Nautilus, Inc.
Q4 2018 Earnings Call Transcript

Published: 26 Feb 2019

[Operator:]

Good day, everyone. Welcome to the Nautilus, Inc. Fourth Quarter 2018 Earnings Results Conference. Today's call is being recorded. At this time for opening remarks, I would like to turn things over to John Mills with ICR. Please go ahead, sir.

[John Mills:]

Great. Thank you. Good afternoon, everyone. Welcome to Nautilus' fourth quarter 2018 conference call. Participants on the call from Nautilus are Bruce Cazenave, Chief Executive Officer; Sid Nayar, Chief Financial Officer; and Bill McMahon, Special Assistant to the Chief Executive Officer. Our earnings release was issued earlier today and may be downloaded from our website at nautilusinc.com on the Investor Relations 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 includes statements concerning financial projections, operating trends, anticipated growth and profitability, anticipated timing and market acceptance of new product introductions and the impact of new product introductions on our future financial results, planned capital expenditures, projected effective tax rates and anticipated results of new product, business development initiatives, and strategic partnerships. Forward-looking statements are subject to a number of risks and uncertainties, and actual results may differ materially from these statements. Additional factors that could cause Nautilus' actual results to differ materially from these forward-looking statements include our ability to timely acquire inventory that leads our quality control standards from sole stores, foreign manufacturers at acceptable costs, changes in consumer fitness trends, changes in the media consumption habits of our target consumers or the effectiveness of our media advertising. And the other risks and uncertainties described in today's earnings announcement in our most recent 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 pertaining 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.

[Bruce Cazenave:]

Thank you, John. Good afternoon, everyone, and thank you for joining our call today. I will start by providing a general overview of the fourth quarter and the full-year 2018 and then we will discuss our business segments as well as product activity before turning it over to Sid Nayar to review our financials in more detail. I will close with a few final remarks and we will open up the call for your questions. In January, we provided preliminary financial results for our fourth quarter and the full-year 2018. As noted, the overall results were disappointing, mostly because of two reasons. First was the weakness in our direct segment, but secondly growth in the retail segment was significantly less than we expected. With the November introduction of our new digital platform, Max Intelligence, we had expected to see stronger sales in the direct segment for the fourth quarter, but this was not the case. While overall, we received strong positive feedback from purchasers, the product is at a slower start than anticipated. There were many valuable lessons from the first two months of introduction, giving us added confidence at this platform and the unique personalization of the fitness experience it provides is unlike anything on the market today. We expect that it will resonate with a broad base of consumers as awareness continues to bell. Needless to say the slow start had a magnified effect in Q4 because the launch coincided with a critical holiday and fitness season. Our retail segment grew 16% in the quarter versus the same quarter of prior year and we experienced growth in all channels within retail, including mass retail, international and the commercial specialty channel. By most metrics, 16% would be a reason to celebrate, but for us it was a disappointment given the new product placements and the strong market position we had achieved going into the peak season. Nevertheless, the continuation of strong double-digit growth does highlight the demand for our brands with both retailers and consumers and was achieved across a broad base of our cardio product lines, including Treadmills and Bikes. Another driver of growth in the channel was the commercial Max Trainer product, the Octane MTX. The MTX features the time savings and performance benefits of the home version of Max line, but with the added durability and features required in the commercial market. We began shipment and installations of this product in the third quarter this year and it was a key driver for growth almost immediately. Commercial Max is an important catalyst in our strategy to drive growth in the commercial and specialty channels of distribution. Our treadmill lineup has become an increasingly larger part of our retail strategy over the last three years and it allows Nautilus to gain share in the single largest category of fitness equipment. In this fitness season we expanded our Bowflex Results Series treadmill lineup with the new Bowflex T6 treadmill, retailing additionally at Dick's Sporting Goods for $999. Our relationship with Dick's is a key strategic relationship and we’ve seen growth and have great support for our new products. We also launched the Schwinn 411 elliptical, which offers high-intensity interval training along with heart rate control programs in a streamline console for easy navigation. The Schwinn 411 elliptical is priced at $499, both the new Bowflex treadmill and the Schwinn elliptical machines offer RunSocial capability the video app allowing users to train in scenic locations. There are several new products in the roadmap for the Retail segment in 2019, including both new modalities and a roll out of our digital platform across other existing products. Turning now to our Direct segment. Our sales declined during Q4 was due to the previously mentioned slower than planned initial adoption of the digital -- of the new digital platform and a decline in the Bowflex Max Trainer sales. Partially offsetting these declines were increased sales of the recently launched Bowflex LateralX treadmills and strength products. We launched the Bowflex LateralX in August and are seeing increasingly positive response rates to the media spend. We completed a number of TV test patterns and have been impressed with the success in reaching incremental customer demographic segments as compared to Max Trainer. We are optimistic about the future of this product and in Direct -- in our Direct channel and have continued to ramp up media spend behind it in Q1 and likely will pick up again as we enter Q4. Moving on to the new digital platform. We’ve spent two years working on enhancing our digital capabilities and bringing to market the Max Intelligence platform, which we believe is both competitive than the marketplace, and more directly align with consumers wants and needs. Through an initial fitness assessment and predictive analytics, Max captures data every time the user steps on the Max Trainer and it learns the user's unique capabilities and delivers a customized workout to help them reach their fitness goals. Max is unique and that it truly is personalized fitness, gathering workout data and user preferences to enhance each of their individual experience and ability to succeed. The platform generates custom programs based on how the individual is feeling, how much time they have, their past performance and their feedback from previous workouts. Max is designed to mirror a personal trainer adapting to the user's capabilities and making unique connections to each subscriber via spoken introduction, instruction, motivation and praise that encourages users to stay focused on achieving their individual goals. The challenges we faced to achieve better traction with the digital platform are understood and can be overcome. We are revamping the marketing message and media spending strategy with plans to relaunch in a significant way as soon as possible this year. Subscriptions became a part of our business last quarter and is continuing to gain traction as consumers gain exposure to our subscription offering. Our initial offering is compelling and is actively growing with more added content and capabilities coming in 2019 to further enhance the overall customer experience. Most importantly, our data indicates that users are actively engaged with the content and subscription per purchasers appear to be getting even better results. Finally, I wanted to comment on our international business. 2018 was the first year in which we raise the level of priority and resource deployment to pursue this underpenetrated market. The team has been put in place and the resources added to achieve our mission of accelerating international growth. While it was a solid growth in Q4 over same quarter prior year, the growth was hampered by systems integration and new warehouse logistics issues, both of which are behind us now. We remain committed to growing this increasingly profitable and sizable growth opportunity for our business. Before I turn the call over to Sid, I wanted to also point out that we made a significant addition to our management team. With the addition of Carlos Navarro as our Vice President and General Manager of the Direct Business segment. Carlos comes to us with a deep marketing digital and general management experience, having worked across a number of blue-chip consumer and industrial companies, including Johnson & Johnson, Bausch + Lomb, Jarden Corporation and most recently South Jersey industries. We're excited at have Carlos on the team. And now, Sid will provide an overview of the financials for the quarter and the full-year. Sid?

[Sidharth Nayar:]

Thank you, Bruce. Good afternoon, everyone. Net sales for the fourth quarter of 2018 totaled $115.4 million, a decrease of 9.7% as compared to the same period in the prior year. Net sales for the year ended December 31, 2018 totaled $396.8 million, slightly lower than the prior year sales of $406.2 million. Fourth quarter gross margins decreased 470 basis points in the Direct segment to 58.7% and were up 220 basis points in the Retail segment to 31.7%, when compared to the same quarter last year. On an overall basis, total company gross margins for the fourth quarter of 2018 decreased 490 basis points to 44% versus the same period of the prior year, primarily due to product mix and the shift in channel mix to an increased percentage of retail sales. For the full-year of 2018, gross margins were 45.8%, which was a 440 basis point decline compared to the prior year. Total operating expenses for the fourth quarter of 2018 as percentage of net sales decreased to 41.6% from 43.9% in the same period last year. Operating expenses were lower as a result of $8.8 million impairment charge in the fourth quarter of last year, partially offset by increased legal litigation expenses in the current year. Operating expenses for the year ended December 31, 2018 as a percentage of sales decreased to 40.6% as compared to 41.3% for the same prior period primarily driven by the aforementioned impairment charge. Sales and marketing expense for the fourth quarter of 2018 was $36.4 million or $31.6 million -- 31.6% of net sales as compared to $36.9 million or 28.9% of net sales in the same period last year. The increase in sales expense as a percentage of revenue was due to higher media spending. For the year ended December 31, 2018, sales and marketing expenses totaled $115.9 million or 29.2% of net sales compared to $116.2 million or 28.6% of net sales for the same period in the prior year, as the decline in Direct segment revenues resulted at lower finance fee expenses. General and administrative expenses were $7.5 million or 6.5% of net sales for the fourth quarter of 2018, which compares to $6 million or 4.7% of net sales in the same period last year. The increased spending was due to higher legal expenses. General and administrative expenses for the year 2018 totaled $28.2 million or 7.1% of net sales compared to $27.1 million or 6.7% of net sales for the same period of the prior year, primarily reflecting higher legal spending. Research and development costs in the fourth quarter of 2018 were $4.1 million or 3.5% of net sales compared to $4.3 million or 3.4% of net sales in the same period last year. The dollar decrease was driven by lower consulting expenses in the current year. Research and development costs for the year of 2018 as a percentage of sales totaled 4.2% as compared to 3.8% for the prior year, reflecting added personnel costs. Operating income for the fourth quarter of 2018 decreased $2.7 million as compared to operating income of $6.4 million in the same quarter of last year. For the year of 2018, operating income totaled $20.8 million or 5.2% of net sales compared to $36.3 million or 8.9% of net sales last year. Income from continuing operations for the fourth quarter of 2018 was $1.5 million or $0.05 per diluted share as compared to $8.5 million or $0.28 per diluted share for the same period last year. The effective tax rate for the fourth quarter of 2018 was 46% compared to a credit of 32.2% in the same period last year. The current year tax rate including -- included adjustments for the state related true-ups and state valuation allowances. The rate in the prior year included tax benefit related to a changing that in United States Tax Law at the end of 2017. Income from continuing operations for the year of 2018 totaled $15.1 million or $0.50 per diluted share as compared to $27.6 million or $0.89 per diluted share for the year of 2017. Turning now to our segment results. Net sales in the Direct business totaled $49.9 million for the fourth quarter of 2018, a 30.3% decrease from the same quarter last year. Direct segment sales reflected a decline in the Bowflex Max trainer product line, partially offset by increases in the recently launched LateralX treadmills and strength products. Gross margin for the Direct business declined to 58.7% for the fourth quarter of 2018 compared to 63.4% in the same quarter of last year. The gross margin decline reflected a shift in product mix along with unfavorable overhead absorption related to the lower net sales. Operating loss for the fourth quarter of 2000 -- in our Direct business was $3.8 million compared to income of $11.8 million in the same quarter prior year. Net sales in our Retail segment for the fourth quarter of 2018 were $64.4 million, an increase of 16.1% compared to $55.5 million in the fourth quarter of last year. The increase in sales reflected growth in mass retail and modest increases in the international and specialty and commercial channels across multiple product categories. Gross margins for the retail business improved by 220 basis points to 31.7% in the fourth quarter of 2018 as compared to 29.5% for the prior period driven by decreases in product costs related to favorable exchange rates experienced during the second half of 2018. In the fourth quarter of 2018, operating income for the retail business totaled $11.3 million as compared to $7.1 million in the same period of last year. The increase is due to the growth in net sales and gross margins. Now turning to the consolidated balance sheet, cash and investments totaled $63.5 million as of December 31, 2018 with $32 million of debt. This compares to $85.2 million in cash and $48 million of debt at December 31, 2017. During the full-year of 2018, the company purchased $13 million of stock in the open market as part of our previously announced stock repurchase plan including $8 million in the fourth quarter of 2018. Working capital totaled $76.6 million as of year-end 2018 compared to $91.1 million at the end of 2017. Inventories were $68.5 million as of December 31, 2018 compared to $53.4 million at December 31, 2017. The increase in inventory versus year-end 2017 primarily reflects the lower-than-expected fourth quarter sales, coupled with a strategic inventory buildup to mitigate supply-chain uncertainties due to potential international tariffs. Trade payables were $87.3 million as of December 31, 2018 compared to $66.9 million at the end of 2017. Capital expenditures totaled $10.4 million for the year ended December 31, 2018 with spending primarily on the new Max intelligence platform, tooling and implementation of new software and hardware information system upgrades. We anticipate full-year CapEx for 2019 to be in the range of $8 million to $10 million. At this time, I would like to turn the call back over to Bruce for his final comments. Bruce?

[Bruce Cazenave:]

Thank you, Sid. 2018 was a challenging year and we expect 2019 to be equally challenging with stepped-up competition, marketing retooling in the works and high retail channel inventories that need to be drawn down. Although we remain confident in the fundamentals of the business and that our strategic priorities are the right ones. Our company has had to make some significant changes in the way we are doing business. The first is evident in the strategic partnerships and investments made last year and this year to enhance and accelerate our ability to develop and commercialize the next stages of our digital platform. These are mentioned in our release and include the acquisitions of assets and intellectual property of RunSocial, investment in Feed.fm and development partnerships with Vi Technologies and Samsung electronics America. These are all key pieces to make our vision of personalized fitness and coaching experiences further reality. Secondly, we need to revamp our marketing message and media spending approach to support the digital platform. The obstacles are clear and the solutions very attainable. As we work through these challenges, we will continue to build out the platform and expanded on to other categories of product. Thirdly, we've already begun steps in order to improve our operating margins. This includes a workforce reduction, product cost containment controls and value engineering initiatives. This aggressive cost containment program will simplify and make processes more efficient, rescale the operations to be more profitable, while we restored growth to the sales base. Finally, and not so much of change in operating mode as the others just mentioned, we will be continuing to -- the steady drumbeat of new product introductions. There is a strong lineup affecting all channels of distribution in 2018. As we've done in the past and past years, during our call in May, at that time, we will provide more details on the exciting new products launching in the back half of this year. As to the near-term outlook, our sales in the Direct segment and the mass retail channel will be challenged in the first half of the year. Until we complete the revamping of the marketing plan and Direct, we anticipate that the recent sales weaknesses experience in the segment will continue through most of the first half of 2019. Additionally, despite the strength of our mass retail channel sell-through in Q4 2018 versus prior year, there are significantly higher anticipated -- than anticipated inventories in the channel that need to be drawn down in the first quarter of this year. At this time, we're not providing specific guidance, but will be providing updates on the progress of our major initiatives as the year progresses. Our company has successfully navigated through setbacks like this before and it come out stronger afterwards. Our goal in 2019 is to do it again and we intend to utilize our many strengths including strong brands, technologies, talent and the ability to adapt and execute well. That concludes our prepared remarks. Now I would like to open up the call to questions. Operator?

[Operator:]

Thank you. [Operator Instructions] We will hear first today from Steve Dyer with Craig-Hallum Capital Group.

[Ryan Sigdahl:]

Hey, guys. Ryan on for Steve.

[Bruce Cazenave:]

Hi, Steve.

[Sidharth Nayar:]

Hi, Steve.

[Ryan Sigdahl:]

With another month since you guys preannounced in mid-January, is it any clearer what happened with Max Trainer and Max Intelligence and why your marketing message hasn’t resonated with consumers?

[Bruce Cazenave:]

Yes, Ryan. It looks like at this point we are still pretty knee-deep in research as we speak, but we basically fundamentally feel that the message in terms of the Max Intelligence platform was perhaps too complicated. We need to find ways to break through and explain this in a way that is better suited for a 30 second and 60 second ad. So once the folks who did purchase the product and went through and got educated, there's general satisfaction it really is more, how do we tell that story more effectively and drive web traffic to the site to learn more. And that’s part of what we talk about when we say we want to retool some of the marketing.

[Ryan Sigdahl:]

All right. And then as you refine that, normally you guys kind of use the summer Q2, Q3 to fine-tune new product launch strategy, marketing campaigns etcetera and then blitz, kind of in Q4, Q1 it's holidays and fitness season. Do you plan to kind of go down that same strategy here for Max Intelligence or as you kind of figure out a new marketing strategy, maybe I will try different things you'll kind of go at those quicker?

[Bruce Cazenave:]

I think urgency would be the word I would use. We are -- as we find things, we will definitely test and apply. If it's successful, we will apply as soon as possible. But you're right, in the general direction we would use the fitness off-season as our proving ground before going into the fall season and our desire would be to find those answers sooner than the fall if possible. But the reality is major impact would come within the normal seasonal behavior of the channel.

[Ryan Sigdahl:]

And then as it relates to the elevated retail channel inventory you commented little bit on it, but is that specific to any market segment or product specifically?

[Bruce Cazenave:]

No, it's pretty -- it was -- it's interesting because the point of sale was very strong as I commented on, Steve. But we had anticipated actually much more growth because of the placements we had. So hence there was a big fourth quarter shipments right and even third quarter last year, if you remember for Retail, up north of 26% over prior year. And essentially that outpace the sell-through through the year, through the tail end of the year, and therefore we have the inventory now to burn off. But it is pretty broad base. Actually the sell-through, positive sell-through was broad-based and the inventory is broad based.

[Ryan Sigdahl:]

And based on what you can see in different product placements in -- from what you can see in the channel, I know first half and probably Q1 specifically, you'll see some weakness, but is it safe to say that that the retail channel overall will grow in 2019?

[Bruce Cazenave:]

Go ahead.

[Sidharth Nayar:]

Yes, we're not commenting on outlook on any of the channels at this point, Ryan. As we sort of navigate through Q1, probably be able to provide better update at a later point.

[Ryan Sigdahl:]

All right. Last one for me, then I will hop back in the queue. With Pelaton creating a lot of buzz and they're certainly not shy about spending on marketing. Do you think that have any impact on your business or is it more so your specific product messaging? Thanks. Good luck.

[Bruce Cazenave:]

I think that's the right question. And it's certainly one that we’re looking at. There's no doubt that given the magnitude and volume of spend of that specific competitor notwithstanding our other competitors, that does create a bit of an effect for us to be shouting against with the new product message ourselves. Our spend level does not approach the level that competitor spends on a routine basis. And so, yes, that would be a headwind. I would not say that all the causes of our challenges though, I'd say many of them are in our own hands. And our approach to these things would be the way it's been consistent for a long time. We will address the things we have control over. And I believe it's very possible for us to carve out our place in the fitness market, no matter how much our competitors are spending. It just puts more pressure on us in terms of what we're doing on the creative and marketing side to tell our story better. And do so again with urgency would be the word I would use.

[Operator:]

We will hear now from Michael Kawamoto with D. A. Davidson.

[Michael Kawamoto:]

Hey, guys. Thanks for taking my questions. Just a couple for you. First, on Max Intelligence. I think you guys have done like pop ups and things like that for the Max Trainer. Have you thought about doing similar for Max Intelligence as well as just to tell -- get that message across?

[Bruce Cazenave:]

I think there is -- thanks, Michael. I think there are a lot of possibilities to expand the marketing of Max Intelligence, and of course across different platforms as well. But I think the key thing that would be kind of a secondary priority to getting the message right first, okay? Including, going up back, heavy up in media and things like that, we have to get as bill alluded to, we have to get the message so that there's clarity, there's no confusion about what it can do. And so some of the things we’ve learned in the first two months of introduction and once we have that honed in, then there are other things that open its way up in terms of marketing, social media, pop-ups as you say and other possibilities. But first we have to get the message right and breakthrough.

[Michael Kawamoto:]

Got it. Yes, that makes sense. And then just on the right sizing of business, it sounds like you’ve started the cost reduction, the couple of weeks ago to the extend you can answer. Where do you think additional cuts will come from the near-term and then also I know you’re not giving guidance, but do you think you will update your long-term target once you have more visibility on how you want to manage the business or find the cost run rate.

[Sidharth Nayar:]

Yes, just coming back to your point on the reductions, it's obviously you’re aware of some of the headcount productions that we did make already. We are looking very broadly at contract services, also looking at other things we can do in terms of value engineering within our product -- on a product cost basis. And part of it really is a reflection of clearly the current run rate that we saw in Q4 on Direct, and certainly what we've sort of on Bruce's point on Q1 at least. We recognized that the gross margins will be -- will remain challenged because of the both product and channel mix. So we've had -- we are really looking at ways to mitigate some of that margin decline on a go forward basis. Well, in terms of the long-term guidance, I would come back to just simply saying that, once we have again a better sense of these initiatives, specifically in the Direct side. I think we would be a better position to provide an update on that as well.

[Michael Kawamoto:]

Got it. Thanks for the time and good luck for the rest of the year.

[Bruce Cazenave:]

Thank you, Michael.

[Operator:]

And from Sidoti we will move next to Frank Camma.

[Frank Camma:]

Good afternoon, guys. Thanks for taking the call.

[Bruce Cazenave:]

Okay, fine.

[Sidharth Nayar:]

Thanks.

[Frank Camma:]

Couple of quick ones. Just the first on clarity on the inventory issue, not channel inventory but your own inventory. Did you say that that is -- or would you say that’s equal or across the Direct and Retail as far as being heavy -- or you heavy on one versus the other?

[Bruce Cazenave:]

Actually we are heavy on -- as far as our own inventory shrink, we’re heavy both in retail -- yes, both at Retail, in Retail and Direct. I mean, it's alluded to a lot of it's because we did not achieve the sales we anticipated in Q4 for either business. And then, of course, we did take the initiative at the time we were going into the later part of Q4, there was still a lot of -- still a lot of debate about tariffs and potentially if we could get rolled into that. So we did take a position. I have your position than we normally would have. Just in case those tariffs did affect us. So some of it was self-created and some of it was not self created by design.

[Frank Camma:]

Okay. And a lot of my questions have been answered, but the other one ahead was on international, I mean, the company used to be pretty big internationally. So these days what do you see as the most important international markets.

[Frank Camma:]

The two key markets start with Western Europe. We see as the biggest immediate potential. It's the most mature market. And its where we are resourcing ourselves or just say more heavily than we aren't elsewhere in the world, whether it would be Asia or Latin America, I would say right behind that though would be Asia. Definitely in China, now that speaks both of the commercial side of the business as well as the home market. But the commercial markets definitely very vibrant and growing there. So those would be the two primary markets. And then after that you would get into Latin America or so forth.

[Bruce Cazenave:]

Just seasoned distributors there, is that correct?

[Bruce Cazenave:]

That would be correct.

[Frank Camma:]

Okay. I guess, last question for me. Just kind of stuck out a little bit was the LateralX, are you seeing similar effectiveness of the marketing there as you have in the past with the Max Trainer. In other words, sort of your spending per sales. Can you just talk about that a little bit since that’s a newer product.

[Bruce Cazenave:]

Sure, Frank. we obviously -- we have a much lower spend on LateralX since the launch product. And we are seeing efficiencies at a low spend. The question would be could it sustain higher spend. In comparison to Max Trainer, no, but nothing we've ever launched really launched in the same trajectory as Max Trainer. That’s not surprising. I would consider LateralX much closer to a Tread Climber launch back. It's already showing more promise than HVT did, so we're not overly concerned about that. We do believe the LateralX had pretty good legs for us going forward and it could be one of the things that we hang around on it in terms of potential growth, down the road.

[Frank Camma:]

How did HVT do during the quarter relative to your [multiple speakers]?

[Bruce Cazenave:]

HVT performed a digital only marketing with a strong ROI, but not a meaningful level of revenue.

[Frank Camma:]

Thanks, guys.

[Bruce Cazenave:]

Okay. Thanks, Frank.

[Operator:]

[Operator Instructions] We will hear now from George Kelly with Imperial Capital.

[George Kelly:]

Hi, guys. Thanks for taking my questions.

[Bruce Cazenave:]

George.

[Bruce Cazenave:]

First just a couple on the direct business. Wondering if suing the fourth quarter, I made -- we made said this in your prepared remarks, but did media advertising grow in the fourth quarter? And then have you pulled it back substantially in 2019?

[Bruce Cazenave:]

It did grow a little bit in Q4. And I would say that we continue to spend pretty heavily as we normally would in the first part of Q1, but we have, I would say, we are adjusting to that. And again, in the spirit of trying to implement the learnings that we've had on

[George Kelly:]

Okay, okay. So it has since the busiest period in January, you have pulled it back to kind of try to figure out how to perfect the message around Max Intelligence. Is that a fair characterization?

[Sidharth Nayar:]

Yes, yes. Although I would say George is typically that pull back that would have been a scale pull back in every given years. So January is always the heaviest sped time and then obviously Feb and March tall off media wise.

[George Kelly:]

But I guess just comparing it to a normal season like comparing it to last year. Do you expect for -- I don't know how long -- that’s to get to specific, but are you pulling back versus last year and versus previous expectations. And when do you expect to come more heavy again within new message?

[Bruce Cazenave:]

I think. We will -- you will see potentially a slightly less media spend in Q1 versus prior year. Not so much at the beginning of the quarter, but towards the end as we're getting in now, okay, the slower part, as Sid mentioned, but keep in mind, it's not -- we are not backing off like we might have done last summer or back in the elections in '16. Nothing like that, okay? So, we believe we need to keep that baseline going and we are going to -- as we go, we will adapt the message and then be testing into heavier levels.

[George Kelly:]

Okay, got you.

[Bruce Cazenave:]

Does that answer your question?

[George Kelly:]

Yes, it does. And then next on the Direct segment, the Intelligence platform or is there -- I understand it's mostly about the messaging, but are there any sort of major or more significant product gaps in that platform or improvements that you are making things that you’ve heard back from customers as you do your surveys that will come back sometime later this year that you will introduce?

[Bruce Cazenave:]

Yes, George, I think we've already adapted to some of the feedback we’ve gotten around some of the feature sets we’ve been hand or -- we are deploying enhancements almost on a weekly basis. Now some of those early on, we are -- what I would call, squashing mugs, there were unusual connectivity issues on certain parts of the Android platform and things like that. But now we are getting more into users what we thought users would use in terms of features compared to what they are actually using for features, and that’s helping us to drive our enhancements of where do we want to go with this to better serve the customer. But we’ve already rolled out multiple updates, including closer integration of our Feed.fm investment and that capability in Bowflex Radio. We've also rolled out integration with RunSocial, which we acquired. So -- and there will be other features, almost as a matter of routine throughout the next few years as we expand both the product breadth in terms of compatibility with our products, as well as the feature set within the platform itself. So there's quite a bit of work going on there. And as Sid alluded to, still some capital being expended towards that.

[George Kelly:]

Okay.

[Sidharth Nayar:]

Yes, the level of the information we get, George, compared to what we used to get before we had Max Intelligence, it's just not comparable. I mean, we can see daily what activity, how many people, how many minutes they’re working out or hours they’re working out, their level of satisfaction. I mean, it's just constant feedback of thousands of users. So that goes back into our artificial intelligence, but also helps us fine-tune the things that Bill is talking about in terms of the next levels of features that we need to bring to market.

[George Kelly:]

Okay. And then last on Intelligence, what about the price point, do you still feel comfortable with what you've been charging? Have you tested any different price points?

[Sidharth Nayar:]

We’ve not tested different price points. We did quite a bit of research going into where we set our pricing at. We feel it's very competitive compared to the market where it sits now. So we’ve not tested any price points. We may experiment a little bit with trial periods going forward, which seems to be a pretty common approach in the industry, but I don’t anticipate us changing our price point in the near future.

[George Kelly:]

Okay. Okay. And then one question on the Retail business. In your press release, you highlighted that the inventory issue is around mass. Is that -- is it just isolated there and can you remind me how much of your Retail business is through mass?

[Bruce Cazenave:]

The largest part of the Retail business is through mass channel, the mass retail. And what was the other question, part of the question, I'm sorry?

[George Kelly:]

I was just wondering if you are seeing inventory issues across more -- if it's broader, if it's specific -- I understand it's the largest part, but what about web and the specialty and everything else?

[Bruce Cazenave:]

No.

[Sidharth Nayar:]

No, and I think this comes back to, I think the combination of what we talked about around expectations. I think both, number of our retail partners as well as we thought that we'd -- even though the sell-through was strong, we had really anticipated even stronger sell-through and I think this is a result of not quite meeting that.

[George Kelly:]

Okay. Thank you.

[Operator:]

We will hear next from Brennan Matthews with Berenberg.

[Brennan Matthews:]

Hi. Thank you very much for taking my question.

[Bruce Cazenave:]

Hi, Brennan.

[Brennan Matthews:]

I wanted to first ask about kind of gross margin. I know that you're not giving any guidance, but just maybe if you could kind of walk us through some of the puts and takes at least through the first half of this year. I know you guys are kind of lapping some higher product costs last year, but then you’ve got the new subscription platform as well as kind of some of the higher inventory. So, I mean, just any more information you could give us on how we should we may be thinking about that when it comes to our model?

[Sidharth Nayar:]

For 2019, I’m not sure I can give you any specifics, Brennan, kind of things through what I can -- I mean, I think just broadly, obviously just based on Q1 with revenues down, you will have -- you will be pressured on gross margins for sure in Q1.

[Brennan Matthews:]

Okay. No, I completely understand. And then I also wanted to ask just a little bit more on competition and I'm not talking about the other really subscription platforms out there, but I know that the club as far as I kind of -- gym subscriptions have been pretty strong, you've seen budget gym growth, your Planet Fitness type model doing pretty well. Do you think that’s had any impact on just overall consumer demand for home fitness?

[Bruce Cazenave:]

We are still seeing -- if the industry data would be correct, we are still seeing solid low single-digit growth year-over-year in the home market. There's definitely a good growth in the commercial space and it is budget level gyms and it also is the high-end gyms where the premiums or the subscriptions go up to over $150 a month. You know, sometimes it's the middle segment that maybe struggling a little bit more between the budget and the high-end gyms. But I would say that’s just general there's good activity across all. What we do know is that there's more and more of a convergence between people who will go to a gym, but also want the home equipment at home. And the last time we got to beat on that, it was approximating almost 50%. And obviously some people are limited, they don't have the space to have a home product, but those that do, generally they will also have some equipment at home. So -- and the commercial industry is realizing that, there's not so much of a differentiation and there's actual partnerships developing between how do you transfer the activities that you are doing at home, outside or in the gym and keep track of all of that on one platform. So that’s an indication of how it's all converging.

[Brennan Matthews:]

Okay. That makes sense. Thank you so much, guys. That's all I have.

[Bruce Cazenave:]

Okay. Thanks, Brennan.

[Operator:]

And from B Riley, we will move to Eric Wold.

[Eric Wold:]

Thanks. Good afternoon.

[Bruce Cazenave:]

Hi, Eric.

[Sidharth Nayar:]

Hi, Eric.

[Eric Wold:]

A few follow-up questions on some of the ones have been asked. I guess, one on the question around, what kind of testing price points for the product. Is that -- well, you kind of answered that, are you referring to the baseline pricing or there been kind of any test on discounting levels ramped up in your, guys, discounting or kind of changes in that into the new year kind of jump-start the matters, does that stay static?

[Bruce Cazenave:]

We have in the Direct side, we have not tried promotional pricing on the subscription itself, but certainly we have a normal rotation of promotional pricing on our products, that’s again pretty routine. We did do some deeper discounting as we started to see some demand challenges and that is a small contributor to the margin pressures that we have. But the bigger ones are around, as Sid alluded to, the product mix, et cetera. I wouldn't say that deep, deep discounting is going to be our answer. We really need to create more demand at the top of the funnel, more web traffic, more awareness of the product and then conversion is still occurring in a reasonably good level, once we have folks coming into the top of the funnel, so to speak.

[Eric Wold:]

Okay. And then kind of at the marketing spend, I guess coming out of Q1, or kind of during the Q1, you mentioned it kind of started to dip a little bit toward the end of the quarter more than normal. Do you expect that's going to ramp up in the back part of the year or is that the overall marketing this year is comparable to last year, or should we expect it to be down or up or how should we think about that just trend wise?

[Sidharth Nayar:]

Yes, it's kind of getting a little bit in the outlook. I would just say that the expectation would be that we -- with the revamped marketing messaging that you're going to get improved return on the spend as we get to the back half. So, I would hope that the spend would be lower, but that the effect on the top line is better. I don't know if that answers your question.

[Eric Wold:]

That does help. And I guess lastly, maybe walk through the process of taking the digital platform to other modalities [ph], I guess, how long do you expect that to -- do you want to kind of make sure you've got Max Trainer and the messaging right there before you try to push onto other modality, kind of what's the cost, the timeframe kind of all that, that will be necessary to get that? And could it happen by this coming holiday [ph] season, an effective launch, or is that something more to think about into 2020?

[Bruce Cazenave:]

Yes, I think it's important that we move in parallel path on that and that we definitely mean to perfect our messaging around Max Intelligence and its relationship with Max Trainer, the product. But we also need to expand the presence of Max Intelligence on other modalities and we will probably talk more about that in the May call, which modalities are coming and we will have some this year -- or we currently anticipate to have additional products this year, I should say. And I would say again, parallel path because perfecting the message of Max Intelligence and Max together is a pretty big task. But at the same time, it also gives us more options for where we go with messaging, if we’ve other modalities that the digital platform is compatible with. Further, in theory, that would allow us to expand the Max Intelligence platform into the Retail space as well where we are having success growing our market share and it would be our ultimate desire to be able to utilize Max Intelligence throughout most of our product lines in the Company and we are committed to that path beginning this year.

[Eric Wold:]

Okay. And then just a quick follow-up on that, it kind of the pattern last year, if I recall was, you are going to relaunch Max Trainer in the fourth quarter with Max Intelligence, you kind of pulled back on the spend into that launch. Would we expect a similar pattern this year launching a new modality with it -- in and around the holiday season kind of a pullback into Q3?

[Bruce Cazenave:]

I think it's too soon for us to say. It would be our desire to follow the more normal media pattern. Assuming all goes well with our testing and we find messaging that works, then we would adjust our media spend based on the more normal historical seasonality, which still would be heavier in Q4, but perhaps not cut back as far in Q3. But I would say, we will probably have more to say about that as the year goes on, it's too soon to say we'd like to continue the work we are doing right now in terms of identifying good path to go with our messaging and spend.

[Eric Wold:]

Thanks, guys.

[Bruce Cazenave:]

Hello?

[Operator:]

Eric, did you have anything else?

[Eric Wold:]

No, I’m all set. Thank you.

[Bruce Cazenave:]

Okay. Thanks, Eric.

[Operator:]

Okay. Thanks. We will go next to Rommel Dionisio with Aegis.

[Rommel Dionisio:]

Thanks very much. Good afternoon. Bruce, as you talked about cost cuts and I realize it's probably going to hit in several different areas, but you've been such an innovative company over the last -- more than a decade now. To what extent will those cost reductions impact your pace or cadence of product innovation, just on a longer term basis going forward?

[Bruce Cazenave:]

Yes, we were -- let's say, we did implement the work force reductions basically across every part of the country -- company and including internationally as well. I would say that, given how the company is transforming itself to become more digitally focused and getting Max Intelligence going and so forth, there were things that we could do even in the product development world where we could realign -- where we need the resources to support the next level of development and acceleration. I'd say that when we made these cuts, we looked at our product roadmap and the priorities over the next 18 months and we tried to ensure that none of the cuts would affect our ability to introduce those products on schedule. And so, that was one of the criteria that we applied at least to that specific part of the company.

[Sidharth Nayar:]

And I think longer term -- yes, and also longer term, I think sort of the way this is scaled, it's still focused on delivering new products each year when we look at the 3-year product roadmap, that is really aligned with both Max Intelligence Platform, but also some of the new products that we know we need in Direct and in Retail, two years from now or three years from now.

[Bruce Cazenave:]

What we had to do, Rommel, to give you an idea on how we decided essentially, we went through an exercise where we looked at all the priorities the company had, and I'm talking about everything from supply chain to product et cetera, technologies, and we went through a heavy reassessment of what are the key priorities and which ones give us the biggest impact, okay, in terms of revenue and profitability going forward. And those that didn’t meet that mark are ones that we looked at, okay, what can we do there to redeploy resources into the ones that do give us the return. So we went through that exercise. It probably took us -- we actually started it even in Q4, but that’s part of what went into the decision making process of finding what we could do this year.

[Rommel Dionisio:]

Okay. That’s helpful. Thanks so much.

[Bruce Cazenave:]

Okay, Rommel.

[Operator:]

At this time, I would like to turn things back to Bruce for any closing remarks.

[Bruce Cazenave:]

Very good. I want to thank everyone for joining our call today and your continued interest in Nautilus. We look forward to providing another update on the business in our first quarter earnings call in a few months. I hope everyone has a great rest of the day. Thank you.

[Operator:]

That does conclude today’s conference. Again, thank you all for joining us.