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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2003
Commission file number: 000-25867
THE NAUTILUS GROUP, INC.
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(Exact name of registrant as specified in its charter)
Washington 94-3002667
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
1400 NE 136th Avenue
Vancouver, Washington 98684
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(Address of principal executive offices, including zip code)
(360) 694-7722
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(Issuer's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the issuer was required
to file such reports), and (2) has been subject to such filing requirements for
the past 90 days.
Yes [X] No [_]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).
Yes [X] No [_]
Number of shares of issuer's common stock outstanding as of May 2, 2003:
32,560,038
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THE NAUTILUS GROUP, INC.
MARCH 31, 2003
INDEX TO FORM 10-Q
PAGE
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PART I - FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited) ................................ 3
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations ....................................... 13
Item 3. Quantitative and Qualitative Disclosures About Market Risk ...... 19
Item 4. Controls and Procedures ......................................... 20
PART II - OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K ................................ 21
Signatures ................................................................ 22
Certifications ............................................................ 23
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
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THE NAUTILUS GROUP, INC.
CONSOLIDATED BALANCE SHEETS
(In Thousands, Except Share Data)
(Unaudited)
MARCH 31, DECEMBER 31,
ASSETS 2003 2002
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CURRENT ASSETS:
Cash and cash equivalents $ 60,415 $ 31,719
Short-term investments, at amortized cost -- 17,578
Trade receivables (less allowance for doubtful accounts
of $3,118 and $3,147 in 2003 and 2002, respectively) 41,485 50,099
Inventories 66,820 63,798
Prepaid expenses and other current assets 4,547 4,919
Short-term notes receivable 3,313 3,067
Current deferred tax assets 3,459 2,924
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Total current assets 180,039 174,104
LONG-TERM NOTES RECEIVABLE 272 363
PROPERTY, PLANT AND EQUIPMENT, net 56,869 55,564
GOODWILL 29,755 29,755
OTHER ASSETS, net 16,515 16,867
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TOTAL ASSETS $ 283,450 $ 276,653
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LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Trade payables $ 29,318 $ 41,288
Accrued liabilities 17,141 15,827
Income taxes payable 10,655 5,284
Royalty payable to stockholders 1,791 1,997
Customer deposits 972 685
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Total current liabilities 59,877 65,081
LONG-TERM DEFERRED TAX LIABILITY 11,046 9,149
COMMITMENTS AND CONTINGENCIES (Note 13)
STOCKHOLDERS' EQUITY:
Common stock - authorized, 75,000,000 shares; of no par value;
issued and outstanding, 2003: 32,550,913 shares, 2002:
32,473,897 shares 677 --
Retained earnings 210,644 201,238
Accumulated other comprehensive income 1,206 1,185
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Total stockholders' equity 212,527 202,423
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TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 283,450 $ 276,653
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See notes to consolidated financial statements.
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THE NAUTILUS GROUP, INC.
CONSOLIDATED STATEMENTS OF INCOME
(In Thousands, Except Share and Per Share Data)
(Unaudited)
THREE MONTHS ENDED MARCH 31,
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2003 2002
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NET SALES $ 129,449 $ 135,914
COST OF SALES 59,502 58,753
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Gross profit 69,947 77,161
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OPERATING EXPENSES:
Selling and marketing 39,501 31,600
General and administrative 6,865 6,264
Related-party royalties 1,791 2,148
Third-party royalties 299 181
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Total operating expenses 48,456 40,193
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OPERATING INCOME 21,491 36,968
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OTHER INCOME (EXPENSE):
Interest income 229 450
Other, net (331) 19
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Total other income (expense), net (102) 469
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INCOME BEFORE INCOME TAXES 21,389 37,437
INCOME TAX EXPENSE 7,700 13,479
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NET INCOME $ 13,689 $ 23,958
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BASIC EARNINGS PER SHARE $ 0.42 $ 0.68
DILUTED EARNINGS PER SHARE $ 0.42 $ 0.67
Weighted average shares outstanding:
Basic shares outstanding 32,550,735 35,008,298
Diluted shares outstanding 32,617,558 35,973,400
See notes to consolidated financial statements.
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THE NAUTILUS GROUP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In Thousands)
(Unaudited)
THREE MONTHS ENDED MARCH 31,
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2003 2002
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CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 13,689 $ 23,958
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization 2,424 1,427
Loss on sale of property, plant and equipment 10 --
Tax benefit of exercise of nonqualified options 447 972
Deferred income taxes 1,362 451
Changes in assets and liabilities, net of the effect of acquisitions:
Trade receivables 8,928 6,786
Inventories (3,077) (8,607)
Prepaid expenses and other current assets 756 (1,382)
Trade payables (12,044) (317)
Income taxes payable 5,369 9,466
Accrued liabilities and royalty payable to stockholders 1,014 (237)
Customer deposits 287 190
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Net cash provided by operating activities 19,165 32,707
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CASH FLOWS FROM INVESTING ACTIVITIES:
Additions to property, plant and equipment (3,630) (9,143)
Proceeds from sale of property, plant and equipment 4 --
Decrease in other assets 251 71
Acquisitions, net of cash acquired -- (24,992)
Purchases of short-term investments -- (9,195)
Proceeds from maturities of short-term investments 17,578 16,112
Issuance of notes receivable (155) (130)
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Net cash provided by (used in) investing activities 14,048 (27,277)
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CASH FLOWS FROM FINANCING ACTIVITIES:
Cash dividends paid on common stock (3,253) --
Funds used for stock repurchase (1,422) --
Proceeds from exercise of stock options 622 862
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Net cash provided by (used in) financing activities (4,053) 862
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Effect of Foreign Currency Exchange Rate Changes (464) (73)
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(Continued)
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THE NAUTILUS GROUP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In Thousands)
(Unaudited)
THREE MONTHS ENDED MARCH 31,
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2003 2002
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NET INCREASE IN CASH AND CASH EQUIVALENTS $ 28,696 $ 6,219
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 31,719 35,639
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CASH AND CASH EQUIVALENTS, END OF PERIOD $ 60,415 $ 41,858
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SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid for income taxes $ 500 $ 1,700
(Concluded)
See notes to consolidated financial statements.
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THE NAUTILUS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In Thousands, Except Share and Per Share Data)
(Unaudited)
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1. BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements of The
Nautilus Group, Inc. have been prepared in accordance with accounting
principles generally accepted in the United States of America ("generally
accepted accounting principles") and pursuant to Securities and Exchange
Commission rules and regulations. Certain information and footnote
disclosures normally included in financial statements prepared in
accordance with generally accepted accounting principles have been
condensed or omitted pursuant to such rules and regulations. These
financial statements should be read in conjunction with the audited
financial statements and notes thereto included in the Company's annual
report on Form 10-K for the year ended December 31, 2002.
The financial information included herein reflects all adjustments
(consisting of normal recurring adjustments), which are, in the opinion of
management, necessary for a fair presentation of the results for the
interim periods presented. The results of operations for the three months
ended March 31, 2003 are not necessarily indicative of the results to be
expected for the full year.
CONSOLIDATION - The consolidated financial statements include The Nautilus
Group, Inc. and its wholly-owned subsidiaries (collectively the
"Company"). All intercompany transactions and balances have been
eliminated.
RECENT ACCOUNTING PRONOUNCEMENTS - In July 2002, the Financial Accounting
Standards Board ("FASB") issued Statement of Financial Accounting
Standards ("SFAS") No. 146, ACCOUNTING FOR COSTS ASSOCIATED WITH EXIT OR
DISPOSAL ACTIVITIES. The standard requires companies to recognize costs
associated with exit or disposal activities when they are incurred rather
than at the date of commitment to an exit or disposal plan. Costs covered
by the standard include lease termination costs and certain employee
severance costs that are associated with a restructuring, discontinued
operation, plant closing, or other exit or disposal activity. The Company
adopted this statement as of January 1, 2003, and the adoption of SFAS No.
146 has not had a material effect on the Company's financial position,
results of operations, or cash flows.
In December 2002, the FASB issued SFAS No. 148, ACCOUNTING FOR STOCK-BASED
COMPENSATION - TRANSITION AND DISCLOSURE. SFAS No. 148 amends SFAS No.
123, ACCOUNTING FOR STOCK-BASED COMPENSATION, to provide alternative
methods of transition for an entity that voluntarily changes to the fair
value based method of accounting for stock-based employee compensation. It
also amends the disclosure provisions of SFAS No. 123 to require prominent
disclosure about the effects on reported net income of an entity's
accounting policy decisions with respect to stock-based employee
compensation. Finally, this statement amends APB Opinion No. 28, INTERIM
FINANCIAL REPORTING, to require disclosure about those effects in interim
financial information. The Company adopted SFAS No. 148 in the fourth
quarter of 2002. Since the Company has not changed to a fair value method
of stock-based compensation, the applicable portion of this statement only
affects our disclosures.
The Company does not recognize compensation expense relating to employee
stock options because it only grants options with an exercise price equal
to the fair value of the stock on the effective date of grant. If the
Company had elected to recognize compensation expense using a fair value
-7-
approach, and therefore determined the compensation based on the value as
determined by the Black-Scholes option pricing model, the pro forma net
income and earnings per share would have been as follows:
THREE MONTHS ENDED MARCH 31,
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2003 2002
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Net income, as reported $ 13,689 $ 23,958
Deduct: Total stock-based employee compensation expense determined
under fair value based method for all awards, net of tax (845) (819)
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Net income, pro forma $ 12,844 $ 23,139
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Basic earnings per share, as reported $ 0.42 $ 0.68
Basic earnings per share, pro forma $ 0.39 $ 0.66
Diluted earnings per share, as reported $ 0.42 $ 0.67
Diluted earnings per share, pro forma $ 0.39 $ 0.64
The pro forma amounts may not be indicative of the effects on reported net
income for future periods due to the effect of options vesting over a
period of years and the granting of stock compensation awards in future
years.
Refer to Note 9 for further information regarding the Company's stock
option plan.
RECLASSIFICATIONS - Certain amounts from 2002 have been reclassified to
conform to the 2003 presentation.
2. ACQUISITIONS
Effective February 8, 2002, the Company acquired the trade receivables,
inventories, prepaid expenses and other current assets, property, plant
and equipment, certain intangible assets and the foreign subsidiaries of
StairMaster Sports/Medical, Inc. ("StairMaster") for a cash purchase price
of approximately $24,924 including acquisition costs.
The Company has determined that the intangible asset associated with the
StairMaster acquisition has an indefinite useful life and thus will not be
amortized. The Company will evaluate the useful life of the trademark each
reporting period to determine whether events or circumstances warrant a
revision to the indefinite useful life assumption or if the asset should
be tested for impairment.
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)
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Total acquisition cost $ 24,924
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The allocation of the StairMaster acquisition cost and final purchase
price above reflects all adjustments made subsequent to the first quarter
of 2002 when the initial purchase took place. The results of operations
subsequent to the date of the StairMaster acquisition are included in the
consolidated financial statements of the Company.
The unaudited pro forma financial information below for the three months
ended March 31, 2002 was prepared as if the transaction involving the
acquisition of StairMaster had occurred at the beginning of the period
presented:
Net sales $ 142,193
Net income $ 24,182
Basic earnings per share $ 0.69
Diluted earnings per share $ 0.67
The unaudited pro forma financial information is not necessarily
indicative of what actual results would have been had the transaction
occurred at the beginning of the period, nor does it purport to indicate
the results of future operations of the Company.
3. INVENTORIES
Inventories consisted of the following:
MARCH 31, DECEMBER 31,
2003 2002
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Finished goods $ 48,138 $ 45,317
Work-in-process 1,526 1,317
Parts and components 17,156 17,164
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Inventories $ 66,820 $ 63,798
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4. PROPERTY, PLANT AND EQUIPMENT, net
Property, plant and equipment consisted of the following:
ESTIMATED
USEFUL LIFE MARCH 31, DECEMBER 31,
(IN YEARS) 2003 2002
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Land N/A $ 3,468 $ 3,468
Buildings 31.5 21,883 21,839
Computer equipment 2 to 5 28,924 26,252
Production equipment 5 14,235 13,647
Furniture and fixtures 5 1,537 1,433
Automobiles and trucks 7 612 549
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Total property, plant and equipment 70,659 67,188
Accumulated depreciation (13,790) (11,624)
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Property, plant and equipment, net $ 56,869 $ 55,564
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-9-
5. GOODWILL AND OTHER ASSETS, net
Other assets consisted of the following:
ESTIMATED
USEFUL LIFE MARCH 31, DECEMBER 31,
(IN YEARS) 2003 2002
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Indefinite life trademarks N/A $ 10,465 $ 10,465
Definite life trademark 20 6,800 6,800
Other assets 1-17 535 797
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Total other assets 17,800 18,062
Accumulated amortization (1,285) (1,195)
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Other assets, net $ 16,515 $ 16,867
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The Company evaluates goodwill and intangible assets with indefinite lives
for impairment annually or more frequently if events or changes in
circumstance indicate that such assets might be impaired. Intangible
assets with finite useful lives are tested for impairment whenever events
or changes in circumstance indicate that such assets might be impaired.
The remaining useful lives of intangible assets with finite useful lives
are evaluated annually to determine whether events or circumstances
warrant changes in the estimated useful lives of such assets.
Amortization of intangible assets for the three months ended March 31,
2003 was $90. The estimated amortization expense for the next five years
is $360 per year. Such estimated amortization will change if businesses or
portions thereof are either acquired or disposed, or if changes in events
or circumstances warrant the revision of estimated useful lives.
6. ACCRUED LIABILITIES
Accrued liabilities consisted of the following:
MARCH 31, DECEMBER 31,
2003 2002
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Accrued payroll $ 5,404 $ 5,436
Accrued warranty expense 7,329 5,358
Sales return reserve 1,875 2,550
Other 2,533 2,483
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Accrued liabilities $ 17,141 $ 15,827
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7. COMPREHENSIVE INCOME
Comprehensive income and its components are as follows:
THREE MONTHS ENDED MARCH 31,
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2003 2002
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Net income $ 13,689 $ 23,958
Foreign currency translation adjustment 21 (73)
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Comprehensive income $ 13,710 $ 23,885
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-10-
Accumulated other comprehensive income at March 31, 2003 and 2002 is due
to the foreign currency translation adjustment to the financial statements
of the foreign subsidiaries.
8. RESEARCH AND DEVELOPMENT
Internal research and development costs are expensed as incurred and
included in cost of sales. Third party research and development costs are
expensed when the work has been performed.
Research and development expense was $1,355 and $773 for the three months
ended March 31, 2003 and 2002, respectively.
9. STOCK OPTIONS
There were 177,316 options exercised at prices ranging from $1.37 to
$13.78 per share during the three months ended March 31, 2003. There were
35,500 new options granted at an exercise price $12.80 per share during
that period. There were 6,220 options canceled at prices ranging from
$13.56 to $34.05 per share during the three months ended March 31, 2003.
10. OPERATING SEGMENTS
Beginning in 2003, the Company augmented its segment reporting with the
addition of a separate reporting segment to reflect the extra-Divisional
activities associated with the corporate holding company. Included in the
segment information is comparative data as if the corporate holding
company existed at January 1, 2002.
The following table presents selected information about the Company's
three operating segments:
COMMERCIAL/
DIRECT RETAIL CORPORATE TOTAL
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PERIOD ENDED MARCH 31, 2003
Net sales $ 78,931 $ 50,518 $ -- $ 129,449
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Segment net income (loss) $ 11,921 $ 2,763 $ (995) $ 13,689
========== ========== ========== ==========
PERIOD ENDED MARCH 31, 2002
Net sales $ 91,082 $ 44,832 $ -- $ 135,914
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Segment net income (loss) $ 22,842 $ 1,917 $ (801) $ 23,958
========== ========== ========== ==========
COMMERCIAL/
DIRECT RETAIL CORPORATE TOTAL
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AS OF MARCH 31, 2003
Segment assets $ 57,559 $ 141,059 $ 84,832 $ 283,450
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AS OF DECEMBER 31, 2002
Segment assets $ 52,251 $ 149,559 $ 74,843 $ 276,653
========== ========== ========== ==========
-11-
11. EARNINGS PER SHARE
Basic earnings per share is computed on the basis of the weighted average
number of common shares outstanding. Diluted earnings per share is
computed on the basis of the weighted average number of common shares
outstanding plus the effect of outstanding stock options calculated using
the treasury stock method. Net income for the calculation of both basic
and diluted earnings per share is the same as reported net income for all
periods.
The calculation of weighted-average outstanding shares is as follows:
THREE MONTHS ENDED MARCH 31, 2003 THREE MONTHS ENDED MARCH 31, 2002
------------------------------------ ------------------------------------
PER SHARE PER SHARE
INCOME SHARES AMOUNT INCOME SHARES AMOUNT
---------- ---------- ---------- ---------- ---------- ----------
Basic EPS:
Net income $ 13,689 32,550,735 $ 0.42 $ 23,958 35,008,298 $ 0.68
Effect of dilutive securities:
Stock options -- 66,823 0.00 -- 965,102 (0.01)
---------- ---------- ---------- ---------- ---------- ----------
Diluted EPS:
Net income $ 13,689 32,617,558 $ 0.42 $ 23,958 35,973,400 $ 0.67
========== ========== ========== ========== ========== ==========
Out of 1,451,951 total options outstanding, 661,350 options were not
included in the calculation of diluted earnings per share for the three
months ended March 31, 2003 because they would be antidilutive. There were
no antidilutive stock options outstanding for the three months ended March
31, 2002.
12. STOCK REPURCHASE PROGRAM
In January 2003, the Board of Directors authorized the expenditure of up
to $50,000 to purchase shares of the Company's common stock in open-market
transactions. During the three months ended March 31, 2003, the Company
repurchased a total of 100,300 shares of common stock in open market
transactions for an aggregate purchase price of $1,422. The authorization
expires on June 30, 2003.
13. COMMITMENTS AND CONTINGENCIES
The Company is subject to litigation, claims and assessments in the
ordinary course of business, many of which are covered in whole or in part
by insurance. Management believes that any liability resulting from such
matters will not have a material adverse effect on the Company's financial
position, results of operations, or cash flows. In December 2002, the
Company filed suit against ICON Health and Fitness, Inc. 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.
14. RELATED-PARTY TRANSACTIONS
The Company incurred royalty expense under an agreement with a stockholder
of the Company of $1,791 and $2,148 for the three months ended March 31,
2003 and 2002, 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.
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
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RESULTS OF OPERATIONS
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FORWARD-LOOKING STATEMENTS
Certain statements contained in this Form 10-Q, including, without limitation,
statements containing the words "could," "may," "will," "should," "plan,"
"believes," "anticipates," "estimates," "predicts," "expects," "projections,"
"potential," "continue," or words of similar import, constitute "forward-looking
statements." Investors are cautioned that all forward-looking statements involve
risks and uncertainties, and various factors could cause actual results to
differ materially from those in the forward-looking statements. From time to
time and in this Form 10-Q, we may make forward-looking statements relating to
our financial performance, including the following:
o Anticipated revenues, expenses, and gross margins;
o Seasonal patterns;
o Expense as a percentage of revenue;
o Anticipated earnings;
o New product introductions; and
o Future capital expenditures.
Numerous factors could affect our actual results, including the following:
o The availability of media time and fluctuating advertising costs;
o A decline in consumer spending due to unfavorable economic conditions;
o Expiration of important patents;
o Our reliance on a limited product line;
o Our ability to effectively develop, market, and sell future products;
o 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-Q and in our most recent annual report on Form 10-K. Although we
believe the expectations reflected in the forward-looking statements are
reasonable, we cannot guarantee future results, levels of activity, performance,
or achievements. We undertake no obligation to update publicly any
forward-looking statements to reflect new information, events, or circumstances
after the date of this Form 10-Q or to reflect the occurrence of unanticipated
events.
CRITICAL ACCOUNTING POLICIES
Certain accounting policies are presented in consideration of their significance
for our Company. These critical policies involve the most complex or subjective
decisions or assessments and consist of warranty reserves, sales return
reserves, the allowance for doubtful accounts, inventory valuation, and
intangible asset valuation.
-13-
WARRANTY RESERVES
The product warranty reserve includes the cost to manufacture (raw materials,
labor and overhead) or purchase warranty parts from our suppliers as well as the
cost to ship those parts to our customers. The cost of labor to install a
warranted part on our manufactured commercial equipment is also included. The
warranty reserve is based on our historical experience with each product. A
warranty reserve is established for new products based on historical experience
with similar products, adjusted for any technological advances in manufacturing
or materials used. We track warranty claims by part and reason for claim in
order to identify any potential warranty trends. The warranty trends are
evaluated periodically with respect to future volume and nature of likely
claims. Adjustments, if any are so indicated, are made to the warranty reserve
to reflect our judgment regarding the likely effect of the warranty trends on
future claims. If we were to experience a significant volume of warranty claims
for a particular part or for a particular reason, we may need to make design
changes to our product, some of which may be required for our warranted
products. A change in warranty experience could have a significant impact on our
financial position, results of operations and cash flows.
SALES RETURN RESERVES
The sales return reserve is maintained based on our historical experience of
product return rates during the period in which a customer can return a product
for refund of the full purchase price, less shipping and handling in most
instances. The return periods for Bowflex, TreadClimber, Champion Nutrition, and
Nautilus Sleep Systems product lines are six weeks, 30 days, 30 days, and 90
days, respectively. Return periods are not offered on our other product lines.
We track all product returns in order to identify any potential customer
satisfaction trends. Our return reserve may be sensitive to a change in our
customers' ability to pay during the trial period due to unforeseen economic
circumstances and to different product introductions that might fulfill the
customers' needs at a perceived better value. Any major change in the
aforementioned factors may increase sales returns, which could have a
significant impact on our financial position, results of operations and cash
flows.
ALLOWANCE FOR DOUBTFUL ACCOUNTS
The allowance for doubtful accounts is maintained at a level based on our
historical experience adjusted for any known uncollectible amounts. We
periodically review the creditworthiness of our customers to help gauge
collectibility. Our allowance is sensitive to changes in our customers' ability
to pay due to unforeseen changes in the economy, including the bankruptcy of a
major customer, our efforts to actively pursue collections, and increases in
chargebacks. Any major change in the aforementioned factors may result in
increasing the allowance for doubtful accounts, which could have a significant
impact on our financial position, results of operations and cash flows.
INVENTORY VALUATION
Our inventory is valued at either the lower of cost (standard or average
depending on location) or market. Inventory adjustments are applied for any
known obsolete or defective products. We periodically review inventory levels of
our product lines in conjunction with market trends to assess salability of our
products. Our assessment of necessary adjustments to market value of inventory
is sensitive to changes in fitness technology and competitor product offerings
driven by customer demand. Any major change in the aforementioned factors may
result in reductions to market value of inventory below cost, which could have a
significant impact on our financial position, results of operations and cash
flows.
-14-
INTANGIBLE ASSET VALUATION
Currently, intangible assets consist predominantly of the Nautilus, Schwinn, and
StairMaster trademarks and goodwill associated with the acquisition of Schwinn
Fitness. Management estimates affecting these trademark and goodwill valuations
include determination of useful lives, and estimates of future cash flows and
fair values to perform an impairment analysis on an annual basis. The useful
lives assigned by management to the Nautilus, Schwinn, and StairMaster
trademarks and Schwinn Fitness goodwill are indefinite, 20 years, indefinite,
and indefinite, respectively. Any major change in the useful lives and/or the
determination of an impairment associated with the valuation of the
aforementioned intangible assets may result in asset value write-downs, which
could have a significant impact on our current and future financial position and
results of operations.
RESULTS OF OPERATIONS
We believe that period-to-period comparisons of our operating results are not
necessarily indicative of future performance. You should consider our prospects
in light of the risks, expenses and difficulties frequently encountered by
companies that operate in evolving markets.
STATEMENT OF OPERATIONS DATA - THREE MONTHS ENDED MARCH 31
The following table presents certain financial data regarding our first quarter
operations in 2003 and 2002, as a percentage of total revenues:
QUARTER ENDED MARCH 31,
----------------------
STATEMENT OF OPERATIONS DATA 2003 2002
-------- --------
Net sales 100.0% 100.0%
Cost of sales 46.0 43.2
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Gross profit 54.0 56.8
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Operating expenses:
Selling and marketing 30.5 23.3
General and administrative 5.3 4.6
Royalties 1.6 1.7
-------- --------
Total operating expenses 37.4 29.6
-------- --------
Operating income 16.6 27.2
Other income (expense), net (0.1) 0.3
-------- --------
Income before income taxes 16.5 27.5
Income tax expense 5.9 9.9
-------- --------
Net income 10.6% 17.6%
======== ========
-15-
COMPARISON OF THE QUARTERS ENDED MARCH 31, 2003 AND 2002
NET SALES
Net sales decreased by 4.8% to $129.4 million in the first quarter of 2003 from
$135.9 million in the first quarter of 2002. The first quarter of 2003 presented
a challenging business environment. We believe this was due to increased
competition, higher advertising costs and lower consumer confidence due to the
war in Iraq and concern regarding the economy. As a result of these factors, in
the first quarter of 2003, we saw conversion rates for our direct-marketed
products decline. Looking ahead, we expect 2003 consolidated sales to be in the
range of $525 million to $545 million.
Sales within our direct segment were $78.9 million in the first quarter of 2003,
a decrease of 13.3% compared with the first quarter of 2002. The majority of the
sales in our direct segment are from our Bowflex product line. Bowflex sales
accounted for 91% of our direct segment net sales in the first quarter of 2003,
down from 93% during the same period in 2002. In March 2003 we expanded our
direct segment product portfolio with the introduction of the TreadClimber, a
revolutionary, patented cardiovascular fitness product. The decrease in direct
segment sales can be attributed to increased competition, lower consumer
confidence due to the war and economic anxieties, as well as the higher
advertising cost environment due to increased demand for advertising time. Our
direct-marketing business is largely dependent upon national cable television
advertising. We experienced considerable changes in the advertising environment
in the first quarter of 2003 compared to the same period in 2002 as costs have
risen. We believe two unusual events affected sales in late 2001 and early 2002:
(1) the nesting effect as a result of the events of September 11, 2001 and (2)
the high availability of television advertising time. Both of these contributed
very positively to Bowflex sales during the first quarter of 2002. The nesting
effect of September 11, 2001 seems to have receded, and the advertising
environment has firmed up considerably as costs rose due to heightened demand
for advertising time. We expect lower direct segment sales for the second
quarter based on seasonal television viewing patterns directly impacting our
direct product sales. Our direct segment accounted for 61% of our aggregate net
sales in the quarter, down from 67% in the first quarter of 2002.
Sales within our commercial/retail segment were $50.5 million in the first
quarter of 2003, an increase of 12.7% over the first quarter of 2002. Excluding
our acquisition of StairMaster, commercial/retail segment sales grew 7.2% in the
first quarter of 2003 compared to the same period in 2002. The increase in sales
within the commercial/retail segment can be attributed to the introduction of
the Bowflex to the retail side of the business, which equated to sales of $4.6
million, or 9% of overall commercial/retail segment sales, during the first
quarter of 2003. Due to encouraging results from our initial test-marketing
plan, we intend to expand the retail rollout of Bowflex products during the
second quarter and throughout 2003. Our commercial/retail segment now accounts
for 39% of our net sales, up from 33% in the first quarter of 2002 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.
During the first quarter of 2003, our commercial sales were a larger percentage
of the total commercial/retail business than in previous quarters. This is due
to continued improvement in our commercial business, as well as experiencing
weaker than expected performance in our retail business. In our commercial
lines, we continue to become more competitive because of our ability to quote
and win more business due to combined offerings from our Nautilus, Schwinn and
StairMaster product lines. By combining cardiovascular and strength products
together we have the ability to sell our products as a packaged offering to our
customers. We saw softness in our retail business especially during the latter
part of the first quarter. We believe this softness is due to war and worry
about the economy, and we anticipate this business will improve as the economy
recovers.
-16-
GROSS PROFIT
Gross profits fell 9.3% to $69.9 million in the first quarter of 2003 from $77.2
million in the same period a year ago. As sales of inherently lower margin
products in the commercial/retail segment continue to grow as a percentage of
total sales, our overall gross profit margin decreased to 54.0% in the first
quarter of 2003, compared to 56.8% in the first quarter of 2002. For the
remainder of 2003, we expect our combined gross margin to be in the range of 52%
to 54%. The gross profit margin within our direct segment was 71.2% in the first
quarter of 2003 compared to 72.2% in the first quarter of 2002. The increase in
gross margins within our commercial/retail segment to 27.1% in the first quarter
of 2003, compared with 25.5% in the first quarter of 2002, was largely due to
$4.6 million in sales of Bowflex products through the retail channel.
OPERATING EXPENSES
SELLING AND MARKETING
Selling and marketing expenses grew to $39.5 million in the first quarter of
2003 from $31.6 million in the same period a year ago, an increase of 25.0%.
This increase in selling and marketing expenses is mainly due to an increase in
direct marketing advertising expenses as we increased the amount of
advertisements we ran due to a decline in our sales conversion rates coupled
with the higher advertising cost environment. We believe the decline in
conversion was a result of increased competition combined with lower consumer
confidence due to the war in Iraq and concern about the economy.
As a percentage of net sales, overall selling and marketing expenses increased
to 30.5% in the first quarter of 2003 from 23.2% in the first quarter of 2002.
Selling and marketing expenses within our direct segment were 41.7% of net sales
in the first quarter of 2003, compared to 28.7% in the first quarter of 2002.
Selling and marketing expenses within our commercial/retail segment were 13.0%
of net sales in the first quarter of 2003, compared to 12.1% in the first
quarter of 2002. For the remainder of 2003, we expect our combined selling and
marketing expenses to be in the range of 30% to 32% of total sales.
GENERAL AND ADMINISTRATIVE
General and administrative expenses grew to $6.9 million in the first quarter of
2003 from $6.3 million in the same period a year ago, an increase of $0.6
million, or 9.6%. Our direct segment accounted for the increase due primarily to
depreciation and wages associated with our information systems. Our financial
statements will now reflect a third segment comprised of our corporate holding
company which will include investor relation expenses, director costs, general
legal and accounting fees and salaries of corporate personnel as well as other
costs not specifically attributable to our other two segments. For financial
reporting purposes we have reclassified prior year balances to conform to this
three-segment presentation.
As a percentage of net sales, general and administrative expenses increased to
5.3% in the first quarter of 2003 from 4.6% in the same period a year ago. For
the remainder of 2003, we expect our combined general and administrative
expenses to be in the range of 5% to 6% of total sales.
ROYALTIES
Royalty expense declined to $2.1 million in the first quarter of 2003 from $2.3
million in the same period a year ago, a decrease of 10.2%. Our direct and
commercial/retail segments have several agreements under which we are obligated
to pay royalty fees on certain products. The decrease in our royalty expense is
primarily attributable to the decreased sales of our Bowflex products in the
quarter. Our royalty expenses will fluctuate in correlation with sales of our
Bowflex products, and will also be impacted by fluctuations in sales of other
products that have royalty agreements. The patent for the Bowflex Power Rod
resistance technology expires April 27, 2004. We will no longer be obligated to
pay royalties related to Bowflex sales following the expiration of this patent.
-17-
OTHER INCOME (EXPENSE)
In the first quarter of 2003, other expense was $0.1 million compared to other
income of $0.5 million for the same period a year ago. The decrease resulted
primarily from lower interest earned on invested cash and cash equivalents due
to lower average interest rates in 2003 coupled with a change to the use of
tax-exempt securities in 2003 in order to maximize tax equivalent yields.
Interest income decreased to $0.2 million in the first quarter of 2003 from $0.5
million in the same period a year ago.
INCOME TAX EXPENSE
Income tax expense decreased by $5.8 million to $7.7 million for the first
quarter of 2003 from $13.5 million for the same period of 2002 due to the
decline in our income before taxes. We expect our income tax expense to
fluctuate in line with changes in our income before taxes.
NET INCOME
For the reasons discussed above, net income declined to $13.7 million in the
first quarter of 2003 from $24.0 million in the same period a year ago, a
decrease of 42.9%.
LIQUIDITY AND CAPITAL RESOURCES
Historically, we have financed our growth and acquisitions primarily from cash
generated by our operating activities. During the first three months of 2003,
our operating activities generated $19.2 million in net cash, which contributed
to an aggregate $60.4 million balance in cash and cash equivalents, compared
with $32.7 million in net cash generated by our operating activities in the
first three months of 2002.
Net cash provided by investing activities was $14.0 million in the first three
months of 2003 compared with net cash used in investing activities in the first
three months of 2002 of $27.3 million. The largest component of this change was
due to the initial acquisition cost of StairMaster in February of 2002 of $25.0
million, net of cash acquired. We also had $17.6 million of maturities of
short-term investments in the first quarter of 2003 compared with net maturities
of $6.9 million in the same period of 2002. Additionally, we used $3.6 million
during the first three months of 2003 for capital expenditures primarily
consisting of manufacturing equipment and information systems and related
equipment. Capital expenditures totaled $9.1 million in the first quarter of
2002.
Net cash used in financing activities was $4.1 million in the first three months
of 2003, which can be attributed to Company stock repurchases of $1.4 million
and dividends paid of $3.3 million offset by $0.6 million of stock option
exercises. Net cash provided by financing activities during the first three
months of 2002 for stock option exercises totaled $0.9 million. There were no
stock repurchases or dividends paid during the first three months of 2002.
Working capital was $120.2 million at March 31, 2003 compared to $109.0 million
at December 31, 2002, largely due to increased cash and cash equivalents as a
result of net income for the quarter. The $3.0 million increase in inventories
was primarily due to slower than expected sales as well as inventory associated
with our Bowflex retail test. The $8.6 million decrease in trade receivables can
primarily be attributed to the seasonal timing of orders for the
commercial/retail segment, as more sales occur later in the fourth quarter
compared with the latter part of the first quarter. The $12.0 million decrease
in accounts payable is primarily due to the timing of inventory purchases, which
are significantly higher later in the fourth quarter compared with the latter
part of the first quarter due to the seasonal nature of the business. We expect
that our working capital will increase going forward as a result of our
continued profitability.
-18-
We maintain a $10 million line of credit with a lending institution. The line of
credit is secured by certain assets and contains several financial covenants. As
of the date of this filing, we are in compliance with the covenants applicable
to the line of credit, and there is no outstanding balance under the line.
As of March 31, 2003, the Company had no contractual capital obligations or
commercial commitments other than operating leases.
We believe our existing cash balances, combined with our line of credit, will be
sufficient to meet our capital requirements for at least the next 12 months.
INFLATION AND PRICE INCREASES
Although we cannot accurately anticipate the effect of inflation on our
operations, we do not believe that inflation has had, or is likely in the
foreseeable future to have, a material adverse effect on our financial position,
results of operations or cash flows. However, increases in inflation over
historical levels or uncertainty in the general economy could decrease
discretionary consumer spending for products like ours. Very little of our
revenue variation from prior periods is attributable to price increases.
RECENT ACCOUNTING PRONOUNCEMENTS
In July 2002, the Financial Accounting Standards Board ("the FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 146, ACCOUNTING FOR
COSTS ASSOCIATED WITH EXIT OR DISPOSAL ACTIVITIES. The standard requires
companies to recognize costs associated with exit or disposal activities when
they are incurred rather than at the date of commitment to an exit or disposal
plan. Costs covered by the standard include lease termination costs and certain
employee severance costs that are associated with a restructuring, discontinued
operation, plant closing, or other exit or disposal activity. The Company
adopted this statement as of January 1, 2003, and the adoption of SFAS No. 146
has not had a material effect on the Company's financial position, results of
operations, or cash flows.
In December 2002, the FASB issued SFAS No. 148, ACCOUNTING FOR STOCK-BASED
COMPENSATION - TRANSITION AND DISCLOSURE. SFAS No. 148 amends SFAS No. 123,
ACCOUNTING FOR STOCK-BASED COMPENSATION, to provide alternative methods of
transition for an entity that voluntarily changes to the fair value based method
of accounting for stock-based employee compensation. It also amends the
disclosure provisions of SFAS No. 123 to require prominent disclosure about the
effects on reported net income of an entity's accounting policy decisions with
respect to stock-based employee compensation. Finally, this statement amends APB
Opinion No. 28, INTERIM FINANCIAL REPORTING, to require disclosure about those
effects in interim financial information. The Company adopted SFAS No. 148 in
the fourth quarter of 2002. Since the Company has not changed to a fair value
method of stock-based compensation, the applicable portion of this statement
only affects our disclosures.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
- ---------------------------------------------------------------------
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.
-19-
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 $0.7 million.
INTEREST RATE RISK
The Company has financed its growth through cash generated from operations. At
March 31, 2003, the Company had no outstanding borrowings and was not subject to
any related interest rate risk.
The Company invests in liquid debt instruments purchased with maturity dates of
less than one year. Due to the short-term nature of those investments,
management believes that any possible near-term changes in related interest
rates would not have a material impact on the Company's financial position,
results of operations, or cash flows.
ITEM 4. CONTROLS AND PROCEDURES
- ----------------------------------
EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES
Our Chief Executive Officer and Chief Financial Officer have reviewed and
evaluated the effectiveness of our disclosure controls and procedures, as
defined in Rules 13a-14(c) and 15d-14(c) under the Securities Exchange Act of
1934 (Exchange Act), as of a date within ninety days of the filing date of this
quarterly report. Based on that evaluation, the Chief Executive Officer and the
Chief Financial Officer have concluded that our disclosure controls and
procedures are adequate and effective for the purposes set forth in the
definition of "disclosure controls and procedures" in Exchange Act Rule
15d-14(c).
CHANGES IN INTERNAL CONTROLS
There were no significant changes in our internal controls or in other factors
that could significantly affect internal controls and procedures including any
corrective actions with regard to significant deficiencies and material
weaknesses subsequent to the date of our most recent evaluation.
-20-
PART II - OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
- -------------------------------------------
(a) Exhibits
The following exhibits are filed herewith and this list constitutes the
exhibit index:
EXHIBIT NO. DOCUMENT DESCRIPTION
----------- --------------------
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
The following reports on Form 8-K were filed during the quarter ended
March 31, 2003:
o Form 8-K associated with the press release announcing initial
quarterly dividend and authorization of stock repurchase program
dated January 29, 2003.
o Form 8-K associated with the press release announcing fourth quarter
and year-end results for 2002 dated February 6, 2003.
-21-
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.
THE NAUTILUS GROUP, INC.
May 14, 2003 By: /s/ Brian R. Cook
- ------------ -----------------------
Date Brian R. Cook, Chief Executive Officer
(Principal Executive Officer)
May 14, 2003 By: /s/ Rod W. Rice
- ------------ -----------------------
Date Rod W. Rice, Chief Financial Officer,
Treasurer and Secretary
(Principal Financial and Accounting
Officer)
-22-
CERTIFICATION
I, Brian R. Cook, Chief Executive Officer, certify that:
1. I have reviewed this quarterly report on Form 10-Q of The Nautilus
Group;
2. Based on my knowledge, this quarterly 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
quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly 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 quarterly 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 quarterly 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
quarterly 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
quarterly 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.
May 14, 2003 By: /s/ Brian R. Cook
- ------------ ---------------------
Date Brian R. Cook, Chief Executive Officer
-23-
CERTIFICATION
I, Rod W. Rice, Chief Financial Officer, certify that:
1. I have reviewed this quarterly report on Form 10-Q of The Nautilus
Group;
2. Based on my knowledge, this quarterly 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
quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly 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 quarterly 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 quarterly 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
quarterly 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
quarterly 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.
May 14, 2003 By: /s/ Rod W. Rice
- ------------ -------------------
Date Rod W. Rice, Chief Financial Officer,
Treasurer and Secretary
-24-