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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-K

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 2002

Commission file number: 000-25867

THE NAUTILUS GROUP, INC.
(Exact name of Registrant as specified in its charter)

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

1400 NE 136TH AVENUE
VANCOUVER, WASHINGTON 98684
(Address of principal executive offices, including zip code)

(360) 694-7722
(Issuer's telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act: NONE
Securities registered pursuant to Section 12(g) of the Act:
COMMON STOCK, WITHOUT PAR VALUE

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

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

Indicate by check mark whether the Registrant is an accelerated filer (as
defined in Rule 12b-2 of the Securities Exchange Act of 1934). Yes [ X ] No [ ]

The aggregate market value of the voting stock held by non-affiliates, computed
by reference to the last sales price ($30.60) as reported on the New York Stock
Exchange, as of the last business day of the Registrant's most recently
completed second fiscal quarter (June 28, 2002) was $955,486,958.

The number of shares outstanding of the Registrant's Common Stock as of March 1,
2003 was 32,528,850 shares.

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DOCUMENTS INCORPORATED BY REFERENCE

The Registrant has incorporated by reference into Part III of this Form 10-K
portions of its Proxy Statement for its 2003 Annual Meeting of Stockholders.
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THE NAUTILUS GROUP, INC.

2002 FORM 10-K ANNUAL REPORT

PART I

Item 1. Business 4

Item 2. Properties 22

Item 3. Legal Proceedings 22

Item 4. Submission of Matters to a Vote of Security Holders 23

PART II

Item 5. Market for Registrant's Common Equity and Related
Stockholder Matters 23

Item 6. Selected Consolidated Financial Data 23

Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations 25

Item 7A. Quantitative and Qualitative Disclosures About Market Risk 37

Item 8. Consolidated Financial Statements and Supplementary Data 37

Item 9. Changes in and Disagreements With Accountants on Accounting and
Financial Disclosure 59

PART III

Item 10. Directors and Executive Officers of the Registrant 59

Item 11. Executive Compensation 59

Item 12. Security Ownership of Certain Beneficial Owners and
Management and Related Stockholder Matters 59

Item 13. Certain Relationships and Related Transactions 59

Item 14. Controls and Procedures 59

PART IV

Item 15. Exhibits, Financial Statement Schedules, and
Reports on Form 8-K 60

Signatures 63

Certifications 64

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PART I

FORWARD-LOOKING STATEMENTS

CERTAIN STATEMENTS CONTAINED IN THIS ANNUAL REPORT ON FORM 10-K, INCLUDING,
WITHOUT LIMITATION, STATEMENTS CONTAINING THE WORDS "COULD," "MAY," "WILL,"
"SHOULD," "PLAN," "BELIEVES," "ANTICIPATES," "ESTIMATES," "PREDICTS," "EXPECTS,"
"PROJECTIONS," "POTENTIAL," "CONTINUE," AND WORDS OF SIMILAR IMPORT, CONSTITUTE
"FORWARD-LOOKING STATEMENTS." INVESTORS ARE CAUTIONED THAT ALL FORWARD-LOOKING
STATEMENTS INVOLVE RISKS AND UNCERTAINTIES AND VARIOUS FACTORS COULD CAUSE
ACTUAL RESULTS TO DIFFER MATERIALLY FROM THOSE IN THE FORWARD-LOOKING
STATEMENTS. FROM TIME TO TIME AND IN THIS FORM 10-K, WE MAY MAKE FORWARD-LOOKING
STATEMENTS RELATING TO OUR FINANCIAL PERFORMANCE, INCLUDING THE FOLLOWING:

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 RATES;
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 GROWTH MANAGEMENT CHALLENGES, INCLUDING THE GROWTH RESULTING FROM THE
ACQUISITION OF THE ASSETS OF THE FITNESS DIVISION OF SCHWINN/GT CORP.
("SCHWINN FITNESS") IN SEPTEMBER 2001 AND THE ACQUISITION OF THE ASSETS
OF STAIRMASTER SPORTS/MEDICAL, INC. ("STAIRMASTER") IN FEBRUARY 2002;
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-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-K OR TO REFLECT THE
OCCURRENCE OF UNANTICIPATED EVENTS.

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ITEM 1. BUSINESS
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INTRODUCTION

The Nautilus Group, Inc. is a leading marketer, developer and manufacturer of
branded health and fitness products sold under such well-known names as
Nautilus, Bowflex, Schwinn, StairMaster and Trimline. We market and sell our
Bowflex and Nautilus Sleep Systems products through our direct-marketing channel
utilizing an effective combination of television commercials, infomercials,
response mailings, the Internet, and inbound/outbound call centers. We market
and sell our Nautilus, Schwinn, and StairMaster commercial fitness equipment
through our sales force and selected dealers to health clubs, government
agencies, hotels, corporate fitness centers, colleges, universities and assisted
living facilities worldwide. We also market a comprehensive line of consumer
fitness equipment sold under the Nautilus, Schwinn, StairMaster, and Trimline
brands, through a network of specialty and sporting goods dealers, distributors
and retailers worldwide.

We have experienced rapid growth, with sales increasing from $63.2 million in
1998 to $584.6 million in 2002, representing a compound annual growth rate of
approximately 74%. This increase was largely the result of organic growth in the
sales of existing Nautilus and Bowflex product lines, and expanded sales through
extensions of existing product lines in new channels and the acquisition of
Schwinn Fitness and StairMaster. We have grown net income from $12.5 million in
1998 to $97.9 million in 2002, representing a compound annual growth rate of
approximately 67%.

Our success to-date, based on sales growth, profitability and cash flow, has
been driven primarily by the expansion of our Bowflex product line in the
direct-to-consumer distribution channel. We believe that we have been able to
capture premium price points as a result of our high quality, innovative
products and direct sales to end customers. We intend to continue driving our
growth through our ability to identify, fulfill and increase customer demand for
fitness and healthy lifestyle products.

Through our extensive experience in direct marketing fitness and healthy
lifestyle products to consumers, we have developed a creative and highly
disciplined sales and marketing process. Over the past 10 years, we have spent
approximately $250 million in television advertising for our direct products.
Core to our strategy is the continuous improvement of our direct marketing
process by challenging and refining all aspects of our marketing and selling
cycle. This improvement has been accomplished in large part by our ability to
gain relatively instantaneous customer feedback from our advertisements. All
customer inquiries are carefully managed through our state-of-the-art inbound
and outbound call center utilizing customized database applications. As a
result, we have been able to predict with a historically high degree of accuracy
the inquiries of our marketing programs and their subsequent conversion into
sales. This highly refined marketing approach, combined with our media
purchasing power, has created an effective and cost efficient means for
stimulating consumer demand.

Our success has been enhanced by our continuing expansion into the commercial
and retail channels of the fitness industry. To expand sales and market share in
these channels, we acquired substantially all of the assets of three companies:
Nautilus International, Inc. ("Nautilus") in January 1999, the Fitness Division
of Schwinn/GT Corp. and its affiliates ("Schwinn Fitness") in September 2001 and
StairMaster Sports/Medical, Inc. ("StairMaster") in February 2002. These
acquisitions have enabled us to considerably expand our portfolio of leading
brands, product lines, channels of distribution, product development
capabilities and the size of our customer base. Through our purchase of Schwinn
Fitness and StairMaster, we believe that we have made significant progress in
diversifying our product line and expanding our presence internationally. We now
offer a comprehensive line of cardiovascular and weight resistance products in
the retail and commercial fitness industry. Our retail and commercial product
lines include home gyms, free weight equipment, treadmills, indoor cycling
equipment, steppers, ellipticals, and fitness accessories. As a result of our

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acquisitions, we have operations in Switzerland, offices in Germany, the United
Kingdom, and Japan, and a worldwide network of distributors. We have continued
to build our presence internationally subsequent to our recent acquisitions with
the addition of an office in Italy.

We believe that our Company possesses distinct competitive advantages as we
build toward our goal of being a complete provider of products to the health and
fitness industry. We have developed and acquired a portfolio of highly
recognized and trusted fitness brands. These brands are utilized, in concert
with focused product development, to meet the differing customer demands of each
distribution channel: direct, commercial and retail. In addition, we have
realized and believe that we will continue to achieve significant synergies by
leveraging our brands, marketing resources, and research and development
capabilities across all three distribution channels. We believe the health and
fitness industry's fragmentation of manufacturers and distribution channels
lends itself to the execution of this strategy.

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

The Nautilus Group was incorporated in California in 1986 and became a
Washington corporation in 1993. On May 21, 2002, the Company changed its
corporate name to The Nautilus Group, Inc. from Direct Focus, Inc. Concurrent
with the name change, trading of the Company's shares were moved from the NASDAQ
National Market to the New York Stock Exchange with a new ticker symbol (NLS).

Our principal executive offices are located at 1400 NE 136th Avenue, Vancouver,
Washington 98684, and our telephone number is (360) 694-7722. We maintain our
corporate web site at www.nautilusgroup.com. None of the information on this web
site or our other web sites is part of this Form 10-K. On our website, we make
available, free of charge, printable copies of our annual report on Form 10-K,
quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to
those reports filed or furnished pursuant to Section 13(a) or 15(d) of the
Exchange Act as soon as reasonably practicable after such material is
electronically filed with or furnished to the Securities and Exchange Commission
("SEC").

As used in this Form 10-K, the terms "we," "our," "us," "Nautilus Group" and
"Company" refer to The Nautilus Group, Inc. and its subsidiaries. The names
Nautilus(R), Bowflex(R), Power Rod(R), TreadClimber(TM), Schwinn(R) (fitness
products), StairMaster(R) and Trimline(R) are trademarks of the Company.

The consolidated financial statements of the Company include The Nautilus Group,
Inc. and its wholly owned subsidiaries (collectively the "Company"). All
intercompany transactions have been eliminated in the preparation of the
consolidated financial statements.

LONG-TERM STRATEGY

Our long-term strategy is to build a complete health and fitness company
offering high quality, premium-branded products enabling health conscious
consumers to maintain active lifestyles. We intend to do this by:

o Utilizing our positioning and capabilities in the direct marketing
channel to launch new, innovative products;
o Capitalizing on the synergy and growth opportunities from acquisitions;
o Continuing to capture premium price points and accelerate demand by
researching and developing high quality, branded products that meet
the needs of our customers and retailers; and
o Expanding our international opportunities by leveraging our branded
products through our recently acquired network of international
operations and distributors.

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INDUSTRY OVERVIEW

CONSUMER TRENDS

We believe that our organic growth has benefited from a number of demographic
and market trends that we expect will continue, including:

o Growing global consumer awareness of positive benefits of good nutrition
and fitness;
o Expanding media attention worldwide on health and fitness;
o An aging population that is maintaining a more active lifestyle;
o Continued attention to appearance and weight by consumers, which is
expected to increase as the "baby-boomers" pass through their 40's,
50's, and 60's;
o High healthcare costs that are focusing more attention on preventative
practices like exercise leading to an increase in the number of
corporate fitness programs and wellness centers;
o Growing rate of obesity which, according to the US Centers for Disease
Control and Prevention, has increased by 74% among US adults since
1991;
o Government financial support for health and fitness programs intended
to combat the growing obesity crisis in the United States;
o Expansion of the market for sophisticated high-quality fitness
equipment due to consumers' continued demand for higher levels of
efficiency in their workout regimes; and
o The continued growth of direct to consumer marketing, which is
estimated to have exceeded $1.0 trillion in annual sales in the United
States in 2002.

We believe these consumer trends bode well for our future growth prospects. Just
as the "baby boomers," those Americans born between 1946 and 1964, started the
modern fitness movement, we believe they will continue to be a driving force as
they age. We believe baby boomers will use more of their increasing leisure time
for exercise and more of their disposable income for fitness equipment purchases
as they strive to counter the effects of aging.

DIRECT TO CONSUMER MARKETING TRENDS

Direct and interactive marketing involves the delivery of marketing messages to
consumers through media predominantly consisting of television, Internet,
telephone, radio, newspapers and magazines, and mail. According to the 2002
ECONOMIC IMPACT: U.S. DIRECT & INTERACTIVE MARKETING TODAY published by the
Direct Marketing Association (the "DMA"), direct marketing-driven sales to
consumers are estimated to have exceeded $1 trillion in 2002, having grown at an
annual rate of 8.8% over the previous 5 years. The DMA estimates that consumer
direct marketing-driven sales will increase at a compound annual growth rate of
8.0% over the next 5 years, compared to an estimated growth rate of 5.5% for
overall U.S. retail sales during the same period. We believe our direct
marketing business is well positioned to take advantage of this economic
environment in which consumers have and continue to demonstrate greater
willingness to make purchase decisions based upon direct marketing.

TRENDS IN FITNESS EQUIPMENT

We market our Nautilus, Bowflex, Schwinn, StairMaster, and Trimline equipment
both domestically and internationally. Since 1990, the fitness equipment
industry has more than doubled in size and has been the most successful category
of sporting goods for years. Interest in exercising with fitness equipment is
supported by the increase in health club memberships in the U.S., which
according to the Sporting Goods Manufacturers Association (the "SGMA"), have
increased 63% from 20.7 million in 1990 to 33.7 million in 2001. The U.S.
fitness equipment market consists of two distinct market segments: home and
institutional. According to the SGMA, the institutional, or commercial, fitness

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market is more visible to consumers, but the home market is much larger. Based
on a study performed by the SGMA, U.S. consumers spent an estimated $6.1 billion
specifically on home fitness equipment in 2002 representing a compound annual
growth rate of 10.2% since 1990. In contrast, the SGMA reports that commercial
sales of fitness equipment to health clubs and other exercise facilities were
estimated to be $0.7 billion in 2002.

Consumer interest in health clubs has benefited the market for home fitness
equipment as well as the commercial fitness equipment business. Consumers who
attend health clubs are exposed to an array of fitness equipment products and
brand names, as well as education about the uses and benefits of fitness
equipment. Using the same brand names in concert with product variations that
make home use feasible, home fitness equipment businesses have been successful
in selling the benefits of fitness equipment for the home.

According to the SGMA, the fitness equipment market is expected to have
increased 4.4% in 2002 comprised of the home fitness equipment increasing 5% in
2002 and the commercial fitness equipment market increasing 2%. The SGMA
projects a 4.5% increase in fitness equipment sales in 2003.

Research from the National Sporting Goods Association (the "NSGA") indicates
that Americans are not only exercising more but are also exercising more with
fitness equipment. Surveys performed by the NSGA indicate that the percentage of
U.S. consumers above the age of seven who participated in exercise with fitness
equipment rose from 35.3% in 1990 to 44.8% in 2000. In addition, the SGMA
estimates that the number of Americans using strength equipment and
cardiovascular equipment increased 5.4% and 3.5% annually, respectively, from
1990 to 2000. A significant component of this growth is attributable to the
aging "baby-boomer" generation.

The international markets represent a strong opportunity for growth, driven by
the continued fitness boom across Europe and the increasing focus on fitness and
healthy lifestyles by more affluent consumers in Asia and Latin America. In
fact, according to recent data published by the International Health, Racquet
and Sportsclub Association (the "IHRSA"), there are approximately 19,500 health
clubs in Europe, 7,800 in Latin America and 4,800 in the Asia/Australia market.
For comparison, there are approximately 20,200 clubs currently operated in the
U.S. According to the IHRSA, health club memberships in the United Kingdom
totaled 4.4 million in 2002 compared with 1.5 million in 1996, an increase of
193.3%. Health club memberships in Germany totaled 5.4 million in 2002 compared
with 3.3 million in 1995, an increase of 63.6%. We believe demand for U.S.
products will increase, as foreign consumers increasingly demand the
reliability, service and innovative designs provided by U.S. suppliers such as
Nautilus, Schwinn, StairMaster, and Trimline.

TRENDS IN SLEEP PRODUCTS

The United States mattress market is large and dominated by several major
manufacturers whose primary focus is the conventional innerspring mattress.
According to the International Sleep Products Association (the "ISPA"), United
States mattress and foundation sales totaled 38.7 million units shipped in 2001,
representing a 2.0% decrease from 2000. Total dollar value of these wholesale
shipments remained relatively constant at $4.6 billion in 2001 compared to 2000.
We believe these wholesale dollars equate to over $7.6 billion in retail sales.

According to a consumer study commissioned by furniture industry publication
HFN, less than 6.0% of all mattress sales are currently made through direct
marketing distribution channels. Prior to 2001, the mattress industry enjoyed
years of uninterrupted growth according to the ISPA, which has led to increased
competition and large-scale retail outlet consolidation. The ISPA states that
the mattress industry can be characterized as having stable sales throughout the

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year with slight increases during the summer months. Queen-sized mattresses,
which became the largest selling segment in 1998, continued to top the U.S.
market in 2001, capturing 34.2% of the market according to the ISPA.

DIRECT BUSINESS SEGMENT

DIRECT TO CONSUMER MARKETING

We market and sell our Bowflex and Nautilus Sleep Systems products through our
direct-marketing channel utilizing a combination of 30-second, 60-second,
2-minute, and in some instances 5-minute "spot" television commercials,
30-minute television "infomercials," response mailings, the Internet, and
inbound/outbound call centers. The direct to consumer distribution channel
involves sales of our products directly to the consumer. Sales leads are derived
primarily from television advertisements, including both commercials and
infomercials. Additional leads and sales are obtained via our internet commerce
web sites. By selling directly to the end consumer, we are able to target
premium price points paid by end consumers, eliminating all other parties from
the supply chain. Our ability to capture the entire gross margin has
consistently produced a high financial return on time and money invested. The
size of the direct market is also substantial. Through our advertising
initiatives, we estimate that we currently target 70 million homes. Success
within this distribution channel is almost entirely dependent on the ability to
capture target demographics. By using hundreds of different toll free numbers,
we are able to measure which ads our customers are responding to, and we have
built a comprehensive database that assists us to adapt marketing strategies to
better target customers. Historically, we have been able to predict, with a high
degree of accuracy, inquiries to specific advertisements and the resulting
sales. We continue to believe that this will serve as a key differentiating
factor and enable us to maintain a competitive advantage within this channel.

We conduct direct to consumer marketing through a combination of television
commercials and infomercials. To date, we have been highly successful with what
we refer to as a "two-step" marketing approach. Our two-step approach focuses
first on generating consumer interest in our products and requests for product
information, which is achieved primarily through the use of spot commercials and
infomercials. The second step focuses on converting inquiries into sales, which
we accomplish through a combination of response mailings and outbound
telemarketing to potential customers who have made initial inquiries based on
our first step advertising efforts.

The effectiveness of our direct marketing is influenced by seasonal factors. We
have found that second quarter influences on television viewership, such as the
broadcast of national network season finales and seasonal weather factors, cause
our spot television commercials on national cable television to be less
effective in the second quarter than in other periods of the year. Additionally,
we have found that advertising availability during the fourth quarter is more
limited due to an increase in annual holiday advertising and political
advertisements during election years.

ADVERTISING

SPOT COMMERCIALS AND INFOMERCIALS. Spot television commercials are a key element
of the marketing strategy for all of our direct-marketed consumer products. For
direct-marketed products that may require further explanation and demonstration,
television infomercials are an important additional marketing tool. We have
developed a variety of spot commercials, infomercials, and marketing videos for
our Bowflex and Nautilus Sleep Systems product lines. We expect to use spot
commercials and, where appropriate, infomercials to market other consumer
products that we determine are appropriate for the direct-marketing channel.

When we market a new product, we test and refine our marketing concepts and
selling practices while advertising the product in spot television commercials.
Production costs for these commercials can range from $50,000 to $150,000. Based

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on results to our spot commercials and marketing efforts, we may produce
additional spot commercials and, if appropriate for the product, an infomercial.
Production costs for infomercials can range from $150,000 to $500,000.
Generally, we attempt to film multiple infomercial and commercial concepts at
the same time in order to maximize production efficiencies. From this footage we
can then develop several varieties of spot commercials and infomercials and
introduce and refine them over time. We typically generate our own scripts for
spot commercials and utilize outside writers to assist with infomercial scripts
on an as-needed basis. Typically, we contract with outside production companies
to produce our spot commercials and infomercials.

We test spot commercials and infomercials on a variety of cable television
networks that have a history of generating favorable responses for our existing
products. Our initial objective is to determine the product's marketing appeal
and evaluate creative or product modifications that may be appropriate. If these
initial tests are successful, we then air the spot commercials and infomercials
on an accelerating schedule of additional cable networks.

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

We book most of our spot commercial and infomercial time on a monthly or
quarterly basis, as networks make time available. Networks typically allow us to
cancel booked time with two weeks advance notice, which enables us to adjust our
advertising schedule if our statistical tracking indicates that a particular
network or time slot is no longer cost effective. In limited situations, we book
contracts with time horizons of up to one year for infomercial time in order to
secure time slots that we feel are likely to generate the greatest number of
potential customer inquiries, and that are also in demand from other
advertisers. Once we acquire this advertising time, we can benefit by rotating
our products into these time slots that demonstrate a history of success.

INTERNET. We expect the Internet to continue as an important part of our
direct-marketing strategy. We consistently promote our web sites in television,
print and direct mail marketing efforts to encourage online product inquiries
and eCommerce transactions. We have also expanded our use of online advertising
on third party sites and paid search engine placement to drive Web browsers to
our sites to request additional information, learn more about our products, or
purchase immediately. Our sites are loaded with informative content including
customer testimonials, online videos, and detailed product information. In 2002,
we operated two direct marketing-oriented web sites: (1) www.bowflex.com that
focuses on our Bowflex line of home exercise equipment and (2)
www.nautilussleepsystems.com that focuses on our Nautilus Sleep Systems line of
luxury air beds.

OPTIMAL USE OF DIRECT MARKETING DATABASE

Since 1994, when we initially started testing our target markets, we have
consistently invested significant resources in order to build a comprehensive
direct marketing database. Our database has allowed us to monitor customer
responses and effectively utilize information to adapt our marketing strategy to
better target such customers with existing and future direct products. We
believe the database creates a competitive advantage for our future direct
product introductions by providing a rich pool of customers that have a proven
relationship with the Company.

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We track the success of each of our spot commercials and infomercials by
determining how many viewers respond to each airing of a spot commercial or
infomercial. We accumulate this information in a database that we use to
evaluate the cost-effectiveness of available media time. We believe the database
enables us to predict with reasonable accuracy how many product sales and
inquiries will result from each spot commercial and infomercial that we air. We
also believe we can effectively track changing viewer patterns and adjust our
advertising accordingly.

CONVERSION OF DIRECT-MARKETED PRODUCT INQUIRIES INTO SALES

CUSTOMER SERVICE CALL CENTER AND ORDER PROCESSING. We operate our own customer
service call center in Vancouver, Washington, that operates 18 to 23 hours per
day and receives and processes all infomercial-generated and customer
service-related inquiries regarding our Bowflex and Nautilus Sleep Systems
products. We have developed a skill-based call routing system that automatically
routes each incoming call to the most highly qualified inside sales agent or
customer service representative available. The appropriate representative then
answers product questions, proactively educates the potential customer about the
benefits of our product line, promotes financing through our third-party private
label credit card, typically up sells the benefits of higher priced models in
our product line, and closes the transaction process by entering the customer
order information. This sophisticated system allows us to better utilize our
agents, prioritize call types and improve customer service.

We employ two large telemarketing companies to receive and process information
requests generated by our spot television advertising 24 hours per day. The
telemarketing agents for these companies only collect names, addresses and other
basic information from callers and do not sell or promote our products. The
telemarketing agents transfer callers that show immediate buying interest in our
products to our own customer service call center.

INTERNET. We use television spot commercials and infomercials to lead consumers
to our web sites, as we believe that consumers who visit our web sites are more
inclined to purchase our products. Our ongoing Internet-related goals include
improving the capabilities of our various web sites. We believe we successfully
balance our goals of finalizing sales and capturing consumer information by
strategically designing our web pages and carefully analyzing web page hits,
conversion rates, average sales prices and inquiry counts. Our eCommerce sales
are an important component of our direct sales channel representing 24%, 22%,
and 19% of direct sales for 2002, 2001, and 2000, respectively.

RESPONSE MAILINGS. We forward a "fulfillment kit" in response to each inquiry
regarding our direct-marketed products. Each kit contains detailed literature
that describes the product line and available accessories, a marketing video
that demonstrates and highlights the key features of our premium product in the
line, and additional information about how to purchase the product. If a
potential customer does not respond within a certain time period, we proceed
with additional follow-up mailings that convey a different marketing message and
typically offer certain inducements to encourage a sale. The specific marketing
message and offer at each stage will vary, based on what our statistical
tracking indicates is most likely to trigger a sale.

CONSUMER FINANCE PROGRAMS. We believe that convenient consumer financing is an
important tool in our direct marketing sales efforts and induces many of our
customers to make purchases when they otherwise would not. Currently, we offer
"zero-down" financing to approved customers on all sales of our Bowflex Products
and Nautilus Sleep Systems. We arrange this financing through a consumer finance
company pursuant to a non-recourse consumer financing agreement. Under this
arrangement, our customer service representatives can obtain financing approval
in a few minutes over the telephone and, if a customer is approved, ship the
ordered product without the need for cumbersome paperwork. The consumer finance
company pays us promptly after submission of the required documentation and
subsequently sends to each approved customer a Nautilus Group private label

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credit card that can be used for future purchases of our products. Approximately
37%, 41%, and 36% of our direct-marketed net sales were financed in this manner
for 2002, 2001, and 2000, respectively, and we believe this program will
continue to be an effective marketing tool.

DIRECT PRODUCTS

BOWFLEX HOME FITNESS EQUIPMENT

We introduced the first Bowflex home exercise machine in 1986, and since then
have implemented several improvements to its design and functionality. We now
offer four different Bowflex machines and nine different models. The key feature
of each Bowflex machine is our patented "Power Rod" resistance technology. Each
Power Rod is made of a solid polymer material that provides resistance in both
the concentric and eccentric movements of an exercise. When combined with a
bilateral cable pulley system, the machines provide excellent range and
direction of motion for a large variety of strength-building exercises. Sales
from our Bowflex product line accounted for 61% of our aggregate net sales in
2002, down from 74% and 83% in 2001 and 2000, respectively, as we continued our
strategies of diversification into the commercial and retail markets and the
introduction of new direct-marketed products.

We currently offer the following Bowflex machines:

o The Ultimate, introduced in late 2001, is our newest product in the
Bowflex line. The Ultimate is available in one model that offers over 80
different strength-building exercises in one compact, foldable, and
portable design and comes with a 310-pound resistance pack that can be
upgraded to 410 pounds. We have also incorporated an integrated
adjustable pulley system feature to allow a user to adjust the range of
motion of many basic exercises to increase workout results. An aerobic
rowing exercise feature has also been incorporated into the Ultimate.

o The Power Pro, introduced in 1993, is our best selling product. The
Power Pro is available in four different models: the base model Power
Pro, the XT, the XTL and the XTLU. Each model offers over 60 different
strength building exercises in one compact, foldable and portable design
and comes with a 210-pound resistance pack that can be upgraded to 410
pounds. We have also incorporated an aerobic rowing exercise feature
into the Power Pro.

o The Motivator, introduced in 1996, is our entry-level strength training
line. It is available in three different models: the base model
Motivator, the XT and the XTL. Each model offers over 40 different
strength building exercises in one compact, foldable design and comes
standard with a 210-pound resistance pack that can be upgraded to 410
pounds.

o The Versatrainer by Bowflex, introduced in 1988, is specifically
designed to accommodate wheelchair-bound users. The Versatrainer's key
advantage is that it permits users to exercise while remaining in their
wheelchair, which offers enhanced independence. The Versatrainer can be
found in many major rehabilitation hospitals, universities and
institutions.

NAUTILUS SLEEP SYSTEMS

In December 1999, we began marketing a line of premium air sleep systems, which
we have named the "Nautilus Sleep Systems." The key feature of the Nautilus
Sleep Systems is the variable firmness support chamber, an air chamber within
each air sleep system that can be electronically adjusted to regulate firmness.
All queen and larger sleep systems in our Signature, Premier and Ultimate Series
are equipped with dual air chambers that enable users to maintain different

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firmness settings on each side of the bed. We believe that variable firmness and
other comfort-oriented features of our Nautilus Sleep Systems favorably
differentiate them from conventional innerspring mattresses.

Our Nautilus Sleep Systems are currently available in four models:

o The Ultimate Series is our top-of-the-line model. It features dual
patent-pending, interlocking variable support air chambers that permit
users to maintain separate firmness settings on each side of the sleep
system. The interlocking chambers regulate airflow and pressure to more
effectively maintain support when a user changes position. The Ultimate
Series comes with removable wool blend and silk blend pillow top
sleeping surfaces, which permits users to easily convert to a "tight
top" surface when they desire extra firmness. The Ultimate Series also
has an upgraded comfort layer of visco-elastic foam that conforms to a
user's body.

o The Premier Series features dual patent-pending, interlocking variable
support air chambers that permit users to maintain separate firmness
settings on each side of the sleep system. The interlocking chambers
regulate airflow and pressure to more effectively maintain support when
a user changes position. The Premier Series comes with a removable wool
blend pillow top sleeping surface, which permits users to easily convert
to a "tight top" surface when they desire extra firmness.

o The Signature Series is designed to appeal to consumers who desire the
flexibility of dual variable firmness support air chambers, but at a
more affordable price. Our customers can choose between a tight top or
pillow-top sleeping surface over a one and one-half inch convoluted foam
comfort layer.

o The Basic Series is our entry-level model, which features a single,
head-to-toe variable firmness support air chamber and a traditional
tight-top sleeping surface over a one and one-half inch thick convoluted
foam comfort layer.

We offer foundations that are specifically designed to support and enhance the
performance of our Nautilus Sleep Systems. We advise consumers to use our
foundations because conventional box springs tend to sag and wear over time,
causing a sleep system to eventually mirror the worn box spring. The majority of
our Nautilus Sleep Systems customers order a complete sleep system, which
includes both a mattress and a foundation.

TREADCLIMBER

In March 2003, we introduced a new line of cardiovascular fitness equipment,
which we have named the "TreadClimber." The TreadClimber incorporates three
popular cardiovascular fitness features in one machine and is marketed through
our direct sales channel to home consumers. TreadClimber provides a unique
combination of movements that allows users to walk forward (like a treadmill)
and step up (like a stair-stepper) while taking advantage of the low impact
movement of an elliptical machine. We believe that the unique combination of
movements of our TreadClimber favorably differentiates it from other
cardiovascular fitness equipment for the home.

CHAMPION NUTRITION

As part of our mission to provide quality healthy lifestyle products, we
obtained an option to purchase Champion Nutrition ("Champion") by entering into
a Loan and Security Agreement ("Loan Agreement") with Champion and its primary
shareholders in May 2001. Champion is a privately held manufacturer of
nutritional supplements. We began selling Champion's product line through our
direct sales channel in June 2001. We package these products as kits and sell
them to our Bowflex customers as add-on items. Under the terms of the Loan
Agreement, the Company's option to buy the stock of Champion expired in February

-12-


2003. Although the option has expired, the Company continues to hold a right of
first refusal on the stock of Champion. If another party offers to buy the stock
of Champion, this right grants the Company the option to buy the stock of
Champion, before any other party, so long as the Company exercises the right
before August 24, 2003.

COMMERCIAL/RETAIL BUSINESS SEGMENT

COMMERCIAL/RETAIL SALES AND MARKETING

We market and sell our Nautilus, Schwinn, and StairMaster commercial fitness
equipment through our direct sales force and selected dealers to health clubs,
government agencies, hotels, corporate fitness centers, colleges, universities
and assisted living facilities. Our commercial direct sales force is focused on
strengthening the market position of our existing Nautilus, Schwinn, and
StairMaster commercial product lines, which we sell principally to health clubs,
large hotels, assisted living facilities and the government. Additionally, as we
continue to broaden our product line with products like Nautilus Nitro and
commercial strength equipment, our direct sales force will target new market
segments and, if successful, broaden our customer base. Internationally, we
market and sell our Nautilus, Schwinn, and StairMaster commercial fitness
products through our foreign subsidiaries and a worldwide network of independent
distributors.

We also market a complete line of consumer fitness equipment, under the
Nautilus, Schwinn, StairMaster, and Trimline brands, through an independent
network of more than 1,200 dealers, sporting goods retailers and specialty
stores worldwide. As part of our September 2001 acquisition of Schwinn Fitness,
we added an experienced management team to oversee the sales and marketing
operations of our retail products business.

In general, sales of our retail fitness equipment is highly seasonal. We believe
that sales within our commercial/retail segment are considerably lower in the
second quarter of the year compared to the other quarters. Our strongest quarter
for the commercial/retail segment is generally the fourth quarter, followed by
the first and third quarters. We believe the principal reason for this trend is
the commercial/retail fitness industry's preparation for the impact of New
Year's fitness resolutions and seasonal weather patterns related to colder
winter months.

COMMERCIAL APPROACH

We position ourselves as "The Health & Fitness Consultants" to encourage our
commercial market customers and potential customers to think of us first when
considering their fitness equipment and programming needs. Our strategy is to
address the needs of the three key constituencies of today's health clubs:

o Club owners (customer satisfaction and profit)
o Club staff (continuing education and career development)
o Club users (improved health and fitness)

FITNESS ACADEMY: The Schwinn Fitness Academy was established in 1997 to provide
programming and educational information for both consumers and fitness
professionals. To date, the Schwinn Fitness Academy has provided training and
certification for hundreds of fitness professionals in the Schwinn Cycling
Program and has recently added a range of strength training programs based on
Nautilus training principles to its repertoire. Many of these programs are
targeted to special populations such as seniors, women and youth that are
particularly important to the fitness industry today.

Schwinn Fitness Academy programs are designed to aid clubs to increase profits
by encouraging cost-efficient group exercise classes; benefit staff members by
helping them increase their range of fitness education skills; and motivate
members to stick with their exercise programs to truly experience fitness
results.

-13-


ADVERTISING: We advertise in select trade publications, including publications
that reach key industry stakeholders such as FITNESS MANAGEMENT, CBI (IHRSA),
CLUB INDUSTRY, and several other publications that serve more specialized
commercial markets, such as GOVERNMENT PRODUCT NEWS and RECREATION MANAGEMENT.
Specific placement is driven by marketing and product development events and ads
are coded to assist us in measuring the effectiveness of each individual ad with
respect to our objectives of increasing brand awareness and increasing sales
leads, as well as aiding in our sales and production forecasting.

DIRECT MAIL PROMOTIONS: We maintain a database that includes contacts at
thousands of commercial facilities in the United States alone and enables us to
monitor responses to direct mail promotions. All direct mail promotions are
supplemented by a telemarketing effort to maximize customer response.

PUBLIC RELATIONS: In the commercial market, public relations is a critical
component in our strategy to build awareness and credibility for the Company and
our products in the marketplace by positioning the Company as the leading
comprehensive provider of fitness equipment and education. This requires that we
change the general perception that our individual brands stand alone to the
understanding that our individual brands combine to deliver the most powerful
fitness system available. In order to meet these objectives we have established
relationships with key press to develop and communicate our competitive
advantages.

TRADE SHOWS: There are several national and regional industry trade shows, such
as the IHRSA (International Health, Racquet and Sportsclubs Association) and
CLUB INDUSTRY, as well as many events that showcase our programs and products.
Trade shows also provide excellent opportunities to meet face-to-face with our
customers and the press to obtain invaluable feedback by being able to test
marketing messages, receive customer input on product designs, and evaluate the
competition.

INTERNET: The Company currently maintains and directs customers to our Nautilus,
Schwinn Fitness and StairMaster websites, which can be found at
www.nautilus.com, www.schwinnfitness.com, and www.stairmaster.com, respectively.
These websites contain company and product information.

RETAIL APPROACH

Our main focus for marketing our retail products is to fully support our
carefully cultivated network of dealers. A combination of Company-sponsored and
cooperative marketing programs has been developed to ensure that our Nautilus,
Schwinn, StairMaster and Trimline brands remain prominent in the minds of dealer
staff and consumers and drive consumers to their local retailers.

HEALTH AND FITNESS E-NEWSLETTER: Created to motivate and educate our customers,
the newsletter is now a consumer campaign, allowing the Company to reach
thousands of health-conscious readers every month. By delivering the newsletter
to the email inboxes of thousands of consumers and making the newsletter
available on our website, we are developing long-term customer relationships and
a community of fitness enthusiasts. In addition, dealers may label and
distribute the newsletter through their stores.

COLLATERAL AND POINT OF SALE MATERIALS: We have developed a collection of
materials to ensure that our brands figure prominently in the minds of retail
staff and consumers, including a full range of product catalogues and sell
sheets, ad planners, signage, and product displays.

PUBLIC RELATIONS: In the retail market, public relations is a cost-effective way
to promote our products in consumer publications. While advertising in fitness
industry publications is expensive, editorial and showcase articles that include

-14-


our products are virtually free. Our public relations strategy in the retail
sector is to build awareness of the general benefits of fitness and specific
contributions of our products to a healthy and fit lifestyle.

TRADE SHOWS: There are three national trade shows that are very important to the
Company's retail division: the Health & Fitness Business Expo, the industry's
premier showcase for retail fitness products; Interbike, the bicycle industry's
premier gathering; and Supershow, the mega-trade show representing retail
products in virtually every category. Trade shows also provide excellent
opportunities to meet face-to-face with our customers and the press to obtain
invaluable feedback by being able to test marketing messages, receive customer
input on product designs, and evaluate the competition.

INTERNET: The Company currently maintains and directs customers to our Nautilus,
Schwinn Fitness, StairMaster, and Trimline websites, which can be found at
www.nautilus.com, www.schwinnfitness.com, www.stairmaster.com, and
www.hebbindustries.com. These websites contain company and product information.

INTERNATIONAL APPROACH

Our international operations are headquartered in Switzerland, which, through
its central location, multi-cultural environment, and multi-lingual population,
is an excellent base for our international operation. We have integrated all of
our brands from an operational standpoint and are distributing our products
through a network of over 90 distributors in over 50 countries divided among
three regions:

o Asia/Pacific
o Europe/Middle East/Africa
o Central/South America

In each of these regions, we have responsible sales people and third party
warehouses (except Central/South America which we support from our United States
distribution facilities) to deliver our products in a timely and cost effective
manner. Currently, we have no long-lived assets outside the U.S. Communication
amongst our business partners within each region is essential to our strategy so
we may achieve product support, innovative marketing activities, and global
brand recognition.

In our largest markets, the United Kingdom and Germany, we operate our own
offices, which possess a team of sales representatives that focus not only on
selling to fitness clubs, but also on the government, hotel, and
medical/paramedical markets. During 2002, we also added an office in Italy as it
represents another market we perceive to be important.

We have formed alliances in most markets with distributors to sell commercial
products from our Nautilus, Schwinn, and StairMaster brands. This enables us to
sell "package deals" to international fitness clubs, which may prefer to buy
from one supplier that can offer the broadest array of products at a competitive
price. By building our portfolio of brand names, we have greater ability to
compete in the international marketplace in which our main competitors have
benefited from the ability to negotiate "package deals" for many years. We
believe our brand names have strong recognition in the international
marketplace, which will allow us to compete more effectively in the future.

Canada represents another significant market for our business. We sell products
from our commercial/retail and direct segment product portfolios to dealers and
retail stores within Canada. Sales within Canada are predominantly generated
from our U.S. operations.

-15-


Sales outside the U.S. represented approximately 10%, 8%, and 4% of consolidated
net sales for 2002, 2001 and 2000, respectively.

COMMERCIAL EQUIPMENT

We currently offer the following Nautilus, Schwinn, and StairMaster equipment
for the commercial market:

NAUTILUS SELECTORIZED EQUIPMENT. Nautilus 2ST line of commercial strength
equipment is specially designed to focus on a particular strength building
exercise. The key component of each Nautilus 2ST machine is either its "cam" or
a four-bar linkage mechanism, which builds and releases resistance as a user
moves through an exercise.

Nautilus NITRO line, introduced in late 2000, is a complete line of compact
selectorized machines. It is intended for clubs and other facilities where floor
space is limited. Nautilus NITRO features smooth belt drives, four-bar linkage,
classic full range variable resistance cams and converging axis movements. Each
Nautilus NITRO machine features 2" by 4" bent steel frames and 5-pound increment
weight adjustments.

NAUTILUS FREE WEIGHT EQUIPMENT. In 1999, we introduced a line of Nautilus free
weight equipment with new innovations in design and engineering intended to help
club owners better serve their customers. This free weight equipment can be
coupled with the Nautilus selectorized equipment circuit to give facility
managers a complete strength gym.

SCHWINN INDOOR CYCLING EQUIPMENT. Indoor cycling is one of the most popular
class training programs in fitness clubs. The Schwinn Indoor Cycling line is a
worldwide leader in classroom exercise bikes. Schwinn Fitness also offers an
array of stationary bikes, all of which feature adjustable resistance,
heavy-duty flywheels, and comfortable seats.

STAIRMASTER. StairMaster introduced the world's first stairclimber in 1983. The
StairMaster product line includes stairclimbers, stepmills, treadmills, and
exercise bikes. These products feature ergonomic designs, comfortable and
user-friendly controls, and geo-mechanically correct exercise equipment.
StairMaster treadmills are built to commercial standards with long lasting
decks, belts, and motors. StairMaster treadmills feature large running surfaces,
various workout programs and offer speeds of up to 12 miles per hour.

RETAIL EQUIPMENT AND ACCESSORIES

We currently offer the following Nautilus, Schwinn, StairMaster, and Trimline
equipment for the retail market:

NAUTILUS FITNESS ACCESSORIES. The Nautilus accessory line includes a wide array
of products. This includes everything from weights, gloves, and yoga kits, to
heart rate monitors, equipment mats, fitness clothing, and hand-held fitness
items.

NAUTILUS HOME GYMS. We offer a full line of home and vertical market gyms that
cover all aspects of strength training, from fixed path to free-motion training.
Nautilus home gyms offer numerous gym exercises such as chest press, shoulder
press, lat pulls, tricep extensions, and leg work. All of our gyms are made from
quality materials such as solid steel guide rods, military spec cable, and
11-gauge steel.

NAUTILUS FREE WEIGHTS AND BENCHES. Nautilus free weight equipment encompasses a
complete line of Olympic weight stations, racks, and benches. Each piece is
biomechanically engineered, crafted for durability and designed for aesthetics.

-16-


NAUTILUS TREADMILLS. Nautilus treadmills offer 11-gauge, powder coated steel
frames for durability and stability during heavy use. They come equipped with
high horsepower motors and have the patented React(TM) Absorption Control
Technology from Quinton Cardiology Systems, Inc. ("Quinton") to lessen the
impact to the user. Some of the models come complete with heart rate control for
added consumer appeal.

NAUTILUS ELLIPTICALS. The Nautilus ellipticals come equipped with a foot motion
that allows a natural articulation of the foot, which matches the user's natural
stride. At the same time, it provides a complete body workout with upper body
handles as well. All of the models include touch heart rate sensors.

NAUTILUS EXERCISE BIKES. The Nautilus exercise bike line is intended for home
use. All of the bikes have touch heart rate sensing and a computer that tracks
user workout time, calories burned, distance and heart rate. The bikes are also
belt-driven with magnetic resistance, allowing them to be virtually silent.

SCHWINN TREADMILLS. Schwinn treadmills for the home offer high horsepower
motors, deck suspension and a wide range of computer options. Schwinn treadmills
also offer patent-pending designs, such as the folding treadmill feature.

SCHWINN STATIONARY BIKES. Schwinn Fitness offers an array of stationary bikes,
all of which feature adjustable resistance, heavy-duty flywheels, and
comfortable seats. The line consists of both recumbent and upright bikes.

SCHWINN WIND RESISTANCE PRODUCTS. For years, Schwinn Fitness has been a leader
in wind resistance technology. It started years ago with the very popular
Airdyne. This technology has advanced into our Evolution(R) fan technology. This
technology is utilized in our latest version of the Airdyne and is also
incorporated into exercise bikes, rowers and upper body ergometers.

SCHWINN ELLIPTICALS. Schwinn ellipticals offer one of the smallest footprints
available, with one of the longest strides for a home elliptical machine. This
technology allows us to put a very natural, low-impact motion into a product
that fits in the customer's home.

STAIRMASTER STAIRCLIMBERS. StairMaster is a market leader in stairclimbers
worldwide. We continue to produce many different models of independent
stairclimbers and stepmills for the home and health club. We build these
products with our advanced technology, which also provides the most natural
motion for a stepper.

STAIRMASTER EXERCISE BIKES. StairMaster club bikes have one of the most
innovative displays available. These bikes are all self-powered and belt-driven.

STAIRMASTER TREADMILLS. StairMaster treadmills are some of the most durable
treadmills available to date. They use technology from Quinton, which has been
building treadmills for 50 years. Some examples of this technology are the
patented Triple Flex shock-absorbing deck suspension and the Hyperdrive drive
system.

TRIMLINE TREADMILLS. Trimline products are sold in over 400 independent
specialty fitness retailers nationwide and are exported to more than 50
countries worldwide. Trimline ranks as one of the best-selling mid-priced
treadmill brands. Trimline uses industrial-strength motors that are the size and
quality often found in higher-priced health club treadmills. The motors are
designed to run smoother, quieter and with less vibration than many motors in
their class.

TRIMLINE ELLIPTICALS. Trimline's Precision Path(TM) Foot Motion Technology
provides a natural elliptical foot pattern, recruiting all major lower-body
muscle groups. Pedal speed is designed to remain equal throughout the entire
elliptical stride resulting in a fluid motion that offers a feeling of comfort

-17-


and control. Precision Path(TM) Foot Motion Technology minimizes stress to the
ankles, knees and back commonly associated with other forms of exercise. The
dual-action arm motion and synchronized stride work together to target all major
muscle groups simultaneously.

NEW PRODUCT DEVELOPMENT AND INNOVATION

We continue to emphasize the expansion and diversification of our product
development capabilities in health and fitness products. New product development
is a focal point of our company. We develop new products either from internally
generated ideas or by acquiring or licensing patented technology from outside
inventors and then enhancing the technology.

Our research and development competencies have been enhanced through the
acquisition of Schwinn Fitness and StairMaster. With the purchase of these
companies, we gained a state-of-the-art test facility and prototype shop. With
the combination of this facility, along with the designers and engineers, we
have the capability of taking a concept from its origin, quickly and cost
effectively through to its completion within our company. This should allow us
to become a leader in new product introduction and technologies. This group
consists of industrial, mechanical, and electrical design personnel.

In recent years, successful new product introductions and extensions have
included the Nautilus Sleep Systems, the Nitro commercial line of strength
equipment, and new Nautilus selectorized home gym and free weight equipment.
Late in 2002, we expanded our portfolio of commercial strength equipment with
the introduction of the Nautilus XPload line of plate-loaded selectorized
equipment. In August of 2002, we expanded our retail product lines with the
introduction of 16 new retail products that were first shown at the Health and
Fitness Business show in Denver, Colorado. The new retail products branded under
our Nautilus name include treadmills, stationary bicycles, an elliptical motion
trainer, home strength equipment, and heart rate monitors. We also introduced
new products under our Schwinn brand name including indoor cycling bicycles and
an elliptical motion trainer. In addition to the 16 new retail products, many of
our existing products were updated and enhanced. In March 2003, we introduced
the TreadClimber, our newest direct-marketed product, under our Nautilus name.

The designs of all new products are rendered in solid modeling software. This
allows us to see and communicate ideas rapidly, do finite element analysis, and
perform costing studies very quickly. Our additional research and development
resources have allowed us to become fully integrated in the product development
process, allowing us to take a new product concept from the beginning of
feasibility studies straight through to production and continuing product
review. This integration allows us a greater degree of control over the new
product process, which should allow us to generate a higher quality product,
increase our speed to market, and control our costs.

For new direct-marketed products, we look for innovative high-quality and
proprietary consumer products that can generate gross profit margins in the
range of 65% to 75%. In addition, we look for products that we anticipate will
have mass consumer appeal, particularly among members of the "baby-boom"
generation who are accustomed to watching television and, in general, are likely
to have higher disposable income.

For commercial/retail fitness products, we gather and evaluate ideas from
various areas, including existing and potential customers, sales and marketing,
manufacturing and engineering, and we determine which ideas will be incorporated
into existing products or will serve as the basis for new products. Based on
these ideas, we design new or enhanced products, develop prototypes, test and
modify products, develop a manufacturing plan, and bring products to market. The
Company evaluates, designs, and develops each new or enhanced product, taking
into consideration our marketing requirements, target price points, gross margin
requirements and manufacturing constraints.

-18-


Research and development expense was $4.5 million, $2.2 million, and $1.2
million for 2002, 2001, and 2000, respectively.

COMPETITION

DIRECT PRODUCTS SEGMENT

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

We compete directly with a large number of companies that manufacture, market
and distribute home fitness equipment. Our principal direct competitors include
ICON Health & Fitness (through its Powerflex, Crossbow, Health Rider,
NordicTrak, Image, ProForm, Weider and Weslo brands) and Fitness Quest (through
its Gazelle and Total Gym brands).

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

NAUTILUS SLEEP SYSTEMS. The sleep products industry is also highly competitive,
as evidenced by the wide range of products available to consumers, such as
innerspring mattresses, waterbeds, futons and other air-supported mattresses. We
believe market participants compete primarily on the basis of price, product
quality and durability, brand name recognition, innovative features, warranties
and return policies.

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

In addition to the conventional mattress manufacturers, several manufacturers
currently offer beds with variable support air chamber technology similar to our
Nautilus Sleep Systems. We believe the largest manufacturer in this niche market
is Select Comfort. Select Comfort offers its sleep systems through retail stores
and engages in a significant amount of direct marketing, including infomercials,
targeted mailings and print, radio and television advertising. Select Comfort
has an established brand name supported by marketing and manufacturing resources
and has significantly greater experience in marketing and distributing sleep
systems. We believe the market for sleep systems is large enough for both
companies to be successful and that our Nautilus Sleep Systems possess features
that will enable us to compete effectively. However, the intense competition in
the mattress industry, both from conventional mattress manufacturers and Select
Comfort, may adversely affect our efforts to market and sell our sleep systems
and, consequently, may adversely affect our financial performance.

COMMERCIAL/RETAIL SEGMENT PRODUCTS

COMMERCIAL FITNESS EQUIPMENT. The market for commercial fitness equipment is
highly competitive. Our Nautilus, Schwinn, and StairMaster products compete
against the products of numerous other commercial fitness equipment companies,
including Life Fitness, Cybex, Star Trac, Precor, and Techno Gym. We believe the
key competitive factors in this industry include price, product quality,

-19-


durability, diversity of features, financing options, product service network,
and warranties. Some of our competitors have greater financial resources, more
experience in the fitness industry, and more extensive experience manufacturing
their products.

RETAIL FITNESS EQUIPMENT. The market for retail fitness equipment is extremely
competitive. Our Nautilus, Schwinn, StairMaster, and Trimline retail products
compete against the products of numerous domestic retail fitness equipment
companies including ICON Health & Fitness (marketing products under the brand
names Weslo, Health Rider, Weider, NordicTrak and ProForm), Star Trac, Life
Fitness, Cybex, Fitness Quest, and Precor. We believe the key competitive
factors in the retail fitness equipment industry include price, product quality,
brand name recognition, customer service and the ability to create and develop
new, innovative products. In addition, there are no significant technological,
manufacturing or marketing barriers to entry into the fitness equipment markets
in which we compete, even though like many companies in the industry, we have
sought and received patent and trademark protection in an effort to protect our
competitive position.

We believe that our combination of high-quality products, recognized brand
names, multiple distribution channels, and dependable customer service gives us
the ability to compete in our current markets.

MANUFACTURING AND DISTRIBUTION

Our primary manufacturing and distribution objectives for all of our products
are to maintain product quality, reduce and control costs, maximize production
flexibility and improve delivery speed. We use computerized inventory management
systems to forecast our manufacturing requirements.

Our commercial strength fitness manufacturing operations are located in
Virginia. These operations are vertically integrated and include such functions
as metal fabrication, powder coating, upholstery and vacuum-formed plastics
processes. By managing our own manufacturing operations, we can control the
quality of our commercial strength products, while offering commercial customers
greater color specification flexibility. Our manufacturing operations also
include a plant in Texas for Schwinn, Trimline, and Nautilus consumer treadmills
and a plant in Oklahoma for our commercial cardiovascular products. By
manufacturing these products in our own facilities, we ensure the highest
quality control standards.

The resistance component of our Bowflex products, the Power Rods, is assembled
exclusively in our facilities to protect our manufacturing trade secrets and to
ensure the highest quality control standards. In addition, we use outside
suppliers to manufacture many of our components and finished parts for our
direct and retail products. Whenever possible, we attempt to use at least two
suppliers to manufacture each product component in order to improve flexibility.

Domestically, we inspect, package, and ship our products from our facilities in
Washington, Virginia, Illinois, Texas, Oklahoma, and Nevada. We rely primarily
on United Parcel Service (UPS) to deliver our Bowflex and our Nautilus Sleep
Systems products. We distribute our retail equipment and accessories and retail
and commercial fitness equipment from our Illinois and Oklahoma facilities using
various commercial truck lines. We distribute commercial strength fitness
equipment from our Virginia warehouse facilities directly to customers primarily
through our truck fleet. This method of distribution allows us to effectively
control the set-up and inspection of equipment at the end-user's facilities.

For international sales, we have distributors in over 50 countries, and we ship
our products from leased facilities in Switzerland, the United Kingdom, and
Germany. We also lease, on a month-to-month basis, flexible warehouse space in
multiple countries in Asia and Europe, the largest of which is located in the
Netherlands. This flexible warehouse space is devoted to international
distribution of our products.

-20-


INTELLECTUAL PROPERTY

We own many trademarks including Nautilus(R), Bowflex(R), Power Rod(R),
Schwinn(R) (fitness products), StairMaster(R) and Trimline(R). Our trademarks,
many of which are registered or subject to pending applications in the United
States and other countries, are used on a variety of our products. We believe
that our trademarks are of great value, providing the consumer with an assurance
that the product being purchased is of high quality and provides a good value.

We also place significant value on product designs (the overall appearance and
image of our products) and processes which, as much as trademarks, distinguish
our products in the marketplace. We hold many United States and foreign patents
and have submitted additional applications for patent protection that are
pending approval. Management believes all patents are important to the Company
strategy and has identified the patents on the Bowflex Power Rod resistance
technology and TreadClimber as the most significant to our business. Although
our Bowflex trademark is protected as long as we continuously use the trademark,
the main U.S. patent on our Bowflex Power Rod resistance technology expires on
April 27, 2004. This patent expiration could trigger the introduction of similar
products by competitors.

Building our intellectual property portfolio is an important factor in
maintaining our competitive position in the fitness and mattress industries. If
we do not or are unable to adequately protect our intellectual property, our
sales and profitability could be adversely affected. We are very protective of
these proprietary rights and take action to prevent counterfeit reproductions or
other infringing products. As we expand our market share, geographic scope and
product categories, intellectual property disputes are anticipated to increase
making it more expensive and challenging to establish and protect our
proprietary rights and to defend against claims of infringement by others.

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

EMPLOYEES

As of December 31, 2002, we employed 1,307 employees, including 4 executive
officers. None of our employees are subject to any collective bargaining
agreements.






-21-


ITEM 2. PROPERTIES
- ------------------

The following is a summary of principal properties owned or leased by the
Company:

Owned or Approximate
Location Segment Primary Function(s) Leased Lease Expiration space
- -------- ------- ------------------- ------ ---------------- -----

Washington Direct Corporate headquarters, call center, Owned 114,000 sq. feet
warehouse, production, and distribution
Washington Commercial/Retail Research and development Leased June 30, 2003 2,500 sq. feet
Virginia Direct Warehouse and distribution Owned 105,000 sq. feet
Virginia Commercial/Retail Commercial equipment manufacturing Owned 124,000 sq. feet
Virginia Commercial/Retail Engineering, prototyping, customer Owned 27,000 sq. feet
service, and administrative
Virginia Commercial/Retail Showroom Owned 9,000 sq. feet
Virginia Commercial/Retail Commercial equipment sales and Owned 29,500 sq. feet
warehouse
Virginia Commercial/Retail Warehouse and distribution Owned 86,000 sq. feet
Virginia Direct Warehouse and distribution Owned 65,000 sq. feet
Nevada Direct Warehouse and distribution Leased December 31, 2003 93,000 sq. feet
Illinois Commercial/Retail Warehouse and distribution Leased October 31, 2003 139,000 sq. feet
Colorado Commercial/Retail Administrative, warehouse, production, Owned 86,000 sq. feet
testing, and distribution
Colorado Commercial/Retail Subleased administrative and warehouse Leased November 30, 2003 3,800 sq. feet
Texas Commercial/Retail Warehouse and distribution Owned 63,000 sq. feet
Texas Commercial/Retail Storage Leased Month-to-month 10,000 sq. feet
Texas Commercial/Retail Manufacturing Leased Month-to-month 14,000 sq. feet
Texas Commercial/Retail Warehouse Leased Month-to-month 24,000 sq. feet
Texas Commercial/Retail Administrative, manufacuring, and Owned 135,000 sq. feet
warehouse
Oklahoma Commercial/Retail Manufacturing Leased December 31, 2011 125,000 sq. feet
Oklahoma Commercial/Retail Distribution Leased April 30, 2005 22,500 sq. feet
Oklahoma Commercial/Retail Distribution Leased Month-to-month 22,500 sq. feet
Switzerland Commercial/Retail Administrative Leased December 31, 2007 1,250 sq. feet
Switzerland Commercial/Retail Warehouse and distribution Leased March 31, 2004 3,390 sq. feet
Germany Commercial/Retail Administrative and distribution Leased Month-to-month 850 sq. feet
United Kingdom Commercial/Retail Administrative, showroom, and warehouse Leased May 24, 2014 3,350 sq. feet
Italy Commercial/Retail Administrative and distribution Leased June 30, 2003 153 sq. feet
Nevada Direct Vacant land which may be used in Owned 19.5 acres
expansion of operations in the future



For our international operations, we also lease, on a month-to-month basis,
flexible warehouse space in multiple countries in Asia and Europe, the largest
of which is located in the Netherlands. This flexible warehouse space is devoted
to international distribution of our products.

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

ITEM 3. LEGAL PROCEEDINGS
- -------------------------

In the normal course of business, the Company is a party to various legal
claims, actions and complaints. Although it is not possible to predict with
certainty whether the Company will ultimately be successful in any of these
legal matters, or what the impact might be, the Company believes that the
disposition of these matters will not have a material adverse effect on the
Company's financial position, results of operations or cash flows.

-22-


In December 2002, the Company filed suit against Icon Health and Fitness, Inc.
in the Federal District Court, Western District of Washington alleging
infringement by Icon of the Company's Bowflex patents. The Company seeks
injunctive relief, unquantified treble damages and its fees and costs.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
- -----------------------------------------------------------

No matters were submitted to a vote of our stockholders during the quarter ended
December 31, 2002.

PART II

ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
- -----------------------------------------------------------------------------

MARKET PRICE OF OUR COMMON STOCK

From May 4, 1999 until May 20, 2002, our common stock was listed for trading
exclusively on The NASDAQ National Market System under the symbol DFXI. On May
21, 2002, we transferred our listing to the New York Stock Exchange and changed
our stock symbol to NLS. The following table summarizes the high and low closing
prices for each period indicated, adjusted to reflect three-for-two stock splits
effective January 2001 and August 2001:

High Low
2002:
Quarter 1 $ 38.05 $ 27.59
Quarter 2 45.45 28.25
Quarter 3 34.05 19.50
Quarter 4 23.85 12.70

2001:
Quarter 1 $ 21.42 $ 12.39
Quarter 2 31.67 15.97
Quarter 3 33.34 17.11
Quarter 4 31.46 19.95

As of March 1, 2003, 32,528,850 shares of our common stock were issued and
outstanding and held by approximately 14,200 beneficial shareholders.

On January 29, 2003, the Board of Directors declared a $0.40 per share annual
dividend payable quarterly. The initial quarterly dividend of $0.10 per share
was paid March 10, 2003, to shareholders of record at the close of business on
February 20, 2003. Payment of any future dividends is at the discretion of our
Board of Directors, which considers various factors, such as our financial
condition, operating results, current and anticipated cash needs and expansion
plans.

ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
- --------------------------------------------

The selected consolidated financial data presented below for each year in the
five-year period ended December 31, 2002 have been derived from our audited
financial statements. The balance sheet data as of December 31, 2002 and 2001
and the statement of operations data for each of the years in the three year
period ended December 31, 2002 have been derived from our audited financial
statements included herein. The balance sheet data as of December 31, 2000,

-23-


1999, and 1998 and the statement of operations data for the years ended December
31, 1999 and 1998 have been derived from our audited financial statements not
included in this document. The data presented below should be read in
conjunction with our financial statements and notes thereto and Item 7,
"Management's Discussion and Analysis of Financial Condition and Results of
Operations." Comparability of financial results is affected by the acquisition
of Schwinn Fitness in September 2001 and StairMaster in February 2002. For
further discussion of financial information related to the acquisitions of
Schwinn Fitness and StairMaster, see Note 3 of the Notes to Consolidated
Financial Statements.


In Thousands (except per share amounts) 2002 2001 2000 1999 1998
---- ---- ---- ---- ----
STATEMENT OF OPERATIONS DATA

Net sales $584,650 $363,862 $223,927 $133,079 $ 63,171
Cost of sales 252,336 140,699 75,573 46,483 18,316
-------- -------- -------- -------- --------
Gross profit 332,314 223,163 148,354 86,596 44,855

Operating expenses:
Selling and marketing 145,258 99,813 73,510 44,630 22,643
General and administrative 25,893 15,574 8,804 4,237 1,701
Royalties 10,108 7,363 4,979 2,897 1,623
Litigation settlement - - - 4,000 -
-------- -------- -------- -------- --------
Total operating expenses 181,259 122,750 87,293 55,764 25,967
-------- -------- -------- -------- --------
Operating income 151,055 100,413 61,061 30,832 18,888

Other income (expense):
Interest income 1,561 4,024 3,632 1,003 527
Other - net 331 381 347 3 (222)
-------- -------- -------- -------- --------
Total other income 1,892 4,405 3,979 1,006 305
-------- -------- -------- -------- --------
Income before income taxes 152,947 104,818 65,040 31,838 19,193
Income tax expense 55,060 38,235 23,414 11,495 6,708
-------- -------- -------- -------- --------
Net income $ 97,887 $ 66,583 $ 41,626 $ 20,343 $ 12,485
======== ======== ======== ======== ========

Basic earnings per share * $ 2.84 $ 1.89 $ 1.18 $ 0.59 $ 0.40
Diluted earnings per share* $ 2.79 $ 1.85 $ 1.16 $ 0.58 $ 0.38

Basic shares outstanding * 34,499 35,184 35,288 34,309 31,511
Diluted shares outstanding * 35,143 35,966 35,997 35,185 32,825

BALANCE SHEET DATA

Cash and short-term investments $ 49,297 $ 51,709 $ 77,181 $ 35,703 $ 18,911
Working capital 109,023 84,366 72,520 38,209 15,682
Total assets 276,653 193,905 117,126 67,310 24,373
Stockholders' equity 202,423 147,414 92,867 53,031 17,651


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

-24-


ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
- -------------------------------------------------------------------------------
OF OPERATIONS
- -------------

CRITICAL ACCOUNTING POLICIES

We have identified the most critical accounting policies 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.

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. In addition, the cost of a technician
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. Thorough testing of new products in the
development stage helps to identify and correct potential warranty issues prior
to manufacturing. Continuing quality control efforts during manufacturing limit
our exposure to warranty claims. We track warranty claims by part and reason for
claim in order to identify any potential warranty trends. If our quality control
efforts were to fail to detect a fault in one of our products, we could
experience an increase in warranty claims resulting in an increase in the
warranty reserve. In addition, if we were to experience a significant number 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 based on our historical experience of product
returns during the trial period in which a customer can return a product for the
full purchase price, less shipping and handling in most instances. The trial
periods for Bowflex, Champion Nutrition, and Nautilus Sleep Systems product
lines are six weeks, 30 days, and 90 days, respectively. Trial 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 based on our historical experience
adjusted for any known uncollectible amounts. We periodically review the
creditworthiness of our customers to help ensure 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 required for any
known obsolete or defective products. We periodically review inventory levels of

-25-


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.

INTANGIBLE ASSET VALUATION

Intangible assets predominantly consist 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 the annual impairment analysis. 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

This discussion and analysis should be read in conjunction with our consolidated
financial statements and related notes included elsewhere in this report. We
believe that period-to-period comparisons of our operating results are not
necessarily indicative of future performance. You should consider our prospects
in light of the risks, expenses and difficulties frequently encountered by
companies experiencing rapid growth and, in particular, rapidly growing
companies that operate in evolving markets. We may not be able to successfully
address these risks and difficulties. Although we have experienced net sales
growth in recent years, our net sales growth may not continue, and we cannot
assure you of any future growth or profitability.

The following table presents certain financial data as a percentage of net
sales:


Year Ended December 31,
-----------------------
Statement of Operations Data 2002 2001 2000

Net sales 100.0 % 100.0 % 100.0 %
Cost of sales 43.2 38.7 33.7
----- ----- -----
Gross profit 56.8 61.3 66.3
----- ----- -----
Operating expenses:
Selling and marketing 24.9 27.4 32.8
General and administrative 4.4 4.3 4.0
Royalties 1.7 2.0 2.2
----- ----- -----
Total operating expenses 31.0 33.7 39.0
----- ----- -----
Operating income 25.8 27.6 27.3
Other income 0.3 1.2 1.8
----- ----- -----
Income before income taxes 26.1 28.8 29.1
Income tax expense 9.4 10.5 10.5
----- ----- -----
Net income 16.7 % 18.3 % 18.6 %
===== ===== =====

-26-


COMPARISON OF THE YEARS ENDED DECEMBER 31, 2002 AND DECEMBER 31, 2001

NET SALES

Net sales increased by 60.7% to $584.6 million in 2002 from $363.9 million in
2001. Excluding our acquisitions of Schwinn Fitness and StairMaster, sales grew
by approximately 32.6% on a consolidated basis in 2002 compared to 2001. The
increase in sales was driven by the growth in our direct segment and continued
expansion of our commercial/retail business.

Sales in our direct segment are comprised primarily of sales from our Bowflex
product line. However, as sales from our Nautilus Sleep Systems product line
continue to grow, they have become an increasingly important component of our
direct segment business. Sales within our direct segment were $392.6 million in
2002, an increase of 34.2% over 2001. A significant reason for the increase in
direct segment sales can be attributed to the introduction of our high-end
Bowflex "Ultimate" at the end of the fourth quarter of 2001. The "Ultimate" has
been well received by consumers leading to sequential growth in the average
selling price of our Bowflex product line in each quarter since its
introduction. The average Bowflex selling price increased 11.5% in the fourth
quarter of 2002 compared to the same period in 2001. Our direct-marketing
business is largely dependent upon national cable television advertising. We
experienced changes in the advertising environment in the second half of 2002 as
costs rose for the first time in two years due to heightened demand for
advertising time. As a result of this higher advertising cost environment,
fourth quarter direct segment revenue showed year-over-year growth but not
sequential growth as we managed our advertising spending to optimize
profitability.

We believe two unusual events affected sales in late 2001 and the first half of
2002: the nesting effect as a result of the events of September 11, 2001 and the
high availability of television advertising time. Both of these contributed very
positively to Bowflex sales during the first half of 2002. As evidenced by
results in the last part of 2002, the nesting effect of September 11, 2001 seems
to be receding, and the advertising environment has changed considerably.

Our direct segment accounted for 67.2% of our aggregate net sales in 2002, down
from 80.4% in 2001, as we continued our strategies of diversification into the
commercial and retail markets and of introducing new direct-marketed products.

Sales within our commercial/retail segment were $192.0 million in 2002, an
increase of 169.3% over 2001. A significant portion of this growth is attributed
to the acquisition of Schwinn Fitness in September 2001 and StairMaster in
February 2002. Our commercial/retail segment now accounts for 32.8% of our net
sales, up from 19.6% in 2001 as we continue to execute our strategy of expanding
our presence, product lines, and brands across all our channels, especially
within the commercial/retail segment. In August of 2002, we expanded our product
lines with the introduction of 16 new retail products. The new retail products
branded under our Nautilus name include treadmills, stationary bicycles, an
elliptical motion trainer, home strength equipment, and heart rate monitors. We
also introduced new products under our Schwinn brand name including indoor
cycling bicycles and an elliptical motion trainer. In addition to the 16 new
retail products, many of our existing products were updated and enhanced. We
began shipping the majority of our new products late in the fourth quarter of
2002.

We believe our business will continue to show considerable seasonality going
forward. In our direct marketing business we have found that second quarter
influences on television viewership, such as the broadcast of national network
season finales and seasonal weather factors, cause our spot television
commercials on national cable television to be less effective in the second
quarter than in other periods of the year. Additionally, we have found that
advertising availability during the fourth quarter is more limited due to an
increase in annual holiday advertising and political advertisements during
election years. Our retail business is also highly seasonal. We believe that
sales within our commercial/retail segment are considerably lower in the second
quarter of the year compared to the other quarters. Our strongest quarter for
the commercial/retail segment is generally

-27-


the fourth quarter, followed by the first and third quarters. We believe the
principal reason for this trend is the commercial/retail fitness industry's
preparation for the impact of New Year's fitness resolutions and seasonal
weather patterns related to colder winter months.

GROSS PROFIT

Gross profits continued to be strong, growing 48.9% to $332.3 million in 2002
from $223.2 million in 2001. However, due to our product diversification
strategy, which has increased sales of inherently lower margin products in the
commercial/retail segment, our overall gross profit margin decreased to 56.8% in
2002, compared to 61.3% in 2001. We expect this trend to continue as we increase
sales in the commercial/retail segment of the market relative to our total
sales.

The gross profit margin within our direct segment was 73.4% in 2002 and 69.8% in
2001. Gross margins on our Bowflex product line continue to be very strong as we
gain cost reductions from vendors and shipping cost savings. For example, the
standard cost for the Bowflex "Power Pro" with a 210-pound rod pack was reduced
approximately 18% by the fourth quarter of 2002 compared with the same period in
2001. In addition, product delivery costs were reduced by approximately 17% by
the end of the fourth quarter of 2002 compared with the same period in 2001.

The decrease in gross profit margin within our commercial/retail segment to
23.0% in 2002, compared with 26.4% in 2001, was largely due to the Schwinn
Fitness and StairMaster acquisitions. Other downward pressure on
commercial/retail margins included discounts offered on sales of discontinued
retail products and manufacturing inefficiencies associated with moves and the
consolidation of our treadmill facilities. Discounts were offered to reduce
inventory levels of older products in order to accommodate 16 new retail fitness
products that were introduced during the third quarter.

OPERATING EXPENSES

SELLING AND MARKETING. Selling and marketing expenses grew to $145.3 million in
2002 from $99.8 million in 2001, an increase of 45.5%. This increase in selling
and marketing expenses resulted primarily from the expansion of our direct
marketing campaign for Bowflex products and Nautilus Sleep Systems, higher
advertising costs in the second half of 2002 due to increased demand for
advertising time, and the acquisitions of Schwinn Fitness and StairMaster.
Advertising costs for our direct marketing segment rose for the first time in
about two years, and we expect costs to remain at higher levels during 2003. We
experienced an increase of approximately 13% in advertising costs from the
fourth quarter of 2001 to the fourth quarter of 2002. We expect to materially
increase our cash expenditures on spot commercials and infomercials as we
anticipate rates to remain higher than we experienced in the first half of 2002
and as we expand the direct marketing campaigns for our Nautilus Sleep Systems
as well as our new TreadClimber, which we introduced in the first quarter of
2003.

As a percentage of net sales, overall selling and marketing expenses decreased
to 24.9% in 2002 from 27.4% in 2001. The decrease was primarily a result of
executing our product diversification strategy leading to a higher proportion of
commercial/retail segment sales. Selling and marketing expenses within our
direct segment were 30.9% of net sales in 2002, compared to 31.3% in 2001.

GENERAL AND ADMINISTRATIVE. General and administrative expenses grew to $25.9
million in 2002 from $15.6 million in 2001, an increase of $10.3 million, or
66.3%. Our commercial/retail segment accounted for $7.4 million of the increase
due primarily to our Schwinn Fitness and StairMaster acquisitions. Our direct
segment accounted for the remaining increase of $2.9 million due primarily to
increased staffing and

-28-


infrastructure expenses necessary to support our growth. As a percentage of net
sales, general and administrative expenses increased marginally to 4.4% in 2002
from 4.3% in 2001.

ROYALTIES. Royalty expense grew to $10.1 million in 2002 from $7.4 million in
2001, an increase of 37.3%. Both our direct and commercial/retail segments have
several royalty agreements. The increase in our royalty expenses is primarily
attributable to the increased sales of our Bowflex products, along with sales of
other products under royalty agreements that have been added as part of our
diversification strategy. The patent for the Bowflex Power Rod resistance
technology expires on April 27, 2004. The Company will no longer be obligated to
pay royalties related to Bowflex sales following the expiration of this patent.

OTHER INCOME

In 2002, other income was $1.9 million compared to $4.4 million for 2001. This
decline resulted primarily from a decrease in interest earned on invested cash
and cash equivalents. Because we used a significant portion of our cash for
acquisitions and stock buybacks, we had less cash from which to derive interest
income. Interest income also decreased due to interest rate cuts by the Federal
Reserve Bank in 2002.

INCOME TAX EXPENSE

Income tax expense increased by $16.8 million for 2002 primarily due to the
growth in our income before taxes. The decrease in our effective tax rate from
36.5% in 2001 to 36.0% in 2002 is due to state income tax issues relating to our
commercial and retail business increasing our 2001 rate while the 2002 rate is
in line with our historical experience. We expect our income tax expense to
increase in line with our growth in income before taxes.

NET INCOME

For the reasons discussed above, net income grew to $97.9 million in 2002 from
$66.6 million in 2001, an increase of 47.0%. Our net income as a percentage of
sales, though down from 18.3% in 2001, was a strong 16.7% in 2002. The expansion
of our commercial/retail segment business and product lines during 2002 resulted
in a decline in net income as a percentage of sales, but increased net income in
real dollars.

COMPARISON OF THE YEARS ENDED DECEMBER 31, 2001 AND DECEMBER 31, 2000

NET SALES

Net sales grew by 62.5% to $363.9 million in 2001 from $223.9 million in 2000.
Sales were driven by the growth in our direct segment and our continued
expansion into the commercial and retail market segments. In 2001, we
capitalized on favorable advertising costs and availability to increase the
consumer awareness of our Bowflex and Nautilus Sleep System product lines.
Meanwhile, we continued to expand our market share in the commercial/retail
products segment, where we grew the Nautilus brand and successfully integrated
the acquisition of the Schwinn Fitness business.

Sales in our direct segment were comprised primarily of sales of our Bowflex
product line; however, as the Nautilus Sleep Systems product line continued to
grow, it also became an increasingly important component of our direct business.
Sales within our direct products segment were $292.5 million in 2001, an
increase of 47.7% over the prior year. Our direct segment accounted for 80.4% of
our aggregate net sales in 2001, down from 88.5% in 2000, as we continued our
strategies of diversification into the commercial and retail products segments
and of introducing new direct-marketed products.

Sales within our commercial/retail products segment were $71.3 million in 2001,
an increase of 176.2% over 2000. Our commercial/retail segment accounted for
19.6% of our net sales, up from 11.5% in 2000 as we

-29-


continued to execute our strategy of expanding our presence, product lines and
brands across all our channels and especially within the commercial/retail
products segment.

GROSS PROFIT

Gross profits continued to be strong, growing 50.4% to $223.2 million in 2001,
from $148.4 million in the same period a year ago. However, due to our product
diversification strategy, which increased sales in the commercial/retail
segment, and due to the inherent lower margins in that segment, our overall
gross profit margin decreased to 61.3% in 2001, from 66.3% in 2000. The gross
profit margin within our direct products segment was 69.8% in 2001 and 70.2% in
2000. The decrease in gross margins within our commercial/retail products
segment to 26.4% in 2001, compared with 36.2% in 2000, was largely due to the
Schwinn Fitness acquisition and higher research and development expenditures for
the Nautilus retail fitness products.

OPERATING EXPENSES

SELLING AND MARKETING. Selling and marketing expenses grew to $99.8 million in
2001 from $73.5 million in 2000, an increase of 35.8%. This increase in selling
and marketing expenses resulted primarily from the expansion of our direct
marketing campaign for Bowflex products and Nautilus Sleep Systems and variable
costs associated with our sales growth.

As a percentage of net sales, overall selling and marketing expenses decreased
to 27.4% in 2001 from 32.8% in 2000. The decrease was a result of our planned
product diversification efforts leading to a higher proportion of
commercial/retail product sales. We also benefited from the increased
availability of advertising time and the reduction of advertising rates due to
the dramatic reduction of dot.com media spending, the effects of September 11,
2001, and the economic downturn. Selling and marketing expenses within our
direct products segment were 31.3% of net sales in 2001, compared to 33.9% in
2000.

GENERAL AND ADMINISTRATIVE. General and administrative expenses grew to $15.6
million in 2001 from $8.8 million in 2000, an increase of 76.9%. Our direct
segment business accounted for $4.0 million of the increase, due primarily to
increased staffing and infrastructure expenses necessary to support our growth.
Our commercial/retail operations accounted for the remaining increase primarily
due to our product diversification strategy. As a percentage of net sales,
general and administrative expenses increased to 4.3% in 2001 from 3.9% in 2000.

ROYALTIES. Royalty expense grew to $7.4 million in 2001 from $5.0 million in
2000, an increase of 47.9%. Both our direct and commercial/retail segments have
several royalty agreements. The increase in our royalty expenses was primarily
attributable to the increased sales of our Bowflex products, along with sales of
other products under royalty agreements that have been added as part of our
diversification strategy.

OTHER INCOME

In 2001, other income was $4.4 million compared to $4.0 million for 2000. The
increase resulted primarily from an increase in interest earned on invested cash
and cash equivalents due to higher invested cash amounts. The increase was
somewhat offset by considerable interest rate cuts by the Federal Reserve Bank
in 2001.

-30-


INCOME TAX EXPENSE

Income tax expense increased by $14.8 million for 2001 primarily due to the
growth in our income before taxes. The increase in our effective tax rate to
36.5% in 2001 from 36.0% in 2000 was due to state income tax issues relating to
our commercial/retail business segment.

NET INCOME

For the reasons discussed above, net income grew to $66.6 million in 2001 from
$41.6 million in 2000, an increase of 60.0%. Not only were we able to maintain a
high sales growth rate, but we also complemented that with control over our
expenses, which grew only marginally as a percentage of sales from 2000. Higher
sales, coupled with controlling our expenses, translated into strong net income
growth in 2001.

QUARTERLY RESULTS OF OPERATIONS

The following table presents our operating results for each of the eight
quarters in the period ended December 31, 2002. The information for each of
these quarters is unaudited and has been prepared on the same basis as the
audited financial statements appearing elsewhere in this Annual Report on Form
10-K. In the opinion of management, all necessary adjustments, consisting only
of normal recurring adjustments, have been included to present fairly the
unaudited quarterly results when read together with our audited financial
statements and the related notes. These operating results are not necessarily
indicative of the results of any future period. Due to recent acquisitions
within our commercial/retail segment, we expect heightened seasonality in our
business. We expect sales in the second quarter to be weakest while the first
and fourth quarter should be our strongest. The fourth quarter should be
stronger than the first quarter.


QUARTER ENDED
-------------------------------------------------------------
In Thousands (except per share) March 31 June 30 September 30 December 31 Total

Fiscal 2002:
- ------------

Net sales $135,914 $140,408 $152,865 $155,463 $584,650
Gross profit 77,161 83,769 88,365 83,019 332,314
Operating income 36,968 39,737 39,194 35,156 151,055

Net income 23,958 25,826 25,059 23,044 97,887

Earnings per share:
Basic 0.68 0.73 0.72 0.69 2.84
Diluted 0.67 0.72 0.71 0.69 2.79

Fiscal 2001:
- ------------

Net sales $ 74,855 $ 75,009 $ 88,702 $125,296 $363,862
Gross profit 49,551 49,237 55,691 68,684 223,163
Operating income 21,534 21,531 25,196 32,152 100,413

Net income 14,739 14,550 16,764 20,530 66,583

Earnings per share:
Basic * 0.42 0.41 0.48 0.59 1.89
Diluted * 0.41 0.40 0.46 0.57 1.85


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

-31-


LIQUIDITY AND CAPITAL RESOURCES

Historically, we have financed our growth and acquisitions primarily from cash
generated by our operating activities. During 2002, our operating activities
generated $100.6 million in net cash, which contributed to an aggregate $31.7
million balance in cash and cash equivalents and $17.6 million of short-term
investments, compared with $66.9 million and $52.8 million net cash generated by
our operating activities in 2001 and 2000, respectively.

Net cash used in our investing activities decreased in 2002 to $57.9 million,
from $94.3 million in 2001, which was up substantially from $8.7 million in
2000. The 2002 activity was primarily due to capital expenditures of $31.5
million and the acquisition of StairMaster for $24.1 million, net of cash
acquired. The 2001 activity was primarily the acquisition of Schwinn Fitness for
$69.8 million, including acquisition costs and $16.1 million of net purchases of
short-term investments. Our capital expenditures in 2002 primarily consisted of
land and buildings, manufacturing equipment, and computer systems and related
equipment. We invested $16.7 million in capital expenditures for our direct
segment computer systems and related equipment to support the growth of the
business. We purchased land and a building in Colorado for $6.7 million,
including improvements, which serve as the commercial/retail segment
headquarters. We also purchased land and buildings in Texas and Virginia for
$3.1 million, including improvements, which serve as manufacturing and warehouse
facilities. We invested $2.3 million in tooling for manufacturing our new
products. We invested $1.7 million at our corporate headquarters in Washington
to consolidate our Washington operations and to expand our call center. Finally,
we invested $1.5 million in 2002 for net purchases of short-term investments.

Net cash used in financing activities increased to $47.2 million from $14.0
million in 2001 and $2.6 million in 2000. Increased use of funds for stock
repurchases during 2002 and 2001 resulted in the increase in net cash used. In
2002 we repurchased $50.0 million of stock and received $2.7 million for stock
option exercises. In 2001 we repurchased $16.3 million of stock and received
$2.3 million for stock option exercises.

Our working capital needs have increased as we continue to implement our growth
strategy. Working capital in 2002, 2001 and 2000 was $109.0 million, $84.4
million and $72.5 million, respectively. We anticipate that our working capital
requirements will increase going forward as a result of us growing our
commercial/retail segment through our acquisition strategy and internal growth.
We also expect to materially increase our cash expenditures on spot commercials
and infomercials as we expect advertising rates to remain higher than we
experienced in the first half of 2002 and as we expand the direct marketing
campaigns for our Nautilus Sleep Systems and our newly introduced TreadClimber.
Commercial/retail segment inventories increased in anticipation of increased
sales, especially of new products and the addition of inventories associated
with the acquisition of StairMaster. The $25.2 million increase in trade
receivables can primarily be attributed to the fourth quarter sales in 2002
being heavily back-end loaded as most of the 16 new retail products were
received for sale late in the quarter. Also contributing to the increase in
receivables was the acquisition of StairMaster. We expect that our working
capital will increase going forward as a result of our anticipated future
profitability.

We maintain a $10 million line of credit with U.S. Bank National Association.
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 December 31, 2002, we had no contractual capital obligations or commercial
commitments other than operating leases, which are described in Note 8 of the
Notes to Consolidated Financial Statements.

-32-


During the first quarter of 2003, we announced a $50 million stock repurchase
program which expires June 30, 2003, and a $0.40 annual stock dividend to be
paid $0.10 per quarter commencing March 10, 2003. We intend to use cash
generated from operations to finance the dividend and any stock repurchase
activity.

We believe our existing cash balances, cash generated from operations and
borrowings available under our line of credit, will be sufficient to meet our
capital requirements for the foreseeable future.

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 results of
operations, cash flows or our financial position. However, increases in
inflation over historical levels or uncertainty in the general economy could
decrease discretionary consumer spending for products like ours. Very little of
our revenue growth is attributable to price increases.

RISKS AND UNCERTAINTIES

While management is optimistic about the Company's long-term prospects, the
following issues and uncertainties, among others, should be considered in
evaluating our growth outlook.

A SIGNIFICANT DECLINE IN AVAILABILITY OF MEDIA TIME OR A MARKED INCREASE IN
ADVERTISING RATES MAY HINDER OUR ABILITY TO EFFECTIVELY MARKET OUR PRODUCTS AND
MAY REDUCE PROFITABILITY.

We depend primarily on 60-second "spot" television commercials and 30-minute
television "infomercials" to market and sell our direct-marketed products.
Consequently, a marked increase in the price we must pay for our preferred media
time or a reduction in its availability may adversely impact our financial
performance.

UNFAVORABLE ECONOMIC CONDITIONS OR GEOPOLITICAL UPHEAVAL COULD CAUSE A DECLINE
IN CONSUMER SPENDING AND HINDER OUR PRODUCT SALES.

The success of each of our products depends substantially on the amount of
discretionary funds available to consumers and their purchasing preferences.
Economic and political uncertainties could continue to adversely impact the U.S.
and international economic environment. A continued decline in economic
conditions could further depress consumer spending, especially discretionary
spending for premium priced products like ours. These poor economic conditions
could in turn lead to substantial decreases in our net sales.

COMPETITION COULD INCREASE SIGNIFICANTLY UPON THE EXPIRATION OF THE PRINCIPAL
U.S. PATENT ON OUR BOWFLEX POWER ROD RESISTANCE TECHNOLOGY ON APRIL 27, 2004.

Although our Bowflex trademark is protected as long as we continuously use the
trademark, the main U.S. patent on our Bowflex Power Rod resistance technology,
a key component of our Bowflex products, expires on April 27, 2004. This
impending patent expiration is expected to trigger the introduction of similar
products by competitors and could result in a significant decline in our net
sales.

A SIGNIFICANT DECLINE IN CONSUMER INTEREST IN BOWFLEX PRODUCTS WOULD SHARPLY
DIMINISH OUR SALES AND PROFITABILITY.

Our financial performance depends significantly on sales of our Bowflex line of
home fitness equipment. During 2002, approximately 61% of our net sales were
attributable to our Bowflex products. Accordingly, any significant decline in
consumer interest in our Bowflex products could significantly reduce our sales
and profitability. Sales of our Bowflex line could significantly decline if, for
example, a competing product were

-33-


effectively marketed and resulted in significant consumer purchases or if the
market demand for our Bowflex line were to become saturated. Although we are
working to diversify our revenue base, we anticipate that sales of our Bowflex
product line will continue to account for a substantial portion of our net sales
for the foreseeable future.

NEW PRODUCT DEVELOPMENT IS AN ESSENTIAL COMPONENT OF OUR GROWTH STRATEGY; AN
INABILITY TO SUCCESSFULLY DEVELOP NEW PRODUCTS COULD NEGATIVELY IMPACT OUR
FUTURE PROFITABILITY.

Our future success depends on our ability to develop or acquire the rights to,
and then effectively market and sell, new products that create and respond to
new and evolving consumer demands. Accordingly, our net sales and profitability
may be harmed if we are unable to develop, or acquire the rights to, new and
different products that satisfy our marketing criteria. In addition, any new
products that we market may not generate sufficient net sales or profits to
recoup their development or acquisition cost.

We also may not be able to successfully acquire intellectual property rights or
potentially prevent others from claiming that we have violated their proprietary
rights when we launch new products. We could incur substantial costs in
defending against such claims, even if they are without basis, and we could
become subject to judgments requiring us to pay substantial damages.

WE HAVE BEEN A RAPIDLY GROWING COMPANY; OUR FAILURE TO PROPERLY MANAGE GROWTH
MAY ADVERSELY AFFECT OUR FINANCIAL PERFORMANCE.

We have grown significantly in recent years, with an increase in net sales from
$9.2 million in 1996 to $584.6 million in 2002. Our organic growth has been
complemented by acquisitions of Nautilus in January 1999, Schwinn Fitness in
September 2001, and StairMaster in February 2002. Our rapid growth and recent
acquisitions may strain our management team, production facilities, information
systems and other resources. In addition, we may be unable to effectively
allocate our existing and future resources to our various businesses while
maintaining our focus on our core competencies. We cannot assure you that we
will succeed in effectively managing our existing operations or our anticipated
growth, which could adversely affect our financial performance.

OUR FAILURE OR INABILITY TO PROTECT OUR INTELLECTUAL PROPERTY COULD
SIGNIFICANTLY HARM OUR COMPETITIVE POSITION.

Protecting our intellectual property is an essential factor in maintaining our
competitive position in the health and fitness industries. If we do not or are
unable to adequately protect our intellectual property, our sales and
profitability could be adversely affected. We currently hold a number of patents
and trademarks and have several patent and trademark applications pending.
However, our efforts to protect our proprietary rights may be inadequate and
applicable laws provide only limited protection.

IF WE ARE UNABLE TO EFFECTIVELY INTEGRATE ACQUIRED BUSINESSES INTO OUR
OPERATIONS, WE MAY NOT ACHIEVE ANTICIPATED REVENUE, EARNINGS AND BUSINESS
SYNERGIES.

We face significant challenges in integrating acquired businesses into our
operations, particularly with respect to corporate cultures and management
teams. Failure to successfully effect the integration could adversely impact the
revenue, earnings and business synergies we expect from the acquisitions. In
addition, the process of integrating acquired businesses may be disruptive to
our operations and may cause an interruption of, or a loss of momentum in, our
core business.

Our future integration efforts may be jeopardized, and our actual return on
investment from such acquisitions may be lower than anticipated, as a result of
various factors, including the following:

-34-


o Challenges in the successful integration of the products, services or
personnel of the acquired business into our operations;
o Loss of employees or customers that are key to the acquired business;
o Time and money spent by our management team focusing on the integration,
which could distract it from our core operations;
o Our potential lack of experience in markets of the acquired businesses;
o Possible inconsistencies in standards, controls, procedures and policies
among the combined companies and the need to implement our financial,
accounting, information and other systems; and
o The need to coordinate geographically diverse operations.

WE DEPEND ON A SINGLE TIER-ONE CONSUMER FINANCE COMPANY TO PROVIDE FINANCING
PACKAGES TO OUR CUSTOMERS; A DETERIORATION OF THE CONSUMER FINANCE MARKET OR
FAILURE BY THE FINANCE COMPANY TO PROVIDE FINANCING TO OUR CUSTOMERS COULD
NEGATIVELY IMPACT SALES OF OUR DIRECT-MARKETED PRODUCTS.

In purchasing our products, approximately 37% of our direct-marketed customers
utilize convenient financing packages provided by an independent finance
company. We believe that convenient consumer financing is an important tool in
our direct marketing efforts and induces many of our customers to make purchases
when they otherwise would not. We facilitate the availability of convenient
financing to our customers in order to increase our sales. Consumers may be less
likely to purchase our products if the consumer finance market were to
deteriorate so that financing is less available or less convenient to our
customers. In addition, we currently utilize the services of a single top tier
consumer finance company. Although we believe we could enter into similar
arrangements with other providers if needed, a failure by the current provider
to adequately service our customers could temporarily disrupt sales.

A DETERIORATION IN PRODUCT QUALITY OR INCREASE IN PRODUCT LIABILITY COULD
ADVERSELY AFFECT OUR BUSINESS.

We rely on third party manufacturers for a significant portion of our product
components, and we may not be able to consistently control the quality of such
components. Any material increase in the quantity of products returned by our
customers for purchase-price refunds could adversely affect revenues. In
addition, we are subject to potential product liability claims if our products
injure, or allegedly injure, our customers or other users. Our financial
performance could be affected if our warranty reserves are inadequate to cover
warranty claims on our products. We could become liable for significant monetary
damages if our product liability insurance coverage and reserves fail to cover
future product liability claims.

GOVERNMENT REGULATORY ACTIONS COULD DISRUPT OUR DIRECT MARKETING EFFORTS AND
PRODUCT SALES.

Various federal, state and local government authorities, including the Federal
Trade Commission and the Consumer Products Safety Commission, regulate our
direct marketing efforts and products. Our sales and profitability could be
significantly harmed if any of these authorities commence a regulatory
enforcement action that interrupts our direct marketing efforts or results in a
product recall.

CHANGES IN FOREIGN CONDITIONS COULD IMPAIR OUR INTERNATIONAL SALES.

A portion of our revenues is derived from sales outside the United States. As of
December 31, 2002, international sales represented approximately 10% of
consolidated net sales. In addition, a substantial portion of our products is
manufactured outside of the United States. Accordingly, our future results could
be materially adversely affected by a variety of factors, including changes in
foreign currency exchange rates, changes in a specific country's or region's
political or economic conditions, trade restrictions, import and export
licensing requirements, the overlap of different tax structures or changes in
international tax laws, changes in regulatory requirements, compliance with a
variety of foreign laws and regulations and longer payment cycles in certain
countries.

-35-


RECENT ACCOUNTING PRONOUNCEMENTS

Effective July 1, 2001, the Company adopted certain provisions of Statement of
Financial Accounting Standards ("SFAS") No. 141, BUSINESS COMBINATIONS, and
effective January 1, 2002, the Company adopted the full provisions of SFAS No.
141 and SFAS No. 142, GOODWILL AND OTHER INTANGIBLE ASSETS. SFAS No. 141
requires business combinations initiated after June 30, 2001 to be accounted for
using the purchase method of accounting and broadens the criteria for recording
intangible assets apart from goodwill. SFAS No. 142 requires that purchased
goodwill and certain indefinite-lived intangibles no longer be amortized but
instead be tested for impairment at least annually. In connection with the
adoption of SFAS No. 142 as of January 1, 2002, the Company evaluated its
identified intangible assets and determined that the Nautilus trademark has an
indefinite useful life.

SFAS No. 142 prescribes a two-phase process for testing the impairment of
goodwill and indefinite life intangibles. The first phase, required to be
completed by June 30, 2002, tested for impairment. If impairment existed, the
second phase, required to be completed by December 31, 2002, measured the
impairment. The Company completed its first phase impairment analysis during the
second quarter and found no instances of impairment of its recorded goodwill or
indefinite life intangibles. Accordingly, no impairment charge has been recorded
as a result of adopting SFAS No. 142. Beginning in the fourth quarter of 2002,
recorded goodwill and indefinite life intangibles were tested as part of an
annual impairment test as prescribed by SFAS No. 142. The Company found no
instances of impairment of its recorded goodwill or indefinite life intangibles.
More frequent testing will be performed if material changes in events or
circumstances arise.

SFAS No. 144, ACCOUNTING FOR THE IMPAIRMENT OR DISPOSAL OF LONG-LIVED ASSETS,
addresses accounting and reporting for the impairment or disposal of long-lived
assets. SFAS No. 144 supersedes SFAS No. 121, ACCOUNTING FOR THE IMPAIRMENT OF
LONG-LIVED ASSETS AND FOR LONG-LIVED ASSETS TO BE DISPOSED OF. SFAS No. 144
establishes a single accounting model for long-lived assets to be disposed of by
sale and expands on the guidance provided by SFAS No. 121 with respect to cash
flow estimations. SFAS No. 144 was effective for the Company's fiscal year
beginning January 1, 2002. The adoption of SFAS No. 144 has not had a material
effect on the Company's financial position, results of operations, or cash
flows.

In July 2002, the Financial Accounting Standards Board ("the FASB") issued 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 a 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. This statement is to be applied prospectively to exit or disposal
activities initiated after December 31, 2002.

In November 2002, the FASB issued Interpretation ("FIN") No. 45, GUARANTOR'S
ACCOUNTING AND DISCLOSURE REQUIREMENTS FOR GUARANTEES, INCLUDING INDIRECT
GUARANTEES OF INDEBTEDNESS OF OTHERS. FIN No. 45 is an interpretation of FASB
Statements No. 5, 57 and 107 and rescinds FIN No. 35. This Interpretation
elaborates on the disclosures to be made by a guarantor in its interim and
annual financial statements about its obligations under certain guarantees that
it has issued. The disclosure requirements in this Interpretation are effective
for financial statements of interim or annual periods ending after December 15,
2002. The Company has adopted the provisions of FIN No. 45 in these financial
statements with respect to product warranty disclosures.

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

-36-


of accounting for stock-based employee compensation. This statement is effective
for fiscal years ending after December 15, 2002. Management does not expect that
the provisions of SFAS No. 148 will have a material effect on the Company's
financial position, results of operations, or cash flows.

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
- -------------------------------------------------------------------

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
December 31, 2002, the Company had no outstanding borrowings and was not subject
to any 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 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
- ----------------------------------------------------------------

Index to Consolidated Financial Statements

Independent Auditors' Report 38

Consolidated Balance Sheets as of December 31, 2002 and 2001 39

Consolidated Statements of Income for the years ended December 31,
2002, 2001, and 2000 40

Consolidated Statements of Stockholders' Equity and Comprehensive
Income for the years ended December 31, 2002, 2001, and 2000 41

Consolidated Statements of Cash Flows for the years ended December 31,
2002, 2001, and 2000 42

Notes to Consolidated Financial Statements 44

-37-


INDEPENDENT AUDITORS' REPORT


Board of Directors and Stockholders of
The Nautilus Group, Inc.

We have audited the accompanying consolidated balance sheets of The Nautilus
Group, Inc. and subsidiaries as of December 31, 2002 and 2001, and the related
consolidated statements of income, stockholders' equity and comprehensive
income, and cash flows for each of the three years in the period ended December
31, 2002. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.

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

In our opinion, such consolidated financial statements present fairly, in all
material respects, the financial position of The Nautilus Group, Inc. and
subsidiaries as of December 31, 2002 and 2001, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 2002, in conformity with accounting principles generally accepted
in the United States of America.





Portland, Oregon
January 21, 2003

-38-


THE NAUTILUS GROUP, INC.
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 2002 AND 2001
(In Thousands, Except Share Data)

- -----------------------------------------------------------------------------------------------

ASSETS 2002 2001
--------- ---------
CURRENT ASSETS:
Cash and cash equivalents $ 31,719 $ 35,639
Short-term investments, at amortized cost 17,578 16,070
Trade receivables (less allowance for doubtful accounts
of $3,147 and $2,064 in 2002 and 2001) 50,099 24,858
Inventories 63,798 45,516
Prepaid expenses and other current assets 4,919 2,007
Short-term notes receivable 3,067 2,672
Current deferred tax assets 2,924 1,425
--------- ---------
Total current assets 174,104 128,187

LONG-TERM NOTES RECEIVABLE 363 --

PROPERTY, PLANT AND EQUIPMENT, net 55,564 25,228

GOODWILL 29,755 29,625

OTHER ASSETS, net 16,867 10,865
--------- ---------
TOTAL ASSETS $ 276,653 $ 193,905

LIABILITIES AND STOCKHOLDERS' EQUITY

CURRENT LIABILITIES:
Trade payables $ 41,288 $ 25,256
Accrued liabilities 15,827 10,888
Income taxes payable 5,284 4,792
Royalty payable to stockholders 1,997 1,885
Customer deposits 685 1,000
--------- ---------
Total current liabilities 65,081 43,821

LONG-TERM DEFERRED TAX LIABILITY 9,149 2,670

COMMITMENTS AND CONTINGENCIES (Notes 8 and 15)

STOCKHOLDERS' EQUITY:
Common stock - 75,000,000 shares authorized; no par value;
issued and outstanding in 2002 and 2001: 32,473,897 shares and
34,954,790 shares -- 4,900
Retained earnings 201,238 142,637
Accumulated other comprehensive income (loss) 1,185 (123)
--------- ---------
Total stockholders' equity 202,423 147,414
--------- ---------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 276,653 $ 193,905
========= =========

See notes to consolidated financial statements.

-39-


THE NAUTILUS GROUP, INC.
CONSOLIDATED STATEMENTS OF INCOME
YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000
(In Thousands, Except Share and Per Share Data)

- -----------------------------------------------------------------------------------------------------------

2002 2001 2000
----------- ----------- -----------
NET SALES $ 584,650 $ 363,862 $ 223,927

COST OF SALES 252,336 140,699 75,573
----------- ----------- -----------
Gross profit 332,314 223,163 148,354

OPERATING EXPENSES:
Selling and marketing 145,258 99,813 73,510
General and administrative 25,893 15,574 8,804
Related-party royalties 9,089 6,786 4,837
Third-party royalties 1,019 577 142
----------- ----------- -----------
Total operating expenses 181,259 122,750 87,293
----------- ----------- -----------
OPERATING INCOME 151,055 100,413 61,061

OTHER INCOME:
Interest income 1,561 4,024 3,632
Other, net 331 381 347
----------- ----------- -----------
Total other income - net 1,892 4,405 3,979
----------- ----------- -----------
INCOME BEFORE INCOME TAXES 152,947 104,818 65,040

INCOME TAX EXPENSE 55,060 38,235 23,414
----------- ----------- -----------
NET INCOME $ 97,887 $ 66,583 $ 41,626
=========== =========== ===========

BASIC EARNINGS PER SHARE $ 2.84 $ 1.89 $ 1.18
=========== =========== ===========

DILUTED EARNINGS PER SHARE $ 2.79 $ 1.85 $ 1.16
=========== =========== ===========

Weighted average shares outstanding:

Basic shares outstanding 34,499,482 35,183,632 35,287,604

Diluted shares outstanding 35,142,794 35,966,038 35,997,366

See notes to consolidated financial statements.

-40-


THE NAUTILUS GROUP, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY AND COMPREHENSIVE INCOME
YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000
(In Thousands, Except Share Data)

- --------------------------------------------------------------------------------------------------------------------------------

Accumulated
Common Stock Other
--------------------------- Retained Comprehensive
Shares Amount Earnings Income (Loss) Total
----------- ----------- ----------- ----------- -----------
BALANCES, JANUARY 1, 2000 35,249,003 $ 18,603 $ 34,428 $ -- $ 53,031

Net income -- -- 41,626 -- 41,626
Options exercised 486,301 622 -- -- 622
Stock repurchased (417,531) (3,252) -- -- (3,252)
Tax benefit of exercise of nonqualified options -- 840 -- -- 840
----------- ----------- ----------- ----------- -----------
BALANCES, DECEMBER 31, 2000 35,317,773 16,813 76,054 -- 92,867

Net income -- -- 66,583 -- 66,583
Cumulative translation adjustment -- -- -- (123) (123)
-----------
Comprehensive income 66,460
Shares issued 11,213 250 -- -- 250
Options exercised 567,563 2,270 -- -- 2,270
Stock repurchased (941,759) (16,310) -- -- (16,310)
Tax benefit of exercise of nonqualified options -- 1,877 -- -- 1,877
----------- ----------- ----------- ----------- -----------
BALANCES, DECEMBER 31, 2001 34,954,790 4,900 142,637 (123) 147,414

Net income -- -- 97,887 -- 97,887
Cumulative translation adjustment -- -- -- 1,308 1,308
-----------
Comprehensive income 99,195
Options exercised 362,227 2,727 -- -- 2,727
Stock repurchased (2,843,120) (10,683) (39,286) -- (49,969)
Tax benefit of exercise of nonqualified options -- 3,056 -- -- 3,056
----------- ----------- ----------- ----------- -----------
BALANCES, DECEMBER 31, 2002 32,473,897 $ -- $ 201,238 $ 1,185 $ 202,423
=========== =========== =========== =========== ===========

See notes to consolidated financial statements.

-41-


THE NAUTILUS GROUP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000
(In Thousands)

- -----------------------------------------------------------------------------------------------------------

2002 2001 2000
----------- ----------- -----------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 97,887 $ 66,583 $ 41,626
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 6,316 3,621 2,874
Loss on sale of property, plant and equipment 126 213 4
Tax benefit of exercise of nonqualified options 3,056 1,877 840
Deferred income taxes 4,980 1,733 145
Changes in assets and liabilities, net of the effect
of acquisitions:
Trade receivables (16,392) (10,108) (197)
Inventories (11,109) (14,006) (3,486)
Prepaid expenses and other current assets (2,307) (482) 1,273
Trade payables 15,356 12,013 6,464
Income taxes payable 1,376 2,146 366
Accrued liabilities and royalty payable to
stockholders 1,724 4,380 1,881
Customer deposits (453) (1,093) 995
----------- ----------- -----------
Net cash provided by operating activities 100,560 66,877 52,785
----------- ----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Additions to property, plant and equipment (31,542) (5,716) (8,762)
Proceeds from sale of property, plant and equipment 31 3 97
Decrease (increase) in other assets 7 42 (13)
Acquisition cost of StairMaster, net of cash acquired (24,131) -- --
Acquisition cost of Schwinn Fitness, net of cash acquired -- (69,843) --
Purchase of short-term investments (39,360) (37,133) --
Proceeds from maturities of short-term investments 37,852 21,063 --
Issuance of notes receivable (758) (2,672) --
----------- ----------- -----------
Net cash used in investing activities (57,901) (94,256) (8,678)
----------- ----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Funds used for stock repurchase (49,969) (16,310) (3,252)
Proceeds from exercise of stock options 2,727 2,270 622
----------- ----------- -----------
Net cash used in financing activities (47,242) (14,040) (2,630)
----------- ----------- -----------
EFFECT OF FOREIGN CURRENCY EXCHANGE
RATE CHANGES 663 (123) --
----------- ----------- -----------
(Continued)

-42-


THE NAUTILUS GROUP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000
(In Thousands)

- -----------------------------------------------------------------------------------------------------------

2002 2001 2000
----------- ----------- -----------
NET INCREASE (DECREASE) IN CASH AND
CASH EQUIVALENTS $ (3,920) $ (41,542) $ 41,477

CASH AND CASH EQUIVALENTS, BEGINNING
OF YEAR 35,639 77,181 35,704
----------- ----------- -----------
CASH AND CASH EQUIVALENTS, END OF YEAR $ 31,719 $ 35,639 $ 77,181
=========== =========== ===========

SUPPLEMENTAL DISCLOSURE OF CASH FLOW
INFORMATION -
Cash paid for income taxes $ 46,627 $ 32,400 $ 21,908
=========== =========== ===========

SUPPLEMENTAL DISCLOSURE OF OTHER
NONCASH INVESTING ACTIVITY -
Champion purchase option paid by restricted stock $ -- $ 250 $ --
=========== =========== ===========
(Concluded)

See notes to consolidated financial statements.
























-43-


THE NAUTILUS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
THREE YEARS ENDED DECEMBER 31, 2002
(In Thousands, Except Share and Per Share Data)
- --------------------------------------------------------------------------------

1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

ORGANIZATION - The Nautilus Group, Inc. (the "Company"), a Washington
corporation, is a leading marketer, developer, and manufacturer of branded
health and fitness products sold under such well-known brands as Nautilus,
Bowflex, Schwinn, StairMaster, and Trimline. These products are distributed
through well established direct to consumer, commercial, and retail
channels. The Company's consumer and commercial fitness equipment products
include a full line of cardiovascular and weight resistance products such
as home gyms, free weight equipment, treadmills, stationary bikes, steppers
and ellipticals. The Company's healthy lifestyle products also include a
line of advanced sleep systems and nutritional products. As a result of the
acquisition of StairMaster Sports/Medical, Inc. ("StairMaster") in February
2002, the Company incorporated The Nautilus Health & Fitness Group Germany
GmbH (formerly StairMaster Sports/Medical Products GmbH), The Nautilus
Health & Fitness Group UK Ltd. (formerly StairMaster Sports/Medical
Products U.K.), and absorbed the U.S. operations (formerly StairMaster
Health and Fitness Products, Inc.) into Nautilus/Schwinn Fitness Group,
Inc.

CONSOLIDATION - The consolidated financial statements of the Company
include The Nautilus Group, Inc. and its wholly owned subsidiaries
(collectively the "Company"). On May 21, 2002, the Company changed its
corporate name to The Nautilus Group, Inc. from Direct Focus, Inc. All
intercompany transactions have been eliminated in the preparation of the
consolidated financial statements.

USE OF ACCOUNTING ESTIMATES - The preparation of financial statements in
conformity with accounting principles generally accepted in the United
States of America requires management to make estimates and assumptions
that affect the reported amounts of assets and liabilities and disclosure
of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates. The
most significant estimates included in the preparation of the financial
statements are related to warranty reserves, sales return reserves,
allowance for doubtful accounts, inventory valuation, and intangible asset
valuation.

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

SHORT-TERM INVESTMENTS - Debt securities with maturities greater than three
months and remaining maturities less than one year are classified as
short-term investments. Short-term investments in debt securities are
classified as held-to-maturity and valued at amortized cost. For the years
ended December 31, 2002 and 2001, the balance in short-term investments
consisted solely of corporate bonds.

-44-



TRADE RECEIVABLES - The Company maintains an allowance for doubtful
accounts receivable based upon our historical experience and the expected
collectibility of all outstanding accounts receivable. Allowance for
doubtful accounts receivable activity for the years ended December 31,
2002, 2001 and 2000 is as follows:

Balance at Charged to Balance at
Beginning Costs and End of
of Period Expenses Deductions* Period

Allowance for doubtful accounts:

2002 $ 2,064 $ 1,369 $ 286 $ 3,147
2001 352 4,478 2,766 2,064
2000 305 425 378 352

* Deductions represent amounts written off against the allowance, net of
recoveries.

INVENTORIES are stated at the lower of average cost (first-in, first-out)
or market or at the lower of standard cost (first-in, first-out) or market.
The Company evaluates the need for inventory valuation adjustments
associated with obsolete, slow-moving and nonsalable inventory by reviewing
current transactions and forecasted product demand.

PROPERTY, PLANT AND EQUIPMENT is stated at cost. Depreciation is computed
using the straight-line method over the estimated useful lives of the
assets.

Management reviews the investment in long-lived assets for possible
impairment whenever events or circumstances indicate the carrying amount of
an asset may not be recoverable. There have been no such events or
circumstances in each of the three years in the period ended December 31,
2002. If there were an indication of impairment, management would prepare
an estimate of future cash flows (undiscounted and without interest
charges) expected to result from the use of the asset and its eventual
disposition. If these cash flows were less than the carrying amount of the
assets, an impairment loss would be recognized to write down the assets to
their estimated fair value.

GOODWILL AND OTHER ASSETS consist of license agreements, patents,
trademarks and goodwill. Amortization is computed using the straight-line
method over estimated useful lives of three to twenty years. Accumulated
amortization was $1,195 and $834 at December 31, 2002 and 2001,
respectively.

In June 2001, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards ("SFAS") No. 142, GOODWILL AND OTHER
INTANGIBLE ASSETS. The statement requires discontinuing the amortization of
goodwill and other intangible assets with indefinite useful lives. Instead,
these assets are to be tested periodically for impairment and written down
to their fair market value as necessary. The Company adopted the provisions
of this statement effective September 20, 2001 with respect to the Schwinn
Fitness acquisition, the effect of which is to not amortize the goodwill
recorded as part of this acquisition but to annually test it for
impairment. The Company adopted SFAS No. 142 effective January 1, 2002 with
respect to the Nautilus and StairMaster trademarks.

REVENUE RECOGNITION - Revenue from product sales is recognized in
accordance with Staff Accounting Bulletin ("SAB") No. 101, REVENUE
RECOGNITION IN FINANCIAL STATEMENTS. For all of the Company's products,
except Nautilus commercial equipment, revenue from product sales is
recognized at the time of shipment. Revenue is recognized upon installation
for the Nautilus commercial equipment if the Company is responsible for
installation.

-45-


Emerging Issues Task Force ("EITF") issue No. 00-10, ACCOUNTING FOR
SHIPPING AND HANDLING FEES AND COSTS, requires all amounts billed to a
customer in a sale transaction related to shipping and handling, if any, be
classified as revenue. Costs incurred for shipping and handling should be
classified as cost of sales. Amounts billed to customers classified as
revenue were $42,314, $29,142, and $20,215 for the years ended December 31,
2002, 2001 and 2000, respectively. Costs incurred for shipping and handling
classified as cost of sales were $24,477, $16,318, and $10,076 for the
years ended December 31, 2002, 2001 and 2000, respectively.

SALES RETURNS - The sales return reserve is based on our historical
experience of product returns during the trial period in which a customer
can return a product for the full purchase price, less shipping and
handling in most instances. The trial periods for Bowflex, Champion
Nutrition, and Nautilus Sleep Systems product lines are six weeks, 30 days,
and 90 days, respectively. Trial periods are not offered on our other
product lines. Sales return reserve activity for the years ended December
31, 2002, 2001 and 2000 is as follows:

Balance at Charged to Balance at
Beginning Sales and Costs End of
of Period and Expenses Deductions* Period

Sales return reserves:

2002 $ 2,100 $ 14,494 $ 14,044 $ 2,550
2001 1,307 12,174 11,381 2,100
2000 787 8,536 8,016 1,307

* Deductions represent product returns, net of recoveries.

WARRANTY COSTS - The Company's warranty policy provides for coverage for
defects in material and workmanship. Warranty periods on the Company's
products range from two years to limited lifetime on the Bowflex lines of
fitness products and twenty years on Nautilus Sleep Systems, on a prorated
basis. The commercial and retail line of fitness products include a
lifetime warranty on the frame and structural parts, a four month to three
year warranty on parts, labor, electronics, upholstery, grips and cables,
and typically a five year warranty on motors. Warranty costs are estimated
based on the Company's experience and are charged to cost of sales as sales
are recognized or as such estimates change. Warranty reserve activity for
the years ended December 31, 2002, 2001 and 2000 is as follows:

Balance at Charged to Balance at
Beginning Costs and End of
of Period Expenses Deductions* Period

Warranty reserves:

2002 $ 2,413 $ 6,155 $ 3,210 $ 5,358
2001 447 3,558 1,592 2,413
2000 383 540 476 447

* Deductions represent warranty claims paid out in the form of cash or
product replacements.

RESEARCH AND DEVELOPMENT - Internal research and development costs relating
to the development of new products, including significant improvements and
refinements to existing products, are expensed as incurred and included in
cost of sales. Third party research and development costs are expensed when

-46-



the contracted work has been performed. Research and development expense
was $4,485, $2,229, and $1,186 for 2002, 2001 and 2000, respectively.

ADVERTISING - The Company expenses advertising costs as incurred except for
commercial advertising production costs, which are expensed at the time the
first commercial is shown on television. Advertising expense was $88,305,
$63,582, and $47,265 for 2002, 2001 and 2000, respectively.

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

FOREIGN CURRENCY TRANSLATIONS - The accounts of our foreign operations are
measured using the local currency as the functional currency. These
accounts are translated into U.S. dollars using exchange rates in effect at
year-end for assets and liabilities and the weighted average exchange rate
during the period for the results of operations. Translation gains and
losses are accumulated as a separate component of stockholders' equity and
comprehensive income.

FOREIGN CURRENCY TRANSACTIONS - Foreign currency transaction gains and
losses are a result of the effect of exchange rate changes on transactions
denominated in currencies other than the functional currency, including
U.S. dollars. Gains and losses on those foreign currency transactions are
included in determining net income or loss for the period in which exchange
rates change. Foreign currency transaction gains and (losses) were $210,
$(54), and zero for the years ended December 31, 2002, 2001 and 2000,
respectively.

STOCK-BASED COMPENSATION - The Company continues to measure compensation
expense for its stock-based employee compensation plans using the method
prescribed by Accounting Principles Board ("APB") Opinion No. 25,
ACCOUNTING FOR STOCK ISSUED TO EMPLOYEES. The Company provides pro forma
disclosures of net income and earnings per share as if the method
prescribed by SFAS No. 123, ACCOUNTING FOR STOCK-BASED COMPENSATION, had
been applied in measuring compensation expense.

If compensation cost on stock options granted under these plans had been
determined based on the fair value of the options consistent with that
described in SFAS No. 123, the Company's net income and earnings per share
would have been reduced to the pro forma amounts indicated below for the
years ended December 31, 2002, 2001 and 2000.

2002 2001 2000

Net income, as reported $ 97,887 $ 66,583 $ 41,626
Net income, pro forma $ 94,746 $ 64,340 $ 40,501

Basic earnings per share, as reported $ 2.84 $ 1.89 $ 1.18
Basic earnings per share, pro forma $ 2.75 $ 1.83 $ 1.15

Diluted earnings per share, as reported $ 2.79 $ 1.85 $ 1.16
Diluted earnings per share, pro forma $ 2.70 $ 1.79 $ 1.13

-47-


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

The fair value of each option grant was estimated on the date of grant
using the Black-Scholes option pricing model with the following
weighted-average assumptions used for the grants in 2002, 2001 and 2000:



2002 2001 2000

Granted option vesting All as scheduled All as scheduled All as scheduled
Dividend yield None None None
Risk-free interest rate 4.1 % 4.4 % 5.0 %
Expected volatility 67 % 67 % 51 %
Expected option lives 5 years 5 years 5 years

Weighted-average fair value of
options granted per share $ 20.52 $ 11.75 $ 14.59


Refer to Note 9 for further information regarding the Company's stock
option plan.

COMPREHENSIVE INCOME is defined as net income as adjusted for changes to
equity resulting from events other than net income or transactions related
to an entity's capital structure. Comprehensive income for the years ended
December 31, 2002 and 2001 equals net income plus or minus the effect of
foreign currency translation adjustments. The foreign currency translation
adjustments are due to the translation of the financial statements of the
foreign subsidiaries acquired as part of the Fitness Division of Schwinn/GT
Corp. ("Schwinn Fitness") and StairMaster. In 2000, the Company had no
foreign subsidiaries.

FAIR VALUE OF FINANCIAL INSTRUMENTS - The carrying amount of the Company's
cash and cash equivalents, short-term investments, trade receivables, notes
receivable, trade payables, royalty payable to stockholders, and accrued
liabilities approximates their estimated fair values due to the short-term
maturities of those financial instruments.

RECENT ACCOUNTING PRONOUNCEMENTS - Effective July 1, 2001, the Company
adopted certain provisions of SFAS No. 141, BUSINESS COMBINATIONS, and
effective January 1, 2002, the Company adopted the full provisions of SFAS
No. 141 and SFAS No. 142, GOODWILL AND OTHER INTANGIBLE ASSETS. SFAS No.
141 requires business combinations initiated after June 30, 2001 to be
accounted for using the purchase method of accounting, and broadens the
criteria for recording intangible assets apart from goodwill. SFAS No. 142
requires that purchased goodwill and certain indefinite-lived intangibles
no longer be amortized but instead be tested for impairment at least
annually. In connection with the adoption of SFAS No. 142 as of January 1,
2002, the Company evaluated its identified intangible assets and determined
that the Nautilus trademark has an indefinite useful life.

SFAS No. 142 prescribes a two-phase process for testing the impairment of
goodwill and indefinite life intangibles. The first phase, required to be
completed by June 30, 2002, tested for impairment. If impairment existed,
the second phase, required to be completed by December 31, 2002, measured
the impairment. The Company completed its first phase impairment analysis
during the second quarter and found no instances of impairment of its
recorded goodwill or indefinite life intangibles. Accordingly, no
impairment charge has been recorded as a result of adopting SFAS No. 142.
Beginning in the fourth quarter of 2002, recorded goodwill and indefinite
life intangibles were tested as part of an annual impairment test as
prescribed by SFAS No. 142. The Company found no instances of impairment of
its

-48-


recorded goodwill or indefinite life intangibles. More frequent testing
will be performed if material changes in events or circumstances arise.

SFAS No. 144, ACCOUNTING FOR THE IMPAIRMENT OR DISPOSAL OF LONG-LIVED
ASSETS, addresses accounting and reporting for the impairment or disposal
of long-lived assets. SFAS No. 144 supersedes SFAS No. 121, ACCOUNTING FOR
THE IMPAIRMENT OF LONG-LIVED ASSETS AND FOR LONG-LIVED ASSETS TO BE
DISPOSED OF. SFAS No. 144 establishes a single accounting model for
long-lived assets to be disposed of by sale and expands on the guidance
provided by SFAS No. 121 with respect to cash flow estimations. SFAS No.
144 was effective for the Company's fiscal year beginning January 1, 2002.
The adoption of SFAS No. 144 has not had a material effect on the Company's
financial position, results of operations, or cash flows.

In July 2002, the Financial Accounting Standards Board ("the FASB") issued
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 a 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. This statement is to be
applied prospectively to exit or disposal activities initiated after
December 31, 2002.

In November 2002, the FASB issued Interpretation ("FIN") No. 45,
GUARANTOR'S ACCOUNTING AND DISCLOSURE REQUIREMENTS FOR GUARANTEES,
INCLUDING INDIRECT GUARANTEES OF INDEBTEDNESS OF OTHERS. FIN No. 45 is an
interpretation of FASB Statements No. 5, 57 and 107 and rescinds FIN No.
35. This Interpretation elaborates on the disclosures to be made by a
guarantor in its interim and annual financial statements about its
obligations under certain guarantees that it has issued. The disclosure
requirements in FIN No. 45 are effective for the year ended December 31,
2002. The Company has adopted the provisions of FIN No. 45 in these
financial statements with respect to product warranty disclosures.

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. This statement
is effective for the year ended December 31, 2002.

2. OPERATING SEGMENTS

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


-49-



The following table presents information about the Company's two operating
segments:



Commercial/
Direct Retail Total
Year ended December 31, 2002:
Revenues $ 392,612 $ 192,038 $ 584,650
Interest income 1,478 83 1,561
Depreciation and amortization expense 2,824 3,492 6,316
Income tax expense 52,221 2,839 55,060
Segment net income 92,838 5,049 97,887
Segment assets 128,204 148,449 276,653
Additions to property, plant and equipment 18,615 12,927 31,542

Year ended December 31, 2001:
Revenues $ 292,539 $ 71,323 $ 363,862
Interest income 3,980 44 4,024
Depreciation and amortization expense 2,256 1,365 3,621
Income tax expense 36,165 2,070 38,235
Segment net income 62,909 3,674 66,583
Segment assets 87,264 106,641 193,905
Additions to property, plant and equipment 5,266 450 5,716

Year ended December 31, 2000:
Revenues $ 198,107 $ 25,820 $ 223,927
Interest income 3,630 2 3,632
Depreciation and amortization expense 2,068 806 2,874
Income tax expense 22,884 530 23,414
Segment net income 40,684 942 41,626
Segment assets 95,815 21,311 117,126
Additions to property, plant and equipment 8,237 525 8,762


3. 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 for a cash purchase price of approximately $25,785, including
acquisition costs. StairMaster was acquired through a bankruptcy auction in
the United States Bankruptcy Court for the Western District of Washington
that was completed on January 17, 2002.

The acquired assets include property, plant and equipment used to
manufacture, assemble, distribute, and sell fitness equipment, including
steppers, stepmills, treadmills and exercise bicycles.

The purchase price for StairMaster was determined in the court auction. The
Company's bid was formulated on the basis of historical and projected
financial performance, which resulted in goodwill that had been recorded in
the Company's commercial/retail segment along with the acquired assets and
liabilities. The Company financed the acquisition with cash-on-hand.

The Company has determined that the StairMaster trademark has an indefinite
useful life and thus will not be amortized. The Company will evaluate the
trademark each reporting period to determine whether events or
circumstances warrant a revision to the indefinite useful life assumption
or whether the asset should be tested for impairment.

-50-


On October 2, 2002, Quinton Cardiology Systems, Inc. ("Quinton") purchased
certain fixed assets and inventories that the Company originally acquired
in the StairMaster acquisition for $1,725 consisting of $1,000 in cash and
a $725 promissory note payable quarterly over a two-year period at prime
plus 2%. These assets consisted of medical treadmill manufacturing fixed
assets and inventories, which StairMaster used for outsourced production of
Quinton branded medical treadmills. The allocation of the purchase price to
the assets acquired and liabilities assumed resulted in no goodwill being
recorded.

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
========

Effective September 20, 2001, 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
Schwinn Fitness for a cash purchase price of approximately $69,843,
including acquisition costs.

The total cost of the Schwinn Fitness acquisition has been allocated to the
assets acquired and liabilities assumed as follows:

Trade receivables $ 9,809
Inventories 18,857
Prepaid expenses and other current assets 933
Property, plant and equipment 6,356
Other assets 40
Trademark 6,800
Goodwill 29,625
Liabilities assumed (2,577)
--------
Total acquisition cost $ 69,843
========

The Company has determined that the Schwinn trademark, acquired as part of
the Schwinn Fitness acquisition, has anticipated use and cash flows of
approximately 20 years. The Company will amortize the trademark using the
straight-line method over this period. The Company will evaluate the
remaining useful life of the trademark each reporting period to determine
whether events or circumstances warrant a revision to the remaining period
of amortization or whether the asset should be tested for impairment.

The results of operations subsequent to the date of the StairMaster and
Schwinn Fitness acquisitions are included in the consolidated financial
statements of the Company.

-51-


The unaudited pro forma financial information below for the years ended
December 31, 2002 and 2001 was prepared as if the transactions involving
the acquisitions of StairMaster and Schwinn Fitness had occurred at January
1, 2001:

Year Ended
December 31,
-----------------------
2002 2001

Net sales $ 590,929 $ 498,690
Net income 98,111 41,879
Basic earnings per share 2.84 1.19
Diluted earnings per share 2.79 1.16

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

4. INVENTORIES

Inventories at December 31 consisted of the following:

2002 2001

Finished goods $ 45,317 $ 34,862
Work-in-process 1,317 1,148
Parts and components 17,164 9,506
--------- ---------
Inventories $ 63,798 $ 45,516
========= =========


5. PROPERTY, PLANT AND EQUIPMENT, net

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

Estimated
Useful Life
(in years) 2002 2001

Land N/A $ 3,395 $ 1,780
Buildings and improvements 31.5 21,912 11,785
Computer equipment 2-5 26,252 10,088
Production equipment 5 13,647 6,567
Furniture and fixtures 5 1,433 1,464
Automobiles 7 549 349
-------- --------
Total property, plant and equipment 67,188 32,033

Accumulated depreciation (11,624) (6,805)
-------- --------
Property, plant and equipment, net $ 55,564 $ 25,228
======== ========

-52-


6. GOODWILL AND OTHER ASSETS, net

Details of other assets are summarized as follows at December 31:

Estimated
Useful Life
(in years) 2002 2001

Indefinite life trademarks N/A $ 10,465 $ 4,350
Definite life trademarks 20 6,800 6,800
Other assets 1-17 797 549
-------- --------
Total other assets 18,062 11,699

Accumulated amortization (1,195) (834)
-------- --------
Other assets, net $ 16,867 $ 10,865
======== ========

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.

Goodwill associated with the Schwinn Fitness acquisition is reported within
the commercial/retail segment. The change in goodwill of $130 for the year
ended December 31, 2002 is attributed entirely to the effect of foreign
currency exchange rate changes.

As discussed in Note 1, the Company adopted SFAS No. 142 on January 1,
2002. In accordance with SFAS No. 142, the effect of this statement, which
ceased the amortization of the Nautilus trademark, is reflected
prospectively. Supplemental comparative disclosure as if the change had
been retroactively applied to the year ended December 31, 2001 is as
follows:

Year Ended
December 31,
-------------------------------------
2002 2001 2000

Reported net income $ 97,887 $ 66,583 $ 41,626
Amortization expense, net of tax -- 139 139
--------- --------- ---------
Adjusted net income $ 97,887 $ 66,722 $ 41,765
========= ========= =========
Basic earnings per share:
Reported net income $ 2.84 $ 1.89 $ 1.18
Adjusted net income $ 2.84 $ 1.90 $ 1.18

Diluted earnings per share:
Reported net income $ 2.79 $ 1.85 $ 1.16
Adjusted net income $ 2.79 $ 1.86 $ 1.16

Amortization of intangible assets for the year ended December 31, 2002 was
$362. The estimated amortization expense for the next five years is $362
each year. Such estimated amortization will change

-53-


if businesses or portions thereof are either acquired or disposed, or if
changes in events or circumstances warrant the revision of estimated useful
lives.

7. ACCRUED LIABILITIES

Accrued liabilities consisted of the following at December 31:

2002 2001

Accrued payroll $ 5,436 $ 4,852
Accrued warranty expense 5,358 2,413
Sales return reserve 2,550 2,100
Accrued other 2,483 1,523
--------- ---------
Accrued liabilities $ 15,827 $ 10,888
========= =========

8. COMMITMENTS AND CONTINGENCIES

LINES OF CREDIT - The Company has a line of credit for $10 million with
U.S. Bank National Association. The line of credit is secured by certain
assets and contains several financial covenants. Interest is payable on
outstanding borrowings under the line at the bank's prime rate (4.25% at
December 31, 2002). The Company is in compliance with the financial
covenants applicable to the line of credit. There were no outstanding
borrowings on the line of credit at December 31, 2002 or 2001.

OPERATING LEASES - The Company has operating leases for various domestic
and international properties with functional uses predominantly ranging
from, but not limited to, warehousing and distribution, product
development, administration, and product sales. The Company also has
operating leases for certain equipment mainly consisting of product
delivery trucks used in our commercial fitness equipment business. Rent
expense under all leases was $4,216, $937, and $474 in 2002, 2001 and 2000,
respectively.

OBLIGATIONS - Operating leases under which the Company is presently
obligated expire over various terms through June 2014. Future minimum lease
payments under the noncancellable operating leases are as follows:

2003 $ 2,179
2004 955
2005 819
2006 774
2007 774
Thereafter 2,622
--------
Minimum lease payments $ 8,123
========

9. STOCK OPTIONS

The Company's stock-based compensation plan was adopted in June 1995. The
Company can issue nonqualified stock options to the Company's officers,
directors and employees and incentive stock options to the Company's
employees. The plan was amended in June 2000 so the Company may grant
options for up to 7,958,118 shares of common stock. At December 31, 2002,
2,142,121 shares are

-54-


available for future issuance under the plan. The plan is administered by
the Company's Board of Directors which determines the terms and conditions
of the various grants awarded under these plans. Stock options granted
generally have an exercise price equal to the closing market price of the
Company's stock on the day before the date of grant, and vesting periods
vary by option granted, generally no longer than four years.

A summary of the status of the Company's stock option plans as of December
31, 2002, 2001 and 2000, and changes during the years ended on those dates
is presented below.


2002 2001 2000
--------------------------- --------------------------- ---------------------------

Weighted- Weighted- Weighted-
Average Average Average
Exercise Exercise Exercise
Shares Price Shares Price Shares Price
Outstanding at beginning
of year 1,726,381 $ 12.79 1,694,195 $ 7.32 1,576,596 $ 2.67

Granted 275,075 33.25 691,650 19.50 805,275 12.43
Forfeited or canceled (39,242) 22.70 (91,901) 16.73 (201,375) 5.98
Exercised (362,227) 7.53 (567,563) 4.00 (486,301) 1.28
----------- ----------- ----------- ----------- ----------- -----------
Outstanding at end of
year 1,599,987 $ 17.26 1,726,381 $ 12.79 1,694,195 $ 7.32
=========== =========== =========== =========== =========== ===========
Options exercisable at
end of year 650,753 540,345 648,507
=========== =========== ===========


The following table summarizes information about stock options outstanding
as of December 31, 2002:



Options Outstanding Options Exercisable
------------------------- -------------------------
Average Weighted- Weighted-
Range of Remaining Average Number of Average
Exercise Number Contractual Exercise Shares Exercise
Prices Outstanding Life (Years) Price Exercisable Price

$0.24 - $6.98 319,723 1.1 $ 4.30 281,472 $ 3.94
$13.56 - $13.78 614,664 2.7 13.65 229,797 13.61
$16.06 - $23.02 257,525 3.4 20.82 94,650 20.50
$24.28 - $30.42 166,500 3.8 25.21 44,834 25.17
$32.80 - $37.70 241,575 4.5 34.32 -- --
--------- --- ---------- --------- ----------
$0.24 - $37.70 1,599,987 2.9 $ 17.26 650,753 $ 11.23
========= === ========== ========= ==========


Refer to Note 1 for disclosure of pro forma results assuming the Company
determined compensation cost on stock options granted under these plans
based on the fair value of the options consistent with that described in
SFAS No. 123.

10. INCOME TAXES

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

-55-


The provision for income taxes consists of the following for the three
years ended December 31, 2002:


2002 2001 2000
Current:
Federal $ 48,483 $ 34,516 $ 22,536
State 1,597 1,986 733
-------- -------- --------
Total current 50,080 36,502 23,269
-------- -------- --------
Deferred:
Federal 4,821 1,706 145
State 159 27 --
-------- -------- --------
Total deferred 4,980 1,733 145
-------- -------- --------
Total provision $ 55,060 $ 38,235 $ 23,414
======== ======== ========

The components of the net deferred tax asset (liability) at December 31,
2002 and 2001 are as follows:

2002 2001
Current:
Assets:
Accrued vacation $ 396 $ 166
Allowance for doubtful accounts 617 112
Inventory valuation 537 166
Uniform capitalization 470 88
Accrued reserves 2,046 1,128
Other 111 125

Liabilities:
Prepaid advertising (502) (210)
Other prepaids (751) (150)
--------- ---------
Net current deferred tax asset 2,924 1,425

Noncurrent liability:
Depreciation and amortization (9,149) (2,670)
--------- ---------
Net deferred tax liability $ (6,225) $ (1,245)
========= =========

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

2002 2001 2000

Federal 35.0 % 35.0 % 35.0 %
State 1.2 1.9 1.1
Other (0.2) (0.4) (0.1)
---- ---- ----
Total 36.0 % 36.5 % 36.0 %
==== ==== ====

-56-


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 for all periods.

The calculation of weighted-average outstanding shares is as follows:

Average Shares
---------------------------------------
2002 2001 2000

Basic shares outstanding 34,499,482 35,183,632 35,287,604
Dilutive effect of stock options 643,312 782,406 709,762
----------- ----------- -----------
Diluted shares outstanding 35,142,794 35,966,038 35,997,366
=========== =========== ===========

Outstanding stock options of 263,575, 169,500, and 278,325 for the years
ended December 31, 2002, 2001 and 2000, respectively, were not included in
the calculation of diluted earnings per share because they would be
antidilutive.

12. STOCK REPURCHASE PROGRAM

Two times during fiscal 2002, the Board of Directors authorized the
purchase of The Nautilus Group, Inc. common stock in open-market
transactions. In June 2002, the Board of Directors authorized the
expenditure of up to $20,000 to purchase shares of the Company's common
stock through and including August 31, 2002. In October 2002, the Board of
Directors authorized the repurchase of the Company's common stock
commencing October 21, 2002 through and including January 31, 2003,
provided the aggregate amount spent on such repurchases during this period
did not exceed $30,000. During the year ended December 31, 2002, the
Company repurchased a total of 2,843,120 shares of common stock in
open-market transactions for an aggregate purchase price of $49,969.

Three times during fiscal 2001, the Board of Directors authorized the
expenditure of up to $20,000 to purchase shares of The Nautilus Group, Inc.
common stock in open-market transactions. In October 2001, the Board of
Directors authorized a $10,000 repurchase program extending through January
31, 2002 and the remaining balance of the $20,000 repurchase program was
terminated. During the year ended December 31, 2001, the Company
repurchased a total of 941,759 shares of common stock in open market
transactions for an aggregate purchase price of $16,310.

13. STOCK SPLITS

On December 8, 2000, the Board of Directors approved a three-for-two stock
split in the form of a share dividend payable to Company stockholders of
record as of January 2, 2001 with a payment date of January 15, 2001. On
July 13, 2001, the Board of Directors approved another three-for-two stock
split in the form of a share dividend, payable August 13, 2001 to the
Company's stockholders of record as of August 2, 2001. All share and
per-share numbers contained herein reflect these stock splits.

-57-


14. RELATED-PARTY TRANSACTIONS

The Company incurred royalty expense under an agreement with a stockholder
of the Company of $9,089 in 2002, $6,786 in 2001, and $4,837 in 2000, of
which $1,997 and $1,885 was payable at December 31, 2002 and 2001,
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 Chief Executive
Officer ("CEO"), 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 CEO and 20% to the former director.

15. LITIGATION

In the normal course of business, the Company is a party to various other
legal claims, actions and complaints. Although it is not possible to
predict with certainty whether the Company will ultimately be successful in
any of these legal matters, or what the impact might be, the Company
believes that disposition of these matters will not have a material adverse
effect on the Company's financial position, results of operations or cash
flows.

In December 2002, the Company filed suit against Icon Health and Fitness,
Inc. in the Federal District Court, Western District of Washington alleging
infringement by Icon of the Company's Bowflex patents. The Company seeks
injunctive relief, unquantified treble damages and its fees and costs.

16. EMPLOYEE BENEFIT PLAN

The Company adopted a 401(k) profit sharing plan (the "Plan") in 1999
covering all employees over the age of 18. The Plan was amended in 2000 to
allow for immediate eligibility in the Plan. Each participant in the Plan
may contribute up to 30% of eligible compensation during any calendar year,
subject to certain limitations. The Plan provides for Company matching
contributions of up to 50% of the first 6% of eligible contributions made
by all participants excluding Nautilus Human Performance Systems, Inc.
("Nautilus HPS") employees. For Nautilus HPS employees, the Company matches
35% of employee contributions up to the first 4% of eligible contributions.
All participants must have completed one year of service before becoming
eligible for Company matching contributions. In addition, the Company may
make discretionary contributions. Employees are 25% vested in the matching
and discretionary contributions per year for the first four years of
service. Expense for the plan was $356, $225, and $135 for the years ended
December 31, 2002, 2001 and 2000, respectively.

17. SUBSEQUENT EVENTS

On January 29, 2003, the Company announced that its Board of Directors
declared an annual dividend. The Board of Directors declared a $0.40 per
share annual dividend payable quarterly. The initial quarterly dividend of
$0.10 per share was paid March 10, 2003, to shareholders of record at the
close of business on February 20, 2003.

On January 29, 2003, the Company also announced that its Board of Directors
authorized management to repurchase up to $50,000 of the Company's common
stock in open-market transactions from February 10, 2003 through June 30,
2003, with the terms of the purchases to be determined by management based
on market conditions.

-58-


ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
- ------------------------------------------------------------------------
FINANCIAL DISCLOSURE
--------------------

None.

PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
- -----------------------------------------------------------

The information required by this item is included under the captions ELECTION OF
DIRECTORS, EXECUTIVE OFFICERS, and SECTION 16(A) BENEFICIAL OWNERSHIP REPORTING
COMPLIANCE, respectively, in the Company's Proxy Statement for its 2003 Annual
Meeting of Stockholders and is incorporated herein by reference.

ITEM 11. EXECUTIVE COMPENSATION
- -------------------------------

The information required by this item is included under the caption EXECUTIVE
COMPENSATION in the Company's Proxy Statement for its 2003 Annual Meeting of
Stockholders and is incorporated herein by reference.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
- ---------------------------------------------------------------------------
RELATED STOCKHOLDER MATTERS
---------------------------

The information required by this item is included under the caption SECURITY
OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER
MATTERS in the Company's Proxy Statement for its 2003 Annual Meeting of
Stockholders and is incorporated herein by reference.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
- -------------------------------------------------------

The information required by this item is included under the caption CERTAIN
RELATIONSHIPS AND RELATED TRANSACTIONS in the Company's Proxy Statement for its
2003 Annual Meeting of Stockholders and is incorporated herein by reference.

ITEM 14. CONTROLS AND PROCEDURES
- --------------------------------

The Company maintains disclosure controls and procedures (as defined in Exchange
Act Rules 13a-14(c) and 15d-14(c)) designed to ensure that it is able to collect
the information it is required to disclose in the reports it files with the
Securities and Exchange Commission ("SEC"), and to process, summarize and
disclose this information within the time periods specified in the rules of the
SEC. The Company's Chief Executive and Chief Financial Officers are responsible
for establishing and maintaining these procedures, and, as required by the rules
of the SEC, evaluate their effectiveness. Based on their evaluation of the
Company's disclosure controls and procedures which took place as of a date
within 90 days of the filing date of this report, the Chief Executive and Chief
Financial Officers believe that these procedures are effective to ensure that
the Company is able to collect, process and disclose the information it is
required to disclose in the reports it files with the SEC within the required
time periods.

INTERNAL CONTROLS

The Company maintains a system of internal controls designed to provide
reasonable assurance that: transactions are executed in accordance with
management's general or specific authorization; transactions are recorded as
necessary (1) to permit preparation of financial statements in conformity with
generally accepted accounting principles, and (2) to maintain accountability for
assets; access to assets is permitted only in accordance with management's
general or specific authorization; and the recorded accountability for assets is

-59-


compared with the existing assets at reasonable intervals and appropriate action
is taken with respect to any differences.

Since the date of the most recent evaluation of the Company's internal controls
by the Chief Executive and Chief Financial Officers, there have been no
significant changes in such controls or in other factors that could have
significantly affected those controls, including any corrective actions with
regard to significant deficiencies and material weaknesses.

PART IV

ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
- -------------------------------------------------------------------------

(A)(1) FINANCIAL STATEMENTS

See the Consolidated Financial Statements in Item 8.

(A)(2) FINANCIAL STATEMENT SCHEDULE

There are no financial statement schedules filed as part of this annual
report, since the required information is included in the consolidated
financial statements, including the notes thereto, or the circumstances
requiring inclusion of such schedules are not present.

(A)(3) EXHIBIT INDEX

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

EXHIBIT NO.
-----------

2.1 Asset Purchase Agreement by and between Direct Focus, Inc. and
Schwinn GT Corp., dated September 6, 2001, and purchase price -
Incorporated by reference to Exhibits 2.1 and 2.3(a) of the Company's
Form 8-K, as filed with the Securities and Exchange Commission (the
"Commission") on October 4, 2001, and Exhibits 99.1 - 99.9 of the
Company's Form 8-K/A, as filed with the Commission on December 3,
2001.

2.2 Asset Purchase Agreement by and between Direct Focus and StairMaster
Sports/Medical Products, Inc., dated January 17, 2002 - Incorporated
by reference to Exhibit 2.1 of the company's Form 8-K, as filed with
the Commission on February 8, 2002.

2.3 Amendment to the Asset Purchase Agreement by and between Direct Focus
and StairMaster Sports/Medical Products, Inc., dated February 7, 2002
- Incorporated by reference to Exhibit 2.2 of the Company's Form 8-K,
as filed with the Commission on February 8, 2002.

3.1 Articles of Incorporation, as Amended - Incorporated by reference to
Exhibits 3.1, 3.2 and 3.3 of the Company's Registration Statement on
Form S-1, as filed with the Commission on March 3, 1999.

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

-60-


3.3 Amendment to Articles of Incorporation - Incorporated by reference to
Exhibit 3.1 to the Company's Quarterly Report on Form 10-Q for the
three months ended June 30, 2002, as filed with the Commission on
August 14, 2002.

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

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

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

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

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

10.6 Second Amended and Restated Merchant Agreement dated February 23,
2000, between Direct Focus, Inc. and Household Bank (SB), N.A. -
Incorporated by reference to Exhibit 10.12 of the Company's Form 10-K
for the year ended December 31, 2000, as filed with the Commission on
March 30, 2001.

10.7 Trademark License Agreement by and between Pacific Direct, LLC,
Nautilus, Inc., and Schwinn Acquisition, LLC - Incorporated by
reference to Exhibit 2.1 of the Company's Quarterly Report on Form
10-Q for the nine months ended September 30, 2001, as filed with the
Commission on November 14, 2001.

10.8 Revolving Credit Agreement, with Addendum, dated June 27, 2002, by
and between The Nautilus Group, Inc. and U.S. Bank National
Association - Incorporated by reference to Exhibit 10.1 to the
Company's Quarterly Report on Form 10-Q for the three months ended
June 30, 2002, as filed with the Commission on August 14, 2002.

21 Subsidiaries of The Nautilus Group, Inc.

23 Consent of Deloitte & Touche LLP.

24.1 Power of Attorney for Peter A. Allen.

24.2 Power of Attorney for Kirkland C. Aly.

24.3 Power of Attorney for C. Rowland Hanson.

24.4 Power of Attorney for Frederick T. Hull.

24.5 Power of Attorney for Paul F. Little.

24.6 Power of Attorney for James M. Weber.

-61-


99.1 Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant
to Section 906 of the Sarbanes-Oxley Act of 2002.

99.2 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

No reports on Form 8-K were filed during the fourth quarter of 2002.

































-62-



SIGNATURES


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


Date: March 26, 2003 THE NAUTILUS GROUP, INC.
--------------

By: /s/ Brian R. Cook
--------------------------------------
Brian R. Cook, Chief Executive Officer

Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the Registrant and
in the capacities indicated on March 26, 2003:

Signature Title
- --------- -----

/s/ Brian R. Cook Chairman and Chief Executive Officer (Principal
- ------------------------ Executive Officer)
Brian R. Cook

/s/ Rod W. Rice Chief Financial Office and Secretary (Principal
- ------------------------ Financial and Accounting Officer)
Rod W. Rice


* Director
- ------------------------
Peter A. Allen


* Director
- ------------------------
Kirkland C. Aly


* Director
- ------------------------
C. Rowland Hanson


* Director
- ------------------------
Frederick T. Hull


* Director
- ------------------------
Paul F. Little


* Director
- ------------------------
James M. Weber


* By: /s/ Rod W. Rice March 26, 2003
--------------------------
Rod W. Rice
ATTORNEY-IN-FACT

-63-


CERTIFICATION

I, Brian R. Cook, Chief Executive Officer, certify that:

1. I have reviewed this annual report on Form 10-K of The Nautilus
Group, Inc.;

2. Based on my knowledge, this annual report does not contain any
untrue statement of a material fact or omit to state a material fact necessary
to make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by this
annual report;

3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this annual report;

4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:

a) Designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities, particularly
during the period in which this annual report is being prepared;

b) Evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of this
annual report (the "Evaluation Date"); and

c) Presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on our evaluation
as of the Evaluation Date;

5. The registrant's other certifying officer and I have disclosed,
based on our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):

a) All significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and

b) Any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's internal
controls; and

6. The registrant's other certifying officer and I have indicated in
this annual report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.


March 26, 2003 By: /s/ Brian R. Cook
- -------------- --------------------------------------
Date Brian R. Cook, Chief Executive Officer


-64-


CERTIFICATION

I, Rod W. Rice, Chief Financial Officer, certify that:

1. I have reviewed this annual report on Form 10-K of The Nautilus
Group, Inc.;

2. Based on my knowledge, this annual report does not contain any
untrue statement of a material fact or omit to state a material fact necessary
to make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by this
annual report;

3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this annual report;

4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:

a) Designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities, particularly
during the period in which this annual report is being prepared;

b) Evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of this
annual report (the "Evaluation Date"); and

c) Presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our evaluation
as of the Evaluation Date;

5. The registrant's other certifying officer and I have disclosed,
based on our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):

a) All significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and

b) Any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's internal
controls; and

6. The registrant's other certifying officer and I have indicated in
this annual report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.


March 26, 2003 By: /s/ Rod W. Rice
- -------------- --------------------------------------
Date Rod W. Rice, Chief Financial Officer,
Treasurer and Secretary

-65-