacted by the decrease in advertising spendingduring fiscal 2006.  Additionally, U.S.Retail net sales growth continues to be constrained by lost sales related tocertain ‘doctors only’ contact lenses that the Company cannot obtain in orderto fill orders for customers who wish to purchase the product.

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Net sales for ClearLab for thesecond quarter of fiscal 2006 and the first two quarters of fiscal 2006 were$5.4 million and $9.7 million, respectively. Net sales for ClearLab for the second quarter of fiscal 2005 and thefirst two quarters of fiscal 2005 were $4.6 million and $8.9 million,respectively.  ClearLab’s resultsfor the second quarter and first two quarters of fiscal 2006 included $1.5million and $3.0 million, respectively, in license fees from the Company’sJapanese license agreement, compared to $1.0 million and $2.0 million in thesecond quarter and first two quarters of fiscal 2005, respectively.  The increase in license fees for the firsttwo quarters of fiscal 2006 was offset by a decrease of $0.4 million inintercompany sales to the Company’s U.S. Retail business, as ClearLab recordedno sales to the U.S. Retail business in the first two quarters of fiscal2006.  ClearLab’s sales have beennegatively impacted by sales delays to external customers due to product andpackaging improvements, including the recent introduction of ClearLab’s newlens design and manufacturing process improvements.

***Gross profit.***  Consolidated gross profit as a percentage ofnet sales decreased to 35.8% for the quarter ended July 1, 2006 from 38.6% forthe quarter ended July 2, 2005.  For thetwo quarters ended July 1, 2006, consolidated gross profit as a percentage ofnet sales decreased to 37.2% from 38.0% for the two quarters ended July 2,2005.

Gross profit as a percentage of net sales for theCompany’s U.S. Retail operations decreased to 39.4% in the second quarter offiscal 2006 from 40.3% in the second quarter of fiscal 2005.  Gross profit as a percentage of net sales forthe Company’s U.S. Retail operations decreased slightly to 39.7% from 39.8% forthe two quarters ended July 1, 2006 and July 2, 2005, respectively.  This decrease from last year was due largelyto increases in select product costs and shipping rates.  The Company expects the U.S. Retail gross profitmargin for the balance of fiscal 2006 to approximate the margin achieved forthe second quarter of fiscal 2006.

Grossprofit (loss) as a percentage of net sales for ClearLab was (3.3)% and 4.7% forthe second quarter and two quarters ended July 1, 2006, respectively.  Gross profit as a percentage of net sales forClearLab was 15.3% and 14.7% for the second quarter and two quarters ended July2, 2005.  The second quarter margin forfiscal 2006 was impacted by provisions of approximately $1.2 million recordedon certain inventory.  The majority ofthis inventory was produced prior to the introduction of a new daily lensdesign.  The Company expects to seeimprovement in gross margins from ClearLab during the remainder of fiscal 2006.

***Advertisingexpense. ***Advertisingexpense for the quarter ended July 1, 2006 decreased to $3.7 million from $7.1million for the quarter ended July 2, 2005. As a percentage of net sales, advertising expense for the second quarterof fiscal 2006 decreased to 5.9% from 11.6% for the second quarter of fiscal2005.  For the two quarters ended July 1,2006, advertising expense decreased to 6.1% from 11.2% for the first twoquarters of fiscal 2005.  The Companyexpects to decrease fiscal 2006 advertising expenses by approximately $10 to$12 million from fiscal 2005 as it continues to focus its resources towardslegislative and public relations initiatives. If, however, opportunitiespresent themselves, the Company may increase advertising spending abovecurrently planned levels.  The Company’sexperience has been that increases in advertising expenditures have a directimpact on the growth of net sales not only in the current period but also infuture periods.

The Company expenses alladvertising costs when the advertising first takes place. As a result,quarter-to-quarter comparisons are impacted within and between quarters by thetiming of television, radio and Internet advertisements and by the mailing ofthe Company’s printed advertisements. The volume of mailings and otheradvertising may vary in different quarters and from year to year depending onthe Company’s assessment of prevailing market opportunities.

***Legaland professional fees. ***Legaland professional fees for the quarter ended July 1, 2006 increased$0.2 million, or 24%, from the second quarter ended July 2, 2005.  As a percentage of net sales, legal andprofessional fees increased to 1.8% for the second quarter of fiscal 2006 from1.5% for the second quarter of fiscal 2005. For the two quarters ended July 1, 2006, legal and professional feesincreased by $0.1 million to $2.2 million from the two quarters ended July 2,2005.  As a percentage of net sales,legal and professional fees remained constant at 1.8% for the first twoquarters of fiscal 2006 compared to the first two quarters of fiscal 2005.

During the first twoquarters of fiscal 2006, the Company continued to incur professional fees forSarbanes-Oxley compliance, and other internal control initiatives, as well asongoing legal, lobbying and

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regulatoryinitiatives. The Company will continue to focus its efforts on compliance withfederal rules and regulations as well as continue to support legal andlegislative initiatives that it believes will benefit contact lenswearers.  As such, the Company expects toexperience continued increases in legal and professional fees during thebalance of fiscal 2006 to support these legislative initiatives.

***Research and developmentexpenses.***  Researchand development expenses for the quarter ended July 1, 2006 increased to $1.6million, or 2.6% of net sales, from $0.8 million, or 1.3% of net sales, fromthe quarter ended July 2, 2005.  For thetwo quarters ended July 1, 2006, research and development expenses were $3.0million, or 2.3% of net sales, up from $1.9 million, or 1.5% of net sales, forthe two quarters ended July 2, 2005. During the first two quarters of fiscal 2006, the Company continued tofund research and development efforts for ClearLab’s operations.

Total fiscal 2006 research and development costs willbe dependent on progress with research and development efforts relating toexpanding ClearLab’s product offering and developing its intellectual property,including it’s recently introduced AquaSoft Singles product.

***Otherselling, general and administrative expenses.***  Other selling, general and administrativeexpenses for the quarter ended July 1, 2006 increased approximately $3.6million, or 29.4%, to $15.9 million from the quarter ended July 2, 2005.  As a percentage of net sales, other selling,general and administrative expenses for the second quarter of fiscal 2006 alsoincreased to 25.1%, from 20.1% for the second quarter of fiscal 2005. As apercentage of net sales, other selling, general and administrative expenses forthe two quarters ended July 1, 2006 increased to 23.4% from 19.7% for the twoquarters ended July 2, 2005, as such expenses increased by approximately $5.8million for the same period.  The resultsfor the second quarter of fiscal 2006 include approximately $0.3 million ofexpense related to stock options granted prior to fiscal 2006 and approximately$0.4 million of expense related to the restricted stock grants, compared toapproximately $39,000 of expense related to restricted stock grants in thesecond quarter of fiscal 2005.  Likewise,the results for the first two quarters of fiscal 2006 include approximately$0.6 million of expense related to stock options granted prior to fiscal 2006and approximately $0.4 million of expense related to restricted stock grants,compared to approximately $44,000 of expense related to restricted stock grantsin the first two quarters of fiscal 2005.

The Company’s U.S. Retailother selling, general and administrative expenses increased approximately $1.8million for the quarter ended July 1, 2006 from the quarter ended July 2,2005.  For the two quarters ended July 1,2006, U.S. Retail other selling, general and administrative expenses increased$3.4 million from the two quarters ended July 2, 2005.  Additionally, such expenses also increased asa percentage of net sales to 21.8% and 20.8%, respectively, for the quarter andtwo quarters ended July 1, 2006, compared to 19.0% and 18.4% for the quarterand two quarters ended July 2, 2005, respectively.  The majority of the increase for U.S. Retailfrom the quarter and two quarters ended July 2, 2005 related to plannedincreases in employee costs.  Theseincreases include restricted stock and stock option expense, as discussedabove, as well as employee costs to support current operations such as costs tostrengthen and build the Company’s information technology organization andcosts to support a retail network, an initiative which is currently focused onexpanding our doctor referral network.  Additionally,increases in other selling, general and administrative expenses related tosupporting the Company’s legislative efforts.

ClearLab’s other selling,general and administrative expenses increased by approximately $1.8 million forthe quarter ended July 1, 2006 from the quarter ended July 2, 2005. ClearLab’sother selling, general and administrative expenses increased by approximately$2.4 million for the two quarters ended July 1, 2006 from the two quartersended July 2, 2005.  A majority ofClearLab’s increase in both the quarter and two quarters ended July 1, 2006related to costs to strengthen its management team and costs related to theintroduction of the AquaSoft Singles product.

***Other income (expense), net.***  Other income (expense)  increased to approximately $0.4 million and$0.7 million for the quarter and two quarters ended July 1, 2006, respectively,from approximately $(1.2) million and $(1.8) million for the quarter and twoquarters ended July 2, 2005, respectively. For the second quarter of fiscal 2006, other income consisted ofapproximately $0.8 million in foreign currency exchange transaction gainsoffset by approximately $0.4 million in interest expense.  Other expense in the second quarter of fiscal2005 consisted mainly of approximately $0.7 million in foreign currencyexchange transaction losses and approximately $0.3 million in interest expense.  For the two quarters ended July 1, 2006 otherincome consisted mainly of approximately $0.8 million in interest expense and$1.5 million of foreign currency exchange transaction gains.  For the two quarters

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ended July 2, 2005,  otherexpense consisted mainly of interest expense of approximately $0.6 million andforeign currency exchange transaction losses of approximately $1.1million.  Interest expense is incurredprimarily due to the use of the Company’s credit facility and other debt.  The exchange gains and losses relateprimarily to intercompany loans to ClearLab.

***Income taxes.*** The Company is taxed in three separatejurisdictions -  the U.S., Singapore andthe United Kingdom.  The Company’seffective U.S. income tax rate for the two quarters ended July 1, 2006 wasapproximately 44%, as compared with the U.S. income tax rate for the twoquarters ended July 2, 2005 of 39%.  Theincrease in the effective U.S. income tax rate primarily resulted from theincrease in permanent nondeductible expenses, including those relating to theCompany’s lobbying efforts.

Duringthe second quarter of fiscal 2006 the Company elected not to finalize thepioneer tax certificate in order to renegotiate the potential benefits and timeperiod for a pioneer tax certificate in Singapore. Through the first quarter offiscal 2006, the Company’s Singapore operations had met the requirements forthe pioneer tax certificate in Singapore. This pioneer tax certificate allowedfor a seven-year tax holiday that reduced the Singapore statutory tax rate to0% on qualified income for 2003 and future periods through the end of the taxholiday. Without the tax holiday, the Singapore statutory tax rate is 20%.During the first two quarters of fiscal 2006, the Company did not record a taxbenefit for the loss from the operations of ClearLab International due to theuncertainty with respect to the realization of a tax benefit in Singaporerelating to losses.  In the first quarterof fiscal 2006 the Company recorded a current tax provision in Singapore due toJapanese withholding tax on payments received from the Japanese licenseagreement. The foreign tax credit for this Japanese withholding tax is noteligible for carryforward in the Singapore tax jurisdiction.

Forthe first two quarters of fiscal 2006, the Company recorded a valuationallowance for the full amount of deferred income tax assets in excess oftaxable temporary differences in Singapore and the U.K., as it is more likelythan not that these deferred tax assets will not be realized.

TheCompany expects that its fiscal 2006 effective income tax rates willapproximate 44% for the U.S. operations. For the U.K. and Singapore operations,the Company expects that the effective tax rate will be 0%, with the exceptionof the Japanese withholding tax on license payments made to ClearLabInternational. The Company’s effective income tax rates may change as facts andcircumstances change.

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**Liquidity and Capital Resources**

The Company’s principalsources of liquidity have been cash provided by operating activities andproceeds from debt financings.  TheCompany’s principal uses of cash have been to meet debt service requirements,finance acquisitions, finance capital expenditures, fund working capital needsand repurchase common stock.  The Companyanticipates that these uses will continue to be the principal demands on itscash in the future.  As of July 1, 2006,the Company had net working capital (deficit) of approximately $(18.9) million,compared to $7.7 million as of December 31, 2005.  This large decrease in net working capital inthe second quarter of fiscal 2006 relates to the Company’s line of credit thatis now classified as current on the condensed consolidated balance sheet as thematurity date is February 27, 2007.  TheCompany intends to renew or refinance this line of credit prior to the maturitydate.

The Company believes thatits cash on hand, together with cash generated from operating activities andthe borrowings available through its credit facility, will be sufficient tosupport planned operations through the foreseeable future.  The Company announced on July 26, 2006 thatit had engaged an investment bank to assist in performing a strategic review ofClearLab.  Based on its strategic review ofClearLab, the Company may determine to retain a portion or all of ClearLab andmay continue developing its operations and products.  In order to fully commercialize its products,particularly the AquaSoft Singles product, the Company anticipates thatClearLab will require significant additional funding over the foreseeablefuture, which may not be available through the Company’s cash flows fromoperations, and will likely require the Company to secure alternativefunding.  Should the Company’s plans orexpectations change, related to ClearLab or otherwise, the Company may be requiredto seek additional sources of funds and there can be no assurance that suchfunds will be available on satisfactory terms. Failure to obtain such financing could delay or prevent the Company’splanned growth, and could adversely affect the Company’s business, financialcondition, liquidity and results of operations.

As a result of regulatoryrequirements, the Company’s liquidity, capital resources and results ofoperations may be negatively impacted in the future if the Company incursincreased costs (including legal fees) or fines, is prohibited from selling itsproducts or experiences losses of a substantial portion of the Company’scustomers for whom the Company is unable to obtain or verify a prescription dueto the requirements of the FCLCA.

The Company has a loanagreement with a U.S. bank providing for a revolving credit facility. OnJanuary 13, 2006, the Company entered into a modified agreement whichmodified this loan agreement effective as of December 30, 2005. Themodified loan agreement provides for borrowings of up to $30 million, $35million or $40 million, depending on the Company’s minimum fixed coverage ratioassessed on a quarterly basis, as defined in the agreement. As of July 1, 2006,the Company could borrow up to $40 million. Subsequent to the second quarter of fiscal 2006, the Company couldborrow up to $30 million.  Additionally,the agreement provides for letters of credit up to a maximum of$15 million outstanding or payable at any time. The amount of any lettersof credit outstanding is deducted from the amount available for borrowing. Thematurity date of the loan agreement remains February 27, 2007, as such,the amounts due under the line of credit are reported as current liabilities inthe condensed consolidated balance sheet as of July 1, 2006. The Companyintends to renew or refinance this line of credit prior to the maturity date. However,there can be no assurance that the Company will be able to renew or refinancethe line of credit on satisfactory terms; which could adversely affect theCompany’s business, financial condition, liquidity and results of operations. Outstandingborrowings on the revolving credit facility bear interest at a floating rateequal to the lender’s prime interest rate plus a margin or the lender’s LIBORrate plus a margin. The interest rate is adjusted quarterly and ranges betweenprime minus 0.25 percent and prime plus 0.25 percent or between theapplicable LIBOR rate plus 1.75 percent and the applicable LIBOR rate plus2.25 percent, depending on the Company’s maximum leverage ratio, asdefined in the agreement. As of July 1, 2006, the prime rate margin is 0percent and the LIBOR rate margin is 2.00 percent. Interest is payablemonthly.  As of July 1, 2006, the Company’soutstanding borrowings on the credit facility, including bank overdrafts, were$19.5 million. Of this amount, $9.0 million bore interest at thelender’s LIBOR rate plus 2.00 percent (7.32% at July 1, 2006) and theremaining $10.5 million bore interest at the lender’s prime rate plus 0 percent(8.25% at July 1, 2006). The facility requires the quarterly payment of anunused credit fee which ranges from 0.25 percent to 0.38 percent,depending on the Company’s maximum leverage ratio.

Outstanding balances onthe credit facility are secured by substantially all of the Company’s U.S.assets, subsidiary debt instruments, 100 percent ownership interests inall domestic subsidiaries and 65 percent ownership interests in foreignsubsidiaries directly owned by the Company. The modified loan agreementincludes various

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financialcovenants including a capital expenditure limit, a maximum leverage ratio and aminimum fixed charge coverage ratio. The modified loan agreement does notpermit the Company or its subsidiaries to dissolve, sell, dispose or merge allof their assets or acquire all of the assets of any entity without the writtenconsent of the U.S. bank, unless the transaction meets the definition of a “PermittedAcquisition Basket”, as defined in the agreement. The modified loan agreementalso places a limit on the amount the Company can loan to any entity, outsidethe normal course of business. Additionally, the modified agreement allows theCompany to declare or pay cash dividends, to repurchase its stock or to performother similar equity transactions if such transactions would not exceed $15million in any fiscal year and subject to other terms. This agreement definesseveral customary events of default including any material adverse change orany event that occurs which may cause a material adverse change in the Company’sor its subsidiaries’ condition.

As of July 1, 2006, the Company had an unsecured, non-interest bearing note to ClearLab International’s chief technology officer with a principal balance of SGD$813,000 (USD$509,000). The note payable is discounted at 7%.  Payments are due in equal monthly installments through July 2007.

As of July 1, 2006, the Company had a term loanpayable to a Singapore bank with a principal balance of SGD$4,610,000(USD$2,886,000) that bears interest at 6.75% and is secured by substantiallyall of the assets of ClearLab International. Interest payments are due monthly. Principal payments are due in monthly installments through December2007.  This note also contains variousfinancial covenants including minimums on net worth and shareholders’funds.  1-800 CONTACTS, INC. hasguaranteed this term loan.

As of July 1,2006, the Company also had a note payable to the former parent of ClearLabInternational with a principal balance of SGD$6,892,000 (USD$4,315,000) thatbears interest at 6% and has a subordinated position to the term loan payableto the Singapore bank.  The note payableis discounted at 7%.  Interest paymentsare due monthly.  Principal payments aredue in monthly installments from January 2008 through December 2009.  1-800 CONTACTS, INC. has guaranteed thisnote.

Cross defaultclauses exist such that if the Company were in default on its U.S. debt, theCompany would also be in default on its Singapore debt. If the Company were indefault on its Singapore bank term loan, the Company would also be in defaulton its note payable to the former parent of ClearLab International and itsrestated loan agreement with its U.S. bank. As of July 1, 2006, the Company was in compliance with all of the restrictivecovenants in its loan documents.

***Cash flows from operatingactivities.***  Forthe two quarters ended July 1, 2006 and July 2, 2005, net cash provided byoperating activities was approximately $8.4 million and $4.7 million,respectively.  During the fiscal 2006period, cash provided by operating activities was primarily from net incomeadjusted for non-cash items such as depreciation, amortization and stockcompensation, increases in the income tax payable and accrued liabilities aswell as decreases in other current assets and inventories.  The increase in cash was partially offset bydecreases in accounts payable and unearned revenue as well as the adjustment tonet income for the foreign currency exchange gain.  In the fiscal 2005 period, cash was providedprimarily by net income adjusted for non-cash items and increases in accountspayable and accrued liabilities as well as by decreases in inventories.  The increase in cash was partially offset byincreases in accounts receivable, other receivables and other current assets aswell as from decreases in income taxes payables and unearned revenue.

***Cash flows from investing activities.***  The Company used approximately $4.3 millionand $5.7 million for investing activities in the two quarters ended July 1, 2006and July 2, 2005, respectively.  Duringthe first two quarters of fiscal 2006 , the Company paid approximately $0.5million towards software licenses.  Inthe first two quarters of fiscal 2005, the Company paid approximately $1.5million in deposits on manufacturing equipment at ClearLab.  The Company also purchased approximately $0.6million of intangible assets during the fiscal 2005 period.

Capital expenditures for infrastructure improvementsfor the two quarters ended July 1, 2006 and July 2, 2005 were approximately$3.7 million and $3.5 million, respectively. Of these amounts, approximately $2.7 million and $2.6 million relate topurchases made at ClearLab, during the respective periods.  The Company anticipates additional capitalexpenditures in fiscal 2006 for infrastructure as it continues to expand andimprove operating

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facilities, telecommunications systems and managementinformation systems in order to handle future operations of both its U.S. andinternational operations.

***Financing activities.***  During the two quarters ended July 1, 2006and July 2, 2005, net cash used in financing activities was approximately $5.2million and $1.6 million, respectively. In the first two quarters of 2006, the Company had net repayments on itscredit facility of approximately $4.3 million and made principal payments ondebt obligations and capital lease obligations of approximately $1.0 million.In the first two fiscal quarters of 2005, the Company paid down its creditfacility by approximately $0.9 million and made principal payments on debtobligations and capital lease obligations of approximately $0.9 million.  In the first two fiscal quarters of both 2006and 2005, these amounts were partially offset by proceeds from the exercise ofcommon stock options.

The Company leasesvarious manufacturing and other equipment from financing companies undercapital lease arrangements.  All of theequipment is maintained at the Company’s Singapore and United Kingdomfacilities.  The majority of the leaseswere assumed in connection with the Company’s acquisitions of ClearLabInternational and ClearLab UK.  As ofJuly 1, 2006, the present value of future minimum lease payments wasapproximately $0.1 million with payments scheduled through fiscal 2009.

**Contractual Obligations and Commitments**

Subsequentto December 31, 2005, there have been no material changes to the Company’scontractual obligations and commitments, outside the normal course of business.

**New Accounting Pronouncements**

InJune 2006, the Financial Accounting Standards Board (FASB) issuedInterpretation No. 48, “Accounting for Uncertainty in Income Taxes,” whichdefines the threshold for recognizing the benefits of tax return positions in thefinancial statements as “more-likely-than-not” to be sustained by the taxingauthority. A tax position that meets the “more-likely-than-not” criterion shallbe measured at the largest amount of benefit that is more than 50% likely ofbeing realized upon ultimate settlement. Interpretation No. 48 applies toall tax positions accounted for under SFAS No. 109, “Accounting for IncomeTaxes.” Interpretation No. 48 is effective for fiscal years beginningafter December 15, 2006. Upon adoption, the Company will adjust itsfinancial statements to reflect only those tax positions that aremore-likely-than-not to be sustained as of the adoption date. Any adjustmentwill be recorded directly to the beginning retained earnings balance in the periodof adoption and reported as a change in accounting principle. The Company iscurrently analyzing the effects of adopting Interpretation No. 48.

**Critical Accounting Policies**

Accountingpolices that require significant judgments and estimates include revenuerecognition (including sales returns and allowances and customer rebates);realizability of inventories; realizability of deferred income tax assets;assessment of realizability of long-lived assets; stock-based compensation; andlegal and regulatory contingencies.  Adescription of the Company’s significant accounting policies is included in thenotes to the consolidated financial statements included in the Company’s AnnualReport on Form 10-K for the fiscal year ended December 31, 2005.  Judgments and estimates are based onhistorical experience as well as relevant facts and circumstances known at eachreporting date.  Actual results maydiffer from these estimates.

Sales are generally recognized when products areshipped and the customer takes ownership and assumes risk of loss, collectionof the related receivable is reasonably assured, persuasive evidence of anarrangement exists and the sales price is fixed or determinable.  U.S. Retail net sales consist of productsales less a provision for sales returns and allowances and estimated customerrebates.  The Company accrues anestimated amount for unclaimed customer rebates and sales returns andallowances based on historical information, adjusted for economic trends.  To the extent actual rebates, returns andallowances vary from historical experience revisions to the allowances may berequired.  ClearLab net sales consist ofproduct sales less a provision for sales returns and allowances. The Companyprovides its customers with standard industry payment terms and performsongoing credit evaluations of its customers and provides for doubtful accountsto the extent determined necessary based on historical data and currenteconomic trends.  ClearLab net sales alsoinclude license fees from the Company’s Japanese license agreement.  Cash payments received from this license arerecognized systematically over the periods that the fees are earned by theCompany.

Inassessing the realizability of inventories, the Company makes judgments as tofuture demand requirements and product expiration dates.  The inventory requirements change based onprojected customer demand, which changes due to fluctuations in marketconditions and product life cycles.

TheCompany has significant long-lived tangible and intangible assets consistingprimarily of property, plant and equipment, goodwill and definite-livedintangibles.  These assets are reviewedfor impairment whenever events or changes in circumstances indicate that thecarrying amounts of such assets may not be recoverable.  In addition, the Company performs animpairment test related to goodwill at least annually.  An impairment analysis related to long-livedtangible and definite-lived intangible assets requires the assessment ofexpected future undiscounted cash flows over the remaining useful life of theasset.  An impairment analysis ofgoodwill requires the use of a fair-value

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basedanalysis.  All of the goodwill and asignificant portion of the other long-lived assets were generated from theCompany’s acquisitions of ClearLab International, ClearLab UK and Lens1st/LensExpress. During the second quarter of fiscal 2006, the Company prepared animpairment analysis and determined there was no impairment on any of the Company’slong-lived assets, definite-lived intangible assets or goodwill as ofJuly 1, 2006. If forecasts and assumptions used to support the realizabilityof long-lived assets change in the future, significant impairment charges couldresult that would adversely affect the Company’s results of operations andfinancial position.

Deferredincome tax assets are assessed for recoverability and valuation allowances areprovided as necessary to reduce deferred income tax assets to amounts expectedto be realized.  Should expectations oftaxable income change in future periods, it may become necessary to change thevaluation allowance, which could affect the Company’s results of operations inthe period such determination is made. The Company records an income tax provision or benefit at a rate that isbased on expected results for the fiscal year. If future changes in market conditions cause actual results to be moreor less favorable, adjustments to the effective income tax rate on a quarterlybasis could be required.

TheCompany records liabilities for legal and regulatory matters when thecontingency is both probable and reasonably estimable.  The Company is involved in several legal andregulatory matters.  The Company, afterconsultation with legal counsel, believes that the ultimate dispositions ofthese matters will not have a material negative impact on its financialposition, liquidity or results of operations. However, there can be no assurance that the Company will be successfulin its efforts to satisfactorily resolve these matters and the ultimate outcomecould result in a material negative impact on the Company’s financial position,liquidity or results of operations.

EffectiveJanuary 1, 2006, the Company adopted the fair value recognition provisionsof SFAS No. 123R, using the modified prospective transition method, andtherefore has not restated prior periods’ results. Under this method the Companyrecognizes compensation expense for all share-based payments granted afterJanuary 1, 2006 and prior to but not yet vested as of January 1,2006, in accordance with SFAS No. 123R. Under the fair value recognitionprovisions of SFAS No. 123R, the Company recognizes stock-based compensationnet of an estimated forfeiture rate and only recognizes compensation cost forthose shares expected to vest over the requisite service period of the award.Prior to SFAS No. 123R adoption, the Company accounted for share-based paymentsunder APB No. 25.  Therefore, the Companygenerally recognized compensation expense for restricted stock awards and whenit granted options with an exercise price below the market price on the date ofgrant. The Company estimates the value of stock option awards on the date ofgrant using a Black-Scholes pricing model. Calculating the fair value ofshare-based payment awards requires the input of highly subjective assumptions,including the expected term of the share-based payment awards and expectedstock price volatility.  The expectedterm represents the average time that options that vest are expected to beoutstanding.  The expected volatilityrates are estimated based on a weighted average of the historical volatilitiesof the Company’s common stock.  Theassumptions used in calculating the fair value of share-based payment awardsrepresent management’s best estimates, but these estimates involve inherentuncertainties and the application of management judgment. As a result, if factorschange and the Company uses different assumptions, its stock-based compensationexpense could be materially different in the future. In addition, the Companyis required to estimate the expected forfeiture rate and only recognize expensefor those shares expected to vest. If the Company’s actual forfeiture rate ismaterially different from its estimate, the stock-based compensation expensecould be significantly different from what the Company has recorded in thecurrent period.

**Forward-LookingStatements**

Exceptfor historical information contained herein, the matters discussed in this Form10-Q are forward-looking statements within the meaning of Section 21E of theSecurities Exchange Act of 1934, as amended, and Section 7A of the SecuritiesAct of 1933, as amended.  Words such as “believes,”“anticipates,” “expects,” “future,” “intends,” “would,” “may” and similarexpressions are intended to identify forward-looking statements.  The Company undertakes no obligation torevise any of these forward-looking statements to reflect events orcircumstances after the date hereof. These forward-looking statements involverisks and uncertainties and often depend on assumptions, data or methods thatmay be incorrect or imprecise.  TheCompany’s future operating results may differ materially from the resultsdiscussed in, or implied by, forward-looking statements made by theCompany.  Factors that may cause suchdifferences include, but are not limited to, general economic conditions, thehealth and size of the contact lens industry, consumer acceptance of ClearLab’sproducts, product health benefits, successful completion and implementation ofthe recommendations from the strategic review of ClearLab, inventoryacquisition and

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management, manufacturingoperations, legislative efforts and results, governmental regulations and otherregulatory considerations, exchange rate fluctuations, advertising spending andeffectiveness, unanticipated costs and expected benefits associated withlicense agreements and supply agreements, research and development initiatives,and prescription requirements of The Fairness to Contact Lens Consumers Act.

**Item 3.  *Quantitativeand Qualitative Disclosures About Market Risk***

***Interest Rate Risk.***** **As of July 1, 2006,the Company was exposed to changes in interest rates relating to its revolvingcredit facility and other debt obligations. The revolving credit facility bears interest at a variable rate based onthe U.S. prime rate or LIBOR. The Company’s outstanding borrowings on thecredit facility, including bank overdrafts, were approximately $19.5 million asof July 1, 2006. The remainder of the Company’s interest bearing debtobligations, including capital lease obligations, is denominated in Singapore dollarsand British pounds and bears interest at a fixed rate.  As of July 1, 2006, the face amounts of theoutstanding borrowings on these fixed rate debt obligations were approximately$7.2 million.  If interest rates were tochange by a full percentage point, the net impact on interest expense would beapproximately $0.2 million per year.

***Foreign Currency Risk***The Companyfaces foreign currency risks primarily as a result of its acquired Singaporeand United Kingdom operations and the intercompany balances between its U.S.and these international operations which are denominated in U.S. dollars.  The functional currency of the Company’sSingapore operations is the Singapore dollar. The Company has debt and other long-term obligations of approximately$7.8 million that are denominated in Singapore dollars and mature over the nextfour years.  If the U.S. dollar weakensrelative to the Singapore dollar, additional funds may be required to meetthese obligations if the debt cannot be adequately serviced from the Singaporeoperations.  Fluctuations in exchangerates between the U.S. dollar and the Singapore dollar could lead to additionalcurrency exchange losses or gains on the intercompany balances and transactionsdenominated in currencies other than the functional currency.  For the second quarter of fiscal 2006, theCompany recorded no foreign currency transaction gains or losses on theintercompany balances between the U.S. and Singapore operations; and recorded approximately$0.3 million of foreign currency transaction gains on sales with externalparties.  From the date of the ClearLabInternational acquisition, July 24, 2002, through August 3, 2006 the exchangerate has fluctuated approximately 10.5 percent (weakening of the U.S. dollar).  If the Singapore dollar were to weakenagainst the U.S. dollar by 10 percent, the Company would record a $2.6 milliondollar foreign currency loss on the intercompany balances that exist as of July1, 2006.

The functional currencyof the Company’s United Kingdom operations is the British pound.  Fluctuations in exchange rates between theU.S. dollar and the British pound could lead to additional currency exchangelosses or gains on intercompany balances and transactions denominated in currenciesother than the functional currency.  Forthe second quarter of fiscal 2006, the Company recorded foreign currencytransaction gains of approximately $0.5 million on the intercompany balancesbetween the U.S. and United Kingdom operations. From the date of the ClearLab UK acquisition, February 24, 2004, throughAugust 3, 2006 the exchange rate has fluctuated approximately 0.5 percent(weakening of the U.S. dollar).  If theBritish pound were to weaken against the U.S. dollar by 10 percent, the Companywould record a $1.6 million dollar foreign currency loss on the intercompanybalances that exist as of July 1, 2006.

The Company has notentered into any foreign currency derivative financial instruments; however, itmay choose to do so in the future in an effort to manage or hedge its foreigncurrency risk. 

**Item 4.****                   *****Controls and Procedures***

***(a)**Evaluation of disclosure controls and procedures*.**  The Company’s Chief Executive Officer andChief Financial Officer, after evaluating the effectiveness of the Company’sdisclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e)and 15d-15(e)) as of the end of the period covered by this report (the “EvaluationDate”), have concluded that, as of the Evaluation Date, the Company’sdisclosure controls and procedures were adequate and effective to ensure thatmaterial information relating to the Company and its consolidated subsidiarieswould be made known to them by others within those entities.

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***(b) Changes in internal controls over financial reporting.***  There were no significant changes in theCompany’s internal controls over financial reporting or in other factors thathave materially affected, or are reasonably likely to materially affect, theCompany’s internal controls over financial reporting subsequent to theEvaluation Date.  As a result, nocorrective actions were taken.

The Company’smanagement, including its Chief Executive Officer and Chief Financial Officer,does not expect that the Company’s disclosure controls and procedures or itsinternal controls over financial reporting will prevent all error and allfraud.  A control system, no matter howwell conceived and operated, can provide only reasonable, not absolute,assurance that the objectives of the control system are met.  Further, the design of a control system mustreflect the fact that there are resource constraints, and the benefits ofcontrols must be considered relative to their costs.  Because of inherent limitations in allcontrol systems, no evaluation of controls can provide absolute assurance thatall control issues and instances of fraud, if any, within the Company have beendetected.

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**PART II.****               ****OTHER INFORMATION**

**Item 1.                 LegalProceedings**

From time to time the Company is involved in legalmatters generally incidental to its business. It is the opinion of management,after discussion with legal counsel that, except for legal and professionalfees that the Company incurs from time to time, the ultimate dispositions ofall of these matters will not have a material impact on the financial position,liquidity or results of operations of the Company. However, there can be noassurance that the Company will be successful in its efforts to satisfactorilyresolve these matters, and the ultimate outcome could result in a material negativeimpact on the Company’s financial position, liquidity or results of operations.

**Item 1A.                Risk Factors**

Other than the additionalrisk factors set forth below, there are no material changes from the riskfactors previously disclosed in our Annual Report on Form 10-K for the fiscalyear ended December 31, 2005.

**TheCompany has expended significant resources in the development of its ClearLaboperations and may not realize value equal to its investment.**

On July 26, 2006, theCompany announced that it had engaged an investment bank to assist inperforming a strategic review of its ClearLab operations.  The Company is in the preliminary stages ofthis review and does not know what conclusions may be reached or what its ultimateactions related to ClearLab will be.  TheCompany has invested significant amounts in acquiring and developing ClearLaband its operations and products and may not realize value equal to itsinvestment.

**TheCompany’s strategic review of ClearLab may result in the Company continuing toown a portion or all of ClearLab and may require that the Company expendsignificant additional amounts to develop its ClearLab operations.**

Based on its strategicreview of ClearLab, the Company may determine to retain a portion or allof  ClearLab and may continue developingits operations and products.  In order tofully commercialize its products, particularly the AquaSoft Singles product, theCompany anticipates that ClearLab will require significant additional fundingover the foreseeable future.  

**Item 2.**                    *Unregistered Sales of Equity Securities and Use of Proceeds*

None.

**Item 3.**                    *Defaults Upon Senior Securities*

None.

**Item 4.**                    *Submission of Matters to a Vote of Security Holders*

The annual meeting of stockholders of the Company washeld on May 19, 2006.  The stockholdersapproved the following matters:

·                  Theelection as directors of E. Dean Butler and Stephen L. Key to serve until theannual meeting of stockholders in 2009 and until their respective successorsare elected and qualified.

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|                | ** ** | **Votes Cast** | ** ** |
|----------------|------------|---------------------|------------|
| ** **     | ** ** | **For**             | ** ** | **Withheld** | ** ** |
| E. Dean Butler |       | 11,211,190          |       | 580,599 |   |
| Stephen L. Key |       | 11,446,455          |       | 345,334 |   |

 

As of the date of theannual meeting of stockholders, the other directors of the Company included thefollowing persons:  (i) Jonathan C. Coonand Bradley T. Knight, who are serving until the annual meeting of stockholdersin 2007; and Thomas H. Boggs, Jr., John F. Nichols and Garth T. Vincent who areserving until the annual meeting of stockholders in 2008.  

·                   Ratificationof appointment of KPMG LLP as independent auditors to audit the Company’s booksand accounts for the fiscal year ending December 30, 2006.

| Votes Cast:                  | ** ** |
|-----------------------------------|------------|
| For                               |       | 11,790,713 |   |
| Against or  Withheld              |       | 976 |   |
| Abstentions and Broker  Non-Votes |       | 100 |   |

 

**Item 5.**                    OtherInformation

None.

**Item 6.**                    Exhibits

**(A)Exhibits**
| Exhibit No. | ** ** | **Description of 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, $0.1 par value per share. (2) |
| 31.1        |       | Certification Required Pursuant to Section 302 of  the Sarbanes-Oxley Act of2002.       |
| 31.2        |       | Certification Required Pursuant to Section 302 of  the Sarbanes-Oxley Actof 2002.       |
| 32.1        |       | Certification Required Pursuant to Section 906 of  the Sarbanes-Oxley Act of 2002.      |
| 32.2        |       | Certification Required Pursuant to Section 906 of  the Sarbanes-Oxley Act of 2002.      |

 

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(1)  Incorporated by reference to the Company’sQuarterly Report on Form 10-Q for the quarterly period ended April 4, 1998(Commission File No. 0-23633).

(2)          Incorporated byreference to the same numbered exhibit to the Company’s Registration Statementon Form S-1 (Registration No. 333-41055).

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**SIGNATURES**

Pursuant to the requirements of the SecuritiesExchange Act of 1934, the Registrant has duly caused this report to be signedon its behalf by the undersigned thereunto duly authorized.
|                         |   | **1-800  CONTACTS, INC.**                                    |                                                         |                 |
|-------------------------|--------|--------------------------------------------------------------|--------------------------------------------------------------|----------------------|
| ** **              |   | ** **                                                   |                                                         |                 |
| ** **              |   | ** **                                                   |                                                         |                 |
| Dated: August  10, 2006 |   | By:                                                          |                                                         | /s/ Jonathan C. Coon |   |
|                    |   |                                                         | Name:   Jonathan C. Coon                      |                 |
|                    |   |                                                         | Title:     Chief Executive  Officer |                 |
|                    |   |                                                         |                                                         |                 |
|                    |   | By:                                                          |                                                         | /s/ Robert G. Hunter |   |
|                    |   | Name:   Robert G. Hunter                      |                                                         |                 |
|                    |   | Title:     Chief Financial  Officer |                                                         |                 |
|                         |        |                                                              |                                                              |                      |  |  |  |  |  |

 

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