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Weight Watchers International, Inc. (NYSE:WTW)

Q2 2008 Earnings Call

July 31, 2008 5:00 pm ET

Executives

Sarika Sahni - IR

David Kirchhoff – President & CEO

Ann Sardini - CFO

Analysts

Alvin Concepcion - Citigroup

Michael Binetti - UBS

Karen Howland - Lehman Brothers

Chris Ferrara - Merrill Lynch

Jerry Herman – Stifel Nicolaus

Operator

Ladies and gentlemen, welcome to the Weight Watchers International second quarter 2008 earnings teleconference call. (Operator Instructions) At this time, I would like to turn the call over to Sarika Sahni of Weight Watchers International; please go ahead.

Sarika Sahni

Thank you to everyone for joining us today for Weight Watchers International second quarter earnings conference call. With us on the call are David Kirchhoff, President and Chief Executive Officer and Ann Sardini, Chief Financial Officer.

At about 4:00 p.m. Eastern Time today the company issued a press release reporting its financial results for the second quarter of fiscal 2008. The purpose of this call is to provide investors with some further details regarding the company’s financial results as well as to provide a general update on the company’s progress. The press release is available at www.weightwatchersinternational.com.

Before we begin, let me remind everybody 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. The company does not undertake any obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events, or otherwise.

I would now like to turn the call over to Mr. Kirchhoff.

David Kirchhoff

Good afternoon and thank you for joining us as we review Weight Watchers International’s performance for the second quarter of 2008. The second quarter despite increasingly difficult economic conditions in some of our major markets largely delivered to our expectations and to the guidance we provided on our last call.

Across our business units NACO’s Q2 volume results were at the lower end of our expectation in the UK and Continental Europe did somewhat better. As awareness of the Weight Watchers online product grows our weightwatchers.com business shows continuing strength.

Total company Q2 revenues grew by 12% with meeting fees up 11%, internet revenues up 28% and product sales and other revenues up 9%. Excluding foreign currency adjustments total revenues were up 9%. Global paid weeks for our meetings and Weight Watchers online offerings were up a combined 15%. Global paid weeks and our meetings were up 9.5% while global attendances were down 2.6%.

As we discussed in the call Q2 benefited from the timing of an earlier Easter. We would estimate on a holiday adjusted basis that Q2 attendances were down about 6% versus prior. Weightwatchers.com had another outstanding quarter with internet revenues up 28% versus prior year and global end of period Weight Watchers online active subscribers up 27%.

Excluding the impact of the recent adverse UK VAT ruling Q2 2008 EPS was $0.87, an increase of $0.14 over Q2 2007. The recent UK VAT ruling which we disclosed in a press release we issued on June 30, had the affect of lowering our reported EPS for Q2 2008 by $0.28, from $0.87 to $0.59 per fully diluted share. Of this $0.28 charge, $0.24 related to an additional reserve for the potential of owing higher UK VAT for the prior years, 2005 through 2007.

The remaining $0.04 charge in our second quarter results related to the cumulative current year impact, both Q1 and Q2 2008 of the higher UK VAT. On a full year and ongoing basis based on the current revenue run rate in the UK this ruling will have the affect of reducing earnings by close to $0.02 per share on a quarterly basis or approximately $0.07 on an annual basis.

I will now briefly review our results in our major geographies and business units. First, our North American meetings business, total second quarter NACO revenues were $226 million an increase of 4% versus the same period in 2007. Q2 paid weeks were up 6% versus prior year while Q2 attendances were down 4%. Without the benefit of prior period acquisitions NACO paid weeks were up 5% while attendances were down 5.6% versus prior.

The continued narrowing of the gap between paid weeks growth rate and attendances of course reflects the attenuation of the incremental benefit of monthly pass as we’re now approaching two years since its launch. We started the second quarter with a marketing campaign that appeared to be meeting or exceeding our early expectations and April was generally a strong from a volume perspective.

However with the rapid rise of gas prices in April and May, May proved to be a more difficult month in terms of recruitments. While the trends moderated somewhat in June the net affect was that the gains from a strong April were offset by a weak May. We last saw this kind of impact on enrollment levels in the post hurricane Katrina environment when gas prices had a similar run up.

While Weight Watchers has a lower price level than many of our commercial competitors we too have seen some evidence of consumers deferring their spending on weight loss efforts with us. Feedback from our field organizations suggests that many consumers are struggling with their finances and we believe that this is starting to have some impact on our business results.

To the extent that the economy is having an impact on our business, it’s been primarily at the meeting enrollment level along with some slight softening of meeting member retention. In contrast as I will discuss later, we have not seen a similar impact on Weight Watchers online which is lower priced.

In response to all this we will be increasingly focusing the value that Weight Watchers brings to a weight loss effort. Weight management is about much more than vanity. It is an important part of preventative healthcare. Looking good might feel like an indulgence but being healthy is never a luxury. We will continue to emphasize that there is no better way to lose weight and keep it off sustainably then with Weight Watchers meetings.

At three times the effectiveness of losing weight on your own our program is a good value. Appropriate for these difficult times we’re taking a different approach to our usual fall promotion. This year we’re introducing a new charitable campaign called Lose for Good. The campaign will work on two levels, one, for every pound lost we will give money to charity to buy a pound of food for those who need it most, up to a million dollars.

And two we will be encouraging grassroots local food drives for the needy conducted through our 820 Weight Watchers centers and 4,500 travelling locations throughout the US. It’s an opportunity for our members to help their own health and wellbeing while helping someone else at the same time. The campaign will have a focus on building participation and PR at the grassroots level, and by actively driving a bring a friend promotion.

We don’t know what kind of incremental business results will come from this but from our point of view it’s the right thing for us to do particularly in this economy. As we move into the second half of the year we expect the consumer economy to continue to pose uncertainty in our meeting enrollment levels, particularly against the backdrop of no meaningful program innovation in close to four years.

Given this environment for the second half of 2008 we expect NACO to deliver flat to low single-digit positive paid weeks and revenue growth and mid to high single-digit negative attendances. Now on to the international business units.

As is our usual practice all the growth statistics I’m discussing will be provided on a constant currency basis. For the second quarter excluding the affect of the UK VAT ruling, UK revenues were up a strong 19% as we see the continuing benefit of last year’s price increase as well as an increase in benefit from the monthly pass commitment plan.

The impact of monthly pass in this market is most clearly seen in paid weeks which were up 23% while attendances were up 2.3% versus prior. Without the benefit of the early Easter attendances would have been down about 3%. As we noted earlier the penetration of monthly pass in this market somewhat lags what we’ve seen both in the US and some of our other international markets. We see this as an opportunity.

In terms of enrollment challenges the UK is seeing many of the same issues as NACO; lack of a new program, and an increasingly difficult consumer environment. Like the US, the UK has the same issues with reduced credit availability, falling home values, and rising inflation having an increasing impact on the consumer. Like the US many of the consumer sectors in the UK economy are now experiencing a slowdown.

The corresponding path forward in the UK will focus on maximizing leverage from the new program in January, 2009 while also introducing a supporting and new marketing campaign. With all these factors in play we’re forecasting paid week’s growth of 20% to 25% for the third and fourth quarters. On the attendance side we’re forecasting low negative single-digit declines in the second half.

Going forward the recent VAT ruling will have the impact of reducing reported revenue versus prior year partially offsetting the revenue benefit of monthly pass. Reflecting the increased reserve against our meeting fees subject to VAT in 2008, UK revenues for the remainder of the year will still be up low single-digit positive versus 2007 which had a lower VAT reserve.

Continental Europe showed a similar trend to what we’ve seen in Q1. Strength in countries such as France, Belgium, and Sweden was offset by some weakness in Germany. Total revenues were up 11% on a currency adjusted basis and paid weeks were up 16%. Overall Q2 attendances were affectively flat to prior at minus 0.4% which translates to about minus 3% on an Easter timing adjusted basis.

Monthly passes contributed to the top line strength we’ve seen in CE as we continue to build on our strong start with monthly pass in Germany and the more recent launch of monthly pass in France. The monthly pass model continues to demonstrate its applicability to a wide variety of markets.

While Continental Europe is being impacted by energy and food inflation, their consumer economic issues do not seem quite as severe as the US and UK. Fueled by monthly pass we are forecasting double-digit revenue growth for the second half but we expect attendances to remain somewhat anemic at low to mid single-digit negative.

Moving on to weightwatchers.com, where the meeting business seems to be somewhat susceptible to the current economic factors impacting the consumers around the world, the Weight Watchers online product with its lower monthly fee has proved to be very resilient in the face of this economy. As noted earlier total internet revenues were up a vibrant 28% and paid weeks for the online product were up 30%.

Again this growth is lapping a very strong Q2 in 2007 at which point we were fully benefiting from the TV campaigns that were put in place beginning January, 2007. One strategy that has proved successful so far has been the introduction of advertising in non-traditional months such as June. We have continued to push this strategy and we’ve been on TV with Weight Watchers online ads in July as well. Early results so far have been very strong.

While we remain cautious about the impact of the economy on both sign-ups and retention for Weight Watchers online we believe that the lower price point combined with the opportunity to significantly increase awareness of this product will contribute to its continued growth.

We will be rolling out significant new improvements to the features and functionalities of this platform over the coming quarters that we believe will further enhance the value and experience to both our Weight Watchers online subscribers and monthly pass members.

For the second half of the year we expect continued 20% plus growth in revenue and online paid weeks. Now I would like to turn the discussion over to Ann Sardini who will elaborate further on our Q2 performance.

Ann Sardini

Thanks David, good afternoon everyone. Before getting into the ongoing business results, I’ll just take a few minutes to recap the components of our reported second quarter 2008 earnings per share. Our ongoing operations generated $0.87 of EPS in the quarter comparable to $0.73 last year and an increase of 19.2%.

There was however a charge in the 2008 quarter which was not present in 2007 and which resulted in a reduction of 2008 Q2 EPS of $0.28 bringing our reported EPS to $0.59. This charge was the consequence of an adverse UK court ruling that we received in the quarter with respect to the imposition of value added tax, or VAT. The ruling which resulted in 100% of our UK meeting fees being subject to VAT starting in 2005 caused the charge for prior years which we recorded in the second quarter and which reduced our second quarter earnings per share by $0.24.

On a going forward basis the 2008 annualized charges resulting from the ruling are now estimated to have the impact of reducing full year earnings per share by approximately $0.07, $0.04 of which has been reflected in our second quarter earning representing the first and second quarter amounts.

Let me also remind you that beginning first quarter this year our reported results include the impact of our China joint venture start-up for which we consolidate 100% of the results into our operating income in accordance with GAAP and back out DANONE’s 49% ownership on a minority interest line item below operating income. Year-to-date the joint venture has incurred $2.2 million of operating expense, $1.4 million of which were in Q2.

In the second quarter we recorded an operating loss for the venture of $0.6 million net of first half tax benefits which was then reduced by the minority interest deduction to $0.3 million reduction to net income. The impact of second quarter EPS was minimal. We now expect that the China JV will reduce full year EPS by $0.03.

Consolidated company revenues in the second quarter were $400 million after $32.5 million of charges related to the UK VAT ruling. On a comparable to last year basis, second quarter revenues of $432.5 million were up 12% in current dollars and 8.6% in constant currency.

Consolidated operating income for the quarter including the impact of the VAT settlement and the China JV was $101.3 million. Excluding these our operating income on a like for like basis was $135.2 million this year versus $123.3 million last year, an increase of 9.6%.

Net income was $46.6 million in the quarter. In the review of operations that follows I’ll omit the impact of both the VAT ruling and the China JV except as specifically noted.

Our 8.6% constant currency revenue growth was spurred by the ramp up of monthly pass in the UK and Germany launched in those countries in August of last year and by our online revenues which grew substantially up 28.4%.

Second quarter global meeting fees were $257.4 million a 10.6% increase over the prior year level, again driven by monthly pass. [inaudible] incomer per attendee increased 10.1% worldwide on a constant currency basis. In addition to the US we now have monthly pass in UK and Germany as noted, and in Australia and France.

Fueled by new product launches second quarter in meetings and product sales per attendee increased 9% in constant dollars over last year’s Q2. Total product sales in our meetings increased in all of our major geographies, up 6.2% constant currency in the quarter versus last year.

A few specifics regarding our geographies financial performance, NACO second quarter meeting revenues including in meeting product sales, were $208.6 million, 4.4% growth over second quarter 2007. Our attendances lagged prior by 4% paid weeks growth of 6% along with strong product sales per attendee were the revenue drivers. The rates of growth of paid weeks and meeting fees per attendee are decelerating to a degree as the monthly pass installed base is stabilizing.

We have approximately 800,000 active monthly pass members in the second quarter of this year, up 11% versus Q2 prior year. As a reminder we are now approaching the second anniversary of the launch of monthly pass in NACO.

In total our international meeting revenues were $131.6 million up 13.3% in local currencies, from a combination of 17.3% growth in paid weeks and a hefty 12.7% growth in in meeting product sales per attendee. In this year’s second quarter both UK and Continental Europe benefitted from monthly pass which as we noted launched in these markets starting in mid third quarter 2007, and also from strong in meeting product sales.

An 11% meeting fee price rise for pay as you go members was taken in the UK concurrent with the launch of monthly pass last August. UK meeting revenues for the second quarter were $51.6 million on a comparable to prior year basis excluding the impact of the recent VAT ruling, an increase of 19.6% in local currency on a 2.3% increase in attendance.

Continental Europe’s meeting revenues were $69 million in the quarter a 12.2% increase versus the same period last year. All of our major European countries were contributors to the revenue increase for a variety of reasons. Product sales in meetings gained 13% overall, with all countries benefiting from a successful strategy of regular new product launches. In Germany monthly pass which is ramping nicely, was an important revenue and paid weeks growth driver, and successful marketing strategy spurred growth in some of our smaller markets.

Other revenues which include franchise commissions, licensing and revenues from our publications were $27.9 million and grew 8.9% over the past year. Franchise commissions were $4.5 million in the quarter up 0.4% but excluding the impact of acquisitions made after Q2 2007 commissions on the remaining franchises grew 6.8% versus prior year.

Licensing revenues in the second quarter increased 13.2% to $17.3 million led by our ice cream and yogurt licenses in the US but with strong contributions across our other geographies as well. Our consolidated gross margin in the second quarter was 56.1% as compared to 56.9% in last year’s second quarter, a decline of 80 basis points. The decline in gross margin percentage was primarily in the meeting business and came from three factors; lower product sales margin in NACO driven by product mix and higher transport costs, start-up costs for the monthly pass commitment plan in Europe, and smaller meeting averages in some of our countries.

These declines were partially offset by the continuing growth of the weightwatchers.com business which carries a structurally higher gross margin. Second quarter 2008 marketing spend was $59.4 million, up 10.8% over prior year. Foreign currency exchange added approximately 3.5% to the marketing spend. As a percentage of revenues Q2 marketing was slightly lower then last year at 13.7% versus 13.9% in 2007.

G&A expenses in the second quarter 2008 were $48 million up 12.4% from the prior year level with 3.8% of the increase coming from foreign currency exchange rates. IT remains the significant driver of the year-over-year increase reflecting our continuing initiative to invest in our systems infrastructure. Expense growth in this area is combination of increased depreciation as we bring new systems online, and higher maintenance related to new systems already put into service.

Excluding the increases from IT depreciation and currency G&A rose 6.8% in the quarter. As a percent of revenues G&A is flat to prior at 11.1%. The company’s consolidated operating income margin was 31.3% as compared to 31.9% in the year earlier quarter. Margin compression was the result of the gross margin decline.

Interest expense in the second quarter 2008 was $21.6 million down $7.7 million or 25.7% versus the second quarter 2007. We reduced our average debt outstanding $168.5 million below the second quarter 2007 level to $1.64 billion. And in addition our average effective interest rate was below last year’s at 5.19% versus 6.38%.

This resulted from a combination of lower market rates and a step down in spread over LIBOR which took affect during the first quarter when our net debt to EBITDA dropped below 3.5x. This step down reduced the spread over LIBOR by 25 basis points across a large portion of our debt.

Now a few words about the tax rate, the reported tax rate in the second quarter was 41.9% primarily as a result of the additional UK expense related to the VAT ruling. In the third and fourth quarters we anticipate a 38.9% rate ending the year with an average rate of 39.5%.

Our consolidated cash flow and balance sheet which I’ll address briefly are consistent with expectations. In the quarter the company generated $102.9 million of cash from operating activities excluding interest. After capital expenditures $95.4 million was available to service our capital structure. With our available cash we made interest payments of $29 million and paid our quarterly dividend of $13.9 million.

Also during the quarter we repurchased 1.2 million of our shares for approximately $53 million. In addition we acquired two small franchises. Fluctuations in the balance sheet between Q2 2008 and year end 2007 primarily reflect the normal seasonality of the business, notably a reduction in inventory which is normal going into the summer season. Deferred revenue rose $27 million versus year end 2007 consistent with the ramp up of monthly pass.

The acquisition of three small franchises in the first half of 2008 resulted in a $39.5 million increase in franchise rights acquired.

Now I’ll turn it back to David.

David Kirchhoff

Thank you Ann, like most consumer product and service companies, we’re seeing some affect on our business from the difficult economic environment. We don’t have a crystal ball into the environment that lies before us but we believe that our operating stance should be to assume that conditions will stay the same and possibly get worse over the coming 12 months.

Our operating philosophy during this time will be to focus our messages and communications to reflect the same reality consumers are seeing. We much continue to focus on the value and underlying efficacy of our approach and to convince consumers that staying healthy is not a luxury but a necessity.

Our fall NACO promotion and our new program for January, 2009 are very much in sync with this philosophy. During this time we will of course prudently manager our cost base. We will continue to invest in marketing but we will focus behind those vehicles that have a proven ROI. We will also seek opportunities to closely manage labor expense and related G&A.

Beyond all these basis tactics our focus as an organization remains unchanged. We are in the business of helping people lose weight and keep it off by adopting a healthier lifestyle. That philosophy has never been more important and more relevant to the consumer of today and tomorrow.

When I assumed the role of CEO of Weight Watchers in January last year, I spoke of the need to increase the relevance and delivery of our products and services to a broader segment of the overweight population. We know we have a highly respected brand and a uniquely effective approach to helping consumers adopt a healthy lifestyle.

But we also know that if we’re to build on our position as the leading global weight management company we must attract new people to our brand and bring back past members by innovating in the areas of convenience and ease of use while further enhancing efficacy and sustainability. Over the past 18 months we’ve made substantial progress as an organization in rebuilding our pipeline in the areas of new program development and service innovation.

Across the organization we’re now actively researching and testing many new initiatives that we believe have the potential to significantly enhance our offerings. While many of these efforts are not yet apparent from the outside I am confident that we are positioned to enhance the relevance of our offerings and to drive growth in our business for years to come.

I expect that I’ll be able to discuss these initiatives in more detail in the near future.

On our last call I provided full year guidance of $2.85 to $3.00 per fully diluted share excluding any impact from the China JV. Based on our performance for the first half of this year and recognizing the difficult economy we’re narrowing our guidance by reducing the top end by $0.04 giving us a new full year range of $2.85 to $2.96 per share.

Beginning this quarter we’re adjusting our guidance base line to include the ongoing annual affect of the adverse UK VAT ruling which is approximately $0.07 per share as well as the full year earnings affect of the China JV which is $0.03 per share. As a result our new restated annual guidance range is $2.75 to $2.86 per share which now includes the combined $0.10 cost from both the ongoing current year impact of the UK VAT ruling and the impact of the China JV.

For modeling purposes if you think about the third and fourth quarter keep in mind that Q4 this year will benefit from 1) the soft launch in December of our new program and 2) an incremental $0.02 from having a 53rd week in this fiscal year.

Finally I’d like to take this opportunity to publically thank my close friend Thilo Semmelbauer who is wrapping up his duties as COO this week. Thilo has worked tirelessly for Weight Watchers for the better part of a decade. He helped build weightwatchers.com as a start-up and while I understand his desire to seek his next entrepreneurial opportunity he is not an easy person to replace.

More importantly I will miss his company and his counsel. As you know from an earlier public filing we are not retaining the role of COO. Rather we will split the job into three positions; President of International, President of weightwatchers.com and President of NACO. We have appointed Melanie Stubbing to the role of President of International. Mel has been running the UK business for four years and has done an excellent job bringing a new level of operating discipline to that country.

I look forward to her leading a relatively new international management team and driving against our strategy of increasing relevance and retention. Mike Bassone has assumed the role of President of weightwatchers.com. Mike joined us as CTO of dot com in 2002 and took on the additional responsibility as CTO for all of Weight Watchers International in 2005. I can think of no one better suited to lead the weightwatchers.com organization then Mike.

We are currently in the process of recruiting for the President of NACO.

We are now ready for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Alvin Concepcion - Citigroup

Alvin Concepcion – Citigroup

I just wanted to get your thoughts on how you are positioned from a pricing perspective on your pay as you go and monthly pass in light of the tough consumer environment.

David Kirchhoff

If you look at our price point for Weight Watchers compared to other commercial offerings we have an advantageous price point. It’s much less expensive to participate in Weight Watchers then other commercial weight loss programs. Furthermore with Weight Watchers because you don’t have to eat any Weight Watchers food the consumer has the opportunity to continue to participate in retail and look for good values in their grocery store as part of maintaining and sustaining a healthy lifestyle and so in that context from a competitive perspective we think that we’ve got a very good price position.

Certainly our real job if you think about it is 80% by our own surveys, 80% of weight loss attempts have been on a self help basis, people trying to do their own thing. Clearly the appeal of that in an economy like this is that doing your own program is technically speaking free. The issue is is that for too many it doesn’t work. They start the program on Monday and by Thursday you’ve quit.

Weight Watchers through basically its ability to provide a much higher level of efficacy and remember through clinical studies people that participate with Weight Watchers lose three times more weight then people that do it their own, we think that we have a very meaningful way of convincing those self help dieters that Weight Watchers is actually quite good value because it is the approach that is most reliably going to lead to good and sustained weight loss. And those are exactly the types of messages that we think we really have to drive as we continue to muscle through this economy.

Alvin Concepcion – Citigroup

How would you characterize the current ad market in terms of how the ad rates are trending and how should we look at that going forward in light of the elections?

David Kirchhoff

Most of our television advertising for North America is purchased in the up front market. We do have some direct response TV. But the majority of our spend is in the up front market which is already locked and loaded per se. And so we’re not seeing the likelihood of a significant impact on our advertising rates or our dollar per GRP rate in the fall campaign although obviously in an election year things can definitely get a little bit challenging. We think that we have the right set up to manage our way through that.

Alvin Concepcion – Citigroup

Was there an impact on the North American organic attendance trend from an early Easter, did you quantify that?

David Kirchhoff

Give or take it would be about another 2.5% to 3%.

Alvin Concepcion – Citigroup

And that was a benefit?

David Kirchhoff

That was a benefit to us this quarter so if you subtract that 2.5% you get to an apples to apples basis. But of course when we provided guidance on the last call we were factoring in Easter so in that sense if you’re comparing what we said in the last call versus this call, that’s where we were talking about the mid single-digit including the benefit of Easter.

Operator

Your next question comes from the line of Michael Binetti - UBS

Michael Binetti – UBS

I’m assuming your expecting people to check in the $0.87 to first call for the quarter but when a lot of us have to base our price targets on 2009 and the out year, when you say there’s probably $0.02 of VAT tax as a going forward number is it fair to say 2Q 2009 we’re going to want to compare it to $0.85 with the $0.02 of the VAT tax in this quarter?

Ann Sardini

Yes. That’s a good assumption. I would look at it as about $0.02 a quarter.

Michael Binetti – UBS

You mentioned your NACO attendance for the second half and I’m guessing there’s going to be some volatility in there, is there any way you can break that down between the quarters and you also mentioned that gas prices are showing some kind of correlation and I’m wondering with the high gas prices that we started out the quarter with is that more of a back weighted guidance on the mid to high single-digit?

David Kirchhoff

I think the volume guidance that we give between Q3 and Q4 also reflected the fact that again NACO has the benefit, typically when we do a soft launch of a new innovation we often see a little pop from a volume point of view through December and we would assume that we’re getting some benefit from that. And then of course this 53rd week which happens every four years, is happening this year and there’s a little bit of benefit there so if you were going to be weighting between Q3 and Q4, Q4 on a relative versus prior basis is going to look a bit stronger then Q3. But the overall guidance that I gave was for the full second half and so then you can just apportion between the two quarters based on that feedback.

Michael Binetti – UBS

It seems like there’s pretty clearly a trade out from consumers to self dieting over the last few years and certainly that comes into focus in times of more difficult economy, how sustainable is it to have 20% online growth with negative meeting trends supporting what you’ve been doing in double-digit EPS growth in the US and I’m just looking at the profit dollars and it looks like more then 100% of the profit dollar growth in the first half of the year has come from the online business and if the answer is that the new diet coming up and if you have it tested, I’m wondering what kind of data points you can give us around, that gives you the confidence in that innovation and perhaps why you wouldn’t be able to bring it out earlier then even December if it’s a fairly strong innovation.

David Kirchhoff

First off I’ve seen conflicting data about whether or not the consumers’ propensity to do weight loss efforts on their own is actually increasing or not increasing. From some of the other data we’ve seen we have not seen a significant change from year to year. I know that there is some MPD data; I believe that’s where it came from to suggest that maybe it is increasing but we’ve seen data from other places that have suggested the contrary, that actually it’s been fairly stable.

We would hypothesize that during times like this that maybe the likelihood that somebody is going to try to lose weight on their own might in fact be somewhat higher during a tough economy but I would also suggest to you that those people, that many of those people when they try to do that are not going to be met with success ultimately and are still going to be in a position of having to deal with the weight issue as we come out of the economy.

And anecdotally some of the feedback, when we do hear feedback from the field, there are quotations like my family is just having a really hard time right now, I just don’t feel like I can spend the money but I promise you I’m coming back as soon as things loosen up, which is why we believe that some of the activity we’re seeing is affectively a deferral if you will.

In terms of the long range trends with meetings I think that our point of view is that there’s nothing structurally wrong with the fundamental premise of delivering weight management through group support and through meetings. I don’t believe that there’s anything out there that would suggest that somehow in this new age of becoming less relevant or less important of peoples success. My starting point in asserting that is the simple fact that again, we know from clinical research that people that go through Weight Watchers meetings are doing better then people that do their own thing and therefore my starting premise is that consumers are ultimately going to go with what works.

The other point I would make is that if I look at the meetings, for example I was in focus groups last week on a different topic but there was a number of Weight Watchers members both current and lapsed and the focus group moderator when through the ranks and asked them what was the thing about Weight Watchers that works and was important to their success, and very consistently what they were talking about was the support that they got in the process.

I believe though that if you look over the past two years and this is what we’ve been talking about for the past two years is that for Weight Watchers to remain relevant both to bringing new people into the fold but frankly also going back to those people that were doing Weight Watchers in 1999 and 2000 and 2001 who might have since left the fold that our ability to drive meaningful innovation that can significantly improve the likelihood of success or the ease of participating that as we’re able to develop those types of innovations we now have an opportunity to attract in a new group of people and we also have an opportunity to go back to those people who we haven’t seen in four or five or six or seven years and bring them back into the fold by saying there’s something new and exciting at Weight Watchers.

And fundamentally that innovation is going to be I believe critical to driving long-term growth in the core meetings business. Now if you look over the past two years the funnel that leads to those good innovations rolling out into the market quite honestly as we’ve been discussing was fairly dry. We had to go through a process to basically go back to the drawing board, do the research, do all the fundamental work, to do a better job of identifying and articulating what is the weight loss problem that we are trying to solve for our members and for consumers.

A lot of that work has been done on the research side and frankly the activity on 2008 therefore as a result of that have been able to shift a lot more toward testing and piloting and doing a lot of that preliminary work and from that point of view, yes I have a new program that’s coming in January of next year but I can also tell you I have program ideas in the pipeline right behind it. And that that’s going to be an ongoing thing. I can also tell you that we have service innovation ideas that we’re working through none of which I can talk about right now, but some of which we believe over time have a good chance of bearing significant fruit in terms of significantly enhancing and improving the fundamental Weight Watchers value proposition.

So I absolutely believe that we’re going to be in a position particularly as we continue to work through this economy and come out the other side we’re going to have a stronger business then we’ve ever had before and we’re going to have more good ideas in terms of how to once and for all get the core meetings business back on the right track and starting to drive good organic enrollment growth in that business and when we do that, the good news is is that that business now has much more leverage then it ever had before.

So for example an enrollment is now worth considerably more to us today then it was four or five years ago. For example commitment plans such as monthly pass have been instrumental in helping us create a much stronger opportunity in gross margin that as we start doing a better job of driving enrollments and refilling our meeting rooms it’s going to have the additional affect of providing leverage on the gross margin line as well. And so based on my confidence that we can actually deliver this innovation plan while continuing to build on the successes that we’ve already been seeing in terms of building a better brand platform through our marketing campaigns and continuing to make sure that we’re giving, putting the right leaders in the right meetings that all those things will start to work together in a place where we are going to start driving top and bottom line growth.

Ann Sardini

Just let me clarify one thing going back to what you said earlier, while we don’t breakout the operating income from meeting business versus dot com business, both businesses experienced profit increases in the quarter and in the first half.

Operator

Your next question comes from the line of Karen Howland - Lehman Brothers

Karen Howland - Lehman Brothers

I know you’re not giving a lot of details as far as the new program that will be launched this upcoming winter but you did indicate that you’re at the stage now where you’re running pilot programs and you’re testing the program, can you give some additional color, you obviously sound very confident about the new program to launch but to give us the comfort that you’re seeing the right trends that this could really drive further attendance to your meetings.

David Kirchhoff

The way I look at the new program and it’s beyond testing right now. We’re literally in the process of putting the finishing touches on the program and getting ready to send it out for printing so its going into production as we speak and as I’ve been saying before all the research and feedback we’ve been getting on it has been very positive both in terms of we think there’s a real opportunity for us to enhance both simplicity and efficacy in ways that we haven’t done before.

My confidence in terms of the potential for this to be a significant plus for next year comes from what I’ve already observe in our advertising trends. Because one of the questions I get is that if we believe that this advertising campaign Stop Dieting Start Living is a good campaign in NACO why aren’t we seeing more benefit from it on the enrollment line in the NACO business? And my view of that has been that the first thing we need to do in terms of getting this brand to the place it deserves to be is to create a foundation of differentiated brand equity by letting the country and the world know that what we offer is different from what everybody else offers and what we offer is sustainable and built around building a healthier lifestyle and that everything we hear is that those are exactly the messages the consumers want to hear and those are the messages that are resonating.

And the scores that we’re now seeing on that and brand attribute scores are bearing that out. Now that kind of brand equity work is great in terms of positioning the overall brand but it doesn’t necessarily drive a sense of urgency to participate because its still what’s new, what is going to lead me to believe that I’m going to have more success so maybe they’re granting all the things that we’re arguing are true about ourselves but they’re still looking for that thing that’s going to grab them and give them a reason to get started in a weight loss effort with us.

What we’ve seen with this brand, if I take the example Weight Watchers online is that when we have meaningful news that consumers care about that they’re incredibly responsive to our advertising in a way that has a one to one relationship between enrollments. And so the Weight Watchers online every time we turn that advertising on, we see a pick up in Weight Watchers online sign up. So our hope is is that as we now go into January with an advertising campaign built around this new program that the kind of news that we’re talking about in this program and the benefits that we’re going to be talking g about are going to be motivating for consumers to get them to now start more actively engaging with us.

I’m always quick to caution that I don’t want this program to be viewed as the [panacea] for all the things we need to do. I think that it is an important step but its also the first major effort that’s coming out of the innovation funnel and what I can tell you is that there’s going to be other things that are going to follow it, that the cumulative affect of all those things over time is going to ultimately be the thing that drives long-term growth.

The other thing I would point out with an innovation and this is absolutely our experience when we launched points, not that this innovation is on that level or scale, but when we launched points it actually took up to two to three years to really see all the organic growth come out of that innovation. The reason is is that I always go back to the fact that roughly 70% or two thirds of our enrollments are coming on the recommendation of a friend or family member. In other words, word of mouth. And with the new program it takes a while to build word of mouth and so its one of these things where you put it out there but its going to take time for it to build over time but I do believe that we can get some short-term drive as we go into December and January.

Karen Howland - Lehman Brothers

When you were testing the program I think you had some select test markets that you were trying it out in, did it run long enough that you could actually tell people were enthusiastic about it driving additional people to the meetings or is that just a sense you get from chatting with your members?

David Kirchhoff

No it was a pilot and I sat through some of that research myself. It was a pilot where we had never members, we had lapsed members, both, actually were recruited in, were doing the program and we tracked them over four or five weeks. And at each point there was a check in and they would come back and talk through their experiences and that feedback in that particular pilot was important one in terms of helping us refine some key elements of the program and two confirming that some of the concepts that we’re starting to push through were having a significant impact on how people thought about their weight loss process and ultimately the way I judge an innovation is that if it provides meaningful help to someone who’s going through a weight loss process.

In other words, if an additional light bulb goes over a member’s head because they have an epiphany or a revelation about how they can adopt a healthier lifestyle, if it causes them to reframe the way they think about food and the relationship with food and activity then if we’re able to do those things that fundamentally those are the types of things that are going to drive more success and that ultimately is what’s going to drive long-term enrollments.

Karen Howland - Lehman Brothers

About your marketing spend this quarter I think you shifted about $6 or $7 million from the second quarter to the first quarter of marketing spend because of the timing of Easter? I was a little surprised to see the acceleration if that was added back, was there anything specific about the marketing spend this quarter?

Ann Sardini

First of all we got a big hit from FX which was in the neighborhood of 3.5%, secondly we did some extended advertising, we did some continuity advertising over periods that we don’t always advertise. We extended TV in France and Germany and we did some radio advertising in some of our markets and that was pretty successful. We also extended our TV advertising in weightwatchers.com which obviously has been very successful as well. So those are the big pieces of what we added.

Karen Howland - Lehman Brothers

You said that the guidance previously was $2.85 to $3.00 that didn’t include the VAT or the JV for China, now it’s $2.85 to $2.96 and that does include the $0.10 hit from the VAT and China?

David Kirchhoff

No think of it as a two step process. Step one is we took the $2.85 to $3.00 that did not include the VAT or the China JV, we took that range and we lowered the top end by $0.04. So that takes us from $2.85 to $2.96. Step two is we now recalibrated to reflect both VAT and the China JV which we had not been including in previous guidance and that had the affect of reducing both by $0.10. And so affectively we’ve just re-expressed guidance to now include both of those things which before we had said explicitly were not included.

Karen Howland - Lehman Brothers

So if you include them is it $2.75 to $2.86?

David Kirchhoff

Yes.

Operator

Your next question comes from the line of Chris Ferrara - Merrill Lynch

Chris Ferrara - Merrill Lynch

On the guidance, the $2.75 to $2.86 that includes the ongoing $0.07 but excludes everything like the—excludes $0.24 out of the $0.28 that you recorded today.

Ann Sardini

Yes that’s right.

Chris Ferrara - Merrill Lynch

Obviously there’s a lot of commentary around the economy from you and from everywhere else, does it mean anything for the winter launch? Had you anticipated taking pricing around the new program? Does it change at all how you think about that new program if you think the consumer is going to be especially cash strapped as they’re seeing their heating bills?

David Kirchhoff

No, we were never planning on taking pricing up with the new program. So it’s not like that was part of our plan so our intention is to continue to hold price where it is. Of course as you go into the next year one can only speculate, well on one hand home heating bills are likely to increase and that’s a good point, but maybe at the same time we’re going to continue to see some declines in gas prices. So you have these different things working against each other. Its sort of hard to predict what the consumer wallet size is going to be as we go into January as well as getting a better sense of when credit is going to start loosening up and everything else and so frankly your guess is probably better then mine but probably subject to all the other uncertainties that you might have.

Nonetheless I think that if you come out with the new program in the winter the primary point in communicating the new program is all the ways we think its going to help people be more successful and that those are the types of messages that directly speak to value and efficacy and having something that works and the better job that we do with that the more likely the consumer is going to increasingly say that Weight Watchers is good value and that maybe I shouldn’t be thinking about it as something I should defer but actually something I should be excited about getting involved in right now.

Chris Ferrara - Merrill Lynch

Does monthly pass make you more cyclical then you would have been on pay as you go?

David Kirchhoff

No it’s actually the opposite. Because pay as you go keep in mind the rhythm of pay as you go particularly from a seasonal point of view is that you would get this rash of enrollments and rapid re-joins that would come around free registration periods but then say after 10 to 14 weeks those people would disappear from the system again. They’d still be doing Weight Watchers by the way by pulling out their books and everything else but Weight Watchers monthly pass has the affect of resulting in a more continuous period of engagement and so I’m not sure that that’s going to have any, I think if anything its helped reduce volatility at least on the top line of our business.

Chris Ferrara - Merrill Lynch

I’m just assuming that you still have not seen, I’m sure you have some degree of attrition on monthly pass, but it hasn’t accelerated at all from what you can see.

David Kirchhoff

No what I said in my prepared remarks is that we have seen some slight softening, not major not significant but we’ve seen a little slight softening of monthly pass retention rates in April, May, and June and of course that’s something we’re watching closely. Frankly my view is that if the recession was going to be really bad that was one of the things that we were more concerned about that we would have seen a greater degree of softening but we haven’t actually seen that kind of an impact.

Again, the place, if there’s a place that we’ve really seen the bite on the economy it’s been much more on the enrollment side.

Chris Ferrara - Merrill Lynch

I didn’t hear you say that it was monthly pass related retention.

David Kirchhoff

Well that’s about 60% of our revenue now in NACO so its sort of, I didn’t explicitly say monthly pass but that’s the majority of the revenue shortage in NACO.

Chris Ferrara - Merrill Lynch

Did you end up pulling some planned advertising in the spring campaign over the environment that you started to see in May?

David Kirchhoff

No. In fact if anything as I mentioned before we were back on TV in July with Weight Watchers online based on good success we saw in June. Our view on advertising is what we were saying in our remarks is that if we have advertising that we know is paying out a good ROI we’re going to keep spending because we know that that’s all plus MPV. I think as we go into the second half of the year we have an opportunity to be more circumspect in terms of there might be something that would have been nice to have but less proved.

I’ll give you an example of that, when we launched the Stop Dieting Start Living campaign we spent quite a bit of money doing an outdoor advertising campaign in December and January of last year which was quite good for creating buzz and interest and some preliminary, it was a nice way to kick off the campaign. But when we looked back at the results of that particular advertising it was clear to us that it wasn’t necessarily delivering enrollments and so as we think about the second half of the year that would be the kind of advertising that we would not be interested in pursuing in this kind of an economy because we just don’t think its prudent given the potential softness in demand.

But on the other hand all the things that have been delivering for us which has been TV it’s been print and particularly online advertising if we think that we’re at the right levels we’re going to hold those.

Operator

Your final question comes from the line of Jerry Herman – Stifel Nicolaus

Jerry Herman – Stifel Nicolaus

The end of the quarter monthly pass subscriber at 800,000 is down sequentially does that affectively reflect what you just said about some softening in retention or are there other seasonal issues that come into play and is there a penetration rate that you can offer?

David Kirchhoff

Its normal seasonality. It doesn’t reflect anything in particular.

Jerry Herman – Stifel Nicolaus

How about penetration rates at this point?

David Kirchhoff

Penetration rates have been a little bit up this year although not massively.

Jerry Herman – Stifel Nicolaus

Do you have any evidence of switching among users between seminars and online?

David Kirchhoff

We don’t think so. We think online is really going after a different market segment and in fact with online there’s a part of it where the world is our oyster. Now come back to the fact that the statistic I was referring to that 80% of weight loss efforts are done on a self help basis, that is the market that online is explicitly going after. But you mention that there’s actually an interesting example that I want to bring up with online which speaks to directly what I just mentioned.

We do satisfaction studies all the time for online where we send out quantitatively a statistically valid survey to existing online subscribers and we measure their satisfaction on a large battery of different questions including some basic ones like did the product meet your expectations, was it a good value, would you recommend it to a friend. We recently started cutting that by age group. And we explicitly started looking at satisfaction scores for example for women who were 20 to 35 versus 35 to 45 or 45 plus but what was striking about that is that the satisfaction scores for young women, in other words women in their 20s and low 30s were frankly through the roof.

Now if you think about it that makes sense because Weight Watchers online if you think about that age demographic this is the customer that is very comfortable doing things online, software is very intuitive to them and the scores we’re getting are tremendous. From our point of view this is kind of exciting because for the better part of 40 some odd years, Weight Watchers has frankly struggled with creating a product that has great appeal to women in their 20s and their low 30s, in other words this particular demographic would have to cycle through all the crazy fad diets and then they would eventually come to us in their 30s.

And Weight Watchers was typically perceived as a brand that was best suited for women as they hit 35 plus. What we’re seeing with Weight Watchers online is that for the very first time we have an ability now to reach into a much younger demographic with a very compelling value proposition in a way that we’ve never done before. We’ve never marketed to college women. We’ve never explicitly marketed to women that were 20 to 30, and it’s a whole new area for us and to me it’s a great reflection of the strength of this particular growth vehicle with online is that its an opportunity for us to bring new people into the fold and again by the way, the number one people when they do quit online the number one answer usually given is to start going to meetings.

In other words, it’s a fantastic gateway into the brand. In terms of switching we have not seen, I haven’t seen any analysis that would suggest that that’s going on right now even in this economy despite the fact that Weight Watchers online is a lower priced product then for example meetings or monthly pass.

Jerry Herman – Stifel Nicolaus

About the upcoming innovation I know you’re not going to talk much about what it will be or what it is but maybe you can touch on some key aspects of how it will be different from those of the past.

David Kirchhoff

The good thing about this innovation is that the key benefits it’s attempting to deliver are the big ideas behind it. So therefore if I talk about specifically the problem it’s addressing its sort of testament to telling you what the innovation is. So I apologize for my continued diligence in being mysterious about it but when we do talk about it I think it will make more intuitive sense but I’m not quite ready to tip my hat in terms of exactly what it is.

But that said I will call attention to the fact that the things that we’re aspiring to improve in our program in our service are elements obviously efficacy, we’re also trying to improve simplicity in a number of those different things and I do believe that the research we’ve done has given us pretty clear guidance that the benefits we’re going after on this new program innovations are significant and meaningful benefits and that’s why I take some comfort in thinking that this particular innovation is going to be a good source for improved member satisfaction.

Jerry Herman – Stifel Nicolaus

Can you just talk about how you’re thinking about the business and any desires or motivations to move beyond the seminar business?

David Kirchhoff

First off the meeting business for me is the business that again I believe the meeting business has significant growth opportunity in front of it. We’ve seen this before. If you go back to the 90s, the Weight Watchers meeting business in the mid 90s if you look at it on an attendance basis went through a period of decline. One could have looked at that at the time, in fact some people did including some of the people that elected not to acquire Weight Watchers from [Heinz] looked at that and said look it must be going through some sort of secular decline but in fact when Weight Watchers points was launched there was a resurgence and there was significant organic growth from 1998 through 2003 on enrollments and attendances which to me suggests that the underlying value proposition remains strong. You just have to have the right combination of good service delivered with program and service innovation to drive long-term growth.

So therefore I don’t think it’s necessary for us to say that the core business doesn’t have the fundamental potential to be a significant growth vehicle in its own right. What I would say though to your point is that what you’re describing is exactly what we’ve been doing, we’ve been growing the heck out of Weight Watchers online for the past couple of years now and frankly if you look at Weight Watchers online as an internet business compared to any other internet business in terms of both top and bottom line delivery and the growth rates we’re seeing and everything else it is a business that in its own right would receive a substantial valuation in terms of the financials that its been delivering at the growth rates with which its been delivering.

And so we look at that as a good example of extending success with the Weight Watchers brand into new places and we think that that’s going to, we’re going to continue through that in areas like licensing and everything else that we have room for growth and let’s not forget the fact that we’re still in the midst of building a joint venture and building a business in China and while we’re being circumspect about what that is we believe that emerging markets are going to represent an important source of long-term growth for us as well.

And so when I look out into the world I’m not seeing any shortage of places where we can look to grow the business, in fact if anything I think the challenge for us as management is to pick the ones that are going to be the highest return, make those our priority and drive like heck against them.

Operator

There are no further questions at this time; I would now like to turn the meeting over to Mr. Kirchhoff.

David Kirchhoff

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

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Source: Weight Watchers International, Inc. F2Q08 (Qtr End 06/28/08) Earnings Call Transcript
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