Slim Pickings

It is, in a sense, a story about cigars. Harold Katz, the dapper president and chairman of Nutri/System Inc., a high-flying INC. 100 company for the past four years, smokes the Veracruz, an elegant cigar that is crafted in Mexico; cedar-wrapped and sealed in glass, it retails for about $5. A box of the cigars sits on the marble conference table tucked away in one corner of Katz's Jenkintown, Pa., office.

Leslie Charm, the admittedly dowdy chairman of Docktor Pet Centers Inc., and the man who, last January, came within an eyelash of buying Nutri/System, smokes the Royal Jamaica Buccaneer, a sensible, cellophane-wrapped cigar that can be had for around $1.20. A box of Buccaneers sits on the functional wooden desk in Charm's barren office in Andover, Mass.

Nutri/System, which owns and franchises weight-loss centers, is a Veracruz company that has found itself, somewhat unexpectedly, competing in a Buccaneer market. This year, for the first time in five years, it does not appear on the INC. 100 list of the fastest-growing public companies in America. From fiscal 1979 to '83, the company had grown at a compound annual rate of 82%, but in fiscal 1984, revenues fell by $17 million (11%). That drop destroyed Nutri/System's earnings: The company plunged from a $13-million profit in fiscal 1983 to a $17.4-million loss in 1984.

Behind the fall? Avarice, it is said. Mismanagement. Loss of momentum, more competition, stockholder lawsuits, and finally a knock-down-drag-out battle that pitted Katz against roughly half of his 550 franchisees. None of that bothered Charm much: He specializes in buying troubled franchising operations and turning them around. And Charm was willing to take on Katz's litany of troubles, provided that the price was right.

In the end, it wasn't. After nearly two years of turmoil and distraction -- and after negotiating with Charm right up to the edge of a deal -- Katz lit up a Veracruz and Called the sale off. Once again, he said, he would turn his attention to running the business.

And once again, that meant, the franchisees would have to deal with Harold Katz.

There was a time when people were happy to deal with Katz. He is, after all, the man who created the concept that made Nutri/System one of the most dynamic and profitable companies -- and a Wall Street leader -- for several years in the early 1980s.

Before Nutri/System, Katz had done a bit of everything, from selling life insurance to running a specialty sales business. He had also watched is mother gain and lose weight repeatedly, as she pursued one dieting plan after another. Katz figured that if he could integrate the various approaches to weight loss -- behavioral counseling, medical supervision, low-calorie meals -- he would have a winner. "I realized then that if you could put all of that under one roof, you'd have a fantastic business," Katz told INC. in 1981. "I had no doubts about it." (see "The Fifty-Million-Dollar Diet," May 1982).

Using $20,000 in savings and $20,000 borrowed on his house, Katz opened his first Nutri/System center in Willow Grove, Pa., a Philadelphia suburb, in December 1971. He opened the second a few months later, and the third -- the first sold to a franchisee -- in September 1972. By the end of 1981, the Nutri/System empire consisted of 496 weight-loss centers (395 of them franchised), with annual revenues of $49.2 million and profits of $9.2 million, a 19% margin. It was, as Katz put it so simply, "a money-making machine."

Katz's formula for losing weight worked well, and customers flocked in. But the reason for Nutri/System's spectacular financial success, the heart of its profitability, was the private-label food that clients were obliged to buy from the centers and eat at least five times a week. The company's markup on that line was the one thing, in 1981, Katz was unwilling to discuss. "Food is generally a low-margin business," notes one of his severest critics, "and what Harold had stumbled onto was a way of making a fortune on it. It was the unconscionable price of the damn food that made Nutri/System."

Katz remains reticent on the subject today. "I admit that we made a very handsome profit on it," he concedes. But at the time, he points out, no one was complaining about it. "Everybody was making large dollars," Katz explains, "and, in a franchise business, if the franchisees are doing well, everybody's happy." The average payback to franchisees was six months; some, says Katz, "got back their entire investment in two months." Profit margins averaged 20%, and a number of franchisees became millionaires. Only the customers paying the big markups might have been tempted to complain, and, for the time being, they seemed happy enough.

For Katz, the benefits were even more impressive. Nutri/System went public over-the-counter in January 1981 (it is now traded on the New York Stock Exchange), and by late 1982 was trading at 48 1/8 a share, making Katz's 67% worth more than $300 million. The company moved into its new $2-million headquarters in Huntingdon Valley, Pa., another Philadelphia suburb, the centerpiece of which was the president's luxurious office. Katz acquired a house that wags dubbed "the castle," along with a $56,000 customized Cadillac Seville and the Philadelphia 76ers basketball team, of which he remains the sole owner. If the word ostentatious had not existed before, it would have been coined for Katz.

Back then, the company's only problems seemed to be finding ways to make use of the incredible cash flow and sustain the phenomenal growth. "They knew," observes James M. Meyer, an analyst who follows Nutri/System for Janney Montgomery Scott Inc., in Philadelphia, "that the United States could accommodate a finite number of centers, something in the 700 to 800 range, and that they had a two-or three-year window in which they could grow very rapidly to opening new ones." Beyond that he adds, "It became clear that they would have to make some fairly serious acquisitions."