<PAGE>
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934 FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 1999
Commission file number: 000-25867
DIRECT FOCUS, INC.
(Exact name of registrant as specified in its charter)
Washington 94300267
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
2200 NE 65th Avenue
Vancouver, Washington 98661
(Address of principal executive offices, including zip code)
(360) 694-7722
(Issuer's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Exchange Act during the past 12 months
(or for such shorter period that the issuer was required to file such reports),
and (2) has been subject to such filing requirements for the past 90 days.
Yes [X] No [ ]
Number of shares of issuer's common stock outstanding as of November 12, 1999:
10,423,748
Page 1 of 22
Exhibit Index on Page 22
<PAGE>
DIRECT FOCUS, INC.
INDEX
<TABLE>
<CAPTION>
PART I - FINANCIAL INFORMATION Page
<S> <C>
Item 1. Financial Statements 3
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 11
PART II - OTHER INFORMATION
Item 2. Changes in Securities and Use of Proceeds 20
Item 6. Exhibits and Reports on Form 8-K
</TABLE>
<PAGE>
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
DIRECT FOCUS, INC.
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
September 30, December 31,
1999 1998
------------------ -----------------
ASSETS
<S> <C> <C>
CURRENT ASSETS:
Cash and cash equivalents $ 30,021,538 $ 18,910,675
Trade receivables (less allowance for doubtful accounts of:
1999, $268,098 and 1998, $40,000) 3,951,316 218,207
Inventories 8,825,559 2,614,673
Prepaid expenses and other assets 439,841 378,409
Current deferred income tax asset 1,104,711 215,737
------------------ -----------------
Total current assets 44,342,965 22,337,701
------------------ -----------------
PROPERTY, PLANT AND EQUIPMENT (less accumulated
depreciation of: 1999, $1,127,528 and 1998, $438,790) 10,431,126 1,842,712
------------------ -----------------
OTHER ASSETS (less accumulated amortization of:
1999, $220,838 and 1998, $49,967) 4,410,070 192,859
------------------ -----------------
TOTAL ASSETS $ 59,184,161 $ 24,373,272
------------------ -----------------
------------------ -----------------
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Trade payables $ 6,812,385 $ 3,602,074
Accrued liabilities 6,608,878 1,851,253
Income taxes payable 810,622 504,775
Royalty payable to stockholders 717,986 548,211
Customer deposits 596,046 148,937
------------------ -----------------
Total current Liabilities 15,545,917 6,655,250
------------------ -----------------
LONG-TERM DEFERRED TAX LIABILITY 118,788 66,880
------------------ -----------------
STOCKHOLDERS' EQUITY:
Common stock - authorized, 50,000,000 shares of no par value;
Outstanding, 1999: 10,423,748 shares, 1998: 9,448,523 shares 18,060,349 3,565,628
Retained earnings 25,459,107 14,085,514
------------------ -----------------
Total stockholders' equity 43,519,456 17,651,142
------------------ -----------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 59,184,161 $ 24,373,272
------------------ -----------------
------------------ -----------------
</TABLE>
See notes to financial statements.
3
<PAGE>
DIRECT FOCUS, INC.
CONSOLIDATED STATEMENT OF OPERATIONS
<TABLE>
<CAPTION>
Three months ended September 30, Nine months ended September 30,
----------------------------------- -----------------------------------
1999 1998 1999 1998
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
NET SALES $ 31,772,893 $ 15,200,261 $ 83,129,639 $ 38,488,009
COST OF SALES 8,790,565 3,434,418 23,541,777 8,640,711
------------ ------------ ------------ ------------
Gross profit 22,982,328 11,765,843 59,587,862 29,847,298
------------ ------------ ------------ ------------
EXPENSES:
Selling and marketing 13,029,343 6,456,905 33,038,869 15,799,731
General and administrative 1,124,363 520,675 3,552,143 1,745,399
Royalties 730,012 418,268 1,991,941 1,066,832
Litigation settlement - - 4,000,000 -
------------ ------------ ------------ ------------
Total operating expenses 14,883,718 7,395,848 42,582,953 18,611,962
------------ ------------ ------------ ------------
INCOME FROM OPERATIONS 8,098,610 4,369,995 17,004,909 11,235,336
------------ ------------ ------------ ------------
OTHER INCOME (EXPENSE):
Interest income 343,730 136,358 580,898 303,708
State business tax and other - net (24,379) (30,448) (122,901) (118,201)
------------ ------------ ------------ ------------
Total other income - net 319,351 105,910 457,997 185,507
------------ ------------ ------------ ------------
INCOME BEFORE INCOME TAXES 8,417,961 4,475,905 17,462,906 11,420,843
------------ ------------ ------------ ------------
INCOME TAX EXPENSE 2,922,640 1,565,990 6,089,313 3,958,388
------------ ------------ ------------ ------------
NET INCOME $ 5,495,321 $ 2,909,915 $ 11,373,593 $ 7,462,455
------------ ------------ ------------ ------------
------------ ------------ ------------ ------------
BASIC EARNINGS PER SHARE $ 0.52 $ 0.31 $ 1.13 $ 0.80
------------ ------------ ------------ ------------
------------ ------------ ------------ ------------
DILUTED EARNINGS PER SHARE $ 0.51 $ 0.30 $ 1.10 $ 0.77
------------ ------------ ------------ ------------
------------ ------------ ------------ ------------
Basic shares outstanding 10,544,572 9,295,192 10,077,190 9,295,192
Diluted shares outstanding 10,814,821 9,717,031 10,345,758 9,717,031
</TABLE>
See notes to financial statements.
4
<PAGE>
DIRECT FOCUS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
Nine months ended September 30,
-------------------------------------
1999 1998
<S> <C> <C>
Net income $ 11,373,593 $ 7,462,455
Adjustments to reconcile net income to net cash provided
by operating activities:
Depreciation and amortization 883,991 221,044
Deferred income taxes (837,066) (172,122)
Changes in:
Trade receivables (726,219) (593,393)
Inventories (3,106,755) 18,968
Prepaid expenses and other current assets 46,774 (88,790)
Trade payables 2,942,251 1,858,542
Income taxes payable 305,847 (801,128)
Accrued liabilities and royalty payable to stockholders 3,370,175 1,471,555
Customer deposits 447,109 76,657
----------------- -----------------
Net cash provided by operating activities 14,699,700 9,657,599
----------------- -----------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Additions to property, plant and equipment (1,306,849) (963,020)
Additions to other assets (29,468) -
Acquisition cost of Nautilus (16,747,241) -
----------------- -----------------
Net cash used in investing activities (18,083,558) (963,020)
CASH FLOWS FROM FINANCING ACTIVITIES:
Principal payments under capital lease obligations - (7,439)
Proceeds from public offering 17,919,146 -
Funds used for stock repurchase (3,698,793) -
Proceeds from exercise of stock options, net 274,368 186,978
----------------- -----------------
Net cash provided by financing activities 14,494,721 179,539
----------------- -----------------
NET INCREASE IN CASH AND CASH EQUIVALENTS 11,110,863 8,874,118
----------------- -----------------
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 18,910,675 4,790,316
----------------- -----------------
CASH AND CASH EQUIVALENTS, END OF PERIOD 30,021,538 13,664,434
----------------- -----------------
SUPPLEMENTAL DISCLOSURE OF CASH FLOW
INFORMATION:
Cash paid for interest 986 434
Cash paid for income taxes 6,510,000 5,165,000
</TABLE>
See notes to financial statements.
5
<PAGE>
DIRECT FOCUS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. BASIS OF PRESENTATION
The accompanying unaudited financial statements of Direct Focus, Inc.
(the "Company") have been prepared in accordance with generally
accepted accounting principles and pursuant to Securities and Exchange
Commission rules and regulations. Certain information and footnote
disclosures normally included in financial statements prepared in
accordance with generally accepted accounting principles have been
condensed or omitted pursuant to such rules and regulations. These
financial statements should be read in conjunction with the audited
financial statements and notes thereto included in the Company's annual
report for the fiscal year ended December 31, 1998.
The financial information included herein reflects all adjustments
(consisting of normal recurring adjustments) which are, in the opinion
of management, necessary for a fair presentation of the results for
interim periods presented. The results of operations for the interim
periods are not necessarily indicative of the results to be expected
for the full year.
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 Corporation, and
Nautilus Fitness Products, Inc. All intercompany transactions have been
eliminated.
2. PUBLIC OFFERING
On May 5, 1999, the Company completed its initial U.S. public offering
of common stock listed on the NASDAQ exchange. The initial offering
consisted of one million total shares at $20.50 per share, of which
825,000 shares were offered by the Company, with an additional 175,000
shares offered by selling shareholders.
On June 10, 1999 the underwriting group exercised a 150,000 share
over-allotment.
Total net proceeds realized by Direct Focus, Inc. from the offerings
were $17.9 million.
The Company was listed on the Toronto Stock Exchange from January 1993
to May 1999.
6
<PAGE>
3. ACQUISITION OF NAUTILUS
Effective January 4, 1999, the Company acquired substantially all of
the net assets of Nautilus International, Inc. ("Nautilus"). Nautilus
was a manufacturer and distributor of commercial fitness equipment and,
to a limited extent, consumer fitness equipment and accessories. The
acquisition has been accounted for under the purchase method of
accounting and, accordingly, the assets acquired, liabilities assumed,
and results of operations have been included in the accompanying
financial statements since the date of acquisition. The Company paid
approximately $16.9 million, including acquisition costs of
approximately $700,000, for the assets and intellectual property of
Nautilus and assumed $1.8 million in current liabilities.
The total cost of the acquisition has been allocated to the assets
acquired and liabilities assumed as follows:
<TABLE>
<S> <C>
Cash $ 8,512
Trade receivables 3,006,890
Inventories 3,104,131
Prepaid expenses and other current assets 108,206
Furniture and equipment 7,991,685
Other assets 4,482,068
Liabilities assumed (1,825,285)
----------------
Total $16,876,207
----------------
----------------
</TABLE>
The unaudited pro forma financial information below for the three
months and nine months ended September 30, 1998 were prepared as if the
transaction had occurred on January 1, 1998:
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, 1998 SEPTEMBER 30, 1998
------------------ ------------------
<S> <C> <C>
Revenue 19,813 53,685
Net income 2,445 6,083
Basic earnings per share 0.12 0.65
Diluted earnings per share 0.11 0.63
</TABLE>
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.
7
<PAGE>
4. 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. The Company made an $8 million cash payment to the competitor,
of which $4 million was paid by insurance.
The Company made no admission of guilt in the settlement and continues
to believe that the competitor's claims were without merit. However,
when the court denied the Company's motions to have the case dismissed
before trial, the Company was faced with a lengthy jury trial and the
possibility of a large jury verdict, including multiple damages as
allowed under federal law. Under those circumstances, the Company
determined that it was in the best interest of its shareholders to
settle the case on terms that will have no negative long-term impact on
the Company.
This settlement does not affect the ongoing direct marketing campaign
for the Company's Bowflex home fitness equipment.
5. STOCK OPTIONS
Options for 205,825 shares of the Company's common stock were exercised
at prices ranging from $.12 to $4.62 per share during the nine months
ended September 30, 1999. During the period, options for 121,600 shares
were granted to 26 employees and five directors of the Company at an
exercise price of $20.50. Options for 16,334 shares were cancelled
during the period.
6. OPERATING SEGMENTS
In June 1997, the Financial Accounting Standards Board ("FASB") issued
SFAS No. 131, DISCLOSURES ABOUT SEGMENTS OF AN ENTERPRISE AND RELATED
INFORMATION, which establishes standards for reporting information
regarding an entity's operating activities. SFAS No. 131 requires that
operating segments be defined at the same level and in a similar manner
as management evaluates operating performance.
8
<PAGE>
The following table presents information about the Company's two
operating segments (in thousands):
<TABLE>
<CAPTION>
DIRECT PRODUCTS NAUTILUS TOTAL
PRODUCTS
THREE NINE THREE NINE THREE NINE
MONTHS MONTHS MONTHS MONTHS MONTHS MONTHS
---------- ------------- --------- ------------- ---------- ------------
<S> <C> <C> <C> <C> <C> <C>
PERIOD ENDED SEPTEMBER 30, 1999
Revenues from external customers $26,416 $70,092 $5,357 $13,038 $31,773 $83,130
---------- ------------- --------- ------------- ---------- ------------
---------- ------------- --------- ------------- ---------- ------------
Segment net income (loss) $5,279 $11,511 $216 $(137) $5,495 $11,374
---------- ------------- --------- ------------- ---------- ------------
---------- ------------- --------- ------------- ---------- ------------
As of September 30, 1999 - Segment assets $39,755 $19,429 $59,184
-------- -------- -------
-------- -------- -------
PERIOD ENDED SEPTEMBER 30, 1998
Revenues from external customers $15,200 $38,488 - - $15,200 $38,488
---------- ------------- --------- ------------- ---------- ------------
---------- ------------- --------- ------------- ---------- ------------
Segment net income $2,910 $7,462 - - $2,910 $7,462
---------- ------------- --------- ------------- ---------- ------------
---------- ------------- --------- ------------- ---------- ------------
As of September 30, 1998 - Segment assets $18,379 - $18,379
------------ ------------- ------------
------------ ------------- ------------
</TABLE>
7. EMPLOYEE BENEFIT PLAN
The Company adopted a 401(k) profit sharing Plan in 1999 covering all
employees over the age of 18, who also have three months of service.
Each participant in the 401(k) Plan may contribute up to 15% of
eligible compensation during any calendar year, subject to certain
limitations. The 401(k) Plan provides for Company matching
contributions of up to 50% for eligible contributions for 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. The
Company has not yet contributed to the Plan.
9
<PAGE>
8. EARNINGS PER SHARE
Basic and diluted earnings per share are reconciled as follows:
<TABLE>
<CAPTION>
THREE MONTHS ENDED SEPTEMBER 30, THREE MONTHS ENDED SEPTEMBER 30,
1999 1998
----------------------------------------- ---------------------------------------
PER SHARE PER SHARE
INCOME SHARES AMOUNT INCOME SHARES AMOUNT
------ ------ ------ ------ ------ ------
<S> <C> <C> <C> <C> <C> <C>
Basic EPS:
Income available to common
Shareholders $5,495,321 10,544,572 $0.52 $2,909,915 9,295,192 $0.31
---------- ----------
Effect of dilutive securities: ---------- ----------
Stock options - 270,249 - 421,839
------------ ------------- ------------- -----------
Diluted EPS:
Income available to common share-
holders plus assumed stock options $ 10,814,821 $0.51 $ 9,717,031 0.30
------------ ------------- ----------- ------------- ----------- ----------
------------ ------------- ----------- ------------- ----------- ----------
<CAPTION>
NINE MONTHS ENDED SEPTEMBER 30, 1999 NINE MONTHS ENDED SEPTEMBER 30, 1998
----------------------------------------- ---------------------------------------
PER SHARE PER SHARE
INCOME SHARES AMOUNT INCOME SHARES AMOUNT
------ ------ ------ ------ ------ ------
<S> <C> <C> <C> <C> <C> <C>
Basic EPS:
Income available to common
shareholders $11,373,593 10,077,190 $1.13 $7,462,455 9,295,192 $0.80
----------- ----------
----------- ----------
Effect of dilutive securities:
Stock options - 268,568 - 421,839
------------ ------------- ------------- ----------
Diluted EPS:
Income available to common share-
holders plus assumed stock options $ 10,345,758 $1.10 $ 9,717,031 $0.77
------------ ------------- ----------- ------------- ----------- ----------
------------ ------------- ----------- ------------- ----------- ----------
</TABLE>
9. STOCK REPURCHASE PROGRAM
In the third quarter, the Board of Directors authorized expenditure
of up to $8 million to purchase shares of Direct Focus common stock
in open-market transactions until December 31, 1999. During the third
quarter, the Company bought back $3.7 million, or 211,200 shares in
the open market.
10
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Statements in this Form 10-Q that Direct Focus considers to be
forward-looking are denoted with an asterisk ("*"), and the following cautionary
language applies to all such statements, as well as any other statements in this
Form 10-Q that the reader may consider to be forward-looking. 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. Direct Focus, from time to time, may make
forward-looking statements relating to its financial performance, including the
following:
- Anticipated revenues, expenses and gross margins;
- Anticipated earnings;
- New product introductions; and
- Future capital expenditures.
Factors that could affect our actual results include our reliance on a
limited product line, market acceptance of our existing and future products,
growth management challenges and difficulties integrating our Nautilus
operations. A more detailed description of certain factors that could affect
actual results include, but are not limited to, those discussed in our recent
registration statement on Form S-1, Registration No. 33-73243, in the section
entitled "Risk Factors."
OVERVIEW
HISTORY OF OPERATIONS
We have generated substantial increases in net sales each year since
1996. Net sales increased from $8.5 million in 1996 to $19.9 million in 1997 and
$57.3 million in 1998. A substantial portion of our net sales growth is
attributable to our Bowflex Power Pro home fitness products. We believe this
growth resulted from our expanded direct marketing campaign for our Bowflex
product line and our ability to quickly provide "zero down" financing for our
customers through third-party financing sources. Sales of our Bowflex Power Pro
represented 90.2%, 91.3% and 93.3%, respectively, of our total net sales during
1996, 1997 and 1998. We expect that sales of our Bowflex Power Pro will continue
to account for a substantial portion of our net sales for the foreseeable
future.*
We expanded our product base in late 1998 by introducing a line of
airbeds under the trade name "Instant Comfort," and more recently under the
trade name "Nautilus Sleep Systems." We are currently refining and testing a
direct marketing campaign for this new product. We are expanding this direct
marketing campaign in the fourth quarter 1999 and anticipate that this expansion
will cause our line of airbeds to generate a material portion of our net sales
in 1999.* However, we expect that the gross margin for our airbed products will
be lower than the current gross margin for our Bowflex products.*
ACQUISITION OF NAUTILUS BUSINESS
In January 1999, we acquired substantially all of the assets of
Nautilus International, a manufacturer and distributor of commercial fitness
equipment and distributor of fitness
11
<PAGE>
accessories. We paid $16.2 million in cash and assumed approximately $1.8
million in liabilities as consideration for these assets, which include the
following:
- All intellectual property rights to the Nautilus name and its
products;
- Warehouse, manufacturing and office facilities in
Independence, Virginia;
- The Nautilus line of commercial fitness equipment;
- The Nautilus line of consumer fitness equipment and fitness
accessories;
- The Nautilus distribution system; and
- All working capital, except cash and finance receivables.
In recent years, Nautilus International suffered from declining
revenues and significant losses. During the fiscal year ended June 27, 1998,
Nautilus International had a net loss of $14.8 million, of which $8.8 million
was attributable to a one-time impairment charge, on net sales of $20.9 million,
compared to a net loss of $6.8 million on net sales of $21.9 million during the
fiscal year ended June 27, 1997. We have identified and begun to implement a
number of initiatives that we believe will continue to effectively integrate
Nautilus into our operations and revitalize its commercial business.* These
initiatives include the following:
- We have hired an experienced management team to oversee and
revitalize the sales and marketing operations of our Nautilus
commercial business;
- We are currently offering creative financing programs, such as
pre-approved leasing;
- We are developing and intend to introduce additional Nautilus
commercial products to serve new market segments and expand
our customer base;*
- We have restructured the management of our Nautilus commercial
manufacturing operations and begun to make other necessary
manufacturing improvements;
- We have implemented and intend to continue to implement
general cost-cutting measures;*
- We are using the excess capacity of our Nautilus warehouse
facilities as an East Coast distribution center for our
Bowflex products; and
- We are working to improve the data gathering and analytical
capabilities of our Nautilus commercial operations by linking
them with our sophisticated management information systems.*
Integration of the Nautilus commercial product line into our operations
has significantly increased our overall net sales. However, our overall gross
profit margin as a percentage of net sales has decreased, principally because we
have integrated two different business models:
- A direct marketing business that historically has generated a
high percentage gross margin; and
- A manufacturing and marketing business that operates in an
industry that traditionally generates a lower percentage gross
margin.
RESULTS OF OPERATIONS
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
12
<PAGE>
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.
STATEMENT OF OPERATIONS DATA - THREE MONTHS ENDED SEPTEMBER 30
The following table presents certain financial data regarding our third
quarter operations in 1999 and 1998, as a percentage of total revenues:
<TABLE>
<CAPTION>
QUARTER ENDED SEPTEMBER 30,
---------------------------
1999 1998
<S> <C> <C>
Net sales ......................... 100.0% 100.0%
Cost of sales ..................... 27.7 22.6
------ ------
Gross profit ...................... 72.3 77.4
Operating expenses
Selling and marketing .... 41.0 42.5
General and administrative 3.5 3.4
Royalties ................ 2.3 2.8
Litigation settlement .... - -
------ ------
Total operating expenses .......... 46.8 48.7
Operating income .................. 25.5 28.7
Other income ...................... 1.0 0.7
------ ------
Income before income taxes ........ 26.5 29.4
Income tax expense ................ 9.2 10.3
------ ------
Net income ........................ 17.3% 19.1%
------ ------
------ ------
</TABLE>
COMPARISON OF THE QUARTERS ENDED SEPTEMBER 30, 1999 AND SEPTEMBER 30, 1998
NET SALES
Net sales grew by 109.2% to $31.8 million in the third quarter of 1999
from $15.2 million in the third quarter of 1998. Sales within our direct
marketing business increased by 73.7% over prior year third quarter levels and
accounted for $26.4 million of our aggregate net sales in the third quarter of
1999. Net sales within our Nautilus business generated $5.4 million, or 35.5%,
of the increase.
Sales growth in the third quarter of 1999 primarily resulted from
expanded direct marketing of our Bowflex products and the addition of our
Nautilus business. In the direct marketing business, we intend to further expand
our use of spot television commercials and infomercials during the remainder of
1999 by increasing our presence in existing television markets and entering new
television markets.* We intend to increase Nautilus sales by
13
<PAGE>
developing new products, expanding creative financing programs, and expanding
our direct sales efforts.* We are continuing to refine our marketing for the
Nautilus sleep systems, but this product did not materially contribute to our
net sales in the third quarter.
Third quarter sales of our Bowflex product line appear to have been
consistent with the historical trend of stronger sales in the second half of
the year.* Sales within our Nautilus business appear to be strongest in the
first and fourth quarters of each year, as the commercial fitness industry
prepares for the impact of the public's New Year fitness resolutions.*
GROSS PROFIT
Gross profit grew 94.9% to $23.0 million in the third quarter of 1999,
from $11.8 million in the same period a year ago. Our gross profit margin
decreased 5.1% to 72.3% in the third quarter of 1999, from 77.4% in the third
quarter of 1998. The decrease in gross profit margin was mainly attributable to
the Nautilus operations, which had a gross profit margin for the quarter of
40.5%.
We expect a lower percentage gross profit margin contribution from our
line of Nautilus sleep systems as we continue our direct marketing campaign for
this product.* At least initially, we expect that the domestic production and
relatively lower sales volume of our Nautilus sleep systems will result in lower
gross profit margins than our Bowflex products.* Similar to our Bowflex
products, with the anticipated future higher sales volume of Nautilus sleep
systems, we expect to take advantage of overseas production to strengthen the
margins for our Nautilus sleep systems.*
OPERATING EXPENSES
SELLING AND MARKETING
Selling and marketing expenses grew to $13.0 million in the third
quarter of 1999 from $6.5 million in the same period a year ago, an increase of
100.0%. This increase in selling and marketing expenses resulted primarily from
the continued expansion of our Bowflex direct marketing campaign and variable
costs associated with our sales growth. The addition of our Nautilus business
accounted for $1.5 million of the increase.
As a percentage of net sales, selling and marketing expenses decreased
by 1.5% in the third quarter of 1999 to 41.0%, compared to 42.5% in the same
period in the prior year. Selling and marketing expenses within our direct
marketing business were $11.6 million, a 1.3% increase as a percentage of net
sales compared to the same period in the prior year. Selling and marketing
expenses within our Nautilus business traditionally have been a lower percentage
of net sales than we have experienced in direct marketing. In real dollar terms,
we expect that our aggregate selling and marketing expenses will continue to
increase, but not materially as a percentage of net sales,* as we:
- Continue to expand our Bowflex direct marketing campaign;*
- Expand the direct marketing campaign for our Nautilus sleep
systems;*
- Integrate the marketing and distribution infrastructure for
our Nautilus line of commercial fitness equipment;* and
14
<PAGE>
- Begin marketing new home fitness equipment products and
fitness accessories under the Nautilus brand name.*
GENERAL AND ADMINISTRATIVE
General and administrative expenses grew to $1.1 million in the third
quarter of 1999 from $521,000 in the same period a year ago, an increase of
111.1%. The direct marketing business accounted for $230,000 of the increase in
general and administrative expenses, due primarily to increased staffing levels
in our accounting and information systems departments necessitated by our
continued growth and the implementation of our new computer system. Nautilus
operations accounted for the remaining increase of $374,000.
As a percentage of net sales, general and administrative expenses
increased to 3.5% in the third quarter of 1999 from 3.4% in the same period a
year ago. The increase in general and administrative expenses as a percentage of
net sales primarily resulted from our substantial increase in net sales. We
believe that our general and administrative expenses in real dollar terms and as
a percentage of net sales will increase in future periods as we integrate the
Nautilus business into our operations and expand our administrative staff and
other resources to manage anticipated growth.*
ROYALTY
Royalty expense grew to $730,000 in the third quarter of 1999 from
$418,000 in the same period a year ago, an increase of 74.6%. The increase in
our royalty expenses is attributable to the increased sales of our Bowflex
products in 1999. Our royalty expenses will increase if sales of our Bowflex
products continue to increase.*
OTHER INCOME
In the third quarter of 1999, other income increased to $319,000 from
$106,000 for the same period a year ago. The $213,000 increase resulted
primarily from interest income generated by higher cash investments accumulated
from a combination of year-to-date results from operations and our public
offering completed during the second quarter.
INCOME TAX EXPENSE
Income tax expense increased by $1.4 million for the third quarter of
1999 compared to the third quarter of 1998. We expect our income tax expense to
increase in line with increases of our income before taxes.*
NET INCOME
For the reasons discussed above, net income increased 89.7% to $5.5
million in the third quarter of 1999 compared to $2.9 million in the same period
in 1998.
15
<PAGE>
STATEMENT OF OPERATIONS DATA - NINE MONTHS ENDED SEPTEMBER 30
The following table presents certain financial data regarding
operations for the first nine months of 1999 and 1998, as a percentage of
total revenues:
<TABLE>
<CAPTION>
NINE MONTHS ENDED SEPTEMBER 30,
-------------------------------
1999 1998
<S> <C> <C>
Net sales ....................... 100.0% 100.0%
Cost of sales ................... 28.3 22.5
-------- --------
Gross profit .................... 71.7 77.5
Operating expenses
Selling and marketing ........ 39.7 41.0
General and administrative ... 4.3 4.5
Royalties .................... 2.4 2.8
Litigation settlement ........ 4.8 -
-------- --------
Total operating expenses ........ 51.2 48.3
Operating income ................ 20.5 29.2
Other income .................... 0.5 0.5
-------- --------
Income before income taxes ...... 21.0 29.7
Income tax expense .............. 7.3 10.3
-------- --------
Net income ...................... 13.7% 19.4%
-------- --------
-------- --------
</TABLE>
COMPARISON OF THE NINE MONTHS ENDED SEPTEMBER 30, 1999 AND SEPTEMBER 30, 1998
NET SALES
Net sales for the first nine months of 1999 increased 115.8% to $83.1
million, from $38.5 million in the same period in 1998. Direct marketing sales
for the first nine months increased by 82.1% to $70.1 million. Sales within our
Nautilus business accounted for $13.0 million of our net sales, or 33.7% of the
increase. Sales growth in the first nine months of 1999 primarily resulted from
expanded direct marketing of our Bowflex products and the addition of our
Nautilus business. We are continuing to refine our marketing for the Nautilus
sleep systems, but this product did not materially contribute to our net sales
in the first nine months of 1999.
GROSS PROFIT
Gross profit grew 100.0% to $59.6 million in the first nine months of
1999, from $29.8 million in the same period a year ago. Our gross profit margin
decreased by 5.8% to 71.7% in the first nine months of 1999, from 77.5% in the
first nine months of 1998. The decrease in
16
<PAGE>
gross profit margin was primarily attributable to the integration of our
Nautilus operations, which had a gross profit margin of 36.2% in the first nine
months of 1999. In the first nine months of the current year, we successfully
tailored our direct marketing efforts in response to seasonal fluctuations in
television viewer habits.* By appropriately emphasizing either spot or
infomercial advertising, we modestly increased the gross profit margin for our
direct marketing business to 78.3%.
OPERATING EXPENSES
SELLING AND MARKETING
Selling and marketing expenses grew to $33.0 million in the first nine
months of 1999 from $15.8 million in the same period a year ago, an increase of
108.9%. This increase in selling and marketing expenses resulted primarily from
the continued expansion of our Bowflex direct marketing campaign and variable
costs associated with our sales growth. The addition of our Nautilus operations
accounted for $3.9 million of the increase.
As a percentage of net sales, selling and marketing expenses decreased
by 1.3% to 39.7% for the first nine months of 1999 compared to 41.0% for the
same period in the prior year. As a percentage of net sales, selling and
marketing expenses for our direct marketing business increased by 0.6% to $29.2
million.
GENERAL AND ADMINISTRATIVE
General and administrative expenses grew to $3.6 million for the first
nine months of 1999 from $1.7 million in the same period a year ago, a 111.8%
increase. Our direct marketing business accounted for $800,000 of the increase
in the first nine months of the year due primarily to increased staffing levels
in our accounting and information systems departments necessitated by our
continued growth and the implementation of our new computer system. Nautilus
operations accounted for the remaining increase of $1.1 million. As a percentage
of net sales, general and administrative expenses decreased to 4.3% for the
first nine months of 1999 from 4.5% in same period a year ago. The decline in
general and administrative expenses as a percentage of net sales for the first
nine months of the year resulted from the substantial increase in net sales.
ROYALTY
Royalty expense grew by 81.8% to $2.0 million during the first nine
months of 1999 from $1.1 million for the same period a year ago. The increase in
royalty expenses is directly related to Bowflex product sales for 1999.
LITIGATION SETTLEMENT
In the second quarter of 1999, we incurred a one-time charge of $4.0
million relating to the settlement of pending litigation with a competitor in
the home fitness market. The settlement does not affect the ongoing direct
marketing campaign for our Bowflex home fitness equipment and is expected to
have no effect on results of operations in future periods.* We determined that
17
<PAGE>
it was in the best interest of our shareholders to settle the case on terms that
will have no negative long-term impact on Direct Focus.*
OTHER INCOME
In the first nine months of 1999, other income increased to $458,000
from $186,000 over the same period a year ago, due to higher average cash
balances during the period which increased our interest income.
INCOME TAX EXPENSE
Income tax expense increased by $2.1 million for the first nine months
of 1999 due to the Company's growth in income before taxes, offset by the
one-time litigation charge effected in the second quarter of $1.4 million.
NET INCOME
For the reasons discussed above, net income for the first nine months
of 1999 grew to $11.4 million ($14 million before litigation charge) from $7.5
million in the same period a year ago. The percentage increase in net income
over the first nine months of 1998 was 52.0%, an 86.7% increase prior to
litigation charge.
LIQUIDITY AND CAPITAL RESOURCES
Historically, we have financed our growth primarily from cash generated
by our operating activities. During the first nine months of 1999, our operating
activities generated $14.7 million in net cash, which contributed to an
aggregate $30.0 million in cash and cash equivalents on hand as of September 30,
1999. We used $16.7 million in cash to fund the Nautilus acquisition in January
1999. Our public offering on May 5, 1999, generated $15.1 million in cash and
the underwriters' exercise of their over-allotment option on June 10, 1999,
generated an additional $2.8 million in cash, bringing the total net offering
proceeds to $17.9 million. Through a stock repurchase program, the Company
bought back $3.7 million in common stock on the open market. These activities
contributed to an $11.1 million, or 58.8%, increase in our cash and cash
equivalents during the first nine months of 1999.
We anticipate that our working capital requirements will increase as a
result of increased inventory and accounts receivable related to our Nautilus
operations.* We also expect to increase our cash expenditures on spot
commercials and infomercials as we continue to expand the direct marketing
campaigns for our Bowflex products and Nautilus sleep systems.* In addition, on
August 4, 1999, the Board of Directors authorized the expenditure of up to $8
million to purchase shares of Direct Focus common stock in open market
transactions during the 90-day period commencing August 9, 1999. The stock
repurchase program was extended until December 31, 1999 with a remaining
expenditure balance available of $4.3 million.
We maintain one $5.0 million line of credit with Bank of America. The
line of credit is secured by our general assets and contains certain financial
covenants. As of the date of these financial statements, we are in compliance
with all material covenants applicable to the line of credit, and there is no
outstanding balance under the line.
18
<PAGE>
We believe that 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.*
YEAR 2000 COMPLIANCE
Many computer software programs, as well as hardware with embedded
software, use a two-digit date field to track and refer to any given year.
After, and in some cases prior to, January 1, 2000, these software and hardware
systems will misinterpret the year "00," which will cause them to perform faulty
calculations or shut down altogether. Notwithstanding the remedial efforts and
third-party assurances discussed below, this "Year 2000" problem may adversely
affect our operations. We believe that the most reasonably likely worst-case
scenario would involve material disruptions in such important functions as:*
- Airing our spot commercials and infomercials;
- Receiving and processing customer inquiries and orders;
- Distributing our products, and
- Processing billings and payments.
Such difficulties could result in a number of adverse consequences,
including, but not limited to, delayed or lost revenue, diversion of resources,
damage to our reputation, increased administrative and processing costs and
liability to suppliers and/or customers.* Any one or a combination of these
consequences could significantly disrupt our operations and have a material
adverse effect on our financial performance.*
Accordingly, we began assessing the scope of our potential Year 2000
exposure both internally and among our suppliers and customers in March 1998,
and started implementing remedial measures soon thereafter. To date, we have
tested and assessed the Year 2000 compliance of all the software and hardware
systems that we use internally in our business. We have upgraded approximately
all of the computer hardware and equipment that we determined had Year 2000
problems. We have spent approximately $1.9 million to upgrade our computer
systems.
Although we believe that these corrective measures will adequately
address our potential Year 2000 problems, including those affecting our Nautilus
operations, we cannot assure you that we will discover and address every Year
2000 problem or that all of our corrective measures will be effective. To the
extent that Year 2000 problems persist, we could experience the adverse
consequences described above, some or all of which could be material.*
We have received assurances from our primary freight carrier, our
primary consumer finance provider, our telephone companies and certain other key
suppliers and vendors that their businesses are Year 2000 compliant. We have
requested but have not yet received such assurances from our other suppliers and
vendors. We have and will continue to work with all of our vendors and suppliers
to resolve any potential Year 2000 problems. However, we have no direct control
over these third parties and cannot assure you that such third-party software
and hardware systems will be timely converted. The failure of certain individual
vendors or suppliers, or a combination of vendors or suppliers, to make their
systems Year 2000 compliant could have a material adverse effect on our
financial results.*
19
<PAGE>
Our Year 2000 contingency plan focuses on our key vulnerabilities over
which we exercise a certain amount of control. To protect against manufacturing
interruptions, we are accumulating a sufficient inventory of products within our
warehouses to satisfy one month of anticipated demand.* We have also acquired
back-up generators for use if we experience power failures.*
PART II - OTHER INFORMATION
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
The effective date of the Company's first registration statement, filed
on Form S-1 under the Securities Act of 1933 (No. 333-73243) relating to the
Company's initial United States public offering of its common stock, was May 4,
1999. The Company sold 825,000 shares of its common stock to the underwriting
syndicate. The managing underwriters were D.A. Davidson & Co., Inc. and First
Security Van Kasper. The offering commenced and was completed on May 5, 1999, at
a price of $20.50 per share. Selling shareholders sold an additional 175,000
shares of common stock as part of the same offering, and the Company
subsequently sold an additional 150,000 shares of common stock to the managing
underwriters upon the exercise of their overallotment option. The public
offering resulted in gross proceeds to the Company and the selling shareholders
of approximately $23.6 million, $1.7 million of which was applied toward the
underwriting discount. The Company incurred approximately $625,000 in expenses
related to the offering, none of which was borne by the selling shareholders.
Net proceeds to the Company and selling shareholders were approximately $17.9
million and $3.3 million, respectively. Through a stock repurchase program,
the Company bought back $3.7 million, or 211,200 common shares in the open
market during the third quarter of 1999. From the time of receipt through
November 10, 1999, the Company invested all of its net proceeds from the
offering in an interest bearing depository account with Bank of America,
pending application of the net proceeds in accordance with the description in
its registration statement on Form S-1.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
27. Financial Data Schedule
(b) Reports on Form 8-K
None.
20
<PAGE>
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.
DIRECT FOCUS, INC.
(Registrant)
November 12, 1999 By: /s/ Brian R. Cook
- ----------------- -----------------------------------------
Date Brian R. Cook, President and
Chief Executive Officer,
November 12, 1999 By: /s/ Rod W. Rice
- ----------------- -----------------------------------------
Date Rod W. Rice, Chief Financial Officer,
Treasurer and Secretary (Principal
Financial and Accounting Officer)
21
<PAGE>
EXHIBIT INDEX
<TABLE>
<CAPTION>
Exhibit Number Title
- -------------- ------------------------------
<S> <C>
27.1 Financial Data Schedule
</TABLE>
22
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> SEP-30-1999
<CASH> 30,022
<SECURITIES> 0
<RECEIVABLES> 4,219
<ALLOWANCES> (268)
<INVENTORY> 8,826
<CURRENT-ASSETS> 44,343
<PP&E> 11,559
<DEPRECIATION> (1,128)
<TOTAL-ASSETS> 59,184
<CURRENT-LIABILITIES> 15,546
<BONDS> 0
0
0
<COMMON> 18,060
<OTHER-SE> 25,459
<TOTAL-LIABILITY-AND-EQUITY> 59,184
<SALES> 83,130
<TOTAL-REVENUES> 83,130
<CGS> 23,542
<TOTAL-COSTS> 23,542
<OTHER-EXPENSES> 42,125
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> 17,463
<INCOME-TAX> 6,089
<INCOME-CONTINUING> 11,374
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 11,374
<EPS-BASIC> 1.13
<EPS-DILUTED> 1.10
</TABLE>
