BOWFLEX INC. - Quarter Report: 2009 June (Form 10-Q)

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SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2009

or

For the transition period from              to             

Commission file number: 000-25867

NAUTILUS, INC.

(Exact name of registrant as specified in its charter)

16400 S.E. Nautilus Drive

Vancouver, Washington 98683

(Address of principal executive offices, including zip code)

(360) 859-2900

(Registrant’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 registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  ¨    No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer” and “large accelerated filer” in Rule 12b-2 of the Exchange Act.

Large Accelerated Filer  ¨            Accelerated Filer  ¨            Non-Accelerated Filer  ¨            Smaller Reporting Company  x

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x

Number of shares of issuer’s common stock outstanding as of July 31, 2009: 30,614,336

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NAUTILUS, INC.

FORM 10-Q

FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2009

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PART I. FINANCIAL INFORMATION

NAUTILUS, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(Unaudited, in thousands)

See accompanying notes to condensed consolidated financial statements.

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NAUTILUS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited, in thousands, except per share amounts)

See accompanying notes to condensed consolidated financial statements.

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NAUTILUS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited, in thousands)

(continued)

See accompanying notes to condensed consolidated financial statements.

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NAUTILUS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited, in thousands)

(concluded)

See accompanying notes to condensed consolidated financial statements.

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NAUTILUS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

(1) General Information

Basis of Consolidation and Presentation

The accompanying condensed consolidated financial statements present the results of operations, financial position and cash flows of Nautilus, Inc. and its subsidiaries (collectively, “Nautilus” or the “Company”), all of which are wholly owned. Intercompany transactions and balances have been eliminated in consolidation.

The accompanying condensed consolidated financial statements have not been audited. We have condensed or omitted certain information and footnote disclosures normally included in financial statements presented in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”). We believe the disclosures are adequate to make the information presented not misleading. However, you should read these condensed consolidated financial statements in conjunction with the consolidated financial statements and notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2008.

The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates. Discussion regarding our significant estimates can be found in the Company’s Annual Report on Form 10-K for the year ended December 31, 2008.

In our opinion, the accompanying condensed consolidated financial statements reflect all adjustments, consisting only of normal recurring items and subsequent events evaluated during the period June 30, 2009, the date of the balance sheet, through August 10, 2009, the date the financial statements are issued, necessary to present fairly our financial position as of June 30, 2009 and December 31, 2008, and our results of operations and our cash flows for the three and six months ended June 30, 2009 and 2008. Interim results are not necessarily indicative of results for a full year.

On April 18, 2008, the Company completed the sale of its former fitness apparel business, DashAmerica, Inc. d/b/a Pearl iZumi (“Pearl iZumi”). Accordingly, all assets and liabilities and results of operations associated with the fitness apparel business have been presented in the condensed consolidated financial statements as discontinued operations.

Liquidity

As of June 30, 2009 and December 31, 2008, the Company had cash and cash equivalents of $7.8 million and $5.5 million, respectively, working capital of $19.6 million and $39.2 million, respectively, and short-term borrowings of zero and $17.9 million respectively. We generated cash from operating activities of continuing operations of $21.3 million during the six months ended June 30, 2009, $7.2 million during the year ended December 31, 2008 and $1.8 million during the year ended December 31, 2007. We incurred losses from continuing operations of $34.6 million for the six months ended June 30, 2009, $93.0 million for the year ended December 31, 2008, and $45.8 million for the year ended December 31, 2007.

During 2008, the Company implemented a number of restructuring initiatives to reduce ongoing operating expenses and improve its overall financial performance. In the first half of 2009, the Company initiated additional restructuring measures aimed at further reducing operating costs and improving the overall alignment of spending and anticipated revenue.

In January 2008, the Company, and its subsidiary Nautilus International S.A., entered into an asset-backed Loan and Security Agreement with Bank of America N.A. (the “Loan Agreement”). The Loan Agreement, as amended provides for $30.0 million of borrowing capacity based primarily on the value of domestic inventory and accounts receivable. The Loan Agreement contains a financial covenant, as well as limitations on capital expenditures, mergers and acquisitions, indebtedness, liens, dispositions, dividends and investments. The financial covenant is applicable only during a trigger period that would be in effect when excess availability (based on the value of our collateral assets, less current borrowings) falls below certain pre-established limits. Once activated, the trigger period would generally last until the Company meets minimum excess borrowing capacity requirements for a 90-day period. Upon an event of default, the lender would have the option of accelerating all obligations under the Loan Agreement or taking possession of collateral supporting the borrowings. Refer to Note 6 for additional description of the Loan Agreement.

The Company’s ability to continue to meet its obligations as they come due is dependent upon retaining access to borrowings available under the Loan Agreement. Based on current plans, the Company believes it will remain in compliance with the covenants under the Loan Agreement. The Company also believes its cash balance at June 30, 2009, available borrowings under the Loan Agreement and anticipated cash that will be provided by operations, will be sufficient to meet expected cash needs for working capital and capital expenditures for at least the next twelve months.

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The Company will monitor and adjust its business plan as necessary to respond to developments in the business, markets and the broader economy. However, there can be no assurance the Company will be able to successfully execute its business plan, further reduce costs as needed, or generate the level of expected revenue necessary to generate positive cash flow from operations. If the Company is unable to generate sufficient cash flow from operations to remain in compliance with the loan limits and covenants under the Loan Agreement, the Company may need to obtain funds through additional financing, which may or may not be available on acceptable terms, if at all.

Critical Accounting Policies and Estimates

The Company’s critical accounting policies and estimates relate to revenue recognition, the valuation of trade receivables and inventories, product warranties, the valuation of goodwill and other intangible assets, litigation and loss contingencies, stock-based compensation and income taxes. These policies are discussed in the Company’s Form 10-K for the year ended December 31, 2008.

Trade Receivables Valuation

The Company evaluates the collectability of its trade receivables each quarter and adjusts its allowance for doubtful accounts accordingly. Changes in the Company’s allowance for doubtful accounts for the three and six month periods ended June 30, 2009 and 2008 were as follows:

Product Warranties

The Company’s products carry limited defined warranties for defects in materials or workmanship. The Company’s warranties generally obligate us to pay for the costs to supply and ship warranty parts to customers and, in certain instances, pay for labor and other costs to service the products. Changes in the Company’s accrued product warranties for the three and six month periods ended June 30, 2009 and 2008 were as follows:

Of the warranty costs paid during the three and six month periods ended June 30, 2009, $1.6 million and $2.5 million, respectively, pertained to issues associated with the commercial TreadClimber, compared to $2.7 million and $4.5 million respectively, for the three and six month periods ended June 30, 2008. As of June 30, 2009 and 2008, the Company’s warranty reserves included $4.7 million and $10.1 million, respectively, related to the commercial TreadClimber, which is no longer being produced. Accrued product warranties at June 30, 2009 and 2008, include $1.6 million and $4.1 million, respectively, in estimated long-term warranty obligations.

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Stock Based Compensation

The Company’s stock based compensation expense for the three and six month periods ended June 30, 2009 was $0.4 million and $0.8 million, respectively, compared to $0.5 million and $2.0 million respectively, for the three and six month periods ended June 30, 2008. During the six month periods ended June 30, 2009 and 2008, the Company issued 58,000 stock option awards (at a weighted average grant-date fair value of $0.99 per share) and 1.0 million stock option awards (at a weighted average grant date fair value of $1.96 per share), respectively. The Company suspended its practice of awarding annual stock option grants to executives and senior employees late in 2008.

As of June 30, 2009, the Company had approximately 1.8 million stock options outstanding with a weighted average exercise price of $10.17. Unamortized compensation expense for unvested stock options, as of June 30, 2009, totaled approximately $2.3 million, which is expected to be recognized over a weighted-average period of 2.3 years.

During the first quarter of 2008, the Company was contractually obligated to accelerate vesting of certain stock options upon the termination of its former Chief Executive Officer and, as a consequence, recognized $1.0 million of stock option compensation charges as a component of restructuring expenses during that period.

New Accounting Pronouncements

On May 28, 2009, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards No. 165, Subsequent Events (“SFAS 165”) which establishes general standards of accounting for and disclosure of events that occur after the balance sheet date but before financial statements are issued or are available to be issued. SFAS 165 requires a company to disclose the date through which the entity has evaluated subsequent events and the basis for selecting that date, more specifically, whether the chosen date represents the date the financial statements were issued or were available to be issued. The Company’s adoption of SFAS 165, effective June 30, 2009, did not have a material impact on its financial statements.

Effective January 1, 2009, the Company adopted Statement of Financial Accounting Standards No. 141 (revised 2007), Business Combinations (“SFAS 141(R)”) which establishes principles and requirements for how an acquirer recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed and any non-controlling interest in the acquired business. SFAS 141(R) applies prospectively to any business combinations the Company may be party to for which the acquisition date is on or after January 1, 2009. The adoption of SFAS 141(R) did not have a material impact on the Company’s financial statements.

Effective January 1, 2009, the Company adopted FASB Staff Position FAS 142-3, Determination of the Useful Life of Intangible Assets (“FAS 142-3”). FAS 142-3 amends FASB Statement No. 142, Goodwill and Other Intangible Assets, and provides guidance for determining the useful life of a recognized intangible asset when the expected cash flows associated with the asset are affected by a company’s intent and/or ability to renew or extend the underlying arrangement. The adoption of FAS 142-3 did not have a material impact on the Company’s financial statements.

Reclassifications

For the three month period ended June 30, 2008, the Company has reclassified $0.5 million previously included in selling and marketing expenses, and $1.9 million previously included in general and administrative expenses, to a separate operating expense line entitled “restructuring”. For the six month period ended June 30, 2008, the Company has reclassified $0.8 million previously included in selling and marketing expenses and $12.4 million previously included in general and administrative expenses to a separate operating expense line entitled “restructuring”. The Company has corrected the presentation of $2.0 million in debt issuance costs, paid during the six month period ended June 30, 2008, from a component of net cash provided by operating activities of continuing operations, where it was previously recorded, to a component of net cash used in financing activities from continuing operations.

(2) Restructuring Activities

During 2008, Nautilus implemented a number of initiatives to reduce operating costs and reorganize its operations, including measures to restructure the Company’s workforce and close its Tulsa manufacturing facility. In the first quarter of 2009, the Company announced the continuation of cost savings plans aimed at further reducing operating costs and improving the overall alignment of spending and anticipated revenue. The 2009 plan impacts all functions through reductions in personnel and other initiatives, including the discontinuation of certain product lines, the abandonment of certain information technology software, the termination of certain leases and warehouse distribution services, and the downsizing of the Company’s corporate headquarters.

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The following is a summary of expenses associated with the aforementioned restructuring activities, all of which are recorded on a separate operating expense line entitled “restructuring”:

Restructuring costs are reported in our corporate segment to allow for a comparable review of operating income or loss by segment.

The following table summarizes the impact of restructuring activities on our accrued liability balances:

As of June 30, 2009, the Company’s long-term liabilities included $0.7 million in accrued lease termination costs associated with the closing of its Tulsa manufacturing facility.

(3) Inventories, net

The figures presented above are net of valuation allowances related to excess parts and finished goods inventories, of $5.5 million and $6.7 million, at June 30, 2009 and December 31, 2008, respectively.

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(4). Property, Plant and Equipment

On June 30, 2009, the Company terminated the lease for its world headquarters facility located in Vancouver, Washington and entered into a new lease agreement to occupy substantially less space in the same building. As a result of the downsizing, the Company abandoned certain leasehold improvements and, during the second quarter of 2009, recorded an impairment charge of $8.0 million as a component of restructuring expense (see Note 2).

(5) Goodwill and Intangible Assets

In accordance with SFAS No. 142, Goodwill and Other Intangible Assets, the Company applies a fair value-based impairment test to evaluate the carrying value of goodwill annually, at October 31, and more frequently if certain events or circumstances indicate that an impairment loss may have been incurred, on an interim basis.

The change in goodwill is due to fluctuations in non-U.S. dollar currency.

(6) Borrowings

The Company’s five year Loan Agreement provides access to a revolving secured credit line available to fund the Company’s letters of credit, working capital needs and other general business purposes. The Loan Agreement was amended, on March 10, 2009, June 12, 2009, and July 31, 2009, to revise the financial covenant and definition of trigger period. The interest rate under the Loan Agreement is either prime rate plus 100 to 175 basis points, or LIBOR plus 250 to 425 basis points, depending on the Company’s fixed charge coverage ratio. The use of prime or LIBOR is at the discretion of the Company. The weighted average interest rate on the outstanding borrowings for December 31, 2008 was 4.0%. The Loan Agreement is collateralized by substantially all of the Company’s U.S. assets. For additional information regarding the Loan Agreement, refer to Note 1 to the condensed consolidated financial statements in this Form 10-Q or the Company’s Annual Report on Form 10-K for the year ended December 31, 2008.

At June 30, 2009 and December 31, 2008, the Company had $5.7 million and $6.7 million, respectively, in standby letters of credit which reduce the balance available under the Loan Agreement. At June 30, 2009, the Company had no borrowings outstanding under the Loan Agreement and an unused, but available, borrowing capacity of $11.5 million.

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(7) Income Taxes

During the first half of 2009, the Company recorded a provision for income tax expense from continuing operations of $1.0 million, compared to an income tax benefit from continuing operations of $7.3 million during the same period of the previous year. Income tax expense recorded in the first six months of 2009 primarily relates to income in certain foreign jurisdictions within the Company’s non-U.S. operations. The change, from an income tax benefit to income tax expense, reflects the Company’s conclusion, in the third quarter of 2008, that losses incurred in recent periods create uncertainty regarding the Company’s ability to utilize net operating loss carry-forwards and other deferred tax assets to offset future taxable income. During the first six months of 2009, and in accordance with Statement of Financial Accounting Standards No. 109, Accounting for Income Taxes, the Company increased its valuation allowance to reduce certain deferred tax assets generated during the period to their anticipated net realizable value. As a result, the Company did not recognize an income tax benefit associated with these deferred tax assets, primarily consisting of U.S. federal net operating loss carry-forwards and tax credits during this period.

During the six month period ended June 30, 2009, there were no material changes to the Company’s uncertain tax positions. Refer to the Company’s Annual Report on Form 10-K, for the year ended December 31, 2008, for further information regarding the Company’s income taxes.

(8) Income (Loss) Per Share

Basic income (loss) per share is calculated based on the weighted-average number of common shares outstanding during the period. Diluted income (loss) per share is calculated based on the weighted-average number of common shares outstanding, after giving effect to the potential dilution that could occur upon exercise of dilutive securities. Dilutive potential common shares resulting from the assumed exercise of outstanding stock-based awards are determined using the treasury stock method.

The following table sets forth the computation of basic and diluted income (loss) per share as reported in the Company’s statements of operations:

During the three and six month periods ended June 30, 2009 there were 1.9 million and 2.0 million shares, respectively, issuable upon exercise of stock options, restricted stock units and performance stock units that were excluded from the calculation of diluted earnings per share because their inclusion would have been anti-dilutive. During the three and six month periods ended June 30, 2008, there were 3.2 million and 3.3 million shares, respectively, issuable upon exercise of stock options, restricted stock units and performance stock units that were excluded from the calculation of diluted earnings per share because their inclusion would have been anti-dilutive.

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(9) Comprehensive Loss

The components of comprehensive loss are as follows:

(10) Reportable Segments and Related Information

At June 30, 2009, the Company’s reportable segments include the direct, retail and commercial business units and its corporate functions. Where applicable, “corporate” generally reflects corporate activity, corporate eliminations, restructuring charges and other amounts necessary to reconcile segment data to the Company’s consolidated financial statements. In the first quarter of 2009, the Company modified its classification of certain non-U.S. operations, and amounts previously reported as part of the retail business segment are now assigned to the Company’s commercial business segment. The revised reporting reflects how management, including the Company’s Chief Executive Officer and chief decision maker, views the business. Prior year amounts have been reclassified to conform to the current year presentation.

The following table presents financial information concerning the Company’s reportable segments for the three month periods ended June 30, 2009 and 2008:

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The following table presents financial information concerning the Company’s reportable segments for the six month periods ended June 30, 2009 and 2008:

Significant judgment is required in allocating operating expenses, depreciation, amortization and assets to the individual business segments. Such allocations were based on a number of methods, including: percentage of revenue, segment headcount and the allocation of amounts evenly across the business segments. In addition, management made several assumptions to present the information in the table on a comparative basis. The Company does not capture and report capital expenditures by business segment.

The table in Note 2 provides a summary of significant charges, included in operating expenses of the corporate segment, related to restructuring activities in these periods.

For the three and six month periods ended June 30, 2009, net sales in the U.S. represented approximately 85% and 87%, respectively, of consolidated net sales, compared to approximately 81% and 84% of consolidated net sales for the three and six month periods ended June 30, 2008. The geographic distribution of the Company’s international net sales is mostly concentrated in Germany and, to a lesser extent, the United Kingdom, Switzerland and Canada.

(11) Commitments and Contingencies

Legal Matters

In 2004, the Company was sued in the Southern District of New York, by BioSig Inc., (“BioSig”) for alleged patent infringement in connection with the Company’s incorporation of heart rate monitors into certain of its cardio products. The Company has now reached an agreement with BioSig in which the plaintiff has agreed to dismiss the action without prejudice and without any payments from the Company. The Court has signed an Order dismissing the action. Dismissal of an action “without prejudice” is not a determination on the merits and allows for BioSig to re-file the action at a later date. The Company has no information as to whether BioSig will re-file the lawsuit in the future.

Guarantees, Commitments and Off-Balance Sheet Arrangements

The Company has long lead times for inventory purchases and therefore needs to secure factory capacity from its vendors in advance. At June 30, 2009, the Company had approximately $16.8 million in non-cancellable market-based purchase obligations, all of which were for inventory purchases expected to be received in 2009. These commitments were entered into in the normal course of business with standard terms and conditions and are not anticipated to exceed our inventory requirements.

At times, the Company becomes involved in third-party lease and financing arrangements which assist customers in obtaining funds to make purchases. While most of these financings are without recourse, in certain cases the Company may offer a guarantee or other recourse provisions. The Company’s financing partner reviews consumer credit information in evaluating the risk of default prior to extending credit. The Company relies on the quality of the financing partner’s review and an internal risk assessment in determining whether to proceed with a recourse transaction. At June 30, 2009 and December 31, 2008, the maximum contingent liability under all recourse provisions was approximately $1.7 million and $1.6 million, respectively.

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At June 30, 2009, the Company had $5.7 million in outstanding commercial letters of credit expiring through September 27, 2010.

(12) Discontinued Operations

In the fourth quarter of 2007, the Company committed to a plan to sell the operations of the fitness apparel division, which operated under the trade name Pearl iZumi. On April 18, 2008 the Company completed the sale of Pearl iZumi. All assets, liabilities and results of operations associated with Pearl iZumi’s activities are presented separately in the condensed consolidated financial statements as discontinued operations.

Revenues, income before income taxes, income tax expense (benefit) and income generated from the discontinued Pearl iZumi operations were as follows: