Nautilus, Inc.
Q4 2022 Earnings Call Transcript

Published: 23 May 2022

[Operator:]

Greetings, ladies and gentlemen and welcome to the Nautilus, Inc. Fourth Quarter 2022 Earnings Conference Call. It is now my pleasure to introduce your host, Mr. John Mills. Thank you. You may begin.

[John Mills:]

Thank you. Good afternoon, everyone. Welcome to Nautilus’ fourth quarter and year end fiscal 2022 conference call. Participants on the call today from Nautilus are Jim Barr, Chief Executive Officer and Aina Konold, Chief Financial Officer. 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 press release was issued today at 1

[Jim Barr:]

Thank you, John, and thank you all for joining us today. As we have closed out fiscal ‘22, I’m very pleased with the progress of our transformation, and we are well positioned to continue our momentum as we begin fiscal ‘23. On today’s call, I’ll cover four key points

[Aina Konold:]

Thanks, Jim. Today, I’ll be speaking to total company results for Q4 and will provide guidance for fiscal year ‘23. Please go to our website to view our press release and the slides accompanying this call for more information on total company full year ‘22 results and for additional information on our segments. I’ll start with Slide 16 of the presentation, P&L results for Q4. As discussed previously, we delivered the two highest sales quarters in our company’s history in the back half of ‘21, fueled in part by pandemic-driven demand. Given the unique nature of last year’s results, we will talk about sales growth versus last year fiscal year ‘21 and versus last, last year fiscal year 2020 to gauge our growth and overall company improvements when compared to more normalized results. Net sales for the fourth quarter were $120 million, down 42% versus last year and up 41% versus last, last year, excluding Octane. Gross profit was $21 million and gross margins were 18%, down 21 points from last year. 16 points of the decline were related to higher product costs, logistics and increased discounting. The remaining 5 points are related to JRNY investments. Turning to operating expenses on Slide 17. We closed on the acquisition of VAY in Q2 ‘22. The next few lines of the P&L have been adjusted to remove costs associated with the acquisition. Please see our press release for a reconciliation to GAAP. Adjusted operating expenses were $42 million or 35% of sales versus last year’s $39 million or 19% of sales. Selling and marketing expenses and adjusted G&A expenses were flat in dollars to last year, but deleveraged as a rate of sale. R&D costs were up $3 million, primarily driven by investments in JRNY. In fiscal year Q4, advertising was $14 million versus $12 million last year. And JRNY OpEx was $5 million versus $4 million last year. Adjusted operating loss was $21 million, and adjusted operating margins were negative 18%, in line with our guidance. And lastly, adjusted EBITDA loss from continuing ops was $17 million or negative 14%. On Slide 18, we included a waterfall that describes the year-over-year change in operating margins. The drivers of the year-over-year decline are increased product costs, logistics and discounting, higher levels of investments in JRNY and incremental advertising. Turning now to the balance sheet as of March 31. Cash was $14 million. Inventory at March 31 was $111 million, down versus the $128 million at December 31 and up versus $68 million 12 months ago. We’re really pleased with how we’re managing inventory down. About 14% of the balance at year-end was in transit. And importantly, our inventory is concentrated in our best-selling SKUs. Over quarter of our inventory cost is in SelectTech weights and benches, which include high NPS product like our 552s. AR was $61 million, and trade payables were $53 million. Debt was $29 million versus $13 million at year-end. And we had $66 million available for borrowing on our facility. Before we turn to our expectations for fiscal ‘23, I want to talk about liquidity. We had about $80 million of liquidity at year-end. And even with the seasonally lower Q1 revenue, we are comfortable about our liquidity coming into the year. Jim spoke to our ability to navigate the near-term macro headwinds. Our confidence stems from the framework we use as we are planning North Star. We started our strategy work pre-pandemic, and at that time, we assumed growth would come from taking market share. We knew we needed fuel for growth, so we made focusing decisions like selling Octane to free up resources for North Star. We also prepare for the inherent volatility in this industry by creating a cost structure that was more semi-variable versus fixed. We’ve intentionally used a combination of employees and key outsource partners to execute against our initiatives, growing headcount by only 20% since year-end 2020. This type of org structure allowed us to ramp up quickly during the pandemic, adding supplier partner capacity in Asia to meet demand and onboarding tech partner resources to accelerate JRNY development. Today, this structure gives us the flexibility to ramp down if needed in response to volatile sales. Turning now to fiscal ‘23 guidance on Slide 20. For fiscal ‘23, we expect to return to a more typical pre-pandemic seasonality, with the second half of the year contributing more of the full year’s revenue. Typically, the first quarter ending in June is the lowest revenue quarter, with September quarter being second lowest. The third quarter ending in December is usually the strongest, with the fourth quarter ending in March being the second strongest. As we started doing in the back half of fiscal year ‘22, we will be comparing our sales to the same period in fiscal year ‘20, as we believe comparing to the last pre-pandemic year allows us to better gauge our growth and progress. We expect Q1 fiscal year ‘23 sales to be between $45 million and $55 million or $50 million at the midpoint. This represents growth versus pre-pandemic Q1 2020 of 4%, excluding Octane. The more muted growth versus fiscal year ‘20 is driven by softer demand this year as retailers are still working through elevated levels of inventory. Given lower top line and deleveraging of fixed costs, we expect Q1 fiscal year ‘23 adjusted EBITDA loss of between minus $22 million and minus $27 million. Turning to second half and full year ‘23 guidance. We expect full year revenue of between $380 million and $460 million. At the midpoint, this represents about 52% growth versus fiscal year ‘20, excluding Octane. Elevated inventory levels at retail partners are slowing down reorders and shifting them to later in the year. Therefore, we expect the second half to represent between 65% and 70% of full year sales, slightly higher than pre-pandemic second have seasonality of approximately 60%. We are expecting the start of gross margin recovery in the second half and expect gross margins to be in the range of 27% to 30%, driven by key actions we’ve taken, particularly in supply chain of North Star pillar. We expect lower inbound freight as we’ve negotiated new rates that while higher than pre-pandemic are much lower than the spot market rates last year, lower detention and demurrage fees as we’ve digested the inventory we purchased last year. We plan to close one of our DCs at lease expiration this fall, and we won’t be renewing leases for some of the storage locations we obtained at the height of the pandemic. Additionally, we’ve negotiated lower costs for our top SKUs. New incoming inventory will have a lower cost base. And lastly, while our guidance includes room for discounts to be competitive during fitness season, our better inventory position reduces some of the pressure relative to LY. Given higher sales levels in the second half, improved gross margins and our continued cost discipline to align variable costs in line with sales, we expect to deliver positive adjusted EBITDA for the second half of fiscal ‘23. And we expect full year adjusted EBITDA loss of between negative $25 million and negative $35 million. Lastly, we expect JRNY members to cross the 0.5 million mark at year-end ‘23. The Board and the management team are committed to creating enduring shareholder value through our North Star transformation. We intend to continue appropriately balancing short-term with long-term and believe we have the liquidity and the flexibility to navigate through this challenging environment. I’ll turn it over now to Jim for his final comments.

[Jim Barr:]

Thank you, Aina. I’m pleased with the progress we made in fiscal ‘22. Looking forward, our opportunity is great. We have created the right strategy and made the right incredible progress, all while executing in a disciplined way navigating an incredibly volatile environment. I’m very proud of our people in doing this. So let me end by thanking all of our employees and all of our partners for their tireless dedication in support of our mission. I’d now like to open it up for questions. Operator?

[Operator:]

Our first question comes from the line of Steve Dyer with Craig-Hallum. You may proceed with your question.

[Steve Dyer:]

Thank you. Good afternoon. If I could start with just a couple on JRNY, first of all, your guidance suggests 500,000 members as of March 31 of ‘22. I presume that, that was supposed to read ‘23.

[Jim Barr:]

Yes.

[Aina Konold:]

Yes. Sorry about that. Thank you.

[Jim Barr:]

Good catch.

[Aina Konold:]

Thank you.

[Steve Dyer:]

Got it. No problem. And then just interesting slide, 2.7 million installed base. Are you having any success with JRNY kind of cultivating that installed base? Or are you finding your new subscribers or your new members to come sort of primarily at the time they buy a new piece of equipment?

[Jim Barr:]

Yes. I mean, as we said, it – I’ll just start and, Aina, I don’t know if you want to add anything to it. So as we said, when we had the original member goal of 250,000, we announced at Investor Day a year ago, we talked about there being three ways to get to that number. One is attaching to products at the time that you purchase them. Two was to go back to the installed base. And three was partnerships over time. And of course, when we’re talking about a 5-year period, we want to consider all of those paths, and we will continue to look at all those paths. So for sure, selling at the time – selling the subscription and attaching at the time of purchase is an important thing, in particular in Direct, where we have the ability to do that kind of nearly 100%. In Retail, it’s a little bit tougher. We have to use some creativity to do that. But yes, that’s very important. And of course, when we start talking about things like churn, you’ll see that it’s lowest when it’s in the console or an embedded experience and it’s more variable in a BYOD experience. But yes, we’re having success on all of those fronts, especially attaching to the products we sold. That’s why that connected fitness JRNY-enabled portfolio that we began really shipping in the last 18 months or so has really built that installed base. And that part is super important. And then it’s a big number when you look at dumbbells and C6 and IC4 and we call the more connectable instead of embedded. Those would be like BYOD things. It’s a little bit less of a take rate, which is exactly what we expected when you go back to that. But really, the one thing we did see this year is the reorder rate of our equipment go up. And one of the reasons we think that reorder rate is going up is because people don’t want to really have a different app for each piece of machinery they have. It used to be – this industry was a bit more one-and-done, and your second purchase didn’t have much to do with the brand affiliation of your first one. And we think that’s really changing because we got a doubling of that repurchase rate. But long story short, yes, we are seeing success across that, about what we expected.

[Steve Dyer:]

Got it. Thanks Jim. As it relates to new products going forward, you guys have done a very good job in the last several years of sort of rationalizing, I guess the SKU base and really focusing. As you look forward, should we think about new products, new SKUs, or is that primarily going to be focused, the innovation, so to speak, more on journey and the connectivity there?

[Jim Barr:]

No, it will be on all. I mean really, we – when we talk about our mission, we talk about connected fitness experiences. And we define that as typically a machine, software and some content. That’s what keeps people working out longer. It gives them the variety they want. So, we are looking to innovate on all those fronts. We think – we are looking at the way stuff I was talking about today, that’s a good start. We are not ready to announce our future products there, but we have done a pretty strong job on cardio. We are doing more on strength, and we are also – there is a few items in cardio that we will be working on, but we are not ready to announce all those. But yes, mechanical engineering is alive and well here at Nautilus. It’s not just about the digital experience. You look at products like VeloCore that does something different anything else does and being able to have their kind of a revitalization of the Max Trainer. We still strive to innovate on both of those levels, both the software and the hardware.

[Steve Dyer:]

Great. Thanks very much. That’s it for me. Good luck.

[Jim Barr:]

Great. Thank you.

[Operator:]

Our next question comes from the line of Mark Smith with Lake Street Capital Markets. You may proceed with your question.

[Mark Smith:]

Hi guys. First off, I just wanted to ask a little bit about pricing. Can you guys talk about if you are taking any, if you have the ability, and kind of where pricing is at today?

[Jim Barr:]

Yes. So, it’s a great question. Of course, we have to continue to monitor the macro. But we have taken some price increases on some core products. So far, they have been holding. But as we discussed, demand has been lower than expected. So, we will have to continue to monitor that. It has a lot to do with what’s going on competitively in the marketplace. As you saw, we did a fair amount of discounting, as did everyone in the industry, in the holiday season. You kind of have to follow in the season. It’s a little bit more optional in the offseason. You have got to make your hay in the season. So – but right now, we are just looking product-by-product. We have been able to take price on several of them, and we will continue to monitor it.

[Mark Smith:]

And that leads to the next question, just discount environment. What does it look like today kind of out of season primarily at retail?

[Jim Barr:]

Yes. I think – great question. I think it looks pretty normal, right. We saw a lot of discounting over the fitness season. But it started to regulate kind of right after January. We have had more – I think everybody runs like a Mother’s Day sale, and everyone will run some sort of Memorial Day sale. But and we will – we ourselves are doing kind of some flash sales and things like that. So, yes, everybody is doing something to move it, but you can really make more choiceful decisions. And again, it’s really focused on the market, but we have seen that come way down to a seasonal level. And also, I will say, you didn’t ask about this, but also what we have really seen over the last quarter or so is we look at our competitors’ advertising and our own advertising. Obviously, we pulled back as this has happened, and I think pretty much everyone, but Tonal, has pulled back on advertising. So, we are kind of more in line with everyone else, and that is somewhat related to the discounting question is how often you are out there.

[Mark Smith:]

Okay. And so in that advertising, as we look at the waterfall on operating margin this year versus a year ago, as we look forward, should we expect to see that advertising impact being less significant moving forward?

[Aina Konold:]

So, great question. So, on a year-over-year basis, especially when comparing to last year, last year still benefited from a lot of the pandemic driven. We didn’t need to advertise as much, right. It was our highest ever quarter ending March last year. So, some of that is going to be less of an issue on a year-over-year comparison, ‘23 to ‘22. Also in ‘22, we did a lot of brand advertising, and that might moderate in fiscal year ‘23.

[Mark Smith:]

Okay. And then I think the last one from me. Just big picture, as we think about JRNY here, 110,000 subscribers versus 325,000 members. If we think about that ratio, what are you looking for? What do you feel like is a healthy place to be or even a goal to be at?

[Jim Barr:]

Yes, we are not providing goals on that. But as we – I know everybody has been itching to get more information on JRNY. And of course, we are trying to balance giving information to our competitors and giving the right things that we find will be helpful to you and to our other investors. So, we will continue to offer more over time. We have picked a set that’s expanded from what we have traditionally given, and we will continue to expand that further. As I mentioned about the churn, too, that’s kind of one thing that everybody asked about. But when you are doing a lot of these free trials, which we are right now, and we will kind of come up in the September, October, November timeframe, which is exactly as we designed, then those churn numbers will be a lot more understandable than it would be right now. So, that was also part of it.

[Mark Smith:]

Okay. Great. Thank you.

[Jim Barr:]

Thank you.

[Operator:]

Our next question comes from the line of Matt Curtis with William Blair. You may proceed with your question.

[Matt Curtis:]

Hi, good afternoon. Thanks for taking my question. I want to ask a question on the full year EBITDA guidance 2023 – that’s pretty significantly. I think you were at positive previously for the full quarter. But could you just clarify the main reason for the shift, primarily the slowdown in retail demand, or is it more related to other things like maybe higher than expected commodity inflation greater supply chain pressures or something else?

[Aina Konold:]

You were kind of breaking up a little bit in the beginning part of your question. But I think what I heard you say is you are asking if we had thought that it would be for the full year that we would have breakeven adjusted EBITDA and you are asking why is it only the second half? Can you confirm?

[Matt Curtis:]

Yes. Sorry. It’s just that your previous ‘23 EBITDA guidance was positive and it’s been – now it’s significantly negative. So, I am wondering if the main reason is the slowdown in retail demand versus your prior view, is it more related to it or something else?

[Aina Konold:]

Yes, it’s more related to the slowdown in the demand and especially a lot of the shifting of the top line from the first half to the second half. So, it’s more related to that. We are actually seeing for inflation. We are expanding gross margins. So, we are able to do things to kind of do some – take some actions against cost. But really, the main reason for the decline versus our previous expectation is the lower retail reorders, which we think is affecting the first half of the year.

[Jim Barr:]

And I will just add that on the gross margin, it’s a combination of things that we hope, of course, like commodity prices that we don’t control and FX. But there are – we have line of sight, as I mentioned, to things that we actually control. We paid for a lot of storage last year. We don’t have to pay for that storage this year. We will be down a DC this year. We have got a number – what else…

[Aina Konold:]

Detention and demurrage, we have digested the inventory. They were very – and naturally just even the great work we are doing with the top SKUs. When you rationalize your SKUs and you really are focusing your assortment, you can do a lot of work to make sure that the suppliers are able to get good costing and pass it on to us on those top 30 SKUs.

[Matt Curtis:]

Okay. Got it. Thanks for that detail. And then, I guess on the retailer inventory levels that are elevated right now. I mean when do you think they will be able to kind of work their way through this access? I mean is this something more near-term where they could get through it potentially by the end of the summer, or would this take longer?

[Jim Barr:]

Yes. First, I will say that each retailer is in a different position. And we have better visibility into some than others. They choose to share with us sometimes and not others. But right now, we have got a pretty good view of that, and it does vary by retailer. It really does depend on a couple of things. First of all, consumer is buying, right. So, if consumers stop buying, that will be later. If they continue buying, then that will be earlier. And it’s really just a number of different factors there. I think it’s also – there is also going to be some risk-taking that I would guess, and this is just my speculation, retailers that are over-inventoried would typically order maybe 90 days in advance of needing the inventory. And so we would start to see that in the second quarter for the holiday season, the fitness season. My guess is that you may not see that, that they may be a bit more risk-averse in moving that inventory. And then we will – we may see the orders that would normally come and second also come into third. And they will expect us to react more rapidly than 90 days. They will expect us to have the inventory in our warehouse. And the good news is we actually do have inventory. So, not for any retailers listening, but that is something I think we would expect to see.

[Aina Konold:]

And then I will just – the only thing I would add to that is that’s a little bit what’s driving the wide range in our full year expectation is, on the lower end, it would mean that it took them a bit longer to clear it through and then on the higher end that they are able to clear it through by summer, early fall.

[Jim Barr:]

And by the way, it’s not like we say you are on your own on this stuff, too. So, I mentioned a few times, we work with the retailers. They have map windows where they have to sell where they can sell at below typical prices. We are working with them to be able to clear that inventory occasionally. And then we coordinate that with our own direct business to make sure nobody is at a disadvantage when we do that. We actually have the same leader now running both direct and retail running North America overall. And we are better coordinating what I call our omnichannel execution.

[Operator:]

Our next question comes from the line of George Kelly with ROTH Capital Partners. You may proceed with your question.

[George Kelly:]

Hi everyone. Thanks for taking my questions. The first one for you is just about your inventory balance. Curious if you could give us any kind of target, or I am just trying to figure out how much drawdown could there be in fiscal year ‘23? Like where do you target inventory to end the year?

[Aina Konold:]

It’s, Aina. Great question. We haven’t really previously guided to like ending inventory balances, but I would tell you that I prefer it to be more like 13 weeks, 15 weeks out rather than the current level. So, we have a fair bit to go. But as Jim just said, it’s actually a little bit of silver lining, having all this inventory because of what’s happening with the retailer environment. If they are unable to order FFO, factory-fulfilled at their normal cadence and they want it in time for holiday, it’s helpful to us to have it already in our DCs.

[George Kelly:]

Okay. And then second question from me is on the SelectTech-JRNY, the tech enhancements that you are beta testing. I didn’t quite follow in the prepared remarks, trying to keep up. But can you just go through the big features that you are testing there?

[Jim Barr:]

Yes. I mean really, we started by connecting JRNY to SelectTech with, call it, some trainer-led videos, right, that walk you through various workouts with SelectTech. And that’s compelling. And we are providing that. But really what VAY adds is, is the tech element of that and kind of the – it works by itself element of it. So, the first thing is really rep counting. So, you are standing in front of a phone or a normal camera of any sort, and we will be able to count your reps, how many curls you are doing, all those types of things. And then the second thing that I am excited about is what we call phone coaching. So, if you are doing it wrong, whether it’s a floor exercise or it’s a JRNY dumbbell exercise in a way that might hurt you or not get the maximum benefit in your workout, we will coach you actively with voice coaching to tell you that you haven’t done it correctly. So, that’s – those are the two things I really like. So, then you add that to an expanding library of content and you start to have a really compelling experience. And that was our whole view in buying VAY other than getting great software engineers to attack any problem and help us be a more digital company also really bringing home those features.

[George Kelly:]

Okay. And then last question, the guidance, the back half weighting on guidance, is that – I understand the normal seasonality. But are there any kind of new product launches that are influencing that guidance, or is it really just a return to normal seasonality?

[Aina Konold:]

It’s primarily a return to normal seasonality. We typically, at this time, wouldn’t talk about new products that are coming in. But it’s primarily just return to seasonality, driven really by the lower first half because of the retailer-elevated inventories.

[George Kelly:]

Okay. Understood. Thank you.

[Jim Barr:]

Thanks George.

[Operator:]

Ladies and gentlemen, we have reached the end of today’s question-and-answer session. I would like to turn this call back over to Mr. Jim Barr for closing remarks.

[Jim Barr:]

Thank you to everyone on the call today for your continued support of Nautilus. We look forward to talking to you again on our first quarter fiscal ‘23 earnings call in August. Have a great rest of the day, onwards and upwards.

[Operator:]

This concludes today’s conference. You may disconnect your lines at this time. Thank you for your participation. Enjoy the rest of your day.