Nautilus, Inc.
Q1 2018 Earnings Call Transcript

Published: 8 May 2018

[Operator:]

Good day, and welcome to the Nautilus First Quarter 2018 Earnings Results Conference Call. Today's conference is being recorded. At this time, I would like to turn the conference over to John Mills with ICR. Please go ahead, sir.

[John Mills:]

Great, thank you. Good afternoon, everyone. Welcome to Nautilus' First Quarter 2018 Conference Call. Participants on the call from Nautilus are Bruce Cazenave, our Chief Executive Officer; Sid Nayar, Chief Financial Officer; and Bill McMahon, Chief Operating Officer. Our earnings release was issued earlier today and may be downloaded from our website at nautilusinc.com, once you go to the website please click on the Investor Relations page and you will see the release on that page. The earnings release includes a reconciliation of the non-GAAP financial measures mentioned in today's call to the most directly comparable GAAP measures. Remarks on today's conference call will include forward-looking statements within the meaning of the securities laws. These include statements concerning financial projections, operating trends, anticipated growth and profitability, anticipated new product introductions, planned capital expenditures, projected effective tax rates, and anticipated results of new product and business development initiatives. Forward-looking statements are subject to a number of risks and uncertainties, and actual results may differ materially from these statements. For more information about these risks, please refer to our annual report on Form 10-K. Nautilus undertakes no obligation to update or otherwise publicly release any revision to forward-looking statements to reflect new information, events or circumstances after they were made or to reflect the occurrence of unanticipated events. All information and comments regarding our operating results pertain to our continuing operations unless otherwise noted. And with that, it is my pleasure to turn the call over to our CEO, Mr. Bruce Cazenave. Please go ahead, Bruce.

[Bruce Cazenave:]

Thank you, John. Good afternoon, everyone, and thank you for joining our call today. I'd like to start by providing a general overview of our first quarter and then we'll turn it over to Sid Nayar to review our financials in more detail. Bill McMahon will then provide updates on the business segments as well as on product activity, and expected introductions for the remainder of this year. Finally, I'd like to provide some closing remarks, including an update on our outlook for 2018 and then we'll open up the call for questions. First quarter 2018 revenue and operating income exceeded our guidance. The performance increases were driven primarily by strong growth in the mass retail channel distribution within the Retail Segment. Other channels of our business performed as expected, with modest growth in the specialty and commercial channel and a decline in the Direct segment due to the phase-down of the mature TreadClimber line. Increased operating expense leverage was achieved in the quarter versus prior year despite stepped up investments in product development and the multifaceted operating improvement plan we outlined in the previous earnings call. I will provide an update on the progress to this plan in my summary comments. Because of our operating model and performance during the quarter, we also continued to strengthen our balance sheet. We ended the quarter with approximately $93 million in cash and marketable securities, and further reduced debt to 44 million. In addition, we repurchased $2.7 million of stock in the open market as part of our previously announced stock repurchase program. As we look forward into 2018, new products planned to be launched this year are tracking as scheduled, as Bill will describe shortly. They are being very positively received in both formal market launches at industry shows as well as with end-users and field tests. Now I'd like to turn the call over to Sid. Sid?

[Sid Nayar:]

Thanks, Bruce. Good afternoon, everyone. I'd like to review the details of our financial results for the first quarter of 2018. Net sales for the first quarter totaled $114.8 million, an increase of 1.4% as compared to the same period in the prior year, reflecting strong growth in the retail channels, partially offset by lower sales in the direct channel. First quarter gross margins decreased by 250 basis points in the direct segment to 63% and were down 80 basis points in the retail segment to 31.2% when compared to the same quarter last year. Direct margins were primarily impacted by a shift in product mix to lower margin products, while retail margins were impacted by higher product costs, reflecting unfavorable exchanges in foreign exchange currency exchange rates. On an overall basis, total company gross margins for the first quarter 2018 decreased by 320 basis points to 51.3% versus the same period prior year, reflecting the lower gross margin rate in Direct and a shift in channel mix to an increased percentage of Retail segment revenues. Total operating expenses for the first quarter of 2018, as a percentage of net sales, decreased to 42% from 43.3% in the same period last year, primarily reflecting decreased sales and marketing expense, partially offset by higher R&D expense. Sales and marketing expense for the first quarter of 2018 was $36.8 million or 32% of net sales as compared to $37.7 million or 33.3% of net sales in the same period last year. The decreased dollar spending reflected a non-recurrence of a $1.2 million reserve recorded in the same period of the prior year, along with lower financing fees of $1.6 million. These decreases were partially offset by $1.3 million increase in media costs, reflecting lower ROIs on our advertising spend. The decrease in sales and marketing expense, as a percentage of sales, reflects the same factors. General and administrative expenses were $6.9 million or 6% of net sales for the first quarter of 2018, which compares to $7.5 million or 6.6% of net sales in the same period last year. The decreased dollar spending in G&A primarily reflects lower litigation costs. Research and development costs in the first quarter of 2018 were $4.5 million or 3.9% of net sales, compared to $3.9 million or 3.5% of net sales in the same period last year. The dollar increase reflects increased investment in the engineering and digital platform resources required to continue to innovate and broaden our product portfolio. Operating income for the first quarter of 2018 decreased to $10.7 million as compared to operating income of $12.7 million in the same quarter of last year. The decrease reflects the decline in gross margin rates, partially offset by the decrease in operating expenses. Operating margin for the first quarter of 2018 decreased 9.3% compared to 11.2% for the same period last year. Income from continuing operations for the first quarter of 2018 was $8.1 million or $0.27 per diluted share as compared to $8.2 million or $0.26 per diluted share for the same period last year. EBITDA from continuing operations in the first quarter of 2018 decreased to $13.1 million versus $14.9 million for the same quarter of the prior year. The effective tax rate for the first quarter of 2018 was 23.7% compared to 33.6% in the same period last year. The reduced tax rate reflects the impact on the quarter of the recently enacted Tax Cuts and Jobs Act. We anticipate the full year effective rate to be in the 24% to 25% range. Total net income, including discontinued operations for the first quarter of 2018, was $8.1 million or $0.26 per diluted share, which includes a $0.1 million loss, net of taxes, from discontinued operations. This compares to the first quarter last year where we reported total net income, including discontinued operations, of $7.1 million or $0.23 per diluted share, which included a net loss from discontinued operations of $1.1 million. Discontinued operations in the prior year included a $1.2 million charge related to the final settlement of a long-standing lawsuit with Biosig Instruments. Turning now to our segment results. Net sales in the direct business totaled $71.2 million for the first quarter of 2018, a 4.7% decrease over the same quarter last year. Direct segment sales were impacted by the continued decline in TreadClimber sales and marginally lower Max Trainer sales. However, sales increase in the Bowflex Results Series and HVT product lines helped to partially offset those declines. Gross margin for the Direct business declined to 63% for the first quarter of 2018, compared to 65.5% in the same quarter of last year due to a shift in product mix to more lower margin HVT and Bowflex Results Series product. Operating income for the first quarter of 2018 in our Direct business was $11.3 million compared to $15.3 million in the same quarter prior year. Operating income was negatively impacted by the lower net sales and gross margins in the first quarter of 2018. Net sales in our Retail segment for the first quarter of 2018 were $43 million, an increase of 13.7% compared to $37.8 million in the first quarter of last year. The increase in retail net sales reflects strong growth across a variety of product lines as well as sales growth in specialty, retail and commercial customers. Gross margins for the Retail business decreased by 80 basis points to 31.2% in the first quarter of 2018 as compared to 32% for the prior period, primarily due to higher product costs related to unfavorable foreign exchange rates. In the first quarter of 2018, operating income for the retail business totaled $3.9 million, as compared to $2.2 million in the same period of last year. The increase is attributable to the higher revenue, coupled with a non-recurrence of a $1.2 million reserve recorded in the same period of the prior year. Now turning to the consolidated balance sheet. Cash and investments totaled $92.7 million as of March 31, 2018, with $44 million of debt. This compares to $85.2 million in cash, and debt of $48 million at December 31, 2017. During the first quarter, the company purchased $2.7 million of stock in the open market as part of its previously announced stock repurchase program. Inventories were $37.7 million as of March 31, 2018, compared to $53.4 million at December 31, 2017 and $34.3 million at March 31, 2017. The decrease in inventory versus year-end 2017 relates to the seasonality of the business. Trade payables were $41.7 million as of March 31, 2018, compared to $66.9 million at the end of 2017 again, reflecting seasonality of purchases. Capital expenditures totaled $1.3 million for the three months ended March 31, 2018, with spending primarily on systems integration, product equipment and tooling. We anticipate full year CapEx to be in the range of $8.5 million to $10.5 million, reflecting increased spend on systems integration, digital platform enhancements and warehouse consolidation initiatives. At this time, I'd like to turn it over to Bill McMahon, our Chief Operating Officer, who will provide additional insights into our business and key products. Bill?

[Bill McMahon:]

Thank you, Sid. Good afternoon, everyone. I'd like to provide further background on our first quarter results and provide some commentary on the opportunities we see in 2018. Starting with our Retail segment. We were pleased with our 14% sales growth in the first quarter. The Q1 sales increase versus prior year was driven by a number of categories in both the mass retail and specialty fitness space. We experienced solid growth in our Bowflex Results line of cardio products, most notably, our treadmill lineup. The performance of Bowflex treadmills was especially encouraging as traction here will allow Nautilus to continue to gain share in the single-largest category of fitness equipment. Other contributors to growth included our Bowflex Max Trainer lineup products, Schwinn and Octane Airdyne bikes, and both standing and seated elliptical products under the Octane brand. Last fall, we introduced over 20 new SKUs into the market, including products like the Schwinn Crewmaster Rower, the Schwinn IC3 indoor cycling bike, the Schwinn 87 and Octane ADX Airdyne bikes, the Octane ZR7000 commercial quality Zero Runner, as well as updates to our popular Schwinn 70 Series line of cardio products. We're encouraged by the initial fitness season performance of these new launches. Presently, we are in the active selling and planning period for the fall 2018 mass retail fitness season. Based on our current knowledge of those discussions, we continue to hold a positive outlook for the remainder of the year in Retail, as previously outlined in our full year guidance. The continued strength of our current products, along with additional retail introductions for later in the year, have us very well-positioned for solid top line growth and market share gains in Retail, including specialty and commercial in 2018. One driver of that growth in the commercial space and vertical will be the new Octane Max Trainer MTX machine. This product was designed through collaboration of the Nautilus Octane product development teams. And the new product was recently unveiled during the International Health, Racquet and Sportsclub Association show, better known as IHRSA, in San Diego, California, as well as at the International Sporting Goods Trade Fair, or ISPO, in Cologne, Germany. Commercial Max features all the time savings and performance benefits of the consumer Max line but built into a commercial-grade machine. The MTX model of commercial Max is specifically designed to perform well in the rapidly growing functional training area, the commercial club space. The Octane commercial Max Trainer was extremely well received at both major trade shows. And we anticipate this product coming to market in fall of this year. Turning now to our Direct segment, our sales declined in Q1, but we're in line with our expectations for our full year guidance. The primary driver of decline in the channel year-over-year was TreadClimber. In the prior year, TreadClimber was still in the television advertising rotation, whereas in this quarter, the product was not on television. Based on current trend, we believe that Q2 of this year will be the last quarter in which TreadClimber declines will materially impact direct channel results as compared to prior year. Additionally, Max Trainer sales in our direct channel were slightly off for the quarter, but within our expectations as weaker Canada results impacted performance. Overall, for the fitness season, which we define as November through February, Max Trainer sales in direct were essentially flat, while growing well overall for the full company through both quarters. Meanwhile, we achieved improved sales from our Bowflex HVT machine and with the Bowflex Results Series of cardio products. Further, we launched new versions of our Nautilus and Schwinn e-commerce websites, and we saw a lift from those sources. During the summer, we'll be introducing another new Direct product that will combine cardio technology from one of Octane's leading products, but now for a home use. The Bowflex LateralX machine will utilize the patented cardio modality that is currently unmatched in the consumer market. Lateral training better matches exercise activity with real-world movements. Our Bowflex LateralX will provide low-impact motion that moves your body in three dimensions, forward and back, up and down, and side to side, strengthening the user for everyday activities, while activating muscle groups. No consumer elliptical or treadmill matches this range of motion. We recently completed user testing with this product and our results were extremely encouraging. We anticipate Bowflex LateralX launching with two models, ranging from $1,999 to $2,700. The product will be supported by television, digital, social and PR advertising. Based on our current direct channel performance and the anticipated product launches coming this year, we feel we're on track for the revenue growth outlined in our full year guidance. The launch of Octane commercial Max Trainer and Bowflex LateralX demonstrate continued advancement of the synergies we anticipated during the acquisition of Octane Fitness. Our product development teams are working closely together on still more innovation as part of our three-year product roadmap. In addition to the products I've discussed today, we continue to make progress in the development of our new digital platform, and anticipate launching this capability, which will also include a subscription model late in the year. For competitive reasons, we'll not be providing more information on this platform today, but we will do so prior to the launch date. Finally, from an operational perspective, we feel that our inventory positions and supplier capacity are well positioned now and for the continued planned growth this year. At this point, I'd like to turn the call back over to Bruce for his comments. Bruce?

[Bruce Cazenave:]

Thank you, Bill. I'd like to make a few final comments before we open up the call for questions. We are pleased with the first quarter results, and remain confident in our ability to return to full year top line growth for both retail and direct segments this year. While it is still early in the year, we believe we are well positioned to deliver results per our full year guidance, given the trajectory of the baseline business, in conjunction with the breadth of truly innovative new product introduction still coming that Bill referred to earlier. Equally important is that the multifaceted operational improvement plan which we discussed in the previous call, is tracking as scheduled, and we expect those initiatives to be mostly completed later this year. As a reminder, the operational improvement plan includes systems integration, consolidation of warehouse facilities, supply base realignment, and restructuring of our international sales and support teams. These initiatives are anticipated to strengthen our infrastructure and support our growth initiatives, including new product introductions and improved margins beginning in 2019. As far as 2018 guidance, the full year outlook remains the same as communicated on our previous call in March. On a full year basis for 2018, we continue to expect revenues between $428 million and $437 million, with operating income in the range of $42 million to $45 million. This is inclusive of the estimated expenses and investments related to the business model improvements we mentioned. Even though we exceeded the first quarter guidance and have started the year well, we feel it is not prudent at this time to change the full year guidance given ongoing product cost pressures and the phasing of investment expenditures to support the key initiatives that remain ahead of us for the balance of this year the balance of this year. While full year expenses and capital expenditures related to the key initiatives are tracking as planned, we now do expect to see heavier concentration of these expenses in the second and third quarters of this year. In closing, I'd like to thank all of our dedicated employees, who are instrumental in our successes and help the company become stronger every quarter as a result of their efforts and initiatives. That concludes our prepared remarks. Now I'd like to open up the call for questions. Operator?

[Operator:]

Thank you. [Operator Instructions] And our first question will come from Michael Swartz with SunTrust.

[Bruce Cazenave:]

Hi, Michael.

[Michael Swartz:]

As I look through kind of the moving parts here and looking out to back half of 2018, I think you've said for the Direct business, you expect revenue to be down year-over-year in the second quarter. You've given us the guidance for Retail. So I guess the implied growth for Direct would be kind of low teens, pushing towards 20% year-over-year in the back half of the year. So I guess, help us understand the comfort level in that type of growth for the year ahead.

[Bruce Cazenave:]

Yes. I think, the first thing that you have to – this is Bruce. The first thing you have to remember, Mike, and I apologize, we missed the first few sentences maybe of your question, so we can come back if we're not addressing something, but I think there are several things happening. Number one is that we do have the new product, the LateralX that Bill is alluding to, coming in. That is going to be shipping in the back half. We also have – keep in mind that the TreadClimber, as Sid has alluded to in earlier calls, that the TreadClimber is not – that the decline of the TreadClimber is becoming really immaterial at the end of Q2. So whereas we had experienced the decline in that heavily in the third and fourth quarter last year and into this year, we will – that will be behind us from a materiality standpoint. Sid?

[Sid Nayar:]

Yes. And Mike, I would just add sort of the strength we're seeing with the Bowflex Results Series and with the HVT as we go into the back half of the year. Sort of having the tailwinds of that, coupled with not having the TreadClimber headwinds, I think, gives us that confidence in the back half.

[Michael Swartz:]

Okay. And just on – in terms of the Max Trainer, I think you said it was down slightly during the quarter. Is that something that you, I guess, anticipate growing in the back half of the year per your guidance? Or should we think of that more flattish?

[Bill McMahon:]

Yes. We'd anticipate, certainly by Q4, having some growth in Max Trainer this year. We have some things in the works that we believe give us confidence for that.

[Michael Swartz:]

Okay. And then, final question, just on the commercial specialty channel, that's something that's been rocky for a lot of people over the past couple of years. It sounds like that may be finally stabilizing. So maybe just a little more color on what you're seeing there. Is it something market-related that's improving, or is it just kind of the cardio in Bowflex, Nautilus product that's doing better?

[Bruce Cazenave:]

I'll let – it's a couple of things, but I think the biggest part of it is that, remember that for the last two years, because of a lot of the M&A activity that was occurring in the specialty side of commercial specialty, those stores that were being acquired and consolidated, that seems to have stabilized. We saw some stabilization in the first quarter, I could say, bottoming out. But we do feel that, that is – that part of the specialty and commercial channel could actually hold its own. It's kind of what we've considered this year not necessarily growing, but at least holding its own versus prior year, on a full year basis. And then, we have, of course, the MTX that Bill alluded to, coming in, in the back half. And all indications are that – the feedback has been very strong, as we said, both in the shows globally, not just in the U.S., but also from an end-user visits and where we're putting it in the gyms.

[Michael Swartz:]

Okay, great. That’s all from me. Thank you.

[Bruce Cazenave:]

Thank you, Michael.

[Operator:]

Our next question will come from Steve Dyer with Craig-Hallum.

[Steve Dyer:]

Thank you. Good afternoon, guys.

[Bruce Cazenave:]

Hi, Steve.

[Sid Nayar:]

Hi, Steve.

[Steve Dyer:]

A couple of questions on the LateralX. First of all, are you able to quantify or willing to quantify sort of how much of this year's revenue guidance implies – is implied for the LateralX sales? And then, secondly, I think, last quarter, you had talked a little bit about being pretty excited for that launch. I think you had even said it's sort of a potential home-run product. Is there anything that you sort of have seen since then, better or worse, that sort of changes your outlook on that later this year?

[Bill McMahon:]

Well, Steve, as you know, we don't provide guidance around individual product category performance, so I will say that our anticipated growth in Direct would require some contribution to come from this product launch indeed. I'm not sure how we'd characterized it previously. I would say we're excited about the product, that's for sure. What gives us some confidence in it is we have been testing this product with users now for many months, and we're getting pretty strong feedback in favor of it. The other side of that is, it's been a successful modality for Octane in the commercial space as well, so we know that user acceptance at the club level has been strong for this product line as well. The challenge has been taking a very complex commercial product and making it accessible for consumers. And I think our engineering teams, together, have done a great job at that, and we're excited to see how the product does. We'll launch it this summer.

[Steve Dyer:]

Great. That's helpful. And then, just jumping over to HVT, I guess. Maybe sounds incrementally more positive relative to the last quarter or two on that launch. Is there anything sort of changed there, in your view, in the last 90 days?

[Bill McMahon:]

No, I think our position has always been that HVT will be a contributor to the company going forward, just not perhaps the homerun we were hoping to hit with it. On the other hand, it's definitely contributed. And I anticipate it'll continue to contribute, and in fact, has a possibility of growing some still for us as we go. So I think we've scaled it appropriately is the way I'd describe it.

[Steve Dyer:]

Great. And then, lastly for me, you guys continue with a very strong balance sheet, keep putting more cash on it. I guess, just any changes, sort of your capital allocation plan there, thoughts on maybe accelerating the buyback, et cetera? Or is sort of an acquisition still on the table? And that's it for me. Thanks.

[Sid Nayar:]

Thanks, Steve. In terms of the capital deployment plan, sort of the priorities remain unchanged. I think we are – I would say, we're still in the market for an appropriate acquisition, but I think as we've laid out on past calls, it would have to be the right filters and the right asset before we went ahead and did it. But we are on – certainly in the market, looking for appropriate assets that could accelerate our strategic initiatives that we've outlined here. We'll continue to be in the market opportunistically on the stock buyback program, as we were in Q1.

[Steve Dyer:]

Thanks guys.

[Sid Nayar:]

Thank you, Steve.

[Operator:]

[Operator Instructions] Our next question will come from Michael Kawamoto with D.A. Davidson.

[Michael Kawamoto:]

Hey guys thanks for taking my questions. So, you recently launched the Octane Max Trainer. Looks like it's generating some excitement, and then you have the LateralX. Can you just talk about your plans or maybe additional opportunities to do similar things across the product portfolio given your ability to stack up and down different lines for different channels?

[Bill McMahon:]

Michael, it is a great question. I think we still have more things that we're looking to leverage in terms of modalities across both up and downward, and this year is a great example of going both ways on that. We're not ready at this time to talk about what some of those things might be. But I can tell you, we're very actively working on another modality, as we speak, that we think has potential.

[Michael Kawamoto:]

And then, did you give a credit approval for the quarter?

[Bill McMahon:]

The credit approvals were up year-over-year in Q1 to 53.5%, which was up from 52.6% in both cases, these are at historical high’s to my knowledge. I would still, I would also add to that, and emphasize that credit card is a payment method for the Direct channel still is the majority. In fact, that percentage moved up in Q1 to roughly 55.5%, Sid, I think. So we still are seeing what I would call a healthy payment mix, and financing is helping, but we're not overly reliant on financing.

[Michael Kawamoto:]

Got it, thanks and good luck for the rest of the year.

[Operator:]

And that does conclude our question-and-answer session for today and I will turn the conference back over to Bruce Cazenave for closing remarks.

[Bruce Cazenave:]

Thank you all for your interest in Nautilus and for joining our call. We look forward to providing another update on the business on our second quarter earnings call in a few months. Hope everyone has a great rest of the day. Thank you.

[Operator:]

This does conclude the conference for today. Thank you for your participation.