Nautilus Inc. on Monday reported net sales for the fourth quarter of $115.4 million, a decrease of 9.7 percent compared to $127.8 million in the same quarter of 2017, however, this beat Wall Street targets by $0.7 million.
The decrease in net sales was driven by a 30.3 percent decline in the direct segment partially offset by 16.1 percent growth in the retail segment, compared to the same quarter of the prior year, reflecting double-digit growth in the mass retail channel and modest gains in the international and specialty and commercial channels.
Direct segment sales were primarily impacted by lower Bowflex Max Trainer product sales, partially offset by increased sales of the recently introduced Bowflex LateralX trainer and strength products. Royalty revenue in the fourth quarter of 2018 increased to $1 million compared to $0.6 million in the same quarter of the prior year due to revenue collected in connection with a trademark infringement claim.
For the full year 2018, net sales were $396.8 million, down 2.3 percent compared to 2017. Gross margins for the fourth quarter of 2018 were 44 percent versus 48.9 percent for the same period of 2017, reflecting a shift in segment revenue mix from direct to retail, coupled with a decline in direct margins related to unfavorable product mix. Gross margins in the retail segment increased by 220 basis points to 31.7 percent.
Operating income for the fourth quarter of 2018 was $2.7 million compared to $6.4 million in the same period of the prior year due to the decline in direct segment net sales and the lower gross margin, partially offset by increases in net sales and gross margin in the retail segment. Additionally, the fourth quarter of 2017 included an $8.8 million non-cash intangible impairment charge.
Operating expenses for the fourth quarter of 2018 were 41.6 percent of revenue versus 43.9 percent in the same period of 2017. Operating expenses declined by $8 million due to the aforementioned intangible impairment in the same quarter of the prior year, partially offset by increased general and administrative costs. For the full year 2018, operating income was $20.8 million compared to $36.3 million in the prior year.
Income from continuing operations for the fourth quarter of 2018 was $1.5 million, or $0.05 per diluted share, compared to income from continuing operations of $8.5 million, or $0.28 per diluted share in the prior year quarter. The tax rate for the fourth quarter of 2018 increased from -32.2 percent in the fourth quarter of 2017 to 46 percent primarily due to $0.6 million of state-related adjustments and state valuation allowances. The tax rate of -32.2 percent for the fourth quarter of 2017 reflected a tax benefit related to a change in United States tax law at the end of 2017. Income from continuing operations for the full year 2018 totaled $15.1 million, or $0.50 per diluted share, compared to $27.6 million, or $0.89 per diluted share in the prior year. EBITDA from continuing operations for the fourth quarter of 2018 totaled $5 million versus $8.9 million in the same quarter of the prior year. For the full year of 2018, EBITDA from continuing operations totaled $30 million compared to $45.2 million for the prior year.
Bruce M. Cazenave, CEO, said, “While there were pockets of growth and profit improvement, the overall results for the quarter were clearly below our expectations. Our direct segment’s disappointing results more than offset the strong retail growth primarily due to much slower than expected sales of our refreshed Max Trainer product line launched in November which now incorporates an innovative digital personalized coaching platform called Max IntelligenceTM. We partially attribute the reduced sales of the Max Trainer product to low consumer awareness and understanding of this added digital capability which delivers a greatly enhanced consumer experience. The negative impact of slow initial traction of the Max Intelligence platform was magnified because the launch coincided with the critical holiday and fitness season, but there were many valuable lessons during these first two months of introduction. Importantly, given that the feedback from purchasers is generally very positive, we continue to believe that this platform and the unique personalization of the fitness experience it provides is unlike anything in the market today and will resonate with a broad base of consumers as awareness continues to build. The current obstacles we have can be overcome and our team is hard at work revamping the marketing message and media spending strategy with plans to relaunch in a significant way as soon as possible this year. Given what we now know and are able to do going forward, we have added confidence and will continue to aggressively invest in building out this platform across additional modalities during 2019.”
Cazenave continued, “As we enter 2019, we have implemented a number of initiatives to further strengthen our business. We have a solid cash flow business model and strong balance sheet that enables us to better educate the consumer on the many benefits of our offerings through robust marketing and with significant multi-media support. We have a healthy new product introduction schedule for 2019 across all channels and have recently acquired additional development assets, including the RunSocial platform, as well as secured strategic relationships with key partners, such as Samsung Electronics America, Feed.fm and Vi Technologies. We expect that these investments and partnerships will deliver significant enhancements to our digital platform across all facets of its individualized customer coaching experience including visuals, music, and voice, and should further expand our product reach and potential subscription base. We are focused on improving earnings and operating margins for the future and have taken several steps in 2019 to help achieve this goal, including a workforce reduction, broad cost containment controls, and value engineering initiatives. There is also added focus on simplification to improve process efficiency and rescale our operations to be more profitable while we drive to restore growth to our direct sales base. As for the near-term outlook, our sales in the direct segment and the mass retail channel will be challenged in the first half of the year. Until we complete the revamping of the marketing plan in direct, we anticipate that the recent sales weakness experienced in the segment will continue through most of the first half of 2019. Additionally, despite the strength of our mass retail channel sell-through in Q4 2018, there are significantly higher than anticipated inventories in the channel that need to be drawn down in the first quarter of 2019. At this time we are not providing specific guidance but will provide ongoing updates on the progress of our major initiatives as the year progresses. We have navigated through setbacks like this before and have come out stronger afterwards. Our goal in 2019 is to do it again, and we intend to utilize our many strengths including strong brands, technologies, talent, and ability to adapt and execute well.”
Segment Results
Net sales for the direct segment were $49.9 million in the fourth quarter of 2018, a decrease of 30.3 percent over the comparable period of the prior year, primarily due to a decline of Max Trainer product line sales. Sales of the recently launched Bowflex LateralX trainer, and strength products partially offset the decline. For the full year 2018, net sales for the direct segment were $184.9 million, a decrease of 15.7 percent over the prior year, reflecting a decline in Max Trainer and TreadClimber product line sales.
Operating loss for the direct segment was $3.8 million for the fourth quarter of 2018 compared to operating income of $11.8 million in the fourth quarter of 2017. The decrease reflected lower net sales and lower gross margin rates coupled with an increase in media spending. Gross margin for the direct business was 58.7 percent for the fourth quarter of 2018, compared to 63.4 percent in the fourth quarter of the prior year. The gross margin decline reflected a shift in product mix, along with unfavorable overhead absorption related to the lower net sales.
Net sales for the retail segment were $64.4 million in the fourth quarter of 2018, an increase of 16.1 percent over the fourth quarter of the prior year. The increase in sales reflected growth in mass retail and modest gains in the international and specialty and commercial channels across multiple product categories. For the full year 2018, net sales for the retail segment totaled $208.1 million, an increase of 13.2 percent over the prior year, reflecting double-digit growth in mass retail accounts and growth in specialty and commercial accounts.
Operating income for the retail segment was $11.3 million for the fourth quarter of 2018, an increase of 60.2 percent compared to operating income of $7.1 million in the fourth quarter of 2017. retail gross margin was 31.7 percent in the fourth quarter of 2018, compared to 29.5 percent in the same quarter of the prior year due to decreases in product costs related to favorable exchange rates.
Balance Sheet
As of December 31, 2018, the company had cash and marketable securities of $63.5 million and debt of $32 million, compared to cash and marketable securities of $85.2 million and debt of $48 million at year end 2017. During the full year of 2018, the company purchased $13 million of stock in the open market as part of its previously announced stock repurchase program, including $8 million of repurchases in the fourth quarter of 2018. Working capital of $76.6 million as of December 31, 2018 was $14.5 million lower than the 2017 year-end balance of $91.1 million, primarily due to a $21.7 million decrease in cash and marketable securities. Inventory as of December 31, 2018 was $68.5 million, compared to $53.4 million as of December 31, 2017. The increase in inventory was due to the lower than expected sales and a strategic inventory buildup to mitigate supply chain uncertainties due to potential international tariffs.
Technology Investments and Strategic Partnerships
As part of our capital deployment strategy, we have made multiple strategic investments which we expect will enhance and accelerate our ability to develop and commercialize the next stages of our digital platform.
In December 2018, Nautilus acquired the assets, trademarks, and intellectual property related to the RunSocial software platform. The RunSocial platform delivers a mixed-reality experience to cardio product users in which they can walk, run, or bike at their own pace through scenic locations around the world. The RunSocial platform provides a unique, immersive experience to the user, utilizing 360-degree high definition video. This platform is already in use and is compatible with several Nautilus product offerings. Key elements of the RunSocial platform’s capabilities have also been incorporated as enhancements to our Max Intelligence™ digital subscription.
Also during the first quarter of 2019, Nautilus made an investment in Feed.fm and signed a strategic development partnership agreement with Vi Technologies Inc., each an emerging technology company. We assumed a minority equity position in Feed.fm, a leader in delivering customized and curated music content within fitness. We believe that music is a key differentiator when fulfilling our promise of an individualized workout experience.
Feed.fm is the engine behind our Bowflex Radio capability which is now part of the Max Intelligence platform. We also entered into a joint development agreement with Vi Technologies, which has developed and marketed an advanced artificial intelligence engine used to deliver real-time, personalized voice coaching to runners. Our partnership with Vi allows us access to technology that can extend well beyond running and should accelerate our efforts to expand our digital platform across more modalities while delivering on the promise of individualized coaching experiences. Finally, our already strong strategic partnership with Samsung Electronics America continues to build on a number of levels including technical development and exploring mutually beneficial co-marketing opportunities.
