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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 SEPTEMBER 30, 2003
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)
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 November 10, 2003:
32,602,448
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THE NAUTILUS GROUP, INC.
SEPTEMBER 30, 2003
INDEX TO FORM 10-Q
PAGE
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited) 3
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 15
Item 3. Quantitative and Qualitative Disclosures About Market Risk 25
Item 4. Controls and Procedures 25
PART II - OTHER INFORMATION
Item 1. Legal Proceedings 27
Item 6. Exhibits and Reports on Form 8-K 27
Signatures 29
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
- ----------------------------
THE NAUTILUS GROUP, INC.
CONSOLIDATED BALANCE SHEETS
(In Thousands, Except Share Data)
(Unaudited)
September 30, December 31,
ASSETS 2003 2002
------------ ------------
CURRENT ASSETS:
Cash and cash equivalents $ 63,825 $ 31,719
Short-term investments, at amortized cost -- 17,578
Trade receivables (less allowance for doubtful accounts of
$2,769 and $3,147 in 2003 and 2002, respectively) 57,388 50,099
Inventories 51,403 63,798
Prepaid expenses and other current assets 5,610 4,919
Short-term notes receivable 2,904 3,067
Current deferred tax asset 3,425 2,924
------------ ------------
Total current assets 184,555 174,104
LONG-TERM NOTE RECEIVABLE 91 363
PROPERTY, PLANT AND EQUIPMENT, net 52,388 55,564
GOODWILL 29,755 29,755
OTHER ASSETS, net 17,282 16,867
------------ ------------
TOTAL ASSETS $ 284,071 $ 276,653
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Trade payables $ 22,660 $ 41,288
Accrued liabilities 22,764 15,827
Income taxes payable 6,927 5,284
Royalty payable to stockholders 1,597 1,997
Customer deposits 1,405 685
------------ ------------
Total current liabilities 55,353 65,081
LONG-TERM DEFERRED TAX LIABILITY 9,819 9,149
COMMITMENTS AND CONTINGENCIES (Note 13)
STOCKHOLDERS' EQUITY:
Common stock - authorized, 75,000,000 shares of no par value;
issued and outstanding, 32,601,323 and 32,473,897 shares
at September 30, 2003 and December 31, 2002, respectively 2,791 --
Unearned compensation (1,629) --
Retained earnings 215,469 201,238
Accumulated other comprehensive income 2,268 1,185
------------ ------------
Total stockholders' equity 218,899 202,423
------------ ------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 284,071 $ 276,653
============ ============
See notes to consolidated financial statements.
3
THE NAUTILUS GROUP, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(In Thousands, Except Share and Per Share Data)
(Unaudited)
Three Months Ended Nine Months Ended
September 30, September 30,
----------------------------- -----------------------------
2003 2002 2003 2002
------------ ------------ ------------ ------------
NET SALES $ 115,958 $ 152,865 $ 346,009 $ 429,187
COST OF SALES 60,508 64,435 168,144 179,687
------------ ------------ ------------ ------------
Gross profit 55,450 88,430 177,865 249,500
OPERATING EXPENSES:
Selling and marketing 34,492 40,654 109,688 106,345
General and administrative 9,241 5,634 24,891 19,338
Related-party royalties 1,597 2,531 4,838 7,092
Third-party royalties 333 384 969 717
------------ ------------ ------------ ------------
Total operating expenses 45,663 49,203 140,386 133,492
------------ ------------ ------------ ------------
OPERATING INCOME 9,787 39,227 37,479 116,008
OTHER INCOME (EXPENSE):
Interest income 134 333 593 1,260
Other, net 459 (408) 1,037 (326)
------------ ------------ ------------ ------------
Total other income (expense), net 593 (75) 1,630 934
------------ ------------ ------------ ------------
INCOME BEFORE INCOME TAXES 10,380 39,152 39,109 116,942
INCOME TAX EXPENSE 3,737 14,093 14,079 42,099
------------ ------------ ------------ ------------
NET INCOME $ 6,643 $ 25,059 $ 25,030 $ 74,843
============ ============ ============ ============
BASIC EARNINGS PER SHARE $ 0.20 $ 0.72 $ 0.77 $ 2.14
DILUTED EARNINGS PER SHARE $ 0.20 $ 0.71 $ 0.76 $ 2.10
Weighted average shares outstanding:
Basic shares outstanding 32,600,101 34,672,293 32,571,840 34,949,988
Diluted shares outstanding 32,980,358 35,343,184 32,982,358 35,692,274
See notes to consolidated financial statements.
4
THE NAUTILUS GROUP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In Thousands)
(Unaudited)
Nine Months Ended September 30,
-----------------------------------
2003 2002
------------ ------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 25,030 $ 74,843
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization 8,961 4,577
Unearned compensation 71 --
Loss on sale of property, plant and equipment 131 104
Tax benefit of exercise of nonqualified options 540 2,868
Deferred income taxes 169 3,526
Changes in assets and liabilities, net of the effect of acquisitions:
Trade receivables (6,502) (4,876)
Inventories 12,855 (10,766)
Prepaid expenses and other current assets (433) (3,350)
Trade payables (18,782) 8,915
Income taxes payable 1,640 (726)
Accrued liabilities and royalty payable to stockholders 6,166 2,794
Customer deposits 716 (109)
------------ ------------
Net cash provided by operating activities 30,562 77,800
------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Additions to property, plant and equipment (5,602) (25,364)
Proceeds from sale of property, plant and equipment 16 26
Net increase in other assets (573) (212)
StairMaster acquisition, net of cash acquired -- (24,131)
Purchases of short-term investments -- (34,811)
Proceeds from maturities of short-term investments 17,578 25,568
Net (increase) decrease in notes receivable 436 (332)
------------ ------------
Net cash provided by (used in) investing activities 11,855 (59,256)
------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Cash dividends paid on common stock (9,769) --
Stock repurchases (1,422) (19,973)
Proceeds from exercise of stock options 942 2,632
------------ ------------
Net cash used in financing activities (10,249) (17,341)
------------ ------------
Effect of foreign currency exchange rate changes (62) 1,018
------------ ------------
(CONTINUED)
5
THE NAUTILUS GROUP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In Thousands)
(Unaudited)
Nine Months Ended September 30,
-----------------------------------
2003 2002
------------ ------------
NET INCREASE IN CASH AND CASH EQUIVALENTS $ 32,106 $ 2,221
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 31,719 35,639
------------ ------------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 63,825 $ 37,860
============ ============
SUPPLEMENTAL DISCLOSURE OF CASH FLOW
INFORMATION:
Cash paid for income taxes $ 11,760 $ 36,327
(CONCLUDED)
See notes to consolidated financial statements.
6
THE NAUTILUS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In Thousands, Except Share and Per Share Data)
(unaudited)
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1. BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements of The Nautilus
Group, Inc. have been prepared in accordance with accounting principles
generally accepted in the United States of America ("generally accepted
accounting principles") and pursuant to Securities and Exchange Commission rules
and regulations. Certain information and footnote disclosures normally included
in financial statements prepared in accordance with generally accepted
accounting principles have been condensed or omitted pursuant to such rules and
regulations. These financial statements should be read in conjunction with the
audited financial statements and notes thereto included in the Company's annual
report on Form 10-K for the year ended December 31, 2002.
The financial information included herein reflects all adjustments (consisting
of normal recurring adjustments), which are, in the opinion of management,
necessary for a fair presentation of the results for the interim periods
presented. The results of operations for the three and nine months ended
September 30, 2003 are not necessarily indicative of the results to be expected
for the full year.
CONSOLIDATION - The consolidated financial statements include The Nautilus
Group, Inc. and its wholly-owned subsidiaries (collectively the "Company"). All
intercompany transactions and balances have been eliminated.
RECENT ACCOUNTING PRONOUNCEMENTS - In July 2002, the Financial Accounting
Standards Board ("FASB") issued Statement of Financial Accounting Standards
("SFAS") No. 146, ACCOUNTING FOR COSTS ASSOCIATED WITH EXIT OR DISPOSAL
ACTIVITIES. The standard requires companies to recognize costs associated with
exit or disposal activities when they are incurred rather than at the date of
commitment to an exit or disposal plan. Costs covered by the standard include
lease termination costs and certain employee severance costs that are associated
with a restructuring, discontinued operation, plant closing, or other exit or
disposal activity. The Company adopted this statement as of January 1, 2003.
During the third quarter ended September 30, 2003, the Company announced and
executed a workforce reduction resulting in a restructuring charge of
approximately $200. 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 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 adoption of FIN No. 45 has not had a material
impact on the Company's financial position, results of operations, or cash
flows.
In May 2003, the FASB issued SFAS No. 150, ACCOUNTING FOR CERTAIN FINANCIAL
INSTRUMENTS WITH CHARACTERISTICS OF BOTH LIABILITIES AND EQUITY, effective for
financial instruments entered into or modified after May 31, 2003, and otherwise
is effective at the beginning of the first interim period beginning after June
15, 2003. The adoption of SFAS No. 150 has not had a material impact on the
Company's financial position, results of operations, or cash flows.
7
RECLASSIFICATIONS - Certain amounts from 2002 have been reclassified to conform
to the 2003 presentation with no effect on previously reported consolidated net
income or stockholders' equity.
2. STOCK-BASED COMPENSATION
With one exception, the Company has not recognized compensation expense relating
to employee stock options because it has only granted options with an exercise
price equal to the fair value of the stock on the effective date of grant. In
July 2003, certain stock options were granted at an exercise price below current
market price on the day of the grant and thus the Company recognized
compensation expense of $71 for the three and nine months ended September 30,
2003. The unearned portion of this stock option grant resides in Stockholders'
Equity in the Consolidated Balance Sheets and will be recognized evenly over the
five-year vesting period as compensation expense. The estimated compensation
expense for the next five years is $340 per year. If the Company had elected to
recognize compensation expense for all other options granted using a fair value
approach, and therefore determined the compensation based on the value as
determined by the Black-Scholes option pricing model, the pro forma net income
and earnings per share would have been as follows:
Three Months Ended Nine Months Ended
September 30, September 30,
-------------------------- --------------------------
2003 2002 2003 2002
---------- ---------- ---------- ----------
Net income, as reported $ 6,643 $ 25,059 $ 25,030 $ 74,843
Add: Stock-based employee compensation
expense included in reported net income,
net of tax 45 -- 45 --
Deduct: Stock-based employee
compensation expense determined under
fair value based method, net of tax (773) (800) (2,450) (2,335)
---------- ---------- ---------- ----------
Net income, pro forma $ 5,915 $ 24,259 $ 22,625 $ 72,508
========== ========== ========== ==========
Basic earnings per share, as reported $ 0.20 $ 0.72 $ 0.77 $ 2.14
Basic earnings per share, pro forma $ 0.18 $ 0.70 $ 0.69 $ 2.07
Diluted earnings per share, as reported $ 0.20 $ 0.71 $ 0.76 $ 2.10
Diluted earnings per share, pro forma $ 0.18 $ 0.69 $ 0.68 $ 2.03
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.
For the nine months ended September 30, 2003, there were 227,726 options
exercised at a prices ranging from $1.37 to $13.78 per share. There were
1,410,500 new options granted at exercise prices ranging from $8.39 to $12.80
per share and 116,533 options canceled at prices ranging from $6.98 to $34.05
per share during the nine months ended September 30, 2003.
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
Sports/Medical, Inc. ("StairMaster") for a cash purchase price of approximately
$24,924 including acquisition costs.
8
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)
--------
Total acquisition cost $ 24,924
========
The allocation of the StairMaster acquisition cost and final purchase price
above reflects all adjustments made subsequent to the first quarter of 2002 when
the initial purchase took place. The results of operations subsequent to the
date of the StairMaster acquisition are included in the consolidated financial
statements of the Company.
The unaudited pro forma financial information below for the nine months ended
September 30, 2002 was prepared as if the transaction involving the acquisition
of StairMaster had occurred at the beginning of the period presented:
Net sales $ 435,466
Net income $ 75,067
Basic earnings per share $ 2.15
Diluted earnings per share $ 2.10
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.
4. INVENTORIES
Inventories consisted of the following:
September 30, December 31,
2003 2002
------------ ------------
Finished goods $ 28,336 $ 45,317
Work-in-process 2,342 1,317
Parts and components 20,725 17,164
---------- ----------
Inventories $ 51,403 $ 63,798
========== ==========
9
5. PROPERTY, PLANT AND EQUIPMENT, NET
Property, plant and equipment consisted of the following:
Estimated
Useful Life September 30, December 31,
(in years) 2003 2002
----------- ------------ ------------
Land N/A $ 3,468 $ 3,468
Buildings and improvements 31.5 21,930 21,839
Computer equipment 2 to 5 28,427 26,252
Production equipment 5 15,654 13,647
Furniture and fixtures 5 1,641 1,433
Automobiles and trucks 7 557 549
-------- --------
Total property, plant and equipment 71,677 67,188
Accumulated depreciation (19,289) (11,624)
-------- --------
Property, plant and equipment, net $ 52,388 $ 55,564
======== ========
6. GOODWILL AND OTHER ASSETS, NET
Other assets consisted of the following:
Estimated
Useful Life September 30, December 31,
(in years) 2003 2002
----------- ------------ ------------
Indefinite life trademarks N/A $ 10,465 $ 10,465
Definite life trademark 20 6,800 6,800
Other assets 1-17 1,482 797
-------- --------
Total other assets 18,747 18,062
Accumulated amortization (1,465) (1,195)
-------- --------
Other assets, net $ 17,282 $ 16,867
======== ========
The Company evaluates goodwill and intangible assets with indefinite lives for
impairment annually or more frequently if events or changes in circumstance
indicate that such assets might be impaired. Intangible assets with finite
useful lives are tested for impairment whenever events or changes in
circumstance indicate that such assets might be impaired. The remaining useful
lives of intangible assets with finite useful lives are evaluated annually to
determine whether events or circumstances warrant changes in the estimated
useful lives of such assets.
Amortization of intangible assets for the three and nine months ended September
30, 2003 was $90 and $270, respectively. The estimated amortization expense for
the next five years is $360 per year. Such estimated amortization will change if
businesses or portions thereof are either acquired or disposed, or if changes in
events or circumstances warrant the revision of estimated useful lives.
10
7. ACCRUED LIABILITIES
Accrued liabilities consisted of the following:
September 30, December 31,
2003 2002
------------ ------------
Accrued payroll $ 6,524 $ 5,436
Accrued warranty expense 9,510 5,358
Sales return reserve 1,700 2,550
Other 5,030 2,483
-------- --------
Accrued liabilities $ 22,764 $ 15,827
======== ========
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 nine months ended September 30, 2003 and year ended
December 31, 2002 is as follows:
Balance at Charged to Balance at
Beginning Costs and End of
of Period Expenses Deductions* Period
---------- ---------- ---------- ----------
Warranty reserves:
2003 $ 5,358 $ 5,512 $ 1,360 $ 9,510
2002 $ 2,413 $ 6,155 $ 3,210 $ 5,358
* Deductions represent warranty claims paid out in the form of cash or product
replacements.
8. COMPREHENSIVE INCOME
Comprehensive income and its components are as follows:
Three Months Ended Nine Months Ended
September 30, September 30,
----------------------- -----------------------
2003 2002 2003 2002
---------- ---------- ---------- ----------
Net income $ 6,643 $ 25,059 $ 25,030 $ 74,843
Foreign currency translation
adjustments 678 432 1,083 1,148
---------- ---------- ---------- ----------
Comprehensive income $ 7,321 $ 25,491 $ 26,113 $ 75,991
========== ========== ========== ==========
Accumulated other comprehensive income at September 30, 2003 and December 31,
2002 is due to the foreign currency translation adjustment to the financial
statements of the foreign subsidiaries.
9. 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 $1,739 and $1,357
for the three months ended September 30, 2003 and 2002, respectively. Research
and development expense was $4,225 and $3,218 for the nine months ended
September 30, 2003 and 2002, respectively.
11
10. OPERATING SEGMENTS
The Company's operating segments include its direct, commercial/retail, and
corporate segments. The direct segment includes all products and related
operations involved in marketing to consumers through a variety of direct
marketing channels. The Bowflex and TreadClimber lines of fitness equipment and
Nautilus Sleep Systems are the principal products in the Company's direct
segment. The commercial/retail segment includes all products and related
operations that do not involve direct marketing to consumers. Products in this
segment include Nautilus, Schwinn, StairMaster, Trimline, and Bowflex commercial
and retail fitness equipment and accessories. Beginning in 2003, the Company
augmented its segment reporting with the addition of a separate reporting
segment to reflect the extra-divisional activities associated with the corporate
holding company. Included in the segment information is comparative data
assuming the corporate holding company existed at January 1, 2002.
The following table presents selected information about the Company's three
operating segments:
Commercial/
Direct Retail Corporate Total
------------------------- ------------------------- ------------------------- -------------------------
Three Months Nine Months Three Months Nine Months Three Months Nine Months Three Months Nine Months
------------ ----------- ------------ ----------- ------------ ----------- ------------ -----------
Period Ended September 30, 2003
Net sales $ 51,926 $ 187,820 $ 64,032 $ 158,189 $ -- $ -- $ 115,958 $ 346,009
========== ========= ========== ========= ========== ========= ========== =========
Segment net income (loss) $ 1,112 $ 16,307 $ 7,388 $ 12,317 $ (1,857) $ (3,594) $ 6,643 $ 25,030
========== ========= ========== ========= ========== ========= ========== =========
Period Ended September 30, 2002
Net sales $ 107,034 $ 301,204 $ 45,831 $ 127,983 $ -- $ -- $ 152,865 $ 429,187
========== ========= ========== ========= ========== ========= ========== =========
Segment net income (loss) $ 26,632 $ 75,847 $ (943) $ 1,202 $ (630) $ (2,206) $ 25,059 $ 74,843
========== ========= ========== ========= ========== ========= ========== =========
Commercial/
Direct Retail Corporate Total
---------- --------- ---------- ---------
As of September 30, 2003
Segment assets $ 45,098 $ 149,694 $ 89,279 $ 284,071
========== ========= ========== =========
As of December 31, 2002
Segment assets $ 52,251 $ 149,559 $ 74,843 $ 276,653
========== ========= ========== =========
12
11. EARNINGS PER SHARE
Basic earnings per share is computed on the basis of the weighted average number
of common shares outstanding. Diluted earnings per share is computed on the
basis of the weighted average number of common shares outstanding plus the
effect of outstanding stock options calculated using the treasury stock method.
Net income for the calculation of both basic and diluted earnings per share is
the same as reported net income for all periods.
The calculation of weighted-average outstanding shares is as follows:
Three Months Ended Three Months Ended
September 30, 2003 September 30, 2002
------------------------------------ ------------------------------------
Per Share Per Share
Income Shares Amount Income Shares Amount
---------- ---------- ---------- ---------- ---------- ----------
Basic EPS:
Net income $ 6,643 32,600,101 $ 0.20 $ 25,059 34,672,293 $ 0.72
Effect of dilutive securities:
Stock options -- 380,257 0.00 -- 670,891 (0.01)
---------- ---------- ---------- ---------- ---------- ----------
Diluted EPS:
Net income $ 6,643 32,980,358 $ 0.20 $ 25,059 35,343,184 $ 0.71
========== ========== ========== ========== ========== ==========
Nine Months Ended Nine Months Ended
September 30, 2003 September 30, 2002
------------------------------------ ------------------------------------
Per Share Per Share
Income Shares Amount Income Shares Amount
---------- ---------- ---------- ---------- ---------- ----------
Basic EPS:
Net income $ 25,030 32,571,840 $ 0.77 $ 74,843 34,949,988 $ 2.14
Effect of dilutive securities:
Stock options -- 410,518 (0.01) -- 742,286 (0.04)
---------- ---------- ---------- ---------- ---------- ----------
Diluted EPS:
Net income $ 25,030 32,982,358 $ 0.76 $ 74,843 35,692,274 $ 2.10
========== ========== ========== ========== ========== ==========
Out of 2,666,228 total options outstanding, 1,222,419 and 1,151,919 options were
not included in the calculation of diluted earnings per share for the three and
nine months ended September 30, 2003, respectively, because they would be
antidilutive. Out of 1,603,854 total options outstanding, 266,075 and 244,075
options were not included in the calculation of diluted earnings per share for
the three and nine months ended September 30, 2002, respectively, because they
would be antidilutive.
12. STOCK REPURCHASE PROGRAM
In January 2003, the Board of Directors authorized the expenditure of up to
$50,000 to purchase shares of the Company's common stock in open-market
transactions. During the nine months ended September 30, 2003, the Company
repurchased a total of 100,300 shares of common stock in open market
transactions for an aggregate purchase price of $1,422. The authorization
expired on June 30, 2003.
13. COMMITMENTS AND CONTINGENCIES
The Company is subject to litigation, claims and assessments in the ordinary
course of business, many of which are covered in whole or in part by insurance.
Management believes that any liability resulting from such matters will not have
a material adverse effect on the Company's financial position, results of
operations, or cash flows.
13
In December 2002, the Company filed suit against ICON Health and Fitness, Inc.
("ICON") in the Federal District Court, Western District of Washington (the
"District Court") alleging infringement by ICON of the Company's Bowflex patents
and trademarks. The Company seeks injunctive relief, unquantified treble damages
and its fees and costs. The District Court denied our motion for a preliminary
injunction for patent infringement and dismissed our patent infringement claims.
We have appealed the District Court's decision to the United States Court of
Appeals for the Federal Circuit (the "Appeals Court"). The Company expects the
District Court to conduct a trial on our trademark infringement claims against
ICON in calendar year 2004.
In July 2003, the District Court ruled in favor of the Company on a motion for
preliminary injunction on the issue of trademark infringement, and entered an
order barring ICON from using the trademark "CrossBow" on any exercise
equipment. In its ruling, the District Court concluded that the Company showed
"a probability of success on the merits and irreparable injury" on its trademark
infringement claim. In August 2003, the Appeals Court granted ICON a temporary
stay regarding the motion for a preliminary injunction enjoining ICON from using
the trademark "CrossBow". This stay allows ICON to continue using the trademark
"CrossBow" until a decision is issued by the Appeals Court.
14. RELATED-PARTY TRANSACTIONS
The Company incurred royalty expense under an agreement with a stockholder of
the Company of $1,597 and $2,531 for the three months ended September 30, 2003
and 2002, respectively. The Company incurred royalty expense of $4,838 and
$7,092 for the nine months ended September 30, 2003 and 2002, respectively. In
addition to the royalty agreement, the stockholder has separately negotiated an
agreement dated September 18, 1992, when the Company was privately held, between
the stockholder, the Company's current Chairman and former Chief Executive
Officer ("Chairman"), and a former director of the Company. That separate
agreement stipulates that annual royalties above $90 would be paid 60% to the
stockholder, 20% to the Chairman and 20% to the former director.
14
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
- -------------------------------------------------------------------------------
OF OPERATIONS
- -------------
FORWARD-LOOKING STATEMENTS
Certain statements contained in this Form 10-Q, including, without limitation,
statements containing the words "could," "may," "will," "should," "plan,"
"believes," "anticipates," "estimates," "predicts," "expects," "projections,"
"potential," "continue," or words of similar import, constitute "forward-looking
statements." Investors are cautioned that all forward-looking statements involve
risks and uncertainties, and various factors could cause actual results to
differ materially from those in the forward-looking statements. From time to
time and in this Form 10-Q, we may make forward-looking statements relating to
our financial performance, including the following:
o Anticipated revenues, expenses, and gross margins;
o Seasonal patterns;
o Expense as a percentage of revenue;
o Anticipated earnings;
o New product introductions; and
o Future capital expenditures.
Numerous factors could affect our actual results, including the following:
o The availability of media time and fluctuating advertising costs;
o A decline in consumer spending due to unfavorable economic conditions;
o Expiration of important patents;
o Our reliance on a limited product line;
o Our ability to effectively develop, market, and sell future products;
o Our ability to adequately protect our intellectual property;
o Our ability to integrate any acquired businesses into our operations;
o Our reliance on the consumer finance market;
o Our reliance on third-party manufacturers;
o Government regulatory action; and
o Changes in foreign conditions that could impair our international sales.
We describe certain of these and other key risk factors elsewhere in more detail
in this Form 10-Q and in our most recent Annual Report on Form 10-K. Although we
believe the expectations reflected in the forward-looking statements are
reasonable, we cannot guarantee future results, levels of activity, performance,
or achievements. Except to the extent required by the federal securities laws,
we undertake no obligation to update publicly any forward-looking statements to
reflect new information, events, or circumstances after the date of this Form
10-Q or to reflect the occurrence of unanticipated events.
CRITICAL ACCOUNTING POLICIES
Certain accounting policies are presented in consideration of their significance
for our Company. These critical policies involve the most complex or subjective
decisions or assessments and consist of warranty reserves, sales return
reserves, the allowance for doubtful accounts, inventory valuation, and
intangible asset valuation.
15
WARRANTY RESERVES
The product warranty reserve includes the cost to manufacture (raw materials,
labor and overhead) or purchase warranty parts from our suppliers as well as the
cost to ship those parts to our customers. The cost of labor to install a
warranted part on our manufactured commercial equipment is also included. The
warranty reserve is based on our historical experience with each product. A
warranty reserve is established for new products based on historical experience
with similar products, adjusted for any technological advances in manufacturing
or materials used. We track warranty claims by part and reason for claim in
order to identify any potential warranty trends. The warranty trends are
evaluated periodically with respect to future volume and nature of likely
claims. Adjustments, if any are so indicated, are made to the warranty reserve
to reflect our judgment regarding the likely effect of the warranty trends on
future claims. If we were to experience a significant volume of warranty claims
for a particular part or for a particular reason, we may need to make design
changes to our product. 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
direct-marketed 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. Sales returns are insignificant for
products sold through our commercial/retail distribution channels. We track all
direct-marketed product returns in order to identify any potential negative
customer satisfaction trends. Our return reserve may be sensitive to a change in
our customers' ability to pay during the trial period due to unforeseen economic
circumstances and to different product introductions that might fulfill the
customers' needs at a perceived better value. Any major change in the
aforementioned factors may increase sales returns, which could have a
significant impact on our financial position, results of operations and cash
flows.
ALLOWANCE FOR DOUBTFUL ACCOUNTS
The allowance for doubtful accounts is maintained at a level based on our
historical experience adjusted for any known uncollectible amounts. We
periodically review the creditworthiness of our customers to help gauge
collectibility. Our allowance is sensitive to changes in our customers' ability
to pay due to unforeseen changes in the economy, including the bankruptcy of a
major customer, our efforts to actively pursue collections, and increases in
chargebacks. Any major change in the aforementioned factors may result in
increasing the allowance for doubtful accounts, which could have a significant
impact on our financial position, results of operations and cash flows.
INVENTORY VALUATION
Our inventory is valued at either the lower of cost (standard or average
depending on location) or market. Inventory adjustments are applied for any
known obsolete or defective products. We periodically review inventory levels of
our product lines in conjunction with market trends to assess salability of our
products. Our assessment of necessary adjustments to market value of inventory
is sensitive to changes in fitness technology and competitor product offerings
driven by customer demand. Any major change in the aforementioned factors may
result in reductions to market value of inventory below cost, which could have a
significant impact on our financial position, results of operations and cash
flows.
16
INTANGIBLE ASSET VALUATION
Currently, intangible assets consist predominantly of the Nautilus, Schwinn, and
StairMaster trademarks and goodwill associated with the acquisition of Schwinn
Fitness. Management estimates affecting these trademark and goodwill valuations
include determination of useful lives and estimates of future cash flows and
fair values to perform an impairment analysis on an annual basis. The useful
lives assigned by management to the Nautilus, Schwinn, and StairMaster
trademarks and Schwinn Fitness goodwill are indefinite, 20 years, indefinite,
and indefinite, respectively. Any major change in the useful lives and/or the
determination of an impairment associated with the valuation of the
aforementioned intangible assets may result in asset value write-downs, which
could have a significant impact on our current and future financial position and
results of operations.
RESULTS OF OPERATIONS
We believe that period-to-period comparisons of our operating results are not
necessarily indicative of future performance. You should consider our prospects
in light of the risks, expenses and difficulties frequently encountered by
companies that operate in evolving markets.
STATEMENT OF OPERATIONS DATA - THREE MONTHS ENDED SEPTEMBER 30
The following table presents certain financial data regarding our third quarter
operations in 2003 and 2002, as a percentage of total revenues:
Quarter Ended September 30,
----------------------------
Statement of Operations Data 2003 2002
---------- ----------
Net sales 100.0% 100.0%
Cost of sales 52.2 42.2
------ ------
Gross profit 47.8 57.8
Operating expenses:
Selling and marketing 29.7 26.6
General and administrative 8.0 3.7
Royalties 1.7 1.9
------ ------
Total operating expenses 39.4 32.2
------ ------
Operating income 8.4 25.6
Other income, net 0.5 0.0
------ ------
Income before income taxes 8.9 25.6
Income tax expense 3.2 9.2
------ ------
Net income 5.7% 16.4%
====== ======
17
COMPARISON OF THE QUARTERS ENDED SEPTEMBER 30, 2003 AND 2002
NET SALES
Net sales decreased by 24.1% to $116.0 million in the third quarter of 2003 from
$152.9 million in the third quarter of 2002. The third quarter of 2003 presented
a challenging business environment for our business. We believe this was mainly
due to increased competition for our Bowflex product line and higher advertising
costs due to increased demand for advertising time. We believe these factors
contributed to lackluster consumer spending for our health and fitness products
and reduced sales conversion rates for our direct-marketed products.
Sales within our direct segment were $51.9 million in the third quarter of 2003,
a decrease of $55.1 million, or 51.5%, compared with the third quarter of 2002.
Our direct segment accounted for 44.8% of our aggregate net sales in the
quarter, down from 70.0% in the third quarter of 2002. The majority of the sales
in our direct segment are from our Bowflex product line, which accounted for
81.4% of our direct segment net sales in the third quarter of 2003, down from
91.0% during the same period in 2002. Additional product lines within our direct
segment include Nautilus Sleep Systems and TreadClimber, which was introduced
during the first quarter of 2003. The decrease in direct segment sales can
mainly be attributed to increased competition and managing our advertising
spending in a higher advertising cost environment to optimize profitability. We
believe competing products have adversely affected demand for our Bowflex
products and advertising costs have risen when comparing the third quarter of
2003 to the same period in 2002, resulting in lower sales of direct-marketed
products for comparable advertising spending. During the second quarter of 2003,
we began a process of reassessing the marketing plan for our Nautilus Sleep
Systems product line. This has involved a reduction in the amount of advertising
spending for this product line, which has also resulted in a reduction in sales.
Consequently, we are no longer projecting sales growth for this product line in
2003. Our new TreadClimber product line has exceeded our expectations for 2003,
and we believe this product will achieve approximately $16.0 to $18.0 million in
sales this year.
Sales within our commercial/retail segment were $64.0 million in the third
quarter of 2003, an increase of $18.2 million, or 39.7%, compared to the third
quarter of 2002. The increase in sales within the commercial/retail segment can
be attributed to the introduction of portions of the Bowflex product line to our
retail business, which has equated to sales of $17.7 million, or 27.7% of
overall commercial/retail segment sales, during the third quarter of 2003. Due
to encouraging results from our initial test-marketing plan that began in the
first quarter of 2003, we expanded the retail distribution of Bowflex products
and plan to continue to do so throughout the remainder of 2003. Besides the
Bowflex, our commercial/retail segment product portfolio consists of a wide
array of both strength and cardiovascular fitness products sold through the
commercial and retail channels under brand names that include Nautilus, Schwinn,
StairMaster, and Trimline. Our commercial/retail segment accounted for 55.2% of
our total net sales during the third quarter of 2003 compared to 30.0% in the
third quarter of 2002 as we continue to execute our strategy of expanding our
presence, product lines, and brands across all our sales channels, especially
within the commercial/retail segment. The increase in commercial/retail segment
sales as a percentage of our total net sales can also be attributed to the
decline in direct segment net sales during the third quarter of 2003 compared to
the same period in 2002.
GROSS PROFIT
Gross profits decreased 37.3% to $55.5 million in the third quarter of 2003
compared to $88.4 million in the same period a year ago. As sales of inherently
lower margin products in the commercial/retail segment continue to increase as a
percentage of total sales, our overall gross profit margin decreased to 47.8% in
the third quarter of 2003, compared to 57.8% in the third quarter of 2002. The
gross profit margin within our
18
direct segment was 64.5% in the third quarter of 2003 compared to 74.8% in the
third quarter of 2002. The decrease in gross profit margins within our direct
segment can mainly be attributed to the change in product sales mix, declining
sales leading to higher fixed costs per sale, and increased research and
development expense. The increase in gross profit margins within our
commercial/retail segment to 34.3% in the third quarter of 2003, compared with
18.4% in the third quarter of 2002, was primarily due to sales of Bowflex
products through the retail sales channel. For all of 2003, we expect our
combined gross profit margin to be in the range of 49% to 51%.
OPERATING EXPENSES
SELLING AND MARKETING
Selling and marketing expenses decreased to $34.5 million in the third quarter
of 2003 from $40.7 million in the same period a year ago, a decrease of 15.2%.
As a percentage of net sales, overall selling and marketing expenses increased
to 29.7% in the third quarter of 2003 from 26.6% in the third quarter of 2002.
Selling and marketing expenses within our direct segment were 52.3% of net sales
in the third quarter of 2003, compared to 31.9% in the third quarter of 2002.
The increase in selling and marketing expenses as a percentage of sales is
mainly due to declines in our direct segment sales conversion rates coupled with
a higher advertising cost environment. We believe the decline in sales
conversion rates was mostly the result of increased competition. Depreciation
associated with our newly implemented customer relationship management
information system also contributed to the increase in selling and marketing
expenses as a percentage of sales. During the second quarter of 2003, we began a
process of reassessing our marketing plan for our Nautilus Sleep Systems
resulting in reduced advertising spending for this product line. Selling and
marketing expenses within our commercial/retail segment were 11.4% of net sales
in the third quarter of 2003, compared to 14.1% in the third quarter of 2002.
For the remainder of 2003, we expect our combined selling and marketing expenses
to be in the range of 31% to 33% of total sales.
GENERAL AND ADMINISTRATIVE
General and administrative expenses increased to $9.2 million in the third
quarter of 2003 from $5.6 million in the same period a year ago, an increase of
$3.6 million, or 64.0%. As a percentage of net sales, general and administrative
expenses increased to 8.0% in the third quarter of 2003 from 3.7% in the third
quarter of 2002. Our direct segment general and administrative expenses
increased $1.8 million in the third quarter of 2003 compared to the same period
a year ago due primarily to depreciation, consulting costs, and wages associated
with our newly implemented computer information systems. Commercial/retail
segment general and administrative expenses remained virtually unchanged in the
third quarter of 2003 compared to the third quarter of 2002.
Our financial statements now reflect a third segment comprised of our corporate
holding company which includes primarily general and administrative expenses
such as investor relations, director costs, legal and accounting fees, and
salaries of corporate personnel, as well as other costs not specifically
attributable to our other two segments. For financial reporting purposes, we
have reclassified prior year balances to conform to this three-segment
presentation with no effect on previously reported consolidated net income or
stockholders' equity. Our corporate segment general and administrative expenses
increased $1.8 million in the third quarter of 2003 compared to the same period
a year ago due primarily to additional legal expenses. For the remainder of
2003, we expect our combined general and administrative expenses to be in the
range of 6% to 7% of total sales.
19
ROYALTIES
Royalty expense decreased to $1.9 million in the third quarter of 2003 from $2.9
million in the same period a year ago, a decrease of 33.8%. 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 decrease in sales of our Bowflex products in the
quarter. Our royalty expenses will primarily fluctuate in correlation with the
sales of our Bowflex products, but will also be impacted by fluctuations in
sales of other products that have royalty agreements. The patent for the Bowflex
Power Rod resistance technology expires April 27, 2004. We will no longer be
obligated to pay royalties related to Bowflex sales following the expiration of
this patent.
OTHER INCOME (EXPENSE)
In the third quarter of 2003, other income was $0.6 million compared to other
expense of $0.1 million for the same period a year ago. Interest income
decreased to $0.1 million in the third quarter of 2003 from $0.3 million in the
same period a year ago 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. The remaining impact on other income and expense in the third
quarter of 2003 and 2002 is primarily due to foreign currency related gains and
losses.
INCOME TAX EXPENSE
Income tax expense decreased by $10.4 million to $3.7 million for the third
quarter of 2003 from $14.1 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 $6.6 million in the
third quarter of 2003 from $25.1 million in the same period a year ago, a
decrease of 73.5%.
20
STATEMENT OF OPERATIONS DATA - NINE MONTHS ENDED SEPTEMBER 30
The following table presents certain financial data regarding operations for the
first nine months in 2003 and 2002, as a percentage of total revenues:
Nine Months Ended September 30,
-------------------------------
Statement of Operations Data 2003 2002
---------- ----------
Net sales 100.0% 100.0%
Cost of sales 48.6 41.9
------ ------
Gross profit 51.4 58.1
Operating expenses:
Selling and marketing 31.7 24.8
General and administrative 7.2 4.5
Royalties 1.7 1.8
------ ------
Total operating expenses 40.6 31.1
------ ------
Operating income 10.8 27.0
Other income, net 0.5 0.2
------ ------
Income before income taxes 11.3 27.2
Income tax expense 4.1 9.8
------ ------
Net income 7.2% 17.4%
====== ======
COMPARISON OF THE NINE MONTHS ENDED SEPTEMBER 30, 2003 AND 2002
NET SALES
Net sales decreased by 19.4% to $346.0 million in the first nine months of 2003
compared to $429.2 million in the same period in 2002. The first nine months of
2003 presented a challenging business environment. We believe this was due to
increased competition and higher advertising costs due to increased demand for
advertising time. These factors reduced sales conversion rates for our
direct-marketed products.
Sales within our direct segment were $187.8 million in the first nine months of
2003, a decrease of 37.6% compared with the same period in 2002. Our direct
segment accounted for 54.3% of our aggregate net sales in the first nine months,
down from 70.2% in the same period in 2002. The decrease in direct segment sales
can be attributed to a combination of factors including increased competition
and managing our advertising spending in a higher advertising cost environment
to optimize profitability.
Sales within our commercial/retail segment were $158.2 million in the first nine
months of 2003, an increase of 23.6% over the same period in 2002. Excluding our
acquisition of StairMaster, commercial/retail segment sales increased 31.2%
during the first nine months of 2003 compared to the same period in 2002. The
increase in sales within the commercial/retail segment can be attributed to the
introduction of the Bowflex to the retail side of the business, which equated to
sales of $29.1 million, or 18.4% of overall commercial/retail segment sales,
during the first nine months of 2003. For the first nine months of 2003, our
commercial/retail segment accounted for 45.7% of our net sales, up from 29.8% in
the same period in 2002 as we continued to execute our strategy of expanding our
presence, product lines, and brands across all our sales channels,
21
especially within the commercial/retail segment. This increase in
commercial/retail segment sales as a percentage of our total net sales can also
be attributed to the decline in direct segment sales during the first nine
months of 2003 compared to the same period in 2002. During the first nine months
of 2003, our commercial/retail business segment sales were comparable to sales
in the same period during 2002, excluding the introduction of the Bowflex
product line to the retail sales channel.
GROSS PROFIT
Gross profits decreased 28.7% to $177.9 million in the first nine months of 2003
compared to $249.5 million in the same period a year ago. As sales of inherently
lower margin products in the commercial/retail segment continued to grow as a
percentage of total sales, our overall gross profit margin decreased to 51.4% in
the first nine months of 2003, compared to 58.1% in the same period in 2002. The
gross profit margin within our direct segment was 69.7% in the first nine months
of 2003 compared to 73.2% for the same period in 2002. The decrease in gross
profit margins within our direct segment can mainly be attributed to the change
in product sales mix, declining sales leading to higher fixed costs per sale,
and increased research and development expense. The increase in gross margin
within our commercial/retail segment to 29.7% in the first nine months of 2003,
compared with 22.7% in the same period in 2002, was primarily due to sales of
Bowflex products through the retail channel.
OPERATING EXPENSES
SELLING AND MARKETING
Selling and marketing expenses increased to $109.7 million in the first nine
months of 2003 from $106.3 million in the same period a year ago, an increase of
3.1%. As a percentage of net sales, overall selling and marketing expenses
increased to 31.7% in the first nine months of 2003 from 24.8% in the same
period in 2002. Selling and marketing expenses within our direct segment were
47.8% of net sales in the first nine months of 2003, compared to 29.5% in the
same period in 2002. The overall increase in selling and marketing expenses in
absolute dollars and as a percentage of sales is mainly due to an increase in
direct marketing advertising spending during the first quarter of 2003 in
response to declines in our sales conversion rates coupled with a higher
advertising cost environment. We believe the decline in conversion was a result
of increased competition throughout the year combined with lower consumer
confidence due to the war in Iraq and concern about the economy during the first
half of the year. In addition, depreciation associated with our newly
implemented customer relationship management information system also contributed
to the increase. Selling and marketing expenses within our commercial/retail
segment were 12.6% of net sales in the first nine months of 2003, compared to
13.7% in the same period in 2002.
GENERAL AND ADMINISTRATIVE
General and administrative expenses increased to $24.9 million in the first nine
months of 2003 from $19.3 million in the same period a year ago, an increase of
$5.6 million, or 28.7%. Our direct segment accounted for $5.5 million of the
increase due primarily to depreciation, consulting costs, and wages associated
with our newly implemented computer information systems. Our commercial/retail
segment general and administrative expenses declined by $1.3 million due mostly
to cost savings associated with the integration of the Schwinn Fitness and
StairMaster businesses that we acquired in September 2001 and February 2002,
respectively. Corporate general and administrative expenses increased $1.4
million due primarily to additional legal expenses. As a percentage of net
sales, general and administrative expenses increased to 7.2% in the first nine
months of 2003 from 4.5% in the same period a year ago.
22
ROYALTIES
Royalty expense decreased to $5.8 million in the first nine months of 2003 from
$7.8 million in the same period a year ago, a decrease of 34.5%. 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. Our
royalty expenses will fluctuate in correlation with sales of our Bowflex
products, but will also be impacted by fluctuations in sales of other products
that have royalty agreements. The patent for the Bowflex Power Rod resistance
technology expires April 27, 2004. We will no longer be obligated to pay
royalties related to Bowflex sales following the expiration of this patent.
OTHER INCOME
Other income increased to $1.6 million in the first nine months of 2003 from
$0.9 million in the same period a year ago. Interest income decreased $0.7
million primarily due to lower interest earned on invested cash and cash
equivalents due to lower average interest rates in 2003 coupled with a change to
the use of tax-exempt securities in 2003 in order to maximize tax equivalent
yields. This decrease in interest income was primarily offset by $0.6 million in
proceeds received during the second quarter of 2003 related to an insurance
recovery from damaged inventory combined with the effect of foreign currency
related gains and losses during the respective periods.
INCOME TAX EXPENSE
Income tax expense decreased by $28.0 million to $14.1 million for the first
nine months of 2003 from $42.1 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 $25.0 million in the
first nine months of 2003 from $74.8 million in the same period a year ago, a
decrease of 66.6%.
LIQUIDITY AND CAPITAL RESOURCES
Historically, we have financed our business primarily from cash generated by our
operating activities. During the first nine months of 2003, our operating
activities generated $30.6 million in net cash, which contributed to an
aggregate $63.8 million balance in cash and cash equivalents, compared with
$77.8 million in net cash generated by our operating activities in the first
nine months of 2002.
Net cash provided by investing activities was $11.9 million in the first nine
months of 2003 compared with net cash used in investing activities in the first
nine months of 2002 of $59.3 million. The largest component of this change was
due to the acquisition cost of StairMaster in February of 2002 of $24.1 million,
net of cash acquired. Additionally, we used $5.6 million during the first nine
months of 2003 for capital expenditures primarily consisting of manufacturing
equipment and information systems and related equipment compared to $25.4
million in the first nine months of 2002.
Net cash used in financing activities was $10.2 million in the first nine months
of 2003, which can be attributed to Company stock repurchases of $1.4 million
and dividends paid of $9.8 million offset by $0.9 million of stock option
exercises. Net cash used in financing activities was $17.3 million in the first
nine months of 2002, which can be attributed to Company stock repurchases of
$20.0 million offset by $2.6 million of stock option exercises.
23
Working capital was $129.2 million at September 30, 2003 compared to $109.0
million at December 31, 2002, largely due to increased cash and cash equivalents
as a result of net income for the period. The $7.3 million increase in trade
receivables can primarily be attributed to the higher volume of sales through
our commercial/retail segment in the latter part of the third quarter of 2003
compared to the fourth quarter of 2002. The $12.4 million decrease in
inventories can primarily be attributed to better alignment of inventory levels
with sales volume. The $18.7 million decrease in trade payables is primarily due
to the timing of inventory purchases, which tend to be higher in the fourth
quarter compared with the third quarter due to the seasonal nature of the
business. The $6.9 million increase in accrued liabilities can mostly be
attributed to warranty and legal related expenses.
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 September 30, 2003, the Company had no contractual capital obligations or
commercial commitments other than operating leases.
We believe our existing cash balances, combined with our line of credit, will be
sufficient to meet our capital requirements for at least the next 12 months.
INFLATION AND PRICE INCREASES
Although we cannot accurately anticipate the effect of inflation on our
operations, we do not believe that inflation has had, or is likely in the
foreseeable future to have, a material adverse effect on our financial position,
results of operations or cash flows. However, increases in inflation over
historical levels or uncertainty in the general economy could decrease
discretionary consumer spending for products like ours. Very little of our
revenue variation from prior periods is attributable to price increases.
RECENT ACCOUNTING PRONOUNCEMENTS
In July 2002, the Financial Accounting Standards Board ("the FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 146, ACCOUNTING FOR
COSTS ASSOCIATED WITH EXIT OR DISPOSAL ACTIVITIES. The standard requires
companies to recognize costs associated with exit or disposal activities when
they are incurred rather than at the date of commitment to an exit or disposal
plan. Costs covered by the standard include lease termination costs and certain
employee severance costs that are associated with a restructuring, discontinued
operation, plant closing, or other exit or disposal activity. The Company
adopted this statement as of January 1, 2003. During the third quarter ended
September 30, 2003, the Company announced and executed a workforce reduction
resulting in a restructuring charge of approximately $0.2 million. The Company
believes this event is not material enough to warrant further disclosure and,
therefore, continues to conclude that 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 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 adoption of FIN No. 45 has not had a material
impact on the Company's financial position, results of operations, or cash
flows.
24
In May 2003, the FASB issued SFAS No. 150, ACCOUNTING FOR CERTAIN FINANCIAL
INSTRUMENTS WITH CHARACTERISTICS OF BOTH LIABILITIES AND EQUITY, effective for
financial instruments entered into or modified after May 31, 2003, and otherwise
is effective at the beginning of the first interim period beginning after June
15, 2003. The adoption of SFAS No. 150 has not had a material impact on the
Company's financial position, results of operations, or cash flows.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
- ------------------------------------------------------------------
There have been no material changes in our reported market risks since the
filing of our 2002 Annual Report on Form 10-K, which was filed with the
Securities and Exchange Commission on March 31, 2003.
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
September 30, 2003, the Company had no outstanding borrowings and was not
subject to any related interest rate risk.
The Company invests in liquid debt instruments purchased with maturity dates of
less than one year. Due to the short-term nature of those investments,
management believes that any reasonably possible near-term changes in related
interest rates would not have a material impact on the Company's financial
position, results of operations, or cash flows.
ITEM 4. CONTROLS AND PROCEDURES
- -------------------------------
EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES
Our management has evaluated, under the supervision and with the participation
of our President and Chief Executive Officer and Chief Financial Officer, the
effectiveness of our disclosure controls and procedures as of the end of the
period covered by this report pursuant to Rule 13a-15(b) under the Securities
Exchange Act of 1934 (the "Exchange Act"). Based on that evaluation, our
President and Chief Executive Officer and Chief Financial Officer have concluded
that, as of the end of the period covered by this report, our disclosure
controls and procedures are effective in ensuring that information required to
25
be disclosed in our Exchange Act reports is (1) recorded, processed, summarized
and reported in a timely manner, and (2) accumulated and communicated to our
management, including our President and Chief Executive Officer and Chief
Financial Officer, as appropriate to allow timely decisions regarding required
disclosure.
CHANGES IN INTERNAL CONTROLS
There has been no change in our internal control over financial reporting that
occurred during our last fiscal quarter that has materially affected, or is
reasonably likely to materially affect, our internal control over financial
reporting.
26
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
- -------------------------
In December 2002, the Company filed suit against ICON Health and Fitness, Inc.
("ICON") in the Federal District Court, Western District of Washington (the
"District Court") alleging infringement by ICON of the Company's Bowflex patents
and trademarks. The Company seeks injunctive relief, unquantified treble damages
and its fees and costs. The District Court denied our motion for a preliminary
injunction for patent infringement and dismissed our patent infringement claims.
We have appealed the District Court's decision to the United States Court of
Appeals for the Federal Circuit (the "Appeals Court"). The Company expects the
District Court to conduct a trial on our trademark infringement claims against
ICON in calendar year 2004.
In July 2003, the District Court ruled in favor of the Company on a motion for
preliminary injunction on the issue of trademark infringement, and entered an
order barring ICON from using the trademark "CrossBow" on any exercise
equipment. In its ruling, the District Court concluded that the Company showed
"a probability of success on the merits and irreparable injury" on its trademark
infringement claim. In August 2003, the Appeals Court granted ICON a temporary
stay regarding the motion for a preliminary injunction enjoining ICON from using
the trademark "CrossBow". This stay allows ICON to continue using the trademark
"CrossBow" until a decision is issued by the Appeals Court.
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
----------- --------------------
10.1 Executive Employment Agreement, dated July 2, 2003,
between The Nautilus Group, Inc. and Gregg Hammann
31.1 Certification Pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002
31.2 Certification Pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002
32.1 Certification pursuant to 18 U.S.C. Section 1350, as
adopted pursuant to Section 906 of the Sarbanes-Oxley Act
of 2002
32.2 Certification pursuant to 18 U.S.C. Section 1350, as
adopted pursuant to Section 906 of the Sarbanes-Oxley Act
of 2002
27
(b) Reports on Form 8-K
The following reports on Form 8-K were filed during the quarter ended
September 30, 2003:
o Form 8-K dated July 9, 2003, under Items 7, 9, and 12, associated with
the press release announcing the revision of second quarter and 2003
earnings estimates.
o Form 8-K dated July 30, 2003, under Items 7, 9, and 12, associated
with the press release announcing second quarter 2003 financial
results and fiscal year 2003 financial guidance, and declaring the
regular quarterly dividend for the third quarter of 2003.
28
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
THE NAUTILUS GROUP, INC.
November 14, 2003 By: /s/ Greggory C. Hammann
- ----------------- ---------------------------
Date Greggory C. Hammann, Chief Executive
Officer and President
(Principal Executive Officer)
November 14, 2003 By: /s/ Rod W. Rice
- ----------------- -------------------
Date Rod W. Rice, Chief Financial Officer,
Treasurer and Secretary (Principal
Financial and Accounting Officer)
29