WASHINGTON 94-3002667
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
|
Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K, or any amendment to this Form 10-K. [ ]
Indicate by check mark whether the Registrant is an accelerated filer (as defined in Rule 12b-2 of the Securities Exchange Act of 1934). Yes [ X ] No [ ]
The aggregate market value of the voting stock held by non-affiliates, computed by reference to the last sales price ($30.60) as reported on the New York Stock Exchange, as of the last business day of the Registrant's most recently completed second fiscal quarter (June 28, 2002) was $955,486,958.
The number of shares outstanding of the Registrant's Common Stock as of March 1, 2003 was 32,528,850 shares.
The Registrant has incorporated by reference into Part III of this Form 10-K portions of its Proxy Statement for its 2003 Annual Meeting of Stockholders.
Item 4. Submission of Matters to a Vote of Security Holders 23
Item 5. Market for Registrant's Common Equity and Related
Stockholder Matters 23
Item 6. Selected Consolidated Financial Data 23
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations 25
Item 7A. Quantitative and Qualitative Disclosures About Market Risk 37
Item 8. Consolidated Financial Statements and Supplementary Data 37
Item 9. Changes in and Disagreements With Accountants on Accounting and
Financial Disclosure 59
Item 10. Directors and Executive Officers of the Registrant 59
Item 11. Executive Compensation 59
Item 12. Security Ownership of Certain Beneficial Owners and
Management and Related Stockholder Matters 59
Item 13. Certain Relationships and Related Transactions 59
Item 14. Controls and Procedures 59
Item 15. Exhibits, Financial Statement Schedules, and
Reports on Form 8-K 60
Signatures 63
Certifications 64
FORWARD-LOOKING STATEMENTS
CERTAIN STATEMENTS CONTAINED IN THIS ANNUAL REPORT ON FORM 10-K, INCLUDING, WITHOUT LIMITATION, STATEMENTS CONTAINING THE WORDS "COULD," "MAY," "WILL," "SHOULD," "PLAN," "BELIEVES," "ANTICIPATES," "ESTIMATES," "PREDICTS," "EXPECTS," "PROJECTIONS," "POTENTIAL," "CONTINUE," AND WORDS OF SIMILAR IMPORT, CONSTITUTE "FORWARD-LOOKING STATEMENTS." INVESTORS ARE CAUTIONED THAT ALL FORWARD-LOOKING STATEMENTS INVOLVE RISKS AND UNCERTAINTIES AND VARIOUS FACTORS COULD CAUSE ACTUAL RESULTS TO DIFFER MATERIALLY FROM THOSE IN THE FORWARD-LOOKING STATEMENTS. FROM TIME TO TIME AND IN THIS FORM 10-K, WE MAY MAKE FORWARD-LOOKING STATEMENTS RELATING TO OUR FINANCIAL PERFORMANCE, INCLUDING THE FOLLOWING:
o ANTICIPATED REVENUES, EXPENSES AND GROSS MARGINS;
o SEASONAL PATTERNS;
o EXPENSE AS A PERCENTAGE OF REVENUE;
o ANTICIPATED EARNINGS;
o NEW PRODUCT INTRODUCTIONS; AND
o FUTURE CAPITAL EXPENDITURES.
NUMEROUS FACTORS COULD AFFECT OUR ACTUAL RESULTS, INCLUDING THE FOLLOWING:
o THE AVAILABILITY OF MEDIA TIME AND FLUCTUATING ADVERTISING RATES;
o A DECLINE IN CONSUMER SPENDING DUE TO UNFAVORABLE ECONOMIC CONDITIONS;
o EXPIRATION OF IMPORTANT PATENTS;
o OUR RELIANCE ON A LIMITED PRODUCT LINE;
o OUR ABILITY TO EFFECTIVELY DEVELOP, MARKET AND SELL FUTURE PRODUCTS;
o GROWTH MANAGEMENT CHALLENGES, INCLUDING THE GROWTH RESULTING FROM THE
ACQUISITION OF THE ASSETS OF THE FITNESS DIVISION OF SCHWINN/GT CORP.
("SCHWINN FITNESS") IN SEPTEMBER 2001 AND THE ACQUISITION OF THE ASSETS
OF STAIRMASTER SPORTS/MEDICAL, INC. ("STAIRMASTER") IN FEBRUARY 2002;
o OUR ABILITY TO ADEQUATELY PROTECT OUR INTELLECTUAL PROPERTY;
o OUR ABILITY TO INTEGRATE ANY ACQUIRED BUSINESSES INTO OUR OPERATIONS;
o OUR RELIANCE ON THE CONSUMER FINANCE MARKET;
o OUR RELIANCE ON THIRD-PARTY MANUFACTURERS;
o GOVERNMENT REGULATORY ACTION; AND
o CHANGES IN FOREIGN CONDITIONS THAT COULD IMPAIR OUR INTERNATIONAL SALES.
WE DESCRIBE CERTAIN OF THESE AND OTHER KEY RISK FACTORS ELSEWHERE IN MORE DETAIL IN THIS FORM 10-K. ALTHOUGH WE BELIEVE THE EXPECTATIONS REFLECTED IN THE FORWARD-LOOKING STATEMENTS ARE REASONABLE, WE CANNOT GUARANTEE FUTURE RESULTS, LEVELS OF ACTIVITY, PERFORMANCE, OR ACHIEVEMENTS. WE UNDERTAKE NO OBLIGATION TO UPDATE PUBLICLY ANY FORWARD-LOOKING STATEMENTS TO REFLECT NEW INFORMATION, EVENTS, OR CIRCUMSTANCES AFTER THE DATE OF THIS FORM 10-K OR TO REFLECT THE OCCURRENCE OF UNANTICIPATED EVENTS.
The Nautilus Group, Inc. is a leading marketer, developer and manufacturer of branded health and fitness products sold under such well-known names as Nautilus, Bowflex, Schwinn, StairMaster and Trimline. We market and sell our Bowflex and Nautilus Sleep Systems products through our direct-marketing channel utilizing an effective combination of television commercials, infomercials, response mailings, the Internet, and inbound/outbound call centers. We market and sell our Nautilus, Schwinn, and StairMaster commercial fitness equipment through our sales force and selected dealers to health clubs, government agencies, hotels, corporate fitness centers, colleges, universities and assisted living facilities worldwide. We also market a comprehensive line of consumer fitness equipment sold under the Nautilus, Schwinn, StairMaster, and Trimline brands, through a network of specialty and sporting goods dealers, distributors and retailers worldwide.
We have experienced rapid growth, with sales increasing from $63.2 million in 1998 to $584.6 million in 2002, representing a compound annual growth rate of approximately 74%. This increase was largely the result of organic growth in the sales of existing Nautilus and Bowflex product lines, and expanded sales through extensions of existing product lines in new channels and the acquisition of Schwinn Fitness and StairMaster. We have grown net income from $12.5 million in 1998 to $97.9 million in 2002, representing a compound annual growth rate of approximately 67%.
Our success to-date, based on sales growth, profitability and cash flow, has been driven primarily by the expansion of our Bowflex product line in the direct-to-consumer distribution channel. We believe that we have been able to capture premium price points as a result of our high quality, innovative products and direct sales to end customers. We intend to continue driving our growth through our ability to identify, fulfill and increase customer demand for fitness and healthy lifestyle products.
Through our extensive experience in direct marketing fitness and healthy lifestyle products to consumers, we have developed a creative and highly disciplined sales and marketing process. Over the past 10 years, we have spent approximately $250 million in television advertising for our direct products. Core to our strategy is the continuous improvement of our direct marketing process by challenging and refining all aspects of our marketing and selling cycle. This improvement has been accomplished in large part by our ability to gain relatively instantaneous customer feedback from our advertisements. All customer inquiries are carefully managed through our state-of-the-art inbound and outbound call center utilizing customized database applications. As a result, we have been able to predict with a historically high degree of accuracy the inquiries of our marketing programs and their subsequent conversion into sales. This highly refined marketing approach, combined with our media purchasing power, has created an effective and cost efficient means for stimulating consumer demand.
Our success has been enhanced by our continuing expansion into the commercial
and retail channels of the fitness industry. To expand sales and market share in
these channels, we acquired substantially all of the assets of three companies:
Nautilus International, Inc. ("Nautilus") in January 1999, the Fitness Division
of Schwinn/GT Corp. and its affiliates ("Schwinn Fitness") in September 2001 and
StairMaster Sports/Medical, Inc. ("StairMaster") in February 2002. These
acquisitions have enabled us to considerably expand our portfolio of leading
brands, product lines, channels of distribution, product development
capabilities and the size of our customer base. Through our purchase of Schwinn
Fitness and StairMaster, we believe that we have made significant progress in
diversifying our product line and expanding our presence internationally. We now
offer a comprehensive line of cardiovascular and weight resistance products in
the retail and commercial fitness industry. Our retail and commercial product
lines include home gyms, free weight equipment, treadmills, indoor cycling
equipment, steppers, ellipticals, and fitness accessories. As a result of our
We believe that our Company possesses distinct competitive advantages as we build toward our goal of being a complete provider of products to the health and fitness industry. We have developed and acquired a portfolio of highly recognized and trusted fitness brands. These brands are utilized, in concert with focused product development, to meet the differing customer demands of each distribution channel: direct, commercial and retail. In addition, we have realized and believe that we will continue to achieve significant synergies by leveraging our brands, marketing resources, and research and development capabilities across all three distribution channels. We believe the health and fitness industry's fragmentation of manufacturers and distribution channels lends itself to the execution of this strategy.
For a discussion of financial information about our two business segments, direct and commercial/retail, see Note 2 of the Notes to Consolidated Financial Statements.
The Nautilus Group was incorporated in California in 1986 and became a Washington corporation in 1993. On May 21, 2002, the Company changed its corporate name to The Nautilus Group, Inc. from Direct Focus, Inc. Concurrent with the name change, trading of the Company's shares were moved from the NASDAQ National Market to the New York Stock Exchange with a new ticker symbol (NLS).
Our principal executive offices are located at 1400 NE 136th Avenue, Vancouver, Washington 98684, and our telephone number is (360) 694-7722. We maintain our corporate web site at www.nautilusgroup.com. None of the information on this web site or our other web sites is part of this Form 10-K. On our website, we make available, free of charge, printable copies of our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act as soon as reasonably practicable after such material is electronically filed with or furnished to the Securities and Exchange Commission ("SEC").
As used in this Form 10-K, the terms "we," "our," "us," "Nautilus Group" and "Company" refer to The Nautilus Group, Inc. and its subsidiaries. The names Nautilus(R), Bowflex(R), Power Rod(R), TreadClimber(TM), Schwinn(R) (fitness products), StairMaster(R) and Trimline(R) are trademarks of the Company.
The consolidated financial statements of the Company include The Nautilus Group, Inc. and its wholly owned subsidiaries (collectively the "Company"). All intercompany transactions have been eliminated in the preparation of the consolidated financial statements.
LONG-TERM STRATEGY
Our long-term strategy is to build a complete health and fitness company offering high quality, premium-branded products enabling health conscious consumers to maintain active lifestyles. We intend to do this by:
o Utilizing our positioning and capabilities in the direct marketing
channel to launch new, innovative products;
o Capitalizing on the synergy and growth opportunities from acquisitions;
o Continuing to capture premium price points and accelerate demand by
researching and developing high quality, branded products that meet
the needs of our customers and retailers; and
o Expanding our international opportunities by leveraging our branded
products through our recently acquired network of international
operations and distributors.
CONSUMER TRENDS
We believe that our organic growth has benefited from a number of demographic and market trends that we expect will continue, including:
o Growing global consumer awareness of positive benefits of good nutrition
and fitness;
o Expanding media attention worldwide on health and fitness;
o An aging population that is maintaining a more active lifestyle;
o Continued attention to appearance and weight by consumers, which is
expected to increase as the "baby-boomers" pass through their 40's,
50's, and 60's;
o High healthcare costs that are focusing more attention on preventative
practices like exercise leading to an increase in the number of
corporate fitness programs and wellness centers;
o Growing rate of obesity which, according to the US Centers for Disease
Control and Prevention, has increased by 74% among US adults since
1991;
o Government financial support for health and fitness programs intended
to combat the growing obesity crisis in the United States;
o Expansion of the market for sophisticated high-quality fitness
equipment due to consumers' continued demand for higher levels of
efficiency in their workout regimes; and
o The continued growth of direct to consumer marketing, which is
estimated to have exceeded $1.0 trillion in annual sales in the United
States in 2002.
We believe these consumer trends bode well for our future growth prospects. Just as the "baby boomers," those Americans born between 1946 and 1964, started the modern fitness movement, we believe they will continue to be a driving force as they age. We believe baby boomers will use more of their increasing leisure time for exercise and more of their disposable income for fitness equipment purchases as they strive to counter the effects of aging.
DIRECT TO CONSUMER MARKETING TRENDS
Direct and interactive marketing involves the delivery of marketing messages to
consumers through media predominantly consisting of television, Internet,
telephone, radio, newspapers and magazines, and mail. According to the 2002
ECONOMIC IMPACT: U.S. DIRECT & INTERACTIVE MARKETING TODAY published by the
Direct Marketing Association (the "DMA"), direct marketing-driven sales to
consumers are estimated to have exceeded $1 trillion in 2002, having grown at an
annual rate of 8.8% over the previous 5 years. The DMA estimates that consumer
direct marketing-driven sales will increase at a compound annual growth rate of
8.0% over the next 5 years, compared to an estimated growth rate of 5.5% for
overall U.S. retail sales during the same period. We believe our direct
marketing business is well positioned to take advantage of this economic
environment in which consumers have and continue to demonstrate greater
willingness to make purchase decisions based upon direct marketing.
TRENDS IN FITNESS EQUIPMENT
We market our Nautilus, Bowflex, Schwinn, StairMaster, and Trimline equipment both domestically and internationally. Since 1990, the fitness equipment industry has more than doubled in size and has been the most successful category of sporting goods for years. Interest in exercising with fitness equipment is supported by the increase in health club memberships in the U.S., which according to the Sporting Goods Manufacturers Association (the "SGMA"), have increased 63% from 20.7 million in 1990 to 33.7 million in 2001. The U.S. fitness equipment market consists of two distinct market segments: home and institutional. According to the SGMA, the institutional, or commercial, fitness
Consumer interest in health clubs has benefited the market for home fitness equipment as well as the commercial fitness equipment business. Consumers who attend health clubs are exposed to an array of fitness equipment products and brand names, as well as education about the uses and benefits of fitness equipment. Using the same brand names in concert with product variations that make home use feasible, home fitness equipment businesses have been successful in selling the benefits of fitness equipment for the home.
According to the SGMA, the fitness equipment market is expected to have increased 4.4% in 2002 comprised of the home fitness equipment increasing 5% in 2002 and the commercial fitness equipment market increasing 2%. The SGMA projects a 4.5% increase in fitness equipment sales in 2003.
Research from the National Sporting Goods Association (the "NSGA") indicates that Americans are not only exercising more but are also exercising more with fitness equipment. Surveys performed by the NSGA indicate that the percentage of U.S. consumers above the age of seven who participated in exercise with fitness equipment rose from 35.3% in 1990 to 44.8% in 2000. In addition, the SGMA estimates that the number of Americans using strength equipment and cardiovascular equipment increased 5.4% and 3.5% annually, respectively, from 1990 to 2000. A significant component of this growth is attributable to the aging "baby-boomer" generation.
The international markets represent a strong opportunity for growth, driven by the continued fitness boom across Europe and the increasing focus on fitness and healthy lifestyles by more affluent consumers in Asia and Latin America. In fact, according to recent data published by the International Health, Racquet and Sportsclub Association (the "IHRSA"), there are approximately 19,500 health clubs in Europe, 7,800 in Latin America and 4,800 in the Asia/Australia market. For comparison, there are approximately 20,200 clubs currently operated in the U.S. According to the IHRSA, health club memberships in the United Kingdom totaled 4.4 million in 2002 compared with 1.5 million in 1996, an increase of 193.3%. Health club memberships in Germany totaled 5.4 million in 2002 compared with 3.3 million in 1995, an increase of 63.6%. We believe demand for U.S. products will increase, as foreign consumers increasingly demand the reliability, service and innovative designs provided by U.S. suppliers such as Nautilus, Schwinn, StairMaster, and Trimline.
TRENDS IN SLEEP PRODUCTS
The United States mattress market is large and dominated by several major manufacturers whose primary focus is the conventional innerspring mattress. According to the International Sleep Products Association (the "ISPA"), United States mattress and foundation sales totaled 38.7 million units shipped in 2001, representing a 2.0% decrease from 2000. Total dollar value of these wholesale shipments remained relatively constant at $4.6 billion in 2001 compared to 2000. We believe these wholesale dollars equate to over $7.6 billion in retail sales.
According to a consumer study commissioned by furniture industry publication HFN, less than 6.0% of all mattress sales are currently made through direct marketing distribution channels. Prior to 2001, the mattress industry enjoyed years of uninterrupted growth according to the ISPA, which has led to increased competition and large-scale retail outlet consolidation. The ISPA states that the mattress industry can be characterized as having stable sales throughout the
DIRECT BUSINESS SEGMENT
DIRECT TO CONSUMER MARKETING
We market and sell our Bowflex and Nautilus Sleep Systems products through our direct-marketing channel utilizing a combination of 30-second, 60-second, 2-minute, and in some instances 5-minute "spot" television commercials, 30-minute television "infomercials," response mailings, the Internet, and inbound/outbound call centers. The direct to consumer distribution channel involves sales of our products directly to the consumer. Sales leads are derived primarily from television advertisements, including both commercials and infomercials. Additional leads and sales are obtained via our internet commerce web sites. By selling directly to the end consumer, we are able to target premium price points paid by end consumers, eliminating all other parties from the supply chain. Our ability to capture the entire gross margin has consistently produced a high financial return on time and money invested. The size of the direct market is also substantial. Through our advertising initiatives, we estimate that we currently target 70 million homes. Success within this distribution channel is almost entirely dependent on the ability to capture target demographics. By using hundreds of different toll free numbers, we are able to measure which ads our customers are responding to, and we have built a comprehensive database that assists us to adapt marketing strategies to better target customers. Historically, we have been able to predict, with a high degree of accuracy, inquiries to specific advertisements and the resulting sales. We continue to believe that this will serve as a key differentiating factor and enable us to maintain a competitive advantage within this channel.
We conduct direct to consumer marketing through a combination of television commercials and infomercials. To date, we have been highly successful with what we refer to as a "two-step" marketing approach. Our two-step approach focuses first on generating consumer interest in our products and requests for product information, which is achieved primarily through the use of spot commercials and infomercials. The second step focuses on converting inquiries into sales, which we accomplish through a combination of response mailings and outbound telemarketing to potential customers who have made initial inquiries based on our first step advertising efforts.
The effectiveness of our direct marketing is influenced by seasonal factors. We have found that second quarter influences on television viewership, such as the broadcast of national network season finales and seasonal weather factors, cause our spot television commercials on national cable television to be less effective in the second quarter than in other periods of the year. Additionally, we have found that advertising availability during the fourth quarter is more limited due to an increase in annual holiday advertising and political advertisements during election years.
ADVERTISING
SPOT COMMERCIALS AND INFOMERCIALS. Spot television commercials are a key element of the marketing strategy for all of our direct-marketed consumer products. For direct-marketed products that may require further explanation and demonstration, television infomercials are an important additional marketing tool. We have developed a variety of spot commercials, infomercials, and marketing videos for our Bowflex and Nautilus Sleep Systems product lines. We expect to use spot commercials and, where appropriate, infomercials to market other consumer products that we determine are appropriate for the direct-marketing channel.
When we market a new product, we test and refine our marketing concepts and selling practices while advertising the product in spot television commercials. Production costs for these commercials can range from $50,000 to $150,000. Based
We test spot commercials and infomercials on a variety of cable television networks that have a history of generating favorable responses for our existing products. Our initial objective is to determine the product's marketing appeal and evaluate creative or product modifications that may be appropriate. If these initial tests are successful, we then air the spot commercials and infomercials on an accelerating schedule of additional cable networks.
MEDIA BUYING. An important component of our direct marketing success is our ability to purchase quality media time at an affordable price. The cost of airing spot commercials and infomercials varies significantly, depending on the network, time slot and, for spot commercials, programming. Each spot commercial currently costs between $25 and $25,000 to air, and each infomercial currently costs between $600 and $55,000 to air. We currently purchase the majority of our media time on cable networks, through which we estimate to reach more than 70 million homes.
We book most of our spot commercial and infomercial time on a monthly or quarterly basis, as networks make time available. Networks typically allow us to cancel booked time with two weeks advance notice, which enables us to adjust our advertising schedule if our statistical tracking indicates that a particular network or time slot is no longer cost effective. In limited situations, we book contracts with time horizons of up to one year for infomercial time in order to secure time slots that we feel are likely to generate the greatest number of potential customer inquiries, and that are also in demand from other advertisers. Once we acquire this advertising time, we can benefit by rotating our products into these time slots that demonstrate a history of success.
INTERNET. We expect the Internet to continue as an important part of our direct-marketing strategy. We consistently promote our web sites in television, print and direct mail marketing efforts to encourage online product inquiries and eCommerce transactions. We have also expanded our use of online advertising on third party sites and paid search engine placement to drive Web browsers to our sites to request additional information, learn more about our products, or purchase immediately. Our sites are loaded with informative content including customer testimonials, online videos, and detailed product information. In 2002, we operated two direct marketing-oriented web sites: (1) www.bowflex.com that focuses on our Bowflex line of home exercise equipment and (2) www.nautilussleepsystems.com that focuses on our Nautilus Sleep Systems line of luxury air beds.
OPTIMAL USE OF DIRECT MARKETING DATABASE
Since 1994, when we initially started testing our target markets, we have consistently invested significant resources in order to build a comprehensive direct marketing database. Our database has allowed us to monitor customer responses and effectively utilize information to adapt our marketing strategy to better target such customers with existing and future direct products. We believe the database creates a competitive advantage for our future direct product introductions by providing a rich pool of customers that have a proven relationship with the Company.
CONVERSION OF DIRECT-MARKETED PRODUCT INQUIRIES INTO SALES
CUSTOMER SERVICE CALL CENTER AND ORDER PROCESSING. We operate our own customer service call center in Vancouver, Washington, that operates 18 to 23 hours per day and receives and processes all infomercial-generated and customer service-related inquiries regarding our Bowflex and Nautilus Sleep Systems products. We have developed a skill-based call routing system that automatically routes each incoming call to the most highly qualified inside sales agent or customer service representative available. The appropriate representative then answers product questions, proactively educates the potential customer about the benefits of our product line, promotes financing through our third-party private label credit card, typically up sells the benefits of higher priced models in our product line, and closes the transaction process by entering the customer order information. This sophisticated system allows us to better utilize our agents, prioritize call types and improve customer service.
We employ two large telemarketing companies to receive and process information requests generated by our spot television advertising 24 hours per day. The telemarketing agents for these companies only collect names, addresses and other basic information from callers and do not sell or promote our products. The telemarketing agents transfer callers that show immediate buying interest in our products to our own customer service call center.
INTERNET. We use television spot commercials and infomercials to lead consumers to our web sites, as we believe that consumers who visit our web sites are more inclined to purchase our products. Our ongoing Internet-related goals include improving the capabilities of our various web sites. We believe we successfully balance our goals of finalizing sales and capturing consumer information by strategically designing our web pages and carefully analyzing web page hits, conversion rates, average sales prices and inquiry counts. Our eCommerce sales are an important component of our direct sales channel representing 24%, 22%, and 19% of direct sales for 2002, 2001, and 2000, respectively.
RESPONSE MAILINGS. We forward a "fulfillment kit" in response to each inquiry regarding our direct-marketed products. Each kit contains detailed literature that describes the product line and available accessories, a marketing video that demonstrates and highlights the key features of our premium product in the line, and additional information about how to purchase the product. If a potential customer does not respond within a certain time period, we proceed with additional follow-up mailings that convey a different marketing message and typically offer certain inducements to encourage a sale. The specific marketing message and offer at each stage will vary, based on what our statistical tracking indicates is most likely to trigger a sale.
CONSUMER FINANCE PROGRAMS. We believe that convenient consumer financing is an important tool in our direct marketing sales efforts and induces many of our customers to make purchases when they otherwise would not. Currently, we offer "zero-down" financing to approved customers on all sales of our Bowflex Products and Nautilus Sleep Systems. We arrange this financing through a consumer finance company pursuant to a non-recourse consumer financing agreement. Under this arrangement, our customer service representatives can obtain financing approval in a few minutes over the telephone and, if a customer is approved, ship the ordered product without the need for cumbersome paperwork. The consumer finance company pays us promptly after submission of the required documentation and subsequently sends to each approved customer a Nautilus Group private label
DIRECT PRODUCTS
BOWFLEX HOME FITNESS EQUIPMENT
We introduced the first Bowflex home exercise machine in 1986, and since then have implemented several improvements to its design and functionality. We now offer four different Bowflex machines and nine different models. The key feature of each Bowflex machine is our patented "Power Rod" resistance technology. Each Power Rod is made of a solid polymer material that provides resistance in both the concentric and eccentric movements of an exercise. When combined with a bilateral cable pulley system, the machines provide excellent range and direction of motion for a large variety of strength-building exercises. Sales from our Bowflex product line accounted for 61% of our aggregate net sales in 2002, down from 74% and 83% in 2001 and 2000, respectively, as we continued our strategies of diversification into the commercial and retail markets and the introduction of new direct-marketed products.
We currently offer the following Bowflex machines:
o The Ultimate, introduced in late 2001, is our newest product in the Bowflex line. The Ultimate is available in one model that offers over 80 different strength-building exercises in one compact, foldable, and portable design and comes with a 310-pound resistance pack that can be upgraded to 410 pounds. We have also incorporated an integrated adjustable pulley system feature to allow a user to adjust the range of motion of many basic exercises to increase workout results. An aerobic rowing exercise feature has also been incorporated into the Ultimate.
o The Power Pro, introduced in 1993, is our best selling product. The Power Pro is available in four different models: the base model Power Pro, the XT, the XTL and the XTLU. Each model offers over 60 different strength building exercises in one compact, foldable and portable design and comes with a 210-pound resistance pack that can be upgraded to 410 pounds. We have also incorporated an aerobic rowing exercise feature into the Power Pro.
o The Motivator, introduced in 1996, is our entry-level strength training line. It is available in three different models: the base model Motivator, the XT and the XTL. Each model offers over 40 different strength building exercises in one compact, foldable design and comes standard with a 210-pound resistance pack that can be upgraded to 410 pounds.
o The Versatrainer by Bowflex, introduced in 1988, is specifically designed to accommodate wheelchair-bound users. The Versatrainer's key advantage is that it permits users to exercise while remaining in their wheelchair, which offers enhanced independence. The Versatrainer can be found in many major rehabilitation hospitals, universities and institutions.
NAUTILUS SLEEP SYSTEMS
In December 1999, we began marketing a line of premium air sleep systems, which we have named the "Nautilus Sleep Systems." The key feature of the Nautilus Sleep Systems is the variable firmness support chamber, an air chamber within each air sleep system that can be electronically adjusted to regulate firmness. All queen and larger sleep systems in our Signature, Premier and Ultimate Series are equipped with dual air chambers that enable users to maintain different
Our Nautilus Sleep Systems are currently available in four models:
o The Ultimate Series is our top-of-the-line model. It features dual patent-pending, interlocking variable support air chambers that permit users to maintain separate firmness settings on each side of the sleep system. The interlocking chambers regulate airflow and pressure to more effectively maintain support when a user changes position. The Ultimate Series comes with removable wool blend and silk blend pillow top sleeping surfaces, which permits users to easily convert to a "tight top" surface when they desire extra firmness. The Ultimate Series also has an upgraded comfort layer of visco-elastic foam that conforms to a user's body.
o The Premier Series features dual patent-pending, interlocking variable support air chambers that permit users to maintain separate firmness settings on each side of the sleep system. The interlocking chambers regulate airflow and pressure to more effectively maintain support when a user changes position. The Premier Series comes with a removable wool blend pillow top sleeping surface, which permits users to easily convert to a "tight top" surface when they desire extra firmness.
o The Signature Series is designed to appeal to consumers who desire the flexibility of dual variable firmness support air chambers, but at a more affordable price. Our customers can choose between a tight top or pillow-top sleeping surface over a one and one-half inch convoluted foam comfort layer.
o The Basic Series is our entry-level model, which features a single, head-to-toe variable firmness support air chamber and a traditional tight-top sleeping surface over a one and one-half inch thick convoluted foam comfort layer.
We offer foundations that are specifically designed to support and enhance the performance of our Nautilus Sleep Systems. We advise consumers to use our foundations because conventional box springs tend to sag and wear over time, causing a sleep system to eventually mirror the worn box spring. The majority of our Nautilus Sleep Systems customers order a complete sleep system, which includes both a mattress and a foundation.
TREADCLIMBER
In March 2003, we introduced a new line of cardiovascular fitness equipment, which we have named the "TreadClimber." The TreadClimber incorporates three popular cardiovascular fitness features in one machine and is marketed through our direct sales channel to home consumers. TreadClimber provides a unique combination of movements that allows users to walk forward (like a treadmill) and step up (like a stair-stepper) while taking advantage of the low impact movement of an elliptical machine. We believe that the unique combination of movements of our TreadClimber favorably differentiates it from other cardiovascular fitness equipment for the home.
CHAMPION NUTRITION
As part of our mission to provide quality healthy lifestyle products, we obtained an option to purchase Champion Nutrition ("Champion") by entering into a Loan and Security Agreement ("Loan Agreement") with Champion and its primary shareholders in May 2001. Champion is a privately held manufacturer of nutritional supplements. We began selling Champion's product line through our direct sales channel in June 2001. We package these products as kits and sell them to our Bowflex customers as add-on items. Under the terms of the Loan Agreement, the Company's option to buy the stock of Champion expired in February
COMMERCIAL/RETAIL BUSINESS SEGMENT
COMMERCIAL/RETAIL SALES AND MARKETING
We market and sell our Nautilus, Schwinn, and StairMaster commercial fitness equipment through our direct sales force and selected dealers to health clubs, government agencies, hotels, corporate fitness centers, colleges, universities and assisted living facilities. Our commercial direct sales force is focused on strengthening the market position of our existing Nautilus, Schwinn, and StairMaster commercial product lines, which we sell principally to health clubs, large hotels, assisted living facilities and the government. Additionally, as we continue to broaden our product line with products like Nautilus Nitro and commercial strength equipment, our direct sales force will target new market segments and, if successful, broaden our customer base. Internationally, we market and sell our Nautilus, Schwinn, and StairMaster commercial fitness products through our foreign subsidiaries and a worldwide network of independent distributors.
We also market a complete line of consumer fitness equipment, under the Nautilus, Schwinn, StairMaster, and Trimline brands, through an independent network of more than 1,200 dealers, sporting goods retailers and specialty stores worldwide. As part of our September 2001 acquisition of Schwinn Fitness, we added an experienced management team to oversee the sales and marketing operations of our retail products business.
In general, sales of our retail fitness equipment is highly seasonal. We believe that sales within our commercial/retail segment are considerably lower in the second quarter of the year compared to the other quarters. Our strongest quarter for the commercial/retail segment is generally the fourth quarter, followed by the first and third quarters. We believe the principal reason for this trend is the commercial/retail fitness industry's preparation for the impact of New Year's fitness resolutions and seasonal weather patterns related to colder winter months.
COMMERCIAL APPROACH
We position ourselves as "The Health & Fitness Consultants" to encourage our commercial market customers and potential customers to think of us first when considering their fitness equipment and programming needs. Our strategy is to address the needs of the three key constituencies of today's health clubs:
o Club owners (customer satisfaction and profit)
o Club staff (continuing education and career development)
o Club users (improved health and fitness)
FITNESS ACADEMY: The Schwinn Fitness Academy was established in 1997 to provide programming and educational information for both consumers and fitness professionals. To date, the Schwinn Fitness Academy has provided training and certification for hundreds of fitness professionals in the Schwinn Cycling Program and has recently added a range of strength training programs based on Nautilus training principles to its repertoire. Many of these programs are targeted to special populations such as seniors, women and youth that are particularly important to the fitness industry today.
Schwinn Fitness Academy programs are designed to aid clubs to increase profits by encouraging cost-efficient group exercise classes; benefit staff members by helping them increase their range of fitness education skills; and motivate members to stick with their exercise programs to truly experience fitness results.
DIRECT MAIL PROMOTIONS: We maintain a database that includes contacts at thousands of commercial facilities in the United States alone and enables us to monitor responses to direct mail promotions. All direct mail promotions are supplemented by a telemarketing effort to maximize customer response.
PUBLIC RELATIONS: In the commercial market, public relations is a critical component in our strategy to build awareness and credibility for the Company and our products in the marketplace by positioning the Company as the leading comprehensive provider of fitness equipment and education. This requires that we change the general perception that our individual brands stand alone to the understanding that our individual brands combine to deliver the most powerful fitness system available. In order to meet these objectives we have established relationships with key press to develop and communicate our competitive advantages.
TRADE SHOWS: There are several national and regional industry trade shows, such as the IHRSA (International Health, Racquet and Sportsclubs Association) and CLUB INDUSTRY, as well as many events that showcase our programs and products. Trade shows also provide excellent opportunities to meet face-to-face with our customers and the press to obtain invaluable feedback by being able to test marketing messages, receive customer input on product designs, and evaluate the competition.
INTERNET: The Company currently maintains and directs customers to our Nautilus, Schwinn Fitness and StairMaster websites, which can be found at www.nautilus.com, www.schwinnfitness.com, and www.stairmaster.com, respectively. These websites contain company and product information.
RETAIL APPROACH
Our main focus for marketing our retail products is to fully support our carefully cultivated network of dealers. A combination of Company-sponsored and cooperative marketing programs has been developed to ensure that our Nautilus, Schwinn, StairMaster and Trimline brands remain prominent in the minds of dealer staff and consumers and drive consumers to their local retailers.
HEALTH AND FITNESS E-NEWSLETTER: Created to motivate and educate our customers, the newsletter is now a consumer campaign, allowing the Company to reach thousands of health-conscious readers every month. By delivering the newsletter to the email inboxes of thousands of consumers and making the newsletter available on our website, we are developing long-term customer relationships and a community of fitness enthusiasts. In addition, dealers may label and distribute the newsletter through their stores.
COLLATERAL AND POINT OF SALE MATERIALS: We have developed a collection of materials to ensure that our brands figure prominently in the minds of retail staff and consumers, including a full range of product catalogues and sell sheets, ad planners, signage, and product displays.
PUBLIC RELATIONS: In the retail market, public relations is a cost-effective way to promote our products in consumer publications. While advertising in fitness industry publications is expensive, editorial and showcase articles that include
TRADE SHOWS: There are three national trade shows that are very important to the Company's retail division: the Health & Fitness Business Expo, the industry's premier showcase for retail fitness products; Interbike, the bicycle industry's premier gathering; and Supershow, the mega-trade show representing retail products in virtually every category. Trade shows also provide excellent opportunities to meet face-to-face with our customers and the press to obtain invaluable feedback by being able to test marketing messages, receive customer input on product designs, and evaluate the competition.
INTERNET: The Company currently maintains and directs customers to our Nautilus, Schwinn Fitness, StairMaster, and Trimline websites, which can be found at www.nautilus.com, www.schwinnfitness.com, www.stairmaster.com, and www.hebbindustries.com. These websites contain company and product information.
INTERNATIONAL APPROACH
Our international operations are headquartered in Switzerland, which, through its central location, multi-cultural environment, and multi-lingual population, is an excellent base for our international operation. We have integrated all of our brands from an operational standpoint and are distributing our products through a network of over 90 distributors in over 50 countries divided among three regions:
o Asia/Pacific
o Europe/Middle East/Africa
o Central/South America
In each of these regions, we have responsible sales people and third party warehouses (except Central/South America which we support from our United States distribution facilities) to deliver our products in a timely and cost effective manner. Currently, we have no long-lived assets outside the U.S. Communication amongst our business partners within each region is essential to our strategy so we may achieve product support, innovative marketing activities, and global brand recognition.
In our largest markets, the United Kingdom and Germany, we operate our own offices, which possess a team of sales representatives that focus not only on selling to fitness clubs, but also on the government, hotel, and medical/paramedical markets. During 2002, we also added an office in Italy as it represents another market we perceive to be important.
We have formed alliances in most markets with distributors to sell commercial products from our Nautilus, Schwinn, and StairMaster brands. This enables us to sell "package deals" to international fitness clubs, which may prefer to buy from one supplier that can offer the broadest array of products at a competitive price. By building our portfolio of brand names, we have greater ability to compete in the international marketplace in which our main competitors have benefited from the ability to negotiate "package deals" for many years. We believe our brand names have strong recognition in the international marketplace, which will allow us to compete more effectively in the future.
Canada represents another significant market for our business. We sell products from our commercial/retail and direct segment product portfolios to dealers and retail stores within Canada. Sales within Canada are predominantly generated from our U.S. operations.
COMMERCIAL EQUIPMENT
We currently offer the following Nautilus, Schwinn, and StairMaster equipment for the commercial market:
NAUTILUS SELECTORIZED EQUIPMENT. Nautilus 2ST line of commercial strength equipment is specially designed to focus on a particular strength building exercise. The key component of each Nautilus 2ST machine is either its "cam" or a four-bar linkage mechanism, which builds and releases resistance as a user moves through an exercise.
Nautilus NITRO line, introduced in late 2000, is a complete line of compact selectorized machines. It is intended for clubs and other facilities where floor space is limited. Nautilus NITRO features smooth belt drives, four-bar linkage, classic full range variable resistance cams and converging axis movements. Each Nautilus NITRO machine features 2" by 4" bent steel frames and 5-pound increment weight adjustments.
NAUTILUS FREE WEIGHT EQUIPMENT. In 1999, we introduced a line of Nautilus free weight equipment with new innovations in design and engineering intended to help club owners better serve their customers. This free weight equipment can be coupled with the Nautilus selectorized equipment circuit to give facility managers a complete strength gym.
SCHWINN INDOOR CYCLING EQUIPMENT. Indoor cycling is one of the most popular class training programs in fitness clubs. The Schwinn Indoor Cycling line is a worldwide leader in classroom exercise bikes. Schwinn Fitness also offers an array of stationary bikes, all of which feature adjustable resistance, heavy-duty flywheels, and comfortable seats.
STAIRMASTER. StairMaster introduced the world's first stairclimber in 1983. The StairMaster product line includes stairclimbers, stepmills, treadmills, and exercise bikes. These products feature ergonomic designs, comfortable and user-friendly controls, and geo-mechanically correct exercise equipment. StairMaster treadmills are built to commercial standards with long lasting decks, belts, and motors. StairMaster treadmills feature large running surfaces, various workout programs and offer speeds of up to 12 miles per hour.
RETAIL EQUIPMENT AND ACCESSORIES
We currently offer the following Nautilus, Schwinn, StairMaster, and Trimline equipment for the retail market:
NAUTILUS FITNESS ACCESSORIES. The Nautilus accessory line includes a wide array of products. This includes everything from weights, gloves, and yoga kits, to heart rate monitors, equipment mats, fitness clothing, and hand-held fitness items.
NAUTILUS HOME GYMS. We offer a full line of home and vertical market gyms that cover all aspects of strength training, from fixed path to free-motion training. Nautilus home gyms offer numerous gym exercises such as chest press, shoulder press, lat pulls, tricep extensions, and leg work. All of our gyms are made from quality materials such as solid steel guide rods, military spec cable, and 11-gauge steel.
NAUTILUS FREE WEIGHTS AND BENCHES. Nautilus free weight equipment encompasses a complete line of Olympic weight stations, racks, and benches. Each piece is biomechanically engineered, crafted for durability and designed for aesthetics.
NAUTILUS ELLIPTICALS. The Nautilus ellipticals come equipped with a foot motion that allows a natural articulation of the foot, which matches the user's natural stride. At the same time, it provides a complete body workout with upper body handles as well. All of the models include touch heart rate sensors.
NAUTILUS EXERCISE BIKES. The Nautilus exercise bike line is intended for home use. All of the bikes have touch heart rate sensing and a computer that tracks user workout time, calories burned, distance and heart rate. The bikes are also belt-driven with magnetic resistance, allowing them to be virtually silent.
SCHWINN TREADMILLS. Schwinn treadmills for the home offer high horsepower motors, deck suspension and a wide range of computer options. Schwinn treadmills also offer patent-pending designs, such as the folding treadmill feature.
SCHWINN STATIONARY BIKES. Schwinn Fitness offers an array of stationary bikes, all of which feature adjustable resistance, heavy-duty flywheels, and comfortable seats. The line consists of both recumbent and upright bikes.
SCHWINN WIND RESISTANCE PRODUCTS. For years, Schwinn Fitness has been a leader in wind resistance technology. It started years ago with the very popular Airdyne. This technology has advanced into our Evolution(R) fan technology. This technology is utilized in our latest version of the Airdyne and is also incorporated into exercise bikes, rowers and upper body ergometers.
SCHWINN ELLIPTICALS. Schwinn ellipticals offer one of the smallest footprints available, with one of the longest strides for a home elliptical machine. This technology allows us to put a very natural, low-impact motion into a product that fits in the customer's home.
STAIRMASTER STAIRCLIMBERS. StairMaster is a market leader in stairclimbers worldwide. We continue to produce many different models of independent stairclimbers and stepmills for the home and health club. We build these products with our advanced technology, which also provides the most natural motion for a stepper.
STAIRMASTER EXERCISE BIKES. StairMaster club bikes have one of the most innovative displays available. These bikes are all self-powered and belt-driven.
STAIRMASTER TREADMILLS. StairMaster treadmills are some of the most durable treadmills available to date. They use technology from Quinton, which has been building treadmills for 50 years. Some examples of this technology are the patented Triple Flex shock-absorbing deck suspension and the Hyperdrive drive system.
TRIMLINE TREADMILLS. Trimline products are sold in over 400 independent specialty fitness retailers nationwide and are exported to more than 50 countries worldwide. Trimline ranks as one of the best-selling mid-priced treadmill brands. Trimline uses industrial-strength motors that are the size and quality often found in higher-priced health club treadmills. The motors are designed to run smoother, quieter and with less vibration than many motors in their class.
TRIMLINE ELLIPTICALS. Trimline's Precision Path(TM) Foot Motion Technology provides a natural elliptical foot pattern, recruiting all major lower-body muscle groups. Pedal speed is designed to remain equal throughout the entire elliptical stride resulting in a fluid motion that offers a feeling of comfort
NEW PRODUCT DEVELOPMENT AND INNOVATION
We continue to emphasize the expansion and diversification of our product development capabilities in health and fitness products. New product development is a focal point of our company. We develop new products either from internally generated ideas or by acquiring or licensing patented technology from outside inventors and then enhancing the technology.
Our research and development competencies have been enhanced through the acquisition of Schwinn Fitness and StairMaster. With the purchase of these companies, we gained a state-of-the-art test facility and prototype shop. With the combination of this facility, along with the designers and engineers, we have the capability of taking a concept from its origin, quickly and cost effectively through to its completion within our company. This should allow us to become a leader in new product introduction and technologies. This group consists of industrial, mechanical, and electrical design personnel.
In recent years, successful new product introductions and extensions have included the Nautilus Sleep Systems, the Nitro commercial line of strength equipment, and new Nautilus selectorized home gym and free weight equipment. Late in 2002, we expanded our portfolio of commercial strength equipment with the introduction of the Nautilus XPload line of plate-loaded selectorized equipment. In August of 2002, we expanded our retail product lines with the introduction of 16 new retail products that were first shown at the Health and Fitness Business show in Denver, Colorado. The new retail products branded under our Nautilus name include treadmills, stationary bicycles, an elliptical motion trainer, home strength equipment, and heart rate monitors. We also introduced new products under our Schwinn brand name including indoor cycling bicycles and an elliptical motion trainer. In addition to the 16 new retail products, many of our existing products were updated and enhanced. In March 2003, we introduced the TreadClimber, our newest direct-marketed product, under our Nautilus name.
The designs of all new products are rendered in solid modeling software. This allows us to see and communicate ideas rapidly, do finite element analysis, and perform costing studies very quickly. Our additional research and development resources have allowed us to become fully integrated in the product development process, allowing us to take a new product concept from the beginning of feasibility studies straight through to production and continuing product review. This integration allows us a greater degree of control over the new product process, which should allow us to generate a higher quality product, increase our speed to market, and control our costs.
For new direct-marketed products, we look for innovative high-quality and proprietary consumer products that can generate gross profit margins in the range of 65% to 75%. In addition, we look for products that we anticipate will have mass consumer appeal, particularly among members of the "baby-boom" generation who are accustomed to watching television and, in general, are likely to have higher disposable income.
For commercial/retail fitness products, we gather and evaluate ideas from various areas, including existing and potential customers, sales and marketing, manufacturing and engineering, and we determine which ideas will be incorporated into existing products or will serve as the basis for new products. Based on these ideas, we design new or enhanced products, develop prototypes, test and modify products, develop a manufacturing plan, and bring products to market. The Company evaluates, designs, and develops each new or enhanced product, taking into consideration our marketing requirements, target price points, gross margin requirements and manufacturing constraints.
COMPETITION
DIRECT PRODUCTS SEGMENT
BOWFLEX. The market for our Bowflex products is highly competitive. Our competitors frequently introduce new and/or improved products, often accompanied by major advertising and promotional programs. We believe the principal competitive factors affecting this portion of our business are price, quality, brand name recognition, product innovation and customer service.
We compete directly with a large number of companies that manufacture, market and distribute home fitness equipment. Our principal direct competitors include ICON Health & Fitness (through its Powerflex, Crossbow, Health Rider, NordicTrak, Image, ProForm, Weider and Weslo brands) and Fitness Quest (through its Gazelle and Total Gym brands).
We believe our Bowflex line of home exercise equipment is competitive within the market for home fitness equipment based on product design, quality, and performance. Additionally, we believe our direct marketing activities are effective in distinguishing our products from the competition.
NAUTILUS SLEEP SYSTEMS. The sleep products industry is also highly competitive, as evidenced by the wide range of products available to consumers, such as innerspring mattresses, waterbeds, futons and other air-supported mattresses. We believe market participants compete primarily on the basis of price, product quality and durability, brand name recognition, innovative features, warranties and return policies.
We believe our most significant competition is the conventional mattress industry, which is dominated by four large, well-recognized manufacturers: Sealy (which also owns the Stearns & Foster brand name), Serta, Simmons and Spring Air. Although we believe our Nautilus Sleep Systems offer consumers an appealing alternative to conventional mattresses, many of these conventional manufacturers, including Sealy, Serta, Simmons and Spring Air, possess greater financial, marketing and manufacturing resources and have better brand name recognition.
In addition to the conventional mattress manufacturers, several manufacturers currently offer beds with variable support air chamber technology similar to our Nautilus Sleep Systems. We believe the largest manufacturer in this niche market is Select Comfort. Select Comfort offers its sleep systems through retail stores and engages in a significant amount of direct marketing, including infomercials, targeted mailings and print, radio and television advertising. Select Comfort has an established brand name supported by marketing and manufacturing resources and has significantly greater experience in marketing and distributing sleep systems. We believe the market for sleep systems is large enough for both companies to be successful and that our Nautilus Sleep Systems possess features that will enable us to compete effectively. However, the intense competition in the mattress industry, both from conventional mattress manufacturers and Select Comfort, may adversely affect our efforts to market and sell our sleep systems and, consequently, may adversely affect our financial performance.
COMMERCIAL/RETAIL SEGMENT PRODUCTS
COMMERCIAL FITNESS EQUIPMENT. The market for commercial fitness equipment is highly competitive. Our Nautilus, Schwinn, and StairMaster products compete against the products of numerous other commercial fitness equipment companies, including Life Fitness, Cybex, Star Trac, Precor, and Techno Gym. We believe the key competitive factors in this industry include price, product quality,
RETAIL FITNESS EQUIPMENT. The market for retail fitness equipment is extremely competitive. Our Nautilus, Schwinn, StairMaster, and Trimline retail products compete against the products of numerous domestic retail fitness equipment companies including ICON Health & Fitness (marketing products under the brand names Weslo, Health Rider, Weider, NordicTrak and ProForm), Star Trac, Life Fitness, Cybex, Fitness Quest, and Precor. We believe the key competitive factors in the retail fitness equipment industry include price, product quality, brand name recognition, customer service and the ability to create and develop new, innovative products. In addition, there are no significant technological, manufacturing or marketing barriers to entry into the fitness equipment markets in which we compete, even though like many companies in the industry, we have sought and received patent and trademark protection in an effort to protect our competitive position.
We believe that our combination of high-quality products, recognized brand names, multiple distribution channels, and dependable customer service gives us the ability to compete in our current markets.
MANUFACTURING AND DISTRIBUTION
Our primary manufacturing and distribution objectives for all of our products are to maintain product quality, reduce and control costs, maximize production flexibility and improve delivery speed. We use computerized inventory management systems to forecast our manufacturing requirements.
Our commercial strength fitness manufacturing operations are located in Virginia. These operations are vertically integrated and include such functions as metal fabrication, powder coating, upholstery and vacuum-formed plastics processes. By managing our own manufacturing operations, we can control the quality of our commercial strength products, while offering commercial customers greater color specification flexibility. Our manufacturing operations also include a plant in Texas for Schwinn, Trimline, and Nautilus consumer treadmills and a plant in Oklahoma for our commercial cardiovascular products. By manufacturing these products in our own facilities, we ensure the highest quality control standards.
The resistance component of our Bowflex products, the Power Rods, is assembled exclusively in our facilities to protect our manufacturing trade secrets and to ensure the highest quality control standards. In addition, we use outside suppliers to manufacture many of our components and finished parts for our direct and retail products. Whenever possible, we attempt to use at least two suppliers to manufacture each product component in order to improve flexibility.
Domestically, we inspect, package, and ship our products from our facilities in Washington, Virginia, Illinois, Texas, Oklahoma, and Nevada. We rely primarily on United Parcel Service (UPS) to deliver our Bowflex and our Nautilus Sleep Systems products. We distribute our retail equipment and accessories and retail and commercial fitness equipment from our Illinois and Oklahoma facilities using various commercial truck lines. We distribute commercial strength fitness equipment from our Virginia warehouse facilities directly to customers primarily through our truck fleet. This method of distribution allows us to effectively control the set-up and inspection of equipment at the end-user's facilities.
For international sales, we have distributors in over 50 countries, and we ship our products from leased facilities in Switzerland, the United Kingdom, and Germany. We also lease, on a month-to-month basis, flexible warehouse space in multiple countries in Asia and Europe, the largest of which is located in the Netherlands. This flexible warehouse space is devoted to international distribution of our products.
We own many trademarks including Nautilus(R), Bowflex(R), Power Rod(R), Schwinn(R) (fitness products), StairMaster(R) and Trimline(R). Our trademarks, many of which are registered or subject to pending applications in the United States and other countries, are used on a variety of our products. We believe that our trademarks are of great value, providing the consumer with an assurance that the product being purchased is of high quality and provides a good value.
We also place significant value on product designs (the overall appearance and image of our products) and processes which, as much as trademarks, distinguish our products in the marketplace. We hold many United States and foreign patents and have submitted additional applications for patent protection that are pending approval. Management believes all patents are important to the Company strategy and has identified the patents on the Bowflex Power Rod resistance technology and TreadClimber as the most significant to our business. Although our Bowflex trademark is protected as long as we continuously use the trademark, the main U.S. patent on our Bowflex Power Rod resistance technology expires on April 27, 2004. This patent expiration could trigger the introduction of similar products by competitors.
Building our intellectual property portfolio is an important factor in maintaining our competitive position in the fitness and mattress industries. If we do not or are unable to adequately protect our intellectual property, our sales and profitability could be adversely affected. We are very protective of these proprietary rights and take action to prevent counterfeit reproductions or other infringing products. As we expand our market share, geographic scope and product categories, intellectual property disputes are anticipated to increase making it more expensive and challenging to establish and protect our proprietary rights and to defend against claims of infringement by others.
Each federally registered trademark is renewable indefinitely if the trademark is still in use at the time of renewal. We are not aware of any material claims of infringement or other challenges to our right to use our trademarks.
EMPLOYEES
As of December 31, 2002, we employed 1,307 employees, including 4 executive officers. None of our employees are subject to any collective bargaining agreements.
The following is a summary of principal properties owned or leased by the
Company:
Owned or Approximate
Location Segment Primary Function(s) Leased Lease Expiration space
-------- ------- ------------------- ------ ---------------- -----
Washington Direct Corporate headquarters, call center, Owned 114,000 sq. feet
warehouse, production, and distribution
Washington Commercial/Retail Research and development Leased June 30, 2003 2,500 sq. feet
Virginia Direct Warehouse and distribution Owned 105,000 sq. feet
Virginia Commercial/Retail Commercial equipment manufacturing Owned 124,000 sq. feet
Virginia Commercial/Retail Engineering, prototyping, customer Owned 27,000 sq. feet
service, and administrative
Virginia Commercial/Retail Showroom Owned 9,000 sq. feet
Virginia Commercial/Retail Commercial equipment sales and Owned 29,500 sq. feet
warehouse
Virginia Commercial/Retail Warehouse and distribution Owned 86,000 sq. feet
Virginia Direct Warehouse and distribution Owned 65,000 sq. feet
Nevada Direct Warehouse and distribution Leased December 31, 2003 93,000 sq. feet
Illinois Commercial/Retail Warehouse and distribution Leased October 31, 2003 139,000 sq. feet
Colorado Commercial/Retail Administrative, warehouse, production, Owned 86,000 sq. feet
testing, and distribution
Colorado Commercial/Retail Subleased administrative and warehouse Leased November 30, 2003 3,800 sq. feet
Texas Commercial/Retail Warehouse and distribution Owned 63,000 sq. feet
Texas Commercial/Retail Storage Leased Month-to-month 10,000 sq. feet
Texas Commercial/Retail Manufacturing Leased Month-to-month 14,000 sq. feet
Texas Commercial/Retail Warehouse Leased Month-to-month 24,000 sq. feet
Texas Commercial/Retail Administrative, manufacuring, and Owned 135,000 sq. feet
warehouse
Oklahoma Commercial/Retail Manufacturing Leased December 31, 2011 125,000 sq. feet
Oklahoma Commercial/Retail Distribution Leased April 30, 2005 22,500 sq. feet
Oklahoma Commercial/Retail Distribution Leased Month-to-month 22,500 sq. feet
Switzerland Commercial/Retail Administrative Leased December 31, 2007 1,250 sq. feet
Switzerland Commercial/Retail Warehouse and distribution Leased March 31, 2004 3,390 sq. feet
Germany Commercial/Retail Administrative and distribution Leased Month-to-month 850 sq. feet
United Kingdom Commercial/Retail Administrative, showroom, and warehouse Leased May 24, 2014 3,350 sq. feet
Italy Commercial/Retail Administrative and distribution Leased June 30, 2003 153 sq. feet
Nevada Direct Vacant land which may be used in Owned 19.5 acres
expansion of operations in the future
|
For our international operations, we also lease, on a month-to-month basis, flexible warehouse space in multiple countries in Asia and Europe, the largest of which is located in the Netherlands. This flexible warehouse space is devoted to international distribution of our products.
In general, our properties are well maintained, adequate and suitable for their purposes, and we believe these properties will meet our operational needs for the foreseeable future. If we require additional warehouse or office space, we believe we will be able to obtain such space on commercially reasonable terms.
ITEM 3. LEGAL PROCEEDINGS
In the normal course of business, the Company is a party to various legal claims, actions and complaints. Although it is not possible to predict with certainty whether the Company will ultimately be successful in any of these legal matters, or what the impact might be, the Company believes that the disposition of these matters will not have a material adverse effect on the Company's financial position, results of operations or cash flows.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of our stockholders during the quarter ended December 31, 2002.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
MARKET PRICE OF OUR COMMON STOCK
From May 4, 1999 until May 20, 2002, our common stock was listed for trading exclusively on The NASDAQ National Market System under the symbol DFXI. On May 21, 2002, we transferred our listing to the New York Stock Exchange and changed our stock symbol to NLS. The following table summarizes the high and low closing prices for each period indicated, adjusted to reflect three-for-two stock splits effective January 2001 and August 2001:
High Low
2002:
Quarter 1 $ 38.05 $ 27.59
Quarter 2 45.45 28.25
Quarter 3 34.05 19.50
Quarter 4 23.85 12.70
2001:
Quarter 1 $ 21.42 $ 12.39
Quarter 2 31.67 15.97
Quarter 3 33.34 17.11
Quarter 4 31.46 19.95
|
As of March 1, 2003, 32,528,850 shares of our common stock were issued and outstanding and held by approximately 14,200 beneficial shareholders.
On January 29, 2003, the Board of Directors declared a $0.40 per share annual dividend payable quarterly. The initial quarterly dividend of $0.10 per share was paid March 10, 2003, to shareholders of record at the close of business on February 20, 2003. Payment of any future dividends is at the discretion of our Board of Directors, which considers various factors, such as our financial condition, operating results, current and anticipated cash needs and expansion plans.
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
The selected consolidated financial data presented below for each year in the five-year period ended December 31, 2002 have been derived from our audited financial statements. The balance sheet data as of December 31, 2002 and 2001 and the statement of operations data for each of the years in the three year period ended December 31, 2002 have been derived from our audited financial statements included herein. The balance sheet data as of December 31, 2000,
In Thousands (except per share amounts) 2002 2001 2000 1999 1998
---- ---- ---- ---- ----
STATEMENT OF OPERATIONS DATA
Net sales $584,650 $363,862 $223,927 $133,079 $ 63,171
Cost of sales 252,336 140,699 75,573 46,483 18,316
-------- -------- -------- -------- --------
Gross profit 332,314 223,163 148,354 86,596 44,855
Operating expenses:
Selling and marketing 145,258 99,813 73,510 44,630 22,643
General and administrative 25,893 15,574 8,804 4,237 1,701
Royalties 10,108 7,363 4,979 2,897 1,623
Litigation settlement - - - 4,000 -
-------- -------- -------- -------- --------
Total operating expenses 181,259 122,750 87,293 55,764 25,967
-------- -------- -------- -------- --------
Operating income 151,055 100,413 61,061 30,832 18,888
Other income (expense):
Interest income 1,561 4,024 3,632 1,003 527
Other - net 331 381 347 3 (222)
-------- -------- -------- -------- --------
Total other income 1,892 4,405 3,979 1,006 305
-------- -------- -------- -------- --------
Income before income taxes 152,947 104,818 65,040 31,838 19,193
Income tax expense 55,060 38,235 23,414 11,495 6,708
-------- -------- -------- -------- --------
Net income $ 97,887 $ 66,583 $ 41,626 $ 20,343 $ 12,485
======== ======== ======== ======== ========
Basic earnings per share * $ 2.84 $ 1.89 $ 1.18 $ 0.59 $ 0.40
Diluted earnings per share* $ 2.79 $ 1.85 $ 1.16 $ 0.58 $ 0.38
Basic shares outstanding * 34,499 35,184 35,288 34,309 31,511
Diluted shares outstanding * 35,143 35,966 35,997 35,185 32,825
BALANCE SHEET DATA
Cash and short-term investments $ 49,297 $ 51,709 $ 77,181 $ 35,703 $ 18,911
Working capital 109,023 84,366 72,520 38,209 15,682
Total assets 276,653 193,905 117,126 67,310 24,373
Stockholders' equity 202,423 147,414 92,867 53,031 17,651
|
* Reflects the three-for-two stock splits effective August 2000, January 2001, and August 2001
CRITICAL ACCOUNTING POLICIES
We have identified the most critical accounting policies for our Company. These critical policies involve the most complex or subjective decisions or assessments and consist of warranty reserves, sales return reserves, the allowance for doubtful accounts, inventory valuation, and intangible asset valuation.
WARRANTY RESERVES
The product warranty reserve includes the cost to manufacture (raw materials, labor and overhead) or purchase warranty parts from our suppliers as well as the cost to ship those parts to our customers. In addition, the cost of a technician to install a warranted part on our manufactured commercial equipment is also included. The warranty reserve is based on our historical experience with each product. A warranty reserve is established for new products based on historical experience with similar products, adjusted for any technological advances in manufacturing or materials used. Thorough testing of new products in the development stage helps to identify and correct potential warranty issues prior to manufacturing. Continuing quality control efforts during manufacturing limit our exposure to warranty claims. We track warranty claims by part and reason for claim in order to identify any potential warranty trends. If our quality control efforts were to fail to detect a fault in one of our products, we could experience an increase in warranty claims resulting in an increase in the warranty reserve. In addition, if we were to experience a significant number of warranty claims for a particular part or for a particular reason, we may need to make design changes to our product, some of which may be required for our warranted products. A change in warranty experience could have a significant impact on our financial position, results of operations and cash flows.
SALES RETURN RESERVES
The sales return reserve is based on our historical experience of product returns during the trial period in which a customer can return a product for the full purchase price, less shipping and handling in most instances. The trial periods for Bowflex, Champion Nutrition, and Nautilus Sleep Systems product lines are six weeks, 30 days, and 90 days, respectively. Trial periods are not offered on our other product lines. We track all product returns in order to identify any potential customer satisfaction trends. Our return reserve may be sensitive to a change in our customers' ability to pay during the trial period due to unforeseen economic circumstances and to different product introductions that might fulfill the customers' needs at a perceived better value. Any major change in the aforementioned factors may increase sales returns, which could have a significant impact on our financial position, results of operations and cash flows.
ALLOWANCE FOR DOUBTFUL ACCOUNTS
The allowance for doubtful accounts is based on our historical experience adjusted for any known uncollectible amounts. We periodically review the creditworthiness of our customers to help ensure collectibility. Our allowance is sensitive to changes in our customers' ability to pay due to unforeseen changes in the economy, including the bankruptcy of a major customer, our efforts to actively pursue collections, and increases in chargebacks. Any major change in the aforementioned factors may result in increasing the allowance for doubtful accounts, which could have a significant impact on our financial position, results of operations and cash flows.
INVENTORY VALUATION
Our inventory is valued at either the lower of cost (standard or average depending on location) or market. Inventory adjustments are required for any known obsolete or defective products. We periodically review inventory levels of
INTANGIBLE ASSET VALUATION
Intangible assets predominantly consist of the Nautilus, Schwinn, and StairMaster trademarks and goodwill associated with the acquisition of Schwinn Fitness. Management estimates affecting these trademark and goodwill valuations include determination of useful lives, and estimates of future cash flows and fair values to perform the annual impairment analysis. The useful lives assigned by management to the Nautilus, Schwinn, and StairMaster trademarks and Schwinn Fitness goodwill are indefinite, 20 years, indefinite, and indefinite, respectively. Any major change in the useful lives and/or the determination of an impairment associated with the valuation of the aforementioned intangible assets may result in asset value write-downs, which could have a significant impact on our current and future financial position and results of operations.
This discussion and analysis should be read in conjunction with our consolidated financial statements and related notes included elsewhere in this report. We believe that period-to-period comparisons of our operating results are not necessarily indicative of future performance. You should consider our prospects in light of the risks, expenses and difficulties frequently encountered by companies experiencing rapid growth and, in particular, rapidly growing companies that operate in evolving markets. We may not be able to successfully address these risks and difficulties. Although we have experienced net sales growth in recent years, our net sales growth may not continue, and we cannot assure you of any future growth or profitability.
The following table presents certain financial data as a percentage of net sales:
Year Ended December 31,
-----------------------
Statement of Operations Data 2002 2001 2000
Net sales 100.0 % 100.0 % 100.0 %
Cost of sales 43.2 38.7 33.7
----- ----- -----
Gross profit 56.8 61.3 66.3
----- ----- -----
Operating expenses:
Selling and marketing 24.9 27.4 32.8
General and administrative 4.4 4.3 4.0
Royalties 1.7 2.0 2.2
----- ----- -----
Total operating expenses 31.0 33.7 39.0
----- ----- -----
Operating income 25.8 27.6 27.3
Other income 0.3 1.2 1.8
----- ----- -----
Income before income taxes 26.1 28.8 29.1
Income tax expense 9.4 10.5 10.5
----- ----- -----
Net income 16.7 % 18.3 % 18.6 %
===== ===== =====
|
NET SALES
Net sales increased by 60.7% to $584.6 million in 2002 from $363.9 million in 2001. Excluding our acquisitions of Schwinn Fitness and StairMaster, sales grew by approximately 32.6% on a consolidated basis in 2002 compared to 2001. The increase in sales was driven by the growth in our direct segment and continued expansion of our commercial/retail business.
Sales in our direct segment are comprised primarily of sales from our Bowflex product line. However, as sales from our Nautilus Sleep Systems product line continue to grow, they have become an increasingly important component of our direct segment business. Sales within our direct segment were $392.6 million in 2002, an increase of 34.2% over 2001. A significant reason for the increase in direct segment sales can be attributed to the introduction of our high-end Bowflex "Ultimate" at the end of the fourth quarter of 2001. The "Ultimate" has been well received by consumers leading to sequential growth in the average selling price of our Bowflex product line in each quarter since its introduction. The average Bowflex selling price increased 11.5% in the fourth quarter of 2002 compared to the same period in 2001. Our direct-marketing business is largely dependent upon national cable television advertising. We experienced changes in the advertising environment in the second half of 2002 as costs rose for the first time in two years due to heightened demand for advertising time. As a result of this higher advertising cost environment, fourth quarter direct segment revenue showed year-over-year growth but not sequential growth as we managed our advertising spending to optimize profitability.
We believe two unusual events affected sales in late 2001 and the first half of 2002: the nesting effect as a result of the events of September 11, 2001 and the high availability of television advertising time. Both of these contributed very positively to Bowflex sales during the first half of 2002. As evidenced by results in the last part of 2002, the nesting effect of September 11, 2001 seems to be receding, and the advertising environment has changed considerably.
Our direct segment accounted for 67.2% of our aggregate net sales in 2002, down from 80.4% in 2001, as we continued our strategies of diversification into the commercial and retail markets and of introducing new direct-marketed products.
Sales within our commercial/retail segment were $192.0 million in 2002, an increase of 169.3% over 2001. A significant portion of this growth is attributed to the acquisition of Schwinn Fitness in September 2001 and StairMaster in February 2002. Our commercial/retail segment now accounts for 32.8% of our net sales, up from 19.6% in 2001 as we continue to execute our strategy of expanding our presence, product lines, and brands across all our channels, especially within the commercial/retail segment. In August of 2002, we expanded our product lines with the introduction of 16 new retail products. The new retail products branded under our Nautilus name include treadmills, stationary bicycles, an elliptical motion trainer, home strength equipment, and heart rate monitors. We also introduced new products under our Schwinn brand name including indoor cycling bicycles and an elliptical motion trainer. In addition to the 16 new retail products, many of our existing products were updated and enhanced. We began shipping the majority of our new products late in the fourth quarter of 2002.
We believe our business will continue to show considerable seasonality going forward. In our direct marketing business we have found that second quarter influences on television viewership, such as the broadcast of national network season finales and seasonal weather factors, cause our spot television commercials on national cable television to be less effective in the second quarter than in other periods of the year. Additionally, we have found that advertising availability during the fourth quarter is more limited due to an increase in annual holiday advertising and political advertisements during election years. Our retail business is also highly seasonal. We believe that sales within our commercial/retail segment are considerably lower in the second quarter of the year compared to the other quarters. Our strongest quarter for the commercial/retail segment is generally
GROSS PROFIT
Gross profits continued to be strong, growing 48.9% to $332.3 million in 2002 from $223.2 million in 2001. However, due to our product diversification strategy, which has increased sales of inherently lower margin products in the commercial/retail segment, our overall gross profit margin decreased to 56.8% in 2002, compared to 61.3% in 2001. We expect this trend to continue as we increase sales in the commercial/retail segment of the market relative to our total sales.
The gross profit margin within our direct segment was 73.4% in 2002 and 69.8% in 2001. Gross margins on our Bowflex product line continue to be very strong as we gain cost reductions from vendors and shipping cost savings. For example, the standard cost for the Bowflex "Power Pro" with a 210-pound rod pack was reduced approximately 18% by the fourth quarter of 2002 compared with the same period in 2001. In addition, product delivery costs were reduced by approximately 17% by the end of the fourth quarter of 2002 compared with the same period in 2001.
The decrease in gross profit margin within our commercial/retail segment to 23.0% in 2002, compared with 26.4% in 2001, was largely due to the Schwinn Fitness and StairMaster acquisitions. Other downward pressure on commercial/retail margins included discounts offered on sales of discontinued retail products and manufacturing inefficiencies associated with moves and the consolidation of our treadmill facilities. Discounts were offered to reduce inventory levels of older products in order to accommodate 16 new retail fitness products that were introduced during the third quarter.
OPERATING EXPENSES
SELLING AND MARKETING. Selling and marketing expenses grew to $145.3 million in 2002 from $99.8 million in 2001, an increase of 45.5%. This increase in selling and marketing expenses resulted primarily from the expansion of our direct marketing campaign for Bowflex products and Nautilus Sleep Systems, higher advertising costs in the second half of 2002 due to increased demand for advertising time, and the acquisitions of Schwinn Fitness and StairMaster. Advertising costs for our direct marketing segment rose for the first time in about two years, and we expect costs to remain at higher levels during 2003. We experienced an increase of approximately 13% in advertising costs from the fourth quarter of 2001 to the fourth quarter of 2002. We expect to materially increase our cash expenditures on spot commercials and infomercials as we anticipate rates to remain higher than we experienced in the first half of 2002 and as we expand the direct marketing campaigns for our Nautilus Sleep Systems as well as our new TreadClimber, which we introduced in the first quarter of 2003.
As a percentage of net sales, overall selling and marketing expenses decreased to 24.9% in 2002 from 27.4% in 2001. The decrease was primarily a result of executing our product diversification strategy leading to a higher proportion of commercial/retail segment sales. Selling and marketing expenses within our direct segment were 30.9% of net sales in 2002, compared to 31.3% in 2001.
GENERAL AND ADMINISTRATIVE. General and administrative expenses grew to $25.9 million in 2002 from $15.6 million in 2001, an increase of $10.3 million, or 66.3%. Our commercial/retail segment accounted for $7.4 million of the increase due primarily to our Schwinn Fitness and StairMaster acquisitions. Our direct segment accounted for the remaining increase of $2.9 million due primarily to increased staffing and
ROYALTIES. Royalty expense grew to $10.1 million in 2002 from $7.4 million in 2001, an increase of 37.3%. Both our direct and commercial/retail segments have several royalty agreements. The increase in our royalty expenses is primarily attributable to the increased sales of our Bowflex products, along with sales of other products under royalty agreements that have been added as part of our diversification strategy. The patent for the Bowflex Power Rod resistance technology expires on April 27, 2004. The Company will no longer be obligated to pay royalties related to Bowflex sales following the expiration of this patent.
OTHER INCOME
In 2002, other income was $1.9 million compared to $4.4 million for 2001. This decline resulted primarily from a decrease in interest earned on invested cash and cash equivalents. Because we used a significant portion of our cash for acquisitions and stock buybacks, we had less cash from which to derive interest income. Interest income also decreased due to interest rate cuts by the Federal Reserve Bank in 2002.
INCOME TAX EXPENSE
Income tax expense increased by $16.8 million for 2002 primarily due to the growth in our income before taxes. The decrease in our effective tax rate from 36.5% in 2001 to 36.0% in 2002 is due to state income tax issues relating to our commercial and retail business increasing our 2001 rate while the 2002 rate is in line with our historical experience. We expect our income tax expense to increase in line with our growth in income before taxes.
NET INCOME
For the reasons discussed above, net income grew to $97.9 million in 2002 from $66.6 million in 2001, an increase of 47.0%. Our net income as a percentage of sales, though down from 18.3% in 2001, was a strong 16.7% in 2002. The expansion of our commercial/retail segment business and product lines during 2002 resulted in a decline in net income as a percentage of sales, but increased net income in real dollars.
COMPARISON OF THE YEARS ENDED DECEMBER 31, 2001 AND DECEMBER 31, 2000
NET SALES
Net sales grew by 62.5% to $363.9 million in 2001 from $223.9 million in 2000. Sales were driven by the growth in our direct segment and our continued expansion into the commercial and retail market segments. In 2001, we capitalized on favorable advertising costs and availability to increase the consumer awareness of our Bowflex and Nautilus Sleep System product lines. Meanwhile, we continued to expand our market share in the commercial/retail products segment, where we grew the Nautilus brand and successfully integrated the acquisition of the Schwinn Fitness business.
Sales in our direct segment were comprised primarily of sales of our Bowflex product line; however, as the Nautilus Sleep Systems product line continued to grow, it also became an increasingly important component of our direct business. Sales within our direct products segment were $292.5 million in 2001, an increase of 47.7% over the prior year. Our direct segment accounted for 80.4% of our aggregate net sales in 2001, down from 88.5% in 2000, as we continued our strategies of diversification into the commercial and retail products segments and of introducing new direct-marketed products.
Sales within our commercial/retail products segment were $71.3 million in 2001, an increase of 176.2% over 2000. Our commercial/retail segment accounted for 19.6% of our net sales, up from 11.5% in 2000 as we
GROSS PROFIT
Gross profits continued to be strong, growing 50.4% to $223.2 million in 2001, from $148.4 million in the same period a year ago. However, due to our product diversification strategy, which increased sales in the commercial/retail segment, and due to the inherent lower margins in that segment, our overall gross profit margin decreased to 61.3% in 2001, from 66.3% in 2000. The gross profit margin within our direct products segment was 69.8% in 2001 and 70.2% in 2000. The decrease in gross margins within our commercial/retail products segment to 26.4% in 2001, compared with 36.2% in 2000, was largely due to the Schwinn Fitness acquisition and higher research and development expenditures for the Nautilus retail fitness products.
OPERATING EXPENSES
SELLING AND MARKETING. Selling and marketing expenses grew to $99.8 million in 2001 from $73.5 million in 2000, an increase of 35.8%. This increase in selling and marketing expenses resulted primarily from the expansion of our direct marketing campaign for Bowflex products and Nautilus Sleep Systems and variable costs associated with our sales growth.
As a percentage of net sales, overall selling and marketing expenses decreased to 27.4% in 2001 from 32.8% in 2000. The decrease was a result of our planned product diversification efforts leading to a higher proportion of commercial/retail product sales. We also benefited from the increased availability of advertising time and the reduction of advertising rates due to the dramatic reduction of dot.com media spending, the effects of September 11, 2001, and the economic downturn. Selling and marketing expenses within our direct products segment were 31.3% of net sales in 2001, compared to 33.9% in 2000.
GENERAL AND ADMINISTRATIVE. General and administrative expenses grew to $15.6 million in 2001 from $8.8 million in 2000, an increase of 76.9%. Our direct segment business accounted for $4.0 million of the increase, due primarily to increased staffing and infrastructure expenses necessary to support our growth. Our commercial/retail operations accounted for the remaining increase primarily due to our product diversification strategy. As a percentage of net sales, general and administrative expenses increased to 4.3% in 2001 from 3.9% in 2000.
ROYALTIES. Royalty expense grew to $7.4 million in 2001 from $5.0 million in 2000, an increase of 47.9%. Both our direct and commercial/retail segments have several royalty agreements. The increase in our royalty expenses was primarily attributable to the increased sales of our Bowflex products, along with sales of other products under royalty agreements that have been added as part of our diversification strategy.
OTHER INCOME
In 2001, other income was $4.4 million compared to $4.0 million for 2000. The increase resulted primarily from an increase in interest earned on invested cash and cash equivalents due to higher invested cash amounts. The increase was somewhat offset by considerable interest rate cuts by the Federal Reserve Bank in 2001.
Income tax expense increased by $14.8 million for 2001 primarily due to the growth in our income before taxes. The increase in our effective tax rate to 36.5% in 2001 from 36.0% in 2000 was due to state income tax issues relating to our commercial/retail business segment.
NET INCOME
For the reasons discussed above, net income grew to $66.6 million in 2001 from $41.6 million in 2000, an increase of 60.0%. Not only were we able to maintain a high sales growth rate, but we also complemented that with control over our expenses, which grew only marginally as a percentage of sales from 2000. Higher sales, coupled with controlling our expenses, translated into strong net income growth in 2001.
QUARTERLY RESULTS OF OPERATIONS
The following table presents our operating results for each of the eight quarters in the period ended December 31, 2002. The information for each of these quarters is unaudited and has been prepared on the same basis as the audited financial statements appearing elsewhere in this Annual Report on Form 10-K. In the opinion of management, all necessary adjustments, consisting only of normal recurring adjustments, have been included to present fairly the unaudited quarterly results when read together with our audited financial statements and the related notes. These operating results are not necessarily indicative of the results of any future period. Due to recent acquisitions within our commercial/retail segment, we expect heightened seasonality in our business. We expect sales in the second quarter to be weakest while the first and fourth quarter should be our strongest. The fourth quarter should be stronger than the first quarter.
QUARTER ENDED
-------------------------------------------------------------
In Thousands (except per share) March 31 June 30 September 30 December 31 Total
Fiscal 2002:
------------
Net sales $135,914 $140,408 $152,865 $155,463 $584,650
Gross profit 77,161 83,769 88,365 83,019 332,314
Operating income 36,968 39,737 39,194 35,156 151,055
Net income 23,958 25,826 25,059 23,044 97,887
Earnings per share:
Basic 0.68 0.73 0.72 0.69 2.84
Diluted 0.67 0.72 0.71 0.69 2.79
Fiscal 2001:
------------
Net sales $ 74,855 $ 75,009 $ 88,702 $125,296 $363,862
Gross profit 49,551 49,237 55,691 68,684 223,163
Operating income 21,534 21,531 25,196 32,152 100,413
Net income 14,739 14,550 16,764 20,530 66,583
Earnings per share:
Basic * 0.42 0.41 0.48 0.59 1.89
Diluted * 0.41 0.40 0.46 0.57 1.85
|
* Reflects the three-for-two stock splits effective January 2001 and August 2001.
Historically, we have financed our growth and acquisitions primarily from cash generated by our operating activities. During 2002, our operating activities generated $100.6 million in net cash, which contributed to an aggregate $31.7 million balance in cash and cash equivalents and $17.6 million of short-term investments, compared with $66.9 million and $52.8 million net cash generated by our operating activities in 2001 and 2000, respectively.
Net cash used in our investing activities decreased in 2002 to $57.9 million, from $94.3 million in 2001, which was up substantially from $8.7 million in 2000. The 2002 activity was primarily due to capital expenditures of $31.5 million and the acquisition of StairMaster for $24.1 million, net of cash acquired. The 2001 activity was primarily the acquisition of Schwinn Fitness for $69.8 million, including acquisition costs and $16.1 million of net purchases of short-term investments. Our capital expenditures in 2002 primarily consisted of land and buildings, manufacturing equipment, and computer systems and related equipment. We invested $16.7 million in capital expenditures for our direct segment computer systems and related equipment to support the growth of the business. We purchased land and a building in Colorado for $6.7 million, including improvements, which serve as the commercial/retail segment headquarters. We also purchased land and buildings in Texas and Virginia for $3.1 million, including improvements, which serve as manufacturing and warehouse facilities. We invested $2.3 million in tooling for manufacturing our new products. We invested $1.7 million at our corporate headquarters in Washington to consolidate our Washington operations and to expand our call center. Finally, we invested $1.5 million in 2002 for net purchases of short-term investments.
Net cash used in financing activities increased to $47.2 million from $14.0 million in 2001 and $2.6 million in 2000. Increased use of funds for stock repurchases during 2002 and 2001 resulted in the increase in net cash used. In 2002 we repurchased $50.0 million of stock and received $2.7 million for stock option exercises. In 2001 we repurchased $16.3 million of stock and received $2.3 million for stock option exercises.
Our working capital needs have increased as we continue to implement our growth strategy. Working capital in 2002, 2001 and 2000 was $109.0 million, $84.4 million and $72.5 million, respectively. We anticipate that our working capital requirements will increase going forward as a result of us growing our commercial/retail segment through our acquisition strategy and internal growth. We also expect to materially increase our cash expenditures on spot commercials and infomercials as we expect advertising rates to remain higher than we experienced in the first half of 2002 and as we expand the direct marketing campaigns for our Nautilus Sleep Systems and our newly introduced TreadClimber. Commercial/retail segment inventories increased in anticipation of increased sales, especially of new products and the addition of inventories associated with the acquisition of StairMaster. The $25.2 million increase in trade receivables can primarily be attributed to the fourth quarter sales in 2002 being heavily back-end loaded as most of the 16 new retail products were received for sale late in the quarter. Also contributing to the increase in receivables was the acquisition of StairMaster. We expect that our working capital will increase going forward as a result of our anticipated future profitability.
We maintain a $10 million line of credit with U.S. Bank National Association. 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 the covenants applicable to the line of credit, and there is no outstanding balance under the line.
As of December 31, 2002, we had no contractual capital obligations or commercial commitments other than operating leases, which are described in Note 8 of the Notes to Consolidated Financial Statements.
We believe our existing cash balances, cash generated from operations and borrowings available under our line of credit, will be sufficient to meet our capital requirements for the foreseeable future.
INFLATION AND PRICE INCREASES
Although we cannot accurately anticipate the effect of inflation on our operations, we do not believe that inflation has had, or is likely in the foreseeable future to have, a material adverse effect on our results of operations, cash flows or our financial position. However, increases in inflation over historical levels or uncertainty in the general economy could decrease discretionary consumer spending for products like ours. Very little of our revenue growth is attributable to price increases.
RISKS AND UNCERTAINTIES
While management is optimistic about the Company's long-term prospects, the following issues and uncertainties, among others, should be considered in evaluating our growth outlook.
A SIGNIFICANT DECLINE IN AVAILABILITY OF MEDIA TIME OR A MARKED INCREASE IN ADVERTISING RATES MAY HINDER OUR ABILITY TO EFFECTIVELY MARKET OUR PRODUCTS AND MAY REDUCE PROFITABILITY.
We depend primarily on 60-second "spot" television commercials and 30-minute television "infomercials" to market and sell our direct-marketed products. Consequently, a marked increase in the price we must pay for our preferred media time or a reduction in its availability may adversely impact our financial performance.
UNFAVORABLE ECONOMIC CONDITIONS OR GEOPOLITICAL UPHEAVAL COULD CAUSE A DECLINE IN CONSUMER SPENDING AND HINDER OUR PRODUCT SALES.
The success of each of our products depends substantially on the amount of discretionary funds available to consumers and their purchasing preferences. Economic and political uncertainties could continue to adversely impact the U.S. and international economic environment. A continued decline in economic conditions could further depress consumer spending, especially discretionary spending for premium priced products lik