Nautilus Inc (NLS) 2002 Q2 法說會逐字稿

Good afternoon. My name is Andrea, and I will be with your conference facilitator today. At this time, I would like to welcome everyone to the The Nautilus Group second quarter 2002 results conference call. All lines have been place on mute to prevent any background noise. After the speaker's remarks, there will be a question and answer period. If you'd like to ask a question during this time, simply press star, then the number one on the telephone keypad. If you would like to withdraw your question, press star and then the number two on your telephone keypad. Thank you, Mr. Cook, you may begin your conference.

Thank you. Good afternoon. I'm Brian Cook, Chief Executive Officer of The Nautilus Group. Thank you for joining us today for our conference call for the second quarter of 2002. Kevin Lamar, our president, Rod Rice, or Chief Financial Officer, and Michael Newman our Investor Relations spokesperson, are here with me today in our headquarters in Vancouver, Washington. As most of you know, The Nautilus Group is a leading marketer, developer and manufacturer of health and fitness products. We sell our Bowflex home fitness equipment and Nautilus Sleep Systems through our direct marketing channel. We sell our Nautilus, Schwinn and StairMaster commercial fitness equipment through our sales force and selected dealers directly to health clubs and other institutions, and we sell our complete line of consumer fitness equipment under our Nautilus, Schwinn and Stairmaster brand names through a network of specialty dealers, distributors, and retailers worldwide. Today we released our results for the second carder ended June 30th, 2002. It was outstanding quarter for our company. We recorded sales and record earnings. In addition during the quarter, we highlighted our position as a leading and diversified health and fitness company by changing our name to The Nautilus Group and by listing our stock on the New York Stock Exchange. Before I go into more detail about our progress during the quarter, I would like to turn the call over to Rod to review our financial performance. Then Kevin and I will come back to discuss some of the significant events of the quarter and our strategy for capitalizing on the market opportunities before us. Rod?

Thanks, Brian. Except for historical information presented, our discussion today contains forward-looking statements which contains words such as intense, belief. These forward-looking statements involve risk and uncertainties may cause our actual results to be materially different from those express or implied by these statements. Factors that may affect The Nautilus Group results are described in detailed in our SEC filings. Today, we released the earnings results for the second quarter ending June 30th, 2002. We reported record sales of 140.4 million, up 87% from 75 million for the second quarter of 2001. for the first six months of 2002, we have total revenue at 276.3 million, an increase of 84% from 149.9 million reported for the same period of 2001. For the second quarter, sales in our direct statement were 103.1 million, up 50% from 68.9 million for the same period last year. As anticipated, our direct sales were stronger than typical for the second quarter, which is normally our seasonally lowest quarter. We continue to see strong demand for our Bowflex and Nautilus Sleep Systems products. In addition, we caught up with the demand for our new high end Ultimate model. We continue to benefit from a stable, favorable advertising environment. E-commerce sales also contributed again to our direct business growth. In the second quarter, E-commerce sales were 22.9 million, up 79% from 12.8 million for the same period last year. Sales from our commercial retail segment were 77.3 million or 27% of total sales. Commercial and retail sales were up 6.1 million for the second quarter of 2001, and down sequentially from 44.8 million for the second quarter of 2002. The sequential decline reflects initial buying patterns for these products. We also continue to integrate our recent acquisitions and consolidate the combined operation in our sales team. We continue to expect higher commercial retail sales in the second half of the year. We believe that our commercial and retail segment will account for about 33 to 35% of total sales for 2002. Our gross margin for the direct statement was 72% for the second quarter, compared to 69% for the second quarter of 2001. Based on our increase in sales volume, we were successful during the first half of the year in gaining cost efficiencies from our gross product suppliers. Gross margin for the commercial and retail segment was 25% for the quarter, compared to 26% for the first quarter 2002, and compared to 31% for the second quarter of 2001. Our commercial retail margin was impacted by the expected seasonal decline in commercial retail sales. We expect to see modest improvements in gross margin for the commercial retail segment during the second half of 2002 as we achieve reasonably higher sales goals. Our combined gross margin for the quarter was 60% compared to 57% for the first quarter of 2002 and 66% for the second quarter of 2001. For the remainder of 2002, as our commercial and retail sales increase, we expect our combined gross margin to be in the range of 54 to 56% of sales. Overall operating expenses for the second quarter were 44 million, up 59% from 27.7 million for the second quarter of 2001. As a percentage of sales, total operating expenses were 31%, compared to 30% for the first quarter of 2002, and 37% compared to the second quarter of 2001. For the remainder of 2002, we expect operating expenses to be in the range from 29 to 31 percent wholesale. Sales and marketing expenses for the second quarter were 34.1 million, up 51% from 22 points, 6 million for the same period in 2001. After a percentage of total sales, sale and marketing expenses were 24%, up from 23% for the first quarter 2002 and down to 30% for the second quarter of 2001. For the remainder of 2002, we expect sales marketing expenses to be about 23 to 24% of total sales. General and administrative expenses for the second quarter were 7.4 million, up from 3.4 million for the same period in 2001. As a percent of sales, G and A expenses were approximately 5%, the same as for the first quarter of 2002 and second quarter of 2001. While we have experienced some increases in overhead related to our acquisitions, we continue to work to control costs as our business grows. For 2002, we expect G and A to remain in the range of 4 to 5% of sales. We add interest income from captioned investments of 477,000 for the second quarter compared to 1.1 million for the same period last year. Interest income reflects lower cash balances and interest rates. Net income for the second quarter was 25.8 million, or 72 cents per diluted share, up 77% from 14.6 million or 40 cents per diluted share We repurchased 287,600 shares of our common stock for approximately 9.1 million. We added capital expenditures of approximately 4.9 million. Our accounts receivable were 22.1 million at the end of the second quarter, down from 24.9 million at the end of 2001. Sales outstanding remain constant under one day for direct business. For commercial and retail segment DSOs were 57 days at the end of the second quarter, compared to 54 days at the end of 2001. Inventories were 68.8 million at the end of the second quarter. They were up from 45.5 million at the end of 2001. We increased inventories for our direct sales growth to catch up with demands of the Ultimate and bring our commercial and retail mix to more optimal levels. We also increased inventory in anticipation of a possible strike by Long Shoremen on the west coast. With these objectives achieved, we are not planning for additional inventory increases in the third quarter. Based on our strong direct business in growing commercial and retail opportunities, we continue to expect year over year sales to increase by approximately 60%. We now expect year over year income to increase by over 50%. For long-term modeling, please keep in mind that we expect normal second quarter seasonalities to return in future periods with the fourth and first quarters typically being the strongest quarters for the commercial and retail products. In addition, we continue to expect quarterly sales to fluctuate according to such factors as cost and availability of advertising, as well as the general state of the economy. In summary, I can report the financial health of the company is excellent. We have maintained strong financial resources while completing two major acquisitions since September, 2001. We expect to continue to generate strong positive cash flows from our business operations as we increase sales and earnings. Overall, we feel that The Nautilus Group is extremely well positioned to capitalize on the marketing opportunities before us. I'll turn it back to Brian.

Thanks Ron. As you can see, we're very pleased with the results for the second quarter. We were especially pleased with our direct business performance, what is normally or seasonably lowest quarter. We believe that our Bowflex and Nautlus Sleep System products continue to meet the fitness and healthy lifestyle needs of our target demographic groups, which include baby boomers, seniors and women, and we continue to increase consumer awareness of our product lines. We also continue to integrate our Nautilus, Schwinn and StairMaster operations and products and to set the stage for growth in the second half of this year and beyond. Finally, as an objective measure of our success, we were pleased to be ranked number two again by Business Week in its annual listing of growth companies. We were the only company to be listed among the top five growth companies for the third consecutive year. At this point, I'd like to turn the call over to Kevin Lamarr to review or progress in the commercial and retail business. Kevin?

Thanks, Brian. During the second quarter, we continue to lay the groundwork for growth in our commercial and retail business. While we had some redun tant overhead at StairMaster during much of the second quarter we continue to integrate and consolidate our recent acquisition. We moved StairMaster's corporate functions to our commercial and retail headquarters in Colorado and we closed the StairMaster head quarters in Kirkland, Washington, last week. Later this year, we plan to consolidate manufacturing operations by producing all of our commercial treadmills in Tulsa, Oklahoma and closing the StairMaster's plant in Baffel, Washington. Our acquisitions have given us a powerful platform for product development and enhancement; however, both Schwinn fitness and StairMaster came from bankruptcy situations. They had been neglecting the R and D investments needed to enhance existing products and roll out new product line. Since we acquired these organizations, we've elimb nationalled weaker products and focused on the best products. We are making the necessary investments to move forward with new product development and existing product enhancements. On August 1st, we plan to introduce 16 new high-quality brand of products at the health and finance expo in Denver, the largest finance dealer show in the world. We are excited about the continued enhancement and expansion of our product lines and the worldwide sales opportunities for all of our strength and cardiovascular products. We're also continuing to build a unified sales organization and worldwide distribution network. We continue to the process of training our sales force to cross-sell all of our Nautilus, Schwinn and StairMaster products on a combined basis. We also expect to see growth in our international sales as we leverage our offices in Switzerland, the UK and Germany and our distribution relationship in over 50 countries. With all of these steps, we're building the foundation for future growth in sales and profits. As we move closer to fall and winter peak selling periods for commercial and retail products, we expect to see growing sales from our commercial and retail business and believe we're on target to meet our goals for 2002. With the completion of our consolidation efforts, our rollout of new and enhanced products and the integration of our sales force and worldwide distribution, we expect to see stronger growth in operating performance for the division in 2003. Over the long-term, we are positioning ourselves to be a global leeered. We believe our combination of brand names, distribution channels and broad cardiovascular and strength training product lines are unmatched in the industry. Now back to you, Brian.

Thanks, Kevin. In light of disturbing recent revelations regarding a number of public companies, we feel it is important to highlight our work and commitment to have the best practices for corporate governance at The Nautilus Group. We are very fortunate to have a strong board of directors that includes seasoned and distinguished business professionals with a wide range of experience and finance, marketing, information technology, and branded consumer goods. We are pleased to announce that Peteral Len is the newest member of our board. Peter is a managing partner at Technology Partners International and has extensive experience in the IT management and consulting. With his skills and experience, Peter brings another strong, independent voice to our board of directors. Our board and our committee meet on a regular basis to review the financial and strategic management of the company. In addition, we have taken a number of steps to ensure the integrity of our financial reporting. For example, last year, we adopted a new charter that gives the audit committee ultimate authority to select, evaluate and more appropriate replace our outsaid auditors. In addition, we've established an internal audit department. We will continue to strive to maintain the highest standards of corporate governance on behalf of our shareholders and the investment community. In summary, we are very pleased with our continued success in becoming a larger and more complete health and finance company. We believe that our powerful brands and multiple distribution channels give us a solid foundation for executing our gross concludes the formal part of our presentation. In accordance with SE C regulation FD, I would like to urge the analysts who follow our company to put forward whatever questions they need to ask in order to build their financial models. In this publicly accessible and broadcasts conference call. Kevin, Rod and I will be pleased to answer your questions at this time.

At this time, I would like to remind everyone in order to ask a question, please press star and then the number one on your telephone keypad. We'll pause for just a moment to compile the Q and A roster. Your first question comes from Dave Chary from Kingford Capital.

Hi, I'm wondering if you could give us the customary break down of Bowflex units sold in the quarter as well as the corresponding average selling price that you're now seeing.

Sure, not a problem. During the second quarter we sold approximately 64,000 units of the Bowflex products. Our ASP was quite amazing, due to the fact that we're innovative, came out with the Bowflex Ultimate, those were over $1470 ASP, that's recovered for our company.

It sure is. Congratulations. That's also a terrific number of units that you're selling. As far as the guidance for inventory in the current situation, can you give us an update of what's happening with the Long Beach Long Shoremen's strike and give us some color just in general about what the sort of, you know, state of affairs is there and what risk is that to getting product imported through that port?

Sure, the last time they went on strike was in 1971, and our calculations, we really believed that they were going to go on strike on July 1 or at least have a work slowdown. It looks like they're still negotiating. We get updates almost on a daily basis right now. I personally, you know, am not the best source for but I personally don't believe they're going to on strike but it's proven to hedge our bet. One thing people have to understand, if they went on strike in the west coast, the Teamsters on the east cost were not going to cross that line, so it wouldn't turn into a national strike.

Just as a general business, so you increase the inventory. Can you give us guidance as to what we should expect for Q3 inventories as a percentage of Q3 sales?

Well, I think the inventory balance in general, you know, what we see, it should at least be flat or possibly going down at this time. We believe it's on the direct side of this so we'll go down on the commercial retail side of business, they're launching new products as Kevin mentioned and when we get our hand on the new products as they get in, the last week of September you might see inventory be flat for the quarter or they're delayed until, you know, October or sometime around that, then you won't see them in the third quarter. It's a little bit quarter on the commercial and retail side of the business but we believe they'll be flat or a little bit down.

In terms of the inventory in general and I'll let someone else ask this question, what percentage do you estimate is roughly the direct products?

On that I would say the direct product, well, the direct product is approximately $28 million of inventory.

Thank you very much and congratulations.

Thank you.

Your next question comes from Eric Wold.

Good afternoon, guys. A couple quick questions first, and there's a slightly longer one after that. Were there any extra G and A costs for the quarter for listing on the NYC, and about how much were those?

There were some extra costs listing, you'd be looking in the 3 to $350,000. Really, where the average of costs are in carrying the dual overhead with the StairMaster acquisition.

Okay and then and then sales and marketing expense for the direct side on itself?

Sure, on the direct side of the business, selling and marketing expense was 28.5 million for the quarter. It represented 27.7% of sales for the quarter, compared to the previous year, it was 21.2 million and represented 30.8% of sales, so we're very efficient in our selling market.

Okay, so that kind of leads into my question on the advertising outlook, you keep rolling up the new commercials on the Bowflex side for the power proand the ultimate. Talk a little bit how those are doing, comparing to the older commercials compared to inquiries and orders and on the same line, what are you seeing in terms of advertising, you know, rates going forward in the Q3 and Q4?

Well, I think we're very pleased with the results of our advertising in general today, Eric. You know, advertising rates are steady. We haven't seen them increase a lot this year at all. Going forward, availability looks good. We certainly expect that to change at some time in the future, but I'm not sure we can predict one when.

One last follow-up question. You guys, are you willing to break out what percentage of sales in the Bowflex that are coming from the Ultimate line?

We have not broken that out at the time. We're not sure if we really will, but as you see, the Ultimate increased net percentage of sales with an ASP of a little over $1470.

Would it be safe to say, maybe 10 to 20% of the sales are Bowflex?

We'll let you two guys take your guess at that, but right now, it's pretty new product, very successful launch, and we're very pleased with where ASC is today.

Thanks a lot, guys.

Thanks.

Next question comes from Anne Nerner.

Hi, Brian. I was wondering if you can explain some recent stock activity specifically referring to in March, a limited partnership that you controlled sold some stock, and I don't recall that form 44 was ever filed. I was just wondering if you could explain how the partnership acquired the shares and how come there was no 144 filing.

To the best of my knowledge, there was a 144 filing. That limited partnership, a family limited partnership my wife and I put together a few years ago. The stock was put into limited partnership by myself, and I do believe that sale was accurately reported.

Okay, thanks.

Your next question comes from Bill Dasellan.

Thank you, I have a couple of questions. First of all, if we can circle back around to the inventory. When will the plant, the StairMaster plant move to Oklahoma be complete, and when that's done, how much inventory will that allow you to take off the books?

Bill, this is Kevin. We target the consolidation of the Baffel factory down to Tulsa, call it around end of September, in and around the October time frame. In the process, we're kind of building inventory at Baffel in preparation for that move and also building some inventory down in Tulsa. As far as the duplicate inventory - I mean, what we'd be looking at is over $1 million

Right.

Would you be able to help me understand how that 20 plus million breaks out?

Well, when you look at it right now, on the direct side of the business, we have $28 million in inventory. When you look at the commercial retail, they approximately have a little bit over 40 million, about $40.8 million in inventory.

Sorry, Rod, I don't think I asked my question the right way. I was really looking to understand the delta, the difference between the 45 and-a-half and the 68 or so this quarter.

When you look at inventory, you know, over the three-month increase by a little bit over $8 million and over the first quarter it increased by a little over $15 million. When you look at the first quarter increase, what that was due to, number one, about $5 million was the StairMaster inventory. As Kevin mentioned, we're producing inventory for that in two locations today on the commercial treadmills, so we got some increases in there, and we're also on the commercial side of the business, too, we're moving the consumer treadmills into the new building. They leased several buildings. So we're producing more inventory for that move, too. And other than that, it was getting optimal levels on the commercial retail side of the business. On the direct side of the business, we've increased our inventory levels in the first quarter due to demand. We never had a sequentially up quarter in the second quarter which is seasonally our weakest quarter and I've got to tell you, we weren't taking the risks reward in the second quarter here with the potential strike of the Long Shoremen. We weren't going to be on TV running out of inventory. So we'll lead the direct site of the inventory down during the third quarter.

That's helpful. Let me shift to a second topic relative to StairMaster, you had referenced dual overhead. I was hoping you could quantify the size that that represents and what the time frame is to get that worked down.

Right now in StairMaster the dual inventory is on the commercial treadmill.

Sorry, Rod, the dual overhead.

Oh, the dual overhead, on which side, G and A, sales and marketing, what is the whole thing, what particularly are you looking for?

The whole thing.

We have dual overhead in G and A even though we closed dun the corporate head quarters we're keeping a lot of upper management in place until the enof the third quarter because we want to make sure the transition goes well and treat the customers the way they should be. We have dual presence in there at this time, so we'll see some cost savings there. You should see probably about $300,000 in the quarter in G and A. You should see that. I don't have the exact number in the marketing side but you see a pretty similar type of number and on the cost of goods sold side, you're really not going to see that one take place until about the end of the year because we are closing down that facility in the fourth quarter, but you'll see that cost disappearing.

And what was that number that you had mentioned? I actually didn't hear it.

Which that I just mentioned in a question you had just mentioned a dual G and A number.

About 300,000 a quarter now.

That's helpful, and then finally, a topic that has not come up for quite some time is the overall conversion ratio. I realize you don't talk about specific numbers, but directionally I'd be curious to understand what's happening with that over the last several quarters.

Well, Bill, this is Brian. We constantly strive to improve on our overall conversion on all of our direct marketing lines and I think the reduction in selling and marketing as a percentage of sales shows that we're still improving, because advertising rates are predominantly constant right now.

Thank you both very much.

Okay, thanks.

Your next question comes from Dan Woodcock.

Good afternoon, gentlemen. A couple questions, if I may. First of all, Rod, cash flow was very strong year over year, but less so versus the first quarter. Can you address any issues that might have affected cash flow in Q2?

Yeah, it's pretty simple. We have to pay federal income taxes, we make two quarterly tax payments in the second quarter and when you look at the first quarter, our federal income taxes we paid 1.7 million. In the second quarter we paid a little bit over $22 million. So when you add that to the equation it was a very impressive cash flow for the quarter. When you take that into the the equation, we would have been close to the 39 or adjusted $37 million, which would have reached the first quarter.

A couple of more questions if I may. Can you tell us what the lead times for delivery lead times for the Ultimate, the Bowflex Ultimate are.

I remember you asking about vendor lead times (inaudible).

To your customers.

To our customers, they were backed down, we like to operate in the two to four week lead time, and we've caught up to the lead teams.

And Roger, you've broken out the Bowflex sales in units. Can you give us any guidance as to how that residual direct sales breakup between bids and nutritionals?

Right now, the analysts on the Nautilus Sleep Systems I think they're looking around 35 or 36 million, up to $40 million and we're comfortable with those estimates. We're selling nutritional products and we think we're going to do so for a long time. For better or worse, we want to concentrate on our overall business here, and we'll not break out those numbers. We do have an understanding that if we ever not do break out the Bowflex, how people would react to it.

Thanks very much, gentlemen. Good quarter.

Thank you.

Your next question comes from Manuel Ortoria.

Good afternoon, guys. A couple quick questions. Could you give us an update on your air bed business, what is the trend that you're seeing on your air bed business as far as ASP in units?

We're certainly very happy about the progress in the air bed business. I think the ASP is still slightly above $1800, and we certainly believe that the analyst estimates that they're looking for in the 35 to $40 million range are within guidelines we'd give.

Now, have you guys started to use infomercial also in a more bigger way for your air bed business, for the Nautilus air bed?

Yes, we are starting to use infomercial more on the air bedside of the

Next question, Brian, maybe you could give us a little bid of an idea as far as new product pipeline, especially on the direct side, any color, any information you could share with us pretty much right now. certainly healthy lifestyle products. We think there are fitness areas that are of interest and we certainly think there are products outside the direct fitness equipment area that we're interested in.

Great, thanks.

Thank you.

Your next question comes from Adam Steinberg.

Hi Brian, Rod, congratulations on a strong quarter. I was wondering if you could help on the retail commercial side, kind of break out what was the ongoing growth and how much of that was acquisition driven.

Well, the majority on the commercial and retail side of the business was, you know, was acquisition driven as we've done the two major acquisitions. Like what I said, this year's sales were 37.3 million dollars. Last year, they were $6.1 million, and most of it is coming from acquisitions.

Right, but I think last quarter you said something like the inorgone achette gross 37%?

When you look athe organic growth for the over all business in the second quarter, counting the direct side of the business, it was right around 47%.

47%?

Right.

Great work, guys. Another question I have is in terms of the building of the inventory in preparation for the potential strike of the long shoremen, when you're building up that inventory, are you bringing in assumptions as to length of strike and what are your plans if there is a strike and it's longer than what you've been projecting.

If you look at the numbers, we have plenty of inventory on hand right now and the biggest risk is what was going to happen on July 1, because a risk is not only can you not get your inventory there but all of the containers would be in the United States. They'd be stuck in the United States, you'd be running out of containers overseas. Since they haven't done this right now, we think every day there's not a strike, there's less of a possibility of a strike occurring so we feel pretty good about that, and that's why we've come out and said we're going to reduce the inventory on the direct side of the business.

Some of the other retailers that would be affected by this, the larger ones have been pressuring the administration to get involved if there is a strike. Do you see that happening?

Well, you know, I think I'd be personally surprised at this point in time, now that it has a lot of public awareness if the administration didn't get surprised or get involved shortly after if there were a strike.

Okay, and on the direct side of the business, is the plan still to introduce something this year?

You know, again, I think the plan is that we certainly think we will continue to introduce new product lines on the direct side of our business, and as I've consistently stated, we just don't comment from a strategic standpoint on when those introductions will be made until we actually do them.

But it's safe to assume you are testing at least one perhaps several other products currently?

I certainly appreciate your questions, Adam. You're very persistent.

All right, guys. Thank you, and I look forward to speaking with you again.

Your next question comes from James Bellessa.

Good afternoon. I'll need a call from Rod earlier or later, because I was cut off in the middle of this call as the operator came in and asked for my name, my number and for my firm affiliation and then put me on music, so I missed the most part of his presentation, but my questions, what was DDNA for the period?

When you look at depreciation and amortization and just let me see here, right before the period was 1.4 million. It's roughly, it's mostly depreciation we had about 1.3 million of depreciation and about $100,000 rounding an amortization.

You bought back some shares. Can you tell us what your share count was at the end of the period?

It was a little bit, I don't have that exact number in front of me. It's going to be a little bit under 35 million shares.

You bought back some shares about, I think you had an authorization of 20 million and maybe I'm wrong, and you bought about half of that back. What are your intentions for addition alibiback here?

With the current stock prices you can anticipate us becoming active after our quiet period is over.

And when is that?

I think it's three days after today.

During the quarter, can you tell us how much was in E-commerce sales?

Sure can. E-commerce sales were 22 points, $9 million, 22.2% of direct sales.

And I had down cap.ex. estimate in my model at 13 million and you already have 14 million at cap.ex. What might be a more accurate target for cap.ex. for this year?

Yeah, last quarter, what I said is we thought cap.ex. would be about $20 million for the year in the last quarter conference call. Now, we see some opportunity of moving the commercial retail treadmill business to a new building to get them out of some leases and see some mother advantages in some manufacturing to drive down costs in our businesses next year. So I think we're looking closer to $24 million this year, and I think next year we could go back to our normal levels which is in the 9 to $10 million range.

And if I heard correctly, your guidance now is for 50% increase in net income, at least 50% for the year, $1.85 last year per share times 50% increase would put that you have $2.78. Did I hear that correct, that that would imply what you're saying?

That is correct, we said we believe income would increase by over 50% this year.

Thank you very much.

Thank you.

Your next question comes from Andrew McQuilling.

Thanks very much. Most of my questions were answered, but a quick question on the supplier efficiencies that you've been gaining in the direct business and their impact on gross margins. Was it really visible for the first time in the March quarter of '02 and you know, is that when the efficiency started to flow in?

Andrew McQuilling you may proceed with your question.

Hello, can you hear me? Hello? Hello? Hello? Hello?

Move on to the next question.

Hello? talked a lot about -

Operator, tell them I start talking and they can't hear me.

Hello?

Yes, we can hear you, Ian.

The last question is with regard to the expansion and retail sales operations, it's been a pretty extensive increase in capacity there and an update on the technology side. How much much of that cost is actually being expensed rather than capitalized over the last I guess six to nine months while that's been in progress?

Sure, to answer your first question, our ASP numbers we've had the past, we do include the shipping revenue side of that.

Thanks.

I'll answer the, your last question and then pass the commercial retail question on to Kevin. On the telemarketing, we opened a state-of-the-art call center, very, very impressive. It will give us more capacity than we've ever had in the past, and when you look at that technology, we did capitalize the cost of that. There was additional expenses of getting that operation opened up, and I'm going to turn the next question over to Kevin.

On the commercial retail portion of your question, we have over 100 items, and when we are consolidating Nautilus, Schwinn and StairMaster, one of the things we identified with the two businesses were 4 million, bankruptcy Schwiin Fitness and StairMaster, there were items that needed immediate revamping. We've identified those items. They cover things like treadmills, recumbent. Bikes, we've got a couple retail additional cardiopieces we're working on, revised strength, upright stationary bikes, so we plan on, it is a big whack to launch this many products, but we've been working at it every since we've taken over Schwinn Fitness and been able to leverage some of our other brands. So we're pretty excited about 16 new products. I think it's going to be something the industry hasn't seen in a while.

Looking forward to joining you in Denver. It sounds pretty exciting. Thanks very much, gentlemen.

We're looking forward to seeing you.

Your next question comes from Carol Buyers.

Hello, can you hear me?

Yes, we can.

Okay, great, because I've been listening to you guys and then I've been drowned out by the monitor of the call as well. Anyway, a couple questions for you. I noticed that when you look at the cash conversion cycle, it's increased and we saw a sequential increase in inventory but not in accounts payable. Can you explain that?

Yeah, when you look at accounts payable side of the business, we've been ramping up our inventory throughout the quarter, so you didn't see inventory just ramp up at the end of the quarter, and we are also getting more favorable terms. We're going to start overseas on the commercial and retail side of the business so we can extend that out so you can see a better correlation between the two.

Sorry, you're saying for the payables it was better termed throughout the quarter as compared to the inventory?

What I am saying is we were ramping up inventory earlier in the quarter and during the quarter, so you see the inventory sitting there because we didn't want to wait until the very end to ramp up the inventory because there could be a chance we couldn't get it through the ports because we're not the only ones out there today that, you know, knew possibly July 1 could have been a strike. So we were worried about the congestion in the hubs at that time.

Okay.

Then on the commercial and retail side of the business, we're working on getting some more favorable terms on that side of the business, so you will see hopefully in the future a better correlation of inventory in accounts payable.

Okay, and this might be more for Kevin Kevin Lamar, but it you quantify better the cost experiences you've been experiencing through consolidating the StairMaster facility and what do you consider, an operating margin, achievable operating margin in the next 12 months and where are you today in just the commercial retail business?

In the commercial retail business we'll go with Rod's guidance of about 300,000 per quarter will continue on. As far as our operating margin, we think it's going to be in the low teens, 12 to 15, and we want to continue to focus on that and obviously try to improve it as we go forward to 2003.

Where are you today with respect to your operating margins in that business?

They're very small right now, because one thing I want to make perfectly clear, we're not seeing any efficiencies in the first half of this year. We're actually seeing the other side of it. We just closed down the Kirkland, Washington, headquarters for StairMaster, but at the same time we're not moving a lot of those people over to our facility in Colorado. So what we had to do is go up higher and get the new people set up and working there. We had a lot of travel costs on the transitions costs, so you're going to see costs starting to come out of the business in the third quarter and heavier in the fourth quarter and this quarter for that business was okay, but this is their seasonably weakest quarter. They typically only do 15% of their overall sales in the second quarter of the year. You'll see that business pick up quite a bit in the second half, and you'll see some of these cost synergies we're talked about. I think we're going to get cost synergies of 300,000 alone out of G and A on a quarterly basis here. I think still in the marketing, the number could be around the same. I think next year after the launch of all of these new products, that business is going to be in pretty good shape.

And would you say from just an integration standpoint, are you pleased with the progress that you've made so far?

Carol, we, you know, as with any of these integrations, they are challenging to do, but we've not seen anything out of the ordinary and we think it's going forward and to add to what rod said, he is right, we did have to hire, and train a lot of people that didn't go forward with us from our StairMaster facility, so we did have to carry those and have had to carry them ever since we acquired stair mast ear and that will start dropping off as we go forward.

One final question with respect to the inventory. You mentioned that you have about 40 million of inventory for the commercial retail side. Is that correct?

Yes.

Do you consider any of the inventory obsolete from your perspective?

No, we're not really concerned about obsolescence on the inventory. Some of it we've brought over. We've had to make some modifications to it almost in inventory, it you will, but we're still comfortable with the saleability of that product.

Okay, well, great. Thanks for answering my questions. the Ultimate, you know, mixed shift and can you talk about when the supplier fishes started to kick in and what's the likely outlook through the year.

Supplier efficiencies really started kicking in the first quarter of this year. I honestly do not have the breakdown of the Ultimate, of how much that added to the fishes. One thing, the Ultimate product adds, increase the volume more, you'll get some mixes from your suppliers. It's a new introduction of a product and you tend not to, I mean, we'll sell more the second half of the year than we have the first half of the year on that product itself, and throughout the rest of the year, I mean, we've talked more on the consolidated basis. We think the gross profit margins can be in the 54 to 56% range.

Fair enough. Can you talk about the direct operating margins in the June quarter?

Sure, sure, not a problem. We'd love to go through some of those. The direct operating margin was over 38%.

Oh, very nice. Question about the bed systems. Is there a pattern of seasonality in bed sales for the overall industry and for the direct business? You know, when do people buy beds? Is it constant through the year?

Well, in our bed business since we're still in a very infant stage, we certainly don't expect seasonality to affect our ongoing growth of that business, especially in the near term.

Terrific, and then one last one. The ad spending in the direct business, can you talk about the shift of moneys from cable TV to direct satellite, can you talk about as a percentage of the overall spend how much is moved to direct satellite this quarter versus, you know, quarter prior?

Yeah, I don't have the exact percentages on that. We know it's increasing with our demographics very well. What's interesting out there in a couple of studies now, what they're showing is a shift in viewership from the national networks, national cable TV and direct TV for the first time. I don't have the exact figures, but I think for the first time I think ever there's more people watching national cable TV than direct TV and the major networks. That's an interesting trend for us.

Just one last one. Your sales gros in June, sales up 87%. You're holding onto a 60% or so sales growth for '02. What drives the slowdown in the back half, given the trends have been so good in the first half?

Well, what you see is we acquired Schwinn at the end of the third quarter.

Sure, but still, that would, you know, September quarter you'd still probably have to see sales slow.

September quarter will be really good because we only had it, it was roughly 9 days at the end of the quarter but in the fourth quarter we'll have it for a full year, and that's why we'd rather be conservative and come out with numbers we could achieve and still look good.

Fair enough. Conservative is good. On the direct business, strength of the business sequentially is also very impressive. What's going on in the direct side? What do you attribute the real strength in pickup in the Bowflex II?

First of all, I think it's the innovation in the Ultimate product. Second, due to the slowness in the economy, maybe what has been referred to as nesting effect, there are more people at home watching television.

All right, terrific, thank you.

Your next question comes from Laura Richardon.

Thank you. Rod, I was wondering if you could break down the revenue guidance in a little more detail, like Bowflex unit growth, maybe some overall internal growth. I just heard that reminder about interversing the Schwinn sales in the fourth quarter which is helpful, but any more color you can give on that, especially in light of some of the negative stuff that was written last quarter. It would be appreciated.

Yeah, unfortunately the only numbers I have right here is the top line growth and bottom line growth on a consolidated basis. I mean, you know, we're comfortable with what we've talked on the commercial re tail side of the business but on consolidated business we see 60% growth and 50% growth on the bottom at this time. And I want to make sure the numbers I give are correct numbers.

Yeah, okay. Then just another question is, regarding the 16 new products for commercial retail, to put that in some perspective, how many new products were all of your commercial retail groups introducing this time last year?

At this time Laura, last year, Schwinn filed bankruptcy in May, so they were introducing none. StairMaster really had put R and D expenditures, because they filed not too long afterrer, so this is almost a two-year refresher for both Schwinn and StairMaster. On the Nautilus side we had introduced a complete new line of home gyms and some strength equipment which helped to broaden redistribution of the Nautilus side so both Schwinn and StairMaster have been pretty dormant for awhile.

Thanks Kevin. Of the new products, would you describe them as more evolutionary or revolutionary.

Some of them are platform, brand new, ground up development product and some are completely what I'll call overhall to existing products, like instead of having a recumbent 499, we may have gone and put a new drive train in it and fix it all up, a 599 and going to kick everything in the industry's butt.

Interesting, and then one more question, regarding the ad climate, is there any way you can forward buy advertising or lock in low rates once you sense the environment to become pricier?

I think the absolute answer to that is no. To a certain extent you can forward buy infomercials for a short period of time, but on the spot market, not really.

Right, right, that's why it's the stock market. Okay, thanks, guys. Good quarter.

Next question is from James Bellessa.

Two questions. Maybe I missed this in the hole that I was on hold but did you say anything about the profitability between the two different segments, the direct side and the commercial and retail?

Yeah, we have not, what we said, we believe the top line to grow my 60% on consolidated day basis.

Talking about the most recent quarter, the second quarter and the breakout of profits, operating income or net income by each -

Certainly. On the direct side of the business, it was a pretty exceptional quarter. We had operating income, income from operations at roughly 39.5 million dollars. On the commercial and retail side of the business, it was right around $270,000, and the reason it's lower is roughly 15% as a retail sales come within the second quarter which you can look at our AKA filings and we put a disclosure in there and you can see that and we carry a lot of dual overhead with the StairMaster acquisition. We expect that business to be strong in the second half of that year.

Thank you.

Your final question comes from Eric Wold.

Hey guys, one quick follow-up question. I know you're not going to break out the bed sales for the quarter but maybe talk conceptually. What's driving bed sales more on a consecutive quarter basis, is it more ads and infomercials you're putting out there or more efficiencies from the ads that you are doing or a combination?

It's a combination of both, the same thing that has driven our Bowflex sales consistently over the past few years. It's a combination of improving efficienc and driving, fueling it with more advertising dollars.

Okay, thanks.

Thank you.

There are no further questions at this time.

Well, okay. Thank you very much for participating in today's conference call. We look forward to speaking with everyone next quarter.

This concludes today's conference call. You may now disconnect.