UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2007MARCH 31, 2008

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

(Issuer’sRegistrant’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  ¨            Accelerated Filer  x            Non-Accelerated Filer  ¨            Smaller Reporting Company  ¨

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 1, 2007:April 30, 2008: 31,557,136

NAUTILUS, INC.

TABLE OF CONTENTS

PART I. FINANCIAL INFORMATION

NAUTILUS, INC.

CONSOLIDATED BALANCE SHEETS

(Unaudited, in thousands)

See notes to consolidated financial statements.

NAUTILUS, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited, in thousands, except per share amounts)

See notes to consolidated financial statements.

NAUTILUS, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited, in thousands)

(continued)

NAUTILUS, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited, in thousands)

See notes to consolidated financial statementsstatements.

(concluded)

NAUTILUS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

1. BASIS OF PRESENTATION

The accompanying consolidated financial statements relate to Nautilus, Inc. and its subsidiaries (the “Company”(“the Company”) as of September 30, 2007March 31, 2008 and for the three and nine month periods ended September 30, 2007March 31, 2008 and 2006.2007. 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 financial statements should be read in conjunction with the audited financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2006.2007.

The financial information included herein reflects all 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 month periodsperiod ended September 30, 2007March 31, 2008 are not necessarily indicative of the results to be expected for the full year.

In the fourth quarter of 2007, management committed to a plan to sell our fitness apparel division, DashAmerica, Inc. d/b/a Pearl Izumi USA (“Pearl Izumi”), which designs, markets and sells branded fitness apparel and footwear sold primarily under the Pearl Izumi brand on a global basis. On April 18, 2008, the Company completed the sale of the fitness apparel division. Accordingly, all assets and liabilities and results of operations associated with the fitness apparel division have been presented in the consolidated financial statements as discontinued operations separate from continuing operations in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 144,Accounting for the Impairment or Disposal of Long-Lived Assets (“SFAS No. 144”). See Note 2 “Discontinued Operations.”

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 expenses and the disclosure of contingent assets and liabilities in the financial statements. Actual results could differ from those estimates. A description of ourOur significant estimates and assumptions can be found in the Company’s Annual Report on Form 10-K for the year ended December 31, 2006.2007.

ReclassificationsRevision of Expense Classification

Prior year amounts – We revised our prior presentation of interest incomeroyalty expense. For all periods presented, we now report royalty expenses related to items manufactured and interest expense which weresold in cost of goods sold. Expenses incurred for preproduction royalties are included in research and development expense. Preproduction royalties represent costs incurred to utilize licensed patent technologies prior to a sellable product being available for manufacture and sale. We have concluded that the effect of these misstatements did not materially impact any previously issued financial statements, however we have revised prior period comparative information presented net have been reclassifiedherein in order to conform to the current year presentation within the consolidated statements of operations. This change had no impactpresent such information on previously reported operating income, net income or stockholders’ equity.a consistent basis.

New Accounting Pronouncements

In February 2007, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”)SFAS No. 159,The Fair Value Option for Financial Assets and Financial Liabilities (“SFAS No. 159”), which expandsgives entities the scope of what companies may carry at fair value. SFAS 159 offers an irrevocable option to carry the vast majority ofmeasure eligible financial assets, and financial liabilities at fair value withon an instrument by instrument basis, that are otherwise not permitted to be accounted for at fair value under other accounting standards. The election to use the fair value option is available when an entity first recognizes a financial asset or financial liability. Subsequent changes in fair value must be recorded in earnings. This statement was effective as of January 1, 2008. The Statement is effective for fiscal years beginning after November 15, 2007. The Company is currently evaluating theadoption of SFAS No. 159 had no impact that the adoption will have on the Company’s results of operations, cash flows or financial position.statements.

In September 2006, the FASB issued SFAS No. 157,Fair Value Measurements(“SFAS No. 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 No. 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007. The Company is currently evaluating theadoption of SFAS No. 157 had no impact that the adoption will have on the Company’s financial statements.

In December 2007, the FASB issued SFAS No. 141 (revised 2007),Business Combinations (“SFAS No. 141(R)”). SFAS No. 141(R) establishes principles and requirements for how an acquirer recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, any noncontrolling interest in the acquiree, and the goodwill acquired in its financial statements. SFAS No. 141(R) also establishes disclosure requirements to enable the evaluation of the nature and financial effects of the business combination. SFAS No. 141(R) is effective for fiscal years beginning after December 15, 2008. The Company is in the process of analyzing the impact of SFAS No. 141(R) on its financial statements.

In December 2007, the FASB issued SFAS No. 160,Noncontrolling Interests in Consolidated Financial Statements—an amendment of Accounting Research Bulletin No. 51(“SFAS No. 160”). SFAS No. 160 establishes accounting and reporting standards for ownership interests in subsidiaries held by parties other than the parent, the amount of consolidated net income attributable to the parent and to the noncontrolling interest, changes in a parent’s ownership interest, and the valuation of retained, noncontrolling equity investments when a subsidiary is deconsolidated. SFAS No. 160 also establishes disclosure requirements that clearly identify and distinguish between the interests of the parent and the interests of the noncontrolling owners. SFAS No. 160 is effective for fiscal years beginning after December 15, 2008. The Company is in the process of analyzing the impact of SFAS No. 160 on its financial statements.

2. DISCONTINUED OPERATIONS

On April 18, 2008 the Company completed the sale of its fitness apparel division. The assets and liabilities and results of operations cash flowsof the fitness apparel division have been presented separately in the consolidated financial statements as discontinued operations.

Revenues, income before income taxes, income tax expense and income from discontinued operations were as follows:

Income from discontinued operations includes a pre-tax impairment charge of $2.6 million in the quarter ended March 31, 2008, to reduce the carrying value of the net assets of the discontinued operations to the net proceeds from the sale. No costs associated with exit or financial position.

In July 2006, the FASB issued FASB Interpretationdisposal activities as contemplated by SFAS No. 48,146Accounting for Uncertainty in Income Taxes – an interpretation of FASB Statement No. 109Costs Associated with Exit or Disposal Activities (“FIN 48”). The Company adopted the provisions of this interpretation on January 1, 2007. The disclosure requirementshave been recorded.

Assets and cumulative effectliabilities of the adoptionfitness apparel division have been segregated and presented as assets and liabilities of FIN 48 are presenteddiscontinued operations in Note 12.the consolidated balance sheets for all periods presented. Depreciation and amortization related to assets held for sale ceased as of December 15, 2007. Assets and liabilities for the discontinued operations were as follows:

3. STOCKHOLDERS’ EQUITY

2.	SHARE BASED COMPENSATION

Stock Options

A summary of the Company’s stock option plan activity for the nine months ended September 30, 2007 is as follows:

The fair value of the Company’s optionequity awards was estimated assumingutilizing the following weighted average assumptions:

The weighted average grant-date fair value of stock options granted during the nine month periods ended September 30, 2007 and 2006 was $5.26 and $5.55, respectively$1.91 per share for stock options granted.granted in the first three months of 2008. The total fair value of options vested during the nine month periods ended September 30, 2007 and 2006first three months of 2008 was $0.8 million and $2.0 million, respectively.$65,000. The total unrecognized compensation cost related to nonvested options was $4.6$4.5 million at September 30, 2007.March 31, 2008. This cost is expected to be recognized over a weighted-average period of 2.472.65 years.

During the first quarter of 2008, the Company accelerated vesting on stock options related to the termination of the former Chief Executive Officer and incurred $1.0 million of shared based compensation charges which are recorded in general and administrative expenses.

In the fourth quarter of 2007, the Board of Directors suspended the payment of quarterly dividends. Payment of any future dividends is at the discretion of our Board of Directors, which considers various factors such as our financial condition, operating results, current and anticipated cash needs and future expansion plans. The Company’s loan agreement contains covenants that include limitations on paying dividends when certain ratios are not met. Based on the covenants, the Company is currently precluded from paying dividends.

Performance Units

A summary of the Company’s performance unit activity as of September 30, 2007, and changes during the nine month period ended September 30, 2007, areis as follows:

At September 30,March 31, 2008 and 2007 there was approximately $0.8$0.7 million and $3.6 million, respectively, of total unrecognized share-based compensation costscost related to performance units with intrinsic value of zero.$0.1 million and $0, respectively. None of the performance units were vested at September 30,March 31, 2008 and 2007. The Company recorded no compensation expense duringof $0 and $37,000 related to the three and nine monthperformance unit awards in the three-month periods ended September 30, 2007.March 31, 2008 and March 31, 2007, respectively.

Restricted Stock

A summary of the Company’s restricted stock activity as of September 30, 2007, and changes during the nine month period ended September 30, 2007, areis as follows:

Restricted stock compensation expense for the three months ended March 31, 2008 was $0.1 million. At September 30, 2007, there was approximately $1.3 million of totalMarch 31, 2008, unrecognized share-based compensation costscost related to restricted stock that willtotaled approximately $0.8 million and is expected to be amortized through the third quarterrecognized over a weighted average period of 2009 with1.37 years. The restricted stock had an intrinsic value of $2.3$0.8 million at September 30, 2007. None of theMarch 31, 2008. There was not any restricted stock awards were vestedissued and outstanding at September 30,March 31, 2007. The Company recorded $0.1 million and $0.1 million of compensation expense during the three and nine month periods ended September 30, 2007, respectively.

4. INVENTORIES

Inventories consisted of the following:

Inventories are stated at the lower of 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 monthly basis.

4.	INTANGIBLE AND OTHER ASSETS

5. OTHER INTANGIBLES AND OTHER ASSETS

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

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 the period they are expected to provide the Company with economic benefit. The amortization expense for the next five full succeeding years is estimated at $3.7$3.0 million, $3.2$2.8 million, $2.9$2.8 million, $2.9$2.8 million and $2.9$2.8 million.

The Company recorded a long-term receivable related to income tax refunds the Company anticipates claiming in the second quarter of 2009, due to anticipated tax losses in 2008, primarily related to certain payments made to Land America (see Note 10) in 2007 and 2008, that can offset taxable income from earlier years.

6. ACCRUED LIABILITIES

The significant accrued liabilities were estimated warranty costs of $17.6 million and $18.3 million increase in the patents intangible asset is due to the ICON Health & Fitness, Inc. litigation settlement described in Note 9 that has been valued at $18.3 million. This settlement allows for the Company to use a variety of fitness equipment patents and technologies. This intangible asset value will be amortized over the useful life of the technologies granted through this settlement.

Accrued liabilities in excess of five percent of total current liabilities consisted of accrued warranty expense of $8.5 million and $9.8 million at September 30, 2007March 31, 2008 and December 31, 2006,2007, respectively and accrued payroll liabilities, including severance and benefits of $5.9$5.4 million and $7.1$6.3 million at September 30, 2007March 31, 2008 and December 31, 2006,2007, respectively.

In February 2007, At March 31, 2008 the Company paid offaccrued $8.0 million for the outstanding balances undersettlement of claims associated with the $65 million facility that it entered in fiscal 2005 as well astermination of the $25 million facility that itpurchase agreement with Land America.

7. LINE OF CREDIT AND OTHER DEBT

On January 16, 2008 the Company and its subsidiary Nautilus International S.A. entered into October 2006. Thereafter,a Loan and Security Agreement (the “Loan Agreement”) with Bank of America N.A., as agent for the lenders party thereto, providing for a $100 million revolving secured credit line including a secured term loan in the principal amount of $18.5 million. The Loan Agreement will be available for letters of credit, working capital and general business purposes, including acquisition financing. On February 29, 2008, the Company entered into the First Amendment to the Loan Agreement which modified minimum Earnings Before Interest, Tax, Depreciation and Amortization (“EBITDA”) covenants, revised the exclusion of certain non-cash charges and unusual expense items from the calculation of EBITDA, and reduced the maximum aggregate revolving commitments of the lenders thereunder to $70 million concurrent with completion of the sale of the Company’s fitness apparel division, which amount may be increased under certain circumstances to $95 million.

On March 31, 2008, the Company entered into a new revolving credit agreementSecond Amendment to Loan Agreement (the “Facility”“Second Amendment”) in respect of the Loan Agreement. Pursuant to the Second Amendment, the Company extended the maturity date of the term loan outstanding under the Loan Agreement to the earlier to occur of (i) April 30, 2008, (ii) the consummation of a sale of the Company’s fitness apparel division or (iii) the consummation of a financing pursuant to which a third party takes a first priority lien in certain intellectual property assets of the Company. In connection with, several financing institutions. The Facility provides for an unsecured revolving credit facilityand pursuant to include revolving loans and a $10the Second Amendment the Company also repaid $3 million swing line, for a maximum commitmentof principal amount of $125 million with an option to increaseoutstanding under the facility to $175 million. The Facility expires on February 14, 2012 and is intended for general corporate purposes, working capital requirements, financing permitted acquisitions and share repurchases. Theterm loan. At March 31, 2008, the Company has $109.0had $63.2 million of borrowings outstanding on the Facility at September 30, 2007.Loan Agreement.

The Facility provides for either Base Rate inCompany completed the principal amountsale of $1.0 million or in incrementsthe fitness apparel division on April 18, 2008 and received net cash proceeds of $0.1 million thereof or Eurodollar Rate loans in$58.4 million. Upon receipt of these proceeds, the principal amount of $2.5 million or in increments of $0.5 million in excess thereof. It also allows for swing loans in minimumCompany paid off all amounts of $0.1 million subjectthen outstanding under the Loan Agreement.

On May 5, 2008, the Company entered into a Third Amendment to its sub-limit of $10.0 million for the durationLoan Agreement (“Third Amendment”). Pursuant to the Third Amendment, the lenders consented to the repurchase by the Company of up to ten business days,$10.0 million of its common stock. In addition, the Third Amendment made modifications to the definition of “EBITDA,” including the exclusion of amounts payable under the Land America settlement agreement and letterscertain other items from the calculation of credit in“EBITDA” for the minimum amount of $0.1 million.

The Facility requires DashAmerica, Inc., d/b/a Pearl Izumi Inc., (“Pearl Izumi”), a wholly-owned subsidiarypurposes 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 a consolidated leverage ratio, a consolidated asset coverage ratio, and a requirement to maintain a minimum consolidated Earnings Before Income Tax, Depreciation and Amortization, (“EBITDA”).

On October 5, 2007, the Company and Pearl Izumi entered into a Security and Pledge Agreement with Bank of America, N.A. (“Security Agreement”) in its capacity as administrative agent under the Facility. The Security Agreement covers substantially all of the personal property assets of the Company and Pearl Izumi and secures the line of credit, swingline credit line and letter of credit subfacility, which had previously been unsecured.8. COMPREHENSIVE INCOME (LOSS)

On October 12, 2007, the Company and its subsidiary Pearl Izumi entered into a First Amendment and Waiver to Credit Agreement (the “Amendment”) in respect of the Facility dated as of February 14, 2007 among Bank of America, N.A. in its capacity as Administrative Agent and the lenders party thereto.

Pursuant to the Amendment, the lenders under the credit facility agreed to waive defaults of the financial covenants under the Facility with respect to the four fiscal quarter period ended September 30, 2007. The applicable margin on borrowings was increased: (i) with respect to Eurodollar Rate loans, to 2.00% per annum, (ii) with respect to Base Rate loans, to 0.50% per annum, and (iii) with respect to Swing Line loans, to 0.50% per annum. Additionally, effective as of January 1, 2008, the maximum amount of the credit line will be restricted to $75,000,000 unless the Company’s consolidated EBITDA is at least $32,500,000 for each of the two most recently ended quarterly periods.

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 accumulated other comprehensive income component of stockholders’ equity, except forequity. Transaction gains or losses with the Company’s international subsidiaries whichincurred by conducting business in other currencies are recorded as part of other income/expense in the Consolidated Statements of Operations.

Comprehensive income (loss) was as follows:

9. EARNINGS PER SHARE

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

10. COMMITMENTS AND CONTINGENCIES

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 hashad 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.

Land America

On April 26,October 17, 2007 the Company and ICONentered into a series of agreements (the “Land America Agreements”) under which the Company or its wholly-owned subsidiaries were to acquire or lease substantially all of the assets of Land America Health & Fitness Co. Ltd. (“ICON”Land America”) settled a series of pending lawsuits between the parties. This settlement included a number of claims and lawsuits between ICON and the Company going back to 2002-2003, and which were pending in federal courts in Salt Lake City, Utah, and Seattle, Washington, and before the Federal Circuit Court of Appeals. Both the Company and ICON have filed dismissals of their respective lawsuits against each other. This settlement and dismissals cleared the previous contingent liability claim of $8.1 million against the Company following a trial in November 2005 in Salt Lake City, and ICON granted the Company use of certain intellectual property for the Company’s use in product development and enhancement valued at $18.3 million.

In October 2006, the Company filed a complaintTreuriver Investments, Ltd. (“Treuriver”). Land America is primarily engaged in the Superior Courtmanufacture of products for Clark County, Washington against Gately’s LLC (“Gately’s”) 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 Gately’s. This case has been dismissed and refiled by the Company in state courta manufacturing facility located in Boulder County, Colorado. InXiamen, People’s Republic of China, and Treuriver is Land America’s related trading company. The Land America Agreements were entered into following the exercise, on June 29, 2007, of purchase options set forth in Purchase Option Agreements which the Company entered into on February 1, 2007. The Company had previously paid Land America and Treuriver non-refundable deposits of $18.5 million in connection with the purchase agreements.

On January 19, 2008, the Company gave written notice to Land America and Treuriver exercising its answerrights to terminate the Land America Agreements on the basis that (i) all of the conditions to closing set forth in the Land America Agreements had not been satisfied or waived, and/or (ii) the Closing (as defined in the Land America Agreements) had not occurred prior to the complaint, Gately’s has asserted defensesTermination Date (as defined in the Land America Agreements).

By letter dated January 21, 2008, legal counsel to paymentLand America and counterclaims against Nautilus in an unspecified amount. In September 2007, Gately’s filed a petition for bankruptcy which has stayed the litigation in Colorado. In September 2007,Treuriver notified the Company reserved an additional $4.8 millionthat Land America and Treuriver consider the Company to be fully reserved for this unpaid receivablein breach of certain duties set forth in the Asset Purchase Agreements and that Land America and Treuriver had incurred economic damages as a result of such alleged breach.

On May 5, 2008, the bankruptcy filing.Company, Land America and Treuriver entered into a settlement agreement providing for the release of all claims arising out of or related to the termination of the Land America Agreements. Pursuant to this settlement agreement, the Company has agreed to pay a total of $8.0 million to Land America and Treuriver. In addition, the Company and Land America entered into a revised supply agreement that extends the relationship by one year to December 31, 2010.

FACTA Litigation

On October 29, 2007, Sue Repenning, individually and on behalf of a group of allegedly similarly situated individuals, filed a suit against the Company for violation of the Federal Fair Credit and Accurate Transaction Act (“FACTA”). The case, filed in federal court in Cleveland, Ohio, alleges that the Company was not compliant with certain aspects of FACTA as regards the proper display of credit card information for customers who place an order for products on the Company’s website. Plaintiff seeks the statutory penalty set forth in FACTA for each violation which ranges from $100 to $1,000 per violation, as well as punitive damages, and attorneys fees and costs.

The case is in the early stages of discovery and has not yet been certified as a class action. The Company denies any liability under FACTA and believes that its procedures and protocols comply with applicable law, including FACTA and further denies that the case is certifiable as a class action. The case recently transferred from federal court in Cleveland, Ohio to Seattle, Washington. The Company is and will continue to vigorously defending the matter.

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 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. As a result, at September 30, 2007 and December 31, 2006, the maximum contingent liability under all recourse and guarantee provisions was approximately $1.3 million and $1.6 million, respectively. At September 30, 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 and $0.1 million was recorded based on historical loss experience and was included in accrued expenses at September 30, 2007 and December 31, 2006, respectively.

The Company has an agreement with a financing company to provide second tier financing for its consumers in which the Company shared financial responsibility if consumer default rates exceeded contractual expectations. During the third quarter of 2007, the Company renegotiated its second tier financing agreements and transferred risk of loss to the financing company for a settlement payment of $0.7 million. As a result, a reserve is no longer established for consumer default on second tier financing arrangements. Our financing partners review consumer credit information and determine which consumers will receive financing and approve the amount of financing provided. The Company had a reserve for second tier consumer financing of $0.3 million at December 31, 2006.

Commitments

At September 30, 2007,March 31, 2008, the Company had approximately $2.3$0.3 million in outstanding commercial letters of credit expiring betweenthrough December 31, 2007 and 2008.

Given that the majority of its inventory is sourced from Asia, theThe Company has long lead times for inventory purchases and therefore needs to secure factory capacity from its vendors in advance. As a result, at September 30, 2007,At March 31, 2008, the Company had approximately $51.3$45.5 million in purchase obligations, all of which was for inventory purchases with the majority payable in the next 12 months.purchases.

11. 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, and International Equipment Business,Business. Accounting policies used by each segment are the

same as those disclosed in Note 1 to the Company’s Annual Report on Form 10-K. In February 2008, the Company entered into an agreement to sell its fitness apparel division and Fitness Apparel Business.completed the sale in the second quarter of 2008. Accordingly all assets and liabilities and results of operations associated with this division have been presented in the consolidated financial statements as discontinued operations and are not included in the segment information below.

The Fitness Equipment Business is responsible for the design, production, marketing and sellingsale 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, CanadaNorth and South America.

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

The Fitness Apparel Business is responsible for the design, production, marketingNorth 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 enterprise 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.South America.

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:

11.	PURCHASE OPTION AGREEMENTS

On October 17, 2007 the Company entered into the following agreements: (i) Asset Purchase Agreement by and among the Company and Land America Health &Fitness Co., Ltd., a company formed under the laws of the People’s Republic of China (“Land America”), Michael C. Bruno (“Bruno”) and Yang Lin Qing (“Yang”) (the “Land America Agreement”); (ii) Asset Purchase Agreement by and among the Company and Treuriver Investments Limited a British Virgin Islands company (“Treuriver”), Bruno and Yang (the “Treuriver Agreement”); (iii) Post-Closing Audit Agreement by and among the Company, Land America, Bruno and Yang (the “Audit Agreement”); and (iv) First Amendment to Escrow Agreement by and among the Company, Treuriver, Bruno (in his capacity as Representative under the Treuriver Agreement), and U.S. Bank National Association (in its capacity as Escrow Agent) (the “First Amendment”). (The Land America Agreement, Treuriver Agreement, Audit Agreement and First Amendment are collectively referred to as the “Agreements”, and Land America, Treuriver, Bruno and Yang are collectively referred to as “Sellers”).

The Agreements provide for the terms and conditions under which the Company or its wholly-owned subsidiaries will acquire or lease substantially all of the assets of Land America and Treuriver. Land America is primarily engaged in the manufacture of products for the Company in a manufacturing facility located in Xiamen, People’s Republic of China (“PRC”), and Treuriver is Land America’s related trading company. The Agreements were entered into following the exercise, on June 29, 2007, of purchase options set forth in Purchase Option Agreements with Land America, Treuriver, Bruno and Yang which the Company entered into on February 1, 2007.

In connection with execution of the Purchase Option Agreements, the Company delivered a non-refundable deposit of $6 million to Sellers. Upon exercise of the options, the Company deposited an additional $30 million into escrow. Under the terms of the First Amendment to Escrow Agreement entered into as part of the Agreements, $12.5 million was released from escrow to Sellers as an additional nonrefundable deposit and $12.5 million was released to the Company. The remaining $5.0 million is to remain in escrow until closing.

Under the terms of the Agreements, on January 1, 2008 a wholly-owned direct or indirect subsidiary of the Company to be formed in Xiamen, Fujian, PRC (“Buyer”) will acquire substantially all of the assets currently used by Land America to manufacture products on behalf of the Company. In addition, Buyer will enter into a Lease Agreement providing for the lease of the land and buildings in which Land America currently conducts its manufacturing operations. The Lease Agreement includes a purchase option and it is anticipated that Buyer will complete the purchase of the buildings and land use rights on or before October 31, 2008. In addition, on January 1, 2008 the Company or a direct or indirect wholly-owned subsidiary of the Company will acquire substantially all of the assets of Treuriver.

In addition to applying the previously delivered deposits as described above, within five business days of closing on January 1, 2008 the Company or its subsidiaries will pay $21.5 million to Sellers. The portion of the total purchase price attributable to inventory is subject to adjustment based on the actual value of inventory on the closing date. On the earlier of October 31, 2008 and the date on which Buyer completes the purchase of the land rights and buildings pursuant to the Lease Agreement, an additional $11 million will be paid to Sellers. The purchase price for the land rights and buildings is $11.5 million. The total acquisition cost, including the purchase of the land rights and buildings, but excluding inventory, is expected to be $63.0 million. The additional purchase of inventory at closing is expected to range from $4.0 million to $6.0 million.

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 was 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 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 2004 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.

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.

As of September 30, 2007, there have been no material changes to the liability for uncertain tax positions.

On October 12, 2007 the Company committed to reduce its workforce by approximately 140 positions. The Company took this action to improve operating margins in a period of lower-than-expected sales. In conjunction with these actions, the Company currently expects to incur restructuring-related charges of approximately $0.8 million pre-tax related to employee termination benefits consisting primarily of severance and related fringe benefits. The Company expects the $0.8 million to result in short-term cash outlays. The Company may incur other costs associated with the announced restructuring activities.

On October 29, 2007, the Company declared a dividend distribution of one common share purchase right for each outstanding share of its common stock (the “Rights”). If a person becomes an Acquiring Person, each Right will entitle its holder to purchase, at the Right’s exercise price, a number of shares of the Company’s common stock having a market value at the time of twice the exercise price of $27. Rights held by the Acquiring Person become void and are not exercisable to purchase shares at the bargain purchase price. An Acquiring Person is defined as a person who acquires 20% or more of the Company’s outstanding common stock (other than a shareholder who beneficially owns more than 20% of the outstanding shares of Common Stock on October 29, 2007, who will be precluded from acquiring any additional shares). In effect, this would enable a holder of Rights (other than an Acquiring Person) to purchase $54 worth of common stock at half price. Additionally, at any time after any person or group becomes an Acquiring Person and prior to the acquisition by such person or group of 50% or more of the outstanding shares of Common Stock the Board of Directors may exchange the Rights (other than Rights owned by such person or group which will have become void), in whole or in part, at an exchange ratio of one share of our common stock, (or of a share of a similar class or series of our common stock having similar rights, preferences and privileges) of equivalent value, per Right (subject to adjustment). The Board of Directors is entitled to redeem the rights at $.01 per right at any time before a person has acquired 20% or more of the outstanding common stock. The rights plan expires on October 28, 2010. The Board of Directors has also resolved to submit the continuation of the Plan to a shareholder vote within 12 months of the adoption of the rights plan.

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

FORWARD-LOOKING STATEMENTS

This quarterly report on Form 10-Q contains forward-looking statements. Forward-looking statements include any statements related to our expectations regarding future performance or conditions, including any statements regarding anticipated sales growth across markets, distribution channels, and product categories, expenses and gross margins, expense as a percentage of revenue, anticipated earnings, new product introductions, acquisition of manufacturing operations in Asia, future capital expenditures, anticipated tax benefits, financing and working capital requirements and resources. These forward-looking statements, and others we make from time to time, are subject to a number of risks and uncertainties. Many factors could cause actual results to differ materially from those projected in forward-looking statements, including the risks described in our most recent Annual Report on Form 10-K. We do not undertake any duty to update forward-looking statements after the date they are made or to conform them to actual results or to changes in circumstances or expectations.

This Management’s Discussion and Analysis of Financial Condition and Results of Operation (the “MD&A”) should be read in conjunction with our consolidated financial statements and related notes located at Item 1 of this Form 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.

SUMMARY OF THE THIRDFIRST QUARTER 20072008 RESULTS

Net sales for the thirdfirst quarter of 20072008 were $133.6$129.6 million, compared to $159.6$137.0 million in the same quarter of 2006,2007, a decrease of 16.3%$7.4 million or 5.4%. Gross profit margins decreased to 39.5%43.2% in the thirdfirst quarter of 2007,2008, compared to 45.2%45.6% in the same quarter of 2006,2007, as a result of changes in product and channel mix and lower sales volume in our Fitness Equipment business. ThisNorth America markets along with a sale of close-out equipment during the quarter. The decrease in sales is primarily due to a soft North American market for home exercise strength products. equipment which led to decreased sales across all channels, but primarily in our rod-based products in the direct and retail channels, offset by increased sales of the Revolution products in the Direct Channel.

Operating expenses for the thirdfirst quarter of 20072008 were $74.4$64.2 million compared to $60.9$61.8 million in the same quarter of 2006,the prior year, an increase of 22.2%4.0%. ThisThe increase in operating expenses is primarily due to the Company’s agreement to make an $8.0 million payment in the second quarter as settlement of all claims arising out of or related to an increase of $4.8 million in our bad debt reserve resulting from a former customer that has filed Chapter 11 bankruptcy, costs of $2.3 million associated with the termination of the employmentagreement to purchase the Land America manufacturing facility in China. In addition, the Company incurred $2.4 million of termination costs in the first quarter of 2008 related to the departure of our former CEO, additional direct marketing spend of $0.9 million and incremental marketing spend of $1.1 million and $0.4 million in our International and Apparel business segments as we realized top line growth in these businesses.CEO. These factors led to a quarterly operating loss of $21.6 million compared to operating income of $11.1 million in the third quarter of 2006. Diluted loss per share for the quarter was 43 cents, compared to earnings of 29 cents per share a year ago. During the third quarter of 2006, we recorded a $3.0 million reduction of tax contingency reserveexpenses were partially offset by reduced costs as a result of closing certain statutory periods. our ongoing restructuring activities.

In October 2007, we announced a reductionApril 2008, the Company completed the sale of its fitness apparel division. Accordingly, the results of operations associated with that division have been presented in force of approximately 140 employees, or 9% of our workforce. The staff reduction includes the elimination of positions in most areas of the Company.consolidated financial statements as discontinued operations.

RESULTS OF OPERATIONS FOR THE THREE MONTHS ENDED SEPTEMBER 30,MARCH 31, 2008 AND 2007 AND 2006

The following tables present certain consolidated financial data as a percentage of net sales and statement of operations data comparing results for the three months ended September 30, 2007March 31, 2008 and 2006:2007: