Nautilus, Inc.

Greetings, ladies and gentlemen, and welcome to the Nautilus Incorporated Third Quarter 2022 Earnings Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. It is now my pleasure to introduce your host, Mr. John Mills. Thank you. You may begin.

Thank you. Good afternoon, everyone. Welcome to Nautilus' Third Quarter Fiscal 2022 Conference Call. Participants on the call today from Nautilus are Jim Barr, Chief Executive Officer, and Ina Knoll, 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 p.m. Pacific time 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. Please note, unless otherwise stated, all comparisons in this call will be against our results for the comparable period of 2020. For today's call, we have a presentation that management will refer to during their prepared remarks. On slide two is our full safe harbor statement, which we ask everyone to read. You can access the presentation by going to nautilusinc.com, then click on the Investor tab, and then click on the Events and Webcast, and the presentation will be there. I would 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 your 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 of our website. And with that, it is my pleasure to turn the call over to Donaldson's CEO, Jim Barr.

Thank you, John, and thank you all for joining us. Before I discuss our quarterly results, I'll begin with a look at the home fitness industry, the market dynamics at play, and our positioning within the industry. The at-home fitness industry has been in the news quite a bit recently, largely due to two issues, speculation about long-term demand and challenges some of our competitors are currently facing. Here's our take on the market and Nautilus' positioning. We are confident that the at-home fitness industry has grown rapidly over the last two years and that the overall opportunity will remain significantly elevated for the long run. Second, we were not surprised that the industry seems to have regulated from its peak and is trending to a new normal level. It's been impossible to be 100% correct in our planning and decisioning at each stage of the pandemic, but we believe we have generally read the market well and have managed our business with disciplined execution through all phases of the pandemic. Third, we have a long-term strategy and a positioning that's quite different from others. And over the past two years, we've built a stronger team with new capabilities to tackle emerging opportunities and challenges. And then finally, as a result, we're emerging as a much stronger company than pre-pandemic. I'll now give you some flavor on each of these statements. Since the outset of the pandemic, there has been a renewed focus on health and overall well-being. And on a larger level, people have gravitated towards well-known brands with strong value propositions. Nautilus fits squarely at the intersection of both these tailwinds. At the center of health and well-being is home fitness, and the market has so far behaved largely as we expected. The market size more than doubled over the past two years, is regulating from its peak with more normal seasonality, and will settle at a new normal significantly above pre-pandemic levels based on profound evolution in consumers' habits. We've been telling you for several quarters that our surveying shows that about 25% of former gym goers say they do not ever intend to return to the gym. That figure actually ticked up to 29% during our third quarter and has held remarkably steady now for 18 months. Those attitudes manifested themselves in the formation of new long-term habits that favor at-home fitness. Pre-pandemic, about 40% of people for whom fitness was important worked out at home. Nearly two years later, that number is close to 70% and is holding steady. The evolution of the work model to working from home or a hybrid model is also a long-term driver of home fitness. Another important catalyst for the change in workout habits is the digital transformation that has been occurring over the past few years in home fitness and was accelerated by the pandemic. More people discovered that connected fitness not only can bring home many of the benefits of the gym, but the variety of programming, such as InJourney, fights boredom and keeps them at their fitness routine for longer. As a result of these changed habits and sentiments, We continue to believe much of the industry growth opportunity will remain at elevated levels relative to pre-pandemic. This results in stronger opportunity for our industry and for Nautilus. In the face of unprecedented challenges and uncertainty over the past two years, I'm proud of how we've managed our business through disciplined execution. Some examples include inventory management, skew rationalization, and regulating expense growth. We have stayed true to our asset light manufacturing model. We built inventories, then regulated our orders once we were ready for fitness season, but have not needed to close facilities or cease production. We are, in fact, now reordering for the first half of fiscal 2023. We focused on fewer SKUs that are largely our best sellers and worked down that inventory during the third quarter as planned. Utilizing our strong culture, noble mission, and a focus on improving the employee experience, we continue to attract and retain strong talent even through the so-called great resignation. We have stayed true to our most important areas of strategic investment, such as Journey and the Bowflex brand, but have regulated our other expenses, such as G&A, until we see where demand normalizes. Just under a year ago, We shared our new long-term strategic plan, our North Star plan. Our strategy differs from other competitors and is built on our key strengths, well-respected brands, a portfolio of products that include multiple modalities and price points, making them more attainable, and broad multi-channel distribution. Our strategy adds greater consumer centricity, a new target consumer, modernization of our Bowflex brand, an enhanced team with expanded long-term capabilities. It also improves and scales our differentiated Journey platform offering. Journey focuses on being your overall personal trainer, offering a variety of ways to work out on and off our products versus tilting towards any single use case, such as predominantly one modality or trainer-led classes. Journey is also more affordable. We are focused on investing in our company for the long term and have continued to keep our foot on the accelerator through our investments in Journey, our brand, and our digital transformation. Our commitment to our strategy continues to strengthen as we begin to see our strategic investments succeed. Our board and our management team are united in maintaining our key investments as we continue to balance the long-term and the short-term. We have also progressed during the pandemic by building enduring assets for the long-term, including Launching a complete suite of new multi-modality connected fitness cardio products, including innovative bikes, treads, and revitalized max trainers. And we have a pipeline of strength products leveraging our way acquisition. A new target customer base with nearly 500,000 new customers since the pandemic began, introduced to our brands. Encouraging early progress on improving and scaling our journey digital platform that makes our equipment even better. I'll share some exciting news about member growth shortly. Significant expansion of our already strong multi-channel distribution, including a vastly expanded and a more diversified set of retailers. New talent and capabilities throughout our business, including software, digital product, supply chain, financial analysis, and customer care, and of course, we have a new transformational North Star strategy. Pulling this all together by leveraging the enhanced long-term industry opportunity and through disciplined execution by staying true to our North Star and by building enduring assets, I'm confident in saying that we are emerging from the pandemic as a much stronger company. Next, I'll speak to our third quarter results. In the third fiscal quarter of 2022, Net sales were $147 million, which represents 63% growth versus two years ago, excluding Octane. While down from the pandemic-driven all-time high of $189 million in the same period last year, this quarter's sales performance remained historically strong. In fact, this was the second highest December quarter in the past 15 years for Nautilus. Our two largest sales channels, Direct and North American Retail, While down versus last year, we're both up over 60% compared to the same period two years ago. Notably, given our strong holiday performance, Direct had a $9 million backlog coming out of the quarter, stocking out on some of our more popular connected cardio products. One area that was softer than expected was international, which is about 10% of our overall business. We have a different operating model there. We work primarily through distributors. This model has an extra level of inventory and fewer levers for us to clear inventory. The UK and EU are our largest international markets, and the shutdowns impacted sell-through. We expect softness in international to continue through the end of this fiscal year. I would characterize our Q3 results to be relatively strong in dollar demand and fantastic from a unit sales perspective. As one response to the chip shortage, we pivoted to aggressively marketing and promoting strength products, specifically the incredibly popular Select Tech line, which also helped drive journey member growth. Impressively, I'm proud to say that we shipped more units in the quarter than any other in Nautilus history, showing not only continued strong demand for our products, but demonstrating new capabilities in our supply chain. We are pleased to report that for the first nine months of 2022, Net sales were $470 million, a 7% increase over the same period last year, and a 144% increase compared to the same period two years ago, excluding octane. The team is proud to have positively comped the year-to-date through three quarters. Gross margin continued to be affected by the widely discussed elevated global supply chain costs. In addition, this quarter's margins were impacted by lower net selling prices resulting from industry-wide discounting during a highly promotional holiday season. The bulk of the discounting that we observed during the fitness season, which typically runs through the end of January, have now concluded. We believe this gross margin pressure is largely temporary in nature. Ina will provide more detail on margins in her section. Importantly, despite the lower gross margins in the third quarter, our Q3 operating margin results were in line with our guidance for the second half. Moving on to progress on our North Star strategy. We've been working tirelessly to make Journey a leading fitness digital service that enhances our incredible lineup of equipment, creates an ongoing relationship with our members, and provides a recurring revenue stream. As we communicated last quarter, We made the strategic decision to accelerate our investment in Journey. The manifestation of our year-to-date investments in Journey include a new Journey update which allows customers to track workouts across cardio, strength, and whole body exercises. That means Journey members can now track their workouts across all the products they own, cardio and strength, and track whole body off-machine workouts on one fitness platform. We expanded the assortment of Journey-enabled products, building our connected fitness install base. We introduced the MaxTotal 16 in the U.S. and Velacor 16 in Canada at the beginning of November and have attached Journey to our Bowflex Select Tech 552 and 1090 dumbbell purchases beginning in mid-October. In the third quarter, we shipped three and a half times the number of Journey-enabled products versus the same period two years ago when we launched our first connected bikes. and 70% of our cardio units shipped this quarter were Journey enabled. Select Tech is one of the strongest selling offerings and attaching Journey to the strength modality has boosted our member base and is the first time we have combined a digital offering with our strength products. The results and feedback from our members have been very encouraging. We've expanded content. We continue to add more Explore the World experiences with over 150 locations around the world now available. Members love the immersive experience and the escapism. We continue to build our trainer-led video library, which now includes over 1,250 trainer-led videos, including new whole body workouts. We've added foundational advances such as journey.com, powered by a new subscription management and billing platform. We began providing a 12-month complimentary trial for a limited time to ensure the maximum number of consumers can use the platform. Here's the punchline. We grew our Journey member base to nearly 250,000 by the end of this quarter and are tracking to cross 300,000 total members by year-end fiscal 22, above the midpoint of our previous guidance. We've grown members by nearly 3x year-over-year and by 700% versus two years ago. As you know, Nautilus got a late start in connected fitness, and while it is still early in our digital transformation with Journey, The strong growth we've experienced to date is exciting. As such, we continue to invest in the platform. Digital is a key component of the future of Nautilus, and investing here will allow us to best leverage our assets and will position us for long-term profitable growth. A second pillar of Northstar is putting the consumer at the center of our decision-making. We are working to transform Nautilus from a product-led hardware company to a consumer-led digital company. This consumer-led approach has permeated our business, including Bowflex advertising. Our focused approach to advertising has punched above its weight, with measured share of voice nearly double our market share in the quarter. A few key highlights. We ran the first ever Bowflex Select Tech dumbbell campaign that included Journey. This also helped drive more Journey memberships. We continued investments in the Bowflex brand with incremental advertising to drive purchase consideration and position the brand in a more modern and inclusive way. In addition to taking a more customer-led approach to advertising, we bolstered our team by hiring a new director of customer success, our first-ever customer experience manager, and are adding critical staff in email and social marketing. Strength is another pivotal part of our consumer-centric approach. Bowflex has long been a leader in strength, and we are working to elevate the consumer experience through our connected strength products. In the second quarter, we completed the acquisition of Way, a leader in motion and vision technology. In the third quarter, we focused on integrating Way's motion tracking capabilities into Journey to further advance and accelerate our highly personalized workout experiences, including Automatic rep counting and form coaching, on and off, both Lex and Schwinn products. We expect to begin testing these features with select customers in the spring. We also focused on hiring more developers. Two years ago, we had about a dozen software developers and UX FTEs, and we're mostly a mechanical engineering company. But today, we have more than 250 people engaged in software development. We are accelerating our software development capabilities and adding new and innovative features to the Journey platform, moving us closer to our vision for Journey as your highly personalized, one-to-one personal trainer. And the last pillar of NorthStar that I'd like to touch on today is our supply chain. We continue to battle unprecedented challenges from container and electronic components availability, elevated commodity costs, and costs of shipping and storing inventory. However, our investment and efforts have bolstered overall supply chain capabilities and are enabling us to successfully manage through this period. Earlier this year, we made a strategic decision in light of the global shipping issues to pre-order inventory in preparation for the seasonally strong third and fourth quarters to ensure that we, along with our retail partners, would be fully stocked. As mentioned previously, driven by strength products, we moved more units in the quarter than any other quarter in the company's long history. In summary, we are emerging from the pandemic as a stronger company. We have new leaders, new tools, and new processes in place, providing us to make a much stronger and more agile company. I'll now turn it over to Ina, who will give us more detail on the third quarter financials and our guidance for the rest of the year.