WW International, Inc. (WW) Q3 2017 Earnings Report, Transcript and Summary

Good afternoon, and welcome to the Weight Watchers Third Quarter 2017 Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions]. After today's presentation, there will be an opportunity to ask questions. [Operator Instructions]. Please note this event is being recorded. I would now like to turn the conference over to Corey Kinger, Investor Relations. Please go ahead.

Thank you, Gary, and thank you to everyone for joining us today for Weight Watchers International's third quarter 2017 conference call. At about 4:15 PM Eastern Time today, the company issued a press release, reporting the third quarter 2017 results. 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 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 Securities and Exchange Commission. 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. Joining today's call are Mindy Grossman, the company's President and CEO; and Nick Hotchkin, CFO. I'll now turn the call over to Mindy.

Thanks, Corey. Good afternoon and thank you for joining us. And it's great to speak with everyone again today. In the four months since I've joined the company, I've done deep dives across our business, met with our teams worldwide, and spent time assessing the opportunities ahead. Now more than ever, I am confident about the opportunity and scalability of the business. There is a tremendous potential to expand the Weight Watchers brand and purpose to help millions of people lead healthier lives. As we map out our vision and strategy for the future, our third quarter results have clearly demonstrated that we continue to have good momentum, and importantly, we have a compelling and comprehensive plan for the forthcoming winter season, which I will discuss shortly. Nick will go into more detail on our financial performance but to summarize we delivered another strong quarter with double-digit revenue growth, good margin expansion, and high quality earnings growth. On a year-over-year and constant currency basis revenue was up 14%, gross margin expanded 320 basis points, and operating income was up 34%. Importantly growth was global with North America, Continental Europe, and the UK markets all increasing revenue and profitability. Year-over-year total Paid Weeks grew 20% and End of Period subscribers increased 18% again with growth from every major geographic segment. Our business is performing well giving us a strong sustainable foundation upon which to innovate, expand our offerings, and broaden our base in the months and years ahead. With that backdrop, let me provide an update on a few key areas where I've identified both strength and opportunity which are an indication of where we'll focus and prioritize going forward. Everything we do is now centered on being a company that is global, brand led, and human centric, and will be supported by community, personalization, and behavioral science. We have the potential to be a truly global brand and company, which is why in my first few months, was a priority for me to spend time with our international teams. As evidenced by the results this year, those teams have been doing an exceptional job. Much of the improvement is due to better collaboration and knowledge sharing across markets. We know that our consumers are much more similar across countries and they are different, and we will continue to leverage our talent and our brand globally. I also visited our team in San Francisco, where members of our talented and creative product and tech group were hand-in-hand with colleagues in New York and around the world. The high quality of talent Weight Watchers attracts speaks to the reputation and potential we have not only as a global business, but more importantly, as an organization with real impact and purpose. This is a key differentiator for us. Weight Watchers is increasingly becoming a technology experience company with true human impact and engagement. As we accelerate that journey, it is vital to have strong executive leadership fueling innovation. We have a vision of delivering a more personalized, seamless, and unified experience for our members, one that helps people to find and form communities that are relevant to them. In service of that vision, last week, we announced that Michael Korcuska joined Weight Watchers as Chief Product Officer, where he will lead product transformation and work to seamlessly integrate an overall product vision into the digital and physical world. Michael was previously at LinkedIn where he oversaw the company's expansion into China and led the product team for the e-learning website Lynda.com, the company's largest acquisition at the time. Michael's 30 years of experience transforming brand and products with a proven track record at a global level make him incredibly well suited to lead the next phase of product evolution at Weight Watchers. His passion for leveraging technology for good embodies our mission and will continue to be the foundation for our future. Michael will work in close collaboration with our Chief Technology Officer, Michael Lysaght who leads our global technology team and has been driving our technology transformation over the last couple of years. We also recently welcome Sanjay Mehra as Chief Strategy and Growth Officer. In this role Sanjay is focused on growth opportunities and developing strategic partnerships and initiatives. With nearly 30 years of experience across consumer and technology industries, Sanjay has held leadership roles at Reliance Industries, Wolverine Worldwide, the Gap brand, and Nike, where he worked directly for me as Head of Strategy for the $4 billion global apparel business. I'm thrilled to have both Sanjay and Michael on board. An area of tremendous strength where we will continue to develop our leadership is behavioral science, which goes much deeper than calories in and calories out. The success of the Weight Watchers program has always been in our understanding and influence on behavior change to help people build healthy habits. Under the leadership of our Chief Scientific Officer, Dr. Gary Foster, who joined the company in 2013 and led the development of our highly successful SmartPoints plan, we will continue to advance our foundation in science and integrate principles of behavioral science throughout our program. As we evaluate opportunities in the health and wellness space, we're using a science-based evidence proven approach. I'm pleased that in addition to overseeing our science team and our scientific advisory board, Gary will now be leading our Corporate Health Solutions Group. The clinical evidence of the efficacy of Weight Watchers continues to grow. In an independent study conducted in the UK and just recently published in the British Medical Journal researchers found considerable reduction in diabetes risk as well as an average weight loss of 22 pounds within a year of patients being referred by physicians to Weight Watchers. With 2 billion adults worldwide being overweight, and of these 670 million being considered obese according to the World Health Organization, the need we serve has never been greater. And according to the CDC's National Center for Health Statistics looking at the U.S. alone more than 70% of the adult population is now overweight or obese. Our clinically proven approach to weight management provides the tools, flexibility, and support to serve people regardless of age, demographic location, or lifestage. Our recent data suggests that if one person in a family does Weight Watchers by changing behavior and making healthier choices, it has a positive ripple effect on other members of the household. This dynamic has the potential to start a positive chain encompassing families, friends, and colleagues. By understanding the science of behavior change and providing personalized tools as well as community, the potential scope of what we can accomplish is significant. Looking now to our upcoming winter season, we are extremely excited about what we'll be introducing to members and prospective members around the world. Over the next month or so, we will launch an evolution of our SmartPoints Food Plan delivering even more freedom and flexibility than ever before. The program has been under development for over a year and the clinical trial results are the best we have ever seen for Weight Watchers program. Those who have tried it have been overwhelmingly positive and give the program high marks for its livability. Oprah is a strong advocate of our new program and will play essential role in our upcoming U.S. marketing campaign. Commencing in late December, each of our global markets will be launching comprehensive and integrated marketing campaign featuring the new program across TV, digital, CRM, PR, and Social. I've enjoyed working with each of our global teams on their campaigns and I'm looking forward to the roll out this winter season. But I'll now hand the call over to Nick to discuss Q3 performance and the outlook for the year.

Thanks Mindy. Our top-line momentum continued in the third quarter. This is our eighth consecutive quarter of member recruitment growth and reflected a balanced disciplined approach to pricing and promotions. For the quarter on a global basis, member average length of stay improved to over nine months an uptick from eight to nine months previously driven by improvements in the product experience and increasing engagement with tools like Connect, as well as success in joining options for longer-term commitment plans. End of Period subscribers increased 18% year-over-year to $3.4 million with Meetings End of Period subscribers up 11% to $1.3 million and Online End of Period subscribers up 24% to $2 million. Momentum in Paid Weeks continued in Q3 with Total Paid Weeks up 20% with Meetings up 11% and Online up 27% versus prior year. This strength resulted in Q3 revenue of $324 million which was up 14% year-over-year on a constant currency basis, an acceleration from 9% and 12% growth in Q1 and Q2 respectively. The strong operating leverage in our business model flowed through to profitability in the quarter. Gross margin rate was 54.7% and on a constant currency basis gross margin increased 320 basis points year-over-year. Operating income was $91 million, up 34% year-over-year on constant currency. GAAP EPS was $0.65, up from $0.53 in Q3 of last year. Note that both periods benefited from lower than usual tax rates. Q3 2017 EPS benefited by $0.03 from the reversal of certain tax reserves and in Q3 2016 EPS included a positive net benefit of $0.13 from tax incentives primarily related to investments in technology in prior years. Turning to our performance by geographic market, North America our largest market continues to generate positive momentum. In Q3 North American revenue increased 16% on constant currency and End of Period Subscribers increased 19%. As discussed previously, performance in our international markets has markedly improved throughout 2017. Continental Europe revenue increased 14% on constant currency and End of Period Subscribers increased 24%. In the UK revenue was up 9% on constant currency and End of Period Subscribers increased 7%. With solid performance year-to-date, we are confident that our top-line momentum will continue for the rest of 2017, and therefore, we expect full-year 2017 revenue of approximately $1.3 billion a double-digit increase over the prior year. While we will have some Q4 expenses related to the upcoming launch of our new program innovation, we continue to expect strong operating income growth reflecting the operating leverage in our model and continued expense discipline. We are raising our full-year GAAP EPS guidance to a range of $1.77 to $1.83 which assumes 68.2 million shares outstanding for the full-year. For the remainder of my comments, I will speak to the midpoint of our full-year EPS range and on a constant currency basis. In North America, we anticipate full-year revenues to be up in the mid-teens reflecting continued momentum. In the Continental Europe, we now expect full-year revenue to be up in the low-double-digits and in the UK; we expect full-year revenue to be up in the mid-single-digits. With solid year-to-date performance and cost efficiencies at higher volumes, we continue to expect gross margin to increase approximately 250 basis points for the full-year. This reflects operating leverage partially offset by incremental investments we're making in the fourth quarter in preparation for winter season and a lower contribution from licensing. Revenue from licensing is about $30 million in 2017, down from approximately $40 million in 2016, and well below peak levels. Absent this decline in licensing, gross margin would have expanded roughly 100 basis points more or about 350 basis points this year and licensing and partnerships represent a long-term opportunity as we reinvent this part of the business. For the year, marketing expense is expected to be about $205 million and G&A expense is also expected to be about $205 million. As a percentage of sales, both marketing and G&A are expected to decline year-over-year. Below the line, we are now assuming a tax rate of approximately 28% for the full-year which reflects the lower than previously anticipated tax rate in Q3 as well as the impact of the tax benefit in Q1 2017 from the cessation of operations in Spain. We expect CapEx primarily driven by tech spend and capitalized software to be consistent with prior year levels at approximately $35 million and D&A is expected to be $50 million. For the full-year, we now expect EBITDA defined as earnings before interest, taxes, depreciation, and amortization, and stock-based compensation, of approximately $345 million, up from $259 million last year demonstrating the power of our highly cash generative business model. To drive future growth, we'll continue to invest in areas such as products, brand, and technology, and at the same time, we intend to maintain a disciplined cost structure reviewing incremental expenses prudently and focusing on those that will drive balanced profitable and long-term growth. Based on continued year-over-year recruitment growth and current retention trends, we anticipate ending 2017 with over 400,000 more End of Period subscribers than year-end 2016. Given the nature of our subscription business model, we expect this will translate into an EPS tailwind of at least $0.30 in 2018. Note that this EPS impact is independent of any member recruitment assumptions for 2018 it's just a quantification of a starting point to assist with modeling. Finally, turning to our balance sheet and cash flow structure. We ended Q3 with $178 million in cash and no borrowings on our revolving credit facility. We're making good progress on reducing our leverage. At the end of Q2, we had a net debt to EBITDAs ratio of 6.1 times which decreased to 5.3 times at the end of Q3. You may recall that in early 2016, we announced our corporate goal to reduce our leverage to below 4.5 times by the end of 2018. I'm pleased to report that we are well ahead of that schedule and we are introducing a long-term leverage target of below 3.5 times net debt to EBITDA reflecting our confidence and the sustainability of our growth and in our cash generative business model. We are committed to prudent capital structure management and balance sheet improvement, while continuing to make the right investments to fuel our growth. And based on our strong business momentum and given recent upgrades from both Moody's and Standard and Poor's we will continue to evaluate refinancing alternatives. With that, I'd like to turn it back to Mindy.

Thanks Nick. Weight Watchers has a tremendous opportunity to continue to evolve our business into a global healthy living brand. At our core, where science-based evidence proven approach for weight loss and weight management, we will continue to leverage the authority of our science and the critical importance of understanding behavior change with engaging touch points across the member experience. As I mentioned earlier, we are very excited about the upcoming launch of our new program which is delivering fantastic results. As we continue to innovate with a focus on livability, we can continue to evolve consumers' perceptions about what it means to be a part of Weight Watchers and begin to broaden our appeal to new audiences and member cohorts in the U.S. and globally. I'm confident that we have the expertise to become an even more dynamic, immersive, and relevant consumer driven global company. The Weight Watchers of the future will be an integrated technology and experience company with significant opportunities to drive continued sustainable growth. We will continue to implement new agile approaches to product development in order to shorten innovation cycles, deliver and improves member experience, and enhance scalability. We also plan to leverage our rich content to create more personal interactions and greater meaning for our members and we will continue to strategically invest in key capabilities including data analytics to create greater personalization for members with a focus on improving interaction, retention, and engagement. Continuously modernizing the product offering through digital capabilities is essential as is fostering the enriching physical human experience. By leveraging the power of community, we can build a 360 degree experience that integrates our technology platform with physical user communities all with the intention to inspire members, encourage engagement, and create experiences to enhance satisfaction and to support success. If we do this well, we will achieve our goal of attracting a broader more diverse audience by gender, ethnicity, age, and lifestage. Weight Watchers has the permission and privilege to help people worldwide live a connected healthy life of meaning. We have work ahead of us but I'm confident that we have the foundation, momentum, and motivation to achieve this mission. So thanks for joining us on the call today and with that, we'll now turn the call over to the operator for Q&A.

We will now begin the question-and-answer session. [Operator Instructions]. The first question comes from Alex Fuhrman with Craig-Hallum Capital. Please go ahead.

Hi guys, thank you very much for taking my question and congratulations on another really exceptional quarter. Something I really wanted to ask about seems like to me probably the biggest take away from the prepared remarks here is this is the second quarter in a row that you've called out increased retention and paid length of stay and here even going so far to quantify that it looks like it's a little bit above nine months, can you give us a little bit of color on what you think is driving that and that seems like a pretty big increase for a paid length of stay that historically hasn't moved a whole lot on. Are you seeing the same trends in different markets and online versus in meetings and curious if you have enough perhaps data at this point to parse out whether or not your user too have been active on the Connect platform or perhaps contributing an outsized amount to that increase in retention? Thanks.

Hi Alex, thanks for that great question. And yes, we are seeing improved retention across our markets and in both our digital and physical assets. And there's a lot of reasons for that. We have focused a tremendous amount on the digital tools that we have to create greater member engagement, we have focused on our content, and you mentioned Connect, that's been a very powerful asset for people within the digital community. In our physical environment, we've really worked to create more and more engaging content and member interaction and really have educated certainly all our members on how they can interact with Weight Watchers every day to further their ability to be successful on the program. And I think all of that has contributed to the success. Certainly the work of the technology teams over the last years to create a really best-in-class product and we will continue to iterate on that. And then, finally, the success of the program, people are seeing success, they’re staying with the program longer and they're engaging with the brand.

Yes, I would just add Alex kind of both Meetings and digital retention are over nine months globally on the United States are over nine months. I mean it's really good progress and the engagement progress that Mindy talked about and also we've been having success offering people longer-term commitment plans on their initial signups but really pleased to see more engagement in the program.

Great. That's really helpful. Thank you. And then following up also on Mindy you mentioned in the prepared remarks the opportunity to become perhaps a bigger global brand with more of a global presence, does that mean you guys are looking at potentially expanding into some markets outside of Europe internationally. And then just kind of curious how you're thinking about the allocation of capital as you consider potentially new international markets versus perhaps taking in-house and buying out maybe some of your domestic meetings, franchisees, if you could maybe talk a little bit about how you potentially balance that allocation of resources?

So let me talk about what I mean by truly becoming a global company because it's not just about geography. It's really about becoming one Weight Watchers around the globe. Having the technology to recognize all members no matter where they are in the world, how we connect our communities globally. To the point about geography though, how do we expand and develop the capabilities for further geographical expansion that we can do efficiently and successfully, how are we going to globalize our food database to be the most comprehensive in the world, and then certainly leverage our talent. We know that there is a need for what we do everywhere and that certainly is an opportunity but what I don't want to do is get ahead of myself. We really want to maximize and continue the growth of the markets we have while we develop the strategies and the capabilities for further expansion. As far as our other opportunities with markets in the U.S. or other markets that we may own or not globally we're certainly doing an assessment of the business all the time to see what makes the most of that.

Yes, if I could just add, Alex, as we look for other opportunities, we've got an awful lot of flexibility given just how good and how cash generative this business model is. So you see us having the ability to invest in our future and improve our balance sheet rapidly at the same time. If you look at the flow through of top-line growth to operating income growth in Q3, we're generating $23 million more OI constant currency on $39 million of revenue that's almost a 60% flow through to the bottom-line. So we can improve our balance sheet quickly as you see in our declining debt-to-EBITDAs leverage and invest in the future too with this sustainable growth.

That's really helpful. Thank you very much.

Thanks, Alex.

The next question comes from Greg Badishkanian with Citi. Please go ahead.

Great. Can you talk a little bit about the key components that drove the EPS guidance upside from $1.77 to $1.88 from $1.57 to $1.67? So you keep the consensus estimate by about $0.14, I'm assuming you're continuing to see momentum in the fourth quarter?

Hey Greg, it’s Nick. Yes continued good momentum in Q3 globally fall campaign was successful and importantly this is a global growth story in 2017. So revenue came in a little bit higher than we thought partly due to a good fall campaign, partly due to the really good retention metrics that we've discussed. So I would say when I look at midpoint of our guidance increasing from what $1.62 to $1.80, $0.18 I'd probably say about half of that is real good performance revenue and retention driving the business and to be fair probably the other roughly half of it is the fact that our tax rate forecast for the year is now 28% versus the prior 31%.

Right. Good color again. And just regarding the launch of the new upcoming winter season program, what's the key reason why the consumers provided enthusiastic feedback in your opinion, is that a good indicator for the success of that program for the upcoming year?

Yes. So what we've seen with the new program and the members response to it. They feel it's giving them simplicity, it's giving them more livability, and more important, it's having results not just on their weight but in their overall feeling of health and contentment and all of that together is what's really fueling the success. And we have thousands of members and non-members on the program as well as 10,000 people in the field and having personally been on the prior program and this program myself, I can echo those same sentiments and yes I have lost weight.

Okay, great. Thank you so much.

The next question comes from Frank Camma with Sidoti & Company. Please go ahead.

Thanks for the results. It's not that surprising to me that you're getting better what's the phrase given that you took a more -- it's a more holistic approach here for the [indiscernible] and the behavioral side of the stuff. I was wondering, now that you've done all that, what sort of the biggest reason someone steps off the program is it that they've reached their goal weight or is it because they didn't feel they don't need it anymore just kind of went from your survey like why do people ultimately cancel their subscription so to speak.

Yes, that's very varied. To your earlier point they may had success on the program but what's interesting is as we continue to engage with content around health, around food, around mindfulness, and other areas of livability, members are being value even when they gotten to their goal and particularly when continuing to engage with the communities that they've built. Certainly people have come off programs because, they went sideways I mean it happens. But we usually find and what we're seeing right now in the results we have a lot of members coming back and we know that when we have new news particularly like the new program that we are launching, we tend to have a significant amount of increased engagement particularly with less members so we're excited about that as well.

Okay. Another question just on the licensing piece. Nick, I think you gave us some numbers around that year-over-year I think it was about $1 million decline from $16 million to $17 million. I'm just if you tell us a little bit more about sort of what product categories that represented and maybe if you could provide some color on now that the brands are bit of a revival or uptick of interest maybe again.

Yes, let me talk to that. As you know, I have a lot of products background and I think that product and licensing business for us is definitely an opportunity. So what we've been doing I've been doing kind of a global assessment and inventory from around the globe of what products we're in, what products we've been in the past, where we feel that there are additional opportunities which I think are many. And so you really will be seeing as we go forward us articulating what we see in those businesses, what new businesses we can potentially be in. But I do think it's definitely an opportunity and to your last point given where the business is today, we're a very valuable partner. Just the fact that our cost of acquisition compared to a lot of companies is so efficient because of the engagement of our audience not just in our digital platforms, but if you think about it in the U.S. alone we have 15,000 meetings a week. So our ability to communicate on end market products is certainly significant and I'm excited about the opportunity.

Yes, you certainly have captive audience. Thanks guys.

Thanks.

Thank you.

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

Well, thank you everyone for joining us today and I want to give a special thanks to our Weight Watchers teams worldwide for all the great work that you are doing in serving our millions of numbers every day so, thank you.

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