Coastal Contacts ( Nasdaq - COA ) -- Loses Focus

Coastal Contacts (COA $4.75) reported Q2 (April) results that were significantly below our expectation.  The company is a leading provider of contact lenses and eyeglasses, sold over the Internet.  Contact lenses account for 2/3 of revenues, but the greatest growth potential lies in the virtually untapped eyeglass segment.  Contact lens sales slowed modestly from the immediately preceeding quarter.  But that was a normal fluctuation influenced by re-order timing.  The overall trend remains intact.  Eyeglass sales, on the other hand, were much slower than anticipated.  Pricing increased, an indication that promotional discounts were relied upon to a lesser extent.  Even with that adjustment volume should have been considerably higher.  Coastal Contacts raised $20 million in fresh equity earlier in the year.  About 25% of that was spent in the April quarter to accelerate growth.  It could be the extra spending will produce higher results in the current quarter.  Demand is likely to be reinforced by a wider selection of brand name frames and sunglasses, and a more streamlined website.  Coastal Contacts elected not to provide a sales forecast, though, so there remains considerable doubt about what the immediate future will bring. 

The long term outlook remains positive.  The on-line eyeglass category holds enormous potential.  Even if only 10% of the eyeglass market goes to the Internet that business will equal the on-line contact lens industry.  Coastal Contacts faces competition at the high and low ends.  But the company remains the leader in the mid-range segment.  Downside risk is limited by the company's acquisition potential.

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Coastal Contacts ( Nasdaq - COA ) -- Deploys New Capital

Coastal Contacts (COA $5.75) appears on track to produce good Q2 (April) results.  Of greater importance, the company raised $18 million in fresh capital during the period.  Three million shares were sold at $6.00 apiece.  That money is being gradually deployed to support the company's penetration of the U.S. on-line eyeglass market.  The template for that business in Canada remains strong.  That operation has been in place for the past few years.  Selling eyeglasses on-line is challenge because new customers are wary of the process.  Once they do place orders, however, the far superior pricing drives repeat business and referrals.  Returning customers are accounting for an increasing share of Canadian orders, generating better margins.  At present the company is focusing on first time buyers in the United States.  As that base starts re-ordering margins promise to surge there, as well.

Large deals with health care insurance companies could amplify growth.  Coastal Contacts provides eyeglasses at approximately 50% lower cost than conventional retailers.  That's opening up opportunities among managed care providers that want to provide eye car insurance at low costs. 

The company's contact lens business continues to grow at a 5%-10% rate.  That segment had been starved for advertising funds before the recent stock offering.  Business in Northern Europe and Canada had held up well despite that lack of marketing effort.  Renewed spending promises to reinforce the company's competitive position in upcoming quarters.

In 4-5 years pretax margins could reach 20%-25%.  We project they will attain half that level by 2014-2015 as marketing costs continue to rise quickly, laying the groundwork for further sales improvements.  In 2-3 years sales could reach $325 million to provide fully taxed earnings of $.75 a share.  In 4-5 years income could hit $2.00 a share.

 

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