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Weight Watchers International, Inc. (NYSE:WTW)

Q3 2010 Earnings Conference Call

November 9, 2010 5:00 PM ET

Executives

Sarika Sahni – Director, IR

David Kirchhoff – President and CEO

Ann Sardini – CFO

Analysts

Robert Craig – Stifel Nicolaus & Co.

Chris Ferrara – Bank of America

Ken Goldman – JP Morgan

Greg Badishkanian – Citigroup

Operator

Ladies and gentlemen, welcome to the Weight Watchers International Third Quarter 2010 Earnings Teleconference Call. (Operator Instructions)

At this time, I would like to turn the call over to Sarika Sahni of Weight Watchers International. Please go ahead.

Sarika Sahni

Thank you. And thank you to everyone for joining us today for Weight Watchers International’s third quarter 2010 conference call. With us on the call are David Kirchhoff, President and Chief Executive Officer; and Ann Sardini, Chief Financial Officer. At about 4 PM Eastern Time today, the company issued a press release reporting its financial results for the third quarter 2010.

The purpose of this call is to provide investors with some further details regarding the company’s financial results as well as to provide a general update on the company’s progress. The press release is available on the company’s corporate website located at www.weightwatchersinternational.com.

Reconciliations of non-GAAP measures disclosed on this conference call to the most directly comparable GAAP financial measure are also available as part of the press release.

Before we begin, let me remind everyone that this call will contain forward-looking statements. Investors should be aware that any forward-looking statements are subject to various risks and uncertainties that could cause actual results to differ materially from those discussed here today. These risk factors are explained in detail in the company’s filings with the Securities and Exchange Commission. Please refer to these filings, our more detailed discussion of forward-looking statements and risks and certainties of such statements.

All forward-looking statements are made as of today and except as required by law, the company undertakes no obligations to publicly update or revise any forward-looking statements whether as a result of new information, future events or otherwise.

I would now like to turn the call over to Mr. Kirchhoff. Please go ahead, David.

David Kirchhoff

Good afternoon and thank you for joining us we review Weight Watchers International’s performance for the third quarter of fiscal year 2010. Our business continued to show encouraging signs during the third quarter, particularly in our WeightWatchers.com and NACO meetings business.

Overall participation of our brand in our critical North American market significantly exceeded the levels of this time last year with solid growth in total paid weeks fueled by our Weight Watchers online product and improving trends in our meeting business.

On the constant currency basis, Q3 revenues grew 3.5% over the prior year period with meetings fees up slightly at 1% and meeting product sales up 1%, internet revenues growing 22% and other revenues declining 9%. This overall increase in revenue was a slight improvement over the term we saw in Q2.

From a volume perspective, combined global, online and meetings paid weeks grew by 11% in the third quarter versus the prior year period. This 11% growth compares to 8% year-over-year growth in Q2 and 1 % growth in Q1. The improvement in paid weeks trends has been driven by improvements in both our meetings and online business as we progress through the year.

Global paid weeks and our meetings were up 3% versus the prior year period in Q3, while paid weeks for Weight Watchers Online accelerated further to a robust 26%.

Q3 2010 EPS was $0.59, compared to $0.68 for the same period in 2009. Included in the Q3 2010 result was a $0.05 reserve taken in the quarter for the pending settlement of litigation in California. Without the impact of this reserve, Q3 EPS would’ve have been $0.64.

I will now briefly review our results in our major geographies and business units. First, our North America meetings business, total NACO revenue were $169 million in Q3, up 2% versus the same period in 2009. This is a slight improvement over the flat year-over-year trend we saw in Q2 and a substantial improvement over the 8% decline we experienced in Q1.

NACO meeting fees grew 2% versus the prior year period, the first time we’ve seen positive trajectory in this trend this year and meeting product sales grew by 5%.

NACO Q3 2010 paid weeks grew 3% versus the prior year period, the first time we’ve seen this growth in this metric this year despite a one week delay to the start of our fall marketing campaign. As a result of this delay and the negative impact from the timing of July 4th, Q3 attendances were down 4%. Without the impact of these two factors, we estimate Q3 attendances would’ve been down roughly 2%.

2010 continues to be a tale of two periods, Q1 and the rest of the year. As we’ve discussed on prior calls, the critical first quarter was a period in which we did not have news to fuel marketing, so our marketing was not punching its weight and we experienced difficult weather conditions beyond our historical norms.

Since the launch of our revamp marketing programs beginning of April 1st of this year, we’ve seen stabilization of our volumes.

As was the case in Q2, third quarter enrollments were flat to slightly positive versus the prior year period.

In addition, we continue to benefit from retention of members who purchase our monthly pass commitment plan.

These two trends have allowed us to come close to rebuilding the membership pace that was weaken by our soft first quarter recruitments. We continue to see strong consumer response to our marketing campaigns featuring Jennifer Hudson, including the launch of several spots for this fall. Marketing that authentically communicates the real successes that our members could achieve and adapting a healthier lifestyle with Weight Watchers clearly resonates with consumers. This much harder hitting marketing has allowed us to stay relatively strong despite consumers remaining cautious with their discretionary spending.

Looking forward, we expect our volume trends in the fourth quarter to roughly mirror the third quarter with attendances slightly below prior year and paid weeks effectively flat with prior year.

As noted on the previous call, the NACO team has been working throughout the year to consolidate its base of meetings in order to focus our efforts on our strongest locations, time slots and leaders. Much of this work is now behind us as we finish the year with a much tighter meeting network.

As of the end of October, our U.S. meeting base is now about 13% smaller than it was this time last year. The beneficial effects of this have already become apparent. The average number of attendances per meeting was up 6% versus a prior year, a trend that should show further improvement in the fourth quarter. The impact of higher attendances per meeting is one more vibrant and energetic meetings, an important ingredient to the motivational elements of our program. Two, higher commissions to our service providers and three, improved profitability for the company.

The NACO team is now in the home stretch for preparing for its new program launch in November 27th leading into its traditional January marketing campaign. As we’ve noted on previous calls, the scope and size of this program launch is substantial. This change over effects virtually every single aspect of the operations of the business including training, supply chain, products, licensing and other areas.

Roughly 20,000 of our North American service providers have had the opportunity to become new members on this new program for the past six weeks. The response has been tremendously positive and they’re eagerly awaiting the opportunity to share the new program with the members in the December.

Now, onto the International meetings business, the U.K. business continued to struggle in Q3 with a difficult consumer economy and without the benefit of program news or our new marketing approach implemented in NACO. The U.K. 2010 Q3 meetings business revenues declined 6% versus the prior year period on a constant currency basis comparable to the trend in Q2. Third quarter paid weeks were effectively flat at 0.5%, while attendance has declined 9%. Again, this trend was almost identical to our Q2 results.

The U.K. made the decision to pull back its media investment in the fall campaign and to focus its effort on its new program launch in November. Accordingly, Q3 and October enrollments have been very soft. Similar to the U.S., the U.K. team has been deeply focus on the launch of its new program ProPoints, which went live in our meeting rooms this past Sunday, November 7th. Like in NACO, the response from U.K. leaders who have been on the new program has been outstanding. The U.K. continues to invest significant energy to ensure that this new program launch is executed in a high quality manner.

For the balance of the year, the U.K. team will remain focus on helping our existing members with the transition to the new program while simultaneously preparing for their January campaign drive.

Given the decision to pull back on marketing spend for the fall campaign; we expect relatively soft volume trends in the seasonally less important fourth quarter. We’re forecasting slightly negative paid weeks and high single to low double digits attendance to [inaudible] for the fourth quarter.

Moving on to Continental Europe, overall, the CE meetings business revenue grew 6% in Q3 versus the prior year period, comparable to the Q2 trend. Paid weeks for the third quarter were up 4% and attendances were down slightly at negative 2%. While we’re seeing varying levels of growth across most of our markets in Europe, the key exception to this is France.

In the third quarter, France was hit hard by a new fab diet referred to as the Dukan Diet [ph]. This diet is very similar to the low carb Atkins Diet that was extremely popular in the U.S. back in 2003 and 2004. We believe it is an extreme diet that results in short-term weight loss, but will ultimately be rejected by the French consumer. Nonetheless, it is having an impact not dissimilar to what the U.S. experienced with Atkins seven years ago. As Atkins came in like a tidal wave, it seemed to recede almost as quickly, we expect the same in France.

Notwithstanding short-term competitive issues in France, the European teams are hard at work writing their winner marketing campaigns. We believe our biggest opportunity in Europe next year is to develop marketing campaigns that connect solidly with consumers who have never been to Weight Watchers before, the segment we refer to as Never Members.

The ProPoints launch campaign in Europe largely focus on reactivating laps members and somewhat ignored the triggers needed to bring in Never Members. This in turn has limited the total impact that this important new program has had in this region. The implications of these are twofold.

First, the European management teams are working hard on new campaigns that will be more effective for January. In general, we need to develop much more compelling marketing in Europe that cuts through the clutter and presents a modern and contemporary image of Weight Watchers that will appeal to Never Members.

Second, our U.K. and U.S. teams have incorporated the learnings of the CE launch into the preparation for their respective program launches this year. Accordingly, we expect the U.S. and U.K. marketing campaigns to be much more effective in delivering the news of the new programs to never members as we end the January.

The fourth quarter is a seasonally very slow time of the year for CE and is therefore more volatile from a volume perspective. CE is being negatively impacted by two factors in Q4. One, the continued competitive issue in France and two, lapping [ph] the soft launch in ProPoints last year, therefore, we expect slightly negative paid weeks for Q4 and attendances to be down in the single digits.

Moving on to WeightWatchers.com. The WeightWatchers.com business continues to surpass our expectations. In the face of a difficult consumer economy, this business reached new highs in the third quarter of this year. Q3 internet revenues were up 22.5% on a constant currency basis versus the prior year period, an improvement over the plus 20% trend we experienced in Q2 and a substantial improvement over the plus 10% trend we saw in Q1. Paid weeks for the Weight Watchers Online product were up 26% for the third quarter versus the prior year period and end of period active subscribers were up 27%.

Growth in our internet businesses was geographically strong across the board, particularly in the U.S. despite the fact that our U.S. internet products has been available for much longer than in many of our newer international WeightWatchers.com markets. All of our evidence continues to show that the driver behind the acceleration and the growth rate for the online business has been marketing and word of mouth buzz. We’ve been able to continue to drive growth through a combination of compelling advertising, effective promotions and increasing media weights.

Importantly, we’ve been able to increase marketing investment behind this product, while experiencing lower cost per acquisition. We believe that the outstanding growth of the online business is also a reflection of the consumers increasing receptivity to Weight Watchers. It’s worth nothing that we are able to maintain stable paid weeks in our North America meeting business, while growing online paid weeks in the mid-20s.

As a result, total combined paid weeks in our North American business were up 11% in the third quarter, a clear demonstration of the consumer’s acceptance of our brand and approach.

For the fourth quarter, we’re forecasting 25 to 30% online paid week’s growth and upward revision of our forecast from last quarter. We’re now forecasting internet revenue growth from greater than 20% for the year as this business is approaching the $250 million annual revenue mark. It is also worth noting that this high margin business will help to close the 25% of total company operating income for the year.

On the product development front, we’re preparing for several key releases in Q4, including the upgrade of the online product for the new programs, our first iPad application launch, iPhone application launches in the U.K. and Australia and new subscription sites for Belgium and Spain.

Now, I’d like to turn the discussion over to Ann, who will elaborate further on our Q3 performance.

Ann Sardini

Thank you, David and good afternoon, everyone. Recapping our financial results for the third quarter. Third quarter revenues of $330.6 million increased 1.9% on an as reported basis and we’re up 3.5% on a comparable constant currency basis. Constant currency revenues grew 0.4% in the meeting business and 22.5% in the WeightWatchers.com business.

Net income of $44.4 million in the quarter, was 15.5% or $8.1 million below the Q3 2009 level. For comparability, there’s an adjustment to last year’s third quarter expense, which should be noted. The adjustment relates to the adverse court ruling we received with regards to the leader self-employment status in the U.K. The ruling, which resulted in a charge to last year’s fourth quarter, $1.1 million of which related to the third quarter of last year has a similar ongoing impact for each quarter going forward.

After making these adjustments to the third quarter 2009 for comparability, net income in the third quarter of 2010 declined by 14.3%. Third quarter net income was negatively impacted by a $6.5 million of pre-tax expense associated with the pending settlement of litigation in California and by $2.4 million pre-tax of incremental interest expense versus the prior year quarter resulting from the debt extension that we undertook earlier this year.

These items together accounts for 73% of the net income decline versus the prior year quarter. Reported EPS was $0.59 versus $0.68 in last year’s third quarter, a decline of $0.09. Adjusting the third quarter 2009 for the U.K. self-employment charge reduces Q3 ‘09 EPS by $0.01 to $0.67. Third quarter 2010 EPS of $0.59 is $0.08 behind the prior year adjusted level with $0.05 of the difference resulting from the charge taken in anticipation of settlement of the California litigation, $0.03 related to expenses associated with the upcoming fulcrum [ph] innovations in NACO and the U.K. and $0.02 related to higher interest expense.

I’ll now review the financial results of operation. Our Q3 2010 operating income was impacted by the $6.5 million charge related to the pending California litigation settlement and came in at $90.4 million, a 10.7% decrease versus the third quarter of last year on as reported basis in constant currency and after adjusting for the U.K. leaders self-employment ruling previously discussed, operating income declined by 8.3%.

In the review thus follows, I’ll discuss our operating performance on this currency neutral adjusted basis. On this basis, our operating income margin declined 350 basis points versus the third quarter of last year to 27.4%. The impact of the $6.5 million of expense in the quarter related to the pending settlement of California litigation was to reduce the OI margin by 190 basis points.

With gross margin virtually flat versus prior despite cost associated with the new program launches, the remaining 160 basis points that decline was the result of higher marketing and to a lesser extend G&A as the percentage of revenues, all of which I will review later in this report.

Summarizing global volume trends in the quarter, global paid weeks of $34.3 million grew by 10.7% versus the prior year quarter, improving on the second quarter’s 7.7% gross level. Third quarter global attendance declined 4.8% as compared to the third quarter of 2009, roughly on par with the second quarter’s 4.4% decline. But markedly ahead of Q1 12% decline.

Third quarter online end of period active [ph] for cyber growth continued the strong trend experienced in the second quarter, increasing by 27.4% in the third quarter versus prior year.

Looking now at the meeting business. Paid weeks in the meeting business grew 2.6% globally in the quarter driven by increases in NACO and Continental Europe. NACO’s improving trend and recruitment and monthly pass retention brought meetings paid weeks in this business to a positive 2.8% growth level versus last year’s third quarter. In Continental Europe, paid weeks grew by 4.1% in the quarter, deferred by the first half of the year success of the innovations in driving recruitment and increasing monthly pass penetration.

In terms of third quarter attendance versus prior year, NACO is down 3.8% and the Continental Europe attendance decreased by 2.1% and U.K. was down 9.4%.

Lecture income revenues of $190.6 million were 1.1% per ahead of the prior year quarter. A change in revenue mix more towards value price monthly pass partially is a respond to increase promotional activity, resulted in a 1.4% decline in lecture income per paid weeks. Higher penetration of monthly pass however results ultimately in longer retention and increase revenue over the customer life cycle versus the pay-as-you-go payment model.

In meeting product sales were $52.2 million globally in the quarter, up 1.4% versus prior, but up a strong 6.4% on the per attendee basis. NACO’s product sales per attendee increased to 8.4% on the strength of promotions as cleared the inventory and advance to see upcoming innovations. Internationally, strength in Continental Europe and product sales per attendee grew over 4.9% increase.

In the WeightWatchers.com business, third quarter paid weeks lead by 26% driving 22.5% revenue growth to $60.5 million. The online business was strong across all major markets, a combination of strong retention and signup growth.

Our other revenues comprised of licensing, franchise commissions and revenues from our publications declined 8.6% in the quarter to $20.2 million. Our licensing revenues of $14.4 million in the quarter, decreased by 4.3%. Licensing continues to be impacted by the weak economy and changes in consumer discretionary spending habits. Franchise commissions, which totaled $2.8 million in the quarter, were down 0.7%, with U.S. franchise commissions up 1%.

The third quarter growth margin was 54%, 50 basis points below the last year’s third quarter, adjusted level with all of the decline attributable to expense associated with the pending House Lending Litigation Settlement, a portion of which is included in operating expenses. A combination of factors contributed to flat versus margin performance in the quarter versus the prior year level.

On the positive side, consolidated gross margin benefited from WeightWatchers.com gross margin expansion as well as from the impact of higher meeting averages resulting from our meeting consolidation strategy in NACO and some of our presently European countries. These benefits were offset by the collectively impact of the significant expenses associated with the upcoming program initiation launches in NACO and U.K. as well as by the impact of lower product margins as we cleared inventory in anticipation of those launches.

Q3 marketing expense was $39.4 million, up 12.2%. In the NACO and Continental European businesses, incremental media and television production expenses resulted in higher marketing. In WeightWatchers.com [inaudible] marketing expense investment versus prior efficiently drove online signup. Marketing as a percent of revenues were 12% in the third quarter of 2010 as compared to 11% in the third quarter of last year.

Q3 G&A expenses were $48.6 million, a 20.1% increase over last year. Excluding expense associated with the pending settlement of the California litigation, a portion of which is included in G&A, G&A expenses rose 8.1%. This increase was primarily the result of investing in business consulting services to assess future growth opportunities in NACO and higher technology expenses from increased depreciation and continued investment in the website. As a percentage of revenues, G&A was 14.6% in the third quarter of 2010 versus 12.6% in Q3 2009.

Interest expense in the third quarter 2010 was $19 million, up $2.4 million or 14.1% in the Q3 2009 levels. The increase is a result of higher portion of our debt being hedged as well as higher interest expense rising from our recent debt extensions. Our effective interest rate in the quarter was 5.06% as compared to 4.19% in the third quarter of last year. Our current projection for interest expense in 2010 is approximately $76 million to full year.

Our cash flow from operations in Q3 2010 was $108.6 million before interest income. After capital expenditures of $6.6 million, we had $102 million of free cash available. We returned cash to our shareholders through payments of our quarterly dividends of $13.2 million and by repurchasing $48.6 million of our stock.

In addition, we made interest payments of $18.1 million and reduced our debt by $17.8 million. We ended the third quarter 2010 with $1.39 billion of debt as compared to $1.74 billion at the end of the third quarter 2009.

Now, I’ll turn it back to David.

David Kirchhoff

Thank you, Ann. As we begin to wrap up 2010, it has been a year of mixed results starting with a weak first quarter and then a stabilization and improvement of our NACO meetings businesses in Q2 and Q3 and an acceleration of our online business during the same period. All of our research continues to show that the consumer is still under considerable stress and remains highly anxious about the economy and their ability to make ends meet. Accordingly, they continue to be incredibly cautious with discretionary spending of across categories including weight loss.

In that context, the improve trends of Q2 and Q3 have been heartening as we believe that they are reflection of our improving level of execution in our business and a strong testimony to the inherent appeal of our online business.

We began this year with a series of initiatives to transform our business over the next three to four years. Step one, marketing. A North American team did an excellent job in significantly improving the impact of our advertising campaigns with the launch of the Jennifer Hudson theme marketing for the meetings business as well as our new Weight Watchers Online spots. This advertising taps into the power source of the Weight Watchers brand are members in the way that clearly communicates our uniqueness and our relevance in dealing with weight and lifestyle issues. We have numerous opportunities now to build on this success in the U.S. market to make similar gains in our international businesses. This starts with the upcoming January campaigns.

Step two, transform our retail infrastructure. Beginning this year, the U.S. took a significant opportunity to change the face of Weight Watchers on the ground. There was the time that a hidden Weight Watchers made sense, when obesity affected 10% of the population. Obesity is now a mainstream majority issue and its time address it in the bright light of day.

Accordingly, it’s time for Weight Watchers retail presence in more visible convenient locations with bright store fronts and more modern designs. We’ve now effectively completed the full conversion of our two pilot markets Tampa and St. Louis. I bend down to both of them before and after the transformation and I was struck by the significance of the shift in our now street visible presentation.

Final touches and center launches were occurring throughout September and October, so it’s still too early to get an accurate read on results although preliminary data points are encouraging. As of the end of this year, we will renegotiate a move to approximately 90 leases or 12% of our total network. This work will continue over the next two years and will be largely complete by the end of 2012.

Step three, invest in technology. Technology has become an increasingly important part of our weight management offerings. For the past 10 years, we’ve invested steadily in new country launches for Weight Watchers Online and monthly pass now available in eight countries with more to follow. Our continued investment in product development including social networking and mobility has been critical in improving the utility and appeal of our offerings to both online subscribers and monthly pass members. We plan to continue and to accelerate the pace of product development going forward.

Step four, modernize the program. We launched a major program innovation in Continental Europe late last year. The learning from this launch have been tremendous from a training, member service or marketing perspective. Armed with these learnings, we now look to introduce major program innovations in the U.S., U.K., Australia and Canada. They will be officially available beginning in November on a staggered basis with full marketing pushes during our traditional January marketing campaigns.

It is not our intention to use these earnings call to present the value proposition of these new programs to the public. So, we’re remaining circumspect on the specifics for each country until we have fully launched in all four markets. However, I can say that I believe that these new programs will set a new framework which will substantially transform the eating habits and choices that we all make in a healthier way.

This program will represent an even stronger platform from which we will build our education and behavior change efforts going forward. Suffice to say, I’m excited and optimistic about its long-term impact on our meeting members and online subscriber success.

Step five, innovate our offerings and open to channels. It is increasingly clear that obesity has become one of the most significant health issues affecting the U.S. and other industrialized countries around the world. By way of example, Diabetes is currently a $174 billion condition in the U.S. alone. Several weeks ago, the CDC estimated that the incidence of diabetes would triple to one out of every three Americans by the year 2050 creating a health condition that many say could bankrupt the healthcare system.

As we’ve noted on prior calls, Weight Watchers is uniquely positioned to play a significant role in addressing this issue as a result of our approach in model, which is one clinically demonstrated with over 60 clinical publications over the past 15 years. Two, low cost but only $9.22 per week for monthly pass and $4.43 per week for online in the U.S. Three, scalable with almost 50,000 meetings per week globally, addressing the needs of 1.4 million in our meetings each week and another 1 million people online. Four, oriented toward lifestyle-based sustainable weight management.

Simply stated, Weight Watchers is the only as scale provider of education, behavior modification for weight management in the world. Our position uniquely situates as a key player in addressing obesity from the healthcare perspective. By forming the right partnerships and relationships with various constituents in the healthcare system, including doctors, payers and public health organizations, we can open an entirely new channel of access to bring in members into our program.

To this end, we recently entered into a partnership with Merck to collaborate to educate doctors in the U.S. on the effectiveness of the Weight Watchers Lifestyle Approach. We expect to begin a major pile of this collaboration this coming January. I expect to have more news on other initiatives supporting this business for us in upcoming calls and presentations.

With all these initiatives, my team and I are excited and optimistic for the future. While some will take time to fully bear fruit, we believe we’re already seeing some of these benefits and they should become increasingly apparent as we fully rollout these initiatives over the next few years.

Weight Watchers has a crucial role to play in being the first sign of defense and offense in addressing the obesity epidemic. We believe that we’re taking the right steps to allow us to increasingly capture this opportunity, fulfill our mission and generate shareholder value simultaneously.

Regarding our EPS outlook for the year, we’re providing a new range of $2.42 to $2.47 per fully diluted share. This new earnings guidance now includes a $0.05 charge for the pending settlement of the California lawsuit, which was not included in our prior guidance range of $2.35 to $2.50 per fully diluted share.

At this time, operator, we would like to take questions.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) First question is from Bob Craig from Stifel Nicolaus. Please, go ahead.

Robert Craig – Stifel Nicolaus & Co.

Thank you, operator. Good evening, everybody. Hey, Bob. Just a couple of questions on a monthly pass to start off. I wonder if you could update penetration rates by geography and also comment on any disengagement that you’d be experiencing there.

Ann Sardini

Well, in terms of the penetration rates, they’ve gone up kind of across the world. As I’m looking at NACO, they’ve gone through up 65% to about 70% of our attendances monthly pass. The U.K. has gone about five points and kind of the rest of the world as well. As we’re looking at the U.K., we’re in around 65% range, and if you’re looking at the major European countries, you’re about 80% penetration of the [inaudible] for monthly pass. We haven’t seen any decline in retention at all. It’s actually doing very well.

Robert Craig – Stifel Nicolaus & Co.

Okay. Would you expect that 80% level that you’d achieved in Continental Europe? Is that a pretty good target for your other geographies or is there some limiting factor to some of the other geographies that may not exist there.

David Kirchhoff

As we’ve always said, the theoretical limiting factors on monthly pass is one internet access and two the willingness to use in a credit card and a recurrent billing model. I think each year what we’ve seen is to varying different levels, increasing penetration rates. With the U.S. being how it is right now and frankly, with a lot of European countries being at similar and sometimes higher ranges, we feel pretty good about the penetration we’re achieving but we’ve always frankly surprised ourselves a little bit with the fact that the penetration seems to keep pushing its self-up.

So, on one hand, it’s difficult for me to imagine, obviously, 100% penetration given some of the aforementioned constraints that I just mentioned. But I don’t have any specific data that would necessarily put an absolute feeling on this, above and beyond say I don’t know 90 or 95%. How long it takes to get there, I think, is to be determined.

Robert Craig – Stifel Nicolaus & Co.

Okay. I know you don’t want to divulge a lot of information about the innovations. But it was certainly been on the U.K. website looking at the ProPoint’s information there. is it a more accurate way or an accurate way of describing of what you might be doing here that really revolves around the more accurate way to assess points values based on food characteristics and how the body processes foods. Is that the general gist of what you’re going to be doing in terms of the innovation?

David Kirchhoff

I appreciate and understand the desire for additional clarity behind it. I think that it’s very important to us that we make our first priority to get the launches as strong as we possibly can and to get messages out the best way possible. Given that this is a public forum, that’s why we really don’t want to use this as a way of talking about the value proposition of the innovation. So, I apologize terribly with the fact that I can’t go into greater detail in terms of what I see as sort of the underlying ump [ph] behind this. But we’re not too many weeks away from that.

Robert Craig – Stifel Nicolaus & Co.

Okay, that’s understandable. Last one, I’ll turn it over. Can you give some sort of guidance here as to what your plan is in terms of marketing spend at least as a percentage of revenue as we head into the launch here in the fourth quarter.

Ann Sardini

We’re looking at a higher percentage of revenues of course than what we’ve seen in the third quarter and it will exceed also what we spent last year in the fourth quarter. So, I think you probably looking at somewhere in the range of what we did in the second quarter, a little bit less than that as a percentage of revenue.

Robert Craig – Stifel Nicolaus & Co.

Okay, that’s great. Thanks guys, I appreciate it.

Operator

Thank you. The next question is from Chris Ferrara from Bank of America. Please, go ahead.

Chris Ferrara – Bank of America

Hey, guys. How are you?

David Kirchhoff

Hey, Chris. How are you?

Ann Sardini

Hey, Chris.

Chris Ferrara – Bank of America

Good, thanks. I guess can we start out with pricing. I know there is – there’s a couple of things going on, I guess, affecting product sales per attendee and one of them seems like it’s the monthly pass while another one is just promotion and pricing. I know I think you mentioned something about in the mix that more of your mix when we talk about monthly pass; we know it’s a little less expensive. There’s a discount on it, but you also mentioned something about promotion on it.

So, I guess how do I think about that and how do I think about modeling that going forward. I mean this monthly pass hit sort of a high penetration rate in space there, will you then have sort of negative pricing effect from there or will that be the end of the positive pricing per meeting that we’ve seeing or I guess I’ll leave it up as you guys talk. But I’m just trying to think about how I think about meeting this per attendance going forward.

Ann Sardini

I mean like the product sales piece apart from the monthly pass fees. I think there is, of course, a difference in price from pay-as-you-go. But overall you get the longer, the much longer retention which of course that’s the customer value. But there’s also – we have not raised the price of monthly pass in any market to this point in any of our major markets at this point and so there’s always a component potentially of pricing there as well.

In terms of the product sales, what we’re seeing a lot in the quarter is high product sales per attendee as a result of promotions to clear out inventory, so that’s really affecting what you’re seeing in terms of the growth in product sales for attendee in NACO and U.K. and some of the other markets. So, that will come down a bit as you go into the next quarter as we finish that process and start selling the innovation products.

David Kirchhoff

Yes. Chris, a couple of points I would just add on top is that a number of the promotions that we have been running in NACO as well as Europe have been oriented around increasing penetration of monthly pass as well as driving an overall lift in enrollment levels and as a result of that, what you sometimes see is a sort of short-term degradation of price per paid week if you will. But over the life of a subscription as Ann noted earlier in her remarks, it is absolutely accretive if you want to think about it that way on the pricing point of view versus the pay-as-you-go model.

So, you could look at price realization for attendance or price realization for per paid week, price realization per paid week in a world with greater monthly pass penetration will by definition be lower than it is, say pay-as-you-go because by definition its value price. But the flipside is that you have such longer retention over a base of attendances that your price per attendance actually expands.

And so, my view is that we’re doing a better job capturing value in each enrollment cycle and so if one looks really sort of pricing, at sort of value achieved per enrollment cycle in revenue attrition, I think we’re doing much better.

Chris Ferrara – Bank of America

That makes sense. Are you guys promoting, it sounds like I guess you just said that you’re promoting more around increasing penetration for monthly pass. I mean do you think also from a tool that you guys hadn’t use a lot in years past, is it sort of a new tool that you’re using and should we expect more of those promotional price points on monthly pass around the innovation in November as well. Is that a good way to think about it?

David Kirchhoff

I think it’s a really astute observation. That in some sense we’re obviously have promotions in our tool kit, our marketing tool kit if you will typically in the form of free registration. But what has been important to us and one of our holy grail goals is to find a way of advertising more consistently over the course of the year and what we find is that increasingly we’ve come to the view that there’s this dimension of our business which is very similar to a classic retail model in which if you’re going to put advertisement out and marketing out, its substantially more effective when combine with a good clever promotional tag to drive action.

By way of example, we were able to actually advertise for NACO meeting business this July, continuity advertising in a period that we traditionally have not been successful in advertising in. We were able to do it because we were able to come out with a good promotion; in that case it was Join for Dollar.

And so one of the things we’re doing is we’re doing more promotion of some level that in a way that will allow us to stay on air longer and to keep our message out there longer because people are trying to lose weight all the time and so therefore, one of our objectives is to always be there whenever they have the impulse to take start of a weight management effort, and it’s therefore very necessary that we have some sort of promotional hook present. That said we’ve very careful in making sure that any promotion we do provides lift and excess of any discount given and so all of our promotions are going to be absolutely revenue accretive and margin accretive ultimately over the duration of each enrollment cycle.

And so, I give our marketing teams a lot of credit for really getting a lot, lot better at integrating smart effective promotional strategies combined with harder hitting and more compelling above the wide advertising. So, this is sort of an increasing level of competence and capability, I would therefore say in our marketing efforts.

Chris Ferrara – Bank of America

Great. That’s really helpful. I appreciate that. I guess one of them on the dotcom and this question probably becomes more, more relevant as you watch paid weeks and dotcom creep above NACO paid weeks, right. I think you might have mentioned a little bit earlier. How do you think now about cannibalization because I think in the past, it wasn’t big enough? It didn’t matter as much as now. It’s got to be very really concern, right? That it’s going to be hard to grow meeting attendances and meeting paid weeks in North America with dotcom doing as well as it has and I think you kind of said that it was good you kept it flat despite the dotcom growth.

I mean so how are you thinking about that going forward? Can both of these aspects as a business grow at a robust rate?

David Kirchhoff

Yes. I mean call me a glass, 7/8 full kind of guy, but anytime I have a 200 or close to $250 million business unit that’s growing 20% a year with really high margins, it generally makes me pretty happy. So that’s kind of my starting point.

With the specific question as to whether or not dotcom is cannibalizing the meeting business, this continues to be our view; we have segmented the weight-concerned consumer a 100 different ways to kingdom come and what we find consistently is that the relevant dimension of understanding different types of consumers is that different people need different things to make an obvious point.

What we find is that there are those consumers out there that are interested in the benefit of a structured program like Weight Watchers, who want access to tools and things that will help them lose weight, but generally are looking for a less intensive form of help and these are people who otherwise wouldn’t have been in the Weight Watchers franchise at all, if you will. And these are the people that largely we believe are bringing into the Weight Watchers online business.

Whereas what we find consistently is that people that are interested in a more intensive form of health that has the benefit of the accountability of an in-person weigh in, personal support by a person who’s face they can see and the supportive education that comes from the community experience, those people continue to gravitate towards meetings.

Now, I look at the NACO results from the following way: First off, if I think about the less of the recession, the dotcom product, the online product has a relatively lower price point and $17.95 per month. therefore, those consumers that were predispose to the dotcom product, it was more of an incidental purchase for that segment of consumers than say, for example, monthly pass which is $39.95 per month would be for the ones that were predispose toward meetings. And so, therefore, it’s hard to believe that the recession have a disproportionately harsh impact on the meetings business.

But the fact that the online business within its segment is growing at the rate it is, in the face of a difficulty economy, we view as tremendously good news. Our strong belief based on everything we’ve seen continues to be that Weight Watchers Online is substantially incremental. I take some comfort in that assertion because again Weight Watchers Online in the U.S. really started to fly off the shelf on April 1st, which is the same time we also saw an immediate positive shift in the enrollment trends for the NACO meeting business. In other words, they both shifted up at the same time.

So, the fact that we’re having unprecedented growth in the online business over the past few quarters, wow, actually making some positive traction, which we believe we can continue to push forward as we go into the coming years. With our face to face product, the meetings business, we think is a good example of how these two businesses ultimately reinforce themselves to build the case even further. What the growth of the online business has allowed us to do is increase marketing investment to get that product, which has allowed us to significantly increase overall marketing spend in the North America which has accrued overall benefits to the brand.

So, therefore, as a result, if you look at North America, total participation in the brand, if you define it as a number of paid weeks, which is effectively approximately if you will of the membership base is up 11% versus the prior year period, which I think is a really good result. As I look forward, particularly with the meeting business and I think about the role that it has to play, the fact that the face to face experience works as a behavior modification vehicle clinically speaking, particularly as I think about tying into the healthcare system, I think that the role of our face to face product meetings is going to play an increasingly important role. I don’t see that going away. I think both products have their own appeal to their own different segments.

Chris Ferrara – Bank of America

I appreciate all that color. Again, I just want to ask one – when does the – so the incremental expenses around launch in the cost of goods sold for the quarter. When do we see that cycle through it all? Because I mean it seems like the dotcom mix alone should have contributed like 50 basis points to gross margins this quarter, I would imagine and certainly the higher number meeting, attendances per meeting would’ve probably done something similar. It looks like a pretty sizeable number, I mean can you quantify it and just talk about what the timeframe of this is.

Ann Sardini

Yes, it’s about $4 million in the quarter and it ends in the quarter actually. So, it’s self-contained in the third quarter.

David Kirchhoff

Yes, I mean Chris to build on Ann’s point, if you go back to the gross margin of the meeting business; there were three what I’ll call sort of one-time things that had a negative impact in comparing gross margin for Q3 of the meetings business. First is Q3 last year. Obviously, there’s the $4 million that Ann referenced, the program innovation. But there were also issues, as you heard her mentioned there were some impacts from the legal settlement as well as the comparability issue due to last year with the U.K. self-employed change of status.

And so, if you take those things out, gross margin and the meeting business was effectively flat year-on-year. And then if you further look at gross margin within the meeting business, on the plus side you have the meeting average going up, which accreting gross margin. On the downside, you have product sales margin and Q3 was down, but a lot of that had to do with clearing inventory, again in preparation for the upcoming innovation.

Chris Ferrara – Bank of America

Right, that’s helpful. And you guys, I guys you don’t want to give the breakout of the legal settlement by SG&A versus COGS.

David Kirchhoff

Not at this point.

Chris Ferrara – Bank of America

Well, I really appreciate all the time. Thanks, guys.

Operator

Thank you. The next question is from Ken Goldman from JP Morgan. Please, go ahead.

Ken Goldman – JP Morgan

Hey good evening, everyone. WeightWatchers.com, I’m going to play double dab that I have a particular opinion on it, but I’m going to play the negative side of it. What bites is there, right? If there’s – you guys mentioned obviously it’s doing great and you mentioned that it’s doing better than you expect, what’s causing it to do better than you expect and we’re seeing great growth right now. What would cause that growth to slow down in the near-term or in the long-term, obviously there’s a law of large numbers. But just thinking about what’s driving that growth and what may stop that growth from moving up unless you guys some more marketing support behind it.

David Kirchhoff

I think it’s a great question. In terms of you look at these growth rates and you say, “Gee, that’s pretty impressive. What do you do for an encore, if you will?” Certainly, there’s going to continue to be an opportunity to continue to press against marketing both in terms of makes it more effective as well as where we can get the right kind of efficiency to increase and continue to increase and weight against it.

My starting point is I always go back to the fact that the share population, a 135 million people in this country has a weight issue. And so, even as excited as I am by how big this 1 million global subscriber base is, in so many ways I feel like we’re still just scratching the surface in terms of the kind of the impact that we can have both in our online and the short-term, but also frankly in our meetings business going forward. I think for us to stay on our game, what we’re going to find is that the only space in theory is you can argue it’s a more competitive space.

A little bit the way I look at that is a little bit different because it’s not like other people haven’t made a play for the online space. They generally haven’t been successfully because frankly they don’t really have a program and they don’t really have a brand that has a lot of credibility with consumers. The biggest thing that I’ve always have going for us with Weight Watchers Online is the Weight Watchers name. People come to our website on their own. It’s a significant part of our traffic. Its traffic that we don’t have to go out and buy, which has allowed us to maintain fairly cost effective, cost per acquisition, which somebody who is trying to do DietsAreUs.com would have a much harder time with.

And so, with that, what’s that always allowed us to do is to invest money back into product development, which we continue to do with gusto and what that’s allowed us to do is continue to push ourselves to both stay trend and I think increasingly stay ahead of trend in terms of continuing to press an aggressive product development agenda and the best examples of this is that – yes, everybody’s got an iPhone application, but we designed in my perspective our iPhone application the right way. it is an application that from day one was designed with cohesion and synchronicity with the website in mind, so everything’s perfectly synchronized in a way that I think really creates a compelling value proposition, particularly because I can’t tell you how many subscribers and members in our meetings I’ve met, who now tell me that they’re more regularly tracking their points because of the ease and convenience of having a great mobile application.

That statement is 10 times more powerful, I would argue when it’s anchored in a respected clinically proven program. In the case of monthly pass, surrounded by a face to face group support system, I think that our product development efforts have that much more power and impact. But to be clear, the onus is on us that we have to stay within or in front of what’s going on out there or somebody’s going to sneak in. So that’s one of the reasons why you’re going to continue hearing us talk about increasing investment both in marketing and product development with the online business, which by the way also accretes benefit to the meeting business because monthly pass gets so much of the same functionality that you see in online.

Ken Goldman – JP Morgan

Thank you for that. One more for you and then one quick one for Ann, if I can. There’s a lot in your plate right now and that’s a good thing, right. You’re rejuvenating the centers. You’re closing some other centers down. You’re introducing the new ProPoints plan; you’re moving it over from overseas. I won’t rehash all of it, but are you comfortable that that’s all okay to do at once or do you feel that there may be more people that need to be brought in on the management level. It’s hard for us to tell on the outside exactly how smoothly some of those transitions are going. So, if you can give us some idea of how you feel you’re capabilities are, not as you as individual but as Weight Watchers as a whole of handling all that, that would be helpful.

David Kirchhoff

Well, my general preference would be to talk about how wonderful I am and how much I’m making all this happen by myself, but certainly …

Ken Goldman – JP Morgan

Of course.

David Kirchhoff

It’s just not the case. Honestly, we really have an incredible and talented management team that makes us all look good. We’ve got a great team in international that’s making a lot of amazing things happens. They’ve been a serious force of innovation for us as an organization. As you readily pointed out, they made a major leap in their program which we’re now attempting to successfully build on in our English speaking markets.

I’ve got a fantastic running North America. We hired Dave Burwick out of PepsiCo, who is now leading North America for us. He’s got a great team. He’s a fantastic leader. Melanie Stubbing is a great leader for International. Mike Basone is a great leader for dotcom and feels like an Oscar’s acceptance speech. But I guess my point is that we really do have the strongest management bench that we’ve ever had and that’s not just with just folks and the people who are running corporate, but it goes now layers down.

And so, I feel that this is definitely an organization that’s pretty stretch in terms of the number of initiatives that it’s doing. But I also feel this is an organization that’s smart about where to add resources in places that can drive investment and performance in our business, so that we can maintain a grip on our cost structure while still making sure that we’re capturing all of our opportunities.

Ken Goldman – JP Morgan

Okay, thanks. Ann, one quick one, can you – I know it’s maybe a little early. But can you give us some sense of cash used to pay down debt next year. I think there’s a little bit more coming due in 2011 and 2010, maybe just some parameters or some guidelines for that would be helpful.

Ann Sardini

Sure. Our kind of required pay down next year is about $166 million.

Ken Goldman – JP Morgan

And do you expect to pay that plus or is that kind of what you’re thinking will be the number?

Ann Sardini

Well, as is kind of the always the case, we kind of weigh that the pay down against other opportunities that might come along, franchise acquisitions are always a question for us, share buyback program you know about. So, we’re kind of weighing our cash flow opportunities against those kinds of three things. So, I’m not ready to say at this time.

Ken Goldman – JP Morgan

Okay, I tried. Thanks, guys.

David Kirchhoff

Thanks, Ken.

Operator

Thank you. The next question is from Greg Badishkanian from Citigroup. Please, go ahead.

Greg Badishkanian – Citigroup

Hey, great. Thanks. Hey, just wondering maybe if you could give us a little bit of color on kind of the trends that you’ve been seeing in October, early November, if you can versus that kind of that third quarter trend.

David Kirchhoff

First off, great to hear from you, Greg.

Greg Badishkanian – Citigroup

Yes.

David Kirchhoff

It is November 9th, I think. So, it would be a little bit crazy for me to put too much about November time [ph], but excellent try. I think the October trends in the forecast that we gave for Q4 for each of the respective geographies were really done with the October trends in mind. So, what we’re seeing in NACO through October is very similar to what we’re seeing through the third quarter and that what gave us some comfort in making that prognosis, same with dotcom and same with U.K., same with CE.

Frankly, what is unknown is the potential impact that this up launch is going to have as we put these programs out and start going into December. Now, that said, the percentages could look kind of interesting but the enrollment levels in December are just so low in our business that it would be nice some extra pop for it, but I think it’s sort of more appropriate for us to remain prudent as we look at our forecast for the duration of the year.

Greg Badishkanian – Citigroup

Great. And just kind of on that lane, not to put you on the spot, but what type of kind of benefits would you see from the program in 2011 and if you don’t have maybe forecast for that, maybe as you look back over the last number of years, typically when you have an innovation at this level, what type of kind of bump up would you see in business trends?

David Kirchhoff

I think one of the reasons why it’s always – as you know the practice we have in terms of providing trends and forecast for the following year is that the Q4 call is usually a pretty important and interesting call, I think for the investment community. Less obviously because of Q4 results and more frankly because it’s our opportunity to give you a sense of how things are going because at that point, we have January under our belt.

Greg Badishkanian – Citigroup

Right.

David Kirchhoff

In January, it’s just such a high – it’s such a high impact month that a lot of the year sort of ends up hanging on it, not completely but wide.

Greg Badishkanian – Citigroup

Right.

David Kirchhoff

And so for that reason, I could tell you that program innovations like this absolutely provide lift. One could look at the CE first quarter, albeit it was somewhat impacted by bad weather and you could look at different analogs if you go back in time. I really think that the best advice I could give you is to let’s wait for that Q4 call, when we can give you a good read on what’s going on because at that point we’ll have much better data that will allow us to guide you in terms of how to shape out the rest of 2011.

Greg Badishkanian – Citigroup

Sure, yes. Absolutely. Just on the competitive landscape, any major changes [ph] in kind what you’re seeing on that landscape in the U.S., U.K., Europe, maybe kind of similar to, I’m assuming in France with the low carb. I’m assuming there’s nothing kind of major going on in the other markets like in France, right?

David Kirchhoff

Yes. France has been a really interesting experience. I’ll tell you interesting, I think for the French team, it’s not been very interesting. It hasn’t been that much fun for them, although they’re doing a great job of doing and responding what – and soldering their way through.

Greg Badishkanian – Citigroup

Right.

David Kirchhoff

But it’s been interesting for me because I feel like I’ve seen a lot of different countries that there will be a big fat diet, almost always a low carb diet comes and takes the country by storm and then goes away, and then we tend not to see it get replaced by anything else.

Greg Badishkanian – Citigroup

Right.

David Kirchhoff

That was certainly the case with Atkins. We saw something similar, for example, in the Netherlands, of all places and we’ve seen this pop up in a number of different countries. What I would tell you is that, not one we have never seen a competitive threat in the U.S. in terms of direct impact on our business that rivals what low carb through Atkins and South Beach, the impact that had in 2003 and 2004 because ultimately, the underlying methodology although it was presented with scientific credence was ultimately rejected by the scientific community and certainly, was ultimate rejected by consumers because it ask them to cut out entire food groups for them life forever.

So, what you found was that Americans were unwilling to do without bread and pasta and fruit for the rest of their life. So, they ultimately rejected extreme low carb diets and my guess is you’re going to see something similar in France. But France, they never had their Atkins and so I think that’s what’s going on in that country. We really have seen very little impact of that particular low carb diet outside of the country and in fact, if you look at a lot of these sorts of hot fad diets, most of them are spread by kind of PR and word of mouth, and PR and word of mouth, particularly in Europe from Dr. Dukan is going to be in the French language. So, you can imagine it doesn’t convey that well over borders.

So, outside of France, I have to say, knock on wood, it’s been pretty quiet. Certainly in the U.S, if anything, it seems that there’s been kind of serial knocking down of obesity medications over the past couple of months. So, if anything, it kind of feels like we’re even more sort of left standing out there as the primary solution to addressing obesity.

Greg Badishkanian – Citigroup

Right. I mean it’s interesting because as you were saying that I was looking at my model. We’re covering you back in ‘03 and ‘04, you had about eight quarters of negative attendance, organic attendance growth and then it turned positive again. In Continental Europe, actually never really felt the impact from Atkins. That’s why it’s a little bit surprised particularly in France, just given their culture that that would be, would’ve taken hold at this point.

David Kirchhoff

Yes, I agree with you.

Greg Badishkanian – Citigroup

Great. Hey, thanks for the time.

David Kirchhoff

Absolutely.

Operator

Thank you. This concludes today’s question session. I would now like to turn the meeting back over to Mr. Kirchhoff.

David Kirchhoff

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

Operator

Thank you. The conference has now ended. Please disconnect your line at this time. We thank you for your participation.

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