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BOWFLEX INC. - Quarter Report: 2017 September (Form 10-Q)

 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
 
FORM 10-Q
 
 
(Mark One)
[x]
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2017
or
[ ]
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                   to                   

Commission file number: 001-31321
 
 
 
NAUTILUS, INC.
(Exact name of Registrant as specified in its charter)
 
 
 
 
Washington
 
94-3002667
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer
Identification No.)

17750 S.E. 6th Way
Vancouver, Washington 98683
(Address of principal executive offices, including zip code)

(360) 859-2900
(Registrant's telephone number, including area code)

N/A
(Former name, former address and former fiscal year, if changed since last report) 
 
 
 
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  [x]    No  [ ]
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and "emerging growth company" in Rule 12b-2 of the Exchange Act.
Large accelerated filer [ ]
 
Accelerated filer [x]
 
Non-accelerated filer [ ]
 
Smaller reporting company [ ]
 
Emerging growth company [ ]
 
 
 
 
(Do not check if a smaller reporting company)
 
 
 
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. [ ]
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  [ ]    No  [x]
Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date:
The number of shares outstanding of the registrant's common stock as of October 31, 2017 was 30,707,103 shares.
 



NAUTILUS, INC.
FORM 10-Q
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2017
 
 
 
Item 1.
 
Item 2.
 
Item 3.
 
Item 4.
 
 
 
 
 
 
 
 
Item 1.
 
Item 1A.
 
Item 2.
 
Item 6.
 
 





PART I.    FINANCIAL INFORMATION
    
Item 1.     Financial Statements

NAUTILUS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited and in thousands)
 
As of
 
September 30, 2017
  
December 31, 2016
Assets
 
  
 
Cash and cash equivalents
$
30,481

  
$
47,874

Available-for-sale securities
47,295

 
31,743

Trade receivables, net of allowances of $472 and $170
38,534

  
45,458

Inventories
57,646

  
47,030

Prepaids and other current assets
6,795

  
8,020

Income taxes receivable
61

  
3,231

Total current assets
180,812

 
183,356

Property, plant and equipment, net
16,166

  
17,468

Goodwill
62,045

  
61,888

Other intangible assets, net
67,354

  
69,800

Deferred income tax assets, non-current

 
11

Other assets
456

  
543

Total assets
$
326,833

 
$
333,066

Liabilities and Shareholders' Equity
 
  
 
Trade payables
$
62,146

  
$
66,020

Accrued liabilities
8,056

  
12,892

Warranty obligations, current portion
3,253

  
3,500

Note payable, current portion, net of unamortized debt issuance costs
 of $7 and $7
15,993

 
15,993

Total current liabilities
89,448

 
98,405

Warranty obligations, non-current
3,048


3,950

Income taxes payable, non-current
2,646

  
2,403

Deferred income tax liabilities, non-current
16,868

 
16,991

Other non-current liabilities
2,365

  
2,481

Note payable, non-current, net of unamortized debt issuance costs
 of $16 and $21
35,984

 
47,979

Total liabilities
150,359

 
172,209

Commitments and contingencies (Note 14)


 


Shareholders' equity:
 
  
 
Common stock - no par value, 75,000 shares authorized, 30,707 and
30,825 shares issued and outstanding
826

  
578

Retained earnings
175,969

  
161,496

Accumulated other comprehensive loss
(321
)
  
(1,217
)
Total shareholders' equity
176,474

  
160,857

Total liabilities and shareholders' equity
$
326,833

  
$
333,066



See accompanying Notes to Condensed Consolidated Financial Statements.

1


NAUTILUS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited and in thousands, except per share amounts)
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2017

2016
 
2017
 
2016
Net sales
$
88,132


$
80,818

 
$
278,413

 
$
280,275

Cost of sales
46,817


41,601

 
136,975

 
132,852

Gross profit
41,315


39,217

 
141,438

 
147,423

Operating expenses:
 

 
 
 
 
 
Selling and marketing
18,028


21,394

 
79,321

 
81,284

General and administrative
6,305


6,177

 
21,106

 
21,611

Research and development
3,617


3,435

 
11,114

 
10,444

Total operating expenses
27,950


31,006

 
111,541

 
113,339

Operating income
13,365


8,211

 
29,897

 
34,084

Other income (expense):
 
 
 
 
 
 
 
Interest income
170

 
60

 
476

 
182

Interest expense
(377
)
 
(489
)
 
(1,233
)
 
(1,469
)
Other, net
46

 
211

 
109

 
(49
)
Total other expense, net
(161
)

(218
)
 
(648
)
 
(1,336
)
Income from continuing operations before income taxes
13,204


7,993

 
29,249

 
32,748

Income tax expense
4,862


148

 
10,156

 
9,621

Income from continuing operations
8,342


7,845

 
19,093

 
23,127

Discontinued operations:
 
 
 
 
 
 
 
Loss from discontinued operations before income taxes
(40
)

(308
)
 
(1,695
)
 
(612
)
Income tax expense (benefit) of discontinued operations
61


(57
)
 
(425
)
 
(53
)
   Loss from discontinued operations
(101
)

(251
)
 
(1,270
)
 
(559
)
Net income
$
8,241


$
7,594

 
$
17,823

 
$
22,568

 
 
 
 
 
 
 
 
Basic income per share from continuing operations
$
0.27


$
0.25

 
$
0.62

 
$
0.74

Basic loss per share from discontinued operations


(0.01
)
 
(0.04
)
 
(0.02
)
Basic net income per share(1)
$
0.27


$
0.24

 
$
0.58

 
$
0.73

 
 
 
 
 
 
 
 
Diluted income per share from continuing operations
$
0.27

 
$
0.25

 
$
0.61

 
$
0.74

Diluted loss per share from discontinued operations

 
(0.01
)
 
(0.04
)
 
(0.02
)
Diluted net income per share
$
0.27

 
$
0.24

 
$
0.57

 
$
0.72

Shares used in per share calculations:
 
 
 
 
 
 
 
Basic
30,749


31,118

 
30,739

 
31,069

Diluted
31,075

 
31,385

 
31,098

 
31,340

(1) May not add due to rounding.


See accompanying Notes to Condensed Consolidated Financial Statements.

2


NAUTILUS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Unaudited and in thousands)
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2017
 
2016
 
2017
 
2016
Net income
$
8,241

 
$
7,594

 
$
17,823

 
$
22,568

Other comprehensive income (loss):
 
 
 
 
 
 
 
Unrealized gain (loss) on available-for-sale securities, net of income tax expense (benefit) of $13, $0, $(4) and $16
22

 

 
(6
)
 
26

Gain (loss) on derivative securities, effective portion, net of income tax expense (benefit) of $14, $150, $79 and $(326)
23

 
248

 
130

 
(539
)
Foreign currency translation, net of income tax expense (benefit) of $1, $(1), $3 and $(6)
371

 
(45
)
 
772

 
397

        Other comprehensive income (loss)
416

 
203

 
896

 
(116
)
Comprehensive income
$
8,657

 
$
7,797

 
$
18,719

 
$
22,452



See accompanying Notes to Condensed Consolidated Financial Statements.


3


NAUTILUS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited and in thousands)  
 
Nine Months Ended September 30,
 
2017
 
2016
Cash flows from operating activities:
 
 
 
Income from continuing operations
$
19,093

 
$
23,127

Loss from discontinued operations
(1,270
)
 
(559
)
Net income
17,823

 
22,568

Adjustments to reconcile net income to cash provided by operating activities:
 
 
 
Depreciation and amortization
6,386

 
5,748

Provision for allowance for doubtful accounts
375

 
183

Inventory lower-of-cost-or-market/NRV adjustments
294

 
72

Stock-based compensation expense
1,938

 
2,045

Loss on asset dispositions
58

 
107

Deferred income taxes, net of valuation allowance
(193
)
 
5,707

Excess tax benefit related to stock-based awards

 
(1,852
)
Other
(101
)
 
6

Changes in operating assets and liabilities:
 
 
 
Trade receivables
6,532

 
13,633

Inventories
(11,056
)
 
(4,716
)
Prepaids and other current assets
1,644

 
(413
)
Income taxes receivable
3,170

 
(5,397
)
Trade payables
(4,275
)
 
(15,475
)
Accrued liabilities, including warranty obligations
(5,875
)
 
(7,286
)
Net cash provided by operating activities
16,720

 
14,930

Cash flows from investing activities:
 
 
 
Purchases of available-for-sale securities
(57,054
)
 
(22,972
)
Proceeds from maturities of available-for-sale securities
41,620

 
24,818

Proceeds from sales of available-for-sale securities

 
71

Acquisition of business, net of cash acquired

 
(3,468
)
Purchases of property, plant and equipment
(2,726
)
 
(3,237
)
Net cash used in investing activities
(18,160
)
 
(4,788
)
Cash flows from financing activities:
 
 
 
Payments on long-term debt
(12,000
)
 
(12,000
)
Payments for stock repurchases
(4,848
)
 

Proceeds from exercise of stock options and employee stock plan purchases
548

 
531

Tax payments related to stock award issuances
(741
)
 
(221
)
Excess tax benefit related to stock-based awards

 
1,852

Net cash used in financing activities
(17,041
)
 
(9,838
)
Effect of exchange rate changes on cash and cash equivalents
1,088

 
87

Increase (decrease) in cash and cash equivalents
(17,393
)
 
391

Cash and cash equivalents:
 
 
 
Beginning of period
47,874

 
30,778

End of period
$
30,481

 
$
31,169

Supplemental disclosure of cash flow information:
 
 
 
Cash paid for interest
$
1,228

 
$
1,462

Cash paid for income taxes, net
5,686

 
11,331

Supplemental disclosure of non-cash investing activities:
 
 
 
Capital expenditures incurred but not yet paid
$
336

 
$
922

See accompanying Notes to Condensed Consolidated Financial Statements.

4


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 financial position, results of operations and cash flows of Nautilus, Inc. and its subsidiaries, 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”). Management believes the disclosures contained herein are adequate to make the information presented not misleading. However, these condensed consolidated financial statements should be read in conjunction with our consolidated financial statements and notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2016 (the “2016 Form 10-K”).
 
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. Further information regarding significant estimates can be found in our 2016 Form 10-K.
 
In the opinion of management, the accompanying condensed consolidated financial statements reflect all adjustments necessary to present fairly our financial position as of September 30, 2017 and December 31, 2016, and our results of operations and comprehensive income for the three and nine months ended September 30, 2017 and 2016, and cash flows for the nine months ended September 30, 2017 and 2016. Interim results are not necessarily indicative of results for a full year. Our revenues typically vary seasonally and this seasonality can have a significant effect on operating results, inventory levels and working capital needs.
 
Unless indicated otherwise, all information regarding our operating results pertain to our continuing operations.
 
New Accounting Pronouncements

ASU 2017-12
In August 2017, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") 2017-12, "Derivatives and Hedging (Topic 815) - Targeted Improvements to Accounting for Hedging Activities". ASU 2017-12 provides better alignment of an entity's risk management activities and financial reporting of hedges through changes to both the designation and measurement guidance for qualifying hedging relationships. In addition, the amendments in ASU 2017-12 also simplify the recognition and presentation of the effects of the hedging instrument and the hedged item in the financial statements to increase the understandability of the results of an entity's intended hedging strategies. ASU 2017-12 is effective for public companies' fiscal years, including interim periods within those fiscal years, beginning after December 15, 2018. Early application is permitted in any interim period after issuance of the new standard, with effect of adoption reflected as of the beginning of the fiscal year of adoption. For cash flow and net investment hedges existing as of the adoption date, an entity should apply a cumulative-effect adjustment related to eliminating the separate measurement of ineffectiveness to accumulated other comprehensive income and opening retaining earnings. Amended presentation and disclosure guidance is required only prospectively, and certain transition elections are available upon adoption. While we do not expect the adoption of ASU 2017-12 to have a material effect on our business, we are evaluating any potential impact that adoption of ASU 2017-12 may have on our financial position, results of operations or cash flows.

ASU 2017-09
In May 2017, the FASB issued ASU 2017-09, "Compensation - Stock Compensation (Topic 718) - Scope in Modification Accounting". ASU 2017-09 provides clarity and reduces diversity in practice and cost and complexity when applying the guidance in Topic 718 to a change to the terms or conditions of a share-based payment award. An entity should account for the effects of a modification unless all of certain criteria are met. Those criteria relate to fair value, vesting conditions and classification of the modified award. If all three conditions are the same for the modified award as for the original award, then the entity should not account for the effects of the modification. ASU 2017-09 is effective for all entities for annual periods, including interim periods within those annual periods, beginning after December 15, 2017. Early adoption is permitted, including adoption in any interim

5


period, for public business entities for reporting periods for which financial statements have not yet been issued. We do not expect the adoption of ASU 2017-09 to have a material effect on our financial position, results of operations or cash flows.

ASU 2017-04
In January 2017, the FASB issued ASU 2017-04, "Intangibles - Goodwill and Other (Topic 350) - Simplifying the Test for Goodwill Impairment". ASU 2017-04 simplifies the subsequent measurement of goodwill by eliminating Step 2 from the goodwill impairment test. An entity should perform its annual, or interim, goodwill impairment test by comparing the fair value of a reporting unit with its carrying amount, and recognize an impairment charge for the amount by which the carrying amount exceeds the reporting unit's fair value, if applicable. The loss recognized should not exceed the total amount of goodwill allocated to the reporting unit. The same impairment test also applies to any reporting unit with a zero or negative carrying amount. An entity still has the option to perform the qualitative assessment for a reporting unit to determine if the quantitative impairment test is necessary. ASU 2017-04 is effective for public companies' fiscal years, including interim periods within those fiscal years, beginning after December 15, 2019, on a prospective basis. Early adoption is permitted for interim or annual goodwill impairment tests performed after January 1, 2017. We do not expect the adoption of ASU 2017-04 to have a material effect on our financial position, results of operations or cash flows.

ASU 2016-15
In August 2016, the FASB issued ASU 2016-15, "Statement of Cash Flows (Topic 230) - Classification of Certain Cash Receipts and Cash Payments." The amendments in ASU 2016-15 are intended to add or clarify guidance on the classification of certain cash receipts and payments in the statement of cash flows, with the intent of reducing diversity in practice for the eight (8) types of cash flows identified. ASU 2016-15 is effective for public companies' fiscal years, including interim periods within those fiscal years, beginning after December 15, 2017. Early adoption is permitted. Entities must apply the guidance retrospectively to all periods presented, but may apply it prospectively if retrospective application would be impracticable. We do not expect the adoption of ASU 2016-15 to have a material effect on our financial position, results of operations or cash flows.

ASU 2016-13
In June 2016, the FASB issued ASU 2016-13, "Financial Instruments - Credit Losses (Topic 326) - Measurement of Credit Losses on Financial Instruments." The amendments in ASU 2016-13 replace the incurred loss impairment methodology in current GAAP with a methodology that reflects expected credit losses and requires consideration of a broader range of reasonable and supportable information to inform credit loss estimates. ASU 2016-13 is effective for public companies' annual periods, including interim periods within those fiscal years, beginning after December 15, 2019, using a modified-retrospective approach, with certain exceptions. Early adoption is permitted. While we do not expect the adoption of ASU 2016-13 to have a material effect on our business, we are evaluating any potential impact that adoption of ASU 2016-13 may have on our financial position, results of operations or cash flows.

ASU 2016-09
In March 2016, the FASB issued ASU 2016-09, "Compensation - Stock Compensation (Topic 718) - Improvements to Employee Share-Based Payment Accounting." ASU 2016-09 simplifies several aspects of the accounting for share-based payment transactions, including the income tax consequences, classification of awards as either equity or liabilities, and classification on the statement of cash flows. ASU 2016-09 is effective for public companies' annual periods, including interim periods within those fiscal years, beginning after December 15, 2016. Early adoption is permitted subject to certain requirements, and the method of application (i.e., retrospective, modified retrospective or prospective) depends on the transaction area that is being amended. Related to forfeitures, we changed our accounting treatment of forfeiture expense reversals from "at vest date" to "at forfeiture date." We applied the guidance on a modified retrospective basis, which resulted in a cumulative effective adjustment (in thousands) of $28 reduction to beginning retained earnings. In addition, related to excess tax benefits, we recognized all current period expense through the statement of operations and presented excess tax benefits as an operating cash flow, applied prospectively, with no adjustment to prior periods. The adoption of ASU 2016-09 in January 2017 did not have a material impact on our financial position, results of operations or cash flows.

ASU 2016-02
In February 2016, the FASB issued ASU 2016-02, "Leases (Topic 842)." ASU 2016-02 replaces the existing guidance in Accounting Standards Codification ("ASC") 840, Leases. The new standard would require companies and other organizations to include lease obligations on their balance sheets, including a dual approach for lessee accounting under which a lessee would account for leases as finance leases or operating leases.  Both finance leases and operating leases will result in the lessee recognizing a right-of-use ("ROU") asset and a corresponding lease liability. For finance leases the lessee would recognize interest expense and amortization of the ROU asset, and for operating leases the lessee would recognize a straight-line total lease expense. Lessees and lessors are required to recognize and measure leases at the beginning of the earliest period presented using a modified retrospective approach. ASU 2016-02 is effective for public companies' annual periods, and interim periods within those fiscal years, beginning after December 15, 2018. We are currently assessing the impact that ASU 2016-02 will have on our consolidated financial statements,

6


and expect that the primary impact upon adoption will be the recognition, on a discounted basis, of our minimum commitments under non-cancellable operating leases on our consolidated balance sheets resulting in the recording of right of use assets and lease liabilities.

ASU 2015-11
In July 2015, the FASB issued ASU 2015-11, “Simplifying the Measurement of Inventory (Topic 330).” ASU 2015-11 simplifies the accounting for the valuation of all inventory not accounted for using the last-in, first-out (“LIFO”) method by prescribing inventory be valued at the lower of cost and net realizable value. ASU 2015-11 is effective for public companies' annual periods, including interim periods within those fiscal years, beginning after December 15, 2016 on a prospective basis. Early adoption is permitted. Our adoption of ASU 2015-11 in January 2017 did not have a material effect on our financial position, results of operations or cash flows.

ASU 2014-09
In May 2014, the FASB issued ASU No. 2014-09, "Revenue from Contracts with Customers." ASU 2014-09 replaces most existing revenue recognition guidance, and requires companies to recognize revenue based upon the transfer of promised goods and/or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods and/or services. In addition, the new guidance requires enhanced disclosures, including revenue recognition policies to identify performance obligations to customers and significant judgments in measurement and recognition. ASU 2014-09 is effective, as amended, for annual and interim periods beginning on or after December 15, 2017, applied retrospectively to each prior period presented or retrospectively with a cumulative effect adjustment recognized as of the adoption date. We do not plan to early adopt this new standard, and accordingly, will adopt the new standard on January 1, 2018. We are planning to adopt using the full retrospective method.

We have identified and made substantial progress in analyzing our principal revenue streams by channel, including potential impacts on the timing of recognition of variable consideration and contract costs, primarily sales commissions, and on presentation of our installation and services revenue. In addition, we are nearing completion of our review of significant contracts and evaluation of the potential changes to our business processes, controls, systems and disclosures resulting from adoption of the new standard. We expect to finish these assessments during the fourth quarter of 2017. Based on our analyses to date, we have identified potential accounting and financial reporting impacts to our business processes, controls, systems and disclosures as a result of the new standard, and we are planning for those changes. Further, while we do not expect the adoption of ASU 2014-09, as amended, to have a material effect on our financial position, results of operations or cash flows, we do anticipate significant additional disclosure requirements upon adoption of the new standard.

(2) DISCONTINUED OPERATIONS

There was no revenue related to discontinued operations for the three and nine months ended September 30, 2017. However, we continue to have product liability expenses associated with product previously sold into the Commercial channel.

(3) FAIR VALUE MEASUREMENTS
  
Factors used in determining the fair value of financial assets and liabilities are summarized into three broad categories:

Level 1 - observable inputs such as quoted prices (unadjusted) in active liquid markets for identical securities as of the reporting date;
Level 2 - other significant directly or indirectly observable inputs, including quoted prices for similar securities, interest rates, prepayment speeds and credit risk; or observable market prices in markets with insufficient volume and/or infrequent transactions; and
Level 3 - significant inputs that are generally unobservable inputs for which there is little or no market data available, including our own assumptions in determining fair value.
 

7


Assets and liabilities measured at fair value on a recurring basis as of September 30, 2017 and December 31, 2016 were as follows (in thousands):
 
 
September 30, 2017
 
 
Level 1
 
Level 2
 
Level 3
 
Total
Assets:
 
 
 
 
 
 
 
 
Cash Equivalents
 
 
 
 
 
 
 
 
Money market funds
 
$
6,848

 
$

 
$

 
$
6,848

Commercial paper
 

 
1,998

 

 
1,998

Total cash equivalents
 
6,848

 
1,998

 

 
8,846

Available-for-Sale Securities
 
 
 
 
 
 
 
 
Certificates of deposit(1)
 

 
14,974

 

 
14,974

Commercial paper
 

 
1,998

 

 
1,998

Corporate bonds
 

 
25,313

 

 
25,313

U.S. government bonds
 

 
5,010

 

 
5,010

Total available-for-sale securities
 

 
47,295

 

 
47,295

Derivatives
 
 
 
 
 
 
 
 
Interest rate swap contract
 

 
170

 

 
170

Total assets measured at fair value
 
$
6,848

 
$
49,463

 
$

 
$
56,311

 
 
 
 
 
 
 
 
 
Liabilities:
 
 
 
 
 
 
 
 
Derivatives
 
 
 
 
 
 
 
 
Foreign currency forward contracts
 
$

 
$
(65
)
 
$

 
$
(65
)
Total liabilities measured at fair value
 
$

 
$
(65
)
 
$

 
$
(65
)


 
 
December 31, 2016
 
 
Level 1
 
Level 2
 
Level 3
 
Total
Assets:
 
 
 
 
 
 
 
 
Cash Equivalents
 
 
 
 
 
 
 
 
Money market funds
 
$
9,635

 
$

 
$

 
$
9,635

Commercial paper
 

 
3,999

 

 
3,999

Total cash equivalents
 
9,635

 
3,999

 

 
13,634

Available-for-Sale Securities
 
 
 
 
 
 
 
 
Certificates of deposit(1)
 

 
22,820

 

 
22,820

Corporate bonds
 

 
6,922

 

 
6,922

U.S. government bonds
 

 
2,001

 

 
2,001

  Total available-for-sale securities
 

 
31,743

 

 
31,743

Total assets measured at fair value
 
$
9,635

 
$
35,742

 
$

 
$
45,377

 
 
 
 
 
 
 
 
 
Liabilities:
 
 
 
 
 
 
 
 
Derivatives
 
 
 
 
 
 
 
 
Interest rate swap contract
 
$

 
$
(38
)
 
$

 
$
(38
)
Total liabilities measured at fair value
 
$

 
$
(38
)
 
$

 
$
(38
)

(1) All certificates of deposit are within current FDIC insurance limits.


8


For our assets measured at fair value on a recurring basis, we recognize transfers between levels at the actual date of the event or change in circumstance that caused the transfer. There were no transfers between levels during the nine months ended September 30, 2017, nor for the year ended December 31, 2016.

We did not have any changes to our valuation techniques during the nine months ended September 30, 2017, nor for the year ended December 31, 2016.

We classify our marketable securities as available-for-sale and, accordingly, record them at fair value. Level 1 investment valuations are obtained from real-time quotes for transactions in active exchange markets involving identical assets. Level 2 investment valuations are obtained from inputs, other than quoted market prices in active markets for identical assets, that are directly or indirectly observable in the marketplace and quoted prices in markets with limited volume or infrequent transactions. The factors or methodology used for valuing securities are not necessarily an indication of the risk associated with investing in those securities. Unrealized holding gains and losses are excluded from earnings and are reported net of tax in comprehensive income until realized.

The fair values of our interest rate swap contract and our foreign currency forward contracts are calculated as the present value of estimated future cash flows using discount factors derived from relevant Level 2 market inputs, including forward curves and volatility levels.
 
We recognize or disclose the fair value of certain assets, such as non-financial assets, primarily property, plant and equipment, goodwill, other intangible assets and certain other long-lived assets in connection with impairment evaluations. All of our nonrecurring valuations use significant unobservable inputs and therefore fall under Level 3 of the fair value hierarchy. We did not perform any valuations on assets or liabilities that are valued at fair value on a nonrecurring basis during the first nine months of 2017. During the fourth quarter of 2016, we performed our annual goodwill and indefinite-lived trade names impairment analyses effective as of October 1, 2016. During the nine months ended September 30, 2017 and the year ended December 31, 2016, we did not record any other-than-temporary impairments on our financial assets required to be measured at fair value on a nonrecurring basis.

The carrying values of cash and cash equivalents, trade receivables, prepaids and other current assets, trade payables and accrued liabilities approximate fair value due to their short maturities. The carrying value of our term loan approximates its fair value and falls under Level 2 of the fair value hierarchy, as the interest rate is variable and based on current market rates.

(4) DERIVATIVES

From time to time, we enter into interest rate swaps to fix a portion of our interest expense, and foreign exchange forward contracts to offset the earnings impacts of exchange rate fluctuations on certain monetary assets and liabilities. We do not enter into derivative instruments for any purpose other than to manage interest rate or foreign currency exposure. That is, we do not engage in interest rate or currency exchange rate speculation using derivative instruments.

As of September 30, 2017, we had a $52.0 million interest rate swap outstanding with JPMorgan Chase Bank, N.A. This interest rate swap matures on December 31, 2020 and has a fixed rate of 1.42% per annum. The variable rate on the interest rate swap is the one-month LIBOR benchmark. At September 30, 2017, the one-month LIBOR rate was 1.24%.

We typically designate all interest rate swaps as cash flow hedges and, accordingly, record the change in fair value for the effective portion of these interest rate swaps in accumulated other comprehensive income rather than current period earnings until the underlying hedged transaction affects earnings. Gains and losses on the derivative representing hedge ineffectiveness are recognized in current earnings. For the three and nine months ended September 30, 2017 and 2016, there was no ineffectiveness. As of September 30, 2017, we expect to reclassify a gain of less than $0.1 million from accumulated other comprehensive income to earnings within the next twelve months.

We may hedge our net recognized foreign currency assets and liabilities with forward foreign exchange contracts to reduce the risk that our earnings and cash flows will be adversely affected by changes in foreign currency exchange rates. These derivative instruments hedge assets and liabilities that are denominated in foreign currencies and are carried at fair value with changes in the fair value recorded as other income. These derivative instruments do not subject us to material balance sheet risk due to exchange rate movements because gains and losses on these derivatives are intended to offset gains and losses on the assets and liabilities being hedged. As of September 30, 2017, total outstanding contract notional amounts were $18.3 million. At September 30, 2017, these outstanding balance sheet hedging derivatives had maturities of 90 days or less.


9


The fair value of our derivative instruments was included in our condensed consolidated balance sheets as follows (in thousands):
 
 
Balance Sheet Classification
 
As of
 
 
 
September 30, 2017
 
December 31, 2016
Derivative instruments designated as cash flow hedges:
 
 
 
 
 
 
Interest rate swap contract
 
Prepaids and other current assets
 
$
170

 
$

 
 
Accrued liabilities
 

 
38

 
 
 
 
$
170

 
$
38

 
 
 
 
 
 
 
Derivative instruments not designated as cash flow hedges:
 
 
 
 
 
 
   Foreign currency forward contracts
 
Accrued liabilities
 
$
65

 
$


The effect of derivative instruments on our condensed consolidated statements of operations was as follows (in thousands):
 
 
Statement of Operations Classification
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
 
 
2017
 
2016
 
2017
 
2016
Derivative instruments designated as cash flow hedges:
 
 
 
 
 
 
 
 
 
 
Income (loss) recognized in other comprehensive income before reclassifications
 
---
 
$
8

 
$
84

 
$
6

 
$
(896
)
Loss reclassified from accumulated other comprehensive income to earnings for the effective portion
 
Interest expense
 
(26
)
 
(167
)
 
(189
)
 
(480
)
Income tax benefit
 
Income tax expense
 
11

 
3

 
65

 
123

 
 
 
 
 
 
 
 
 
 
 
Derivative instruments not designated as cash flow hedges:
 
 
 
 
 
 
 
 
 
 
Loss recognized in earnings
 
Other, net
 
$
(53
)
 
$

 
$
(53
)
 
$

Income tax benefit
 
Income tax expense
 
18

 

 
18

 


For additional information related to our derivatives, see Notes 3 and 10.

(5) INVENTORIES

Inventories are stated at the lower of cost and net realizable value, with cost determined based on the first-in, first-out method. Our inventories consisted of the following (in thousands):
 
As of
 
September 30, 2017
 
December 31, 2016
Finished goods
$
53,271

  
$
43,130

Parts and components
4,375

  
3,900

Total inventories
$
57,646

  
$
47,030




10


(6) PROPERTY, PLANT AND EQUIPMENT

Property, plant and equipment consisted of the following (in thousands):
 
Estimated
Useful Life
(in years)
 
As of
 
 
September 30, 2017
 
December 31, 2016
Automobiles
5
to
6
 
$
23

 
$
139

Leasehold improvements
4
to
20
 
3,426

 
3,388

Computer software and equipment
3
to
7
 
26,138

 
25,899

Machinery and equipment
3
to
5
 
14,732

 
13,085

Furniture and fixtures
5
to
20
 
2,230

 
2,238

Work in progress(1)
N/A
 
1,647

 
768

Total cost
 
 
 
 
48,196

 
45,517

Accumulated depreciation
 
 
 
 
(32,030
)
 
(28,049
)
Total property, plant and equipment, net
 
 
 
 
$
16,166

 
$
17,468


(1) Work in progress includes computer software and production tooling.

(7) GOODWILL AND OTHER INTANGIBLE ASSETS

Goodwill
The rollforward of goodwill was as follows (in thousands):
 
Direct
 
Retail
 
Total
Balance, January 1, 2016
$
2,113

 
$
58,357

 
$
60,470

Currency exchange rate adjustment
67

 
3

 
70

Business acquisition - measurement period adjustments

 
1,348

 
1,348

Balance, December 31, 2016
2,180

 
59,708

 
61,888

Currency exchange rate adjustment
168

 
(11
)
 
157

Balance, September 30, 2017
$
2,348

 
$
59,697

 
$
62,045


Other Intangible Assets
Other intangible assets consisted of the following (in thousands):
 
Estimated
Useful Life
(in years)
 
As of
 
 
September 30, 2017
 
December 31, 2016
Indefinite-lived trademarks
N/A
 
$
32,052

 
$
32,052

Definite-lived trademarks
10
to
15
 
2,600

 
2,600

Patents
8
to
24
 
15,187

 
31,487

Customer relationships
10
to
15
 
24,700

 
24,700

 
 
 
 
 
74,539

 
90,839

Accumulated amortization - definite-lived intangible assets
 
 
 
 
(7,185
)
 
(21,039
)
Other intangible assets, net
 
 
 
 
$
67,354

 
$
69,800



Amortization expense was as follows (in thousands):
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2017
 
2016
 
2017
 
2016
Amortization expense
$
812

 
$
817

 
$
2,446

 
$
2,738




11


Future amortization of definite-lived intangible assets is as follows (in thousands):
Remainder of 2017
$
810

2018
3,164

2019
3,134

2020
3,108

2021
3,078

Thereafter
22,008

 
$
35,302



(8) ACCRUED LIABILITIES

Accrued liabilities consisted of the following (in thousands):
 
As of
 
September 30, 2017
 
December 31, 2016
Payroll and related liabilities
$
2,199

 
$
4,579

Other
5,857

 
8,313

  Total accrued liabilities
$
8,056

 
$
12,892



(9) PRODUCT WARRANTIES

Our products carry defined warranties for defects in materials or workmanship which, according to their terms, generally obligate us to pay the costs of supplying and shipping replacement parts to customers and, in certain instances, pay for labor and other costs to service products. Outstanding product warranty periods range from thirty days to, in limited circumstances, the lifetime of certain product components. We record a liability at the time of sale for the estimated costs of fulfilling future warranty claims. If necessary, we adjust the liability for specific warranty-related matters when they become known and are reasonably estimable. Estimated warranty expense is included in cost of sales, based on historical warranty claim experience and available product quality data. Warranty expense is affected by the performance of new products, significant manufacturing or design defects not discovered until after the product is delivered to the customer, product failure rates, and higher or lower than expected repair costs. If warranty expense differs from previous estimates, or if circumstances change such that the assumptions inherent in previous estimates are no longer valid, the amount of product warranty obligations is adjusted accordingly.

Changes in our product warranty obligations were as follows (in thousands):
 
 
Nine Months Ended September 30,
 
 
2017
 
2016
Balance, beginning of period
 
$
7,450

 
$
8,545

Accruals
 
2,163

 
2,132

Payments
 
(3,312
)
 
(2,857
)
Balance, end of period
 
$
6,301

 
$
7,820




12


(10) ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS)

The following tables set forth the changes in accumulated other comprehensive income (loss), net of tax (in thousands) for the periods presented:
 
Unrealized Gain (Loss) on Available-for-Sale Securities
 
Gain on Derivative Securities (Effective Portion)
 
Foreign Currency Translation Adjustments
 
Accumulated Other Comprehensive Income (Loss)
Balance, July 1, 2017
$
(36
)
 
$
83

 
$
(784
)
 
$
(737
)
Current period other comprehensive income
before reclassifications
22

 
8

 
371

 
401

Reclassification of amounts to earnings

 
15

 

 
15

Net other comprehensive income during period
22

 
23

 
371

 
416

Balance, September 30, 2017
$
(14
)
 
$
106

 
$
(413
)
 
$
(321
)
 
Unrealized Loss on Available-for-Sale Securities
 
Gain (Loss) on Derivative Securities (Effective Portion)
 
Foreign Currency Translation Adjustments
 
Accumulated Other Comprehensive Income (Loss)
Balance, January 1, 2017
$
(8
)
 
$
(24
)
 
$
(1,185
)
 
$
(1,217
)
Current period other comprehensive income (loss) before reclassifications
(6
)
 
6

 
772

 
772

Reclassification of amounts to earnings

 
124

 

 
124

Net other comprehensive income (loss) during period
(6
)
 
130

 
772

 
896

Balance, September 30, 2017
$
(14
)
 
$
106

 
$
(413
)
 
$
(321
)
 
Unrealized Gain on Available-for-Sale Securities
 
Gain (Loss) on Derivative Securities (Effective Portion)
 
Foreign Currency Translation Adjustments
 
Accumulated Other Comprehensive Income (Loss)
Balance, July 1, 2016
$
10

 
$
(787
)
 
$
(869
)
 
$
(1,646
)
Current period other comprehensive income (loss) before reclassifications

 
84

 
(45
)
 
39

Reclassification of amounts to earnings

 
164

 

 
164

Net other comprehensive income (loss) during period

 
248

 
(45
)
 
203

Balance, September 30, 2016
$
10

 
$
(539
)
 
$
(914
)
 
$
(1,443
)
 
Unrealized Gain (Loss) on Available-for-Sale Securities
 
Loss on Derivative Securities (Effective Portion)
 
Foreign Currency Translation Adjustments
 
Accumulated Other Comprehensive Loss
Balance, January 1, 2016
$
(16
)
 
$

 
$
(1,311
)
 
$
(1,327
)
Current period other comprehensive income (loss) before reclassifications
26

 
(896
)
 
397

 
(473
)
Reclassification of amounts to earnings

 
357

 

 
357

Net other comprehensive income (loss) during period
26

 
(539
)
 
397

 
(116
)
Balance, September 30, 2016
$
10

 
$
(539
)
 
$
(914
)
 
$
(1,443
)



13


(11) STOCK REPURCHASE PROGRAM

On May 4, 2016, our Board of Directors authorized the repurchase of up to $10.0 million of our outstanding common stock from time to time through May 4, 2018.

On April 25, 2017, our Board of Directors authorized an additional $15.0 million share repurchase program, bringing the total authorization under existing programs to $25.0 million. Under the new program, shares of our common stock may be repurchased from time to time through April 25, 2019. Repurchases may be made in open market transactions at prevailing prices, in privately negotiated transactions, or by other means in accordance with federal securities laws. Share repurchases will be funded from existing cash balances, and repurchased shares will be retired and returned to unissued authorized shares.

As of September 30, 2017, there was $18.2 million remaining available for repurchases under the share repurchase programs.

Cumulative repurchases pursuant to the programs are as follows:
Quarter Ended
 
Number of Shares
 
Repurchased Amount
 
Average Price Per Share
December 31, 2016
 
120,996
 
$1,957,882
 
$16.18
March 31, 2017
 
218,515
 
3,426,959
 
15.68
September 30, 2017
 
86,856
 
1,420,934
 
16.36
Totals-to-Date
 
426,367
 
$6,805,775
 
$15.96

 
(12) INCOME PER SHARE

Basic per share amounts were computed using the weighted average number of common shares outstanding. Diluted per share amounts were calculated using the number of basic weighted average shares outstanding increased by dilutive potential common shares related to stock-based awards, as determined by the treasury stock method. The weighted average numbers of shares outstanding used to compute income per share were as follows (in thousands):
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2017
 
2016
 
2017
 
2016
Shares used to calculate basic income per share
30,749

 
31,118

 
30,739

 
31,069

Dilutive effect of outstanding stock options, performance stock units and restricted stock units
326

 
267

 
359

 
271

Shares used to calculate diluted income per share
31,075

 
31,385

 
31,098

 
31,340



The weighted average numbers of shares outstanding listed in the table below were anti-dilutive and excluded from the computation of diluted income per share. In the case of stock options, this is because the average market price did not exceed the exercise price. These shares may be dilutive potential common shares in the future (in thousands):
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2017
 
2016
 
2017
 
2016
Stock options
7

 
4

 
8

 
11



(13) SEGMENT AND ENTERPRISE-WIDE INFORMATION

In accordance with FASB ASC 280, Segment Reporting, we determined that we have two operating segments - Direct and Retail. There have been no changes in our operating segments during the nine months ended September 30, 2017.

We evaluate performance using several factors, of which the primary financial measures are net sales and reportable segment contribution. Contribution is the measure of profit or loss, defined as net sales less product costs and directly attributable expenses. Directly attributable expenses include selling and marketing expenses, general and administrative expenses, and research and development expenses that are directly related to segment operations. Segment assets are those directly assigned to an operating segment's operations, primarily accounts receivable, inventories, goodwill and other intangible assets. Unallocated assets primarily include cash and cash equivalents, available-for-sale securities, derivative securities, shared information technology infrastructure,

14


distribution centers, corporate headquarters, prepaids and other current assets, deferred income tax assets and other assets. Capital expenditures directly attributable to the Direct and Retail segments were not significant in any period.

Following is summary information by reportable segment (in thousands):
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2017
 
2016
 
2017
 
2016
Net sales:
 
 
 
 
 
 
 
Direct
$
33,986

 
$
33,710

 
$
147,800

 
$
159,884

Retail
53,505

 
46,223

 
128,393

 
117,939

Royalty
641

 
885

 
2,220

 
2,452

Consolidated net sales
$
88,132

 
$
80,818

 
$
278,413

 
$
280,275

Contribution:
 
 
 
 
 
 
 
Direct
$
5,289

 
$
2,584

 
$
23,141

 
$
31,253

Retail
12,118

 
9,164

 
20,427

 
17,225

Royalty
638

 
871

 
2,206

 
2,419

Consolidated contribution
$
18,045

 
$
12,619

 
$
45,774

 
$
50,897

 
 
 
 
 
 
 
 
Reconciliation of consolidated contribution to income from continuing operations:
 
 
 
 
 
 
 
Consolidated contribution
$
18,045

 
$
12,619

 
$
45,774

 
$
50,897

Amounts not directly related to segments:
 
 
 
 
 
 
 
Operating expenses
(4,680
)
 
(4,408
)
 
(15,877
)
 
(16,813
)
Other expense, net
(161
)
 
(218
)
 
(648
)
 
(1,336
)
Income tax expense
(4,862
)
 
(148
)
 
(10,156
)
 
(9,621
)
Income from continuing operations
$
8,342

 
$
7,845

 
$
19,093

 
$
23,127


There was no material change in the allocation of assets by segment during the first nine months of 2017 and, accordingly, assets by segment are not presented.

Certain customers individually represented 10% or more of total net sales as follows:
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2017
 
2016
 
2017
 
2016
Customer:
 
 
 
 
 
 
 
   Customer #1
18.5
%
 
17.2
%
 
13.5
%
 
12.1
%
   Customer #2
13.7
%
 
*

 
*

 
*

* Less than 10%

(14) COMMITMENTS AND CONTINGENCIES

Guarantees, Commitments and Off-Balance Sheet Arrangements
As of September 30, 2017, we had no standby letters of credit.

We have long lead times for inventory purchases and, therefore, must secure factory capacity from our vendors in advance. As of September 30, 2017, we had approximately $37.5 million in noncancelable market-based purchase obligations, primarily for inventory purchases expected to be received within the next twelve months. Purchase obligations can vary from quarter-to-quarter and versus the same period in prior years due to a number of factors, including the amount of products that are shipped directly to Retail customer warehouses versus through Nautilus warehouses.

In the ordinary course of business, we enter into agreements that require us to indemnify counterparties against third-party claims. These may include: agreements with vendors and suppliers, under which we may indemnify them against claims arising from use of their products or services; agreements with customers, under which we may indemnify them against claims arising from their

15


use or sale of our products; real estate and equipment leases, under which we may indemnify lessors against third-party claims relating to the use of their property; agreements with licensees or licensors, under which we may indemnify the licensee or licensor against claims arising from their use of our intellectual property or our use of their intellectual property; and agreements with parties to debt arrangements, under which we may indemnify them against claims relating to their participation in the transactions.

The nature and terms of these indemnification obligations vary from contract to contract, and generally a maximum obligation is not stated within the agreements. We hold insurance policies that mitigate potential losses arising from certain types of indemnification obligations. Management does not deem these obligations to be significant to our financial position, results of operations or cash flows, and therefore, no related liabilities were recorded as of September 30, 2017.

Legal Matters
From time to time, we may be involved in various claims, lawsuits and other proceedings. These legal and tax proceedings involve uncertainty as to the eventual outcomes and losses which may be realized when one or more future events occur or fail to occur.

Litigation and jury verdicts are, to some degree, inherently unpredictable, and although we have determined that a loss is not probable in connection with any current legal proceeding, it is reasonably possible that a loss may be incurred in connection with proceedings to which we are a party. Assessment of whether incurrence of a loss is probable, or a reasonable possibility, in connection with a particular proceeding, and estimation of the loss, or a range of loss, involves complex judgments and numerous uncertainties. Management is unable to estimate a range of reasonably possible losses related to litigation in which the damages sought are indeterminate, or the legal and factual basis for the relevant claims have not been developed with specificity. As such, zero liability is recorded as of September 30, 2017.

We regularly monitor our estimated exposure to these contingencies and, as additional information becomes known, may change our estimates accordingly. We evaluate, on a quarterly basis, developments in legal proceedings, investigations or claims that could affect the amount of any accrual, as well as any developments that would make a loss probable or reasonably possible, and whether the amount of a probable or reasonably possible loss is estimable. Among other factors, we evaluate the advice of internal and external counsel, the outcomes from similar litigation, current 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.

Indemnification Settlement
During the three months ended September 30, 2017, we received payment in settlement of an indemnification claim related to the December 31, 2015 purchase of Octane. The settlement totaled $1.5 million, and was related to excess royalty expense, obsolete inventory, duty on tooling equipment, and uncollectible accounts receivable. These amounts were credited to the condensed consolidated statement of operations for the third quarter of 2017 in the line items for selling and marketing and cost of sales in accordance with the accounting of the original costs.


16


Item 2.     Management's Discussion and Analysis of Financial Condition and Results of Operations

The following discussion and analysis is based upon our financial statements as of the dates and for the periods presented in this section. You should read this discussion and analysis in conjunction with the financial statements and notes thereto found in Part I, Item 1 of this Form 10-Q and our consolidated financial statements and notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2016 (the “2016 Form 10-K”). All references to the third quarter and first nine months of 2017 and 2016 mean the three and nine-month periods ended September 30, 2017 and 2016, respectively. Unless the context otherwise requires, “Nautilus,” “we,” “us” and “our” refer to Nautilus, Inc. and its subsidiaries. Unless indicated otherwise, all information regarding our operating results pertains to our continuing operations.

Our results of operations may vary significantly from period-to-period. Our revenues typically fluctuate due to the seasonality of our industry, customer buying patterns, product innovation, the nature and level of competition for health and fitness products, our ability to procure products to meet customer demand, the level of spending on, and effectiveness of, our media and advertising programs and our ability to attract new customers and maintain existing sales relationships. In addition, our revenues are highly susceptible to economic factors, including, among other things, the overall condition of the economy and the availability of consumer credit in both the U.S. and Canada. Our profit margins may vary in response to the aforementioned factors and our ability to manage product costs. Profit margins may also be affected by fluctuations in the costs or availability of materials used to manufacture our products, costs associated with acquisition or license of products and technologies, product warranty costs, the cost of fuel, and changes in costs of other distribution or manufacturing-related services. Our operating profits or losses may also be affected by the efficiency and effectiveness of our organization. Historically, our operating expenses have been influenced by media costs to produce and distribute advertisements of our products on television, the Internet and other media, facility costs, operating costs of our information and communications systems, product supply chain management, customer support and new product development activities. In addition, our operating expenses have been affected from time-to-time by asset impairment charges, restructuring charges and other significant unusual or infrequent expenses.

As a result of the above and other factors, our period-to-period operating results may not be indicative of future performance. You should not place undue reliance on our operating results and should consider our prospects in light of the risks, expenses and difficulties typically encountered by us and other companies, both within and outside our industry. We may not be able to successfully address these risks and difficulties and, consequently, we cannot assure you of any future growth or profitability. For more information, see our discussion of risk factors located at Part I, Item 1A of our 2016 Form 10-K.

Forward-Looking Statements

This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Words such as "plan," "expect," "aim," "believe," "project," "intend," "estimate," "will," "should," "could," and other terms of similar meaning typically identify forward-looking statements. Forward-looking statements include any statements related to our future business and financial performance; anticipated fluctuations in net sales due to seasonality; plans and expectations regarding gross and operating margins; plans and expectations regarding research and development expenses and capital expenditures; anticipated losses from discontinued operations; results of media investment in the Direct segment; plans for new product introductions and anticipated demand for our new and existing products; and statements regarding our inventory and working capital requirements and the sufficiency of our financial resources. These forward-looking statements, and others we make from time-to-time, are subject to a number of risks and uncertainties. Many factors could cause actual results to differ materially from those projected in forward-looking statements, including our ability to timely acquire inventory that meets our quality control standards from sole source foreign manufacturers at acceptable costs, the effectiveness, availability and price of media time consistent with our cost and audience profile parameters, greater than anticipated costs associated with launch of new products, our ability to successfully integrate acquired businesses, a decline in consumer spending due to unfavorable economic conditions, softness in the retail marketplace, an adverse change in the availability of credit for our customers who finance their purchases, our ability to pass along vendor raw material price increases and increased shipping costs, our ability to effectively develop, market and sell future products, our ability to protect our intellectual property, the introduction of competing products, and our ability to get foreign-sourced product through customs in a timely manner. Additional assumptions, risks and uncertainties are described in Part I, Item 1A, "Risk Factors," in our 2016 Form 10-K as supplemented or modified in our quarterly reports on Form 10-Q. We do not undertake any duty to update forward-looking statements after the date they are made or conform them to actual results or to changes in circumstances or expectations.


17


Overview
 
We are committed to providing innovative, quality solutions to help people achieve a fit and healthy lifestyle. Our principal business activities include designing, developing, sourcing and marketing high-quality cardio and strength fitness products and related accessories for consumer use, primarily in the U.S., Canada and Europe. Our products are sold under some of the most-recognized brand names in the fitness industry: Nautilus®, Bowflex®, Octane Fitness®, Schwinn® and Universal®.

We market our products through two distinct distribution channels, Direct and Retail, which we consider to be separate business segments. Our Direct business offers products directly to consumers through television advertising, catalogs and the Internet. Our Retail business offers our products through a network of independent retail companies and specialty retailers with stores and websites located in the U.S. and internationally. We also derive a portion of our revenue from the licensing of our brands and intellectual property.

Net sales for the first nine months of 2017 were $278.4 million, a decrease of $1.9 million, or 0.7%, as compared to net sales of $280.3 million for the first nine months of 2016. Net sales of our Direct segment decreased $12.1 million, or 7.6%, in the first nine months of 2017, compared to the first nine months of 2016, primarily due to a decline in TreadClimber® sales. Net sales of our Retail segment increased by $10.5 million, or 8.9%, in the first nine months of 2017, compared to the first nine months of 2016, reflecting increases for both traditional and e-commerce customers across multiple product categories.

Gross profit for the first nine months of 2017 was $141.4 million, or 50.8% of net sales, a decrease of $6.0 million, or 4.1%, as compared to gross profit of $147.4 million, or 52.6% of net sales, for the first nine months of 2016. The decrease in gross profit dollars was primarily due to the decrease in net sales. Gross margin percentage points decreased 1.8%, due to a shift in segment mix, reflecting an increased percentage of Retail sales, and a decline in the Direct channel margin.

Operating expenses for the first nine months of 2017 were $111.5 million, a decrease of $1.8 million, or 1.6%, as compared to operating expenses of $113.3 million for the first nine months of 2016. The decrease in operating expenses was primarily related to decreased sales and marketing expense. The decrease in sales and marketing expense was due to a retroactive financing fees rebate of $2.1 million, and a $1.0 million settlement payment received in connection with an indemnification claim.

Operating income for the first nine months of 2017 was $29.9 million, a decrease of $4.2 million, or 12.3%, as compared to operating income of $34.1 million for the first nine months of 2016. The decrease in operating income for the first nine months of 2017 compared to the first nine months of 2016 was driven primarily by the lower net sales and gross margin dollars.

Income from continuing operations was $19.1 million for the first nine months of 2017, or $0.61 per diluted share, compared to income from continuing operations of $23.1 million, or $0.74 per diluted share, for the first nine months of 2016. The effective tax rates for the first nine months of 2017 and 2016 were 34.7% and 29.4%, respectively. The 5.3% year-over-year percentage rate increase was due to the release of previously unrecognized tax benefits associated with certain non-U.S. filing positions during the third quarter of 2016.

Net income for the first nine months of 2017 was $17.8 million, compared to net income of $22.6 million for the first nine months of 2016. Net income per diluted share was $0.57 for the first nine months of 2017, compared to $0.72 for the first nine months of 2016.

Discontinued Operations

Results from discontinued operations relate to the disposal of our former Commercial business, which was completed in April 2011. We reached substantial completion of asset liquidation at December 31, 2012. Although there was no revenue related to the Commercial business in either the 2017 or 2016 periods, we continue to have product liability and other legal expenses associated with product previously sold into the Commercial channel.


18


RESULTS OF OPERATIONS

Results of operations information was as follows (dollars in thousands):
 
Three Months Ended September 30,
 
Change
 
2017
 
2016
 
$
 
%
Net sales
$
88,132

 
$
80,818

 
$
7,314

 
9.0
 %
Cost of sales
46,817

 
41,601

 
5,216

 
12.5
 %
Gross profit
41,315

 
39,217

 
2,098

 
5.3
 %
Operating expenses:
 
 
 
 
 
 
 
Selling and marketing
18,028

 
21,394

 
(3,366
)
 
(15.7
)%
General and administrative
6,305

 
6,177

 
128

 
2.1
 %
Research and development
3,617

 
3,435

 
182

 
5.3
 %
Total operating expenses
27,950

 
31,006

 
(3,056
)
 
(9.9
)%
Operating income
13,365

 
8,211

 
5,154

 
62.8
 %
Other income (expense):
 
 
 
 
 
 
 
Interest income
170

 
60

 
110

 
 
Interest expense
(377
)
 
(489
)
 
112

 
 
Other, net
46

 
211

 
(165
)
 
 
Total other expense, net
(161
)
 
(218
)
 
57

 
 
Income from continuing operations before income taxes
13,204

 
7,993

 
5,211

 
 
Income tax expense
4,862

 
148

 
4,714

 
 
Income from continuing operations
8,342

 
7,845

 
497

 
 
Loss from discontinued operations, net of taxes
(101
)
 
(251
)
 
150

 
 
Net income
$
8,241

 
$
7,594

 
$
647

 
 
 
Nine Months Ended September 30,
 
Change
 
2017
 
2016
 
$
 
%
Net sales
$
278,413

 
$
280,275

 
$
(1,862
)
 
(0.7
)%
Cost of sales
136,975

 
132,852

 
4,123

 
3.1
 %
Gross profit
141,438

 
147,423

 
(5,985
)
 
(4.1
)%
Operating expenses:
 
 
 
 
 
 
 
Selling and marketing
79,321

 
81,284

 
(1,963
)
 
(2.4
)%
General and administrative
21,106

 
21,611

 
(505
)
 
(2.3
)%
Research and development
11,114

 
10,444

 
670

 
6.4
 %
Total operating expenses
111,541

 
113,339

 
(1,798
)
 
(1.6
)%
Operating income
29,897

 
34,084

 
(4,187
)
 
(12.3
)%
Other income (expense):
 
 
 
 
 
 
 
Interest income
476

 
182

 
294

 
 
Interest expense
(1,233
)
 
(1,469
)
 
236

 
 
Other, net
109

 
(49
)
 
158

 
 
Total other expense, net
(648
)
 
(1,336
)
 
688

 
 
Income from continuing operations before income taxes
29,249

 
32,748

 
(3,499
)
 
 
Income tax expense
10,156

 
9,621

 
535

 
 
Income from continuing operations
19,093

 
23,127

 
(4,034
)
 
 
Loss from discontinued operations, net of taxes
(1,270
)
 
(559
)
 
(711
)
 
 
Net income
$
17,823

 
$
22,568

 
$
(4,745
)
 
 


19


Results of operations information by segment was as follows (dollars in thousands):
 
Three Months Ended September 30,
 
Change
 
2017
 
2016
 
$
 
%
Net sales:
 
 
 
 
 
 
 
Direct
$
33,986

 
$
33,710

 
$
276

 
0.8
 %
Retail
53,505

 
46,223

 
7,282

 
15.8
 %
Royalty
641

 
885

 
(244
)
 
(27.6
)%
 
$
88,132

 
$
80,818

 
$
7,314

 
9.0
 %
Cost of sales:
 
 
 
 
 
 
 
Direct
$
12,401

 
$
11,579

 
$
822

 
7.1
 %
Retail
34,413

 
30,008

 
4,405

 
14.7
 %
Royalty
3

 
14

 
(11
)
 
(78.6
)%
 
$
46,817

 
$
41,601

 
$
5,216

 
12.5
 %
Gross profit:
 
 
 
 
 
 
 
Direct
$
21,585

 
$
22,131

 
$
(546
)
 
(2.5
)%
Retail
19,092

 
16,215

 
2,877

 
17.7
 %
Royalty
638

 
871

 
(233
)
 
(26.8
)%
 
$
41,315

 
$
39,217

 
$
2,098

 
5.3
 %
Gross margin:
 
 
 
 
 
 
 
Direct
63.5
%
 
65.7
%
 
(220
)
basis points
Retail
35.7
%
 
35.1
%
 
60

basis points
 
Nine Months Ended September 30,
 
Change
 
2017
 
2016
 
$
 
%
Net sales:
 
 
 
 
 
 
 
Direct
$
147,800

 
$
159,884

 
$
(12,084
)
 
(7.6
)%
Retail
128,393

 
117,939

 
10,454

 
8.9
 %
Royalty
2,220

 
2,452

 
(232
)
 
(9.5
)%
 
$
278,413

 
$
280,275

 
$
(1,862
)
 
(0.7
)%
Cost of sales:
 
 
 
 
 
 
 
Direct
$
52,525

 
$
53,732

 
$
(1,207
)
 
(2.2
)%
Retail
84,436

 
79,087

 
5,349

 
6.8
 %
Royalty
14

 
33

 
(19
)
 
(57.6
)%
 
$
136,975

 
$
132,852

 
$
4,123

 
3.1
 %
Gross profit:
 
 
 
 
 
 
 
Direct
$
95,275

 
$
106,152

 
$
(10,877
)
 
(10.2
)%
Retail
43,957

 
38,852

 
5,105

 
13.1
 %
Royalty
2,206

 
2,419

 
(213
)
 
(8.8
)%
 
$
141,438

 
$
147,423

 
$
(5,985
)
 
(4.1
)%
Gross margin:
 
 
 
 
 
 
 
Direct
64.5
%
 
66.4
%
 
(190
)
basis points
Retail
34.2
%
 
32.9
%
 
130

basis points


20


The following table compares the net sales of our major product lines within each business segment (dollars in thousands):
 
Three Months Ended September 30,
 
Change
 
2017
 
2016
 
$
 
%
Direct net sales:
 
 
 
 
 
 
 
Cardio products(1)
$
30,087

 
$
30,548

 
$
(461
)
 
(1.5
)%
Strength products(2)
3,899

 
3,162

 
737

 
23.3
 %
 
33,986

 
33,710

 
276

 
0.8
 %
Retail net sales:
 
 
 
 
 
 
 
Cardio products(1)
39,389

 
33,280

 
6,109

 
18.4
 %
Strength products(2)
14,116

 
12,943

 
1,173

 
9.1
 %
 
53,505

 
46,223

 
7,282

 
15.8
 %
 
 
 
 
 
 
 
 
Royalty
641

 
885

 
(244
)
 
(27.6
)%
 
$
88,132

 
$
80,818

 
$
7,314

 
9.0
 %
 
Nine Months Ended September 30,
 
Change
 
2017
 
2016
 
$
 
%
Direct net sales:
 
 
 
 
 
 
 
Cardio products(1)
$
133,421

 
$
149,074

 
$
(15,653
)
 
(10.5
)%
Strength products(2)
14,379

 
10,810

 
3,569

 
33.0
 %
 
147,800

 
159,884

 
(12,084
)
 
(7.6
)%
Retail net sales:
 
 
 
 
 
 
 
Cardio products(1)
96,249

 
86,739

 
9,510

 
11.0
 %
Strength products(2)
32,144

 
31,200

 
944

 
3.0
 %
 
128,393

 
117,939

 
10,454

 
8.9
 %
 
 
 
 
 
 
 
 
Royalty
2,220

 
2,452

 
(232
)
 
(9.5
)%
 
$
278,413

 
$
280,275

 
$
(1,862
)
 
(0.7
)%
 
 
 
 
 
 
 
 
(1)   Cardio products include: Max Trainer®, TreadClimber®, HVT™, Zero Runner®, treadmills, exercise bikes and ellipticals.
(2)   Strength products include: home gyms, selectorized dumbbells, kettlebell weights and accessories.

Direct     

Direct net sales increased 0.8% for the three month period ended September 30, 2017 compared to the same period of 2016 as new products, including the Bowflex HVTTM, offset a decline in TreadClimber® sales. For the nine months ended September 30, 2017, Direct net sales decreased 7.6% compared to the same period of 2016 due to a decline in TreadClimber® sales, partially offset by a 33.0% increase in strength product sales.

Combined consumer credit approvals by our primary and secondary U.S. third-party financing providers for the third quarter of 2017 were 53.7%, compared to 47.9% in the same period of 2016. We continue to experience improved credit approval rates due to our media strategy, which focuses on generation of responses from consumers with relatively high credit quality. Additionally, our Tier 1 credit provider has noted strong performance from our account portfolio, and, due to that credit profile, has progressively expanded its approval standards. We remain focused on maintaining a healthy payment balance between cash and financed purchases.

The $0.8 million increase in cost of sales of our Direct business for the three month period ended September 30, 2017 compared to the same period of 2016 was due to the higher volume of sales. The $1.2 million decrease in cost of sales of our Direct business for the nine months ended September 30, 2017 compared to the same period of 2016 was due to lower net sales.


21


For the three and nine month periods ended September 30, 2017, Direct gross margins decreased 220 and 190 basis points, respectively, as compared to the same periods of 2016 primarily due to unfavorable product mix and higher discounting for older products.
 
Retail

Retail net sales increased 15.8% and 8.9% for the three and nine month periods ended September 30, 2017 compared to the same periods of 2016. The increases in both periods reflected growth in traditional and e-commerce customers across multiple product categories.

The increases in cost of sales of our Retail business for the three and nine month periods ended September 30, 2017 compared to the same periods of 2016 were primarily related to the increases in Retail net sales as discussed above.

For the three and nine month periods ended September 30, 2017, Retail gross margin increased by 60 and 130 basis points, respectively, compared to the same periods of 2016 due to favorable absorption of fixed costs over the increased sales volume and the one-time settlement of an indemnification claim.

Selling and Marketing
Dollars in thousands
Three Months Ended September 30,
 
Change
 
2017
 
2016
 
$
 
%
Selling and marketing
$18,028
 
$21,394
 
$(3,366)
 
(15.7)%
As % of net sales
20.5%
 
26.5%
 
 
 
 
Dollars in thousands
Nine Months Ended September 30,
 
Change
 
2017
 
2016
 
$
 
%
Selling and marketing
$79,321
 
$81,284
 
$(1,963)
 
(2.4)%
As % of net sales
28.5%
 
29.0%
 
 
 
 

The $3.4 million decrease in selling and marketing expense in the three month period ended September 30, 2017 compared to the same period of 2016 was due to lower variable selling expenses of $2.6 million, primarily related to lower financing fees reflecting a retroactive contract adjustment of $2.1 million and receipt of a one-time settlement payment of $1.0 million for an indemnification claim.

The $2.0 million decrease in selling and marketing expense in the nine month period ended September 30, 2017 as compared to the same period of 2016 was related to a $4.7 million decrease in variable selling costs, including the factors noted above, and lower marketing program costs of $1.0 million, offset by increases of $2.9 million in media advertising and $0.8 million in photo and video production costs.

Media advertising expense of our Direct business is the largest component of selling and marketing and was as follows:
Dollars in thousands
Three Months Ended September 30,
 
Change
 
2017
 
2016
 
$
 
%
Media advertising
$11,114
 
$10,790
 
$324
 
3.0%
Dollars in thousands
Nine Months Ended September 30,
 
Change
 
2017
 
2016
 
$
 
%
Media advertising
$43,704
 
$40,804
 
$2,900
 
7.1%

The increases in media advertising in the three and nine month periods ended September 30, 2017 compared to the same periods of 2016 reflected lower response rates that drove the increased investments in advertising.


22


General and Administrative
Dollars in thousands
Three Months Ended September 30,
 
Change
 
2017
 
2016
 
$
 
%
General and administrative
$6,305
 
$6,177
 
$128
 
2.1%
As % of net sales
7.2%
 
7.6%
 
 
 
 
Dollars in thousands
Nine Months Ended September 30,
 
Change
 
2017
 
2016
 
$
 
%
General and administrative
$21,106
 
$21,611
 
$(505)
 
(2.3)%
As % of net sales
7.6%
 
7.7%
 
 
 
 

The increase in general and administrative for the three months ended September 30, 2017 compared to the same period of 2016 was primarily due to higher legal expenses of $0.4 million, offset by $0.4 million lower integration costs and administrative cost savings related to Octane incurred in the same comparative period.

The decrease in general and administrative for the nine months ended September 30, 2017 compared to the same period of 2016 was primarily due to $0.8 million savings related to lower integration costs and administrative cost savings related to Octane, and lower employee incentives and compensation costs of $0.9 million. These costs were partially offset by higher litigation-related expenses of $1.3 million for the same comparative period.

Research and Development
Dollars in thousands
Three Months Ended September 30,
 
Change
 
2017
 
2016
 
$
 
%
Research and development
$3,617
 
$3,435
 
$182
 
5.3%
As % of net sales
4.1%
 
4.3%
 
 
 
 
Dollars in thousands
Nine Months Ended September 30,
 
Change
 
2017
 
2016
 
$
 
%
Research and development
$11,114
 
$10,444
 
$670
 
6.4%
As % of net sales
4.0%
 
3.7%
 
 
 
 

The increases in research and development in the three and nine month periods ended September 30, 2017 compared to the same periods of 2016 were primarily due to our investment in additional engineering and product development headcount as we continue to supplement our new product development resources required to innovate and broaden our product portfolio.

Interest Expense
Interest expense of $0.4 million and $1.2 million for the three and nine month periods ended September 30, 2017 decreased $0.1 million and $0.2 million, respectively, compared to the same periods of 2016. The decreases were due to reductions in principal balance on our term loan.

Other, Net
Other, net relates to the effect of exchange rate fluctuations between the U.S. and our foreign subsidiaries, primarily Canada, China and Europe.


23


Income Tax Expense
Dollars in thousands
Three Months Ended September 30,
 
Change
 
2017
 
2016
 
$
 
%
Income tax expense
$4,862
 
$148
 
$4,714
 
*
Effective tax rate
36.8%
 
1.9%
 
 
 
 
Dollars in thousands
Nine Months Ended September 30,
 
Change
 
2017
 
2016
 
$
 
%
Income tax expense
$10,156
 
$9,621
 
$535
 
5.6%
Effective tax rate
34.7%
 
29.4%
 
 
 
 

* Not meaningful.

Income tax expense and effective tax rates from continuing operations for the three and nine month periods ended September 30, 2017 was primarily related to our profitable U.S and foreign operations. The reduced effective tax rates from continuing operations for the three and nine month periods ended September 30, 2016 were primarily due to the release of, on a non-recurring basis, previously unrecognized tax benefits associated with certain non-U.S. filing positions. These resulted from completion of the deregistration process of a certain foreign entity. In addition, the effective tax rate for the nine months ended September 30, 2017 included $0.7 million of excess tax benefits related to stock-based compensation recognized as a current period benefit through the statement of operations, resulting from the adoption of ASU 2016-09 in January 2017.

LIQUIDITY AND CAPITAL RESOURCES
 
As of September 30, 2017, we had $77.8 million of cash and investments compared to $79.6 million as of December 31, 2016. Cash provided by operating activities was $16.7 million for the nine months ended September 30, 2017, compared to $14.9 million for the nine months ended September 30, 2016. We expect our cash, cash equivalents and available-for-sale securities at September 30, 2017, along with cash expected to be generated from operations, to be sufficient to fund our operating and capital requirements for at least twelve months from September 30, 2017.

The increase in cash flows from operating activities for the nine months ended September 30, 2017 as compared to the same period of 2016 was primarily due to the changes in our operating assets and liabilities as discussed below, partially offset by the decline in operating performance.

Trade receivables decreased $6.9 million to $38.5 million as of September 30, 2017, compared to $45.5 million as of December 31, 2016, due to seasonally lower net sales to specialty retail and commercial customers. Trade receivables as of September 30, 2017 compared to September 30, 2016 increased $7.3 million due to the increase in Retail net sales.

Inventories increased $10.6 million to $57.6 million as of September 30, 2017, compared to $47.0 million as of December 31, 2016 due to seasonal preparations for the fourth quarter. Inventories as of September 30, 2017 compared to September 30, 2016 increased by $8.4 million due to increased in-transit inventory.

Trade payables decreased $3.9 million to $62.1 million as of September 30, 2017, compared to $66.0 million as of December 31, 2016, due to seasonality of the business. Trade payables as of September 30, 2017 compared to September 30, 2016 increased $17.4 million. The higher amount outstanding as of September 30, 2017 was due to the increased inventory.

Accrued liabilities decreased $4.8 million to $8.1 million as of September 30, 2017, compared to $12.9 million as of December 31, 2016, due to payout of accrued incentive compensation during the first quarter of 2017 and settlement of a royalty dispute in the second quarter of 2017.

Cash used in investing activities of $18.2 million for the first nine months of 2017 was primarily related to net purchases of marketable securities of $15.4 million. In addition, $2.7 million was used for capital expenditures primarily related to production equipment tooling and implementation of new software systems. We anticipate spending between $4.5 million and $5.5 million in 2017 for product tooling, computer equipment and software, and production equipment.

Cash used in financing activities of $17.0 million for the first nine months of 2017 was primarily related to principal repayments on our term loan of $12.0 million and share repurchases of $4.8 million.


24


Financing Arrangements
We have a Credit Agreement with JPMorgan Chase Bank, N.A. (“Chase Bank”) that provides for an $80.0 million term loan and a $20.0 million revolving line of credit. The term of the Credit Agreement expires on December 31, 2020 and is secured by substantially all of our assets.

The Credit Agreement, as amended, contains customary covenants, including minimum fixed charge coverage ratio and funded debt to EBITDA ratio, and limitations on capital expenditures, mergers and acquisitions, indebtedness, liens, dispositions, dividends and investments. The Credit Agreement also contains customary events of default. Upon an event of default, the lender may terminate its credit line commitment, accelerate all outstanding obligations and exercise its remedies under the continuing security agreement.

Borrowing availability under the revolving line of credit is subject to our compliance with certain financial and operating covenants at the time borrowings are requested. Letters of credit under the Credit Agreement are treated as a reduction of the available borrowing amount and are subject to covenant testing.

The interest rate applicable to the term loan, as well as each advance under the revolving line of credit, is based on either Chase Bank's floating prime rate or adjusted LIBOR, plus an applicable margin. As of September 30, 2017, our borrowing rate for both the term loan and line of credit advances was 2.49%.

As of September 30, 2017, the balance on our term loan was $52.0 million, and we had no outstanding borrowings under the line of credit. As of September 30, 2017, we were in compliance with the financial covenants of the Credit Agreement and $20.0 million was available for borrowing under the line of credit.

As of September 30, 2017, we had a $52.0 million receive-variable, pay-fixed interest rate swap outstanding with Chase Bank. The interest rate swap amortizes monthly in line with the outstanding principal balance on our term loan and is classified as a cash flow hedge. The swap matures on December 31, 2020 and has a fixed rate of 1.42% per annum. The variable rate on the interest rate swap is the one-month LIBOR benchmark. At September 30, 2017, the one-month LIBOR rate was 1.24%.

Commitments and Contingencies
For a description of our commitments and contingencies, refer to Note 14 to our condensed consolidated financial statements in Part I, Item 1 of this Form 10-Q.

Off-Balance Sheet Arrangements
In the ordinary course of business, we enter into agreements that require us to indemnify counterparties against third-party claims. These may include: agreements with vendors and suppliers, under which we may indemnify them against claims arising from our use of their products or services; agreements with customers, under which we may indemnify them against claims arising from their use or sale of our products; real estate and equipment leases, under which we may indemnify lessors against third-party claims relating to the use of their property; agreements with licensees or licensors, under which we may indemnify the licensee or licensor against claims arising from their use of our intellectual property or our use of their intellectual property; and agreements with parties to debt arrangements, under which we may indemnify them against claims relating to their participation in the transactions.

The nature and terms of these indemnifications vary from contract to contract, and generally a maximum obligation is not stated. We hold insurance policies that mitigate potential losses arising from certain types of indemnifications. Management does not deem these obligations to be significant to our financial position, results of operations or cash flows, and therefore, no liabilities were recorded at September 30, 2017.

Stock Repurchase Program
On May 4, 2016, our Board of Directors authorized the repurchase of up to $10.0 million of our outstanding common stock from time to time through May 4, 2018.

On April 25, 2017, our Board of Directors authorized an additional $15.0 million share repurchase program, bringing the total authorization under existing programs to $25.0 million. Under the new program, shares of our common stock may be repurchased from time to time through April 25, 2019. Repurchases may be made in open market transactions at prevailing prices, in privately negotiated transactions, or by other means in accordance with federal securities laws. Share repurchases will be funded from existing cash balances, and repurchased shares will be retired and returned to unissued authorized shares.

For the nine months ended September 30, 2017, we had repurchased a total of 305,371 shares for $4.8 million. As of September 30, 2017, there was $18.2 million remaining available for repurchases under the share repurchase programs.

25


SEASONALITY
 
We expect our sales from fitness equipment products to vary seasonally. Sales are typically strongest in the first and fourth quarters, followed by the third quarter, and are generally weakest in the second quarter. We believe that, during the spring and summer months, consumers tend to be involved in outdoor activities, including outdoor exercise, which impacts sales of indoor fitness equipment. This seasonality can have a significant effect on our inventory levels, working capital needs and resource utilization.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES
 
Our critical accounting policies have not changed from those discussed in our 2016 Form 10-K.

NEW ACCOUNTING PRONOUNCEMENTS

See Note 1 of Notes to Condensed Consolidated Financial Statements included in Part I, Item 1 for a discussion of new accounting pronouncements.

Item 3.
Quantitative and Qualitative Disclosures About Market Risk

Interest Rate and Foreign Exchange Risk
Our exposure to market risk from changes in interest rates relates primarily to our cash equivalents, marketable securities, derivative assets and variable-rate debt obligations. As of September 30, 2017, we had cash equivalents of $8.8 million held in a combination of money market funds and commercial paper, and marketable securities of $47.3 million, held in a combination of certificates of deposit, commercial paper, corporate bonds, and U.S. government bonds. Our cash equivalents mature within three months or less from the date of purchase. Marketable securities with original maturities of greater than three months and remaining maturities of less than one year are classified as short-term investments. Investments with maturities beyond one year may be classified as short-term based on their highly liquid nature and because such marketable securities represent the investment of cash that is available for current operations. We have classified our marketable securities as available-for-sale and, therefore, we may choose to sell or hold them as changes in the market occur. Because of the short-term nature of the instruments in our portfolio, a decline in interest rates would reduce our interest income over time, and an increase in interest rates may negatively affect the market price or liquidity of certain securities within the portfolio.

Our negotiated credit facilities generally charge interest based on a benchmark rate such as LIBOR. Fluctuations in short-term interest rates may cause interest payments on term loan principal and drawn amounts on the revolving line to increase or decrease. As of September 30, 2017, the outstanding balances on our credit facilities totaled $52.0 million.

As of September 30, 2017, we had a $52.0 million receive-variable, pay-fixed interest rate swap outstanding with Chase Bank, which amortizes monthly in line with the outstanding principal balance on our term loan. The swap is classified as a cash flow hedge and effectively fixes the interest rate on our variable-rate term loan. The interest rate swap matures on December 31, 2020 and has a fixed interest rate of 1.42% per annum. The variable rate on the interest rate swap is the one-month LIBOR benchmark, which was 1.24% at September 30, 2017.

The fair value of our interest rate swap agreement represents the estimated receipts or payments that would be made to terminate the agreement. The amounts related to our cash flow hedge are recorded as deferred gains or losses in our consolidated balance sheets with the offset recorded in accumulated other comprehensive income, net of tax. At September 30, 2017, the fair value of our interest rate swap agreement was an asset of $0.2 million. The estimated amount expected to be reclassified into earnings within the next twelve months was less than $0.1 million at September 30, 2017.

We enter into foreign exchange forward contracts to offset the earnings impacts of exchange rate fluctuations on certain monetary assets and liabilities. Total notional amounts outstanding at September 30, 2017 were $18.3 million.

A hypothetical 10% increase in interest rates, or a 10% movement in the currencies underlying our foreign currency derivative positions, would not have material impacts on our results of operations, financial position or cash flows. We do not enter into derivative instruments for any purpose other than to manage our interest rate or foreign currency exposure. That is, we do not engage in interest rate or currency exchange rate speculation using derivative instruments.


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Item 4.     Controls and Procedures

Evaluation of Disclosure Controls and Procedures
 
In accordance with Rule 13a-15 of the Securities Exchange Act of 1934 (the “Exchange Act”), as of the end of the period covered by this Quarterly Report on Form 10-Q, our management evaluated, with the participation of our Chief Executive Officer and our Chief Financial Officer, the effectiveness of our disclosure controls and procedures (as defined in Rule 13a-15(e) and Rule 15d-15(e) under the Exchange Act). Based upon their evaluation of these disclosure controls and procedures, our management, including the Chief Executive Officer and Chief Financial Officer, have concluded that our disclosure controls and procedures were effective as of the end of the period covered by this report.
Changes in Internal Control over Financial Reporting

We are implementing an enterprise resource planning ("ERP") system and complementary systems that support our Retail operations related to Octane. During the third quarter of 2017, the technical design was completed and development of features of the ERP and complementary systems were in progress. We expect to continue developing and deploying these features during the fourth quarter of 2017 with full implementation planned to be completed in the second quarter of 2018. As each phase of the implementation occurs, we are taking steps to monitor and maintain appropriate internal control over financial reporting and will continue to evaluate these controls for effectiveness.

There were no other changes in our internal control over financial reporting that occurred during the three months ended September 30, 2017, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.


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PART II.    OTHER INFORMATION

Item 1.
Legal Proceedings

From time to time, we may be involved in various claims, lawsuits and other proceedings. These legal and tax proceedings involve uncertainty as to the eventual outcomes and losses which may be realized when one or more future events occur or fail to occur.

Item 1A.    Risk Factors

We operate in an environment that involves a number of risks and uncertainties. The risks and uncertainties described in our 2016 Form 10-K are not the only risks and uncertainties that we face. Additional risks and uncertainties that presently are not considered material or are not known to us, and therefore are not mentioned herein, may impair our business operations. If any of the risks described in our 2016 Form 10-K actually occur, our business, operating results and financial position could be adversely affected. There has not been a material change to the risk factors as set forth in our 2016 Form 10-K.

Item 2.    Unregistered Sales of Equity Securities and Use of Proceeds

Issuer Purchases of Equity Securities
The following table provides information about our repurchases of our equity securities during the third quarter ended September 30, 2017:
Period
 
(a)


                 
Total Number of Shares
Purchased
 
(b)



Average
Price Paid
per Share
 
(c)

Total Number of Shares Purchased
as Part of Publicly Announced Plans or Programs (1),(2)
 
(d)

Approximate Dollar
Value of Shares that May Yet Be Purchased Under the Plans or Programs (1),(2)
July 1 - July 31
 
 
$—
 
 
$19,615,159
August 1 - August 31
 
86,856
 
16.36
 
86,856
 
18,194,225
September 1 - September 30
 
 
 
 
18,194,225
Total
 
86,856
 
$16.36
 
86,856
 
$18,194,225
 
 
 
 
 
 
 
 
 
(1)  On May 4, 2016, our Board of Directors authorized the repurchase of up to $10.0 million of our outstanding common stock from time to time through May 4, 2018.
(2)  On April 25, 2017, our Board of Directors authorized the repurchase of an additional $15.0 million of our outstanding common stock from time to time through April 25, 2019.


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Item 6.    Exhibits

The following exhibits are filed herewith and this list is intended to constitute the exhibit index:
Exhibit No.
 
Description
 
 
 
  
Certification of Chief Executive Officer pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934, as amended.
 
 
 
 
Certification of Chief Financial Officer pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934, as amended.
 
 
 
  
Certification of Chief Executive Officer and Chief Financial Officer pursuant to Rule 13a-14(b) of the Securities and Exchange Act of 1934, as amended, and 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
 
 
 
101.INS
 
XBRL Instance Document - the instance document does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL document.
 
 
 
101.SCH
 
XBRL Taxonomy Extension Schema Document
 
 
 
101.CAL
 
XBRL Taxonomy Extension Calculation Linkbase Document
 
 
 
101.DEF
 
XBRL Taxonomy Extension Definition Linkbase Document
 
 
 
101.LAB
 
XBRL Taxonomy Extension Label Linkbase Document
 
 
 
101.PRE
 
XBRL Taxonomy Extension Presentation Linkbase Document


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.  
 
 
NAUTILUS, INC.
 
 
(Registrant)
 
 
 
 
November 2, 2017
 
By:
/S/    Bruce M. Cazenave
Date
 
 
Bruce M. Cazenave
 
 
 
Chief Executive Officer
(Principal Executive Officer)

 
 
NAUTILUS, INC.
 
 
(Registrant)
 
 
 
 
November 2, 2017
 
By:
/S/    Sidharth Nayar
Date
 
 
Sidharth Nayar
 
 
 
Chief Financial Officer
(Principal Financial and Accounting Officer)


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