UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549


FORM 10-Q


 

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

FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2006MARCH 31, 2007

or

 

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

For the transition period from            to

Commission file number: 000-25867


NAUTILUS, INC.

(Exact name of registrant as specified in its charter)


 

Washington 94-3002667

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

16400 S.E. Nautilus Drive

Vancouver, Washington 98683

(Address of principal executive offices, including zip code)

(360) 859-2900

(Registrant’s telephone number, including area code)


Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the 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 whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filerfiler” and large“large accelerated filer” in Rule 12b-2 of the Exchange Act.

Large Accelerated Filer  x¨    Accelerated Filer  x¨    Non-Accelerated Filer  ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x

Number of shares of issuer’s common stock outstanding as of November 2, 2006: 31,472,886April 30, 2007: 31,545,136

 



NAUTILUS, INC.

TABLE OF CONTENTS

 

     Page

PART I. FINANCIAL INFORMATION

  
Item 1. Financial Statements (Unaudited)  3
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations  1613
Item 3. Quantitative and Qualitative Disclosures About Market Risk  2417
Item 4. Controls and Procedures  2518
PART II. OTHER INFORMATION  
Item 1. Legal Proceedings  2618
Item 1A. Risk Factors  27
Item 2.Unregistered Sales of Equity Securities and Use of Proceeds2719
Item 6. Exhibits  2720
Signatures  2821

Exhibit Index

  2922

- 2 -


PART I. FINANCIAL INFORMATION

 

Item 1.Financial Statements

NAUTILUS, INC.

CONSOLIDATED BALANCE SHEETS

(Unaudited, in thousands)

 

  

September 30,

2006

  

December 31,

2005

   

March 31,

2007

  

December 31,

2006

ASSETS

        

CURRENT ASSETS:

        

Cash and cash equivalents

  $3,404  $7,984   $4,745  $4,262

Trade receivables (net of allowance for doubtful accounts of $3,544 and $4,085 at September 30, 2006 and December 31, 2005, respectively)

   120,901   116,908 

Trade receivables (net of allowance for doubtful accounts of $3,499 and $3,893 at March 31, 2007 and December 31, 2006, respectively)

   98,025   137,714

Inventories

   69,546   96,084    89,856   75,832

Prepaid expenses and other current assets

   8,002   8,369    24,393   23,093

Short-term notes receivable

   2,556   2,496    2,600   2,461

Assets held for sale

   1,742   6,115    1,677   1,677

Deferred tax assets

   5,633   7,235    5,557   5,722
             

Total current assets

   211,784   245,191    226,853   250,761

PROPERTY, PLANT AND EQUIPMENT (at cost, net of accumulated depreciation of $48,026 and $43,802 at September 30, 2006 and December 31, 2005, respectively)

   54,374   59,320 

PROPERTY, PLANT AND EQUIPMENT (at cost, net of accumulated depreciation of $54,658 and $51,262 at March 31, 2007 and December 31, 2006, respectively)

   51,423   52,658

GOODWILL

   65,064   64,404    65,095   65,037

INTANGIBLE AND OTHER ASSETS, net

   50,353   44,371    56,473   56,486
             

TOTAL ASSETS

  $381,575  $413,286   $399,844  $424,942
             

LIABILITIES AND STOCKHOLDERS’ EQUITY

        

CURRENT LIABILITIES:

        

Trade payables

  $49,704  $61,132   $52,382  $61,375

Accrued liabilities

   25,388   29,097    27,692   31,444

Short-term borrowings

   35,000   40,147    37,200   47,500

Income taxes payable

   1,843   3,810 

Income tax payable

   1,336   4,551

Customer deposits

   2,084   3,327    1,894   2,229

Current portion of long-term debt

   178   707    205   259
             

Total current liabilities

   114,197   138,220    120,709   147,358

LONG TERM DEBT

   4,245   5,610 

NONCURRENT DEFERRED TAX LIABILITIES

   16,917   16,990 

COMMITMENTS AND CONTINGENCIES (Note 11)

    

LONG-TERM DEBT

   4,070   4,158

NON-CURRENT INCOME TAX LIABILITIES

   3,191   —  

NON-CURRENT DEFERRED TAX LIABILITIES

   15,401   16,792

COMMITMENTS AND CONTINGENCIES (Note 9)

    

STOCKHOLDERS’ EQUITY:

        

Common stock – no par value, 75,000 shares authorized; 31,473 and 32,780 shares issued and outstanding at September 30, 2006 and December 31, 2005, respectively

   405   3,549 

Unearned stock compensation

   —     (1,947)

Common stock – no par value, 75,000 shares authorized; 31,545 and 31,482 shares issued and outstanding at March 31, 2007 and December 31, 2006, respectively

   2,581   1,026

Retained earnings

   241,719   248,123    249,403   251,418

Accumulated other comprehensive income

   4,092   2,741    4,489   4,190
             

Total stockholders’ equity

   246,216   252,466    256,473   256,634
             

TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY

  $381,575  $413,286   $399,844  $424,942
             

See notes to consolidated financial statements.

- 3 -


NAUTILUS, INC.

CONSOLIDATED STATEMENTS OF INCOME

(Unaudited, in thousands, except per share amounts)

 

  

Three Months

Ended September 30,

  

Nine Months

Ended September 30,

  

Three Months

Ended March 31,

 
  2006 2005  2006 2005  2007 2006 

NET SALES

  $159,583  $163,308  $482,185  $449,277  $158,839  $184,990 

COST OF SALES

   87,493   91,022   270,192   242,164   85,571   105,678 
                   

Gross profit

   72,090   72,286   211,993   207,113   73,268   79,312 
                   

OPERATING EXPENSES:

         

Selling and marketing

   42,621   44,526   137,887   129,425   50,776   52,154 

General and administrative

   14,507   11,146   40,399   34,567   13,323   13,650 

Research and development

   2,521   2,856   8,321   8,768   3,215   3,268 

Royalties

   1,296   1,297   3,991   3,952   1,319   1,579 
                   

Total operating expenses

   60,945   59,825   190,598   176,712   68,633   70,651 
                   

OPERATING INCOME

   11,145   12,461   21,395   30,401   4,635   8,661 

OTHER INCOME (EXPENSE):

         

Interest income (expense), net

   (537)  145   (1,152)  1,460

Other income (expense), net

   (2)  31   1,220   542

Interest income

   75   138 

Interest expense

   (941)  (589)

Other income, net

   252   15 
                   

Total other income (expense)

   (539)  176   68   2,002

Total other expense

   (614)  (436)
                   

INCOME BEFORE INCOME TAXES

   10,606   12,637   21,463   32,403   4,021   8,225 

INCOME TAX EXPENSE

   1,230   4,366   5,215   11,373   1,557   3,024 
                   

NET INCOME

  $9,376  $8,271  $16,248  $21,030  $2,464  $5,201 
                   

EARNINGS PER SHARE:

         

BASIC

  $0.29  $0.25  $0.50  $0.63  $0.08  $0.16 

DILUTED

  $0.29  $0.24  $0.50  $0.62  $0.08  $0.16 

WEIGHTED AVERAGE SHARES OUTSTANDING:

         

BASIC

   32,138   33,549   32,577   33,367   31,508   32,796 

DILUTED

   32,240   34,365   32,732   34,090   31,729   33,025 

See notes to consolidated financial statements.

NAUTILUS, INC.

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY AND COMPREHENSIVE INCOME

NINE MONTHS ENDED SEPTEMBER 30, 2006 AND YEAR ENDED DECEMBER 31, 2005

(In Thousands, Except Share Data)

 

   Common Stock  

Unearned

Stock

Compensation

  

Retained

Earnings

  

Accumulated

Other

Comprehensive

Income

  Total 
  Shares  Amount     

BALANCES, January 1, 2005

  33,147,758  $10,682  $(1,204) $238,474  $4,084  $252,036 

Net income

  —     —     —     23,000   —     23,000 

Foreign currency translation adjustment

  —     —     —     —     (1,343)  (1,343)
          

Comprehensive income

        21,657 

Dividends paid

  —     —     —     (13,351)  —     (13,351)

Unearned stock compensation

  —     1,106   (1,106)  —     —     —   

Amortization of unearned stock compensation

  —     —     363   —     —     363 

Options exercised

  462,553   5,609   —     —     —     5,609 

Stock repurchased

  (830,700)  (15,636)  —     —     —     (15,636)

Tax benefit of exercise of nonqualified options

  —     1,788   —     —     —     1,788 
                        

BALANCES, DECEMBER 31, 2005

  32,779,611   3,549   (1,947)  248,123   2,741   252,466 

Net income

  —     —     —     16,248   —     16,248 

Foreign currency translation adjustment

  —     —     —     —     1,351   1,351 
          

Comprehensive income

        17,599 

Dividends paid

  —     —     —     (9,760)  —     (9,760)

Stock repurchased

  (1,344,200)  (3,761)  —     (12,892)  —     (16,653)

Unearned stock compensation

  —     (1,947)  1,947   —     —     —   

Stock-based compensation

  —     2,044   —     —     —     2,044 

Options exercised

  37,100   484   —     —     —     484 

Tax benefit of exercise of nonqualified options

  —     36   —     —     —     36 
                        

BALANCES, SEPTEMBER 30, 2006

  31,472,511  $405  $—    $241,719  $4,092  $246,216 
                        

See notes to consolidated financial statements.- 4 -


NAUTILUS, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited, in thousands)

 

  

Nine Months Ended

September 30,

   

Three Months Ended

March 31,

 
  2006 2005   2007 2006 

CASH FLOWS FROM OPERATING ACTIVITIES:

      

Net income

  $16,248  $21,030   $2,464  $5,201 

Adjustments to reconcile net income to net cash provided by operating activities:

      

Depreciation and amortization

   12,815   11,066    3,961   4,511 

Amortization of unearned stock compensation

   —     255 

Stock-based compensation

   2,044   —   

Amortization of discount on long-term debt

   —     12 

Loss on sale of property, plant and equipment

   109   15 

Tax benefit from exercise of nonqualified options

   —     1,942 

Share-based compensation

   704   778 

(Gain) / Loss on sale of property, plant and equipment

   (16)  48 

Excess tax benefit from exercise of employee stock options

   (36)  —      (95)  —   

Deferred income taxes

   1,182   2,032    (671)  (1,967)

Foreign currency transaction gain

   (1,115)  —      (148)  —   

Changes in assets and liabilities:

      

Trade receivables

   (2,338)  8,935    39,843   4,842 

Inventories

   27,559   (21,035)   (13,835)  19,883 

Prepaid expenses and other current assets

   370   (7,064)   (1,282)  2,789 

Trade payables

   (12,678)  (617)   (8,987)  (9,996)

Income taxes payable

   (1,985)  4,709 

Accrued liabilities

   (4,072)  (2,812)   (3,832)  (727)

Income taxes payable

   (1,907)  (7,651)

Customer deposits

   (1,523)  542    (338)  (111)
              

Net cash provided by operating activities

   36,658   6,650    15,783   29,960 
              

CASH FLOWS FROM INVESTING ACTIVITIES:

      

Purchases of property, plant and equipment

   (8,372)  (23,210)   (2,213)  (2,028)

Proceeds from sale of property, plant and equipment, and assets held for sale

   6,064   2,972    16   6,064 

Net increase in intangible and other assets

   (7,501)  (306)   (328)  (40)

Acquisition, net of cash acquired

   —     (73,688)

Purchases of short-term investments

   —     (49,352)

Proceeds from maturities of short-term investments

   —     134,671 

Net increase (decrease) in notes receivable

   (60)  107 

Net (increase) decrease in notes receivable

   (139)  11 
              

Net cash used in investing activities

   (9,869)  (8,806)

Net cash (used in) provided by investing activities

   (2,664)  4,007 
              

CASH FLOWS FROM FINANCING ACTIVITIES:

      

Cash dividends paid on common stock

   (9,760)  (10,010)   (3,156)  (3,280)

Proceeds from exercise of stock options

   484   5,565    756   324 

Excess tax benefit from exercise of employee stock options

   36   —      95   —   

Stock repurchases

   (16,653)  (4,580)

Net reduction in short-term borrowings

   (5,147)  —      (10,300)  (29,147)

Principal payments on long-term debt

   (1,900)  (89)   (142)  (254)
              

Net cash used in financing activities

   (32,940)  (9,114)   (12,747)  (32,357)
              

Net Effect of Foreign Currency Exchange Rate Changes

   1,571   (566)

Net effect of foreign currency exchange rate changes

   111   (133)
              

Net Decrease in Cash and Cash Equivalents

   (4,580)  (11,836)

Cash and Cash Equivalents, beginning of period

   7,984   19,266 

Net increase in cash and cash equivalents

   483   1,477 

Cash and cash equivalents, beginning of period

   4,262   7,984 
              

Cash and Cash Equivalents, end of period

  $3,404  $7,430 

Cash and cash equivalents, end of period

  $4,745  $9,461 
              

Supplemental Disclosures:

   

Supplemental disclosures:

   

Cash paid for interest

  $1,479  $55   $661  $845 
              

Cash paid for income taxes

  $6,685  $14,461   $4,048  $—   
              

Supplemental Disclosure of Other Non-cash Investing and Financing Activities:

   

Promissory notes issued or assumed in business acquisitions

  $—    $6,854 
       

See notes to consolidated financial statements.

- 5 -


NAUTILUS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

1. BASIS OF PRESENTATION

1.BASIS OF PRESENTATION

Nautilus, Inc. is referred to as “we,” “us,” “our” or “Company” in this report. The accompanying consolidated financial statements relate to Nautilus, Inc. and its subsidiaries (“the Company”) as of September 30, 2006March 31, 2007 and for the three and nine month periods ended September 30, 2006March 31, 2007 and 2005.2006. The consolidated financial statements of the Company include the accounts of Nautilus, Inc. and its wholly-owned subsidiaries. All intercompany transactions and balances have been eliminated in consolidation.

The accompanying unaudited consolidated financial statements of the Company have been prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”) for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by U.S. GAAP for complete financial statements. These consolidated financial statements should be read in conjunction with the consolidated audited financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2005.2006.

The financial information included herein reflects all adjustments (consisting of normal recurring adjustments), which are, in the opinion of management, necessary for a fair presentation of the results for the interim periods presented. The results of operations for the three and nine monthsmonth period ended September 30, 2006March 31, 2007 are not necessarily indicative of the results to be expected for the full year.

Use of Accounting Estimates

The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues, and liabilitiesexpenses and the disclosure of contingent assets and liabilities at the date ofin the financial statements, and the reported amounts of revenues and expenses during the reporting period.statements. Actual results could differ from those estimates. Our significant estimates relatecan be found in the Company’s Annual Report on Form 10-K for the year ended December 31, 2006.

Reclassifications

Prior year amounts of interest income and interest expense which were presented at net have been reclassified to revenue recognition, stock-based compensation, warranty reserves, legal reserves, sales returns and discounts,conform to the allowance for doubtful accounts, inventory valuation, intangible asset valuation, andcurrent year presentation within the consolidated statements of income. This change had no impact on previously reported operating income, taxes.net income or stockholders’ equity.

New Accounting Pronouncements

In September 2006,February 2007, the staff of the Securities and Exchange CommissionFinancial Accounting Standards Board (“SEC”FASB”) issued Staffthe Statement of Financial Accounting BulletinStandards (“SAB”SFAS”) No. 108,��159,ConsideringThe Fair Value Option for Financial Assets and Financial Liabilities(“SFAS 159”), which expands the Effectsscope of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements (“SAB 108”). In SAB 108,what companies may carry at fair value. SFAS 159 offers an irrevocable option to carry the SEC staff established an approach that requires quantificationvast majority of financial statement misstatements based on the effects of the misstatements on each of the Company’s financial statementsassets and the related financial statement disclosures.liabilities at fair value, with changes in fair value recorded in earnings. The Statement is effective for fiscal years beginning after November 15, 2007. The Company will adopt SAB 108 in December 2006 and is currently evaluating the impact that the adoption will have on the Company’s results of operations, cash flows or financial position.

In September 2006, the Financial Accounting Standards Board (“FASB”)FASB issued Statement of Financial Accounting Standard (“SFAS”)SFAS No. 157,Fair Value Measurements(“SFAS 157”). This statement defines fair value, establishes a framework for measuring fair value in U.S. GAAP, and expands disclosures about fair value measurements. SFAS 157 is effective for financial statements issued for fiscal years beginning after November 15, 2006.2007. The Company is currently evaluating the impact that the adoption will have on the Company’s results of operations, cash flows or financial position.

In July 2006, the FASB issued FASB Interpretation No. 48,Accounting for Uncertainty in Income Taxes – an interpretation of FASB Statement No. 109 (“FIN 48”). FIN 48 provides a two-step approach for recognizing and measuring tax benefits and requires companies to make disclosures about uncertainties in their income tax position, including a detailed rollforward of tax benefits taken that do not qualify for financial statement recognition. FIN 48 is effective for fiscal years beginning after December 15, 2006. The Company is currently evaluating the impact that the adoption will have on the Company’s results of operations, cash flows or financial position.

2.STOCK BASED COMPENSATION

2005 Long Term Incentive Plan

In 2005, the Company’s shareholders approved the Company’s 2005 Long Term Incentive Plan (the “Plan”). The Plan permits flexibility in types of awards, and specific terms of awards, which allow future awards to be based on then-current objectives for aligning compensation with increasing long-term shareholder value. The aggregate number of shares of common stock authorized for issuance as awards under the Plan is 4,000,000, plus any shares of common stock that were previously reserved for issuance under the Company’s Stock Option Plan and were not subject to grant on June 6, 2005 or as to which the option award is forfeited on or after June 6, 2005. The maximum aggregate number of shares of common stock subject to stock options, stock appreciation rights, restricted stock or stock unit awards which may be granted to any one participant in any one year under the Plan is 1,000,000. The aggregate number of shares available for issuance under the Plan is reduced by two shares for each share delivered in settlement of any stock appreciation rights, restricted stock, stock unit or performance unit award, and one share for each share delivered in settlement of a stock option award.

Adoption of SFAS 123(R)

Effective January 1, 2006, the Company adopted the provisions of SFAS No. 123 (revised 2004),Share-Based Payment (“SFAS 123(R)”) for its share-based compensation plan using the modified prospective transition method.this interpretation on January 1, 2007. The Company previously accounted for the plan under the recognition and measurement principles of Accounting Principles Board (“APB”) Opinion No. 25,Accounting for Stock Issued to Employees (“APB 25” or “Opinion 25”) and related interpretations and disclosure requirements established by SFAS 123,Accounting for Stock-Based Compensation,and SFAS No. 148,Accounting for Stock-Based Compensation — Transition and Disclosure. In March 2005,cumulative effect of the SEC issued SAB No. 107,Share-Based Payment (“SAB 107”), relating to SFAS 123(R). The Company has applied the provisions of SAB 107 in its adoption of SFAS 123(R).

Under APB 25, no expense was recordedFIN 48 are presented in the income statement for the Company’s stock options granted at fair market value. The pro forma effect on income for stock options was instead disclosed in a footnote to the financial statements. Expense was recorded in the income statement for equity awards granted below fair market value on the date of grant.

Under SFAS 123(R), the Company recognizes compensation expense from share-based payments over the requisite service periods of the individual grants, which generally equal the vesting periods. Consistent with prior years, the fair value of each equity award is estimated at the date of grant using the Black-Scholes-Merton option pricing model which requires extensive use of accounting judgment, including estimates of the expected volatility of the Company’s common stock price over the expected term, the dividend yield, expected term option holders will retain their vested awards before exercising them, and the number of awards that will be forfeited prior to the completion of their vesting requirements. Application of alternative assumptions could produce significantly different estimates of the fair value of equity awards and consequently the related amounts of compensation cost recognized in the Consolidated Statements of Income.

The following table illustrates the effect on net income and earnings per share as if the Company had applied the fair value recognition provisions of SFAS No. 123 to its equity awards for the periods prior to adoption of SFAS 123(R):Note 12.

 

(in thousands, except per share amounts)  

Three Months Ended

September 30, 2005

  

Nine Months Ended

September 30, 2005

 

Net income, as reported

  $8,271  $21,030 

Add: Stock-based employee compensation expense included in reported net income, net of tax

   55   165 

Deduct: Stock-based employee compensation expense determined under fair value based method, net of tax

   (664)  (1,837)
         

Net income, pro forma

  $7,662  $19,358 
         

Basic earnings per share:

   

As reported

  $0.25  $0.63 

Pro forma

  $0.23  $0.58 

Diluted earnings per share:

   

As reported

  $0.24  $0.62 

Pro forma

  $0.22  $0.57 

As a result of adopting SFAS 123(R), the Company’s income before income taxes and net income for the three months ended September 30, 2006 are $0.7 million and $0.6 million lower, respectively, than if it had continued to account for share-based compensation under Opinion 25. The Company’s income before income taxes and net income for the nine months ended September 30, 2006 are $2.0 million and $1.5 million lower, respectively, than if it had continued to account for share-based compensation under Opinion 25. The Company’s basic and diluted earnings per share for the three and nine months ended September 30, 2006 are $0.02 and $0.06, respectively, lower than if it had continued to account for share-based compensation under APB 25. The Company did not capitalize any of its share-based compensation costs in any of the periods.- 6 -


2. STOCKHOLDERS’ EQUITY

Stock Options

Stock option awards are granted with an exercise price equal to the market price of the Company’s stock on the date prior to the award grant date, generally vest based on four years of continuous service and have a seven year contractual term.

A summary of the Company’s stock option plan activity for the three months ended September 30, 2006 is as follows:

 

(in thousands, except exercise price)  

Total

Shares

  Weighted-Average
Exercise Price
  

Weighted-
Average
Remaining

Contractual Life

(in years)

  Aggregate
Intrinsic
Value

Outstanding at June 30, 2006

  2,702  $16.63    

Granted

  4   13.06    

Forfeited or canceled

  (39)  18.74    

Expired

  (19)  28.03    

Exercised

  (13)  10.49    $39
             

Outstanding at September 30, 2006

  2,635  $16.54  6.75  $2,671
              

A summary of the Company’s stock option plan activity for the nine months ended September 30, 2006 is as follows:

(in thousands, except exercise price)  

Total

Shares

 

Weighted-Average

Exercise Price

  

Weighted-

Average

Remaining

Contractual Life

(in years)

  

Aggregate

Intrinsic

Value

  

Total

Shares

 

Weighted-Average

Exercise Price

  

Weighted-

Average

Remaining

Contractual Life

(in years)

  

Aggregate

Intrinsic

Value

Outstanding at December 31. 2005

  2,277  $17.39    

Outstanding at January 1, 2007

  2,568  $16.44    

Granted

  645   15.63      585   16.12    

Forfeited or canceled

  (123)  19.82      (69)  18.88    

Expired

  (127)  24.96      (28)  25.12    

Exercised

  (37)  13.06    $135  (63)  11.97    $364
                      

Outstanding at September 30, 2006

  2,635  $16.54  6.75  $2,671

Outstanding at March 31, 2007

  2,993  $16.33  6.36  $2,722
                        

Exercisable at September 30, 2006

  938  $16.78  6.27  $1,386
            

Vested and expected to vest at March 31, 2007

  2,231  $16.29  6.28  $2,441

Exercisable at March 31, 2007

  1,159  $16.60  6.01  $1,662

The fair value of the Company’s equity awards was estimated utilizing the following assumptions:

 

  

Three months ended

September 30,

2006

 

Nine months ended

September 30,

2006

   

Three Months Ended

March 31,

 

Expected life (years)

  4.75  4.75 
  2007 2006 

Expected Life (years)

  4.8  5.5 

Risk-free interest rate

  4.8% 4.8%  4.6% 4.5%

Expected dividend yield

  3.1% 2.6%

Dividend yield

  2.5% 2.4%

Expected volatility

  44% 44%  43% 44%

Expected life representsThe weighted average grant-date fair value of stock options granted was $5.62 for stock options granted in the period thatfirst three months of 2007. The total fair value of options vested during the Company’s equity awards arefirst three months of 2007 was $105,939. The total unrecognized compensation cost related to nonvested options was $7.1 million at March 31, 2007. This cost is expected to be outstanding and was determined based on historical experiencerecognized over a weighted-average period of similar awards, giving consideration to the contractual terms of the equity awards and vesting schedules. Risk-free interest rate is based on the implied U.S. Treasury zero coupon yield curve in effect in the month of grant. Expected dividend yield is calculated based on the authorization by the Company’s Board of Directors of the payment of the 2006 quarterly dividends in the amount of $0.10 per share. Expected volatility utilized in the model is calculated using daily historical volatility of the Company’s stock price. When estimating forfeitures, the Company considers terminations as well as anticipated retirements based on an analysis of historical data.2.73 years.

Performance Units

In December 2005, the Company granted performance unit awards to members of its executive team. The performance unit awards vest if the Company meets earnings targets set by the Compensation Committee of the Board of Directors. The fair value of the performance units is based on the closing market priceA summary of the Company’s common stock on the date preceding the grant date andperformance unit’s activity is amortized over the estimated requisite service period when it becomes probable that the performance targets are expected to be met. The amount of stock-based compensation expense is based on the number of performance unit awards ultimately expected to vest, and therefore has been reduced for estimated forfeitures.

as follows:

(in thousands, except fair value amounts)

Performance

Units

Weighted Average

Grant Date Fair

Value

Outstanding at January 1, 2007

174$12.52 - 17.70

Granted

4516.10 - 16.80

Forfeited or canceled

—  —  

Expired

—  —  

Exercised

—  —  

Outstanding at March 31, 2007

219$12.52 -17.70

At September 30,March 31, 2007 and 2006 there waswere approximately $2.9$3.6 million and $2.7 million, respectively, of total unrecognized stock-basedshare-based compensation costs related to performance units with the intrinsic value of approximately $2.4 million.zero in both periods. None of the performance units were vested at September 30,March 31, 2007 and 2006. There were no performance units in the comparable period of fiscal 2005. The Company did not record anyrecorded compensation expense of $37,000 and $112,000 related to the performance unit awards in the three and nine monththree-month periods ended September 30, 2006. A summary of the Company’s performance units activity for the three months ended September 30,March 31, 2007 and March 31, 2006, is as follows:respectively.

 

(in thousands, except fair value amounts)  

Performance

Units

  

Weighted Average

Grant Date Fair

Value

Outstanding at June 30, 2006

  156  $15.15 - $17.70

Granted

  18   12.52

Forfeited or canceled

  —     —  

Expired

  —     —  

Exercised

  —     —  
       

Outstanding at September 30, 2006

  174  $ 12.52 -$ 17.70
       

A summary of the Company’s performance units activity for the nine months ended September 30, 2006 is as follows:- 7 -


3. INVENTORIES

(in thousands, except fair value amounts)  

Performance

Units

  

Weighted Average

Grant Date Fair

Value

Outstanding at December 31, 2005

  125  $17.70

Granted

  49   12.52 -15.15

Forfeited or canceled

  —     —  

Expired

  —     —  

Exercised

  —     —  
       

Outstanding at September 30, 2006

  174  $12.52 -$ 17.70
       

3.INVENTORIES

Inventories consisted of the following:

 

(in thousands)  

September 30,

2006

  

December 31,

2005

  

March 31,

2007

  

December 31,

2006

Finished goods

  $49,029  $69,178  $67,528  $55,235

Work-in-process

   1,431   1,368   1,455   1,154

Parts and components

   19,086   25,538   11,503   10,003

Raw materials

   9,370   9,440
            

Inventories

  $69,546  $96,084  $89,856  $75,832
            

Inventories are stated at the lower of standard cost or market. The Company evaluates the need for inventory valuation adjustments associated with obsolete, slow-moving and not saleable inventory by reviewing current transactions and forecasted product demand on a quarterlymonthly basis.

4. INTANGIBLE AND OTHER ASSETS

4.INTANGIBLE AND OTHER ASSETS

Intangible assets, exclusive of goodwill, consisted of the following:

 

(in thousands)  

Estimated Useful

Life (in years)

  September 30, 2006  December 31, 2005 

Intangible assets:

     

Indefinite life trademarks

  N/A  $37,310  $30,465 

Definite life trademarks

  20   —     6,800 

Patents

  1 to 17   7,336   1,597 

Customer base

  8   3,400   3,400 

Developed technology

  4   2,500   2,500 

Non-compete agreements

  3   1,722   1,647 
           

Total intangible assets

     52,268   46,409 

Accumulated amortization

     (4,746)  (3,233)
           

Intangible assets, net

     47,522   43,176 
           

Other assets

     2,831   1,195 
           

Intangible and other assets

    $50,353  $44,371 
           

(in thousands)

  Estimated
Useful Life
(in years)
  March 31, 2007  December 31, 2006 

Intangible assets:

     

Indefinite life trademarks

  N/A  $37,523  $37,523 

Patents

  1 to 17   7,697   7,697 

Customer base

  8   3,400   3,400 

Developed technology

  4   2,500   2,500 

Non-compete agreements

  3   1,662   1,647 
           

Total intangible assets

     52,782   52,767 

Accumulated amortization:

     

Patents

     (911)  (730)

Customer base

     (737)  (631)

Developed technology

     (1,084)  (927)

Non-compete agreements

     (1,062)  (916)
           

Total accumulated amortization

     (3,794)  (3,204)
           

Intangible assets, net

     48,988   49,563 

Other assets

     7,485   6,923 
           

Intangible and other assets, net

    $56,473  $56,486 
           

Identifiable intangible assets such as license agreements, patents, and trademarks are recorded at cost, or when acquired as part of a business combination, at estimated fair value and are amortized straight-line over athe period they provide the Company with economic benefit, or using the straight-line method over their estimated useful life.benefit. The amortization expense for the next five full succeeding years is estimated at $2.3$2.0 million, $1.9$1.5 million, $1.4$1.1 million, $1.1 million and $1.1 million per year.million.

5. ACCRUED LIABILITIES

5.ACCRUED LIABILITIES

Accrued liabilities in excess of five percent of total current liabilities consisted of the following:accrued warranty expense of $9.0 million and $9.8 million at March 31, 2007 and December 31, 2006, respectively, and accrued payroll of $6.1 million and $8.5 million at March 31, 2007 and December 31, 2006, respectively.

 

(in thousands)  

September 30,

2006

  

December 31,

2005

Accrued warranty expense

  $8,258  $10,210

Payroll

   5,794   8,457

Sales return reserve

   1,555   1,049

Royalty reserve

   1,255   1,685

Other

   8,526   7,696
        

Accrued liabilities*

  $25,388  $29,097
        

- 8 -

*Other accrued liabilities consist primarily of finance fees, commissions, accrued advertising and marketing fees, reserve for product liability, and miscellaneous accruals.

Warranty reserve activity for the nine months ended September 30, 2006 and 2005 was as follows:


6. LINE OF CREDIT AND OTHER DEBT

(in thousands)  

Balance at

Beginning

of Period

  

Charged to

Costs and

Expenses

  Deductions*  

Balance at

End of

Period

2006

  $10,210  $5,831  $7,783  $8,258

2005

  $7,537  $6,442  $5,617  $8,362

*Deductions represent warranty claims paid out in the form of service costs and/or product replacements.

Warranty costs are estimated based on the Company’s historical experience and are charged to cost of sales. Beginning in 2006,In February 2007, the Company has been able to offset its warranty costs by recovering a portion of such costs from its suppliers.

6.LINE OF CREDIT AND OTHER DEBT

In November 2005,paid off the Company entered into an unsecured credit agreement with two domestic lending institutions. In August 2006,outstanding balances under the Company amended its credit agreement. The agreement, as amended, provides for a revolving credit facility for a maximum commitment of $65 million includes revolving loans, letters of creditfacility that it entered in fiscal 2005 and swing loans, and expires on November 17, 2010. Under this credit facility, borrowings bear interest based at either the Prime Rate, Federal Funds Effective Rate or Eurodollar rates plus the applicable margin for either Base Rate Loans or Eurodollar Loans based upon the Company’s consolidated leverage ratio. The credit facility has a default rate of two percent in excess of the rate otherwise applicable and provides for a facility fee at the annual rate equal to the applicable Facility Fee Rate in effect on the payment date. The facility fee is based on the average daily total commitment amount in effect during the quarter and is payable quarterly. At September 30, 2006, the borrowing limit under the credit facility was $65 million of which $23.5 million was available. The interest rate on the amount of borrowings outstanding at September 30, 2006 ranged between 5.990% and 6.025%. The interest rates ranged between 5.025% and 5.275% on the amount of borrowings outstanding at December 31, 2005. At September 30, 2006, the Company had $6.5 million in standby letters of credit primarily with Asian vendors which reduced the balance available under the credit facility.

Under the terms of the credit facility, the Company may use proceeds for working capital and other general corporate purposes, including acquisitions. The terms of the credit facility also allow the use of funds for the repurchase of shares of the Company’s common stock in an aggregate amount not to exceed $30 million until the fixed charge coverage ratio is equal to or greater than 1.20 to 1.00. The credit facility, as amended, contains certain financial and non-financial covenants with which the Company was in compliance at September 30, 2006.

As part of its plan to expand its borrowing capacity to $125 million, the Company entered into a $25 million unsecurednew revolving credit agreement (the “Facility”) with several financing institutions. The Facility provides for an unsecured revolving credit facility to include revolving loans, a lender in October 2006.$10 million swing line sub-facility, and a $25 million line of credit sub-facility, for a maximum commitment amount of $125 million with an option to increase the facility to $175 million. The Facility expires on December 30, 2006. The FacilityFebruary 14, 2012 and is intended for general corporate purposes, including working capital stock repurchases,requirements, financing permitted acquisitions and permitted acquisitions. share repurchases.

The Facility provides for either Base Rate or Eurodollar Rate loans.loans with each revolving loan in the principal amount of $2.5 million or in increments of $0.5 million in excess thereof. It also allows for swing loans in minimum amounts of $0.1 million subject to its sub-limit of $10.0 million for a duration of up to ten business days, and letters of credit in the minimum amount of $0.1 million. Base Raterate revolving loans bear interest at the higher of the Federal Funds Raterate plus 1/2 of 1.0% 0.5% or the Prime Rate;prime rate per annum; Eurodollar revolving loans bear interest at the Eurodollar Rate plus 1.00%.a margin of from 0.75% to 1.5% per annum; Swing line loans bear interest at the Base Rate minus a margin of from 1.15% to 1.9% per annum. The Facility includes a commitment fee of 0.25%from 0.75% to 3.0% per annum for the unused portion of the commitment andcommitment.

The Facility requires Pearl Izumi, a wholly-owned subsidiary of the Company, to be a guarantor; other domestic subsidiaries may be required to become guarantors under certain circumstances. The Facility also contains certain financial and non-financial covenants which include but are not limiteda consolidated leverage ratio, a consolidated asset coverage ratio, and a requirement to maintain a leverage ratio.

minimum consolidated Earnings Before Income Tax, Depreciation and Amortization, or EBITDA.

In 2005,As of March 31, 2007, the Company issued a $1.5 million non-interest bearing promissory note ($1.3 million, net of imputed interest) as part of the purchase price of the Belko Canada acquisition payableis in full in May 2008. At June 30, 2006, the Company reached an agreementcompliance with the noteholder to settle the entire amount of the note in fiscal 2006. The Company paid off the remaining balance of the note in August of 2006.its debt covenants.

As part of the acquisition of Pearl Izumi, the Company became obligated on two non-interest bearing notes of $4.4 million and $0.9 million, net of imputed interest. The $4.4 million note requires payments of $0.3 million in February 2006, and $0.15 million per quarter beginning March 2007 through December 2016. The $0.9 million note requires payments of $0.15 million per quarter beginning September 2005 through December 2006.7. COMPREHENSIVE INCOME

7.COMPREHENSIVE INCOME

Accounts of the Company’s foreign operations are measured using the local currency as the functional currency. These accounts are then translated into U.S. dollars using the current rate method with translation gains and losses accumulated as the comprehensive income component of stockholders’ equity, except for gains or losses from intercompany transactionswith the Company’s international subsidiaries which are recorded as part of other income/expense in the Consolidated StatementStatements of Income.

Comprehensive income was as follows:

 

(in thousands)  

Three Months Ended

September 30,

  

Nine Months Ended

September 30,

 
  

Three Months Ended

March 31,

 
(in thousands) 2006  2005  2006  2005   2007  2006 
  $9,376  $8,271  $16,248  $21,030   $2,464  $5,201 

Foreign currency translation adjustments

   300   226   1,351   (1,041)   299   (189)
                    

Comprehensive income

  $9,676  $8,497  $17,599  $19,989   $2,763  $5,012 
                    

8. EARNINGS PER SHARE

8.EARNINGS PER SHARE

The calculation of the number of outstanding shares is as follows:

 

   

Three Months Ended

September 30, 2006

  

Three Months Ended

September 30, 2005

 
(in thousands, except per share amounts)  Income  Shares  

Per Share

Amount

  Income  Shares  

Per Share

Amount

 

Basic EPS:

            

Net income

  $9,376  32,138  $0.29  $8,271  33,549  $0.25 

Effect of dilutive securities:

            

Stock options

   —    102   0.00   —    816   (0.01)
                       

Diluted EPS:

            

Net income

  $9,376  32,240  $0.29  $8,271  34,365  $0.24 
                       

Antidilutive stock options *

    1,864      250  
              

   Nine Months Ended
September 30, 2006
  Nine Months Ended
September 30, 2005
 
(in thousands, except per share amounts)  Income  Shares  Per Share
Amount
  Income  Shares  Per Share
Amount
 

Basic EPS:

            

Net income

  $16,248  32,577  $0.50  $21,030  33,367  $0.63 

Effect of dilutive securities:

            

Stock options

   —    155   0.00   —    723   (0.01)
                       

Diluted EPS:

            

Net income

  $16,248  32,732  $0.50  $21,030  34,090  $0.62 
                       

Antidilutive stock options *

    1,818      263  
              

   Three months ended March 31,

(in thousands, except per share amounts)

  2007  2006

Basic shares outstanding

   31,508   32,796

Dilutive effect of stock options

   221   229
        

Diluted shares outstanding

   31,729   33,025
        

Antidilutive stock options*

   1,803   1,688
        

Net income

  $2,464  $5,201

Earnings per share:

    

Basic

  $0.08  $0.16

Diluted

  $0.08  $0.16

*Stock options not included in the calculation of diluted earnings per share for each respective period because they would be antidilutive.

9.STOCK REPURCHASE PROGRAM

In March 2005, the Company’s Board of Directors authorized the repurchase of up to $100 million of the Company’s common stock in open-market transactions at times and in such amounts as management deems appropriate depending on market conditions and other factors. The authorization expires on March 31, 2008 unless extended by the Board of Directors. The repurchase program does not obligate the Company to acquire any specific number of shares or acquire shares over any specified period of time. During the three and nine months ended September 30, 2006, the Company acquired 1,344,200 shares of common stock at an average price of $12.42 per share for a total cost of $16.7 million. During 2005, the Company acquired 830,700 shares of common stock at an average price of $18.82 per share for a total cost of $15.6 million.

 

10.INCOME TAXES

The Company’s effective tax rates for the three and nine months ended September 30, 2006 were 11.6% and 24.3%, respectively. The income tax provision for the three months ended September 30, 2006 includes a discrete $3.0 million net benefit related to the reduction of tax contingency reserves resulting from determination that certain statutory periods for the assessment of additional state income tax are now closed, and a discrete $0.2 million net increase related to adjustments of the 2005 tax provision to the final filed tax returns. The Company’s effective tax rates for the three and nine months ended September 30, 2005 were 34.5% and 35.1%, respectively.- 9 -


9. COMMITMENTS AND CONTINGENCIES

11.COMMITMENTS AND CONTINGENCIES

Legal Matters

We are involved in various claims, lawsuits and other proceedings from time to time. Such litigation involves uncertainty as to possible losses we may ultimately realize when one or more future events occur or fail to occur. We accrue and charge to income estimated losses from contingencies when it is probable that a liability hadhas been incurred and the amount of loss can be reasonably estimated. Differences between estimates recorded and actual amounts determined in subsequent periods are treated as changes in accounting estimates. The Company estimates the probability of losses on legal contingencies based on the advice of internal and external counsels, outcomes from similar litigation, the status of the lawsuits (including settlement initiatives), legislative developments, and other factors. Due to numerous variables associated with these judgments and assumptions, both the precision and reliability of the resulting estimates of the related loss contingencies are subject to substantial uncertainties. We regularly monitor our estimated exposure to these contingencies and, as additional information becomes known, may change our estimates significantly. A significant change in our estimates, or a result that materially differs from our estimates, could have a significant impact on our financial position, results of operations and cash flows.

In 2003, the Company sued Icon Health & Fitness, Inc. (“ICON”) in federal district court in Seattle, Washington for trademark infringement in connection with ICON’s use of the trademark “CrossBow” on exercise equipment. The District Court ruled in favor of the Company in July 2003 on a motion for preliminary injunction on the issue of trademark infringement and entered an order barring ICON from using the trademark “CrossBow” on any exercise equipment. That decision was subsequently affirmed by the Court of Appeals. A trial on the Company’s claims against ICON was pending in Seattle.

In November 2005, the Company proceeded to trial in Salt Lake City, Utah in a case filed by ICON Health & Fitness, Inc. (“ICON”) claiming false advertising involving the Company’s advertising and promotion going back to 1987 for certain elements of its Bowflex home gyms and claiming trademark infringement for the name placed on a treadmill belt sold in 2002. On November 15, 2005, the jury returned a verdict in favor of ICON in the amount of $7.8 million which the Court subsequently increased to $8.1 million. By an order dated April 21, 2006, the Court refusedThat case is on appeal to modify the amount of the jury verdict. The Company has filed a notice of appeal of this judgment and has posted the necessary bond with the Court for the appeal. The Company, based on discussion with its legal counsel, believes the verdict is inconsistent with the law and the evidence presented at trial. Further, the Company believes that the evidence does not support the damage award and thus the likelihood of loss is neither probable nor is the amount of potential loss estimable. Therefore, no accrual has been recorded by the Company.

In December 2002, the Company filed suit against ICON in the Federal District Court, Western District of Washington (the “District Court”) alleging infringement by ICON of the Company’s Bowflex patents and trademarks. The Company sought injunctive relief, monetary damages and its fees and costs. In October 2003, the District Court dismissed the patent infringement claims. The Company appealed the District Court’s decision to the United States Court of Appeals for the Federal Circuit (the “Appeals Court”) and in November 2003, the Appeals Court overruled the District Court and reinstated the patent infringement claims. In May 2005, the District Court again dismissed the patent infringement case against ICON. The Company appealed this case to the Appeals Court, which issued an order in August 2006 affirming the ruling of the District Court dismissing the patent infringement case.Appeals.

In July 2003, the District Court ruled in favor ofOn April 26, 2007, the Company on a motion for preliminary injunction onand ICON settled all outstanding claims between the issueparties in federal court in Salt Lake City, Utah, Seattle, Washington, and before the Federal Circuit Court of trademark infringement and entered an order barring ICON from using the trademark “CrossBow” on any exercise equipment. In its ruling, the District Court concluded thatAppeals. Both the Company showed “a probabilityand ICON will be filing dismissals of success ontheir respective lawsuits against each other. This settlement cleared the meritsprevious contingent liability claim of $8.1 million and irreparable injury” on its trademark infringement claim. In August 2003,ICON granted the Appeals Court granted ICON a temporary stay regardingCompany use of certain intellectual property for the motion for a preliminary injunction, which enjoined ICON from using the trademark “CrossBow.” This stay allowed ICON to continue using the trademark “CrossBow” until a decision was issued by the Appeals Court. In June 2004, the Appeals Court issued its decision

upholding the issuance of an injunctionCompany’s use in product development and preventing ICON from selling exercise equipment using the trademark “CrossBow” pending trial on the trademark issue. A trial date has been set for February 2007 in the District Court on this claim.enhancement.

In October 2006, the Company filed a complaint in the Superior Court for Clark County, Washington against Gately’s LLC (the “defendant”) seeking damages in the amount of $5.1 million plus interest, attorney’s fees and costs, for collection of outstanding accounts receivable for product purchased by the defendant. No trial dateGately’s. This case has been setdismissed and refiled by the Company in this matter.

There have been no other significant subsequent developments relatingstate court in Boulder County, Colorado. It is currently being litigated and is in the early stages of discovery. In its answer to the commitmentscomplaint, Gately’s has asserted defenses to payment and contingencies reportedcounterclaims against Nautilus in the Company’s most recent Annual Report on Form 10-K.an unspecified amount.

In addition to the matters described above, from time to time the Company is subject to litigation, claims and assessments that arise in the ordinary course of business, including disputes that may arise from intellectual property related matters. Many of our legal matters are covered in whole or in part by insurance. Management believes that any liability resulting from such matters will not have a material adverse effect on the Company’s financial position, results of operations, or cash flows.

Guarantees

From time to time,At times the Company arranges for commercial leases or other financing sources with third parties to enable certain of its commercial customers to purchase the Company’s commercial products. While most of these financing arrangements are without recourse, in certain cases the Company providesAs a guarantee or other recourse provisions to the independent finance company of all or a portion of the lease payments in order to facilitate the sale of the commercial products. In such situations, the Company ensures that the transaction between the independent leasing company and the commercial customer represents a sales-type lease. The Company monitors the payment status of the lessee under these arrangements and provides a reserve under SFAS No. 5,Accounting for Contingencies, in situations when collection of the lease payments is not probable. At September 30, 2006result, at March 31, 2007 and December 31, 2005,2006, the maximum contingent liability under all recourse and guarantee provisions was approximately $2.2$1.4 million and $4.1$1.6 million, respectively. At September 30, 2006,March 31, 2007, lease terms on outstanding commercial customer financing arrangements were between 3 and 5 years. A reserve for estimated losses under recourse provisions of approximately $0.1 million was recorded based on historical loss experience and iswas included in accrued expenses at both September 30, 2006March 31, 2007 and December 31, 2005. In accordance with FASB Interpretation No. 45,Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others, the Company has also recorded a liability and corresponding reduction of revenue for the estimated fair value of the Company’s guarantees issued during those periods. The fair value of the guarantees was determined based on the estimated risk premium a bank or similar institution would require in order to extend financing to a customer in the absence of a third-party guarantee. This liability is being reduced over the life of each respective guarantee. In most cases if the Company is required to fulfill its obligations under the guarantee, it has the right to repossess the products from the commercial customer. It is not practical to estimate the amount of proceeds that would be generated from the sale of these assets in such situations.2006.

The Company has an agreement with a financing company to provide second tier financing for its consumers. Under normal circumstances,Generally, funding for this reserve comes from a percentage of each sale held back by the financing company. In the event that the financing company experiences higher consumer default rates than specified under our contract, the Company will be required to pay an additional amount to the financing company. At September 30,March 31, 2007 and December 31, 2006, the Company accrued approximately $0.6$0.5 million and $0.3 million, respectively, for this liability.liability which is recorded as part of accrued liabilities.

Commitments

At September 30, 2006,March 31, 2007, the Company also had approximately $6.5$2.3 million in outstanding commercial letters of credit expiring between December 200631, 2007 and January 2007.2008.

 

12.REPORTABLE SEGMENTS

- 10 -


Given that the majority of the inventory is sourced from Asia, the Company has long lead times for inventory purchases and therefore needs to secure factory capacity from its vendors in advance. As a result, at March 31, 2007, the Company had approximately $40.3 million in purchase obligations most of which were for inventory purchases.

10. REPORTABLE SEGMENTS AND RELATED INFORMATION

The Company’s operating segments are evidence of the structure of the Company’s internal organization and are organized to allow focus on specific business opportunities in the Company’s worldwide market place. The Company’s three business segments are Fitness Equipment Business, International Equipment Business, and Fitness Apparel Business.

The Fitness Equipment Business is responsible for the design, production, marketing and selling of branded fitness equipment sold under the Nautilus, Bowflex, Schwinn Fitness and Stairmaster brand names and is responsible for servicing customers within the Americas, which includes the United States, Mexico, Canada and South America.

The International Equipment Business is responsible for the marketing and selling of branded fitness equipment sold under the Nautilus, Bowflex, Schwinn Fitness and Stairmaster brand names and is responsible for servicing customers outside of the Americas.

The Fitness Apparel Business is responsible for the design, production, marketing and selling of branded fitness apparel, footwear and accessory products sold primarily under the Pearl Izumi brand in both domestic and international markets.

The three business segments are supported by teams that provide services to support the entire entity including finance and reporting, legal, human resources and other centralized functions. Management does not allocate expenses from the centralized functions to the business segments. As a result, the business segments operating results are reviewed based on revenue and gross profit.

Net sales from external customers for the Company’s consolidated operations were as follows:

 

  Three Months Ended
September 30,
  Nine Months Ended
September 30,
  Three Months Ended
March 31,
(in thousands)  2006  2005  2006  2005  2007  2006

Fitness Equipment Business

  $128,257  $134,013  $389,176  $395,057  $120,400  $152,043

International Equipment Business

   14,584   14,160   43,002   39,085   16,573   13,514

Fitness Apparel Business

   16,742   15,135   50,007   15,135   21,866   19,433
                  

Net Sales

  $159,583  $163,308  $482,185  $449,277

Net sales

  $158,839  $184,990
                  

Gross profit from external customers for the Company’s consolidated operations was as follows:

 

  Three Months Ended
September 30,
  Nine Months Ended
September 30,
  Three Months Ended
March 31,
(in thousands)  2006  2005  2006  2005  2007  2006

Fitness Equipment Business

  $61,687  $61,647  $179,621  $189,186  $58,441  $67,609

International Equipment Business

   2,994   3,615   10,473   10,903   5,153   3,436

Fitness Apparel Business

   7,409   7,024   21,899   7,024   9,674   8,267
                  

Gross Profit

  $72,090  $72,286  $211,993  $207,113

Gross profit

  $73,268  $79,312
                  

AssetsTotal assets from the Company’s three operating segments were as follows:

 

(in thousands)  September 30,
2006
  December 31,
2005
  March 31,
2007
  

December 31,

2006

Fitness Equipment Business

  $262,648  $304,033  $267,812  $298,459

International Equipment Business

   32,274   31,034   36,459   37,052

Fitness Apparel Business

   86,653   78,219   95,573   89,431
            
  $381,575  $413,286  $399,844  $424,942
            

- 11 -


11. PURCHASE OPTION AGREEMENTS

On February 1, 2007, the Company entered into purchase option agreements to acquire substantially all of the assets of its manufacturing partner, Land America Health and Fitness Co., LTD, an enterprise organized under the laws of the Peoples Republic of China, and a related trading company, Treuriver Investments Limited, an enterprise organized under the laws of the British Virgin Islands. The Company has paid a non-refundable $6.0 million option fee that will be applied to the purchase price if the option is exercised and the asset purchase is completed. The purchase options are exercisable through June 30, 2007 to allow the Company time to complete necessary due diligence. The total purchase price for the assets is approximately $72 million in cash and stock, adjusted for the amounts of fixed assets and inventory held on the closing date, with an anticipated closing date of December 31, 2007. The Company also has a formal supplier relationship with the sellers that guarantees certain volumes and pricing for products and provides a rebate program.

12. IMPLEMENTATION OF FIN 48

The Company adopted the provisions of FIN 48 –Accounting for Uncertainty in Income Taxes – an interpretation of FASB Statement No. 109,on January 1, 2007. As a result of the implementation of FIN 48, the Company made a comprehensive review of its portfolio of uncertain tax positions in accordance with recognition standards established by FIN 48. In this regard, an uncertain tax position represents the Company’s expected treatment of a tax position taken in a filed tax return, or planned to be taken in a future tax return, that has not been reflected in measuring income tax expense for financial reporting purposes. As a result of this review, the Company adjusted the estimated value of its uncertain tax positions by recognizing additional liabilities totaling $1.3 million through a charge to retained earnings. Upon the adoption of FIN 48, the estimated value of the Company’s uncertain tax positions is a liability of $3.2 million resulting from unrecognized tax benefits. If the Company’s positions are sustained by the taxing authority in favor of the Company, approximately $2.6 million would reduce the Company’s effective tax rate.

The Company believes it is reasonably possible that, within the next 12 months, $1.1 million of previously unrecognized tax benefits related to domestic filing positions, of which $0.8 million would reduce the Company’s effective tax rate, will be recorded primarily as a result of the expiration of federal and state statutes of limitation.

The Company recognizes accrued interest and penalties related to uncertain tax positions in federal, state, and foreign income tax expense. As of January 1, 2007, the Company had accrued approximately $0.8 million for the payment of tax-related interest and penalties.

The Company’s federal income tax returns for 2003 through 2006 are open tax years. The Company’s unrecognized state tax benefits are related to state returns open from 2000 through 2006 depending on each state’s statute of limitation. In addition, the Company files in numerous foreign jurisdictions with varying statutes of limitation.

As of March 31, 2007, there have been no material changes to the liability for uncertain tax positions.

- 12 -


Item 2.Management’s Discussion and Analysis of Financial Condition and Results of Operations

FORWARD-LOOKING STATEMENTS

Certain statements contained in thisThis Form 10-Q contains forward-looking statements. Forward-looking statements include any statements related to our expectations regarding future performance or conditions, including without limitation,any statements containing the words “could,” “may,” “will,” “should,” “plan,” “believes,” “anticipates,” “estimates,” “predicts,” “expects,” “projections,” “potential,” “continue,”regarding anticipated sales growth across markets, distribution channels, and wordsproduct categories, expenses and gross margins, expense as a percentage of similar import, constitute “forward-looking statements.” Investors are cautioned that allrevenue, anticipated earnings, new product introductions, acquisition of manufacturing operations in Asia, future capital expenditures, financing and working capital requirements and resources. These forward-looking statements, involveand others we make from time to time, are subject to a number of risks and uncertainties, and variousuncertainties. Many factors could cause actual results to differ materially from those projected in the forward-looking statements. From time to time and in this Form 10-Q, we may make forward-looking statements, relating to our financial performance, including the following:

Anticipated revenues, expenses and gross margins

Seasonal patterns

Expense as a percentage of revenue

Anticipated earnings

New product introductions, and

Future capital expenditures.

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

The availability of media time and fluctuating advertising rates

A decline in consumer spending due to unfavorable economic conditions including high fuel and energy costs, as well as increasing interest rates

Our ability to effectively develop, manufacture, market and sell future products

Our ability to get foreign sourced products through customs in a timely manner

Our ability to effectively identify and negotiate any future strategic acquisitions

Our ability to integrate any acquired businesses into our operations

Our ability to adequately protect our intellectual property

Introduction of lower priced competing products

Unpredictable events and circumstances relating to our international operations, including our use of foreign manufacturers

Unpredictable changes in exchange rates of foreign currencies and the market cost of key commodities such as steel

Government regulatory action, and

Our ability to retain key employees.

We describe certain of these and other key risk factors elsewhere in more detail in this Form 10-Q andrisks described in our most recent Annual Report on Form 10-K. Although we believe the expectations reflected in theWe do not undertake any duty to update forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance, or achievements. Except to the extent required by the federal securities laws, 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-Qthey are made or to reflect the occurrence of unanticipated events.conform them to actual results or to changes in circumstances or expectations.

This Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MDOperation (the “MD&A”) should be read in conjunction with our Interim Consolidated Financial Statementsconsolidated financial statements and related notes included elsewhere inlocated at Item 1 of this report as well as with the MD&A in our most recent Annual Report on Form 10-K.10-Q. 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 that operate in evolving markets. We may not be able to successfully address these risks and difficulties and, consequently, we cannot assure you of any future growth or profitability.

OVERVIEW

Nautilus, Inc. (“we,” “us,” “our” or “Company”) is a leading marketer, developer and manufacturer of branded health and fitness products sold under well-known names such as Nautilus, Bowflex, Schwinn Fitness, StairMaster and Pearl Izumi. Our products are distributed through diversified direct, retail and commercial sales channels, both domestically and internationally. We market and sell a variety of branded products that are targeted at specific locations where people shop or exercise. Nautilus, StairMaster and Pearl Izumi brands are most commonly marketed through the commercial and high-end specialty retail markets, while the Bowflex and

Schwinn Fitness branded products are marketed primarily through retail and direct sales channels. Our product marketing includes direct response marketing utilizing a combination of television commercials, infomercials, response mailings, the Internet, catalog, and inbound/outbound call centers to sell our products directly to customers. It also includes a sales force and dealer network marketing to retail organizations, health clubs, government agencies, hotels, corporate fitness centers, colleges, universities and assisted living facilities worldwide.

Summary of the Third Quarter 2006 ResultsSUMMARY OF THE FIRST QUARTER 2007 RESULTS

Net sales for the thirdfirst quarter of 20062007 were $159.6$158.8 million, compared to $163.3$185.0 million in the same quarter of 2005,2006, a decrease of $3.7$26.2 million or 2.3%14.1%. The decrease is primarilyDuring the resultquarter we experienced a slowdown in the North American market for home fitness equipment, which resulted in reduced sales in both our retail and direct channel by 45.2% and 11.7%, respectively. While consumer trends attributed to a significant decline in our retail and direct channel sales we also continue to add visibility of greater visibility provided by our new information system allowingcustomer, channel and product level detail that has allowed us to better analyze our sales and margin information by customer, channel, brand and product.information. As a result, we have restructured some ofcontinue to evaluate our relationships with existing customers and have discontinued certain less profitable product offerings and limited offerings of products to certain channels to improve profitability. Additionally, seasonal purchase patterns by retailers with more purchases moving into the last quarter of the current year further contributedoverall profitability and to a decline in net sales. reduce channel conflict.

Gross profit margin increasedimproved to 45.2%46.1% in the thirdfirst quarter of 20062007 compared to 44.3%42.9% in the same quarter of 20052006 as a result of continuing improvements in our operational and manufacturing efficiency, our ability to reduce warranty costs by recovering a portion of such costs from our suppliers, and reducing cost of our internationally sourced products.

Quarterly operating income declined to $11.1$4.6 million or 7.0%2.9% of net sales compared to $12.5$8.7 million or 7.7%4.7% of net sales in the third quartersame period of 2005. During the third quarter of 2006, the Company recorded a $3.0 million reduction of tax contingency reserves2006. Operating expenses as a resultpercentage of closing of certain statutory periods and $0.7 million of equity compensation expense; theresales were no similar items in the corresponding quarter of 2005. Diluted earnings per share for the quarter were 29 cents, compared to 24 cents a year ago.

CRITICAL ACCOUNTING ESTIMATES AND ASSUMPTIONS

The preparation of financial statements in conformity with U.S. GAAP requires estimates and assumptions that affect the reported amounts of assets and liabilities, revenues and expenses, and related disclosures of contingent assets and liabilities in the consolidated financial statements. As described by the Securities and Exchange Commission, critical accounting estimates and assumptions are those that may be material500 basis points higher primarily due to the levelsrevenue shortfall. Operating expenses decreased $2.0 million, or 2.9%, from the year ago quarter. The increase in operating expenses as a percentage of subjectivity and judgment necessary to account for highly uncertain matters or the susceptibility of such matters to change, and that have a material impact on the financial condition or operating performance of the company. There were no changes to our critical accounting estimates and assumptionssales was mostly reflected in the threeselling and nine month periods ended September 30, 2006. Refermarketing expense where we incurred incremental expense related to our most recent Annual Report on Form 10-K for a complete description of our critical accounting estimates and assumptions.new advertising creative costs.

- 13 -


RESULTS OF OPERATIONS FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2005MARCH 31, 2007 AND 2006

The following tables present certain consolidated financial data as a percentage of net sales and statement of income data comparing results for the three months ended September 30, 2006March 31, 2007 and 2005:

Statement of Income Data

(In thousands)2006:

 

  Three Months Ended September 30,   Three Months Ended March 31, 
  2006 

% of

net sales

 2005  

% of

net sales

 $ change 

%

change

 

(in thousands)

  2007 

% of

net sales

 2006 

% of

net sales

 $ change 

%

change

 

Net sales

  $159,583  100.0% $163,308  100.0% $(3,725) (2.3%)  $158,839  100.0% $184,990  100.0% $(26,151) (14.1)%

Cost of sales

   87,493  54.8%  91,022  55.7%  (3,529) (3.9%)   85,571  53.9%  105,678  57.1%  (20,107) (19.0)%
                          

Gross profit

   72,090  45.2%  72,286  44.3%  (196) (0.3%)   73,268  46.1%  79,312  42.9%  (6,044) (7.6)%

Operating expenses:

               

Selling and marketing

   42,621  26.7%  44,526  27.3%  (1,905) (4.3%)   50,776  32.0%  52,154  28.2%  (1,378) (2.6)%

General and administrative

   14,507  9.1%  11,146  6.8%  3,361  30.2%   13,323  8.4%  13,650  7.4%  (327) (2.4)%

Research and development

   2,521  1.6%  2,856  1.7%  (335) (11.7%)   3,215  2.0%  3,268  1.8%  (53) (1.6)%

Royalties

   1,296  0.8%  1,297  0.8%  (1) (0.1%)   1,319  0.8%  1,579  0.9%  (260) (16.5)%
                          

Total operating expenses

   60,945  38.2%  59,825  36.6%  1,120  1.9%   68,633  43.2%  70,651  38.2%  (2,018) (2.9)%
                          

Operating income

   11,145  7.0%  12,461  7.7%  (1,316) (10.6%)   4,635  2.9%  8,661  4.7%  (4,026) (46.5)%

Other Income (Expense):

               

Interest income (expense), net

   (537) (0.3%)  145  0.1%  (682) (470.3%)

Other income (expense), net

   (2) 0.0%  31  0.0%  (33) (106.5%)

Interest income

   75  0.0%  138  0.1%  (63) (45.7)%

Interest expense

   (941) (0.6)%  (589) (0.3)%  (352) 59.8%

Other income, net

   252  0.2%  15  0.0%  237  1580.0%
                          

Total other income (expense)

   (539) (0.3%)  176  0.1%  (715) (406.3%)

Total other expense

   (614) (0.4)%  (436) (0.2)%  (178) 40.8%
                          

Income before income taxes

   10,606  6.7%  12,637  7.8%  (2,031) (16.1%)   4,021  2.5%  8,225  4.4%  (4,204) (51.1)%

Income tax expense

   1,230  0.8%  4,366  2.7%  (3,136) (71.8%)   1,557  1.0%  3,024  1.6%  (1,467) (48.5)%
                          

Net income

  $9,376  5.9% $8,271  5.1% $1,105  13.4%  $2,464  1.6% $5,201  2.8% $(2,737) (52.6)%
                          

Net Sales

Fitness Equipment Business

- The fitness equipment business designs, produces, markets and sells fitness products sold under the Nautilus, Bowflex, Schwinn Fitness, and StairMaster brand names. Depending on the brand, our fitness equipment is marketed and sold through the direct, commercial, and retail channels of distribution located in the Americas, which includes the U.S., Canada, Mexico and South America. Total net sales for the Fitness Equipment Business were $128.3$120.4 million in the thirdfirst quarter of 20062007 compared to $134.0$152.1 million in the same period of 2005,2006, a decrease of $5.7$31.7 million or 4.3%20.8%. The decrease is primarily attributed to reduced sales in the North American market for home fitness equipment. In addition, the decrease is also a result of our strategyanalysis by customer, channel and product that resulted in exiting certain customer relationships along with discontinuing less profitable SKU offerings of products to certain channels in order to improve profitability by refining or eliminating certain of our customer relationships, sloweroverall profitability. Specific channel net sales duringinformation is detailed below:

In the quarter as a result of seasonal purchase patterns by retailers with more purchases moving into the last quarter of the current year, discontinuation of less profitable product offerings, and decreased advertising.

Net sales from the commercial channel, were $17.9 net sales remained relatively flat at $18.2 million in the thirdfirst quarter of 2006 compared to $18.2$18.0 million in the same period of 2005. Commercial sales include sales2006. Sales in this channel primarily constitute those to commercial dealers, health clubs, hotels and living complexes. We experienced increasing demand for our commercial grade TreadClimber, which was offset by a decline in weight stack sales. The decreaseTreadClimber product overcame initial quality issues in 2006 and it has now become a strong selling product for our commercial net salescustomers. In addition, the Company introduced product enhancements on the Nautilus brand commercial bikes during the last half of 2006. During the most recent International Health, Racquet and Sports Club Association commercial show, which was held the last three days of the quarter, we received strong support for our commercial grade TreadClimber and our new recumbent bikes, as well as for our new Nautilus One strength line that is primarily dueexpected to price increases and renegotiation of less profitable volume terms with our dealers to increase profitability.

Net sales from the specialty retail channel were $15.9 millionbegin shipping in the third quarter of 2007. As previously disclosed, we made a financial decision during 2006 to renegotiate terms and discounts with some of our commercial dealers in order to increase overall profitability within the channel. As a result of these negotiations we have realized a reduction in commercial dealer sales volumes.

In theretail channel, net sales decreased to $27.6 million as compared to $17.8$50.4 million last year, or 45.2%. Sales in the same period of 2005, a decrease of $1.9 million or 10.7%. Specialty retail sales include salesthis channel are primarily to various sporting good stores, warehouse clubs, department stores, fitness retail stores and independent bicycle dealers that typically sell health club-quality equipment to the end consumer for home and small business use. The decreasedecline in specialty net salesthis channel is primarilymainly due to slowersoftness in the consumer retail market for home fitness equipment. The home fitness market softness in the first quarter led to lower sales during as our retail partners carried existing inventory through

- 14 -


the quarter as a result of seasonal purchase patterns by retailers with more purchases moving into the last quarter of the current year.

Net sales from the retail channel, which include sales to sporting good stores, warehouse clubs, and department stores, were $27.1 million in the third quarter of 2006 compared to $29.7 in the same period of 2005, a decrease of $2.6 million or 8.8%.did not make expected significant additional purchases. The decrease in retail net sales is primarily duealso attributable to our strategy to discontinue less profitable product offerings and refiningrefine or eliminationeliminate of some customer relationships to improve overall channel profitability.

In thedirect channel, net sales declined 11.7% to $73.9 million compared to $83.7 million last year. Sales in the direct channel consist of our Bowflex branded products and primarily include our rod-based home gyms, TreadClimber products, SelectTech dumbbells, and the Bowflex Revolution. The overall decrease in net sales was slightly offset by additional net salesis due to launching the Bowflex Blaze product during the quarter.

Net sales from the direct channel were $67.1 milliona combination of reduced advertising earlier in the third quarter as a result of 2006 comparedincreased competition for media space and lower conversion rates due to $68.3 millionthe slow-down in the same period of 2005, a decrease of $1.2 million or 1.8%. The direct channel includes internet sales, catalog salesNorth American market for home fitness equipment. Sales increases in our Bowflex TreadClimber and sales from direct response advertising. During the current quarter, we increased our media support for our new generation of Bowflex home gyms, the Bowflex Revolution which was launchedwere offset by softness in July of 2005, and decreased the amount of advertising spent on our rod basedrod-based home gyms.

International Equipment Business

Net sales from the International Equipment Business were $14.6$16.6 million in the thirdfirst quarter of 20062007 compared to $14.2$13.5 million in the same period of 2005,2006, an increase of $0.4$3.1 million or 2.8%23.0%. The International Equipment Business represents sales outside of the Americas and includesconsists primarily of commercial sales, with increasingand retail and initial direct marketing sales. The increase in net sales is mainly due to expansion of the commercial and retail channels in Germany andInternational Distributor business, expansion of the commercial sales channel in Italy.the four West European subsidiaries, and some currency translation benefit from a weaker U.S. dollar.

Fitness Apparel Business

Net sales from the Fitness Apparel Business were $16.7$21.9 million in the thirdfirst quarter of 20062007 compared to $15.1$19.4 million in the same period of 2005,2006, an increase of $1.6$2.5 million or 10.6%12.9%. The Fitness Apparel Business was created in July 2005 with the Company’s acquisition of Pearl Izumi. The Fitness Apparel Business sells high quality fitness apparel and footwear for cyclists, runners and fitness enthusiasts. The revenue stream of the Fitness Apparel Business is generally seasonal with the first and third quarters having the highest sales and the second and fourth quarters having lower sales. Much of this is related to the timing of when our customers purchase inventory to stock their shelves. The increase in net sales is primarily due to strongincreasing net sales of theour core Pearl Izumi cycling and running apparel and cycling footwear products within the domestic net sales increasing approximately $0.5 million,market and in the international direct and distributor net sales contributing approximately $0.6 million and $0.3 million, respectively.markets.

Gross Profit

As a result of lower net sales, total gross profit was $72.1$73.3 million in the thirdfirst quarter of 20062007 compared to $72.3$79.3 million in the same period of 2005,2006, a decrease of $0.2$6.0 million or 0.3%7.6%. As a percentage of net sales, gross profit marginsmargin increased to 45.2%46.1% in the thirdfirst quarter of 20062007 compared to 44.3%42.9% in the comparable period of 2005.2006. The increase is the result of increased financial visibility as provided by our new information system, which allows us to better analyze our relationships with existing customers resulting in sales to more profitable customers. Additionally, we have been able to offset our warranty costs by recovering a portion of such costs from our suppliers. Further, as a result of procurement purchasing power, improving our operating efficiencies and sustaining engineering efforts we realizedhave continued to focus on reducing the cost reductions forof our sourced products sourced internationally.from our Asian manufacturers.

Fitness Equipment Business

Gross profit for the Fitness Equipment Business remained unchanged at $61.7decreased primarily as a result of lower sales to $58.4 million in the thirdfirst quarter of 20062007 compared to $61.6$67.6 million in the same period of 2005.2006. As a percentage of net sales, gross profit margins increased to 48.1%48.5% in the thirdfirst quarter of 20062007 compared to 46.0%44.5% in the comparable period of 2005, an increase of 2.1%. The increase in the2006. Factors affecting gross profit margin is attributable toimprovement included a reduction of our ability to reduce warranty costs by recoveringdue to an overall improvement in quality, and through the recovery of a portion of suchwarranty costs from our suppliers. We have alsoAsian manufacturers. In addition, we realized reductions of the actual cost reductions forof our sourced products sourced internationally whichthrough various sustained engineering efforts and continued vendor contract negotiations as we seek strong partnerships with fewer vendors. These cost savings were offset slightly by a continuingan increase in freight expenses due to high fuel prices.costs and changes in both the sales channel and product sales mix within the product categories.

International Equipment Business

Gross profit for the International Equipment Business was $3.0$5.2 million in the thirdfirst quarter of 20062007 compared to $3.6$3.4 million in the same period of 2005, a decrease2006, an increase of $0.6$1.8 million or 16.7%52.9%. As a percentage of net sales, gross profit margin was 20.5%31.1% in the thirdfirst quarter of 20062007 compared to 25.4% in the comparable period of 2005.2006. The decreaseincrease in gross profit is the result of clearing out older cardio products at discounted prices.primarily attributed to higher sales volume and product mix.

Fitness Apparel Business

Gross profit for the Fitness Apparel Business was $7.4$9.7 million in the thirdfirst quarter of 20062007 compared to $7.0$8.3 million in the same period of 2005,2006, an increase of $0.4$1.4 million or 5.7%16.9%. As a percentage of net sales, gross profit margin decreasedincreased to 44.3%44.2% in the thirdfirst quarter of 20062007 compared to 46.4%42.5% in the comparable period of 2005, a decrease of 2.1%.2006. The decreaseincrease in the profit margin is due to the mix of products offeredsold by the Fitness Apparel Business and a larger portion of sales coming fromimproved profit margins in the international direct and distributor markets which have lower profit margins.business.

- 15 -


Operating Expenses

Selling and Marketing

Selling and marketing expenses were $42.6$50.8 million in the thirdfirst quarter of 20062007 compared to $44.5$52.2 million in the same period of 2005,2006, a decrease of $1.9$1.4 million or 4.3%2.6%. The decrease is primarily due to a reduction of discretionary amounts spent onthe reduced sales volume offset by additional creative marketing costs.production costs in our direct channel advertising, incremental commission’s expense related to our new affiliate sales program, and additional expenditures to continue to enhance our corporate and product websites.

General and Administrative

General and administrative expenses were $14.5$13.3 million in the thirdfirst quarter of 20062007 compared to $11.1$13.7 million in the same period of 2005, an increase2006, a decrease of $3.4$0.4 million or 30.2%2.4%. As a percentage of net sales, general and administrative expenses were 9.1%8.4% in the thirdfirst quarter of 20062007 compared to 6.8%7.4% in the same period of 2005.2006. The increasedecrease in expense is primarily due to expenses relating to our new ERP system that was implemented in the third quarter of 2005,continued cost savings across departments and reduced legal costs, additional depreciation and rent for our new corporate headquarters which we occupied late in the third quarter of 2005, and stock-based compensation expense resulting from the adoption of SFAS 123(R).costs.

Research and Development

Research and development expenses were $2.5$3.2 million in the thirdfirst quarter of 20062007 compared to $2.9$3.3 million in the same period of 2005,2006, a decrease of $0.3$0.1 million or 11.7%1.6%. As a percentage of net sales, research and development expenses were 1.6%2.0% in the thirdfirst quarter of 20062007 compared to 1.7%1.8% in the same period of 2005.2006. The slight decrease in expense is due to a reduced headcount as we aligned our research and development to support our current pace of product innovation.innovation, offset slightly by incremental expense associated with our new partnership with the National Association of Sports Medicine (“NASM”).

Royalties

Royalty expenses were $1.3 million in the thirdfirst quarter of both 2006 and 2005.

Interest income (expense), net

Net interest expense increased to $0.5 million in the third quarter of 20062007 compared to interest income of $0.1$1.6 million in the same period of 2005.2006. We have several agreements, which we are obligated to pay royalty fees on certain product sales. The decrease in our royalty expense is primarily a result of the purchase of a patent portfolio after which certain product sales no longer have associated royalties applicable to those patents, partially offset by an increase in sales volumes related to our Bowflex Revolution and TreadClimber.

Other Income (Expense)

Interest expense

Interest expense increased to $0.9 million in the first quarter of 2007 compared to interest expense of $0.6 million in the same period of 2006. The increase in interest expense is due to the increased average short-term borrowings outstanding during the thirdfirst quarter of 2007 as compared to 2006. The Company did not have such borrowings

Other income (expense), net

Net other income increased to $252,000 in the comparablefirst quarter of 2007 from $15,000 in the same period of 2005.2006 primarily due to additional foreign currency gains realized in the first quarter of 2007.

Income Tax Expense

IncomeThe provision for income tax expense was approximately $1.2$1.6 million in the thirdfirst quarter of 20062007 compared to $4.4$3.0 million in the same period of 2005,2006, a decrease of $3.1$1.4 million or 71.8%. Our effective tax rate for the third quarter of 2006 was 11.6% compared to 34.5% in the same period of 2005. The decrease in the effective tax rate is primarily due to a $3.0 million reduction of tax contingency reserves resulting from our determination that certain statutory periods for the assessment of additional state income tax are now closed.

RESULTS OF OPERATIONS FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2006 AND 2005

The following tables present certain consolidated financial data as a percentage of net sales and statement of income data comparing results for the nine months ended 2006 and 2005:

Statement of Income Data

(In thousands)

   Nine Months Ended September 30, 
   2006  

% of

net sales

  2005  

% of

net sales

  $ change  

%

change

 

Net sales

  $482,185  100.0% $449,277  100.0% $32,908  7.3%

Cost of sales

   270,192  56.0%  242,164  53.9%  28,028  11.6%
                

Gross profit

   211,993  44.0%  207,113  46.1%  4,880  2.4%

Operating expenses:

        

Selling and marketing

   137,887  28.6%  129,425  28.8%  8,462  6.5%

General and administrative

   40,399  8.4%  34,567  7.7%  5,832  16.9%

Research and development

   8,321  1.7%  8,768  2.0%  (447) (5.1%)

Royalties

   3,991  0.8%  3,952  0.9%  39  1.0%
                

Total operating expenses

   190,598  39.5%  176,712  39.4%  13,866  7.9%
                

Operating income

   21,395  4.4%  30,401  6.7%  (9,006) (29.6%)

Other income (expense):

        

Interest income (expense), net

   (1,152) (0.2%)  1,460  0.3%  (2,612) (178.9%)

Other income, net

   1,220  0.3%  542  0.1%  678  125.1%
                

Total other income (expense)

   68  0.1%  2,002  0.4%  (1,934) (96.6%)
                

Income before income taxes

   21,463  4.5%  32,403  7.1%  (10,940) (33.8%)

Income tax expense

   5,215  1.1%  11,373  2.5%  (6,158) (54.1%)
                

Net income

  $16,248  3.4% $21,030  4.6% $(4,782) (22.7%)
                

Net Sales

Net sales were $482.2 million for the first nine months of 2006 compared to $449.3 million in the same period of 2005, an increase of $32.9 million or 7.3%. The increase is attributable to the acquisition of the Fitness Apparel Business in the third quarter of 2005 which contributed approximately $50.0 million of net sales in the first nine month period ended September 30, 2006 compared to $15.1 million in the same period of 2005.

Fitness Equipment Business

Net sales for the Fitness Equipment Business were $389.2 million for the first nine months of 2006 compared to $395.1 million in the same period of 2005, a decrease of $5.9 million or 1.5% primarily due to lower net sales in the direct channel and discontinuation of less profitable product offerings.

Net sales from the commercial channel were $52.1 million for the first nine months of 2006 compared to $53.1 million for the same period of 2005, a decrease of $1.0 million or 1.9%. The decrease in net sales is the result of greater visibility provided by our new information system which allows us to refine our relationships with existing customers and to identify less profitable product offerings which we discontinued to improve profitability.

Net sales from the specialty retail channel were $53.7 million for the first nine months of 2006 compared to $52.8 million for the same period of 2005, an increase of $0.9 million or 1.7%. The increase in net sales is primarily due to gaining additional customers and expanding the number of products offered at existing dealers.

Retail net sales were $72.2 million for the first nine months of 2006 compared to $66.8 million for the same period of 2005, an increase of $5.4 million or 8.1%. The increase is due to gaining additional customers, introduction of new product offerings within our Schwinn Fitness line of cardio equipment, and launching the Bowflex Blaze product in the third quarter of 2006.

Net sales from the direct channel were $211.0 million for the first nine months of 2006 compared to $222.3 million for the same period of 2005, a decrease of $11.3 million or 5.1%. The decrease is due to a combination of reduced advertising in the second quarter of 2006 as a result of increased competition for media space, lower conversion rates as consumer confidence was negatively affected by higher interest rates and fuel prices, and a decrease in sales of our Bowflex rod based technology home gyms as a result of the introduction of a new generation of Bowflex home gyms, the Bowflex Revolution.

International Equipment Business

Net sales from the International Equipment Business were $43.0 million for the first nine months of 2006 compared to $39.1 million for the same period of 2005, an increase of $3.9 million or 10.0%. The increase is due to net sales from the addition of new retail distributors, including expansion of our commercial and retail channels in China, and increased sales in Sweden, Germany, India, Russia and the Benelux countries.

Fitness Apparel Business

Net sales from the Fitness Apparel Business were $50.0 million for the first nine months of 2006 compared to $15.1 million in the same period of 2005, an increase of $34.9 million. The Fitness Apparel Business was created in July 2005 with the Company’s acquisition of Pearl Izumi.

Gross Profit

Gross profit was $212.0 million for the first nine months of 2006 compared to $207.1 million in the same period of 2005, an increase of $4.9 million or 2.4%. The increase is primarily attributable to the full integration of the Fitness Apparel Business acquired in the third quarter of 2005. As a percentage of net sales, gross profit margin decreased to 44.0% in the first nine months of 2006 compared to 46.1% in the comparable period of 2005. The decrease is a result of lower direct channel sales which generally have a higher margin than sales in our other channels, and the addition of the Fitness Apparel Business which had a gross profit margin of 43.8% for the first nine months of 2006.

Fitness Equipment Business

Gross profit for the Fitness Equipment Business was $179.6 million for the first nine months of 2006 compared to $189.2 million for the same period of 2005, a decrease of $9.6 million or 5.1%. As a percentage of net sales, the gross profit margin was 46.1% in the first nine months of 2006 compared to 47.9% in the comparable period of 2005. The decrease in the gross profit margin as a percent of net sales is primarily due to changing channel and product mix and increased freight costs experienced in the first nine months of the current year, offset by reduced warranty costs as a result of recovering a portion of such costs from suppliers and reducing the cost of our sourced products. In addition, the gross profit margin decreased as a result of lower margins realized in the direct channel and the higher margin direct channel representing a smaller percentage of total sales. The direct channel represented approximately 54.2% of net sales during the first nine months of 2006 compared to 56.3% of net sales in the same period of the prior year.

International Equipment Business

Gross profit for the International Equipment Business was $10.5 million for the first nine months of 2006 compared to $10.9 million for the same period of 2005, a decrease of $0.4 million or 3.7%. As a percentage of net sales, the gross profit margin was 24.4% in the first nine months of 2006 compared to 27.9% for the same period of 2005. The decrease in the profit margin is a result of competitive pressures in Europe, increases in freight costs, and clearing out both our older cardio products at discounted prices.

Fitness Apparel Business

Gross profit for the Fitness Apparel Business was $21.9 million for the first nine months of 2006 with a gross profit margin of 43.8% compared to $7.0 million and 46.4%, respectively, during the same period of 2005. The Fitness Apparel Business was acquired in the third quarter of 2005. The decrease in the profit margin is due to the mix of products offered by the Fitness Apparel Business and a larger portion of sales coming from the international direct and distributor markets which have lower profit margins.

Operating Expenses

Selling and Marketing

Selling and marketing expenses were $137.9 million for the first nine months of 2006 compared to $129.4 million for the same period of 2005, an increase of $8.5 million or 6.5%. The increase is primarily due to including operating results of two acquisitions made in 2005.

General and Administrative

General and administrative expenses were $40.4 million for the first nine months of 2006 compared to $34.6 million for the same period of 2005, an increase of $5.8 million or 16.9%. As a percentage of net sales, general and administrative expenses were 8.4% in the first nine months of 2006 compared to 7.7% in the same period of 2005. The increase is due to inclusion of expenses of our

acquired businesses in 2005, expenses relating to our new ERP system that was implemented in the third quarter of 2005, legal costs, additional depreciation and rent for our new corporate headquarters which we occupied late in the third quarter of 2005, and stock-based compensation expense resulting from the adoption of SFAS 123(R).

Research and Development

Research and development expenses were approximately $8.3 million for the first nine months of 2006 compared to approximately $8.8 million for the same period of 2005, a decrease of approximately $0.4 million or 5.1%. The slight decrease is due to a reduced headcount as we aligned our research and development to support our current pace of product innovation.

Royalties

Royalty expenses remained unchanged for the first nine months of 2006 and 2005 at $4.0 million in each of the periods.

Interest and other income (expense), net

Net interest expense increased to $1.2 million in the first nine months of 2006 compared to net interest income of $1.5 million in the same period of 2005. The increase in expense is due to an average balance of short-term borrowings outstanding during 2006; the Company was in a cash investment position during the same period of 2005.

Net other income increased to $1.2 million in the first nine months of 2006 from $0.5 million in the comparable period of 2005. The increase is due to additional foreign currency gains realized by the Company in the second quarter of 2006.

Income Tax Expense

Income tax expense was approximately $5.2 million for the first nine months of 2006 compared to $11.4 million in the same period of 2005, a decrease of $6.2 million or 54.1%46.7%. Our effective tax rate for the first nine monthsquarter of 20062007 was 24.3%38.7% compared to 35.1%36.8% in 2005.the same period of 2006. The decreaseincrease in the effective tax rate iswas primarily due to a $3.0 million reduction of tax contingency reserves resulting from our determination that certain statutory periods for the assessment of additional state income tax are now closed. Including this and an additional expected tax reserve reversal of $0.8 million in the fourth quarter, we expect our 2006 effective tax rate be 28.5%, returning to 37% in fiscal 2007.discrete items.

LIQUIDITY AND CAPITAL RESOURCES

During the first ninethree months of 2006,2007, our operating activities generated $36.7$15.8 million in net cash compared to $6.7$30.0 million in the same period of the prior year. The improvementdecline from the prior year was primarily the result of a decreaseincreased cash collections on our trade receivables offset by an increase in inventories as the Company focused on improving its forecasting and distribution processes.inventory.

Net cash used in investing activities was approximately $9.9$2.7 million in the first ninethree months of 20062007 compared to $8.8cash provided by investing activities of $4.0 million in the same period of 2005. Capital expenditures were2006. The change is primarily due to cash proceeds of approximately $8.4 million in the first nine months of 2006 compared to $23.2 million in the same period of 2005. Capital expenditures during the first nine months of 2006 consisted of manufacturing equipment, website development costs to support our innovative product offerings, and computer equipment to maintain and expand current information systems for future growth. We have also purchased an intellectual property package for $5.8 million. Further, the Company collected $6.1 million from the sale of our former headquarters building located in Vancouver, Washington.Washington in the first three months of 2006.

- 16 -


Net cash used in financing activities was $32.9$12.7 million in the first ninethree months of 20062007 compared to $9.1$32.4 million in the same period of the prior year. The increasedecrease was primarily due to the Company’s stock repurchases of $16.7 million and paying down its short and long-term borrowings by $7.0 million.lower net payments on short-term borrowings.

We believe our existing cash and cash equivalents, cash generated from operations and borrowings available under our credit facilities will be sufficient to meet our capital requirements in the foreseeable future.

OFF-BALANCE SHEET ARRANGEMENTS

FromAs described in notes to the consolidated financial statements in our most recent Annual Report on Form 10-K, from time to time, we arrange for leases or other financing sources with third parties to enable certain of our commercial customers to purchase our commercial products. While most of these financings are without recourse, in certain cases we may offer a guarantee or other recourse provisions. The purpose of these guarantees is to increase our selling opportunities to commercial customers that would not otherwise be able to obtain affordable financing to purchase our commercial products. At September 30, 2006March 31, 2007 and December 31, 2005,2006, the maximum contingent liability under all recourse provisions was approximately $2.2$1.4 million and $4.1$1.6 million, respectively.

In addition, the Company haswe have an agreement with a financing company to provide second tier financing for our consumers. Refer to Note 11 ofnotes to the Notes to Consolidated Financial Statementsconsolidated financial statements in our most recent Annual Report on Form 10-K for further discussion of the accounting treatment for these arrangements.arrangements and the related disclosures, respectively.

INFLATION AND PRICE CHANGES

Although we cannot accurately anticipate the effect of inflation on our operations, we do not believe that inflation has had, or is likely in the foreseeable future to have, a material adverse effect on our financial position, results of operations or cash flows. However, increases in inflation over historical levels or uncertainty in the general economy could decrease discretionary consumer spending for products like ours.

During both 2006 and 2005,into 2007 we have experienced increases in transportation costs as a result ofdue to increases in the price for fuel. To the extent these costs continue to increase and we are unable to pass these costs to the customer, our gross margins in 2006 may continue to be negatively impacted. Additionally, during 2006 and 2005, the Company implemented transportation surcharges passing some of these cost increases to the end consumer.

SEASONALITY

In general, based on historic trends, we expect our sales from fitness equipment products both domesticin the U.S. and internationalinternationally to vary seasonally with net sales typically the strongest in the fourth quarter, followed by the thirdfirst and firstthird quarters, and the weakest in the second quarter. Our analysis shows that such factors as the broadcast of national network season finales and seasonal weather patterns influence television viewership and cause our television commercials on national cable television to be less effective in the second quarter than in other periods of the year. In addition, during the spring and summer consumers tend to do more activities outside including exercise, which impacts sales of fitness equipment that is used indoors. Sales from our fitness apparel products are strongest in the first and third quarters and weakest during the fourth quarter. We expect the fluctuation in our net sales between our highest and lowest quarters to be betweenapproximately 40%.

CRITICAL ACCOUNTING ESTIMATES AND ASSUMPTIONS

The preparation of financial statements in conformity with U.S. GAAP requires estimates and 70%.assumptions that affect the reported amounts of assets and liabilities, revenues and expenses, and related disclosures of contingent assets and liabilities in the consolidated financial statements. As described by the Securities Exchange Commission (“SEC”), critical accounting estimates and assumptions are those that may be material due to the levels of subjectivity and judgment necessary to account for highly uncertain matters or the susceptibility of such matters to change, and that have a material impact on the financial condition or operating performance of the company. There were no changes to our critical accounting estimates and assumptions in the three-month period ended March 31, 2007. Refer to our most recent Annual Report on Form 10-K for a complete description of our critical accounting estimates and assumptions.

NEW ACCOUNTING PRONOUNCEMENTS

For a description of the new accounting standards that affect us, refer to Note 1 to our Consolidated Financial Statements included under Part I, Item 1 of this Form 10-Q.

 

Item  3.Quantitative and Qualitative Disclosures About Market Risk

There have been no material changes in our reported market risks since the filing of our 20052006 Annual Report on Form 10-K, which was filed with the Securities and Exchange Commission on March 16, 2006.2007.

We hold our cash and cash equivalents primarily in bank deposits and in liquid debt instruments with maturity dates of less than one year. We are subject to concentration of credit risk as bank deposits may exceed federally insured limits. Additionally, there is risk of loss of the entire principal with any debt instrument we invest in. To reduce risk of loss, we limit our exposure to any individual debt issuer and require certain minimum ratings for debt instruments that we purchase.

- 17 -


FOREIGN EXCHANGE RISK

We are exposed to foreign exchange risk from currency fluctuations, mainly in Canada and Europe, due to sourcing of our products in the U.S. Dollarsdollars and selling of productsthem primarily in Canadian Dollars,dollars, Swiss FranksFrancs, and Euros, respectively.Euros. Given the relative size of our current foreign operations, wethe exposure to the exchange risk could have chosen not to enter intoa material impact on the results of operations. Management estimates the maximum impact on stockholders’ equity of a ten percent change in any applicable foreign currency hedges.to be approximately $1.2 million.

INTEREST RATE RISK

We are exposedFluctuations in the general level of interest rates on our current variable rate credit agreements expose us to market risk for changes in interest rates related torisk. As of March 31, 2007, our credit agreements. The credit agreements are at variable interest rates and, at September 30, 2006, we had outstanding borrowings under the credit facilityfacilities were $37.2 million and represented 25.9% of $35 million.our total liabilities. Due to the short-term nature of these borrowings, management believes that any reasonably possible near-term changes in related interest rates would not have a material impact on the Company’s financial position, results of operations, or cash flows.

Item  4.Controls and Procedures

Evaluation of Disclosure Controls and Procedures

Our management has evaluated, under the supervision and with the participation of our Chairman, Chief Executive Officer and President, and Chief Financial Officer, Treasurer and Secretary, the effectiveness of the design and operation of our disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934 (the “Exchange Act”), as amended) as of the end of the period covered by this quarterly report on Form 10-Q pursuant to Rule 13a-15(b) and 15d-15(b) under the Exchange Act. Based on this evaluation, our Chairman, Chief Executive Officer and President, and Chief Financial Officer, Treasurer and Secretary, concluded that, as of the end of the period covered by this report, our disclosure controls and procedures were effective at the reasonable assurance level that information required to be disclosed in our Exchange Act reports is: (1) recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and (2) accumulated and communicated to our management, including our Chairman, Chief Executive Officer and President, and Chief Financial Officer, Treasurer and Secretary, as appropriate to allow timely decisions regarding required disclosure. Management does not expect that our disclosure controls and procedures will prevent or detect all errors and fraud. Any control system, no matter how well designed and operated, is based on certain assumptions and can provide only reasonable, not absolute assurance, that its objectives will be met. Further, no evaluation of controls can provide absolute assurance that misstatements due to error or fraud will not occur or that all control issues and instances of fraud, if any, within the Company have been detected.

Changes in Internal Controls

As reported in the Company’s Annual Report on Form 10-K for the year ended December 31, 2005, management identified a material weakness in the Company’s controls for testing of and training for the enterprise resource planning (“ERP”) system. In addition, management also determined that efforts to mitigate the impact from the lack of testing and training for the implementation of the ERP system resulted in an additional material weakness from insufficient resources being devoted to controls over analyzing and recording contingencies. During the first nine months of 2006, the Company took action to correct the material weaknesses in internal control over financial reporting by:

Identifying and correcting data migration issues;

Providing additional training on the effective and efficient use of the ERP system to ensure data accuracy;

Enhancing system reporting from the ERP system;

Providing additional training to staff responsible for determining the financial impact of each contingency;

Enhancing the review process and responsibility for review of accounting estimates and contingencies; and

Implementing an additional level of review for all significant accounting estimates by the Vice President of Finance, Fitness Equipment Business.

Management believes it has made considerable progress in its efforts to remediate the material weaknesses since December 31, 2005. As on-going remediation continues, the Company is focusing its training and education efforts so that operating effectiveness can be demonstrated over a period of time that is sufficient to conclude that the material weaknessesThere have been remediated.

Except for the items identified above, there have been no other changes in the Company’s internal control over financial reporting during the most recently completed fiscal quarter that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

PART II. OTHER INFORMATION

 

Item  1.Legal Proceedings

We are involved in various claims, lawsuits and other proceedings from time to time. Such litigation involves uncertainty as to possible losses we may ultimately realize when one or more future events occur or fail to occur. We accrue and charge to income estimated losses from contingencies when it is probable that a liability hadhas been incurred and the amount of loss can be reasonably estimated. Differences between estimates recorded and actual amounts determined in subsequent periods are treated as changes in accounting estimates. The Company estimates the probability of losses on legal contingencies based on the advice of internal and external counsels, outcomes from similar litigation, the status of the lawsuits (including settlement initiatives), legislative developments, and other factors. Due to numerous variables associated with these judgments and assumptions, both the precision and reliability of the resulting estimates of the related loss contingencies are subject to substantial uncertainties. We regularly monitor our estimated exposure to these contingencies and, as additional information becomes known, may change our estimates significantly. A significant change in our estimates, or a result that materially differs from our estimates, could have a significant impact on our financial position, results of operations and cash flows.

- 18 -


In 2003, the Company sued Icon Health & Fitness, Inc. (“ICON”) in federal district court in Seattle, Washington for trademark infringement in connection with ICON’s use of the trademark “CrossBow” on exercise equipment. The District Court ruled in favor of the Company in July 2003 on a motion for preliminary injunction on the issue of trademark infringement and entered an order barring ICON from using the trademark “CrossBow” on any exercise equipment. That decision was subsequently affirmed by the Court of Appeals. A trial on the Company’s claims against ICON was pending in Seattle.

In November 2005, the Company proceeded to trial in Salt Lake City, Utah in a case filed by ICON Health & Fitness, Inc. (“ICON”) claiming false advertising involving the Company’s advertising and promotion going back to 1987 for certain elements of its Bowflex home gyms and claiming trademark infringement for the name placed on a treadmill belt sold in 2002. On November 15, 2005, the jury returned a verdict in favor of ICON in the amount of $7.8 million which the Court subsequently increased to $8.1 million. By an order dated April 21, 2006, the Court refusedThat case is on appeal to modify the amount of the jury verdict. The Company has filed a notice of appeal of this judgment and has posted the necessary bond with the Court for the appeal. The Company, based on discussion with its legal counsel, believes the verdict is inconsistent with the law and the evidence presented at trial. Further, the Company believes that the evidence does not support the damage award and thus the likelihood of loss is neither probable nor is the amount of potential loss estimable. Therefore, no accrual has been recorded by the Company.

In December 2002, the Company filed suit against ICON in the Federal District Court, Western District of Washington (the “District Court”) alleging infringement by ICON of the Company’s Bowflex patents and trademarks. The Company sought injunctive relief, monetary damages and its fees and costs. In October 2003, the District Court dismissed the patent infringement claims. The Company appealed the District Court’s decision to the United States Court of Appeals for the Federal Circuit (the “Appeals Court”) and in November 2003, the Appeals Court overruled the District Court and reinstated the patent infringement claims. In May 2005, the District Court again dismissed the patent infringement case against ICON. The Company appealed this case to the Appeals Court, which issued an order in August 2006 affirming the ruling of the District Court dismissing the patent infringement case.Appeals.

In July 2003, the District Court ruled in favor ofOn April 26, 2007, the Company on a motion for preliminary injunction onand ICON settled all outstanding claims between the issueparties in federal court in Salt Lake City, Utah, Seattle, Washington, and before the Federal Circuit Court of trademark infringement and entered an order barring ICON from using the trademark “CrossBow” on any exercise equipment. In its ruling, the District Court concluded thatAppeals. Both the Company showed “a probabilityand ICON will be filing dismissals of success ontheir respective lawsuits against each other. This settlement cleared the meritsprevious contingent liability claim of $8.1 million and irreparable injury” on its trademark infringement claim. In August 2003,ICON granted the Appeals Court granted ICON a temporary stay regardingCompany use of certain intellectual property for the motion for a preliminary injunction, which enjoined ICON from using the trademark “CrossBow.” This stay allowed ICON to continue using the trademark “CrossBow” until a decision was issued by the Appeals Court. In June 2004, the Appeals Court issued its decision upholding the issuance of an injunctionCompany’s use in product development and preventing ICON from selling exercise equipment using the trademark “CrossBow” pending trial on the trademark issue. A trial date has been set for February 2007 in the District Court on this claim.enhancement.

In October 2006, the Company filed a complaint in the Superior Court for Clark County, Washington against Gately’s LLC (the “defendant”) seeking damages in the amount of $5.1 million plus interest, attorney’s fees and costs, for collection of outstanding accounts receivable for product purchased by the defendant. No trial dateGately’s. This case has been setdismissed and refiled by the Company in this matter.

There have been no other significant subsequent developments relatingstate court in Boulder County, Colorado. It is currently being litigated and is in the early stages of discovery. In its answer to the commitmentscomplaint, Gately’s has asserted defenses to payment and contingencies reportedcounterclaims against Nautilus in the Company’s most recent Annual Report on Form 10-K.an unspecified amount.

In addition to the matters described above, from time to time the Company is subject to litigation, claims and assessments that arise in the ordinary course of business, including disputes that may arise from intellectual property related matters. Many of our legal matters are covered in whole or in part by insurance. Management believes that any liability resulting from such matters will not have a material adverse effect on the Company’s financial position, results of operations, or cash flows.

Item  1A.Risk Factors

There have been no material changes to the risk factors identified in our annual report on Form 10-K for the year-ended December 31, 2005.2006.

 

Item 2.Unregistered Sales of Equity Securities and Use of Proceeds

Registrant’s Purchases of Equity Securities:- 19 -

Period

  

Total Number of

Shares Purchased

  

Average Price

Paid per Share

  

Total Number of

Shares Purchased

as Part of

Publically

Announced Plans

or Programs (1)

  

Approximate Dollar

Value of Shares that

May Yet Be

Purchased Under

the Plans or

Programs

July 1, 2006 to July 31, 2006

  —    $—    —    $84,364,000

August 1, 2006 to August 31, 2006

  1,300,700   12.43  1,300,700   68,241,000

September 1, 2006 to September 30, 2006

  43,500   12.20  43,500   67,710,000
              

Total

  1,344,200  $12.42  1,344,200  $67,710,000
              

(1)In March 2005, the Company’s Board of Directors authorized the repurchase of up to $100 million of the Company’s common stock in open-market transactions, at times and in such amounts as management deems appropriate, depending on market conditions and other factors. The authorization expires on March 31, 2008, unless extended by the Board of Directors. The repurchase program does not obligate the Company to acquire any specific number of shares or acquire shares over any specified period of time.


Item  6.Exhibits

The following exhibits are filed herewith.

 

Exhibit No.

 

Description

  3.1

Amendment to Amended and Restated Bylaws of the Company - Incorporated by reference to Exhibit 3.1 the Company’s Current Report on Form 8-K, as filed with the Commission on January 31, 2007.

10.1

 Summary2007 Compensation of Performance Unit AwardExecutive Officers - Incorporated by reference to the Company’s Current Report on Form 8-K, as filed with the Commission on August 3, 2006.January 31, 2007.

10.2

 First AmendmentPurchase Option Agreement, dated January 31, 2007, by and between the Company and Treuriver Investments Limited – Incorporated by reference to Nautilus, Inc. 2005 Long Term Incentive Planthe Company’s Annual Report on Form 10-K, as filed with the Commission on March 16, 2007. Confidential treatment has been requested for certain portions of this exhibit.

10.3

Purchase Option Agreement, dated January 31, 2007, by and between the Company and Land America Health & Fitness Co., Ltd. – Incorporated by reference to the Company’s Annual Report on Form 10-K, as filed with the Commission on March 16, 2007. Confidential treatment has been requested for certain portions of this exhibit.

10.4

Credit Agreement dated as of February 14, 2007, by and among the Company, certain of the Company’s subsidiaries named therein, Bank of America, N.A., as administrative agent, swingline lender and L/C issuer, U.S. Bank, National Association, as syndication agent and Keybank National Association, as documentation agent – Incorporated by Reference to the Company’s Current Report on Form 8-K, as filed with the Commission on February 20, 2007.

31.1

 Certification of Principal Executive Officer pursuant to Rule 13a-14 (a) of the Securities Exchange Act of 1934, as amended

31.2

 Certification of Principal Financial Officer pursuant to Rule 13a-14 (a) of the Securities Exchange Act of 1934, as amended

32.1

Certification of Principal Executive Officer and Principal Financial Officer pursuant to Rule 13a-14(b) of the Securities and Exchange Act of 1934, as amended, and 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

SIGNATURES

Pursuant to the requirements 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.

NAUTILUS, INC.
November 8, 2006

By:

/s/ Greggory C. Hammann
DateGreggory C. Hammann, Chairman, Chief Executive
Officer and President (Principal Executive Officer)

November 8, 2006

By:

/s/ William D. Meadowcroft
DateWilliam D. Meadowcroft, Chief Financial Officer,
Treasurer and Secretary (Principal Financial Officer)

EXHIBIT INDEX

Exhibit No.

Description

10.1Summary of Performance Unit Award - Incorporated by reference to the Company’s Current Report on Form 8-K, as filed with the Commission on August 3, 2006.
10.2First Amendment to Nautilus, Inc. 2005 Long Term Incentive Plan
31.1Certification of Principal Executive Officer pursuant to Rule 13a-14 (a) of the Securities Exchange Act of 1934, as amended
31.2Certification of Principal Financial Officer pursuant to Rule 13a-14 (a) of the Securities Exchange Act of 1934, as amended
32.1 Certification of Principal Executive Officer and Principal Financial Officer pursuant to Rule 13a-14(b) of the Securities and Exchange Act of 1934, as amended, and 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

 

29- 20 -


SIGNATURES

Pursuant to the requirements 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.

NAUTILUS, INC.
May 8, 2007By:

/s/ Greggory C. Hammann

DateGreggory C. Hammann, Chairman, Chief Executive
Officer and President (Principal Executive Officer)
May 8, 2007By:

/s/ William D. Meadowcroft

DateWilliam D. Meadowcroft, Chief Financial Officer,
Treasurer and Secretary (Principal Financial Officer)
May 8, 2007By:

/s/ Aaron G. Atkinson

DateAaron G. Atkinson, Corporate Controller
(Principal Accounting Officer)

- 21 -


EXHIBIT INDEX

Exhibit No.

Description

  3.1

Amendment to Amended and Restated Bylaws of the Company - Incorporated by reference to Exhibit 3.1 the Company’s Current Report on Form 8-K, as filed with the Commission on January 31, 2007.

10.1

2007 Compensation of Executive Officers - Incorporated by reference to the Company’s Current Report on Form 8-K, as filed with the Commission on January 31, 2007.

10.2

Purchase Option Agreement, dated January 31, 2007, by and between the Company and Treuriver Investments Limited – Incorporated by reference to the Company’s Annual Report on Form 10-K, as filed with the Commission on March 16, 2007. Confidential treatment has been requested for certain portions of this exhibit.

10.3

Purchase Option Agreement, dated January 31, 2007, by and between the Company and Land America Health & Fitness co., Ltd. – Incorporated by reference to the Company’s Annual Report on Form 10-K, as filed with the Commission on March 16, 2007. Confidential treatment has been requested for certain portions of this exhibit.

10.4

Credit Agreement dated as of February 14, 2007, by and among the Company, certain of the Company’s subsidiaries named therein, Bank of America, N.A., as administrative agent, swingline lender and L/C issuer, U.S. Bank, National Association, as syndication agent and Keybank National Association, as documentation agent – Incorporated by Reference to the Company’s Current Report on Form 8-K, as filed with the Commission on February 20, 2007.

31.1

Certification of Principal Executive Officer pursuant to Rule 13a-14 (a) of the Securities Exchange Act of 1934, as amended

31.2

Certification of Principal Financial Officer pursuant to Rule 13a-14 (a) of the Securities Exchange Act of 1934, as amended

32.1

Certification of Principal Executive Officer and Principal Financial Officer pursuant to Rule 13a-14(b) of the Securities and Exchange Act of 1934, as amended, and 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

- 22 -