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Nutrisystem Inc. (NASDAQ:NTRI)

Q4 2013 Earnings Conference Call

February 26, 2014 04:30 PM ET

Executives

Joe Hassett - IR

Dawn Zier - President and CEO

Keira Krausz - CMO

Mike Monahan - CFO

Analysts

Alvin Concepcion - Citi

Frank Camma - Sidoti

Kurt Frederick - Wedbush Securities

Mitch Pinheiro - Imperial Capital

Alec Jaslow - Midtown Partners

Operator

Ladies and gentlemen please stand by we’re about to begin. Good day and welcome to the Nutrisystem Fourth Quarter Fiscal Year 2013 Earnings Conference Call. Today's conference is being recorded.

At this time, I would like to turn the conference over to Mr. Joe Hassett, Investor Relations; please go ahead.

Joe Hassett

Thank you, Shannon and Good afternoon everyone and thank you for joining us to discuss Nutrisystem's fourth quarter and full-year 2013 financial results. Today, we will hear remarks about the quarter and outlook from Dawn Zier, President and Chief Executive Officer; Keira Krausz, Chief Marketing Officer; and Mike Monahan, Chief Financial Officer.

Before we begin, I would like to remind everyone that during this conference call, Nutrisystem management will make certain forward-looking statements about its outlook for 2013 and beyond that that involve risks and uncertainties. Forward-looking statements are generally preceded by words such as believe, plan, intend, expect, anticipate, or similar expressions.

Forward-looking statements are protected by the Safe Harbor contained in the Private Securities Litigation Reform Act of 1995. Factors that could cause actual results to differ from expectations include, but are not limited to, those factors set forth in Nutrisystem's filings with the SEC. Nutrisystem is making these statements as of February 26, 2014 and assumes no obligations to publicly update or revise any of the forward-looking information in this announcement.

In addition to the GAAP results, Nutrisystem will provide certain non-GAAP financial measures in this conference call. Nutrisystem's earnings press release for the fourth quarter and full year 2013 can be found under the News Release link on the Investor Relations page of the company's website at www.nutrisystem.com.

The table attached to the earnings press release includes a reconciliation of the historical non-GAAP financial measures to the most directly comparable GAAP financial measures. We do not present in the earnings press release the comparable GAAP financial measure and the related reconciliation for forward-looking non-GAAP financial measures included in this conference call because management cannot predict with sufficient reliability certain contingencies required to estimate the comparable GAAP financial measures.

With that, I will now turn the call over to Dawn Zier.

Dawn Zier

Thank you, Joe. Good afternoon, everyone, and thank you for joining us today. We released our fourth quarter and full-year 2013 results right after the market closed today. And I hope that everyone has had a chance to review that.

The fourth quarter was our second consecutive quarter of the year-over-year revenue growth, with revenues up 12%. This reflects growth on both our direct and retail channel. Earnings improved even more it adjusted EBITDA up 67%. All-in-all 2013, and particularly the second half of 2013 when the new management team was fully in place was the year of transformation exhibiting solid performance and significant shareholder value, as demonstrated by the more than doubling of our adjusted earnings per share over a 12 month period.

Or financial performance clearly indicates that we are making significant progress with our four point turnaround plan. As you will recall, we outlined our strategy early on in the year stating that we use to focus on (1) products and program innovation; (2) margin improvement; (3) operational excellence, particularly e-commerce and direct marketing fundamentals and (4) clear prioritization of our growth initiatives, including sales channel and market segment diversification; and we executed with rigour.

In the second half of the year, net revenues were up 8% versus prior year as compared to being down 20% during the first half of 2013. And very importantly as we began to articulate clear messaging, and benefits around the brand, we saw a new customer growth in the back half of the year.

We also had success as a new entrant in the retail space. Based on our performance over the second half of 2013 I think we are beginning to demonstrate our long term potential. While I am pleased with the progress that the company has made during year one of its turnaround, I want to emphasise that there is still much to do and that we are still in the early stages.

To be successful in this noisy market, we believe winning is about innovating and connecting with customers in a more personalised way. We had a good start with price and program innovation in 2013 with the development of NutriSystem My Way, Fast 5, EnergiZING and Craving Crusher Shakes, not to mention our highly successful 5-Day Jumpstart Your Weight Loss Kit available in Walmart.

And we have more in the price line for 2014 as we continue to move away from "One size fits all" program, beginning to more fully address all stages of the weight loss journey, capitalize on other diet windows throughout the year, and also weight loss programs that appeal to an expanded set of consumers.

At early Q2, we released a digital product is will not only complement our existing program but also can stand on its own. New products and programs will be developed at an accelerated pace and Keira will elaborate more on our plans in just a few minutes.

Now while we all know growth in the third and fourth quarter is good news, the real time for measurement of a weight management company is Diet Season, which begins a day after New Year. We are very pleased that our new program, Nutrisystem My Way with the Fast 5 Kit is off to a very good start, and is resonating well with consumers.

New customer signups are up year-over-year for the first time in several years, and we were able to achieve it by focusing on strong consumer benefits rather than messaging around discounts. On the strength of the successful Diet Season, and continued growth in retail, we feel confident that Q1, 2014 will be our third consecutive quarter of revenue growth and that is meaningful.

Even more encouraging, we believe we are on a trajectory that will drive our first full year of revenue growth in five years, that’s a strong endorsement of our brand, our programs and our team. While [indiscernible] continuing to strengthen the direct marketing and e-commerce fundamentals of our business may not sound sexy, it is and will continue to be in area of key leverage and growth. Discipline and execution in this business are critical from the product through the creative messaging, through the sale formal process, to customer health and counselling, every component can meaningfully impact the track from the experience, operational excellence matter.

We are fortunate to not only be one of the most recognized and trusted weight loss brands in this space but also one with the sophisticated and cost effective distribution network as well as a strong e-commerce platform in which we will continue to invest. We have been an e-commerce business for many years and are beginning to wrap more engagement and community into our online experience. This is important as we listen to others in our industry talk about clients gravitating away from in-person weight loss meetings and opting for on-demand advice and solutions as well as convenience whether that be in the form of food delivered to your doorstep or around the cost feedback and counselling. Nutrisystem is well positioned to meet the evolving demands of our customer stat.

So to recap, our early success in the new diet season has been the function of a comprehensive plan involving all aspects of our business. This is a model that is sustainable and repeatable. It is based on sound direct-to-consumer fundamental and product innovation. It is based on quantitative and qualitative data and analytic modelling that reduces risk. And while we are pleased with what we were able to accomplish for this diet season, we are encouraged knowing that there is much more we can still do.

Moving onto our retail channel, we successfully launched and tapped into 2,500 Wal-Mart stores for diet season 2014 and both the diet and diabetic kit as well as the shakes and snack pack continues to perform well.

Full year revenues are expected to be up 50% year-over-year which is lower than we originally predicted but still significant to our business. Less than anticipated for traffic in stores and regional analysis indicate that intense winter weather conditions across the much of the country in January and February may have impacted sales. We will continue to work with Walmart to identify additional promotional opportunities during key diet windows throughout the year to drive incremental top-line growth.

Nutrisystem continues to differentiate its product offerings and meet consumer needs with the complete 5-day Jumpstart kit as well as unique single offering of muffins, cinnamon buns and cookies which has resulted in new customers as a brand switching within the category.

Our retail business represents progress on our plan to expand our sales channels and to expand reach. We are pleased with our projected market share in both the diet and diabetic isle in Walmart and will focus on further increasing our share and growing the overall category through product innovation and promotion. Channel expansion will be focused on math and club with a test line approach before expanding nationally. Our first test is with Target in Q2. We are adding additional resources to our retail team to support our growth strategy.

We are encouraged by the start to 2014. Based on year-to-date sales in both our direct and retail channel, we expect the critical first quarter to be our third consecutive quarter of top-line growth. To sustain the momentum, we will continue to evolve our four point plan as we begin the growth phase of our turnaround. From a competitive perspective, I feel we are well positioned. We are growing, profitable and have a strong balance sheet. Our brand and franchise are on the rise and we have the equity with consumers to introduce new products and enter new markets. Our plans are producing results and our new management team is eager to build on our early success.

I will now turn the call over to Keira, who will take us through marketing and speak more about some of our plans on the product innovation front.

Keira Krausz

Thanks, Dawn. In 2013, we hit the ground running to improve our direct business. We return to direct marketing basics and fact-based analytic decision making. We manage media carefully to optimize profitability, we seek quick wins in cross-selling products that help customers while on their weight loss journeys, we instituted better database segmentation practice to retain customers and win them back more effectively. As a result in Q4, we saw year-over-year growth in first time orders in revenue and we are off to a strong start in 2014. We spent more in this January than in 2013 and attracted more new customers at the same acquisition cost per customer. Our success this diet season has largely resulted from four actions which I will discuss.

First, we quickly developed this program with powerful promotional appeal and conducted clinical offer and creative testing. Two, we improved the way we attract new customers via laser like focus on refuelling our short form and long form [indiscernible]. Third, we ramped up our PR efforts to create and sustain buzz for diet season 2014 and beyond. And fourth, we made straight forward changes in our e-commerce business to improve conversion on highly -- higher daily unique visitors.

A cornerstone of our growth is product and program innovation, at the start of 2013 we quickly realized that almost no product development has been and the product pipeline was virtually empty. But as a result of our work in 2013 even before diet season began, we knew Fast 5 our one week jump start kit clinically tested to deliver a five time weight loss, resonated with consumers because we researched and tested it. We knew that the combination of the new craving crusher and energizing shakes plus the substantiated weight loss claims plus our brand equity would be powerful, and we knew that the Fast 5 offer would beat previous offers because we did AB testing before diet season.

We also introduced the more customer oriented way of tailoring our NutriSystem My Way program to individual needs. As part of our selling process, we now invite people to answer a short series of questions. We tested adding this guided selling to our online sales growth in 2013 and based on results, we rolled it out in our call centre and online for diet season. We customized the My Way program based on the information we collect from customers, there are many benefits to this approach.

For example we shifted the conversation away from price and discounting and towards achieving healthy weight loss and consequently we've increased sales. And we set ourselves up to be able to refine our offerings around customers’ needs.

With strong products in hand we made short and long-term commercials that employee directly response to best practices to make our phones ring, drive visitors to nutrisystem.com and result in higher purchases. This work resulted in significantly higher calls and more online visitors. We were able to spend more across all media including television in January to bring in even more orders without increasing our acquisition costs per order. Improved and creative not only measurably improves the direct business but also by allowing us to tell our brand story more often, we enhance all selling efforts through direct and retail channels.

We then supported our selling efforts with cost efficient and effective PR. We leveraged the power of our celebrity brand ambassador via high reach media like People magazine, a weekly magazine, The Rachael Ray Show, CBS This Morning, Piers Morgan Live and Fox & Friends. Our bloggers shared their experiences with Fast 5 and NutriSystem My Way with almost two million readers. We shared our before and after journeys via [indiscernible] and via other channels.

We work with Dr. Andy Baldwin and our own Dr. Anthony Fabricatore to create video, audio and print content that reach an audience of over 35 million people. As a result of these efforts according CisionPoint, a media monitoring service, NutriSystem appeared in over 1,000 articles in January compared to less than 500 for our nearest competitors. We know that most of our response generated by television PR and other efforts, come to us via our commerce channel. So we made some relatively quick tactical moves to improve our online results.

We re-instituted a test, learn and adapt culture and successfully tested changes made in 2012 and 2013, we suspected at the press conversion. We revamped the purchasing experience for paid search; we rebuilt our affiliate and partnership program as a result of these moves, results improved. What excites us is that our [indiscernible] on our current site is launched, which means that we still have tremendous upside in the ecommerce business, even before we released a new site.

[As part of our 2013, as 2014 story was fixed fast] and the working title for the remainder of 2014 is in a [great degree], our top areas for innovation on products and program developments and ecommerce, we see these areas as key to future growth and those with the highest return on investments.

As mentioned, we had a good start to product and program development in 2013, now we are combining our decades of experience with new internal and external product development talents to make ourselves more customer focused and innovative. We plan on offering products for each phase of the weight loss journey, introduction, weight loss, transition and maintenance. We will also make that journey increasingly more personal.

We expect to introduce more jump start products like Fast 5 over the year to take advantage of multiple diet windows and we plan to focus on transition offerings in Q2 and Q3 to address the needs of customer that came to us in the third quarter.

We’re also already working on new products and programs for 2015 and 2016 and we are coordinating price development and launches across our direct and retail channels so that we will win from direct retail and vice versa.

Because of the strength of our product for people with type 2 diabetes at retail and the fact that we already have a scalable NutriSystem B product line in our direct business, despite not having focused marketing resources on it in the past two years; we know there is an unmet consumer need we can address. People with type 2 diabetes have a pressing need to lose weight and take control of their condition, if the structure and information they receive today is minimal. Our programs which need ADA guidelines and satisfy the need for taste and variety have considerable appeal to these consumers. We plan to expend our products and programs in both the retail and direct channels.

We will also launch a multi-platform digital weight loss product early in the second quarter. This will complement and extend our relationship with existing customers and can also serve as a standalone non-food based weight loss system that offers flexibility, adaptability and convenience to the Do It Yourself dieter, a potential new segment for us. Our product will integrate with existing fitness devices and scale but unlike current digital experiences that are flat, one dimensional and largely trackers, we have developed a holistic, complete and interactive solution backed by 40 years of science and expertise in the weight loss space for a Do It Yourself dieter's weight loss journey.

As with most digital products introduced into the marketplace, it will take time to have visibility into the revenue stream and profit potential. However, whether large or small, we feel as a weight loss company, it is important to have a digital product as part of our portfolio of offerings and that this product is consistent with our continued focus on innovation. We will provide more details on the product after we have launched it.

As for ecommerce, we recognize that while we are a weight management company, because the majority of our customers interact with us digitally, we are also an eCom business. We have made some improvements in the second half of 2013, enough to understand the upside potential from ecommerce investments. Everywhere we look, mobile and large screen, sales conversion and on program experience, transactional and social, we have large opportunities for improvement in growth.

In 2014, we will continue to inerrably improve our current online experiences and we have begun a more extensive overhaul that is designed to deliver improved results in 2015 and beyond. Many of these changes will be visible to the customer but many will simply allow us to be more flexible, nimble, and enable one-for-one customer experiences. The success we’ve had so far this diet season in both our direct and retail businesses confirms the power of the NutriSystem brand and the appeal of our approach to weight loss and we look forward to doing more about new and existing customers reach their weight loss goals, so they can enjoy healthier and happier lives.

Thanks for listening. Mike will now take us through the financials.

Mike Monahan

Thanks Keira. 2013 finished strong and as projected. For the fourth quarter, revenue was 69.9 million, up 12% year-over-year, representing our second consecutive quarter of growth since we began executing on our turnaround plan. We successfully grew both operating income and adjusted net income in the fourth quarter and over the full year. We also grew free cash flow for the year enabling us to both fund our dividend and continue to invest in our future growth.

Revenue growth in the fourth quarter was primarily driven by an increase in new customers in our direct channel and higher sales in the retail channel. Retail contributed 5.9 million in the quarter, representing 8.4% of total revenues as w shift products to be in stores for the 2014 diet season. Our revenue per customer improved slightly year-over-year primarily driven by our cross-sell initiative and a favourable average length of stay. Net reactivation revenue also grew as improvements in conversion yield offset pressure from customer aging in our database.

Gross margin declined in the fourth quarter to 47.7% versus 48.3% from the year ago due to the higher percentage of retail revenues. Marketing expense was 15.2 million in the fourth quarter or 21.8% of revenue versus an adjusted 25.6%. Our goal is to optimize and increase our media spend so that we can accelerate profitable top line growth.

Fourth quarter general and administrative expenses were 15.3 million, up from an adjusted 13.2 million a year ago. This increase reflects higher call centre commission expense due to increased sale, severance and a write-down of certain capitalized software costs. Operating income in the fourth quarter improved to 741,000 from an adjusted loss of 1.2 million. This increase was primarily driven by retail expansion and new customer revenue growth in the direct-to-consumer channel. Net income was favourable at 1.3 million resulting in earnings per share of $0.04 for the quarter versus the $0.06 loss on an adjusted basis in the prior year.

Moving to our year-end balance sheet, we had cash and short term investments of 26.3 million, up 6.9 million from a year ago. Inventories increased to 26.1 million from 23.6 million as we prepare for the 2014 diet season and our national retail launch. For the year, we generated 35.4 million in cash from operations, up from 22.8 million in 2012. The increase was primarily driven by EBITDA growth and timing of working capital. We had no debt outstanding under our $40 million revolving line of credit.

In summary, we have entered 2014 with the strong financial position. As we close 2013 with higher new customer [slots], we will benefit in 2014 with higher program, [higher up] program revenues to start the year. Combined this with a solid start to 2014 diet season and the national rollout of retail, we are projecting revenues of 116 million to 121 million for the first quarter and 385 million to 405 million for the full year. This guidance includes an expected $25 million contribution from the retail channel for the full year.

We expect the loss in the first quarter in the range of negative $0.07 to negative $0.02 and full year 2014 earnings in the range of $0.51 to $0.61. The first quarter loss is driven by the planned economics of our new promotion which because of the [indiscernible] up has a lower gross margin on the first order but increases on subsequent orders.

While consolidated gross margin will be pressured in Q1, we expect to finish the full year in the 50% range. Marketing efficiency is anticipated to be approximately 26% to 27% of revenues. General and administrative spending is expected to be consistent with 2013 at approximately 15% to 16% which is inclusive of investment and spending on new program and product initiative and non-cash compensation. Depreciation and amortization are expected to be consistent with our 2013 full year expense and we anticipate our effective tax rate to be in the range 34% to 34.5%.

We expect capital expenditures of approximately 12 million to 15 million for the year and support new initiatives and position ourselves for future growth. The year-over-year increase is primarily due to the timing of planned eCommerce initiatives that were delayed from 2013 due to competing priorities.

The Company has also announced that the Board of Directors has declared a quarterly dividend of $0.175 per share, payable March 20, 2014, to shareholders of record as of March 10, 2014. We expect our results to generate sufficient cash to satisfy our anticipated 2014 needs and do not anticipate borrowings under our $40 million revolving line of credit.

I would now like to turn the call back to Dawn.

Dawn Zier

Thanks Mike. So all in all we are pleased with our progress and our results. We have a newly leadership team in place with a demonstrated ability to execute. We’ve instituted a performance based culture and expect accountability throughout all levels of the organization. We demonstrated revenue growth at a faster anticipated rate by quickly addressing issues in our direct to consumer business and expanding our reach into retail. We developed new products and programs to feel diet season 2014 and last but not least we demonstrated financial discipline improving margins as well as cutting cost in certain areas to fund growth initiative. In short, we did what we told you we would do.

As we move forward, our four point turnaround plan will evolve slightly as our focus becomes more top line oriented. Our four areas of focus in 2014 for continued turnaround are; one, growing our direct to consumer channel, we intent to do this by investing in eCommerce and data analytics developing compelling benefit oriented messaging and creative and focusing on the customer experience through all phases of their weight loss journey; two, launching new products and programs at an accelerated pace through existing customers as well as expanding into new customer segment; three, capturing greater retail market share through both channel and product expansion; and four, operating with excellence and continued cost discipline.

Obesity and diabetes continue to be two of the largest health issues plaguing the American population and these diseases attack on many fronts physically, emotionally and financially. The weight loss solution an individual chooses is a very personal decision and what works for one individual may not be appropriate for another. There are no one size fits all solution that is why we must and will continue to innovate and build out personal and customized programs tailored to meet different needs.

We believe that there is significant opportunity to innovate and grow within our current direct to consumer business as well as in the adjacent space where we can leverage our broad integrated marketing and distribution capability. The strength of the NutriSystem brand continues to rise and I’m finding that our brand equity is giving us license to diversifying into new marketing channels and offer solutions to more customer segments. We are excited that a broader array of consumers is increasingly embracing what our brand stands for nutritious, effective, scientifically based weight loss and is giving us permission to do more.

Before we take questions, I want to assure you that we are very focused on delivering long-term shareholder value. We want to thank our investors who believe in this company and this management team for your support over the past year and appreciate your continued support and confidence into the future. We recognize that trust is earned and Mike and I will continue to be accessible, listen to feedback and show you as much transparency as we competitively can.

Thank you for listening to our opening remarks. We’ll now open the lines for questions.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) and we first go to Alvin Concepcion with Citi.

Alvin Concepcion - Citi

Hi, good afternoon and thanks for taking the call. And congrats on a strong start to the diet season. How would you characterize conversion because it definitely looks like the new program was generating a lot interest on the website, so just curious how you felt about that?

Keira Krausz

This is Keira, hi. Conversion improved and we’re happy about that.

Alvin Concepcion - Citi

And I was also wondering how if you could help us understand a little bit better, I know you went over it in some detail about the revenue growth in the first quarter, EPS is declining, I understand there is free week, but what have seen happen with the gross margin in the following weeks as its significantly higher than on a year-over-year basis, are you seeing changes in the level of retention, just wondering what gives you sort of confidence that the profitability has significantly improved?

Mike Monahan

Yes, so the promotion last year that we had was Lose More, Save More and so the way that worked was for each subsequent order that you accepted we discounted the program for the second, third and fourth quarter. This year with our Fast 5 promotion, we eliminated the discounting going forward, but we included it with the Fast 5 as a free week. So the overall margin on the first order is lower, but then jumps for orders two, three, four and five and so on, to increase the overall average gross margin. So when you look at our full-year the most pressure that we see in the gross margin is in the first quarter, and then it jumps back up in the second quarter as those customers that we bring in during Diet Season start to except their second and third orders.

Dawn Zier

And just want something in ad that before we even -- first of all we tested this offer against Lose More Save More offer, and we did that last September and before we even tested, we did run the P&L to make sure that even on flat response we would be okay, and then of course we did not have flat response, we had improved response. So we are confident that this was the way to go.

Alvin Concepcion - Citi

And then just on the retention.

Mike Monahan

So we have early indicators of retention consistent with our previous offers.

Operator

And next we go toFrank Camma with Sidoti.

Frank Camma - Sidoti

How many Target stores will you be rolling into, is it April, is that when you’re going into it?

Dawn Zier

We’re doing a test in Target to about 100 stores, so similar to what we did when we first tested into Walmart. We will test into target on April 20. We will begin our test and then based on those results we'll determine our national expansion ability.

Frank Camma - Sidoti

The product that you have developed, you’ve given us; I know you can’t give away too much on that, but is that something you’ve developed with a partner? Do you do that in-house; I’m sure you’re doing the production outside but; can you just give us a little more detail about that? That wasn’t really clear on how that, does that tie into your direct product or is that a standalone product, a digital weight loss program as well, you're sort of talking about?

Dawn Zier

So this is an in-house product that we developed. We actually have a standalone entrepreneurial team [in-house] that has been working on this for quite a while. This product will augment our existing customers’ experience with us and address other parts of their weight loss journey such as transition and maintenance which was an area that we have not fully reached the potential in. And we also believe that the [online] audience will find it compelling as well. So we developed a product in-house. Obviously we worked with people on the outside to get it to where it needs to be. But it was an in-house innovation.

Frank Camma - Sidoti

Okay, and you'll market that through your website, is that correct?

Dawn Zier

We are going to move, we will talk more about those plans in the future, but we will be offering the product to our current customers through transition and maintenance, and also testing the product on a standalone basis. We’ll be testing all standard media channels, but our investments will be on a customer basis. We don’t plan doing any television commercials on this testing. It will be online channels only.

Frank Camma – Sidoti

And jumping around here a little bit, the retail revenue, I think, Mike you called out that you’re expecting about 25 million for next year. Did I break that down correctly?

Mike Monahan

Yes that’s correct.

Frank Camma - Sidoti

And did you say in previous calls that you’re expecting roughly 10%; does the difference kind of represent kind of the weak retail foot traffic that we are seeing at Walmart; is that just an approximation?

Mike Monahan

So our overall retail channel is still early on, and so we feel that it’s really still in its infancy, so overall long-term we believe that the channel kind of contribute a significant amount of growth to our revenue stream. But in the upcoming year we saw that the overall weather at Walmart affected some of our expectations and ended up driving a little bit less traffic than we anticipated in our original forecast.

Frank Camma - Sidoti

The final question from me is just on the tax rate in the current quarter. Why was there a benefit if you actually had some income? Why did that come about?

Mike Monahan

We had a reversal of a tax accrual from an investment from five or six years ago. You might remember in the financial statements, we made an investment in the Zero Water, and the accrual expired, and we need to reverse it.

Operator

And next we go to Kurt Frederick with Wedbush Securities.

Kurt Frederick - Wedbush Securities

I just had a question on the retail as well, I guess if you’re looking at Q1, ’14 versus ’13, I think you're in what, five times [indiscernible] is that where most of the growth is coming from then for ’14, and is it --

Dawn Zier

Kurt can you speak up a little, we are having a hard time hearing you, I am sorry. So it’s Q1 growth?

Kurt Frederick - Wedbush Securities

Right, for the retail account; is that basically where the growth for the year is coming from, it’s because the (indiscernible) in this year first quarter than last year?

Mike Monahan

So, Kurt, you faded out, but tell me if I missed your question, that if the question is where is the growth coming from, is it primarily driven by the expanded store count, the answer is yes, we basically have a full launch of stores coming into the diet season in the retail space, and so if you look on a year over year basis the revenue contribution is up significantly because of that.

Dawn Zier

We expanded on our expansion last year happened in Q2 primarily so yes the Q1 diet season didn’t look like that last year.

Kurt Frederick - Wedbush Securities

Okay, and then I’ll try one more, the cost for the digital build and the kind of like the Target preparation, is there a lot of that running through the P&L in the first quarter?

Mike Monahan

So, for the digital investment, we’ve been making investments for the past -- they were through 2013 and so you’re going to see expenses associated with that in both our G&A line primarily and it’s a portion of our CapEx, and so it’s up this year before the launch, but we’ve been spending throughout 2013 in a similar fashion. For the expanded retail launch there is some G&A investment in Q1 but it’s not significant.

Operator

And next we go to Mitch Pinheiro with Imperial Capital.

Mitch Pinheiro - Imperial Capital

First a couple of questions on the quarter, so I heard you say, Keira that you had new customer growth in the back half. Did you have new customer growth in the -- I know it’s positive in Q3 with the positive in Q4.

Keira Krausz

Yes, it was.

Mitch Pinheiro - Imperial Capital

Just like sort of the same rate low single digit kind of number.

Mike Monahan

Our new customer growth was actually higher in Q4 on a year over year basis than it was in Q3, so it accelerated.

Mitch Pinheiro - Imperial Capital

How about -- what about net reactivation revenue, did you give the number.

Mike Monahan

For last year?

Mitch Pinheiro – Imperial Capital

Yes for fourth quarter or last year, either way.

Mike Monahan

Last year total net reactivation revenue contributed about 33% of the total revenues so it was about a 117 million for the year, for the fourth quarter it was kind of similar in those lines, it was about 25 million.

Mitch Pinheiro - Imperial Capital

Okay great and then, of the 5.9 million of retail revenue in the quarter was that, a part of that is, you were shipping in for the holiday, is that correct, for the holiday, for diet season, my bad. So what happens as you get to Q1, does that accelerate like you would expect because its diet season or is it kind of, or did you ship more than consumption or how should we look at that for Q1?

Mike Monahan

So about two thirds of the revenue for retail was towards the end of the year in preparation for the 2014 diet season, so what happens is all the stores get stock and then we start replenishing throughout the quarter, and so in terms of timing, each year as we plan for the upcoming diet season, in retail you’ll have revenue contribution in the fourth quarter, but again as we start selling that product, it begins to be replenished as early as January.

Mitch Pinheiro - Imperial Capital

Okay, so then, looking at the first quarter I can’t get my arms around the loss with the nice increase in revenue, it looks like gross margin would have to be significantly down year over year for you to have a loss, or is there a significant increase in marketing as well, I mean I have to drop my gross margin down into the low 40s to sort of get to a loss, am I thinking about this right.

Mike Monahan

That’s too low, so our gross margin isn’t that dramatically different I would think it’s in the high 40% range for the first quarter and then it increases throughout the second, third and fourth quarter to average out around a 50% for the year in our guidance, and so the other line item that is putting pressure on our overall EPS is marketing. And so as we bring in more customers we’re obviously spending more money on all that marketing customer acquisition cost goes against that first order and so what we’ll get is we’ll get a larger EBTDA and an EPS contribution in the subsequent quarters after Q1.

Dawn Zier

We don’t consider that bad at all, we actually think that is very healthy for the business as we are bringing in, we’re able to spend more because of our improved promotion and our ability to bring in customers at our allowable cost per customer, so in my mind that is a good news story.

Mitch Pinheiro - Imperial Capital

Okay, that’s helpful. And then so also talk me through the gross margin as you go forward through the year. If you are going to give the new customers a free first week, would you always have that gross margin pressure other than you have more business in the first quarter, is that -- why wouldn’t we see gross margin pressure all year long with the free week of food for new customers?

Dawn Zier

It’s only on the first order.

Mitch Pinheiro - Imperial Capital

Okay. So the new customer -- but new customers in the second quarter are new customers and they get a free order every week. So, is it just because of the waiting of the number of new customers you get in Q1, is that carried through for the rest of the year, is that how that works?

Mike Monahan

So, the lion’s share of new customers that we bring in the year come in through in the first quarter and then we get the follow-on orders from them. We are also feeling -- we also get the effects of last year’s promotion for those customers who stayed on, they are actually at a lower gross margin later in their cycles because that explains the four under our lose more save more promotion last year. The more orders you accepted, the lower your price point was, so when you combine those two together into Q1 that’s where it ends up getting the most margin pressure in total. So, as you go throughout the year, the customers on the 2013 program will start to fall off, will start bringing a lower number of customers for Fast 5 and the combination of that will drive the margins up.

Operator

And we next go to Alec Jaslow with Midtown Partners.

Alec Jaslow - Midtown Partners

Yes, I just wanted to get a general sense of your expectations for next year, the overall size of the weight loss market seems like after the Weight Watchers called, there is a lot of negative sentiment, appster kind of picking up, so I want to get a sense if your view has changed or what you see next year for the overall market size?

Dawn Zier

Next year being ‘15 or ‘14?

Alec Jaslow - Midtown Partners

Yes, this year, I am sorry. This year, ‘14.

Dawn Zier

The overall weight loss market is growing and we feel that by offering new products and diversifying our channel to gain customer reach that we can continue to capture a large share of the market going forward. Again, we think there are significant growth within core direct-to-consumer channel as well as the adjacent state. We believe that at Healthcare Reform, source itself out, it will offer more opportunities for weight loss programs that has demonstrated and documented success. And as far as the free app, we have said this before that we do not believe that free app have impacted our result. We actually see them as complementary to our structured program experience but they don’t replace what we do in the area of portion size meal delivery and [counselling], you can’t really eat an app. So, basically we see future opportunity being bright.

Alec Jaslow - Midtown Partners

Okay. And just correct me if I am wrong, but I think in the past usually said that the direct sale segment was a 70-30 split and if that’s correct, do you see a material shift this year, a much larger percentage of new customers?

Dawn Zier

You mean the new customers versus on programs.

Alec Jaslow - Midtown Partners

Yes, yes.

Mike Monahan

Overall we should expect the percentage of revenue to go down and that’s a combination of exactly what you just said, that as we bring in a higher number of new customers they are going to contribute a larger percentage of the revenue stream.

Alec Jaslow - Midtown Partners

Okay. So, we should use a 70-30 split and then kind of see it -- the change in what you just said.

Mike Monahan

30 being reactivation revenue.

Alec Jaslow - Midtown Partners

Yes, yes, 70 being new customers.

Mike Monahan

Reactivation revenue in our guidance is closer to high 20s and 30.

Alec Jaslow - Midtown Partners

Okay. And just to get a sense of Walmart, can you give an idea in the split between the diabetic kit versus the diet kit and maybe how either one has done better than the other or they both met your expectations?

Dawn Zier

We are pleased with the results of both of those products, about 70% of the revenue coming from our diet products and about 30% from diabetics.

Alec Jaslow - Midtown Partners

Okay.

Dawn Zier

Again both products are weight loss products but being those two programs.

Operator

And that does conclude today’s question-and-answer session. I would like to turn the conference over to Mr. Joe Hassett for any closing or additional remarks.

Joe Hassett

Okay, and thank you everyone for joining us today, if you do have any further questions you can contact us at either 610-228-2110 or email ir@nutrisystem.com. We look forward to talking to you again soon after we release our first quarter 2014 results, thanks and have a great day.

Operator

And that does conclude today’s conference, we do thank you for your participation, you may now disconnect.

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