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

For the quarterly period ended June 30, 2016
or
[ ]
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                   to                   


Commission file number: 001-31321

 
 
 
NAUTILUS, INC.
(Exact name of Registrant as specified in its charter)
 
 
 
 

Washington
 
94-3002667
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer
Identification No.)

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

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

N/A
(Former name, former address and former fiscal year, if changed since last report)
 
 
 
 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  [x]    No  [ ]
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  [x]    No  [ ]
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definition of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act:
Large accelerated filer  [ ]            Accelerated filer  [x]        Non-accelerated filer  [ ]            Smaller reporting company  [ ]
(do not check if a smaller
         reporting company)
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  [ ]    No  [x]
Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date:
The number of shares outstanding of the registrant's common stock as of July 31, 2016 was 31,106,068 shares.
 



NAUTILUS, INC.
FORM 10-Q
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2016
 
 
 
Item 1.
 
Item 2.
 
Item 3.
 
Item 4.
 
 
 
 
 
 
 
 
Item 1.
 
Item 1A.
 
Item 6.
 
 





PART I.    FINANCIAL INFORMATION
    
Item 1.     Financial Statements

NAUTILUS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited and in thousands)
 
As of
 
June 30, 2016
  
December 31, 2015
Assets
 
  
 
Cash and cash equivalents
$
40,184

  
$
30,778

Available-for-sale securities
33,294

 
29,998

Trade receivables, net of allowances of $78 and $918
19,670

  
45,155

Inventories
42,995

  
42,729

Prepaids and other current assets
7,006

  
6,888

Income taxes receivable
8,479

  
439

Deferred income tax assets

  
8,904

Total current assets
151,628

 
164,891

Property, plant and equipment, net
17,457

  
16,764

Goodwill
60,475

  
60,470

Other intangible assets, net
71,433

  
73,354

Other assets
575

  
433

Total assets
$
301,568

 
$
315,912

Liabilities and Shareholders' Equity
 
  
 
Trade payables
$
43,247

  
$
61,745

Accrued liabilities
10,491

  
13,027

Warranty obligations
3,865

  
4,753

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

 
15,993

Total current liabilities
73,596

 
95,518

Warranty obligations, non-current
4,264


3,792

Income taxes payable, non-current
5,126

  
4,116

Deferred income tax liabilities, non-current
13,109

 
18,380

Other long-term liabilities
4,806

  
3,144

Note payable, non-current, net of unamortized debt issuance costs
 of $25 and $29
55,975

 
63,971

Total liabilities
156,876

 
188,921

Commitments and contingencies (Note 15)


 


Shareholders' equity:
 
  
 
Common stock - no par value, 75,000 shares authorized, 31,105 and 31,005 shares issued and outstanding
3,842

  
796

Retained earnings
142,496

  
127,522

Accumulated other comprehensive loss
(1,646
)
  
(1,327
)
Total shareholders' equity
144,692

  
126,991

Total liabilities and shareholders' equity
$
301,568

  
$
315,912



See accompanying Notes to Condensed Consolidated Financial Statements.

1


NAUTILUS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited and in thousands, except per share amounts)
 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2016

2015
 
2016
 
2015
Net sales
$
78,529


$
59,695

 
$
199,457

 
$
155,934

Cost of sales
36,667


29,039

 
91,251

 
71,389

Gross profit
41,862


30,656

 
108,206

 
84,545

Operating expenses:
 

 
 
 
 
 
Selling and marketing
24,711


20,052

 
59,890

 
48,451

General and administrative
7,203


4,293

 
15,434

 
9,871

Research and development
3,375


2,379

 
7,009

 
4,686

Total operating expenses
35,289


26,724

 
82,333

 
63,008

Operating income
6,573


3,932

 
25,873

 
21,537

Other income (expense):
 
 
 
 
 
 
 
Interest income
68

 
59

 
122

 
103

Interest expense
(514
)
 
(6
)
 
(980
)
 
(11
)
Other, net
(136
)
 
(281
)
 
(260
)
 
(397
)
Total other expense, net
(582
)

(228
)
 
(1,118
)
 
(305
)
Income from continuing operations before income taxes
5,991


3,704

 
24,755

 
21,232

Income tax expense
2,295


1,485

 
9,473

 
8,154

Income from continuing operations
3,696


2,219

 
15,282

 
13,078

Discontinued operations:
 
 
 
 
 
 
 
Loss from discontinued operations before income taxes
(180
)

(160
)
 
(304
)
 
(313
)
Income tax expense (benefit) from discontinued operations
(14
)

(365
)
 
4

 
(391
)
   Income (loss) from discontinued operations
(166
)

205

 
(308
)
 
78

Net income
$
3,530


$
2,424

 
$
14,974

 
$
13,156

 
 
 
 
 
 
 
 
Basic income per share from continuing operations
$
0.12


$
0.07

 
$
0.49

 
$
0.42

Basic income (loss) per share from discontinued operations
(0.01
)

0.01

 
(0.01
)
 

Basic net income per share
$
0.11


$
0.08

 
$
0.48

 
$
0.42

 
 
 
 
 
 
 
 
Diluted income per share from continuing operations
$
0.12

 
$
0.07

 
$
0.49

 
$
0.41

Diluted income (loss) per share from discontinued operations
(0.01
)
 
0.01

 
(0.01
)
 

Diluted net income per share
$
0.11

 
$
0.08

 
$
0.48

 
$
0.41

Shares used in per share calculations:
 
 
 
 
 
 
 
Basic
31,072


31,485

 
31,044

 
31,441

Diluted
31,335

 
31,791

 
31,315

 
31,801



See accompanying Notes to Condensed Consolidated Financial Statements.

2


NAUTILUS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Unaudited and in thousands)
 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2016
 
2015
 
2016
 
2015
Net income
$
3,530

 
$
2,424

 
$
14,974

 
$
13,156

Other comprehensive income (loss):
 
 
 
 
 
 
 
Unrealized gain on available-for-sale securities, net of income tax expense of $4, $5, $16 and $5
8

 
14

 
26

 
13

Loss on derivative securities, effective portion, net of income tax benefit of $63, $0, $476 and $0
(105
)
 

 
(787
)
 

Foreign currency translation, net of income tax (benefit) expense of $2, $(1), $(5) and $4
(110
)
 
132

 
442

 
(352
)
        Other comprehensive income (loss)
(207
)
 
146

 
(319
)
 
(339
)
Comprehensive income
$
3,323

 
$
2,570

 
$
14,655

 
$
12,817



See accompanying Notes to Condensed Consolidated Financial Statements.


3


NAUTILUS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited and in thousands)  
 
Six Months Ended June 30,
 
2016
 
2015
Cash flows from operating activities:
 
 
 
Income from continuing operations
$
15,282

 
$
13,078

Income (loss) from discontinued operations
(308
)
 
78

Net income
14,974

 
13,156

Adjustments to reconcile net income to cash provided by operating activities:
 
 
 
Depreciation and amortization
3,964

 
1,718

Benefit from allowance for doubtful accounts
(876
)
 
(118
)
Inventory lower-of-cost-or-market adjustments
133

 
68

Stock-based compensation expense
1,489

 
669

Loss on asset dispositions
127

 
258

Deferred income taxes, net of valuation allowance
5,629

 
7,322

Excess tax (benefit) deficiency related to stock-based awards
(1,729
)
 
1

Other
5

 

Changes in operating assets and liabilities:
 
 
 
Trade receivables
26,260

 
13,899

Inventories
1,115

 
(3,537
)
Prepaids and other current assets
(445
)
 
2,679

Income taxes receivable
(8,040
)
 
(121
)
Trade payables
(17,530
)
 
(15,281
)
Accrued liabilities, including warranty obligations
(2,062
)
 
(2,008
)
Net cash provided by operating activities
23,014

 
18,705

Cash flows from investing activities:
 
 
 
Purchases of available-for-sale securities
(20,305
)
 
(43,240
)
Proceeds from maturities of available-for-sale securities
16,938

 
17,095

Proceeds from sales of available-for-sale securities
71

 
3,381

Acquisition of business, net of cash acquired
(3,468
)
 

Purchases of property, plant and equipment
(706
)
 
(1,252
)
Net cash used in investing activities
(7,470
)
 
(24,016
)
Cash flows from financing activities:
 
 
 
Payments on long-term debt
(8,000
)
 

Payments for stock repurchases

 
(1,996
)
Proceeds from exercise of stock options and employee stock plan purchases
431

 
975

Tax payments related to stock award issuances
(221
)
 
(775
)
Excess tax benefit (deficiency) related to stock-based awards
1,729

 
(1
)
Net cash used in financing activities
(6,061
)
 
(1,797
)
Effect of exchange rate changes on cash and cash equivalents
(77
)
 
(609
)
Increase (decrease) in cash and cash equivalents
9,406

 
(7,717
)
Cash and cash equivalents:
 
 
 
Beginning of period
30,778

 
45,206

End of period
$
40,184

 
$
37,489

Supplemental disclosure of cash flow information:
 
 
 
Cash paid for interest
$
(975
)
 
$
(11
)
Cash paid for income taxes, net
(11,305
)
 
(760
)
Supplemental disclosure of non-cash investing activities:
 
 
 
Capital expenditures incurred but not yet paid
$
1,701

 
$
1,166

See accompanying Notes to Condensed Consolidated Financial Statements.

4


NAUTILUS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

(1) GENERAL INFORMATION
 
Basis of Consolidation and Presentation
 
The accompanying condensed consolidated financial statements present the financial position, results of operations and cash flows of Nautilus, Inc. and its subsidiaries, all of which are wholly owned. Intercompany transactions and balances have been eliminated in consolidation.
 
The accompanying condensed consolidated financial statements have not been audited. We have condensed or omitted certain information and footnote disclosures normally included in financial statements presented in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”). Management believes the disclosures contained herein are adequate to make the information presented not misleading. However, these condensed consolidated financial statements should be read in conjunction with our consolidated financial statements and notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2015 (the “2015 Form 10-K”).
 
The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates. Further information regarding significant estimates can be found in our 2015 Form 10-K.
 
In the opinion of management, the accompanying condensed consolidated financial statements reflect all adjustments necessary to present fairly our financial position as of June 30, 2016 and December 31, 2015, and our results of operations and comprehensive income for the three and six months ended June 30, 2016 and 2015, and cash flows for the six months ended June 30, 2016 and 2015. Interim results are not necessarily indicative of results for a full year. Our revenues typically vary seasonally and this seasonality can have a significant effect on operating results, inventory levels and working capital needs.
 
Unless indicated otherwise, all information regarding our operating results pertain to our continuing operations.
 
New Accounting Pronouncements

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

ASU 2016-12
In May 2016, the FASB issued ASU 2016-12, "Revenue from Contracts with Customers (Topic 606) - Narrow-Scope Improvements and Practical Expedients." ASU 2016-12 clarifies aspects of Topic 606 related to assessing collectibility, presentation of sales taxes, non-cash consideration, and completed contracts and contract modifications at transition, while retaining the related core principles for those areas. The effective date and transition requirements for ASU 2016-12 are the same as the effective date and transition requirements for Topic 606 (ASU 2014-09). While we do not expect the adoption of ASU 2016-12 to have a material effect on our business, we are evaluating any potential impact that adoption of ASU 2016-12 may have on our financial position, results of operations or cash flows.
 
ASU 2016-10
In April 2016, the FASB issued ASU 2016-10, "Revenue from Contracts with Customers (Topic 606) - Identifying Performance Obligations and Licensing." ASU 2016-10 clarifies aspects of Topic 606 related to identifying performance obligations and the licensing implementation guidance, while retaining the related core principles for those areas. The effective date and transition requirements for ASU 2016-10 are the same as the effective date and transition requirements for Topic 606 (ASU 2014-09). While

5


we do not expect the adoption of ASU 2016-10 to have a material effect on our business, we are evaluating any potential impact that adoption of ASU 2016-10 may have on our financial position, results of operations or cash flows.
    
ASU 2016-09
In March 2016, the FASB issued ASU 2016-09, "Compensation - Stock Compensation (Topic 718) - Improvements to Employee Share-Based Payment Accounting." ASU 2016-09 simplifies several aspects of the accounting for share-based payment transactions, including the income tax consequences, classification of awards as either equity or liabilities, and classification on the statement of cash flows. ASU 2016-09 is effective for public companies' annual periods, including interim periods within those fiscal years, beginning after December 15, 2016. Early adoption is permitted subject to certain requirements, and the method of application (i.e., retrospective, modified retrospective or prospective) depends on the transaction area that is being amended. We do not expect the adoption of ASU 2016-09 to have a material effect on our financial position, results of operations or cash flows.

ASU 2016-02
In February 2016, the FASB issued ASU 2016-02, "Leases (Topic 842)." ASU 2016-02 replaces the existing guidance in Accounting Standards Codification ("ASC") 840, Leases. The new standards will require companies and other organizations to include lease obligations on their balance sheets, including a dual approach for lessee accounting under which a lessee would account for leases as finance leases or operating leases. Both finance leases and operating leases will result in the lessee recognizing a right-of-use ("ROU") asset and a corresponding lease liability. For finance leases the lessee would recognize interest expense and amortization of the ROU asset, and for operating leases the lessee would recognize a straight-line total lease expense. ASU 2016-02 is effective for public companies' annual periods, and interim periods within those fiscal years, beginning after December 15, 2018. We are currently evaluating any potential impact that adoption of ASU 2016-02 may have on our financial position, results of operations or cash flows.

ASU 2015-17
In November 2015, the FASB issued ASU 2015-17, "Income Taxes (Topic 740) - Balance Sheet Classification of Deferred Taxes." ASU 2015-17 simplifies the presentation of deferred income taxes, and requires that deferred tax liabilities and assets be classified as noncurrent in a classified statement of financial position. The amendments apply to all entities that present a classified statement of financial position, and aligns the presentation of deferred income tax assets and liabilities with International Financial Reporting Standards ("IFRS") IAS 1. ASU 2015-17 is effective for public companies' financial statements issued for annual periods beginning after December 15, 2016, and interim periods within those annual periods. Early application is permitted and may be applied either prospectively to all deferred tax liabilities and assets or retrospectively to all periods presented. Our early adoption of ASU 2015-17 in January 2016 did not have a material effect on our financial position, results of operations or cash flows. We are applying ASU 2015-17 on a prospective basis to all deferred tax liabilities and assets, and prior periods have not been retrospectively adjusted.

ASU 2015-16
In September 2015, the FASB issued ASU 2015-16, "Business Combinations (Topic 805) - Simplifying the Accounting for Measurement-Period Adjustments." ASU 2015-16 simplifies the presentation of provisional amounts reported for items in a business combination for which the accounting is incomplete by the end of the reporting period in which the combination occurs and during the measurement period have an adjustment to provisional amounts recognized. The amendments in ASU 2015-16 require an entity to recognize adjustments to provisional amounts that are identified during the measurement period in the reporting period in which the adjustment amounts are determined, and to present separately on the face of the income statement or disclose in the notes the portion of the amount recorded in current-period earnings by line item that would have been recorded in previous reporting periods if the adjustment to the provisional amounts had been recognized as of the acquisition date. ASU 2015-16 is effective for public companies' financial statements issued for fiscal years, including interim periods within those fiscal years, beginning after December 15, 2015 on a prospective basis. Our adoption of ASU 2015-16 as of January 2016 did not have a material effect on our financial position, results of operations or cash flows.

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

ASU 2015-05
In April 2015, the FASB issued ASU 2015-05, “Intangibles - Goodwill and Other - Internal-Use Software (Subtopic 350-40).” ASU 2015-05 provides guidance regarding the accounting for a customer's fees paid in a cloud computing arrangement, specifically about whether a cloud computing arrangement includes a software license, and if so, how to account for the software license. ASU

6


2015-05 was effective for public companies' annual periods, including interim periods, beginning after December 15, 2015. Our adoption of ASU 2015-05 in January 2016 did not have a material effect on our financial position, results of operations or cash flows.

ASU 2014-12
In June 2014, the FASB issued ASU No. 2014-12, "Compensation - Stock Compensation (Topic 718)." ASU No. 2014-12 addresses accounting for share-based payments when the terms of an award provide that a performance target could be achieved after the requisite service period. ASU 2014-12 indicates that, in such situations, the performance target should be treated as a performance condition and, accordingly, the performance target should not be reflected in estimating the grant-date fair value of the award. Instead, compensation cost should be recognized in the period in which it becomes probable that the performance target will be achieved. ASU 2014-12 is effective for annual periods and interim periods within those annual periods beginning after December 15, 2015. Our adoption of ASU 2014-12 in January 2016 did not have a material effect on our financial position, results of operations or cash flows.

ASU 2014-09
In May 2014, the FASB issued ASU No. 2014-09, "Revenue from Contracts with Customers." ASU 2014-09 clarifies the principles for recognizing revenue and develops a common revenue standard for U.S. GAAP and the International Accounting Standards Board that:
• removes inconsistencies and weaknesses in revenue requirements;
• provides a more robust framework for addressing revenue issues;
• improves comparability of revenue recognition practices across entities, industries, jurisdictions and capital markets;
• provides more useful information to users of financial statements through improved disclosure requirements; and
• simplifies the preparation of financial statements by reducing the number of requirements to which an entity must refer.

ASU 2014-09 is effective, as amended, for annual and interim periods beginning on or after December 15, 2017. While we do not expect the adoption of ASU 2014-09 to have a material effect on our business, we are still evaluating any potential impact that adoption of ASU 2014-09 may have on our financial position, results of operations or cash flows.

(2) BUSINESS ACQUISITION

On December 31, 2015, we acquired all of the outstanding capital stock of OF Holdings, Inc., sole parent of Octane Fitness, LLC ("Octane"), for an aggregate base purchase price of $115.0 million, plus net adjustments for working capital and cash acquired on the closing date. We funded the acquisition through an $80.0 million term loan and cash on hand.

For the three and six months ended June 30, 2016, Octane contributed net sales of $12.2 million and $24.7 million, respectively. Octane broke even for the second quarter of 2016, and contributed a net loss of $0.7 million for the first six months of 2016. Operating results for the three-month current and year-to-date periods included amortization of acquired assets of $0.8 million and $1.5 million, respectively, and purchase accounting related inventory step-up charges of $0.3 million and $1.0 million, respectively. Working capital and other measurement period adjustments as of June 30, 2016 totaled $0.7 million and are detailed in the preliminary valuation table shown below.

Total acquisition costs incurred for the six months ended June 30, 2016 were $0.2 million, and cumulative-to-date costs total $0.9 million. These charges were expensed as incurred in general and administrative costs.

Purchase Price Allocation
Acquired assets and liabilities were recorded at estimated fair value as of the acquisition date. The excess of the purchase price over the estimated fair value of identifiable net assets resulted in the recognition of goodwill of $58.2 million, all of which was assigned to the Retail segment, and is attributed primarily to Octane's intellectual property base, benefits of access to different markets and customers, and employee workforce. The goodwill is not expected to be deductible for income tax purposes.


7


The following table summarizes the preliminary fair values of the net assets acquired and liabilities assumed and measurement period adjustments since December 31, 2015, the acquisition date (in thousands):
 
Preliminary valuation at December 31, 2015
 
Measurement period adjustments
 
Adjusted preliminary valuation at June 30, 2016
Cash
$
7,759

 
$

 
$
7,759

Accounts receivable
12,507

 

 
12,507

Inventories
12,168

 
1,515

 
13,683

Prepaid expenses
1,028

 
(144
)
 
884

Deferred tax assets
1,287

 
(571
)
 
716

Property, plant and equipment
3,240

 

 
3,240

Intangible assets
63,100

 

 
63,100

   Total assets acquired
101,089

 
800

 
101,889

 
 
 
 
 
 
Accounts payable
6,215

 

 
6,215

Accrued liabilities
1,614

 

 
1,614

Warranty obligations
5,550

 

 
5,550

Deferred tax liabilities, non-current
20,914

 

 
20,914

Other non-current liabilities
519

 

 
519

   Total liabilities assumed
34,812

 

 
34,812

 
 
 
 
 
 
Net identifiable assets acquired
66,277

 
800

 
67,077

Goodwill
58,357

 
(138
)
 
58,219

Net assets acquired
$
124,634

 
$
662

 
$
125,296


The allocation of the purchase price is preliminary and is based upon valuation information available and estimates and assumptions made as of June 30, 2016. We are still in the process of verifying data and finalizing information including valuation and recording of the assets acquired and liabilities assumed, and the resulting amount of recognized goodwill.

The following table sets forth the components of identifiable intangible assets and their estimated fair values and useful lives as of December 31, 2015, the acquisition date (dollars in thousands):
 
Estimated fair value
 
Estimated useful life (years)
 
Weighted-average amortization period (years)
Trade name - Octane Fitness
$
23,000

 
Indefinite
 
N/A
 
 
 
 
 
 
Trade name - others
2,600

 
10 - 15
 
12.5
Patents
12,800

 
11 - 24
 
18
Customer relationships
24,700

 
10 - 15
 
13
Definite-lived intangible assets
40,100

 
 
 
 
Total intangible assets
$
63,100

 
 
 
 


8


Summary of Unaudited Pro Forma Information
The following table reflects the unaudited pro forma consolidated results of operations for the periods presented, as though the acquisition of Octane had occurred on January 1, 2015 (in thousands, except per share amounts):
 
 
(unaudited)
 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
 
2016
 
2015
 
2016
 
2015
Net sales
$
78,529

 
$
73,361

 
$
199,457

 
$
184,491

Net income
3,907

 
2,220

 
15,867

 
12,596

Net income per share:
 
 
 
 
 
 
 
 
Basic
$
0.13

 
$
0.07

 
$
0.51

 
$
0.40

 
Diluted
0.12

 
0.07

 
0.51

 
0.40


The unaudited pro forma financial information is presented for illustrative purposes only and is not indicative of the results of operations that would have been realized if the acquisition had been completed on the date indicated, nor is it indicative of future operating results.

(3) DISCONTINUED OPERATIONS

There was no revenue related to discontinued operations for the six months ended June 30, 2016 or the year ended December 31, 2015. However, we continue to have legal and accounting expenses as we work with authorities on final deregistration of certain foreign entities and product liability expenses associated with product previously sold into the Commercial channel.

The following table summarizes liabilities for exit costs related to discontinued operations, included in accrued liabilities in our Condensed Consolidated Balance Sheets (in thousands):
 
Facilities
Leases
Balance, December 31, 2015
$
300

Payments
(150
)
Balance, June 30, 2016
$
150


We expect the lease obligations to be paid out through 2016.

(4) FAIR VALUE MEASUREMENTS

Factors used in determining the fair value of financial assets and liabilities are summarized into three broad categories:

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

9


Assets and liabilities measured at fair value on a recurring basis as of June 30, 2016 and December 31, 2015 were as follows (in thousands):
 
 
June 30, 2016
 
 
Level 1
 
Level 2
 
Level 3
 
Total
Assets:
 
 
 
 
 
 
 
 
Cash Equivalents
 
 
 
 
 
 
 
 
Money market funds
 
$
6,594

 
$

 
$

 
$
6,594

Commercial paper
 

 
5,996

 

 
5,996

Corporate bonds
 

 
2,012

 

 
2,012

Total cash equivalents
 
6,594

 
8,008

 

 
14,602

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

 
28,235

 

 
28,235

Corporate bonds
 

 
3,054

 

 
3,054

U.S. government bonds
 

 
2,005

 

 
2,005

Total available-for-sale securities
 

 
33,294

 

 
33,294

 
 
 
 
 
 
 
 
 
Total assets measured at fair value
 
$
6,594

 
$
41,302

 
$

 
$
47,896

 
 
 
 
 
 
 
 
 
Liabilities:
 
 
 
 
 
 
 
 
Derivatives
 
 
 
 
 
 
 
 
Interest rate swap contract
 
$

 
$
(1,263
)
 
$

 
$
(1,263
)
 
 
 
 
 
 
 
 
 
Total liabilities measured at fair value
 
$

 
$
(1,263
)
 
$

 
$
(1,263
)

 
 
December 31, 2015
 
 
Level 1
 
Level 2
 
Level 3
 
Total
Assets:
 
 
 
 
 
 
 
 
Cash Equivalents
 
 
 
 
 
 
 
 
Money market funds
 
$
1

 
$

 
$

 
$
1

Corporate bonds
 

 
733

 

 
733

Total cash equivalents
 
1

 
733

 

 
734

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

 
25,234

 

 
25,234

Corporate bonds
 

 
4,764

 

 
4,764

  Total available-for-sale securities
 

 
29,998

 

 
29,998

 
 
 
 
 
 
 
 
 
Total assets measured at fair value
 
$
1

 
$
30,731

 
$

 
$
30,732


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

We did not have any liabilities measured at fair value on a recurring basis as of December 31, 2015.

For our assets measured at fair value on a recurring basis, we recognize transfers between levels at the actual date of the event or change in circumstance that caused the transfer.  There were no transfers between levels during the three and six months ended June 30, 2016, nor for the year ended December 31, 2015.


10


We did not have any changes to our valuation techniques during the three and six months ended June 30, 2016, nor for the year ended December 31, 2015.

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

The fair value of our interest rate swap contract is calculated as the present value of estimated future cash flows using discount factors derived from relevant Level 2 market inputs, including forward curves and volatility levels.
 
We recognize or disclose the fair value of certain assets, such as non-financial assets, primarily property, plant and equipment, goodwill, other intangible assets and certain other long-lived assets in connection with impairment evaluations. All of our nonrecurring valuations use significant unobservable inputs and therefore fall under Level 3 of the fair value hierarchy. We did not perform any valuations on assets or liabilities that are valued at fair value on a nonrecurring basis during the first six months of 2016. During the fourth quarter of 2015, we performed our annual goodwill and indefinite-lived trade names impairment analyses effective as of October 1, 2015. During the six months ended June 30, 2016 and the year ended December 31, 2015, we did not record any other-than-temporary impairments on our financial assets required to be measured at fair value on a nonrecurring basis.

(5) DERIVATIVES

From time to time, we enter into interest rate swaps to fix a portion of our interest expense. We do not enter into derivative instruments for any purpose other than to manage interest rate exposure to fluctuations in the one-month LIBOR benchmark. That is, we do not engage in interest rate speculation using derivative instruments.

As of June 30, 2016, we had a $72.0 million interest rate swap outstanding with JPMorgan Chase Bank, N.A. This interest rate swap matures on December 31, 2020 and has a fixed rate of 1.42% per annum. The variable rate on the interest rate swap is the one-month LIBOR benchmark. At June 30, 2016, the one-month LIBOR rate was 0.45%.

We typically designate all interest rate swaps as cash flow hedges and, accordingly, record the change in fair value for the effective portion of these interest rate swaps in accumulated other comprehensive income rather than current period earnings until the underlying hedged transaction affects earnings. Gains and losses on the derivative representing either hedge ineffectiveness or hedge components excluded from the assessment of effectiveness are recognized in current earnings. For the three and six months ended June 30, 2016, there was no ineffectiveness. As of June 30, 2016, we expect to reclassify $0.3 million from accumulated other comprehensive income to earnings within the next twelve months.

The fair value of our derivative instruments was included in our Condensed Consolidated Balance Sheets as follows (in thousands):
 
 
Balance Sheet Classification
 
As of
 
 
 
June 30, 2016
 
December 31, 2015
Derivatives instruments designated as cash flow hedges:
 
 
 
 
 
 
Interest rate swap contract
 
Accrued liabilities
 
$
298

 
$

 
 
Other long-term liabilities
 
965

 

 
 
 
 
$
1,263

 
$



11


The effect of derivative instruments on our Condensed Consolidated Statements of Operations was as follows (in thousands):
 
 
Statement of Operations Classification
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
 
 
2016
 
2015
 
2016
 
2015
Derivatives instruments designated as
cash flow hedges:
 
 
 
 
 
 
 
 
 
 
Loss recognized in other comprehensive income before reclassifications
 
---
 
$
(219
)
 
$

 
$
(980
)
 
$

Loss reclassified from accumulated other comprehensive income to earnings for the effective portion
 
Interest expense
 
$
(185
)
 
$

 
$
(313
)
 
$

Related tax effect
 
Income tax benefit
 
$
71

 
$

 
$
120

 
$


(6) INVENTORIES

Inventories are stated at the lower of cost or market, with cost determined based on the first-in, first-out method. Our inventories consisted of the following (in thousands):
 
As of
 
June 30, 2016
 
December 31, 2015
Finished goods
$
39,082

  
$
39,115

Parts and components
3,913

  
3,614

Total inventories
$
42,995

  
$
42,729


(7) PROPERTY, PLANT AND EQUIPMENT

Property, plant and equipment consisted of the following (in thousands):
 
Estimated
Useful Life
(in years)
 
As of
 
 
June 30, 2016
 
December 31, 2015
Automobiles
5
to
6
 
$
139

 
$
139

Leasehold improvements
5
to
16
 
3,084

 
3,397

Computer software and equipment
3
to
7
 
25,689

 
23,991

Machinery and equipment
3
to
5
 
11,993

 
10,867

Furniture and fixtures
5
to
20
 
2,124

 
1,605

Work in progress(1)
N/A
 
488

 
1,655

Total cost
 
 
 
 
43,517

 
41,654

Accumulated depreciation
 
 
 
 
(26,060
)
 
(24,890
)
Total property, plant and equipment, net
 
 
 
 
$
17,457

 
$
16,764

(1) Work in progress includes production tooling and internal use software development.


12


(8) GOODWILL AND OTHER INTANGIBLE ASSETS

Goodwill
The rollforward of goodwill was as follows (in thousands):
 
Direct
 
Retail
 
Total
Balance, January 1, 2015
$
2,520

 
$

 
$
2,520

Currency exchange rate adjustment
(407
)
 

 
(407
)
Business acquisition (Note 2)

 
58,357

 
58,357

Balance, December 31, 2015
2,113

 
58,357

 
60,470

Currency exchange rate adjustment
149

 
(6
)
 
143

Business acquisition (Note 2) - measurement period adjustments

 
(138
)
 
(138
)
Balance, June 30, 2016
$
2,262

 
$
58,213

 
$
60,475


Other Intangible Assets
Other intangible assets consisted of the following (in thousands):
 
Estimated
Useful Life
(in years)
 
As of
 
 
June 30, 2016
 
December 31, 2015
Indefinite-lived trademarks
N/A
 
$
32,052

 
$
32,052

Definite-lived trademarks
10
to
15
 
2,600

 
2,600

Patents
8
to
24
 
31,487

 
31,487

Customer relationships
10
to
15
 
24,700

 
24,700

 
 
 
 
 
90,839

 
90,839

Accumulated amortization - definite-lived intangible assets
 
 
 
 
(19,406
)
 
(17,485
)
Other intangible assets, net
 
 
 
 
$
71,433

 
$
73,354


Amortization expense was as follows (in thousands):
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2016
 
2015
 
2016
 
2015
Amortization expense
$
961

 
$
179

 
$
1,921

 
$
469


Future amortization of definite-lived intangible assets is as follows (in thousands):
Remainder of 2016
$
1,633

2017
3,256

2018
3,164

2019
3,134

2020
3,108

Thereafter
25,086

 
$
39,381


(9) ACCRUED LIABILITIES

Accrued liabilities consisted of the following (in thousands):
 
As of
 
June 30, 2016
 
December 31, 2015
Payroll and related liabilities
$
4,070

 
$
6,556

Other
6,421

 
6,471

  Total accrued liabilities
$
10,491

 
$
13,027



13


(10) PRODUCT WARRANTIES

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

Changes in our product warranty obligations were as follows (in thousands):
 
 
Six Months Ended June 30,
 
 
2016
 
2015
Balance, beginning of period
 
$
8,545

 
$
2,246

Accruals
 
1,644

 
1,691

Payments
 
(2,060
)
 
(1,118
)
Balance, end of period
 
$
8,129

 
$
2,819


(11) ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS)

Accumulated other comprehensive income (loss), net of applicable taxes, reported on our Condensed Consolidated Balance Sheets consists of unrealized holding gains and losses on available-for-sale securities, effective portions of gains and losses of derivative securities designated as cash flow hedges, and foreign currency translation adjustments. The following tables set forth the changes in accumulated other comprehensive income (loss), net of tax (in thousands) for the periods presented:
 
Unrealized Gain on Available-for-Sale Securities
 
Loss on Derivative Securities (Effective Portion)
 
Foreign Currency Translation Adjustments
 
Accumulated Other Comprehensive Loss
Balance, March 31, 2016
$
2

 
$
(682
)
 
$
(759
)
 
$
(1,439
)
Current period other comprehensive income (loss) before reclassifications
8

 
(219
)
 
(110
)
 
(321
)
Reclassification of amounts to earnings

 
114

 

 
114

Net other comprehensive income (loss) during period
8

 
(105
)
 
(110
)
 
(207
)
Balance, June 30, 2016
$
10

 
$
(787
)
 
$
(869
)
 
$
(1,646
)
 
Unrealized Gain (Loss) on Available-for-Sale Securities
 
Loss on Derivative Securities (Effective Portion)
 
Foreign Currency Translation Adjustments
 
Accumulated Other Comprehensive Loss
Balance, December 31, 2015
$
(16
)
 
$

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

 
(980
)
 
442

 
(512
)
Reclassification of amounts to earnings

 
193

 

 
193

Net other comprehensive income (loss) during period
26

 
(787
)
 
442

 
(319
)
Balance, June 30, 2016
$
10

 
$
(787
)
 
$
(869
)
 
$
(1,646
)

14


 
Unrealized Gain (Loss) on Available-for-Sale Securities
 
Foreign Currency Translation Adjustments
 
Accumulated Other Comprehensive Income (Loss)
Balance, March 31, 2015
$
(19
)
 
$
(774
)
 
$
(793
)
Current period other comprehensive income
14

 
132

 
146

Balance, June 30, 2015
$
(5
)
 
$
(642
)
 
$
(647
)
 
Unrealized Gain (Loss) on Available-for-Sale Securities
 
Foreign Currency Translation Adjustments
 
Accumulated Other Comprehensive Loss
Balance, December 31, 2014
$
(18
)
 
$
(290
)
 
$
(308
)
Current period other comprehensive income (loss)
13

 
(352
)
 
(339
)
Balance, June 30, 2015
$
(5
)
 
$
(642
)
 
$
(647
)

(12) STOCK REPURCHASE PROGRAM

On November 3, 2014, our Board of Directors approved a stock repurchase program that authorized us to repurchase up to $15.0 million of our outstanding common stock from time to time during the ensuing period of 24 months. On May 4, 2016, our Board of Directors approved an expansion of our share repurchase program that authorized us to repurchase up to an additional $10.0 million of our outstanding common stock from time to time during the period of 24 months following such approval. Repurchases may be made in open market transactions at prevailing prices, in privately negotiated transactions, or by other means in accordance with federal securities laws. Share repurchases are funded from existing cash balances, and the repurchased shares are retired and returned to unissued authorized shares.

As of June 30, 2016, a total of $13.4 million remains available for future repurchases. The repurchase program expires on November 3, 2016 as to the approximately $3.4 million remaining available for repurchases under the original $15.0 million authorization. The repurchase program expires on May 4, 2018 as to the $10.0 million available for repurchases under the $10.0 million expansion.

There were no repurchases during the three and six months ended June 30, 2016. Repurchases pursuant to the program were as follows:
Quarter Ended
 
Number of Shares
 
Repurchased Amount
 
Average Price Per Share
March 31, 2015
 
133,877
 
$1,995,982
 
$14.91
September 30, 2015
 
577,831
 
9,571,545
 
16.56
Totals to Date
 
711,708
 
$11,567,527
 
$16.25
 
(13) INCOME PER SHARE

Basic per share amounts were computed using the weighted average number of common shares outstanding. Diluted per share amounts were calculated using the number of basic weighted average shares outstanding increased by dilutive potential common shares related to stock-based awards, as determined by the treasury stock method. The weighted average numbers of shares outstanding used to compute income per share were as follows (in thousands):
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2016
 
2015
 
2016
 
2015
Shares used to calculate basic income per share
31,072

 
31,485

 
31,044

 
31,441

Dilutive effect of outstanding stock options, performance stock units and restricted stock units
263

 
306

 
271

 
360

Shares used to calculate diluted income per share
31,335

 
31,791

 
31,315

 
31,801



15


The weighted average numbers of shares outstanding listed in the table below were anti-dilutive and excluded from the computation of diluted income per share because the average market price did not exceed the exercise price. These shares may be dilutive potential common shares in the future (in thousands):
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2016
 
2015
 
2016
 
2015
Stock options
11

 
8

 
11

 
11


(14) SEGMENT AND ENTERPRISE-WIDE INFORMATION

We operate in three segments - Direct, Retail, and Commercial and Specialty. Based on the aggregation criteria of ASC 280-10, we determined that two of the operating segments (Retail and Commercial and Specialty) can be aggregated due to these segments having similar economic and other characteristics. As a result, we have two reportable segments - Direct and Retail. This financial reporting structure was effective as of December 31, 2015, the date on which we acquired Octane.

We evaluate performance using several factors, of which the primary financial measures are net sales and reportable segment contribution. Contribution is the measure of profit or loss, defined as net sales less product costs and directly attributable expenses. Directly attributable expenses include selling and marketing expenses, general and administrative expenses, and research and development expenses that are directly related to segment operations. Segment assets are those directly assigned to an operating segment's operations, primarily accounts receivable, inventories, goodwill and other intangible assets. Unallocated assets primarily include cash and cash equivalents, available-for-sale securities, shared information technology infrastructure, distribution centers, corporate headquarters, prepaids and other current assets, deferred income tax assets and other assets. Capital expenditures directly attributable to the Direct and Retail segments were not significant in any period.

Following is summary information by reportable segment (in thousands):
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2016
 
2015
 
2016
 
2015
Net sales:
 
 
 
 
 
 
 
Direct
$
44,940

 
$
41,662

 
$
126,174

 
$
115,719

Retail
32,911

 
17,404

 
71,716

 
38,694

Royalty
678

 
629

 
1,567

 
1,521

Consolidated net sales
$
78,529

 
$
59,695

 
$
199,457

 
$
155,934

Contribution:
 
 
 
 
 
 
 
Direct
$
7,525

 
$
5,106

 
$
28,669

 
$
24,677

Retail
4,117

 
1,176

 
8,061

 
2,676

Royalty
678

 
629

 
1,548

 
1,521

Consolidated contribution
$
12,320

 
$
6,911

 
$
38,278

 
$
28,874

 
 
 
 
 
 
 
 
Reconciliation of consolidated contribution to income from continuing operations:
 
 
 
 
 
 
 
Consolidated contribution
$
12,320

 
$
6,911

 
$
38,278

 
$
28,874

Amounts not directly related to segments:
 
 
 
 
 
 
 
Operating expenses
(5,747
)
 
(2,979
)
 
(12,405
)
 
(7,337
)
Other expense, net
(582
)
 
(228
)
 
(1,118
)
 
(305
)
Income tax expense
(2,295
)
 
(1,485
)
 
(9,473
)
 
(8,154
)
Income from continuing operations
$
3,696

 
$
2,219

 
$
15,282

 
$
13,078


There was no material change in the allocation of assets by segment during the first six months of 2016 and, accordingly, assets by segment are not presented.

For the three and six months ended June 30, 2016, Amazon.com accounted for 12.3% and 10.0%, respectively, of total net sales. For the second quarter of 2015, Amazon.com represented 13.2% of our total net sales, and no customer represented 10.0% or more of total net sales for the first six months of 2015.

16



(15) COMMITMENTS AND CONTINGENCIES

Guarantees, Commitments and Off-Balance Sheet Arrangements
As of June 30, 2016, we had approximately $0.6 million in standby letters of credit with certain vendors expiring April 2017.

We have long lead times for inventory purchases and, therefore, must secure factory capacity from our vendors in advance. As of June 30, 2016, we had approximately $36.2 million in noncancelable market-based purchase obligations, primarily for inventory purchases expected to be received within the next twelve months. Purchase obligations can vary from quarter-to-quarter and versus the same period in prior years due to a number of factors, including the amount of products that are shipped directly to Retail customer warehouses versus through Nautilus warehouses.

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

The nature and terms of these indemnification obligations vary from contract to contract, and generally a maximum obligation is not stated within the agreements. We hold insurance policies that mitigate potential losses arising from certain types of indemnification obligations. Management does not deem these obligations to be significant to our financial position, results of operations or cash flows and, therefore, no related liabilities were recorded as of June 30, 2016.

Legal Matters
In 2004, we were sued in the Southern District of New York by BioSig Instruments, Inc. for alleged patent infringement in connection with our incorporation of heart rate monitors into certain cardio products. No significant activity in the litigation occurred until 2008. In 2012, the United States District Court granted summary judgment to us on grounds that BioSig’s patents were invalid as a matter of law. BioSig appealed the grant of summary judgment and, in April 2013, the United States Court of Appeals for the Federal Circuit reversed the District Court’s decision on summary judgment and remanded the case to the District Court for further proceedings. On January 10, 2014, the U. S. Supreme Court granted our petition for a writ of certiorari to address the legal standard applied by the Federal Circuit in determining whether the patents may be valid under applicable law. The case was argued before the Supreme Court on April 28, 2014. By decision dated June 2, 2014, the Supreme Court unanimously reversed the Federal Circuit, holding that its standard of when a patent may be “indefinite” was incorrect and remanding to the Federal Circuit for reconsideration under the correct standard. The remand hearing in the Federal Circuit was held on October 29, 2014. By decision dated April 27, 2015, the same panel of the Federal Circuit affirmed its earlier reversal of the District Court’s decision on summary judgment. On May 27, 2015, we filed a petition for a rehearing en banc in the Federal Circuit, which was denied on August 4, 2015 and a Petition for Review by the U. S. Supreme Court which was also denied. The case has been returned to the District Court, and the parties are currently engaged in discovery and other pre-trial motion practice. We do not believe that our use of heart rate monitors utilized or purchased from third parties, and otherwise, infringes the BioSig patents.

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

Litigation and jury verdicts are, to some degree, inherently unpredictable, and although we have determined that a loss is not probable in connection with any current legal proceeding, it is reasonably possible that a loss may be incurred in connection with proceedings to which we are a party. Assessment of whether incurrence of a loss is probable, or a reasonable possibility, in connection with a particular proceeding, and estimation of the loss, or a range of loss, involves complex judgments and numerous uncertainties. Management is unable to estimate a range of reasonably possible losses related to litigation in which the damages sought are indeterminate, or the legal and factual basis for the relevant claims have not been developed with specificity. As such, zero liability is recorded as of June 30, 2016.

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

17


developments and other factors. Due to the numerous variables associated with these judgments and assumptions, both the precision and reliability of the resulting estimates of the related loss contingencies are subject to substantial uncertainties.

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

The following discussion and analysis is based upon our financial statements as of the dates and for the periods presented in this section. You should read this discussion and analysis in conjunction with the financial statements and notes thereto found in Part I, Item 1 of this Form 10-Q and our consolidated financial statements and notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2015 (the “2015 Form 10-K”). All references to the second quarter and first six months of 2016 and 2015 mean the three and six-month periods ended June 30, 2016 and 2015, respectively. Unless the context otherwise requires, “Nautilus,” “we,” “us” and “our” refer to Nautilus, Inc. and its subsidiaries. Unless indicated otherwise, all information regarding our operating results pertains to our continuing operations.

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

As a result of the above and other factors, our period-to-period operating results may not be indicative of future performance. You should not place undue reliance on our operating results and should consider our prospects in light of the risks, expenses and difficulties typically encountered by us and other companies, both within and outside our industry. We may not be able to successfully address these risks and difficulties and, consequently, we cannot assure you of any future growth or profitability. For more information, see our discussion of risk factors located at Part I, Item 1A of our 2015 Form 10-K.

Forward-Looking Statements

This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Words such as "plan," "expect," "aim," "believe," "project," "intend," "estimate," "will," "should," "could," and other terms of similar meaning typically identify forward-looking statements. Forward-looking statements include any statements related to our future business and financial performance; anticipated fluctuations in net sales due to seasonality; plans and expectations regarding gross and operating margins; plans and expectations regarding research and development expenses and capital expenditures; anticipated losses from discontinued operations; the anticipated outcome of litigation to which we are a party; results of media investment in the Direct segment; plans for new product introductions and anticipated demand for our new and existing products; and statements regarding our inventory and working capital requirements and the sufficiency of our financial resources. These forward-looking statements, and others we make from time-to-time, are subject to a number of risks and uncertainties. Many factors could cause actual results to differ materially from those projected in forward-looking statements, including our ability to timely acquire inventory that meets our quality control standards from sole source foreign manufacturers at acceptable costs, the effectiveness, availability and price of media time consistent with our cost and audience profile parameters, greater than anticipated costs associated with launch of new products, our ability to successfully integrate acquired businesses, a decline in consumer spending due to unfavorable economic conditions, softness in the retail marketplace, an adverse change in the availability of credit for our customers who finance their purchases, our ability to pass along vendor raw material price increases and increased shipping costs, our ability to effectively develop, market and sell future products, our ability to protect our intellectual property, the introduction of competing products, and our ability to get foreign-sourced product through customs in a timely manner. Additional assumptions, risks and uncertainties are described in Part I, Item 1A, "Risk Factors," in our 2015 Form 10-K as supplemented or modified in our quarterly reports on Form 10-Q. We do not undertake any duty to update forward-looking statements after the date they are made or conform them to actual results or to changes in circumstances or expectations.


18


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

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

Net sales for the first six months of 2016 were $199.5 million, an increase of $43.5 million, or 27.9%, as compared to net sales of $155.9 million for the first six months of 2015. Net sales of our Direct segment increased $10.5 million, or 9.0%, in the first six months of 2016, compared to the first six months of 2015, primarily due to increased consumer demand for our cardio products, especially the Bowflex Max Trainer®. Net sales of our Retail segment increased by $33.0 million, or 85.3%, in the first six months of 2016, compared to the first six months of 2015, primarily due to the addition of Octane sales, coupled with strong organic Retail sales growth across both cardio and strength product offerings.

Gross profit for the first six months of 2016 was $108.2 million, or 54.3% of net sales, an increase of $23.7 million, or 28.0%, as compared to gross profit of $84.5 million, or 54.2% of net sales, for the first six months of 2015. The increase in gross profit dollars was primarily due to the increase in net sales as well as margin improvements in both segments, as further described in the discussion of segment results.

Operating expenses for the first six months of 2016 were $82.3 million, an increase of $19.3 million, or 30.7%, as compared to operating expenses of $63.0 million for the first six months of 2015. The growth in operating expenses was primarily related to an increase in selling and marketing expenses, reflecting increased advertising and sales-related variable spending, together with incremental operating expenses from the Octane acquisition.

Operating income for the first six months of 2016 was $25.9 million, an increase of $4.3 million, or 20.1%, as compared to operating income of $21.5 million for the first six months of 2015. The improvement in operating results for the first six months of 2016 compared to the first six months of 2015 was driven primarily by higher net sales and improved gross profits.

Income from continuing operations was $15.3 million for the first six months of 2016, or $0.49 per diluted share, compared to income from continuing operations of $13.1 million, or $0.41 per diluted share, for the first six months of 2015. The effective tax rates for the first six months of 2016 and 2015 were 38.3% and 38.4%, respectively.

Net income for the first six months of 2016 was $15.0 million, compared to net income of $13.2 million for the first six months of 2015. Net income per diluted share was $0.48 for the first six months of 2016, compared to $0.41 for the first six months of 2015.

Discontinued Operations

Results from discontinued operations relate to the disposal of our former Commercial business, which was completed in April 2011. We reached substantial completion of asset liquidation at December 31, 2012. Although there was no revenue related to the Commercial business in either the 2016 or 2015 periods, we continue to have legal and accounting expenses as we work with authorities on final deregistration of each entity, and product liability and other legal expenses associated with product previously sold into the Commercial channel.


19


RESULTS OF OPERATIONS

Results of operations information was as follows (dollars in thousands):
 
Three Months Ended June 30,
 
Change
 
2016
 
2015
 
$
 
%
Net sales
$
78,529

 
$
59,695

 
$
18,834

 
31.6
%
Cost of sales
36,667

 
29,039

 
7,628

 
26.3
%
Gross profit
41,862

 
30,656

 
11,206

 
36.6
%
Operating expenses:
 
 
 
 
 
 
 
Selling and marketing
24,711

 
20,052

 
4,659

 
23.2
%
General and administrative
7,203

 
4,293

 
2,910

 
67.8
%
Research and development
3,375

 
2,379

 
996

 
41.9
%
Total operating expenses
35,289

 
26,724

 
8,565

 
32.0
%
Operating income
6,573

 
3,932

 
2,641

 
67.2
%
Other income (expense):
 
 
 
 
 
 
 
Interest income
68

 
59

 
9

 
 
Interest expense
(514
)
 
(6
)
 
(508
)
 
 
Other, net
(136
)
 
(281
)
 
145

 
 
Total other expense, net
(582
)
 
(228
)
 
(354
)
 
 
Income from continuing operations before income taxes
5,991

 
3,704

 
2,287

 
 
Income tax expense
2,295

 
1,485

 
810

 
 
Income from continuing operations
3,696

 
2,219

 
1,477

 
 
Income (loss) from discontinued operations, net of taxes
(166
)
 
205

 
(371
)
 
 
Net income
$
3,530

 
$
2,424

 
$
1,106

 
 

 
Six Months Ended June 30,
 
Change
 
2016
 
2015
 
$
 
%
Net sales
$
199,457

 
$
155,934

 
$
43,523

 
27.9
%
Cost of sales
91,251

 
71,389

 
19,862

 
27.8
%
Gross profit
108,206

 
84,545

 
23,661

 
28.0
%
Operating expenses:
 
 
 
 
 
 
 
Selling and marketing
59,890

 
48,451

 
11,439

 
23.6
%
General and administrative
15,434

 
9,871

 
5,563

 
56.4
%
Research and development
7,009

 
4,686

 
2,323

 
49.6
%
Total operating expenses
82,333

 
63,008

 
19,325

 
30.7
%
Operating income
25,873

 
21,537

 
4,336

 
20.1
%
Other income (expense):
 
 
 
 
 
 
 
Interest income
122

 
103

 
19

 
 
Interest expense
(980
)
 
(11
)
 
(969
)
 
 
Other, net
(260
)
 
(397
)
 
137

 
 
Total other expense, net
(1,118
)
 
(305
)
 
(813
)
 
 
Income from continuing operations before income taxes
24,755

 
21,232

 
3,523

 
 
Income tax expense
9,473

 
8,154

 
1,319

 
 
Income from continuing operations
15,282

 
13,078

 
2,204

 
 
Income (loss) from discontinued operations, net of taxes
(308
)
 
78

 
(386
)
 
 
Net income
$
14,974

 
$
13,156

 
$
1,818

 
 

20


Results of operations information by segment was as follows (dollars in thousands):
 
Three Months Ended June 30,
 
Change
 
2016
 
2015
 
$
 
%
Net sales:
 
 
 
 
 
 
 
Direct
$
44,940

 
$
41,662

 
$
3,278

 
7.9
 %
Retail
32,911

 
17,404

 
15,507

 
89.1
 %
Royalty
678

 
629

 
49

 
7.8
 %
 
$
78,529

 
$
59,695

 
$
18,834

 
31.6
 %
Cost of sales:
 
 
 
 
 
 
 
Direct
$
14,781

 
$
15,730

 
$
(949
)
 
(6.0
)%
Retail
21,886

 
13,309

 
8,577

 
64.4
 %
 
$
36,667

 
$
29,039

 
$
7,628

 
26.3
 %
Gross profit:
 
 
 
 
 
 
 
Direct
$
30,159

 
$
25,932

 
$
4,227

 
16.3
 %
Retail
11,025

 
4,095

 
6,930

 
169.2
 %
Royalty
678

 
629

 
49

 
7.8
 %
 
$
41,862

 
$
30,656

 
$
11,206

 
36.6
 %
Gross margin:
 
 
 
 
 
 
 
Direct
67.1
%
 
62.2
%
 
490

basis points
Retail
33.5
%
 
23.5
%
 
1,000

basis points

 
Six Months Ended June 30,
 
Change
 
2016
 
2015
 
$
 
%
Net sales:
 
 
 
 
 
 
 
Direct
$
126,174

 
$
115,719

 
$
10,455

 
9.0
%
Retail
71,716

 
38,694

 
33,022

 
85.3
%
Royalty
1,567

 
1,521

 
46

 
3.0
%
 
$
199,457

 
$
155,934

 
$
43,523

 
27.9
%
Cost of sales:
 
 
 
 
 
 
 
Direct
$
42,153

 
$
41,477

 
$
676

 
1.6
%
Retail
49,079

 
29,912

 
19,167

 
64.1
%
Royalty
19

 

 
19

 
%
 
$
91,251

 
$
71,389

 
$
19,862

 
27.8
%
Gross profit:
 
 
 
 
 
 
 
Direct
$
84,021

 
$
74,242

 
$
9,779

 
13.2
%
Retail
22,637

 
8,782

 
13,855

 
157.8
%
Royalty
1,548

 
1,521

 
27

 
1.8
%
 
$
108,206

 
$
84,545

 
$
23,661

 
28.0
%
Gross margin:
 
 
 
 
 
 
 
Direct
66.6
%
 
64.2
%
 
240

basis points
Retail
31.6
%
 
22.7
%
 
890

basis points









21


The following table compares the net sales of our major product lines within each business segment (dollars in thousands):
 
Three Months Ended June 30,
 
Change
 
2016
 
2015
 
$
 
%
Direct net sales:
 
 
 
 
 
 
 
Cardio products(1)
$
41,434

 
$
37,849

 
$
3,585

 
9.5
 %
Strength products(2)
3,506

 
3,813

 
(307
)
 
(8.1
)%
 
44,940

 
41,662

 
3,278

 
7.9
 %
Retail net sales:
 
 
 
 
 
 
 
Cardio products(1)
23,506

 
9,352

 
14,154

 
151.3
 %
Strength products(2)
9,405

 
8,052

 
1,353

 
16.8
 %
 
32,911

 
17,404

 
15,507

 
89.1
 %
 
 
 
 
 
 
 
 
Royalty
678

 
629

 
49

 
7.8
 %
 
$
78,529

 
$
59,695

 
$
18,834

 
31.6
 %

 
Six Months Ended June 30,
 
Change
 
2016
 
2015
 
$
 
%
Direct net sales:
 
 
 
 
 
 
 
Cardio products(1)
$
118,526

 
$
107,883

 
$
10,643

 
9.9
 %
Strength products(2)
7,648

 
7,836

 
(188
)
 
(2.4
)%
 
126,174

 
115,719

 
10,455

 
9.0
 %
Retail net sales:
 
 
 
 
 
 
 
Cardio products(1)
53,459

 
23,238

 
30,221

 
130.0
 %
Strength products(2)
18,257

 
15,456

 
2,801

 
18.1
 %
 
71,716

 
38,694

 
33,022

 
85.3
 %
 
 
 
 
 
 
 
 
Royalty
1,567

 
1,521

 
46

 
3.0
 %
 
$
199,457

 
$
155,934

 
$
43,523

 
27.9
 %
 
 
 
 
 
 
 
 
(1)   Cardio products include: Max Trainer®, TreadClimber®, Zero Runner®, treadmills, exercise bikes and ellipticals.
(2)   Strength products include: home gyms, selectorized dumbbells, kettlebell weights and accessories.

Direct     

Direct net sales increased by 7.9% and 9.0%, respectively, for the three and six month periods ended June 30, 2016 compared to the same periods of 2015. The increases in net sales were primarily related to our cardio products, especially the Bowflex Max Trainer®. The gains in cardio were offset by declines in strength sales of 8.1% and 2.4%, respectively, for the three and six month periods ended June 30, 2016 compared to the same periods of 2015.

Combined consumer credit approvals by our primary and secondary U.S. third-party financing providers for the second quarter of 2016 increased to 47.3%, compared to 46.1% in the same period of 2015. We attribute the increase to sales of the Bowflex Max Trainer®, which has continued to attract consumers with better credit scores, and our media strategy focused on driving quality consumer leads.

The $0.9 million decrease in cost of sales of our Direct business in the second quarter of 2016 compared to the same period of 2015 was due to favorable product mix and lower reserve requirements. These factors were offset by growth in net sales in the six month period ended June 30, 2016, resulting in a $0.7 million increase in cost of sales for the Direct business.

For the three and six month periods ended June 30, 2016, Direct gross margin increased 490 and 240 basis points, respectively, as compared to the same periods of 2015 primarily due to product mix and lower reserve requirements.
 

22


Retail

Retail net sales increased by 89.1% and 85.3%, respectively, for the three and six month periods ended June 30, 2016 compared to the same periods of 2015. The increases were primarily driven by the acquisition of Octane, as well as organic growth across a variety of cardio and strength products.

The increases in cost of sales of our Retail business for the three and six month periods ended June 30, 2016 compared to the same periods of 2015 were almost entirely related to the growth in Retail net sales as discussed above, as well as the acquisition of Octane.

For the three and six month periods ended June 30, 2016, Retail gross margin increased 1,000 and 890 basis points, respectively, compared to the same periods of 2015 due to the inclusion of Octane, which has higher margins, along with leveraging of supply chain costs and lower reserve requirements in the organic Retail business. The margin increases for the three and six month periods of 2016 are net of purchase price accounting-related inventory step up charges of $0.3 million and $1.0 million, respectively, that are included in cost of sales.

Selling and Marketing
Dollars in thousands
Three Months Ended June 30,
 
Change
 
2016
 
2015
 
$
 
%
Selling and marketing
$24,711
 
$20,052
 
$4,659
 
23.2%
As % of net sales
31.5%
 
33.6%
 
 
 
 
Dollars in thousands
Six Months Ended June 30,
 
Change
 
2016
 
2015
 
$
 
%
Selling and marketing
$59,890
 
$48,451
 
$11,439
 
23.6%
As % of net sales
30.0%
 
31.1%
 
 
 
 

The increases in selling and marketing expense in the three and six month periods ended June 30, 2016 compared to the same periods of 2015 were primarily related to higher media advertising of $1.0 million and $4.3 million, respectively; increased variable sales expenses of $0.6 million and $1.4 million, respectively; and incremental selling and marketing expenses related to the inclusion of Octane of $2.4 million and $4.9 million, respectively.

The decreases in selling and marketing expense as a percentage of net sales in the three and six month periods ended June 30, 2016 compared to the same periods of 2015 were primarily due to the acquisition of Octane and growth in the organic Retail business, both of which have a lower selling and marketing expense percentage than the company average.

Media advertising expense of our Direct business is the largest component of selling and marketing and was as follows:
Dollars in thousands
Three Months Ended June 30,
 
Change
 
2016
 
2015
 
$
 
%
Media advertising
$12,505
 
$11,459
 
$1,046
 
9.1%
Dollars in thousands
Six Months Ended June 30,
 
Change
 
2016
 
2015
 
$
 
%
Media advertising
$30,014
 
$25,701
 
$4,313
 
16.8%

The increases in media advertising in the three and six month periods ended June 30, 2016 compared to the same periods of 2015 were primarily to drive incremental leads and sales in the Direct business.


23


General and Administrative
Dollars in thousands
Three Months Ended June 30,
 
Change
 
2016
 
2015
 
$
 
%
General and administrative
$7,203
 
$4,293
 
$2,910
 
67.8%
As % of net sales
9.2%
 
7.2%
 
 
 
 
Dollars in thousands
Six Months Ended June 30,
 
Change
 
2016
 
2015
 
$
 
%
General and administrative
$15,434
 
$9,871
 
$5,563
 
56.4%
As % of net sales
7.7%
 
6.3%
 
 
 
 

The increases in general and administrative in the three and six month periods ended June 30, 2016 compared to the same periods of 2015 were primarily due to the addition of Octane ($0.8 million and $1.9 million, respectively), infrastructure ($0.7 million and $1.5 million, respectively), and employee-related costs ($0.7 million and $1.1 million, respectively), and lower expense in the prior periods due to state business tax refund of $0.5 million received in the second quarter of 2015. In addition, the three and six month periods ended June 30, 2016 include amortization related to Octane acquired assets of $0.8 million and $1.5 million, respectively.

The increases in general and administrative as a percentage of net sales in the three and six month periods ended June 30, 2016 compared to the same periods of 2015 were due to the increased spending as discussed above.

Research and Development
Dollars in thousands
Three Months Ended June 30,
 
Change
 
2016
 
2015
 
$
 
%
Research and development
$3,375
 
$2,379
 
$996
 
41.9%
As % of net sales
4.3%
 
4.0%
 
 
 
 
Dollars in thousands
Six Months Ended June 30,
 
Change
 
2016
 
2015
 
$
 
%
Research and development
$7,009
 
$4,686
 
$2,323
 
49.6%
As % of net sales
3.5%
 
3.0%
 
 
 
 

The increases in research and development in the three and six month periods ended June 30, 2016 compared to the same periods of 2015 were primarily due to our investment in additional engineering and product development headcount as we continue to supplement our new product development resources required to innovate and broaden our product portfolio, coupled with the incremental impact of the research and development expenses related to Octane.

The increases in research and development as a percentage of net sales in the three and six month periods of 2016 compared to the same periods of 2015 were primarily due to the increased investment discussed above.

Interest Expense
Interest expense increased $0.5 million and $1.0 million, respectively, for the three and six month periods ended June 30, 2016 compared to the same periods of 2015 due to borrowings under our new term loan in connection with the Octane acquisition on December 31, 2015.

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


24


Income Tax Expense
Dollars in thousands
Three Months Ended June 30,
 
Change
 
2016
 
2015
 
$
 
%
Income tax expense
$2,295
 
$1,485
 
$810
 
54.5%
Effective tax rate
38.3%
 
40.1%
 
 
 
 
Dollars in thousands
Six Months Ended June 30,
 
Change
 
2016
 
2015
 
$
 
%
Income tax expense
$9,473
 
$8,154
 
$1,319
 
16.2%
Effective tax rate
38.3%
 
38.4%
 
 
 
 

The increases in income tax expense from continuing operations for the three and six month periods ended June 30, 2016 compared to the same periods of 2015 primarily related to increases in the profitability of our U.S. and Canadian operations.

LIQUIDITY AND CAPITAL RESOURCES
 
As of June 30, 2016, we had total cash and investments of $73.5 million compared to $60.8 million as of December 31, 2015. Cash provided by operating activities was $23.0 million for the six months ended June 30, 2016, compared to $18.7 million for the six months ended June 30, 2015. We expect our cash, cash equivalents and available-for-sale securities at June 30, 2016, along with cash expected to be generated from operations, to be sufficient to fund our operating and capital requirements for at least twelve months from June 30, 2016.

The increase in cash flows from operating activities for the six months ended June 30, 2016 as compared to the same period of 2015 was primarily due to improved operating performance, as well as changes in our operating assets and liabilities as discussed below.

Trade receivables decreased $25.5 million to $19.7 million as of June 30, 2016, compared to $45.2 million as of December 31, 2015, due to seasonally lower net sales in the Retail business. Trade receivables as of June 30, 2016 compared to June 30, 2015 increased $7.0 million due to the acquisition of Octane.

Inventories increased $0.3 million to $43.0 million as of June 30, 2016, compared to $42.7 million as of December 31, 2015. Inventories as of June 30, 2016 compared to June 30, 2015 increased by $14.6 million, primarily due to the acquisition of Octane.

Net deferred income tax liability increased $3.6 million to $13.1 million as of June 30, 2016, compared to $9.5 million as of December 31, 2015, primarily due to the utilization of tax credit carryforwards from prior periods.

Trade payables decreased $18.5 million to $43.2 million as of June 30, 2016, compared to $61.7 million as of December 31, 2015, due to seasonality in the business. Trade payables as of June 30, 2016 compared to June 30, 2015 increased $10.5 million. The lower amount outstanding as of June 30, 2015 was primarily due to a temporary acceleration of payment terms for a vendor to support inventory positions.

Accrued liabilities decreased $2.5 million to $10.5 million as of June 30, 2016, compared to $13.0 million as of December 31, 2015, due to a reduction in accrued incentive compensation in the first six months of 2016, reflecting payout of incentive compensation during the first quarter.

Cash used in investing activities of $7.5 million for the first six months of 2016 was primarily related to $3.5 million of payments to Octane under the December 31, 2015 stock purchase agreement, and net purchases of marketable securities of $3.3 million. In addition, $0.7 million was used for capital expenditures during the period primarily for production tooling and computer hardware and software. We anticipate spending between $5.5 million and $6.5 million in 2016 for software, equipment, and product tooling.

Cash used in financing activities of $6.1 million for the first six months of 2016 was related to repayments on our term loan of $8.0 million, partially offset by $1.7 million of recognized excess tax benefits related to stock-based compensation.


25


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

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

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

The interest rate applicable to the term loan, as well as each advance under the revolving line of credit, is based on either Chase Bank's floating prime rate or adjusted LIBOR, plus an applicable margin. As of June 30, 2016 our borrowing rate for both the term loan and line of credit advances was 1.70%.

As of June 30, 2016, the balance on our term loan was $72.0 million, and we had no outstanding borrowings under the line of credit. In addition, $0.6 million in letters of credit that expire in April 2017 were outstanding under the Credit Agreement. As of June 30, 2016, we were in compliance with the financial covenants of the Credit Agreement and approximately $19.4 million was available for borrowing under the line of credit.

As of June 30, 2016, we had a $72.0 million receive-variable, pay-fixed interest rate swap outstanding with Chase Bank. The interest rate swap amortizes monthly in line with the outstanding principal balance on our term loan and is classified as a cash flow hedge. The swap matures on December 31, 2020 and has a fixed rate of 1.42% per annum. The variable rate on the interest rate swap is the one-month LIBOR benchmark. At June 30, 2016, the one-month LIBOR rate was 0.45%.

Commitments and Contingencies
For a description of our commitments and contingencies, refer to Note 15 to our Condensed Consolidated Financial Statements in Item 1 of this Form 10-Q.

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

The nature and terms of these indemnifications vary from contract to contract, and generally a maximum obligation is not stated. We hold insurance policies that mitigate potential losses arising from certain types of indemnifications. 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 June 30, 2016.

Stock Repurchase Program
On November 3, 2014, our Board of Directors approved a stock repurchase program that authorized us to repurchase up to $15.0 million of our outstanding common stock from time to time during the ensuing period of 24 months. On May 4, 2016, our Board of Directors approved an expansion of our share repurchase program that authorized us to repurchase up to an additional $10.0 million of our outstanding common stock from time to time during the period of 24 months following such approval. Repurchases may be made in open market transactions at prevailing prices, in privately negotiated transactions, or by other means in accordance with federal securities laws. Share repurchases are funded from existing cash balances, and the repurchased shares are retired and returned to unissued authorized shares.

As of June 30, 2016, we have repurchased 711,708 shares at an average price of $16.25 per share for a total of $11.6 million, and

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$13.4 million remains available for future repurchases. The repurchase program expires on November 3, 2016 as to the approximately $3.4 million remaining available for repurchases under the original $15.0 million authorization. The repurchase program expires on May 4, 2018 as to the $10.0 million available for repurchases under the $10.0 million expansion.

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

CRITICAL ACCOUNTING POLICIES AND ESTIMATES
 
Our critical accounting policies have not changed from those discussed in our 2015 Form 10-K.

Item 3.
Quantitative and Qualitative Disclosures About Market Risk

Interest Rate Risk
Our exposure to market risk from changes in interest rates relates primarily to our cash equivalents, marketable securities, variable-rate debt obligations, and derivative liabilities. As of June 30, 2016, we had cash equivalents of $14.6 million held in a combination of money market funds, commercial paper and corporate bonds, and marketable securities of $33.3 million, held in a combination of certificates of deposit, corporate bonds, and U.S. government bonds. Our cash equivalents mature within three months or less from the date of purchase. Marketable securities with original maturities of greater than three months and remaining maturities of less than one year are classified as short-term investments. Investments with maturities beyond one year may be classified as short-term based on their highly liquid nature and because such marketable securities represent the investment of cash that is available for current operations. We have classified our marketable securities as available-for-sale and, therefore, we may choose to sell or hold them as changes in the market occur. Because of the short-term nature of the instruments in our portfolio, a decline in interest rates would reduce our interest income over time, and an increase in interest rates may negatively affect the market price or liquidity of certain securities within the portfolio, but a change in interest rates would not have a material impact on our results of operations, financial position or cash flows.

Our negotiated credit facilities generally charge interest based on a benchmark rate such as LIBOR. Fluctuations in short-term interest rates may cause interest payments on term loan principal and drawn amounts on the revolving line to increase or decrease. As of June 30, 2016, the outstanding balances on our credit facilities totaled $72.0 million.

In January 2016, we entered into an $80.0 million receive-variable, pay-fixed interest rate swap agreement, amortizing monthly in line with the outstanding principal balance on our term loan. The swap is classified as a cash flow hedge and effectively fixes the interest rate on our variable-rate term loan. The interest rate swap matures on December 31, 2020 and has a fixed interest rate of 1.42% per annum. The variable rate on the interest rate swap is the one-month LIBOR benchmark, which was 0.45% at June 30, 2016.

The fair value of our interest rate swap agreement represents the estimated receipts or payments that would be made to terminate the agreement. The amounts related to our cash flow hedge are recorded as deferred gains or losses in our Consolidated Balance Sheets with the offset recorded in accumulated other comprehensive income, net of tax. At June 30, 2016, the fair value of our interest rate swap agreement was a liability of $1.3 million. The estimated amount expected to be reclassified into earnings within the next twelve months was $0.3 million at June 30, 2016.

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



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Item 4.     Controls and Procedures

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

At this time, we continue to evaluate the business and internal controls and processes associated with Octane and are making various changes to its operating and organizational structure based on our business plan. We are in the process of implementing our internal control structure over this acquired business. The SEC’s rules require us to include acquired entities in our assessment of the effectiveness of internal control over financial reporting no later than the annual management report following the first anniversary of the acquisition. We plan to complete the evaluation and the integration of Octane within the required time frames and report management’s assessment of our internal control over financial reporting in our first annual report in which such assessment is required for this acquisition.
 
There were no changes in our internal control over financial reporting that occurred during the three months ended June 30, 2016, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II.    OTHER INFORMATION

Item 1.
Legal Proceedings

Patent Infringement Case
In 2004, we were sued in the Southern District of New York by BioSig Instruments, Inc. for alleged patent infringement in connection with our incorporation of heart rate monitors into certain cardio products. No significant activity in the litigation occurred until 2008. In 2012, the United States District Court granted summary judgment to us on grounds that BioSig’s patents
were invalid as a matter of law. BioSig appealed the grant of summary judgment and, in April 2013, the United States Court of Appeals for the Federal Circuit reversed the District Court’s decision on summary judgment and remanded the case to the District Court for further proceedings. On January 10, 2014, the U. S. Supreme Court granted our petition for a writ of certiorari to address the legal standard applied by the Federal Circuit in determining whether the patents may be valid under applicable law. The case was argued before the Supreme Court on April 28, 2014. By decision dated June 2, 2014, the Supreme Court unanimously reversed the Federal Circuit, holding that its standard of when a patent may be “indefinite” was incorrect and remanding to the Federal Circuit for reconsideration under the correct standard. The remand hearing in the Federal Circuit was held on October 29, 2014. By decision dated April 27, 2015, the same panel of the Federal Circuit affirmed its earlier reversal of the District Court’s decision on summary judgment. On May 27, 2015, we filed a petition for a rehearing en banc in the Federal Circuit, which was denied on August 4, 2015 and a Petition for Review by the U. S. Supreme Court which was also denied. The case has been returned to the District Court, and the parties are currently engaged in discovery and other pre-trial motion practice. We do not believe that our use of heart rate monitors utilized or purchased from third parties, and otherwise, infringes the BioSig patents.

In addition to the matter described above, from time to time we are subject to litigation, claims and assessments that arise in the ordinary course of business, including disputes that may arise from intellectual property related matters. Management believes that any liability resulting from such additional matters will not have a material adverse effect on our financial position, results of operations or cash flows.



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Item 1A.    Risk Factors

We operate in an environment that involves a number of risks and uncertainties. The risks and uncertainties described in our 2015 Form 10-K are not the only risks and uncertainties that we face. Additional risks and uncertainties that presently are not considered material or are not known to us, and therefore are not mentioned herein, may impair our business operations. If any of the risks described in our 2015 Form 10-K actually occur, our business, operating results and financial position could be adversely affected. There has not been a material change to the risk factors as set forth in our 2015 Form 10-K.
 
 
 
 
 
Item 6.    Exhibits

The following exhibits are filed herewith and this list is intended to constitute the exhibit index:
Exhibit No.
 
Description
 
 
 
31.1
  
Certification of Chief Executive Officer pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934, as amended.
 
 
 
31.2
 
Certification of Chief Financial Officer pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934, as amended.
 
 
 
32.1
  
Certification of Chief Executive Officer and Chief Financial Officer pursuant to Rule 13a-14(b) of the Securities and Exchange Act of 1934, as amended, and 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
 
 
 
101
 
The following financial statements from Nautilus, Inc.'s quarterly report on Form 10-Q for the three and six months ended June 30, 2016 formatted in XBRL (eXtensible Business Reporting Language): (i) Condensed Consolidated Balance Sheets (unaudited), (ii) Condensed Consolidated Statements of Operations (unaudited), (iii) Condensed Consolidated Statements of Comprehensive Income (unaudited), (iv) Condensed Consolidated Statements of Cash Flows (unaudited) and (v) Notes to Condensed Consolidated Financial Statements (unaudited).



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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.  
 
 
NAUTILUS, INC.
 
 
(Registrant)
 
 
 
 
August 4, 2016
 
By:
/S/    Bruce M. Cazenave
Date
 
 
Bruce M. Cazenave
 
 
 
Chief Executive Officer
(Principal Executive Officer)

 
 
NAUTILUS, INC.
 
 
(Registrant)
 
 
 
 
August 4, 2016
 
By:
/S/    Sidharth Nayar
Date
 
 
Sidharth Nayar
 
 
 
Chief Financial Officer
(Principal Financial and Accounting Officer)


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