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eDiets.com

Q4 2005 Earnings Conference Call

March 9, 2006, 10:30 a.m. EST

Executives:

Ciaran G. McCourt, President and Chief Operating Officer

Robert T. Hamilton, Chief Financial Officer

Alison C. Tanner, Chief Strategist, Director Investor Relations

Analysts:

Richard Fetyko, Merriman Curhan Ford

Scott Van Winkle, Canaccord Adams

Brad Vassallo, Riveredge Capital

Mike Wallace, White Pine Capital

Operator

Good day ladies and gentleman and welcome to the 4th Quarter 2005 eDiets.com Earnings Conference Call. My name is Michelle and I’ll be your audio coordinator for today. At this time, all participants are in a listen-only mode. We will be facilitating a question and answer session towards the end of today’s conference. If at any time during the call you require assistance, please press “*” followed by “0” and a coordinator will be happy to assist you. As a reminder, this conference is being recorded for replay purposes. I would now like to turn the presentation over to your host for today’s call, Mr. John Mills with ICR. Please proceed.

John Mills, ICR

Thank you and good morning everyone. Thank you for joining us today for our 4th Quarter and full year 2005 call. Speaking today on behalf of eDiets will be Mr. Ciaran McCourt, President and Chief Executive Officer, and Mr. Robert Hamilton, Chief Financial Officer. Alison Tanner, Chief Strategist, will also be present on the call. Before we begin, I would like to remind you these statements we make this morning that are not historical in nature are called forward-looking statements. These forward-looking statements involve known and unknown risk and uncertainties that could cause our actual results, performance, or achievements to be materially different from those that we may express or imply today. The risks and uncertainties include among others that we would not be able to obtain sufficient and/or acceptable outside financing when and if required, changes in general economic and business conditions, changes in the acceptance of our product by consumers, a decline in the effectiveness of our sales and marketing efforts, loss of market share and pressure on prices resulting from competition, volatility in the advertising market that we utilize, and termination of contractual relationships with our brand partners which license certain brand components and other proprietary information from our subscription program, regulatory actions affecting our marketing activities, and the outcome of any litigations pending against us. For additional information on this, you can refer to our Form 10-K for the year ended December 31, 2004 and other reports that we file from time to time with the SEC. All forward-looking statements made today are current-only as of today. We do not undertake any obligation to publicly update any forward-looking statements. And now, I’d like to turn the call over to the company’s President and Chief Executive Officer, Mr. Ciaran McCourt.

Ciaran G. McCourt, President and Chief Operating Officer

Thank you John and good morning everyone and welcome to the call. Firstly, as this is my first call as COO I want to thank Dave Humble, our founder, for his 10 years of dedication to eDiets and for assisting in a smooth management transition. This morning I will provide a general review of 2005 before I turn the call over to Rob to discuss the financials in more detail. I’ll finish the call with comments about how our business model is developing and our plans for 2006 and beyond. I can say that fiscally speaking 2005 has been a turn-around year for eDiets. We delivered recording breaking revenue and we reached a profitable equilibrium on our traditional subscription model. I’m also pleased to say that we’ve grown average revenue per subscriber at 11% through better offerings, price increases, and early attrition strategies. Q4 was also strong as we continued to execute by intensifying our focus on acquiring profitable customers in order to balance our topline growth with our net income, which our 4th Quarter results proved out. eDiets’ principle business model has been acquiring subscribers for online dieting programs through online display ads, Internet search, television advertising, and internal marketing. Going forward, the key to maintaining the subscriber business profitable is to continue to place ad dollars in profitable channels only.

On the cost side, we reduced our cost for acquisition, where by sales and marketing as a percentage of revenue fell 21 basis points from 89% in 2004 to 68% in 2005. As we move forward, we will continue to drive this down as we diversify our business. In addition, our overhead remains flat for the year, even with a full year of expenses associated with eDiets Europe.

Other highlights include the launch of three new diet plans, the Mediterranean Diet, the Mayo Clinic, and the GI to bring us a total of 22 diet plans. This year will also see significant investment in R&D. We are examining our new plan and site architecture and plan dramatic improvements by the end of the year. We expect that these efforts will also boost retention. We’re also promising to improve our scientific credibility and are in the process of engaging an academic from a leading university to validate the efficacy of our services. We’re also exploring ways to increase interactivity on the site, which will speak to compliance and incentives, and I’m confident as we continue to roll out better services our retention will increase. I expect these to roll out later in the year. This is the future of online dieting and we will be there. I would also like to say that we will have our press release of a mobile product shortly. You can expect to see more activity in this space.

Before I get into our strategic long-term plan, I’d like to turn the call over to Rob to give you more details on the Quarter and the year. Rob…

Robert T. Hamilton, Chief Financial Officer

Thanks Ciaran and welcome everyone to our 4th Quarter and fiscal year 2005 conference call. We are very pleased with our earnings result as we achieved recording breaking annual topline performance and significantly improved our profitability cash flow. As anticipated, total revenues for the three months ended December 31, 2005, increased 8.5% to $12.1 million compared to $11.1 million for the same period in 2004. Revenue for the 12 months ending December 31, 2005, increased 18.2% to a record $53.7 million compared to $45.4 million during the same period in 2004. Our topline growth was driven by strong membership revenue, which increased 9% and 18% for the 4th Quarter and full year of 2005 respectively. We averaged about 220,000 paying members during the year and ended 2005 with about 190,000 paying members, which is about the same number as last year. In early 2005, we improved our website and expanded our content and that allowed us to increase average weekly prices by about 11%. Average weekly fees for 2005 was approximately $3.95 per subscriber versus $3.56 per subscriber a year ago. We recently enacted a similar increase in early January 2006 without any degradation to conversion and that should help us drive more profit from subscribers in 2006.

Other revenues which included advertising, e-Commerce, and licensing revenues from Tesco in the UK and all of which have very attractive operating margins increased 5% and 19% for the 4th Quarter and the full year 2005 respectively. During 2005, we focussed on operating efficiencies and continue to implement cost saving initiatives by prudently managing advertising spending, organizing selling and marketing strategies, and lowering customer acquisition cost. As a result, net income for the 4th Quarter 2005 totaled $1.5 million or 7 cents per diluted share, compared to a net loss of $0.1 million or 0 cents per diluted share in the same period last year. Net income for the full year of 2005 was $1.3 million, that’s 6 cents per diluted share compared to a net loss of $9.9 million or 49 cents per diluted share in 2004. Gross margin for 2005 was 85% for Q4 and 86% for the year with cost of sales mainly for royalty costs, offerings to diet partners, and costs related for credit card processing. The 4th Quarter sales and marketing expense, which consists primarily of Internet and television advertising expenses and compensation for employees in the sales, marketing, and support groups, decreased 6% to $7 million compared to $7.4 million in the 4th Quarter of 2004. For the full year of 2005, sales and marketing expense decreased 11% to $36.3 million compared to $40.6 million in 2004. Included in sales and marketing is our advertising spend of $29.2 million, which yielded over 450,000 new subscribers resulting in a $64 CPA for the year. For comparison purposes, in 2004 we spent about $32.6 million in advertising to acquire about the same number of subscribers. The 2005 CPA is down about 10% from last year and reflects our improving efficiency and advertising spending. We expect our advertising expenses to be down again throughout 2006 as we plan to shift our focus to more profitable revenue streams. For comparison purposes, at year end, we have about $6 million in contractual advertising obligations versus $17 million a year ago with most of the reduction related to major portals. It doesn’t mean our ad spending this year will be down $10 million compared to last year, but it does reflect how flexible our advertising commitments have become.

Income from operations for the 4th Quarter of 2005 was $1.4 million compared to a loss from operations of $0.1 million in the prior year quarter. In 2005, we considerably improved our cash flow. During the 4th Quarter, we generated $1.1 million of cash from operating activities versus $3.10 million of cash used in the 4th Quarter of 2004. Cash used in operations for 2005 was $0.3 million and that includes $1 million used for acquisition-related tax liabilities incurred back in 2004. In 2004, we used $7.7 million in cash from operations.

Turning to our balance sheet of December 31, 2005, we had $8.6 million in cash and cash equivalents, $4.8 million in deferred revenue, and approximately $400,000 of debt related to capital needs with the loans payable for computer equipment. And lastly with $28 million in NOLs, we do not anticipate becoming a tax payer in the near term. That concludes my comments for 2005, now Ciaran will share more about the future.

Ciaran McCourt, President and Chief Executive Officer

Thanks Rob. I want to highlight some of the changes we can expect in our model as we move forward. Firstly, with regards to subscriptions, as we’ve explained, at a certain level of ad spending our subscription model is profitable but potentially limited in terms of growth due to current online market dynamics and our current level of customer monetization. Over the long term, the subscription business has a healthy future and we will continue to be top of mind for consumers. However, given the current parameters we work within, it makes sense to modify our business model and aggressively add more diversified revenue streams.

Let me speak about our e-Commerce potential: eDiets has always been a direct marketing company albeit with exclusively online services. Many competitors in this space use online challenge to support their offline growth. We conducted some market research and by branching out to the food business we are responding to consumer demands for a direct-to-consumer food product. This is a prudent decision. We officially launched our food service on January 1 and early signs are positive. I want to stress to all that we are in very early stages. We are excited about developing the business on a standalone basis as we work out lifetime values, re-up percentages, and margins. We will start to share more detail after we report our Q1 numbers.

We’re also testing new forms of marketing and we will rollout our infomercial for this product in the future. Clearly, there is huge potential in this space and customer reaction to our product is very good indeed. However, we are going to get there in a phased and sensible way. There are many distribution challenges to investigate. I am clear where we need to go. We will have a superior white property supporting a superior product and I am confident that with the brand equity and direct marketing skills we have a great opportunity lies ahead.

Thirdly, I’ll speak about our media and publishing potential. We believe we will see ad revenue grow in 2006 despite our de-emphasis on subscriber volume. Clearly, we have an attractive audience for advertisers. Thanks to the efforts of our sales team, we have finally made great progress in the quality of advertisers. You will see advertisers such as Coke and Quaker Oats on our site, which has mainly hit record CPMs. The challenge as it is for everyone online is to grow traffic. Importantly, we are seeing an increase in page use per unique visitor, and through better traffic management more pages in our health category where the CPMs are delivered. Our recently launched website, gleemagazine.com, which is aimed at our advertisers, who shy away from the diet category but want our highly priced target audience, is a first start on our path to grow out our network and create more traffic and uniques. High quality content will be vital and we will increase our investment in the variant 2006. We also see huge potential for the rollout of video content in this space and we are investigating this presently.

Our fourth revenue stream is focussed on ASP and licensing income. Our capital license revenue continues to perform well. On the business-to-business side, we see a lot of activity and opportunity in this area. The web has huge value to the healthcare and insurance industry, employers, food companies and supermarkets, in the meal planning, lifestyle counseling, and compliant areas. This presents a fascinating opportunity for our business. We have begun to reach out and though the lead time is slow and the technology challenging, we’re getting some very good preliminary signs. I’m confident that we would see expansion here later in 2006. We will be investing in our technology to allow us to get into this market. As a result of these changes, we are exchanging topline growth for bottomline improvements. This is the correct strategy. And I will turn the call back to Rob briefly for some comments on guidance.

Robert Hamilton, Chief Financial Officer

Thanks Ciaran. With regards to guidance for 2006, which is as you refer in the year of repositioning, the company expects to have fewer online subscribers in the 1st Quarter and the full year compared to the prior periods on a lower ad spend. This will lead to a decline in subscription revenue but that should be more than offset by increases in non-subscription revenue, primarily food. Revenue growth for Q1 is expected to be in the 4-6% range as we continue to ramp up our new offerings. In Q1 we expect to record about $1 million of revenue related to FreshCuisine. We shall be recording this FreshCuisine revenue on a gross basis with a corresponding charge to cost to sales for food cost. This brand new offering is only a few hundred thousands dollars of print and search advertising to date, as most of these sales have come CPA free, as they have come through our homepage or through up-sell to our online diet programs. Overall, we expect our loss in Q1 to be markedly lower than the previous year. For the full year, we are forecasting growth in the 8-10% range with a decrease in subscription revenues offset by non-subscription revenues. In 2006, we expect to at least double our profitability and have significant positive cash flow from operations, as you want know that this profitability forecast is after including non-cash stock based compensation expense, which was not required in 2005. Looking further out, we expect higher revenue growth and profitability looking towards 2007 and beyond.

Ciaran McCourt, President and Chief Executive Officer

In summary then, we are setting out to maximize revenue growth and profits from our four verticals. By being smarter about our ad spending for our subscription model and adopting a multifaceted strategy, we believe that we are positioning eDiets for long-term opportunities in the healthy lifestyle and diet industry. We believe we have an outstanding strategy as we respond to consumer needs for insurance services and food products and business needs for advertising real estate and technology solutions. We are steering our company in this direction in order to create a diversified and long-term business. Our challenge is to execute and I’m confident that we will and deliver an exciting business with profitable growth. With that, let me turn the call over to the operator so we can take your questions.

Question-and-Answer Session

Operator:

Thank you sir. Ladies and gentlemen, if you wish to ask a question, please key “*” followed by “1” on your touchtone telephone. If your question has been answered or you wish to withdraw your question, please key “*” followed by “2.” And our first question comes from the line of Richard Fetyko of Merriman Curhan Ford. Please proceed.

Richard Fetyko, Merriman Curhan Ford

Thanks for taking my question. Like you guys really have a lot of conflicts in the FirstCuisine product, so, if you don’t mind, drilling in a little more on what you’re seeing, what kind of tick rates if you can…what have you done so far to generate what you estimate to be $1 million in growth revenues in the 1st Quarter? How have you marketed the product so far and what will you do starting in the 2nd Quarter and so forth to more than offset the declines in revenues in the core business? Thanks.

Ciaran McCourt, President and Chief Executive Officer

Thanks Richard. Well clearly, as we said, these are very early days in this new product. We did launch with some print advertising in January in the early part of the Quarter. It was very much a test campaign to see what the reaction would be. But as Rob said in his statement, the majority of business is coming from our existing white properties, so we’re seeing traffic on our homepage to the food product service. We’re seeing nice up sale percentages in the funnel for the online diet customer; essentially, these customers are CPA free. In terms of how we build this model as a standalone business, we’re investing in the infomercial at the moment. We’re shooting that very shortly. We are very confident that we can create a substantial business in this category. But, as I said, it’s too early to tell, we’re only nine weeks into this product and in terms of margins and lifetime value and real percentages, it’s almost impossible to tell at this stage what the ultimate value of this business will be. And I think we’ll definitely have more to tell you after we actually report Q1 numbers.

Richard Fetyko, Merriman Curhan Ford

Okay, in terms of marketing to your current subscriber base, so far you’ve been basically up selling it new subscribers, have you marketed to the existing subscribers and also tapped into the 10 million or so opted e-mail database that you have from the online newsletters and eDiets magazines?

Ciaran McCourt, President and Chief Executive Officer

It’s fair to say that this is really phase 1 of the rollout. In phase 2, we will have an integrated service, so that the existing eDiets members will be able to purchase a direct-to-consumer food product that matches their current diet. So, in essence, we haven’t fully exploited the subscriber base when it comes to selling this new service. So, you’re correct in saying that the new subscribers are seeing the offering and we’re seeing encouraging up-sale percentages. In terms of the e-mail database, we’ve had very limited rollout of the product there. We haven’t fully exploited that either. So, we want to build the integrated product service first before we fully market to the existing database. So, that we expect in the next couple of weeks.

Richard Fetyko, Merriman Curhan Ford

Also, what about the margin profile of this business relative to the core business?

Ciaran McCourt, President and Chief Executive Officer

We need to really drill down on our numbers more, I mean, this is a moving target. We’re experimenting with different price points, you know, we can drive volume, we can drive margin almost as we will, but we really want to get more weeks behind us before we can get clear visibility. And clearly the margins are higher on those customers who come in without spending any marketing dollars against them. But as we build up a standalone model we’ll have a clear picture as to what the net margins are.

Robert Hamilton, Chief Financial Officer

Richard, this is Rob, I’ll just add to that. As we start to get into the tangible products our overall company margins will start to decline, because as you know 85% margins right now are primarily royalty fees and credit card fees. So, we will see that start to decline because of the tangible nature of this product. As we mentioned earlier though, we also see significant decline in sales and marketing as a percentage of revenue. There’s a little bit of shift going on there and this transformation will start to occur over the course of the year.

Richard Fetyko, Merriman Curhan Ford

Lower gross margins obviously, but higher operating and net income margins.

Robert Hamilton, Chief Financial Officer

Yes Sir.

Richard Fetyko, Merriman Curhan Ford

All right thanks. I’ll go back in the queue, bye.

Operator:

And our next question comes from the line of Scott Van Winkle or Canaccord Adams. Please proceed.

Scott Van Winkle, Canaccord Adams

Hi, a couple of questions. First, maybe you said this and I didn’t catch it, but if you took price up by an equal amount here in January 2006 to say 11% like last year and you’re expecting a mid-to-high single digit decline in subscription revenues, so are you assuming about a 20% decrease in total subscribers?

Robert Hamilton, Chief Financial Officer

Scott, this is Rob. Actually, with regard to that price increase, I want to make something clear. When we do that we always to that on a prospective basis. So the beginning pool of 190,000 members is grandfathered in at the older price itself. This typically takes at least two quarters or so for a price increase to kind of make its way through the paying base, and that’s what our traditional philosophy is, worked out pretty well in the past with regards to that.

Scott Van Winkle, Canaccord Adams

Wouldn’t that have been the same thing last year or was that 11% price increase an average price increase for the year.

Robert Hamilton, Chief Financial Officer

Exactly, that 11% was an average price increase.

Scott Van Winkle, Canaccord Adams

So, this year you’re talking more of a 5% average price increase.

Robert Hamilton, Chief Financial Officer

On top of where we are now, yes, exactly. The reference with newer members only, correct.

Scott Van Winkle, Canaccord Adams

I’m doing the math correct about…say a mid-to-high decline in subscription revenue and a 5% price increase, I can get a 15% decline in subs, am I doing the math right?

Robert Hamilton, Chief Financial Officer

That’s probably in the ballpark.

Scott Van Winkle, Canaccord Adams

Okay, great.

Robert Hamilton, Chief Financial Officer

Actually, that’s probably at a high end and obviously it depends. As we continue to advertise, we will be advertising out there and as we explore new opportunities we will continue to invest accordingly.

Scott Van Winkle, Canaccord Adams

Is there a thinking in your mind that now depending on the other legs of the business and how profitable and how much revenue they generate, you would then pour that money back into driving the subscription base.

Ciaran G. McCourt, President and Chief Operating Officer

Well, clearly, as we have less commitment on the ad side in terms of driving subscribers, that equals more flexibility. So, we have the dollars there and when we can spend it. In previous years we were committed to spending regardless of the CPA. So, I think this is encouraging because we can spend the dollars at the appropriate time. So, yes in theory, we can redirect those as and when it is appropriate.

Scott Van Winkle, Canaccord Adams

Okay, and that’s far in the first couple of months of this year, is any one particular advertising medium performing your expectations or relative to the others?

Ciaran G. McCourt, President and Chief Operating Officer

I would say search is driving very well for us at the moment, both paid and natural search are star performers for us. Television is performing quite well. The less significant players like the affiliates, etc. are also doing very well.

Robert T. Hamilton, Chief Financial Officer

And Scott I would just add to that. It doesn’t make sense for us to continue to spend $100-200 for ads that are not working, especially when we have viable alternative dollars to work, and that’s effectively how we started.

Scott Van Winkle, Canaccord Adams

Okay, Rob, what was a good option expense in 2005 if you’d expense it, and I would assume it’s going to be relatively the same in ’06?

Ciaran G. McCourt, President and Chief Operating Officer

Yeah, it’s probably about $1.1 million, so that would probably be the high point. The new calculations make a few other assumptions, so I would expect something lower than that, but probably not too far away, in that ballpark.

Scott Van Winkle, Canaccord Adams

Okay, and on the FirstCuisine, can you give us an idea of where that average selling price is kind of shaping out or is it too early?

Ciaran G. McCourt, President and Chief Operating Officer

Well, as you know, we launch with the high-end products and we had three price points between $22 and $35 a day excluding shipping. We’ve experimented with sub $20 a day products and we have some interesting results there. But, because we’re still in test mode, on average you could probably say around $25 a day. But again, the intention is to get a model working below $20 a day, that’s what we’re driving.

Scott Van Winkle, Canaccord Adams

Okay, also in that vein, is there one…and I’ll try and understand it correctly…you can have the food made to fit a certain diet, are there any more diets that are more popular than another, and are there are any diets that are more profitable for you that maybe you have pay a royalty on or something of that nature?

Ciaran G. McCourt, President and Chief Operating Officer

In terms of the food product, no, there are no royalty implications. These are generic plans that feature very basic low-calorie or low-carb dieting, but they’re generic programs.

Scott Van Winkle, Canaccord Adams

So, it’s not like you’re going to order the zone diet and then…

Ciaran G. McCourt, President and Chief Operating Officer

No, we’re not intending at this stage to go the branded route with the offline products.

Scott Van Winkle, Canaccord Adams

Okay, thank you very much.

Operator:

And once again ladies and gentleman, if you wish to ask a question, please press “*” followed by “1” on your touchtone telephone.

And our next question comes from the line of Brad Vassalo of Riveredge Capital. Please proceed.

Brad Vassallo, Riveredge Capital

Hi, good morning. I just wanted to ask a few more questions on your marketing strategy at this point with FreshCuisine, really focusing on what you’re doing in the 1st Quarter. How do you expect to increase the mix, basically beyond eDiets website, are you focusing a lot more now on paid search, are you planning on doing more print ads, and when can we expect the infomercial to air?

Ciaran G. McCourt, President and Chief Operating Officer

Yeah, we came up with very modest print spends in the early part of the Quarter and we’re relying principally on paid search and leveraging the eDiet’s website for the moment. We’re holding back until we shoot the infomercial and that will be released we expect in the early part of Q2. So that’s really our main strategy in terms of growing the standalone FreshCuisine product, is very much hinging on the infomercial. After that, once you shoot the infomercial and it works well, we can begin to explore things like QVC or HSN if this product truly flies. But for the moment, the infomercial is the main focus for us in terms of growing the standalone business.

Brad Vassallo, Riveredge Capital

Okay, and at this point, you’re not willing to sort of share what type of subscriber numbers you have? I mean, obviously based on what you’ve given out on the revenue basis I assume some sort of average subscriber numbers for quarter, but would you be willing to share what you have on an absolute basis at this point for FreshCuisine?

Ciaran G. McCourt, President and Chief Operating Officer

I think it’s probably just a little early. We really prefer to get the Quarter behind us and open up the numbers after that, if that’s okay?

Robert T. Hamilton, Chief Financial Officer

I think that we are please that the proof of concept has been validated and that we believe we are addressing a market need with regards to fresh food, and obviously Ciaran talked about the price points and that’ll come over a variety of months and quarters, but at the current price points we are excited by what the consumers are telling us as far as response, and we want to make sure we do everything we can with regards to continuity programs and reoperate and all that. So, from the consumer side, we’re very happy on that end. A lot of things we need to do, continue to make sure this grows accordingly, but we are feeling very good from that point obviously.

Brad Vassallo, Riveredge Capital

Is it fair to say it has exceeded your expectations thus far in terms of subscriber growth, or could you put that in context?

Ciaran G. McCourt, President and Chief Operating Officer

I would say, yes. I mean this is a dramatically different product to anything we’ve ever launched before in terms of price point. I mean, the typical customer we were dealing with had an LTV license value, whatever $130-145, now we’re talking about selling a product for $230-250 a week plus shipping, and to be quite honest, as Rob said earlier, the proof of concept is well and truly past us and I’m very excited about the potential. Obviously, a lot hinges on the standalone efforts, because we can prove out that we can sell this product with our media efforts and our e-mail database, the next stage is to prove out that this can survive as a standalone business and thrive with every confidence with our brand equity and the quality of the product we have, the price point that we’ll be aiming towards that we have an excellent chance of this succeeding as a standalone product.

Brad Vassallo, Riveredge Capital

Great and then just a question on the online advertising side, have you guys increased the number of sales people you have allocated towards that? Do you have a separate sales force for Glee Magazine? I would like you to talk a little bit about that.

Ciaran G. McCourt, President and Chief Operating Officer

Yeah, the online is pretty much the same, but what we are doing is we’re changing our tactics and using the agencies much more effectively and pitching much better to them and getting an excellent response from the current advertisers. So, this is a sort of step-child of the business and by reorganizing the department and reassigning resources there, we’re beginning to see some very nice results. We do plan to expand the department as we grow. Glee Magazine is very embryonic. It was released 10 days ago, now we’re seeing some very encouraging signs in terms of increasing our overall traffic, but at this point the agencies are doing a tremendous job in getting the quality of advertisers that we are looking for. I mean, if it was a paper just throwing sales people out and thereby growing ad revenue, we would do that, but quite frankly I think the agencies are more than fulfilling their duties. In fact, the site is actually sold out on a regular basis.

Brad Vassallo, Riveredge Capital

Interesting, okay, great, I’ll turn it over.

Operator:

And our next question comes from the line of Mike Wallace of White Pine Capital. Please proceed.

Mike Wallace, White Pine Capital

Good morning. I have two questions for you. One is a little bit on the elasticity of demand for your subscriber base. Last year you raised prices about 10% and you were able to hold them in, and now you’re paying subs about flat, yet in ’06 you’re going to raise them 10%, but you’re telling us and based on a question that you think subs are going to decline, more in that sort of mid-teen rate. What’s the basis for that? Is that something you’ve experience so far in the first couple of months of ’06 and you’re forecasting that out, you get to that point where your prices are getting high enough where your subs are going to really fall off, can you give us a little more clarity on that?

Ciaran G. McCourt, President and Chief Operating Officer

Well, it surprises me as not price sensitive, at least in terms of the increase in price that we introduced in the early part of the year. We saw little or no drop in conversion, but it’s really a factor of our ad spends and because we have this more flexibility in terms of how we apply those ad dollars we’re not locked into these very tricky contracts wit major portals. I mean to put it another way, we could grow subscribers. We could be sitting here and reporting subscriber growth, but the question is do we want to grow subscribers at any unacceptable CPA? The answer to that, that we’ve concluded, is no we don’t. So, really subscribers are a factor of ad spend, price increases, little-to-no impact on conversion. And because we have the flexibility in the ad dollars we’re holding back and applying those as we see appropriate.

Mike Wallace, White Pine Capital

Okay, so you feel that you still got lots of room on the pricing side, conversion rates are strong?

Ciaran G. McCourt, President and Chief Operating Officer

Yeah. Conversions are strong. We have upside in terms of premium services and quality of product and retention, and as I said in my segment, we’re investing more than ever on the R&D side in terms of producing a high-quality product. So, I do believe the subscriber business is going to be very, very strong for us and very profitable. But, we’re just not in the business of locking ourselves into these owners’ contracts.

Mike Wallace, White Pine Capital

Yeah, and you mentioned those earlier, something like $10 million savings in ’06 versus ’05 on the commitments, and you look at this…this is the sort of the second area of the question. Marketing spend was down about $4.3 million year over year and roughly $700,000 in Q4, is it reasonable to assume a similar sort of decline, more on the annual side or you take Q4 and annualize it out, so could that spending be down somewhere from $3-4 million next year?

Robert T. Hamilton, Chief Financial Officer

Well Mike, it’s all branded. I will say the last spending typically corresponds to the diet treatment, which is stronger in the first half of the year than it is in the second. So, you should expect a sequential spending, but if I recall we spent about $10 million in advertising in Q1 last year and we said that will be lower this year in Q1, and we expect that trend to continue. But again, I will point out though that we are committed to still putting dollars. There and a lot of good pockets of business out there in the subscription area. What we’re doing is we’re peeling off the most unprofitable pieces. There’s still a lot of excellent inventory and good inventory that we want to continue to advertise with and again be a major player in the online dieting world. We’re not abandoning the acquisition of members, 450,000 last year. We’ll still be bringing in a lot this year, but the ones that we do bring in will be a lot more attracted to us and again redeploy themselves elsewhere. So again, these are only selective cutbacks, but cutbacks where they’re fairly material and pretty extensive CPA cuts.

Mike Wallace, White Pine Capital

Yeah, is Q4 a representation of those cutbacks and that sort of thing that we could look out and say “at sales and marketing and support lines, the total spend for ’06 is going to be about $3 million less than it was in ‘05?”

Robert T. Hamilton, Chief Financial Officer

I guess it’s a ballpark, I mean I wouldn’t annualize Q4 just because of seasonality issue, but I can say that the cutback did start to occur in Q4.

Mike Wallace, White Pine Capital

But it could be a little higher than that?

Alison C. Tanner, Chief Strategist, Director Investor Relations

Yeah, you want to clarify, Rob, the difference between overall budgeted ad spend for this and ad spend specifically for the subscription business?

Robert T. Hamilton, Chief Financial Officer

Yes, that’s a great point Alison, in that clearly the majority of our ad spend this year will still be on the subscription business. We haven’t thought specifically with regards to the dollars on FreshCuisine. That will start to begin in Q2 and again, depending on the result on that, we’ll just take the overall level for the full year. So, a vast majority of ad dollars is still on the core business, the FreshCuisine and the other adverts will have ad dollars apply to it, but obviously much more ____

Mike Wallace, White Pine Capital

Great. So, I was just going to come back. So, you have about $10 million on your ad spend on subscriptions because of these commitments that are going to roll out?

Robert T. Hamilton, Chief Financial Officer

Mike, you need to get off to $10 million…what I said earlier is that’s the contractual committed. That doesn’t mean that we are going to spend $10 million less. It won’t be as much as $10 million. It just means that we have the flexibility, we’ll go into the stock market accordingly, and ad dollars where we need to. So, it’s more about flexibility component, don’t go by the $10 million.

Operator:

And our next question sir is a followup question from the line of Richard Fetyko of Merriman Curhan Ford. Please proceed.

Richard Fetyko, Merriman Curhan Ford

Yeah guys, just curious on the FreshCuisine side again. What type of customer feedback have you received on the quality of the product and also what type of customer, the profiles of the customers, the demographics of the customers, have you seen any patterns that you could share with us? Thanks.

Ciaran G. McCourt, President and Chief Operating Officer

Again a little early on the demographics, I have to come back to you on that, but the customer feedback is excellent. We really are dealing with, in my opinion, the fastest direct consumer food product in the nation, and we are getting excellent feedback. We had some initial bumps in terms of our launch, but apart from that we were very, very happy with the customer feedback and the real upside we’re seeing very early on are positive. We concentrate on fresh, on the taste factor, and we described it as real food for real people. This is a high quality product. So, on that side we’re thrilled, but in terms of the demographics we just don’t have enough data at this stage.

Robert T. Hamilton, Chief Financial Officer

Rich, reviewing the shipping bills, it’s clearly a national distribution at this point, and again we’ll have more details after the quarter has ended with regards to that.

Richard Fetyko, Merriman Curhan Ford

Okay, you mentioned that you want to build in the ability for existing customers who may not take the product initially but may want to perhaps sign up for it at a later stage, you’re building that into your service, when will that be launched and will that be sort of a case where I signed up for a low-carbohydrate diet, I didn’t take the FirstCuisine initially, but now I’m thinking that I would like to try it and I can sort of now order food that’s tailored to my diet, when will that be launched?

Ciaran G. McCourt, President and Chief Operating Officer

I mean the picture is that the current users, as they login and review their online diet will have an option at every point or just a tangible product to fit their calorie needs, and obviously that’s a highly targeted consumer base. We’re hoping that we’ll launch in probably mid Q2. We’re working very hard at it at the moment. So, we will have a sort of three-month experience. I mean obviously it’s much more difficult to produce a tangible product with the logistics involved than it is to produce a virtual online diet. So we have to breach those two issues, but in essence our ambition is to offer this tangible product to as many of our customers as possible given their dietary profile.

Richard Fetyko, Merriman Curhan Ford

Okay, thanks.

Operator:

And our next question is a followup question from the line of Scott Van Winkle of Canaccord Adams. Please proceed.

Scott Van Winkle, Canaccord Adams

Hi, quickly following up on that last question about customer response to the food offering, what’s been the reorder rate, if you can share it?

Ciaran G. McCourt, President and Chief Operating Officer

As I said it’s very early, but it’s a weekly product and you can count at any point after a week’s supply, and we’re seeing very encouraging signs on the re-up. I don’t want to go into more details because we’ve just got nine weeks of data and it’s almost impossible to say whether these people…for example, if a customer joined us on week one and is still on the program, for every week they add, at this point is week ten, it moves the average significantly.

Scott Van Winkle, Canaccord Adams

So, you’re just not seeing a lot of sampling, you’re actually seeing people get out and stay on it.

Ciaran G. McCourt, President and Chief Operating Officer

Oh yes, absolutely.

Robert T. Hamilton, Chief Financial Officer

Scott, I will add that we are seeing that we are exceeding our internal model projections with regards to…on the other side, but complete from that perspective and obviously a lot more detail to come with Q1 results.

Ciaran G. McCourt, President and Chief Operating Officer

I will say one thing. The experience of our partner in this business dictates…the recycle rate is quite high, and this is something that’s obviously very early to tell, but we’re expecting customers to use this product now and pull away, whether it’s after three, four, five, six weeks, they will come back in two or three months and order again. I mean, it’s very early and we have no data on that at this point, but, because of the quality of the products, because of the quality of the service, this is coming built into our model.

Scott Van Winkle, Canaccord Adams

Yes, well I can vouch for that product, it was phenomenal. Another question and maybe I’ll see if my thinking is on the right track, I think you used the term repositioning in ’06, you have all these new revenue opportunities that are non-subscription based that you’re trying to grown essentially from zero, and while ultimately those non-subscription revenues are going to be highly correlated with your subscriber base I would think from the size of your subscriber base, you’ve got so much opportunity going from zero, you’re kind of focusing on those now, but down the road subscription revenue will be growing, am I thinking about it correctly?

Ciaran G. McCourt, President and Chief Operating Officer

Subscription will be…

Scott Van Winkle, Canaccord Adams

Grow in the longer run.

Ciaran G. McCourt, President and Chief Operating Officer

Yes. I mean, we’re not exactly coming up with zero base on these other verticals, but the exception policy of the licensing potential, which is the most R&D focused, I mean ad sales are there, they’re about…

Scott Van Winkle, Canaccord Adams

But not maximized to any…

Ciaran G. McCourt, President and Chief Operating Officer

Correct, we’re paying attention to that vertical as much as we can and then of course the one vertical that’s going to move most significantly is the e-Commerce because of the food products, and we have nine weeks under us and we were very positive about the upside.

Robert T. Hamilton, Chief Financial Officer

But Scott you’re right, the subscriber growth is not going to be negative forever. We do think that there’s some strength to that and obviously we want to take advantage of that and it’s a good feeder into the builder of the media and the food guide as well. So, we are not abandoning the subscription business, we’re just kind of branching out a little bit and as the economics improve on the subscription business we’ll get back into that accordingly from the ad spending side.

Ciaran G. McCourt, President and Chief Operating Officer

And interestingly just to answer that, there isn’t a direct correlation between the ad spend in terms of driving subscribers and the ad revenue that we can expect. I mean we have built up a significant media asset out there and it has its own momentum. I mean, obviously if you’re out there spending nothing on promoting your service maybe ultimately you could see some deterioration. For example, if ____, you don’t see them spending ad dollars in promoting their service, but it has its own momentum, so that’s encouraging in terms of developing that vertical.

Scott Van Winkle, Canaccord Adams

That’s perfect. Thank you.

Operator:

And ladies and gentleman, this does conclude the question and answer portion of today’s conference call. I’d like to turn the presentation back over to Mr. Ciaran McCourt for closing remarks.

Ciaran G. McCourt, President and Chief Operating Officer

I want to thank everyone for joining us on the call and look forward to re-engaging with you with our Q1 06’ call. Thank you very much.

Operator:

Ladies and gentleman thank you for your participation in today’s conference call. This does conclude your presentation and you may now disconnect. Have a great day.

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Source: eDiets.com Q4 2005 Earnings Conference Call Transcript (DIET)
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