Nautilus: A Sporting Goods Maker To Look Out For

| About: Nautilus, Inc. (NLS)

For many people, weight loss is an ongoing issue. Achieving a healthy weight requires a lifestyle change, and that is something that diet pills cannot provide. Troublesome side effects are often a deterring factor for those considering taking weight loss pills on a long-term basis, and it can be difficult to predict what the long-term effects will be. According to MSNBC, many people who stop taking weight loss pills end up putting weight back on. Ongoing exercise and healthy eating is the only way to keep the extra weight off for good.

The number of people experiencing the disadvantages of 'the magic pill' is increasing, as well as the number of people prepared to actually really change their lifestyle. Whole foods stores have experienced a noticeable increase in revenue and customers the last couple of years, as most Americans start to see they really need to start living more healthily.

A small cap company that might be well positioned to attract people who really want to change their lifestyle is Nautilus Inc (NYSE:NLS), a pure fitness company that provides tools and education necessary to help people achieve a fit and healthy lifestyle. The company contains 6 well known brands: Nautilus (maker of high-quality cardiovascular equipment), Bowflex (maker of home exercise gyms), Schwinn (market leader in cycling equipment), Corebody Reformer (a fitness breakthrough built specifically to reform a woman's body), Peak Fit System (a box of DVDs which contains 8 different workouts) and Universal (offers a line of kettlebell weights and weight benches)

Strength and growth opportunity
Nautilus' biggest strength is probably its capability of targeting a very wide range of customers. Not only fitness enthusiasts but also individuals who are seeking the benefits of regular exercise could become customers of Nautilus. One should not forget that many people often get discouraged to go to the gym as they are intimidated by more experienced fitness attendees and just feel more comfortable at home. Nautilus' brand Bowflex is specialized in making gym equipment for home-usage. This way, 'newbies' will be able to prepare themselves privately and might become member of the gym after they've become confident enough.

Nautilus' biggest growth opportunity is currently coming from their cardio products (especially the Bowlfex TreadClimber is very popular) as cardio represents the largest component of the fitness equipment market. Consequently, Nautilus' advertising emphasis has shifted toward cardio products. Through this advertising, cardio products represented 81% of the company's 'Direct channel' revenue in 2012 compared to 56% in 2010.

Little interesting side note: the Bowflex TreadClimber cardio machine, model TC20 has been selected as the 2012 Readers' Choice Award for Best Premium Treadmill. This shows us that Nautilus is one of the leaders in the industry with a lot of know-how and expertise.

Innovation is a vital part of Nautilus' business
Innovation is very important for companies like Nautilus. Without innovation, no new products would be launched and customers would leave after having used Nautilus' -by then- outdated equipment. To ensure new product designs and innovations, Nautilus leveraged their research and development capabilities. Research and development expenses were $4.2 million in 2012 vs. $2.9 million in 2010. Nautilus' R&D expenses will, of course, continue to increase in 2013 and future years. Due to these extra investments in R&D, Nautilus was able to successfully launch 4 new products in 2012 who definitely contributed to the $13M revenue increase.

Sales of Nautilus are typically strongest in the first (New Year's resolutions) and fourth quarters and are generally weakest in the second quarters. Various factors such as the broadcast of network season finales and seasonal weather patterns, influence television viewers and cause their advertising on cable television stations to be less effective in the second quarter than in other periods. In addition, during the spring and summer months, consumers tend to be involved in outdoor activities, including outdoor exercise, which impacts sales of indoor fitness equipment. This seasonality can strongly affect Nautilus' working capital. It's very important to look at Nautilus' first quarter to ensure the rest of the year will be good. If the first quarter is already bad, then the other quarters will probably be even worse.

Nautilus during and after the recession
While the industry hasn't been completely recession proof, it has remained remarkably resilient due to consumers' increasing desire to improve health and well-being and fight obesity and other health-related illnesses. "In 2009, gym membership and attendance was actually at its highest," says industry analyst Dmitry Kopylovsky, referencing data from the International Health, Racquet and Sportsclub Association. "Not only did people have more leisure time, but they were also working out more to relieve stress related to the recession."

So even though the industry performed quite well during the recession, Nautilus did not. Why was this? During 2008, 2009 and 2010 the company made losses of $90.59M, $53.3M and $22.84M respectively. Thankfully, after the takeover by Sherborne, a lot of things changed at Nautilus. Under new leadership, Nautilus streamlined its operations, sold off its Pearl Izumi athletic clothing and footwear brand and canceled its planned Land America acquisition. Nautilus' 2006 10-K described Land America as its Asian manufacturing partner.

In 2008, Nautilus had a commercial segment, a direct segment, and a retail segment. The commercial segment sold exercise equipment to gyms, schools, hotels, and other organizations that offered exercise facilities for their visitors. The retail segment offered exercise equipment through fitness stores and other retailers, and the direct segment used infomercials and other marketing channels to sell exercise equipment directly to shoppers. The recession convinced Nautilus to streamline even further. Nautilus decided to get rid of its commercial segment in 2009. Nautilus' retail and direct segment remained.

After these changes, Sherborne distributed its Nautilus shares to its investors in 2011. The activist investor group left a profitable exercise equipment maker behind as Nautilus reported income of $1.42 million in 2011. The turnaround effort picked up more steam in the following year as the housing market recovered. In 2012, Nautilus' net income soared even higher, to $16.9 million.

Nautilus' share price has continued its recovery. This exercise equipment company reported 7.5% sales growth in 2012. With a forward P/E of 14.7, Nautilus might not be the best deal around. Long term income growth around 7.5% and a forward P/E of 14.7 would produce a forward PEG ratio around 1.96. Last quarter's top line came in a lot stronger for Nautilus, though.

Nautilus reported overall sales growth of 15.5% for 1Q 2013, with its direct segment leading the way. Direct sales rose 26.4% to $42.6 million, while retail sales shrank 9% to $15.1 million. Royalty income grew 62.5%, but this segment only provided $1.4 million in revenue. These results look like bad news for brick and mortar fitness stores, but Nautilus might not need these stores as much anymore. Nautilus' main segment looks like it's doing fine.

As consumer fitness and health consciousness continue to be top of mind, gyms and fitness program providers will reap the benefits. Americans' move toward preventative healthcare, especially by the aging baby boomers, will also drive growth. The number of club memberships is expected to reach 46.5 million in 2015, and revenue for the industry is forecast to increase 3.3% per year to $28.2 billion.

The health trends in each industry clearly show that Americans are growing increasingly aware of and concerned for their health, the question still remains as to whether the changing preferences are more than just trends. Looking at the numbers over the coming years, however, declines in "unhealthy" industries aren't expected to stop any time soon and growth in most "healthy" industries will continue on the path upward. The move toward healthier lifestyles will get an immediate boost thanks to the tradition behind New Year's resolution, but over the long term, working out, eating healthy and kicking bad habits are here to stay.

During the last couple of years, Nautilus has definitely become a stronger company, well positioned for the cardio market. Its great start of fiscal year 2013 makes clear that it's already benefiting from the above mentioned developments and circumstances. Further innovation, combined with an expanding market for its goods, will probably ensure Nautilus' growth and profitability for many years to come. Unfortunately, with a forwarded P/E ratio of 14.70 it's hard to say Nautilus is cheap. The current share price has already priced in a lot of good news and therefore I believe it is correctly valuated. A dip to $8 would make this stock a lot more interesting, but waiting for a fallback seems a little bit useless, as its share price will probably continue to go higher in the near-term because of its positive momentum.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: The opinions in this document are for informational and educational purposes only and should not be construed as a recommendation to buy or sell the stocks mentioned or to solicit transactions or clients. Past performances of the companies discussed may not achieve the earnings growth as predicted. The information in this document is believed to be accurate. All the project earnings in this article are not accurate. They are a result of the assumptions used in my personal earnings model. Under no circumstances should a person act upon the information contained within. I do not recommend that anyone act upon any investment information without first making an analysis yourself or without first consulting an investment adviser.