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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D. C. 20549

FORM 10-K


/x/
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934

For the Fiscal Year Ended: December 31, 2000

OR

/ /
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934

Commission File Number: 000-25867

DIRECT FOCUS, INC.
(Exact name of registrant as specified in its charter)

Washington
(State or other jurisdiction of incorporation
or organization)		   94-3002667
(I.R.S. Employer Identification No.)

1400 NE 136th Avenue, Vancouver, WA
(Address of principal executive offices)
 
98684
(Zip Code)

Registrant's telephone number, including area code: 360-694-7722

Securities registered pursuant to Section 12(b) of the Act: None

Securities registered pursuant to Section 12(g) of the Act: Common Stock, without par value

    Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days: Yes /x/  No / /

    Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K, or any amendment to this Form 10-K. / /

    The aggregate market value of the voting stock held by non-affiliates of the Registrant is $543,460,314 as of February 28, 2001 based upon the last sales price as reported by the Nasdaq National Market System.

    The number of shares outstanding of the Registrant's Common Stock as of February 28, 2001 was 23,744,414 shares.

    The Index to Exhibits appears on page 45 of this document. This document consists of 89 pages.

Documents Incorporated by Reference

    The Registrant has incorporated by reference into Part III of this Form 10-K portions of its Proxy Statement for its 2001 Annual Meeting of Stockholders.


DIRECT FOCUS, INC.
2000 FORM 10-K ANNUAL REPORT
TABLE OF CONTENTS

 
    
   Page
PART I

Item 1.
 
Business
 
3

Item 2.
 
Properties
 
15

Item 3.
 
Legal Proceedings
 
15

Item 4.
 
Submission of Matters to a Vote of Security Holders
 
15

PART II

Item 5.
 
Market for Registrant's Common Equity and Related Stockholder Matters
 
16

Item 6.
 
Selected Consolidated Financial Data
 
16

Item 7.
 
Management's Discussion and Analysis of Financial Condition and Results of Operations
 
17

Item 7A.
 
Quantitative and Qualitative Disclosures About Market Risk
 
23

Item 8.
 
Consolidated Financial Statements and Supplementary Data
 
24

Item 9.
 
Changes in and Disagreements With Accountants on Accounting and Financial Disclosure
 
39

PART III

Item 10.
 
Directors and Executive Officers of the Registrant
 
40

Item 11.
 
Executive Compensation
 
40

Item 12.
 
Security Ownership of Certain Beneficial Owners and Management
 
40

Item 13.
 
Certain Relationships and Related Transactions
 
40

PART IV

Item 14.
 
Exhibits, Financial Statement Schedules and Reports on Form 8-K
 
40

Signatures
 
44

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PART I

Item 1. Business

Forward Looking Statements

    Certain statements contained in this Annual Report on Form 10-K, including, without limitation, statements containing the words "believes," "anticipates," "estimates," "intends," "expects," "projections," and words of similar import, constitute "forward-looking statements." Investors are cautioned that all forward-looking statements involve risks and uncertainties and various factors could cause actual results to differ materially from those in the forward-looking statements. From time to time and in this Form 10-K, we may make forward-looking statements relating to our financial performance, including the following:

    Numerous factors could affect our actual results, including the following:

    We describe certain of these and other key risk factors elsewhere in this Form 10-K. Readers are further cautioned not to place undue reliance on forward-looking statements, which speak only as of the date of this Form 10-K. We undertake no obligation to update publicly any forward-looking statements to reflect new information, events or circumstances after the date of this Form 10-K or to reflect the occurrence of unanticipated events.

INTRODUCTION

    Direct Focus, Inc. is a leading marketing company for fitness and healthy lifestyle products with a highly-effective direct business model. We market consumer products within our direct marketing segment 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 direct-marketed product to date has been our Bowflex line of home fitness equipment. We also offer a line of premium quality air sleep systems under the name "Nautilus Sleep Systems," which we began direct marketing on a nationwide basis in December of 1999.

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    Another significant component of our operations is our commercial and retail products segment, which encompasses products and operations outside of our direct products segment. Our commercial and retail products segment includes Nautilus commercial and retail fitness equipment and accessories, which we added in January 1999 as part of our acquisition of Nautilus International, Inc. We anticipate further leveraging our Nautilus brand name through expanded marketing of new Nautilus home gyms and a new line of Nautilus free weight home gym equipment which we introduced in the summer of 2000, as well as any other Nautilus-branded home exercise products we may introduce in 2001. We market and sell our Nautilus commercial fitness equipment domestically through a direct sales force and internationally through independent sales representatives. We market our other Nautilus retail products domestically through non-exclusive independent sales representatives. We believe we have effectively integrated the Nautilus commercial business into our operations and stabilized its financial performance, as evidenced by its profitability during our first two years of ownership.

    For a discussion of financial information about our two business segments, direct products and commercial and retail products, see Note 2 of the Notes to Consolidated Financial Statements.

    Direct Focus was incorporated in California in 1986 and became a Washington corporation in 1993. Our principal executive offices are located at 1400 NE 136th Avenue, Vancouver, Washington 98684, and our telephone number is (360) 694-7722. We maintain our corporate web site at www.directfocusinc.com. None of the information on this web site or our other web sites is part of this Form 10-K.

    As used in this Form 10-K, the terms "we," "our," "us," "Direct Focus" and "the Company" refer to Direct Focus, Inc. and its subsidiaries. The names Bowflex®, Nautilus®, Bowflex Power-Pro®, Motivator®, Versatrainer®, Power Rod®, Direct Focus®, Instant Comfort® and Nautilus Sleep Systems® are registered trademarks of Direct Focus, Inc.

DIRECT MARKETING

    We direct market our Bowflex home fitness equipment and Nautilus Sleep Systems principally through 30- and 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 direct marketed consumer products. For direct marketed products that may require further explanation and demonstration, television infomercials are an important additional marketing tool. We have developed a variety of spot commercials and infomercials for our Bowflex product line and several commercials and marketing videos for our Nautilus Sleep Systems product line. We expect to use spot commercials and, where appropriate, infomercials to market any 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 $50,000 to $150,000. Based on 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

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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.

    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 the product's 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 of additional cable networks.

    Media Buying.  An important component of our direct marketing success is our ability to purchase quality media time at an affordable price. The cost of airing spot commercials and infomercials varies significantly, depending on the network, time slot and, for spot commercials, programming. Each spot commercial costs between $25 and $5,000 to air, and each infomercial costs between $600 and $55,000 to air. We currently purchase the majority of our media time on cable networks, through which we reach more than 70 million homes.

    We 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 the database enables us to predict with reasonable accuracy how many product sales and inquiries will result from each spot commercial and infomercial that we air. We also believe we can effectively track changing viewer patterns and adjust our advertising accordingly.

    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.  Our eCommerce sales have grown from 7.8% of direct sales in 1999 to 18.6% of direct sales in 2000 (24.4% in the fourth quarter of 2000), and we expect the Internet to continue as an increasingly important part of our direct marketing strategy. For example, we are promoting our web sites in spot commercials and infomercials in an effort to further stimulate electronic product inquiries and eCommerce transactions. We do not presently advertise our products on third-party web sites, but may do so in the future.

    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.nautilussleepsystems.com, focuses on our Nautilus Sleep Systems. In an effort to expand and enhance our web presence, we have added dedicated web site development and management personnel. Our immediate Internet-related goals include improving the capabilities at our Bowflex and Nautilus Sleep System web sites. In 1999, 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. In 2000, we believe we achieved a balance between our goals of finalizing sales and capturing consumer information by strategically designing our web pages and carefully analyzing web page hits, conversion rates, average sales prices and inquiry counts.

    Print Media.  We have advertised direct-marketed products in health and fitness-related consumer magazines and, to a limited extent, in entertainment, leisure and specialty magazines. We have

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determined that television advertising and the Internet generate more immediate consumer responses at a lower cost per inquiry and therefore have reduced the print media advertising expenditures for our direct marketed products. We will evaluate print media advertising expenditures for other direct-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 16-17 hours per day and receives and processes all infomercial-generated and customer service-related inquiries regarding our Bowflex products and Nautilus Sleep Systems. 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 typically upsells the benefits of higher priced models in our product line. This sophisticated system allows us to better utilize our agents, prioritize call types and improve customer service.

    We employ two large telemarketing companies to receive and process information requests generated by our spot television advertising 24 hours per day. The telemarketing agents for these companies 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.

    Internet.  We use television and print media to lead consumers to our web sites as we believe that consumers who visit our web sites are more inclined to purchase our products.

    Response Mailings.  We forward a "fulfillment kit" in response to each inquiry regarding our direct-marketed products. Each kit contains detailed literature that describes the product line and available accessories, a marketing video that demonstrates and highlights the key features of our premium product in the line, and additional information about how to purchase the product. If a potential customer does not respond within a certain time period, we proceed with additional follow-up mailings that convey a different marketing message and typically offer certain inducements to encourage a sale. The specific marketing message and offer at each stage will vary 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 Products and Nautilus Sleep Systems. We arrange this financing through a consumer credit company pursuant to a non-recourse consumer financing agreement. Under this arrangement, our customer service agents can obtain financing approval in a few minutes over the telephone and, if a customer is approved, immediately ship product without the need for cumbersome paperwork. The consumer finance company pays us promptly after submission of the required documentation and subsequently sends to each approved customer a Direct Focus private label credit card that can be used for future purchases of our products. There were approximately 131,000 private label cards with available credit of approximately $489 million outstanding as of February 28, 2001. During 2000, approximately 36.0% of our net sales were financed in this manner, and we believe 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, as well as a limited dealer network and internationally through independent sales distributors.

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During 2000, we hired a management team to oversee the sales and marketing operations of our Nautilus retail products business. Each member of the management team has significant industry experience and a history of sales and marketing success. Our retail product line is marketed through specialty fitness, sporting good and other retailers domestically through a direct sales force and independent sales representatives.

    Our commercial direct sales force focuses on strengthening the market position of our existing Nautilus product line, which we sell principally to health clubs, large hotels, assisted living facilities and the government. Additionally, as we continue to broaden our product line with products like Nautilus Nitro commercial equipment, 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 independent distributors.

PRODUCTS

    We introduced the first Bowflex home exercise machine in 1986, and since then have implemented several improvements to its design and functionality. We now offer three different Bowflex machines and eight different models. The key feature of each Bowflex machine is our patented "Power Rod" resistance technology. Each Power Rod is made of a solid polymer material that provides lineal progressive resistance in both the concentric and eccentric movements of an exercise. When combined with a bilateral cable pulley system, the machines provide excellent range and direction of motion for a large variety of strength-building exercises.

    We currently offer the following Bowflex machines:

    We currently offer the following Nautilus strength training equipment for the commercial market:

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    In December 1999, we began marketing a line of premium air sleep systems which we have named the "Nautilus Sleep Systems." The key feature of each Nautilus Sleep System is its variable firmness

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support chamber, an air chamber within each airbed that can be electronically adjusted to regulate firmness. All queen and larger airbeds in our Signature, Premier and Ultimate Premier Series are equipped with dual air chambers that enable users to maintain different firmness settings on each side of the bed. We believe that variable firmness and other comfort-oriented features of our Nautilus Sleep Systems favorably differentiate them from conventional innerspring mattresses.

    We currently offer four models of our Nautilus Sleep System:

    We offer foundations that are specifically designed to support and enhance the performance of our Nautilus Sleep Systems. We advise consumers to use our foundations because conventional box springs tend to sag and wear over time, causing an airbed to eventually mirror the worn box spring. We believe the majority of our Nautilus Sleep System customers will order a complete sleep system, which includes both a mattress and a foundation. Our foundations currently range in price from $199 for a twin to $399 for a California king.

NEW PRODUCT DEVELOPMENT AND INNOVATION

    We develop direct marketing products either from internally generated ideas or, as with its Bowflex technology, by acquiring or licensing patented technology from outside inventors and then enhancing the technology. During the evaluation phase of product development, we evaluate the suitability of the product for direct marketing, whether the product can be developed and manufactured in acceptable

9

quantities and at an acceptable cost, and whether it can be sold at a price that satisfies our profitability goals. More specifically, we look for high-quality consumer products that:

    In addition, because of our relatively high retail price target, we typically require that a product have a potential television advertising life cycle of at least five years and the possibility of an extended life cycle in retail stores.

    Once we determine that a product may satisfy our criteria, we further assess the product's direct marketing potential by continuing to research the product and its probable market and by conducting blind product and focus group studies. If we develop the product internally, or if we acquire or license the rights to the product, we will then proceed to develop and test a direct marketing campaign for the product. In most cases, our direct marketing campaigns will emphasize the use of spot commercials and television infomercials, which we supplement with print media advertisements, written materials, marketing videos and our web sites.

    Our growth strategy and financial performance depend in part on our ability to develop or acquire the rights to, and then direct 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 direct market may not generate sufficient net sales or profits to justify their development or acquisition costs.

    Our Nautilus commercial product development group develops and refines our commercial fitness products. The group's members gather and evaluate ideas from various areas, including existing and potential customers, sales and marketing, manufacturing, engineering and finance, and then determine which ideas will be incorporated into existing products or will serve as the basis for new products. Based on these ideas, the group designs new or enhanced products, develops prototypes, tests and modifies products, develops a manufacturing plan, and finally brings products to market. The group evaluates, designs and develops each new or enhanced product, taking into consideration our marketing requirements, target price points, target gross margin requirements and manufacturing constraints. In addition, each new or enhanced product must maintain the Nautilus standard of quality and reputation for excellence. We incorporate principles of physiology, anatomy and biomechanics into all of our Nautilus machines in order to match the movements of the human body throughout an exercise. Our key objective is to produce products that minimize the stress on users' skeletal systems and connective tissues and maximize the safety and efficiency of each workout. In late 2000, the Nautilus Nitro line was introduced after extensive research and development by this group.

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    We have developed a line of Nautilus retail strength training fitness equipment and hand-held fitness accessories. Current products include free weight home gym equipment, selectorized weight stack home gyms and a variety of hand held fitness accessories, such as jump ropes, hand weights and other similar devices.

MANUFACTURING AND DISTRIBUTION

    Our primary manufacturing and distribution objectives for our Bowflex products and Nautilus Sleep Systems are to maintain product quality, reduce and control costs, maximize production flexibility and improve delivery speed. We use a computerized inventory management system to forecast our manufacturing requirements. In general, we attempt to use outside suppliers to manufacture a majority of our raw materials and finished parts. We select these suppliers based upon their production quality, cost and flexibility. Whenever possible and in order to improve flexibility, we will attempt to use at least two suppliers to manufacture each product component. We currently use overseas suppliers to manufacture most of our Bowflex components, although we produce the main component of our Bowflex products, the Power Rods, exclusively in the United States. We intend to use outside suppliers that meet our manufacturing criteria. We have transferred production of some of our Nautilus Sleep Systems components overseas and we are also changing suppliers as we increase sales to enable us to reduce product cost while improving quality.

    We inspect, package and ship our products from our Washington, Virginia and Nevada facilities. We rely primarily on UPS to deliver our Bowflex and our Nautilus Sleep Systems products.

    Our Nautilus manufacturing operations are vertically integrated and include such functions as metal fabrication, powder coating, upholstery and vacuum-formed plastics processes. By managing our own manufacturing operations, we can control the quality of our Nautilus products and offer our commercial customers the opportunity to order certain color variations. We currently distribute Nautilus commercial fitness equipment from our Virginia warehouse facilities directly to customers primarily through our truck fleet. This method of distribution allows us to effectively control the set-up and inspection of equipment at the end-user's facilities. We outsource the manufacturing of Nautilus retail fitness equipment and fitness accessories to outside foreign manufacturers. We currently distribute our Nautilus fitness equipment and accessories from our Nevada facilities using various commercial truck lines or direct to customers at overseas ports.

INDUSTRY OVERVIEW

    We market our Bowflex home fitness equipment principally in the United States, which we believe is a large and growing market. According to the Sporting Goods Manufacturers' Association, United States consumers spent roughly $5.5 billion on home exercise equipment in 1999 and 1998. While sales are flat overall, sales of products in the categories we compete in are up as much as 13% from 1998 to 1999.

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    We market our Nautilus commercial fitness equipment throughout the world, including the United States, Europe, Asia, the Middle-East, Latin America and Africa. Within these markets, we target the following commercial customers, among others:

•   Health clubs   •   Corporate fitness centers
•   Rehabilitation clinics   •   Colleges and universities
•   The military   •   Governmental agencies
•   Hospitals   •   YMCA's and YWCA's
•   Hotels and motels   •   Professional sports teams

    According to the Sporting Goods Manufacturers' Association, aggregate sales of fitness equipment to commercial purchasers in the United States soared from $575 million in 1998 to $700 million in 1999, a 22% increase.

    The United States mattress market is large and dominated by four major manufacturers whose primary focus is the conventional innerspring mattress. According to the International Sleep Products Association, United States mattress and foundation sales totaled 38.2 million units shipped in 1999, representing a 4.4 percent increase from 1998. Total dollar value of these wholesale shipments reached $4.3 billion in 1999, an 8% increase from 1998. We believe this equates to over $7.6 billion in retail sales. The International Sleep Products Association (ISPA) estimates that innerspring mattresses accounted for approximately 90% of total domestic mattress sales in 1999. The ISPA also believes that less than 7% of all mattress sales are made through direct marketing channels. According to the ISPA, the bedding industry has enjoyed years of uninterrupted growth. In 1998, queen-sized mattresses became the largest selling segment. Both queen- and king-sized mattresses picked up market share in 1999.

COMPETITION

    The market for our Bowflex products is highly competitive. Our competitors frequently introduce new and/or improved products, often accompanied by major advertising and promotional programs. We believe the principal competitive factors affecting this portion of our business are price, quality, brand name recognition, product innovation and customer service.

    We compete directly with a large number of companies that manufacture, market and distribute home fitness equipment, and with the many health clubs that offer exercise and recreational facilities. We also compete indirectly with outdoor fitness, sporting goods and other recreational products. Our principal direct competitors include ICON Health & Fitness, Inc. (through its Health Rider, NordicTrak, Image, Proform, Weider and Weslo brands), Schwinn Fitness, Precor and Total Gym. In addition, some of our competitors have significantly greater financial and marketing resources, which may give them and their products an advantage in the marketplace.

    We believe our Bowflex line of home exercise equipment is competitive within the market for home fitness equipment based on product design, quality and performance and that our direct marketing activities are effective in distinguishing our products from the competition.

    The market for commercial fitness equipment is highly competitive. Our Nautilus products compete against the products of numerous other commercial fitness equipment companies, including Life Fitness, Cybex and Precor. Many of our competitors have greater financial and marketing

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resources, significantly more experience in the commercial fitness equipment industry, and more extensive experience manufacturing their products. We believe the key competitive factors in this industry include price, product quality and durability, diversity of features, financing options and warranties. Many commercial customers are also interested in product-specific training programs that educate them regarding how to safely maximize the benefits of a workout and achieve specific fitness objectives. In addition, certain commercial customers, such as hotels and corporate fitness centers, have limited floor space to devote to fitness equipment. These customers tend to favor multi-function machines that require less floor space.

    Our principal line of Nautilus commercial fitness equipment, the Nautilus 2ST, carries a premium price, however, we believe its reputation for quality and durability appeals to a significant portion of the market that strives for long-term product value. In addition, the Nautilus 2ST possesses unique features that appeal to the commercial market, such as low friction working parts, one-pound incremental weight stacks and hydraulic seat adjustments. We also offer training programs that are responsive to marketplace demands.

    Our newest line of Nautilus commercial fitness equipment, the Nautilus NITRO was developed especially to meet the needs of commercial customers such as hotels and fitness centers with limited floor space. In addition to being compact, Nautilus NITRO has competitive price points and a universal design that looks good in a variety of settings. With both the 2ST and Nautilus NITRO, we offer low cost lease and rental programs, as well as a wide array of value-added marketing, profit enhancing, and training programs.

    The mattress industry is also highly competitive, as evidenced by the wide range of products available to consumers, such as innerspring mattresses, waterbeds, futons and other air-supported mattresses. According to the International Sleep Products Association, conventional innerspring mattresses presently account for at least 90% of all domestic mattress sales. We believe market participants compete primarily on the basis of price, product quality and durability, brand name recognition, innovative features, warranties and return policies.

    We believe our most significant competition is the conventional mattress industry, which is dominated by four large, well-recognized manufacturers: Sealy (which also owns the Stearns & Foster brand name), Serta, Simmons and Spring Air. Although we believe our Nautilus Sleep Systems offer consumers an appealing alternative to conventional mattresses, many of these conventional manufacturers, including Sealy, Serta, Simmons and Spring Air, possess significantly greater financial, marketing and manufacturing resources and have better brand name recognition.

    Moreover, several manufacturers currently offer beds with firmness technology similar to our Nautilus Sleep Systems. We believe the largest manufacturer in this niche market is Select Comfort, Inc. Select Comfort offers its sleep systems at company-owned retail stores throughout the United States and engages in a significant amount of direct marketing, including infomercials, targeted mailings, print, radio and television advertising. Select Comfort has an established brand name, marketing and manufacturing resources. Select Comfort also has significantly greater experience in marketing and distributing airbeds. Despite these advantages, we believe the market for airbeds is large enough for both companies to be successful. In addition, we believe our Nautilus Sleep Systems possess features that will enable us to compete effectively against Select Comfort and other airbed companies.

    We believe our success in the mattress business depends in part on convincing consumers that variable firmness control and other features of our sleep system favorably differentiate our products from those of our competitors. We also believe our experience with direct marketing will enable us to successfully convey this message. However, the intense competition in the mattress industry, both from

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conventional mattress manufacturers and Select Comfort, may adversely affect our efforts to market and sell our airbeds and, consequently, may adversely affect our financial performance.

INTELLECTUAL PROPERTY

    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. Accordingly, we have taken the following protective measures:

    Notwithstanding these measures, our efforts to protect our proprietary rights may be inadequate, and applicable laws provide only limited protection. For example, of our four Bowflex patents, the most important covers our Power Rods, and this patent expires on April 27, 2004. The other three patents expire on February 16, 2005, April 14, 2007, and January 4, 2010. 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.

    Each federally registered trademark is renewable indefinitely if the mark is still in use at the time of renewal. We are not aware of any material claims of infringement or other challenges to our right to use our marks.

ENVIRONMENTAL REGULATION

    Environmental regulations most significantly affect our Nautilus facilities in Independence, Virginia. The Virginia Department of Environmental Quality has issued an air permit for several point sources at this facility. The sources include boilers, flash ovens and high solids paint booths. The permit imposes operation limits based on the length of time each piece of equipment is operated each day, and we operate the plant within these limits. The town of Independence, Virginia has issued an industrial user's wastewater permit that governs our discharge of on-site generated wastewater and storm water. In addition to the foregoing, in early 1999, we completed a Phase I Environmental Site Assessment and a limited Phase II Soil Analysis Assessment at our Nautilus facilities in Independence, Virginia. No significant deficiencies or violations were noted. We do not believe that continued compliance with federal, state and local environmental laws will have a material effect upon our capital expenditures, earnings or competitive position.

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EMPLOYEES

    As of December 31, 2000, we employed 398 full-time employees, including 3 executive officers and 38 part-time employees. None of our employees are subject to any collective bargaining agreement.


Item 2. Properties

    In August 2000, we purchased a 90,000 square foot facility in Vancouver, Washington as a warehouse, production, distribution and administrative facility. We retained our lease on an approximately 17,325 square foot facility in Vancouver, Washington which we will continue to use as our customer call center. We lease this property pursuant to an operating lease that expires April 30, 2002. The aggregate base rent is approximately $6,629 per month and is subject to annual adjustments based upon changes in the consumer price index, but no adjustment may exceed 6.0% in any calendar year.

    We house our Nautilus commercial operations and our East Coast distribution center for our Bowflex products in Independence, Virginia. We own 54 acres of commercial real property include the following facilities:

    We also have a distribution center in Las Vegas, Nevada. We distribute Bowflex equipment, Nautilus Sleep Systems and Nautilus retail fitness products and accessories from this 93,332 square foot facility. This lease expires November 30, 2002. The aggregate base rent is approximately $27,066 per month, and is subject to an annual cost of living increase of 3.5%.

    In 2000, we purchased approximately 19.5 acres of land in Las Vegas, Nevada for $1.1 million. We may build a distribution, warehouse and administrative facility on the land.

    In general, our properties are well maintained, adequate and suitable for their purposes, and we believe these properties will meet our operational needs for the foreseeable future. If we require additional warehouse or office space, we believe we will be able to obtain such space on commercially reasonable terms.


Item 3. Legal Proceedings

    As of March 2001, there were no material pending legal proceedings to which we or our subsidiaries were a party. From time to time, we become involved in ordinary, routine or regulatory legal proceedings incidental to our business.


Item 4. Submission of Matters to a Vote of Security Holders

    No matters were submitted to a vote of our shareholders during the quarter ended December 31, 2000.

15


PART II

Item 5. Market for Registrant's Common Equity and Related Stockholder Matters

Market Price of Our Common Stock

    Since May 4, 1999, our common stock has been listed for trading exclusively on The Nasdaq National Market System under the symbol DFXI. Prior to such date, our common stock was listed for trading exclusively on the Toronto Stock Exchange in the Province of Ontario, Canada, under the symbol DFX. The following table summarizes the high and low closing prices for each period indicated, adjusted to reflect the three-for-two splits effective August 2000 and January 2001:

 
   High
   Low
1999            
Quarter 1   $ 8.17   $ 5.37
Quarter 2     11.55     7.22
Quarter 3     9.33     6.67
Quarter 4   $ 12.89   $ 8.11

2000
 
 
 
 
 
 
Quarter 1   $ 13.33   $ 9.67
Quarter 2     21.78     11.95
Quarter 3     27.17     18.17
Quarter 4   $ 31.00   $ 21.21

    As of February 28, 2001, 23,744,414 shares of our common stock were issued and outstanding and held of record by shareholders.

    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.

USE OF PROCEEDS

    We received approximately $17.9 million in net proceeds from the sale of 975,000 shares of common stock in our May 1999 initial U.S. public offering, which includes proceeds from the overallotment option exercised by the managing underwriters. We applied $7 million of the net proceeds toward stock repurchases, $1.3 million toward computer and related technology upgrades, $1.1 million to purchase land for a potential distribution site in Nevada, and $4.2 million to purchase a building in Washington. We also used approximately $4.3 million of the net proceeds for working capital purposes, including increased direct marketing expenditures and increases in inventory and accounts receivable balances due to the growth of our business.


Item 6. Selected Consolidated Financial Data

    The selected consolidated financial data presented below for each of the years in the three-year period ended December 31, 2000 and the selected consolidated balance sheet data presented below as of December 31, 1999 and 2000 have been derived from the audited consolidated financial statements of the company included elsewhere in this report. The selected consolidated statement of operations data for the years ended December 31, 1996 and 1997 and the selected consolidated balance sheet data as of December 31, 1996 and the selected consolidated balance sheet data as of December 31, 1996, 1997 and 1998 have been derived from audited financial statements of the Company not included

16

herein. The data presented below should be read in conjunction with our financial statements and notes thereto and Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations."

IN THOUSANDS
(except per share amounts)
   1996
   1997
   1998
   1999
   2000
Statement of Operations Data                              
Net Sales+   $ 9,224   $ 21,546   $ 63,171   $ 133,079   $ 223,927
Cost of sales+     3,330     6,774     18,316     46,483     75,573
   
 
 
 
 
  Gross profit     5,914     14,772     44,855     86,596     148,354
Operating expenses:                              
  Selling and marketing     4,712     9,600     22,643     44,630     73,510
  General and administrative     473     975     1,701     4,237     8,804
  Royalties     269     581     1,623     2,897     4,979
  Litigation settlement     —     —     —     4,000     —
   
 
 
 
 
    Total operating expenses     5,454     11,156     25,967     55,764     87,293
   
 
 
 
 
Operating income     460     3,616     18,888     30,832     61,061
Other income (expense)                              
  Interest income     37     119     527     1,003     3,632
  Other-net     (53 )   (88 )   (228 )   3     347
   
 
 
 
 
    Total other income (expense)     (16 )   31     305     1,006     3,979
   
 
 
 
 
Income before income taxes     444     3,647     19,193     31,838     65,040
Income tax expense (benefit)     (249 )   1,226     6,708     11,495     23,414
   
 
 
 
 
Net income   $ 693   $ 2,421   $ 12,485   $ 20,343   $ 41,626
   
 
 
 
 
Basic earnings per share(1)*   $ 0.03   $ 0.12   $ 0.59   $ 0.89   $ 1.77
Diluted earnings per share(1)*   $ 0.03   $ 0.11   $ 0.57   $ 0.87   $ 1.73

Basic shares outstanding*
 
 
19,256
 
 
20,222
 
 
21,008
 
 
22,874
 
 
23,525
Diluted shares outstanding*     20,123     21,401     21,884     23,457     23,999

Balance Sheet Data
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Cash and cash equivalents   $ 1,154   $ 4,790   $ 18,911   $ 35,703   $ 77,181
Working capital     1,973     4,100     15,682     38,209     72,520
Total assets     3,515     7,922     24,373     67,310     117,126
Stockholders' equity     2,220     4,592     17,651     53,031     92,867
+
Balances reflect adoption of EITF Consensus 00-10

*
Reflects the three-for-two stock splits effective August 2000 and January 2001

(1)
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.


Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations

RESULTS OF OPERATIONS

    We believe that period-to-period comparisons of our operating results are not necessarily indicative of future performance. You should consider our prospects in light of the risks, expenses and difficulties frequently encountered by companies experiencing rapid growth and, in particular, rapidly growing

17

companies that operate in evolving markets. We may not be able to successfully address these risks and difficulties. Although we have experienced net sales growth in recent years, our net sales growth may not continue, and we cannot assure you of any future growth or profitability.

    The following table presents certain financial data as a percentage of total revenues:

 
   Year Ended December 31,
  
 
   1998
   1999
   2000
  
Statement of Operations Data              

Net sales
 
100.0
%
100.0
%
100.0
%
Cost of sales   29.0   34.9   33.7  
   
 
 
 
Gross profit   71.0   65.1   66.3  

Operating expenses
 
 
 
 
 
 
 
  Selling and marketing   35.8   33.5   32.8  
  General and administrative   2.7   3.2   3.9  
  Royalties   2.6   2.2   2.2  
  Litigation settlement   —   3.0   —  
   
 
 
 
Total operating expenses   41.1   41.9   38.9  
Operating income   29.9   23.2   27.4  
Other income   0.5   0.7   1.6  
   
 
 
 
Income before income taxes   30.4   23.9   29.0  
Income tax expense   10.6   8.6   10.5  
   
 
 
 
Net income   19.8 % 15.3 % 18.6 %
   
 
 
 

COMPARISON OF THE YEARS ENDING DECEMBER 31, 2000 AND DECEMBER 31, 1999

Net Sales

    Net sales grew by 68.3% to $223.9 million in 2000 from $133.1 million in 1999. Sales within our direct products segment increased by 75.3% over prior year levels and accounted for $198.1 million, or 88.5%, of our aggregate net sales in 2000. Net sales within our commercial and retail product segment increased by 28.6% over prior year levels and accounted for $25.8 million, or 11.5% of our net sales.

    Sales growth in 2000 primarily resulted from expanded direct marketing of our Bowflex and Nautilus Sleep Systems products and the growth we experienced in eCommerce sales, as well as the positive impact of the strong domestic economy that existed until late 2000. Within our direct products segment, with respect to both our Bowflex products and our Nautilus Sleep Systems, we intend to further expand our use of spot television commercials and expand our use of infomercials of our Bowflex products during 2001 by increasing our presence in existing television markets and entering new television markets. We intend to increase sales within our Nautilus products segment by continuing to develop new products and expanding our direct sales efforts both domestically and internationally.

    Except for the fourth quarter, fiscal 2000 sales of our Bowflex products appear to have been consistent with historic trends. As in prior years, first and third quarter sales of our Bowflex products were strong, while the second quarter reflected seasonal weakness. Our direct marketing business is largely dependent upon national cable television advertising, and we are finding that second quarter influences on television viewership, such as the broadcast of national network season finales and seasonal weather factors, are causing our spot television commercials on national cable television to be marginally less effective than in other periods of the year. During the fourth quarter of 2000 and 1999,

18

we experienced unusually strong consumer demand compared to the third quarter for our Bowflex products, which we believe is a trend that will not continue for the fourth quarter in future periods.

    Sales within our commercial and retail business were, and we believe will continue to be, strongest in the third and fourth quarters. We believe the principal reason for this trend is the commercial fitness industry's preparation for the impact of New Year fitness resolutions and seasonal weather factors in the fourth quarter, and retail fitness store purchases of fitness equipment in preparation for the Christmas buying season and New Year fitness resolutions in the third and fourth quarters.

    Notwithstanding our product diversification efforts, we anticipate that sales of our Bowflex Power Pro will continue to account for a substantial portion of our net sales for the foreseeable future. Any significant diminished consumer interest in this product line would sharply reduce our net sales and profitability. In addition, the success of each of our products depends substantially on how consumers decide to spend their money and the amount of disposable income they have. Unfavorable economic conditions may depress consumer spending, especially for premium priced products like ours.

Gross Profit

    Gross profit grew 71.3% to $148.4 million in 2000, from $86.6 million in 1999. Our gross profit margin increased 1.2% to 66.3% in 2000, from 65.1% in 1999. This increase was mainly attributable to the net sales of direct products as a percentage of total net sales. The margin within our direct products segment was 70.2% in 2000, while there was a 36.2% margin within our commercial and retail products segment for 2000. Sales of our direct products comprised 88.5% of net sales in 2000, compared with 84.9% in 1999. This increase in percentage of direct products sold, along with strong eCommerce sales at higher margins, resulted in the higher profit margin for 2000.

    We expect a lower percentage gross profit margin contribution from our Nautilus Sleep Systems, compared to our Bowflex products, as we continue our direct marketing campaign for this product. Similar to our Bowflex products, with the anticipated future higher sales volume of Nautilus Sleep Systems, we expect to take advantage of overseas production and new vendor relationships to strengthen the margins for these products.

Operating Expenses

    Selling and marketing expenses grew to $73.5 million in 2000 from $44.6 million in 1999, an increase of 64.7%. This increase in selling and marketing expenses resulted primarily from the continued expansion of our direct marketing campaign for Bowflex products and Nautilus Sleep Systems and variable costs associated with our sales growth.

    As a percentage of net sales, selling and marketing expenses decreased by 0.7% in 2000 to 32.8% in 2000, compared to 33.5% in 1999. Selling and marketing expenses within our direct products segment were $67.1 million, a 1.1% increase as a percentage of net sales compared to 1999. Selling and marketing expenses within our commercial and retail business traditionally have been a lower percentage of net sales than we have experienced in direct marketing and were $6.4 million in 2000 compared with $5.1 million in 1999. In real dollar terms, we expect our aggregate selling and marketing expenses will continue to increase in real dollar terms, but will also increase as a percentage of net sales, as we:

19

    General and administrative expenses grew to $8.8 million in 2000 from $4.2 million in 1999, an increase of 107.8%. As a percentage of net sales, general and administrative expenses increased to 3.9% in 2000 from 3.2% in 1999. Our direct products segment accounted for $4.0 million of the increase in general and administrative expenses, due primarily to increased staffing and infrastructure expenses necessitated by our continued growth and the implementation of our information systems. Commercial and retail operations accounted for the remaining increase of $0.6 million. We believe our general and administrative expenses will continue to increase in future periods in real dollar terms and also as a percentage of net sales.

    Royalty expense grew to $5.0 million in 2000 from $2.9 million in 1999, an increase of 71.9%. The increase in our royalty expense is attributable to increased sales of our Bowflex products in 2000, plus new royalty agreements related to the development of additional products. Our royalty expenses will increase if sales of our Bowflex products continue to increase.

Other Income

    In 2000, other income increased to $4.0 million from $1.0 million in 1999. The $3.0 million increase resulted primarily from interest earned on invested cash and cash equivalents. We expect other income to increase if invested cash balances increase and interest rates remain steady.

Income Tax Expense

    Income tax expense increased by $11.9 million in 2000 compared to 1999. We expect our income tax expense to increase in line with increases of our income before taxes.

Net Income

    For the reasons discussed above, net income increased 104.6% to $41.6 million in 2000 compared to $20.3 million in 1999.

Comparison of Years Ending December 31, 1999, and December 31, 1998

Net Sales

    Net sales grew by 110.6% to $133.1 million in 1999 from $63.2 million in 1998. Sales within our direct products segment increased by 78.9% over prior year levels and accounted for $113.0 million, or 84.9%, of our aggregate net sales in 1999. Net sales within our commercial and retail segment generated $20.1 million of our aggregate net sales and accounted for 33.4% of the aggregate increase. Sales growth in 1999 primarily resulted from expanded direct marketing of our Bowflex products and the addition of our commercial and retail segment.

    Except for the fourth quarter, fiscal 1999 sales of our Bowflex products appear to have been consistent with historic trends. As in prior years, first and third quarter sales of our Bowflex products were strong, while the second quarter reflected seasonal weakness. Our direct products segment is largely dependent upon national cable television advertising, and we found that second quarter influences on television viewership, such as the broadcast of national network season finales and seasonal weather factors, caused our spot television commercials on national cable television to be marginally less effective than in other periods of the year. During the fourth quarter of 1999, we

20

experienced unusually strong consumer demand compared to the third quarter for our Bowflex products.

    Sales within our commercial and retail segment were stronger in the third and fourth quarters. We believe the principal reason for this trend is the commercial fitness industry's preparation for the impact of New Year fitness resolutions and seasonal weather factors in the fourth quarter, and retail fitness store purchases of fitness equipment in preparation for the Christmas buying season and New Year fitness resolutions in the third and fourth quarters.

Gross Profit

    Gross profit grew 93.0% to $86.6 million in 1999, from $44.9 million in 1998. Our gross profit margin decreased 5.9% to 65.1% in 1999, from 71.0% in 1998. The decrease in gross profit margin was mainly attributable to our commercial and retail operations, which had a gross profit margin in 1999 of 36.6%.

Operating Expenses

    Selling and marketing expenses grew to $44.6 million in 1999 from $22.6 million in 1998, an increase of 97.1%. This increase in selling and marketing expenses resulted primarily from the continued expansion of our Bowflex direct marketing campaign and variable costs associated with our sales growth. The addition of our commercial and retail business accounted for $5.1 million of the increase.

    As a percentage of net sales, selling and marketing expenses decreased by 2.3% in 1999 to 33.5%, compared to $22.6 million, or 35.8%, a 0.7% decrease as a percentage of net sales compared to 1998. Selling and marketing expenses within our commercial and retail business traditionally have been a lower percentage of net sales than we have experienced in direct marketing. In real dollar terms, we expect our aggregate selling and marketing expenses will continue to increase, but not materially as a percentage of net sales.

    General and administrative expenses grew to $4.2 million in 1999 from $1.7 million in 1998, an increase of 149.1%. Our direct marketing business accounted for $1.3 million of the increase in general and administrative expenses, due primarily to increased staffing levels in our accounting and information systems departments necessitated by our continued growth and the implementation of our new information system. Commercial and retail operations accounted for the remaining increase of $1.2 million. As a percentage of net sales, general and administrative expenses increased to 3.2% in 1999 from 2.7% in 1998.

    Royalty expense grew to $2.9 million in 1999 from $1.6 million in 1998, an increase of 81.3%. The increase in our royalty expense is attributable to increased sales of our Bowflex products in 1999.

Other Income

    In 1999, other income increased to $1.0 million from $0.3 million in 1998. The $0.7 million increase resulted primarily from interest income generated by higher cash investments accumulated from a combination of results from operations and our public offering completed during the second quarter of 1999.

21

Income Tax Expense

    Income tax expense increased by $4.8 million in 1999 compared to 1998. Our effective tax rate increased by 1.2% to 36.1% due to state tax liability.

Net Income

    For the reasons discussed above, net income increased 62.4% to $20.3 million in 1999 compared to $12.5 million in 1998.

Quarterly Results of Operations

    The following table presents our operating results for each of the eight quarters in the period ended December 31, 2000. The information for each of these quarters is unaudited and has been prepared on the same basis as the audited financial statements appearing elsewhere in this Annual Report on Form 10-K. In the opinion of management, all necessary adjustments, consisting only of normal recurring adjustments, have been included to present fairly the unaudited quarterly results when read together with our audited financial statements and the related notes. These operating results are not necessarily indicative of the results of any future period.

Selected Quarterly Information

 
   QUARTER ENDED
 
   March 31
   June 30
   September 30
   December 31
 
   (In thousands, except per share)
Fiscal 2000:                
  Net sales+   47,333   48,131   57,834   70,629
  Gross profit   32,149   31,190   39,063   45,952
  Operating income   13,359   11,815   16,262   19,625
 
Net income
 
8,919
 
8,168
 
11,082
 
13,457
 
Earnings per share
 
 
 
 
 
 
 
 
    Basic*   .38   .35   .47   .57
    Diluted*   .37   .34   .46   .55
Fiscal 1999:                
  Net sales+   28,782   27,829   34,878   41,589
  Gross profit   18,723   17,882   22,982   27,008
  Operating income   6,907   1,999 (1) 8,099   13,827
 
Net income
 
4,479
 
1,399
(1)
5,495
 
8,969
 
Earnings per share
 
 
 
 
 
 
 
 
    Basic*   .21   .06 (1) .23   .38
    Diluted*   .20   .06 (1) .23   .37
+
Net sales reflects the adoption of EITF Consensus 00-10

*
Reflects the three-for-two stock splits effective August 2000 and January 2001.

(1)
Includes a $4 million litigation settlement expense. Net income and earnings per share amounts also reflect $1.4 million of income tax benefit related to the litigation settlement.

22

Liquidity and Capital Resources

    Historically, we have financed our growth primarily from cash generated by our operating activities. During 2000, our operating activities generated $52.8 million in net cash, which contributed to an aggregate $77.2 million in cash and cash equivalents on hand as of December 31, 2000 compared to $35.7 million in cash and cash equivalents at December 31, 1999. Through a stock repurchase program, we bought back $3.3 million in common stock on the open market. Our capital expenditures in 2000 totaled $8.8 million, including $1.1 million for land in Las Vegas, Nevada and $4.2 million for land and a building in Vancouver, Washington. These activities resulted in a $41.5 million, or 116% increase in our cash and cash equivalents during 2000.

    We anticipate our working capital requirements will increase as a result of growing our Nautilus commercial and retail fitness operations. We also expect to increase our cash expenditures on spot commercials and infomercials as we continue to expand the direct marketing campaigns for our Bowflex products and Nautilus Sleep Systems. In January 2001, the Board of Directors authorized management to repurchase up to $20 million of the Company's common stock in open-market transactions from January 25, 2001 through April 30, 2001, with the terms of the purchases to be determined by management based on market condition.

    We maintain a $10 million line of credit with Bank of America (increased from $5.0 million on April 1, 2000). The line of credit is secured by our general assets and contains certain financial covenants. As of the date of these financial statements, we are in compliance with all material covenants applicable to the line of credit and there is no outstanding balance under the line.

    We believe our existing cash balances, combined with our line of credit, will be sufficient to meet our capital requirements for at least the next twelve months.

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, cash flows or our financial position. However, increases in inflation over historical levels or uncertainty in the general economy could decrease discretionary consumer spending for products like ours. We have not raised the prices on any of our products since 1997. Consequently, none of our revenue growth is attributable to price increases.

Recent Accounting Pronouncement

    In June 1998, the FASB issued Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities" ("SFAS 133"). SFAS 133 establishes accounting and reporting standards for all derivative instruments. SFAS 133, as amended, is effective for fiscal years beginning after June 15, 2000. We do not currently have any derivative instruments and, accordingly, do not expect the adoption of SFAS 133 to have an impact on our financial position, results of operations, or cash flows.

    In the fourth quarter of 2000, we adopted Emerging Issues Task Force Consensus 00-10, "Accounting for Shipping and Handling Costs" ("EITF 00-10"). As a result of this adoption, we now account for revenue generated by shipping products to customers as net sales. Previously, these amounts were included in cost of sales along with the related costs incurred to ship the products. Net sales and cost of sales for prior periods have been restated to reflect EITF Consensus 00-10.


Item 7A. Quantitative and Qualitative Disclosures About Market Risk

    To date, we have invested cash with banks and in highly liquid debt instruments purchased with maturity dates of three months or less. Our bank deposits may exceed federally insured limits and there is risk of loss of the entire principal with any debt instrument. To reduce risk of loss, we limit our exposure to any one debt issuer and require certain minimum ratings for debt instruments that we purchase.

23


Item 8. Consolidated Financial Statements and Supplementary Financial Data

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

 
   Page
Direct Focus, Inc. Consolidated Financial Statements    

Independent Auditors' Report
 
25

Consolidated Balance Sheets as of December 31, 1999 and 2000
 
26

Consolidated Statements of Income for the three years ended December 31, 2000
 
27

Consolidated Statements of Stockholders' Equity for the three years ended December 31, 2000
 
28

Consolidated Statements of Cash Flows for the three years ended December 31, 2000
 
29

Notes to Consolidated Financial Statements
 
30

24

INDEPENDENT AUDITORS' REPORT

Board of Directors and Stockholders
of Direct Focus, Inc.:

    We have audited the accompanying consolidated balance sheets of Direct Focus, Inc. and subsidiaries as of December 31, 1999 and 2000, and the related consolidated statements of income, stockholders' equity, and cash flows for each of the three years in the period ended December 31, 2000. Our audits also included the financial statement schedule at Item 14. These financial statements and financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on the financial statements and financial statement schedule based on our audits.

    We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

    In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Direct Focus, Inc. and subsidiaries at December 31, 1999 and 2000 and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2000 in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, such financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly in all material respects the information set forth therein.

DELOITTE & TOUCHE LLP
Portland, Oregon
January 19, 2001

25

DIRECT FOCUS, INC.

CONSOLIDATED BALANCE SHEETS

 
   December 31,
1999
   December 31,
2000
ASSETS
CURRENT ASSETS:            
  Cash and cash equivalents   $ 35,703,457   $ 77,181,064
  Trade receivables (less allowance for doubtful accounts of:
1999, $304,727 and 2000, $352,279)		     4,744,213     4,941,286
  Inventories     9,167,554     12,653,117
  Prepaid expenses and other current assets     1,863,951     591,453
  Current deferred tax asset     820,789     950,363
   
 
    Total current assets     52,299,964     96,317,283
   
 
PROPERTY, PLANT AND EQUIPMENT, NET     10,644,838     16,668,884
   
 
OTHER ASSETS     4,364,963     4,140,277
   
 
TOTAL ASSETS   $ 67,309,765   $ 117,126,444
   
 

LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:            
  Trade payables   $ 5,871,369   $ 12,335,776
  Accrued liabilities     4,051,540     5,344,225
  Income taxes payable     2,177,236     2,542,967
  Royalty payable to stockholders     893,563     1,481,886
  Customer deposits     1,097,748     2,092,611
   
 
    Total current liabilities     14,091,456     23,797,465
   
 
LONG-TERM DEFERRED TAX LIABILITY     187,484     462,004
   
 
COMMITMENTS AND CONTINGENCIES (Notes 8 and 15)            
STOCKHOLDERS' EQUITY:            
  Common stock—authorized, 75,000,000 shares of no par value; Outstanding, 1999: 23,499,333 shares, 2000: 23,545,181 shares     18,602,420     16,812,476
  Retained earnings     34,428,405     76,054,499
   
 
    Total stockholders' equity     53,030,825     92,866,975
   
 
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY   $ 67,309,765   $ 117,126,444
   
 

See notes to consolidated financial statements.

26

DIRECT FOCUS, INC.

CONSOLIDATED STATEMENTS OF INCOME

Three years ended December 31, 2000

 
   1998
   1999
   2000
NET SALES   $ 63,171,376   $ 133,078,513   $ 223,927,365

COST OF SALES
 
 
18,316,803
 
 
46,482,613
 
 
75,573,619
   
 
 
 
Gross profit
 
 
44,854,573
 
 
86,595,900
 
 
148,353,746
   
 
 

EXPENSES:
 
 
 
 
 
 
 
 
 
Selling and marketing     22,642,885     44,629,825     73,509,675
General and administrative     1,700,956     4,236,804     8,804,446
Royalties     1,622,726     2,897,278     4,979,287
Litigation settlement     —     4,000,000     —
   
 
 
 
Total operating expenses
 
 
25,966,567
 
 
55,763,907
 
 
87,293,408
   
 
 

INCOME FROM OPERATIONS
 
 
18,888,006
 
 
30,831,993
 
 
61,060,338
   
 
 

OTHER INCOME (EXPENSE):
 
 
 
 
 
 
 
 
 
Interest income     526,961     1,003,586     3,631,993
Other, net     (221,889 )   2,737     347,175
   
 
 
  Total other income, net     305,072     1,006,323     3,979,168
   
 
 

INCOME BEFORE INCOME TAXES
 
 
19,193,078
 
 
31,838,316
 
 
65,039,506

INCOME TAX EXPENSE
 
 
6,707,584
 
 
11,495,425
 
 
23,413,412
   
 
 

NET INCOME
 
$
12,485,494
 
$
20,342,891
 
$
41,626,094
   
 
 

BASIC EARNINGS PER SHARE
 
$
0.59
 
$
0.89
 
$
1.77
   
 
 

DILUTED EARNINGS PER SHARE
 
$
0.57
 
$
0.87
 
$
1.73
   
 
 

Basic shares outstanding
 
 
21,007,181
 
 
22,872,638
 
 
23,525,069

Diluted shares outstanding
 
 
21,883,406
 
 
23,456,718
 
 
23,998,244

See notes to consolidated financial statements.

27

DIRECT FOCUS, INC.

CONSOLIDATED STATEMENTS OF STOCKHOLDER'S EQUITY

For the three years ended December 31, 2000

 
   Common Stock
    
    
  
 
   Retained Earnings
    
  
 
   Shares
   Amount
   Total
  
BALANCES, JANUARY 1, 1998   20,261,988   $ 2,992,172   $ 1,600,020   $ 4,592,192  

Options exercised
 
997,190
 
 
134,004
 
 
—
 
 
134,004
 
Tax benefit of exercise of nonqualified options   —     439,452     —     439,452  
Net income   —     —     12,485,494     12,485,494  
   
 
 
 
 
BALANCES, DECEMBER 31, 1998   21,259,178   $ 3,565,628   $ 14,085,514   $ 17,651,142  
   
 
 
 
 
Public offering   2,193,750     17,937,691           17,937,691  
Options exercised   521,607     300,482     —     300,482  
Stock repurchased   (475,200 )   (3,698,793 )   —     (3,698,793 )
Tax benefit of exercise of nonqualified options   —     497,412     —        
Net income   —     —     20,342,891     20,342,891  
   
 
 
 
 
BALANCES, DECEMBER 31, 1999   23,499,335   $ 18,602,420   $ 34,428,405   $ 53,030,825  
   
 
 
 
 
Options exercised   324,201     622,236     —     622,236  
Stock repurchased   (278,354 )   (3,252,043 )   —     (3,252,043 )
Tax benefit of exercise of nonqualified options   —     839,863     —     839,863  
Net income   —     —     41,626,094     41,626,094  
   
 
 
 
 
BALANCES, DECEMBER 31, 2000   23,545,182   $ 16,812,476   $ 76,054,499   $ 92,866,975  
   
 
 
 
 

See notes to consolidated financial statements

28

DIRECT FOCUS, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

Three years ended December 31, 2000

 
   1998
   1999
   2000
  
CASH FLOWS FROM OPERATING ACTIVITIES:                    
Net income   $ 12,485,494   $ 20,342,891   $ 41,626,094  
Adjustments to reconcile net income to net cash provided by operating activities:                    
  Depreciation and amortization     301,913     1,183,412     2,874,101  
  Loss on equipment disposal     —     1,262     4,504  
  Tax benefit of exercise of nonqualified options     439,452     497,412     839,863  
  Deferred income taxes     99,484     (484,448 )   144,945  
  Changes in:                    
    Trade receivables     41,336     (1,519,116 )   (197,073 )
    Inventories     (668,900 )   (3,448,750 )   (3,485,563 )
    Prepaid expenses and other current assets     (166,027 )   (1,377,336 )   1,272,498  
    Trade payables     2,423,819     2,001,235     6,464,407  
    Income taxes payable     (296,353 )   1,672,461     365,731  
    Accrued liabilities and royalty payable to Stockholders     1,099,819     988,414     1,881,008  
    Customer deposits     107,084     948,811     994,863  
   
 
 
 
  Net cash provided by operating activities     15,867,121     20,806,248     52,785,378  
   
 
 
 
CASH FLOWS FROM INVESTING ACTIVITIES:                    
  Additions to property, plant and equipment     (1,738,836 )   (1,929,137 )   (8,761,526 )
  Proceeds from sale of property, plant and equip.     —     159,238     97,067  
  Additions to other assets     (12,309 )   (167,935 )   (13,505 )
  Acquisition cost of Nautilus     (120,454 )   (16,615,012 )   —  
   
 
 
 
  Net cash used in investing activities     (1,871,599 )   (18,552,846 )   (8,677,964 )
   
 
 
 
CASH FLOWS FROM FINANCING ACTIVITIES:                    
  Principal payments under capital lease obligations     (9,167 )   —     —  
  Proceeds from public offering     —     17,937,691     —  
  Funds used for stock repurchase     —     (3,698,793 )   (3,252,043 )
  Proceeds from exercise of stock options     134,004     300,482     622,236  
   
 
 
 
  Net cash provided by (used in) financing activities     124,837     14,539,380     (2,629,807 )
   
 
 
 
NET INCREASE IN CASH AND CASH EQUIVALENTS     14,120,359     16,792,782     41,477,607  
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR     4,790,316     18,910,675     35,703,457  
   
 
 
 
CASH AND CASH EQUIVALENTS, END OF YEAR   $ 18,910,675   $ 35,703,457   $ 77,181,064  
   
 
 
 
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:                    
  Cash paid for interest     455     —     —  
  Cash paid for income taxes     6,465,006     9,835,000     21,907,800  

See notes to consolidated financial statements

29


DIRECT FOCUS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Three years ended December 31, 2000

1.  ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES

    Direct Focus Inc. (the "Company," a Washington corporation) is a leading marketing company for fitness and healthy lifestyle products with highly-effective direct business model. The Company has two operating segments. One is the direct business through which they market consumer products directly through a variety of direct marketing channels, including spot television commercials, infomercials, response mailings, and the Internet. The Company's principal direct segment products are the Bowflex line of home fitness equipment and a line of premium quality sleep systems (Nautilus Sleep Systems). As a result of the acquisition in January 1999 of Nautilus International, Inc., the Company added a second business segment which comprises a significant component of the Company's operations and includes Nautilus commercial and retail fitness equipment and accessories.

    The consolidated financial statements of the Company include Direct Focus, Inc., Nautilus HPS, Inc., Nautilus, Inc., DFI Properties, LLC, BFI Advertising, Inc., DFI Sales, Inc., and Nautilus Fitness Products, Inc. All inter-company transactions have been eliminated.

    The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

    Cash and cash equivalents include cash on hand, cash deposited with banks and financial institutions and highly liquid debt instruments purchased with maturity dates of three months or less at date of acquisition. The Company maintains its cash in bank deposit accounts which, at times, may exceed federally insured limits. The Company has not experienced any losses in such accounts.

    Inventories are stated at the lower of average cost or market.

    The Company expenses the production costs of advertising the first time the advertising takes place.

    Property, plant and equipment is stated at cost. Depreciation is computed using the straight-line method over the estimated useful lives of the assets.

30

    Management reviews the investment in long-lived assets for possible impairment whenever events or circumstances indicate the carrying amount of an asset may not be recoverable. There have been no such events or circumstances in the three years ended December 31, 2000. If there were an indication of impairment, management would prepare an estimate of future cash flows (undiscounted and without interest charges) expected to result from the use of the asset and its eventual disposition. If these cash flows were less than the carrying amount of the asset, an impairment loss would be recognized to write down the asset to its estimated fair value.

    Other assets consist of license agreements, patents and trademarks. Amortization is computed using the straight-line method over estimated useful lives of three to twenty years. The trademark associated with the Nautilus acquisition was valued at $4,349,839 and is being amortized over twenty years. Accumulated amortization was $272,183 and $510,374 at December 31, 1999 and 2000, respectively.

    The Company's warranty policy provides for coverage for defects in material and workmanship. Warranty periods on the Company's products range from two years to limited lifetime on the Bowflex lines of fitness products and twenty years on airbeds. The Nautilus commercial line of fitness products includes a lifetime warranty on the structural frame, welded moving parts and weight stacks, a 120-day warranty on upholstery and padded items, and a one-year warranty on all other parts.

    Revenue from product sales is generally recognized at the time of shipment. Revenue is recognized upon installation for the Nautilus commercial equipment, if the Company's truck fleet is used for delivery of the products.

    In the fourth quarter of 2000, the Company adopted Emerging Issues Task Force Consensus 00-10 "Accounting for Shipping and Handling Costs" (EITF 00-10). As a result, the Company now accounts for revenue generated by shipping products to customers as net sales. Previously, these amounts were included in cost of sales along with the related costs incurred to ship the products. Net sales and cost of sales for prior periods have been restated to reflect EITF 00-10. This change has no effect on reported net income or earnings per share.

    Internal research and development costs are expensed as incurred and included in cost of sales. Third party research and development costs are expensed when the contracted work has been performed.

    Research and development expense was $64,973, $716,240 and $1,186,216 for 1998, 1999 and 2000, respectively.

    The Company continues to measure compensation expense for its stock-based employee compensation plans using the method prescribed by APB Opinion No. 25, "Accounting for Stock Issued to Employees." The Company provides pro forma disclosures of net income and earnings per share as if

31

the method prescribed by Statement of Financial Accounting Standards ("SFAS") No. 123, "Accounting for Stock-Based Compensation," had been applied in measuring compensation expense. See Note 9.

    Deferred income tax assets and liabilities are computed annually for differences between the financial statement and tax bases of assets and liabilities that will result in taxable or deductible amounts in the future based on enacted tax laws and rates applicable to periods in which the differences are expected to affect taxable income. A valuation allowance is established when necessary to reduce deferred tax assets to the amount more likely than not to be realized. Income tax expense is the tax payable or refundable for the period plus or minus the change during the period in deferred tax assets and liabilities.

    Effective January 1, 1998, the Company adopted 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. Comprehensive income equaled net income for all periods presented.

    The carrying amount of the Company's cash and cash equivalents, trade receivables, trade payables, royalties payable, and accrued liabilities approximates their estimated fair values due to the short-term maturities of those financial instruments.

    In June 1999, the FASB issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities" ("SFAS 133"). SFAS 133 establishes accounting and reporting standards for all derivative instruments. SFAS 133, as amended, is effective for fiscal years beginning after June 15, 2000. We do not currently have any derivative instruments and, accordingly, do not expect the adoption of SFAS 133 to have an impact on our financial position or results of operations.

    Certain amounts from 1998 and 1999 have been reclassified to conform to the 2000 presentation.

2.  OPERATING SEGMENTS

    The Company's operating segments include its direct products segment which includes all products marketed directly to consumers through a variety of direct marketing channels. The Bowflex line of fitness equipment and the Nautilus Sleep Systems are the principal products in the Company's direct products segment. The other operating segment is the commercial and retail products line which includes products and operations that are not direct marketed to consumers. Products in this segment include Nautilus commercial and retail fitness equipment and accessories. Accounting policies used by the segments are the same as those disclosed in Note 1.

32

    The following table presents information about the Company's two operating segments (in thousands):

 
   Direct Products
   Commercial and
Retail Products
   Total
Year Ended December 31, 2000                  
  Revenues from external customers   $ 198,107   $ 25,820   $ 223,927
  Interest income     3,630     2     3,632
  Depreciation and amortization expense     2,068     806     2,874
  Income tax expense     22,883     530     23,413
  Segment net income     40,684     942     41,626
  Segment assets     95,815     21,311     117,126
  Additions to property, plant and equipment     8,237     525     8,762

Year Ended December 31, 1999
 
 
 
 
 
 
 
 
 
  Revenues from external customers   $ 113,004   $ 20,075   $ 133,079
  Interest income     1,002     2     1,004
  Depreciation and amortization expense     565     411     1,183
  Income tax expense     11,084     618     11,495
  Segment net income     19,715     628     20,343
  Segment assets     47,753     19,557     67,310
  Additions to property, plant and equipment     1,379     550     1,929

Year Ended December 31, 1998
 
 
 
 
 
 
 
 
 
  Revenues from external customers   $ 63,171     —   $ 63,171
  Interest income     527     —     527
  Depreciation and amortization expense     302     —     302
  Income tax expense     6,708     —     6,708
  Segment net income     12,485     —     12,485
  Segment assets     24,373     —     24,373
  Additions to property, plant and equipment     1,739     —     1,739

3.  PUBLIC OFFERING

    On May 5, 1999, the Company completed its initial U.S. public offering of common stock listed on the Nasdaq exchange. The initial offering consisted of 2,250,000 total shares at $9.11 per share, of which 1,856,250 shares were offered by the Company, with an additional 393,750 shares offered by selling shareholders. On June 10, 1999, the underwriting group exercised a 337,500-share over-allotment. Total net proceeds realized by Direct Focus, Inc. from the offerings were $17.9 million. The Company was listed on the Toronto Stock Exchange from January 1993 to May 1999.

4.  ACQUISITION OF NAUTILUS

    Effective January 4, 1999, the Company acquired substantially all of the net assets of Nautilus International, Inc. ("Nautilus"). Nautilus was a manufacturer and distributor of commercial fitness equipment and, to a limited extent, retail fitness equipment and accessories. The acquisition was accounted for under the purchase method of accounting and, accordingly, the assets acquired, liabilities assumed, and results of operations have been included in the accompanying financial statements since the date of acquisition. The Company paid approximately $16.7 million, including acquisition costs of approximately $500,000, for the assets and intellectual property of Nautilus and assumed $1.8 million of current liabilities.

33

    The total cost of the acquisition was allocated to the assets acquired and liabilities assumed as follows:

Cash   $ 8,512  
Trade receivables     3,006,890  
Inventories     3,104,131  
Prepaid expenses and other current assets     108,206  
Furniture and equipment     7,991,685  
Other assets     4,349,839  
Liabilities assumed     (1,825,285 )
   
 
 
Total
 
$
16,743,978
 
   
 

    The unaudited pro forma financial information below for the year ended December 31, 1998 was prepared as if the transaction had occurred on January 1, 1998:

Revenue   $ 76,600,696
Net income   $ 9,868,213
Basic earnings per share   $ .47
Diluted earnings per share   $ .45

    The unaudited pro forma information is not necessarily indicative of what actual results would have been had the transaction occurred at the beginning of the respective year, nor does it purport to indicate the results of future operations of the Company.

5.  INVENTORIES

    Inventories at December 31 consisted of the following:

 
   1999
   2000
Finished goods   $ 4,682,659   $ 8,093,919
Work in process     1,141,803     1,160,647
Parts and components     3,343,092     3,398,551
   
 
    $ 9,167,554   $ 12,653,117
   
 

6.  PROPERTY, PLANT AND EQUIPMENT

    Details of property, plant and equipment are summarized as follows at December 31:

 
   Estimated
Useful Life
   1999
   2000
  
 
   (in years)

    
    
  
Land   N/A   $ 140,000   $ 1,718,495  
Buildings   31.5     5,870,592     9,636,774  
Computer equipment   2-5     2,737,488     5,179,365  
Production equipment   5     2,481,839     2,778,679  
Furniture and fixtures   5     462,174     915,040  
Automobiles   7     53,000     53,000  
       
 
 
          11,745,093     20,281,353  
Less accumulated depreciation         (1,100,255 )   (3,612,469 )
       
 
 

Property, plant and equipment, net
 
 
 
$
10,644,838
 
$
16,668,884
 
       
 
 

34

7.  ACCRUED LIABILITIES

    Accrued liabilities at December 31 consisted of the following:

 
   1999
   2000
Accrued payroll   $ 2,318,771   $ 3,178,847
Accrued warranty expense     383,356     447,194
Sales return reserve     786,921     1,307,000
Accrued other     562,472     411,184
   
 
 
Total
 
$
4,051,540
 
$
5,344,225
   
 

8.  COMMITMENTS AND CONTINGENCIES

    During 1999, the Company obtained a line of credit for $5 million with a bank which was increased to $10 million in 2000. The line is secured by the Company's general assets, and interest is payable on outstanding borrowings under the line at the bank's prime rate (9.5% at December 31, 2000). There were no outstanding borrowings on the line of credit at December 31, 2000.

    The Company leases its Vancouver, Washington call center facility under an operating lease which expires April 30, 2002. The lease commitment is subject to an annual rent adjustment based upon changes in the consumer price index, limited to a 6.0% annual change. The agreement provides for an annual cancellation provision by the Company upon proper notification.

    Since December 1999, the Company has leased a distribution center in Las Vegas, Nevada to service the Southwestern United States. This operating lease expires November 30, 2002.

    Nautilus HPS, Inc. leases trucks and trailers and other equipment used in the Nautilus commercial business. These leases expire over various terms through December 2002.

    Rent expense under all leases was $239,197 in 1998, $664,922 in 1999, and $473,920 in 2000.

    Future minimum lease payments under the operating leases during the years ending December 31 are as follows:

2001   $ 595,141
2002     416,130
   
Total minimum lease payments   $ 1,011,271
   

9.  STOCK OPTIONS

    The Company's stock-based compensation plan was adopted in June 1995. The Company can issue both nonqualified stock options to the Company's officers and directors and qualified options to the Company's employees. The plan was amended in June 2000 so the Company may grant options for up to 5,305,412 shares of common stock. At December 31, 2000, 1,985,136 shares are available for future issuance under the plan. The plan is administered by the Company's Board of Directors which determines the terms and conditions of the various grants awarded under these plans. Stock options granted generally have an exercise price equal to the closing market price of the Company's stock on

35

the date of the grant, and vesting periods vary by option granted, generally no longer than four years. If compensation cost on stock options granted under these plans had been determined based on the fair value of the options consistent with that described in SFAS No. 123, the Company's net income and earnings per share would have been reduced to the pro forma amounts indicated below for the years ended December 31, 1998, 1999 and 2000.

 
   1998
   1999
   2000
Net income, as reported   $ 12,485,494   $ 20,342,891   $ 41,626,094
Net income, pro forma     12,274,208     19,958,204     40,500,561

Basic earnings per share, as reported
 
$
0.59
 
$
0.89
 
$
1.77
Basic earnings per share, pro forma   $ 0.58   $ 0.87   $ 1.72

Diluted earnings per share, as reported
 
$
0.57
 
$
0.87
 
$
1.73
Diluted earnings per share, pro forma   $ 0.56   $ 0.85   $ 1.69

    The pro forma amounts may not be indicative of the effects on reported net income for future years due to the effect of options vesting over a period of years and the granting of stock compensation awards in future years.

    The fair value of each option grant was estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted-average assumptions used for grants in 1998, 1999 and 2000, respectively; all options granted will vest as scheduled; no dividend yield for all three years; risk-free interest rate of 5%, 6.4% and 5%; expected volatility of 76%, 60% and 51%; and expected lives of five years for all three years.

    A summary of the status of the Company's stock option plans as of December 31, 1998, 1999 and 2000, and changes during the years ended on those dates is presented below.

 
   1998
   1999
   2000
 
   Shares
   Weighted
Average
Exercise
Price
   Shares
   Weighted
Average
Exercise
Price
   Shares
   Weighted
Average
Exercise
Price
Outstanding at beginning of year   1,829,505   $ 0.21   1,238,891   $ 1.06   1,051,064   $ 4.01
Granted   423,000     2.53   381,780     8.98   536,850     18.65
Forfeited or cancelled   (16,425 )   0.43   (48,001 )   4.76   (134,250 )   8.97
Exercised   (997,190 )   0.13   (521,607 )   0.58   (324,201 )   1.92
   
 
 
 
 
 
Outstanding at end of year   1,238,891   $ 1.06   1,051,064   $ 4.01   1,129,463   $ 12.89
   
 
 
 
 
 
Options exercisable at end of year   695,699         482,630         432,339      
   
       
       
     

    The following table summarizes information about stock options outstanding as of December 31, 2000:

 
    
   Options Outstanding
   Options Exercisable
Range of Exercise Prices
   Number
Outstanding
   Average
Remaining
Contractual
Life (Years)
   Weighted
Average
Exercise
Price
     
Number of
Shares
Exercisable
   Weighted
Average
Exercise
Price
$0.11 — $0.43   154,578   1.3   $ 0.39   154,578   $ 0.39
$2.05 — $4.33   204,014   2.2     2.11   146,264     2.05
$9.11 — $10.47   353,384   3.7     9.17   119,684     8.90
$20.33 — $24.09   417,488   4.5     20.78   11,813     20.33
 
 
 
 
 
$0.11 — $24.09   1,129,464   3.4   $ 10.99   432,339   $ 3.85
   
 
 
 
 

36

10.  INCOME TAXES

    The Company realizes income tax benefits as a result of the exercise of non-qualified stock options and the exercise and subsequent sale of certain incentive stock options (disqualifying dispositions). For financial statement purposes, any reduction in income tax obligations as a result of these tax benefits is credited to common stock.

    The provision for (benefit from) income taxes consists of the following for the three years ended December 31, 2000:

 
   1998
   1999
   2000
Current:                  
  Federal   $ 6,608,100   $ 11,973,989   $ 23,247,566
  State     —     5,884     20,901
   
 
 
    Total Current     6,608,100     11,979,873     23,268,467
   
 
 
Deferred:                  
  Federal     99,484     (484,448 )   144,945
  State     —     —     —
   
 
 
    Total Deferred     99,484     (484,448 )   144,945
   
 
 
Total Provision   $ 6,707,584   $ 11,495,425   $ 23,413,412
   
 
 

    The components of the net deferred tax asset/(liability) at December 31, 1999 and 2000 are as follows:

 
   1999
   2000
  
Current:              
  Assets:              
    Accrued vacation   $ 124,933   $ 132,725  
    Allowance for doubtful accounts     106,633     94,742  
    Inventory reserve     107,083     148,959  
    Uniform capitalization     43,750     102,882  
    Accrued reserves     442,847     560,927  
    Customer deposits     384,034     52,128  
    Other     202,205     —  
  Liabilities:              
    Prepaid advertising     (440,476 )   —  
    Other prepaids     (150,220 )   (142,000 )
   
 
 
  Net current deferred tax asset   $ 820,789   $ 950,363  
   
 
 
Noncurrent              
  Liabilities:              
    Other   $ (39,908 ) $ —  
    Depreciation     (147,576 )   (462,004 )
   
 
 
  Net long-term deferred tax liability   $ (187,484 ) $ (462,004 )
   
 
 

37

    A reconciliation of the statutory income tax rate with the Company's effective income tax rate is as follows:

 
   1999
   2000
  
Federal   35.00 % 35.00 %
State   1.08 % 0.03 %
Other   0.03 % 0.97 %
   
 
 
  Total   36.11 % 36.00 %
   
 
 

11.  EARNINGS PER SHARE

    The per share amounts are based on the weighted average number of basic and dilutive common equivalent shares assumed to be outstanding during the period of computation. Net income for the calculation of both basic and diluted earnings per share is the same for all periods.

    The calculation of weighted average outstanding shares is as follows:

 
   Average Shares
 
   1998
   1999
   2000
Basic shares outstanding   21,007,180   22,872,637   23,525,068
Dilutive effect of stock options   876,225   584,080   473,175
   
 
 
Diluted shares outstanding   21,883,405   23,456,717   23,998,243
   
 
 

12.  STOCK REPURCHASE PROGRAM

    Four times during fiscal 2000, the Board of Directors authorized the expenditure of up to $8 million to purchase shares of Direct Focus, Inc. common stock in open market transactions. During the year ended December 31, 2000, the Company repurchased a total of 278,353 shares of common stock in open market transactions for an aggregate purchase price of $3.3 million. All authorizations had expired at December 31, 2000.

13.  STOCK SPLITS

    On June 26, 2000, the Board of Directors approved a three-for-two stock split in the form of a share dividend, payable to the Company's stockholders of record as of July 31, 2000. Shares resulting from the split were distributed by the transfer agent on August 14, 2000. On December 8, 2000, the Board of Directors approved another three-for-two stock split payable to Company stockholders of record as of January 2, 2001 with a payment date of January 15, 2001. All share and per-share numbers contained herein reflect these stock splits.

14.  RELATED-PARTY TRANSACTIONS

    The Company incurred royalty expense under an agreement with a stockholder of the Company of $1,603,821 in 1998, $2,815,116 in 1999, and $4,837,212 in 2000, of which $893,563 and $1,481,886 was payable at December 31, 1999 and 2000, respectively.

15.  LITIGATION SETTLEMENT

    On July 17, 1999, the Company reached an agreement with a competitor to settle pending litigation. As a result of the settlement, the Company took a one-time, after-tax charge of $2.6 million in the second quarter of fiscal 1999. The Company made an $8 million cash payment to the competitor, of which $4 million was paid by insurance.

38

    This settlement did not affect the ongoing direct marketing campaign for the Company's Bowflex home fitness equipment. Additionally, in the normal course of business, the Company is a party to various other legal claims, actions and complaints. Although it is not possible to predict with certainty whether the Company will ultimately be successful in any of these legal matters, or what the impact might be, the Company believes that disposition of these matters will not have a material adverse effect on the Company's financial position, results of operations or cash flows.

16.  EMPLOYEE BENEFIT PLAN

    The Company adopted a 401(k) profit sharing Plan in 1999 covering all employees over the age of 18, who also have three months of service. The Plan was amended in 2000 to allow for immediate eligibility in the plan. Each participant in the 401(k) Plan may contribute up to 20% of eligible compensation during any calendar year, subject to certain limitations. The 401(k) Plan provides for Company matching contributions of up to 50% for eligible contributions for participants who have one year of service. In addition, the Company may make discretionary contributions. Employees are 100% vested in the matching and discretionary contributions after four years of service. Expense for the Plan was $103,793 and $134,669 for the years ended December 31, 1999 and 2000, respectively.


Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

    None.

39


PART III

Item 10. Directors and Executive Officers of the Registrant

    The Information required by this item is included under the captions "Election of Directors," "Executive Officers" and "Section 16(a) Beneficial Ownership Reporting Compliance," respectively, in the Company's Proxy Statement for its 2001 Annual Meeting of Shareholders and is incorporated herein by reference.


Item 11. Executive Compensation

    The information required by this item is included under the caption "Executive Compensation" in the Company's Proxy Statement for its 2001 Annual Meeting of Shareholders and is incorporated herein by reference.


Item 12. Security Ownership of Certain Beneficial Owners and Management

    The information required by this item is included under the caption "Security Ownership of Certain Beneficial Owners and Management" in the Company's Proxy Statement for its 2001 Annual Meeting of Shareholders and is incorporated herein by reference.


Item 13. Certain Relationships and Related Transactions

    The information required by this item is included under the caption "Certain Relationships and Related Transactions" in the Company's Proxy Statement for its 2001 Annual Meeting of shareholders and is in-corporated herein by reference.


PART IV

Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K

(a)(1)  Financial Statements

    See the Consolidated Financial Statements in Item 8.

40

(a)(2)  Financial Statement Schedule


DIRECT FOCUS, INC.

Schedule II

Valuation and Qualifying Accounts

Three years ended December 31, 2000

(in thousands)

Description
   Balance at
Beginning
of Period
   Charged to
Costs and
Expenses
   Deductions
   Balance at
End of
Period
Allowance for doubtful accounts:                
1998   85,000   —   45,000   40,000
1999   40,000   264,727   —   304,727
2000   304,727   47,552   —   352,279
Sales returns and allowances:                
1998   285,000   315,704   —   600,704
1999   600,704   186,217   —   786,921
2000   786,921   520,079   —   1,307,000
Warranty reserves                
1998   20,000   50,000   —   70,000
1999   70,000   313,356   —   383,356
2000   383,356   63,838   —   447,194

    All other financial statement schedules have been omitted since they are not required, not applicable, or the information is included in the consolidated financial statements or notes thereto.

(a)(3)  Exhibits

    The following exhibits are filed herewith and this list is intended to constitute the exhibit index:

Exhibit No.
    
3.1   Articles of Incorporation, as Amended—Incorporated by reference to Exhibits 3.1, 3.2 and 3.3 of the Company's Registration Statement on Form S-1, as filed with the Securities and Exchange Commission (the "Commission") on March 3, 1999.

3.2
 
Amendment to Articles of Incorporation—Incorporated by reference to Exhibit 3 to the Company's Quarterly Report on Form 10-Q for the three months ended June 30, 2000, as filed with the Commission on August 10, 2000.

3.3
 
Amended and Restated Bylaws—Incorporated by reference to Exhibit 3.4 of Amendment No. 2 to the Company's Registration Statement on Form S-1, as filed with the Commission on April 30, 1999.

10.1
 
Direct Focus, Inc. Stock Option Plan, as amended—Incorporated by reference to Exhibit 10.1 to the Company's Registration Statement on Form S-1, as filed with the Commission on March 3, 1999.

10.2
 
Amendment to Direct Focus, Inc. Stock Option Plan—Incorporated by reference to Exhibit 10 to the Company's Quarterly Report on Form 10-Q for the three months ended June 30, 2000, as filed with the Commission on August 10, 2000.


 
 

41


10.3
 
Lease Agreement dated September 16, 1992, between Bow-Flex of America, Inc. and Christensen Group, Inc.—Incorporated by reference to Exhibit 10.4 of the Company's Registration Statement on Form S-1, as filed with the Commission on March 3, 1999.

10.4
 
First Amendment to Lease dated September 16, 1992, between Bow-Flex of America, Inc. and Christensen Group, Inc.—Incorporated by reference to Exhibit 10.5 of the Company's Registration Statement on Form S-1, as filed with the Commission on March 3, 1999.

10.5
 
Amendment to Bowflex, Inc. Lease Extension, dated August 27, 1996, between Bowflex, Inc. and Ogden Business Park Partnership—Incorporated by reference to Exhibit 10.7 of the Company's Registration Statement on Form S-1, as filed with the Commission on March 3, 1999.

10.6
 
First Amendment to Lease, dated December 10, 1996, between Bowflex, Inc. and Ogden Business Park Partnership—Incorporated by reference to Exhibit 10.8 of the Company's Registration Statement on Form S-1, as filed with the Commission on March 3, 1999.

10.7
 
Borrowing Agreement, dated December 16, 1998, between Direct Focus, Inc. and Seafirst Bank—Incorporated by reference to Exhibit 10.11 of the Company's Registration Statement on Form S-1, as filed with the Commission on March  3, 1999.

10.8
 
Modification to Borrowing Agreement dated March 30, 2000 between Direct Focus, Inc. and Bank of America, N.A.

10.9
 
Royalty Agreement, dated as of April 9, 1988, between Bow-Flex of America, Inc. and Tessema D. Shifferaw—Incorporated by reference to Exhibit 10.9 of the Company's Registration Statement on Form S-1, as filed with the Commission on March 3, 1999.

10.10
 
Royalty Payment Agreement, dated as of June 18, 1992, between Tessema D. Shifferaw, Brian R. Cook and R.E. "Sandy" Wheeler—Incorporated by reference to Exhibit 10.10 of the Company's Registration Statement on Form S-1, as filed with the Commission on March 3, 1999.

10.11
 
First Amended and Restated Merchant Agreement dated as January 27, 1999, between Direct Focus, Inc. and Household Bank (SB), N.A.—Incorporated by reference to Exhibit 10.11 of the Company's Registration Statement on Form S-1, as filed with the Commission on March 3, 1999.

10.12
 
Second Amended and Restated Merchant Agreement dated February 23, 2000 between Direct Focus, Inc. and Household Bank (SB), N.A.

10.13
 
Lease Agreement, dated July 19, 1999, between Direct Focus, Inc. and Las Vegas Motor Speedway, LLC.—Incorporated by reference to Exhibit 10.12 of the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1999, as filed with the commission on March 29, 2000.

10.14
 
Agreement of Purchase and Sale and Joint Escrow Instructions dated June 7, 2000, by and between Tyco Valves & Controls, Inc. and Direct Focus, Inc.

21
 
Subsidiaries of Direct Focus, Inc.

23
 
Consent of Deloitte & Touche LLP

24.1
 
Power of Attorney for Kirkland C. Aly

24.2
 
Power of Attorney for C. Rowland Hanson


 
 

42


24.3
 
Power of Attorney for Paul F. Little

24.4
 
Power of Attorney for Roger J. Sharp

24.5
 
Power of Attorney for Roland E. "Sandy" Wheeler

(b)  Reports on Form 8-K

    No reports on Form 8-K were filed during the quarter ended December 31, 2000.

43


SIGNATURES

    Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

Date: March 28, 2001   DIRECT FOCUS, INC.

 
 
By:
 
/s/ BRIAN R. COOK, President   

    Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities indicated on March 28, 2001.

Signature
   Title

 
 
 
/s/ BRIAN R. COOK   
Brian R. Cook		   President (Principal Executive Officer)

/s/ ROD W. RICE   
Rod W. Rice
 
Chief Financial Officer and Secretary
(Principal Financial and Accounting Officer)

KIRKLAND C. ALY *
Kirkland C. Aly
 
Director

C. ROWLAND HANSON *
C. Rowland Hanson
 
Director

PAUL F. LITTLE *
Paul F. Little
 
Director

/s/ RANDAL R. POTTER   
Randal R. Potter
 
Director

ROGER J. SHARP *
Roger J. Sharp
 
Director

ROLAND E. "SANDY" WHEELER *
Roland E. "Sandy" Wheeler *
 
Director

* By: /s/ ROD W. RICE
Rod W. Rice
 Attorney-In-Fact
 
March 28, 2001

44



QuickLinks

DIRECT FOCUS, INC. 2000 FORM 10-K ANNUAL REPORT TABLE OF CONTENTS
PART I
PART II
DIRECT FOCUS, INC. CONSOLIDATED BALANCE SHEETS
DIRECT FOCUS, INC. CONSOLIDATED STATEMENTS OF INCOME Three years ended December 31, 2000
DIRECT FOCUS, INC. CONSOLIDATED STATEMENTS OF STOCKHOLDER'S EQUITY For the three years ended December 31, 2000
DIRECT FOCUS, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS Three years ended December 31, 2000
DIRECT FOCUS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Three years ended December 31, 2000
PART III
PART IV
DIRECT FOCUS, INC. Schedule II Valuation and Qualifying Accounts Three years ended December 31, 2000 (in thousands)
SIGNATURES
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Exhibit 10.8


BANK OF AMERICA
Modification to Borrowing Agreement

    This Modification modifies the Borrowing Agreement dated December 10, 1999 ("Borrowing Agreement"), in the maximum principal amount of $5,000,000.00, executed by DIRECT FOCUS CORPORATION ("Borrower") in favor of Bank of America, N.A. ("Bank"). Terms used in this Modification and defined in the Borrowing Agreement shall have the meaning given to such terms in the borrowing Agreement. For mutual consideration, Borrower and Bank agree to amend the Borrowing Agreement as follows:

    1.  Credit Limit.  The maximum principal amount of the Loan is hereby changed to $10,000,000.00, and Borrower's maximum liability for the Obligations is also changed to $10,000,000.00.

    2.  Maturity Date.  The maturity date of the Loan is changed to June 1, 2001. Bank's commitment to make advances to Borrower under the Loan is also extended to June 1, 2001.

    3.  Letter of Credit Facility.  The Letter of Credit Facility of the Agreement is changed in its entirety to read as follows:

    4.  Covenants.  The following covenant of the Borrowing Agreement is deleted in it's entirety:

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    5.  Other Terms.  Except as specifically amended by this Modification or any prior amendment, all other terms, conditions, and definitions of the Borrowing Agreement, and all other security agreements, guaranties, deeds of trust, and other instruments or agreements entered into with regard to the Loan, shall remain in full force and effect.

    DATED 3/30/2000

Bank:   Borrower:

BANK OF AMERICA, N.A.
 
DIRECT FOCUS CORPORATION

By:
 
/s/ DANIEL J. RILER   
 
By:
 
/s/ ROD W. RICE   

Title:
 
Vice President
 
Title:
 
Chief Financial Officer

46



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BANK OF AMERICA Modification to Borrowing Agreement
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Exhibit 10.12

SECOND AMENDED AND RESTATED MERCHANT AGREEMENT

BANK:   Household Bank (SB), N.A.
1111 Town Center Drive
Las Vegas, Nevada 89134		   MERCHANT:   Direct Focus, Inc. f/k/a Bowflex, Inc.
2200 NE 65th Avenue
Vancouver, WA 98661
Phone: 360-418-6178
Facsimile No.: 360-694-7755

    This Second Amended and Restated Merchant Agreement ("Agreement") is made and entered into as of the 23rd day of February, 2000 ("Effective Date"), by and between Household Bank (SB), N.A. for itself and as assignee of Household Bank (Nevada), N.A. (herein "Household") and Direct Focus, Inc., formerly known as Bowflex, Inc., a Washington corporation (herein "Merchant") and shall be effective as of February 23, 2000. In consideration of the mutual promises, covenants, and agreements set forth below and for other good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, Merchant and Household agree as follows:

    Section 1.  Definitions.  In addition to the words and phrases defined above and elsewhere in this Agreement, the following words and phrases shall have the following meanings:

    a.  "Account" means an account resulting from the issuance of a Card. An Account may have more than one Card issued for it. Each Account shall be owned by, and deemed to be the property of, Household.

    b.  "Affiliate" means any entity that is owned by, owns or is under common control with Household or its ultimate parent or Merchant or its ultimate parent.

    c.  "Applicable Law" means collectively or individually any applicable law, rule, regulation or judicial, governmental or administrative order, decree, ruling, opinion or interpretation.

    d.  "Application" means an application for an Account under the Program.

    e.  "Authorization" means permission from Household to make a Card Sale.

    f.   "Authorization Center" means the facility designated by Household as the facility at which Card Sales are authorized.

    g.  "Business Day" means any day except Saturday or Sunday or a day on which banks are closed in the State of Illinois.

    h.  "Card" means the private label credit card bearing Merchant's name and/or logo issued by Household for the Program.

    i.   "Cardholder" means (i) the person in whose name an Account is opened, and (ii) any other authorized users of the Account and Card.

    j.   "Cardholder Agreement and Disclosure Statement" (hereafter "Cardholder Agreement") means the credit card agreement between Household and each Cardholder providing for the extension of credit by Household under the Program pursuant to which the Cardholder is issued a Card, as the same may be revised from time to time by Household with notification to Merchant.

    k.  "Card Sale" means any sale of Goods that Merchant makes to a Cardholder pursuant to this Agreement that is charged to an Account.

    l.   "Chargeback" means the return to Merchant and reimbursement to Household of a Sales Slip for which Merchant was previously paid pursuant to Section 8 herein.

47

    m.  "Credit Slip" means evidence of credit in electronic or paper form for Goods purchased from Merchant.

    n.  "Discount" means the fee payable by Merchant to Household as described in Section 3.b.(ii) hereof.

    o.  "Goods" means the products described in Section 2 below, certain warranties expressly authorized by Household, and related services sold by Merchant in the ordinary course of Merchant's business to consumers for individual, family, personal or household use.

    p.  "Internet Application" means any Application for a Card which is received by Household on-line via the Household web site.

    q.  "Mailed-In Application" means any Application for a Card which is received by Merchant or Household through the mail.

    r.  "Operating Instructions" means the regulatory guidelines and operating instructions and/or procedures or written instructions designated by Household and agreed to by Merchant, which agreement shall not be unreasonably withheld, from time to time concerning the Program.

    s.  "Program" means the private label revolving credit card program promoted by Merchant whereby Accounts will be established and maintained by Household, Cards issued by Household to qualified consumers purchasing Merchant's Goods, and Card Sales funded all pursuant to the terms of this Agreement.

    t.   "Sales Slip" means evidence of a Card Sale in electronic or paper form for Goods purchased from Merchant.

    u.  "Telephone Application" means any Application for a Card which is received from a consumer or solicited by Merchant via telephone and for which the applicant's credit or other information required to apply for a Card is obtained by Merchant from the applicant over the telephone.

    v.  "Terminal" means an electronic terminal or computer capable of communicating by means of an on-line or dial-up electronic link with an Authorization Center.

    Section 2.  Scope and Purpose.  Merchant engages in the sale of fitness equipment and other products. Pursuant to that certain Merchant Agreement dated February 4, 1997, as amended by that First Amended and Restated Merchant Agreement (collectively referred to as the "Existing Merchant Agreement"), Household and Merchant had agreed that Household would make financing available to customers of Merchant purchasing Goods from Merchant. Merchant has requested Household to continue to make financing available to consumers purchasing Goods from Merchant and Merchant has agreed to execute this Agreement in order to continue the Program and secure its benefit for Merchant. Household and Merchant agree that this Agreement shall supersede and replace the Existing Merchant Agreement. Household, a credit card bank in the business of providing revolving credit financing pursuant to a credit card, has agreed to continue to provide financing under the Program to individual qualified consumers purchasing Merchant's Goods pursuant to the terms and conditions set forth in this Agreement.

    a.  Forms and Cards.  Household will provide to Merchant standard Sales Slips, Credit Slips and other forms from time to time for use by Merchant in the Program, which documents may be changed from time to time by Household. Merchant agrees to pay for the combined Application and Cardholder Agreement and Disclosure Statement and will be charged a fee for non-standard forms and for forms in excess of normal usage. The design and content of Cards and billing statements and the terms and conditions of Accounts and combined Applications and Cardholder Agreement and Disclosure Statement shall be determined by Household and are subject to change by Household from time to time.

48

    b.  Credit Review, Ownership of Accounts.  All completed Applications for Accounts submitted by Merchant to Household whether mailed, telephoned or otherwise electronically transmitted will be processed and approved or declined in accordance with Household's credit criteria and procedures from time to time established by Household, with Household having and retaining all rights to reject or accept such Applications. Household will only accept Applications for revolving credit pursuant to the credit card it issues for individual, personal, family or household use. Household or its Affiliates shall own, all Cardholder e-mail addresses and the Accounts and shall bear the credit risk for such Accounts, except as otherwise provided in this Agreement. Merchant acknowledges and agrees that it shall have no interest whatsoever in the Accounts. Household shall not be obligated to take any action under an Account, including making future advances or credit available to Cardholders. Household shall not be obligated to accept Applications for a Card or to approve any Card Sale for consumers that do not have their principal residence and billing address in the fifty United States and the District of Columbia.

    c.  Card Promotions, Services and Enhancements.  Household and Merchant may from time to time mutually agree to offer to existing or potential Cardholders special credit promotions, additional services and/or enhancements. The terms of such promotions, services and enhancements shall be mutually agreed upon by Household and Merchant and are subject to change or discontinuance by Household and Merchant. In consideration of Household's providing special credit promotions and to compensate Household for such promotions, Merchant agrees to pay to Household for the period agreed upon by Household and Merchant such rates, amounts and/or discounts set forth herein. Household may deduct amounts owed to it hereunder from amounts owed to Merchant under this Agreement.

    d.  Merchant Customer Lists.  Household acknowledges that the names and addresses of Merchant customers provided by Merchant to Household constitute a merchant list and customer list respectively, of Merchant in which Merchant has proprietary rights and which Merchant regards as (and which is acknowledged by Household to constitute) a trade secret of Merchant. Accordingly, Household shall not use such list except with the prior written consent of Merchant, or to carry out its obligations under this Agreement. Merchant grants to Household the right to use such merchant and customer lists solely for such purposes. Household shall exercise such care with respect to such merchant and customer lists as it does with its own trade secrets. Notwithstanding the confidentiality provisions of this Agreement, Merchant as owner of such merchant and customer list may use such names and addresses for any purpose.

    e.  Cardholder List.  Merchant agrees that Household is the owner of the Cardholder list and that Household and its Affiliates may use such list to solicit Cardholders for credit card products offered by Household and/or any of its Affiliates or other types of accounts or financial products or insurance services offered by Household and/or any of its Affiliates. Household agrees that Merchant may solicit, at its expense the Cardholder list for products or services offered by Merchant; provided that such products or services, as determined by Household do not compete with the Program, Household or its Affiliates and such solicitation does not reference the Program. The Cardholder list shall be subject to the confidentiality provisions of this Agreement.

    Section 3.  Fees, Discounts, Charges, Rates and Funding.  Except as otherwise provided herein, the following consumer rate, fees, Discount and charges shall be effective for the Initial Term of this Agreement.

    a.  Consumer Rate.  The consumer rate to be charged on purchases with the Card shall be 21.8%, subject to change from time to time by Household.

    b.  Determination of Fees and Discounts.  The rate, fees, discounts and charges described in this Section 3 are subject to change from time to time by Household.

49

    c.  Merchant.  Merchant agrees to pay Household the following fees and discounts (some of which are more fully described in this Agreement):

Promotional Period
   Promotional Type
   Discount Fee
  
Regular Sale   Non-Promotional Card Sale   .15 %
3 Months   Same As Cash W/O Payment   2.66 %
6 Months   Same As Cash W/Payment   5.18 %
7 Months   Same As Cash W/Payment   6.21 %
8 Months   Same As Cash W/Payment   7.10 %
9 Months   Same As Cash W/Payment   7.99 %
10 Months   Same As Cash W/Payment   8.88 %
11 Months   Same As Cash W/Payment   9.76 %
12 Months   Same As Cash W/Payment   10.65 %

    d.  Acceptance, Offset & Funding.  Subject to the terms, conditions, warranties and representations in this Agreement and provided that Merchant has satisfied all of the conditions set forth in this Agreement, including, without limitation, Sections 4, 5, 6 and 7, Household agrees to pay to Merchant the amount of each valid and authorized Sales Slip presented to Household during the term of this Agreement, less the amount of the fees, charges, and Discounts described above in this Section, outstanding Account balances for Sales Slips subject to Chargeback, reimbursements, refunds, customer credits and any other amounts owed to Household under this Agreement by Merchant. Household may also offset or recoup said amounts from future amounts owed to Merchant under this Agreement. Any amounts owed by Merchant to Household which cannot be paid by the aforesaid means shall be due and payable by Merchant on demand. Any payment made by Household to Merchant shall not be final but shall be subject to subsequent review and verification by Household. Household's liability to Merchant with respect to the funding of any Card Sale, Sales Slip or Credit Slip shall not exceed the amount on the Sales Slip or Credit Slip in connection with such transaction. In no event shall Household be liable for incidental or consequential damages.

    e.  Funding.  Funding of Sales Slips by Household to Merchant shall be made to Merchant's account at a bank designated by Merchant. Household will use its best efforts to make such payments on the first Business Day after receipt, verification and processing by Household of the transmission of the transaction data, if such transmission is received by 7:30 am Central Standard Time; if received later than 7:30 am Central Standard Time, then on the second Business Day after said transmission, however, in no event shall such payments be made later than the third Business Day after receipt of said transmission by Household.

50

    Section 4.  Merchant Responsibilities Concerning Consumer Transactions.  Merchant covenants and agrees that Merchant shall:

    a.  Honor all valid Cards without discrimination, when properly presented by Cardholders for payment of Goods.

    b.  Not require, through an increase in price or otherwise, any Cardholder to pay any surcharge at the time of sale or pay any part of any charge imposed by Household on Merchant.

    c.  Not establish minimum or maximum charge amounts without Household's prior written approval.

    d.  Prominently display at each of its locations, advertising and promotional materials relating to the Card, including, without limitation, take-one Applications for the Card and use and display such materials in accordance with any specifications provided by Household. Such materials shall be used only for the purpose of soliciting accounts for the Program. Any solicitation, written material, advertising or the like relating to the Program or the products offered pursuant to the Program shall be prepared or furnished by Household or shall receive Household's prior written approval. Household will charge Merchant and Merchant agrees to pay for any such advertising and promotional materials. Any such materials shall not be used by Merchant following termination of this Agreement.

    e.  Use only the form of, or modes of transmission for, Application/Cardholder Agreements, Sales Slips and Credit Slips as are provided by Household, and not use any Application/Cardholder Agreements, Sales Slips, and Credit Slips provided by Household other than in connection with a Card transaction.

    f.   With respect to Telephone Applications, Merchant shall:

    g.  With respect to Mailed-In Applications, Merchant shall:

51

    h.  With respect to Internet Applications, Merchant shall:

    i.   With respect to Sales Slips Merchant shall:

52

    j  Credit Slips.  If Goods are returned, any Card Sale or services are terminated or canceled, or Merchant allows any price adjustment, then Merchant shall not make any cash refund, but shall complete and deliver promptly to Household a Credit Slip evidencing the refund or adjustment and deliver to the Cardholder a true and complete copy of the Credit Slip at the time the refund or adjustment is made. Merchant shall sign and date each Credit Slip and include thereon a brief description of the Goods returned, services terminated or canceled, refund or adjustment made, the date of the original Card Sale, Authorization number, Cardholder's name, address and Account number, and the date and amount of the credit, all in sufficient detail to identify the transaction. Merchant shall imprint or legibly reproduce on each Credit Slip the embossed legends from the Card and from Merchant's imprinter plate. The amount of the Credit Slip cannot exceed the amount of the original transaction as reflected on the Sales Slip. Merchant shall issue Credit Slips only in connection with previous bona fide Card Sales and only as permitted hereunder.

53

    k.  Not receive any payments from a Cardholder for charges included on any Sales Slip resulting from the use of any Card, nor receive any payments from a Cardholder to prepare and present a Credit Slip for the purpose of effecting a deposit to the Cardholder's Account.

    l.  Cardholder Complaints.  Merchant shall within five (5) days of receipt provide Household with a copy of any written complaint from any Cardholder concerning an Account.

    m.  Right of First Refusal.  Merchant shall actively promote the Program. Merchant agrees to give Household right of first refusal in presenting consumer credit Applications and/or Sales Slips. During the term of this Agreement, Merchant shall not issue, arrange to issue, or accept, in the fifty United States and the District of Columbia, any private label credit card or account other than the Card, under any of Merchant's names or logos, except with respect to Applications declined by Household. To the extent Merchant displays other third party credit or charge card materials, it shall display the advertising and promotional materials relating to the Card in a manner and with a frequency equal to or greater than that accorded any other third party credit or charge card.

    n.  Satisfy all other requirements designated in any Operating Instructions or as may be required from time to time by Household. In the event there is any inconsistency between any Operating Instructions and this Agreement, this Agreement shall govern unless otherwise expressly indicated by Household in any Operating Instructions.

    o.  Present each Sales Slip and deliver each Credit Slip to Household or such other person designated by Household, within ten (10) Business Days after the date of the respective sale or credit transaction.

    Section 5.  Merchant Representations and Warranties.  Merchant represents and warrants to Household as of the Effective Date and throughout the term of this Agreement the following:

    a.  That each Card Sale will arise out of a bona fide sale of Goods by Merchant and will not involve the use of the Card for any other purpose.

    b.  That each Card Sale will be to a consumer for personal, family, or household purposes.

    c.  That Cardholder Applications will be available to the public (i) without regard to race, color, religion, national origin, sex, marital status, or age (provided the applicant has the capacity to enter into a binding contract) and (ii) not in any manner which would discriminate against an applicant or discourage an applicant from applying for the Card.

    d.  That it has full corporate power and authority to enter into this Agreement; that all corporate action required under any organization documents to make this Agreement binding and valid upon Merchant according to its terms has been taken; and that this Agreement is and will be binding, valid and enforceable upon Merchant according to its terms.

    e.  That it is not in violation of any covenants in any debt instruments to which it is a party as of the Effective Date of this Agreement.

    f.   Neither (i) the execution, delivery and performance of this Agreement, nor (ii) the consummation of the transactions contemplated hereby will constitute a violation of law or a violation or default by Merchant under its articles of incorporation, by laws or any organization documents, or any material agreement or contract and no authorization of any governmental authority is required in connection with the performance by Merchant of its obligations hereunder.

    g.  There are no proceedings or investigations pending, or, to the knowledge of Merchant, threatened, before any court, regulatory body, administrative agency, or other tribunal or governmental instrumentality having jurisdiction over Merchant or its properties: (i) asserting the invalidity of this Agreement or seeking to prevent the consummation of any of the transactions contemplated hereunder,

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or (ii) which, individually or in the aggregate, could reasonably be expected to have a material adverse effect on the ability of Merchant to perform its obligations hereunder.

    h.  Merchant has and will retain throughout the term of this Agreement all required licenses to perform it's obligations under this Agreement.

    i.   Any Card Sale subject to rescission has not been rescinded.

    Section 6.  Chargebacks to Merchant.  Merchant agrees as follows:

    a.  Chargebacks.  Any Sales Slip or Card Sale is subject to Chargeback under any one or more of the following circumstances, and thereupon the provisions of Section 6.b. below shall apply:

    b.  Resolution and Payment.  Merchant is required to resolve any dispute or other of the circumstances described above in (a) of this Section 6 to Household's satisfaction within fifteen (15) days of notice of Chargeback or Merchant shall pay to Household the full amount of each Sales Slip subject to Chargeback or the portion thereof designated by Household, as the case may be, plus the finance charges thereon, any attorney fees incurred by Household, and other fees and charges provided for in the Cardholder Agreement. Upon Chargeback to Merchant of a Sales Slip, Merchant shall bear all liability and risk of loss associated with such Sales Slip or Account, or the applicable portion thereof, without warranty by, or recourse or liability to, Household. Household may deduct amounts owed to Household under this Section from any amounts owed to Merchant under this Agreement.

    c.  Excessive Chargebacks.  If (i) the aggregate number of Sales Slips subject to Chargeback exceeds 3.0% of the total number of Card Sales submitted by Merchant with respect to an individual Merchant location in any calendar quarter or (ii) the aggregate dollar amount of all Sales Slips subject to Chargeback in any monthly billing cycle exceeds 5% of the total net balances of all Accounts at the

55

end of such monthly billing cycle ((i) and (ii) are herein individually and collectively called "Excessive Chargebacks"). Excessive Chargebacks shall be deemed a material breach of this Agreement and Household has the right, in its sole discretion, to terminate this Agreement pursuant to Section 15.

    d.  The terms and provisions of this Section 6 shall survive the termination of this Agreement.

    Section 7.  Tape or Electronic Transmission & Records.  Data, records and information shall be transmitted and maintained as described below.

    a.  Transmission of Data.  In lieu of depositing paper Sales Slips and Credit Slips with Household, Merchant shall transmit to Household, by electronic transmission or other form of transmission designated by Household all data required by this Agreement to appear on Sales Slips and Credit Slips. All data transmitted shall be in a medium, form and format designated by Household and shall be presorted according to Household's instructions. Any errors in such data or in its transmission shall be the sole responsibility of Merchant. The means of transmission indicated above in this Section or other means approved by Household, shall be the exclusive means utilized by Merchant for the transmission of Sales Slip or Credit Slip transaction data to Household. Merchant shall use a leased line, supplied by Household, for communicating with Household pursuant to the guidelines set forth in Section 4. Household's voice Authorization Center will be available for use for times when the leased line authorization system is not in operation.

    b.  Receipt of Transmission.  Upon successful receipt of any transmission, Household shall accept such transmission and pay Merchant in accordance with this Agreement, subject to subsequent review and verification by Household and to all other rights of Household and obligations of Merchant as set forth in this Agreement. If data transmission is by tape, Merchant agrees to deliver upon demand by Household a duplicate tape of any prior tape transmission, at the expense of Household, if such demand is made within forty-five (45) calendar days of the original transmission.

    c.  Records.  Merchant shall maintain the actual paper Sales Slips, Credit Slips, and other records pertaining to any transaction covered by this Agreement for such time and in such manner as Household or any law or regulation may require, but in no event less than two (2) years after the date Merchant presents each transaction data to Household, and Merchant shall make and retain for at least seven (7) years legible copies of such actual paper Sales Slips, Credit Slips or other transaction records. Within fifteen (15) days, or such earlier time as may be required by Household, of receipt of Household's request, Merchant shall provide to Household the actual paper Sales Slips, Credit Slips or other transaction records, and any other documentary evidence available to Merchant and reasonably requested by Household to meet its obligations under law (including its obligations under the Fair Credit Billing Act) or otherwise to respond to questions, complaints, lawsuits, counterclaims or claims concerning Accounts or requests from Cardholders, or to enforce any rights Household may have against a Cardholder, including, without limitation, litigation by or against Household, collection efforts and bankruptcy proceedings, or for any other reason. In the event Merchant fails to comply in any respect with the provisions of this Section 7, Household may process a Chargeback for each Card Sale involved pursuant to Section 6 above.

    d.  Production.  Promptly upon termination of this Agreement or upon the request of Household, Merchant will provide Household with all original and microfilm copies of documents required to be retained under this Agreement.

    Section 8.  Payments by Cardholder and Endorsement.  Merchant agrees that Household has the sole right to receive payments on any Sales Slip funded by Household. Unless specifically authorized in writing by Household, Merchant agrees not to make any collections on any such Sales Slip. Merchant agrees to hold in trust for Household any payment received by Merchant of all or part of the amount of any such Sales Slip and to deliver promptly the same in kind to Household as soon as received together with the Cardholder's name, Account number, and any correspondence accompanying the

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payment and deliver same promptly within five (5) days of receipt by Merchant. Merchant agrees that Merchant shall be deemed to have endorsed any Sales Slip, Credit Slip, or Cardholder payments by check, money order, or other instrument made payable to Merchant that a Cardholder presents to Household in Household's favor, and Merchant hereby authorizes Household to supply such necessary endorsements on behalf of Merchant.

    Section 9.  Merchant Credit Information.  Household may annually review Merchant's financial stability. To assist Household in doing this, Merchant shall deliver to Household no later than ninety (90) days after the end of each fiscal year, an audited financial statement, including, without limitation, all footnotes, and supporting materials with sufficient detail to accurately portray the financial condition of Merchant. Merchant warrants and represents that its credit Application and financial statements submitted to Household by or on behalf of Merchant are true and accurate and Merchant agrees to supply such additional credit information as Household may reasonably request from time to time. Merchant understands that Household may verify the information on any financial statement or other information provided by Merchant and, from time to time, may seek credit and other information concerning Merchant from others and may provide information regarding this Program including financial and other information to its Affiliates or others for purposes of its asset securitizations and sales.

    Section 10.  Merchant Business Practices.  Merchant agrees to provide adequate services in connection with each Card Sale pursuant to standard customs and trade practices and any applicable manufacturer's warranties, and to provide such repairs, service and replacements and take such other corrective action as may be required by law.

    Section 11.  Cardholder Account Information.  Merchant shall comply with all Applicable Law regarding privacy and the Direct Marketing Association privacy promise. Merchant shall not sell, purchase, provide, or exchange Account information in the form of imprinted Sales Slips, carbon copies of imprinted Sales Slips, mailing lists, tapes or other media obtained by reason of a Card transaction to any third party other than to Merchant's agents for the purpose of assisting Merchant in its business with Household or pursuant to a government request.

    Section 12.  Change in Ownership.  Each party agrees to send the other party at least thirty (30) days prior written notice of any change in such party's name or location, any material change in ownership of Merchant's business or any change in Sales Slip or Credit Slip information concerning Merchant.

    Section 13.  Indemnification.  

    a.  Indemnification by Merchant.  Merchant shall be liable to and shall indemnify and hold harmless Household and its Affiliates associated with the Program and their respective officers, employees, agents and directors from any losses, damages, claims or complaints incurred by Household or any Affiliate of Household or their respective officers, employees, agents and directors arising out of: (i) Merchant's failure to comply with this Agreement or any of the Operating Instructions; (ii) any claim, dispute, complaint or setoff made by a Cardholder with respect to anything done or not done by Merchant in connection with Card Sales or Credit Slips; (iii) anything done or not done by Merchant in connection with the furnishing of any Goods, warranties or services purchased by Cardholders; (iv) the death or injury to any person or the loss, destruction or damage to any property arising out of the design, manufacture or furnishing by Merchant of any Goods, warranties or services purchased by Cardholders; (v) any claim or complaint of a third party in connection with Merchant's advertisements and promotions relating to the Card which have not been reviewed or approved by Household; (vi) any illegal or improper conduct of Merchant or its employees or agents; and (vii) any claim or complaint by a consumer that Merchant has violated the Equal Credit Opportunity Act, Truth in Lending Act, or any other act and related Applicable Laws. Household may deduct any amounts incurred by Household under this Section from amounts owed Merchant under this Agreement.

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    b.  Indemnification by Household.  Household shall be liable to and shall indemnify and hold harmless Merchant and its subsidiaries or Affiliates and their respective officers, employees, agents and directors from any losses, damages, claims or complaints incurred by Merchant or any subsidiary or affiliate of Merchant or their respective officers, employees, agents and directors arising out of (i) Household's failure to comply with this Agreement or any of the Operating Instructions; (ii) any claim, dispute or complaint by a Cardholder made in good faith resulting from anything done or not done by Household in connection with such Cardholder's Account; (iii) any illegal or improper conduct of Household, or its employees or agents with respect to the Card, a Card Sale, an Account or any other matters relating to the Program; (iv) any claim, dispute, complaint or setoff by a consumer made in good faith resulting from a violation by Household, with respect to the Application/Agreement, of the Equal Credit Opportunity Act, Truth in Lending Act or any other act and related Applicable Laws and regulations; and (v) any claim, dispute or complaint of any thirty party made in good faith in connection with advertisements and promotions prepared by Household relating to the Card. Notwithstanding the foregoing, the indemnification by Household shall not apply to any claim or complaint relating to the failure of Merchant to resolve a billing inquiry or dispute with a Cardholder where such failure was not caused by Household.

    c.  Internet Purchases.  Merchant shall reimburse Household for any losses suffered by Household for any reason if Merchant ships to an address that does not match Household's billing address.

    d.  Notice of Claim & Survival.  In the event that Household or Merchant shall receive any claim or demand or be subject to any suit or proceeding of which a claim may be made against the other under this Section, the indemnified party shall give prompt written notice thereof to the indemnifying party and the indemnifying party will be entitled to participate in the settlement or defense thereof with counsel satisfactory to indemnified party at the indemnifying party's expense. In any case, the indemnifying party and the indemnified party shall cooperate (at no cost to the indemnified party) in the settlement or defense of any such claim, demand, suit, or proceeding. The terms of this Section  13 shall survive the termination of this Agreement.

    Section 14.  Nonwaiver.  Merchant's liability under this Agreement, including, without limitation, its liability under Section 6 above, shall not be affected by any settlement, extension, forbearance, or variation in terms that Household may grant in connection with any Sales Slip or Account or by the discharge or release of the obligations of the Cardholder(s) or any other person by operation of law or otherwise. Merchant hereby waives any failure or delay on Household's part in asserting or enforcing any right that Household may have at any time under this Agreement or under any Account.

    Section 15.  Term and Termination.  

    a.  Term.  This Agreement shall be effective as of the Effective Date and shall remain in effect for three (3) years ("Initial Term"), subject to earlier termination as set forth below. Thereafter, this Agreement shall be automatically renewed for successive one year terms (the "Renewal Term(s)") unless and until terminated as provided herein. The termination of this Agreement shall not affect the rights and obligations of the parties with respect to transactions and occurrences which take place prior to the effective date of termination, except as otherwise provided herein.

    b.  Termination.  This Agreement may be terminated:

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    c.  Termination of Card Acceptance.  Household upon notice to Merchant may elect to terminate the acceptance of the Card at a particular Merchant location if at such location there are Excessive Chargebacks, high fraudulent activity or other course of business conduct that is injurious to the business relationship between Household and Merchant. In addition, Household may terminate this Agreement upon thirty (30) days prior notice to Merchant if the termination of a particular Merchant location materially affect(s) the volume of Card Sales generated by Merchant.

    d.  Duties and Rights Upon Termination.  Upon termination of this Agreement, Merchant will promptly submit to Household all Card Sales, Sales Slips, credits and other data made through the date of termination. Household is not liable to Merchant for any direct damages that Merchant may suffer as a result of Household's termination of this Agreement as provided in this Agreement. In the event this Agreement is terminated for any reason or notice of termination is given by either party, Household may take such other reasonable actions including but not limited to establishing and maintaining a reserve from payments otherwise payable to Merchant to protect Household's rights under this Agreement and to cover Chargeback amounts and other amounts owing to Household.

    e.  Purchase Requirements.  Upon termination of this Agreement due to material breach or termination without notice by Merchant, Merchant, its successors and assigns shall, at Household's option and upon Household's request, purchase or arrange to purchase by a third party, the Accounts, without recourse to Household and without representations or warranty, express or implied, at a price determined by Household, in Household's sole discretion, but not less than the full amount of all of the outstanding Account balances; the purchase to occur not later than ninety (90) days after the effective date of termination of this Agreement and to be under such terms and conditions as are reasonably acceptable to Household. In any event, commencing on the effective date of termination of this Agreement, Merchant shall pay to Household, monthly, within ten (10) days of Household's request, a liquidation fee in the amount of $5.00 per active Account per month until such time as the outstanding Account balances/receivables are liquidated and paid in full or, if a purchase is required as stated above, such purchase of all of the outstanding Account balances is consummated and Household receives the purchase price.

    Section 16.  Status of the Parties.  In performing their responsibilities pursuant to this Agreement, Household and Merchant are in the position of independent contractors, and in no circumstances shall either party be deemed to be the agent or employee of the other. This Agreement is not intended to create, nor does it create and shall not be construed to create, a relationship of partner or joint venturer or an association for profit between Household and Merchant. Any amounts ever owing by Merchant pursuant to this Agreement represent contractual obligations only and are not a loan or debt.

    Section 17.  Force Majeure.  Neither party to this Agreement shall be liable to the other by reason of any failure in performance of this Agreement in accordance with its terms if such failure arises out of a cause beyond the control and without the fault or negligence of such party. Such causes may

59

include but are not limited to acts of God, of the public enemy or of civil or military authority, unavailability of energy resources, system or communication failure, delay in transportation, fires, strikes, riots or war. In the event of any force majeure occurrence, the disabled party shall use its best efforts to meet its obligations as set forth in this Agreement.

    Section 18.  Limited License.  Merchant hereby authorizes Household for purposes of this Agreement to use Merchant's name, logo, registered trademarks and servicemarks (if any) and any other proprietary designations ("Proprietary Materials") on the Cards, Applications, periodic statements, billing statements, collection letters or documents, promotional or advertising materials and otherwise in connection with the Program, subject to Merchant's periodic reasonable review of such use and to such reasonable specifications of Merchant. Merchant represents and warrants that it has obtained appropriate federal and state trademark registrations to protect its interest in the use and ownership of the Proprietary Materials. Merchant shall, indemnify, defend and hold Household harmless from any loss, damage, expense or liability arising from any claims of alleged infringement of the Proprietary Materials (including attorneys' fees and costs). Merchant may not use any name or service mark of Household or any of its Affiliates in any manner without the prior written consent of Household.

    Section 19.  Confidentiality.  Merchant will keep confidential and not disclose to any person or entity (except to employees, officers, partners or directors of Merchant who are engaged in the implementation and execution of the Program) all information, software, systems and data, that Merchant receives from Household or from any other source, relating to the Program and matters which are subject to the terms of this Agreement, including, but not limited to, Cardholder names and addresses or other Account information, and shall use, or cause to be used, such information solely for the purposes of the performance of Merchant's obligations under the terms of this Agreement. Household will keep confidential and not disclose to any person or entity (except employees, officers, agents or directors of Household, its subsidiaries or affiliates who are engaged in the implementation and execution of the Program) any information that Household receives from Merchant which is designated confidential by Merchant. In the event Household sells or assigns the Accounts or any portion of the Accounts under the Program, Household may disclose any information under this provision reasonably necessary or required to effectuate such sale or assignment. The provisions of this Section 19 shall survive the termination of this Agreement.

    Section 20.  Additional Products & Services.  Household and/or any of its Affiliates may at any time, whether during or after the term of this Agreement and whether the Accounts are owned by Household, solicit Cardholders for any other credit cards or other types of accounts or financial products or insurance services offered by Household and/or any of its Affiliates.

    Section 21.  Notices.  All notices required or permitted by this Agreement shall be in writing and shall be sent to the respective parties; if to Household, to the Attention of President (with a copy to the Attention of General Counsel, HRS Law Department 2700 Sanders Road, Prospect Heights, IL 60070); if to Merchant, to the Attention of General Counsel, Direct Focus, Inc. 2200 NE 65th Avenue, Vancouver, WA 98661, or such other addresses as each party may designate to the other by notice hereunder. Said notices shall be deemed to be received when sent to the above addresses (i) upon three (3) Business Days after deposit in the U.S. first class mail with postage prepaid, (ii) upon personal delivery, or (iii) upon receipt by telex, facsimile, or overnight/express courier service or mail.

    Section 22.  Amendments and Supplementary Documents.  Household may amend this Agreement upon ten (10) days prior notice to Merchant if such modification is reasonably determined by Household to be required by any state or federal law, rule, regulation, governmental or judicial order, opinion, interpretation or decision. Reference herein to "this Agreement" shall include any schedules, appendices, exhibits, and amendments hereto. Any amendment or modification to this Agreement must

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be in writing and signed by a duly authorized officer of Household to be effective and binding upon Household; no oral amendments or modifications shall be binding upon the parties.

    Section 23.  Assignment.  This Agreement is binding upon the parties and their successors and assigns. Notwithstanding Merchant may not assign this Agreement without the prior written consent of Household; any purported assignment without such consent shall be void. Household may without Merchant's consent assign this Agreement or any of its rights or obligations hereunder to any Affiliate of Household at any time. In the event of such assignment, the assignee shall have the same rights and remedies as Household under this Agreement.

    Section 24.  Nonwaiver and Extensions.  Household shall not by any act, delay, omission, or otherwise be deemed to have waived any rights or remedies hereunder. Merchant agrees that Household's failure to enforce any of its rights under this Agreement shall not affect any other right of Household or the same right in any other instance.

    Section 25.  Rights of Persons Not a Party.  This Agreement shall not create any rights on the part of any person or entity not a party hereto, whether as a third party beneficiary or otherwise.

    Section 26.  Section Headings.  The headings of the sections of this Agreement are for reference only, are not a substantive part of this Agreement and are not to be used to affect the validity, construction or interpretation of this Agreement or any of its provisions.

    Section 27.  Integrations.  This Agreement contains the entire agreement between the parties. There are merged herein all prior oral or written agreements, amendments, representations, promises and conditions in connection with the subject matter hereof. Any representations, warranties, promises or conditions not expressly incorporated herein shall not be binding on Household or Merchant.

    Section 28.  Governing Law/Severability.  This Agreement shall be governed by and construed in accordance with the laws of the State of Illinois. If any provision of this Agreement is contrary to Applicable Law, such provision shall be deemed ineffective without invalidating the remaining provisions hereof.

    Section 29.  JURISDICTION.  ANY SUIT, COUNTERCLAIM, ACTION OR PROCEEDING ARISING OUT OF OR RELATING TO THIS AGREEMENT MUST BE BROUGHT BY EITHER PARTY IN THE COURTS OF THE STATE OF ILLINOIS OR IN THE UNITED STATES DISTRICT COURT FOR THE NORTHERN DISTRICT OF ILLINOIS; AND MERCHANT HEREBY IRREVOCABLY SUBMITS TO THE EXCLUSIVE JURISDICTION OF SUCH COURTS AND ANY APPELLATE COURTS THEREOF FOR THE PURPOSE OF ANY SUCH SUIT, COUNTERCLAIM, ACTION, PROCEEDING OR JUDGMENT (IT BEING UNDERSTOOD THAT SUCH CONSENT TO THE EXCLUSIVE JURISDICTION OF SUCH COURTS WAIVES ANY RIGHT TO SUBMIT ANY DISPUTES HEREUNDER TO ANY COURTS OTHER THAN THOSE ABOVE). NOTHING HEREIN SHALL PRECLUDE HOUSEHOLD FROM BRINGING AN ACTION OR PROCEEDING RELATED TO THIS AGREEMENT IN ANY OTHER STATE OR PLACE HAVING JURISDICTION OVER SUCH ACTION.

    Section 30.  WAIVER OF JURY TRIAL.  HOUSEHOLD AND MERCHANT HEREBY KNOWINGLY, VOLUNTARILY AND INTENTIONALLY WAIVE ANY RIGHT TO A TRIAL BY JURY IN ANY ACTION, SUIT, PROCEEDING OR COUNTERCLAIM CONCERNING ANY RIGHTS UNDER THIS AGREEMENT, ANY RELATED DOCUMENT OR UNDER ANY OTHER DOCUMENT OR AGREEMENT DELIVERED OR WHICH MAY IN THE FUTURE BE DELIVERED IN CONNECTION HEREWITH OR THEREWITH, OR ARISING FROM ANY RELATIONSHIP EXISTING IN CONNECTION WITH THIS AGREEMENT, AND AGREE THAT ANY SUCH ACTION, SUIT, PROCEEDING OR COUNTERCLAIM SHALL BE TRIED BEFORE A COURT AND NOT BEFORE A JURY; THIS PROVISION IS A MATERIAL INDUCEMENT FOR HOUSEHOLD AND MERCHANT ENTERING INTO THIS AGREEMENT.

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    IN WITNESS WHEREOF, Household and Merchant have caused their duly authorized representatives to execute this Agreement as of the date set forth above.

BANK:       MERCHANT:

HOUSEHOLD BANK (SB), N.A.
 
DIRECT FOCUS, INC.

By:
 

 
By:
 

Print Name:
 

 
Print Name:
 

Title:
 

 
Title:
 

ATTESTED OR WITNESSED
 
ATTESTED OR WITNESSED

By:
 

 
By:
 

Print Name:
 

 
Print Name:
 

Title:
 

 
Title:
 

 
 
 
 
Merchant's Federal Tax ID #'s:

 
 

 
 

 
 

 
 

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Exhibit 10.12
SECOND AMENDED AND RESTATED MERCHANT AGREEMENT
Prepared by MERRILL CORPORATION www.edgaradvantage.com
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Exhibit 10.14

AGREEMENT OF PURCHASE AND SALE
AND JOINT ESCROW INSTRUCTIONS

By And Between

TYCO VALVES & CONTROLS, INC., a Texas corporation
("Seller")

DIRECT FOCUS, INC., a Washington corporation
("Purchaser")

Property Address: 1400 N.E. 136th Avenue
Vancouver, Washington

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TABLE OF CONTENTS

 
    
   Page
ARTICLE 1. PURCHASE AND SALE   1
1.1   Purchase and Sale   1
1.2   Excluded Items   1

ARTICLE 2. PURCHASE PRICE
 
2
2.1   Purchase Price   2
2.2   Payment of Purchase Price   2
2.3   Earnest Money   2

ARTICLE 3. TITLE, SURVEY, BOOKS AND RECORDS AND OTHER CONTINGENCIES
 
3
3.1   Title and Survey   3
3.2   Books and Records   3
3.3   Purchaser's Contingencies and Waiver Thereof   4
3.4   Purchaser's Right of Inspection   5
3.5   Notices   7
3.6   Termination   7
3.7   Confidentiality   7

ARTICLE 4. COVENANTS AND AGREEMENTS
 
8
4.1   Existing Employment and Service Contracts   8
4.2   Materialman's and Mechanic's Liens   8
4.3   Property Condition at Closing   8

ARTICLE 5. REPRESENTATIONS AND WARRANTIES
 
9
5.1   Representations and Warranties of Seller   9
5.2   Representations and Warranties of Purchaser   11
5.3   Seller's Knowledge   12

ARTICLE 6. TITLE POLICY
 
12
6.1   Title Policy   12

ARTICLE 7. CLOSING
 
13
7.1   Closing Date   13
7.2   Seller's Closing Obligations   13
7.3   Purchaser's Closing Obligations   14
7.4   Allocation of Closing Expenses   14
7.5   Proration of Income and Expenses   15
7.6   Post-Closing Adjustments   15

ARTICLE 8. CONDITIONS
 
16
8.1   Purchaser's Conditions   16
8.2   Seller's Conditions    

ARTICLE 9. AGENCY DISCLOSURE
 
16
9.1   Brokerage Commissions   16

ARTICLE 10. TERMINATION AND REMEDIES
 
17
10.1   Purchaser's Defaults   17
10.2   Seller's Defaults   18

ARTICLE 11. MISCELLANEOUS
 
18
11.1   IRC § 1031 Exchange   18

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11.2   Assignment of Contract   18
11.3   Risk of Loss   18
11.4   Entire Agreement; Modifications   19
11.5   Time of Essence   19
11.6   Survival of Terms   19
11.7   Interpretation   19
11.8   Captions   19
11.9   Multiple Counterparts/Facsimile Signature   19
11.10   Binding Effect   19
11.11   Attorneys' Fees   19
11.12   Separability   20
11.13   Further Action   20
11.14   Right to Possession   20
11.15   Agreement Date   21
11.16   Applicable Law   21
11.17   Waiver of Jury Trial   21
11.18   Construction of Agreement   21
11.19   Escrow Instructions   21
11.20   Termination of Offer   21

65


AGREEMENT OF PURCHASE AND SALE
AND JOINT ESCROW INSTRUCTIONS

    THIS AGREEMENT OF PURCHASE AND SALE AND JOINT ESCROW INSTRUCTIONS (the "Agreement") is entered into and effective as of the 7th day of June 2000 (the "Effective Date") by and between Tyco Valves & Controls, Inc., a Texas corporation ("Seller") and Direct Focus, Inc., a Washington corporation.


ARTICLE 1.
PURCHASE AND SALE

    1.1  Purchase and Sale.  Subject to the terms and conditions of this Agreement, Seller hereby agrees to sell and convey to Purchaser, and Purchaser hereby agrees to buy and pay for through an escrow to close on or before August 1, 2000, the following properties and assets:

All of the foregoing items to be purchased under this Agreement shall be herein collectively referred to as the "Property."

    1.2  Excluded Items.  Notwithstanding anything to the contrary set forth above or elsewhere in this Agreement, Purchaser and Seller agree that the following items are not included within the purchase and sale terms of this Agreement, shall remain the property of Seller, and shall be removed from the Property by Seller (without harm to the remaining improvements) prior to Closing:

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ARTICLE 2.
PURCHASE PRICE

    2.1  Purchase Price.  The purchase price for the Property (the "Purchase Price") shall be Four Million Four Hundred Twenty-Five Thousand Dollars ($4,425,000).

    2.2  Payment of Purchase Price.  Subject to the adjustments required by Sections 7.4 and 7.5, the Purchase Price shall be payable to Seller as follows:

    2.3  Earnest Money.  Within three (3) business days of the mutual execution of this Agreement by both Purchaser and Seller, Purchaser shall open an escrow respecting this Agreement with Fidelity National Title Insurance Company, 703 Broadway, Suite 100, Vancouver, Washington 98660 (the "Title Company") and at that time deliver to the Title Company, as escrow, the sum of One Hundred Thousand Dollars ($100,000) (the "Earnest Money"). The Earnest Money together with any and all other Purchaser deposits required by this Agreement, and any interest earned thereon, shall be referred to herein as the "Earnest Money." The Earnest Money shall be deposited into an interest-bearing account maintained by the Title Company (using a state or federal FDIC insured bank) to be invested at the direction of Purchaser and the amount in that account, including interest thereon, shall be credited against the Purchase Price if and when Closing occurs or shall be released to Purchaser or Seller as otherwise provided for in this Agreement.


ARTICLE 3.
TITLE, SURVEY, BOOKS AND RECORDS AND OTHER CONTINGENCIES

    3.1  Title and Survey.  Within ten (10) days following the Execution Date, Seller, at its sole cost and expense, shall furnish or cause to be furnished to Purchaser:

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    By the execution of this Agreement, Seller hereby authorizes and directs the Title Company to furnish to Purchaser the items referred to in this Section 3.1.

    3.2  Books and Records.  Within ten (10) days following the mutual execution of this Agreement, Seller, at its sole cost and expense, shall furnish or cause to be furnished to Purchaser complete and legible copies of each of the following: (a) any agreements to be assigned to Purchaser at closing including any existing employment and service contracts; (b) all property tax statements, assessments, liens, L.I.D.'s or other governmental assessments relating to the property for the current year; and (c) to the extent Seller has actual knowledge of the following items and such items are reasonably accessible to Seller and are not otherwise of public record: (i) any surveys, soils studies, environmental surveys, structural reports, or other reports and plans in Seller's possession relating to the Real Property or Improvements; (ii) all governmental permits and approvals relating to the construction, operation, use or occupancy of the Property, as well as all zoning, land use, subdivision, environmental, building and construction rulings and permits restricting, regulating or otherwise affecting the use and occupancy or enjoyment of the Property, together with any notices of violation of any of those permits or any of the laws and regulations governing the Property; (iii) any reports relating to environmental remediation or structural repairs; and (iv) any warranties or similar contract rights relating to the Property which are to be assigned to Purchaser at Closing (collectively "Books and Records"). Within ten (10) days following the mutual execution of this Agreement, Seller shall provide Purchaser written notice designating one or more persons who shall be available to Purchaser to respond to questions and coordinate Purchaser's review of Books and Records and Purchaser's inspection of the Property pursuant to the terms hereof.

    3.3  Purchaser's Contingencies and Waiver Thereof.  Purchaser's obligation to close shall be subject to the following contingencies (collectively "Purchaser's Contingencies"), each of which Purchaser shall waive, or be deemed to have waived, as provided below:

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    3.4  Purchaser's Right of Inspection.  Throughout each of the above contingency periods, and subject to the provisions of Section 3.4.1 below, Purchaser shall have reasonable access to the Property, through its employees, representatives and agents, to inspect the Property, including, but not limited to, the physical and environmental condition thereof. Such inspections shall not unreasonably interfere with Seller's use of the Property and shall be at Purchaser's sole risk and expense. Purchase shall at its sole cost return the Property to the same condition as existed prior to any such inspection. Purchaser shall not allow any liens or encumbrances of any kind to attach to the Property. Purchaser agrees to indemnify, defend and hold Seller harmless from any and all liens, personal injuries, property damages, cost and expenses, including attorney fees, arising from or relating to the activities of Purchaser, its

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employees, contractors and agents on the Property. The indemnity set forth herein shall survive any termination or expiration of this Agreement.

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    3.5  Notices.  Any Notices required to be sent by either party pursuant to this Agreement shall be in writing and shall be either personally delivered, sent overnight courier (next day delivery), or sent by facsimile, to either Purchaser or Seller at the address set forth under each parties signature to this Agreement. Notice sent by overnight courier shall be deemed given the day following the date the same is deposited with the courier service.

    3.6  Termination.  If this Agreement is rightfully terminated by Purchaser pursuant to any provisions of this Agreement, the Title Company (or Seller as the case may be) shall return to Purchaser the Earnest Money and thereafter the parties hereto shall have no further obligations or liabilities hereunder, one to the other, except to the extent that either party is expressly entitled under this Agreement to seek indemnification from the other party notwithstanding such termination. In the event of such termination by Purchaser, Purchaser shall provide Seller copies of any and all written reports, surveys, studies or feasibility analysis respecting the property and prepared by or on behalf of Purchaser.

    3.7  Confidentiality.  Purchaser agrees that any and all environmental reports (including without limitation any Phase I or Phase II reports) respecting the Property, and all other reports or documentation respecting the Property, received or created during the Feasibility Contingency (collectively "Evaluation Material") shall be used by Purchaser for the sole purpose of evaluating its purchase of the Property as set forth herein. Purchaser shall keep the Evaluation Material confidential and shall not disclose any of the Evaluation Material in any manner whatsoever; provided, however, that, (i) Purchaser may make disclosure of information to which Seller gives its prior written consent, and (ii) any information contained in the Evaluation Material may be disclosed to Purchaser's directors, officers, employees, agents, lenders, attorneys, accountants and consultants who need to know such information for purposes of evaluating or closing this transaction and who agree to keep the same Confidential. In the event this Agreement is terminated through no default of Seller, Purchaser shall continue to maintain the confidentiality provided above and deliver to Seller all reports, studies and investigations performed by Purchaser, or otherwise in Purchaser's possession, and relating to the Property. This Section 3.7 shall survive the termination of this Agreement, other than by Closing.


ARTICLE 4.
COVENANTS AND AGREEMENTS

    4.1  Existing Employment and Service Contracts.  If requested by Purchaser in writing at least 30 days prior to closing, Seller shall terminate or cause to e terminated, as of the Closing Date, any and all agreements affecting the Property including without limitation any maintenance, management, security, service, supply, snow removal and other similar contracts and agreements. Otherwise, such

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agreements shall be assigned to Purchaser at Closing and Purchaser shall assume all of Seller's rights and obligations thereunder as of the Closing Date.

    4.2  Materialman's and Mechanic's Liens.  On or before the Closing Date, Seller shall pay for any materials, supplies or work provided or ordered for the Property by Seller or Seller's agent prior to the Closing and for which a labor, materialman's or mechanic's lien may be claimed under applicable law and, if required by the Title Company, shall provide the Title Company with such indemnifications or security as it may require to insure title to the Property at the Closing without exception for any unrecorded labor, materialman's or mechanic's claim of lien arising through Seller.

    4.3  Property Condition at Closing.  At Closing Seller shall deliver the Property to Purchaser in substantially the same condition as existing as of the date of this Agreement, except for normal wear and tear, and except as follows:

Each of the above conditions shall conclusively be deemed satisfied, or waived, upon the Closing.


ARTICLE 5.
REPRESENTATIONS AND WARRANTIES

    5.1  Representations and Warranties of Seller.  For the purposes of inducing Purchaser to enter into this Agreement and to consummate the transactions contemplated hereby pursuant to the terms and conditions hereof, and to Seller's actual knowledge, Seller represents and warrants to Purchaser, as of the date hereof and as of the Closing Date, except as otherwise set forth herein, as follows:

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    5.2  Representations and Warranties of Purchaser.  For the purpose of inducing Seller to enter into this Agreement and to consummate the transactions contemplated hereby pursuant to the terms and conditions hereof, to the extent of Purchaser's actual knowledge, Purchaser represents and warrants to Seller, as of the date hereof, and except as otherwise set forth herein, as of the Closing Date, as follows:

    5.3  Seller's Knowledge.  As used in this Agreement, references to "Seller's Knowledge," "Seller's Actual Knowledge" or similar phrases shall mean the actual knowledge of the following persons employed by Seller: Tom Pickett and Keith Thompson.

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ARTICLE 6.
TITLE POLICY

    6.1  Title Policy.  At the Closing, Seller agrees, at its sole cost and expense, to furnish to Purchaser a standard ALTA Owner's Title Policy, insurable at standard rates, or, if such a policy is not available in the jurisdiction where the Property is located, a comparable policy with substantially the same coverage (the "Title Policy"), issued by the Title Company, in Purchaser's favor in the amount of the Purchase Price, insuring Purchaser's marketable and indefeasible fee simple title to the Real Property, subject only to those exceptions, if any, approved by Purchaser pursuant to Section 3.3.1 of this Agreement, and the printed form of general exceptions contained in such standard ALTA Owner's Title Policy; provided, Purchaser may purchase an extended ALTA Owner's Title Policy so long as Purchaser pays all costs in excess of the cost of a standard ALTA Owner's Title Policy. If title is not insurable as provided above and cannot be made so insurable by the date of Closing, this Agreement shall terminate; provided, however, Purchaser may in its sole discretion elect to waive one or more of the defects to title and proceed with the acquisition of the Property pursuant to the terms of this Agreement.


ARTICLE 7.
CLOSING

    7.1  Closing Date.  The consummation of the purchase and sale contemplated hereby (the "Closing") shall be held on or before August 1, 2000 in the offices of the Title Company, or at such other place as may be agreed upon in writing by Seller and Purchaser; provided, if Purchaser's Phase II Environmental Audit report pursuant to Section 3.4.1 above has not been completed due to reasons other than Purchaser caused delay, and Purchaser has otherwise fully and irrevocably waived all other contingencies to Purchaser's obligation to close on its purchase of the Property, Purchaser may at its option extend the Closing Date (by notice to Seller on or prior to July 27, 2000), to a date that is on or prior to ten (10) business days from the date Purchaser received the completed Phase II Environment Audit report. The date and hour of Closing are referred to as the "Closing Date." Each party hereto agrees to undertake all actions and procedures reasonably necessary as when and required by this Agreement and execute and deliver to the title Company such closing escrow instructions as may be necessary to implement and coordinate the Closing as set forth in this Agreement.

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    7.2  Seller's Closing Obligations.  At the Closing, Seller shall:

    7.3  Purchaser's Closing Obligations.  At the Closing, Purchaser shall:

    7.4  Allocation of Closing Expenses.  The cost of closing the transaction shall be allocated between Seller and Purchaser as follows:

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    7.5  Proration of Income and Expenses.  The following items shall be adjusted or prorated between Seller and Purchaser at the Closing, as of the Closing Date:

    7.6  Post-Closing Adjustments.  Seller and Purchaser agree that, to the extent items are prorated or adjusted at the Closing on the basis of estimates, or are not prorated or adjusted at the Closing pending actual receipt of funds or compilation of information upon which such prorations or adjustments are to be based, each of them will, upon a proper accounting, pay to the other such amounts as may be necessary such that Seller will receive the benefit of all income and will pay all expenses of the Property prior to the Closing Date and Purchaser will receive all income and will pay all expenses of the property after the Closing Date to the extent required by Section 7.5. If Purchaser receives any bill or invoice which relates to periods prior to the Closing, Purchaser will refer such bill to Seller and Seller agrees to pay, promptly upon receipt, such a portion of the bill or invoice as relates to the period prior to the closing Date for which it is responsible. If Seller does not pay such bill in a timely manner, Purchase may, at its option, pay such bill or invoice and Seller shall become liable to Purchaser for the full amount of such payment.

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ARTICLE 8.
CONDITIONS

    8.1  Purchaser's Conditions.  Purchaser shall not be obligated to close the transaction unless and until:

    8.2  Seller's Conditions.  Seller shall not be obligated to close the transaction unless and until:


ARTICLE 9.
AGENCY DISCLOSURE

    9.1  Brokerage Commissions.  At the time of signing this Agreement, Shawn Kelter of Grubb & Ellis Company represented Seller and Scott Fraser of Grubb & Ellis Company represented Purchaser, and upon consummation of Closing Seller agrees to pay said brokers a commission through escrow in accordance with the terms of a separate written agreement between Seller and said brokers. Except as disclosed in the preceding sentence, at the time of signing this Agreement neither party has incurred any liability to any real estate broker or agent and each party agrees to indemnify and hold the other party harmless from and against any and all claims for brokerage commission arising out of this transaction and occasioned by the actions of such indemnifying party.


ARTICLE 10.
TERMINATION AND REMEDIES

    10.1  Purchaser's Defaults.  

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Seller's Initials
 
Purchaser's Initials

    10.2  Seller's Defaults.  


ARTICLE 11.
MISCELLANEOUS

    11.1  IRC § 1031 Exchange.  At Seller's request, Purchaser agrees to cooperate in qualifying all or any portion of this transaction as an Internal Revenue Code Section 1031 tax deferred exchange for Seller. Seller agrees to hold Purchaser harmless from any and all claims, costs or other liability and to indemnify Purchaser for any loss which may arise from Seller's Section 1031 tax deferred exchange, including without limitation any loss arising from the acquisition of the exchange property.

    11.2  Assignment of Contract.  Except in connection with an assignment to a facilitator for purposes of completing an I.R.C. Section 1031 exchange, this Agreement may not be assigned by Purchaser without the prior written consent of the Seller; provided, however, that Seller hereby consents to any assignment by Purchaser to any affiliate of Purchaser in which Purchaser has a controlling interest or to a limited partnership in which Purchaser serves as a general partner. In the event

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Purchaser assigns its rights under this Agreement pursuant to the terms of this Section, there shall be no release of Purchaser from any liability hereunder, Purchaser shall notify Seller of such assignment prior to the closing and the assignee shall for all purposes be regarded as Purchaser under this Agreement.

    11.3  Risk of Loss.  

    11.4  Entire Agreement; Modifications.  This Agreement embodies and constitutes the entire understanding between the parties with respect to the transactions contemplated herein, and all prior to contemporaneous agreements, understandings, representations, and statements, oral or written, are merged into this Agreement and are of no further force or effect. Neither this Agreement nor any provision hereof may be waived, modified, amended, discharged or terminated except by an instrument in writing signed by the party against which the enforcement of such waiver, modification, amendment, discharge or termination is sought, and then only to the extent set forth in such instrument.

    11.5  Time of Essence.  Time shall be of the essence of this Agreement.

    11.6  Survival of Terms.  The terms and provisions hereof shall survive the Closing and shall remain in full force and effect thereafter.

    11.7  Interpretation.  Words of any gender used in this Agreement shall be held and construed to include any other gender, and words of a singular number shall be held to include the plural, and vice versa, unless the context requires otherwise.

    11.8  Captions.  The captions used in this Agreement are for convenience only and shall not be deemed to construe or to limit the meaning of the language of this Agreement.

    11.9  Multiple Counterparts/Facsimile Signature.  This Agreement may be executed in a number of identical counterparts and by facsimile signature. If so executed, each of such counterparts and signatures is to be deemed an original for all purposes, and all such counterparts shall collectively constitute one agreement.

    11.10  Binding Effect.  Subject to the restrictions on assignment contained in Section 11.1, this Agreement shall be binding upon and shall inure to the benefit of the parties hereto and their respective heirs, legal representatives, successors and assigns.

    11.11  Attorneys' Fees.  Should either party employ an attorney or attorneys to enforce any of the provisions hereof or to protect its interest in any manner arising under this Agreement, or to recover

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damages for the breach hereof, the nonprevailing party in any action pursued in courts of competent jurisdiction (the finality of which action is not legally contested) agrees to pay to the prevailing party all reasonable costs, damages and expenses, including attorneys' fees, expended or incurred in connection therewith; provided, however, that if more than one item is disputed and the final decision is against each party as to one or more of the disputed items, then such costs, expenses and attorneys' fees shall be apportioned in accordance with the monetary values of the items decided against each party.

    11.12  Separability.  If one or more of the provisions of this Agreement or any application thereof shall be invalid, illegal or unenforceable in any respect, the validity, legality and enforceability of the remaining provisions or any other application thereof shall in no way be affected or impaired.

    11.13  Further Action.  Seller and Purchaser agree that they will, at any time and from time to time after the Closing Date, upon the request of the other party, do, execute, acknowledge, and deliver or will cause to be done, executed, acknowledged and delivered all such further acts, deeds, assignments, transfer, conveyances, powers of attorney and assurances as may be reasonably required for the effective assigning, transferring, granting, conveying, assuring and confirming to them, their heirs, legal representatives or assigns or for aiding and assisting in the collecting and reducing to possession, any and all of the assets or property to be assigned to them as provided herein, at the cost of the requesting party.

    11.14  Right to Possession.  Upon Closing, Purchaser shall be entitled to exclusive possession of the Property subject to the following:

    11.15  Agreement Date.  All references in this Agreement to the "date hereof," "the date of this Agreement," or other phrases of similar import shall be deemed to refer to the date first written above at the beginning of this Agreement.

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    11.16  Applicable Law.  This Agreement shall be governed by and construed in accordance with the laws of the State in which the Property is located.

    11.17  Waiver of Jury Trial.  Seller and Purchaser hereby waive their respective rights to trial by jury in any action or proceeding involving the Property or arising from this Agreement.

    11.18  Construction of Agreement.  This Agreement has been mutually negotiated by both parties and, therefore, shall not be construed as if prepared by one of the parties, but rather according to its fair meaning as a whole as if prepared by both parties.

    11.19  Escrow Instructions.  Upon acceptance hereof by Seller, this Agreement shall constitute not only the agreement of purchase and sale between Purchaser and Seller, but also irrevocable escrow instructions to the Title Company for the consummation of this agreement through the Closing of escrow. Title Company shall not prepare any further escrow instructions restating or amending the Agreement unless specifically so instructed by both parties. Subject to the reasonable approval of both parties, Title Company may, however, include its standard general escrow provisions.

    11.20  Termination of Offer.  This Agreement is submitted by Seller to Purchaser as an offer to purchase the Property on the terms and conditions set forth herein. This offer shall expire if Seller and Purchase have not fully executed this Agreement by 5:00 p.m., June 6, 2000.

    IN WITNESS WHEREOF, this Agreement has been executed by each of the parties as of the first date set forth above.

        SELLER   TYCO VALVES & CONTROLS, INC.
a Texas corporation

 
 
 
 
 
 
 
 
 
Date:   06/07/2000
       By:   /s/ John J. Guarnieri
            Its:   Vice President

 
 
 
 
 
 
Seller's Address for Notice:
One Tyco Park
Exeter, NH 09833

 
 
 
 
PURCHASER
 
DIRECT FOCUS, INC.
a Washington corporation

Date:
 
06/02/2000
 
 
 
By:
 
/s/ Brian R. Cook
            Its:   President

 
 
 
 
 
 
Purchaser's Address for Notice:
2200 N.E. 65th Avenue
Vancouver, WA 98661

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TABLE OF CONTENTS
AGREEMENT OF PURCHASE AND SALE AND JOINT ESCROW INSTRUCTIONS
ARTICLE 1. PURCHASE AND SALE
ARTICLE 2. PURCHASE PRICE
ARTICLE 3. TITLE, SURVEY, BOOKS AND RECORDS AND OTHER CONTINGENCIES
ARTICLE 4. COVENANTS AND AGREEMENTS
ARTICLE 5. REPRESENTATIONS AND WARRANTIES
ARTICLE 6. TITLE POLICY
ARTICLE 7. CLOSING
ARTICLE 8. CONDITIONS
ARTICLE 9. AGENCY DISCLOSURE
ARTICLE 10. TERMINATION AND REMEDIES
ARTICLE 11. MISCELLANEOUS
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Exhibit 21

SUBSIDIARIES OF DIRECT FOCUS, INC.

Nautilus Fitness Products, Inc., a Washington corporation
Nautilus Human Performance Systems, Inc., a Virginia corporation
Nautilus, Inc., a Washington corporation
Direct Focus Sales Corporation, a Washington corporation
Direct Focus FSC, Ltd., a Barbados corporation
DFI Properties, LLC, a Virginia limited liability company
BFI Advertising, Inc., a Washington corporation
DFI Leaseco, LLC, a Washington limited liability company

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SUBSIDIARIES OF DIRECT FOCUS, INC.
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Exhibit 23

INDEPENDENT AUDITORS' CONSENT

    We consent to the incorporation by reference in Registration Statements No. 333-79643 and No. 333-46936 of Direct Focus, Inc. on Form S-8 of our report dated January 19, 2001, appearing in the Annual Report on Form 10-K of Direct Focus, Inc. for the year ended December 31, 2000.

DELOITTE & TOUCHE, LLP
Portland, Oregon
March 28, 2001

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INDEPENDENT AUDITORS' CONSENT
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Exhibit 24.1

POWER OF ATTORNEY

KIRKLAND C. ALY

    KNOW ALL MEN BY THESE PRESENTS, that the undersigned, Kirkland C. Aly, hereby constitutes and appoints Brian R. Cook or Rod W. Rice, severally and not jointly, his true and lawful attorney-in-fact and agent, for him and his name, place and stead, in any and all capacities, to sign the Form 10-K of Direct Focus, Inc., a Washington corporation, for the fiscal year ended December 31, 2000, and any amendments or supplements thereto, and to file this Power of Attorney and the Form 10-K, with all exhibits thereto, and other documents in connection therewith, with the Securities and Exchange Commission and the NASDAQ National Market System, granting unto said attorney-in-fact and agent full power and authority to do and perform each requisite and necessary act to be done in and about the premises, as fully to all intents and purposes as he might or could do in person, hereby ratifying and confirming all that said attorney-in-fact and agent, may do or cause to be done by virtue hereof.

Dated this 27th day of March, 2001.    

Signature:
 
 

/s/ KIRKLAND C. ALY   
Kirkland C. Aly
 
 

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POWER OF ATTORNEY KIRKLAND C. ALY
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Exhibit 24.2

POWER OF ATTORNEY

C. ROWLAND HANSON

    KNOW ALL MEN BY THESE PRESENTS, that the undersigned, C. Rowland Hanson, hereby constitutes and appoints Brian R. Cook or Rod W. Rice, severally and not jointly, his true and lawful attorney-in-fact and agent, for him and his name, place and stead, in any and all capacities, to sign the Form 10-K of Direct Focus, Inc., a Washington corporation, for the fiscal year ended December 31, 2000, and any amendments or supplements thereto, and to file this Power of Attorney and the Form 10-K, with all exhibits thereto, and other documents in connection therewith, with the Securities and Exchange Commission and the NASDAQ National Market System, granting unto said attorney-in-fact and agent full power and authority to do and perform each requisite and necessary act to be done in and about the premises, as fully to all intents and purposes as he might or could do in person, hereby ratifying and confirming all that said attorney-in-fact and agent, may do or cause to be done by virtue hereof.

Dated this 27th day of March, 2001.    

Signature:
 
 

/s/ C. ROWLAND HANSON   
C. Rowland Hanson
 
 

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POWER OF ATTORNEY C. ROWLAND HANSON
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Exhibit 24.3

POWER OF ATTORNEY

PAUL F. LITTLE

    KNOW ALL MEN BY THESE PRESENTS, that the undersigned, Paul F. Little, hereby constitutes and appoints Brian R. Cook or Rod W. Rice, severally and not jointly, his true and lawful attorney-in-fact and agent, for him and his name, place and stead, in any and all capacities, to sign the Form 10-K of Direct Focus, Inc., a Washington corporation, for the fiscal year ended December 31, 2000, and any amendments or supplements thereto, and to file this Power of Attorney and the Form 10-K, with all exhibits thereto, and other documents in connection therewith, with the Securities and Exchange Commission and the NASDAQ National Market System, granting unto said attorney-in-fact and agent full power and authority to do and perform each requisite and necessary act to be done in and about the premises, as fully to all intents and purposes as he might or could do in person, hereby ratifying and confirming all that said attorney-in-fact and agent, may do or cause to be done by virtue hereof.

Dated this 27th day of March, 2001.    

Signature:
 
 

/s/ PAUL F. LITTLE   
Paul F. Little
 
 

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POWER OF ATTORNEY PAUL F. LITTLE
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Exhibit 24.4

POWER OF ATTORNEY

ROGER J. SHARP

    KNOW ALL MEN BY THESE PRESENTS, that the undersigned, Roger J. Sharp, hereby constitutes and appoints Brian R. Cook or Rod W. Rice, severally and not jointly, his true and lawful attorney-in-fact and agent, for him and his name, place and stead, in any and all capacities, to sign the Form 10-K of Direct Focus, Inc., a Washington corporation, for the fiscal year ended December 31, 2000, and any amendments or supplements thereto, and to file this Power of Attorney and the Form 10-K, with all exhibits thereto, and other documents in connection therewith, with the Securities and Exchange Commission and the NASDAQ National Market System, granting unto said attorney-in-fact and agent full power and authority to do and perform each requisite and necessary act to be done in and about the premises, as fully to all intents and purposes as he might or could do in person, hereby ratifying and confirming all that said attorney-in-fact and agent, may do or cause to be done by virtue hereof.

Dated this 27th day of March, 2001.    

Signature:
 
 

/s/ ROGER J. SHARP   
Roger J. Sharp
 
 

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POWER OF ATTORNEY ROGER J. SHARP
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Exhibit 24.5

POWER OF ATTORNEY

ROLAND E. "SANDY" WHEELER

    KNOW ALL MEN BY THESE PRESENTS, that the undersigned, Roland E. Wheeler, hereby constitutes and appoints Brian R. Cook or Rod W. Rice, severally and not jointly, his true and lawful attorney-in-fact and agent, for him and his name, place and stead, in any and all capacities, to sign the Form 10-K of Direct Focus, Inc., a Washington corporation, for the fiscal year ended December 31, 2000, and any amendments or supplements thereto, and to file this Power of Attorney and the Form 10-K, with all exhibits thereto, and other documents in connection therewith, with the Securities and Exchange Commission and the NASDAQ National Market System, granting unto said attorney-in-fact and agent full power and authority to do and perform each requisite and necessary act to be done in and about the premises, as fully to all intents and purposes as he might or could do in person, hereby ratifying and confirming all that said attorney-in-fact and agent, may do or cause to be done by virtue hereof.

Dated this 27th day of March, 2001.    

Signature:
 
 

/s/ ROLAND E. WHEELER   
Roland E. Wheeler
 
 

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POWER OF ATTORNEY ROLAND E. "SANDY" WHEELER