Nautilus Inc (NLS) 2008 Q1 法說會逐字稿

Welcome to the Nautilus, Inc. first quarter 2008 results 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. (OPERATOR INSTRUCTIONS). This conference is being recorded on Monday May 5, 2008.

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 do not guarantee future performances. Nautilus under takes 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 review 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 with the Securities and Exchange Commission for a more detailed discussion of the factors that could cause actual results to differ materially from those projected in forward looking statements.

Now I would like to conference over to Mr. Ed. Bramson, Chairman, Nautilus, Inc. Please go ahead, sir.

Thank you. Good afternoon everybody and thank you for joining us. I don't really have any prepared remarks this afternoon. AS you know, I wasn't actually the Chief Executive during the first quarter. So Bill Meadowcroft is going to go through the first quarter in detail. We will be happy to answer your questions after the meeting.

At the moment, we are working on a plan to improve things in a number of areas, which as we've previously announced we are hoping to communicate to shareholders, after the second quarter results sometime in the third quarter. So a lot of your questions might be better answered then.

At the moment, I can certainly say that our balance sheet is stronger than it was at the end of the quarter, because we have not sold Pearl iZUMi and paid off our debt as a result. Although, that's not reflected at the end of March. Also, I think the earnings, while they're not good in the first quarter might be a little better than had been expected, if you make allowance for the two one-time items we have announced. One, having to do with Land America and the other one with some severance for the prior Chief Executive.

So as I said we'll be happy to answer questions after the meeting. We are not imposing a limit on the number of questions as we have sometimes in the past, but obviously if you could keep to it two that would help things to move smoothly. With that, I would like to turn things over to Bill Meadowcroft to take you through the results of the first quarter.

Thanks, Ed. Net sales from continuing operations were $129.6 million compared to $137 million for the corresponding period last year. The Commercial business recorded 16 million in net sales which was 10% below last year. Direct sales were about $69 million, down 6% from last year and retail sales were $25 million, about 9% down from last year.

Our international business recorded 18 million in net sales, which was about 6% growth, but it's currency related. We also had $1.1 million from royalty income, which was up $700,000 in the same period last year.

Our gross profit margin was 43.2%, compared to 45.6% in the year ago quarter. The decrease is primarily due to some lower margin sales and increased inventory reserves as we reduce our SKUs to simplify our product portfolio. Higher warranty cost also contributed to lower margins compared with Q1 2007.

Operating expenses were 50% of revenue, which was up 450 basis points from last year's first quarter. On a dollar basis operating expenses were $64 million or up $2.5 million compared to the $62 million last year. As Ed mentioned this was primarily due to the $8 million to be paid to Land America and 2.4 million of severance cost for our change in CEO's in March. These were offset by reduced selling and marketing expenses for a reduced head count and lower advertising, production and trade show costs.

Our net loss from continuing operations for the quarter was 6.9 million or $0.22 per diluted share, which included $0.18 for the Land America payment and $0.06 for the severance cost, this compared to a net loss from continuing Ops of about $9,000 last year's quarter or zero per diluted share. Results from continuing operations exclude the company's apparel segment which is considered a discontinued operation, which as we sold it on April 18, 2008 for the $69.4 million consideration.

Our consolidated net loss for the first quarter of 2008 was 6.4 million or $0.20 per diluted share.

Turning to our balance sheet. Inventories were 66 million compared to 59 at the end of 2007 due to building some safety stock on main SKUs, one of our projects is to improve inventory turns so we expect inventory reduction in future periods.

DSO's were 52 days and we'll continue to work on reducing that figure.

After the sale of Pearl iZUMi, we had a $7 million net cash position at the end of April and we expect a positive net cash position at the end of the second quarter. We enter May with over $45 million in borrowing capacity under our asset based facility. We recently entered into an agreement to pay $8 million to a major supplier, Land America Health and Fitness to settle all claims from the previously announced termination of the agreement to purchase their China based manufacturing assets.

The settlement was accrued in Q1 but is expected to be paid in June. We expect that the $8 million payment will be largely offset from a cash flow standpoint by a tax refund of 7.1 million that we filed for, for the draw back of last year's losses to prior years.

We also renegotiated and added one year to our supply agreement with Land America which now expires on December 31, 2010 and expect a good relationship with them going forward.

Because of our improving balance sheet our Board of Directors has authorized a share repurchase program for the purchase of up to $10 million of the company's common stock. Under the authorization, we'll purchase shares from time-to-time in the open market or privately and privately negotiated transactions in compliance with rules of the SEC. However, the timing of the amount of such purchases, if any, would be at the discretion of Management and would depend on market conditions and other considerations.

Looking forward our current expectation is that the uncertain consumer environment will continue to affect us in the second quarter, which seasonally our weakest as it did in the first quarter. We expect pressure on gross margins given the expiration of the Land America rebates and increasing cost pressures from our vendors and suppliers. We continue to work on aligning the cost structure of the business to conform to our expected revenues and these plans will be discussed during the third quarter as Ed mentioned. With that, Shawn, Ed and I are ready to take questions.

Thank you, very much, ladies and gentlemen. (OPERATOR INSTRUCTIONS). One moment, gentlemen, for the first question. Our first question comes from the line of Kathryn Thompson with Avondale Partners, please go ahead.

Thanks. First of all, I know you are limiting a lot of your comments to the out quarter, but could you at least give us some idea for your gross margin targets for '08 and also any type of general time horizon for consistent profitability.

I think both of us should probably take a shot at that one. In terms of gross margin, if you look at it statically, as Bill has said earlier, we got pressure on gross margin from cost increases in China.

On the other hand as part of the plan we are looking to come out with an third quarter, we will have plans to offset that improvements and efficiency and repositions of prices. So I think there are really two answers to the question. Bill, would you like to expand on that?

Yes, Kathryn, there has been lots we are doing and continue to do. We don't want to peg a figure at this point. But we certainly would be looking with the pressures we'll be facing and the rebates going away, we look to being in the 40s from a margin standpoint. But again, we will have to give more color on that as we continue the plans and take some actions heading into the third quarter.

Okay. I understand with there being some management changes also there are some forecasts you had in the past that may have changed. First of those might be CapEx. What are your CapEx assumption for '08?

We will still keep them lower. We had already gotten a plan this year of down below $6 million and certainly in this environment we're continuing to evaluate every project and make sure that it has a suitable return for the economics of the business we expect going forward. That would certainly be an outside number and we would be looking to reduce that further.

Also, in the past you obviously talked about forecasting savings for OpEx for fiscal '08. Where are you on track for that, how much savings was there in Q1 and what do you expect for '08?

You're certainly hitting again on stuff that I think we are going to be more prepared to talk through as we go forward. Certainly moves have been made and some progress has been made. As you have seen we were able to cut G&A, ex the one-time items by a few million dollars. There certainly been reductions in S&M of about $5 million. There have been some -- I mean we are seeing the early returns of the moves that are being made, but there's still a lot of actions being determined and that will be executed over the next several months. And the rest of this year.

But still not willing to pin a number on that generally speaking for the year?

I think it's probably a bit early, Kathryn. If you think about it more broadly, our expenses break down to two buckets. You've got the cost in operations and manufacturing logistics, that sort of thing, which is almost 300 million a year. Then you have got cost of sales and marketing and overhead which is 200 million a year as well. So there are different approaches to both of those. We would like to set some fairly aggressive targets, but since we haven't actually got real numbers yet, I don't think it's wise to give you a projection until we have a detailed story for you.

Sure, okay. I will get back into queue, thank you very much.

All right.

Our next question comes from the line of Paul Swinand from Stephens, Inc.

Good afternoon. First question is you have talked in the past about trying to improve the productivity of your advertising dollars spent and how you generate leads. How did that go in the quarter compared to the fourth quarter, just on the traffic generation side?

Bill, do you want to take a shot at them and I will maybe follow up.

Sure. We are, as you know, focused on continuing to try to improve that. Our effectiveness looking at the creative-- making sure we keep it fresh. We are seeing some improvements in lead generations, but it's certainly also a softer environment out there. And so they are not necessarily, we're not being as productive as we have historically been. We are attributing that to the softer environment that is out there right now.

So would it be fair to say that your generation side is holding steady but your conversion is falling off?

Yes. At this point that's what we are. We are seeing some softness in conversion but we are continuing to be able to generate leads.

Okay. Then just a follow up, on the last call you talked about a little bit more difficult environment for credit approval, some of that was due to higher price points. Has that changed at all? Is it harder to get people approved? That's one of the reasons people are falling out?

Yes, we certainly believe that's a contributing factor. We are looking at price points, continue to look at price points as one of the opportunities to get back down to where the consumer is able to finance. Given that it's obviously an important part of our business.

Yes, I think that is something that we want to talk about. This is Ed, when we get into the third quarter, because as you probably know because you followed the company for a while, what we have been doing is our price points have been drifting up, because it gives you better coverage of the cost of generating the lead. We probably moved a bit too far, so one of the areas of product innovation really is to take a tight look at that and move the price points back to where you would like them to be.

My impression is that at the standard price point, we are not seeing a tremendous amount of pressure from credit disapprovals. As you go to the higher price points it gets more of a problem. The solution is not just for the economy to get better, it's also to retarget where we put the price levels we're selling at.

Got it. Okay. Real quick question on the comment on the warranties, I thought you were getting rid of the high warranty cost product line, the commercial tread climber and elliptical. Is that including some of those discontinued line cost in the warranty or is that other items?

Right, Paul there were some incremental costs in the quarter related to the tread climber as we still had sold some before we made the final move to get out of the product. There were sales and we had to provide for additional warranties on those sales.

That's done now you won't see those in subsequent quarters.

From the TC-916, that's right and then we have gotten out of the EV as well. The final EV9-- EV7, so it's those costs, we expect that to get better going forward.

Thank you.

Thanks.

Our next question comes from the line of Scott Krasik with CL King, please go ahead.

Yes, hi, thank you.

Hi, Scott.

In the fourth quarter, you guys accrued or took charges for 19 million plus associated with the Land America deal and now it appears like the cost is going to be 8 million. Did you take some reversals this quarter? Or how did that square up?

The 8 million is incremental to the 19, it's the costs to just settle everything and be able to move forward with a positive clean relationship with Land America and be in a good position; sufficient supply going forward. It's really the cost of fully getting out of the purchase agreement.

Okay. So the 19 million was done, accounted for and then there is an incremental 8 million that ensures the relationship going forward?

Correct.

It settles any possible litigation.

Okay.

The one way to 19 continues to manifest as we will be able to deduct that in 2008. So we will get a tax benefit next May or in that time frame, a significant tax refund. Cash flow wise, it will be a positive coming.

That would be -- you would get that in 2009 from charges -- ?

Yes, it's a 2008 event from a tax standpoint.

Okay. Retail, maybe, Ed, if you could talk about where we are at retail and a 9% decline is significantly better than I was modeling. Nobody is really speaking that positively about the category. And I think you got a lot of SKUs, you had some buildup there in the inventory. It's a little bit better than I thought. Maybe talk about what happened at retail in the quarter.

Maybe I will take a shot at that. It's a little difficult for me to do comparisons to prior periods because I don't have that much knowledge of it. My sense of what is going on at retail at the moment is that the problems that had occurred in the middle of last year have now gone away. So you have a more steady state environment. We are adding stuff to the line as the year goes on. So retail actually for us seems to be doing reasonably well. I don't know if that speaks to the industry as a whole or not. It's a little bit ahead of our expectations too.

Is it, Bill, maybe you can chime in, mostly home gyms still? Is there a balance yet?

It's actually not. It's more so, we did have some good sales of select [techs], the 552's, some of the Schwinn indoor bikes and Ellipticals. We saw some softness on the [rodman] side because we were not pushing them in as we had in the past.

Okay. So you feel like maybe this is a good idea now, forget about any future expansion. This 25 million in the first quarter, that's a pretty balanced number?

I think so. As Bill sort of touched on. If you look at the direct business, that's principally a strength business and we may try and add a bit more cardio there. The retail business is principally cardio, it's what the customers want. We have been feeding more cardio product to them. That's really what is driving the sales growth.

Do you feel like on the commercial side, some of your competitors have gotten aggressive because you are pulling stuff out and not delivering some of that original stuff you said you would with the Tread Climber and the Ellipticals that they are taking share at this point?

I'm not close enough to it to tell you quite honestly. Ask me that in the third quarter and I will tell you.

Thank you very much, guys.

Thanks Scott.

Thank you. Our next question comes from the line of Reed Anderson with D.A. Davidson.

Good afternoon. Wondering, if you look at the selling and marketing piece, it was actually pretty good relative to where sales were and looking at percent. I'm curious was that more of a savings on the direct side of your business from just kind of dialing it down or was it related more to retail, kind of exiting some of your products at retail. Give us a little color on that perhaps.

It was broad based although certainly on the direct side. Getting out of, we had done some creative last year and so we have a reduction of about 1.6 million in charges around some creative that we haven't renewed at this point.

It's also getting out of trade shows or reducing our trade show exposure. It's also obviously with the sales decline there is some commission reductions as well. It's not specific to one challenge. It would be heavier on the direct end commercial as opposed to retail. Retail is not as intense from a selling and marketing standpoint.

Okay. And then getting back to the question someone had earlier about the financing piece. What percent of your customers that come indirect to you typically help get-- arrange the financing, what does the look like today, what did it look like before?

It hasn't really shifted a lot. It continues to be in the 60 to 70% and moves in that range. That has continued.

Who have you typically used to help them get financing? Remind us of that please.

Right, we have HSBC as our first tier and then they also buy deeper than just A credits and health card takes the true second tier.

At this point they made no formal changes to your arrangement with them or have there been anything that has changed?

There have been some tightening of score cards as they have gotten some -- as they've watched the environment and what's been going on and seeing changes to the portfolio.

And then some approval reductions at the bottom, at the very bottom end, obviously with all the credit concerns down at the very bottom, there's been some ratcheting up to make sure we're not as exposed.

Okay. Then shifting gears a little bit. Cash flow statement maybe just what was depreciation in the quarter?

D&A was $3.8 million in the quarter.

Then tax rates, so the low tax rate, that's partly attributable to the benefit you were talking about in your prepared remarks. Is that correct?

Yes, the tax rate is messy, because we're right down around zero. Every little change or every deferred item really affects the tax rate. I think what you can expect as you model for this year is for continuing Ops, we should be in about a 30% rate, but because of the unusual-- the discontinued, the nondeductible, current nondeductible nature of the impairment on Pearl, at this point we would expect a blended rate down around 20, but modeling the continuing operations of the business we would expect around a 30% rate this year.

Okay, maybe one more. In terms of, you have now settled with Land America. Any meaningful, either benefits that you now if you restructured your deal whether it's better savings, I don't know. Anything that would be worth noting as you have now basically put in place a [renew] on your agreement.

I think the -- we did have rebates in prior years, which went away at the beginning of this year. So, we haven't renewed those but the pricing that we have now has fairly decent predictability. On a like for like basis, it's up a little bit. There supply is mostly in our direct area where the gross margins are very high any way. So I would say we came out of the discussion pretty favorably.

In addition, we accelerated our 30 day terms. We had been on ten days. We now have 30 day terms.

Just lastly related to that, are you relatively costed out for the rest of '08? Or is there a fair amount of uncertainty relative to what could be out there with steel and stuff like that for you guys.

We are covered through October. Then we will have to look at it again.

Great, I will let it go at that, thank you.

Ladies and gentlemen, to register a question, please press the one, followed by the four on your telephone key pad. Our next question comes from the line of Rommel Dionisio with Wedbush Morgan, please go ahead.

Bill, in your prepared comments you talked about the lower margin mix on gross profits. Well, direct was down 6%, which was lower than the total and that's got a much higher gross margin, could you just clarify that comment?

Rommel, what was it?

I thought you said the gross profits were down somewhat because of the lower margin mix.

No, lower margin sales. There were lower margin sales. As we are continuing to rationalize our SKUs and deciding to get out of some products, there is obviously that move to try and get-- to sell out of the older products; the sunsetted products. So, there was some of that action going on in the first quarter and that helped to draw down margins somewhat. That's what that meant. Sorry about that.

Okay. All right, just wanted to clarify that, thanks, Bill.

Our next question comes from Laura Richardson with BB&T.

Thanks, a couple of questions for you all. Ed, when you talk about having the plan by the third quarter, are you talking about one quarter from now we will have a conference call for the second quarter results but it will be in the third quarter or are you talking about one quarter beyond that.

No, I think the hope would be that when we talk about the second quarter earnings, that we could be ready to lay out everything for you. We are leaving ourselves with a little bit flexibility in case it needs to be a little bit after the second quarter earnings call. Because when we do it we want to lay out not just the plan but why we have the plan, so I want to make sure we do it right. It will be in that range.

Okay. Bill, a couple of numbers questions for you. So G&A, ex those one-time items should have been about 9 million in the quarter.

Yes, about 9.6 or 9.4.

Does that also include royalty expense which I didn't see a line for this time?

The royalty, as of last year, the end of last year we reclassified it up to cost of sales to the extent it was on existing products and then the preproduction royalties are now in R&D. It's on a consistent basis in '07 and '08, there is a reclass of royalties up to the proper line item.

Got it. So is 9 million a reasonable G&A to use for the next couple of quarters for our modeling purposes?

Right. We will be taking some additional charges for severance in the second quarter as you saw from announcements around the second quarter. I don't want to commit immediately because we are continuing to make steps to pull them down. There wasn't anything unusual in the first quarter that we wouldn't expect coming forward other than those two line items. We are trying to get it down as much as we can.

Right. So have you estimated what the severance is going to be in Q2?

We don't know what the number of people leaving is going to be. We know there is some already but don't know what it is for the quarter as a whole.

Can you talk me through, I think I heard you say after the sale of Pearl iZUMi, you would have 7 million cash on the balance sheet. Did I hear that right? And then how do you get there, do you pay your debt down with that money?

Exactly. We used all the proceeds to pay down debt at this point. Obviously, that balance will through the period fluctuate based on working capital.

When Bill talks about cash, he means cash net of debt.

Okay. Then, Ed, this might be more for you. Are you able to buy more Nautilus stock at this point? And if not, when could you and would you want to?

I would have to see if I have any money left. We have to comply with the close periods as the employee of the company would. When is that Bill? I guess you could buy from late this week until the end of the month?

Right, our window internally opens on Thursday and then closes on May 31st.

Now whether or not we being [Sherborn] would, I couldn't say but the company can start to use the repurchase during that period.

Understood. Was there some legal reason that [Sherborn] was capped at what was it 26% of the stock, where you ended up?

No. It was really more market related.

Okay.

That was all the shares we were able to accumulate at the time.

You are not saying you'll buy more but you are not saying you aren't. There is no legal reason you can't?

We are free to. Whether we will or not is a different issue.

Thanks a lot, guys.

Thank you, we have a follow up question from the line of Scott Krasik with CL King.

Just some numbers questions, Bill. The $8 million for Land America, is any of that in cost of goods sold or is that all in operating expenses?

That all hit G&A.

That's all in -- okay so nothing in [COG]. Can you give us the actual sales numbers just for modeling purposes by division?

I have got them rounded to the 100,000, if that helps.

That is fine.

69.4 for direct; 25.2 for retail; 16.3 for commercial; 17.6 for international and then the royalty of 1.1.

Thank you very much.

Thank you, we do have another follow up question from the line of Paul Swinand from Stephens, Inc.

Real quick on your credit agreement with HSBC, how long do those typically run for and when does this agreement expire?

We had it from three years was the old agreement and then we extended it one year. So, we are certainly talking with them at this point. This one expires at the end of this year and we are working with them on the new agreement.

Thank you.

Thank you. We do have another follow up question from Reed Anderson with D.A. Davidson.

Bill, curious, because we don't have all the numbers but ex-Pearl, what were your inventory turns in '07, approximately?

Down in the four's.

Low fours?

I think so. I don't have the exact number in front of me but that would be my recollection.

Second question, in terms of your line or the new line now that you have closed the sale, what amount do they allow you to use for buy backs?

Well, we have approval at this point to do the $10 million.

That's incorporated into that?

Yes.

Just to clarify on that, it's permitted under the borrowing agreement. Our intention really is not to borrow to any significant extent to fund buybacks, we want to do it out of our own cash. We need the permission but we're not going to be planning to borrow to do it.

Perfect, thank you.

Thank you. Our next question comes from the line of Jim Chartier Monness, Crespi & Hardt.

Getting back to the gross margin. You indicated some pressures that you see in gross margin for the rest of the year. Are those pressures greater than what you saw in first quarter or is it going to just be a continuation of pressures you saw in first quarter?

I think the pressure continues and certainly China, there is uncertainty over there as far as currency. So I would say there is risks that the pressure heightens. Again, with our Land American agreement we have got some set pricing for a while. Again, it's something that we will continue to monitor and work to offset in our available ways to us to do.

Then on international, excluding currency the growth there is basically flat versus some good growth last year. Was that a conscious effort to reduce sales there if they were lower profit?

There is some of that, Jim. And also the TC-916 was much stronger than last year's Q1 and then we had the residual sales this year's Q1. So, ex the tread climber we would have grown. We were down about 2.5 million in the quarter for TC-916. Otherwise, there was some growth in the existing product line.

Thanks.

Gentlemen, there are no further questions at this time.

Thank you very much for joining us everybody. And we look forward to talking to you in the second quarter.

Ladies and gentlemen that does conclude today's conference call. We thank you very much for your participation and we ask that you please disconnect your lines. Have a great afternoon everyone.