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NLS > SEC Filings for NLS > Form 10-Q on 9-May-2013All Recent SEC Filings

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Form 10-Q for NAUTILUS, INC.


9-May-2013

Quarterly Report


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

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, 2012 (the "2012 Form 10-K"). All references to the first quarter and first three months of 2013 and 2012 mean the three-month periods ended March 31, 2013 and 2012, 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 United States 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, 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 air television advertisements of our products, 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 any future growth or profitability. For more information, see our discussion of Risk Factors located at Part I, Item 1A of our 2012 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. The forward-looking statements in this report include, without limitation: anticipated consumer credit financing approval rates for the remainder of 2013; expectations for increased Research and Development expenses; the amount expected to be spent on software and equipment in 2013; fluctuations in Net sales due to seasonality; and our ability to continue to fund our operating and capital needs for the following twelve-month period . Forward-looking statements also include any statements related to our expectations regarding future business and financial performance or conditions, anticipated sales growth across markets, distribution channels and product categories, expenses and gross margins, profits or losses, losses from discontinued operation, settlements of warranty obligations, new product introductions, financing and working capital requirements and 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 the risks described in Part I, Item 1A, "Risk Factors," in our 2012 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 to conform them to actual results or to changes in circumstances or expectations.


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Available Information

We make our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports, available free of charge on our website, www.nautilusinc.com. In addition, our Code of Business Conduct and Ethics, corporate governance policies, and the charters of our Audit Committee, Compensation Committee and Nominating and Corporate Governance Committee are available on our website. The information presented on our website is not part of this report.

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 United States and Canada. Our products are sold under some of the most-recognized brand names in the fitness industry: Nautilus®, Bowflex®, Schwinn®, Schwinn Fitness™ 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 with stores and websites located in the United States and internationally. We also derive a portion of our revenue from the licensing of our brands and intellectual property.

Net sales for the first quarter of 2013 were $59.2 million, an increase of $7.9 million, or 15.5%, as compared to net sales of $51.3 million for the first quarter of 2012. Net sales of our Direct segment for the first quarter of 2013 rose $8.9 million, or 26.4%, compared to the first quarter of 2012, primarily due to strong consumer demand for our cardio products, especially the Bowflex® TreadClimber®. Net sales of our Retail segment for the first quarter of 2013 declined by $1.5 million, or 9.0%, compared to the first quarter of 2012 primarily due to lower sales of certain cardio products, including indoor bikes and ellipticals.

Income from continuing operations was $5.5 million for the first quarter of 2013, or $0.18 per diluted share, compared to income from continuing operations of $2.6 million, or $0.09 per diluted share, for the first quarter of 2012. Net income for the first quarter of 2013 was $5.2 million, compared to net income of $2.5 million for the first quarter of 2012. Net income per diluted share was $0.17 for the first quarter of 2013, compared to $0.08 per diluted share for the first quarter of 2012.
The improvement in our results of continuing operations for the first quarter of 2013 was driven primarily by strong demand and higher sales in our Direct channel and a 520 basis point improvement in our gross margin over the same period of last year. The increase in gross margin was attributable to increases in both the Direct and Retail businesses, as well as increased royalty income. Discontinued Operation

Results from discontinued operation relate to the disposal of our former Commercial business, which began in April 2011. We reached substantial completion of asset liquidation at December 2012. However, we continue to have minor legal and accounting expenses as we work with authorities on final deregistration of each entity.


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Results of Operations

Results of operations information was as follows (in thousands):
                                           Three months ended March 31,                   Change
                                              2013               2012                $                %
Net sales                               $      59,214       $      51,262     $      7,952            15.5  %
Cost of sales                                  28,520              27,357            1,163             4.3  %
Gross profit                                   30,694              23,905            6,789            28.4  %
Operating expenses:
Selling and marketing                          18,626              16,066            2,560            15.9  %
General and administrative                      4,947               4,010              937            23.4  %
Research and development                        1,127               1,000              127            12.7  %
Total operating expenses                       24,700              21,076            3,624            17.2  %
Operating income                                5,994               2,829            3,165           111.9  %
Other income (expense):
Interest income                                     1                   6               (5 )         (83.3 )%
Interest expense                                   (9 )                78              (87 )          n.m.
Other                                            (109 )                (2 )           (107 )          n.m.
Total other income (expense), net                (117 )                82             (199 )
Income from continuing operations
before income taxes                             5,877               2,911            2,966           101.9  %
Income tax expense                                353                 264               89            33.7  %
Income from continuing operations               5,524               2,647            2,877           108.7  %
Loss from discontinued operation, net
of income taxes                                  (365 )              (125 )           (240 )
Net income                              $       5,159       $       2,522     $      2,637           104.6  %


n.m. = not meaningful

Results of operations information by segment was as follows (in thousands):

                  Three months ended March 31,                Change
                     2013               2012             $             %
Net sales:
Direct         $      42,635       $      33,734     $ 8,901          26.4  %
Retail                15,134              16,639      (1,505 )        (9.0 )%
Royalty income         1,445                 889         556          62.5  %
               $      59,214       $      51,262     $ 7,952          15.5  %
Cost of sales:
Direct         $      17,158       $      14,670     $ 2,488          17.0  %
Retail                11,362              12,687      (1,325 )       (10.4 )%
Royalty income             -                   -           -
               $      28,520       $      27,357     $ 1,163           4.3  %
Gross profit:
Direct         $      25,477       $      19,064     $ 6,413          33.6  %
Retail                 3,772               3,952        (180 )        (4.6 )%
Royalty income         1,445                 889         556          62.5  %
               $      30,694       $      23,905     $ 6,789          28.4  %
Gross margin:
Direct                  59.8 %              56.5 %       330   basis points
Retail                  24.9 %              23.8 %       110   basis points


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The following table compares the net sales of our major product lines within each business segment (in thousands):

                                        Three months ended March 31,                 Change
                                          2013               2012               $              %
Direct net sales:
Cardio products(1)                   $      35,643      $      26,476      $    9,167         34.6  %
Strength products(2)                         6,992              7,258            (266 )       (3.7 )%
                                            42,635             33,734           8,901         26.4  %
Retail net sales:
Cardio products(1)                           6,898             10,465          (3,567 )      (34.1 )%
Strength products(2)                         8,236              6,174           2,062         33.4  %
                                            15,134             16,639          (1,505 )       (9.0 )%

Royalty income                               1,445                889             556         62.5  %
                                     $      59,214      $      51,262      $    7,952         15.5  %

(1) Cardio products include: TreadClimbers, treadmills, exercise bikes, ellipticals, CoreBody Reformer® and DVDs.
(2) Strength products include: home gyms, selectorized dumbbells, kettlebell weights, UpperCut™ and accessories.

Direct

The 26.4% increase in Direct Net sales was primarily related to strong consumer demand for our cardio products, especially the Bowflex® TreadClimber®, which we believe was driven by increased advertising effectiveness, improved call center effectiveness and higher U.S. consumer credit approval rates.

Combined consumer credit approvals by our primary and secondary U.S. third-party financing providers increased to 35% in the first quarter of 2013 from 30% in the same period last year. We expect U.S. consumer credit financing approval rates during the remainder of 2013 to remain in the 30 - 35% range.

The increase in the Direct Net sales of cardio products was partially offset by the 3.7% decline in Direct Net sales of strength products, primarily rod-based home gyms. The decline in sales of rod-based home gyms is attributable, in part, to the cessation of television advertising for these products, as management determined that television ad spending on this mature product category was generating suboptimal returns. We have continued to market and sell rod-based home gyms through more cost efficient online media since early 2011.

The increase in Cost of sales of our Direct business was almost entirely related to the growth in Direct Net sales and was partially offset by the improvement in Gross margin.

The 330 basis point increase in the Gross margin of our Direct business was primarily due to greater absorption of fixed supply chain costs due to higher sales volume.

Retail

The 9.0% decrease in Retail Net sales was primarily due to the 34.1% decline in cardio sales, primarily indoor bikes and ellipticals. This decline was partially offset by the 33.4% increase in Retail Net sales of strength products, which was primarily due to higher sales of selectorized dumbbells.

The decline in Retail Cost of sales was almost entirely due to the decline in Retail Net sales, and was partially offset by the improvement in Retail Gross margin.

The 110 basis point improvement in Retail Gross margin was primarily due to the positive impact of retail pricing strategies implemented in the third quarter of 2012.


Table of Contents

Selling and Marketing
Dollars in thousands    Three months ended March 31,         Change
                           2013              2012          $        %
Selling and Marketing    $18,626           $16,066       $2,560   15.9%
As % of Net sales         31.5%             31.3%

The increase in Selling and Marketing was primarily due to an increase in media advertising, which contributed to the improvement in Net sales.

Media advertising expense of our Direct business is the largest component of Selling and Marketing. Media advertising expense increased $1.2 million, or 14.0%, to $10.0 million in the first quarter of 2013 compared to $8.8 million in the first quarter of 2012, primarily due to strategic increases in media advertising investments as we experience strong consumer response and positive media return on investment.

General and Administrative
Dollars in thousands        Three months ended March 31,        Change
                               2013              2012         $       %
General and Administrative    $4,947            $4,010       $937   23.4%
As % of Net sales              8.4%              7.8%

The increase in General and Administrative was primarily due to higher infrastructure costs. The increase as a percentage of Net sales was primarily due to one-time negative anomalies in the first quarter of 2013 and one-time positive anomalies in the same period last year, generally related to personnel changes.

Research and Development
Dollars in thousands      Three months ended March 31,        Change
                             2013              2012         $       %
Research and Development    $1,127            $1,000       $127   12.7%
As % of Net sales            1.9%              2.0%

The increase in Research and Development was primarily due to our continued investment in new products. We expect Research and Development expense to increase for the full year 2013, compared to 2012, as we continue to invest in new product development.

Interest Expense

Negative interest expense of $0.1 million for the first quarter of 2012 arose from the early repayment in March 2012 of our Increasing-Rate Senior Discount Notes. Early repayment of the notes resulted in a lower average effective interest rate over the term of the notes than would have applied if the notes had been held to maturity. In prior periods, we used the average effective interest rate as if the notes were held to maturity in determining the amount of interest expense incurred.

Other Expense

Other expense of $0.1 million in the first quarter of 2013 primarily relates to the effect of exchange rate fluctuations between the U.S. and Canada.

Income Tax Provision
Dollars in thousands Three months ended March 31, Change 2013 2012 $ % Income Tax Provision $353 $264 $89 33.7%


Table of Contents

Income Tax Provision for the first quarter of 2013 and 2012 was primarily related to our profitable Canadian operations and an increase in deferred tax liabilities for indefinite lived tradename intangibles that cannot be used to reduce our valuation allowance in the United States.

We periodically evaluate the potential realization of our Deferred Income Tax Assets and, if necessary, record a valuation allowance to reduce the net carrying value of such assets to the amount expected to be realized. As part of this assessment, we consider positive and negative evidence, including cumulative income or loss for the past three years and forecasted taxable income. We evaluated the potential realization of deferred income tax assets as of March 31, 2013 and concluded that the existing valuation allowance was required. It is at least reasonably possible that, within the next twelve months, a review of the objective evidence may indicate that a portion of our valuation allowance will no longer be appropriate. If such a determination is made, release of the valuation allowance would be recognized as an income tax benefit to continuing operations in the period in which such assessment is made and the amount recognized could be material.

LIQUIDITY AND CAPITAL RESOURCES

As of March 31, 2013, we had $28.7 million of Cash and Cash Equivalents, compared to $23.2 million as of December 31, 2012. Cash provided by operating activities was $6.0 million for the three months ended March 31, 2013, compared to cash provided by operating activities of $8.2 million for the three months ended March 31, 2012. We expect our Cash and Cash Equivalents at March 31, 2013, 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 March 31, 2013.

The decline in cash flows from operating activities was primarily due to changes in our operating assets and liabilities as discussed below, partially offset by increased Net Income of $5.2 million for the three months ended March 31, 2013, compared to Net Income of $2.5 million for the three months ended March 31, 2012.

Trade Receivables decreased $9.5 million to $12.3 million as of March 31, 2013, compared to $21.8 million as of December 31, 2012, due to seasonally lower activity with our Retail business customers. Days sales outstanding at March 31, 2013 were 22.5 days compared to 23.7 days as of December 31, 2012.

Inventories decreased $5.1 million to $13.7 million as of March 31, 2013, compared to $18.8 million as of December 31, 2012, as we intentionally lower inventories heading into the second quarter, which is our seasonally slowest quarter of the year.

Trade Payables decreased $15.0 million to $17.8 million as of March 31, 2013, compared to $32.8 million as of December 31, 2012, due to lower inventory purchases and the timing of those purchases in the first quarter of 2013.

Accrued Liabilities decreased $1.7 million to $6.5 million as of March 31, 2013 compared to $8.2 million as of December 31 2012, primarily due to incentive compensation payments made in the first quarter of 2013 that related to 2012 performance.

Cash used in investing activities for purchases of software and equipment were $0.8 million for the three months ended March 31, 2013 and were primarily for tooling for new products and software updates. We anticipate spending $2.0 million in all of 2013 for software and equipment, which is consistent with spending levels in 2012.

Financing Arrangements

We have a Credit Agreement (the "Loan Agreement") with Bank of the West that provides for a $15,750,000 maximum revolving secured credit line. The line of credit is available through March 31, 2015 for working capital, standby letters of credit and general corporate purposes. Borrowing availability under the Loan Agreement is subject to our compliance with certain financial and operating covenants at the time borrowings are requested. Standby letters of credit under the Loan Agreement are treated as a reduction of the available borrowing amount and are subject to covenant testing.

The interest rate applicable to borrowings under the Loan Agreement is based on either, at our discretion, Bank of the West's base rate, a floating rate or LIBOR , plus an applicable margin based on certain financial performance metrics. Our borrowing rate was 1.5% as of March 31, 2013 . The Loan Agreement contains customary covenants, including minimum fixed charge coverage ratio and leverage ratio, and limitations on capital expenditures, mergers and acquisitions, indebtedness, liens, dispositions, dividends and investments. The Loan Agreement also contains customary events of default. Upon an event of default, the lender has the option of terminating its credit commitment and accelerating all obligations under the Loan Agreement. Borrowings under the Loan Agreement are collateralized by substantially all of our assets, including intellectual property assets.


Table of Contents

As of March 31, 2013, we had no outstanding borrowings and $1.0 million in standby letters of credit issued under the Loan Agreement. As of March 31, 2013, we were in compliance with the financial covenants of the Loan Agreement and approximately $14.8 million was available for borrowing.

Commitments and Contingencies

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

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 various factors, such as the broadcast of network season finales and seasonal weather patterns, influence television viewers and cause our advertising on cable television stations to be less effective in the second quarter than in other periods. In addition, 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 2012 Form 10-K.

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