WW International, Inc.
Q1 2015 Earnings Call Transcript

Published: 6 May 2015

[Operator:]

Good afternoon everyone and welcome to the Weight Watchers First Quarter 2015 Earnings Conference Call. All participants will be in a listen-only mode. After today's presentation, there will be an opportunity to ask questions. Please also note today's event is being recorded. At this time, I'd like to turn the conference call over to Ms. Corey Kinger, Investor Relations. Ma'am, please go ahead.

[Corey Kinger:]

Thank you, Jamie, and thank you to everyone for joining us for Weight Watchers International's first quarter 2015 conference call. With us on the call are Jim Chambers, our President and Chief Executive Officer; and Nick Hotchkin, our Chief Financial Officer. At about 4

[James R. Chambers:]

Thanks, Corey. Good afternoon, everyone, and thank you for joining us. My remarks today will focus on our Q1 performance and our near-term priorities in support of our transformation plan. Nick will discuss the financials in more detail, but to quickly summarize, our first quarter results were in line with our expectations we shared with you in our February call. First quarter revenue declined to $322 million, adjusted operating income came in at $24 million, and adjusted earnings per share was a loss of $0.09. End of period global actives declined 20% year-on-year to 2.9 million, with 1.7 million online and 1.2 million in meetings. While Q1 results were helped by aggressive cost reductions, our recruitments were negative across all of our geographic markets. Our top and bottom line outlook for the year remains in line with what we had outlined on our last call with the negative recruitment trend expected to continue through the year. Looking at our marketing efforts, after a tough start to the year, we have been testing and deploying different promotional tactics, varying our messaging and delivery mechanisms, as well as the depth and duration of discounts. We have had some positive results. For example, the Lose 10 Lbs On Us promotion and the flash sale mechanism. However, our promotional lifts have not carried forward into sustained recruitment growth. The U.S. spring campaign features a strong call to action through compelling offers and advertising that presents a confident inspiring view of the Weight Watchers brand, as well as the livability of our program. Also this spring, we are leveraging versions of the Lose 10 Lbs On Us offer in additional international markets. I would like to step back now and provide some context on our transformation journey. 18 months ago, we introduced our multi-year transformational plan. Central to this plan is repositioning our brand, improving our offering, expanding our position in the healthcare channel and building organizational capabilities. We are making progress on this plan. Recently completed consumer research gives us new confidence in where our brand and offering can go and what will resonate with consumers. Our market experience and testing is showing us how to evolve our recently introduced Expert Chat and coaching platforms. We remain convinced that bringing our strategic advantage in human support into the digital realm will be a winning formula. Our technology transformation is well underway and we are encouraged by the potential for improved effectiveness and significantly lower costs. We continue to build functional capabilities and insights, product, marketing and engineering and our first U.S. healthcare partnership is up and running. However, it will take longer than we thought to return to growth. Our starting point proved to be more challenged than we thought, particularly in the area of technology where our legacy systems and architecture have made change more difficult. While we are encouraged by the product enhancements we introduced in winter season 2015, our efforts fell short of the mark as we did not meet the historical best practice of using compelling marketing to leverage meaningful program innovation. We are fully engaged in executing our transformational plan. We firmly believe we are pursuing the right strategies and are confident we can implement them successfully. We have four implementation priorities that we are focused on delivering by the end of the year. Number one, complete the development of a meaningful new program innovation that broadens and strengthens our offer. Two, develop and validate our marketing approach in support of that innovation. Three, make our Humana partnership successful, and four, substantially complete our technology transformation. Let me expand on these priorities. While weight loss remains critically important, increasingly, consumers are asking us to think more expansively about the role Weight Watchers can play in their lives. As we stated in our last call, the underlying desire for weight loss is still a very important part of the equation. However, the consumer wants to get there through a more holistic mindset of generally healthier eating, wellness and fitness with weight loss being a critical element of this bigger picture. This new mindset is more forgiving and allows for success across many metrics and less emphasis on the number on the scale. This suggests a compelling opportunity for Weight Watchers to take our program beyond the scale, broadening our program to include fitness among other things. The consumer gives us permission to play in this broader space with opportunities for both our face-to-face and digital offerings. These are the insights that are driving the meaningful program innovation that we will be introducing for winter season 2016 as well as the marketing that will support its launch. We have made significant progress in building the systems and processes to support our healthcare initiatives. Our partnership with Humana is off to a positive start with the launch having gone well. Humana members and qualified employer-sponsored health plans, now have free access to six months in Weight Watchers through an integrated wellness program. The partnership is in its early days and as we have said before, we do not expect it to be a material contributor to revenue this year. We remain enthusiastic about the potential of the partnership to lead the way and bringing Weight Watchers to more people as we expand participation in the healthcare channel. A year ago, we laid out an aggressive plan for technology transformation. Some of the choices we made to meet the January 2015 new product introduction deadline extended our timeline, but we now believe that our tech transformation will be substantially complete by yearend. I've talked before about our efforts in our products and technology functions to improve our innovation process, and move to agile product development. I'm encouraged by our progress here as we have strengthened our teams, and deployed new technologies, resulting in the significant majority of our new development efforts now being agile. Today, we can release new digital functionality biweekly as compared to our prior capability of only a handful of releases per year. Our agile development model, as it has for numerous leading tech companies, will allow us to build and validate new functionality more quickly and reliably than in the past. In addition to techs rolling our agile product development efforts, we have implemented new architectural choices, and new development methodologies that will improve our effectiveness, while lowering our costs. We have ramped up our recruiting efforts to build our internal tech teams allowing us to reduce our dependence on external resources. Part of our product and technology strategy involves making select tuck-in acquisitions that bring us capabilities and talent in strategic areas, such as coaching, fitness and community. Over the last year, we have made three such acquisitions, namely Wello, Weilos and most recently Hot5. The teams of each are co-located in our San Francisco office. In combination with their New York-based colleagues, our new West Coast team brings strong design, product and engineering expertise to our company. Near-term, we are focused on optimizing our current offerings, broadening our stance for the future in both face-to-face meetings and digital and extending our capabilities. Our near-term optimization efforts include, expanding our API program, improving the visitor site and sign-up experience and upgrading our search capability. We're continuing to refine our coaching and Expert Chat platforms, while we look to increase their penetration. In the UK, for example, we are leveraging the expansion of Expert Chat through a strong social marketing campaign that demonstrates the power of providing anytime, anywhere access to our roster of leaders for online members as well as in between meetings for meetings members, members getting a real support from real people who have successfully lost weight and kept it off on the Weight Watchers program. We are working hard on our short-term priorities as well as our strategies for going beyond the scale and returning Weight Watchers to growth. We remain confident in our plan to transform our business. Before I turn it over to Nick, I would like to take a moment and pay respects to our founder Jean Nidetch, who passed away last week at the age of 91. What started as gatherings in our Queens, New York living room became Weight Watchers, the most well-known weight management brand in the world. Jean was a true visionary who inspired millions to live a healthier lifestyle and achieve weight loss success. We remain committed to carrying forth her legacy. Now, I'll turn it over to Nick.

[Nicholas P. Hotchkin:]

Thanks, Jim, and good afternoon, everyone. Before I discuss the results, I would like to note the disclosure in this afternoon's 8-K regarding a pending restatement of our 2014 10-K. To summarize, as a result of conversations with the staff of the Securities and Exchange Commission about a particularly complex and technical hardware accounting literature, we have decided to reclassify how certain 2012 and 2013 franchise acquisitions appear on our balance sheet. Specifically, the balance sheet as of January 3, 2015 will reflect a reduction of $38.9 million of franchise rights acquired and an increase in goodwill of $61.5 million. Previously, these franchise rights acquired were accounted as having an indefinite life; after the correction these rights will have a finite life without giving effect to any renewal rights. The resulting difference in franchise rights will now be reallocated to goodwill. As a result of this reclassification, we have also reversed the $26 million impairment charge to franchise rights acquired, which we took at yearend 2014, because of its difference in methodologies for impairment testing of franchise rights acquired versus goodwill. There is no cash impact related to this reclassification and impairment reversal. We intend to issue restated financial statements prior to the filing of our first quarter 10-Q. Now to review our financial performance for the first quarter. Our Q1 results were in line with the expectations we outlined on our February call, with marginal operating income profitability and an EPS loss. In the quarter, total company revenue declined 16% on a constant currency basis to $322 million and we delivered adjusted operating income of $24 million. The GAAP EPS loss was $0.10. Excluding $0.06 in restructuring costs and a $0.05 gain as a result of our debt tender offer, adjusted EPS loss was $0.09 per share. Turning now to our results by geographic segments. In the first quarter North America revenues declined 21.5% with meeting fees down 18.5% and online revenue down 24.3%, all on a constant currency basis. Meetings paid weeks declined 20.1% and online paid weeks declined 28.7%. On a constant currency basis, in the UK business, first quarter total revenue was down 10.9% with meeting fees down 10.1% and online revenues down 12.7%. Meeting paid weeks declined 12.1% and online paid weeks declined 13.1%. In continental Europe, total revenues declined 3.4%, with online revenue up 1.7% and meeting fees down 8.9%, all on constant currency. Online paid weeks decreased 1% and meeting paid weeks declined 7.1%. Now, to review some additional financial metrics for Q1. We incurred pre-tax restructuring charges of $5.8 million in connection with our previously disclosed plan to restructure our organization and a $4.8 million benefit on the early extinguishment of debt. Now, to the P&L detail, excluding the impact of those adjustments. In the first quarter, gross margin declined 500 basis points on a constant currency basis from the prior year to 49.5%, primarily due to operating cost deleverage. Q1 marketing expense decreased $21.8 million on constant currency to $87.3 million and G&A expenses declined $4.1 million on constant currency to $48.2 million. Our Q1 tax rate was 38%. Our cash balance at quarter-end was $211 million after spending approximately $60 million on our debt tender offer. As discussed on our last call, our plan for 2015 has a focus on cash generation to enable us to pay down our remaining 2016 debt maturity and to invest in the business. We are targeting to end the year with a cash balance of $290 million, in line with our previous $350 million expectation when adjusted for the Q1 debt tender. And now, I'd like to provide our detailed guidance for 2015. I view the year's operating performance as largely unchanged from what we shared in February. For the year, we expect revenue of $1.15 billion, with the strengthening U.S. dollar now driving an approximately $80 million decline versus prior year. Since our last call, our forecast incorporates some softening in the UK and CE markets, partially offset by some marginal improvement in North America. We are maintaining our full year adjusted EPS guidance in a range of $0.40 to $0.70. This EPS guidance now includes an approximately $0.21 negative impact from foreign exchange versus the $0.15 impact in our original guidance, and it also excludes the restructuring costs and the gain associated with our Q1 debt tender. Included in our guidance is our $100 million gross cost savings target for 2015, which is on top of the $150 million gross cost reductions achieved over 2013 and 2014. The 2015 cost initiatives are progressing on plan. Operating expense savings are coming from meeting footprint optimization and field management restructuring, marketing savings from changes in our media mix and lower production costs, and G&A savings primarily from reduced head count, as well as lower professional fees. In total, we anticipate restructuring charges associated with this effort to total approximately $10 million for the year, $5.8 million of which was recorded in the first quarter. Now, for some detail on our volume of metrics. Total paid weeks are expected to be down in the high-teens for Q2 and for the full year, with meetings paid weeks performing better than online. In North America, we anticipate that second quarter and full year revenues will decline by up to 20% on constant currency and Q2 paid weeks will decline in the low-20% range with meetings paid weeks performing better than online. In the UK, we expect revenue for Q2 and the full year to decline in the mid-to-high teens on constant currency. UK Q2 paid weeks are expected to decline in the mid-to-high teens with meetings performing better than online. And for CE, we expect revenues to be down in the mid-to-high single-digit range on constant currency for Q2 and for the full year. CE Q2 paid weeks are expected to be down in the mid-to-high single digits with online performing slightly better than meetings. Now, some detail on expenses, factoring in the cost reduction actions that I have outlined. We expect our gross margin percentage decline in Q2 to be similar to Q1 decline, which reflects the lower volumes as well as the added costs for 24X7 Expert Chat and coaching. We expect full year gross margin rate decline of approximately 450 basis points versus 2014 and this includes around 40 basis points of unfavorable foreign exchange impact. Q2 marketing expenses is expected to be in-line with last year's spend of $46 million and for the full year, marketing expense is anticipated to be approximately $210 million, as we focus our spend on key media that drives recruits. This compares with marketing expense of $262 million in 2014 and approximately $15 million of the year-over-year decrease is driven by foreign exchange. G&A is expected to be in the $200 million range for the full year, split relatively evenly across the quarters and this compares to $234 million in G&A last year approximately $10 million of the year-over-year decrease in G&A is driven by foreign exchange. Below the line for the year, we expect interest expense to be approximately $123 million and our tax rate to be approximately 39%. We now expect CapEx of less than $35 million in 2015, reflecting more focus on tech cost savings, and D&A is expected to be in the $55 million range. Thanks for joining us today. I'll now turn the call back to the operator for questions.

[Operator:]

Ladies and gentlemen, we'll now begin the question-and-answer session. Our first question comes from Jason Anderson from Stifel. Please go ahead with your question.

[Jason P. Anderson:]

Good evening, guys. Just wanted to ask about Humana. You sounded like things are starting off pretty good. I was wondering, could you give us any maybe color on maybe take up rate or I realized it might be early, but are you seeing enrollments or subscriptions happening through Humana?

[James R. Chambers:]

Yeah, Jason. It is early and we are seeing take up and process of on-boarding and getting people going is working smoothly, which as you know is where we made some considerable investments in our technology and processes this year.

[Nicholas P. Hotchkin:]

I think that's right. Launch has gone well, it's great to see both teams working together to drive the business.

[Jason P. Anderson:]

Okay. And then also just – and I know you are very focused on Humana and rightfully so. But thinking as a whole healthcare corporate initiative, even though we are focused there, are you building a pipeline or is there any progress on a pipeline of additional partnerships happening or is there activity there, is that more pushing out into 2016?

[Nicholas P. Hotchkin:]

Yeah. Well, look I think our strategy had been very focused on building the necessary capabilities and expertise to serve this space, and that's why we were so thrilled to answer this partnership with Humana. Now look, we're focused on as we have been growing our strategic accounts business and that is pursuing good growth this year. With regard to the healthcare space, look job one is making the Humana relationship successful and where you saw us in probably in 2014 investing ahead of the curve, you can expect us going forward to be investing in line with further opportunities as they arise. But we remain very confident that there is good demand for Weight Watchers in the healthcare space.

[James R. Chambers:]

And we are in conversations and actively cultivating that pipeline and staying close to the changes in the regulatory environment, which we feel will increasingly put us in a good position to add value to that channel.

[Jason P. Anderson:]

Great. Thanks and f I could squeeze in one more and I might have missed it, my phone cut out. The marketing expense is a bit lower than you had previously guided to, did you say it was mostly FX or is there anything else or did anything push out to later in the year?

[Nicholas P. Hotchkin:]

In Q1, you're absolutely right, Jason. We had guided last time to $95 million, came in at $87 million, yeah, FX was a major piece of that, but some good cost actions by the team to really make every dollar we just spend effective.

[Jason P. Anderson:]

Great. Great, thanks for all that.

[Operator:]

Our next question comes from Meredith Adler from Barclays. Please go ahead with your question.

[Meredith Adler:]

Yeah. Thank you very much. I know this is a business that really gets its big energy towards the end of the year, but are you expecting any kind of improvement based on the things you're doing right now between now and the end of the year? I think you said that you thought that North America would get a bit better, but I'm a little concerned that you have a whole new program, but it's not actually going to come out till the 2016 and then you got to wait and see how people respond to it? Is that a question?

[Nicholas P. Hotchkin:]

Yeah. Meredith, thanks – yeah, look, your perspective on North America is right, our initial guidance was full year revenue to decline in the low 20% range, now it's up to 20%, so some marginal improvement there, but it's just marginal improvement, because really as we look across our markets, our overall demand profile is what we thought it would be when we talked to you all at the end of February. That doesn't mean to say we're not – we're doing some very good things, starting with the promotion activity that Jim mentioned and running into a spring campaign to drive every recruit we can, but a view of the top line is essentially pretty much how we're performing currently. Our guidance doesn't really bake in much improvement as we go through the year.

[James R. Chambers:]

Meredith, with respect to the end of the year, as you know, we do take advantage of the natural consumer tailwind when we can get it, but to stress that our combination for this upcoming season includes a meaningful program innovation as well as clarity around the positioning that we will market against, and that has been a historical success formula for Weight Watchers and it represents a considerable amount of work and that's what we are focused on, making that a success for January.

[Meredith Adler:]

That's fair. And then I have another question. In part of your marketing efforts, are you doing anything uniquely for different kinds of customers? I think, Jim, you once talked about flavors and I'm wondering whether that's something that would be helpful if you were talking more particularly to the individual groups of people?

[James R. Chambers:]

Yes. I think our flavors program was central to most of the international markets as they launched this past January. And while I think it did build equity for exactly the reasons you're referencing, it is a more customized approach allowing people to eat particular ways according to their preference more easily on our program. It wasn't enough on its own to offset the recruiting challenges. Further, I think as we go forward and with respect to what we're going to do for the next winter season as well, you will see us increasingly presenting customized and customizable options for consumers as we broaden the program and understand that they see things differently, particularly as we look towards fitness where the range of activities that consumers would classify as fitness range from closer in to our consumers in terms of more activity and motion and then all the way out through significant intensive athletic activity which is the other end of the spectrum. So, by its nature, that brings us down a bit of a more personalized or customized route. So that continues to be a dimension of the strategy. It did resonate in our European markets when we launched it this year in the form of flavors, which was food personalization.

[Meredith Adler:]

I do have one other question. I'm assuming that some of the people you partner with and who pay you licensing revenues are aware of the fact that your membership has been declining. Has there been any discussion about wanting to renegotiate or pull out of some of those licensing agreements?

[James R. Chambers:]

I don't think we would share details of specific negotiations and relationships with our partners. I think we consider these to be strategic relationships and we consider them to be invested in our turnaround plans as well and work with them accordingly.

[Nicholas P. Hotchkin:]

Yes, and look, a lot of our licensee partners who have been with us for many years, so they've seen the business go through cycles and they know that we're very focused on renewing the brand and returning to growth.

[Meredith Adler:]

Okay. That's fair. Thank you very much for answering my questions.

[James R. Chambers:]

Thanks, Meredith.

[Operator:]

Our next question comes from R.J. Hottovy from Morningstar. Please go ahead with your question.

[R.J. Hottovy:]

Yes. Thanks and good afternoon. I had a two-parter question about some of the new offering and pricing tiers that you put in place earlier in the year. Jim, with some of the discussion about increased promotional activity, have you had any thought about where pricing currently stands with the different tiers and any potential changes or are you pretty comfortable with the pricing where that's at? Second question is, if we could get an update on the level of engagement with the Personal Coaching. I believe you said it was 3% on the last call as well as how consumers have adopted the 24/7 Chat and just what kind of levels of engagement you're seeing on that end. Thanks.

[James R. Chambers:]

Sure. With respect to pricing, I think, in the framing of your question, we are experimenting with a number of things. I would see them all as contributing to our work around our value proposition, pricing and promotion, the ability to add value to our products and then finally how we experience the product, some would consider it a freemium model. There's a line between what might be sampled and what might be paid. And we have significantly more testing and experimentation going on in this arena than we have had in the past, but too early to tell exactly what the implications of that might be. With respect to Personal Coaching, the penetration of that remains low and we are focused on increasing that. The satisfaction with Personal Coaching remains high. We see it as a significant strategic opportunity for us as we did when we announced its launch to bring the power of our leaders to members in a digital environment, and we will continue to experiment and continue to push the penetration of this product as we go forward.

[Nicholas P. Hotchkin:]

Yes. If I could just add to what Jim said on pricing. Absolutely right, kind of the focus on focused promotions and offers is a deliberate strategy and you can see in the 10 Lbs On Us example. We're pleased with that innovation. We'd like to stress, though, when you look at our pricing approach holistically, while we are promoting more this year, of course, it's in the context of it being a very high-margin business where the value of an incremental recruit is substantial to us. And also recall that at the start of the year, we increased our pricing headroom with price increases. So net-net, we're actually experiencing better price realization in the first quarter versus same period last year when you look at those two impacts together.

[R.J. Hottovy:]

Thanks. I did have one quick follow-up question. With remarks about the consumers taking a more holistic approach to weight management and overall wellness, I wanted to see if we could get an update on the entire API launch, the partnerships that you have out there. What kind of adoption rates you've seen from your customers on that end, and how that may play into the winter 2016 plan? I mean it's probably pretty early to tell, but just any indications or any sense of how that's going would be helpful? Thanks.

[James R. Chambers:]

Yes. As you set it up, I think it's a good indication of the potential of the more holistic strategy. We have on the order of 0.5 million connected members at this point with fitness devices and the penetration has been good and the affinity is natural. And I think we see more opportunity there in the future as we go forward to not just to connect on a tools basis but further integrate fitness into our program thinking.

[Operator:]

Our next question comes from John Faucher from JPMorgan.

[John A. Faucher:]

Thank you. I know you guys talked a little bit about the pricing, but can you talk a little bit about the whole 10 Lbs campaign and you said it had some impact but wasn't sustained. Is this something where you need to keep the promotional levels higher as you go through the year? Is that something you can run more consistently I guess? And then one housekeeping item, can you just give me a repeat of the gross margin guidance? I just want to make sure I nailed that? Thanks.

[James R. Chambers:]

I'll take the first one. Yes. I think we have more headroom in this business around intelligent promotion. Versus other businesses I've been in, our promotions are very profitable. And I think when we look back to 10 Lbs On Us, I think as we're continuing to do the analysis here, I think we will see that there were value effects to that and that there were also behavioral encouragement effects to that that reduced the barriers for people to consider starting the program. And I think that's why we'll see it as being successful and we are pushing it into other markets, as we speak. We won't talk about specific plans beyond that from a commercial perspective, but I think it represents a foundation for us to expand throughout the year.

[Nicholas P. Hotchkin:]

Yes. And John, on the gross margin, in the first quarter, gross margin declined on a constant currency basis 500 basis points. And we expect Q2's decline to be similar to Q1, primarily lower volume driven, and for the full year gross margin rate decline of approximately 450 basis points.

[John A. Faucher:]

Okay. Great. Thank you.

[Operator:]

And ladies and gentlemen, we've reached the end of today's allotted time for the question-and-answer session and today's conference has now concluded. We do thank you for attending today's presentation. You may now disconnect your telephone lines.