Nautilus: New Products, Efficiency And Poised For Growth

| About: Nautilus, Inc. (NLS)

The CDC recommends that adults aim for 150 minutes of moderate exercise each week. Upon further review of their activity guidelines, you can also attain the benefits by exercising more vigorously for half that time. There have been a slew of recent studies that show the benefits for higher intensity, interval training. So if you can find 75 minutes per week, five to 15 minute sessions, perhaps in the comfort, convenience of your own home, you're in business. Yet the No. 1 reason for failed health resolutions is lack of time and why most gym memberships don't pan out.

So this generally leaves one time-efficient alternative, working out at home. Yes, it's a novel concept and distractions abound but if you can make it a habit several times per week, you will rid yourself of most recurring gym and fitness related fees. There are lots of practical, functional exercises that you can do with zero equipment. I often exercise at home and know this can become a bit tedious and repetitive. However, by adding a few pieces of simple equipment or a machine or two you create a "home gym," to beat boredom and take your fitness to the next level.

One company that targets mostly home gym enthusiasts is Nautilus (NYSE:NLS). Due in large part to their predecessor's success of the Bowflex trainer in the 1990s, Nautilus became a household name to most who have stepped foot in a gym during the past 20 years. In 1986, the company then known as Bowflex, Inc. debuted on the Toronto Stock Exchange. Their products successfully sold mostly through retail channels for the next 10 years. In 1996, with the prospects for stronger growth in retail seeming limited the company changed its name to Direct Focus, Inc. embarking on a new strategy, direct marketing. The move proved effective and in order to capitalize on the success of this strategy as well as their patents associated with the Bowflex systems the company IPOed on the Nasdaq in 1999.

With momentum of the recent IPO and increasing Bowflex sales Direct Focus purchased the Nautilus Corporation, Schwinn Fitness, and Stairmaster fitness in the next 18 months. The advent of e-commerce, lengthier infomercials and new ad mediums provided an ideal platform that allowed the company to grow tremendously in the next few years. Revenues grew from $63 million in 1998 to $584 million in 2002. Margins were running strong at 15%-20% and net income climbed to $98 million in 2002. Not even the bursting tech bubble in 2001 would slow down the stock's rise. The stock split in 2000 and twice in 2001 on its way to a share price of $45.89 in May 2002. The company subsequently moved their listing to the NYSE and changed their name to The Nautilus Group to address a larger, diverse group of investors and customers.

Facing increased competition and higher advertising costs sales slowed in 2003. The company responded by investing more in R&D and launching the TreadClimber, a somewhat innovative product at the time. It was advertised to burn twice as many calories as a traditional treadmill at the same speed. With an important upcoming patent expiration in 2004 on their Power Rod technology more competition was anticipated and slower sales of their Bowflex line. In addition to the TreadClimber launch a greater emphasis was placed on the much larger market for aerobic products. The company also began offering discounted packages of complimentary strength and cardiovascular products.

In addition to product innovation and refocused marketing efforts Nautilus was optimistic that a series of recent acquisitions and partnerships beginning in 2001 would stem declining sales. The company now offered a line of nutritional products that were sold in direct format and also bundled at a discount with larger purchases. Apparel was offered primarily through the Pearl Izumi brand in retail space in eight states and three countries. More than 70,000 sq. ft. of retail space was being leased to support this business. Additionally another 1.9 million sq. ft. of space was either leased or owned in seven countries to support production, R&D and sales efforts across their various brands.

The new products, marketing efforts and discounts did help to revive sales. By 2005 the company was again growing sales at a 20% rates and achieved record revenue of $630 million. However, due to higher transportation/fuel costs, shifts in product sales and aggressive discounting margins sharply contracted. Sales peaked in 2006 at $680 million, but margins were continuing to deteriorate and net income had declined 70% from its peak of $98 million four years earlier. During this time of declining profitability, the ranks had swelled to 1,500 employees.

In addition to quality control issues that caused large product recalls in 2004-06, sales were also hit hard by the severe economic downturn in 2008-09. With rapidly declining sales the company began to go through a series of cost-cutting measures and product realignments. The apparel business was exited in 2007, manufacturing was transferred to owned facilities, U.S. distribution was consolidated and several marketing relationships were terminated. Sale of the TreadClimber, mostly responsible for product recalls, was also suspended in 2008 so it could be redesigned. Employee count was reduced to 330 by 2011, where it has remained over the last few years.

With the stock trading well below a $1 in 2009 and on the verge of being delisted, the situation looked bleak. However, as the economy began to rebound in 2010 their reorganization plan and more streamlined, efficient business began to show signs of life, even modest growth. The company avoided any adverse credit events and returned to profitability in 2011, with sales of $180 million and net income of $1.4 million. By placing greater emphasis on the higher margin direct business and sales of more aerobic oriented products, Nautilus has continued to increase sales, profitability and margins since 2010. The recently launched Bowflex MAX trainer was designed and engineered for the time-crunched masses to attain a total body workout in 15 minutes. Here's a good video that explains the engineering and innovation of the machine. Sales grew more than 12% in 2013 to $218 million with margins approaching 10%.

The stock has rebounded sharply and been one of the best performers on the NYSE in recent years. Approaching close to $10 in July 2013 the shares are trading around $8.20 with a multiple in the 12-14 range. Earnings were positively affected in 2013 by a partial reversal of a valuation allowance on deferred tax assets that contributed $33 million to earnings. Subtracting that, the company produced net income of $20 MM on $207 MM in sales over the trailing 12 months. With a market cap of $265 MM and 31.1 shares outstanding the shares can, and have been volatile. Average daily trading volume is 175,000 over the past three months, so liquidity is adequate.

Shorter- and longer-term moving averages are exhibiting positive momentum, but the stock has appreciated significantly in the past 12 months, so caution is advised. The CEO and COO have acquired shares in the past six months and there has not been any significant insider selling. Full-year 2013 and Q4 2013 preliminary results were issued on Jan. 13 that pushed the stock 10% higher. Full operating results will be released in late February and could provide a pullback for a better entry price. Based on a free cash flow model with sales growth in the 10% range, a 12% discount rate and slight margin improvements, I think 25% upside is reasonable over the next 12-18 months.

Disclosure: I am long NLS. (Risk Level: Speculative.) I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

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