Nautilus Inc (NLS) 2002 Q3 法說會逐字稿

Good afternoon, ladies and gentlemen, and welcome to the Nautilus Group quarter three 2002 earnings conference call. At this time, all participants are in a listen-only mode. Following today's presentation, instructions will be given for the question-and-answer session. If anyone needs assistance at any time during the conference, please press the star followed by the zero. As a reminder, this conference is being recorded Tuesday, October 15th of 2002. I would now like to turn the conference over to Mr. Brian Cook, Chief Executive Officer. Please go ahead, sir.

Thank you. Good afternoon. I'm Brian Cook, Chief Executive Officer of the Nautilus Group. Thank you for joining us today to discuss our results for the third quarter of 2002. Kevin Lamar, our President, and Rod Rice, our Chief Financial Officer, are here today with me in our offices in Colorado. Michael Newman, our investor relations spokesperson joins us via conference from his offices in Seattle.

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 to health clubs and other institutions, and we sell a complete line of consumer fitness equipment under our Nautilus, Schwinn, Stairmaster, and Trimline brands through a network of specialty dealers, distributors, and retailers worldwide.

Today we released the results for the third quarter of 2002. It was another great quarter. We reported strong sales and strong earnings. We are especially pleased with our operating performance in light of the more challenging macroeconomic and retail spending environment. 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 results and our outlook for coming periods. Then Kevin and I will come back to discuss some of the significant events of the quarter and our strategy for capitalizing on the opportunities before us. Rod?

Thanks, Brian. Except for historical information presented, our discussion today contains forward-looking statements which contains words such as intends, believes, anticipates, and expects. These forward-looking statements involve risks and uncertainties that may cause our actual results to be materially different from those expressed or implied by these statements. Factors that may affect the Nautilus Group results are described in detail in our SEC filings.

Today we released results for third quarter ended September 30, 2002. We reported record net sales of 152.9 million, up 72 percent from 88.7 million for the third quarter of 2001. For the first nine months of 2002, we had net sales of 429.2 million, an increase of 80 percent from 238.6 million reported for the same period of 2001. For the third quarter, sales in our direct business segment were 107 million, up 45 percent from 74 million for the same period last year. We continued to see strong demand for our Bowflex Ultimate model. E-commerce sales contributed again to our direct business growth. In the third quarter e-commerce sales were 26.7 million, up 60 percent from 16.7 million for the same period last year. Sales from our commercial and retail segment were 45.8 million or 30 percent of total sales. Commercial and retail sales were up from 14.7 million for the third quarter of 2001, but please note in third quarter of last year, we did not own Stairmaster and had just purchased Schwinn Fitness at the end of the quarter on September 20, 2001. Our gross margin for the direct segment was 75 percent for the third quarter compared to 70 percent for the same period in 2001. Based on our increased sales volume, we continue to be successful in gaining cost efficiencies from our direct product suppliers.

Gross margin for the commercial and retail segment was 18 percent for the quarter compared to 29 percent for the third quarter of 2001. Our lower commercial and retail gross margins primary reflect not having our new high-margin retail products available for sale combined with discounts of sales of discontinued retail products and manufacturing inefficiencies associated with the move and consolidation of our treadmill manufacturing facilities. These events were isolated to the third quarter, and we expect to see substantial improvement in gross margin during the fourth quarter as we achieve seasonally higher sales levels and increased shipment of our new retail products.

Our combined gross margin for the quarter was 58 percent compared to 63 percent for the third quarter of 2001. The decrease and combined gross margin is due to the higher percentage of commercial and retail products, which have lower margins than our direct products. For the fourth quarter of 2002, we expect our combined gross margin to be in the range of 55 percent to 57 percent as commercial and retail sales increase.

Overall operating expenses for the third quarter were 49.2 million, up 61 percent from 30.5 million for the third quarter of 2001. As a percent of sales, total operating expenses were 32 percent compared to 34 percent for the third quarter of 2001. For the fourth quarter of 2002, we expect operating expenses to be in the range of 30 to 32 percent total sales.

Sales and marketing expense for the third quarter were 40.7 million, up 62 percent from 25.1 million for the same period in 2001. As a percent of total sales, selling and marketing expenses were 27 percent, down from 28 percent for the third quarter of 2001. We did see an increase in direct segment sales in marketing sequentially as a percentage of total sales, which reflected an increase in advertising rates during the quarter for the first time in about two years. For the fourth quarter of 2002, we expect combined sales and marketing expenses to be about 25 to 27 percent of total sales.

General and administrative expenses for the third quarter were 5.6 million, up from 3.7 million for the same period in 2001. As a percent of total sales, G&A expenses were 4 percent, essentially unchanged from the same period last year. For the fourth quarter of 2002, we expect G&A to remain in the range of 4 to 5 percent of sales.

Net income for the third quarter was 25.1 million or 71 cents per diluted share, up 49 percent from 16.8 million or 46 cents per diluted share for the same period of 2001. For the first nine months of 2002, net income was 74.8 million, an increase of 63 percent from 46.1 million for the first nine months of 2001. Our cash and short-term investment position at the end of the third quarter was 63.2 million compared to 51.7 million at the end of 2001. During the quarter our cash flow from operations was approximately 25.7 million. We repurchased 430,500 shares of our common stock for approximately 10.9 million, and we had capital expenditures of approximately 11.4 million for new computer systems in our direct business and new consumer treadmill manufacturing facilities and equipment. Our accounts receivable were 37.8 million at the end of the third quarter, up from 24.9 million at the end of 2001.

Day sales outstanding were under two days for our direct business. For our commercial and retail segments, DSOs were 72 days at the end of the third quarter compared to 54 days at the end of 2001. The increase in commercial and retail segment DSOs is due to seasonal timing of orders in the last month and third quarter where more sales occurred in September because retail and commercial fitness centers are taking delivery of products for the fitness season, which typically begins on October.

Inventories were 62.4 million at the end of the third quarter, up from 45.5 million at the end of 2001, but down from 68.8 million at the end of the second quarter. We increased our inventory direct products during the year to catch up with demand for the Ultimate and also to be prepared for a possible strike by longshoremen. Inventory in commercial and retail segment has increased primarily as a result of the Stairmaster acquisitions in February of this year.

Looking ahead, we expect sequentially stronger fourth quarter commercial and retail sales based on seasonal buying patterns and increased shipments of our new retail products. As a result, we continued to expect year-over-year sales to increase by approximately 60 percent and year-over-year income to increase by 50 percent.

In addition, we expect that our commercial and retail segment will account for about 32 to 33 percent in total sales in 2002. As we move toward 2003, we continue to assess how the recent macroeconomic trends that may impact our business. These trends include indications of more cautious consumer spending, a decline in overall consumer confidence and higher advertising rates for the first time in nearly two years. Assuming these trends continue into 2003, we would expect to see substantially lower sales growth in the next year, while continuing to generate profits comparable to 2002.

Nevertheless, we like our business model because we believe, even in times of geopolitical and economic uncertainty, we can continue to remain very profitable and, over the long term, we continue to see a very positive outlook for the global health and fitness markets. We hope to provide you with better visibility for the coming year in our next quarterly conference call.

Finally, you should keep in mind that we expect to return to normal seasonal patterns in 2003, with important first quarters typically being the strongest quarters for commercial retail products, and the second quarter being our slowest quarter overall. In addition, we continue to expect quarterly sales to fluctuate according to such factors as costs and availability of advertising as well as the general state of the economy.

In summary, I'd like to report the financial health of the company is excellent. It continues to generate strong positive cash flows from our business operations. We are investing in our future by continuing to develop new products, expanding our sales and marketing infrastructure, upgrading our IT systems. Overall, we feel that Nautilus Group is extremely well positioned to capitalize on the market opportunity before us. Now I'd like to turn it back to Brian. Brian?

Thanks, Rod. During the quarter we continue to maintain our leading position in the health and fitness markets. While we are preparing for the possibility of lower growth in 2003 because of the macroeconomic conditions related to consumer spending and advertising rates, we believe that long-term trends for our business remain very positive. Health and fitness are important goals for people around the world and especially for our target demographics groups, which include baby boomers, women, and seniors. In our direct business, we offer a selection of high-quality premium products that address the major components of a health lifestyle - exercise, rest, and nutrition.

As we said before, our long-term growth strategy involves introducing new products to our direct business, drawing on our powerful consumer and media database, and further leveraging our stable of powerful consumer brands. In our commercial and retail business, we continue to expand our product lines, integrate our recent acquisitions, and leverage the synergies of our Nautilus, Schwinn, and Stairmaster brands and distribution channels.

At this point, I'd like to turn the call over to Kevin Lamar to discuss our progress and strategies for growing the business.

Thank you, Brian. In our commercial retail business, we continue to integrate our Nautilus, Schwinn Fitness, and Stairmaster operations during the third quarter. Our performance in the commercial retail business was clearly below our expectation, both from a sales and margin standpoint. The shortfall in sales was substantially due to the fact that the new products we introduced during the third quarter were not available for shipment during the quarter, but these new products are expected to contribute to fourth quarter sales, and, as Rod discussed, the weaker gross margin in the commercial and retail business was substantially due to not having our new high-margin products available for sale, combined with discounts on sales of discontinued retail products and manufacturing inefficiencies associated with moves and consolidations of our treadmill facilities. These events were isolated to the third quarter, and we expect substantial improvement in both sales levels and margins in the fourth quarter.

In addition, we're especially pleased with our successful introduction of 16 new retail products and product enhancements at the Health and Fitness Business Show in Denver. Under the Nautilus name we introduced new premium strength equipment for the home, which builds on the commercial reputation of Nautilus for quality strength equipment. At the same time, we introduced a new line of consumer retail cardio equipment including treadmills, stationary bikes, recumbent bikes, and ellipticals. That continues to strengthen the Nautilus brand across the complete spectrum of fitness products. Likewise, we continue to enhance our Schwinn retail brand. We introduced two new Schwinn Evolution indoor cycling bikes to maintain our product leadership in the indoor cycling movement. We also introduced a new line of Schwinn consumer retail elliptical trainers to bring the Schwinn name to the fast-growing segment of the fitness market.

We are also continuing to broaden our worldwide sales and marketing efforts. We believe that our new products help support our dealers who are looking for exciting new products to draw consumers to their showroom. By offering new products and complete lines under Nautilus, Schwinn, and Stairmaster brands, we are working to solidify our position as a single-source supplier for our retail dealers.

In the fourth quarter we expect to see stronger sales from our commercial and retail business driven by seasonal buying patterns and demand for our new retail products. In addition we have recently begun new radio campaigns in the U.S. using well-known personalities such as Paul Harvey and ESPN's Mike and Mike to promote our retail products.

There is still a lot of work to do to integrate and streamline the business. We are positioning ourselves to be a global leader over the long term. 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 addition to our business progress, we continue to implement and observe best business practices for corporate governance. For example, we are now including the CEO and CFO certifications required under the Sarbanes-Oxley Act when we file our quarterly reports to the SEC, and our board of directors and management team are prepared to comply with all other aspects of Sarbanes-Oxley and the regulation adopted by the SEC to implement that Act.

We also announced today that our board of directors has authorized a new share buyback program to repurchase up to $30 million of our common stock and open market transactions from October 21, 2002, through January 31, 2003. The terms of the purchases are to be determined based on market conditions.

Given our expectations for a continued strong, positive cash flow and prospects for long-term growth, we believe our stock is undervalued and that stock repurchases will benefit the company and our shareholders.

In summary, we are pleased with our strong sales and profits for third quarter despite continued challenges in the macroeconomic environment. In our direct business we continue to see strong demand for our high-quality products. In our commercial and retail business, we continue to integrate the acquisitions and consolidate operations, laying the groundwork and foundation for future long-term growth and further leveraging of our powerful brands, quality product lines, and outstanding product development platforms. As we move towards 2003 we continue to assess how recent macroeconomic and geopolitical trends may impact our business. Even in times of economic uncertainty and substantially slower sales growth, we continue to believe in our strong business fundamentals and our ability to continue to remain very profitable.

We have a very strong balance sheet with over 63 million cash short-term investments and no debt. We continue to have a very positive outlook for the global health and fitness markets over the long term and remain very excited about our long-term growth strategy and worldwide market opportunities.

This concludes the formal part of our presentation. In accordance with SEC 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 accessful and broadcasted conference call. Kevin, Rod, and I will be pleased to answer your questions at this time.

Thank you, sir. Ladies and gentlemen, at this time we will begin the question-and-answer session. If you have a question, please press the star followed by the 1 on your pushbutton phone. If you'd like to remove your question from the polling process, please press the star followed by the 2. You will hear a three-tone prompt acknowledging your selection. Your questions will be polled in the order they are received, and if you are using speaker equipment, please lift your handset before pressing the numbers. One moment, please, for the first question. The first question comes from Andrew McQuilling with UBS Warburg. Please go ahead, sir.

Thanks very much. Rod, I was hoping you could talk about sales growth for 2003 - just a rough idea what you're thinking for the direct business and for the commercial and retail business and what Bowflex units are you currently estimating right now for 2003? And then the second question is what type of spending increase on S&M expense do you expect in 2003 on the full year as a percentage of sales for the direct business? Thanks.

Well, Andrew, this is Brian. Over the past 18 months we've had very strong performance despite the economic slowdown. Today we're seeing continued economic slowdown, lower consumer confidence, and if those trends continue, combined with higher advertising rates, we expect that they will affect our performance in 2003. I don't think we have very good visibility at this time on whether or not those are trends that are going to continue or reverse themselves, but we certainly expect to update you further at the end of next quarter.

And, Brian, could you talk at all about the increase in ad spend rates. What type of increases you're seeing year-on-year third and fourth quarters? And what do you think is a likely number? What's the shakeout for cable ad rates and for the satellite business?

Sure. Andrew, this is Rod. I'll try to answer that. For example, when you compare the direct marketing - it's hard to compare that quarter to the third quarter on the direct side, because in the second quarter what we're doing, we're catching up with demand for the Ultimate product we launched in the first quarter. So it's not comparable, but our selling and marketing expense on the direct side of the business in the second quarter was 27.7 percent. In the third quarter it was 31.9 percent. You know, it's our first sequential increase that we've had in two years. So it's really hard to predict. In the fourth quarter we expect that same type of trend to continue, if not go up a little bit, but we need a little bit more time to read for 2003.

Okay, and, Rod, what was the Bowflex unit growth number for the third quarter? And can you tell us what you're expecting for the fourth? Bowflex units?

Sure. You know, when you look at the second quarter what you're going to see is we got caught up with demand for the Bowflex Ultimate. We sold 63,000 units in the third quarter and that compares to 64,000, second quarter. So one of the real positive sides today is ASP. What kind of really amazed me - ASP was $1,540 in the third quarter approximately compared to about $1,470. So what we're seeing, we're seeing a very positive trend in consumers that buy our products are wanting to buy upper-end quality products, and, you know, really looking at the fourth quarter what we're expecting for the overall business this year, and that would be grow the top line of about 60 percent and the bottom line by 50 percent, and we expect that commercial and retail will account for roughly 32 to 33 percent of the business.

Rod, and just a last one - and I apologize - fourth quarter sales growth, you were expecting fourth quarter sales growth of 20 percent or so?

I think if you calculate it out, it's going to be a little bit higher than 20 percent.

Terrific, thank you.

Okay, thank you.

Thank you. The next question comes from Carol Byers of RBC Capital Markets. Please go ahead.

Hi, good afternoon. Just a number of questions. Could you discuss the monthly trends that you saw throughout the quarter? I'm just trying to get a sense of, really, what happened throughout the quarter to really spook you guys as to the next four quarters? What happened in July, August, and September with respect to the direct side?

Well, I think, Carol, in general, you know, everybody is hearing a lot about the macroeconomic and geopolitical climate. There's a lot of uncertainty out there today. I wouldn't want to characterize being spooked, that was your word. We certainly are cautious, as we, I think, have been consistently in our guidance. We have been part of a recessionary economy or an economic slowdown for the past 18 months and, at least the things that I read, there's not a lot pointing to that it's going to get over very quickly. We're in the depth of a bear market. I think we're being cautious.

No, I hear you, but I guess I just want a little bit more specifics about the trends in your business. Were the months consistent? Were July, August, and September consistent across the board, or were July and August stronger than September? What happened throughout the quarter on the revenues?

What we're seeing here - each quarter is a little bit different as far as what happens in the outside environment - what's in season and what's out of season, but what we did in the overall quarter was selling and marketing expense as percents of sales on direct business and all that. I mean, we have not really seen that in two years, even though we compare the previous year - like this year was 31.9 percent compared to the previous year third quarter at 31.6 percent, you look sequentially, and we would expect that we would have done a little bit better than that. Did third quarter, if you look at fitness season, which we talked about commercial and retail fitness season, the consumers - now, later in the quarter that's when the fitness season really starts. So right now we think there's an identified trend, and we've looked at the macroeconomic conditions out there, geopolitical - if we go to war, we think we could be an impact on this. It's very hard to read what the impact is going to be. We're trying to be as cautious as we can.

But just following up on your selling and marketing comment - if we looked at the increase - the sequential increase that you talked about with selling and marketing - were you having to spend more for sales? What impact - where is the impact coming from? Is it having to spend more for sales or is it the actual advertising rate going up? And can you quantify that better for us just to better understand.

Without a doubt, we saw two things. We saw actual advertising rates increasing as well as availability somewhat tightening. I'm not sure we can tell you why that is, because, certainly, in light of the macroeconomic trends, I'm not sure I understand why. But we can tell you we certainly didn't see that.

Are you seeing a similar return on the sales - on the spending that you're getting - that you're investing in today as compared to last quarter?

The overall conversion rate on our spending?

Yes.

We think it's very positive.

And you didn't comment on the mattress sales - how is that business going?

Oh, I think, overall, the analysts, in general, are looking for that segment to do or that product to do $35 million to $40 million. I'm very comfortable with those ranges, and they're certainly in line with ours.

Okay, let me open to other people. I may jump back on. Thanks.

Thank you. The next question comes from David Dially with Kingsford Capital. Please go ahead.

Thanks. A couple of questions - first, the net sales that you guys provide - does that reflect a net of return calculation?

Yes, it does.

And then separately, on the approval rates, can you give us any color as to what household has been doing recently in terms of approval rates for consumer buying?

You know, the trend is down somewhat.

Okay, and then do you guys - are you participating in managing that credit risk, I guess, on their part?

We have a non-recourse agreement - things that we learned a long time ago, things that we know how to do are the things that we do - other things that we don't. We outsource. We are not credit experts. So we're going to keep it a non-recourse agreement. We don't want to be aggressive. We're making a lot of money today, and we believe we can make a lot of money in the future.

Okay, and then lastly, there seems to be some new competition that's shown up in the last couple of weeks, specifically a new product from Icon. Have you guys any color about that product?

Which product are you referring to specifically?

It's a product that they're calling the "Crossbow," which has a resistance system that - to be honest, it looks like they've copied the Bowflex Power Rod.

Well, I certainly saw that product. We haven't seen any impact on the product at this time. It's a brand-new product on the market, and we're certainly reviewing it at this time.

Do you think that your best guess at this time - does it look like it infringes on your patent?

I don't think I could comment on that at this point.

Okay, fair enough. I'm sorry. Okay, thank you.

Thank you. The next question comes from Maynard Arup with Wells Fargo. Please go ahead.

Good afternoon, guys, just a couple of questions. Have you guys seen any impact from the port workers' walkout recently on your supply?

Well, Maynard, as we stated, actually, in the last conference call - on the direct side of our business, we increased inventories in anticipation of some sort of labor disruption. On the commercial retail side, we certainly have a lot of product on the water, and we're hoping that the dockworkers get up to speed in the very near future. We would be the first ones to say, as many people that rely on product sources outside the U.S., we would not want to see a continued slowdown or a strike in that area.

Okay, and are you guys planning to somehow reroute shipment, maybe, to East Coast or something like that? For your commercial and retail products?

Certainly, if things don't straighten out. We're hopeful that, as discussed by most of the media sources, that everything will be flowing back to normal within three or four weeks.

Okay. Also, a question for Kevin - can you give us an update on the integration - what you guys have done, and what is left in the fourth quarter, if any?

Maynard, we anticipate the integration to be done by the end of the year. We're finishing up the integration with our inside sales group and with some remaining IT infrastructure integration, and we expect that to be done, again, by the end of the year.

Great, and last question from me - if you look at the direct business, you know, we haven't really seen, I guess, a new product introduction. Brian, maybe you can give us any idea - do you guys have something in the pipeline or are you guys planning to introduce new products?

Oh, as I stated before, we have multiple products in development on the direct side. We certainly do intend on introducing new direct - new products through the direct channel in the future, but we also will announce the products at the time they are introduced. So I guess I'll just have to say, "Stay tuned."

Great, thank you.

Thank you. The next question comes from Laura Richardson with Adams Harkness and Hill. Please go ahead.

Yes, thanks. Guys, I'm just trying to still get a better understanding of what your thinking related to the statement about substantially slower sales growth and profit comparable to 2002 next year. I mean, is substantially slower - do you consider the fourth quarter that Rod gave some pretty clear guidance on substantially slower? Or are you talking even slower than that?

Well, I think what we are saying is, given the the over trends that we see, you know, and cautious consumer spending, consumer attitude, declining consumer confidence, and higher advertising rates, that I can't tell you whether those things are going to continue, can't tell you how much deeper the recession may get or whether it's going to get better, but we're certainly being cautious in our guidance.

Laura, compared to the fourth quarter, we want to be conservative, and we're talking slower growth than what we're projecting for fourth quarter if the trends continue, which is - it's really hard for us to read at this point. You know, in one more quarter I think we could shed a lot more light on that, but we want to give very conservative guidance.

Okay, and then on the profitability side of that - are you talking about EPS comparable to 2002 or margins comparable? You know, net margin?

Laura, I guess we're very confident in our business model that, given good times or given bad times, that we can still generate significant profits, and we feel strongly about that.

Yeah, Brian, I understand - I'm just trying to get a little more sense, like, if you're growing revenues a little, advertising cost pressures, but you've got some efficiencies from the integration, you know, does that mean EPS grows next year or is flat?

Well, Laura, I think what we're saying is, at this time, given all the things in the economy and the geopolitical environment, we don't think we have great visibility on the exact growth rate for next year or profitability. We do think that we'll have much better visibility over the next 90 days.

Okay, that's fair. Then let me switch gears for a second, just asking about the commercial retail product comments. Was manufacturing not capable of meeting the demand that you had in terms of orders or why were - what was the issue there?

Laura, this is Kevin. The products did get into production, but we had some pretty strenuous QC processes that happened, and it cost us, literally, you know, a week here, a few days there, and stuff like that, and so some of that delivery is happening now, and some of it did get held up in the recent dockworker strike, but we did get them into production. It was a little bit later than we anticipated, but we were very careful and very conscious to make sure that we brought the best product to market that we can.

Okay, thanks, Kevin and Brian and Rod.

Thank you. The next question comes from Ian Ellis with Micro Capital. Please go ahead.

Yeah, good afternoon, gentlemen. I'd just like to go onto the sales and marketing expense ratio - up 320 basis points over the previous quarter. What actually was your advertising rate increase that you experienced? I'm just trying to work out to what extent that was a function of higher advertising cost or advertising rates and to what extent it was the result of a change in the ratio between input and output? And then I'd just like to go on to the following - I understand it's hard to give specific guidance for next year, but that sentence in your press release is vague. Are you talking about comfortable profits in terms of net income or comfortable profits in terms of margins?

Ian, first of all, on the advertising side, what you saw was rate increases. With regard to talking about next year, what we're saying, and I don't mean to be alarmist, we're being cautious.

- right -

- we're saying that we're seeing cautious consumer spending trends, declines in overall consumer confidence. The recession continues. We're seeing higher advertising rates. We're just saying that if these continue, we would expect to see slower growth next year.

Right, no, I understand. Okay, that's fine. Thanks.

Ian, the only comment I would like to add is, yes, we did see advertising rates going up, but the second quarter at 27.7, because we're catching up with demand for the Ultimate, it's not an exact ratio to use the 31.9, but I would say pretty substantial in the third quarter.

Can I just follow up, then, putting those two comments together - Brian's response and yours, Rod - is it fair to assume that ad-per-ad, and it's always hard to go exact comparisons, but ad-per-ad it is still generating the same similar types of revenue numbers?

Well, I think it's safe to say that our conversion rates remain solid.

Right.

That average increase you would expect your cost per inquiry to increase.

Right.

Okay?

Thanks.

Thank you. The next question comes from James Sellessa with D.A. Davidson and Company. Please go ahead.

Good afternoon. What are QC processes?

I'm sorry?

Yes, there was a statement that there was a QC processes.

Quality control, James. On some of the quality controls, we inspected everything from the finish of the product to the drive train mechanisms - you name it. We went over those products with a fine-tooth comb and not just spot inspection - almost every one of them, James.

So QC processes and the dockworker slowdown prevented you having all the product that you thought you were going to have in the quarter, is that correct?

James, it was a combination of having that. We did launch the 16 new products. We received incredible response from our dealer network, and then we began the process of getting them in production. Some of them, because of the quality control processes were late here by a day or two or a week here, and then the slowdown of the import mechanism, we, in essence, had hardly any realization of the profitability that these new products could bring to us.

Rod, did you revise lower the Bowflex unit sales in the second quarter? I had down in my model 64,000. Did you say 63,000 this time?

What I said is, I said we had 64,000 units in Q2. We had 63,000 in Q3. I did not change any previous numbers that were given out about Q2.

It's 63,000, the most recent quarter?

That is correct.

And the average selling price in the third quarter was?

Approximately $1,540 compared to the second quarter of $1,470, approximately.

Your gross profit margin on the direct side this quarter was what again?

It was approximately 75 percent.

And the direct side was 18 percent, did I hear that correctly?

The commercial retail side was approximately 18 percent, yes.

And you said something about approval rates of Household Finance, or whatever their name is, is down. Can you elaborate what that means and what's happening there?

Well, I think, you know, Household is just seeing the effect of the overall economy, even though that interest rates have gone down, the banks have seen a general tightening. So we've seen somewhat of a tightening, but I think our results in our direct business right now, what we've really seen is an increase of advertising. Our conversion is doing very well.

Can you share with us what percentage of your direct sales are through third-party, non-recourse debt?

Sure, it ranges from about 36 to 40 percent. It depends on the quarter.

And the most recent quarter was?

That information, unfortunately, I do not have in front of me.

Okay. Can you go through the C&R, the commercial and retail business revenues all the way down to the net income line?

Sure. And I'll round here a little bit - net sales, 45.8 million; gross profit, 8.4 million; selling and marketing, 6.5 million; G&A, 2.7 million; royalties about 250,000; you've got total operating or income from operations was negative about 1.1 million; and it gets you down to net income, and we have other net, which includes currency fluctuations and a few others things of about 400,000; that gets you down to net income of minus about 960,000.

And this suggests to me, looking at the numbers, that your direct side was much more profitable than it has been. Is that correct? And, if so, why?

It was very profitable, and it was a couple of things driven. Number one was the top line - $107 million in sales. And the other thing, we've been very good about and very efficient about getting the best pricing from our suppliers. I mean, they're feeling macroeconomic conditions, too, and we have a gross profit margin of approximately 75 percent on the direct side of the business. We've worked with our in-house logistics department. They're doing a very good job of saving us money on shipping our products.

And do you think this type of a profitability level may continue in the fourth quarter?

I think we're going to achieve the results that we talked about last quarter that we could use the 60 percent top line, 50 percent bottom line. I think when you look at those numbers, it's pretty comparable to third quarter.

And did you say, if I heard correctly, that -

- on a combined basis, though.

Your C&R business should account for, in 2002, 32 to 33 percent of your total?

That is correct. We're expecting seasonally higher sales for fourth quarter for that business, and substantially higher gross profit margins.

Thank you very much.

Thank you. The next question comes from [Michael Polis] with [Glenhill Capital]. Please go ahead.

Hey, how ya doin'? A couple of questions - first is, can you elaborate a little bit on the competitive threat, specifically with regards to the BandFlex and the Crossbow, which are both coming in at less than one-half your price point and both of which were released in the past few weeks? I guess my concern is that, based upon a conversation with Icon and Crossbow, that they're running at a run rate of about 10,000 units for the fourth quarter off a base of zero units in the third quarter, and that both Crossbow and BandFlex are utilizing a direct compare ad campaigns, which seems different from past competition.

Well, first of all, we are the leading marketer in our category. Secondly, the Bowflex sales continue to be strong. We have not seen any impact from either of those products, and we'll certainly continue to evaluate that situation.

Well, I guess, one of the concerns, I guess, would be is that you mentioned that your ASP increase from about 1,470 to 1,540 in the quarter, and both these products are coming out with price points at around $500. Is there any concern about pricing coming up? Does that lead into some lower revenue numbers that you guys are projecting?

Our customer wants quality product. Our customer has shown us, over the introduction of the Ultimate, that they are even more inclined to buy our higher-priced products. These products are not even in the price ranges that any of our products are in. To date, we haven't seen any effect of the BandFlex. It's been around for a while now, and we certainly - the Crossbow is a brand-new product, we haven't seen any effect, and I'm not sure whether we anticipate seeing any effect from it.

All right, and then, I guess, secondarily, I have a question on sales and marketing expense. If you look at third-party information services, such as IMSTV.com, you're ad volumes increased about 51 percent sequentially, and the ads were showing in better slots and on higher profile stations and the gain of viewership increased about 106 percent sequentially, yet your direct marketing and selling expenses were up about 20 percent sequentially, and you guys had mentioned that your CPM rates had also increased. So I was curious, sort of, if there was a disconnect there or whether some of the increase in prepaid expense or on some other items in the balance sheet are reflected with regards to sales and marketing stuff.

You know, I'd be more than happy to have you send us the information you have, because I don't believe that would be correct whatsoever. We track to each and every commercial, and ours is very accurate, and prepaid expenses, first of all, when we air a commercial, we expense it. There's no prepaid - we don't air a commercial and put it in prepaid, any portion of it whatsoever - you air it, you expense it. That's our policy. There's nothing in prepaid, actually. When you take a look at prepaid, for example, we have in our new insurance policies up, we have about 1.9 million there, and we do have some trade shows and we also, what we did, is for the [Quinton] acquisition, or we sold [Quinton] Manufacturing, what Kevin mentioned is we reduced our purchase pricing. So we've taken those assets out of purchase price allocation, put them into prepaid, because the sale of that occurred on San Juan of those. When we ran a commercial, we expensed it, and I'll be more than happy to go over your data and give it to our marketing partner, and -

Sure, well, it's on IMSTV.com. That's where I got the data, exactly, from. So it's possible I'd like to follow up after - offline.

That would be great.

Great. Thank you very much.

Thank you. The next question comes from Tim Phillips with Barclays. Please go ahead.

Yes, you said the unit sales in Q2 were 64,000, in Q3, 63,000. Do you have an estimate for Q4?

We don't really give estimates on unit sales. What we believe is, you know, for the year, we grew the top line by 60 percent, and the bottom line by 50 percent, and we believe that the commercial retail will represent about 20- or excuse me, 32 to 33 percent of the overall sales. So what you're going to see is commercial and retail should be higher sequentially in the fourth quarter.

OK, then the increase quarter to quarter in receivables from $22 million to $37 million? You said, you know, timing, you shipped a lot in September-

Yeah, what happened, it's all-- it's really on the commercial/retail side of the business, and there's two components of that, and they kind of work the same. There's the commercial fitness centers, and then there's the retailers. The fitness season really begins the beginning of October, so what the commercial fitness facilities are doing, they start getting their new equipment in September when the members, the new members, come into the club. Having new equipment is very important in that industry. Then in the retailers, what they will do, too, is they're going to start getting product in September, for when the customers come in October. So your slower months are July and August, and in fact, the second quarter is very slow, where you historically do about 15 percent of your overall sales. Then when you get into Q3, you do 22 to 23 percent of your overall sales. And that's the reason for this increase in receivables.

When I looked at the June quarter to September quarter of last year, I didn't see-- you know, there were minimal receivables, $4.5 million--

Right. When you look at for last year, you've got to remember, we bought Schwinn on September 20th, out of bankruptcy. They kept most of their receivables, and what we got out of that was nine days of sales, and we didn't own Stairmaster at that time. We bought Stairmaster in February of this year. And in June, it's just a real flat quarter. The hotter it gets outside, the less people go to commercial facilities, the less people who go into stores to buy fitness equipment. So when you look at the second quarter, it was actually just the opposite. What happened is, you really look at your fitness season as October, you know, through about February or so, so you would expect your April sales to be better than your May and June.

OK. Next question. I really like the machines, I bought one in July for my home, and then I bought one again and ordered one in September for my vacation home. When I ordered the one in July, it only took 11 days to get it. Or excuse me, the other way around, when I ordered it in July, it took five weeks to get it. When I ordered it in September, it only took 11 days. Is that the backlog dropping, or is that just production schedules? Can you explain the differences?

I can't explain the entire differences, but I think we've said that we were catching up with the Ultimate production. I don't know which models you got. And we typically-- we typically have a backlog of a week to two weeks. The five-week delay, I don't understand.

It's not optimal to run your business.

OK, thank you.

Thank you. The next question comes from [John Boddie] with [Boddie Brown]. Please go ahead.

Hi. Just a quick question -- can you give us some sense of where you think commercial and retail will be next year, as a percentage of sales?

I think we're, you know, in general, we're-- we can go to our long-term guidance of about 35 percent of our total sales, but we're still, you know, assessing the macroeconomic conditions. We'll be able to talk more specifically in our next quarterly conference call.

OK. And then I guess I'm confused -- and maybe some other people are as well, but I mean, if I read it correctly, you're taking down estimates next year by 15 to 17 percent, and you're guiding for substantially slower sales. I guess I'm trying to get some sense as to-- I mean, you talk about the weakening consumer, and this has been in the recession, and this has been going on for quite some time. It seems like there has to be something that would be creating concern for you which you're not talking about. Is there anything else you can tell us?

Well, first of all, I don't know that we're guiding on next year; I think what we're telling people is we're not guiding, we're seeing some trends that concern us, and consumer spending, the overall economy, has been in recession for quite a while.

But--

Excuse me. We're seeing, you know, some declines in consumer confidence and higher advertising rates. What we are saying is we don't know whether those trends are going to continue, but if they do, they certainly could impact next year's sales growth. We've said that we believe we'll have better visibility on that at the end of the fourth quarter, and we'll certainly update people at that time.

I mean, maybe I'm reading the press release wrong, but it doesn't say ``possibly'' - it says ``we would expect,'' and it also-- it's not just about sales, it says about profits, and it says, ``generate profits comparable to 2002,'' which is a 3.40 estimate for next year, and profits this year are around $2.80. That's a 15 to 17 percent decline. So, I mean, am I reading it wrong, give us some guidance?

OK. Now, I'd like to try to answer it as correctly as I can. Assuming trends continue, you know, we would expect, if the trends for cautious consumer spending, decline in consumer confidence, and higher advertising rates continue, we would expect to see slower sales growth, exactly what the press release says. I don't think we're prepared to say exactly what the percent sales growth, because we're still assessing.

OK, but that's really not what my question is. My question is, the consumer has been weak, we've been in a recession for a long time, so what has made you change your guidance, because it is a change in guidance?

Well, I don't think we've changed. I mean, again, I want to say, as-- as straightforward as I can, we're just seeing cautious consumer spending Yes, we have been in a recession for a long time, and our company has done very well, up to date, and we think we'll fare well going forward. However, there are some trends that we're seeing, and we've said that these may affect next year's sale growth. And I hope I've answered your question, you know?

OK, no, but-- so essentially, you're saying the only trends you've seen are macro trends that, you know, reported by ISI, or in the newspaper, ``Wall Street Journal,'' so and so on, you're saying you see no trends in your business whatsoever that's making you change your guidance?

Other than the higher advertising rates that we've mentioned.

OK. Thanks very much.

Thank you. The next question comes from [Bill Deselum] with [Davidson Investment Advisers]. Please go ahead.

The prior questioner actually asked some of the direction where I was going, so I'd like to pick up on that. Brian, you were just saying relative to what the factors that led you to throw out the caution, if I may use that phrase. In fact, the-- are there other specific items to your business, not macro-- not the macro factors, but specific items that you are seeing, other than the advertising rate increases?

Well, Bill, I think we've been very straightforward in saying, you know, we've seen higher advertising rates, tighter advertising availability, we think we're seeing a decline in consumer confidence and cautious spending trends. And you know, I don't want to alarm anyone, but this has been a long recession, and if those trends continue, they may well affect us going forward.

OK. And just to make-- I want to make sure I'm really truly understanding your comment there, because I could interpret it two different ways. The first way is that you are seeing the slower consumer spending and lower consumer confidence impact the way the sales process goes, or is going, for Nautilus, or I could take the other approach and say that the management of Nautilus recognizes that there has been weak consumer confidence and soft spending, consumer spending, for some time, and at some point, this may catch up with your business. Which of those two should-- are the proper interpretations?

I think that the second characterization is what we're trying to express, that there has been a lengthened period of economic slowdown, that we are seeing cautious consumer spending. I think if you look at our third quarter results, you'll see, especially on the direct side, we had great results, but we are cautioning that, ``hey, if these economic trends continue into the future, we may be affected.''

That's helpful. Let me ask another question that kind of sends us maybe down a similar path, but I hope adds some clarity, at least for me, anyhow. Relative to the next 90 days, you folks had mentioned that on the December quarter conference call that you'll provide more clarity relative to what your thoughts are on calendar '03. So my question is, what happens in the next 90 days that clears some of the fog on '03?

Well, first, we're going to be into fitness season. We're going to get better clarity on the commercial retail business, and we'll get another 90-day view at the overall macroeconomic and geopolitical arena, and I think those could all add to clarity.

That's helpful. And then in the press release, the term ``comparable''-- I think ``comparable earnings'' or something to that effect was used, and then on this call-- I've had some interruptions, so I hope I'm either not repeating or am going the wrong direction here or taking things out of context, but I thought I heard on this call reference to slower growth, and I actually ``view comparable'' as a word that equates to ``flat,'' whereas ``slower growth'' would equate to saying, ``hey, if we're going to grow 50 percent earnings this year, we're going to grow less than that.'' Which of the two contexts, flat or growing less than 50 percent, were you intending in the press release?

I don't think your growth expectations for next year were ever 50 percent. I think previously-- previous guidance was more in the 25 percent range. So-- and I think that what we've said and what I'm going to say one more time is, we don't see clear visibility for next year for the reasons that we've stated in the press release and on this conference call. We think we'll have better visibility 90 days from now.

That's helpful, and then I do appreciate you trying to provide some clarity here because I know I'm a little slow. Relative, then, to trying to make sure that I understand, when you say the ``comparable,'' and I'm specifically pulling that word out of the press release because it has the connotation of no growth, but I don't know if that's what I'm hearing you say on the conference call in terms of what you're currently cautioning toward.

Well, and I think that the line in the press release is saying, ``assuming these trends continue,'' you know? That's an assumption. We don't have good visibility on whether they will or will not. So I think we're trying to be cautious, as we always have been, and conservative, and but we're telling we really think we'll have better visibility in another 90 days.

Brian, that's helpful. I actually do have one more question, and this, I just- I think you addressed earlier in the call, but I missed it, and that was relative to the fourth quarter, versus the third quarter, the direct business, and what-- what are your general thoughts on the direct business, Q4 versus Q3? Up, down, or flat?

You know-- you know, overall, we see the business growing 60 percent, top line, 50 percent bottom line, and we expect higher seasonal sales from the commercial, you know, retail business. We're comfortable with, you know, the previous guidance for the year, that we can achieve those results, and you know, we're just going to have get there and wait and see. We think we've got a good handle on the fourth quarter.

Rod, off the top of my head here, I'm not able to put together, given that the commercial/retail, that's actually changed, because we've added Stairmaster and probably actually added Schwinn to a large degree here also. That's why I'm circling back specific to the direct side of the business, is I'm not able, in my mind, to separate out what the proper-- the proper pieces are here.

Well, we continue to see strong demand for the Bowflex product line, and we think sales in the fourth quarter will continue to be strong.

And we've seen real strong demand in the second quarter. I mean, we did sales of $107 million, but we did see selling and marketing expense go up, but we also have seen gross profit margin go up.

OK, thank you.

Thank you. The next question comes from [Hale Holp] with [Enwood Capital]. Please go ahead.

Good afternoon. Most of my questions have been answered, but regarding, and not to beat a dead horse, but regarding your cautious outlook, is any of that a factor of Household Finance being more cautious on their lending? You've said that-

Not at all.

I'm sorry, what?

Not at all.

Not at all? OK, well, that helps very much. Thank you.

Thank you. And we have time for one additional question. The question comes from Douglas Whitlock with DA Davidson & Company. Please go ahead, sir.

Rod, if you don't mind, I'm going to probe a little more on Q4. You've indicated that sales growth for 2002 will be 60 percent, that commercial and retail sales will be up in Q4 versus Q3. If you do the math, it suggests that we could see lower direct sales in Q4 than Q3. Is that an erroneous assumption, or is that a fair assumption?

You know, it could be a possibility. You know, at this time, we're getting all our new products in for the commercial/retail business, we expect that business to do seasonally very well. You know, there's these macroeconomic conditions. You know, 16 new products. We'll just have to wait and see how the quarter comes out. On a consolidated basis, we feel comfortable with the quarter at this time.

I'm sorry, I may have misspoken. I said it suggested that direct sales could be down in Q4 versus Q3.

Well, Doug--

I may have misspoken.

That's a possibility.

OK, OK. Did you see-- was there a softening on the direct side, as the quarter progressed, as Q3 progressed?

No. I think that what we saw was not a softening of demand, is higher advertising costs and probably slightly better availability. You know, and again, as many people know, we run our businesses as a commercial retail division and a direct division, but we strive for overall combined results. So, we run our company to try to maximize our profitability.

Is the advertising strategy going to continue to be exclusively on cable TV?

It's-- it's not exclusively on cable today. When you say cable, let me be- I'm trying to be very accurate.

Cable networks, I'm sorry.

--we use cable, we also use Dish TV. And we use some local network, although we believe, in the future, going forward, we're certainly going to try to expand into more local network.

And I suspect I may be covering some ground that others have. In the press release, when you said that, assuming these trends continue, you would expect to see substantially slower sales growth next year while continuing to generate profits comparable to 2002. With respect to profits, was it your intent to be referring to operating income, net income, earnings per share, or margins?

Net income. Net income.

Net income? OK, thank you very much.

Thank you, and I want to thank everyone for participating in today's conference call. We look forward to speaking with you again next quarter.

Thank you, sir. Ladies and gentlemen, this does conclude the Nautilus Group quarter three 2002 earnings conference call. If you'd like to listen to a replay of today's conference, you may dial 1-800-405-2236, or 303-590-3000. The access code is 499948. Once again, the dial-in numbers are 1-800-405-2236, or 3030-590-3000. The access code will be 499948. Thank you for your participation. You may now disconnect.