NutriSystem, Inc.

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NutriSystem, Inc.

200 Welsh Road
Horsham, Pennsylvania 19044
U.S.A.
Telephone: (215) 706-5300
Toll Free: (800) 321-8446
Fax: (215) 706-5388
Web site: http://www.nutrisystem.com

Public Company
Incorporated: 1971 as Shape-Up, Inc.
Employees: 107
Sales: $22.57 million (2003)
Stock Exchanges: American
Ticker Symbol: NSI
NAIC: 541990 All Other Professional, Scientific and Technical Services

NutriSystem, Inc., formerly an operator of weight-loss centers, offers its services on the Internet, providing diet programs on its web site, www.nutrisystem.com. The company offers counseling online and via telephone, provides weight-loss programs, and distributes prepackaged foods. Through a contract with QVC, Inc., a television shopping network, NutriSystem sells its food on television, deriving more than 20 percent of its total revenues from QVC-related sales. NutriSystem also owns Slim and Tone, a franchiser of fitness clubs.

Origins

For roughly a decade, Harold Katz enjoyed a level of success that most entrepreneurs could only dream of reaching. Quickly, however, his job of running one of the fastest growing companies in the United States became a litigious affair, rife with hostility, and generally a nightmarish ordeal. For Katz, the son of a grocer who received no formal education beyond high school, the path to possessing a personal fortune valued at more than $300 million began in 1971. He was 34 years old at the time, having spent the years after high school floating from one job to another. He started working at his father's grocery store, spent a short time running a specialty sales business, and got involved in the insurance business. By the beginning of the 1970s, Katz was looking for another job, and he got the inspiration for his try at an entrepreneurial career from his mother. Katz had watched his mother gain and lose weight repeatedly, fueling his desire to find a better solution to controlling weight. He decided to integrate behavioral counseling, medical supervision, and low-calorie meals into one business concept, developing weight loss "centers" that looked like medical offices. "I realized then that if you could put all of that under one roof, you'd have a fantastic business," Katz reflected in a May 1985 interview with Inc. magazine.

Katz bet everything he had that his business would succeed. He emptied his savings account, totaling $20,000, and took out a second mortgage on his house, giving him another $20,000. With the start-up capital, Katz opened his first weight-loss center in Willow Grove, a suburb of his native Philadelphia, in December 1971. The first center was named Shape Up, Inc. Several months later, he opened a second center, and in September 1972 he discovered the concept's primary growth engine, selling the third center to a franchisee. (Katz's weight-loss centers underwent several name changes during their first decade, becoming Shape-Up Weight Control Centers of America, Inc. in 1976, Weight Loss Medical Centers of America, Inc. in 1977, Nutri-System Weight Loss Medical Centers of America, Inc. in 1979, and Nutri/System, Inc. in 1980.) As the Nutri/System concept quickly blossomed into a nationwide chain of weight-loss centers, it did so largely though franchise agreements, becoming what Katz referred to as a "money-making machine" in his interview with Inc.

Each Nutri/System center earned its money through a set-up fee to clients and by charging each client according to the amount of weight lost. The centers earned most of their money from another source, however, recording hefty profits from the sale of private-label food, which Nutri/System clients were obliged to purchase at least five times a week. As one critic of the Katz-led organization put it, as quoted in Inc. article on the company, "It was the unconscionable price of the damn food that made Nutri/System."

During the 1970s, there was little controversy about the price of the company's food, at least in comparison to the uproar surrounding the issue a decade later. During the 1970s, everything was fine because everyone was making money, Katz and his franchisees included, several of whom became millionaires during the decade. By the end of the 1970s, Katz's enterprise ranked as one of the 100 fastest growing companies in the country, quickly blanketing the nation with Nutri/System centers. Beginning in 1979, Nutri/System began a four-year period that would see the company record revenue growth at a compound annual rate of 82 percent. Katz took the company public during this period, debuting on the over-the-counter exchange in January 1981, before moving to the more prestigious New York Stock Exchange. By late 1982, Katz, who owned 67 percent of Nutri/System's stock, had parlayed his $40,000 initial investment into a fortune valued at more than $300 million. Katz was immensely wealthy, a stature he relished. He moved the company into a new $2 million headquarters facility in Huntingdon, Pennsylvania, equipped with a lavish office with stained glass, a wet bar, and a model of his corporate jet. Katz bought a massive estate, a $56,000 customized Cadillac Seville, and, lastly, he purchased his hometown basketball team, the Philadelphia 76ers.

Katz's chain operated in 50 states during the early 1980s, comprising 500 weight-loss centers, 400 of which were franchised units. Together, the centers generated nearly $50 million in sales a year, a total that was practically doubling every year. The pressing problem at this point was trying to sustain a phenomenal record of growth, which threatened to become increasingly difficult as the company reached its projected saturation point of between 700 and 800 Nutri/System weight-loss centers. Katz had an enormous flow of cash at his disposal and put it to use to find new areas of growth. He began acquiring other businesses, convinced that his success with Nutri/System reflected a talent that could be grafted onto other businesses. "I'd been in business for nearly 31 years," he said in his Inc. interview. "And I'd hate to think that all I, and the people that I'd surrounded myself with, knew was weight loss. We knew franchising, we knew the service business; we were salesmen, marketers."

The Turbulent Early 1980s

When Nutri/System was at its peak, Katz began spending some of the money earned from his rousing success. In August 1981, he acquired a Philadelphia-based executive placement firm named Fox-Morris Associates, paying $4.2 million for the company. In March 1982, he purchased Gloria Marshall Figure Salons for $15.1 million and Nutrient Cosmetic Ltd. for $8.1 million. Katz also started a new business, Tele-Cut, a hair-styling salon he designed as a franchise concept. His foray into other business areas swiftly proved that he was not blessed with a Midas touch. The acquired companies, each generating less profit than they should have before they were acquired, worsened under Katz's control, turning into money-losers. The acquisition of Gloria Marshall, in particular, was a disaster, presenting what many Nutri/System franchisees perceived as a competitor operating within their organization. Despite the anemic state of the chain and Katz's assurances that Gloria Marshall presented no threat to Nutri/System centers, franchisees looked at Gloria Marshall and saw a business offering a computerized diet, a weight-maintenance program, and a diet supplement, which was supplied by Nutri/System. The acquisition, according to Katz's comments in his interview with Inc., "led to the end of the honeymoon" between Nutri/System and its franchisees. Within a short time, corporate divorce appeared to be the only solution to resolve the enmity between Katz and his franchisees.

The missteps on the acquisition front were followed by actions that caused further anxiety for Nutri/System franchisees. Senior Nutri/System officials began selling large amounts of stock they held in the company, beginning in January 1983 when Katz sold 670,000 shares. During the ensuing two months, Katz's brother, Nutri/System's vice-president Robert Katz, sold 42,250 shares, the company's marketing vice-president sold 58,250 shares, and its national medical director sold 7,000 shares. In mid-March 1983, nine days after the sale of stock by senior executives ended, the company announced its earnings for the third quarter would drop by as much as $1.8 million, a revelation that led shareholders to file a class-action lawsuit against the company. Meanwhile, another contentious battle was taking place, pitting Katz against a large number of franchisees, who, like their customers, felt gouged by the price of the food they were obliged to buy from Katz. The franchisees formed a federation that sought compromise from Katz, eventually resulting in a lawsuit filed against Nutri/System that counted 280 of the 550 franchised centers as litigants in the antitrust lawsuit.

The good times were through for Katz, as they were for the company he presided over. Nutri/System posted a $17.4 million loss in 1984, one year after reaping a $13 million profit. Katz, exasperated by his experience dealing with an increasingly hostile group of franchisees, looked to sell the company and nearly did so, but the buyer backed out at the last moment, unwilling to pay for a company whose market value was plummeting. Everyone within the organization, including Katz, believed Nutri/System was headed toward an imminent ownership change, but the aborted sale of the company kept the same personalities in place, creating an uncomfortable chemistry within the organization that Katz realized he needed to do something about. "For the benefit of everyone," he said in his interview with Inc., "it's important that we have a new chief executive officer, some new life, some new thinking, somebody coming in clean."

Company Perspectives:

NutriSystem now stands as a constant pillar of support and information for those looking to lose weight in a busy world. As an Internet force, its wide-ranging web content, combined with its knowledgeable and professional counselors, equals a powerful resource for all dieting consumers. And it's available 24 hours a day, 7 days a week, with no waiting for weekly meetings or worry about expensive membership fees. NutriSystem believes in its clients and is there to help them, every step of the way. Together with its growing online member community, NutriSystem makes weight loss—and the goal of becoming healthy and fit—a reality for millions.

The untarnished executive selected by Katz was A. Donald McCulloch, who became chief executive officer of the troubled Nutri/System organization in 1985. McCulloch, 39 years old at the time, possessed a wealth of marketing experience gained while working for General Foods, Wilson Sporting Goods, Pizza Hut, and Hathaway shirt. McCulloch used his experience to develop a turnaround plan, a plan that, if successful, would give him an opportunity to acquire the company, according to his stipulation to Katz in accepting the chief executive officer position. "On an Amtrak napkin on my way back from Nutri/System," McCulloch said in a November 13, 1989 interview with Forbes, "I made a list of five things we needed to do: control our finances, bring in new management, innovate marketing, upgrade operations, and restructure the branch network system." McCulloch's influence on the organization produced encouraging results, paving the way for his acquisition of the company and the exit of Katz.

In 1986, the Katz era came to an end. McCulloch and four other executives completed a leveraged buyout of the company, a $69.5 million deal that netted Katz $37.9 million. Although far from impoverished, Katz ended his relationship with his entrepreneurial creation with substantially less than the $300 million he could have taken away only a few years earlier. For Nutri/System, the change in ownership marked a fresh start and a return to a privately-held status. The company expanded aggressively for the remainder of the 1980s, developing into a chain of 1,800 weight-loss centers that generated $764 million in revenues by the decade's conclusion.

Collapse in the Early 1990s

Despite the change in ownership, Nutri/System continued to find itself involved in damaging legal battles. During the early 1990s, the company faced hundreds of lawsuits alleging the Nutri/System weight-loss program created medical problems resulting in the loss of a client's gallbladder. By 1991, the company conceded it faced about 300 lawsuits nationally, while other sources put the number closer to 800, each claiming that the rapid loss of weight increased the saturation of bile with cholesterol, directly contributing to the formation of symptomatic gallstones and gallbladder disease. In mid-1993, the company succumbed to the forces against it, operating as a debtor in possession under Chapter 11 of the U.S. Bankruptcy Code until it was discharged the following year.

Nutri/System was a shadow of its former self throughout the 1990s. The company operated only a fraction of the weight-loss centers it had operated during the 1980s and it was a perennial money loser. Annual sales, which had neared $800 million in 1989, hovered around the $50 million range throughout the 1990s. As the company entered the late 1990s, the decision was made to abandon its traditional approach to offering weight-loss programs in favor of becoming an Internet-based provider of weight loss solutions. Nutri/System sold its company-owned centers to Complete Wellness Weight Management, Inc. in 1997 and re-emerged as an e-commerce company with a new name, nutrisystem.com inc.

NutriSystem in the 21st Century

The company's web site launched in 1999, beginning a new era for the Nutri/System diet plan. In 2000, the first full year of Internet-based sales, the company generated $20 million in revenue, a total that was nearly matched by the $14 million it lost during the year. The beginning of the new decade was a time of rebuilding, to be sure, requiring new methods and a new approach to running the 30-year-old brand. In an effort to improve its financial health, the company purchased the Sweet Success product line from Nestlé USA. Inc. in August 2000, just before it changed its corporate title to Nutri/System, Inc. Sweet Success was a diet meal replacement line distributed in traditional retail locations such as supermarkets, drugstores, and discount chains, but Nutri/System executives decided to drop the product line four months after acquiring it, officially discontinuing it in June 2001.

The brief and unproductive association with Sweet Success was countered with a more lasting and lucrative relationship forged in 2001. Nutri/System reached an agreement with the shopping network QVC, Inc. to sell the company's food on television, which developed into a sizeable business. By 2004, food sales through QVC accounted for more than one-fifth of Nutri/System's total revenue.

Key Dates:

1971:: Harold Katz opens his first weight-loss center, called Shape-Up, in suburban Philadelphia.
1972:: Katz begins franchising his concept.
1981:: NutriSystem debuts as a publicly traded company.
1985:: A. Donald McCulloch is named chief executive officer after a tumultuous struggle between Katz and NutriSystem franchisees.
1986:: McCulloch leads a leveraged buyout of NutriSystem, ending Katz's involvement with the company.
1989:: NutriSystem, with roughly 1,800 weight-loss centers, generates nearly $800 million in revenue.
1997:: The company decides to sell its weight-loss centers and focus on the growth of an Internet-based business.
1999:: The company's web site is launched.
2001:: NutriSystem brokers a distribution agreement with QVC, Inc.
2003:: A new food line, NutriSystem Nourish, is introduced.
2004:: The company acquires Slim and Tone, a franchiser of fitness centers.

As Nutri/System completed its first 30 years of business, new owners took control of the company. In December 2002, HJM Holdings LLC and NewSpring Ventures L.P. acquired 58.4 percent of Nutri/System, giving the two investment concerns majority control over Nutri/System. HJM Holdings' Michael J. Hagan, the cofounder of VerticalNet, a business-to-business Internet and software company, was named chairman and chief executive officer of Nutri/System. Under his leadership, the company, which changed its name to NutriSystem, Inc. in 2003, introduced its first new food line in a dozen years, a line of more than 100 food selections with a low glycemic index called NutriSystem Nourish. The new program debuted in December 2003. The introduction of NutriSystem Nourish was followed by the acquisition of Slim and Tone, a franchiser of fitness centers, in late 2004. These two new avenues of potential growth represented Hagan's attempt to move the company beyond its past and reinvent a successful business model for the future, something NutriSystem needed as it entered the mid-2000s.