WASHINGTON 3949 943002667 (State or other (Primary Standard (I.R.S. Employer jurisdiction of Industrial Identification incorporation or Classification Code Number) organization) Number) |
(Address, including zip code, and telephone number, including area code, of registrant's principal executive offices)
(Name, address, including zip code, and telephone number, including area code, of agent for service)
COPIES TO:
BRUCE A. ROBERTSON NOLAN S. TAYLOR
MICHAEL J. KING SAMUEL P. GARDINER
Garvey, Schubert & Barer LeBoeuf, Lamb, Greene & MacRae, L.L.P.
1191 Second Avenue, 18th Floor 1000 Kearns Building
Seattle, WA 98101-2939 136 South Main Street
Salt Lake City, UT 84101-1685
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If any of the securities being registered on this Form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933, check the following box: / /
If this Form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, please check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering: / /
If this Form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement or the earlier effective registration statement for the same offering: / /
If this Form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering: / /
If delivery of this Prospectus is expected to be made pursuant to Rule 434,
please check the following box: / /
THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(A) OF THE SECURITIES ACT OF 1933 OR UNTIL THE REGISTRATION STATEMENT SHALL BECOME EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SAID SECTION 8(A), MAY DETERMINE.
THE INFORMATION IN THIS PROSPECTUS IS NOT COMPLETE AND MAY BE CHANGED. WE MAY NOT SELL THESE SECURITIES UNTIL THE REGISTRATION STATEMENT FILED WITH THE SECURITIES AND EXCHANGE COMMISSION IS EFFECTIVE. THIS PROSPECTUS IS NOT AN OFFER TO SELL THESE SECURITIES, AND IT IS NOT SOLICITING AN OFFER TO BUY THESE SECURITIES IN ANY STATE WHERE THE OFFER OR SALE IS NOT PERMITTED.
Our common stock currently trades on the Toronto Stock Exchange under the symbol DFX. This is our first public offering in the United States. We expect the initial public offering price to be between $19.00 and $21.00 per share. We have filed an application for our common stock to be listed on the Nasdaq National Market under the symbol DFXI.
We are offering 825,000 shares of common stock and the selling shareholders identified in this prospectus are offering an additional 175,000 shares of common stock. The underwriters also hold an option to purchase up to an additional 150,000 shares from us to cover over-allotments, which the underwriters must exercise within 30 days after the date of this prospectus. We will not receive any proceeds from the sale of common stock by the selling shareholders.
UNDERWRITING PROCEEDS TO
PRICE TO DISCOUNTS AND PROCEEDS TO SELLING
PUBLIC COMMISSIONS THE COMPANY SHAREHOLDERS
------------------ ------------------ ------------------ ------------------
Per Share..................... $ $ $ $
Total......................... $ $ $ $
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Neither the Securities and Exchange Commission nor any state securities commission has approved or disapproved of these securities or determined if this prospectus is truthful or complete. Any representation to the contrary is a criminal offense.
D.A. DAVIDSON & CO. FIRST SECURITY VAN KASPER
The date of this Prospectus is , 1999
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PAGE
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Prospectus Summary............................. 3
Risk Factors................................... 6
Use of Proceeds................................ 11
Market Price of our Common Stock and Dividend
Policy....................................... 12
Capitalization................................. 13
Dilution....................................... 13
Selected Financial Data........................ 14
Management's Discussion and Analysis of
Financial Condition and Results of
Operations................................... 16
Business....................................... 25
PAGE
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Management..................................... 39
Certain Relationships and Related
Transactions................................. 44
Principal and Selling Shareholders............. 45
Underwriting................................... 46
Description of Capital Stock................... 48
Shares Eligible for Future Sale................ 49
Legal Matters.................................. 50
Experts........................................ 50
Additional Information......................... 51
Index to Financial Statements.................. F-1
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YOU SHOULD RELY ONLY ON THE INFORMATION CONTAINED IN THIS DOCUMENT. WE HAVE NOT AUTHORIZED ANYONE TO PROVIDE YOU WITH INFORMATION THAT IS DIFFERENT. THIS DOCUMENT MAY ONLY BE USED WHERE IT IS LEGAL TO SELL THESE SECURITIES.
As used in this prospectus, the terms "we," "our," "us," "Direct Focus" and "the Company" refer to Direct Focus, Inc. and its subsidiaries. The names Bow-Flex-Registered Trademark-, Nautilus-Registered Trademark-, Bowflex Power-Pro-Registered Trademark-, Motivator-Registered Trademark-, Versatrainer-Registered Trademark- and Power Rod-Registered Trademark- are registered trademarks of Direct Focus, Inc. We have filed trademark applications for the names Direct Focus-TM- and Instant Comfort-TM-. Except where we state otherwise, we present the information in this prospectus assuming no exercise of the underwriters' over-allotment option.
UNTIL , 1999 (25 DAYS AFTER THE COMMENCEMENT OF THE OFFERING), ALL DEALERS THAT EFFECT TRANSACTIONS IN THESE SECURITIES, WHETHER OR NOT PARTICIPATING IN THIS OFFERING, MAY BE REQUIRED TO DELIVER A PROSPECTUS. THIS IS IN ADDITION TO THE DEALER'S OBLIGATION TO DELIVER A PROSPECTUS WHEN ACTING AS AN UNDERWRITER AND WITH RESPECT TO UNSOLD ALLOTMENTS OR SUBSCRIPTIONS.
Along the left border of a fold-out page is a shaded column with the Direct Focus logo atop the column, beneath which is the following text: "A rapidly growing direct marketing company that:". Below the logo and text are the following bullet points: (1) "Develops and markets high-end, branded consumer products through spot television commercials and infomercials, the internet and print media"; and (2) "Recently solidified its presence in the health and fitness market by acquiring the Nautilus product line and brand name."
Adjacent to the first column are three additional columns that depict and
briefly describe the Company's products. Atop the first product column is the
Bowflex logo, beneath which is a picture of a male torso and the following text:
"Fitness, weight loss and muscle building in one convenient, easy to use
machine!" Below this are pictures of the Company's eight Bowflex machines,
labeled "Power Pro," "Power Pro XT," "Power Pro XTL," "Power Pro XTLU,"
"Motiviator," "Motivator XT," "Motivator XTL" and "Versatrainer." Adjacent to
the Bowflex images are the following four bullet points: (1) "Seven strength
training machines designed for home use"; (2) "One strength training machine
designed for wheel chair users"; (3) "Patented design and technology"; and (4)
"A complementary line of accessory equipment." Below these bullet points is a
close-up picture of the Company's Bowflex Power Rods with the following text:
"Each Bowflex fitness machine uses our patented Power Rod-Registered Trademark-
technology and comes with 210 pounds of resistance that can be upgraded to
deliver over 400 pounds of resistance."
Atop the second product column is the Nautilus logo. Under the logo is a picture of a Nautilus fitness machine and a shaded Nautilus shell in the background, with the following caption: "The equipment that has been making America stronger for over 30 years!" Below the picture and caption are pictures of ten Nautilus machines, labeled "Pec Fly," "Lateral Raise," "Abdominal," "Low Back," "Bench Press," "Compound Row," "Leg Extension," "Triceps Ext.," "Preacher Curl" and "Seated Leg Curl." Adjacent to these pictures are the following bullet points: (1) "27 all new strength training machines"; (2) "Patented technology and design"; (3) "A full free weight equipment line"; and (4) "An extensive consumer fitness accessory line." Below the bullet points are pictures of three Nautilus fitness accessories (a handgrip, jump rope and dumbbells) with the following caption: "In addition to high quality commercial fitness equipment, our Nautilus business offers an extensive line of consumer fitness accessories."
Atop the third product column is the Nautilus Sleep Systems logo. Below the
logo is a picture of the Company's airbed mattress in a bedroom setting with the
Company's Instant Comfort logo and the following caption: "Our airbeds allow
users to control the comfort and firmness of their sleeping surface." Below the
picture and caption are pictures of the Company's airbed product line, labeled
"The Ultimate Premier Series," "The Premier Series," "The Signature Series" and
"The Basic Series." Adjacent to these pictures are the following bullet points:
(1) "Four luxury air support sleep systems available in all standard sizes"; (2)
"Patent pending technology and design"; and (3) "A complementary accessory
line." Below the bullet points are pictures of the product components with the
following caption: "Inside our premier air bed sleep system are dual variable
firmness support chambers that allow users to independently control the firmness
on each side of the bed. Our directly connected remote permits easy
adjustments."]
This summary highlights selected information from this prospectus and does not contain all of the information that you need to consider before purchasing our common stock. You should read the entire prospectus carefully, including the financial statements and related notes appearing elsewhere in this prospectus, in order to make an informed investment decision.
Direct Focus is a rapidly growing, direct marketing company that develops and markets premium quality, premium priced, branded consumer products. We market our consumer products directly to consumers through a variety of direct marketing channels, including spot television commercials, infomercials, print media, response mailings and the internet. Our principal and most successful directly marketed product to date has been our Bowflex line of home fitness equipment, and we recently developed and began testing a direct marketing campaign for a line of airbed mattress systems.
We have experienced recent rapid sales and earnings growth, based almost entirely on the strength of our Bowflex products. In 1998, we generated net income of $12.5 million on net sales of $57.3 million. This represents a 420.8% increase in net income and a 187.9% increase in net sales from 1997, when we generated net income of $2.4 million on net sales of $19.9 million.
In January 1999, we acquired substantially all of the assets of Nautilus International, Inc., the manufacturer and marketer of Nautilus brand commercial fitness equipment and consumer fitness accessories. Before the acquisition, Nautilus International suffered from several years of declining revenues and significant losses. In fiscal 1998, Nautilus International lost $14.8 million, of which $8.8 million constituted a one-time impairment charge, on net sales of $20.9 million. We believe that we can effectively integrate the Nautilus business into our operations and stabilize its financial performance. We also believe that Nautilus is one of the most recognized brand names in the fitness industry and possesses significant direct marketing potential.
We believe that we have been successful primarily because of the direct marketing expertise, systems and procedures we have developed and refined while directly marketing our Bowflex products. We have developed sophisticated database management systems, a state-of-the-art customer service call center and a system for accurately tracking our advertising success and customer buying habits. We believe this expertise and experience enable us to:
- Develop proprietary, branded product lines with broad consumer appeal that can be sold effectively through direct marketing channels;
- Develop and implement effective advertising and marketing strategies;
- Convert consumer interest and inquiries into sales;
- Effectively manage our product sourcing, manufacturing and distribution operations; and
- Provide excellent customer service.
We believe Direct Focus is well positioned to become a leading direct marketer of premium quality, premium priced consumer products. Key elements of our growth strategy include the following:
- Continue to grow sales of our highly successful Bowflex line of home fitness equipment by expanding our direct marketing campaign and continuing to introduce enhancements and additions for these products;
- Expand our direct marketing campaign for our newly introduced line of airbeds;
- Revitalize sales of Nautilus fitness equipment in the commercial market;
- Capitalize on the well-recognized Nautilus brand name by introducing and marketing consumer fitness equipment and related products under the Nautilus name;
- Capitalize on direct marketing and e-commerce opportunities presented by the internet, which currently generates 10.0% of our net sales; and
- Explore growth opportunities through strategic acquisitions that would enhance our direct marketing capabilities or our product lines.
Our principal executive offices are located at 2200 NE 65th Avenue, Vancouver, Washington 98661, and our telephone number is (360) 694-7722. We maintain web sites at www.bowflex.com, www.nautilus.com, www.nautilusdirect.com and www.instantcomfort.com. None of the information on our web sites is part of this prospectus.
Common stock offered.............................. 1,000,000 shares
Common stock offered by the Company............... 825,000 shares
Common stock offered by the selling
shareholders.................................... 175,000 shares
Common stock to be outstanding after this
offering........................................ 10,359,599 shares(1)
Common stock underlying over-allotment option..... 150,000 shares
Use of proceeds................................... Working capital, capital equipment
purchases and other general corporate
purposes.
Dividend policy................................... We have never declared or paid dividends
on our common stock and do not presently
intend to declare any dividends in the
near future.
Proposed Nasdaq National Market symbol............ DFXI
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(1) Based on 9,534,599 shares outstanding as of March 31, 1999. Includes 86,076 shares of common stock issued after December 31, 1998, upon the exercise of options. Excludes:
- 464,542 shares of common stock issuable upon the exercise of outstanding options; and
- 696,961 shares available for future issuance under our Stock Option Plan.
See "Management - Benefit Plans" for a description of our Stock Option Plan.
You should read the following summary financial information together with the financial statements and related notes and "Management's Discussion and Analysis of Financial Condition and Results of Operations" included elsewhere in this prospectus.
YEAR ENDED DECEMBER 31,
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HISTORICAL PRO FORMA(1)
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1994 1995 1996 1997 1998 1998
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(IN THOUSANDS, EXCEPT PER SHARE DATA) (UNAUDITED)
STATEMENT OF OPERATIONS DATA:
Net sales..................................... $ 4,415 $ 4,772 $ 8,517 $ 19,886 $ 57,297 $ 76,601
Gross profit.................................. 2,841 3,156 5,914 14,772 44,855 50,295
Operating income (loss)....................... (531) (59) 460 3,616 18,888 15,776
Net income (loss)............................. $ (510) $ 15 $ 693 $ 2,421 $ 12,485 $ 9,868
Basic earnings (loss) per share............... $ (0.06) $ 0.00 $ 0.08 $ 0.27 $ 1.34 $ 1.06
Diluted earnings (loss) per share............. $ (0.06) $ 0.00 $ 0.08 $ 0.25 $ 1.28 $ 1.01
WEIGHTED AVERAGE COMMON SHARES:
Basic outstanding shares...................... 8,132 8,132 8,558 8,987 9,337 9,337
Diluted outstanding shares.................... 8,132 8,132 8,943 9,511 9,726 9,726
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DECEMBER 31, 1998
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PRO FORMA
ACTUAL PRO AS
--------- FORMA(2) ADJUSTED(2)
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(UNAUDITED) (UNAUDITED)
BALANCE SHEET DATA:
Working capital......................................... $ 15,682 $ 2,772 $ 17,513
Total assets............................................ 24,373 27,431 42,172
Long-term liabilities................................... 67 166 166
Total stockholders' equity.............................. $ 17,651 $ $17,651 $ 32,392
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(1) The unaudited pro forma statement of operations data was prepared as if the Nautilus acquisition occurred on January 1, 1998. The data reflects certain adjustments for the effects of purchase accounting, certain assumptions regarding financing and cash management and an adjustment for income taxes. The data is not necessarily indicative of what our actual results would have been if the Nautilus acquisition had occurred on January 1, 1998, nor does it purport to indicate the future results of our operations. See "Management's Discussion and Analysis of Financial Condition and Results of Operations - Unaudited Pro Forma Combined Results of Operations" for a discussion of pro forma adjustments.
(2) The unaudited pro forma and pro forma as adjusted balance sheet data assumes that we consummated the Nautilus acquisition on December 31, 1998. The data reflects the effects of purchase accounting adjustments. These adjustments are set forth in our "Unaudited Pro Forma Combined Financial Statements - Pro Forma Combined Balance Sheet," included elsewhere in this prospectus. We also adjusted the pro forma as adjusted balance sheet data to give effect to this offering and the application of the net proceeds as described under "Use of Proceeds."
You should carefully consider the risks described below before making an investment decision. The risks and uncertainties described below are not the only ones facing our company. Our business, financial condition and results of operations could be materially adversely affected by any of the following risks. The trading price of our common stock could decline due to any of the following risks, and you might lose all or part of your investment.
A SIGNIFICANT DECLINE IN CONSUMER INTEREST IN BOWFLEX PRODUCTS WOULD SHARPLY DIMINISH OUR SALES AND PROFITABILITY.
Our financial performance depends significantly on sales of our Bowflex line of home fitness equipment. Any significant diminished consumer interest in our Bowflex products would sharply reduce our sales and profitability. In 1998, approximately 99.6% of our net sales were attributable to our Bowflex products.
WE ARE A RAPIDLY GROWING COMPANY, AND OUR FAILURE TO PROPERLY MANAGE GROWTH MAY ADVERSELY AFFECT OUR FINANCIAL PERFORMANCE.
Our financial performance may be harmed if we are unable to effectively manage our existing operations or our anticipated growth. We have grown significantly since 1996, with increases in net sales from $8.5 million in 1996 to $19.9 million in 1997 and $57.3 million in 1998. We also recently added substantial operations through our Nautilus acquisition and intend to continue to pursue an aggressive growth strategy. Our growth and the Nautilus acquisition have strained our management team, production facilities, information systems and other resources. See "Business - Growth Strategy" for a discussion of our growth strategies.
IF WE ARE UNABLE TO EFFECTIVELY INTEGRATE THE NAUTILUS BUSINESS INTO OUR OPERATIONS, WE MAY NOT ACHIEVE ANTICIPATED REVENUE, EARNINGS AND BUSINESS SYNERGIES.
We face significant challenges integrating our recently acquired Nautilus business into our operations, any of which could adversely affect the revenue, earnings and business synergies we expect from the acquisition. The distance between our Vancouver, Washington and Independence, Virginia facilities amplifies these challenges. Specifically, we must successfully integrate the following aspects of the Nautilus business into our operations:
- Manufacturing and other production facilities, including a new manufacturing management team;
- Employees, including those working in production, product development and administration;
- Marketing and product distribution systems, including a new marketing management team; and
- Administrative and financial policies and procedures.
OUR PROFITABILITY WILL DECLINE IF WE ARE UNABLE TO REVERSE NAUTILUS INTERNATIONAL'S RECENT LOSSES.
Prior to our Nautilus acquisition, Nautilus International had incurred several years of declining sales and accelerating losses. Unless our new Nautilus management team is able to revitalize commercial sales and reduce costs, our profitability will decline. For example, for the fiscal year ended June 27, 1998, Nautilus International had an operating loss of approximately $14.8 million, of which $8.8 million constituted a one-time impairment charge, on net sales of $20.9 million.
As a direct marketing company, our success depends on our key marketing, sales, technical and managerial personnel, including our recently hired Nautilus management team. The loss of any of our executive officers or other key personnel could adversely affect our business. All of our executive officers are under employment contracts, but none for longer than one year. We currently maintain key man life insurance policy in the amount of $500,000 on Brian R. Cook, our President and Chief Executive Officer.
WE HAVE LIMITED EXPERIENCE MARKETING AND SELLING OUR AIRBEDS, AND OUR AIRBEDS MAY NOT GENERATE THE NET SALES OR PROFITS WE ANTICIPATE.
We began test marketing our line of premium airbeds in August 1998, and therefore have limited operating experience with these products. If our marketing efforts are unsuccessful, or if we incur unexpected costs, our airbeds may not generate the net sales or profits we anticipate and our overall financial performance may be harmed.
OUR FINANCIAL PERFORMANCE WOULD BE HARMED IF WE ARE UNABLE TO SUCCESSFULLY DEVELOP OR DIRECTLY MARKET NEW CONSUMER PRODUCTS.
Our growth strategy and financial performance depend in part on our ability to develop or acquire the rights to, and then directly market, new consumer products. Our net sales and profitability would be harmed if we are unable to develop or acquire the rights to premium quality, premium priced consumer products that satisfy our direct marketing criteria. In addition, any new products that we directly market may not generate sufficient net sales or profits to justify their development or acquisition costs. See "Business - New Product Development and Innovation" for a discussion of our product development efforts.
A DECLINE IN CONSUMER SPENDING DUE TO UNFAVORABLE ECONOMIC CONDITIONS COULD HINDER SALES OF OUR CONSUMER PRODUCTS.
The success of each of our products depends substantially on how consumers decide to spend their money. Unfavorable economic conditions may depress consumer spending, especially for premium priced products like ours.
OUR FINANCIAL PERFORMANCE MAY BE VULNERABLE TO RAPIDLY CHANGING PREFERENCES IN THE CONSUMER FITNESS MARKET.
Our net sales and profitability depend significantly on the acceptance of our existing and future fitness products within the consumer fitness market. This market is characterized by rapidly changing fitness trends and fads, and frequent innovations and improvements are necessary to maintain consumer interest in fitness products. Our financial performance may be harmed if we are unable to successfully adapt our Bowflex and Nautilus consumer fitness products to these changing trends and fads.
GOVERNMENT REGULATORY ACTIONS COULD DISRUPT OUR DIRECT MARKETING EFFORTS AND PRODUCT SALES.
Various federal, state and local government authorities, including the Federal Trade Commission and the Consumer Products Safety Commission, regulate our direct marketing efforts and products. If any of these authorities commence a regulatory enforcement action that interrupts our direct marketing efforts or results in a product recall, our sales and profitability could be significantly harmed.
Our common stock has been publicly traded on the Toronto Stock Exchange since 1993, and we believe that as many as 8.3 million shares of our common stock will be freely tradable in the public market following this offering. Public sales of a substantial number of these shares could depress the market price for our common stock. See "Shares Eligible for Future Sale" for a more detailed discussion of our currently outstanding common stock and applicable resale restrictions.
AN ADVERSE OUTCOME FROM PENDING LITIGATION WITH SOLOFLEX, INC. COULD SIGNIFICANTLY HARM OUR FINANCIAL POSITION.
Soloflex, Inc., a company that manufactures and directly markets home fitness equipment, has filed an action against Direct Focus and Randal R. Potter, our Vice President of Marketing. If Soloflex successfully prosecutes any of its claims against us, our financial position could be significantly harmed. Although we intend to vigorously defend against Soloflex's claims, we cannot assure you that we will prevail in this dispute. Soloflex claims that we are improperly using certain slogans and images to market our Bowflex products and that we have misappropriated some of its marketing trade secrets. Soloflex has requested both monetary damages and injunctive relief. The requested injunctive relief would prohibit us from airing advertisements that allegedly would infringe upon Soloflex's intellectual property rights. See "Business - Legal Proceedings" for a more detailed description of the Soloflex litigation.
IF A UNITED STATES MARKET FOR OUR COMMON STOCK DOES NOT DEVELOP, SHAREHOLDER LIQUIDITY AND OUR STOCK PRICE COULD BE ADVERSELY AFFECTED.
We have applied to have our common stock listed for trading on Nasdaq, and we intend to delist our common stock from the Toronto Stock Exchange upon the completion of this offering. If an active United States market for our common stock fails to develop and our common stock is no longer publicly traded in Canada, our shareholders may have difficulty selling their shares and our stock price may decline.
WE MAY FAIL TO EFFECTIVELY IDENTIFY AND RESOLVE SIGNIFICANT YEAR 2000 PROBLEMS WITHIN OUR BUSINESS, OR IMPORTANT SUPPLIERS MAY BE UNABLE TO SUPPLY GOODS AND SERVICES TO US DUE TO YEAR 2000 PROBLEMS.
We may not accurately identify all potential Year 2000 problems within our business, and the corrective measures that we implement may be ineffective or incomplete. Any such problems could interrupt our ability to process orders and ship our products. The resulting costs could be significant and we could suffer a significant decrease in sales. Similar problems and consequences could result if any of our key suppliers, such as telephone companies, carriers, manufacturers, suppliers and our consumer credit facilitator, experience Year 2000 problems. See "Management's Discussion and Analysis of Financial Condition and Results of Operations - Year 2000 Compliance" for a more detailed discussion of Year 2000 issues as they affect our business.
WE HAVE A LIMITED OPERATING HISTORY ON WHICH YOU CAN BASE YOUR ANALYSIS OF OUR BUSINESS.
We altered our business plan in 1993 when we began our current direct marketing activities. Accordingly, we have only a limited operating history on which you can base your evaluation of our business and prospects. Despite our recent growth in sales and net income, we cannot assure that these trends will continue or that we will remain profitable.
Any material increase in the quantity of products returned by our customers for purchase-price refunds could adversely affect our financial performance. We have limited operating experience with our airbeds, which we began test marketing in August 1998, and therefore limited experience with the return rates for these products. See "Business - Products" for a discussion of our return policies.
OUR WARRANTY RESERVES MAY BE INSUFFICIENT TO COVER FUTURE WARRANTY CLAIMS, WHICH COULD ADVERSELY AFFECT OUR FINANCIAL PERFORMANCE.
We offer warranties on all of our principal products. If our warranty reserves are inadequate to cover future warranty claims on our products, our financial performance could be adversely affected. We have limited operating experience with our airbeds, which we began test marketing in August 1998, and therefore limited experience with warranty claims for these products. See "Business - Products" for a discussion of our warranty policies.
PRODUCT LIABILITY CLAIMS EXCEEDING OUR PRODUCT LIABILITY INSURANCE COVERAGE AND RESERVES COULD ADVERSELY AFFECT OUR BUSINESS.
We are subject to potential product liability claims if our products injure or allegedly injure our customers or other users. If our product liability insurance coverage and reserves fail to cover future product liability claims, we could become liable for significant monetary damages.
FUTURE ACQUISITIONS MAY DISRUPT OR OTHERWISE ADVERSELY AFFECT OUR BUSINESS.
As part of our growth strategy, we intend to explore strategic acquisitions that would enhance our direct marketing capabilities or our product lines. Future acquisitions are subject to the following risks that may negatively impact our financial performance and cause fluctuations in our operating results:
- Acquisitions may disrupt our ongoing operations and distract our management team;
- We may not be able to successfully integrate the products, services or personnel of the acquired businesses into our operations;
- We may acquire companies in markets in which we have little experience;
- Any acquisition may not produce the revenue, earnings or business synergies we anticipate; and
- An acquired product or technology may not perform as we expect.
To pay for an acquisition, we may use common stock or cash, including the proceeds of this offering. Alternatively, we may borrow money from banks or other lenders. If we use common stock, the ownership interest of our shareholders would be diluted. If we use cash or debt, our financial liquidity will be reduced.
CERTAIN RISKS IN OUR INTERNATIONAL OPERATIONS COULD INTERRUPT THE SUPPLY OF OUR PRODUCT COMPONENTS OR THE INTERNATIONAL DISTRIBUTION OF OUR NAUTILUS PRODUCTS.
We currently acquire many of our product components from foreign manufacturers and distribute our Nautilus products internationally. Our international operations are subject to the inherent risks of doing business abroad. The loss of certain foreign suppliers, customers or distributors could harm our ability to deliver our products on time and cause our sales to decline. Our financial performance could be materially adversely affected by many events and circumstances relating to our international operations, including:
- Shipping delays and cancellations;
- Foreign exchange rate fluctuations;
- Changes in foreign laws and regulations; and
- Political and economic instability.
INCREASES IN ADVERTISING RATES MAY REDUCE OUR PROFITABILITY.
We depend primarily on 60-second or "spot" television commercials and television infomercials to market our products. Consequently, the price we must pay for our preferred media time significantly affects our financial performance. If the cost of our preferred media time increases, it may increase our selling and marketing expenses and decrease our profitability. See "Business - Direct Marketing" for a more detailed discussion of our advertising efforts.
OUR SALES MAY MATERIALLY DECLINE IF OUR CUSTOMER SERVICE CALL CENTER STOPS OPERATING.
We receive and process almost all orders for our directly marketed products through our customer service call center. Our sales could materially decline if our call center stops operating for a significant time period. Our call center could stop operating for a number of reasons, including poor weather, natural disaster, fire or Year 2000 problems. If our backup facilities and contingency plans are ineffective to handle such problems, we could not sell our directly marketed products during the affected period. See "Business - Direct Marketing" for a more detailed description of our call center operations.
OUR FAILURE OR INABILITY TO PROTECT OUR INTELLECTUAL PROPERTY COULD SIGNIFICANTLY HARM OUR COMPETITIVE POSITION, AND WE COULD ALSO INCUR SUBSTANTIAL COSTS TO DEFEND CLAIMS THAT WE HAVE VIOLATED THE PROPRIETARY RIGHTS OF OTHERS.
Protecting our intellectual property is an important factor in maintaining our competitive position in the fitness and mattress industries. If we do not or are unable to adequately protect our intellectual property, our sales and profitability could be adversely affected. We currently hold a number of patents and trademarks and have several patent and trademark applications pending. However, our efforts to protect our proprietary rights may be inadequate and applicable laws provide only limited protection. For example, the patent on our Bowflex Power Rods, a key component of our Bowflex products, expires on April 27, 2004. In addition, we may not be able to successfully prevent others from claiming that we have violated their proprietary rights. We could incur substantial costs in defending against such claims, even if they are invalid, and we could become subject to judgments requiring us to pay substantial damages. For a more detailed discussion of our efforts to protect our intellectual property rights, see "Business - Intellectual Property."
CERTAIN ANTITAKEOVER PROVISIONS OF WASHINGTON LAW MAY REDUCE OUR STOCK PRICE.
As a Washington corporation, we are subject to the Washington Business Corporation Act. Certain antitakeover provisions of this Act may make it more difficult for a third party to acquire us, even if an acquisition would benefit our shareholders. Under the Act, a person who beneficially owns 10.0% or more of our common stock cannot engage in certain transactions with us, such as a merger, during the five-year period after the person becomes a 10.0% shareholder. The five-year waiting period would not apply if a majority of our board of directors gave advance approval to the transaction or share acquisition. See "Description of Capital Stock - Antitakeover Effects of Certain Provisions of Washington Law" for a more detailed discussion of the antitakeover provisions.
We expect to receive approximately $14,740,500 in net proceeds from the sale of the 825,000 shares of common stock in this offering. If the underwriters fully exercise their over-allotment option, we expect to receive an additional $2,775,000 in net proceeds. In calculating estimated net proceeds, we assume an offering price of $20.00 per share and take into account the underwriting discount and estimated offering expenses. We will not receive any proceeds from the sale of shares by the selling shareholders.
We intend to use the net proceeds of this offering for the following purposes and in the following order of priority:
PERCENTAGE OF
AMOUNT NET PROCEEDS
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Working capital..................................................... $ 8,240,500 55.9%
Capital equipment................................................... 1,500,000 10.2
General corporate................................................... 5,000,000 33.9
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Total............................................................... $ 14,740,500 100.0%
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We intend to direct the working capital proceeds toward such needs as increased direct marketing expenditures for our existing products, the growth of our Nautilus consumer product business, including the introduction of new Nautilus consumer products, and other working capital needs associated with our growth. We intend to direct our capital equipment proceeds toward such needs as the addition of a second product assembly and distribution center in the western United States and computer and related technology upgrades. We may use a portion of the general corporate proceeds for strategic acquisitions that would enhance our direct marketing capabilities or our product lines. Although we evaluate potential acquisitions from time to time, we are not currently negotiating any acquisitions, nor do we have any specific oral or written plans, agreements or commitments to enter into or consummate any such transactions.
The amounts that we actually expend for any of these purposes will vary significantly depending upon a number of factors, including future revenue growth, if any, the amount of cash we generate from operations and the progress of our product development efforts. As a result, we will retain broad discretion in allocating the net proceeds of this offering. Pending the uses described above, we will invest the net proceeds in short-term, interest-bearing, investment grade securities.
Our common stock has been listed on the Toronto Stock Exchange in the Province of Ontario, Canada, since January 26, 1993, and currently trades under the symbol DFX. Currently, there is no established trading market for our common stock in the United States. However, we have applied to have our common stock listed on Nasdaq under the symbol DFXI.
The following table summarizes the high and low sales prices for our common stock as reported on the Toronto Stock Exchange during the current year and the preceding two years. The prices listed below are in Canadian dollars, the currency in which they were quoted, and in United States dollars, which we calculated based on the currency exchange rate in effect on the date of each high and low quarterly price.
UNITED STATES
CANADIAN DOLLARS DOLLARS
-------------------- --------------------
HIGH LOW HIGH LOW
--------- --------- --------- ---------
1997
1(st) Quarter........................................ $ 1.60 $ 1.01 $ 1.16 $ 0.75
2(nd) Quarter........................................ 1.41 1.10 0.99 0.80
3(rd) Quarter........................................ 3.00 1.06 2.17 0.77
4(th) Quarter........................................ $ 4.00 $ 2.39 $ 2.80 $ 1.70
1998
1(st) Quarter........................................ $ 10.05 $ 3.50 $ 7.07 $ 2.45
2(nd) Quarter........................................ 15.00 10.00 10.48 7.05
3(rd) Quarter........................................ 18.00 11.80 12.09 7.67
4(th) Quarter........................................ $ 23.00 $ 10.50 $ 14.95 $ 6.80
1999
1(st) Quarter........................................ $ 28.00 $ 18.55 $ 18.39 $ 12.09
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As of March 31, 1999, 9,534,599 shares of our common stock were issued and outstanding and held of record by 81 shareholders. See "Shares Eligible for Future Sale" for a discussion of our outstanding common stock.
Payment of any future dividends is at the discretion of our board of directors, which considers various factors, such as our financial condition, operating results, current and anticipated cash needs and expansion plans. Our credit lines do not restrict the payment of dividends. To date, we have never declared or paid any cash dividends on our common stock and do not presently intend to declare any cash dividends in the near future. Instead, we intend to retain and direct any future earnings to fund our anticipated expansion and growth.
The following table describes our capitalization as of December 31, 1998:
- On an actual basis;
- On a pro forma basis to reflect the effects of the Nautilus acquisition, assuming the acquisition was consummated on December 31, 1998; and
- On an as adjusted basis to reflect our sale of 825,000 shares of common stock under this prospectus at an assumed public offering price of $20.00 per share, after deducting estimated underwriting discounts and offering expenses.
You should read this information in conjunction with our financial statements and notes thereto and with the unaudited pro forma combined financial statements, which appear elsewhere in this prospectus.
DECEMBER 31, 1998 (IN THOUSANDS)
-----------------------------------
ACTUAL
---------
PRO FORMA PRO FORMA
----------- AS ADJUSTED
-----------
(UNAUDITED)
(UNAUDITED)
Common Stock, no par value; 50,000,000 shares
authorized; 9,448,523 shares issued and outstanding,
actual; 10,273,523 shares issued and outstanding, as
adjusted(1)........................................... $ 3,566 $ 3,566 $ 18,307
Retained earnings....................................... 14,085 14,085 14,085
--------- ----------- -----------
Total stockholders' equity............................ 17,651 17,651 32,392
--------- ----------- -----------
Total capitalization.................................. $ 17,651 $ 17,651 $ 32,392
--------- ----------- -----------
--------- ----------- -----------
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(1) Excludes:
- 86,076 shares of common stock issued after December 31, 1998, upon the exercise of options;
- 464,542 shares of common stock issuable upon the exercise of outstanding options under our Stock Option Plan at a weighted average exercise price of $2.39 per share; and
- 696,961 shares available for future issuance under the Stock Option Plan.
See "Management - Benefit Plans" for a description of our Stock Option Plan.
As of December 31, 1998, we had a net tangible book value of approximately $17.5 million, or $1.85 per share of our common stock. Net tangible book value per share represents the amount of our total assets reduced by our total intangible assets and liabilities, divided by the number of shares of our common stock outstanding. After giving effect to the receipt of estimated net proceeds from our sale of 825,000 shares of common stock in this offering, at an assumed public offering price of $20.00 per share, our adjusted net tangible book value as of December 31, 1998, would have been approximately $32.2 million, or $3.13 per share. This represents an immediate increase in net tangible book value of $1.28 per share to existing shareholders and an immediate dilution of $16.87 per share to new investors. The following table illustrates this per share dilution:
Assumed public offering price per share......................................... $ 20.00
Net tangible book value per share before this offering.......................... $ 1.85
Increase per share attributable to new investors................................ 1.28
---------
Adjusted net tangible book value per share after this offering.................. 3.13
---------
Dilution per share to new investors............................................. $ 16.87
---------
---------
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SHARES PURCHASED AVERAGE
------------------------- TOTAL PRICE
NUMBER PERCENT CONSIDERATION PERCENT PER SHARE
------------ ----------- ------------- ----------- -----------
Existing shareholders(1).............................. 9,448,523 92.0% $ 3,565,628 17.8% $ 0.38
New investors(1)...................................... 825,000 8.0 16,500,000 82.2 20.00
------------ ----- ------------- -----
Total........................................... 10,273,523 100.0% $ 20,065,628 100.0%
------------ ----- ------------- -----
------------ ----- ------------- -----
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(1) Sales by the selling shareholders in this offering would reduce the number of shares held by existing shareholders to 9,273,523 shares, or approximately 90.3% of the total number of shares outstanding upon the closing of this offering, and the number of shares held by new investors would be 1,000,000, or approximately 9.7% of the total number of shares outstanding after this offering. See "Principal and Selling Shareholders" for more detailed information about the selling shareholders.
If the underwriters fully exercise their over-allotment option, our adjusted net tangible book value per share as of December 31, 1998, would have been $3.36 per share, which would have resulted in a dilution of $16.64 per share to new investors. In addition, the number of shares held by new investors would increase to 975,000, or 9.4% of the total number of shares outstanding upon the closing of this offering, and the number of shares held by existing shareholders would be 9,448,523 shares, or 90.6% of the total number of shares outstanding upon the closing of this offering.
The foregoing tables assume no exercise of any outstanding options to purchase Direct Focus common stock. As of December 31, 1998, options to purchase 550,618 shares of Direct Focus common stock were outstanding, of which options to purchase 309,199 shares were then exercisable. The weighted average exercise price of outstanding options was $2.39 per share, with actual exercise prices ranging between $0.12 and $9.75 per share. To the extent option holders exercise their options, new and existing investors will experience further dilution. See "Management - Benefit Plans" and Note 7 to our financial statements for more information about our Stock Option Plan and outstanding options.
The selected financial data presented below for, and as of the end of, each of the three years ended December 31, 1998, have been derived from our audited financial statements included elsewhere in this prospectus. The selected financial data for, and as of the end of, each of the years ended December 31, 1994, and December 31, 1995, have been derived from our audited financial statements that are not included herein.
The unaudited pro forma combined statement of operations data for the fiscal year ended December 31, 1998, contain certain adjustments and were prepared as if the Nautilus acquisition had occurred on January 1, 1998. In our management's opinion, all adjustments necessary to present fairly such pro forma financial statements have been made. The unaudited pro forma combined balance sheet was prepared as if the Nautilus acquisition had occurred on December 31, 1998. These unaudited pro forma financial statements are not necessarily indicative of what actual results would have been if the acquisition had occurred at the beginning of the period, nor do they purport to indicate the results of our future operations.
The selected financial data should be read in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations" and our financial statements and unaudited
YEAR ENDED DECEMBER 31,
------------------------------------------------------------------
HISTORICAL PRO FORMA
----------------------------------------------------- -----------
1994 1995 1996 1997 1998 1998(1)
--------- --------- --------- --------- --------- -----------
(IN THOUSANDS, EXCEPT PER SHARE DATA) (UNAUDITED)
STATEMENT OF OPERATIONS DATA
Net sales...................................... $ 4,415 $ 4,772 $ 8,517 $ 19,886 $ 57,297 $ 76,601
Cost of sales.................................. 1,574 1,616 2,603 5,114 12,442 26,306
--------- --------- --------- --------- --------- -----------
Gross profit................................... 2,841 3,156 5,914 14,772 44,855 50,295
Operating expenses
Selling and marketing........................ 2,834 2,644 4,712 9,600 22,643 28,373
General and administrative................... 393 370 473 975 1,701 4,523
Royalties.................................... 145 201 269 581 1,623 1,623
--------- --------- --------- --------- --------- -----------
Total operating expenses................... 3,372 3,215 5,454 11,156 25,967 34,519
--------- --------- --------- --------- --------- -----------
Operating income (loss)........................ (531) (59) 460 3,616 18,888 15,776
Other income (expense)
Interest income.............................. 16 26 37 119 527 --
Interest expense............................. (4) (3) (2) (1) (1) (388)
State business tax and other-net............. (22) (17) (51) (87) (221) (222)
--------- --------- --------- --------- --------- -----------
Total other income (expense)............... (10) 6 (16) 31 305 (610)
--------- --------- --------- --------- --------- -----------
Income (loss) before income taxes.............. (541) (53) 444 3,647 19,193 15,166
Income tax expense (benefit)................... (31) (68) (249) 1,226 6,708 5,298
--------- --------- --------- --------- --------- -----------
Net income (loss).............................. $ (510) $ 15 $ 693 $ 2,421 $ 12,485 $ 9,868
--------- --------- --------- --------- --------- -----------
--------- --------- --------- --------- --------- -----------
Basic earnings (loss) per share(2)............. $ (0.06) $ 0.00 $ 0.08 $ 0.27 $ 1.34 $ 1.06
Diluted earnings (loss) per share(2)........... $ (0.06) $ 0.00 $ 0.08 $ 0.25 $ 1.28 $ 1.01
Basic shares outstanding....................... 8,132 8,132 8,558 8,987 9,337 9,337
Diluted shares outstanding..................... 8,132 8,132 8,943 9,511 9,726 9,726
BALANCE SHEET DATA(3)
Cash and cash equivalents...................... $ 603 $ 756 $ 1,154 $ 4,790 $ 18,911 $ 2,711
Working capital................................ 1,015 1,063 1,973 4,100 15,682 2,772
Total assets................................... 1,940 2,150 3,515 7,922 24,373 27,431
Current liabilities............................ 654 858 1,281 3,330 6,655 9,614
Long term liabilities.......................... 27 18 14 -- 67 166
Total stockholders' equity..................... $ 1,259 $ 1,274 $ 2,220 $ 4,592 $ 17,651 $ 17,651
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(1) See "Management's Discussion and Analysis of Financial Condition and Results of Operations - Unaudited Pro Forma Combined Results of Operations" for a discussion of the adjustments included in the pro forma statement of operations data.
(2) Basic earnings per share have been computed by dividing net income by the weighted average number of shares of common stock outstanding during each period. Diluted earnings per share have been computed by dividing net income by the weighted average number of shares of common stock and common stock equivalents, such as stock options, outstanding during each period.
(3) See "Pro Forma Combined Balance Sheet, December 31, 1998," included elsewhere in this prospectus, for a discussion of the adjustments included in the pro forma balance sheet data.
You should read the following discussion of our financial condition and results of operations in conjunction with the financial statements and related notes included elsewhere in this prospectus. This section of the prospectus includes a number of forward-looking statements that reflect our current views with respect to future events and financial performance. We use words such as "anticipate," "believe," "expect," "future," "intend" and similar expressions to identify forward-looking statements. You should not unduly rely on these forward-looking statements, which apply only as of the date of this prospectus. These forward-looking statements are subject to certain risks and uncertainties that could cause actual results to differ materially from historical or anticipated results. For a discussion of some of these risks, see "Risk Factors" beginning on page 6.
OVERVIEW
We have generated substantial increases in net sales each year since 1996. Net sales increased from $8.5 million in 1996 to $19.9 million in 1997 and $57.3 million in 1998. A substantial portion of our net sales growth is attributable to our Bowflex Power Pro home fitness products. We believe this growth resulted from our expanded direct marketing campaign for our Bowflex product line and our ability to quickly provide "zero down" financing for our customers through third-party financing sources. Sales of our Bowflex Power Pro represented 90.2%, 91.3% and 93.3%, respectively, of our total net sales during 1996, 1997 and 1998. We expect that sales of our Bowflex Power Pro will continue to account for a substantial portion of our net sales for the foreseeable future.
We expanded our product base in 1998 by introducing a line of airbeds under the trade name "Instant Comfort," and more recently under the trade name "Nautilus Sleep Systems." We are currently developing and testing a direct marketing campaign for this new product. We intend to expand this direct marketing campaign in 1999 and anticipate that this expansion will cause our line of airbeds to generate a material portion of our net sales in 1999. However, we expect that the gross margin for our airbed products will, at least initially, be lower than the current gross margin for our Bowflex products.
In January 1999, we acquired substantially all of the assets of Nautilus International, a manufacturer and distributor of commercial fitness equipment and distributor of fitness accessories. We paid $16.2 million in cash and assumed approximately $2.6 million in liabilities as consideration for these assets, which include the following:
- All intellectual property rights to the Nautilus name and its products;
- Warehouse, manufacturing and office facilities in Independence, Virginia;
- The Nautilus line of commercial fitness equipment;
- The Nautilus line of consumer fitness equipment and fitness accessories;
- The Nautilus distribution system; and
- All working capital, except cash and finance receivables.
In recent years, Nautilus International suffered from declining revenues and significant losses. During the fiscal year ended June 27, 1998, Nautilus International had a net loss of $14.8 million, of which $8.8 million was attributable to a one-time impairment charge, on net sales of $20.9 million, compared to a net loss of $6.8 million on net sales of $21.9 million during the fiscal year ended June 27, 1997. We have identified and begun to implement a number of initiatives that we believe will
- We have hired an experienced management team to oversee and revitalize the sales and marketing operations of our Nautilus commercial business;
- We are currently evaluating and intend to offer creative financing programs, such as pre-approved leasing;
- We intend to develop and introduce additional Nautilus commercial products to serve new market segments and expand our customer base;
- We have restructured the management of our Nautilus commercial manufacturing operations and begun to make other necessary manufacturing improvements;
- We have implemented and intend to continue to implement general cost-cutting measures;
- We are using the excess capacity of our Nautilus warehouse facilities as an East Coast distribution center for our Bowflex products; and
- We are working to improve the data gathering and analytical capabilities of our Nautilus commercial operations by linking them with our sophisticated management information systems.
We expect that the integration of the Nautilus commercial product line into our operations will significantly increase our overall net sales. We also expect that our overall gross margin as a percentage of net sales will decrease, principally because we are integrating two different business models:
- A direct marketing business that historically has generated a high percentage gross margin; and
- A manufacturing and marketing business that operates in an industry that traditionally generates a lower percentage gross margin.
Cost of sales primarily consists of:
- Inventory component costs;
- Manufacturing and distribution salaries and bonuses;
- Distribution expense and shipping costs; and
- Facility costs.
Selling and marketing expenses primarily consist of:
- Television advertising expenses;
- The cost of printed and video marketing materials;
- Television commercial production and marketing material expenses;
- Commissions, salaries and bonuses earned by sales and marketing personnel; and
- Facility and communication costs.
General and administrative expenses primarily consist of salaries, benefits and related costs for our executive, financial, administrative and information services personnel and professional services fees.
Other income (expense) historically has consisted of interest income on our cash investments and state business tax expenses.
OUR RESULTS OF OPERATIONS
We believe that period-to-period comparisons of our operating results are not necessarily indicators 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. Our future operating results will depend on many factors including those factors discussed in "Risk Factors" beginning on page 6.
The following table presents certain financial data as a percentage of total revenues:
YEAR ENDED DECEMBER 31,
-------------------------------
1996 1997 1998
--------- --------- ---------
STATEMENT OF OPERATIONS DATA
Net sales................................................................................ 100.0% 100.0% 100.0%
Cost of sales............................................................................ 30.6 25.7 21.7
--------- --------- ---------
Gross profit............................................................................. 69.4 74.3 78.3
Operating expenses
Selling and marketing.................................................................. 55.3 48.3 39.5
General and administrative............................................................. 5.5 4.9 3.0
Royalties.............................................................................. 3.2 2.9 2.8
--------- --------- ---------
Total operating expenses................................................................. 64.0 56.1 45.3
Operating income......................................................................... 5.4 18.2 33.0
Other income (expense)................................................................... (0.2) 0.2 0.5
--------- --------- ---------
Income before income taxes............................................................... 5.2 18.4 33.5
Income tax expense (benefit)............................................................. (2.9) 6.2 11.7
--------- --------- ---------
Net income............................................................................... 8.1% 12.2% 21.8%
--------- --------- ---------
--------- --------- ---------
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COMPARISON OF THE YEARS ENDING DECEMBER 31, 1998, AND DECEMBER 31, 1997
NET SALES
Our net sales grew by 187.9% to $57.3 million in 1998, from $19.9 million in 1997. Sales of our Bowflex Power Pro grew by 199.0% and accounted for 93.3% of our aggregate net sales in 1998. Sales of our Bowflex Motivator increased by 73.0% and sales of our Bowflex accessories increased by 148.0% in 1998, and accounted for 1.8% and 4.5% of our aggregate net sales, respectively. We introduced and began test marketing our airbeds in August 1998, but this product did not materially contribute to our net sales in 1998.
Our sales growth in 1998 primarily resulted from expanded direct marketing of our Bowflex products. In 1998, we increased our advertising expenditures by 196.1%, focusing principally on expanded broadcasts of our Bowflex spot television commercials and television infomercials. Both of these direct marketing techniques generated strong sales in 1998. We intend to further expand our use of spot television commercials and infomercials in 1999 by increasing our market presence in our existing television markets and entering new television markets.
Our gross profit grew 203.4% to $44.9 million in 1998, from $14.8 million in 1997. Our gross profit as a percentage of net sales increased by 4.0% to 78.3% in fiscal 1998, from 74.3% in 1997. We believe that our improved percentage gross profit in 1998 resulted primarily from a March 1998 increase in the shipping charge for our Bowflex products, as well as reduced component costs for our Bowflex products and improved labor and overhead efficiencies. We benefited from reduced component costs principally through volume discounts. Our improved labor and overhead efficiencies resulted primarily from improved manufacturing methods and the implementation of a second work shift.
We anticipate an increase in the percentage gross profit on our Bowflex products associated with the opening of our East Coast distribution center in March 1999. However, we expect our aggregate gross profit as a percentage of net sales to materially decline in 1999, principally due to the significantly lower gross profit margin on our Nautilus line of commercial fitness equipment. Initially, we also expect a lower percentage gross profit on our line of airbeds as we continue to develop our direct marketing campaign for this product and increase our marketing efforts.
OPERATING EXPENSES
Selling and marketing expenses grew to $22.6 million in 1998 from $9.6 million in 1997, an increase of 135.4%. This increase in selling and marketing expenses resulted primarily from the expansion of our Bowflex direct marketing campaign and variable costs associated with our sales growth.
As a percentage of net sales, selling and marketing expenses decreased to 39.5% in 1998 from 48.3% in 1997. This decrease in selling and marketing expenses as a percentage of net sales reflects the improved efficiency of our Bowflex direct marketing campaign. As we refined our spot commercial and infomercial advertising policies and our customer response techniques, we were able to stimulate sales growth at a more rapid rate than the growth in our selling and marketing expenses. We expect that our selling and marketing expenses will continue to increase in real dollar terms, but not as a percentage of net sales, as we:
- Continue to expand our Bowflex direct marketing campaign;
- Expand the direct marketing campaign for our airbeds;
- Integrate the marketing and distribution infrastructure for our Nautilus line of commercial fitness equipment; and
- Begin marketing new home fitness equipment products and fitness accessories under the Nautilus brand name.
General and administrative expenses grew to $1.7 million in 1998 from $975,000 in 1997, an increase of 74.3%. This increase in general and administrative expenses was due primarily to increased staffing and infrastructure expenses necessary to support our continued growth. As a percentage of net sales, general and administrative expenses decreased to 3.0% in 1998 from 4.9% in 1997. The decline in general and administrative expenses as a percentage of our net sales resulted primarily from our substantial increase in net sales. We believe that our general and administrative expenses will continue to increase in future periods, in both real dollar terms and as a percentage of net sales, as we integrate the Nautilus business into our operations and expand our administrative staff and other resources to manage growth.
Royalty expense grew to $1.6 million in 1998 from $581,000 in 1997, an increase of 175.4%. The increase in our royalty expenses is attributable to the increased sales of our Bowflex products in 1998. Our royalty expenses will increase if sales of our Bowflex products continue to increase.
In 1998, other income (expense) increased to $305,000 from $31,000 in 1997. The $274,000 increase resulted primarily from interest income generated by our cash investments, which was partially offset by a $135,000 increase in our state business tax expense.
Income tax expense increased by $5.5 million in 1998 because of the growth in our income before taxes. We expect our income tax expense to increase in line with increases in our income before taxes.
NET INCOME
For the reasons discussed above, net income grew to $12.5 million in 1998 from $2.4 million in 1997, an increase of 420.8%.
COMPARISON OF YEARS ENDING DECEMBER 31, 1997, AND DECEMBER 31, 1996
NET SALES
Net sales grew to $19.9 million in 1997 from $8.5 million in 1996, an increase of 134.1%. Net sales of our Bowflex Power Pro grew by 137.7% and accounted for 91.3% of our aggregate net sales in 1997. Sales of our Bowflex Motivator increased by 766.7% and sales of our Bowflex accessories increased by 60.4% in 1997, and accounted for 3.0% and 5.4% of our aggregate net sales, respectively. This increase in net sales resulted from increased advertising and marketing expenditures, increased average sales price and improved marketing efficiencies.
GROSS PROFIT
Gross profit grew 150.8% to $14.8 million in 1997 from $5.9 million in 1996. As a percentage of net sales, gross profit grew to 74.3% in 1997 from 69.4% in 1996. The principal reason for this increase was our substantial growth in net sales, combined with increased production efficiencies and reduced costs associated with overseas component purchases.
OPERATING EXPENSES
Selling and marketing expenses increased to $9.6 million in 1997 from $4.7 million in 1996, but declined as a percentage of net sales to 48.3% in 1997 from 55.3% in 1996. The growth in selling and marketing expenses resulted primarily from our expanded direct marketing campaign and increased staffing and infrastructure expenditures necessary to support our growth. Our selling and marketing expenses declined as a percentage of net sales principally because our net sales growth outpaced the growth in our selling and marketing expenses.
General and administrative expenses increased to $975,000 in 1997 from
$473,000 in 1996, but declined as a percentage of net sales to 4.9% in 1997 from
5.5% in 1996. The increase in general and
Royalty expense increased to $581,000 in 1997 from $269,000 in 1996 but remained relatively constant as a percentage of net sales. Royalty expense increased because we sold more Bowflex products in 1997 than in 1996.
Other income (expense) was $31,000 in 1997, compared to an expense of ($16,000) in 1996. The $47,000 increase was primarily derived from interest income and was partially offset by a $36,000 increase in state business tax expense in 1997.
We incurred an income tax expense of $1.2 million in 1997, which was $1.5 million higher than in 1996. The principal reason for this increase was our higher profitability and the accounting treatment of deferred taxes associated with tax loss carrybacks.
NET INCOME
For the reasons described above, net income grew to $2.4 million in 1997 from $693,000 in 1996, a 246.0% increase.
UNAUDITED PRO FORMA COMBINED RESULTS OF OPERATIONS
As a result of the Nautilus acquisition, several adjustments and factors will impact the comparability of our historical financial results with our future results of operations. We paid $16.2 million in cash for the Nautilus assets and assumed approximately $2.6 million in liabilities. The unaudited pro forma combined statements of operations reflect:
- Certain adjustments for the effects of purchase accounting;
- Certain assumptions described below regarding financing and cash management; and
- A provision for income taxes as if the combined operations had been taxed as a C-corporation for all periods presented.
In addition, the unaudited pro forma combined statement of operations for the year ended December 31, 1998 was prepared as if the Nautilus acquisition occurred on January 1, 1998. The unaudited pro forma financial statements and the information set forth below should be read in conjunction with our financial statements and accompanying notes and the financial statements of Nautilus International and related notes appearing elsewhere in this prospectus. The following summarizes certain adjustments that are reflected in the unaudited pro forma combined statement of operations data set forth below and included elsewhere in this prospectus:
- A $1.1 million decrease in depreciation expense associated with the depreciation of acquired property having an estimated fair value of $8.6 million. Depreciation is on a straight-line basis over periods ranging from 7 to 31.5 years;
- A $340,000 decrease in total operating expenses relating to the reduced amortization of the estimated intangible asset value of $4.4 million and $56,000 relating to reduced depreciation expense. As discussed below, Nautilus recorded an impairment charge to reduce the net
- An $11.2 million adjustment to eliminate the effect of a one-time impairment charge taken by Nautilus International in connection with the revaluation of its assets based upon the $18.8 million acquisition price including assumption of $2.6 million of current liabilities;
- A $2.8 million decrease in interest expense, which we would have incurred had the acquisition occurred on January 1, 1998;
- A $608,000 decrease in other income, to reflect interest income foregone by the use of cash in the acquisition; and
- A $1.4 million decrease in income tax expense, to reflect income tax expense at our effective tax rates after giving effect to the adjustments described above.
The following table sets forth the specific components of income and expense as a percentage of net sales, on a pro forma basis for the period presented. See the unaudited pro forma combined financial statements and the related notes thereto included elsewhere in this prospectus.
YEAR ENDED
DECEMBER 31,
1998
---------------
Net sales....................................................................... 100.0%
Cost of sales................................................................... 34.3
-----
Gross profit.................................................................. 65.7
Operating expenses
Selling and marketing......................................................... 37.1
General and administrative.................................................... 5.9
Royalties..................................................................... 2.1
-----
Total operating expenses.................................................... 45.1
-----
Income from operations.......................................................... 20.6
Other expense................................................................... 0.8
-----
Income before income taxes...................................................... 19.8
Pro forma income taxes.......................................................... 6.9
-----
Pro forma net income............................................................ 12.9%
-----
-----
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LIQUIDITY AND CAPITAL RESOURCES
Historically, we have financed our growth primarily from cash generated by our operating activities. During 1998, our operating activities generated over $15.9 million in net cash, which contributed to an aggregate $14.1 million, or 294.8%, increase in cash and cash equivalents. This increase was primarily due to the substantial sales growth associated with our Bowflex products. At December 31, 1998, we had a cash balance of $18.9 million. We used $16.2 million in cash to fund the Nautilus acquisition in January 1999. We anticipate that our working capital requirements will increase as a result of increased inventory and accounts receivable related to our Nautilus operations. We also expect to materially increase our cash expenditures on spot commercials and informercials as we expand the direct marketing compaigns for our Bowflex and airbed products.
We believe that our existing cash balances, combined with our line of credit and the net proceeds of this offering, will be sufficient to meet our capital requirements for at least the next 12 months. Thereafter, if our capital requirements increase, we could be required to secure additional sources of capital. We cannot assure you that we will be able to secure additional capital or that the terms upon which such capital will be available to us will be acceptable. If we proceed with any other acquisitions, we may be required to use cash to fund the purchase price or fund operations or expansion of the acquired business.
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 materially adversely affect our results of operations or our financial condition. However, increases in inflation over historical levels or uncertainty in the general economy could decrease discretionary consumer spending for products like ours. We have not raised the prices on our Bowflex products since 1994. Consequently, none of our revenue growth is attributable to price increases.
RECENT ACCOUNTING PRONOUNCEMENTS
Effective January 1, 1998, we adopted Statement of Financial Accounting Standards ("SFAS") No. 130, REPORTING COMPREHENSIVE INCOME, which requires presentation of comprehensive income within an entity's primary financial statements. Comprehensive income is defined as net income as adjusted for changes to equity resulting from events other than net income or transactions related to an entity's capital structure. From 1996 to 1998, our comprehensive income equaled our net income.
Effective January 1, 1998, we adopted SFAS No. 131, DISCLOSURES ABOUT SEGMENTS OF AN ENTERPRISE AND RELATED INFORMATION, which establishes standards for reporting information regarding an entity's operating activities. SFAS No. 131 requires that operating segments be defined at the same level and in a similar manner as management evaluates operating performance. We currently operate under two segments: direct marketing products and Nautilus commercial products. Through December 31, 1998, we operated as a single segment.
In February 1998, the Financial Accounting Standards Board, (the "FASB") issued SFAS No. 132, EMPLOYER'S DISCLOSURES ABOUT PENSIONS AND OTHER POSTRETIREMENT BENEFITS, which revises current disclosure requirements for an employer's pension and other retiree benefits. The pronouncement does not have a material impact on our financial statements, because it does not impact the measurement of pension benefits or other post-retirement benefit costs. Instead, it impacts only financial statement disclosure.
In March 1998, the Accounting Standards Executive Committee issued Statement of Position 98-1 ("SOP 98-1"), ACCOUNTING FOR THE COSTS OF COMPUTER SOFTWARE DEVELOPED OR OBTAINED FOR INTERNAL USE, which establishes accounting requirements for the capitalization of software costs incurred for use by the organization. We adopted this pronouncement on a prospective basis as of January 1, 1999. We do not anticipate that SOP 98-1 will materially impact our financial statements.
Effective July 1, 1998, the FASB adopted SFAS No. 133, ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES, which establishes accounting requirements for derivative instruments and for activities related to the holding of such instruments, including hedging activities. SFAS No. 133 expanded the definition of derivative instruments and revised accounting practices related to hedging and other activities associated with derivative instruments. Although we do not currently hold or issue instruments that qualify as derivative instruments, our future activities could fall within the scope of the new pronouncement, in which case SFAS No. 133 could materially affect our business.
Many computer software programs, as well as hardware with embedded software, use a two-digit date field to track and refer to any given year. After, and in some cases prior to, January 1, 2000, these software and hardware systems will misinterpret the year "00," which will cause them to perform faulty calculations or shut down altogether. Notwithstanding the remedial efforts and third-party assurances discussed below, this "Year 2000" problem may adversely affect our operations. We believe that the most reasonably likely worst-case scenario would involve material disruptions in such important functions as:
- Airing our spot commercials and infomercials;
- Receiving and processing customer inquiries and orders;
- Distributing our products; and
- Processing billings and payments.
Such difficulties could result in a number of adverse consequences, including, but not limited to, delayed or lost revenue, diversion of resources, damage to our reputation, increased administrative and processing costs and liability to suppliers and/or customers. Any one or a combination of these consequences could significantly disrupt our operations and have a material adverse effect on our financial performance.
Accordingly, we began assessing the scope of our potential Year 2000 exposure both internally and among our suppliers and customers in March 1998, and started implementing remedial measures soon thereafter. To date, we have tested and assessed the Year 2000 compliance of over 90.0% of the software and hardware systems that we use internally in our business. We have upgraded approximately 95.0% of the computer hardware and equipment that we determined had Year 2000 problems. We expect to have a Year 2000 compliant financial accounting system and database marketing system installed by early June 1999.
We will continue to test our software and hardware systems and modify and replace these systems as necessary. We expect to complete our internal assessment, testing, and remediation program by July 1999. To date, we have spent approximately $1.3 million to upgrade our computer systems, and we believe we will need to spend an additional $400,000 to complete our upgrade. Although we believe that these corrective measures will adequately address our potential Year 2000 problems, including those affecting our Nautilus operations, we cannot assure you that we will discover and address every Year 2000 problem or that all of our corrective measures will be effective. To the extent that Year 2000 problems persist, we could experience the adverse consequences described above, some or all of which could be material.
We have received assurances from our primary carrier, our primary consumer finance provider and certain other key suppliers and vendors that their businesses are Year 2000 compliant. We have requested but have not yet received such assurances from our other suppliers and vendors, the most important of which is our local telephone company. We have and will continue to work with all of our vendors and suppliers to resolve any potential Year 2000 problems. However, we have no direct control over these third parties and cannot assure you that such third-party software and hardware systems will be timely converted. The failure of certain individual vendors or suppliers, or a combination of vendors or suppliers, to make their systems Year 2000 compliant could have a material adverse effect on our financial results.
We are currently developing a contingency plan, but cannot finalize the plan until we have received responses from all of our critical vendors and service providers. We expect to finalize the plan in July 1999.
OVERVIEW
We are a rapidly growing, direct marketing company that develops and markets premium quality, premium priced, branded consumer products. We market our consumer products directly to consumers through a variety of direct marketing channels, including spot television commercials, infomercials, print media, response mailings and the internet.
We were incorporated in California in 1986 and initially focused on developing our first line of Bowflex home fitness equipment, the Bowflex 2000X. We sold the Bowflex 2000X through various channels, including direct marketing and retail stores. In 1988, we developed a new model, the Schwinn Bowflex, which we marketed exclusively through Schwinn Bicycle Company until late 1992. When our exclusive relationship with Schwinn ended, we seized the opportunity to study and develop our own direct marketing campaign for the next generation Bowflex product, the Power Pro. In 1993, we became a Washington corporation. Over the next several years, we tested and refined our direct marketing techniques, developed our customer call center systems and procedures, and developed our market analysis techniques, media buying tools and performance tracking measures. Using our market research and knowledge base, we embarked on our first widespread direct marketing campaign in 1996. Building upon our initial success, in early 1997 we began offering our current "zero-down" financing program through a third-party finance company, and in mid-1997 we started airing our first infomercial. Based on positive viewer response, we accelerated our direct marketing campaign during the remainder of 1997 and throughout 1998. In May 1998, we changed our name to Direct Focus, Inc. to reflect our transformation from a home fitness equipment company into a direct marketing company.
In 1997, we also recognized that our direct marketing expertise and techniques could be used to market other premium quality, premium priced branded products. After a careful review process that began in late 1997, in August 1998 we began test marketing a line of airbed mattress systems under the brand name "Instant Comfort" and more recently under the brand name "Nautilus Sleep Systems." We also recently acquired substantially all of the assets of Nautilus International, including the Nautilus line of commercial fitness equipment and the widely recognized Nautilus brand name. Our primary objectives with respect to Nautilus include revitalizing sales of Nautilus products in the commercial fitness market and capitalizing on the Nautilus brand name by introducing and directly marketing a line of Nautilus consumer fitness equipment.
GROWTH STRATEGY
Our objective is to become a leading direct marketer of premium quality, premium priced, branded consumer products. Our growth strategy includes the following key elements:
INCREASE SALES OF OUR HIGHLY SUCCESSFUL BOWFLEX PRODUCTS. We intend to continue to expand the direct marketing campaign for our Bowflex products by airing our spot commercials and infomercials to broader audiences and by increasing the frequency of airings on proven cable and network stations. Consistent with historical practices, we also intend to introduce enhancements and additions to our Bowflex product line.
EXPAND THE DIRECT MARKETING CAMPAIGN FOR OUR AIRBEDS. We began test marketing a line of airbeds in August 1998 under the brand name "Instant Comfort." More recently, we began test marketing our airbeds under the brand name "Nautilus Sleep Systems." We are encouraged by our initial test results and intend to continue testing and refining, and plan to expand, our direct marketing campaign for this product throughout 1999.
- Have patented or patentable features that enhance our competitive position, increase product life and add real and perceived value to the product;
- Have a retail price point between $500 and $2,500;
- Can be marketed as a line that facilitates the promotion of premium products to consumers who are initially attracted by lower-priced, entry-level products; and
- Have the potential for mass consumer appeal, particularly among members of the "baby boom" generation.
REVITALIZE SALES OF THE NAUTILUS LINE OF COMMERCIAL FITNESS EQUIPMENT. Our immediate objective for our Nautilus business is to revitalize sales of the Nautilus line of commercial fitness equipment, which we believe will ultimately strengthen our ability to market Nautilus branded products. We believe that we can most effectively achieve this objective by rebuilding our commercial sales and marketing operations. We have already hired a new management team to oversee and implement changes in the way we market and sell Nautilus commercial fitness equipment. Each member of the management team has significant experience in the industry and a history of sales and marketing success. We intend to focus on strengthening the domestic market position for our existing Nautilus products. As we expand our commercial product line, we will attempt to service new market segments, both domestically and internationally, and thereby broaden our commercial customer base.
CAPITALIZE ON STRONG CONSUMER RECOGNITION OF THE NAUTILUS BRAND NAME. A principal motivation in purchasing the Nautilus business was to acquire rights to the Nautilus brand name, which we believe is one of the most widely-recognized names in the fitness industry. We also believe that the brand identity and consumer appeal of the Nautilus name, in combination with our direct marketing expertise, will enable us to introduce and directly market innovative consumer fitness equipment and related products under the Nautilus name. In addition, we intend to introduce and market to specialty fitness and sporting goods stores more traditional home fitness equipment and accessories under the Nautilus name, such as treadmills, recumbent bicycles, elliptical trainers, jump ropes, workout mats and hand grips. In appropriate circumstances, we may also license the Nautilus name to manufacturers of high-quality consumer products that do not fit within our current strategic plan, such as clothing and related accessories.
CAPITALIZE ON INTERNET MARKETING AND E-COMMERCE OPPORTUNITIES. In 1998, approximately 5.8% of our Bowflex product inquiries and 10.0% of our net sales were initiated through our Bowflex web site. Our experience in 1998 indicates that internet-based inquiries are more likely to be converted into sales than inquiries generated by other media forms, such as television or print media. We believe that the increasing consumer acceptance of e-commerce and internet-based marketing will also enhance and complement our direct marketing efforts. Consequently, we intend to expand and enhance our web sites to more fully integrate the internet into our direct marketing strategy and facilitate e-commerce transactions.
EXPLORE GROWTH THROUGH STRATEGIC ACQUISITIONS. We will continue to explore growth opportunities through strategic acquisitions that would enhance our direct marketing capabilities or our product lines. We do not currently have any oral or written plans, agreements or commitments regarding any acquisitions.
We directly market our Bowflex home fitness equipment and airbeds principally through 60-second or "spot" television commercials, television infomercials, the internet, response mailings and print media. To date, we have been highly successful with what we refer to as a "two-step" marketing approach. In general, our two-step approach focuses first on spot commercials, which we air to generate consumer interest in our products and requests for product information. The second step focuses on converting inquiries into sales, which we accomplish through a combination of response mailings and outbound telemarketing. We supplement our two-step approach with infomercials, which generally are designed to provide potential customers with sufficient product information to stimulate an immediate purchase.
SPOT COMMERCIALS AND INFOMERCIALS. Spot television commercials are a key element of the marketing strategy for all of our directly marketed consumer products. For directly marketed products that may require further explanation and demonstration, television infomercials are an important additional marketing tool. We have developed a variety of spot commercials and infomercials for our Bowflex product line and several commercials and marketing videos for our airbed product line. We expect to use spot commercials and, where appropriate, infomercials to market any Nautilus consumer products that we determine are appropriate for direct marketing.
When we begin marketing a new product, we typically test and refine our marketing concepts and selling practices while advertising the product in spot television commercials. Production costs for these commercials can range from $40,000 to $130,000. Based on our market research and viewer response to our spot commercials, we may produce additional spot commercials and, if appropriate for the product, an infomercial. Production costs for infomercials can range from $150,000 to $500,000, depending on the scope of the project. Generally, we attempt to film several infomercial and commercial concepts at the same time in order to maximize production efficiencies. From this footage we can then develop several varieties of spot commercials and infomercials and introduce and refine them over time. We typically generate our own scripts for spot commercials and hire outside writers to assist with infomercial scripts. We also typically contract with outside production companies to produce spot commercials and infomercials. We may outsource all of these functions if we continue to grow.
Once produced, 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 their marketing appeal and what, if any, creative or product modifications may be appropriate. If these initial tests are successful, we then air the spot commercials and infomercials on an accelerating schedule on 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 typically costs between $50 and $5,000 to air, and each infomercial typically costs between $1,200 and $15,000 to air. We currently purchase the majority of our media time on cable networks, through which we reach more than 70 million homes. We recently began testing the effectiveness of our spot commercials and infomercials on broadcast networks, through which we hope to reach a broader viewing audience.
We track the success of each of our spot commercials and infomercials by determining how many viewers respond to each airing of a spot commercial or infomercial. We accumulate this information in a database that we use to evaluate the cost-effectiveness of available media time. In addition, we believe that the database enables us to predict with reasonable accuracy how many product sales and
We do not currently purchase media time under long-term contracts. Instead, we book most of our spot commercial time on a quarterly basis and most of our infomercial time on a monthly or quarterly basis, as networks make time available. Networks typically allow us to cancel booked time with two weeks' advance notice, which enables us to adjust our advertising schedule if our statistical tracking indicates that a particular network or time slot is no longer cost effective. Generally, we can increase or decrease the frequency of our spot commercial and infomercial airings at almost any time.
INTERNET. In 1998, approximately 5.8% of our Bowflex product inquiries and 10.0% of our net sales were initiated through our Bowflex web site, and we expect the internet to become an increasingly important part of our direct marketing strategy. For example, we are now promoting our web sites in our spot commercials and infomercials in an effort to further stimulate electronic product inquiries and e-commerce transactions. We do not presently advertise our products on third-party web sites, but we may in the future.
Our experience indicates that internet-based inquiries are more likely to be
converted into sales
than inquiries generated by other media forms, such as television or print
media. Consequently, we believe that consumers who visit our web sites are more
inclined to purchase our products than are the consumers we target through other
media.
We currently operate two direct marketing-oriented web sites. The first, www.bowflex.com, focuses on our Bowflex line of home exercise equipment. The second, www.instantcomfort.com, focuses on our newly introduced line of airbeds. In an effort to expand and enhance our web presence, we recently added dedicated web site development and management personnel. Our immediate internet-related goals include improving the e-commerce capabilities at our Bowflex web site and adding e-commerce capabilities to our airbed web site. We also plan to redesign our web sites to enhance their role as a medium for finalizing sales. Previously, we used our web sites to generate interest in our products, but limited the information we provided to potential customers in an effort to induce them to initiate a telephone inquiry. We now believe that we can achieve a balance between our twin 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.
PRINT MEDIA. We advertise our directly marketed products in various print media when we believe that such advertising can effectively supplement our direct marketing campaigns. For example, we have advertised our Bowflex home fitness equipment in health and fitness-related consumer magazines and, to a limited extent, in entertainment, leisure and specialty magazines. We recently determined that television advertising and the internet generate more immediate consumer responses at a lower cost per inquiry and therefore have begun to reduce the print media advertising expenditures for our Bowflex products. In contrast, our experience to date suggests that print media can play an effective role in the direct marketing campaign for our line of airbeds. Consequently, we intend to devote a higher portion of our overall advertising budget for our airbed products to print media. We will evaluate print media advertising expenditures for other directly marketed products on a case-by-case basis.
CUSTOMER SERVICE CALL CENTER AND ORDER PROCESSING. We operate our own customer service call center in Vancouver, Washington, which operates 16 hours per day and receives and processes all infomercial-generated and customer service-related inquiries regarding our Bowflex and airbed products. We have developed a skill-based call routing system that automatically routes each incoming call to the most highly qualified inside sales agent or customer service representative available. The appropriate representative then answers product questions, pro-actively educates the potential customer about the benefits of our product line, promotes financing through our private label credit card, and
We employ two large telemarketing companies to receive and process information requests generated by our spot television advertising 24 hours per day. These companies also serve as overflow agents for our call center during peak times. The telemarketing agents for these companies collect only names, addresses and other basic information from callers and do not sell or promote our products. Consequently, we do not need to train these telemarketing agents. To preserve flexibility, we do not have formal contracts with the telemarketing companies.
RESPONSE MAILINGS. We forward a "fulfillment kit" in response to each inquiry regarding our directly 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 on a case-by-case basis, 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 and airbed products. We arrange this financing through a consumer credit company with whom we recently signed a new non-recourse consumer financing agreement. Under this arrangement, our customer service agents can obtain financing approval in a few minutes over the phone and, if a customer is approved, immediately ship product without the need for cumbersome paperwork. The consumer finance company pays us promptly after we submit required documentation and subsequently sends to each approved customer a Direct Focus private label credit card that can be used for future purchases of our products. During 1998, approximately 39.7% of our net sales were financed in this manner, and we believe that this program will continue to be an effective marketing tool.
NAUTILUS SALES AND MARKETING
We market and sell our Nautilus commercial fitness equipment domestically through a direct sales force and internationally through various distributors. We market and sell our Nautilus fitness accessories and consumer fitness equipment through non-exclusive independent sales representatives.
We recently hired a new management team to oversee and revitalize the sales and marketing operations of our Nautilus business. Each member of the management team has significant industry experience and a history of sales and marketing success. Our commercial direct sales force will focus on strengthening the domestic market position of our existing Nautilus product line, which we sell principally to health clubs, large hotels, assisted living facilities and the government. As we broaden our product line, our direct sales force will target new market segments and, if successful, broaden our customer base. Internationally, we market and sell our Nautilus commercial fitness products through a worldwide network of distributors.
We intend to implement additional sales and marketing strategies for our Nautilus commercial equipment, including the following: