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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, 2005

Commission file number: 000-25867

NAUTILUS, INC.

(Exact name of registrant as specified in its charter)

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 April 30, 2005: 33,290,663

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NAUTILUS, INC.

MARCH 31, 2005

INDEX TO FORM 10-Q

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PART I – FINANCIAL INFORMATION

NAUTILUS, INC.

CONSOLIDATED BALANCE SHEETS

(In Thousands, Except Share Data)

(Unaudited)

See notes to consolidated financial statements.

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NAUTILUS, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

(In Thousands, Except Share and Per Share Data)

(Unaudited)

See notes to consolidated financial statements.

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NAUTILUS, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(In Thousands)

(Unaudited)

(Continued)

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NAUTILUS, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(In Thousands)

(Unaudited)

See notes to consolidated financial statements.

(Concluded)

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NAUTILUS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(In Thousands, Except Share and Per Share Data and Footnote 7)

(Unaudited)

The accompanying unaudited consolidated financial statements of Nautilus, Inc. have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) 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, 2004.

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, 2005 are not necessarily indicative of the results to be expected for the full year.

Consolidation – The consolidated financial statements include Nautilus, Inc. and its wholly-owned subsidiaries (collectively the “Company”). All intercompany transactions and balances have been eliminated.

Use of Accounting Estimates – The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. The most significant estimates included in the preparation of the financial statements are related to revenue recognition, stock-based compensation, warranty reserves, legal reserves, sales return reserves, the allowance for doubtful accounts, inventory valuation, intangible asset valuation, and income tax provision.

Stock-Based Compensation – The Company continues to measure compensation expense for its stock-based employee compensation plans using the method prescribed by Accounting Principles Board (“APB”) Opinion No. 25, Accounting for Stock Issued to Employees. The Company provides pro forma disclosures of net income and earnings per share as if the method prescribed by Statement of Financial Accounting Standards (“SFAS”) No. 123, Accounting for Stock-Based Compensation, had been applied in measuring compensation expense.

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With one exception, the Company has not recognized compensation expense relating to employee stock options because it has 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 $85 in the first quarter of 2005 and 2004. 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 years 2005-2007 is $340 per year and for 2008 is $184. If the Company had elected to recognize compensation expense for all 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:

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, the granting of stock compensation awards in future years and option cancellations associated with employee terminations.

A summary of the Company’s stock option plans as of March 31, 2005 and 2004 is presented below.

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Recent Accounting Pronouncements – In December 2004, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 123 (revised 2004), “Share-Based Payment” (“FAS 123R”), which addresses the accounting for share-based payment transactions in which an enterprise receives employee services in exchange for either equity instruments of the enterprise or liabilities that are based on the fair value of the enterprise’s equity instruments or that may be settled by the issuance of such equity instruments. The statement eliminates the ability to account for share-based compensation transactions, as the Company currently utilizes the intrinsic value method as prescribed by APB Opinion No. 25, “Accounting for Stock Issued to Employees,” and generally requires that such transactions be accounted for using a fair-value-based method and be recognized as expenses in our consolidated statement of income. The statement requires companies to assess the most appropriate model to calculate the value of the options. We currently use the Black-Scholes option pricing model to value options. We are currently assessing which model we will use in the future under the new statement and may deem an alternative model to be the most appropriate. The use of a different model to value options may result in a different fair value than the use of the Black-Scholes option pricing model. In addition, there are a number of other requirements under the new standard that would result in differing accounting treatment than that currently required. These differences include, but are not limited to, the accounting for the tax benefit on employee stock options and for stock issued under our employee stock purchase plan, and the presentation of these tax benefits within the consolidated statement of cash flows. In addition to the appropriate fair value model to be used for valuing share-based payments, we will also be required to determine the transition method to be used at the date of adoption. The allowed transition methods include prospective and retroactive adoption options. The prospective method requires that compensation expense be recorded for all unvested stock options and restricted stock at the beginning of the first quarter of adoption of FAS 123R, while the retroactive methods would record compensation expense for all unvested stock options and restricted stock beginning with the first period restated.

In April 2005, the Securities and Exchange Commission announced the adoption of a new rule that amends the effective date of FAS 123R. The effective date of the standard under these new rules for our consolidated financial statements is January 1, 2006. Adoption of FAS 123R will have a significant impact on our consolidated financial statements as we will be required to expense the fair value of our stock option grants and stock purchases under our employee stock purchase plan rather than disclose the impact on our consolidated net income within the footnotes, as is the Company’s current practice.

Reclassifications – Certain amounts from 2004 have been reclassified to conform to the 2005 presentation with no effect on previously reported consolidated net income or stockholders’ equity. Specifically, variable rate debt instruments, historically classified as cash and cash equivalents, have been reclassified within the Consolidated Statement of Cash Flows as short-term investments for the quarter ended March 31, 2004. Cash and cash equivalents at March 31, 2004 decreased by $70.1 million while short-term investments increased by the same amount.

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Inventories consisted of the following:

Property, plant and equipment consisted of the following:

Other assets consisted of the following:

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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, 2005 was $115. The estimated amortization expense for the next five full succeeding years is $460 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.

Accrued liabilities consisted of the following:

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 three months ended March 31, 2005 and 2004 is as follows:

* Deductions represent warranty claims paid out in the form of service costs and/or product replacements.

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Comprehensive income and its components are as follows:

Accumulated other comprehensive income at March 31, 2005 and 2004 is due to the foreign currency translation adjustment to the financial statements of the Company’s foreign subsidiaries.

As a result of further integration of our facilities, systems, and people through the Company’s Power of One initiative, effective January 1, 2005 the Company has consolidated its reportable segments to reflect the Company acting as a single organization. The Company operates predominantly in one industry segment: the design, production, marketing and selling of branded health and fitness products sold under the Nautilus, Bowflex, Schwinn, StairMaster and Trimline brand names.

Net sales by sales channel are as follows:

* Reflects net sales outside the Americas

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Prior year net sales by sales channel have been reclassified to conform to the current year presentation with no effect on previously reported consolidated net income or stockholders’ equity as follows:

Fiscal 2004

* Reflects net sales outside of the Americas

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:

Out of 2,713,783 total options outstanding, 795,590 options were not included in the calculation of diluted earnings per share for the three months ended March 31, 2005 because they would have been antidilutive. Out of 2,855,348 total options outstanding, 557,345 options were not included in the calculation of diluted earnings per share for the three months ended March 31, 2004 because they would have been antidilutive.

Guarantees – From time to time, the Company arranges for commercial leases or other financing sources to enable certain of its commercial customers to purchase the Company’s equipment. While most of these financings are without recourse, in certain cases the Company provides a guarantee or other recourse provisions to the independent finance company of all or a portion of the lease payments in order to facilitate the sale of the commercial equipment. In such situations, the Company ensures that the transaction between the independent leasing company and the commercial customer represents a

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sales-type lease. The Company monitors the payment status of the lessee under these arrangements and provides a reserve under SFAS No. 5, Accounting for Contingencies, in situations when collection of the lease payments is not probable. At March 31, 2005 and 2004, the maximum contingent liability under all recourse and guarantee provisions, including recourse and guarantee provisions issued prior to January 1, 2003, was approximately $4,386 and $3,968, respectively. As of March 31, 2005 and 2004, lease terms on outstanding commercial customer financing arrangements was between 3 and 7 years. A reserve for estimated losses under recourse provisions of $75 and $36 has been recorded based on historical loss experience and is included in accrued expenses at March 31, 2005 and 2004, respectively. In accordance with FASB Interpretation No. 45, Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others, the Company has also recorded additional liability and corresponding reduction of revenue of $36 and $46 for the three months ended March 31, 2005 and 2004, respectively, for the estimated fair value of the Company’s guarantees issued during the period. The fair value of the guarantees was determined based on the estimated risk premium a bank or similar institution would require in order to extend financing to a customer in the absence of a third-party guarantee. This liability is being reduced over the life of each respective guarantee. In most cases if the Company is required to fulfill its obligations under the guarantee, it has the right to repossess the equipment from the commercial customer. It is not practical to estimate the approximate amount of proceeds that would be generated from the sale of these assets in such situations.

Product Warranty Matters – The product warranty accrual reflects management’s best estimate of probable liability under product warranties. The Company determines the warranty accrual based on known product failures (if any), historical experience, and other currently available evidence.

Legal Matters – The Company is subject to litigation, claims and assessments in the ordinary course of business, including disputes that may arise from intellectual property related matters. Many of our legal matters are covered in whole or in part by insurance. Management believes that any liability resulting from such matters will not have a material adverse effect on the Company’s financial position, results of operations, or cash flows.

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 sought injunctive relief, monetary damages and its fees and costs. In October 2003, the District Court dismissed the patent infringement claims. The Company appealed the District Court’s decision to the United States Court of Appeals for the Federal Circuit (the “Appeals Court”) and in November 2003, the Appeals Court overruled the District Court and reinstated the patent infringement claims. The District Court has scheduled a trial on our patent infringement claim against ICON in June 2005.

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 which enjoined ICON from using the trademark “CrossBow.” This stay allowed ICON to continue using the trademark “CrossBow” until a decision was issued by the Appeals Court. In June 2004, the Appeals Court issued its decision upholding the issuance of an injunction, and preventing ICON from selling exercise equipment using the trademark “CrossBow” pending trial on the trademark issue. No trial date has been established on the trademark claim, but the Company expects trial to be set sometime in 2005.

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ICON has been using the term “CrossBar” on certain exercise equipment in response to the litigation regarding its use of “CrossBow.” In July 2004, the Company filed an additional suit against ICON in the District Court alleging that ICON has further infringed on the Bowflex trademark by the use of the “CrossBar” trademark. The Company seeks injunctive relief to prevent the sale of any fitness equipment that bears the trademark “CrossBar” as well as monetary damages.

In February 2004, the Company was notified that the U.S. Consumer Products Safety Commission (the “CPSC”) was investigating whether the Company violated the reporting obligations of the Consumer Product Safety Act (the “Act”) in connection with bench and lat tower incidents reported by users of the Bowflex Power Pro with lat tower attachment. Under the Act, the CPSC may assess penalties if it is determined that a product defect was not reported in accordance with the Act. During March 2005, the Company entered into a settlement agreement with the CPSC pursuant to which the Company will pay a civil penalty in the amount of $950,000. The Company entered into the settlement agreement to resolve the CPSC’s claims without the expense and distraction of litigation. By agreeing to this settlement, the Company does not admit any of the allegations set forth by the CPSC, or any fault, liability or statutory or regulatory violation.

The Company incurred royalty expense under an agreement with a stockholder of the Company of $1,566 for the three months ended March 31, 2004. In addition to the royalty agreement, the stockholder had separately negotiated an agreement dated June 18, 1992, when the Company was privately held, between the stockholder, the Company’s former Chairman and Chief Executive Officer (“former Chairman”), and a former director of the Company. That separate agreement stipulated that annual royalties above $90 would be paid 60% to the stockholder, 20% to the former Chairman and 20% to the former director. Both of these agreements expired in April 2004.

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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:

Numerous factors could affect our actual results, including the following:

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.

EXECUTIVE OVERVIEW

Nautilus, Inc. is a leading marketer, developer and manufacturer of branded health and fitness products sold under such well-known names as Nautilus, Bowflex, Schwinn, StairMaster and Trimline. Our products are marketed and sold through direct-marketing, retail, commercial, specialty retail and international sales channels.

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Within our direct-marketing sales channel we market and sell primarily our Bowflex brand utilizing a combination of television commercials, infomercials, response mailings, the Internet, catalog and inbound/outbound call centers.

In the retail sales channel we market and sell a comprehensive line of consumer fitness equipment under the Nautilus, Bowflex, Schwinn, StairMaster and Trimline brand names through a network of sporting good dealers, distributors and retailers.

We market and sell our Nautilus, Schwinn, and StairMaster commercial fitness equipment through our sales force and selected dealers to health clubs, government agencies, hotels, corporate fitness centers, colleges, universities and assisted living facilities.

We market and sell a comprehensive line of consumer fitness equipment under the Nautilus, Schwinn, StairMaster and Bowflex, brand names through a network of specialty retailers.

Through our international sales channel we market and sell Nautilus, Bowflex, Schwinn, StairMaster and Trimline brands to geographic locations outside of the Americas using a combination of direct-marketing, our sales force, and a network of specialty and sporting goods dealers, distributors and retailers.

First Quarter 2005 Results

The first quarter of 2005 is the first quarter of our three year plan, during which our consumer and brand-based business strategy is intended to help us grow sales and increase market share. This year our focus is on driving growth and investing in the future, as we look to build a solid foundation to continue growing our business profitably. During the quarter we had solid revenue growth in four of our five sales channels, with the fifth anticipated to show growth in later quarters.

Net sales for the quarter were $156.4 million, compared to $130.9 million in the same quarter of 2004, an increase of 19.5%. Gross profit margins increased to 49.1% in the first quarter of 2005 compared to 43.4% in the first quarter of 2004, in response to innovation, operating improvements and product mix. Operating income in the first quarter was $14.1 million or 9.0% of net sales compared to $9.8 million or 7.5% of net sales in the first quarter of 2004. This reflects our plan to drive growth while investing in the future, by strengthening our supply chain, operations, information systems, investing in product development, and protecting our intellectual property. Diluted earnings per share for the quarter were 28 cents, compared to 19 cents a year ago, a 46.5% improvement. The first quarter 2005 diluted earnings per share includes a settlement charge of $950,000 related to the Consumer Product Safety Commission (“CPSC”), which is included in general and administrative expenses. We ended the quarter with cash and short-term investments of $123.3 million, an increase of $18.7 million, and we continue to have no outstanding debt.

CRITICAL ACCOUNTING POLICIES

This management discussion and analysis (“MD&A”) is based upon our Consolidated Financial Statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”). The preparation of these financial statements requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue and expenses, and related disclosure of contingent assets and liabilities. Management bases its estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Senior management has discussed the development, selection

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and disclosure of these estimates with the Audit Committee of our Board of Directors. Actual results may differ from these estimates under different assumptions or conditions.

An accounting policy is deemed to be critical if it requires an accounting estimate to be made based on assumptions about matters that are highly uncertain at the time the estimate is made, and if different estimates that reasonably could have been used, or changes in the accounting estimates that are reasonably likely to occur periodically, could materially impact the financial statements. Management believes the following critical accounting policies reflect its more significant estimates and assumptions used in the preparation of the Consolidated Financial Statements.

Revenue Recognition

We recognize revenue when products are shipped and we have no significant remaining obligations, persuasive evidence of an arrangement exists, the price to the buyer is fixed or determinable, collectibility is reasonably assured or probable, and title and risk of loss have passed. Revenue is recognized net of applicable promotional discounts, rebates, and return allowances. In addition, revenue is recognized upon final installation for the Nautilus commercial equipment if we are responsible for installation. Return allowances, which reduce product revenue by our best estimate of expected product returns, are estimated using historical experience. In addition, from time to time, we arrange for leases or other financing sources to enable certain of our commercial customers to purchase our equipment. In the event that a guarantee of the commercial customer’s lease obligation is made, we record a liability and corresponding reduction of revenue for the estimated fair value of the guarantee and then recognize that revenue over the life of the lease obligation.

Stock-Based Compensation

We measure compensation expense for our stock-based employee compensation plans using the method prescribed by Accounting Principles Board (“APB”) Opinion No. 25, Accounting for Stock Issued to Employees. In Note 1 of the Notes to Consolidated Financial Statements, we provide pro forma disclosures of net income and earnings per share as if the method prescribed by Statement of Financial Accounting Standards (“SFAS”) No. 123, Accounting for Stock-Based Compensation, had been applied in measuring compensation expense. A change to recognize compensation expense for all options granted using a fair value approach, which will be required starting in January 2006 under SFAS No. 123R, Share-Based Payment, will have a significant impact on our financial position and results of operations.

Warranty Reserves

Accrued warranty expense 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 claims 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. If we believe it is necessary to implement those design changes to our installed base of products, our warranty costs could change materially. A change in warranty experience could have a significant impact on our financial position, results of operations and cash flows.

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Legal Reserves

We are involved in various claims, lawsuits and other proceedings from time to time. Such litigation involves uncertainty as to possible losses we may ultimately realize when one or more future events occur or fail to occur. We accrue and charge to income estimated losses from contingencies when it is probable (at the balance sheet date) that an asset has been impaired or liability incurred and the amount of loss can be reasonably estimated. Differences between estimates recorded and actual amounts determined in subsequent periods are treated as changes in accounting estimates (i.e., they are reflected in the financial statements in the period in which they are determined to be losses, with no retroactive restatement). The Company estimates the probability of losses on legal contingencies based on the advice of internal and external counsel, the outcomes from similar litigation, the status of the lawsuits (including settlement initiatives), legislative developments, and other factors. Due to the numerous variables associated with these judgments and assumptions, both the precision and reliability of the resulting estimates of the related loss contingencies are subject to substantial uncertainties. We regularly monitor our estimated exposure to these contingencies and, as additional information becomes known, may change our estimates significantly. A significant change in our estimates, or a result that materially differs from our estimates, could have a significant impact on our financial position, results of operations and cash flows.

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 certain instances. The return periods for direct marketed product lines range from 30 days to six weeks depending on the specific product. We track 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. We also provide for estimated sales returns from distributors, retailers and specialty retailers as reductions to revenues and accounts receivable. The estimates are based on historical rates of product returns. Actual returns in any future period are inherently uncertain and thus may differ from the estimates. 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, 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 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

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aforementioned factors may result in reductions to market value of inventory below cost, which could have a significant impact on our financial position, results of operations and cash flows.

Intangible Asset Valuation

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 or more frequently if additional circumstances arise. The useful lives assigned by management to the Nautilus, Schwinn, and StairMaster trademarks are indefinite, 20 years, 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 results of operations in the period or periods in which the asset write-down is recorded.

Income Tax Provision

Income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carry forwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.

Inherent in the measurement of these deferred balances are certain judgments and interpretations of existing tax law and other published guidance as applied to our operations. When it is more likely than not that all or some portion of specific deferred tax assets will not be realized, a valuation allowance must be established for the amount of the deferred tax assets that are determined not to be realizable. No valuation allowance has been provided for deferred tax assets, since we anticipate the full amount of these assets should be realized in the future. Accordingly, if the Company’s facts or financial results were to change thereby impacting the likelihood of realizing the deferred tax assets, judgment would have to be applied to determine changes to the amount of the valuation allowance required to be in place on the financial statements in any given period.

As a matter of course, the Company may be audited by federal, state and foreign tax authorities. We provide reserves for potential exposures when we consider it probable that a taxing authority may take a sustainable position on a matter contrary to our position. We evaluate these reserves, including interest thereon, on a quarterly basis to ensure that they have been appropriately adjusted for events that may impact our ultimate payment for such exposures. Management believes that an appropriate liability has been established for estimated exposures; however, actual results may differ materially from these estimates. To the extent the audits or other events result in a material adjustment to the accrued estimates, the effect would be recognized in income tax expense (benefit) in the Consolidated Statement of Income in the period of the event.

RESULTS OF OPERATIONS

This MD&A should be read in conjunction with our Consolidated Financial Statements and related notes included elsewhere in this report. We believe that period-to-period comparisons of our operating results are not necessarily indicative of future performance. You should consider our prospects in light of the risks, expenses and difficulties frequently encountered by companies that operate in evolving markets. We may not be able to successfully address these risks and difficulties and, consequently, we cannot assure you of any

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future growth or profitability. 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.

STATEMENT OF OPERATIONS DATA – THREE MONTHS ENDED MARCH 31

The following tables present certain consolidated financial data as a percentage of net sales and statement of operations data comparing results for the first quarter of 2005 and 2004:

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COMPARISON OF THE QUARTERS ENDED MARCH 31, 2005 AND 2004

Net Sales

Net sales were $156.4 million in the first quarter of 2005 compared to $130.9 million in the first quarter of 2004, an increase of $25.5 million or 19.5%.

Net sales from the commercial channel were $17.2 million in the first quarter of 2005 compared to $15.1 million in the first quarter of 2004, an increase of $2.1 million or approximately 13.9%. Commercial sales which include sales to health clubs, hotels and living complexes, represented approximately 11.0% of our total net sales in the quarter. The increase in net sales is attributed to excellent results from the IHRSA fitness show that occurred in March 2005. Additionally during the first quarter we began shipping our new Nautilus Commercial Series treadmills, allowing the Nautilus brand to offer a complete line of strength and cardio products.

Net sales from the specialty retail channel were $20.0 million in the first quarter of 2005 compared to $22.0 million in the first quarter of 2004, a decrease of $2.0 million or 9.1%. Specialty retail sales include sales to fitness retail stores that typically sell high-end equipment to the end consumer for home use. The decrease in net sales is primarily due to product supply constraints which began in the fourth quarter of 2004.

Net sales from the retail channel were $21.2 million in the first quarter of 2005 compared to $19.1 million in the first quarter of 2004, an increase of $2.1 million or 11.0%. Retail sales include sales to sporting good stores, warehouse clubs, and department stores and represent a $2.7 billion market opportunity. The increase in net sales is due to gaining additional customers as well as expanding the number of products offered at existing dealers.

Net sales from the direct channel were $84.9 million in the first quarter of 2005 compared to $63.2 million in the first quarter of 2004, an increase of $21.7 million or 34.3%. The direct channel involves sales derived

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from the internet, catalog and direct response advertising. The increase in direct channel sales is due to new advertising, better ad placement and format mix, and new promotions such as a cross-merchandising program with a major retail partner.

Net sales from the international channel were $13.1 million in the first quarter of 2005 compared to $11.5 million in the first quarter of 2004, an increase of $1.6 million or 13.9%. The international channel represents sales outside of the Americas and includes commercial, retail and direct marketing. We estimate this channel to represent a market opportunity in excess of $1 billion. The increase in net sales is attributed to expanded business with several large commercial customers and new retail relationships in the United Kingdom, Germany and Italy markets.

Gross Profit

Gross profits were $76.8 million in the first quarter of 2005 compared to $56.9 million in the first quarter of 2004, an increase of $19.9 million or 35.0%. As a percentage of net sales, gross profit margins were 49.1% in the first quarter of 2005 compared to 43.4% in the first quarter of 2004. During the first quarter of 2004 the Company incurred additional warranty and product safety reinforcement related costs associated with doubling of the Bowflex Power Pro warranty and greater than anticipated customer response for the Bowflex Power Pro reinforcement kit. Similar expenses were not incurred during the first quarter of 2005, resulting in the increased gross margins. Gross profit margin also increased as a result of the product sales mix with the direct channel, which represented approximately 54% of net sales during the first quarter of 2005 as compared to 48% during the first quarter of 2004.

Operating Expenses

Selling and Marketing

Selling and marketing expenses were $44.9 million in the first quarter of 2005 compared to $35.7 million in the first quarter of 2004, an increase of $9.2 million or 25.7%. As a percentage of net sales, selling and marketing expenses were 28.8% in the first quarter of 2005 as compared to 27.3% in the first quarter of 2004.

Due to continued strong consumer demand for our direct channel products, advertising declined as a percentage of direct channel revenues by approximately 5.3% during the first quarter of 2005 compared to the first quarter of 2004. These savings were offset by an increase in consumer financing fees, direct mailing costs and outside ad agency costs. Because our fitness equipment generally requires a substantial investment, over 90% of our direct channel customers use either popular credit cards such as VISA or MasterCard, or take advantage of the private Nautilus card. The number of direct market consumers taking advantage of the private Nautilus card increased as a percentage of direct channel net sales from 55.7% during the first quarter of 2004 to 81.4% in the first quarter of 2005, resulting in an increase in consumer financing fees. The strong consumer demand resulted in an increase in direct mailing costs as we processed more information requests and sales orders. Additionally during the first quarter of 2005 we used the services of an outside ad agency to improve the effectiveness of our overall marketing program.

General and Administrative

General and administrative expenses were $13.4 million in the first quarter of 2005 compared to $7.2 million in the first quarter of 2004, an increase of $6.2 million or 86.2%. As a percentage of net sales, general and administrative expenses were 8.6% in the first quarter of 2005 compared to 5.5% in the first quarter of 2004. The increase in general and administrative expenses is primarily attributable to a number of non-recurring events, including the settlement of the CPSC investigation in the amount of $950,000, a litigation reserve and

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increased legal fees in preparation of the trademark and patent infringement cases against ICON Health and Fitness (“ICON”). Consistent with our consumer-based business strategy to drive growth while investing in our future, general and administrative costs also increased due to expenses associated with implementing a common information technology platform and hiring and relocating personnel to help drive and manage our growth.

Research and development

Research and development expenses were $2.8 million in the first quarter of 2005 compared to $1.8 million in the first quarter of 2004, an increase of $1.0 million or 54.8%. The increase in research and development expenses is primarily attributable to increased staffing levels to support the innovation component of our consumer driven business strategy. We expect to continue to increase our research and development investment going forward to support our ongoing commitment to a fast pace of innovation.

Royalties

Royalty expenses were $1.5 million in the first quarter of 2005 compared to $2.3 million in the first quarter of 2004, a decrease of $0.8 million or 35.0%. The decrease in our royalty expense is primarily attributable to the expiration of the Bowflex Power Rod resistance technology patent on April 27, 2004, after which time we were no longer obligated to pay royalties related to Bowflex product sales. Our current royalty agreements are based on sales of our TreadClimber and elliptical products.

Operating Income

Operating income was $14.1 million in the first quarter of 2005 compared to $9.8 million in the first quarter of 2004, an increase of $4.3 million or 44.0%. As a percentage of net sales, operating income was 9.0% in the first quarter of 2005 compared to 7.5% in the first quarter of 2004, an improvement of 150 basis points. The improvement in operating income is attributed to improving our gross profit margin from 43.4% in the first quarter of 2004 to 49.1% in the first quarter of 2005, offset by an increase in our operating expenses as a percentage of net sales from 35.9% in the first quarter of 2004 to 40.1% in the first quarter of 2005.

Income Tax Expense

Income tax expense was $5.3 million in the first quarter of 2005 compared to $3.6 million in the first quarter of 2004, an increase of $1.7 million or 45.7%. We expect our income tax expense to fluctuate in line with changes in our income before taxes. The effective income tax rate decreased from 36.0% during the first quarter of 2004 to 35.9% during the first quarter of 2005.

LIQUIDITY AND CAPITAL RESOURCES

Historically, we have financed our business primarily from cash generated by our operating activities. During the first quarter of 2005, our operating activities generated $22.2 million in net cash, which contributed to an aggregate $123.3 million balance in cash, cash equivalents and short-term investments. $22.9 million in net cash was generated by our operating activities in the first quarter of 2004.

Net cash provided by investing activities was $2.9 million in the first quarter of 2005 compared with net cash used by investing activities in the first quarter of 2004 of $19.2 million. The largest component of this change was due to short-term investments decreasing by $3.4 million during the first quarter of 2005 compared to increasing by $18.9 million during the first quarter of 2004. Capital expenditures were $2.8 million in the first quarter of 2005 compared to $0.4 million in the first quarter of 2004. Capital expenditures

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during the first quarter of 2005 consisted of manufacturing equipment to support our new, innovative product offerings and information systems to support the implementation of a unified technology platform. The capital expenditures in 2004 primarily consisted of manufacturing equipment and information systems and related equipment. Additionally during the first quarter of 2005 the Company collected $3.0 million from the sale of a property in Las Vegas that occurred during the third quarter of 2004.

Net cash used in financing activities was $2.9 million in the first quarter of 2005, which can be largely attributed to cash dividends paid of $3.3 million offset by the proceeds from the exercise of stock options of $0.5 million. Net cash used in financing activities was $3.0 million in the first quarter of 2004, which can be attributed to cash dividends paid of $3.3 million offset by the proceeds from the exercise of stock options of $0.2 million.

Working capital was $171.7 million at March 31, 2005 compared to $169.5 million at December 31, 2004. The slight increase in working capital is due to a $4.1 million decline in current liabilities offset by a $2.0 decline in current assets. Accounts receivable decreased by $24.7 million as the result of the collection of year end balances. Inventory increased by $5.8 million in anticipation of several new product launches as well as mitigating the supply chain problems experienced in the specialty retail channel. Prepaid expenses and other current assets decreased by $1.9 million as the result of collecting the other receivable amount associated with the sale of the Las Vegas property that occurred during the third quarter of 2004. Trade payables decreased by $9.4 million due to a slow down in inventory purchases towards the end of the quarter in anticipation of the seasonal slowdown historically experienced during the second quarter. Accrued liabilities increased by $1.3 million primarily as the result of accruing for the CPSC settlement which will be paid during the second quarter. Income taxes payable increased by $4.3 million due to the timing of estimated income tax payments related to the first quarter earnings.

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. At March 31, 2005 and 2004, the Company had $8.1 million and $5.5 million, respectively in standby letters of credit primarily with Asian vendors reducing the available balance of the $10.0 million line of credit.

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

OFF-BALANCE SHEET ARRANGEMENTS

From time to time, we arrange for leases or other financing sources with third parties to enable certain of our commercial customers to purchase our equipment. While most of these financings are without recourse, in certain cases we may offer a guarantee or other recourse provisions. The purpose of these guarantees is to increase our selling opportunities to commercial customers that would not otherwise be able to obtain affordable financing to purchase our equipment. At March 31, 2005 and 2004, the maximum contingent liability under all recourse provisions was approximately $4.4 million and $4.0 million, respectively. Refer to Note 9 of the Notes to Consolidated Financial Statements for further discussion of the accounting treatment for these arrangements. We expect an increase in these types of arrangements going forward.

INFLATION AND PRICE CHANGES

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

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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 changes.

RECENT ACCOUNTING PRONOUNCEMENTS

In December 2004, the FASB issued SFAS No. 123 (revised 2004), “Share-Based Payment” (“FAS 123R”), which addresses the accounting for share-based payment transactions in which an enterprise receives employee services in exchange for either equity instruments of the enterprise or liabilities that are based on the fair value of the enterprise’s equity instruments or that may be settled by the issuance of such equity instruments. The statement eliminates the ability to account for share-based compensation transactions, as the Company currently utilizes the intrinsic value method as prescribed by APB Opinion No. 25, “Accounting for Stock Issued to Employees,” and generally requires that such transactions be accounted for using a fair-value-based method and be recognized as expenses in our consolidated statement of income. The statement requires companies to assess the most appropriate model to calculate the value of the options. We currently use the Black-Scholes option pricing model to value options. We are currently assessing which model we will use in the future under the new statement and may deem an alternative model to be the most appropriate. The use of a different model to value options may result in a different fair value than the use of the Black-Scholes option pricing model. In addition, there are a number of other requirements under the new standard that would result in differing accounting treatment than that currently required. These differences include, but are not limited to, the accounting for the tax benefit on employee stock options and for stock issued under our employee stock purchase plan, and the presentation of these tax benefits within the consolidated statement of cash flows. In addition to the appropriate fair value model to be used for valuing share-based payments, we will also be required to determine the transition method to be used at the date of adoption. The allowed transition methods include prospective and retroactive adoption options. The prospective method requires that compensation expense be recorded for all unvested stock options and restricted stock at the beginning of the first quarter of adoption of FAS 123R, while the retroactive methods would record compensation expense for all unvested stock options and restricted stock beginning with the first period restated.

In April 2005, the Securities and Exchange Commission announced the adoption of a new rule that amends the effective date of FAS 123R. The effective date of the standard under these new rules for our consolidated financial statements is January 1, 2006. Adoption of FAS 123R will have a significant impact on our consolidated financial statements as we will be required to expense the fair value of our stock option grants and stock purchases under our employee stock purchase plan rather than disclose the impact on our consolidated net income within the footnotes, as is the Company’s current practice.

There have been no material changes in our reported market risks since the filing of our 2004 Annual Report on Form 10-K, which was filed with the Securities and Exchange Commission on March 16, 2005.

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 individual debt issuer and require certain minimum ratings for debt instruments that we purchase.

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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 $1.4 million at March 31, 2005.

INTEREST RATE RISK

The Company has financed its growth through cash generated from operations. At March 31, 2005, 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.

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 were effective in providing reasonable assurance that material information required to be disclosed in our Exchange Act reports is (1) recorded, processed, summarized and reported in a timely manner, and (2) accumulated and communicated to our management, including our President and Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure. Management does not expect that our disclosure controls and procedures will prevent or detect all error and fraud. Any control system, no matter how well designed and operated, is based upon certain assumptions and can provide only reasonable, not absolute assurance that its objectives will be met. Further, no evaluation of controls can provide absolute assurance that misstatements due to error or fraud will not occur or that all control issues and instances of fraud, if any, within the Company have been detected.

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.

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PART II – OTHER INFORMATION

In December 2002, the Company filed suit against 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 sought injunctive relief, monetary damages and its fees and costs. In October 2003, the District Court dismissed the patent infringement claims. The Company appealed the District Court’s decision to the United States Court of Appeals for the Federal Circuit (the “Appeals Court”) and in November 2003, the Appeals Court overruled the District Court and reinstated the patent infringement claims. The District Court has scheduled a trial on our patent infringement claim against ICON in June 2005.

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 which enjoined ICON from using the trademark “CrossBow.” This stay allowed ICON to continue using the trademark “CrossBow” until a decision was issued by the Appeals Court. In June 2004, the Appeals Court issued its decision upholding the issuance of an injunction, and preventing ICON from selling exercise equipment using the trademark “CrossBow” pending trial on the trademark issue. No trial date has been established on the trademark claim, but the Company expects trial to be set sometime in 2005.

ICON has been using the term “CrossBar” on certain exercise equipment in response to the litigation regarding its use of “CrossBow.” In July 2004, the Company filed an additional suit against ICON in the District Court alleging that ICON has further infringed on the Bowflex trademark by the use of the “CrossBar” trademark. The Company seeks injunctive relief to prevent the sale of any fitness equipment that bears the trademark “CrossBar” as well as monetary damages.

In February 2004, the Company was notified that the CPSC was investigating whether the Company violated the reporting obligations of the Consumer Product Safety Act (the “Act”) in connection with bench and lat tower incidents reported by users of the Bowflex Power Pro with lat tower attachment. Under the Act, the CPSC may assess penalties if it is determined that a product defect was not reported in accordance with the Act. During March 2005, the Company entered into a settlement agreement with the CPSC pursuant to which the Company will pay a civil penalty in the amount of $950,000. The Company entered into the settlement agreement to resolve the CPSC’s claims without the expense and distraction of litigation. By agreeing to this settlement, the Company does not admit any of the allegations set forth by the CPSC, or any fault, liability or statutory or regulatory violation.

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The following exhibits are filed herewith:

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

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EXHIBIT INDEX