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 MARCH 31, 1999
Commission file number 000-25867
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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 [ ] No [X]
Number of shares of issuer's common stock outstanding as of May 10, 1999:
10,359,599
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Page 1 of 14
Exhibit Index on Page II-1
DIRECT FOCUS, INC.
INDEX
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements 1
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 7
Item 3. Quantitative and Qualitative Disclosures About Market Risk 14
PART II - OTHER INFORMATION
Item 1. Legal Proceedings II-1
Item 2. Changes in Securities and Use of Proceeds II-1
Item 6. Exhibits and Reports on Form 8-K II-1
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
DIRECT FOCUS, INC.
CONSOLIDATED BALANCE SHEETS
March 31, December 31,
ASSETS 1999 1998
---- ----
CURRENT ASSETS:
Cash and cash equivalents $ 8,587,211 $ 18,910,675
Trade receivables (less allowance for doubtful accounts of:
1999, $573,964 and 1998, $40,000) 3,519,360 218,207
Inventories 7,696,781 2,614,673
Prepaid expenses and other current assets 213,969 378,409
Current deferred tax asset 644,504 215,737
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Total current assets 20,661,825 22,337,701
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FURNITURE AND EQUIPMENT:
Equipment 10,175,390 1,822,205
Furniture and fixtures 480,974 459,297
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10,656,364 2,281,502
Accumulated depreciation (642,647) (438,790)
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Total furniture and equipment - net 10,013,717 1,842,712
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OTHER ASSETS (Less accumulated amortization of:
1999, $104,924 and 1998, $49,967) 4,665,476 192,859
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TOTAL $ 35,341,018 $ 24,373,272
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(continued)
1
March 31, December 31,
LIABILITIES AND STOCKHOLDERS' EQUITY 1999 1998
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CURRENT LIABILITIES:
Trade payables $ 5,794,947 $ 3,602,074
Income taxes payable 2,628,225 504,775
Accrued liabilities 3,639,539 1,851,253
Royalty payable to stockholders 611,758 548,211
Customer deposits 356,656 148,937
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Total current liabilities 13,031,125 6,655,250
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LONG-TERM DEFERRED TAX LIABILITY 134,080 66,880
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STOCKHOLDERS' EQUITY:
Common stock - authorized, 50,000,000 shares of no par value;
outstanding, 1999: 9,534,599 shares, 1998: 9,448,523 shares 3,611,086 3,565,628
Retained earnings 18,564,727 14,085,514
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Total stockholders' equity 22,175,813 17,651,142
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TOTAL $35,341,018 $24,373,272
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See notes to financial statements. (Concluded)
2
DIRECT FOCUS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
Three months ended March 31,
-------------------------------
1999 1998
---- ----
NET SALES $ 26,112,530 $ 11,051,299
COST OF SALES 7,389,196 2,554,145
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Gross profit 18,723,334 8,497,154
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OPERATING EXPENSES:
Selling and marketing 10,088,754 3,813,204
General and administrative 1,101,372 526,177
Royalties 625,921 306,071
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Total operating expenses 11,816,047 4,645,452
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INCOME FROM OPERATIONS 6,907,287 3,851,702
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OTHER INCOME (EXPENSE):
Interest income 61,923 75,529
State business tax and other - net (78,114) (41,044)
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Total other income (expense) - net (16,191) 34,485
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INCOME BEFORE INCOME TAXES 6,891,096 3,886,187
INCOME TAX EXPENSE 2,411,883 1,315,158
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NET INCOME $ 4,479,213 $ 2,571,029
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BASIC EARNINGS PER SHARE $ 0.47 $ 0.28
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DILUTED EARNINGS PER SHARE $ 0.45 $ 0.27
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See notes to financial statements.
3
DIRECT FOCUS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
Three months ended March 31,
1999 1998
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 4,479,213 $ 2,571,029
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization 261,813 76,734
Deferred income taxes (361,567) 13,732
Changes in:
Trade receivables (294,263) (100,446)
Inventories (1,977,977) 226,539
Prepaid expenses and other current assets 272,646 (16,612)
Trade payables 1,924,813 776,056
Income taxes payable 2,123,450 476,426
Accrued liabilities and royalty payable to stockholder 294,608 608,412
Customer deposits 207,719 37,349
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Net cash provided by operating activities 6,930,455 4,669,219
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CASH FLOWS FROM INVESTING ACTIVITIES:
Additions to furniture and equipment (383,177) (95,937)
Acquisition cost of Nautilus (16,747,241) -
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Net cash used in investing activities (17,130,418) (95,937)
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CASH FLOWS FROM FINANCING ACTIVITIES:
Prepaid public offering cost (168,959) -
Proceeds from issuance of common stock 45,458 61,805
Principal payments under capital lease obligation - (2,420)
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Net cash provided by (used in) financing activities (123,501) 59,385
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NET INCREASE (DECREASE) IN CASH AND CASH
EQUIVALENTS (10,323,464) 4,632,667
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 18,910,675 4,790,316
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CASH AND CASH EQUIVALENTS, END OF PERIOD $ 8,587,211 $ 9,422,983
------------ ------------
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SUPPLEMENTAL DISCLOSURE OF CASH FLOW
INFORMATION:
Cash paid for interest $ - $ 203
Cash paid for income taxes 650,000 825,000
See notes to financial statements.
4
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. The results of operations for the three months ended March 31,
1999 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, Nautilus, Inc, DFI Properties,
and Nautilus Fitness Products. All intercompany transactions have been
eliminated.
2. 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 $0.7 million, for the
assets and intellectual property of Nautilus and assumed $1.8 million in
current liabilities.
The total cost of the acquisition of the Company has been allocated to the
assets acquired and liabilities assumed as follows:
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)
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Total $16,876,207
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5
The unaudited pro forma financial information below for the three months
ended March 31, 1998 were prepared as if the transaction had occurred on
January 1, 1998:
Revenue $16,322
Net income 2,117
Basic earnings per share 0.23
Diluted earnings per share 0.22
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 do they purport to indicate the
results of future operations of the Company.
3. REGISTRATION STATEMENT
Subsequent to March 31, 1999, the Company registered its shares on the
NASDAQ exchange.
4. STOCK OPTIONS
There were 86,079 options exercised at prices ranging from $.12 to $4.62
per share during the three months ended March 31, 1999. There were no new
options granted during that period.
5. 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.
The following table presents information about the Company's two operating
segments (in thousands):
6
DIRECT NAUTILUS
PRODUCTS PRODUCTS TOTAL
Quarter ended March 31, 1999:
Revenues from external customers $22,139 $ 3,974 $26,113
------- ------- -------
------- ------- -------
Segment net income (loss) $ 4,674 $ (195) $ 4,479
------- ------- -------
------- ------- -------
As of March 31, 1999 - segment assets $16,949 $18,392 $35,341
------- ------- -------
------- ------- -------
Quarter ended March 31, 1998:
Revenues from external customers $11,051 $ - $11,051
------- ------- -------
------- ------- -------
Segment net income $ 2,571 $ - $ 2,571
------- ------- -------
------- ------- -------
As of March 31, 1998 - segment assets $12,451 $ - $12,451
------- ------- -------
------- ------- -------
6. 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 50% of 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.
7. EARNINGS PER SHARE
Basic and diluted earnings per share are reconciled as follows:
MARCH 31, 1999 MARCH 31, 1998
-------------------------------------- ------------------------------------
PER SHARE PER SHARE
INCOME SHARES AMOUNT INCOME SHARES AMOUNT
Basic EPS:
Income available to common
shareholders $4,479,213 9,517,579 $ 0.47 $2,571,029 9,184,371 $ 0.28
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------- ------
Effect of dilutive securities:
Stock options - 384,458 - 463,380
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Diluted EPS:
Income available to common share-
holders plus assumed stock options $4,479,213 9,902,037 $ 0.45 $2,571,029 9,647,751 $ 0.27
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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
7
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
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 developing and testing
a direct marketing campaign for this new product. We intend to expand this
direct marketing campaign in 1999 and anticipate that this expansion will
cause our line of airbeds to generate a portion of our net sales in 1999.*
However, we expect that the gross margin for our airbed products will, at
least initially, be lower than the gross margin for our Bowflex products.*
ACQUISITION OF NAUTILUS BUSINESS
In January 1999, we acquired substantially all of the assets of Nautilus
International, Inc., the manufacturer and distributor of commercial fitness
equipment and distributor of fitness 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;
8
- 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 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 expanded financing programs, such as
pre-approved leasing;*
- We intend to develop and 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.*
We expect that the integration of the Nautilus commercial product line into
our operations will significantly increase our overall net sales.* We also
expect that our overall gross margin as a percentage of net sales will
decrease,* principally because we are integrating 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.
9
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 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.
The following table presents certain financial data regarding our first
quarter operations in 1998 and 1999 as a percentage of total revenues:
QUARTER ENDED MARCH 31,
-----------------------
1999 1998
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STATEMENT OF OPERATIONS DATA
Net sales ..................................... 100.0% 100.0%
Cost of sales ................................. 28.3 23.1
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Gross Profit .................................. 71.7 76.9
Operating expenses
Selling and marketing .............. 38.6 34.5
General and administrative ......... 4.2 4.7
Royalties .......................... 2.4 2.8
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Total operating expenses ...................... 45.2 42.0
Operating income .............................. 26.5 34.9
Other income (expense) ........................ 0 0.3
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Income before income taxes .................... 26.5 35.2
Income tax expense ............................ 9.3 11.9
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Net income .................................... 17.2% 23.3%
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COMPARISON OF THE QUARTER ENDING MARCH 31, 1999 AND MARCH 31, 1998
NET SALES
Net sales grew by 135.1% to $26.1 million in the first quarter of 1999,
from $11.1 million in the first quarter of 1998. Sales of our Bowflex products
increased by 99.1% and accounted for $22.1
10
million of our aggregate net sales in the quarter. Sales of our Nautilus
commercial products accounted for $4.0 million of our net sales, or 26.7% of
the increase. We are continuing to test market our airbed sleep systems, but
this product did not materially contribute to our net sales in the quarter.
Our sales growth in the first quarter of 1999 primarily resulted from
expanded direct marketing of our Bowflex products and our acquisition of the
Nautilus business in January 1999. We intend to further expand our use of spot
television commercials and infomercials in 1999 by increasing our market
presence in our existing television markets and entering new television
markets.*
GROSS PROFIT
Gross profit grew 120.0% to $18.7 million in the first quarter of 1999,
from $8.5 million in the same period a year ago. Gross profit as a
percentage of net sales decreased by 5.2% to 71.7% in the quarter, from 76.9%
in the first quarter of 1998. This decrease resulted from our addition of
the Nautilus commercial product line, which generated a percentage gross
profit of 32.1% during the quarter. The percentage gross profit generated by
our Bowflex products increased by 1.9% to 78.8% in the quarter, primarily due
to reduced component costs associated with volume discounts.
We anticipate an increase in the percentage gross profit on our Bowflex
products associated with the March 1999 opening of our East Coast
distribution center.* However, we expect our aggregate gross profit as a
percentage of net sales to remain below historical levels, principally due to
the significantly lower gross profit margin on our Nautilus commercial
fitness equipment.* Initially, we also expect a lower percentage gross profit
on our line of airbeds as we continue to develop the direct marketing
campaign for this product and increase our marketing efforts.*
OPERATING EXPENSES
SELLING AND MARKETING
Selling and marketing expenses grew to $10.1 million in the first
quarter of 1999 from $3.8 million in the same period a year ago, an increase
of 165.8%. This increase in selling and marketing expenses resulted primarily
from the expansion of our Bowflex direct marketing campaign and variable
costs associated with our sales growth. The addition of our Nautilus
operations accounted for $1.3 million of the increase.
As a percentage of net sales, selling and marketing expenses increased
to 38.6% in the first quarter of 1999 from 34.5% in the first quarter of
1998. The aggregate percentage in 1998 was 39.5%, which we believe is more
typical. Overall, we expect that our selling and marketing expenses will
continue to increase in real dollar terms, 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 airbeds;*
- Integrate the marketing and distribution infrastructure for our
Nautilus line of commercial fitness equipment;* and
- Begin marketing new home fitness equipment products and fitness
accessories under the Nautilus brand name.*
11
GENERAL AND ADMINISTRATIVE
General and administrative expenses grew to $1.1 million in the first
quarter of 1999 from $526,000 in the same period a year ago, an increase of
109.1%. Our direct marketing business accounted for $262,000 of the
increase, due primarily to increased staffing and infrastructure expenses
necessary to support our anticipated growth. Our Nautilus operations
accounted for the remaining increase of $312,000. As a percentage of net
sales, general and administrative expenses decreased to 4.2% in the first
quarter of 1999 from 4.7% in same period a year ago. The decline in general
and administrative expenses as a percentage of our net sales resulted
primarily from our substantial increase in net sales. We believe that our
general and administrative expenses will continue to increase in future
periods, in both real dollar terms and as a percentage of net sales, 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 $626,000 in the first quarter of 1999 from
$306,000 in the same period a year ago, an increase of 104.6%. The increase
in our royalty expenses is attributable to the increased sales of our Bowflex
products in the quarter. Our royalty expense will increase if sales of our
Bowflex products continue to increase.*
OTHER INCOME (EXPENSE)
In the first quarter of 1999, other income (expense) decreased to
$(16,000) from $35,000 in the same period a year ago. The $51,000 decrease
resulted primarily from a $51,000 increase in our state business tax expense.
INCOME TAX EXPENSE
Income tax expense increased by $1.1 million in the first quarter of
1999 because of the growth in our income before taxes. We expect our income
tax expense to increase in line with increases in our income before taxes.*
NET INCOME
For the reasons discussed above, net income grew to $4.5 million in the
first quarter of 1999 from $2.6 million in the same period a year ago, an
increase of 73.1%. Our direct marketing business generated $4.7 million in
net income and our Nautilus business lost $200,000 in the first quarter of
1999.
LIQUIDITY AND CAPITAL RESOURCES
Historically, we have financed our growth primarily from cash generated
by our operating activities. During the first quarter of 1999, our operating
activities generated over $6.9 million in net cash, which contributed to an
aggregate $8.6 million balance in cash and cash equivalents. We used $16.7
million in cash to fund the Nautilus acquisition in January 1999, which
decreased our cash and cash equivalents by $10.3 million or 54.5% in the
first quarter of 1999. We anticipate that our working capital requirements
will increase as a result of increased inventory and accounts receivable
related to
12
our Nautilus operations.* We also expect to materially increase our cash
expenditures on spot commercials and infomercials as we expand the direct
marketing campaigns for our Bowflex and airbed products.* To accomodate our
anticipated growth, we expect to open an additional West Coast distribution
center during 1999.*
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 this filing, we are in compliance
with all material covenants applicable to the line of credit, and there is no
outstanding balance under the line.
We believe that our existing cash balances, combined with our line of
credit and the $15.1 million net proceeds of our May 5, 1999, public
offering, will be sufficient to meet our capital requirements for at least
the next 12 months.* Thereafter, if our capital requirements increase, we
could be required to secure additional sources of capital. We cannot assure
you that we will be able to secure additional capital or that the terms upon
which such capital will be available to us will be acceptable. If we proceed
with any other acquisitions, we may be required to use cash to fund the
purchase price or fund operations for expansion of the acquired business.
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 over 90.0% of the software
and hardware systems that we use internally I our business. We have upgraded
approximately 95.0% of the computer hardware and equipment that we determined
had Year 2000 problems. We expect to have a Year 2000 compliance financial
accounting system and database marketing system installed by late June 1999.*
We will continue to test our software and hardware systems and modify and
replace these systems as necessary.* We expect to complete our internal
assessment, testing, and remediation
13
program by July 1999.* To date, we have spent approximately $1.3 million to
upgrade our computer systems, and we believe we will need to spend an
additional $400,000 to complete our upgrade. Although we believe that these
corrective measures will adequately address our potential Year 200 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 carrier, our primary
consumer finance provider 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, the most
important of which is our local telephone company. 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.*
We are currently developing a contingency plan, but cannot finalize the
plan until we have received responses from all of our critical vendors and
service providers. We expect to finalize the plan in July 1999.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
None.
14
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
On May 1, 1998, Soloflex, Inc., a company that manufactures and directly
markets home fitness equipment, filed an action against Direct Focus and
Randal R. Potter, our Vice President of Marketing, in the United States
District Court for the District of Oregon. The suit is titled Soloflex, Inc.
v. Bowflex, Inc. and Randy Potter, Cause No. 98-557-JO. The judge has set a
trial date of July 6, 1999, and both parties are now proceeding with
discovery. Our insurers are paying the costs of defending against these
claims.
Soloflex is pursuing two categories of claims, both of which relate to
activities that allegedly violate its intellectual property rights. First,
Soloflex claims that we violated the Lanham Act, which relates to trademark
and trade dress infringement, and infringed upon several of its copyrights.
The principal basis for these claims is Soloflex's contention that our print
and video advertisements are too similar to its advertisements. For example,
Soloflex asserts that we are prohibited from marketing our products with
advertisements that:
- Feature Mr. Potter, a former model for Soloflex;
- Feature an image of Mr. Potter removing his shirt; and
- Use phrases with the words "unlock your body's potential" or "the
body you always wanted."
Second, Soloflex claims we misappropriated certain of its marketing
trade secrets. The principal basis for this claim is Soloflex's allegation
that Mr. Potter had access to marketing knowledge and physical documents
while an employee of Soloflex, and that Mr. Potter improperly used this
knowledge and documentation to our competitive advantage. Mr. Potter joined
us in 1991 as a creative director and marketing manager. Soloflex further
alleges that we hired another Soloflex employee, who also possessed this type
of information, for the specific purpose of acquiring such information and
obtaining a competitive advantage.
Soloflex has requested both monetary damages and injunctive relief in
connection with its claims. Specifically, Soloflex is seeking to recover:
- Any profits it would have earned but for our allegedly improper
activities;
- Any profits we earned during the period when an alleged violation may
have occurred; and/or
- The cost of corrective advertising to remedy the allegedly "false
impressions" created by our advertising activities.
The injunctive relief that Soloflex is seeking would prohibit us from
airing advertisements that allegedly would infringe upon Soloflex's
intellectual property rights. We intend to vigorously defend against these
claims. However, we cannot assure you that we will prevail in this dispute.
If Soloflex successfully prosecutes any of its claims, the resulting
monetary damages and/or injunctive relief could significantly harm our
business.
We are also involved in various legal proceedings incident to the
ordinary course of our business. We believe that the outcome of these pending
legal proceedings will not, in the aggregate, have a material adverse effect
on our business.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
The effective date of the registrants first registration statement,
filed on Form S-1 under the Securities Act of 1933 (No. 333-73243) relating
to the registrant's initial United States public offering of its common
stock, was May 4, 1999. The registrant 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. The public offering resulted in gross proceeds to the
registrant and the selling shareholders of $20.5 million, $1.435 million of
which was applied toward the underwriting discount. The registrant
anticipates that expenses related to the offering will total approximately
$625,000, all of which will be borne by the registrant. Net proceeds to the
registrant and selling shareholders are anticipated to be $15.1 million and
$3.3 million, respectively. From the time of receipt through May 12, 1999,
the registrant 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
27.1 Financial Data Schedule
(n) Reports on Form 8-K
None.
II-1
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)
May 14, 1999 By: /s/ Brian R. Cook
- ------------ --------------------------
Date Brian R. Cook, President and
Chief Executive Officer
May 14, 1999 By: /s/ Rod W. Rice
- ------------ --------------------------
Date Rod W. Rice, Chief Financial Officer,
Treasurer and Secretary (Principal
Financial and Accounting Officer)
EXHIBIT INDEX
Exhibit Number Title
- -------------- ------------------------------
27.1 Financial Data Schedule
5
1,000
12-MOS
DEC-31-1999
JAN-01-1999
MAR-31-1999
8,587
0
4,093
(574)
7,697
20,682
10,656
(643)
35,341
13,031
0
0
0
3,611
18,565
35,341
26,113
26,113
7,389
7,389
11,832
0
0
6,891
2,412
4,479
0
0
0
4,479
0.47
0.45
