Nautilus, Inc.
Q2 2020 Earnings Call Transcript

Published: 11 Aug 2020

[Operator:]

Greetings and welcome to the Nautilus Incorporated Second Quarter 2020 Earnings Results Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Ms. Deirdre Thomson of ICR. Please go ahead, Ms. Thomson.

[Deirdre Thomson:]

Thank you. Good afternoon, everyone. Welcome to the Nautilus' second quarter 2020 conference call. Participants on the call from Nautilus are Jim Barr, Chief Executive Officer; Aina Konold, Chief Financial Officer; Chris Quatrochi, Senior Vice President of Product Development; and Bill McMahon, Special Assistant to the CEO. Please note this call is being webcast and will be available for replay for the next 14 days. We will be happy to take your questions at the conclusion of our prepared remarks. Our earnings release was issued today at 1

[Jim Barr:]

Thank you, Deirdre. Good afternoon, everyone. And thank you for joining today's call. I'm incredibly proud of our second quarter results and the truly amazing efforts from our team to achieve them. Operational improvements that we implemented in late 2019 are beginning to bear fruit. We built on our Q4 2019 change in trajectory by delivering in Q1, our first positive comp in over two years and now in Q2 producing these extremely strong financial results. Despite being supply constrained for the entire quarter, our net sales nearly doubled, up 94% year-over-year. This makes it our best year-over-year growth since becoming a public company. Our best second quarter in over a decade and one of our top quarters period in our long history. Gross margin rate expanded almost 1,200 basis points to 42%. And most importantly, adjusted EBITDA swung to positive $25 million from negative $10 million in the year ago, quarter markedly improving our liquidity to fuel our short and long-term growth opportunities. We did not experience the second quarter seasonal decline that we typically see with demand strongly accelerating from Q1 levels. Our performance was driven by accelerated demand of at-home fitness due to COVID-19 gym closures, broad growth across both segments in our consumer-focused brands and products and excellent execution in response to what proved to be a full sustained quarter of enhanced demand. In addition, despite incredible efforts in our supply chain and a dramatic increase in our manufacturing capacity, we ended Q2 with $34 million in back orders. While we wish we could have satisfied even more customers, this gives us a nice start to Q3. Next, I'd like to remind everyone of our company's priorities, as we navigate the extended COVID-19 pandemic. Our first priority remains the health and safety of our employees and partners. I'm happy to report that to our knowledge, none of our approximately 500 employees has tested positive to-date. Second, our mission and culture drives us to deliver for our customers, especially in their time of greatest need. In response, we massively expanded production capacity and supply chain throughput. Our distribution centers, customer care, and the rest of our operations remained open and at elevated levels of activity, throughout the quarter. Third, we are leveraging all our capabilities of our assets, including strength of our brands, our quality products, and our omnichannel model to make the most of the at-home fitness tailwind. We want to maximize this opportunity and have responded well in the short-term. And while doing so, we have built confidence, new skills, capabilities, and attracted new customers to the company that I believe will serve us well in the long-term. I'll cover some of these with specific examples in a moment. Finally, while we were delivering strong, short-term results, we also remain focused on the importance of the long-term transformation of our company. We are continuing to fix the underlying issues that led to our multi-year decline, topics that we've highlighted previously. And we've made significant progress on our insights driven, long-term vision and multi-year strategic plan that I've mentioned in the quarterly call since I arrived a year ago. We have already delivered several elements of this plan and some of the growth from them and believe that our long-term opportunity has been enhanced by the events of the quarter and the anticipated continuation of the at-home fitness trend. While our results were undeniably aided by the tailwind from gym closures, the main character of our Q2 and first half performance story is our team, their resilience, agility, and incredible response to unexpected challenges and opportunities. I would like to share some examples of the remarkable response this past quarter. They include expansion of production and supply chain throughput, agile and decisive actions to drive profitability, investing in our omnichannel approach and retailer relationships, accelerating progress on our own websites and keeping our 2020 new product launches a major step in our transformation on track despite logistical challenges. Our supply chain from manufacturing to logistics did some incredible work to respond to accelerated demand and a rapidly evolving outlook of the likely duration of COVID-related impacts. As the quarter unfolded and we saw sustained elevated demand. We moved to massively increased production capacity and supply chain throughput. For example, in the quarter, we saw an incredible 500% increase in IC bike production capacity. To do this in our asset-light manufacturing model requires having built long-term partnerships and good will, which can then be leveraged at a time like this. We are grateful to our production partners and suppliers who themselves responded admirably and with agility to profound and unanticipated levels of demand. On top of enhanced production capacity, we increased the flow through of inventory through outstanding execution and planning, purchasing, and inbound logistics. Our team worked quickly to find solutions to get our goods from manufacturers to the ports, despite COVID-19 restrictions, and then secure the quickest vessels to get the product to our DCs. We fast boated over half of our containers this past quarter to help close Q1 back orders. Once the product was at the port, the team used a variety of strategies to reduce the lead time from port to customer, including cross-docking at the port and extra shifts in the DCs. To illustrate the overall improved throughput, though, the second quarter is typically our lowest volume quarter. We shipped about the same volume in Q2, as we did in Q4 of 2019. Our management team also made key agile decisions to drive profitability. For example, we took reasonable price increases on key high demand products. We sharply decrease the proportion of unit sales on promotion, leveraged our current and anticipated volume to gain cost improvements from suppliers and cut back on media spending. We continue to invest in the long run health of our omnichannel approach, utilizing an allocation decision framework intended to balance inventory between direct and retail segments. We leverage retail partners to provide our customers with greater ability to engage with and buy our products, when, where, and how they prefer. This quarter, our retail partners also experienced elevated demand for our products as well as acceleration of their own digital transformations from changes in consumer behavior that I believe will have lasting benefits for us. Both our retail partners drove growth through curbside pickup capabilities that did not exist before the pandemic hit. And they accelerated the growth of their fitness categories on their dotcoms. We believe trends accelerated in the pandemic will have long-term benefit for Nautilus by reducing traditional barriers, such as floor space constraints and price point ceilings of brick-and-mortar retail. We also use the moment to build relationships and gain greater scale with new retail partners. A new retail customer, Best Buy quickly rose to become a top retailer in sales volume in the first full quarter of offering our products on their website. Our own websites saw a 300% increase in visits driven by an amazing 700% increase in organic traffic, as consumers sought out our brands and our products. To capture this demand, our websites added improvements in SEO, content, ability to take orders with longer extended promise periods, lead capture for out-of-stocks and in-stock notifications and ways to promote slower moving products. While we pulled back on television advertising, we continued investing in digital channels, such as search and social media. We also saw disproportionate growth in new customers, introduced to our brands and products. Finally, we overcame restrictions in travel and working face-to-face to keep our 2020 new product roadmap builds associated advertising production and overall launch plans largely unscheduled. I'm excited to tell you more about our 2020 new products shortly. Before I turn the call over to Aina, I thought I would cover one other topic. In such an unusual time where people's lives have been altered so significantly and industries, including our own have been changed so profoundly. What will the impact be? Given how rapidly the situation is evolving and that typical seasonal trends have proven less relevant in predicting the future. No one can answer such questions with any degree of certainty. But I thought it might be helpful to share how we're thinking about our business for the rest of the year and into 2021. Based on what we've seen so far and the assumptions underlying the decisions to this point. We believe that a component of the COVID effect on our business is undeniably temporary, as gyms open and their capacity increases over the next 12 to 18 months, demand for our products will likely decline from the current elevated levels. However, we believe there's another portion of the COVID impact that is longer term, and perhaps even permanent. In our own research, 12% to 25% of gym-goers are saying that they will never go back to the gym. They will focus on other solutions, including home fitness permanently. We also believe that a portion of those who say they will eventually return to gyms either because they think it's safer sometime, or when there's a vaccine will rely – will not rely 100% on the availability of their gym. They were caught without options when the gym closure orders began and felt a loss of control in an important aspect of their life. In their new normal, we believe they will invest in home fitness solutions as a hedge against another outbreak and will balance their workouts between the gym and home differently than they did before the pandemic. Digital solutions will help by bringing aspects of the gym experience home. Further, the supply of available gym membership options will likely be at least temporarily disrupted because unfortunately some of the gyms will not survive. Due to these factors, we think the at-home fitness market will experience important growth. The size of the gym membership market is roughly 10 times that of the at-home fitness equipment market. We have already seen evidence of movement from the former to the latter and envision a less defined boundary between the two. Thus, companies like Nautilus, who are well-established in the at-home market and have strong brands in a portfolio of leading products, should have an enhanced opportunity. There are clearly barriers to capturing the incremental demand, such as short-term supply availability, readiness of respective solutions to meet the needs of gym-goers and fierce competition, including some upstart competitors. Longer term, important factors such as reliable products, well-known brands and strong established go-to-market solutions will play an important role. The situation is highly uncertain and rapidly evolving, but has already impacted our inventory and supply planning, our go-forward strategy, our product development roadmap both physical and digital and our investment posture. We will keep reading the market and will evolve as the situation develops. With that, I'd like to turn it over to our CFO, Aina Konold, who will go over financial results in more detail. Aina?

[Aina Konold:]

Thank you, Jim, and good afternoon, everyone. As Jim mentioned in Q2, we saw a significant surge in consumer demand for our high quality home fitness equipment. Record setting traffic to our websites and continued strong orders from our retail partners reflect the power of our brands. We're also quite pleased about the expansion on a gross margin rate, a key metric we focus on as we make progress on our path to sustainable profitable growth. I'll begin today by speaking to total company P&L results for Q2 2020 with comparisons to Q2 2019. As a reminder, we've hired William Blair to help us with the sale of Octane Fitness, our commercial-focused business. As a result, this quarter, we recognize a loss of $29 million on the disposal group. In Q2 last year, we booked a $72 million impairment of goodwill and other intangible assets. Both of these non-cash charges are included in operating expenses. The P&L that I'll be speaking to now is adjusted to remove the impact of both of these one-time significant charges. Please see our press release on our website for reconciliation of these non-GAAP numbers to our GAAP reported results. Net sales almost doubled to $114 million compared to last year’s $59 million. As Jim noted earlier, this is the best Q2 sales result in the past decade. The meaningful uptick in our sales trajectory is a result of our team's ability to rapidly pivot and take advantage of the surge in demand that began in March, when stay-at-home orders first went into effect. Our team quickly rebooted our supply chain once China eased COVID-19 restrictions and then they accelerated it, increasing output on some of our bestselling products by about 500%. Although, we significantly increased production capacity and we invested in expedited shipping costs, supply was still insufficient to meet demand in the quarter. Our most popular products have been on extended promise periods on our websites and out-of-stock in our retail partners. We entered Q3 with over $34 million in backorders and are pulling all levers to get products to our customers as quickly as possible. Gross margin rate increased by almost 1,200 basis points to 42%, gross profit was $47 million, $30 million higher than last year. Strong execution across both segments was a key driver of the increase, favorable mix was also a factor. Direct was 44% of sales this year versus 35% last year. And for the first time since Q4 2017, we had year-over-year growth in sales of our higher margin Max Trainer line. In COGS, we saw leverage on fixed costs, offset by continued pressure on product landed costs. Products we import from China are subject to a seven and a half tariff versus no tariff last year. And we've continued to incur extra fees to expedite shipments. And lastly, overall shipping costs are rising, driven by lower supply as ocean carriers have reduced the number of sailings. Adjusted operating expenses were 18% lower, declining to $25 million or 22% of net sales. Selling and marketing expenses were down 29% to $12 million or 11% of net sales compared to $18 million or 30% of net sales. The decrease in expense was primarily in advertising, as this year, we spent $2 million versus $7 million last year. Customer acquisition costs were meaningfully lower as the company pulled back on paid advertising, given strong organic demand and inventory scarcity. R&D costs were down 3% to $4 million or 3% of net sales compared to $4 million or 7% of net sales last year, driven by lower maintenance expenses related to our JRNY Digital Platform. G&A expenses were basically flat at $9 million, 8% of net sales this year versus 16% last year. Adjusted operating income was $22 million, $35 million better than last year, driven primarily by increased gross profit and expense leverage. Adjusted income from continuing ops increased to $17 million or $0.56 per diluted share, compared to last year's loss of $10 million or minus-$0.33 per diluted share. Adjusted EBITDA from continuing ops improved by $35 million. We delivered $24.7 million of adjusted EBITDA this year compared to a loss of $10.5 million last year. Turning now to Q2 2020 performance by segment. I'll be comparing this year’s Q2 results with last year's Q2 results. Net sales in the Direct Segment were $50 million, up 142%. After years of these sales declined, this is the second consecutive quarter of sales growth for direct. Higher sales were driven primarily by cardio, which grew 183% driven by the Bowflex C6 and Schwinn IC4 bikes and our Max Trainer. Direct entered Q3 with $21 million in backlog, compared to $8 million at the end of Q1 2020. Gross margin rate rose to 55% versus 43% last year, driven by favorable product mix offset by higher landed product costs. Gross profit was $28 million, $19 million higher than last year. Segment contribution was $17 million compared to a loss of $6 million last year. The improvement was driven by increased gross profit and a $4 million reduction in media spend. Turning now to Retail segment results. Net sales were a historic $63 million up 68%. Q2 2020 is this segment’s second highest quarterly sales in history, second only to Q4 2019. Cardio sales were up 88% driven by the Schwinn IC4 bike and Max Trainer. Strength product sales were up only 22% limited by inventory scarcity of SelectTech weights and benches. Importantly, if we exclude sales related to our commercial focus Octane brand, Q2 2020 net sales for the retail segment grew 95% versus Q2 2019. Retail's backlog at the end of Q2 was $14 million compared to $6 million at the end of Q1. We disposed retail customers whose sales are greater than 10% of total company net sales. This quarter, Amazon accounted for 18% of total company net sales. Gross margin rate was 30% up from 21% last year, driven by favorable sales mix offset by higher landed product costs. Gross profit was $19 million, $11 million higher and segment contribution was $12 million, compared to break even last year, the improvement driven by higher gross profit. Turning now to other Q2 highlights. We've grouped the assets and liabilities associated with Octane into current assets held for sale and current liabilities held for sale on the face of our balance sheet. Please see our press release on our website for more detailed regarding this new presentation. Strong sales growth and great flow-through to earnings resulted in a much stronger balance sheet at the end of the quarter. Cash was $48 million and debt was $15 million, compared to cash of $11 million and debt of $14 million at year end. We had $29 million available for borrowing in our Wells Fargo credit facility. AR was $34 million, 38% lower than $55 million at year end, the decrease was due to the timing of customer payments and certain receivables included in the held for sale disposal group. Trade payables were $45 million, 39% lower than $74 million at year end, primarily due to timing of inventory payments and reduced advertising related payments. Capital expenditures were $5 million year-to-date. Inventory was $21 million compared to $55 million at year end, the decrease is due in part to $12 million of inventory being reclassified into the held for sale disposal group and the surge in demand that began in mid-March. Our Q1 ending inventory would have been more in line with a seasonally normal Q2. Our team's ability to ramp up our supply chain is what allowed us to meet the increased demand in the quarter. We accelerated factory output and decreased lead times from port to DC by FASB boarding containers, cross-docking IC bikes at the port and adding extra shifts at the DC to process volumes more in line with Q4 versus Q2. To secure factory capacity, we routinely issue non-cancelable POs for expected inventory purchases in the next 12 months. These obligations are disclosed in our 10Qs. At the end of Q2, we had about $128 million of non-cancelable purchase obligations, compared to $20 million last year and $35 million at the end of Q1 2020. Turning now to our expectations for the rest of the year. We are operating in a highly vaulted environment and like other companies in our industry we are trying to determine the magnitude and duration of the current at-home fitness trend. Our perspective on the duration of this elevated consumer demand depends in part on how long gyms will be closed and/or capacity constrained and when customers would be more comfortable returning to their gyms. Given this uncertainty, we're not providing specific guidance for the back half of the year. But we do want to give some color on trends that we're seeing and how they've affected our plans for the back half. First, we believe that in the near-term, consumer demand will continue to be elevated relative to pre-COVID levels, and that the new JRNY connected products that we're launching in the fall will be met favorably. Our confidence is reflected in the significant increase in our inventory commitments. That said, constraints in our supply chain could limit our ability to fulfill all of the demand in the back half. And until a vaccine becomes widely available, we remain concerned about unforeseen disruptions to our supply chain. In Q2 COVID-19 restrictions affected sailing schedules and port working hours, creating uncertainty in our delivery schedules and making it more difficult to predict when customer orders could ship. We anticipate this difficulty to continue through the rest of 2020. Second, given the imbalance in demand and supply, we expect continued cost pressure and logistics versus last year which puts pressure on our gross margins. Ocean shipping providers continue to constrain supply and rates have been rising. And our logistics partners in the U.S. have already told that the shipping capacity will be severely constrained in the upcoming holiday season. We expect to incur increased cost to secure delivery slots for our goods. Third, with regard to operating expenses. We plan on spending more on marketing in the back half in support of our new product launches. So are not expecting the same level of year-over-year expense leverage that we saw in Q2. Finally, we are reiterating our full year capital guidance range of $8 million to $10 million. In summary, we are pleased with the sales momentum in the business and how our team has responded to the surge in demand for at-home fitness. We're proud to have delivered another quarter with results, but as Jim has mentioned, we are still in the early stages of our transformation and anticipate that the way forward will not always be smooth. We continue to balance delivering improved short-term results with making the structural changes required to return Nautilus a sustainable profitable growth. I look forward to sharing our progress with you in next quarter. Now, I'd like to turn the call back over to Jim for his final comments. Jim?

[Jim Barr:]

Thank you, Aina. We're certainly pleased with the superior results in the quarter and the improvements we are making in our business. However, we must remind ourselves that some of the underlying challenges in our business remain and the operating landscape is highly uncertain due to the COVID-19. While we were delivering historical Q2 financial results, our management team was also dedicating significant time and energy on our transformative long-term strategy work. As you can see from our recent announcement to explore the sale of the Octane Fitness, we are making important strategic changes to our business. However, it's important to remember that transforming a company doesn't happen overnight. And even though we're making strong recent progress, that this will be a long process and there may not always be a quarter-to-quarter linear progress. As a proof point to our continued focus and our long-term priorities, we are poised to launch an innovative and exciting lineup of 2020 new personalized connected fitness products and services. You will see more details on all of these in the coming weeks as we roll them out. But I'm delighted to give you a quick overview, so that you get a sense of where we're going. We have seen a surge in demand for strength products, and we have already added to our strength category with a launch at the Bowflex, SelectTech 2080 Barbell and Curl Bar set and new benches. Our customers cannot get enough of many of our strength products, including SelectTech. The 2018 sold out in less than 24 hours on bowflex.com and we're working hard to get them back in stock. Nautilus is on a quest to become a more digital company where physical equipment, content and software come together to deliver an experience that could not have been imagined several years ago. As such, we will launch an improved experience on JRNY, our personalized connected fitness digital platform. JRNY will feature an updated user interface, new content, including a more robust library of on-demand streaming workouts and integration of Explore The World and Apple health. Most importantly, we have integrated it into more products, so that the JRNY experience is available on more modalities and to more customers. Often the first piece of equipment bought for home fitness is a treadmill, it's most easily understood modality. Thus, we are super excited to launch three new connected fitness treads with different sized screens and loaded with JRNY, weight, there is more. The Max Trainer is a modality we invented, a unique and patented combination of an elliptical and stepper that gives you an excellent workout in as little as 14 minutes a day, and takes up half the space in your home that a tread does. It is one of our all-time best sellers having sold 100s of 1,000s of units. The sales declines the company suffered in the last few years were in part driven by the transition of the Max from high volume hero product to low volume later in its life cycle. We believe this product – we believe in this product and we're betting that an immersive digital experience delivered via JRNY will modernize and make the Max even better. So we're launching two rejuvenated Max Trainers with screens and JRNY embedded. Finally, we've seen tremendous demand for our bikes. We launched the first Bowflex bike, the C6 and the first Schwinn connected bike, the IC4 late last year, both bikes were instant resounding hits pre-and-post-COVID. Therefore, we're launching three new bikes with embedded screens and JRNY, including some that will deliver a very special differentiating surprise that I wish I could show you now, but I don't want to steal the thunder of our launch activities. These new products will be added to our already robust product portfolio. We relate to connected fitness, but have taken another important step in 2020 with these launches. In just two years, we will have increased the mix of units, which offer connected fitness from single-digits to a strong majority of our portfolio. This gives our customers the best possible modern at-home fitness experience, gives us greater ability to deliver on our mission to help people live healthier lives through fitness and fuels our growing membership business model. I'm tremendously excited to see these products hit the market, especially in the midst of the at-home fitness trend. I have just a few more comments before I end my prepared remarks. Last week marked my one year anniversary with Nautilus and I found myself taking stock at what's been a truly remarkable year for our company. When I joined the company was in the middle of a difficult year, we had missed some important market trends, we’re suffering from incompletely and undiagnosed problems and constrained resources. And we were delivering poor financial results. I knew we were in for a multiyear turnaround, but I was excited and energized that the company had most of the important ingredients it needed to return to its leadership position in the fitness industry. One year later, I believe this more than ever. 2019 was a year to forget with the company continuing a multi-year sales decline losing over 20% of its revenue base, that resulted in an operating loss of $100 million. We had cut 13% of our workforce to survive, and we had lost our confidence, but our people were resilient, gaining experience at managing through crisis and remained passionate about our noble mission. Q4 2019 ended with a moderate change in trajectory, and some reason for optimism, we re-launched JRNY and added connected fitness bikes, treads, and the Max total to our portfolio, the bikes gained immediate traction due to their quality and value proposition. We diagnose the root causes of the biggest problems and put early actions against them, which continue today. We secured new financing and hired new leaders in marketing and finance. We also made some bold revisions to our 2020 product lineup. Although, we limped out of 2019, we entered 2020 with renewed optimism. Q1 2020 produced our first top line growth quarter since 2018, the connected fitness bikes continued to sell without the typical seasonal drop-off. We felt COVID-19’s effect first as a supply chain disruptor in China, losing several weeks of production on our new bikes. Then, when COVID-19 began to affect the rest of the world and demand at-home fitness skyrocketed, demand for our quality products turned an already good quarter into a great one. We saw a rush to our quality products and well known brands. We sold through almost everything in our DCs in the last two weeks of March and our supply chain team went to work to accelerate our pipeline. In Q2 2020, we produced historic financial results, fueled by the at-home fitness tailwind for a full quarter, broad growth across both segments and in our consumer focused brands and products and witnessed the team's excellent response in execution. We changed our whole working model shifting to working from home, the team faced many challenges in its new normal, while we were managing a sales volume nearly double last year, we also worked on our long-term transformational growth plan, including important focusing decisions like the difficult one to sell Octane. We are optimistic about our 2020 new products and our improved cash and liquidity position, which gives us greater capabilities and expanded options. I'm proud of our progress, but I'm constantly reminded that we have more work to do on our path to sustainable profitable growth. As I said, at the top of the call, a portion of our results in the quarter were driven by COVID-19 tailwinds. However, the team's execution allowed us to meaningfully increase supply chain output, capture new customers, expand product margins, all while maintaining our cost discipline. And for that, I'm incredibly proud to be part of this company and to be teammates of such dedicated individuals. I want to, again, thank our employees and partners who stand committed to our mission, even during these difficult times. And I'm excited to begin my year two. And now, I'd like to open the call up to your questions. Operator?

[Operator:]

Thank you. We will now be conducting a question-and-answer session. [Operator Instructions] The first question is from Steve Dyer, Craig-Hallum. Please go ahead, sir.

[Steve Dyer:]

Good afternoon, congratulations and – on the terrific results.

[Jim Barr:]

Thanks, Steve.

[Steve Dyer:]

Just I guess as you look at sort of revenue or capacity in the near-term, I know you didn't give guidance, but I mean, is it reasonable to think kind of Q2 is best case scenario. I mean, you started with a backlog, ended with a backlog, didn't start with much inventory, didn't end with much inventory. I mean, you were clearly going sort of full out, is it reasonable to think that's kind of a best case scenario right now, or are there puts and takes that we should consider?

[Jim Barr:]

Yes. I'll start and then I'll ask Aina to jump in. So it's a great question, Steve. And of course, we're trying to figure this out. As we talked about last quarter, you've got two things going on at the same time, you've got a demand that continues to be extremely high, and then you have a response in supply. Our demand – our view of demand is it will continue as I said in my comments. On supply side, it has a lot to do with how well we match supply and demand, how well we anticipate these types of things. We're – I will also say on supply we're learning and growing, I would have never thought that we could increase our bike capacity by 500% within one quarter. I just didn't know that was a capability. And so I'm learning what we're capable of, and we're still looking at that as we continue moving forward. I will tell you that one thing you can look at is the – is our commitment and our balance sheet commitment of $128 million, because that gives some view to where we think things are going. But every day, this changes, both the supply and the demand side and our ability to match those things and it's pretty tricky as you might imagine to get it, absolutely right. We've definitely already kind of made our bets for Q3 and we're pretty locked and loaded on what we're ability to – our ability to deliver in that particular one. But Q4, by the end of Q3, what we have done in terms of increasing our capacity even further, we'll bring on some second suppliers and things like that during this quarter and we'll continue to increase that capacity. Obviously, first thing you do is with your existing suppliers, you add new lines and you get that to happen and they have to invest with you to get those new lines. And then if that's not even enough, then you have to go to second supplier to actually implement and add to that, so – augment that. So there's so many – it's hard to tell, but we're pretty optimistic.

[Aina Konold:]

The only thing I'd add to that is, you said it correctly, when you first looked at it, if you're coming in with low inventory, it may seem difficult to ramp up, but we showed in Q2 that we have the capability to do that. We're very focused on expanding our supply chain and doing what we can through these deals, non-cancelable POs of reserving spots on those existing lines and then continuing to expand them. Hopefully that's helpful.

[Steve Dyer:]

Yes. Very helpful. Thanks. And you raised the price on some of your products during the quarter, particularly the bikes and really kind of a couple of questions around that. One is, did you see any elasticity around that or any sort of noticeable difference after you did that? Where was the demand crush just so much? And then secondly, not just the bikes, but overall, I mean, do you have a sense as to what kind of cancellation rates you're seeing that you're leaving on the table as you ramp?

[Jim Barr:]

Sure. I'll start again and I'll ask Aina to augment anything she has going. But no, we didn’t see any noticeable difference, and we didn't think we would. We had tried a cost – a price increase on the C6 in the first quarter, if you recall, and that was pre-pandemic. And we didn't see any drop, if seasonal or otherwise in that particular demand. And that gave us even before COVID hit, we had a pretty good idea that we might look at, can we raise this a little bit more? It's still such a fantastic value proposition relative to many of the competitors out there. And with an open platform and all that sort of thing, that it really worked well. So we felt that, that would work and we also felt the same thing about the SelectTech 552s, I mean, those things were kind of the new toilet paper and people, we couldn't keep them in stock, so raising that a little bit, we weren't price gouging in any way. We just thought, hey, these things are in high demand and we've got a little room there. So we raised both of those and we saw no decrease in demand. In terms of cancellations, I think it's kind of a function of how long you make people wait. I think given other alternatives in the market, they're willing to wait quite a while. Some of our competitors are out 10, 12, 15 weeks, things like that. So they're willing to wait, they're actually quite happy to be at a spot list and have you committed to fulfilling that need. Occasionally you'll get a cancellation, for example, if we had some IC4s that we had gotten orders from our direct division from schwinnfitness.com, and then all of a sudden, Amazon goes back and stock on those items. People will buy them immediately from Amazon and they'll cancel ours. So you do see some cancellations and we won't likely fulfill the $34 million of back orders dollar for dollar. But a lot of it sticks around because our products are good, our brands are there and people are willing to wait for them. Anything you'd like to add.

[Aina Konold:]

No. I think you covered it Jim.

[Steve Dyer:]

Great. And last one for me, and then I'll pass it along. You talked about all the great new products, there's a ton coming and you talked about sort of throwing some marketing dollars behind that, which I get. Any willingness to sort of quantify that at all? And then maybe how we should think about the split between Q3, Q4?

[Jim Barr:]

I'll just tell you how I think about it and then Aina can answer the numeric question, as far as she feels comfortable doing it. As we didn't need to spend as much on marketing, even in first quarter and definitely in second quarter, I think if you asked our CMO, are you permanently saving it or are you putting it in piggy piggybank for product launches? She would say the latter. And it's probably some combination of the two. I mean, we think we've got some great products that get out there in the marketplace, we fought through producing some what I think are some really good commercials, that wasn't easy by the way to do casting remotely and to go to California and film some commercials just before California closes again and then shift to the New York area as well, on top of that, it was one of those logistic things we fought against. But, the way I think about it, we definitely want to keep that money in the piggybank, because we – it'll be just as it has been, if we don't need to spend a ton of it to sell everything we have, well, then we won't spend it, but if we can really go big, especially on some new products and get them out there. And by the way, there is also brand building too. I mean, that's something in our long-term strategy that we really believe, we haven't done enough of. We've done – we’ve only been able to afford for the last couple of years enough advertising to basically drive transactions and not get our brands to the very best place it could be. So we want to spend a little bit of money on that too. I know it's kind of a non-answer because you were looking for a dollar, but that's just really the framework we have, which is probably the best way we can answer any question in these types of situations. Aina, do you have anything to add?

[Aina Konold:]

The one thing I'd add as I remind everybody that our focus on being really more efficient and effective in a marketing spend started happening in Q4 last year. So when you're looking at year-over-year compares, just be mindful that the improvements in our efficiency already began in Q4 2019, so just something to think about on top of the product launches that we're going to plan to put marketing behind.

[Steve Dyer:]

Well, that's helpful. Thank you both.

[Aina Konold:]

Okay, thanks.

[Jim Barr:]

Thanks, Steve.

[Operator:]

The next question is from Mike Swartz of Truist Securities. Please, go ahead, sir.

[Mike Swartz:]

Yes. Hey, good afternoon guys. Just first question, maybe provide a little context or perspective. I think on the last call you’ve had expected your backlog to go into early to mid-third quarter. So I just wanted to take a step back and look at the backlog where it is today. Is that something you can satisfy during the calendar year? And then related to that, just on the purchase obligations, maybe for Aina is, what percentage of your sales in the back half – do you typically have that kind of line of sight into, at this point in the year?

[Jim Barr:]

So I'll start with the backlog question and then we'll have Aina go to the purchase obligations. So for the backlog, look, we – last time we spoke COVID was still kind of unwinding, like we were just starting to develop. I think, at first we thought, hey, this might be a couple of weeks. And I mean, we in the collective sense of the world, thought it would be a couple of weeks and then we thought maybe it'd be a month. And then we thought it'd be a couple of months. So when we made those statements in early May that we would perhaps catch up in the third quarter, we just didn't see this continue elevation of demand. And so, if you have demand kind of running away from you and in your supply side, you haven't pushed all the levers yet to increase the supply and the output of the supply chain yet, because you weren't quite sure how long it was going to last. Then you suddenly realize, hey, it's going to be longer and that was after our last call. So what we try to do on these calls is give you the best information we have, how we're making decisions at the time. But I'd say within a few weeks of that call, we knew this is going to be a longer-term catch up mode on inventory. And then Aina, do you want to cover the purchase obligations?

[Aina Konold:]

I want to add to the backlog question. I want to just make sure that it's not the same population of backlogs that were there earlier in the year, because we are fulfilling them, but as demand continues to be high and the promise periods are longer, it's almost just, if you think of like something that slides along as the time progresses, I want to make sure I call that out. And then second, when you think about the POs that we've issued what we wanted to do, because although we're not certain how long the high level of demands will continue, we are seeing that they're going to continue for the near-term. So we want to reserve as much capacity as we can. So I don't want you to think that all of this 100 plus million of POs are necessarily for just only Q3. So we’re just reserving as far as we can see in the factories that we work with to make sure we don't run into a constraint. So that's, hopefully will be helpful to you when you're thinking about inventory POs.

[Mike Swartz:]

No, that's great. Thank you. And then Jim, maybe a question on marketing. I know this is kind of an extraordinary environment we're in today and then you haven't had to spend as much as maybe you would have been in a typical year to stimulate demand. But can you talk about maybe some of the underlying tools you're putting in place as far as customer attribution and maybe pack the purchase and any early learnings from that?

[Jim Barr:]

Sure. It's a great question because at some point gravity comes back, right? I mean, it's a – we've – this moment where our cost of customer acquisition has dropped so precipitously, that's not going to persist for years and years and years, so we know we're going back. So your questions are really in the right spot. And that's really, probably the main thing I talk about when I say we still have these underlying issues that we're working on. I know it was great to point out that, kind of beginning the fourth quarter of last year, we really focused on ROI. And we just look at our product portfolio and the hand that we have, and we're smart about how we're – how much money we're going to spend. The second thing is how – what vehicles do you spend the money on? We were two-thirds TV, one-third digital for five years in a row. And every year got worse than the other, I think I've called that the definition of media buying and sanity, so we kept doing that and doing that. Of course you say, just do something different there. So we started to do something different in the fourth quarter, in the first quarter, then beginning in the second quarter, we have a new media buying agency. They are quite a bit more digital than the last one, they come – what comes with it is attribution tools, you're right on it there. Even when things went wrong, we didn't know what part of our spending went wrong, it's the old advertising adage that half of your advertising is wasted, you just don't know which half. We started to get a better idea of that. And so, working with this new agency with their own tools, proprietary tools that help us attribute to TV and to the various digital marketing things, we at least know where – what's working and what isn't. And we do more of what's working in less of what isn't. Then as we moved into the strategic planning process, we did some great new consumer research. We have and we’ll share with you when we talk about the strategy, we have new market segments, we kind of just did a demographic in an age group segmentation, now we’ve done behavioral segmentation and that's super important to our industry. So we're getting a much – we're getting to know our customers, our different types of customers, a lot better than we had before. And then we've done this path to purchase that you mentioned as well. And, we're learning things like most of the time people choose a modality before they choose anything else. So you have to take them on your website and other places from that to the exact right thing that's right for them. We definitely learned that, purchasing products in our – and we knew this already, but it's a very complex decision for people to purchase fitness equipment and spend the money that they do. So we've – we on our website are getting better at making that decision a little bit easier, making the decision clearer to them doing the right kinds of comparisons and things like that. And that's really just the tip of the iceberg. That's really what I collectively say, look, we haven't solved everything yet, right now, we have an amazing media efficiency, ROI, and a low cost of customer acquisition. But eventually that's going to be more normalized. And in the meantime, we have to learn all the things we can to make sure that we're prepared for that moment. So it's a great question, I appreciate it.

[Mike Swartz:]

Thanks a lot for the color, Jim.

[Jim Barr:]

Sure.

[Operator:]

Our next question is from George Kelly, ROTH Capital Partners. Please go ahead, sir.

[George Kelly:]

Hi, everyone. Thanks for taking my questions.

[Aina Konold:]

Hi, George.

[George Kelly:]

So just a couple of questions for you. First, just about sort of the demand momentum, how do you measure what that looks like? And what if you could kind of break it down sort of what you saw as the summer progressed and maybe subsequent to quarter-end? I guess what I'm trying to get at is just, have you seen any kind of slow down or has it really accelerated or what does that momentum, what does it look like?

[Jim Barr:]

You want to start?

[Aina Konold:]

I’ll start. I'll limit our comments to what we saw in the quarter. We didn't really see – we had expected to see a slowdown because as Jim said, we thought it was a little bit more shorter term situation. And maybe most of it had happened already in the first – the last two weeks of March, early few weeks of April. But we did not see really any sort of drop-off in Q2. We were looking for the normal seasonal drop-off. We were looking for sub drop-off when some of the restrictions began to be eased when some people started returning to gyms, but we did not see any drop-off in Q2.

[Jim Barr:]

And I'll just add that, it's tough to completely take supply and demand and kind of pull them apart. Because what ends up happening, let's say, if you're out of stock, out of an item for a few weeks, people that – people stop checking back on that. And so you don't know if that means there's a drop in natural demand or that someone just got tired of checking your website, right. So we see short-term periods of that, but overall, we haven't seen that drop-off in any significant way. And of course, you have to think about Q3 as well as, most of our Q3 activity is in the September timeframe as well. So you can't really draw a lot of conclusions on the early parts, but overall we're just doing our best to get back in stock and as many things as possible and fulfill our backlog. The 552s, we started originally taking a notify me when approach, when we ran out. Because we just didn't want to show him a grayed out button on our website and people were just dying for these things. So we put that in there and right now, we have 300,000 leads to work out, so – work off. So that's one of the main reasons why we're not back in stock on that is because we kind of feel like we made somewhat of a commitment to those people. And we've got to send them notifications as we get each batch in and that sort of thing. So, we're still in that, demands very much outstripping supply. And we haven't seen a significant drop off in any way.

[George Kelly:]

Okay. Okay. And then next question for me, it's just about the retail business. And I remember on the prior call, you had mentioned two new big retailers for the fall. I'm guessing one was Best Buy.

[Jim Barr:]

Yes.

[George Kelly:]

I guess, the broader question is just, I know that you’re supply constraint but are there a lot of kind of unexpected retailers coming to you trying to develop a relationship? What does that all look like?

[Jim Barr:]

The short answer is yes, absolutely. Some retailers that you wouldn't have expected would carry fitness equipment are now deciding, hey, this is so important in our customers' lives and they’re reading their customers behavior. And they're saying, hey, look, I need to start selling this whole category. So they're well-known names and there are some well known names you wouldn't have expected necessarily to carry fitness equipment. And yes, one of the ones we mentioned last time was Best Buy and we've gotten some terrific traction with them. They're great – they're a great team to work with. And then of course, Dick's Sporting Goods and Amazon, as our premier partners have seen a fantastic surge in demand and have grown – we've grown together. And like I said, in my comments, we need to feed these retailers at the appropriate level. We first made commitments to them that we had to fulfill. In this particular business, especially when you're not paying for media in a big way. The margin suggests you should sell everything direct, but that's not a long-term view. We know, number one, for our customers to have choices to buy things. And number two, we've invested for years and years of in this retailer network. We grow together with our retailers and we – even when we don't have enough equipment to feed every mouth we – to the extent, everybody wants to, we make sure we feed the mouth and make sure we keep our partnership intact for the long run.

[George Kelly:]

Okay, great. And then last question for me is just about JRNY, the new – it sounds like there's a lot of new features, and it's a real kind of step up from the prior version. So I was just curious what you're most excited about? What do you think the prior version was lacking that this one really nails?

[Jim Barr:]

Well, I was excited before, but it's a piece of software, right. And it's a part of our experience with content in software and our equipment, they all go together. And so I was super excited about it, the thing I was probably least excited about it was, it was only on the Max total, in the way that we wanted it to actually come alive. So I would say the most excited I am is just that it's going to be available through the portfolio. And people are going to get a chance to use it without buying the top of the line, $2,800 model as being the only option. So I'm like super excited about that. I would say, I continue to be excited about the AI-driven coaching that makes it feel like it's a one-to-one experience, even though it's algorithmic. And that we think is still, it's a differentiator for us. And the customized workouts, a differentiating – differentiator for us, we love those things. And I think the things that I would have said, where's our weakness. The one I would've pointed to, especially when COVID hit is trainer-led videos. I would have said, hey, you know, people want to use those more often, maybe even when they're not using our equipment. And we had some, but not enough. And that's one of the things that I'm really excited we're bringing home. Now we're not betting on live, the way some others have. We are looking at, everything in JRNY is based on big time consumer insight. And we don't have a lot of people saying, I really want to have a live experience. They want variety. And they want something that like our coaching and like our customized workouts that change every day and keep it interesting. They like to use our Netflix capabilities, Hulu, we're even adding some more this particular time. So it's just a bunch of combination of these things. Explore the world, I'm also quite excited about too, because that was a separate SKU. And now that is coming, that will be usable within the JRNY members platform. And that's going to be exciting too. So bunch more options on a bunch more equipment, and then still leading with our algorithmic approach. And I would say over time and taking a big step, any perceived weakness we have, we feel like we're backfilling. And like I said, it's software so we're going to keep on that particular JRNY. Chris, is there anything you would add to that?

[Chris Quatrochi:]

No, Jim. Perfect, I think you covered everything.

[Bill McMahon:]

Jim talks long enough. He's going to…

[George Kelly:]

Well, that's great. Thank you and again, congrats on a great quarter.

[Jim Barr:]

Thank you.

[Operator:]

We have a question from Mark Smith, Lake Street Capital Markets. Please go ahead, sir.

[Mark Smith:]

Hi guys. First one for me, can you guys quantify at all the shipping costs increases during the quarter and maybe where that is today?

[Aina Konold:]

We're not going to disclose that publicly, right. Because we think we have some pretty good deals that we've come up with. But I think, I just wanted to point out and make sure that you – the analysts were aware of the different pressures on margin. We're going to do a lot of things on the promotional pricing and some of the costs concessions we're getting from our suppliers, but not all of it can flow down to the bottom line because we do have these things that are new this year versus last year related to logistics.

[Jim Barr:]

And obviously, if they were way too expensive and would really kill our margins, we wouldn't do them. But we just, we're trying to deliver for our customers and match supply and demand. And if there's slight differences in costs, we're going to go ahead and do that because we think that's what builds our business over time. Bill, is there anything you'd like to add to that?

[Bill McMahon:]

No, I agree. Aina said it well, Jim. I mean, the cost pressures are both on the inbound and the outbound side and just be aware of that as we navigate through those challenges. But I agree with that, I think we've negotiated some comparatively favorable deals even at elevated rates. So we'd like to keep that under our hat.

[Jim Barr:]

Yes. We're just trying to wink at you. So you don't take the Q2 margin rate and apply it to infinity.

[Mark Smith:]

No, that's fair. It's a helpful call out. Is there anything else as we kind of look out there in raw materials or labor, anything else along the line in the supply chain that maybe as a potential headwind to call out?

[Jim Barr:]

I'd say we're in pretty favorable conditions regarding commodities and things and labor costs are certainly under control. It really is that the challenges of getting product movement in a COVID environment.

[Mark Smith:]

Okay, perfect. And then just as we look at it, shipping and getting the product into customer's hands. Can you talk about expected delivery times today kind of where you're at versus where you were during the quarter? And then also talk about where you are versus – maybe versus your peers?

[Jim Barr:]

Yes. I mean, it's a constantly evolving thing and it's almost product-by-product. The thing I actually do is I put the major products in a basket on our website and I check back every day to see what our promise period is and whether you can buy them, that's a pretty good indicator. That helps me not even have to read management reports, but let's see what our customers are seeing. And if you do that, you'll see promise periods that are pretty click, quick, a matter of days to things that are out 30, 60 days. And then you eventually see some products like the 552s where you got a grayed out button and a notify me when, because we're working out that long-term backlog there, relative to competitors, I think I don't know how quickly, as one of the few public companies in the space. And I think one of the first to report, we don't know what other people are experiencing other than taking that same approach that I mentioned with our basket. And we see many of our competitors who only have a few products actually out of stock for eight, 10, 12 weeks at a time. So we know we're not the only ones. And we do think a lot of the secrets to our success will be how we continue to push ourselves on the ability to add to our supply base and match that well with our demand.

[Mark Smith:]

Okay. And then last one from me just – and this might be hard to call out or quantify, but as you look at any changes in consumer behavior during the quarter, even post-quarter in price points, maybe they're looking more at anything that you've seen really changing in consumer behavior here over the last, if we look at the last 60 days?

[Jim Barr:]

I don't – I can't think of anything that jumps out at me other than we've been able to sell some products that we haven't sold well for a while. Meaning I think people look for the most popular products and when they can't find it here, or maybe at a competitor, they'll try something that, they wouldn't have tried before. And we've seen that on our few of our products. It's always been – it's also been great to see the Max total. That's another one that sort of jumps out. Of course, that was so much of our decline as a company wrapped up in that one. And then we said for several quarters, hey, the quarter that we get to when we actually positively comp, Max total is going to be a super nice margin quarter while we did that. Now, I don't know if that's sustainable or not or whether that was just part of this. I am optimistic about our new offerings in the Max line, as I mentioned. So I hope hopefully it's that there, but those are the only things that really come to mind. Is anyone else have…

[Bill McMahon:]

No. I think the strength trend is something we're watching closely. There's certainly with the gym closures that impacts the strength of people pretty significantly. And we obviously have some excellent strength products. So we're really watching those trends closely.

[Jim Barr:]

Yes. That's probably the one that if we could go back and rewrite history, other than warn people that this was coming, we probably would have ordered a lot more strength, because people could go out, as we mentioned on the last call, people could go out and get some cardio, especially as the weather got better. But they didn't really have an alternative to their gym in terms of strength training that that's the one that we wish we could have possibly had a crystal ball on.

[Mark Smith:]

Okay. That's great. Thank you, guys.

[Jim Barr:]

Thank you.

[Operator:]

There are no further questions at this time. I'd like to turn the floor over to Jim Barr for closing comments. Please go ahead, sir.

[Jim Barr:]

Thank you, Jerry. I'd like to thank everyone for joining our call today and for your continued support of Nautilus. We look forward to providing you with another update on the business in a few months on our third quarter earnings call. Please stay safe and healthy, have a good rest of the day onwards and upwards. Thank you.

[Operator:]

This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.