WW International, Inc. (NASDAQ:WW) Q3 2022 Earnings Conference Call November 3, 2022 5:00 PM ET
Company Participants
Corey Kinger – Investor Relations
Sima Sistani – Chief Executive Officer
Amy O’Keefe – Chief Financial Officer
Conference Call Participants
Spencer Hanus – Wolfe Research
Jason English – Goldman Sachs
Alex Fuhrman – Craig-Hallum Capital Group
Operator
Good afternoon, and welcome to the WW International Third Quarter 2022 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 that 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, everyone, for joining us today for WW International’s third quarter 2022 conference call. At about 4:00 p.m. Eastern Time today, we issued a press release reporting our third quarter 2022 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 corporate.ww.com.
Supplemental investor materials are also available on the company’s corporate website in the Investor section under Presentations and Events. 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 also 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 Sima Sistani, CEO; and Amy O’Keefe, CFO.
I will now turn the call over to Sima.
Sima Sistani
Thanks Corey. Good afternoon, everyone, and thank you for joining us today. We are encouraged by early indicators that our data-informed approach to product development focused our four pillars of community, accountability and coaching and yielding positive results. That being said, we are eyes wide open that our turnaround will take time.
We have a substantial amount of work to do to update our product to deliver the most compelling solution, but the initiatives driven in the short time that I’ve been here already, are resulting in a sequential improvement in our year-over-year sign-ups trend. We have identified critical experience moments to increase member retention and are leaning in building momentum for us through the next year and beyond.
Despite headwinds, I’m confident that we will continue to grow our position as the leader in our category. We have a program that works, members who love us, 60 years of efficacy in a space where new entrants come and go. We are turning that solid foundation into a best-in-class digital experience for the future.
We have been consistent that 2022 would be a year of transition, shifting focus and resources back to what we do better than anyone else, waive off and away from initiatives that were not driving an impact and complicating the member experience. We have done that with urgency.
We have improved trends and are focused on positioning the company for a return to growth. The need for efficacious and sustainable weight loss solutions, remain confident. Our agreement is to make Weight Watchers, a solution of choice.
Relative to Q2, while still down on a year-over-year basis, we delivered an improvement in sign-up trajectory during the quarter, with sign-ups coming in modestly above our internal expectations, despite demand pressure in our category. We were pleased with the performance of our creative in the fall campaign, where our simplified messaging and our stance has being unapologetic about weight loss broke through. The US ran a modern, high energy spot with a simple message that Weight Watchers is here for people who want to lose weight. The campaign has proven to be effective, both for efficient member acquisition as well as positive brand building. We showed up differently and consumers took notice. Importantly, not only among former Weight Watchers members, but also new consumer cohorts.
Ad awareness is up significantly year-over-year and on par with winter campaigns, despite significantly lower spend. The spots [ph] became a topic of conversation on social media, showcasing our ability to break through culturally and we saw significant increases in brand consideration. We are seeing positive impacts from the shift from traditional media buying to data-driven global performance marketing. By in-housing our team in North America, we are faster to market, responsive to media and creative trends and more efficient with spend, and we will be leveraging all of these learnings as we headed to our peak season.
But while we are making progress on sign-up trends, we also saw a modest uptick in cancellations during the quarter, largely related to six-month commitment plans that ended in July. We have found that member engagement and satisfaction has declined with personal points compared to prior programs, an issue we are actively following for. This simply reinforces what we already knew that our program and our product must provide a simple and engaging member experience.
As a result, our teams have begun tracking a new measure activation rates. Activation rate is defined by a member’s engagement and progress during their first month on the program and is directly tied to member success. Our data shows that activated members churn at a rate that is roughly half of a non-activated member. In addition, the science and our data supports that these members will be more successful on Weight Watchers over the long term.
Now that we are measuring activation rates, we have observed a promising uptick in recent months demonstrating that the changes we have made to the app are working, driving the behaviors and connections that lead to member success will create a network effect that delivers efficient acquisition and longer retention. We are now better able to calibrate our product road map moving forward. With that in mind, we have considerably increased our technical velocity, choosing future improvements to increase engagement and retention in our products.
Recent changes include, a meaningful update to our food search algorithm with test results showing a double-digit reduction in customer service contact and a reduction in churn, streamlining weight tracking to drive consistent accountability, demonstrated by a material increase in the usage of this future, last month, we rolled out a new onboarding funnel in the US, increasing the share of lineups choosing our premium products, and we enhance our in-app encouragement of weight and food tracking activity which has contributed to the increase in our activation rate. This has demonstrated that our gamification techniques are a meaningful lever, and we are excited about future iterations planned in the coming quarters.
In short, there is a clear order of operations, greater activation leads to improved engagement, which leads to greater weight loss and satisfaction, ultimately driving greater retention and positive word of mouth, which makes marketing more efficient driving sites.
I believe that, as an organization, we need to be agile, continuously testing, learning and evolving the program to better fit the needs of members. We are committed to instilling a company culture a bias to action, data-informed decision-making and evergreen innovation.
As we noted during our last earnings call in August, our analysis has shown that personal points could have and should have performed better. After challenging ourselves to understand how members behave through analytics and a laser focus on activation rate, — we implemented the following actions, uncovered and diagnosed issues with our current program to inform a new direction, for the first time ever, rolled out an AV test to a subset of new members to inform a food plan change through data and further validated the results Early member survey results show that the simplified plan outperformed personal points on MPS, supporting our decision to scale quickly.
And we did it all in under three months. Because of this tremendous effort, we plan to begin rolling out the simplified program in the coming weeks. We believe the changes will make Weight Watchers easier to follow and help members achieve their weight loss goals. We announced this decision to our coaches recently and their feedback has been overwhelmingly positive. And this has been what their members have been asking for.
We will be retaining certain key elements of personal points, including the ability to deliver a program for members living with diabetes and a point algorithm that incorporates the latest nutritional science, including advances in fiber, healthy fats and added sugar. There is no question that the Weight Watchers program works. That has been well documented in more than 130 peer-reviewed studies and 35 randomized controlled trials.
We just need to deliver it better, both from a product and brand standpoint, as we look ahead to the peak winter season, we have the essentials in place to deliver a strong member experience that will put us on a path for improved performance. However, — we still have a good deal of work to do to deliver the connected community at the intersection of digital and IRL that I believe is our future, which will drive subscriber growth.
I will turn the call over to Amy to discuss Q3 performance and our outlook.
Amy O’Keefe
Thanks, Sima. Adjusted operating income was ahead of our expectations in the quarter despite revenue pressure, including FX headwinds. The actions that we have taken to address our cost base are delivering efficiencies. We — for Q3 2022, we finished the quarter with 3.8 million subscribers, down 15% from the prior year.
As we mentioned, our year-over-year sign-up trends improved sequentially in Q3. However, this was offset by a modest increase in cancellations. – average retention slipped to just under 10 months in the third quarter. Revenue of $250 million was down 15% and including approximately 420 basis points of FX headwinds, primarily due to lower subscription revenues. Adjusted gross margin of 61% was down approximately 130 basis points from prior year, primarily related to the mix of subscription revenue with 50 basis points of decline due to unfavorable FX.
However, adjusted gross margin remains strong with workshop adjusted gross margin improving over 400 basis points from prior year on a constant currency basis, as a result of actions taken to optimize the studio footprint.
Marketing spend in the quarter of $36 million was up just slightly year-over-year, with increased working marketing, offset by efficiencies in nonworking marketing and the benefit of FX. Adjusted G&A of $55 million was down $5 million or 9% versus prior year, reflecting savings from our restructuring actions, overall expense discipline, as well as a benefit from FX.
Adjusted operating income was $62 million, down $26 million versus the year ago quarter, primarily due to revenue pressure and FX headwinds. During the quarter, we identified several factors, including business performance, market capitalization and interest rates that indicated a triggering event for impairment testing. In Q3 2022, we recorded noncash impairment charges of franchise rights acquired, totaling $313 million. The impairment charges were almost entirely driven by an increase in the weighted average cost of capital.
GAAP net loss per share was $2.93, which incorporates the negative impact of $3.38 of items affecting comparability, including noncash intangible impairments and net restructuring charges. A few updates to our previously announced restructuring plan. You will recall that this action was focused on streamlining the organizational structure, which will primarily impact G&A.
In Q3, we reported approximately $4 million of restructuring costs and expect to report $10 million in restructuring charges in Q4, increasing our full year estimate to $33 million versus our prior estimate of $27 million. The increase in estimate reflects noncash impairment of operating lease assets related to the reduction of corporate office space, resulting in approximately $5 million of annual cash savings going forward.
In addition to rationalizing our consumer product SKU count in North America, we have made the decision to discontinue sales of consumer products in our international markets, both in workshops and online. These lines of business were unprofitable. We have started the wind-down process and expect it to be complete in the first half of 2023.
Importantly, we will continue to license consumer products in international markets, and expanding this channel remains a priority. In total, we now expect annual savings from our restructuring actions to be over $40 million, which includes sublease income, up from our prior estimate of $35 million, within year 2022 savings, approaching $20 million. We expect further revenue pressure in Q4 as a result of lower end-of-period subscribers at the end of Q3 and a significant FX headwind. We expect to end the year at approximately 3.4 million subscribers, which will be down 18% on a year-over-year basis.
Revenue for the full year is now expected to be approximately $1.04 billion, down in the mid-teens on a reported basis, reflecting FX pressure and lower subscribers. Adjusted gross margin for the year is expected to be similar to 2021 at approximately 51%. For marketing, we anticipate full year spend to be down approximately $15 million from 2021. Adjusted G&A for the full year is expected to be in the $235 million range down 10% year-over-year.
We are revising our adjusted operating income guidance to reflect lower revenue and incorporate additional FX headwinds. We now expect full year adjusted operating income to be in the $150 million to $155 million range.
The effective tax rate for the year is expected to be approximately 23%. For clarity, this excludes the impact of restructuring, impairment and other items affecting comparability. Full year interest expense is expected to be approximately $81 million.
Note that we have a $500 million hedge to protect against rising interest rates on our variable term loan of $945 million and our $500 million notes are fixed rate. So only 31% of our total debt is floating. Therefore, at our current debt level, we anticipate interest expense to be approximately $90 million in 2023.
Therefore, our GAAP EPS loss is expected to be in the range of $3.16 to $3.21 per diluted share, which incorporates the net negative impact of approximately $3.94 of restructuring, impairment and other items affecting comparability.
Turning to the balance sheet. We continue to generate strong cash flow from our subscription model and benefit from low CapEx and working capital. We ended Q3 with approximately $188 million of cash, an increase of $40 million versus Q2, plus an undrawn revolver.
Q3 net-debt-to-EBITDA leverage ratio was 5.2 times, up from 4.8 times at the end of Q2. We expect our trailing 12-month leverage ratio to further increase in Q4 and into 2023. Therefore, in Q4, we expect to exceed the first lien leverage ratio under our revolving credit facility, which will limit our access to the revolver to $61.25 million, which should still provide a more-than-ample liquidity cushion.
CapEx and D&A primarily due to capitalized software are both expected to be in the $45 million range. We will continue to manage cash and liquidity responsibly in this period of declining revenue. From a capital allocation perspective, the current discounted trading levels of our term loan and notes are certainly attractive as is our stock price.
However, given the expected subscriber headwind entering 2023 and overall macro risk, we believe it is prudent to preserve liquidity, particularly, through our peak sign-up season. We will reevaluate our view on utilizing excess cash for opportunistic debt prepayments in 2023, but have no plans to repurchase shares in the foreseeable future.
Related to 2023, as we have discussed, we expect a significant revenue headwind compared to 2022, given the expected year-over-year decline in opening active subscribers.
Given the nature of our subscription business model, the starting subscriber base is an important component of revenue even before factoring in any year-over-year change in sign-ups. Using the expected ending subscriber level of $3.4 million for 2022, the lower 2023 opening subscribers would now translate into a subscription revenue headwind in 2023 and of over $90 million on a constant currency basis to help illustrate in a scenario where sign-ups in 2023 are flat with 2022 and assuming the same pricing mix and FX rate, subscription revenue would be over $90 million lower year-over-year.
In addition, the actions we’ve taken to rationalize consumer products in North America and exit in international markets will also create a product sales headwind in 2023 of approximately $20 million, albeit with a negligible impact on earnings and a favorable impact to working capital.
In summary, while we exceeded our adjusted operating income expectation during the third quarter, the negative impact from FX and a lower opening active base will further pressure financial performance in Q4 and into 2023. We are confident that we are taking the appropriate cost actions and we’ll continue to do so as required to manage the business through the earnings trough.
I will now turn the call back to Sima.
Sima Sistani
Thanks, Amy. With that context, we are looking ahead to 2023 and focus on the following; improving our sign-up trends over the course of the year and returning to a year-over-year growth trajectory in the second half of 2023, improving new member activation, which would translate into gains and retention, shipping key digital product milestones, including new in-app community features in the first half of 2023 and later in the year, our integrated product feature with Abbott, exercising strong cost discipline throughout the organization and executing on a narrow list of clear priorities, which we believe are the critical drivers for returning the company to a growth trajectory.
I believe that we are better when Weight Watchers was a movement. People were proud to be members. They came to us for education, but more so for support. Whenever I meet members from the Gen United era, they love to tell me that they are a Weight Watcher. Their identity is wrapped in our branch. These women make up the bulk of lifetime members and show us that meaningful, long-lasting retention is possible when we get the experience right.
As we move into our 60th year, we must evolve to deliver the experience of today. The consumer has changed. Culture has changed. Technology is changing, to maintain our position as the global leader in sustainable science-backed weight management, we have to better meet consumer needs across education and tools, human led support, health indicators and insights and clinical intervention. And our growth strategy must mimic those needs.
Coaching and community is part of our DNA with 80% of our members now being digital-only are at must evolve from being effected screen tool to a truly digital-first experience. From enhanced community features to device integration, there are significant opportunities for us to match our premium and studio experience with a premium digital counterpart.
And for members seeking in-person community, workshops will continue to set us apart. We are working to ensure we have the right workshops, open in the right places and staffed by the right coaches, to deliver with excellence, the program that we know will drive success for our members. Weight Watchers needs to be a culturally relevant brand that delivers against today. We must break through the noise with our reasons to believe, namely science, community, livability and sustainability.
Thank you for joining us today. And we’re now happy to take your questions.
Question-and-Answer Session
Operator
We will now begin the question-and-answer session. [Operator Instructions] Our first question is from Spencer Hanus with Wolfe Research. Please go ahead.
Spencer Hanus
Good afternoon. Thanks for taking my question. Can you talk a little bit about what’s driving the up-tick in cancellations? And how has that been trending exiting the quarter? And do you think any changes need to be made from a pricing standpoint to improve member retention?
Sima Sistani
Hi Spencer. So the up-tick in cancellations, as we mentioned, was we saw about 50 that it was driven mostly by the six-month plan. So we relate that back to personal points and people satisfaction with that program. And we don’t anticipate having to take any different actions around pricing to address that.
Rather, we’ve focused on addressing the program itself. And as noted, our within the last three months have rolled out and tested a new version, that is based on a cohort of members on personal points that we saw outperforming. So we’re excited to be again rolling that out in the next few weeks and anticipate an associated lift in activation rate with that.
Spencer Hanus
Okay. That’s helpful. And then, as we look to the next diet season, how are you approaching this one differently than the team has in the past? And just any additional thoughts on how you’re thinking about simplifying the program going forward, whether that’s membership tiers or other ways to make the program easier to use.
Sima Sistani
Sure. Sorry, there’s some feedback on the line, that’s making it a little bit hard to hear, but I think you asked about our diet season. So — this is a program simplification. And which is different than our more traditional innovation years.
And I think it’s exciting the way we’re evolving to an evergreen innovation cycle. We’re taking into account our existing member base and what’s working for them. And we’ve heard loud and clear from coaches and from our members that they are asking for a more simplified program.
And so not only have we improved the UX, we have also observed, as I mentioned, a specific cohort that has outperformed and have seen more success. And by that, we mean engagement and weight loss.
And so, that is something that we can speak to meaningfully as we look to in the fall with all about consideration and really showing up from a brand standpoint, and the peak season is about turning that consideration into conversion. And so we’re going to have meaningful value to speak to, to our target consumer. And that’s what we’re really focused on moving into the peak season.
Spencer Hanus
Yeah. Great. Thank you so much.
Operator
The next question is from Jason English with Goldman Sachs. Please go ahead.
Jason English
Yes. Hey, folks. Good evening. Thanks for slotting me in. A couple of questions. So first, I guess, stick on the topic of the approaching diet season and the recruitment cycle. Should we expect any new news on a marketing front like spokesperson, anything like that, or is the message really going to be about kind of back to basics, keep it simple in the simplify program we’re talking about?
Sima Sistani
Yes. That’s right. Look, I think that in the past, we’ve relied on new news to drive interest, and we’re seeing, at the moment, that the new news is really about simplification. That’s — again, we’re listening and we’ve heard our members, and that’s what they’re asking for.
And not only that, but again, we’ve observed that those members on this version of the program are better activated and have better success. And so, I think, that’s a powerful message to our existing member base who’s been asking for this change, but also to new customer cohorts and our last members who are — who need that reason to believe. And the reasoning there around the science, the livability community, it’s all there.
And so, we’re really excited about showing up in that way. And matching sort of our learnings from the past and what works with our new in-house performance marketing muscle and being more nimble around how and when we deliver those messages. So that’s what we’re looking forward to in the peak season in addition to some exciting community feature improvements that will roll out throughout Q1.
Jason English
Thanks for that. And on cancellations, do you have any good intel on where the canceled consumers are going, whether it be like these new pharma solutions like Wegovy or maybe to a competitor like Noom or just out into the DIY world and getting off of the pay program. And if you do have that intel, can you share what you’ve learned from it?
Sima Sistani
That’s an interesting question. I think that, when we look at our market and we think about it more broadly, the demand, overall, for in the wellness space is still there. You’ve got 70% of adult Americans who are struggling with overweight and obesity. And they’re looking for opportunities to — for support. And so, ultimately, when we think about our competitive landscape, more than anything, it’s — the competition is doing it yourself.
And that really intensified over COVID, where everybody was learning how to be more industrious. I mean, gosh, my husband was fixing our washer. My brother was teaching himself how to play the guitar, and people turn to social media and to different resources to have — find the support to try to lose weight.
And so, when we see people canceling or moving off our plan, it’s because we’re not giving them the value — and that’s what we’re focused on, and we’re confident that we’re doing the work in the product, in the program to ensure that we are giving outsized value for what they pay for.
So that’s really, I think, what’s happening there is, we saw with the NPS on personal points, people were not happy with that program. And so, when the opportunity came, they rolled off of it. And I think that we have been able to diagnose that.
We’re addressing it. We’re going to go back and speak to those members who did choose to leave our program and let them know that we’ve addressed the problem. And I think that there is a real big opportunity there. Again, when we’re thinking about innovation in the more evergreen styles for us to continue to think about how to make the program we have better versus trying to always deliver something shiny, there is new news can come in a lot of different packages. And for us, that’s about taking the program that we have that we know works for people and continuing to elevate it and make it better because that leads to more positive word of mouth, which leads to more application to — leads to more efficient sign-ups. And so that’s the virtuous cycle that we’re trying to create here and what we’re focused on.
Now in terms of the second part of your question, you did mention the pharmaceuticals and I think that there is still significant financial barriers to the drugs in order to — for them to — for those — for the drug to address mass market needs. And outside of that, though, I just think generally, it’s really exciting.
Look, we’re here to help people, manage their way to lose weight and — and there are — there is a population where a clinical intervention is necessary to help jump start their weight loss schools. And so we’re really excited to see the pharmacology evolve and to partner so that we can introduce those interventions responsibly and eventually get people off the drug so that they’re not living with that for the rest of their lives. And so I think that is — it’s a very interesting space for us, especially as the leader in the market who’s been around for 60 years, clearly, I believe we make a great partner to the pharmaceutical companies that are looking for ways to bring responsible weight management to that population.
Jason English
Got it. Makes sense. Thank you.
Operator
[Operator Instructions] The next question is from Alex Fuhrman with Craig-Hallum Capital Group. Please go ahead.
Alex Fuhrman
Hi, thanks very much for taking my question. I’d like to talk a little bit more about the increase in cancellations that you’re seeing. I’m curious if some of the regions you operate in that are experiencing, particularly high inflation, like Europe and the UK are seeing an outsized chunk of cancellations? And then if I could just get a little bit more color on the comment you made about people kind of rolling off the six-month membership after they signed up for personal points. Can you give us a sense of how many of your members in the brand today signed up during personal points? And how would that compare to what percentage of your membership in November in a new program year would typically be in that new program? Is it about the same? Just curious what share of your membership has that personal point membership?
Sima Sistani
Well, certainly, thank you for your question. Anybody who’s signing up for Weight Watchers would have been signing up for personal point. And about 50% of our sign-ups during last peak season signed up for a six-month plan, which canceled as a higher rate than the prior year as we mentioned. So we believe this to be this uptick would be a Q3 event. And I’m really confident in our ability to address it. As I noted before, we are now — we have a new measurement in activation rate. This is a key metric for us. It’s the way that we look at new member engagement in the first 30 days. And based on specific actions that where we’re making through data science, we’ve been able to model that as a leading indicator of success.
And so when you looked at — when we were looking at activation in January 2022 compared to 2021 levels, we had already seen at that point, a 5% drop in activation and the trend was moving in the wrong direction.
Now I’ll remind you that I joined about seven months ago, and I’ve been incredibly impressed that in a short amount of time, we have been able to turn that line around and make it smile. So that 5% drop in activation that I mentioned, we’ve already narrowed that gap back to 2021 levels, and that is happening through our shipping velocity around new features and the work that we’re doing, and we haven’t even rolled out our new simplified program yet. So again, I think that, that uptick in cancellations was a Q3 event, and we’re looking to meaningfully improve it because as we improve activation, we also reduce churn.
Alex Fuhrman
Okay. That’s really helpful. And then the other part of the question — sorry, it was a long question is, are you seeing that drop off evenly throughout the globe, or have you seen a particularly big hit in Europe and the UK.
Sima Sistani
It was even around the globe.
Alex Fuhrman
Okay. That’s very helpful. Thank you very much.
Sima Sistani
Thank you.
End of Q&A
Operator
This concludes our question-and-answer session. I would like to turn the conference back over to Sima Satani for any closing remarks.
Sima Sistani
So with nearly 60 years of weight loss efficacy and a community of millions — we have a strong foundation on which to build a digital experience for the future. We have work to do to deliver the connected community that I know is our future, but I’m confident that we have the essentials in place to deliver a strong member experience. This is going to put us on a path for improved performance and return our company to sustainable growth. We are looking forward to our peak winter season and connecting with you again in the future. Thank you so much.
Operator
The conference has now concluded. Thank you for attending today’s presentation. You may now disconnect.
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