Direct Focus, Inc. Business Information, Profile, and History

Company Perspectives:

Direct Focus, Inc. is a leading marketing company for fitness and healthy lifestyle products with direct, retail, and commercial sales channels.

History of Direct Focus, Inc.

Direct Focus, Inc. is a Vancouver, Washington, direct marketing company originally dedicated to the manufacture and marketing of the Bowflex exercise machines. Since building up its sales operation, the company has expanded to market other products, developed either internally, such as a high-tech air mattress, or externally through acquisition, such as the fitness products gained through the purchase of Nautilus, StairMaster, and Schwinn fitness equipment. Direct Focus has achieved spectacular results, due in large part to its sophisticated direct marketing model. The company employs what it calls a "two-step" approach. Customer interest is generated through one-minute television commercials and infomercials, which generally appear on cable channels, as well as through print advertising. Once customers inquire about a product, Direct Focus follows up with response mailings and outbound telemarketing to convert interest into sales. The Internet has also become an important tool, generating an increasing level of sales while fitting in nicely with the company's overall marketing effort. Not only do product web sites generate interest and provide a depository of detailed information, they offer a chance to close a sale at any time of day. While Bowflex and the air mattresses are sold exclusively through the company's direct marketing operations, Nautilus, Schwinn, and StairMaster fitness products are sold to health clubs and sporting goods retailers. In addition, Direct Focus is testing the possibility of selling nutritional supplements and is active in searching for new products that it can sell through direct marketing.

Conception of Bowflex: 1979

The Bowflex exercise machine was invented by Tessema Dosho Shifferaw, who was born in Ethiopia, the son of a prominent army general. He was a teenager attending college in California when in September 1974 the Ethiopian government, headed by Emperor Haile Selassie, was toppled by a socialist revolution. Shifferaw's father, mother, and brother were jailed, and his father was ultimately executed. Shifferaw, who came from a rich and influential family and was well positioned for a political career, now found himself penniless in a foreign land. He moved to San Francisco and drove a cab to earn his way through San Francisco City College, where he studied industrial design. It was in 1979 that he first conceived of a new weight training machine that relied on a system of "power rods" and pulleys to provide increased resistance, as well as being easy to store.

Shifferaw spent several years refining the product, while lining up a group of investors, who incorporated Bow Flex of America, Inc. in California in 1986. They then hired Brian R. Cook, the current chairman and chief executive officer of Direct Focus, to form a company and develop the Bowflex technology commercially. Cook was a certified public accountant who earned a bachelor of arts degree in business administration from Western Washington University. He had worked as an accountant for Peat, Marwick, Mitchell & Co., then served as the chief financial officer for a manufacturer of industrial fasteners and held a number of financial and managerial positions at Sea Galley Stores, a restaurant chain. From 1986 to 1987, Bow Flex developed its first product and secured a patent on the power rod and pulley technology. Initially, Cook approached retailers about carrying the new machine but received a tepid response. He also made an early attempt to use direct marketing but in 1988 signed an exclusive distribution deal with Schwinn Cycling and Fitness, producing a new model called the Schwinn Bowflex.

The Schwinn arrangement lasted five years, during which Cook and his young company were able to mature and learn the fitness business. When Schwinn began to experience serious financial difficulties in the early 1990s, it appeared that the future for the Bowflex machine was dim. In order to induce Cook and another executive to stay on with the company, Shifferaw cut them in on a share of his royalties. When Schwinn went bankrupt in 1993, Cook was then able to terminate the exclusive distribution arrangement. In order to stand on its own, the company, which changed its name to Bow Flex, Inc., began to develop a direct marketing program to sell its new generation of the Bowflex system, the Power Pro line, funded by $2 million raised through a public offering on the Toronto Stock Exchange. From 1993 to 1995, Bow Flex refined its marketing approach and infrastructure. Although sales showed little improvement between 1994 and 1995, increasing from just $4.4 million to $4.8 million, the company turned a $510,000 loss in 1994 into a modest $15,000 net profit in 1995. More importantly, the company was now poised in 1996 to launch its first widespread direct marketing campaign, which helped to support the new Motivator line, an entry level Bowflex system. Revenues in 1996 almost doubled the results of the previous year, climbing to $8.5 million, while net income improved to $693,000.

Infomercials Launched in 1997

In 1997, Bow Flex introduced a "zero-down" financing program through a third party finance company, and it also tripled its advertising budget to about $9.5 million in order to launch its first infomercials, resulting in a sharp spike in sales. Revenues grew by 134 percent, to $19.9 million, and net income showed even more impressive improvement, topping $2.4 million. Clearly the company had developed a solid direct marketing operation and protected its Bowflex franchise by refusing to sell it through any other avenues. Corporate philosophy maintained that if customers knew that Bowflex was available at a store, they would be less likely to respond to the advertising call for immediate action. Nevertheless, the company had to face the reality that no matter how polished the sales operation, the life of a home fitness product rarely lasted for more than ten to 15 years. Constant improvements and the introduction of new models was part of the program as well, but Cook recognized the need for diversity. By now the company was in reality a direct marketing business that happened to sell a fitness product. There was no reason that the company's approach could not be applied to other products.

In late 1997 the company began to review possible new products to market. To reflect the changing nature of its business, in May 1998 Bow Flex changed its name to Direct Focus, Inc. In August of that year, it began to test market a second product, a high-end airbed mattress that permitted users to adjust the firmness on either side of the bed. Unlike most direct marketers, Direct Focus preferred higher cost, high quality products. The new airbed system, under the brand name "Instant Comfort," was a good fit within that approach. Moreover, the mattress market was large, representing over $7.5 billion in annual retail sales in the United States. Late in 1998, Direct Focus also diversified within the fitness sector when it acquired the Nautilus line of equipment from Delta Woodside Industries at a cost of $18.8 million, which included $16 million in cash and the assumption of $2.8 million in liabilities. Acquiring Nautilus, the best-known brand name in the fitness industry, was considered a coup for Direct Focus. A textile and fabric manufacturer, Delta Woodside had purchased Nautilus in 1993 with the intent of selling sportswear apparel under the Nautilus label, an idea that failed to pan out for the company, which then licensed the Nautilus name to other apparel companies. The business had been on the block for several months before Direct Focus stepped in and was able to pick up Nautilus at what was considered a highly reasonable price.

In 1998, Direct Focus posted results that were again a dramatic improvement over the previous year, with revenues totaling $63.1 million and net profits reaching nearly $12.5 million. The company encountered one problem in 1998 when it was sued by Soloflex, a prime competitor in the home fitness market. Soloflex alleged that Direct Focus copied its marketing strategies, stole marketing slogans, and made misleading, negative claims about the Soloflex system. Moreover, Soloflex named Randy Potter, Direct Focus's vice-president for marketing, as a defendant in the suit. Before joining Bow Flex of America in 1991, Potter had served as a Soloflex model. The matter would be settled a year later when Direct Focus agreed to pay $8 million.

It was an active year for Direct Focus in 1999. The company netted $15.1 million on a public offering of stock, which now began trading on the NASDAQ. It also took over Nautilus in the beginning of the year and initiated efforts to incorporate it into its business mix. It cut the workforce at the Nautilus plant in Virginia by 50 employees and introduced new products for sale under the Nautilus name: a weight bench and a strength station. Rather than direct marketing, Nautilus equipment, for both the home and clubs, were sold to specialty fitness and upper end sporting goods retailers. In addition, Direct Focus decided to apply the Nautilus name to its airbed mattresses, which now became known as the Nautilus Sleep System and was launched in December 1999. Like Bowflex it would be exclusively sold through the company's direct marketing operation, which began in 1999 to experience tangible benefits from its Internet site. Until late in the year the site was purely informational, lacking the ability to conduct sales transactions online, yet email leads from the site resulted in 10 percent of the company's overall sales. For the year, Direct Focus again posted impressive results: Revenues for 1999 more than doubled the previous year's total, exceeding $133 million, while net income climbed to $20.3 million. Investors, however, remained somewhat skeptical of the company, opting to wait to see how successful it would be in leveraging the Nautilus name. As a result, Direct Focus stock was considered undervalued by management, prompting the company to institute a buyback program in early 2000.

Direct Focus augmented its Internet business by introducing online credit in 2000. Direct Focus was hardly a dot-com business, but the Internet was such a natural fit with its direct marketing operation, and cost less per sale, that the company

Schwinn Fitness Products Acquired in 2001

Direct Focus aggressively pursued external growth in 2001. It signed a deal with Champion Nutrition, a California manufacturer of nutritional supplements that gained prominence after signing an endorsement deal with baseball star Mark McGuire. Direct Focus agreed to loan $3 million to Champion and gained a 15-month option to purchase the company for $6 million. Champion planned to use the money, as well as names from the Bowflex customer database, to ramp up its marketing efforts. In effect, Direct Focus would have a chance to determine if the supplements business achieved synergy with its fitness products before having to decide if it wanted to buy Champion. Also in 2001, Direct Focus became reconnected to Schwinn. In June, a former Bow Flex executive who had gone to work for Schwinn, Kevin Lamar, returned to the company, taking over as president, an unoccupied slot in the organization. He had gone over to Schwinn in 1989 and was instrumental in building up a fitness equipment business.

The 106-year-old Schwinn was now once again in financial straits and Direct Focus offered $140 million for the company, although it was only interested in acquiring the fitness operation and had a partner, Huffy Corp., ready to purchase the cycling division for $68.3 million. Rather than accept the offer, however, Schwinn filed for Chapter 11 bankruptcy protection in July 2001 and other suitors for the cycling division weighed in. In September, Direct Focus completed a successful bid for the Schwinn fitness division, agreeing to pay $65 million in cash, a significant reduction on its pre-bankruptcy offer. As with the Nautilus acquisition, Direct Focus was able to acquire a solid brand at minimal cost, adding both the Schwinn and Trimline labels and a popular line of cardio-equipment, including treadmills, stationary bikes, and steppers. It was expected that Direct Focus would tab one or more of its new aerobic machines to join Bowflex and the Nautilus Sleep System as products sold exclusively through its successful direct marketing operation. In the meantime, another prominent exercise brand appeared on the company's radar screen, StairMaster Sports/Medical, Inc., which had also been forced into bankruptcy and was on the block. In court filings the only potential purchaser listed was Direct Focus, which stood to yet again pick up a major brand at distressed prices. In January 2002 the company successfully bid $25 million to acquire StairMaster and its line of stair-climbing machines, elliptical trainers, and treadmills.

Shortly after the StairMaster announcement, Direct Focus released its 2001 results, again showing massive gains over the previous year. Revenues for the year totaled almost $363.9 million and net income grew to $66.6 million. Following a year in which it made two significant acquisitions, Direct Focus still had no debt and nearly $52 million in cash at its disposal. It was now positioned as a leading manufacturer of fitness equipment with the ability to sell directly to customers as well as through retailers in both the home and club markets. Moreover, its direct sales operation was now finely tuned and the company actively looked for new product ideas to feed into the system. Not only was it generating ideas internally, the company's success resulted in a constant pitch of products from outside sources. Direct Focus remained thorough in its evaluation of new products, however, and it was likely that it would not stray far from its current product lines, nor would it act too hastily. It was unlikely that the company could continue to maintain its accelerated pace of mounting revenues and profits, but there was no reason to doubt its ability to continue a steady upward trend.

Principal Competitors: Sybex International; Icon Health & Fitness, Inc.; Select Comfort Corporation; Soloflex.

Chronology

• Key Dates:
• 1979: Tessema Shifferaw invents Bowflex machine.
• 1986: Bow Flex of America, Inc. is formed.
• 1988: Exclusive distribution agreement is signed with Schwinn.
• 1993: Schwinn files for bankruptcy protection and the company regains distribution rights.
• 1996: The first widespread direct marketing of Bowflex is launched.
• 1998: The company changes its name to Direct Focus, Inc.
• 1999: The Nautilus brand is acquired.
• 2000: Schwinn's fitness equipment division is acquired.
• 2001: The StairMaster brand is acquired.