Nautilus Inc. Q3 2008 Earnings Call Transcript

Nov. 4.08 | About: Nautilus, Inc. (NLS)

Nautilus Inc. (NYSE:NLS)

Q3 2008 Earnings Call

November 4, 2008 4:30 pm ET

Executives

Edward J. Bramson – Chairman and Chief Executive Officer

William D. Meadowcroft – Chief Financial Officer

Ken Fish – Chief Administrative Officer

Analysts

Reed Anderson – D.A. Davidson

Eric Wold – Merriman Curhan Ford & Co.

Rommel Dionisio – Wedbush Morgan Securities

Operator

Welcome to the Nautilus Incorporated 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 the questions. These statements do not guarantee future performance.

Nautilus undertakes no obligations to update publically any forward-looking statements to reflect new information, events or circumstances after the date they were made or to reflect those kinds of unanticipated events. Therefore, undue reliance should not be placed upon them.

Listeners should review the earnings release to which this conference call relates. And the company’s most recent periodic reports on Form 10-K and Form 10-Q filed with the Securities and 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.

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

Edward J. Bramson

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

Turning to earnings, you’ll see that we’ve taken as a first item a significant non-cash write off of our deferred tax assets and Bill is going to explain this a little bit later. From an operating standpoint our sales were down about 18%, almost all of which came from the direct to consumer business which was particularly hard hit in September and fell more than 30% for the quarter.

Offsetting this, our cost reductions came in more than 30% better than we had forecast on the last earnings call. So that ameliorated the net effect somewhat. We’re obviously in a tough sales period at the moment so we’re managing our costs very carefully. But I want to assure you that we’re continuing to ready our new products and marketing programs for next year as we said we would on the last earnings call.

And we still plan to talk to you about them after the year end and bring you up to date with our progress at that point. Now that’s really it by way of introduction. So at this point I’d like to turn the call over to Bill Meadowcroft to go through the earnings release with you.

William D. Meadowcroft

Thanks Ed. Before I begin discussing the results I’d like to point out that we’ve added four additional tables to our press release. They include a reconciliation of loss from operations before income taxes on a GAAP and adjusted basis. We’ve also added segment operating earnings to our segment net sales disclosure. In addition we’ve updated two slides from our second quarter earnings presentation including the expected timing of additional cost reductions by quarter and the estimated composition of restructuring costs.

We are anticipating increased cost reductions as we continue to restructure the business and as a result an increase in the cost of restructuring as you can see in those schedules. While the cost of the restructuring activities are one time we look forward to the ongoing benefits of the cost reduction activities.

Now to our results. Net sales from the continuing operations were $93.8 million compared to $115.3 million for the corresponding period last year. An 18.7% decrease from Q3 2007 due primarily to the weak consumer and tight credit environment along with commercial sales reductions due to the suspension of Tread Climber sales earlier this year.

As we mentioned on our second quarter call as part of our restructuring we have realigned the company and our financial reporting by global, commercial, retail and direct businesses. The goal is to make each business unit more accountable with P&L responsibility to improve operating effectiveness and costs, marketing position and product innovation with an overall goal of improving shareholder value.

In the earnings release we included an exhibit showing the net sales and the operating earnings of each business on an unadjusted basis along with footnotes to indicate the restructuring and other charges recorded in each segment to help you track progress.

The overall sales decline was primarily due to the result of weakness in our direct business where sales were $38.7 million, down 34% from last year’s $58.8 million. The declines due' to the overall consumer environment and credit market disruptions as well as an internal decision to reduce the level of discounting versus the prior year to improve product margins. We continue to focus on introducing lower priced products into the direct channel to take advantage of the sweet spot for consumer financing that we discussed in our last earnings call.

Commercial business sales were down 5% from $29.7 million to $28.4 million. This decline is primarily due to reduced Tread Climber sales. We continue to plan on the future introduction of a new version of this highly desired product for the commercial market even as we continue to sell our popular consumer Tread Climbers through our direct channel.

Retail sales of $26.4 million were flat with last year and royalty income was also basically flat with last year with $0.4 million. Our gross profit margin was 31.7% compared to 37.6% in the year ago quarter. The decrease is primarily due to the lower sales, particularly in our higher margin direct business and restructuring and other charges.

We recorded a $4.1 million charge associated with the closing of our Tulsa facility, $1.8 million in reserve, inventory reserve adjustments as well. Excluding the charges, our adjusted gross profit margin was 38%. We will continue to face gross margin pressures until the sales mix shifts back towards the direct channel.

As shown in Exhibit C to our earnings release we continue to successfully reduce costs to our restructuring activities. Through the third quarter, cost reductions of $11.5 million, including cost of sales reductions of $1.2 million and operating expense reductions of $10.3 million have been achieved thus far. This compares favorably to our quarterly projection of $8.5 million of reductions.

As noted in Exhibit C to the earnings release we still see additional opportunities to increase our annualized reductions from $58.2 million to $64 million. As noted in Exhibit D to the release we are increasing our restructuring charges by $6.6 million of which $3.2 million will be cash expenditures while the balance will be non-cash charges.

Our operating expenses were $43.1 million down 35% from $66.6 million in Q3 2007 due to the progress we are making with our restructuring plan. We’re looking at the components of operating expenses excluding charges our selling and marketing declined from $45.1 million in Q307 to $29.3 million in Q308, while G&A was reduced from $11.8 million to $9.7 million. On an adjusted basis operating expenses improved to 43% of revenue, down from 53% in Q3 2007.

Due to our improved liquidity position following the sale of Pearl Izumi our interest expense decreased to $169,000 from $1.6 million in Q3 of ’07. Our loss from containing operations before income taxes for the quarter was $13.7 million compared to a loss of $24.3 million in the same period last year, which shows the considerable progress we are making on our restructuring efforts.

In connection with restructuring we recorded $8.2 million of charges principally related to the Tulsa closure costs, inventory reserves, debt fee write downs, due to the reduction in our line of credit, loss on the sale of our Tyler facility and bad debt reserves. On an adjusted basis our loss from continuing operations before taxes, of $5.5 million compares favorably with $17.2 million of loss in Q3 2007.

Our loss from continuing operations for Q3 2008 was $35.3 million or $1.15 per diluted share which includes restructuring related charges, of $8.2 million or $0.17 per diluted share and a non-cash tax charge of $26.8 million or $0.87 per diluted share related to evaluation allowance against substantially all of the deferred tax assets due to the accounting requirements of Financial Accounting Standard 109.

In the third quarter of 2007 our loss from continuing operations was $14.4 million or $0.46 per diluted share which included charges of $0.15 per diluted share after tax -elated to reserves for bad debt and severance costs.

Excluding the special items, reflecting the tax evaluation allowance, as if it was incurred in both periods for comparability, our third quarter 2008 adjusted net loss was $5.5 million or $0.18 per diluted share compared to Q3 2007 adjusted net loss of $17.2 million or $0.54 per diluted share.

The tax allowances recorded to comply with FAS-109 as mentioned, under which companies with three years of accumulative pre-tax losses are required to test for impairment of the deferred tax assets. Though we have a 20 year carry forward period for our tax losses, the accounting rules required us to reserve our tax assets in the third quarter.

We expect to be able to use our deferred tax assets as we generate profits in the future. Please note that we will be recording essentially no tax expense or benefit on our earnings or losses for future periods until that valuation allowance is fully utilized or is reversed.

In addition to the tax asset valuation allowance, we are required to test our goodwill and trademarks for impairment as of October 31st each year. Given the ongoing turmoil in the financial markets, and the weak economy there is possibility that our testing will require a noncash charge for the impairment of all or a portion of our $32 million of goodwill or our other intangible assets. At present we don’t know if a charge will be required.

On an adjusted basis, our EBITDA of approximately negative $1.8 million is close to positive. We look to take an additional $4.5 million of costs out of the business which would make us cash flow positive even with the low sales we are experiencing in this difficult consumer environment. Preserving cash and restoring positive cash flow, our primary focuses in these uncertain economic times.

Turning to our balance sheet, inventories were $50 million compared to $59 million at the end of 2007 due to focused inventory management. We expect our inventory to be even lower at the end of the fourth quarter despite being in the midst of the prime fitness selling season.

Our DSOs are 45 days as of September 30th, '08 were down slightly from 46 days at September 30th, 2007. We will continue to work on reducing DSOs as we focus on profitable sales as well as working capital management. As of September 30th, 2008 we had $3.2 million in net debt compared to net cash of $4 million at June 30, 2008 and a net debt position of $71 million as of year-end December 31, 2007.

Year-to-date through September 30th we have repurchased approximately 5.3 of common stock with our focus on cash and liquidity due to the uncertain economy we are facing. We do not expect to repurchase additional shares at this time.

As Ed said at the start, we are not satisfied with our sales and earnings performance. However, by lowering our break-even point, we are successfully laying the right foundation for strong profits and cash flows when the consumer environment strengthens again. We are now available to take your questions.

Question-and-Answer Session

Operator

(Operator Instructions). Your first question comes from Reed Anderson – D. A. Davidson.

Reed Anderson – D.A. Davidson

Couple of questions, I had to jump off the call for a little bit, so I may have missed this and I apologize if that’s the case, but first of all in terms of the cost reductions, Ed you talked about that they were I think you said 30% more than you anticipated or laid out for people. Was that more a function of timing or was it also a function of obviously seeing more opportunity once you got inside there?

Edward J. Bramson

It was a little bit of each, Reed. When it actually, if you look at Exhibit C on the back of the release. We did accelerate the timing somewhat. We also actually have increased the total amount we're looking for. I think at the end of the second quarter, we’d said $58 million and with a little more work, we’re now looking for $64 million. And we did in fact take a little bit of extra restructuring charge to get there. So we did do it sooner, but we're also doing a little bit more than we originally said.

Reed Anderson – D.A. Davidson

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

Edward J. Bramson

There are some people it’s some more facilities savings it’s really all across the board.

Reed Anderson – D.A. Davidson

And from a timeframe like when we last, when you first rolled it out, I think the anticipation was we’d get most of this kind of in place by the end of March or first quarter. Does that still make sense for the additional amount you’ve identified as well?

Edward J. Bramson

Yes there’s a little bit of run over into Q2 but by far the majority of it will still be done by March.

Reed Anderson – D.A. Davidson

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

Edward J. Bramson

Well also that knowing Ken commented on it, and basically I think the agreement is an extension of what we had before. So I don’t think there are major changes positive or negative and I think the big thing it does is that, as you know a lot of our turnaround next year hinges on getting the direct business ramped up with new products and some new marketing programs and a key part of that is the ability to have consumer financing for the people who want it. So I'd say in that sense it's good news. And then perhaps Bill or Ken would like to amplify on that.

Ken Fish

One thing to have in mind is that the relationship with HSBC has been long-term with Nautilus and we have a current agreement that goes through the end of the year. So, we were really negotiating an amendment that extended the relationship for another five years so there was nothing specific on the negotiations that impacted the sales in Q3. It was more of just extending the current relationship. Clearly the overall economy and the lowering credit scores for consumers did have an impact as far as those people who where being approved. But that was more of the economic driven rather than anything specific on the negotiations of the extended agreement.

Reed Anderson – D.A. Davidson

But was it I guess coming out of Q2 though, when you had to back away from subsidizing the financing and so that's why it was down so much. What I was trying to link together was that why is that still a big piece of what's going on here is because you weren’t subsidizing? You're kind of this transition where they're kind of that's the absolute number they wanted to approve and that's why it's down so much? That's what I was getting at.

Edward J. Bramson

Well I think there was some reduction because we did stop subsidizing financing. I'd say the biggest single piece is really the economy and then you've had, as Ken said, a little bit of a drop in credit scores and we don’t really control this, but I think our sense would be that also HSBC has tightened up their standards. Would you agree with that, Ken?

Ken Fish

Yes, definitely somewhat.

Reed Anderson – D.A. Davidson

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

Edward J. Bramson

Of the leads that we're getting, I think we talked about this on the second quarter call, the price for the leads that we're getting in terms of advertising costs, has actually been fairly good compared to what you would expect. And that's been continuing to trend that way. The problem is, and it's to a large extent, the credit quality problem. The number of leads that are converging isn't where we want it to be and that's what we need to get back up.

Operator

Your next question comes from Eric Wold – Merriman Curhan Ford & Co.

Eric Wold – Merriman Curhan Ford & Co.

I guess that's me. A couple questions, one you talked about how the inventory is down in Q3 and inventory's expected to be down year end versus Q3. Could you talk about kind of the make up of your inventory, in terms of commercial products versus direct retail and kind of the health of it and anything in there that older products or is everything pretty much up to date?

William D. Meadowcroft

Yes, there's still, as we are transitioning out of Tulsa, there will be a lot of opportunity there for the commercial reduction. We've had significant raw materials there to continue the production of the cardio, and as you know some products will be going offshore and so that will lessen some of that. We've also done a good job in the retail business of cleaning up the inventory and having a very clean set of inventory there. And then in direct it's also clean; it’s a matter of us selling through. Obviously we, with sales down, there's opportunity to sell what we've got but at least it's all A quality stuff; it's just a matter of making sure that we've got the volumes flowing to continue to reduce the direct inventory.

Edward J. Bramson

As comment I would say the biggest opportunities are in commercial and within that the international piece we're managing tighter than we used to so probably that's the largest opportunity overall in commercial.

Eric Wold – Merriman Curhan Ford & Co.

Perfect, and one follow up question, there's a press release out yesterday by Dick's Sporting Goods about they're going to beef up their product offering in doing it at a kind of a big push with LifeFitness, store within a store experience ahead of the of the Thanksgiving holiday. How does that mesh with your announcement last December with an integrated partnership with Dick's to launch this fall. Is that going to be coinciding? Is LifeFitness taking the place of Nautilus, how is that going to work?

William D. Meadowbrook

The LifeFitness arrangement is a result of Busy Body and Omni Fitness and their issues so, Life needed a partnership up into the northeast I think Eric] you noticed it was all pretty much northeast related. We continue to grow in our relationship with Dick's and in fact see an increase of probably 250% in revenues this year versus last year, probably about $6 million to $15 million as a result of the relationship that we do have. But we did not go forward with that actual store within a store concept but continue to have a very strong relationship with Dick's at this time.

Operator

Your next question comes from Rommel Dionisio – Wedbush Morgan.

Rommel Dionisio – Wedbush Morgan Securities

I wonder if you could just, two quick questions, first could you comment on how the drop off in raw material prices commodity cost benefit and freight costs benefited you in the Q3 and maybe the outlook going forward on that, and then the follow up

Edward J. Bramson

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

Rommel Dionisio – Wedbush Morgan Securities

Okay, and just a follow up question you know, I know you guys – direct was one of the channels that you wanted to focus on obviously as a growth platform for the company going forward maybe pull back a little bit on the retail side. But just given that the macro environment has obviously changed pretty dramatically, has that changed your view there just from big picture perspective in terms of the direction you want to take the company over the next couple of years.

Edward J. Bramson

I would have said not. I mean if you think about direct the advantages of it are that it’s very, very capital efficient so you can grow without absorbing a lot of capital. And I think the thing that we also have focused on if you look at the cost of getting a lead, it's actually continued to be pretty favorable and actually even maybe going to get a little bit better.

The key really is getting the conversion up, which as we were saying on last quarter's call, has to do principally with getting the price points within the financing that people can afford is what we are working on. So though I still think, although we are not ignoring retail which is doing quite nicely as you can see, that the real upside is still on direct.

Operator

Mr. Bramson, there are no further calls at this time please continue with your presentation and closing remarks.

Edward J. Bramson

All right, well thank you very much everybody. Obviously it's Election Day so you have other things on your mind, but if you do think of subsequent questions please do give probably Bill is the best person to call, and we'll look forward to speaking with you on the fourth quarter call, perhaps with some better news.

Operator

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.

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