WW International, Inc.
Q4 2015 Earnings Call Transcript

Published: 26 Feb 2016

[Operator:]

Good afternoon and welcome to the Weight Watchers Fourth Quarter and Full Year 2015 Earnings Call. All participants will be in a listen-only mode. 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, Amy, and thank you to everyone for joining us today for Weight Watchers International's fourth quarter and full year 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. I'm very pleased to say that our transformation is building momentum and delivering on our core objective of driving recruitment growth. We have introduced a new Weight Watchers through our Beyond the Scale program and it is resonating with consumers. Furthermore, our partnership with Oprah Winfrey is off to a strong start and her involvement has already contributed to renewed interest in our brand. While we have more work to do, we are highly confident in our direction and pleased by our improving performance. My remarks today will focus on three areas. First, our business performance where in the fourth quarter our business fundamentals strengthened. Second, we'll assess our winter season which started with the launch of our holistic Beyond the Scale program including the rollout of our new SmartPoints food plan and introduced Oprah Winfrey as a partner in our marketing and member engagement activities. And third, following Nick's discussion of our financial performance, I will outline our path forward including our focus areas for 2016. Starting with our 2015 performance, for the full year, revenue was $1.16 billion, adjusted operating income came in at $190 million, and adjusted earnings per share was $0.67. We ended the year with 2.4 million global active members with 1.4 million online and 1.0 million in meetings. Since the very slow start we experienced in January of 2015, we have seen positive improvements in our recruitment trends. In fact, in Q4 for the first time since 2011 we had positive year-over-year global recruitments on a like-for-like week's basis led by particular strength in North America. Through 2015 we reduced our gross annualized expenses by $250 million versus our 2012 cost base. We have fundamentally changed the cost culture of the company so now as we return to growth we have enhanced operating leverage. Entering winter season we were confident that our partnership with Oprah Winfrey would accelerate our transformation by amplifying the impact of our new Beyond the Scale program launch. Since the launch, both meetings and online recruitments have been growing with strong contributions from both rejoining as well as new members. Particularly gratifying is the strong double-digit recruitment growth in our North America meetings business. Since our new program launch, our best performing markets are the U.S., Canada, the UK and Australia. The performance of Continental Europe is not quite as strong but our teams are quickly adjusting our advertising and promotional strategies to improve further the results there. Now let's take a closer look at our new Beyond the Scale program. In early December we launched Beyond the Scale globally. Beyond the Scale represents a new core program for Weight Watchers and takes a more holistic approach in line with consumers' mindsets. Key themes of Beyond the Scale include, first, losing weight while at the same time making healthier eating simple. Our new SmartPoints food plan delivers weight loss while using the latest nutritional science to go beyond counting calories. While everything is still on the menu, SmartPoints takes our strongest stance ever on eating healthier foods by nudging members toward a pattern of eating that includes more lean protein, fruits and vegetables and less sugar and saturated fat. Members tell us they are having great weight loss success on the program and satisfaction levels are high. We believe following the SmartPoints food plan is highly differentiated from generic calorie counting. The second theme is moving more with fitness that fits your life. Our new fitness approach offers a personalized FitPoints activity goal, whether members want to get active and don't know where to start or are ready to take it to the next level. In addition, to help guide members on a variety of simple ways to turn everyday down-time into up-time, we introduced a new free standalone app, FitBreak, which offers a series of easy routines to stay active. And third, personalizing Weight Watchers for you. We're encouraging members to define their own success, create their own goals, take the time to appreciate themselves and celebrate their weight loss, as well as non-scale victories, along their individual journeys. Based on a personal assessment, members receive customized daily and weekly SmartPoints targets and can set their own activity goals. With content designed to help find and fuel inner strength, we are focused on giving members the motivation to stay inspired and the positive energy to keep going. In addition, this winter season as part of our improved digital experience we launched Connect, a new social platform embedded in our mobile app that brings the support and magic of the Weight Watchers community to members anytime, any place. Connect is a safe, trusted place where members share their stories, inspire and encourage each other, and share tips and hacks for getting the most out of the Weight Watchers experience. It is simple and engaging and has experienced high penetration among our mobile member community since its launch and has generated nearly 1 million posts in less than 2.5 months. In support of our new program launch, our winter season advertising campaign kicked off with Oprah telling the world, in her words, why she joined Weight Watchers and inviting others to join her on her journey. This direct and emotional appeal resonated strongly with members and non-members alike and grabbed significant media attention. We augmented Oprah's message with separate ads focused on the new Beyond the Scale program and SmartPoints to begin to build awareness of our new program. And to drive urgency during the peak winter season, we paired this creative with compelling offers including our popular Lose 10 Lbs On Us! promotion. In addition to having appeared in commercials, Oprah has posted updates and anecdotes about her journey on social media, including on the Connect feature of the Weight Watchers mobile app. And she recently hosted a conference call with Weight Watchers members about shared member experiences. More than 40,000 members participated live and nearly double that listened in via replay. The response to Oprah's participation in the member community has been overwhelmingly positive. During 2015 we made significant progress on our technology transformation enabling us to launch our new program globally and laying a foundation for an increasingly tailored experience. We rebuilt our consumer facing website and mobile platforms on new technologies, largely replacing our legacy.com infrastructure with open-source cloud-based technology. In addition, we implemented a new agile approach to product development which will allow us to shorten our innovation cycle. These changes are enabling us to reduce our cash spend rate on technology, ending 2015 at a run rate of around $70 million after having spent approximately $85 million and $115 million in 2015 and 2014 respectively. While we did have a few technical difficulties with our website and apps around the time of the launch related to the upgrading of our tech infrastructure, these issues were resolved by mid-December. And now I will turn it over to Nick for a review of our financial performance.

[Nicholas P. Hotchkin:]

Thanks, Jim, and good afternoon, everyone. As a reminder, our 2014 results included an extra week that impacts year-over-year comparability. While this impact is not carved out of our reported results, when I speak to recruitment trends in the fourth quarter of 2015, I am referring to trends on a comparable like-for-like weeks basis. Let me start by highlighting a few key items in our Q4 financial performance. Global member recruitment was positive in the fourth quarter driven by the great response to our partnership with Ms. Winfrey and the December launch of Beyond the Scale. This dramatically improved the year-over-year End of Period Active Base, with Q4 ending down 4.8% versus prior as compared to the 12.7% decline we reported in Q3 2015. Q4 is our smallest quarter, so while the revenue benefits from the recruitment's improvements are not meaningful in terms of our 2015 results, they do improve our 2016 starting point. Specifically, where we previously thought we would have a $35 million revenue headwind going into 2016, our Q4 performance reduced this to $20 million. In addition, in Q4 we incurred added expenses in preparation for the Q4 program launch and marketing campaigns. These items, as well as higher than anticipated tax reserves, resulted in an adjusted EPS of negative $0.03 in the fourth quarter. Absent the one-time tax adjustment impact of $0.04 per share and the negative FX impact of $0.02 per share, we would've generated a profit in Q4. For the full year, total company revenue declined 16.3% on a constant currency basis to $1.16 billion driven by lower Meetings and Online paid weeks compared to the prior year. Given the upgrading deleverage pressures indicated by gross margin decline of 480 basis points on an adjusted constant currency basis for the year, we focused hard on cost and we achieved our $100 million gross annual cost savings target with expenses coming out across cost of sales, marketing and G&A. G&A spend decreased to $185 million, a level not seen since 2010. On an adjusted basis, EPS was $0.67 for the full year. This excludes the $0.14 per share total impact related to the share option grant to Ms. Winfrey, as well as related transaction cost, $0.09 per share in restructuring costs and $0.12 per share in gains associated with our 2015 debt tenders where we prepaid a portion of our B1 term loan at a 9% discount. Our adjusted EPS includes an approximately $0.19 negative impact from FX versus the prior year. We ended 2015 with a cash position of $242 million. This was about $30 million lower than anticipated with approximately half of the shortfall related to a delay in the receipt of an international withholding tax and the bulk of the remainder due to temporary changes in the working capital timing which unwound in the first quarter. Turning to our capital structure, using cash on hand, we will repay the $144 million B1 term loan due in April. As a reminder, we also have a $2 billion B2 term loan, 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 covenant on any of our debt. And now I'd like to provide our outlook for 2016. We are having a strong start to 2016. Due to positive recruitment and stable retention, we expect full year 2016 revenue to be up in the low single digits. This revenue guidance incorporates the drag from two headwinds to the business. First, we entered this year with a lower starting active base, which will have a negative impact of approximately $20 million in revenue and $0.14 of EPS versus 2015 and which disproportionately affects our first quarter. Second, based on current foreign exchange rates and the strong U.S. dollar, we expect to have a further negative FX revenue impact of about $16 million for 2016 versus 2015. For 2016, we expect full year adjusted EPS to be in the range of $0.70 to $1. This EPS guidance includes an approximately $0.02 negative impact from unfavorable year-over-year foreign exchange, and as a reminder, the investment by Oprah Winfrey and related option grant increased our fully diluted share count for 2016. This higher share count creates an approximately $0.12 drag on full year EPS. While our trends in Q1 to date are strong, we anticipate reporting an EPS loss in the first quarter in the range of negative $0.20. Recall that the negative EPS impact of $0.14 from the lower starting active base is primarily in Q1 and in addition, Q1 absorbs the brunt of marketing and other winter season expenses. In the remainder of my comments, I will speak to the midpoint of our full-year guidance range and on a constant currency basis. We ended the year at 2.4 million active members. Based on strong recruitment growth and steady retention, our guidance assumes we grow our active base in 2016 allowing us to enter 2017 with a revenue tailwind for the first time since 2012. To illustrate, if we were to end 2016 with mid single-digits growth in our active base, that would translate into a $30 million revenue tailwind, and a $0.19 EPS benefit in 2017. Total global paid weeks are expected to be up in the low single-digits in Q1, and be up in the mid single-digits for the full year 2016. In North America, we anticipate that Q1 revenues will be flat, and for the full year revenue is expected to be up in the high single-digits. In the UK, we expect revenue for Q1 2016 to be down in the low double-digits. We expect recruitment trends to improve over the year, and as a result, we anticipate revenue for the full year to be down in the low single-digits. And for Continental Europe, we expect Q1 revenue to be down in the low double-digits, and down in the low single digits-for the full year 2016. Now some detail on expenses. We expect our gross margin to be down approximately 150 basis points in Q1, due to changes in mix, and shifts in the promotional calendar. For the full year, we expect gross margin to be up about 100 basis points versus 2015. We expect Q1 marketing spend will be approximately $90 million, and the full year marketing expense will be roughly flat year-over-year as a percent of revenue. 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 expect G&A for the year to be flat, versus prior, on a percent of sales basis. Below the line for the year, we expect interest expense to be approximately $115 million, and our tax rate to be about 39%. We expect CapEx, primarily driven by tax spend and capitalized software, to be in line with prior-year levels in the $35 million range, and G&A in the $55 million range. Generating cash to reduce leverage is our clear capital structure priority. In addition, uses of cash could also include select tuck-in acquisitions. In summary, the work we have done is now bearing fruits in our business performance. We will continue to build on our revenue growth trajectory while maintaining cost discipline. Now, I'll turn it back to Jim.

[James R. Chambers:]

Thanks, Nick. We're excited about the progress we have made in transforming Weight Watchers. We have more to do and many more opportunities ahead of us. But we believe in 2016 we will deliver on our primary objective of reversing four years of annual decline and returning the company to full year recruitment and revenue growth. We have leveraged our insight's capabilities to launch the Beyond The Scale program and an associated improved service experience for both our digital and meeting room products. We have the opportunity to increase the awareness of Beyond the Scale and SmartPoints, as currently in the U.S., three out of five lapsed members and four out of five never members have yet to be made aware that Weight Watchers has a new program. In addition, we have the opportunity to increase the penetration and consistency of our meetings experience enhancements. Our technology environment is running at lower cost with higher capability, and improvements to our agile innovation model reflect our strategy to deliver continuous innovation validated through consumer exposure. We are continuing our strong partnership with Humana and while not a near-term revenue growth driver at a company level, we continue to see longer-term potential in the Health Solutions business. We are excited about a study published last week by Indiana University, which showed that adults with prediabetes who followed Weight Watchers lost significantly more weight and experienced better blood glucose control than those following a self-initiated program using supplemental counseling materials. As a science-based, evidence-proven approach, we believe we are well-positioned to serve the corporate and healthcare markets as they continue to develop. And we're just scratching the surface of the potential engagement opportunities between members and Oprah. Behind the scenes, Oprah is equally as involved as a board member and advisor, contributing insights and ideas that are informing our view of future opportunities. In closing, I'd like to thank the entire team at Weight Watchers and especially our leaders, coaches and other members of our extraordinary field service provider organization for the progress you have made and the confidence and resolve with which you have made it. Thanks again for joining us today. I'll now turn the call to the operator for questions and answers.

[Operator:]

Thank you. Our first question is from Meredith Adler at Barclays.

[Meredith Adler:]

Thanks for taking my question. I guess, I'd like to ask you, Nick, you're very good at guiding and making sure that we don't' get over optimistic. If we think about the various drivers for 2016, what area do you think has the most upside to get you to the high end of your guidance?

[Nicholas P. Hotchkin:]

Well, let me tell you about the thing I'm most pleased about and thanks for the question, Meredith. It's terrific to see recruitments growing on both meetings and online and, frankly, now that we're through tech transformation, we have an opportunity to continue to innovate and add value through our tech product online throughout the year. So it's great to see recruitments growing. But as you know, our model has a timing lag inherent in our business model. So as we return to growth, recruitment is a leading indicator, but you know what, we should think about revenue as a lagging indicator. Frankly, with the impact of the lower starting actives headwind as we entered 2016, it's probably right to think about recruitment growth that we're experiencing somewhere in the range of double the revenue growth that we'll experience this year. So that's what I'm most pleased about and that's what really sets us up not only to have a strong 2016 as I believe we're guiding to, but also to propel us into 2017 with more people in the brand at the end of this year.

[Meredith Adler:]

Great. And then I have a question for Jim. When you look at the response you've gotten from consumers, first, I don't know if you've been sort out there surveying them and what kind of feedback you get from them. And then I sort of have a question about whether you feel that you've got the response you expected to get from the new program and from Oprah.

[James R. Chambers:]

Yes, Meredith, hi. Look, I couldn't be happier with the new program, but I also would like to talk to the opportunities we have to sustain momentum through the year. We do have a lot of feedback from consumers, both from development, which we've shared with you in the past but now importantly when they're experiencing the program in the real world and the satisfaction is very high. It's high on both the meetings product and the online product. They're telling us that they're having very strong weight loss. They are telling us that upon coming into the program they had confidence that their participation in the program is going to get them the results that they want. They are experiencing a better integration and better digital tool supporting that, and as we have said many times in the past, just the general positioning of Weight Watchers is not a diet but more of a holistic program with integrated fitness. They're responding very, very well to that. An opportunity for us at the same time is the awareness of the program has a lot of upside. We know from our research that when consumers are aware that Weight Watchers has a new program, there's approximately two times the likelihood that they will take an action step, which might be going to the website or the likelihood of attending a meeting or signing up. So we know the awareness of the fact that Weight Watchers has a new program is very motivating. We also know that once they're in the program, as I described, the satisfaction is high. And so when we think about and using some U.S. numbers as I talk to in the script, when we think about the fact that we have 60 points of upside and awareness for lapsed members, which we know are generally speaking very brand favorable as well as 80% upside and awareness from "never" members, that gives us a lot of confidence that we can sustain the momentum. Last point I'll throw out there and Nick touched on this a teeny bit, we have improved the digital tools that are the online product and that support the meeting room product. And we are innovating in a different way there, and so we will be bringing feature enhancements and changes much more periodically to that product than we have in the past. And that's all a function of having a new technology environment and a new development model. So I think the response has been very strong. I would say that our relevance is there. It's been across both meetings and online and we have more to go.

[Nicholas P. Hotchkin:]

I'd just add, Jim, that every operating indicator that I track is moving in the right direction. So, satisfaction, retention on the program is strong, Jim said folks like SmartPoints, the response to the Connect feature, as Jim mentioned in his comments, and through not only through response to our advertising been good, but we're seeing word of mouth being strong among our membership base for the first time in a few years.

[Meredith Adler:]

Great. Thank you. That's very helpful.

[Operator:]

Your next question is from Alex Fuhrman, Craig-Hallum.

[Alex Joseph Fuhrman:]

Great. Thank you for taking my question and congratulations on really some transformational change here for the better. Would love to get a sense of the marketing opportunity throughout the balance of the year. Obviously having Oprah Winfrey on board as a marketing partner I would think creates a lot of opportunities that you might not have had during the 10 months or 11 months non-diet period in prior years. What are some things that you're looking at for the balance of the year? And what sort of recruitment trends as the year progresses are baked into the guidance for the full year?

[James R. Chambers:]

I'd like to take the first part of that, Alex. And as you know, I'll steer clear of very specific things that relate to commercial plans. But I would say in general, as we entered this year, as we launched the program, we had a two-pronged strategy where Oprah was inspiring and inviting and other ads and consumer activation were communicating the strength and the power of the new program. As I just mentioned, one of the critical dimensions of opportunity for us going forward, one of the ways to put metrics around that are the awareness levels. And when people are aware of the fact that we have a program that sparks a lot of activity, and so strategically I think you'll see us focus on that this year. The other thing that's been incredibly powerful and responsive is Oprah's engagement in the community. If you happen to go on the Connect tool and follow her, you'll see a little taste of what I'm describing. But her natural ability, her authenticity as a member sharing the journey has been a very, very positive thing. The response has been strong to that and I think it's a big part, as Nick was referring to a minute ago, why we think we're going to have a stronger word of mouth. So without getting into the tactics, I think that touches on what the core strategic for us will be from a marketing perspective.

[Alex Joseph Fuhrman:]

Great. Thanks, Jim. That's really helpful. And then looking at the balance sheet, I know you mentioned you have the B2 term loan coming up in four years after the B1 redemption coming up in the next few months. I mean, if your debt were to continue trading around $0.70 on the dollar, the B2s that is, for the foreseeable future, what would your options be looking into the balance of the year? Would it be reasonable to think that at some point with all the cash you're going to generate, you would consider doing a tender to buy back some of the B2s similar to what you did last year with the B1s?

[Nicholas P. Hotchkin:]

Fundamentally, Alex, the benefit of returning to a strong recruitment growth and generating revenue and increased profitability is that with the leverage in our operating model, now that we have a much better cost structure, we're going to generate substantially more cash flow than we did last year. So that's the basis on which we're comfortable we can use that cash to delever over time here.

[Alex Joseph Fuhrman:]

That's great. Thanks, Nick. And then, lastly, just thinking about your guidance for the year. It sounds like the business is trending a lot better at least on a revenue basis in the United States than in Europe. And some of that is surely currency related. But was there a discernible difference in the immediate lift that you saw from Oprah's partnership in the United States versus elsewhere?

[James R. Chambers:]

Are you asking about the markets Oprah participated in from a marketing perspective versus the others?

[Alex Joseph Fuhrman:]

Yes, that would certainly be part of it or just trying to get a sense of if there were maybe some markets where there was a much bigger initial response maybe because of just a bigger reach on her part in some markets versus others?

[James R. Chambers:]

I think the program and the synergy with Oprah participating in the consumer activation was a strong factor in all of the markets that we cited as having improved performance

[Nicholas P. Hotchkin:]

Yes, the only thing I'd add is I'd say while we're particularly pleased with the North America performance and obviously given our cost base is fantastic to see meetings growing so well and especially as you know, Alex, we get $44.95 a month from everybody who shows up for meetings versus $19.95 for online, so great economics of a strong meetings business. So particularly pleased with North America, but I'd say while performance isn't as strong in our continental Europe markets, they are still seeing a substantial trend change. So the trajectory is improving nicely there, too.

[Alex Joseph Fuhrman:]

Okay. That's really helpful. Thank you and good luck this year.

[James R. Chambers:]

Thanks, Alex.

[Operator:]

Our next question is from R.J. Hottovy at Morningstar.

[R.J. Hottovy:]

Thanks, guys. And thanks for taking my question. First question I had was just on recruitment trends in general and with that obviously headed in the right direction, maybe what's the next step to bringing people up to some of the higher-priced offerings or some of the more value-added offerings that are out there? I'm assuming most of the recruitment that's coming in is kind of at that opening price point on both the in-person and online meetings. And what's the next trigger point for you to kind of maybe make more aggressive marketing towards some of those higher price points? Just kind of how you think about that over the next couple years?

[Nicholas P. Hotchkin:]

Yes, I think, R.J., thanks for the question. Obviously we have a premier Personal Coaching product and a Total Access product. I think it's really been terrific to see how we brought the meeting coaches into the online space, and so bringing that human touch into everything we do at Weight Watchers is helping us. And, of course, going forward, strategically, we'll continue to look at more value-added opportunities.

[James R. Chambers:]

Yes, if I could just add. I know you mentioned in the question, and Nick has mentioned that we have had a strengthening meetings business and he did indicate that that is also a strong point for us financially. We've been confident in the changes that we've made to the meeting experience, making it a better experience in confidence, putting our recommendation flag more aggressively towards that for consumers, encouraging them to try the flagship product, which is a higher price point but is an experience that we think is right for a lot of people and generates great success. And so the second part of it, just as Nick said, we've been experimenting for a year now with strategies that allow us to bring the expertise that is associated with the meeting room to other moments and other dimensions of our product. So Coaching was a way to bring that expertise, Click to Chat was a way to bring that expertise. We continue to experiment with things that go down the same path, whether it results in an improved experience for an existing product at an existing price point, or presents the opportunity for us to enhance revenues by providing a more value-added product. But we're still experimenting with those platforms, but that strategy is still very core to us.

[R.J. Hottovy:]

That's very helpful. Second question I had, and this is I guess for you Jim. You mentioned at the end of your prepared remarks about the Humana deal and potentially it being a springboard with the pre-diabetes study that was just released. At the Analyst Day at the end of the 2013, you talked about the Health Solutions business potentially being a $300 million to $500 million-type opportunity. And I just wanted to see if perhaps the timetable has changed and been pushed back a bit. But what is the longer opportunity in that business now as you've had a chance to kind of refine the offering and make it more accommodating to the insurance partners and other players in the space. Just kind of what the longer-term opportunity that you see in that business.

[James R. Chambers:]

I'll let Nick make any comments on the timetable that he might like. But you know, from prior calls, you probably remember that we had along with many other players in the health care ecosystem anticipated the regulatory environment shifting very quickly. We knew that our product, with the kind of economic advantage and the scalability and reach, that our product could play a very significant role in helping with obesity and obviously, now with pre-diabetes as well. You know, that read was a tough read. And things didn't move anywhere near as quickly as we had thought. And we had made some investments in that arena that we are now leveraging in our B2B business. But we remain focused on the fact that when the conditions become more favorable, we are a cost effective, scalable, very efficacious way to address these challenges that are of incredible proportion and significance to not just the U.S. healthcare environment, but globally. That having been said and reflecting on the strength of the recent study with respect to how encouraging our service can be in diabetes prevention. We would need some things to go well in the marketplace that we don't fully control before these opportunities would become something that would really affect our near-term revenue projections. So we continue to progress. We are optimizing how we work in the vertical with our great Humana partnership. We're not projecting anything very near term to be significant from a revenue perspective in this regard. But strategically, I still believe this is going to be happen. But we don't control all the inputs. And we will be ready.

[Nicholas P. Hotchkin:]

Yes. I think that's absolutely right. I feel the same way about the business strategically. Great long-term potential. The business as a whole is still north of $60 million today. But importantly, as the consumer businesses returning to growth, both the at-work or regional side of our business and the more larger corporate accounts, our strategic business, both are growing right now. So we certainly see the long run potential.

[R.J. Hottovy:]

Thanks.

[Operator:]

This concludes our question-and-answer session. And so the conference is also now concluded. Thank you for attending today's presentation. You may now disconnect.