How 1-800 Contacts Says It Violates the Law

Company clearly discloses that two-thirds of sales violate state laws.
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There's no denying the eye-catching financial performance of

1-800 Contacts

(CTAC) - Get Report

, which is best known for selling contact lenses over the telephone and the Internet. The company posted its first-ever profit last year, while sales in the past two years lifted to $98.5 million, from $59.9 million.

But it's the way the company gets those profits that raises eyebrows -- or should've raised eyebrows when the company issued a prospectus last year for a secondary stock offering that was subsequently canceled: To get the bulk of those sales, the Utah-based company conceded in its prospectus that it violates the law. In the company's words: "A significant portion of our sales do not comply with applicable state laws and regulations governing the delivery of sales of contact lenses."

That disclosure, at the very top of the "risk factors" section, sets the tone for a series of disclosures that, in the very least, suggest that 1-800 Contacts is at risk for possible regulatory action that could severely curtail future sales. (That's an actual warning from the

SEC

filing.)

For example, according to the prospectus:

Despite the requirements by many states that contact lenses be dispensed "in face-to-face meetings or by a person licensed by such state to dispense lenses and also require that lenses only be dispensed pursuant to a valid prescription," 1-800 Contacts employs licensed or registered "dispensers" only in California and Texas. Still, the Texas attorney general, who came close to shutting down

Lens Express

a few years ago for breaking similar rules, is acting on behalf of the Texas Optometry Board in suing 1-800 Contacts, claiming it illegally dispensed contact lenses in Texas. A similar suit has been filed by the Kansas Board of Examiners in Optometry.

While the company tries to verify that a customer has a valid prescription, the lack of proof doesn't stop it from going ahead and shipping the lenses based on the information provided by the customer. As a result, certain sales "violate the applicable statute or regulation in the state in which the customer is located," the company said. Also, the company said, "it is possible that the FDA will consider certain of the contact lenses we sell to be misbranded."

The company purchases "a substantial portion of our products from unauthorized distributors and are not an authorized dealer for the majority of the products that we sell."

The company sometimes sells lenses marked as "samples" -- the kind usually marked as

not for sale to the public

-- to the public at discounted prices.

CFO Scott Tanner says the disclosures are the result of doctors not complying with laws in many states that require them to verify prescriptions. He adds that 33 state attorneys general are suing eye doctors on the grounds they are engaging in a "conspiracy" and "restraint of trade" for not abiding by state laws. "If doctors refuse to verify prescriptions, we can't verify that."

Perhaps, but does that justify breaking the law?

Tanner noted that disclosures from the prospectus are nearly a year old. Does that mean that two-thirds of the company's sales are no longer in violation of state laws? He wouldn't say. He also said the company hadn't updated its disclosures (as many companies do) in its just-published 10-K, "because it's not the right thing to do at this point of time."

Why? He didn't elaborate.

As originally published, this story contained an error. Please see

Corrections and Clarifications.

Herb Greenberg writes daily for TheStreet.com. In keeping with TSC's editorial policy, he doesn't own or short individual stocks, though he owns stock in TheStreet.com. He also doesn't invest in hedge funds or other private investment partnerships. He welcomes your feedback at

herb@thestreet.com. Greenberg also writes a monthly column for Fortune.

Mark Martinez assisted with the reporting of this column.