I just dumped my shares in Vancouver-based Coastal Contacts

by Chris on July 24, 2013

A few years ago I made an investment in a Canadian small cap company called Coastal Contacts. In Canada they are better known under the banner Clearly Contacts, and their primary business is selling contact lenses online. I didn’t buy the stock until they expanded into the glasses business. I think they had a great concept, which was to manufacture high quality glasses at very low cost. The gross margins on glasses are over 40% last quarter despite the company almost always running some sort of promo. You’d be crazy to ever pay full price on their website.

I’m a customer too. I buy my contacts and glasses there. I recommend them to almost everyone I know. I’ve had a good experience when buying from them. But today I’ve dumped my shares, which I’ve held for a few years. I’m pleased. The position more than doubled, so I did just fine.

My worry is the company (particularly marketing) is not being managed well. I remember a few years ago when I got a contact lens order in the mail, they sent along a nice little promo card advertising their glasses business. I already knew about the glasses biz, but I found something really wrong with the promo card. Plastered on the card was a photo of the company’s CEO, as if he was the model for the glasses business. Except he was NOT wearing glasses. Hello? McFly?

The CEO may really like to see his picture on things. And that’s fine, but he’s not even wearing the product being advertised? Did nobody in marketing point this out? Or did they not have the guts to speak up? Or did someone speak up and nobody listened? I’m not sure if this means marketing is really run by the CEO despite someone else holding the marketing title. Maybe, maybe not … but I’ve seen other companies where a former CEO ran marketing and it didn’t turn out well.

Fast forward a couple of years. I’ve noticed the company continues to run promo after promo. I don’t think they are doing enough to capture return business from existing customers. Yes, on contact lenses I think they are doing fine with 70% of orders are from return customers. But on glasses? Put it this way … I’m on their mailing list as a customer. All I ever get are some un-interesting promo emails. I think they could be doing a LOT more to grab more revenue from me (and other customers). They’re failing miserably in my opinion.

And this brings me to the Selling and Marketing income statement line. Last quarter they completed a $20 million equity financing. It looks like they are burning through this cash already. They did gross margin of $21.7 million last quarter, and fulfillment costs were $5.6 million (which you could argue are part of COGS). That leaves $16.1 million in OpEx to spend if they want to break even. Yet selling and marketing spending was $16.8 million. We’ve still got G&A of over $6 million.

A huge ramp up in marketing spending should be accompanied by a huge increase in order volume. Marketing should bring in orders, right? So how does the company explain spending about 50% more on marketing this year while actually bringing in less order volume than the year ago quarter? This is not a healthy sign for marketing spending.

So after being in business for quite some time, and seeing growth slow to a not-horrible 11% YoY rate, they are burning cash. Folks, this is not a startup business. I think they should be making solid profits at this point. Given my own personal view on the effectiveness of their advertising (from what I see), I can’t believe they’re earning a decent return on their sales and marketing dollars.

So I’m out.

I’ll watch from the sidelines now. With over $50 million in quarterly revenue and a market cap of just over $150M, the stock has potential. But only if they execute well on marketing. I still think they have growth potential as a business, but I’m not impressed with the results this management team is generating. I’ll keep my eye on it either for improved return on marketing dollars or a change in management.

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