NutriSystem Inc. Q2 2008 Earnings Call Transcript

NutriSystem Inc. (NTRI)

Q2 2008 Earnings Call

July 23 2008 4:30 pm ET

Executives

Cindy Warner - Manager of IR

Joe Redling - President and CEO

David Clark - CFO

Analysts

Greg Badishkanian - Citigroup

Laura Richardson - BB&T

Jim Duffy - Thomas Weisel Partners

Karen Howland - Lehman Brothers

Nicole Jacoby - Liberation

Bill Sutherland - Boenning & Scattergood

Presentation

Operator

Good day, ladies and gentlemen, and welcome to the second quarter 2008 NutriSystem Earnings Call. My name is Su, and I will be your coordinator for today. At this time, all participants are in a listen-only mode. We will be conducting a question-and-answer session towards the end of this conference. (Operator Instructions). As a reminder, this conference is being recorded for replay purposes.

I would like now to turn the presentation over to your host for today's call, Ms. Cindy Warner, Manager of Investor Relations. Please proceed.

Cindy Warner

Good afternoon, everyone, and thank you for joining us to discuss NutriSystem's second quarter 2008 financial results. With us today from management are Joe Redling, President and Chief Executive Officer and David Clark, Chief Financial Officer.

Before we begin, I would like to remind everyone that this announcement contains forward-looking statements that involve risks and uncertainties. Such information includes statements about NutriSystem's second quarter financial results as well as statements that are preceded by, followed by or include words believes, plans, intends, expects, anticipates or similar expressions.

Statements regarding NutriSystem's outlook and guidance for the third quarter of 2008 and the full-year 2008, its expectations regarding the effect of the economy on customer spending and similar statements that are not statements of historical facts constitute forward-looking statements.

For such statements, NutriSystem claims protection of the Safe Harbor for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995. Actual results may differ materially from the results predicted and the reported results should not be considered as an indication of future performance.

Factors that could cause actual results to differ from those contained in the forward-looking statements include but are not limited to those factors set forth in NutriSystem's Annual Report on Form 10-K for the year ended December 31, 2007, which has been filed with the SEC.

NutriSystem is making these statements as of July 23, 2008 and assumes no obligation to publicly update or revise any of the forward-looking information in this announcement.

And with that, I would like to turn the call over to Joe Redling, our President and Chief Executive Officer.

Joe Redling

Thank you, Cindy. Good afternoon, everyone, and thank you for joining us on today's conference call.

Let's dive into second quarter results and review some key highlights. Revenues came in at $194 million, down 9% versus a very strong Q2 of 2007. Gross margin for the second quarter was 50.4%, versus a year ago of 54.9%, reflecting increases in cost of food and transportation. Marketing, as a percentage of revenue, was 21.6%, only slightly changed from a year ago at 21.3%.

Adjusted EBITDA was $39.4 million, down versus prior year of $55.4 million. And operating income came in at approximately $36 million. Revenues for the second quarter at a $194 million, exceeded guidance of a $180 million to $190 million, as forecasted pressure continues on gross margin with Q2 down 10 basis points versus Q1 of 2008.

We are attacking the gross margin decline, with a full supply chain optimization effort and as I mentioned in the Q1 call, we will be testing various price increase options to help offset increases in both food and transportation costs. The price testing begins in early August, as we expect to see continued pressure on the gross margin line, we do anticipate initiating price increases in the fourth quarter unless we see stronger demand trends and improved response to current value offerings and promotional programs. In the interim, we will continue to explore new offer strategies and value messaging to provide additional incentives for diet consumers to buy.

Now onto some addition highlights for the quarter. First, let me begin by updating you on our second quarter management transition. As you know, on May 1st, I assumed the role of President and CEO and Mike Hagan, transition to Non-Executive Chairman of the company. The transition went very well. And Mike and I continue to work closely together as we navigate through this challenging operating environment.

In my initial 60 days in the role, while keeping the company focused on delivering our quarterly operating results, it was also critical to better align the organization against our top priorities and strengthen our leadership team. Consistent with that direction in May, we announced the addition of Scott Falconer as our new Executive Vice President of Customer Management and Product Development. Scott is responsible for many functions, including call center operations, customer service, supply chain management and product development.

Under Scott's experienced leadership, we will be initiating plans to improve call center productivity and customer retention. All key customer touch points are being reviewed with a goal of setting and achieving higher performance metrics across all customer touching operations such as customer service, order management, sales and counseling.

In addition, we are rolling out an aggressive product development initiative with the goal of expanding our offerings to better serve our customers, drive retention and to track new segments. Scott will also be leading a major effort to improve gross margins via one, working closely with our suppliers to reduce cost in the supply chain area. Two, improving order accuracy and inventory management, thereby reducing cost and improving overall customer satisfaction. And three, increasing sales with profit enhancement opportunities to cross sell, up sell and increasing overall revenue per customer.

As discussed on previous calls, our conversion to the new eCommerce platform has been completed. We fully transition to the new platform in early June and have begun to operationalize the toolset and data mining capabilities of this new platform. This will provide us with numerous opportunities to gain critical insights into real time web performance, marketing effectiveness and conversion rates, well also providing the infrastructure to support our customers in new and exciting ways on the web.

QVC is also a positive highlight in the quarter. NutriSystem Advanced launched on QVC on April 12th and led to a record second quarter sales performance exceeding prior year sales by over 30%. We are very pleased with the response our new product has generated on QVC and we look forward to our upcoming TSV next week on July 27th and continuing to build on our strong partnership with the QVC organization.

We recently announced the acquisition of NuKitchen, a leader in the premium freshly-prepared meal delivery business. NuKitchen provides a full menu of fresh, restaurant-quality prepared meals delivered daily to their customers. The two NuKitchen co-founders, Mark Newhouse and Bryan Janeczko have joined the NutriSystem team to manage the NuKitchen brand and to oversee the expansion of its local daily delivery service.

With this addition, and the plan launch of our frozen line, we will be able to offer a complete spectrum of options to the weight-loss and weight-maintenance consumer, as we continue to expand our product offers, menu selection, and price points.

Now let's look at marketing efficiency for the quarter. Q2 saw a return to 21% marketing spend as a percentage of revenue. This improved significantly from Q1 and is consistent with Q2 of 2007. This improvement has come from finding the right mix of media channels and offers that deliver the appropriate levels of profitability.

We continue to see economic obstacles with the dieting consumer, but our business model enables us to continue to spend efficiently in what is clearly a softer demand market. As you may recall, we have previously guided to a full-year marketing efficiency percent in the mid-20s, as a percentage of revenue. Q2 is a strong indicator that we are well on our way to meet that objective.

Now turning to the remainder of 2008 and our full year outlook, we are maintaining our full year revenue guidance of $700 to $720 million. We are updating full year adjusted EBIDTA guidance to be between $110 million and $120 million. There are three factors contributing to our new adjusted EBIDTA outlook.

First, additional and accelerated one time investments that support both, our revenue growth initiatives and cost optimization programs within our supply chain area. These initiatives may have a near-term negative impact of adjusted EBIDTA, but are expected to result in positive ROI in 2009.

We also continue to see pressure on the gross margin line. And we have a mindful view, regarding demand for the second half of the year. While we have performed above or within expectations for the first half of 2008, we remain concerned about the economic picture and demand, as we look ahead to the fall. Our initial read in July is we are seeing softness and we have reflected that in our full year guidance.

I continue to believe, we have a strong opportunity to build the business in 2009, and we are investing accordingly in those areas that will improve our operational capabilities and efficiencies going forward. We have stabilized the business in the first half of 2008, as we enter the second half of the year, I remain optimistic, but I believe prudently cautious.

With that I'd like to turn the call over to David Clark, our CFO.

David Clark

Thank you, Joe. The second quarter 2008, we generated $194,029,000 worth in revenues, a 10% decrease from the seasonally strong first quarter. Reactivations continue to attract at 20% of revenues and gross margins came in at 50.4%, down from 50.5% last quarter. Marketing as a percent of sales was 21.6% in the second quarter, improved from 31.1% in the first quarter of 2008.

Operating income was $35,566,000 and represented an 18.3% operating margin and an improvement of nearly 800 basis points in margin over the first quarter of 2008. Our adjusted EBITDA came in at $39.4 million, up from $26.6 million in the first quarter, and our adjusted EBITDA margin was 20.3%, again an improvement of 800 basis points from the first quarter of 2008. Net income from continuing operations was $21,968,000.

For below the line items, Slim & Tone posted a discontinued operations loss of $14,000 and our investments in the development of Zero Water resulted in a recognized loss of just under $1 million for the quarter. The company has accrued for a 37% tax rate so far through the year and diluted earnings per share came in at $0.71 for second quarter, down from $0.96 a year ago.

Non-cash employee stock compensation had a $3.8 impact on earnings per share or $1.9 million in total. Our direct channel generated 93% of our revenue and QVC generated 6%. QVC Jet totaled $11.4 million and the remaining 1% came from other channels. Our inventory levels totaled $45 million on June 30th of this year. Currently we are down to the final $1.2 million of Nourish inventory on hand.

We expect to run through the balance by the continued use of our clearance centre on our website and continuing our relationship with the distributor who places the product with outlet such as Big Lots or other grocery outlets. This month, we repurchased about approximately $15.2 million of our own stock, which totaled 1 million shares or approximately 3% of the outstandings. A stock buyback authorization of roughly $123 million remains in place, and we currently have approximately 31 million shares issued.

From a liquidity standpoint on June 30, 2008, we had $62 million in cash and equivalents, and we continue to be invested entirely in money-market accounts and hold no auction rate securities. Our capital expenditures for the second quarter were $3.1 million. Our $200 million credit facility remains unused and available should we need it.

Our business generates free cash flow that can sustain our dividend, which is going to be $17.05 this quarter, which represents approximately 25% of our net income, and a smaller portion of our overall total free cash flow, which we define as cash flow from operations minus CapEx. This dividend I mentioned returns about a 3.5% annualized dividend yield on $20 share price, and yet allows sufficient liquidity to opportunistically repurchase shares, and most importantly have free cash flow available to make investments in growing our business.

Now moving to guidance, as Joe mentioned, we are maintaining our full year revenue guidance at between $700 million to $720 million. And our full year adjusted EBITDA is going to come in between $110 million and $120 million to reflect one-time investments in growth and cost optimization initiatives. Consistent with our earlier guidance, we are anticipating that our gross margins will come in around 50% and will continue to be pressured by higher food and freight cost.

In addition, we are expecting continued economic pressure on new customer demand for the balance of the year. Slightly lifting our percentage of marketing spend to revenues to the mid-20% area, we also define that metric as marketing efficiency.

Lastly, we expect to spend between $5 million and $6 million in the back half of this year in G&A expenses, representing investments in initiatives designed to enhance profitability in the coming year 2009. Specifically, those include a substantial reengineering of our supply chain that involves the consolidation of two of our distribution centers in this quarter alone, adapting several best practices and procurement inventory management and final distribution.

We also have solidified our rollout plans and better estimated the costs associated with our frozen and maintenance initiatives. These offerings will not only broaden our appeal within our addressable market of an estimated 100 million dieters, but also allows us to extend length of stay of our existing customers.

We expect to continue investment in our eCommerce capabilities to drive higher conversion through that all important channel, and we will be focused with new call center upgrades to prolong customer length of stays, also supporting some marketing call center staffing to support our growing business in Canada and additional programs and revenue enhancement. We expected all of these initiatives taken collectively should have a strong return on investment in 2009, even at the low end of our expectations.

Our third quarter revenues are expected to be between a $160 million and $170 million, and we expect adjusted EBITDA for the third quarter to be between $25 million and $30 million.

And with that, I will turn it back over to Joe.

Joe Redling

Thanks, David. Before we open it up to Q&A, I would like to highlight a few important themes coming out of today's call.

First, we were able to deliver on our second quarter results and get our marketing efficiency in line. That reenforces the flexibility of our direct-to-consumer business model. The fact that we can operate efficiently and profitably in tough economic times supports both the longevity of the business and the enduring nature of the product we offer.

Second, that same business model, despite significant pressures on the gross margin side of the business, enables us to generate significant levels of cash. Through the first half of 2008, we have generated $72 million in cash from operating activities. Adding to our cash flow is our available credit facility of $200 million, which provides us with more than adequate liquidity to invest in the core business, selectively pursue acquisitions and/or provide strong returns to shareholders via stock buybacks.

As discussed, we are initiating numerous new products and initiatives in the company with minimum capital. This is a capital light business and the return on invested capital has been and we will expect it continue to be strong as we move forward.

Lastly, I have complete confidence in the depth and experience of our talented management team. We are well positioned to continue to improve our operations and our customer economics to get smarter about how to leverage marketing spend and to gain share by introducing new products. We believe our market is large and growing.

NutriSystem is one of three top tier brands in the category and we intend to leverage that position for growth. While we are experiencing challenges this year, I am proud of the way the team and the company has responded as we weather the storm and we remain confident in our future prospects.

With that Operator, we would like to open it up for some questions.

Question-and-Answer Session

Operator

(Operator Instructions). Your first question comes from the line of Greg Badishkanian from Citi. Please proceed.

Greg Badishkanian - Citigroup

That's Greg Badishkanian, Citigroup. Great, thanks. Hey, guys, just a few questions here. You did a nice job in turning around business trends in the second quarter in our sales and EPS estimates. Just wanted to understand a little bit more about your more cautious outlook for second half '08? On the demand side, is it more the consumer? You're seeing a little bit more pick up in the competitive environment. Looking to kind of point to, that might lead to a little bit more tempered outlook?

Joe Redling

Hi, Greg, I think what we are seeing is what we've been seeing most of this year, really a softness on the front end demand side. Our early indicators in July, we've seen continued softness in July, and the reason for the cautious outlook is, while we've performed relatively well in the first half of the year, as you will know, that's the strongest demand periods of the year in Q1 and Q2.

As we enter into the second half of the year, we are coming into much softer demand period from a seasonality standpoint. So we just want to be cautious there. We also have some additional factors on the marketing side, with the Olympics in August, as well as the political in the fall. So we predominantly see it as taking a look at the second half of the year and reviewing that.

So, really we haven't seen any unexpected competitive activity. We expect it to kind of run its course, as we normally we see the second half of the year. So, it's really about a combination of what we are seeing in softer demand, as well as some of the external factors on the media side.

Greg Badishkanian - Citigroup

Right, yes. Absolutely, on the macro front and, I think, everyone’s seeing that, in terms of the competitive outlook. I mean, are you seeing Weight Watchers and others being stepping up marketing and advertising, or is it kind of a study?

Joe Redling

Yes, I think as you follow our business, typically we have the flexibility in our model to continue to spend through periods like the summer for a number of reasons. One is because we really manage our media based on profitability, as we did in Q2, and we also can deliver product wherever you are during the summer, where visiting a centre or being more locked to your home might be more difficult for other programs.

So, we have the capabilities and the opportunity to continue to spend through periods like, June, July, August. So, we really haven’t seen any other competitive activity out of the norms there. We do expect, as we normally see as we move in to the back to school September period, typically, competitive spend increases during that period, as does ours.

Greg Badishkanian - Citigroup

Great, okay, that's very helpful. And looking a little bit at the gross margin line, obviously, everyone sees the commodity cost going up. Can you talk a little bit at the timing of contracts you have with co-packers that might be kicking in, and obviously, you have, although the revenues of the trend has turned around positively, it's still declined year-over-year. So are you getting a little bit less favorable rates than you did in the previous year?

David Clark

Yes, on the gross margin side, the way the contracts come through, we get price increases all throughout the year based on the new product ordering. So, we're expecting those to happen, several of those happening in the second half of the year, some of that actually occurs in the first quarter of next year. So, we have that view into that business, and we continue to see that there is not a lot of unknown there for us. We're just forecasting that to continue as these new price increases in the contracts come into play.

Greg Badishkanian - Citigroup

Right, absolutely. And moving over to reactivation, did you see any major deviation from the trend that you have been seeing in the past few quarters on that?

David Clark

Actually, we haven’t. It's a very positive point in this environment. I think we said it on the last earnings call, the trends on reactivation revenue continue to be solid. We still expect it to account for 20% of our revenue on a full year basis, and we're seeing pretty good news on that front.

Greg Badishkanian - Citigroup

Yes, that's encouraging. And moving over to call center productivity, you mentioned that you have, you've added management talent there. What are some of the areas that you can improve upon? Am I assuming that maybe the close rate on incoming calls would be probably the good move in need of the most?

Joe Redling

Yes, I think there are two sides to that, Greg. You hit the first one, taking a much more specific professional view of our close rates by channel, which we have already launched. So, we have a great deal of activity going on regarding training, investment in training, expanding our queues, call routing, and actually having more opportunities to provide more offers to close customers, who are calling in on the phones. But we've also launched retention queue at the end of June, where all of our customers who are either delaying or stopping orders actually have to call us. And we launched a retention queue with fully trained staff that are compensated on retraining that customer and servicing them to continue to be on our program, and we think could have a pretty substantial impact as well.

So, on that front, so you’ve got the front-end and the back-end, but also making sure we’re utilizing our manpower properly through all the calls that we get, and moving as much as we can online in terms of supporting our customers. And there is also cross-sell, upsell as an opportunity. I mean one of the biggest factors of moving our Nourish inventory outdoors this year has been done through upsells in our call center, and we tested a number of different up sell programs, like snack packs and other things, that could provide incremental revenue to us as we move forward. So, there is a number of initiatives. We think is a big opportunity. We have tremendous number of touch points with our customers on a daily, weekly, monthly basis, and we need to make sure how we raise the level of service, but also understand how we create incremental revenue opportunities.

Greg Badishkanian - Citigroup

And just finally, in terms of marketing, can you just give us an update on current celebrities now and in the pipeline, to the extent that you can talk about that? And will you be serving the back half of the year, or maybe just kind of hold off on those till the start of the new diet season in January?

Joe Redling

Yeah, we're kind of going with our existing stable of great celebrities. Marie has done well for us. Billie Jean King, we just launched this July with our seniors program. One of the things that we are doing with some of our expenses on the investment side is making sure we have a robust amount of creative, for when we move into the first quarter and then to the primary diet season.

We'll be looking at a number of different celebrities as we move into the fall. And we will be making those decisions on whether we launch those new celebrities now or we wait till January. But we really don't have any new celebrities to announce at this time.

Greg Badishkanian - Citigroup

Right, good, well good to see things turned around a bit in 2Q. Thanks.

Joe Redling

Thanks, Greg.

Operator

And your next question comes from the line of Laura Richardson from BB&T. Please proceed.

Laura Richardson - BB&T

Thanks. I want to dig a little more into the comment on the softness in July. And just are you seeing the trend in terms of year-over-year decline was weaker than it had been in the second quarter?

Joe Redling

Well, actually, typically what we've seen in July is a bump in demand. And that's what we were expecting, as we have experienced pretty much each July for the last several years. Mainly because, you see media race and clearances open up. And as we come off that 4th July weekend, we typically have seen from a trend standpoint improvement in trends. We actually saw a kind of almost a reversal, we saw a very strong June. We actually did better in June than we actually anticipated.

We really didn't see the anticipated bump in July demand that we normally would see. And we are in new territories now. Where we were able to move demand with our media spending in normal economic times, we think there may just be a little bit more headwinds now for us to try to get those people to reach down and dip into their wallet in the middle of the summer. So, we didn't see the improvement that we expected, and that's what we kind of reflected in our guidance.

Laura Richardson - BB&T

Okay. And is that mostly new customers, then, in direct marketing, and not reflected in what you're seeing with reactivations, for example, or is it a similar trend there?

Joe Redling

No, that's correct. As I said earlier, that we have a lot of strength in reactivations. It's very stable. We haven't brought down that number at all. So it will be 20% of our full year revenue. It's a very steady revenue stream.

Laura Richardson - BD&T

Okay. And then, I mean, getting the sense, you're basically saying you're continuing to invest a lot in the second half for growth in 2009, and at a high-level. Can you just refresh my memory, as the growth drivers for revenue in '09, we know frozen. But how many items is that, or what percentage expansion is it of your current line up, and is the fresh going to be a factor in '09, or is it going to be still like one market?

Joe Redling

It will be one market. We'll begin expanding the fresh. But we think we have some interesting marketing messages to use with fresh. The frozen line, we expect to increase our selection at the tune of about 40% more items on the frozen line -- as we move into the end of December. So we're pretty excited about that and have accelerated the development of each of those items, and having those items be equally provided across all meal occasions, which also includes breakfasts, lunches, entrees and desserts.

Our initial effort here, as we started looking at frozen, was predominantly entrees. And as we get into more of our testing, we're finding huge opportunities with both our base and potential new consumers in other meal occasions. Clearly, eating ice cream for dessert is a great thing for a dieter. And also the frozen provides you with some easy-to-handle, on-the-go type product that we think can change a lot of the program perceptions that we have in the business.

So we've kind of expanded our view on the number of items in frozen. The growth initiatives really run the gambit, really, but clearly we'll continue to invest in the web. Our ATG platform is launched, it gives us a great infrastructure. But now we need to start working on that front end to continue with our process to redesign our website over the next three to five months, and get that up to speed to be ready for the first quarter.

Laura Richardson - BB&T

Okay. Let me follow-up on one thing. So 40% more items, so if there were a 100 items now in NutriSystem Advanced, there would be 40 more coming in frozen?

Joe Redling

Yes, well 40 to 50 items by the time we get into the peak diet season.

Laura Richardson - BB&T

Okay. Thanks and good luck.

Joe Redling

Thank you so much.

Operator

Your next question comes from the line of Jim Duffy from Thomas Weisel Partners. Please proceed.

Jim Duffy - Thomas Weisel Partners

Thanks, hello.

David Clark

Hi, Jim.

Jim Duffy - Thomas Weisel Partners

Question for you guys on the price increases, is my understanding you tested these and are comfortable that would be with some level of acceptance from the customer base true?

Joe Redling

We are testing in the beginning of August.

Jim Duffy - Thomas Weisel Partners

Okay. And then to be clear, does the gross margin guidance, as you laid it out, depend on this price increases or is that?

David Clark

No, there is no price increase build into the guidance at all.

Jim Duffy - Thomas Weisel Partners

Okay, good.

Joe Redling

And the reason we did that, Jim, is, again as we look at price increase, we'll be testing a number of levels of prices as we done in the past anywhere from a $5 increase to a 15% across the board. But we need to kind of really track it against demand. We won't do it if we see it really impacting demand and conversion on the front end, and also we have some spots running now which are offering locking in pricing for the rest of 2008 and with a really strong value message.

If any of that seems to take hold from a demand standpoint, we wouldn't increase the price. But if we don't see any traction in those efforts, we think we would have a high probability we will be looking at price increases by the fall.

Jim Duffy - Thomas Weisel Partners

Joe, I want to ask you about those, I have seen those spots. What do you see in terms of responses from customers to those value messages and offerings?

Joe Redling

Yes, it's interesting. The early indications are somewhat positive, but it's pretty early. We actually launched these value spots on July 14th, so it's really a limping out there a week. Typically, it takes us at least a week to two to get seasoning in those commercials as we track them against our control.

But the early indicators are there. They are at least performing as well as our current commercials, which we've been running for a while. That's typically a positive thing. We have to kind of see how we convert when those people call on the phone. You may notice we're going out with additional attempts to kind of invigorate our value proposition with less than $3 a meal claims, versus the free weeks and some with free weeks. So we continue to test to figure out if we can find kind of decode this in this economy to see if we can get something that could attract consumers.

Jim Duffy - Thomas Weisel Partners

And from a behavioral standpoint, what are you seeing from the prospects? Have you seen a lot of evidence of Sticker Shock? The customer is getting to the page that requires the entry of the credit card number and marking? Has there been any sort of increase in that?

Joe Redling

No. Jim, we saw that in Q1, right. We were the first guys to come out and talk about the economy, I think, because we saw sort of that fall out in the sales funnel. That's clearly where we see it today when we show the price. But the customers that are buying are highly qualified, better customers, and we're seeing their length to stay improve, and our revenue per customer improve on those customers that are buying today, which is not surprising in this environment that the people who actually decide to commit are very qualified.

But, yeah, and that's where with our new ATG platform, we have the capabilities to do real time offers to those folks. If they come in and they cancel out of that sales funnel when they see price, we can make them real time offers and those are the things we're testing as we speak.

Jim Duffy - Thomas Weisel Partners

Okay. And Joe, you and I spoke earlier in the year, and you talked about some prospecting initiatives that you had in the works, working with third party list, outbound calling, so forth. Is there any update on those, or are you still kind of in early days there?

Joe Redling

Yeah. We've actually made some good progress on that. We've expanded our volumes pretty significantly in March and April, and the results have been pretty positive, so we have a few more testings to go, as we scale that direct mail business. It's all about first getting the right list, which I think we've kind of accomplished that.

Now it's really segmenting those with testing a lot of a creative, and that's kind of the process we are in now. Our goal is to see if we can reach some level of mass by the time we get into the main diet season in 2009.

Jim Duffy - Thomas Weisel Partners

Okay. And then a final question, media rates for the Olympics and the election and so forth, do you expect some pressure there as you look to find media time?

Joe Redling

We finally have seen media rates start coming down in July, that's some of the good news, as our clearances were pretty big and our media rates came down significantly from the end of the second quarter. The Olympics in August, we don't feel we'll get a lot of pressure there.

The politicals is something that we will be watching very closely. We typically think, we can buy around it, because of the way we buy. But it is the factor that could be challenging for us as we move into September and October.

Jim Duffy - Thomas Weisel Partners

Okay, thanks very much. I'll let someone else to jump in.

Joe Redling

Thanks.

Operator

Your next question comes from the line of Karen Howland from Lehman Brothers. Please proceed.

Karen Howland - Lehman Brothers

Hi, thanks for taking my call. Hello?

Joe Redling

Hi, Karen.

Karen Howland - Lehman Brothers

Hi, sorry about that. I was wondering if you could talk a little bit about the any additional marketing expense you expect to see coming from the launch of the frozen, and I know you've spoken, I don't think you talked at all about the maintenance line that you spoke about last quarter, if that was still on the pipeline and any thoughts on that as well?

Joe Redling

Yes, the program for both frozen and maintenance. Maintenance clearly is an incremental marketing spend investment in terms of how we do that. The good news about that is we primarily will do that online and primarily through our call center. But they will be testing, there will be research, non-media related sort of spend against maintenance that is included in some of the numbers that David mentioned earlier.

The frozen component will be incorporated into our typical marketing. It's going to be a core message point for us of expanding our product line. So, we don't have a plan to go out individually with a frozen promotion or frozen marketing effort, it will be incorporated. But we will have a number of different creatives who will be producing, and a number of different channels we’ll be investing in to push that new creative into the market, as we get into the first quarter, so there will be some pre-investment on development of that marketing.

David Clark

Yes, I think it's a good question, Karen, because we specifically obviously called out 5 to 6 million to spend on initiatives, including maintenance and frozen. But I'd say a portion of our expectation of our marketing as a percent of revenues going up from 21% to the mid-20s, and really coming in that mid-20 area for the balance of the year is, mostly a cautious outlook on demand, but also, as Joe says, some spending around getting initiatives ready to go for the new diet season.

Joe Redling

And we think about maintenance, I mean maintenance, really, the investment there. We think our maintenance program is a unique online program, and so that needs to be worked on, to integrate the program into the online space, and that takes some investment. But again the maintenance program initially will be sold to our existing customers, even though we are very aware, say if there is 35 million dieting consumers, who want weight maintenance programs on their own, and we'll test into ways to figure how to do that. We think the web is the best way to approach that initially, to be very efficient, as well as getting people to our website overall with our general marketing and then segmenting them into a maintenance cell, if that’s appropriate for that particular consumer.

Karen Howland - Lehman Brothers

Perfect, thanks for that additional color. I was wondering if you could go back and talk a little bit about the value proposition ads. I recall, probably in the May time period, I saw a good number of ads that were really focusing on that $10 a day message. It seems that the advertising hosted in June, and I obviously don’t sit around just watching, waiting for your commercials to come on, that I haven’t seen that as much. I was wondering if you gotten the response you were looking forward to with the value propositions, or if there is any change as far as that market?

Joe Redling

Yeah, I mean $10 a day has been a pretty standard. It’s still in most of our commercials that we have today. What really changed over that first, second quarter were the three week free offer. And really the first step into to a new positioning for value was what we just recently did in early July, which is $3 a meal locking your prices. We are experimenting with another promotional offer, which is plans as low as $7 a day.

We have a 28-day Flex Program, that I think we talked about on the last conference call, which really provides 20 days worth of food in the 28-day program, and eight days of venue development help and coaching, and that's a $200 price point. While we went to sell that price point, we haven't seen a big, any sort of real scale interest in just the fact that it's a lower price point. So, we will be testing, you’ll probably see it first on the web. We will be testing plans for as low as $7 a day. So, we will continue to explore this area about how we kind of get through and break through on a value message.

Karen Howland - Lehman Brothers

Perfect. Thanks. And I was wondering, the price increases that are going have to come with frozen and the price increases you are going to give testing later on this year, can you talk all about the about the magnitude of those.

Joe Redling

Yes. The general price increases, it’s a little early for us to say, because we do test a number of different price points. They could be as low as $1 million in 2008, to three to four times that, depending on the level of flexibility we have in the testing. It's really more of a 2009 play for us because of the offset gross margin. So, on full year basis, it could have clearly a much bigger impact on that, but that will be driven by the level of price increase we think we can take without hurting demand. So, we continue to drive the bottom line.

On the frozen side, it's a very interesting component because we think, again we will be testing this, as we gets towards the later half of this year, as we get into the fall, we will be testing price points in frozen, we think we have the capabilities of bringing our average price pretty significantly, with 28 to 30 frozen items included in a one month order.

We will pass through any of the delivery cost that we incur to the consumer, because our research shows that that's pretty expected if you are buying frozen foods, yet there are special delivery requirements for that. But we do think we have that opportunity, without a price increase, to bring our average cost per order up. But again we need to get some time and testing once we get this pilot out and running, probably in the October, November time period.

Karen Howland - Lehman Brothers

And for the pilot program, if frozen is going to be October, November, and then, full rollout in the New Year?

Joe Redling

That's correct.

Karen Howland - Lehman Brothers

Okay. And then again, obviously, cash generation is very strong coming from this business. I was wondering if there is a reason -- [now tomorrow if it's] got buyback?

Joe Redling

You know, as we said before, we implemented a dividend because we tend to be cautious around how we deploy our buyback dollars, just given the outlook on what investments we are going to make. So, we are very aggressive in the first quarter, this quarter is formalized, kind of what we thought the second half of the year would look like.

We put $15 million to work, and so far this year, at $60 million. So, I think we continue to be aggressive around share repurchases. And the dividend is just supposed to give a consistent return to capital, in the cases in certain quarters where you want to be prudent and conserve cash.

Karen Howland - Lehman Brothers

And can you actually -- can you give the actual dollars coming from the reactivations in sales this quarter?

David Clark

It's roughly 20% of revenue, so it's in low 30s.

Karen Howland - Lehman Brothers

So 20% of total revenue, or the direct channel revenue?

David Clark

Total net revenues.

Karen Howland - Lehman Brothers

Perfect. Thanks very much.

David Clark

Welcome.

Operator

And your final question comes from the Nicole Jacoby from Liberation. Please proceed.

Nicole Jacoby - Liberation

Hi, and thanks for taking the call. I wondered, if you could just walk us through how many shares did you say you have again now?

David Clark

Right around 31 million.

Nicole Jacoby - Liberation

31 million, okay, because you were, as of April, at 30.5 million, right?

David Clark

Right.

Nicole Jacoby - Liberation

On your Q in July you bought back a million shares.

David Clark

Right, right. Remember the 31 million on the financial statements are going to reflect an average number, well probably just below 30. But there've been some additional issuances in relation to some of the key hiring we did in the quarter, as well.

Nicole Jacoby - Liberation

Okay. So it’s -- I was talking about the number on the front of the Q as of April 30th. But, okay, I get that. So that's really from new, there wasn't any other…

David Clark

Yes, fully diluted, which obviously is an average number, is 30996 for June 30.

Nicole Jacoby - Liberation

Okay.

David Clark

The actual is probably something less than that. But then, we've got an ongoing, obviously, management incentive program that will add to that overtime. But 31 is a good working number.

Nicole Jacoby - Liberation

Okay, great. Thank you. And on the cash number the -- whatever funds that were paid through the acquisition of NuKitchen, that was after the end of the quarter?

David Clark

Yes, so you would take $62 million at the end of the quarter. Obviously, we continue to see cash build. But $62 million would be reduced by the acquisition of NuKitchen and all of the share buyback activity that occurred in July.

Nicole Jacoby - Liberation

Okay, right, got that. And those were -- actually the share buyback was, however, larger -- significantly larger than the acquisition?

David Clark

Yes, it was $15 million.

Nicole Jacoby - Liberation

Right, okay.

David Clark

Yes.

Nicole Jacoby - Liberation

Did you made public how much you spent on the acquisition?

David Clark

No, we have not, yet.

Nicole Jacoby - Liberation

Okay. Can you walk through – you've talked about a couple of times some G&A -- additional G&A that you'll be spending in Q3 in the second half, generally to help out with, basically to be seen as investments for next year. Can you tell me what has changed since last quarter? So when you were giving guidance last quarter, and you had in mind a new model already of certain amount of G&A spend, and at certain level of investment you had in mind. And then, can you talk about what new initiatives have been decided to be spent this year?

David Clark

Yes, I think there was couple of things. First of all, we knew that we were going to be working on reengineering of our supply chain. But we did not have yet identified either the spending, or the on going expense savings that would be the result of the reengineering. So that's number one, we've gotten more precision around that effort. Similarly, we've got much more precision, as you've heard from Joe, around our frozen launch and the initial setup cause around that, as well as maintenance.

And then to a smaller degree, although no less important, the spending on the sort of users side of our website improvements. We've probably got a little more precision looking into the second half of the year. So that's probably what's been headed as to the G&A line since we last release guidance.

Joe Redling

I know also, and I think, again since bringing in new leadership into the customer management side, we've really accelerated our investment to improve the call center operations. We've got real solid plans, real solid kind of ROI reviews on that. And we really didn't have a good view into that before. And I think we really solidified kind of our view on the opportunities we have there and are investing as fast as we can.

Nicole Jacoby - Liberation

Okay. So are other -- I guess then the question that naturally comes from that is, do you -- are there still a fair number of plans or initiatives that you have in mind, now that you don't have good numbers around yet, or you don't have a good plan yet that you're going to find out about next quarter. Say you don't know?

David Clark

No.

Nicole Jacoby - Liberation

Okay.

David Clark

It's a good question. I think I remember that the launching during the key diet season, we need a six-month window to do that. So anything we sort of find out pretty now and then won't be ready for the new diet season, so wouldn't be what we're spending money on.

Nicole Jacoby - Liberation

Got it, okay. That's sort of where it's getting at. Do you anticipate any changes -- the activation model you said isn't fairly stable view, and based on any of the marketing or anything you're doing, anticipate any changes going forward in that or not?

Joe Redling

No, I think it's very consistent.

Nicole Jacoby - Liberation

Okay, great. And then finally, before you were talking about the potential increase cost in certain windows of marketing, as in TV spots during the political campaigns and what not. To the extent if there are some increases that you can't buy around, will that reduce the number of spots, would that increase your marketing spend, or a little bit both?

Joe Redling

We again -- we will manage, because we always manage to, the profitability metrics. So if we see a media environment that is more expensive, and it gets us beyond our profitability ceiling, then we'll move to other channels. There are other channels we can move to, so we won't -- what we try to do is really not allow ourselves to get to a point where we are spending above the marketing efficiency ceilings that we're looking for.

Nicole Jacoby - Liberation

Okay, great. Thanks very much.

Joe Redling

Sure.

Operator

Our next question comes from Bill Sutherland from Boenning & Scattergood. Please proceed.

Bill Sutherland - Boenning & Scattergood

Thanks for taking my question guys. Any update on some of the international plans or initiatives that you have preliminarily about.

David Clark

Sure. So, Canada, just quick update, that continues to roll along. I mean one of the things, where we've really not mentioned is that we are investing as, where we've just launched a completely separate inbound queue here at our call center for Canada. We are seeing good efficiency there. We need to improve conversion rate. So, we are putting some additional management power against that, with someone here in Horsham that is responsible only for the Canada marketing operation. So, Canada continues to move along, and we expect it again to kind of be on par with the plan for this year, and hopefully continue to grow as we move into 2007.

We've talked about the UK before. The UK environment is no better than our environment here from an economic standpoint. We do have a plan currently that gets us into that market with pilot and testing. At the end of 2009, we'll be looking at that very closely. I mean one of the challenges we have with that type of rollout is, when you are in test in a difficult economic environment, it has a tendency to kind of give you bad data, in terms of how do invest and where to go. So, we've the opportunity and the flexibility to move that out if we need to. But right now, it's kind of still on plan for getting into the market in the UK at the end of '09. If we see the economic environment is a bit more difficult we could push that off.

Operator

I'd like to turn the call back over to Cindy Warner. Please proceed.

Cindy Warner

We'd like to thank everyone for their time and we hope you will join us in October for our next conference call, when we discuss our third quarter results. Thank you.

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