10-K 1 nautilus10-k2016.htm 10-K Document
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
 
FORM 10-K
 
 
(Mark One)
[x]
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2016
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)
 
Securities registered pursuant to Section 12(b) of the Act:
Title of each class
 
Name of each exchange on which registered
Common Stock, no par value
 
New York Stock Exchange

Securities registered pursuant to Section 12(g) of the Act: None.
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes  [ ]  No  [x]
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.    Yes  [ ]    No  [x]
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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.    [ ]
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definition of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act:
Large accelerated filer  [ ]            Accelerated filer  [x]        Non-accelerated filer  [ ]            Smaller reporting company  [ ]
(do not check if a smaller reporting company)
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).    Yes  [ ]    No  [x]
The aggregate market value of the voting and non-voting common equity held by non-affiliates computed by reference to the last sales price ($17.84) as reported on the New York Stock Exchange as of the last business day of the registrant's most recently completed second fiscal quarter (June 30, 2016) was $541,556,142.
The number of shares outstanding of the registrant's common stock as of February 24, 2017 was 30,700,791 shares.
Documents Incorporated by Reference
The registrant has incorporated by reference into Part III of this Form 10-K portions of its Proxy Statement for its 2017 Annual Meeting of Shareholders.
 



NAUTILUS, INC.
2016 FORM 10-K ANNUAL REPORT
 
 
 
Item 1.
 
Item 1A.
 
Item 1B.
 
Item 2.
 
Item 3.
 
Item 4.
 
 
 
 
 
 
 
 
Item 5.
 
Item 6.
 
Item 7.
 
Item 7A.
 
Item 8.
 
Item 9.
 
Item 9A.
 
Item 9B.
 
 
 
 
 
 
 
 
Item 10.
 
Item 11.
 
Item 12.
 
Item 13.
 
Item 14.
 
 
 
 
 
 
 
 
Item 15.
 
 
 
 
 





PART I

Forward-Looking Statements

This Annual Report on Form 10-K 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: our prospects, resources or capabilities; current or future financial trends; future operating results; future plans for introduction of new products; anticipated demand for our new and existing products; anticipated benefits of the acquisition of Octane Fitness; maintenance of appropriate inventory levels; growth in revenues and profits; leverage of operating expenses; future revenues from licenses of our intellectual property; results of increased media investment in the Direct segment; continued improvement in operating margins; expectations for increased research and development expenses; anticipated capital expenditures; 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 operations, settlements of warranty obligations, the anticipated outcome of litigation to which we are a party, 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 of this report and in other reports we file with the Securities and Exchange Commission. 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.

Item 1. Business

OVERVIEW

Founded in 1986, Nautilus, Inc. and subsidiaries (collectively, "Nautilus" or the "Company") is a consumer fitness products company headquartered in Vancouver, Washington and incorporated in the State of Washington in January 1993. We are committed to providing innovative, quality solutions to help people achieve their fitness goals through 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. and Canada, but also in international markets outside North America. 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 companies to reach consumers in both the home use as well as commercial use markets in the U.S. and internationally. We also derive a portion of our revenue from the licensing of our brands and intellectual property.

BUSINESS STRATEGY

We are focused on developing and marketing consumer fitness equipment and related products to help people enjoy healthier lives. Our products are targeted to meet the needs of a broad range of consumers, including fitness enthusiasts and individuals who are seeking the benefits of regular exercise. We have diversified our business by expanding our portfolio of high quality fitness equipment into multiple product lines utilizing our well-recognized brand names. We are focused on consumer markets and specialty and commercial distribution channels, and view the continual innovation of our product offerings as a key aspect of our business strategy. We regularly refresh our existing product lines with new technologies and finishes, and focus significant effort and resources on the development or acquisition of innovative new fitness products for introduction to the marketplace at periodic intervals.
 
Our strategies incorporate the individual characteristics of our Direct and Retail businesses. Our Direct business focuses on: (i) the development of, or acquisition of rights to, unique products; (ii) the application of creative, cost-effective ways to communicate the benefits of their use; and (iii) making various payment options available to our customers. We are particularly attentive to Direct business metrics that provide feedback regarding the effectiveness of our media marketing programs and attractiveness of third-party consumer financing programs.


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In our Retail business, we strive to develop long-term relationships with key retailers of sports or fitness equipment. The primary objectives of our Retail business are (i) to offer a selection of innovative, unique products at key price-points to capture market share; and (ii) to utilize the strength of our brands and long-standing customer relationships to secure more floor space with our Retail customers for our products, as well as support efforts to gain share in multi-user environments.

Our long-term strategy involves:
Creatively marketing our equipment, both directly to consumers and through our Retail customers, while leveraging our well-known brand names;
Enhancing our product lines by designing fitness equipment that meets or exceeds the high expectations of our customers;
Utilizing our strengths in product engineering to reduce product costs;
Continuing our investment in research and development activities aimed at acquiring or creating new technologies;
Increasing our international Retail sales and distribution; and
Maximizing available royalty revenues from the licensing of our brands and intellectual property.

PRODUCTS

We market quality cardiovascular and strength fitness products that cover a broad range of price points and features. Our products are designed for home use and multi-user environments by individuals with varying exercise needs. From the person who works out occasionally to the serious athlete, we have products that will help them achieve their fitness objectives.

Nautilus® is our corporate umbrella brand and is also used to differentiate certain specialized cardio, treadmills, ellipticals and bike products.
Our Bowflex® brand represents a highly-regarded line of fitness equipment comprised of both cardio and strength products, including the Max Trainer® and TreadClimber® specialized cardio machines, PowerRod® and Revolution® home gyms and SelectTech® dumbbells.
Our Octane Fitness® brand is known for its innovation around low-impact cardio products, including the perfection of the traditional elliptical machine, along with the creation of new categories of exercise, including the xRide® recumbent elliptical, the LateralX® elliptical, and the Zero Runner®.
Our Schwinn® brand is known for its popular line of exercise bikes, including the Airdyne®, as well as Schwinn-branded treadmills and ellipticals.
Our Universal® brand, one of the oldest and most recognized names in the fitness industry, currently offers a line of kettlebell weights and weight benches along with a recently launched cardio line.
  
We generally differentiate the product models offered in our Direct and Retail sales channels. Currently, our Max Trainer® and TreadClimber® product lines are offered for sale primarily through our Direct sales channel.

Approximately 85% of our revenue in 2016 was derived from sales of consumer cardio products. While we continue to be a leader in the consumer strength product category, we believe the much larger market for cardio products offers us greater opportunity for growth.
 
BUSINESS SEGMENTS AND GEOGRAPHIC INFORMATION

We conduct our business in two segments, Direct and Retail. For further information regarding our segments and geographic information, see Note 20, Segment and Enterprise-Wide Information, to our consolidated financial statements in Part II, Item 8 of this report.

SALES AND MARKETING

Direct
In our Direct business, we market and sell our products, principally Bowflex® cardio and strength products, directly to consumers. While we are, and plan to continue to be, a large direct marketer of strength products in the U.S., our advertising emphasis has shifted toward cardio products, especially the Max Trainer® and TreadClimber®, as cardio products represent the largest component of the fitness equipment market and a majority of our business. Sales of cardio products represented 93% of our Direct channel revenues in 2016, compared to 93% in 2015 and 91% in 2014.

Our marketing efforts are based on an integrated combination of media and direct consumer contact. In addition to television advertising, which ranges in length from 30 seconds to as long as three minutes, we utilize Internet advertising, product websites, inquiry-response mailings, catalogs and inbound/outbound call centers. Marketing and media effectiveness is measured continuously based on sales inquiries generated, cost-per-lead, conversion rates, return on investment and other performance

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metrics and we strive to optimize the efficiency of our marketing and media expenditures based on this data. Almost all of our Direct customer orders are received either on our Internet websites or through company-owned and third-party call centers.

In order to facilitate consumer purchases, we partner with several third-party credit providers. Credit approval rates are an important variable in the number of Direct products we sell in a given period. Combined consumer credit approvals by our primary and secondary U.S. third-party financing providers increased to 51% in 2016 from 48% in 2015 and 41% in 2014. The year-over-year boost in approval rates for 2016 compared to 2015 was due to expansion of credit approval standards, primarily by our Tier 1 third-party credit provider. The expansion of approval standards was driven by strong performance of their Bowflex® credit portfolio. Also contributing, was our marketing and media strategy which has attracted customers with higher credit scores. Our marketing and media strategy was the primary driver of higher credit approval rates in 2015 compared to 2014.
 
Retail
In our Retail business, we market and sell a comprehensive line of consumer fitness equipment under the Nautilus®, Octane Fitness®, Schwinn®, Universal® and Bowflex® brands. Our products are marketed through a network of retail companies, consisting of sporting goods stores, Internet retailers, large-format and warehouse stores, smaller specialty retailers, independent bike dealers, and to specialty commercial customers purchasing our products for multi-user environments.

We offer programs that provide price discounts to our Retail customers for ordering container-sized shipments or placing orders early enough in the season to allow for more efficient manufacturing by our Asian suppliers. These programs are designed to reduce our shipping and handling costs, with much of the savings being passed on to our customers. In addition, we often offer other types of sales incentives to our Retail customers, including volume discounts and various forms of rebates or allowances, which generally are intended to increase product exposure and availability for consumers, reduce transportation costs, and encourage marketing and promotion of our brands or specific products.

PRODUCT DESIGN AND INNOVATION

Innovation is a vital part of our business, and we continue to expand and diversify our product offerings by leveraging our research and development capabilities. We constantly search for new technologies and innovations that will help us grow our business, either through higher sales or increased production efficiencies. To accomplish this objective, we seek out ideas and concepts both within our company and from outside inventors.

We rely on financial and engineering models to assist us in assessing the potential operational and economic impacts of adopting new technologies and innovations. If we determine that a third-party technology or innovation concept meets certain technical and financial criteria, we may enter into a licensing arrangement to utilize the technology or, in certain circumstances, purchase the technology for our own use. Our product design and engineering teams also invest considerable effort to improve product design and quality. As a consumer-driven company, we invest from time-to-time in qualitative and quantitative consumer research to help us assess new product concepts, optimal features and anticipated consumer adoption.

Our research and development expenses were $13.9 million, $9.9 million and $7.2 million in 2016, 2015 and 2014, respectively, as we increased our investment in new product development resources and capabilities. We expect our research and development expenses to increase in 2017 as we continue to supplement our investment in new product development and engineering capabilities.

SEASONALITY

We expect our revenue 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 consumers tend to be involved in outdoor activities during the spring and summer months, 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.

MERCHANDISE SOURCING

All of our products are produced by third-party manufacturers, and, in 2016, our manufacturing partners were primarily located in Asia. Although multiple factories bid on and are able to produce most of our products, we typically select one factory to be the primary supplier of any given product. Lead times for inventory purchases from our Asian suppliers, from order placement to receipt of goods, generally range from approximately two to three months, of which transit time represents three-to-four weeks. The length of our lead times requires us to place advance manufacturing orders based on management forecasts of future demand for our products. We attempt to compensate for our long replenishment lead times by maintaining adequate levels of inventory at our warehousing facilities.

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We monitor our suppliers' ability to meet our product needs and we participate in quality assurance activities to reinforce adherence to our quality standards. Our third-party manufacturing contracts are generally of annual or shorter duration, or manufactured products are sourced on the basis of individual purchase orders. Our manufacturing relationships are non-exclusive, and we are permitted to procure our products from other sources at our discretion.  None of our manufacturing contracts include production volume or purchase commitments on the part of either party. Our third-party manufacturers are responsible for the sourcing of raw materials and producing parts and finished products to our specifications.

LOGISTICS

Our warehousing and distribution facilities are located in Oregon and Ohio. In addition to Company-operated distribution centers, we utilize third-party warehouses and logistics providers to fulfill orders. In our Direct business, we strive to maintain inventory levels that will allow us to ship our products shortly after receiving a customer's order. We use common carriers for substantially all of our merchandise shipments to Direct customers.

In our Retail business, we manage our inventory levels to accommodate anticipated seasonal changes in demand. Generally, we maintain higher inventory levels at the end of the third and fourth quarters to satisfy relatively higher consumer demand in the fourth and first quarters of each year. Many of our Retail customers place orders well in advance of peak periods of consumer demand to ensure an adequate supply for the anticipated selling season.

In 2016, approximately 52% of our Retail customers' orders were shipped by our contract manufacturers in Asia directly to our Retail customer locations, typically in container loads. The use of such direct shipments allows us to maintain lower levels of inventory in our warehouses, resulting in lower storage, handling, freight, insurance and other costs, with much of the savings being passed on to our customers. We use various commercial truck lines for our merchandise shipments to Retail customers.

COMPETITION

The markets for all of our products are highly competitive. We believe the principal competitive factors affecting our business are quality, brand recognition, innovation and pricing. We believe we are well positioned to compete in markets in which we can take advantage of our strong brand names, and that our focus on innovative product design, quality, and performance distinguishes our products from the competition.

Our products compete directly with those offered by a large number of companies that market consumer fitness equipment and fitness programs. As the use of Internet websites for product sales by traditional retailers has increased, our competitors have become increasingly similar across our Direct and Retail sales channels.

Our principal competitors include: Fitness Quest, ICON Health & Fitness, Johnson Health Tech, Beach Body, American Telecast, Life Fitness, and Precor. We also compete with marketers of computer-based physical activity products, such as the Nintendo Wii® and Microsoft Xbox® Kinect®, weight management companies, such as Weight Watchers, gym memberships and group fitness, such as cross-fit classes, each of which offers alternative solutions for a fit and healthy lifestyle.

EMPLOYEES

As of February 24, 2017, we had approximately 469 employees, substantially all of whom were full-time. None of our employees are subject to collective bargaining agreements. We have not experienced a material interruption of our operations due to labor disputes.

INTELLECTUAL PROPERTY

Trademarks, patents and other forms of intellectual property are vital to the success of our business and are an essential factor in maintaining our competitive position in the health and fitness industry.


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Trademarks
We own many trademarks, including Nautilus®, Bowflex®, Max Trainer®, TreadClimber®, Power Rod®, Bowflex Revolution®, SelectTech®, Octane Fitness®, LateralX®, xRide®, Zero Runner®, Airdyne®, and Universal®. Nautilus is the exclusive licensee under the Schwinn® mark for indoor fitness products. We believe that having distinctive trademarks that are readily identifiable by consumers is an important factor in creating a market for our products, maintaining a strong company identity and developing brand loyalty among our customers. In addition, we have granted licenses to certain third-parties to use the Nautilus, Schwinn and TreadClimber trademarks on commercial fitness products, for which we receive royalty income and expanded consumer awareness of our brands.

Each federally registered trademark is renewable indefinitely if the trademark is still in use at the time of renewal.

Patents and Designs
Building our intellectual property portfolio is an important factor in maintaining our competitive position in the health and fitness equipment industry. We have followed a policy of filing applications for U.S. and non-U.S. patents on utility and design inventions that we deem valuable to our business.

We own or license patents and design registrations covering a variety of technologies, some of which are utilized in our selectorized dumbbells, treadmills, exercise bikes, and elliptical machines. Patent and design protection for these technologies, which are utilized in products sold in both the Direct and Retail segments, extends as far as 2028.

We maintain a portfolio of patents related to our TreadClimber® specialized cardio machines, which are sold primarily in our Direct segment. The portfolio includes approximately 25 issued U.S. patents. A patent covering certain aspects of our TreadClimber® products expired in 2013. Additional individual U.S. patents covering elements of our TreadClimber® products have expiration dates ranging from 2021 to 2027. Expiration or invalidity of patents within our TreadClimber® portfolio could trigger the introduction of similar products by our competitors. Although we view each of the patents within our portfolio as valuable, we do not view any single patent as critical to our success or ability to differentiate our TreadClimber® products from similar products that may be introduced by competitors in the future. We regularly monitor commercial activity in our industry to guard against potential infringement. We protect our proprietary rights and take prompt, reasonable actions to prevent counterfeit products and other infringement on our intellectual property.

We maintain a portfolio of patents related to our MaxTrainer® specialized cardio machines, which are sold primarily in our Direct segment. The portfolio includes 1 issued U.S. patent and additional pending patents. The issued patent expires in 2034.

Nautilus is also the licensee of patents related to the Bowflex Revolution® home gyms. These patents have expiration dates ranging from 2018 to 2025. Through its Octane Fitness subsidiary, Nautilus owns and licenses certain patents related to Octane's LateralX®, xRide® and Zero Runner® products. These patents have expiration dates ranging from 2017 to 2034.

BACKLOG

We define our customer order backlog to include firm orders for future shipment to our Retail customers, as well as unfulfilled consumer orders within the Direct segment.

Backlog as of a given date fluctuates based on specific timing of product shipment within the typical shipment timeframes for each of our segments. Retail orders comprise the larger portion of our order backlog, while Direct orders comprise a smaller portion of our backlog due to shorter fulfillment timeframes.

Our customer order backlog as of December 31, 2016 and 2015 was approximately $4.9 million and $5.0 million, respectively.

SIGNIFICANT CUSTOMERS

In 2016, 2015 and 2014, Amazon.com accounted for 11.3%, 11.1% and 11.3%, respectively, of our net sales.

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ENVIRONMENTAL AND OTHER REGULATORY MATTERS

Our operations are subject to various laws and regulations both domestically and abroad. In the U.S., federal, state and local regulations impose standards on our workplace and our relationship with the environment. For example, the U.S. Environmental Protection Agency, Occupational Safety and Health Administration and other federal agencies have the authority to promulgate regulations that may impact our operations. In particular, we are subject to legislation placing restrictions on our generation, emission, treatment, storage and disposal of materials, substances and wastes. Such legislation includes: the Toxic Substances Control Act; the Resource Conservation and Recovery Act; the Clean Air Act; the Clean Water Act; the Safe Drinking Water Act; and the Comprehensive Environmental Response and the Compensation and Liability Act (also known as Superfund). We are also subject to the requirements of the Consumer Product Safety Commission and the Federal Trade Commission, in addition to regulations concerning employee health and safety matters.

Our operations and certain disposed components of our former Commercial business expose us to claims related to environmental matters. Although compliance with federal, state, local and international environmental legislation has not had a material adverse effect on our financial condition or results of operations or cash flows in the past, there can be no assurance that material costs or liabilities will not be incurred in connection with such environmental matters in the future.

AVAILABLE INFORMATION

Our common stock is listed on the New York Stock Exchange and trades under the symbol “NLS.” Our principal executive offices are located at 17750 SE 6th Way, Vancouver, Washington 98683, and our telephone number is (360) 859-2900. The Internet address of our corporate website is http://www.nautilusinc.com.

We file annual reports, quarterly reports, current reports, proxy statements and other information with the Securities and Exchange Commission (the “SEC”) under the Securities Exchange Act of 1934, as amended. You can inspect and obtain a copy of our reports, proxy statements and other information filed with the SEC at the offices of the SEC's Public Reference Room at 100 F Street N.E., Washington, D.C. 20549, on official business days during the hours of 10 a.m. to 3 p.m. EST. Please call the SEC at 1-800-SEC-0330 for further information on the Public Reference Room. The SEC maintains an Internet website at http://www.sec.gov where you can access copies of most of our SEC filings.

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, and other information as filed with the SEC, available free of charge on our corporate website. 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 corporate website. The information presented on our corporate website is not part of this report.

Item 1A. Risk Factors

Nautilus operates in an environment that involves a number of risks and uncertainties. The risks and uncertainties described in this Annual Report on 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 this Annual Report on Form 10-K actually occur, our business, operating results and financial position could be adversely affected.

Our revenues and profitability can fluctuate from period to period and are often difficult to predict due to factors beyond our control.
 
Our results of operations in any particular period may not be indicative of results to be expected in future periods, and have historically been, and are expected to continue to be, subject to periodic fluctuations arising from a number of factors, including:
Introduction and market acceptance of new products and sales trends affecting specific existing products;
Variations in product selling prices and costs and the mix of products sold;
Size and timing of Retail customer orders, which, in turn, often depend upon the success of our customers' businesses or specific products;
Changes in the market conditions for consumer fitness equipment;
Changes in macroeconomic factors;
Availability of consumer credit;
Timing and availability of products coming from our offshore contract manufacturing suppliers;
Seasonality of markets, which vary from quarter-to-quarter and are influenced by outside factors such as overall consumer confidence and the availability and cost of television advertising time;

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Effectiveness of our media and advertising programs;
Customer consolidation in our Retail segment, or the bankruptcy of any of our larger Retail customers;
Restructuring charges;
Goodwill and other intangible asset impairment charges; and
Legal and contract settlement charges.
 
These trends and factors could adversely affect our business, operating results, financial position and cash flows in any particular period. 

The loss of one or more of our large Retail customers could negatively impact our revenue and operating results.

We derive a significant portion of our revenue from a small number of Retail customers. A Retail customer recently closed down its business, and other retail partners may in the future experience difficulties in their businesses that could prompt store closures or reorganizations. A loss of business from one or more of these large customers, if not replaced with new business, could negatively affect our operating results and cash flows.

A decline in sales of TreadClimber® and/or Max Trainer® products without a corresponding increase in sales of other products would negatively affect our future revenues and operating results.

Sales of cardio products, especially TreadClimber® and Max Trainer® products, represent a substantial portion of our Direct segment revenues. Our products are sold in highly competitive markets with limited barriers to entry. Introduction by competitors of comparable products at lower price-points, a maturing product lifecycle or other factors could result in a decline in our revenues derived from these products. A significant decline in our revenue of these products would have a material adverse effect on our operating results, financial position and cash flows.

Portions of our operating expenses and costs of goods sold are relatively fixed, and we may have limited ability to reduce expenses sufficiently in response to any revenue shortfalls.

Many of our operating expenses are relatively fixed. We may not be able to adjust our operating expenses or other costs sufficiently to adequately respond to any revenue shortfalls. If we are unable to reduce operating expenses or other costs quickly in response to any declines in revenue, it would negatively impact our operating results, financial condition and cash flows.

If we are unable to anticipate consumer preferences or to effectively develop, market and sell future products, our future revenues and operating results could be adversely affected.
 
Our future success depends on our ability to effectively develop, market and sell new products that respond to new and evolving consumer preferences. Accordingly, our revenues and operating results may be adversely affected if we are unable to develop or acquire rights to new products that satisfy consumer preferences. In addition, any new products that we market may not generate sufficient revenues to recoup their acquisition, development, production, marketing, selling and other costs.

Decline in consumer spending would likely negatively affect our product revenues and earnings.
 
Success of each of our products depends substantially on the amount of discretionary funds available to our customers. Global credit and financial markets have experienced extreme disruptions in the recent past, including severely diminished liquidity and credit availability, declines in consumer confidence, declines in economic growth, increases in unemployment rates and uncertainty about economic stability. There can be no assurance that similar disruptions will not occur in the future. Deterioration in general economic conditions may depress consumer spending, especially spending for discretionary consumer products such as ours. Poor economic conditions could in turn lead to substantial decreases in our net sales or have a material adverse effect on our operating results, financial position and cash flows.

Our business is affected by seasonality which results in fluctuations in our operating results.
 
We experience fluctuations in aggregate sales volume during the year. Sales are typically strongest in the first and fourth quarters, followed by the third quarter, and are generally weakest in the second quarter. However, the mix of product sales may vary considerably from time to time as a result of changes in seasonal and geographic demand for particular types of fitness equipment. In addition, our customers may cancel orders, change delivery schedules or change the mix of products ordered with minimal notice. As a result, we may not be able to accurately predict our quarterly sales. Accordingly, our results of operations are likely to fluctuate significantly from period to period.
 

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Government regulatory actions could disrupt our marketing efforts and product sales.
 
Various international and U.S. federal, state and local governmental authorities, including the Federal Trade Commission, the Consumer Product Safety Commission, the Securities and Exchange Commission and the Consumer Financial Protection Bureau, regulate our product and marketing efforts. Our revenue and profitability could be significantly harmed if any of these authorities commence a regulatory enforcement action that interrupts our marketing efforts, results in a product recall or negative publicity, or requires changes in product design or marketing materials.

Substantially higher advertising rates or a significant decline in availability of media time may hinder our ability to effectively market our products and may reduce profitability.
 
We depend on television advertising to market certain products sold directly to consumers. Consequently, a marked increase in the price we must pay for our preferred media time and/or a reduction in its availability may adversely impact our financial performance.
 
We may be unable to adapt to significant changes in media consumption habits and media coverage of current events may compete for consumer attention, which could diminish the effectiveness or efficiency of our advertising.

New television technologies and services, such as video-on-demand, digital video recorders and Internet streaming services are changing traditional patterns of television viewing. Additionally, consumer attention is increasingly fragmented across a variety of games, apps, the Internet and other digital media, the balance of which may shift at any time in response to media coverage of current events and the advancement of new technologies. We believe that consumer attention to media coverage of major events like the Olympics and the U.S. presidential election have in the past impacted the effectiveness of our media advertising. Future events that draw significant media coverage may similarly impact our ability to engage consumers with our media advertising. If we are unable to successfully adapt our media strategies to new television viewing and media consumption habits, or if consumer attention is focused on other events, the effectiveness and efficiency of our media placements could be adversely affected, and our operating results may be harmed.

Our revenues could decline due to changes in credit markets and decisions made by credit providers.
 
Historically, a significant portion of our Direct sales have been financed for our customers under various programs offered by third-party consumer credit financing sources. Reductions in consumer lending and the availability of consumer credit could limit the number of customers with the financial means to purchase our products. Higher interest rates could increase monthly payments for consumer products financed through one of our financing partners or through other sources of consumer financing. In the past, we have partnered with financial service companies to assist our customers in obtaining financing to purchase our products. Our present agreements with our third party consumer credit financing providers enable certain customers to obtain financing if they qualify for the provider's private label revolving credit card. We cannot be assured that our third party financing providers will continue to provide consumers with access to credit or that credit limits under such arrangements will not be reduced. Such restrictions or reductions in the availability of consumer credit could have a material adverse impact on our results of operations, financial position and cash flows.

We may encounter difficulties in integrating acquired businesses and anticipated benefits of acquisitions may not be realized.

On December 31, 2015, we acquired all of the outstanding capital stock of OF Holdings, Inc., sole parent of Octane. The ultimate success of our acquisition of Octane, and any future acquisitions we may complete, depends, in part, on our ability to realize the anticipated synergies, channel and product diversification and growth opportunities from integrating newly-acquired businesses or assets into our existing businesses. However, the acquisition and successful integration of independent businesses or assets is a complex, costly and time-consuming process, and the benefits we realize may not meet targeted expectations. The risk and difficulties associated with acquiring and integrating companies and other assets include, among others:
Consolidating research and development, logistics, product sourcing, human resources, information technology and other aspects of the combined operations, where appropriate;
Integrating newly-acquired businesses and product lines into a uniform financial reporting system;
Coordinating sales, distribution and marketing functions and strategies across new and existing channels of trade;
Establishing or expanding manufacturing, research and development, sales, distribution and marketing functions in order to accommodate newly-acquired businesses or product lines or rationalizing these functions to take advantage of synergies;
Preserving the important licensing, research and development, manufacturing and supply, distribution, marketing, customer and other relationships of acquired businesses;

8


Minimizing the diversion of management’s attention from ongoing business concerns;
Potential loss of key employees of the acquired business;
Coordinating geographically separate operations; and
Regulatory and legal issues relating to the integration of legacy and newly-acquired businesses.

The purchase consideration and other costs and expenses of acquisitions could negatively impact our net income and earnings per share and a failure to realize the anticipated benefits of acquisitions would have a material adverse effect on our business, results of operations or financial condition.

If our contract manufacturers experience any delay, disruption or quality control problems in their operations, we could lose revenues, and our reputation and market share may be harmed.
 
We have outsourced the production of all of our products to third-party manufacturers. We rely on our contract manufacturers to procure components and provide spare parts in support of our warranty and customer service obligations. We generally commit the manufacturing of each product to a single contract manufacturer.
 
Our reliance on contract manufacturers exposes us to the following risks over which we may have limited control:
Unexpected increases in manufacturing and repair costs;
Interruptions in shipments if our contract manufacturer is unable to complete production;
Inability to completely control the quality of finished products;
Inability to completely control delivery schedules;
Changes in our contract manufacturer's business models or operations;
Potential increases in our negotiated product costs as a result of fluctuations in currency exchange rates;
Impact of the global market and economic conditions on the financial stability of our contract manufacturers and their ability to operate without requesting earlier payment terms or letters of credit;
Potential lack of adequate capacity to manufacture all or a part of the products we require; and
Potential unauthorized reproduction or counterfeiting of our products.
 
Substantially all of our contract manufacturers are located in Asia, primarily China and Taiwan, and may be subject to disruption by natural disasters, as well as political, social or economic instability. The temporary or permanent loss of the services of any of our primary contract manufacturers could cause a significant disruption in our product supply chain and operations and delays in product shipments.
 
Our third-party manufacturing contracts are generally of annual or shorter duration, or manufactured products are sourced on the basis of individual purchase orders. There is no assurance that we will be able to maintain our current relationships with these parties or, if necessary, establish future arrangements with other third-party manufacturers on commercially reasonable terms. Further, while we maintain an active quality control, factory inspection and qualification program, we cannot assure that their manufacturing and quality control processes will be maintained at a level sufficient to meet our inventory needs or prevent the inadvertent sale of substandard products. While we believe that products manufactured by our current third-party manufacturers could generally be procured from alternative sources, temporary or permanent loss of services from a significant manufacturer could cause disruption in our supply chain and operations.

Changes in international trade policy could adversely affect our business and results of operations.

All of our products are produced by third-party manufacturers, substantially all of which are located in Asia, primarily in China and Taiwan. Additionally, we make significant sales to customers worldwide, in particular to customers in Canada. Most of our imported products are subject to duties or tariffs that affect the cost and quantity of various types of goods imported into the U.S. or our other markets. The new U.S. presidential administration has indicated that it may seek changes to or withdraw the United States from various international treaties and trade arrangements. Uncertainty regarding policies affecting global trade may make it difficult for our management to accurately forecast our business, and increases in the duties, tariffs and other charges imposed on our products by the United States or other countries in which on our products are manufactured or sold, or other restraints on international trade, could negatively affect our business and the results of our operations.

Our inventory purchases are subject to long lead times, which could negatively impact our revenue, cash flows and liquidity.
 
All of our products are produced by third-party manufacturers, substantially all of which are located in Asia, primarily China and Taiwan. Lead times for inventory purchases from our Asian suppliers, from order placement to receipt of goods, generally range from approximately two to three months, of which transit time represents three-to-four weeks. The length of our lead times requires

9


us to place advance manufacturing orders based on management forecasts of future demand for our products. Due to the length of our lead times, our revenue and cash flows may be negatively impacted if we do not have sufficient inventory on hand to meet customer demand for such items. In addition, our liquidity and cash flows may be negatively affected, and inventory obsolescence may increase, if the quantity of products we order exceeds customer demand for such items.
 
A delay in getting non-U.S.-sourced products through port operations and customs in a timely manner could result in reduced sales, canceled sales orders and unanticipated inventory accumulation.
 
Our business depends on our ability to source and distribute products in a timely manner. As a result, we rely on the free flow of goods through open and operational ports worldwide. Labor disputes or other disruptions at ports create significant risks for our business, particularly if work slowdowns, lockouts, strikes or other disruptions occur during our peak importing seasons. Any of these factors could result in reduced sales, canceled sales orders and unanticipated inventory accumulation and have a material adverse effect on our operating results, financial position and cash flows.
 
Unpredictable events and circumstances relating to our international operations, including our use of non-U.S. manufacturers, could have a material adverse effect on our business.

Substantially all of our products are manufactured outside of the U.S. and a portion of our revenue is derived from sales outside the U.S., primarily in Canada, but also in markets outside North America. Accordingly, our future results could be materially adversely affected by a variety of factors pertaining to international trade, including: changes in a specific country's or region's political or economic conditions; trade restrictions; import and export licensing requirements; changes in regulatory requirements; additional efforts to comply with a variety of foreign laws and regulations; and longer payment cycles in certain countries, thus requiring us to finance customer purchases over a longer period than those made in the U.S. In addition, we rely on the performance of our employees located in foreign countries. Our ability to control the actions of these employees may be limited by the laws and regulations in effect in each country. Changes in any of the above factors could have a material adverse effect on our operating results, financial position and cash flows.

Currency exchange rate fluctuations could result in higher costs, reduced margins or decreased international sales.
 
Substantially all of our products are manufactured outside of the U.S. and, therefore, currency exchange rate fluctuations could result in higher costs for our products, or could disrupt the business of independent manufacturers that produce our products, by making their purchases of raw materials more expensive and more difficult to finance. Our future financial results could be significantly affected by the value of the U.S. dollar in relation to the foreign currencies in which we, our customers or our suppliers conduct business. Past fluctuations in currency exchange rates versus the U.S. dollar have caused our costs for certain products to increase, reducing our margins and cash flows. Similar fluctuations and cost increases may occur in the future. If we are unable to increase our selling prices to offset such cost increases, or if such increases have a negative impact on sales of our products, our revenues and margins would be reduced and our operating results and cash flows would be negatively impacted. In addition, a portion of our revenue is derived from sales outside the U.S., primarily in Canada and Europe. Currency rate fluctuations could make our products more expensive for foreign consumers and reduce our revenue, which would negatively affect our operating results and cash flows.
 
We may face competition from providers of comparable products in categories where our patent protection is limited or reduced due to patent expiration. Increased competition in those product categories could negatively affect our future revenues and operating results.

While we own a number of patents covering aspects of our TreadClimber® products, the introduction of comparable products designed to compete with our TreadClimber® line of specialized cardio machines may increase in the future as a result of certain patent expirations. Sales of cardio products, including TreadClimber® and Max Trainer® products, represent a substantial portion of our Direct segment revenues. Introduction by competitors of comparable products, a maturing product lifecycle or other factors could result in a decline in our revenues derived from these products. A significant decline in our revenue of these products, without offsetting sales gains, would have a material adverse effect on our operating results, financial position and cash flows.

Failure or inability to protect our intellectual property could significantly harm our competitive position. 

Protecting our intellectual property is an essential factor in maintaining our competitive position in the health and fitness industry. Failure to maximize or to successfully assert our intellectual property rights could impact our competitiveness. We rely on trademark, trade secret, patent and copyright laws to protect our intellectual property rights. Many factors bear upon the exclusive ownership and right to exploit intellectual properties, including, without limitation, prior rights of third parties and nonuse and/or nonenforcement by us and/or related entities. While we make efforts to develop and protect our intellectual property, the validity,

10


enforceability and commercial value of our intellectual property rights may be reduced or eliminated. We cannot be sure that our intellectual property rights will be maximized or that they can be successfully asserted. There is a risk that we will not be able to obtain and perfect our own intellectual property rights or, where appropriate, license intellectual property rights necessary to compete successfully within the marketplace for our products. We cannot be sure that these rights, if obtained, will not be invalidated, circumvented or challenged in the future. If we do not, or are unable to, adequately protect our intellectual property, then we may face difficulty in differentiating our products from those of our competitors and our business, operating results and financial condition may be adversely affected.
 
Trademark infringement or other intellectual property claims relating to our products could increase our costs.
 
Our industry is susceptible to litigation regarding trademark and patent infringement and other intellectual property rights. We could become a plaintiff or defendant in litigation involving trademark or patent infringement claims or claims for breach of a license agreement. The prosecution or defense of intellectual property litigation is both costly and disruptive of the time and resources of our management, regardless of the claim's merit. We could also be required to pay substantial damages or settlement costs to resolve intellectual property litigation or related matters.

We may not be able to successfully acquire intellectual property rights, protect existing rights, or potentially prevent others from claiming that we have violated their proprietary rights. We could incur substantial costs in defending against such claims even if they are without basis, and we could become subject to judgments or settlements requiring us to pay substantial damages, royalties or other charges.

Future impairments of intangible assets could negatively impact our operating results.

We had goodwill of $61.9 million and other intangible assets of $69.8 million as of December 31, 2016. Any future impairment charges, if significant, could materially and adversely affect our operating results. An unexpected decline in revenue, changes in market conditions, changes in competitive products or technologies or a change in management's intentions regarding utilization of intangible assets could lead to future impairment charges.

We are subject to periodic litigation, product liability risk and other regulatory proceedings, which could result in unexpected expense of time and resources.
 
From time to time, we may be a defendant in lawsuits and regulatory actions relating to our business or the former operations of our discontinued Commercial business segment. Due to the inherent uncertainties of litigation and regulatory proceedings, we cannot accurately predict the ultimate outcome of any such proceedings. An unfavorable outcome could have a material adverse impact on our business, financial condition and results of operations. In addition, any significant litigation in the future, regardless of its merits, could divert management's attention from our operations and may result in substantial legal costs.
 
We are subject to warranty claims for our products, which could result in unexpected expense.
 
Many of our products carry warranties for defects in quality and workmanship. We may experience significant expense as the result of product quality issues, product recalls or product liability claims which may have a material adverse effect on our business. We maintain a warranty reserve for estimated future warranty claims. However, the actual costs of servicing future warranty claims may exceed the reserve and have a material adverse effect on our results of operations, financial condition and cash flows.
  
Disruption to our information and communication systems could result in interruptions to our business and potential implementation of new systems for critical business functions may heighten the risk of disruption.
 
Our business is reliant on information and communication technology, and a substantial portion of our revenues are generated with the support of information and communication systems. The success of our Direct business is heavily dependent on our ability to respond to customer sales inquiries and process sales transactions using our call center communication systems, Internet websites and similar data monitoring and communication systems provided and supported by third-parties. If such systems were to fail, or experience significant or lengthy interruptions in availability or service, our revenues could be materially affected. We also rely on information systems in all stages of our product cycle, from design to distribution, and we use such systems as a method of communication between employees, suppliers and customers. In addition, we use information systems to maintain our accounting records, assist in trade receivables collection and customer service efforts, and forecast operating results and cash flows.
 
System failures or service interruptions may occur as the result of a number of factors, including: computer viruses; hacking or other unlawful activities by third parties; disasters; equipment, hardware or software failures; ineffective design or implementation of new systems or systems upgrades; cable outages, extended power failures, or our inability or failure to properly protect, repair

11


or maintain our communication and information systems. To mitigate the risk of business interruption, we have in place a disaster recovery program that targets our most critical operational systems. If our disaster recovery system is ineffective, in whole or in part, or efforts conducted by us or third-parties to prevent or respond to system interruptions in a timely manner are ineffective, our ability to conduct operations would be significantly affected. If we do not consider the potential impact of critical decisions related to systems or process design and implementation, this could lead to operational challenges and increased costs. Any of the aforementioned factors could have a material adverse effect on our operating results, financial position and cash flows.

System security risks, data protection breaches and cyber-attacks could disrupt our operations.

We manage and store various proprietary information and sensitive or confidential data relating to our business, including sensitive and personally identifiable information. Breaches of our security measures or the accidental loss, inadvertent disclosure or unapproved dissemination of proprietary information or sensitive or confidential data about us, or our customers, including the potential loss or disclosure of such information or data as a result of fraud, trickery or other forms of deception, could expose us, our customers or the individuals affected to a risk of loss or misuse of this information, result in litigation and potential liability for us, damage our brand and reputation or otherwise harm our business. In addition, the cost and operational consequences of implementing further data protection measures could be significant.

Experienced computer programmers and hackers may be able to penetrate our network security and misappropriate or compromise our confidential information or that of third parties, create system disruptions or cause shutdowns. Computer programmers and hackers also may be able to develop and deploy viruses, worms and other malicious software programs that attack or otherwise exploit any security vulnerabilities of our systems. In addition, sophisticated hardware and operating system software and applications that we procure from third parties may contain defects in design or manufacture, including "bugs" and other problems that could unexpectedly interfere with the operation of the system. The costs to us to eliminate or alleviate cyber or other security problems, bugs, viruses, worms, malicious software programs and security vulnerabilities could be significant, and our efforts to address these problems may not be successful and could result in interruptions, delays, cessation of service and loss of existing or potential customers that may impede our revenue, manufacturing, distribution or other critical functions.

Item 1B. Unresolved Staff Comments

None.

Item 2. Properties

Following is a summary of each of our properties as of December 31, 2016:
Company
 
Location
 
Primary Function(s)
 
Owned or
Leased
Nautilus
 
Washington
 
Corporate headquarters, customer call center, retail store and R&D facility
 
Leased
Octane
 
Minnesota
 
Design, sales, service and R&D facility
 
Leased
Nautilus
 
Ohio
 
Warehouse and distribution facility
 
Leased
Nautilus
 
Oregon
 
Warehouse and distribution facility
 
Leased
Nautilus
 
China
 
Quality assurance office
 
Leased
Octane
 
Indonesia
 
Sales office
 
Leased
Octane
 
Netherlands
 
Sales and service office
 
Leased

The Nautilus properties are used by both our Direct and Retail segments, and the Octane properties are primarily used for our Retail segment. The properties generally are well-maintained, adequate and suitable for their intended purposes, and we believe our existing properties will meet our operational needs for the foreseeable future. If we require additional warehouse or office space in the future, we believe we will be able to obtain such space on commercially reasonable terms.

Item 3. Legal Proceedings

Patent Infringement Case
In 2004, we were sued in the Southern District of New York by BioSig Instruments, Inc. for alleged patent infringement in connection with our incorporation of heart rate monitors into certain cardio products. No significant activity in the litigation occurred until 2008. In 2012, the U.S. District Court granted summary judgment to us on grounds that BioSig’s patents were invalid as a matter of law. BioSig appealed the grant of summary judgment and, in April 2013, the U.S. Court of Appeals for the Federal Circuit reversed the District Court’s decision on summary judgment and remanded the case to the District Court for further proceedings. On January 10, 2014, the U. S. Supreme Court granted our petition for a writ of certiorari to address the legal standard applied by the Federal Circuit in determining whether the patents may be valid under applicable law. The case was argued before the Supreme Court on April 28, 2014. By decision dated June 2, 2014, the Supreme Court unanimously reversed the Federal Circuit, holding that its standard of when a patent may be “indefinite” was incorrect and remanding to the Federal Circuit for reconsideration under the correct standard. The remand hearing in the Federal Circuit was held on October 29, 2014. By decision dated April 27, 2015, the same panel of the Federal Circuit affirmed its earlier reversal of the District Court’s decision on summary

12


judgment. On May 27, 2015, we filed a petition for a rehearing en banc in the Federal Circuit, which was denied on August 4, 2015 and a Petition for Review by the U. S. Supreme Court which was also denied. The case has been returned to the District Court, and the parties are currently engaged in discovery and other pre-trial motion practice. We do not believe that our use of heart rate monitors utilized or purchased from third parties, and otherwise, infringes the BioSig patents.

In addition to the matter described above, 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 4. Mine Safety Disclosures

Not applicable.

13



PART II

Item 5. Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

Market for our Common Stock
Our common stock is listed on the New York Stock Exchange (the “NYSE”) and trades under the symbol “NLS.” As of February 24, 2017, there were 45 holders of record of our common stock and approximately 10,500 beneficial shareholders. The following table sets forth the high and low sales prices of our common stock for each period presented:
 
High
 
Low
2016
 
 
 
Quarter 1
$
21.04

 
$
16.80

Quarter 2
$
21.10

 
$
16.80

Quarter 3
$
24.99

 
$
17.68

Quarter 4
$
22.59

 
$
15.65

2015
 
 
 
Quarter 1
$
15.97

 
$
14.13

Quarter 2
$
22.81

 
$
15.42

Quarter 3
$
22.63

 
$
14.15

Quarter 4
$
19.68

 
$
14.57


We did not pay any dividends on our common stock in 2016 or 2015, and we currently have no plans to pay dividends on our common stock in future periods. Payment of any future dividends, in accordance with our borrowing arrangements, is at the discretion of our Board of Directors, which considers various factors such as our financial condition, operating results, current and anticipated cash needs and future expansion plans.

Equity Compensation Plans
See Part III, Item 12 for equity compensation plan information.

Issuer Purchases of Equity Securities
The following table provides information about our repurchases of our equity securities during the fourth quarter ended December 31, 2016. See Note 17 of Notes to Consolidated Financial Statements for information regarding our public share repurchase programs.
Period
(a)




Total Number of
Shares Purchased
(1)
(b)



Average
Price Paid
per Share
(c)

Total Number of Shares Purchased
as Part of Publicly Announced Plans or Programs
 (2),(3)
(d)

Approximate Dollar
Value of Shares that May Yet Be Purchased Under the Plans or Programs
(2),(3)
October 1 - October 31
79,586
$17.78
78,609
$12,034,844
November 1 - November 30
241,196
16.55
241,196
8,042,118
December 1 - December 31
8,042,118
Total
320,782
$16.86
319,805
$8,042,118
 
 
 
 
 
(1)  Includes shares withheld from the vesting portions of stock unit awards made to certain management personnel to satisfy their tax withholding obligations incident to said vesting.
(2)  On November 3, 2014, our Board of Directors approved a stock repurchase program that authorized us to repurchase up to $15.0 million of our outstanding common stock from time to time over a period of 24 months. We repurchased the full $15.0 million, and the original repurchase program expired on November 3, 2016.
(3)  On May 4, 2016, our Board of Directors approved an expansion of our stock repurchase program that authorized us to repurchase up to an additional $10.0 million of our outstanding common stock from time to time during the period of 24 months following such approval. The repurchase program expansion expires on May 4, 2018.

14


Stock Performance Graph
The graph below compares the cumulative total stockholder return of our common stock with the cumulative total return of the NYSE Composite Index and the S&P SmallCap 600 index for the period commencing December 31, 2011 and ending on December 31, 2016. The S&P SmallCap 600 was chosen because we do not believe we can reasonably identify an industry index or specific peer issuer that would offer a meaningful comparison. The S&P SmallCap 600 represents a broad-based index of companies with similar market capitalization.
 
The graph assumes $100 was invested, on December 31, 2011, in our common stock and each index presented. The comparisons in the table below are not intended to forecast or be indicative of future performance of our common stock.s102dataforstockperformanceg.jpg

15


Item 6. Selected Financial Data

The following selected consolidated financial data should be read in connection with our audited consolidated financial statements and related notes thereto and with Management's Discussion and Analysis of Financial Condition and Results of Operations, which are included elsewhere in this Form 10-K. The consolidated statements of operations data for fiscal years 2016, 2015 and 2014, and the selected consolidated balance sheets data as of December 31, 2016 and 2015 are derived from, and are qualified by reference to, the audited consolidated financial statements which are included in this Form 10-K. The consolidated statements of operations data for fiscal 2013 and 2012 and the consolidated balance sheets data as of December 31, 2014, 2013 and 2012 are derived from audited consolidated financial statements which are not included in this Form 10-K.
 
 
For the Year Ended December 31,
(In thousands, except per share amounts)
 
2016
 
2015
 
2014
 
2013
 
2012
Consolidated Statements of Operations Data
 
 
 
 
 
 
 
 
 
 
Net sales
 
$
406,039

 
$
335,764

 
$
274,447

 
$
218,803

 
$
193,926

Cost of sales
 
194,514

 
162,530

 
133,872

 
112,326

 
102,889

Gross profit
 
211,525

 
173,234

 
140,575

 
106,477

 
91,037

 
 
 
 
 
 
 
 
 
 
 
Operating expenses:
 
 
 
 
 
 
 
 
 
 
  Selling and marketing
 
115,437

 
101,618

 
81,059

 
66,486

 
58,617

  General and administrative
 
28,775

 
21,441

 
22,131

 
18,705

 
17,669

  Research and development
 
13,919

 
9,904

 
7,231

 
5,562

 
4,163

    Total operating expenses
 
158,131

 
132,963

 
110,421

 
90,753

 
80,449

 
 
 
 
 
 
 
 
 
 
 
Operating income
 
53,394

 
40,271

 
30,154

 
15,724

 
10,588

 
 
 
 
 
 
 
 
 
 
 
Other income (expense):
 
 
 
 
 
 
 
 
 
 
  Interest income
 
234

 
218

 
63

 
14

 
18

  Interest expense
 
(1,928
)
 
(22
)
 
(25
)
 
(36
)
 
56

  Other, net
 
(119
)
 
(445
)
 
32

 
337

 
(246
)
    Total other income (expense)
 
(1,813
)
 
(249
)
 
70

 
315

 
(172
)
 
 
 
 
 
 
 
 
 
 
 
Income from continuing operations before income taxes
 
51,581

 
40,022

 
30,224

 
16,039


10,416

Income tax expense (benefit)(1)
 
16,480

 
13,219

 
9,841

 
(32,085
)
 
(226
)
Income from continuing operations
 
35,101

 
26,803

 
20,383

 
48,124

 
10,642

Income (loss) from discontinued operations
 
(923
)
 
(201
)
 
(1,588
)
 
(170
)
 
6,241

Net income
 
$
34,178

 
$
26,602

 
$
18,795

 
$
47,954

 
$
16,883

 
 
 
 
 
 
 
 
 
 
 
Basic income per share from continuing operations
 
$
1.13

 
$
0.86

 
$
0.65

 
$
1.55

 
$
0.34

Basic income (loss) per share from discontinued operations
 
(0.03
)
 
(0.01
)
 
(0.05
)
 
(0.01
)
 
0.21

Basic net income per share
 
$
1.10

 
$
0.85

 
$
0.60

 
$
1.54

 
$
0.55

 
 
 
 
 
 
 
 
 
 
 
Diluted income per share from continuing operations
 
$
1.12

 
$
0.85

 
$
0.64

 
$
1.53

 
$
0.34

Diluted income (loss) per share from discontinued operations
 
(0.03
)
 
(0.01
)
 
(0.05
)
 
(0.01
)
 
0.21

Diluted net income per share
 
$
1.09

 
$
0.84

 
$
0.59

 
$
1.52

 
$
0.55

 
 
 
 
 
 
 
 
 
 
 
Shares used in per share calculations:
 

 
 
 
 
 
 
 
 
  Basic
 
31,032

 
31,288

 
31,253

 
31,072

 
30,851

  Diluted
 
31,301

 
31,589

 
31,688

 
31,457

 
30,974

 
 
 
 
 
 
 
 
 
 
 
 
 
As of December 31,
Consolidated Balance Sheets Data
 
2016
 
2015
 
2014
 
2013
 
2012
Cash and investments(2)
 
$
79,617

 
$
60,776

 
$
72,190

 
$
40,979

 
$
23,207

Working capital(2)
 
84,951

 
69,373

 
83,080

 
45,662

 
25,410

Total assets
 
333,066

 
315,912

 
175,654

 
143,567

 
94,311

Long-term note payable, net of current portion(3)
 
47,979

 
63,971

 

 

 

Other long-term liabilities
 
25,825

 
29,432

 
4,911

 
4,077

 
6,508

Total shareholders' equity
 
160,857

 
126,991

 
111,072

 
91,565

 
43,326



16


(1) 
Income tax benefit in 2013 includes a $38.9 million credit related to the reversal of our deferred tax asset valuation allowance.
 
 
(2) 
The decreases in cash and investments and working capital at December 31, 2015 compared to December 31, 2014 were primarily due to our purchase of Octane on December 31, 2015. See Note 2 of Notes to Consolidated Financial Statements for additional information.
 
 
(3) 
The increase in long-term notes payable at December 31, 2015 compared to December 31, 2014 was due to our purchase of Octane on December 31, 2015. See Notes 2 and 13 of Notes to Consolidated Financial Statements for additional information.

Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations

You should read the following discussion and analysis of our financial condition and results of operations together with the consolidated financial statements and related notes that are included in Part II, Item 8 of this Form 10-K. This discussion contains forward-looking statements based upon current expectations that involve risks and uncertainties.

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, 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 any future growth or profitability. For more information, see our discussion of Risk Factors located at Part I, Item 1A of this Form 10-K.

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 in 2016 were $406.0 million, an increase of $70.3 million, or 20.9%, compared to net sales of $335.8 million in 2015. Net sales of our Direct segment decreased $0.5 million, or 0.2%, compared to 2015, primarily due to decreased consumer demand for our TreadClimber® cardio products, partially offset by growth in the Max Trainer® product line. Net sales of our Retail segment increased by $71.7 million, or 67.5% in 2016, compared to 2015, primarily due to the acquisition of Octane Fitness, coupled with strong organic growth in the segment.

Income from continuing operations was $35.1 million, or $1.12 per diluted share, in 2016, compared to $26.8 million, or $0.85 per diluted share, in 2015. Income from continuing operations in 2016 included a non-recurring tax benefit of $2.7 million related to the release of previously unrecognized tax benefits associated with certain non-U.S. filing positions, which resulted from

17


completing the deregistration of a certain foreign entity. In 2015, income from continuing operations included a $2.4 million credit related to the reversal of our deferred tax asset valuation allowance. Further, results for 2015 were negatively impacted by several unusual items including the following: settlement expense related to a licensing arbitration ($2.5 million); write-off of nutrition inventory ($1.4 million); unrecorded current period royalty revenue and reversal of prior period royalty revenue related to a dispute with the licensee ($1.4 million); an accounts receivable reserve related to potentially uncollectible balances from a large sporting goods retailer ($0.9 million); and transaction expenses related to the acquisition of Octane ($0.6 million). Without consideration of the reversals of deferred tax asset valuation allowances and the other unusual items noted above, the improvement in our results from continuing operations in 2016, compared to 2015, was driven primarily by higher sales and increased operating income in both our Direct and Retail segments.

Net income was $34.2 million, or $1.09 per diluted share, in 2016, compared to $26.6 million, or $0.84 per diluted share, in 2015.

BUSINESS ACQUISITION

On December 31, 2015, we acquired all of the outstanding capital stock of OF Holdings, Inc., sole parent of Octane, for an aggregate base purchase price of $115.0 million, plus adjustments for working capital and cash on the closing date. We funded the acquisition through an $80.0 million term loan and cash on hand. Based in Brooklyn Park, Minnesota, Octane is a leader in zero-impact training with a line of fitness equipment focused on Retail specialty and commercial channels. The acquisition of Octane strengthened and diversified our brand portfolio, broadened our distribution and deepened our talent pool. Octane's business is highly complementary to our existing business from both product and channel perspectives and is expected to create numerous revenue synergies for us.

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 2016, 2015 or 2014, we continue to incur legal and accounting expenses as we work with authorities on final deregistration of each international entity, as well as product liability and other legal expenses associated with product previously sold into the Commercial channel.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

The preparation of financial statements in conformity with generally accepted accounting principles requires estimates and assumptions that affect the reported amounts of assets and liabilities, revenues and expenses, and related disclosures of contingent assets and liabilities in the consolidated financial statements. An accounting estimate is considered to be critical if it meets both of the following criteria: (i) the estimate requires assumptions about matters that are highly uncertain at the time the accounting estimate is made, and (ii) different estimates reasonably could have been used, or changes in the estimate that are reasonably likely to occur from period to period may have a material impact on the presentation of our financial condition, changes in financial condition or results of operations.

Our critical accounting policies and estimates are discussed below. We have not made any material changes in the methodologies we use in our critical accounting estimates during the past three fiscal years. If our assumptions or estimates change in future periods, the impact on our financial position and operating results could be material.

Business Combinations
The Company accounts for its business combinations under the provisions of Accounting Standards Codification ("ASC") Topic 805-10, Business Combinations ("ASC 805-10"), which requires that the purchase method of accounting be used for all business combinations.  Assets acquired and liabilities assumed, including non-controlling interests, are recorded at the date of acquisition at their respective fair values.  ASC 805-10 also specifies criteria that intangible assets acquired in a business combination must meet to be recognized and reported apart from goodwill.  Goodwill represents the excess purchase price over the fair value of the tangible net assets and intangible assets acquired in a business combination.  Acquisition-related expenses are recognized separately from the business combinations and are expensed as incurred.  


The estimated fair value of net assets acquired, including the allocation of the fair value to identifiable assets and liabilities, was determined using third-party valuations.  The estimated fair value of the net assets acquired was determined using the income approach to valuation based on the discounted cash flow method.  Under this method, expected future cash flows of the business on a stand-alone basis are discounted back to a present value.  The estimated fair value of identifiable intangible assets, consisting of trade names, patents and customer relationships were determined using the relief-from-royalty method for trade names and patents, and the multi-period excess earnings method for the customer relationships.

18



The most significant assumptions under the relief of royalty method used to value trade names and patents include: projected revenue attributable to the products or services using the asset, estimated economic life of the asset, royalty rate and discount rate. Significant assumptions under the multi-period excess earnings method include: forecasted revenue and earnings generated by the asset, expected economic life of the asset, contributory asset charges, and discount rate.  

Management has developed these assumptions on the basis of historical knowledge of the business and projected financial information of the Company.  These assumptions may vary based on future events, perceptions of different market participants and other factors outside the control of management, and such variations may be significant to estimated values.
 
Revenue Recognition
Direct and Retail product sales and shipping revenues are recorded when products are shipped and title passes to customers. In most instances, Retail sales to customers are made pursuant to a sales contract that provides for transfer of both title and risk of loss to the customer upon our delivery to the carrier. For Direct sales, revenue is generally recognized when product is shipped. Revenue is recognized net of applicable sales incentives, such as promotional discounts, rebates and return allowances. We estimate the revenue impact of incentive programs based on the planned duration of the program and historical experience.

Sales Discounts and Allowances
Product sales and shipping revenues are reported net of promotional discounts and return allowances. We estimate the revenue impact of retail sales incentive programs based on the planned duration of the program and historical experience. If the amount of sales incentives is reasonably estimable, the impact of such incentives is recorded at the later of the time the customer is notified of the sales incentive or the time of the sale. We estimate our liability for product returns based on historical experience and record the expected obligation as a reduction of revenue. If actual return costs differ from previous estimates, the amount of the liability and corresponding revenue are adjusted in the period in which such costs occur.
 
Our calculations of amounts owed for sales discounts and allowances contain uncertainties because they require management to make assumptions in interim periods and to apply judgment regarding a number of factors, including estimated future customer purchases and returns.

Goodwill and Other Long-Term Assets Valuation
We evaluate our indefinite-lived intangible assets and goodwill for potential impairment annually or when events or circumstances indicate their carrying value may be impaired. Definite-lived intangible assets, including acquired trade names, customer relationships, patents and patent rights, and other long-lived assets, primarily property, plant and equipment, are evaluated for impairment when events or circumstances indicate the carrying value may be impaired. No goodwill or other long-term asset impairment charges were recognized in 2016, 2015 or 2014.

Our impairment evaluations contain uncertainties because they require management to make assumptions and to apply judgment in order to estimate future cash flows and asset fair values. Our judgments regarding potential impairment are based on a number of factors including: the timing and amount of anticipated cash flows; market conditions; relative levels of risk; the cost of capital; terminal values; royalty rates; and the allocation of revenues, expenses and assets and liabilities to reporting units. Each of these factors can significantly affect the value of our goodwill or other long-term assets and, thereby, could have a material adverse effect on our financial position and results of operations.

Product Warranty Obligations
Our products carry defined warranties for defects in materials or workmanship. Our product warranties generally obligate us to pay for the cost of replacement parts, cost of shipping the parts to our customers and, in certain instances, service labor costs. At the time of sale, we record a liability for the estimated costs of fulfilling future warranty claims. The estimated warranty costs are recorded as a component of cost of sales, based on historical warranty claim experience and available product quality data. If necessary, we adjust our liability for specific warranty matters when they become known and are reasonably estimable. Our estimates of warranty expenses are based on significant judgment, and the frequency and cost of warranty claims are subject to variation. Warranty expenses are 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 variances in expected repair costs.


19


Litigation and Loss Contingencies
From time to time, we may be involved in claims, lawsuits and other proceedings. Such matters involve uncertainty as to the eventual outcomes and any losses or gains we may ultimately realize when one or more future events occur or fail to occur. We record expenses for litigation and loss contingencies when it is probable that a liability has been incurred and the amount of the loss can be reasonably estimated. We estimate the probability of such losses based on the advice of internal and external counsel, outcomes from similar litigation, status of the lawsuits (including settlement initiatives), legislative developments and other factors.

Due to the numerous variables associated with these judgments and assumptions, both the precision and reliability of the resulting estimates of the related loss contingencies are subject to substantial uncertainties. We regularly monitor our estimated exposure to these contingencies and, as additional information becomes known, we may change our estimates accordingly.

Deferred Tax Assets - Valuation Allowance
We account for income taxes based on the asset and liability method, whereby deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts and the tax basis of existing assets and liabilities. Deferred tax assets and liabilities are measured using the enacted tax rates that are expected to be in effect when the temporary differences are expected to be included, as income or expense, in the applicable tax return. The effect of a change in tax rates on our deferred tax assets and liabilities is recognized in the period of the enactment.

We have recorded a valuation allowance to reduce our deferred income tax assets to the amount we believe is more likely than not to be realized. Each quarter, we assess the total weight of positive and negative evidence including cumulative income or loss for the past three years and forecasted taxable income and re-evaluate whether any adjustments or release of all or any portion of valuation allowance is appropriate. As a result of this evaluation, in 2014, we determined that a portion of the existing valuation allowance against state net operating loss deferred tax assets was no longer necessary. Accordingly, an income tax benefit of $1.2 million was recorded in the fourth quarter of 2014 related to the reduction of our existing valuation allowance. Further, in the fourth quarter of 2015, after re-evaluating the potential realization of the remainder of our deferred income tax assets, we concluded that, as of December 31, 2015, the existing valuation allowance against the foreign tax credit deferred tax assets, as well as substantially all of the remaining state net operating loss deferred tax assets, were no longer necessary. As such, an income tax benefit of $2.4 million was recorded in the fourth quarter of 2015 related to the reduction of our existing valuation allowance.

As of December 31, 2016, we had a valuation allowance against net deferred income tax assets of $0.9 million. If our assumptions change and we determine we will be able to realize any portion of deferred income tax assets, the tax benefits related to any reversal of the valuation allowance will be accounted for in the period in which we make such determination. Likewise, should we determine that we would not be able to realize our deferred income tax assets in the future, an adjustment to the valuation allowance to reserve for the deferred income tax assets would increase expense in the period such determination is made.

Unrecognized Tax Benefits
Significant judgments are required in determining tax provisions and evaluating tax positions. Such judgments require us to interpret existing tax law and other published guidance as applied to our circumstances. If our financial results or other relevant facts change, thereby impacting the likelihood of realizing the tax benefit of an uncertain tax position, significant judgment would be applied in determining the effect of the change. A tax benefit from an uncertain tax position may be recognized when it is more likely than not that the position will be sustained based on the technical merits of the position upon examination, including resolutions of any related appeals or litigation.



20


RESULTS OF OPERATIONS

The discussion that follows should be read in conjunction with our consolidated financial statements and the related notes in this report. All comparisons to prior year results are in reference to continuing operations only in each period, unless otherwise indicated.

Results of operations information was as follows (in thousands):
 
 
Year Ended December 31,
 
 
 
 
 
2016
 
2015
 
Change
 
% Change
Net sales
$
406,039

 
$
335,764

 
$
70,275

 
20.9
%
Cost of sales
194,514

 
162,530

 
31,984

 
19.7
%
Gross profit
211,525

 
173,234

 
38,291

 
22.1
%
Operating expenses:
 
 
 
 
 
 


Selling and marketing
115,437

 
101,618

 
13,819

 
13.6
%
General and administrative
28,775

 
21,441

 
7,334

 
34.2
%
Research and development
13,919

 
9,904

 
4,015

 
40.5
%
Total operating expenses
158,131

 
132,963

 
25,168

 
18.9
%
Operating income
53,394

 
40,271

 
13,123

 
32.6
%
Other income (expense):
 
 
 
 


 
 
Interest income
234

 
218

 
16

 
 
Interest expense
(1,928
)
 
(22
)
 
(1,906
)
 
 
Other, net
(119
)
 
(445
)
 
326

 
 
Total other income (expense), net
(1,813
)
 
(249
)
 
(1,564
)
 
 
Income before income taxes
51,581

 
40,022

 
11,559

 
 
Income tax expense
16,480

 
13,219

 
3,261

 
 
Income from continuing operations
35,101

 
26,803

 
8,298

 
 
Loss from discontinued operations, net of income taxes
(923
)
 
(201
)
 
(722
)
 
 
Net income
$
34,178

 
$
26,602

 
$
7,576

 
 
 
 
Year Ended December 31,
 
 
 
 
 
2015
 
2014
 
Change
 
% Change
Net sales
$
335,764

 
$
274,447

 
$
61,317

 
22.3
 %
Cost of sales
162,530

 
133,872

 
28,658

 
21.4
 %
Gross profit
173,234

 
140,575

 
32,659

 
23.2
 %
Operating expenses:
 
 
 
 
 
 


Selling and marketing
101,618

 
81,059

 
20,559

 
25.4
 %
General and administrative
21,441

 
22,131

 
(690
)
 
(3.1
)%
Research and development
9,904

 
7,231

 
2,673

 
37.0
 %
Total operating expenses
132,963

 
110,421

 
22,542

 
20.4
 %
Operating income
40,271

 
30,154

 
10,117

 
33.6
 %
Other income (expense):
 
 
 
 


 
 
Interest income
218

 
63

 
155

 
 
Interest expense
(22
)
 
(25
)
 
3

 
 
Other, net
(445
)
 
32

 
(477
)
 
 
Total other income (expense), net
(249
)
 
70

 
(319
)
 
 
Income before income taxes
40,022

 
30,224

 
9,798

 
 
Income tax expense
13,219

 
9,841

 
3,378

 
 
Income from continuing operations
26,803

 
20,383

 
6,420

 
 
Loss from discontinued operations, net of income taxes
(201
)
 
(1,588
)
 
1,387

 
 
Net income
$
26,602

 
$
18,795

 
$
7,807

 
 

21



Results of operations information by segment was as follows (in thousands):
 
Year Ended December 31,
 
 
 
 
 
2016
 
2015
 
Change
 
% Change
Net sales:
 
 
 
 
 
 
 
Direct
$
225,057

 
$
225,595

 
$
(538
)
 
(0.2
)%
Retail
177,920

 
106,195

 
71,725

 
67.5
 %
Royalty
3,062

 
3,974

 
(912
)
 
(22.9
)%
 
$
406,039

 
$
335,764

 
$
70,275

 
20.9
 %
 
 
 
 
 
 
 
 
Cost of sales:
 
 
 
 
 
 
 
Direct
$
75,390

 
$
83,238

 
$
(7,848
)
 
(9.4
)%
Retail
119,080

 
79,292

 
39,788

 
50.2
 %
Royalty
44

 

 
44

 
 %
 
$
194,514

 
$
162,530

 
$
31,984

 
19.7
 %
Gross profit:
 
 
 
 
 
 
 
Direct
$
149,667

 
$
142,357

 
$
7,310

 
5.1
 %
Retail
58,840

 
26,903

 
31,937

 
118.7
 %
Royalty
3,018

 
3,974

 
(956
)
 
(24.1
)%
 
$
211,525

 
$
173,234

 
$
38,291

 
22.1
 %
Gross margin:
 
 
 
 
 
 
 
Direct
66.5
%
 
63.1
%
 
340

 basis points
Retail
33.1
%
 
25.3
%
 
780

 basis points

 
Year Ended December 31,
 
 
 
 
 
2015
 
2014
 
Change
 
% Change
Net sales:
 
 
 
 
 
 
 
Direct
$
225,595

 
$
175,593

 
$
50,002

 
28.5
 %
Retail
106,195

 
93,223

 
12,972

 
13.9
 %
Royalty
3,974

 
5,631

 
(1,657
)
 
(29.4
)%
 
$
335,764

 
$
274,447

 
$
61,317

 
22.3
 %
 
 
 
 
 
 
 
 
Cost of sales:
 
 
 
 
 
 
 
Direct
$
83,238

 
$
64,362

 
$
18,876

 
29.3
 %
Retail
79,292

 
69,510

 
9,782

 
14.1
 %
 
$
162,530

 
$
133,872

 
$
28,658

 
21.4
 %
Gross profit:
 
 
 
 
 
 
 
Direct
$
142,357

 
$
111,231

 
$
31,126

 
28.0
 %
Retail
26,903

 
23,713

 
3,190

 
13.5
 %
Royalty
3,974

 
5,631

 
(1,657
)
 
(29.4
)%
 
$
173,234

 
$
140,575

 
$
32,659

 
23.2
 %
Gross margin:
 
 
 
 
 
 
 
Direct
63.1
%
 
63.3
%
 
(20
)
 basis points
Retail
25.3
%
 
25.4
%
 
(10
)
 basis points


22


The following tables compare the net sales of our major product lines within each business segment (in thousands):
 
Year Ended December 31,
 
 
 
 
 
2016
 
2015
 
Change
 
% Change
Direct net sales:
 
 
 
 
 
 
 
Cardio products(1)
$
209,569

 
$
210,578

 
$
(1,009
)
 
(0.5
)%
Strength products(2)
15,488

 
15,017

 
471

 
3.1
 %
 
225,057

 
225,595

 
(538
)
 
(0.2
)%
Retail net sales:
 
 
 
 
 
 
 
Cardio products(1)
135,562

 
63,762

 
71,800

 
112.6
 %
Strength products(2)
42,358

 
42,433

 
(75
)
 
(0.2
)%
 
177,920

 
106,195

 
71,725

 
67.5
 %
 
 
 
 
 
 
 
 
Royalty income
3,062

 
3,974

 
(912
)
 
(22.9
)%
 
$
406,039

 
$
335,764

 
$
70,275

 
20.9
 %

 
Year Ended December 31,
 
 
 
 
 
2015
 
2014
 
Change
 
% Change
Direct net sales:
 
 
 
 
 
 
 
Cardio products(1)
$
210,578

 
$
160,249

 
$
50,329

 
31.4
 %
Strength products(2)
15,017

 
15,344

 
(327
)
 
(2.1
)%
 
225,595

 
175,593

 
50,002

 
28.5
 %
Retail net sales:
 
 
 
 
 
 
 
Cardio products(1)
63,762

 
56,262

 
7,500

 
13.3
 %
Strength products(2)
42,433

 
36,961

 
5,472

 
14.8
 %
 
106,195

 
93,223

 
12,972

 
13.9
 %
 
 
 
 
 
 
 
 
Royalty income
3,974

 
5,631

 
(1,657
)
 
(29.4
)%
 
$
335,764

 
$
274,447

 
$
61,317

 
22.3
 %
 
 
 
 
 
 
 
 
(1)   Cardio products include: MaxTrainer®, TreadClimber®, Zero Runner®, treadmills, exercise bikes and ellipticals.
(2)   Strength products include: home gyms, selectorized dumbbells, kettlebell weights and accessories.

Net Sales and Cost of Sales

Direct

The 0.2% decrease in year-over-year Direct net sales for 2016 compared to 2015 was primarily due to decreased consumer demand for our TreadClimber® cardio products, partially offset by growth in the Max Trainer® cardio product line and a 3.1% increase in strength products. The 28.5% increase in year-over-year Direct net sales for 2015 compared to 2014 was due primarily to growth of the Max Trainer®cardio product line, partially offset by declines in TreadClimber® cardio products and a 2.1% decline in strength products. The business also benefited from higher U.S. consumer credit approval rates in both years.

Combined consumer credit approvals by our primary and secondary U.S. third-party financing providers were 50.6% in 2016 compared to 48.1% in 2015 and 41.4% in 2014.

The decrease in Direct cost of sales in 2016 compared to 2015 was related to improvements in product mix and supply chain efficiencies. In addition, unusual items that occurred in 2015, including an arbitration settlement of $2.5 million and write-off of nutrition inventory of $1.4 million, contributed to the decrease in the year-over-year cost of sales for 2016 compared to 2015.

The majority of the increase in Direct cost of sales in 2015 compared to 2014 was related to the growth in Direct net sales. In addition, unusual items including an arbitration settlement of $2.5 million and write-off of nutrition inventory of $1.4 million contributed to the increase in the year-over-year cost of sales for 2015 compared to 2014.

23



The 340 basis point increase in the gross margin of our Direct business for 2016 compared to 2015 was primarily driven by the arbitration settlement and reserves for nutrition product inventory discussed above, as well as improvements in product mix and improved supply chain efficiencies.

The 20 basis point decrease in the gross margin of our Direct business for 2015 compared to 2014 was primarily driven by the aforementioned unusual items in 2015.

Retail

The 67.5% increase in Retail net sales in 2016 compared to 2015 was driven primarily by increased sales of our cardio products, due to the acquisition of Octane Fitness, coupled with growth in organic product sales.

The 13.9% increase in Retail net sales in 2015 compared to 2014 was driven primarily by increased sales of our cardio products. The 13.3% increase in Retail cardio sales for 2015 compared to 2014 was primarily due to the strong acceptance of our new line of cardio products introduced in the third quarter of 2013, along with additional cardio products launched in the third quarter of 2014. Net sales of strength products in the Retail business increased 14.8% in 2015 compared to 2014, primarily driven by higher sales of SelectTech® dumbbells.

The increases in Retail cost of sales in 2016 compared to 2015, and in 2015 compared to 2014, were due to the increases in Retail net sales mentioned above.

The 780 basis point increase in Retail gross margin in 2016 compared to 2015 was primarily due to the acquisition of Octane Fitness, which had a higher gross margin, coupled with improvements in product mix and supply chain efficiencies.

The 10 basis point decrease in Retail gross margin in 2015 compared to 2014 was primarily due to unfavorable product and customer mix as increased treadmill sales drove product mix and currency exchange rates negatively impacted international sales.

Selling and Marketing
Dollars in thousands
Year Ended December 31,
 
Change
 
2016
 
2015
 
$
 
%
Selling and marketing
$115,437
 
$101,618
 
$13,819
 
13.6%
As % of net sales
28.4%
 
30.3%
 
 
 
 
Dollars in thousands
Year Ended December 31,
 
Change
 
2015
 
2014
 
$
 
%
Selling and marketing
$101,618
 
$81,059
 
$20,559
 
25.4%
As % of net sales
30.3%
 
29.5%
 
 
 
 

The increase in selling and marketing in 2016 compared to 2015 was primarily due to incremental sales and marketing expenses of $10.3 million related to the acquisition of Octane Fitness, coupled with a $4.9 million increase in media advertising, partially offset by decreased program costs of $0.8 million.

The increase in selling and marketing in 2015 compared to 2014 was primarily due to increases in media advertising of $12.1 million, as well as increased variable sales expenses and program costs of $6.5 million and $0.9 million, respectively.

The decrease in sales and marketing as a percentage of net sales in 2016 compared to 2015 was primarily due to the acquisition of Octane and growth in the organic Retail business, both of which have a lower selling and marketing expense percentage than the company-wide average.

The increase in sales and marketing as a percentage of net sales in 2015 compared to 2014 was primarily due to the increased investment in media advertising, as well as new marketing initiatives intended to broaden the reach of Direct products to the consumer.


24


Media advertising expense of our Direct business is the largest component of selling and marketing and was as follows:
Dollars in thousands
Year Ended December 31,
 
Change
 
2016
 
2015
 
$
 
%
Media advertising
$59,638
 
$54,756
 
$4,882
 
8.9%
Dollars in thousands
Year Ended December 31,
 
Change
 
2015
 
2014
 
$
 
%
Media advertising
$54,756
 
$42,643
 
$12,113
 
28.4%

We continued to increase investment in media during 2016 to grow sales of the Max Trainer® and optimize TreadClimber® sales.

General and Administrative
Dollars in thousands
Year Ended December 31,
 
Change
 
2016
 
2015
 
$
 
%
General and administrative
$28,775
 
$21,441
 
$7,334
 
34.2%
As % of net sales
7.1%
 
6.4%
 
 
 
 
Dollars in thousands
Year Ended December 31,
 
Change
 
2015
 
2014
 
$
 
%
General and administrative
$21,441
 
$22,131
 
$(690)
 
(3.1)%
As % of net sales
6.4%
 
8.1%
 
 
 
 

The increase in general and administrative in 2016 compared to 2015 was attributable to the inclusion of the Octane business in the amount of $3.8 million and amortization of Octane acquired assets of $3.1 million.

The decrease in general and administrative in 2015 compared to 2014 was due to reduced spending on intellectual property registration and legal fees for patent enforcement of $0.7 million and state business tax refunds and credits of $0.6 million, offset by increased employee-related costs of $0.8 million, and transaction costs related to the Octane acquisition of $0.6 million.

The increase in general and administrative as a percentage of net sales in 2016 compared to 2015 was primarily due to the amortization of Octane acquired assets.

The decrease in general and administrative as a percentage of net sales in 2015 compared to 2014 was primarily due to higher net sales.

Research and Development
Dollars in thousands
Year Ended December 31,
 
Change
 
2016
 
2015
 
$
 
%
Research and development
$13,919
 
$9,904
 
$4,015
 
40.5%
As % of net sales
3.4%
 
2.9%
 
 
 
 
Dollars in thousands
Year Ended December 31,
 
Change
 
2015
 
2014
 
$
 
%
Research and development
$9,904
 
$7,231
 
$2,673
 
37.0%
As % of net sales
2.9%
 
2.6%
 
 
 
 

The increases in research and development in 2016 compared to 2015, and in 2015 compared to 2014, 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, coupled with the addition, in 2016, of the research and development expenses related to Octane.


25


Interest Expense
Interest expense of $1.9 million in 2016 was primarily related to the term loan that was used to finance the Octane acquisition.

Interest expense in 2015 and 2014 was less than $0.1 million each year, and was related to financing costs associated with capital equipment lease payments.

Other, Net
Other, net primarily relates to the effect of exchange rate fluctuations between the U.S. and the currencies of our foreign subsidiaries, primarily Canada, China and Europe. In addition, 2015 included losses on asset dispositions of $0.3 million, and 2014 included gains of $0.1 million related to refunds of state sales taxes previously paid by us.

Income Tax Expense
Dollars in thousands
Year Ended December 31,
 
Change
 
2016
 
2015
 
$
 
%
Income tax expense
$16,480
 
$13,219
 
$3,261
 
24.7%
Effective tax rate
31.9%
 
33.0%
 
 
 
 
Dollars in thousands
Year Ended December 31,
 
Change
 
2015
 
2014
 
$
 
%
Income tax expense
$13,219
 
$9,841
 
$3,378
 
34.3%
Effective tax rate
33.0%
 
32.6%
 
 
 
 

Income tax expense in 2016 was primarily attributable to the income generated domestically and internationally, partially offset by a $2.7 million of income tax benefit related to the release of previously unrecognized tax benefits associated with certain non-U.S filing positions. These resulted from completing the deregistration of a certain foreign entity during 2016. Income tax expense for 2015 and 2014 included a $2.4 million and a $1.2 million release of our domestic valuation allowance, respectively.

Each quarter, we assess the total weight of positive and negative evidence including cumulative income or loss for the past three years and forecasted taxable income, and re-evaluate whether any adjustments or release of all or any portion of the valuation allowance is appropriate. As a result of this evaluation, in 2014, we determined that a portion of the existing valuation allowance against state net operating loss deferred tax assets was no longer necessary. Accordingly, an income tax benefit of $1.2 million related to the reduction of our existing valuation allowance was recorded in the fourth quarter of 2014. Further, in 2015, after re-evaluating the potential realization of the remainder of our deferred income tax assets, we concluded that the existing valuation allowance against the foreign tax credit deferred tax assets as well as substantially all remaining valuation allowance against the state net operating loss deferred tax assets were no longer necessary. Accordingly, an income tax benefit of $2.4 million was recorded in the fourth quarter of 2015 related to the reduction of our existing valuation allowance.  
The amount of valuation allowance offsetting our deferred tax assets was $0.9 million as of December 31, 2016. Of the total remaining valuation allowance, $0.6 million primarily relates to domestic state credit carryforwards as we currently do not anticipate generating income of appropriate character to utilize those credits. Should it be determined in the future that it is more likely than not that our domestic deferred income tax assets will be realized, an additional valuation allowance would be released during the period in which such an assessment is made. In addition, $0.3 million of the remaining valuation allowance relates to foreign net operating loss carryforwards. There have been no material changes to our foreign operations since December 31, 2015 and, accordingly, we maintain our existing valuation allowance on foreign deferred income tax assets in such jurisdictions at December 31, 2016.

Refer to Note 14, Income Taxes, to our consolidated financial statements included in Part II, Item 8 of this report for additional information.

LIQUIDITY AND CAPITAL RESOURCES
 
As of December 31, 2016, we had $79.6 million of cash and investments, compared to $60.8 million as of December 31, 2015. The balance sheet as of December 31, 2015 included Octane, which was acquired on December 31, 2015. For additional information on the acquisition, see Note 2, Business Acquisition, to our consolidated financial statements included in Part II, Item 8 of this report for additional information.


26


Cash provided by operating activities was $45.9 million for 2016, compared to cash provided by operating activities of $41.1 million for 2015. We expect our cash, cash equivalents and available-for-sale securities at December 31, 2016, 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 December 31, 2016.

The increase in cash flows from operating activities for 2016, compared to 2015, was primarily due to improved operating performance and the changes in our operating assets and liabilities as discussed below.

Trade receivables increased $0.3 million to $45.5 million as of December 31, 2016, compared to $45.2 million as of December 31, 2015, due to the timing of sales during the quarter.

Inventories increased $4.3 million to $47.0 million as of December 31, 2016, compared to $42.7 million as of December 31, 2015, due to the increased stocking of specific product lines.

Prepaids and other current assets increased $1.1 million to $8.0 million as of December 31, 2016, compared to $6.9 million as of December 31, 2015, due to increased advertising and creative content for 2017.

Net deferred income tax liabilities increased by $7.5 million to $17.0 million as of December 31, 2016, compared to $9.5 million as of December 31, 2015, primarily due to the utilization of tax credit carryforwards from prior periods.

Trade payables increased $4.3 million to $66.0 million as of December 31, 2016, compared to $61.7 million as of December 31, 2015, primarily due to increased inventory purchases to support select product lines.

Accrued liabilities decreased $0.1 million to $12.9 million as of December 31, 2016 compared to $13.0 million as of December 31, 2015, due to reductions in accrued compensation, offset by increased royalties payable and deferred revenues.

Warranty obligations decreased $1.1 million to $7.5 million as of December 31, 2016 compared to $8.5 million as of December 31, 2015, primarily due to improvement in the experience rates of our products, resulting from better product quality, full stock of parts availability and sales mix.

Cash used in investing activities of $9.9 million for 2016 was primarily related to $3.5 million used for the purchase of Octane and the net purchases of $1.7 million of marketable securities. In addition, $4.7 million was used for capital expenditures during 2016, primarily for tooling and implementation of new software and hardware information system upgrades. We anticipate spending $7.0 million to $8.0 million in 2017 for product tooling and systems integration.

Cash used in financing activities of $19.0 million for 2016 was primarily related to principal repayments of our term loan of $16.0 million related to the 2015 Octane acquisition and share repurchase program spending of $5.4 million, partially offset by $1.9 million of recognized excess tax benefits related to stock-based compensation.

Financing Arrangements
On December 31, 2015 we entered into an amendment (the “Amendment”) to our existing Credit Agreement, dated December 5, 2014, with JPMorgan Chase Bank, N.A. (“Chase Bank”) that provided for an $80.0 million term loan (the “Term Loan”) to finance the acquisition of Octane. The Term Loan and our existing $20.0 million revolving line of credit with Chase Bank are secured by substantially all of the assets of Nautilus. The Term Loan matures on December 31, 2020. Under the terms of the Amendment, the maturity date of our existing revolving line of credit was extended to December 31, 2020.

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 Credit Agreement 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 December 31, 2016 our borrowing rate for both the Term Loan and line of credit advances was 1.86%.

27



As of December 31, 2016, we had outstanding borrowings of $64.0 million on our term loan and $0.5 million in letters of credit issued under the Credit Agreement with expiration dates through April 2017. As of December 31, 2016, we were in compliance with the financial covenants of the Credit Agreement and approximately $19.5 million was available for borrowing under the line of credit.

Stock Repurchase Program
On November 3, 2014, our Board of Directors approved a stock repurchase program that authorized us to repurchase up to $15.0 million of our outstanding common stock from time to time during the ensuing period of 24 months. On May 4, 2016, our Board of Directors approved an expansion of our share repurchase program that authorized us to repurchase up to an additional $10.0 million of our outstanding common stock from time to time during the period of 24 months following such approval. The repurchase program expired on November 3, 2016 as to the original $15.0 million authorization. The repurchase program expires on May 4, 2018 as to the $10.0 million expansion. Share repurchases are funded with existing cash balances and repurchased shares are retired and returned to unissued authorized shares. During 2016, we repurchased 319,805 shares at an average price of $16.86 per share for an aggregate purchase price of $5.4 million. As of December 31, 2016, $8.0 million remained available for future repurchases.

Commitments and Contingencies
For a description of our commitments and contingencies, refer to Note 21, Commitments and Contingencies, to our consolidated financial statements in Part II, Item 8 of this report.
  
Non-Cancellable Contractual Obligations
Our operating cash flows include the effect of certain non-cancellable, contractual obligations. A summary of such obligations as of December 31, 2016 is as follows (in thousands):
 
 
Payments due by period
 
Total
  
Less than 1
year
  
1-3 years
  
3-5 years
  
More than 5
years
Long-term debt obligations, including interest
$
67,162

 
$
17,371

 
$
33,581

 
$
16,210

 
$

Operating lease obligations
30,620

 
4,608

  
9,968

 
8,993

 
7,051

Purchase obligations(1)
17,630

 
17,630

  

  

  

Minimum royalty obligations
4,458

 
4,458

  

  

  

Total
$
119,870

  
$
44,067

  
$
43,549

  
$
25,203

  
$
7,051


(1) 
Our purchase obligations are comprised primarily of inventory purchase commitments. Because substantially all of our inventory is sourced from Asia, we have long lead times and therefore need to secure factory capacity from our vendors in advance.

Due to uncertainty with respect to the timing of future cash flows associated with our unrecognized tax benefits at December 31, 2016, we are unable to make reasonably reliable estimates of the timing of any cash settlements with the respective taxing authorities. Therefore, approximately $2.6 million of liabilities related to unrecognized tax benefits, including interest and penalties on uncertain tax positions, have been excluded from the contractual table above. For further information, refer to Note 14, Income Taxes, to our consolidated financial statements in Part II, Item 8 of this report.

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. Because we are unable to estimate our potential obligation, and because management does not expect these obligations to have a material adverse effect on our consolidated financial position, results of operations or cash flows, no liabilities are recorded at December 31, 2016.

28



SEASONALITY
 
We expect our revenue 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 consumers tend to be involved in outdoor activities during the spring and summer months, 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.

INFLATION

We do not believe that inflation had a material effect on our business, financial condition or results of operations in 2016, 2015 or 2014. Inflation pressures do exist in countries where our contract manufacturers are based; however, we have largely mitigated these increases through cost improvement measures.

NEW ACCOUNTING PRONOUNCEMENTS

See Note 1, Significant Accounting Polices, to our consolidated financial statements in Part II, Item 8 of this report.

Item 7A. Quantitative and Qualitative Disclosures About Market Risk

Interest Rate Risk
Our exposure to market risk from changes in interest rates relates primarily to our cash equivalents, marketable securities, variable-rate debt obligations, and derivative liabilities. As of December 31, 2016, we had cash equivalents of $13.6 million held in a combination of money market funds and commercial paper, and marketable securities of $31.7 million, held in a combination of certificates of deposit, 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, but a change in interest rates would not have a material impact on our results of operations, financial position or cash flows.

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 December 31, 2016, the outstanding balances on our credit facilities totaled $64.0 million.

In January 2016, we entered into an $80.0 million receive-variable, pay-fixed interest rate swap agreement, amortizing 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 0.61% at December 31, 2016.

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 December 31, 2016, the fair value of our interest rate swap agreement was a liability of $0.04 million. The estimated amount expected to be reclassified into earnings within the next twelve months was $0.04 million at December 31, 2016.

We do not enter into derivative instruments for any purpose other than to manage our interest rate exposure. That is, we do not engage in interest rate speculation using derivative instruments.

29


Item 8. Financial Statements and Supplementary Data

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Shareholders of
Nautilus, Inc.
Vancouver, Washington

We have audited the accompanying consolidated balance sheets of Nautilus, Inc. and subsidiaries (the “Company”) as of December 31, 2016 and 2015, and the related consolidated statements of operations, comprehensive income, shareholders' equity, and cash flows for each of the three years in the period ended December 31, 2016. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
 
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Nautilus, Inc. and subsidiaries as of December 31, 2016 and 2015, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2016, in conformity with accounting principles generally accepted in the United States of America.
 
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company's internal control over financial reporting as of December 31, 2016, based on the criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated February 27, 2017 expressed an unqualified opinion on the Company's internal control over financial reporting.


/s/ Deloitte & Touche LLP

Portland, Oregon
February 27, 2017

30


NAUTILUS, INC.
CONSOLIDATED BALANCE SHEETS
(In thousands)
 
 
As of December 31,
 
2016
  
2015
Assets
 
  
 
Cash and cash equivalents
$
47,874

  
$
30,778

Available-for-sale securities
31,743

 
29,998

Trade receivables, net of allowances of $170 and $918
45,458

  
45,155

Inventories
47,030

  
42,729

Prepaids and other current assets
8,020

  
6,888

Income taxes receivable
3,231

  
439

Deferred income tax assets

  
8,904

    Total current assets
183,356

  
164,891

Property, plant and equipment, net
17,468

  
16,764

Goodwill
61,888

  
60,470

Other intangible assets, net
69,800

  
73,354

Deferred income tax assets, non-current
11

 

Other assets
543

  
433

Total assets
$
333,066

  
$
315,912

Liabilities and Shareholders' Equity
 
  
 
Trade payables
$
66,020

  
$
61,745

Accrued liabilities
12,892

  
13,027

Warranty obligations, current portion
3,500

  
4,753

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

 
15,993

    Total current liabilities
98,405

  
95,518

Warranty obligations, non-current
3,950


3,792

Income taxes payable, non-current
2,403

  
4,116

Deferred income tax liabilities, non-current
16,991

  
18,380

Other long-term liabilities
2,481

  
3,144

Note payable, non-current, net of unamortized debt issuance costs of $21 and $29
47,979

 
63,971

Total liabilities
172,209

  
188,921

Commitments and contingencies (Note 21)


  


Shareholders' equity:
 
  
 
Common stock - no par value, 75,000 shares authorized, 30,825 and 31,005 shares issued and outstanding
578

  
796

Retained earnings
161,496

  
127,522

Accumulated other comprehensive loss
(1,217
)
  
(1,327
)
Total shareholders' equity
160,857

  
126,991

Total liabilities and shareholders' equity
$
333,066

  
$
315,912


See accompanying Notes to Consolidated Financial Statements.


31


NAUTILUS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share amounts)
 
 
Year Ended December 31,
 
2016
 
2015
 
2014
Net sales
$
406,039

 
$
335,764

 
$
274,447

Cost of sales
194,514

 
162,530

 
133,872

Gross profit
211,525

 
173,234

 
140,575

Operating expenses:
 
 
 
 

Selling and marketing
115,437

 
101,618

 
81,059

General and administrative
28,775

 
21,441

 
22,131

Research and development
13,919

 
9,904

 
7,231

Total operating expenses
158,131

 
132,963

 
110,421

Operating income
53,394

 
40,271

 
30,154

Other income (expense):
 
 
 
 
 
Interest income
234

 
218

 
63

Interest expense
(1,928
)
 
(22
)
 
(25
)
Other, net
(119
)
 
(445
)
 
32

Total other income (expense), net
(1,813
)
 
(249
)
 
70

Income from continuing operations before income taxes
51,581

 
40,022

 
30,224

Income tax expense
16,480

 
13,219

 
9,841

Income from continuing operations
35,101

 
26,803

 
20,383

Discontinued operations:
 
 

 
 
Loss from discontinued operations before income taxes
(1,077
)
 
(601
)
 
(1,134
)
Income tax expense (benefit) of discontinued operations
(154
)
 
(400
)
 
454

Loss from discontinued operations
(923
)
 
(201
)
 
(1,588
)
Net income
$
34,178

 
$
26,602

 
$
18,795

 
 
 
 
 
 
Basic income per share from continuing operations
$
1.13

 
$
0.86

 
$
0.65

Basic loss per share from discontinued operations
(0.03
)
 
(0.01
)
 
(0.05
)
Basic net income per share
$
1.10

 
$
0.85

 
$
0.60

 
 
 
 
 
 
 Diluted income per share from continuing operations
$
1.12

 
$
0.85

 
$
0.64

Diluted loss per share from discontinued operations
(0.03
)
 
(0.01
)
 
(0.05
)
Diluted net income per share
$
1.09

 
$
0.84

 
$
0.59

Shares used in per share calculations:
 
 
 
 
 
Basic
31,032

 
31,288

 
31,253

Diluted
31,301

 
31,589

 
31,688



See accompanying Notes to Consolidated Financial Statements.

32


NAUTILUS, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(In thousands)
 
 
Year Ended December 31,
 
2016
 
2015
 
2014
Net income