Nautilus, Inc.
Q2 2008 Earnings Call Transcript

Published: 15 Sep 2008

[Operator:]

Welcome to the Nautilus, Inc. second quarter 2008 results conference call. (Operator Instructions) 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 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 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 report on Form 10K and Form 10Q 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. In addition to today’s prepared remarks Nautilus has provided a PowerPoint presentation of its restructuring plans to accompany today’s remarks. The presentation can be found on the Nautilus website at www.nautilusinc.com/earnings. And now I would like to turn the conference call over to Ed Bramson, Chairman and Chief Executive Officer of Nautilus, Inc.

[Edward J. Bramson:]

Bill Meadowcroft is going to review the second quarter results in detail and then I intend to discuss the turnaround plan with the progress of it to date in greater detail using a PowerPoint presentation that was referred to in the introduction and you can find it on our website at www.nautilusinc.com/events. Bill Meadowcroft’s going to take you through the Q2 results and then I’ll come back on the restructuring. And since we’ve got a lot of territory to cover today, I think it would be best if we took questions on both topics in the end. So I’m going to turn the thing over to Bill now and he’ll take you through the results of the second quarter.

[William D. Meadowcroft:]

Net sales from continuing operations were $95.6 million compared to $102.5 million for the corresponding period last year. This 7% decline compares with the reduction of 5.4% in Q1 2008 compared with Q1 2007. An important part of our restructuring and operational improvement process is the establishment of separate teams with authority and responsibility for the profitability of each of our global business units

[Edward J. Bramson:]

I’m going to give everybody a few seconds to access the PowerPoint presentation and then we’ll make a start. If everybody can see the presentation, I’m going to try and remember to mention page numbers as we go through it. So starting on page 2 which is the Safe Harbor statement, obviously we’d refer you to all the cautions in here but a particular thing I want to point out is that we’re going to be discussing some profitability and other information by business unit which we haven’t done before and that involves making some management allocations. And I just want to point that out specifically in the Safe Harbor statement that they are estimates. If you go to page 3, the firm I’m with Pier One Investors really got interested in Nautilus some time ago because we saw potentially a very strong growth business with some very valuable brands, which on the other hand clearly needed a turnaround. And I think as of today we’re perhaps halfway through the turnaround and I’ll get into what that means in a second. As we saw it there were three things that needed to be done in the turnaround, and we’ll take you through each of them. The first we want is as exciting as the strategy which is the third but then necessary to put in place the foundation for us to grow. So the first necessity is on page 3, it’s the balance sheet and liquidity. We’ll talk about it in more depth but clearly we got into a fairly risky situation to the point where the balance sheet was making it difficult for us to have a consistent growth strategy. And I think we moved on from that now. The second element of the turnaround is to become profitable with sales levels where they are and not where we might hope they’ll be at some point in the future, and our break-even level that got too high as a result of which when sales went off it caused us to lose money. So most of what we’re going to talk about today actually is the second point, which is improving profitability with sales where they are. And we’re going to talk briefly about some strategic opportunities we see but we plan to come back to that in a later conference call. If we turn to page 4, the first item is the balance sheet and liquidity. Just repeating some of what Bill had said, at the end of ‘07 we had net debt of $71 million. We also had an obligation to purchase Land America, our Chinese supplier, for $69 million. So in essence we had a financing need of $140 million. The company at that point was losing money and we were entering a credit crunch, so I would say that was not a very good situation. Since then we’ve sold the apparel business which was something that was in process when I arrived. We’ve also terminated the agreement to acquire Land America for $8 million as a result of which we are completely clean in that matter and we have no further obligations. We also have a good relationship with our supplier going forward so I think that’s a major progress. So where we are today as Bill said we have $4 million of net cash at the end of June versus $70 million of debt the end of the year. We also have quite a bit of availability under our borrowing facilities. Sometimes this gets to be confusing. The maximum available under the facility is a fairly high number but it depends on the availability of working capital to support it. So at the end of June we could have borrowed another $35 million. I think the balance sheet position now really is quite a bit better as evidence of which the lenders were prepared to give us a consent to start a share repurchase program, which previously had been prohibited. And as Bill mentioned we’ve actually done some of that already. If you go to page 5, most of today’s discussion is about getting profitable in current conditions and the table’s a little bit complicated but I think the easiest way to start to look at it is to compare 2003 with 2006. And I should say that all of these numbers exclude the apparel business and they also exclude non-recurring items. Back in that period I think it’s fairly clear that the company’s principal objective was to grow the top line and up until 2006 that was actually accomplished. The problem with it is that the cost of getting those sales increases was greater than the profits that they delivered. This is not something that happened in just one year; it was a continuing trend. So again if you look at 2006, you’ll say that sales were up $120 odd million, gross profit was up $22 million as a result of that, but the GS&A costs that it took to get it were $35 million so net net you were worse off. It also put you in the position where in 2007 when sales tailed off, it had a very disproportionate effect on earnings and put us into a significant loss position. So this page is basically where we have been. As you go to page 6, we’ll start to get into where we’re trying to get to. What we’re to do is we believe it is a good business and want to get it back on a growth track but we want to grow with profits. So if you try to reduce that to practicalities, what are you trying to do? And we said that one objective is that this is quite a seasonal business. Q2 and Q3 are typically much lower in sales than Q1 and Q4 and often as a result generate a loss. So our belief is that to the extent we can, if we don’t lose money in the bad quarters it can only help you in the good ones. So that was the first objective

[Operator:]

(Operator Instructions) Our first question comes from Paul Swinand - Stephens, Inc.

[Paul Swinand:]

My first question is on the restructuring to Virginia. What is your capacity like there? How many shifts are you running? How many buildings do you have there? Can you give us a little more detail on how that’s going to work out as you have to move other operations there?

[Edward J. Bramson:]

Both of the factories are highly underutilized and it depends on how you look at it. Tulsa was probably less than 20% utilized on an effective basis and the factory in Virginia I believe is running a single shift most of the time Bill.

[William D. Meadowcroft:]

Yes. In fact it had some shutdowns this last quarter as well.

[Edward J. Bramson:]

It was not an issue of physical capacity. The belief that we have is that we can take all of the fixed costs that were incurred in Tulsa and absorb them for no extra money in Virginia. But you’d need to add some hourly labor and I think the issue is just making sure that you can go into the local labor pool and get the extra hourly workers you need, which I believe you can do.

[Paul Swinand:]

And those are at a similar rate I assume?

[Edward J. Bramson:]

Actually it’s very similar, yes.

[Paul Swinand:]

And just something that caught my eye on the PowerPoint, I was surprised to see on one of the earlier slides comparing 2003 and 2007 that they’re actually spending less on marketing in the direct business. Was the former plan actually under-investing in advertising or were they just shifting stuff around?

[Edward J. Bramson:]

Do you want to say that one again? I think you’re on page 6, is that right?

[Paul Swinand:]

I’m looking for it here. It was comparing 2003. Direct business spent $79.6 million in advertising and they only expensed $75.9 million in 2007. I was surprised it went down.

[Edward J. Bramson:]

I think it was because in direct marketing what typically you do is when the efficiency of advertising drops, you reduce the advertising. Because if you find that when you advertise for another dollar, you get two dollars of sales, you advertise more. When you find that you’re only getting another dollar, you advertise less. So it’s a relatively minor change but I think that’s the reason.

[Paul Swinand:]

Are you net spending less then on advertising?

[Edward J. Bramson:]

Well we’re spending $3 million a year less.

[Paul Swinand:]

And it’s just a matter of the efficiency?

[Edward J. Bramson:]

It is. If you could spend more and get good returns on it, I’d be the first to do it. But when the conversion rate’s dropping, the first advertising you do gets the best returns, the second gets less. So it’s just where you are on the curve of efficiency.

[Operator:]

Our next question comes from Rommel Dionsio - Wedbush Morgan Securities.

[Rommel Dionsio:]

A question on the plans to grow the cardio business. The prior management team always talked about growing cardio, leveraging the Bowflex and Nautilus brands which were [inaudible] strength and the cardio. Can you just maybe share with us what you plan on doing a little differently than what had occurred over the last few years because to my knowledge it was always a strategic focus for the firm to grow the cardio business?

[Edward J. Bramson:]

There’s a difference between planning and doing, which I think is what you’re saying. If you look at cardio, the big parts of the business are treadmills and ellipticals. And we have products there but honestly so does everybody else. So when we talk about growing in cardio what we really mean is in areas where you have some differentiation, and that basically comes down to TreadClimber. We think there’s a big opportunity to grow the TreadClimber direct business because it’s relatively small right now and it’s a distinguishable product. It hasn’t been put into retail. And the commercial TreadClimber was not one of our better design efforts I’d have to say, but customers love it. So when we say growing cardio, we’re not saying sell more treadmills. We need to sell them just to have a full line in commercial but it’s really products that are specifically Nautilus products.

[Operator:]

Our next question comes from Reed Anderson - D.A. Davidson & Co.

[Reed Anderson:]

I would also add that I really appreciate the additional detail and transparency. I think that’s very helpful. A couple questions. One is just thinking about the direct business, which correct me if I’m wrong but what I was hearing is that consciously based on how you were managing that business in the second quarter, you were really trying to take that down and that’s why we saw the growth rate slower, that it dipped quite a bit. How should we think about that and its implications for the second half? Should we continue to see that business down that sort of level or was 2Q sort of an anomaly?

[Edward J. Bramson:]

I would have to say that we didn’t plan for the sales to come down as much as they did. I think we aggravated it by cutting the promotions, and the promotions are not coming back. The key to making this thing profitable is product innovation, getting your price points right. And I haven’t really been around long enough and Bill has so he should comment on this separately. I know what people are telling me we’re going to do. I haven’t been around long enough to know how realistic it is. We’re not forecasting sales declines at the same rate in direct as we had in the second quarter but we are forecasting direct to be down year-over-year I think in the third and fourth quarter too. Bill?

[William D. Meadowcroft:]

Right. Not at nearly as much of a pace.

[Reed Anderson:]

I didn’t hear all the detail in the call, but what specifically did you do and what was the timing of that in the direct business when you pulled the promotion, the support? What exactly was that?

[Edward J. Bramson:]

Promotion in the direct, what happens is to get sales up you tend to sort of do things at the end of the quarter. So we’re not giving free freight which actually is fairly expensive. Another thing is in the credit area, what you can do if you want to is you can subsidize the cost of credit and that’s what shows up in marketing. So you actually pay some dollars to the credit card company and they lend more than they otherwise would or they lend it at a lower rate. Sort of like the automobile business if you want to think of it that way. And we were doing a lot of that. So what it was doing is it was polluting the margins. You think your margin’s higher than it really is. And we just sort of said, “Look, you don’t really need to do that.” And a better way of doing it is getting the price point to where you don’t have to subsidize financing. So I’m not sure when we cut that off Bill but it was during the second quarter?

[William D. Meadowcroft:]

It was the end of May.

[Reed Anderson:]

The last question is just on the cost side. Ed you commented a little bit about what you’re seeing out there and I think back to the last call, I think at one point you talked you had maybe some price adjustments potentially coming in September or October. Bill or Ed, could you just give us an update of how far out your costs as you think about the expectations you gave us today and where the inflections might be?

[Edward J. Bramson:]

I think it goes through October on the cost side.

[William D. Meadowcroft:]

Yes. The windows have certainly narrowed Reed as you can expect. In China there’s a lot of pressure there so we are pretty much out through October for the majority at this point.

[Edward J. Bramson:]

We are actually out bidding some new products as part of the strategic development. And the 4% to 6% number at least on new stuff doesn’t appear to be changing all that much.

[Operator:]

Our next question comes from Greg Scott - Merriman Curhan Ford & Co.

[Greg Scott:]

I was just wondering if you could give me a little color. With everything else being so weak, I was just kind of curious why retail was so strong? Definitely up a lot higher than what we were modeling. I know you mentioned Schwinn and Bowflex but could you give a little more color on the retail?

[Edward J. Bramson:]

Part of it is you’re comparing with the really absolutely horrible quarter last year and we have had a fairly strong emphasis on specialty retail which as you know we’ve been de-emphasizing lately, so what you had was the sales to specialty retail going down. And we’ve got better relationships going now with some of the larger fitness retailers and they’ve now started to pick up and that’s really what you’re seeing. And we’ve also got additional cardio products that we’re putting in and we have a relatively small share of floor space in the places that we’re in and we’re finding that if we say we’d like to have a new product. Like we actually have a new elliptical that we’re going to be putting in that was a direct product that’s going into retail now, we’re finding a fairly good response. Starting from a relatively small base, it’s doing well. And one thing I would say is we do monitor sell-through pretty clearly now which we didn’t always in the past. And I’m told that the sales we’re making are representative of sell-through.

[Greg Scott:]

Do you have any sense that there’s a lot of product on the shelves or are the retailers seeing decreased demand right now?

[Edward J. Bramson:]

That’s what I was trying to say that what we’re experiencing is about what they’re selling to the best of my knowledge.

[Operator:]

At this time there are no further questions. This concludes today’s conference call.