Nautilus Inc (NLS) 2011 Q3 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the Nautilus third quarter earnings 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, November 7, 2011. I would now like to turn the conference over to Michael Mulholland. Please go ahead, sir.

Thank you. Good afternoon. This is Michael Mulholland, along with Bruce Cazenave and Bill McMahon. Today, we will provide you with our comments regarding our operating results for the recently completed third quarter and nine months ended September 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 these 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 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 our CEO, Bruce Cazenave.

Thank you, Mike. Good afternoon, everyone, and thank you for joining our call. Our third quarter this year represents a milestone quarter in the course of successfully building the profitability of our business. We are pleased to report another step in the steady string of quarter-over-quarter improvements versus prior year that we have posted to date.

Importantly, key initiatives were launched during the quarter which support long-term business growth and improve profitability. These include reorganizing and adding resources to our product development organization, successfully introducing new products at new price points, broadening our supply base and beginning gross margin stabilization via improving product margins.

In terms of revenue growth, our Direct business continued posting positive gains while our Retail business was impacted by retailers' caution and conservatism in terms of timing their inventory purchases in Q3 versus Q4. We're seeing a confirmation of this shift based on the early Q4 orders received to date. Bill McMahon, our Chief Operating Officer, will provide further details on new product initiatives, including product margins as well as other back half activity within our Retail and Direct businesses.

First I would like to turn it back over to Mike, who will take you through the financial results.

Thank you, Bruce. Now, turning to our third quarter results, net sales for the three months ended September 30, 2011 totaled $37.4 million, a decline of 2.8% as compared to net sales of $38.5 million for the third quarter last year. Higher third-quarter sales in our Direct business were more than offset by lower comparable sales in our Retail segment.

For the nine months ended September 30, 2011 net sales totaled $120.4 million, an increase of 4.9% or $5.7 million over the same period last year. Net sales of our Direct business increased by 10.1% over the first nine months of last year while net sales of our Retail segment declined 4.1% compared to the same nine-month period last year. Later in the call, we will provide you additional comments on the variables which affected our Direct and Retail segments.

Income from continuing operations of $281,000 for the 2011 third quarter compared to a loss from continuing operations of $2.4 million for the 2010 third quarter. Diluted income per share from continuing operations for Q3 2011 was $0.01 compared to a loss of $0.08 per share for Q3 2010. These improved results were driven mostly by lower operating expenses, particularly selling and marketing expenses.

We reported a net loss of $92,000 for Q3 2011, which compares favorably to a net loss of $4.3 million for Q3 2010. Diluted net loss per share for the 2011 third quarter was a breakeven as compared to diluted net loss per share of $0.14 for the 2010 third quarter. The net loss for Q3 2011 included a loss from discontinued operations of $373,000 or $0.01 per diluted share compared to a loss of $1.9 million or $0.06 per diluted share for Q3 2010.

We are making progress towards closing down our foreign subsidiaries connected with our formal commercial equipment business, which represents the primary source of our pre-tax loss from our discontinued operation in 2011.

For the nine months ended September 30, 2011, loss from continuing operations was approximately $800,000, a significant improvement over a loss from continuing operations of $11.8 million for the same period in 2010. Diluted loss per share from continuing operations for the first nine months of 2011 was $0.03 compared to $0.38 for the same period a year ago. Again, our improved results were driven primarily by a more efficient operating expense structure.

Net loss of $1.8 million for the nine months ended September 30, 2011 represented an improvement of approximately $21 million over the same period a year ago. Diluted loss per share for the first nine months of 2011 was $0.06 as compared to a diluted net loss per share of $0.74 for the same period a year ago. Our results for the first nine months of 2011 included a loss from discontinued operation of approximately $1 million or $0.03 per diluted share compared to a loss of $11 million or $0.36 per diluted share for the same period in 2011.

Total operating expenses for the 2011 third quarter were $16.5 million, which represented a decrease of $3.3 million or 16.8% from the third quarter of last year. This decrease was due to lower selling and marketing expenses as well as to reduced general and administrative expenses.

Selling and marketing expenses totaled $11.5 million for the 2011 third quarter, a decline of $2.8 million or 19.7% as compared to the third quarter of 2010. This reduction was primarily achieved through lower direct advertising expenses as well as the result of media efficiencies and to reallocating home gym advertising to more cost-effective online and social media.

General and administrative expenses amounted to $4.1 million for the 2011 third quarter, a decrease of approximately $700,000 or 13.8% as compared to the 2010 third quarter, primarily due to lower depreciation, personnel costs and legal expenses.

Turning now to our segment results, net sales of our Direct business increased 5.3% for Q3 2011 over the same quarter last year. Key drivers of the sales performance included continued strong momentum of our TreadClimber product category and improved consumer credit approval rates. Credit approval rates by our third party consumer financing sources averaged approximately 27% for Q3 2011 compared to approximately 24% in the second quarter of 2011 and 21% for the third quarter of 2010.

Operating income for Q3 2011 in our direct Segment improved by $2.8 million over the same quarter last year, primarily due to lower advertising expenses offset in part by higher consumer financing fees. Gross margin for our Direct business was 52% for Q3 2011, a decrease of 310 basis points from the comparable 2010 period. The decrease in gross margin percent was principally due to higher freight and warranty expenses, partially offset by improved product margins.

Net sales of our Retail segment for Q3 2011 decreased by 14.9% compared to the third quarter last year. The decrease in sales was primarily attributable to a sales promotion of cardio products in Q3 2010 that was not repeated this year. In addition, our Retail customers in general remained cautious during the third quarter with their inventory levels, in light of weak economic indicators, and shifted some product orders to the current fourth quarter. Operating income for our Retail segment in Q3 2011 declined $682,000 from Q3 2010, primarily due to lower sales and lower gross margin, which was 21.6% for Q3 2011, representing a decrease of 280 basis points compared to Q3 2010. This decline was attributable to higher supply chain costs, which are somewhat fixed, combined with lower sales volume. These higher costs, however, were partially offset by improved product margins as compared to the third quarter of last year.

It should be noted that we achieved higher product margins in both the Direct and Retail segments in Q3 2011 as compared to Q3 2010.

Turning to our consolidated balance sheet, cash and cash equivalents totaled $11.5 million as of September 30, 2011, compared to $14.3 million at the end of 2010. Inventories increased to $13.5 million as of September 30, 2011, compared to $10.3 million at the end of 2010. This increase in inventory over year end and compared to Q3 2010 reflects an improved in-stock condition to meet our future sales expectations.

Trade receivables of $11.5 million as of September 30, 2011 reflect seasonably lower business activity with our retail customers during the third quarter as compared to the fourth quarter last year combined with continued improvement in retail DSO since year end. It is important to also note that we have over $76 million in federal net operating loss carry-forwards available to offset future taxable income.

At this time I would like to introduce Bill McMahon, our Chief Operating Officer, who will provide additional insights into our business for the recently completed quarter. Bill?

Thanks, Mike. I'd like to make a few brief comments regarding our operations to provide some additional background for the results that Mike has just shared with you.

In our Direct channel, we are continuing to see growth in our Bowflex TreadClimber cardio machine sales. This improvement remains attributable to a successful multichannel media campaign that includes television, online and social media combined with our improvement in consumer financing capabilities. Also in early October, we launched a refresh series of products in the TreadClimber consumer line, featuring an updated look, expanded entry-level price point and overall improved product margin for the category. We are hopeful these updates will prepare this important platform for 2012 and beyond.

As we announced in late October, we have also reached agreement to license the global rights to our proprietary TreadClimber technology within the commercial fitness market. With this agreement we will better leverage our valuable intellectual property with this successful modality from a corporate financial standpoint as well as create the opportunity to introduce still more consumers to the benefits of TreadClimber in fitness clubs throughout the US and the world. We expect that this increased awareness will drive incremental consumer in-home sales.

Also new in Direct, on October 31 we launched an entirely new product initiative with the introduction of the Nautilus CoreBody Reformer. The CoreBody Reformer is a fitness equipment and DVD-based programming package designed to combine the popular and growing participation segments of Pilates, yoga and dance while doing so at an affordable price point. The product is an important launch for us for three key reasons. First, CoreBody Reformer targets a new incremental segment of customers for our business as compared to the classic Bowflex strength products. Second, it is positioned at a price point that is well below our former average order value in the Direct business, and thus is less dependent on consumer financing for conversion in these uneven economic times. Finally, CoreBody Reformer provides another vehicle for us to use in driving repeat sales to our large existing database of leads and customers. We will utilize a combination of longform infomercial advertising, online, mobile Web, public relations and social media marketing efforts to promote the product.

Turning to our Retail business, while this channel continues to deliver a strong positive contribution, our sales in Q3 were below our expectation, and we are focusing much of our attention to this key area of the business. This slowdown was attributable to several factors, including cautious buying during the quarter by several of our key Retail partners as well as the timing of a new Olympic Gold product launch moving into Q4.

Importantly, we have not seen signs of a large-scale across-the-board slowdown in the velocity of our products at point-of-sale in the bricks and mortar stores or online. The new incremental product placements we discussed in the August earning call will all occur before the end of this year. However, as Mike noted in his comments, some product placement timing has shifted into Q4.

Related to this topic, we have recently added still another SKU placement in a large national sporting goods retailer with initial sell-in planned now for late Q4 and early Q1. This news, combined with or early Q4 sell-in today, leaves us optimistic for a strong finish to the year in this business segment. Of note, we have already launched some of the new Retail products the season including an upright recumbent exercise bike as well as a lower price point indoor cycling bike. We are encouraged by the initial performance of these products and plan to build on this preliminary success as the fitness season ramps up.

One of Bruce's top priorities since his arrival has been to reverse our trend over the past years regarding product margin. Importantly in Q3, we were able to take our first steps in this direction by delivering year-over-year improvement in product margins within both consumer segments. We still have more work to do here in order to raise the overall gross profit margins and are launching several initiatives targeting that improvement, but we are encouraged by the efforts to date.

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

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

As mentioned on our last earnings call back in August, our back-half priority initiatives were threefold. One is to build new product capabilities and successfully execute the planned launches in Q3 and Q4. Secondly, to begin stabilizing our margins and utilize alternative media strategies to gain efficiencies and improve bottom-line profitability. And finally, thirdly, to continue challenging every aspect of our operations from sourcing through after-sales support for new ways to improve the methods in which we do things. This will enable our organization to more efficiently and effectively handle the increased levels of volume and activity we anticipate.

I'm extremely proud of the team and the progress we've made on all three fronts. The pace and momentum we have established is very encouraging, and I'm confident will result in both the successes we expect in the marketplace as well as measured by future positive operating results.

This concludes our prepared remarks for today. Thank you. We will now open up the call for questions.

(Operator instructions) Reed Anderson, D.A. Davidson.

A couple questions -- first, let's just talk about sales first. You were talking, Bill, about looking at the expanded price points and so forth, particularly on the lower end, I guess, at the entry level. And I wonder if you would just kind of maybe add a little bit more color to that comment, either order of magnitude or breadth, just get a sense of what specifically you're going to talk about.

Sure, Reed. On the TreadClimber product line, we've introduced a new product that now launches at $999. It's our first TreadClimber below $1000. That should have twofold positive effect for us, which will be greater lead generation because you're not disqualifying people who look at this and say, well, that's too expensive, I can't afford that no matter how good the pitch is. Secondly, obviously, a lower price point generally drives higher conversion. It's more attainable overall. So we are really looking for the incremental effect of that.

Historically, as well, in our Direct channel selling products at that lower price point doesn't actually meet you sell a lot of lower-priced product. You merely get folks into the category and then they decide from there which model is best suited for them. So we are taking a look at all the early performance on that and hoping to see what our historical tests have proven to provide future benefit. And so far, we are, but it's early and I would hate to go beyond the comments (multiple speakers).

And when you are able to take that pricing down, is that simply by just maybe taking out some of the features or the functionality? Or are you now a more efficient producer of that, so really you are able to offer more for less?

You know, it's actually efficiency in design. This is our first real refresh of the TreadClimber line since, frankly, introduction. And we've learned a lot over the years on how to make TreadClimbers, so we are able to go to a lower price point but actually increase the overall product margin for that line of products, which is a nice combination that certainly the $999 unit doesn't have the same feature set as, say, our former $2000 units. But it is a TreadClimber and provides the same benefits.

And then on the CoreBody, obviously it's brand-new, it's very early and we can all kind of just speculate what that might do. But just kind of give us a sense of the cadence of maybe how that is going to be coming to market here and what kind of -- what media might be involved, what the ramp, that sort of thing might be, just to give us an idea of how that might play out in your mind. And then secondly, on that product, I'm presuming that the margin structure is very similar to your existing Direct products. Is that correct? Higher, lower? Just a sense, please.

Sure. Let me answer the second part first. The product margin on that product is actually incremental to where we are now with our current margins, so it's a little bit of help.

In terms of our media standpoint, we have really done quite a few things we hadn't done in the past year. One is to throw a lot of attention on public relations leading in. So during the summer we worked with magazines and we will be featured in some gift guides for the fall on this product. The website was up early and started taking some pre-sales, so we have a solid website. We have a mobile web that you can access on your smartphones, which is important these days. And we're doing longform infomercials to introduce the product and explain it.

But I think, having followed us a long time, as you know, over time we will certainly utilize other TV as it proves itself out and awareness grows. And we have a heavy social media presence. We have a large presence on Facebook for this product with a lot of information, so we are really trying to get the word of mouth as well to the traditional PR advertising going on this product. It is pretty exciting, to be honest.

That's great. Bruce, when you first took the job, I remember you were talking about one of the things that I think impressed you coming in from the outside and learning was that you had a lot more going on from the product development side. And this is obviously the first kind of push in that direction outside of the refresh and things like that. Do you still feel that way? Has that even got better? Just kind of your high-level view of that initiative, having now launched essentially a very new product.

Well, I think it's a good question. There was a pretty good product pipeline already in the works when I arrived about five months ago. So obviously, that's going to come to fruition and come to the marketplace over the next year and two years out.

I would say that it's -- we are gearing up to be able to bring more new product to the marketplace and potentially with even broader appeal like the CoreBody Reformer is in some of our traditional products. So that's what you're going to see a little bit more of -- more and potentially with broader appeal and at different price points that you heard Bill talk about.

So that's a little bit of what we are doing there. I think we consider CoreBody Reformer kind of a new-new type of product as opposed to a refresh, as you said. And we hope to have more of those new-new items coming in the future.

Absolutely, and then just a couple last ones and I'll let somebody else jump in. Gross margins have -- they're right where I thought they would be. They are still down, but kind of narrowing that gap. And I guess we're going to be an anniversarying some of the things here coming up. I'm just curious; do we get to the point now in the fourth quarter and early next year where maybe margins are still down a little bit but the gap narrows pretty substantially compared to maybe what it was the last couple quarters?

Yes, I think that's a very good observation. As I noted in my remarks, that we were very pleased in reporting or achieving internally year-over-year increases in what we call product margins, which are -- which one would define as selling price less landed cost as well as less various discounts, returns and allowances. So before we get into the rest of the gross margin structure related to supply chain, customer service, operations management and the like, those external issues and our product margins stepped up quite nicely on a comparable basis.

And the last I guess not related question but similar logic in that year-over-year, your compares on the credit approval side -- you're still -- it's going higher; it's just you don't have as much low-hanging fruit compared to a couple quarters back. So does it make sense to -- you will still see credit approval rates tick up sequentially from here, but it's not like it's going to jump up by 500 basis points a quarter. I would think that would be unrealistic. Does that logic still hold, or has that changed?

No, I think we've gotten into a period of stability, as I noted in my comments. Yes, we were up at 27% compared to a year ago at 21%. But for the quarter completed in June, we were at 24%. So we have ratcheted up nicely sequentially by, say, 300 basis points. But I think, given the overall economic climate, that our approval rates should be somewhat stable at this level.

That's what I was thinking too; good. Thanks very much. Good luck. I'll let somebody else jump in.

Joe Munda, Sidoti.

I was wondering -- the comment you guys made on product placement and a little bit of a delay on customer orders and you are going to see that carry over into the fourth quarter, where you expect to recoup some of those orders -- so are we expected to see, I guess, high revenue number, a higher sales number in the fourth quarter as opposed to the same time last year?

Yes. We are not really providing sales guidance at this time going forward. But what we are hopeful (multiple speakers) -- reverse the Q3 trend, that's for certain.

Can you provide us a little bit more color on why there was some delay by customer orders? Is it that -- you had mentioned a new release of an elliptical machine. Is that -- are customers waiting or holding off to order some of these new products you guys are putting out?

What we saw was, in some cases, a plan to go late placement in September, sort of slide into October as the retailers tried to finish clearing out what they had already on the floor. And in one specific case we had our Retail elliptical product that moved into the middle of Q4 from originally been planned in Q3.

But the same incremental placements that we've talked about previously still exist. We are seeing the retailers began to ramp up their buying, at least to date here in Q4. So we are hopeful really for the second half that we probably achieved the targets that we were looking for originally. The only risk is, the longer the floor placements occur with the retailers is you potentially lose a sales turn. So that's why it's hard to answer the question accurately for you. We just like to get our products and I get them placed and then go from there. The ones that we do have placed are doing well.

You had mentioned -- you touched a little bit on CoreBody Reformer. Can you give us a little bit more color on those pre-sales are going? Are they meeting the targets that you guys have put in place, or is it better than anticipated? Can you give us a little bit more color on that?

Well, it's -- the first thing I would caution; it's very early. We have been on TV about a week as of today and what we've seen so far is the response level that we expected and we are deriving the ROI we were looking for overall in our media.

But I'd also say, and this goes to the prior question as well, this is different than some launches in that we are doing a traditional launch here and our desire is to test right now, especially in the TV market, and be prudent about this and figure out what works, what doesn't, what are our best times, what networks. And that will prepare us for what is the peak that the season for us, which is later in the quarter in January. So we are really trying to take your time right now to test around a little bit and turn the dials, as we would say, and see where the best response is. So we're pleased with some of the things we're finding already, but we are still want to do a little bit more testing before we go all out.

Okay. And just as a follow up with that, with all these fitness shows that are on now, is here any opportunity to put the Core Reformer to use in some of those fitness shows, or are you seeing any response in that matter, I guess, as far as product placement in like some shows or some fitness programs? Has anybody approached you on that?

We actually have had discussions in regards to public relations and such about what our opportunities are in this area. And we are looking at some things, and then there's always the -- can you get the product in the hands of some celebrities and let them use it, and then you get peripheral coverage that way? We're pursuing all those what I would call non-DR opportunities very aggressively and trying to see what we can do from a public relations standpoint. As of now I don't have any news I can give on that, though.

Or perhaps anything like the Home Shopping Network or QVC? Would you guys be willing to go that route as well?

We certainly intend to explore all opportunities to provide the best distribution for CoreBody. And as we arrive at those areas of opportunity going forward, we will certainly share.

Okay, thanks, guys.

(Operator instructions) Jason Stankowski, Clayton Partners.

Great expense and marketing management to get to a nice bottom line number.

Can you -- Bruce, maybe can you kind of lay out how you see the margins? Obviously, it would be nice to get to a quarter where we are not talking about losses and losses compared to losses, but rather profits. And just curious, over the next year or so, how you see the margins laying out. And what should investors be thinking about in terms of whether it's operating margin or net margin, how you look at the business and where you are driving towards a particular model for the Company?

Okay, well, I think it's -- as I laid out in my commentary, it is somewhat of a milestone quarter for us because, as Mike mentioned, our actual product cost, our product margin improved this quarter over the same quarter of last year, which to me is a leading indicator in terms of what we can potentially see in a gross margin level in the quarters to come. And the reason for that is because, if nothing else, the fixed component of gross margin will be more fully absorbed as you go into the bigger quarters. So that's one thing.

The second thing is new products. Every time that we bring a new product, starting with the TreadClimber refreshes, additionally the CoreBody Reformer, every single new product that comes in is accretive to our current rate of margin on a gross basis. So as we -- the mix of new product, which will accelerate next year as a percentage of our total volume, of our total revenues in both Direct and Retail, you will see an uplift in margin. I'm not going to quantify for you. I'll just tell you directionally, it will be better than what we've seen directionally this year, for sure.

Finally, we are working on a number of supply chain initiatives. We have launched -- Bill and I were in China in early October, and we had a sit-down with all of our key suppliers, including a number of new suppliers. And we talked to them about how do we get efficiencies in our supply chain, not just in product cost, value engineering, things like that, but also the logistics of bringing the product across the ocean to our warehouse and ultimately to our consumers.

So we have a lot of work in that area which I think will bear some fruit starting very soon. And if nothing else, if the currency continues to work against us -- I'm talking about the Chinese RMB versus the dollar, which we expect it to continue its trend, then we will resort to pricing as appropriate, in order to make sure that we are getting the margins up to where we want them to be.

So that's a little bit of a long-winded answer to your question, but I will tell you that we are attacking it from a number of different fronts. But the first and foremost will be the mix of new product and higher margins going forward.

With still a commitment movement towards profitable growth?

Yes.

All right, good. And what can you say, Bill, about -- I know you are taking it cautious, which seems to be very prudent versus some of the other launches. But how far into the process will you know what kind of resources you can possibly put towards the CoreBody? Is it something that by the end of November, mid-December you should have a pretty good idea about the quantities and the level of dollars that you need to put behind the product?

I think so, Jason. That would be our target because I want to be able to make a run at the Christmas gift season as well as the fitness season in January. And remember, some of that could be -- well, we've found things that work and then we've found things that we want to edit to make areas that aren't quite working work a little better. So it's a learning process along the way.

I think we're taking the prudent path of spending resources as appropriate and then putting the money where we have proven success going forward versus just a blanket spend.

Great, okay, great, thanks a lot, guys.

Mike Dwyer, Compass Capital.

Good quarter. I just wanted to, I guess, go over a few things. The first thing was, I noticed that you guys had mentioned it, that the bottom line had improved by about $2.8 million for the quarter in continuing ops. Are you guys expecting to see a similar kind of improvement over Q4 of last year?

We really can't comment on that as far as where the fourth quarter or next year in terms of quantifying the improvements, Mike, I apologize for that. We just don't do that.

We are not there yet.

I guess one of the things I'm wondering is, in the business, do you see a significant amount of room to cut costs with marketing expenses flat in Q4?

I think one of the things we are really looking at in terms of marketing expenses, making sure we're spending money where it's driving an ROI that's measurable and provide us return. Because in a perfect world, we would actually spend more on marketing and drive higher profitable revenues. As we sit now, we have optimized our direct spend. And a lot of times, when you see the reduction in the marketing spend that we are doing now, it's not a reduction in spending against TreadClimber, it's a reduction in spend against other categories that were not performing with sufficient ROI, hence the improvement in the profitability. But we are always looking for ways to actually increase our spend, if possible. As it sits now, the optimization of our spend has called for some reductions in the past year. We will continue to operate the business the same way, looking for the best profitable outcomes that we can derive.

The other thing I can add to it is, what you can see a little bit of a tick up on in the future quarters is our R&D spend. We are investing, we've put a number of additional people into our product line management and engineering functions over the last two months. And this is all in the interest of building the capability to handle the kind of new product engine that we are building. So that you will see tick up year-over-year.

Okay. So are you going to be targeting those products at the -- you mentioned that the expanded price points on those TreadClimbers -- are you seeing any price points in there that are selling better? And are you targeting new products toward that price point? Is that what you're doing with the new product development?

I think, with CoreBody Reformer we're going into an incremental Direct price point we just haven't been at in a combined -- a target market that we haven't played in, either. So we're hopeful for good outcomes there.

On TreadClimber, yes; we are trying to extend the product line a little bit further. But we are also looking for products that aren't quite as low-cost as CoreBody but maybe slightly below TreadClimber's entry point.

At this point, honestly, our look is, is we look at what we think is a good idea and then we test it against either the market itself or with focus groups or a variety of other factors or research we use to see whether or not we think it's a winning product. And then from there the price sort of -- the research tells you what is sustainable as well in terms of price.

So a long-winded answer to say we are not closing out any price points, but we're definitely interested in things that diversify our product mix and, certainly, things that diversify our product mix and are not necessarily dependent on consumer financing to drive success.

I noticed on your press release you had mentioned that there was a maturing product lifecycle for home gyms. Is this an industry-wide thing you're seeing, or is it specific to the products that you guys offer?

For us it's definitely against our current product line, but the Sporting Goods Manufacturer Association data for the home gym category in general would say that there's also a decline in participation in sales in that category to our competitors' products as well. And that's due to a variety of factors, which includes the housing market and such. Home gyms take up a lot of room or a lot of footprint. So in that case it's not even just financing; there are other factors in the current economic situation that say that home gyms are a little challenged.

So does that impact your sales to Retail? (multiple speakers) Is that why your Retail division, I guess, is -- it's becoming a smaller and smaller portion of your overall business.

I think both channels are seeing roughly an equal percent decline in home gyms sales. If anything, Retail has seen a little bit of stability of home gyms sales as it reaches sellable lower price points. The Retail decline this quarter was really mostly due to these product placement timings.

Okay, got you. And another question I had was on the royalty income. I noticed that your royalty income is now -- it's about $1 million per quarter, which seems like it's getting bigger and bigger, to the point where it may start making an impact on your bottom line. Is that just 100% margins that you are seeing on that? What kind of margin rate are you seeing on that? And what's your strategy for that whole -- just the royalty income in general?

Well, it certainly is a full-margin product for us. But -- with tongue in cheek. We are pleased with the incremental gains we have been able to achieve relatively, year after year. The Company has a very significant portfolio of intellectual property, and it's a key opportunity for us going forward. And I think Bruce would like to expand on that as well.

I would say that actually, when we laid out our plans going out for the next three years, our strategic plan, we call it internally, it was one of the six strategies that we outlined that there was potential for significant 100% margin type of an opportunity. And it's in two areas. One is utilizing the brands that we have, and in some cases the trademarks within those brands like we have, like the TreadClimber as a modality, but also in the form of intellectual property we have in terms of technologies. Today a large portion of that $1 million a quarter that you referenced is coming from technologies that we license to other equipment manufacturers who appreciate what we have and utilize it in their products. So it is a significant opportunity for us going forward. We intend to make it a bigger part of our revenue and profitability mix in the years to come.

That's great news. Anything you guys can do on that front -- obviously, it's going to go right to the bottom line.

So one other question I had was you mentioned that in the Retail division there was a product that was sold in Q3 2010 that wasn't in Q3 2011. Does that account for the decrease in sales?

Yes. In Q3 2010, we had a rather large position in certain types of treadmills, and there was a large effort in that quarter a year ago to reduce that position. And that somewhat accounts for some of the delta in sales this year.

Okay, so it's not necessarily an apples-to-apples kind of thing?

Not completely. The way we're looking at it internally, to be honest, is sort of what do we think about the second half of this year in Retail, just due to the retailers' timing being a little bit different than the timing we would like to have. And again, the only impact to us potentially is the missed sales turn, which is concerning, but we are getting the product incremental placements, and we are happy with that.

And then the last question I had -- it's related to that CoreBody Reformer. My wife had actually seen that, and the first thing that you said to me was, doesn't it have a yoga mat? And I didn't get a chance to look at it. Does it have a yoga mat with that?

We are happy to sell an accessory mat to go with the product, so please advise your wife to add that to the card (multiple speakers).

Thanks a lot, guys. Great quarter.

It's a pretty competitive package of products, but the product itself is constructed such that you can use it on many surfaces. But we do also have a mat accessory available for those who would like that as well.

You can put over your shoulder like a yoga mat with a strap that we provide.

Yes, yes, I did see that. Thanks a lot, guys. I appreciate it.

Jason Stankowski.

I just had a question if -- you've talked a lot about how this new product is at a much different price point. I assume that that means the quantities that you might be moving would be a lot larger as well. And not to get ahead of ourselves here, but if we are successful, what plans and how prepared are you to meet demand, should it actually come? And what types of steps have you taken in order to be able to deliver on a larger demand in terms of units than we might otherwise see in the larger price point products?

Good question, Jason. Certainly, if the product is successful we expect to have a several-fold increase in unit volume that's associated to this product. And to us it starts from China, so we have dual-sourced this product through two suppliers who both have large capacity to produce the product. We are keeping both those suppliers online producing so that we can respond to surges in volumes, should we hit upon early some things that really work out of the gate.

And then, secondly, it's the getting it here, getting it around and turning and shipping it quickly because this sort of product acquires a service level that is pretty quick -- ship it the same day or the next day. Our operations team is very keen to this, and our distribution center is prepared to deal with the volume. I've worked closely with the heads of our group running our distribution and logistics capabilities, and we are ready for that volume as it starts to happen. And we will certainly measure and keep an eye on it as we go. We have several contingencies on what to deal with this if it turns into a runaway hit. That would be a problem I would love to go ahead and execute those contingencies if they come up.

But you have thought through many have some plans if that does happen?

Most definitely.

Great, all right, thanks a lot, guys.

Thank you, there are no further questions. Please continue with your presentation, sir.

I just wanted to thank everyone for their interest and participation in the call today, and we look forward to next call in March. Thank you all and have a great afternoon.

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