Nautilus Inc (NLS) 2005 Q1 法說會逐字稿

Thank you for standing by, and welcome to the Nautilus, Inc., first quarter 2005 earnings conference call. As a reminder, this call is being recorded on Wednesday, April 27, 2005.

Before the call begins, listeners should be advised of the Safe Harbor statements that applies to today’s call. Prepared remarks during this call include forward-looking statements and additional forward-looking statements made be made to response to questions. These statements include information about our Company’s market, products, brands, and channels do not guarantee future performance. Undue reliance should be not placed upon these. Listeners should review the Company’s most recent periodic reports on the Form 10-K and 10-Q filed with the Securities and Exchange Commission for more details and discussion of the factors that could cause actual results to differ materially from those [inaudible] in forward-looking statements.

And now I’d like to turn the conference over to Mr. Gregg Hammann, Chairman and Chief Executive Officer of Nautilus, Inc.

Please go ahead, sir.

Good afternoon, and thanks for joining us. With me today are Bill Meadowcroft, our Chief Financial Officer; and Tim Hawkins, our Chief Customer and Chief Marketing Officer.

Today’s discussion provides insights into the first quarter of our 3-year plan where our consumer and brand-based business strategy is helping us grow sales and increase market share. This year our focus is on driving growth and investing in the future as we build a solid foundation to continue growing our business profitably for years to come.

On this call we’re going to cover our first quarter results, provide net sales by each of the 5 channels, as we promised last quarter, and then we’re going to conclude with some comments and guidance for the second quarter and the year.

Now about an hour ago we posted our first quarter 2005 financial statements which showed we delivered the quarter a little bit better than expected. Net sales of $156.4 million was an improvement of 19%, while earnings finished at $0.28 cents of diluted share, a 46% improvement, which includes a CPSC settlement we announced a few weeks ago. Now the fun part of this is, this is our seventh straight quarter of meeting or exceeding our guidance. So as promised on our last call, our cash and short-term investments improved to $123.3 million, an increase of 18.7 million. Our DSOs have dropped to 40 days from 51 at year end. Our inventories are up about 8% from a year-ago quarter at a comfortable rate of less than half the rate of sales growth. We had a solid improvement in 4 of our 5 business channels with the fifth anticipated to show growth in later quarters. In addition to driving growth, operating margins improved to 9%, or about 150 basis points, while still making the necessary investments in our future. We boosted R&D, marketing, operations, information system improvements, and accommodated a one-time expense involving litigation in a CPSC settlement.

For more detail in the first quarter, allow me to introduce Bill Meadowcroft, our Chief Financial Officer.

Thanks, Greg.

As you just heard, the first quarter marks the seventh straight quarter that our revenue and earnings met or exceeded our guidance. Net sales for the quarter were $156.4 million, compared to $130.9 million the preceding year, an increase of 19%. Gross profit margins were 49.1%, compared to 43.4% for the year ago, in response to innovation, improved operation, and product mix.

Operating income in the quarter was $14.1 million, or 9%, compared to 7.5% for the year-ago quarter. This reflects our plan to drive growth while investing in the future, strengthening our supply chain operation, investing in our brands, information system, product development, and protecting our intellectual property.

Diluted earnings per share for the quarter were $0.28 cents, compared $0.19 a year ago, a 46% improvement. The first quarter of 2005 diluted earnings per share includes the CPSC settlement charge of $950,000, which is in the G&A expense line.

Through our power of one initiative, we are further integrating our facilities, systems, innovation, and people, and functioning as a single organization. That is why we changed our name to Nautilus, Inc., in March. Our leadership team evaluates overall net sales progress by reviewing results in 5 different channels where we compete. To give you more information on how we are performing, we will provide you with net sales and additional insights in these 5 channels going forward. Furthermore, we will report operating income as a single organization as a result of our power-of-one consolidation efforts, which is how management evaluates our business.

Net sales showed double-digit improvement in 4 of our 5 channels, with specialty retail soft this quarter due to limited product supply. Tim will provide net sales and additional insights into each of our 5 channels in a few minutes.

Operating margins for the first quarter of 2005 improved to 9% from 7.5% in the first quarter a year ago, a 150 basis point improvement, which is in line with our expected margin improvement of 100 to 150 basis points for the year. This improvement can be attributed to functioning as a single company, improved operations, and stronger net sales.

Regarding operating expenses, selling and marketing was 28.8% of sales, up from 27.3% for the year-ago quarter. The increase involves support for the Nautilus brand, special offer promotion, and testing new direct marketing and cross-channel marketing opportunities.

General and administrative expense was 8.6% of sales, up from 5.5%. The quarter contains a one-time event including a CPSC settlement charge, litigation reserve, information technology investment, and some relocation costs. It also reflects legal fees in preparation for several cases against ICON Health & Fitness. Research and development was 1.8% of sales, up 40 basis points, reflecting our ongoing commitment to a fast pace of innovation.

Turning to our strong balance sheet, we finished the quarter with cash and short-term investments of $123.3 million compared to $104.6 million at the end of 2004, an $18.7 million improvement over the previous quarter. Our Company has no debt. DSOs dropped 40 days from 51 days the previous quarter and were 38 for the year ago quarter. Annualized inventory turned 6 times in the quarter, an improvement from last year. Inventories were $54.9 million, an increase of 12% from the previous quarter, and up 8% from a year ago, which was less than half the resales growth.

As our business generates cash, we envision continuing to pay dividends, increasing investments and innovation, making acquisitions at the right opportunity surface, and buying back stock from time to time. For a more complete overview of our business by each of our 5 primary business channels, I would like to introduce Tim Hawkins, our Customer and Chief Marketing Officer.

Thanks, Bill.

Last quarter we explained that the global fitness equipment industry is about 6.4 billion, and growing at 4% or greater each year. Today we have about an 8 share and are seeking to grow our share as we leverage our 4 industry leading brands in places where people shop and exercise. We envision a leadership share approaching 40% over time, getting there through steady growth and innovation. As we outlined on the last call, we want to provide additional insights into the business channels where we compete.

Let’s begin with the commercial channel such as clubs, hotels, and living complexes. This market is about 800 million and we have about an 8 share. Net sales for the first quarter were 17.2 million, up about 14% from the year-ago quarter. We had excellent results from the Annual [inaudible] Fitness Show in March. We also had gains with key accounts such as YMCA, local clubs, and grew through the vertical market by adding commercial dealers.

We began shipping our new Nautilus commercial series treadmills positioning the Nautilus brand as the category leader offering both a complete line of strength and cardio products for this channel. For the second quarter, we will begin marketing Nautilus commercial series TreadClimber cardio products in partnership with 24-Hour Fitness, the world’s largest club chain. We also expect to expand sales of our new treadmills and introduce commercial series My Stride Ellipitcals. Looking toward the second half, we will continue to pace and continue our pace of revolutionary and evolutionary innovation with cardio and strength process.

Our next channel is specialty retail where people buy club quality equipment for the home. The market is about 800 million and we have a 10 share and have a presence in about 40% of the estimated 420 doors in this category. Net sales for the first quarter were $20 million, down about 9% from the year-ago quarter. The decline was due to primarily to product supply constraints from the previous quarter and from which we have taken proper steps for improvement, specifically collaborative customer planning and integrative vendor supply planning.

In the second quarter, we expect improvement from our March introduction of Nautilus ProSeries Treadmills and My Stride Ellipiticals, which are designed for specialty fitness customers. We also anticipate adding some doors mid year that will strengthen sales in the back half of the year. So despite a soft first quarter, the new products, programs, and customers lead us to expect growth in this channel over the course of the year.

Our U.S. retail channel including sporting goods, warehouse clubs, and department stores is about $2.7 billion across 8500 doors. Our presence is in about 2100 doors which carry a couple of SKUs on average. For the first quarter, we had net sales of 21.2 million, up about 11% from last year. The drivers are annualizing new doors and SKUs at current retailers, broadening product assortments, and gaining initial presence at 100 doors of Big 5 Sporting Goods. For the first time we launched a new product on QVC, the BowFlex Motivator II Home Gym, with excellent results and then cascaded it to the balance of retail. We are also rolling our make-room-for-fitness merchandising display to another 200 Sports Authority stores after a very successful test in 15 stores in the Northeast.

Looking into the second quarter, we will be adding 111 doors with the Michigan-based retailer, Dunham’s, with a 2 to 3 SKU assortment that will hit the floor in the second quarter. We are in [inaudible] discussions with current and perspective retailers in preparation for the fall and winter assortments which are floored in September and October. Most retailers have these decisions resolved prior to Independence Day and we anticipate growth by increasing the number of customers and broadening our product assortments as we roll into the fall season, which is built into our annual plan.

Our direct channel involves Internet, catalog, and direct-response advertising. The market is about 1.1 billion, and we have a 24 share. Our first quarter, net sales rose to 84.9 million, up 34% over the year-ago quarter. We continue to experience strong trends in direct due to innovation. We had healthy year-over-year growth in home gyms and TreadClimber products and are benefitting from SelectTech dumbbells, our new catalog, and Internet sales. In addition, growth is being fueled through new advertising, better placement, and format mix, new promotions such as cross channeling merchandising program with a major retail partner, and minimal competitive pressure.

In the second quarter, we expect strong sales results from the March introduction of our new BowFlex Ultimate II Home Gym. We will also be introducing a new 2 to 20 pound version of our BowFlex SelectTech dumbbells targeted for women and we will make final preparations for the launch of our new BowFlex Home Gym that uses new resistance mechanism different from Power Rod technology.

Later in the year, we will be introducing a 10 to 90 pound SelectTech dumbbell set, a trio of new BowFlex TreadClimber products based upon the Nautilus commercial series TreadClimber platform in time for the fall and winter fitness seasons.

Lastly, our international channel includes business outside of the Americans which traditionally for us has just been commercial but is expanding into other channels. We estimate this market to be more than 1 billion and we have about a 6 share. For the first quarter, we had net sales of 13.1 million, which is up 14% from the same quarter last year. Key drivers include growing business with large commercial customers in Western Europe such as Fitness First and LA Fitness, and in China with Power House Gyms and new retail relationships in the UK, Germany, and Italy. We expect ongoing growth in the international marketplace as we build our commercial business, expand our retail presence, and test the merits of direct-to-consumer marketing in key countries mostly in Western Europe and Southeast Asia.

In summary, we are very pleased with our pace of growth and sell-through of our product line. With 4 of our 5 channels growing at double-digit rates, and a fifth poise for growth, we believe our consumer and brand-based business planning is driving sales and market share growth. We anticipate net sales growth of more than 25% for the second quarter over the year-ago quarter and we are excited about the upcoming fall and winter seasons.

With that, I’ll turn it back over to Greg.

Thanks, Tim.

So we’re very pleased with the quarter and our overall progress as we drive growth and invest in our future. So here’s a quick update on our strategic initiatives. First, we’ve made a number of necessary improvements in our supply chain and are positioning ourselves for continued growth. We’ve synchronized our supply chain with our product development and sales and marketing teams as one element. A second element of our supply chain is that we’ve opened a logistics office in Shanghai to assure that our contract manufactures in China and Taiwan are prepared to scale to accommodate the market demand. The third element of it is beginning our Lean manufacturing process at our 3 domestic facilities. So these steps, we believe, are going to help us accommodate the growth in product demand in the back half of 2005 and beyond. Now our information system initiative is moving well. A portion of our direct business is already converted and a portion of our retail business is converted to a state-of-the-art enterprise resource planning platform that provides electronic data interchange with our retail partners. The second retailer became operational this week. Now we envision having most of our domestic business converted by the end of the year and our full conversion completed by the second quarter of 2006. We are continuing our fast pace of innovation in product development and marketing. We are implementing a formal go-to-market process which is helping us consistently execute our fast pace of innovation and delivery our innovations as planned. As a result, we anticipate at least 30% of our net sales coming from new products again this year as we bring innovation to every channel where we compete. We have a patent infringement trial against ICON Health & Fitness that is scheduled to begin in June and we are prosecuting 2 trademark infringement cases against ICON that are lined up behind the patent trial, for which dates are not yet set. We will vigorously protect our intellectual property and ensure we return maximum value to our customer and shareholders.

Okay. So let’s move on to guidance. For the second quarter, traditionally our lightest quarter of the year, we anticipate diluted earnings per share of $0.09 cents to $0.10 cents on an improvement of about 50% compared to the same period of last year. Net sales growth should be around 125 to 130 million, an improvement of about 25%. We are comfortable raising our first full-year guidance to $1.17 to $1.19, reflecting the upside of our first quarter and results we’re seeing in each of our 5 sales channels. Now expensing of stock options is not factored into our 2005 guidance and, as you are aware, this accounting treatment has been pushed off until 2006.

So let me conclude by saying that our team is proud of the first quarter results. We’re very excited about our business going forward as we drive growth and invest in our future.

Now with that, Ralph, I believe we are ready for questions.

Mark Rupe.

Please proceed with your question.

Great quarter. Just curious to see on the TSA rollout of the additional 200 displays, were there any factors cited to you in the first 3 months of the 15 displays that was the reason behind the 200 or are there any specific details they provided you?

Tim, do you want to cover that?

Sure. Hey, Mark. Thanks for the question and the nice comment. Yes, I mean, so just a recap of results. You know, we ran those 15 stores and measured those against control stores and sales volume across, obviously, the new stores which was very exciting on both our side as well as their side and great brand recognition which is something that was really lacking, I think, at retail in total. In terms of the stores that they’re choosing are really – are based upon where the biggest opportunity is for them to continue to drive revenue and sell-through and, obviously, those are the highest selling fitness stores which is the path we’re following with them.

Is there an average SKU figure that you have at TSA right now? I know it’s obviously ramping but is there an average out there right now?

I would say where we’re shooting for, Mark, is 8 to 10, I would say, on an average right now, if I’m taking a guess. We’re probably in the 5 to 6. We’re ramping right now.

Okay. And the Dunham’s opportunity, I assume that the new one – I mean, with 2 to 3 SKUs, how big is there opportunity there on a SKU basis?

I wouldn’t think that it would be any less than where we’re shooting right now with our other customers. I think this is, you know, [inaudible] we’re starting small with them and working through that relationship. We should have no reason we shouldn’t be able to get to the 8 to 10 with them as well.

Okay. And as far as some new doors added in the [inaudible], is there anything that would prevent you from supplying or supporting a big retailer in the back half of the year from a capacity point of view?

Good question. We’re working our fannies off to plan with the customer. So collaborative planning with them, so we’re forecasting following an early 2006 business with them so we can be ready for it at the same time we take that information and do supply planning with our vendors. So the fact that we’re doing our homework now upfront makes me feel very confident we can make those demands.

Okay. And then lastly, just commodity issues, anything you’re seeing overseas that would lead you to believe that there could be some pressure?

No. At this point, we’re really not, Mark. Things continue to look good relative to how we planned for the year.

Okay. Great quarter, guys, thanks.

Ed Aaron.

Please proceed with your question.

Thanks. Congratulations on the quarter. A couple questions. First, could you give us the margins by segment? I know you’re classifying things a little bit differently now than you have been but it would be helpful to know sort of how the operating income shook out by, you know, direct versus nondirect.

Ed, as we said, we are really with the power of one initiative and as we consolidate operations and as evidenced by our change from the Nautilus Group, the multi company, to Nautilus, Inc., we really are looking at this as one company from a standard margin on down. We do have some visibility as we are continuing that operation, though – or that consolidation, we do have some visibility this quarter but that will continue to get hazier as we bring things together. We saw margins of about 67.6% on the direct side this quarter in the commercial retail. Old commercial retail would have been around 27.1%.

Do you happen to have that for the operating line as well?

No, again, Ed. As a result of the consolidation, they would have been comparable in around the 15%-16% on the direct side and about 12%-13% on the commercial retail side.

Okay. Great. And also with the – you know, you’ve done – you’ve changed things around a little bit in terms of the timing of the – some of the BowFlex launches in the direct channel, particularly the one without the power rod technology. You know, to what extent might give you some additional benefit in the back half of the year because I would assume that since the products been pushed out you might – you know, you might be sort of saving some of the sales that you might have had for the back half of the year.

Well, we think our plan is pretty solid right now, Ed, and I – you know, I don’t – at this point we’ve taken the guidance to 117 and 119 and we’re going to hold pad at that. I think, you know, any time you launch a new product you’ve got a little bit of a ramp-up period to it, so we’re going to invest pretty heavily in the marketing side of this as we move into it, but we’re not changing our guidance any further than we have at this point.

Yes, and I definitely understand that. I’m just – I guess my question was more actually about the ramp. You know, does – with that particular product line, would you expect it to contribute more or less in the back half of the year than it had – than it would if you had launched it say in March?

Well, I think if you look at the total brand for BowFlex, I think that’s the way we’re looking at it right now, and the BowFlex brand is extremely healthy right now and so as we look at individual products within it, I guess if you had to say are you going to sell more or less units of an individual product, well, we don’t introduce until later, we’ll loss probably sell a few less units, but we’ve done so well with the units that [inaudible], if you want to call it that, that we’ve continued to run those. So in total, you know, for our overall business, it makes our business much more healthy and it saves us a little gun powder for not only the back half of the year but in the first part of ’06 and on into ’07.

Okay. Great. And lastly, could you just specify as to which – where the product shortage is in the specialty this channel this quarter?

Yes because of some supply constraints, we had to have vendors shift over from one of our other product lines and shift out of some of our basic strength product. So where we’re seeing a shortness in our specialty channel is your basic sort of free weight benches and those kind of things and that’s a short-term glitch. We’re back on line with that at this point, but it was just a little bit of a carryover from the fourth quarter.

Great. Thanks.

Thanks, Ed.

Eric Wold.

On the guidance you gave for this year of 117 and 119, maybe just give us a sense in terms of, you know, what’s included in that guidance? You know, whether it’s kind of what’s known with the current customers? Is there some kind of assumption of new wins in there or any kind of additional major wins down the road [inaudible] guidance?

Tim, do you want to cover that?

Yes, Eric, we’ve got growth in some new customers in both specialty fitness and in retail planned in those numbers, but it’s very conservative. Specifically we do not have any major new customer launches with major customers planned in there. As we did our 2006 plan, it was way too earlier to be able to even load that in and as we work through this here we continue to firm up those opportunities but no significant major customer rollouts in those numbers, especially for Q2.

Okay. And now going back to kind of the TSA question, you know, that Mark had. With the good results you’ve had there, you know, [inaudible] building within those stores, what have you heard from the other sporting good guys in terms of wanting to do something along the same lines as TSA and with their stores and how quickly could something like that get done?

Great question, Eric. Two points I want to make. One is receiving a lot of interest in looking at the way we merchandise our products on the floor because we truly are changing the way the consumers buy products. We’re giving them a reason to focus on brands. We’re giving a way to organize the floor and it’s really changing the game in those retail spaces. Other retails are interested and what we’re looking at for them are differentiated ways to do that on floor. Clearly we don’t want to have a lot of me-too out there but we are looking to do something specific for other major retailers. We’re talking to Dick’s about. We’ve had conversations with Dunham’s as we’ve rolled those out as well. They’re all – they all love what we’re doing. We’re now figuring out ways to make it work for their concept and make it work for their consumers.

And you have very little in Dick’s right now, correct?

Actually TSA is really the only significant customer that has make room for fitness on the floor so it’s very different. I would say then the balance of all of the other sporting goods retailers look exactly the same as just kind of a dump zone for fitness equipment right now.

And the last question. Can you just give us the – I guess kind of two-part – one give us how much of the Q1 G&A you consider those one-time charges. You know, the CPSC, the litigation reserve, and relocation costs. And then two, how much is kind of one-time – how much one-time G&A could there be in Q2 maybe specifically associated with the ICON court case?

Eric, we would expect that about $3 million in Q1 could be termed infrequent or one-time. We would expect that this year our G&A should run around $10 to $10.5 million per quarter. Obviously, with the litigation, that’s going to push up Q2 a little bit. Hopefully, we’ll actually go to trial and get to stop that investment in the future and perhaps [inaudible] expectation going forward.

Okay. Perfect. Thank you, guys.

James Bellessa.

Good afternoon. You were talking about G&A line item and I think you mentioned the consumer product safety counsel civil penalty that was almost a million dollars – litigation, relocation costs, and I don’t know what else you said, but all that totals through for the $3 million that are infrequent or one-time, is that what you’re saying?

Right, Jim, and in addition there would be some IT investments there as well – information system investments.

You went over the numbers fast on how some of your margins were under the old direct and commercial and retail format segment breakdown. Let me repeat what I think I heard, and then please correct me. The direct gross profit margin was 67.7 and a commercial and retail profit margin was 27.1?

Correct.

And then the operating profit margins were 15% to 16% and 12% to 13%, respectively?

Yes. Jim, that’s correct.

You went through the size of each of the markets and when we got to the retail segment, the retail channel rather, the size of the share was not stated and was there a reason not to state the share size or was that inadvertent?

Jim, it’s less than 2%.

In the retail?

Yes, sir.

Okay. And you said that there was a – that the buyers of retail fitness equipment, they make their decision by July 4th, or you said Independence Day. I’m believing that’s the domestic Independence Day of July 4th? Is that what you were saying?

That’s correct.

And have they started to make those decisions or will they make the decisions in the next 3 months?

Jim, they’re in the process of making those decisions right now. They have not firmed up their assortments for fall. They are getting closer by the day and by the Fourth of July, typically, they’re at a position to make their buys.

Okay. And would you care to put – give us the share – or the sales amount for the 5 segments, 5 channel business channels for the year-ago figure rather than you just gave us the percentage increase. Can you give us the dollar amount?

No. There’s a couple things here, Jim. One, we’re – for competitive reasons here, we’re going to try to give you a relatively health of those channels and share with you, you know, how we’re progressing, but we’re going to be very careful going forward because about 10% to 20% of the people listening right now are competitors and they get more interest everyday.

Let me ask that question a little differently then. In the commercial side, in that channel there, you said that you had 17.2 million in sales and that was up 14%. Is that correct?

Right.

And then we could calculate I guess all of the year-ago comparisons, if that’s what you’re saying.

I think – hey, Jim, I’ll tell you what, why don’t we do this off line. Why don’t you call us back, and we can take you through some of this detail stuff.

Okay.

If that will help because I think what you’re asking here is some real detailed questions. We’d be happy to walk you through those one-on-one if you want to go through them.

Okay. Very good. Thank you very much for your answers.

Thanks, Jim.

John Moran.

Please proceed with your question.

Hi, guys. Thanks for taking my question. Just real quick, and I missed it in the prepared comments, how many doors are you guys going into in Dunham’s?

Dunham’s stores is 111.

111. Thanks. And then, secondly, if you guys could give us any sort of additional detail on what you’re seeing in terms of retail inventory levels, both in sort of large format sporting goods stores as well as specialty. I know in specialty there are some supply shortages, so I think it’s safe to assume that inventories are pretty tight there but on retail.

Good assumption. [Inaudible]. As I would classify we’re too light. In retail actually, based on where we are in the selling season, this is typically the lowest season of the year for fitness and this is when retails are normally doing their floor promotions. This is when clearance sales happen. The great news for us is because the way we manage through this in fourth quarter, we’re sitting in a great spot right now at retail. We – I can’t tell you, John, that we’re overstocked on any item right now in any retail. We are sitting in a great place, which positions us in a super spot for Q3 and Q4 as we begin now to ramp back up for the holiday season. As you know, this is when the [inaudible] we’re in a very positive spot right now. We stayed close to this in Q4 intentionally and Q1 to make sure that we weren’t loading retailers as we went into the soft season.

Okay. Great. Thanks very much, guys.

And John, just one other thing I would say is the retailers, I would say, are thin across the board. I don’t think – as you’ve been listening to conference call – I don’t think any of these retailers are really in a high inventory spot.

Okay. I appreciate it. Thanks.

Thank you. That was the final question. I would now like to turn the conference back to you. Please continue with your presentation or closing remarks.

All right. Thanks, Ralph.

So the bottom line is I think we made a lot of progress here in the first quarter. We are certainly – had our celebration about 2 days ago and we are now focused on the second quarter and the back half of the year, so the fun times here are over and we’re back at it and I think – you know, we’re really excited about the opportunity that we see. It’s been fun for us, I think, as a management team to be able to put this plan together and see it really start to come to fruition. So we’re real excited about where we’re headed, where the business is going, and the strength of it, and frankly, one of the more elements is the flexibility that this new business model now provides us to continue to grow shareholder value. So we’re excited, more good news to come, and we’ll see you back here in the second quarter conference call. Thanks.

Thank you, ladies and gentlemen. That does conclude the conference call. We thank you for your participation and ask that you please disconnect your lines. 9