Weight Watchers (WTW) reported quarterly earnings last Wednesday, with the stock falling double digits Thursday. I thought it would be worthwhile to take a closer look at the results and reassess the current situation at the company.
In the third quarter, revenues declined by 13.5% on a constant currency basis, to $345 million; compared to prior quarters, this was a slight improvement: in both the first and second quarter of the current fiscal year, revenues declined by roughly 17% on a constant currency basis. Total paid weeks declined 12.4% in the third quarter, with a near split between meeting and online; paid weeks fell ~14% in the first and second quarter.
Operating expenses didn’t fall as quickly as revenues, resulting in an outsized decline in operating income: the company earned $91 million in the quarter, a decline of 27% from the prior year (improvement versus the first half trends). Through the first nine months of fiscal 2014, Weight Watchers has reported $257 million in operating income – a decline of 33% from the comparable period in 2013. It’s important to note that this has happened despite a significant reduction in marketing expenditures in the current year ($198 million versus $241 million); in the fourth quarter, marketing spend will be $5-10 million higher than in the prior year period.
North America continues to be an issue for Weight Watchers: revenues for the region fell ~17% in the quarter, which was a move in the right direction from the second quarter but similar to the decline in the first quarter. End of period active subs were 1.93 million in North America, down 16.7% from the third quarter of 2013 – a loss of 387,000 customers in the region over the past twelve months. Even after the decline, North America still accounts for two-thirds of Weight Watchers' total subscribers.
Management noted that, while they’re skeptical that new competitors (mobile apps and activity monitors) offer a successful solution for a meaningful percentage of the people who are using them, they continue to impact trial for WTW’s offerings; with recruitment down in many of the company’s operating regions, these headwinds are greatest in the United States. The trend in the online business in North America remains troubling and is reflective of these competitive forces: online revenues declined more than 20% in the third quarter, just as they did in the second quarter; this is an acceleration from the high teens decline the company reported in the first three months of the year. At the end of the third quarter, Weight Watchers had 1.12M active online subscribers in North America – a loss of 240,000 active subs over the past twelve months; online accounts for nearly two-thirds of customer losses to date in the region.
While North America continues to struggle, the company’s other regions are less discouraging (with less impact from new competitors impacting trial): UK end-of-period subscribers were down 7% year over year, with an increase in recruitments as compared to the prior year; the year-over-year decline in paid weeks and service revenues in the UK is in the single digits. As management noted on the call, the company has made significant performance improvements in this market over the course of the year and has good momentum heading into the winter season.
Continental Europe is the company’s best performing region at this point: revenues were flat in the quarter at $54 million (mid-teens percentage of total), with total paid weeks and end of period active subscribers increasing 1% (comparable to the second quarter gains). Collectively, Weight Watchers had roughly 950,000 active subscribers in the UK and Continental Europe at the end of the third quarter, down roughly 2% from the year ago period. With North American subs declining precipitously, UK & CE are providing some much needed stability for WTW.
Management raised its full-year 2014 earnings guidance yet again in Q3, to $1.95-$2.05 per share; from an original guidance of $1.30 to $1.60 per share to start the year, we’ve now seen a raise to $1.45-$1.70 (in the first quarter), then to $1.65-$1.85 (in the second quarter), and finally the most recent increase. The stock trades at roughly 12x the 2014 earnings estimate.
Before investors get too giddy about the most recent raise, just remember that the midpoint still represents a 48% decline from the figure for the prior year ($3.87 per share); in addition, management has been clear that investors should stay prepared for tough times ahead (“we continue to expect 2015 to be a challenging year on the bottom line for Weight Watchers”).
More broadly, I think management remains conservative in its assumptions and continues to be straightforward with investors about the challenges that the company is currently facing, as well as its plan for repositioning the company for growth in the years ahead (to the extent it can without telegraphing details of their strategy to competitors).
The upcoming winter season is show time for management: we will see the first “market visible steps” of its new strategy, including a new marketing strategy as well as product offering improvements/changes. One key component of the strategy will be one on one personal advice from Weight Watchers experts to online members for the first time; the company will also reveal changes focused on driving greater personalization in between meetings for meeting members. In the words of CEO Jim Chambers, Weight Watchers will be “pairing, at scale, the world’s leading clinically proven weight loss program with the personal support, skills and community needed for a successful weight loss journey.” With Wello, the possibilities for oneon-one personal advice have extended beyond meetings; for investors, there’s now line of sight to an online product with value added services that differentiates the company’s offering from mobile apps.
Conclusion
On the call, CEO Jim Chambers made a statement that strikes at the core of my thesis: “Tools alone, technology alone, food programming alone will never reach the levels of success that are possible when they are brought together and combined with expert human engagement to guide and provide accountability.” In the long run, consumers will use offerings that are effective; Weight Watchers efficacy has been proven time and time again – and I think it's moving towards integrating activity monitors and other tracking tools with the personalized support and accountability that members need to succeed. The combination of multiple access routes, as shown in last year’s trial by the Baylor College of Medicine, can be a critical driver to long term success; Weight Watchers' offering will be unrivaled in this regard and will present a materially differentiated value proposition from its competitors (in my opinion).
Over the past six months, I’ve slightly increased the level at which I feel comfortable buying WTW shares: I believe that the stock is attractive for long term investors at any price in the low $20s per share. I’m hoping we keep moving lower and get there so that I can buy some more…
