-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, LcFwwN+ujBDgsVaOP1s52zCTgUephqx7M4J8VQi6nkCjZnN3FbXdvSoMW2PJsOlL tAEVThEKgroxlR4QtKbSIA== 0001072613-03-001841.txt : 20031114 0001072613-03-001841.hdr.sgml : 20031114 20031114160126 ACCESSION NUMBER: 0001072613-03-001841 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 6 CONFORMED PERIOD OF REPORT: 20030930 FILED AS OF DATE: 20031114 FILER: COMPANY DATA: COMPANY CONFORMED NAME: NAUTILUS GROUP INC CENTRAL INDEX KEY: 0001078207 STANDARD INDUSTRIAL CLASSIFICATION: [3949] IRS NUMBER: 943002667 STATE OF INCORPORATION: WA FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 001-31321 FILM NUMBER: 031004614 BUSINESS ADDRESS: STREET 1: 1400 NE 136TH AVENUE CITY: VANCOUVER STATE: WA ZIP: 98684 BUSINESS PHONE: 3606947722 MAIL ADDRESS: STREET 1: 1400 NE 136TH AVENUE CITY: VANCOUVER STATE: WA ZIP: 98684 FORMER COMPANY: FORMER CONFORMED NAME: DIRECT FOCUS INC DATE OF NAME CHANGE: 19990202 10-Q 1 form10-q_12302.txt FORM 10-Q FOR PERIOD ENDED 9/30/03 ================================================================================ SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2003 Commission file number: 000-25867 THE NAUTILUS GROUP, INC. (Exact name of registrant as specified in its charter) Washington 94-3002667 ---------- ---------- (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 1400 NE 136th Avenue Vancouver, Washington 98684 --------------------------- (Address of principal executive offices, including zip code) (360) 694-7722 -------------- (Issuer's telephone number, including area code) 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 issuer 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 is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes [X] No [ ] Number of shares of issuer's common stock outstanding as of November 10, 2003: 32,602,448 ================================================================================ THE NAUTILUS GROUP, INC. SEPTEMBER 30, 2003 INDEX TO FORM 10-Q PAGE PART I - FINANCIAL INFORMATION Item 1. Financial Statements (Unaudited) 3 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 15 Item 3. Quantitative and Qualitative Disclosures About Market Risk 25 Item 4. Controls and Procedures 25 PART II - OTHER INFORMATION Item 1. Legal Proceedings 27 Item 6. Exhibits and Reports on Form 8-K 27 Signatures 29 PART I - FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS - ---------------------------- THE NAUTILUS GROUP, INC. CONSOLIDATED BALANCE SHEETS (In Thousands, Except Share Data) (Unaudited)
September 30, December 31, ASSETS 2003 2002 ------------ ------------ CURRENT ASSETS: Cash and cash equivalents $ 63,825 $ 31,719 Short-term investments, at amortized cost -- 17,578 Trade receivables (less allowance for doubtful accounts of $2,769 and $3,147 in 2003 and 2002, respectively) 57,388 50,099 Inventories 51,403 63,798 Prepaid expenses and other current assets 5,610 4,919 Short-term notes receivable 2,904 3,067 Current deferred tax asset 3,425 2,924 ------------ ------------ Total current assets 184,555 174,104 LONG-TERM NOTE RECEIVABLE 91 363 PROPERTY, PLANT AND EQUIPMENT, net 52,388 55,564 GOODWILL 29,755 29,755 OTHER ASSETS, net 17,282 16,867 ------------ ------------ TOTAL ASSETS $ 284,071 $ 276,653 ============ ============ LIABILITIES AND STOCKHOLDERS' EQUITY CURRENT LIABILITIES: Trade payables $ 22,660 $ 41,288 Accrued liabilities 22,764 15,827 Income taxes payable 6,927 5,284 Royalty payable to stockholders 1,597 1,997 Customer deposits 1,405 685 ------------ ------------ Total current liabilities 55,353 65,081 LONG-TERM DEFERRED TAX LIABILITY 9,819 9,149 COMMITMENTS AND CONTINGENCIES (Note 13) STOCKHOLDERS' EQUITY: Common stock - authorized, 75,000,000 shares of no par value; issued and outstanding, 32,601,323 and 32,473,897 shares at September 30, 2003 and December 31, 2002, respectively 2,791 -- Unearned compensation (1,629) -- Retained earnings 215,469 201,238 Accumulated other comprehensive income 2,268 1,185 ------------ ------------ Total stockholders' equity 218,899 202,423 ------------ ------------ TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 284,071 $ 276,653 ============ ============
See notes to consolidated financial statements. 3 THE NAUTILUS GROUP, INC. CONSOLIDATED STATEMENTS OF OPERATIONS (In Thousands, Except Share and Per Share Data) (Unaudited)
Three Months Ended Nine Months Ended September 30, September 30, ----------------------------- ----------------------------- 2003 2002 2003 2002 ------------ ------------ ------------ ------------ NET SALES $ 115,958 $ 152,865 $ 346,009 $ 429,187 COST OF SALES 60,508 64,435 168,144 179,687 ------------ ------------ ------------ ------------ Gross profit 55,450 88,430 177,865 249,500 OPERATING EXPENSES: Selling and marketing 34,492 40,654 109,688 106,345 General and administrative 9,241 5,634 24,891 19,338 Related-party royalties 1,597 2,531 4,838 7,092 Third-party royalties 333 384 969 717 ------------ ------------ ------------ ------------ Total operating expenses 45,663 49,203 140,386 133,492 ------------ ------------ ------------ ------------ OPERATING INCOME 9,787 39,227 37,479 116,008 OTHER INCOME (EXPENSE): Interest income 134 333 593 1,260 Other, net 459 (408) 1,037 (326) ------------ ------------ ------------ ------------ Total other income (expense), net 593 (75) 1,630 934 ------------ ------------ ------------ ------------ INCOME BEFORE INCOME TAXES 10,380 39,152 39,109 116,942 INCOME TAX EXPENSE 3,737 14,093 14,079 42,099 ------------ ------------ ------------ ------------ NET INCOME $ 6,643 $ 25,059 $ 25,030 $ 74,843 ============ ============ ============ ============ BASIC EARNINGS PER SHARE $ 0.20 $ 0.72 $ 0.77 $ 2.14 DILUTED EARNINGS PER SHARE $ 0.20 $ 0.71 $ 0.76 $ 2.10 Weighted average shares outstanding: Basic shares outstanding 32,600,101 34,672,293 32,571,840 34,949,988 Diluted shares outstanding 32,980,358 35,343,184 32,982,358 35,692,274
See notes to consolidated financial statements. 4 THE NAUTILUS GROUP, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (In Thousands) (Unaudited)
Nine Months Ended September 30, ----------------------------------- 2003 2002 ------------ ------------ CASH FLOWS FROM OPERATING ACTIVITIES: Net income $ 25,030 $ 74,843 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 8,961 4,577 Unearned compensation 71 -- Loss on sale of property, plant and equipment 131 104 Tax benefit of exercise of nonqualified options 540 2,868 Deferred income taxes 169 3,526 Changes in assets and liabilities, net of the effect of acquisitions: Trade receivables (6,502) (4,876) Inventories 12,855 (10,766) Prepaid expenses and other current assets (433) (3,350) Trade payables (18,782) 8,915 Income taxes payable 1,640 (726) Accrued liabilities and royalty payable to stockholders 6,166 2,794 Customer deposits 716 (109) ------------ ------------ Net cash provided by operating activities 30,562 77,800 ------------ ------------ CASH FLOWS FROM INVESTING ACTIVITIES: Additions to property, plant and equipment (5,602) (25,364) Proceeds from sale of property, plant and equipment 16 26 Net increase in other assets (573) (212) StairMaster acquisition, net of cash acquired -- (24,131) Purchases of short-term investments -- (34,811) Proceeds from maturities of short-term investments 17,578 25,568 Net (increase) decrease in notes receivable 436 (332) ------------ ------------ Net cash provided by (used in) investing activities 11,855 (59,256) ------------ ------------ CASH FLOWS FROM FINANCING ACTIVITIES: Cash dividends paid on common stock (9,769) -- Stock repurchases (1,422) (19,973) Proceeds from exercise of stock options 942 2,632 ------------ ------------ Net cash used in financing activities (10,249) (17,341) ------------ ------------ Effect of foreign currency exchange rate changes (62) 1,018 ------------ ------------ (CONTINUED)
5 THE NAUTILUS GROUP, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (In Thousands) (Unaudited)
Nine Months Ended September 30, ----------------------------------- 2003 2002 ------------ ------------ NET INCREASE IN CASH AND CASH EQUIVALENTS $ 32,106 $ 2,221 CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 31,719 35,639 ------------ ------------ CASH AND CASH EQUIVALENTS, END OF PERIOD $ 63,825 $ 37,860 ============ ============ SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION: Cash paid for income taxes $ 11,760 $ 36,327 (CONCLUDED)
See notes to consolidated financial statements. 6 THE NAUTILUS GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (In Thousands, Except Share and Per Share Data) (unaudited) - -------------------------------------------------------------------------------- 1. BASIS OF PRESENTATION The accompanying unaudited consolidated financial statements of The Nautilus Group, Inc. have been prepared in accordance with accounting principles generally accepted in the United States of America ("generally accepted accounting principles") and pursuant to Securities and Exchange Commission rules and regulations. Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to such rules and regulations. These financial statements should be read in conjunction with the audited financial statements and notes thereto included in the Company's annual report on Form 10-K for the year ended December 31, 2002. The financial information included herein reflects all adjustments (consisting of normal recurring adjustments), which are, in the opinion of management, necessary for a fair presentation of the results for the interim periods presented. The results of operations for the three and nine months ended September 30, 2003 are not necessarily indicative of the results to be expected for the full year. CONSOLIDATION - The consolidated financial statements include The Nautilus Group, Inc. and its wholly-owned subsidiaries (collectively the "Company"). All intercompany transactions and balances have been eliminated. RECENT ACCOUNTING PRONOUNCEMENTS - In July 2002, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 146, ACCOUNTING FOR COSTS ASSOCIATED WITH EXIT OR DISPOSAL ACTIVITIES. The standard requires companies to recognize costs associated with exit or disposal activities when they are incurred rather than at the date of commitment to an exit or disposal plan. Costs covered by the standard include lease termination costs and certain employee severance costs that are associated with a restructuring, discontinued operation, plant closing, or other exit or disposal activity. The Company adopted this statement as of January 1, 2003. During the third quarter ended September 30, 2003, the Company announced and executed a workforce reduction resulting in a restructuring charge of approximately $200. The adoption of SFAS No. 146 has not had a material effect on the Company's financial position, results of operations, or cash flows. In November 2002, the FASB issued Interpretation ("FIN") No. 45, GUARANTOR'S ACCOUNTING AND DISCLOSURE REQUIREMENTS FOR GUARANTEES, INCLUDING INDIRECT GUARANTEES OF INDEBTEDNESS OF OTHERS. FIN No. 45 is an interpretation of FASB Statements No. 5, 57 and 107 and rescinds FIN No. 35. This Interpretation elaborates on the disclosures to be made by a guarantor in its interim and annual financial statements about its obligations under certain guarantees that it has issued. The disclosure requirements in FIN No. 45 are effective for the year ended December 31, 2002. The adoption of FIN No. 45 has not had a material impact on the Company's financial position, results of operations, or cash flows. In May 2003, the FASB issued SFAS No. 150, ACCOUNTING FOR CERTAIN FINANCIAL INSTRUMENTS WITH CHARACTERISTICS OF BOTH LIABILITIES AND EQUITY, effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003. The adoption of SFAS No. 150 has not had a material impact on the Company's financial position, results of operations, or cash flows. 7 RECLASSIFICATIONS - Certain amounts from 2002 have been reclassified to conform to the 2003 presentation with no effect on previously reported consolidated net income or stockholders' equity. 2. STOCK-BASED COMPENSATION With one exception, the Company has not recognized compensation expense relating to employee stock options because it has only granted options with an exercise price equal to the fair value of the stock on the effective date of grant. In July 2003, certain stock options were granted at an exercise price below current market price on the day of the grant and thus the Company recognized compensation expense of $71 for the three and nine months ended September 30, 2003. The unearned portion of this stock option grant resides in Stockholders' Equity in the Consolidated Balance Sheets and will be recognized evenly over the five-year vesting period as compensation expense. The estimated compensation expense for the next five years is $340 per year. If the Company had elected to recognize compensation expense for all other options granted using a fair value approach, and therefore determined the compensation based on the value as determined by the Black-Scholes option pricing model, the pro forma net income and earnings per share would have been as follows:
Three Months Ended Nine Months Ended September 30, September 30, -------------------------- -------------------------- 2003 2002 2003 2002 ---------- ---------- ---------- ---------- Net income, as reported $ 6,643 $ 25,059 $ 25,030 $ 74,843 Add: Stock-based employee compensation expense included in reported net income, net of tax 45 -- 45 -- Deduct: Stock-based employee compensation expense determined under fair value based method, net of tax (773) (800) (2,450) (2,335) ---------- ---------- ---------- ---------- Net income, pro forma $ 5,915 $ 24,259 $ 22,625 $ 72,508 ========== ========== ========== ========== Basic earnings per share, as reported $ 0.20 $ 0.72 $ 0.77 $ 2.14 Basic earnings per share, pro forma $ 0.18 $ 0.70 $ 0.69 $ 2.07 Diluted earnings per share, as reported $ 0.20 $ 0.71 $ 0.76 $ 2.10 Diluted earnings per share, pro forma $ 0.18 $ 0.69 $ 0.68 $ 2.03
The pro forma amounts may not be indicative of the effects on reported net income for future periods due to the effect of options vesting over a period of years and the granting of stock compensation awards in future years. For the nine months ended September 30, 2003, there were 227,726 options exercised at a prices ranging from $1.37 to $13.78 per share. There were 1,410,500 new options granted at exercise prices ranging from $8.39 to $12.80 per share and 116,533 options canceled at prices ranging from $6.98 to $34.05 per share during the nine months ended September 30, 2003. 3. ACQUISITIONS Effective February 8, 2002, the Company acquired the trade receivables, inventories, prepaid expenses and other current assets, property, plant and equipment, certain intangible assets and the foreign subsidiaries of StairMaster Sports/Medical, Inc. ("StairMaster") for a cash purchase price of approximately $24,924 including acquisition costs. 8 The Company has determined that the intangible asset associated with the StairMaster acquisition has an indefinite useful life and thus will not be amortized. The Company will evaluate the useful life of the trademark each reporting period to determine whether events or circumstances warrant a revision to the indefinite useful life assumption or if the asset should be tested for impairment. The total cost of the StairMaster acquisition has been allocated to the assets acquired and liabilities assumed as follows: Cash and cash equivalents $ 793 Trade receivables 8,025 Inventories 6,158 Prepaid expenses and other current assets 2,381 Property, plant and equipment 4,807 Trademark 6,115 Liabilities assumed (3,355) -------- Total acquisition cost $ 24,924 ======== The allocation of the StairMaster acquisition cost and final purchase price above reflects all adjustments made subsequent to the first quarter of 2002 when the initial purchase took place. The results of operations subsequent to the date of the StairMaster acquisition are included in the consolidated financial statements of the Company. The unaudited pro forma financial information below for the nine months ended September 30, 2002 was prepared as if the transaction involving the acquisition of StairMaster had occurred at the beginning of the period presented: Net sales $ 435,466 Net income $ 75,067 Basic earnings per share $ 2.15 Diluted earnings per share $ 2.10 The unaudited pro forma financial information is not necessarily indicative of what actual results would have been had the transaction occurred at the beginning of the period, nor does it purport to indicate the results of future operations of the Company. 4. INVENTORIES Inventories consisted of the following: September 30, December 31, 2003 2002 ------------ ------------ Finished goods $ 28,336 $ 45,317 Work-in-process 2,342 1,317 Parts and components 20,725 17,164 ---------- ---------- Inventories $ 51,403 $ 63,798 ========== ========== 9 5. PROPERTY, PLANT AND EQUIPMENT, NET Property, plant and equipment consisted of the following: Estimated Useful Life September 30, December 31, (in years) 2003 2002 ----------- ------------ ------------ Land N/A $ 3,468 $ 3,468 Buildings and improvements 31.5 21,930 21,839 Computer equipment 2 to 5 28,427 26,252 Production equipment 5 15,654 13,647 Furniture and fixtures 5 1,641 1,433 Automobiles and trucks 7 557 549 -------- -------- Total property, plant and equipment 71,677 67,188 Accumulated depreciation (19,289) (11,624) -------- -------- Property, plant and equipment, net $ 52,388 $ 55,564 ======== ======== 6. GOODWILL AND OTHER ASSETS, NET Other assets consisted of the following: Estimated Useful Life September 30, December 31, (in years) 2003 2002 ----------- ------------ ------------ Indefinite life trademarks N/A $ 10,465 $ 10,465 Definite life trademark 20 6,800 6,800 Other assets 1-17 1,482 797 -------- -------- Total other assets 18,747 18,062 Accumulated amortization (1,465) (1,195) -------- -------- Other assets, net $ 17,282 $ 16,867 ======== ======== The Company evaluates goodwill and intangible assets with indefinite lives for impairment annually or more frequently if events or changes in circumstance indicate that such assets might be impaired. Intangible assets with finite useful lives are tested for impairment whenever events or changes in circumstance indicate that such assets might be impaired. The remaining useful lives of intangible assets with finite useful lives are evaluated annually to determine whether events or circumstances warrant changes in the estimated useful lives of such assets. Amortization of intangible assets for the three and nine months ended September 30, 2003 was $90 and $270, respectively. The estimated amortization expense for the next five years is $360 per year. Such estimated amortization will change if businesses or portions thereof are either acquired or disposed, or if changes in events or circumstances warrant the revision of estimated useful lives. 10 7. ACCRUED LIABILITIES Accrued liabilities consisted of the following: September 30, December 31, 2003 2002 ------------ ------------ Accrued payroll $ 6,524 $ 5,436 Accrued warranty expense 9,510 5,358 Sales return reserve 1,700 2,550 Other 5,030 2,483 -------- -------- Accrued liabilities $ 22,764 $ 15,827 ======== ======== Warranty costs are estimated based on the Company's experience and are charged to cost of sales as sales are recognized or as such estimates change. Warranty reserve activity for the nine months ended September 30, 2003 and year ended December 31, 2002 is as follows: Balance at Charged to Balance at Beginning Costs and End of of Period Expenses Deductions* Period ---------- ---------- ---------- ---------- Warranty reserves: 2003 $ 5,358 $ 5,512 $ 1,360 $ 9,510 2002 $ 2,413 $ 6,155 $ 3,210 $ 5,358 * Deductions represent warranty claims paid out in the form of cash or product replacements. 8. COMPREHENSIVE INCOME Comprehensive income and its components are as follows: Three Months Ended Nine Months Ended September 30, September 30, ----------------------- ----------------------- 2003 2002 2003 2002 ---------- ---------- ---------- ---------- Net income $ 6,643 $ 25,059 $ 25,030 $ 74,843 Foreign currency translation adjustments 678 432 1,083 1,148 ---------- ---------- ---------- ---------- Comprehensive income $ 7,321 $ 25,491 $ 26,113 $ 75,991 ========== ========== ========== ========== Accumulated other comprehensive income at September 30, 2003 and December 31, 2002 is due to the foreign currency translation adjustment to the financial statements of the foreign subsidiaries. 9. RESEARCH AND DEVELOPMENT Internal research and development costs are expensed as incurred and included in cost of sales. Third party research and development costs are expensed when the work has been performed. Research and development expense was $1,739 and $1,357 for the three months ended September 30, 2003 and 2002, respectively. Research and development expense was $4,225 and $3,218 for the nine months ended September 30, 2003 and 2002, respectively. 11 10. OPERATING SEGMENTS The Company's operating segments include its direct, commercial/retail, and corporate segments. The direct segment includes all products and related operations involved in marketing to consumers through a variety of direct marketing channels. The Bowflex and TreadClimber lines of fitness equipment and Nautilus Sleep Systems are the principal products in the Company's direct segment. The commercial/retail segment includes all products and related operations that do not involve direct marketing to consumers. Products in this segment include Nautilus, Schwinn, StairMaster, Trimline, and Bowflex commercial and retail fitness equipment and accessories. Beginning in 2003, the Company augmented its segment reporting with the addition of a separate reporting segment to reflect the extra-divisional activities associated with the corporate holding company. Included in the segment information is comparative data assuming the corporate holding company existed at January 1, 2002. The following table presents selected information about the Company's three operating segments:
Commercial/ Direct Retail Corporate Total ------------------------- ------------------------- ------------------------- ------------------------- Three Months Nine Months Three Months Nine Months Three Months Nine Months Three Months Nine Months ------------ ----------- ------------ ----------- ------------ ----------- ------------ ----------- Period Ended September 30, 2003 Net sales $ 51,926 $ 187,820 $ 64,032 $ 158,189 $ -- $ -- $ 115,958 $ 346,009 ========== ========= ========== ========= ========== ========= ========== ========= Segment net income (loss) $ 1,112 $ 16,307 $ 7,388 $ 12,317 $ (1,857) $ (3,594) $ 6,643 $ 25,030 ========== ========= ========== ========= ========== ========= ========== ========= Period Ended September 30, 2002 Net sales $ 107,034 $ 301,204 $ 45,831 $ 127,983 $ -- $ -- $ 152,865 $ 429,187 ========== ========= ========== ========= ========== ========= ========== ========= Segment net income (loss) $ 26,632 $ 75,847 $ (943) $ 1,202 $ (630) $ (2,206) $ 25,059 $ 74,843 ========== ========= ========== ========= ========== ========= ========== ========= Commercial/ Direct Retail Corporate Total ---------- --------- ---------- --------- As of September 30, 2003 Segment assets $ 45,098 $ 149,694 $ 89,279 $ 284,071 ========== ========= ========== ========= As of December 31, 2002 Segment assets $ 52,251 $ 149,559 $ 74,843 $ 276,653 ========== ========= ========== =========
12 11. EARNINGS PER SHARE Basic earnings per share is computed on the basis of the weighted average number of common shares outstanding. Diluted earnings per share is computed on the basis of the weighted average number of common shares outstanding plus the effect of outstanding stock options calculated using the treasury stock method. Net income for the calculation of both basic and diluted earnings per share is the same as reported net income for all periods. The calculation of weighted-average outstanding shares is as follows:
Three Months Ended Three Months Ended September 30, 2003 September 30, 2002 ------------------------------------ ------------------------------------ Per Share Per Share Income Shares Amount Income Shares Amount ---------- ---------- ---------- ---------- ---------- ---------- Basic EPS: Net income $ 6,643 32,600,101 $ 0.20 $ 25,059 34,672,293 $ 0.72 Effect of dilutive securities: Stock options -- 380,257 0.00 -- 670,891 (0.01) ---------- ---------- ---------- ---------- ---------- ---------- Diluted EPS: Net income $ 6,643 32,980,358 $ 0.20 $ 25,059 35,343,184 $ 0.71 ========== ========== ========== ========== ========== ========== Nine Months Ended Nine Months Ended September 30, 2003 September 30, 2002 ------------------------------------ ------------------------------------ Per Share Per Share Income Shares Amount Income Shares Amount ---------- ---------- ---------- ---------- ---------- ---------- Basic EPS: Net income $ 25,030 32,571,840 $ 0.77 $ 74,843 34,949,988 $ 2.14 Effect of dilutive securities: Stock options -- 410,518 (0.01) -- 742,286 (0.04) ---------- ---------- ---------- ---------- ---------- ---------- Diluted EPS: Net income $ 25,030 32,982,358 $ 0.76 $ 74,843 35,692,274 $ 2.10 ========== ========== ========== ========== ========== ==========
Out of 2,666,228 total options outstanding, 1,222,419 and 1,151,919 options were not included in the calculation of diluted earnings per share for the three and nine months ended September 30, 2003, respectively, because they would be antidilutive. Out of 1,603,854 total options outstanding, 266,075 and 244,075 options were not included in the calculation of diluted earnings per share for the three and nine months ended September 30, 2002, respectively, because they would be antidilutive. 12. STOCK REPURCHASE PROGRAM In January 2003, the Board of Directors authorized the expenditure of up to $50,000 to purchase shares of the Company's common stock in open-market transactions. During the nine months ended September 30, 2003, the Company repurchased a total of 100,300 shares of common stock in open market transactions for an aggregate purchase price of $1,422. The authorization expired on June 30, 2003. 13. COMMITMENTS AND CONTINGENCIES The Company is subject to litigation, claims and assessments in the ordinary course of business, many of which are covered in whole or in part by insurance. Management believes that any liability resulting from such matters will not have a material adverse effect on the Company's financial position, results of operations, or cash flows. 13 In December 2002, the Company filed suit against ICON Health and Fitness, Inc. ("ICON") in the Federal District Court, Western District of Washington (the "District Court") alleging infringement by ICON of the Company's Bowflex patents and trademarks. The Company seeks injunctive relief, unquantified treble damages and its fees and costs. The District Court denied our motion for a preliminary injunction for patent infringement and dismissed our patent infringement claims. We have appealed the District Court's decision to the United States Court of Appeals for the Federal Circuit (the "Appeals Court"). The Company expects the District Court to conduct a trial on our trademark infringement claims against ICON in calendar year 2004. In July 2003, the District Court ruled in favor of the Company on a motion for preliminary injunction on the issue of trademark infringement, and entered an order barring ICON from using the trademark "CrossBow" on any exercise equipment. In its ruling, the District Court concluded that the Company showed "a probability of success on the merits and irreparable injury" on its trademark infringement claim. In August 2003, the Appeals Court granted ICON a temporary stay regarding the motion for a preliminary injunction enjoining ICON from using the trademark "CrossBow". This stay allows ICON to continue using the trademark "CrossBow" until a decision is issued by the Appeals Court. 14. RELATED-PARTY TRANSACTIONS The Company incurred royalty expense under an agreement with a stockholder of the Company of $1,597 and $2,531 for the three months ended September 30, 2003 and 2002, respectively. The Company incurred royalty expense of $4,838 and $7,092 for the nine months ended September 30, 2003 and 2002, respectively. In addition to the royalty agreement, the stockholder has separately negotiated an agreement dated September 18, 1992, when the Company was privately held, between the stockholder, the Company's current Chairman and former Chief Executive Officer ("Chairman"), and a former director of the Company. That separate agreement stipulates that annual royalties above $90 would be paid 60% to the stockholder, 20% to the Chairman and 20% to the former director. 14 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS - ------------------------------------------------------------------------------- OF OPERATIONS - ------------- FORWARD-LOOKING STATEMENTS Certain statements contained in this Form 10-Q, including, without limitation, statements containing the words "could," "may," "will," "should," "plan," "believes," "anticipates," "estimates," "predicts," "expects," "projections," "potential," "continue," or words of similar import, constitute "forward-looking statements." Investors are cautioned that all forward-looking statements involve risks and uncertainties, and various factors could cause actual results to differ materially from those in the forward-looking statements. From time to time and in this Form 10-Q, we may make forward-looking statements relating to our financial performance, including the following: o Anticipated revenues, expenses, and gross margins; o Seasonal patterns; o Expense as a percentage of revenue; o Anticipated earnings; o New product introductions; and o Future capital expenditures. Numerous factors could affect our actual results, including the following: o The availability of media time and fluctuating advertising costs; o A decline in consumer spending due to unfavorable economic conditions; o Expiration of important patents; o Our reliance on a limited product line; o Our ability to effectively develop, market, and sell future products; o Our ability to adequately protect our intellectual property; o Our ability to integrate any acquired businesses into our operations; o Our reliance on the consumer finance market; o Our reliance on third-party manufacturers; o Government regulatory action; and o Changes in foreign conditions that could impair our international sales. We describe certain of these and other key risk factors elsewhere in more detail in this Form 10-Q and in our most recent Annual Report on Form 10-K. Although we believe the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance, or achievements. Except to the extent required by the federal securities laws, we undertake no obligation to update publicly any forward-looking statements to reflect new information, events, or circumstances after the date of this Form 10-Q or to reflect the occurrence of unanticipated events. CRITICAL ACCOUNTING POLICIES Certain accounting policies are presented in consideration of their significance for our Company. These critical policies involve the most complex or subjective decisions or assessments and consist of warranty reserves, sales return reserves, the allowance for doubtful accounts, inventory valuation, and intangible asset valuation. 15 WARRANTY RESERVES The product warranty reserve includes the cost to manufacture (raw materials, labor and overhead) or purchase warranty parts from our suppliers as well as the cost to ship those parts to our customers. The cost of labor to install a warranted part on our manufactured commercial equipment is also included. The warranty reserve is based on our historical experience with each product. A warranty reserve is established for new products based on historical experience with similar products, adjusted for any technological advances in manufacturing or materials used. We track warranty claims by part and reason for claim in order to identify any potential warranty trends. The warranty trends are evaluated periodically with respect to future volume and nature of likely claims. Adjustments, if any are so indicated, are made to the warranty reserve to reflect our judgment regarding the likely effect of the warranty trends on future claims. If we were to experience a significant volume of warranty claims for a particular part or for a particular reason, we may need to make design changes to our product. A change in warranty experience could have a significant impact on our financial position, results of operations and cash flows. SALES RETURN RESERVES The sales return reserve is maintained based on our historical experience of direct-marketed product return rates during the period in which a customer can return a product for refund of the full purchase price, less shipping and handling in most instances. The return periods for Bowflex, TreadClimber, Champion Nutrition, and Nautilus Sleep Systems product lines are six weeks, 30 days, 30 days, and 90 days, respectively. Sales returns are insignificant for products sold through our commercial/retail distribution channels. We track all direct-marketed product returns in order to identify any potential negative customer satisfaction trends. Our return reserve may be sensitive to a change in our customers' ability to pay during the trial period due to unforeseen economic circumstances and to different product introductions that might fulfill the customers' needs at a perceived better value. Any major change in the aforementioned factors may increase sales returns, which could have a significant impact on our financial position, results of operations and cash flows. ALLOWANCE FOR DOUBTFUL ACCOUNTS The allowance for doubtful accounts is maintained at a level based on our historical experience adjusted for any known uncollectible amounts. We periodically review the creditworthiness of our customers to help gauge collectibility. Our allowance is sensitive to changes in our customers' ability to pay due to unforeseen changes in the economy, including the bankruptcy of a major customer, our efforts to actively pursue collections, and increases in chargebacks. Any major change in the aforementioned factors may result in increasing the allowance for doubtful accounts, which could have a significant impact on our financial position, results of operations and cash flows. INVENTORY VALUATION Our inventory is valued at either the lower of cost (standard or average depending on location) or market. Inventory adjustments are applied for any known obsolete or defective products. We periodically review inventory levels of our product lines in conjunction with market trends to assess salability of our products. Our assessment of necessary adjustments to market value of inventory is sensitive to changes in fitness technology and competitor product offerings driven by customer demand. Any major change in the aforementioned factors may result in reductions to market value of inventory below cost, which could have a significant impact on our financial position, results of operations and cash flows. 16 INTANGIBLE ASSET VALUATION Currently, intangible assets consist predominantly of the Nautilus, Schwinn, and StairMaster trademarks and goodwill associated with the acquisition of Schwinn Fitness. Management estimates affecting these trademark and goodwill valuations include determination of useful lives and estimates of future cash flows and fair values to perform an impairment analysis on an annual basis. The useful lives assigned by management to the Nautilus, Schwinn, and StairMaster trademarks and Schwinn Fitness goodwill are indefinite, 20 years, indefinite, and indefinite, respectively. Any major change in the useful lives and/or the determination of an impairment associated with the valuation of the aforementioned intangible assets may result in asset value write-downs, which could have a significant impact on our current and future financial position and results of operations. RESULTS OF OPERATIONS We believe that period-to-period comparisons of our operating results are not necessarily indicative of future performance. You should consider our prospects in light of the risks, expenses and difficulties frequently encountered by companies that operate in evolving markets. STATEMENT OF OPERATIONS DATA - THREE MONTHS ENDED SEPTEMBER 30 The following table presents certain financial data regarding our third quarter operations in 2003 and 2002, as a percentage of total revenues: Quarter Ended September 30, ---------------------------- Statement of Operations Data 2003 2002 ---------- ---------- Net sales 100.0% 100.0% Cost of sales 52.2 42.2 ------ ------ Gross profit 47.8 57.8 Operating expenses: Selling and marketing 29.7 26.6 General and administrative 8.0 3.7 Royalties 1.7 1.9 ------ ------ Total operating expenses 39.4 32.2 ------ ------ Operating income 8.4 25.6 Other income, net 0.5 0.0 ------ ------ Income before income taxes 8.9 25.6 Income tax expense 3.2 9.2 ------ ------ Net income 5.7% 16.4% ====== ====== 17 COMPARISON OF THE QUARTERS ENDED SEPTEMBER 30, 2003 AND 2002 NET SALES Net sales decreased by 24.1% to $116.0 million in the third quarter of 2003 from $152.9 million in the third quarter of 2002. The third quarter of 2003 presented a challenging business environment for our business. We believe this was mainly due to increased competition for our Bowflex product line and higher advertising costs due to increased demand for advertising time. We believe these factors contributed to lackluster consumer spending for our health and fitness products and reduced sales conversion rates for our direct-marketed products. Sales within our direct segment were $51.9 million in the third quarter of 2003, a decrease of $55.1 million, or 51.5%, compared with the third quarter of 2002. Our direct segment accounted for 44.8% of our aggregate net sales in the quarter, down from 70.0% in the third quarter of 2002. The majority of the sales in our direct segment are from our Bowflex product line, which accounted for 81.4% of our direct segment net sales in the third quarter of 2003, down from 91.0% during the same period in 2002. Additional product lines within our direct segment include Nautilus Sleep Systems and TreadClimber, which was introduced during the first quarter of 2003. The decrease in direct segment sales can mainly be attributed to increased competition and managing our advertising spending in a higher advertising cost environment to optimize profitability. We believe competing products have adversely affected demand for our Bowflex products and advertising costs have risen when comparing the third quarter of 2003 to the same period in 2002, resulting in lower sales of direct-marketed products for comparable advertising spending. During the second quarter of 2003, we began a process of reassessing the marketing plan for our Nautilus Sleep Systems product line. This has involved a reduction in the amount of advertising spending for this product line, which has also resulted in a reduction in sales. Consequently, we are no longer projecting sales growth for this product line in 2003. Our new TreadClimber product line has exceeded our expectations for 2003, and we believe this product will achieve approximately $16.0 to $18.0 million in sales this year. Sales within our commercial/retail segment were $64.0 million in the third quarter of 2003, an increase of $18.2 million, or 39.7%, compared to the third quarter of 2002. The increase in sales within the commercial/retail segment can be attributed to the introduction of portions of the Bowflex product line to our retail business, which has equated to sales of $17.7 million, or 27.7% of overall commercial/retail segment sales, during the third quarter of 2003. Due to encouraging results from our initial test-marketing plan that began in the first quarter of 2003, we expanded the retail distribution of Bowflex products and plan to continue to do so throughout the remainder of 2003. Besides the Bowflex, our commercial/retail segment product portfolio consists of a wide array of both strength and cardiovascular fitness products sold through the commercial and retail channels under brand names that include Nautilus, Schwinn, StairMaster, and Trimline. Our commercial/retail segment accounted for 55.2% of our total net sales during the third quarter of 2003 compared to 30.0% in the third quarter of 2002 as we continue to execute our strategy of expanding our presence, product lines, and brands across all our sales channels, especially within the commercial/retail segment. The increase in commercial/retail segment sales as a percentage of our total net sales can also be attributed to the decline in direct segment net sales during the third quarter of 2003 compared to the same period in 2002. GROSS PROFIT Gross profits decreased 37.3% to $55.5 million in the third quarter of 2003 compared to $88.4 million in the same period a year ago. As sales of inherently lower margin products in the commercial/retail segment continue to increase as a percentage of total sales, our overall gross profit margin decreased to 47.8% in the third quarter of 2003, compared to 57.8% in the third quarter of 2002. The gross profit margin within our 18 direct segment was 64.5% in the third quarter of 2003 compared to 74.8% in the third quarter of 2002. The decrease in gross profit margins within our direct segment can mainly be attributed to the change in product sales mix, declining sales leading to higher fixed costs per sale, and increased research and development expense. The increase in gross profit margins within our commercial/retail segment to 34.3% in the third quarter of 2003, compared with 18.4% in the third quarter of 2002, was primarily due to sales of Bowflex products through the retail sales channel. For all of 2003, we expect our combined gross profit margin to be in the range of 49% to 51%. OPERATING EXPENSES SELLING AND MARKETING Selling and marketing expenses decreased to $34.5 million in the third quarter of 2003 from $40.7 million in the same period a year ago, a decrease of 15.2%. As a percentage of net sales, overall selling and marketing expenses increased to 29.7% in the third quarter of 2003 from 26.6% in the third quarter of 2002. Selling and marketing expenses within our direct segment were 52.3% of net sales in the third quarter of 2003, compared to 31.9% in the third quarter of 2002. The increase in selling and marketing expenses as a percentage of sales is mainly due to declines in our direct segment sales conversion rates coupled with a higher advertising cost environment. We believe the decline in sales conversion rates was mostly the result of increased competition. Depreciation associated with our newly implemented customer relationship management information system also contributed to the increase in selling and marketing expenses as a percentage of sales. During the second quarter of 2003, we began a process of reassessing our marketing plan for our Nautilus Sleep Systems resulting in reduced advertising spending for this product line. Selling and marketing expenses within our commercial/retail segment were 11.4% of net sales in the third quarter of 2003, compared to 14.1% in the third quarter of 2002. For the remainder of 2003, we expect our combined selling and marketing expenses to be in the range of 31% to 33% of total sales. GENERAL AND ADMINISTRATIVE General and administrative expenses increased to $9.2 million in the third quarter of 2003 from $5.6 million in the same period a year ago, an increase of $3.6 million, or 64.0%. As a percentage of net sales, general and administrative expenses increased to 8.0% in the third quarter of 2003 from 3.7% in the third quarter of 2002. Our direct segment general and administrative expenses increased $1.8 million in the third quarter of 2003 compared to the same period a year ago due primarily to depreciation, consulting costs, and wages associated with our newly implemented computer information systems. Commercial/retail segment general and administrative expenses remained virtually unchanged in the third quarter of 2003 compared to the third quarter of 2002. Our financial statements now reflect a third segment comprised of our corporate holding company which includes primarily general and administrative expenses such as investor relations, director costs, legal and accounting fees, and salaries of corporate personnel, as well as other costs not specifically attributable to our other two segments. For financial reporting purposes, we have reclassified prior year balances to conform to this three-segment presentation with no effect on previously reported consolidated net income or stockholders' equity. Our corporate segment general and administrative expenses increased $1.8 million in the third quarter of 2003 compared to the same period a year ago due primarily to additional legal expenses. For the remainder of 2003, we expect our combined general and administrative expenses to be in the range of 6% to 7% of total sales. 19 ROYALTIES Royalty expense decreased to $1.9 million in the third quarter of 2003 from $2.9 million in the same period a year ago, a decrease of 33.8%. Our direct and commercial/retail segments have several agreements under which we are obligated to pay royalty fees on certain products. The decrease in our royalty expense is primarily attributable to the decrease in sales of our Bowflex products in the quarter. Our royalty expenses will primarily fluctuate in correlation with the sales of our Bowflex products, but will also be impacted by fluctuations in sales of other products that have royalty agreements. The patent for the Bowflex Power Rod resistance technology expires April 27, 2004. We will no longer be obligated to pay royalties related to Bowflex sales following the expiration of this patent. OTHER INCOME (EXPENSE) In the third quarter of 2003, other income was $0.6 million compared to other expense of $0.1 million for the same period a year ago. Interest income decreased to $0.1 million in the third quarter of 2003 from $0.3 million in the same period a year ago due to lower average interest rates in 2003 coupled with a change to the use of tax-exempt securities in 2003 in order to maximize tax equivalent yields. The remaining impact on other income and expense in the third quarter of 2003 and 2002 is primarily due to foreign currency related gains and losses. INCOME TAX EXPENSE Income tax expense decreased by $10.4 million to $3.7 million for the third quarter of 2003 from $14.1 million for the same period of 2002 due to the decline in our income before taxes. We expect our income tax expense to fluctuate in line with changes in our income before taxes. NET INCOME For the reasons discussed above, net income declined to $6.6 million in the third quarter of 2003 from $25.1 million in the same period a year ago, a decrease of 73.5%. 20 STATEMENT OF OPERATIONS DATA - NINE MONTHS ENDED SEPTEMBER 30 The following table presents certain financial data regarding operations for the first nine months in 2003 and 2002, as a percentage of total revenues: Nine Months Ended September 30, ------------------------------- Statement of Operations Data 2003 2002 ---------- ---------- Net sales 100.0% 100.0% Cost of sales 48.6 41.9 ------ ------ Gross profit 51.4 58.1 Operating expenses: Selling and marketing 31.7 24.8 General and administrative 7.2 4.5 Royalties 1.7 1.8 ------ ------ Total operating expenses 40.6 31.1 ------ ------ Operating income 10.8 27.0 Other income, net 0.5 0.2 ------ ------ Income before income taxes 11.3 27.2 Income tax expense 4.1 9.8 ------ ------ Net income 7.2% 17.4% ====== ====== COMPARISON OF THE NINE MONTHS ENDED SEPTEMBER 30, 2003 AND 2002 NET SALES Net sales decreased by 19.4% to $346.0 million in the first nine months of 2003 compared to $429.2 million in the same period in 2002. The first nine months of 2003 presented a challenging business environment. We believe this was due to increased competition and higher advertising costs due to increased demand for advertising time. These factors reduced sales conversion rates for our direct-marketed products. Sales within our direct segment were $187.8 million in the first nine months of 2003, a decrease of 37.6% compared with the same period in 2002. Our direct segment accounted for 54.3% of our aggregate net sales in the first nine months, down from 70.2% in the same period in 2002. The decrease in direct segment sales can be attributed to a combination of factors including increased competition and managing our advertising spending in a higher advertising cost environment to optimize profitability. Sales within our commercial/retail segment were $158.2 million in the first nine months of 2003, an increase of 23.6% over the same period in 2002. Excluding our acquisition of StairMaster, commercial/retail segment sales increased 31.2% during the first nine months of 2003 compared to the same period in 2002. The increase in sales within the commercial/retail segment can be attributed to the introduction of the Bowflex to the retail side of the business, which equated to sales of $29.1 million, or 18.4% of overall commercial/retail segment sales, during the first nine months of 2003. For the first nine months of 2003, our commercial/retail segment accounted for 45.7% of our net sales, up from 29.8% in the same period in 2002 as we continued to execute our strategy of expanding our presence, product lines, and brands across all our sales channels, 21 especially within the commercial/retail segment. This increase in commercial/retail segment sales as a percentage of our total net sales can also be attributed to the decline in direct segment sales during the first nine months of 2003 compared to the same period in 2002. During the first nine months of 2003, our commercial/retail business segment sales were comparable to sales in the same period during 2002, excluding the introduction of the Bowflex product line to the retail sales channel. GROSS PROFIT Gross profits decreased 28.7% to $177.9 million in the first nine months of 2003 compared to $249.5 million in the same period a year ago. As sales of inherently lower margin products in the commercial/retail segment continued to grow as a percentage of total sales, our overall gross profit margin decreased to 51.4% in the first nine months of 2003, compared to 58.1% in the same period in 2002. The gross profit margin within our direct segment was 69.7% in the first nine months of 2003 compared to 73.2% for the same period in 2002. The decrease in gross profit margins within our direct segment can mainly be attributed to the change in product sales mix, declining sales leading to higher fixed costs per sale, and increased research and development expense. The increase in gross margin within our commercial/retail segment to 29.7% in the first nine months of 2003, compared with 22.7% in the same period in 2002, was primarily due to sales of Bowflex products through the retail channel. OPERATING EXPENSES SELLING AND MARKETING Selling and marketing expenses increased to $109.7 million in the first nine months of 2003 from $106.3 million in the same period a year ago, an increase of 3.1%. As a percentage of net sales, overall selling and marketing expenses increased to 31.7% in the first nine months of 2003 from 24.8% in the same period in 2002. Selling and marketing expenses within our direct segment were 47.8% of net sales in the first nine months of 2003, compared to 29.5% in the same period in 2002. The overall increase in selling and marketing expenses in absolute dollars and as a percentage of sales is mainly due to an increase in direct marketing advertising spending during the first quarter of 2003 in response to declines in our sales conversion rates coupled with a higher advertising cost environment. We believe the decline in conversion was a result of increased competition throughout the year combined with lower consumer confidence due to the war in Iraq and concern about the economy during the first half of the year. In addition, depreciation associated with our newly implemented customer relationship management information system also contributed to the increase. Selling and marketing expenses within our commercial/retail segment were 12.6% of net sales in the first nine months of 2003, compared to 13.7% in the same period in 2002. GENERAL AND ADMINISTRATIVE General and administrative expenses increased to $24.9 million in the first nine months of 2003 from $19.3 million in the same period a year ago, an increase of $5.6 million, or 28.7%. Our direct segment accounted for $5.5 million of the increase due primarily to depreciation, consulting costs, and wages associated with our newly implemented computer information systems. Our commercial/retail segment general and administrative expenses declined by $1.3 million due mostly to cost savings associated with the integration of the Schwinn Fitness and StairMaster businesses that we acquired in September 2001 and February 2002, respectively. Corporate general and administrative expenses increased $1.4 million due primarily to additional legal expenses. As a percentage of net sales, general and administrative expenses increased to 7.2% in the first nine months of 2003 from 4.5% in the same period a year ago. 22 ROYALTIES Royalty expense decreased to $5.8 million in the first nine months of 2003 from $7.8 million in the same period a year ago, a decrease of 34.5%. Our direct and commercial/retail segments have several agreements under which we are obligated to pay royalty fees on certain products. The decrease in our royalty expense is primarily attributable to the decreased sales of our Bowflex products. Our royalty expenses will fluctuate in correlation with sales of our Bowflex products, but will also be impacted by fluctuations in sales of other products that have royalty agreements. The patent for the Bowflex Power Rod resistance technology expires April 27, 2004. We will no longer be obligated to pay royalties related to Bowflex sales following the expiration of this patent. OTHER INCOME Other income increased to $1.6 million in the first nine months of 2003 from $0.9 million in the same period a year ago. Interest income decreased $0.7 million primarily due to lower interest earned on invested cash and cash equivalents due to lower average interest rates in 2003 coupled with a change to the use of tax-exempt securities in 2003 in order to maximize tax equivalent yields. This decrease in interest income was primarily offset by $0.6 million in proceeds received during the second quarter of 2003 related to an insurance recovery from damaged inventory combined with the effect of foreign currency related gains and losses during the respective periods. INCOME TAX EXPENSE Income tax expense decreased by $28.0 million to $14.1 million for the first nine months of 2003 from $42.1 million for the same period of 2002 due to the decline in our income before taxes. We expect our income tax expense to fluctuate in line with changes in our income before taxes. NET INCOME For the reasons discussed above, net income declined to $25.0 million in the first nine months of 2003 from $74.8 million in the same period a year ago, a decrease of 66.6%. LIQUIDITY AND CAPITAL RESOURCES Historically, we have financed our business primarily from cash generated by our operating activities. During the first nine months of 2003, our operating activities generated $30.6 million in net cash, which contributed to an aggregate $63.8 million balance in cash and cash equivalents, compared with $77.8 million in net cash generated by our operating activities in the first nine months of 2002. Net cash provided by investing activities was $11.9 million in the first nine months of 2003 compared with net cash used in investing activities in the first nine months of 2002 of $59.3 million. The largest component of this change was due to the acquisition cost of StairMaster in February of 2002 of $24.1 million, net of cash acquired. Additionally, we used $5.6 million during the first nine months of 2003 for capital expenditures primarily consisting of manufacturing equipment and information systems and related equipment compared to $25.4 million in the first nine months of 2002. Net cash used in financing activities was $10.2 million in the first nine months of 2003, which can be attributed to Company stock repurchases of $1.4 million and dividends paid of $9.8 million offset by $0.9 million of stock option exercises. Net cash used in financing activities was $17.3 million in the first nine months of 2002, which can be attributed to Company stock repurchases of $20.0 million offset by $2.6 million of stock option exercises. 23 Working capital was $129.2 million at September 30, 2003 compared to $109.0 million at December 31, 2002, largely due to increased cash and cash equivalents as a result of net income for the period. The $7.3 million increase in trade receivables can primarily be attributed to the higher volume of sales through our commercial/retail segment in the latter part of the third quarter of 2003 compared to the fourth quarter of 2002. The $12.4 million decrease in inventories can primarily be attributed to better alignment of inventory levels with sales volume. The $18.7 million decrease in trade payables is primarily due to the timing of inventory purchases, which tend to be higher in the fourth quarter compared with the third quarter due to the seasonal nature of the business. The $6.9 million increase in accrued liabilities can mostly be attributed to warranty and legal related expenses. We maintain a $10 million line of credit with a lending institution. The line of credit is secured by certain assets and contains several financial covenants. As of the date of this filing, we are in compliance with the covenants applicable to the line of credit, and there is no outstanding balance under the line. As of September 30, 2003, the Company had no contractual capital obligations or commercial commitments other than operating leases. We believe our existing cash balances, combined with our line of credit, will be sufficient to meet our capital requirements for at least the next 12 months. INFLATION AND PRICE INCREASES Although we cannot accurately anticipate the effect of inflation on our operations, we do not believe that inflation has had, or is likely in the foreseeable future to have, a material adverse effect on our financial position, results of operations or cash flows. However, increases in inflation over historical levels or uncertainty in the general economy could decrease discretionary consumer spending for products like ours. Very little of our revenue variation from prior periods is attributable to price increases. RECENT ACCOUNTING PRONOUNCEMENTS In July 2002, the Financial Accounting Standards Board ("the FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 146, ACCOUNTING FOR COSTS ASSOCIATED WITH EXIT OR DISPOSAL ACTIVITIES. The standard requires companies to recognize costs associated with exit or disposal activities when they are incurred rather than at the date of commitment to an exit or disposal plan. Costs covered by the standard include lease termination costs and certain employee severance costs that are associated with a restructuring, discontinued operation, plant closing, or other exit or disposal activity. The Company adopted this statement as of January 1, 2003. During the third quarter ended September 30, 2003, the Company announced and executed a workforce reduction resulting in a restructuring charge of approximately $0.2 million. The Company believes this event is not material enough to warrant further disclosure and, therefore, continues to conclude that the adoption of SFAS No. 146 has not had a material effect on the Company's financial position, results of operations, or cash flows. In November 2002, the FASB issued Interpretation ("FIN") No. 45, GUARANTOR'S ACCOUNTING AND DISCLOSURE REQUIREMENTS FOR GUARANTEES, INCLUDING INDIRECT GUARANTEES OF INDEBTEDNESS OF OTHERS. FIN No. 45 is an interpretation of FASB Statements No. 5, 57 and 107 and rescinds FIN No. 35. This Interpretation elaborates on the disclosures to be made by a guarantor in its interim and annual financial statements about its obligations under certain guarantees that it has issued. The disclosure requirements in FIN No. 45 are effective for the year ended December 31, 2002. The adoption of FIN No. 45 has not had a material impact on the Company's financial position, results of operations, or cash flows. 24 In May 2003, the FASB issued SFAS No. 150, ACCOUNTING FOR CERTAIN FINANCIAL INSTRUMENTS WITH CHARACTERISTICS OF BOTH LIABILITIES AND EQUITY, effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003. The adoption of SFAS No. 150 has not had a material impact on the Company's financial position, results of operations, or cash flows. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK - ------------------------------------------------------------------ There have been no material changes in our reported market risks since the filing of our 2002 Annual Report on Form 10-K, which was filed with the Securities and Exchange Commission on March 31, 2003. We have primarily invested cash with banks and in liquid debt instruments purchased with maturity dates of less than one year. Our bank deposits may exceed federally insured limits, and there is risk of loss of the entire principal with any debt instrument. To reduce risk of loss, we limit our exposure to any one debt issuer and require certain minimum ratings for debt instruments that we purchase. FOREIGN EXCHANGE RISK The Company is exposed to foreign exchange risk from currency fluctuations, mainly in Europe. Given the relative size of the Company's current foreign operations, the Company does not believe the exposure to changes in applicable foreign currencies to be material, such that it could have a significant impact on our current or near-term financial position, results of operations, or cash flows. Management estimates the maximum impact on stockholders' equity of a 10% change in any applicable foreign currency to be $1.1 million. INTEREST RATE RISK The Company has financed its growth through cash generated from operations. At September 30, 2003, the Company had no outstanding borrowings and was not subject to any related interest rate risk. The Company invests in liquid debt instruments purchased with maturity dates of less than one year. Due to the short-term nature of those investments, management believes that any reasonably possible near-term changes in related interest rates would not have a material impact on the Company's financial position, results of operations, or cash flows. ITEM 4. CONTROLS AND PROCEDURES - ------------------------------- EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES Our management has evaluated, under the supervision and with the participation of our President and Chief Executive Officer and Chief Financial Officer, the effectiveness of our disclosure controls and procedures as of the end of the period covered by this report pursuant to Rule 13a-15(b) under the Securities Exchange Act of 1934 (the "Exchange Act"). Based on that evaluation, our President and Chief Executive Officer and Chief Financial Officer have concluded that, as of the end of the period covered by this report, our disclosure controls and procedures are effective in ensuring that information required to 25 be disclosed in our Exchange Act reports is (1) recorded, processed, summarized and reported in a timely manner, and (2) accumulated and communicated to our management, including our President and Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure. CHANGES IN INTERNAL CONTROLS There has been no change in our internal control over financial reporting that occurred during our last fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting. 26 PART II - OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS - ------------------------- In December 2002, the Company filed suit against ICON Health and Fitness, Inc. ("ICON") in the Federal District Court, Western District of Washington (the "District Court") alleging infringement by ICON of the Company's Bowflex patents and trademarks. The Company seeks injunctive relief, unquantified treble damages and its fees and costs. The District Court denied our motion for a preliminary injunction for patent infringement and dismissed our patent infringement claims. We have appealed the District Court's decision to the United States Court of Appeals for the Federal Circuit (the "Appeals Court"). The Company expects the District Court to conduct a trial on our trademark infringement claims against ICON in calendar year 2004. In July 2003, the District Court ruled in favor of the Company on a motion for preliminary injunction on the issue of trademark infringement, and entered an order barring ICON from using the trademark "CrossBow" on any exercise equipment. In its ruling, the District Court concluded that the Company showed "a probability of success on the merits and irreparable injury" on its trademark infringement claim. In August 2003, the Appeals Court granted ICON a temporary stay regarding the motion for a preliminary injunction enjoining ICON from using the trademark "CrossBow". This stay allows ICON to continue using the trademark "CrossBow" until a decision is issued by the Appeals Court. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K - ---------------------------------------- (a) Exhibits The following exhibits are filed herewith and this list constitutes the exhibit index: EXHIBIT NO. DOCUMENT DESCRIPTION ----------- -------------------- 10.1 Executive Employment Agreement, dated July 2, 2003, between The Nautilus Group, Inc. and Gregg Hammann 31.1 Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 31.2 Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 32.1 Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 32.2 Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 27 (b) Reports on Form 8-K The following reports on Form 8-K were filed during the quarter ended September 30, 2003: o Form 8-K dated July 9, 2003, under Items 7, 9, and 12, associated with the press release announcing the revision of second quarter and 2003 earnings estimates. o Form 8-K dated July 30, 2003, under Items 7, 9, and 12, associated with the press release announcing second quarter 2003 financial results and fiscal year 2003 financial guidance, and declaring the regular quarterly dividend for the third quarter of 2003. 28 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. THE NAUTILUS GROUP, INC. November 14, 2003 By: /s/ Greggory C. Hammann - ----------------- --------------------------- Date Greggory C. Hammann, Chief Executive Officer and President (Principal Executive Officer) November 14, 2003 By: /s/ Rod W. Rice - ----------------- ------------------- Date Rod W. Rice, Chief Financial Officer, Treasurer and Secretary (Principal Financial and Accounting Officer) 29 EX-10.1 3 exhibit10-1_12302.txt EXECUTIVE EMPLOYMENT AGREEMENT EXHIBIT 10.1 ------------ EXECUTIVE EMPLOYMENT AGREEMENT THIS EXECUTIVE EMPLOYMENT AGREEMENT (this "Agreement") is executed this 2nd day of July, 2003 by and between THE NAUTILUS GROUP, INC., a Washington corporation (the "Company"), and Gregg Hammann, an individual ("Executive). In consideration of the mutual covenants and agreements hereinafter contained, it is hereby agreed by and between the parties hereto as follows: 1. EMPLOYMENT, SERVICES AND DUTIES. 1.1 Employment. The Company hereby employs Executive as the Chief Executive Officer of the Company ("CEO") as of the Commencement Date and Executive hereby accepts such employment upon the terms, covenants and conditions set forth herein. Executive agrees to commence employment with the Company no later than July 15, 2003 and the date that he commences employment shall be the "Commencement Date". 1.2 Duties. As CEO, Executive shall report to the Board of Directors, or their designee, and shall have such duties and responsibilities as determined by the Board, including generally such duties and powers that are commonly incident to that position. Executive shall also be elected to the Board of Directors within thirty (30) days of the Commencement Date. Executive shall (a) devote his entire professional time, attention, and energies to his positions, (b) use his best efforts to promote the interests of the Company; (c) perform faithfully, honestly and efficiently his responsibilities and duties to the satisfaction of the Company, and (d) refrain from any endeavor outside of his employment which interferes with his ability to perform his obligations hereunder. Executive additionally agrees to abide by any general employment guidelines or policies adopted by the Company such as those detailed in the Company's handbook or communicated to the Company's employees, as such guidelines or policies may be implemented and/or amended from time to time. 1.3 Volunteer Activities. Executive may serve in various capacities for various non-profit civic, charitable and educational organizations from time to time. Any such non-profit work that has the potential to interfere to any degree with Executive's services to the Company or where Executive will be taking a visible role in the organization must be disclosed to, and approved by, the Board of Directors prior to Executive performing such services. 1.4 Outside Activities. Executive agrees that he shall not accept any position with, be employed by, provide any paid services to, or serve on any Board of Directors for a for profit organization or entity other than the Company without the express written prior approval of the Company's Board of Directors. 2. TERM. This Agreement shall have an initial one-year term from the Commencement Date (Initial Term), and such term shall automatically renew for subsequent one-year terms ("Renewal Terms") unless either party has given at least one hundred and twenty (120) days advance written notice of the termination of the Agreement prior to the end of the Term or Renewal Term. If the Agreement is terminated, then Executive may continue to be employed without a written contract. Notwithstanding the termination of this Agreement, the parties agree that the Business Protection Agreement, attached as Exhibit A, shall remain in full force and effect. Executive agrees that his employment relationship is "at-will" and may be terminated with or without Cause. The at-will character of the employment relationship may be changed only by resolution adopted by the Board of Directors. However, during the Term of this Agreement, the various possible ways in which Executive's employment with the Company may be terminated will determine the payments that may be due to Executive under this Agreement. 3. SALARY, BENEFITS, AND OPTIONS. 3.1 Base Salary. As payment for the services rendered by Executive under this Agreement, Executive shall receive an initial salary of Five Hundred Thousand Dollars ($500,000) per year ("Base Salary") beginning on his first day of employment, earned and payable in regular installments in accordance with the customary payroll practices of the Company. Executive's Base Salary shall be subject to such payroll deductions as required by law or as are appropriate under the Company's payroll deduction procedures and policies. Executive's Base Salary shall be reviewed annually by the Compensation Committee of the Board of Directors and may be increased (but not decreased) and such increased amount shall thereafter be his "Base Salary". 3.2 Options. Within thirty (30) days after the Commencement Date, Executive shall be granted a non-qualified stock option to purchase 850,000 shares of the Company's Common Stock at a per share exercise price that is $2.00 less than the closing price of the Company's Common Stock on the New York Stock Exchange on the business day immediately preceding such date, and as more particularly set forth on the Nonstatutory Stock Option Agreement attached hereto as Exhibit A. This option shall become exercisable as to twenty percent (20%) of the total shares on the first anniversary of the grant date, provided that Executive has been continuously employed by the Company during the preceding 12-month period, and as to an additional ten percent (10%) of the total shares each six months thereafter, provided that Executive has been continuously employed by the Company during the preceding six-month period. The option shall remain exercisable for a period of ten (10) years from the date of grant, subject to earlier termination in the event of the termination of Executive's employment with the Company. The option shall be issued pursuant to the Company's 1995 Stock Option Plan, as amended, and shall be subject to the terms of that Plan, including without limitation the acceleration of vesting provisions set forth in Section 10 of the Plan. 3.3 Bonus. ----- (a) First Twelve Months of Employment. Executive shall receive a bonus in cash in a single lump sum in the gross amount of Five Hundred Fifty Thousand Dollars ($550,000) on April 1, 2004 ("First Year Bonus Payment Date") for the 2003 fiscal year. Subject to Section 5, to be eligible to receive such bonus, Executive must be employed by the Company on the First Year Bonus Payment Date and as of the First Year Bonus Payment 2 Date must not have been given notice of termination for Cause by the Company and must not have given the Company notice of termination without Good Reason. (b) Thereafter. Executive shall be eligible to receive a performance-based annual cash bonus based upon Executive's and the Company's performance in the fiscal year in a targeted amount of 100% of Executive's Base Salary. The terms and amount of such bonus shall be determined by the Compensation Committee of the Board of Directors in its sole discretion, after consulting Executive, based on performance factors such as the Company's sales and profits versus targets and other performance based goals and objectives (of which not more than 25% shall be based on subjective targets and goals) that are established not later than 90 days after the first day of the fiscal year. Subject to Section 5, to be eligible to receive such bonus, Executive must be employed by the Company on the Bonus Payment Date and as of the Bonus Payment Date must not have been given notice of termination for Cause by the Company and must not have given the Company notice of termination without Good Reason. The Bonus Payment Date shall be approved by the Board of Directors and shall be not later than thirty (30) days after release of the audit report for the Company's audited annual financial statements. (c) Any bonus payment shall be subject to such payroll deductions as required by law or as are appropriate under the Company's payroll deduction procedures and policies. 3.4 Relocation Bonus. Executive agrees to establish permanent residence within 25 miles of the Company's headquarters. After Executive has established such permanent residency, he will receive a lump-sum relocation bonus in the amount of One Million Dollars ($1,000,000) ("Relocation Bonus"). This payment shall be subject to such payroll deductions as required by law or as are appropriate under the Company's payroll deduction procedures and policies. This Relocation Bonus must be repaid in its entirety if at any time prior to the first anniversary of the Commencement Date, Executive's employment is terminated by the Company for Cause or by the Executive without Good Reason. If Executive is terminated for Cause or terminates his employment without Good Reason on or after the first anniversary and before the second anniversary of the Commencement Date, then he must repay Two-Thirds (2/3) of the Relocation Bonus. If Executive is terminated for Cause or terminates his employment without Good Reason on or after the second anniversary and before the third anniversary of the Commencement Date, then he must repay One-Third (1/3) of the Relocation Bonus; provided, if the Company notifies Executive that it shall not renew the Term of his employment under Section 2, no amount of the Relocation Bonus shall be repayable to the Company. 3.5 Benefits. Executive shall be entitled to participate in or receive benefits under any formal or informal benefit plan or other arrangement made available by the Company generally to all its officers and key management executives, subject to and on a basis consistent with the terms, conditions and overall administration of such plans and arrangements, as such may be amended from time to time; provided, Executive shall be entitled to not less than six weeks vacation per year. The Company shall reimburse Executive for the reasonable professional fees incurred by Executive to negotiate and prepare this Agreement and Exhibits thereto, not to exceed $15,000. 3 3.6 Reimbursement of Relocation Expenses. Upon receipt of documentation of actual expenses, the Company shall reimburse Executive for all reasonable expenses associated with his household's relocation, including, the costs of packing, moving and unpacking household goods and no more than two vehicles, temporary storage of property (if required), temporary living expenses (not to exceed $15,000), travel for Executive and his family for househunting (not more than once per month) up to the amount of $15,000, a non-itemized allowance of $2,500 for incidental moving expenses, closing costs on purchase of a new residence (not including the costs of any mortgage issuance points). To be reimbursed, all relocation expenses must be incurred within the first six months of the Commencement Date. The amount of any reimbursement shall be grossed-up, if necessary, to ensure that Executive does not incur any tax consequences as a result of such reimbursement of expenses. 3.7 Sale of Home. Addendum A to this Executive Employment Agreement details the parties' agreements related to the sale of Executive's primary residence. Such addendum is hereby incorporated herein. 3.8 Life Insurance. Assuming that Executive is insurable at a reasonable and normal cost, the Company shall purchase and maintain in force during Executive's employment with the Company life insurance covering Executive's death in the face amount of Three Million Dollars ($3,000,000) with the primary beneficiary being Executive's spouse. At the Executive's election, if allowable under the policy at no cost to the Company and with no risk of potential future obligation to the Company, the Company shall assign such life insurance policy to Executive or other assignee designated by Executive upon a termination of Executive's employment. 3.9 Disability Insurance. Assuming that Executive is insurable at a reasonable and normal cost, the Company shall purchase a disability insurance policy covering Executive in the event that he is unable to work for greater than 90 consecutive days due to disability. Such policy shall provide at a minimum salary continuation to the Executive at an amount equal to sixty (60%) of his Base Salary for a period of ten years. At the Executive's election, if allowable under the policy at no cost to the Company and with no risk of potential future obligation to the Company, the Company shall assign such disability insurance policy to Executive upon a termination of Executive's employment. 4. TERMINATION. Executive's employment may be terminated pursuant to the following: 4.1 Termination for Cause. The Company may terminate Executive's employment for Cause. Termination of Executive's employment for "Cause" shall mean a termination due to a preponderance of objective evidence of any of the following: (i) Executive's indictment for, or 4 conviction (or plea of nolo contendere) of a felony; (ii) a material1 act of dishonesty by Executive related to his employment; (iii) proof of willful violation of a key Company policy by Executive (such policy violation must be of a substantial nature similar in magnitude to acts of harassment or discrimination or use of unlawful drugs or drunkenness on Company property during normal work hours); (iv) insubordination (i.e. willful conduct such as refusal to follow lawful direct orders of the Board of Directors) or gross dereliction of duty by Executive after written warning;2 (v) Executive's competition with the Company, diversion of any corporate opportunity, breach of fiduciary duty, a serious conflict of interest, or self-dealing inuring to the Executive's direct or indirect benefit and the Company's detriment; (vi) willful or grossly negligent conduct by Executive that is demonstrably and significantly injurious to the Company or its affiliates; (vii) a material breach of this Agreement that is not corrected within thirty (30) days of the date of receipt by the Executive of such written notice from the Company; or (viii) a material breach of the Business Protection Agreement by Executive. An act or omission shall not be "willful" if conducted with a reasonable belief that such act or omission is in the best interests of the Company. Executive shall not be terminated for Cause, other than pursuant to clause (i), except upon the affirmative vote of two-thirds of the Board of Directors (excluding Executive). Other than pursuant to clause (i), Executive shall receive reasonable prior notice of any Board meeting where a vote will be taken on the possible termination of Executive for Cause. Such notice shall include a description of the circumstances that may constitute Cause. Executive shall have the opportunity to attend such Board meeting and present relevant information to the Board prior to any vote on the matter. Legal counsel may be present and may participate in the presentation. 4.2 Termination Without Cause. The Company may terminate the employment of Executive and all of the Company's obligations hereunder (except as expressly provided) at any time and for any reason or for no reason ("without Cause"). 4.3 Termination Due to Disability or Death. Executive's employment shall be terminable immediately upon Executive's death or after an indefinite leave or a leave of more than ninety (90) days due to disability. "Disability" is defined for purposes of this subsection as a condition that renders Executive eligible to commence disability benefits pursuant to the policy provided pursuant to Section 3.8. Hence, neither party can claim Executive is disabled for any purpose unless the condition renders Executive eligible to commence disability benefits. The parties agree that due to the importance of Executive's position with the Company, either an indefinite leave or a leave of absence in excess of 90 days within a twelve month period would cause an undue hardship to the Company and would not constitute a reasonable accommodation. Nothing in this Section 4.3 is intended to violate any federal or state law regarding medical leave. Upon such a termination, all vested stock options granted pursuant to Section 3.2 shall be exercisable for three years after the date of termination of employment. - --------------------- 1 As used in this Agreement, "material" shall be given a reasonable interpretation. 2 The parties intend the gross dereliction of duty standard to be a high one. 5 4.4 Voluntary Termination by Executive. Executive may terminate his employment with the Company at any time by giving the Company written notice of such termination, to be effective thirty (30) days following the giving of such written notice. The Company, at its election, may or may not require Executive to continue to perform his duties hereunder for all or some of such thirty (30) day notice period. 4.5 Termination by Executive for Good Reason. Executive may terminate his employment with the Company for Good Reason (as defined below) by giving the Board of Directors thirty (30) calendar days written notice of intent to terminate, which notice sets forth in reasonable detail the facts and circumstances claimed to provide a basis for such Good Reason termination. For the purposes of this Agreement, "Good Reason" shall mean, without Executive's express consent, the occurrence of any one or more of the following: (i) the assignment of Executive to duties or title substantially inconsistent with his position as CEO (not including a failure to be elected to the Board of Directors by the shareholders after nomination by the Board of Directors); (ii) a reduction by the Company in Executive's Base Salary; or (iii) a reduction in Executive's target bonus opportunity, benefits or perquisites, other than a reduction applicable to all senior executives of the Company; (iv) the Company's relocation of its headquarters more than 50 miles away from its current location, and requirement that Executive relocate to the new headquarters; (v) the decision by the Company not to renew the Term of the Agreement set forth at Section 2; or (vii) a material breach by the Company of this Agreement or the Nonstatutory Stock Option Agreement. No event shall constitute "Good Reason" unless the Executive shall have notified the Company as set forth above of the conduct allegedly constituting Good Reason and the Company shall have failed to correct such conduct within thirty (30) days of the date of its receipt of such written notice from the Executive. Moreover, unless Executive shall have notified the Company of the conduct allegedly constituting Good Reason within six months of the first occurrence of such conduct, then Executive shall have waived his right to claim that such conduct constitutes "Good Reason" under this Agreement. In the event that there is a Change of Control of the Company, for a window of time from the conclusion of six months following the Change of Control until the end of twelve months following the Change of Control, Executive may terminate his employment for Good Reason without making any showing beyond Change of Control. Such Good Reason related to the Change of Control shall expire twelve months after each such Change of Control. For the purpose of this Agreement, Change of Control shall mean any event whereby any person or entity, including any "person" as such term is used in Section 13(d)(3) of the Exchange Act, becomes the "beneficial owner," as defined in the Exchange Act, of Common Stock representing fifty percent (50%) or more of the combined voting power of the voting securities of the Company. 4.6 Termination by Mutual Agreement of the Parties. Executive's employment pursuant to this Agreement may be terminated immediately at any time upon a mutual agreement in writing of the parties. 6 5. SEVERANCE. 5.1 Upon termination of Executive's employment under this Agreement by the Company without Cause (as defined hereunder) or by Executive for Good Reason, then, in lieu of any further or other payments, if the termination occurs during the Initial Term, the Company shall pay to the Executive (a) his Base Salary accrued through the date of termination and any unreimbursed business expenses submitted in accordance with Company policy (collectively, the "Accrued Obligations"), and (b) severance equal to his monthly Base Salary (determined without regard for any reduction constituting Good Reason) for twelve months, and Executive's First Year Bonus Payment. During any Renewal Term, upon Executive's termination by the Company without Cause or by Executive for Good Reason, then, in lieu of any further or other payments, the Company shall pay to the Executive (x) his Accrued Obligations, (y) if and only if targets are satisfied at the end of the applicable fiscal year, a pro rata bonus related to such year payable at such time as bonuses are paid to senior executives, and (z) severance equal to his then current monthly Base Salary (determined without regard for any reduction constituting Good Reason) for twelve months. Additionally, upon a termination of Executive's employment under this Agreement by the Company without Cause or by Executive for Good Reason at any time (i) the Company shall pay Executive's COBRA premiums during the period in which he is entitled to severance payments (ii) Executive's stock option granted pursuant to Section 3.2 of this Agreement shall continue to vest as if Executive had remained employed during the period in which Executive is entitled to receive severance pay pursuant to this Section 5.1, and (iii) Executive's stock option granted pursuant to Section 3.2 of this Agreement shall be exercisable for fifteen months after the date of termination of employment as to the shares vested on or before such date of termination and for fifteen months after the date of vesting as to shares vesting after the date of termination. Any severance payment shall be made according to the Company's normal payroll process spread out equally over the severance period. Violation of this Agreement, the Business Protection Agreement (as contemplated by Section 7 below) and/or failure to sign the Release and Waiver Agreement shall immediately relieve the Company from its payment obligation under this Section 5.1(b), 5.1(y) and 5.1(z) and entitle it to recover any amounts paid under Section 5.1(b), 5.1(y) and 5.1(z). The Executive shall not be required to mitigate the amount of any payment provided for in this Section 5.1 by seeking other employment or otherwise, and no such payment shall be offset or reduced by the amount of any compensation provided to the Executive in any subsequent employment. 5.2 If the Company terminates the Executive's employment for Cause, due to Executive's death or disability, or if the Executive terminates his employment without Good Reason, then the Company shall have no payment obligations to Executive besides paying the Accrued Obligations and all further stock option vesting shall cease as of the date of termination. 6. RETURN OF DOCUMENTS. Executive understands and agrees that all equipment, records, files, manuals, forms, materials, supplies, computer programs, and other materials furnished to him by the Company or used on Company's behalf, or generated or obtained during the course of his employment shall remain the property of Company. Upon termination of this Agreement or at any other time upon the Company's request, Executive agrees to return all documents and property belonging to the 7 Company in his possession including, but not limited to, customer lists, contracts, agreements, licenses, business plans, equipment, software, software programs, products, work-in-progress, source code, object code, computer disks, information reasonably deemed confidential by the Company (including, without limitation, information subject to the confidentiality and trade secret provisions of the Business Protection Agreement, books, notes and all copies thereof, whether in written, electronic or other form. In addition, Executive shall certify to the Company in writing as of the effective date of termination that none of the assets or business records belonging to the Company is in his possession, remain under his control, or have been transferred to any third person. 7. NON-COMPETITION, CONFIDENTIALITY, NON-SOLICITATION. By virtue of his employment, Executive will have access to confidential, proprietary and trade secret information, the ownership and protection of which is very important to the Company. Executive hereby agrees to execute the Business Protection Agreement attached as Exhibit B hereto at the same time as his execution of this Agreement, which shall be effective on the Commencement Date. Executive understands that his execution of the attached Business Protection Agreement is an important part of this Agreement. Executive agrees that this Business Protection Agreement shall remain in full force and effect after the expiration of the Term of this Agreement and after the termination of his employment without regard to the circumstances of such termination. 8. NOTIFICATION TO NEW COMPANY If Executive leaves the employ of the Company, Executive consents to the Company's notification to any new Company of Executive's rights and obligation under this Agreement. 9. RELEASE OF CLAIMS As a precondition to receipt of the severance provided in Section 5 of this Agreement, Executive acknowledges and understands that he must sign a Waiver and Release of Claims Agreement. Such Agreement shall be substantially similar to the Agreement attached as Exhibit C. Executive understands that he will not be entitled to receive any severance payments under this Agreement until he executes and delivers the Waiver and Release of Claims Agreement, and the revocation period set forth in the Waiver and Release of Claims Agreement has run. 10. TRANSITIONAL ASSISTANCE During the severance period while Executive is receiving severance payments from the Company, or for ninety (90) days following a voluntary termination by Executive of his employment without Good Reason, the Employee agrees to provide the Company with any reasonable assistance requested by the Company without the necessity of any additional payment to Employee other than payment of Executive's reasonable out-of-pocket expenses. 8 11. ASSIGNMENT This Agreement is personal in nature, and neither this Agreement nor any part of any obligation herein shall be assignable by Executive. The Company shall be entitled to assign this Agreement to any other person or entity. 12. SEVERABILITY Should any term, provision, covenant or condition of this Agreement be held to be void or invalid, the same shall not affect any other term, provision, covenant or condition of this Agreement, but such remainder shall continue in full force and effect as though each such voided term, provision, covenant or condition is not contained herein. 13. GOVERNING LAW AND SUBMISSION TO JURISDICTION This Agreement shall be governed by and construed in accordance with the laws of the State of Washington applicable to contracts made and to be carried out in Washington. Each of the parties submits to the exclusive jurisdiction of any state or federal court sitting in Clark County or King County, Washington in any action or proceeding arising out of or relating to this Agreement and further agrees not to bring any action or proceeding arising out of or relating to this Agreement in any other court. Each party agrees that a final judgment in any action or proceeding so brought shall be conclusive and may be enforced by suit on the judgment or in any other manner so provided by law. 14. BINDING AGREEMENT This Agreement shall inure to the benefit of and shall be binding upon the Company, its successors, and assigns. 15. CAPTIONS The Section captions herein are inserted only as a matter of convenience and reference and in no way define, limit or describe the scope of this Agreement or the intent of any provisions hereof. 16. ENTIRE AGREEMENT This Agreement, the Nonstatutory Stock Option Agreement attached as Exhibit A and the Business Protection Agreement attached as Exhibit B contain the entire agreement of the parties relating to the subject matter hereof, and the parties hereto have made no agreements, representations or warranties relating to the subject matter of this Agreement that are not set forth otherwise herein. This Agreement supersedes any and all prior agreements, written or oral, between the Executive and the Company. Any such prior agreements are hereby terminated and of no further effect. No modification of this Agreement shall be valid unless authorized by the Board of Directors of the Company and set forth in a writing executed by Executive and the Chairman of the Company's Board of Directors. The parties hereto agree that in no event shall an oral modification of this Agreement be enforceable or valid. 9 17. NOTICE All notices under this Agreement shall occur upon receipt in writing (including, without limitation, telegraphic, telex, telecopy, or cable communication) and mailed, telegraphed, telexed, telecopied, cabled or delivered by hand or by a nationally recognized courier service guaranteeing overnight delivery to a party at the following address (or to such other address as such party may have specified by notice given to the other party pursuant to this provision): If to the Company: The Nautilus Group, Inc. 1400 N.E. 136th Avenue Vancouver, WA 98684 Attn: Chairman of the Board of Directors With a copy or copies to such other persons as the Board may designate to Executive in writing from time to time. If to the Executive: Gregg Hammann [at his last designated home address] 18. ATTORNEY'S FEES In the event that any party shall bring an action, arbitration or proceeding in connection with the performance, breach or interpretation of this Agreement, then the prevailing party in such action, arbitration or proceeding as determined by the court or other body having jurisdiction shall be entitled to recover from the losing party all reasonable costs and expenses of such action, arbitration or proceeding, including reasonable attorneys' fees, court costs, costs of investigation, expert witness fees and other costs reasonably related to such proceedings. 19. ACKNOWLEDGMENT The Executive acknowledges that he has read this Agreement, he understands that the Company has been represented by Garvey, Schubert Barer in this matter, he has been encouraged to consult with an attorney representing him regarding the terms and conditions hereof, and has done so, and that he accepts and signs this Agreement as his own free act and in full understanding of its present and future legal effect. 20. INDEMNIFICATION The Company shall indemnify Executive and hold him harmless to the maximum extent permitted under the articles of incorporation and by-laws of the Company and applicable law, and shall provide for directors and officers liability insurance to the same extent as provided to officers of the Company and members of the Board of Directors. 10 21. INCONSISTENCY This Agreement and the Nonstatutory Stock Option Agreement shall govern any inconsistency between those agreements and any plan, program, policy, practice or other agreement (collectively, "Plans") by or with the Company in existence on the date of this Agreement or as any such Plan may be adopted, amended or terminated thereafter. IN WITNESS WHEREOF, this Agreement is executed as of the day and year above written. "COMPANY" "EXECUTIVE" The Nautilus Group, Inc. By: Gregg Hammann By: /s/ Brian R. Cook By: /s/ Gregg Hammann -------------------- --------------------- Brian R. Cook Gregg Hammann 11 EXHIBIT A TO EMPLOYMENT AGREEMENT THE NAUTILUS GROUP, INC. NONSTATUTORY STOCK OPTION AGREEMENT The Nautilus Group, Inc. (the "Company") has granted to GREGG HAMMANN (the "Optionee"), an option to purchase a total of 850,000 shares of Common Stock, at the price determined as provided herein, and in all respects subject to the terms, definitions and provisions of the 1995 Stock Option Plan (the "Plan") adopted by the Company which is incorporated herein by reference. The Terms defined in the Plan shall have the same defined meanings herein. 1. Nature of the Option. This Option is a nonstatutory stock option and is not intended to qualify for a special tax benefit to the Optionee. 2. Exercise Price. The exercise price is $8.39 U.S. for each share of Common Stock. 3. Exercise of Option. The Option shall be exercisable during its term in accordance with the provisions of the Plan as follows: (i) Right to Exercise. (a) This Option shall be exercisable as provided in Section 8 below. (b) This Option may not be exercised for a fraction of a share. (ii) Method of Exercise. This Option shall be exercisable by written notice which shall state the election to exercise the Option, the number of Shares in respect of which the Option is being exercised, and such other representations and agreements as to the Optionee's investment intent with respect to such shares of Common Stock as may be required by the Company pursuant to the provisions of the Plan. Such written notice shall be signed by the Optionee and shall be delivered in person or by certified mail to the Secretary or Assistant Secretary of the Company. The written notice shall be accompanied by payment of the exercise price as provided in Section 5 below. No shares will be issued pursuant to the exercise of an Option, unless such issuance and such exercise shall comply with all relevant provisions of law and the requirements of any stock exchange upon which the Shares may then be listed. 4. Optionee's Representations. In the event the Shares purchasable pursuant to the exercise of the Option have not been registered under the Securities Action of 1933, as amended, at the time this Option is exercised, Optionee shall, concurrently with the exercise of all or any portion of this Option, deliver to the Company the Optionee's Investment Representation Statement in such form as may be required in the opinion of the Company's legal counsel to comply with applicable state and federal securities laws. 12 5. Method of Payment. Payment of the exercise price shall be in cash. Any Common Stock delivered in full or partial payment for the exercise price shall be valued at the fair market value thereof the day of exercise. If the value of the Common Stock delivered in payment of the exercise price exceeds the exercise price, no fractional shares will be issued and Optionee will receive cash in the amount of such excess. 6. Restrictions on Exercise. This Option may not be exercised if the issuance of such Shares upon such exercise or the method of payment of consideration for such shares would constitute a violation of any applicable federal or state securities or other law or regulation, or the rules, regulations or listing requirements of any stock exchange upon which the shares are listed or included. 7. Non-Transferability of Option. This Option may not be transferred in any manner otherwise than by will or by the laws of the descent or distribution or pursuant to a qualified domestic relations order as defined by Section 414(p) of the Internal Revenue Code or Title I of the Employee Retirement Income Security Act or the rules thereunder, and may be exercised during the lifetime of Optionee only by the Optionee. The terms of this Option shall be binding upon the executors, administrators, heirs, successors and assigns of the Optionee. 8. Term of Option. The term of this Option shall be as follows: (i) Vesting Period of Option. This option shall become exercisable as to twenty (20%) of the total shares covered hereby at the end of the 12-month period of Optionee's continuous employment with the Company following the date of grant, and shall thereafter become exercisable as to an additional ten percent (10%) of the total shares covered hereby at the end of each subsequent six-month period of Optionee's continuous employment with the Company. In the event of the termination of the Optionee's employment with the Company, whether by dismissal, resignation, death, disability, or otherwise, all further vesting of this Option shall cease as of the effective date of such termination; provided, that in the event the Company terminates Optionee's employment without Cause or Optionee terminates his employment for Good Reason (as those terms are defined in Optionee's Employment Agreement with the Company dated July 15, 2003 (the "Employment Agreement")), this Option shall continue to vest as if Optionee had remained employed during the period in which Optionee is entitled to receive severance pay pursuant to Section 5 of the Employment Agreement. (ii) Exercisable Period. This Option may not be exercised more than ten (10) years from the date of grant of this Option, and may be exercised during such term only in accordance with the Plan and the terms of this Option. In the event the Company terminates Optionee's employment without Cause or Optionee terminates his employment for Good Reason (as such terms are defined in the Employment Agreement), this Option shall remain exercisable for a period of fifteen (15) months after the date of termination of employment as to the shares vested on or before such date of termination and for fifteen months after the date of vesting as to shares vesting after the date of termination. In the event of Optionee's resignation other than for Good 13 Reason (as such term is defined in the Employment Agreement) after giving the Company at least thirty (30) days' advance written notice, this Option shall remain exercisable as to the vested shares for a period of ninety (90) days from the effective date of such termination. In the event of termination of Optionee's employment with the Company by reason of death or disability, this Option shall remain exercisable as to the vested shares for a period of three (3) years from the effective date of such termination. In the event Optionee's employment with the Company is terminated for Cause ( as such term is defined in the Employment Agreement) or if Optionee voluntarily terminates his employment without giving the Company at least thirty (30) day's advance written notice, this Option shall not be exercisable after the effective date of such termination. 9. Taxation Upon Exercise of Option. Optionee understands that pursuant to certain provisions of the Internal Revenue Code of 1986, as amended, upon exercise of this Option, Optionee may recognize income for tax purposes in an amount equal to the excess of the then fair market value of the Shares of the exercise price. The Company will be required to withhold tax from Optionee's current compensation with respect to such income; to the extent that Optionee's current compensation is insufficient to satisfy the withholding tax liability, the Company may require the Optionee to make a cash payment to cover such liability as a condition of exercise of this Option. DATE OF GRANT: 7-15-03. THE NAUTILUS GROUP, INC. By: /s/ Brian R. Cook --------------------------- SIGNATURE Brian R. Cook --------------------------- PRINT NAME Its: Chairman ---------------------- Optionee acknowledges receipt of a copy of the Plan, a copy of which is annexed hereto, and represents that Optionee is familiar with the terms and provisions thereof. Dated: July 2, 2003 /s/ Gregg Hammann --------------------------- (Optionee) Gregg Hammann --------------------------- Print Name 14 EXHIBIT B TO EMPLOYMENT AGREEMENT BUSINESS PROTECTION AGREEMENT In consideration of an offer of employment by The Nautilus Group, Inc., a Washington corporation ("Company") and/or as a condition of continued employment by Company, Gregg Hammann, ("Executive") an individual resident of Clark County, agrees to enter into this business protection agreement ("Agreement") as follows: 1. WORK FOR HIRE, INVENTIONS AND ASSIGNMENT. 1.1 Work for Hire/Assignment of Inventions. Executive agrees that all creative work, whether tangible or intangible, including without limitation designs, drawings, specifications, techniques, models, processes and software, prepared or originated by Executive during or within the scope of his or her employment by Company (collectively "Work"), whether or not subject to protection under federal copyright or other law constitutes Work Made for Hire, all rights to which are owned by Company. Executive further agrees that any and all ideas, inventions, discoveries, improvements, whether or not patentable, created during or within the scope of his or her employment by Company (collectively "Inventions") shall be owned by Company and hereby assigns to Company all right, title and interest, whether by way of copyright, patent, trade secret or otherwise, in such Work and Inventions. Executive represents and warrants to Company that all Work and Inventions are original, that he or she has not copied any Work or Inventions from another's work, and that the Work and/or Inventions do not infringe the rights of any third party. 1.2 List of Inventions. Executive warrants that any invention(s) that Executive created, alone or with others, before beginning work for Company, and that Executive has rights in are listed on the attached Exhibit A ("Prior Inventions"). Executive acknowledges and agrees that Company would not employ Executive if Company did not believe all information provided by Executive to Company, including without limitation the information listed on Exhibit A, to be true, accurate and complete. If Executive does not list any inventions on Exhibit A, Executive's signature on this Agreement acknowledges that Executive does not claim any Prior Inventions. In the event that Executive fails to include a Prior Invention on Exhibit A, Executive hereby grants to Company a perpetual, royalty-free, irrevocable, world-wide license to make, have made, use, modify, sell and otherwise exploit such invention(s) at Company's discretion for use in Company's business, and to license such rights to third parties. 1.3 Exceptions. Section 1.1 does not apply to any invention, discovery or improvement that Executive developed or develops during the period of time he or she is employed by Company if such invention, discovery or improvement is developed by Executive entirely on his or her own time without using Company's equipment, supplies, facilities, or trade secret information, except for those inventions that either (a) related at the time of conception or reduction to practice to Company's business, or to actual or demonstrably anticipated research or development of Company, or (b) result from any work performed by Executive for Company. 15 2. PERFECTION OF RIGHTS, TITLE AND INTEREST. Executive agrees, without further consideration, to perform, at the request and expense of Company, all lawful acts and execute, acknowledge and deliver all instruments deemed necessary or desirable by Company to vest in Company the entire right, title and interest in works to which the Company has rights, including without limitation all Work and Inventions, and to enable Company to properly prepare, file and prosecute applications for and obtain and defend patents, copyrights and other rights in the United States and foreign countries, as well as reissues, renewals and extensions of such rights, and to obtain and record title to such applications, so that Company shall be the sole and absolute owner thereof in any and all countries in which it may desire protection. 3. CONFIDENTIAL INFORMATION. 3.1 Definition. During the course of his or her employment by Company, Executive may have access to Company's Confidential Information, as defined below. Executive understands that the ownership and confidential status of the Confidential Information is highly important to Company, and that Company has a vital and substantial interest in (a) maintaining the confidentiality of its Confidential Information, (b) maintaining a stable work force, (c) continuing its relationships with its Business Contacts, as defined below, (d) remaining in business and (e) avoiding or minimizing any disruption of, damage or impairment to, or interference with its business. For purposes of this Agreement, "Confidential Information" shall include all information that (i) is treated by Company as confidential or proprietary; (ii) would reasonably be viewed as confidential; (iii) would reasonably be viewed as having value to a competitor of Company; or (iv) Company is under an obligation to a third party to keep confidential. Consistent with this definition, Confidential Information shall include: confidential, nonpublic or proprietary information concerning Company's business, customers, employees, vendors, products and services, including without limitation information concerning Company's financial affairs; methods of conducting or obtaining business; marketing plans or strategies; current or future business opportunities; current or future products; technology; licenses; software or other programs (including source code); customer or contact lists; relationships with third party companies; actual or prospective (to be "prospective," there have been business discussions with such persons during the twelve months prior to termination of Executive's employment with the Company and are known to Executive) clients, customers, business partners, or investors (collectively "Business Contacts"); contract terms; reports; legal affairs; ideas; inventions; methods; processes; research; development; operations; systems; algorithms; improvements; know-how or any other information disclosed by Company or a third party under Company's authority or discovered by Executive in connection with any such disclosure, including without limitation all such information disclosed in writing, or other fixed media or disclosed in any other manner, including without limitation oral, visual, or electronic disclosure. 16 "Confidential Information" does not include information that is generally known to the public or is disclosed to Executive by Company without restriction. 3.2 Ownership. Executive acknowledges that all Confidential Information is the valuable and confidential property of Company. Executive acknowledges and agrees that all Confidential Information is, and shall continue to be, the exclusive and permanent property of Company, whether or not prepared in whole or in part by Executive, and whether or not disclosed or entrusted to Executive in connection with his or her employment by Company. 3.3 Restrictions on Disclosure and Use of Confidential Information. Executive agrees to hold all Confidential Information in a fiduciary capacity, to exercise the highest degree of care in safeguarding Confidential Information against loss, theft, or other inadvertent disclosure, and to take all steps reasonably necessary to maintain the confidentiality of the Confidential Information. Executive shall not, without the prior written permission of Company, directly or indirectly, either during the term of his or her employment (except as required in the normal course of the performance of his or her duties, and only for the sole benefit of Company), or at any time after his or her employment is terminated for any reason: 3.3.1. Disclose to any person, corporation or other entity or use in his or her own or in any other person's business, any Confidential Information; 3.3.2. Remove any Confidential Information from Company's premises without the prior written permission of Company; or 3.3.3. Take advantage of any business opportunity obtained on the basis of Confidential Information known to Executive in the course of his employment by Company. Executive acknowledges and agrees that the restrictions contained in this Agreement on the use and disclosure of Confidential Information are in addition to any other restrictions that may apply under contract, statute or common law including, without limitation, trade secret, copyright, and patent. 3.4 Disclosures to Governmental Entities. If Executive becomes legally obligated to disclose Confidential Information to any governmental entity with jurisdiction over Executive, Executive will give Company prompt written notice of such obligation, sufficient to allow Company to obtain a protective order or other appropriate remedy. Executive agrees to disclose only such information as Executive is legally required to disclose, and to use his or her reasonable best efforts to obtain confidential treatment for any Confidential Information he or she is required to disclose. 3.5 Trade Secret. Executive agrees that all Confidential Information constitutes the valuable trade secret property of the Company; that Company has taken steps that are reasonable under the circumstances to maintain the confidentiality of such information; and that such information derives independent economic value from not generally being known to and by not readily being ascertainable by others. Executive further agrees that if, for any reason, a court or other body with jurisdiction to determine the trade secret status of the Confidential Information 17 declares that any portion of the Confidential Information is not subject to protection as a trade secret, such information shall nevertheless remain subject to the limitations on use and disclosure of Confidential Information contained in this Agreement. 3.6 No License. Executive understands that, during employment by Company, Executive may have access to information that does not meet the definition of Confidential Information, but is nevertheless protected from unauthorized use by copyright, patent, and other laws. Executive acknowledges that the fact that any such information is not Confidential Information as defined herein does not give Executive any right or license to use such information or limit the other protections available to the Company for such information under contract, statute or common law. 4. PROTECTION OF THIRD PARTY INFORMATION. Executive understands that he/she may have access to information submitted by or relating to third parties, including individuals, that may be protected from use, disclosure, and/or infringement by laws and regulations governing such information including copyright laws, trade secret laws and other laws and regulations and by contract with third parties. Executive shall strictly safeguard and maintain the security and privacy of any such protected information and shall adhere to any policies and procedures with respect to the safeguarding of such information as from time to time directed by the Company. Executive further understands failure to comply with these requirements may subject the Company and the Executive to liability and may be grounds for discharge. 5. SCOPE OF COMPANY PROTECTION. Company is or expects to be a multi-national concern that conducts business throughout the world. In employment with the Company Executive has performed and/or will perform services in more than one city, county, state or country, and has gained and/or will gain access to Confidential Information that pertains not only to the specific area in which Executive lives and/or works but also to other cities, counties, states and countries in which Company does business. The parties acknowledge that due to the character of Company's business, a geographic restriction on this Agreement would not adequately protect Company's legitimate business interests. The protections stated herein are intended to protect Company to the fullest extent possible in all of the cities, counties, states, and countries in which Company does business or contemplates doing business. 6. ADDITIONAL PROTECTIONS. Executive acknowledges that his or her position with Company is such that he or she has had and/or will have access to important and sensitive information that is unique to the Company regarding the Company's business, including without limitation its strategies for designing and delivering services and/or goods, identifying markets for services and/or goods, developing and introducing services and/or goods, selecting business partners and third party products, targeting and exploiting business opportunities and pricing services and/or goods. Executive acknowledges that all such information is critical to Company's success and/or to the success of Company's affiliates, parents, partners and subsidiaries (collectively, "Company Group"), constitutes Confidential Information and/or trade secret information, and gives Company an advantage over its competitors. Executive understands that such information would be extremely valuable to a competitor of Company Group, since it would permit the competitor to anticipate and potentially pre-empt Company Group's future business plans and that such disclosure would seriously damage Company Group's business. 18 7. DISCLOSURE OF PRIOR RESTRICTIONS. Company is not employing Executive to obtain any information that is the property of any previous employers or any other person or entity. Executive represents and warrants that he or she is not currently subject to any restriction that would prevent or limit Executive from carrying out his or her duties for Company. Executive agrees not to take any action on behalf of Company that would violate a prior restriction or agreement to which Executive is subject, to notify Company immediately if any such restriction or situation should arise, and to fulfill all obligations to present or former employers and others during his or her service to Company. 8. RETURN OF COMPANY PROPERTY. Upon termination of employment, or upon demand by Company, Executive agrees to promptly return to Company all Confidential Information, including all tangible and intangible work product containing or reflecting Confidential Information or any part thereof, and all other Company property in Executive's possession or control, including but not limited to: all papers, records, memoranda, notes, or other documents of any kind; all video and audio tapes; all computer software or hardware in any form, all computer tapes, disks and other magnetic media; any and all copies of any of the above; all equipment; all credit cards; all keys; and any other property or Confidential Information that belongs to Company, whether or not generated by Company. Executive understands and agrees that his or her obligations under this Agreement shall survive the termination of his or her employment, and shall inure to the benefit of any successor of Company. 9. NON-COMPETITION. Executive acknowledges that Company is engaged in a highly competitive business and that by virtue of his position with Company, Executive will perform services that are of a competitive value to Company and which, if used in competition with Company, could cause it serious harm. Accordingly, Executive agrees as follows: during the term of his employment by Company, and for one (1) years after termination, Executive shall not directly or indirectly own, operate, provide financial, technical or other assistance or services to, or be connected with as stockholder (other than as an owner of less than 5% of the stock of a publicly held corporation whose stock is traded on a national securities exchange or in the over-the-counter market) any organization or entity which designs, manufactures or distributes exercise or fitness equipment. 10. NON-SOLICITATION OF EMPLOYEES/CONTRACTORS. 10.1 Unless Executive receives the prior express written consent of Company, Executive shall not, during employment, or for one (1) year after termination of employment, induce or solicit, or attempt to induce or solicit, directly or indirectly, any person who is in the employment of, or is providing services to, Company, to leave or terminate such employment or business relationship. 10.2 If Executive violates Section 10.1 above, then at the sole election of Company, Company shall be entitled to seek and obtain an injunction in addition to any other remedies available under this Agreement or by law. 19 11. NON-INTERFERENCE WITH BUSINESS CONTACTS. Unless Executive receives the prior, express, written consent of Company, Executive shall not, during employment, or for one (1) year after the termination of employment, solicit or entice any Business Contact to decrease, discontinue, terminate, cancel or revoke its relationship with Company. 12. EXTENSION OF OBLIGATIONS. The periods in which the obligations under Sections 6, 9, 10, and 11 remain in effect shall be extended day-for-day for any period in which Executive is in breach of this Agreement. 13. AT-WILL EMPLOYMENT STATUS. Executive acknowledges and agrees that Executive's employment with the Company is at-will. As a result, either Executive or Company may terminate the employment relationship at any time, with or without cause. Nothing in this Agreement shall alter the at-will nature of the employment relationship. 14. INJUNCTIVE RELIEF. Executive acknowledges that breach of Section 3, 6, 9, 10 and/or 11 of this Agreement, or of any other term or provision of this Agreement with regard to Company's ownership or confidentiality rights, would irreparably injure Company, which injury could not adequately be compensated by money damages. Accordingly, Executive agrees that Company may seek and obtain injunctive relief from the breach or threatened breach of any provision, requirement or covenant of this Agreement, without any requirement to post bond and in addition to and not in limitation of any other legal remedies. 15. BANKRUPTCY. In the event Company becomes subject to (a) an insolvency proceeding where there is a liquidation of substantially all of Company's assets; or (b) a Chapter 7 bankruptcy liquidation, then Company agrees the provisions of Sections 6, 9, 10 and 11 shall terminate upon such liquidation. 16. GOVERNING LAW, JURISDICTION, AND ATTORNEYS' FEES. This Agreement shall be construed and enforced in accordance with the laws of the State of Washington, without giving effect to its choice of law provisions. Executive agrees that the exclusive jurisdiction and venue for any dispute arising out of this Agreement shall be the state courts located in Clark County and/or King County, Washington or the federal district court for the Western District of Washington in Seattle, and Executive further consents to the jurisdiction of such courts; provided that Company may seek injunctive relief in another venue when Company believes such relief may not be effective unless obtained in such other venue. In any action to enforce this Agreement, including, as applicable, gaining injunctive relief, the prevailing party shall be entitled to recover, in addition to all other relief, its reasonable attorneys' fees, costs and expenses incurred in such enforcement action. 17. SEVERABILITY. If any provision of this Agreement or portion thereof shall be held by a court of competent jurisdiction to be illegal, invalid or unenforceable, the remaining provisions and all other portions thereof shall remain in full force and effect. 18. ENTIRE UNDERSTANDING. This Agreement sets forth the entire understanding with respect to its subject matter and supersedes all previous agreements to which Executive is a party regarding its subject matter. No provision of this Agreement shall be deemed waived, amended, or modified by either party unless such waiver, amendment, or modification is in writing and 20 signed by the party against whom it is sought to be enforced. Executive hereby agrees that all Confidential Information disclosed or learned, and all Work and/or Inventions created, produced or developed, prior to the date of this Agreement shall be subject to the provisions contained herein. 21 NOTICE TO EXECUTIVE This Agreement may require the transfer to Company of certain inventions and may restrict your ability to perform services in the future. You may wish to consult your legal counsel for advice concerning your rights and obligations. By executing this Agreement, Executive and Company agree to be bound its terms. EXECUTIVE THE NAUTILUS GROUP, INC. Signature: /s/ Gregg Hammann By: /s/ Brian R. Cook ------------------- ---------------------------------- Print name: Gregg Hammann Printed name and title: Brian R. Cook, Chairman ------------------ ------------------------ Date: 7/2/03 Date: 7/8/03 ------------------------ -------------------------------- 22 EXHIBIT 1 TO BUSINESS PROTECTION AGREEMENT LIST OF EMPLOYEE'S PRIOR INVENTIONS. List all Inventions created prior to work with Company: 23 EXHIBIT C TO EMPLOYMENT AGREEMENT CONFIDENTIAL WAIVER AND RELEASE OF CLAIMS AGREEMENT This Waiver and Release of Claims Agreement and Release (herein "Agreement") dated this 2nd day of July, 2003, is entered into by and between Employer ("The Nautilus Group, Inc." or "We") and Gregg Hammann (herein "Hammann" or "You/Your"). NOW, THEREFORE, in consideration of the mutual promises and undertakings herein, the parties agree as follows: AGREEMENTS 19. SEPARATION OF EMPLOYMENT. We and you agree that your employment with the Company is terminated as of _______________ ("date of separation"). 20. COMPENSATION. You have been paid all wages and other amounts owed to you through the date of termination. In addition, you will receive severance and other benefits as set forth in your Employment Agreement. You expressly acknowledge and agree that no further payments or monies are owing from us to you relating in any way to your employment/termination or otherwise under the terms of this Agreement or your Employment Agreement. You also acknowledge that absent execution of this Waiver and Release of Claims Agreement you have no right to severance pay. 21. RELEASE. (a) In exchange for severance, you, on your own behalf, as well as on behalf of your marital community and your heirs, executors, administrators and assigns, hereby release in full and forever discharge, acquit and hold harmless The Nautilus Group, Inc. and any parent, subsidiary or otherwise affiliated corporation, partnership or other business enterprise, and all of its or their past or current affiliates, related entities, partners, subsidiaries, insurers, predecessors, successors, assigns, directors, officers, shareholders, investors, representatives, agents, attorneys and employees (herein collectively referred to as "Associated Persons") from any and all claims, causes of action, demands, suits, liabilities, damages, expenses and obligations of every nature, character or kind, (collectively "Claims"), whether known or unknown, suspected or unsuspected, matured or contingent, existing or hereafter discovered, including, but not limited to, any Claims which in any manner or fashion arise from or relate to your employment with us, any contractual agreements between us, or your separation from Employment with us. You understand that this release specifically refers to and includes any Claims arising under the Federal Age Discrimination in Employment Act and any applicable provisions of state or local law, as well as any other Claims arising under any federal, state, local or provincial law, regulation, ordinance or order or otherwise. You further understand that this release specifically refers to and includes any damages or other personal remedies that you could obtain as a result of prevailing on a claim or charge filed with the EEOC or any other administrative agency. 24 (b) Through this release you are fully, finally, and for all times settling and releasing all disputes and differences within the scope of matters known or unknown, suspected or unsuspected, which now exist, may exist or have existed between you and us or Associated Persons. In furtherance of this intention, this release shall be and remain in effect as a full and complete release notwithstanding the discovery or existence of any such additional or different Claim or fact. The provisions of any law, regulation, statue or ordinance providing in substance that releases shall not extend to Claims, damages or injuries which are unknown or unsuspected to exist at the time of the person executing the release are hereby expressly waived by you. 22. STRICT CONFIDENTIALITY. You agree to keep the terms and conditions of this Agreement, including any payments made hereunder, strictly confidential. You further agree not to disclose such terms or conditions in any manner whatsoever, unless required by law; provided that you may share the provisions with your spouse, attorneys, mental health counselor and tax advisors. In such cases you shall take reasonable precaution to ensure that such information will be protected within the spirit of this Agreement and agree to be personally responsible for any disclosure as if you had made it. 23. NONADMISSION OF LIABILITY. You expressly agree and acknowledge that this Agreement in no way constitutes an admission of liability on our part, including Associated Persons, and this Agreement does not constitute the admission of any fact from which liability to us, including Associated Persons, can be attributed now or at any time in the future. 24. PROMISE NOT TO SUE. You represent that you have not filed any complaints, charges, or lawsuits against us, including Associated Persons, and agree that you will not do so at any time hereafter for Claims released herein, except as may be necessary to enforce your rights pursuant to this Agreement. 25. NON-DISPARAGEMENT. Except as required by law, you agree not to make public disparaging or negative remarks about The Nautilus Group, Inc. and Associated Persons. Except as required by law, the officers and executives of the Company shall not make public disparaging or negative remarks about you. 26. REPRESENTATIONS. You acknowledge that no other party or person, nor any agent or attorney of any party or person, has made any promise, representation or warranty whatsoever, express or implied, not contained herein concerning the subject matter hereof, to induce you to execute this instrument, and you acknowledge that this Agreement has not been executed in reliance on any such promise, representation or warranty not contained herein. 27. ENFORCEABILITY OF PRIOR AGREEMENTS. You acknowledge and agree that any previous agreement, including the Business Protection Agreement, you have signed relating to noncompetition, confidential information and materials, assignment of rights, and nonsolicitation, will continue in full force and effect in accordance with the terms of any such agreement. 25 28. ENTIRE AGREEMENT. This Agreement, your Employment Agreement, the Business Protection Agreement and your Nonstatutory Stock Option Agreement express the full and complete agreement between us and you regarding the subject matters hereof. The terms of those Agreements are contractual, and not a mere recital of promises. The promises are mutually beneficial. There is no understanding or agreement to make any payment or perform any act other than what is provided for in those Agreements. Any modification of this Agreement shall not be effective unless it is in writing signed by all parties to this Agreement. 29. VOLUNTARY AGREEMENT. We have encouraged you to consult with an attorney before signing this Agreement. We and you acknowledge that you may consider this Agreement for a period of up to twenty-one (21) days before signing it and that you may revoke this Agreement within seven (7) days after all parties have signed it. Only after the seven-day period has passed will this Agreement become effective and binding on the parties. You acknowledge that you have read this entire Agreement, have had the opportunity to consult with your attorney and secure advice with regard thereto, and endorsed your name hereon with the full and complete understanding of the terms of this Agreement and its present and future legal effect. 30. BREACH OF AGREEMENT. In the event there is a breach of this Agreement or non-compliance with a term contained herein, the non-prevailing party shall be responsible for the payment of any and all reasonable attorneys' fees, expenses and costs incurred by the other party in enforcing this Agreement, including reasonable attorneys' fees and costs at all levels of proceedings. 31. GOVERNING LAW AND SUBMISSION TO JURISDICTION. This Agreement shall be governed by and construed in accordance with the laws of the State of Washington applicable to contracts made and to be carried out in Washington. Each of the parties submits to the exclusive jurisdiction of any state or federal court sitting in Clark County or King County, Washington in any action or proceeding arising out of or relating to this Agreement and further agrees not to bring any action or proceeding arising out of or relating to this Agreement in any other court. Each party agrees that a final judgment in any action or proceeding so brought shall be conclusive and may be enforced by suit on the judgment or in any other manner so provided by law. IN WITNESS WHEREOF, the parties have executed this Agreement voluntarily and free of all duress or any other encumbrance as of the date and year set forth above. THE NAUTILUS GROUP By: By: ------------------------------- ---------------------------- Its: Its: ------------------------------ -------------------------- 26 ADDENDUM A TO EXECUTIVE EMPLOYMENT AGREEMENT, DATED JULY 2, 2003, BY AND BETWEEN THE NAUTILUS GROUP, INC. AND GREGG HAMMANN The Company shall enter into an agreement with a relocation services provider ("Relocation Service") on the following terms: a) The Relocation Service shall immediately provide Executive with a list of appraisers doing business in the area of Executive's residence in Marin County, California. Executive shall select two appraisers from this list and these appraisers shall prepare a written appraisal of Executive's residence. If the lower of the two appraisals is more than 5% less than the higher appraisal, the Relocation Service shall select a third appraiser and obtain a third written appraisal. b) Upon receipt of the two or three appraisals as described in the preceding paragraph, the Relocation Service shall promptly deliver a written offer to purchase Executive's residence at a price equal to Fair Market Value. If two appraisals are obtained, as provided in the preceding paragraph, Fair Market Value shall be the greater of (i) the average of the two appraisals, and (ii) Two Million Seven Hundred Fifty Thousand Dollars ($2,750,000). If three appraisals are obtained, Fair Market Value shall be the greater of (i) the average of the two highest appraisals, and (ii) Two Million Seven Hundred Fifty Thousand Dollars ($2,750,000). However, if the average of the appraisals is less than Two Million Five Hundred Thousand Dollars ($2,500,000), no offer shall be delivered until the parties have reached further agreement concerning the determination of Fair Market Value. Following the receipt of a purchase offer from the Relocation Service, Executive shall have a period of sixty (60) days to consider and accept the purchase offer. If Executive rejects the offer, neither the Company nor the Relocation Service shall have any further obligation to purchase or offer to purchase Executive's residence. If Executive accepts the offer, the purchase and sale of the residence shall be completed in accordance with a purchase agreement entered into between Executive and the Relocation Service. c) In the event that (i) the purchase price paid to Executive by the Relocation Service is greater than the highest appraisal obtained in accordance with paragraph (a) above, and (ii) prior to the second anniversary of the Commencement Date, the Company terminates Executive's employment for Cause or Executive voluntarily terminates his employment without Good Reason, then in such event Executive shall be obligated to promptly make payment to the Company in the amount of any Shortfall. Shortfall shall be defined as the lesser of (i) the amount by which the purchase price paid to Executive exceeds the highest appraisal obtained in accordance with paragraph (a), and (ii) the amount by which the purchase price paid to Executive exceeds the price at which the residence is sold by the Relocation Service or the Company. In the event the price at which the residence is sold by the Relocation Service or the Company exceeds the price paid to Executive, there shall be no Shortfall and Executive shall have no payment obligation. 27 EX-31.1 4 exhibit31-1_12302.txt 302 CERTIFICATION OF CHIEF EXECUTIVE OFFICER EXHIBIT 31.1 ------------ CERTIFICATION I, Greggory C. Hammann, certify that: 1. I have reviewed this quarterly report on Form 10-Q of The Nautilus Group, Inc.; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have: (a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; (b) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and (c) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): (a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and (b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. November 14, 2003 By: /s/ Greggory C. Hammann - ----------------- ----------------------------- Date Greggory C. Hammann, Chief Executive Officer and President EX-31.2 5 exhibit31-2_12302.txt 302 CERTIFICATION OF CHIEF FINANCIAL OFFICER EXHIBIT 31.2 ------------ CERTIFICATION I, Rod W. Rice, certify that: 1. I have reviewed this quarterly report on Form 10-Q of The Nautilus Group, Inc.; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have: (a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; (b) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and (c) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): (a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and (b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. November 14, 2003 By: /s/ Rod W. Rice - ----------------- -------------------------- Date Rod W. Rice, Chief Financial Officer, Treasurer and Secretary EX-32.1 6 exhibit32-1_12302.txt 906 CERTIFICATION OF CHIEF EXECUTIVE OFFICER EXHIBIT 32.1 ------------ CERTIFICATION PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 (SUBSECTIONS (a) AND (b) OF SECTION 1350, CHAPTER 63 OF TITLE 18, UNITED STATES CODE) Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (Subsections (a) and (b) of Section 1350, Chapter 63 of Title 18, United States Code), the undersigned officer of The Nautilus Group, Inc., a Washington corporation (the "Company"), does hereby certify that: To my knowledge, the Quarterly Report on Form 10-Q for the quarter ended September 30, 2003 (the "Form 10-Q") of the Company fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934 and information contained in the Form 10-Q fairly presents, in all material respects, the financial condition and results of operations of the Company. November 14, 2003 By: /s/ Greggory C. Hammann - ----------------- ----------------------------- Date Greggory C. Hammann, Chief Executive Officer and President A signed original of this written statement required by Section 906 has been provided to the Company and will be retained by the Company and furnished to the Securities and Exchange Commission or its staff upon request. EX-32.2 7 exhibit32-2_12302.txt 906 CERTIFICATION OF CHIEF FINANCIAL OFFICER EXHIBIT 32.2 ------------ CERTIFICATION PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 (SUBSECTIONS (a) AND (b) OF SECTION 1350, CHAPTER 63 OF TITLE 18, UNITED STATES CODE) Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (Subsections (a) and (b) of Section 1350, Chapter 63 of Title 18, United States Code), the undersigned officer of The Nautilus Group, Inc., a Washington corporation (the "Company"), does hereby certify that: To my knowledge, the Quarterly Report on Form 10-Q for the quarter ended September 30, 2003 (the "Form 10-Q") of the Company fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934 and information contained in the Form 10-Q fairly presents, in all material respects, the financial condition and results of operations of the Company. November 14, 2003 By: /s/ Rod W. Rice - ----------------- --------------------- Date Rod W. Rice, Chief Financial Officer, Treasurer and Secretary A signed original of this written statement required by Section 906 has been provided to the Company and will be retained by the Company and furnished to the Securities and Exchange Commission or its staff upon request. -----END PRIVACY-ENHANCED MESSAGE-----