WW International, Inc.
Q3 2015 Earnings Call Transcript

Published: 6 Nov 2015

[Operator:]

Good afternoon, and welcome to the Weight Watchers Third Quarter 2015 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, this event is being recorded. I would now like to turn the conference over to Corey Kinger, Investor Relations. Please go ahead.

[Corey Kinger:]

Thank you to everyone for joining us today for Weight Watchers International's third 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:]

Thank you, Corey. Good afternoon, everyone, and thank you for joining us. My remarks today will cover three topics. First, as Nick will discuss, with cost performance ahead of our expectations, we delivered adjusted earnings per share of $0.39 for the quarter. Second, the December launch of our comprehensive program innovation is fast-approaching. We have been working on key aspects of this launch for over a year, and we are confident it will be a major driver of our company's return to recruitment growth. And third, after the close of the quarter, on October 19, we announced a groundbreaking partnership with Oprah Winfrey. We could not be more excited about the opportunities presented by this wide-ranging and long-term relationship and what this will do to accelerate our company transformation. So let me start by addressing the market-facing impact of our partnership with Oprah. In a few minutes, Nick will provide some color on the financial terms of the relationship. Oprah Winfrey is not only a highly respected and influential public figure, but also an extraordinary human being. Our entire company is proud to have this opportunity to partner with her, and our common view of the future is compelling. I've been personally touched by her candor about her own weight loss journey and her strong belief in our mission, and believe that both current and prospective members will be equally inspired to join her in a journey to living healthier, happier lives. Oprah has a remarkable ability to connect with people and inspire them to realize their full potential, which is uniquely complementary to our powerful community, extraordinary coaches and proven program. Oprah's role with Weight Watchers will be multi-faceted. As a member, over this coming year and beyond, she will candidly share her experiences through a variety of means, including an action plan where she will invite prospective members to come join her. As a board member and adviser, she will bring insight and strategy to program development and execution that reflects not only her own experiences as a member, but also her unique ability to inspire and connect people to live their best lives. As an owner, she is invested in our growth and success. As she recently commented, "This was a personal decision that allowed me to make a smart business decision. I always lead with my heart, because the truth is, my heart is my brand." This is a long-term strategic relationship. We are excited about the opportunities it presents on many levels, and while we are not discussing our detailed execution plans today, Oprah will be part of the upcoming winter season marketing effort, inviting prospective members to join her on her journey. The response to this partnership announcement has been terrific. The general press has taken a great interest in the news, and we have seen significant improvement in visitors to our website, which has translated into a strong response in the business, albeit during a seasonally low period. Turning now to our third quarter performance. Revenue was $273 million, adjusted operating income came in at $64 million, and adjusted earnings per share was $0.39. End of period global active subscribers declined 13% year-over-year to 2.6 million active subscribers, with 1.5 million active subscribers online and 1.1 million active subscribers in meetings. Q3 member recruitment trends, while still negative overall, were in line with our expectations and continued to reflect improvement versus what we experienced early in the year. In addition to repeating our successful Lose 10 Lbs On Us! promotional campaign in the U.S., we introduced local versions in certain international markets with positive results. As you've heard me say before, our technology transformation is a vital part of our overall company transformation, and we continue to make solid progress on this front. As we maintain our laser focus to be well-prepared for winter season, I am pleased to report the majority of our consumer-facing functionality will be operating on our new platform by launch. The innovation that we will be launching, both in meetings and online, in all our major markets, has been built on strong consumer insights. Today's consumers want more than diet and restriction. They want a more holistic and personalized solution, integrating healthier eating, fitness and emotional wellbeing. Based on the feedback from the thousands of test participants who have been on the new program, we believe we have developed a program that consumers will love, a program that meets them where they are and one that will make a difference in their lives. And now, I will turn it over to Nick.

[Nicholas P. Hotchkin:]

Thanks, Jim, and good afternoon, everyone. First, to recap some details of our recently announced long-term partnership with Oprah Winfrey; as Jim mentioned, Ms. Winfrey invested $43.2 million to purchase 6.4 million shares of Weight Watchers common stock in a private placement offering. In addition, in conjunction with this strategic collaboration agreement, she received 3.5 million vested stock options. Consistent with our shared commitment to a long-term partnership, her liquidity rights will phase-in over the next five years. Following the transaction, Artal owns 46.3% of Weight Watchers total shares outstanding or 41.9% on a fully diluted basis, assuming all outstanding stock awards vest and are exercised. Artal and Winfrey have entered into a voting agreement, where together, they control 56% on a fully diluted basis, assuming all stock-based awards vest and are exercised. Turning to our Q3 results. In Q3, total company revenue declined 15.6% on a constant currency basis to $273.3 million, and we delivered adjusted operating income of $64.2 million. GAAP EPS was $0.38, and excluding restructuring costs of $0.01 per share, adjusted EPS was $0.39. This was prior; Q3 included a $0.07 per share unfavorable foreign exchange impact. And while still negative, Q3 recruitment trends continued to show stability and were in line with our expectations, and our EPS was better than expected due to continued good cost management by the entire team. The stabilization in our recruitment performance and continued solid member retention are reflected in our year-to-date global paid weeks' trends. In Q3, year-over-year global paid weeks declined 15.7%, an improvement from declines of 17.6% in Q2 and 18.9% in Q1. In Q3, we saw a sequential improvement from Q2 in our paid weeks' trends in our major geographies. In the third quarter, total North America revenues declined 17.9%, with meeting fees down 18.1% and online revenue down 16.4%, all on a constant currency basis. Meetings paid weeks declined 17.6% and online paid weeks declined 19.5%. On a constant currency basis in the U.K., third quarter total revenue was down 14.8%, with meeting fees down 13.4% and online revenues down 14.5%. Meetings paid weeks declined 12.4% and online paid weeks declined 15.3%. In Continental Europe, total revenues declined 8%, with meeting fees down 10.4% and online revenues down 6.8%, all on constant currency. Meetings paid weeks declined 9.1% and online paid weeks decreased 7.4%. Now to the P&L detail, on an adjusted basis. In the third quarter, gross margin was 50%, representing a decline from the prior year of nearly 400 basis points on a constant currency basis. Our marketing spend was $27.2 million, declining $7.7 million on constant currency, as we continued to focus our spend on key media that drives recruits and to lower our non-working media costs. G&A expenses were $45.2 million, a decline of $10.9 million on constant currency, as we continued to exercise stringent cost discipline across the organization. Our GAAP Q3 tax rate was 33.1%. And now I'd like to provide our updated outlook for 2015, all on a constant currency basis. In North America, we anticipate that full year revenues and total paid weeks will decline in the 20% range. In the U.K., we expect revenue and total paid weeks for the full year to decline in the mid-teens, and for CE we expect revenues and total paid weeks to be down in the mid to high single-digit range for the year. Total global paid weeks are expected to be down in the mid to high teens for the full year. We now expect full year 2015 revenue of roughly $1.16 billion, with foreign exchange accounting for an approximately $75 million decline versus prior year. We expect a full year gross margin rate decline of up to 525 basis points versus 2014, which is primarily driven by our lower volumes. This includes around 30 basis points of unfavorable foreign exchange impact. Full year marketing expense is anticipated to be approximately $200 million, down by about $60 million from 2014, and approximately $15 million of the year-over-year decrease is driven by foreign exchange. We expect G&A to be approximately $185 million for the full year, down from $234 million last year, and approximately $10 million of the year-over-year decrease is driven by foreign exchange. Our cost-savings initiatives are progressing well, and this guidance reflects us modestly exceeding the $100 million gross cost savings target for 2015 on a constant currency basis that we announced in February. Below the line for the year, we expect interest expense to be approximately $122 million and our tax rate to be approximately 38.5%. We continue to expect CapEx of less than $35 million in 2015, reflecting our focus on tech cost savings. And D&A is expected to be in the $55 million range. With the positive response to our partnership with Ms. Winfrey that we have seen to date, combined with our upcoming program launch in December, it is now likely that global recruitments will be positive in the fourth quarter. Recall that Q4 is our seasonally lowest volume quarter, but includes costs associated with our program launch. And in anticipation of an even stronger response to our December program roll-out, we are selectively adding expenses to further support key launch and delivery areas, such as call center and training. We are also increasing marketing weights in the last week of December. These added costs will more than offset the impact of the positive fourth quarter recruitments, as most of the revenue benefits from Q4 recruits will fall into 2016. And these assumptions and added expenses are reflected in our guidance provided today. And as a result, we are increasing our full year 2015 adjusted EPS guidance to a range of $0.64 to $0.74. Note that we have previously assumed a share count of 57.2 million for the purposes of calculating full year EPS, but following the private placement, we now anticipate a weighted share count of 59 million. This higher share count results in a $0.02 EPS negative impact for the year, which is included in our guidance. Our 2015 EPS guidance also includes an approximately $0.19 negative impact from foreign exchange versus prior year. Note that the 2015 full year adjusted EPS guidance excludes one-time transaction expenses associated with the entering of the partnership with Oprah Winfrey, the impact will be approximately $12.8 million or $0.14 per share stock option expense for the 3.5 million share option grant, $0.11 per share in restructuring costs, and the $0.12 per share in gains associated with our debt tenders. Now, I'd like to update you on our balance sheet and capital structure. Our company has strong liquidity and demonstrates good cash generation, even at these lower revenue levels. At quarter-end, our cash balance was $212 million and did not include the $43 million received from Oprah Winfrey's investment in Weight Watchers. We expect to end the year with a cash balance in the range of $275 million. Moving to our debt. Recall that we started the year with $300 million due on our B-1 tranche in April 2016. Following the completion of two debt tender offers earlier this year, we now have a remaining balance of $144 million, which we plan to repay in cash upon maturity. In addition, we have a $2 billion B-2 tranche, which is not due until 2020. Given our high margins and improved cost structure, recruitment growth translates into substantial incremental cash generation, and reducing leverage remains our capital structure priority. You will recall that we have no financial leverage covenants on any of our debt, minimal amortization, and we also have the right to prepay before maturity. Now, while we are not giving any 2016 volume or EPS guidance today, I'd like to take a minute to walk you through some of our current thinking for next year to assist you with your modeling. Despite the improved trends, overall recruitment in 2015 is negative. Therefore, we will begin 2016 with a lower starting actives base. We estimate this will drive a negative impact of approximately $35 million in revenue and $0.25 of EPS versus prior year, which disproportionately impacts our first quarter. Note that this impact is independent of any 2016 recruitment assumptions. It's just a quantification of the starting point to assist you with your modeling. In addition, note that we also have a higher share count for 2016 versus 2015 due to the partnership with Ms. Winfrey. We will continue to manage our marketing spend dynamically as we move through the year and at this time, we expect that our Q1 2016 marketing spend will be comparable to 2015 levels. As we return to recruitment growth, we will continue to keep a tight lid on our overall cost structure so that we benefit from the operating leverage inherent in our business model. We do not expect 2016 CapEx to be materially higher than 2015. In summary, we are very confident that our program innovation and strong marketing will drive recruitment growth throughout 2016, and as usual, we plan to provide you with our full financial guidance for 2016 on our fourth quarter earnings call. Now, I will turn it back to Jim.

[James R. Chambers:]

Thanks, Nick. The third quarter results reported today reflect a backward look at where we have been in recent years, but not where I believe we are going. We are all aware of the fact that obesity is a major problem in the U.S. and growing globally. We also know that consumers want to do something about it. They want to lose weight and are actively trying to do so. However, in the face of this significant consumer demand, Weight Watchers and commercial plans in general still have low market penetration. Weight Watchers is the leading commercial weight loss plan. Weight Watchers is a plan that works. It is science-based, proven in a multitude of clinical studies and enjoys a strong brand position in consumers' minds rooted in efficacy and trust. This has never changed. Yet, despite this large unmet need and our leading brand position, we have struggled to attract members in recent years. Why? What has changed? Over the last few years, as the world appified and activity monitors experienced significant increases in penetration, our competitive frame shifted dramatically and we were competing for consumer attention with new competitors in a new ways. In 2013, we embarked on a multiyear transformation plan confident that we could address these challenges and turn the company around. Our transformation plan focused on reshaping our company to be consumer-driven, enhancing our insights capabilities and improving how they translate into better marketing and winning product offerings, including targeting ways to leverage our field service provider team, a competitive advantage of tens of thousands of dedicated successful role models who have lost weight on Weight Watchers and kept it off. And we committed ourselves to turn our technology environment from what was a legacy challenge into an enabling asset. As we engaged with our new external realities, we realized three critical things. First, while activity monitors did initially crowd out consumer trial, over time, they are, in the consumers' eyes and behavior patterns, in fact complementary to their weight loss efforts, not a stand along solution. Belatedly, we opened up our technology environment and added the capability for our members to easily integrate any leading device to their Weight Watchers experience. In fact, penetration of activity monitors amongst the Weight Watchers member base is significantly higher than that of the population at large. Second, free apps, on the other hand, are directly competitive, but are they effective? The weight loss category has a history of free alternatives, generating massive waves of trial, only to be judged in retrospect by whether or not they solved the consumer's problem. Here, while undoubtedly more work will be done in the future, a recent independent study assessing the efficacy of the leading free weight loss app published in the Annals of Internal Medicine found no significant change in body weight over six months. Third, and most importantly, while consumers are deeply interested in weight loss, their mindset has changed. They want to get there in new ways. Less attractive is the approach of dieting and restriction. Rather, they are seeking solutions that reflect a more holistic integration of healthy food choices, relevant fitness activity and the right degree of personalization. We have responded to this consumer reality, developing what is perhaps the most significant program innovation in our company's history. Our new product strategy reflects this more holistic mindset as we expand our purpose from weight loss alone to more broadly helping people lead healthier, happier lives. With our launch next month, we will be unveiling a whole new Weight Watchers. Historically, in addition to attracting new members, major program innovations have reignited our former member base. We believe our new innovation will resonate strongly with them. With 20 million former members in North America alone, many of whom have a high regard and affinity for our services and our brand, it only takes a small percentage to return to make a meaningful impact on our current active base of 1.6 million. And now we have a partnership with Oprah Winfrey. Oprah will bring new magic to this great company. She will inspire consumers and improve our ability to create strong brand experiences for their individual journeys. I have every confidence that this will accelerate our company transformation and will have a significant positive impact on millions and millions of lives over the coming years. Let me finish by thanking the entire Weight Watchers team around the globe for their continued efforts on our transformation plan, and in particular, their efforts in preparation for this winter season. Thanks for joining us today, and I'll now turn the call to the operator for Q&A.

[Operator:]

We will now begin the question-and-answer session. Our first question comes from Alex Fuhrman of Craig-Hallum Group. Please go ahead.

[Alex Joseph Fuhrman:]

Great. Thanks for taking my questions and congratulations, a lot of exciting developments here. One thing I really wanted to touch in here is your plan for marketing expense. Obviously, with Oprah joining into a strategic partnership here, it seems like there is an incredible opportunity to market with her. How much of the – as you think about your marketing expense being more or less flat in Q1, how much should we think about that marketing expense being geared towards communicating changes around the new program launch you have? I'm curious to, what kind of a marketing trend you would typically see in a year when you launch a program change versus perhaps, you're maybe willing to put more marketing dollars into your campaign for this diet season knowing that maybe you're going to get a better bang for your buck having Oprah on board? Just trying to understand, kind of where that's coming from, from those two buckets.

[James R. Chambers:]

Hi, Alex. It's Jim. Thanks for the question. Yeah, we're – to start where you started, we're super excited, obviously, and Oprah will play a role in our upcoming marketing efforts. Without giving away too much commercially sensitive information, I would say that we do have a couple of strong messages to put to the market this year. One is around the program and what is new about it and what it brings and the promise for consumers. And the other is Oprah and her invitation for folks to join her. The only other thing I'll add is I think we have plenty of ammunition in Q1, and I think our marketing is going to be very effective, strengthened by the fact that we have both of those messages and two strong ways to talk to them.

[Nicholas P. Hotchkin:]

The only thing I'd add to that is, as we've seen in addition to our own marketing efforts, buzz and word of mouth can be such a powerful tool for this brand, and we're very confident with having such wonderful news. That can certainly play a major role in our 2016 efforts also.

[Alex Joseph Fuhrman:]

Great. That's helpful. Thanks. And then, it sounds like there is a lot of optimism about your ability to perhaps get back to positive recruitment growth in Q4 or next year. It doesn't seem like that's reflected certainly in the price of your debt. What is the thinking? I mean, you mentioned that with the growth in recruitment you could have a really strong generation of free cash flow here. I mean, is there thought towards maybe being proactive and pre-paying some of the B2s, while they still remain cheap? Or are you going to kind of allow some cash to accumulate on the balance sheet after you get through the B1 repayment and then kind of reassess things this time next year?

[Nicholas P. Hotchkin:]

Well, thanks for that. Look, it's a great question and we are thrilled to guide that we'll be returning to, more than likely, returning to positive recruitment growth in Q4. And we expect to have positive recruitment throughout 2016. We've got the same high margin business model we've always had, and we've taken a lot of costs out of this company. So as we return to recruitment growth, we throw off a lot of cash. And we look forward to using it.

[Alex Joseph Fuhrman:]

Great. That's really helpful. I look forward to seeing the new changes in a few months.

[Operator:]

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

[R.J. Hottovy:]

Thanks. First question I had was with respect to investment, and particularly, the healthcare and the tech investments you guys have been making. Nick, I appreciate you probably don't want to give away your 2016 CapEx guidance for the year or even just the investment spending, but just kind of maybe give us a little bit of color where you stand on the technology and the healthcare investments as we look into the 2016 and potentially beyond that?

[Nicholas P. Hotchkin:]

Yeah. No, thanks, R.J. Look, I mean throughout this transformation we've had stringent cost controls, but we've invested where we've needed to, to build for our future. So when you look at what's been driving our historically high CapEx, the tech transformation and our retail reinvention, our footprint reinvention are behind this. So in 2016, we'll continue to invest in the business for growth, but we don't expect 2016 CapEx to be materially higher than the $35 million or so we're guiding to for 2015.

[R.J. Hottovy:]

Thanks. Also had a product-related question; as I was playing around with the Weight Watchers sales website earlier this weekend, I noticed that there was a – at least for a few days ago, there was a test for at-home pre-portioned meals in a partnership that looks like with Chef'd, and I just kind of wanted to get your sense on what that might be going forward? And kind of your plans for at-home pre-portioned meals and the opportunity that, that partnership might open up?

[James R. Chambers:]

Hi, R.J. It's Jim. I think this is first and foremost a reflection of the amount of innovation and the work we are doing to understand how best to serve our consumers and our members across a broad range of activities. It is real early days for the partnership that you referenced, but the idea here is to provide convenience oriented healthy food choices, again, consistent with the direction we're heading in, in ways for consumers that they know this is going to fit their point budget for the day. So that's the idea. Again, early days. And it's way too early to kind of predict how far and in what way we'll take that forward.

[R.J. Hottovy:]

Thanks.

[Operator:]

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