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Nautilus (NLS), the maker of the well-known Bowflex line of fitness products, announced fourth quarter 2006 results on Wednesday. Earnings increased an astounding 555% while revenue increased a modest 9.49% when compared to the fourth quarter of 2005. The company has clearly overcome the manufacturing problems it was plagued with last year and has pulled off a turnaround from an operations standpoint. Nautilus expects to earn between 97 cents and $1.05 per share in 2007 representing a 20 to 30% increase in earnings.

The stock rose almost 10% the following day with more than 3 million shares exchanging hands, almost six times the average daily volume. However over the next two days trading volume fell to 697,100 and 407,800. The short interest for Nautilus stood at 9.25 million shares as of Jan 9th.

Assuming that this number did not change much between Jan 9th and Feb 7th when the quarterly results were announced and further assuming that all the trading volume over the last three days was short covering (highly unlikely), that still leaves more than 5 million shares short and a short ratio of over 9. Why anyone would still be short a company that expects to grow earnings by 20 to 30% and expects to generate $65 million in cash flow in 2007 is beyond me. Nautilus also sports a dividend yield of 2.2% and only has $43.2 million in short-term debt. It would be interesting to hear the thoughts of someone who is actually short Nautilus at this point.

While I believe that 2006 results were excellent and like the earnings forecast for 2007, I am disappointed by the sales forecast for their apparel line. I was expecting the Pearl Izumi acquisition to drive both revenue and earnings growth at Nautilus but it looks like earnings growth will mostly be driven by operational efficiencies. I felt that the stock was undervalued at the start of 2007 and that is why I featured it on my list of Ten Stock Picks for 2007. In spite of the almost 30% appreciation that the stock has seen since the beginning of 2007, I expect additional upside over the next few years.

Highlights from the fourth quarter 2006 conference call:

  • Revenue came in at $199.3 million vs $182.03 million for the fourth quarter of 2005, an increase of 9.49% year-over-year.
  • Income for the fourth quarter came in at $12.9 million or 41 cents per share when compared to $1.97 million or 6 cents per share last year, an increase of almost 555% year-over-year.
  • For the full year 2006, the company generated $681.5 million in sales vs $631.3 in 2005, an increase of 7.95%.
  • Income for 2006 came in at $29.1 million vs $23 million in 2005, an increase of 26.52%.
  • Nautilus expects revenue growth of approximately 10% and earnings growth of 20 to 30% in 2007.
  • First quarter 2007 earnings forecast of 18 to 21 cents is below analyst expectations. The company expects Q1 2007 revenue to come in between $185 and $195 million.
  • Gross margins in Q4 2006 were 44%, a 460 basis points (just another way of saying 4.6%) improvement year-over-year.
  • The company expects significant improvements in gross margins by 2008.
  • Nautilus generated $33 million in cash flow in 2006 and expects to generate $65 million in cash flow in 2007.
  • Nautilus now has $15 million more in prepaid assets when compared to the year ago period.
  • 2006 supply side efficiencies improved by $14 million and the company expects to save an additional $3 to $4 million by closing its Tyler, Texas plant.
  • 75% of products are now sourced from Asia.
  • Nautilus plans to acquire its largest contract manufacturer, China-based Land America Health and Fitness in 2007.
  • Current short-term debt of $43.2 million is expected to fall to $0 by Q2 2007 but is expected to rise to $40 to $50 million in the second half of 2007 due to the acquisition of Land America.
  • After promising the launch of 14 products in 2006, the company exceeded expectations by launching a total of 17 products in 2006.
  • 95% of revenue came from products that did not exist before the current management team took over.
  • Customer satisfaction increased from 65% in Fall 2005 to 82% by the end of 2006.
  • After the acquisition of Universal Health and Fitness, the company now has six leading brands.
  • Their international equipment business grew by 49% and is expected to grow by 15 to 30% in 2007.
  • The Pearl Izumi line of cycling apparel and footwear grew 46% to $13 million in sales.
  • Nautilus branded apparel was launched in Q3 2006.
  • Apparel growth is expected to be between 10 to 20% in 2007.
  • Nautilus is currently in the process of testing its apparel at 5 to 10 Sports Authority stores.
  • NLS 1-yr chart
    NLS

    Disclosure: Author has no position in Nautilus.

    Source: Nautilus Gains Muscle: What's With all the Short Interest?