NutriSystem, Inc. Q1 2009 Earnings Call Transcript

NutriSystem, Inc. (NTRI)

Q1 2009 Earnings Call

April 29, 2009 4:30 pm ET

Executives

Joe Redling – CEO

David Clark – CFO

Cindy Warner - IR

Analysts

Gregory Badishkanian - Citigroup

James Duffy – Thomas Weisel Partners

William Sutherland – Boenning & Scattergood

Karen Howland – Barclays Capital

Mitchell Pinheiro – Janney Montgomery

Presentation

Operator

Good afternoon, at this time I’d like to welcome everyone to the NutriSystem first quarter 2009 earnings conference call. (Operator Instructions) I would now like to turn the presentation over to your host for today’s call, Ms. Cindy Warner, Investor Relations; please go ahead.

Cindy Warner

Good afternoon everyone and thank you for joining us to discuss NutriSystem’s first quarter 2009 financial results. With us today from management are Joe Redling, Chairman and Chief Executive Officer and David Clark, Chief Financial Officer.

Before I begin I’d like to remind everyone that this announcement contains forward-looking statements that involve risks and uncertainties. Such information includes statements about NutriSystem’s first quarter 2009 financial results as well as statements that are preceded by, followed by or include the words believes, plans, intends, expects, anticipates or similar expressions.

Statements regarding NutriSystem’s plans and expectations for the second quarter of 2009 and the full year 2009 and similar statements that are not statements of historical fact constitute forward-looking statements. For such statements, NutriSystem claims protection of the Safe Harbor for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995.

Actual results may differ materially from the results predicted and the reported results should not be considered an indication of future performance. Factors that could cause actual results to differ from those contained in the forward-looking statements include, but our not limited to, those factors set forth in NutriSystem’s Annual Report on Form 10-K for the year ended December 31, 2008, which has been filed with the SEC.

NutriSystem is making these statements as of April 29, 2009 and assumes no obligation to publicly update or revise any of the forward-looking information in this announcement.

And with that I’d like to turn the call over to Joe Redling, our Chairman and Chief Executive Officer.

Joe Redling

Thank you Cindy, good afternoon and thank you for joining us on today’s conference call. I will review the company’s first quarter 2009 results, some key highlights, and David will provide more detail on financials in a few minutes.

First quarter revenues came in at $163 million, down 25% versus a year ago. The first quarter of 2009 brought in the lowest measured consumer confidence ever and we certainly were impacted by this further retrenchment in consumer spending.

Gross margin for Q1 2009 was 53% as compared to 52% a year ago, due to reduced inbound and outbound freight costs as well as reduction in the use of food based promotions in the first quarter. Marketing as a percentage of revenue was 29% as compared to 31% a year ago and is in line with the marketing efficiency objective of mid 20’s as a percentage of revenues for full year 2009.

Adjusted EBITDA was $19.4 million, down versus prior year of $26.7 million and within the range of our most recent guidance. We continue to be debt free and had $74 million in cash on hand at the end of the first quarter. We generated $46 million in cash in Q1, nearly $3 million more then a year ago. We also announced that we will be paying our regular dividend in May.

The first quarter of 2009 was a busy quarter of product and channel launches that I will go into in just a moment but it was also full of macroeconomic challenges. While we tracked to our internal forecast in January, we experienced significant consumer pull back in February when negative financial news once again dominated the headlines.

Continued negative news on unemployment, new lows in the market, and daily coverage of continuing challenges in major business sectors, seemed to have an immediate impact on consumer demand. In fact we saw the most aggressive decline in the consumer confidence index since the financial market collapse in October of 2008.

The conference board consumer confidence index dropped to an all time low in February with only a slight increase in March. Even after an improvement in April, the index is only back to its October, 2008 level.

As we witnessed the shift and the impact in consumer demand we adjusted our marketing mix and spending levels and we were able to manage our marketing efficiency to acceptable levels through the second half of the quarter.

March performance improved but not enough to offset tougher prior year comparables due to the Easter period falling into the second quarter this year versus March 23 in 2008. In addition we experienced some media volatility in Q1. Early January provided us with excellent media rates and clearances that enabled us to get off to a good start. But DR media was pressured due to lower rates as we entered February and major networks began to tighten inventories to manage rates which in turn created a more unpredictable clearance and delivery environment on a week to week basis.

Fortunately we have seen that volatility moderate in April and we expect to see a more traditional media marketplace with advantageous buying opportunities in Q2 and the rest of the year. In light of the broadcast media environment we shifted a higher percentage of our media investment to the web.

We have seen and continue to see a positive return on our increased spending on the web. Our newly designed site and ecommerce platform continue to enable us to drive improved conversion and efficiency and have opened the door for more aggressive spending.

We continue to leverage our new lead generation model to get smarter about analyzing ROI and leveraging spend to optimize profitability. We have also seen attractive rates for online advertising in Q1 which has contributed to our effort to continually drive efficiencies across all our web channels.

This ability to shift dollars across our many channels is more evidence supporting the flexibility of our business model as recessionary pressure continues to challenge momentum and we need to adjust and prioritize spending against our most efficient channels.

Building upon our December website redesign for prospective customers we launched a redesigned members site in January. This new design allows us up sell and cross sell opportunities to current and previous customers through highly personalizeable web modules as well as begins to incorporate our highly used community features throughout the user experience.

In February we launched in beta our exclusive online behavior modification program called Mindset Makeover, on line, a 13-week interactive hands on guide featuring videos, tutorials, quizzes, and downloadable worksheets. These practical solutions and tactics for weight loss were created in partnership with the renowned weight loss expert Dr. Gary Foster, Director for the Center of Obesity Research and Education at Temple University.

Over 25% of our users are using this program already. In early May internet retailer will introduce NutriSystem.com as one of the top 50 ranked ecommerce websites for ecommerce revenue generation in 2008 further validating our growth through the web.

Turning to new channels, our expansion into the retail channel with Costco has been a positive experience. We had our first fully integrated quarter with Costco in Q1. Our NutriSystem women’s and men’s programs were offered through US and Canadian Costco stores during the first quarter.

We also were integrated in the web channel of Costco.com. This has been a successful new partnership and represents our first scaled entry into the retail channel. While it is still early, our initial evaluation indicates that we are reaching a new customer segment that benefits from our general market advertising and generates incremental business for both NutriSystem and our partner Costco.

We will be rotating in and out of US Costco stores on a seasonal basis to optimize sell through for both parties. We plan on maintaining a strong presence during key seasonal periods but will allow for hiatus periods and soft seasonal periods to maintain a high level of interest and profitability.

We will continue to be offered year round through Costco.com and Costco’s Canadian locations. We are encouraged with our early performance in the retail channel and are exploring additional opportunities to further leverage our brand and expand our presence while always protecting the core tenants of our direct to consumer business model.

Now looking at new program offerings, the first quarter also marked the marketing supported launch of our new Flex product. This program provides 20 days of food and eight days of meal planning allowing the customer more flexibility in their meal planning while still losing weight.

We positioned this program as weekends off as it was designed to appeal to a specific customer segment at a lower price point. With an introductory price of $199 during January and February, it quickly became a strong part of the product mix, strong enough that we did see some cannibalization of our core offering as customers opted for the lower price.

In response we quickly increased the price to $234.95 to manage gross margin dollars and manage our sales mix. It is still a strong contributor to our overall sales with improved gross margin. We estimate that the revenue impact of the product mix regarding Flex in the first quarter was between $1 and $2 million.

We also have found Flex to be a very effective web offer where we can keep our acquisition costs low and attract new customers very efficiently. We will continue to promote Flex through our most cost efficient channels and it remains an important component of our overall product mix.

Our other key new product initiative for Q1 was the introduction of NutriSystem Select. As a reminder this new program combines our core also known as Ready to Go menu items with our new fresh frozen line developed in cooperation with our new partner, Schwan’s Home Service.

Similar to Flex this program targets the specific customer segment that prefers frozen menu options and is less sensitive to pricing. We knew it would be challenging to introduce a premium priced product in this environment but we felt it was strategically important for the brand and our business to establish this line for future growth.

While it is still early we remain encouraged about the opportunities this new line presents. We have received valuable feedback from our customers on our new Select program launch. While our customers are excited about the expanded variety and the high level of quality, the feedback received was that the value proposition was not in line with their expectations.

In response we recently launched Select 7, an offering of one week of frozen menu items which is available to all current customers. That effort was based on customer requests to supplement their existing plans with fresh frozen menu items and we believe this reinforces the strategic value of this new line.

Later in Q2 we plan to offer a 2 plus 2 option for Select that combines two weeks of frozen with two weeks of Ready to Go foods. Going forward we plan to test different price points for the Select offerings to create the right value proposition for the consumer while maintaining gross margin requirements.

Operationally we also executed this program flawlessly with our new partner, Schwan’s. This was a complex undertaking utilizing two distinct [of merged] supply chain operations and the teams did an outstanding job delivering for our customers.

With these product and web enhancements we realized continued stability and strength in our reactivation revenue in Q1 of 2009. Reactivation dollars for Q1 were flat year over year and contributed approximately $40 million and now make up nearly 25% of overall revenues for the first quarter.

This represents a sequential increase of 36% over Q4 of 2008. All indicators with four months under our belts are that we anticipate reactivation revenue to be stable on a year over year basis for the balance of 2009. Recall that reactivation revenue has a larger contribution margin as its directly applicable marketing spend is quite low.

Looking ahead in Q2, we continue our focus on introducing new compelling products as we prepare to launch our marketing campaign for NutriSystem D, our program for people with diabetes. There are approximately 24 million Americans with diabetes as well as 57 million Americans who are at risk for diabetes. Nearly 80% of people with diabetes are over weight.

Dieting for this segment is more complicated and challenging as they need to balance their sugar levels while managing choleric intake. Tackling this complexity often results in frustration and failure. By design NutriSystem D removes this complexity to create a path to success.

This past Thursday, the aforementioned Dr. Gary Foster presented the results of the NutriSystem D clinical study at the American College of Physicians Symposium. In a clinical study at Temple University School of Medicine people with Type 2 diabetes on NutriSystem D lost as much as 16 times more weight while lowering their A1C scores by 0.9% as compared to those following a hospital directed diet regimen.

The weight loss was also associated with significant reductions in triglycerides, cholesterol, and [whey] circumference. We are excited about the results of this study and hope to deliver the message of improved health with proven weight loss to the diabetic community with our marketing launch.

To be clear we have had this diabetic program available for some time with no marketing behind it and consumers have found it on their own to the extent that it represents approximately 7% of our current orders.

While we have high hopes for NutriSystem D over the long run, we do believe this opportunity may be somewhat suppressed by the current consumer sentiment. We do strongly believe that this segment is much more likely to place the appropriate value on a clinically tested and effective weight loss program, however we also understand it will take time to see the message and raise awareness of the extraordinary benefits of NutriSystem D.

In fact we expect the launch to be a drag on Q2 earnings as we invest in the product introduction and we do expect to see positive incremental financial returns in Q3 and beyond. Net, net we believe NutriSystem D represents a strategic product extension to address the large and growing segment that is well underserved in the weight loss arena.

Our team has done a phenomenal job in developing the program and validating the program’s efficacy. We look forward to providing a new and effective option to people with diabetes and playing an important role in addressing their specific needs.

Even with these opportunities ahead of us we clearly remain cautious about our ability to impact consumer demand in the current climate. We have seen continuing softness in April even during the Easter period where demand normally shows seasonal strength.

While we have seen some improvement in volume in April, it is still well below historical patterns for the Easter diet season. As the consumer continues to struggle with the recession we will continue our focus on ways to improve processes to both improve the customer experience and overall efficiency.

We have initiated a plan to optimize performance in 2009, right size our costs for our current revenue reality and better prepare us to improve our margins in anticipation of an eventual economic and consumer recovery.

So far this year we are seeing improvements in length of stay, revenue per customer, and overall customer satisfaction, all of which better position us to drive incremental profitability as consumer spending improves. We will continue to super serve our current customers and make the most out of each and every customer contact.

Although our visibility and forecasting revenue generation is somewhat limited due to our reliance on new customer revenue and consumers’ discretionary spending we can be aggressive on the cost side of our business.

We have initiated a comprehensive cost reduction plan that will touch every area of our business. We expect this effort to reduce cash operating costs by 15% over 2008. This plan is well underway and David will go into the specifics after he gives the detailed results of Q1.

Before I turn the call over to David let me summarize just a few key points, first while we continued to be pressured on the revenue line our business model remains in tact. We remain very profitable, generate strong free cash flow and have no debt.

We generated $46 million in cash from operations in Q1. In fact this represents an increase of nearly $3 million over Q1 2008 on lower sales volumes. This performance again reinforces our improved operational processes and our ability to generate positive cash even during challenging economic times.

Second, reactivation revenue is stable and becoming a larger contributor of overall revenue and profits which provides us with earning stability as our returning customers continue to recognize the value of our offering.

Third in the most difficult consumer environment we faced in 30 years, our marketing model continues to be a key advantage as we have maintained a high level of ROI on our marketing spend in Q1 and we plan to continue this focus for the remainder of 2009.

We will maintain the flexibility to increase our marketing investment if the opportunity presents itself. Finally we have made progress on improving gross margins in Q1 and we will continue to optimize margins throughout 2009 as part of our overall effort to drive significant productivity improvement across the organization.

I remain steadfast and confident in both our ability to navigate through this period and emerge in a stronger leadership position to deliver proven weight loss and improved health to a large and growing consumer market.

With that, I will turn it over to David Clark, our CFO.

David Clark

Thank you Joe, before I go through the first quarter I want to share two accounting changes. Historically the commissions paid to our sales and customer service employees have been a part of our cost of goods sold. This expense has been reclassed to general and administrative expenses so [inaudible] all other components of employee wages and benefits.

This cost runs about 2% of revenues. Prior periods are adjusted as well. All reporting now reflects this change. In June, 2008 FASB issued FSP emerging issues taskforce number 03-6-1, effective for fiscal years beginning after December 15, 2008.

Under it invested shares base payment awards that contain rights to receive [non fortitable] dividends whether paid or unpaid, are considered participating securities and should be included in the two class method of computing earnings per share. Effective January 1, 2009 the non vested shares issued under our company’s equity incentive plan were a second class of stock for the purpose of earnings per share calculations.

This resulted in lower income allocations to our common stock and impacted our reported income per share by $0.01 for the three months ended March 31, 2009 as well as March 31, 2008 and this will continue to effect earnings per share going forward.

Now let’s go through the first quarter results, for the first quarter of 2009 we generated $162.7 million in revenues, a 25% decrease over prior year. Gross margin came in at 53.1%, up 80 basis points from 52.3% a year ago. Marketing as a percentage of sales was 29% in Q1, down 200 basis points from 31% a year ago and is on track for the targeted range of mid 20’s percent for the full year.

For the first quarter of 2009 our direct channel generated 93% of our revenue, QVC generated 6%, and less then 1% of our revenue came from other channels. QVC revenue for the first quarter of 2009 was $10.6 million, down 25% versus last year. Despite the pressure on first time order revenues, reactivation revenue was flat to the first quarter of last year at approximately $40 million. Notably those revenues are up 36% from Q4 of 2008, and in line with seasonal trends.

However much of that growth came from customers beyond their 24 month anniversary as that cohort continues to grow as a component of the overall customer database. This increase was a consistent trend in 2008. The higher proportion of older reactivations shows encouraging signs on our efforts to broaden reactivation from all cohort groups.

While reacts have not been immune to economic woes and we don’t want to firmly project these trends we will continue to focus on broader web based and product based efforts to drive react revenues.

Q1 2009 operating income from continuing operations was $14.7 million, and represented a 9% operating margin. Our first quarter 2009 adjusted EBITDA came in at $19.4 million. Depreciation and amortization was $2.7 million and our noncash employee stock compensation totaled $2 million.

Adjusted EBITDA margin was 11.9%. The company’s effective tax rate for the first quarter of 2009 was 37.6% and our adjusted earnings per share came in at $0.31 a share, down from $0.44 a year ago.

The aforementioned accounting changes and our portion of zero orders lost totaled $0.02 for the first quarter of 2009 and $0.03 for the first quarter of 2008 bringing our reported EPS down to $0.29 and $0.41 respectively.

Noncash employee stock compensation had a $0.04 impact on earnings per share. These items will continue to effect ongoing earnings per share for most of the remaining year. From a liquidity standpoint on March 31, 2009 we had $73.7 million in cash and cash equivalents, compared to $38.3 million at the beginning of the quarter and we continue to be invested in treasury and money market fund accounts.

Capital expenditures for the first quarter of 2009 were $2.3 million, the same level as first quarter 2008. We do plan for capital expenditures in 2009 to come in below that level experienced in 2008. Our unused $200 million credit facility remains available should we need it.

In this economy we are managing all components of working capital as well as expenses. We ended the first quarter with inventory at $35.3 million as compared with $51 million a year ago. Last year inventory was higher then normal as we were moving out of nourish inventory, however, our inventory management during a period of uncertainty has been exemplary.

The Board of Directors approved dividend payment of $0.17.5 per share payable May 18, 2009 for holders of record on May 8, 2009. We continue to see dividends as a consistent method to directly return value to our shareholders.

In January we bought back 1.9 million of our own stock and while the Board of Directors approved the remaining stock buy back authorization for two years in the current environment we will prioritize cash availability.

For the balance of 2009 we are planning for the current macroeconomic conditions to continue for US consumers making the predictability of levels of new customer demand particularly challenging. In the face of this we do believe our reactivation revenue for the year should be flat to last year consistent with what we saw in the first quarter.

Therefore we will focus on areas we can directly impact and control such as cost of good sold, marketing spend, general and administrative costs, and our capital spending. While we will not provide guidance at this point I want to highlight our financial priorities.

We are focusing on the following cost objectives to reduce our cash operating costs by 15% as Joe previously mentioned. These cost objectives include; targeting 100 to 150 basis point increase year over year improvement on gross margin, having heavily negotiated our food and packaging costs over the last 12 months, renegotiate our freight contracts, and we are now focused on reducing fulfillment costs and reduce our distribution centers from six down to four.

We are now holding an [RFP] process for our fulfillment vendors. Managing our marketing spend to revenue percentages to come in in the mid 20’s by daily management of media spend, proactively reducing production costs and limiting low efficiency media such as long form TV and direct mail continue.

Consistent with last year this is accomplished through the daily, weekly, and monthly monitoring of the effectiveness of all of our spending based on customer response. We will see some pressure this quarter as Joe mentioned, due to the expense in our launch in NutriSystem D.

Reducing year over year cash G&A expense to right sizing our business revenue levels through reduction in items like outside IT spending, hiring freezes, salary freezes, benefit cost reductions, and other activities will also be a priority.

Again we expect capital expenditures and G&A to be below what they were in 2008. Capital and operating cost initiatives will be the financial focus of our business for the remainder of the year. I want to stress that we are focused on expense control not only for the current year, but to make ourselves all the more profitable when customer demand returns.

In addition we will build upon our existing financial flexibility to compete in a market that we believe has a great and growing potential over the long-term.

Thank you and I’ll now turn it back over to Joe.

Joe Redling

Thanks David, before we open it up to Q&A, I want to make a special point. While everyone has been focused on the recession and the impact of the financial crisis, we need to move forward and focus on the health of the community and its people.

NutriSystem is a key part of that community and we are focused on providing healthy weight loss options for everyone, whether they are diabetic, in need of a structured diet, or in need of a program that provides more flexibility.

It is imperative that NutriSystem provides this weight loss leadership today and every day to a community that is over weight, obese, and is seeking answers. A leader is strong and in it for the long haul. At NutriSystem we are asset strong, not only on our balance sheet and in our product offering, but in our people as well.

The heart of a community is its people and I cannot emphasize enough the efforts that the employees here have put forth to make us the flexible organization we are, an organization that can turn on a dime and respond to changes in the marketplace, in customer behavior, and in cost structure.

This has led to continued improved customer satisfaction as evidenced by reactivation and extended length of stay. We are prepared to move forward to the next level of healthy weight loss leadership that in turn provides excellent shareholder value for the long run.

With that we would like to open it up for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Gregory Badishkanian - Citigroup

Gregory Badishkanian - Citigroup

Just a few questions, first is over the last month or two have you noticed any changes in terms of consumer demand from either new customers reactivations and also marketing effectiveness then maybe you saw at the beginning of the quarter or even towards the end of last year.

Joe Redling

We saw, as we walked into the Easter period we had what we would typically call an improvement in demand and volume. It was below what we expected for the period. Last year we saw a much bigger ramp up even though Easter was earlier. So we saw some efficiency there but nothing that would indicate that there is a improved environment for consumer spending.

So we’ve been managing our marketing spend accordingly, again as we always do focusing on profitability but kind of the only change coming from March to April was really a seasonal increase in volume that you would typically see. So we really couldn’t isolate any improvements in consumer sentiment.

Gregory Badishkanian - Citigroup

And also looking at the cost side of the business, in terms of your cost of goods sold, commodity costs have come down, you also have contracts so I’m just wondering when would you expect to see sort of the big benefits from the cost of goods sold due to the declining commodity cost deflation.

David Clark

I think a couple of things, first of all we did announce that we renegotiated our UPS contract in the first quarter of this year and we are starting to see the benefits of that contract savings. The food costs really go on schedule of when we’re actually doing our buying so we will probably start to see some food cost improvement in the second half of the year, but obviously the key savings are achieved when we do our year end build in anticipation of the seasonal first quarter lift.

So we’re projecting some improvement but some of the key initiatives in the supply chain are continued efforts around food and packaging but also all the efforts around fulfillment that I mentioned earlier on. And as I said we have an RFP process going on for our fulfillment services right now.

Gregory Badishkanian - Citigroup

Also just on new kitchen, maybe a little bit on how you think that’s doing and potential to kind of roll that out outside of New York City.

Joe Redling

We’re still happy with new kitchen clearly they’re experiencing some of the same resistance. They have a very loyal customer base. Bringing in new customers has been somewhat challenging for them but we are seeing some real efficiency because of the localized nature of that business using local web components.

We are waiting to get a little bit more volume before we expand but we do have a very easy way to expand geographies outside the New York region into the boroughs, into the Tri State area and we are reviewing that. We just want to get a little bit more baseline business coming in in the second quarter to determine the best time to do that.

Gregory Badishkanian - Citigroup

As you kind of look at your revenue growth drivers over the next one or two years what do you think, if you were to rank them one, two, three, what do you think are going to be the strongest growth drivers for you over the next one to two years assuming the economy continues to stabilize and maybe even gets better.

Joe Redling

I think firstly is our core business, right, that we would expect a rebound in the core business which is serving the what I would call the general market component. The second piece would be this product extension. We believe that the products that we’ve invested in both Flex Select as well as diabetic will add incremental business to us in the future. If you think about the diabetic category as about the same size of the men diet category, we think there’s opportunity there for incremental growth and its in a really specific segment.

Thirdly we think channel expansion, so as we look at the experience we’ve had with Costco and other opportunities to partner with a very well known brand, our marketing spend really benefits us entering new channel as we pick up new and incremental customers and that’s not just in the medical channel as we look at things like diabetic we believe there’s opportunities for us to accelerate additional channels both on the medical side as well as, as we started this year, to accelerate into the B to B side as we provide more programs for employers.

So really the way we think about this is continued focus on increasing the core business and driving a lot more profitability on increased revenue. Its continuing to look at new segments as we’ve done this year to bring incremental customers and gain share in the weight loss side and then expand our presence into additional channels.

Operator

Your next question comes from the line of James Duffy – Thomas Weisel Partners

James Duffy – Thomas Weisel Partners

Question related to your projections for reactivation revenue and your confidence that you can show improvement for the year, can you help us a little bit with what are the drivers that you see in place that give you the confidence to make that projection.

Joe Redling

What we said was that we believe reactivation revenue will be stable. We were encouraged that we sort of demonstrated the same sequential growth in Q4 to Q1 that we did last year. Clearly last year our total revenue was higher and our new customer performance was better. So to see reactivations performing in a similar fashion as we did in a much better economic period, is very encouraging.

The other thing we’re seeing is that our marketing efforts continue to evolve and drive better response. The smarter we get about using the web, the very efficient channel to drive reactivation is as David mentioned in his comments, we’re actually seeing some movement from those older cohort groups that I think even we felt would have been the most difficult cohort group to move because of [inaudible]. But we’re seeing some good news there.

And thirdly the new products and the new advertising that we launched this year had almost more of an impact on reactivation it seems because of their value perception of our product. They’ve been on our product before, they know it works, and Select, Flex, and our new positioning with high quality foods seemed to really generate a lot of interest in that segment with reactivation and will continue to do that.

So we are correlating media in what we’re doing in our general market with its impact on reactivation so first quarter being a pretty difficult economic environment, while as David said we don’t think they’re immune to the economy, but if we can hold the stability of that reactivation revenue in this climate in the first quarter we feel pretty good about what we expect for the rest of the year.

James Duffy – Thomas Weisel Partners

Given the amount of media that’s been spent behind the brand over the past five or six years do you feel as though you’ve picked all the low hanging fruit and do you have any studies that give you evidence that the brand awareness still remains low enough or program awareness still remains low enough that within the audience of potential dieters, there’s still attractive opportunity out there.

Joe Redling

Yes, surprisingly enough that despite the spend because of the way we buy, if you think about us versus the category, our buys are all direct buys for transactional purposes so where a buyer remnant, everything we do is based on response. That is not the most efficient way to drive unaided awareness with a specific category. Our internal tracking shows we have significant growth opportunities in unaided awareness as we track it now, we are well below our other two main competitors in the category, almost half when you ask about unaided awareness which is really the most important thing to track.

So we do believe that’s why we’re so focused in this channel expansion by us having presence in Costco, it helps our media go that much further and actually introduces us to people that aren’t top of mind aware of the brand. So we do think we have opportunities and we’re looking at how to address that going forward. So we are, in our view, we’re no where near saturation in terms of the diet sector.

James Duffy – Thomas Weisel Partners

Anything you’re particularly excited about from a celebrity endorser standpoint on the horizon, which may not have been disclosed yet.

Joe Redling

We continue to look at that as you all know, we constantly get calls from actual celebrities who are on our program losing weight, the latest announcement was Lawrence Taylor, who was on Dancing With The Stars, who was on our program before. We evaluate that on an ongoing basis. We continue to value our relationship with Marie Osmond, Julian Barbarian of course in men’s, Dan Marino and Chris Berman who continue to really perform well for us, but we do look at that on an ongoing basis and look at it opportunistically but we also need, believe its very important to balance the celebrity positioning of our brand with real people because where we differ then on many of our competitors is the celebrities that are on our program actually have lost weight and have seeked our program out on their own and have contacted us pretty much after the fact in most cases.

But we think its really important to balance our real people stories and real people results because all the people in our ad that we put in our advertising are actual true customers of NutriSystem so while we’ll always be opportunistic for celebrity opportunities, we’ll always balance that with real people stories.

Operator

Your next question comes from the line of William Sutherland – Boenning & Scattergood

William Sutherland – Boenning & Scattergood

Did you mentioned how the Costco channel did for you in the quarter, is there any—

Joe Redling

We don’t break it out as a channel only because its relatively new and it was our first quarter. What we have shared is that we’re very happy with the incrementality of that channel. One of the things you always think about as you move into retail in any direct model is cannibalization. The good news about our program with Costco is there is no inventory involved. Its prepaid ticket program or a prepaid card program where the card is purchased at Costco, the Costco member then comes to our website, fills in their personal information and we then ship the product directly to the consumer.

So we actually share the customer relationship with Costco. What we’re very encouraged about is the majority of those customers, well over 90% of those customers, had no historical relationship with NutriSystem before that purchase. So that says to us that we are reaching a new segment through that store channel and its one of the areas where we’re looking to explore as we look ahead to expanding channels in the future.

William Sutherland – Boenning & Scattergood

The other initiative that I don’t think you mentioned is Canada, is that pulling up alright?

Joe Redling

Yes, we have some of the same challenges there. Our focus there is aligned with what we’re doing in the US. We’re really taking a hard look at productivity, efficiency, and cost. We’re encouraged about what we can do on the marketing side there but that marketing is going to be tempered with profitability. We feel we have established a good bulkhead there and I think we’ve just got to wait for the right opportunity to step on the gas which is very similar to what we’re experiencing in the US.

William Sutherland – Boenning & Scattergood

I wasn’t sure I followed exactly the point you’re mainly making on Select in terms of the value proposition not being obvious as you got customer feedback, can you just maybe go through that one more time as to what happened.

Joe Redling

So when you think about value proposition it comes down to two things; price and value. So we, our price point is $100 premium, so $399 price point. We were concerned going into this climate with that but we felt very strongly that we had to establish a premium price point. We needed to establish that price point to drive our gross margin and the interesting response from the consumer was that the $399 price point while high, was not something that they would not consider but they felt that the amount of fresh frozen items in that program were not enough to support the price point.

So what we had was a three week of Ready to Go with one week on frozen and through this feedback from our customers it seemed appropriate that as you moved to a 50/50 split, what we call the 2 plus 2, we had a much higher level of acceptance of a $399 price point. So in our conversations and work with our partner, we were able to manage our cost side on the COGS side, to be able to come up out of the $399 price point with a 2 plus 2.

So we feel, we’re excited about launching that in the next 30 days to see how our customers respond and we’ll continue to monitor that. But we believe a $399 price point for two weeks of frozen and two weeks of Ready to Go is a very good value proposition. It really is a significant price advantage over our competitors that are offering frozen foods.

William Sutherland – Boenning & Scattergood

So you’ll be, the 2 plus 2 becomes a Select line for you, right?

Joe Redling

Correct.

William Sutherland – Boenning & Scattergood

Okay and then the Select 7, is that something you do kind of separately from the shelf stable if you were to buy, are they matching that with the core $300 offer.

Joe Redling

Yes, so its an up sell. So again, the immediate feedback from our customers on the message boards was, hey how do I try this frozen food, it sounds great. And there’s a lot of viral sharing of, we hear this food is really terrific, but I’m on core. And so we very quickly worked with our partner and came up with Select 7 so people can supplement on an ongoing basis, with one week of frozen, it’s a very simple process, our price point is $129, its good margin for us.

We’re hoping it gets a great introductory program for people to try our frozen and then if they see one week is $129, and its only $100 premium on the new 2 plus 2 to move from core to Select, we think that’s going to provide incentive as well. So Select 7 is really an attempt of us to drive trial, while still keeping it a profitable exercise.

William Sutherland – Boenning & Scattergood

You mentioned on the share buyback that you did, I think I heard 1.9 million shares in January.

David Clark

It was $1.9 million, fairly small.

William Sutherland – Boenning & Scattergood

Dollars, that makes more sense, and that you’re, what did you say about continuing?

David Clark

We do have Board authorization to renew through 2011 but I just think our tendency is going to be to prioritize cash availability for the balance of this year.

William Sutherland – Boenning & Scattergood

So you’re not even going to reauthorize it at this point?

David Clark

It is authorized. Reauthorized through 2011.

Operator

Your next question comes from the line of Karen Howland – Barclays Capital

Karen Howland – Barclays Capital

I was wondering if you could go into a little bit more detail on the cost cutting initiatives you had as far as reducing your overall expense by 15%, I might have just missed part of it, I know you said 100 to 150 basis points coming from gross margin from reducing fulfillment rates, I was wondering if that was in addition to the gross margin improvement we saw this quarter or if that is already somewhat included.

David Clark

No, that would basically be, our target is to improve year over year gross margin by 100 to 150 basis points. And the 15% is all cash operating expenses so that, obviously we manage our marketing spend versus our demand so you can see that our marketing spend for the first quarter as an example was down 25%, actually a little more then 25% versus last year.

And then the G&A I think earlier on the fourth quarter call we had mentioned looking at targeting $3 to $5 million in reduction in G&A, we are actually going to look at more then that, more like a $5 to $8 million number as we look deeply into some of our computer spend.

Karen Howland – Barclays Capital

On the G&A I was surprised to see that it was actually up year over year this quarter, are some of these other initiatives just taking longer, we should expect in the second half of the year.

David Clark

Yes, I think as we said the G&A reductions in particular were probably going to occur in the third and fourth quarter, the first quarter we were really just kind of sizing the opportunity and so its really going to be a second, third, and fourth quarter execution.

Karen Howland – Barclays Capital

So we think about the way the second quarter will play out, marketing expense perhaps a little bit higher as a percentage of sales as you advertise the D program, but G&A should be lower as a percentage of sales as some of these initiatives flow through.

David Clark

No the marketing spend should not be higher then it was in the first quarter similar to the last year, your marketing percentage as a result of overall revenue should come down but we were just expressing some caution because there may not be right at the mid 25% level, 24% 25% level because there might be some pressure from the initial launch of D that just started.

Joe Redling

I think the point I was trying to make was more of an EBITDA point that because we’re launching D end of May that the customers we bring in will not be throwing off any profitability. So because typically you need 30 to 60 days to kind of drive that profitability at the marketing costs so the launch, think about the launch expense being front loaded so when you launch a product, we got to see the product, we got to spend the marketing money.

We’re still going to do it within the efficiency on the revenue controls, but it’s the EBITDA flow through that would be impacted at the end of that second quarter.

Karen Howland – Barclays Capital

The Select program, are customers able to customize that at this point.

Joe Redling

No, it’s the most efficient way for us to do that is in a kit. We are working on multiple kits with our partner but right now think of it as our favorites kit. We do have customization in our core product. A lot of our new customers choose the favorites kit and so we have a favorite kit of frozen and we’ll be looking at having multiple kits in the future.

But this kit has a tremendous amount of variety in it. It includes all meal occasions, desserts, breakfast, lunches, and dinners.

Operator

Your final question comes from the line of Mitchell Pinheiro – Janney Montgomery

Mitchell Pinheiro – Janney Montgomery

I just want to ask, first of all did you break out yet what QVC contributed this quarter.

David Clark

Contributed from a—

Mitchell Pinheiro – Janney Montgomery

On the revenue line, I’m sorry.

David Clark

It was 6% of revenues.

Mitchell Pinheiro – Janney Montgomery

Also looking at length of stay, what are you seeing right now from not only new customers but also in your reactivation pool, maybe in your reactivation pool relative to new customers, how long are they staying, are they staying longer then new customers, or longer then they did before.

Joe Redling

We’re seeing pretty consistent trends so on new customers we’re seeing increased length of stay. So that’s the good news. Our reactivation customers typically have a shorter length of stay because they know our programs so well, they’re really just sort of coming back to knock off a couple of pounds. The initial weight loss cycle is always longer.

So we are seeing better revenue for customer overall and we are seeing improvements in length of stay driven by second month [take] rates and a lot of the initiatives we have that are related to a number of things, not just the different product but how we deliver product, how fast we get product, what we’ve mentioned before in terms of our perfect order index, getting people exactly what they ordered 90% plus of the time is a very big indicator of satisfaction and length of stay.

So the good news is we are seeing people stay longer which is making our marketing that much more profitable.

Mitchell Pinheiro – Janney Montgomery

UK and Japan, I think last we heard was maybe end of 2009, where are you on that as far as going forward.

Joe Redling

On new geographies we have signed a licensing agreement with a partner in Japan. We have not disclosed that partner to date really out of courtesy of that partner. It is a public company and they are going through their own process of timing, launch timing.

They’ve been working with us for over a year now. So it’s a licensing arrangement with the NutriSystem brand that this company will operate in Japan. UK we’ve done a lot of work on, we’ve spent a lot of time on that over the last year or so. Its not necessarily the right timing for us to go into the UK. Obviously they are challenged with similar recessionary issues as we are. We as I mentioned in one of the last calls that we want to make sure when we launch into a new geography where our brand had no presence previously, that we go in at the right and most appropriate time to give us the best chance to get off on the right foot.

We do think we can move into the UK relatively quickly. Its not a very expensive capital investment. Its really a $5 to $8 million investment for us to do that. We think we could be up and running within nine to 12 months. So we have those plans on the back burner and we’ll be evaluating those based on how the global economy responds.

Operator

There are no additional questions at this time; I would like to turn it back over to management for any additional or closing comments.

Cindy Warner

We’d like to thank everyone for their time and we hope that you’ll join us in July for our next conference call when we discuss our second quarter 2009 results.

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