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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2003
Commission file number: 000-25867
THE NAUTILUS GROUP, INC.
(Exact name of registrant as specified in its charter)
Washington 94-3002667
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
1400 NE 136th Avenue
Vancouver, Washington 98684
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(Address of principal executive offices, including zip code)
(360) 694-7722
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(Issuer'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 issuer 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 an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).
Yes [X] No [ ]
Number of shares of issuer's common stock outstanding as of August 8, 2003:
32,599,073
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THE NAUTILUS GROUP, INC.
JUNE 30, 2003
INDEX TO FORM 10-Q
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 15
Item 3. Quantitative and Qualitative Disclosures About Market Risk 24
Item 4. Controls and Procedures 25
PART II - OTHER INFORMATION
Item 1. Legal Proceedings 26
Item 4. Submission of Matters to a Vote of Security Holders 26
Item 6. Exhibits and Reports on Form 8-K 26
Signatures 28
-2-
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
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THE NAUTILUS GROUP, INC.
CONSOLIDATED BALANCE SHEETS
(In Thousands, Except Share Data)
(Unaudited)
JUNE 30, DECEMBER 31,
ASSETS 2003 2002
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CURRENT ASSETS:
Cash and cash equivalents $ 59,730 $ 31,719
Short-term investments, at amortized cost -- 17,578
Trade receivables (less allowance for doubtful accounts of
$2,643 and $3,147 in 2003 and 2002, respectively) 36,972 50,099
Inventories 62,282 63,798
Prepaid expenses and other current assets 3,802 4,919
Short-term notes receivable 3,058 3,067
Current deferred tax asset 3,905 2,924
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Total current assets 169,749 174,104
LONG-TERM NOTE RECEIVABLE 181 363
PROPERTY, PLANT AND EQUIPMENT, net 54,739 55,564
GOODWILL 29,755 29,755
OTHER ASSETS, net 16,432 16,867
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TOTAL ASSETS $ 270,856 $ 276,653
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Trade payables $ 21,735 $ 41,288
Accrued liabilities 17,212 15,827
Income taxes payable 4,191 5,284
Royalty payable to stockholders 1,450 1,997
Customer deposits 1,033 685
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Total current liabilities 45,621 65,081
LONG-TERM DEFERRED TAX LIABILITY 10,560 9,149
COMMITMENTS AND CONTINGENCIES (Note 13)
STOCKHOLDERS' EQUITY:
Common stock - authorized, 75,000,000 shares of no par value;
issued and outstanding, 32,590,198 and 32,473,897 shares
at June 30, 2003 and December 31, 2002, respectively 999 --
Retained earnings 212,086 201,238
Accumulated other comprehensive income 1,590 1,185
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Total stockholders' equity 214,675 202,423
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TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 270,856 $ 276,653
========== ==========
See notes to consolidated financial statements.
-3-
THE NAUTILUS GROUP, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(In Thousands, Except Share and Per Share Data)
(Unaudited)
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
--------------------------- ---------------------------
2003 2002 2003 2002
----------- ----------- ----------- -----------
NET SALES $ 100,602 $ 140,408 $ 230,051 $ 276,322
COST OF SALES 48,203 56,571 107,636 115,252
----------- ----------- ----------- -----------
Gross profit 52,399 83,837 122,415 161,070
OPERATING EXPENSES:
Selling and marketing 35,695 34,091 75,196 65,691
General and administrative 8,752 7,412 15,650 13,704
Related-party royalties 1,450 2,413 3,241 4,561
Third-party royalties 337 152 636 333
----------- ----------- ----------- -----------
Total operating expenses 46,234 44,068 94,723 84,289
----------- ----------- ----------- -----------
OPERATING INCOME 6,165 39,769 27,692 76,781
OTHER INCOME:
Interest income 230 477 459 927
Other, net 945 107 578 82
----------- ----------- ----------- -----------
Total other income, net 1,175 584 1,037 1,009
----------- ----------- ----------- -----------
INCOME BEFORE INCOME TAXES 7,340 40,353 28,729 77,790
INCOME TAX EXPENSE 2,642 14,527 10,342 28,006
----------- ----------- ----------- -----------
NET INCOME $ 4,698 $ 25,826 $ 18,387 $ 49,784
=========== =========== =========== ===========
BASIC EARNINGS PER SHARE $ 0.14 $ 0.73 $ 0.56 $ 1.42
DILUTED EARNINGS PER SHARE $ 0.14 $ 0.72 $ 0.56 $ 1.39
Weighted average shares outstanding:
Basic shares outstanding 32,564,141 35,173,064 32,557,475 35,091,136
Diluted shares outstanding 32,621,774 36,060,891 32,584,219 35,921,542
See notes to consolidated financial statements.
-4-
THE NAUTILUS GROUP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In Thousands)
(Unaudited)
SIX MONTHS ENDED JUNE 30,
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2003 2002
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CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 18,387 $ 49,784
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization 5,630 2,861
(Gain) loss on sale of property, plant and equipment 43 (25)
Tax benefit of exercise of nonqualified options 516 2,674
Deferred income taxes 429 1,257
Changes in assets and liabilities, net of the effect of acquisitions:
Trade receivables 13,776 11,188
Inventories 1,901 (16,581)
Prepaid expenses and other current assets 1,484 (958)
Trade payables (19,699) (248)
Income taxes payable (1,099) (500)
Accrued liabilities and royalty payable to stockholders 541 746
Customer deposits 348 142
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Net cash provided by operating activities 22,257 50,340
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CASH FLOWS FROM INVESTING ACTIVITIES:
Additions to property, plant and equipment (4,619) (14,006)
Proceeds from sale of property, plant and equipment 6 25
(Increase) decrease in other assets 255 (590)
Acquisitions, net of cash acquired -- (24,992)
Purchases of short-term investments -- (25,674)
Proceeds from maturities of short-term investments 17,578 16,336
(Increase) decrease in notes receivable 191 (136)
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Net cash provided by (used in) investing activities 13,411 (49,037)
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CASH FLOWS FROM FINANCING ACTIVITIES:
Cash dividends paid on common stock (6,509) --
Stock repurchases (1,422) (9,087)
Proceeds from exercise of stock options 875 2,114
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Net cash used in financing activities (7,056) (6,973)
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Effect of Foreign Currency Exchange Rate Changes (601) 716
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(Continued)
-5-
THE NAUTILUS GROUP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In Thousands)
(Unaudited)
SIX MONTHS ENDED JUNE 30,
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2003 2002
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NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS $ 28,011 $ (4,954)
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 31,719 35,639
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CASH AND CASH EQUIVALENTS, END OF PERIOD $ 59,730 $ 30,685
========== ==========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW
INFORMATION:
Cash paid for income taxes $ 10,503 $ 24,500
See notes to consolidated financial statements. (Concluded)
-6-
THE NAUTILUS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In Thousands, Except Share and Per Share Data)
(Unaudited)
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1. BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements of The
Nautilus Group, Inc. have been prepared in accordance with accounting
principles generally accepted in the United States of America ("generally
accepted accounting principles") and pursuant to Securities and Exchange
Commission rules and regulations. Certain information and footnote
disclosures normally included in financial statements prepared in
accordance with generally accepted accounting principles have been
condensed or omitted pursuant to such rules and regulations. 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, 2002.
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 six
months ended June 30, 2003 are not necessarily indicative of the results to
be expected for the full year.
Consolidation - The consolidated financial statements include The Nautilus
Group, Inc. and its wholly-owned subsidiaries (collectively the "Company").
All intercompany transactions and balances have been eliminated.
Recent Accounting Pronouncements - In July 2002, the Financial Accounting
Standards Board ("FASB") issued Statement of Financial Accounting Standards
("SFAS") No. 146, Accounting for Costs Associated with Exit or Disposal
Activities. The standard requires companies to recognize costs associated
with exit or disposal activities when they are incurred rather than at the
date of commitment to an exit or disposal plan. Costs covered by the
standard include lease termination costs and certain employee severance
costs that are associated with a restructuring, discontinued operation,
plant closing, or other exit or disposal activity. The Company adopted this
statement as of January 1, 2003, and the adoption of SFAS No. 146 has not
had a material effect on the Company's financial position, results of
operations, or cash flows.
In December 2002, the FASB issued SFAS No. 148, Accounting for Stock-Based
Compensation - Transition and Disclosure. SFAS No. 148 amends SFAS No. 123,
Accounting for Stock-Based Compensation, to provide alternative methods of
transition for an entity that voluntarily changes to the fair value based
method of accounting for stock-based employee compensation. It also amends
the disclosure provisions of SFAS No. 123 to require prominent disclosure
about the effects on reported net income of an entity's accounting policy
decisions with respect to stock-based employee compensation. Finally, this
statement amends APB Opinion No. 28, Interim Financial Reporting, to
require disclosure about those effects in interim financial information.
The Company adopted SFAS No. 148 in the fourth quarter of 2002. Since the
Company has not changed to a fair value method of stock-based compensation,
the applicable portion of this statement only affects our disclosures.
-7-
Through the period ended June 30, 2003, the Company has not recognized
compensation expense relating to employee stock options because it has only
granted options with an exercise price equal to the fair value of the stock
on the effective date of grant. If the Company had elected to recognize
compensation expense using a fair value approach, and therefore determined
the compensation based on the value as determined by the Black-Scholes
option pricing model, the pro forma net income and earnings per share would
have been as follows:
Three Months Ended Six Months Ended
June 30, June 30,
---------------------- ----------------------
2003 2002 2003 2002
-------- -------- -------- --------
Net income, as reported $ 4,698 $ 25,826 $ 18,387 $ 49,784
Stock-based employee compensation
expense, net of tax (832) (716) (1,677) (1,535)
-------- -------- -------- --------
Net income, pro forma $ 3,866 $ 25,110 $ 16,710 $ 48,249
======== ======== ======== ========
Basic earnings per share, as reported $ 0.14 $ 0.73 $ 0.56 $ 1.42
Basic earnings per share, pro forma $ 0.12 $ 0.71 $ 0.51 $ 1.37
Diluted earnings per share, as reported $ 0.14 $ 0.72 $ 0.56 $ 1.39
Diluted earnings per share, pro forma $ 0.12 $ 0.70 $ 0.51 $ 1.34
The pro forma amounts may not be indicative of the effects on reported net
income for future periods due to the effect of options vesting over a
period of years and the granting of stock compensation awards in future
years.
Refer to Note 9 for further information regarding the Company's stock
option plan.
Reclassifications - Certain amounts from 2002 have been reclassified to
conform to the 2003 presentation with no effect on previously reported
consolidated net income or stockholders' equity.
2. ACQUISITIONS
Effective February 8, 2002, the Company acquired the trade receivables,
inventories, prepaid expenses and other current assets, property, plant and
equipment, certain intangible assets and the foreign subsidiaries of
StairMaster Sports/Medical, Inc. ("StairMaster") for a cash purchase price
of approximately $24,924 including acquisition costs.
The Company has determined that the intangible asset associated with the
StairMaster acquisition has an indefinite useful life and thus will not be
amortized. The Company will evaluate the useful life of the trademark each
reporting period to determine whether events or circumstances warrant a
revision to the indefinite useful life assumption or if the asset should be
tested for impairment.
-8-
The total cost of the StairMaster acquisition has been allocated to the
assets acquired and liabilities assumed as follows:
Cash and cash equivalents $ 793
Trade receivables 8,025
Inventories 6,158
Prepaid expenses and other current assets 2,381
Property, plant and equipment 4,807
Trademark 6,115
Liabilities assumed (3,355)
-------
Total acquisition cost $24,924
=======
The allocation of the StairMaster acquisition cost and final purchase price
above reflects all adjustments made subsequent to the first quarter of 2002
when the initial purchase took place. The results of operations subsequent
to the date of the StairMaster acquisition are included in the consolidated
financial statements of the Company.
The unaudited pro forma financial information below for the six months
ended June 30, 2002 was prepared as if the transaction involving the
acquisition of StairMaster had occurred at the beginning of the period
presented:
Net sales $ 282,601
Net income $ 50,008
Basic earnings per share $ 1.43
Diluted earnings per share $ 1.39
The unaudited pro forma financial information is not necessarily indicative
of what actual results would have been had the transaction occurred at the
beginning of the period, nor does it purport to indicate the results of
future operations of the Company.
3. INVENTORIES
Inventories consisted of the following:
June 30, December 31,
2003 2002
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Finished goods $ 42,327 $ 45,317
Work-in-process 1,708 1,317
Parts and components 18,247 17,164
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Inventories $ 62,282 $ 63,798
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-9-
4. PROPERTY, PLANT AND EQUIPMENT, net
Property, plant and equipment consisted of the following:
Estimated
Useful Life June 30, December 31,
(in years) 2003 2002
----------- ---------- ----------
Land N/A $ 3,468 $ 3,468
Buildings 31.5 21,950 21,839
Computer equipment 2 to 5 28,480 26,252
Production equipment 5 14,881 13,647
Furniture and fixtures 5 1,634 1,433
Automobiles and trucks 7 600 549
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Total property, plant and equipment 71,013 67,188
Accumulated depreciation (16,274) (11,624)
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Property, plant and equipment, net $ 54,739 $ 55,564
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5. GOODWILL AND OTHER ASSETS, net
Other assets consisted of the following:
Estimated
Useful Life June 30, December 31,
(in years) 2003 2002
----------- ---------- ----------
Indefinite life trademarks N/A $ 10,465 $ 10,465
Definite life trademark 20 6,800 6,800
Other assets 1-17 542 797
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Total other assets 17,807 18,062
Accumulated amortization (1,375) (1,195)
-------- --------
Other assets, net $ 16,432 $ 16,867
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The Company evaluates goodwill and intangible assets with indefinite lives
for impairment annually or more frequently if events or changes in
circumstance indicate that such assets might be impaired. Intangible assets
with finite useful lives are tested for impairment whenever events or
changes in circumstance indicate that such assets might be impaired. The
remaining useful lives of intangible assets with finite useful lives are
evaluated annually to determine whether events or circumstances warrant
changes in the estimated useful lives of such assets.
Amortization of intangible assets for the three and six months ended June
30, 2003 was $90 and $180, respectively. The estimated amortization expense
for the next five years is $360 per year. Such estimated amortization will
change if businesses or portions thereof are either acquired or disposed,
or if changes in events or circumstances warrant the revision of estimated
useful lives.
-10-
6. ACCRUED LIABILITIES
Accrued liabilities consisted of the following:
June 30, December 31,
2003 2002
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Accrued payroll $ 5,325 $ 5,436
Accrued warranty expense 7,661 5,358
Sales return reserve 1,400 2,550
Other 2,826 2,483
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Accrued liabilities $ 17,212 $ 15,827
========== ==========
7. COMPREHENSIVE INCOME
Comprehensive income and its components are as follows:
Three Months Ended Six Months Ended
June 30, June 30,
------------------ ------------------
2003 2002 2003 2002
------- ------- ------- -------
Net income $ 4,698 $25,826 $18,387 $49,784
Foreign currency translation
adjustments 384 789 405 716
------- ------- ------- -------
Comprehensive income $ 5,082 $26,615 $18,792 $50,500
======= ======= ======= =======
Accumulated other comprehensive income at June 30, 2003 and December 31,
2002 is due to the foreign currency translation adjustment to the financial
statements of the foreign subsidiaries.
8. RESEARCH AND DEVELOPMENT
Internal research and development costs are expensed as incurred and
included in cost of sales. Third party research and development costs are
expensed when the work has been performed.
Research and development expense was $1,131 and $1,088 for the three months
ended June 30, 2003 and 2002, respectively. Research and development
expense was $2,486 and $1,861 for the six months ended June 30, 2003 and
2002, respectively.
9. STOCK OPTIONS
There were 216,601 options exercised at prices ranging from $1.37 to $13.78
per share during the six months ended June 30, 2003. There were 73,000 new
options granted at exercise prices ranging from $11.91 to $12.80 per share
during that period. There were 54,783 options canceled at prices ranging
from $6.98 to $34.05 per share during the six months ended June 30, 2003.
10. OPERATING SEGMENTS
The Company's operating segments include its direct, commercial/retail, and
corporate segments. The direct segment includes all products and related
operations involved in marketing to consumers through a variety of direct
marketing channels. The Bowflex and TreadClimber lines of fitness equipment
and
-11-
Nautilus Sleep Systems are the principal products in the Company's direct
segment. The commercial/retail segment includes all products and related
operations that do not involve direct marketing to consumers. Products in
this segment include Nautilus, Schwinn, StairMaster, Trimline, and Bowflex
commercial and retail fitness equipment and accessories. Beginning in 2003,
the Company augmented its segment reporting with the addition of a separate
reporting segment to reflect the extra-divisional activities associated
with the corporate holding company. Included in the segment information is
comparative data assuming the corporate holding company existed at January
1, 2002.
The following table presents selected information about the Company's three
operating segments:
Commercial/
Direct Retail Corporate Total
-------------------- -------------------- --------------------- --------------------
Three Six Three Six Three Six Three Six
Months Months Months Months Months Months Months Months
-------- -------- -------- -------- -------- -------- -------- --------
Period Ended June 30, 2003
Net sales $ 56,963 $135,894 $ 43,639 $ 94,157 $ -- $ -- $100,602 $230,051
======== ======== ======== ======== ======== ======== ======== ========
Segment net income (loss) $ 3,274 $ 15,195 $ 2,166 $ 4,929 $ (742) $ (1,737) $ 4,698 $ 18,387
======== ======== ======== ======== ======== ======== ======== ========
Period Ended June 30, 2002
Net sales $103,088 $194,170 $ 37,320 $ 82,152 $ -- $ -- $140,408 $276,322
======== ======== ======== ======== ======== ======== ======== ========
Segment net income (loss) $ 26,371 $ 49,215 $ 228 $ 2,145 $ (773) $ (1,576) $ 25,826 $ 49,784
======== ======== ======== ======== ======== ======== ======== ========
Commercial/
Direct Retail Corporate Total
-------- -------- -------- --------
As of June 30, 2003
Segment assets $ 51,520 $134,337 $ 84,999 $270,856
======== ======== ======== ========
As of December 31, 2002
Segment assets $ 52,251 $149,559 $ 74,843 $276,653
======== ======== ======== ========
11. EARNINGS PER SHARE
Basic earnings per share is computed on the basis of the weighted average
number of common shares outstanding. Diluted earnings per share is computed
on the basis of the weighted average number of common shares outstanding
plus the effect of outstanding stock options calculated using the treasury
stock method. Net income for the calculation of both basic and diluted
earnings per share is the same as reported net income for all periods.
The calculation of weighted-average outstanding shares is as follows:
Three Months Ended Three Months Ended
June 30, 2003 June 30, 2002
------------------------------------ ------------------------------------
Per Share Per Share
Income Shares Amount Income Shares Amount
-------- ---------- ------ -------- ---------- ------
Basic EPS:
Net income $ 4,698 32,564,141 $ 0.14 $ 25,826 35,173,064 $ 0.73
Effect of dilutive securities:
Stock options -- 57,633 0.00 -- 887,827 (0.01)
-------- ---------- ------ -------- ---------- ------
Diluted EPS:
Net income $ 4,698 32,621,774 $ 0.14 $ 25,826 36,060,891 $ 0.72
======== ========== ====== ======== ========== ======
-12-
Six Months Ended Six Months Ended
June 30, 2003 June 30, 2002
------------------------------------ ------------------------------------
Per Share Per Share
Income Shares Amount Income Shares Amount
-------- ---------- ------ -------- ---------- ------
Basic EPS:
Net income $ 18,387 32,557,475 $ 0.56 $ 49,784 35,091,136 $ 1.42
Effect of dilutive securities:
Stock options -- 26,744 0.00 -- 830,406 (0.03)
-------- ---------- ------ -------- ---------- ------
Diluted EPS:
Net income $ 18,387 32,584,219 $ 0.56 $ 49,784 35,921,542 $ 1.39
======== ========== ====== ======== ========== ======
Out of 1,401,603 total options outstanding, 1,213,669 options were not
included in the calculation of diluted earnings per share for the three and
six months ended June 30, 2003 because they would be antidilutive. Out of
1,659,810 total options outstanding, 22,000 options were not included in
the calculation of diluted earnings per share for the three and six months
ended June 30, 2002 because they would be antidilutive.
12. STOCK REPURCHASE PROGRAM
In January 2003, the Board of Directors authorized the expenditure of up to
$50,000 to purchase shares of the Company's common stock in open-market
transactions. During the six months ended June 30, 2003, the Company
repurchased a total of 100,300 shares of common stock in open market
transactions for an aggregate purchase price of $1,422. The authorization
expired on June 30, 2003.
13. COMMITMENTS AND CONTINGENCIES
The Company is subject to litigation, claims and assessments in the
ordinary course of business, many of which 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.
In December 2002, the Company filed suit against ICON Health and Fitness,
Inc. ("ICON") in the Federal District Court, Western District of Washington
(the "Court") alleging infringement by ICON of the Company's Bowflex
patents. The Company seeks injunctive relief, unquantified treble damages
and its fees and costs. In May 2003, the Court denied the Company's motion
for a preliminary injunction and granted partial summary judgment to ICON
on the issue of "literal infringement." The Company has appealed this
motion denying our preliminary injunction on literal patent infringement,
and a hearing on this appeal is scheduled to be heard in September 2003.
In July 2003, the Court ruled in favor of the Company 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. In its ruling, the Court concluded that the Company showed "a
probability of success on the merits and irreparable injury" on its
trademark infringement claim. In August 2003, the United States Court of
Appeals for the Federal Circuit granted ICON a temporary stay regarding the
motion for a preliminary injunction enjoining ICON from using the trademark
"CrossBow". This stay allows ICON to continue using the trademark
"CrossBow" until a decision is issued by the Federal Circuit Court of
Appeals.
14. RELATED-PARTY TRANSACTIONS
The Company incurred royalty expense under an agreement with a stockholder
of the Company of $1,450 and $2,413 for the three months ended June 30,
2003 and 2002, respectively. The Company incurred royalty expense of $3,241
and $4,561 for the six months ended June 30, 2003 and 2002,
-13-
respectively. In addition to the royalty agreement, the stockholder has
separately negotiated an agreement dated June 18, 1992, when the Company
was privately held, between the stockholder, the Company's current Chairman
and former Chief Executive Officer ("Chairman"), and a former director of
the Company. That separate agreement stipulates that annual royalties above
$90 would be paid 60% to the stockholder, 20% to the Chairman and 20% to
the former director.
-14-
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
- -------------------------------------------------------------------------------
OF OPERATIONS
- -------------
FORWARD-LOOKING STATEMENTS
Certain statements contained in this Form 10-Q, including, without limitation,
statements containing the words "could," "may," "will," "should," "plan,"
"believes," "anticipates," "estimates," "predicts," "expects," "projections,"
"potential," "continue," or words of similar import, constitute "forward-looking
statements." Investors are cautioned that all forward-looking statements involve
risks and uncertainties, and various factors could cause actual results to
differ materially from those in the forward-looking statements. From time to
time and in this Form 10-Q, we may make forward-looking statements relating to
our financial performance, including the following:
o Anticipated revenues, expenses, and gross margins;
o Seasonal patterns;
o Expense as a percentage of revenue;
o Anticipated earnings;
o New product introductions; and
o Future capital expenditures.
Numerous factors could affect our actual results, including the following:
o The availability of media time and fluctuating advertising costs;
o A decline in consumer spending due to unfavorable economic conditions;
o Expiration of important patents;
o Our reliance on a limited product line;
o Our ability to effectively develop, market, and sell future products;
o Our ability to adequately protect our intellectual property;
o Our ability to integrate any acquired businesses into our operations;
o Our reliance on the consumer finance market;
o Our reliance on third-party manufacturers;
o Government regulatory action; and
o Changes in foreign conditions that could impair our international sales.
We describe certain of these and other key risk factors elsewhere in more detail
in this Form 10-Q and in our most recent Annual Report on Form 10-K. Although we
believe the expectations reflected in the forward-looking statements are
reasonable, we cannot guarantee future results, levels of activity, performance,
or achievements. 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-Q or to reflect the occurrence of unanticipated
events.
CRITICAL ACCOUNTING POLICIES
Certain accounting policies are presented in consideration of their significance
for our Company. These critical policies involve the most complex or subjective
decisions or assessments and consist of warranty reserves, sales return
reserves, the allowance for doubtful accounts, inventory valuation, and
intangible asset valuation.
-15-
Warranty Reserves
The product warranty reserve includes the cost to manufacture (raw materials,
labor and overhead) or purchase warranty parts from our suppliers as well as the
cost to ship those parts to our customers. The cost of labor to install a
warranted part on our manufactured commercial equipment is also included. The
warranty reserve is based on our historical experience with each product. A
warranty reserve is established for new products based on historical experience
with similar products, adjusted for any technological advances in manufacturing
or materials used. We track warranty claims by part and reason for claim in
order to identify any potential warranty trends. The warranty trends are
evaluated periodically with respect to future volume and nature of likely
claims. Adjustments, if any are so indicated, are made to the warranty reserve
to reflect our judgment regarding the likely effect of the warranty trends on
future claims. If we were to experience a significant volume of warranty claims
for a particular part or for a particular reason, we may need to make design
changes to our product, some of which may be required for our warranted
products. A change in warranty experience could have a significant impact on our
financial position, results of operations and cash flows.
Sales Return Reserves
The sales return reserve is maintained based on our historical experience of
product return rates during the period in which a customer can return a product
for refund of the full purchase price, less shipping and handling in most
instances. The return periods for Bowflex, TreadClimber, Champion Nutrition, and
Nautilus Sleep Systems product lines are six weeks, 30 days, 30 days, and 90
days, respectively. Return periods are not offered on our other product lines.
We track all product returns in order to identify any potential customer
satisfaction trends. Our return reserve may be sensitive to a change in our
customers' ability to pay during the trial period due to unforeseen economic
circumstances and to different product introductions that might fulfill the
customers' needs at a perceived better value. Any major change in the
aforementioned factors may increase sales returns, which could have a
significant impact on our financial position, results of operations and cash
flows.
Allowance for Doubtful Accounts
The allowance for doubtful accounts is maintained at a level based on our
historical experience adjusted for any known uncollectible amounts. We
periodically review the creditworthiness of our customers to help gauge
collectibility. Our allowance is sensitive to changes in our customers' ability
to pay due to unforeseen changes in the economy, including the bankruptcy of a
major customer, our efforts to actively pursue collections, and increases in
chargebacks. Any major change in the aforementioned factors may result in
increasing the allowance for doubtful accounts, which could have a significant
impact on our financial position, results of operations and cash flows.
Inventory Valuation
Our inventory is valued at either the lower of cost (standard or average
depending on location) or market. Inventory adjustments are applied for any
known obsolete or defective products. We periodically review inventory levels of
our product lines in conjunction with market trends to assess salability of our
products. Our assessment of necessary adjustments to market value of inventory
is sensitive to changes in fitness technology and competitor product offerings
driven by customer demand. Any major change in the aforementioned factors may
result in reductions to market value of inventory below cost, which could have a
significant impact on our financial position, results of operations and cash
flows.
-16-
Intangible Asset Valuation
Currently, intangible assets consist predominantly of the Nautilus, Schwinn, and
StairMaster trademarks and goodwill associated with the acquisition of Schwinn
Fitness. Management estimates affecting these trademark and goodwill valuations
include determination of useful lives and estimates of future cash flows and
fair values to perform an impairment analysis on an annual basis. The useful
lives assigned by management to the Nautilus, Schwinn, and StairMaster
trademarks and Schwinn Fitness goodwill are indefinite, 20 years, indefinite,
and indefinite, respectively. Any major change in the useful lives and/or the
determination of an impairment associated with the valuation of the
aforementioned intangible assets may result in asset value write-downs, which
could have a significant impact on our current and future financial position and
results of operations.
RESULTS OF OPERATIONS
We believe that period-to-period comparisons of our operating results are not
necessarily indicative of future performance. You should consider our prospects
in light of the risks, expenses and difficulties frequently encountered by
companies that operate in evolving markets.
STATEMENT OF OPERATIONS DATA - THREE MONTHS ENDED JUNE 30
The following table presents certain financial data regarding our second quarter
operations in 2003 and 2002, as a percentage of total revenues:
Quarter Ended June 30,
STATEMENT OF OPERATIONS DATA ----------------------
2003 2002
------ ------
Net sales 100.0% 100.0%
Cost of sales 47.9 40.3
------ ------
Gross profit 52.1 59.7
Operating expenses:
Selling and marketing 35.5 24.3
General and administrative 8.7 5.3
Royalties 1.8 1.8
------ ------
Total operating expenses 46.0 31.4
------ ------
Operating income 6.1 28.3
Other income, net 1.2 0.4
------ ------
Income before income taxes 7.3 28.7
Income tax expense 2.6 10.3
------ ------
Net income 4.7% 18.4%
====== ======
-17-
COMPARISON OF THE QUARTERS ENDED JUNE 30, 2003 AND 2002
NET SALES
Net sales decreased by 28.4% to $100.6 million in the second quarter of 2003
from $140.4 million in the second quarter of 2002. The second quarter of 2003
presented a challenging business environment laden with unfavorable economic
conditions to our business. We believe this was due to increased competition
primarily from ICON Health and Fitness, Inc. ("ICON"), higher advertising costs
due to increased demand for advertising time, consumer anxiety about the economy
and war in Iraq, and normal seasonality in our business. We believe these
factors all contributed to lackluster consumer spending for our fitness products
and reduced sales conversion rates for our direct-marketed products.
Sales within our direct segment were $57.0 million in the second quarter of
2003, a decrease of $46.1 million, or 44.7%, compared with the second quarter of
2002. Our direct segment accounted for 57% of our aggregate net sales in the
quarter, down from 73% in the second quarter of 2002. The majority of the sales
in our direct segment are from our Bowflex product line. Additional product
lines within our direct segment consist of Nautilus Sleep Systems and
TreadClimber, which was introduced during the first quarter of 2003. Bowflex
sales accounted for 85% of our direct segment net sales in the second quarter of
2003, down from 92% during the same period in 2002. During the second quarter of
2003, we began a process of reassessing the marketing plan for our Nautilus
Sleep Systems product line. This involves a reduction in the advertising budget
for this product line, which we believe will also result in a reduction in
sales. Consequently, we are no longer projecting sales growth for this product
line in 2003.
The decrease in direct segment sales can be attributed to a combination of
factors including increased competition, lackluster consumer spending attributed
to consumer anxiety about the economy and the war in Iraq, managing our
advertising spending in a higher advertising cost environment to optimize
profitability, and lower demand for fitness products due to normal seasonality.
During the fourth quarter of 2002, ICON began marketing a product called the
"CrossBow" that is similar to our Bowflex products, but carries a lower retail
price. We believe this product violates our Bowflex patents and trademarks and
have filed suit against ICON as detailed in "Part II, Item 1. Legal Proceedings"
of this Form 10-Q. Due to general anxiety about the economy and the war in Iraq,
we believe consumers have become increasingly cautious in their decisions
regarding discretionary spending. We believe the combination of cautious
consumer spending and competing products such as the "CrossBow" has adversely
affected demand for our Bowflex products. In addition to increased competition
and cautious consumer spending, advertising costs have risen considerably when
comparing the second quarter of 2003 to the same period in 2002, resulting in
lower sales of direct-marketed products for comparable advertising spending. The
success of our direct-marketing business is largely dependent upon national
cable television advertising. We believe two unusual events affected sales in
late 2001 and early 2002: (1) the nesting effect as a result of the events of
September 11, 2001 and (2) the high availability of television advertising time.
Both of these contributed very positively to Bowflex sales during the second
quarter of 2002. The nesting effect of September 11, 2001 seems to have receded,
and the advertising environment has firmed up considerably as costs have risen
due to heightened demand for advertising time. Finally, we have found that
influences on television viewership during the second quarter, such as the
broadcast of national network season finales and seasonal weather factors cause
our spot television commercials to be less effective in the second quarter than
in other periods of the year. We believe consumers tend to watch less television
and spend more time outdoors when the weather improves, and consequently, tend
to purchase less indoor fitness equipment and related products during the second
quarter. Contrary to normal seasonal fluctuation, the second quarter of 2002 was
unseasonably strong due to the unusual events described above combined with
strong consumer demand for our Bowflex "Ultimate" model, which was first
introduced late in the fourth quarter of 2001.
-18-
Sales within our commercial/retail segment were $43.6 million in the second
quarter of 2003, an increase of $6.3 million, or 16.9%, over the second quarter
of 2002. The increase in sales within the commercial/retail segment can be
attributed to the recent introduction of the Bowflex to our retail business,
which equated to sales of $6.7 million, or 15% of overall commercial/retail
segment sales, during the second quarter of 2003. Due to encouraging results
from our initial test-marketing plan that began in the first quarter of 2003, we
expanded the retail distribution of Bowflex products during the second quarter
and plan to continue to do so throughout 2003. Besides the newly introduced
Bowflex, our commercial/retail segment product portfolio consists of a wide
array of both strength and cardiovascular fitness products sold through the
commercial and retail channels under brand names that include Nautilus, Schwinn,
StairMaster, and Trimline. Our commercial/retail segment now accounts for 43% of
our total net sales, up from 27% in the second quarter of 2002 as we continue to
execute our strategy of expanding our presence, product lines, and brands across
all our sales channels, especially within the commercial/retail segment. This
increase in commercial/retail segment sales as a percentage of our total net
sales can also be attributed to the decline in direct segment sales during the
second quarter of 2003 compared to the same period in 2002. We believe that
sales within our commercial/retail segment are considerably lower in the second
quarter of the year compared to the other quarters as consumers spend more time
outdoors when the weather improves, and consequently, tend to purchase less
indoor fitness equipment and related products during the second quarter.
GROSS PROFIT
Gross profits fell 37.5% to $52.4 million in the second quarter of 2003 from
$83.8 million in the same period a year ago. As sales of inherently lower margin
products in the commercial/retail segment continue to grow as a percentage of
total sales, our overall gross profit margin decreased to 52.1% in the second
quarter of 2003, compared to 59.7% in the second quarter of 2002. The gross
profit margin within our direct segment was 72.2% in the second quarter of 2003
compared to 72.4% in the second quarter of 2002. The increase in gross margins
within our commercial/retail segment to 25.9% in the second quarter of 2003,
compared with 24.8% in the second quarter of 2002, was largely due to $6.7
million in sales of Bowflex products through the retail channel. For the
remainder of 2003, we expect our combined gross profit margin to be in the range
of 50% to 52%.
OPERATING EXPENSES
Selling and Marketing
Selling and marketing expenses grew to $35.7 million in the second quarter of
2003 from $34.1 million in the same period a year ago, an increase of 4.7%. As a
percentage of net sales, overall selling and marketing expenses increased to
35.5% in the second quarter of 2003 from 24.3% in the second quarter of 2002.
Selling and marketing expenses within our direct segment were 52.2% of net sales
in the second quarter of 2003, compared to 27.7% in the second quarter of 2002.
The increase in selling and marketing expenses as a percentage of sales is due
to declines in our direct segment sales conversion rates coupled with a higher
advertising cost environment. We believe the decline in sales conversion rates
was mostly the result of increased competition combined with lower consumer
confidence due to the war in Iraq and concern about the economy. In addition,
depreciation associated with our newly implemented customer relationship
management information system also contributed to the increase. During the
second quarter of 2003, we began a process of reassessing our marketing plan for
our Nautilus Sleep Systems product line. This involves a reduction in the
advertising budget for this product line, which we believe will result in a
reduction in sales. Selling and marketing expenses within our commercial/retail
segment were 13.7% of net sales in the second quarter of 2003, compared to 14.9%
in the second quarter of 2002. For the remainder of 2003, we expect our combined
selling and marketing expenses to be in the range of 31% to 33% of total sales.
-19-
General and Administrative
General and administrative expenses grew to $8.8 million in the second quarter
of 2003 from $7.4 million in the same period a year ago, an increase of $1.3
million, or 18.1%. As a percentage of net sales, general and administrative
expenses increased to 8.7% in the second quarter of 2003 from 5.3% in the second
quarter of 2002. Our direct segment general and administrative expenses
increased $2.6 million in the second quarter of 2003 compared to the same period
a year ago due primarily to depreciation, consulting costs, and wages associated
with our newly implemented information systems. Commercial/retail segment
general and administrative expenses decreased $0.9 million in the second quarter
of 2003 compared the second quarter of 2002 due mostly to cost savings
associated with the integration of the Schwinn Fitness and StairMaster
businesses that we acquired in September 2001 and February 2002, respectively.
For the remainder of 2003, we expect our combined general and administrative
expenses to be in the range of 6% to 7% of total sales.
Our financial statements now reflect a third segment comprised of our corporate
holding company which will include primarily general and administrative expenses
such as investor relations, director costs, general legal and accounting fees,
and salaries of corporate personnel, as well as other costs not specifically
attributable to our other two segments. For financial reporting purposes, we
have reclassified prior year balances to conform to this three-segment
presentation with no effect on previously reported consolidated net income or
stockholders' equity.
Royalties
Royalty expense declined to $1.8 million in the second quarter of 2003 from $2.6
million in the same period a year ago, a decrease of 30.3%. Our direct and
commercial/retail segments have several agreements under which we are obligated
to pay royalty fees on certain products. The decrease in our royalty expense is
primarily attributable to the decreased sales of our Bowflex products in the
quarter. Our royalty expenses will fluctuate in correlation with sales of our
Bowflex products, and will also be marginally impacted by fluctuations in sales
of other products that have royalty agreements. The patent for the Bowflex Power
Rod resistance technology expires April 27, 2004. We will no longer be obligated
to pay royalties related to Bowflex sales following the expiration of this
patent.
OTHER INCOME
In the second quarter of 2003, other income was $1.2 million compared to $0.6
million for the same period a year ago. The majority of the increase resulted
from proceeds of $0.6 million from a subsequent insurance recovery related to
damaged inventory. Because of lower interest earned on invested cash and cash
equivalents due to lower average interest rates in 2003 coupled with a change to
the use of tax-exempt securities in 2003 in order to maximize tax equivalent
yields, interest income decreased to $0.2 million in the second quarter of 2003
from $0.5 million in the same period a year ago.
INCOME TAX EXPENSE
Income tax expense decreased by $11.9 million to $2.6 million for the second
quarter of 2003 from $14.5 million for the same period of 2002 due to the
decline in our income before taxes. We expect our income tax expense to
fluctuate in line with changes in our income before taxes.
NET INCOME
For the reasons discussed above, net income declined to $4.7 million in the
second quarter of 2003 from $25.8 million in the same period a year ago, a
decrease of 81.8%.
-20-
STATEMENT OF OPERATIONS DATA - SIX MONTHS ENDED JUNE 30
The following table presents certain financial data regarding operations for the
first six months in 2003 and 2002, as a percentage of total revenues:
Six Months Ended June 30,
----------------------
Statement of Operations Data 2003 2002
---- ----
Net sales 100.0% 100.0%
Cost of sales 46.8 41.7
---- ----
Gross profit 53.2 58.3
Operating expenses:
Selling and marketing 32.7 23.8
General and administrative 6.8 4.9
Royalties 1.7 1.8
---- ----
Total operating expenses 41.2 30.5
---- ----
Operating income 12.0 27.8
Other income, net 0.5 0.3
---- ----
Income before income taxes 12.5 28.1
Income tax expense 4.5 10.1
---- ----
Net income 8.0% 18.0%
==== ====
COMPARISON OF THE SIX MONTHS ENDED JUNE 30, 2003 AND 2002
NET SALES
Net sales decreased by 16.7% to $230.1 million in the first six months of 2003
from $276.3 million in the same period in 2002. The first six months of 2003
presented a challenging business environment laden with unfavorable economic
conditions to our business. We believe this was due to increased competition,
higher advertising costs due to increased demand for advertising time, and
consumer anxiety about the economy and the war in Iraq. We believe these factors
all contributed to lackluster consumer spending for our fitness products and
reduced sales conversion rates for our direct-marketed products.
Sales within our direct segment were $135.9 million in the first six months of
2003, a decrease of 30.0% compared with the same period in 2002. Our direct
segment accounted for 59% of our aggregate net sales in the first six months,
down from 70% in the same period in 2002. The decrease in direct segment sales
can be attributed to a combination of factors including increased competition,
lackluster consumer spending attributed to consumer anxiety about the economy
and the war in Iraq, and managing our advertising spending in a higher
advertising cost environment to optimize profitability.
Sales within our commercial/retail segment were $94.2 million in the first six
months of 2003, an increase of 14.6% over the same period in 2002. Excluding our
acquisition of StairMaster, commercial/retail segment sales grew 12.1% during
the first six months of 2003 compared to the same period in 2002. The increase
in sales within the commercial/retail segment can be attributed to the
introduction of the Bowflex to the retail side of the business, which equated to
sales of $11.3 million, or 12% of overall commercial/retail segment
-21-
sales, during the first six months of 2003. For the first six months of 2003,
our commercial/retail segment accounted for 41% of our net sales, up from 30% in
the same period in 2002 as we continued to execute our strategy of expanding our
presence, product lines, and brands across all our sales channels, especially
within the commercial/retail segment. This increase in commercial/retail segment
sales as a percentage of our total net sales can also be attributed to the
decline in direct segment sales during the first six months of 2003 compared to
the same period in 2002. During the first six months of 2003, our
commercial/retail business segment sales were comparable to sales in the same
period during 2002, excluding the introduction of the Bowflex product line to
the retail sales channel.
GROSS PROFIT
Gross profits fell 24.0% to $122.4 million in the first six months of 2003 from
$161.1 million in the same period a year ago. As sales of inherently lower
margin products in the commercial/retail segment continued to grow as a
percentage of total sales, our overall gross profit margin decreased to 53.2% in
the first six months of 2003, compared to 58.3% in the same period in 2002. The
gross profit margin within our direct segment was 71.7% in the first six months
of 2003 compared to 72.3% for the same period in 2002. The increase in gross
margin within our commercial/retail segment to 26.6% in the first six months of
2003, compared with 25.2% in the same period in 2002, was largely due to $11.3
million in sales of Bowflex products through the retail channel.
OPERATING EXPENSES
Selling and Marketing
Selling and marketing expenses grew to $75.2 million in the first six months of
2003 from $65.7 million in the same period a year ago, an increase of 14.5%. As
a percentage of net sales, overall selling and marketing expenses increased to
32.7% in the first six months of 2003 from 23.8% in the same period in 2002.
Selling and marketing expenses within our direct segment were 46.1% of net sales
in the first six months of 2003, compared to 28.2% in the same period in 2002.
The overall increase in selling and marketing expenses in absolute dollars and
as a percentage of sales is mainly due to an increase in direct marketing
advertising spending during the first quarter of 2003 in response to declines in
our sales conversion rates coupled with a higher advertising cost environment.
We believe the decline in conversion was a result of increased competition
combined with lower consumer confidence due to the war in Iraq and concern about
the economy. In addition, depreciation associated with our newly implemented
customer relationship management information system also contributed to the
increase. Selling and marketing expenses within our commercial/retail segment
were 13.3% of net sales in the first six months of 2003, compared to 13.4% in
the same period in 2002.
General and Administrative
General and administrative expenses grew to $15.7 million in the first six
months of 2003 from $13.7 million in the same period a year ago, an increase of
$1.9 million, or 14.2%. Our direct segment accounted for the increase due
primarily to depreciation, consulting costs, and wages associated with our newly
implemented information systems. As a percentage of net sales, general and
administrative expenses increased to 6.8% in the first six months of 2003 from
4.9% in the same period a year ago.
Royalties
Royalty expense declined to $3.9 million in the first six months of 2003 from
$4.9 million in the same period a year ago, a decrease of 20.1%. Our direct and
commercial/retail segments have several agreements under
-22-
which we are obligated to pay royalty fees on certain products. The decrease in
our royalty expense is primarily attributable to the decreased sales of our
Bowflex products. Our royalty expenses will fluctuate in correlation with sales
of our Bowflex products, and will also be impacted by fluctuations in sales of
other products that have royalty agreements. The patent for the Bowflex Power
Rod resistance technology expires April 27, 2004. We will no longer be obligated
to pay royalties related to Bowflex sales following the expiration of this
patent.
OTHER INCOME
In the first six months of 2003 and 2002, other income was $1.0 million.
Interest income declined primarily due to lower interest earned on invested cash
and cash equivalents due to lower average interest rates in 2003 coupled with a
change to the use of tax-exempt securities in 2003 in order to maximize tax
equivalent yields. This decline in interest income was partially offset by $0.6
million in proceeds received during the second quarter of 2003 related to a
subsequent insurance recovery from damaged inventory.
INCOME TAX EXPENSE
Income tax expense decreased by $17.7 million to $10.3 million for the first six
months of 2003 from $28.0 million for the same period of 2002 due to the decline
in our income before taxes. We expect our income tax expense to fluctuate in
line with changes in our income before taxes.
NET INCOME
For the reasons discussed above, net income declined to $18.4 million in the
first six months of 2003 from $49.8 million in the same period a year ago, a
decrease of 63.1%.
LIQUIDITY AND CAPITAL RESOURCES
Historically, we have financed our business primarily from cash generated by our
operating activities. During the first six months of 2003, our operating
activities generated $22.3 million in net cash, which contributed to an
aggregate $59.7 million balance in cash and cash equivalents, compared with
$50.3 million in net cash generated by our operating activities in the first six
months of 2002.
Net cash provided by investing activities was $13.4 million in the first six
months of 2003 compared with net cash used in investing activities in the first
six months of 2002 of $49.0 million. The largest component of this change was
due to the initial acquisition cost of StairMaster in February of 2002 of $25.0
million, net of cash acquired. Additionally, we used $4.6 million during the
first six months of 2003 for capital expenditures primarily consisting of
manufacturing equipment and information systems and related equipment compared
to $14.0 million in the first six months of 2002.
Net cash used in financing activities was $7.1 million in the first six months
of 2003, which can be attributed to Company stock repurchases of $1.4 million
and dividends paid of $6.5 million offset by $0.9 million of stock option
exercises. Net cash used in financing activities was $7.0 million in the first
six months of 2002, which can be attributed to Company stock repurchases of $9.1
million offset by $2.1 million of stock option exercises.
Working capital was $124.1 million at June 30, 2003 compared to $109.0 million
at December 31, 2002, largely due to increased cash and cash equivalents as a
result of net income for the period. The $13.1 million decrease in trade
receivables can primarily be attributed to the seasonal timing of orders for the
commercial/retail segment, as more sales occur later in the fourth quarter
compared with the second quarter.
-23-
The $19.6 million decrease in trade payables is primarily due to the timing of
inventory purchases, which are significantly higher in the fourth quarter
compared with the second quarter due to the seasonal nature of the business.
We maintain a $10 million line of credit with a lending institution. The line of
credit is secured by certain assets and contains several financial covenants. As
of the date of this filing, we are in compliance with the covenants applicable
to the line of credit, and there is no outstanding balance under the line.
As of June 30, 2003, the Company had no contractual capital obligations or
commercial commitments other than operating leases.
We believe our existing cash balances, combined with our line of credit, will be
sufficient to meet our capital requirements for at least the next 12 months.
INFLATION AND PRICE INCREASES
Although we cannot accurately anticipate the effect of inflation on our
operations, we do not believe that inflation has had, or is likely in the
foreseeable future to 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. Very little of our
revenue variation from prior periods is attributable to price increases.
RECENT ACCOUNTING PRONOUNCEMENTS
In July 2002, the Financial Accounting Standards Board ("the FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 146, Accounting for
Costs Associated with Exit or Disposal Activities. The standard requires
companies to recognize costs associated with exit or disposal activities when
they are incurred rather than at the date of commitment to an exit or disposal
plan. Costs covered by the standard include lease termination costs and certain
employee severance costs that are associated with a restructuring, discontinued
operation, plant closing, or other exit or disposal activity. The Company
adopted this statement as of January 1, 2003, and the adoption of SFAS No. 146
has not had a material effect on the Company's financial position, results of
operations, or cash flows.
In December 2002, the FASB issued SFAS No. 148, Accounting for Stock-Based
Compensation - Transition and Disclosure. SFAS No. 148 amends SFAS No. 123,
Accounting for Stock-Based Compensation, to provide alternative methods of
transition for an entity that voluntarily changes to the fair value based method
of accounting for stock-based employee compensation. It also amends the
disclosure provisions of SFAS No. 123 to require prominent disclosure about the
effects on reported net income of an entity's accounting policy decisions with
respect to stock-based employee compensation. Finally, this statement amends APB
Opinion No. 28, Interim Financial Reporting, to require disclosure about those
effects in interim financial information. The Company adopted SFAS No. 148 in
the fourth quarter of 2002. Since the Company has not changed to a fair value
method of stock-based compensation, the applicable portion of this statement
only affects our disclosures.
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 2002 Annual Report on Form 10-K, which was filed with the
Securities and Exchange Commission on March 31, 2003.
-24-
We have primarily invested cash with banks and in liquid debt instruments
purchased with maturity dates of less than one year. Our bank deposits may
exceed federally insured limits, and there is risk of loss of the entire
principal with any debt instrument. To reduce risk of loss, we limit our
exposure to any one debt issuer and require certain minimum ratings for debt
instruments that we purchase.
FOREIGN EXCHANGE RISK
The Company is exposed to foreign exchange risk from currency fluctuations,
mainly in Europe. Given the relative size of the Company's current foreign
operations, the Company does not believe the exposure to changes in applicable
foreign currencies to be material, such that it could have a significant impact
on our current or near-term financial position, results of operations, or cash
flows. Management estimates the maximum impact on stockholders' equity of a 10%
change in any applicable foreign currency to be $1.1 million.
INTEREST RATE RISK
The Company has financed its growth through cash generated from operations. At
June 30, 2003, the Company had no outstanding borrowings and was not subject to
any related interest rate risk.
The Company invests in liquid debt instruments purchased with maturity dates of
less than one year. Due to the short-term nature of those investments,
management believes that any 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 President and Chief Executive Officer and Chief Financial Officer, the
effectiveness of our disclosure controls and procedures as of the end of the
period covered by this report pursuant to Rule 13a-15(b) under the Securities
Exchange Act of 1934 (the "Exchange Act"). Based on that evaluation, our
President and Chief Executive Officer and Chief Financial Officer have concluded
that, as of the end of the period covered by this report, our disclosure
controls and procedures are effective in ensuring that information required to
be disclosed in our Exchange Act reports is (1) recorded, processed, summarized
and reported in a timely manner, and (2) accumulated and communicated to our
management, including our President and Chief Executive Officer and Chief
Financial Officer, as appropriate to allow timely decisions regarding required
disclosure.
Changes in Internal Controls
There has been no change in our internal control over financial reporting that
occurred during our last fiscal quarter that has materially affected, or is
reasonably likely to materially affect, our internal control over financial
reporting.
-25-
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
- -------------------------
In December 2002, the Company filed suit against ICON Health and Fitness, Inc.
("ICON") in the Federal District Court, Western District of Washington (the
"Court") alleging infringement by ICON of the Company's Bowflex patents. The
Company seeks injunctive relief, unquantified treble damages and its fees and
costs. In May 2003, the Court denied the Company's motion for a preliminary
injunction and granted partial summary judgment to ICON on the issue of "literal
infringement." The Company has appealed this motion denying our preliminary
injunction on literal patent infringement, and a hearing on this appeal is
scheduled to be heard in September 2003.
In July 2003, the Court ruled in favor of the Company 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. In its ruling, the Court concluded that the Company showed "a
probability of success on the merits and irreparable injury" on its trademark
infringement claim. In August 2003, the United States Court of Appeals for the
Federal Circuit granted ICON a temporary stay regarding the motion for a
preliminary injunction enjoining ICON from using the trademark "CrossBow". This
stay allows ICON to continue using the trademark "CrossBow" until a decision is
issued by the Federal Circuit Court of Appeals.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
- -----------------------------------------------------------
The annual meeting of shareholders of The Nautilus Group, Inc. was held on June
9, 2003, at which the following actions were taken:
1. The shareholders elected an eight-person board of directors. The eight
directors elected, together with the voting results for such directors, are
as follows:
NAME FOR WITHHELD
Peter A. Allen 21,432,466 66,277
Kirkland C. Aly 21,431,966 66,777
Brian R. Cook 21,380,366 118,377
Robert S. Falcone 21,432,325 66,418
C. Rowland Hanson 21,432,466 66,277
Frederick T. Hull 21,432,466 66,277
Paul F. Little 21,431,825 66,918
James M. Weber 21,431,966 66,777
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
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(a) Exhibits
The following exhibits are filed herewith and this list constitutes the
exhibit index:
EXHIBIT NO. DOCUMENT DESCRIPTION
----------- --------------------
31.1 Certification Pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002
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31.2 Certification Pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002
32.1 Certification pursuant to 18 U.S.C. Section 1350, as
adopted pursuant to Section 906 of the Sarbanes-Oxley Act
of 2002
32.2 Certification pursuant to 18 U.S.C. Section 1350, as
adopted pursuant to Section 906 of the Sarbanes-Oxley Act
of 2002
(b) Reports on Form 8-K
The following reports on Form 8-K were filed during the quarter ended June
30, 2003:
o Form 8-K dated April 7, 2003, under Items 7, 9, and 12, associated
with the press release announcing the revision of first quarter and
2003 earnings estimates.
o Form 8-K dated April 30, 2003, under Items 7, 9, and 12, associated
with the press release announcing first quarter 2003 financial results
and fiscal year 2003 financial guidance, and declaring the regular
quarterly dividend for the second quarter of 2003.
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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.
THE NAUTILUS GROUP, INC.
August 14, 2003 By: /s/ Greggory C. Hammann
- --------------- ------------------------------
Date Greggory C. Hammann, Chief Executive Officer
and President (Principal Executive Officer)
August 14, 2003 By: /s/ Rod W. Rice
- --------------- ------------------------------
Date Rod W. Rice, Chief Financial Officer,
Treasurer and Secretary (Principal Financial
and Accounting Officer)
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