Nautilus Inc (NLS) 2004 Q2 法說會逐字稿

Good afternoon ladies and gentlemen and welcome to the Nautilus Group 2nd quarter 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 on Thursday July 22, 2004. I would now like to turn the conference over to Mr. Gregg Hammann, Chairman, President and CEO. Please go ahead sir.

Thank you Kristen. Good afternoon, and thanks for joining us for our review of the 2nd quarter and 1st 6 months ended June 30, 2004. With us today is Rod Rice, our CFO. Now on the call today we're going to update everyone on progress of our turnaround plan. The focus will be on how investments in our product innovation, sales channel development and executive management team are beginning to produce material results.

All of this is being done with the goal of positioning Nautilus for long term diversified growth opportunities, and becoming the clear leader in health and fitness. Rod is then going to take us through our operating and financial results for the 2nd quarter, and for the 1st 6 months of 2004. He'll also provide guidance. I'll then conclude this section of the call with a summary of our current trends in our overall business, and then we're going to open the call up to questions.

So before I get started, I want to review the Safe Harbor statement and remind everyone that our prepared remarks contain forward-looking statements. Now we may make additional forward looking statements in response to your questions. These statements do not guarantee future performance, and undue reliance should not be placed on them. We refer you to the most recent periodic reports on our Form 10K and 10Q, as filed with the SEC for more detailed discussions of the factors that could cause actual results to differ materially from those projected in our forward-looking statements.

Okay with that out of the way, I'm encouraged by our financial and operating results for the 2nd quarter. These results are a clear indicator that our [Fit 1] principles and our turnaround plan are on track. We've achieved our revenue and earnings guidance estimates for the 4th straight quarter and continue to diversify our revenue and new product introductions by offering our brands through additional channels. For the 2nd quarter we delivered approximately $100m in revenue by maintaining our focus on the customer and addressing the demand for Nautilus strength in cardiovascular equipment in the appropriate distribution channels. Also our cash flow from operations continues to be strong, and as of June 30th our cash position was approximately $90m with no debt.

At the beginning of the 2nd quarter we entered the stabilized phase of our turnaround plan. And as we discussed in our 3rd quarter conference call in 2003, we began this 3 phase, approximate 18 month turnaround plan to reposition our brands and improve our sales channels in order to grow revenue and earnings again. These 3 phases were, one, gain control, two, stabilize, and three, grow again. So we completed phase one, the gain control phase, at the end of the 1st quarter and we are now in the stabilized phase of our turnaround. We will continue in the stabilized phase through Q3.

To properly execute the remaining phases of our turnaround, and to reposition our company for long-term growth, we've enhanced our senior management team during the first few months, and I'll be discussing this later in more detail. So in phase 2, stabilize. We've begun to execute upon the diversification, development and repositioning of our brands, and leveraging those brands in each one of our sales channels. Our goal is to have healthy brands with differentiated consumer focused products being sold through the appropriate sales channels. We are now undergoing a sales channel and brand shift from primarily the direct channel to a more diversified and balanced penetration in retail, commercial and direct, while simultaneously creating a better balance between our cardiovascular and strength training products.

Less than a year ago our company was focused mainly on the direct channel, which according to our research represents only approximately 20% of the market opportunity, since over 80% of fitness equipment is purchased through retail. Also we are focusing mostly on strength equipment instead of strength and cardiovascular. Now research showed that 60% of all dollars spent on consumer fitness equipment is for cardiovascular equipment. So about a year ago, of you do the math, we were expending most of our company's resources on only about 8% of the market opportunity. Now our lack of revenue and earnings diversity was the result of that focus. Today, we are positioning our company to leverage our leading brands across multiple channels, in order to properly position our company in the $5b equipment market.

We have a lot of work to do, but we're making great strides toward our goals, and we are on track for t his turnaround. So in the final phase of our plan, we are going to begin to experience meaningful growth, and as we've previously stated, we believe this will begin in the 4th quarter of 2004. This final phase is when we have repositioned our brands and we've differentiated our sales channel. At that point, we will be in a position to consider more aggressively pursuing the segments of rest and nutrition to further fuel our growth.

I'm encouraged by our accomplishments in the 1st half of this year including our new product introductions, new sales channels, the new enhancements to our senior management team and developing and starting to implement our Nautilus quality standard. But I want to be clear-we still have a lot of opportunity for improvement in our company. Before I get into more detail about how we will continue to take advantage of the market opportunities and make improvements within our company during the latter half of 2004, I'd like to turn the call over to Rod who's going to take you through a review of our operating and financial results for the 2nd quarter and the first 6 months. Rod is also going to provide you with guidance. Rod?

Thanks Gregg. As we look at our financial and operating results for the 2nd quarter, and the first 6 months of 2004, we continue to move to a more diversified revenue stream and we expect to experience seasonality similar to the retail and commercial sales channels. Which means, on an annual basis, we expect more revenue and earnings in the 3rd and 4th quarters. During the 2nd quarter, a number of our brands performed very well, including the TreadClimber, the Bowflex, our commercial StairMaster Elliptical line and our Nautilus Nitro Plus commercial strength line. This improvement is directly due to our increased focus and investment in R&D. Over the past 9 months we have been increasing our spending on R&D. We are beginning to experience the early benefits of this investment. You know, Bowflex is a great example. In the last 9 months, we have introduced 4 new Bowflex products. In the previous 5 years, we only introduced 2 new Bowflex products. During the 2nd quarter our Bowflex brand has stabilized with sales of 27,000 units through our direct channels, and 15,000 units through the retail channel. This is compared to 31,000 units in the direct channel and 11,000 units through the retail channel during the 2nd quarter of 2003. We are experiencing positive results on our retail channel in part due to our direct channel advertising and strong brand recognition. We are encouraged by the stabilization of sales trends for this brand. And we are looking forward to a bright future for the Bowflex brand.

This innovation strategy along with our strong Bowflex brand should allow us to maintain our leadership position in the home gym market for years to come. Now we are very pleased on June 22nd the US Court of Appeals for the Federal Circuit confirmed our strong brand identity by ruling in favor of Nautilus but affirming the grant of a preliminary injunction as previously granted by the Federal District Court. As a result, Icon Health and Fitness was immediately barred from using the trademark 'CrossBow' on any exercise equipment pending trial. I want to turn to our cardio lines for a minute. We continue to gain traction with our improved cardio products, including the TreadClimber. This product contributed $12.7m in revenue for the quarter, compared to $2.6m during the same period last year. We are very pleased with the performance of this brand during the seasonally softer 2nd quarter. Historically, cardio equipment sales during the 2nd and 3rd quarters are softer than the 1st and 4th quarters. This is due to warmer weather when consumers get their cardio exercise by walking, biking and running outdoors. We began marketing the TreadClimber in March 2003, and we're excited about the potential this brand will offer for years to come. Based on results for the 1st 6 months of this year, we are very comfortable with our projections of reaching approximately $60m in revenue for 2004, with the TreadClimber.

During the quarter we also continued to diversify our revenue from a channel perspective. Commercial retail segment revenues increased by over 6% compared to the same period in 2003. And commercial and retail made up over 46% of our overall revenue for the 2nd quarter of 2004. In addition, our operating margins in the commercial and retail channel improved by over 25% compared to the same period last year.

Turning to the financials, our revenues slightly exceeded our guidance we gave at the beginning of the 2nd quarter. And our earnings were in line with our guidance. Net sales for the 2nd quarter were $100.2m compared to $100.6m for the corresponding period last year. Net income during the period was $1.9m and earnings per diluted share for the second quarter were $0.06. Compared to $4.7m or $0.14 per diluted share for the corresponding quarter in 2003. Net sales for the 1st 6 months ended June 30, 2004 were $231.1m compared to $230.1m for the corresponding comparable period last year. Net income during the 1st 6 months was $8.4m or $0.25 per diluted share compared to $18.4m or $0.56 per diluted share for the comparable period last year.

Gross profit margin for the 2nd quarter was 49.2% compared to 52.1% for the 2nd quarter of 2003. A reduction in gross profit margin was mainly due to a higher percentage of commercial retail products which have lower gross profit margins, but operating margins that are very similar to our direct marketed products as well as the shift in our direct sales from higher margin Bowflex to TreadClimbers. Selling and marketing expense for the 2nd quarter was $36.6m or $36.5% of net sales compared to $35.7m or 35.5% of net sales for the 2nd quarter of 2003.

G&A expenses for Q2 were $7.4m. This is down from $8.8m for the same period in 2003. Consolidated operating income for the 2nd quarter was $2.7m, equating to a 2.7% operating income margin, compared to $6.2m and a 6.1% operating margin for the 2nd quarter of 2003. Our reduction in operating margin was primarily due to the mix of products sold in direct channels combined with higher direct selling and marketing costs.

We expect our operating margins to improve during the 2nd half of 2004, as we enter the seasonally stronger 3rd and 4th quarters. To help you understand our continuing diversification of revenue, I would like to discuss our direct and commercial retail sales and earnings by segment. For the 2nd quarter net sales from our direct segment were $53.8m compared to $57m for Q2 last year. Direct segment earnings per share for the 2nd quarter were $0.04 per diluted share, compared to $0.11 per diluted share for the same period last year. For our commercial retail segment, net sales were $46.4m for the 2nd quarter compared to $43.6m for the same quarter last year. This is a 6.2% increase. Commercial and retail segment earnings per diluted share for the 2nd quarter was $0.07 flat with the same period last year. Operating margins for the direct segment were 3.9% compared to 9.4% for the same period last year. Operating margins for our commercial retail segment of our business improved to 7.5% for the quarter. This compares to 5.9% for the same period last year. This is a strong indication of our improvement in marketing and positioning our products in the commercial retail channels.

Now I believe it is important to reiterate that our commercial and retail revenue accounted for approximately 46.3% of overall revenue for the 2nd quarter. This is up from approximately 43.4% in the 2nd quarter of 2003. And one real important point is non-Bowflex revenue, company wide, accounted for 52% of sales in the second quarter of 2004. This is compared to 41% for the same period in 2003, pointing out that we are realizing our goal of diversifying our revenue. The operating expenses for the holding company in the 2nd quarter were $2.8m compared to $1.8m in the 2nd quarter of 2003. This increase is primarily due to legal expenses and costs to strengthen our management team. Our cash and short-term position was $89.9m at the end of Q2, 2004, compared to approximately $72.6m at the end of 2003.

Our accounts receivable at the end of the 2nd quarter were $47.2m compared to $75.5m at the end of 2003. This decrease was really due to seasonality. Our DSOs were 43 days in the 2nd quarter compared to 33 days in Q2 2003. Inventories decreased to $49.7m at the end of the 2nd quarter from $53.1m at year-end. Our cash flow from operations was $1.4m for Q2 2004, compared to $1.8m for the same period last year.

We continue to generate positive cash flow, to pay out dividends to shareholders, increase our investment in research, and we are in a position to make acquisitions if the right opportunity presents itself. Keep in mind that due to our seasonal nature of our business, our cash flow from operations is expected to considerably increase over the next couple of quarters.

Moving to guidance. I would like to elaborate on a few factors that we consider when determining guidance. First, as we move to a more diversified revenue stream, we expect to experience seasonality similar to the retail and commercial sales channels. We believe our revenue and earnings will be lower in the 1st half of 2004 compared to the latter half of this year, the 2nd quarter experiencing the most softness. Second, as we have now entered the stabilized phase of our turnaround, we are more confident in our ability to forecast our performance. The gain control phase element of phase one that create volatility and in some cases uncertainty, are behind us. Obviously market conditions can always change, but at this time, our 3rd quarter revenue is expected to be in the range of $110m - $120m with earnings per diluted share in the range of $0.18 - $0.20, we are projecting our operating margin to be in the range of 8-10%. For the 4th quarter, we expect revenue to be in the range of $155m - $165m with earnings per diluted share in the range of $0.38 - $0.40. We are projecting our operating margin to be in the range of 12-14%. We expect to update guidance for 2004 as well as update you on the progress of our turnaround during our 3rd quarter conference call.

Lastly before I turn the call back over to Gregg, the company announced today that our board of directors has declared a regular quarterly dividend of $0.10 per common share, payable September 10, 2004, to shareholders of record as of August 20, 2004.

Now I'd like to turn the call back over to Gregg to discuss the trends of our business. Gregg?

Thanks Rod. I would like to quickly discuss in more detail a few of the 2nd quarter results that Rod mentioned. I'm very pleased that our company continued to diversify our revenue with multiple brands through multiple sales channels. Our cardiovascular product, the TreadClimber, continues to exceed our expectations and is on track to generate approximately $60m in revenue this year, compared to $19m in 2003. Also I'd like to point out that over 30% of our revenue for the 2nd quarter was from new products. In addition, commercial retail sales increased from 41% of net sales in the 1st 6 months of 2003 to approximately 50% of our sales in the 1st 6 months of 2004. All of these results are signs that our strategies are gaining momentum and are being executed effectively. These results are examples of what our company and our shareholders can expect more of in the future as we realize the power of one company working together. Our turnaround is based on 4 key things. 1, continually investing in innovation, 2, continually improving our customer service, 3, diversifying our brands and sales channels, and 4, building a strong management team. I'd like to highlight a few of these areas. Our strategy of driving innovation is gaining momentum. We have introduced 3 new Bowflex strength products during the first 6 months of this year. The difference in these introductions compared to previous introductions by Nautilus, is that these products are differentiated in price specifically for a particular consumer in the channel where they shop. This product diversification strategy is not only good for our company, but allows our retail partners to have differentiated brands and products between retail distribution channels, and diversification also allows our retailers to capture a greater margin due to their unique product offering.

This avoids the competition between retailers across different retail distribution channels. For example, the Bowflex Xtreme 2 is a new innovative product that does not require cable changes between different exercises. This new technology is ideal for a launch in the direct sales channel. The new Schwinn Force from Bowflex is an affordable Schwinn brand product design for the retail mass market. The Bowflex Sport is designed specifically for consumers buying fitness equipment in the sporting goods channel. And our Ultimate and Xtreme models are designed for the high-end specialty fitness channel. Each of these models is unique, and yet leverage the power of the Bowflex brand. Okay. We also introduced a new commercial strength line called the Nautilus Nitro Plus, and the new StairMaster commercial elliptical machine. Both of these products are performing better than expected in clubs and demand for them continues to grow. In the 3rd quarter, we'll be introducing our first branded series of Bowflex treadmills for the specialty fitness and sporting goods stores. This branding strategy is a direct result of our marketing study we completed last year. Consumer surveys stated that the Bowflex brand is much more than a product, Bowflex is known as an innovative fitness brand based on technology. The hundreds of millions of dollars invested in advertising to create this brand have provided us the platform to leverage this brand in other categories. This is just the start of the Bowflex brand diversification strategy.

During the latter part of the 4th quarter of 2004, we plan on introducing another new direct product. This new direct product has a strong patent protection, and the technology that was tested and used by [masses]. It will be another example of the Bowflex brand diversification strategy. We will also be introducing 5 new high-end Nautilus products for specialty fitness stores in the 4th quarter of this year to address where the enthusiast fitness consumer shops. Another new innovative product introduction in the 4th quarter will be our consumer variable stride elliptical product for sale in specialty fitness stores. This product will solve the common problem with ellipticals of users not obtaining a full natural stride, regardless of the person's normal stride length.

Okay, to give you a glimpse into 2005. We will be introducing several new cardio products in the commercial channel including TreadClimber that will truly change the game in the commercial cardio segment. By placing this product in commercial facilities, it will help us drive our direct channel TreadClimber sales, and also will be the technology platform for the new direct version in the 2nd half of 2005. This strategy will pave the way for introduction of the retail TreadClimber by building demand and credibility in the commercial facilities and leveraging the advertising power of our direct business.

Early retail sales projections indicate our average number of SKUs per store will approximately increase from 2 SKUs in 2003 to 5 SKUs in the latter part of 2004. Also, the number of stores will expand in the 3rd and 4th quarters from the previous year. These are just a few of the examples of our opportunity with our strong brands, new innovative products, and our strategic sales approach. We will expect to update you on our progress with additional retail opportunities in the coming months.

All of these new channel opportunities, and the new product introductions would not be possible without the exceptional team we've assembled at Nautilus. We will continue to strengthen our management team as we expand existing markets, enter into new markets, and offer more brands and products. During the last couple of months, we've strengthened our senior team by adding an experienced executive, and promoting an employee from within our organization. Holly Valkama joined Nautilus as Senior Vice President of Manufacturing and Operations. Holly has an extensive background in manufacturing and operations for a variety of Fortune 500 companies, including Thomas and Betts where she had responsibility for global manufacturing and operations with 22 manufacturing sites. She has a strong reputation in lean manufacturing and her expertise in lean manufacturing and improving speed to market will enhance our strong focus on innovation and delivering customer needs.

Holly's expertise will help our company formally develop and implement the Nautilus standard of quality and durability and will improve our speed to market at a low cost. Holly will help us step even further above the industry standard as a leader in quality products. The second person is Pat Warner. And Pat's been promoted to Sr. Vice President of Product Development. Under Pat's direction the product development group will continue to lead the company's efforts to design the products that will fuel our future growth. Pat will now be reporting directly to me, which reinforces our emphasis on market leading innovation. Pat has led the recent stream of innovation from our company. He is creative, he's proactive, and he's driven. Our company is excited to have these experienced leaders joining our executive team, and we look forward to their contribution to Nautilus.

In summary, we are encouraged by the progress we've made in our turnaround plan, and we believe that Nautilus' strong portfolio of health and fitness brands, fiscal discipline and commitment to increasing shareholder value will enable the company to be an innovator and brand leader in the health and fitness industry for years to come. We will continue to face challenges during our turnaround plan, but I believe we are on course and now have the management team that's poised to deliver. The plan we embarked on over ten months ago is a rigorous undertaking, but I have confidence that the branded channel segmentation work we initiated will create the leading health and fitness company and deliver long-term value for our shareholders and employees.

Now I'd like to open the call up for questions.

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 would like to decline from the polling process, please press the star followed by the (2). You will hear a 3-tone prompt acknowledging your selection. Your questions will be polled in the order that they are received. If you are using speaker equipment you will need to lift the handset before pressing the numbers. One moment please for our first question. Our first question comes from Eric Wold with Merriman, Curhan, Ford and Company, please go ahead with your question.

Hi, good afternoon guys.

Hi Eric.

First of all, obviously the past couple of days there's been increasing concern out there with Hibbits [ph] and Sports Authority pre-announcing. Do you think that's more of an overall issue with demand in the category or do you think that's more specific to them and kind of the brand mix that they've been carrying.

This is Gregg, Eric. I'll take this one, Rod. So, yeah, here's what's going on, I think here. One, we've got less than 10% of the retail floor in TSA and a lot less than that even in Hibbits [ph] today. We've been in pretty significant conversations with the Sports Authority over the last 6 months. And Doug Morton [ph] and I have been very close in conversations, and Doug has been pushing very hard to reinvent the fitness floor at The Sports Authority and we're going to pay a pretty key role in that starting in the 4th quarter. So he saw this trend coming. I think Doug was aware that they needed to do something different. They've taken the appropriate steps I think, and I think you're going to see their business start to improve from a sporting goods, fitness standpoint here in the 4th quarter pretty substantially. Now, we're going to play a much more aggressive role going forward, and I think part of the problem that Doug saw, and I saw as well, is they really don't have any branded merchandise there, it's sort of the lower end product, and they want to trade their customers up, and I think they've got a great opportunity to do that. We think similar to The Sports Authority, Hibbits [ph] had those same kind of opportunities.

Is that more of a competition with them and people like Wal Mart, than, in terms of what's hitting them right now?

Yeah, I think it's hard. I think the thing that makes it tough for the sporting goods chain right now, they've kind of gone head-to-head with the mass channel, like Wal Mart and K-Mart Target, and those customers out there are $50 less on the average pricepoint. So, it makes it tough, I think, for them to be competitive going at a down channel market. I think what they're going to start to do is look more aggressively at a higher quality branded product, and we obviously would fit very strongly into that mix. So, the confidence we have in sharing with you the 3rd and 4th quarter guidance is mainly driven on the fact that we think we're going to be able to, in working with these customers, really help them dramatically improve their business.

Okay, on the TreadClimber, can you talk about how gross margins have moved on that from Q1 to Q2 and kind of update us on your thoughts on the margins toward the end of this year.

Sure, Rod, do you want to handle that one?

Sure, Eric. What we're seeing, is we're seeing favorable trends on the margins, they're up about 200 basis points at this time in Q2 from Q1. Some of the things that are happening is we went through a 3 box configuration. This has been of benefit to our customers, it's not as heavy a box as now it's in 3, and we're experiencing less warranty on this too. And we're real excited about having Holly come aboard, because we think she's going to bring out some operational efficiencies. And we're going to get a lot of those anyway, as this product starts growing, and we think we could be close to the high 60s by the end of this year, and for a direct marketed product, that is a great spot to be in.

Okay, then last question. Maybe talk about kind of going back to the retail issue. Maybe talk a little about what you're seeing in terms of inventory levels out there in the channel right now, with your products, kind of as you move into Q3, Q4, when you expect to get more of a high level of selling.

So on the retail inventory side, Eric, we've got, in most of our customers, we're in a very good position, in fact, you brought TSA up earlier-our sales are up over 100% in TSA versus the previous year, and our inventories are only up about 80%, so what you're seeing is a lot more product on the floor from us than you saw a year ago, but as a percentage of inventory, actually lower than their average. So I think we're in pretty good shape there. I think the specialty retail segment side we're in good shape. We talked about, at Costco, with some of the merchandise we had there, that we had some inventory, there still is some inventory, but I think both Costco and all of us at Nautilus feel a lot more comfortable with how that inventory is working down. So, we feel really good about it right now, I don't think we've got any major issues out there that we're having to deal with.

Perfect, thanks guys.

Our next question comes from Karen Lemark [ph] with Merrill Lynch Investment Management, please go ahead with your question.

Hi. The strong cash position you have, can you give us an update on your thoughts on a buyback, and then I've got a follow-up.

Rod, do you want to do that?

Sure. You know, we feel very comfortable where we are right now, in the turnaround, and we do have more cash than we need to run this business. I think we're probably a quarter or two away from determining what we're going to do with our excess cash. We want to get further along in turnaround to where we could possibly look at some acquisition opportunities in 2005. We want to finish up that analysis and strategy. If we don't see the acquisition side of that, I believe, at least me personally, that we could start buying back the stock at that time.

And also, are there any new retail relationships that you can update us on as far as test?

Yeah, on the retail customer side, we're in discussion with several major retailers out there, and I'm not-Karen, I'm going to try to be a little careful here, I just want to-for competitive reasons-we've made a lot of progress with several customers. Sears we've got a test with now, we're looking at expanding fairly aggressively The Sports Authority as I mentioned earlier, in the 4th quarter of this year. We've got several other customers that we'll share more with you about as we go into the 3rd quarter conference call that we're in the process of working through what the 4th quarter might look like.

Okay, and then lastly, any comment on the estimates that out there for 2005? There's a fairly wide range on earnings, but consensus is one eleven, and it looks like revenues are around $541m. Any comment at all whether or not those are in the ballpark?

Well, we'll come back in the 3rd quarter conference call and potentially provide some insight into the early part of '05. I think it's premature for us to comment on that unless Rod, you want to say anything in that regard.

Yeah, I think either in the 3rd or 4th conference call we'll come out with guidance, that we're driving to a much higher plan that what's out there on the street.

Great, thank you.

Thank you. Our next question comes from Mark Rupe with Adams Harkness. Please go ahead with your question.

Hi guys, how are you. Just curious to see what the status was obviously with the CrossBow, I've seen a lot of it, being clearanced in a lot of retail locations. Do you anticipate any impact from that, or maybe a benefit from that on the direct side or the retail side in the next couple of quarters?

Well, the feedback we've gotten from several of the retailers was that CrossBow sales had slowed down dramatically and one way they're trying to get through this injunction quickly is to mark it down and get it off the floor. So it could, short-term, as you pump a lot of product out into the market like that, it could short-term impact us, but in the long term it's actually a very good thing because it clears out the retail floor for us and allows us to get in there with our higher branded Bowflex product, and really start to drive the business there. So I think over the long term it's actually a good sign for us.

Sure. Have you had any discussion with any of the retailers about displacing the CrossBow product altogether?

Yes we have.

Any thoughts-any hopeful thoughts on that?

I want to be a little careful on this one Mark. I think there's several customers that are looking at CrossBow at this point as being redundant.

Okay. As far as the average SKUs per store, you mentioned 2 in '03, and 5 in the latter part of '04. What ultimately do you think that, is the number of SKUs you can get to?

Well, if you look at the average retail floor there's-and this is just on the bigger merchandise, for sporting goods for example, there's between 25 and 35 items, depending on the size of store, and then in the specialty fitness arena, obviously double and triple those numbers. So we think, we would love to be able to be between the 30 and 40 percentile range. So if you do the quick math on that, we're hoping to get somewhere around 10-12 SKUs in there. This year for the 4th quarter we'll have on average between 5 and 7, but as you look at '05, I think that's where the real traction comes on for us, and I think as we start to reinvent those retail floors and really think differently about how people shop for fitness equipment that's when I think you'll start to see us move more into that 30-40% of the retail space. And I think that's when I start to get real excited about how we can really merchandise and work in partnership with our retailers.

Exactly. Any initial indications on the Sears relationship?

Well, it's awful early. We just started this, and they've had a senior management shakeup there and so I think they're probably adjusting a little bit from that. We just started the test, and really don't have any results yet, so we'll certainly keep you posted.

Okay. And then lastly, on the holding company expenses, obviously there's some legal in there. Do you anticipate legal to continue to be a decent chunk of that going forward, or it will be sporadic?

Well, I think it's going to be there for a while. One of the things we want to make sure we do is we invest in our brands and we're investing in innovation, that we continue to protect them aggressively, and when people infringe on trademarks or infringe on patents, we're going to go after them. And I think we have to send a message that, if you want to do that, you're in for a fight, and that's going to cost us a little bit of money, but I think in the long-term, you'll start to see less and less of people trying to do this, as they end up having to pay back all those profits that they made in the short term.

Exactly.

So, we're going to stay all over it.

Final question. If there is one product of all the products that you have on the schedule to come out, which product are you most excited about as far as having an impact, strategically or financially.

Wow.

I don't mean to corner you or anything.

I have to pick one?

Well you could pick a couple I guess.

Obviously I think TreadClimber is huge, right? I think that's going to reinvent the cardio category and I think we're just getting started there, right? That brand is still a little baby trying to learn how to walk, and I think as that brand grows, and gets up and gets moving, and we get it into the commercial segment, into the clubs, I think it's going to be big hit there. So TreadClimber is something I'm very excited about. The other one is, we've been a little bit quiet about this one, but the new Bowflex product we're coming out in the 4th quarter with, I think is going to be huge, and that's exciting. I think the Nitro Plus line frankly, has got the best biomechanics in the industry, but it's also a great looking product, and certainly the clubs have responded positively to that. So if I had to pick my top 3, that would be the 3 big ones, but there's 4 or 5 right behind that that are right in there with it.

Perfect. Thanks a lot.

Our next question comes from Connor McCaulkin [ph] with JLF [ph] please go ahead with your question sir.

Hey guys, congrats on the good quarter. Just a quick question-did somebody ask kind of preliminary about '05, just [inaudible] we're kind of playing around with numbers in our models, is it just fair to assume though, if one were to assume you'd get back to the $600-$650m type of revenue level next year, I would assume that could get you to somewhere around $1.25 - $1.50 in earnings. Is that a safe assumption, if you just made the assumption you could get to that type of revenue level?

Rod do you want to comment on that?

I think our plan, it looks like next year that the Street's looking for about $1.07, and we're in our planning process as we speak, and we're driving to a much higher level. I think we're a little bit preliminary to talk about that, I think we've got a lot of opportunity, the 3rd quarter, especially the 4th quarter. We want to see our execution of those and then we'll come out with '05 numbers.

Okay.

We're going to be done with our turnaround, hopefully here and [enter into that] so I think there's a lot of opportunity.

Okay, no problem. I just-obviously when you play around with the numbers, like you said, obviously if you can get back to certain levels like that, it's clear the analysts haven't really reflected that in their models yet. Just out of curiosity, when you look in the past, at the type of growth the business has been able to handle in the past, you mentioned the exciting new products, the new Bowflex coming out in Q4, when you step back and look at it today, is there any reason why you wouldn't fundamentally or structurally you wouldn't be able to grow 20% next year? From a structural standpoint or anything like that?

No, I think we're pretty confident. All the work that we're doing this year, and we actually embarked upon last year in the 3rd and 4th quarter is preparing us for '05. And I think we're in a very, very good position. I think we've got the right people in place now. I think, from an operational standpoint we're ramping up. We feel very confident in our product development team, and their ability to flow the work through. I think our marketing team and our sales team have improved dramatically. So, I feel really good about not only '05 but '06 and '07 as well, and I think you're going to see us continue to hit the accelerator pedal harder and harder.

That's really exciting. And one other thing I wanted to ask. When you had mentioned previously about the gross margins in the high 60s by the end of Q4, I just want to make sure I understand that, Gregg. Were you talking about just the TreadClimber business, or were you talking about the company as a whole?

Just the TreadClimber business.

What's the gross margin for the TreadClimber currently?

They're in the low 60s right now, they're in the 62% - 63% range.

You think you'll get into the high 60s by [kind of the] run rate in Q4?

Yes, with the-you're going to get some leverages from the increased sales, and having Holly come aboard too is going to help us with the manufacturing opportunities.

Sure. And what percent of your sales, I'm sorry, I'm sure you've already given this, was TreadClimber again this quarter?

They were-you know, the TreadClimber sales themselves were $12.7m, so it was 12.7%.

Okay, because when you look at the run rate, when you look at the kind of run rate and the growth of the business, and you look at the gross margin opportunity just in the TreadClimber numbers itself, would actually suggest that even the kind of the operating margins targets that you get to in Q4, you guys are being pretty conservative there as well. You know, when you look at the guidance there.

I think that for our business right now, that's the best approach, I would agree.

Okay, thanks guys, keep up the good work.

Our next question comes from Jim Bellessa with D.A. Davidson, please go ahead with your question.

Is that Jim Bellessa being called?

Hey Jim, how are you?

I didn't hear the name very clearly, the last name. I'm doing real fine. And I'm first asking about ASPs for Bowflex direct and retail, might they have been, ah, hold up, or?

Sure, what we're seeing on the direct side is they're holding up well, they're over [$1500]. We have seen them decline on the retail side, they're a little bit over $450, and it's really due to getting positioned correctly in the market, in the second quarter, or late first quarter we came out with two new products. They were aimed at sporting goods, one is the Bowflex Sport, it's a lower ASP product. The other one was the Schwinn Force which is a blocking strategy for our competition. Where I do expect in the 3rd and 4th quarter to see our ASP go is in the high $500s and in the 4th quarter we should be in the low $600s. We're not in position right now, we're coming out with a new Bowflex for retail, and it's going to be for the middle market warehouse clubs, specifically for that channel, differentiated from a product we're coming out in the specialty fitness, in the 3rd quarter, so we'll be properly differentiated in the 3rd and 4th quarter this year.

It's regularly said that the 2nd quarter is a seasonal low in the industry-did the TreadClimber sequential decline in sales disturb you at all?

Well, you know, we expected the 2nd quarter, because of the seasonality, you know, a TreadClimber is much like any other cardio machine, and the cardio segment, the worst quarter in the year is that 2nd quarter, so we had planned the TreadClimber business to come in about where it did, and actually with the fact that I think some of our advertising got a little dated, TreadClimber actually came in a little better than I would have expected. So we've got some new advertising breaking here in the next 2 or 3 weeks, that I think will freshen that up and get us really prepared for the 3rd and 4th quarter. But, no, I feel really good about it.

What was wrong with the old advertisement?

Well, you just, you keep running the same thing over, and over and over, and people get used to it, right? And I don't think you get that excitement in the response. And I think we let that advertising, in the spirit of trying to save money, probably let that advertising go a little bit too long, and when I say a little bit, I'm not talking about a lot, you know, I think it was about 6 weeks past its shelf life. And so, we're going to do a better job in the future, I think, in rotating through those spots and making sure we keep it fresh for the consumer. But it's all learning, you know, as you go through these turnarounds, and you learn about what the product response rate is with the consumers, it takes a little bit of time to kind of dial it in, and I think on the TreadClimber certainly, we think we've got that model better set up now to lead us into the big volume months.

Does this NASA tested product, is there a name for it? Or something that we can at least describe it by?

Yes, you can call it Super Bowflex for now.

The actual share count, what might that have been at the end of the quarter?

The actual share count at the end of the quarter was about 32.7m shares.

And you-talk about your percentage of floor space with retailers is less than 10% today, how do you measure that? Is that with all fitness equipment retailers, or just with your customers, or how do you define it?

Well, it' with customers that we do business with today, on average. So if you took all retail space across the country, obviously it would be significantly less than that, but we're talking about just people that we have at least some relationship with today.

Thank you very much.

Thank you. Ladies and gentlemen, if there are any additional questions at this time, please press the star followed by the (1). As a reminder, if you are using speaker equipment, you will need to lift the handset before pressing the numbers. Our next question is a follow-up question from Eric Wold, please go ahead with your question, sir.

Just one quick follow-up and then a longer one after that. Could you give the gross margin percentage in the quarter between the two segments direct and commercial retail?

Sure, when you look at direct for the 2nd quarter, we were, just give me a second here, we were actually 66.2%, and on the commercial retail side of the business, we came in, we had a real good quarter, we came in at 29.5%.

Okay. That's really good given the seasonality of the business. And then, just to go back a little bit on the situation with Icon, and the injunction against the CrossBow. The previous question about the retailers out there trying to get them off the floor now, and just discount them and get them out of there. What's the situation in terms of, with the injunction there, if the products, obviously if they're called CrossBar that's something different, but the products on the floor are still called CrossBow, what is stopping you from forcing them to take those off the floor now, without being able to discount them and sell them at all.

Well, we believe, that is our interpretation, actually, of this injunction. However, it's our interpretation and we're trying to get clarity on that. The other side of it is, this is a short-term issue in our mind of getting that product out of there, and we certainly don't want to harm our retail partners in the process of doing that. So, we're trying to look at this as a long-term partnership and a win-win strategy. Now, we'd love to have them box them up and ship them back to Icon, and that's frankly what we think they should do. If they want to choose a different approach to that, then we're trying to be flexible and work with them on it.

Would it be fair to say that that flexibility is a little bit higher during a weak selling season but might become a little less flexible during the holiday season at the end of this year?

I think that's fair, yeah, and I also think we've extended the olive branch here. And I would also think that if I were in Icon's shoes, I'd want to be doing the right thing by my customers, so I'd probably be more apt to say I'd take that return. Although I'm not sure what their approach on that is today. Certainly they're marking it down and selling it on the floor at this point.

: Yes, if I could add, just a comment to that. We can't determine what the court is going to say about that when we go to court, and this gets tried, about the damages. I mean, we don't want to see any of our potential retailers damages, but somewhat, when it goes to court, if they continue to sell the product, it's out of our control.

Okay, and just lastly, so as of now we just have the court date set in April for the patent infringement, but nothing has been set for the trademark case, right?

That's correct.

Okay, thank you guys.

Our next question comes from Sid Nedcarney [ph] with Royal Capital. Please go ahead with your question.

Hi guys, sorry, congratulations on a good quarter, and sorry if I missed the figures earlier, but can you give me the split between selling and marketing, as a percentage of sales for direct and retail. And then also the Bowflex revenue split between the two segments.

Yes, the Bowflex revenue was about 48% for the entire company. And given the units there, selling and marketing, when you're looking at that on a consolidated basis, was running about 55.6%. When you look at that on a direct channel, it was, actually it was 55.6%, and on a commercial retail, it was 14.4%. What was the other part of your question you'd like to be answered?

The other was the Bowflex revenue split between the two channels, I got the units, but if you had an exact revenue breakdown?

Yes, sure. When we look at this, it was 42%. I actually don't have right in front of me, per segment, the Bowflex revenue.

Okay.

But what we did is, we had 27,000 units, average ASP about $1500, on the direct side, and on the commercial and retail side we had about 15,000 units of about $450.

Okay. And then, what's your gross margin on Bowflex on direct versus on retail, given that on retail you're obviously at lower pricepoints.

Yeah, on direct it runs a little bit over 70%, you know, it depends on the time of the year. There is fixed costs in that business, on the operations and distribution side of it. And it really just varies on the retail given the time of year. We do give the retailers various discounts, and it depends on what channel we're selling product into.

Okay, but is it kind of in the 40-50% range?

That is one number I want to keep a little bit-we want to keep control of. We do have retail partnerships out there and we do have competitors out there, but you're somewhere in the range.

Okay. Thank you very much.

Thank you. Our next question comes from Wayne Smith [ph] with Touchtone Investments, please go ahead with your question, sir.

Hi guys. I just had a couple of quick questions. Just as far as the sales of the Nautilus Suite System, where did those come in for the quarter?

Nautilus Suite System, and we're in the middle of the re-launch of that, right about $1.5m. To give you an example, in Q1 it was about a couple of million dollars.

Gotcha. And then, as far as, I guess, I'm having a little trouble getting to the $100m in revenue. It looks like you're going to do about $48m in Bowflex, and the TreadClimber is $12.7, and then the Suite System, $1.5, everything else was, I thought you said sales were up year-over-year in kind of the commercial, by 6%. Am I missing something in that component? I had that being $30m last year.

$30m. We had actually, this year, commercial retail was $46.4m, last year it was $43.6m.

Gotcha. Okay. Okay, that's helpful. And then, you were saying that the legal costs, are they buried in I guess either G&A or Sales and Marketing? Where are those exactly?

Those are in G&A.

Those are in G&A. And your G&A was down, 2% points on a revenue basis, year-over-year, how much further are you thinking you can press that down? And it seems like you're putting on a lot of hires to have SG&A coming down that hard.

Yes, we had some costs in last year, there was even more litigation last year where we were at that time in the case. Remember our first ruling came down actually in June, as a primary injunction in the District Court of Washington. So we were at trial. We won that in summary judgment, and Icon added appeal from that, and the Federal District Court affirmed our action and we got that done at that point. So, I would say, given the fact that how strongly we believe in our technology, in our trademark, you shouldn't see G&A actually come down from the standpoints of where they are now.

So how much was legal in the quarter?

We don't separately break that out, but it's running over $1m a quarter at this point, and given the fact that we're going to trail in April of next year for the patent, we believe sometime next year we'll go for the trademark. So, we'll be seeing Icon Health and Fitness in court quite a bit next year.

Gotcha. Okay, thanks guys.

Our next question is a follow-up question from Mark Rupe, please go ahead with your question sir.

Hey, guys, real fast. On the [Weeder] XP 800 and 600 platinum ones, on the back of those models they have a plastic molding with a CrossBow logo, do those apply like the other CrossBow products?

It should.

Okay. I would assume that's much harder to convert that to a different name with it basically being blazoned into the plastic mold.

Yeah, I would think so.

All right, thanks.

At this time we have no further questions, please continue with any further remarks that you would like to make.

Okay, well we're going to close the conference call off at this point, I think everybody for dialing in today and spending the time with us. And we're very much looking forward to the back half of the year, and look forward to getting back with you at the end of the 3rd quarter. So thank you.

Ladies and gentlemen, this concludes the Nautilus Group 2nd quarter earnings conference call. If you would like to listen to a replay of today's conference, please dial into 1-800-405-2236 or for international participants, 303-590-3000 and use the access code of 11003173.

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