Nautilus looks to revive brands, get "FIT"

There's nothing to tip-toe around: After a long growth period that included several high-profile acquisitions and huge stock gains, The Nautilus Group hasn't met its own, Wall Street's or its customers' high expectations lately.
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There's nothing to tip-toe around: After a long growth period that included several high-profile acquisitions and huge stock gains, The Nautilus Group hasn't met its own, Wall Street's or its customers' high expectations lately.

That's where new president and CEO, Gregg Hammann, who is known as a brand strategist, has taken the bull by the horns to make sure the company turns around. In a program for which the groundwork was laid even as he hung pictures on a bare office wall his first day on the job -- that July day included a long conference call on the topic -- Hammann has kicked off a three-phase turnaround program with the management team that has the internal moniker "FIT1."

Hammann formally introduced the program to analysts in the company's quarterly conference call two weeks ago. Even with its help, he said he still expects Nautilus (NYSE: NLS) to take most of the next year to begin to grow again.

"We've got work to do here. But what we have to do is make sure things are well laid-out and thought through," he told SNEWS about the plans. "This is a big company and doing things like this takes time."

As Hammann describes it, the program has three "no-brainer" parts:

>> Gain Control -- Imagine driving along steadily in a car, then hitting an unforeseen patch of black ice and sliding out of control. That could loosely describe what happened: Nautilus (also in its Direct Focus days) was speeding along, but then something happened. In this case, one of the primary "somethings" was Icon going after the Bowflex market with its Crossbow product before the Nautilus patent expired. And -- here's perhaps the kicker -- a lawsuit filed by Nautilus in December 2002 charging patent and trademark infringement actually became an expensive, drawn-out court battle that as of last month the district court had dismissed, meaning Icon has effectively won the patent portion unless the federal court steps in. "That was a patch of black ice," Hammann said. "That was the major piece that put us in that spin unexpectedly. This company because of how fast it grew didn't expect a competitor to infringe on a patent or trademark until the patent expired." The patent expires in April.

Compounding the problem were several acquisitions of large brands in the last couple of years, work to integrate and align those brands and products under one banner, and management of the infrastructure, accounting and personnel issues that sat in the passenger seat.

He said the company expects this portion -- emphasizing increasing efficiency and lowering expenses -- to last through the first quarter of 2004.

>> Stabilize Business -- This phase will focus on further developing and repositioning all the brands and their products, including any that are under-performing. Hammann said the company has relied too heavily in the past on strength-training products despite the fact that cardiovascular products represent some 70 percent of the money spent by consumers, meaning the company was missing a large part of the potential market. Already at the October Club Industry show, Nautilus introduced new StairMaster treadmills and a StairMaster ellipitical to help fill that gap, and the company will continue on that track. The direct-channel TreadClimber will also counterbalance the needs of
more cardio products, he said. Additionally, this means making sure the retail part of the company becomes stronger since many consumers still hesitate to buy a product without seeing and touching it.

"After phase two, we believe we will have four to five healthy brands," Hammann commented during the late October call.

This phase should continue through the end of the third quarter of 2004.

>> Grow Again -- Of course, growth is next on the list. And Hammann said that only once the company can leverage the various parts of its business and work as one can it strive upward. This phase isn't expected to begin until a year from now or in the fourth quarter of 2004.

Nevertheless, there were some little hiccups upward in stock prices -- from about $10 to $15 -- since Hammann came on board, but financial experts know that any company that gets a new CEO will see its value jump a bit -- simply on the hope that the new CEO can do the job and grow the business again. In addition, the stock prices before, in the 40s to near 60 in the past were considered somewhat over-inflated in the financial community, with even some savvy analysts not taking the time to look at cash flows, as they should, before telling people to buy.

Getting FIT

Now, what about that FIT1 moniker? Everybody loves an acronym, and this one representing the entire turnaround program stands for Financial rigor, Innovation and Trust, with the numeral "1" representing the company's drive to be No. 1.

"We plan on being No. 1 in each category in which we compete, and we plan on delivering against that," Hammann told analysts in the October call.

The parts of the FIT program are:

>> Financial Rigor -- Getting tighter controls on expenses and costs, as well as working on logistics such as proper forecasting.

>> Innovation -- Making sure the company is bringing relevant products to consumers, at a faster pace, and building brand names in the process. For example, lacking enough treadmills, the company lost in that popular arena, but this year introduced StairMaster club and home models. In addition, Hammann said, the company will likely introduce commercial product first, then "draft off that" to build the retail versions.

>> Trust -- Re-establishing trust with Wall Street, analysts and financial advisors, as well as with customers (clubs and dealers) and consumers.

Research needed

To reach all of its goals as it builds and re-builds step-by-step, the company needed research. But, Hammann found, nothing really good enough existed in the fitness industry, so the company hired an independent research company to do a study. One part of the study asked consumers, for example, what they wanted in equipment, what they thought of certain brands, and what prices they were willing to pay.

"The good, the bad and the ugly is in there," Hammann said about the results, which the company was just beginning to sort through this week. "But it's what you want."

In addition, in the first few weeks on the job, he toured the country to talk to analysts, club owners, gym members and store owners -- all in a quest to fill in the knowledge blanks.

Although Hammann said the company should begin to grow again in about 12 months, one analyst who covers the company estimates a turnaround may take as long as 36 months.

"The next three years are clearly going to be turnaround mode," said RBC Capital Markets analyst Carole Buyers. "Whether Nautilus can grow again will depend on the success of new products in direct and at retail."

Now, earnings per share for 2004 are estimated to be up to $1.05, or relatively flat on an earnings basis compared to 2003 -- figures that Hammann says he has no argument with. The third quarter EPS was $0.20 compared to $0.71 last year. RBC Capital in recent published comments also has issued a preliminary estimate for 2005 EPS of $0.75, but it has maintained its rating for the company of "underperform."

"Gregg has credibility, but the jury's still out," Buyers added. "The road to repair is a very long one."

SNEWS View: Without getting into complicated financial analysis, we can say we feel we've ridden the waves with Nautilus as we watched it go from a rock-and-rollin' Wall Street sweetheart to a company that became the punching bag for some -- unfairly in some cases, but not completely uncalled-for. One thing we think the company learned during this time was to communicate and be forthright about where it is, what it's doing, what that means and why. Drawing up the bridge over the moat and battening the hatches in rough times doesn't build anyone's confidence and, in fact, only builds suspicion and breeds more rumors. Thank goodness the company got over that, and is now doing a fine job at communicating.

But where Nautilus is now is also only a symptom of the entire fitness industry's problem: Way too much product that mostly looks the same and only serves to confuse consumers -- those are the very people that could help stoke the industry's fires. Unlike other industries, the barriers to entering the market with a product are mighty low -- particularly for the low-end pieces that all look alike, aren't very durable in most cases, and frustrate the entry-level consumers when they aren't comfortable, don't work right, or out-and-out break down. Ergo: Another fitness consumer lost. OK, Company A and Store B made some money. Once. But that consumer won't ever come back again to buy and may be gone forever as a fitness consumer or even healthier individual. We as an industry should think about that before selling garbage. As it is, the fitness industry is a mere speck in comparison to others and is one that's not truly growing, but rather still consolidating.

Specifically to Nautilus: The company landed an amiable and credible leader in Hammann. If anyone can gain control of the car that is skidding on the ice, he can -- he and the rest of the management team, including Kevin Lamar, president of the commercial and retail areas, plus Randy Potter from the direct side and product development guru Pat Warner. With the collection of brand names the company has under one roof -- Nautilus, StairMaster, Schwinn, Bowflex, etc. -- we hope it steers the car in the right direction, doesn't cheapen them just to sell more, and builds more innovative and quality products. The entire industry needs this turnaround to succeed if the industry as a whole is going to continue to be vital.

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