Nautilus looking for a comeback

For a while now, Nautilus Inc. (NYSE: NLS) has looked more like an injured athlete craving a chance to get back in the game than one of those sculpted, ready-to-win models featured in its Bowflex TV ads.

In the second quarter of this year, the publicly traded Vancouver-based maker of fitness equipment found itself nursing yet another quarterly net loss, $10.7 million, or 35 cents a share. The bright spot, if one could call it that, was that the loss was smaller than the $20.8 million, or 68 cents a share, it lost in the second quarter of 2009.

What hasn’t been lost is the company’s drive to get back on track. Spurring Nautilus forward is its dedication to research and development, which consume 2 to 3 percent of total revenues, or roughly $3 million a year, said Bill McMahon, senior vice president of consumer business. While the company has made several painful cuts, “We continue to invest in R&D,” McMahon said. That fuels everything from new product offerings to improvements to the company’s Bowflex home gym.

Nautilus, with equipment that has helped countless customers lose unwanted weight, shed some pounds itself last year. It shuttered its commercial division, which sold equipment to health clubs and hotel chains, to focus on its direct-to-consumer and retail business units. Now, the company is at a crossroads, as it aims for a return to profitability after three turbulent years.

Among the recent challenges and corporate skirmishes Nautilus has faced:

• In October 2007, then-CEO Robert Falcone, trying to turn the company around, told shareholders that Nautilus had grown too fast in its pursuit of revenue. “Our plan is to build a sleek company designed to leverage our strong foundations,” he said.

• By January 2008, New York investment firm Sherborne Investors LP, which held a 25 percent stake in Nautilus at the time, had overcome Falcone’s resistance in order to win four seats on the company’s seven-person board of directors.

• In March 2008, Falcone was removed and Edward Bramson, a partner in Sherborne who had become chairman of Nautilus’ board after his firm’s hostile takeover, replaced him as CEO.

If the company had grown too fast and lost its way, and if the proxy battle served to highlight this, then rising unemployment and a national credit crunch only exacerbated the company’s problems. Nautilus sales depend on consumers who must be willing and able to open their wallets or take on debt to buy the company’s costly fitness equipment. Bramson became CEO just as the recession hit.

In the three months ending March 31, 2008, sales were down at an annual rate of 5.7 percent, the company was more than $63 million in debt, and its lenders were pressuring Nautilus to pay down its loans.

Bramson decided to scale back. He backed out of an agreement to buy a Chinese manufacturer and started cutting jobs. Nautilus also sold off Pearl iZumi, which it had bought in an unsuccessful bid to break into fitness apparel. Buyer Shimano American Corp. paid $65.3 million in cash and assumed $4.2 million of long-term debt.

“We’ve taken $90 million out of the business in two years,” McMahon said, referring to the company’s rounds of cost cutting, including layoffs and asset sales.

In early 2008, the company employed more than 1,400 people worldwide, including more than 500 at its Vancouver headquarters. Now it has 357 employees, with 273 in Vancouver and 33 at its distribution center in Portland.

At the height of Sherborne Investors’ battle for boardroom control, the Falcone-led Nautilus charged that Sherborne wanted the company only for short-term gain. And at least one analyst said Sherborne had provided only general ideas about what it would do with Nautilus if it gained control. The question arose: Would Nautilus’ new leadership just sell off the company’s’ brands and dissolve the business altogether?

To this day, it remains a legitimate question.

McMahon said Bramson — the third CEO Nautilus has had since August 2007 — is committed to putting the company back on a path to growth and profitability.

Investing for growth

Even after making cuts, Nautilus remains a major Clark County employer. And it hasn’t been shy about creating other ties to the community. Adjacent to the company’s headquarters are fields Nautilus developed that local sports teams use for football, soccer and baseball games. Runners frequent a jogging track the company installed.

McMahon cited a recent $5 million loan that Sherborne extended to Nautilus as proof of the current leadership’s long-term commitment to the fitness company.

“That money is really earmarked for investment,” he said. “We want to make sure we have the capital necessary to do it.”

Bramson “is committed to doing this,” McMahon said.

Despite its struggles, the company has a lot going for it: It has no debt, excluding its new loan, McMahon said. And it does have plenty of brand recognition, including from its Bowflex, Nautilus, Schwinn Fitness and Universal brands.

Moreover, the company’s second-quarter results this year were peppered with bright spots: Nautilus’ retail business, which sells through stores such as Dick’s Sporting Goods and Sears, increased 4 percent in the second quarter. The increase occurred primarily because of customer demand for the company’s newly redesigned fitness bikes and elliptical products. Sales of free-weight products were also up, and Nautilus is attracting new customers.

Market data suggest that sales could continue to climb. The Sporting Goods Manufacturers Association predicts manufacturers’ U.S. sales of sporting goods, fitness equipment and related accessories will increase by between 2 and 4.5 percent this year, up from $72 billion in 2009.

“The main category drivers in the industry will be athletic footwear and consumer fitness equipment,” according to the association’s 2010 State of the Industry Report. “The treadmill is the most popular piece of fitness equipment.”

Nautilus also believes it will benefit as America’s population ages and a growing number of retiring baby boomers look to stay fit. One product that’s helping the company serve that growing population is its TreadClimber, which is key to Nautilus’ long-term focus on its direct-to-consumer business. The exercise machine, which costs $1,298 to $3,299, combines the stride of a treadmill, the stepping motion of a stair climber and the low impact of an elliptical.

The machine can be a tough sell when a good pair of running shoes and some willpower will get people fit for far less money, however.

McMahon, who comes off as equal parts realist and savvy business strategist, acknowledges that in this economic climate many people are choosing to save or pay off debt rather than invest in expensive fitness machines. But the economy is going to get better, he said. And a newly energized Nautilus will be ready.

To prepare for that day, the company signed a new partnership on June 15 with General Electric’s consumer credit arm — General Electric Money Bank — aimed at helping its customers buy exercise equipment on credit.

McMahon said the agreement enables Nautilus to offer more flexible financing options to consumers.

Heart of the business

To visit the lower levels of the company’s cavernous headquarters is to further understand why Nautilus believes it has the wherewithal to make a comeback. Research labs form the company’s beating heart. In one room, a computer-controlled device cranks the locking mechanism of a SelectTech dumbbell, stress-testing the product. Nearby, several steel contraptions, lined up in a row, simulate walkers and runners using TreadClimber machines, shock-testing the treadles by moving poles up and down in a piston-like manner, delivering steady blows.

It’s all about making sure that Nautilus maintains and protects the credibility of its products and brands. To be sure, its track record shows some stumbles. In 2004, Nautilus recalled its Bowflex Power Pro strength machine after discovering a defect that had injured 70 people. In 2009, it recalled 78,000 Bowflex Ultimate 2 home gyms after reports of 18 injuries linked to that machine. Both moves were approved by regulators.

Standing inside a Nautilus lab, Farid Farbod, vice president of product development, said the company puts its products through the most extreme testing to ensure they meet the highest consumer-safety regulations of each country in which it sells its products, including the U.S., Canada and Europe.

“This is a cycle that never stops,” Farbod said of the company’s testing and retesting. Farbod said Nautilus immediately responds to any problems that crop up with its products, and it monitors consumers’ reviews of its fitness equipment on the Internet to stay ahead of complaints.

The sound from the company’s machine-testing lab is a steady stream of thumps and whumps, and whirs and claps. It’s the sound of progress, of things being hammered out and refined, and that’s what Nautilus wants more than anything now. After all the financial pain and layoffs, the company believes it has made the necessary cuts, slimmed down to the right size and raised the necessary capital to put itself in the right direction. After trimming down its operations, Nautilus is now eager to bulk up its sales and return to profitability.

For reasons of competition, McMahon said, he can’t divulge how the company plans to use the infusion of cash it got from Sherborne or what new product offerings the company plans to roll out or how, exactly, it will successfully market its products. He’s looking forward to next year, he said, especially the period immediately after the New Year’s holiday, when people make resolutions to get fit.

“The objective,” McMahon said, “is to stay healthy right now as we see what this economy is really doing.”