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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D. C. 20549
FORM 10-K/A
(Amendment No. 1)
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[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the Year Ended December 31, 2001
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
Commission File Number: 000-25867
DIRECT FOCUS, INC.
(Exact name of registrant as specified in its charter)
WASHINGTON 94-3002667
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
1400 NE 136TH AVENUE, VANCOUVER, WA 98684
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: 360-694-7722
Securities registered pursuant to Section 12(b) of the Act: NONE
Securities registered pursuant to Section 12(g) of the Act:
COMMON STOCK, WITHOUT PAR VALUE
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Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes |X| No |_|
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K, or any
amendment to this Form 10-K. |_|
The aggregate market value of the voting stock held by non-affiliates
of the Registrant is $1,047,236,796 as of March 1, 2002 based upon the last
sales price as reported by the Nasdaq National Market System.
The number of shares outstanding of the Registrant's Common Stock as of
March 1, 2002 was 35,012,932 shares.
DOCUMENTS INCORPORATED BY REFERENCE
The Registrant has incorporated by reference into Part III of this Form
10-K portions of its Proxy Statement for its 2002 Annual Meeting of
Stockholders.
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EXPLANATORY NOTE
Pursuant to this Form 10-K/A, the Registrant amends "Item 8. Consolidated
Financial Statements and Supplementary Financial Data - Footnote 3" of Part II
of its Annual Report on Form 10-K for the year ended December 31, 2001 to
correct a typographical error in the amount of pro forma revenue for the year
ended December 31, 2000, formerly reported as $322,199 (in thousands). This
amount was previously reported correctly as $338,231 (in thousands) in the
Registrant's Form 8-K/A filed on December 3, 2001. Other than the change noted
above, no other changes have been made to the Form 10-K for the year ended
December 31, 2001.
DIRECT FOCUS, INC.
2001 FORM 10-K ANNUAL REPORT
TABLE OF CONTENTS
PAGE
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PART I
Item 1. Business 4
Item 2. Properties 19
Item 3. Legal Proceedings 21
Item 4. Submission of Matters to a Vote of Security Holders 21
PART II
Item 5. Market for Registrant's Common Equity and Related
Stockholder Matters 21
Item 6. Selected Consolidated Financial Data 22
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations 22
Item 7A. Quantitative and Qualitative Disclosures About
Market Risk 33
Item 8. Consolidated Financial Statements and Supplementary Data 34
Item 9. Changes in and Disagreements With Accountants on
Accounting and Financial Disclosure 54
PART III
Item 10. Directors and Executive Officers of the Registrant 54
Item 11. Executive Compensation 54
Item 12. Security Ownership of Certain Beneficial Owners
and Management 54
Item 13. Certain Relationships and Related Transactions 54
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports
on Form 8-K 55
Signatures 58
2
PART I
FORWARD-LOOKING STATEMENTS
CERTAIN STATEMENTS CONTAINED IN THIS ANNUAL REPORT ON FORM 10-K,
INCLUDING, WITHOUT LIMITATION, STATEMENTS CONTAINING THE WORDS "COULD," "MAY,"
"WILL," "SHOULD," "PLAN," "BELIEVES," "ANTICIPATES," "ESTIMATES," "PREDICTS,"
"EXPECTS," "PROJECTIONS," "POTENTIAL" OR "CONTINUE," AND WORDS OF SIMILAR
IMPORT, CONSTITUTE "FORWARD-LOOKING STATEMENTS." INVESTORS ARE CAUTIONED THAT
ALL FORWARD-LOOKING STATEMENTS INVOLVE RISKS AND UNCERTAINTIES AND VARIOUS
FACTORS COULD CAUSE ACTUAL RESULTS TO DIFFER MATERIALLY FROM THOSE IN THE
FORWARD-LOOKING STATEMENTS. FROM TIME TO TIME AND IN THIS FORM 10-K, WE MAY MAKE
FORWARD-LOOKING STATEMENTS RELATING TO OUR FINANCIAL PERFORMANCE, INCLUDING THE
FOLLOWING:
o ANTICIPATED REVENUES, EXPENSES AND GROSS MARGINS;
o SEASONAL PATTERNS;
o EXPENSE AS A PERCENTAGE OF REVENUE;
o ANTICIPATED EARNINGS;
o NEW PRODUCT INTRODUCTIONS; AND
o FUTURE CAPITAL EXPENDITURES.
NUMEROUS FACTORS COULD AFFECT OUR ACTUAL RESULTS, INCLUDING THE
FOLLOWING:
o OUR RELIANCE ON A LIMITED PRODUCT LINE;
o EXPIRATION OF IMPORTANT PATENTS;
o OUR ABILITY TO EFFECTIVELY DEVELOP, MARKET, AND SELL FUTURE PRODUCTS;
o GROWTH MANAGEMENT CHALLENGES, INCLUDING THE GROWTH RESULTING FROM
THE ACQUISITION OF THE ASSETS OF THE FITNESS DIVISION OF
SCHWINN/GT CORP. IN SEPTEMBER 2001, AND THE ACQUISITION OF THE
ASSETS OF STAIRMASTER IN FEBRUARY 2002;
o OUR ABILITY TO INTEGRATE THE STAIRMASTER BUSINESS, AND ANY OTHER
ACQUIRED BUSINESSES INTO OUR OPERATIONS;
o A DECLINE IN CONSUMER SPENDING DUE TO UNFAVORABLE ECONOMIC
CONDITIONS;
o THE AVAILABILITY OF MEDIA TIME AND FLUCTUATING ADVERTISING RATES;
o OUR RELIANCE ON THE CONSUMER FINANCE MARKET;
o OUR ABILITY TO ADEQUATELY PROTECT OUR INTELLECTUAL PROPERTY;
o OUR RELIANCE ON THIRD-PARTY MANUFACTURERS; AND
o GOVERNMENT REGULATORY ACTION.
WE DESCRIBE CERTAIN OF THESE AND OTHER KEY RISK FACTORS ELSEWHERE IN
MORE DETAIL IN THIS FORM 10-K. ALTHOUGH WE BELIEVE THE EXPECTATIONS REFLECTED IN
THE FORWARD-LOOKING STATEMENTS ARE REASONABLE, WE CANNOT GUARANTEE FUTURE
RESULTS, LEVELS OF ACTIVITY, PERFORMANCE OR ACHIEVEMENTS. WE UNDERTAKE NO
OBLIGATION TO UPDATE PUBLICLY ANY FORWARD-LOOKING STATEMENTS TO REFLECT NEW
INFORMATION, EVENTS OR CIRCUMSTANCES AFTER THE DATE OF THIS FORM 10-K OR TO
REFLECT THE OCCURRENCE OF UNANTICIPATED EVENTS.
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ITEM 1. BUSINESS
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INTRODUCTION
Direct Focus, Inc. is a leading marketer, developer and manufacturer of
branded health and fitness products sold under such well-known names as
Nautilus, Bowflex, Schwinn Fitness and StairMaster. We market and sell our
Bowflex and Nautilus Sleep Systems products through our direct-marketing channel
utilizing an effective combination of television commercials, infomercials,
response mailings, the Internet, and inbound/outbound call centers. We market
and sell our Nautilus, Schwinn Fitness, StairMaster and Quinton commercial
fitness equipment through our sales force and selected dealers to health clubs,
government agencies, hotels, corporate fitness centers, colleges, universities
and assisted living facilities. We also market a complete line of consumer
fitness equipment, also sold under the Nautilus, Schwinn Fitness, Trimline, and
StairMaster brands, through a network of specialty dealers, distributors and
retailers worldwide.
We have experienced rapid growth, with sales increasing from $133.1
million in 1999 to $363.9 million in 2001, representing a compound annual growth
rate of over 65%. This increase was primarily the result of organic growth in
the sales of existing Nautilus and Bowflex product lines. In addition, we
significantly expanded our market through extensions of existing product lines
in new channels and the strategic acquisition of Schwinn Fitness and
StairMaster. We have grown net income from $20.3 million in 1999 to $66.6
million in 2001, representing a compound annual growth rate of over 81%.
Our success to-date, based on sales growth, profitability and cash
flow, has been driven primarily by the expansion of our Bowflex and Nautilus
Sleep Systems product lines in the growing, direct-to-consumer distribution
channel. We believe that we have been able to capture premium price points as a
result of our high quality, innovative products and direct sales to end
customers. We intend to continue driving our growth through our ability to
identify, fulfill and increase customer demand for health and fitness products.
Through our extensive experience in direct marketing health and fitness
products to consumers, we have developed a creative and highly disciplined sales
and marketing program. Over the past 9 years, we have spent over $164 million in
television advertising for our direct products. Core to our strategy is the
continuous improvement of our direct marketing process by challenging and
refining all aspects of our marketing and selling cycle. This improvement has
been accomplished in large part by our ability to gain relatively instantaneous
customer feedback from our advertisements. All customer inquiries are carefully
monitored and analyzed through our state-of-the-art inbound and outbound call
center utilizing a customized automated database and its statistical
applications. As a result, we have been able to predict with a historically high
degree of accuracy the inquiries of our marketing programs and their subsequent
conversion into sales. This highly refined marketing program, combined with our
media purchasing power, has created an effective and cost efficient means for
driving consumer demand.
Our success has been enhanced by our continuing expansion into the
commercial and retail channels of the fitness industry. To expand sales and
market share in these channels, we acquired substantially all of the assets of
Nautilus International, Inc. ("Nautilus") in January 1999, the fitness division
of Schwinn/GT Corp. and its affiliates ("Schwinn Fitness") in September 2001,
and StairMaster Sports/Medical, Inc. ("StairMaster") in February 2002. These
acquisitions have enabled us to considerably expand our portfolio of leading
brands, product lines, channels of distribution, product development and the
size of our customer base. Through our purchase of Schwinn Fitness and
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StairMaster, we believe that we have made significant progress in diversifying
our product line and expanding our presence internationally. We now offer a
comprehensive line of cardiovascular and weight resistance products in the
retail and commercial fitness industry. Our retail and commercial product lines
include home gyms, free weight equipment, treadmills, indoor cycling equipment,
steppers and ellipticals. As a result of our acquisitions, we have also added
operations in Switzerland, Germany and England, a sales office in Japan, and a
worldwide network of distributors.
We believe that our Company possesses distinct competitive advantages
as it builds towards its goal of being a complete provider of products to the
health and fitness industry. We continue to develop a portfolio of highly
recognized and trusted fitness brands. These brands are utilized, in concert
with tailored product development, to meet the differing customer demands of
each distribution channel: direct, commercial and retail. In addition, we have
realized, and believe that we will continue to realize, significant synergies by
leveraging our brands, marketing resources, and research and development
capabilities across all three distribution channels. We believe the health and
fitness industry's fragmentation of manufacturers and distribution channels
lends itself to the execution of this strategy.
For a discussion of financial information about our two business
segments, direct products and commercial/retail products, see Note 2 of the
Notes to Consolidated Financial Statements.
Direct Focus was incorporated in California in 1986 and became a
Washington corporation in 1993. Our principal executive offices are located at
1400 NE 136th Avenue, Vancouver, Washington 98684, and our telephone number is
(360) 694-7722. We maintain our corporate web site at www.directfocusinc.com.
None of the information on this web site or our other web sites is part of this
Form 10-K.
As used in this Form 10-K, the terms "we," "our," "us," "Direct Focus"
and "Company" refer to Direct Focus, Inc. and its subsidiaries. The names
Nautilus(R), Bowflex(R), Bowflex Power-Pro(R), Motivator(R), Versatrainer(R),
Power Rod(R), Direct Focus(R), Instant Comfort(R), Nautilus Sleep Systems(R),
Airdyne(R), Fitness Advisor(R), StairMaster(R), and Trimline(R) are registered
trademarks of Direct Focus, Inc.
The consolidated financial statements of the Company include Direct
Focus, Inc., Nautilus HPS, Inc., Nautilus, Inc., DFI Properties, LLC, BFI
Advertising, Inc., DFI Sales, Inc., DFI Leaseco, LLC, Nautilus Fitness Products,
Inc., Nautilus/Schwinn Fitness Group, Inc., DF Hebb Industries, Inc., Schwinn
Fitness International SA, Schwinn Holdings International SA, and Schwinn Fitness
SA. All intercompany transactions have been eliminated in the preparation of the
consolidated financial statements. While StairMaster is discussed throughout
this document due to its significance to our business strategy, its financial
results are not included in our financial statements as it was acquired
subsequent to year end 2001.
LONG-TERM STRATEGY
Our long-term strategy is to build a complete health and fitness
company offering high quality, premium-branded products enabling health
conscious consumers to maintain active lifestyles. We intend to do this by:
o Utilizing our positioning and capabilities in the direct marketing
channel to launch new, innovative products;
o Capitalizing on the synergy and growth opportunities from
acquisitions;
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o Continuing to capture premium price points and accelerate demand by
researching and developing high quality, branded products that better
meet the needs of our customers and retailers; and
o Expanding our international opportunities by leveraging our recently
acquired network of international distributors and operations.
INDUSTRY OVERVIEW
CONSUMER TRENDS
We believe that our organic growth has benefited from a number of
demographic and market trends that we expect will continue, including:
o Growing consumer awareness of positive benefits of good nutrition
and fitness;
o Expanding media attention on health and fitness;
o An aging population that is maintaining a more active lifestyle;
o Continued attention to appearance and weight by consumers, which is
expected to increase as the "baby-boomers" pass through their 40's;
o High healthcare costs that are focusing more attention on
preventative practices including an increase in the number of
corporate fitness programs and wellness centers;
o Expansion of the market for sophisticated high-quality fitness
equipment due to consumers' continued demand for higher levels of
efficiency in their workout regimes; and
o The continued growth of direct to consumer marketing, which is
estimated to exceed $1.0 trillion in annual sales in the United
States in 2002.
We believe these consumer trends bode well for our future growth
prospects. Just as the "baby boomers," those Americans born between 1946 and
1964, started the modern fitness movement, they will continue to be a driving
force as they age. We believe baby boomers will use more of their increasing
leisure time for exercise and more of their disposable income for fitness
equipment purchases as they strive to counter the effects of aging.
TRENDS IN FITNESS EQUIPMENT
We market our Nautilus, Bowflex, Schwinn Fitness and StairMaster
equipment in the United States, as well as internationally. According to the
Sporting Goods Manufacturing Association ("SGMA"), United States consumers were
projected to spend $16.6 billion on sports equipment in 2001. Based on a study
performed by the SGMA, U.S. consumers spent roughly $5.8 billion specifically on
home fitness equipment in 2000.
Due to a difficult economic climate and the fact that sports equipment
may be considered as discretionary spending, the market experienced a difficult
year in 2001. According to the SGMA, the sports equipment market in the U.S. is
expected to have declined 4.5% in 2001. However, the exercise equipment market
is expected to have only declined 3.6%.
The SGMA expects the overall sports equipment market to continue to
contract a further 0.7% in 2002; however, they are projecting a quick recovery
for fitness equipment and expect the category to grow 4.0% in 2002 to return to
2000 levels.
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Research from the National Sporting Goods Association ("NSGA")
indicates that Americans are not only exercising more but are also exercising
more with fitness equipment. Surveys performed by the NSGA indicate that the
percentage of U.S. consumers above the age of seven who participated in exercise
with fitness equipment rose from 35.3% in 1990 to 44.8% in 2000. In addition,
the SGMA estimates that a number of Americans using strength equipment and
cardiovascular equipment increased 5.4% and 3.5% annually, respectively, from
1990 to 2000. A significant component of this growth is attributable to the
aging "baby-boomer" generation.
The commercial market has benefited from continued strength and
increase in health club memberships. Health club memberships have grown an
average of 5.0% annually for the past 13 years, according to the SGMA. The SGMA
estimates that there were 32.8 million health club memberships at the end of
2000.
The worldwide travel industry has recognized that providing travelers
with the fitness equipment required to maintain their regular exercise and
fitness programs while away from home enhances customer satisfaction. Fitness
facilities have become important factors in attracting and retaining hotel
guests.
The international markets represent a strong opportunity for growth,
driven by the continued fitness boom across Europe and the increasing focus on
fitness and healthy lifestyles by more affluent consumers in Asia and Latin
America. In fact, according to the International Health, Racquet and Sportsclub
Association ("IHRSA"), there are approximately 19,500 health clubs in Europe,
7,800 in Latin America and 4,800 in the Asia/Australia market, compared to
approximately 17,800 clubs in the U.S. We believe demand for U.S. products will
increase, as foreign consumers increasingly demand the reliability, service and
innovative designs provided by U.S. suppliers such as Nautilus, Schwinn Fitness,
and StairMaster.
TRENDS IN SLEEP PRODUCTS
The United States mattress market is large and dominated by four major
manufacturers whose primary focus is the conventional innerspring mattress.
According to the International Sleep Products Association ("ISPA"), United
States mattress and foundation sales totaled 39.5 million units shipped in 2000,
representing a 2.2 percent increase from 1999. Total dollar value of these
wholesale shipments reached $4.6 billion in 2000, a 5.4% increase from 1999. We
believe this equates to over $7.6 billion in retail sales. The ISPA estimates
that innerspring mattresses accounted for approximately 90% of total domestic
mattress sales in 2000. The ISPA also believes that less than 6% of all mattress
sales are made through direct marketing channels. According to the ISPA, the
bedding industry has enjoyed years of uninterrupted growth, which has led to
increased competition and retail outlet consolidation. Queen-sized mattresses,
which became the largest selling segment in 1998, continued to top the U.S.
market in 2000, capturing 33.1% of the market.
DIRECT BUSINESS SEGMENT
DIRECT TO CONSUMER MARKETING
We market and sell our Bowflex and Nautilus Sleep Systems products
through our direct-marketing channel utilizing an effective combination of
television commercials, infomercials, response mailings, the Internet, and
inbound/outbound call centers. The direct to consumer distribution channel
involves sales of our range of products directly to the consumer. This is
derived almost entirely from television advertisements, including both
commercials and infomercials. By
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selling directly to the end consumer, we are able to target premium price points
paid by end consumers, eliminating all other parties from the supply chain. Our
ability to capture the entire gross margin has consistently produced a high
financial return on time and money invested. The size of the direct market is
also substantial. Through our advertising initiatives, we estimate that we
currently target 70 million homes. Success within this distribution channel is
almost entirely dependent on the ability to capture target demographics. By
using over 1,000 different 800 numbers, we are able to measure exactly which ads
our customers are responding to, and we have built a comprehensive database that
enables us to scientifically adapt marketing strategies to better target
customers. Historically, we have been able to predict, with a good degree of
accuracy, inquiries to specific advertisements and the resulting sales. We
continue to believe that this will serve as a key differentiating factor and
enable us to maintain a competitive advantage within this channel.
We conduct direct to consumer marketing through a combination of
60-second "spot" television commercials and 30-minute television "infomercials."
To date, we have been highly successful with what we refer to as a "two-step"
marketing approach. Our two-step approach focuses first on generating consumer
interest in our products and requests for product information, which is achieved
primarily through the use of spot commercials and infomercials. The second step
focuses on converting inquiries into sales, which we accomplish through a
combination of response mailings and outbound telemarketing to potential
customers who have made initial inquiries based on our first step advertising
efforts. We have found that second quarter influences on television viewership,
such as the broadcast of national network season finales and seasonal weather
factors, cause our spot television commercials on national cable television to
be marginally less effective in the second quarter than in other periods of the
year.
ADVERTISING
SPOT COMMERCIALS AND INFOMERCIALS. Spot television commercials are a
key element of the marketing strategy for all of our direct-marketed consumer
products. For direct-marketed products that may require further explanation and
demonstration, television infomercials are an important additional marketing
tool. We have developed a variety of spot commercials and infomercials for our
Bowflex product line and several commercials and marketing videos for our
Nautilus Sleep Systems product line. We expect to use spot commercials and,
where appropriate, infomercials to market consumer products that we determine
are appropriate for the direct-marketing channel.
When we begin marketing a new product, we typically test and refine our
marketing concepts and selling practices while advertising the product in spot
television commercials. Production costs for these commercials can range from
$50,000 to $150,000. Based on market research and viewer response to our spot
commercials, we may produce additional spot commercials and, if appropriate for
the product, an infomercial. Production costs for infomercials can range from
$150,000 to $500,000. Generally, we attempt to film several infomercial and
commercial concepts at the same time in order to maximize production
efficiencies. From this footage we can then develop several varieties of spot
commercials and infomercials and introduce and refine them over time. We
typically generate our own scripts for spot commercials and utilize outside
writers to assist with infomercial scripts on an as-needed basis. Typically, we
contract with outside production companies to produce our spot commercials and
infomercials.
We test spot commercials and infomercials on a variety of cable
television networks that have a history of generating favorable responses for
our existing products. Our initial objective is to determine the product's
marketing appeal and evaluate creative or product modifications that may be
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appropriate. If these initial tests are successful, we then air the spot
commercials and infomercials on an accelerating schedule of additional cable
networks.
MEDIA BUYING. An important component of our direct marketing success is
our ability to purchase quality media time at an affordable price. The cost of
airing spot commercials and infomercials varies significantly, depending on the
network, time slot and, for spot commercials, programming. Each spot commercial
costs between $25 and $25,000 to air, and each infomercial costs between $600
and $55,000 to air. We currently purchase the majority of our media time on
cable networks, through which we reach more than 70 million homes.
We do not currently purchase media time under long-term contracts.
Instead, we book most of our spot commercial time on a quarterly basis and most
of our infomercial time on a monthly or quarterly basis, as networks make time
available. Networks typically allow us to cancel booked time with two weeks
advance notice, which enables us to adjust our advertising schedule if our
statistical tracking indicates that a particular network or time slot is no
longer cost effective. Generally, we can increase or decrease the frequency of
our spot commercial and infomercial airings at almost any time.
INTERNET. We expect the Internet to continue as an increasingly
important part of our direct- marketing strategy. For example, we are promoting
our web sites in spot commercials and infomercials in an effort to further
stimulate electronic product inquiries and eCommerce transactions. We presently
advertise our products on third-party web sites on a limited basis. Our site is
loaded with informative customer testimonials and allows consumers to view our
video online and obtain more information about our products. We currently
operate two direct marketing-oriented web sites. The first, www.bowflex.com,
focuses on our Bowflex line of home exercise equipment. The second,
www.nautilussleepsystems.com, focuses on our Nautilus Sleep Systems. In an
effort to expand and enhance our web presence, we have added dedicated web site
development and management personnel.
OPTIMAL USE OF DIRECT MARKETING DATABASE
Since 1994, when we initially started testing our target markets, we
have consistently invested significant resources in order to build a
comprehensive direct marketing database. Our database has allowed us to monitor
customer responses and effectively utilize information to adapt our marketing
strategy to better target such customers. We track the success of each of our
spot commercials and infomercials by determining how many viewers respond to
each airing of a spot commercial or infomercial. We accumulate this information
in a database that we use to evaluate the cost-effectiveness of available media
time. In addition, we believe the database enables us to predict with reasonable
accuracy how many product sales and inquiries will result from each spot
commercial and infomercial that we air. We also believe we can effectively track
changing viewer patterns and adjust our advertising accordingly.
CONVERSION OF DIRECT-MARKETED PRODUCT INQUIRIES INTO SALES
CUSTOMER SERVICE CALL CENTER AND ORDER PROCESSING. We operate our own
customer service call center in Vancouver, Washington, which operates 18-23
hours per day and receives and processes all infomercial-generated and customer
service-related inquiries regarding our Bowflex and Nautilus Sleep Systems
products. We have developed a skill-based call routing system that automatically
routes each incoming call to the most highly qualified inside sales agent or
customer service representative available. The appropriate representative then
answers product questions, pro-actively educates the potential customer about
the benefits of our product line, promotes financing
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through our third-party private label credit card, and typically up sells the
benefits of higher priced models in our product line. This sophisticated system
allows us to better utilize our agents, prioritize call types and improve
customer service.
We employ two large telemarketing companies to receive and process
information requests generated by our spot television advertising 24 hours per
day. The telemarketing agents for these companies only collect names, addresses
and other basic information from callers and do not sell or promote our
products.
INTERNET. We use television spot commercials and infomercials to lead
consumers to our web sites, as we believe that consumers who visit our web sites
are more inclined to purchase our products. Our ongoing Internet-related goals
include improving the capabilities of our Bowflex and Nautilus Sleep System web
sites. In 1999, we used our web sites to generate interest in our products but
limited the information we provided to potential customers in an effort to
induce them to initiate a telephone inquiry. In 2000, we believe we achieved a
balance between our goals of finalizing sales and capturing consumer information
by strategically designing our web pages and carefully analyzing web page hits,
conversion rates, average sales prices and inquiry counts, which we continued to
enhance in 2001. Our eCommerce sales are an increasingly important component of
our direct sales channel and have grown from 8% to 19% to 22% of direct sales
for 1999, 2000 and 2001, respectively.
RESPONSE MAILINGS. We forward a "fulfillment kit" in response to each
inquiry regarding our direct-marketed products. Each kit contains detailed
literature that describes the product line and available accessories, a
marketing video that demonstrates and highlights the key features of our premium
product in the line, and additional information about how to purchase the
product. If a potential customer does not respond within a certain time period,
we proceed with additional follow-up mailings that convey a different marketing
message and typically offer certain inducements to encourage a sale. The
specific marketing message and offer at each stage will vary, based on what our
statistical tracking indicates is most likely to trigger a sale.
CONSUMER FINANCE PROGRAMS. We believe that convenient consumer
financing is an important tool in our direct marketing sales efforts and induces
many of our customers to make purchases when they otherwise would not.
Currently, we offer "zero-down" financing to approved customers on all sales of
our Bowflex Products and Nautilus Sleep Systems. We arrange this financing
through a consumer finance company pursuant to a non-recourse consumer financing
agreement. Under this arrangement, our customer service representatives can
obtain financing approval in a few minutes over the telephone and, if a customer
is approved, immediately ship the ordered product without the need for
cumbersome paperwork. The consumer finance company pays us promptly after
submission of the required documentation and subsequently sends to each approved
customer a Direct Focus private label credit card that can be used for future
purchases of our products. There were approximately 220,000 active private label
cards with aggregate available credit of approximately $118 million outstanding
as of December 31, 2001. During 2001, over 41% of our net sales were financed in
this manner, and we believe this program will continue to be an effective
marketing tool.
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DIRECT PRODUCTS
BOWFLEX HOME FITNESS EQUIPMENT
We introduced the first Bowflex home exercise machine in 1986, and
since then have implemented several improvements to its design and
functionality. We now offer four different Bowflex machines and nine different
models. The key feature of each Bowflex machine is our patented "Power Rod"
resistance technology. Each Power Rod is made of a solid polymer material that
provides progressive resistance in both the concentric and eccentric movements
of an exercise. When combined with a bilateral cable pulley system, the machines
provide excellent range and direction of motion for a large variety of
strength-building exercises. Although Bowflex equipment continues to be our most
successful product, due to our product diversification efforts, sales of our
Bowflex products, as a percentage of our total sales, have decreased to 74% in
2001 from 80% and 83% in 1999 and 2000, respectively.
We currently offer the following Bowflex machines:
o The Ultimate, introduced in late 2001, is our newest product in the
Bowflex line. The Ultimate is available in one model that offers over
80 different strength building exercises in one compact, foldable,
and portable design and comes with a 310-pound resistance pack that
can be upgraded to 410 pounds. We have also incorporated an
integrated adjustable pulley system feature to allow a user to adjust
the range of motion of many basic exercises to increase workout
results. Prices currently range from $1,999 to $2,098, depending on
the available resistance upgrade.
o The Power Pro, introduced in 1993, is our best selling product. The
Power Pro is available in four different models: the basic Power Pro,
the XT, the XTL and the XTLU. Each model offers over 60 different
strength building exercises in one compact, foldable and portable
design and comes with a 210-pound resistance pack that can be
upgraded to 410 pounds. We have also incorporated an aerobic rowing
exercise feature into the Power Pro. Prices currently range from $999
to $1,597, depending on the model and add-on features.
o The Motivator, introduced in 1996, is our entry-level strength
training line. It is available in three different models: the basic
Motivator, the XT and the XTL. Each model offers over 40 different
strength building exercises in one compact, foldable design and comes
standard with a 210-pound resistance pack that can be upgraded to 410
pounds. Prices currently range from $699 to $1,049, depending on the
model and add-on features.
o The Versatrainer by Bowflex, introduced in 1988, is specifically
designed to accommodate wheelchair-bound users. The Versatrainer's
key advantage is that it permits users to exercise while remaining in
their wheelchair, which offers enhanced independence and esteem. The
Versatrainer can be found in many major rehabilitation hospitals,
universities and institutions. The Versatrainer is currently priced
at $1,699.
11
NAUTILUS SLEEP SYSTEMS
In December 1999, we began marketing a line of premium air sleep
systems, which we have named the "Nautilus Sleep Systems." The key feature of
each Nautilus Sleep System is its variable firmness support chamber, an air
chamber within each air sleep system that can be electronically adjusted to
regulate firmness. All queen and larger sleep systems in our Signature, Premier
and Ultimate Series are equipped with dual air chambers that enable users to
maintain different firmness settings on each side of the bed. We believe that
variable firmness and other comfort-oriented features of our Nautilus Sleep
Systems favorably differentiate them from conventional innerspring mattresses.
We currently offer four models of our Nautilus Sleep System:
o The Ultimate Series is our top-of-the-line Nautilus Sleep System. It
features dual patent-pending, interlocking variable support chambers
that permit users to maintain separate firmness settings on each side
of the sleep system. The interlocking chambers regulate airflow and
pressure to more effectively maintain support when a user changes
position. The Ultimate Series comes with removable wool blend and
silk blend pillow top sleeping surfaces, which permits users to
easily convert to a "tight top" surface when they desire extra
firmness. The Ultimate Series also has an upgraded comfort layer of
visco-elastic foam that conforms to a user's body. The Ultimate
Series is available in seven sizes and currently ranges in price from
$1,399.99 for a twin to $1,999.99 for a California king, excluding
foundation.
o The Premier Series features dual patent-pending, interlocking
variable support chambers that permit users to maintain separate
firmness settings on each side of the sleep system. The interlocking
chambers regulate airflow and pressure to more effectively maintain
support when a user changes position. The Premier Series comes with a
removable wool blend pillow top sleeping surface, which permits users
to easily convert to a "tight top" surface when they desire extra
firmness. The Premier Series is available in seven sizes and
currently ranges in price from $799.99 for a twin to $1,399.99 for a
California king, excluding foundation.
o The Signature Series is designed to appeal to consumers who desire
the flexibility of dual variable firmness support chambers, but at a
more affordable price. Our customers can choose between a tight top
or pillow-top sleeping surface over a one and one-half inch
convoluted foam comfort layer. The Signature Series is available in
seven sizes and currently ranges in price from $499.99 for a twin to
$1,099.99 for a California king, excluding foundation.
o The Basic Series is our entry-level Nautilus Sleep System, which
features a single, head-to-toe variable firmness support chamber and
a traditional tight-top sleeping surface over a one and one-half inch
thick convoluted foam comfort layer. The Basic Series is available in
five sizes and currently ranges in price from $349.99 for a twin to
$799.99 for a California king, excluding foundation.
We offer foundations that are specifically designed to support and
enhance the performance of our Nautilus Sleep Systems. We advise consumers to
use our foundations because conventional box springs tend to sag and wear over
time, causing a sleep system to eventually mirror the worn box
12
spring. The majority of our Nautilus Sleep System customers order a complete
sleep system, which includes both a mattress and a foundation. Our foundations
currently range in price from $199 for a twin to $399 for a California king.
CHAMPION NUTRITION
In May 2001, we entered into a financing agreement with Champion
Nutrition ("Champion") and its primary shareholder. Champion is a privately held
manufacturer of nutritional supplements. We began selling Champion's product
line through our direct sales channel in June 2001. We package these products as
kits and sell them to our Bowflex customers as add-on items. Under the terms of
the agreement, we have an option to buy the stock of Champion for $6 million
through October 2002.
COMMERCIAL/RETAIL BUSINESS SEGMENT
COMMERCIAL/RETAIL SALES AND MARKETING
We market and sell our Nautilus, Schwinn Fitness, StairMaster, Quinton
and Trimline commercial fitness equipment through our sales force and selected
dealers to health clubs, government agencies, hotels, corporate fitness centers,
colleges, universities and assisted living facilities. Our commercial direct
sales force is focused on strengthening the market position of our existing
Nautilus, Schwinn Fitness, and StairMaster commercial product lines, which we
sell principally to health clubs, large hotels, assisted living facilities and
the government. Additionally, as we continue to broaden our product line with
products like Nautilus Nitro commercial equipment, our direct sales force will
target new market segments and, if successful, broaden our customer base.
Internationally, we market and sell our Nautilus, Schwinn Fitness, and
StairMaster commercial fitness products through a worldwide network of
independent distributors and our foreign operations.
We also market a complete line of consumer fitness equipment, under the
Nautilus, Schwinn Fitness, and StairMaster brands, through a dealer network of
more than 1,200 dealers, specialty retailers and specialty stores worldwide. As
part of our acquisition of Schwinn Fitness, we have added an experienced
management team to oversee the sales and marketing operations of our retail
products business.
In general, sales of commercial/retail fitness equipment and
accessories are seasonal. Typically, sales are higher in the first and fourth
quarters with considerable weakness experienced in the second quarter. We
believe the principle reason for this trend is the commercial and retail fitness
industry's preparation for the impact of New Year's fitness resolutions and
seasonal weather patterns related to colder winter months.
COMMERCIAL EQUIPMENT
We currently offer the following Nautilus, Schwinn Fitness, and
StairMaster equipment for the commercial market:
NAUTILUS SELECTORIZED EQUIPMENT. The Nautilus 2ST line of commercial
strength equipment offers 27 high quality, technologically advanced strength
building machines, each of which is specially designed to focus on a particular
strength building exercise, such as leg presses, bench presses, super pullovers,
hip abductors and adductors and leg curls. In addition, we offer a line of
specially designed Nautilus 2ST equipment that we market principally to medical
therapy and
13
rehabilitation clinics. The key component of each Nautilus 2ST machine is either
its "cam" or a four-bar linkage mechanism, which builds and releases resistance
as a user moves through an exercise. The resistance is at its minimum during the
initial and final stages of an exercise, and at its maximum in the middle of an
exercise. The cam or four-bar linkage mechanism is designed to accommodate and
maximize the benefits associated with the motion required for that machine.
Other features are convergent and divergent upper body compound movements,
four-bar linkages that produce functional movement, Kevlar belt drive,
selectorized one pound add-on weight system, seat accessible weight stacks, low
friction bearings and pulleys, hydraulic seat adjustments, machine-mounted
instructional placards, tethered magnetic weight pins, powder coat finish, and
quick release shields.
The Nautilus NITRO line, introduced in late 2000, is a complete line of
compact selectorized machines. It is ideal for clubs and other facilities where
floor space is limited. Nautilus NITRO features super-smooth belt drives,
patented four-bar linkage, classic full range variable resistance cams and
converging axis movements. Each Nautilus NITRO machine features 2" by 4" bent
steel frames and 5-pound increment weight adjustments. In addition, EZ Glide
seat adjustments make Nautilus NITRO easily adaptable to a variety of sizes,
tastes, and exercise movements.
NAUTILUS FREE WEIGHT EQUIPMENT. In 1999, we introduced a line of
Nautilus free weight equipment with new innovations in design and engineering
intended to help club owners better serve their customers. The product line
offers a sleeker look, tougher components and increased versatility. This new
free weight gear can be coupled with the Nautilus selectorized equipment circuit
to give facility managers a complete strength gym to serve all strength fitness
tastes.
SCHWINN FITNESS INDOOR CYCLING EQUIPMENT. Our line of Schwinn Fitness
indoor cycling products are used as part of a cycling-based exercise program
that is popular among health clubs worldwide, and offer adjustable resistance,
heavy-duty flywheels, plush seats and Schwinn's high-quality construction
methods.
STAIRMASTER. StairMaster introduced the world's first stairclimber in
1983. Its full product line now includes stairclimbers, treadmills, exercise
bikes, and Crossrobics. These products feature ergonomic designs, comfortable
and user-friendly controls and smoothly performing equipment. StairMaster
treadmills are built to commercial standards with long lasting decks, belts and
motors. StairMaster treadmills feature large running surfaces, various workout
programs and offers speeds of up to 12 miles per hour. Crossrobics machines
allow individuals to engage in both strength training and cardiovascular
training at the same time.
RETAIL EQUIPMENT AND ACCESSORIES
Nautilus retail equipment includes a wide variety of products for the
retail consumer in the following categories:
o Fitness Accessories - a full line of fitness accessories, such as
weight belts, jump ropes and ankle weights distributed to specialty
fitness retailers and the sporting goods industry. The current line
includes over fifty products.
o Gyms - Nautilus gyms are designed to give a complete, total body
workout, and are built with the same commitment to quality and
biomechanical function as our commercial equipment. Our gyms allow
the consumer to perform a wide variety of exercises such as chest
press, shoulder press, lat pulls, tricep extensions, leg work and
more.
14
o Free Weights and Benches - allow gym-quality exercises with
adjustable workout benches, free weight systems, dumbbell racks,
weight trees and more.
o Weights - commercial quality barbells and dumbbells for personal use.
Constructed of durable chrome and iron, many of these sets are
packaged in a convenient storage case allowing easy organization of
plates and bars.
o Apparel - Nautilus hats, shirts, t-shirts and other apparel are all
made with high quality materials and workmanship.
Schwinn Fitness offers a wide variety of retail products in the
following categories:
o Treadmills - Schwinn Fitness offers a wide variety of treadmills for
use in the home. All are made in the USA and feature high power
motors and quality electronics.
o Stationary Bikes - Schwinn Fitness' line of stationary bikes includes
both upright and recumbent style exercise bikes with features
including self-generating computers with various exercise programs
and computer-controlled resistance.
o Steppers - Schwinn Fitness' steppers feature independent stepping
action, and certain models feature computer-controlled exercise
programs.
o Wind - Schwinn Fitness' line of wind resistance exercise equipment
uses fans to create resistance that increases with workout intensity.
The line includes the Airdyne exercise bike and other products using
wind resistance for upper body and full body workouts.
o Strength Equipment - Schwinn Fitness' strength equipment includes
multi-station weight machines with models for both home and
institutional use.
o Elliptical - Schwinn Fitness' elliptical trainers provide a
low-impact natural motion workout and feature self-generating
computers with multiple exercise programs.
StairMaster offers high-end products in the following categories:
o Stairclimbers - StairMaster is the market leader in stairclimbers.
These products provide superior cardiovascular workouts and condition
major lower-body muscle groups with less impact than conventional
aerobic machines.
o Stationary Bikes - StairMaster offers both an upright and recumbent
stationary exercise bike for home use. These products feature
cordless operation and variable resistance workouts.
NEW PRODUCT DEVELOPMENT AND INNOVATION
We continue to emphasize the expansion and diversification of our
product development capabilities in health and fitness products. New product
development is a focal point of our company. We develop new products either from
internally generated ideas or by acquiring or licensing patented technology from
outside inventors and then enhancing the technology.
15
In recent years, successful new product introductions and extensions
have included the Nautilus Sleep Systems, the Nitro commercial line of strength
equipment, and new Nautilus selectorized home gym and free weight equipment.
Our research and development competencies have been augmented through
the acquisition of Schwinn Fitness and StairMaster. Schwinn Fitness possesses
advanced design development and testing expertise and a state-of-the-art
prototype and test facility. Schwinn Fitness has successfully developed and
grown many new product categories, including both indoor group cycling and wind
resistance machines sold under the Airdyne brand name. The acquisition of
StairMaster has brought additional capabilities and product development in the
stepper and stair climbing categories. StairMaster is widely credited with
creating and growing these categories.
Our additional research and development resources have allowed us to
become fully integrated in the product development process, allowing us to take
a new product from the beginning of feasibility studies straight through to
production and continuing product review. This integration allows us a greater
degree of control over the new product process, which will allow us to generate
a higher quality product, increase our speed to market, and control our costs.
For new direct-marketed products, we look for high-quality, high
margin, and proprietary consumer products. In addition, these products should
have the potential for mass consumer appeal, particularly among members of the
"baby-boom" generation, who are accustomed to watching television and, in
general, are likely to have higher disposable income.
For commercial/retail fitness products, we gather and evaluate ideas
from various areas, including existing and potential customers, sales and
marketing, manufacturing and engineering, and we determine which ideas will be
incorporated into existing products or will serve as the basis for new products.
Based on these ideas, we design new or enhanced products, develop prototypes,
test and modify products, develop a manufacturing plan, and finally bring
products to market. The Company evaluates, designs, and develops each new or
enhanced product, taking into consideration our marketing requirements, target
price points, gross margin requirements and manufacturing constraints. In
addition, each new or enhanced product must maintain the Nautilus, Schwinn
Fitness, and StairMaster standard of quality and reputation for excellence.
Research and development expense was $716,240, $1,186,216, and
$2,229,242 for 1999, 2000, and 2001, respectively.
COMPETITION
DIRECT PRODUCTS SEGMENT
BOWFLEX. The market for our Bowflex products is highly competitive. Our
competitors frequently introduce new and/or improved products, often accompanied
by major advertising and promotional programs. We believe the principal
competitive factors affecting this portion of our business are price, quality,
brand name recognition, product innovation and customer service.
We compete directly with a large number of companies that manufacture,
market and distribute home fitness equipment. We also compete with the many
health clubs that offer exercise and recreational facilities and, indirectly,
with outdoor fitness, sporting goods and other recreational products. Our
principal direct competitors include ICON Health & Fitness (through its Health
Rider, NordicTrak, Image, ProForm, Weider and Weslo brands), Precor and Total
Gym. Some of our competitors have
16
greater financial and marketing resources, which may give them and their
products an advantage in the marketplace.
We believe our Bowflex line of home exercise equipment is competitive
within the market for home fitness equipment based on product design, quality
and performance and that our direct marketing activities are effective in
distinguishing our products from the competition.
NAUTILUS SLEEP SYSTEMS. The sleep products industry is also highly
competitive, as evidenced by the wide range of products available to consumers,
such as innerspring mattresses, waterbeds, futons and other air-supported
mattresses. We believe market participants compete primarily on the basis of
price, product quality and durability, brand name recognition, innovative
features, warranties and return policies.
We believe our most significant competition is the conventional
mattress industry, which is dominated by four large, well-recognized
manufacturers: Sealy (which also owns the Stearns & Foster brand name), Serta,
Simmons and Spring Air. Although we believe our Nautilus Sleep Systems offer
consumers an appealing alternative to conventional mattresses, many of these
conventional manufacturers, including Sealy, Serta, Simmons and Spring Air,
possess significantly greater financial, marketing and manufacturing resources
and have better brand name recognition.
In addition to the conventional mattress manufacturers, several
manufacturers currently offer beds with firmness technology similar to our
Nautilus Sleep Systems. We believe the largest manufacturer in this niche market
is Select Comfort. Select Comfort offers its sleep systems through retail stores
and engages in a significant amount of direct marketing, including infomercials,
targeted mailings, print, radio and television advertising. Select Comfort has
an established brand name supported by marketing and manufacturing resources.
Select Comfort also has significantly greater experience in marketing and
distributing sleep systems. We believe the market for sleep systems is large
enough for both companies to be successful and that our Nautilus Sleep Systems
possess features that will enable us to compete effectively. However, the
intense competition in the mattress industry, both from conventional mattress
manufacturers and Select Comfort, may adversely affect our efforts to market and
sell our sleep systems and, consequently, may adversely affect our financial
performance.
COMMERCIAL/RETAIL SEGMENT PRODUCTS
COMMERCIAL FITNESS EQUIPMENT. The market for commercial fitness
equipment is highly competitive. Our Nautilus, Schwinn Fitness, and StairMaster
products compete against the products of numerous other commercial fitness
equipment companies, including Life Fitness, Cybex, Star Trac and Precor. We
believe the key competitive factors in this industry include price, product
quality and durability, diversity of features, financing options and warranties.
Some of our competitors have greater financial resources, significantly more
experience in the fitness industry, and more extensive experience manufacturing
their products.
RETAIL FITNESS EQUIPMENT. The market for retail fitness equipment is
extremely competitive. Our Nautilus, Schwinn Fitness, and StairMaster retail
products compete against the products of numerous domestic retail fitness
equipment companies including ICON Health & Fitness (marketing products under
the brand names Weslo, Health Rider, Weider, NordicTrak and ProForm), Star Trac,
Life Fitness, Cybex, Fitness Quest, Bollinger Industries, and Precor. The
Company's products also indirectly compete with outdoor fitness, sporting goods
and other recreational products. We believe the key competitive factors in the
retail fitness equipment industry include price, product quality, brand name
recognition, customer service and the ability to create and develop new,
innovative
17
products. In addition, there are no significant technological, manufacturing or
marketing barriers to entry into the fitness equipment markets in which we
compete, even though like many companies in the industry, we have sought and
received patent and trademark protection in an effort to protect our competitive
position.
We believe that our combination of high-quality products, recognized
brand names, multiple distribution channels, and dependable customer service
gives us the ability to compete in our current markets.
MANUFACTURING AND DISTRIBUTION
Our primary manufacturing and distribution objectives for all of our
products are to maintain product quality, reduce and control costs, maximize
production flexibility and improve delivery speed. We use computerized inventory
management systems to forecast our manufacturing requirements.
Our Nautilus commercial fitness manufacturing operations are located in
Virginia. These operations are vertically integrated and include such functions
as metal fabrication, powder coating, upholstery and vacuum-formed plastics
processes. By managing our own manufacturing operations, we can control the
quality of our Nautilus commercial products, while offering commercial customers
greater color specification flexibility.
Our manufacturing operations also include a plant in Texas for Schwinn
Fitness and Trimline consumer treadmills and a plant in Oklahoma for StairMaster
products. By manufacturing these products in our own facilities, we ensure the
highest quality control standards.
The main components of our Bowflex products, the Power Rods, are
exclusively produced in our facilities to protect our manufacturing trade
secrets and to ensure the highest quality control standards. In addition, we use
outside suppliers to manufacture many of our components and finished parts for
our direct and retail products. Whenever possible, we attempt to use at least
two suppliers to manufacture each product component in order to improve
flexibility.
Domestically, we inspect, package, and ship our products from our
facilities in Washington, Virginia, Illinois, Texas, and Nevada. We rely
primarily on United Parcel Service (UPS) to deliver our Bowflex and our Nautilus
Sleep Systems products. We distribute our Nautilus, Schwinn Fitness retail
equipment and accessories, and StairMaster retail and commercial fitness
equipment from our Illinois and Oklahoma facilities using various commercial
truck lines. We distribute Nautilus commercial fitness equipment from our
Virginia warehouse facilities directly to customers primarily through our truck
fleet. This method of distribution allows us to effectively control the set-up
and inspection of equipment at the end-user's facilities.
For international sales, we have distributors in over 50 countries, and
we inspect, package and ship our products from leased facilities in Switzerland,
the United Kingdom, and Germany. We also lease, on a month-to-month basis,
flexible warehouse space in multiple countries in Asia and Europe devoted to
international distribution of Schwinn Fitness products.
INTELLECTUAL PROPERTY
Protecting our intellectual property is an important factor in
maintaining our competitive position in the fitness and mattress industries. If
we do not, or are unable to, adequately protect our intellectual
18
property, our sales and profitability could be adversely affected. Accordingly,
we have taken the following protective measures:
o We hold 17 United States patents and have applied for three
additional United States patents with respect to our Nautilus
products;
o We hold 20 United States patents and have 25 applications pending
internationally with respect to our Schwinn Fitness products;
o We hold four patents relating to our Bowflex home fitness equipment;
o We have applied for one patent relating to our Nautilus Sleep
Systems;
o We have obtained United States trademark protection for various names
associated with our products, including "Bowflex," "Nautilus," "Power
Rod," "Bowflex Power Pro," "Motivator," "Versatrainer," "Schwinn,"
"Airdyne," and "Fitness Advisor";
o We have applied for United States trademark protection for the names
"Direct Focus," "Instant Comfort" and various other names and slogans
associated with our products;
o We have registered the name "Bowflex" in Canada and the European
Community, and have registered or applied to register the "Nautilus"
trademark in approximately 30 foreign countries;
o We have obtained trademark protection for the "look" of our Bowflex
Power Rods; and
o We hold eight United States copyright registrations relating to our
Nautilus products.
Each federally registered trademark is renewable indefinitely if the
mark is still in use at the time of renewal. We are not aware of any material
claims of infringement or other challenges to our right to use our marks.
EMPLOYEES
As of December 31, 2001, we employed 825 full-time employees, including
4 executive officers and 15 part-time employees. None of our employees are
subject to any collective bargaining agreement.
ITEM 2. PROPERTIES
-------------------
Our corporate headquarters is located in Vancouver, Washington. It is a
Company-owned 90,000 square foot facility that serves as a warehouse,
production, distribution and administrative facility. We also lease a 17,000
square foot facility in Vancouver, which we use as our customer call center. We
lease this property pursuant to an operating lease that expires April 30, 2002,
which is subject to an optional extension period. We plan to move our entire
Vancouver operation to our headquarters building in 2002.
Our Nautilus commercial operations and our East Coast distribution
centers for our direct-segment products are located in Independence, Virginia.
The following Company-owned facilities are part of 54 acres of commercial real
property, which were acquired in 1999 with the acquisition of Nautilus:
o A 124,000 square foot building devoted to fabrication, finishing,
assembly, plastics, upholstery, warehousing and shipping;
o A 100,000 square foot building devoted to fabrication and Bowflex
warehousing and shipping;
o A 27,000 square foot building that houses our Nautilus engineering,
prototyping, customer service and administrative operations; and
19
o A 9,000 square foot administrative and product display building.
In 2001, we purchased a 29,500 square foot building in Independence
devoted to used commercial equipment sales and warehousing. In addition to the
purchase, we leased, with the option to buy, an 86,000 square foot building in
Independence to serve as our East Coast distribution center for Nautilus Sleep
System products. We purchased this building in January 2002 for approximately
$600,000.
We also have a distribution center in Las Vegas, Nevada. We originally
leased 93,000 square feet, for which the lease expires November 30, 2002. We
distribute direct segment products from this facility. In 2001, we leased an
additional 40,000 square feet of space adjacent to the original facility to be
devoted as the West Coast distribution center for Nautilus retail fitness
equipment. The lease for the additional space expired January 31, 2002. Nautilus
retail fitness products are now distributed from our facility in Bolingbrook,
Illinois.
In 2000, we purchased approximately 19.5 acres of land in Las Vegas for
$1.1 million. We may build a distribution, warehouse and administrative facility
on the land.
Additional facilities occupied in 2001 through the acquisition of
Schwinn Fitness are as follows:
o A leased 139,000 square foot building in Bolingbrook devoted to
Schwinn and Nautilus Fitness product warehousing and distribution;
o An owned 62,000 square foot building in Tyler, Texas devoted to
manufacturing and distribution of treadmills;
o A leased 40,000 square foot building in Boulder that serves as the
Schwinn and Nautilus Fitness warehouse, production, testing,
distribution and administrative facility;
o 3,800 square feet of leased office space in Boulder devoted to
research and development administration;
o A leased 11,280 square foot building in Freibourg, Switzerland
devoted to international distribution; and
o A leased 6,300 square foot building in Givisiez, Switzerland devoted
to international sales and administration.
In addition to the acquired facilities, we lease, on a month-to-month
basis, flexible warehouse space in multiple countries in Asia and Europe devoted
to international distribution of Schwinn Fitness products.
On March 1, 2002, we purchased an 85,000 square foot building in
Boulder for $6 million. This facility will be used for Schwinn Fitness corporate
offices, warehouse storage, production, testing, and distribution. The new
building will replace the leased facilities in Boulder described above.
Our acquisition of StairMaster in 2002 added leased facilities in
Tulsa, Oklahoma; Bothell, Washington; Milton Keynes, England; and Bergisch
Gladbach, Germany.
In general, our properties are well maintained, adequate and suitable
for their purposes, and we believe these properties will meet our operational
needs for the foreseeable future. If we require
20
additional warehouse or office space, we believe we will be able to obtain such
space on commercially reasonable terms.
ITEM 3. LEGAL PROCEEDINGS
--------------------------
In the normal course of business, the Company is a party to various
legal claims, actions and complaints. Although it is not possible to predict
with certainty whether the Company will ultimately be successful in any of these
legal matters, or what the impact might be, the Company believes that
disposition of these matters will not have a material adverse effect on the
Company's financial position, results of operations or cash flows.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
------------------------------------------------------------
No matters were submitted to a vote of our stockholders during the
quarter ended December 31, 2001.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
------------------------------------------------------------------------------
MARKET PRICE OF OUR COMMON STOCK
Since May 4, 1999, our common stock has been listed for trading
exclusively on The Nasdaq National Market System under the symbol DFXI. The
following table summarizes the high and low closing prices for each period
indicated, adjusted to reflect the three-for-two stock splits effective August
2000, January 2001 and August 2001:
HIGH LOW
---------- ----------
2000
Quarter 1........... $ 8.89 $ 6.45
Quarter 2........... 14.52 7.97
Quarter 3........... 18.11 12.11
Quarter 4........... 20.67 14.14
2001
Quarter 1........... 21.42 12.39
Quarter 2........... 31.67 15.97
Quarter 3........... 33.34 17.11
Quarter 4........... $ 31.46 $ 19.95
As of March 1, 2002, 35,012,932 shares of our common stock were issued
and outstanding and held by 14,611 beneficial shareholders.
Payment of any future dividends is at the discretion of our board of
directors, which considers various factors, such as our financial condition,
operating results, current and anticipated cash needs and expansion plans. Our
credit lines do not restrict the payment of dividends. To date, we have never
declared or paid any cash dividends on our common stock and we do not presently
intend to declare any cash dividends in the near future. Instead, we intend to
retain and direct any future earnings to fund our anticipated expansion and
growth.
21
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
------- ------------------------------------
The selected consolidated financial data presented below for each year
in the five-year period ended December 31, 2001 have been derived from our
audited financial statements. The data presented below should be read in
conjunction with our financial statements and notes thereto and Item 7,
"Management's Discussion and Analysis of Financial Condition and Results of
Operations."
IN THOUSANDS
(EXCEPT PER SHARE AMOUNTS) 1997 1998 1999 2000 2001
-------------------------------- ---------- ---------- ---------- ---------- ----------
STATEMENT OF OPERATIONS DATA
Net sales $ 21,546 $ 63,171 $ 133,079 $ 223,927 $ 363,862
Cost of sales 6,774 18,316 46,483 75,573 140,699
---------- ---------- ---------- ---------- ----------
Gross profit 14,772 44,855 86,596 148,354 223,164
Operating expenses:
Selling and marketing 9,600 22,643 44,630 73,510 99,814
General and administrative 975 1,701 4,237 8,804 15,574
Royalties 581 1,623 2,897 4,979 7,363
Litigation settlement - - 4,000 - -
Total operating expenses ---------- ---------- ---------- ---------- ----------
11,156 25,967 55,764 87,293 122,751
---------- ---------- ---------- ---------- ----------
Operating income 3,616 18,888 30,832 61,061 100,413
Other income (expense):
Interest income 119 527 1,003 3,632 4,024
Other-net (88) (228) 3 347 381
---------- ---------- ---------- ---------- ----------
Total other income 31 305 1,006 3,979 4,405
---------- ---------- ---------- ---------- ----------
Income before income taxes 3,647 19,193 31,838 65,040 104,818
Income tax expense 1,226 6,708 11,495 23,414 38,235
---------- ---------- ---------- ---------- ----------
Net income $ 2,421 $ 12,485 $ 20,343 $ 41,626 $ 66,583
========== ========== ========== ========== ==========
Basic earnings per share * $ 0.08 $ 0.39 $ 0.59 $ 1.18 $ 1.89
Diluted earnings per share* $ 0.07 $ 0.38 $ 0.58 $ 1.15 $ 1.85
Basic shares outstanding * 30,330 31,511 34,309 35,288 35,184
Diluted shares outstanding * 32,099 32,825 35,185 35,997 35,966
BALANCE SHEET DATA
Cash and short-term investments $ 4,790 $ 18,911 $ 35,703 $ 77,181 $ 51,709
Working capital 4,100 15,682 38,209 72,520 84,366
Total assets 7,922 24,373 67,310 117,126 193,904
Stockholders' equity 4,592 17,651 53,031 92,867 147,414
*Reflects the three-for-two stock splits effective August 2000, January 2001 and
August 2001
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
--------------------------------------------------------------------------------
OF OPERATIONS
-------------
CRITICAL ACCOUNTING POLICIES
We have identified the most critical accounting principles upon which
our financial status depends. We determined the critical principles by
considering accounting policies that involve the most complex or subjective
decisions or assessments. We identified our most critical accounting policies to
be those related to warranty reserves, sales return reserves, and the allowance
for doubtful accounts.
22
WARRANTY RESERVES
The costs for product warranties included in our warranty reserve are
for the cost to manufacture (raw materials, labor and overhead) or purchase
warranty parts from our suppliers and the cost to ship those parts to our
customers. In addition, the cost of a technician to install a warranted part on
our manufactured commercial equipment is also included.
The warranty reserve is based on past historical experience with each
product. A warranty reserve is established for new products based on historical
experience with similar products, adjusted for any technological advances in
manufacturing or materials used. Thorough testing of new products in the
development stage helps to identify and correct potential warranty issues prior
to manufacturing. Continuing quality control efforts during manufacturing limit
our exposure to warranty claims. We track all warranty claims by part and reason
for claim in order to identify any potential warranty trends.
If our quality control efforts were to fail in detecting a fault in one
of our products, we could experience increased warranty claims resulting in
increasing the warranty reserve, which could have a significant impact on
current and future financial position, results of operations and cash flows.
SALES RETURN RESERVES
The sales return reserve is based on past historical experience of
product returns during the trial period in which a customer can return a product
for the full purchase price, less shipping and handling. The trial period for
Bowflex products is 45 days and, for our Nautilus Sleep Systems, 90 days. Trial
periods are not offered on our other product lines. We track all product returns
in order to identify any potential customer satisfaction trends. Our return
reserve may be sensitive to a change in our customers' ability to pay during the
trial period due to unforeseen economic circumstances and to different product
introductions that might fulfill the customers' needs at a perceived better
value. In such cases, we could experience increased sales returns resulting in
increasing the return reserve, which could have a significant impact on current
and future financial position, results of operations and cash flows.
ALLOWANCE FOR DOUBTFUL ACCOUNTS
The allowance for doubtful accounts reserve is based on past historical
experience adjusted for any known uncollectible amounts. We periodically review
the creditworthiness of our customers to help ensure collectability. Our
allowance is sensitive to changes in our customer's ability to pay due to
unforeseen changes in the economy, including the bankruptcy of a major customer,
our efforts to actively pursue collections, and increases in chargebacks. Any
major change in the aforementioned factors may result in increasing the
allowance for doubtful accounts, which could have a significant impact on
current and future financial position, results of operations and cash flows.
RESULTS OF OPERATIONS
This discussion and analysis should be read in conjunction with our
consolidated financial statements and related notes included elsewhere in this
report.
We believe that period-to-period comparisons of our operating results
are not necessarily indicative of future performance. You should consider our
prospects in light of the risks, expenses and difficulties frequently
encountered by companies experiencing rapid growth and, in particular, rapidly
growing companies that operate in evolving markets. We may not be able to
successfully address these risks and difficulties. Although we have experienced
net sales growth in recent years, our net sales growth may not continue, and we
cannot assure you of any future growth or profitability.
23
The following table presents certain financial data as a percentage of
net sales:
Year Ended December 31,
-----------------------------------------
1999 2000 2001
------------- ------------ ------------
STATEMENT OF OPERATIONS DATA
Net sales........................ 100.0% 100.0% 100.0%
Cost of sales.................... 34.9 33.7 38.7
------------- ------------ ------------
Gross profit..................... 65.1 66.3 61.3
Operating expenses
Selling and marketing........ 33.5 32.8 27.4
General and administrative... 3.2 3.9 4.3
Royalties.................... 2.2 2.2 2.0
Litigation settlement........ 3.0 - -
------------- ------------ ------------
Total operating expenses......... 41.9 38.9 33.7
Operating income................. 23.2 27.4 27.6
Other income..................... 0.7 1.6 1.2
------------- ------------ ------------
Income before income taxes....... 23.9 29.0 28.8
Income tax expense............... 8.6 10.5 10.5
------------- ------------ ------------
Net income....................... 15.3% 18.6% 18.3%
============= ============ ============
COMPARISON OF THE YEARS ENDED DECEMBER 31, 2001 AND DECEMBER 31, 2000
NET SALES
Net sales grew by 62.5% to $363.9 million in 2001 from $223.9 million
in 2000. Sales were driven by the growth in our direct-marketing business and
the continued expansion into the commercial and retail market segments. In 2001,
we capitalized on favorable advertising costs and availability to increase the
consumer awareness of our Bowflex and Nautilus Sleep System product lines.
Meanwhile, we have continued to expand our market share in the commercial and
retail products segment, where we have grown the Nautilus brand and successfully
integrated the acquisition of the Schwinn Fitness business.
Sales in our direct segment are comprised primarily of sales of our
Bowflex product line; however, as the Nautilus Sleep Systems product line
continues to grow, it is also becoming an increasingly important component of
our direct business. Sales within our direct products segment were $292.5
million in 2001, an increase of 47.7% over the prior year. Our direct segment
accounted for 80.4% of our aggregate net sales in 2001, down from 88.5% in 2000,
as we continued our strategy of diversification into the commercial and retail
products segments.
Sales within our commercial and retail products segment were $71.3
million in 2001, an increase of 176.2% over 2000. Our commercial and retail
segment now accounts for 19.6% of our net sales, up from 11.5% in 2000 as we
continued to execute our strategy of expanding our presence, product lines and
brands across all our channels and especially within the commercial and retail
products segment. In 2002, with a
24
full year of results from Schwinn and with the acquisition of StairMaster, we
expect our commercial and retail segment to continue to grow as a percentage of
our net sales.
Our direct-marketing business is largely dependent upon national cable
television advertising. We have found that second quarter influences on
television viewership, such as the broadcast of national network season finales
and seasonal weather factors, cause our spot television commercials on national
cable television to be marginally less effective in the second quarter than in
other periods of the year. We believe that sales within our commercial and
retail products segment will be considerably lower in the second quarter of the
year compared to the other quarters. Our strongest commercial/retail products
quarter should be the fourth quarter, followed by the first and third quarters.
We believe the principle reason for this trend is the commercial and retail
fitness industry's preparation for the impact of New Year's fitness resolutions
and seasonal weather patterns related to colder winter months.
GROSS PROFIT
Gross profits continued to be strong, growing 50.4% to $223.2 million
in 2001, from $148.4 million in the same period a year ago. However, due to our
product diversification strategy, which has increased sales in the commercial
and retail segment and due to the inherent lower margins in that segment, our
overall gross profit margin decreased 5.0% to 61.3% in 2001, from 66.3% in 2000.
We expect this trend to continue as we further expand in the commercial and
retail segments of the market.
The gross profit margin within our direct products segment was 69.8% in
2001 and 70.2% in 2000. Gross margins on our Bowflex product line continue to be
very strong. We also outsource all non-proprietary manufacturing through
established overseas production. The decrease in gross margins within our
commercial and retail products segment to 26.4% in 2001, compared with 36.2% in
2000, was largely due to the Schwinn Fitness acquisition and higher research and
development expenditures for the Nautilus retail fitness products. Schwinn's
manufactured treadmill inventory was subject to purchase accounting guidelines
that required step-up basis adjustments, negatively affecting our gross profit
margins. Research and development costs increased 83.3% to $2.2 million in 2001
from $1.2 million in 2000.
OPERATING EXPENSES
SELLING AND MARKETING
Selling and marketing expenses grew to $99.8 million in 2001 from $73.5
million in the same period a year ago, an increase of 35.8%. This increase in
selling and marketing expenses resulted primarily from the expansion of our
direct marketing campaign for Bowflex products and Nautilus Sleep Systems and
variable costs associated with our sales growth.
As a percentage of net sales, overall selling and marketing expenses
decreased to 27.4% in 2001 from 32.8% in 2000. The decrease was a result of our
planned product diversification efforts leading to a higher proportion of
commercial and retail product sales. We benefited from the increased
availability of advertising time and the reduction of advertising rates due to
the dramatic reduction of dot.com media spending coupled with the economic
downturn. Selling and marketing expenses within our direct products segment were
31.3% of net sales in 2001, compared to 33.9% in 2000. Overall, we expect that
our selling and marketing expenses will increase in real dollar terms, but not
as a percentage of net sales, as we continue to expand our Bowflex and Nautilus
Sleep Systems direct-marketing campaign and expand our product diversification
efforts in the commercial and retail segment.
25
GENERAL AND ADMINISTRATIVE
General and administrative expenses grew to $15.6 million in 2001 from
$8.8 million in 2000, an increase of 76.9%. Our direct-marketing business
accounted for $4.0 million of the increase, due primarily to increased staffing
and infrastructure expenses necessary to support our growth. Our commercial and
retail operations accounted for the remaining increase primarily due to our
product diversification strategy. As a percentage of net sales, general and
administrative expenses increased to 4.3% in 2001 from 3.9% in 2000. We believe
that our general and administrative expenses will increase in future periods in
real dollar terms, and increase marginally as a percentage of sales.
ROYALTY
Royalty expense grew to $7.4 million in 2001 from $5.0 million in 2000,
an increase of 47.9%. Both our direct and commercial/retail segments have
several royalty agreements. The increase in our royalty expenses is primarily
attributable to the increased sales of our Bowflex products, along with sales of
other products under royalty agreements which have been added as part of our
diversification strategy. Our royalty expenses will increase if sales of our
Bowflex products continue to increase and as we sell recently acquired products
which have royalty agreements associated with them.
OTHER INCOME
In 2001, other income was $4.4 million compared to $4.0 million for
2000. The small increase resulted primarily from an increase in interest earned
on invested cash and cash equivalents due to the effect of higher invested cash
amounts offset by considerable interest rate cuts by the Federal Reserve Bank in
2001. Interest income should be lower in future periods due to the lower rate
environment and the use of cash to acquire Schwinn Fitness and StairMaster.
INCOME TAX EXPENSE
Income tax expense increased by $14.8 million for 2001 primarily due to
the growth in our income before taxes. The increase in our effective tax rate
from 36.0% in 2000 to 36.5% in 2001 is due to state income tax issues relating
to our commercial and retail business. We expect our income tax expense to
increase in line with our growth in income before taxes.
NET INCOME
For the reasons discussed above, net income grew to $66.6 million in
2001 from $41.6 million in 2000, an increase of 60.0%. Not only were we able to
maintain a higher sales growth rate, but we also complemented that with a
control on our expenses, which grew only marginally as a percentage of sales
from 2000. Higher sales, coupled with controlling our expenses, translated into
strong net income growth in 2001.
COMPARISON OF THE YEARS ENDED DECEMBER 31, 2000 AND DECEMBER 31, 1999
NET SALES
Net sales in 2000 grew by 68.3% to $223.9 million from $133.1 million
in 1999. Our Bowflex line of products continued to exhibit strong growth and was
the primary reason for the strong sales growth in 2000. This was also enhanced
by the full integration of Nautilus within our business. New products provided
momentum to our sales, primarily in the direct products segment through the
Nautilus Sleep
26
Systems, as well as in the commercial and retail products segment due to the
addition of Nautilus Nitro commercial equipment and a line of Nautilus-branded
retail products and home gyms.
Sales within our direct business segment increased substantially by
75.3% over prior year levels and accounted for $198.1 million, or 88.5% of our
net sales in 2000, compared with $113.0 million or 84.9% in 1999 of our net
sales.
Net sales within our commercial and retail products segment also
continued to show growth, increased by 28.6% over 1999 and accounted for $25.8
million, or 11.5% of our net sales in 2000 as we embarked on expanding our
market share and reach in this segment of the market.
GROSS PROFIT
Gross profit grew 71.3% to $148.4 million in 2000, from $86.6 million
in 1999. Our gross profit margin increased 1.2% to 66.3% in 2000, from 65.1% in
1999. This increase was mainly attributable to the growth of direct product
sales due to the launch of the Nautilus Sleep System and the growth in Bowflex
revenues enhanced by strong eCommerce sales. The margin within our direct
products segment was 70.2% in 2000, while there was a 36.2% margin within our
commercial and retail products segment for 2000.
OPERATING EXPENSES
SELLING AND MARKETING
Selling and marketing expenses grew to $73.5 million in 2000 from $44.6
million in 1999, an increase of 64.7%. This increase in selling and marketing
expenses resulted primarily from the continued expansion of our direct marketing
campaign for Bowflex products and Nautilus Sleep Systems and variable costs
associated with our sales growth.
As a percentage of net sales, selling and marketing expenses decreased
by 0.7% in 2000 to 32.8%, compared to 33.5% in 1999. Selling and marketing
expenses within our direct products segment were 33.9% of net sales in 2000
compared to 35.2% in 1999. Selling and marketing expenses within our commercial
and retail business traditionally have been a lower percentage of net sales than
we have experienced in direct marketing and were $6.4 million in 2000 compared
with $5.1 million in 1999.
GENERAL AND ADMINISTRATIVE
General and administrative expenses grew to $8.8 million in 2000 from
$4.2 million in 1999, an increase of 107.8%. As a percentage of net sales,
general and administrative expenses increased to 3.9% in 2000 from 3.2% in 1999.
Our direct products segment accounted for $4.0 million of the increase in
general and administrative expenses, due primarily to increased staffing and
infrastructure expenses necessitated by our continued growth and the
implementation of our information systems. Commercial and retail operations
accounted for the remaining increase of $0.6 million.
ROYALTY
Royalty expense grew to $5.0 million in 2000 from $2.9 million in 1999,
an increase of 71.9%. The increase in our royalty expense is attributable to
increased sales of our Bowflex products in 2000, plus new royalty agreements
related to our product diversification strategy.
27
OTHER INCOME
In 2000, other income increased to $4.0 million from $1.0 million in
1999. The $3.0 million increase resulted primarily from interest earned on
invested cash and cash equivalents.
INCOME TAX EXPENSE
Income tax expense increased by $11.9 million in 2000 compared to 1999.
NET INCOME
For the reasons discussed above, net income increased 104.6 % to $41.6
million in 2000 compared to $20.3 million in 1999. As a percentage of net sales,
our net income was markedly higher in 2000 at 18.6%, compared with 15.3% in
1999.
QUARTERLY RESULTS OF OPERATIONS
The following table presents our operating results for each of the
eight quarters in the period ended December 31, 2001. The information for each
of these quarters is unaudited and has been prepared on the same basis as the
audited financial statements appearing elsewhere in this Annual Report on Form
10-K. In the opinion of management, all necessary adjustments, consisting only
of normal recurring adjustments, have been included to present fairly the
unaudited quarterly results when read together with our audited financial
statements and the related notes. These operating results are not necessarily
indicative of the results of any future period. Given our acquisition strategy,
we expect heightened seasonality in our business. We expect sales in the second
quarter to be weakest while the first and fourth quarter should be our
strongest. The fourth quarter should be stronger than the first quarter.
QUARTER ENDED
(In thousands, except per share)
--------------------------------
March 31 June 30 September 30 December 31 Total
-------- -------- ------------ ----------- ---------
Fiscal 2001:
Net sales $ 74,855 $ 75,010 $ 88,702 $125,295 $ 363,862
Gross profit 49,551 49,237 55,691 68,685 223,164
Operating income 21,534 21,532 25,196 32,151 100,413
Net income 14,739 14,550 16,764 20,530 66,583
Earnings per share
Basic * .41 .41 .48 .59 1.89
Diluted * .41 .40 .46 .57 1.85
Fiscal 2000:
Net sales $ 47,333 $ 48,132 $ 57,834 $ 70,628 $ 223,927
Gross profit 32,149 31,190 39,063 45,952 148,354
Operating income 13,359 11,814 16,261 19,625 61,060
Net income 8,918 8,167 11,082 13,459 41,626
Earnings per share
Basic * .25 .23 .31 .39 1.18
Diluted * .25 .23 .31 .37 1.15
* Reflects the three-for-two stock splits effective August 2000, January 2001
and August 2001.
28
LIQUIDITY AND CAPITAL RESOURCES
Historically, we have financed our growth and acquisitions primarily
from cash generated by our operating activities. During 2001, our operating
activities generated approximately $66.9 million in net cash, which contributed
to an aggregate $35.6 million balance in cash and cash equivalents and $16.1
million of short-term investments, compared with $52.8 million and $20.8 million
net cash generated by our operating activities in 2000 and 1999, respectively.
Net cash used in our investing activities increased substantially in
2001 to $94.3 million, from $8.7 million in 2000 and $18.6 million in 1999. This
was primarily due to the acquisition of Schwinn Fitness and net purchase of
short-term investments.
Net cash used in financing activities increased to $14.0 million from
$2.6 million in 2000, compared with net cash generated from financing activities
in 1999 of $14.5 million. In 1999, cash was largely generated by our public
offering in the United States, while increased use of funds for stock
repurchases during 2001 resulted in the increase in net cash used. In January
2001, our Board of Directors authorized management to repurchase up to $20
million of the Company's common stock in open-market transactions, with the
terms of the purchases to be determined by management based on market
conditions. In 2001, the Company used $16.3 million of the authorized $20
million to repurchase shares. A $10 million repurchase program was approved in
October 2001 by the Board of Directors and the remaining balance of the $20
million repurchase program was terminated. As of January 31, 2002, the $10
million repurchase authorization had expired unused.
Despite the drop in the balance of cash and cash equivalents from $77.2
million as of December 31, 2000 to $35.6 million as of December 31, 2001, our
cash flow position remains very strong. The decrease last year was primarily due
to the $69.8 million paid to acquire Schwinn Fitness, the purchase of short-term
investments of $16.1 million, and the repurchase of $16.3 million of the
Company's stock, part of which was offset by cash generated from operations.
Our working capital needs have increased marginally as we continue to
implement our growth strategy. Working capital in 2001, 2000 and 1999 was $84.4
million, $72.5 million and $38.2 million, respectively. We anticipate that our
working capital requirements will increase going forward as a result of us
growing our commercial and retail segment through our acquisition strategy and
internal growth. We also expect to materially increase our cash expenditures on
spot commercials and infomercials as we expand the direct marketing campaigns
for our Bowflex products and Nautilus Sleep Systems.
We maintain a $10 million line of credit with US Bank National
Association. The line of credit is secured by certain assets and contains two
financial covenants. As of the date of this filing, we are in compliance with
the covenants applicable to the line of credit and there is no outstanding
balance under the line.
As of December 31, 2001, the Company had no contractual capital
obligations or commercial commitments other than operating leases, which are
described in Note 8 of the Notes to Consolidated Financial Statements.
On February 8, 2002, the Company paid approximately $26.1 million to
acquire StairMaster Sports/Medical Products, Inc., as described in Note 17 of
the Notes to consolidated Financial Statements. The Company used cash generated
from operations to finance the acquisition.
29
We believe our existing cash balances, combined with our line of
credit, will be sufficient to meet our capital requirements for at least the
next 12 months.
INFLATION AND PRICE INCREASES
Although we cannot accurately anticipate the effect of inflation on our
operations, we do not believe that inflation has had, or is likely in the
foreseeable future to have, a material adverse effect on our results of
operations, cash flows or our financial position. However, increases in
inflation over historical levels or uncertainty in the general economy could
decrease discretionary consumer spending for products like ours. Very little of
our revenue growth is attributable to price increases.
RISKS AND UNCERTAINTIES
While management is optimistic about the Company's long-term prospects,
the following issues and uncertainties, among others, should be considered in
evaluating our growth outlook.
A SIGNIFICANT DECLINE IN CONSUMER INTEREST IN BOWFLEX PRODUCTS WOULD SHARPLY
DIMINISH OUR SALES AND PROFITABILITY.
Our financial performance depends significantly on sales of our Bowflex
line of home fitness equipment. During 2001, approximately 68% of our net sales
were attributable to our Bowflex products. Accordingly, any significant decline
in consumer interest in our Bowflex products could significantly reduce our
sales and profitability. Sales of our Bowflex line could significantly decline
if, for example, a competing product were effectively marketed and resulted in
significant consumer purchases or if the market demand for our Bowflex line were
to become saturated. Although we are working to diversify our revenue base, we
anticipate that sales of our Bowflex product line will continue to account for a
substantial portion of our net sales for the foreseeable future.
OUR SALES COULD DECLINE SIGNIFICANTLY UPON THE EXPIRATION OF THE PRINCIPAL
PATENT ON OUR BOWFLEX POWER RODS ON APRIL 27, 2004.
Although our Bowflex trademark is protected as long as we continuously
use the trademark, the patent on our Bowflex Power Rods, a key component of our
Bowflex products, expires on April 27, 2004. This patent expiration could
trigger the introduction of similar products by competitors and result in a
significant decline in our sales and revenues.
NEW PRODUCT DEVELOPMENT IS AN ESSENTIAL COMPONENT OF OUR GROWTH STRATEGY; AN
INABILITY TO SUCCESSFULLY DEVELOP NEW PRODUCTS COULD NEGATIVELY IMPACT OUR
FUTURE PROFITABILITY.
Our future success depends on our ability to develop or acquire the
rights to, and then effectively market and sell, new products that create and
respond to new and evolving consumer demands. Accordingly, our net sales and
profitability may be harmed if we are unable to develop, or acquire the rights
to, new and different products that satisfy our marketing criteria. In addition,
any new products that we market may not generate sufficient net sales or profits
to recoup their development or acquisition cost.
We also may not be able to successfully acquire intellectual property
rights or potentially prevent others from claiming that we have violated their
proprietary right when we launch new products. We could incur substantial costs
in defending against such claims, even if they are without basis, and we could
become subject to judgments requiring us to pay substantial damages.
30
WE ARE A RAPIDLY GROWING COMPANY; OUR FAILURE TO PROPERLY MANAGE GROWTH MAY
ADVERSELY AFFECT OUR FINANCIAL PERFORMANCE.
We have grown significantly in recent years, with an increase in net
sales from $9.2 million in 1996 to $363.9 million in 2001. Our organic growth
has been complemented by acquisitions of Schwinn Fitness in September 2001 and
StairMaster in February 2002. Our rapid growth and recent acquisitions may
strain our management team, production facilities, information systems and other
resources. In addition, we may be unable to effectively allocate our existing
and future resources to our various businesses while maintaining our focus on
our core competencies. We cannot assure you that we will succeed in effectively
managing our existing operations or our anticipated growth, which could
adversely affect our financial performance.
IF WE ARE UNABLE TO EFFECTIVELY INTEGRATE NEWLY ACQUIRED BUSINESSES, SUCH AS
STAIRMASTER, INTO OUR OPERATIONS, WE MAY NOT ACHIEVE ANTICIPATED REVENUE,
EARNINGS AND BUSINESS SYNERGIES.
We face significant challenges in integrating acquired businesses,
including recently acquired StairMaster, into our operations, particularly with
respect to corporate cultures and management teams. Failure to successfully
effect the integration could adversely impact the revenue, earnings and business
synergies we expect from the acquisition. In addition, the process of
integrating acquired businesses may be disruptive to our operations and may
cause an interruption of, or a loss of momentum in, our core business.
Our future integration efforts may be jeopardized, and our actual
return on investment from such acquisitions may be lower than anticipated, as a
result of various factors, including the following:
o Challenges in the successful integration of the products, services or
personnel of the acquired business into our operations;
o Loss of employees or customers that are key to the acquired business;
o Time and money spent by our management team focusing on the
integration, which could distract it from our core operations;
o Our potential lack of experience in markets of the acquired
businesses;
o Possible inconsistencies in standards, controls, procedures and
policies among the combined companies and the need to implement our
company financial, accounting, information and other systems; and
o The need to coordinate geographically diverse operations.
UNFAVORABLE ECONOMIC CONDITIONS COULD CAUSE A DECLINE IN CONSUMER SPENDING AND
ACCORDINGLY HINDER OUR PRODUCT SALES.
The success of each of our products depends substantially on the amount
of discretionary funds available to consumers and their purchasing preferences.
Economic and political uncertainties could continue to adversely impact the U.S.
and international economic environment. Although our revenues have not been
adversely impacted by the current economic slowdown to date, a continued decline
in economic conditions could further depress consumer spending, especially
discretionary spending for premium priced products like ours. These poor
economic conditions could in turn lead to substantial decreases in our sales and
revenues.
31
A SIGNIFICANT DECLINE IN AVAILABILITY OF MEDIA TIME AND A MARKED INCREASE IN
ADVERTISING RATES MAY HINDER OUR ABILITY TO EFFECTIVELY MARKET OUR PRODUCTS AND
MAY REDUCE PROFITABILITY.
We depend primarily on 60-second "spot" television commercials and
30-minute television "infomercials" to market and sell our direct-marketed
products. Consequently, a marked increase in the price we must pay for our
preferred media time or a reduction in its availability may adversely impact our
financial performance.
WE DEPEND ON A SINGLE CONSUMER FINANCE COMPANY TO PROVIDE FINANCING PACKAGES TO
OUR CUSTOMERS; A DETERIORATION OF THE CONSUMER FINANCE MARKET OR FAILURE BY THE
FINANCE COMPANY TO PROVIDE FINANCING TO OUR CUSTOMERS COULD NEGATIVELY IMPACT
SALES OF OUR DIRECT-MARKETED PRODUCTS.
In purchasing our products, approximately 41% of our direct-marketed
customers utilize convenient financing packages provided by an independent
finance company. We believe that convenient consumer financing is an important
tool in our direct marketing efforts and induces many of our customers to make
purchases when they otherwise would not. We facilitate the availability of
convenient financing to our customers in order to increase our sales. Consumers
may be less likely to purchase our products if the consumer finance market were
to deteriorate so that financing is less available or less convenient to our
customers. In addition, we currently utilize the services of a single consumer
finance company. Although we believe we could enter into similar arrangements
with other provides if needed, a failure by the current provider to adequately
service our customers could temporarily disrupt sales.
OUR FAILURE OR INABILITY TO PROTECT OUR INTELLECTUAL PROPERTY COULD
SIGNIFICANTLY HARM OUR COMPETITIVE POSITION.
Protecting our intellectual property is an essential factor in
maintaining our competitive position in the fitness and health industries. If we
do not or are unable to adequately protect our intellectual property, our sales
and profitability could be adversely affected. We currently hold a number of
patents and trademarks and have several patent and trademark applications
pending. However, our efforts to protect our proprietary rights may be
inadequate and applicable laws provide only limited protection.
A DETERIORATION IN PRODUCT QUALITY OR INCREASE IN PRODUCT LIABILITY COULD
ADVERSELY AFFECT OUR BUSINESS.
We rely on third party manufacturers for a significant portion of our
product components and we may not be able to consistently control the quality of
such components. Any material increase in the quantity of products returned by
our customers for purchase-price refunds could adversely affect revenues. In
addition, we are subject to potential product liability claims if our products
injure, or allegedly injure, our customers or other users. Our financial
performance could be affected if our warranty reserves are inadequate to cover
warranty claims on our products. We could become liable for significant monetary
damages if our product liability insurance coverage and reserves fail to cover
future product liability claims.
GOVERNMENT REGULATORY ACTIONS COULD DISRUPT OUR DIRECT MARKETING EFFORTS AND
PRODUCT SALES.
Various federal, state and local government authorities, including the
Federal Trade Commission and the Consumer Products Safety Commission, regulate
our direct marketing efforts and products. Our sales and profitability could be
significantly harmed if any of these authorities
32
commence a regulatory enforcement action that interrupts our direct marketing
efforts or results in a product recall.
RECENT ACCOUNTING PRONOUNCEMENTS
On January 1, 2001, the Company adopted Statement of Financial
Accounting Standards ("SFAS") No. 133, "Accounting for Derivative Instruments
and Hedging Activities," as amended, which establishes accounting and reporting
standards for derivative instruments and hedging activities requiring that all
derivatives be recognized in the balance sheet and measured at fair value. The
adoption of SFAS No. 133 did not have a material effect on the Company's
financial position, results of operations or cash flows.
The Company adopted SFAS No. 141, "Business Combinations," effective
July 1, 2001. SFAS No. 141 requires all business combinations initiated after
June 30, 2001 to be accounted for using the purchase method of accounting.
In June 2001, the Financial Accounting Standards Board issued SFAS No.
142, "Goodwill and Other Intangible Assets." The statement requires
discontinuing the amortization of goodwill and other intangible assets with
indefinite useful lives. Instead, these assets are to be tested periodically for
impairment and written down to their fair market value as necessary. The Company
adopted the provisions of this statement effective September 20, 2001 as a
result of the Schwinn Fitness acquisition, the effect of which is to not
amortize the goodwill recorded as part of this acquisition but to annually test
it for impairment.
SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived
Assets," addresses accounting and reporting for the impairment or disposal of
long-lived assets. SFAS No. 144 supersedes SFAS No. 121, "Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of."
SFAS No. 144 establishes a single accounting model for long-lived assets to be
disposed of by sale and expands on the guidance provided by SFAS No. 121 with
respect to cash flow estimations. SFAS No. 144 becomes effective for the
Company's fiscal year beginning January 1, 2002. The Company is evaluating SFAS
No. 144 and has not yet determined the impact of adoption on its financial
position or results of operations.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
-------------------------------------------------------------------
We have primarily invested cash with banks and in liquid debt
instruments purchased with maturity dates of less than one year. Our bank
deposits may exceed federally insured limits and there is risk of loss of the
entire principal with any debt instrument. To reduce risk of loss, we limit our
exposure to any one debt issuer and require certain minimum ratings for debt
instruments that we purchase.
FOREIGN EXCHANGE RISK
The Company is exposed to foreign exchange risk to the extent of
fluctuations in the Euro, the Swiss Franc, German Mark and the British Pound.
Based on the relative size of the Company's foreign operations, management
believes that its exposure to foreign exchange risk is not material and that any
possible near-term changes in the related exchange rates would not have a
material impact on the Company's financial position, results of operations or
cash flows.
33
INTEREST RATE RISK
The Company has financed its growth through cash generated from
operations. At December 31, 2001, the Company had no outstanding borrowings and
was not subject to any interest rate risk.
The Company invests in liquid debt instruments purchased with maturity
dates of less than one year. Due to the short-term nature of those investments,
management believes that any possible near-term changes in related interest
rates would have not have a material impact on the Company's financial position,
results of operations, or cash flows.
ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY FINANCIAL DATA
---------------------------------------------------------------------------
Index to Consolidated Financial Statements Page
----
Independent Auditors' Report 35
Consolidated Balance Sheets as of December 31, 2000 and 2001 36
Consolidated Statements of Income for the years ended December
31, 1999, 2000, and 2001 37
Consolidated Statements of Stockholders' Equity and Comprehensive
Income for the years ended December 31, 1999, 2000, and 2001 38
Consolidated Statements of Cash Flows for the years ended December
31, 1999, 2000, and 2001 39
Notes to Consolidated Financial Statements 41
34
INDEPENDENT AUDITORS' REPORT
Board of Directors and Stockholders
of Direct Focus, Inc.:
We have audited the accompanying consolidated balance sheets of Direct
Focus, Inc. and subsidiaries as of December 31, 2000 and 2001, and the related
consolidated statements of income, stockholders' equity and comprehensive
income, and of cash flows for each of the three years in the period ended
December 31, 2001. Our audits also included the financial statement schedule at
Item 14. These financial statements and financial statement schedule are the
responsibility of the Company's management. Our responsibility is to express an
opinion on the financial statements and financial statement schedule based on
our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States of America. Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly,
in all material respects, the financial position of Direct Focus, Inc. and
subsidiaries at December 31, 2000 and 2001 and the results of their operations
and their cash flows for each of the three years in the period ended December
31, 2001 in conformity with accounting principles generally accepted in the
United States of America. Also, in our opinion, such financial statement
schedule, when considered in relation to the basic consolidated financial
statements taken as a whole, presents fairly in all material respects the
information set forth therein.
DELOITTE & TOUCHE LLP
Portland, Oregon
January 21, 2002 (February 8, 2002 as to Note 17)
35
DIRECT FOCUS, INC.
CONSOLIDATED BALANCE SHEETS
December 31, December 31,
2000 2001
------------- -------------
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 77,181,064 $ 35,638,944
Short-term investments, at amortized cost -- 16,069,691
Trade receivables (less allowance for doubtful accounts of:
$352,279 and $2,064,139 in 2000 and 2001) 4,941,286 24,858,295
Inventories, net 12,653,117 45,516,207
Prepaid expenses and other current assets 591,453 2,006,623
Notes receivable -- 2,671,838
Current deferred tax asset 950,363 1,425,190
------------- -------------
Total current assets 96,317,283 128,186,788
------------- -------------
PROPERTY, PLANT AND EQUIPMENT, NET 16,668,884 25,228,130
OTHER ASSETS 4,140,277 40,489,574
------------- -------------
TOTAL ASSETS $ 117,126,444 $ 193,904,492
============= =============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Trade payables $ 12,335,776 $ 25,255,352
Accrued liabilities 5,344,225 10,888,442
Income taxes payable 2,542,967 4,792,170
Royalty payable to stockholders 1,481,886 1,885,186
Customer deposits 2,092,611 999,759
------------- -------------
Total current liabilities 23,797,465 43,820,909
------------- -------------
LONG-TERM DEFERRED TAX LIABILITY 462,004 2,669,540
COMMITMENTS AND CONTINGENCIES (Notes 8 and 15)
STOCKHOLDERS' EQUITY:
Common stock - authorized, 75,000,000 shares of no par value;
issued and outstanding, 2000: 35,317,773 shares, 2001:
34,954,790 shares 16,812,476 4,900,241
Retained earnings 76,054,499 142,637,163
Accumulated other comprehensive loss -- (123,361)
------------- -------------
Total stockholders' equity 92,866,975 147,414,043
------------- -------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 117,126,444 $ 193,904,492
============= =============
See notes to consolidated financial statements.
36
DIRECT FOCUS, INC.
CONSOLIDATED STATEMENTS OF INCOME
FOR THE YEARS ENDED DECEMBER 31, 1999, 2000, AND 2001
1999 2000 2001
------------ ------------ ------------
NET SALES $133,078,513 $223,927,365 $363,862,384
COST OF SALES 46,482,613 75,573,619 140,698,578
------------ ------------ ------------
Gross profit 86,595,900 148,353,746 223,163,806
------------ ------------ ------------
OPERATING EXPENSES:
Selling and marketing 44,629,825 73,509,675 99,813,812
General and administrative 4,236,804 8,804,446 15,573,667
Royalties 2,897,278 4,979,287 7,363,067
Litigation settlement 4,000,000 - -
------------ ------------ ------------
Total operating expenses 55,763,907 87,293,408 122,750,546
------------ ------------ ------------
OPERATING INCOME 30,831,993 61,060,338 100,413,260
------------ ------------ ------------
OTHER INCOME (EXPENSE):
Interest income 1,003,586 3,631,993 4,024,095
Other, net 2,737 347,175 380,623
------------ ------------ ------------
Total other income, net 1,006,323 3,979,168 4,404,718
------------ ------------ ------------
INCOME BEFORE INCOME TAXES 31,838,316 65,039,506 104,817,978
INCOME TAX EXPENSE 11,495,425 23,413,412 38,235,314
------------ ------------ ------------
NET INCOME $ 20,342,891 $ 41,626,094 $ 66,582,664
============ ============ ============
BASIC EARNINGS PER SHARE $ 0.59 $ 1.18 $ 1.89
============ ============ ============
DILUTED EARNINGS PER SHARE $ 0.58 $ 1.15 $ 1.85
============ ============ ============
Basic shares outstanding 34,308,957 35,287,604 35,183,632
Diluted shares outstanding 35,185,077 35,997,366 35,966,038
See notes to consolidated financial statements.
37
DIRECT FOCUS, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY AND COMPREHENSIVE INCOME
FOR THE YEARS ENDED DECEMBER 31, 1999, 2000, AND 2001
Accumulated
Other
Common Stock Comprehensive
Shares Amount Retained Earning Loss Total
------------- ------------- ------------- ------------- -------------
BALANCES, JANUARY 1, 1999 31,888,767 $ 3,565,628 $ 14,085,514 $ - $ 17,651,142
Net income - - 20,342,891 - 20,342,891
Public offering 3,290,625 17,937,691 - - 17,937,691
Options exercised 782,411 300,482 - - 300,482
Stock repurchased (712,800) (3,698,793) - - (3,698,793)
Tax benefit of exercise of nonqualified
Options - 497,412 - - 497,412
------------- ------------- ------------- ------------- -------------
BALANCES, DECEMBER 31, 1999 35,249,003 18,602,420 34,428,405 - 53,030,825
============= ============= ============= ============= =============
Net income - - 41,626,094 - 41,626,094
Options exercised 486,302 622,236 - - 622,236
Stock repurchased (417,531) (3,252,043) - - (3,252,043)
Tax benefit of exercise of nonqualified
Options - 839,863 - - 839,863
------------- ------------- ------------- ------------- -------------
BALANCES, DECEMBER 31, 2000 35,317,773 16,812,476 76,054,499 - 92,866,975
============= ============= ============= ============= =============
Net income - - 66,582,664 - 66,582,664
Cumulative translation adjustment - - - (123,361) (123,361)
-------------
Comprehensive income 66,459,303
Shares issued 11,213 250,000 - - 250,000
Options exercised 567,563 2,270,226 - - 2,270,226
Stock repurchased (941,759) (16,309,486) - - (16,309,486)
Tax benefit of exercise of nonqualified
Options - 1,877,025 - - 1,877,025
------------- ------------- ------------- ------------- -------------
BALANCES, DECEMBER 31, 2001 34,954,790 $ 4,900,241 $ 142,637,163 $ (123,361) $ 147,414,043
============= ============= ============= ============= =============
See notes to consolidated financial statements
38
DIRECT FOCUS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 1999, 2000, AND 2001
1999 2000 2001
------------ ------------ ------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 20,342,891 $ 41,626,094 $ 66,582,664
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 1,183,412 2,874,101 3,620,954
Loss on equipment disposal 1,262 4,504 212,713
Tax benefit of exercise of nonqualified options 497,412 839,863 1,877,025
Deferred income taxes (484,448) 144,945 1,732,709
Changes in assets and liabilities, net of the
effect of acquisitions:
Trade receivables (1,519,116) (197,073) (10,107,949)
Inventories (3,448,750) (3,485,563) (14,005,616)
Prepaid expenses and other current assets (1,377,336) 1,272,498 (481,841)
Trade payables 2,001,235 6,464,407 12,013,031
Income taxes payable 1,672,461 365,731 2,145,862
Accrued liabilities and royalty payable to
Stockholders 988,414 1,881,008 4,379,916
Customer deposits 948,811 994,863 (1,092,852)
------------ ------------ ------------
Net cash provided by operating activities 20,806,248 52,785,378 66,876,616
------------ ------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Additions to property, plant and equipment (1,929,137) (8,761,526) (5,716,348)
Proceeds from sale of property, plant and equip 159,238 97,067 3,000
Additions to other assets (167,935) (13,505) 41,976
Acquisition cost of Nautilus (16,615,012) -- --
Acquisition cost of Schwinn -- -- (69,843,214)
Purchase of short-term investments -- -- (37,132,771)
Proceeds from sales and maturities of short-term
investments -- -- 21,063,080
Issuance of notes receivable -- -- (2,671,838)
------------ ------------ ------------
Net cash used in investing activities (18,552,846) (8,677,964) (94,256,115)
------------ ------------ ------------
CASH FLOWS FROM FINANCING
ACTIVITIES:
Proceeds from public offering 17,937,691 -- --
Funds used for stock repurchase (3,698,793) (3,252,043) (16,309,486)
Proceeds from exercise of stock options 300,482 622,236 2,270,226
------------ ------------ ------------
Net cash provided by (used in) financing activities 14,539,380 (2,629,807) (14,039,260)
------------ ------------ ------------
Effect of exchange rate changes -- -- (123,361)
39
NET INCREASE (DECREASE) IN CASH AND
CASH EQUIVALENTS 16,792,782 41,477,607 (41,542,120)
CASH AND CASH EQUIVALENTS,
BEGINNING OF YEAR 18,910,675 35,703,457 77,181,064
============ ============ ============
CASH AND CASH EQUIVALENTS,
END OF YEAR $ 35,703,457 $ 77,181,064 $ 35,638,944
============ ============ ============
SUPPLEMENTAL DISCLOSURE OF
CASH FLOW INFORMATION:
Cash paid for income taxes 9,835,000 21,907,800 32,400,000
Supplemental disclosure of other non-cash
investing activities:
Champion purchase option paid by stock -- -- 250,000
See notes to consolidated financial statements
40
DIRECT FOCUS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
THREE YEARS ENDED DECEMBER 31, 2001
1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
ORGANIZATION
Direct Focus Inc. (the "Company," a Washington corporation) is a
leading marketer, developer and manufacturer of branded health and fitness
products sold under such well-known brands as Nautilus, Bowflex, Schwinn and
StairMaster. These products are distributed through well established direct to
consumer, commercial and retail channels. Our consumer and commercial fitness
equipment products include a full line of cardiovascular and weight resistance
products such as home gyms, free weight equipment, treadmills, stationary bikes,
steppers and ellipticals. Our healthy lifestyle products also include a line of
advanced sleep systems and nutritional products. As a result of the acquisition
of the Fitness Division of Schwinn/GT Corp. ("Schwinn Fitness") in September
2001, the Company incorporated the Nautilus/Schwinn Fitness Group, Inc., DF Hebb
Industries, Inc., Schwinn Fitness International SA, Schwinn Holdings
International SA, and Schwinn Fitness SA, which include commercial and retail
cardio fitness equipment and accessories, into the commercial/retail segment of
the business.
CONSOLIDATION
The consolidated financial statements of the Company include Direct
Focus, Inc., Nautilus HPS, Inc., Nautilus, Inc., DFI Properties, LLC, BFI
Advertising, Inc., DFI Sales, Inc., Nautilus/Schwinn Fitness Group, Inc., DF
Hebb Industries, Inc., Schwinn Fitness International SA, Schwinn Holdings
International SA, Schwinn Fitness SA and Nautilus Fitness Products, Inc. All
inter-company transactions have been eliminated in the preparation of the
consolidated financial statements.
The accounts of foreign operations are measured using the local
currency as the functional currency. These accounts are translated into U.S.
dollars using exchange rates in effect at year-end for assets and liabilities
and the average exchange rate during the period for the results of operations.
Translation adjustments are accumulated as a separate component of equity and
comprehensive income.
USE OF ACCOUNTING ESTIMATES
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities and disclosure of contingent assets and liabilities at
the date of the financial statements and the reported amounts of revenues and
expenses during the reporting period. Actual results could differ from those
estimates. The most significant estimates included in the preparation of the
financial statements are related to warranty reserves, sales return reserves,
and allowance for doubtful accounts.
CASH AND CASH EQUIVALENTS
Cash and cash equivalents include cash on hand, cash deposited with
banks and financial institutions and highly liquid debt instruments purchased
with maturity dates of three months or less at the date of acquisition. The
Company maintains its cash in bank deposit accounts, which, at times, may exceed
federally insured limits. The Company has not experienced any losses in such
accounts.
41
SHORT-TERM INVESTMENTS
Debt securities with original maturities greater than three months and
remaining maturities less than one year are classified as short-term
investments. Short-term investments in debt securities are classified as
held-to-maturity and valued at amortized cost with gains and losses recognized
upon the sale of the security.
INVENTORIES
Inventories are stated at the lower of average cost or market.
PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment is stated at cost. Depreciation is
computed using the straight-line method over the estimated useful lives of the
assets.
Management reviews the investment in long-lived assets for possible
impairment whenever events or circumstances indicate the carrying amount of an
asset may not be recoverable. There have been no such events or circumstances in
each of the three years in the period ended December 31, 2001. If there were an
indication of impairment, management would prepare an estimate of future cash
flows (undiscounted and without interest charges) expected to result from the
use of the asset and its eventual disposition. If these cash flows were less
than the carrying amount of the assets, an impairment loss would be recognized
to write down the assets to their estimated fair value.
OTHER ASSETS
Other assets consist of license agreements, patents and trademarks and
goodwill. Amortization is computed using the straight-line method over estimated
useful lives of three to twenty years. Accumulated amortization was $510,374 and
$833,565 at December 31, 2000 and 2001, respectively.
In June 2001, the Financial Accounting Standards Board issued SFAS No.
142, "Goodwill and Other Intangible Assets." The statement requires
discontinuing the amortization of goodwill and other intangible assets with
indefinite useful lives. Instead, these assets are to be tested periodically for
impairment and written down to their far market value as necessary. The Company
adopted the provisions of this statement effective September 20, 2001 as a
result of the Schwinn acquisition, the effect of which is to not amortize the
goodwill recorded as part of this acquisition but to annually test it for
impairment.
REVENUE RECOGNITION
For all of the Company's products, except Nautilus commercial
equipment, revenue from product sales is recognized at the time of shipment.
Revenue is recognized upon installation for the Nautilus commercial equipment if
the Company is responsible for installation.
WARRANTY COSTS
The Company's warranty policy provides for coverage for defects in
material and workmanship. Warranty periods on the Company's products range from
two years to limited lifetime on the Bowflex lines of fitness products and
twenty years on sleep systems. The Nautilus commercial line of fitness products
includes a lifetime warranty on the structural frame, welded moving parts and
weight stacks, a 120-day warranty on upholstery and padded items, and a one-year
warranty on all other parts. The Nautilus and Schwinn Fitness commercial and
retail line of fitness products includes lifetime warranty on the frame and
42
structural parts, a six month to three year warranty on parts, labor,
electronics, upholstery, grips and cables, and a five year warranty on motors.
Warranty costs are estimated based on the Company's experience and are charged
to cost of sales as sales are recognized or as such estimates change.
RESEARCH AND DEVELOPMENT
Internal research and development costs are expensed as incurred and
included in cost of sales. Third party research and development costs are
expensed when the contracted work has been performed. Research and development
expense was $716,240, $1,186,216 and $2,229,242 for 1999, 2000 and 2001,
respectively.
ADVERTISING
The Company expenses all advertising costs as incurred. Advertising
expense was $27,698,564, $47,264,904, and $63,581,847 for 1999, 2000, and 2001,
respectively.
INCOME TAXES
Deferred income tax assets and liabilities are computed annually for
differences between the financial statement and tax bases of assets and
liabilities that will result in taxable or deductible amounts in the future
based on enacted tax laws and rates applicable to periods in which the
differences are expected to affect taxable income. A valuation allowance is
established when necessary to reduce deferred tax assets to the amount more
likely than not to be realized. Income tax expense is the tax payable or
refundable for the period plus or minus the change during the period in deferred
tax assets and liabilities.
STOCK-BASED COMPENSATION
The Company continues to measure compensation expense for its
stock-based employee compensation plans using the method prescribed by APB
Opinion No. 25, "Accounting for Stock Issued to Employees." The Company provides
pro forma disclosures of net income and earnings per share as if the method
prescribed by SFAS No. 123, "Accounting for Stock-Based Compensation," had been
applied in measuring compensation expense. See Note 9.
COMPREHENSIVE INCOME
Comprehensive income is defined as net income as adjusted for changes
to equity resulting from events other than net income or transactions related to
an entity's capital structure. Comprehensive income equals net income for the
years ended December 31, 1999 and 2000.
FAIR VALUE OF FINANCIAL INSTRUMENTS
The carrying amount of the Company's cash and cash equivalents,
short-term investments, trade receivables, trade payables, royalty payable to
stockholders, and accrued liabilities approximates their estimated fair values
due to the short-term maturities of those financial instruments.
RECENT ACCOUNTING PRONOUNCEMENTS
On January 1, 2001, the Company adopted Statement of Financial
Accounting Standards ("SFAS") No. 133, "Accounting for Derivative Instruments
and Hedging Activities," as amended, which
43
establishes accounting and reporting standards for derivative instruments and
hedging activities requiring that all derivatives be recognized in the balance
sheet and measured at fair value. The adoption of SFAS No. 133 did not have a
material effect on the Company's financial position, results of operations or
cash flows.
The Company adopted SFAS No. 141, "Business Combinations," effective
July 1, 2001. SFAS No. 141 requires all business combinations initiated after
June 30, 2001 to be accounted for using the purchase method of accounting.
In June 2001, the Financial Accounting Standards Board issued SFAS No.
142, "Goodwill and Other Intangible Assets." The statement requires
discontinuing the amortization of goodwill and other intangible assets with
indefinite useful lives. Instead, these assets are to be tested periodically for
impairment and written down to their fair market value as necessary. The Company
adopted the provisions of this statement effective September 20, 2001 as a
result of the Schwinn acquisition, the effect of which is to not amortize the
goodwill recorded as part of this acquisition but to annually test it for
impairment.
SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived
Assets," addresses accounting and reporting for the impairment or disposal of
long-lived assets. SFAS No. 144 supersedes SFAS No. 121, "Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of."
SFAS No. 144 establishes a single accounting model for long-lived assets to be
disposed of by sale and expands on the guidance provided by SFAS No. 121 with
respect to cash flow estimations. SFAS No. 144 becomes effective for the
Company's fiscal year beginning January 1, 2002. The Company is evaluating SFAS
No. 144 and has not yet determined the impact of adoption on its financial
position or results of operations.
RECLASSIFICATIONS
Certain amounts from 1999 and 2000 have been reclassified to conform to
the 2001 presentation.
2. OPERATING SEGMENTS
The Company's operating segments include its direct products segment
that includes all products marketed directly to consumers through a variety of
direct marketing channels. The Bowflex line of fitness equipment and the
Nautilus Sleep Systems are the principal products in the Company's direct
products segment. The other operating segment is the commercial and retail
products segment, which includes products and operations that are not direct
marketed to consumers. Products in this segment include Nautilus and Schwinn
commercial and retail fitness equipment and accessories. Accounting policies
used by the segments are the same as those disclosed in Note 1.
The following table presents information about the Company's two
operating segments (in thousands):
Commercial and
Direct Products Retail Products Total
------------------- --------------------- -----------------
YEAR ENDED DECEMBER 31, 2001
Revenues from external customers $ 292,539 $ 71,323 $ 363,862
Interest income 3,980 44 4,024
Depreciation and amortization expense 2,256 1,365 3,621
Income tax expense 36,166 2,069 38,235
Segment net income 62,908 3,675 66,583
44
Segment assets 87,264 106,640 193,904
Additions to property, plant and equipment 5,266 450 5,716
YEAR ENDED DECEMBER 31, 2000
Revenues from external customers $ 198,107 $ 25,820 $ 223,927
Interest income 3,630 2 3,632
Depreciation and amortization expense 2,068 806 2,874
Income tax expense 22,883 530 23,413
Segment net income 40,684 942 41,626
Segment assets 95,815 21,311 117,126
Additions to property, plant and equipment 8,237 525 8,762
YEAR ENDED DECEMBER 31, 1999
Revenues from external customers $ 113,004 $ 20,075 $ 133,079
Interest income 1,002 2 1,004
Depreciation and amortization expense 565 618 1,183
Income tax expense 11,084 411 11,495
Segment net income 19,715 628 20,343
Segment assets 47,753 19,557 67,310
Additions to property, plant and equipment 1,379 550 1,929
3. ACQUISITION OF SCHWINN
Effective September 20, 2001, the Company acquired the accounts
receivable, inventories, fixed assets, certain intangible assets and all assets
and liabilities of the foreign subsidiaries of the Fitness Division ("Schwinn
Fitness") of Schwinn/GT Corp. and its affiliates for a cash purchase price of
approximately $69.8 million, including acquisition costs of $ 4.2 million.
Schwinn Fitness was acquired through a bankruptcy auction in the United States
Bankruptcy Court for the District of Colorado, which auction was completed on
September 12, 2001. The Company's bid for Schwinn Fitness was submitted as part
of a $151 million bid with Pacific Cycle, LLC, which was awarded the right to
purchase Schwinn/GT Corp.'s cycling division through the Chapter 11 proceeding.
Schwinn/GT Corp. filed voluntary petitions for reorganization under Chapter 11
of the U.S. Bankruptcy Code on July 16, 2001.
The acquired assets include plant, equipment and other property used to
manufacture, assemble, distribute and sell fitness equipment, including
treadmills, upright stationary bicycles, recumbent stationary bicycles,
elliptical machines and stair-climbing machines. The Company intends to continue
to use the acquired assets for these purposes.
The purchase price for Schwinn Fitness was determined in the court
auction. The Company's bid was formulated on the basis of historical and
projected financial performance, which resulted in goodwill that has been
recorded in the Commercial/Retail segment along with the acquired assets and
liabilities. The Company financed the acquisition from cash-on-hand. In
accordance with the Asset Purchase Agreement by and among the Company and
Schwinn, the purchase price based on the formula set forth in the Asset Purchase
Agreement was finalized in January 2002.
The Company has determined that the intangible asset associated with
the Schwinn Fitness acquisition (a trademark valued at $6.8 million) has an
indefinite useful life. However, as the expected use and cash flows from the
trademark is expected to be approximately 20 years, the Company will amortize
the trademark using the straight-line method over this period. The Company will
evaluate the remaining useful life of the trademark that is being amortized each
reporting period to determine whether
45
events and circumstances warrant a revision to the remaining period of
amortization or if the asset should be tested for impairment.
The total cost of the acquisition has been allocated to the assets
acquired and liabilities assumed as follows:
Trade receivables $ 9,809,060
Inventories 18,857,474
Prepaid and other current assets 933,329
Property, plant and equipment 6,356,374
Other assets 39,479
Trademark 6,800,000
Goodwill 29,624,985
Liabilities assumed (2,577,487)
-------------
Total acquisition cost $ 69,843,214
=============
The results and operations subsequent to the date of acquisition are
included in the consolidated statements of the Company.
The unaudited pro forma financial information below for the year ended
December 31, 2001 and 2000 were prepared as if the transaction had occurred at
the beginning of the respective year (in thousands, except per share data):
YEAR ENDED DECEMBER 31,
----------------------------------
2000 2001
------------- --------------
Revenue $ 338,231 $ 429,186
Net income 49,566 66,838
Basic earnings per share 1.41 1.90
Diluted earnings per share 1.38 1.86
The unaudited pro forma financial information is not necessarily
indicative of what actual results would have been had the transaction occurred
at the beginning of the respective year, nor does it purport to indicate the
results of future operations of the Company.
4. INVENTORIES
Inventories at December 31 consisted of the following:
2000 2001
------------ ------------
Finished goods...................... $ 8,093,919 $ 34,861,800
Work in process..................... 1,160,647 1,148,066
Parts and components................ 3,398,551 9,506,341
------------ ------------
Total inventories................... $ 12,653,117 $ 45,516,207
============ =============
46
5. PROPERTY, PLANT AND EQUIPMENT
Details of property, plant and equipment are summarized as follows at
December 31:
Estimated
Useful Life
(in years) 2000 2001
----------- ------------ ------------
Land ................................. N/A $ 1,718,495 $ 1,779,795
Buildings and improvements ........... 31.5 9,636,774 11,785,435
Computer equipment ................... 2-5 5,179,365 10,088,243
Production equipment ................. 5 2,778,679 6,567,368
Furniture and fixtures ............... 5 915,040 1,463,741
Automobiles .......................... 7 53,000 348,825
------------ ------------
Total property, plant and equipment .. 20,281,353 32,033,407
Accumulated depreciation ............. (3,612,469) (6,805,277)
------------ ------------
Property, plant and equipment, net ... $ 16,668,884 $ 25,228,130
============ ============
6. OTHER ASSETS
Details of other assets are summarized as follows at December 31:
2000 2001
------------ ------------
Trademarks and patents ........................ $ 4,594,927 $ 11,394,928
Goodwill ...................................... - 29,624,985
Other assets .................................. 55,724 303,226
------------ ------------
Total other assets ......................... 4,650,651 41,323,139
Accumulated amortization ...................... (510,374) (833,565)
------------ ------------
Other assets, net .......................... $ 4,140,277 $ 40,489,574
============ ============
The goodwill is part of our commercial/retail segment.
7. ACCRUED LIABILITIES
Accrued liabilities consisted of the following at December 31:
2000 2001
------------ ------------
Accrued payroll................................ $ 3,178,847 $ 4,852,398
Accrued warranty expense....................... 447,194 2,413,267
Sales return reserve........................... 1,307,000 2,100,000
Accrued other.................................. 411,184 1,522,777
------------ ------------
Total accrued liabilities................... $ 5,344,225 $ 10,888,442
============ ============
47
8. COMMITMENTS AND CONTINGENCIES
LINES OF CREDIT
The Company has a line of credit for $10 million with a bank. The line
is secured by the Company's general assets, and interest is payable on
outstanding borrowings under the line at the bank's prime rate (4.5% at December
31, 2001). There were no outstanding borrowings on the line of credit at
December 31, 2001.
OPERATING LEASES
The Company leases its Vancouver, Washington call center facility under
an operating lease, which expires April 30, 2002. We plan to move our entire
Vancouver operation to our headquarters building in 2002.
Since December 1999, the Company has leased a distribution center in
Las Vegas, Nevada to service the Southwestern United States. This operating
lease expires November 30, 2002.
Nautilus HPS, Inc. leases trucks and trailers and other equipment used
in the Nautilus commercial business. These leases expire over various terms
through December 2002.
Leased facilities were acquired in 2001 due to the acquisition of the
Fitness Division of Schwinn/GT Corp. We lease sales and administrative office
space in various properties in Boulder, Colorado. All but one of these leases
are month-to-month with no defined future commitment. Due to the purchase of the
new 85,000 square foot facility on March 1, 2002, for $6 million, all previous
Boulder facility leases will be canceled. The only exception is the 40,000
square foot facility that carries a lease term through November 30, 2003, which
we intend to sublease through the remaining lease term once we move into the new
facility. We also lease manufacturing and distribution facilities in
Bolingbrook, Illinois, and Tyler, Texas. Additionally, we lease sales and
administrative office space in Givisiez, Switzerland and warehouse space in
Fribourg, Switzerland. These leases expire over various terms through November
30, 2003.
In addition to the acquired facilities, the Fitness Division leases, on
a month-to-month basis flexible warehouse space in multiple countries in Asia
and Europe devoted to international distribution.
In general, our properties are well maintained, adequate and suitable
for their purposes, and we believe these properties will meet our operational
needs for the foreseeable future. If we require additional warehouse or office
space, we believe we will be able to obtain such space on commercially
reasonable terms.
Rent expense under all leases was $664,922 in 1999, $473,920 in 2000,
and $937,078 in 2001.
OBLIGATIONS
Future minimum lease payments under the operating leases for the years
ending December 31 are as follows:
2002.......................................... $ 1,151,528
2003.......................................... 527,461
------------
Total minimum lease payments.................. $ 1,678,989
============
48
9. STOCK OPTIONS
The Company's stock-based compensation plan was adopted in June 1995.
The Company can issue both nonqualified stock options to the Company's officers,
directors and employees, and incentive stock options to the Company's employees.
The plan was amended in June 2000 so the Company may grant options for up to
7,958,118 shares of common stock. At December 31, 2001, 2,377,954 shares are
available for future issuance under the plan. The plan is administered by the
Company's Board of Directors which determines the terms and conditions of the
various grants awarded under these plans. Stock options granted generally have
an exercise price equal to the closing market price of the Company's stock on
the day before the date of grant, and vesting periods vary by option granted,
generally no longer than four years. If compensation cost on stock options
granted under these plans had been determined based on the fair value of the
options consistent with that described in SFAS No. 123, the Company's net income
and earnings per share would have been reduced to the pro forma amounts
indicated below for the years ended December 31, 1999, 2000 and 2001.
1999 2000 2001
-------------- -------------- --------------
Net income, as reported ..................... $ 20,342,891 $ 41,626,094 $ 66,582,664
Net income, pro forma ....................... 19,958,204 40,500,561 64,340,210
Basic earnings per share, as reported ....... $ 0.59 $ 1.18 $ 1.89
Basic earnings per share, pro forma ......... $ 0.58 $ 1.15 $ 1.83
Diluted earnings per share, as reported ..... $ 0.58 $ 1.15 $ 1.85
Diluted earnings per share, pro forma ....... $ 0.57 $ 1.13 $ 1.79
The pro forma amounts may not be indicative of the effects on reported
net income for future years due to the effect of options vesting over a period
of years and the granting of stock compensation awards in future years.
The fair value of each option grant was estimated on the date of grant
using the Black-Scholes option-pricing model with the following weighted-average
assumptions used for the grants in 1999, 2000 and 2001:
1999 2000 2001
-------------------- ------------------ -------------------
Granted option vesting All as scheduled All as scheduled All as scheduled
Dividend yield None None None
Risk-free interest rate 6.4% 5.0% 4.4%
Expected volatility 60% 51% 67%
Expected option lives 5 years 5 years 5 years
Weighted-average fair value of options
granted $2,000,003 $4,564,198 $8,128,933
A summary of the status of the Company's stock option plans as of
December 31, 1999, 2000 and 2001, and changes during the years ended on those
dates is presented below.
49
1999 2000 2001
--------------------- ------------------------- -------------------------
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
Shares Price Shares Price Shares Price
---------- ------ ---------- ----------- ---------- -----------
Outstanding at beginning of year ................ 1,858,337 $ .71 1,576,596 $ 2.67 1,694,195 $ 8.59
Granted ......................................... 572,670 5.99 805,275 12.43 691,650 19.50
Forfeited or cancelled .......................... (72,001) 3.17 (201,375) 5.98 (91,901) 16.73
Exercised ....................................... (782,410) 0.39 (486,301) 1.28 (567,563) 4.00
---------- ------ ---------- ----------- ---------- -----------
Outstanding at end of year ...................... 1,576,596 $ 2.67 1,694,195 $ 8.59 1,726,381 $ 12.79
========== ====== ========== =========== ========== ===========
Options exercisable at end of year .............. 723,945 648,507 540,345
========== ========== ==========
The following table summarizes information about stock options
outstanding as of December 31, 2001:
Options Outstanding Options Exercisable
------------------- -------------------
Average Weighted Number Weighted
Remaining Average of Average
Number Contractual Exercise Shares Exercise
RANGE OF EXERCISE PRICES Outstanding Life (Years) Price Exercisable Price
------------------------ ----------- ------------ ----- ----------- -----
$0.24 - $6.98 585,060 2.2 $ 4.51 417,442 $ 3.75
$13.56 - $13.78 691,921 3.7 13.64 102,653 13.56
$16.06 - $23.02 279,900 4.3 20.63 20,250 16.06
$24.28 - $30.42 169,500 4.7 25.01 - -
-------------------------------------------- ----------------- ------------- -------------- -------------- -------------
$0.24 - $30.42 1,726,381 3.4 $12.79 540,345 $ 6.07
================= ============= ============== ============== =============
10. INCOME TAXES
The Company realizes income tax benefits as a result of the exercise
of non-qualified stock options and the exercise and subsequent sale of certain
incentive stock options (disqualifying dispositions). For financial statement
purposes, any reduction in income tax obligations as a result of these tax
benefits is credited to common stock.
The provision for (benefit from) income taxes consists of the following
for the three years ended December 31, 2001:
1999 2000 2001
------------ ------------ ------------
Current:
Federal ..................... $ 11,634,863 $ 22,535,917 $ 34,516,381
State ....................... 345,010 732,550 1,986,224
------------ ------------ ------------
Total current .......... 11,979,873 23,268,467 36,502,605
------------ ------------ ------------
Deferred:
Federal ..................... (484,448) 144,945 1,706,171
State ....................... -- -- 26,538
------------ ------------ ------------
Total deferred ......... (484,448) 144,945 1,732,709
------------ ------------ ------------
Total Provision ............... $ 11,495,425 $ 23,413,412 $ 38,235,314
============ ============ ============
50
The components of the net deferred tax asset (liability) at December
31, 2000 and 2001 are as follows:
2000 2001
----------- -----------
Current:
Assets:
Accrued vacation ........................ $ 132,725 $ 166,249
Allowance for doubtful accounts ......... 94,742 112,005
Inventory reserve ....................... 148,959 166,239
Uniform capitalization .................. 102,882 87,886
Accrued reserves ........................ 560,927 1,128,180
Customer deposits ....................... 52,128 --
Other ................................... -- 124,975
Liabilities:
Prepaid advertising ......................... -- (210,137)
Other prepaids .............................. (142,000) (150,207)
----------- -----------
Net current deferred tax asset ................. $ 950,363 $ 1,425,190
=========== ===========
Noncurrent
Liabilities:
Depreciation ................................ (462,004) $(2,669,540)
----------- -----------
Net long-term deferred tax liability ........... $ (462,004) $(2,669,540)
=========== ===========
A reconciliation of the statutory income tax rate with the Company's
effective income tax rate is as follows:
2000 2001
------------ -----------
Federal...................................... 35.00% 35.00%
State........................................ 1.13% 1.89%
Other........................................ (.13)% (.41)%
------------ -----------
Total..................................... 36.00% 36.48%
============ ===========
11. EARNINGS PER SHARE
The per share amounts are based on the weighted average number of basic
and dilutive common equivalent shares assumed to be outstanding during the
period of computation. Net income for the calculation of both basic and diluted
earnings per share is the same for all periods.
The calculation of weighted average outstanding shares is as follows:
Average Shares
------------------------------------------------
1999 2000 2001
------------ ------------ ------------
Basic shares outstanding ................. 34,308,957 35,287,604 35,183,632
Dilutive effect of stock options ......... 876,120 709,762 782,406
------------ ------------ ------------
Diluted shares outstanding ............... 35,185,077 35,997,366 35,966,038
============ ============ ============
51
12. STOCK REPURCHASE PROGRAM
Four times during fiscal 2000, the Board of Directors authorized the
expenditure of up to $8 million to purchase shares of Direct Focus, Inc. common
stock in open market transactions. During the year ended December 31, 2000, the
Company repurchased a total of 417,531 shares of common stock in open market
transactions for an aggregate purchase price of $3.3 million. All authorizations
had expired at December 31, 2000.
Three times during fiscal 2001, the Board of Directors authorized the
expenditure of up to $20 million to purchase shares of Direct Focus, Inc. common
stock in open market transactions. In October 2001, the Board of Directors
authorized a $10 million repurchase program extending through January 31, 2002
and the remaining balance of the $20 million repurchase program was terminated.
During the year ended December 31, 2001, the Company repurchased a total of
941,759 shares of common stock in open market transactions for an aggregate
purchase price of $16.3 million.
13. STOCK SPLITS
On June 26, 2000, the Board of Directors approved a three-for-two stock
split in the form of a share dividend, payable to the Company's stockholders of
record as of July 31, 2000. Shares resulting from the split were distributed by
the transfer agent on August 14, 2000. On December 8, 2000, the Board of
Directors approved another three-for-two stock split payable to Company
stockholders of record as of January 2, 2001 with a payment date of January 15,
2001. On July 13, 2001, the Board of Directors approved another three-for-two
stock split in the form of a share dividend, payable August 13, 2001 to the
Company's stockholders of record as of August 2, 2001. All share and per-share
numbers contained herein reflect these stock splits.
14. RELATED-PARTY TRANSACTIONS
The Company incurred royalty expense under an agreement with a
stockholder of the Company of $2,815,116 in 1999, $4,837,212 in 2000, and
$6,786,211 in 2001, of which $1,481,886 and $1,885,186 was payable at December
31, 2000 and 2001, respectively. In addition to the royalty agreement, the
stockholder has separately negotiated an agreement dated June 18, 1992, when the
Company was privately held, between the stockholder and the Company's Chief
Executive Officer and a former Director of the Company, whereby the stockholder
agreed to pay each twenty percent of the royalty amount paid to him.
15. LITIGATION SETTLEMENT
On July 17, 1999, the Company reached an agreement with a competitor to
settle pending litigation. As a result of the settlement, the Company took a
one-time, after-tax charge of $2.6 million in the second quarter of fiscal 1999.
The Company made an $8 million cash payment to the competitor, of which $4
million was paid by insurance. This settlement did not affect the ongoing direct
marketing campaign for the Company's Bowflex home fitness equipment.
Additionally, in the normal course of business, the Company is a party
to various other legal claims, actions and complaints. Although it is not
possible to predict with certainty whether the Company will ultimately be
successful in any of these legal matters, or what the impact might be, the
Company believes that disposition of these matters will not have a material
adverse effect on the Company's financial position, results of operations or
cash flows.
52
16. EMPLOYEE BENEFIT PLAN
The Company adopted a 401(k) profit sharing plan in 1999 covering all
employees over the age of 18. The plan was amended in 2000 to allow for
immediate eligibility in the plan. Each participant in the 401(k) plan may
contribute up to 20% of eligible compensation during any calendar year, subject
to certain limitations. The 401(k) plan provides for Company matching
contributions of up to 50% of the first 6% of eligible contributions made by
participants who have one year of service. In addition, the Company may make
discretionary contributions. Employees are 100% vested in the matching and
discretionary contributions after four years of service. Expense for the plan
was $103,793, $134,669, and $224,806 for the years ended December 31, 1999,
2000, and 2001, respectively.
17. ACQUISITION OF STAIRMASTER
Effective February 8, 2002, the Company acquired the accounts
receivable, inventories, fixed assets, certain intangible assets and all assets
and liabilities of the foreign subsidiaries of StairMaster Sports/Medical, Inc.
("StairMaster") and its affiliates for a cash purchase price of approximately
$26.1 million, including acquisition costs. StairMaster was acquired through a
bankruptcy auction in the United States Bankruptcy Court for the Western
District of Washington, which auction was completed on January 17, 2002.
The acquired assets include property, plant, equipment and other
property used to manufacture, assemble, distribute and sell fitness equipment,
including steppers, stepmills, treadmills and exercise bicycles. The Company
intends to continue to use the acquired assets for these purposes.
The purchase price for StairMaster was determined in the court auction.
The Company's bid was formulated on the basis of historical and projected
financial performance. The Company financed the acquisition from cash-on-hand.
In accordance with the Asset Purchase Agreement by and among the Company and
StairMaster, the purchase price based on the formula set forth in the Asset
Purchase Agreement should be finalized in the second quarter of 2002.
The Company has determined that the intangible asset associated with
the StairMaster acquisition (a trademark valued at $6.2 million) has an
indefinite useful life and thus will not be amortized. The Company will evaluate
the remaining useful life of the trademark each reporting period to determine
whether events and circumstances warrant a revision to the remaining period of
amortization or if the asset should be tested for impairment.
The total cost of the acquisition has preliminarily been allocated to
the assets acquired and liabilities assumed as follows:
Trade receivables $ 8,421,618
Inventories 6,689,414
Property, plant and equipment 5,250,079
Other assets 309,887
Trademark 6,200,000
Goodwill 2,438,792
Liabilities assumed (3,252,010)
--------------
Total acquisition cost $ 26,057,780
==============
53
The unaudited pro forma financial information below for the year ended
December 31, 2001 and 2000 were prepared as if the transaction had occurred on
January 1, 2000 (in thousands, except per share data):
YEAR ENDED DECEMBER 31,
-----------------------
2000 2001
---- ----
Revenue $310,801 $433,366
Net income 43,802 41,624
Basic earnings per share 1.24 1.18
Diluted earnings per share 1.22 1.16
The unaudited pro forma financial information is not necessarily
indicative of what actual results would have been had the transaction occurred
at the beginning of the respective year, nor does it purport to indicate the
results of future operations of the Company.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
--------------------------------------------------------------------------
FINANCIAL DISCLOSURE
--------------------
None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
-------------------------------------------------------------
The information required by this item is included under the captions
"ELECTION OF DIRECTORS," "EXECUTIVE OFFICERS" and "SECTION 16(A) BENEFICIAL
OWNERSHIP REPORTING COMPLIANCE," respectively, in the Company's Proxy Statement
for its 2002 Annual Meeting of Stockholders and is incorporated herein by
reference.
ITEM 11. EXECUTIVE COMPENSATION
--------------------------------
The information required by this item is included under the caption
"EXECUTIVE COMPENSATION" in the Company's Proxy Statement for its 2002 Annual
Meeting of Stockholders and is incorporated herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
------------------------------------------------------------------------
The information required by this item is included under the caption
"SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT" in the
Company's Proxy Statement for its 2002 Annual Meeting of Stockholders and is
incorporated herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
--------------------------------------------------------
The information required by this item is included under the caption
"CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS" in the Company's Proxy
Statement for its 2002 Annual Meeting of Stockholders and is incorporated herein
by reference.
54
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
-------------------------------------------------------------------------
(A)(1) FINANCIAL STATEMENTS
See the Consolidated Financial Statements in Item 8.
(A)(2) FINANCIAL STATEMENT SCHEDULE
DIRECT FOCUS, INC.
Schedule II
Valuation and Qualifying Accounts
Three years ended December 31, 2001
(in thousands)
Balance at Charged to Balance at
Beginning Costs and End of
Description of Period Expenses Deductions Period
--------------------------------- ------------ ---------- ---------- ----------
Allowance for doubtful accounts:
1999............................. 40,000 264,727 - 304,727
2000............................. 304,727 47,552 - 352,279
2001............................. 352,279 1,711,860 - 2,064,139
Inventory reserves
1999............................. 50,000 255,951 - 305,951
2000............................. 305,951 254,128 - 560,079
2001............................. 560,079 1,060,392 - 1,620,471
Sales returns and allowances:
1999............................. 600,704 186,217 - 786,921
2000............................. 786,921 520,079 - 1,307,000
2001............................. 1,307,000 793,000 - 2,100,000
All other financial statement schedules have been omitted since they
are not required, not applicable, or the information is included in the
consolidated financial statements or notes thereto.
(A)(3) EXHIBIT INDEX
The following exhibits are filed herewith and this list is intended to
constitute the exhibit index:
EXHIBIT NO.
-----------
2.1 Asset Purchase Agreement by and between Direct Focus, Inc. and
Schwinn GT Corp., dated September 6, 2001, and purchase price
- Incorporated by reference to Exhibits 2.1 and 2.3(a) of the
Company's Form 8-K, as filed with the Securities and Exchange
Commission (the "Commission") on October 4, 2001, and Exhibits
99.1 - 99.9 of the Company's Form 8-K/A, as filed with the
Commission on December 3, 2001.
55
2.2 Asset Purchase Agreement by and between Direct Focus and
StairMaster Sports/Medical Products, Inc., dated January 17,
2002 - Incorporated by reference to Exhibit 2.1 of the
company's Form 8-K, as filed with the Commission on February
8, 2002.
2.3 Amendment to the Asset Purchase Agreement by and between
Direct Focus and StairMaster Sports/Medical Products, Inc.,
dated February 7, 2002 - Incorporated by reference to Exhibit
2.2 of the Company's Form 8-K, as filed with the Commission on
February 8, 2002.
3.1 Articles of Incorporation, as Amended - Incorporated by
reference to Exhibits 3.1, 3.2 and 3.3 of the Company's
Registration Statement on Form S-1, as filed with the
Commission on March 3, 1999.
3.2 Amendment to Articles of Incorporation - Incorporated by
reference to Exhibit 3 to the Company's Quarterly Report on
Form 10-Q for the three months ended June 30, 2000, as filed
with the Commission on August 10, 2000.
3.3 Amendment to Articles of Incorporation, dated September 25,
2000.
3.4 Amended and Restated Bylaws - Incorporated by reference to
Exhibit 3.4 of Amendment No. 2 to the Company's Registration
Statement on Form S-1, as filed with the Commission on April
30, 1999.
10.1 Direct Focus, Inc. Stock Option Plan, as amended -
Incorporated by reference to Exhibit 10.1 to the Company's
Registration Statement on Form S-1, as filed with the
Commission on March 3, 1999.
10.2 Amendment to Direct Focus, Inc. Stock Option Plan -
Incorporated by reference to Exhibit 10 to the Company's
Quarterly Report on Form 10-Q for the three months ended June
30, 2000, as filed with the Commission on August 10, 2000.
10.3 Royalty Agreement, dated as of April 9, 1988, between Bow-Flex
of America, Inc. and Tessema D. Shifferaw - Incorporated by
reference to Exhibit 10.9 of the Company's Registration
Statement on Form S-1, as filed with the Commission on March
3, 1999.
10.4 Royalty Payment Agreement, dated as of June 18, 1992, between
Tessema D. Shifferaw, Brian R. Cook and R.E. "Sandy" Wheeler -
Incorporated by reference to Exhibit 10.10 of the Company's
Registration Statement on Form S-1, as filed with the
Commission on March 3, 1999.
10.5 First Amended and Restated Merchant Agreement dated as of
January 27, 1999, between Direct Focus, Inc. and Household
Bank (SB), N.A. - Incorporated by reference to Exhibit 10.11
of the Company's Registration Statement on Form S-1, as filed
with the Commission on March 3, 1999.
10.6 Second Amended and Restated Merchant Agreement dated February
23, 2000, between Direct Focus, Inc. and Household Bank (SB),
N.A.
10.7 Trademark License Agreement by and between Pacific Direct,
LLC, Nautilus, Inc., and Schwinn Acquisition, LLC -
Incorporated by reference to Exhibit 2.1 of the Company's
Quarterly Report on Form 10-Q for the nine months ended
September 30, 2001, as filed with the Commission on November
14, 2001.
56
10.8 Business Loan Agreement, dated June 15, 2001, by and between
Direct Focus, Inc. and U.S. Bank National Association.
21 Subsidiaries of Direct Focus, Inc.
23 Consent of Deloitte & Touche LLP.
24.1 Power of Attorney for Kirkland C. Aly.
24.2 Power of Attorney for C. Rowland Hanson.
24.3 Power of Attorney for Frederick T. Hull.
24.4 Power of Attorney for Paul F. Little.
24.5 Power of Attorney for James M. Weber.
(B) REPORTS ON FORM 8-K
The following reports on Form 8-K were filed during the quarter ended
December 31, 2001:
o Form 8-K related to the acquisition of Schwinn Fitness filed on
October 4, 2001.
o Form 8-K/A related to the acquisition of Schwinn Fitness filed on
December 3, 2001.
57
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
Date: April 9, 2002 DIRECT FOCUS, INC.
By /s/ Brian R. Cook
----------------------------------
Brian R. Cook, Chairman and Chief
Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
Registrant and in the capacities indicated on April 9, 2002:
Signature Title
/s/ Brian R. Cook Chairman and Chief Executive Officer
------------------------------------ (Principal Executive Officer)
Brian R. Cook
/s/ Rod W. Rice Chief Financial Officer and Secretary
------------------------------------ (Principal Financial and Accounting
Rod W. Rice Officer)
* Director
------------------------------------
Kirkland C. Aly
* Director
------------------------------------
C. Rowland Hanson
* Director
------------------------------------
Frederick T. Hull
* Director
------------------------------------
Paul F. Little
/s/ Randal R. Potter Director
------------------------------------
Randal R. Potter
* Director
------------------------------------
James M. Weber
* By: /s/ Rod W. Rice April 9, 2002
------------------------------
Rod W. Rice
ATTORNEY-IN-FACT
58