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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-K

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES

EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 2003

Commission file number: 000-25867

THE NAUTILUS GROUP, INC.

(Exact name of Registrant as specified in its charter)

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)

Securities registered pursuant to Section 12(b) of the Act:

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K, or any amendment to this Form 10-K.  ¨

Indicate by check mark whether the Registrant is an accelerated filer (as defined in Rule 12b-2 of the Securities Exchange Act of 1934).    Yes  x    No  ¨

The aggregate market value of the voting stock held by non-affiliates, computed by reference to the last sales price ($12.40) as reported on the New York Stock Exchange, as of the last business day of the Registrant’s most recently completed second fiscal quarter (June 30, 2003) was $356,283,062.

The number of shares outstanding of the Registrant’s Common Stock as of March 1, 2004 was 32,611,073 shares.

Documents Incorporated by Reference

The Registrant has incorporated by reference into Part III of this Form 10-K portions of its Proxy Statement for its 2004 Annual Meeting of Stockholders.

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THE NAUTILUS GROUP, INC.

2003 FORM 10-K ANNUAL REPORT

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PART I

Forward-Looking Statements

Certain statements contained in this Annual Report on Form 10-K, including, without limitation, statements containing the words “could,” “may,” “will,” “should,” “plan,” “believes,” “anticipates,” “estimates,” “predicts,” “expects,” “projections,” “potential,” “continue,” and 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-K, we may make forward-looking statements relating to our financial performance, including the following:

Numerous factors could affect our actual results, including the following:

We describe certain of these and other key risk factors elsewhere in more detail in this 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. 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-K or to reflect the occurrence of unanticipated events.

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Item 1. Business

OVERVIEW

The Nautilus Group, Inc. (the “Company”) is a leading marketer, developer and manufacturer of branded health and fitness products sold under such well-known names as Nautilus, Bowflex, Schwinn, StairMaster, TreadClimber and Trimline. Our products are distributed through diversified direct, retail and commercial sales channels. We market and sell our Bowflex, TreadClimber, and Nautilus Sleep Systems products through our direct-marketing channel utilizing an effective combination of television commercials, infomercials, response mailings, the Internet, and inbound/outbound call centers. We market and sell our Nautilus, Schwinn, and StairMaster commercial fitness equipment through our sales force and selected dealers to health clubs, government agencies, hotels, corporate fitness centers, colleges, universities and assisted living facilities worldwide. We also market a comprehensive line of consumer fitness equipment sold under the Nautilus, Schwinn, StairMaster, Bowflex, and Trimline brands, through a network of specialty and sporting goods dealers, distributors and retailers worldwide.

Founded in 1986, the Company has grown to approximately $500 million in annual sales through a combination of internal growth of our Bowflex product line and a series of strategic acquisitions, including Nautilus International, Inc. (“Nautilus”) in January 1999, the fitness division of Schwinn/GT Corp. and its affiliates (“Schwinn Fitness”) in September 2001 and StairMaster Sports/Medical, Inc. (“StairMaster”) in February 2002. As a result of these acquisitions, we considerably expanded our portfolio of leading brands, product lines, channels of distribution, product development capabilities and the size of our customer base. We now offer a comprehensive line of cardiovascular and weight resistance products in the direct, retail and commercial fitness channels. Our product lines include home gyms, free weight equipment, treadmills, indoor cycling equipment, steppers, ellipticals, and fitness accessories, as well as premium air support sleep systems. We have over 1,200 dealers in the U.S., a worldwide network of distributors, operations in Switzerland, and offices in Italy, Germany, and the United Kingdom.

The Company was incorporated in California in 1986 and became a Washington corporation in 1993. On May 21, 2002, the Company changed its corporate name to The Nautilus Group, Inc. from Direct Focus, Inc. Concurrent with the name change, trading of the Company’s shares was moved from the NASDAQ National Market to the New York Stock Exchange with a new ticker symbol (NLS).

Our principal executive offices are located at 1400 NE 136^th Avenue, Vancouver, Washington 98684, and our telephone number is (360) 694-7722. We maintain our corporate website at www.nautilusgroup.com. None of the information on this website or our other websites is part of this Form 10-K. On our website, we make available, free of charge, printable copies of our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act as soon as reasonably practicable after such material is electronically filed with or furnished to the Securities and Exchange Commission (“SEC”). In addition, our code of business conduct and ethics, corporate governance guidelines, and the charters of our Audit Committee, Compensation Committee and Nominating and Corporate Governance Committee are available on our corporate website. These corporate governance documents are available in print to any stockholder who requests them.

As used in this Form 10-K, the terms “we,” “our,” “us,” “Nautilus Group” and “Company” refer to The Nautilus Group, Inc. and its subsidiaries. The names Nautilus^®, Bowflex^®, Power Rod^®, TreadClimber^®, Schwinn^® (fitness products), StairMaster^® and Trimline^® are trademarks of the Company.

The consolidated financial statements of the Company include The Nautilus Group, Inc. and its wholly owned subsidiaries (collectively, the “Company”). All intercompany transactions have been eliminated in the preparation of the consolidated financial statements.

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BUSINESS SEGMENTS

Our operating segments include the 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 line of strength equipment and TreadClimber line of cardiovascular equipment are the principal fitness equipment products in our direct segment. Sales from our Bowflex product line, including related shipping revenue, accounted for 52% of our aggregate net sales in 2003, down from 61% and 74% in 2002 and 2001, respectively, as we continued our strategies of diversification into the commercial and retail markets and the introduction of new direct-marketed products. In the rest product market, we offer a line of premium air sleep systems, called Nautilus Sleep Systems, which are also marketed through our direct segment. In the nutrition market, we have established a strategic relationship with Champion Nutrition (“Champion”) as supplier of nutritional supplements that are complementary with our fitness and healthy lifestyle product offerings and are marketed through our direct segment.

The commercial/retail segment includes all products and related operations that do not involve direct marketing to consumers. Products in this segment currently consist of fitness equipment branded under the Nautilus, Schwinn, StairMaster, Trimline, and Bowflex names, and depending on the brand, are sold through commercial and/or retail sales channels. Product categories sold through the commercial/retail segment include strength equipment, treadmills, ellipticals, exercise bikes, stairclimbers, stepmills, and other fitness-related accessories.

Beginning in 2003, we augmented our segment reporting with the addition of a separate reporting segment to reflect the activities associated with the corporate holding company. Activities reflected in this segment consist mainly of director costs, general legal and accounting fees, salaries of corporate personnel, as well as other costs not specifically attributable to the other two business segments. In addition, treasury is a corporate function, so interest income from investments is included in the corporate segment.

Detailed financial information about our three business segments is included in Note 3 of the Notes to Consolidated Financial Statements. Certain prior period balances have been reclassified to conform to this three-segment presentation with no effect on previously reported consolidated net income or stockholders’ equity.

DIRECT BUSINESS SEGMENT

Direct to Consumer Marketing

Through our direct-to-consumer sales and distribution channel, we market and sell our products directly to the end customer. We market and sell Bowflex, TreadClimber, and Nautilus Sleep Systems products through this channel utilizing an integrated combination of media and direct customer contact. Along with “spot” television advertising, which ranges in length from 30 seconds to as long as five minutes, we also utilize extended 30-minute television “infomercials,” Internet advertising, our product websites, inquiry response mailings, and inbound/outbound call centers. By selling directly to consumers, we are able to fully realize premium price points paid for our products by the end customer, eliminating all other parties from the sales transaction. Our ability to capture the full amount of sales revenue in our direct channel has consistently produced a high level of financial return on our time and invested money. The size of the direct market is substantial. Through our advertising initiatives, we estimate that we currently reach approximately 70 million homes. Success within this distribution channel is almost entirely dependent on the ability to accurately measure target customer demographics. Toward this aim, we employ hundreds of separate toll free telephone numbers and dozens of Internet address URLs in our sales and marketing efforts, which allow us to measure very specifically the consumer response rates to each of our advertising placements. We have built a comprehensive database that allows us to hone our marketing strategies and more effectively reach our

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target customers. Historically, we have been able to measure with a high degree of accuracy inquiries to specific advertisements, and in turn, predict the sales that will result from those inquiries. We believe that this expertise will continue to serve as a key factor that differentiates us from competitors and will enable us to maintain a competitive advantage within the direct marketing arena.

To date, we have been highly successful with what we refer to as a “two-step” marketing approach. Our two-step approach focuses first on generating consumer interest in our products while eliciting consumer requests for product information. Development of this interest is achieved primarily through the use of spot commercials and infomercials, supplemented by Internet advertising. The second step focuses on converting the informational requests into sales, which we accomplish through a combination of response mailings and outbound calling.

Advertising

Spot Television Commercials and Infomercials. Spot commercials are a key element of our direct marketing strategy. For products that may lend themselves to a more in-depth explanation and demonstration, television infomercials are another important marketing tool. We have developed a variety of spot commercials, infomercials, and marketing videos to support the marketing and sale of our products.

When we begin marketing a newly introduced product, we generally test and refine our marketing concepts and selling practices while advertising the product in spot commercials. Production costs for spot commercials typically range from $50,000 to $150,000. Based on initial results from the airing of this spot advertising, we may produce additional spot commercials and/or an infomercial, if suitable. Production costs for infomercials tend to range from $150,000 to $500,000. Generally, we attempt to film multiple infomercial and commercial concepts at the same time, in order to maximize production efficiencies. From this footage we can then develop a variety of spot commercials and infomercials, introducing and refining them over time.

We test spot commercials and infomercials on a variety of cable television networks that have a history of generating favorable responses for our existing products. Our initial objective is to more fully understand the product’s marketing appeal and to evaluate advertising or product modifications that may be appropriate. As we experience success, we then advertise on a wider number of additional cable networks.

Media Buying. An important component of our direct marketing success is our ability to purchase quality media time at an affordable price. Depending on the network, time slot and, programming length, the cost of airing spot commercials and infomercials varies significantly. Each spot commercial currently costs between $25 and $25,000 to air, and each infomercial between $600 and $55,000 to air. Historically, we have purchased the majority of our media time on cable networks.

We book most of our spot commercial and infomercial time on a monthly or quarterly basis, as networks make time available. Networks typically allow us to cancel booked time with two weeks’ advance notice, which enables us to adjust allocation of our advertising spending if our statistical tracking indicates another network or time slot is proving to be particularly effective.

Internet. The Internet continues to play an important role in our direct marketing strategy. We consistently promote our product websites in our television and print advertising and in our response mailing materials to encourage online product inquiries and transactions. Use of online advertising on third party sites and paid search engine placement also helps drive Internet browsers to our product websites to request additional information, learn more about our products, or to make immediate purchases. Our websites are loaded with informative content including detailed product information, online videos, and testimonials from our satisfied customers. We operate direct marketing-oriented websites in support of each of our products generating significant direct to consumer sales activity. None of the information in these websites is part of this Form 10-K.

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Optimal Use of Direct Marketing Database

Since we initially developed our direct to consumer strategy in 1994, we have consistently invested significant resources to build a comprehensive direct marketing database. Our database has allowed us to monitor customer responses and effectively utilize that information to adapt our marketing techniques, thereby reaching consumers with ever-increasing effectiveness. We track the success of each of our spot commercials and infomercials by determining how many viewers respond to each airing. We accumulate this information in our database to evaluate the cost-effective utilization of available media time. We believe the database enables us to predict with reasonable accuracy the levels of product sales and inquiries that will result from each spot commercial and infomercial.

Furthermore, our compilation of consumer inquiries contained within our database represents a rich pool of marketing leads for additional product sales. We believe this pool of contacts, a significant number of whom already have a proven and satisfied customer relationship with the Company, provides us a competitive advantage when introducing new products.

Conversion of Direct-Marketed Product Inquiries Into Sales

Customer Service Call Center and Order Processing. We manage our own customer service call center in Vancouver, Washington. It operates 18 to 23 hours per day to receive and process the vast majority of all infomercial-generated and customer service-related inquiries. We have developed a skills-based call routing system that automatically routes each incoming call to the most highly qualified inside sales agent or customer service representative available. Using our highly integrated telephony, customer relationship management, and customized order management systems, the appropriate sales professional answers product questions, proactively educates the potential customer about the benefits of our product line, promotes financing through our third-party private label credit card, typically up sells the benefits of higher priced models in our product line, and closes the transaction process by capturing the customer’s order information. These sophisticated systems allow us to most effectively utilize our customer service staff, prioritize call types, and improve customer service.

We contract with large telemarketing companies to receive and process information requests generated by our spot television advertising 24 hours per day. The telemarketing agents for these companies collect names, addresses and other basic information from callers but do not directly sell our products. During our own call center’s hours of operations, the outside telemarketing agents may transfer callers that show immediate buying interest for our products to one of our specially trained sales professionals.

Internet. We use spot commercials and infomercials, together with Internet advertising and search-engine placement, to lead consumers to our websites, as we believe consumers who visit our websites are more inclined to purchase our products. We believe we successfully balance our goals of finalizing sales and capturing consumer information by strategically designing our web pages and carefully analyzing web page visits, conversion rates, average sales prices and inquiry counts. Our eCommerce sales are an important component of our direct sales channel representing approximately 26% of total direct channel sales for 2003, 24% of sales in 2002, and 22% of sales in 2001.

Consumer Finance Programs. We believe that convenient consumer financing is an important tool in our direct marketing sales efforts and that the availability of financing induces many of our customers to make inquiries and purchases when they otherwise would not. For several years we have offered “zero-down” financing to approved customers on all direct-to-consumer sales, and in the latter portion of 2003, we tested a

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highly competitive low, fixed payment financing promotion in support of the sale of our Bowflex product line. We arrange financing for our customers through two separate consumer finance companies, pursuant to non-recourse consumer financing agreements. Under these arrangements, based on a brief application process that simply involves a few minutes over the telephone with one of our customer service professionals or during a visit to one of our websites, we can obtain financing decisions for our customers in what literally amounts to a matter of seconds. Once a customer is approved, the ordered product can be immediately submitted for fulfillment, without any need for cumbersome follow-on paperwork. The consumer finance companies pay us promptly following delivery of product and concurrently send to each approved customer a Nautilus Group private label credit card that may be used for future purchases of our products. Approximately 43% of our direct to consumer sales were financed in this manner during 2003, with financed orders representing approximately 37% of sales in 2002 and 41% of sales in 2001. We believe these financing programs will continue to be an important and effective marketing tool for customers purchasing products directly through our call center and product websites.

Seasonality

The effectiveness of our direct marketing is influenced by seasonal factors. We have found that second quarter influences on television viewership, such as the broadcast of national network season finales and seasonal weather factors, cause our spot television commercials on national cable television to be less effective in the second quarter than in other periods of the year.

COMMERCIAL/RETAIL BUSINESS SEGMENT

Commercial/Retail Sales and Marketing

We market and sell our Nautilus, Schwinn, and StairMaster commercial fitness equipment through our sales force and selected dealers to health clubs, government agencies, hotels, corporate fitness centers, colleges, universities and assisted living facilities. Our commercial sales force is focused on strengthening the market position of our existing Nautilus, Schwinn, and StairMaster commercial product lines. Internationally, we market and sell our Nautilus, Schwinn, and StairMaster commercial fitness products through our foreign subsidiaries and a worldwide network of independent distributors.

We also market a complete line of retail consumer fitness equipment, under the Nautilus, Bowflex, Schwinn, StairMaster, and Trimline brands, through an independent network of more than 1,200 dealers, sporting goods retailers, wholesale clubs and specialty stores worldwide. During 2003, we successfully introduced selected Bowflex products to our retail sales channel. Sales of Bowflex products through the retail channel in 2003 represented approximately 20% of total sales for the commercial/retail business segment. In addition to products already offered through our retail sales channel, we intend to continue bringing products previously sold exclusively through our direct sales channel to retail. By leveraging the advertising dollars spent on direct marketing, we believe we can effectively sell our direct-marketed products through our retail sales channel to consumers that would not purchase our products through one of our direct purchase options.

Commercial Approach

We position ourselves as “The Health & Fitness Consultants” to encourage our commercial market customers and potential customers to think of us first when considering their fitness equipment and programming needs. Our strategy is to address the needs of the three key constituencies of today’s health clubs:

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Fitness Academy. The Fitness Academy was established in 1997 to provide programming and educational information to both consumers and fitness professionals. To date, the Fitness Academy has provided training and certification to hundreds of fitness professionals in the Schwinn Cycling Program and has recently added a range of strength training programs based on Nautilus training principles to its repertoire. Many of these programs are targeted to special groups such as seniors, women and youth that are particularly important to the fitness industry today.

Fitness Academy programs are designed to aid clubs in increasing profits by encouraging cost efficient group exercise classes; benefit staff members by helping them increase their range of fitness education skills; and motivate members to stick with their exercise programs to truly experience fitness results.

Advertising. We advertise in select trade publications, including publications that reach key industry stakeholders. Specific placement is driven by marketing and product development events and ads are coded to assist us in measuring the effectiveness of each individual ad with respect to our objectives of increasing brand awareness and increasing sales leads.

Direct Mail Promotions. We maintain a database that includes contacts at thousands of commercial facilities and enables us to monitor responses to direct mail promotions. All direct mail promotions are supplemented by a telemarketing effort to maximize customer response.

Public Relations. In the commercial market, public relations are a critical component in our strategy to build awareness and credibility for the Company and our products in the marketplace. Positioning the Company as the leading comprehensive provider of fitness equipment and education requires us to change the general perception that our brands stand alone to the understanding that our brands work together to deliver the most complete fitness system available. In order to meet these objectives, we have established relationships with key media outlets to develop and communicate our competitive advantages.

Trade Shows. There are several national and regional industry trade shows, such as the IHRSA and Club Industry, as well as many events that showcase our programs and products. Trade shows also provide excellent opportunities to meet face-to-face with our customers and the press to obtain valuable feedback by being able to test marketing messages, receive customer input on product designs, and evaluate the competition.

Internet. We currently maintain and direct customers to our Nautilus, Schwinn Fitness and StairMaster websites, which can be found at www.nautilus.com, www.schwinnfitness.com, and www.stairmaster.com, respectively. These websites contain Company and product information. None of the information on these websites is part of this Form 10-K.

Retail Approach

The main focus for marketing our retail products is two-fold: 1) fully support our network of dealers, and 2) leverage our direct marketing advertising dollars to market products through the retail sales channel that were previously only available to consumers through the direct sales channel. Company sponsored marketing programs have been developed to ensure that our Nautilus, Schwinn, Bowflex, StairMaster and Trimline brands remain prominent in the minds of dealer staff and consumers and drive consumers to their local retailers.

Health and Fitness e-newsletter. Created to motivate and educate our customers, the newsletter is now a consumer campaign, allowing the Company to reach thousands of health conscious readers every month. By delivering the newsletter to the email inboxes of thousands of consumers and making the newsletter available on our website, we are developing long-term customer relationships and a community of fitness enthusiasts. In addition, dealers may label and distribute the newsletter through their stores.

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Public Relations. In the retail market, public relations is a cost-effective way to promote our products in consumer publications. While advertising in fitness industry publications is expensive, editorial and showcase articles that include our products are virtually free. Our public relations strategy in the retail sector is to build awareness of the general benefits of fitness and specific contributions of our products to a healthy and fit lifestyle.

Trade Shows. There are three national trade shows that are very important to the Company’s retail division: the Health & Fitness Business Expo, the industry’s premier showcase for retail fitness products; Interbike, the bicycle industry’s premier gathering; and Supershow, the mega-trade show representing retail products in virtually every category. Trade shows also provide excellent opportunities to meet face-to-face with our customers and the press to obtain valuable feedback on marketing messages, product designs, and the competition.

Internet. The Company currently maintains and directs customers to our Nautilus, Schwinn Fitness, Bowflex, StairMaster, and Trimline websites, which can be found at www.nautilus.com, www.schwinnfitness.com, www.bowflex.com, www.stairmaster.com, and www.hebbindustries.com. These websites contain Company and product information. None of the information on these websites is part of this Form 10-K.

International Approach

Our international operations are headquartered in Switzerland. Currently, the amount of long-lived assets outside the U.S. is not material. We have integrated all of our brands from an operational standpoint and are distributing our products through a network of over 90 distributors in over 50 countries divided among three regions:

In each of these regions, we have responsible sales people and third party warehouses (except Central/South America which we support from our United States distribution facilities) to deliver our products in a timely and cost effective manner. Communication amongst our business partners within each region is essential to our strategy so we may support our products, develop innovative marketing activities, and achieve global brand recognition.

In two of our largest international markets, the United Kingdom and Germany, we operate our own offices, which possess a team of sales representatives that focus not only on selling to fitness clubs but also on selling to the government, hotel, and medical/paramedical markets. We added a sales office in Italy in 2002, as Italy represents another market we perceive to be important. Canada is another significant market for our business, but we do not maintain operations in Canada as product distribution is conveniently supported from our U.S. operations. We sell products from our commercial/retail and direct segment product portfolios to dealers and retail stores within Canada.

We have alliances with distributors in most markets to sell commercial products from our Nautilus, Schwinn, and StairMaster brands. This enables us to sell “package deals” to international fitness clubs, which may prefer to buy from one supplier that can offer the broadest array of products at a competitive price. By

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building our portfolio of brand names, we have greater ability to compete in the international marketplace in which our main competitors have benefited for many years from the ability to negotiate “package deals.” We believe our brand names have strong recognition in the international marketplace, which will allow us to compete more effectively in the future.

Sales outside the U.S. represented approximately 13%, 10%, and 8% of consolidated net sales for 2003, 2002 and 2001, respectively.

Seasonality

In general, sales of our retail fitness equipment are highly seasonal. We believe that sales within our commercial/retail segment are considerably lower in the second quarter of the year compared to the other quarters. Our strongest quarter for the commercial/retail segment is generally the fourth quarter, followed by the first and third quarters. We believe the principal reason for this trend is the commercial/retail fitness industry’s preparation for the impact of New Year’s fitness resolutions and seasonal weather patterns related to colder winter months.

CONSUMER TRENDS

We believe our organic growth has benefited from a number of demographic and market trends that we expect will continue, including:

We believe these consumer trends bode well for our future growth prospects. Just as the “baby boomers,” those Americans born between 1946 and 1964, started the modern fitness movement, we believe they will continue to be a driving force as they age. According to the Sporting Goods Manufacturers Association (the “SGMA”), the population of Americans fitting this demographic profile is estimated to be around 77 million. We believe baby boomers will use more of their increasing leisure time for exercise and more of their disposable income for fitness equipment purchases as they strive to counter the effects of aging.

Trends in Exercise Equipment

Since 1990, the fitness equipment industry has more than doubled in size and has been the most successful category of sporting goods. Interest in exercising with fitness equipment is supported by the increase in health club memberships in the U.S., which according to the SGMA, have increased 75% from 20.7 million in 1990 to 36.3 million in 2002. Consumer interest in health clubs has benefited the market for home fitness equipment as well as the commercial fitness equipment business. Consumers who utilize health clubs are exposed to an array of fitness equipment products and brand names, as well as education about the uses and benefits of fitness equipment.

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The U.S. fitness equipment market consists of two distinct market segments: home and institutional. The institutional, or commercial, fitness market is more visible to consumers, but the home market is much larger and has experienced much of the meaningful growth in the overall market. Based on statistics provided by the SGMA, 2003 sales of home equipment by manufacturers in wholesale dollars totaled approximately $3.2 billion, representing more than 80% of the overall fitness equipment market. We believe these wholesale dollars translate to approximately $6.4 billion in retail sales of home fitness equipment in 2003, representing a compound annual growth rate of approximately 10% since 1990. In contrast, the SGMA reports that sales of commercial fitness equipment totaled approximately $0.7 billion in 2003, which is flat compared to 2002. We estimate our target market to be approximately $5.0 billion as our products are sold at both wholesale and retail prices.

According to the SGMA, the fitness equipment market increased an estimated 2.8% in 2003 after less than 2.0% growth during the previous two years. Market conditions improved during the second half of 2003 consistent with the broader U.S. economic recovery. According to the SGMA, the outlook for 2004 is even better, with projected growth of 3.9% in fitness equipment sales. The SGMA cites anticipated continued economic recovery, continued expansion of the new housing market where consumers have trended to building larger homes, and a renewal of health club expansion plans in light of the recent economic recovery as reasons for the growth expectation.

The SGMA identifies strength training equipment as an expanding segment of the fitness equipment market. Cardiovascular fitness equipment has historically been and continues to be the most popular with consumers. Treadmills have been best sellers among the cardiovascular fitness equipment category representing approximately one-third of overall fitness equipment sales in 2002. The outlook for strength training equipment is positive as its use is becoming widely recognized not just for its impact on appearance, but also for the health benefits it can provide. According to a survey by American Sports Data, Inc., the number of Americans who frequently used strength equipment in their workout routines increased approximately 65% from 1990 to 2002 compared to 35% growth in the use of cardiovascular equipment.

The international markets represent a strong opportunity for growth, driven by the continued fitness boom across Europe and the increasing focus on fitness and healthy lifestyles by more affluent consumers in Asia and Latin America. In fact, according to recent data published by the International Health, Racquet and Sportsclub Association (the “IHRSA”), there are approximately 29,000 health clubs in Europe, 7,800 in Latin America and 4,800 in the Asia/Australia market. For comparison, there are approximately 22,000 clubs currently operated in the U.S. According to the IHRSA, health club memberships in the United Kingdom totaled 4.4 million in 2002 compared with 1.5 million in 1996, an increase of 194%. Health club memberships in Germany totaled 5.4 million in 2002 compared with 3.3 million in 1995, an increase of 64%. We believe demand for U.S. products will increase, as foreign consumers increasingly demand the reliability, service and innovative designs provided by U.S. suppliers.

Trends in Rest Products

The United States mattress market is large and dominated by several major manufacturers whose primary focus is the conventional innerspring mattress. According to the International Sleep Products Association (the “ISPA”), United States mattress and foundation sales totaled 38.9 million units shipped in 2002, representing a 0.7% increase from 2001. Total dollar value of these wholesale shipments increased 3.8% to $4.8 billion in 2002 compared to 2001. We believe these wholesale dollars equate to over $8.0 billion in retail sales. The ISPA attributes this growth in 2002 to the significant expansion in the housing market, where new housing starts increased by approximately 5% in 2002. We believe the market for specialty sleep systems to be approximately $1.0 billion.

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Trends in Nutrition Products

The market for nutritional supplements is large and yet is highly fragmented with many manufacturers. According to the Nutrition Business Journal (the “NBJ”), United States nutritional supplement sales totaled $18.0 billion in 2002, representing a 4.0% increase compared to 2001. Within the nutritional supplements industry category, sports nutrition supplements and meal replacement products are the market segments in which we compete. According to the NBJ, wholesale sales of sports nutrition supplements and meal replacement products totaled $4.4 billion in 2002, representing increases of 6.0% and 12.0% compared to 2001, respectively. We estimate our target market to be approximately $5.4 billion as our products are sold at both wholesale and retail prices. Sports nutritionals have gained wide acceptance as an essential component of a committed athletic lifestyle, but increasing numbers of consumers who aren’t necessarily health club devotees are also turning to sports nutritionals, often in lieu of traditional beverages and snacks. Marketers across the board have responded by downplaying their long-standing hard-core sports image and highlighting the broader nutritional, energy-boosting, and wellness benefits of their products.

COMPETITION

Direct Business Segment

Home Fitness Equipment. The market for our Bowflex strength and TreadClimber cardiovascular fitness products is highly competitive. Our competitors frequently introduce new and/or improved products, often accompanied by major advertising and promotional programs. We believe the principal competitive factors affecting this portion of our business are price, financing options, warranties, quality, brand name recognition, product innovation and customer service. Our Bowflex and TreadClimber products compete directly with a large number of companies that manufacture, market and distribute home fitness equipment. Our principal direct competitors include ICON Health and Fitness (marketing products under the brand names Powerflex, Crossbow, Health Rider, NordicTrak, Image, ProForm, Weslo, and under license, Weider and Gold’s Gym) and Fitness Quest (through its Gazelle, Total Gym, and SlamMan brands). We believe our Bowflex and TreadClimber lines of home exercise equipment are competitive within the market for home fitness equipment based on innovative product design, quality, and performance. Additionally, we believe our direct marketing activities are effective in distinguishing our products from the competition.

Nautilus Sleep Systems. The sleep products industry is also highly competitive, as evidenced by the wide range of products available to consumers, such as innerspring mattresses, waterbeds, futons and other air-supported mattresses. We believe market participants compete primarily on the basis of price, product quality and durability, brand name recognition, innovative features, warranties and return policies. We believe our most significant competition is the conventional mattress industry, which is dominated by four large, well recognized manufacturers: Sealy (which also owns the Stearns & Foster brand name), Serta, Simmons and Spring Air. Although we believe our Nautilus Sleep Systems offer consumers an appealing alternative to conventional mattresses, many of these conventional manufacturers, including Sealy, Serta, Simmons and Spring Air, possess greater financial, marketing and manufacturing resources and have better brand name recognition.

In addition to the conventional mattress manufacturers, several manufacturers currently offer beds with variable support air chamber technology similar to our Nautilus Sleep Systems. We believe the largest manufacturer in this niche market is Select Comfort. Select Comfort offers its sleep systems through retail stores and engages in a significant amount of direct marketing, including infomercials, targeted mailings and print, radio and television advertising. Select Comfort has an established brand name supported by marketing

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and manufacturing resources and has significantly greater experience in marketing and distributing sleep systems. We believe the market for sleep systems is large enough for both companies to be successful and that our Nautilus Sleep Systems possess features that will enable us to compete effectively. However, the intense competition in the mattress industry, both from conventional mattress manufacturers and Select Comfort, has adversely affected our efforts to market and sell our sleep systems. Consequently, we decreased direct advertising for our sleep systems during 2003 in order to reassess our marketing message. A new marketing campaign for our Nautilus Sleep Systems is expected to be launched in 2004.

Commercial/Retail Segment Products

Commercial Fitness Equipment. The market for commercial fitness equipment is highly competitive. Our Nautilus, Schwinn, and StairMaster products compete against the products of numerous other commercial fitness equipment companies, including Life Fitness (a division of Brunswick), Cybex, Star Trac, Precor (owned by Amer Group, PLC), and Techno Gym. We believe the key competitive factors in this industry include price, quality, durability, diversity of features, financing options, product service network, and warranties. Some of our competitors have greater financial resources, more experience in the fitness industry, and more extensive experience manufacturing their products.

Retail Fitness Equipment. Strong competition exists with respect to the retail fitness equipment market. Our Nautilus, Schwinn, Bowflex, StairMaster, and Trimline retail products compete against the products of numerous domestic retail fitness equipment companies including ICON Health & Fitness (marketing products under the brand names Weslo, Crossbow, Health Rider, NordicTrak, ProForm, Image and, under license, Reebok, Weider and Gold’s Gym), Life Fitness, Star Trac, True Fitness Technology, HOIST Fitness Systems, Horizon Fitness (a division of Johnson Health Tech), Cybex, Fitness Quest, and Precor. The principal competitive factors in the retail fitness equipment industry include price, quality, brand name recognition, customer service and the ability to create and develop new, innovative products. There are limited technological, manufacturing or marketing barriers to entry into the fitness equipment markets in which we compete. Like many companies in the industry, we have sought and received patent and trademark protection on our products in an effort to protect our competitive position.

We believe that our combination of recognized brand names, high quality products, multiple distribution channels, and dependable customer service allows us to remain competitive in our current markets.

STRATEGY

Our mission is to be a complete provider of products to the health and fitness industry and help people achieve a fit and healthy lifestyle through proper exercise, rest and nutrition. At the core of this mission is an internal initiative called FIT #1, which is the foundation of our plan to create long-term shareholder value.

FIT #1 stands for Financial rigor, Innovation, Trust and a drive to be #1 in the categories in which we compete. These are the core strategic elements around which we plan to structure our activities, enabling us to refocus our efforts and begin to grow again. Financial rigor means we must ensure accurate and streamlined financial and forecasting processes. Innovation means we must apply creative solutions to both research and development and business operations. Trust means we must ensure we are taking care of our customers and stockholders and doing everything we can to serve them.

In 2003, we conducted a thorough due diligence process, in which we interviewed our internal team, spoke with industry consultants, and conducted the most comprehensive market research study in our history in order to help identify and realize our growth opportunities. We have targeted several areas as significant opportunities for growth, including leveraging our research and development capabilities to launch new products and repositioning our strength, cardiovascular, and sleep products to better meet customer demand and shopping patterns. We also seek to improve operating efficiencies and cash flow by streamlining operations and maximizing business synergies, such as brand equity, sales channels and marketing resources.

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Market Research

Our market research indicated that while we possess distinct competitive advantages, we have not fully capitalized on the many opportunities available to us in the $11.4 billion exercise, rest and nutrition markets that we compete in. During 2003, we performed in-depth analysis of our business model and believe that we have significant opportunities to optimize our sales channel mix for our brands. We are a leader in selling strength products through the direct marketing channel, but our research showed that approximately 80% of our target consumer market buys fitness products through the retail channel and 60% of the dollars are spent on cardiovascular products.

Focus on Innovation

We plan to leverage our advanced research and development capabilities and our strong brand names to expand our existing product lines and launch new innovative products. Innovation is an important part of our strategy as we continue to emphasize the expansion and diversification of our product development capabilities in health and fitness products. We develop new products either from internally generated ideas or by acquiring or licensing patented technology from outside inventors and then enhancing the technology.

Our research and development competencies have been enhanced through the acquisition of Schwinn Fitness and StairMaster. With the purchase of these companies, we gained a state-of-the-art test facility and prototype shop, along with added designers and engineers. Our additional research and development resources have allowed us to become fully integrated in the product development process, allowing us to take a new product concept from the beginning of feasibility studies straight through to production and continuing product review. This integration allows us a greater degree of control over the new product process, which should allow us to generate a higher quality product, increase our speed to market, and control our costs.

Research and development expense was $5.7 million, $4.5 million, and $2.2 million for 2003, 2002, and 2001, respectively.

Leverage Sales Channels

We are repositioning our products to better meet customer demand and shopping patterns. This means offering more of the products consumers want (e.g. cardiovascular fitness equipment) in the places consumers want to buy our products (e.g. retail outlets). We are moving more of our products to the retail channel and are differentiating our products to specifically fit the needs of the consumer shopping in each sales channel. For example, we will sell different models of Bowflex in specialty retail as compared to the direct sales channel. This strategy will allow us and our partners to have differentiated products under the same brand, enabling each channel to provide the products its consumers demand. In addition, we plan to reposition our Nautilus Sleep Systems line of premium air support sleep mattresses with an enhanced product and more effective marketing through our direct business segment.

Streamline Company Operations

Another foundational element of our strategy is our effort to reorganize from a channel focus to a customer focus. We intend to manage and operate as one company and not several separate channel-based businesses. Included in this focus change is a drive to leverage our expertise, experience and diversity of thought from across our organization to realize synergies, efficiencies and cost savings. In 2004 we will seek to adopt best practices across our locations and experience the benefits of one research and development team, one sales

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methodology, and common warehousing and distribution facilities for all our products in the most effective locations. We are establishing a performance-driven culture based on teamwork that clearly ties employee compensation to both company and individual performance. We are seeking to develop a high-energy collaborative culture with a clear focus on the metrics that drive performance and create shareholder value. Into 2005 we will seek common technology platforms, including our websites to further capitalize on the power of one team, one Company.

EMPLOYEES

As of December 31, 2003, we employed 1,126 employees, including 4 executive officers. None of our employees are subject to any collective bargaining agreements.

INTELLECTUAL PROPERTY

We own many trademarks including Nautilus^®, Bowflex^®, Power Rod^®, TreadClimber^®, Schwinn^® (fitness products), StairMaster^® and Trimline^®. Our trademarks, many of which are registered or subject to pending applications in the United States and other countries, are used on a variety of our products. We believe that our trademarks are of great value, assuring the consumer that the product being purchased is of high quality and provides a good value.

We also place significant value on product designs (the overall appearance and image of our products) and processes which, as much as trademarks, distinguish our products in the marketplace. We hold many United States and foreign patents and have submitted additional applications for patent protection that are pending approval. We believe all patents are important to our strategy and have identified the patents on the Bowflex Power Rod resistance technology and TreadClimber as the most significant to our business. Although our Bowflex trademark is protected as long as we continuously use the trademark, the main U.S. patent on our Bowflex Power Rod resistance technology expires on April 27, 2004. The main U.S. patent on our TreadClimber line of cardiovascular equipment expires on December 13, 2013. The expiration of our patents could trigger the introduction of similar products by competitors.

Building our intellectual property portfolio is an important factor in maintaining our competitive position in the fitness and mattress industries. If we do not or are unable to adequately protect our intellectual property, our sales and profitability could be adversely affected. We are very protective of these proprietary rights and take action to prevent counterfeit reproductions or other infringing products. Refer to Item 3, Legal Proceedings, and Note 15 of the Notes to Consolidated Financial Statements for a discussion of significant intellectual property disputes. As we expand our market share, geographic scope and product categories, intellectual property disputes are anticipated to increase making it more expensive and challenging to establish and protect our proprietary rights and to defend against claims of infringement by others.

Each federally registered trademark is renewable indefinitely if the trademark is still in use at the time of renewal. We are not aware of any material claims of infringement or other challenges to our right to use our trademarks.

MANUFACTURING AND DISTRIBUTION

Our primary manufacturing and distribution objectives for all of our products are to maintain product quality, reduce and control costs, maximize production flexibility and improve delivery speed. Our product components are manufactured primarily in the U.S. and Asia. We have not experienced any significant issues with availability of raw materials or quality control either domestically or abroad, and do not anticipate any in the foreseeable future.

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For our direct-marketed and retail products, we mainly use Asian suppliers to manufacture the components and finished goods. Whenever possible, we attempt to use at least two suppliers to manufacture each product component in order to improve flexibility, efficiency, and emphasis on product quality. We do have domestic operations in Texas that manufactures our various lines of consumer treadmills and the TreadClimber product line.

Our commercial strength fitness products are manufactured in Virginia and our commercial cardiovascular fitness products are manufactured in Oklahoma. These operations are vertically integrated and include such functions as metal fabrication, powder coating, upholstery and vacuum-formed plastics processes. By managing our own manufacturing operations, we can control the quality of our commercial products, and offer customers greater color specification flexibility, build-to-order capability, and unique product configurations.

Domestically, we inspect, package, and ship our products from our facilities in Washington, Virginia, Illinois, Texas, and Oklahoma. We rely primarily on United Parcel Service (UPS) to deliver our Bowflex, TreadClimber, and Nautilus Sleep Systems products. We distribute our retail and commercial fitness equipment from our facilities in Illinois, Oklahoma, and Texas using various commercial truck lines. We distribute commercial strength fitness equipment from our Virginia warehouse facilities directly to customers primarily through our truck fleet. This method of distribution allows us to effectively control the set up and inspection of equipment at the end-user’s facilities.

For international sales, we have distributors in over 50 countries, and we ship our products from leased facilities in Switzerland, the United Kingdom and Germany. We also lease, on a month-to-month basis, flexible warehouse space in multiple countries in Asia and Europe, the largest of which is located in the Netherlands. This flexible warehouse space is devoted to international distribution of our products.

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Item 2. Properties

The following is a summary of principal properties owned or leased by the Company: