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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, 2001
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, Washington 98684
(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, 2001: 34,916,315
Page 1 of 21
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DIRECT FOCUS, INC.
INDEX
PART I - FINANCIAL INFORMATION Page
Item 1. Financial Statements 3
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 11
Item 3. Quantitative and Qualitative Disclosures about Market Risk 19
PART II - OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K 20
Signatures 21
2
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
DIRECT FOCUS, INC.
CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
September 30, December 31,
2001 2000
------------ ------------
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 34,895,769 $ 77,181,064
Short-term investments 9,234,970 -
Trade receivables (less allowance for doubtful
accounts of: 2001, $1,294,765 and 2000,
$352,279) 19,383,886 4,941,286
Inventories 37,868,001 12,653,117
Prepaid expenses and other assets 1,751,241 591,453
Note receivable 2,739,785 -
Current deferred tax asset 740,511 950,363
------------ ------------
Total current assets 106,614,163 96,317,283
------------ ------------
PROPERTY, PLANT AND EQUIPMENT (less
accumulated depreciation of: 2001,
$5,749,323 and 2000, $3,612,469) 25,487,497 16,668,884
OTHER ASSETS (less accumulated amortization of:
2001, $689,018 and 2000, $510,374) 37,511,187 4,140,277
------------ ------------
TOTAL ASSETS $169,612,847 $117,126,444
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Trade payables $ 20,541,540 $ 12,335,776
Accrued liabilities 9,472,470 5,344,225
Income taxes payable 9,957,479 2,542,967
Royalty payable to stockholders 1,617,383 1,481,886
Customer deposits 853,219 2,092,611
------------ ------------
Total current liabilities 42,442,091 23,797,465
------------ ------------
LONG-TERM DEFERRED TAX LIABILITY 1,037,023 462,004
------------ ------------
STOCKHOLDERS' EQUITY:
Common stock - authorized, 75,000,000
shares of no par value;
Issued and outstanding, 2001:
34,901,315 shares, 2000: 4,026,320 16,812,476
35,317,771 shares
Retained earnings 122,107,413 76,054,499
------------ ------------
Total stockholders' equity 126,133,733 92,866,975
------------ ------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $169,612,847 $117,126,444
============ ============
See notes to consolidated financial statements
3
DIRECT FOCUS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
Three months ended Nine months ended
September 30, September 30,
---------------------------- ----------------------------
2001 2000 2001 2000
------------ ------------ ------------ ------------
NET SALES $ 88,701,883 $ 57,834,085 $238,566,220 $153,298,248
COST OF SALES 33,011,137 18,770,650 84,087,294 50,896,359
------------ ------------ ------------ ------------
Gross profit 55,690,746 39,063,435 154,478,926 102,401,889
------------ ------------ ------------ ------------
OPERATING EXPENSES:
Selling and marketing 25,082,161 19,054,085 70,867,246 51,270,420
General and administrative 3,726,318 2,459,320 10,342,756 6,241,623
Royalties 1,685,888 1,288,811 5,007,430 3,454,124
------------ ------------ ------------ ------------
Total operating expenses 30,494,367 22,802,216 86,217,432 60,966,167
------------ ------------ ------------ ------------
INCOME FROM OPERATIONS 25,196,379 16,261,219 68,261,494 41,435,722
------------ ------------ ------------ ------------
OTHER INCOME
Interest income 966,162 969,872 3,478,664 2,409,584
Other - net 30,657 83,866 217,490 168,897
------------ ------------ ------------ ------------
Total other income - net 996,819 1,053,738 3,696,154 2,578,481
------------ ------------ ------------ ------------
INCOME BEFORE INCOME TAXES 26,193,198 17,314,957 71,957,648 44,014,203
INCOME TAX EXPENSE 9,429,682 6,233,387 25,904,734 15,845,114
------------ ------------ ------------ ------------
NET INCOME $ 16,763,516 $ 11,081,570 $ 46,052,914 $ 28,169,089
============ ============ ============ ============
BASIC EARNINGS PER SHARE $ 0.48 $ 0.31 $ 1.31 $ 0.80
============ ============ ============ ============
DILUTED EARNINGS PER SHARE $ 0.46 $ 0.31 $ 1.28 $ 0.78
============ ============ ============ ============
Basic shares outstanding 35,209,547 35,283,269 35,268,137 35,280,281
Diluted shares outstanding 36,180,686 36,186,172 36,090,841 36,030,996
See notes to consolidated financial statements
4
DIRECT FOCUS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
Nine months ended September 30,
----------------------------
2001 2000
------------ ------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 46,052,914 $ 28,169,089
Adjustments to reconcile net income to net cash provided
by operating activities:
Depreciation and amortization 2,391,999 1,936,371
Tax benefit of exercise of nonqualified options 1,147,456 801,897
Deferred income taxes 784,871 (2,137,380)
Changes in:
Trade receivables (4,033,198) (282,210)
Inventories (6,806,039) (5,143,339)
Prepaid expenses and other current assets (247,940) (143,352)
Trade payables 6,815,367 4,453,705
Income taxes payable 7,289,086 2,035,321
Accrued liabilities and royalty payable to stockholders 3,179,994 1,711,502
Customer deposits (1,239,392) 361,159
------------ ------------
Net cash provided by operating activities 55,335,118 31,762,763
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CASH FLOWS FROM INVESTING ACTIVITIES:
Additions to property, plant and equipment (4,004,095) (7,170,418)
Proceeds from sale of property, plant and equipment - 60,000
Additions to other assets 8,195 (9,215)
Acquisition cost of Schwinn (67,466,146) -
Purchases of short term investments (24,001,776) -
Proceeds from sales and maturities of short-term investments 14,766,806 -
Issuance of note receivable (2,739,785) -
------------ ------------
Net cash used in investing activities (83,436,801) (7,119,633)
------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from exercise of stock options 2,115,994 494,911
Stock repurchase (16,299,606) (3,251,931)
------------ ------------
Net cash used in financing activities (14,183,612) (2,757,020)
------------ ------------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (42,285,295) 21,886,110
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 77,181,064 35,703,457
------------ ------------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 34,895,769 $ 57,589,567
============ ============
SUPPLEMENTAL DISCLOSURE OF INFORMATION:
Cash paid for income taxes $ 16,700,000 $ 14,907,800
SUPPLEMENTAL DISCLOSURE OF OTHER NON-CASH INVESTING ACTIVITY:
Champion purchase option paid by restricted stock $ 250,000 $ -
See notes to consolidated financial statements
5
DIRECT FOCUS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements of Direct
Focus, Inc. (the "Company") have been prepared in accordance with accounting
principles generally accepted in the United States of America and pursuant to
Securities and Exchange Commission rules and regulations. Certain information
and footnote disclosures normally included in financial statements prepared in
accordance with accounting principles generally accepted in the United States of
America 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, 2000.
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, 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.
SHORT-TERM INVESTMENTS - The Company invests from time-to-time in
short-term investments, which consist primarily of commercial paper and
corporate bonds with maturities at time of acquisition of greater than 90 days
and less than one year. These short-term investments are typically held to
maturity.
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
6
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 (see Note 2), 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.
2. ACQUISITION OF SCHWINN
Effective September 20, 2001, the Company acquired the accounts
receivable, inventories, fixed assets and the foreign subsidiaries of the
fitness equipment division ("Schwinn") of Schwinn/GT Corp. and its affiliates
for a cash purchase price of approximately $67.5 million, including acquisition
costs. Schwinn was acquired through a bankruptcy auction, completed on September
12, 2001, in the United States Bankruptcy Court for the District of Colorado.
The Company's bid for Schwinn 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 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
Schwinn, the purchase price based on the formula set forth in the asset purchase
agreement will be finalized late in the fourth quarter of 2001.
7
The total cost of the acquisition has been preliminarily allocated to
the assets acquired and liabilities assumed as follows:
Trade receivables $ 10,409,402
Inventories 18,408,845
Prepaid and other current assets 911,848
Property, plant and equipment 7,027,874
Other assets 39,479
Trademark 6,800,000
Goodwill 26,468,269
Liabilities Assumed (2,599,571)
------------
$ 67,466,146
============
The Company has determined that the intangible asset associated with
the Schwinn 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 events and circumstances warrant a revision to the
remaining period of amortization.
The unaudited pro forma financial information below for the three
months and nine months ended September 30, 2001 and 2000 were prepared as if the
transaction had occurred on January 1, 2000. The pro forma financial information
includes all operating costs including corporate allocations and income taxes
related to the Fitness Division of Schwinn/GT Corp. (in thousands, except per
share data):
THREE MONTHS ENDED SEPT. 30, NINE MONTHS ENDED SEPT. 30,
---------------------------- ----------------------------
2001 2000 2001 2000
------------ ------------ ------------ ------------
Revenue $ 108,256 $ 84,471 $ 303,890 $ 229,348
Net income 15,433 13,033 46,308 33,510
Basic earnings per share .44 .37 1.31 .95
Diluted earnings per share .43 .36 1.28 .93
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.
3. INVENTORIES
September 30, December 31,
2001 2000
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Finished goods $ 29,890,219 $ 8,093,919
Work in process 1,239,898 1,160,647
Parts and components 6,737,884 3,398,551
------------ ------------
Total $ 37,868,001 $ 12,653,117
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8
4. NOTE RECEIVABLE
In May 2001, the Company entered into a financing agreement with
Champion Performance Products ("Champion") and its primary shareholder to
provide them with a revolving credit facility and a term loan. The loan is
secured by certain assets of Champion and contains several financial covenants.
Under the terms of the agreement, Champion may borrow up to a maximum of
$3,000,000 under the revolving credit facility and a $140,000 term loan.
Interest on both notes is at the current prime rate and is payable monthly. In
return for providing the credit facilities and the issuance of $250,000 in value
of the Company's restricted stock to Champion's primary shareholder, the Company
has an option to purchase the outstanding common stock of Champion for $6
million through October 2002.
5. PROPERTY, PLANT AND EQUIPMENT
Details of property, plant and equipment are summarized as follows at
December 31:
Estimated Sept. 30, Dec. 31,
Useful Life 2001 2000
----------- ------------ ------------
(in years)
Land................................. N/A $ 2,149,258 $ 1,718,495
Buildings............................ 31.5 11,197,852 9,636,774
Computer equipment................... 2-5 9,206,876 5,179,365
Production equipment................. 5 7,076,217 2,778,679
Furniture and fixtures............... 5 1,267,641 915,040
Automobiles and trucks............... 7 338,976 53,000
------------ ------------
31,236,820 20,281,353
Less accumulated depreciation........ (5,749,323) (3,612,469)
------------ ------------
Property, plant and equipment, net... $ 25,487,497 $ 16,668,884
============ ============
6. RESEARCH AND DEVELOPMENT
Internal research and development costs are expensed as incurred. Third
party research and development costs are expensed when the contracted work has
been performed. Research and development costs are included in cost of sales.
Research and development expense was $507,000 and $225,000 for the
quarters ended September 30, 2001 and 2000. Research and development expense was
$1,406,000 and $667,000 for the first nine months of 2001 and 2000,
respectively.
7. STOCK OPTIONS
There were 514,061 options exercised at prices ranging from $.07 to
$13.56 per share during the nine months ended September 30, 2001. There were
548,650 new options at prices ranging from $13.78 to $30.42 per share granted
during the nine months ended September 30,
9
2001. There were 66,029 options cancelled at prices ranging from $6.07 to $23.02
per share during the nine months ended September 30, 2001.
8. OPERATING SEGMENTS
The following table presents information about the Company's two
operating segments (in thousands):
DIRECT COMMERCIAL & RETAIL
PRODUCTS PRODUCTS TOTAL
THREE NINE THREE NINE THREE NINE
MONTHS MONTHS MONTHS MONTHS MONTHS MONTHS
---------- ---------- ---------- ---------- ---------- ----------
PERIOD ENDED SEPTEMBER 30, 2001
Revenues from external customers $ 74,010 $ 210,529 $ 14,692 $ 28,037 $ 88,702 $ 238,566
========== ========== ========== ========== ========== ==========
Segment net income $ 15,807 $ 44,918 $ 957 $ 1,135 $ 16,764 $ 46,053
========== ========== ========== ========== ========== ==========
PERIOD ENDED SEPTEMBER 30, 2000
Revenues from external customers $ 51,143 $ 136,355 $ 6,691 $ 16,943 $ 57,834 $ 153,298
========== ========== ========== ========== ========== ==========
Segment net income $ 10,855 $ 27,974 $ 227 $ 195 $ 11,082 $ 28,169
========== ========== ========== ========== ========== ==========
9. EARNINGS PER SHARE
Basic and diluted earnings per share are reconciled as follows:
THREE MONTHS ENDED THREE MONTHS ENDED
SEPTEMBER 30, 2001 SEPTEMBER 30, 2000
------------------------------------ ------------------------------------
PER SHARE PER SHARE
INCOME SHARES AMOUNT INCOME SHARES AMOUNT
---------- ---------- ---------- ---------- ---------- ----------
Basic EPS:
Net income $16,763,516 35,209,547 $ 0.48 $11,081,570 35,283,269 $ 0.31
Effect of dilutive securities:
Stock options - 971,139 (0.02) - 902,903 0.00
---------- ---------- ---------- ---------- ---------- ----------
Diluted EPS:
Net income $16,763,516 36,180,686 $ 0.46 $11,081,570 36,186,172 $ 0.31
10
NINE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, 2001 SEPTEMBER 30, 2000
------------------------------------ ------------------------------------
PER SHARE PER SHARE
INCOME SHARES AMOUNT INCOME SHARES AMOUNT
---------- ---------- ---------- ---------- ---------- ----------
Basic EPS:
Net income $46,052,914 35,268,137 $ 1.31 $28,169,089 35,280,281 $ 0.80
Effect of dilutive securities:
Stock options - 822,704 (0.03) - 750,715 (0.02)
---------- ---------- ---------- ---------- ---------- ----------
Diluted EPS:
Net income $46,052,914 36,090,841 $ 1.28 $28,169,089 36,030,996 $ 0.78
========== ========== ========== ========== ========== ==========
10. STOCK REPURCHASE PROGRAM
In January 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. During the nine months ended September 30, 2001, the
Company repurchased a total of 941,700 shares of common stock in open market
transactions for an aggregate purchase price of $16.3 million.
In October 2001, the Board of Directors authorized the repurchase of
the Company's common stock in open-market transactions from time to time,
commencing October 16, 2001 through and including January 31, 2002, provided the
aggregate amount spent on such repurchases during this period will not exceed
$10 million. The previously authorized expenditure of $20 million, which was to
expire on October 31, 2001, was terminated by the Board of Directors.
11. STOCK SPLIT
On July 13, 2001, the Board of Directors approved a 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. This split is reflected in all
share and per share amounts in this report.
12. CONTINGENCIES
The Company is subject to litigation, claims, and assessments in the
ordinary course of business, many of which are covered in whole or in part by
insurance. Management believes that any liability resulting from such matters
will not have any material adverse effect on the Company's financial position,
results of operations or cash flows.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Certain statements contained in this Form 10-Q, including, without
limitation, statements containing the words "believes," "anticipates,"
"estimates," "intends," "expects," "projections," "should," and words of similar
import, constitute "forward-looking statements."
11
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-Q, 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 Market acceptance of our existing and future products;
o Growth management challenges, including the growth resulting from the
acquisition of the assets of Schwinn in September 2001;
o Fluctuating advertising rates;
o A decline in consumer spending due to unfavorable economic conditions;
o Government regulatory action;
o Our ability to effectively identify and negotiate any future strategic
acquisitions;
o Our ability to integrate the Schwinn business and any other acquired
businesses into our operations; and
o Unpredictable events and circumstances relating to international operations,
including our use of foreign manufacturers.
We describe certain of these and other key risk factors elsewhere in
this Form 10-Q. Readers are further cautioned not to place undue reliance on
forward-looking statements, which speak only as of the date of this Form 10-Q.
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-Q or to reflect the occurrence of unanticipated events.
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.
12
STATEMENT OF OPERATIONS DATA - THREE MONTHS ENDED SEPTEMBER 30, 2001
The following table presents certain financial data regarding our third
quarter operations in 2001 and 2000, as a percentage of total revenues:
QUARTER ENDED SEPTEMBER 30,
2001 2000
------------ ------------
STATEMENT OF OPERATIONS DATA
Net sales............................... 100.0% 100.0%
Cost of sales........................... 37.2 32.5
------------ ------------
Gross profit............................ 62.8 67.5
Operating expenses
Selling and marketing........... 28.3 32.9
General and administrative...... 4.2 4.3
Royalties....................... 1.9 2.2
------------ ------------
Total operating expenses................ 34.4 39.4
Operating income........................ 28.4 28.1
Other income............................ 1.1 1.8
------------ ------------
Income before income taxes.............. 29.5 29.9
Income tax expense...................... 10.6 10.8
------------ ------------
Net income.............................. 18.9% 19.2%
============ ============
COMPARISON OF THE QUARTERS ENDED SEPTEMBER 30, 2001 AND SEPTEMBER 30, 2000
NET SALES
Net sales grew by 53.4% to $88.7 million in the third quarter of 2001
from $57.8 million in the third quarter of 2000. Sales within our direct
products segment increased by 44.7% over prior year third quarter levels and
accounted for $74.0 million, or 83.4%, of our aggregate net sales in the
quarter. Sales within our commercial and retail products segment accounted for
$14.7 million, or 16.6%, of our net sales.
Sales growth in the third quarter of 2001 resulted from expanded direct
marketing of Bowflex and Nautilus Sleep Systems products, as well as from the
acquisition of Schwinn, which increased sales in our commercial and retail
products segment by $4.3 million. Within our direct products segment, with
respect to both our Bowflex products and our Nautilus Sleep Systems, we intend
to further expand our use of spot television commercials and infomercials during
the remainder of 2001 by increasing our presence in existing television markets
and entering new television markets. We intend to increase sales within our
commercial and retail products segment due to the Schwinn acquisition and by
developing new products and expanding our sales efforts both domestically and
internationally.
13
Notwithstanding our product diversification efforts, we anticipate that
sales of our Bowflex Power Pro will continue to account for a substantial
portion of our net sales for the foreseeable future. Any significant diminished
consumer interest in this product line would sharply reduce our net sales and
profitability. In addition, the success of each of our products depends
substantially on how consumers decide to spend their money. Unfavorable economic
conditions may depress consumer spending, especially for premium priced products
like ours.
During the third quarter of 2001, we continued to experience unusually
strong consumer demand for our Bowflex products compared to 2000. We believe
this stronger than normal growth rate will not continue in future years. Our
direct marketing business is largely dependent upon national cable television
advertising, and we found there was considerable available time and rates were
favorable in the third quarter of 2001, resulting in more time purchased and
stronger sales.
We believe sales within our commercial and retail products segment,
although stronger than the third quarter of 2000, will typically be lower in the
second and third quarters of the year than in the first and fourth 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 profit grew 42.6% to $55.7 million in the third quarter of 2001,
from $39.1 million in the same period a year ago. Our overall gross profit
margin decreased 4.7% to 62.8% in the third quarter of 2001, from 67.5% in the
third quarter of 2000, as a result of the shift of product mix due to the
acquisition of Schwinn and stronger than expected third quarter sales in the
commercial and retail segment. Our proportion of commercial and retail sales as
a percentage of total net sales increased to 16.6% from 12.3% while our
proportion of direct sales as a percentage of total sales decreased to 83.4%
from 87.7%.
The gross margin within our direct products segment was 69.6% in the
third quarter of 2001. Within our direct segment, we expect a lower percentage
gross profit margin contribution from our Nautilus Sleep Systems as we continue
our direct marketing campaign for this product. Similar to our Bowflex products,
with the anticipated future higher sales volume of Nautilus Sleep Systems, we
are starting to take advantage of overseas production and better pricing from
domestic suppliers to strengthen the margins for these products.
The decrease in gross margin within our commercial and retail products
segment to 28.7% in 2001 compared with 33.5% in 2000 for the third quarters
respectively, is due to the Schwinn acquisition and higher research and
development expenditures for the Nautilus consumer fitness products. Schwinn's
manufactured treadmill inventory was subject to purchase accounting guidelines
which require step-up basis adjustments. We stepped up the value of manufactured
finished goods inventory acquired, in accordance with accounting principles
generally accepted in the United States of America. This adjustment is to state
the value of such inventories at its net realizable value, less a margin to
allow for costs incurred to sell such inventory. This adjustment applies only to
the inventory manufactured by Schwinn for resale to
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third parties. In the fourth quarter of 2001 we expect our commercial and retail
product segment to have a lower gross margin due to purchase accounting
guidelines for Schwinn manufactured treadmill inventory.
OPERATING EXPENSES
SELLING AND MARKETING
Selling and marketing expenses grew to $25.1 million in the third
quarter of 2001 from $19.1 million in the same period a year ago, an increase of
31.6%. 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 28.3% in the third quarter of 2001 from 32.9% in the third quarter
of 2000. The decrease was a result of the higher proportion of commercial and
retail product sales due to the acquisition of Schwinn combined with the
availability of advertising time and the reduction of advertising rates as the
economy has slowed. 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:
o Continue to expand our Bowflex direct marketing campaign;
o Increase the commercial and retail segment sales as a percentage
of our overall sales; and
o Expand the direct marketing campaign for our Nautilus Sleep Systems.
GENERAL AND ADMINISTRATIVE
General and administrative expenses grew to $3.7 million in the third
quarter of 2001 from $2.5 million in the same period a year ago, an increase of
51.5%. Our direct marketing business accounted for $0.8 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 the Schwinn acquisition. As a percentage of
net sales, general and administrative expenses decreased to 4.2% in the third
quarter of 2001 from 4.3% in the same period a year ago. 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 $1.7 million in the third quarter of 2001 from
$1.3 million in the same period a year ago, an increase of 30.8%. 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 in the quarter. Our royalty expenses will increase
if sales of our Bowflex products continue to increase. In addition, the
acquisition of Schwinn will result in increased royalty expenses in future
periods.
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OTHER INCOME
In the third quarter of 2001, other income was $1.0 million compared to
$1.1 million for the same period a year ago. The decrease resulted primarily
from lower interest earned on invested cash and cash equivalents due to
considerable interest rate cuts in 2001 offsetting the effect of higher invested
cash amounts. Interest income will drop considerably in future periods due to
the lower rate environment and the use of cash to acquire Schwinn.
INCOME TAX EXPENSE
Income tax expense increased by $3.2 million for the third quarter of
2001 because of the growth in our income before taxes. 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 grew to $16.8 million in
the third quarter of 2001 from $11.1 million in the same period a year ago, an
increase of 51.3%.
STATEMENT OF OPERATIONS DATA - NINE MONTHS ENDED SEPTEMBER 30, 2001
The following table presents certain financial data regarding
operations for the first nine months of 2001 and 2000, as a percentage of total
revenues:
NINE MONTHS ENDED SEPTEMBER 30,
----------------------------
2001 2000
------------ ------------
Net sales............................... 100.0% 100.0%
Cost of sales........................... 35.2 33.2
------------ ------------
Gross profit............................ 64.8 66.8
Operating expenses
Selling and marketing........... 29.7 33.4
General and administrative...... 4.3 4.1
Royalties....................... 2.1 2.3
------------ ------------
Total operating expenses................ 36.1 39.8
Operating income........................ 28.6 27.0
Other income............................ 1.5 1.7
------------ ------------
Income before income taxes.............. 30.2 28.7
Income tax expense...................... 10.9 10.3
------------ ------------
Net income.............................. 19.3% 18.4%
============ ============
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COMPARISON OF THE NINE MONTHS ENDED SEPTEMBER 30, 2001 AND SEPTEMBER 30, 2000
NET SALES
Net sales for the first nine months of 2001 increased 55.6% to $238.6
million, from $153.3 million in the same period in 2000. Direct marketing sales
for the first nine months of 2001 increased by 54.4% to $210.5 million. Sales
within our commercial and retail business accounted for $28.0 million of our net
sales. Sales growth in the nine-month period of 2001 primarily resulted from
expanded direct marketing of our Bowflex and Nautilus Sleep System products.
GROSS PROFIT
Gross profit grew 50.9% to $154.5 million in the first nine months of
2001, from $102.4 million in the same period a year ago. Our gross profit margin
decreased by 2.0% to 64.8% in the third quarter of 2001, from 66.8% in the first
nine months of 2000, as a result of the shift of product mix due to the
acquisition of Schwinn and strong sales in the commercial and retail segment.
OPERATING EXPENSES
SELLING AND MARKETING
Selling and marketing expenses grew to $70.9 million in the first nine
months of 2001 from $51.3 million in the same period a year ago, an increase of
38.2%. This increase in selling and marketing expenses resulted primarily from
the continued expansion of our direct marketing campaign and variable costs
associated with our sales growth. As a percentage of net sales, selling and
marketing expenses decreased by 3.7% to 29.7% for the first nine months of 2001
compared to 33.4% for the same period in the prior year mainly due to the higher
proportion of commercial and retail product sales combined with the availability
of advertising time and the reduction of advertising rates as the economy has
slowed.
GENERAL AND ADMINISTRATIVE
General and administrative expenses grew to $10.3 million for the first
nine months of 2001 from $6.2 million in the same period a year ago, a 65.7%
increase. Our direct marketing business accounted for $3.4 million of the
increase through the first nine months of 2001 due primarily to increased
staffing and infrastructure expenses necessary to support our growth. Commercial
and retail operations accounted for the remaining increase of $0.7 million. As a
percentage of net sales, general and administrative expenses increased to 4.3%
for the first nine months of 2001 from 4.1% in the same period a year ago.
ROYALTY
Royalty expense grew by 45.0% to $5.0 million during the first nine
months 2001 from $3.5 million for the same period a year ago. The increase in
royalty expenses is primarily related to Bowflex product sales for 2001.
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OTHER INCOME
In the first nine months of 2001, other income increased to $3.7
million from $2.6 million over the same period a year ago, due to higher average
cash balances during the period that increased our interest income.
INCOME TAX EXPENSE
Income tax expense increased by $10.1 million for the first nine months
of 2001 due to the Company's growth in income before taxes.
NET INCOME
For the reasons discussed above, net income for the first nine months
of 2001 grew to $46.1 million from $28.2 million in the same period a year ago.
The percentage increase in net income over the first nine months of 2000 was
63.5%.
LIQUIDITY AND CAPITAL RESOURCES
Historically, we have financed our growth primarily from cash generated
by our operating activities. During the first nine months of 2001, our operating
activities generated approximately $55.3 million in net cash, which contributed
to an aggregate $34.9 million balance in cash and cash equivalents and $9.2
million of short-term investments. The cash and cash equivalent balance dropped
from $77.2 million at December 31, 2000 due primarily to the $67.5 million paid
to acquire Schwinn. We anticipate that our working capital requirements will
increase as a result of growing our commercial and retail segment through the
acquisition of Schwinn 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. 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 the first nine months of 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.
We maintain a $10 million line of credit with US Bank. The line of
credit is secured by certain assets and contains several financial covenants. As
of the date of this filing, we are in compliance with all covenants applicable
to the line of credit and there is no outstanding balance under the line.
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.
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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 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 3. 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 and Swiss Franc. Based upon the relative size of the
Company's operations in Europe, management does not believe that the reasonably
possible near-term change in the related exchange rate would have a material
effect on the Company's financial position, results of operations or cash flows.
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PART II - OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
The following exhibits are filed herewith and this list constitutes
the exhibit index.
EXHIBIT NO. DOCUMENT DESCRIPTION
2.1 Trademark License Agreement by and between Pacific
Direct, LLC., Nautilus, Inc., and Schwinn
Acquisition, LLC.
(b) Reports on Form 8-K
The Company filed a report on Form 8-K dated October 4, 2001,
reporting the acquisition of Schwinn.
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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, 2001 By: /s/ Brian R. Cook
- ----------------- ---------------------------------------
Brian R. Cook, Chief Executive Officer
November 12, 2001 By: /s/ Rod W. Rice
- ----------------- ---------------------------------------
Rod W. Rice, Chief Financial Officer,
Treasurer and Secretary (Principal Financial
and Accounting Officer)
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