Nautilus Inc (NLS) 2008 Q3 法說會逐字稿

Welcome to the Nautilus Incorporated third 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. As a reminder, this conference is being recorded, Tuesday November 4, 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 the questions. These statements 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 current 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 Form 10-Q, filed with the Securities and Exchanges Commission for a more detailed discussion of the factors that could cause actual results to differ materially from those projected in forward-looking statements.

I would like to turn the conference call over to Mr. Ed Bramson, Chairman and Chief Executive Officer of Nautilus Incorporated. Please go ahead, sir.

Thank you. Thank you everybody for joining us this evening. Before we get to the earnings release, I belive that you have seen that we announced that Bill Meadowcroft will be leaving Nautilus at the end of the year, replaced as Chief Financial Officer by Ken Fish, who is currently our Chief Administrative Officer. Ken is with us on the call today as well as Bill. Many of you would have known Bill Meadowcroft for several years and I'm sure you will join me in thanking him and wishing him the very best in what he does next.

Turning to earnings, you'll see that we've taken as a first item, a significant noncash write off of deferred tax assets and Bill can explain this a little later. From operating standpoint sales were down about 18%, almost all of which came from the direct-to-consumer business, which was particularly hard hit in September and fell more than 30% for the quarter. Offsetting this, our cost reductions came in more than 30% better than we had forecast on the last earnings call. So that (inaudible) the net effect somewhat.

We are obviously in a tough sales period at the moment so we are managing our costs very carefully. But I want to ensure that we are continuing to ready our new products and our marketing programs for next year as we said we would on the last earnings call. We still plan to talk to you about them after the year end. And bring you up to date with progress at that point. That's really it by way of introduction.

So at this point, I would like to turn the call over to Bill Meadowcroft to go through the earnings release with you.

Thanks, Ed. Before I begin discussing the results, I'd like to point out that we added four additional tables to the press release, they include a reconciliation of loss from operations before income taxes on a GAAP and adjusted basis, we have also added segment operating earnings to our segment net sales disclosure. In addition, we have updated two slides from our second quarter earnings presentation including the expected timing of additional cost reductions by quarter and the estimated compensation of restructuring cost. We are anticipating increased cost reductions as we continue to restructure the business and as a result an increase in the cost of restructuring as you can see in those schedules. While the cost of the restructuring activities are onetime we look forward to the on going benefits of the cost reduction activities.

Now to our results. Net sales from the continuing operations were $93.8 million compared to 115.3 million for the corresponding period last year, an 18.7% decrease from Q3 2007, due primarily to the weak consumer and tight credit environment along with commercial sales reduction due to suspension of Treadclimber sales earlier this year. As we mentioned on our second quarter call as part of restructuring we have realigned the Company and our financial reporting by global, commercial, retail, and direct businesses. The goal is to make each business unit more accountable with P&L responsibility to improve operating effectiveness and costs, marketing position and product innovation with overall goal of improving shareholder value. In the earnings release we included an exhibit showing the net sales and the operating earnings of each business on an unadjusted basis, along with foot notes to indicate the restructuring and other charges recorded in each segment; to help you track progress. The overall sales decline was primarily due to the result of weakness in our direct business, where sales for 38.7 million down 34% from last year's 58.8 million. The declines due to overall consumer environment and credit market disruptions as well as an internal decision to reduce the level of discounting verse the prior year to improve product margins. We continue to focus on introducing lower price products into the direct channel to take advantage of the sweet spot to consumer financing that we discussed in our last earnings call.

Commercial business sales were down 5%, from 29.7 million to 28.4 million, this decline is primarily due to reduced Treadclimber sales. We continue to plan on the future introduction of a new version of this highly desired product for the commercial market even as we continue to sell our popular consumer Treadclimber, through our direct channel. Retail sales of 26.4 million were flat with last year, and royalty income was also basically flat with last year at $0.4 million. Our gross profit margin was 31.7% compared to 37.6% in the year ago quarter. The decrease is primarily due to the lower sales, particularly in our higher margin direct business and restructuring and other charges. We recorded a $4.1 million charge associated with the closing of our Tulsa facility, 1.8 million in reserve, inventory reserve adjustments as well. Excluding the charges our adjusted gross profit margin 38%. We will continue to face gross margin pressures until the sales mix shifts back towards the direct channel. As shown in Exhibit C to the earnings release, we continue to successfully reduce costs to our restructuring activities. Through the third quarter cost reductions of 11.5 million including cost of sales reduction of 1.2 million and operating expense reductions of 10.3 million have been achieved thus far. This compares favorably to our quarterly projection of $8.5 million of reductions. As noted in Exhibit C to the earnings release we still see additional opportunities to increase our annualized reductions from 58.2 million to $64 million. As noted in Exhibit D to the release we are increasing our restructuring charges by $6.6 million of which $3.2 million will be cash expenditures, while the balance will be noncash charges.

Our operating expenses were 43.1 million, down 35% from 66.6 million in Q3 2007, due to progress we are making with our restructuring plan. However, looking at the components of operating expenses excluding charges our selling and marketing declined from 45.1 million in Q3 '07 to 29.3 million in Q3 '08, while G&A was reduced from 11.8 million to $9.7 million. On an adjusted basis operating expenses improved to 43% of revenue down from 52% in Q3 2007. Due to our improved liquidity position, following the sale of Pearl iZUMi our interest expense decreased to $169,000 from $1.6 million in Q3 of '07.

Our loss from continuing operations before income taxes for the quarter was $13.7 million, compared to a loss of 24.3 million, in the same period last year, which shows the considerable progress we are making on restructuring efforts. In connection with restructuring we recorded $8.2 million of charges, principally related to the Tulsa closure cost, inventory reserves, debt fee write downs due to the reduction in our line of credit, loss on the sale of Tyler facility and bad debt reserves. On an adjusted basis our loss from continuing operations before taxes, of $5.5 million, compares favorable with $17.2 million of of loss in Q3 2007. Our loss from continuing operations for Q3 2008 was $35.3 million or a $1.15 per diluted share, which includes restructuring related charges of 8.2 million or $0.17 per diluted share and a noncash tax charge of 26.8 million or $0.87 per diluted share related to evaluation allowance against substantially all deferred tax assets due the accounting requirements of Financial Accounting Standard 109.

In the Q3 of 2007, our loss from continuing operations was 14.4 million or $0.46 per diluted share, which included charges of $0.15 per diluted share after tax related to reserves for bad debt and severance costs . Excluding the special items reflecting the tax valuation allowance as if it was incurred in both periods for comparability, our third quarter 2008 adjusted net loss was $5.5 million or $0.18 per diluted share compared to a Q3 2007 adjusted net loss of $17.2 million or $0.54 per diluted share. The tax allowance is recorded to comply with FAS 109 as mentioned under which companies with 3 years of cumulative pretax losses are required to test for impairment of the deferred tax assets. Though we have a 20 year carry forward period for our tax losses the accounting rules required us to reserve our tax assets in the third quarter. We expect to be able to use our deferred tax assets as we generate profits in the future. Please note, that we will be recording essentially no tax expense or benefit on our earnings or losses for future periods until that valuation allowance is fully utilized or reversed.

In addition to the tax asset valuation allowance we are required to test our good will and trade marks for impairment as of October 31, each year. Given the on going turmoil on the financial markets and the weak economy, there is possibility that our testing will require a noncash charge for the impairment of all or a portion of our $32 million of good will or our other intangible assets. At present, we don't know if a charge will be required. On an adjusted basis our EBITDA, of approximately negative $1.8 million is close to positive. We look to take an additional 4.5 million of costs our of the business, which would make us cash flow positive even with the low sales we are experiencing in this difficult consumer environment. Preserving cash and restoring positive cash flow are primary focuses in the uncertain economic times.

Turning to our balance sheet, inventories were $50 million compared to $59 million at the end of 2007 due to focused inventory management. We expect our inventory to be even lower at the end of the four quarter despite being in the midst of the prime fitness selling season. Our DSOs of 45 days at September 30, 08 were down slightly from 46 days at September 30, 2007. We will continue to work on reducing DSO's as we focus on profitable sales as well as working capital management. As of the September 30, 2008 we had $3.2 million, in net debt, compared to net cash of $4 million at June 30, 2008, in a net debt position of $71 million as of year end December 31, 2007. Year to date through September 30, we have repurchased approximately 5.3 million of common stock, with our focus on cash and liquidity due to the uncertain economy we are facing we do not expect to repurchase additional shares at this time. As Ed said at the start, we are not satisfied with our sales and earnings performance; however, by lowering our break even point we are successfully laying the right foundation for strong profits and cash flows when the consumer environment strengthens again. We are now available to take your questions,

(OPERATOR INSTRUCTIONS) . First question from Reed Anderson with D. A.

Good afternoon. a couple of questions, I had to jump off the call for a bit, I may have missed this, in terms of the cost reductions Ed you talked about 30% more than you anticipated or laid out for people, was that a function of timing or was it also a function of obviously seeing more opportunity once you got inside there?

It was a little bit of each, if you look at Exhibit C, on the back of that release, we did accelerate the timing somewhat, we actually increased the total amount we were looking for. I think at the end of the second quarter we said 58 million. We are now looking for 64. We took a little bit of restructuring charge to get there. We did do it sooner but also doing more than originally said.

And the additional saves is that more at the people level, is that where you would see that or is that somewhere else?

There are some people, more facility savings, it's really all across the board.

Okay from a time frame, when you first rolled it out the anticipation most of this in place by the end of March or first quarter, does that make sense for the additional amount you identified as well?

Yes, little bit of runover into Q2, by far the majority will be done by March.

One other question I had was on I seen you had renegotiated or amended the deal with HSBC, and I'm curious to what extent that-- obviously that played a part I would think in how the revenue decline in the direct business in the third quarter but can you -- any thoughts you can give us Ed or Bill, on the amendment can help you going forward or elements you can call out? Any detail would be helpful.

I will let Bill and Ken comment on it. Basically the agreement is an extension of what we had before. I don't think there are major changes positive or negative. I think the big thing it discuss that as you know a lot of our turn around hinges on getting the direct business revved up with newer products and marketing programs and a key part of that is the ability to have consumer financing for the people that want it. In that since it's good news. If Bill or Ken would like to amplify on that.

Yes, Reed this Ken. One thing to have in mind is that the relationship with HSBC has been long-term with Nautilus and a current agreement through the end of the year, we were negotiating amendment that extended the relationship for another five years, nothing specific on the negotiations that impacted the sales in Q3, it was more of just extending the current relationship. Clearly the overall economy and the lowering credit scores for consumers could have an impact as far as the people being approved but that was more of the economic driven rather than anything specific on the negotiating of the extended agreement.

Coming out of Q2, back away from subsidizing the financing. What I was trying to link together is that why-- is that still a big piece of what is going on here is because you weren't subsidizing, that's the absolute number they are willing to improve, that's why it's down so much, that's what I was getting at.

I think there was some reduction because we did stop subsidizing financing. The biggest single piece is the economy. Then you had as Ken said, a bit of a drop in credit scores and we don't control this but our sense would be HSBC tightened up standards. Do you agree with that, Ken?

Yes, definitely somewhat.

That's what we have been hearing from other customers too, that makes sense.

Of the leads we are getting, we talked about this on the second quarter call, the price for the leads that we are getting terms of advertising cost has been good compared to what you would expect. Continuing to trend that way. The problem is, to a large extent, a credit quality problem, the number of leads that are converting isn't where we want it to be. That's where we need to get back up.

Next question from the line of Eric Wold with Merriman Curhan.

I guess that's me. Eric Wold.

Hey Eric.

Couple of questions, one you talked about inventories down in Q3 and expected to be down year end, versus Q3, can you talk about kinds of did the make up of your inventory in terms of commercial products versus direct retail and the health of it, anything in the older products or is everything up to date?

Eric, there is still as we are transitioning out of Tulsa there will be a a lot of opportunity there for the commercial reduction. We had significant raw materials there to continue to production of cardio, some going offshore, that will lessen some of that, we have also done a good job in the retail business of cleaning up the inventory, having a very clean set of inventory there, in direct, it's also clean, it is a matter of us selling through with sales down, there is opportunity to sell what we got but it's at least it's all "A" quality stuff. It's a matter if we got the volume slowing to continue to reduce the direct inventory.

If I could just comment, the biggest opportunities are in commercial. And within that international piece we are managing tighter than we used to. Probably that's the largest opportunity overall in commercial.

One follow up question, there is a press release out yesterday by Dicks Sporting Goods about they are going to beef up product offering and do big push with Life Fitness, store within a store experience ahead of the Thanksgiving Holiday. How did that mesh with your announcement last December with a integrated partnership with Dicks to launch this fall, how is that going to work?

The Life Fitness arrangement is a result of Busy Body and Omni Fitness and their issues. So Life needed a partnership into the northeast, I think Eric you noticed it was all northeast related. We continue to grow in our relationship with Dicks, and in fact, seen increase of probably 250% in revenue this year versus last year, 6 million, to $15 million as a result of relationship that we do have. But we did not go forward with that actual store with any store concept but continue to have a strong relationship with Dicks at this time.

Perfect. Thank you guys, appreciate it.

Ladies and gentlemen, as a reminder, to register for a question, press star followed then the number one. You next question comes from the line of Rommel Dionisio with Wedbush Morgan.

I was wondering, can you comment on how much the drop off in raw material prices, commodity and freight costs benefited you in the Q3 and the outlook going forward? And I have a follow up.

In terms of the costs coming down, where there is a bit of a lag there, I don't think we saw most of the benefit in Q3, earlier in the year, particularly in retail, we had put through some price increases which didn't really take affect until this quarter. So I think what you were seeing is stable input costs, and little bit of increase in prices. I would say that maybe fourth quarter into next year, you will start to see the benefit of steel coming down, savings on things like freight.

Follow up question, I know you guys direct was one of the -- channels you wanted to focus on, growth platform for the Company going forward, pull back on the retail side, given that the macroenvironment has changed dramatically, has that changed your view there just from big picture perspective in terms of the direction you want to take the Company over the next several years?

I would have said not. If you think about direct, the advantages are that it's capital efficient. You can grow without absorbing a lot of capital. I think the thing we also focus on, if you look at the cost of getting a lead, continues to be favorable and going to maybe get a little bit better, the key is getting the conversion up, we were saying on last quarter's call has to do principally with getting the price points within the financing that people can afford, which is what we are working on. I still think they were not ignoring retail which is doing quite nicely as you can see. The real upside is on direct.

Okay. Thanks very much.

You're welcome.

Mr. Bramson, there are no further questions at this time. I will now turn the call back to you, please continue with your presentation or closing remarks.

Thank you very much everybody. Obviously it's election day so you had other things on your mind but if you think of subsequent questions, please do give Bill, is the best person a call. We look forward to speaking to you on the fourth quarter call perhaps with some better news. So thank you very much, good-bye.

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