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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
 
 
FORM
10-K
 
 
 
 
(Mark One)
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2019
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
Trading Symbol(s)
Name of each exchange on which registered
 Common Stock, no par value
NLS
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 every Interactive Data File required to be submitted 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 such files).    Yes  [x]    No  [ ]

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and "emerging growth company" in Rule 12b-2 of the Exchange Act.
Large accelerated filer
[ ]
Accelerated Filer
[x]
Non-accelerated filer
[ ]
Smaller reporting company
Emerging growth company
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. [ ]
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the 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 ($2.21) 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, 2019) was $56,791,913.
The number of shares outstanding of the registrant's common stock as of February 21, 2020 was 29,781,288 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 2020 Annual Meeting of Shareholders, which will be filed within 120 days after the end of the fiscal year covered by this Form 10-K. Except with respect to information specifically incorporated by reference in this Form 10-K, the Proxy Statement shall not be deemed to be filed as part hereof.
 



NAUTILUS, INC.
2019 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.
 
Item 16.
 
 
 
 
 




Table of Contents

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: weaker than expected demand for new or existing products; our ability to timely acquire inventory that meets our quality control standards from sole source foreign manufacturers at acceptable costs; an inability to pass along or otherwise mitigate the impact of raw material price increases and other cost pressures, including unfavorable currency exchange rates; experiencing delays and/or greater than anticipated costs in connection with launch of new products, entry into new markets, or strategic initiatives; our ability to hire and retain key management personnel; changes in consumer fitness trends; changes in the media consumption habits of our target consumers or the effectiveness of our media advertising; a decline in consumer spending due to unfavorable economic conditions; and softness in the retail marketplace. Additional assumptions, risks and uncertainties are described in detail in our registration statements, reports and other filings with the Securities and Exchange Commission, including the “Risk Factors” set forth in our Annual Report on Form 10-K, as supplemented by our quarterly reports on Form 10-Q. Such filings are available on our website or at www.sec.gov. You are cautioned that such statements are not guarantees of future performance and that our actual results may differ materially from those set forth in the forward-looking statements. We do not undertake any duty to publicly update or revise forward-looking statements to reflect subsequent developments, events or circumstances.

Item 1. Business

OVERVIEW

Founded in 1986, Nautilus, Inc. and subsidiaries (collectively, "Nautilus" or the "Company") is a global technology driven fitness solutions company headquartered in Vancouver, Washington and incorporated in the State of Washington in January 1993. We believe everyone deserves a fit and healthy life. Our products are sold under some of the most-recognized brand names in the fitness industry: Nautilus®, Bowflex®, Octane Fitness® and Schwinn®. We develop innovative products to support healthy living through direct and retail channels as well as in commercial channels.

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, social media, our websites and catalogs. 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 and technologies for introduction to the marketplace at periodic intervals.

Our long-term strategy involves:
Enhancing our product lines by designing personalized connected-fitness equipment that meets or exceeds the high expectations of our existing and new customers;
Continuing our investment in innovation, with a particular focus on expanding the reach of our digital platform, JRNY;
Creatively marketing our equipment, both directly to consumers and through our Retail customers, while leveraging our well-known brand names;
Increasing our international Retail sales and distribution; and
Maximizing available royalty revenues from the licensing of our brands and intellectual property.
 
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, branded products and technologies; (ii) the application of creative, cost-effective

1

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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 and efficiency of our media marketing programs and attractiveness of third-party consumer financing programs.

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.

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 Total®, Max Trainer®, TreadClimber® and LateralX® specialized cardio machines, PowerRod® and Revolution® home gyms and SelectTech® dumbbells and kettlebells.
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® specialized cardio machine.
Our Schwinn® brand is known for its popular line of exercise bikes, including the Airdyne® air bike, as well as Schwinn-branded treadmills and ellipticals.
Our JRNYTM brand is our personalized connected-fitness digital platform featuring artificial intelligence powered, adaptive coaching to create truly personalized home workouts.

Approximately 77% of our revenue in 2019 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 23, 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 continue to be a large direct marketer of strength products in the U.S. our advertising efforts are focused on our cardio products, especially the Max Trainer®, as sales of cardio product represented 82% of our Direct channel revenues in 2019, compared to 87% in 2018.

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 60 seconds, we utilize our websites, social media, digital advertising capital 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 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 websites or through call centers.

Retail
In our Retail business, we market and sell a comprehensive line of consumer fitness equipment under the Nautilus®, Octane Fitness®, Schwinn® 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.


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Table of Contents

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. Recently, our investments have been focused on personalized connected-fitness such as voice coaching, simulated outdoor exploration and diverse music play list options with copyright clearance. Our JRNY digital platform uses artificial intelligence and data from an initial assessment and every workout, to create, and continually evolve, personalized daily workouts based on the user's fitness goals and capabilities. Our data shows the JRNY system is coaching people to work out longer and getting them to stay with their fitness journey longer.

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 $14.3 million and $16.8 million in 2019 and 2018, respectively, as we increased our capitalized investment in connected-fitness. We expect our research and development expenses to remain approximately the same in 2020 as we continue to supplement our investment in new product development, technology initiatives, and engineering capabilities.

SEASONALITY

We expect our revenue from fitness equipment products to vary seasonally. Sales are typically strongest in the fourth 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 2019, 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.

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.


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Table of Contents

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 2019, approximately 50% of our Retail customers' orders were shipped by our contract manufacturers in Asia directly to our Retail customers 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: ICON Health & Fitness, Johnson Health Tech, Peloton, Beach Body, American Telecast, Life Fitness, Precor and Technogym. We also compete with marketers of mobile device applications focused on fitness training and coaching on both iOS® and Android™ platforms, such as Mirror Workout Companion, Peloton, Zwift, Strava, Fulgaz Video Cycling, Sufferfest Training Systems, At Home Workouts by Daily Burn, and NIKE® Training Club. Additional marketers of competitive products include the following: activity trackers and content-driven physical activity products, such as Fitbit® and Garmin vivofit®; computer-based recreation products, such as the Microsoft Xbox®; weight management companies, such as Weight Watchers® and Nutrisystem®; group fitness, such as cross-fit classes; and gym memberships, each of which offers alternative solutions for a fit and healthy lifestyle.

EMPLOYEES

As of February 21, 2020, we had 434 employees, 433 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. We consider our relations with our employees to be good.

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. We regularly monitor commercial activity in our industry to identify potential infringement of our intellectual property. We protect our proprietary rights and take prompt, reasonable actions to prevent counterfeit products and other infringement on our intellectual property.

Trademarks
We own many trademarks, including Nautilus®, Bowflex®, Max Trainer®, TreadClimber®, Power Rod®, Bowflex Revolution®, SelectTech®, Octane Fitness®, LateralX®, xRide®, Zero Runner®, Airdyne®, Max TotalTM, Explore the WorldTM, and JRNYTM. 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 a third party 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

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Table of Contents

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 2036.

We maintain a portfolio of patents related to our TreadClimber® specialized cardio machines, which are sold primarily in our Direct segment. The portfolio includes patents with expiration dates ranging from 2021 to 2027.

We maintain a portfolio of patents and patent applications related to our Max Trainer® specialized cardio machines, which are sold in our Direct and Retail segments. The portfolio includes issued patents with expiration dates ranging from 2024 to 2037, and additional pending patent applications.

Nautilus is also the licensee of patents related to the Bowflex Revolution® home gyms. These patents have expiration dates ranging from 2022 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 2022 to 2035.

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, 2019 and 2018 was approximately $5.8 million and $2.9 million, respectively. The increase in our customer order backlog was primarily driven by strong demand for our recently introduced connected fitness introductions in fourth quarter of 2019.

SIGNIFICANT CUSTOMERS

In 2019 and 2018, Amazon.com and Dick's Sporting Goods accounted for more than 10% of total net sales as follows:
 
 
2019
 
2018
Amazon.com
 
15.2
%
 
11.5
%
Dick's Sporting Goods
 
11.7
%
 
13.8
%
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.

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Our digital platforms may receive, process, transmit and store personal health and fitness information relating to identifiable individuals. Consumer demand for personalized fitness experiences, through mobile applications or wearable fitness trackers and our focus on digital fitness solutions for our products may increase the volume of identifiable individual information we receive on our platforms and through our products. We also receive, process, transmit and store information relating to identifiable individuals in our capacity as an employer. As a result, we may be subject to numerous United States (both federal and state) and foreign jurisdiction laws and regulations designed to protect both individually identifiable information as well as personal health information, including the Health Insurance Portability and Accountability Act of 1996, as amended (“HIPAA”) and the European Union’s General Data Protection Regulation (“GDPR”), each of which governs, among other things, the privacy, security and electronic transmission of individually identifiable health information. The GDPR includes, and a growing number of legislative and regulatory bodies elsewhere in the world have adopted, consumer notification requirements in the event of unauthorized access to or acquisition of certain types of personal data. These breach notification laws continue to evolve and include jurisdiction-specific obligations.

We believe that we comply with such laws and regulations in all material respects and our controls in place are adequate for our continued compliance.

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 maintain an investor relations page on our corporate website accessible at http://www.nautilusinc.com/investors.

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. 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 the investor relations page of our corporate website. In addition to our SEC filings, we also webcast our earnings calls and certain events we participate in with members of the investment community on our investor relations page. Further, we use our investor relations page to make presentations and other materials regarding our business and financial performance available, along with 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. The contents of our websites are not incorporated by reference into this Annual Report on Form 10-K or in any other report or document we file with the SEC, and any references to our websites are intended to be inactive textual references only.


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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;
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 or any of our 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 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 Max Trainer® products, represent a substantial portion of our Direct and Retail 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 this product line. A significant decline in our revenue from this product line would have a material adverse effect on our operating results, financial position and cash flows.

We are in the process of implementing strategic initiatives necessary to improve our results of operations, and there is no guarantee that such efforts will be successful.

We are currently experiencing a multi-year revenue decline, driven mostly by a decline in our Direct business. We missed early connected fitness trends and despite recent acceleration, are continuing to catch-up. We are facing unprecedented levels of competition, from some companies that continue to significantly outspend us. To address these challenges, we have implemented strategic initiatives to improve our results of operations, including but not limited to initiatives relating to the development and improvement of our products and technology, revisions to our marketing strategies and methods, adjustments to staffing and restructuring of certain of our operations to reduce costs.


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While we expect these initiatives to result in a strengthened financial position and healthier business, they are based on several assumptions that may prove to be inaccurate, and as a result, there can be no assurance that we will realize, or sustain, profits, cost savings, a stronger brand or improved financial results. Our turnaround and transformation, if it occurs, is expected to take multiple years and may not be linear. If we fail to achieve or experience delays in achieving projected levels of performance from such strategic initiatives, or such initiatives create unintended or adverse impacts, our business, reputation, financial condition and results of operations could be negatively affected.

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.

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.

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

As of December 31, 2019, we did not have any goodwill due to an impairment in the second quarter of 2019 and had other intangible assets of $43.2 million. 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 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.

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.

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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 fourth 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.
 
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, 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.

We are subject to laws of the United States and foreign jurisdictions relating to individually identifiable information and personal health information, and failure to comply with those laws, whether or not inadvertent, could subject us to legal actions and could materially adversely affect our business, financial condition and results of operations.

Our digital platforms may receive, process, transmit and store personal health and fitness information relating to identifiable individuals. Consumer demand for personalized fitness experiences, through mobile applications or wearable fitness trackers, and our strategy to focus on digital fitness solutions for our products may increase the volume of identifiable individual information we receive on our platforms and through our products. We also receive, process, transmit and store information relating to identifiable individuals in our capacity as an employer. As a result, we may be subject to United States (both federal and state) and foreign jurisdiction laws and regulations designed to protect both individually identifiable information and personal health information, including HIPAA and its regulations, and the GDPR, which became effective in May 2018. The GDPR includes, and a growing number of legislative and regulatory bodies elsewhere in the world have adopted, consumer notification requirements in the event of unauthorized access to or acquisition of certain types of personal data. These breach notification laws continue to evolve and include jurisdiction-specific obligations. Complying with these obligations could cause us to incur substantial costs and could increase negative publicity surrounding any incident that compromises personal data.

These and other related laws have been subject to frequent changes, and new legislation in this area may be enacted at any time. Changes to existing laws, introduction of new laws in this area or failure to comply with existing laws that are applicable to us may subject us to, among other things, additional costs or changes to our business practices, liability for monetary damages, fines and/or criminal prosecution, unfavorable publicity, restrictions on our ability to obtain and process information and allegations by our customers and consumers that we have not performed our contractual obligations, any of which could materially adversely affect our business, financial condition and results of operations.

We may in the future be subject to claims and lawsuits alleging that our products fail to provide accurate measurements and data to our users.

Some components of our digital platform are used to track and display various information about users’ activities, such as calories burned, distance traveled and floors climbed. We anticipate new features and functionality in the future, as well. We believe that we have done and will continue to do everything we can to ensure accuracy of measurements in our digital system, but as with all such systems, there is always the risk that there may be an unintentional software design issue that results in measurements being inaccurately reported. We may receive reports made against us alleging that our products do not provide accurate measurements and data to users, including claims asserting that certain features of our products do not operate as advertised. Such reports and claims may result in negative publicity, and may require us to expend time and resources to defend litigation. If our products fail to provide accurate measurements and data to users, or if there are reports or claims of inaccurate measurements, claims of false advertisement, or claims of inaccuracy regarding the overall health benefits of our products and services in the future, we may become the subject of negative publicity, litigation, including class action litigation, regulatory proceedings, and warranty claims, and our brand, operating results, and business could be harmed.

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.


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We depend on television and other media advertising to market certain products sold directly to consumers. Consequently, a marked increase in the price we must pay for our preferred media time, 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, such as 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 negatively impacted.

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.

The ultimate success of current, 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;
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;
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:

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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, public health crises, such as pandemics and epidemics, 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. For example, the recent spread of the novel coronavirus (COVID-19) and related quarantines and work and travel restrictions in China has disrupted, and may continue to disrupt, production for certain of our products, and the extent to which these events will affect our results of operations and financial position remains uncertain. Such uncertainties, and disruptions caused by other public health crises, natural disasters and instability, could impair our ability to deliver products to our customers on a timely basis, reduce demand for our products or force us to incur remediation costs, any of which may have a material adverse effect on our results of operations and financial condition.
 
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 current U.S. presidential administration has sought changes to, or the withdrawal of the United States from various international treaties and trade arrangements. Our operating results have already been negatively impacted by tariffs imposed by the current U.S. presidential administration. Uncertainty regarding future 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 business, financial condition and results of operations depend on our ability to attract and retain adequate skilled labor and on the successful implementation of succession plans for key personnel.

Our future success depends on, among other factors, our ability to attract and retain qualified personnel, including executives and skilled labor. Availability of skilled workers is critical to our operations. We may experience difficulty maintaining desired staffing levels with unemployment rates at low levels in many of the geographic areas in which we manufacture or distribute goods. The loss of qualified personnel, our inability to attract new qualified employees or adequately train employees or a delay in hiring key personnel, could materially adversely affect our business, financial condition and results of 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 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

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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.

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.

Sales of cardio products, especially 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 continued decline in our revenues derived from this product line. A significant decline in our revenue from this product line, without offsetting sales gains, would have a material adverse effect on our operating results, financial position and cash flows.

We operate in a highly competitive market and we may be unable to compete successfully against existing and future competitors.

The markets for our products and services are characterized by intense competition, new industry standards, evolving distribution models, limited barriers to entry, disruptive technology developments, short product life cycles, customer price sensitivity and frequent product introduction. Our products and services face significant competition in every aspect of our business, including at-home fitness equipment and digital platforms, fitness clubs, in-studio fitness classes, and health and wellness apps. Further, we expect the competition in our market to intensify in the future as new and existing competitors introduce new or enhanced products and services that compete with ours.

Our competitors may develop, or have already developed, products, features, content, services, or technologies that are similar to ours or that achieve greater acceptance, may undertake more successful product development efforts, create more compelling employment opportunities, or marketing campaigns, or may adopt more aggressive pricing policies. Our competitors may develop or acquire, or have already developed or acquired, intellectual property rights that significantly limit or prevent our ability to compete effectively in the public marketplace. In addition, some competitors may have greater resources, or lack a short-term profitability motive, allowing them to identify and capitalize more efficiently upon opportunities in new markets and consumer preferences and trends, quickly transition and adapt their products and services, devote greater resources to marketing and advertising, or be better positioned to withstand substantial price competition. If we are not able to compete effectively against our competitors, they may acquire and engage customers or generate revenue at the expense of our efforts, which could have an adverse effect on our business, financial condition, and operating results.

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,

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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, 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, patent 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.

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 effect 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.

Our business is exposed to potential false advertising and other related claims, which could adversely affect our financial condition and performance.

The global nature of our business involves a risk of exposure under U.S. (both federal and state) and foreign laws and regulations related to false advertising. A false advertising claim or related judgment against us could result in substantial and unexpected expenditures, affect consumer or customer confidence in our products and services, and divert management’s time and attention from other responsibilities. Although we maintain product and general liability insurance, there can be no assurance that the type or level of coverage we have is adequate (or will apply to the claim at hand) or that we will be able to continue to maintain our existing insurance or obtain comparable insurance at a reasonable cost, if at all. A false advertising or other judgment against us and related negative publicity could have a material adverse effect on our reputation, results of operations and financial condition.
 
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

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of new systems or systems upgrades; cable outages, extended power failures, or our inability or failure to properly protect, repair 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.

We are subject to a number of debt covenants

We recently entered into new credit facilities for a period of five years ending January 2025. The proceeds from these new credit facilities were used to refinance the Company’s existing indebtedness. Our new credit facilities contain certain debt covenants and other customary events of default. Our ability to comply with these debt covenants may be affected by the other factors described in this “Risk Factors” section and other factors outside of our control. Failure to comply with one or more of these debt covenants may result in an event of default. Upon an event of default, if not waived by our lenders, our lender may declare all amounts outstanding as due and payable. If our current lender accelerates the maturity of our indebtedness, we may not have sufficient capital available at that time to pay the amounts due to our lenders on a timely basis. In addition, these debt covenants may prevent us from engaging in transactions that benefit us, including responding to changing business and economic conditions and taking advantage of attractive business opportunities. If we need additional capital and cannot raise it on acceptable terms, our business, financial condition and operating results could be materially and adversely affected.

Item 1B. Unresolved Staff Comments

None.


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Item 2. Properties

Following is a summary of each of our properties as of December 31, 2019:
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 and software engineering offices
 
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

From time to time, in the ordinary course of business, we may be involved in various claims, lawsuits and other proceedings. These legal 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.

As of the date of filing of this Annual Report on Form 10-K, we were not involved in any material legal proceedings.

Item 4. Mine Safety Disclosures

Not applicable.

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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 21, 2020, there were 43 holders of record of our common stock and approximately 6,500 beneficial shareholders.

We did not pay any dividends on our common stock in 2019 or 2018. 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
During the fourth quarter ended December 31, 2019 no repurchases of our equity securities were made. On February 21, 2018, our Board of Directors authorized a $15.0 million repurchase of our outstanding common stock from time to time through February 21, 2020. As of December 31, 2019 $14.0 million was the approximate dollar value of shares that may yet be purchased under the program. See Note 20 of Notes to Consolidated Financial Statements for information regarding our public share repurchase programs.
 
 
 
 
 

Item 6. Selected Financial Data

Not required for smaller reporting companies.

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.

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, related accessories and digital platform for consumer use, primarily in the U.S., Canada, Europe and Asia. Our products are sold under some of the most-recognized brand names in the fitness industry: Nautilus®, Bowflex®, Octane Fitness® and Schwinn®.

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, our websites, social media channels, and catalogs. 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.
 
Our results for 2019 were primarily impacted by lower sales, however, we believe the appropriate improvements are being implemented into our overall business to address this trend. The primary actions taken include extensive, in-depth consumer insights research, which has identified an effective new positioning for the Bowflex® brand, and which is now underway through a new advertising campaign and updates to our websites, television commercials, social media, and other digital platforms. Additionally, we expect to launch targeted new products across all our channels over the next twelve months. In parallel, we plan to continue our digital transformation with the inclusion of updated digital experience platforms on key new products, moving toward our goal of having the majority of our products equipped with subscription-based digital experience offerings.

Net sales for 2019 were $309.3 million, reflecting a 22.0% decrease as compared to net sales of $396.8 million for 2018. Net sales of our Direct segment decreased by $65.3 million, or 35.3%, in 2019, compared to 2018, primarily driven by lower Bowflex Max Trainer® product sales and the impact of the planned reduction in advertising spending.

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Net sales of our Retail segment decreased by $21.5 million, or 10.3%, for 2019, compared to 2018, primarily reflecting the decline in Bowflex Max Trainer® product sales and decreases in commercial products.

Royalty income for 2019 decreased by $0.7 million compared to 2018, which included payment of royalties related to a new agreement in the prior year.

Gross profit for 2019 was $110.6 million, or 35.8% of net sales, a decrease of $71.1 million, or 39.1%, as compared to gross profit of $181.7 million, or 45.8% of net sales, for 2018. The decrease in gross profit dollars was primarily due to lower sales coupled with lower gross margin percentages in both the Direct and Retail segments. Gross margin decreased 10.0% points in 2019, compared to 2018, due to unfavorable sales mix and overhead absorption.

Operating expenses for 2019 were $211.1 million, an increase of $50.1 million, or 31.1%, as compared to operating expenses of $161.0 million for 2018. The increase in operating expenses was primarily related to a goodwill and intangible impairment charge of $72.0 million, partially offset by lower media spending and stock-based compensation expense.

Operating loss for 2019 was $100.5 million, a decrease of $121.3 million, or 584.1%, as compared to operating income of $20.8 million for 2018. The decrease in operating income for 2019, compared to 2018, was primarily driven by a goodwill and intangible impairment charge and lower gross margins associated with our lower sales during the year, partially offset by reductions in media spending and other operating expenses.

Loss from continuing operations was $92.3 million for 2019, or $3.11 per diluted share, compared to income from continuing operations of $15.1 million, or $0.50 per diluted share, for 2018. The effective tax rates for 2019 and 2018 were 9.4% and 28.1%, respectively. The 18.7% year-over-year percentage tax rate differential was due primarily to the goodwill impairment charge and valuation allowance recorded in 2019, for which no tax benefit was recognized and which reduced the effective tax rate for the year.

Net loss for 2019 was $92.8 million, compared to net income of $14.7 million for 2018. Net loss per diluted share was $3.13 for 2019, compared to net income per diluted share of $0.48 for 2018.

Factors Affecting Our Performance

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.


BUSINESS ACQUISITION

On December 6, 2018, we acquired certain assets of Paofit Holdings Pte Limited, its subsidiaries and related companies (collectively, "Paofit") for an aggregate purchase price of $2.8 million. The acquisition was funded with cash on hand. Based primarily in

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Singapore, the Paofit business is focused on developing and distributing software applications known as RunSocial® and RideSocial™. The acquisition of Paofit's assets broadened our digital platform applications and deepened our talent pool.

DISCONTINUED OPERATIONS

Results from discontinued operations relate to the disposal of our former Nautilus® 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 2019 and 2018, we continue to incur product liability expenses associated with product previously sold into the Commercial channel, and accrued interest associated with an uncertain tax position on discontinued international operations.

CRITICAL ACCOUNTING 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 nature of the estimate is material due to the levels of subjectivity and judgment necessary to account for highly uncertain matters or the susceptibility of such matters to change, and (b) the impact of the estimate on financial condition or operating performance is material. Our critical accounting estimates are discussed below.

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. In 2019, we recognized a non-cash goodwill and intangible asset impairment charge of $72.0 million primarily related to the goodwill and indefinite-lived Octane Fitness brand name. No goodwill or other long-term asset impairment charges were recognized in 2018.

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.

Income Tax
Significant judgments are required in determining tax provisions in relation to valuation allowance and 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 factors change, thereby impacting the likelihood of realizing the tax benefit of an uncertain tax position or deferred tax assets, 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. Furthermore, valuation allowance would be provided against deferred tax assets if we determine it is no longer more likely than not that such assets would be fully realized based on the objectively verifiable evidence available.



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RESULTS OF OPERATIONS

The discussion that follows regarding our financial condition and results of operations for fiscal 2019 compared to fiscal 2018 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. A discussion regarding our financial condition and results of operations for fiscal 2018 compared to fiscal 2017 can be found under Item 7 in our Annual Report on Form 10-K for the fiscal year ended December 31, 2018, filed with the SEC on February 27, 2019, which is available free of charge on the SEC’s website at www.sec.gov and our Investors website at http://www.nautilusinc.com/investors/sec-filings/.

Results of operations information was as follows (in thousands):
 
 
Year Ended December 31,
 
 
 
 
 
2019
 
2018
 
Change
 
% Change
Net sales
$
309,285

 
$
396,753

 
$
(87,468
)
 
(22.0
)%
Cost of sales
198,702

 
215,013

 
(16,311
)
 
(7.6
)%
Gross profit
110,583

 
181,740

 
(71,157
)
 
(39.2
)%
Operating expenses:
 
 
 
 
 
 
 
Selling and marketing
94,595

 
115,920

 
(21,325
)
 
(18.4
)%
General and administrative
30,242

 
28,226

 
2,016

 
7.1
 %
Research and development
14,282

 
16,825

 
(2,543
)
 
(15.1
)%
Goodwill and intangible impairment charge
72,008

 

 
72,008

 
 %
Total operating expenses
211,127

 
160,971

 
50,156

 
31.2
 %
Operating (loss) income
(100,544
)
 
20,769

 
(121,313
)
 
(584.1
)%
Other income (expense):
 
 
 
 


 
 
Interest income
162

 
1,044

 
(882
)
 
 
Interest expense
(980
)
 
(1,051
)
 
71

 
 
Other, net
(470
)
 
239

 
(709
)
 
 
Total other (expense) income, net
(1,288
)
 
232

 
(1,520
)
 
 
(Loss) income from continuing operations before income taxes
(101,832
)
 
21,001

 
(122,833
)
 
 
Income tax (benefit) expense
(9,537
)
 
5,891

 
(15,428
)
 
 
(Loss) income from continuing operations
(92,295
)
 
15,110

 
(107,405
)
 
 
Loss from discontinued operations, net of income taxes
(505
)
 
(452
)
 
(53
)
 
 
Net (loss) income
$
(92,800
)
 
$
14,658

 
$
(107,458
)
 
 


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Results of operations information by segment was as follows (in thousands):
 
Year Ended December 31,
 
 
 
 
 
2019
 
2018
 
Change
 
% Change
Net sales:
 
 
 
 
 
 
 
Direct
$
119,651

 
$
184,925

 
$
(65,274
)
 
(35.3
)%
Retail
186,584

 
208,092

 
(21,508
)
 
(10.3
)%
Royalty
3,050

 
3,736

 
(686
)
 
(18.4
)%
 
$
309,285

 
$
396,753

 
$
(87,468
)
 
(22.0
)%
 
 
 
 
 
 
 
 
Cost of sales:
 
 
 
 
 
 
 
Direct
$
60,101

 
$
73,446

 
$
(13,345
)
 
(18.2
)%
Retail
138,601

 
141,564

 
(2,963
)
 
(2.1
)%
Royalty

 
3

 
(3
)
 
(100.0
)%
 
$
198,702

 
$
215,013

 
$
(16,311
)
 
(7.6
)%
Gross profit:
 
 
 
 
 
 
 
Direct
$
59,550

 
$
111,479

 
$
(51,929
)
 
(46.6
)%
Retail
47,983

 
66,528

 
(18,545
)
 
(27.9
)%
Royalty
3,050

 
3,733

 
(683
)
 
(18.3
)%
 
$
110,583

 
$
181,740

 
$
(71,157
)
 
(39.2
)%
Gross margin:
 
 
 
 
 
 
 
Direct
49.8
%
 
60.3
%
 
(1,050
)
 basis points
Retail
25.7
%
 
32.0
%
 
(630
)
 basis points

The following tables compare the net sales of our major product lines within each business segment (in thousands):
 
Year Ended December 31,
 
 
 
 
 
2019
 
2018
 
Change
 
% Change
Direct net sales:
 
 
 
 
 
 
 
Cardio products(1)
$
97,824

 
$
160,132

 
$
(62,308
)
 
(38.9
)%
Strength products(2)
21,827

 
24,793

 
(2,966
)
 
(12.0
)%
 
119,651

 
184,925

 
(65,274
)
 
(35.3
)%
Retail net sales:
 
 
 
 
 
 
 
Cardio products(1)
141,331

 
165,911

 
(24,580
)
 
(14.8
)%
Strength products(2)
45,253

 
42,181

 
3,072

 
7.3
 %
 
186,584

 
208,092

 
(21,508
)
 
(10.3
)%
 
 
 
 
 
 
 
 
Royalty income
3,050

 
3,736

 
(686
)
 
(18.4
)%
 
$
309,285

 
$
396,753

 
$
(87,468
)
 
(22.0
)%
 
 
 
 
 
 
 
 
(1)   Cardio products include: Max Trainer®, TreadClimber®, Zero Runner®, Lateral X®, treadmills, exercise bikes, ellipticals and subscription services.
(2)   Strength products include: home gyms, selectorized dumbbells, kettlebell weights and accessories.

Net Sales and Cost of Sales

Direct

The 35.3% decrease in year-over-year Direct net sales for 2019 compared to 2018 was primarily due to decreased consumer demand for our cardio products sales, which was largely related to Bowflex Max Trainer® products and a reduction in advertising spending. Improvements are being implemented that we believe should be effective in addressing this trend. The primary actions taken include extensive, in-depth consumer insights research, which has identified an effective new positing for the Bowflex brand, and which is now underway through a new advertising campaign and updates to our website, television, social media and other

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digital platforms. Also, based on customer insights we will continue our investments in personalized connected-fitness and will be made available on more Bowflex, Nautilus and Schwinn equipment over time.

The rates of combined consumer credit approvals by our primary and secondary U.S. third-party financing providers were 54.1% in 2019 compared to 55.3% in 2018. The decrease in approvals reflects lower credit quality applications.

The decrease in Direct cost of sales in 2019 compared to 2018 was due to the decrease in net sales.

The 10.5% decrease in the gross margin of our Direct business for 2019 compared to 2018 was primarily due to shift in product mix and unfavorable overhead absorption related to lower net sales.

Retail

Retail net sales decreased by 10.3% in 2019 compared to 2018. The decrease was primarily due to the decline in Bowflex Max Trainer® product sales and decreases in commercial products.

The decrease in Retail cost of sales in 2019 compared to 2018 was due to the decreases in Retail net sales mentioned above.
 
The decrease in Retail gross margin in 2019 compared to 2018 was due to unfavorable sales mix and overhead absorption.

Selling and Marketing
Selling and marketing expenses include payroll, employee benefits, and other headcount-related expenses associated with sales and marketing personnel, and the costs of media advertising, promotions, trade shows, seminars, and other programs.
Dollars in thousands
Year Ended December 31,
 
Change
 
2019
 
2018
 
$
 
%
Selling and marketing
$
94,595

 
$
115,920

 
$
(21,325
)
 
(18.4)%
As % of net sales
30.6%
 
29.2%
 
 
 
 

The decrease in selling and marketing expenses in 2019 compared to 2018 was primarily due to lower media spending of $20.1 million partially offset by a major new multi-media advertising and communication campaign behind the Bowflex brand and new products.

The slight increase in sales and marketing as a percentage of net sales in 2019 compared to 2018 was primarily due to less efficient performance of media.

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
 
2019
 
2018
 
$
 
%
Media advertising
$
44,916

 
$
65,017

 
$
(20,101
)
 
(30.9)%

The return metrics we achieved on media performance declined in 2019, and as a result we decreased media spend to focus on improved profitability.

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General and Administrative
General and administrative expenses include payroll, employee benefits, stock-based compensation expense, and other headcount-related expenses associated with finance, legal, facilities, certain human resources and other administrative personnel, and other administrative fees.
Dollars in thousands
Year Ended December 31,
 
Change
 
2019
 
2018
 
$
 
%
General and administrative
$
30,242

 
$
28,226

 
$
2,016

 
7.1%
As % of net sales
9.8%
 
7.1%
 
 
 
 

The increase in general and administrative in 2019 compared to 2018 was primarily due to increased legal expenses.

The increase in general and administrative as a percentage of net sales in 2019 compared to 2018 was primarily due to the increase in legal expenses and the lower total net sales.

Research and Development
Research and development expenses include payroll, employee benefits, other headcount-related expenses and information technology associated with product development.
Dollars in thousands
Year Ended December 31,
 
Change
 
2019
 
2018
 
$
 
%
Research and development
$
14,282

 
$
16,825

 
$
(2,543
)
 
(15.1)%
As % of net sales
4.6%
 
4.2%
 
 
 
 

The decrease in research and development expenses in 2019 compared to 2018, was primarily due to higher investments in digital platforms that were capitalized.

Goodwill and Intangible Impairment Charge
In accordance ASC 350 — Intangibles — Goodwill and Other, we perform a goodwill and indefinite-lived asset impairment evaluation during the fourth quarter of each year. However, as a result of the decline in our market value relative to the market and our industry, identified as a triggering event, we performed an interim evaluation and a market capitalization reconciliation during the second quarter of 2019, which resulted in a non-cash goodwill and indefinite-lived intangible assets impairment charge of $72.0 million.

ASC 350 requires us to make significant assumptions and estimates about the extent and timing of future cash flows, discount rates, growth rates and terminal value. The cash flows are estimated over a significant future period of time, which makes those estimates and assumptions subject to an even higher degree of uncertainty. We also use market valuation models and other financial ratios, which require us to make certain assumptions and estimates regarding the applicability of those models to our assets and businesses.

In accordance ASC 360 — Property, Plant, and Equipment and other long-lived assets, we performed a test for recoverability of our assets as the goodwill and indefinite-lived intangible asset impairment created a triggering event. The long-lived assets were recoverable and no impairment was required.

For additional information related to our goodwill and intangible impairment charge, see Notes 5, 11 and 12.

Interest Expense
Interest expense of $1.0 million and $1.1 million in 2019 and 2018, respectively, was primarily related to the outstanding balance on our line of credit and term loan.

Other, Net
Other, net primarily relates to the effect of currency exchange rate fluctuations with the U.S. and our foreign subsidiaries.


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Income Tax Expense
Income tax provision includes U.S. and international income taxes, and interest and penalties on uncertain tax positions.
Dollars in thousands
Year Ended December 31,
 
Change
 
2019
 
2018
 
$
 
%
Income tax (benefit) expense
$
(9,537
)
 
$
5,891

 
$
(15,428
)
 
(261.9)%
Effective tax rate
9.4%
 
28.1%
 
 
 
 

Income tax benefit of $9.5 million was primarily related to our losses generated in the U.S. in 2019. The reduced effective tax rate for 2019 compared to 2018 was due to the valuation allowance recorded as well as the goodwill impairment charge for which no tax benefit was recognized in 2019. Income tax expense in 2018 was primarily related to our income generated domestically and internationally.

Refer to Note 17, Income Taxes, to our consolidated financial statements included in Part II, Item 8 of this report for additional information.

LIQUIDITY AND CAPITAL RESOURCES

Our future capital requirements may vary materially from those currently planned and will depend on many factors, including our levels of revenue, the timing and extent of spending on research and development efforts and other business initiatives, the expansion of sales and marketing activities, the timing of new product introductions, market acceptance of our products, and overall economic conditions. To the extent that current and anticipated future sources of liquidity are insufficient to fund our future business activities and requirements, we may be required to seek additional equity or debt financing. The sale of additional equity would result in additional dilution to our stockholders. The incurrence of debt financing would result in debt service obligations and the instruments governing such debt could provide for operating and financing covenants that would restrict our operations.

As of December 31, 2019, we had $11.1 million of cash and cash equivalents, compared to cash and investments of $63.5 million as of December 31, 2018. Cash used in operating activities was $22.6 million for 2019, compared to cash provided by operating activities of $21.3 million for 2018. The decrease in cash flows from operating activities for 2019, compared to 2018, was primarily due to decreased operating performance and the changes in our operating assets and liabilities as discussed below.

Trade receivables increased by $8.8 million to $54.6 million as of December 31, 2019, compared to $45.8 million as of December 31, 2018, due to the increase in Retail sales in the fourth quarter of 2019 compared to the same period of 2018.

Inventories decreased by $13.7 million to $54.8 million as of December 31, 2019, compared to $68.5 million as of December 31, 2018, primarily due to the efforts to align inventory levels more closely with sales trends.

Prepaids and other current assets increased by $0.3 million to $8.3 million as of December 31, 2019, compared to $8.0 million as of December 31, 2018, due to added marketing costs for future campaigns, partially offset by royalty payments received in 2019.

Trade payables decreased by $13.0 million to $74.3 million as of December 31, 2019, compared to $87.3 million as of December 31, 2018, primarily due to the decrease in inventory in the fourth quarter of 2019 compared to the fourth quarter of 2018.

Accrued liabilities decreased by $0.7 million to $7.6 million as of December 31, 2019, compared to $8.4 million as of December 31, 2018, primarily due to reductions in income tax payable and sales returns reserves in 2019.

Operating lease liabilities, net of operating lease assets, increased by $1.9 million as of December 31, 2019 due to the adoption of the new lease accounting standard.

Warranty obligations increased by $0.1 million to $5.7 million as of December 31, 2019, compared to $5.6 million as of December 31, 2018, primarily due to the products and sales mix.

Net deferred income tax liabilities decreased by $10.6 million to $1.2 million as of December 31, 2019, compared to $11.8 million as of December 31, 2018, primarily due to the net operating loss deferred tax asset generated in U.S. reducing the overall net tax liability balance.

Cash provided by investing activities of $12.8 million for 2019 was primarily related to the net maturities of marketable securities of $25.3 million, partially offset by $9.0 million used for capital expenditures during 2019, primarily for information technology

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assets, our digital platform JRNYTM, and production tooling and equipment. We anticipate spending $8.0 million to $10.0 million in 2020 for digital platform enhancements and production tooling.

Cash used in financing activities of $17.5 million for 2019 was primarily related to principal repayments on our term loan and line of credit of $50.7 million, partially offset by proceeds from our line of credit of $33.0 million.

Financing Arrangements
On December 31, 2015 we entered into an amendment (the “Amendment”) to our existing Credit Agreement, dated December 5, 2014, with Chase (as amended, the "2014 Chase Credit Agreement") that provided for an $80.0 million term loan (the “Term Loan”) to finance the acquisition of Octane Fitness, which matures on December 31, 2020. The Term Loan and our existing $20.0 million revolving line of credit with Chase are secured by substantially all of our assets. The 2014 Chase Credit Agreement was amended again on December 21, 2018, which, among other changes, extended the term of the $20.0 million revolving line of credit to December 31, 2021.

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 2014 Chase Credit Agreement was subject to our compliance with certain financial and operating covenants at the time borrowings are requested. Letters of credit under the 2014 Chase Credit Agreement are treated as a reduction of the available borrowing amount and are subject to covenant testing. During the three months ended March 31, 2019, we paid down our existing term loan of $32.0 million and refinanced the remaining portion with borrowings under our new line of credit.

We have a 2019 Chase Credit Agreement with Chase that provides for a $40.0 million revolving line of credit. The term of the 2019 Chase Credit Agreement expires on March 29, 2022 and is secured by substantially all of our assets. As of December 31, 2019, our line of credit had $14.1 million of outstanding borrowings and $24.0 million remained available for borrowing. The interest rate applicable to each advance under the revolving line of credit is based on either Chase's floating prime rate or adjusted London Interbank Offer Rate ("LIBOR"), plus an applicable margin. As of December 31, 2019, our borrowing rate for line of credit advances was 3.69%.

The 2019 Chase Credit Agreement contains customary covenants for financings of this type, including, among other terms and conditions, revolving availability subject to a calculated borrowing base, minimum cash reserves and minimum fixed charge cover ratio covenants, as well as limitations and conditions on our ability to (i) create, incur, assume or be liable for indebtedness; (ii) dispose of assets outside the ordinary course of business; (iii) acquire, merge or consolidate with or into another person or entity; (iv) create, incur or allow any lien on any of our property; (v) make investments; or (vi) pay dividends or make distributions, in each case subject to certain exceptions. In addition, the 2019 Chase Credit Agreement provides for certain events of default such as nonpayment of principal and interest when due thereunder, breaches of representations and warranties, noncompliance with covenants, acts of insolvency and default on indebtedness held by third parties (subject to certain limitations and cure periods), as well as a subjective acceleration clause.

Based on our forecast, we concluded a breach of the minimum fixed charge coverage ratio covenant on the 2019 Chase Credit Agreement at the December 31, 2019 measurement date. We classified the 2019 Chase Credit Agreement as a non-current liability as of the December 31, 2019 financial statements as the covenant being breached at the balance sheet date was cured with alternative sources of funding obtained to terminate the 2019 Chase Credit Agreement as of the issuance of these financial statements. See Note 26, Subsequent Events to our consolidated financial statements in Part II, Item 8 of this report.

Stock Repurchase Program
On April 25, 2017, our Board of Directors authorized a $15.0 million share repurchase program. Under this program, shares of common stock may be repurchased from time to time through April 25, 2019. During 2018, repurchases under this program totaled $12.0 million. As of November 2018, the stock repurchases under this program were completed in full and the program expired.

On February 21, 2018 our Board of Directors authorized an additional $15.0 million share repurchase program. Under this program, shares of our common stock may be repurchased from time to time through February 21, 2020. As of December 31, 2019, repurchases under this program totaled $1.0 million.

During 2018, we repurchased 990,229 shares at an average price of $13.12 per share for an aggregate purchase price of $13.0 million. As of December 31, 2019, $14.0 million remained available for future repurchases under the existing program.

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Repurchases may be made in open market transactions at prevailing market prices, in privately negotiated transactions, or by other means in accordance with federal securities laws. Share repurchases are funded with existing cash balances, and the repurchased shares are retired and returned to unissued authorized shares.

Commitments and Contingencies
For a description of our commitments and contingencies, refer to Note 24, Commitments and Contingencies, 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, 2019.

INFLATION

We do not believe that inflation had a material effect on our business, financial condition or results of operations in 2019 or 2018. 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 Policies, to our consolidated financial statements in Part II, Item 8 of this report.


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Item 7A. Quantitative and Qualitative Disclosures About Market Risk

Interest Rate and Foreign Exchange Risk
Our exposure to market risk from changes in interest rates relates primarily to our cash equivalents, marketable debt securities, derivative assets, and variable-rate debt obligations. As of December 31, 2019, we held no money market funds, and marketable debt securities 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.

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, 2019, the outstanding balances on our credit facilities totaled $14.3 million.

We enter into foreign exchange forward contracts to offset the earnings impacts of exchange rate fluctuations on certain monetary assets and liabilities. Total notional amounts outstanding at December 31, 2019 were $33.2 million. A hypothetical 10% increase in interest rates, or a 10% movement in the currencies underlying our foreign currency derivative positions, would have material impacts on our results of operations, financial position or cash flows.

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



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Item 8. Financial Statements and Supplementary Data

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM


To the Shareholders and Board of Directors
Nautilus, Inc.:

Opinion on the Consolidated Financial Statements
We have audited the accompanying consolidated balance sheets of Nautilus, Inc. and subsidiaries (the Company) as of December 31, 2019 and 2018, the related consolidated statements of operations, comprehensive (loss) income, shareholders’ equity, and cash flows for each of the years in the two‑year period ended December 31, 2019 and the related notes (collectively, the consolidated financial statements). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2019 and 2018, and the results of its operations and its cash flows for each of the years in the two‑year period ended December 31, 2019, in conformity with U.S. generally accepted accounting principles.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company’s internal control over financial reporting as of December 31, 2019, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission, and our report dated February 26, 2020 expressed an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting.
Change in Accounting Principle
As discussed in Note 10 to the consolidated financial statements, the Company has changed its method of accounting for Leases as of January 1, 2019 due to the adoption of Financial Accounting Standards Board (FASB) Accounting Standards Update (ASU) No. 2016-02, Leases (Topic 842).

Basis for Opinion
These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that our audits provide a reasonable basis for our opinion.



/s/ KPMG LLP

We have served as the Company's auditor since 2017.

Portland, Oregon
February 26, 2020





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Report of Independent Registered Public Accounting Firm
To the Shareholders and Board of Directors
Nautilus, Inc.:

Opinion on Internal Control Over Financial Reporting
We have audited Nautilus, Inc. and subsidiaries’ (the Company) internal control over financial reporting as of December 31, 2019, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2019, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated balance sheets of the Company as of December 31, 2019 and 2018, the related consolidated statements of operations, comprehensive (loss) income, shareholders’ equity, and cash flows for each of the years in the two-year period ended December 31, 2019, and the related notes (collectively, the consolidated financial statements), and our report dated February 26, 2020 expressed an unqualified opinion on those consolidated financial statements.
Basis for Opinion
The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Assessment. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
Definition and Limitations of Internal Control Over Financial Reporting
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
/s/ KPMG LLP


Portland, Oregon
February 26, 2020


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NAUTILUS, INC.
CONSOLIDATED BALANCE SHEETS
(In thousands)
 
 
As of December 31,
 
2019

2018
 
 
 
 
Assets
 
 
 
Cash and cash equivalents
$
11,070


$
38,125

Available-for-sale securities

 
25,392

Trade receivables, net of allowances of $45 and $99
54,600


45,847

Inventories
54,768


68,465

Prepaids and other current assets
8,283

 
7,980

Income taxes receivable
472

 
5,653

    Total current assets
129,193


191,462

Property, plant and equipment, net
22,755


22,216

Operating lease right-of-use assets
20,778

 

Goodwill


63,452

Other intangible assets, net
43,243


55,240

Other assets
4,510


574

Total assets
$
220,479


$
332,944

Liabilities and Shareholders' Equity
 
 
 
Trade payables
$
74,255


$
87,265

Accrued liabilities
7,633


8,370

Operating lease liabilities, current portion
3,720

 

Warranty obligations, current portion
3,100


3,213

Note payable, current portion, net of unamortized debt issuance costs of $0 and $7

 
15,993

    Total current liabilities
88,708


114,841

Operating lease liabilities, non-current
18,982

 

Warranty obligations, non-current
2,617


2,362

Income taxes payable, non-current
3,676


3,427

Deferred income tax liabilities, non-current
1,783


11,888

Other long-term liabilities
46


1,837

Debt payable, non-current, net of unamortized debt issuance costs of $230 and $7
14,071

 
15,993

Total liabilities
129,883

 
150,348

Commitments and contingencies (Note 24)


 


Shareholders' equity:
 
 
 
Common stock - no par value, 75,000 shares authorized, 29,781 and 29,545 shares issued and outstanding
1,261

 
215

Retained earnings
90,272

 
183,290

Accumulated other comprehensive loss
(937
)
 
(909
)
Total shareholders' equity
90,596


182,596

Total liabilities and shareholders' equity
$
220,479


$
332,944




See accompanying notes to consolidated financial statements.


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NAUTILUS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share amounts)
 
 
Year Ended December 31,
 
2019
 
2018
 
 
 
 
Net sales
$
309,285

 
$
396,753

Cost of sales
198,702

 
215,013

Gross profit
110,583

 
181,740

Operating expenses:
 
 
 
Selling and marketing
94,595

 
115,920

General and administrative
30,242

 
28,226

Research and development
14,282

 
16,825

Goodwill and intangible impairment charge
72,008

 

Total operating expenses
211,127

 
160,971

Operating (loss) income
(100,544
)
 
20,769

Other income (expense):
 
 
 
Interest income
162

 
1,044

Interest expense
(980
)
 
(1,051
)
Other, net
(470
)
 
239

Total other (expense) income, net
(1,288
)
 
232

(Loss) income from continuing operations before income taxes
(101,832
)
 
21,001

Income tax (benefit) expense
(9,537
)
 
5,891

(Loss) income from continuing operations
(92,295
)
 
15,110

Discontinued operations:
 
 

Loss from discontinued operations before income taxes
(206
)
 
(206
)
Income tax expense of discontinued operations
299

 
246

Loss from discontinued operations
(505
)
 
(452
)
Net (loss) income
$
(92,800
)
 
$
14,658

 
 
 
 
Basic (loss) income per share from continuing operations
$
(3.11
)
 
$
0.50

Basic loss per share from discontinued operations
(0.02
)
 
(0.02
)
Basic net (loss) income per share(1)
$
(3.13
)
 
$
0.49

 
 
 
 
 Diluted (loss) income per share from continuing operations
$
(3.11
)
 
$
0.50

Diluted loss per share from discontinued operations
(0.02
)
 
(0.01
)
Diluted net (loss) income per share(1)
$
(3.13
)
 
$
0.48

Shares used in per share calculations:
 
 
 
Basic
29,684

 
30,099

Diluted
29,684

 
30,355

(1) May not add due to rounding.


See accompanying notes to consolidated financial statements.

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NAUTILUS, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE (LOSS) INCOME
(In thousands)
 
 
Year Ended December 31,
 
2019
 
2018
 
 
 
 
Net (loss) income
$
(92,800
)
 
$
14,658

Other comprehensive income (loss):
 
 
 
Unrealized gain on marketable securities, net of income tax expense of $6 and $13
6

 
58

(Loss) gain on derivative securities, effective portion, net of income tax benefit of $139 and $17
(223
)
 
7

Foreign currency translation adjustment, net of income tax benefit of $27 and $2
189

 
(715
)
Other comprehensive loss
(28
)
 
(650
)
Comprehensive (loss) income
$
(92,828
)
 
$
14,008




See accompanying notes to consolidated financial statements.


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NAUTILUS, INC.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
(In thousands)  
 
 
Common Stock
 
Retained
Earnings
 
Accumulated
Other
Comprehensive
Income (Loss)
 
Total
Shareholders'
Equity
 
 
Shares
 
Amount
 
 
 
Balances at December 31, 2017
 
30,305

 
$

 
$
179,448

 
$
(259
)
 
$
179,189

Net income
 

 

 
14,658

 

 
14,658

Unrealized loss on marketable securities, net of income tax expense of $13
 

 

 

 
58

 
58

Gain on derivative securities, effective portion, net of income tax benefit of $17
 

 

 

 
7

 
7

Foreign currency translation adjustment, net of income tax benefit of $2
 

 

 

 
(715
)
 
(715
)
Stock-based compensation expense
 

 
1,981

 

 

 
1,981

Common stock issued under equity
compensation plan, net of shares withheld
for tax payments
 
192

 
(30
)
 

 

 
(30
)
Common stock issued under employee stock purchase plan
 
38

 
444

 

 

 
444

Repurchased shares
 
(990
)
 
(2,180
)
 
(10,816
)
 

 
(12,996
)
Balances at December 31, 2018
 
29,545

 
215

 
183,290

 
(909
)
 
182,596

Net loss
 

 

 
(92,800
)
 

 
(92,800
)
Unrealized gain on marketable securities, net of income tax expense of $6
 

 

 

 
6

 
6

Loss on derivative securities, effective portion, net of income tax benefit of $139
 

 

 

 
(223
)
 
(223
)
Foreign currency translation adjustment,
  net of income tax benefit of $27
 

 

 

 
189

 
189

Stock-based compensation expense
 

 
837

 
(218
)
 

 
619

Common stock issued under equity
  compensation plan, net of shares withheld
  for tax payments
 
135

 
(32
)
 

 

 
(32
)
Common stock issued under employee stock purchase plan
 
101

 
241

 

 

 
241

Balances at December 31, 2019
 
29,781

 
$
1,261

 
$
90,272

 
$
(937
)
 
$
90,596



See accompanying notes to consolidated financial statements.

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NAUTILUS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
 
Year Ended December 31,
 
2019
 
2018
 
 
 
 
Cash flows from operating activities:
 
 
 
(Loss) income from continuing operations
$
(92,295
)
 
$
15,110

Loss from discontinued operations
(505
)
 
(452
)
Net (loss) income
(92,800
)
 
14,658

Adjustments to reconcile net (loss) income to net cash (used in) provided by operating activities:
 
 
 
Depreciation and amortization
10,811

 
8,942

Bad debt expense
19

 
27

Inventory lower-of-cost-or-market/NRV adjustments
770

 
558

Stock-based compensation expense
619

 
1,981

Loss on asset disposals
1,191

 
32

Goodwill and intangible impairment charge
72,008

 

Deferred income taxes, net of valuation allowances
(10,613
)
 
3,229

Other
(90
)