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Nautilus Lets Go CEO

VANCOUVER, WA — It was little surprise to most analysts when Gregg Hammann stepped down as president and chief executive officer of Nautilus Inc. last month. The Vancouver, WA-based equipment manufacturer released falling net sales and net income for the first and second quarters of 2007, and has posted increased net sales and net income in only two quarters of the last 2 ½ years.

“I've been calling for [Hammann's] resignation in public notes,” says Eric Wold, managing director of Equity Research at Merriman Curhan & Ford Co. (MCF), a financial services holding company. “I'm just surprised it took this long for the board to act.”

Hammann also resigned his seat on the company's board. Robert Falcone, Nautilus's lead independent director, will serve as chairman, president and chief executive officer on an interim basis, according to the company. The company's independent directors have formed a search committee for a new chief executive officer. A company spokesperson declined to comment on how long the search was expected to take, nor did he comment on the company's declining sales and profits.

Net sales for the second quarter of 2007 were down 15 percent at $117.1 million compared to $137.6 million in the second quarter of 2006. Net income for second quarter 2007 was $1.1 million, or $0.04 per share, compared to $1.7 million, or $0.05 per share, for the second quarter of 2006.

Industry experts and analysts blame some of the falling sales on Nautilus's emphasis on the home-equipment market, which has been slowing due to a weakening economy. Hammann also blamed the retail slowdown for the company's second quarter performance.

“Our quarter was primarily affected by a softer-than-expected consumer environment in the North American home fitness market served by our retail and direct channels, especially within the home exercise gym segment,” Hammann said in Nautilus's second-quarter report, which was released on July 16.

In the first quarter of 2007, net sales dropped 14 percent to $158.8 million from $185 million in the first quarter of 2006. Net income fell from $5.2 million, or $0.16 per share, in the first quarter of 2006 to $2.5 million, or $0.08 per share, in the first quarter of 2007.

In March 2007, Nautilus introduced its newest line, Nautilus One. The strength equipment features a non-intimidating dial for users to change the weight they're lifting. The line will begin shipping in the next few months, says Ron Arp, spokesperson for Nautilus.

Hammann isn't the first executive to be shown the door. The company let go Tim Hawkins, president of Nautilus's fitness equipment business, which represents 80 percent of the company's revenues. Both Hammann and Hawkins had previously worked at Levi Strauss and Co., Coca-Cola, and Rayovac Corp.

In late June, Nautilus exercised a purchase option to acquire the assets of its largest contract manufacturer, Land America Health and Fitness Co. Ltd, based in Xiamen, China. The all-cash-transaction of approximately$72 million is expected to close Jan. 2, 2008, and improve company gross margins by at least 1.5-2.0 percentage points in 2008, according to the company. Land America has made the Bowflex home exercise gyms for more than eight years and began manufacturing Bowflex TreadClimber cardio trainers for the company last year. Also, Nautilus and Land America teams have built a new production line that will manufacture and ship additional products from the facility later this year.

Before his departure, Hamman touted the purchase of Land America Health and Fitness, saying, “A diversified manufacturing and supply base is important to maximize our margin potential and to mitigate supply risks.” However, some analysts have suggested that Nautilus should get out of the Land America deal to free up cash. Others say the investment will pay off, although it may take time.

Manufacturing problems have plagued the company since 2005. During the fourth quarter of 2005, the company announced a net income of $2.8 million, which was more than an 80 percent drop from the fourth quarter of 2004 due to manufacturing production glitches. The company had planned to introduce six new residential and commercial treadmills and TreadClimbers during the 2005 holiday season, but manufacturing issues caused delays in getting the products to the consumers, including the withdrawal of TreadClimbers to strengthen its hydraulic system in fall 2005.

In 2006, after announcing fourth quarter 2005 results, Nautilus reorganized the company into three separate business divisions — fitness equipment, international equipment and fitness apparel. First quarter 2006 net income was $5.2 million, down from $9.4 million in the same period during the previous year. However, net sales were up 18.3 percent from first quarter 2005 at $185 million.

In the second quarter of 2006, net sales were up 6.2 percent, and net income was down from $3.3 million in the second quarter of 2005 to $1.17 million. During this time, Nautilus reintroduced 500 TreadClimbers at about 80 24 Hour Fitness facilities across the country.

The third quarter of 2006 brought more bad news, as the company reported net sales dropping from $163.3 million in the third quarter of 2005 to $159.6 million. Net sales also dropped from $7.7 million to $6.4 million, excluding a tax reversal credit that was awarded to the company. The fourth quarter of 2006 showed promise, with record net sales for the fourth quarter at $199.3 million, and net income was up at $10.9 million from fourth quarter 2005.

Wold has advised his clients to avoid shares of Nautilus stock. On July 17, MFC released a report highlighting weakness in Nautilus's core channels, including a 62 percent decline in retail sales and 11 percent decline in direct sales.

“We have been stressing the risk to these channels from increasing competition, internal channel cannibalization, tightening credit/sub-prime markets and consumer spending headwinds — and these continued to play out during second quarter,” the report states.

Competing manufacturers say they have taken note of the change in Nautilus's leadership and see this period as an opportunity. Wold says any leadership changes will take time and that the competition should use the time of confusion effectively to take market share from Nautilus.

Nautilus includes the brands Nautilus, Bowflex, Schwinn Fitness, StairMaster and Pearl iZUMi.

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