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NutriSystem Inc. (NASDAQ:NTRI)

Q3 2012 Earnings Call

November 9, 2012 8:30 AM ET

Executives

Joe Crivelli - IR

Mike Hagan - Chairman of the Board of Directors

Mike Amburgey - CMO

David Clark - CFO

Analysts

Greg Badishkanian - Citi

Frank Camma - Sidoti & Company

Kurt Frederick - Wedbush Securities

Operator

Welcome to the Nutrisystem’s Third Quarter 2012 Earnings Conference Call. Today’s call is being recorded. At this time, I would like to turn the conference over to Joe Crivelli. Please go ahead, sir.

Joe Crivelli

Good morning everyone and thank you for joining us to discuss Nutrisystem’s third quarter 2012 financial results. Today, we’ll hear remarks about the quarter and outlook from Mike Hagan, Chairman of the Board of Directors; Mike Amburgey, Chief Marketing Officer; and David Clark, Chief Financial Officer.

Before we begin, I’d like to remind everyone that during this conference call, Nutrisystem management will make certain forward-looking statements about its outlook for 2012 and beyond that involve risks and uncertainties. Forward-looking statements are generally preceded by words such as believes, plans, intends, expects, anticipates or similar expressions.

Forward-looking statements are protected by the Safe Harbor contained in the Private Securities Litigation Reform Act of 1995. Factors that could cause actual results to differ from expectations include, but are not limited to factors set forth in Nutrisystems’s filings with the SEC. Nutrisystem is making these statements as of November 09, 2012 and assumes no obligation to publicly update or revise any of the forward-looking information in this announcement.

In addition to the GAAP results, Nutrisystem has provided certain non-GAAP financial measures in this conference call, such as adjusted EBITDA. Nutrisystems’s earnings Press Release for the third quarter 2012 can be found under the News Release link on the Investor Relations page of the company’s website www.nutrisystem.com.

The tables attached to this Earnings Release include a reconciliation of the historical non-GAAP financial measures to the most directly comparable GAAP financial measures. We do not present any earnings release to comparable GAAP financial measure and related reconciliation for forward-looking, non-GAAP financial measures included in this conference call because management cannot predict with sufficient reliability, certain contingencies required to estimate the comparable GAAP financial measure.

I’ll now turn the call over to Mike Hagan. Mike?

Mike Hagan

Thanks Joe. And good morning everyone. The third quarter was a tough one for Nutrisystem with revenue and net income down year-over-year. I’m personally disappointed that the turnaround has been slow to come for our business. Clearly, we have been impacted by tough consumer spending environment and intense competitive pressure, and net effect in our financial performance for the past several years.

When I re-joined the company in mid-2012 as Chairman of the Board of Directors, I did so because I believe in this company. There is no question that Nutrisystem has a strong brand, a proving business model and a weight loss system that really works for our customers, helping them to lose weight, improve their health and live better lives.

At a time when so many are struggling with their weight, when the obesity epidemic is high on the national radar screen and when diabetes is spiralling out of control, Nutrisystem weight loss programs are needed more than ever. So I’m grateful that we have an experienced proven leader like Dawn Zier stepping into the role of President and Chief Executive Officer.

I’m confident that Dawn will bring a fresh outsiders prospective to our business and operations. The Board of Directors conducted an extensive national search and evaluated executives from a range of different industry backgrounds. It was clear to us Dawn was the best candidate for the job because of previous career successes, intersecting with all of our requirements and are extremely relevant to strategic initiatives we are executing here at Nutrisystem.

First and foremost, track record of building direct consumer response businesses for Reader’s Digest is important as we solidify the core Nutrisystem weight loss business. In the direct response arena, her management style is intestinally focused on analytics and optimization as a foundation for any business discussion.

She leverages thorough demographics and cerographic research to inform new product development efforts, marketing campaign and decisions about sales channels and she is respected leader in direct marketing, having served as a Board Member for the DMA since 2008 but she also brings relevant food industry experience as she ran the food affinity marketing channel for Reader’s Digest.

She has proven experience in product innovation as a cornerstone for building a marketing-driven business. In this capacity, she has been a leader in the development and roll out of new digital products that enable Readers Digest to capitalize on changes in the publishing arena over the past 10 years.

Throughout the interview process, Dawn has been proactive in bringing great ideas to the table for exciting new weight loss products that will resonate with today’s dieters while introducing new potential marketing segments to the Nutrisystem brand.

Additionally, Dawn’s most recent role at Readers Digest was to lead the international business and in this capacity, she found new ways to leverage the brand in international markets through licensing agreements in Europe and Asia. This experience could lead to an interesting new growth opportunity for Nutrisystem over the next couple of years. Finally, as a majority of our customers are woman, we are proud that Dawn will be the first woman to lead Nutrisystem in our 40 year history.

Once Dawn is in place, we will make arrangements to introduce her to our investors and analysts and brief you on our plans to turnaround the company and grow shareholder value. So, stay tuned on that front.

I'm likewise encouraged by this plan our team has put in place through 2013 diet season launch. Mike Amburgey and his Marketing Team have stepped back, taken a fresh look at all of our marketing initiatives and developed a creative, focused plan for the new launch.

As you remember, Mike joined Nutrisystem over a year ago in October 2011 and our 2012 diet season launch plans were already well underway at that time. Heading into 2013, his team has made a number of adjustments and refinements that we believe will help to get the top line moving in the right direction, while improving margins and profitability.

Mike, will share some additional details with you at this time. Mike?

Mike Amburgey

Thanks, Mike. In the past year, several things have become clear to me as Chief Marketing Officer. First and foremost, we have a unique and differentiated business model in this category. Thank to our true direct response ecommerce enabled system, that allows us to home deliver customized orders and eliminate the guess work from successful healthy weight loss.

As Mike said Nutrisystem has a product that American consumers need as they struggle with their weight and seek to change their lives for the better. Within the last five years, the weight loss world has become an even more crowed and competitive space. With a little explosion of low and no (ph) cost do it yourself options in digital, retail, fast food and other channels. These solutions create noise and confusion for consumers who are trying decide, whether to allocate scarce discretionary spending to a weight loss program.

In the midst of all this change, we have not done a good job of keeping pace and leveraging the unique advantages of our business model and it’s clear to all of us that while our program and our business model is unique and differentiated and worse for consumers who have come to us for help, our marketing has failed to cut through clutter, reach the consumer and communicate this fundamental message.

We have to make it easy for the consumer to understand the real benefit of buying Nutrisystem weight loss programs. The good news about our business model is that even a modest incremental improvement in core fundamentals can drive major changes to our financial results.

It should not be a surprise to you then, where our focus is for the upcoming diet season. With our powerful scalable business model, we don’t need massive flash and sizzle to create meaningful change in the trajectory of this business. While this is not a forecast, to give you an example of how this could work, based on 2012 numbers we estimate that all other things being equal, just a 5% increase in call volume and unique website visitors could have driven over $6.5 million in additional EBIDTA or a near 0.1% increase in web conversion could have yielded over $4 million in additional EBITDA.

We would only have to go back a few years to see response and conversion rates like these articulated in this example. So these kinds of improvements in one or more of our key performance indicators is in our view reasonable with an intense focus on fundamentals.

Obviously I don’t want to tip our hand too much as we are in the process of finalizing our 2031 launch, but without providing too much detail, we are focused on a fourfold strategy designed to one, improve response to our advertising communication; two, drive media efficiency through smarter platform (inaudible) media buys; three, improve conversion in the call center and on the web to improve technology and re sought (ph) approach to our sales funnel that better matches our program offering; and four, bring excitement and profitability through new product launches.

While we still have our team of brand ambassadors, you will see less focus on celebrity and more focus at the program as a euro (ph), it’s unique point of difference and the support we have for that point of difference. We will focus on the nuts and bolts of running a successful direct to consumer, direct response marketing company, with the goal being driving the key performance indicators mentioned earlier in the right direction.

Now word on Q3. The third quarter, especially July and August was extremely challenging on the consumer response front. We compensated by reducing marketing investments, thus finishing the quarter generating 5% less revenue than a year ago and 10% lower marketing expense. All of this makes even more evident the need for us to launch a fresh approach to the consumer, as I mentioned earlier. From a retail standpoint, we expect rollout additional, regional retailers during the fourth quarter and we are on plan to reach out to make a mid-single digit contribution for revenue in 2012.

David Clark, our Chief Financial Officer will now talk about financials in more detail.

David Clark

Thanks Mike. I trust everyone has seen the financial statements in the Press Release that was issued before the call started. So I’ll discuss a few key highlights before we open the call for Q&A.

Revenue for the quarter was $81.3million, down 5% from the third quarter of 2011 and net reactivation revenue was approximately $25 million, in line with our expectations. Gross margin for the quarter was 46.1% down slightly from the second quarter. While we saw improvements in margins in each successive month in the second quarter, this trend did not continue in the third quarter, as we looked to leverage promotions to optimize conversion rates during one of their remaining peak demand periods in 2012.

As the promotions performed below expectations we’ve (tailored it back to raise current pricing) (ph). We will continue to focus on building gross margins in the balance of the year and we now estimate that each customer currently joining Nutrisystem program are at margins closer to our historical norms in a low 50% range.

Our marketing expense totaled $18.2 million for the quarter, down from $20.3 million last year. In light of lower customer response we dialed back marketing expense, so our marketing efficiency was consistent with the second quarter’s level at just over 22%, down from almost 24% a year ago. One-time charges in the third quarter were $2.9 million and these one-time charges impacted our third quarter 2012 after-tax net income by $2 million and earnings per share by $0.07.

The biggest component of the one-time charge this quarter was the write down of a supplier advance. Last year, we entered into an agreement and provided an advance payment to a frozen food supplier to exclusively manufacture our Chef's Table entrees. Since, then the supplier has (inaudible).

In the third quarter we recorded an impairment charge, expecting a sale (ph) or restructuring of the supplier that requires to write down on our advance. This $2.1 million charge reflects our net exposure and is the main reason for our G&A expense increase to $14.8 million. We are expecting their sufficient frozen food supply to meet demand for the upcoming diet season.

Excluding one-time charges, general and administrative expenses were $11.9 million, up slightly from the $11.5 million in the third quarter 2011 and our cash G&A expense was $10.4 million, up from $9.4 million last year.

Excluding one-time charges, adjusted EBITDA for the third quarter 2012 was $8.9 million, compared to $14.7 million in the third quarter 2011. A definition of our adjusted EBITDA as well as a reconciliation to GAAP is included in the tables of our Press Release which is available on our IR website at www.nutrisystem.com.

Depreciation and amortization was $2.6 million and non-cash employee stock compensation was $1.5 million in the third quarter 2012. Including one-time charges, operating income was $1.9 million. We realized an income tax benefit in the third quarter which increased net income to $2.6 million or $0.09 per share after one-time charges. The reason for this benefit is to bring our full year book tax accrual in line with our expected cash tax rate.

This was driven by lower than expected full year profitability and certain adjustments related to our CFO transition. Excluding one-time charges, net income was $4.6 million and EPS was $0.16 per share. Our original guidance for the quarter was earnings per share of $0.13 to $0.18 before one-time charges, so we are within that range.

From a liquidity standpoint on September 30, 2012, we had $68.8 million of cash, cash equivalents and marketable securities, compared with $57.6 million at yearend 2011. We ended the quarter with $30 million of outstanding debt. We have just closed our new $40 million credit line to replace our existing $100 million syndicated bank line of credit.

To better position our company for a successful turnaround, we felt a simplified single bank facility was more appropriate going forward. We believe this new credit facility provides us with adequate power and capacity for foreseeable future and has certain features that better fit our current liquidity needs.

Cash flow from operations was $6 million for the quarter, CapEx was $2.8 million, and we returned $5 million to shareholders in the form of dividend payments. The Board of Directors has authorized a quarterly payment of a dividend of $0.175 per share, payable November 29, 2012 to stockholders of record November 19, 2012. We did not repurchase any shares in the third quarter.

We are revising downward our guidance for the full fiscal year, reflecting our expectation that the trends we saw in the third quarter will continue into Q4. We expect full year earnings per share before one-time charges to be in the range of $0.15 to $0.20 per share.

In addition, we are evaluating a range of decisions that could reduce earnings per share by $0.05 to $0.15 for both the fourth quarter and the full year. We expect revenue to be flat to slightly down for 12 month period. We expect CapEx in the range of $9 million to $10 million for the year, including ongoing maintenance.

And now we’ll open it up for questions. Operator, you may open up the call for Q&A.

Question-and-Answer Session

Operator

(Operator Instructions) And we’ll first hear from Greg Badishkanian with Citi.

Greg Badishkanian - Citi

First question is can you talk a little bit about, just looking at next year, 2013, the initiatives that you have that your planning; how innovative do you think they are going to be versus what we saw in 2012? Should next year be a much better year than we’re seeing now or is it kind of same level of innovation and marketing, et cetera?

Joe Crivelli

Our focus is going to be on leveraging the strength of our business model with creative and compelling communications that better leverage the product and why people should select us in preference to other choices they may be considering, improving the way we leverage our uniquely trackable platform, dealing with some of the barriers we know customers have to converge in both in the call center to improve technology as well as by improving our sales funnel, as well as by offering programs options that specifically address what we know to bring customer barriers to conversion and for creating excitement through all of this in a unique way. So, yes we believe it sets us up to better leverage what our business model has to offer and perhaps what we’ve done recently.

Greg Badishkanian - Citigroup

Okay. Have you touched any of this to know what type of response that you think you’re going to expect for next year?

Joe Crivelli

Yes. We’ve been testing in the last several months promotional offers and creative approaches. We have certainly talked to a lot of the types of customers over the summer that are open to our business model but have been challenging for us to convert. So, we’ve been doing a lot of that background (ph) work to prepare for the diet season.

Greg Badishkanian - Citigroup

Okay. And the $0.05 to $0.15 initiatives that you may or may not implement what type of initiatives are those? Are those expected to be kind of testing for next year or can you give us a little bit more color on those?

David Clark

Greg, its David, I think with honestly, an incoming new leader, we will be evaluating a number of different commitments and looking at things. It could be things as simple as maybe accelerating marketing in the December timeframe to build momentum going to 2013. We’ll be evaluating our celebrities as well and things like different commitments to round certain initiatives that also weigh, a spare office lease may decide to vacate, to finish off the consolidation of all of our operations to the one building. So, it’s sort of fallen in a number of different categories.

Greg Badishkanian - Citi

Okay. And then this finally (inaudible), you gave some color in terms of the new CEO hire. Can you give us a little bit more color in terms of when you talked to her, ideas maybe she had, how much is she actually contributing? You mentioned that she’s (inaudible) ideas all along and just more insight around that deficiency since you hired her would be very helpful.

Joe Crivelli

Sure I think it gets down to three things, Greg that, the board got excited about, as well as management once I got the chance to know Dawn, it should be starting in about a week, but she's got a real appreciation for the core business which I do and the board does and that's priority number one.

We need to create a healthy core business, we have to change the trajectory of that business and she's person that understands how the intersection of product innovation analytically driven marketing decisions and good old fashioned messages and offers that resonate with today's dieters to turnaround a business like this. And in some ways they are quite quickly and quite dramatically we've seen it in the past.

So the core business is priority number one. But Dawn is very strategic. She's been involved in an industry that's been under quite a bit of duress as publishing (inaudible) and she's kind of proving her chops you with a number of new product introductions that demonstrates to us and the board and next to shareholders, that there is going to be new and interesting levers that Dawn will locate in driving our business to hopefully act as a catalyst for growth.

And I think that there’s a third thing that she's been very involved in, especially recently at Reader's Digest is kind of thinking differently that ways to grow the business internationally. She's been very effective at RDA, with partnerships licensing some of the brands and some of these international fields which are a lot more capital light and the return to especially if you have a good brand could be quite exciting.

So I think that Dawn is going to bring a different lend to this business. And as I mentioned in my prepared remarks, she's the first woman that's ever run Nutrisystem in forty years. So she will bring some interesting new ideas. We believe quickly and she'll be starting in a week and hopefully get out in to me you and others and short order, but we’re excited about Dawn’s arrival.

Operator

(Operator Instructions) Next, we will hear from Frank Camma of Sidoti & Company.

Frank Camma - Sidoti & Company

Couple of questions, one, you spoke about retail being for next year about single mid-digit growth accounting for some single mid digit growth; can you give us some statistics on how it’s actually doing at Kroger currently?

David Clark

Actually, frank what we said was that we expect in 2012 for retail to be a mid-single digit contributor to revenues in 2012 really in common on 2013.

Frank Camma - Sidoti & Company

Okay, I’m sorry.

David Clark

We remain in Kroger, we've been looking at other retailers, we've not without any plans for 2013 as yet.

Frank Camma - Sidoti & Company

Okay. So retail contributed or will contribute single digit growth for 2012?

David Clark

It will be a single digit percentage contribution to revenue in 2012, what we said, all along, yes.

Frank Camma - Sidoti & Company

And did that have any negative impact on your growth margin, I mean; your growth margin obviously was pretty disappointing or was it really the promotion?

David Clark

Yes. It’s not a big enough business, it does have a lower gross margin, it’s not a big enough business to really be the real cause, I mean the real cause was that we went out with promotions to try to take advantage of one last, the last sort of seasonal demand side that you see in the diet business in the calendar year. And the promotions didn’t drive enough response. And so we pivoted back to rate card pricing which is what we have right now.

Frank Camma - Sidoti & Company

And just a clarification on your guidance on, you’re at $0.32 now if you adjust your numbers correct?

David Clark

Yes.

Frank Camma - Sidoti & Company

Yes. And so you’re guiding to a pretty significant loss for the fourth quarter on revenue that’s going to be essentially flat maybe down a little bit, what’s the driver for the losses, what I am trying to reconcile my numbers.

David Clark

We can walk you through it, because there is lot of moving parts going on the tax line, as we shift it over to lower profitability, starting to trigger us into a tax benefit position, so it’s hard as sort of added across sequentially but we can take it’s through it after the call and they walk you through the different steps.

Frank Camma - Sidoti & Company

Okay. And the final question is just, can you update us on, I know you had a kind of not refreshed but you were putting some emphasis behind Nutrisystem D, did that gain any traction during the quarter?

Joe Crivelli

Yes, we continue to test different media channels and different approaches to Nutrisystem D. it’s a challenging demographic for us to convert. We definitely have a product that works for them, that’s clinically proven to work for that population. The population has some characteristics about it that has traditionally made it difficult for us to convert at levels that we find acceptable and we continue to test in that area, we’ve seen some things that are working and some things that aren’t and you can expect us to continue to do that. But I’m not sure there is a quick fix for it in the short term.

Frank Camma - Sidoti & Company

Are you working with any insurance companies to seek out reimbursement? Because I assume that that would really accelerate the growth of that product if it was reimbursable or somewhat reimbursable?

Joe Crivelli

We’re looking at a number of options and you’re absolutely right that getting the customers in chunks rather than one at a time would be a very useful thing for us to do.

Frank Camma - Sidoti & Company

Okay.

Joe Crivelli

And so partnerships and things like and all of those instalments are things that we are evaluating and looking at actively.

Operator

(Operator Instructions) We’ll now hear from Kurt Frederick of Wedbush Securities.

Kurt Frederick - Wedbush Securities

I have a question I guess on the timing of some of the new food roll. Is that going to occur in late December like the Chef's Table on the product launch expansion?

Joe Crivelli

The timing of new product, is that what you’re saying?

Kurt Frederick - Wedbush Securities

Right.

Joe Crivelli

Well, we always refresh the food choices going into the new diet season, I don’t know when we would announce, so as (inaudible) mid-December or?

David Clark

Yes, we’ll start rolling in as the month of December goes on. But the actual, obvious launch of new programs and the diet season would after the holiday season. So, we’ll start to see some new food options both in the frozen and in the ready-to-go side of our business roll in as the quarter closes.

Kurt Frederick - Wedbush Securities

Okay. I think before we talked about the I guess the line was going to expand, is that still the case? I think you talked about going beyond 130 products?

David Clark

Yes

David Clark

Yes. We will have a broader selection and diet season 2013 than we’ve had in the past and really one of the areas that we think that’s important is in RGG area, last year we reduced some RGG foods and didn’t entirely replace them and that’s important to a certain segments of our customer base, so you’ll see some additional foods there as well, as some new options in the frozen area.

Kurt Frederick - Wedbush Securities

Okay. And then on Nutrisystem D, that going to be a little bit bigger piece of the marketing strategy as you head into 2013?

Joe Crivelli

Is D going to be a bigger piece of the marketing strategy, is that the question correct?

Kurt Frederick - Wedbush Securities

Yes.

Joe Crivelli

I think what we’ll continue to do with cash flow profitable options to convert those customers, you may be aware we added some diabetes educators to our contact center and try to help the patients with diabetes we’re calling in, they have the confidence to convert without feeling like they needed to consult their doctors. We also know that there are sometimes, they are more challenging to convert financially, so we’ll be looking at payment options that might help in that area as well. We’re testing different media channels where unique for us, are different for us from an acquisition standpoint, we’ve seen some positive rays of light in there. But like I said, we want to test and improve and then test it and improve or kind of build into this so that we do profitably and make it a bigger part of the business. And as previously mentioned, we’re also looking at other ways or partnerships that might help us find groups of patients with diabetes at one time as opposed to (inaudible).

Operator

And it appears there are no further questions. Mr. Crivelli, I’ll turn the conference back over to you for any additional or closing comments.

Joseph Crivelli

Thank you. And thanks everyone for joining us today. If you have any additional questions, please do not hesitate to call me at 610-228-2100. We look forward to speaking to all of you in the near future. Thank you.

Operator

And that does conclude today’s conference. Thank you all for your participation.

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