Nautilus' (NLS) CEO Bruce Cazenave on Q4 2017 Results - Earnings Call Transcript

Nautilus, Inc. (NYSE:NLS) Q4 2017 Earnings Conference Call March 5, 2018 4:30 PM ET

Executives

Bruce Cazenave - CEO and Director

Sidharth Nayar - CFO

William McMahon - COO

John Mills - IR, ICR, Inc.

Analysts

Frank Camma - Sidoti & Company

George Kelly - Imperial Capital

Andrew Burns - D.A. Davidson

Operator

Good day, and welcome to the Nautilus Fourth Quarter 2017 Earnings Results Conference Call. Today's conference is being recorded.

At this time, I would like to turn the conference over to John Mills with ICR. Please go ahead, sir.

John Mills

Thank you. Good afternoon, everyone. Welcome to Nautilus' Fourth Quarter 2017 Conference Call. Participants on the call from Nautilus are Bruce Cazenave, our Chief Executive Officer; Sid Nayar, Chief Financial Officer; and Bill McMahon, Chief Operating Officer.

Our earnings release was issued earlier today and may be downloaded from our Web site 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 on today's conference call will include forward-looking statements within the meaning of the securities laws. These include statements concerning financial projections, operating trends, anticipated growth and profitability, anticipated new product introductions, planned capital expenditures and anticipated results of new product and business development initiatives. Forward-looking statements are subject to a number of risks and uncertainties, and actual results may differ materially from these statements. For more information about these risks, please refer to our most recent annual report on Form 10-K. Nautilus undertakes no obligation to update or otherwise publicly release any revision to forward-looking statements to reflect new information, events or circumstances after they were made or to reflect the occurrence of unanticipated events. All information and comments regarding our operating results pertain to our continuing operations.

And with that, it is my pleasure to turn the call over to our CEO, Mr. Bruce Cazenave. Please go ahead, Bruce.

Bruce Cazenave

Thank you, John. Good afternoon, everyone, and thank you for joining our call today. I'd like to start by providing a general overview of our fourth quarter and then will turn it over to Sid Nayar to review our financials in more detail.

Bill McMahon will then provide updates on the business segments as well as on product activity. Finally, I will provide some closing remarks including an update on our outlook for 2018, and then we’ll open up the call for questions.

We achieved our fourth quarter and full year revenue guidance primarily due to a 10% increase in Direct segment results. This was driven by strong sales of the Bowflex MaxTrainer line and a steady improvement in the performance of the Bowflex Hybrid Velocity Trainer.

This growth was partially offset by the expected fourth quarter decline in Retail segment revenue due to the timing of some mass retail customer orders which shipped late in the third quarter as opposed to early in the fourth quarter.

Because there is such a fine line between the third and fourth quarters as far as when these seasonal pipeline fill orders ship, we always measure the health of our mass retail customer base looking at both quarters combined.

On that basis, we experienced growth of over 10% versus the same two quarters combined from last year. The other channels of distribution within our Retail segment, mainly our commercial and specialty channels, experienced continued weakness.

Excluding a non-cash impairment charge that Sid will discuss in a few moments, operating performance was also in line with our guidance and this is while we continued to increase investments in research and development as well as incurring certain incremental expenses associated with operational improvements and efficiencies we will be implementing in 2018.

With that said, overall, the full year operating performance in 2017 was significantly below what we had expected to achieve as we entered the year. Despite the challenges we faced, we were able to continue the momentum on key strategic initiatives which I will speak to later and generate $54 million of EBITDA from continuing operations after adjustment to include the non-cash impairment charge.

At year end 2017, our already healthy balance sheet is even stronger with a net cash position of 37 million and having repurchased $11 million of stock in the open market during the year.

We are now in full stride into 2018 and I’m excited to share some highlights of a multifaceted plan designed to get our company back on the desired accelerated growth trajectory. I will address this during my summary comments.

But first, let me turn the call over to Sid. Sid?

Sidharth Nayar

Thank you, Bruce. Good afternoon, everyone. I'd like to provide an update on our financial results for the fourth quarter of 2017.

In this release we’re reporting certain results on an unadjusted and adjusted basis where adjusted numbers exclude a non-cash impairment charge related to the carrying value of the Octane Fitness trade name intangible asset, as well as a tax benefit related to recent changes in the United States tax code.

Net sales for the fourth quarter of 2017 totaled $127.8 million, an increase of 1.6% as compared to the same period in the prior year as strong Direct sales performance offset weaker Retail sales performance. Net sales for the year ended December 31, 2017 totaled $406.2 million, flat to the prior year’s sales of $406 million.

Fourth quarter gross margins decreased 340 basis points in the Direct segment to 63.4% and were down 380 basis points in the Retail segment to 29.5% when compared to the same quarter last year.

On an overall basis, total company gross margins for the fourth quarter 2017 decreased 210 basis points to 48.9% versus the same period prior year reflecting lower margins across both segments, partially offset by a channel mix shift to the higher margin Direct segment. For the full year 2017, gross margins were 50.2% which was a 190-basis point decline compared to the prior year.

Total operating expenses for the fourth quarter of 2017 as a percentage of net sales increased to 43.9% from 35.6% in the same period last year primarily driven by an $8.8 million non-cash impairment charge related to the carrying value of the Octane Fitness trade name intangible asset. Excluding this charge, operating expenses were 37% of revenues.

Operating expenses for the year ended December 31, 2017 as a percentage of sales increased to 41.3% as compared to 38.9% for the same prior period primarily driven by the aforementioned impairment charge. On an adjusted basis, operating expenses as a percentage of revenues for the year ended December 31, 2017 totaled 39.1%.

Sales and marketing expense for the fourth quarter of 2017 were $36.9 million or 28.9% of net sales as compared to $34.2 million or 27.2% of net sales in the same period last year, primarily reflecting higher media spending.

For the year ended December 31, 2017, sales and marketing expenses totaled $116.2 million or 28.6% of net sales compared to $115.4 million or 28.4% of net sales for the same period in the prior year with higher media spending being the main driver offset by a reduction in financing fees.

General and administrative expenses were $6 million or 4.7% of net sales for the fourth quarter of 2017, which compares to $7.2 million or 5.7% of net sales in the same period last year. The decreased dollar spending in G&A was due to cost savings related to the Octane integration of 0.5 million and lower incentive and stock-comp expense of 0.7 million. General and administrative expenses for the year 2017 as a percentage of net sales totaled 6.7% as compared to 7.1% for the same prior period.

Research and development costs in the fourth quarter of 2017 were $4.3 million or 3.4% of net sales compared to $3.5 million or 2.8% of net sales in the same period last year. The dollar increase was driven by additional resources to supplement our new product development capability required to innovate our product portfolio. Research and development costs for the year 2017 totaled $15.5 million or 3.8% of sales as compared to $13.9 million or 3.4% of sales for the same prior period.

Operating income for the fourth quarter of 2017 was 6.4 million as compared to operating income of 19.3 million in the same quarter of last year. Adjusted operating income for the fourth quarter of 2017, excluding the non-cash impairment charge of 8.8 million, was 15.2 million reflecting the lower gross margins and increased media spend.

For the full year 2017, operating income totaled 36.3 million or 8.9% of net sales versus 53.4 million or 13.1% of net sales in the prior year. Again, excluding the 8.8 million impairment charge, adjusted operating income was 45.1 million or 11.1% of net sales reflecting the impact of lower gross margins and higher media spending.

Income from continuing operations for the fourth quarter of 2017 was $8.5 million or $0.28 per diluted share as compared to $12 million or $0.38 per diluted share for the same period last year.

The effective tax rate for the fourth quarter of 2017 was a credit of 32.2% reflecting an income tax benefit of 5.6 million related to the recent tax law change compared to an expense of 36.4% in the same period last year.

For the full year 2017, income from continuing operations totaled $27.6 million or $0.89 per diluted share compared to $35.1 million or $1.12 per diluted share for the same period last year.

EBITDA from continuing operations was 45.2 million versus 61 million in the prior year. Adjusted to exclude the impairment charge, EBITDA from continuing operations was $54 million.

Turning now to our segment results. Net sales in the Direct business totaled $71.6 million for the fourth quarter of 2017, a 9.9% increase over the same quarter last year. Direct segment sales benefitted from growth across the product offering, including the Bowflex MaxTrainer and the Bowflex HVT line, which more than offset the decline in TreadClimber sales.

Gross margin for the Direct business declined to 63.4% for the fourth quarter of 2017 compared to 66.8% in the same quarter of last year. The decline was due to a shift in product mix to lower margin items like HVT and treadmills coupled with increases in product cost due to the unfavorable impact of foreign currency exchange rates. Operating income for the fourth quarter of 2017 in our Direct business was $11.8 million compared to $12 million in the same quarter prior year.

Net sales in our Retail segment for the fourth quarter of 2017 were $55.5 million, a decrease of 7.5% compared to $60 million in the fourth quarter of last year. The decrease reflected the previously reported sales timing shift from Q4 into Q3 in the mass retail channel that resulted in stronger than usual seasonal selling in Q3 coupled with continued weakness in specialty and commercial customers. Mass retail channel grew 10.5% in the second half of 2017 while specialty commercial sales saw declines in that same period.

Gross margins for the Retail business declined by 380 basis points to 29.5% in the fourth quarter of 2017 as compared to 33.3% for the prior period, driven by unfavorable product mix and increases in product cost related to unfavorable foreign exchange rates coupled with higher seasonal discounting.

In the fourth quarter of 2017, operating income for the Retail business totaled $7.1 million as compared to $12.2 million in the same period of last year. The decrease is due to the lower gross margins noted above coupled with operating expense increases related to creative and video production for new product launches.

Now turning to the consolidated balance sheet. Cash totaled $85.2 million as of December 31, 2017 with $48 million in debt. This compares to $79.6 million in cash and $64 million of debt at December 31, 2016.

During the full year of 2017, the company purchased $11.1 million of stock in the open market as part of its stock repurchase plan, including $6.2 million in the fourth quarter of 2017.

Working capital totaled $91.1 million as of year-end 2017 compared to $85 million at the end of 2016. Inventories were $53.4 million as of December 31, 2017 compared to $47 million at December 31, 2016. The increase in inventory versus year-end 2016 reflects the addition of several new products and timing of purchases.

Trade payables were $66.9 million as of December 31, 2017 compared to $66 million at the end of 2016. Capital expenditures totaled $3.8 million for the year ended December 31, 2017 with spending primarily on tooling and implementation of new software and hardware information system upgrades. We anticipate full year CapEx for 2018 to be in the range of $8.5 million to $10.5 million.

At this time, I’d like to turn it over to Bill McMahon, our Chief Operating Officer who will provide additional insights into our business and key products. Bill?

William McMahon

Thank you, Sid. Good afternoon, everyone. I'd like to provide further background on our results and provide some commentary on the opportunities we see in 2018.

Starting with our Direct segment. We were pleased with our 10% sales growth in the fourth quarter. The Q4 sales increase versus prior year was driven by a number of products, including solid growth in Bowflex MaxTrainer as well as contributions from our recently introduced Bowflex HVT and the Bowflex Results Series of cardio products. As expected, this was partially offset by continued decline in our Bowflex TreadClimber sales.

During Q4, we introduced new media and network mix approaches to our television and advertising and we were encouraged to see those strategies contribute to growth in Bowflex MaxTrainer. We feel these changes are sustainable during peak seasons and the measured performance gives us confidence that MaxTrainer should remain a strong contributing category for Direct going forward.

To further boost Bowflex sales overall, we’re getting more creative and delivering what our customers want with product personalization. For example, we recently partnered with LIFT Digital to provide Bowflex customers with free personalized training sessions. This program provides an opportunity for Bowflex customers to seek advice from a trained fitness professional and supplements the existing product tutorial videos with a customized plan to help them get the maximum benefit from their equipment.

Also during the quarter, we made progress in improving the overall performance of Bowflex HVT. We launched a new creative focused on addressing what we believe were the barriers to conversion with the product and we saw continued steady improvement. Consumer reviews and satisfaction remained very positive and we’ve also received strong recognition from the industry.

In one example, HVT captured the ISPO Health & Fitness Award for design, innovation and quality. The ISPO Award honors the most exceptional sporting goods products from around the world and we were very pleased with this new distinction joining our prior winners such as Bowflex MaxTrainer.

After a peak season of measuring Bowflex HVT performance, we’re encouraged by the continued improvement. We also feel it would benefit from further wider distribution in order to better introduce this unique product to the mass market. As such, we will explore omni-channel options just as we have with the MaxTrainer during the coming year while continuing to use direct media strategically during opportune times such as during peak season.

As mentioned, the Bowflex MaxTrainer continued to deliver the majority of sales in our direct segment during Q4 but we also generated meaningful growth in our strength product category and in our new line of Bowflex treadmills which exceeded our expectations.

Bowflex TreadClimber continued to decline at a rate worst than our expectations. We anticipate this decline will continue to be a headwind in Q1 2018. But we expect that TreadClimber sales will be at a level that will no longer have material growth impact by midyear 2018.

Finally, we’ve spent time over the past year evaluating unique offerings under the Schwinn brand. Schwinn is best known for quality and ease of accessibility for everyone from beginners to even the most experienced hardcore CrossFit participants.

We recently introduced a Retro-Inspired Bike that combines nostalgia with modern technology. The Schwinn Classic Cruiser bike is compatible with popular apps like Zwift and Ride Social and it allows users to pedal through scenic locations with other cyclists from around the world and it makes reality a virtual world.

With the official Schwinn Classic Cruiser app, our customers can monitor time, calories burned and distance while also playing a Paperboy game that matches the nostalgia of the bike itself. This product is launched in Direct and it will be moving to Retail later this year.

Future growth in our direct channel will, as always, be driven by product innovation. Our next major Direct product launch is on track for midyear 2018 and it involves the patented cardio-modality that will be new to the consumer market. We’ll provide more information on this product in our next earnings call.

Turning now to our Retail segment. Our Q4 revenues were down by approximately 7.5% year-over-year and those results were driven by the previously mentioned decrease in sales reflecting the year-over-year timing shift of fall orders from Q4 into Q3 being stronger than normal.

As noted earlier in the call, we do evaluate our Retail business over halves of the year and on that basis we are pleased with over 10% growth in the mass retail sales channel in the second half of 2017 as compared to the same period prior year, this despite continued weakness in specialty and commercial sales.

Growth in our retail channel was driven by continued strong performance of Bowflex MaxTrainer as well as with the introduction of the Bowflex cardio line of treadmills and ellipticals. The performance of Bowflex treadmills was especially encouraging as traction here will allow Nautilus to make gains in the single largest category of fitness equipment, a category in which we have previously been underrepresented.

During the second half of 2017, we introduced several new products into the Retail channel beyond even the Bowflex cardio lines and these included the Schwinn Crewmaster rowing machine, the Schwinn IC3 indoor cycling bike, the Schwinn 87 and the Octane ADX Airdyne bikes, the Octane ZR7000 commercial quality Zero Runner as well as updates to our popular Schwinn 70 Series line of cardio products.

These new products, more than 20 new to market SKUs, are performing well. We are seeing solid results and excellent reviews on these new products and I want reiterate that because of the earlier selling of products in the third quarter, you should not view the down fourth quarter sales as an indication of how well these products are performing. We are in fact experiencing good point of sale sell-through at retail and we would expect that our retail sales will be up in 2018 as compared to 2017.

Overall, we’ve consistently commented in the past that our future growth will be driven by product innovation and expansion of international sales. To that end, we’re driving two strategic initiatives this year. First, we’re consolidating our international sales teams from Nautilus and Octane into one team under a proven leader.

Further, we will make investments in infrastructure, product readiness for the international market and global distribution to arm our new combined international team with the marketing and operational support needed to drive faster growth. We believe we have the right team and the right leader in place to drive growth and now we’re better aligning the company’s capabilities and focus to support these efforts.

Secondly, we’ve observed the growing use of digital subscription models and online group exercise in the fitness space and we’re very aware of these trends in the market. In the past year, we have completed several iterations of research related to this space and we have identified a new and unique to market approach to enable our customers to achieve success. This approach will be digital based and will involve a core product as well as compelling paid subscription content.

Further, this platform over time will be exportable across a variety of our products allowing our customers to use the product of their choice or even multiple products while remaining in our new ecosystem of coaching support. We are currently targeting Q4 to introduce this new digital platform, including our subscription model which will launch in the Direct channel.

Our Direct business is already uniquely positioned to deliver a digital experience as currently about three quarters of our sales are online and over 60% of our Web traffic is from mobile devices. Our customers are comfortable with digital solutions and we’ll be providing them with a compelling platform when the new system launches. We’ll have more information on this capability as we approach the launch date later this year.

Completion of this new digital platform along with investment in our international sales capabilities will have some impact on near-term profitability in 2018. However, we are confident that this path is critical to Nautilus in order to create a foundation for long-term sustained growth. Regarding our inventory and supply chain, we feel that our inventory balance is appropriate both with our retail partners and within our own distribution centers.

Finally, though we outlined in the call today multiple new product introductions occurring this year, please keep in mind that we also have a very robust multiyear product roadmap in place and we’re already preparing for new product launches in 2019 and beyond.

At this point, I’d like to turn the call back over to Bruce for his comments. Bruce?

Bruce Cazenave

Thank you, Bill. I’d like to make a few final comments before we open up the call for questions. As you can determine from the new products we are introducing both at the beginning of 2018 and towards the end of 2018, our plans are expected to generate return to a healthy level of top line growth.

We continue to gain market share with traditional and ecommerce retail customers and are expecting that our recently introduced new Octane branded products will help drive growth in our commercial and specialty retail channels of distribution as well.

With 2017 financial performance coming in well below our expectations, we recognize that we needed to increase our focus and provide added investments in key strategic initiatives in order to drive the desired higher levels of revenue and operating growth.

As mentioned, our 2018 plan is multifaceted and will involve approximately $3 million to $4 million in incremental expenses and $5 million to $6 million in additional capital expenditures. These investments will be mostly concentrated in the following four areas.

One, rapidly building out the innovation platform that Bill mentioned and it is in development pipeline and capitalizes on evolving technologies. Bill mentioned this and our research suggested the capabilities this platform will provide will resonate well with all of our customer bases, plus give us potential entrée into subscription services.

Two, we have recently restructured our international sales and support teams and consolidated the Nautilus and Octane teams under one leader. This will give us added focus in order to drive targeted doubling of international revenue to $60 million by 2020.

In the first half of 2018, we will have incremental expense related to redeployment of resources to support international as well as ramped up marketing spend for things such as translations, training videos and creating new Web sites.

Three, we are consolidating warehousing facilities and realigning our supply base. By the end of 2018, we will have an integrated worldwide network of fewer third-party warehousing locations and for the first time each of our global facilities will be able to service all of our brands. Not only will this give us added supply chain flexibility and the ability to be more responsive, but it is also expected to be at a lower cost.

And finally, four, we are completing the ERP integration of Octane Fitness. This is a key milestone which enables the other integration and resource optimization activities to occur and the schedule to be completed by midyear.

All of these changes and related investments which will mostly occur during the first three quarters of 2018 are anticipated to position our company to better execute on a number of high return growth opportunities, plus provide a more efficient cost structure to realize them.

It is important to note that our fundamental strategies centered on continuing to invest in product innovation, brand building, channel diversification and achieving additional market access points remains intact and we intend to stay the course while adapting tactics as necessary.

As we did in the prior year, I’d like to share our outlook for full year 2018 as well as the first quarter both of which are inclusive of the estimated expenses and investments related to the business model changes I just mentioned.

On a full year basis for 2018, we are projecting company revenues of between $428 million to $437 million with operating income in the range of $42 million to $45 million. For the first quarter of 2018, we are projecting revenues between $110 million and $113 million and operating income in the range of $8.5 million to $9.5 million. We also anticipate the effective tax rate in 2018 to be in the range of 24% to 25%.

In closing, I’d like to thank all of our dedicated employees who are instrumental in our successes and help the company become stronger every quarter as a result of their efforts and initiatives.

That concludes our prepared remarks. Now, I’d like to open up the call for questions. Operator?

Question-and-Answer Session

Operator

[Operator Instructions]. We’ll take our first question from Frank Camma with Sidoti.

Frank Camma

Hi. Good afternoon, guys.

Bruce Cazenave

Hi, Frank.

Sidharth Nayar

Hi, Frank.

William McMahon

Hi, Frank.

Frank Camma

One of the things I noticed you did mention was Modern Movement and I notice it’s now available at least at the local DICK’S around here. I was wondering if you could talk about that a little bit, the launch there given it’s a lower price point and everything.

Bruce Cazenave

Yes, I’d still say it’s a little early on Modern Movement. It is deployed now. It is available in DICK’s Sporting Goods. It’s also available in certain online partners and we anticipate further growth. Early on, I’d say we’re encouraged by it but it’s pretty early so we need to give it a chance to get awareness up over time.

Frank Camma

Given its price point, how do you increase awareness for something like that? It is on the shelf obviously at DICK’S, but is that – someone’s got to be I guess looking for it. So I know it’s kind of known in niche circles, but how do you increase that? Are you doing some digital campaigns behind it?

Bruce Cazenave

We do some digital, we also do social media and we – a lot of it is good old fashioned public relations in doing efforts to get to media influencers and create awareness that way so we get some word of mouth telling people, hey, you need to try this out. As you know, if you try it out; it’s a pretty compelling product but it’s getting people to try it is always the challenge.

Frank Camma

Okay. And my other question was just on the general trend in media. You’re spending here more. I’ve noticed more ads that I would call more general branding ads versus specific product ads. I was wondering if you could talk about that trend at all and how you measure its returns since it’s not – there’s not a direct correlation there in the short term.

Bruce Cazenave

Yes, great question. One of the things we definitely did during Q4 is we tried some testing around higher visibility, network ads with more of a branding message versus a pure DR message. And I would say we are pretty pleased. Now how do you measure success? A lot of that is then it puts a lot of burden on your ability to use your ecommerce capabilities to measure Web traffic and attribute that Web traffic in a way that gives you confidence that you’re doing it accurately. So we feel pretty good about our effort there and likely we’ll repeat that effort in the future.

Frank Camma

Good. Thanks, guys.

Bruce Cazenave

Thank you, Frank.

Operator

[Operator Instructions]. We’ll take our next question from George Kelly with Imperial Capital.

George Kelly

Hi, guys. Thanks for taking my questions. Just a couple for you. First, if I could start with your 2018 guidance. Can you help at all directionally with what you expect in each of the business segments with Retail and Direct? Do you expect one to grow faster than the other and then same with margin, any commentary around margin expectations for '18 would be helpful too? Thanks.

Sidharth Nayar

Yes, just talking about the channels, we do expect the Retail channel to grow faster than the Direct channel right now and some part of that is obviously with the launch of the new product as well in the Direct, we’re taking a more conservative outlook on Direct until we get to after the launch in the second half of the year. So again if you wanted just a sense, it was probably mid-to-high-single digits on the Retail side and probably low-single digits on the Direct side from a revenue growth perspective. And then as far as the gross margins are concerned, we do continue to anticipate some falloff in Direct margins just based on both product cost increases anticipated as well as the revenue mix shift to some of these new products we’re introducing, so probably 100 to 150-basis point negative impact on margins in '18 versus '17 on Direct. And on the Retail side, we actually expect it to be relatively flat to reported numbers for '17, maybe even a slight improvement.

George Kelly

That’s the gross margin?

Sidharth Nayar

That’s the gross margin.

George Kelly

Okay. And then second question for you on the Direct segment. What have you seen – so it sounds like MaxTrainer in Direct grew in the fourth quarter? What have you seen so far this year? And you didn’t say it in the prepared remarks but are there new iterations you could put out of MaxTrainer? How are you going to keep that growth vehicle? It’s such an important piece of your business. How are you going to keep that growing?

Bruce Cazenave

Yes, I think we definitely see Max as a platform, George, that we could certainly iterate with and bring both incremental products to the table as well as refreshing the original line of products. And we would likely do that in conjunction with our view on what we would do with digital platforms going forward.

George Kelly

Okay. I guess I do have one more question on the digital side. Just as I’m thinking about that launch, is that and I guess more importantly the 2019, is that a product that you expect to – it’s such a competitive advertising market out there. There are people that already offer digital products. How aggressively do you expect to market behind that initiative?

Bruce Cazenave

Well, we think we don’t want to give too much away on it yet. We think we’ll have a unique offering first of all. Secondly, I do think it does need to be paired with a compelling product platform would be the difference maker. I think advertising that just on its own would not be as successful, and our intention would be to pair it as a solution and then bring people into – if you want to call it an ecosystem or bring people into the platform that way.

George Kelly

Okay. Thanks.

Bruce Cazenave

Thanks, George.

Operator

[Operator Instructions]. We’ll take our next question from Andrew Burns with D.A. Davidson.

Andrew Burns

Thanks. Good afternoon. A couple of questions for you. On the headwinds that the business faces, you outlined that the TreadClimber once you pass the first quarter, the impact starts to diminish. Just curious on the weakness in the commercial and specialty channel sort of the magnitude of the impacts in '18 and what you can do to minimize that softness?

Bruce Cazenave

Yes, we’re still facing some of the – particularly within the commercial, specialty channel, the specialty dealers. In fact, if you – there’s a certain segment of specialty dealers, Andrew, where our business is considerably off and others around the country it’s sizably up, like double digits up. So you have to kind of peel it back a little bit. But we still expect some headwinds in that marketplace and I would say that we probably might be happy if that particular channel or segment within commercial, specialty was flat year-over-year with some ups in certain areas and some downers in other areas. I think we are and we do have a significant new introduction coming in the back half of the year that will affect these channels and that could be – well, we expect it to be something that would get us back on a track of growth within those two channels, probably first the commercial side and then eventually the specialty side.

Andrew Burns

Great. Thanks. And then in the press release, the Retail gross margin performance there was higher seasonal promotional activity noted. Just curious, that seems to keep popping up during these peak volume seasons. Is that the new normal or did that vastly – is that vastly different than what you were expecting?

Bruce Cazenave

I think it was a little more than we originally anticipated in our view of the year to be certain. However, I would expect that we are – we need to solve for that as a new normal going forward. And most of the promotional activity candidly is around the online space and online advertising now in Retail.

Andrew Burns

Great. And then one last one. In terms of the digital ecosystem and the potential subscription model, is all of that completely separate from the LIFT partnership? And it sounded like that was just going to be available on one product platform to start. Just wondering how quickly you validate will be able to extend that into new additional products.

Bruce Cazenave

It is separate and incremental from things like the LIFT partnership and our Run Social partnership that we have. It will launch our one product but it is our desire to extend it to multiple products both across Direct and throughout the company in the long run. And we’d anticipate being able to do that pretty quickly afterwards but it does take several months in each iteration to make the preparation work and get it deployed live. So I’d expect an initial launch this year and in 2019 you could see another major platform receive the upgrade as well and so forth going from there.

Andrew Burns

Okay. Thanks and good luck.

Bruce Cazenave

Thank you, Andrew.

Operator

Next, we’ll take a follow up from George Kelly with Imperial Capital.

George Kelly

Hi, guys. Thanks for taking another quick question. Just looking through your guidance, can you – it looks like first quarter the operating income that you expect in 2018 looks a bit heavier for the – is it the back half of the year and just wondering if I’m reading that right and what is the – is it new products or can you talk about sort of first half, second half operating profitability? Thanks.

Sidharth Nayar

Yes, George, it is heavily skewed to the back half of the year from actually both from a revenue growth perspective as well as an operating income perspective. Q1 is particularly hit by the TreadClimber revenue decline specifically in the Direct channel which in turn translates to the operating income shortfall that we’re projecting year-over-year. But again, what you are going to see is given the new product introductions that Bill mentioned and some of the platform introductions, Q4 into the holiday season is going to be a significant – there’s going to be a significant shift in both revenues and operating income to that quarter.

George Kelly

Got you. Thank you.

Operator

That concludes today’s question-and-answer session. At this time, I’ll turn the conference back to Mr. Bruce Cazenave for any final remarks.

Bruce Cazenave

Thank you all for your interest in Nautilus and for joining our call today. We look forward to providing another update on the business on our first quarter earnings call in a few months. Hope everyone has a great day. Thank you.

Operator

This does conclude today’s conference. Thank you for your participation. You may now disconnect.