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NutriSystem Inc. (NASDAQ:NTRI)

Q4 2010 Earnings Conference Call

February 24, 2011, 4:30 pm ET

Executives

Joe Crivelli – SVP, IR

Joe Redling – CEO and Chairman

David Clark – CFO

Analysts

Alvin Concepcion – Citi

Mitch Pinheiro – Janney Montgomery Scott

Kurt Frederick – Wedbush Securities

Greg Rashar – Lazard Capital Markets

Operator

Good day, and welcome to the NutriSystem’s fourth quarter 2010 earnings conference call. As a reminder, today’s conference is being recorded.

And this time I would like to turn the conference over to Mr. Joe Crivelli. Please go ahead, sir.

Joe Crivelli

Good afternoon, everyone. Thank you for joining us to discuss NutriSystem’s fourth quarter and full year 2010 financial results. With us today from management are Joe Redling, Chairman and Chief Executive Officer; and David Clark, Chief Financial Officer.

Before we begin, I’d like to remind everyone that during this conference call, NutriSystem management will make certain forward-looking statements about its outlook for 2011 and beyond that involve risks and uncertainties. Forward-looking statements are generally preceded by words such as, believes, plans, intends, expects, anticipates or similar expressions.

Forward-looking statements are protected by the safe harbor contained in the Private Securities Litigation Reform Act of 1995. Factors that could cause actual results to differ from expectations include, but are not limited to those factors set forth in NutriSystem’s filings with the SEC.

NutriSystem is making these statements as of February 24, 2011 and assumes no obligation to publicly update or revise any of the forward-looking information in this conference call.

I will now turn the call over to Joe Redling, NutriSystem’s Chairman and Chief Executive Officer.

Joe Redling

Thank you, Joe. Good afternoon everyone, and thanks for joining us on today’s conference call. We have a lot to talk about today, so let us get right into it. Today we announced our fourth quarter results, which were generally in line with our expectations and guidance for the year. David will review the financial results in more detail shortly and step through all of the puts and takes that got us to final 2010 figures.

So we ended the year with revenues of $509.5 million, operating profit of 53.2 million, and 12 months EPS of $1.12 per share. 2010 was challenging on a lot of levels. In the first-half of the year, many of the positive turns we saw in late 2009 carry over, and delivered sequential improvements in revenue and new customer trends. When we ended the June quarter it seemed the business was back on a growth trajectory. But in the second half of 2010, the tone of the business changed considerably with softness in customer starts and revenues, and we ended the year down 3% on the top line.

Focusing on Q4, its performance highlights, our ability to manage profitability at the top line was pressured. Revenues were in line with seasonal patterns as we continued to lag on year-over-year comparisons in revenue due to the strong performance of the NutriSystem D launch in 2009. Also noteworthy is the fourth quarter new product launch at a major competitor that created a great deal of interest, and also pressured our new customer starts in the last week of December. This is normally a strong week for us as we traditionally maintained a strong presence prior to the official start of the diet season in the first week of January. Despite this, we carefully managed expenses to drive a 33% increase in operating profit in the fourth quarter, and a 16% improvement in adjusted EBITDA. Full year results also improved as operating profits and adjusted EBITDA both increased 8%.

Margins were up across the board during the year, with solid increases in growth, operating, and adjusted EBITDA margin. Net income and EPS were up 17% and 22% respectively. This demonstrates the team’s ability to carefully control expenses and maximize profitability when the top line is under pressure. I am sure top of mind for all on the call today is the expectation for 2011.

As I mentioned, the relaunch of a major brand in the diet industry generating a lot of excitement with dieters beginning in the latter part of Q4, and continued to build momentum into January. This negatively impacted our start from the critically important first quarter diet season, and more specifically in the month of January. The foundation for our plan for the 2011 diet season was based on a comprehensive consumer insight study that was conducted in 2010. This quantitative study identified the key challenges and obstacles our brand and category faced with diet intenders and highlighted the key needs of important diet segments.

This effort was launched to gain additional insights and how to reposition our brand and increase penetration on this large and growing market. Out of that research we determined that food quality and variety, value and dieting motivation were the biggest obstacles for our brand and the category in general. Hence we leveraged our select program with our frozen food partner, Schwan, in order to dramatically increase the percentage of our customers receiving our highest quality food. And we launched a new campaign featuring real customers telling their motivational success stories in their own words.

While we still had creative in the market through our various channels highlighting our celebrity spokespeople, the new campaign was the main focus in our short form television advertising, as we proactively sought to expand our reach within the diet category. We reviewed the campaign using our quantitative testing process and the ads performed well resonating with customers and prospective customers, and enhancing our brand appeal.

In addition to the inclusion of frozen, in our base offering we also lowered the price to match our core ready-to-go program price aimed at a strong value proposition to prospective customers. In short, we thought we had thoroughly prepared for the 2011 launch and we’re hitting the market with a plan for success. Despite early indicators that the new campaign is moving soft metrics like brand appeal, consideration and purchase intent, it was clear that the campaign under delivered on the key performance measures of response and conversion.

Needless to say, we were extremely disappointed by the results. During the first three weeks of January, we saw significant declines in response and conversion across all of channels, and customer starts were considerably below 2010 levels on some days as much as 40%.

We believe there are three primary factors impacting our results in January. First was the intense competitive pressure from a major new product launch in the category, the first of its kind in many years from the largest player in the category. Second, dieting consumer was actively seeking deals and bargain shopping. We witnessed this behavior online as we tracked conversion of shopping to buying. And third, our new campaign and offer was ineffective and did not resonate with consumers. Our campaign focused on new frozen foods at a reduced price with one free week.

We had anticipated that this offer would be effective in the peak demand month of January. But the intense competitive environment, coupled with a highly promotional minded consumer was difficult to overcome. As we tested various rate card changes in early January, we found that in fact as we lowered price, we were seeing significant improvement in conversion. While we did have a reduced price point on the newly formatted select frozen product, it was still a $300 price point.

Two things turned the tide; first, as we recognized the need for a much more promotionally driven marketing, we relaunched our rollback price promotion in the third week of January. This effort spiked response, web traffic and call lines back to normalized levels. Second, we saw an immediate improvement in conversion rates across all channels. This resulted in reversing negative year-over-year customer trends, and shifting to strong increases in first-time orders.

In February, once our price rollbacks were funneled through all of our sales channels and reflected in our advertising, we saw excellent customer response. Since that time, customer starts are up consistently in the low double-digits compared to 2010. But the January declines coupled with aggressive price discounting were costly, and we believe this will have a detrimental effect in Q1 and full year 2011 performance.

We expect January declines to have a compounding effect as we roll through the year. New customers in late December and January typically drive significant margin gains with repeat orders throughout the year, and help to normalize the significant upfront advertising expenditures across a broader base of customers. If we fail to realize the surge in new customers, it impacts full-year results. Consequently, we are lowering expectations for 2011 and forecasting an annual decrease in revenues and net income versus prior year.

A number of factors contribute to the 2011 forecast. Anticipated continued competitive pressure throughout the year, expected lower revenues throughout the year due to the decreased number of first-time orders and to a lesser extent reactivation revenues in January, an anticipated hit to gross margin due to our price rollback promotion, which was introduced in late January. This promotion spurred demand and customer orders, but at the expense of margins.

Our continued focus on optimizing marketing efficiency and an estimated $9 million reduction in G&A in 2011 as a result of expense cuts, including a reduction in force that we implemented today. A challenging Q2 that we expect will be driven by strong prior year performance, as well as a late Easter holiday.

While it has been really reinforced for NutriSystem management as a result of 2010 and early 2011 that we need to accelerate our investment in new products and new channels. New product launches are needed to drive growth, and while we have introduced new segments over the past few years, we have not innovated our core offering. The lack of an exciting new product offering in 2011 and that we were focused on food-based offerings, marketing and pricing tweaks to generate customer excitement, an effort that clearly was ineffective in the face of a major competitive product launch.

So job one 2011 will be to optimize the core business and maximize profitability at the expected lower demand levels. Then we plan to accelerate core product offering innovation, develop new products to target specific diet segments, and explore expanding our channels of distribution.

We believe we have an opportunity to develop a broader array of offerings that are complementary to our existing business with the goal of having news on these fronts heading into 2012.

With that, I would like to turn the call over to David Clark, our CFO, to discuss the financials.

David Clark

Thank you, Joe. Before we go through the financial results in detail, let me say this, we are all disappointed with the start of 2011 diet season, and its implications for 2011 expected financial results.

But with that said, we still have a profitable business that we expect to generate revenues in excess of $400 million even in a down year. We demonstrated in 2010 that this management team can move quickly to adjust controllable expenses and protect the bottom line during tough times. This is also a business that does not consume a lot of capital, and now that the facilities consolidation is behind us, Capex should return to historical levels.

The entire NutriSystem management team is motivated to protect shareholder value in 2011, and to that end, we are reducing expenses with the goal of driving profitable full year financial reserves, positive cash flow and protecting the balance sheet. In addition, the board of directors have declared a $0.175 per share dividend payable March 17, 2011 to shareholders of record as of March 7, 2011.

Now let us go through fourth quarter results of 2010. For the fourth quarter of 2010, we generated $87.9 million in revenues compared with $105.5 million in the prior year’s fourth quarter. While this is a 16.7% decrease in a year-over-year basis, it is consistent with prior year’s history for sequential revenue change. Note that 2009 sequential change from Q3 to Q4 was tempered by the launch of NutriSystem D.

Gross margin came in at 56.5%, up from 54.3% the prior year. This is the second highest gross margin in the past two years, reflecting a considerable progress we had made to resume fulfillment and freight costs.

Marketing as a percentage of sales was 21.3% in Q4 versus 26.5% in the prior year. We made a concerted effort to manage our marketing spend in Q4, positioning our ads to run closer to the start of the January diet season, and this includes postponing the airing of new creative from late December into early January.

Our fourth quarter adjusted EBITDA came in at 16.9 million and our non-cash employee stock compensation totaled 2.8 million. Adjusted EBITDA margin was 19.2% versus 13.8% the prior year.

Q4 operating income from continuing operations was $11.4 million, and represented a 13% operating margin, the highest operating margin in the past two years, firmly demonstrating management's ability to maximize profits when revenues are under pressure.

Q4 fully diluted EPS came in at $0.25, which represents a significant increase from $0.09 in the prior year, that was primarily driven by cost control measures we implemented during the quarter in light of the softening demand trends that were exacerbated by a competitive relaunch within the category in December.

Now looking to the full year 2010, we generated $509.9 million in revenue; a 2.9% decrease over prior year, gross margin was 55.9%, up from 54% in the prior year reflecting the success of our cost reduction efforts. In fact, this is the highest annual gross margin for the company in its current incarnation.

Marketing as a percentage of sales was 28.6% compared with 27.9% in 2009. The increase was entirely due to media rate pressure and the one-time retail launch costs in Q1 2010, and in fact marketing efficiency in the remaining quarters of 2010 all improved on a year-over-year basis.

Full year diluted EPS was $1.12, up 21.7% from $0.92 per share in 2009. QVC was 4% of our revenue in 2010 and continued to be an area of intense focus in 2011, our goal to stabilize and grow that business with new product sets. Expanding on Joe’s point that we experience two distinct periods in 2010, new customer results was healthy through the first two quarters of the year, growing 18% versus the prior year.

Conversely, the second half of 2010 experienced a 20% new customer start decline versus prior year, which left us at 1% growth in total for the year. As I will detail in a moment, these trends are expected to contribute to revenue and adjusted EBITDA shortfalls in 2011.

For the full year, net reactivation revenue came in where we originally forecasted it at this time last year, down 10% versus the prior year, and represented 24% of our consolidated net revenue.

NutriSystem continued to maintain a solid balance sheet. As of December 31, 2010, we had over 41 million in cash and marketable securities, and only 30 million of borrowings under our $200 million credit facility. And that facility remains fully available to us.

Turning to cash flow, we generated operating cash flow of $66.6 million in 2010, with capital expenditures of $19.6 million as we completed our facility consolidation, and another 20.7 million for payment of dividends. We have no major capital expenditures planned for 2011, and accordingly we expect our Capex to return to the normalized range of $6 million to $8 million for the year.

Let us talk about guidance for the first quarter and full year 2011. Joe covered a lot of this material in his discussion, but to reiterate, we expect gross margin pressure in the first quarter and full year primarily reflecting the impact of our rollback pricing initiatives, and to a lesser extent the incorporation of frozen food into our primary product offering.

With that said, we expect sequential improvement in gross margin over the course of 2011 as a manage our product mix, expenses and pricing to maximize margin. We expect to reduce general and administrative expenses by $9 million in calendar 2011. And we expect new customer starts to be down roughly 15% versus the prior year, driven by the first quarter performance, and coupled with tough comparison from Q2 2010, when we first leveraged our rollback promotion.

We expect net reactivation revenue to be down roughly 10% versus the prior year, and it should continue to represent in the mid-20% range of our consolidated net revenue. We expect to remain profitable in 2011 with earnings in the range of $0.40 to $0.50 per diluted share; although in the first quarter we expect to lose $0.30 to $0.35 per share.

Obviously, the outsized negative impact for this down year occurs principally in the first quarter. I want to give a little more precision on that impact, much of which we think will be non-recurring for the rest of the year. Excluding one-time severance costs of approximately $2 million, our EPS guidance implies that our Q1 adjusted EBITDA is forecasted to be approximately breakeven.

First quarter last year we reported $13 million in adjusted EBITDA. We believe the factors that lead to this year-over-year adjusted EBITDA erosion are as follows, a reduction in on-program orders and lower second half 2010 new customer starts, leading to a Q1 adjusted EBITDA driver of $4 million, lower January year-over-year new customer starts resulting in an $8 million negative adjusted EBITDA variance, approximately $2 million of adjusted EBITDA pressure from lower reactivation revenues, expected gross margin pressure from rollback pricing of approximately 5 million, all partially offset by an anticipated $6 million reduction in year-over-year marketing expense.

While many of these were unique in the first quarter, our full year anticipates continuing the competitive pressure. To put a final point on this, January was a horrible month, but since then we have significantly turned things around. In January, the year-over-year decline in customer starts was approximately 30%, but since then with the implementation of our rollback promotion, we are seeing customer starts up as much as 20% in February.

Now with heavy marketing spend, January is traditionally an adjusted EBITDA negative month. However, adjusted EBITDA in January 2011 was a heavy $16 million loss. Despite this, by the end of the quarter we expect to turn that around to achieve breakeven adjusted EBITDA before one-time severance charges. While marketing efficiency was significantly challenged in January, we are now back to more normalized marketing efficiency in the mid-20% range.

We think that we have identified our problems and responded in real time, and are on a path to recover performance as much as possible for the balance of the year. At these forecasted profitability levels, we still anticipate that our company will generate excess free cash flow after Capex and working capital, and will remain in covenant compliance throughout the year.

Joe will now make some closing comments before we open the call-up for Q&A.

Joe Redling

Thanks David. I continue to believe that the NutriSystem brand has tremendous appeal, and that the overall model can continue to deliver substantial value to our shareholders. As David mentioned, despite significant business pressure in the beginning of Q1 the team has been able to coarse correct real time, and as a result we expect to be profitable in 2011.

The entire management team will be focused this year on expanding our brand presence, and product portfolio to reach more weight and health conscious consumers where they make their purchase decisions, and we expect to share more details in upcoming calls.

Thank you. We will now open up the line for questions.

Question-and-Answer Session

Operator

(Operator instructions) And for our first question we will go to Greg [ph] with Citi. Go ahead.

Alvin Concepcion – Citi

Actually Alvin Concepcion in for Greg. Just wanted to talk about your marketing strategy in 2011, I know the price rollbacks were driving some nice customer starts. But can you talk about the marketing strategy you plan to implement throughout the year, and also your marketing efficiency in February?

Joe Redling

Sure Alvin, I think what we are planning to do as David pointed out, we are planning to get gross margin back up sequentially quarter-to-quarter. We expect to return more to normalized pricing as we enter Q2 but we will be supporting that with a return to free week offers, which are very efficient for us as we head into April. So we will continue the rollback promotion through the rest of the quarter, and we think it will continue to provide us strength through March and a strong close in Q1, but we will shift away from that as we move into April.

Marketing efficiency, the second part of your question, in February is very strong. We are seeing, as David said, a significant shift from January to February, and we are very happy with those results. Clearly we had to put some pretty deep discounting in the marketplace to achieve that in the light of the pressure we are seeing in the market, but it was an immediate response and we are happy with what we are seeing in the numbers right now.

Alvin Concepcion – Citi

Okay, great. And then regarding the competitive environment, are you seeing the momentum from the new product by your competitor subside since you started the rollback promotion in February?

Joe Redling

We are seeing the impact subside. So clearly we recognize that our original offer going into the market in the typical January would have been effective we believe, but because of the change in the market competitively we felt to protect share we needed to move aggressively into the rollback period, and moving from – clearly being down 30% new customers in January, moving to be 20% up in February really says we are protecting and actually potentially growing share in the marketplace, and we thought that was really necessary for us to do as fast as we could in the quarter.

Alvin Concepcion – Citi

Okay, great. Do you have any plans for a major product innovation in 2011? I know you did diabetic in the fall previously. So is there anything sort of like that being considered in 2011?

Joe Redling

We do have some programs that we will be testing as we move into the second quarter. We also have a new clinical, where we expect to be completed, which is supporting diabetic by Q2. So, we think we will have some new news on diabetic as we head into the third quarter. And we are actually spending a lot of time at this point trying to understand how we could update our product innovation cycle within the year. So there are things on the planning board for that that you could see coming from us in the second and third quarter.

Alvin Concepcion – Citi

Okay, great. Thank you very much.

Operator

And now we will go to Mitch Pinheiro, go ahead please, with Janney Capital Market [ph].

Mitch Pinheiro – Janney Montgomery Scott

Hi, good afternoon. We are throwing the operators some curve balls, aren't we, with the last names? So regarding the dividend, which is a $0.70 sort of pay out – or annualized rate, which obviously is far in excess of your $0.40 to $0.50, how is the board thinking about this? I mean, is it – well, you will finance it for one quarter, sort of the first quarter? Because if you look at if you sort of add back a bad first quarter to the numbers, you would be somewhere earning your dividend. How are you thinking about that?

David Clark

Well, we really look at it from a liquidity perspective, Mitch, and as I said at the close of my remarks, even at the reduced profitability levels, when you look at the free cash flow of the business, it can clearly support the dividend at the level we are at, and in fact based on these expected profitability levels, and the expected Capex at $6 million to $8 million this year, our forecast is we can pay the dividend and actually put cash on to the balance sheet.

Mitch Pinheiro – Janney Montgomery Scott

Okay. David, does your guidance also include or anticipate higher food costs in the back half?

David Clark

We have got some food costs increase built into the costs, yes.

Mitch Pinheiro – Janney Montgomery Scott

Okay. What is going on with NutriSystem D? Why hasn't that had sort of a more momentum type of impact, building as things go forward?

Joe Redling

Yes, I think what we focused on early in the quarter was more of a totality message, we had it represented equally with our women’s and men’s program and Silver as we launched since January, and when we moved into the highly promotional period, we realized that we had to focus it on our core, and even in rollback, it was really a totality message. So our strategy going in was to give equal representation to all of the various program options that we have from women, men, silver and D and that ran for a couple of weeks, and then when we saw the pressure we moved to a promotional offer.

We do think Mitch that we have an opportunity later in the year, we think we will have new news with this clinical, it is a pretty major clinical, and I think it will provide us the opportunity to go back into market.

Mitch Pinheiro – Janney Montgomery Scott

Okay. So this category is sort of – is crazy in the sense where you are down big in the first three weeks of January, you make a little bit of a tweak, and you are up big in February, which I think is up against tough comps if I recall. I mean there are enormous swings, which obviously exacerbate predictability. I mean is adding new channels – first can you talk about that a little bit how you can swing that big just by tweaking your program a touch? Talk about the channels that you maybe anticipate maybe broadening into if you can at this point? And then the third, third question and final question, is in this economy I thought we were seeing a little bit of a bifurcation – good at the top and not so good at the bottom end. Given your pricing and where commercial dieting falls, it's probably – I thought it would be more appealing to the top end, meaning you would be okay here, but clearly commercial dieting doesn't fall or doesn't have any sort of normal sense like consumer stratification. Can you talk about that as well?

Joe Redling

Sure. So let me start with the swing. So, clearly the good news about the – couple of good things about category, new news still works in the category. So we are actually encouraged to see that category doing well, we’re not benefiting from it right now, but it is great to see at least some encouragement on the category, the category has been real challenged for the last three years just looking at commercial weight loss.

Now I think the second piece of that is we really don’t see this type of product introduction that often in the category. You know, we have seen this before typically moderate over time and things normalize. I think what happened here with the swing is the reason you see such a shift from January to February, we actually saw the price sensitivity, we can go into the market, we knew we had offers out there, we knew we had shoppers. And they were checking a lot of various options, and we could go out and lower our price in real-time and see what happens with conversion.

So clearly our potential customers were looking for deals, and we just didn’t have the deals that they thought were compelling enough to buy. When we made that shift and actually lowered our price, it was immediate, and I think that goes to a little bit about what is happening with consumer behavior today. If you think about the holiday season, 50%, 60%, 70% discounts driving holiday purchases, consumers coming to January, they are looking for deals. What is really interesting Mitch is when you look at how we try to enter January and then we move into February with promotional discounting, the interest level, the immediate response to that really shows that that was a key factor in what consumers were waiting for.

So you are right, it is a pretty major swing, but I think in this environment we are seeing a great deal of price sensitivity and a great deal of bargain shopping on the side of consumers. Before I go into the channels, let me skip ahead to your third piece, which is sort of the pricing model and the economy, I mean we all know – the whole category experienced real pressure on discretionary spending. I mean this is just the very discretionary category, even though our recent indication is consumer confidence is improving, it is still around 60%, and you know that is nowhere near where it was in 2006 or 2007, where you typically see it over 100%.

Consumer behavior is not back to normal, so even though we believe a $300 price point and the rationale behind the value in our product is very solid, I still think people are making very careful decisions about where they spend their money in this environment. So I do think as those things get better, it opens up our opportunity. We don’t think our price point is out of line. As a matter of fact, you know, when you look at other free packaged food offerings, our price point is literally more than 50% lower.

So we think we’re well-positioned, but we’re still in this environment where we are trying to understand the new consumer, and still in a recovery period from a recession. The second piece that you asked about, channel, we do believe there is a couple of opportunities for us, as we have been pursuing, we have a great diabetic program. We think the medical channel was one that provides strategic value to us. We think it is a long-term opportunity, a longer term opportunity to set up product in a different framework with both primary care physicians, employers who are trying to manage their health care costs, as well as companies that are trying to manage the insurance side of that business, and helping employers manage healthcare costs.

The reason we have had a delay in moving into that channel, is that channel requires more credible support, and more clinical, and that is what decides that a clinical really provides for us. It is a full 12 month clinical, it is what opens the door to that channel, and we think through direct contact with primary care physicians as a channel, and through partnerships we could enter that channel and be prepared to have some, hopefully some incremental business coming from the channel in 2012.

We have also talked about retail a number of times, and while that is not something that we see in the short-term in 2011, we do believe it is a place where dieting decisions are being made. We do believe our brand has pretty strong appeal with that segment in retail, and I think what we have to do in 2011 is just continue to explore that Channel, understand if there are opportunities for us to introduce products that are actually complementary to our direct business. That won’t cannibalize it, but actually complement our business to actually broaden our ecosystem and allow us to serve more consumers who are interested in weight management and are health conscious.

And we think that channel is just something that we have to look at and explore. So that is what we mean by channel expansion. From a real strategic point of view, we view that as really being in more places where weight conscious consumers are making decisions and being influenced. And we think long term that is pretty critical to us.

Mitch Pinheiro – Janney Montgomery Scott

All right. Thank you.

Joe Redling

Thank you, Mitch.

Operator

(Operator instructions) We will now go to our next question from Kurt Frederick with Wedbush Securities. Please go ahead.

Kurt Frederick – Wedbush Securities

Thanks. I was just wondering with the big cut in the select program, and then latest on the rollback as well I was wondering if you saw maybe a shift between the core and the select programs, or if those percentages of sales kind of stayed the same.

Joe Redling

It is a great question Kurt. As a matter of fact, we – the earlier reasons I addressed in my prepared remarks talked about the study we did, and we believe that frozen foods, the quality of our frozen food is very strong. And literally last year, last two years really our frozen food penetration among our base was in single digits. And we had seen a dramatic shift, where the majority of orders, well over 60% of our orders now include frozen foods. And that was one of our big strategies because we knew that the quality of that food has a great potential to increase customer satisfaction, and potentially increase length of stay.

So we are very happy with those results, and I think we have proven at least to ourselves we can really build a pretty large frozen food business with over 60% of our orders including frozen food as we sit here today.

Kurt Frederick – Wedbush Securities

Okay. So you guys plan on – like once this promotion is kind of up do you plan on bringing the price level for the select back up to where it was, or are you going to have it more of somewhere in between there, like a lower price point?

Joe Redling

We plan on bringing it back up from where it is today. We will not be in bringing it up to the levels we were at prior to the January launch. So we will be testing actually between now and April, where we are testing into new price points, we expect those price points to come up as we try to optimize gross margins in the second quarter and beyond.

So we will be bringing those prices up. We will also be supporting that with some additional promotional programs as well. But we think it is important to get those gross margins up in this type of year.

Kurt Frederick – Wedbush Securities

Okay. Just one more, typically, when a customer signs up on whatever program it is, do they tend to stay on that program for as long as they are with you guys? Or do they move around to different programs based on whatever promotional offers or whatever is going on at the time?

Joe Redling

They typically – I mean again we are seeing actually higher rates of order delivery this year, so we’re well over 80% of our orders choose auto delivery, which is really our bread-and-butter. So typically if they choose select, they stay on select with the frozen food, if they choose our ready-to-go line, they typically stay on that. We have seen à la carte purchases, where customers are on our base program, are ready to go further and will buy a week of frozen food in addition to that. But typically they stay on the program they start with.

Kurt Frederick – Wedbush Securities

Okay. All right, thank you.

Joe Redling

You are welcome.

Operator

We will now go to Colin Sebastian [ph] with Lazard Capital Markets.

Greg Rashar – Lazard Capital Markets

This is Greg Rashar [ph] in for Colin Sebastian. I just had a question regarding the impact that you guys saw at the end of Q4 and then Q1. You mentioned that there was the intense competitive pressure, as well as the general sort of bargain mentality on the consumer side. But on the competitive front, you could break that down into pricing competitive pressures, as well as product competitive pressures and it would appear that it was more product competitive pressures that impacted you guys at the end of Q4 and the beginning of Q1. Would you confirm that is the case or –?

Joe Redling

I think it is right. I think it is also a comparison of price value proposition. I think when you are looking at monthly membership as a price point that is in the mid-teens versus committing to a $300 program for a month, it is an easy choice to rationalize on either side of that, but I do agree with you. I think it was the power of the new message that seems to create a lot of momentum.

Greg Rashar – Lazard Capital Markets

Okay, and you also mentioned that you felt that it was necessary to engage in some more or do some more fundamental innovation on the product front. How long do you think that would take to get the organization retooled to do that? I don't know if retooled is the correct word, but –?

Joe Redling

Yes, I think it is the right word. I think we have already initiated that program and as we mentioned on the call, we initiated some organizational changes today, and some of those relate to how we are approaching new products. We expect – there has been a lot of work done on this, but we just want to accelerate. We expect to have new programs ready for 2012.

Greg Rashar – Lazard Capital Markets

Okay. All right, thank you.

Operator

This concludes the question-and-answer session today. At this time, I would like to turn the call back over to our speakers for any additional or closing remarks.

Joe Crivelli

Okay. We like to thank everybody for their time today, and we hope you will join us for the next conference call when we discuss first-quarter 2011 results later in the spring. Thanks for joining us. Talk to you later.

Operator

This concludes today’s conference call. Thank you for your participation.

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