UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

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

or

For the transition period from            to

Commission file number: 000-25867

NAUTILUS, INC.

(Exact name of registrant as specified in its charter)

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

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PART I. FINANCIAL INFORMATION

NAUTILUS, INC.

CONSOLIDATED BALANCE SHEETS

(Unaudited, in thousands)

See notes to consolidated financial statements.

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NAUTILUS, INC.

CONSOLIDATED STATEMENTS OF INCOME

(Unaudited, in thousands, except per share amounts)

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)

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.

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:

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

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

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.

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.

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

3. INVENTORIES

Inventories consisted of the following:

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

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

(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

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.

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

6. LINE OF CREDIT AND OTHER DEBT

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.

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.

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

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:

8. EARNINGS PER SHARE

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

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.

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

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.

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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:

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

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

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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.

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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:

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

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.

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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: