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Executives

Lori Scherwin – Vice President, Investor Relations

David P. Kirchhoff – President and Chief Executive Officer

Analysts

Christopher Ferrara – Bank of America Merrill Lynch

Jerry Herman - Stifel Nicolaus

Brian Joseph Wang – Barclays Capital Inc.

Peter Wahlstrom - Morningstar Investments

Greg Badishkanian – Citigroup

Johan Faucher - J.P. Morgan

Weight Watchers International, Inc. (WTW) Q2 2012 Earnings Call August 1, 2012 5:00 PM ET

Operator

Ladies and gentlemen, welcome to Weight Watchers International's Second Quarter 2012 Earnings Teleconference Call. (Operator instructions) As a reminder, this conference call is being recorded today, Wednesday, August 1, 2012.

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

Lori Scherwin

Thank you, operator, and thank you to everyone for joining us today for Weight Watchers International second quarter 2012 conference call. With us on the call is David Kirchhoff, President and CEO. At about 4:30 Eastern Time today the company issued a press release reporting its financial results for the second quarter of fiscal '12.

The purpose of this call is to provide investors with some further details regarding the company's financial result 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 measures 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 for a more detailed discussion of forward-looking statements and the risks and uncertainties of such statements.

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

As has been previously been announced, the company has hired a new Chief Financial Office, Nick Hotchkin, who starts his employment with the company as of August 20 of this year. Consequently, for this call, David's remarks will also cover the financial section of the company's results.

I would now like to turn the call over to Dave. Please go ahead.

David Kirchhoff

Good afternoon and thank you for joining as we review Weight Watchers International's performance for the second quarter of fiscal 2012. Overall, Q2 2012 financial results were in line with our expectations and previously provided guidance. However, as we will discuss later, we are now taking a more cautious view of the second half of the year.

During June and July we've seen weakening in our business trends we believe driven by the combination of increasing uncertainty in the economy, as well as some indications of wear-out of our current advertising campaign in the U.S.

Turning back to a review of the second quarter. On a constant currency basis Q2 2012 total revenue was up slightly at plus 2.3% over the prior year period. With meeting fees down 5.5% and meeting product sales down 8.1% and Internet revenue growing 31%.

Global combined paid weeks were up 11% in Q2 2012 versus the same period last year. Global meeting paid weeks were down 4.7% in Q2 while global paid weeks for our online product were up 30%. For Q2 2012 our operating income margin was effectively flat to prior. While gross margin was up 1.5 percentage points, marketing as percentage of revenue was up 1.8 percentage points primarily reflecting continued investment and driving awareness of our Weight Watchers online product.

G&A, as a percentage of revenue, was close to flat versus prior. Q2 2012 EPS was $1.36 compared to $1.17 for the same period in 2011 benefitting from a share repurchases earlier this year. We experienced about $0.06 of unfavorable Forex impact in the second quarter of this year versus prior.

I will now briefly review our results on our major geographies and business units. First, our North American meeting business. Total make on revenue, which includes the U.S. and Canada in Q2 2012 was down 6.1% on a constant currency basis versus the same period in 2011, a slight improvement over the -8.9% result for the first quarter.

(inaudible) meeting fees declined 6.3% and meeting product sales declined 7.5% versus the prior year quarter driven entirely by attendance volume declines as product sales per attendance grew 2.7%.

NACO Q2 2012 paid weeks declined 5.5% while attendance has declined 9.9% versus a prior year period. As was the case in Q1, the material portion of the volume shortfall was a result of the continued impact of the execution issues we had earlier this year and the small accounts portion of our corporate business.

Excluding the corporate business, NACO paid weeks and attendances in the second quarter were down an estimated 3.6% and 7.4%, respectively. In reviewing the NACO results I will first provide an update on the status of our efforts to address the issues and the small accounts corporate business.

As noted on our previous two calls, our issues in the small account portion of our business were driven by our decision to transition all of our corporate accounts, including small accounts from defined length series to a corporate version of monthly pass. This resulted in changes, disruptions and problems in the following areas: 1) in shifting to an automated web-based signup process we lost the benefit of having an on-premise information session, which is an important recruiting tool to ensure that enough employees are signed up at a given worksite to allow a new at-work meeting to start, 2) there were a number of technical problems associates with the web-based enrollment portal and 3) significant changes in procedure created extra burdens for the sales organization, which resulted in slow follow-up on new sales leads and in addressing issues.

By March we had fully diagnosed all of the issues and determine the proper path forward and began to systematically implement changes, including, one, fixing the technical issues associated with the online enrollment portal, two, fully reinstituting the on-premise information sessions and, three, beginning in early September we will return to selling fixed durations series for accounts with less than 5,000 employees and without a subsidy in place.

By that point, we will have effectively addressed and fixed all of the issues which have negatively impacted the volume of meetings starts of January this year. These changes, combined with a range of other initiatives to improve selling effectiveness and product management should make the selling process and our small accounts business stronger than it's ever been before. The key selling season for the small accounts portion of the corporate business begins in the fall and we plan to be positioned to be operating at full capacity when it begins.

Despite all of our efforts to make up the difference from the weak start, we won't be able to compensate for the significant double-digits in declines in enrollments we had in this sector of our business in the first quarter.

For the full year we now expect operating income associated with this line of business to be negatively impacted by about $19 million. As we look to 2013, our expectation is that we will recover much of the volume we lost this year. This combined with continued growth in the strategic accounts portion of our corporate business will be a meaningful revenue and profit driver in 2013.

The second significant issue facing our North American meetings business comes from our efforts to attract members through our traditional consumer channel. While enrollment level were solid in April and early May, we saw a considerable slow down beginning in June and continuing into July

While these are traditionally slower months for enrollments, we are nonetheless concerned by the trends we're seeing. During the last two months we, like many other consumer businesses, have seen clear indications of consumer disengagement as consumer confidence levels and spending have fallen.

Our ability to enroll members into our program is linked to consumer confidence and spending given that the timing of a consumer's decision to start a weight-loss effort is inherently discretionary. Whereas, in 2011 we had the benefit of a strong innovation and a relatively fresh advertising campaign to counter the general economic weakness, this year we do not.

It is clear that being at the tail end of our typical two-year innovation cycle and in the third year of marketing campaign coupled with increasing weakness in the economy is negatively impacting our business.

Despite our challenges in attracting members, retention remains strong. As many of you have heard, Jessica Simpson entered into a partnership with us and she's been on the program for the past few months. She's doing great on the program and we're excited to work with her. We believe Jessica will be a great role model and spokesperson for us, along with Jennifer Hudson, as we enter 2013, but we're not assuming that this new partnership will result in much enrollment benefit in 2012.

In this context, we're now operating under the assumption that enrollment trends for the remainder of the year will be worse than we had originally forecasted. While we originally expected second half attendances to be roughly flat to prior and for paid weeks to grow modestly, we're now forecasting high single-digit declines in attendances and paid weeks.

Now on to the International Meetings business. As expected, the U.K. business continued on its existing negative trend in the second quarter as enrollment levels remain weak. Q2 2012 total meetings business revenues declined 11% on a constant currency basis with meeting fees down 13% and in-meeting products sales down 12% versus the prior year period. As noted on our last quarterly call, the U.K.'s advertising campaign has been relatively ineffective and driving un-enrollment since it was launched this past year, particularly in light of the recessionary environment in that country.

As we noted previously, the process of redoing an advertising campaign takes time, however, the U.K. team is continuing to work towards it goal of (inaudible) 2013 with a completely new, higher impact advertising campaign. For the remainder of the year we expect the trends in the second half to effectively mirror the first half of the year.

Moving on to Continental Europe. Continental Europe continued to be a bright spot in our meetings business despite the weak economy with particular strength in France and Germany, which are both benefitting from high-impact advertising campaigns and the ProPoints 2.0 innovation we launched earlier this year.

Overall, total (inaudible) meetings business revenues grew 5.7% in the constant currency basis in Q2 versus prior, with meeting fees up 7.5% and meeting product sales down 1.8%. Paid weeks grew 11% compared to prior, while attendances grew 2.7%. We expect these revenue and volume trends to continue throughout the second half of the year.

Moving on to weightwatchers.com. For the second quarter overall results for our Internet business remains strong, particularly in our CE business. Internet revenues were up 31% on a constant currency basis, paid weeks for our online product were up a similar 30% and end of period active subscribers were up 26%. Recruitment trends in the first half in Q2 were for the Weight Watchers online product across the board, including in the U.S. However, the end of May and much of June was weaker due primarily to the differences in the promotional campaigns employed, as well as a somewhat different media mix.

Online signups have since strengthened in the U.S., although not to the levels that we had previously forecasted. The fact that we're at the end of our two-year innovation cycle and the increase in weakness in the economy are also having an impact on the weightwatchers.com business tempering the overall growth rates relative to what we saw in the first half.

For the second half of the year, we expect paid weeks growth of 15% to 20%. This will result in full year volume growth of roughly 25% for the year rather than the previous provided guidance of 30%. The difference in operating income resulting from this forecast change is roughly $20 million for the year, most of which will come in the second half.

Despite our second half outlook, we see significant growth ahead of us for the Weight Watchers online product, both domestically and internationally. Our strategy will be to continue increasing value in both program and software tools in ways that no one else can match. This combined with a new program innovation and fresh marketing in 2013 will create new opportunities to drive further growth in this highly profitable product line while we still deliver an excellent financial result in 2012.

Now I will review some additional financial results for the quarter. Our other revenues declined 2.8% on a constant currency basis. Within this franchise, commissions declined 11.2% versus prior. Licensing revenues were up 2.5% without the benefit of a one-time termination from a licensee, who we replaced.

In the quarter currency negatively impacted revenue by 2.5%, operating income by 2.3% and net income by 3.7% resulting in a roughly $0.06 negative impact to diluted EPS. For the balance of 2012 we're assuming continued softness in key exchange rates for our business, notably the euro.

Gross margin was 150 basis to 60.6% in the quarter, a high watermark driven mainly by the mix shift toward our higher margin weightwatchers.com business. The gross margin benefit from the weightwatchers.com business was partially offset by a decline in meetings gross margin which was negatively impacted by lower volume, as well as expenses associated with our healthcare and B2B initiatives.

Meetings pricing is measured by (inaudible) income per paid week was down about 1% versus prior. Although we're starting to realize benefits from the price increase taken last year in the U.S., it was offset this quarter by the continued mix shift to monthly pass on a global basis, the impact of the monthly pass and transition and small accounts portion of our corporate in the U.S. and some promotional timing changes in the quarter. We expect to see improvement in this pricing metric in the second half of 2012.

For the full year we expect gross margin expansion of 100 to 150 basis points driven by improved price realization and continued benefits from the dot.com business. Within the second half, the large majority of the year-over-yea increase will come in the fourth quarter relative to the third.

As expected, marketing investment was up in the support of the men's initiative in the U.S. and the international online TV campaigns. Specifically, marketing rose 14.4% on a constant currency basis and was up 180 basis points to 17.3% of revenue. For the year, our marketing spend expectations on a dollar basis are unchanged. But given the weaker top line outlook as a percentage of sales, we now expect marketing to be up around 300 basis points for the full year versus 2011.

In the second half we expect a much larger increase in Q3 relative to Q4. G&A declined 10 basis points as a percentage of sales to 11.6% in Q2, which was below our earlier expectations due to the timing of investments and the impact of lower expenses tide to business performance.

We remain committed to investing behind our long-term growth platforms including B2B, technology and SRM and expect full year dollar spending to be in line with our prior expectations. However, given the lower sales outlook on a percentage of revenue basis, we now expect SG&A to be up about 100 basis points for the year.

We thought it would be helpful to provide a little more color on our spend levels for key initiatives. For 2012, these investments total $39 million and are $20 million incremental to what we spent in 2011. The largest buckets in terms of instrumentality are healthcare and CRM, which total roughly $11 million. Within healthcare and B2B, we're spending against new hires, technology training and consulting.

Our (inaudible) operating margin declined 30 basis points to 31.7%. Below operating profit, our interest expense was $8.8 million higher than the prior year quarter due to higher debt levels and we also had a one-time charge of roughly $2 million related to the write-down of an investment.

We had no change to our prior expectations for a share count of $56 million in the second half leading to a full year average count of 61 million shares driven by the tender and related share repurchase we executed earlier this year. We entered the quarter with $2.5 billion of debt on the balance sheet and $2.4 billion of net debt. Our net debt to EBITDAS ratio was 4.4 at the end of the second quarter and we expect to finish the year roughly at the same level.

Furthermore, we expect full year 2012 interest expense to be in the range of $85 million inclusive of $3 million to $4 million of incremental amortization of fees related to the transactions. In Q2 we had cash flow from operating activities of $70 million. Our priorities for free cash flow remain unchanged. Franchise acquisitions deleveraging from the transaction and paying our quarterly dividend. We continue to expect the 2012 tax rate to be 38.5%.

Looking forward. Despite a strong year for Weight Watchers online and our CE business, we are very far from satisfied with our results for this year. While NACO in the U.K. undoubtedly had difficult comparables, given the success of last year's innovation, we can and will do better to drive more consistent results in these businesses.

Weight management has proven to be sensitive to consumer discretionary spend and larger macro economic trends have not been favorable. For example, a review of Internet search volume for us and our largest competitors suggest that consumer interest in the weight management category as a whole has been soft. Fundamentally, the process of convincing a person to start a weight management is never an easy one. Its consumers are often inclined to procrastinate, particularly when they're anxious about other things such as the economy, political climate, etc.

In review of 2012, our business was particularly hurt by the following: 1) a continued weak consumer economy in both U.S. and Europe, 2) the exceptional breakdown of our small accounts corporate business and 3) a weak U.K. advertising campaign. Based on the economic trends we're seeing, we do not have expectations of a brighter consumer economy in 2013. However, our experience in 2011 demonstrates that the combination of innovation and fresh marketing can allow us to rise above macro economic trends.

With all of this in mind we have much in the works for 2013, including, one, a new program. While it is still too soon to reveal many of the details, we're in the process of wrapping up the development of a significant new program upgrade across all of our major markets currently planned for launch in time for January next year.

We believe that this new program the potential to significantly improve our ability to help members make sustained changes in their weight-loss behaviors. While this innovation is not of the same scope as the platform change we launched with ProPoints in 2011, we believe it will be meaningful nonetheless.

Two, new advertising campaigns. With all the learnings from 2012, as well as the opportunity to build new partnership with new brand ambassador such as Jessica Simpson, we will be in a position to deliver much more effective marketing campaigns next year.

Three, recovery of the small accounts business. With the execution issues that caused the January breakdown behind us, we plan to enter 2013 with the strongest selling capability ever and minimum recapturing a significant portion of the volume we lost this year would result in a meaningful financial improvement for 2013.

Four, continued growth in our strategic accounts business. This line of business has grown significantly in 2012. It is beginning to become much more revenue significant in our corporate portfolio. We will have more specifics to share about our plans and expectations for this business in future earnings calls.

Five, we remain on track to have 80% of our retail system fully converted to stronger locations and better stores in the U.S. by year end. Of course, we're continuing to work on our long-term growth objectives, particularly in the healthcare context. All of the trends here continue to be favorable for us in the medium to long term.

Most recently, the United States Preventive Services Task Force updated its recommendations on obesity for physicians with the following key points: 1) that doctors should screen all adults patients for obesity, 2) that doctors should refer patients with a BMI of 30 or higher to intensive multi-component behavioral interventions. The recommendations defines elements of the intensive multi-component behavioral therapy to include group sessions, individual sessions, setting weight-loss goals, improving diet or nutrition, physical activity sessions, addressing barriers to change, active use of self-monitoring and strategizing how to maintain lifestyle changes. In other words, programs like Weight Watchers. It then went on to note that although intensive interventions may be impractical within many primary care settings, patients may be referred from primary care to community-based programs for these interventions, 4) the recommendation was given a rating of B. The Affordable Care Act either requires or provides strong incentives for all major payers to cover USPSTF recommended preventive services, either A or B ratings and such coverage must with no-cost sharing.

The result of the B rating under this recommendation on obesity is any non-grandfathered group health planner, individual health insurance coverage, must cover the screening or referral to intensive multi-component behavioral therapy and by implication, should ultimately lead to the covering of the cost of therapy, i.e. Weight Watchers.

There's a significant distance between a USPSTF recommendation and actually securing reimbursement for Weight Watchers, but we believe these types of changes to the healthcare system only benefit us in the coming years. We're actively developing and refining our broader healthcare strategy, objectives and milestones, which we will share on future calls. Undoubtedly, we will have to pursue a range of strategies and pilots to unlock this opportunity.

Guidance. Given the weakness we're now seeing in the NACO that began in June and some of its spillover effect on the U.S. Weight Watchers online business, were in the difficult position of having to reduce our guidance for this year again. The second half recovery that we previously forecasted will not happen. A revised view of the NACO and weightwatchers.com business has a combined effect of $0.40 to $0.50 per fully diluted share. We also see some additional vulnerability in Europe given economic uncertainty, as well as additional Forex exposure.

Given all of the above, we are now forecasting EPS of $4.00 to $4.20 for the year. As we look at 2013 we're optimistic about our ability to strengthen our trends, but we realize that we start the year with a lower membership base in our meetings business, given expected weeks second half 2012 recruitments.

At this time, I would like to take questions.

Question-and-Answer Session

Operator

Thank you. (Operator instructions) Our first question is from Christopher Ferrara, Bank of America. Please go ahead.

Christopher Ferrara – Bank of America Merrill Lynch

Hey, thanks. David, can you talk a little bit about CPs and marketing and I guess a decision to keep the marketing budget in dollars despite the weakness. I mean I know it would sound like the right thing to do, but I think it deviates a little bit from what we've seen from you guys in the past. So, can you just talk about your feeling on the returns on those investments and the change in philosophy there?

David Kirchhoff

Yeah, its a great question, Chris, thank you. When I look at the marketing spend, let me first make the distinction between the marketing investments we've made in the dot.com business versus the investments we've made in the meetings business. We continue to feel good about the marketing investments we've made in the dot.com business relative to many of our expected CPAs in overall marketing efficiency. I mean with some of the general top line weakness we've seen in June and July that we're expecting to go into the second half, that will obviously have somewhat of a deleterious impact on marketing efficiency, but we continue to believe that the return on investments on those dollars are going to continue to be attractive

You know, what we saw is what we got into June and July, which was something that we weren't expecting is that ramped, for example, four weeks of advertising in June and we've been running another four weeks of advertising in July and, you know, frankly we simply did not see a very meaningful lift in terms of enrollment levels when we turned on advertising versus when advertising was off. And to us that's a pretty clear indication that the advertising messages that we're delivery, which as you heard me mention in my remarks are getting toward very much of the tail end of that campaign are just not having salience with consumers, particularly in kind of this current macro contest. So we think it's sort of the combination of general consumer sentiment and the fact that we're now effectively in the third year of this particular marketing campaign.

And those two things they came on a lot faster than we expected in terms of what seems to be wear-out and that the fact that we didn't see mix. Obviously, if I'd have had foresight into that, we wouldn't have been on air in June and July because I can't believe that the return on investment that would be attractive. And that leaves us with another frankly six weeks of marketing we have coming up this fall.

As I think you know, the majority of the advertising that we purchase we buy in the up-fronts market and as a result, to a certain extent, say six months or out, we have a certain amount of flexibility in terms of reducing or trading off some of our advertising commitments.

But the relative speed in which sort of this kind top line or responsiveness softening happened, I think limits our options in terms of making adjustments for the marketing spend this fall. So to a certain extent, the die for the second half of this year has been somewhat cast. I think what this is showing us is that as we go forward into 2013, I think we need to seriously evaluate other options to afford ourselves more flexibility. To be a little bit more responsive in the way we deploy marketing dollars so that we can, on one hand, be opportunistic when we have a good hand and at the other hand we can effectively pull back some of that spend that would be on the margin less efficient when some of the sort of broader trends are working against us.

Christopher Ferrara – Bank of America Merrill Lynch

Thanks. That's helpful. And, I guess, you know, to that effect too, I mean, the SG&A now your saying up 100 basis points. It's a little more. There's also... you guys are choosing to pull any levers there? Right? To kind of manage earnings a little. I'm just curious why you're taking that approach?

David Kirchhoff

Well, if you look at the G&A for the second half of the year, in particular there's a number of ins and outs. You know there's things as esoteric as copying against an accrual drop that we have last that we don't have this year. That's impacting G&A. You know we're out of time on our lease of our office building so we're having to incur some costs for a move that's going to be happening in April of next year.

So, there were a number of one-time events that we couldn't avoid or move out of. The areas where we're particularly seeing G&A spending that we're continuing to sort of push behind are what we consider to be kind of critical investment areas. So, for example, our efforts around B2B and related healthcare initiatives that, for example, includes a significant strategy consulting effort in the healthcare space, which is going to be an important part of building out that sort of three-year strategic plan.

We felt that it was important to continue to investing behind that given the critical roll we believe that that nascent business unit is going to play in our future over the coming years. And related to that there's a certain amount of technology spend that we're having to deploy, particularly in data capture and meeting rooms that's going to be important in terms of unlocking that opportunity.

On the other hand, when I look at other aspects of G&A, I would characterize the organization as having a fairly high degree of lockdown in terms of deferring hirings, cutting back expenses anywhere we can find them and so we're in kind of the balancing act of making sure we don't cut off oxygen to critical investment areas, while at the same time sharpening our pencils in places where its not going to have a meaningful impact on business results.

Christopher Ferrara – Bank of America Merrill Lynch

That's helpful and then just one last one on dot.com, I guess. I know you're saying, again, (inaudible) very well this quarter. Right? In the back half of the year you're looking at 15% to 20% growth, I think you said. Can you talk about the cadence of that? Right? I mean are we talking a much growth rate in Q3 versus Q4 or do you think they'll be relatively evenly spread? And then if you could kind of comment even if its qualitatively on the growth rate of that business and the sustainability of the annual growth number.

David Kirchhoff

Yeah. I mean the expectation we have in terms of volume growth in paid weeks in Q3 and Q4 are fairly comparable, looking for, lets say, give or take 15% to 20% paid weeks growth. There might be a little bit of variation within that. You know, if you look at what impacts dot.com, its both a combination of the advertising that's specifically developed to drive awareness to dot.com product, but it also the dot.com product benefits as the brand in general is doing well.

So, if your brand campaign, the (inaudible) campaign loses a little bit of salience, that also has somewhat of a negative impact on the dot.com business. And then, furthermore, the same thing is true for being at the tail end of the innovation cycle.

So, therefore, in a lot of what we're doing in forecasting the second half of the year is really based on making a judgment call based on what we saw, which was a relatively more sudden shift in June and July and choosing to be conservative on that basis. As we enter 2013, we obviously have a different set of expectations on the online business because we kind of get back to the point that, yes, the economy is still difficult, but then the dot.com business you have the benefit of the fact that it has a relatively lower price point, which has traditionally allowed it fair better during the recessionary environment that we've now been in for the past three or four years.

And then if you add on top of that the benefit of program news, continued innovation around the actual set of software tools and new marketing campaigns that we believe that those are the types of things that are going to allow us to sort of push growth back into the volume of that business.

Also, recognize that, for us, by the time you get into the second half of the year, in terms of marketing levers, there’s really not that much left. We have a fall campaign, which is our lightest campaign of the year, versus winter and spring. It’s not very many weeks, and then you’re kind of like - we basically go dark in November and December, so there’s not a lot to be done to shift the trends.

So, I think a lot of what you’re hearing, both about .com as well as with meetings business more broadly is the reflection of the fact that given what we’re seeing right now, given the degrees of freedom we have and the options we have in the second half, this really is lending us to spend therefore the vast majority of our time of doing what we can to manage as financially responsibly as possible in the second half, while making sure that we’re in position as we enter January 2013.

Christopher Ferrara – Bank of America Merrill Lynch

Okay. Thanks for all the color, Dave.

David Kirchhoff

Yep.

Operator

Thank you. The next question comes from Jerry Herman of Stifel Nicolaus. Please go ahead.

Jerry Herman - Stifel Nicolaus

Thanks. Good afternoon, everybody.

David Kirchhoff

Hey, Jerry.

Jerry Herman - Stifel Nicolaus

Dave, the first question is about pricing, and in particular any evidence that last year’s increases are having an impact, especially in light of the extra economic circumstances? Then, conversely, sort of given that notion, would the new program also be potentially accompanied by some promotional activity?

David Kirchhoff

In terms of pricing, it’s always a little difficult for us to tease out what might be impacting our ability to bring members in or in better years, what’s helping our abilities to bring members in. But specifically with pricing, I can’t rule out the possibility that is contributed a little bit to the effect that the headwinds are having on us.

I would tell you on a positive note that I can say definitively is that the price increase has had zero negative impact on retention. In other words, we’re able to see people who came in at the new price look at their retention trends longitudinally, and compare that to people who came in at the old price, look at their retention trends longitudinally and we don’t see a difference between the two.

So, from a retention point of view, we don’t see anything. From an enrollment point of view, it’s harder to tease those things out. What I would tell you is that the price increase we took this year, which again was the first one we had taken in six years, at the rate in which the consumer economy is going, at some point if you want to take pricing, you have to take pricing. Because, given that it doesn’t seem like the consumer environment is going to turn around anytime soon.

I don’t necessarily have any second guesses or regrets about increasing pricing in January. I certainly believe that as we enter a 2013, were there any issues in terms of it having an ability of us to attract new members, I think that would be largely mitigated. Also keep in mind, the way we communicate that price increase is we tend, in our marketing and in our web pages where we talk about the pricing of different options, we refer to it in dollars per week. At our current price point, we’re still below $10 per week, so we haven’t crossed that threshold.

One other point on pricing is that, in the first quarter, because it was not applied to people that were already customers prior to putting the price in, i.e. we grandfathered people, only about 33% give or take of our paid weeks in the first quarter of third were at the higher price point. That increased to, say, give or take 50% of our paid weeks for North America in the second quarter.

That’s going to continue increasing over time, so that’s why we expect to finally start getting some good leverage on lecture income per paid week as we enter into the second half and certainly as we enter into the first quarter of 2013.

What I would say is that our historic practice is that when we think that we have meaningful program news and something to talk about, we do everything we can to talk about it. So, I think you can absolutely expect us, using a range of vehicles such as PR and others to make sure in direct mails, particularly for lapsed members, to make sure that we’re doing a good job of communicating what’s new in the new program.

Again, while apologizing for not being able to get into the details, we feel like this program is another very important step forward in terms of the way we systematically help people, not just lose weight, but keep it off.

Jerry Herman - Stifel Nicolaus

Great, thanks. You alluded to, actually, the next question I was going to ask, and it’s about retention. Can you perhaps update us on the retention trends and some of the key channels in the business, i.e. pay weeks, pay as you go, and online?

David Kirchhoff

Yeah. The continued good news for us is that even during economically tough times where tension has continued to show itself to be incredibly resilient. So, despite the fact that we’ve seen a fairly steady drop in consumer confidence throughout 2012, we haven’t seen any drop in retention on either monthly pass or on Weight Watchers Online. So, those will continue to hold up really well.

It’s a bit of a recurring theme, is that when the economy bites us it does it almost exclusively in the form of our ability to enroll new members into the program. Again, it’s why we’re as focused as we are in making sure that we have something that’s much higher impact as we go into 2012 so we can be much more effective in turning some of those trends around.

Jerry Herman - Stifel Nicolaus

Great, thanks. I’ll turn it over.

Operator

Thank you. Our next question is from Brian Wang of Barclays. Please go ahead.

Brian Joseph Wang – Barclays Capital Inc.

Yeah. Hi, David. Actually, just a follow up on the last question, aren’t enrollments a much smaller percentage of the total in the second half of the year? So, I guess if you’d just comment on that.

David Kirchhoff

Yeah, they absolutely are a smaller percentage of total. If you look at the enrollment impact on our business, when I think about it, I actually think about it for seven months of the year because I start with June, which is when we first started seeing the slowdown. I take it, and I just basically take June and July and I project it forward across the five months that follow.

September and October are pretty strong months for us, whereas November and particularly December are relatively soft, except for the last week of December, which is typically a very big week. So, if you look at the seven months that we’re talking about versus the first five months, I think it’s safe to say the first five months are a bit bigger, but not necessarily as much bigger as you might think.

Brian Joseph Wang – Barclays Capital Inc.

All right.

Operator

Thank you. I’m sorry.

Brian Joseph Wang – Barclays Capital Inc.

Hello? Yeah. I had a couple other follow ups.

David Kirchhoff

Yeah, please.

Brian Joseph Wang – Barclays Capital Inc.

Oh, thank you. Which is also, yeah, going on the small accounts business, I guess, what changes have you made in people, accountability, or incentive that gives you the confidence that that’ll be executed better going forward or for the following…

David Kirchhoff

Yeah. Kind of everything, which is we have a new person who is responsible for the sales organization in that small accounts business. We’re putting in an entirely new process that we’re using to measure and keep track of inbound leads, conversion of leads, getting a much clearer visibility into the pipeline per sales rep. Putting in sort of, frankly, sales tools that, honestly, when I look back I would argue that we probably should have had in place in the first place.

But again, it’s sort of as we’re kind of getting better at becoming sort of more [fast flow] in what I’ll call B2B skills, we’re employing a lot of those practices that you would expect from a company that perhaps would have already been doing it for 20 years. So, we’re putting in a pretty wide - we really have had a full chord press on that business over the past six months.

Going through every single nook and cranny of it and completely changing around the entire way that we manage it and being much more focused on it. Frankly, more focused on it than we’ve been in the 12 years plus I’ve been associated with weight watchers.

When I look at the plans that we have in place and I look at the amount of attention being put against it, and I look at the leadership we’re deploying against it, it makes me feel much more confident that we’re going to be in a much better position going into this October than we were when we were going in last October.

Brian Joseph Wang – Barclays Capital Inc.

All right. Can you just let us know - I think first quarter, is the attendance in that small accounts business was down about 30%. Can you give us an update for what that was in second quarter?

David Kirchhoff

It was down less in the second quarter. What I would say is that was at least as significant is that if attendances were down 30%, enrollments were down even more than that in the small account portion of that business. So, what I would say is that the attendance trends, and actually more specifically the paid weeks trends that we’ve seen have continued to moderate over the course of the year.

Again, we had hoped that we were going to be able to cross the line and come even with prior year by this time. That’s not happening quite yet. But I think now we’re talking more in kind of the single digits on paid weeks, versus prior today than as opposed to where we were in the first quarter.

Brian Joseph Wang – Barclays Capital Inc.

All right. Do you have any visibility into if those customers are going to some of your competitors, whether they’re self-dieting, or whether they’re just not doing anything? I don’t know if you have any visibility into that?

David Kirchhoff

I think that the trick, the problem, or however you want to think about it is that there’s really not that many competitors that do exactly what we do in terms of providing group support and behavior modification for weight management for corporate customers. So, I think what literally happens is that - and again, I’ll continue to press upon the point that this was the small accounts portion of the business. Our business in the large accounts side of the portfolio is up significantly in double digits.

So, we’re doing fine. We have new accounts that we just brought on board, yet again this quarter. That part of the business is doing fine. In fact, the only thing that’s at all an issue in the strategic business is that we’ve had to allocate so many resources to clean up the small account. We didn’t have quite as much focus on building up the strategic side of the business as we would have liked. Fortunately, we’re kind of moving past that point until we can start bringing more attention back to the strategic side of the business.

If you go back to the small account portion of the business, a lot of times this would be a local school, where historically we had a 20-person meeting. As a result of us not being able to get enough critical mass for the meeting, I think what’s mostly happening is they’re simply not having a meeting onsite. So, the opportunity now comes back to us to, as we approach this coming January, to win back as much of that business as we possibly can, as well as bring in new small account business.

Brian Joseph Wang – Barclays Capital Inc.

All right. Then, just one last one touching on the large employer, obviously you said it was up double digits. But I’m guessing that’s off a pretty small base. You’ve talked about it a lot. I guess what gives you the confidence that you’ll succeed with this initiative, and what can you share with us that will give us a little bit more confidence?

I know you’ve invested obviously a lot of money into that, and you talk a lot about the opportunity, which we agree is huge. But I guess we get, not a huge amount of color on just the progress that’s being made.

David Kirchhoff

Let me say a couple things on that. First off, I agree that we have not yet been at a position to provide the clarity for the investment community that we’d like to in terms of a lot more specifics around our plans, milestones, and targets for the large account business. We’re in the process of actually pulling a lot of that together as we speak.

I think on the coming next couple of calls, without being too definitive on timing, we’re going to be able to share a lot more specifics in terms of what our two to three-year expectations are for that business. Because I can understand that without seeing that it’s kind of hard to measure and understand success.

What I would say for right now is that, that business was almost negligible three or four years ago. There were like two or three, or four, or five accounts that were meaningful. It’s now about, give or take, a quarter of our corporate portfolio. So, it’s become material and significant for us.

What I would say is that, even though it’s become material and significant, even today if you look at the number of accounts we have where we have meaningful business… The way it is tending to work is they tend to be large, kind of leading edge, wellness, HR practice organizations, where we’re seeing really high penetration and participation rates, sometimes going into the double digits across all employees.

So, what we tend to have right now is a small but increasing base of highly engaged accounts. If you look at the business for as large as it is, versus the penetration across all of the large strategic accounts that we might target, where we would have and hope to have large penetration, I would say that we’re two outs into the first inning. We’re still incredibility early days in terms of demonstrating meaningful penetration.

So, we remain incredibly bullish on this opportunity. We recognize, though, that to capture it, and again, this is what we’ve been saying on past calls, is that we have to be able to execute on a number of different dimensions, which are relatively new for us as an organization. Specifically, we have to make sure that we have the product right for this kind of client.

We have to make sure that we have the pricing, particularly as it relates to the pricing structure of the product. We have to make sure that we have the right kind of sales organization and sales process. We have to make sure that we can meet the expectations of these large accounts in terms of data reporting, being able to provide national coverage to those types of things.

So, we’re working like crazy to make sure that we have all of those capabilities installed so that we can finally get to this point of being able to turn on effectively, or turn loose a sales organization to really start operating at full capacity. To start bringing these companies in, because again, the incredibly consistent message I’m continuing to get, particularly in rooms full of CEO’s is that there is a huge concern over, that they’re seeing in terms of benefit costs and healthcare costs, and increasing recognition that they’re not going to make progress against it until they can get their employees to more systematically adopt a healthy lifestyle.

So, I would agree with you that we’re obviously also very enthusiastic about this opportunity. We believe that, given all of our inherent advantages in terms of being able to deliver clinical outcomes, being able to do it cost-effectively, being able to do it with a brand their employees want, there’s no one else that comes close. We just need to make sure we have the right B2B toolkit so that we can service the accounts properly and once and for all capture this opportunity, more to come on that.

Brian Joseph Wang – Barclays Capital Inc.

Great, thank you. Just, I think one last question, on the .com business. I believe you started investing on the advertising a little more heavily in the second quarter of last year. Now, you’ve fully lapped, I guess, those incremental investments. I guess, one could make the argument that, while you’ve made those incremental investments, in the advertising it drove, obviously, very strong growth on the online business.

You probably even have additional growth because the average customers stick around for eight or nine months. But, I guess, what would your response be to the fact that you’re seeing a slowdown already as you lapse some of those advertising investments on the online business?

David Kirchhoff

Yeah. I think again, what I would talk about is, specifically to the slowdown, I would suggest that the slowdown that we’re seeing in June. That we’re now forecasting throughout the rest of the year, again is significantly a function of where we are relatively speaking on the advertising campaign and where we are into the innovation cycle. So, my inclination would not be to overly extrapolate from what we’re saying we’re going to see over the next six months, to extrapolate that beyond, for those reason.

That said, you’re right, last spring, we turned on advertising to men for the first time. This year, we’re on air with men winter, spring, and fall. We turned on advertising for the first time for .com in CE, this January. Now we’re on January, spring, and to a certain extent in a couple selective places in fall.

What I would suggest though, is that even in some of those places, we’ve been on in relatively light weight in not very many weeks of the year. What we’ve typically done is that as we’re able to work out CPA targets to our satisfaction, we look for opportunities to be on air more weeks and to look for opportunities to potentially heavy up GRPs per week.

So, as we look at the .com business, the way I generally look at is… For example, if you take the U.S. You look at paid weeks for online and paid weeks for meetings. For the first time, online paid weeks are now surpassing the level of paid weeks we have in meetings. However, if I look at the relative price point of Weight Watchers Online at $18.95 a month, versus meetings at $42.95 a month, I would argue that the paid weeks for online should be actually quite a bit bigger than what we’re currently seeing for the meetings.

What that suggests to me is that we still have a good distance to go until we start to sort of more fully penetrate this opportunity, even within our existing countries, more mature countries such as the U.S.

Brian Joseph Wang – Barclays Capital Inc.

All right, thank you.

David Kirchhoff

Yep.

Operator

Thank you. Next question is from Peter Wahlstrom from Morningstar Investments. Please go ahead.

Peter Wahlstrom - Morningstar Investments

Good afternoon. Thanks for taking my question.

David Kirchhoff

Absolutely.

Peter Wahlstrom - Morningstar Investments

Certainly, in the last couple months we’ve seen headlines about new diet pills coming to market and FDA approval and so forth. You’ve talked about what turned out to be fad diets in the past. Could you talk a little bit about how you might have, or you might be baking in those pills coming to market in the second half, into your full-year projection?

David Kirchhoff

We’re not assuming any impact of diet pills in our forecast for the second half. For the simple reason that we don’t think that you’re going to see significant deployment of diet pills in the second half.

If you look at what is going to be required for them to get full release to start marketing diet pills the way that they’re looking at scaling up their efforts in terms of reaching out to doctors, and the fact that as it currently stands, very few health plans actually provide reimbursement for diet pills. There are a lot of unanswered questions in terms of what their relative price points are going to be, how doctors are actually going to feel about prescribing them.

The way I look at these two particular diet pills, and I think it’s interesting to look at the FDA language around it, in which they suggested that these diet pills could be beneficial to lifestyle change efforts. To me that’s interesting because it’s not that they’re saying, “Take this pill to lose weight, and you’ll be more effective if you also change behavior.” They’re saying, “Change behavior, and this pill might make you more effective in doing so.” In other words, lifestyle change remains at the center of what the recommendation is to physicians, with respect to even medication.

Now, you have two medications out there. One is lorcaserin, in which the clinical outcomes haven’t been particularly stellar compared to - if you look at average weight loss compared to other weight loss drugs that have been out in the market. But it has the advantage of having relatively modest side effects.

Then you have another in the form of Qnexa, which would appear to have somewhat better weight loss outcomes, particularly at heavier dosages. But the issue, I think for Qnexa, continues to be questions over, at those heavier dosages, what is the impact of side effects? What does it do in terms of drug adherence and everything else, not to mention potential issues down the road?

All this is to say, our natural wiring as an organization, and my natural wiring is to be paranoid about everything. So, obviously, I am concerned about any new threat that comes into the market. But what I would say, particularly with respect to this medication is that I take some comfort in the fact that we have seen this before.

I would argue that when Alli came on the market over the counter, a couple three years ago, honestly, that was incredibly terrifying because that was effectively a previously prescribed weight loss drug, Xenical, that was being sold over the counter that had a giant pharma company in the form of GSK doing massive trade spend behind it. To the point that they literally were almost having the appearance of buying out drug stores, where anybody could basically buy these pills and not bother with talking to their physician, and they’re price points that were, frankly, affordable. We literally saw no impact on our business.

So, we haven’t gotten hit by a diet drug since Fen-Phen. Again, I’m not saying that we’re not going to be impacted in the future, but what I am saying is that I fundamentally believe over the short, medium, and long-term that lifestyle has to remain that the center of meaningful and sustained weight loss as an obesity treatment.

Peter Wahlstrom - Morningstar Investments

Okay, thank you. Circling back to the retention item, given the outlook and kind of weaker consumer sentiment, I was wondering if you are seeing, maybe a shift in the current population, current subscribers, from the meeting to the online? As you point out, Weight Watchers is a discretionary purchase. Are they looking to pair back, or are those individuals just dropping out entirely? Or could they be changing channels?

David Kirchhoff

None of the above. In fact, what we’re saying is that, once people are with us, we’re seeing good economy, bad economy - recently it’s been only bad economy - but once people are with us and once they’re enrolled, we’ve seen literally no change in retention behavior. So, in other words, we haven’t seen any loss of retention in our meetings product over the past seven months, and we look at this longitudinally every month.

So, what we’re not seeing is people down-trading from meeting to online at any greater rates than we’d ever seen in the past, nor are we seeing any indications of increase in cancelation rates as a result of softening consumer sentiment.

Peter Wahlstrom - Morningstar Investments

Okay and one last item. As you see a structural growth in the .com business, are you also able to sell the Weight Watchers product? The products that you sell in meetings currently, do you have the same success with the take rate for that individual who is a .com subscriber?

David Kirchhoff

We don’t, and we think it’s an opportunity going into the future. You can purchase products via ecommerce is you’re a Weight Watchers Online subscriber. So, you can buy the bars and the pedometers, and those types of things. The penetration of those sales with the online subscribers is a tiny fraction of what we’ve seen with meeting members. But the .com team has increasingly become focused on trying to identify ways of potentially increasing penetration of ecommerce sales against the subscriber base.

We’ll see how far it gets, because I think one of the issues with ecommerce is that, unlike when you’re in a meeting room and you’re sort of seeing kind of everything right in front of you, I think it’s hard to match the level of sort of impulse purchasing behavior that you’re going to see in a Weight Watchers meeting room. But nonetheless, I would argue that there’s probably more opportunity in driving ecommerce sales against Weight Watchers Online subscriber base.

How meaningful that would be in terms of the overall scope of the financials of the organization is yet to be seen, but it is something that’s on our mind.

Peter Wahlstrom - Morningstar Investments

Okay, thank you very much.

Operator

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

Greg Badishkanian – Citigroup

Great thanks. Just, the first question is, I know you said the new innovations for 2013 won’t be as big as the ones that were launched last year. But, could it be pretty sizeable relative to some other kind of smaller launches that you’ve done in the past? Or how would you categorize how impactful it could be?

David Kirchhoff

Yeah. It’s always a little hard for us to judge these. What I would say is that internally, we love it. The response that we’re getting internally, including from the people who were actually responsible for delivering it, all the early indications are terrific. It is definitely more significant than the change that we put in this year, which I would say was a pretty modest level of innovation.

So, I think it’s what we would typically… If I had to ballpark it, I would say it’s what I would categorize as what we’ve historically called a major innovation. So, let me kind of provide a little bit of color around my definitions. I think of innovations in three buckets. One is platform change. The next level down is major innovation, and the next level down below that is what I would call minor innovation.

I would call PointsPlus 2012 a minor innovation. I would call PointsPlus itself a platform change, platform changes typically being every 10 years. Major innovations for us have typically been every two to three years. Momentum was a major innovation. There were a number of others like it. I would put this current rate in that category. At least that’s the expectation we have for it as we’re thinking about our marketing and PR plans as we go into January.

Greg Badishkanian – Citigroup

Good, thank you.

Operator

Thank you. The next question is from John Faucher of J.P. Morgan. Please go ahead.

Johan Faucher - J.P. Morgan

Thanks. Two questions, first off, on the online business, you talked about maybe seeing some other trends in online with some competitors. Are you seeing any shift to some of the free products that are out there with the economic weakness, and do you perceive this as being more of a threat if the economic weakness continues?

Then, secondly, it seems as though some of the executional problems this year came from trying to execute a number of different ideas at once, most of those in the first quarter. You’ve still got a lot on your plate at this point, so can you talk about sort of managing through lots of different things going on as we head into 2013 to ensure maybe some more consistent execution?

David Kirchhoff

Yes. Both good and fair questions, so let me start with the free app. Of course I’m always concerned about anything that’s being given away. There certainly have been a lot of distribution of free mobile applications that help people count calories, and that’s typically what they’ve been. Most of the apps I’ve seen, they’ve tended to focus on one specific element of the weight loss process. They tend not to have a complete program built around them.

What I would say is that when we see people signing up for Weight Watchers online, what we hear is that they want to do Weight Watchers the program, and the software tools are merely a way of helping them do Weight Watchers. So, their purchase decision isn’t so much of comparing our points tracker versus someone else’s calorie tracker. It’s more a decision of, “Do I want to do Weight Watchers, because I know other people that have done Weight Watchers? Is it a program that can work for me?”

Further to that point, what I would argue is that the Weight Watchers program is obviously… I would argue, because I’m bias of course. But it’s a much more comprehensive form of behavior change and tools, and resources stretching from. Not just mobile but also including website across and having a completely full-blown program that is much more comprehensive in nature than what is available on a free app.

Finally, what I would suggest is, one of the challenges with free apps is that it’s pretty easy to get someone to download something that’s free. It’s less clear how long someone is going to actually use it once they download it. So, I wouldn’t be surprised if you had a number of people out there that had three or four free weight loss apps on their phone, and perhaps weren’t even using any of them.

So, what I’m trying to say is that we, like any other competitive threat, we take this seriously. Our best way of defending against it is to continue to oppress an aggressive agenda in terms of product and program development and getting people excited about Weight Watchers as a way of helping them achieve their goals in a way that a free application would have a hard time matching.

That’s kind of our starting point in terms of how we address that particular issue. I would also point out that a lot of the sort of mass of downloads on free apps has been happening even while we were experience… For example, it was going on all through 2011, when we were also experiencing a huge amount of sales growth for Weight Watchers Online product.

In terms of the executional issues in sort of managing bandwidth and prioritization, exactly for the reason that you’ve cited, we’ve been looking for ways of basically increasing management bandwidths in particular by having people more dedicated around specific opportunity areas in ways that we didn’t have at the end of last year. So, in particular, if I look at the issues that we’re now dealing with in terms of the transition on health care, we did not have an executive dedicated to the healthcare initiative.

We do now, as you’ve heard me reference on previous calls, Colin Watts, who we hired away from Walgreens is now heading up that initiative. We did not have the benefit of his leadership when we were going through this transition last year. So, in recognition of what you’re describing, we’ve tried to make sure that we’ve (inaudible) key gaps in terms of making sure that we’re getting the right kind of focus and prioritization in terms of specific growth opportunities that we’re trying to pursue.

Johan Faucher - J.P. Morgan

Okay, thanks.

David Kirchhoff

Yep.

Operator

Thank you. There are no further questions registered at this time. I would like to turn the meeting back over to Mr. Kirchhoff.

David Kirchhoff

Okay, thank you for joining us today. I look forward to speaking with you again at our next quarterly earnings release.

Operator

Thank you. That concludes today’s conference. Please disconnect your lines at this time, and we thank you for your participation.

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