Nautilus, Inc. (NYSE:NLS) Q3 2023 Earnings Call Transcript

Nautilus, Inc. (NYSE:NLS) Q3 2023 Earnings Call Transcript February 9, 2023

Operator: Good day, and welcome to the Nautilus, Inc. Third Quarter 2023 Earnings Results Conference Call. All participants will be in a listen-only mode. After today’s presentation, there will be an opportunity ask questions. Please note today’s event is being recorded. I would now like to turn the conference over to Mr. John Mills with ICR. Please go ahead, sir.

John Mills: Thank you, Paul. Good afternoon, everyone. Welcome to Nautilus’ fiscal 2023 third quarter ended December 31st conference call. Participants on the call today from Nautilus are Jim Barr, Chief Executive Officer; and Aina Konold, Chief Financial Officer. Please note, this call is being webcast and will be available for replay for the next 14 days. We will be happy to take your questions at the conclusion of our prepared remarks. Our earnings press release was issued today at 1:05 PM Pacific Time and may be downloaded from our website at nautilusinc.com on the Investors 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.

Please note, we will be comparing results versus last year fiscal 2022 and also versus fiscal 2020, as we believe comparing to the last pre-pandemic period is helpful in demonstrating our growth and progress. For today’s call, we have a presentation that management will refer to during their prepared remarks. On Slide 2 is our full safe harbor statement, which we ask everyone to read. You can access the presentation now by going to the Investors page on our website and clicking on Events and Webcasts. I’d like to remind everyone that during this conference call, Nautilus management will make certain forward-looking statements. These forward-looking statements are based on the beliefs of management and information currently available to us as of today.

Such forward-looking statements are not guarantees of future performance, and therefore, one should not place undue reliance on them. Our actual results will be affected by known and unknown risks, trends, uncertainties and factors that are beyond our control and ability to predict. For additional information concerning these factors, please refer to the safe harbor statement and to our SEC filings, which can be found in the Investor Relations section on our website. And with that, it is my pleasure to turn the call over to Nautilus’ CEO, Mr. Jim Barr.

Jim Barr: Thank you, John, and thank you all for joining us. Before I review our Q3 performance, I would like to highlight three key topics we will focus on during today’s call. First, through our focus on operational excellence, we have implemented strategic margin management initiatives that drove significant gross profit and EBITDA improvement in the third quarter. Second, we are continuing to face headwinds in our retail channel and have taken deliberate actions to address them and return to positive EBITDA in 2024. Third, we are confident in the long-term opportunity because we are on the right side of industry trends. Turning to Q3, I’m pleased with the results we delivered. Q3 net sales were $98 million with direct sales, up 30% compared to Q3 fiscal 2020.

Growth was driven by our broad portfolio of strengthened cardio offerings reinforcing our strategic advantage of being able to offer products in both. Our strategic actions to enhance supply chain and improve our inventory position are yielding margin improvement. As such, gross margins for the third quarter expanded 300 basis points year-over-year, largely driven by our planned improvements in inventory levels. In Q3, we continue to reduce our operating expenses driven by our efforts to optimize and lower advertising spend. These results translated to continued improvement in our adjusted EBITDA, with Q3 adjusted EBITDA loss reducing by 67% year-over-year. We see continued momentum in our differentiated digital offering. We added more than 50,000 JRNY members in Q3, reaching approximately 450,000 total JRNY members, an increase of over 88% compared to the same period last year.

Of these members, 156,000 were subscribers, representing 134% growth year-over-year. While we continue to see solid demand in our direct business and with sales up 30% to Q3 fiscal 2020 and momentum on JRNY, the retail headwinds that we’ve been discussing at length have persisted. This resulted in retail net sales decline of 6% compared to Q3 fiscal 2020, excluding sales related to the Octane brand. Retailers continue to take a conservative approach across many categories, including home fitness, as a result of inventory positions and uncertainty in the near-term economic environment. So while sell through to consumers at retail is progressing, we are seeing lower levels of reorders, which is impacting our sale outlook for our retail segment in the fourth quarter and likely into the first half of fiscal 2024.

We have taken additional near-term steps to rightsize our business to reflect our current expectations. With our strong market share and having significantly increased the number of retailers and retail doors over the past couple years, we believe the retail channel will remain an important long-term component of our business model as the macro environment stabilizes. As part of our ongoing commitment to operational excellence, we have driven operational efficiencies across our business, including enhancements to our supply chain, improvements to our inventory management and optimization of our advertising spent. As challenges in the retail business persist, we have taken additional proactive steps to reduce our cost by an expected $30 million on an annualized basis.

We operate an asset-light, semi variable operating model, which enables us to adjust our cost structure to align with demand trends. Leveraging the flexibility of this operating model, we reduced our contracted labor. Separately, we also implemented a reduction in our workforce by about 15%. These actions, while difficult, are grounded in our priority to continue to align our cost structure with our revenue expectations and are aimed at driving profitability and improving cash flow. We are also taking the necessary steps to strengthen our balance sheet. We continue to improve our inventory position per our plan, inventory was $77 million at the end of Q3, fiscal 2023 down 40% versus Q3 last fiscal year. And we expect inventory levels to come down further in the coming quarters.

We are implementing cost reduction initiatives aimed at improving cash flow and we believe we have the right levers to pull to maintain our balance sheet. We are actively managing near-term challenges within the business while maintaining €“ while remaining committed to our North Star strategy, which is made up of five key pillars: adopt a consumer-first mindset; scale a differentiated digital offering; focus investments on our core businesses; evolve our supply chain to be a strategic advantage and build organizational capabilities to win. We have made strong progress on all these pillars over the past two years, and I firmly believe we have set the foundation for our path to becoming a leader in connected fitness by leveraging our equipment business and scaling a differentiated offer.

At our core, we excel at equipment, we continue to see demand for our fast moving top sellers and traction in our direct channel. Our focus remains on providing consumers with a broad variety of superior products at a range of price points. We have an exciting pipeline of new products planned for calendar year 2023 with a strong lineup of updated connected fitness equipment carrying our innovative new Bowflex digital branding. It’s important to stress that we make money in the equipment business and this will be key to our path back to profitability. At the same time, we’ve continued to enhance and scale our differentiated digital offering JRNY, enabling us to better serve our customers and capture long-term revenue and profit. While we have made tremendous progress in bringing hyper personalized experiences to JRNY members.

Photo by Humphrey Muleba on Unsplash

We recently debuted JRNY with motion tracking, which offers personalized form coaching and feedback, rep counting and individualized workout recommendations. This enhances our strength offerings with workouts that are designed to use with Bowflex SelectTech 552s and Bowflex SelectTech 1090 dumbbells and can be used on Android and iOS tablets. We continue to target approximately 500,000 members by the end of the fiscal year, which implies approximately 54% year-over-year growth in fiscal 2023. We are also seeing progress on conversion to paid subscribers, which are growing faster members. The groundwork for JRNY is late thanks to our investments to date, which enables us to reduce near-term spend while continuing to drive consumer adoption. Moving forward, we will be disciplined in our investments in JRNY with a focus around quality, personalization and adaptability.

We have conviction in the long-term opportunity of home fitness. Our research shows the shift to home exercise remains steady now for two plus years. Over 65% of U.S. adults recently surveyed continue to say they work out at home up from 43% who reported the same at the beginning of 2020. In our target segments, this trend is even more pronounced with about 85% working out at home. This is a prevailing shift in trends and Nautilus is well positioned to take advantage of this sustainable increase and demand in our long-term addressable markets. I would also like to touch on our updated outlook on which Aina will expound. Due to the current economic environment and the conservative position of our retail partners, we are lowering our previous revenue and profitability expectations for the remainder of fiscal 2023.

We are taking the necessary actions that will best position us to operate more efficiently, minimize cash consumption, return to profitability and ultimately progress towards our goal of being EBITDA positive for fiscal 2024. I will now turn it over to Aina who will give us more detail on the third quarter results and the guidance for the full year. Aina?

Aina Konold: Thank you, Jim, and good afternoon, everyone. Today I’ll be speaking to total company results for Q3 fiscal year 2023, and will provide guidance for full year fiscal year 2023. Please visit our investor relations website to view our press release and the slides accompanying this call for more information on Q3 and year-to-date results. Given the unique nature of last year’s results, we’ll be comparing this year’s revenue to fiscal year 2020 to gauge our growth in overall company improvements versus more normalized pre-pandemic results. Turning now to Slide 8. Total company P&L results for the quarter with comparisons primarily to last year. Net sales for the third quarter were $98 million, down 33% versus last year and up 9% versus the same quarter in fiscal year 2020, excluding Octane.

Our Direct segment grew 30% versus the same quarter in fiscal year 2020, while the Retail segment declined by 6%. Gross profit was $23 million and gross margins were 23.3%. Gross margins were up 3 percentage points from last year and up sequentially 6 percentage points to last quarter. As Jim mentioned earlier, we’ve executed on several initiatives aimed at driving operational efficiency. In addition, we’ve lapped unfavorable pandemic-related supply chain costs. We are pleased that our equipment gross margins are beginning to return to more normalized levels. I’ll now review the drivers of this quarter’s gross margin improvement from last year. Up 2 percentage points due to improved product costs and up 3 percentage points due to decreases in inventory adjustments.

These improvements were partially offset by 1 point of deleverage of logistics overhead, 1 point related to higher outbound freight and 40 basis points of deleverage in JRNY investments, which were lower in dollars year-over-year. Turning now to adjusted operating expenses. The next few lines of the P&L have been adjusted to exclude acquisition and other costs related to the purchase of VAY and last year’s legal settlement. Please see our press release for a reconciliation to GAAP. Adjusted operating expenses were $33 million, down 33% to last year’s $49 million. The primary driver of the decrease was lower media spending, which was $10 million versus $22 million last year. Adjusted operating expenses, excluding advertising were $23 million down 13% versus last year even with continued investments in JRNY, which dollar spent was down slightly versus last year.

We controlled variable expenses across all functions to ensure that they remained in line with lower sales. Adjusted operating loss was $10 million compared to $19 million last year. And adjusted EBITDA loss from continuing operations was $5 million, a $10 million improvement compared to last year’s loss of $15 million. Turning now to the balance sheet as of December 31. Cash was $17 million, per our plan quarter ending inventory was $77 million down 40% versus last year and down 30% versus year end fiscal 2022. About 18% of our inventory at 12/31 was in transit and continues to be weighted to our best-selling SKUs. AR was $43 million and trade payables were $35 million, both down from year end. Debt was $60 million, we had $27 million available for borrowing, bringing our liquidity at the end of December to $44 million.

We’re introducing free cash flow to enhance our disclosures around our balance sheet and liquidity. At 12/31 free cash flow was negative $5 million in the quarter, an improvement of $2 million versus last quarter, and an improvement of $34 million versus last year. While we recognize the headwinds impacting our business, we feel good about the levers available to us to continue to support our balance sheet. As Jim said earlier, we’ve implemented additional cost reductions to keep us on path to profitability despite market headwinds. We’ve structured our operating model to give us flexibility to respond to evolving market dynamics, to take advantage of attracted demand trends and streamline in softer periods. Consistent with this approach, we are proactively realigning our cost structure to support our current expectations for the business.

As such, we’ve reduced our contracted labor and yesterday implemented a reduction in force, which affected about 15% of our employees. As a result, we expect to recognize annualized cost savings of approximately $30 million beginning in Q4 fiscal year 2023. We also expect to incur restructuring and other one-time charges of approximately $3 million over the next six months between Q4 fiscal 2023 and Q1 fiscal 2024. We believe these actions better position Nautilus to manage through near-term headwinds in our Retail segment, while continuing to drive performance in direct and serve our growing base of JRNY members. Turning now to guidance for the rest of the year. Our revised guidance reflects lower expectations in the Retail segment as our retail partners have taken very conservative inventory positions amid an uncertain macro environment.

As a result, we are lowering full year revenue guidance to about $270 million, which implies Q4 revenue of about $52 million. Given the adjustment to our revenue expectations, we are now guiding to full year adjusted EBITDA loss of approximately $50 million, which implies Q4 adjusted EBITDA loss of about $15 million. Our adjusted EBITDA guidance excludes the impact of about $3 million of restructuring costs. Lastly, we continue to target approximately 500,000 JRNY members at year end 2023. While we expect retail headwinds to impact sales for the first half of 2024, the cost actions we’ve already taken give us a flexibility to navigate the near-term and keep us on path to improving cash flow and returning to profitability. I’ll turn it now back to Jim for his final comments.

Jim Barr: Thank you, Aina. For the near-term, we are taking necessary actions to realign our cost base, while executing on ongoing strategic margin management initiatives. We recognize the impact some of these actions have on our employees and are focused on supporting those impacted. I want to thank both our current and departing employees for all that they have done to advance Nautilus’ noble mission to build a healthier world one person at a time. Looking further ahead, we are confident in the long-term because we are on the right side of industry trends as we continue to execute on our vision of being a leader in connected fitness. We excel at equipment and are building and scaling a strong differentiated digital platform.

The shift to home fitness remains solid and we see an attractive opportunity for upside over time. Lastly, our comprehensive review of strategic alternatives is ongoing, and our board remains focused on identifying partner of opportunities to accelerate the company’s strategic transformation and enhance shareholder value. We have no additional information to share regarding this process at this time. And with that, I’d like to turn it over for questions. Operator?

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Q&A Session

Operator: Thank you. Thank you. Our first question is from Sharon Zackfia with William Blair. Please proceed with your question.

Sharon Zackfia: Hi, good afternoon. I was guess, I was hoping to give some clarity on the Retail channel and, I’m sorry if you mentioned this, but how are inventories in the Retail channel? Is it just a matter of retailers being cautious? Or are they still over inventoried? And then I guess kind of with that question, as you look for this decline in revenue in the March quarter, I mean, how should we dimensionalize or think about the delta between the Direct and Retail channels as we’re here in the March quarter?

Jim Barr: Sure, I’ll start and then I’ll kick it to Aina for the second part, Sharon. I think it’s a good question. Retailers continue to sell down. So, we are seeing active sell-through through the Retail channel not as much as we’d like it to be, but we’ve continued to see that all the way through the end of the fitness season. I think the €“ really what we’re seeing is this very cautious nature where retailers are kind of acting instead of acting as they normally act as, I’ll call it sales optimizers and margin optimizers. They’re willing to stock out on certain products in order to just drive down their overall inventories, not just in our category, but in several categories. So when faced with those choices, they’re choosing more often to continue to drive down their inventory levels and not take on much, much more inventory.

And then as we kind of looked at the outlook, as you get to the end of our fitness season, as you well know where things start to tail off a bit at the end of January and this is kind of our low period between kind of right now and when they start to reorder for next year, then you have a realization that it’s probably not going to cut. If they’ve been conservative so far, they’ll probably continue to be somewhat conservative and we baked that into our outlook and that’s why it has changed quite dramatically from the last time we spoke. And we’ve taken the actions we think are necessary to address that, so that no matter how long that takes to come back since that’s uncertain that we are here to address that. It’s also; I’d also say there hasn’t been anything structural changed.

So it’s not like retailers have dropped the product, dropped the number of doors or any retailers drop the category altogether. So that structurally is held up. It’s just this conservative nature of reordering that’s been at play here. And then Aina maybe you could

Aina Konold: The one thing, Sharon, maybe to help you, I want to just reiterate that the reduction in our Q4 expectations is really primarily driven by Retail.

Sharon Zackfia: Okay. Thank you.

Jim Barr: Sure. Thanks, Sharon.

Operator: Thank you. Our next question is from JP Wollam with Roth MKM. Please proceed with your question.

JP Wollam: Hi, Jim. Hi, Aina. Thanks for taking the question. Maybe if we could just start high level, it’s perhaps a little follow-up from the first question, but maybe what are some of the biggest takeaways from the holiday season, whether that’s on the equipment you are selling whether that’s where buyers are meeting your product, just kind of as we move into the last quarter here and into next year. What are the biggest takeaways we saw over the holidays?