Weight Watchers International, Inc. F2Q09 (Qtr End 07/04/09) Earnings Call Transcript

| About: Weight Watchers (WTW)

Weight Watchers International, Inc. (NYSE:WTW)

F2Q09 Earnings Call

August 6, 2009 5:00 pm ET


Sarika Sahni – Investor Relations

David P. Kirchhoff – President and Chief Executive Officer

Ann M. Sardini - Chief Financial Officer


Robert Craig - Stifel Nicolaus

Michael Binetti – UBS

Christopher Ferrara – BAS-ML

Analyst for Gregory Badishkanian – Citi


Thank you to everyone for joining us today for Weight Watchers International’s second quarter 2009 conference call. With us on the call are David Kirchhoff, President and Chief Executive Officer and Ann Sardini, Chief Financial Officer. At about 4:00 pm Eastern time today the company issued a press release reporting its financial results for the second quarter 2009.

The purpose of this call is to provide investors with some further details regarding the company’s financial results as well as to provide a general update on the company’s progress. The press release is available at www.WeightWatchersInternational.com. Before we begin let me remind everyone that this call will contain forward-looking statements. Investors should be aware that any forward-looking statements are subject to various risks and uncertainties that could cause actual results to differ materially from those discussed here today. These risk factors are explained in detail in the company’s filings with the Securities and Exchange Commission. The company does not undertake any obligation to publicly update or revise any forward-looking statements whether as a result of new information, future events or otherwise.

I would now like to turn the call over to Mr. Kirchhoff.

David P. Kirchhoff

Thank you for joining us as we review Weight Watchers International's performance for the second quarter of fiscal year 2009.

Consistent with the trends we saw in Q1 of this year, the recession continued to have an impact on our business throughout Q2. While there were indications of improvement in the economy in certain sectors, the recession continued to put considerable pressure on consumers and their ability to make discretionary purchases. The impact of the global recession was greatest on our U.S. business while results in some other countries were relatively better, particularly in the U.K.

As was the case in Q1, the impact of the economy on our business was primarily in enrollments and related to that, attendances, which in turn affected product sales. On the positive side, we saw increased penetration for Monthly Pass and retention for that plan remained at levels consistent with Q1 trends despite pressure from overall credit card default rates rising.

While our licensing and online businesses are continuing to grow, they were somewhat less robust than the results we saw in Q1.

Prior to reviewing the Q2 volume and financial results, I would like to remind our listeners of the various calendar and timing issues that affect the comparability of our second quarter results versus prior year.

First, Easter fell into the second quarter this year versus the first quarter last year, which resulted in a later start to the spring marketing campaigns, creating unfavorable effect on volumes, and timing of marketing programs.

In addition, another unfavorable timing impact came from Independence Day in the U.S., which fell into the second quarter this year as opposed to the third quarter last year.

I will also take this opportunity to remind listeners that we took an adjustment in revenues and income in Q2 of 2008 reflecting the adverse impact of the U.K. VAT ruling.

In Q2 of last year, we recognized revenue and income adjustments for the prior years of 2005 through 2007 as well as for Q1 2008. This had the effect of lowering Q2 2008 reported revenues and operating income by $30.0 million, net income by $20.5 million, and EPS by $0.26.

In referencing our operating results for the benefit of comparability, we will be comparing 2009 with 2008 after adjusting for the VAT ruling.

For Q2 2009, total company revenues declined by 13% versus the prior-year period. Unfavorable foreign currency accounted for $27.0 million, roughly half of the decline of revenues. The remainder of the revenue decline was primarily the result of softness in our NACO business.

On an as-reported basis, meeting fees were down 15%, in-meeting product sales were down 15%, other revenues were down 13%, and Internet revenues were up 2%.

On a constant-currency basis meeting fees were down 9%, in-meeting product sales were down 6%, other revenues were down 7%, and Internet revenues were up 6%.

From a volume perspective, global paid weeks in our meetings were down 6% versus the prior-period quarter where global attendances were down 12%.

Adjusting for Easter and Fourth of July timing, global paid weeks were down 4% while global attendances were down 9%. These trends were very consistent with Q1 timing invested paid week and attendance declines of 5% and 10% respectively. Global paid weeks for Weight Watchers Online were up 8% for Q2 of 2009 versus the prior-year period. Total billable paid weeks for our combined meetings and online businesses were down 2% on an as-reported basis and down 1% on a timing-adjusted basis.

Operating income declined 14% after factoring out the 2008 VAT impact and an additional $2.0 million of restructuring charges we booked during the second quarter this year. Gross margins were effectively flat at 55.7% versus the comparable period in 2008.

Marketing expenses were 14.3% of revenues, up from 13.8% in the prior year, due to the shift of the spring marketing campaigns as a result of the later Q2 Easter timing this year.

G&A in Q2 was down 11% on a constant-currency basis versus the prior-year period and represented 11% of revenues versus 11.4% in the prior-year quarter.

On an as-reported basis, Q2 2009 EPS was $0.76 per share, including $0.02 in charges for Q2 restructuring initiatives. Excluding this, Q2 EPS was $0.78 per share on a fully-diluted basis, including a $0.01 loss related toward China JV.

On an as-reported basis, Q2 2008 EPS was $0.59 per share. After adjusting for the VAT ruling in Q2 2008 EPS was $0.85 per share, therefore, on a comparable basis Q2 2009 EPS was down $0.07, or 8%, versus the same period in 2009. Foreign exchange accounted for $0.06 of the $0.07 EPS decline.

I will now briefly review our results in our major geographies and business units. First, our North American meetings business. For Q2 2009 total NACO revenues were $196.0 million, a decrease of 13% versus the same period last year. NACO meeting fees declined 14% while in-meeting product sales declined 11% versus the comparable 2008 period.

Q2 paid weeks were down 11% on an as-reported basis and down 9.5% after adjusting for the timing of Easter and Independence Day on our fiscal calendar.

As-reported attendances were down 14.3% in Q2 2009 versus Q2 2008. Without the benefit of prior-period acquisitions and the impact of the timing of Easter and independence day, attendances were down 12.6% versus the prior year. This compares to the 11% timing adjusted decline that we saw in Q1 2009.

The consumer environment in Q2 was similar to the challenging conditions we saw in Q1 of 2009. Unemployment continued to rise, the housing market continued to all, and consumers were under increasing pressure from rising credit card debt. As was the case in Q1, the impact of the economy on our business was primarily on our ability to recruit new members into Weight Watchers.

Retention slightly improved as we progressed through the quarter despite the pressures of the weak economy. In June and July our Monthly Pass retention rates moved into slightly positive territory versus the comparable months last year.

We are benefitting from a series of steps we took to improve our ability to reduce involuntary cancellations and improve service while continuing to make it easy and user-friendly for members to cancel their memberships, if they so choose.

With consumers in most of our markets tightening their wallets due to the current economic environment, we have begun to explore new approaches beyond the preregistration promotion we have historically offered during major campaign seasons. Our objective is to develop a portfolio of new promotional approaches which can accentuate our value proposition in a way that helps spur the decision to lose weight. We will be pursuing those promotions for which we believe the lift provided will more than pay for the discount over the course of a 12-month period.

In fact, a number of our international markets implemented new promotional approaches during the recent spring campaign which have had a positive effect on their businesses.

In NACO we have been actively testing several new promotional approaches over the past several months and will be launching a new promotion tied to our Monthly Pass as part of our fall marketing campaign.

While we expect the upfront discount associated with this campaign to dilute our third quarter EPS by $0.01 and fourth quarter EPS by $0.03 to $0.04, the volume lift in increased Monthly Pass penetration, which we believe this campaign will drive, will at least pay back this investment in 2010.

NACO and meeting product sales were down 11% in Q2 2009 versus the same period in 2008, with product sales per attendance increasing 4%. This reversed the 9% decline in product sales for attendance we saw in Q1 2009 and was largely driven by effective promotions, strong electronic sales, and strength in several of our newer products.

For the purposes of planning and forecasting our business, our operating assumption is that the economic environment facing the consumer will not significantly improve in the second half of 2009. To this end, we expect the underlying second half trend to be slightly improved versus the first half trends, with low double-digit negative results in paid weeks and attendances, reflecting some volume benefit from our fall promotion.

Should our promotional efforts for the fall campaign prove particularly effective, there may be some upside in this volume forecast.

Keep in mind that the comparison in as-reported volumes between Q4 2009 and Q4 2008 will be negatively affected by the fact that last year's fourth quarter contained an additional week.

Now on to the international business units. For the second quarter, excluding the prior period and UK VAT, U.K. revenues were down 16% on an as-reported basis but were up 6% on a constant-currency basis. Paid weeks were up 7% on an as-reported basis while attendances were down 4%. However, after adjusting for Easter timing, paid weeks were up 9% and attendances were down only 1%. This reflects a significant improvement from the negative 8% attendance trend that we saw in Q1 2009.

Like the U.S., the economic environment in the U.K. continued to be challenging, particularly for the consumer. However, unlike the U.S., and most of our other markets, the U.K. does have look-alike competition, which provides us with the opportunity to grow volume in a weak market by taking share.

As we noted on our last call, we took a more aggressive approach to our promotion in value-oriented messaging in the U.K. toward the end of Q1 and throughout Q2. This allowed us to significantly improve our enrollment trends during key campaign weeks. Perhaps most importantly, having new promotional offers created a way to extend our advertising campaigns through continuity placements, creating further lift to enrollments.

The U.K. also benefited by continuing increases in Monthly Pass penetration throughout the second quarter, which will benefit it's paid-weeks trend throughout this year.

Licensing and in meeting product sales were also strong in the second quarter, further benefiting the U.K. results.

For the second half of 2009, after adjusting for the extra week in last year's fourth quarter, we expect the U.K. to deliver single-digit paid week growth and low single-digit attendance declines.

Continental Europe did not fare as strongly as the U.K. due to variable results among different countries. Overall, CE revenues were down 21% on an as-reported basis and were down 9% on a constant-currency basis. Paid weeks were up 2% in Q2 2009, while attendances were down 16% on an as-reported basis.

After adjusting for holiday timing, CE paid weeks for Q2 were up 4% while attendances were down 12%. The attendance drain in Q2, on a timing-adjusted basis, was a slight improvement to the trend we saw in Q1 2009.

Most of our markets in CE were affected by the difficult economic conditions. Our approach across continental Europe has been to develop sharper marketing messages combined with stronger promotional calls to action. In a number of countries, including Germany, our largest market, we have taken the opportunity to focus our efforts on supporting our stronger meetings and our stronger leaders, which we believe will ultimately improve the foundational strength of our business.

This in turn will create a better platform from which we can grow as the economy rebounds. To this end, we have seen stabilization in our meeting averages in key countries, including Germany, which is important to their long-term vitality.

In the meantime, the CE management teams continue to prepare for the launch of an important new program innovation. We expect to soft launch this new program in late fall with a full marketing supported launch this January.

For the second half of 2009, we are anticipating some softening of paid week trends in CE as the Monthly Pass space matures and we are forecasting second half attendance trends that are comparable to the underlying trends we saw in the first half. After factoring out the additional week in Q4 2008, we expect second half paid weeks in the low single digit negative and attendances in the low double digit negatives.

Moving on to WeightWatchers.com. We saw some slowing of growth of WeightWatchers.com in Q2 with Internet revenues up 2% on an as-reported basis and up 6% on a constant-currency basis. Paid weeks were up a solid 8% and end-of-period active subscribers were also up 8%.

As was the case in Q1 2009, growth in the international part of our WeightWatchers.com business was particularly strong due to effective valuing of messaging, campaign integration, and increased product awareness.

The U.S. Weight Watchers Online business faced the difficult series of comparables in June and early July, a period in which our advertising media weights were particularly high last year. We have seen improved trends as we've entered into the second half of July and we've also seen relative improvements in retention.

As is the case with our NACO meetings business, we will also be rolling out a new promotional offer for Weight Watchers Online in the U.S. this fall which could provide further support to our recently improving volume trends.

For the second half of 2009, we are forecasting single-digit growth in paid weeks for Weight Watchers Online.

On the dot.com product development front, the Weight Watchers.com launched new social networking functionalities this June with which our users can create their own blogs, form their own challenges, and micro communities.

Our subscribers and users have indicated to us that they wanted facebook-like functionality and personalization, while continuing to be able to participate anonymously in our community.

Early receptivity has been strong and we are looking forward to several functional upgrades to these new features throughout the remainder of 2009.

We are in the final stages of development of a new iPhone application which we will be submitting to Apple for final approval later this month.

Our Weight Watchers Online and Monthly Pass subscribers will have free access to a full, robust suite of offerings that will effectively allow them to manage nearly all aspects of their points plan via their iPhone. This represents an important new dimension of providing convenience and information on demand to further their weight-loss success and to further modernize the Weight Watchers' brand.

Now I would like to turn the discussion over to Ann, who will elaborate further on our Q2 performance.

Ann M. Sardini

First, recapping our revenue performance, on an as-reported basis second quarter consolidated company revenues were $372.5 million, a decrease of $27.5 million, or 6.9%, versus $400.0 million last year. There are two significant items affecting the year-to-year revenue comparison: foreign currency exchange in 2009 and the 2008 unfavorable U.K. VAT ruling.

Foreign currency conversion reduced our second quarter 2009 revenues by $27.5 million, or 6.9%. In 2008, second quarter revenues were reduced by $30.3 million as a consequence of negative U.K. VAT ruling, which required us to record a revenue reduction related to prior periods in that quarter.

When we exclude the impact of foreign currency in the second quarter of 2009, and adjust 2008 Q2 for U.K. VAT, second quarter 2009 revenues were down 7% from $430.3 million last year. The revenue decline is volume-related as global paid weeks are 1.7% below prior and global attendance lagged by 12.3%.

Reported net income in the second quarter 2009 was $58.8 million, up 26% versus prior. However, after adjusting 2008 by $20.5 million net of tax from the U.K. VAT ruling, and eliminating from 2009 $1.2 million of restructuring charges net of tax, net income is $7.2 million, or 10.7% behind prior.

Making these adjustments to EPS, Q2 2009 EPS was $0.78 compared to $0.85 in the year-ago quarter. $0.06 of the $0.07 shortfall was related to foreign currency fluctuations. On a GAAP basis, our second quarter 2009 EPS was $0.76 versus $0.59 last year.

In my operations overview that follows, I will present the information on a currency-neutral basis, except as noted, and will report excluding restructuring charges and the impact to 2008 of the VAT ruling related to prior-periods revenue.

On this basis, our operating income is $120.3 million, 8.5% or $11.2 million behind prior year. Our operating income margin is 30.1%, 50 basis points below the 2008 second quarter level.

Margin compression resulted from an increase in the China joint venture investment as well as pressure on gross margin in the meeting business as a result of lower volumes.

G&A, however, is down as a percentage of revenue.

Now recapping some of the operational trends that David discussed. Globally in the meeting business second quarter paid weeks declined 5.8% versus prior. While domestic paid weeks decreased 10.9%, international paid weeks were up 4.7%, reflecting increasing Monthly Pass penetration in our international market.

The later Easter this year, which was in the second quarter versus in the first quarter last year, had a negative impact on attendance volumes. Attendance has declined 12.3% on a global basis in the quarter. Adjusting for the estimated impact of timing shifts, global attendance was 9% below prior year in the quarter.

Global meeting revenues, that's the combination of meeting fees and in-meeting product sales, were $308.6 million in the second quarter, posting a volume-driven decline versus the prior-year quarter of 8.5% in constant dollars.

Globally, meeting fees for attendees increased by 3.4% in constant dollars. Internationally, meeting fees for attendees were up 8.4% as a result of strong growth in the Monthly Pass install base across all of its international markets. In the U.S., where Monthly Pass is more mature, meeting fees per attendees rose just under 1%.

After a difficult first quarter, global product sales per attendee returned to a positive trajectory of 7% on a local-currency basis, despite the soft economies across our markets. North American in-meeting product sales per attendee, having come off a first quarter of negative growth, increased by 5.1% in the second quarter versus prior year on the strength of new product introductions and promotions.

Product sales per attendee in our international business posted continued strong performance of 7.1% in constant currency in the quarter compared to prior year.

In the WeightWatchers.com business second quarter revenues increased 5.4% over prior year in constant dollars to $52.3 million with paid weeks and online subscriber growth of 7.9% on the strength of the international market. End of period active online subscribers also increased 7.9% versus Q2 2008, to $843,000.

Now turning to a review of the performance of our other revenues, which include licensing, franchise commissions, and revenues from our publication.

Other revenues were $24.1 million, down 6.6% from the prior year in constant dollars, driven in large part by lower franchise commissions. Franchise commissions, which totaled $3.3 million in the quarter, were down 18.7%, 15.6% adjusted for acquisitions which took place during 2008, reflecting the impact of the weakened U.S. economy.

Our licensing revenues were up 2.6% in constant currency, even with the recession, to $16.1 million.

Our consolidated gross margin in the second quarter was 55.7%. This compares to 55.9% in last year's second quarter, after adjusting for the impact of the U.K. VAT ruling.

The 20 basis points of concession this year results from the combination of lower attendance per meeting and in-meeting product promotions, mainly in the U.S., which also put pressure on gross margin.

Partially offsetting these was the positive impact of Monthly Pass on meeting revenue per attendee, gross margin accretion in WeightWatchers.com, and the benefits from our operational cost savings initiatives.

Second quarter market expense of $53.2 million decreased by 4.8%, or $2.9 million, from the prior-year level in constant currency.

The timing of Easter coincides with the start of our spring advertising campaign launches worldwide. This year with Easter two weeks later and in the second quarter, the impact was a shifting of approximately $5.5 million of advertising spend into the second quarter, which was in first quarter last year. This dollar increase to the quarter was more than offset by a combination of advertising rate efficiencies and lower spending in some of our European countries.

Marketing as a percentage of revenues was 14.3% this year as compared to 13.8% last year.

Now moving to G&A. In the second quarter of this year we incurred $2.0 million of additional expense associated with the restructuring which began last quarter. Year-to-date these expenses were $5.1 million. Excluding restructuring charges, Q2 G&A expenses were $41.0 million, a 16.8% decrease in current dollars. In constant currency, G&A expenses decreased by 11%, or approximately $5.4 million, from the prior-year level. As a percentage of adjusted revenue, G&A, excluding restructuring cost, was 40 basis points lower than last year, at 11%.

We gained operating leverage as a result of benefits from our lease structuring and other cost-savings efforts, which has taken hold in the second quarter and will continue to be felt throughout the year. This prior-year G&A expense has posted increases in the area of depreciation associated with our IT initiatives and investment in our China joint venture.

As noted on previous calls, 100% of our China joint venture is consolidated into our operating income and our partner, Groupe DANONE's, 49% share of the operating loss is reflected as non-controlling interest in the line item before net income.

The total operating loss of the venture in the second quarter was $2.7 million, mainly a combination of G&A and marketing, as compared to $1.4 million in the second quarter last year.

In summary, our consolidated operating income margin, excluding the Q2 2009 restructuring charges, was 30.1% in the quarter as compared to 30.6% last year adjusted for U.K. VAT comparability.

The 50 basis point reduction in the line margin was the result of lower gross margin and higher marketing as a percentage of revenues.

Interest expense in the second quarter 2009 was $17.0 million, down $4.6 million, or 21.4%, from the Q2 2008 level. As a result of lower market rates, our average effective interest rate declined 101 basis points to 4.18% from 5.19% in the second quarter last year.

Our required debt pay down in 2009 is $162.5 million. In the first half of this year we have already reduced our debt by $117.3 million.

In terms of cash flow, in the quarter we generated $69.4 million from operations before interest payments. After capital expenditures of $6.6 million we had $62.8 million of free cash available to service our capital structure. We made interest payments of $16.6 million, paid our quarterly dividends of $13.5 million, and reduced our debt by $38.6 million.

Our priority use of cash is debt pay down. We entered the second quarter with $1.53 billion of debt versus $1.648 billion at the end of fiscal 2008. Other than the debt pay down of $117.3 million, fluctuations in the Q2 2009 balance sheet as compared to year end 2008 balance sheet, primarily reflect the normal seasonalities of the business.

There are a couple of final notes to add. For those of you who are modeling our business on a quarterly basis, as you look at Q4 keep in mind that this year's Q4 is a normal 13-week quarter versus last year's fourth quarter, which was 14 weeks. Furthermore, last year the fourth quarter began on September 28 and ended on January 3, 2009, while this year's fourth quarter will begin a week later, on October 4, 2009, and end on January 2, 2010.

When comparing 2009 fourth quarter to 2008 reported fourth quarter, keep in mind that the loss of a late September, early October week in the fourth quarter, everything else being equal, has the impact of reducing our paid weeks in attendance by 7% to 8%.

And finally, on another subject, I am happy to report that in June we took the opportunity to proactively amend our credit facility to provide the company with greater flexibility in the future to selectively extend term maturity on portions of our debt.

Now I will turn it back to David.

David P. Kirchhoff

As we outlined during our investment presentation in March, we are pursuing a range of initiatives to improve significantly our retention relevance. These initiatives include: increasing convenience in visibility through improved retail locations, as well as by keeping our centers open during selective non-meeting time slots; upgrading the functionality, look and feel of our centers; improving our programs and sharpening our meeting topics; continuing our drive to improve the quality of our service and of our service providers; and strengthening our presence on the work site.

We have been making steady progress across all of the initiatives throughout 2009. To identify a couple of notable highlights:

We partnered with an analytic firm to comprehensively assess every location for suitability, given our desired target audience and traffic patterns. With this analysis we will accelerate our program to either improve the terms of our lease where we are in appropriate locations, or look to relocate to better locations.

And another example, earlier this year we hired a well-regarded retail design firm to help us undertake our first comprehensive center redesign effort in over a decade. This partner specializes in developing attractive, functional retail designs that are also cost effective through value engineering.

We launched our first four pilot centers in Atlanta and New York this July and feedback from staff and members has been fantastic. While we will learn from these pilots and continue iterating on the new design throughout the course of 2009, ultimately we are working to create a new template that represents a step function improvement in member experience and branding while being capex neutral to what we otherwise would have paid during a location move or a scheduled retrofit.

We believe that the combined efforts of all of these improvements will reflect a fundamental transformation of our core meetings proposition. They represent the largest comprehensive effort to improve and modernize our service since the acquisition of the company from Heinz in 1999. This will be an effort that will transpire over a two- to three-year period and we believe its impact on the long-term growth of the meetings business will be real and significant.

While we invest in the future, we will continue to closely manage our business reflecting the near-term challenges of the recession. To this end, we have completed most of our restructuring efforts and we will benefit from them in lower cost and operating expenses throughout the remainder of 2009 and then gaining full-year effect of them in 2010.

With respect to 2009 EPS guidance, we are slightly narrowing the range to $2.52 to $2.70 per fully diluted share before restructuring charges.

While today we face the difficult environment of a tough recession and all the impact it is having on consumers, on a broader context we find ourselves in an interesting time in the evolution of Weight Watchers, particularly in light of the national debate on the long-term cost and efficacy of our healthcare system. It is increasingly clear that the need for Weight Watchers has never been greater.

I recently had the opportunity to participate and present at the CDC's first Annual Weight of the Nation conference in Washington, D.C. It was an honor for us to have the opportunity to be one of the very few for-profit companies invited to present. During that conference several well-regarded economists presented their research demonstrating that obesity now accounts for approximately $137.0 billion a year in annual healthcare costs, or 10% of the total U.S. healthcare budget.

The same research demonstrated how an obese individual has healthcare costs that are approximately 40% higher than their healthy-weight counterparts. This increased expanse has shown to have significant impact across payer groups, including private insurance, Medicaid, and Medicare.

During the same conference, policy experts, public health officials, academics, and healthcare provider groups all noted the need for our country to place a greater emphasis on investing in preventive healthcare and taking meaningful steps to help people adopt healthier habits.

There was wide recognition that failing to make progress on this would become a burden not just for our generation but for our children and their children.

To help people adopt healthier habits we believe that society will need and require weight management tools in forms of assistance that are scalable, efficacious, and cost-effective. Weight Watchers fits squarely into this definitely.

The efficacy of our program has been clinically demonstrated. Further, our group support model allows us to be both scalable and cost-effective versus other approaches.

Finally, our orientation toward behavior modification and lifestyle management is firmly within the desired range of approaches. It is up to us to deliver our program in the best way possible to ensure we are the best partner in society's war against obesity and ultimately the long-term cost containment of our healthcare system.

At this time we would like to take questions.

Question-and-Answer Session


(Operator Instructions) Your first question comes from Robert Craig - Stifel Nicolaus.

Robert Craig - Stifel Nicolaus

I was wondering if you could review penetration rates by geography with Monthly Pass.

Ann M. Sardini

Looking at NACO it's roughly 60%. In the U.K. we're up to 52%. And in Germany and France, we're close to 70%.

Robert Craig - Stifel Nicolaus

Are you able to quantify at all, or you mentioned earlier that retention was improved, any way to quantify that for us?

David P. Kirchhoff

We have not reported those types of retention metrics on past calls and so that's not something I think that a level of detail on the volumes that we would be getting into, other than to say that I would characterize the retention improvements we've seen, particularly in NACO, as slight improvements in retention, but I think considering the trends that we have been seeing, where I think we've been reporting on the past several calls, that we've been seeing a little bit of softening versus prior-year periods, beginning in Q3 going into Q4, then in Q1. The fact that that then reversed a little bit in the positive territory, we thought was very good news.

Robert Craig - Stifel Nicolaus

Is it possible to provide any color on the nature of some of the promotions that are being considered for the NACO market?

David P. Kirchhoff

For competitive reasons, we're not revealing the exact nature of the promotion. For obvious competitive reasons I should say. What I can say and what you can certainly interpret from my remarks, is obviously it is in the form of a discount. I think the way that you can think about, or approach, the promotions, is consider the fact that an average retention for Monthly Pass is about 8 months. And that the overage retention for Weight Watchers Online is about 9 months.

Also consider the fact that our challenge has been to try to push sort of that marginal, undecided consumer over the edge and to get them to start a weight-loss effort. And so therefore, the approach would be to try to find a way to give them an extra inducement to start as opposed to doing any discounting sort of further down their enrollment cycle.

And so, from that point of view, the nature of this is that it would be the kind of discount program where it would be around the inducement of getting people started as opposed to sort of ongoing. Also, reflecting the fact that our retention has held up very well.

The other thing that I should be pointed out about this new promotional approach, and I mentioned this on the last call, is that historically NACO has always promoted. They've done promotions primarily in the form of giving registration for free. As you know, with Monthly Pass registration is always free and as you know, Monthly Pass now accounts for about 60% of the NACO business in terms of enrollments.

The impact of this has been, with the success of Monthly Pass, is that for 60% of our consumers we have effectively had no promotions whatsoever. And so we view coming up with a new promotion as a way of introducing and sort of replacing effectively through registration. And so in that sense you could think of it almost not as incremental.

I think the other thing that's worth mentioning is that whatever we do in fall, our objective is to not just have one new promotion that works well for us, but really to spend time developing a portfolio of different promotional approaches that we can use in different times per year, which ultimately creates the possibility for us to potentially expand our advertising seasons to reflect that people are always losing weight but that we need promotional inducement to close the sale, if you will, on each piece of marketing communication we put out.

And so we really view whatever we do in the fall campaign as sort of a first step in a start, in terms of the NACO business. But it is a first step in a new journey, if you will, in terms of coming up with a more comprehensive approach for creating a call to action to get people to start their weight-loss efforts.

Robert Craig - Stifel Nicolaus

Is it possible for you to share some of the assumptions behind the third quarter and fourth quarter promotional impact that you delineated earlier?

David P. Kirchhoff

I think what we wanted to provide in talking about the $0.01 in Q3 and the $0.03 to $0.04 in Q4 was a reflection of the fact that if you think about the promotion we're doing, we would be recognizing all that discount, if you will, in revenue in Q3 and Q4 this year, when the promotions would fall.

However, we would get the full benefit of those promotions in 2010 as those enrollment cohorts continue to expend out their retention over 8 to 12 months and beyond.

What we also referenced was what we said was a slight improvement in attendance trends versus perhaps the trend we've been seeing in NACO in the first half.

And so that hopefully gives you some pretty good clues in terms of the relative impact on top and bottom line.

Robert Craig - Stifel Nicolaus

Is it reasonable math to do this—take the $0.035 just isolating the fourth quarter, multiplying it by your share count, about 2.5 million to 3.0 million, and net income gross it up by your normal net margins, it's about $18.0 million in revenue divided by 7.0 million attendees, as an estimate, about $2.50 per attendee?

David P. Kirchhoff

You guys are great modelers. I don't want to go into more detail than that but I think that is a way of thinking through the math. I think that it's a reasonable way of looking at it.


Your next question comes from Michael Binetti – UBS.

Michael Binetti – UBS

Is there anything you could call out to us related to how trends were in July so far, quarter-to-date?

David P. Kirchhoff

This is such a seasonally slow time of year in terms of Weight Watchers, and I'm not being coy when I say this, but I tend not to spend too much time thinking about the trends in July and August. Really, for us, we're going to be watching very closely to see what happens with the business as we go into September, particularly in light of some of the actions that I referenced during the call.

Other than what I referenced, which is I was heartened by the fact that we saw some strengthening and some of the trends with the online business, which is always a good underlying indicator for the brand, and the fact that we have seen a little bit of a pickup in retention and NACO Monthly Pass in June. And the fact that we saw that again in July, we also took as good news.

But I think in terms of trying to sort of read the tea leaves as they reflect a change in consumer sentiment or anything else, I'd be loathe to try to extrapolate off of what is typically such a slow time of year for us.

Michael Binetti – UBS

Can you give us just an idea of what you think caused the slowdown in the Internet business in the quarter and perhaps what gives you confidence, make some data-based testing that you've seen, that gives you confidence in the new promotional efforts that you're going to see in the fall?

David P. Kirchhoff

In terms of the dot-com business, as I referenced on the call, we had an interesting period where we were trying new continuity TV for the first time with Weight Watchers Online in June and July of last year and for a significant period of that, we were at media rates that I would argue are actually pretty high for what we normally would do.

So in an effort to sort of get the economics right and everything else we sort of moderated to what we thought was a more appropriate level of media weight. And as a result of that we had sort of a little bit of predicted drop off in volume trends.

Now, above and beyond that, I looked at the Weight Watchers Online performance, as I sort of think about how it looks in the U.S., which has been in positive territory through the first half and the fact that it is, although it's a lower price point than meetings, it's still a discretionary purchase. The fact that it's been in plus territory, if I think it compared to most consumer discretionary purchases, retail sectors, however you want to look at it, I feel very good about the fact that in the U.S. it's been in plus territory. The fact that it's been in very plus territory in international, I view as great.

In terms of your question about promotional impact, obviously we didn't come out with some specific forecast around what we think the promotion is going to do for us in the second half, other than to say that we have been doing testing, both in the U.S. as well as observing some of our results overseas, and we do believe that the online product, like any product, really, particularly in the world of weight loss, is that sometimes when you give people enough of an inducement, it can really overcome a barrier to get engaged with the weight-loss effort that they might otherwise have put off for a year or so.

And so we view this as reasons to believe that the promotional efforts for online, just as we believe they would be for Monthly Pass, that consumers would be responsive to that. But the big test for that, or sort of our first shot out of the gate, really is going to come this fall. And we'll report back on the results of that as we get to that point.

Michael Binetti – UBS

Are there any metrics you can give us yet around the investment dollars or the lift that you're seeing at the new centers as you're going through and remodeling some of the system at this point?

David P. Kirchhoff

I would say it's way too early. We opened those new pilot centers in the first two weeks in July. We just literally opened up the pilot centers in New York last week. And so it's just entirely too early.

And I think the other thing is that when you come out with a new store format, any retailer would say inevitably there's just 109 different bugs you have to work out and prove usability flow, figure out which design elements are working and contributing and which aren't.

What I take a lot of comfort in is that the anecdotal feedback, so while we don't have quantitative metrics, that the anecdotal feedback has been absolutely fantastic. And I think if you saw the centers you would see why.


Your next question comes from Christopher Ferrara – BAS-ML.

Christopher Ferrara – BAS-ML

On the promotion, is this something that you would put in place on a permanent basis or is this something to temporarily induce people, or does it just depend on the type of results that it generates?

David P. Kirchhoff

For whatever it's worth, the type of promotion we're talking about is not a price cut. Which is what I think would be suggested by a permanent reduction. It is a promotional discount. There are a number of different ways of doing and conveying a promotional discount. But it would be something that would be oriented around a specific period of time so a campaign if you will. And it would be something that was designed to induce trial and participation during a period of time. I don't know if that answers the question or not.

Christopher Ferrara – BAS-ML

So it's got to bring with it some value, right? Maybe it's not, like to put it in packaged-goods terms, it's not going to be a reduction in the price you pay but maybe there will be more chips in the bag. Am I thinking about it wrong?

David P. Kirchhoff

I don't know whether a consumer model is necessarily a good example because in a consumer model if I sell my product and I take $0.20 off, it's basically a full discount on the price and that's it. We're different. If you think about Monthly Pass, there's the $39.95 we charge in the first month, but there's that same $39.95 charge that continues throughout the period of someone's subscription.

And so something that we would do would be focused on trial. As I think I've been sort of alluding to, it would be something that would obviously focus on say for example the first month or second month, something like that, as opposed to a permanent discount on the price throughout the subscription.

And so in that case it's not a permanent price cut, it is simply a promotion. And if you think about it, it's not that different from free registration. Because what free registration does is that during non-campaign periods we charge a registration fee, then people pay for each week as long as they remain a member. A paying member in good standing. And so in the case of free registration we waive the registration fee and they continue participating.

A gym might do the same thing. A gym might give half off the first month. Those are the types of things I think are more endemic with a subscription model or an ongoing service fee model, which is more the way we would be looking at it.

In terms of the value for it, you would have to believe, as we would, and as we're assuming, that the lift in volume associated with that inducement, if you look at the increased volume spread over the expected period of retention for those customers, that the aggregate lift in revenue more than compensates for the revenue loss, if you will, during the initial discount.

Christopher Ferrara – BAS-ML

I thought you said like it's not a price cut but you compare it to a gym membership where you get the first month free but that is a temporary sort of price reduction.

David P. Kirchhoff

Then maybe I don't understand what a promotion is, other than that. We're not a bag of chips in the sense that we can't squeeze more things into our bag that I can think of. Although let me give you an example. From time to time, for example in France, they've done promotions where they have given away starter kits with a new enrollment. That is actually the kind of promotion and that's the kind of thing that we potentially consider within our portfolio of tools, so it can take a variety of different forms.

To your point, a promotion and the way we define the term could be some sort of a value added or give away and sometimes it could be a discount. It's just going to depend on what we think is going to deliver the best lift and what is going to have attractive economics in terms of the expected revenue versus the discount or give away provided.

Christopher Ferrara – BAS-ML

Also, is it something that let's say if I'm already a Monthly Pass member and I see new people coming and getting some kind of a valuable promotion, is there any kind of make good to people who are already loyal customers? How does that work?

David P. Kirchhoff

We have. And for example, we have always had a situation where some people would historically sign up for us and pay the registration fee and then three weeks later there would be free registration. And so they would have paid the registration fee but the person who joined three weeks later didn't and they would say, okay, they weren't on sale then.

So I think from that point of view, it's never proven to be an issue for us in the past. Nor have we ever done make-goods for the people who did pay for registration and we've never had an issue that resulted from that.


Your next question comes from Analyst for Gregory Badishkanian – Citi.

Analyst for Gregory Badishkanian – Citi

Can you provide more color on any changes in the marketing effectiveness as the quarter progressed and maybe for July, are you seeing more favorable media rates as the quarter progressed?

David P. Kirchhoff

As I think we've referenced on past calls, like a lot of major advertisers, particularly in the U.S., we participate in the upfront buy, which is typical of national advertisers. And the calendar period for the upfront buy, particularly for network, is September through September, so we are still in that phase of the advertising world in which the rates we're paying now reflected the conditions of last September.

And what you would probably know from many of the other companies that you follow is that the networks were able to hold their media rates up.

What remains to be seen is what is going to happen to advertising media rates as we go into the new season. It is not on our behalf but literally on major advertisers' behalf, they're literally in the midst of those negotiations now and there aren't any early indications of that.

What we have seen is that outside—so the U.S., most of the people who are prognosticating are suggesting that there's a good opportunity for cost per GRP for TV to be down next year. It's sort of the proof is in the pudding I guess and we'll probably know that going into fall. What we're seeing outside the U.S. has actually been much more in the ways of efficiencies on media buying, so we've been having better luck overseas, where we don't have the peculiarities of how the TV advertising market is set up, as is the case in the U.S.

Analyst for Gregory Badishkanian – Citi

Can you talk about the SG&A, how that's going to play out over the next coming quarters?

Ann M. Sardini

You're going to continue to see the benefits that we've seen in the second quarter, based on the cost efficiencies we've managed to get. So within the next couple of quarters you can expect to see at least the same as a percentage of revenue as prior year, and likely come down a bit.

Analyst for Gregory Badishkanian – Citi

Has there been any impact from swine flu, maybe people aren't going to the meetings?

David P. Kirchhoff

Absolutely none that we can indentify.


Your next question is a follow-up from Michael Binetti – UBS.

Michael Binetti – UBS

Could you tell us about how the growth trends are in the at-work business that you do.

David P. Kirchhoff

I think the at-work business has been, we've seen some similarity in trends between the at-work business and the traditional business in NACO this year. A lot of our efforts to improve the at-work business relate to the efforts that we're talking to restructuring the sales force and enhancing our sales capability. And we've been making good progress along those fronts. I think the other thing that gives us good feelings about the prospects for the at-work business going forward is that what we're increasingly seeing is that more and more employers are starting to clue into this.

Obviously during this time we also have to combat the fact that a lot of companies are cutting back in lots of different places and so sort of the availability of benefit dollars and things like that, like every part of everybody's budget during a recession, are under a certain amount of pressure. But I think that I've been very pleased with the progress the team has been making, particularly recently, to push a new level of energy back into the at-work business.

Michael Binetti – UBS

I heard the question about G&A trends, Ann. I think the last time we talked you said you were expecting marketing to be flat for the year and maybe gross margins to be down 50 to 100 for the year. Are those numbers still intact or have those changed?

Ann M. Sardini

Yes. The only issue that brings the gross margins down maybe a little bit more is the promotions, but we'll see that improvement come back in the first half of 2010.

Michael Binetti – UBS

And marketing?

Ann M. Sardini

As I said, flat.


There are no further questions in the queue.

David P. Kirchhoff

Thank you for joining us today and I look forward to speaking with you at our next earnings release.


This concludes today’s conference call.

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