Weight Watchers (WTW) recently reported second quarter results, and there were a few things that caught my eye. Just to be clear, this isn’t a complete review of the quarterly numbers. This article looks at a few of those things that I thought were particularly noteworthy from the call:
(1) Improving trends in North America subscriber count
In the first quarter of 2014, Weight Watchers ended with 2.425 million active subscribers in North America; three months later, the company had 2.198 million subscribers in the region – an absolute loss of 227,000 subscribers, and a nearly 10% decline in percentage terms. This loss was split between a 5% decline in Meetings subs and a 12% decline in Online subs.
In the first quarter of the current year, Weight Watchers ended with 1.820 million active subscribers in North America; three months later (the end of the second quarter), the company had 1.767 million subscribers in the region – an absolute loss of 53,000 subscribers (one-fourth of last year’s decline), and a loss of roughly 3% in percentage terms. The number of Online subs fell roughly 5% in the period, with the number of Meetings subs up marginally year over year.
Stated differently, the North America Meetings business lost 45,000 subscribers during last year’s second quarter; this year, Meeting subs actually improved. The number of net sub losses in the Online business also declined by ~70% from the prior year period. These results were attained despite a pretty sizable cut to the marketing budget in the current quarter (with room to go on right-sizing this spend). With North America accounting for nearly two-thirds of total active subs, the region is a major priority for Weight Watchers; positive steps need to continue.
Overall, the numbers in North America continue to be quite poor - and that will be the case for the full year. With that said, improvements in recruitment and trial are a necessary first step towards changing that trajectory in future periods. For the first time in a while, I think there’s reason to be somewhat optimistic about the underlying business trends in North America.
(2) Improvements on the expense line
A key part of my thesis is based on the company’s ability to adjust operating expenses as necessary – most notably SG&A –Â in the face of declining subscriber numbers (like what we’ve seen in recent years). For some time, I started to wonder if 15 years of financial data had misled me; a material change may have occurred that I was overlooking in order to continue justifying my thesis (obviously I don’t think that’s the case, but I could be wrong).
It should be noted that, if this assumption doesn’t hold, the normalized financials would be greatly diminished at lower sub counts than what I previously expected. In that scenario, a key tenet of my thesis – that efficacy will matter in the long run – becomes less relevant: there’s a good chance Weight Watchers would not be able to be around in the “long run” due to the debilitating impact of near-term losses on a stretched balance sheet (to say the least). To put that all succinctly, I believe that holding expenses as a percentage of sales relatively in line with the historic results is critical to my thesis; I built in a margin of error for additional flexibility. As I hinted at above, this is something I’ve been disappointed on in the past: the income statement has not responded as I had hoped in the face of subscriber losses.
However, the first six months of this year – and particularly the second quarter –Â has allowed me to breathe a sigh of relief. For the first time in as long as I can remember, Weight Watchers managed to reduce SG&A expense in-line with or in excess of the rate of revenues (this does not include marketing); in prior quarters, this metric has been moving in the wrong direction – and in a big way (a few hundred basis points). Without digging too deep into the numbers, the company reported SG&A as a percentage of revenues in the first half of 2015 that improved versus the 2014 results (the changes in subscriber counts that I discussed above is clearly having an impact here). Based on the historic data, there’s still a few hundred basis points of excess cost (for the full year, G&A is expected to decline ~19%); while it’s difficult to right size when revenues are fluctuating widely, I ultimately believe SG&A will revert towards historic trends.
One way they’ll do so is more effective tech spending, as outlined on the conference call:
“As we have built out our base of internal tech talent, we have ratcheted down our use of external resources and thereby reduced our expenses. With our new labor, development and infrastructure models in place, we are getting a lot more from tech at a significantly lower cost. To give you some perspective technology-related cash spending this year is expected to be around $85 million in total, down from $115 million at our peak last year. And we expect to end the year at a roughly $60 million annual run rate.”
At the company’s projected full year revenues in 2015, the $55 million difference between fiscal 2014 and projected run rate revenues at year end 2015 is equal to nearly 5% of revenues. This is one example of a significant opportunity to improve WTW’s cost structure; my analysis leads me to believe that there continues to be sizable opportunities for improvement on the P&L. This is a critical component of my investment in WTW.
(3) Gross margins and price realization
In the first half of 2015, Weight Watchers reported gross margins of 50.1%, or roughly 550 basis points below the trailing ten year average (the increase through fiscal 2012 was largely a reflection of the mix shift to the higher gross margin Online business). It’s interesting to consider that statistic in the context of this statement from the second quarter call:
“We continue to view the strategic use of promotions as an effective way to drive recruits in our category. Recall that we implemented price increases late last year in North America. Even with the use of promotions, our price realization has been marginally higher in 2015 than it was in 2014. And importantly, we have seen no meaningful change in our member retention patterns.”
The gross margin declines reflect lower volumes, as well as costs associated with investment in preparation for the winter season offering (including increased access to leaders / coaches in the digital offering). To date, the cumulative impact of pricing and promotion on the gross margin line has been a twenty basis point improvement; the company has started strategically using promotions to lower barriers to trial (a much needed change) while holding the line on pricing. For the company to return to historic levels of profitability, this is another important factor.
Conclusion
I first wrote about Weight Watchers back in April 2014, and the stock has been absolutely slaughtered since then. Up until this earnings report, I had not added to the position in a while; I had a few concerns that were not addressed in prior periods that kept me on the sidelines. After reviewing this quarter’s results, I felt it was appropriate to buy some more. With that said, I’m still moving relatively gingerly for the time being. I’m thinking in terms of years, not weeks or quarters; my activity in the stock will correspond with that time frame.
If we see similar improvements in the third quarter (or what I perceive to be improvements), it’s likely I’ll add some more to my position. I’ll make a concerted effort to act with an eye on the long term, something that I’ve previously struggled with (as I discussed with accumulating Staples (SPLS) shares previously).
For the time being, I hope the stock stagnates or moves lower; I want the opportunity to buy more WTW as cheaply as possible if I ultimately decide to do so.
As always, I’m interested in hearing the thoughts of readers who think differently than I do.
