**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington,DC  20549**

 

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**FORM 10-Q**

 

**(Mark one)**

**ý****                                ****QUARTERLYREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACTOF 1934**

 

**For thequarterly period ended October 1, 2005**

 

**o****                                ****TRANSITIONREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACTOF 1934**

 

**For thetransition period from                          to                          .**

 

**Commissionfile number:        0-23633**

 

**1-800 CONTACTS, INC.**

(Exact name ofregistrant as specified in its charter)

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

 
| **(801)  924-9800**                                        |
|------------------------------------------------------------|
| (Registrant’s  telephone number, including area code) |

 

Indicate by check mark whether the registrant (1) has filed allreports required to be filed by Section 13 or 15(d) of the SecuritiesExchange Act of 1934 during the preceding 12 months (or for such shorter periodthat the registrant was required to file such reports) and (2) has beensubject to the filing requirements for at least the past 90 days.

ý  Yes          No  o

 

Indicate by check markwhether the registrant is an accelerated filer (as defined in Rule 12b-2of the Exchange act).

ý  Yes          No  o

 

Indicate by check markwhether the registrant is a shell company (as defined in Rule 12b-2 of theExchange act).

o  Yes          No  ý

 

As of November 7, 2005, the Registrant had 13,339,557shares 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                                                                                                                     |   |
|                                                | Condensed Consolidated Balance Sheets as of January 1,  2005  and October 1, 2005                                              |   |
|                                                | Condensed Consolidated Statements of  Operations for the Quarter and Three Quarters Ended  October 2, 2004 and October 1, 2005 |   |
|                                                | Condensed Consolidated Statements of Cash Flows for  the Three Quarters Ended  October 2, 2004 and October 1, 2005             |   |
|                                                | 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  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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**PART 1.FINANCIAL INFORMATION**

**Item1.  Financial Statements**

 

**1-800CONTACTS, INC.**

**CONDENSEDCONSOLIDATED BALANCE SHEETS**

**(inthousands)**

**(unaudited)**

 

**ASSETS**

 
| ** **                                                            | ** ** | **January 1,** | ** ** | **October 1,** | ** ** |
|-----------------------------------------------------------------------|------------|---------------------|------------|---------------------|------------|
| ** **                                                            | ** ** | **2005**            | ** ** | **2005**            | ** ** |
| CURRENT ASSETS:                                                       |       |                |       |                |       |
| Cash                                                                  |       | $                   | 3,105      |                | $          | 226 |   |
| Accounts  receivable, net                                             |       | 3,178               |       | 4,247               |       |
| Other  receivables                                                    |       | 2,398               |       | 2,083               |       |
| Inventories,  net                                                     |       | 22,206              |       | 27,963              |       |
| Deferred  income taxes                                                |       | 1,328               |       | 1,402               |       |
| Other  current assets                                                 |       | 1,546               |       | 2,541               |       |
| Total  current assets                                                 |       | 33,761              |       | 38,462              |       |
| PROPERTY AND EQUIPMENT,  net                                          |       | 20,618              |       | 25,173              |       |
| DEFERRED INCOME TAXES                                                 |       | 720                 |       | 908                 |       |
| GOODWILL                                                              |       | 34,320              |       | 35,223              |       |
| DEFINITE-LIVED  INTANGIBLES, net                                      |       | 17,897              |       | 14,864              |       |
| OTHER ASSETS                                                          |       | 1,669               |       | 3,398               |       |
| Total  assets                                                         |       | $                   | 108,985    |                | $          | 118,028 |   |
|                                                                  |       |                |       |                |       |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY**                        |       |
| CURRENT LIABILITIES:                                                  |       |                |       |                |       |
| Current  portion of long-term debt                                    |       | $                   | 1,632      |                | $          | 1,603 |   |
| Current  portion of capital lease obligations                         |       | 47                  |       | 43                  |       |
| Income  taxes payable                                                 |       | 1,560               |       | 171                 |       |
| Accounts  payable                                                     |       | 9,762               |       | 17,386              |       |
| Accrued  liabilities                                                  |       | 7,303               |       | 10,065              |       |
| Unearned  revenue                                                     |       | 3,500               |       | 2,036               |       |
| Total  current liabilities                                            |       | 23,804              |       | 31,304              |       |
| LONG-TERM LIABILITIES:                                                |       |                |       |                |       |
| Line  of credit                                                       |       | 14,404              |       | 19,449              |       |
| Long-term  debt, net of current portion                               |       | 8,170               |       | 6,742               |       |
| Capital  lease obligations, net of current portion                    |       | 98                  |       | 60                  |       |
| Deferred  income tax liabilities                                      |       | 1,458               |       | 188                 |       |
| Unearned  revenue, net of current portion                             |       | 1,667               |       | —              |       |
| Other  long-term liabilities                                          |       | 880                 |       | 736                 |       |
| Total  long-term liabilities                                          |       | 26,677              |       | 27,175              |       |
| STOCKHOLDERS’ EQUITY                                             |       |                |       |                |       |
| Common  stock, 13,299 and 13,340 issued and outstanding, respectively |       | 133                 |       | 133                 |       |
| Additional  paid-in capital                                           |       | 46,061              |       | 48,505              |       |
| Deferred  compensation on restricted stock grants                     |       | (103                | )          | (666                | )          |
| Retained  earnings                                                    |       | 12,218              |       | 11,868              |       |
| Accumulated  other comprehensive income (loss)                        |       | 195                 |       | (291                | )          |
| Total  stockholders’ equity                                      |       | 58,504              |       | 59,549              |       |
| Total  liabilities and stockholders’ equity                      |       | $                   | 108,985    |                | $          | 118,028 |   |

 

Seeaccompanying notes 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**   | ** ** | **Three Quarters Ended** | ** ** |
|-------------------------------------------------------|------------|---------------------|------------|--------------------------|------------|
| ** **                                            | ** ** | **October 2,** | ** ** | **October 1,**      | ** ** | **October 2,** | ** ** | **October 1,** | ** ** |
| ** **                                            | ** ** | **2004**            | ** ** | **2005**                 | ** ** | **2004** | ** ** | **2005** | ** ** |
| NET  SALES                                            |       | $                   | 56,893     |                     | $          | 60,858 |   | $ | 157,713 |   | $ | 182,506 |   |
| COST  OF GOODS SOLD                                   |       | 34,889              |       | 37,706                   |       | 97,140 |   | 113,178 |   |
| Gross  profit                                         |       | 22,004              |       | 23,152                   |       | 60,573 |   | 69,328 |   |
| SELLING,  GENERAL AND ADMINISTRATIVE EXPENSES:        |       |                |       |                     |       |   |   |   |   |
| Advertising                                           |       | 6,533               |       | 6,606                    |       | 22,572 |   | 20,264 |   |
| Legal  and professional                               |       | 1,026               |       | 1,210                    |       | 4,207 |   | 3,400 |   |
| Research  and development                             |       | 567                 |       | 426                      |       | 1,902 |   | 2,292 |   |
| Purchased  in-process research and development        |       | —              |       | —                   |       | 83 |   | — |   |
| Other  selling, general and administrative            |       | 10,789              |       | 13,538                   |       | 31,437 |   | 37,359 |   |
| Total  selling, general and administrative expenses   |       | 18,915              |       | 21,780                   |       | 60,201 |   | 63,315 |   |
| INCOME  FROM OPERATIONS                               |       | 3,089               |       | 1,372                    |       | 372 |   | 6,013 |   |
| OTHER  EXPENSE, net                                   |       | (216                | )          | (755                     | )          | (1,271 | ) | (2,562 | ) |
| INCOME  (LOSS) BEFORE PROVISION FOR INCOME TAXES      |       | 2,873               |       | 617                      |       | (899 | ) | 3,451 |   |
| PROVISION  FOR INCOME TAXES                           |       | (1,520              | )          | (1,191                   | )          | (1,102 | ) | (3,801 | ) |
| NET  INCOME (LOSS)                                    |       | $                   | 1,353      |                     | $          | (574 | ) | $ | (2,001 | ) | $ | (350 | ) |
|                                                  |       |                |       |                     |       |   |   |   |   |
| PER  SHARE INFORMATION:                               |       |                |       |                     |       |   |   |   |   |
| Basic  and diluted net income (loss) per common share |       | $                   | 0.10       |                     | $          | (0.04 | ) | $ | (0.15 | ) | $ | (0.03 | ) |

 

See accompanyingnotes to condensed consolidated financial statements.

 

4

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**1-800 CONTACTS, INC.**

**CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS**

**(in thousands)**

**(unaudited)**

 
| ** **                                                                       | ** ** | **Three Quarters Ended** | ** ** |
|----------------------------------------------------------------------------------|------------|--------------------------|------------|
| ** **                                                                       | ** ** | **October 2,**      | ** ** | **October 1,** | ** ** |
| ** **                                                                       | ** ** | **2004**                 | ** ** | **2005** | ** ** |
| CASH FLOWS FROM  OPERATING ACTIVITIES:                                           |       |                     |       |   |   |
| Net  loss                                                                        |       | $                        | (2,001     | ) | $ | (350 | ) |
| Adjustments  to reconcile net loss to net cash provided by operating activities: |       |                     |       |   |   |
| Depreciation  and amortization                                                   |       | 5,630                    |       | 6,572 |   |
| Amortization  of debt issuance costs and discounts                               |       | 247                      |       | 138 |   |
| Foreign  currency exchange loss                                                  |       | 27                       |       | 1,390 |   |
| Stock-based  compensation                                                        |       | 8                        |       | 79 |   |
| Purchased  in-process research and development                                   |       | 83                       |       | — |   |
| Loss  on disposal of property and equipment                                      |       | 89                       |       | 519 |   |
| Deferred  income taxes, net of effects of acquisition                            |       | (1,439                   | )          | (1,463 | ) |
| Changes  in operating assets and liabilities, net of effects of acquisition:     |       |                     |       |   |   |
| Accounts  receivable, net                                                        |       | (671                     | )          | (1,193 | ) |
| Inventories,  net                                                                |       | 695                      |       | (6,025 | ) |
| Other  receivables                                                               |       | (1,443                   | )          | 315 |   |
| Other  current assets                                                            |       | 333                      |       | (1,047 | ) |
| Income  taxes payable                                                            |       | 2,170                    |       | (1,245 | ) |
| Accounts  payable                                                                |       | (1,621                   | )          | 5,917 |   |
| Accrued  liabilities                                                             |       | 3,014                    |       | 4,656 |   |
| Unearned  revenue                                                                |       | (158                     | )          | (3,110 | ) |
| Net  cash provided by operating activities                                       |       | 4,963                    |       | 5,153 |   |
| CASH FLOWS FROM  INVESTING ACTIVITIES:                                           |       |                     |       |   |   |
| Purchase  of property and equipment                                              |       | (5,996                   | )          | (9,549 | ) |
| Proceeds  from sale of property and equipment                                    |       | 3                        |       | 27 |   |
| Purchase  of definite-lived intangible assets                                    |       | (3,997                   | )          | (610 | ) |
| Cash  paid for acquisition of VisionTec                                          |       | (3,776                   | )          | — |   |
| Deposits  and other                                                              |       | (289                     | )          | (2,121 | ) |
| Net  cash used in investing activities                                           |       | $                        | (14,055    | ) | $ | (12,253 | ) |
|                                                                             |       |                     |       |   |   |
| CASH FLOWS FROM  FINANCING ACTIVITIES:                                           |       |                     |       |   |   |
| Proceeds  from exercise of common stock options                                  |       | $                        | 159        |   | $ | 381 |   |
| Net  borrowings on line of credit                                                |       | 16,351                   |       | 5,045 |   |
| Principal  payments on capital lease obligations                                 |       | (219                     | )          | (35 | ) |
| Debt  issuance costs                                                             |       | (196                     | )          | — |   |
| Principal  payments on long-term debt                                            |       | (8,511                   | )          | (1,261 | ) |
| Proceeds  from international government grant                                    |       | 873                      |       | — |   |
| Net  cash provided by financing activities                                       |       | 8,457                    |       | 4,130 |   |
| EFFECT OF FOREIGN  EXCHANGE RATES ON CASH                                        |       | (67                      | )          | 91 |   |
|                                                                             |       |                     |       |   |   |
| NET DECREASE IN CASH                                                             |       | (702                     | )          | (2,879 | ) |
| CASH AT BEGINNING OF  PERIOD                                                     |       | 1,075                    |       | 3,105 |   |
| CASH AT END OF PERIOD                                                            |       | $                        | 373        |   | $ | 226 |   |
|                                                                             |       |                     |       |   |   |
| SUPPLEMENTAL CASH FLOW  INFORMATION:                                             |       |                     |       |   |   |
| Cash  paid for interest                                                          |       | $                        | 964        |   | $ | 807 |   |
| Cash  paid for income taxes                                                      |       | 370                      |       | 6,510 |   |

 

SUPPLEMENTAL DISCLOSURESOF NONCASH INVESTING AND FINANCING ACTIVITIES:

 

During the first quarter of 2004, the Companypurchased the stock of VisionTec (subsequently renamed ClearLab UK, Ltd.).  The purchase consideration included cash of$3,776 and common stock with a fair value of $3,200.

 

As part of the acquisition of ClearLab Internationalin 2002, the Company entered into an agreement to issue 270,000 options topurchase shares of 1-800 CONTACTS, INC. common stock in three equaltranches.  The first tranche of 90,000options vested on July 24, 2005. The Company used the Black-Scholes option-pricing model to determine thefair-value of these options, as of the vesting date.  Using this method, the vested options werevalued at approximately $1.3 million and the Company recorded this amount asadditional purchase consideration, increasing goodwill.

 

Seeaccompanying notes to condensed consolidated financial statements.

 

5

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**1-800 CONTACTS, INC.NOTES TO CONDENSED CONSOLIDATED FINANCIALSTATEMENTS(Unaudited)**

 

# **NOTE 1. PRESENTATION OF CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

 

The accompanying condensedconsolidated financial statements have been prepared by the Company, withoutaudit, pursuant to the rules and regulations of the Securities andExchange Commission.  Certain informationand disclosures normally included in financial statements prepared inaccordance with accounting principles generally accepted in the United Statesof America have been condensed or omitted pursuant to such rules andregulations.  These condensedconsolidated financial statements reflect all adjustments (consisting only ofnormal recurring adjustments), which in the opinion of management, arenecessary to present fairly the results of operations of the Company for theperiods presented.  It is suggested thatthese condensed consolidated financial statements be read in conjunction withthe audited financial statements and the notes thereto included in the Company’sAnnual Report on Form 10-K for the year ended January 1, 2005.

 

The preparation offinancial statements in conformity with accounting principles generallyaccepted in the United States of America requires management to make estimatesand assumptions that affect the reported amounts of assets and liabilities anddisclosure of contingent assets and liabilities at the date of the financialstatements and the reported amounts of revenue and expenses during thereporting period.  Actual results coulddiffer from these estimates.

 

# **NOTE 2. INVENTORIES**

# ** **

Inventories are recorded at the lower of cost (usingthe first-in, first-out method) or market value.  Elements of cost in the Company’smanufactured inventories generally include raw materials, direct labor,manufacturing overhead and freight-in.  Inventories consisted of the following (in thousands):

 

| ** **                                | ** ** | **January 1,** | ** ** | **October 1,** | ** ** |
|-------------------------------------------|------------|---------------------|------------|---------------------|------------|
| ** **                                | ** ** | **2005**            | ** ** | **2005**            | ** ** |
| Purchased contact  lenses and accessories |       | $                   | 16,216     |                | $          | 19,789 |   |
| Manufactured  inventories:                |       |                |       |                |       |
| Raw  materials                            |       | 930                 |       | 1,343               |       |
| Work  in process                          |       | 1,796               |       | 1,878               |       |
| Finished  goods contact lenses            |       | 3,264               |       | 4,953               |       |
| Total                                     |       | $                   | 22,206     |                | $          | 27,963 |   |

 

Provision is made to reduce excess and obsoleteinventories to their estimated net realizable values.  As of January 1, 2005 and October 1,2005, reserves for excess and obsolete inventories were approximately $1.2million and $1.0 million, respectively.

 

**NOTE 3.  NET INCOME (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.  Thecomputation of Diluted EPS does not assume exercise or conversion of securitiesthat would have an antidilutive effect on net income (loss) per common share.For the quarter and three quarters ended October 1, 2005, options topurchase 1,278,569 and 974,339 shares of common stock, respectively, were notincluded in the computation of Diluted EPS because the effect would beantidilutive.  For the quarter and threequarters ended October 2, 2004, options to purchase 956,071

 

6

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and 1,257,476 shares ofcommon stock, respectively, 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 October 2, 2004** | ** ** | **Quarter Ended October 1, 2005** | ** ** |
|-------------------------|------------|----------------------------------------|------------|----------------------------------------|------------|
| ** **              | ** ** | **Net Income**                         | ** ** | **Shares**                             | ** ** | **Per-Share****Amount** | ** ** | **Net Loss** | ** ** | **Shares** | ** ** | **Per-Share****Amount** | ** ** |
|                    |       |                                   |       |                                   |       |   |   |   |   |   |   |   |   |
| Basic EPS               |       | $                                      | 1,353      |                                   | 13,287     |   | $ | 0.10 |   | $ | (574 | ) | 13,329 |   | $ | (0.04 | ) |
| Effect of stock options |       |                                   |       | 86                                     |       |   |   |   |   | — |   |   |   |
| Diluted EPS             |       | $                                      | 1,353      |                                   | 13,373     |   | $ | 0.10 |   | $ | (574 | ) | 13,329 |   | $ | (0.04 | ) |

 
| ** **               | ** ** | **Three Quarters Ended October 2, 2004** | ** ** | **Three Quarters Ended October 1, 2005** | ** ** |
|--------------------------|------------|-----------------------------------------------|------------|-----------------------------------------------|------------|
| ** **               | ** ** | **Net Loss**                                  | ** ** | **Shares**                                    | ** ** | **Per-Share****Amount** | ** ** | **Net Loss** | ** ** | **Shares** | ** ** | **Per-Share****Amount** | ** ** |
|                     |       |                                          |       |                                          |       |   |   |   |   |   |   |   |   |
| Basic  EPS               |       | $                                             | (2,001     | )                                             | 13,254     |   | $ | (0.15 | ) | $ | (350 | ) | 13,315 |   | $ | (0.03 | ) |
| Effect  of stock options |       |                                          |       | —                                        |       |   |   |   |   | — |   |   |   |
| Diluted  EPS             |       | $                                             | (2,001     | )                                             | 13,254     |   | $ | (0.15 | ) | $ | (350 | ) | 13,315 |   | $ | (0.03 | ) |

 

**NOTE4.  COMPREHENSIVE INCOME (LOSS)**

 

Comprehensive income(loss) for the quarter and three quarters ended October 2, 2004 and October 1,2005 consists of the following components (in thousands):

 
| ** **                    | ** ** | **Quarter Ended**         | ** ** | **Three Quarters Ended**  | ** ** |
|-------------------------------|------------|---------------------------|------------|---------------------------|------------|
| ** **                    | ** ** | **October 2,  2004** | ** ** | **October 1,  2005** | ** ** | **October 2,  2004** | ** ** | **October 1,  2005** | ** ** |
| Net income (loss)             |       | $                         | 1,353      |                      | $          | (574 | ) | $ | (2,001 | ) | $ | (350 | ) |
| Foreign currency  translation |       | 45                        |       | (127                      | )          | (125 | ) | (487 | ) |
| Comprehensive income  (loss)  |       | $                         | 1,398      |                      | $          | (701 | ) | $ | (2,126 | ) | $ | (837 | ) |

 

The foreign currency translationgain (loss) results primarily from changes in exchange rates relative to theU.S. dollar from the translation of the Company’s Singapore and United Kingdomsubsidiaries’ financial statements.

 

**NOTE 5.  STOCK-BASED COMPENSATION**

 

The Company appliesAccounting Principles Board Opinion No. 25, “Accounting for Stock Issuedto Employees,” and related interpretations and uses the intrinsic method ofaccounting for its stock option grants to employees and directors.  No compensation expense has been recognizedfor stock option awards granted at or above fair market value of the stock onthe date of grant.

 

Financial AccountingStandards (“SFAS”) No. 123, “Accounting for Stock-Based Compensation,” andSFAS No. 148, “Accounting for Stock-Based Compensation—Transition andDisclosure,” established accounting and disclosure requirements using a fair-valuebased method of accounting for stock-based employee compensation plans. Aspermitted by existing accounting standards, the Company has elected to continueto apply the intrinsic-value-based method of accounting described above, andhas adopted only the disclosure requirements of SFAS No. 123.

 

7

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If compensation expensefor all stock options had been determined consistent with SFAS No. 123,the Company’s net income (loss) and basic and diluted net income (loss) percommon share would have been as follows (in thousands, except per shareamounts):

 
| ** **                                            | ** ** | **Quarter Ended**         | ** ** |
|-------------------------------------------------------|------------|---------------------------|------------|
| ** **                                            | ** ** | **October 2,  2004** | ** ** | **October 1,  2005** | ** ** |
| Net income (loss):                                    |       |                      |       |   |   |
| As  reported                                          |       | $                         | 1,353      |   | $ | (574 | ) |
| Fair-value  based compensation, net of tax            |       | (380                      | )          | (155 | ) |
| Pro  forma                                            |       | $                         | 973        |   | $ | (729 | ) |
|                                                  |       |                      |       |   |   |
| Basic and diluted net  income(loss) per common share: |       |                      |       |   |   |
| As  reported                                          |       | $                         | 0.10       |   | $ | (0.04 | ) |
| Pro  forma                                            |       | $                         | 0.07       |   | $ | (0.05 | ) |

 
| ** **                                    | ** ** | **Three Quarters Ended**  | ** ** |
|-----------------------------------------------|------------|---------------------------|------------|
| ** **                                    | ** ** | **October 2,  2004** | ** ** | **October 1,  2005** | ** ** |
| Net loss:                                     |       |                      |       |   |   |
| As  reported                                  |       | $                         | (2,001     | ) | $ | (350 | ) |
| Fair-value  based compensation, net of tax    |       | (1,208                    | )          | (727 | ) |
| Pro  forma                                    |       | $                         | (3,209     | ) | $ | (1,077 | ) |
|                                          |       |                      |       |   |   |
| Basic and diluted net  loss per common share: |       |                      |       |   |   |
| As  reported                                  |       | $                         | (0.15      | ) | $ | (0.03 | ) |
| Pro  forma                                    |       | $                         | (0.24      | ) | $ | (0.08 | ) |

 

The weighted average pershare fair value of options granted during the quarter ended October 2,2004 and the three quarters ended October 2, 2004 was $6.77 and $11.69,respectively.  No options were grantedduring the quarter ended October 1, 2005. The weighted average per share fair value of options granted during thethree quarters ended October 1, 2005 was $11.30.  The fair value of each option grant has beenestimated on the grant date using the Black-Scholes option-pricing model withthe following weighted average assumptions:

 
| ** **              | ** ** | **Quarter Ended**         | ** ** | **Three Quarters Ended**  | ** ** |
|-------------------------|------------|---------------------------|------------|---------------------------|------------|
| ** **              | ** ** | **October 2,  2004** | ** ** | **October 1,  2005** | ** ** | **October 2,  2004** | ** ** | **October 1,  2005** | ** ** |
| Risk-free interest rate |       | 3.6                       | %          | —                    |       | 3.2 | % | 3.7 | % |
| Expected dividend yield |       | 0.0                       | %          | —                    |       | 0.0 | % | 0.0 | % |
| Volatility              |       | 65.9                      | %          | —                    |       | 67.6 | % | 65.5 | % |
| Expected life           |       | 5 years                   |       | —                    |       | 5 years |   | 5 years |   |

 

**NOTE 6.  RECENT TRANSACTIONS AND AGREEMENTS**

 

***Japanese License and Royalty Agreement***

 

On December 15, 2004the Company signed an agreement which grants Menicon Co., Ltd. (Menicon)exclusive rights to develop, manufacture and market certain disposable contactlenses and related intellectual property in Japan.

 

Under the terms of theagreement, Menicon licenses from the Company different types of intellectualproperty, including contact lens material, manufacturing technology and relatedknowledge.  In consideration, Menicon isexpected to pay nonrefundable license fees of $18 million, of which$5 million was paid in December 2004 upon signing the agreement. Theremaining $13 million is expected to be paid over the next three to fiveyears as the

 

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Company fulfills itsobligations and as corresponding milestones relating to Japanese regulatoryapproval and Menicon’s launch of the product in the Japanese market are met. Ofthe total $18 million license fee, $10 million is guaranteed.

 

The Company evaluated theagreement under Emerging Issues Task Force 00-21, Revenue Arrangements withMultiple Deliverables, and determined that this arrangement should beconsidered a single unit of accounting. Therefore, in applying the principles of Staff Accounting Bulletin No. 104to the license agreement, the Company considered the terms and conditions ofthe agreement to arrive at a proportional performance methodology ofrecognizing revenue.  Accordingly, theCompany is recognizing the guaranteed portion of the license fees from thisagreement on a straight-line basis, limited by the amount of cash received,over the period of the Company’s continued involvement in meeting itsobligations, estimated to be through June of 2007.   In the event the Company achieves amilestone (not relating to the guaranteed portion of the license fees) prior tothe completion of its obligations under the agreement, the milestone paymentwill be recognized on a straight-line basis over the remaining period of theCompany’s continued involvement in meeting its obligations.  Upon completion of this agreement, theCompany will recognize the remaining milestone payments as the agreed uponmilestones are achieved.   The Companyrecorded income of $1.0 million and $3.0 million for the fiscal quarter andthree quarters ended October 1, 2005, respectively.

 

If Menicon has notreceived regulatory approval on or before December 31, 2009, it may returnall intellectual property covered by the agreement and in-process regulatoryapprovals to the Company, and the Company may pursue the Japanese market on itsown and terminate the exclusive agreement.

 

Under the terms of theagreement, Menicon will also pay royalties for a period of at least15 years from the product launch date in Japan on contact lenses sold thatwere manufactured using the licensed technology, with a guaranteed minimum of$5 million per year beginning the earlier of the second year after productlaunch or 2012. The agreement does not include the sale of any of the Company’scurrent equipment, facilities or capacity and is limited to the Japanesecontact lens market.

 

***Optical Retail Store Agreement***

 

During the latter part of2004, the Company entered into an agreement with a regional optical retailchain in Utah in which the two companies would jointly market and sell contactlenses in Utah.  In December 2004,the companies began jointly serving these Utah customers. The agreement is forone year, with one year renewals at the option of both parties.

 

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, the Company has guaranteed that theretail chain will receive at least $0.5 million of annual earnings under thearrangement.  Additionally, the Companycommitted to purchase approximately $0.3 million per year in inventory from theretail chain’s source of supply.  Underthe arrangement, the Company records gross revenues for all orders fulfilledand records selling, general and administrative expense for the retail chain’sshare of the net operating results.

 

**NOTE 7.  COMMON STOCK TRANSACTIONS**

 

During the three quartersended October 1, 2005, employees exercised stock options to purchase39,903 shares of common stock for a total of approximately $0.4 million.  The Company recorded an increase inadditional paid-in capital of approximately $0.1 million as a result of theincome tax benefit related to these stock option exercises.

 

During the three quartersended October 1, 2005, the Company granted nonqualified stock options topurchase 1,000 shares of common stock to employees of the Company.  The exercise price of the options was $22.00per share, which was not less than the quoted fair market value at the grantdate. The options vest equally over a four-year period and expire in five years.

 

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During the three quartersended October 1, 2005, the Board of Directors granted 30,000 shares ofrestricted common stock to three employees of the Company.  Two of the grants totaling 20,000 shares werevalued at the closing stock price of $22.67 on March 21, 2005, the date ofthe grant.  The third grant of 10,000 wasvalued at the closing stock price of $18.84 on May 2, 2005, the date ofthe grant.  The restrictions on thecommon stock lapse in equal amounts over a five-year period. ** **The Company recordedexpense of approximately $35,000 and $79,000 related to restricted stock duringthe quarter ended and three quarters ended October 1, 2005,respectively.  As of October 1, 2005approximately $0.7 million has been deferred and will be recognized over thevesting period.

 

As part of theacquisition of ClearLab International in 2002, the Company entered into anagreement to issue 270,000 options to purchase shares of 1-800 CONTACTS, INC.common stock in three equal tranches. The three tranches of 90,000 options vest on July 24, 2005, 2006and 2007, respectively.  The first trancheof 90,000 options vested on during the third fiscal quarter ended October 1,2005.  The Company used the Black-Scholesoption-pricing model to determine the fair-value of these options, as of thevesting date.  Using this method, thesevested options were valued at approximately $1.3 million and the Companyrecorded this amount as additional purchase consideration, increasing goodwill.  Goodwill associated with the ClearLabInternational acquisition amounted to approximately $12.9 million as of October 1,2005.

 

**NOTE 8.  DEBT OBLIGATIONS**

 

The Company has a loan agreementwith a U.S. bank providing for a revolving credit facility for borrowings of upto $25.6 million as of October 1, 2005, which amount is reduced thereafteron the first day of each September, December, March and June by$0.4 million until the maturity date of February 27, 2007.Additionally, the agreement provides for letters of credit up to a maximum of$15 million outstanding or payable at any time. The loan agreementspecifies that if the maximum leverage ratio, as defined in the agreement, isgreater than 2.5, then the amounts outstanding on the revolving credit facilitytogether with the amount of all outstanding letters of credit can at no timeexceed the Company’s book value of inventory. As of October 1, 2005, theCompany was not subject to this restriction and could borrow up to $25.6 million.Outstanding borrowings on the revolving credit facility bear interest at afloating rate equal to the lender’s prime interest rate plus a margin or thelender’s LIBOR rate plus a margin. The interest rate is adjusted quarterly andranges between prime plus 0.0 percent and prime plus 1.25 percent orbetween the applicable LIBOR rate plus 2.0 percent and the applicableLIBOR rate plus 3.25 percent, depending on the Company’s maximum leverageratio. As of October 1, 2005, the prime rate margin is 0.0 percent and theLIBOR rate margin is 2.0 percent. Interest is payable monthly. As of October 1,2005, the Company’s outstanding borrowings on the credit facility, includingbank overdrafts, were $19.4 million. Of this amount, $10.0 millionbore interest at the lender’s LIBOR rate plus 2.0 percent (5.83% at October 1,2005) and the remaining $9.4 million bore interest at the lender’s prime rateplus 0.0 percent (6.75% at October 1, 2005). The facility requiresthe quarterly payment of an unused credit fee which ranges from 0.38 percentto 0.5 percent, depending on the Company’s maximum leverage ratio.

 

All outstanding balanceson this 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 loan agreement includes variousfinancial covenants including a capital expenditure limit, a maximum leverageratio, a minimum working capital requirement, a minimum fixed charge coverageratio and a minimum net worth requirement. The loan agreement does not permitthe Company or its subsidiaries to dissolve, sell, dispose or merge all oftheir 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 loan agreement alsoplaces a limit on the amount the Company can loan to any entity, outside thenormal course of business. Additionally, the agreement does not permit theCompany to declare or pay any cash dividends, to repurchase its stock or toperform other similar equity transactions prior to December 31, 2005;thereafter, such transactions are subject to other terms. This agreementdefines several customary events of default including any material adversechange or any event that occurs which may cause a material adverse change inthe Company’s or its subsidiaries’ condition.

 

As of October 1, 2005, the Company had an unsecured, non-interest bearing note to ClearLab International’s chief technology officer with a principal balance of SGD$1,375,000 (USD$814,000). The note payable is discounted at 7%.  Payments are due in equal monthly installments through July 2007.

 

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As of October 1, 2005, the Company had aterm loan payable to a Singapore bank with a principal balance of SGD$6,110,000(USD$3,618,000) 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 December 2007.  This note also contains various financialcovenants including minimums on net worth and shareholders’ funds.  1-800 CONTACTS, INC. has guaranteed this termloan.

 

As of October 1, 2005, the Company also hada note payable to the former parent of ClearLab International with a principalbalance of SGD$6,892,000 (USD$4,082,000) that bears interest at 6% and has asubordinated position to the term loan payable to the Singapore bank.  The note payable is discounted at 7%.  Interest payments are due monthly.  Principal payments are due in monthlyinstallments from January 2008 through December 2009.  1-800 CONTACTS, INC. has guaranteed thisnote.

 

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.

 

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**NOTE 9.  COMMITMENTS AND CONTINGENCIES**

 

***Legaland Regulatory Matters***

 

The sale anddelivery of contact lenses are governed by both federal and state laws andregulations, including the federal Fairness to Contact Lens Consumer Act (“FCLCA”).  The FCLCA requires that contact lenses onlybe sold to consumers based on the seller obtaining a copy of the prescriptionitself or verifying the prescription by direct communication with the customer’sprescriber. Consistent with this requirement, the Company’s current operatingpractice is to require all customers to provide either a valid copy of theirprescription or the contact information for their prescriber so that theCompany can verify their prescription by direct communication with theirprescriber.  If the Company does not havea valid copy of the customer’s prescription, the Company directly communicatesto the customer’s prescriber the precise prescription information received fromthe customer and informs the prescriber that it will proceed with the salebased on this prescription information unless the prescriber advises it withineight business hours that such prescription information is expired or otherwiseinvalid.  If the prescriber properlyadvises the Company within this time period that the customer’s prescription isexpired or otherwise 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 writtenprescriptions that it receives and maintains records of its communications withthe customer’s prescriber.  The Companybelieves that it is complying with the regulations of the FCLCA.

 

On October 13, 2005,the Company received a letter from the Federal Trade Commission (“FTC”)notifying the Company that the FTC had received numerous complaints from eyecare providers about the Company’s inbound fax system.  Copies of the FTC letter and the Company’sresponse to the FTC are available on the Company’s website atwww.order.1800contacts.com/compliance. The FTC letter states that the “complaintsallege that [the Company’s] fax lines are often busy, and that prescribers aretherefore unavailable to communicate with it regarding verification requests.”

 

In response to thisletter from the FTC, the Company conducted a thorough review of its systems andfound that its verification fax system (provided by a third party with capacityto receive more than a hundred simultaneous faxes) has maintained 99.96%availability to date in 2005.  However,the Company points out in its response to the FTC that with millions of ordersprocessed each year by the Company, even this near perfect uptime could resultin instances where a small number of prescribers find the system unavailablefor a brief period of time.  In order toensure compliance with the FCLCA, the Company suspends shipping during averification system outage and does not take advantage of any system outages toreduce the eight business hours available to prescribers to respond toverification requests as required by the FCLCA.

 

From time to time theCompany is involved in legal matters generally incidental to its business.  It is the opinion of management, afterdiscussion with legal counsel that, except for legal and professional fees thatthe Company incurs from time to time, the ultimate dispositions of all of thesematters will not have a material impact on the financial position, liquidity orresults of operations of the Company. However, there can be no assurance that the Company will be successfulin its efforts to satisfactorily resolve these matters, and the ultimateoutcome could result in a material negative impact on the Company’s financialposition, liquidity or results of operations.

 

***AdvertisingCommitments***

 

As of October 1,2005, the Company had entered into certain noncancelable commitments withvarious advertising companies that will require the Company to payapproximately $2.2 million and $7.6 million for advertising during theremainder of 2005 and in 2006, respectively.

 

**NOTE10.  SEGMENT INFORMATION**

 

The Company has two operating segments. Theseoperating segments represent components of the Company for which separatefinancial information is available and are evaluated regularly by management indetermination of

 

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resource allocation and performance assessment. TheCompany’s U.S. Retail segment includes the operations of 1-800 CONTACTS, adirect marketer of replacement contact lenses. The Company’s Internationalsegment includes the operations of ClearLab International and ClearLab UK,which are developers, marketers, manufacturers and distributors of contactlenses. The U.S. Retail segment includes revenue from the optical retail storeagreement and the International segment includes revenue from the Japaneselicense and royalty agreement.   Operating segment information for the quarterand three quarters ended October 2, 2004 and October 1, 2005 is asfollows (in thousands):

 
| **Quarter Ended October 2, 2004**                                   | ** ** | **U.S. Retail** | ** ** | **International** | ** ** | **Eliminations** | ** ** | **Total** | ** ** |
|--------------------------------------------------------------------------|------------|-----------------|------------|-------------------|------------|------------------|------------|-----------|------------|
| Net sales                                                                |       | $               | 54,966     |              | $          | 1,927            |       | $         | —     |   | $ | 56,893 |   |
| Gross profit (loss)                                                      |       | 22,235          |       | (231              | )          | —           |       | 22,004    |       |
| Research and development                                                 |       | —          |       | 567               |       | —           |       | 567       |       |
| Other selling, general and administrative expense                        |       | 9,701           |       | 1,088             |       | —           |       | 10,789    |       |
| Income (loss) from operations                                            |       | $               | 5,179      |              | $          | (2,090           | )          | $         | —     |   | $ | 3,089 |   |
|                                                                     |       |            |       |              |       |             |       |      |       |
| **Quarter Ended October 1, 2005**                                   | ** ** | **U.S. Retail** | ** ** | **International** | ** ** | **Eliminations** | ** ** | **Total** | ** ** |
| Net sales (International segment includes intersegment  sales of $917)   |       | $               | 55,791     |              | $          | 5,984            |       | $         | (917       | ) | $ | 60,858 |   |
| Gross profit                                                             |       | 21,928          |       | 1,841             |       | (617             | )          | 23,152    |       |
| Research and development                                                 |       | —          |       | 426               |       | —           |       | 426       |       |
| Other selling, general and administrative expense                        |       | 10,998          |       | 2,540             |       | —           |       | 13,538    |       |
| Income (loss) from operations                                            |       | $               | 3,367      |              | $          | (1,378           | )          | $         | (617       | ) | $ | 1,372 |   |
|                                                                     |       |            |       |              |       |             |       |      |       |
| **Three Quarters Ended October 2,  2004**                           | ** ** | **U.S. Retail** | ** ** | **International** | ** ** | **Eliminations** | ** ** | **Total** | ** ** |
| Net sales                                                                |       | $               | 153,159    |              | $          | 4,554            |       | $         | —     |   | $ | 157,713 |   |
| Gross profit (loss)                                                      |       | 60,990          |       | (417              | )          | —           |       | 60,573    |       |
| Research and development                                                 |       | 536             |       | 1,366             |       | —           |       | 1,902     |       |
| Purchased in-process research and development                            |       | —          |       | 83                |       | —           |       | 83        |       |
| Other selling, general and administrative expense                        |       | 28,276          |       | 3,161             |       | —           |       | 31,437    |       |
| Income (loss) from operations                                            |       | $               | 5,865      |              | $          | (5,493           | )          | $         | —     |   | $ | 372 |   |
|                                                                     |       |            |       |              |       |             |       |      |       |
| **Three Quarters Ended October 1,  2005**                           | ** ** | **U.S. Retail** | ** ** | **International** | ** ** | **Eliminations** | ** ** | **Total** | ** ** |
| Net sales (International segment includes intersegment  sales of $1,291) |       | $               | 168,924    |              | $          | 14,873           |       | $         | (1,291     | ) | $ | 182,506 |   |
| Gross profit                                                             |       | 66,972          |       | 3,147             |       | (791             | )          | 69,328    |       |
| Research and development                                                 |       | —          |       | 2,292             |       | —           |       | 2,292     |       |
| Other selling, general and administrative expense                        |       | 31,870          |       | 5,489             |       | —           |       | 37,359    |       |
| Income (loss) from operations                                            |       | $               | 12,159     |              | $          | (5,355           | )          | $         | (791       | ) | $ | 6,013 |   |

 

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The following reconciles totalsegment income from operations to income (loss) before provision for incometaxes for the quarter and three quarters ended October 2, 2004 and October 1,2005 as follows (in thousands):

 
| ** **                                         | ** ** | **Quarter Ended**        | ** ** |
|----------------------------------------------------|------------|--------------------------|------------|
| ** **                                         | ** ** | **October 2, 2004** | ** ** | **October 1, 2005** | ** ** |
| Income  from operations                            |       | $                        | 3,089      |   | $ | 1,372 |   |
| Interest  expense                                  |       | (374                     | )          | (347 | ) |
| Foreign  currency exchange transaction gain (loss) |       | 58                       |       | (330 | ) |
| Other  income (expense), net                       |       | 100                      |       | (78 | ) |
| Income  before provision for income taxes          |       | $                        | 2,873      |   | $ | 617 |   |

 
| ** **                                       | ** ** | **Three Quarters Ended** | ** ** |
|--------------------------------------------------|------------|--------------------------|------------|
| ** **                                       | ** ** | **October 2, 2004** | ** ** | **October 1, 2005** | ** ** |
| Income  from operations                          |       | $                        | 372        |   | $ | 6,013 |   |
| Interest  expense                                |       | (1,176                   | )          | (995 | ) |
| Foreign  currency exchange transaction loss      |       | (27                      | )          | (1,390 | ) |
| Other  expense, net                              |       | (68                      | )          | (177 | ) |
| Income  (loss) before provision for income taxes |       | $                        | (899       | ) | $ | 3,451 |   |

 

Identifiablesegment assets are as follows (in thousands):

 
| **Fiscal Year Ended January 1, 2005** | ** ** | **U.S. Retail** | ** ** | **International** | ** ** | **Total** | ** ** |
|--------------------------------------------|------------|-----------------|------------|-------------------|------------|-----------|------------|
|                                       |       |            |       |              |       |      |       |
| Long-lived  assets, net                    |       | $               | 33,374     |              | $          | 39,461    |       | $ | 72,835 |   |
| Total  assets                              |       | 56,216          |       | 52,769            |       | 108,985   |       |
|                                            |            |                 |            |                   |            |           |            |  |  |  |

 
| **Quarter Ended October 1, 2005** | ** ** | **U.S. Retail** | ** ** | **International** | ** ** | **Total** | ** ** |
|----------------------------------------|------------|-----------------|------------|-------------------|------------|-----------|------------|
|                                   |       |            |       |              |       |      |       |
| Long-lived  assets, net                |       | $               | 35,854     |              | $          | 43,712    |       | $ | 79,566 |   |
| Total  assets                          |       | 59,653          |       | 58,375            |       | 118,028   |       |
|                                        |            |                 |            |                   |            |           |            |  |  |  |

 

**NOTE 11.  RECENTLY ISSUED ACCOUNTING STANDARDS**

 

In December 2004,the FASB issued SFAS No. 123 (revised 2004), “Share-Based Payment” (“SFAS 123R”),which replaces SFAS No. 123, “Accounting for Stock-Based Compensation,” (“SFAS 123”)and supercedes APB Opinion No. 25, “Accounting for Stock Issued toEmployees.” SFAS 123R requires all share-based payments to employees,including grants of employee stock options, to be recognized in the financialstatements based on their fair values beginning with the first annual periodafter June 15, 2005, with early adoption encouraged. The pro formadisclosures previously permitted under SFAS 123 will no longer be analternative to financial statement recognition. The Company is required toadopt SFAS 123R in the first fiscal quarter of 2006, beginning January 1,2006. Under SFAS 123R, the Company must determine the appropriate fairvalue model to be used for valuing share-based payments, the amortizationmethod for compensation cost and the transition method to be used at date ofadoption. The transition methods include prospective and retroactive adoptionoptions. Under the retroactive option, prior periods may be restated either asof the beginning of the year of adoption or for all periods presented. Theprospective method requires that compensation expense be recorded for allunvested stock options at the beginning of the first quarter of adoption ofSFAS 123R, while the retroactive methods would record compensation expensefor all unvested stock options and beginning with the first period restated.The Company is evaluating the requirements of SFAS 123R and expects thatthe adoption of SFAS 123R will have a material adverse impact on itsconsolidated results of operations and earnings per share. The Company has notyet determined the method of adoption or the effect of adopting SFAS 123R.

 

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In November 2004, the FASB issued SFAS No. 151,“Inventory Costs” (“SFAS 151”). The provisions of this statement becomeeffective for the Company in fiscal 2006. SFAS 151 amends the existingguidance on the recognition of inventory costs to clarify the accounting forabnormal amounts of idle expense, freight, handling costs, and wasted material(spoilage). Existing rules indicate that under some circumstances, itemssuch as idle facility expense, excessive spoilage, double freight, andrehandling costs may be so abnormal as to require treatment as current periodcharges. SFAS 151 requires that those items be recognized as currentperiod charges regardless of whether they meet the criterion of “so abnormal”.In addition, SFAS 151 requires that allocation of fixed productionoverheads to the costs of conversion be based on the normal capacity of theproduction facilities. The Company is required to adopt SFAS 151 in thefiscal year beginning January 1, 2006. The Company has not yet determinedthe impact of SFAS 151.

 

In June 2005, theFASB issued SFAS No. 154, “Accounting Changes and Error Corrections (“SFAS154”) — a replacement of APB Opinion No. 20, Accounting Changes, and SFAS No. 3,Reporting Accounting Changes in Interim Financial Statements.” Under theprovisions of SFAS No. 154, voluntary changes in accounting principles areapplied retrospectively to prior periods’ financial statements unless it wouldbe impractical. SFAS No. 154 supersedes APB Opinion No. 20, which requiredthat most voluntary changes in accounting principles be recognized by includingin the current period’s net income the cumulative effect of the change. SFAS No. 154also makes a distinction between “retrospective application” of a change inaccounting principle and the “restatement” of financial statements to reflectthe correction of an error. The provisions of SFAS No. 154 are effectivefor accounting changes made in fiscal years beginning after December 15,2005. The Company does not expect adoption to have a material impact on theconsolidated financial statements, results of operations or liquidity of theCompany.

 

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

 

**Overview**

 

The Company is a leadingdirect marketer of replacement contact lenses and also conducts contact lensmanufacturing, development and distribution operations in Singapore and theUnited Kingdom.  The Company’s U.S.Retail operations sell almost all of the popular brands of contacts lenses,including those manufactured by Johnson & Johnson Vision Care, CIBAVision, Bausch & Lomb and CooperVision.

 

**Recent Transactions andAgreements**

 

***International Operations (ClearLab). ***On February 24, 2004,the Company acquired VisionTec, a developer and manufacturer of daily contactlenses based in the United Kingdom.  VisionTec developed a method for lowcost, high quality production of daily disposable contact lenses using a uniqueproprietary material.  VisionTec has subsequently been renamed ClearLab UKLtd (“ClearLab UK”).  The business operates as a research and developmentand a manufacturing affiliate of ClearLab International.  The Companybegan shipping its daily disposable contact lenses in the first quarter offiscal 2004 and is currently expanding its production capabilities for theselenses.

 

ClearLab, the Company’sinternational contact lens development, manufacturing and distributionbusiness, includes the operations of ClearLab International and ClearLabUK.  ClearLab recently began to sellfrequent replacement lenses in the U.S. through the Company’s retail opticalpartnership. ClearLab will increase its product offerings to the internationalmarkets throughout the remainder of fiscal 2005 from its production facilitiesin Singapore and the U.K. as demand for its product continues to grow.

 

***Japanese License and Royalty Agreement.***        On December 15, 2004,the Company signed an agreement which grants Menicon Co., Ltd. (Menicon),Japan’s largest independent contact lens manufacturer, exclusive rights todevelop, manufacture and market certain disposable contact lenses and relatedintellectual property in Japan.

 

Under the terms of theagreement, Menicon licenses from the Company different types of intellectualproperty, including contact lens material, manufacturing technology and relatedknowledge.  In consideration, Menicon isexpected to pay nonrefundable license fees of $18 million, of which $5 millionwas paid in December 2004 upon signing the agreement. The remaining$13 million is expected to be paid over the next three to five years asthe Company fulfills its obligations and as corresponding milestones relatingto Japanese regulatory approval and Menicon’s launch of the product in the Japanesemarket are met. Of the total $18 million license fee, $10 million isguaranteed.  Accordingly, the Company isrecognizing the guaranteed portion of the license fees from this agreement on astraight-line basis, limited by the amount of cash received, over the period ofthe Company’s continued involvement in meeting its obligations, estimated to bethrough June of 2007.  In the eventthe Company achieves a milestone (not relating to the guaranteed portion of thelicense fees) prior to the completion of its obligations under the agreement,the milestone payment will be recognized on a straight-line basis over theremaining period of the Company’s continued involvement in meeting itsobligations.  Upon completion of thisagreement, the Company will recognize the remaining milestone payments as theagreed upon milestones are achieved.

 

If Menicon has notreceived regulatory approval on or before December 31, 2009, it may returnall intellectual property covered by the agreement and in-process regulatoryapprovals to the Company, and the Company may pursue the Japanese market on itsown and terminate the exclusive agreement.

 

Under the terms of theagreement, Menicon will also pay royalties for a period of at least15 years from the product launch date in Japan on contact lenses sold thatwere manufactured using the licensed technology, with a guaranteed minimum of$5 million per year beginning the earlier of the second year after productlaunch or 2012. The agreement does not include the sale of any of the Company’scurrent equipment, facilities or capacity and is limited to the Japanesecontact lens market.

 

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***Optical Retail Store Agreement. ***During the latter partof 2004, the Company entered into an agreement with a regional optical retailchain in Utah in which the two companies would jointly market and sell contactlenses in Utah.  In December 2004,the companies began jointly serving these Utah customers. The agreement is forone year, with one year renewals at the option of both parties.

 

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, theCompany has guaranteed that the retail chain will receive at least $0.5 millionof annual earnings under the arrangement. Additionally, the Company committedto purchase approximately $0.3 million per year in inventory from the retailchain’s source of supply.

 

The Company does not planto launch a national network until a resolution can be found to industry practicesrelating to “doctor only” lenses.  Thesepractices prevent the Company from obtaining certain lenses because some manufacturersrefuse to sell these lenses to parties other than eye care practitioners.

 

***SupplierAgreements.*** The Company has agreements with its top threevendors for improved pricing and marketing support.  This support comes in the form of cooperativemarketing and rebate programs designed to promote the manufacturer’s productsand build sales.  As part of its ongoingrelationship with its suppliers, the Company periodically reviews its specificmarketing plans and negotiates cooperative marketing programs and productpricing.

 

# **Regulatory Considerations**

 

***Fairnessto Contact Lens Consumer Act. *** In November 2003,Congress passed the Fairness to Contact Lens Consumer Act (“FCLCA”), whichestablishes a national uniform standard for both eye care practitioners anddirect marketers with regard to releasing and verifying consumer contact lensprescriptions as well as other requirements relating to the sale of contactlenses.  The FCLCA became effective February 4,2004, and now requires all eye care practitioners to give patients a copy oftheir prescription as soon as they have been fitted for contact lenses, whetherthe patients ask for it or not.  It alsodirects contact lens sellers to contact eye care practitioners to requestverification of consumer prescriptions before shipping all orders (if theprescription is not already on file), and it provides that failure to respondwithin eight business hours shall result in the prescription being presumedvalid, thereby eliminating the ability of eye care practitioners to impedesales by direct marketers simply by ignoring or refusing to respond to theirrequests to verify prescriptions.  TheFCLCA also provides that prescriptions will be valid for a minimum of at leastone year (absent some special medical reason justifying a shorter period).  It also directed the Federal TradeCommission (“FTC”) to conduct a study examining the strength of competition inthe market for contact lenses and to submit a report to Congress within twelvemonths of the FCLCA effective date. This FTC completed and published this studyon February 15, 2005, with no recommendations for further changes infederal law.

 

Satisfying theprescription 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 theCompany within 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 writtenprescriptions that it receives and maintains records of its communications withthe customer’s prescriber.  The FCLCAprovides for several means of direct communication with eye care practitioners,

 

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and the Company may alterits prescription verification procedures from time to time in keeping with theFCLCA and FTC guidelines.

 

On October 13, 2005,the Company received a letter from the Federal Trade Commission (“FTC”)notifying the Company that the FTC had received numerous complaints from eyecare providers about the Company’s inbound fax system.  Copies of the FTC letter and the Company’sresponse to the FTC are available on the Company’s website atwww.order.1800contacts.com/compliance. The FTC letter states that the “complaintsallege that [the Company’s] fax lines are often busy, and that prescribers aretherefore unavailable to communicate with it regarding verification requests.”

 

In response to thisletter from the FTC, the Company conducted a thorough review of its systems andfound that its verification fax system (provided by a third party with capacityto receive more than a hundred simultaneous faxes) has maintained 99.96%availability to date in 2005.  However,the Company points out in its response to the FTC that with millions of ordersprocessed each year by the Company, even this near perfect uptime could resultin instances where a small number of prescribers find the system unavailablefor a brief period of time.  In order toensure compliance with the FCLCA, the Company suspends shipping during averification system outage and does not take advantage of any system outages toreduce the eight business hours available to prescribers to respond toverification requests as required by the FCLCA.

 

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**Results of Operations**

 

The Company’s fiscal yearconsists of a 52/53-week period ending on the Saturday nearest to December 31.Fiscal 2005 is a 52-week year and will end on December 31, 2005.

 

The Company has twooperating segments referred to below. The Company’s domestic segment is represented by operations within theU.S. and is referred to as “U.S. Retail” by the Company, whereas the Company’sinternational segment is represented by operations in both Singapore and theU.K. and is referred to as “ClearLab” by the Company.

 

The following tablepresents the Company’s results of operations expressed as a percentage of netsales for the periods indicated: 

 
| ** **                                                 | ** ** | **Quarter Ended**   | ** ** | **Three Quarters Ended** | ** ** |
|------------------------------------------------------------|------------|---------------------|------------|--------------------------|------------|
| ** **                                                 | ** ** | **October 2,** | ** ** | **October 1,**      | ** ** | **October 2,** | ** ** | **October 1,** | ** ** |
| ** **                                                 | ** ** | **2004**            | ** ** | **2005**                 | ** ** | **2004** | ** ** | **2005** | ** ** |
| NET SALES                                                  |       | 100.0               | %          | 100.0                    | %          | 100.0 | % | 100.0 | % |
| COST OF GOODS SOLD                                         |       | 61.3                |       | 62.0                     |       | 61.6 |   | 62.0 |   |
| Gross  profit                                              |       | 38.7                |       | 38.0                     |       | 38.4 |   | 38.0 |   |
|                                                       |       |                |       |                     |       |   |   |   |   |
| SELLING, GENERAL &  ADMINISTRATIVE EXPENSES:      |       |                |       |                     |       |   |   |   |   |
| Advertising                                                |       | 11.4                |       | 10.9                     |       | 14.3 |   | 11.1 |   |
| Legal  and professional                                    |       | 1.8                 |       | 2.0                      |       | 2.7 |   | 1.9 |   |
| Research  and development                                  |       | 1.0                 |       | 0.7                      |       | 1.2 |   | 1.3 |   |
| Purchased  in-process research and development             |       | —              |       | —                   |       | 0.1 |   | — |   |
| Other  selling, general & administrative          |       | 19.0                |       | 22.2                     |       | 19.9 |   | 20.4 |   |
| Total selling, general &  administrative expenses |       | 33.2                |       | 35.8                     |       | 38.2 |   | 34.7 |   |
| INCOME FROM OPERATIONS                                     |       | 5.5                 |       | 2.2                      |       | 0.2 |   | 3.3 |   |
| OTHER EXPENSE, net                                         |       | (0.4                | )          | (1.2                     | )          | (0.8 | ) | (1.4 | ) |
| INCOME  (LOSS) BEFORE PROVISION FOR INCOME TAXES           |       | 5.1                 |       | 1.0                      |       | (0.6 | ) | 1.9 |   |
| PROVISION FOR INCOME  TAXES                                |       | (2.7                | )          | (2.0                     | )          | (0.7 | ) | (2.1 | ) |
| NET INCOME (LOSS)                                          |       | 2.4                 | %          | (1.0                     | )%         | (1.3 | )% | (0.2 | )% |

 

***Netsales***.  Net salesfor the quarter ended October 1, 2005 increased 7.0% to $60.9 million from$56.9 million for the quarter ended October 2, 2004.  For the three quarters ended October 1,2005, net sales increased 15.7% to $182.5 million from $157.7 million for the threequarters ended October 2, 2004.  Netsales for the Company’s U.S. Retail operations, for the third quarter of fiscal2005 and the first three quarters of fiscal 2005 were $55.8 million and $168.9million, respectively, an increase from the prior year periods of 2% and 10%,respectively.  Approximately half of the year-to-dateincreases in U.S. Retail net sales are due to a decrease in the number andpercentage of orders the Company canceled as a result of prescriptionverification procedures (see “Regulatory Considerations”).  For the third quarter of fiscal 2005 adecrease in the number and percentage of orders the Company canceled accountedfor approximately $0.5 million of the increase in net sales from the prior yearquarter.  The Company believes thecancellation rate has now stabilized and does not anticipate any significantchange in the balance of fiscal 2005. The Company is continually taking steps to minimize canceled orders,including continued development of a more integrated national retail storenetwork and the continued development of internal procedures to help obtain thenecessary prescription information that is required to fulfill an order.  The balance of the increase in U.S. Retailnet sales for the third quarter and first three quarters of fiscal 2005 can beattributed largely to an increase in average order size due principally to anincreased number of customer rebate programs instituted during fiscal 2004 andthe first three quarters of fiscal 2005 and an increase in accessory sales.

 

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U.S. Retail net sales forthe first three quarters of fiscal 2005 were negatively impacted by the Company’sdecision during the fourth quarter of fiscal 2004 to suspend sales of aspecific brand of lens, as the Company is unable to obtain sufficientquantities of this lens from anyone other than the manufacturer, who refuses tosell the Company this lens.  Sales ofthis lens represented approximately 2.5% of the Company’s fiscal 2004 U.S.Retail net sales.  Additionally, netsales during the third quarter of fiscal 2005 were negatively impacted byapproximately $0.7 million due to temporary disruptions in service to theCompany’s internet customers as the Company upgraded its website to a newerversion with enhanced features.

 

Net sales for ClearLabfor the third quarter of fiscal 2005 and the first three quarters of fiscal2005 were $6.0 million and $14.9 million, respectively.  Net sales for ClearLab, for the third quarterof fiscal 2004 and the first three quarters of fiscal 2004 were $1.9 millionand $4.5 million, respectively.  ClearLab’sresults for the first three quarters of fiscal 2005 include $1.0 million perquarter in license fees from the Company’s Japanese license agreement.  Additionally, $0.9 million and $1.3 millionof ClearLab’s sales during the third fiscal quarter and first three fiscalquarters of 2005, respectively, were intercompany sales to the Company’s U.S.retail business and are eliminated for consolidation purposes, as the Companyrecognizes retail sales when the product is sold to external customers.  During the first three quarters of fiscal2005, ClearLab realized increased sales to existing and new customers as it hasenhanced its product offerings and expanded its production capabilities.

 

***Grossprofit.*** Consolidated gross profit as a percentage of net sales for the quarterand three quarters ended October 1, 2005 was 38.0% for each period comparedto 38.7% and 38.4%, respectively, for the quarter and three quarters ended October 2,2004.

 

Gross profit as apercentage of net sales for the Company’s U.S. Retail operations decreased to 39.3%for the third quarter of fiscal 2005 from 40.5% in the third quarter of fiscal2004. This decrease can be attributed largely to an increased number ofcustomer rebate programs instituted during fiscal 2004 and the first threequarters of fiscal 2005.  However, grossprofit as a percentage of net sales for the Company’s U.S. Retail operations remainedrelatively consistent at 39.6% from 39.8% for the three quarters ended October 1,2005 and October 2, 2004, respectively.

 

Gross profit as apercentage of net sales for ClearLab was 30.8% and 21.2% for the quarter and threequarters ended October 1, 2005, respectively. For the prior year quarterand three quarters ended October 2, 2004, gross profit as a percentage ofnet sales was negative due to the start-up nature of ClearLab UK, which wasacquired on February 24, 2004.  Theincrease in gross profit as a percentage of net sales during the fiscal 2005periods is due mainly to the Company’s continued improvement of its salesvolume and manufacturing efficiencies.  TheCompany expects to see continued improvement in gross margins from ClearLabthroughout fiscal 2005.

 

***Advertisingexpense. ***Advertisingexpense for the quarter ended October 1, 2005 was $6.6 million, an increaseof $0.1 million from the quarter ended October 2, 2004.  As a percentage of net sales, advertisingexpense decreased to 10.9% for the third quarter of fiscal 2005 from 11.4% forthe third quarter of fiscal 2004.  Forthe three quarters ended October 1, 2005, advertising expense was $20.3million, a decrease of $2.3 million from the three quarters ended October 2,2004.  As a percentage of net sales,advertising expense decreased to 11.1% for the first three quarters of fiscal2005 from 14.3% for the first three quarters of fiscal 2004.  The Company expects advertising expenses ofapproximately $25 million for fiscal 2005. However, if opportunities present themselves, the Company may increaseadvertising spending above currently planned levels.  The Company’s experience has been thatincreases in advertising expenditures have a direct impact on the growth of netsales not only in the current period but also in future periods.

 

The Company expenses alladvertising costs when the advertising first takes place.  As a result, quarter-to-quarter comparisonsare impacted within and between quarters by the timing of television, radio andInternet advertisements and by the mailing of the Company’s printedadvertisements. The volume of mailings and other advertising may vary indifferent quarters and from year to year depending on the Company’s assessmentof prevailing market opportunities.

 

***Legaland professional fees.*** Legal and professional fees for the quarter ended October 1, 2005 increased

 

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$0.2 million to $1.2million from the quarter ended October 2, 2004.  As a percentage of net sales, legal andprofessional fees increased to 2.0% for the third quarter of fiscal 2005 from 1.8%for the third quarter of fiscal 2004. For the three quarters ended October 1, 2005, legal andprofessional fees decreased $0.8 million to $3.4 million from the three quartersended October 2, 2004.  As apercentage of net sales, legal and professional fees decreased to 1.9% for thefirst three quarters of fiscal 2005 from 2.7% for the first three quarters offiscal 2004.

 

During the first quarterof fiscal 2004 the Company invested considerable effort preparing comments forthe Federal Trade Commission (“FTC”) relating to final rules associatedwith the FCLCA.  During the first threequarters of fiscal 2005, the Company continued to incur professional fees forSarbanes-Oxley compliance, and other internal control initiatives, as well asongoing legal, lobbying and regulatory initiatives.

 

The Company will continueto focus its efforts on compliance with federal rules and regulations aswell as continue to support legal and legislative initiatives that it believeswill benefit contact lens wearers and the industry.

 

***Researchand development expenses.*** Research and development expenses for the quarter ended October 1,2005 decreased to $0.4 million, or 0.7% of net sales, from $0.6 million, or 1.0%of net sales, from the quarter ended October 2, 2004.  For the three quarters ended October 1,2005, research and development expenses were $2.3 million, or 1.3% of netsales, up from $1.9 million, or 1.2% of net sales, for the three quarters endedOctober 2, 2004.  During the first threequarters of fiscal 2005, the Company continued to fund research and developmentefforts for ClearLab’s operations.

 

Total fiscal 2005research and development costs will be dependent on progress with research anddevelopment efforts relating to expanding ClearLab’s product offering anddeveloping its intellectual property.

 

***Otherselling, general and administrative expenses.***  Other selling, general and administrativeexpenses for the quarter ended October 1, 2005 increased approximately $2.7million from the quarter ended October 2, 2004.  As a percentage of net sales, other selling,general and administrative expenses for the quarter ended October 1, 2005 alsoincreased to 22.2% from 19.0% for the quarter ended October 1, 2004.  As a percentage of net sales, other selling,general and administrative expenses for the three quarters ended October 1,2005 increased to 20.4% from 19.9% for the three quarters ended October 2,2004; such expenses also increased by approximately $5.9 million for the sameperiod.

 

The Company’s U.S. Retailother selling, general and administrative expenses increased by approximately $1.3million for the quarter ended October 1, 2005 from the quarter ended October 2,2004; additionally, such expenses also increased as a percentage of net salesto 19.7% from 17.6% respectively, for the same period.  ClearLab’s other selling, general andadministrative expenses increased by approximately $1.5 million for the quarterended October 1, 2005 from the quarter ended October 2, 2004.  For the three quarters ended October 1,2005, the Company’s U.S. Retail other selling, general and administrativeexpenses increased by approximately $3.6 million from the three quarters ended October 2,2004.  As a percentage of net sales, U.S.Retail other selling, general and administrative expenses for the threequarters ended October 1, 2005 increased to 18.9% from 18.5% for the threequarters ended October 2, 2004. ClearLab’s other selling, general and administrative expenses increasedby approximately $2.3 million for the three quarters ended October 1, 2005from the three quarters ended October 2, 2004.

 

The majority of theincrease for U.S. Retail relates to the continued enhancement of its operatinginfrastructure and management team to meet the demands of the business andvariable costs associated with higher net sales and the requirements of theFCLCA.  A majority of ClearLab’s increaserelated to the enhancement and scale up of its operating infrastructure,including the operations of ClearLab UK, which was partially offset in thethird quarter by a Singapore government grant of approximately $0.4 million forcertain qualifying expenditures which was recorded as a reduction of selling,general and administrative expenses.

 

The Company expects otherselling, general and administrative expenses to fluctuate as a percentage ofnet sales as the Company continues to grow and expand its U.S. andinternational operations.

 

***Otherexpense, net.*** Other expense increased to approximately $0.8 million and $2.6 millionfor the quarter and three quarters ended October 1, 2005, respectively,from approximately $0.2 million and $1.3 million for the

 

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quarter and threequarters ended October 2, 2004, respectively.  For the third quarter of fiscal 2005, otherexpense consisted mainly of approximately $0.3 million in interest expense and$0.3 million in foreign currency exchange transaction losses.  Other expense in the third quarter of fiscal2004 consisted mainly of interest expense of $0.4 million, offset by unrealizedforeign exchange transaction gains of approximately $0.1 million.  For the first three quarters of fiscal 2005,other expense consisted mainly of foreign currency exchange transaction lossesof approximately $1.4 million and interest expense of approximately $1.0million.   For the first three quartersof fiscal 2004, other expense consisted mainly of interest expense ofapproximately $1.2 million and foreign currency exchange transaction losses ofless than $0.1 million.  The foreigncurrency exchange transaction losses related primarily to intercompany loans toClearLab.

 

***Incometaxes. ***The Companyis taxed in three separate jurisdictions - U.S., Singapore and the UnitedKingdom.  The Company’s effective U.S.income tax rate for the three quarters ended October 1, 2005 isapproximately 40% as compared with the 39% reported for the three quartersended October 2, 2004.   During thefirst three quarters of fiscal 2005, the Company did not record a tax benefitfor the loss from the operations of ClearLab International due to theuncertainty with respect to the realization of a tax benefit in Singapore.  For the first three quarters of fiscal 2005,the Company provided a valuation allowance for the full amount of deferredincome tax assets in Singapore.   For thefirst three quarters of fiscal 2005, the Company recorded a tax benefit for theloss from operations of ClearLab UK using an effective tax rate of approximately25%. The Company provided a valuation allowance for a portion of the deferredincome tax assets in the United Kingdom based on the excess of the deferred taxliabilities recorded as of the date of acquisition of ClearLab UK over thedeferred tax assets generated by the loss from operations during fiscal 2004and the expected loss for fiscal 2005, which operating loss can be carriedforward indefinitely.  The Company’seffective income tax rates may change as facts and circumstances change.  The Company anticipates that its fiscal 2005effective income tax rate for the U.S. and the United Kingdom will beconsistent with the respective effective rates recorded during the first threequarters of fiscal 2005.

 

**Liquidity and Capital Resources**

 

The Company’s principal sources of liquidity have beencash provided by operating activities and proceeds from debt financings.  The Company’s principal uses of cash havebeen to meet debt service requirements, finance acquisitions, finance capitalexpenditures, fund working capital needs and repurchase common stock.  The Company anticipates that these uses willcontinue to be the principal demands on its cash in the future.  As of October 1, 2005, the Company hadnet working capital of approximately $7.2 million, compared to $10.0 million asof January 1, 2005.

 

The Company believes thatits cash on hand, together with cash generated from operating activities andthe borrowings available through the credit facility, will be sufficient tosupport planned operations through the foreseeable future.  Should the Company’s plans or expectationschange, the Company may be required to seek additional sources of funds andthere can be no assurance that such funds will be available on satisfactoryterms.  Failure to obtain such financingcould delay or prevent the Company’s planned growth, which could adverselyaffect the Company’s business, financial condition, liquidity and results ofoperations.

 

As a result of regulatory requirements, the Company’sliquidity, capital resources and results of operations may be negativelyimpacted in the future if the Company incurs increased costs (including legalfees) or fines, is prohibited from selling its products or experiences lossesof a substantial portion of the Company’s customers for whom the Company isunable to obtain or verify a prescription due to the requirements of the FCLCA.

 

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The Company has a loan agreementwith a U.S. bank providing for a revolving credit facility for borrowings of upto $25.6 million as of October 1, 2005, which amount is reduced thereafteron the first day of each September, December, March and June by$0.4 million until the maturity date of February 27, 2007.Additionally, the agreement provides for letters of credit up to a maximum of$15 million outstanding or payable at any time. The loan agreementspecifies that if the maximum leverage ratio, as defined in the agreement, isgreater than 2.5, then the amounts outstanding on the revolving credit facilitytogether with the amount of all outstanding letters of credit can at no timeexceed the Company’s book value of inventory. As of October 1, 2005, theCompany was not subject to this restriction and could borrow up to $25.6 million.Outstanding borrowings on the revolving credit facility bear interest at afloating rate equal to the lender’s prime interest rate plus a margin or thelender’s LIBOR rate plus a margin. The interest rate is adjusted quarterly andranges between prime plus 0.0 percent and prime plus 1.25 percent orbetween the applicable LIBOR rate plus 2.0 percent and the applicableLIBOR rate plus 3.25 percent, depending on the Company’s maximum leverageratio. As of October 1, 2005, the prime rate margin is 0.0 percent and theLIBOR rate margin is 2.0 percent. Interest is payable monthly. As of October 1,2005, the Company’s outstanding borrowings on the credit facility, includingbank overdrafts, were $19.4 million. Of this amount, $10.0 millionbore interest at the lender’s LIBOR rate plus 2.0 percent (5.83% at October 1,2005) and the remaining $9.4 million bore interest at the lender’s prime rateplus 0.0 percent (6.75% at October 1, 2005). The facility requiresthe quarterly payment of an unused credit fee which ranges from0.38 percent to 0.5 percent, depending on the Company’s maximumleverage ratio.

 

All outstanding balanceson this 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 loan agreement includes variousfinancial covenants including a capital expenditure limit, a maximum leverageratio, a minimum working capital requirement, a minimum fixed charge coverageratio and a minimum net worth requirement. The loan agreement does not permitthe Company or its subsidiaries to dissolve, sell, dispose or merge all oftheir 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 loan agreement alsoplaces a limit on the amount the Company can loan to any entity, outside thenormal course of business. Additionally, the agreement does not permit theCompany to declare or pay any cash dividends, to repurchase its stock or toperform other similar equity transactions prior to December 31, 2005;thereafter, such transactions are subject to other terms. This agreementdefines several customary events of default including any material adversechange or any event that occurs which may cause a material adverse change inthe Company’s or its subsidiaries’ condition.

 

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 restatedloan agreement with its U.S. bank.

 

***Cashflows from operating activities.***  For the three quarters ended October 1,2005 and October 2, 2004, net cash provided by operating activities wasapproximately $5.2 million and $5.0 million, respectively.  In the fiscal 2005 period, cash was providedprimarily by adjustments to the net loss for non-cash items, increases inaccounts payable and accrued liabilities as well as a decrease in otherreceivables partially offset by increases in inventories, accounts receivable,other current assets as well as from decreases in income taxes payable andunearned revenue.  In the fiscal 2004period, cash was provided primarily by a decrease in inventories offset byincreases in accounts receivable and other current assets.  Also in the 2004 period, cash was provided byan increase in various accrued liabilities partially offset by a decrease inaccounts payable.

 

***Cash flows from investing activities.***  The Company used approximately $12.3 millionand $14.1 million for investing activities in the three quarters ended October 1,2005 and October 2, 2004, respectively. In the first three quarters of fiscal 2005, the Company’s depositsincreased by approximately $2.1 million of which the majority relates tomanufacturing equipment at ClearLab.  TheCompany also purchased approximately $0.6 million of intangible assets duringthe fiscal 2005 period.  In the fiscal2004 period, the Company paid approximately $3.8 million in cash (including$0.6 million in transaction costs) in connection with the acquisition ofVisionTec.  The Company also purchasedapproximately $4.0 million of intangible assets during the fiscal 2004 period.

 

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Capital expenditures forinfrastructure improvements for the first three quarters ended October 1,2005 and October 2, 2004 were approximately $9.5 million and $6.0 million,respectively.  Of these amounts,approximately $5.9 million and $3.5 million relate to ClearLab purchases forthe 2005 and 2004 fiscal periods, respectively. The Company anticipates additional capital expenditures in fiscal 2005for infrastructure as it continues to expand and improve operating facilities,telecommunications systems and management information systems in order tohandle future operations of both its U.S. and international operations.

 

***Financing activities.***  During the three quarters ended October 1,2005 and October 2, 2004, net cash provided by financing activities wasapproximately $4.1 million and $8.5 million, respectively.  In the first three fiscal quarters of 2005,the Company had net borrowings on its credit facility of approximately $5.0million and made principal payments on debt obligations and capital leaseobligations of approximately $1.3 million. In the first three fiscal quarters of 2004, the Company had netborrowings on its credit facility of approximately $16.4 million and madeprincipal payments on debt obligations and capital lease obligations ofapproximately $8.7 million and incurred approximately $0.2 million in debtissuance costs.  The Company alsoreceived a governmental regional development grant in the U.K. of approximately$0.9 million.  This grant was designed toassist in employment creation while the amount of the grant is based onClearLab UK capital expenditures.  In thefiscal 2005 and 2004 periods, proceeds from the exercise of common stockoptions were $0.4 million and $0.2 million, respectively.

 

As of October 1, 2005, the Company had an unsecured, non-interest bearing note to ClearLab International’s chief technology officer with a principal balance of SGD$1,375,000 (USD$814,000). The note payable is discounted at 7%.  Payments are due in equal monthly installments through July 2007.

 

As of October 1, 2005, the Company had aterm loan payable to a Singapore bank with a principal balance of SGD$6,110,000(USD$3,618,000) 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 December 2007.  This note also contains various financialcovenants including minimums on net worth and shareholders’ funds.  The Company has guaranteed this term loan.

 

As of October 1, 2005, the Company also hada note payable to the former parent of ClearLab International with a principalbalance of SGD$6,892,000 (USD$4,082,000) that bears interest at 6% and has asubordinated position to the term loan payable to the Singapore bank.  The note payable is discounted at 7%.  Interest payments are due monthly.  Principal payments are due in monthlyinstallments from January 2008 through December 2009.  The Company has guaranteed this note.

 

The Company leasesvarious manufacturing and other equipment from financing companies undercapital lease arrangements.  All of theequipment is maintained at the Singapore and United Kingdom facilities.  The majority of the leases were assumed inconnection with the Company’s acquisitions of ClearLab International andClearLab UK.  As of October 1, 2005, the present value of futureminimum lease payments was approximately $0.1 million with payments scheduledthrough fiscal 2009.

 

**Contractual Obligations andCommitments**

 

Subsequent to January 1,2005, there have been no material changes to the Company’s contractualobligations and commitments, outside the normal course of business.

 

**New Accounting Pronouncements**

 

In December 2004,the FASB issued SFAS No. 123 (revised 2004), “Share-Based Payment” (“SFAS 123R”),which replaces SFAS No. 123, “Accounting for Stock-Based Compensation,” (“SFAS 123”)and supercedes APB Opinion No. 25, “Accounting for Stock Issued toEmployees.” SFAS 123R requires all share-based payments to employees,including grants of employee stock options, to be recognized in the financialstatements based on their fair values beginning with the first annual periodafter June 15, 2005, with early adoption encouraged. The pro formadisclosures previously permitted under SFAS 123 will no longer be analternative to financial statement recognition. The Company is required toadopt SFAS 123R in the first fiscal quarter of 2006, beginning January 1,2006. Under SFAS 123R, the Company must determine the appropriate fairvalue model to be used for valuing share-based

 

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payments, theamortization method for compensation cost and the transition method to be usedat date of adoption. The transition methods include prospective and retroactiveadoption options. Under the retroactive option, prior periods may be restatedeither as of the beginning of the year of adoption or for all periodspresented. The prospective method requires that compensation expense berecorded for all unvested stock options at the beginning of the first quarterof adoption of SFAS 123R, while the retroactive methods would recordcompensation expense for all unvested stock options and beginning with thefirst period restated. The Company is evaluating the requirements of SFAS 123Rand expects that the adoption of SFAS 123R will have a material adverse impacton its consolidated results of operations and earnings per share. The Companyhas not yet determined the method of adoption or the effect of adoptingSFAS 123R.

 

In November 2004, the FASB issued SFAS No. 151,“Inventory Costs” (“SFAS 151”). The provisions of this statement becomeeffective for the Company in fiscal 2006. SFAS 151 amends the existingguidance on the recognition of inventory costs to clarify the accounting forabnormal amounts of idle expense, freight, handling costs, and wasted material(spoilage). Existing rules indicate that under some circumstances, itemssuch as idle facility expense, excessive spoilage, double freight, andrehandling costs may be so abnormal as to require treatment as current periodcharges. SFAS 151 requires that those items be recognized as currentperiod charges regardless of whether they meet the criterion of “so abnormal”.In addition, SFAS 151 requires that allocation of fixed productionoverheads to the costs of conversion be based on the normal capacity of theproduction facilities. The Company is required to adopt SFAS 151 in thefiscal year beginning January 1, 2006. The Company has not yet determinedthe impact of SFAS 151.

 

In June 2005, theFASB issued SFAS No. 154, “Accounting Changes and Error Corrections (“SFAS154”) — a replacement of APB Opinion No. 20, Accounting Changes, and SFAS No. 3,Reporting Accounting Changes in Interim Financial Statements.” Under theprovisions of SFAS No. 154, voluntary changes in accounting principles areapplied retrospectively to prior periods’ financial statements unless it wouldbe impractical. SFAS No. 154 supersedes APB Opinion No. 20, whichrequired that most voluntary changes in accounting principles be recognized byincluding in the current period’s net income the cumulative effect of thechange. SFAS No. 154 also makes a distinction between “retrospectiveapplication” of a change in accounting principle and the “restatement” offinancial statements to reflect the correction of an error. The provisions ofSFAS No. 154 are effective for accounting changes made in fiscal yearsbeginning after December 15, 2005. The Company does not expect adoption tohave a material impact on the consolidated financial statements, results ofoperations or liquidity of the Company.

 

**Critical Accounting Policies**

 

Accounting polices thatrequire significant judgments and estimates include revenue recognition(including sales returns and allowances and customer rebates); realizability ofinventories; realizability of deferred income tax assets; accounting forbusiness combinations including assessment of realizability of long-livedassets; stock-based compensation; and legal and regulatory contingencies.  A description of the Company’s significantaccounting policies is included in the notes to the consolidated financialstatements included in the Company’s Form 10-K for the fiscal year ended January 1,2005.  Judgments and estimates are basedon historical experience as well as relevant facts and circumstances known ateach reporting date.  Actual results maydiffer from these estimates.

 

Sales are generallyrecognized when products are shipped and the customer takes ownership andassumes risk of loss, collection of the related receivable is reasonablyassured, persuasive evidence of an arrangement exists and the sales price isfixed or determinable.  U.S. Retail netsales consist of product sales less a provision for sales returns andallowances and estimated customer rebates. The Company accrues an estimated amount for unclaimed customer rebatesand sales returns and allowances based on historical information, adjusted foreconomic trends.  To the extent actualrebates, returns and allowances vary from historical experience revisions tothe allowances may be required.  ClearLabnet sales consist of product sales less a provision for sales returns andallowances. The Company provides its customers with standard industry paymentterms and performs ongoing credit evaluations of its customers and provides fordoubtful accounts to the extent determined necessary based on historical dataand current economic trends.  ClearLabnet sales also include license fees from the Company’s Japanese licenseagreement.  Cash payments received fromthis license are recognized systematically over the periods that the fees areearned by the Company.

 

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In assessing therealizability of inventories, the Company makes judgments as to future demandrequirements and product expiration dates. The inventory requirements change based on projected customer demand,which changes due to fluctuations in market conditions and product life cycles.

 

The Company hassignificant long-lived tangible and intangible assets consisting of property,plant and equipment, goodwill and definite-lived intangibles.  These assets are reviewed for impairmentwhenever events or changes in circumstances indicate that the carrying amountsof such assets may not be recoverable. In addition, the Company performs an impairment test related to goodwillat least annually.  An impairmentanalysis related to long-lived tangible and definite-lived intangible assetsrequires the assessment of expected future undiscounted cash flows over theremaining useful life of the asset.  Animpairment analysis of goodwill requires the use of a fair-value 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.  If forecasts and assumptionsused to support the realizability of long-lived assets change in the future,significant impairment charges could result that would adversely affect theCompany’s results of operations and financial position.

 

Deferred income taxassets are assessed for recoverability and valuation allowances are provided asnecessary to reduce deferred income tax assets to amounts expected to berealized.  Should expectations of taxableincome 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.

 

The Company recordsliabilities for legal and regulatory matters when the contingency is bothprobable and reasonably estimable.  TheCompany is involved in several legal and regulatory matters.  The Company, after consultation with legalcounsel, believes that the ultimate dispositions of these matters will not havea material impact on its financial position, liquidity or results ofoperations.  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 materialnegative impact on the Company’s financial position, liquidity or results ofoperations.

 

**Forward-Looking Statements**

 

Except for the historicalinformation contained herein, the matters discussed in this Form 10-Q areforward-looking statements within the meaning of Section 21E of theSecurities Exchange Act of 1934, as amended, and Section 27A of theSecurities Act of 1933, as amended. These forward-looking statements involve risks and uncertainties andoften depend on assumptions, data or methods that may be incorrect orimprecise.  The Company’s futureoperating results may differ materially from the results discussed in, orimplied by, forward-looking statements made by the Company.  Factors that may cause such differencesinclude, but are not limited to, those discussed below and the other risksdetailed in the Company’s other reports filed with the Securities and ExchangeCommission.  Words such as “believes,” “anticipates,”“expects,” “future,” “intends,” “would,” “may” and similar expressions areintended 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.

 

  *Factors that may affect future results may include, but are not limitedto the following:*

 

•                                          TheCompany may encounter unforeseen difficulties in managing its future growth;

 

•                                          TheCompany obtains a large percentage of its retail inventory from a limitednumber of suppliers, with a single manufacturer accounting for 35%, 23% and 44%of the Company’s inventory purchases in fiscal 2002, 2003 and 2004,respectively.  In addition, the Company’stop three suppliers accounted for 63%, 59% and 83% of the Company’s inventorypurchased in fiscal 2002, 2003 and 2004, respectively;

 

•                                          Continuedgrowth of “doctors only” lenses could compel contact lens manufacturers toadopt or expand a “doctors only” distribution strategy for all or some of thelenses they manufacture.

 

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•                                          TheCompany may continue to experience order cancellations due to the prescriptionverification requirements of the Fairness to Contact Lens Consumers Act;

 

•                                          TheCompany may not be able to establish a sufficient network of eye carepractitioners to prescribe the products manufactured by the Company;

 

•                                          TheCompany may incur unforeseen costs or not realize all of the anticipatedbenefits from its relationships with Johnson & Johnson Vision Care,CIBA Vision and Menicon;

 

•                                          Becausethe Company does not manufacture most of the contact lenses that it sells, theCompany cannot ensure that all of the contact lenses it sells meet all federalregulatory requirements;

 

•                                          Itis possible that the FDA could consider certain of the contact lenses theCompany sells to be misbranded or adulterated;

 

•                                          TheCompany, through a wholly owned subsidiary, is registered as an initialdistributor/importer with the FDA, and the Company’s failure to comply withcertain regulatory responsibilities and requirements could result inenforcement by the FDA;

 

•                                          TheCompany currently purchases a portion of its products from unauthorizeddistributors and is not an authorized distributor for some of the products thatit sells;

 

•                                          TheCompany may continue to incur significant legal and professional fees relatedto its legal matters and its efforts to proactively influence the industry onbehalf of itself and consumers;

 

•                                          TheCompany’s quarterly results are likely to vary based upon the level of sales andmarketing activity in any particular quarter;

 

•                                          TheCompany is dependent on its telephone, Internet and management informationsystems for the sale and distribution of contact lenses;

 

•                                          Theretail sale of contact lenses is highly competitive and certain of the Company’scompetitors are large, national optical chains that have greater resources thanthe Company;

 

•                                          Thedemand for contact lenses could be substantially reduced if alternativetechnologies to permanently correct vision gain in popularity;

 

•                                          Increasesin the cost of shipping, postage or credit card processing could harm theCompany’s business;

 

•                                          TheCompany’s business could be harmed if it is required to collect state sales taxon the sale of all products;

 

•                                          TheCompany faces an inherent risk of exposure to product liability claims in theevent that the use of the products it manufacturers or sells results inpersonal injury;

 

•                                          TheCompany conducts its retail operations through a single distribution facility;

 

•                                          TheCompany’s success is dependent, in part, on continued use of the Internet;

 

•                                          Governmentregulation and legal uncertainties relating to the Internet and online commercecould negatively impact the Company’s business operations;

 

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•                                          Changingtechnology could adversely affect the operation of the Company’s website;

 

•                                          TheCompany may not be able to develop and manufacture viable, high quality contactlenses for sale to consumers that meets all federal regulatory requirements;

 

•                                          TheCompany may not be able to fully integrate the operations of its acquisitionsinto its business;

 

•                                          Consumeracceptance of the Company’s manufactured products may not meet the Company’sexpectations;

 

•                                          TheCompany’s intellectual property rights may be challenged;

 

•                                          TheCompany may encounter legal, regulatory and government agency oversight riskswith foreign operations;

 

•                                          TheCompany may not be able to adequately manage its foreign currency risk;

 

•                                          TheCompany may be required to reduce the carrying value of its intangible assetsif events and circumstances indicate the remaining balance of intangible assetsmay not be recoverable;

 

•                                          TheCompany may not be able to complete its milestones and obligations in a timelymanner under the Japanese license agreement;

 

•                                          TheCompany may not receive the amount of license fees and royalties that itpresently anticipates under the Japanese license agreement;

 

•                                          Aportion of the Company’s sales may be found not to comply with state laws andregulations concerning the delivery and sale of contact lenses; and

 

•                                          TheCompany does not have any property rights in the 1-800 CONTACTS telephonenumber or the Internet addresses that it uses.

 

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**Item 3.****          *****Quantitative and QualitativeDisclosures About Market Risk***

 

***Interest Rate Risk.***** **As of October 1, 2005, the Company wasexposed to changes in interest rates relating to its revolving credit facilityand other debt obligations.  Therevolving credit facility bears interest at a variable rate based on the U.S.prime rate or LIBOR. The Company’s outstanding borrowings on the creditfacility, including bank overdrafts, were approximately $19.4 million as of October 1,2005. The remainder of the Company’s interest bearing debt obligations,including capital lease obligations, is denominated in Singapore dollars andBritish pounds and bears interest at a fixed rate.  As of October 1, 2005, the face amountsof the outstanding borrowings on these fixed rate debt obligations wereapproximately $7.8 million.  If interest rates were to change by a fullpercentage point, the net impact on interest expense would be approximately $0.2million per year.

 

***Foreign CurrencyRisk.***  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 $8.6million that are denominated in Singapore dollars and mature over the next fiveyears.  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 first three quarters of fiscal 2005,the Company recorded a foreign currency transaction loss of approximately $0.6million on the intercompany balances between the U.S. and Singaporeoperations.  From the date of theClearLab International acquisition, July 24, 2002, through November 2,2005 the exchange rate has fluctuated approximately 3.0 percent (weakening ofthe U.S. dollar).   If the Singapore dollarwere to weaken against the U.S. dollar by 10 percent, the Company would recorda $2.2 million dollar foreign currency loss on the intercompany balances thatexist as of October 1, 2005.

 

The functional currency of the Company’s UnitedKingdom operations is the British pound. Fluctuations in exchange rates between the U.S. dollar and the Britishpound could lead to additional currency exchange losses or gains onintercompany balances and transactions denominated in currencies other than thefunctional currency.  For the first threequarters of fiscal 2005, the Company recorded a foreign currency transactionloss of approximately $0.8 million on the intercompany balances between theU.S. and United Kingdom operations.  Fromthe date of the ClearLab UK acquisition, February 24, 2004, through November 2,2005 the exchange rate has fluctuated approximately 5.4 percent (strengtheningof the U.S. dollar).  If the Britishpound were to weaken against the U.S. dollar by 10 percent, the Company wouldrecord a $1.2 million dollar foreign currency loss on the intercompany balancesthat exist as of October 1, 2005.

 

The Company has not entered into any foreign currencyderivative financial instruments; however, it may choose to do so in the futurein an effort to manage or hedge its foreign currency risk.

 

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

 

***(a) Evaluation of disclosure controls andprocedures*.**  TheCompany’s Chief Executive Officer and Chief Financial Officer, after evaluatingthe effectiveness of the Company’s disclosure controls and procedures (asdefined in Exchange Act Rules 13a-14 and 15d-14) as of the end of theperiod covered by this report (the “Evaluation Date”), have concluded that, asof the Evaluation Date, the Company’s disclosure controls and procedures were adequateand effective to ensure that material information relating to the Company andits consolidated subsidiaries would be made known to them by others withinthose entities.

 

***(b) Changes in internal controls.***  There were no significant changes in the Company’sinternal controls or in other factors that could significantly affect theCompany’s disclosure controls and procedures subsequent to the EvaluationDate.  As a result, no corrective actionswere taken.

 

The Company’s management,including its Chief Executive Officer and Chief Financial Officer, does notexpect that the Company’s disclosure controls and procedures or its internalcontrols will prevent all error and all

 

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fraud.  A control system, no matter how wellconceived and operated, can provide only reasonable, not absolute, assurancethat 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 beendeducted.

 

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

 

**Item 1.****                   *****Legal Proceedings***

 

See notes to condensedconsolidated financial statements.

 

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

 

None.

 

**Item 3.****                    DefaultsUpon Senior Securities**

 

None.

 

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

 

None.

 

**Item 5.****                                                           OtherInformation**

 

On August 31, 2005,the Company hired Robert Main as the Company’s Senior Vice President,Professional Network.  Although adefinitive agreement is not yet finalized, the principal terms of Mr. Main’semployment are summarized as follows: four year employment term, with apossible one-year severance payment upon termination without cause; annualsalary of approximately $210,000; annual bonus range between 0%-60% of theannual base salary; and a grant of the Company’s restricted shares, with theamount, vesting conditions and other terms of such grant to be determined inaccordance with, and upon final approval of, a long-term incentive plan.  The Company will file a copy of thefinalized, definitive employment agreement upon execution.

 

**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)                                                                                          |
| 10.1                 |       | Third Amendment to  Lease between the Company and ProLogis North American Properties Fund I LLC,  dated August 24, 2005, with respect to the Company’s distribution  center. |
| 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 Act of 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’s Quarterly Report on Form 10-Q for the  quarterly period ended April 4, 1998 (Commission File No. 0-23633). |
|--------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

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|   |   | (2)                                  Incorporated  by reference to the same numbered exhibit to the Company’s Registration  Statement on Form S-1 (Registration No. 333-41055). |
|--------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

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**SIGNATURES**

 

Pursuant to therequirements of the Securities Exchange Act of 1934, the Registrant has dulycaused this report to be signed on its behalf by the undersigned thereunto dulyauthorized.

 

 
|                           | **1-800 CONTACTS, INC.** |
|--------------------------------|--------------------------|
|                           | ** **               |
|                           |                     |   |
| Dated: November 10,  2005 | By:                      | /s/ Jonathan C. Coon |   |
|                           | Name:                    | Jonathan C. Coon |
|                           | Title:                   | Chief Executive Officer |
|                           |                     |   |
|                           | By:                      | /s/ Brian W. Bethers |   |
|                           | Name:                    | Brian W. Bethers |
|                           | Title:                   | President and Chief  Financial Officer |

 

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