Nautilus [NLS] Conference call transcript for 2021 q3
2021-11-09 23:23:10
Fiscal: 2022 q2
Operator: Greetings ladies and gentlemen, and welcome to the Nautilus Incorporated Second 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.
John Mills: Thank you, Jen. Good afternoon, everyone. Welcome to Nautilus' second quarter fiscal 2022 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 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 2 is our full Safe Harbor statement, which we ask everyone to read. You can access the presentation by going to nautilusinc.com and click on the Investors tab and then click on the Events and Webcast and the presentation will be right there for you. I'd like to remind everyone that during the conference call, Nautilus management will make certain forward-looking statements. These forward-looking statements are based upon 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 of our website. And with that, it is my pleasure to turn the call over to the Nautilus' CEO, Jim Barr.
Jim Barr: Thank you, John, and thank you all for joining us. Today I'll begin with some thought on the home fitness market dynamics over the past 18 months and the outlook going forward as context, then cover our financial performance in the quarter and the first half. Next I'll discuss our strong progress on our North Star strategy including JRNY. I'll end with our plans to further accelerate our investments in JRNY and in marketing. You've heard us talk in detail over the past 18 months about the dramatic expansion in the size of our SAM, 2 to 3x by our most recent estimates. This kind of industry growth is very rare and underscores our strong opportunity as the #3 in market share. There is strong evidence that much of this margin expansion maybe permanent, because the principal driver is profound and fundamental secular changes in workout attitudes and habits that favor home fitness. Our frequent surveys continue to indicate that 25% of former gym goers do not intend to ever go back to the gym, and others who say they will return to the gym plan to work out more often at home than they did pre-pandemic due to remote or hybrid work models workout place is highly correlated with workplace. We are seeing these changes and attitudes play out in consumer behavior. For example, in a recent study we commissioned 66% of respondents report that they work out at home versus 43% pre-pandemic. Connected fitness and our transformation are still in early innings. I'm proud that we have positioned ourselves well during the pandemic for post pandemic success. We now have a portfolio of new connected products, a strengthened JRNY digital offering with a growing member base, stronger consumer targeting, expanded omni-channel distribution, and a stronger team. It is remarkable what we have accomplished in the last two years. I'll talk more about that a bit later. Now, I'll briefly speak to our second quarter and first half financial results. In the second fiscal quarter of 2022 net sales were $138 million which represents nearly 125% growth versus two years ago. Our net sales were $155 million in the same period last year. The primary driver of our missed guidance was due to global shipping challenges beyond our control that affected the end of quarter cutoff. Specifically, we would have met our guidance of $145 million to $155 million if just a portion of the $22 million of FFO finished goods inventory we had ready and waiting on the dock for retail customers had been picked up, due to a variety of reasons for the delay in pick up, including retailers' inability to secure containers in time. In fact $12 million of the $22 million had shipped by the end of October. For additional perspective, this was the second strongest September quarter in the past decade for Nautilus. Excluding Octane, our retail segment in the second quarter was up 19% compared to the prior year period and up 175% compared to the same period two years ago. The direct channel exceeded our internal goals and was down in the second quarter due to seasonality which didn't occur last year but it was up 134% compared to the second quarter two years ago. International, which was -- which is reported as part of the retail segment continued to achieve very strong year-over-year and two year growth in the second quarter, up 57% and 655% respectively. As expected, gross margin for the second quarter of fiscal year '22 was lower due to abnormal shipping and logistics costs 8 points. Commodities and components and foreign exchange 4 points, and continued investment in JRNY 1 point. The cost pressures related to the global supply chain disruptions are obviously affecting many industries including ours. While the impact is significant, we believe these external margin pressures will normalize over time and when coupled with the expansion of our addressable market will result in improved operating margins for Nautilus. Despite our sales miss, we achieved our adjusted operating margin guidance for the second quarter of low single digits, while increasing our investment in advertising in JRNY by nearly $8 million versus LY. Especially given the atypical retail seasonality patterns we have seen, it is important to also discuss the first half of the year in aggregate. For the first half net sales were $323 million, a 28% comp to LY and a 215% comp to LLY excluding Octane. Keep in mind 2022 is comping against the pandemic sales in 2021, so we're quite pleased with our first six months performance. And in fact, this first half rates as the best comparable period in Nautilus' history. For the first half adjusted operating income was $22 million or 7%. Moving on to our progress on our North Star Strategy. During our Investor Day in March when we laid out our long-term vision and strategic plan, North Star, one of the areas we highlighted was our supply chain. We have made great strides by working down backlog, improving our inventory position relative to last year, and opening a new DC to alleviate the widely known supply issues affecting global shipping. We are proud to have built and shipped the inventory to meet consumer demand without the disappointment of last year's long waits. We have overcome shipping issues and will not be among those sellers with empty shelves this holiday season. Even with these successful investments we expect gross margins to continue to be under pressure as global supply chain disruptions continue to persist. We continue to address unprecedented challenges such as container availability, cost of shipping and storing inventory, elevated commodity costs, availability and spot prices of electronic components, and delayed retailer FFO pickups. But we have developed a much stronger and more agile supply chain, thanks to disciplined execution on our North Star strategic plan. Next, I would like to turn to innovations. This quarter we announced and completed the acquisition of VAY, a leader in motion and vision technology. This acquisition directly supports our aim to accelerate our software development capabilities and add new and innovative features to the JRNY platform, moving us closer to our vision for JRNY as your highly personalized one-on-one way fitness coach. VAY's proprietary technology enables computers to understand human motion using cameras on its computer vision software, analyzes movements and provides real-time individualized feedback and coaching on exercise. VAY has a particular unique strength in using cameras found on today's mobile devices such as smartphones and tablets. VAY's existing partners include Microsoft and ETH Zürich, one of the top science and technology universities in the world. We plan to integrate VAY's motion tracking capabilities into JRNY to further advance and accelerate our highly personalized workout experiences, including automatic rep counting and form coaching. Our initial focus will be on strength training and off-product workouts, such as body weight, yoga and floor exercises. We are excited to have increased our software capabilities through this tuck-in acquisition and plan to incorporate the first set of features from VAY into the JRNY experience during our fiscal '22 fourth quarter. Over the past year we've made tremendous advancements with JRNY and are seeing very strong adoption and tremendous growth in JRNY members. We are excited about the value and the experience that JRNY provides. It is focused on the individual. It provides a greater variety of choices of equipment and ways to workout than competitors. We have added classes of course, but JRNY brings what we call entertainment beyond the class, and we provide all this at a great value, typically one half, to one third the price of our competition. Just last week we announced that JRNY now includes strength video workouts for Bowflex SelectTech 552 and 1090 dumbbells. SelectTech is one of our strongest selling offerings and this is our first entry into strength training with JRNY. The new updated digital platform now includes a video library of instructor-led strength workouts for these Bowflex SelectTech dumbbells. In the near future, we will also be adding strength workouts specific for the Bowflex SelectTech 840 kettlebell and the Bowflex SelectTech 2080 barbell. We also announced that for a limited time new JRNY members are eligible to receive a 12-month complementary trial membership. This marks the latest step to make the JRNY experience available to more consumers whether they are using cardio or strength equipment or both. Previously consumers could not easily experience JRNY without owning one of our connected cardio products. We are excited to expose the JRNY experience to a much broader audience. We were also excited to announce last week our latest connected cardio product, the new connected Bowflex Max Total 16. The new Max offers a 16 inch HD touch screen and integration with the JRNY digital fitness platform, so users stay engaged and motivated during high calorie burn interval workouts. The Bowflex Max Total 16 machine blends the low impact of an elliptical and the high intensity of a stepper to offer short high-intensity interval workouts in a compact design. The initial reception of our JRNY powered Max machines has been phenomenal and we are excited about how we have improved upon this industry-leading product unique to Bowflex. We've increased JRNY content adding over 100 explore the world immersive experiences and have released hundreds of new trainer-led videos during the first half of the fiscal year '22. We've done so with our own first party content and through partners such as FitOn. We also launched jrny.com a new web-based consumer portal to better highlight JRNY platform's features and benefits, as well as helping members more easily manage their journey accounts without calling customer service. The team and I are delighted with our execution and progress in connected fitness via our new equipment and the JRNY platform and we're only just beginning. All of this progress in the last few months has led to very strong membership growth and lowered our churn significantly. While it is early, our growth is extremely promising. I am pleased to report that our current member account is approximately 200,000, more than three times the year ago period when we had about 65,000 members and this incredible growth is before the holiday season, before our new product introductions, JRNY enhancements and special limited time trial offers that I discussed. As planed in our North Star plan we have stood up and are building a highly profitable digital business on top of the successful equipment business. The consumer experience on our equipment is enhanced by our digital offering and our digital businesses fueled by economics of the equipment we have been working tirelessly to make JRNY a leading fitness service that matches our incredible line of equipment. Our digital connected subscription service is driving the future of Nautilus and the execution and results of our North Star strategy have exceeded our expectations to date. I'm delighted that we are even further along in our long-term transformation that we expected on Investor Day in March. This progress ultimately will enable us to have more predictable growth and higher profitability that will generate attractive long-term returns. There remain challenges to overcome such as post COVID recovery driven margin pressure from inflation and transportation costs which has been more severe than anyone expected, in fact 12 points in Q2. In the first half of our fiscal year, we were proud to have overcome these challenges, stayed committed to North Star investment, and still remained profitable. It was an incredible accomplishment to do it all. As we look at the second half we assume that these margin challenges while temporary, will likely persist for the remainder of our fiscal year. This led us to an important decision point. Do we choose to remain profitable by pausing or reducing our North Star strategy investments or do we capitalize on our progress and continue to invest with confidence using our balance sheet. Faced with this choice, our Board and Management Team have made the strategic decision to not only stay committed to North Star, but to accelerate our investment in the second half of the year. We are choosing progress towards our long-term goals over short term profit maximization. Specifically, we are increasing our second half forecasted OpEx spend by $12 million to $14 million in JRNY versus LY and marketing as a percentage of sales will increase by 9 to 11 points versus last year. This will permit us to grow -- to more quickly grow our membership base and transition to a higher gross margin business earlier than originally laid out on our Investor Day. Additionally, we have improved our liquidity by increasing our line of credit to $100 million. This allowed us to deploy cash for tuck-in acquisitions like VAY, gave us working capital to invest in inventory and importantly, gives us room to accelerate our long-term investments. We also expect that this near-term investment will enable our JRNY digital platform business to be accretive sooner than previously expected. Aina will be providing specific 2022 guidance during her remarks and will include a waterfall of margins to show where we're investing. We also expect margins to decline each year from 2023 to 2026 and beyond. Simply put, we are leveraging our profitable equipment business to build digital faster due to strong results. We are unified in our confidence that this is the best approach for our company and for our shareholders. I'll now turn it over to Aina, who will give us more detail on our second quarter financials and guidance for the rest of the year. Aina?
Aina Konold: Thanks Jim and good afternoon everyone. Today I'll talk to results for Q2 and the first half of fiscal year '22 and will provide guidance for the second half. I'll start with Slide 11 of the presentation. Total company P&L results for Q2 '22 with comparisons to the same quarter last year. Net sales were $138 million, down 11% LY on a GAAP basis, excluding Octane were down 5% and up 150% to LLY. Sales declined year-over-year primarily due to products return to normal seasonality and global logistics challenges affecting retail. As Jim mentioned earlier, we had over $22 million of FFO orders ready for pick up that didn’t make the cut off. Unfortunately our sales driving strength wasn’t wide enough to accommodate this level of disruption. Gross profit was $42 million and gross margins was $30.5 million, down 13 points from LY. 8 points of the decline is due to logistics, 4 points due to raw material components and FX, and 1 point related to increased JRNY journey investment. Turning to operating expenses, this year we booked a $5 million settlement related to a Class action law suit and incurred $1 in acquisition costs for VAY. Last year we booked $8 million of gain on disposal group related to Octane. Given these unusual costs, we believe it's better to look at our operating results on an adjusted basis. Please see our press release for reconciliation to GAAP. Adjusted operating expenses were $39 million or 28% of sales versus last year's $32 million or 12% of sales. Selling and marketing expenses were $22 million or 16% of sales, up $3 million from last year, driven by higher advertising. Adjusted G&A expenses were $11 million or 8% of sales, up $2 million to LY, primarily driven by increased investments in JRNY. R&D was $6 million or 4% of sales, up $1 million compared to LY, again driven by increased costs related to JRNY. In fiscal Q2 advertising was $12 million and JRNY OpEx was $5 million. Adjusted operating income was $4 million and adjusted operating margins were 3% in line with guidance of low single-digit. Our presentation includes a waterfall chart on page 13 that describes the year-over-year change in operating margins. The biggest driver is lower gross margins followed by increased advertising and investments in JRNY. Adjusted income from continuing ops was $1 million or $0.03 per diluted share versus last year's $28 million or $0.87 per diluted share. Adjusted EBITDA from continuing ops were $7 million or 5% compared to last year's $38 million or 25%. Please refer to our press release in the presentation accompanying this call for more information on segment performance for the periods three months and six months ending September. Let me now turn to Slide 15 for results for the first half, which is the six months ended September 30, 2021 compared to the same period last year. Net sales were $323 million, up 20% on a GAAP basis. Excluding octane, sales were up 28% versus LY and up 215% versus LLY, driven by strong growth in retail. Gross profit was $98 million and gross margins were 30%, down 13 points versus last year. The decrease was primarily due to increased logistics 7 points, raw materials components and FX 5 points, and 1 point related to increased investments in JRNY. The following statements for the first half exclude the impacts of this year's legal settlement and acquisition costs and last year's loss in disposal group. Adjusted OpEx were $76 million or 24% of sales versus last year's $58 million or 21% of sales. The $18 million increase was essentially driven by $12 million more in advertising and $6 million more in JRNY. When we saw direct begin to return to seasonality in Q1, the equipment side of our business worked hard to keep costs flat to LY despite higher unit sales this year, while continuing to advance North Star. First half advertising spend was $23 million and first half JRNY OpEx was $8 million. Adjusted operating income was $22 million or 7% compared to last year's $58 million or 21% driven by lower gross margins and higher OpEx. Please see Slide 17 in the presentation for a waterfall chart walking through the year-over-year changes. Similar to Q2, the largest driver of the decline was supply chain related followed by increased investments in advertising and JRNY, partially offset by operational improvements as the organization worked to keep costs in line with lower sales. Adjusted income from continuing ops was $15 million or $0.46 per diluted share compared to $45 million or $1.40 per diluted share. Adjusted EBITDA from continuing ops was $28 million or 9% compared to$6 4 million or 24% of net sales. Turning now to the balance sheet as of September 30, cash was $22 million and inventory was $163 million, with about 40% in transit as of 9/30 compared to $68 million at year end. Given the continued disruption in global logistics, we made a strategic decision to bring inventory in earlier to be in a better position to meet peak seasonal demand. Our inventory is concentrated in our best selling products and we're incurring incremental storage and transportation fees to position us well for holiday. AI was mostly flat at $89 million and trade payables were $115 million versus $99 million at 3/31 primarily due to the timing of payments for inventory. Debt was $17 million versus $13 million at year end and we had $49 million available for borrowing on our facility. On October 29 we amended our facility increasing our revolver size from $55 million to 100 million and extending the maturity date to October 29, 2026. On a pro forma basis, using our new expanded facility, we would have had $he would have had $94 million available for borrowing at 9/30. Turning now to our expectations for the rest of the year. As Jim highlighted, we're pleased with the progress we're making at North Star and the solid momentum in our JRNY business. We now have 200,000 members. Engagement is growing, churn is declining and our path to bringing JRNY to scale has become clear as we gain new capabilities through our recent acquisition and content partnerships. Certain aspects of our environment are challenging like nearly every other business we're experiencing near-term external pressures on gross margins which worsened in Q2 versus Q1. While we're really proud that we're able to overcome the majority of the pressures in the first half, we don't believe that putting our future on hold for near-term results is the best way to deliver long-term shareholder value. Our Board and Management Team and our employees have strong conviction that the path to sustainable, profitable growth is through having a high-margin subscription business to complement our enduring equipment business. We'll do that by capturing greater share of the connected fitness market by improving and enhancing the JRNY platform and we'll be investing in that. Let me now share our expectations for the second half of fiscal year '22 six months ending March 2022. Please follow along starting on Slide 20 of the presentation as the slide includes a waterfall helpful and understand the changes in operating margin. We expect sales to be between $290 million and $320 million, which represents growth versus LLY between 47% and 62% or a two-year CAGR of 21% to 27% versus the six months ending March 2020. This sales guidance reflects our plan to continue bundling 12-month JRNY trials of cardio equipment sales. We will be deferring the JRNY portion of the bundled sale revenue and amortizing it monthly for the subsequent 12 months. Our expected deferred revenue of $6 million to $7 million will reduce sales and negatively impact gross margins in the second half by 2 to 3 points. We expect the same macro supply chain headwind to continue in the second half negatively impacting gross margins by 12 points. We continue to increase our investment in JRNY in the second half. Second half JRNY COGS which includes depreciation, content, customer support and per subscriber variable costs, will be between $6 million and $8 million this year. Second half OpEx JRNY which includes R&D, IT, product management, and the amortization of stock based compensation and earn out associated with our VAY acquisition will be between $18 million and $20 million this year. We plan on investing more in advertising this year to remain competitive and share of voice and to highlight the improvements in our connected fitness experience, as a rate of sales advertising will increase by 9% to 11%. Lastly, we'll continue to invest in our infrastructure and in our team. We doubled our equipment business, but most of our increased costs have been targeted towards JRNY. We're upgrading our tools and adding new capabilities to the equipment side to optimize and scale for the future. We believe these investments will accelerate membership acquisition and will ultimately result in the JRNY business unit being accretive several quarters faster than originally planned. We could have chosen to pull back on spend in the second half, put our future on hold and deliver operating income in the low single-digits. But as we told you during Investor Day we'll always lean more towards protecting the long-term prosperity of the company versus achieving near term profits. Therefore, for the second half of the year, we expect operating loss margins in the mid-teens and adjusted EBITDA margins in the low teens. We continue to expect CapEx to be between $12 million and $14 million for the full-year with the majority earmarked for JRNY and lastly, we now expect JRNY members to be between 250,000 and 350,000 by the end of fiscal '22. Looking beyond fiscal '22 and into fiscal '23, we will be at par to adjusted EBITDA profitability. Specifically we anticipate year-over-year gross margin expansion driven by stabilization in the logistics environment. We will also begin to recognize accretive impact of our higher margin digital subscription business as we add members and leverage our growing scale. This will enable to achieve gross margins in the low 30% on a blended basis for the full year. As a result we expect to be adjusted EBITDA profitable for the full fiscal '23. One final comment on our long term expectations, by accelerating our investment into JRNY we now expect to achieve mid-teen operating margins by fiscal year end '25, one year earlier than we initially modeled with fiscal year-end '26 delivering operating margins in the high-teens. In closing, our liquidity position is strong. We've invested our cash in our best performing inventory, and we have an expanded $100 million credit line. We are well prepared for the upcoming fitness season with a robust inventory position, strong digital offering well-funded marketing, leading equipment connectivity, and achieve passionate about our vision of creating a healthier world one person at a time. Now, I'd like to turn it over back to Jim for his financial comments.
Jim Barr: Thank you, Aina. Before we go to questions, I would like to briefly take stock in our progress over the past two years. Faced with a favorable market dynamic we acted decisively to set a new strategy and execute against it. Our progress to date is undeniable. I'd like to give just a few examples. In 2019 we had only one connect product in our portfolio until December and no meaningful installed base for our subscription business. Now we have a complete portfolio of connected fitness cardio machines unified by the JRNY membership platform and ecosystem. Our installed base picked up in late 2019 with the launch of two new bikes, but we did not have much scale in connected cardio units sold. By contrast, in just the last year, we have sold more than four times the number of connected cardio units as 2019 rapidly growing our installed base of JRNY powered units. The Max trainer, our most important and proprietary product was in a multiyear decline in 2019. This quarter I'm delighted to report that the new connected Max connected fitness and M9 Max trainer now revitalized with JRNY was #1 in dollar sales and direct. Two years ago we were mostly a mechanical engineering company with about a dozen developers in software U.S. FTEs. Today we continue our legacy with strong equipment, while we have 160 people engaged in software development. This fundamental change in our business toward connected fitness has already yielded tangible results. JRNY had 14,000 members at the end of 2019. Today as we've said, we have approximately 200,000 and are on our way to achieving our first your goal and accelerating towards our two million-member goal. JRNY has been built on consumer insight and we are improving it every quarter with accelerated investment. We are inspired by our mission to be a leader in individualized connected fitness. Two years ago we had no meaningful consumer segmentation. our products and marketing appealed more to consumers who didn't like working out and we were not driving a significant number of new customers to our brands. Today we are relentlessly focused on high-value targets who prioritize fitness day in and day out, and are highly correlated with gym goers displaced during the pandemic. As a result, we added over 400,000 new customers to our brands versus a typical year of adding 100,000. We also are recalibrating the Bowflex brand to ensure we resonate equally with men and women and to bring our younger cohorts who thrive on connected fitness and will appreciate the variety of the challenge that our JRNY platform offers. In 2019, we were still not fully committed to omni-channel. Today we are passionate about letting our consumer shop when, where, and how they want. I'm really proud of the way we have invigorated and strengthened our retail segment more than doubling our number of retail doors and radically diversifying our retailer base. We were shrinking and in survival mode in 2019 in need of a turnaround, greater liquidity and a clear strategic direction. Since then we have more than doubled our revenue and strengthened our capital structure, which gives us the confidence to continue to invest in the future and an inspiring on point and very focused strategy North Star that we believe will deliver more consistent, more predictable growth, based on balanced equipment portfolio and a growing recurring revenue base, and levels of profitability not achieved in our history. We have also built a world-class team and strengthened our digital talent. Our market opportunity has grown tremendously. The U.S. home fitness market size appears to have doubled or tripled after 2019 base due to important changes in habits and trends favoring home fitness. The progress our company has made over the last two years is incredible and gives us strong confidence that our outlook for the future had never been stronger. It is with this confidence that we stay committed to our North Star strategy and are investing for the future. I want to thank all our leaders, employees, suppliers, distributors, and retail partners. Your incredible efforts are not only transforming our company, but changing consumers' lives by empowering healthier living through individualized connected fitness experiences. I'd now like to turn it over to questions. Operator?
Operator: Thank you. Our first question comes from the line of Steve Dyer with Craig-Hallum. Please proceed with your question.
Steve Dyer: Thanks for taking my question. Good afternoon everybody. A couple of questions and during some encouraging early signs there I guess, a two-part question there, one I guess that you're willing to share or able to share anything that you are sort of seeing that's better than expectations, are you seeing sort of more subscribers, are you seeing more associated sort of members or accounts on those subscriptions? Anything maybe I guess would be what your thoughts you're seeing would be the first one? The second one then would be the increased JRNY spend, is that sort of to the extent you can sort of talk about that, is that accelerating spend that otherwise would have been done next year or are you just, are you ramping up sort of marketing, what's going on in the marketplace to stay relevant and front of mind? And then I have probably one more, thanks.
Jim Barr: Sure. Now thank you for the questions Steve, good questions. Yes, so I guess the short answer is everything on JRNY seems to be going better than we expected. Specifically we did call out the member number that's going faster and as I mentioned it's kind of pre-business season and pre-some special offers to get this out there. We've disconnected JRNY from the cardio equipment, so more people can experience it. I guess, that's one is just the membership. The churn is down. We're not providing as you know, we're committed to providing a set of metrics on an ongoing basis beginning with our fourth quarter call when we said it would be materials. So we'll continue to do that. Engagement is quite high and by that I mean the number of hours and work outs per user are going up. Attachment is up, so that's -- of the people who are eligible to use JRNY how many of them are actually using it. So all of those things give us really a lot of a lot of confidence that we are ahead of schedule on many of these things and hence we sort of could change our goals as well and are more aggressively moving towards our long-term goals. And I'll hand it to Aina on the spend question.
Aina Konold: So you have two questions on the spend. First about JRNY spend, yes it's an acceleration of spend we thought we'd be doing a little bit later, but we thought given the momentum and the proof points that we could accelerate it. You asked about marketing, so yes we're increasing marketing as a percentage of sales and that's a combination of we now have a great set of connected products and experiences we don’t want to talk too much about and we do want to be a little bit more competitive in just share of voice in the back half of the year.
Jim Barr: And as we said about the brand advertising as well, we think a portion of this investment is durable. Right? And we talked about the fact that we have the Bowflex brand that is kind of top of the market in terms of recognition relative to our closest competitors. So people know the brand. The brand, when we talk about the brand it sometimes emotes the idea of the and we want people to be thinking about more modern use of our of our brand related to JRNY and digital experiences and things like that. So we'll be spending on that so that we're moving the brand to where we want to move it.
Steve Dyer: That's very helpful. Just a couple of quick ones, I think you had talked back at your Analyst Day about staying profitable through all of this and paying as you go again, so it was a term you used a couple of times. The decision to swing negative or unprofitable over the next two quarters, is that primarily a function of accelerating JRNY or is that also sort of some of these other cost headwinds are just bigger than you anticipated at that time?
Jim Barr: Yes it’s a combination of both those things. Our strong progress is a big part of it. So when you're doing well you go, hey can we get there faster and you challenge yourself to do that. But to be totally honest it's -- these 12 points of margin compression, when we started out at that pay-as-you-go and we thought we could do it all. We thought we had such a strong tailwind there that we'd be able to overcome all of those points, especially the land and product cost of about 7 points. So we thought we could overcome all of that and still invest in JRNY, but then by the time we got to the second half and we looked at it, and we were really looking at the logistics problems getting worse throughout the first half and sort of peaking in the second quarter. And then we have to anniversary that for the entire back half, and that's just too much to overcome when you look at it that way. So then we were really faced with that choice and we just really wanted to put investors in our framework there. We literally said, hey look, we can breakeven, but is that the right thing for business? We would have to actually slow things down, we'd slow down some hiring, we'd slow down JRNY development, we wouldn’t market as much, and we could deliver a profitable second half, but that did not seem right. What you're seeing in the market is nobody is really going for a profit motive. Growth is more important, membership growth is more important and we saw later to really accelerate towards that much after. So that's why we made a decision. We didn’t want to kind of put you all in a mindset. We are 100% confident that is the right decision. All right? I mean we do not -- we didn’t come, we came here to change the company in this direction. We have tremendous opportunity to do that. We have a balance sheet that supports it and we're going for it and we think that's the right way to go. Some investors might want the short-term profit, but we want the investors that are here for the long-term because the long-term is just a beautiful thing.
Steve Dyer: Yes, got it. Thank you for the color. I appreciate it.
Jim Barr: Sure.
Operator: Thank you. Ladies and gentlemen our next question comes from the line of Michael Swartz with Truist Securities. Please proceed with your question.
Michael Swartz: Hey, good evening guys. Maybe just first question, I guess how do you think about customer acquisition costs in the current environment and I guess where do we expect that to level out and really start to see some benefits over the next couple of years?
Jim Barr: Yes, I mean obviously direct businesses are challenged with the cost of customer acquisition. I was trying to get it out a little bit in my script and my talk, because we're actually -- you know if we were -- we were trying to acquire jury members without an equipment business that would be brutal. Right? The cost of customer acquisition in a purely digital business would be very, very tough. The way we look at it and we described a little bit of this at Investor Day, but still the way we think about it is we are leveraging our equipment business by selling the equipment at the margins that we're selling them we acquire customers and then those customers attach to JRNY. And you'll see in our advertising over time that JRNY will go from being -- having a cameo appearance in our advertising to costar, to being the star over time. That's all of -- it will roll and we are really leveraging that that customer, cost of customer acquisition for a highly profitable piece of equipment to acquire customers this way. And then of course we're doing these free trials as well and we're doing free trials on the SelectTech and so you can go back to previous customers and acquiring previous customers for journey much easier. Then you have their email addresses. You just send them a note saying, hey we've got a great way for you to use your SelectTech that you've been waiting for. We probably should have had it earlier, but we have it now. Why don’t you come try it? And then that product gets better over time. We talk about the VAY acquisition and rough accounting and form coaching and things like that on that. So that's the way we think about it and if you know it's still a challenge for all these businesses that have a direct component. But as I said we are really -- we're in a nice place where we have this digital business and this physical equipment business.
Michael Swartz: All right, great, thanks for the color. And a second question just on, I think you've provided some longer term margin targets and it sounds like you're moving them, one when you're ahead of maybe when you previously thought you would generate target margins. So I guess, it this purely just a function of JRNY proceeding faster than expected or are you changing any of the margin targets that you gave before and then specifically I think you said subscription margins run closer to the 20% to 25% is that still the right way to think about that?
Jim Barr: Yes, I mean, we're thinking two ways, we're thinking about it earlier and accelerating it and we also, as we've gotten to see how the early economics have worked out on our subscription business we think will have elevated margins. Aina, anything to add to that?
Aina Konold: No, when we were working at it at the beginning of the year, we had to ink a lot of these contracts that we now have. So we have a lot more clarity and we've acquired our first tuck-in and can see the underlying cost structure and its favorable to what we were thinking and then the economics are improving faster than we had initially modeled.
Michael Swartz: Okay, that's helpful. And maybe one final question from me, I think you've said the 200,000 subscribers at the end of the quarter, can you provide any context or color on how many of those are paying subscribers?
Jim Barr: Just to correct you, we said members which is a different definition than subscribes. Yes, no problem. We will demystify this over time and as we said, we're actually providing a lot more about our subscription business than we planned to do and our commitment is by the fourth quarter of this year when we report fourth quarter that we'll have a set of metrics that you can look at for our subscription business that will be robust enough for you to really look at the health of that business. Until then we're providing selective information and we've focused on this member amount. We're not saying what this chart is, but I'm happy that it's really coming down as we work on quality, as we get our analytics better, as we get our jrny.com stood up, as we build more content, as we add new features, that's coming down. So that's it and so we'll stay committed to giving you a robust set of metrics in the timeframe that we promised, but we're kind of leaking it a little bit early and a part of the reason for that is we wanted people to understand why we're making this decision to invest further into JRNY.
Michael Swartz: All right, got you, thanks Jim.
Jim Barr: Sure, thanks Mike.
Operator: Thank you. Our next question comes from the line of Sharon Zackfia with William Blair. Please proceed with your question.
Unidentified Analyst: Hi, it's Michael on for Sharon actually. Thanks for taking the question. First question is on the product pipeline. I mean you recently added the Max Total 16, I'm just wondering how many more product introductions you have scheduled for this fiscal year and roughly when those are expected to launch?
Jim Barr: Yes, I mean, we don’t provide a complete roadmap for competitive reasons. They seem to just popup. You've seen our competitors doing the same thing, so we don’t want people of our total roadmap. But we did the M9 recently, the 9-inch screen and the Max Trainer and then 16, our new Max Total as you alluded to. Last week I talked about the BYOD strength product in JRNY, so basically it's not a new physical product, but it's a new way to use our physical products. So you can buy the dumbbell and the training together or if you have the dumbbell you can just get the training added to your account going forward. So that's a big thing. And then like I said, the VAY acquisition we're continue building more features into that, that will help you with those workouts. So that's kind of our -- the early part of Strength and what we said on the call that that part is coming in the fourth quarter of this year. Beyond that we're not commenting, but I will say we have a robust pipeline of Strength products. Now we kind of worked our way all the way through the cardio line and modernized that, and now we're focused on Strength which for Bowflex is really what the brand stands for. So we're very excited about several products we have in the pipeline, but I am not at liberty to talk about them in detail right now.
Unidentified Analyst: Okay, understood. And then on the margin pressure you have expected to see -- you are expecting to see in the second half of the year, could you just help us flush out what quarter that pressure would be more weighted to? I mean I would expect it to be more pre-holidays, but I'm just wondering if that's the case or if it's going to be more evenly spread out?
Aina Konold: That's a great question. So let's start with the supply chain that will be more evenly spread out. Same thing with the fixed investments in JRNY like OpEx coming, were building like an infrastructure for that. It is advertising that I think will be movable, and I can't give any more color than what I have now for the back half because we really want to preserve our agility and we will deploy that marketing firepower in the appropriate moment to like really drive membership growth and people to our website and to our retail partner store so they can buy the equipment.
Unidentified Analyst: Okay, understood, thanks very much and good luck during the holidays.
Aina Konold: Thank you.
Operator: Thank you. Our next question comes from the line of George Kelly with ROTH Capital Partners. Please proceed with your questions.
George Kelly: Hey everybody. Thanks for taking my questions. So maybe to start with your comments on 2023, still I was curious if you could bridge, if the second half of this year is I think it's 10% to 12% negative EBITDA margin. Can you help bridge the gap most of that margin to get to profitable EBITDA next . So what else is implied in that? And then also kind of similar question, but what about sales growth? Do you expect to hit positive sales growth at any point next year?
Aina Konold: Great questions. So I'll start with the margins. The big driver of our path back to profitability really is the expansion or the easing of the headwind in gross margins specific to logistics. We are already, we have a very clear path on how some of these things will moderate. The most important would be as we work down our inventory and sell the inventory that we brought in early, we won't need as much as a storage and the extra transportation costs that we're incurring this back half. Secondarily, we began already the negotiations for a larger portion of our containers being under our fixed contract rather than being on the spot market. And then lastly, it is a small piece, but we're really pleased that JRNY will actually begin to help us on the gross margin line next year, so excited for that to be helping us. So those are really the big drivers of us getting back to adjusted EBITDA profitability in fiscal '23.
George Kelly: And then I don’t know if you want to comment, but can you talk about your expectation on revenue growth for next year?
Aina Konold: I think it is similar to everybody right? We also planned and we talked about this during Investor Day that if there is a pandemic high it would likely moderate and there would be some sort of settling down. Again, not settling back down to where it was in 2019, but settling down and not continuing to grow at this fanatic pace. We are like similar to other people trying to figure out is that now, is that going to go on for a few more quarters. So our assumptions are pretty buoyed to get to that adjusted EBITDA profitability, where we either model out slight decline and be a slight increase, but I'm not counting on the sales growth to deliver the profitability.
Jim Barr: And I'll just reiterate what I said about the market, that's why I really wanted to start this whole talk today with what we're seeing in the market, and we just really believe in the strong secular changes in towards home fitness. It doesn’t tell us where it's going to peak and what it comes down to, but it's not going to be down to anywhere near where it was as Aina said. We see that and we see it not only in attitudes, but we see it in actual workout habits that we're monitoring, and then connected fitness, that's the other reason to believe as well as that is just in its early innings. And we are just, so many people found connected fitness during the pandemic, but not everybody is delivering great against that and it's all very early relative to what we all think we can deliver for consumers. So I think no matter what you think the industry dynamics are and even if it does craft and work its way down a little bit, the whole idea of connected business I think is another add on top of that. So we're feeling very strong about that. Obviously it takes a crystal ball to know for sure. The other thing that's really touch is cut offs right? And we just talked about, we just got killed with this September 30 cut off where we had enough to easily meet our guidance there, so on the sales side, but it didn’t happen. So that holds back a little bit especially when we're talking about next year already. So we were providing the first half year and then as we get closer we'll let you know what we think about 2023 as things work themselves out. I guess another thing I'll just say is that, like the reason we changed our fiscal year honestly was so that we could take stock in the fitness season and how the results went before trying to predict the next year. And at the core of your question is exactly that. So we're just about, just before Black Friday is when we start seeing seasonal pickup in both retail and the direct business, so we're kind of weeks away from knowing how that's going to begin and then we're fitness season away from knowing how it's going to actually play out, so hopefully that makes sense to your.
George Kelly: Yes, that's helpful. And then last question from me is, what was direct media spending in the quarter?
Aina Konold: I'll send that, I have the total advertising for the quarter, but I don’t have just direct. For the quarter of Q2 it was $12 million, but it's primarily direct.
George Kelly: Okay, so most of $12 million.
Jim Barr: Yes, most of $12 million.
George Kelly: Thanks everybody. Have a good one.
Jim Barr: Thank you.
Operator: Thank you. Our next question comes from the line of Mark Smith with Lake Street Capital Markets. Please proceed with your questions.
Mark Smith: Hi guys, can you guys talk a little bit about the pricing environment and competition whilst we move into the important holiday in early January season, what you're seeing especially as people are using equipment for kind of member acquisition?
Jim Barr: Yes, now that's a great question and I think we're all seeing it right? I think it's a combination of using the equipment to acquire members as we're doing ourselves and also some of the competition having equipment probably a lot of inventory equipment. I've seen it mostly in bikes, but I've seen it kind of across the board where the promotion, you know nobody promoted much last year and everybody is promoting most things this year in particular bikes. We've seen high footdrop there, their primary bike down to about the $1500 range. We've seen Pelican do the same. So we have to be competitive with that. We think the combination of JRNY trials, which we can afford to give away and bundle I'd say helps us to do that, and it doesn't hurt our P&L at this point as much. So that's part of our approach to that, but then we're also running promotions on our stuff as well. I will point out though the early -- earlier when we had pricing power probably more pricing power, we were not promotional, in fact we raised our prices. So that helped us kind of fight off this margin pressure a little bit longer, but now we have to look at the market and especially in these days where it is the high-volume part of the year, I mean we look at it almost every day about whether we should do a promotion of price change there. So we continue to do that, but I do think you're going to see a lot of promotion this holiday because I think we're not the only ones that said, we've got to bring in inventory early and so I think people have a lot of inventory. I'm just deducing that from what we said and then we'll see what's being reported as well.
Mark Smith: Yes, and on that as we look at inventory within retail, moving into this important season, how confident are you in your inventory that you have enough out there and especially in kind of this pricing environment?
Jim Barr: Sure. Yes, I mean, we definitely have enough. I would say we have stocked up and we stocked up on the best selling products, because we knew that we weren't actually going to be able to perfectly predict as our results showed what sells in what quarter, we invested in the inventory of our new and high, best selling products, and we're in much fewer SKUs than we were before this. We've got a ton of SKUs. We're just focusing on kind of the back part of the curve and that gives us a lot of confidence. So I think we have enough and we believe it's in the right stuff. That's always the second thing to try to make sure you have. So we've got it, it's all fairly new, nothing old and dusty, nothing kind of at the tail of the curve. So we feel like as confident we usually could feel going into this holiday season and we've made the right choices and we'll see how it turns out. Any think to add?
Aina Konold: I don’t have anything to add in inventory, but I do want to correct what I said about advertising. So total advertising is $12 million, and we attributed $7 million to direct and $5 million was brand, because in Q2 we invested a lot of brand marketing and things like the Olympics. So $12 million in total, $7 million for direct, $5 million for branded.
Mark Smith: Yes, no that helps. Thank you.
Jim Barr: Sure.
Operator: Thank you. Ladies and gentlemen, at this time there are no further questions. I'd like to turn the floor back to management for closing comments.
Jim Barr: Thank you to everyone on our call today for your continuous support of Nautilus. We look forward to talking to you again on our third quarter fiscal year '22 earnings call in February. Have a great rest of the day onwards and upwards.
Operator: Thank you. Ladies and gentlemen, this concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.
