Nautilus: Proxy Power - American Executive - RedCoat Publishing - American Executive

Nautilus: Proxy Power

Manufacturing

Written by John Zorabedian

Friday, 29 February 2008

Nautilus: Proxy Power - American Executive - RedCoat Publishing

An opportunistic hedge fund snatched up almost a quarter of Nautilus’ stock and took control of its board in a proxy contest in December. CEO Bob Falcone tells us how he plans to win back investor confidence.

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The year 2007 was not a very good one for Nautilus, Inc., the iconic maker of home- and commercial fitness equipment including the Bowflex brand. After a series of missteps by management, the company’s losses mounted, and its stock plummeted. Just when the company was most vulnerable, a New York hedge fund bought up 19% of its stock and waged a public fight to take over its board.

Bob Falcone, CEO

Nautilus’ board tried to hold the fund, Sherborne Investors, at bay, passing a shareholders’ rights plan to limit any investor from owning more than a 20% interest. During the ensuing proxy contest last December, when Sherborne asked investors to remove four of Nautilus’ board members in favor of its own nominees, Nautilus sent a letter to investors asking for forbearance.

But the investors voted no confidence. Sherborne installed its four nominees, including its managing partner, Edward Bramson, as chairman, removing as chairman Bob Falcone, the Nautilus CEO, who retained a seat on the board.

Sherborne’s move to buy up stock and wage a proxy fight was a shock to the board, said Falcone, whom the newly constituted board has voted to keep on as chief executive. “It was news to us,” Falcone said. “We had never heard of them before.”

And although Falcone spoke with a measured optimism about going forward, there is still uncertainty surrounding the board’s transition. “You have new people coming into the picture that don’t know a lot about the company,” he said. “The biggest challenge we have is making sure they become educated about the company and understand where we’ve been, and where we’re going, so that we can make informed decisions.”

Nautilus was to host a conference call for investors to report its year-end earnings at the beginning of February, but Falcone said the company would have to convince investors that its prospects are much better going forward than what is reflected in the year just passed.

In the first three quarters of 2007, Nautilus posted a loss of $9.8 million, sales were down 15%, and the company’s stock was at $4.55 per share, a steep drop from $14 a share at the end of 2006. Falcone knew the company had a lot of work to do to get back to profitability and in the good graces of its investors.

Cutting back
Nautilus got into trouble in 2007 by growing too fast and not in the right direction. The previous management, including former CEO Greg Hammann (whom Falcone replaced in October 2007), was overly concerned with sales growth rather than bottom-line growth, Falcone said.

The company had also planned to buy Land America, a Chinese company with which Nautilus had a previous relationship for manufacturing its fitness equipment, for $63 million. In January, the new board scrapped that plan, forfeiting $18.5 million in non-refundable deposits.

“The Land America acquisition was started about two years ago. It was a different world, different economy, different management,” Falcone said. Although Nautilus may pursue another deal with Land America, he said, the company has to consider its current position.

“We’re looking at that deal in the context of the entire universe of things we have to do to fix the company and make it better,” he said. “One piece of it has to do with certain products that we make in that factory. So, is it better for us to own the factory or to have a different deal with the factory that allows us to have the same end result?”

Also in January, the company restructured a $100 million line of secured credit from Bank of America. Under its arrangement with the bank, Nautilus must restrict its spending to be in line with its assets. “We can’t borrow beyond our means, which isn’t such a bad idea,” Falcone said.

The company put in place a new strategy over the last six months of 2007 to refocus on certain profitable product lines. Falcone brought in new management and worked to sort out marketing and sales channels. Primarily, the company needed to readjust its retail strategy.

Nautilus’ leading brand, Bowflex, gained sales and market power through direct marketing on infomercials. But after the company moved to introduce its Bowflex products to retail stores, those sales began cannibalizing direct marketing sales.

“The company went a bit astray,” Falcone said. “Prior management was really hoping to drive the top line so much that they were taking products into the retail channel that didn’t belong there. There was too much confusion in some of our Bowflex products being taken into the retail channel. They are direct products and should stay as direct products.”

It was a mistake to sell such a popular product for a lower margin in retail stores, one that Falcone said is being corrected. “That made no sense. It’s one of the things we’ve changed. We’ve cleaned up our channels so we’re selling through the channels that are most profitable for our products.”

As part of a new retail strategy, Nautilus will focus on selling to larger stores, such as Dick’s Sporting Goods, and forego sales to much smaller retailers. Servicing a few large retailers makes more sense for distribution and marketing purposes. “It’s a higher cost for us to deal with multiple retail customers, so we’re much better off narrowing our focus, dealing with the bigger ones and those that are easy to do business with,” Falcone said.

Building confidence
Falcone expects the new strategy will take a year, at minimum, to return the company to strong profitability. It is a long-term strategy, but it is complicated by the fact that investors may not wait around to see if it works.

Investment funds seeking a short-term gain can damage a company, and its other investors, if they sell large portions of a company stock when they think the getting is good. Sherborne’s board members, at least, now have a fiduciary responsibility to the company, holding Nautilus’ interests above their own.

“From my dealings with Sherborne so far, they seem like very solid people—they’re smart, and they understand business,” Falcone said. Yet he also believes Sherborne has to prove that it brings a level of expertise about Nautilus’ business to the table.

Falcone said that the board should take a more hands-off approach, allowing the management team to get to work, while providing its proper role of oversight. “The board shouldn’t decide the strategy, be part of executing the strategy, and then be part of the group that oversees that strategy, because how do you check and balance yourself?” he said.

In early 2008, management continued to pare back the company—cutting its workforce, dropping unprofitable product lines, and taking a close look at spending, particularly in the areas of marketing and advertising.

With respect to its investors, Falcone said the company has to show progress and a willingness to follow through on what it says it will do. “It will take a couple of quarters, and we’re going to have to show progress,” he said. “We’re going to have to show them what we’re doing, and we’re going to have to show some good numbers.”

In the case of Sherborne, which now owns 25% of the company’s stock, Nautilus has little choice but to heed its advice. When a company reaches a low, as Nautilus did in 2007, it is vulnerable to takeovers and at the mercy of its investors.

“The company was very vulnerable because it was underperforming and shareholders were not happy with the stock price,” Falcone said. “It’s like a political campaign. If investors are not happy with the way things are being run, they say they want change.”

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