Nautilus (NYSE:NLS), the maker of the Bowflex exercise machine, announced fantastic first quarter earnings May 6. Its stock jumped almost 20% on the news. The fitness company once had a market cap greater than $1 billion. Now a micro cap, I'll look at why its 200% increase over the past 52 weeks is just the beginning. By the end of 2014, with the market's cooperation, it could once again be worth more than a billion dollars. Here's why.
Anyone who's followed Nautilus' history knows that its real growth came when it went by another name: Direct Focus. Inc. Originally known as Bowflex of America, it manufactured home fitness equipment under the Bowflex brand name, selling its equipment through various distribution channels. Management decided in 1996 to focus on direct marketing; two years later due to its success, it changed its name to reflect this transition. Between 1998 and 2002, its revenues grew 825% from $63.2 million to $584.7 million while operating income jumped 700% from $18.9 million in 1998 to $151.1 million four years later. By then known as Nautilus as it is today, its stock gained 1400% from its IPO in May 1999 through its all-time high of $45.89 on May 2, 2002.

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Hit The Wall
As if somebody turned off a switch; Bowflex unit sales for the direct sales channel went into the toilet in 2003, declining by 42.5%. What had worked for several years no longer seemed effective. While revenues rebounded in 2004, its operating income went into the tank. By 2007 it was losing money on an operating basis and wouldn't turn into the black again until 2011. Down went its stock trading below 50 cents at the market lows in March 2009.
It looked very bleak for a very long time.
Then I started noticing its business was slowly improving. By March 2011, I was cautiously optimistic that an entire year of profitability would deliver a $9 share price. Although it brought the operating profit I was looking for, its stock price never made it anywhere near $9. The good news is that it achieved an even bigger operating profit in 2012, which led to a 101% total return and more than that in 2013! Business definitely seems to be moving in the right direction.

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Current Business
Its direct business (internet and catalog) in the first quarter saw revenues grow 26.4% year-over-year to $42.6 million. More importantly, its operating income increased 121.5% in Q1 to $6.7 million, higher than its entire 2011 operating profit. CEO Bruce Cazenave, who was hired in May 2011 after stints running businesses for Central Garden & Pet (Nasdaq:CENTA), Stanley Black & Decker (NYSE:SWK), Dorel Industries (OTCBB:DIIBF) and Timberland, has brought operational experience with major consumer brands to a company that was struggling to find its way. It's not all the way back but it's doing enough things right to suggest the future is bright.
Products such as the Bowflex Treadclimber, CoreBody Reformer and Bowflex UpperCut all helped deliver an excellent quarter for its direct business. Even on the retail side (selling to fitness retailers), which saw revenues decline by 9% year-over-year, it was able to increase its gross margin by 330 BPs (basis points) to 59.8%. Cazenave mentioned in the Q1 press release that it was introducing some new products into the retail market this fall that could contribute positively to the segment's results in the back half of 2013. Assuming it grows revenues by 15% in fiscal 2013, it should finish the year with revenues of $223 million and an operating profit of $22 million. The last time it had more than $22 million in operating profits was 2006 when operating margins were 6%. Over 10% today, its stock price should definitely see double-digits in 2013.

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Bottom Line
There are a slew of investment newsletters out there that focus on stocks trading for less than $10. In my opinion Nautilus has to be near the top of almost any list for the best stocks to buy under $10. Unless something unexpected crops up later this year or into the next, I could see its stock trading above $20 by the end of 2014. Of course, I also thought its stock price would be at $9 by the end of 2009--so do your own due diligence

At the time of writing, Will Ashworth did not own shares in any of the companies mentioned in this article.