BowFlex Inc (BFX) 2005 Q4 法說會逐字稿

Welcome to the Nautilus incorporated fourth quarter 2005 earnings conference call. [OPERATOR INSTRUCTIONS] As a reminder this conference is being recorded on Friday, February 3, 2006. Before the call begins, listeners should be advised of the Safe Harbor statement that applies to today's call. Prepared remarks during this call contain forward-looking statements. Additional forward-looking statements may be made in response to questions. These statements including information about first quarter and long-term estimates, along with new products and channels, do not guarantee future performance. Nautilus undertakes no obligation to update publicly any forward-looking statement to reflect new information, events, or circumstances after the date they were made or to reflect the occurrence of unanticipated events. Therefore, undue reliance should not be placed upon them.

Listeners should review the earnings release to which this conference call relates and the company's most recent periodic reports on Form 10-K and 10-Q filed with the Securities and Exchange Commission for more detailed discussions of the factors that could cause actual results to differ materially from those projected in forward-looking statements. And now, it's my pleasure to turn the conference call over to Mr. Gregg Hammann, Chairman and Chief Executive Officer of Nautilus, Incorporated. Please go ahead, sir.

Good afternoon. Thanks for joining us. With me today are Bill Meadowcroft, our Chief Financial Officer; and Tim Hawkins, our Chief Customer and Chief Marketing Officer. Today I will explain what caused our disappointing fourth quarter, how we're addressing it, and what investors can expect in the first quarter and beyond. Bill will give a brief overview on the fourth quarter financials and Tim will provide an update on sales by channel. So let's get right to the fourth quarter.

The short answer is I'm very disappointed in the fourth quarter performance. Two important areas affected our results. The primary one involves slower than expected ramp-up on manufacturing of new products at two of our domestic facilities. The other dealt with our ERP conversion and in change to a new system. So first, we were slow to ramp up manufacturing volumes on new product innovations. We moved into the fourth quarter with six complex new cardio products in the product ramp-up stage in two of our domestic manufacturing facilities. We experienced some issues with those products including problems with component parts from our sub suppliers. As a result, these products did not reach production in time for us to realize our sales forecast. But we still incurred all the expenses of launching these products.

Not only did we lose orders on these products, but we also lost sales on existing products that were to be bundled with our new products. Some customers and consumers were forced to work with our competitors. Virtually all of these issues are relatively easy to address, and as of today, four of these products are now in full market launch, and we are completing refinements on the additional two. We have addressed the issues with our sub suppliers to assure they deliver what we expect of them.

The situation was compounded with the launch of our new enterprise resource planning system. We need the system consolidate about five systems we have been using to run the business. And to help us improve data interchange with our large customers. So we took another step in this conversion in the fourth quarter for our commercial, specialty retail businesses. The system did help improve data interchange with retail customers. But for those of you on the call who have been through one of these system conversions I know you understand that the maiden voyage can sometimes be a bumpy one. And we certainly experienced that. The result of these situations caused us to miss our top line by about 15% in the quarter, trimming our growth in the quarter to about 7%. With these changes in place, we are working with affected customers to regain their trust, deliver these products, and capture the remaining volume in this selling season.

So let me outline specific things we're doing as a result. We're requiring on-site sub supplier inspection for each new product innovation. We estimate this could have trimmed about two-thirds of the extra time it took to bring these product to market. Second, we have added a step in our go to market plan to allow time for manufacturing ramp-up. This includes a capacity assessment to assure that we have the resources in place to handle incorporating new innovations. Third, we'll slow down our cadence of innovation by prioritizing about 15 new products in 2006 and by executing well, this will allow us to improve our margins while continuing our innovation leadership in the category. Fourth, we continued to adjust and improve the reporting capability of our new Oracle system but will delay conversion of our international and apparel businesses until 2007 after we have fully optimized the current system. Fifth, we've strengthened our manufacturing and operations team.

In Tulsa, Oklahoma, where we make our commercial cardio products, we have a new leader in Mark Muser. Mark came to us in mid-October from Ford Visteon and has since put in motion plans to assess our domestic manufacturing capacity, improve our systems and processes, and help us retire a number of old product SKUs. He's assisted by three new engineers with a combined 60 years of quality and manufacturing expertise. Mark also is overseeing an improvement program in our Tyler, Texas manufacturing facility where we make our Nautilus Sport Series treadmills and our Bowflex Treadclimber products.

Significant changes have also been made in our operations. We've appointed Dustin Groves to oversee our operations. He has nearly a decade of experience with our company and has returned after a couple of years as a consultant. Quickly after Dustin returned he alleviated the distribution center bottleneck we experienced in the third quarter and has an initiative underway to improve our distribution and parts management. In addition, we are shifting more of the product handling and packaging upstream from our domestic distribution centers to our Asian suppliers, yielding substantial savings in transportation, inventory, and logistics costs. Finally, we're going to slow down on acquisitions until the operational issues are behind us.

So our results in the fourth quarter, while disappointing and unacceptable, are a result of growing pains. We are very confident in our innovation center business plan and believe there is a substantial and growing appetite for high quality branded fitness products in education. We need to continue making improvements to execute on that business opportunity. After the market closed we posted our fourth quarter 2005 financial statements. So I'll now ask Bill Meadowcroft to cover our financials. Bill?

Thanks, Gregg. Net sales for the fourth quarter were 181.3 million, an increase of 6.9% over the year-ago quarter, but about 29 million short of our expectations. Gross profit margins were 39.8% compared to 47.2% for the year-ago quarter. The difference is attributable to mix, costs to introduce new products, and to inventory, warranty, and factory-related costs and adjustments. Operating income in the fourth quarter was 4.6 million, or 2.6%, compared to 20.6 million or 12.2% of sales for the year-ago quarter. Diluted earnings per share for the quarter were $0.08 compared to $0.42 a year ago. For full year 2005 we delivered net sales of 630.6 million, a 20.4% increase and the largest in our company's history, and earnings per share of $0.70.

Turning to our balance sheet, 2005 was a year of driving growth while investing in the future to position our company for long-term growth. We invested heavily in R&D. We made two important acquisitions in 2005. We launched our new ERP platform. We made substantial investments in the Nautilus brand and in the Nautilus institute, and we bought back stock. As a result of these investments, borrowings net of cash were $32 million, this is funded by a $65 million multiyear revolving credit facility established in the fourth quarter. Our trade receivables increased about $21 million reflecting our ongoing growth in channels with longer payment terms. Inventories were up to $96 million, up from 84 million in the previous quarter. During the quarter we bought back 638,000 shares of Nautilus stock. For 2005 we bought back a total of 831,000 shares at an average price of 18.82, for an investment of $15.6 million. This leaves about 84% of our three-year $100 million buyback authorization available.

On the litigation front, with ICON Health and Fitness, we are awaiting the judge's ruling on our motion to set aside or reduce damages on a jury trial verdict in Federal Court in Utah. Depending upon that ruling, we may appeal, and thus have not accrued funds in the quarter. We also have an October 10, court date in federal court in Seattle to prosecute a trademark infringement claim. In addition a patent infringement case we are prosecuting remains under review by the Federal Circuit Court of Appeals. Finally, our Board of Directors has approved a regular quarterly dividend of $0.10 per common share payable March 10, 2006 to shareholders of record as of February 20, 2006. For a more complete overview of our business by each of our five sales channels and an update on our apparel division, I'd like to introduce Tim Hawkins, our Chief Customer Officer and Chief Marketing Officer.

Thanks, Bill. Here's a brief rundown of our net sales by channel. Let's begin with retail which includes sporting goods, warehouse clubs, and department stores. Fourth quarter net sales were $46 million up 46% from the year-ago quarter. Our retail partners report sell-throughs to be good and store inventory levels on plan as we enter the new year. We achieved 55% growth in retail in 2005 and expect growth of 30 to 40% in 2006.

Our next channel is specialty retail where people buy club-quality equipment for their homes. Fourth quarter sales were $23 million, up 14% from the year-ago quarter. While our performance here was good this improvement was below our plan due to the new product delays that Gregg just discussed, primarily Sports Series treadmills, and Pro Series Ellipticals. We expected 11% growth -- excuse me, we experienced 11% growth in specialty retail in 2005 and expect 10 to 20% growth in 2006.

Let's move on to the commercial channel such as clubs, hotels, living complexes. Our fourth quarter net sales were $18.2 million, up 5% from the year-ago quarter. We're very pleased with the results from our long-term durability tests and field tests on the new Nautilus Commercial Series Treadclimber. We expect to reintroduce this product in the March-April time frame. For commercial we achieved 6% growth in 2005 and expect 15 to 20% growth in 2006.

Next is our direct channel which involves Internet, catalog, and direct response advertising. Our fourth quarter net sales were $71.2 million, down 17% over the year-ago quarter. We had an unusually large comp from a year ago but our performance was lower than we expected due to delays in ramping up volumes of the Treadclimber 5300 model. We also experienced a more competitive environment for advertising this year compared to an inexpensive post-election ad inventories just a year ago. We achieved 10% growth in direct in 2005 and expect single-digit growth in 2006. Our international channel which includes commercial, along with retail and direct sales outside of the Americas, for the fourth quarter we had net sales of $14 million, down 4% from the same quarter last year. Our sales were slowed here too due to the product manufacturing ramp-up delays. For 2005 we finished with an 8% growth in international and expect 20% growth in 2006. Finally, the Nautilus apparel division delivered $8.9 million in net sales for the fourth quarter which was slightly below our plan due to timing of a shipment to an international distributor. We expect about 20% growth through our apparel division in 2006.

We're very excited about the ongoing interest and demand for our brands and innovation. For 2005 our overall business grew 20%. Retail grew 55%. Our two newest products in direct, the brand-new Bowflex Revolution and the Bowflex Treadclimber 5300 became the number one and number two most inquired about products in our direct business driving our average selling prices higher. Our new products have been reviewed and praised in leading consumer rating guides, on-line guides and in some recent publications. Our SelectTech dumbbells have become one of the fastest growing unit sellers at sporting goods. With all that said we have terrific demand for our products but we have got to be able to make it and ship it. I'll turn the call back over to Gregg.

Thanks Tim. All right, moving on to 2006, our growth and performance will be driven by, leveraging our pipeline of innovative products, expanding our assortments with existing partners, reaping the benefits of our substantial capital investments in 2005, and a corporate-wide focus on quality, customer service, and cost take-out. These drivers will help us achieve growth in every business channel again in 2006, including direct, which continues to be healthy and profitable. Furthermore, we will hold firm to the FIT one operating principles that have guided our company for the last two-and-a-half years. Financial rigor, innovation, trust, and a commitment to be the leader in every category where we compete.

Now, let me walk you through our guidance and approach for 2006. We faced some significant challenges in the fourth quarter 2005. Before that time, we delivered nine quarters in a row of meeting or exceeding our guidance. As we look although 2006, in the spirit of underpromising and overdelivering we're going to take a conservative approach and provide guidance one quarter at a time. As our business improves we will consider whether we will revise this approach. Having said all that, we remain committed to our long-term business strategy and growth plans. So as we look to the first quarter 2006, we expect net sales around 180 to 185 million, and earnings of $0.14 to $0.18, including about $0.02 per share for the quarter due to the FAS 123R new requirement of expensing of stock options.

So in closing, we went through some growing pains in the fourth quarter 2005, but we did make progress including a record 2005 net sales and four previous quarters of earnings growth. We must get our operations and manufacturing to catch up with our sales demand. We're very excited about what's ahead in 2006, and we are fully committed to delivering upon our plans. With that, I believe we are ready for questions.

[OPERATOR INSTRUCTIONS] Our first question comes from the line of Rick Nelson. Please go ahead.

Thanks. Good afternoon.

Hey, Rick.

Can you let us know if the the rod products, how they're performing on a year-over-year basis and if they're meeting plan?

Yes, they're actually doing extremely well. That's the -- our Extreme 2, our Ultimate 2 did very well for us in the fourth quarter. So actually still on a growth curve.

And the two product refinements, is that the Nautilus Treadclimber one of them?

Yes, the new 5300 has a four foot treadle, and we had to make a few refinements on that, mainly on the plastics components from sub suppliers.

And what is the other product? The Nautilus branded Treadclimber, is that right?

Yes, in the commercial segment.

And where are you in terms of a new head of manufacturing?

Actually, we have a new head of manufacturing, which is Mark Muser, that I mentioned earlier on the call. He's going to run manufacturing for our company and Dustin Groves is going to run operations. So instead of having one person responsible for manufacturing and operations we've split those jobs in two so that we can provide greater focus.

Got it. Thank you.

Thanks, Rick.

Our next question comes from the line of Kathryn Thompson. Please go ahead.

Thanks. Just to start off, I know that last year you had some capital outlays and you had CapEx just north of $30 million. What will it be in '06?

Kathryn, this year we're looking at about 14 to $16 million.

Okay.

Kathryn, let me just tailgate off of Bill's comment there. So we had over $30 million we invested in 2005 in new products, and we made some significant investments to help us drive the 2006 business, so literally, in 2005 we had huge investments we made in manufacturing, in getting laser cutters and tools put in place for us to be able to improve our efficiency as move through 2006. So those went into place at the last part of 2005. We had the ERP system we launched and several other things, so we feel like we made some huge investments in '05 that we're looking to get big benefit out of in '06.

Of that $15 million in CapEx, how much of that would be qualified as just maintenance CapEx?

About 8 million of that will be maintenance. The rest will be additional investment. It's obviously being the IT-related investments.

I know you talked a little bit about having, Mark heading up the manufacturing side, Dustin heading up more the supply chain. Do you intend to have a more of a COO type position to lead those tow operations? What are your general thoughts on really your manufacturing and supply chain side? Because the way I see it, the main issue with Nautilus right now is that of execution of your products, not only of manufacturing but also with your suppliers. Could you give a little bit more detail on your broader plans to that end?

Yes, that's a great question, Kathryn. So one of the things we're looking at here is making sure that we link the entire go to market process together by division. So as you think about our equipment business, which is where we've struggled here in the fourth quarter of having the manufacturing operations component keep up with the sales demand, getting a close linkage between sales, marketing, operations, manufacturing, and product development is pretty critical. So we're right now working through with our Board of Directors and a few consultants on how best to structure our organization going forward in order to take advantage of that. But we will probably have a resolution on that in the next week or so.

But just to clarify, both Mark and Dustin came on in mid to late October?

Yes, and we definitely, from that standpoint, have made a decision that we want to split manufacturing and operations into two segments in order to really provide the focus and both of those folks come to us with huge, huge backgrounds in those respective areas.

So it seems to me, and correct me if I'm wrong, that by bringing them on in that time period, you had a pretty good idea by then that there were some fairly meaningful issues on the operations and supply chain side. Is that correct?

Yes, absolutely. I think as we talked in our Q3 call, we made some changes, and both in our personnel standpoint and an approach standpoint to the business. I think a lot of the manufacturing efficiencies and the things that happened to us in the fourth quarter could have been avoided had we been able to move on them in the second and third quarter. And we just got behind in taking action around those activities. And Mark has done a tremendous job I think in catching us up already and getting us out of the gate here. So we've got four of the six items out of there, moving at the right pace now, and then from an operational standpoint moving things upstream with having some of our supplies start to take over packaging and some of the moving of the goods for us versus us having to handle everything through our DC's is helping from that standpoint. And Dustin has already brought that to the table. So I think there's a lot of things we've got moving that make me feel very, very good about the operation and manufacturing side of our business and the fact that we're getting our act together. Now, we've got some work to do yet, I don't want to kid you there, but I think we have made a great deal of progress with these two leaders in place.

Okay. I know that you've already gotten the ball rolling and fixing the problem, but what's a reasonable time frame for essentially really fixing the major problems on the manufacturing side? You can have great products, but if you can't get it to market, that's obviously -- it's a huge hurdle.

Yes. Great plans without execution don't do much for you, right. What I'd say is this. I think we're going to have some residual overflow of this, from our Q4 issues into Q1 but we're closing those down daily, and so will it hamper Q1? Yes. Will it flow into Q2? I sure doubt it and I think we're going to be able to get our act back together here pretty quickly, so the great thing about this is they're very visible issues. The things I just walked you through, for example, are things that are not rocket science, they aren't difficult to fix. You've just got to get at them and get after it. So I think we've got a team that's got a lot of energy and passion around this one right now, and we are sure working hard to close these as fast as we can.

And also could you just remind for us the six products that were in question?

Yes. Really, the best way to do this is kind of break them up. It's what I would call cardio, for the home market, and for the commercial side. So if you look at Treadclimber, both in the 5300 for the home market, and the commercial Treadclimber for the commercial market, were two of the items. Then we had on the treadmill side we add a Sports Series treadmills, then we had -- what's that?

Commercial treadmills.

Oh, yes, the commercial treadmills as well, then we had two Ellipticals both commercial and for the home market. So if you really break them up. You go cardio, and you go treadmill, Treadclimber, Elliptical, one for the home, one for the commercial market each, and that's where we ran into some trouble. Now, that sounds like, boy, you covered all the categories, and, in fact, we did. We had one one issue in each category. On the other hand we have several treadmills that functioned just fine for us. It was only one item that didn't. And on the Elliptical side we've actually had a couple Ellipticals out there, been out there for a couple of years now that work just fine for us but it's that new innovation and the stuff we were trying to bring to the market in the fourth quarter that really hurt us and we didn't get it out of the gate. So you take all the expense for it and you don't get any of the value from it. So we're sure anxious and excited about getting some value out of these things now that they're ramping up.

Finally, just real quick, I noticed you had a lower tax rate in the quarter. What is the rate going forward?

About 35.5 to 36%. Use 35.5 for now.

Our next question comes from the line of Ed Aaron. Please go ahead.

Hi, good afternoon.

Hey, Ed.

A few questions. In your prerelease you talked about your 20 to 30% annual earnings growth targets. I know you're not prepared to give full-year guidance at this time, but there's quite a bit of confusion around what you would view as the appropriate 2005 earnings base. Could you just maybe address that?

Yes. So like you said, we're not going to give 2006 guidance at this point in time, but I will say this. We are committed to the long range plan, our three-year business plan of growing at 15 to 20% top line and 20 to 30% bottom line. So how quickly we're able to get back on plan here in the first quarter and get things moving, we're going to take a fairly conservative approach at this point in time and try to, as we just did with you in the first quarter announcement here. So I think it's a matter of how quickly we can shut these things down and get the business moving again in the right direction here. So we are committed to the long term plan. We can get this thing back on track fairly quickly. But it is over a three-year plan that we're looking at the 20 to 30% bottom line.

On the retail side of the business do you have a sense that you can give us of how much inventory is currently out in the channel right now versus maybe same time last year?

Yes. Let me start this, and then I'm going to turn it over to Tim. If you look at -- we talked about in the third quarter conference call a little bit about a couple of our key customers who through better inventory management were actually cutting in half the amount of inventory they were carrying on the floor. The Sports Authority and Sears as an example cut their inventories that they normally carry on the floor in half, which is great for them. Unfortunately for us we already had product on the water before we knew they were going to do that. So better planning with our customers will help in the future. But what I would tell you is I think we're relatively healthy right now at retail, in fact maybe maybe a little bit light. So Tim you want to touch on that?

In absolute numbers there's more inventory out there because we're in over twice as many doors as we were just a year ago so we've really expanded our distribution in terms of last year, a year ago now to where we sit right now. But in terms of inventory positions as retail, all of our major retailers are reporting very healthy inventory levels and we're seeing that carry over into Q1 as well.

As you look out to 2006 I think you mentioned you're targeting a 30 to 40% growth rate for your retail business. How much do you expect that to come from comp store growth versus new distribution?

Good question, Ed. I would say, if you think about what we accomplished in 2005 we grew additional customers. And 2006 is about now beginning to work aggressively with those established customers. So I would say 75% of our growth in that area will come from current existing retailers. We will see some new retailer growth, not nearly as aggressive as we did this year, but continuing to enhance our relationships with our current customers on the floor.

Right. But you had some -- part of that growth is going to be annualizing new distribution that you brought on in 2005? I guess I was trying to figure out what sort of like -- what kind of same-store sales growth assumptions you look at when you plan that business?

I'm not sure we're in a position to talk in great detail about that but it certainly is two strategies. It's what we're calling more from our current customers, then more from additional customers.

If you look at, Ed, just general math, you can kind of take a look at Sears and say one of the largest retailers we do business with didn't come on until the back quarter really. I mean fourth quarter was the first time they really came on and then it was a little bit late in the fourth quarter with them, so call it November, December shipments. So you've got only two months of a given year in 2005 there. So as you start to annualize that volume that's a certain -- certainly an important percentage of that growth as well.

On the commercial business, I think you had mentioned you're looking for 15 to 20 there in '06. That's the one that strikes me as being the channel where you probably have the most residual impact from manufacturing issues, mainly because those products seem like they're taking longer to ramp back up. Can you kind of address any strain that you've seen with your key accounts there and, in light of that how -- what your comfort level is for the 15 to 20% growth number for '06 in that channel?

Well, I'd say this. There's no doubt there was some strain there. I think you hit it right on the head. We do have a -- in the commercial segment of the business we did have some issues, but the net-net is we had very, very positive discussions with all of our customers. We let them know in advance of some of these issues that we're having. One example would be 24-Hour Fitness and Brian Bouma their President and Mark Mastrov their Chairman and CEO were both very, very helpful with us in working through these issues so I think we've gotten through the fourth quarter in pretty good shape. And Mike Feeney, one of the key leaders over at 240Hour has been helping us as well.

So I think we've come through this in reasonable shape on the commercial side. We bruised a few folks on the retail side with the specialty retail guys because they were counting on us to get these products to the floor so they could make their fourth quarter sales, we were late. So we've got a little bit of kiss and make up to do there and we're working on that very, very hard and I think we're repairing those relationships and will continue to as we move through the first quarter. So there's no doubt it did hurt us, from that standpoint, but we're working real hard to make it up to them.

Okay. Then the manufacturing process changes that you're making, I guess the concern would be that as those changes get made they're perhaps not seamless. What's kind of the risk of those changes in terms of further disruptions to the business as a result of the implementation of those changes?

Yes. So there's a few things there, Ed. I'll try to touch base on. One is four of the six issues we had on those items we talked about in the fourth quarter are fixed. So they are flowing as we speak and doing just fine. The other two, we expect to have fixed very, very soon and there's not major issues with them. We're talking about plastics fitting correctly, and those kinds of things. It's not a major equipment issue here. This is little stuff. We've just got to get it fixed. I think those will come up pretty quickly on line here.

So the net is as we introduce new products we've learned a heck of a lot about it going through to this fourth quarter. When you get knocked on your face you don't want to have it happen to you twice, right. So you get back up, you dust yourself off, and you learn from it. I think in this case we certainly have. We have got it documented and incorporated now into our go-to-market process, so we can do a much better job of ramping innovation as we go through the year. We're also going to try and push it to earlier times in the year as you see us launch innovation in the future so that we've got some real reads from it in the third quarter as an example of next year versus waiting for the fourth.

One for you Bill, can you give us -- I know you gave us total inventory numbers but how much finished goods did you have at the end of the year compared to the same time last year?

The total inventories were up obviously because of the acquisitions was a piece of it, but we have about $25 million of additional finished goods inventory at the end of this year versus last year.

Yes, and if you look at a base line, Ed, we finished last year with about 49 million in inventory, which was light. It should have been closer to 55. We left orders with customers last year because of out of stock. So we should have been sitting with about 55 million of inventory, then you add on top of that the base inventory that we would have had with Pearl iZUMi and our Canadian acquisition which would add about another 14 million. So round it, we should have been sitting, a base number for last year is about 70 million, then you say 20% sales growth, puts you in that fort of 80 to 85 million range is about where we should have been. So call it 10 million high in inventory. Certainly driven by the sales shortfall is a lot what caused that but I think if you look at how -- if you're trying to get an idea for how it will look at the end of Q1 we hope to have this thing, as we burn off some of this inventory we hope to be sitting somewhere in that 80 to 85 range.

What about the end of 2006?

That's a good question. I think as we move through the year we'll go back and take a look at that. But I think -- I'd like to believe that 80 to 85 number is probably a pretty good place for us to be going into Q4. So as we look at that we'll go back and see, as we improve our operation supply chain and our manufacturing processes, those two new guys that we've got running it, they may be able to tighten it up a little bit for us, but I would expect us to be somewhere in that 80 to 85 range.

Our next question comes from the line of Scott Mushkin. Please go ahead.

Thank you very much. Just wanted to understand how you're accounting actually for the direct business. Is that accounted when you actually book the sale or when it shifts?

It is when it shifts, Scott.

When it shifts okay. Great. Makes a lot of sense. Just wanted to circle back to, the third quarter, obviously down guidance, realized you had some manufacturing problems, and I guess, my thought is what's the biggest surprise going through the fourth quarter? Because it seems like, it seemed pretty much under control but then a few things must have happened. So I just wanted to get a little bit more color and your perspective there.

Yes. I'll give you kind of the one, two, three of this, Scott. We converted to the new Oracle system, and as we were going through the learning of that and getting some of the reports ramped up that we could look at, any time you go through a system change like that, there's a little bit of a shakeout. So that certainly impacted us to some degree of how we were looking at the business, but the second, and the more important elements of this were really, as we got into the manufacturing processes for the fourth quarter here on some of those new items, we expected them to come off a lot more cleanly than they did.

I'll just give you, as a little bit of color here, since you asked for it, our 5300 commercial -- or our home Treadclimber, the 5300 that has the new four-foot treadles on it, that product itself is absolutely fine. We had a sub supplier who sent us plastic, they go on the side of the treadles that had two different colors on it, then a third color that went over the housing panel for the motor that actually the color had some swirls in it. So we could have shipped it, frankly. We could have shipped it to customers and maybe half of them would have said, hey, it's okay, and the other half would have either called us and asked to us fix it or send it back to us, but that isn't the kind of quality I think that this company should stand for, and so we held off on shipping those product until we got the plastic right. Now, was it a big change? No.

There's a $10,000 piece of equipment that measures the amount of pixels of colors that go into an injection molding process. We sent two of those to the sub supplier, we actually bought them ourself, sent them to that sub supplier and had them incorporate that into their process so we don't have that issue going forward. But it sure did screw us up for the fourth quarter and -- on that 5300, and we had similar issues on some of the other products. The Sport Series treadmill, exact same thing, was just plastic. So how much can you blame our plants for that? You can't blame them at all. They can't help that fact. But, we got that fixed, we got -- there's an O-ring, which for those of you that know what an O-ring it's a -- if you look at -- that are married that have a ring finger, and a ring on your finger right now, if you look at that, of all the parts on that commercial Treadclimber, one of the most complicated pieces of commercial equipment out there, that O-ring was the thing that brought us to our knees.

Do we have it fixed? Absolutely. Did we get it fixed as fast as we wanted to and did we get as many units out the door as we would have liked to? No. Are they shipping now? Absolutely. So we feel really good about the changes we made. They just got done too slow. Just got done too slow.

So Treadclimber, shipping 24-Hour Fitness?

Yes, we got the first few units in. We're shipping those out. The majority of those will start going in March as our sub supplier that's making the cylinders for us gets their inventory built up so that we can actually provide those cylinders to our manufacturing plant in Tulsa. So we're ramping up as we speak on that.

Then just shifting gears a little, I believe you guys balance sheet is still in good shape. We go from a--.

Scott, you kind of broke up on me there. You were asking a question about the balance sheet. I'm going to just take a guess at what you might have been getting at there, but what I would say is this. One, on the inventory side, as we talked about already, we carried a little additional inventory because of the sales shortfall but we feel like that will come down into a reasonable range in Q1. As we move to more retail you're going see a higher AR rate going through the fourth quarter because we shipped those goods in November and December and we don't get receipt for them and paid for them until January, February. So you'll see the AR come back into alignment. So I think you're going to see us improve as we move through the first quarter there with the balance sheet.

And I don't know if you can hear me. Obviously I'm breaking up. I just wanted to hear your thoughts about where you want your debt levels to be and that type of thing. Obviously you're buying back shares but you also incurred some debt. Just your thought about future acquisitions in that regard.

Well, I'll tell you, one of the reasons we're pushing back on some of the future acquisitions right now is because we think our stock is undervalued and we're going to buy back some shares. So that's part one. We'll probably finish, if we -- not considering buying back shares here, if you took that out of the number, we'll probably finish between -- call it 5 and $10 million of debt in the first quarter, somewhere in that range, but as we move through the quarter, depending on what happens here, we will probably be buying back stock. So we think that's a good investment for this company right now.

Perfect. Thanks. Sorry for breaking up on you, but thank you very much.

All right, Scott.

[OPERATOR INSTRUCTIONS] Our next question comes from the line of Steve Martin. Please go ahead.

Thanks, guys. You seem to have had a lot of success in the retail channel. You announced a lot of new customers during the course of '05. Can you talk about the status of the rollout at Sports Authority, Dick, and Sears?

Yes. Tim, you want to cover that?

Sure. Steve, our relationship with Sports Authority is really probably the most mature. We have a very strong relationship with their buying and their store ops team. I think we're probably the most penetrated there in terms of number of SKUs and number of doors. Dicks would be probably the second most mature retail customer. We are still working through expansion there of both doors and SKUs and we see 2006 be a good year with them as well working on kind of a separate -- a differentiated assortment for them as well. And then Sears, as Gregg alluded to is the most fledgling. We really started shipping them at the end of Q3 and we had a slow ramp-up in stores. I don't think we were really fully into a position with Sears until even later in December. So we see our biggest opportunity with Sears coming here in 2006. We continue to look to additional doors with them as well as additional SKUs. So obviously those are our three biggest retail customers and business with all three of them were very healthy for the fourth quarter.

Are there any other new customers that you can share with us for '06?

We will obviously always be looking for new customer growth. I think there are other potential small regional -- smaller or regional sporting goods folks we'd work with. There's certainly other growth in the department store channel. We don't see us going any further than that.

Thank you very much.

Mr. Hammann, there are no further questions at this time. I will now turn the call back to you. Please continue with your presentation or closing remarks.

Thanks, Elizabeth. I think, in closing, all I can tell you is we're looking forward to 2006 and I look forward to meeting with investors in New York and San Francisco next week. So for those of you that are going to be out there, look forward to seeing you. Thank you very much.

Ladies and gentlemen, that does conclude the conference call for today. We thank you for your participation and ask that you please disconnect your lines.