Nautilus Inc. (NYSE:NLS) Q4 2015 Earnings Conference Call January 19, 2016 4:30 PM ET
John Mills - ICR
Bruce Cazenave - Chief Executive Officer
Sid Nayar - Chief Financial Officer
Bill McMahon - Chief Operating Officer.
Lee Giordano - Sterne Agee GRT
Andrew Burns - D.A. Davidson
Frank Camma - Sidoti & Company
Ladies and gentlemen, thank you for standing by. Welcome to the Nautilus Q4FY 2015 Preliminary Results Conference Call. During the presentation, all participants will be in a listen-only mode. Afterwards we will conduct a question-and-answer session. [Operator instructions] As a reminder, this conference is being recorded Tuesday, January 19th of 2016.
I would now like to turn the conference over to Mr. John Mills, partner at ICR. Please go ahead.
Great. Thank you. Good afternoon everyone. Welcome to Nautilus' preliminary fourth quarter 2015 conference call. Participants on the call from Nautilus are Bruce Cazenave, Chief Executive Officer, Sid Nayar, Chief Financial Officer, and Bill McMahon, Chief Operating Officer.
Our preliminary 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 from today’s conference call may include forward-looking statements within the meaning of the securities laws. These statements include statements concerning the Company's current or future financial and operating trends, anticipated gross margin improvements, future operating results, anticipated new product introductions, available supply of certain products, planned and anticipated results of new product and channel development initiatives, and anticipated benefits and cost of the acquisition of Octane Fitness.
Forward-looking statements are subject to a number of risks and uncertainties, and actual results may differ materially from those statements. For more information about these risks, please refer to our quarterly and annual reports filed with the SEC, as well as the Safe Harbor statements in today's press release.
Nautilus undertakes no obligation to update publicly any forward-looking statements to reflect new information, events, or circumstances after they are made, or to reflect the occurrence of unanticipated events unless otherwise indicated. All information and comments regarding our operations results pertain to our continuing operations.
And with that, it’s my pleasure to turn the call over to Bruce. Go ahead, Bruce.
Thank you, John. Good afternoon, everyone and thank you for joining our call today. As those of you know, who have been following us for a while, things were quite busy through the holidays with the closing of the recent acquisition of Octane Fitness on December 31.
We shared with you during our call on January 4 that the Octane business is a perfect strategic fit with Nautilus and the growth opportunities created are significant for our business going forward.
Today, we thought it would be appropriate to provide a brief update on our preliminary Q4 results, as well as share key initiatives as we head into 2016. I’d like to start by providing a general overview of the fourth quarter and then we’ll turn it over to Bill McMahon to provide an update on key business and product initiatives during Q4 and Sid will then provide preliminary Q4 results, as well as some further details on the Octane transaction and other unusual expense items we disclosed in the press release earlier today. I will then close with some summary remarks before we open up the call for questions.
We are pleased to report another strong quarter of financial performance for our company. Fourth quarter sales increased 16%, compared to the same period prior year which was driven by double-digit growth in both our Direct and Retail segments. This top-line performance is the result of a number of initiatives, but is mostly attributable to the successful development and marketing of new products.
On the Direct side, our business benefited from continued strong sales of the Bowflex Max Trainer and good early demand for our Refresh TreadClimber line. Given that this channel grew 35% in the fourth quarter of 2014 over 2013, we are particularly pleased with the continued momentum.
The Direct business will end 2015 posting full year revenue gains of approximately 28% over the full year 2014. Our Retail business sales growth reflects good base momentum across a range of products and the steady building of greater retail presence with our partners both in North America and in international markets.
The Retail business benefited most from robust sales of strength products and the launch of Max Trainer into international markets starting in the late Q3 timeframe. The Retail business will end 2015 posting full year revenue growth of approximately 14% versus prior year.
Excluding the transaction cost and other unusual items that Sid will discuss in more detail, earnings per share from continuing operations for the fourth quarter is expected to be in the range of $0.37 to $0.39 versus $0.33 for the prior year. While the prior year comps for this quarter were very challenging, it is encouraging to note we were able to increase earnings on an adjusted basis.
During the period, we improved gross margins in both channels excluding the unusual items, we continued to achieve greater leverage of fixed cost across the higher sales volume and finally, we executed well on our strategic growth initiatives.
At this time, I’d like to turn it over to Bill McMahon, our Chief Operating Officer to provide a Q4 recap and general business update. Bill?
Thank you, Bruce. I’d like to take a few minutes to highlight business trends and touch on two matters related to the unusual charges Sid will detail. Both of our channels performed well in Q4 and we’re very encouraged by the consumer response and sales momentum we saw on December as we enter our peak fitness season.
In the Direct channel, as Bruce noted, we were facing significant year-over-year comp challenges but we still anticipate reporting approximately 16% growth for the fourth quarter, compared to fiscal 2014.
Revenue growth in the Direct segment was driven by the continued strong performance of the Bowflex Max Trainer. This product line continues to exceed our expectations from both a response and conversion standpoint, but also just as importantly, in terms of consumer satisfaction, measured by buyer surveys and via tangible metrics such as low return rates.
Also, in late November, we launched the newest additions to our TreadClimber line, the Bowflex TC100 and TC200. It’s early in their sales cycles, so it’d be premature to draw conclusions on the success of these two new models, but we can say that the TC100 and TC200 sales today have improved the sales trajectory of the TreadClimber category and we are pleased by that early trend.
Direct sales continuing to grow versus challenging prior year growth rates is a success, however, as long time investors know, we are most interested in growing operating income and we are pleased with our Direct sales success was achieved without significant discounting, which was reportedly prevalent amongst many retailers during the holiday period.
Our products continue to perform well and do not require deep pricing cuts to drive sales volumes. In prior calls, we’ve discussed our initiative in nutrition. The Bowflex Body line of products has been reviewed well and positively received by those who have purchased. Bowflex Body continued to grow quarter-over-quarter since its launch and did so even into Q4 of this year.
However, that growth was below what we wanted to see from this category and we need to see more from nutrition to justify the amount of internal effort that was being applied to it.
In Q4, we tried multiple tests in both messaging and pricing to see if there would be a path that would meaningfully accelerate the adoption of Bowflex Body products. Ultimately, our assessment concluded that continued investment in this line would not provide the same return as compared to pursuing other initiatives and was not the highest in best use of our resources.
Thus, as Sid will outline in his remarks, we are taking a reserve against the remaining inventory of this line and we’ll be removing this from our offerings during the first half of 2016. The decision on nutrition, while difficult given our hopes for the category, was prudent and a highlight for commitment to remain disciplined in our approach to our business.
Fortunately, we continued at several areas of opportunity to focus our efforts, most notably as related to our acquisition of Octane Fitness. As part of our integration plans, we’ll explore the areas of collaboration that include operations, logistics, international sales, and most definitely product development. We’ll have more information on direction in our February earnings call.
Turning now to our Retail business, we continued to gain market share in Q4 and anticipate reporting 21% growth in revenue, compared to 2014 fourth quarter. This was driven by incremental placement of products in national sporting goods accounts, continued success with our major online partners and some returned to growth in international markets driven by the launch of MaxTrainer on the global stage.
Our Retail channel benefited in 2015 from several product launches including our Nautilus line of cardio products, which consisted of bikes, ellipticals and treadmills. The Nautilus cardio line helped us gain ground in multiple doors during the year and our success there was further supported by ongoing sales of the Schwinn branded cardio products.
Additionally, our Schwinn AD Pro bike launched in Q4 and it’s been very well received in specialty fitness and CrossFit environments contributing to Retail channel growth.
Another strong area of growth for Retail in Q4 of 2015 was in dumbbells. Our Bowflex SelectTech 552 dumbbell product sales grew significantly in the quarter and the Selectorized Weight category overall is very healthy for us as we enter 2016. That said, previously, we had planned to further advance our position with the launch of the Bowflex SelectTech 560 product.
While we have launched this product in the small test and we are happy with the performance of the units in the field from that test, we are not yet satisfied that our manufacturing partner is ready to support the high volumes associated with the full product launch.
Our strict policy has been that we will not launch a product until it’s ready from a quality, feature and production standpoint. Our partner is diligently working to address the remaining issues and we will launch the product on a wide scale when those final production throughput issues are addressed. The delay in the lighter launch of Bowflex SelectTech 560 did not have material impact on our Q4 results.
As noted in prior calls, one of our key initiatives was improving margin in our Retail business. Margin erosion was especially acute in early 2015 where Retail segment gross margins had fallen to near 22%. We are pleased by the improvement in margins in Q4, which we anticipate reporting to be significantly improved over that Q1 2015 low point, as well as well improved over the same quarter prior year.
It’s important to remember that there is seasonality in Retail margins due to the variance in revenues versus fixed cost. But overall, we feel our relative improvements are sustainable going forward. Thus the revenue and margin growth in our Retail channel is encouraging to see.
Before turning the call over to Sid, I want to briefly touch on one other unusual charge. One of our previously disclosed legal matters involve the dispute over a contract related to the original patent for Treadclimber technology.
In Q4, the company arrived at a settlement in this matter through an arbitration process. Nautilus benefits from this settlement and that there is now certainty as to when royalty payments end for this technology plus the effective royalty rate over the remaining term of the licensing agreement is well below previous levels.
We do not anticipate any material impact on future operating results as a result of this settlement. As we close 2015, and look forward to 2016 and beyond, I am proud of what our team has accomplished today and excited about what we can accomplish in the future.
Both our Direct and Retail channels are growing in revenue and profitability and now we’ve added still more positive momentum with Octane Fitness joining our team covering the specialty vertical in commercial markets.
While we have a busy time ahead of us in terms of integrating and optimizing, our core focus will remain on delivering profitable growth. And with that, I’d like to turn the call over to Sid for details and comments on our results. Sid?
Thanks, Bill. I would like to provide a brief update on our preliminary financial results for the fourth quarter of 2015. As a reminder, our audited results for 2015 will be presented on a conference call towards the end of Feb 2016.
Net sales for the fourth quarter were projected at a $109.1 million, an increase of 15% as compared to the same period in the prior year. We saw strong revenue growth in both segments during the quarter with Retail projected to be up 21% and Direct projected up approximately 16%.
Royalty income for the quarter is projected to be down sharply to $0.4 million as a result of a dispute with a licensee who you know latterly reduced royalty payments. For the full year of 2015, net sales are expected to total $335.8 million, up 22.3% as compared to net sales of $274.4 million for the same period last year.
As indicated on the press release, the fourth quarter projected earnings per share was impacted by several acquisition-related transaction cost and other unusual items and I wanted to provide further color around these items.
Bill referenced the settlement related to the patent dispute regarding TreadClimber technology earlier. The expense related to this settlement represents future payments over multiple years; however, for GAAP accounting guidelines this amount was recorded in 2015 and is included in our preliminary results released today resulting in a $0.05 earnings per share impact.
Our decision to transition out of the nutrition business and stay focused on other growth drivers including the recent Octane acquisition resulted in the company setting up a reserve for inventory on hand. While we expect to continue to sell the inventory through normal channels over the next few months from an accounting perspective, it was appropriate to reserve completely for the product resulting in an earnings per share impact of $0.03 during the quarter.
Additionally, the company did not record any royalty due from a licensee during the fourth quarter and reversed out estimated royalties for the third quarter as a result of a dispute that arose during the quarter. We have filed a breach of contract lawsuit against the licensee and intent to vigorously pursue all remedies for payment but pending resolution in this matter negatively impacted EPS by $0.03 for the quarter.
The Octane Fitness acquisition drove transaction-related expenses, primarily legal and audit, which resulted in an earnings per share impact of $0.02 per share for the quarter.
Finally, the company also released a valuation allowance related to its foreign tax credit reflecting its ability to accelerate generation of its foreign source income on a go-forward basis resulting in a projected lower tax rate that favorably impacted GAAP earnings per share in Q4 and the full year by $0.06 per share.
Excluding these unusual items, earnings per share for Q4 is projected to be in the range of $0.37 to $0.39 and $0.91 to $0.93 for the full year. Including these items, earnings per share is projected to be in the range of $0.31 to $0.33 for the quarter and $0.85 to $0.87 for the full year.
Gross margins for the Direct segment are projected to increase compared to the same period last year excluding the unusual items noted and as noted by Bill, Retail segment margins are also expected to come in well above prior year.
The recovery in retail margins is particularly noteworthy and should be further strengthened by the anticipated accretion in earnings per share of $0.15 to $0.17 from the Octane Fitness acquisition during 2016.
Now turning to the consolidated balance sheet, cash and investments totaled $5 million as of December 31, 2015 with $80 million in term debt. This compares to $72 million in cash and no debt at December 31, 2014. The acquisition of Octane Fitness for $115 million plus working capital and other adjustments is a primary driver for the reduction in cash and the addition of debt.
At this time, I’d like to turn it back to Bruce for his final comments. Bruce?
Thank you, Sid. I would like to make a few final comments before opening up the call for questions. As we began 2016, we are cautiously optimistic about our ability to continue delivering strong results in 2016. While the Octane Fitness acquisition in itself provides earnings accretion opportunity and accelerates our ability to grow via greater penetration of new distribution channels, we will remain true to the formula that has driven our success today focused on product innovation, improving margins, and leveraging our newly expanded platform and infrastructure have served us well and will continue to be the drivers for our investment decisions and priorities going forward.
We are heading into a new chapter of growth and innovation for our company and despite the market success is achieved and momentum our team has built thus far, we believe that the company is still in the early stages of realizing its full potential. It is critical, we remain focused and disciplined in all areas of the business to ensure we continue to build on the success and execute our plans.
In closing, I am extremely proud and thankful to our team for their incredible efforts and dedication over the past year to allow us to accomplish so much operationally and financially while maintaining the energy and passion that is a hallmark of our culture.
That concludes our prepared remarks. Now, I’d like to open up the call for questions. Operator?
[Operator Instructions] Our first question comes from the line of Lee Giordano
of Sterne Agee GRT. Please go ahead.
Thanks. Good afternoon everybody. Just – it’s good to see the Retail margins are improving. Could you talk a little more about what’s driving the improvement there? The puts and takes and it sounds like it’s sustainable, is that something we should continue to see going into 2016? Thanks.
Yes, Lee, this is Sid. The drivers for the Retail improvement stem back to some of the things we have talked about on the past calls. Some of that is improved product mix, some of it is improved channel mix. We saw a growth back in the international channel in the Q4 timeframe and as we talked about some part of it also around the efforts on the product cost side, engineering and other efforts by the R&D team. So we think that’s sustainable going into 2016, yes.
Okay, great. And then just on the MaxTrainer going internationally, can you just talk about where it is today at this point and what else the opportunity? How you speed down the road? And is it Retail or Direct overseas? Thanks
It’s being sold via direct models overseas in Australia and Southeast Asia, but not by distributors who are selling at that way and we also have some market penetration in Europe, specifically in the UK. So, a lot of the world is still lapped, it just began for rollout sort of in the second half of last year. But to be clearly all of that is rolling up into our Retail channel, the sales.
Got it. Thank you.
Thank you. Our next question comes from the line of Andrew Burns of D.A. Davidson. Please go ahead.
Thanks. Good afternoon. Just a question on the SelectTech Dumbbells, suffice it see the strength you are seeing in the quarter. Is that an acceleration in growth that’s driving in and then just any color in terms of the 560, whether it maybe first quarter, first half, any additional thoughts there?
On the 552, we saw pretty a pretty good surge across a variety of accounts online and in-store. For that product which of course is, really already well placed and so velocity of sales has been great with that product. And I think the driver is that fitness to SelectTech can moved back towards strength based training and especially with CrossFit and other trends. Our product fits pretty well with that. And so we are seeing the benefits of that being in essence to leaders in the selectorized weight category. In the 552, having incredibly high number of online reviews that are very, very positive for that type of products, I think was the driver. In terms of 560, certainly in the first half of the year, I would anticipate that, hopefully, sooner rather than later, but we do – the products we have and I think you are out at our retail store, the product we have looks great. We just need to have a repeatable and sustainable high velocity production of that product and we are not quite there yet, but I am sure we will get there.
Thanks. And could you provide any color in terms of initial thoughts from your store there in Vancouver as well as the pop-off shots that you placed in malls for this season? Any early reads there?
I think we’ll have more to say on the pop-up efforts and some of the other event type marketing that we tried this year when we do the official call in February. We are still in the compiling what do we know mode and some of those pop-ups are still active as we speak. On the store, I have to say, the intent of the store is not to drive Retail’s revenue with one door in a suburb of Portland Oregon, but, I’d say that we are uniformly pretty pleased with what we see so far both in the concept in the sales today.
Great, thanks and just one last one in terms of the TreadClimber refresh. It sounds like you are pleased with the early progress there. How should we think about that evolving in terms of your marketing spend and the potential to stabilize or grow that platform? Thanks.
Well, I think we are hoping that it will indeed drive some stabilization in that platform which should still be a very large category for us overall. It’s a little premature to say. We can’t say that we are seeing a positive changing from what their trajectory was which was losing ground and if nothing else we’ve stemmed some of that tied. But I need to see more of that in three weeks worth of real sales in fitness season before we’ll go out and make any claims about what it’s going to do. But it’s definitely soon enough to say it’s helping.
Thanks and best of luck.
Thank you. [Operator Instructions] Our next question comes from the line of Frank Camma of Sidoti. Please go ahead.
Hi, guys. How are you doing?
Hey, could you talk about overall selling and marketing expense, not necessarily just in the quarter, but like how we should view that going forward now that you have Octane and how that’s going to over – affect spending on a percentage basis or revenue?
Frank, I probably won’t be able to give you the answer you are looking for on this call. May not something that we – as we get provide more detail coming out of our Feb call, we can certainly give more color around the Octane acquisition and how those numbers will impacted to, primarily because we haven’t provided any – we haven’t released any of the specific numbers around selling and marketing.
Okay. All right, okay, that’s fine. And just a follow-up on the royalty question, going forward, I think you said there was 400,000 generated in the quarter, I know you didn’t book it, right, because of the reversal. Did I catch that correctly?
No, we actually only booked 400,000 for the quarter which were from other licensees and we would have expected to book a much larger number in Q4.
Okay, so you did actually book revenue. Is that’s something – so until you settle that, that agreement, will the – is that the level of royalty going forward, is there any clarity you can give us on that?
Well, we had sort of indicated that we felt that the royalty levels going forward would be running at about half the rate they were running for this year, primarily because a lot of those patents were expiring as of Jan of this year.
Okay, great. That’s really all I have for now.
Thank you, Frank.
Thank you. [Operator Instructions] And we are turning the conference back over to Bruce. Please go ahead.
Thank you. Thank you everyone for joining our call today and your interest in Nautilus. As Sid mentioned, we will be hosting another call in late February to provide details of our 2015 – Q4 and 2015 overall results. I hope you all have a great afternoon. Thank you.
Thank you. Ladies and gentlemen, that does conclude the conference call for today. We thank you for your participation and ask that you please disconnect your lines.
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