Nautilus Inc (NLS) 2007 Q4 法說會逐字稿

Ladies and gentlemen, welcome to the Nautilus Incorporated fourth quarter 2007 results conference call. At this time, all participants are in a listen-only mode. Following today's presentation, we'll have a question-and-answer session. We will ask all callers to limit their questions to two. If no one needs assistance during the call, please press the star key followed by the zero. This conference is being recorded February 13th, 2008.

Before the call begins, listeners should be advised of the safe harbor statement that applies to today's call. Prepared remarks in today's call contain forward-looking statements. Forward-looking statements may be made in response to questions. Reorganization and turn around plans do not guarantee future performance. Nautilus undertakes no obligation to update forward-looking statements to reflect new information, events or circumstances after the date they were made or to reflect the occurrence of the unanticipated event. Therefore undue reliance shouldn't been placed upon them. Review the earnings release to which this call relates and the Company's most recent periodic reports on Form 10K and 10Q 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 to Mr. Bob Falcone, President and Chief Executive Officer. Please go ahead, sir.

Thank you operator. Hello, everyone, and thanks for joining us today. Sorry the call was a bit delayed. I'm joined here today by Bill Meadowcroft, our Chief Financial Officer. This afternoon Nautilus posted fourth quarter and year end unaudited results. Net tales for the quarter were $147 million which excludes the Apparel Division which is reported as discontinued operation. Including the apparel division, our net sales were for the quarter were $160 million which as in line with the guidance we provided at the beginning of the quarter. We also recorded substantial unusual expenses in the quarter and Bill will detail those in a moment. We are relieved to move past the year that produced the company's first ever operating loss as a public company and triggered a number of changes to our board, our leadership team and to our organization.

We look to 2008 as a year where we aggressively pursue restoring profitability to the bottom line and position our organization for profitable growth for the long-term. But first I'd like to turn the call over to Bill for some details about the fourth quarter results and results for the fiscal year 2007.

Thanks, Bob. Please keep in mind that you review the financials that we are treating apparel as a discontinued operation given that the segment was for sale at year end. Net sales for the fourth quarter were $147.3 million, a decrease of 20% from the fourth quarter last year. Compared to the year-ago quarter, net sales by channel were as follows. International sales were $24.3 million, up 17%. Commercial sales were $22.3 million, up 6%. Retail sales were $62.1 million, down 14%, retail sales were $37.1 million, down 47% and royalty income was $1.5 million, up 36%. Apparel sales were $12.4 million, down 5% from the fourth quarter last year. Including apparel we achieved $159.7 million in net sales.

Loss from continuing operations for the fourth quarter of 2007 was $31.4 million or $0.99 per share compared to year-ago results when income from continuing operations was $12.6 million and we delivered earnings of $0.40 a share. The quarterly loss from continuing operations was $48.7 million before income taxes. This included certain pretax charges totaling $45.1 million. These charges include $19.4 million related to the suspended acquisition of Land America manufacturing facility in China, $16.9 million in warranty and inventory reserves primarily associated with certain commercial cardiovascular products. Bob will explain this shortly.

$3 million for intellectual property impairments and $5.8 million of other items including $2.6 million for the special shareholder meeting, $1.2 million to exit certain marketing contracts, $1.3 million related to staff restructurings and $0.7 million for debt restructuring. Except for these certain charges, our loss from continuing operations before income taxes for the fourth quarter 2007 would have been $3.6 million. Our gross margins of 24.9% would have been about 36.3% without the certain warranty and inventory related charges. This is not satisfactory.

We are in the process of implementing improvements including product segmentation, minimum order quantities, customer profitability analysis and improvements to our manufacturing and distribution costs. General and administrative expenses of $37.6 million would have been $10.6 million without the charges compared with $12 million in the fourth quarter of 2006. Overall operating expenses of $84 million for the quarter included $28.2 million of certain charges. Absent those charges, operating expenses would have been $55.8 million for the quarter or approximately $6 million lower than the year-ago quarter of $61.7 million. Under discontinued operations, you'll note that we're recognizing a quarterly loss of $17.1 million for the apparel business, primarily due to a $15.9 million impairment in its book value in anticipation of the sale of that business.

Turning to our balance sheet, short-term borrowings, net of cash was $73.9 million. We did secure our $100 million line of credit with Bank of America in January providing sufficient liquidity to operate the business. We do expect borrowings to be reduced upon the sale of our apparel division by the end of the first quarter. Inventories were $58.6 million which reflects the reclassification of apparel inventory to net assets of the discontinued operations line of the balance sheet. We continue to have opportunities to reduce fitness equipment inventory through a focus on fewer products and better forecasting. Bob?

Thanks, Bill. Just to go over a couple of those numbers. In the beginning, the direct sales for the quarter were $62.1 million and the retail sales were $37.1, Just so there's no mistake on some of those numbers. There's no denying the fact that 2007 was a difficult year for Nautilus. The year showed a loss for the first time in the company's history, a change in the company's CEO, a proxy contest, four new directors and several changes in senior management. Some of the actions we've taken during my first 120 days as CEO have included a reduction in our work force, reorganized the company along product lines instead of sales channels, a renegotiated debt agreement, a decision to sell the company's apparel unit Pearl Izumi, a decision to close our Canadian call center, a large distribution facility near Chicago and our Australia direct business. And we made strategic decisions to improve the business going forward as evidenced by the special charges this quarter.

We move into 2008 with a renewed sense of optimism for the company. Management and employees are focused on the task of making the company profitable and are working hard to reduce costs in all areas. Sell only the products that produce the best returns for the company, renew our pledge to our customers to provide excellent products and service, make our manufacturing operations more efficient and provide consumers with the best products, at the right price, to help them achieve a fit and healthy life. We're also continuing with our global expansion as we gain presence in health clubs around the world with our Nautilus, Schwinn and StairMaster brands. I am convinced that we have the brands and the team to do this. And we will work hard to gain back the confidence of our shareholders and customers. It's not going to be an easy task and I'm sure there'll be bumps along the way We are faced with returning the company to profitability in the face of a severe slump in the housing market, the worst retail environment in 17 years, the fear of a U.S. recession as consumers pull back on discretionary spending and massive losses in the financial services industry which impacts a large cross section of our customers. These things, coupled with a rising unemployment rate, weak U.S. dollar and price increases from our suppliers cause us to rethink and rework all aspects of our business.

We firmly believe in the face of this economic environment, our path to profitability will come from cost containment and margin improvement, rather than from an increase in sales. We will be making better selling decisions, introducing new products to the marketplace, only when they are ready and be more disciplined about product segmentation into the right channels. Our direct channel will continue to carry the well-recognized and innovative Bowflex branded products which have been the heritage of this company. We are taking a fresh look at our significant spending to drive business to this direct consumer channel and are convinced we can be more productive and efficient to increase our margins.

Our retail channel will have more focus on fewer accounts and will continue to sell our Schwinn indoor fitness line, some of our Nautilus home equipment and other products not available through the direct channel. The retail channel will also carry our new introductions of universal branded products either later this year or early next year. We believe that with the proper segmentation of all of our brands across all of our channels we can optimize our margins and provide all segments of our customer base with the right products at the right price.

Our commercial and international channels will continue to carry our Nautilus brands, our StairMaster offerings and Schwinn indoor fitness line. However, we are making several changes specially in the area of commercial cardio products. Our extremely popular commercial Treadclimber has exceeded our expectations in sales and usage but has not performed up to our expectations in durability. Because the product is being used well beyond our original performance tolerances, we are seeing more frequent service issues than we forecast. This is not acceptable to us and is well above the normal service records of our other products. Therefore, we have added $12.7 million to our warranty reserves and will be suspending sales of this product at the commercial level until we re-engineer it and reintroduce it to the marketplace when we have it right. We remain committed to our commercial customers with both strength and cardio products. And we will continue to stand behind all our warranties and service contracts.

Our Bowflex branded Treadclimber models for the home continue to perform well and we continue to offer that product in our direct channel as before. We are also in the process of evaluating the profitability of various other products and we'll discontinue the sale of several products over the course of the year. We do not anticipate any additional charges to be incurred for this activity.

Going forward, we are committing 2/3 of our R&D budget to cost and quality improvements for existing products. We are being highly selective with new product development activities. We will continue to be committed to offering innovative strength and cardio products to the marketplace, but are equally committed to offering the best quality products. Our commercial strength lines including our recently introduced Nautilus 1 products are performing extremely well both from a sales and quality standpoint.

Another area of the company of which we are taking a hard look is our manufacturing and distribution operations. Do we have the right mix of domestic and offshore manufacturing? The right warehouses and the right locations to best serve our customer base and are we utilizing the most efficient means of transporting our products around the world? As you know we have cancelled our proposed acquisition of Land America, our China manufacturer of Bowflex products. While this produced a charge of $19.4 million in our financial statements for forfeited option payments and write off of acquisition costs, the board decision was made in the best long-term interests of the company to simplify our operations and preserve liquidity. We continue to hold discussions with Land America management to determine ways we can continue to work together to reduce product costs and enhance our margins. However, as these costs are continuing, we may see some price increases in our product purchases during the first several quarters of this year until some supply contract issues are worked out.

Recently we made the decision to close our distribution facility in Bowling Brook near Chicago to add some efficiencies to our distribution model. While this will not have an immediate impact on our financials, the move eventually will provide a long-term benefit to our distribution costs. We also made the decision to close our call center in Winnipeg, Canada and consolidate those operations into our call center in Vancouver, Washington. While we will maintain a small distribution center and retail store in Winnipeg, we believe we can efficiently service our direct and retail customers from one North American location. This change will also produce some ongoing benefits to our cost structure.

Finally the sale of our apparel unit, Pearl Izumi is progressing nicely. We should have some announcements on that matter in the few weeks ahead. Although we received a great amount of interest in this company from prospective buyers, valuations have come down significantly over the past several years in the face of the many economic uncertainties we all face. We have therefore booked a non-cash write down of $15.9 million in the carrying value of this asset.

Since coming on board as the CEO I have made a number of management changes and additions. At the senior ranks we have a new head of global sales, a new chief marketing officer, have appointed an internal veteran as the new head of our D&D and added two newly created senior positions of product general managers, one internal and one newly hired. At other levels of the organization there have been significant changes in responsibilities of current employees to take advantage of their experience with the company. All of these changes will take some time to have a significant impact on the company. But I am greatly encouraged by the intensity and enthusiasm with which all of these individuals have attacked their new areas of responsibility. With these individuals supplementing the already solid group of employees we have at all levels of the company, I am convinced that we can succeed making this company the leader in the fitness industry, not only with the products we produce and sell, but with the profits we can return to our shareholders.

It will be a very challenging 2008 as we turn this company around in the face of a lack luster economy. However, I firmly believe we have the right people, the right products and the right brands to get the job done. I'll be happy to take any questions you might have.

Thank you gentlemen. (OPERATOR INSTRUCTIONS). One moment for your first question. Our first question comes from the line of Reed Anderson. Please go ahead, sir.

Good afternoon. I guess, first question would be on the retail side, Bob, could you remind us or give us a sense, in terms of just the retail business, how much of that was in the Bowflex brands?

Well, you know, it's hard to say exactly how much was in the Bowflex brand. Bill, do you have the number?

Yes. Obviously Reed, we continue to move away from the Bowflex brand as opposed to 2006 with the Schwinn brands continuing to be popular there. Bowflex is down now, less than 25%.

Okay, and so to the extent you move entirely Bowflex out of that channel, at what point in time will we no longer walk into a sporting goods store and see Bowflex? Will that be the end of this year or is that something's that going to take place over the next couple of quarters. Just a sense of timing.

Yes. Reed, I think basically you're going to see that disappearing over the next couple of quarters. You know, you have to flush it through and sell through the product that's there now, but we're not selling into the channels anymore with Bowflex products so you'llsee it flushing through pretty quickly.

Last question, from a cash flow standpoint, Bill, CapEx-wise, how should we think about that this year?

This year obviously, we're tightening the belt around that and expect to be in the 6 to $7 million range.

6 to $7 million.

Great, thanks a lot.

Again, ladies and gentlemen, we'd like to ask you to limit your questions to a total of two at a time. Our next question comes from the line of Laura Richardson. Please go ahead.

Thanks, hi everybody. And that doesn't count as a question. Ha ha ha. My two questions, one is in terms of the cost cutting, this is kind of a two-parter, is there more to come and have you cut enough that you think you could be profitable on the sales you're anticipating next year?

Yes, I think we could be. We have, we have a lot of costs to take out. We've taken out some already. Our plans going forward indicate that we're going to take out a lot more. And we're also working on some margin improvements at the same time in various areas. And so I think a combination of those two will get us there.

Okay, and then Bob, last call you were talking about second half of 08 as the horizon for returning to profitability, I think, and do you still think that that's feasible, having gotten more under your belt?

Yes, let's kind of be clear here about this turn around situation that we could be talking about. Most U.S. companies that have issues and need a turn around take about three years to accomplish. And you know, I think that anticipating anything, if they see any big changes before the last couple of quarters of this year is going to be a little bit foolish to anticipate too much. It just takes a little bit of time to turn it around. I think we will, as I mentioned earlier, by the third quarter, start seeing some definite improvements. We'll see some definite improvements in the first quarter when it comes to cost. We'll see that coming down every quarter. And we'll see some slow improvements in a lot of other areas of the company. But I think that, you know, our objective is to turn this thing around properly and it's just going to take a little bit of time.

That's totally fair, and I'm following up on this question, so profitability, I mean, there's improvement in loss percentages and in expense ratios and then there's actual P&L profitability, so when do you think we might see the latter?

Yes, you're going to try to tear me down. I really think that you're going to see something close to profitability hopefully by the end of the year. That's my objective.

Okay.

And we have a huge turn around here to do.

Okay, thanks, and good luck.

Sure.

Our next question comes from the line of Kathryn Thompson. Please go ahead.

Hi, thanks. As far as, I'm going to put this in, a bit cliched baseball terms, in terms of what innings you're in in terms of the turn around, where would you be? And also tagging along with that, what are the forecasted cost savings that you project for the remainder of 08?

You know, what inning am I in? I guess I'm in the bottom of the first.

Okay.

You know, we have a lot to do here and we've accomplished a lot already, but that just kind of shows the magnitude of how much has to be done. I think that, you know, as far as the magnitude of cost take outs, I'm not really able to go there right now, Kathryn. Bill, do you have any... you want to...

Yes. Certainly as you see our OpEx for the year, we were, ex litigation sentiment, we were up around 270. We're looking to take (unintelligible) up to 25% of that out in this year through some of the efficiencies, some of the run rates and things we've already done and some of the ongoing. I see selling and marketing as the biggest bucket there. And we have got some work to do there but also some opportunity to see improvement there.

Okay. And just to clarify, take 25% off of --?

OpEx.

Yes. Of OpEx of this year's run rate which was obviously also in the high.

I just wanted to triple check on that. And do you anticipate any additional Good Will write-offs?

We should not. I mean, we've been picked and prodded and we've looked at everything and we're not expecting anything now unless some decisions change in which case there's a chance that some of that icon asset may get impaired with our trademarks and the Good Will. At this point we're not expecting anything.

And with the, I know you are shying away from profitability questions, which I understand, but speaking more on an operating basis, kind of addressing the earlier question, do you see yourself on a pure operating basis excluding charges on a profitable path by Q3?

By Q4.

Okay. All right, thank you.

Uh-hm.

Our next question comes from the line of Eric Wold. Please go ahead.

Hi, good afternoon. Just want to follow back up on the, a couple of the past people have asked questions about your cost cutting and I know you just mentioned that you cut 25% out of the $270 million expenses this year. How much of that, 25% is, call it $70 million or so, how much of that $70 million or so has already been announced and cut and just hasn't flowed through yet and how much was still to be kind of put into place? I guess another way to answer that is if you look at what you did in Q4 -- I know you have announced budget cost cutting -- how much was kind of not already reflected in the fourth quarter and will start coming to fruition the next couple of quarters?

You've got, when you say 70, you're talking about, there must be special charges in there, right?

Yes, I know. Exactly.

Okay, um... As far as in the G&A area, we have made some significant moves, obviously again our run rate was really high this year at $75 million and we would look to be getting that down more into, and it'll be improving as we go through, but probably more in the $12 millionish dollar range for the first quarter. And we'll see improvements to that as it gets down closer to $10 million as we see some of those ongoing benefits. Selling and marketing, there's still stuff to be done. There's still opportunity on the direct side, that being the biggest area to spend. We have implemented procedures in the commercial, or cost control measures in the commercial as well as in the retail businesses, but there's still , with the direct, there's still opportunity and things that need to be done there. R&D will be probably running at about, you know, about 10% less, but we want to be able to focus on some of those cost takeout measures as important as improve the product we've got out there so that we don't run into these ongoing cost of quality issues and then the, the royalty will be probably pretty consistent given, depending on -- all depends on sales

Okay, and second question. Some of the competitors out there have still been putting up decently healthy numbers for the fourth quarter, what with you know, you started, it's a tough environment, with you guys kind of struggling the past couple quarters and being in a state of flux, unknown, and not sure what these retailers and consumers are going to think, does it get tougher as these other equipment companies kind of entrench themselves, maybe play on your weakness, get out there, get to the retailers, put some products in there, gain shelf space, maybe, you know, put some promotions out there, whatever, does it get tougher and tougher to turn that momentum around and get the retailers to think back more the Nautilus way instead of the competitor way?

Yes. Of course it's tough, Eric. You know, people like to kick you while you're down and we have had some issues out there in the marketplace and we understand we have a battle to fight but our sales team is a great team and they have great relationships with a lot of the retailers and their commercial customers so, you know, we're seeing some signs of customers hanging in there. They understand where we are. They understand what the situation is. They like the new management,they like things that we're doing. So I think that they're going to ride with us. And they love the Nautilus products which is the key. So, you know, we've probably lost some share in some, you know, sectors throughout the country. There's no question in my mind that that has happened, but can we get it back? Absolutely, we can. And I think we have the products and people to do it.

Perfect, thank you guys, appreciate it

Our next question comes from the line of Rick Nelson. Please go ahead your line is open.

Thank you, good afternoon.

Hi.

Got a question, on the inventory and warranty reserve, if you could provide a little more color on what led to that decision and I guess the big component is the warranty issue, what products and if warranty experience proves you know better than you think, gets reversed back into operating income.

Right. Yes so we, we talked about the warranty piece which was $12.7 million specifically pertaining to the Treadclimber, the commercial Treadclimber product. And yes, you're right, Rick, depending on what we experience and how the actual warranty, the fixes go down the road versus our estimation at this point, there would be opportunity to bring it in, conversely, if things, for some reason go worse, then what we're expecting obviously it will go the other way. Other charges specifically related to the Treadclimber were about a million dollars worth of tooling written off while we're trying to work on the fix around the product and also raw materials written off. All that was about a million and one. Also, our variable stride elliptical or [REV nine], we actually pulled from the market as well and have gotten out of that, given some issues around that. And that's about a million nine of incremental costs there and then our fitness advisor product, also we got out of, after trying to get that to work for the last, well, handful of years. And that was about a quarter of a million dollars and then there were some other import duty customs related costs that make up the difference there.

Would you expect the future improvement is going to be more gross margin driven or expense reduction driven?

I'd say initially it's going to be expense reduction and then slowly throughout the year some margin improvement.

We're certainly working in both areas, but we know there's cost pressures coming from China. But we're making the moves we need to to get that margin back up into the low to mid-40s.

One final question if I could, the Sherbourne investment in the new board states, I'm wondering how that's changing your approach to the business?

Well, it really isn't changing our approach to the business. I think, it's the - the situation has gone very well. We have, as you know, two members from Sherbourne on our board, we have two new independent directors along with the three existing directors that we had. It takes a little time for the four new directors to get up to speed with the business. Obviously, because the business is a little bit complex, different channels, different products so -- and they've only about on the board now for a month and a half. It takes a little while to get up to speed, but you know, everything has gone well so far. I think that they're very supportive of management and all the things we've done. We've started a lot of these things well before the change over on the board took place and continuing with them after the change over took place and you know, as long as we're making progress, that's all a board can ask for, I think.

Thank you, good luck.

Thanks

Our next question comes from the line of Marc Bettinger . Please go ahead

Hi. Good afternoon, guys.

Hi.

Hi.

Bill when you look at the cash flow estimate for the year and the assumed sale of Pearl Izumi, are you going to need capital this year?

No we shouldn't this year. In fact we are hoping with the Pearl sale and then obviously into the lower season for working capital that through the summer we're actually trying to get cash positive. That will obviously then, as we get back into October, November, December timeframe, that'll go back towards a borrowing position, but a much healthier, more comfortable position to be in at that point.

Okay, so you don't see running into the bank lines too heavily by the end of the year?

Correct.

No deeper than we are right now.

A lot less given the payout, right. A lot less.

And also--

I can't wait for that day.

Okay, Bob can you discuss your prospects of how you see the direct channel?

Yes, as far as what's happening in sales and that area?

Well in terms of, as a channel and how you'd like to be in there and positioned and what you think the prospects are?

Well the direct channel -- the direct channel is a very strong channel for us. It probably encompasses half of our revenue. And it's, you know, but it's a difficult channel. You know, as you go through the years with improvements in the internet and improvements in the way people shop online, buy their products through infomercials and all those kinds of things, the cost of infomercials going up, the cost of other placements going up, it's a difficult channel to continue with real high profitability. So what we're trying to do is we're trying to, you know, keep those margins up by making our advertising more efficient. In other words, we're trying to get experts in to help us with analyzing how we're spending our significant marketing spend to drive customers and consumers to that particular channel. So, we're hoping to get a little more efficient in that ad spend and we have a new Chief Marketing Officer and that's one of his big tasks is to do a good job in making that ad spend more efficient. I'm hopeful that the channel will continue to be a very high profit item for us.

Okay, and lastly, Bill, how do you see the gross margin improving from here? I would imagine if the retail channel shrinks a little bit, you know, that should help . But can you elaborate on

Certainly as we work in retail, not only is it perhaps a lesser percentage, but we're focusing on core customers there, and making sure that we're selling profitably. So as opposed to just, the theme of the past was drive the top line as hard as possible without a real strong eye to the, down to the operating margins. Now that has shifted and we would rather sell less, but drive the dollars to the bottom line as opposed to selling more and obviously hitting the losses that we've seen in the last three quarters. So retail will be getting down to core customers so the focus and minimum order quantities -- it obviously costs to fulfill. When you're doing onesies, twosies, that cost becomes prohibitive to making money on individual orders. In commercial, as we're able to deal with some of these quality issues, that will cut, our warranty costs and very large for the commercial cardio products, much less so for the retail compared to the strength products. And then obviously much less so for the consumer products. So as we focus on those core products where we are more likely to be able to do them profitably and as we focus on our facilities, both distribution and manufacturing and make sure that our capacities, we're utilizing capacity effectively and efficiently so that we're able to reduce our overhead per unit, et cetera. Those are the focuses we'll be having this year. And then on the direct side, it's making sure that we've got products for the direct that aren't being, you know, abused over on the retail channel so that we're able to capture that margin, that premium direct margin and without competing against ourselves even on our internet providers that we were selling to during 2006 and 2007. So there are a lot of opportunities there that we are working on capitalizing on to get those margins back up again into the low to mid-40s.

Okay. Thank you very much and good luck.

Thanks, Marc.

Thanks, Marc.

Our next question comes from the line of Scott Krasik. Please go ahead.

Hi, thanks. I'm having trouble getting this. So you've suspended sales of both the Treadclimber and you variable stride elliptical?

Yes Scott, that's correct. Due to the issues that we face it didn't make sense either for the shareholders or our customers or their consumers or you know, their people to continue to sell them with the frustrations we've had at this point. We intend to still work on the TC 916 to come out with a compelling product that will be, should be a real Trojan horse for the future for us.

Sure, just a little , you know, your best products, it's a little -- it's a

Well, yes, I mean, they were some of our most innovative products, I guess when you put it in perspective, the total sales of those two products were about 5% of our sales.

Right.

You have to remember we're not taking the consumer Treadclimber off the market because that's performing very well. That sells through direct channel.

Okay. Anything differently in terms of the customer's credit worthiness, default rates or anything in the direct channel?

Right, we are continuing to monitor that and in fact just initiated conversations with our second tier organization. We've been sending them -- we have an automated process that we're getting them more apps, but they are feeling some discomfort on their credit risk and so our pulling back a bit on approvals, but because we're sending them more, we're actually not necessarily seeing a reduction in volumes to that versus what we've seen. But there's certainly, people are sweating out there over what's going on with this, in the sub prime world.

So then (unintelligible) so that the declines we've seen in direct haven't been related to, you know, people not being approved or not being able to get....

Yes, there's some of that, but we're not seeing necessarily severe hits there. You know the one thing, Scott that you have to look at and understand is that when you look at 07 compared to 06 in the fourth quarter and you see direct year-over-year is down, 06, fourth quarter, really had a high amount of direct sales because they were pushing extra promotions out and pushing product out the door to make sure that we got some sales. So you know, there were sales, but I'm not saying they were the most profitable sales you'd ever see.

Bill, can you run through the numbers and give us what the cost of goods sold were and G&A in the quarter unaffected by the charges?

Yes, I also wanted to comment, Scott, that obviously we had also made a move towards the much higher-priced products which makes it tougher for people to qualify so the REVO and the higher end Treadclimbers and so to an extent we created some of problem in getting people qualified. And we'll be focusing more on that mid-tier thousand to two thousand as opposed to we were going north of even $2,500. So that's some of the approach that we were taking on working through approvals. Yes so ex some of these one time charges, cost of sales would have been about $93.8 million giving us gross profit of 53.5. Our selling and marketing would have been about $41.7 million, G&A would have been $10.6 million and R&D and royalties would have stayed the same. We would have then had a total operating expenses of $55.8 million and an operating loss of about $3 million.

Okay, well good luck. Hope it works out.

Thanks, Scott

And our final question comes from the line of Scott Mushkin. Please go ahead, sir.

Yes. Hey, thanks. Wanted to follow up on that last question and ask something else as well. Credit cards as a percent of your direct channel, what's that?

Scott, the credit cards are running uh, about 25 to 30%. Financing is the bigger issue, and that's been in the 65 to 70% and then the rest would be cash basis or check or et cetera.

So when we look at it 08, and we look at revenue assumptions, how conservative of you guys baked in credit markets continue to be problematic here. As I look at this, this is clearly a risk factor as we move through 08 how this plays out, especially given what you said to the last questioner.

Yes, I mean, obviously we build within, within the plan, you got the (unintelligible) you have to take into account the risks and so we have done what we can in realizing that not come out with heightened expectations as we work through our plan.

Trying to work through some of our direct sales though, I think you really have to be careful what you're offering. Like Bill said a few minutes ago, offering too many products north of $2500 is an issue with the credit on some of these. We go South of $2,000, it makes it a little bit better. So it's a question of you know what products we're offering and how we're pricing the products?

Have you built into expectations that it's going to be harder for people to get credit or is that not built?

No of course it's built in.

So the second thing it seems to me as a -- that could a focal point is cost of goods sold. It seems like you're getting your expenses under control and of course, you do a lot of sourcing from China. What percent is that?

It's about 70%. Coming from China.

So I mean I guess, you know, looking at that, is there any way, from our perspective, as analysts and investors that we can try to understand the risks associated with the evaluations and that type of stuff given the amount of sourcing you're doing? Over there...

As far as labor costs, renminbi and all that?

Yes, exactly.

We have modelled some expectations based on what we're hearing from either the economic or the economist community et cetera, so we aren't ignoring those factors and we certainly are seeing pressure coming--

Are you seeing your costs go up?

There is certainly pressure for increased pricing.

Yes, we are. And you know, when you take our direct channel products which, all of which come from just about, which come from Land America, you know we have an opportunity there to work together with Land America to create some efficiencies in their operations. I think that's going to help keep the costs stabilized in that channel.

Potentially if the credit markets weaken plus the costs continue to go up, you could be squeezed here in 08 a little bit further?

Oh, yes. Sure. Absolutely.

Is that how you guys, is that the main risk you see to 08, what I'm outlining or is that not what you see?

Oh I see that amongst about 20 others. That's pretty close to the top of the list.

Okay. That's it for me. Thanks guys.

Thanks.

Gentlemen, that does end the questions. I'll turn the call back to you for any closing remarks.

Okay, well thanks for joining us on the call today. We're looking forward to getting into 2008 with a lot of improvements in the operations. So look forward to our next call. Thank you very much.

Ladies and gentlemen, that does conclude today's conference call. We thank you for your participation, and ask that you now please disconnect your lines. Have a good day.