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Cybex International, Inc. (NASDAQ:CYBI)

Q3 2008 Earnings Call

October 21, 2008 4:30 pm ET

Executives

John Aglialoro – Chairman, Chief Executive Officer

Arthur Hicks, Jr. – President, Chief Operating Officer

Analysts

Ian Corydon – B. Riley & Company

Rick Nelson – Stephens, Inc

Reed Anderson – D.A. Davidson

Bruce Koepfgen – Oppenheimer & Company

Presentation

Operator

Good day and welcome to the Cybex International Incorporated third quarter 2008 earnings conference call. (Operator Instructions)

This conference call may contain forward-looking statements. There are a number of risks and uncertainties that can cause actually results to differ materially from those anticipated by the statements that follow.

These include, but are not limited to, competitive factors, technological and product developments, market demand, economic conditions, the resolution of litigation involving the company and the ability of the company to comply with the terms of its credit facilities.

Further information on these and other factors which could affect the company’s financial results can be found in the company’s previously filed report on form 10K for the year ended December 31, 2007. Its reports on form 10Q, its current reports on form 8K and its proxy statements dated April 4, 2008.

It is now my pleasure to turn the floor over to your host, Mr. John Aglialoro, CEO of Cybex.

John Aglialoro

Thank you, Pam. Good afternoon, everyone. The company is pleased that we were able to eke out a small profit on increased revenues for third quarter. I think it’s no secret to anyone that clarity in the global marketplace is currently gripped with whether it’s fear or uncertainty, but we’re bringing in orders. We do have a small backlog in our Medway plant, where we make bikes and treadmills.

We’re about two or three weeks backlogged on the strength equipment in our main plant in Owatonna, Minnesota. Other than that, I don’t think there’s ever been a time where I would say that we are going to have increased or decreased revenues.

I must say to you as fellow share holders, depending on what the political and economic chieftains decide in terms of credit and really confidence coming back, I think no matter what one is manufacturing or the retail side or energy or any sort of business right now.

I’m not saying anything that you probably didn’t suspect anyway. We don’t have a gloomy sense of things. On the other hand, we can’t give any clarity for future revenue generation, but we are busy currently.

I think given the current situation, I want to say little more about that. However, we are looking to ship currently the new home market. It’s our second try. It’s called the 360. We started with the 350. As you know, Cybex makes everything from scratch.

We are working with a vendor, an OEM source and we think the 360 has been radically redone and we took a few false steps, but we’re really pleased with the current product and are happy to now enter the fourth quarter─ probably the mid-late part of the fourth quarter─ our first home product that we think should do well.

The consumer market, in general, for fitness products has been extremely soft, so we haven’t lost anything. We haven’t gained anything. We’re just entering cautiously. We’ve been in testing and pre-production runs, which has been very valuable to the company that we instituted in the last year or so.

So, we’ll add that market. It becomes better. We have a good product that we’re very proud of. In addition, we’ve got─ let’s call it an Arc II or next generation Arc, which aesthetically very pleasing. I was happy in Birmingham, U.K. There was a show there and we had very favorable results. We’ve been looking at, as I’ve mentioned in other meetings, two things we want to do better in ’08-’09 in going forward was the aesthetics in the products and in our marketing.

And we’ve got a good balance sheet. We’ve got, we think, some great products to continue our income statement going forward favorably. So, we think we’ve gotten there with the aesthetics on the Arc II as well as a new totally improved commercial bike and constantly looking at the video, which is a real important aspect to the exerciser, the end user or health club, not only wants good equipment, approachable, aesthetically pleasing, usable, but they want additional things than just the reading rack.

They want T.V., wireless headphones, connectivity and that’s where I think the competition and now and into the second decade will be is in the connectivity features that fitness products come up with.

So, we’ve got a good, clear, positive focus. We’re in a much stronger financial position than five or six years ago. Let’s hope this uncertain storm clears. But, we’re ready for a fight and to grow and move forward. And with that, we’ll get more specific on the financials and I’ll turn it over to Arthur Hicks, Jr.; Art.

Arthur Hicks, Jr.

Thanks, John. Good afternoon. I have some comments discussing the income statement and balance sheet for Q3.

Sales, up $35, 753,000, were up about 10%. Cardio equipment for the quarter was $19, 162,000, an increase of 8%. The increase in cardio equipment driven mostly by treads. Our trainers were down about 1%, not including the Home Arc. Home Arc was down $388,000 for the quarter.

Strength equipment up $13, 605,000 was up 13%, driven by our Selectorized Lines, particularly or VR1 sales were strong. The other category made up by freight and parts was $2,986,000, up 4%.

International sales for the quarter were $10,275,000, up 7% and North America sales of $25,487,000, increased 11% in the quarter.

Gross profit margins continue to be a challenge, although warranty expense was down, showing improvement, about 1% in the quarter. Last year, we had a move in Owatonna facilities. That also counted for about a 1% increase in margin and then those increases were offset by steel cost increases, overhead costs partially related to our new facility, freight costs and product mix.

General administrative expenses were down 754,000 in the quarter compared to the prior year, Q3 2007, did included roughly a million dollars in charges that were outlined the 10Q of last year. Interest expense was down with lower debt levels in the quarter, 306,000 versus 422,000. Income tax for ’07 included a reduction in the valuation allowance of roughly 5.2 million, which was again, described in last year’s Q and press releases.

The EPS for Q3 2008 was a profit of $0.02.

The balance sheet continues to be strong. Accounts receivable are healthy. They filled (ph 00:10:32) outstanding measurement of 45 days, it's still considered to be very strong. Inventory turns improved marginally from the second quarter of '08 to 6.35 turns. Still not where we need to be, but a slight improvement. Debt is down $2,057,000 from the end of the year and it is down in the quarter $380,000 from the end of June of '08.

We continue to have good availability. The revolver is unused at this time. We have $15 million availability and we also have $3 million available under our capital expenditure line.

John, that was my prepared comments for the income statement and balance sheet.

John Aglialoro

Alright, thank you, Art. Pam, we'd like to open up for Q&A now.

Question-and-Answer Session

Operator

Sir, thank you. If you would like to ask questions, you may do so by pressing star one on your telephone keypad. We will take as many questions as time permits. If you are joining us on a speaker phone, please make sure your mute function is off to allow your signal to reach our equipment. Again, that is star one if you have a question and we will pause for a moment. We will take our first question from Ian Corydon at B. Riley & Company.

Ian Corydon – B. Riley & Company

Question. Regarding steel and rate (ph 00:11:56) prices, are you seeing any relief there. Do you have kind of an outlook for what you expect to see over the next couple of quarters?

John Aglialoro

I think the outlook is clearly will follow commodities in general. So I would think first quarter would see a definitive decrease in steel and some relief in the fourth quarter. That said, you're heavily dependent upon revenue generation, so there's a point where if we can generate enough revenue, that will swallow the bottom line.

Ian Corydon – B. Riley & Company

Okay. And price increases – could you talk about when you took your last increase and if you can, what your average selling price on like items is, or was in the quarter versus last year.

Arthur Hicks, Jr.

Ian, you were fading out at the end, but I think you were asking about price increases. ASPs (ph 00:12:54) are generally above where they were for Q3 of '07. We had increased particularly about 75% of our strength line earlier this year, and those prices are generally holding true. We're evaluating price increases going forward with the new models that John described. There will be small price increases for the Arc Trainer and the new bikes and then we'll look at the strength line going into '09.

Ian Corydon – B. Riley & Company

Okay. My last question is on Owatonna. Are you guys operating as efficiently as you can. Obviously you need some bigger volumes to leverage that facility, but with the volumes you have, are you running as efficiently as you think you can be?

Arthur Hicks, Jr.

Labor as a percentage of sales is down well over 1% and we are getting the labor efficiencies that we expected from the new plant, particularly the (inaudible 00:13:50) robotic welding and the laser cutters that we added. So you're right, we'll just continue to increase those efficiencies and dollars at the bottom line with volume.

Ian Corydon – B. Riley & Company

Alright. Thank you.

Operator

Our next question comes from Rick Nelson at Stephens, Inc.

Rick Nelson – Stephens, Inc.

Thank you. Good afternoon.

Arthur Hicks, Jr.

Hi, Rick.

John Aglialoro

Hi, Rick.

Rick Nelson – Stephens, Inc.

In the second quarter you reported seeing some volatility in revenues from month to month. I'm wondering if that continued to be the case in the third quarter, then maybe what you're seeing in October thus far.

John Aglialoro

Rick, I don't know. We saw the uncertainty begin last August. From an expense point of view, SG&A is 12 months essentially flat and off from last quarter. So we really had been preparing from that side of it. It was a surprise to us that second quarter revenues dropped. It was a surprise that third quarter were as high as they were. I mean I think they were just a hair under 10%. So it's just been very strange. Credit has dried up for a lot of sources, and yet we still seem to get orders. Art, what's your view on this?

Arthur Hicks, Jr.

I would agree. We saw things start to slide in February, then in mid-May they started picking up. September orders were a little below prior year, but up 33% over '06. '07 order rates are a little hard to interpret since we had some back-up with the move and the like. So, as John said before, I think clarity is at a premium at this time and it's a little foggy how things will turn out.

Rick Nelson – Stephens, Inc.

Have things been pretty choppy here in the third quarter that you reported today?

Arthur Hicks, Jr.

I think the orders for July and August were strong and September was fairly solid as well. But as John said, we only have a two to three-week lead time, which I think is consistent (ph 0:16:08) throughout the third quarter. But we would typically like to see a little longer lead time going into this period, so we have some idea where the fourth quarter would pan out. At this point, it's a little shorter view that we would like to have.

Rick Nelson – Stephens, Inc.

You talked about some of the reasons for the gross margin pressures in the quarter, steel which you just addressed. How about the mix shift? What was the kind (ph 0:16:38) there that caused some of the march (ph 00:16:41) in revenues?

Arthur Hicks, Jr.

Well, we think that the new Arc Trainer will reinvigorate sales levels with that product. But that is our highest margin product. So, as that is increased as a percentage of sale, that has hurt us. The new 750 Treadmill has done very well. As I said, treads were up substantially in the quarter. The bad news is as we've had with other treadmill products, the first year out it comes out at a higher cost of goods, and then generally we've been successful in getting those down. So as this thing has started out, the margins are at the low end of our product mix, so I would say there's the two biggest variable higher. 750 T sales at lower margins, and lower Arc sales at the high margin.

Rick Nelson – Stephens, Inc.

I guess, finally, your customers, have you seen push-back from your major customers? How do you think they're underlying business is doing during this downturn and what do you expect there?

John Aglialoro

Our client base is governmental, is a good piece, or universities. Those type of customers that have a budget, governmental sources, so that's somewhat more secure. The guy that's got five clubs and he wants to build a sixth, he just may be thinking a little longer on that. So that's really where we are. Are they going to step up and grow their own businesses? Then it's just a phone call away and we build it for them. So we really are dependent upon the very large chains and the small mom-and-pops that are saying, you know, it's ready for us to step it up. We have seen some acquisition at work. We've seen some players. I know that one of the dealers, Busy Body, declared bankruptcy today, a large dealer for consumer products. A lot of our dealers are mixed. They're commercial and consumer. Some are only consumer. So we're seeing some people fade out and we see new players coming in and some are doing a little acquisition down at that level. I mean that's what gives me confidence. When you get a weaker player outs and the stronger one coming into that area, ready to invest, because he got the price low enough, and he's got a successful model in his own business. That's what gives me confidence. In this area, it's nature just taking its course and the small, yes, but still growing customers are taking advantage of this tough time that a lot of businesses are going through.

Rick Nelson – Stephens, Inc.

Is credit availability an issue for your dealers?

John Aglialoro

Yes, it is. We've worked real hard in the last year to continue the number and the quality of the relationships. So we do take some recourse, it's a limited number, I think it's $4 million, Art?

Arthur Hicks, Jr.

$4.8 million at the end of the quarter.

John Aglialoro

$4.8 million. So we keep it under five. When it goes down, we build it back up again so it’s kind of near the high side right now of that limit. But as it gets paid off, we'll do a little bit of that. But the lenders are ─ I thought it would be a lot worse than it is, and they do have lines, there are a lot more scrutiny and before they okay a deal, but we find that that's probably one of the other things that is a savior for us. And it's something we did years and years ago with Cybex Capital. So those lines a few people have gotten out of the game. A few people have pulled back a bit. But overall, if one of our customers has some level of credit worthiness. They're getting the credit from our sources of credit.

Rick Nelson – Stephens, Inc.

Thank you and good luck.

John Aglialoro

Thank you.

Operator

(Operator instructions) And we will take our next question from Reed Anderson from D.A. Davidson.

Reed Anderson – D.A. Davidson

Good afternoon everyone. Hi! Just following up on one of Rick's questions. Just back to the notion of your – how you figure your customers are ordering in that sort I'm just curious, are you seeing yet anything in their order habits or patterns meetings. But normally a guy would order $100,000 of equipment. He's now taking it down to 90 for a store or something like that. Any delineation or any change in that product?

John Aglialoro

I don't know. I haven't see that.

Reed Anderson – D.A. Davidson

Well, okay. So─

John Aglialoro

They just─ they don't say it was. I was going to order 100% but now I'm only going to order 90 specifically. They have─ they don't commensurate with us on that side of it.

Reed Anderson – D.A. Davidson

Understood. But me, I'm─ from your end, what you see though you haven't noticed any change or meaningful change in their behavior in the last 90 days if you will.

Arthur Hicks, Jr.

Well, on my side─ there's a couple of change of pullback on expansion a little bit but I would agree in terms of their buying habits. I haven't anything wherein they're not buying four threads instead of six (inaudible 00:22:23) something.

Reed Anderson – D.A. Davidson

Okay. Okay. That's what I was (inaudible 00:22:25) but I would just.

Arthur Hicks, Jr.

That's not as overt as that.

Reed Anderson – D.A. Davidson

Okay. Okay. And then, another question I was curious about. The new products you talked about, when will those start shipping or have they started shipping or what kind of time frame of that over the next few months?

John Aglialoro

For the new Arcs, we will start shipping later this month in limited quantities and through our new procedure, ramp up throughout the quarter so it'll be full steam ahead by the second half of December and bikes following just a couple weeks behind. So we'll have some sales in the quarter for both products and probably─ we expect them to be full steam ahead beginning January 1. It's probably one of the toughest things we've done still about a year, a year and half ago which was you get for your beta testing and you get the bugs out and then you sell, and you ramp up the production level of that amount. But we started this post beta testing, this first run and it's a small number but the rarely products that people buy. It's not that we put in places and we're getting engineers testing them. Somewhere along the line, it's just different than when you're selling a product and that customer has it and uses it.

You just seem to get different bugs bent and bugs, they can really hurt you down the line so when we're ready and I'd say probably well under the first quarter then we can really feel we can get some clear sailing and not have to mess up a quarter or year with warranty expenses that were needlessly put on because we didn't take that time, that extra measure of time to get a number of your new product sold and generally weak and heavily discounted just for that purpose but we get testing numbers and things like that from the customer. So these are great─ these are good products. The Arc 2 we know we will have to be a lot of interest there so we have to give good looking products and the same with the rest of them.

So I think you may ride around mid-part of the first quarter the dual stacks and some of the other strength products we've got coming out. So it takes a little bit more patience but we think it's worth it.

Reed Anderson – D.A. Davidson

Okay, and then, also just thinking about the fourth quarter obviously it's a big quarter for you. But still, is there a point elsewhere? You reach first week in December, and just like and think about things better or worse. The point where he is kind of like we can make it to this point and that kind of─ its two to three weeks (inaudible 00:25:10) I would think that the first part of December you kind of know what things are going to shape up. Is that fair?

Arthur Hicks, Jr.

I think within a range it's true. You sell─ there still can be a few hundred thousand-dollars placed the last week to the first week of the following month but vice versa but within a range. We would know whether we're going to be up 10% or down 10% probably.

Reed Anderson – D.A. Davidson

Okay. And then last question. I was just curious─ have you done any, have you made any headcount reductions or trimming or not hiring, anything on that level based on what you said.

John Aglialoro

What we’ve done is, over the last 12 months where we were maybe a year ago, let’s say nine or 10 weeks on lead time. We’ve had a fair amount of part-timers that we consciously have, well-trained, they like the part-time idea, certain people want just that and so we really could cut that back to a great amount. So we trim the sale through release part timers and try to hold on to our full time family.

Reed Anderson – D.A. Davidson

Thank you. Good luck.

Arthur Hicks, Jr.

Thank you.

Operator

And our next question comes from Bruce Koepfgen with Oppenheimer.

Bruce Koepfgen – Oppenheimer & Company

Art, I have a question for you. It seems like you guys─ UM Holdings─ it seems that you guys are the bushel bag. I call it the bushel basket. Because every time I see a block trade on the stock, I know it’s UM Holdings and I sort of added up what that total has been over the last year and it comes close to 1.3 million shares. My questions is a) what’s your plan here, it seems like a buyback, it seems that you have an advertisement out there that anybody wants to sell the stock, call the company and we'll take it, and b) where’s the stock coming from?

Arthur Hicks, Jr.

There was some fore selling in the quarter. Yes, we generally won’t speak for UM Holdings during this call so there’s─ UM Holdings is obviously supportive of the business and through their actions showed that they believe the stocks are undervalued but no definitive plans beyond that. But we do believe there was fore selling in the quarter and we do know there were some hedge funds that were liquidated.

Bruce Koepfgen – Oppenheimer & Company

John, would you be open to – I know what you did for the company, I know you were always were sensitive (ph 00:27:49) to the stock and this is the lowest it has been in quite some time.

John Aglialoro

Well you know I am not going to answer that kind of question, Bruce. But what I will say is that when there was a block, I think it came out at─ and the stock─ one of the problem is not much of volume, so when someone is coming in as Art said, there’s a couple of fore sellers occasionally are coming in that just had to have large amounts of the volume or small and it─ I think (inaudible 00:28:25) one given that just to make an example and stock went to $1.50.

Bruce Koepfgen – Oppenheimer & Company

Right. Right.

John Aglialoro

And I know that UM Holdings put in just a safety valve order just so there was an order with a higher limit there just to not cause panic. It’s been pretty panicky in the last several months.

Bruce Koepfgen – Oppenheimer & Company

Are you surprised where you─ I mean the stock right now, I believe it’s not even selling at $850 million market cap.

John Aglialoro

Surprisingly, the number of stocks that are just sold down beyond reasonable value just as there too many or too many times bullet up to an unreasonable value.

Bruce Koepfgen – Oppenheimer & Company

Well, thanks very much.

John Aglialoro

Thanks, Bruce.

Operator

And our next question comes from Bradley Wheeler (ph 00:29:12) from Wheeler Limited. And there are no further questions in the queue. I'd like to turn─

John Aglialoro

Okay. (Inaudible 00:29:22) thank you very much.

Operator

You're welcome.

John Aglialoro

Okay. Thank you everyone and we'll see you next quarter and look forward to sharing our progress at that time. Bye bye.

Operator

That does conclude today's conference. Thank you for attending and have a wonderful day.

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