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Nautilus Inc  (NYSE:NLS)
Q3 2018 Earnings Conference Call
Oct. 29, 2018, 4:30 p.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good day, and welcome to the Nautilus Third Quarter 2018 Earnings Results Conference Call. Today's conference is being recorded.

At this time, I would like to turn the conference over to John Mills with ICR. Please go ahead, sir.

John Mills -- IR

Thank you, Ian. Good afternoon, everyone. Welcome to Nautilus' third quarter 2018 conference call. Participants on the call from Nautilus are Bruce Cazenave, our Chief Executive Officer; Sid Nayar, Chief Financial Officer; and Bill McMahon, Chief Operating Officer.

Our earnings release was issued earlier today and maybe 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.

Remarks on today's conference call will include forward-looking statements within the meaning of the securities laws. These include statements concerning financial projections, operating trends, anticipated growth and profitability, anticipated timing and market acceptance of new product introductions and the impact of new product introductions on our future financial results, planned capital expenditures, projected effective tax rates and anticipated results of new product and business development initiatives.

Forward-looking statements are subject to a number of risks and uncertainties and actual results may differ materially from these statements. Additional factors that could cause Nautilus's actual results to differ materially from these forward-looking statements include our ability to timely acquire inventory that meets our quality control standards from sole source foreign manufacturers at acceptable costs; changes in consumer fitness trends, changes in the media consumption habits of our target consumers or the effectiveness of our media advertising and the other risks and uncertainties described in today's earnings announcement and in our most recent Annual Report on Form 10-K as supplemented by our quarterly reports on Form 10-Q.

Nautilus undertakes no obligation to update or otherwise publicly release any revision to forward-looking statements to reflect new information, events or circumstances after they were made or to reflect the occurrence of unanticipated events. All information and comments regarding our operating results pertain to our continuing operations unless otherwise noted.

I would also like to note that Nautilus' management team will be showcasing its new products in New York at the new Samsung building on November '13. If you'd like to attend, please use the contact information on our earnings release to discuss with me your desire to attend and I'll be happy to get you signed up.

And with that, it is my pleasure to turn the call over to our CEO, Mr Bruce Cazenave.

Bruce Cazenave -- Chief Executive Officer

Thank you, John. Good afternoon, everyone and thank you for joining our call today. I will start by providing a general overview of our third quarter and our upcoming new product releases before turning it over to Sidharth Nayar to review our financials in more detail. Bill McMahon will follow with updates on the business segments, as well as more in-depth look at our new product introductions for the remainder of the year. I will then close with a few final remarks, including a review of our outlook for 2018 and we'll open up the call for your questions.

Third quarter results were in line with our expectations with net sales increasing 3% over prior year to approximately $91 million. The retail segment continued to deliver double-digit growth, increasing 15% to approximately $62 million in the quarter. The growth achieved in mass retail as well as the commercial specialty channel was due to increases in a number of product categories, including bikes, treadmills and both the Bowflex and Octane versions of the Max Trainer. We are pleased with the quarter and the momentum we have in the retail segment going into the peak season. In the Direct segment, as expected, we continue to see softness with revenue down roughly 15% in the quarter and which correlates to reduced overall media spending of 18%.

During the quarter, we purposely pulled back spending on Max Trainer as we prepared to transition our media and promotional efforts to support the upgraded and refreshed product line planned to be launched in November. We anticipate a reversal of recent sales trends in our Direct segment during the fourth quarter based on three factors; the launch of the new Max Trainer line; second, the increased traction we expect from the recently introduced Bowflex LateralX; and third, the marketing and media we plan to support in support of the launch of our new and exciting digital platform. Bill will go into more detail on the LateralX as well as the dosage digital launch later in the call.

Now, I'd like to turn it over to Sid. Sid?

Sid Nayar -- Chief Financial Officer

Thanks, Bruce. I'd like to provide a detailed update on our financial results for the third quarter of 2018. Net sales for the third quarter totaled $91.1 million, an increase of 3.3% as compared to the same period in the prior year, reflecting a 14.9% increase in the retail segment, partially offset by a 14.8% decline in the Direct segment. For the first nine months of 2018, net sales were $281.4 million, an increase of 1.1% over the same period last year.

Third quarter gross margins decreased by 620 basis points for the Direct segment to 57.3% and were down 100 basis points in the Retail segment to 34.7% when compared to the same quarter last year, reflecting higher product costs and a shift in product mix to lower margin SKUs. On an overall basis, total Company gross margins for the third quarter of 2018 decreased by 460 basis points to 42.3% versus the same period prior year, reflecting margin declines in both the Direct and Retail segments, coupled with a shift in mix of segment revenues to the lower gross margin retail channel. Year-to-date 2018 gross margins of 46.6% were 420 basis points lower than 2017 year-to-date gross margins.

Total operating expenses for the third quarter of 2018 as a percentage of net sales increased to 35.5% from 31.7% in the same period last year. Total operating expenses for the first nine months of 2018 as a percentage of sales were flat to last year at 40.1%.

Sales and marketing expense for the third quarter of 2018 was $20.6 million or 22.7% of net sales as compared to $18 million or 20.5% of net sales in the same period last year. The increased dollar spending reflects higher spending for creative costs related to product launch of $1.1 million. Also, the prior year period was favorably impacted by a $2.1 million retroactive adjustment to finance fees related to a contract extension and $1 million favorable settlement related to an indemnification claim. For the first nine months of 2018, sales and marketing expenses totaled $79.5 million or 28.2% of net sales compared to $79.3 million or 28.5% of net sales for the same period in the prior year.

General and administrative expenses were $7.5 million or 8.2% of net sales for the third quarter of 2018, which compares to $6.3 million or 7.2% of net sales in the same period last year. The increased dollar spending in G&A primarily reflects legal expenses related to litigation and patent legal fees.

General and administrative expenses for the first nine months of 2018 as a percentage of net sales totaled 7.4% as compared to 7.6% for the same prior period. Research and development cost in the third quarter of 2018 were $4.2 million or 4.6% of net sales compared to $3.6 million or 4.1% of net sales in the same period last year. The dollar increase reflects our continued investments in the engineering and design resources required to continue to innovate and broaden our product portfolio. Research and development expenses for the first nine months of 2018 as a percentage of net sales totaled 4.5% as compared to 4% for the same prior period.

Operating income for the third quarter of 2018 was $6.2 million as compared to operating income of $13.4 million in the same quarter of last year. The decrease reflects the decline in gross margin rates coupled with higher operating expenses. Operating margin for the third quarter of 2018 decreased to 6.8% compared to 15.2% for the same period last year. For the first nine months of 2018, operating income was $18.1 million or 6.4% of net sales versus $29.9 million or 10.7% of net sales in the same period last year.

Income from continuing operations for the third quarter of 2018 was $4.5 million or $0.15 per diluted share as compared to $8.3 million or $0.27 per diluted share for the same period last year. For the first nine months of 2018, income from continuing operations was $13.7 million or $0.45 per diluted share compared to $19.1 million or $0.61 per diluted share for the same period in the prior year.

EBITDA from continuing operations in the third quarter of 2018 was $8.5 million versus $15.3 million for the same quarter of the prior year. Year-to-date EBITDA from continuing operations totaled $24.9 million versus $36.4 million in the same period last year.

The effective tax rate for the third quarter of 2018 was 29.3% compared to 36.8% in the same period last year. The lower tax rate reflected the favorable impact of the federal tax rate reduction resulting from the Tax Cuts and Jobs Act, partially offset by true-ups related to 2017 taxes filed during Q3, 2018. We anticipate the full-year effective tax rate to be in the range of 24% to 26%.

Total net income including discontinued operations for the third quarter of 2018 was $4.3 million or $0.14 per diluted share, which includes a $0.2 million loss from discontinued operations. This compares to the third quarter last year, where we reported total net income including discontinued operations of $8.2 million or $0.27 per diluted share, which included a net loss from discontinued operations of $0.1 million. Year-to-date net income for 2018 totaled $13.3 million or $0.44 per diluted share versus $17.8 million or $0.57 per diluted share for the same prior period.

Turning now to our segment results. Net sales in the Direct business totaled $29 million for the third quarter of 2018, a 14.8% decrease over the same quarter last year. Direct sales were unfavorably impacted by lower than anticipated Max Trainer sales as we scaled back media spend by 18% to focus on the new digital platform and upgraded Max Trainer introductions in the fourth quarter, partially offset by the ramp up of media spending to support the new Bowflex LateralX product, which we launched during Q3.

Year-to-date sales of $135 million are down 8.7% year-over-year due to the anticipated declines in TreadClimber product line during the first half of the year and the Q3 factors noted above. Gross margin for the Direct business declined 57.3% for the third quarter of 2018 compared to 63.5% in the same quarter last year due to higher product cost, reflecting commodity input price increases and the unfavorable impact of foreign exchange rates coupled with a slightly unfavorable product mix.

Operating loss for the third quarter of 2018 in our Direct business was $1.4 million compared to operating income of $5.3 million in the same quarter in the prior year. Operating income was negatively impacted by the lower net sales and gross margins in the third quarter 2018. Additionally, the third quarter 2017 operating expense included $2.1 million favorable retroactive adjustment to finance fees related to a contract extension.

Year-to-date 2018 operating income for the Direct segment totaled $10.7 million or 7.9% of net sales compared to $23.1 million or 15.7% of net sales in the same prior period.

Net sales in our Retail segment for the third quarter of 2018 were $61.5 million, an increase of 14.9% compared to $53.5 million in the third quarter of last year. The increase in Retail net sales reflects robust growth across a variety of product lines driven by double-digit growth in both the Mass Retail channel and the Specialty Commercial channel.

Gross margins for the Retail business decreased by 100 basis points to 34.7% in the third quarter of 2018 as compared to 35.7% for the prior period, mostly due to higher product cost related to commodity input pricing and unfavorable foreign exchange rates.

In the third quarter of 2018, operating income for the Retail business totaled $12.7 million as compared to $12.1 million in the same period of last year. The increase is attributable to the higher revenue, partially offset by an increase in operating expenses.

The third quarter of 2017 operating expense included a $1 million favorable settlement related to an indemnification claim. Year-to-date 2018 operating income for the Retail business totaled $20.2 million versus $20.4 million for the same period in the prior year.

Now turning to the consolidated balance sheet. Cash and investments totaled $71.1 million as of September 30, 2018 with $36 million of debt. This compares to $85.2 million in cash and investments and debt of $48 million at December 31, 2017 and $77.8 million in cash and debt of $52 million at September 30, 2017.

During the third quarter, the Company purchased $1.9 million of stock in the open market as part of our previously announced stock repurchase program. As of September 30, 2018, we had $22 million remaining available for future stock repurchases under the repurchase program. The Company has repurchased an additional $4.7 million of stock between October 1, 2018 and October 26, 2018. Working capital of $88.5 million as of September 30, 2018 was $2.6 million lower than the 2017 year-end balance of $91.1 million.

Inventories were $55.5 million as of September 30, 2018, compared to $53.4 million at December 31, 2017 and $57.6 million at September 30, 2017. Capital expenditures totaled $6.6 million for the nine months ended September 30, 2018, reflecting investments in developing the digital platform, system integration efforts and new product tooling costs. We anticipate full year CapEx to be in the range of $9 million to $11 million.

At this time, I'd like to turn it over to Bill McMahon, our Chief Operating Officer, who will provide additional insights into our business and key products. Bill?

Bill McMahon -- Chief Operating Officer

Thank you, Sid. Good afternoon, everyone. I'd like to provide further background on our third quarter results and then discuss the product introductions we made in Q3 and the ones we will be introducing in the coming weeks.

Starting with our Retail segment, we're pleased with the roughly 15% sales growth in the third quarter. This growth was delivered versus a very difficult comparison hurdle from the prior year when this segment also achieved 15% growth. The continued sales increase versus prior year was driven by performance in both the Mass Retail and Specialty Commercial channels and the growth came from many of our cardio product lines including our Upright Recumbent and IC bikes.

Further, our commercial Max Trainer product, the Octane MTX Max Trainer, began shipment and installation during the third quarter, and was a key growth driver out of the gate. We were very pleased with the initial response to this product. Commercial Max is an important catalyst in our strategy to drive growth in our Commercial and Specialty sales. Early feedback from commercial clubs and specialty users has been strong.

We also continue to see strong performance from the Bowflex Results series treadmill lineup, which will expand further this fitness season with the new Bowflex BXT6 treadmill starting at $999. This treadmill will initially be offered exclusively at Dick's Sporting Goods. And we're encouraged by our continued growth with this key strategic relationship. We're also launching the Schwinn 411 Elliptical, which features a new and innovative compact footprint. It offers high intensity interval training and heart rate control programs as well as a streamlined console for easy navigation. The Schwinn 411 Elliptical will be priced at $499. Both of our new Bowflex and Schwinn machines offer run social compatibility, the mixed reality app, allowing users to train in scenic locations.

Further to innovation in our Octane brand, earlier this month we announced our free updated version of our popular Octane fitness workout apps, initially on iOS and soon for Android-based devices. This app currently works with Octane fitness home equipment and will be released for Octane's commercial models during the quarter. The launch of updated digital capabilities in Schwinn and Octane products represents our commitment to advance our mobile application and smart console-based technologies throughout all products in the organization.

As we look forward to fitness season, we currently anticipate continued growth across both Mass Retail and Commercial Specialty this fall. Our retail teams continue to gain share in the Mass Retail space. We've also noted the bankruptcy filing of Sears Holding Corporation. While we did have a small amount of sales with this retailer, Sears is not a top 10 account for Nautilus and we had previously mitigated our receivables risk for those sales. This bankruptcy filing will not have a direct financial impact on Nautilus.

Turning to our Direct segment, our sales were down 14.8% in Q3, mostly due to a decline in Bowflex Max Trainer sales. It's important to note that we intentionally reduced media spend by roughly 18% versus prior year and that decision was a contributor to the decline. As we noted last quarter, over the past two years, Max Trainer's demonstrated a more pronounced seasonal pattern of performance in Direct and we allocated our immediate dollars to better align with that pattern. Additionally, as we look ahead to the launch of our new digital platform, we felt that media investments would be better made in supportive of that program launch, hence our decision to remain conservative on Max Trainer media in Q3. We believe our Direct product lines have likely been impacted by the lack of stronger digital training features as compared to other high-spending TV direct advertisers currently in the market.

The launch of our new digital platform during this quarter is intended to address that competitive challenge and we plan to return to a significant media spend pattern in support of our new product offering. Before outlining the details on the new digital platform, we should note that we also launched the Bowflex LateralX in August. We were pleased with many elements of this launch. Most importantly, we observed increasing ROI and response rates each progressive week the product was on TV. Further, we were pleased with the average selling price in model mix. We completed an initial test pattern of TV spend during the quarter and the product succeeded in reaching incremental customer demographic segments as compared to Max and we're optimistic about the future of LateralX in the Direct channel. For Q4, our primary media focus will be the launch of our new digital platform. However, we will continue to support LateralX on TV and anticipate further increasing spend on LateralX in Q1 2019.

As Bruce stated in his opening remarks, we're excited about the pending launch of our new digital capability, which we have named the Max Intelligence Platform. The Max Intelligence Platform is Nautilus' groundbreaking cloud-based adaptive coaching technology, designed to help our customers reach their fitness goals. Through an initial fitness assessment and ongoing predictive analytics, Max Intelligence tracks and collects data from the user's history of workouts, learns their capabilities and customizes new workouts every day. Initially available on the new Bowflex Max Trainer M6 and M8 cardio machines, the Max Intelligence Platform brings Max to life as a virtual personal fitness coach, making unique connections to subscribers via spoken instruction, motivation and praise that encourages users to stay focused on achieving our goals.

Max's tone is friendly, approachable and delivers the guidance and fitness fundamentals that users need to succeed. Max Intelligence achieves this via sophisticated and proprietary artificial intelligence platform that utilizes data from work out history as well as feedback from the user to deliver a unique personalized fitness experience. At launch, Max Intelligence will include multiple features such as the intelligent coaching technology, which drives the unique and custom workouts, a significant level of video content with instructor-led training, an AI based motivational tool designed to provide encouragement and rewards-based feedback. Subscriptions to the Max Intelligence Platform will be available at launch via an annual plan or on a month-to-month basis. Pricing will be $149 annually or $14.95 per month. We feel our content and personalized experience is very competitively priced versus the subscription offerings of other fitness companies.

While others claim to personalize fitness, Max is unique gathering workout data and user experience preferences to dramatically enhance the end user experience. From daily workouts and the content provided, nearly every aspect of the workout can be tailored to an individual. Again, this is not simply serving up video content. Just like the personal trainer, Max Intelligence learns the unique capabilities of each user, monitors performance, coaches and motivates the user, while generating and delivering new unique workouts based on what that user needs to achieve their fitness goals.

We've not yet opened sales to the public and that's coming very soon. However, we have established a preview page for investors and media at www.maxintelligence.com. We intend to continue to add features to this platform post launch, including Bowflex Radio and integration with One Social to enable users to explore many parts of the world in high-definition while engaging with the Max AI. This technology is extensible and ultimately could be deployed to all product lines in the Company, which will create a differentiated customer experience unique to all of our brands. I'm extremely grateful for the hard work of our team. We continue to evolve as a Company and within the larger fitness market.

The new products described today, including Max Intelligence Platform are the results of 10s of thousands of hours of innovation work and we're excited to bring this capability to the market.

And with that, I'd like to turn the call back over to Bruce for his final comments. Bruce?

Bruce Cazenave -- Chief Executive Officer

Thank you, Bill. We are pleased with progress on the key strategic initiatives outlined at the beginning of the year, including completion of key logistics and systems integration initiatives and the ramp up of investments to build our international channel. We are excited about our growth opportunities in 2019 as the new products we've introduced over the last 18 months give us a good base for growth. And adding the new digital platform coming this quarter provides an even broader foundation for near-term and longer-term growth. This new platform will completely change the way we engage with consumers, including using new methods like offering value-added content-rich subscriptions. Importantly, we remain grounded as a company designing and marketing a broad range of high-quality innovative products, but we'll now be layering on a new level of enhanced consumer experience with AI driven technology that uniquely adapts to the individual user desires and needs as they progress through or even just start their fitness journey.

As Bill mentioned, the initial launch leads with the Direct segment and with our most popular product line and we expect that ultimately, it will be offered across many of our brands, product lines and channels of distribution. For two years, our team has been researching, designing and building the capabilities to be a force in the digital world of fitness and doing it in a way no one else is or can do today. We are in a good place and continue to build on the initial digital and subscriptions offering at a rapid but deliberate pace and our strong financial position and balance sheet can be used as a means to accelerate certain future planned enhancements. While it is difficult at this time before lunch to project with certainty how meaningful the platform can be, we do expect it to be significant and are preparing for the likelihood it will impact everything we do as a company.

Speaking to the near term as it relates to guidance, based on our expected continued growth in the retail segment and anticipated significant improvement in the trajectory of the Direct business, reflecting the refreshed Max Trainer product line and the digital platform launch, we project our full year revenue and operating income guidance ranges to remain unchanged at $431 million to $440 million and $42 million to $45 million, respectively.

In closing, I'd like to thank all of our dedicated employees who are instrumental in our success and helped the Company become stronger every quarter as a result of their efforts and initiatives. That concludes our prepared remarks. Now I'd like to open up the call for questions. Operator?

Questions and Answers:

Operator

Thank you. (Operator Instructions) And we'll take our first question from Michael Swartz of SunTrust. Please go ahead.

Michael Swartz -- SunTrust -- Analyst

Hey, good afternoon guys.

Bruce Cazenave -- Chief Executive Officer

Hey, Michael.

Sid Nayar -- Chief Financial Officer

Hi, Mike.

Michael Swartz -- SunTrust -- Analyst

Just wanted to touch on the, I guess, the shift in spending around the Max Trainer and some of the other new products for '19, it sounds like you've decided to allocate more of that spending to the fourth quarter, it sounds like that probably had a little bit more of a pronounced impact on Max Trainer in the third quarter. Is there any way to isolate how much impact that might have had to revenue during the third quarter?

Bill McMahon -- Chief Operating Officer

Yes, Mike, this is Bill. Taking down media 18% in the quarter would be the primary driver of the revenue decline in the Max category year-over-year, which was the primary driver of the 15% down. So, while we don't breakout category performance, as you know, that change in media spend certainly was the primary driver in revenue change.

Michael Swartz -- SunTrust -- Analyst

Okay, great. And second question, and you'd mentioned it on the call, but just with the announcement of Sears, with their Chapter 11 announcement, I mean is there any way to look at how other retailers are viewing this? Is this something where they maybe take a bit more of a conservative tone with inventory with reorders as we go through the holiday season and then really I guess prepare for '19 and beyond?

Bill McMahon -- Chief Operating Officer

Mike, it's a (inaudible) question, there could be some short-term disruption coming out of added promotional activity or discounting or -- in sort of a worst-case scenario, which a potential liquidation scenario. On the flip side, we do view it as an opportunity from a consolidation perspective certainly for some of the key remaining retailers who are out there. So, I think we just need to navigate a little bit through Q4 and sort of determine how that plays out, but longer term, we certainly, from our perspective, don't see this as a longer term negative for us.

Unidentified Participant -- -- Analyst

Okay. And then just final question on Specialty Commercial, I think this is probably the most positive commentary we've heard about that channel in some time given some of the disruption that has gone on there, and it sounds like your business is up double digits in the quarter, but I'm trying to understand how much of that maybe is from the launch of some new product and I think it was -- correct me if I'm wrong, is it the Max Trainer LateralX in the quarter and -- or how much of that is just from maybe that channel, starting to stabilize?

Bill McMahon -- Chief Operating Officer

Yes, that -- good question, Mike. I would say, certainly the Octane MTX was a big factor, we launched it in the quarter and as Bill alluded to it, the receptivity was very positive and continues to be. so that helped. But there was a number of other elements in terms, it was pretty broadly based across both the Commercial and the Specialty channels where we saw growth and across a number of product lines. So, it wasn't just relating to the MTX. So -- and including the Ys, were very strong for us in the quarter, YMCAs. So that -- I think that answers your question, it was across a broad base, but certainly MTX really was a significant factor there.

Michael Swartz -- SunTrust -- Analyst

Okay, great. Thanks a lot.

Bruce Cazenave -- Chief Executive Officer

Thank you.

Operator

(Operator Instructions) We will now take our next question from Eric Wold of B. Riley. Please go ahead.

Michael Kawamoto -- D.A. Davidson -- Analyst

Thank you, good Afternoon.

Bruce Cazenave -- Chief Executive Officer

Hi, Eric.

Bill McMahon -- Chief Operating Officer

Hi, Eric.

Michael Kawamoto -- D.A. Davidson -- Analyst

So a few questions on the Direct side. I guess one, so it sounds from your commentary like you're kind of pushing more of the normal kind of holiday push on LateralX into Q1 to kind of give more room for Max Trainer and you expect to kind of spend around Max channel with the new digital launch in the quarter. Is that an indication of a need to refine the messaging around LateralX or you had just where it is now, I know you gave some color on LateralX in terms of ramping kind of week to week, maybe generally, give us some sense of where LateralX is and kind of response rates and conversions relative to ATT at the same point in its life cycle?

Unidentified Speaker --

Yes, great question, Eric, this is Bill. As we noted, we're pretty pleased with the way we saw increasing response on LateralX. But as always, after that initial test pattern, we definitely have some tweaks we want to make on LateralX as well and I think we'll be doing that during this quarter and testing as we go, but we feel pretty good that it has legs for us going forward. But as always, we learn from everything that happened in the initial launch.

Eric Wold -- B. Riley -- Analyst

Okay. And then maybe compared to HVT?

Bill McMahon -- Chief Operating Officer

I would say we were more pleased with -- in terms of both product mix and in terms of the consumer response and web traffic with LateralX as compared to HVT. LateralX was definitely reaching the demographic that we liked and let's just say it was appropriate-sized income demographic and a little bit younger than the Max Trainer buyers. So, for us, it represents a potential line extension opportunity. So, we're going to continue to pursue that opportunity as we go forward here with our messaging.

Eric Wold -- B. Riley -- Analyst

Okay. And then on Max Trainer, how long has -- I guess when did you really kind of take it off media and when will it go back on (inaudible)? I just wanted to get to is any concerns you're going to go back in late -- when you -- in the last election cycle, you kind of came off of media spend and TreadClimber didn't come back up, any chance, something like that (inaudible) going to be small enough not to have a material impact?

Bill McMahon -- Chief Operating Officer

I don't think so, because I think on Max, we did reduce the media, but we didn't go off, so we just went to a lower level against a core set of networks that can keep awareness alive as we go and we certainly would anticipate with the launch of the digital platform, we have new creative and new messaging to go out with, so I would not expect it to behave the same way as TreadClimber did which was already a pretty mature product at the point that that happened in 2016.

Eric Wold -- B. Riley -- Analyst

Okay. And then as final question for me, if I may. How long do you expect to have an adverse impact to material cost inventory from the higher exchange rate, kind of when we could that taper off or how much of an impact could that be in the next couple of quarters?

Sid Nayar -- Chief Financial Officer

Yes. So, I think the exchange rate impact should taper off now in Q4, we were selling through -- typically selling through inventory that we would have purchased 90 days prior. So, we saw some part of that impact in Q3. Obviously, the mix component of the impact on product cost, both the product mix and the channel mix that will continue, but I think for the full year, we're still pretty much in line with, I think some of the guidance that was provided previously.

Eric Wold -- B. Riley -- Analyst

Perfect. Thank you, guys.

Bruce Cazenave -- Chief Executive Officer

Thanks, Eric.

Bill McMahon -- Chief Operating Officer

Thanks, Eric.

Operator

We'll now take our next question from Michael Kawamoto of DA Davidson. Please go ahead.

Michael Kawamoto -- D.A. Davidson -- Analyst

Yes. Hey, guys. Thanks for taking my question.

Bruce Cazenave -- Chief Executive Officer

Hi, Michael.

Michael Kawamoto -- D.A. Davidson -- Analyst

Just kind of building on -- but on the advertising, yes, I understand why ad spend was down, but just on a related note, have you seen any shift there, just given the mid-term elections and how people are watching TV, I would imagine it wouldn't be as severe as it was in '16 given the Presidential Election, but is there anything to call out there?

Bill McMahon -- Chief Operating Officer

Yes, you're accurate on that, Michael, it's not as severe as the 2016 election. However, I would say as we approach here the election next week, the media spends are pretty intense right now. So, the near-term disruption is happening with the elections and hence, we haven't quite launched our digital platform yet, but it's nowhere near like it was in 2016.

Michael Kawamoto -- D.A. Davidson -- Analyst

Got it, thanks. And then on the M6 and M8, real excited about the digital platform launch. Are these new iterations of Max, are there aspects of the modality that are being updated as well, or they just the digital integration? And then on the timing of the refresh as well as some of those new retail products, is that launch timing just an effort to capture a lot that peak season demand that we see kind of late in 4Q?

Bill McMahon -- Chief Operating Officer

Yes, it's time to take advantage of fitness season this year. And there are features in M6 and M8 that are updated in summer visual like color, in touch points and others that are improvements of the inner electronics of the machines to support the Max Intelligence Platform going forward. So definitely that's the other aspect about Max's, it's been in market, this will be almost five years, and it's definitely time to refresh it either way. So the combination of refreshing the machines and bringing it out this capability on top of it, we feel like should be a strong catalyst for Max going forward.

Michael Kawamoto -- D.A. Davidson -- Analyst

Got it. Thanks for taking my questions and good luck for the rest of the year.

Bruce Cazenave -- Chief Executive Officer

Thank you Michael.

Operator

We will now take our next question from George Kelly of Imperial Capital. Please go ahead.

George Kelly -- Imperial Capital -- Analyst

Hi guys.

Bill McMahon -- Chief Operating Officer

Hi, George.

Bruce Cazenave -- Chief Executive Officer

Hello, George.

George Kelly -- Imperial Capital -- Analyst

Hi. Couple of questions about the new digital platform. You mentioned in your prepared remarks that it will include motivational tools and videos, I'm just wondering if you could talk a little bit about what those -- what are the videos, what are the tools, any kind of overview there would be helpful.

Sid Nayar -- Chief Financial Officer

Yes. The videos are basically instructions on helping people to get the most out of their machine as well as training that's appropriate to them. So one of the elements of the Max intelligence platform is it's going to adapt to where you're at in your journey. So if you're just starting out, then the video content and actually the coaching and encouragement that comes along will be tailored to where you're at on that journey. If you're a world-class athlete and you jump on the machine and start to use it, you're going to be offered up a different variety of coaching along the way. So, it really is a unique customer experience based on where you start from and how you're progressing with the product over time and the video content reflects that.

George Kelly -- Imperial Capital -- Analyst

Okay. Okay. And how are --?

Bill McMahon -- Chief Operating Officer

And I should mention, Sid, it's great to call out, the motivational tools are based on the AIs reading of how you're doing and basically your demonstrated performance level. So you will be receiving encouragement by the voice coach from Max along the way as well.

George Kelly -- Imperial Capital -- Analyst

Okay. And is the -- what's the delivery mechanism?

Bill McMahon -- Chief Operating Officer

So actually the -- at launch on M6 and M8, it will be a bring-your-own-device type environments, so a mobile device like a smartphone or a tablet, we'll work with you and talk to the machine and basically it's a cloud-based service, so it's providing this engine or platform where we collect the data from how you're doing and then the machine reads that data and compares it to what we know about you and what you're trying to do and it delivers personalized workout performance based on where you're at. And so I would caution, it's not just selecting from one of 27 different workouts or things like that, it's actually delivering custom workouts for you based on where you're at in your performance to date and what you're trying to get to.

George Kelly -- Imperial Capital -- Analyst

Okay. And will most of the content maybe suitable for people that buy the newest machines?

Bill McMahon -- Chief Operating Officer

We will have the ability to upgrade prior versions of our Max M5 and M7 machines and we'll be offering that capabilities starting in Q -- this quarter and into next year. So that it's possible if you'll be able to buy an upgrade kit to then upgrade your existing Max Trainer and have a subscription that works with that going forward. And as you might guess, we'll likely have promotions for trade in, trade up programs as well.

George Kelly -- Imperial Capital -- Analyst

Okay. And then couple other more I guess modeling questions. What was the approval rate in the third quarter?

Bill McMahon -- Chief Operating Officer

Approval rate increased again in the third quarter over prior year to 54.5%, that's up from 53.7%, so we continue to be at historically high approval rates. We still continue to get strong feedback from our Tier 1 partner that our account is performing extremely well by comparison to other accounts. So we're pleased with that. But I would also caution that credit card continues to be the majority of payment method for direct purchases currently at 55% last quarter.

George Kelly -- Imperial Capital -- Analyst

Okay. And then last question from me. Fourth quarter does reflect a pretty big reversal in the sort of growth trends that we've seen. So do you -- just as we look between the Retail and Direct segments, should retail kind of continue on this similar path to what we've seen year-to-date or do you expect will retail as well grow a lot in the fourth quarter?

Sid Nayar -- Chief Financial Officer

Yes. No, we do expect retail to grow significantly in Q4. Certainly, if you recall last year, we saw retail take a dip during Q4 and again related to several factors. But again, our current thinking is -- and based on certainly the order pipeline and hopefully what will materialize as the reorders as we get to the back half of the year with all the new SKUs that have launched in Retail that we see a very healthy double-digit growth pattern in Retail, pretty consistent, and maybe even a little faster than we've seen year-to-date. On the Direct side, obviously the return back into a growth mode in Q4 is heavily dependent on the traction with the new platform that we're launching now, so the digital platform and the associated sales with M6 and M8 will be the key driver coupled with ongoing sales of the LatX and the other product launches. So -- and then obviously sort of within the Retail, the other -- within the Retail segment, the other channel is we're also expecting pretty strong growth in the Commercial Specialty channel in Q4.

Bruce Cazenave -- Chief Executive Officer

The other area, I would add, I think Sid said it well, George is just keep in mind that sometimes in retail, similar to our Q3, Q4, where you have those few days that could work where business could fall into one quarter or the other, we have a similar scenario in Q4, Q1 too sometimes on the retail side. So just to the degree that certain things go out in Q4 versus Q1 that can make a difference on how much growth is in retail versus how much might slip into Q1, just as a caveat there to our commentary.

George Kelly -- Imperial Capital -- Analyst

Thank you.

Bruce Cazenave -- Chief Executive Officer

Thanks, George. Thanks.

Operator

We will now take our next question from Steve Dyer. Please go ahead.

Unidentified Speaker --

Hi, good afternoon guys. This is Ryan on for Steve.

Bruce Cazenave -- Chief Executive Officer

Hi, Ryan.

Sid Nayar -- Chief Financial Officer

Hi, Ryan.

Unidentified Speaker --

One clarification on the MAX Intelligence, is it correct that the intelligent coaching and feedback is--it's all automated, so I'd think that would be really high margin and scalable or am I missing some interaction with the real coach in there?

Sid Nayar -- Chief Financial Officer

No, it is all interactive and built in against our back-end AI.

Bruce Cazenave -- Chief Executive Officer

But I would just caution, your takeaway, Ryan, that it's all high-margin again, some key in terms of investments that we have to make for that both from a technology perspective, which will be in cost of sales as well as some of the content and the continued addition of content. I would say, certainly in year one, we would just caution you not to expect it to be significantly accretive to the margin numbers for Direct.

Unidentified Speaker --

Makes sense, but it's highly scalable over time, once you build up that (inaudible)?

Bruce Cazenave -- Chief Executive Officer

Yes.

Unidentified Speaker --

Yes. And switching gears to the Mass Retail, the strength there, is that primarily a function of taking more floor space at existing customers such as Dick's or is it a function of gaining new customers or what's -- what could you attribute that to?

Sid Nayar -- Chief Financial Officer

Most of our retail gains are -- we exist with some floor space in many retail bricks and mortar and of course we're strong players in the dotcom world ourselves on Amazon and Walmart.com. So most of our gains in Mass Retail have come from gaining additional floor share with key partners and that continues this fall with the addition of our new Schwinn 411 and the extension to our popular Result series treadmill line. So even with our gains, it's important to remember that our mass retail share, the total retail market is still not to double digits even yet. So we feel like we have large share that we can gain. Now, we won't play in all price points, we won't go to the lowest price points, but we do feel like we can play in the mid to high range and still gain additional share going forward. And you're seeing that reflected as our products prove that they can sell-through then retailers are willing to take more of our products. So we just need to stay on our game in that regard and keep innovating in the Retail space.

Unidentified Speaker --

And lastly for me, the balance sheet remains in extremely good shape, any change to capital deployment, look like reacceleration of buybacks in October, but any thoughts there?

Bill McMahon -- Chief Operating Officer

No, I think the priorities that we'd outlined previously still remain intact. We're so focused very much on those three priorities as we've outlined previously.

Unidentified Speaker --

Great. Thanks and good luck.

Bruce Cazenave -- Chief Executive Officer

Thank you, Ryan.

Operator

It appears we have no further questions at this time. I'd like to turn the call back to you for any additional or closing remarks.

Bruce Cazenave -- Chief Executive Officer

Thank you, operator. I just want to thank all of you for joining our call today and for your continued interest in Nautilus. We look forward to seeing some of you in our -- in New York on November 13 for our Product Showcase Day where we will be unveiling the new digital products. If you would like to attend, please reach out to John Mills at ICR, as he mentioned, and we look forward to speaking to everyone in the New Year and providing an update on our fourth quarter and full year 2018 results. Have a great rest of teh day. Thank you.

Operator

This concludes today's call. Thank you for your participation. You may now disconnect.

Duration: 50 minutes

Call participants:

John Mills -- IR

Bruce Cazenave -- Chief Executive Officer

Sid Nayar -- Chief Financial Officer

Bill McMahon -- Chief Operating Officer

Michael Swartz -- SunTrust -- Analyst

Unidentified Participant -- -- Analyst

Michael Kawamoto -- D.A. Davidson -- Analyst

Unidentified Speaker --

Eric Wold -- B. Riley -- Analyst

George Kelly -- Imperial Capital -- Analyst

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