Nautilus Inc (NLS) 2011 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to Nautilus's Q2 2011 conference call. During the presentation, all participants will be in a listen-only mode. Afterwards we will conduct a question-and-answer session.

(Operator Instructions)

As a reminder, this conference is being recorded, Monday August 8, 2011.

I would now like to turn the conference over to Michael Mulholland, Chief Financial Officer. Please go ahead, sir.

Thank you. Good afternoon. This is Mike Mulholland, along with Bruce Cazenave and Bill McMahon.

Today we will provide you with our comments regarding our operating results for the recently completed second quarter and 6 months ended June 30, 2011. Our remarks during today's conference call may include forward-looking statements concerning the Company's prospects, current or future financial and operating trends, or new product introductions. These statements, along with other information presented that are not historical facts, are subject to a number of risks and uncertainties. Actual results may differ materially from those forward-looking statements.

Nautilus undertakes no obligation to publicly update any forward-looking statements to reflect new information, events, or circumstances after they are made; or to reflect the occurrence of unanticipated events. Please refer to our quarterly and annual reports filed with the Securities and Exchange Commission for more information about the risks and uncertainties that could cause our actual results to differ. Unless otherwise indicated, all information and comments regarding our operating results pertain to our continuing operations.

At this time, I would like to introduce Bruce Cazenave, our new CEO.

Thank you, Mike.

Good afternoon everyone, and thank you for joining our call. As you know, the second quarter is always our most challenging quarter from a profitability point of view. But nevertheless, I'm very pleased overall with the improvements we made on a number of our key operational metrics in the quarter. Despite the second quarter being challenged by consumer uncertainty and retail conservatism, we managed to post a significant increase in revenue versus prior year, and continued to advance improvements in operating metrics, which will bode well for us in the future. We will talk about a few of these today. But bottom line is, we are making very good decisions as to how to deploy our resources, such as advertising dollars and others, to optimize the financial results. I'm also very enthusiastic about the near-term new product development and business opportunities that are well underway, all of which support our overall goal of generating profitable growth in the future.

I will now turn it back over to Mike, who will walk you through the financial results; and then to Bill, who will provide further insights on our operations. After Bill, I will provide a brief comment on our plans and priorities, and then we will open the call up for questions. Mike?

Thank you, Bruce.

Now turning to our second quarter results. Net sales for the 3 months ended June 30, 2011 rose 13.3% to $34.7 million, as compared to net sales of $30.6 million for the second quarter last year. This represents 2 consecutive quarters of positive quarter-over-quarter sales growth. The comparable sales increase for 2Q 2011 was driven primarily by strong sales of our TreadClimber cardio machines.

An additional factor contributing to our improved second quarter sales was our new consumer financing programs. As previously reported, we transitioned to a new Tier 1 consumer credit financing provider in September of 2010, after experiencing continued declines in credit approvals from our previous consumer financing source. Credit approvals from our new primary consumer financing source averaged approximately 17% in 2Q 2011, compared to approximately 13% for 2Q 2010. Credit approvals from our secondary consumer financing sources added another 7%, for a combined financing approval rate of 24% in the 2011 second quarter. We did not have a secondary consumer financing program during the second quarter last year.

For the 6 months ended June 30, 2011, net sales totaled $83 million, an increase of 8.8%, or $6.7 million over the same period last year. Both direct and retail posted period-over-period gains for the first 6 months of 2011. As reported, we incurred a loss from continuing operations of $2.2 million for the 2011 second quarter, which represented an improvement of 68.6%, or $4.4 million, over a loss from continuing operations of $7 million for the 2010 second quarter. Diluted loss per share from continuing operations for Q2 11 was $0.07, compared to a loss of $0.23 per share in 2Q 2010. As noted in our release, these improved results were driven in part by lower operating expenses, particularly selling and marketing, and G&A expenses.

We reported a net loss of $3.3 million for 2Q 2011, which was an improvement of 69.5% or $7.4 million, over a net loss of $10.7 million for 2Q 2010. Diluted net loss per share for the 2011 second quarter was $0.11, as compared to a diluted net loss per share of $0.35 for the 2010 second quarter. The net loss for 2Q 2011 included a loss from discontinued operation of $1.1 million, or $0.04 per diluted share; compared to a loss of $3.7 million or $0.12 per diluted share for 2Q 2010. Our management team is very focused on stemming the financial drain of the discontinued business.

For the 6 months ended June 30, 2011, loss from continuing operations was $1.1 million, an improvement of 88.5%; or $8.3 million over a loss from continuing operations of $9.4 million for the same period in 2010. Diluted loss per share from continuing operations for the first 6 months of 2011, was $0.03; compared to $0.30 for the same period a year ago. Again, our improved results were driven by a more efficient operating expense structure. The net loss of $1.7 million for the 6 months ended June 30, 2011, represented an improvement of 91% over the same period a year ago. Diluted net loss per share for the first 6 months of 2011 was $0.05, as compared to a diluted net loss per share of $0.60 for the same period a year ago. The results for the first 6 months of 2011 included a loss from discontinued operations of $600,000, or $0.02 per diluted share; compared to a loss of $9.1 million, or $0.30 per diluted share for the same period in 2010.

Selling and marketing expenses totaled $12.2 million for the 2011 second quarter; a decrease of $2.4 million, or 16.6%, as compared to the second quarter of 2010. This reduction was primarily achieved through lower direct advertising expenses as a result of media efficiencies, and the decision to leverage higher-performing products. General and administrative expenses were $4.3 million for the 2011 second quarter; a decrease of $500,000, or 10.8%, as compared to the 2010 second quarter; primarily due to lower depreciation, personnel, and legal expenses.

Turning now to our segment results. Net sales of our direct business increased 21.8% for 2Q 2011 over the comparable period last year. The key drivers of the sales performance were -- continued strong momentum of our TreadClimber product category, and improved consumer credit approval rates -- specifically, 24% for 2Q 2011 versus 13% for 2Q 2010. Net sales in our retail segment for the 2Q 2011 totaled $11.4 million, down slightly, or $400,000, from a year ago. Most retailers have been very cautious with their inventory levels as they prepare for the fall selling season. Operating income for 2Q 2011 in our direct segment improved 79.5%, or nearly $4 million over the same quarter last year; primarily due to higher sales and low advertising expenses, offset in part by higher consumer financing fees.

Gross margin for our direct business was 50% for 2Q 2011, a decrease of 410 basis points from the comparable 2010 period. The decrease in gross margin percent was principally due to a shift in product mix, higher product costs, and freight expense. Operating income for our retail segment in 2Q 2011 declined $500,000 from 2Q 2010; primarily due to lower sales and lower gross margin, which was 21.7% for 2Q 2011, representing a decrease of 470 basis points compared to 2Q 2010. This decline was attributable to increased product cost and a change in product mix. In connection with our income tax provision, we expect our effective book rate for the full year to be approximately 18%.

Turning now to our consolidated balance sheet. Cash and cash equivalents totaled $15.1 million as of June 30, 2011; compared to $14.3 million at the end of 2010. Inventories increased to $12.5 million as of June 30, 2011, compared to $10.3 million at the end of 2010. This sequential increase over year end, as well as 1Q 2011, reflects an improved in-stock condition to meet our sales expectations. Trade receivables of $7.9 million, as of June 30, 2011, reflects seasonally lower business activity with our retailers. We remain very pleased with our retail DSO. It is also important to note that we have over $75 million in federal net operating loss, carry forward available to offset future taxable income.

At this time, I would like to introduce Bill McMahon, our Senior Vice President of the Consumer Business, who will provide additional insights into our business for the recently completed second quarter. Bill?

Thanks, Mike.

I would like to make a few brief comments regarding the business operations, to provide you with some background to our results that Mike shared with you. In our direct channel, we continue to see growth in the cardio segments, specifically the TreadClimber line of products. This trend is fueled by year-over-year improvement in consumer financing approval rates, as well as the growing awareness of this product, driven by our current creative advertising and marketing campaigns that are delivering greater efficiency from our media spend. TreadClimber as a platform is proprietary, and these products can only be purchased from Nautilus. It's important we support and update this unique product line. We are doing just that with the planned launch of new and refreshed TreadClimber models later this year. Our intent will be to update the look and feel of the product while incorporating several cost improvements into the design.

In home gyms, we continue to see some decline in sales for this mature product line, which is more than offset by growth in TreadClimber. However, our revamped online advertising and promotional strategy is proving effective by delivering an improved operating profit in this category. While we are pleased with TreadClimber's continued growth, we are also cognizant of our need to diversify our product mix on the direct business. Over the past year, we have evaluated several concepts for unique and innovative products that reach incremental consumers at price points that are less dependent on financing than our current products. We anticipate that our first launch of one such product will occur later this year, and we'll have more information on this launch at our November earnings call.

Turning now to the retail business. This channel continues to deliver a positive contribution, and sales have grown 2.3% overall year to date. The retail environment for fitness equipment is always competitive, and we began to encounter modest headwinds in this segment in Q2. However, we hope to offset any slowing in this market, and return to a growth path, with the launch of new and refreshed Schwinn Fitness products in the fall of 2011. These products include new extensions into the Schwinn indoor cycling line; our first new Airdyne-based product in many years; a new mid-price-point adjustable ramp elliptical machine; and a refresh of our popular Schwinn upright and recumbent bikes. We continue to collaborate with our online and bricks-and-mortar retail partners to identify new opportunities for profitable growth. Further, we are targeting an increase in our market share beginning in late 2011, through the placement of two Schwinn bike SKUs at an incremental national retailer; as well as with an increase in store placement for our Schwinn 420 ellipticals with the current large US retailer account.

Finally, our sourcing and logistics teams continue to monitor commodity pricing in the China currency situation closely. We have already experienced an increase in freight charges and associated pressure on our margins in the form of rate changes and fuel surcharges, primarily driven by oil prices. Our manufacturing supply chain is China-based, and thus the continuing movement of currency and commodities prices will always be a concern. Year-to-date, we work closely with our suppliers to address these issues; and with few exceptions, we've been able to hold our costs in line with forecasts.

Looking forward, we anticipate continued pressure in the near term; and we will prioritize efforts to find additional cost savings with our suppliers or with new suppliers as appropriate, to mitigate currency effects. It remains possible, though, that some additional product cost increases will occur. In those cases, we plan to pass those increases along to the market, and anticipate many of our competitors will need to do the same. One of Bruce's primary strategies is to first stabilize and later grow our margins via strong partnership with our supply base. We will drive to achieve that goal.

And now, I would like to turn the call back over to Bruce for his further views on the business. Bruce?

Thanks, Bill. I would like to make some final comments before opening up the call for questions.

As Bill mentioned, we have several priority initiatives going into the back half of the year. One is to successfully launch the new products mentioned -- everything from refreshed TreadClimbers to new Schwinn bikes and others. Concurrently, we will be building an even deeper pipeline for the next year that follows our product themes of being innovative, effective, physiologically correct, and engaging for our customers. Secondly, we are working to stabilize and grow our margins. While all of our new products are planned at higher margins, certain existing mature strength products will be supported using different media approaches than in the past; and thereby increase their bottom-line profit contribution with less gross margin required.

Finally, we will be continually challenging every aspect of our operations, including working closely with our supply partners to find efficiencies, as Bill mentioned. A lot of good progress has been made in this area already, as evidenced by our growing revenues and declining operating expense ratios. Having seen firsthand what elements are necessary, 4 have to be created in order for a company to grow profitably. We are fortunate that at Nautilus, many of these are already in place, and represent significant building opportunities for the future.

Thank you. This concludes our prepared remarks; and we will now open up the call for questions.

(Operator Instructions)

Our first question comes from the line of Reed Anderson with DA Davidson. Please proceed.

Good afternoon. Thanks for taking my questions.

Let me start kind of talking about gross margins. I think -- I think I understand kind of where, why they came out the way they did. I would like you to expands on a couple of things, though. One is, just a little more granularity on the mix commentary, how that impacts margins? And then secondly, as we look at the second half of this year, is it -- does it make sense that the margin, margin decline, if you will, might be kind of on the order of magnitude we saw in 2Q?

Hi Reed. This is Bill. I'll take that question.

In regards to direct on the product mix issue, what we are seeing is a continued shift in to cardio and the continued shift out of our home gym products. And the home gym products carried margins that were in the high 70%s to 80%s. The Treadclimber product carries margins that sit around a 70% mix right now. So what we're doing with our refresh product launch is attempting to address the margin issue via both working with our suppliers as well as introducing some cost savings in that line in attempting to attack it that way with product launch.

Okay. And then in -- but in terms of the second half, any color on expectations for gross margin? Does it -- is what we saw in the 2Q, is that probably represent what you might see in the second half as well? Or is it too early to tell?

This is Bill, Reed. Excuse me, this is Bruce, Reed. (laughter) We will definitely see a stabilization in the back half of the year. Okay?

Okay.

Nothing like what we've experienced, I believe, in the second quarter. Like I said, that is one of our top priorities is to -- we understand that mix, we understand product cost. We also understand that in certain cases, we will not advertise a high margin product, but will get leverage in the operating expense area to still contribute more bottom line profitability as in the example of home gyms that Bill alluded to. So just because our margins are going down doesn't necessarily mean we are not becoming more profitable in the product category.

That makes perfect sense. Very helpful, thank you. Then, Bill, you talked about it a couple of different product launches which are very interesting. On the -- I'm curious on the Schwinn product you are bringing out, even on the direct piece, too. I'm just curious, from a pricing standpoint are you looking, are there sweet spots you are seeing opportunities, for example maybe a little lower on some of the price points, or -- just give us a flavor of how you are thinking of positioning some of these new products?

No problem, Reed. In general, in the direct side we feel like there is great opportunity to go at price points that are lower than where we are currently operating. It carries the advantage of being less dependent on financing overall, as well as it's a market that gives us incremental sales to existing customers in addition to bringing in new customers for future products. So direct, we are going lower.

On the retail side, it's little bit of a mix to be honest. I mean, some of the refresh products are at lower price points and more competitive. But in some cases like the ramped elliptical I talked about, that's a mid price point elliptical and we think there is great market opportunity there as retailers are looking to raise their margins themselves as well.

Good, that's great thank you. And then one last one, and I will let somebody else jump in. On the -- it's a small number but it's a big jump up. I'm just curious, you had a lot more royalty income than you typically have had. I'm just wondering for there was anomaly in there, or if that's something that is -- there is something a new initiative there that we'll see that number tick higher?

We're seeing -- our interest, Reed, in ellipticals is based on we are seeing a lot of royalty income from some of the IP we own around that area.

Okay.

We continue to look at, where is it working, how can we take advantage of that market knowledge.

Well thank you. Best of luck.

Thank you, Reed.

Our next question comes from the line of Joe Mundo with Sidoti. Please proceed.

Good afternoon, guys. Hello?

Hello, Joe.

Yes, good afternoon. I just wanted to, well, in light of what is going on right now in the market, can you give us some color on, or your thoughts, on what you see on consumer spending as a whole going forward for your products?

This is Bruce, Joe. I think it's probably not the best time to make a judgment in terms of what the trajectory is going to be in consumer spending with what happened today and recently here. But, I will tell you that we are playing it conservatively in terms of what we think retailers reactions are going to be going in to the back half of the year.

We've already seen it. When I mentioned conservatism in terms of inventory purchases, which normally happens at this time of the year anyway. I just -- we just think that there will be potentially some additional caution placed.

As far what is the consumer is going to do, that remains to be seen. I think maybe that will play out in the next month or so.

Yes. I mean, what I'm really getting at here is do you foresee any tightening on consumer credit that you -- that you guys are providing via third party to the consumer?

Joe, this is Bill. We work closely with our partner now to sort of monitor those trends. I suspect that what is really going to happen is there probably will not be stepped improvement in our approval rates while we navigate through this period. Most of their determinations on that have a lot more to do with oil costs as well as unemployment and housing, more than it does, say, what the markets are doing in a day. But I think that consumer sentiment is obviously something that we are concerned about as well.

I would say, though, it's all the more reason why we want to get into in our direct business into some incremental categories for us at price points that are more attainable and less dependant on aspirational purchases.

Yes --.

This could be quite incremental or at least we are hoping it will be.

As we move forward and broaden the portfolio of price points for our products, that's going to have a couple of benefits or the companies Bill just mentioned. It's going to lessen the dependency on financing, thus help strengthen margins going forward.

Okay. I had one other question, I think follow up to the caller before. Can you give us just a little bit more color on the marketing campaigns that you guys are doing right now? You said you are spending less on marketing and doing more creative marketing campaigns and it seems to be paying off. I was just wondering if you could provide us a little bit more color. Is it social media, or is it more Google Ads? How is that working?

Joe, it's a variety of things. One of the things we did is we refreshed our creative on our Treadclimber twice in the past year and in both cases the creative team here internally has produced some really powerful creative. To give you a flavor, we are paying about half per lead as we did the same point last year. So the results of that improved messaging we feel like there is growing awareness around Treadclimber, and it's starting to build on itself.

We do do social media as well. We have a pretty good Facebook presence in a lot of activity there. We have always been large players in the on line advertising arena, both through various types of display, retargeted and predictive, as well as you might guess, Google search terms and everything else under the sun.

The net effect of all the efforts, though, we measure in are we bringing in leads at a lower price than we did before and are those leads of good quality so we can convert them? And the big movement in the direct business here is that efficiency in media that we are earning from these efforts; improved credit, improved creative, good placement of those ads, it's coming together and it's working pretty well at the moment. Driving some (inaudible).

Okay. Just one last question. When can we expect to see a clean quarter without discontinued operations playing a role?

Joe, we are working, we are working hard on trying to wind up the continued financial drain on that activity. 2Q was higher than we had expected. It was primarily related to legal costs, professional accounting services, and some facility expenses. We expect to incur a modest amount of expenses in the second half of 2011. Really, based upon the effectiveness of that concerted effort, some expenses may trickle in to 2012, but we would expect by this time next year to have it pretty well wrapped up.

I mean, can we expect going forward what we saw this quarter? That we saw discontinued operations?

Absolutely not. Second half of the year, we could incur potentially up to another $0.5 million and that would be for the entire second half of the year. And again, there maybe some carrying, a modest amount carrying over into 2012. But it is a very high priority within the business.

Okay, thanks, guys.

Thank you, Joe.

(Operator Instructions)

Our next question comes from the line of Jason Stankowski with Clayton Partners. Please proceed.

Hi. Looks like a decent quarter. It's nice to hear you have a little momentum.

Can you talk a little bit about the strategy around new products? I guess, with any more specificity? Are you just creating the same products and different price points? Is there anything new? And just maybe how your product development efforts are going?

Yes, Jason, this is Bruce. I will start and then maybe turn it over for -- to Bill for some further elaboration. I would say that the way to characterize what we are doing is we are looking at new categories that we feel fit well within the scope of our core competencies and that are products that are very much would be interested by a large target consumer based today. So that's one area. We are even calling it alternative cardio. Okay?

The second, we don't have products in that category today, but we plan to shortly. The tech --.

And is that from -- I'm sorry. Is that from internal R&D efforts?

Combination of internal R&D and outside advisers that we have.

Okay.

The second area is what you alluded to, which is we know that in certain of our other cardio categories, we do not have the price points covered the way we would like to. In some cases that means moving up in price to higher price point products, in other cases it means moving down into lower price point products, that are all still great values to the consumer. So those are two of the key areas. And as we expand in to new customers, which we are approaching as we speak, then there will be probably some new other types of products that we will be developing to advance with them.

Bill, do you have anything to add?

Yes, Bruce, I think it's well said what you just passed on. I would only add that one of the things, Jason, we are looking at in terms of any new direct products we do, is we like products that have at least some peripheral tie to our existing data base of customers and leads. We have a rather significant size lead pool of former folks who have inquired with us. It gives us a jump start on launching new products if we were able to in turn market those products to those folks in advance as well as our usual advertising campaigns. So, we are looking for things that are related and innovative and meet all the things that Bruce talked about in his closing remarks.

So is that effort really started, Bill, since Bruce got there? Or is it, is there more focus on it now that you kind of righted the ship with regard the P&L and Sherborne is kind of out of there? Is there is a renewed effort? Or is this kind of ongoing, because it seems like there hasn't been much of that over the last two years or 18 months?

Yes, Jason, you hit a lot on the head here. It's a little bit of both and let me explain. So the, as we were going through the depths of our turn around and I was here at that point, obviously, and in that time, dreaming about lots of new products was a difficult thing to comprehend while we were still trying to right the ship on the business and get it steered right.

About a year ago, we recognized that things are coming together and we would have the pieces in place we expected to perform reasonably well. We started to look and do the research into what are some of these incremental product categories we could get into and start to do some evaluation of what we think the best options are. So, Bruce's arrival has only hastened that process as well. Bruce is very much a believer in product as a growth vehicle. That's been our history as well in terms of innovative products.

So, I would say we are accelerating now. We intend to invest further in R&D as we go forward. But we definitely had some work underway for a while now anticipating the opportunity to take advantage of where we are today.

Okay. That's great. And I'd -- sounds like you are not starting flat footed at least. So that should be good.

Yes, but we recognize we want to keep growing and doing better as we go.

I've got one last question. Did we just get really lucky on our landlord needing our space?

(Laughter) We actually think in the long run, this is -- you know, it's very good for our shareholders obviously, but we also think it's great for the Company. And so it was several events coalesced together. But we are certainly pleased with the outcome.

So, so is the ultimate answer they had somebody who needed it? And did I read the press release right that they are actually making some concessions for us and now they are building a new building that we are signing up to be the tenant in?

That is correct. Along with the attendant savings and our partner will incur all move costs associated with this.

Wow, that's --.

It will result with overall reduction in our occupancy costs going forward.

Right. Because -- you probably need twice the space you got, I know that. (laughter)

Great. Good, that's great news. It's nice to hear something going our way. Thanks a lot.

Thank you, Jason.

Thank you.

Okay.

There appear to be no further questions at this time, gentlemen. I would now turn the call back to you for closing remarks you may have.

Thank you. Thanks again to everyone for participating on the call and we look forward to our next call in November. Thank you, gentlemen. Bye-bye.

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