Nautilus, Inc. (NYSE:NLS) Q3 2019 Results Earnings Conference Call November 7, 2019 4:30 PM ET
John Mills - ICR
James Barr - CEO & Director
Dave Wachsmuth - Senior Director, Finance
William McMahon - Special Assistant to the CEO
Conference Call Participants
Michael Kawamoto - D.A. Davidson & Co.
George Kelly - Imperial Capital
Ryan Sigdahl - Craig-Hallum Capital Group
Good day, and welcome to the Nautilus, Inc. Third Quarter 2019 Earnings Results Conference Call. Today's conference is being recorded. At this time, I would like to turn the conference over to Mr. John Mills of ICR. Please go ahead, sir.
Thank you. Good afternoon, everyone. Welcome to Nautilus' Third Quarter 2019 Conference Call. Participants on the call from Nautilus are Jim Barr, Chief Executive Officer; Bill McMahon, Special Assistant to the CEO; Chris Quatrochi, Senior Vice President Innovation and Engineering and Dave Wachsmuth, Senior Director, Finance.
Our 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. Also on today's call we are going to be referring to a slide presentation deck that Jim will discuss to access this presentation if you would please now go to our website at nautilusinc.com and the investor presentation will be under the events and webcast section.
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 timing and market acceptance of new product introductions, planned investments and strategic and operational initiatives and the anticipated or targeted results of such initiatives, expected growth of our user base, consumer and retail demand for our products and the impact of new product introductions and marketing campaign on our future financial results, planned capital expenditures and anticipated results of new product, business development initiatives and strategic partnerships.
Forward-looking statements are subject to a number of risks and uncertainties, and actual results may differ materially from these statements. Additional factors that could cause Nautilus' actual results to differ materially from these forward-looking statements include weaker-than-anticipated demand for new and existing products, our ability to timely acquire inventory that meets our quality control standard from sole-sourced foreign manufacturers at acceptable costs, experiencing delays and/or greater-than-anticipated cost in connection with launches of new products, entry into new markets, our strategic initiatives, including recurring revenue offerings, our ability to hire and retain key management personnel, changes in consumer fitness trends and our ability to anticipate and satisfy consumer preferences in a timely manner, changes in the media consumption habits of our target consumers or the effectiveness of our media advertising, a decline in consumer spending due to unfavorable economic conditions and softness in the retail marketplace.
For more information about these risks and uncertainties, please refer to today's earnings announcement and our most recent annual report on Form 10-K as supplemented by our quarterly report on Form 10-Q.
Nautilus undertakes no obligation to update or 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 unless otherwise noted.
And with that, it is my pleasure to turn the call over to Nautilus' CEO, Mr. Jim Barr.
Thank you, John. Good afternoon, everyone, and thank you for joining our call today. I have now been CEO of Nautilus for 90 days. My welcome to Nautilus has been energizing, my onboarding going well and I am spending time systematically learning our businesses. While continuing my education I am also balancing near term decisive actions and holiday season execution while diving into a longer term strategic review.
So far I am very encouraged about the opportunities ahead for our company and I am convinced that we have the right raw materials for good comeback story. We have earned top of industry brand reputation over decades of innovative design sourcing great products and standing behind them.
As a result these brands remain very strong in the market. In addition, we provide customers with great choice. They can choose from multiple modalities of equipment. They can choose their price points and features from budget conscious to top of the line technology latent models.
As an omni channel company choice even extends to multiple ways to buy direct at leading retailers and through commercial channels. The team has some of the best talent in the industry and the culture is strong with little resistance to change in contrast to many other growth transformations even some I've witnessed firsthand. A positive development has been our differentiated digital platform which is now manifesting itself in exciting product offerings entering the market.
When I decided to take the position of CEO, I knew we would face significant challenges. I've confirmed the belief that my background in digital products and marketing and my experience driving growth transformations at legacy brands in several industries in the face of technological disruption and changes in value proposition is a strong fit for the areas that need improvement at Nautilus.
Our recent results are indicative of there being a lot of work to do but I'm convinced we can reclaim our leadership position in the fitness industry.
Even though being CEO for a few months is not enough time to make a full and proper assessment of our overall business especially in our busiest season. I thought it might be helpful to share a few initial high-level observations.
First our direct business has been declining for several years and thus I do not expect it to recover in just a few quarters. There are multiple causes including adjusting to evolving shopping habits and media consumption which are changing at an accelerating pace. We are actively mining insights from consumers and are making adjustments to better deliver the right marketing message to the right audience at the right time.
Recently based on extensive consumer insight work we’ve launched a brand positioning for both flex as well as a new advertising campaign stronger every day. The campaign better positions us for where the market is today.
We have provided links to these TV spots in our materials to give you a sense of this positioning. We are just beginning to enter our heavier spending period and believe the campaign will resonate and be one important step to meeting this challenge. We have work to do to return this channel to profitable growth.
Second, technology is driving our industry in a great direction for both customers and fitness companies. Through connected fitness we know more about where they are in their fitness journeys. We can engage frequently with them to assist them in meeting their goals. We can help motivate users so they stick with it for longer. In short, we now have more ways to deliver on our long-standing mission to make fitness more attainable and motivate people to live healthier lives.
One current challenge is that this is attracted competition at times making it more difficult for our messages to be heard when these entrants strongly outspend us to build their brands. We need to strive for strong and sustained innovation in overall fitness while making sure our brands get credit, the credit they deserve for our connected fitness experience which now spans software content and machines.
Ultimately that experience still centers around a wide choice of reliable and attainable equipment across multiple modalities and price points which we intend to continue to deliver.
Third, one size does not fit all which is why our product portfolio is so comprehensive spanning several brands, exercise modalities and price points providing many choices in home fitness versus one brand or one or two types of equipment.
This also helps protect us against in the inevitable up-and-down popularity of any particular type of equipment. Today our digital product offerings are strong and differentiated. We are squarely and digitally connected fitness space.
However, I wish we were further along and getting the platform on more products in our broad portfolio. We're making progress including several recent connected fitness launches I'll discuss on this call but I will be looking to accelerate connected fitness through the portfolio giving customers even better choices sooner.
Finally, as someone has spent a lot of my career driving on the channel growth I am pleased we also give consumers great choices to buy.
Our retail channel in particular has good growth potential, has been profitable and should provide a meaningful economic base while we correct and improve our direct channel.
These are some initial observations that is mentioned. We have initiated a full assessment of our overall business.
From this we plan to create a new insights driven long-term TrueNorth vision and multi-year strategic plan which we will unveil and transition to during 2020. A durable vision and plan takes time get it right. However, I assure you we won't wait for the plan to begin to move in the right direction.
I would now like to provide a quick overview of our third quarter 2019 results, discuss our business segments as well as our new product offerings and then turn the call over Dave to review our financials in more detail. I will close with a few final remarks before opening up the call to your questions.
We experienced declines in both of our segments in the third quarter. The decline of our
Direct segment is primarily related to our 37% reduction in advertising expense compared to the prior year. As discussed in prior calls we intend to increase this ad spend in the fourth quarter to support new offerings and improved advertising and messaging.
Retail sales were down 27.1% from the same quarter in the prior year primarily reflecting partial shipment delays until the beginning of the fourth quarter due to recently imposed tariffs and some weaknesses from max trainer sales in the segment.
While our overall results in direct segments have been disappointing, we have been pleased with a recent rollout of our new MaxTotal product. It has done well and we are looking forward to its performance in the fourth quarter holiday season and the first quarter 2020 fitness season.
This new trainer features the company's first integrated digital touch screen that directly connects the user to the features of our upgraded AI powered [indiscernible] digital platform. The MaxTotal also delivers a connected fitness experience incorporating both a cardio and upper body workout in as few as 14 minutes with customized personalized coaching driven by built in machine learning capabilities.
Last week we relaunched our digital platform under the new journey brand, the name reflects our belief that fitness is a lifelong pursuit. It is our goal to accompany users on this journey and help them stay with fitness for the long run. The new brand also makes it easier to enable a connected fitness experience across our portfolio of brands and modalities converging into one digital platform that we expect to be leveraged throughout our product portfolio.
At its core journey features in AI driven true personalization engine that suggests customized workouts and adjust to individual fitness levels along with friendly coaching vet, customers tell us feels a lot like having an on-demand one-on-one personal trainer.
Journeys adaptive coaching technology uses algorithms, data from an initial assessment and tracking from previous workouts to create personalized daily workouts based on the user's fitness goals. Each custom workout is adjusted automatically based on input about how the user is feeling, how much they improve and their past performance.
In addition to the true personalization engine journey features an array of choices to motivate and entertain during workouts. This starts with our proprietary explore the world experience which allows users to virtually train in locations across the globe from the Irish countryside to the beaches of Australia via high-definition video. This will launch featuring numerous locations and we expect it to be available later this year.
Journey also features an expanded library of trainer led workouts based on a user's fitness level, personalized running and walking coaching for treadmill users and additional rewards to celebrate achievements and motivate users to complete their workouts. Journey also gives users a curated matching music -- music matching their workout and access their streaming entertainment subscriptions including Netflix, Amazon Prime video and Hulu. Journey is integrated onto the new Bowflex MaxTotal and is available via an app for selected Bowflex result series treadmills. It will be made available on more Bowflex,
Nautilus and Schwinn equipment over time.
Before I leave the discussion of our digital platform I'm excited to report that subscribers to journey are working out 70% more than non-subscribers which is a great early indicator of the exciting ways we can achieve our noble mission through technology.
Moving to the cycling category, I'm proud to say that in late October we debuted the first-ever Bowflex indoor bike for the direct channel that delivers an excellent connected fitness experience.
The Bowflex C6 bike features an open platform so users can connect with our explore the world app as well as third-party cycling apps including Peloton and Zwip. We are very excited to now offer bike users a more attainable and affordable option under the Bowflex brand. In fact, the Bowflex C6 delivers a great connected fitness experience at less than half the price of some of our competitors. We are also continuing to expand our digital platform across our portfolio with the new Schwinn IC4 bike and the 810 treadmill both of which we also launched in October.
While we are very excited about these new offerings we still have a lot of work to do to improve the business. We're developing actionable insights, meaningful innovation and increasing our digital focus in marketing and inner products. I look forward to speaking more about this transformation in the coming months. In the meantime, we will do all we can to shore up our short-term financial performance to give us the runway to execute our transformative strategy and now Dave will provide an overview of the financials for the quarter. Dave?
Thank you Jim. I would like to review the details of our financial results for the third quarter of 2019. Net sales for the third quarter totaled $61.7 million a decrease of 32.2% as compared to the same period in the prior year reflecting a 44.1% decline in direct segment sales and a 27.1% decrease in the retail segment. For the first nine months of 2019 net sales were $205.1 million down 27.1% compared to the same period last year.
Third quarter growth margins in the direct segment decreased to 38.3% compared to 57.3% in the same quarter of last year and retail segment margins declined to 27.1% compared to 34.7% in the same quarter of last year. Margins in both statements were negatively impacted by unfavorable product mix coupled with unfavorable over at absorption related to the decline and sales. On an overall basis total company gross margins for the third quarter 2019 were 30.9% versus 42.3% in the same period of the prior year reflecting the lower rate in both segments.
The first nine months of 2019 gross margins were 35.3% a decline of 11.3% from 46.6% in the first nine months at the same period last year. Total operating expenses for the third quarter of 2019 as a percentage of net sales increased to 44.3% from 35.5% in the same period last year primarily reflecting the decrease in sales.
Total operating expenses for the first nine months of 2019 as a percentage of sales were 85.9% as compared to 40.1% in the same prior period. Operating expenses for the first nine months of 2019 included a $72 million of goodwill and tangible impairments.
Sales and marketing expense for the third quarter of 2019 was $17.5 million or 28.3% of net sales as compared to $20.6 million or 22.7% net sales in the same period last year.
The decrease dollar spending reflected a reduction in media spent partially offset by increased advertising production costs. The increase in sales and marketing as a percentage of sales reflects the decrease in sales.
For the first nine months of 2019 sales and marketing expenses totaled $69.1 million or 33% net sales compared to $79.5 million or 28.2% net sales for the same period in the prior year with lower media spend and financing fees being partially offset by increased advertising production costs.
General and administrative expenses were $6.7 million or 10.9% net sales for the third quarter of 2019 which compares to $7.5 million or 8.2% net sales in the same period last year. The decreased dollar spending in G&A primarily reflects lower litigation expense.
General and administrative expenses for the first nine months of 2019 as a percentage of net sales totaled 11.6% as compared to 7.4% for the same prior period. The increase in G&A as percentage of sales reflects the decrease in sales as well as higher litigation expense and a legal filament completed in the second quarter of the current year.
Research and development costs in the third quarter of 2019 were $3.1 million or 5.1% of net sales compared to $4.2 million or 4.6% percentage of net sales in the same period last year. The dollar decrease primarily reflects an increase internal capitalized labor and reduction in third party app development spending.
Research and development expenses for the first nine months of 2019 as a percentage of net sales totaled 5.5% as compared to 4.5% for the same prior period.
Operating loss the third quarter 2019 was $8.3 million as compared to operating income of $6.2 million the same quarter of last year. The decrease reflects the decline in sales and gross margin rates along with increases in advertising production costs partially offset by lower advertising expense.
EBITDA loss from continuing operations in the third quarter of 2019 was $5.5 million versus income of $8.5 million for the same quarter of the prior year for the first nine months of 2019 operating loss was $103.8 million as compared to operating income of $18.1 million in the same prior period. Year-to-date operating loss includes goodwill and intangible impairments of $72 million in the second quarter.
Loss from continuing operations for the third quarter of 2019 was $10.6 million or minus $0.36 per diluted share as compared to income of 4.5 million or $0.15 per diluted share for the same period last year.
For the first nine months of 2019 loss from contained operations was $97.8 million or $3.30 per diluted share as compared to income of $13.7 million or $0.45 per diluted share in the same period last year.
The effective tax rate for the third quarter of 2019 was minus 21.9% compared to 29.3% in the same period last year. Tax expense in the current year quarter included a $3.9 million valuation allowance against the company's deferred tax assets to reduce the assets to anticipated realizable value based on our recent financial performance.
Total net loss including discontinued operations for the third quarter of 2019 was $10.7 million or minus $0.36 per diluted share which includes 0.1 million loss net of taxes from discontinued operations. This compares at the third quarter last year when we reported total net income including discontinued operations a $4.3 million or $0.14 per diluted share which includes a net loss from discontinued operations of 0.2 million. Year-to-date net loss for 2019 totaled 98.1 million or $3.31 per share versus income of $13.3 million or $0.44 per diluted share for the first night nine months of 2018.
Turning now to our set of results net sales for the direct business told 16.2 million for the third quarter of 2019 a 44.1% decrease over the same quarter last year. The decline was primarily from lower sales and max trainer products and was related to 37% reduction in advertising expense compared to the prior year quarter as a company prepared to increase spend on a new advertising campaign in the fourth quarter of 2019.
2019 year-to-date sales of $83.7 million in the segment were down 38% year-over-year. Gross margin for the direct business declined to 38.3% for the third quarter of 2019 compared to 57.3% in the same quarter of last year due to unfavorable over absorption relates to lower sales coupled with unfavorable product mix due to lower max trainer sales.
Operating loss for the third quarter of 2019 in our direct business was $8.7 million compared to a loss of $1.4 million in the same quarter of the prior year. The operating loss was negatively impacted by the lower net sales and gross margins in the third quarter of 2019 partially offset by reduced advertising expenses.
Year-to-date 2019 operating loss for the direct segment totaled $19.6 million compared to income of $10.7 million for the same prior year period.
Net sales in our retail segment for the third quarter of 2019 were 44.8 $million a decrease of 27.1% compared to $61.5 million in the third quarter of last year. The decrease primarily reflected delays and product placements until the beginning of the fourth quarter of 2019 resulting from recently imposed tariffs as well as a decline in max trainer product sales.
Gross margins for the retail business decreased by 760 basis points to 27.1% and the third quarter of 2019 as compared to 34.7% for the prior period mostly from unfavorable product mix and unfavorable overhead absorption related to lower sales.
Year-to-date 2019 gross margins for retail were 23.9% down 820 basis points versus the same period in the prior year primarily driven by similar factors.
In the third quarter of 2019 operating income for the retail business totaled $4.8 million as compared to income of $12.7 million in the same period of last year. The decrease is primarily attributable to the lower sales and gross margin rates. Year-to-date 2019 operating income for the retail business totaled $3.8 million versus $20.2 million for the same period in the prior year.
Now turning to the consolidated balance sheet cash totaled $5.8 million as of September 30, 2019 with $20.3 million of debt. This compares to $63.5 million in cash and marketable securities in debt of $32 million at December 31, 2018. The company had $12.7 million available for borrowing on this line of credit as of September 30, 2019.
Inventories were $50.1 million as of September 30 of 2019 compared to $68.5 million at December 31, 2018 and $35.5 million at September 30, 2018. The decrease is primarily reflect our efforts to reduce inventories from the higher than desired levels we ended at in December of 2018.
Trade payables were $38.5 million as of September 30, 2019 compared to $87.3 million at the end of 2018 primarily reflecting and seasonality of purchases. Capital expenditures totaled $6.6 million for the nine months ended September 30, 2019 with spending primarily on new software systems and production tooling and equipment. We anticipate full year CapEx to be in the range of $8 million to $10 million.
At this time we'd like to turn the call back over to Jim for his final comments. Jim?
Thank you Dave. Nautilus is a company with multiple strong brands including Bowflex, Nautilus, Octane fitness and Schwinn which are among the most recognized fitness brands in the world and our equipment is known for its tremendous results. We now need to combine our improving product offerings with advertising and messaging that delivers the right message to our customers at the right point of contact.
We also need to continue launching innovative products, drive connected fitness across our portfolio and keep improving our digital platform.
Our efforts to right-size of the business announced in July are progressing and we expect to save approximately $6 million in workforce and shared support cost reductions in 2020. During the fourth quarter we expect to achieve positive cash flow from operations and positive EBITDA from continuing operations. There's a lot of work to do. This turnaround is not going to occur overnight.
However, I expect we will make good progress each quarter and I look forward to telling you about it as we do. Our entire company is aligned in our goals and the belief that we will restore Nautilus to its leadership position in the fitness industry.
And now I'd like to open up the call to your questions. Operator?
Thank you. [Operator Instructions]
The first question is from Michael Swartz of SunTrust. Please go ahead.
Hey good afternoon guys. I just wanted to start off with the retail side of the business trying, just trying to understand what exactly occurred in the quarter with regard to the tariffs? Was this something related to the cancellation of direct import orders and you are forced to import them yourself or maybe just help us understand that I guess maybe also how much in revenue that shifted between the quarters?
Yes hi, this is Bill so the impact was not really cancellation of orders so much as renegotiating in light of the new cost structure related to the tariff imposition and the biggest challenge was there was really no runway imposed to allow us time to do this. In fact we product on the water that was already subject to the increased tariffs at the time it was announced. So it was a bit of scrambling I can tell you that those shipments which I believe Dave was 6 million impacted have already shipped in Q4. So it really was literally down to the hours of trying to hit the deadline to make Q3 still with all the renegotiation that had to happen.
Okay. That's great. Thank you and then I know we're in early days here as part of this turnaround and new product and connected fitness platform but have you given any thought to what the margin structure of this business should look like longer term I know there's some targets that were put out years ago but just trying to see if you ever need any general thoughts on that?
No, I don't think we have anything really to share at this point I mean it would be part of our TrueNorth strategic planning to take a look at the trade-offs we have. Obviously there are impacts a positive and negative to connected fitness. You've got large screens that constitute a larger part of the cost of goods sold but then you also have revenue streams that that weren't in the original model. We have our own internal view of that but we've not gotten to the point where we would share any of that.
Okay. Thanks a lot.
The next question is from George Kelly of Imperial Capital. Please go ahead.
Hi guys thanks for taking my questions. So more questions on the retail side. That segment has been a bit weak now for a few quarters. So just wondering if there's anything else you can talk to? I don't know if it's the category has seen more pressure or there's too much retail inventory or a loss of share just wondering if you can go into more sort of depth about what else is as you know now that you've been here for several months if there's any other observations about the retail business.
Yes. Sure. This is Dave, so I think aside from the I mean I think about first half of the year there was the high level channel inventory which we have talked about in previous calls and that has fixed itself. Aside from the tariff issue the one other dynamic going on is just as max trainer within the channel and I think just some of our sense it's been selling to a little slower in the first half of the year a little bit ended last year. I think the customers have this being more conservative about how much inventory they want to take on that.
And does max trainer still represent a pretty material portion of your retail business?
I mean it's material.
Yes. Okay. Okay and then so I guess just as you look forward in retail then, I mean should the fourth quarter is it too soon to expect kind of a return to more flat-ish or positive revenue growth or what's your forward outlook in the retail business?
We are not providing guidance actually on the top line in the segment at this point but I think I mean general I think the normal seasonality whether it would apply as well as those shipments that didn't happen in Q3 are definitely rolled into Q4.
Okay. And then next question for me just on the balance sheet, can you that was helpful. I think I heard just say positive cash flow from operations in the fourth quarter. Anything else you can share just about your expected inventory at yearend or availability on your facility anything else? It just would be helpful.
Sure in regards to the facility, it's the availability is based on the amount of working capital primarily accounts receivable inventory we have and generally seasonality wise we end up with a higher amount of account [indiscernible] at the end of the year so that should be positive in that regard. On the inventory side we know we fit as we said we finished high last year and our goal and our goal is to drop that by around 10 million at the end of this year.
Okay. Drop that 10 million versus the close to 7. So inventory could come back up in the fourth quarter?
Correct yes because you guys remember that we saw the fitness season continues on to Q1 so we still haven't up inventory position at the in December support them.
Okay. All right. Thanks.
There are no further questions at this time. I would like to turn the floor back over to Jim Barr, CEO for closing comments.
Thank you for joining our call today and your continued interest in Nautilus. We look forward to providing you with another update on the business in a few months on our fourth-quarter earnings call. Have a great rest of the day onwards and upwards.
This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation and have a great day.