WW International, Inc. (WW) Q3 2013 Earnings Report, Transcript and Summary

Good afternoon, and welcome to the Weight Watchers Third Quarter 2013 Earnings Conference Call. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Lori Scherwin, Vice President of Investor Relations. Please go ahead.

Thank you, operator, and thank you to everyone for joining us today for Weight Watchers International's Third Quarter 2013 Conference Call. With us on the call today are Jim Chambers, our President and CEO; and Nick Hotchkin, Chief Financial Officer. At about 4:00 p.m. Eastern Time today, the company issued a press release reporting the third quarter financial results of fiscal '13. The purpose of this call is to provide investors with some further details regarding the company's financial results, as well as to provide a general update on the company's progress. The press release is available on the company's corporate website located at www.weightwatchersinternational.com. Reconciliations of non-GAAP measures disclosed on this conference call to the most directly comparable GAAP financial measures are also available as part of the press release. Before we begin, let me remind everyone that this call will contain forward-looking statements. Investors should be aware that any forward-looking statements are subject to various risks and uncertainties that could cause actual results to differ materially from those discussed here today. These risk factors are explained in detail in the company’s filings with the SEC. Please refer to these filings for a more detailed discussion of forward-looking statements and the risks and uncertainties of such statements. All forward-looking statements are made as of today and except as required by law, the company undertakes no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. I would now like to turn the call over to Jim. Please go ahead.

Thanks, Lori, and good afternoon, everyone. Today, our planned remarks will address 4 topics: our third quarter results; the outlook for the remainder of 2013; context for our early thinking on 2014; and I would also like to share with you my assessment of why we are where we are and the strategies we will employ to improve performance going forward. Next Wednesday, at our Investor Day, we will share more detail on these same strategies and have a underpin our transformation plan, as well as how we will keep you up-to-date on our progress. I see now that this situation we are facing as a business and organization is more difficult than it originally appeared. Although our third quarter profit results exceeded our expectations as a result of strong cost management, it is clear that our top line momentum is weak across nearly all our business lines and geographies with steep declines in recruitment being the principal cause. This weakness has accelerated as we have moved further into 2013 and will continue into the fourth quarter and calendar year 2014 as the wave of free apps stealing trial in the category continues to adversely impact our online recruitments in particular. Notwithstanding their easily understandable appeal, we do not believe that free apps will solve the obesity epidemic. We do believe that Weight Watchers is best positioned to do so, but we need to change to accomplish it. That having been said, I want to be clear: I believe we can transform this company, but we have a lot of work to do to finalize, validate and deliver our strategic initiatives and achieve our potential. It will take time. There is no silver bullet. Weight Watchers has built a good business and a great brand over the last 50 years. On this, there is no debate. We have helped tens of millions of people tackle their weight challenges and changed many, many, many lives forever. We have learned a lot about the critical aspects of weight loss, including the importance of support, being there when people need help, face-to-face in many cases. We've learned that engagement drives success. The more ways we can touch a consumer in meetings, online and via mobile technology, encouraging the use of tools in planning and monitoring their weight loss actions, the more they will succeed. But to generalize intentionally, we've done this largely by pushing solutions at consumers, taking our strong, validated core program and pushing it at a segment of the consumer population. I believe this push mentality is one of the reasons that participation in the commercial weight-loss category is small relative to the total population of people that state they want to lose weight. The consumer has changed and we haven't kept pace. It's too simple a diagnosis to say that we blindly push the same old thing at consumers and that's why we're struggling. We have innovated. We have built strong consumer activation programs. But we have not been consistent enough in doing so and it hasn't been the central focus of the company. Push must become pull. We need to wrap increasingly individualized content and support models around an increasingly fragmenting consumer, leveraging technology, the strength of our brand and the distribution assets we have to meet her on her terms, retaining her trust, giving her hope and mentoring her success. We need to turn this company inside out. Frankly, I'm not sure if it's inside out or upside down, I just know that to win, we need to change. To fulfill our mission, we need to change. No one doubts that the market we serve has great potential. However, taken collectively, companies that provide products and services for weight management have a long way to go to fully develop this opportunity. We'll explore this further next week. But let's look at the U.S., for example, the largest commercial weight loss market. Of the people who are actively engaged in weight management, fewer than 1 in 10 is using a commercial weight loss plan. This is an opportunity. This is a market with tremendous value-creation potential waiting for a better set of solutions. All of that said, there is and has been a significant gap between our market potential and our performance. The last 2 years have proven more challenging with recruitment trends softening significantly. Our commercial activities have not consistently delivered. We have been a bit insular in our thinking and less quick to notice and address competitive threats. We have not consistently leveraged consumer insights to drive commercial results. And our offering has been bifurcated not by consumer design, but by a legacy approach. Our technology costs have increased significantly without a clear and commensurate increase in product preference. And our marketing, while positive in impact, has been inconsistent in execution. We have failed appropriate resource growth opportunities like health care, at times letting them operate as people's part-time jobs. In addition, our cost structure has not been managed as dynamically as it could have been. Recently, we were shown great momentum with reduction initiatives, but we have more to do to flex the operating model given the near-term revenue picture, improved prioritization and reduced reliance on external services. Finally, to become more responsive to market opportunities, we need to become a more agile organization. That is a lot to say. That is a lot to acknowledge and accept, particularly for a passionate, talented and proud organization. But it is the reality of the business we are trying to change. The task at hand is not easy. We have a lot of work to do and this will certainly be a multiyear effort. But that said, we are confident. We are a well-resourced market leader with a clear view of our challenges and a commitment to improve performance. We are confident that if we execute well against our 4 areas of strategic focus, referred to as our strategic pillars, we can transform our company. So what are our strategic pillars? Let me list them first and spend a minute or two on each one. Once again, please understand we'll go into more detail next week at our Investor Day. They are: one, addressing our immediate market performance; two, reimagining our core offering; three, growing our health care business; and four, strengthening the organization. Taking these one at a time, let's look at pillar 1, addressing our immediate market performance. This includes focusing our commercial agenda to improve execution and driving cost savings. Think of it as doing what we need to do to deliver as much as we can over the next year. This won't solve our fundamental issues, but it will contribute in the short run. We will be focused on our January innovation, which will make it easier for people to join and get started on Weight Watchers; retention initiatives focused on the first of 4 weeks of a member's experience; short-term product improvements, particularly enhancing our online offering; and aggressive consumer activation through brand marketing, promotion and advocacy efforts. Our second strategic pillar is reimagining our core offering. This is innovating our consumer offer, leveraging insights to provide the market what it needs to meet consumers on their terms. We have a lot of assets to work with, but also much to do. It's clear that our online product requires enhancement and differentiation. Our meetings offering needs to become more relevant to additional consumer segments. But the future opportunities are not defined by the boundaries of the current offerings. Rather, they will be more targeted and individualized, displaying greater depth against the drivers of value in the category. As the global category leader, we have the resources to define and pursue meaningful consumer innovation. But we need to change how we listen, how we learn and how we build. Given the difficulty in this category of relying on consumer research alone, we are establishing a broader capability around rapid consumer piloting to facilitate product development. You may have seen the recent findings of a study conducted by researchers at the Baylor College of Medicine, which lends further support to the principle that multiple points of consumer engagement drive greater weight loss success. This strengthens our belief in the efficacy of our program as is and more so gives us conviction that we can leverage the building blocks within our portfolio to drive a reimagined consumer proposition. Pillar 3 is growing our health care business. The health care landscape continues to evolve. Our strong brand and proven program efficacy makes us a compelling partner for corporations, as well as larger health care players, to pursue the benefits of improved weight management on a population level. We're making progress. But we need to scale up and dedicate the appropriate capital and resources to do this effectively. Colin Watts, President of recently established Weight Watchers Health Solutions business unit, will share our road map with you next week on how, when and what it will take to get ready for greater market participation and the return we expect to see from these efforts. Finally, let me turn to pillar 4, strengthening the organization. Pillar 4 is about driving the organizational mechanisms we need to ensure success in pillars 1, 2 and 3. How do we align our structure with our strategy? How do we fill talent gaps and improve organizational efficiencies? How do we instill the critical cultural forces of a more entrepreneurial organization, including agility, teamwork and empowerment? What new capabilities do we need to create, for example, building out our domain expertise in health care and improving the depth of our product and innovation teams? In that vein, I am thrilled to welcome 2 new members to our organization and executive team, namely, Dan Crowe joins us as Chief Technology Officer; and Lesya Lysyj joins us as President of our North America business unit. These are both critically important roles particularly at this time. Dan has over 25 years of consulting and IT experience in technology leadership and product management roles; and Lesya, with whom I had the pleasure of working at Kraft and Cadbury, has tremendous experience in building and transforming consumer brands. They will both bring fresh perspectives to our teams and I look forward to them starting next month. Separately, Bruce Rosengarten, our President of Asia Pacific, will be leaving us at the end of this month to take a position in another industry. We are evaluating this part of the organization and we'll announce our intentions in the future. We have a lot of work to do to bring our 4 pillars into full force. I am confident in our ability to succeed. And as I have said, I recognize it will not come overnight. We are committed to sharing with you where we are, what we've identified and what still needs to be done when we get together at our Investor Day on Wednesday next week. Nick will now provide more detail in the quarter, as well as provide you with our outlook on Q4 2013 and context for early thinking on 2014. Then we will be both available for your questions.

Thanks, Jim, and good afternoon, everyone. Similar to the first half results, the third quarter showed continued progress with our cost agenda, but also saw weakening revenues as a result of negative recruitment trend. We were pleased that results exceeded our expectations given the team's aggressive focus on costs. But as Jim described, there is much more to do to get the top line moving and then even more aggressive cost agenda to pursue. The key issue we have faced this year is negative recruitment. Paid weeks and revenue growth lags recruitment, given our subscription-based model, which is why you have seen the revenue trend get progressively worse throughout the year. Specifically, total company revenue declined 3% in Q1, 4% in Q2 and 8.5% in Q3. Third quarter total paid weeks were down 6.6%, embedding declines for both meetings and WeightWatchers.com. Operating income declined 6% as cost savings only partially offset the impact of lower revenue and investments in the business. As a result of this and higher interest expense related to our April 2013 refinancing, our Q3 EPS was $1.07 versus $1.20 in Q3 2012. Let me share more detail on the quarter, starting with WeightWatchers.com. The competitive environment is challenging, driven by pressure from free apps and the proliferation of activity monitors. These continue to hit our recruitment, though, importantly, our retention remained solid. Third quarter revenue rose 1%. Paid weeks declined 2.6% and this is the first time in our history that WeightWatchers.com paid weeks have declined on a year-over-year basis. End-of-period active subscribers declined 5%. Given this trend, we expect Q4 paid weeks to be down mid-single digit and online revenue to decline by a similar percentage. Within the meetings business, NACO remains under pressure. In the quarter, total NACO meeting fees declined 11%, paid weeks declined 11% and attendance was down 15%. In-meeting product sales declined 25% with product sales per attendee down 11%. Post Q3, we completed the purchase of our Manitoba franchise for $5.2 million. North America is now about 87% company-owned. The acquisitions we have completed in the past year contributed about 2% in NACO's top line results in the third quarter. Within B2B, the strategic business continued to perform well with revenue up in the high teens. However, the regional At Work business, which is not subsidized and tends to follow similar trends as in B2C NACO was down in the mid-teens. For the fourth quarter, we expect total NACO volume trends to be similar to the third quarter. Next, U.K. meetings. This business remains under pressure from an aggressive local competitor. In the quarter, paid weeks and attendance were down in the low 20s and we expect a similar trend in Q4. Finally, Continental Europe meetings. Paid weeks declined 2% and attendance was down 8%. We expect Q4 to show further decline. Globally, our other revenues, which include franchise commissions and licensing revenue, declined 9% in the quarter. Now some color on costs. At the start of 2013, given the weak recruitments in our winter diet season, we kicked off our cost reduction initiative. This year, we expect to achieve $75 million in gross cost savings. This translates to $90 million of savings on an annualized basis. Approximately 2/3 of these savings have been driven by a rightsizing of a marketing spend with the balance driven by a reduction in G&A and operating expense. Big areas of cost savings to date have included marketing efficiencies, reduction of external spend, vendor contract negotiations and T&E discipline. I am proud of our team's accomplishments so far, but we have more to do to ensure that our costs and organization are aligned with our business transformation plan. And that is why we are challenging ourselves by raising our expectation for our multiyear cost savings effort to $150 million in gross annualized savings over 2013 through 2015. I will share more color on our cost savings initiative next week. Q3 gross margin was down 100 basis points to 58.4%. This is better than our expectations with mix and cost savings being the primary drivers. Relative to the prior year, the decline was driven largely by operating cost deleverage and the initial impact from our U.S. service provider compensation changes. The impact of these compensation changes was a $3 million increase of costs in the third quarter, the amount that will increase in the fourth quarter and total nearly $8 million for the year. In Q3, both the meetings and WeightWatchers.com segments saw declines in their gross margins and we continue to expect gross margin decline in the fourth quarter to be worse than the third. But we now expect the full year gross margin to be down by about 100 basis points. Q3 marketing spend was down nearly $20 million versus prior and represented 11.8% of sales versus 15.3% a year ago. The decline was driven by reductions in our TV and digital spend, as well as the lack of a men-specific U.S. campaign this year. For the full year, we now expect marketing spend to be down by nearly $60 million. G&A expense rose 2% in the quarter and represented 15% of sales versus 13.5% a year ago. Good traction on cost savings only partially offset investments. That said, we've made more progress on G&A than we anticipated and now expect full year 2013 G&A spend to be up no more than $10 million. There are no changes to our below-the-line assumptions for interest, tax or share count. In addition, we continue to expect cash from operations for the full year to be in the $300 million range. As a result of our cost savings initiatives being ahead of plan, we are raising our full year 2013 EPS guidance to a range of $3.85 to $3.95 versus prior guidance of $3.55 to $3.70. This assumes fourth quarter global revenue down low double digits with meetings paid weeks down low double digits and online paid weeks down mid-single digits. I would also like to provide some additional perspective on next year. While we plan to provide guidance for 2014 in February, we wanted to share with you our primary areas of focus in analyzing our expectations for 2014, notably our starting actives base, recruitment trends and trust management. You will recall that in our Q2 earnings call, we discussed that regardless of the success of our 2014 recruitment drive, the reality is that we will have a much lower active base at the start of 2014 than we had at the start of 2013. This remains the same. We are working very hard on our 2014 winter season plan and are optimistic they can have a positive impact on our trajectory. That said, we are not currently expecting the wave of free app trials to abate in 2014. In fact, it's likely to be tougher than ever. As such, the revenue pressures affecting our business are not likely to lessen. Based on this, the decline in 2013 enrollment trends could persist into 2014. If our expected negative recruitment trends in the fourth quarter were to persist through 2014, this, combined with a lower starting actives base, would result in a low double-digit revenue decline next year. Clearly, we hope to do better, but we do not expect a return to revenue growth until our strategic initiatives bear fruit. While we will aggressively pursue cost savings opportunities and are confident in our ability to generate incremental savings, there are a few things to call out: First, while we realized significant marketing savings in 2013 versus prior year, we do not expect to make additional marketing cuts next year as we invest in our program and brand. Therefore, we expect marketing spend next year to be materially in line with our 2013 level. Second, we recently announced an improved compensation program for our U.S. service providers to better reflect the value they provide to our business, reduce complexity and better align their incentives with our business objectives. This represents an annual investment of roughly $23 million, approximately $8 million in 2013, mostly in the second half, and an incremental $15 million in operating expenses for the full year 2014. Lastly, I want to address the dividend announcement. Our board certainly considered the decision to suspend our dividend. While we have a strong liquidity position today, it is important to note that our leverage is already over 4x and given our business trends, will likely be higher next year. In light of this, the board elected to act proactively to build flexibility on the balance sheet to fund the company's transformation while preserving cash for future debt payments. We will now open this up for your questions. Thanks, operator.

[Operator Instructions] And our first question is from Jerry Herman of Stifel. Jerry R. Herman - Stifel, Nicolaus & Co., Inc., Research Division: I guess, the first question relates to the launch, if you will, in January of next year. It seems like your expectations are relatively low there and is it too early to get any read or test activity on the receptivity of that program?

Yes, thanks for the question Jerry, this is Jim. We're confident in what we have planned for the market in January. I'm not going to share too much detail around the testing and validation path there, but we are -- we're tapping into some core category drivers and we're facing head-on some of the consumer perceptions around our service and we're centered on making an easy way to start Weight Watchers working against a consumer sense that maybe were a little too complicated and maybe require a bit too much of a commitment. So we're tapping into an insight that we think is very compelling and we're ramping a program around that. Important to note, at the same time, we are tempering our confidence in our programming next year, not just in January but in general, with our increasing sense of how trial is being impacted in this marketplace associated with the continued activity of free apps. So we do have confidence, but we're cautious as to where that will net out.

Yes, I think that's right. And if I could just add, Jerry, look, we're confident in our program in looking to drive the top line aggressively in the winter diet season. But as you saw in what I said about our revenue trend leading to a low double-digit decline in the fourth quarter, we're really just starting to feel the full impact of the steep recruitment declines we've seen this year. So that's particularly true for dotcom, with the dotcom only turning negative in Q4. So regardless of how successful our winter diet season is, we know that 2014 will be a very challenging year. Jerry R. Herman - Stifel, Nicolaus & Co., Inc., Research Division: And my second question, just with regard to online, maybe a 3-parter, if I may, the first part easy. Do you intend on reintroducing a male initiative in next year? And then, the second part and third part, I guess, relates to the relationship between pricing and cost structure and online. I know you folks have devoted a lot of resource to building online. Jim, do you think those 2 metrics are aligned properly at this point?

First off, with respect to men as a strategy, if you will, as a target segment, I think we had pretty good results with the initiative we did in the past. But frankly, we see a bigger strategic opportunity going forward that needs cultivation and assessment. We would have to approach that a different way. So that is on -- that's on the agenda strategically, but I wouldn't expect that in the near term. And broadly, with respect to pricing and the competitive frame, I think I alluded in the remarks to the fact that we do see, particularly on the online product, that we need to provide enhancements to bolster the value proposition there. The folks who are using that offering with us are having success or having good levels of satisfaction. But that is where the competitive changes are focused and we need to evolve and stay ahead of at that and enhance that product offering to deliver more value there. That could include features, that could include different promotion tactics. I think there are a number of options on the table.

Yes. And look, Jerry, obviously, look, our men's dotcom sign-ups in the U.S. are down given the decision not to run a specific men's campaign. But in Q3, men still represented, roughly, 12% of monthly past sign-ups in the U.S. So we're still attracting men to this business.

[Operator Instructions] And our next question is from Meredith Adler of Barclays.

There was one -- when you did your launch, Jim, you talked about a couple of things that were particularly interesting. One was personalization, making WeightWatchers.com more like Match.com. You also talked about multiple flavors and I think you were talking about combining support with the online tools. Do you have any more sort of visibility into how you leverage your greatest strength, which is support?

I think this question ladders up directly to our strategy around reimagining the core offering. And if I remember that conversation -- and arguably not as well as you do, apparently, but if I remember that conversation, I think what I was evidencing was the way that we could imagine taking the gems in the current offer that we have and bundling, arranging, presenting them in different ways to reach the same targets in a more compelling and deeper fashion, as well as a different targets altogether. And that combination of leveraging what we have that we know works, including support, as you mentioned, against a consumer-defined set of needs and opportunity, that's basically what that strategy is about. Does that answer your question?

I think so. I mean, I think, hopefully, some of that will be fleshed out a little bit more. And I guess, another question I have is you've obviously brought in some new senior leadership in a couple of important areas. I had asked you this question at the launch, but I guess I'll ask it again, how much change is really needed in the organization to get you where you want to be? Is it remedial work that can be done? Or are there going to be more significant changes in the staff?

I think in general, a lot of change is needed. I wouldn't jump to a conclusion about how much that is or isn't with respect to the staff, in particular. But I think a lot of change is needed. We have a lot to work with. We have a lot of institutional knowledge around this category and the products and the history of what we have done, what works, what doesn't work, the depths of scientific perspective. But there's a big difference between being in a company that looks at the consumer but thinks about what it has and pushes it, versus a company that is day-to-day, without even knowing it, running by responding to the marketplace. And I've spent the better part of 30 years in those kinds of businesses. So for me, maybe it's a little bit second nature. And that's the transformation that we need to make. And I think it sits above the concept of staff. Will we make additional organization changes to better align ourselves with that kind of a model? Yes. But a lot of it has to do with the processes we put in place and a lot of it has to do with kind of creating the inspiration around the folks that are there to get attached to that mission and to learn to do it that way. It is a very powerful thing when an organization lives in the marketplace first and translates that into their actions second. And I think that's a big part of why I'm confident that we can get there. If we take all the raw materials we have and we lay it into a structure like that and we push ourselves to move quickly and respond to what the marketplace is telling us, I think we can be the ones to meet the opportunity. So I took your question and I spun it a bit into a platform speech, but I hope I addressed it.

Yes. And I'll just ask one more question. What is your sense of the response in the organization to what you're doing and what you're talking about?

I think people are extremely liberated by the sense that we are looking at things with fresh eyes. And that, whether you've been here a week or you've been here 10 years, we're all new, we're all starting from this point and we're going forward. And we'll take the best of what we have and the best of what we've learned, but we're able to leave a little bit of the baggage behind. So I think there's an excitement around feeling that liberation. That having been said, I hope they feel energized and I certainly hope they don't feel overconfident. This is a hell of a journey we're going to go on and we need to respect the degree of difficulty and just get each other primed and focused on what we've got to do. So I think that translates into a little bit of -- if that translates into a little bit of nervous energy, I'd be thrilled. So liberated and a little bit excited. But since we haven't laid all of it out there exactly, I hope they also feel like they will be invited into the solution. I mentioned in the critical cultural forces section of the talk that the word, impairment, which is such a terribly overused word, but fundamentally I think there's a lot of power to be unleashed in this organization by letting people do what they know how to do. Let's get lined up against the same objectives, but let's not run as much top down. Let's create the agility and let people get on with doing what we need to do.

And our next question is from Kurt Frederick of Wedbush.

A couple of questions. One is just on, generally, you do kind of like these product launches in market kind of every other year. I'm just wondering if your plans for next year are, I guess, more, I guess, encompassing, just going into all your markets and trying to make some program changes and updates?

I'm sorry, Kurt, is the question how universal might our innovation agenda be across our markets?

Right.

I think we need to be an equal opportunity employer with respect to where we see the value creation. Taking a perspective that isn't simply one market at a time can give us some leverage and efficiencies for having a multi-market footprint. In fact, as you see the January program unfold, I think you'll see a little bit of that play out already. That having been said, there are clearly markets where we are much more deeply penetrated and have much more, financially speaking, we have much more at stake and those are markets we have to get right. We've seen, as we've been in the other markets, levels of local innovation that are really exciting that we can steal with pride and use back in some of the bigger markets as well. So I think, as a place to cultivate, as a place to pilot, we have lots of opportunities and you'll see us test in places other than the United States, for example. So I think, we have a multi-market view. I think it's based on what we think the potential opportunity-by-opportunity is, but we do see the leverage in doing things the same way in many places at once.

Okay. And then just a question on the like the apps and activity monitors. Is that pressure seen, is that consistent across your geographies, or is it much more impactful in certain markets?

It does vary to -- to say again, the quantitative data on these things is not the best. But it does vary. And the U.S. is one of the more developed, one of the more pressured environments with respect to the kind of, what I talked to you before, the consumer trough around the free app offerings.

Okay. Then could you repeat, what was the comments you had made earlier about the Asia Pacific? Did you say you're evaluating whether or not you want to continue to invest there? Or what was the...

No, just in response to the resignation, we're evaluating what our structure and staffing options are going forward.

This concludes our question-and-answer session. I would like to turn the conference back over to Jim Chambers for any closing remarks.

We appreciate your participation in today's call. While disappointed with our near-term performance and outlook, we are excited about the potential to transform our business. We look forward to continuing our dialogue, in particular, at our Investor Day next week. Thank you.

The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.