Nautilus Inc (NLS) 2006 Q2 法說會逐字稿

Welcome to the Nautilus Inc. second quarter 2006 earnings conference call. (OPERATOR INSTRUCTIONS). As a reminder, this conference is being recorded on Monday, July 31, 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, including information about third quarter and long-term sales and earnings (technical difficulty) estimates 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 appearance of unanticipated events, therefore undue reliance should not be placed upon them.

Listeners should review the earnings release to which the conference call relates and the Company's most recent periodic reports on Form 10-K and 10-Q filed with the Securities and Exchange Commission for more detailed discussions of the factors that could cause actual results to differ materially from those projected in forward-looking statements.

Now I would like to turn the conference over to Mr. Gregg Hammann, Chairman and Chief Executive Officer at Nautilus Inc. Please go ahead, sir.

Good afternoon and thanks for joining us. With me today are Bill Meadowcroft, our Chief Financial Officer; Tim Hawkins, President of our Fitness Equipment business; and Mark Meussner, our Vice President of Manufacturing.

In this call we are going to update you on the progress in the second quarter, provide third quarter guidance, and give you a progress report on our improving business results. Bill will give a brief overview on our second quarter financials. Tim is going to provide a business update on the fast approaching fall selling season, and Mark will provide an update on our manufacturing improvements.

The second quarter is seasonally our slowest, with nice weather attracting people outdoors for their fitness activity. We finished the quarter with about 138 million in net sales, slightly lower than our expected 145 to 150 million. Despite lower sales, our cost takeout initiative helped us deliver $0.05 per share in earnings, which is in line with our $0.04 to $0.07 guidance.

Our balance sheet is strong, and continues to strengthen, with positive net cash position and inventories at the appropriate levels. It is tough to draw too many conclusions from the slow second quarter. We experienced both negative and positive signals during the quarter, so let's start with the negative.

First, sales were a little lighter than expected as consumers acted cautiously in the wake of fuel prices and continued interest rate increases. But retailers appear to be even more cautious based upon recent meetings with them, and the channel checks that we've done.

Backroom inventories at store level appear to be very low. Open to buy authorizations are modest, and floor resets are later than usual. We believe out of stock positions have risen substantially on fast-moving products such as our SelectTech dumbbells, home gyms and recumbent bikes. These conditions will require intensive management with our retail partners to assure they have proper inventory stock on hand inventory for consumer take away.

Another negative, we're facing pressures associated with high petroleum costs. The variances to plan are showing mostly when freight and transportation companies tack on unplanned surcharges as high as 20%. We have been moderately successful in negotiating them or passing them along, but this has had a negative impact of about $0.04 in the second quarter.

In light of these higher operating costs and considering the strengthen of our brands and products, we elected to take a 4% price increase, restructure our freight programs, and revise our discount programs in our commercial, specialty and retail lines beginning July 1. We expect this to improve our ability to neutralize freight impact in the back half of this year.

Now with the uglies out of the way, our business is strong foundationally and it keeps getting stronger. Let me share with you some examples. First, our operational infrastructure continues to improve. After ten months of determined efforts. Our domestic plants are operating very well by producing high-quality products and generating positive operating and purchase price variances. And we are beginning to consolidate our Asia source goods with fewer more strategic contract manufacturers. This serves to increase quality, product delivery times, and ultimately our profitability.

For those investors and analysts who were able to join us in May at our cardio plant in Tulsa, Oklahoma, you will be pleased to know that all of the improvement outlined there are on track. You'll hear more about that in a moment.

Second, are management of the flow of goods is helping to keep inventories low. We remain on track to consolidate our distribution centers from 14 to 10 by the fourth quarter of 2006, and down to 7 by the fourth quarter of 2007. We also are preparing to flow goods more directly to our customers, minimizing transportation, handling, damage and inventory volumes.

Third, new products are performing well in the marketplace, and we are finalizing our 2006 product innovations in keeping with the improvements we've made in our go-to-market process. Therefore we do not foresee a risk of repeating the bottleneck that set us back in the fourth quarter of last year.

What we are seeing is a warm welcome across all channels for our exciting new revolutionary and evolutionary innovation, resulting from three years of intense product development, planning and marketing. About 95% of our current sales volume is from products and models that didn't even exist three years ago. Some of the product lineup ready for the fall includes the Ellipticals, with My Stride technology, new customized treadmills, new home gyms in commercial, retail and direct, new commercial and retail stationary bikes, new commercial and direct free weights, two new branded lines of apparel in limited launch, the breakthrough Bowflex Revolution Home Gym, and now five models of our popular TreadClimber cardio units. Most important, we're already producing all of these lines successfully.

Four, our pipeline of innovation is loaded for the next several years, as we build upon some of our revolutionary innovations and prepare ourselves for 2007 and beyond. And we continue to strengthen our intellectual property surrounding our innovations.

Finally, the balance sheet continues to improve. As expected we have a positive net cash position in the second quarter, and our inventories are steadily improving. The quality of our inventory is the best it has been in the past three years, reducing the risk of markdowns or obsolete inventory write-downs. Our business is well-prepared for the primary fitness season when we will again realize the full impact of our investments in innovation, manufacturing and operations.

Let's get to the second quarter financials.

Net sales for the second quarter were $137.6 million, an increase of 6% over the year ago quarter. Gross profit margin was 44%, which is on the upper side of the 42 to 45% gross margin range we estimated for each quarter this year. Gross margins were 80 basis points lower than a year ago, due mostly to channel and product mix. Operating expenses were 90 basis points higher as we fully annualized our two acquisitions from last year. We are realizing margin improvement as our new information systems provide greater decision-making clarity regarding profitability by customer and product SKU.

Operating income in the second quarter was $1.6 million, or 1.2% of net sales, compared to 3.8 million, or 2.9% of sales, for the year ago quarter. Other income was 30 basis points softer than the year ago quarter. We benefited from favorable exchange rates in both years, but paid some interest in 2006 versus earning interest income in the prior year.

Diluted earnings per share for the quarter were $0.05 compared to $0.08 a year ago on a non-GAAP basis, when adjusted for FAS 123R, on 33 million diluted shares.

Turning to our balance sheet. As expected, we had a positive cash position net of short-term borrowings of $2.4 million. Inventories were further reduced to 75.4 million compared to 76.2 million in the previous quarter. We're not satisfied with our Accounts Receivable position, and we expect improvement resulting from the intense focus we have on it.

Our positive cash position, combined with generating 5 to $10 million in cash in the third quarter, and our short-term credit line of $65 million, is available for working capital acquisitions or stock buybacks. We did not repurchase any stock in the second quarter as we continue to focus on polishing the balance sheet and pursue strategic investments. We have about $84 million on our buyback authorization, and at current stock valuations level we intend to buyback stock in Q3.

On the litigation front with ICON Health & Fitness, we have an October 10 date in federal court in Seattle to prosecute a trademark infringement claim.

Finally, the Company announced today that our Board of Directors has declared a regular quarterly dividend of $0.10 per common share, payable September 8, 2006 to shareholders of record as of August 18, 2006. At recent trading prices that equals to a 3% yield.

I will turn the call over to Tim Hawkins, President of the Fitness Equipment business, for an overview of our business by channel.

As Gregg explained, we did experience some choppiness in the second quarter. Three channels were up, one was flat, and two declined compared to same quarter last year. Our channel diversification strategy helped us improve sales. And our new ERP systems helped us focus on more profitable products and accounts. We remain confident in s strong selling season this fall and winter. I will begin with the four components of the Fitness Equipment division.

Our first channel is specialty retail, where people buy quality equipment for the home or small-business. First quarter net sales were $16.6 million, up 11% from the year ago quarter, despite a very soft retail environment. We have about a half-dozen new specialty retailer relationships giving us greater geographic reach for the fall. In total we will go into the fall with about 260 specialty retail doors, and about 950 independent bike dealers, both up from last year.

We will be having meetings this weekend to finalize the assortments at the Health and Fitness Show in Denver, Colorado. With new products at the right time we expect door growth of around 10%, and now expect full year sales growth of 10 to 20% in this channel.

Next is retail, including sporting goods, warehouse clubs and department stores. Second quarter net sales were $15.8 million, flat with the year ago quarter. Retailers appear to be demonstrating caution by maintaining low inventories at the store level, leading to potential out of stocks, particularly on fast-moving items. Plus the open to to buy is later and smaller than recent years.

We're still negotiating fall assortments well past the traditional Independence Day cutoff, likely pushing floor resets into October. With these conditions, we have kept firm on protecting profitable margins, even if it means foregoing some volume. As we look towards the fall season, we expect to have products in about 3,200 retail doors at an average of 4 to 5 SKUs per door, reflecting 10 to 15% growth. For 2006 we now expect about 15 to 20% growth at retail.

Next is the commercial channel, such as clubs, hotels and living complexes. We recorded $16.2 million, down 8% from the year ago quarter. The year ago quarter included a $3 million load in of the first commercial TreadClimber units.

Some commercial customers slowed their purchase commitments in the second quarter on softer membership trends. That said, we expect in the next few quarters to deliver substantial year-over-year growth. We're identifying excellent support for our complete lineup of products, led by the commercial TreadClimber, Ellipticals with My Stride technology, a brand-new free weight line, and revitalized interest in indoor cycling and stepping products. We continue to expect commercial sales to be up 15 to 20% for the year.

Next is our direct channel, which involves Internet, catalog and direct response advertising. Our second quarter net sales were $60.2 million, down about 13% over the year ago quarter. We are coming through a period of higher advertising rates and tighter direct response media inventory, causing us to further diversify our direct response methods.

Lead generation and conversion rates slowed in the second half of the quarter, no doubt in part due to worries over high fuel prices. That said, our new Bowflex Revolution Home Gym doubled our sales estimates, and Bowflex TreadClimber 5300 and 5000 continue to perform well.

With volumes ramping on products above $2,000, we will be introducing two new Bowflex Home Gyms targeted at a broader portion of direct shoppers. We expect a positive comp in the third quarter and even better performance in the fourth. For the full year we continue to expect single digit growth for the direct channel.

Let's turn to our international equipment business, which includes commercial, along with retail and direct sales outside the Americas. For the second quarter we delivered net sales of $14.9 million, up 25% from a year ago. In addition to sales in large Western European countries, we are expanding on the commercial and retail front in China, along with commercial sales progress in Sweden, India, Russia and the Benelux countries. We continue to expect around 20% growth in international sales for the full year.

Finally, the apparel business delivered $13.8 million in net sales for the second quarter compared to approximately 12.4 million in the year ago quarter under prior ownership, or growth of about 11%. Sales growth is coming from both -- from the core Pearl iZUMi cycling and running business to specialty dealers and retailers like Performance Inc. and REI. In addition we're testing a of Schwinn quality apparel with a retail partner.

And we're excited to be rolling out a line of Nautilus Responsiv Fitness Apparel, the first apparel line positioned for indoor workouts, after a successful introduction last week at the IDEA show for fitness professionals. Both are expected to deliver modest sales this year and strong growth in future years. We continue to expect around 20% growth in apparel for the full year.

At this point, we expect all channels to have positive comps for the next two quarters and for the full year. Our strong brands, innovative products, and diversified channel approach is setting us up well for an excellent back half.

For a quick update on a number of our cost saving initiatives, I would like to turn the call over to a special guest, our Vice President of Manufacturing, Mark Meussner.

When investors and analysts joined us in Tulsa, Dustin Grosz, our Vice President of Operations, and I outlines detailed plans to save about $11.5 million this year. I'm very pleased to report that we're tracking above this level.

Specific to manufacturing, we have made the necessary adjustments to adapt to a faster pace of innovation. As a result, our first-time yield is approaching 95%, which is near world-class performance levels, and our overall quality performance continues to improve.

We've also launched a sustaining engineering effort, finding ways to further drive down costs while improving product performance. As just one example, our Tulsa cardio facility has begun in sourcing about 25 components from our strength manufacturing facility in Independence, Virginia. This will save us nearly $400,000 on the annualized runrate. And we're just getting started.

The closure of our Tyler facility and transition of manufacturing is on plan. We will wrap up manufacturing there by September, and close the remaining operations in the fourth quarter. We are absorbing the transition costs in the second and third quarters, and will begin to realize positive variances in the fourth quarter.

Dustin and I are working on a number of initiatives to further support gross margins over the next several years. We're seeking ways to further leverage our Company's buying power and leverage our manufacturing and distribution facilities. Our team is absolutely ready. Our quality is high, and we're really looking forward to the season ahead.

Thanks a lot, Mark. And thanks for all the work you are doing. Great progress is coming from our plant. Here's a quick summary of what we have talked about here. Second quarter sales were a little lighter than we expected, but the shortfall was offset by good expense management and keeping focused on our customer product sales with better margin. Our balance sheet is clean, inventories are in check, our quality, customer service and cost takeout initiatives are performing well. We're in the best position we have ever been to deliver on the upcoming selling season.

We will keep a watchful eye on consumer spending and fuel prices. We're in a good position to weather some softness if this continues. So let's get to guidance.

We're continuing to approach specific guidance one quarter at a time. As we look to the third quarter 2006, we can expect net sales of around 165 to $180 million. That would translate into $0.16 to $0.24, including about $0.015 per share for the quarter due to FAS 123R, and a penny or two in wrapping up our Tyler operations.

The wider range in guidance is driven by the uncontrollable factors, such as the economy and the discretionary spending ability of consumers. Despite the uncontrollables in economy, I want to step back for a second and outline the significant progress we have made with controllable factors for our business in transforming our Company. I would also like to describe why the past three years of work has made us confident in our ability to deliver the back half of the year and continue to build a long-lasting, profitable business model.

First, we cleaned up legacy issues. We had only one highly profitable product at the end of its lifecycle in a single channel, facing a recall, and having a competitor infringe on a trademark and patent. We also integrated three previously acquired companies that were in many respects operating independently.

Second, we made a tremendous investment in innovation. The fruits of that investment include products in virtually every product category in fitness, and even creating new categories. TreadClimbers, My Stride Ellipticals, and SelectTech dumbbells are just a few of our industry chaining developments.

Third, we developed a revenue driving marketing plan. It is informed by research, backed by strong brands, and built through customer relationships. Today we market innovative products across multiple channels where ever consumers shop and exercise.

Fourth, come up we have dramatically improved our manufacturing and operations. This concludes managing our global suppliers directly rather than working through brokers, investing in our domestic plants to improve performance, and streamlining our flow of goods. We've also launched a formal go-to-market process and a sustainable engineering and global sourcing capability.

Fifth, we have consolidated management information systems, giving us better visibility into our business performance by customer and by SKU. Sixth, we have broadened our business to a pure fitness platform. In addition to building out our equipment lines, we launched the Nautilus Institute for Education, and we acquired Pearl iZUMi, the leader in high-performance Fitness Apparel.

Seven, we have successfully pursued and incorporated acquisitions to strengthen our core business. These include the acquisition of our Canadian distributor, acquisition of patents, acquisition of the Universal brand, and strengthening our intellectual property. We're now at a positive inflection point, consistent with our focus this year of achieving leverage through operating excellence.

Based on these controllables we remain confident we can deliver 10 to 20% topline annualized growth, and 20 to 30% bottom line annualized growth over the three-year period beginning in 2006. For 2006 we're tracking in the middle of that range for net sales growth and at the high-end of this range for earnings growth. We remain confident in our business model, generating profitable volume and leverage.

With that, I believe we're ready for questions.

(OPERATOR INSTRUCTIONS). Ed Aaron, RBC Capital Markets.

A couple of questions for you. First, I wanted to ask you a little bit about your guidance. You put a range for Q3 and then some directional comments about Q4, which give us a little bit of insight into what you're thinking about for the fourth quarter. I know you have a bit of a wide range out there for Q3 because of what is going on with the consumer, but could you maybe address your thoughts on Q4, and exactly what is in those expectations from the perspective of the overall consumer environment?

Great question. Let me kill two birds with one stone here. Q3, let me address that one first. If things stay the way they are from a consumer standpoint, we think we will be in the top end of that range that we provided. I think if we get a little slippage on the economy here, if interest rates get clicked up another notch, or gas prices continue to pull away to consumer discretionary income like it has been, we could see the lower end of that range. That is why we have given you a little wider here for Q3.

I think as we head into Q4, the thing we're going to monitor through Q3 is just how quickly the product ramps up. As you have probably seen in the last five to ten years as the economy goes through these kinds of ebbs and flows, what typically happens in the fourth quarter is consumers may wait a little bit longer to make their purchases and then they come in like gangbusters. Instead of having a more smooth sort of September, October, November, December season, we may see much higher mid-October through December on the purchase cycle. We're going to monitor that as close as we can. But we feel pretty bullish right now about the fourth quarter and feel very good obviously about the third quarter.

On the retail business, I look at that business, I think of the sales coming in three components. You have some from new stores that you are bringing online, and then some from expanding your productline within existing retails. And then you have kind of the comp growth on existing products in existing stores. When you talk about retailers being cautious is it kind of across the board in those three categories, or is there one area within that demand where you're seeing things soften up more than the others?

Hawk, do you want to cover that?

I would say any caution would be fairly consistent across the board. They are all experiencing similar impacts. I think what we're focusing on more now is more about profitability from each SKU and from each customer. As we work with these guys for the back half of the year, we're focusing hard on what is the right product assortment. You see our assortments are going to grow. But it is about smart growth, profitable growth. There's a lot the pressure I think for the resellers at the lower price points, and typically we don't play there.

But they are seeing a lot of choppiness in that price point. And we are a little bit of a -- we play a little bit of a backlash on some of that. I would say across those three areas you talked about it is fairly consistent.

Just one last question as kind of an observation from what we have seen around here in Colorado with some of the specialty stores here. Here's some chatter about maybe even getting the Evolution in those stores this season. It struck me as being a little bit early to have that product moved out of the direct channel. Could you comment on that?

The specialty fitness channel is interesting. Obviously it is a very small portion of the consumer base that actually shops in the specialty fitness channel. We always see the specialty fitness channel oftentimes complementary to the direct channel -- very high-end price points, very high-end retail. We look at that channel as an opportunity to test and look at a cascade from the direct.

We continue to talk about -- obviously there is always pressure from the retailers. We always -- but we will often take an opportunity to look and see that that business can do to us to drive incremental sales of certain products. So relative to the Revolution we have had some conversation with some retailers. We continue -- as we go into this weekend with them in a big way, we will continue to talk about that.

Mark Rupe, Ryan Beck & Co.

I just would like some input on your overall thoughts on the brands you have acquired, obviously Universal in recent months. Any thoughts on brand strategy going forward? Is it going to change? Are you satisfied with where you are right now and how the brands are being used?

Great question. And on the brand side, and let's talk about that, we've now got, from the consumer research that we've done, the top five brands in the fitness industry, which feels pretty darn good. And I think adding that Universal brand with the stable of brands that we already have really fills it out well for us.

Now we aren't going to change the positioning of the existing brands that we have in any substantial manner. We think the Universal brand has two or three different areas that it can play for our Company, in both from the high-end as well as from some of the more mid tier price point lines. And we're exploring a few of those opportunities right now. We would be getting back to you probably in the end of the third quarter call with a little more detail around that. For competitive reasons I am just going to be a little careful.

You mentioned 3,200 retail doors heading into the back half of this year. I'm assuming that is up from about 2,800 last year or so. Is that from existing accounts or is that actually new retailers being added?

Obviously, we're expanding doors with customers that we are in, Sears being one of the bigger ones. And we have added a couple of other customers. We talked to [Modell's]. We're looking at BJ's for some closeout activity. So it is both.

Steve Colbert from Canaccord Adams.

Can you comment on your SKU count at some of the key retailers? And then if you have any color on orders or SKU count for the fall season.

Tim, do you want handle that one?

I'm not sure how much detail I can go into here. I have to be a little careful. But there is -- I would say there're a couple of components of what the retail sort of looks like. One would be a Bowflex Home Gym positioning. Most retailers are taking a position in a home gym or two.

Secondly, would be an offering from Schwinn that would normally include one or two bikes and/or an Elliptical. And then third, you would look at something from our Bowflex free weight grouping of SelectTech, whether it be 5 to 52 or 2 to 20. Very general, two big brand offerings. It was probably about a 3 to 4 SKU assortment this time last year. We are now looking at a 4 to 5 SKU assortment for this year.

Then stepping back, was the softness that you saw in any one particular productline or price range or was it more of a broad-based softness, if you will?

It was across the Board.

Looking net sales pattern, were they relatively consistent throughout the quarter or did it pick up or fall off as time progressed?

For retail or for direct?

Just in general.

There were days in direct where you that we were to have an unbelievable quarter, and days we thought we were going to be looking at having a tough quarter. We actually netted out somewhere a little on the sell side of that.

The consumer is really choppy. On the direct side it is very choppy. And obviously, current events have a lot to do with that, as well as our ability to [clear leaves and to clear media], which was tough at the beginning of the quarter and softened up in the back half of the quarter.

On retail, it is a quarter that normally ramps -- starts low and begins to ramp towards the end of the year. We definitely saw that same trend continue through this quarter.

James Bellessa, Davidson & Co.

I totaled the channel sales that you told us and came up 1.9 million more than you reported. So either one or two things has happened. Probably my writing them down was wrong. Specialty retail, was that 16.6 million?

16.6.

Retailers at 15.8?

15.8.

Commercial 16.2?

Yes.

Direct, 60.2.

Right.

International 14.9?

You wrote that down correctly.

And apparel at 15.8?

13.8. 13.8.

That's my error.

That could be my bad use of the English language as well.

That clears that up. Anything else, Jim?

I will catch other questions later.

(OPERATOR INSTRUCTIONS). Scott Krasik, CL King.

A question on direct. Just talked a little bit about -- you said you had some trouble generating leads, conversions. Were people adverse -- because these are people I guess that are spending 19.99 a month or 29.99 a month, whatever it is. Is it that they don't have that access to credit or they just don't want to spend? Sort of give us some more color there on the consumer?

It is not -- it wasn't a credit issue. I think what you've got is just -- as you look at consumer confidence out there. I think it is more driven by that. And so what we saw happening here in the second quarter was nothing more than probably the same thing you felt, and I know I felt, which is every time you fill up your car, you are hitting the $75 maximum number. That was the main driver of it.

Then as you said, just to -- your guidance for Q3 is just a consistent consumer would get you to the high end of the guidance?

Yes, I think if we looked at things stabilizing here in the market -- if the consumer manages the third and the fourth quarter the way they managed it last year, which they start their buying patterns in that late August period that runs right through September, October, November, December, we're in pretty good shape. If they hold off on their buying patterns, and it shifts the seasonality to a little later in the fourth quarter, we could see the lower end of that guidance range.

Then just lastly on the retail, obviously there has been a lot of talk with Sports Authority managing its working capital differently. As people have sellouts, are you guys carrying stock inventory, how are you filling that? What is the relationship there?

Tim, do you want to handle that?

We're not carrying the inventory, as you can see by our balance sheet. What we are doing is a much tighter planning process with the customer. It is required. Otherwise one of us is going to be left in trouble. If we don't pay attention to sell throughs -- you heard me talk about them in the script a little bit, about really getting close to what do on-floor inventories look like? What do backroom inventories look like? What do customer distribution center inventories look like? That is a daily process for our sales team, and our sales planning group. So really tight watch of the inventories.

And I think, just to tag onto Tim's comment here, probably the thing that makes me more nervous is if that consumer purchase behavior shifts to later in the fourth quarter, and then they come on like thing gangbusters and start flooding the stores, buying SelectTechs and Schwinn bikes, but ability for us to restock at store level inventory. We can get them to the warehouses. It is getting it to the retail level that worries me a little bit. We are already monitoring that and trying to get ourselves in the best position possible to manage it through it if, in fact, that becomes a reality.

Kathryn Thompson, Avondale.

I just want to go back to your guidance for the quarter. I think you made it pretty clear that assumes a basically softer consumer. But what I want to dig a little bit more into is how much of the turnaround initiatives are baked in the guidance? You had indicated that you're ahead of schedule, or above your 11.5 million that you outlined at the Analyst Day. How much of this is baked into Q3 guidance and your full year expectations? And just any color on that particular subject would be helpful.

Here's what -- if I could give you [headlines], I would like say this. If you looked at Q2, picture in your head a bucket. And we put $8 million of savings into that bucket. Unfortunately because of freight and the shortfall in revenue, we leaked out about 9. So at the end of the day you come up short. That is basically what happened to us in Q2.

What have we done to mitigate that and what gives me confidence that we can deliver the back half of the year? One, we are tracking ahead on those initiatives that we shared with all of you at Analyst Day. I believe we're going to continue to deliver upon those. And in fact we will deliver all of those with maybe a little bit upside potential in the back half of year.

On the leaky bucket component of it -- so we're going to fill the bucket the way we would expect to, and maybe just a little bit more. On the leaky bucket components we have taken the price increase. We have adjusted and put in some freight surcharges. We've done some other things to fix those areas that were leaking. The one thing we can't control, and it is the uncontrollable bucket, is that consumer element. We think, based on the way we built our plan now, we're going to be able to flex from a spending standpoint in order to make sure we deliver on that earnings guidance that you talked about.

Just kind of getting to the point, you had indicated that you could see about $0.30 round numbers from these specific initiatives. Is that still your position for fiscal '06?

Yes. Sorry, I should have just said that, uh?

I kind of danced around the subject too.

I didn't mean to dance. I thought I was answering, you know. Yes, is the answer.

And my next question, and then I will get out in queue, is just could you explain a little bit more -- you mentioned in passing product developments and how it is a little bit different this year versus last year in rolling out. If you collaborate a little bit more on that, that would be great.

On the product developments side we have either in production and out in the market in tests or beginning production on all of the new items that we going to have in the back half of the year. We're 90 to 120 days ahead of our schedule that we would have normally been on, and that we were on last year.

Remember, before we really got things managed in the way they would have liked, we were talking January, February last year. You can back that up 90 to 120 days now. So we're going to hit the target right on plan. The fact is the complexity of the new products that we're introducing this year versus last year are much less complex as well. We are pretty bullish on the fact that we've got this thing under control and we are managing it in the appropriate way to make sure we deliver these things on time and get the revenue and profit out of it that we expect.

Marc Bettinger, Stanford Group.

Gregg, a couple of quick questions. If I understand you correctly, the profit is going to be a function really of demand, and your ability to deliver supply has really all been solved at this point?

We feel pretty confident on the supply chain side. Yes.

We're really looking at the consumer, within reason, for their ability to come through and deliver the sales?

Yes.

Also, the runrate saves -- the savings of 11.5, is that runrate or absolute for the year?

That is a runrate number because we will be above that as we head into the back half.

How much do you expect to I guess realize in 2006?

We are looking more at that 13 to 15 mark, so 13 to 15 million.

In Q3 and Q4 combined you're going to realize about 13 million?

No, if you take 8 that we've got in the first half, and then say you got another 13 to 15, so you have got at least another 7 coming in the back half of the year, probably somewhere between that 5 and 7 mark.

Okay, got it. You are saying -- when you put it together that was partially offset at the 9 million?

Correct. And now if you look at that and you say, okay, I get 5 to 7 million in savings in the back half, and then I add on top of that the ability to neutralize that $0.04 leakage that we had in Q2 from freight, so you balance that off. Really the only non-controllable -- or the only thing we're dealing with here is on the consumer side. I feel like from a business standpoint we're pretty solid at this point. We've just got to see how the consumer responds here.

Bill, what kind of gross margins and EBIT margins are you assuming for Q3 and Q4 (multiple speakers) estimates?

We will continue to be in that 42 to 45 range, more towards the middle on that range on the back half.

Laura Richardson, BB&T.

I still could ask a lot of questions, but I think I'm going to try to roll it into kind of one bigger question. Based in the guidance I see why you're being fairly cautious for Q3. Can you just explain again what do you think is going to be different in Q4 this year from Q3 this year that is going to generate more sales growth, more earnings growth, and also how that is different from Q4 last year?

Great question. So two things. One if the consumer pulls back and waits, which is possible, we think that there is more upside potential than in Q4, because all they have done is delayed their purchase. And we have seen that happen on a couple of these business cycles, and we think that is likely, if in fact we see a little bit of a soft September, for example.

Whatever we feel we would get to the low end of earnings guidance in Q3, we think we can then pick back up in Q4. So that is part of the confidence level. I think the second thing is we've got our hands wrapped around the new products at this point. We feel very confident in the ability to manufacture and deliver them with quality. So that feels really good to me.

And then finally, I think the operational infrastructure and being able to deliver those products on time, that Dustin Grosz on the operating side and his team have done, has really got us in a pretty solid position here. Those three factors are the things that make we feel pretty confident that on Q4 side you're looking at a much, much different environment than we were looking at in Q4 of last year.

That makes sense to me. In terms of the consumer environment, did you say you think Q4 -- gas prices are not going to go down. We could still be in some kind of lovely war and have a CNN effect. Or what is you're thinking on this sale side and is it many more new products in many more new doors that drive your better sales forecast in Q4 from Q3, or is it the environment not being as crappy or some combination thereof?

I think last year we had some product issues right (multiple speakers).

I'm thinking more of Q3 to Q4 this year, because Q4 last year, yes, it sounds like the sales would have been there if the product could have shipped.

Correct.

That is not going to happen again this year.

That's right. And I think there is your big difference, right.

That's your big difference from last year, but then this -- so looking at this year, it seems like a lot needs to be better in Q4 than it is going to be in Q3, and that is where I'm still a little confused.

Yes. And the only way -- I'm sorry if I'm not describing this correctly -- but the best way I can describe it is we've typically see in a stabilized environment, much like we had in the back half of last year, you would see a slow ramp up from August, September October. Right through December you would see -- if you picture it on a graph you would see kind of a linear curve with a little bit of bump at December.

A little bit of what we don't know the answer to and we will probably have visibility to for another 30 to 45 days is, is that consumer going to delay their purchase behavior until later in the holiday season, for example? If in fact they do that, all we're looking at here is a delayed purchase and the downside or risk to the business plan then is really about the retail environment and our ability to respond to replenishing those retail inventories. Does that help?

I show there are no further questions at this time. Gentlemen, I'll turn the call back to for your closing remarks.

Here's how we're kind of looking at wrapping up this second quarter and heading into the back half of year. What I would tell you is on the controllable side of the business, we're really excited. We think we're very prepared and we are focused on delivering the back half. The new items are already in production, our operating and manufacturing initiatives are on track and ahead of plan.

On the non-controllable side we're going to continue to watch the economy and consumer spending carefully, and manage our expenses and deliver upon the guidance. We feel pretty confident right now that, even if there is a bit of a revenue shortfall, with the ability for our company to flex and manage on the cost-saving side of the business that we are going to be able to bring in the earnings on the upper range of that 20 to 30% for the year.

To say we're bullish, I think, would be appropriate. We're pretty confident I think at this point. And we are -- I can tell you this -- very, very focused. And we're excited to prove to you what we can do here in the back half of the year.

With that we're going to get back to work. Thanks for listening in on the call today. And it is back to you, Amy.

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