Why Are Weight Watchers’ Earnings Likely To Shrink 50% In 2019?

Weight Watchers International, Inc.  (NASDAQ: WW) has achieved steady growth over 2015-2018, with the company’s net income witnessing a 6.8x increase over this period thanks to a combination of surging revenues as well as falling expenses (as a percentage of revenues). Although expenses in dollar terms are expected to remain stable in the near term, total expenses as a percentage of revenue are expected to jump in 2019 mainly as a result of a 7% decline in Weight Watchers’ Revenues for the year. This should result in Weight Watchers’ earnings margin (i.e. revenues less all expenses, expressed as a percentage of revenues) being slashed from 14.8% in 2018 to an expected 7.9% in 2019 – representing a 50% decline in Weight Watchers’ earnings. Trefis breaks down the company’s major expense components in its interactive dashboard How Does Weight Watchers Spend Its Money? parts of which are summarized below.

Notably, selling costs (SG&A) (which represents the selling, general and administrative expenses, and other management costs) are expected to be $255 million in 2019, making up 20% of Weight Watchers’ $1.3 billion in 2019 expected total costs. Weight Watchers’ selling expenses are only about 41% of the company’s largest expense driver – the cost of sales.

• Weight Watchers’ total expenses have gone up 14% since 2015, increasing from $1.1 billion to $1.3 billion in 2018 driven by an increase across all operating heads.
• Total expenses are expected to remain stable in 2019 as a decrease in the cost of sales is likely to be offset by an expected increase in marketing, and SG&A expenses.
• However, the company’s total expenses as % of revenue are projected to increase 690 basis points, from 85.2% in 2018 to 92.1% in 2019.

Breaking Down Weight Watchers’ Total Expenses

Cost Of Sales

• The cost of sales primarily consists of expenses to operate studios and workshops, costs to sell consumer products and costs to develop and operate websites and other digital products. The cost of sales is the largest expense driver, accounting for nearly 50% of the company’s total expenses in 2018.
• Total cost of sales as % of revenues has declined from 50.7% in 2015 to nearly 43% in 2018 driven primarily by the shift in revenue mix towards the higher-margin Digital business, and improved operating leverage across the company’s businesses.
• However, the cost of sales in absolute terms has increased from $590 million to $648 million over the same time period.
• Lower cost of sales (as % of revenues) coupled with steady revenue growth have helped Weight Watchers’ gross margin expand from 49.3% in 2015 to 57.2% in 2018.
• Going forward, we expect the cost of sales to marginally decline to $626 million in 2019, representing 44.3% of total revenues of $1.4 billion.

Operating Expenses

• Weight Watchers’ Operating Expenses include SG&A and marketing expenses. Operating expenses have increased 18% since 2015, going up from $406 million in 2015 to $477 million in 2018, led by a $46 million increase in SG&A as well as a $25 million increase in marketing expenses.
• SG&A expenses have increased 23% over 2015-18, going up from $205 million in 2015 to around $251 million in 2018 driven primarily by higher compensation and incentive-related costs as well as investments in strategic initiatives.
• Moreover, marketing expenses have consistently increased since 2015 and we expect this trend to carry over in 2019. Higher expenses are likely to be driven by investments in both digital marketing initiatives.
• Overall, total operating expenses are projected to increase by 5.8% to $505 million in 2019, representing 35.8% of total revenues.

Non-Operating Expenses (Income)

• Weight Watchers’ non-operating expenses have increased from $112 million in 2015 to $145 million in 2018 driven by a combination of higher interest and other expenses.

Additional details about how Weight Watchers’ Non-Operating Expenses (Income) have trended over the years are available in our interactive dashboard.

Income Tax Expense

• Weight Watchers’ income tax expense has hovered around $20 million over 2015-2018, apart from 2017, when this metric was -$18 million due to the enactment of the U.S. Tax Reform Act.
• In addition, the company’s effective tax rate for fiscal 2017 included a one-time benefit of $11.6 million related to the cessation of operations of the Spanish subsidiary.
• We expect the company’s effective tax rate to be around 20% in 2019.

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