WW International, Inc.
Q3 2016 Earnings Call Transcript

Published: 3 Nov 2016

[Operator:]

Good afternoon, and welcome to the Weight Watchers Third Quarter 2016 Earnings Conference Call. All participants will be in listen-only mode. After today's presentation there will be an opportunity to ask questions. Please note that this event is being recorded. Now I'd like to turn the conference over to Corey Kinger of Investor Relations. Please go ahead.

[Corey Kinger:]

Thank you, Nance. And thank you to everyone for joining us today for Weight Watchers International third quarter 2016 conference call. At about 4

[Christopher J. Sobecki:]

Thanks, Corey. Good afternoon, everyone, and thank you for joining us. Before we review the Q3 results, let me recap our recent CEO announcement. In September, the company announced that Jim Chambers resigned as CEO and that Thilo, Nick and I would together lead the organization on an interim basis until a new CEO is appointed. Jim led the company through a difficult period, which included rebuilding several core competencies that have been critical in returning the company to growth over the past year. The company has returned to solid footing, and our Beyond the Scale program is resonating, and we feel good about the preparedness of our winter 2017 initiative. The company is, therefore, now well positioned to look for the next CEO who will lead Weight Watchers to achieve its long-term potential. During this interim period, Nick, Thilo and I are working with the talented team at Weight Watchers and, together, we are focused on accelerating momentum in the business. To provide a bit more context in this interim organizational structure, the three of us are deeply involved in the business and all have offices at headquarters. While major decisions are made jointly, we each have specific areas of focus

[Nicholas P. Hotchkin:]

Thanks, Chris. Now, to more details on our third quarter financial results. Total Q3 revenue was $281 million, up 4% year-over-year on a constant currency basis. Service Revenues grew 5% year-over-year on constant currency and product sales and other were about flat to prior on constant currency. Q3 operating income was $67 million, a 5% increase year-over-year on an adjusted and constant currency basis. Q3 GAAP EPS was $0.53. Note that this includes a $0.13 one-time tax benefit and also reflects the negative impact of $0.08 of dilution from a higher share count year-over-year. For comparison, GAAP EPS in Q3 2015 was $0.38, which included a $0.01 negative impact due to restructuring charges. Looking at our performance by geographic market, North America total revenue increased 8% with Meeting Fees up 13%, Online revenue flat, and Product Sales and Other revenue up 6%, all on a constant currency basis. Total North American Paid Weeks grew 10% year-over-year. Meeting Paid Weeks increased 15% and Online Paid Weeks increased 7%. While these trends in our operating metrics are encouraging, Online revenue came in a bit below our expectation. The team has been testing various promotional strategies, many of which have been highly effective in driving recruits. We are focused on better optimizing the balance of recruitments and revenue in our promotions. Importantly, our retention metrics remain stable at eight to nine months. In the UK, our performance has been impacted by a direct competitor in that market. On a constant currency basis, third quarter total revenue in the UK was down 7%, with Meeting Fees down 7% and Online revenue down 1%. Total UK Paid Weeks declined 5% year-over-year, Meeting Paid Weeks declined 7% and Online Paid Weeks declined 3%. In Continental Europe, total revenue declined 3%, with Meeting Fees down 6% and Online revenue up 3%, all on constant currency. Total CE Paid Weeks grew 2% year-over-year, Meeting Paid Weeks declined 4% and Online Paid Weeks increased 6%. Continental Europe is showing significant improvement from the revenue trends we saw in the first half of 2016 and we expect further year-over-year improvement in Q4. Improving our international performance is a key priority. It was encouraging to see good consumer response to our fall campaign and weight loss results. Keys to improving international performance going forward include sharing our U.S. learnings to evolve our meeting experience, improving member on-boarding, and improving business site conversion, as well as improving the consistency of our marketing execution. Looking at our P&L detail with all comparisons on an adjusted and constant currency basis, in the third quarter, gross margin was 51%, up 130 basis points from the prior year, primarily due to improved meetings cost leverage from higher volumes. This was partially offset by promotional activity as well as a lower contribution from licensing. Our marketing spend was $30 million, up $4 million (sic) [$3 million] versus the prior year, primarily driven by unusually low production costs in the prior year period. G&A expenses were $47 million, up $3 million (sic) [$1 million] versus the prior year. Interest expense for the quarter was $28 million, with the decline from $30 million in the prior year primarily reflecting the Q1 pay-down of the remaining balance of our B1 term loan. The tax rate in the quarter was 10% as compared to 33% in the prior year period, primarily driven by one-time items. The lower tax rate in the quarter was driven by net tax incentives, primarily related to investments in technology in prior years. These benefits were partially offset by out-of-period adjustments. The net impact of these items positively impacted Q3 EPS by $0.13 per fully diluted share. Turning to the balance sheet, we ended the quarter with $99 million in cash. During the quarter, we paid back the full amount outstanding on our revolver. And going forward, our revolver will remain available for temporary working capital needs. As a reminder, our $2 billion B2 term loan is not due until 2020. Our debt has no financial leverage covenants. We have the ability to prepay before maturity. And now, I'd like to update our outlook for the year. We now expect full year 2016 revenue to be approximately $1.17 billion. Note that this includes an expected negative foreign exchange revenue impact of $15 million for 2016 versus 2015. Our full year GAAP EPS guidance is a range of $0.95 to $1.05. For the remainder of my comments, I'll speak to the midpoints of our full year range and on a constant currency basis. Total global Paid Weeks are expected to be up in the mid-single digits for the full year, with Meetings slightly outperforming Online. In North America, we anticipate full year revenues to be up in the mid-single digits, reflecting continued strength. In the UK, we expect revenue for the full year to be down in the low-double digits. And for CE, we expect full year revenue to be down in the mid-single digits, but with continued year-over-year sequential improvement. We expect gross margin growth of up to 100 basis points for the full year, primarily reflecting cost efficiencies at higher volumes. We expect full year marketing expense to be about $195 million. We expect G&A for the year to be approximately $190 million. Below the line for the year, we expect interest expense to be approximately $116 million. We expect CapEx, primarily driven by tech spend and capitalized software, to be in line with prior year levels in the $35 million range and D&A in the $55 million range. We expect EBITDAS of up to $265 million for the year. And on that basis, we anticipate ending 2016 with a cash balance approaching $140 million with no revolver borrowing. Reducing leverage remains our top capital structure priority and, as discussed previously, we are targeting a year-end 2018 net debt-to-EBTIDAS ratio of less than 4.5 times. As you can see, overall improvement in our operating metrics is now being reflected in our financial performance. As discussed previously, with a subscription business model, there is an inherent lag between member recruitment growth, which began in Q4 2015 and full revenue and profit realization. To put this in perspective, we entered 2016 with 120,000 fewer people in the brand versus the prior year. We ended Q3 with 260,000 or 10% more subscribers than the prior year period. We are confident this momentum will continue for the remainder of the year, resulting in a double-digit earnings tailwind heading into 2017. And with that, I would like to turn it over to Thilo.

[Thilo Semmelbauer:]

Thanks, Nick. It's a great honor to be back at Weight Watchers to serve on the board and in this interim period as a Member of the Office of the CEO. By way of background, I spent most of my career in technology. When the Internet was in its youth in early 2000, I was fortunate to be part of the original team building weightwatchers.com. After Weight Watchers acquired an integrated weightwatchers.com, I became President of North America and then Global Chief Operating Officer. So, I was deeply involved in the meeting business when we first introduced monthly pass and moved to a subscription model for the whole organization. I left in 2008 to get back into technology startups. From 2010 to 2015, I was President and COO of Shutterstock, which grew from a startup to become the global leader in commercial imagery. My passion is building great products, putting the necessary infrastructure and platforms in place, and getting teams to work in a more agile fashion. And after my first month back at Weight Watchers, it's been very gratifying to see a strong product and tech team in place as well as a shift to a more agile innovation process that's well underway. Throughout 2016 many enhancements have been made to our digital platforms and tools and I believe the foundation is in place to make tremendous progress with our products to further increase engagement with our members and to support their success. As we prepare for the upcoming winter season, all of our key systems are already in place as our teams prepare for seasonally high-volume. This is a shift from the last several years where the company was implementing major architectural and product changes just ahead of the peak season. On the marketing front, we look forward to prominently featuring Oprah in our winter season marketing campaign. You may have already seen that our cookbook, Food, Health and Happiness is launching in January. She worked closely with her favorite chefs and consulted with Weight Watchers to develop and share SmartPoints friendly recipes for her favorite foods, and we look forward to sharing these with our members. Our strategic collaboration with Oprah is just getting started. And together, our priority is to maximize our potential for winter 2017 and beyond. Thank you for joining us today. And with that, we'll turn the call to the operator for Q&A.

[Operator:]

Thank you. Our first question comes from Alex Fuhrman of Craig-Hallum Capital Group. Please go ahead.

[Alex Joseph Fuhrman:]

Hi. Thank you, guys, very much for taking my questions and congratulations on such strong recruitment growth here. Something I'd like to ask about is, obviously, your growth year-over-year in recruitment has gotten pretty significantly better this year as the year has progressed, and it seems to me that that was similarly the case last year, although obviously the numbers were working in the other direction, where Q2 and Q3 subsequently showed a much better trend than Q1. I'm just trying to understand is there a historical precedent for the numbers getting significantly better or worse in terms of recruitment as the year progresses? Because if I remember correctly, last year, I feel like the company – you guys weren't thrilled with your marketing campaign and were able to make some improvements thereafter. What really drove the change in trend throughout the year this year? Do you feel that there was perhaps some opportunity left on the table with your Diet Season 2016 campaign that you were able to kind of tweak and improve as the year progressed, or is there maybe something going on with the consumer that that was able to help your recruitment trends later in the year?

[Nicholas P. Hotchkin:]

Thanks, Alex. Let me start with that. First of all, the business has great momentum. Having four quarters in a row of positive recruitment, allowing us to post 4% revenue growth on a constant currency, first revenue growth since Q4 2012, and ending the quarter with 10%, 260,000 more people in the brand versus prior year shows that not only is the Beyond the Scale strategy resonating, but folks are succeeding with their weight loss journeys on SmartPoints, finding the program livable and, of course, all of that is being elevated by strong marketing efforts. When I look at the year, the trends in North America have been strong throughout the year. Obviously, we were forthright that Q2 was a little bit softer recruitment than we would've liked, but the marketing efforts in Q3 with a terrific fall campaign with compelling weight loss messaging really helped the propel us forward. So, through the year, international got off to a slower start in winter than we would've liked, but as we refocused our messaging on the celebration of food and the benefits of Weight Watchers, we've seen some good sequential improvement, particularly in our largest continental market, Germany. We're pleased with the trends and we think we've got good momentum headed into winter, where, of course, Oprah Winfrey will feature promptly in our campaign.

[Christopher J. Sobecki:]

The only thing I would – maybe to your question is there some kind of historical pattern that things get – the answer is, I don't think so. Every year is a different pattern. So, I think what we're seeing in the strength – and I think one of things that I alluded in my remarks was as we've progressed through the year, the product that we're offering, particularly the digital product we're offering, has been improving. I think we got off to a bit of a rough start at the beginning of 2016 with a few of the technology sort of hiccups that we experienced. And I think, as the team sort of began to improve the app, improve the web performance, I think what we're delivering as we progressed through the year improved considerably, and we're in a much stronger position today than we were earlier in the year.

[Nicholas P. Hotchkin:]

I think that's a great point. And just to mention, by the time we got to the fall campaign, we were really proud of a modern suite of new apps and we wanted to share that with a lot of people and that effectively drove our strategy in Q3.

[Alex Joseph Fuhrman:]

Great. That is helpful. Thanks. And then, I guess just to follow-up there and talk about the international business, obviously, you mentioned for a couple conference calls in a row here, there's been competitive issues in the UK. Trying to understand, given the success you've had here in North America this year, where are you guys going to be focusing both your time and your marketing dollars for next year? If things don't start to see improvement there, do you guys really just push more into the North American marketing or do you think that, ultimately, you can get past those issues and show similar levels of growth one or two years out in Europe?

[Christopher J. Sobecki:]

This is Chris. I think we're spending our time both in North America and in the international market. Nick and I were – we spent time in Europe within the last month. I think there's a little bit of a different situation in the UK versus Continental Europe. Continental Europe, the business has turned weaker, I think, after the U.S. did, but I think some of the basic structural issues around free apps and may be our slow execution into mobility impacted that market in sort of a delayed fashion. And as we've improved our product, we've been a bit slower moving those improvements into Europe, but we're seeing that happening now. And I think if you look at Continental Europe, you'll see sequential quarterly improvement in that business as it's gone through this year. I think one of their big issues that they've struggled with over last years, is with their marketing execution with each market sort of independently developing their own execution and probably not enough sharing of sort of best practices in and ideas. And the company made a big push early this year to kind of get that aligned and improve the execution. I think we're all heartened to see what they – and the fall campaign was much improved in terms of what we saw in the execution and in the numbers. And then, I think we will probably continue to see that. We know we'll continue to see that in the fourth quarter and, hopefully, into next year. UK is a little bit of a different story. I think the UK is an interesting market because it really demonstrates the vibrancy of the meetings approach. It's a market that still today has a much bigger meeting business as a market than even a digital business. The issue that we've struggled with in the UK is that we have a very savvy competitor there that is primarily an only-meetings business and, frankly, they've out-executed Weight Watchers over the last few years and they've taken share from us. The meetings business is not shrinking there. We've lost share. And I think we are spending time there. The team there is highly focused on the turnaround. Like Continental Europe, they did a very nice job in terms of their fall campaign. We saw a positive recruitment in that fall campaign in the UK, which is the first time we've seen that in a while. And we think there is a lot of work to do there, but it's not to be spontaneous. But if we get it right, we think we can take back our fair share of that meeting business as well as continue to grow the Online business.

[Alex Joseph Fuhrman:]

That's terrific. Well, congratulations again on such strong recruitment growth in the quarter and thanks for taking my questions.

[Operator:]

Thank you. This concludes our question-and-answer session and our conference call. Thank you for attending today's presentation. You may now disconnect your lines.