Nautilus Inc (NLS) 2003 Q3 法說會逐字稿

Good afternoon, ladies and gentlemen, and welcome to the Nautilus Group quarter 3 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 0. As a reminder, this conference is being recorded Tuesday, October 28th of 2003.

I would now like to turn the conference over to Mr. Greg Hammann, president and chief executive officer. Please go ahead, sir.

Thank you. Good afternoon and thanks for joining us for the review of the third quarter and the 9 months ended September 30th, 2003. With me today is Rod Rice, our chief financial officer. I've also asked Kevin Lamar, president of our commercial retail business, to give you an update on the progress of his division.

On this call today, I'll discuss the strategic turnaround plans and how we believe we will capitalize on the growth opportunities we see ahead of us. Then Rod will review our operating and financial results for the third quarter, and also the 9 months for September 30th. Kevin Lamar will give you an update on our commercial and retail business segment, and then I'm going to conclude with the section of the call of the summary of our current trends in the overall business. We'll then open up the call for questions.

Before I begin, I'd like to remind everyone that our prepared remarks contain forward-looking statements. We may make additional forward looking statements in response to your questions. These statements do not guarantee future performance, and therefore undue reliance should not be placed on them. We refer all of you to our most recent periodic reports on the form 10-K and 10-Q as filed by the Securities and Exchange Commission.. For more detailed discussions of the factors that could cause actual results to differ materially from those projected in our forward-looking statements.

So, with that, let me begin by saying that I'm excited to be at the Nautilus Group. It's a little over three months since I joined the company as president and CEO. And during this time I've gotten to appreciate the opportunities that are available to us in the exercise, rest and nutrition markets. We know that we have the most recognized and respected portfolio brands in the health and fitness industry. We're developing the most advanced research and development capabilities in our industry. We have an experienced management team and we maintain the strongest financial position in the industry.

Yet despite the positive things I've just talked about, the past 9 months have been pretty challenging for the Nautilus Group. And we currently are not capitalizing on our strengths. However, we do believe our plan to turn around these sales and earnings trends will prove to be very rewarding for our shareholders over the long term.

Before we set our turnaround plan into action, we need to understand why we have not fully capitalized on our company's strengths to date. In order to answer this question, we conducted lengthy interviews with our internal team. We talked with industry consultants, and we conducted the most comprehensive marketing research study our company has ever undertaken. This study revealed to us the size of our consumer market, where our consumer base prefers to shop, what they are willing to pay for healthy lifestyle products, and what type of attributes they are looking for in the health and lifestyle product brands.

This study pointed out that our direct channel has been very effective and only accounts for about 20% of the consumer market we are targeting. The other approximate 80% of sales opportunities are through the retail channel. We also confirmed that 70% of the dollars spent by these targeted consumers are for cardiovascular equipment, and only 30% of those are for strength training. However, most of our product offerings and branding to date has been directed toward the strength market and through the direct channel. Now, this information points out that we're missing a very large part of this $5 billion market and thus the opportunity it creates for us.

To provide consumers with the key products they want at the locations where they shop, and to begin growing revenue and earnings again, we need to reposition some of our brands and improve our distribution channels.

Our company believes it's going to make this happen by embarking on what we're calling a traditional three phase turnaround process. And that starts with part one of gaining control.

We are currently in what we call our gain control phase of the business turnaround, which will probably last until the end of the first quarter of 2004. Now, what this phase involves is leveraging each sales opportunity to maximize revenue from our brands. In addition, we must continue to focus on increasing efficiencies by finding ways to reduce expense.

Cash flow from step 1 will provide the necessary capital for us to refocus the company in brands, and that leads to step 2, the next phase, which is stabilize the business. We have the most recognized and respected brands in the industry, tremendous talent and a very solid R&D group. But we need to focus on the development and/or repositioning of our under performing brands. And leverage each one of our channels before our business will begin to grow revenue and earnings again.

After phase 2, we will believe -- we believe we will have 4 to 5 healthy brands that are contributing to our growth and will improve our performance within the four to five channels of distribution that we will operate in. We believe the stabilize business phase will be completed by the end of the third quarter in 2004.

Step 3 of the final phase is begin to grow begin. This occurs when we reposition some of our brands. We've had the chance to improve our sales channels and distribution offerings of the consumer products and delivering these products where consumers shop. And leveraging all of the aspects of our company's competency so we're working as one powerful company. Then, and only then will we begin to experience meaningful growth. And we believe this will start to occur in the fourth quarter of 2004.

In addition to the three-step turnaround process, our entire company has refocused its efforts to identify specific areas of opportunity for us to improve upon and create long-term shareholder value by building a blueprint for growth. As part of this effort, we recently launched a new internal initiative that we're calling fit 1. That stands for financial rigor, innovation, trust and a drive to be number one in the categories we compete in. These are the core strategic elements around which we will structure our activities, enabling us to refocus our efforts and begin to grow again.

Financial rigor focuses on attention to detail in our forecasting and planning activities. It also means a tight control on expenditures and taking immediate steps to drive costs out of the system. Innovation means providing our customers with new products they desire but at a faster pace than in the past, and improving operational efficiencies throughout the company.

The third part of fit 1 is trust. We must reestablish our credibility with financial community, and our shareholders by delivering upon what we promised. It also means we must ensure we are taking care of our customers and doing everything we can to serve them.

Number 1 in the categories we compete, that's an easy one. We need to be number one in each category as we have defined the exercise rest and nutrition segment. And we plan on delivering against that.

Before I get into more detail about how our initiatives are positioning our company to grow again, I'd like to turn the call over to Rod, the chief financial officer, for a thorough review of our operating and financial results for the third quarter in the 9 months ended September 30th. He'll also provide you guidance for the remainder of the year. Rod?

Thanks, Greg. As we look at our results for the third quarter in 9 months, I am excited to say that we are seeing the initial results of our turnaround plan Greg just mentioned. We certainly have a lot of work ahead of us, but I'd like to point out a number of trends we saw during the third quarter that we hope to build upon.

First, our earnings increased by over 40% compared to the second quarter of 2003. Also, our new tread climber continues to exceed expectations. We believe this product will achieve approximately $16 to 18 million in sales this year through a planned restrained demand. This approach ensures that when we roll out brands, our manufacturing, marketing and operations are all performing in unison before we expand our marketing efforts. We are excited about the potential this newly created brand will offer for years to come. Remember, we have 10 years of patent protection remaining on this product.

Also in the third quarter, our Bowflex brand sold 29,000 units through the direct channel. That's compared to 31,000 for the second quarter of 2003. And combined, we achieved sequential quarterly unit sales growth for the first time since the second quarter the previous year, with over 49,000 units sold of our direct and retail channels compared to 42,000 units sold in the second quarter.

One of the reasons we're able to achieve this growth in the Bowflex units is because of our synergies between the direct and retail channels. An example, during the third quarter, is when our direct direct segment leveraged its vendor relationship to market our Bowflex retail locations in Canada. Regarding our Nautilus Sleep Systems, we are repositioning this product by improving the features of the brand and exploring unique specialized channels of distribution. We also introduced new commercial cardiovascular products at the end of the third quarter that will focus on 70% of the fitness equipment market, where we've been underrepresented in the past.

Our revenue and earnings for the third quarter were in line with guidance we gave during the second quarter conference call. Net sales for the third quarter were $116 million, compared to $152.9 million for the corresponding period last year. Net income during the period was $6.6 million. And earnings per share for the third quarter were 20 cents per diluted share, compared to $25.1 million or 71 cents per diluted share for the corresponding period in the previous year. Net sales for 9 months ended September 30th, 2003, were $346 million, compared to $429.2 million for the corresponding period last year.

Net income during the 9 months was $25 million or 76 cents per diluted share, compared to 74.8 million or $2.10 per diluted share for the comparable period last year. Gross profit margin for the third quarter was 47.8% compared to 57.8% for the third quarter of 2002. For the first 9 months of 2003, it was 51.4% compared to 58.1% in the first 9 months of 2002. The reduction in gross profit margin was mainly due to a higher percentage of commercial and retail products, which have lower margins than our direct marketing products.

In addition, declining sales in the direct segment have resulted in higher fixed costs per sale, a change in sales mix from higher margin Bowflex to the tread climber further reduced gross margin. Now, marketing expense for the third quarter was $34.5 million, or 29.7% of sales, compared to $40.7 million or 26.6% of sales for the third quarter of 2002. For the 9 months, sales and marketing expense was $109.7 million, compared to $106.3 million last year. The increase in selling and marketing is mainly due to increased competition and increasing rates, which have resulted in reduced effective of our advertising efforts.

However, it is important to note that marketing expense declined from the second quarter of 2003. General and administrative expenses for the third quarter was $9.2 million, up from $5.6 million for the same period in 2002. For the 9 months, G&A expense was $24.9 million, compared to $19.3 million for the same period last year. Increased G&A expenses are due to costs associated with our new computer systems and legal expenses.

Consolidated offering income for the third quarter was $9.8 million, equating to an 8.4% operating income margin, compared to $39.2 million and a 25.77% operating margin for the third quarter of 2002. For 9 months, operating income was $37.5 million, compared to $116 million for the same period last year. A reduction in operating margin was primarily due to a higher percentage of commercial retail products, combined with higher direct marketing expenses due to increased advertising costs and competition.

Now I'd like to discuss our revenue and earnings by segment. Our corporate holding company segment, which includes direct to cost, general, legal, accounting fees and salary for corporate personnel, as well as other costs not specifically attributable to the other two segments. In addition, treasuries of corporate function, so interest income is included in the corporate segment. For financial reporting purposes, we have reclassified prior year balances to conform to this three segment presentation.

For the third quarter, net sales from our direct segment were $51.9 million, compared to $107 million for the third quarter last year. Direct segment earnings per share for the third quarter were 3 cents per diluted share, compared to 75 cents per diluted share for the same period last year. For the 9 months direct segment net sales were $187.8 million and earnings were 49 cents per diluted share, compared to net sales of $301.2 million and $2.12 per diluted share for the same period last year.

We believe the decrease in net sales was primarily due to competition which has examined continued to adversely impact Bowflex sales through our direct segment. We are seeing signs that the decrease in Bowflex units sold through our direct segment is slowing. We sold 29,000 Bowflex units direct during the third quarter, compared to 31,000 units during the second quarter. And overall Bowflex units sold through the direct and retail channels increased from 42,000 units during the second quarter to 49,000 units during the third quarter of this year.

For our commercial and retail segment, net sales were $64 million for the third quarter, compared to $45.8 million for the same quarter last year, an increase of 40%. Commercial retail earnings per diluted share for the third quarter were 22 cents, compared to a loss of 3 cents for the same period last year. For 9 months, net sales were $158.2 million, and earnings per share were 37 cents compared to sales of $128 million and earnings per share of 3 cents for the corresponding period last year.

Please note we acquired Stairmaster during the first quarter of 2002. Also our Bowflex retail sales equated to $17.7 million or 28 percent of the overall commercial retail sales in the third quarter. Operating expenses for the holding company in the third quarter were $3.1 million, compared to $1.3 million in the third quarter of 2002. This increase primarily due to the legal costs.

For the 9 months, operating expenses for the hold holding company were $6.1 million, compared to $4.7 million for the same period in 2002. Our cash and short term investment position improved to $63.8 million at the end of third quarter, compared to $49.3 million at year end. This was achieved even after paying $9.8 million in dividends, and spending approximately $5.6 million in capital expenditures during the first 9 months of 2003.

Our accounts receivable at the end of third quarter were $57.4 million, compared to $50.1 million at year end. This increase is due to higher volume of sales through our commercial retail division in the latter part of the third quarter of 2003, compared to the fourth quarter of 2002. Remember our DSOs on the direct side average about 3 days. Commercial retail DSOs were 77 days compared to 72 days for this period last year. Inventories decreased to $51.4 million, from $63.8 million at year end.

Moving to guidance. We are comfortable with our previously provided guidance range for the year. Revenues expected to be in the range of $450 to $470 million. Furthermore, we believe earnings per share for the full year will likely be in the range of $1.00 to $1.10 with operating cash flow to be in the range of $35 to $40 million. We are projecting our gross profit margin for the year to be in the range of 49 to 51%. And we are projecting our operating margin for the year to be in the range of 10% to 12%. We will update you on guidance for 2004 on the fourth quarter conference call.

Our next dividend payment of 10 cents per share will be payable on December 10th, 2003, to shareholders of record at the close of business on November 20th, 2003. Now I'd like to turn the call over to Kevin Lamar to discuss the results for the commercial retail segment of the business. Kevin?

Thanks, Rod. Looking at the overall retail fitness industry, we continue to see softness. However, in spite of the overall industry softness, during the third quarter we continued to see strong sales momentum for our Bowflex brand. In the strength fitness retail industry, this product is widely regarded as one of the most highly sought-after products this year. Bowflex is now leading in -- is now leading in such retailers as Sports Authority, Sports Shallay [sp] and Costco, just to name a few. We continue to leverage our existing relationship with top retailers to increase the floor space for additional brands such as Schwinn and Nautilus.

In our commercial business, we launched the new Stairmaster 2100 treadmill in the third quarter. We also introduced a number of new products at the October club industry show in Chicago. One of the products was the new Stairmaster elliptical machine. We are beginning production this month and begin to ship the new elliptical machine before the end of the year.

We also introduced the new Nautilus Nitro Plus with optimum strength curve technology. We believe we will begin production of this new strength machine and line of machines at the end of the fourth quarter. And begin to sell the machines in the first quarter of 2004.

Looking forward, we continue to become more competitive in our commercial and retail business because of our ability to offer a combination of Nautilus, Schwinn and Stairmaster brands. By combining cardiovascular and strength products together, we have the ability to sell our products as a packaged offering.

As Rod mentioned about 70% of a dollar spent in the commercial industry for cardiovascular products. In the past, it has been an underrepresented area of our product offering. However, with the addition of our new Eliptical, and additional Stairmaster cardiovascular machine offering, we are beginning to address this underserved market opportunity.

Now I'd like to turn the call back over to Greg. Greg?

Thanks, Kevin. I'd like to now update you on our overall current business.

Our gain control phase of the turnaround plan is underway and on track. The plan we embarked upon over two months ago is a rigorous undertaking, but I have confidence in this team. We do believe that the brand and channel segmentation work we initiated will deliver long-term value for our shareholders and our employees.

As part of this plan, we announced during the third quarter a staff reduction. That's expected to produce approximately $4 million in annual pretax savings.

In our direct and retail divisions we leveraged each other's channels this quarter to begin marketing Bowflex in the Canadian retail channel. The tread climber brand continues to grow in the planned restrained demand phase of its development.

Number four, we leveraged one of our brands in channels of distribution by developing a strategic relationship with Amazon.com. And number five, our R&D team has developed two new cardiovascular products to address the cardio market where we've been underrepresented in the past.

In summary, we believe we can deliver more of a results like the ones I just mentioned in the fourth quarter and beyond. We're excited about Nautilus prospects, as we build on our solid foundation with a blueprint based on financial rigor, innovation, trust, and a drive to be number one in the categories we compete. We expect to deliver both sales and earnings growth over the long term. And we have the infrastructure, balance sheet and management team to support this growth.

Over the next 9 months, 9 to 12 months, we intend to continue to lay the foundation for clear and sustainable progress. And we believe we can show measurable results from these efforts in the latter part of 2004 and beyond. Let me be clear. We have a lot of work to do. Turnarounds are challenging, and there are always unexpected surprises. We are working diligently on our plan, and we believe it will build long-term value for our shareholders and employees.

At this time, I'd like to open up the call for questions. Operator?

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 push button phone. If you would 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 Carol Buyers with RBC Capital Markets.

It's Carol Buyers, good afternoon. Just four questions for you.

First of all, I was wondering if you look at the commercial and retail business. If you exclude Bowflex, revenues were down versus the previous quarter where it was flat. Is the sales team just more focused on Bowflex right now? Or is that business still weak?

Second, I was wondering what the average selling price of Bowflex was in direct.

Third, once again, on the commercial and retail business, as you focus on this business, it's going to be a use of cash to finance receivables. Any thoughts on how you want to manage the balance sheet or the dividend policy?

And then finally, the contra equity line item that showed up, unearned compensation, can you explain that?

Hey, Carol, it's Greg.

Hi, Greg.

Can you say question four again for me? I just missed that one.

There is a contra equity line called unearned compensation. I was wondering what that was.

Why don't we do this, if it's all right with you, Carol. I'm going to have Kevin handle one and two for you, and then I'll turn it over to Rod for 3 and 4, okay?

Okay.

I'm going to need help on the average for the direct side for Rod.

But on the Bowflex side, Carol, it's not often that you get a chance to take a product like Bowflex into retail. One of the things that we clearly focused on is expanding distribution into such great retailers as Gart [sp] Sports, Sports Authority, Sports Shallay and Costco.

So I would say that we did put a large effort in taking Bowflex to retail. We felt we were successful with that. I anticipate that the fruit of doing that will pay dividends for us in the future by continuing to leverage new products in there as we go forward.

And ASP, on our direct channel, is about $1500. And it's about, on the retail side, it's about $950. So hopefully that answers questions one and two for you.

The $950 -- that's what they sell to the direct to the customer?

Yes, and that's a combination of the Schwinn Bowflex comp with power on technology and the Bowflex Power Pro that is sold in the specialty channel and at Costco. That's correct.

Okay.

Carol, I've got question four, but if you could repeat question three for me, please.

Just on the receivables. Obviously that's going to become a use of cash going forward as you focus on the commercial and retail division expanding Bowflex. Is there any thoughts on the dividend policy? I know you've said you are adamant about that, but just your thoughts on managing the balance sheet?

Sure, let's, you know -- accounts receivable is a very back-end loaded quarter for the commercial retail business. We are at 77 days, you know? We could do better, I think we could do better than that.

And also to you, what you're starting to see is our inventory starting to go down. I think there is still some further opportunities in there. You know, to be quite honest with you, I think there is some opportunities in accounts payable, too, to be able to increase those somewhat. And to manage our working capital even better on that side.

And even though our DSOs went to 77 days on the commercial retail side during the quarter, we increased our cash position in the third quarter. That dividend is going be here for a long time. We believe in it. We are cash-flow positive business. One of the other things to look at is last year we spent $31.5 million on capital expenditures. This year we expect to spend about $8 million dollars.

So we have some -- even with the initiatives that Greg talked about innovation, we still have plenty of cash to grow this business and pay a good difficult dividend.

And just to follow-up on that, Rod. I know you are not ready to give guidance. But based on the comments of Greg first gaining control and stabilizing the business, is it fair to say that we're going to see earnings year over year decline through the third quarter of next year?

I think what we're going to do is we're going to we just come off a good quarter when you look at it sequentially compared to second quarter, it's up 40%. We wanted to see the results of fourth quarter. One thing Greg talked about is step one is T for trust. We want to make sure when we give guidance it's very accurate at this point. And to answer your last question, unearned compensation. What that is unearned compensation for our CEO.

In the form of options?

It's in the form of options and some cash payments. And I've got to tell you from my perspective, he's worth every penny.

Great. Thanks, guys.

Thank you. The next question comes from Laura Richardson with Adams, Harkness & Hill.

Hi, everybody.

Hi, Laura.

I was wondering if there was an update on the sleep system, which I don't think I heard you say anything about. Then I'll give you my list of questions up front, too.

Can you comment on the gross margin you get on Bowflex retail versus direct? And then can you share any thoughts you have about if you're managing a product life cycle. Does the new products early in their life cycle start indirect and then maybe translate into retail when they are more mature? How do you see that working? And keeping product differentiation between retail and direct. Thanks.

Okay. So if it's all right, Laura, I'm going to handle all three of those.

Sure.

On Nautilus sleep system. We think that -- we've been doing a lot of work on that over the last 90 days. I know you asked that question in our last call, and I thought appropriately pushed where you should have, so let me tell you what we've done. At this point, as we've gone through and said, how do we want to reposition this product line and brand’, as we think about branding it and take another run at it and try to build it.

So, part 1 is defining the market space that we want to participate in. And we're going to come at this with a little more of a niche mentality. I can't talk a lot about it today, but you'll see that at the end of the fourth quarter when we make the announcement on it. We're going to take a little more of a niche approach to this brand and position it more appropriately to our heritage of our company and the athletic lifestyle component.

Secondarily, as part of going through that process, we've revamped the product line. We're looking at everything at this point now that we've got the product set of how we want to distribute that product, to what channels of distribution it should play in, whether it's the traditional direct side or maybe a synergistic approach with the combination of retail and direct. And then we're also looking at how we want to handle the advertising and marketing component of it.

So the first part on the product side, we think we've got a pretty good defined product at this point. We're now working on the second and third component of that which is, we've got product pricing done. Now, how is it we want to get the placement to the consumer. And what are the distribution channels that we participate in in order to make sure we maximize that opportunity. So that's Nautilus Sleep Systems.

That's pretty thorough, I've got to say.

I hope it's a better answer than we had for you last quarter.

That's a lot better.

We're going to take one more run at this thing and see what we can do with it. I think we have a very, very good chance of being successful with it at this approach. I'm excited about it, and I think we have a great product there, but that will be for all of you on the phone here and others to decide once we launch it.

The second question you asked was on the gross margins, retail versus direct. So on the gross margin side there really isn't a big variance there. In fact, it's very nominal. So if you look at it from the standpoint as we start to expand more with Bowflex on it, what you would call traditional retail path versus direct, the margin erosion there is not something that would be substantial for us. So, we actually feel fairly confident in our approach there.

Okay.

Now, on the product life cycle question you asked. The approach that we're going to take on this is more of a -- what I would say first defining the consumer segment is step 1, so who are the consumers out there that are using health and fitness equipment that we would target. The second piece is what are the products we would need to develop to match against that. Third step is aligning the brand with that product. And then the fourth step of that is when when you pull all of that together, how do these brands now with the product line targeted to a consumer, where is it that that consumer shops for the product.

On a product life cycle standpoint, we really want to approach it as a, it was a direct brand and now it becomes a retail brand. Rather that's it's going to be approached from a standpoint of who is that consumer, who is buying that product and where do they shop.

Hmm. I guess -- if I could ask that question a little differently.

Okay.

Because being multichannel, the difficulty is not cannibalizing your higher ticket or more premium vendors versus your more discount vendors. So like you go into Costco, and that creates risk of disrupting another retailer who wants to sell it at a higher ticket, which in the case of you guys is your direct channel. I mean, how do you manage that?

That's a great question, so sorry I didn't interpret it that way.

It's okay.

Yeah, and I think that one of the things that we're going make sure we're very, very careful about is in each one of those channels where the consumer is shopping. When you look at a specialty retailer, for example, the specialty dealers that are out there, we need to make sure for them that we've got a premium product line that they have the opportunity to sell that's differentiated from other retailers who may be more price conscious. So, there is consumers looking for a value, and there are consumers looking for the best, highest quality equipment they can find and are willing to pay a premium price for that. We need to make sure that we're differentiating by channel and the direct business as we look at it is a channel of distribution. And we need to make sure that we're appropriately segmenting the brands within those as well, within that channel.

So what you'll see -- what I tell you today, the stuff you see in Costco, the Power Pro. That is not on strategy to where we're going to be going in the future. What it is, we think there is some product lines that will be very appropriate for Costco and we're working with them in a collaborative fashion to determine exactly what that looks like. But we need to make sure we're differentiating these products for the other channels as well to maximize the sales for each one of those customers, while at the same time we're protecting our brands and building equity in them.

Okay. And so it's part of the plan to figure out how to do that basically?

Yeah, in fact next week is our second meeting in regard -- we've got a two-day session that we're going to go through as an executive team. I guess you would call it siphoning through all of the data that we've got back from this market research. And really starting to get very firm on what channels of distribution and how we will segment each one of the brands.

Okay.

There is a lot of work to be done there.

Okay, thanks. That was very helpful.

Thank you. The next question comes from Neal Jacobs with Qadry [sp] Capital Management. Please go ahead sir.

Good afternoon. Just a couple of questions for you.

One on the tread climber. You talked about this restrained demand environment. I'd just be curious what you mean by that. And you also attributed part of the lower gross margin to introduction of the tread climber. Do you expect, then, that the tread climber will be a lower gross margin project when it's mature or is that just a function of the ramp?

Neal, can I take both these, if that's all right.

Sure.

On the tread climber to start with -- first, let me answer the second question. As we look at the gross margin percent, it is lower right now and has pulled it down. That's part of the ramp up phase. We anticipated that going into in. In fact, it's actually a little bit higher than we had expected. So it's actually doing slightly better than we had planned.

Restrained demand on the tread climber is -- sorry to use a marketing geek term here, but what we're trying to do there is just make sure that as we -- any time you introduce a product that's as innovative as this product is and is different and new to the marketplace as it is, you want to make sure that you do it in a very thoughtful manner. And so what we're doing right now is we're actually, what we're calling restraining advertising dollars.

So instead of going out there with blitzing the media and blitzing consumers and getting thousands and thousands of phone calls on this thing, we're actually growing this brand in a way that we're calling restrained demand, which means controlling the advertising dollars, managing the amount of inflow that we have and product outflow to those customers that we have, make sure that our delivery processes, the assembly processes, the order handling, and then the follow-up that customers have is all done in a very high quality fashion.

So, when we say "restrained demand", that's what we mean. And we're going to continue to ramp this brand over the next several quarters, but we're going to do it in a way that we make sure we're managing each and every sale with each and every customer in a way that meets their expectations.

Thanks. If I could just one more, the question was asked about the gross margin difference between retail and direct. I guess I'd ask it from a different perspective, and more from sort of the operating model.

If I just looked at operating margin contribution from both of those segments of your business, could you just talk about the differences as you ramp the retail side of it? I mean, do you expect that over time those become more or less on par with each other or will there be a slight difference?

Well, again, our projections right now are that it would be nominal. Even on an operating margin standpoint. And let me give you a couple of examples of what I mean by that.

When you manage things on a piece basis, as we have to in the direct business -- so it's a one-unit in, one unit out approach -- there are costs and overhead costs associated with doing that. The great thing about the retail side of it is you're managing truck loads. Even though you are sharing margin with a retailer and the expenses associated with that that you have incurred, that efficiency that you gain in those delivery charges or delivery cost efficiencies offset some of the other costs that you have on the direct side.

So, as we've started to look at this -- and part of the reason we're being somewhat selective with the retailers that we're working with is to make sure that our internal systems are matching up with the capabilities required by those customers. So that we can make sure that we're providing profit for the retailer and providing profit for our company.

We really do believe on an operating margin standpoint as well and it certainly seems to be proving itself out at this point, that they are actually fairly similar. Pretty nominal difference.

Okay. Thank you.

Thank you. We have time for one final question. It comes from Karen Laymac [sp] with Merrill Lynch investors. Please go ahead.

Hi. Sorry, it won't be one now.

Hi, Karen.

I'm going to do like everybody else. On Amazon, can you give us color on who is buying the products and what they are buying? Maybe whether or not it's a different sort of socioeconomic profile than the direct buyer? That would be first and then I'll go on, I guess, from there.

Okay. Do you want me to answer that first?

Yeah, if you don't mind.

Unfortunately, it's a very short answer. It's too early for us to make a call on that one. We've been up for a pretty short period of time with these folks. They are just starting to get data back. So, if I could, I'll try to address that in the fourth quarter. Hopefully we'll have a little better answer for you.

Okay. On the balance sheet, you guys obviously have a lot of cash. What are you thinking these days about any buybacks?

We have no plans for that at this point.

Okay. And on the commercial retail side of things, you said sales growth was up 40% and some that have was due to the acquisition of Stairmaster. Can you tell us how much? I don't remember the sales contribution from that.

Yeah, the Stairmaster, I don't have those exact numbers in front of me. But we acquired it in the middle of February of 2002, so there's a piece. And I would say probably about $4 or $5 million. But I don't have those numbers particularly in front of me.

Would you say it's disproportionately the contributor for to the 40% increase in the sales?

I would say the biggest increase in the 40% increase is $17.7 million of Bowflex retail. That's going to be the majority.

All right. And on the sleep system, I understand you are considering different options as far as distribution. But are you considering your own retail stores or somebody else's, if you do decide to go that route?

We're actually exploring both of those opportunities at this point in time. And we'll probably engage in a test of that nature with both.

Okay. And 2004 earnings, I know you're not giving any guidance. But I wonder, directionally, are we going to be down versus 2003 or up?

What we want to do is we want to get through the fourth quarter and make sure the numbers we give to the Street are accurate. So we're just going to wait until the fourth quarter.

Terrific. Thank you.

All right, thanks, Karen.

Thank you. Mr. Hammond, please continue with any closing remarks.

Thanks, Stephanie. I would just say we look forward to getting back to you in the fourth quarter. As I would call this right now, we've got one in a row. We've delivered one quarter here.

We've got a lot of work to do to make sure that we deliver upon the estimates for the fourth quarter. And I can tell you that the entire executive management team is focused against that, as well as an eye to the future. And we're very excited about the potential for this company, and excited about the opportunities that are in front of us. But we have got a lot of work to do, and I don't want to make any bones about it.

So, you know, we are excited. We are driven, and we are looking forward to getting back to you in the fourth quarter and continuing to build the trust back into this business.

And that's all I have to say for today. Thank you very much for the call and taking the time.

Thank you, sir. Ladies and gentlemen, this concludes the Nautilus Group quarter 3 earnings conference call. If you would like to listen to a replay of today's conference, please dial 1-800-405-2236, or 303-590-3000 with pass code 5560011. The dial-in numbers are 1-800-405-2236, or 303-590-3000 with pass code 5560011. We thank you for your participation today. You may now disconnect.