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Trying to get the straight story (or the story straight!) on
As evidenced by inaccuracies in CFO Rod Rice's biography, you can't count on the company's
filings for clarity. That's especially true when it comes to disclosures about royalties paid to the inventor of Bowflex, Tessema D. Shifferaw, and, in turn, to Nautilus CEO Brian Cook and former director Roland Wheeler.
Disclosures regarding those royalties contain unexplained inconsistencies and numbers that simply don't add up. And as I discovered after interviewing Rice, don't expect him to help you figure it out, either.
Take the disclosure about who pays the Bowflex royalty to Cook and Wheeler.
According to the company's IPO prospectus and proxies for the years 1999 and 2000, the company pays 3% of Bowflex net sales to Shifferaw. In turn, through a separate agreement from 1992, according to the disclosures, Shifferaw "is obligated to pay" Cook and Wheeler each 20% of annual royalties above $90,000. Cook even "emphasized" in an interview last August with the
Business Journal of Portland
, Ore., that the money comes from Shifferaw, not the company.
'The Important Issue'
Enter Nautilus's latest proxy, filed in April. Instead of saying that Shifferaw "is obligated to pay" Cook and Wheeler, as had been the case in prior-year disclosures, the proxy doesn't specify who pays their royalties. Three days later, in an earnings conference call, an analyst raised the issue about who pays the subroyalties. After an exchange with Rice, the analyst said that it was his understanding that "the company is paying the CEO and the former board member directly."
"Right," Rice responded.
Lo and behold, the actual agreement between Cook, Wheeler and Shifferaw says that Shifferaw "instructs the company to pay" Cook and Wheeler.
Rice conceded the same thing to me in an interview Wednesday. But when pressed on why the disclosure was changed, he said, "The important issue here is not who pays who. The important issue is did we disclose the amount paid to Cook, and we have -- to the exact dollar."
But why were the disclosures changed? Rice again avoided the question, saying, "The issue of disclosure is did we accurately reflect how much they earned, and we did that to the dollar."
Asked yet again why the disclosures were changed, Rice replied: "I try to focus on the important issues. Did we show what Brian Cook earned? ... That's the important issue; I think the issue of who pays who is not the important issue here."
Glad we cleared that up.
Next question: Why do SEC disclosures say the royalty payments to Cook and Wheeler are calculated after $90,000 in royalties, when the original agreement says $70,000? Rice responded that Cook, Wheeler and Shifferaw struck a side deal agreeing to boost the amount to $90,000. Why wasn't that disclosed to investors? "According to our attorneys," Rice said, "that
agreement is not with the company, so we didn't have to file that." Since when don't investors need to be apprised of changes and amendments on a related-party transaction? (Any other side deals we don't know about?)
The discrepancies don't end there. In 2000, according to a calculation Rice directed me to do, Nautilus apparently began disclosing the
royalty payable to Shifferaw; previously it listed the
royalty due him. It did so without changing a word of the disclosure boilerplate.
Why did the company make that change? Rice would only say the disclosures are sometimes written differently.
Even accepting the switch on the Shifferaw royalties to a net number from the gross, it's hard to make sense of the royalty figures. For 2000, Nautilus said in its proxy that it had paid Shifferaw around $2.9 million in net royalties. At the same time, according to the proxy, payments to each Cook and Wheeler were $939,572 -- reflecting payment to each of an amount equal to 20% of the gross amount due Shifferaw, according to the 10-K.
But if you add the $939,572 paid to Cook and Wheeler each to the $2.9 million the company claims it paid Shifferaw, which is the calculation Rice said I
be doing, the total is $4.779 million --
the $4.837 million Nautilus claims in the 10-K to be Shifferaw's full Bowflex royalty in 2000 (and which also happens to be the amount Rice said I would get when I did
Why the discrepancy?
When I first asked about it, Rice blamed the difference on "rounding," which he said is "common practice" in the industry. Later, when I again asked the question -- this time to the company's outside investor relations representative, who subsequently became the intermediary between the company and me -- I was told the discrepancy was due to an "overstatement" discovered in the 10-K before the royalty was paid. It wasn't corrected, the company says, because the overstatement wasn't deemed material.
But wait -- the original royalty agreement with Shifferaw says payment should be made by 30 days after the end of each quarter. How could the supposed overstatement have been caught
the royalty had been paid when the 10-K came out
the royalty was supposed to have been paid?
Good question. The next day the spokeswoman called to "correct what I told you earlier" about the difference being an overstatement. After "additional research" with the company's lawyers and accountants, she said, the correct number is the $4.779 million I arrived at by summing royalties listed in the proxy -- not the $4.837 million total from the 10-K. The 10-K, she explained, "is filed first, and according to GAAP, at the time it's filed first, it's an estimate. So it's perfectly acceptable for the two to be different."
How can it have been an estimate if the 10-K, which arrived three months after year-end, was audited? According to forensic accountant Paul Regan of the CPA firm Hemming Morse, not speaking about Nautilus in particular: "By the time they do the 10-K they should know what the royalty was." And if it were an estimate shouldn't there, at the very least, have been a footnote explaining that it was an estimate?
(What's more, how could it be an estimate if the same number was repeated a year later in the 2001 10-K as the amount paid in 2000? Shouldn't they have known the correct number by then?!)
And if the difference was, indeed, the result of having been "an estimate," why did the company originally tell me it had been an overstatement, a position that itself marked a revision from Rice's earlier comment that the difference was due to rounding? According to the spokeswoman, "When they first looked at the numbers they assumed it was an overstatement," until they checked with the accountants and attorneys. (But Rice is the CFO! Shouldn't he have known?)
Add It Up
That's not all: The company claimed in the 10-K that the total royalty paid in 2000 on
products was $4.979 million. However, on the fourth-quarter 2001 conference call Rice was asked what all non-Bowflex royalties were for 2000. He said $350,000; he even confirmed the number when the analyst asked if he was sure.
Well, consider this: $4.979 million
$350,000 is about $4.629 million --
the $4.837 million the 10-K lists in 2000 Bowflex royalties due Shifferaw. What accounts for the discrepancy? Rice didn't have an immediate answer. After I pressed the issue via emails and phone messages, the spokeswoman, after checking with the company, told me that Rice had made a mistake on the conference call because the real non-Bowflex royalty number for 2000 was $142,074. Subtract
from $4.979 million and, by golly, you get $4.837 million -- down to the penny.
The only trouble with
explanation is that a day
the spokeswoman called saying that the $4.837 million had only been an estimate, and was, in fact, not the real Bowflex royalty number. (A number, I repeat, that was used as
royalty number for 2000 in 2001's 10-K, as well.)
Confused? You're not alone. Something sure doesn't add up.
Herb Greenberg writes daily for TheStreet.com. In keeping with TSC's editorial policy, he doesn't own or short individual stocks, though he owns stock in TheStreet.com. He also doesn't invest in hedge funds or other private investment partnerships. He welcomes your feedback and invites you to send any to
Herb Greenberg. Greenberg also writes a monthly column for Fortune.
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Brian Harris and Mark Martinez assisted with the reporting of this column.