Nautilus Inc (NLS) 2006 Q1 法說會逐字稿

Ladies and gentlemen, welcome to the Nautilus, Incorporated first quarter 2006 earnings conference call. At this time, all participants are in a listen only mode. Following today's presentation, we will have a question and answer session. We will ask callers to limit their questions to one plus one follow-up if necessary. After your questions have been asked, we will place your call back in queue in case you would like to ask additional questions as time permits. If anyone needs assistance during the call, please press the star key followed by the 0. As a reminder, this conference is being recorded on Wednesday, May 3rd, 2006.

Before the call begins, listeners should be advised of the Safe Harbor statement that applies to today's call. Prepared remarks during this call contain forward-looking statements. Additional forward-looking statements may be made in response to questions. These statements include information about second quarter and long-term estimates, and operating improvements do not guarantee future performance. Nautilus undertakes no obligation to update publicly any forward-looking statements to reflect new information, events, or circumstances after the date they were made, or to reflect the occurrence of unanticipated events. Therefore, undue reliance should not be placed upon them. Listeners should refer to the earnings release to which this conference call relates and the Company's most recent periodic reports on Form 10-K and 10-Q filed by the with the Securities and Exchange Commission for more discussions of the factors that could cause actual results to differ materially from those projected 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, Incorporated. Please go ahead, sir.

Thanks, Jim. Good afternoon, and thanks for joining us. With me today are Bill Meadowcroft, our Chief Financial Officer and Tim Hawkins, President of our equipment Fitness Equipment business. We made significant investments in the past two and a half years to prepare for sustained growth. As you know, often there is a lead lag affect where our revenue growth can cause pressure on operations and ultimately earnings. That was clearly our problem in Q4. I'm pleased to report that while we still have room for improvement, most the systems, processes and infrastructure are now functioning properly. We are continuing to improve our operations to deliver a strong back half of the year.

In this call, we'll provided an update to you on our progress to the first quarter, provide a second quarter guidance, and outline plans to improve our business results. Bill will give a brief overview of our first quarter financials and Tim will provide an update on net sales by channel. For the first quarter, our sales and earnings were in line with our guidance and we continued to leverage our brands and innovation to grow market share. Net sales were about 185 million and earnings were $0.16 per diluted share. This is about 2.5 times better than our fourth quarter results on roughly equivalent sales. This is a result of activating the initiatives I outlined in our previous calls.

Our balance sheet is substantially improved in the first quarter, with inventories down about 20 million from year-end levels and net borrowings down about 30 million to just 1.5 million. We experienced sales growth in all three of our businesses: Fitness equipment, international equipment, and apparel. The manufacturing issues we experienced in the fourth quarter are being addressed. All six cardio products that were slow to ramp in Q4 are now in production. We're also taking advantage of the second quarter, seasonally the slowest, to gear up for the next fitness cycle and to further advance our plans to improve margins over the next several years. We'll get into some additional discussion later, but first, let's get to the numbers. Bill?

Thanks, Gregg. Net sales for the quarter were 185 million, an increase of 18% over the year-ago quarter. This is the largest revenue quarter in the history of our Company. Gross profit margin was 42.9%, which is within the 42 to 45% gross margin range we estimated for each quarter of this year. Compared to the year-ago quarter of 49.1%, about 200 basis points of the decrease can be attributed to mix shift. The other 420 basis points can be attributed to costs related to ramp of a new products and increased distribution costs, including increased warehousing, transportation and fuel costs. We are implementing a number of improvements that are expected to further strengthen gross margins. Gregg will elaborate on them later. For the first quarter 2006, Selling and Marketing and General and Administrative expenses were both down as a percent of revenue compared to the first quarter of 2005.

Operating expenses for the first quarter as percent of revenue dropped almost 200 basis points compared to the first quarter of 2005. Operating income in the first quarter was $8.7 million or 4.7% compared to 14.1 million or 9% for the year-ago quarter. The reduction operating margins mirrors the reduction in gross margins. Diluted earnings per share for the quarter were $0.16 compared to $0.28 a year-ago. The 2006 results included about one and a half cents per share for stock option expensing as required by FAS 123-R. As Gregg said, this is a much improved result compared to the fourth quarter, reflecting the progress we've made in addressing issues that affected our fourth performance. Turning to our balance sheet, we also made progress on inventory and borrowings, and in the second quarter we're working to deliver considerable improvement in DSOs.

Borrowings net of cash were just 1.5 million. We expect to have a positive balance at the end of the second quarter of 2-5 million after two tax payments totaling approximately 7.6 million in the quarter. We did not purchase any stock in the quarter, as we focused on improvements to the balance sheet. We have about $84 million of our buyback authorization, and remain open to buying back stock. Inventory decreased to 76.2 million, down $19.9 million from the previous quarter. This number, which includes about 12.5 million from two acquisitions will likely come down further over the course of the year through improvements we are making in our forecasting and inventory flow process. On the litigation front with Icon Health and Fitness, we are appealing an unfavorable ruling in Federal District Court in Salt Lake City. We also have an October 10th court date in Federal Court in Seattle to prosecute a trademark infringement claim against Icon.

In addition, a patent infringement case we are prosecuting against Icon remains under review by the Federal Circuit Court of Appeals. For a more complete overview of our fitness equipment, international equipment and apparel businesses, I will turn the call over to Tim Hawkins, President Fitness Equipment.

Thanks, Bill. Each channel performed as expected for the quarter and is on track for the annual sales plan I outlined on the last call. I will begin with the four components of the fitness equipment business. Let's begin with retail, including sporting goods, warehouse clubs, and department stores. First quarter net sales were $29.2 million, up 38% from the year-ago quarter. Our retail partners report strong sell through and light back of room inventories as we wind down the primary fitness selling season and continue preparations for the next season. Our next channel is specialty retail, where people buy club quality equipment for the home or small businesses. First quarter net sales were $21.2 million, up 6% from the year-ago quarter. We are appreciative of how our customers have aligned with us to continue bringing innovation -- innovative products to the market.

We held in person senior level planning meetings with virtually all of our key accounts, where we recommitted ourselves to the highest quality and customer service standards. As a result, we continue to expect 10% or better growth in this channel for the year. Next is the commercial channel, such as clubs, hotels, and living complexes. We recorded $18 million in sales, up 5% from the year-ago quarter. We had excellent show in late March at ERSA, the largest commercial show in the Americas. We formally introduced, took orders for, and shipped the Nautilus Commercial Series Treadclimber units. And I am happy to report from a quality perspective the units are performing very well. We also received strong with feedback on the Nautilus Commercial Ellipticals with My Stride technology, new upright and recumbent bikes, new free weights, and a new entertainment system.

Next is our direct channel, which involves internet, catalog and direct response advertising. Our first quarter net sales were right on plan at $83.7 million, down about 2% over the year-ago quarter, which was up 34% from 2004 and up nearly 20% from the previous quarter. Our new Bowflex Revolution Home Gym and Bowflex Treadclimber 5300 performed very well, as it did our second annual winter catalog. Now let's turn to our international equipment business, which includes commercial along with retail and direct sales outside the Americas. For the first quarter, we delivered net sales of 13.5 million, up 4% from a year ago. Our international team recently wrapped up [FIBO] in Germany, the world's largest fitness exposition, were they received very favorable support for our new line of Nautilus cardio products.

And then finally, the apparel business delivered $19.4 million in net sales for the first quarter compared to approximately 18 million in the year-ago quarter under prior ownership, or growth of about 8%. The apparel business is gearing up for expanded business volumes later this year. In addition to solid sales performance, we are making excellent progress on the supply side of our business. Gregg will provide an update in this area. Gregg?

Thanks, Bill and Tim. We're pleased with the progress of our first quarter, although expect more improvement in gross margins, and in turn operating margins. Here's a brief progress support on how some of the improvements we've made this is the fourth quarter. Now under Mark [Muster]'s manufacturing leadership, all six cardio products that were slow to ramp in the fourth quarter are in production. They include a treadmill, Elliptical, and Treadclimber model for each of the commercial and high end home markets. Our ERP system conversion is in the process of business implementation this year for commercial, specialty, retail, and portions of our direct business.

We're generating daily flash reports on sales, producing reports that are revealing areas for improvement and expect it to improve the accounting close process. While we're still getting used to the new system and it's still a bit clunky, we are improving every day. So this year, our Company is focused on achieving leverage through operating at excellence. To achieve that goal, we've put in place an initiative initiative called QC Squared to take costs out of the system and improve margins. It stands for quality, customer service, and cost take-out. The quality components include increasing the number of on floor quality engineers in our domestic plants and improving first time yield. The customer service element includes a number of new capabilities and delivery improvements. As one example, we've installed self service capabilities in customer service where people can check their order status online or by phone. That accounted for 20% of the customer service call volume in Q1..

With that system operational, we are working further upstream on making improvements to our parts delivery and to our product delivery. The cost take-out elements consist of six key focus areas: First, we're streamlining our domestic manufacturing. This includes significant improvements in quality, efficiency, and procurement. As part of this initiative, we elected to close our cardio facility in Tyler, Texas. Production will be shifted to Tulsa and to an international supplier before the end of the fourth quarter. We expect slight improvement in 2006 from these moves, and at least 3 to 4 million in annual savings going forward. Second, we're reducing the number of distribution centers for the fitness equipment business by improving inventory flow. With the power of one view of our inventory, our operations team already has reduced the number of distribution and temporary storage facilities from 24 to 14.

While carrying these facilities was a drag on our Q1 earnings, eliminating them will pay big dividends for us in the back half of the year. Our plans cause -- excuse me -- our plans call for operating efficiently with 10 distribution centers by the fourth quarter of 2006 and just 7 by the end of 2007. With proper inventory flow, our distribution center requirements are about 40% of what was required in the fall of 2005. Okay, third. We are moving our packaging upstream to our suppliers. Our products can be tested and packed by our contract manufacturers rather than in our DCs. This will result in savings for our suppliers and for Nautilus.

Fourth, we're making arrangements to ship products directly to customers from our trusted manufacturers. This will open up more possibilities for [FOB] shipments from Asia and cross document initiatives where customers can take the goods from their arrival point. Fifth, we're continuing to work in partnership with our suppliers to look for cost savings This includes sustainable engineering work to find ways to make the product better at less cost. This approach can help us significantly improved gross margins on our new product over time. Six, reduce continuing older and redundant product SKUs in our line. This product life cycle management work is long overdue. This year, we'll be sunsetting as many as 100 older product SKUs that accounted for less than 2% of last year's revenue and produced minimal financial results. Simplification will allow us to focus our attention on higher-margin products. These initiatives are already being activated and had some positive impact in the first quarter.

We believe these initiatives will help us achieve significant gross margin improvement and operating income improvement in the back half of the year and beyond. So let's get the guidance. We're going to continue our conservative approach to guidance, providing one quarter at a time. As we look to the second quarter of 2006, we expect net sales of around 145 to 150 million and earnings of $0.04 to $0.07, including about $0.02 per share in the quarter due to FAS-123R, the new requirement of expensing stock options. So we're building a solid foundation for our business to grow profitably for years to come, and we believe we're off to a very good start in 2006. We appreciate the trust you've placed in us and are working diligently to meet and exceed those expectations. And with that, Tim, I believe we're ready for questions.

Thank you, sir. [OPERATOR INSTRUCTIONS]. Our first question comes from the line of Kathryn Thompson. Please proceed with your question.

Thanks. I have two questions. The first is on gross margins and the second is a follow-up on guidance. The first one on gross margins, when can we start to see a lift in gross margins? And of the compression in Q1, how much is related to new product ramp and how much is more related to the manufacturing initiatives? And also, can you walk us through the improvement in gross margins going forward?

Yes. Let me take a shot at it. This is Bill. Thank, Kathryn, that's a big question -- I'll try to take a run at this one. So on the gross margin side first, I think as we look at what happened in the first quarter, what drug down the gross margins a little bit from what we see -- although we were in a gross margin range of that 42 to 45 we promised -- significant investments were made in these new products we talked about in the ramp up phase of those. So as we get more efficient in running those through the factories and distributing them, we expect some margin improvement there. Secondarily, I think as we look at some of the operating opportunities that we have -- and more in the operating margin side of the business, which is where I think we're going to get a lot of leverage this year -- we have tremendous, I think, opportunities in some of those initiatives; in specific, those six initiatives we just talked about. So I think that's where you'll see us give a tremendous amount of leverage that will carry through to the bottom line.

On the gross margin side, we are going to continue, as we said, and a couple of those operating components to work with, you know, both our manufacturing plants here domestically, as well as our international suppliers, on how we can take costs out of the system. And I think you can see us, you know, in that 42 to 45 range continuing to make progress upward. You know, this quarter is 42.9; we expect that to continue to move forward to that 45 range as we move through the year.

Okay. Would you say that you probably, maybe have 20% remaining, or 20, 25% remaining in your manufacturing changes?

Well, with the closure of the Tyler plant, will take a charge this year and it will have some affect on our second quarter earnings, so that will have some impact of about a penny to maybe a little bit more than a penny on earnings in Q2 as we prepare to close that facility. So that will be somewhat of a drag; and if what you're referring to is how much is that going to affect us ongoing, I think you'll see that be somewhat of a drag in Q2, a little bit remaining in Q3 and then actually start to become a positive earnings for us in Q4 and beyond.

Our next question comes from the line of Scott [Krassik]. Please proceed with your question.

Hi, and good afternoon.

Hi, Scott.

A question on the direct channel. You know, the Bowflex Revolution and the Treadclimber 5300 probably are higher ticket items than normally sell in this channel. Are you guys looking at that and thinking about launching products, newer products that address a lower price point? And will that mitigate growth in direct channel or do you think you can succeed at that higher price point?

Well, let me kind of take a quick run at that. On the gross margin percentage sides, those products are slightly lower but they bring in more gross margin dollars for us, right, because they're higher price points. So although you might see margin percent shrink a little bit as a mix shift, you will see the margin dollars actually go up for us as we ship products over to those newer items like the Revolution and the 5300 you mentioned. We actually, as we've looked at our business, see the baby boomer as a huge potential for our Company, and they're looking for higher end products like that, and I think that's what we're starting to see some success for. Tim, you can also -- maybe -- you might touch on some of the other items that we have that round out the bread so we have lower price points [INAUDIBLE].

Sure. Yes, Scott, I think the way we see innovation for direct is really trying to cover -- we look to cover all price points. So while the last two have been at the most highest price points, we do opportunity for growth in other price points. lines. So don't be surprised to see us having innovation come in all the Treadclimber home gyms and SelectTech dumbbells, if not other products, coming into other price points than just the high. So we don't -- certainly don't want to get blamed by any means. We see a big opportunity, as Gregg just pointed out, of reaching higher end consumers and baby boomers as well as attracting other market segments that may not have a higher price points. So expect to see innovation from us at other price points this year.

Okay, good. Great. And then, Gregg, can you talk about maybe marketing plans for the second half of the year that you've held back on last year that should really be sort of industry specific or unique for Nautilus?

Yes, that's a great question. I think -- I'm going to try to be a little careful with this one, Scott, just because of competitive reasons, so I want to be a little careful there. But what I will tell you is, you know, we've got 15 new products we plan on a launching this year, as we've talked about. Every single one of those products has a marketing campaign behind it. Some of them have a lot of emphasis behind them; and as Tim alluded to, we're covering a broad breadth of price points and consumer targets.

You know, as we've gotten better and more filled out now and our distribution channels are starting to mature that, it creates an opportunity for us now to start really driving additional organic growth in customer relationship management and marketing and how we're approaching it. So I think you're going to see us get very, very aggressive in the back half, and I think we've got a pretty good plan put together. And in fact, a much more integrated and exciting plan than even we had last year, but much more manageable for us. You know, we went from 26 new items to 15, so we think we can really hit these out of the park. So we're pretty excited about it, and that's about all I want to say at this point.

Our next question comes from the line of Rick Nelson. Please proceed with your question.

Thank you, and good afternoon, guys.

Hey, Rick.

This question is probably for Tim. The big box sporting goods stores -- Dick's, TSA's, Sears, et cetera -- are you seeing any change in SKU accounts in those retailers, and how do the orders look for the fall?

Hey, Rick. Yes, we're right now, as you can imagine, in the process of selling the back half of the year. We're finishing up our stewardship reviews and firming up plans and very soon we'll be where we were last year. We see growth in two avenues. One is additional doors and the other is additional SKUs in same doors. And we've got growth plans with each of the customers you discussed to do both of those. So, you know, we're still very fledgling in our retail relationship, with lots of opportunity to grow. So we're -- big focus on obviously more profitable SKUs for both us and the retailer; but continue to grow what we call call from the core, and then grow more with them as well.

And if I could do just a follow-up on [INAUDIBLE], the 8% kind of growth you talked about in the first quarter was below what they have been growing historically, and what caused the slow down there and how do see that [INAUDIBLE] business shaking out?

I'll answer that one for you, Ric. It -- on the apparels and new side of the business and the apparel side, actually they are doing extremely well and brought in earnings right where we expected. The only real issue we went through that pulled down the topline revenue a little bit in the first quarter was a couple of things. One, just a little shift in the shipping at the end of the quarter where some fell over into the first and second week of April. And then the second thing was we we had one shipment of product that got over to the states on some tops that didn't meet the quality specs that we have, and we had to reject those, so we did not get some of the orders we expected.

But I think overall, the apparel business from a brand standpoint, the brand is extremely strong. It's doing well. The apparel team is functioning at a very high level, and I think doing a very, very good job. So we expect to see some continued great things coming from that team.

Our next question comes from the line of Scott Mushkin. Please proceed with your question

Hi, this is actually Baily [INAUDIBLE] filling in for Scott here. I guess just a couple of questions in terms of -- in terms of sort of CapEx and what you're thinking about? You know, obviously, you got out of the Texas facility, but are you going to have to put some money into the Oklahoma facility this year, next year? Or what are your feelings on CapEx going forward?

Yes, so from a CapEx standpoint, we made some huge investments in '05 to really prepare us for some of these opportunities. And so we're -- you know, our CapEx is going to sit down in that 13 range for the year, I think, and Baily, I think, you know, good question; and really the answer to that is, '05 was the big investment. And I think you'll see '06, as we've talked about, will spend a lot less. And we really don't need to do a lot to that Tulsa factory to get that ramped up. So you aren't going to see a lot of expenses associated with that.

Okay. And I mean, do you have -- I guess do you have any general feelings in the out years at all, or is that something you don't want to get into, sort of '07, '08, that kind of thing?

Can you repeat that question?

Sorry about that. I guess I'm also just wondering if you have any thoughts on in terms of looking out into '07, '08, that kind of thing.

Oh, so from a CapEx standpoint specifically?

Yes.

Okay. As we look at '07, '08, '09, I think, you know, a lot of that will depend on some of the channels that -- and new product opportunities that we have; but right now, certainly with the product mix that we have, we don't see any need for any more significant investments from a capital perspective.

Our next question comes from the line of James Bellessa. Please proceed with your question.

James Bellessa, Jr.: Good afternoon. The building -- the headquarters building -- now, was that a first quarter event, the sale of that building?

Yes, it was.

James Bellessa, Jr.: And did you have a gain from that sale?

We actually ended up with a very small loss of about $48,000 in the quarter.

James Bellessa, Jr.: Okay and I think I heard that you didn't make any share purchases, is that correct? And how many shares outstanding do you have?

In the quarter we did not. We were focusing on the balance sheet and solidifying that, and we're still just under 33 million shares outstanding. The change from year and was only about $50,000 additional shares

Our next question comes from the line of Rommel Dionsio. Please proceed with your question.

Good afternoon. A question on the inventories, You made obviously very good progress in the quarter on that. As you look to streamline the infrastructure further, should we expect inventories to decline on an absolute basis, or is this more [INAUDIBLE] to address, you know, sort of cost of distribution and so forth?

I think, you know, not too get far ahead of ourselves here, but we think that as you look at 75, 76 million in inventory, actually we believe we can carry that kind of inventory in the back half of the year Because of all the initiatives that we've put in place, Rommel. We moved -- you know, we've moved a lot of the packaging upstream, which makes the inventory flow a lot better through our DCs so we aren't clogging up the DCs with guys having to prepack and repacked goods. So that helps us with streamlining and also frees up a lot of square footage for us. We've moved packaging upstream. We're doing direct shipment to customers that don't even flow through our DCs.

And then another piece were looking at is actually cross docking on the DCs, where orders that we know we're going to turn quickly we prepack and they don't even go into the racking system. So that in itself -- those three main elements -- are allowing us to get much more efficient with the amount of inventory we carry. And I think what you saw for us in the first quarter through reduction of those DCs, you'll see, you know, continued progress of the number of DCs that we have and the number of square footage needed, therefore, a reduction in the amount of inventory that needs to be carried on a seasonal basis, so.

Okay, great. Thanks very much, Gregg.

Our next question comes from the line of Brian Murphy. Please proceed with your question.

Good afternoon. Two quick questions. One, on bonus accruals, did they come in, you know, lower or at [INAUDIBLE] level for the quarter, and did you accrue for the normal level for the year or was it a little light during the quarter?

We actually accrued heavy. We think were going to make some progress in the back half of the year here, so we're right where we believe we will finish the year. We accrued appropriately.

Okay. And then, you know, on the channel breakout, you know, you mentioned the 6% gain on specialty, but certainly you'd expect 10% or maybe even a little better going forward. You know, where do you see the opportunity? Is it with the existing relationships? Is it new relationships, or is it maybe a mixed shift as far a different products at current retailers?

Yes, that's a great question. Tim, you want to take that one?

Sure, yes. Brian, I'm glad you brought that up, because we're pretty proud of what happened in Q1. We see our growth in that channel, though, happening a couple of different ways. One is forming relationships and forging relationships with customers that believe in our strategy. And in some cases, that means living with existing partners and in some cases finding new partners. And I think you will see some things from us of the back half of the year that really demonstrate that we're putting our money where our mouth is by having very unique relationships with some of these customers. So we've had -- you know, we called it in the last quarter the "kiss and make up" relationship we've been doing with these guys. And it's very successful.

You've got to understand that we've had, in some cases, 20, 30 your relationships with some of these customers. Does that mean that every single year is perfectly smooth and flawless? No. I mean, for those of you that are married, you know what that feels like. We just [INAUDIBLE] finished last year, and we've been out there and enjoying the relationship we have with them and talking about the success we've had in the past and sharing with them our business strategy going forward. We've had a number of partners really step up in a big way, and you can look market to market and see where we've had those type of opportunities.

Yes, I think just to tag onto Tim's comments, the power of innovation has really meant something to these customers and these partners that we work with, and I think I can also say, it's really hard in this channel because of the fragmentation in the actual number of customers out there to look at one or two specific customers and try to make a channel specific call. So you really can't go out and look at one or two customers and say this is how the channel is going to play overall, because there's literally thousands of specialty retailers out there. So I think what Tim talked about of the "kiss and make up," we've really worked hard on going out and meeting with all of our key customers in this channel, spending time with them and talking about the innovation and what we're going to do going forward and getting the right products on the floor for them here in the first quarter. And it's obviously paying some dividends for both us and them, and I think we'll continue through the back half of the year.

Our next question comes from the line of Mark Rupe. Please proceed with your question.

Hey, guys, good quarter. Question for you, Tim. In the sporting goods channel, where do you see the biggest opportunity in terms of SKU opportunity in the upcoming year? Are there any gaps that are open right now from a product point of view?

Mark, any gaps in our line?

Yes. I've seen the BowFlex 3 Series starts getting traction, and I know [INAUDIBLE] at sporting goods retail specifically have open gaps.. But just curious in fact that is the case.

Yes, you nailed it. I mean, obviously, where we're strong, where we have =truly differentiated line and brand is obviously in the home gyms and free weights. Our Ellipticals -- our Schwinn Ellipticals are having huge traction. Our Schwinn bikes, our 213 Schwinn bike was a Best Buy last quarter. I mean -- and we've been chasing that product hard. Treadmills is the one place where we're gapped in terms of our assortment. And I got to tell you, you know, that is a commodity business.

And until we can come to the table with something truly differentiated and truly revolutionary, I think you'll continue to see us, you know, dance around the edges of that category. You know, with the -- not to throw the Bowflex treadmills under the bus, the 7 Series Treadmill -- BowFlex Treadmill -- also got a Best Buy as well from a leading magazine. So that's a place where you're going to see us -- we're not going to be in the fray with our competitive group there, but we will press hard with our Treadclimbers, where we'e the truly differentiated and unique. We'll press hard with our SelectTech technology and with home gyms. But certainly from our [INAUDIBLE], Treadclimbers is the softest piece.

[INAUDIBLE]. And then just one other real factor. Relative to your direct channel expectations, any thoughts on being able to leverage that expense this year?

I'm not sure I understand the question.

As far as the overall advertising and kind of budgeting from an expense point of view, do you see a decent amount of leverage there this year?

Yes. Absolutely. And where we're seeing it is really is in mix assortment. So if we were to do nothing and stay in the same advertising channels we're in right now, we would be getting hurt in terms of a leverage standpoint. But where see leverage coming is in diversifying our advertising mix, so you're seeing a lot more radio for us. You're seeing a lot more print. You're seeing -- and you'll see some things in the back half that are even more unique than those, but I don't want to disclose those for competitive reasons. But we're gaining leverage and efficiency there and maintaining our CPIs by broadening our assortment in terms of where we're advertising.

Yes, the direct segment, I think -- just to tag along with Tim here -- the direct segment is something that we continue to evolve our marketing and sales approach to that business as other competitors, you know, like Procter and Gamble and some of these other guys start to get into the DRTV business, we've -- we start to move around and do some things a little bit differently, and are having some very good success with it, as you can see based on the numbers. So we had one heck of a big Q1 in 2005; and to come in at almost comp that in 2006 is one heck of an accomplishment.

So, you know, I think our direct business is only going to get better as things go forward, and I think you're going to see us be smarter and smarter about how we do that marketing and advertising expense side of that line

Our next question comes from the line of Laura Richardson. Please proceed with your question.

Hey, Laura, you there?

Ms. Richardson, your line is open. Please proceed with your question.

Hi, can you hear me now?

Yes, welcome back.

Okay, yes. Thanks, hi. Good to be back. A question about expenses for you guys. It seems like there are a lot of transition type costs this year for the Texas plant, finishing the work you need to do around ERP -- litigation, I hope, is not a prominent expense in your P&L. But you could talk about the magnitude of some of those expenses this year, what you're budgeting for those things?

Yes, I would tell you this. I think, Laura, as you look at those those three categories specifically that you just outlined -- and our CFO is sitting next to me, he'll kick me if I'm wrong -- but I think, you know, you could say there's somewhere between 3 and $5 million tied up in those three categories by themselves for expenses this year, that we would see not being ongoing expenses as we move forward with the business.

So we'll get some efficiency out of that going forward.

And Gregg, did you say earlier a penny in Q2 is what you estimate the cost is going to be for the planned consolidation?

Yes, I think -- you can call it roughly a penny. You know, it could be a penny, penny and a half, but that's why we're being a little bit conservative in our guidance here. You know, we say $0.04 to $0.07. We need to get, you know, the Tyler plant taken care of. We've had some increases in fuel cost, as you know everybody had is dealing with that has ever been to a gas pump. So we're dealing with that, and so we just -- you know, until we really got a handle on it, we're going to be a little bit conservative for Q2.

But what I'd tell you is that I think a lot of those things that were putting in place from operation standpoint and from a manufacturing standpoint are really starting to get traction, so I'm excited about that. I'm happy about the way the top line is work. It's just, you know, in making the right long-term move, with ERP, with Tyler, Texas, with, you know, some of these things we're having to defend our intellectual property, you know, those can be a little bit of a drag on earnings. But it's the right thing to do for the business long term and we're going to stay the course here. So yes, it will hurt us a couple of pennies in totality here for Q2; but all in all, business is coming along pretty healthy here.

Our next question comes from the line of [INAUDIBLE]. Please proceed with your question.

Hi. Good afternoon.

Hi. How are you?

Hello?

Yes.

A question on the expenses again. In your 10-K, said legal fees increased almost $6 million in 2005. And then you spent about $8 million to consolidate IT systems in 2005. I was just wondering how much of that was one time in nature?

Yes, well, the ERP project for the most part in totality is a one time in nature, and there will just be some maintenance costs associated with it going forward. And on the legal side of the business, you know, we continue to be in litigation with Icon in a couple components, and we're going to -- you know, we go on offense here as I would call it in October up in Seattle. And so we're going to keep the pedal to the metal on that on and see what happens there. So I think you'll see some expenses for us here in 2006 associated with that; but I think, you know, if you look at it on an ongoing basis, certainly into 2007 and beyond, I think you will start to see it return to more normalized levels.

Our final question as a follow-up from the line of Kathryn Thompson. Please proceed with your question.

I think you've already answered it, I just wanted to clarify on Q2, the plant closure is going to be a penny to two pennies impact for your guidance. What are the other components for your guidance and Q2, really specifically focusing on manufacturing and progress there?

Great question, Kathryn. So here's what I'd say, to be very clear on the Tyler, Texas facility, it's a penny, maybe a little bit more than a penny. The combination of legal expenses, freight charges, transportation costs, fuel costs, those kind of things, all come up with that $0.02 to $0.03 range. So when you add all that up, that's where we're getting some of the -- you know, if you look at it since the first of the prior year, about $0.08, we could have $0.02 to $0.03 of degradation in there because of those one time deals, but you know, payoff dividends in the back half of the year hopefully, and we certainly plan on it being that way. But they are one time shot.

On the manufacturing side, let me tell you some of the things that I'm really excited about. The Tulsa plant has not only absorbed those new items that we've had trouble with the fourth quarter, but are now producing those very efficiently for us and are ramping up and finding greater efficiency as every day goes by. So we expect to see some margin improvement there as we go into Q2 in the back half of the year; and you know, if you look at Treadclimber, the Treadclimbers we've got out in the commercial marketplace right now are doing extremely well. They're all up and running, they're performing great. So, you know, hats off to our Tulsa team for doing one heck of a job there. In Independence, Virginia, the gang is doing a great job of continuing to produce our commercial cardio, our commercial strength equipment, and we've got great orders coming in and business looks really solid there for Q2 into the back half of the year. So we feel good about our commercial strength business.

Our Tyler, Texas facility, even though that's going to be closed, the folks down there have done a great job in working on our Treadclimber product and making sure they're keeping the quality standards are up there and really working hard on helping us be successful. So in return we're trying to treat them right with the way that we're doing that closure and trying to help them find jobs and all the other things. So all in all, from a domestic standpoint, I feel really good; and I spent almost two weeks over in China working with our suppliers over there and spending some time with them, talking about the initiatives we have in place and the things we're trying to accomplish. And I can tell you, we're already getting lots of phone calls from those suppliers saying, hey, I've got an idea on a way to cut some costs and actually improve the quality of your product -- let's talk through this together.

And they're going back and looking at their engineering processes and finding out how they can be more efficient so that we can not only be, you know, more cost competitive from our standpoint and improve our margins, but also take costs out of the system for them as well so they make more money. So it's really a win-win from a supplier standpoint as well. So I think all in all, you know, that margin side of the business, we have got a laser focus on right now and we're going after it in a big way. And I think those six initiatives that I talked to you about earlier are the things that we make progress on them literally daily. And it feels really good to see that kind of activity taking place, both in this building, in this country, and in our Asian facilities as well. So we feel really good about

Mr. Hammann, I will now turn the call back over to you.

All right. Well, thanks, everybody, for listening in today. What I will tell you is that I think we've -- you know, they always say that the strength in somebody is not how many times they get knocked down, but how many times they get back up. And we got knocked on our tail of the fourth quarter. There's no doubt about it. And what I can tell you is we got up about as mad as a hen, and we got back after it in the first quarter. I think we've made a lot of great progress. I feel really good about the way this team has performed, and I think, you know, more good news to come in our Q2 call, and we really look forward to sharing more information with you at that time about the back half of the year. So with that, we're going to get back to work. Thank you very much.

Ladies and gentlemen, that does conclude the conference call for today. We thank you for your participation and ask that you please disconnect your lines.