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Nutrisystem Inc. (NASDAQ:NTRI)

Q2 2014 Earnings Conference Call

July 29, 2014 5:00 PM ET

Executives

John Mills - IR, ICR Inc.

Dawn Zier - President and CEO

Keira Krausz - Chief Marketing Officer

Michael Monahan - CFO

Analysts

Frank Camma - Sidoti

Linda Bolton-Weiser - B. Riley

Kurt Frederick - Wedbush Securities

Mitch Pinheiro - Imperial Capital

Matthew Gall - Barrington Research

Alec Jaslow - Midtown Partners

Operator

Greetings and welcome to the Nutrisystem Second Quarter 2014 Earnings Conference Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation (Operator Instructions) As a reminder, this conference is being recorded.

I would now like to turn the conference over to John Mills. Thank you. You may begin.

John Mills

Thank you. Good afternoon everyone and thank you for joining us to discuss Nutrisystem's second quarter 2014 financial results. Today, Dawn Zier, President and Chief Executive Officer will provide an overview of the quarter achievements and strategic direction. Keira Krausz, Chief Marketing Officer will review and provide insight into the company’s marketing initiatives; and Mike Monahan, Chief Financial Officer, will review our first quarter financial results and provide an update on financial guidance.

Before we begin, I would like to remind everyone that during this conference call, Nutrisystem's management will make certain forward-looking statements about its outlook for 2014 and beyond, 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; because forward-looking statements relates to the future, they are subject to inherit uncertainties, risks and changes in circumstance that are difficult to predict, and many of which are outside of our control. 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 July 29, 2014 and assumes no obligation 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 second quarter 2014 can be found under the News Release link on the Investor Relations page of the company's website at nutrisystem.com. The table attached to this earnings press release includes a reconciliations of the non-GAAP financial measures to the most directly comparable GAAP financial measures.

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

Dawn Zier

Thank you, John. Good afternoon everyone and thank you for joining us. The momentum we achieved during diet season continued into the second quarter. Our strong results for the second quarter reflect the success of our four point plan and our drive to accelerate growth.

Second quarter revenue increased 14% to $111 million, and came in on the high end of our guidance range. This is our fourth consecutive quarter of year-over-year revenue growth, and third consecutive quarter of double digit growth.

In addition, earnings per share and adjusted EBITDA, both exceeded our guidance expectations. Our positive results were driven by growth in both our direct and retail channels. We are pleased with our performance in the second quarter, and the progress we are making against our strategic plan, to deliver long term sustainable business growth.

I would now like to focus on our direct-to-consumer channel, in which we grew revenue, customers and profit in the second quarter. Year-over-year new customer accounts grew by double digits for the second quarter in a row, and we simultaneously improved the efficiency of our overall marketing spend.

As expected, we saw our consolidated growth revenue -- our consolidated growth margins improved from Q1 to Q2 by 230 basis points, driven as a result of the first phase implementation of our pricing and promotion strategy.

As we have said before, we believe that we have been undervaluing and underpricing our weight loss programs, and our testing has confirmed this. Keira will elaborate more on pricing, amongst other initiatives within our direct business that we have underway in the areas of acquisition, e-commerce and retention, that we believe will allow us to continue our growth trajectory into 2015.

Turning to our retail channel; results were consistent with our expectation. We are pleased with our performance in the second quarter, and are well on our way to achieving 50% year-over-year revenue growth in fiscal 2014. Nutrisystems [indiscernible] Jumpstart your weight loss kits were the number one ranked products, in both the diet and diabetic aisles for dollar sales over the last 26 weeks, and we were able to capture share from the competition. We expect to continue to innovate with Walmart, and introduce more products into the diet and diabetic aisles in diet season 15th, and expand options on the shelves beyond traditional bars and shakes, that meet evolving customer needs.

As reported on our last call, we were in the process of conducting a 12-week test within 100 Target stores that concluded in June. Target will be making their decisions for their diet season line-up in August, but we will have more to report on the next call.

We also secured a national test in Sam's Club for an in and out display during diet season 2015. Continued growth will come primarily from more product introductions, which will allow us to become a destination brand in Walmart, and secondarily from strategically expanding distribution in select venues.

We intend to continue to push the envelope with product innovation in both the direct-to-consumer and retail channels. We introduced many exciting products in the 2014 diet season, including Nutrisystem My Way and the Fast 5 Kit as well as our Men's Protein-Powered Kit in retail. Our expansion of a digital toolset, with the introduction of NuMi, which focuses on behavior modification and provides real time and guidance throughout all phases of the weight loss journey, gives existing customers who are transitioning or dieters trying to lose weight on their own, the extra help they need.

Our delicious new fruit smoothies, a new Craving Crusher and Energizing Shakes are a hit this summer, as our customers are able to enjoy both nutritious and refreshing products that support their weight loss goals.

While diet season begins in January, we find that many people continue to seek weight loss solutions in the warmer months, and that there are other diet windows throughout the year as well. Our innovative products offer a wide variety of options in order to keep our customers on-track and focus on their goal, to become the healthiest versions of themselves.

Looking ahead, we have more in the pipeline that we plan to introduce throughout 2014, including limited time seasonal offering. I look forward to sharing these with you on future calls.

Our execution of our strategic four point plan, which is now driving towards accelerating growth is our top priority, and I am pleased with our progress. We have the right team, right formula, and meaningful levers in place for continued growth. As a reminder, this plan has the Nutrisystem teams focused on; one, launching new products and program to better serve our existing customer segment and attract new customer segments to the brand.

Two, growing our direct-to-consumer business by focusing on key levers to accelerate growth, optimize acquisitions, and increase retention. Three, capturing greater retail market share to both products and channel expansion; and four, operating with excellence and continued cost discipline.

The success of Nutrisystem is based on these four points, as well as sound direct-to-consumer fundamentals researched and product innovation. With four quarters of consecutive revenue growth to-date, we are confident in our ability to achieve our first full year of revenue growth in seven years. We also anticipate delivering meaningful EPS growth, with the mid-range estimate that is up 60%. This speaks to the successful execution of our plans, to bring in more customers through our direct program, as well as our ability to provide increased customer relevance through innovation and channel expansion.

I will now turn the call over to Keira.

Keira Krausz

Thanks Dawn. Hello everyone. I appreciate the opportunity to share our progress to-date, and talk about what's on the near horizon. Our direct business continues to improve. We still have a significant opportunity to grow via our current product line, and we are positioning ourselves to be able to leverage our marketing capabilities, to expand into new segments and businesses.

In the second quarter, we continued to grow new customers versus 2013. Consumer response to our television advertisements continues to exceed prior year. Based on [indiscernible] diet season, and as we learn more, about what appeals most to potential customers, we were able to release several new spots that actually performed better than some of our diet season spots.

Our infomercial continues to run profitably, and we have been able to keep both 50-second and 120-second spots working. Our ability to run longer spots, allows us to tell our brand stories, while driving response.

Diet season will always be the strongest time of the year, since we are all influenced by New Year's resolutions, and the immediate focus on new beginning. But, we are beginning to make the most of diet windows throughout the year, with new commercials built around seasonal themes, and adjustments to our authors.

Thanks to a strong response, and an increase in our call center and online conversion rates, we were able to increase our future media spend by 6% versus last year, yet lower our acquisition costs for first time orders by 8%. Our all-in acquisition costs, another measure of efficiency, improved by 6%. We were more efficient with our marketing spend, and recruit new customers.

Our [indiscernible] unique customers outpaced our increase in media spend, and our online conversion rates grew in the second quarter, showing solid progress in e-commerce. We believe we have much untapped potential in e-com, and are executing gift plans to increase conversion more.

As we moved away from screening discounts in our television commercials, we were able to shift the conversation of consumers from price to benefit. This allowed us to raise price twice this year, and increased average selling price. While we did see some mix shift between programs, those shifts were unrelated to price increases. We were taking actions to adjust that product mix back, and we believe that through further price optimization, we can make ourselves neutral to product shifts, so that we can allow ourselves to market programs to our customers based on their needs, not ours.

We have said that we want to be able to offer customers products throughout their weight loss journey, and we started to do so, by launching our Kickstart Plateau Buster. We also expanded our cross-selling by introducing smoothies, and continuing to sell our proprietary shakes, all designed to work with our weight loss programs.

While it’s a small piece of the business, cross-sell revenue per new order is up 30% in the second quarter versus prior year. Our reactivation results are in line with expectations. We believe we are positioned well for 2015, when we will have a larger reactivation, thanks to our improved ability to attract new customers in 2014.

The direct business is in considerably better shape than it was one year ago, and we are excited about upcoming events. Just as our formula for 2014 diet season success was to build products around consumer need, and combine it with direct response best practices, we are now preparing for 2015 and are on pace. Our talented creative team is working on new commercials with newer theme for 2015, in conjunction with the agencies that produce the winning spots for 2014, as we innovate and test new product lines, the creative team is able to take strong marketing practices and apply them to new products and program. We think this will be a key strength in the longer term.

We have been through e-commerce conversion in the second quarter, and know that improvements to our online shopping experience can be a major driver of revenue and profit growth. With the new e-commerce leader, the team is highly productive and working toward a common goal. We are focused on making our business more nimble, helping consumers learn about our offerings and order more easily, leveraging mobile, and launching new businesses quickly. Our development work is completely customer centric, while changes are based on research and are extensively usability tested before launch. Please look for significant changes this fall, as we change our site and test our major developments live.

We continue to test pricing and changes to product configurations, and believe we have significant upside to raise revenue and gross margin dollars. We have made some changes to our organization, so that we have top direct marketing channel, focused on increasing lengths of stay and revenue per customer. We are improving our digital tools, personalizing the communications to on-program customers to deepen our connection with them, designing and executing weight loss challenges that leverage the power of social media, and offer reward for using our tools and staying on-program. We know that customers who use our tools and engage with us, have significantly longer length of stay. So we believe that by supporting [ph] attention to engagement, we can measurably increase retention. And once we have even more customers tracking and telling us where they are on their weight loss journey, we will be able to increase our sales of our transition and maintenance programs.

While we saw a decline in paid length of stay in the first part of the year, we have not seen further deterioration. We had to analyze the root causes, and should have fixes in place during Q3, including new acquisition offers, pricing to optimize product mix, and adjustments in the contact center, that should help our reps maintain their excellent conversion rates, that also encourage them to sell the best products for customers, and thus raise, length of stay.

We have made progress in becoming more data driven. We are leveraging internal and external modeling and data resources to improve media efficiency and acquisition retention and reactivation. Based on the success of our diabetes offerings at retail, and our understanding of the diabetes customer, we are now growing our Nutrisystem D programs through our direct channels. We have revamped the program, so that the nutrition meets the needs of a customer with type-II diabetes even better, and we have redesigned all the onboarding and communications just for those customers. We are in the midst of designing the sales funnel.

In the third quarter, we will be testing ways we can leverage our current media investments by making mention of our Nutrisystem D program more prominent in our online and offline channel. Then in diet season, we will begin testing new direct channel for the Nutrisystem D program.

We are grateful, that more people are considering Nutrisystem to help them reach a healthy weight. We are committed to serving them better, by delivering significantly enhanced e-commerce and digital tools, and even more relevant and personal experience, and introducing innovative products and businesses, at an even faster pace.

Now Mike will take us through the financials. Mike?

Michael Monahan

Thanks Keira. We completed the first half of 2014, with strong top and bottom line results. Year-to-date, our revenue and adjusted EPS are up 15% and 3% respectively. In the second quarter, we achieved the top end of our revenue expectations and exceeded our EPS and adjusted EBITDA guidance.

Revenue was $111.1 million, up 14% year-over-year, representing a fourth consecutive quarter of growth. We grew earnings per share of approximately 36% as compared to the prior year, while continuing to increase our investments in both marketing and G&A.

Revenue growth in the second quarter was driven by both the direct and retail channels. Within the direct channel, we drove greater response with our improved marketing campaign, as reflected by increased web traffic and calls into our call center. This along with modestly higher conversion rates, resulted in double digit increase year-over-year and new customer starts in the second quarter.

Our price increases in the first half of the year raised our average selling price by $7 for new customers in the second quarter net of mix.

Over the balance of the year, we continue to look at ways to positively influence customer purchasing behavior, to maximize paid length of stay and gross margin profits.

As discussed on the last call, partially offsetting the new customer starts and increased average selling price, was the decline in the number of paid days customers were on program. This was primarily due to product mix changes, and the inclusion of a free week of food.

Total customer days on program, inclusive of the free week, were up slightly up year-over-year in the second quarter, and we have tested and validated products and promotion adjustments, that should positively impact the number of paid days in the second half of the year.

As expected, we delivered $29 million of reactivation revenue in the second quarter, representing 26% of revenue. We have the highest likelihood of reactivating customers within two years of their initial start date, and are able to reactivate them with much lower marketing costs than new customers.

For the full year, we believe that our reactivation yields will improve and partially offset a smaller two year customer pool. This year's new customer growth will enable us to replenish these pools, which should have a favorable impact to adjusted EBITDA in subsequent years.

Retail revenue was $5.4 million, up 34% from Q2 2013. Gross profit increased 14% to $56.9 million for the second quarter of 2014, compared to the same period last year, due to our overall increase in revenue.

Gross margin increased 20 basis points in the second quarter to 51.2%, due to the price increases in the direct channel, partially offset by a higher percentage of retail revenues, and the success of the fast five promotion, driving new customers. As a reminder, retail gross margins are lower than direct gross margins, but contribute similar operating margins. In addition, the fast five offer, front-loaded the promotional cost on the first shipment and delivered stronger gross margin by subsequent orders to customers.

Marketing expense for the second quarter of 2014 was $26 million or 23.4% of revenue, compared to $24.3 million for the second quarter of 2013, or 24.9% of revenue. The 150 basis point improvement reflects a higher number of new customer starts from the first quarter, contributing to second quarter revenue. As long as our efficiency holds, we will continue to increase our marketing spend, to leverage our platform to drive profitable growth.

Second quarter general and administrative expenses were $15.8 million, as compared to $13.4 million in the prior year. The year-over-year increase in G&A reflects higher call center commissions and labor costs, stemming from our second quarter's new customer growth, and increased labor spend against key operational initiatives.

For the second quarter, adjusted EBITDA increased 25% to $17 million compared to $13.5 million a year ago. The increase was primarily due to revenue growth and marketing efficiency. Depreciation and amortization was $1.9 million, driving the quarter and non-cash compensation expense was $1.8 million.

On a GAAP basis, operating income in the second quarter increased $3.4 million or 35% to $13.2 million compared to $9.8 million in the prior year. This results in earnings per share of $0.30 for the second quarter, versus $0.22 the prior year.

Moving to our balance sheet; as of June 30, 2014, we have cash and short term investments of $39.5 million, up $13.2 million from December 31, 2013. Receivables increased $3.4 million to $11.1 million from $7.7 million at year end due to timing. Inventories decreased to $19.7 million from $26.1 million, as we began to manage through the seasonality of our business. Lastly, we do not have any debt outstanding under our $40 million revolving line of credit.

As a result of our second quarter performance and continued success in growing our customer base, we are raising our full year adjusted EBITDA and earnings per share guidance, along with the bottom range of our revenue guidance. We are now projecting full year revenue in the range of $397 million to $407 million; adjusted EBITDA in the range of $41 million to $44.2 million, and earnings per share of $0.60 to $0.68.

For the third quarter, we are projecting a revenue range of $85 million to $90 million; adjusted EBITDA of $8.75 million to $10.75 million, and earnings per share of $0.12 to $0.17. This full year guidance implies a return to double digit year-over-year growth in the fourth quarter, due to improved media mix, improved web conversion rates from our recent e-commerce initiatives, and improved growth in retail revenue, as we begin to ship for the 2015 diet season.

Our estimates also include additional marketing and G&A investment spend in the third and fourth quarters of 2014, to begin testing new product and marketing initiatives, designed to evaluate new market segments in future revenue streams.

Capital expenditures of approximately $12 million to $14 million are projected for the year, and supported new initiatives and to position ourselves for future growth. The year-over-year increase is primarily due to investments in e-commerce initiatives.

For Q2, the Board of Directors have declared a dividend of $0.175 per share payable August 18, 2014, to shareholders of record as of August 8, 2014. At this time, we feel that our capital structure is appropriate, however, the Board continues to evaluate the best ways we can return and maximize value for our shareholders.

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

Dawn Zier

Thank you, Mike. I am very pleased with our results for the first six months of fiscal 2014, and with management team's track record to-date of achieving what we say we are going to do. I believe our accomplishments so far this year are a result of our laser focus on executing against our four point, which is essential to increasing shareholder value in both the short and long term.

In closing, I would like to summarize around four points; we are delivering consistently strong financial performance, generating a significant return on investments. Two, we believe we have meaningful opportunities for growth, within our direct-to-consumer and retail businesses. Three, we also are positioning ourselves to be able to leverage our considerable marketing and distribution capabilities, to expand into new segments and businesses; and four, we are innovating at an accelerated pace, of thinking outside of our 28-day box.

We have a track record of doing what we say we are going to do. We are pleased that we are raising our full year EPS and EBITDA guidance, and we are confident in our full year projection. We are very optimistic about our future, and excited about our growth opportunity. I would like to take this time to thank our investors for their continued support.

And we will now open the line for questions.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions). And our first question comes from the line of Frank Camma with Sidoti. Please proceed with your question.

Frank Camma - Sidoti

Good afternoon. Can you hear me?

Michael Monahan

How are you doing, Frank?

Frank Camma - Sidoti

Good. Congratulations on the quarter. Couple of quick questions here. So if I calculated this right, I came up with about -- if you strip out retail revenue about 12% organic growth for the quarter, roughly. And I am wondering why -- and clearly the first quarter exceeded that I believe. I am just wondering, why is the third quarter your, your growth going to -- your overall growth is actually going down there about -- even on the high end about 5% from your guidance?

Michael Monahan

So there is a couple of thinks that are driving -- you're referring to the revenue guidance?

Frank Camma - Sidoti

Yes, yeah, revenue I am sorry.

Michael Monahan

Yeah. There is a couple of things on the revenue side; so, we are seeing the higher new customer starts, and we are getting the benefit of increased pricing. So offsetting some of that is the overall paved length of stay that we are seeing for customers, and a product mix shift, where customers are buying slightly lower priced programs. So we have initiatives in place to address that, but we factored those changes that we saw in Q2 and to the Q3 guidance.

Frank Camma - Sidoti

Okay. So you're seeing that obviously through July is what that implies, and so you factor that in. But then you obviously, in the final quarter now, going off through your -- kind of mid range of the revenue for the full year, you're expecting the fourth quarter, the implication will be a significant ramp in revenue growth, about 14%, what could you --?

Dawn Zier

Its consistent, Frank, with what we have done in Q1 and Q2. so in Q1, we showed revenue growth of 16%, Q2 at 14%, and I think the velocity of the direct-to-consumer business, Q1, Q2 is not shifting.

Frank Camma - Sidoti

Okay. now the only reason I asked is, the fourth quarter tends to be your weakest quarter from a revenue standpoint, correct?

Dawn Zier

Its the latest quarter from a revenue perspective, yeah.

Frank Camma - Sidoti

But it sounds like you have some programs in place that give you confidence, that there will be a balance there at the end?

Dawn Zier

Yes.

Frank Camma - Sidoti

Okay. And can you just -- you said there was an increase of $7 into average selling price in the quarter; could you remind us what it was year-to-date, if you add up both quarters?

Michael Monahan

Sure. In the first quarter, we saw approximately $10 worth of an increase year-over-year, and so the difference between the second quarter and the first quarter was the move -- is really the comp. So in the prior year, there was a higher level of discounting in the first quarter.

Frank Camma - Sidoti

Okay. All right. So $17 altogether. Also, your average -- it is still around, what about $2.50, is it correct?

Michael Monahan

The average would be a combination averaging the first quarter increase and the second quarter increase.

Frank Camma - Sidoti

Okay, okay. All right. Okay. And a final question, I was just wondering if you had -- because your marketing methods just changed a little. Have there been any meaningful shift, or have you seen any trends and difference, as far as your demographics between customer -- male customers and female customers, or has it been pretty static this year?

Keira Krausz

We saw a slight shift towards female customers.

Frank Camma - Sidoti

Towards female. Right; because you haven't really run as many headline mail advertisements, is that correct?

Keira Krausz

We are basically constant with last year. But basically, male customers and female customers both grew. Female customers grew at a faster pace.

Frank Camma - Sidoti

Faster rate.

Dawn Zier

Yeah. So both [indiscernible].

Frank Camma - Sidoti

Okay, great. Thank you.

Dawn Zier

Thank you.

Operator

And our next question comes from the line of Linda Bolton-Weiser with B. Riley. Please proceed with your question.

Linda Bolton-Weiser - B. Riley

Hi. So you know, with this issue with a lower length of stay, it seems like you were relying on this promotion and the structure of it, to enhance the growth margin sequentially as you go along through the year. But if you are experiencing lower length of stay, I am wondering if that is going to play out as anticipated. So what is that lower length of stay implied by your growth margin progress, as you progress through the year. But with that question in mind, your gross margin in the quarter was actually quite a bit better than we had modeled. So --

Keira Krausz

Linda, the -- which exactly reflects the -- what we said was going to happen in terms of the promotional change, as well as the price increases. So there is no reason to think that, that trajectory would change. Mike, anything to add on that?

Michael Monahan

Yeah I think, so on the positive side, in fact in gross margins was the pricing. We have successfully been able to increase pricing throughout the first half of the year, and we are looking to leverage that going forward the best we can and test into that on a continual basis. Offsetting that is the paved length of stay in the revenue mix, so that the revenue mix in terms of the balance between retail and direct. But overall, when you look at over the course of the year, we still are projecting improved gross margin, as we march throughout the back half of the year.

Dawn Zier

And as Mike said in his script, we also believe we have something in place that we tested, which will change that in Q3. We are rolling out other things in Q3 and Q4 that we believe will address the issue we sought on paved length of stay and overall length of stay should stay where its at.

Linda Bolton-Weiser - B. Riley

Okay.

Dawn Zier

And retails [indiscernible].

Linda Bolton-Weiser - B. Riley

All right. So that would be the key reason why you're expecting probably slightly higher sales growth year-over-year in fourth quarter than in third quarter?

Dawn Zier

There are multiple things that are driving that. We said that it was web conversion. It was -- we expect more FTOs. It was a change in our media spend, which was allocated towards better performance channel. Mike, a couple of things?

Michael Monahan

Those are the main three. So when you look at the benefits in Q4, the first would be -- as we built for the 2015 diet season, Dawn talked about expanding our retail channels, and we have actually seen improved DA sell-through rates at Walmart. So in anticipation of that, we have factored in an increase in retail revenue in the fourth quarter.

The second two pieces, really relate to the direct business, and there, as we go throughout the year, we have been able to optimize our media mix, and as you look over the fourth quarter of last year, compared to the fourth quarter projected this year, we have, what we believe, and we have tested and feel much better media mix is going to drive a higher level of customers. That coupled, we have made pretty significant investments in our web site, that are going to start to roll out towards the end of Q3, and we expect to see an improvement from some of those investments in the fourth quarter of this year. In terms of translating into more customers.

Dawn Zier

I also want to say that the Q3-Q4 numbers are not a surprise out here. So if, what we were expecting and forecasting for the year, so this is not new news to us, what we are seeing is going to happen. I think its important to understand that. Its not a change of strategy, its not a change of direction. Its what we were planning.

Linda Bolton-Weiser - B. Riley

Okay. and then, can you -- I know its very early days, but can you tell us any metrics or numbers that are related to the NuMi web site, number of visitors or even, is there any revenue that you can talk about, that you have been able to post so far. Anything at all?

Michael Monahan

So NuMi is -- we just started spending media about three to four weeks ago, and so its still very small. So we are not in a position to report it. We didn't have meaningful revenue contribution in the second quarter. We have a modest amount of revenue in the back half of the year, but overall, mostly, we have factored in investment spend for NuMi into the P&L, as we continue to ramp up and we are trying to penetrate the do-it-yourself market and leverage the technology with our core customers.

Linda Bolton-Weiser - B. Riley

Okay. Also, can I just ask you -- I believe it was this close in the filing, that you modified some elements of your credit facility I believe, to enable you to do share repurchase. Is there a reason for that? Is that something to do as a routing or is that an active decision to actually make that change?

Michael Monahan

Actually the modification in the credit agreement changed our covenants? And so when the credit agreement was put in place, the covenants were pretty restricted in my view, and so I worked with the banks to lower them, just to provide additional flexibility to the company. Additionally, there was a clause in there that prevented share repurchase, which didn't really need to be there. So as a result of kind of doing the amendment on the covenants, we took that out.

I would say that, we don't have board authorization at this point to do a share repurchase, and so really the modification to the credit agreement just provided us as management team and accompanying with more flexibility going forward.

Linda Bolton-Weiser - B. Riley

Okay. Thank you very much.

Michael Monahan

Thanks Linda.

Operator

And our next question comes from the line of Kurt Frederick with Wedbush. Please proceed with your question.

Kurt Frederick - Wedbush Securities

Hi, thanks for taking the question. I am going to go back to Q4 as well. I am going to look at it from, I guess, a net income side. Historically, Q4 profit really is quite less than the other quarters. This year, you're really forecasting a really strong Q4 on the net income side. As I am trying to tie that back to I guess your earlier comments. I mean, is this related to like the web conversion and the media mix spending in that, is that how you're getting to that number, or is there something that was going on, as far as the net income?

Michael Monahan

Yeah, there is two main drivers in the fourth quarter, that's different on a year-over-year basis. The first is our promotions that we have talked about, where as last year with the promotion that the company had, the lose more save more promotion, we really had declining gross margins throughout the year. So the fourth quarter of last year, had the lowest overall gross margin of each quarter, whereas you look at this year, and its actually, Q1 ends up being the lowest gross margin, because of the frontloading of the fast five promotion. And so that's the first thing that's contributing to it.

The second thing, as I talked about, is really on the revenue side, and there is the retail component, and then on the direct business, its really around marketing efficiency, and the efficiency is driven by two things, its driven by optimizing our media mix in terms of how much money we put towards short form TV, prints, long form TV and the like, and the second is the investments we have made in web conversion, which as we are able to convert more people on our web site, that gives us an overall benefit on the marketing efficiency side.

Kurt Frederick - Wedbush Securities

Okay. And then a question on the mix shift that you were talking about, is that people switching within the 20-day packages to a different package, or is that across to whatever shapes or some of the other products or across channels?

Michael Monahan

So the mix shift primarily is in within our continuity based programs, and so its between -- we have lower priced option that you can't customize. We have a medium priced option that you have from customization. We obviously have a higher end product that has a mix of frozen foods. We also have a weekends on your own and dinners on your own options. So between all of those different continuity based programs, we saw a shifting in customer selections, that ultimately ended up lowering the impact on a blended basis of the price basis we implemented.

Kurt Frederick - Wedbush Securities

[Indiscernible] with the first price increase?

Michael Monahan

We did a price increase in the first quarter, and then we did a second price increase late in the second quarter.

Kurt Frederick - Wedbush Securities

Okay. How are the margins for Nutrisystem D compared to the other products?

Dawn Zier

It’s the same.

Kurt Frederick - Wedbush Securities

Same. Okay. All right. That's all I have. Thank you.

Michael Monahan

Thanks Kurt.

Operator

And our next question comes from the line of Mitch Pinheiro with Imperial Capital. Please proceed with your question.

Mitch Pinheiro - Imperial Capital

Hey. Good afternoon. I may have missed this, and I am sorry to make you repeat it, but what was your -- did you give the retail revenue in the quarter?

Michael Monahan

We did. It was $5.4 million.

Mitch Pinheiro - Imperial Capital

Okay. And what about QVC?

Michael Monahan

QVC was about a little under $3.5 million.

Mitch Pinheiro - Imperial Capital

Okay. Thank you for that. And then, when you look at -- I mean, how would you characterize the retail environment? We are hearing mixed signals on one hand, you have Starbucks and Chipotle up strongly, and then you have the McDonalds and some others down, and weakening and I am trying to get a sense for how that might be affecting Nutrisystem one way or another, and how you view that?

Dawn Zier

So the retail environment Mitch? Program? I would say we are pleased with retail. Retail is meeting our expectations.

Mitch Pinheiro - Imperial Capital

Excuse me. Dawn I meant retail to consumer. The consumer in general.

Dawn Zier

I think the consumer -- we are not seeing any impact from that. I think that we are continuing to innovate and look at new products that we can have, as we continue to expand our breadth and reach. But we have been able to, in Q1 and Q2, grow new customers by double digits. So we feel we are trending pretty well.

Mitch Pinheiro - Imperial Capital

And does your price increase sort of indicate that -- you feel that your target audience has healthy economics to spend on the products, is that --?

Dawn Zier

We felt we were undervaluing and underpricing our product, and that our ability to raise price did not impact response.

Mitch Pinheiro - Imperial Capital

Did you raise prices, is that list price, or was it sort of less promotional --

Keira Krausz

We raised the actual -- well we raised --

Dawn Zier

So we raised both the actual price fee and the manufacturer suggested retail price in the direct business.

Keira Krausz

So customers are paying more.

Mitch Pinheiro - Imperial Capital

So the retail price is the manufacturer suggested retail price, but higher?

Dawn Zier

Yes. If you're familiar with the way the web site works, there is an MSRP shown. But the most important price that's really shown, and that customers pay attention to is that the price that they pay, and that's what we are raising and focusing our attention on.

Keira Krausz

And retail price in Walmart has remained unchanged.

Dawn Zier

So its $44.98.

Mitch Pinheiro - Imperial Capital

Okay. And so is the pricing, is there an element of less promotion, or higher promoted prices? Is that in essence what you're doing?

Dawn Zier

Well first stage was to stop using discounts as our lead acquisition technique; because when you do discounting like that, on television in particular, the people that are going to call you up or go to your web site, are usually by definition, more interested in prices. And so, the first stage was just to try to stop doing that on television and on the web site's homepage. Then, that allowed us to shift the conversation to benefit to more than how much is this going to cost me, and then that allowed us to slowly but sequentially, start testing higher prices, and I think that's how we have been successful. The next phase will be trying to optimize product mix and optimize margin between the products, and then after that, we have another phase where, we will try to add services etcetera. That some ways out. So --

Keira Krausz

As we are looking at the overall consumer mix, the consumer is more health conscious, but still seeking value. So the pricing equation is something that we look at very carefully we test into, but we believe we still provided very good value to customers, but we are not going to undersell our products.

Mitch Pinheiro - Imperial Capital

And then, just changing subjects, how would you characterize the media and advertising rates? I was reading about the upfront, being a little soft, and I was wondering, if you had any color on that? I know you buy remnants, but --

Dawn Zier

We are not seeing -- I mean, everyday is a new story and on the continuity [ph] that we buy, but we are not facing significant rate pressure.

Mitch Pinheiro - Imperial Capital

Are you seeing any relief, or do you anticipate any relief?

Dawn Zier

We do not anticipate any dramatic decreases in rates or increases.

Mitch Pinheiro - Imperial Capital

Okay. Thank you very much. Appreciate your time.

Michael Monahan

Thanks Mitch.

Operator

Thank you. (Operator Instructions). And our next question comes from the line of Matthew Gall with Barrington Research. Please proceed with your question.

Matthew Gall - Barrington Research

Hello. Thank you very much for taking my questions. Congratulations on a good quarter. Just wanted to follow-up. I think most of the other questions, kind of addressed some of the same things that we were thinking here. But I know that you were trying to give some guidance here towards some of the CapEx expenditures maybe being more second half loaded, on some of the e-commerce initiatives. Is there may be some of the new -- the NuMi platform or something like that, that that would go into as well, or any more color that you can provide a little bit more CapEx in the second half?

Michael Monahan

Yeah. So the second half is split about equal between maintenance and growth CapEx. It leans a little bit more towards the growth. We have some ERP investments on the maintenance side that we are making in the back half of the year, and then the remainder of the CapEx, as you put it, really is around digital initiatives, which I will include NuMi, and the investments we are making in the e-commerce platform for the direct business.

Matthew Gall - Barrington Research

Okay, great. And actually I think that be it for me. Thank you.

Dawn Zier

Thank you, Matt.

Operator

Thank you. (Operator Instructions). Our next question comes from the line of Linda Bolton-Weiser with B. Riley and Company. Please proceed with your question.

Linda Bolton-Weiser - B. Riley

Hi. Just as a follow-up, you had mentioned with regard to the tests at Target that they will be deciding what to do with the DI program in August. Do you mean deciding what to do for the fall, or deciding what to do for the early 2015 diet season?

Keira Krausz

There are long lead times in retail, so they are making their decision. Typically retailers reset their blocks or determine their [indiscernible] once or twice a year for diet season. But Q4 for retail, it is all about flu and cold. Q1 is about diet. So they will be making their decisions in August for diet season, which would be the January period.

Linda Bolton-Weiser - B. Riley

Is there anything you can say about how the tests went? Was it very successful, kind of on track, or can you say anything about how it went?

Dawn Zier

We were pleased with the results of it. But again, unfortunately, Target doesn't operate to our earnings call schedule, which is ideally what we would have liked for. But we will find out in a couple of weeks, but we thought the tests went well.

Linda Bolton-Weiser - B. Riley

Great. Thanks a lot.

Operator

And our next question comes from the line of Alec Jaslow with Midtown Partners. Please proceed with your question.

Alec Jaslow - Midtown Partners

Hey guys. Just wondering about your expectations for Walmart for the full year? I think you said in the last call $25 million. But you just said it was around -- this quarter is around $5.4 million, was that -- do you still expect $25 million for the year, or can you just talk a little bit more about the results for this quarter in Walmart, versus your expectation?

Michael Monahan

Yes, we are still on track with the $25 million guidance for the Walmart contribution to the revenue stream this year. What you see, in terms of kind of the seasonality of the revenue stream for Walmart, is Q1 tends to be a very large quarter. But the next highest quarter tends to be Q4, because you have the load-in of product that we ship out, we record the revenue when we ship it, for the January 1 retail shows. So you will see in the third quarter, retail revenue will be slightly down from the second quarter, and then it will be a larger contribution in the fourth quarter.

Alec Jaslow - Midtown Partners

Okay. So Q4 would be almost similar more to Q1 results for Walmart?

Michael Monahan

It would be comparable, its kind of the guidance range of where we are at.

Alec Jaslow - Midtown Partners

Okay. And question about Sam's Club. Do you have any timeline of when you might talk about the expansion in that area?

Michael Monahan

So we factored in the total retail contribution for the year, is $25 million from Walmart, and about $0.25 million from Sam's Club as an estimate. We are still working with them to understand what the purchase order would be, for the first quarter, and so we estimated that as a potential load-in, that would be booked in December for the January timeframe. We will have a more detailed update on that, as we progress throughout the back half of the year, and get more insight and understanding as to how much of the product we think will be delivered.

Alec Jaslow - Midtown Partners

As you get -- it sounds like as you get -- develop a better relationship with Walmart, with Sam's Club as well. Could that affect your ability to expand other retail channels, or maybe you can give us some color on their thoughts potentially of you testing out in Target as well?

Dawn Zier

I think most retail players operate in more than one channel. But we have said that we believe our growth primarily will come from product innovation, and that would be primarily within the Walmart channel, and then we would expand into select other venues, such as Sam's, such as Target.

Alec Jaslow - Midtown Partners

Okay. And in terms of where you're placing the product in retail stores, is it going to be a similar location pattern to what you did with Walmart? You're in 2,500. There is 4,000 in the U.S. So are you going to say in terms of geographic region, are you starting to mix into different areas?

Dawn Zier

Walmart I think, we are in 2,500 stores for retail, for the diet product, and that's optimized. We do not want to be in every store, because different stores have different velocity. We are very careful, as we expand into retail. That we don't want it to be a revenue-only priority. That we want to make sure, we are protecting our margins, which we are. So our expansion into other channels is very specific and deliberate.

Alec Jaslow - Midtown Partners

Okay. And for Walmart, going forward maybe in future years, are you going to give some type of same store sales growth number for locations, or are the products going to be pretty simple, in terms of diabetic kits of similar price points?

Michael Monahan

Yeah we will start expanding our retail metrics really. We were fully ramped in Walmart towards the end of Q3, beginning of Q4, last year. And so as we enter into 2015, we will be able to provide some more meaningful same-store sales metrics and the like.

Alec Jaslow - Midtown Partners

Okay. In terms of marketing, its very efficient and impressive; I think most people thought you'd do a little bit of more marketing. Was there any -- maybe you could talk about why you didn't do more marketing, or is that just the general thesis behind the amount of deployment you did for marketing?

Keira Krausz

Sorry, so in what way was it expected to do more in marketing, just help me understand where you're coming from?

Alec Jaslow - Midtown Partners

Just where I look at consensus revenue, and it seemed more likely that there is like maybe $2 million, $3 million more in marketing, based on the efficiency of past year?

Michael Monahan

I would say, some of the investments that we are making, specifically around the e-commerce initiatives, will enable us to accelerate some of the marketing spend into next year. So as you can convert more customers, that gives you the ability to -- it improves your overall customer acquisition costs in marketing efficiency, which enables the marketing team to spend more dollars. And so a lot of the investments around CapEx and resources that we have focused in on this year, we expect to start to see some of the benefit to that towards the end of this year, and into 2015.

Dawn Zier

That's right. And I mean, we basically are managing to on acquisition costs, and that acquisition costs, that [indiscernible] will begin to creep up, as conversion goes up, and we are more and more efficient. So it gets back in half, and then we will be able to spend much more.

Keira Krausz

And again, we were pleased that we were able to deliver double digit customer growth at an improved media [indiscernible].

Alec Jaslow - Midtown Partners

Do you have a number for that customer growth, just you gave it in the first quarter, its like 20% plus. Is there like a rough number on that?

Michael Monahan

Yeah, the customer growth was between 12% and 15%.

Dawn Zier

Which is expected [ph] on the seasonality.

Alec Jaslow - Midtown Partners

Okay. And I think that's it. Thanks guys.

Dawn Zier

Thank you.

Keira Krausz

Thank you.

Operator

Thank you. And that concludes the question-and-answer session. I would like to turn the floor back to management for closing remarks.

Michael Monahan

Thank you. As a reminder we will be attending a number of investor events in the coming months and look forward to updating you on our progress, when we announce our third quarter results in October-November timeframe. Thank you very much.

Operator

This concludes today's teleconference. You may disconnect your lines at this time, and thank you for your participation.

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Source: Nutrisystem's (NTRI) Dawn Zier on Q2 2014 Results - Earnings Call Transcript
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