Weight Watchers International, Inc. (NASDAQ:WW) Q2 2019 Earnings Conference Call August 6, 2019 5:00 PM ET
Corey Kinger – Investor Relations
Mindy Grossman – President and Chief Executive Officer
Nick Hotchkin – Chief Financial Officer, Operating Officer-North America and President-Emerging Markets
Conference Call Participants
Brian Nagel – Oppenheimer
Michael Lasser – UBS
Frank Camma – Sidoti
Michael Swartz – SunTrust
Ed Huma – KeyBanc Capital Markets
Spencer Hanus – Citi
Marc Wiesenberger – B. Riley FBR
R. J. Hottovy – Morningstar
Jason English – Goldman Sachs
Good afternoon, and welcome to the WW Second Quarter 2019 Earnings Conference Call. All participants will be in a listen-only mode. [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, Ben and thank you to everyone for joining us today for WW’s Second Quarter 2019 Conference Call. At about 4:05 p.m. Eastern Time today, we issued a press release reporting our second quarter 2019 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 Investors section under Presentations & 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 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, President and CEO; and Nick Hotchkin, CFO, Operating Officer, North America and President, Emerging Markets.
I will now turn the call over to Mindy.
Thanks Corey. Good afternoon, everyone. And thank you for joining our call today. Through intense focus, creative marketing and detailed execution by our global teams, I’m proud to say that we ended the quarter with 4.6 million subscribers, up 1.5% from a year ago and beating our expectations. In fact, this is the highest Q2 end subscriber level the company’s ever had, demonstrating the significant month by month improvement in our recruitment trends and the continued strength in member retention. This drove revenue of $369 million, operating income of $105 million and EPS is $0.78.
Growth in operating margins and EPS all nicely outperformed our expectations. Member recruitment trends gave momentum in the second quarter with digital recruitment trending positive for the quarter as a whole, not only stabilizing the business, but also providing a foundation upon which we can return to a growth trajectory. Digital gain momentum across all our geographic markets with particular strength in continental Europe.
Studio + Digital recruitment also show the relative improvement and we are intensely focused on returning studio to a positive recruitment trajectory in the second half of the year. Q3 is off to a strong start, which is particularly encouraging as we were off air in July this year versus in 2018 where we ran TV in the summer but not during the fall season.
We are looking forward to returning to TV during our upcoming fall campaign in the U.S. as well as several international markets. As we’ve outlined previously, we have five key priority areas for 2019 that all aligned with our key objectives of recruitment, retention, and elevating the WW brand.
We have marketing execution and strategy, studio strategy and future experience, 2020 innovation, personalization and global community activation.
Starting with marketing execution, which was a major driver of our Q2 performance. I’m glad to say that our spring season marketing campaigns were effective and deeply impactful across all our global markets driving a notable uptick in our recruitment trends sequentially.
Our integrated global campaign leveraged the unified message, it works, and were adapted locally to share the stories of our members as well as our celebrity ambassadors conveying joy, enthusiasm, and illustrating as WW delivers weight loss that fits into your life.
I’m sure many of you saw the U.S. campaign with Oprah Winfrey surprising WW members with a video of FaceTime call to celebrate the success on WW. We mirror this approach in many of our international markets, including utilizing Alison Hammond in the UK and Motsi Mabuse in Germany. The surprise and delight these calls elicited has definitely resonated across media channels and social.
Our digital marketing continues to drive results, creating interest and converting it very attractive cost per acquisition. Our performance marketing approach on social platforms is going very well, driving increased traffic and interest within new audience. We’re finding success in a variety of digital ads covering topics including highlighting member weight loss results, sharing success stories, featuring the science of the WW program, reinforcing our holistic approach to weight loss and myth-busting what it means to be on WW.
We are now localizing our best performing U.S. assets for use on social channels through our international markets. As a result of these expanded digital marketing initiatives, we are generating significantly higher impressions in website traffic year-over-year seizing our awareness with new audiences.
We are focused on further optimizing our digital exposure to convert prospects into members. Our celebrity ambassador roster continues to grow and diversify. From Loni Love and Tamela Mann in the U.S., to Alison Hammond in the UK, to Sam Armytage in Australia. The announcement that Australian TV host, Sam Armytage joined WW delivered a significant change in our sign up trends in this market and to continue the momentum we are currently teaching her in a TV campaign in key Australian market.
In total, our celebrity ambassadors have a combined reach of 112 million social media followers with whom they are sharing their WW journeys. And so far in 2019, ambassadors delivered original content generating 1.4 billion impressions worldwide.
Recently, both Kate Hudson and Robbie Williams surprised fans by sharing details of their weight loss success on WW. In addition to sharing her 25-pound weight loss, Kate continues to share the ways WW is integrated into her life, including cooking WW recipes for her family using our in-app barcode scanner while grocery shopping. Robbie discussed his own mindset shifts and how that’s impacting his behaviors and improving his lifestyle, even joking concert-goers at the British Summer Time festival about how many SmartPoints are in hummus. Now similarly, DJ Khaled highlighting his weight loss success on WW during the fun segment of The Tonight Show with Jimmy Fallon.
So in addition to presenting WW in a modern relative way. These moments are authentic, engaging, relatable, and highly impactful. In short, spring was a big step forward and we will leverage our learnings into our fall campaigns, which Nick will discuss in more depth shortly.
In addition to strong marketing execution, our team continues to make excellent progress and further enhancing the member experience and driving strong member engagement. We closely watch MPS, the magic per customer satisfaction, and trends are nicely stable or improving for both our studio and our digital experiences and across our geographic markets. The value our members find in our mobile app is being reflected in our user rating just steadily improved since January. The average rating of new reviews being 4.8 stars.
By delivering more content, functionality, gamification, and human connection, our app has become an essential part of the WW experience for the majority of our members, including our digital studio plus digital members who are also highly engaged in app. Member app engagement continues to be strong with steady to rising trends in a percentage of members who are tracking foods, logging weight, using connect and thinking of fitness device. Awareness of our newly launched connect groups is increasing and the percentage of connect users visiting our groups grew to 14% doubling in just a few months.
In Q2, our members created more than 2 million posts with nearly 14 million comments together with 70 million likes on Connect. The number of members seeking an activity device reached 1.6 million in Q2, a new high and up from approximately 1.4 million in a year ago quarter.
In addition, more than 1 million members each month in Q2 manually tracked physical activity, demonstrating that fitness and activity is very much a part of their wellness and weight loss journey. In fact, we have found that members using Aaptiv by the WW app are tracking activity 30% to 45% more often than those not using Aaptiv. And we look forward to bringing more Aaptiv content to our members in the coming months.
WW is truly a human impact company with a technology foundation. The many ways that we’ve evolved our digital platform to better serve our members. It’s something we’re incredibly proud of.
And I will now hand the call over to Nick to discuss our financials and outlook and then I will come back and finish discussing our 2019 priorities.
Thanks, Mindy. We ended the second quarter with 4.6 million subscribers, up 1.5% year-over-year and ahead of our expectations as a result of good execution. End of period digital subscribers were up 8.3% year-over-year to 3.2 million and end of period studio subscribers were down 11.1% year-over-year to 1.4 million.
Our total global recruitment was still slightly negative for Q2 as a whole. I’m pleased to say that recruitment for digital members was positive in the second quarter and we expect total recruitment to also turn positive in Q3. Recruitment channels such as Invite a Friend and In-App Purchase continued to work well for us and are highly effective in attracting first time members.
In Q2, approximately 15% of our global recruits joined through these two channels. Total revenue in the second quarter was $369 million, down 8% year-over-year on a constant currency basis. Digital subscription revenues increased 6% and studio decreased 17% year-over-year on constant currency.
Gross margin rate was 58%, down 120 basis points year-over-year on constant currency, much better than we had anticipated due to continued cost discipline.
Operating income was $105 million, down 16% year-over-year on constant currency, primarily driven by operating deleverage on lower revenues versus the prior year period.
Q2 GAAP EPS was $0.78 ahead of our expectations. This compares to GAAP EPS of $1.1 in Q2 2018. EBITDAS was $121 million in Q2 compared to $142 million in the year ago quarter.
Turning to our outlook. Overall, we expect to have subscriber trends for the rest of the year to be consistent with our normal seasonality and to end Q3 with subscribers approaching 4.3 million. We believe that by giving people more ways to engage with WW, we can drive even further increases in retention and we are starting to see the results.
Our global overall retention is now in the high 9s and I’m pleased to say that average retention of U.S. studio members and of international digital members are now both over 10 months.
We are intensely focused on further extending retention with various efforts to engage more with our members, including through more personalized communications, a more targeted windbag strategy for former members and by adding new enhancements and more gamification to WellnessWins.
We now expect full year 2019 revenue to be at least $1.4 billion. This slightly higher revenue guidance assumes an estimated foreign exchange negative impact of $20 million, which is $8 million more than anticipated previously. This guidance also assumes a continued mix shift towards digital subscriptions and anticipates some further improvement in recruitment trends in the back half of the year as we lap easier comparisons.
Our product sales were down year-over-year in Q1 and Q2. We expect the product sales to turn positive in the second half as we benefit from expanded line of our offerings and improving studio attendance.
Overall, we continue to expect subscription revenues to be about 85% of our total revenue in 2019. We continue to expect North America and the UK full year revenue to be down in the mid single digits on a constant currency basis and we now expect Continental Europe full year revenue to be flat year-over-year on a constant currency basis, a modest improvement versus our prior guidance.
Our full year GAAP EPS guidance range has increased to $1.55 to $1.70, reflecting slightly improved revenue trends and good cost management partially offset by strategic investments in the second half as we prepare for the upcoming program innovation launch and our winter season. This guidance assumes 70 million shares outstanding for the full year. For the remainder of my comments, I'll speak to the midpoint of our full year EPS range and on a constant-currency basis.
We now expect gross margin rate to decrease by about 150 basis points in 2019, an improvement from our prior guidance, due to increased digital mix and continued cost savings. This implies Q3 and Q4 declines of about 300 basis points due to preparations for winter launch, including filed training, contact center staffing, studio location improvement, as well as higher inventory reserves versus the year ago.
Marketing expense in 2019 is expected to be approximately $250 million, with Q3 spend of about $40 million. We’ll continue to be flexible and agile in our approach investing behind initiatives that produce results and in addition to an always-on digital and social marketing approach globally, this year we’ll run TV advertising in the fall. And we’re also planning to be very visible across all marketing platforms following our program launch in Q4.
G&A expense in 2019 is expected to be approximately $250 million, with similar absolute dollar spending in Q3 and Q4. Below the line, we assume full year interest expense to be approximately $137 million and a full year effective tax rate of about 25%.
For the year, we expect CapEx primarily driven by tech spend, capitalized software and some Studio network improvements, to be in the $60 million range and D&A is expected to be approximately $50 million.
Now I'd like to spend a few minutes talking about our capital structure and our cash generation. Our liquidity position is strong with business trends improving and strong cash generation in May, we elected to voluntarily prepaid $50 million of term loans under our credit agreement. We do not anticipate having a required excess cash flow payment due in the first quarter of 2020. At Q2 end after the $50 million prepayment, we had $180 million of cash on our balance sheet and an undrawn revolver.
We now expect EBITDA of about $360 million for the full year, demonstrating our continued strong cash generation. Absence any further debt pre payments we'd expect to end 2019 with a cash balance slightly higher than the end of 2018.
We’ve got a covenant-light debt structure and the flexibility to prepay out term loan at any time. We ended Q1 with a net debt-to-EBITDAS leverage ratio of 3.7 times. Note that the leverage calculations used in our credit agreement are on a first-lien basis and at Q1 end, our consolidated first lien net debt-to-EBITDAS leverage ratio was 2.9 times.
Looking ahead, we expect to end 2019 with more subscribers year-over-year, which given the nature of our subscription business model would translate to a modest revenue tailwind entering 2020. Note, that's only the starting point before factoring in any benefit from member recruitment growth next year. And while we're not providing specific 2020 revenue guidance today with our momentum and initiatives this year combined with our upcoming program launch, we plan to deliver higher recruitment subscribers, revenue and profitability in 2020. With a highly cash-generative business model, we have the resources and flexibility, not only to operate the business, but also to continue to invest in the initiatives that will drive our growth.
And now I'd like to reflect on my first full quarter leading on North America business. The speed with which the team came together and the creative thinking and dedication, has been truly inspiring. When I took on the role, I had two immediate priorities: first, I wanted to prepare and execute strong spring and fall campaigns in close partnership with Gail Tifford, our Chief Brand Officer. Our spring campaign drove good sequential progress in our member recruitment strategy. And we aim to continue that momentum in the fall campaign, which in the U.S. will feature the experience of 10 of our members visiting Oprah Winfrey's home in Maui. The joy and excitement from members as they share their stories is inspiring and highly engaging, which we will be highlighting in an integrated campaign at across TVs, social, digital NPR and I look forward to the campaign’s launch early in September.
Second, I wanted to get closer to our Studio business and execute concrete near term actions to quickly improve performance. In just a few short months, the progress made by our North American studio teams is demonstrating how concentrated focus can yield results. And our actions in Q2 included a studio listening tour. The WW leadership team and I have gained incredibly value in science from coaches and guides in group discussions and every major geography in the U.S. and this important feedback including results from field surveys and a newly formed field advisory council is informing our go-forward studio actions.
Training, we have elevated our training curriculum for coaches and guides with new focus sessions on our new wellness check-in and workshop facilitation. Celebration and weight loss success. Celebrating successes has always been an essential part of the workshop culture. We are adding more milestone charms, increasing the opportunities for coaches to celebrate members' successes.
Attendance challenges, this summer our workshop attendance challenge resulted in an uptick in members propensity to attend and we look forward to launching another challenge later this year, bringing more fun and celebration to the studio experience.
Open houses, to enable both current members and potential members alike to learn more about WW and everything we offer, in June, we held a week of successful open houses across our studio locations. Pricing and promotion, we are implementing a new office strategy designed to boost studio conversion by highlighting the reasons to choose studio. Studio experience by year end most of our locations will have new WW studio signage and we'll also have refreshed the look and feel of over 75 locations. Further in select high volume locations we are hiring dedicated studio managers to elevate our retail experience, drive community awareness, attendance and enrollment. And finally, new tools for new members to get started.
And then an example of best practice sharing from Europe, we've introduced a meal planning guide to help studio members on board during their first two weeks with WW. With these initiatives we’re confidence we're on the right track to improve on our near term performance trajectory.
And with that I'd like to turn it back to Mindy.
Thanks Nick. So as Nick mentioned, we're intensely focused on implementing local market adaptations of the immediate actions Nick discussed globally. For motivation and incentive challenges, to open houses, from studio location enhancements to expanding our range of WW products. In addition, and as discussed on our last call, we are putting customer satisfaction at the heart of everything we do. With our proprietary and customized global Quail Track system, we are getting real time NPS data on our studios down to the individual workshop level and are using data across all our decision making.
Long-term, we are both elevating and creating new experiences for our members. Our in-person workshops with 16,000 studio team members worldwide are a key differentiator in providing the community and inspiration that many people look for in their weight loss and wellness journeys. We're testing more elevated retail strategy where potential members can learn more about WW outside of our workshop sessions, experience a variety of wellness programming and see our growing line of products. We've also revamped studio spaces in Germany and Australia and are working on bringing these new experiences to other markets.
As part of our partnership with Kohl's to democratize wellness, we're opening our first WW studio and in Kohl’s store later this month. In addition to hosting WW workshops, this 1,200 square foot studio in the Greater Chicago area will be open 72 hours a week and have a schedule of additional wellness programming. The location also includes dedicated retail space where we can showcase an expanded assortment of WW products. We're excited to open this test and learn location to explore the potential for future in store studios, extended hours and expanded programming. There's no doubt that this pilot will inform future studio experiences. We are also in conversations with other potential strategic partners on how we could integrate WW into their platforms.
Building upon the first phase of the revamp of our entire consumer product line earlier this year where we reformulated and repackaged our entire line of products globally, which temporarily reduced the number of skews we offer, but as we imagined this business, we're focused on expanding the variety and availability of WW products and expect that this business will return to growth in the second half of the year. We're having encouraging results in Sweden, for example, where we're testing a WW section in the health food aisle in three big retail stores. And as part of our strategic partnership with Kohl's, you can now find WW products in over 200 stores and online.
And as we expand our robust lines of products, including cookbooks and kitchen tools, snacks to meal kits, we intend to make an impact in defining the healthy kitchen and build momentum in 2020.
As we live up to our purpose of inspiring healthy habits for real life for people, families, communities, world for everyone, we plan to offer more ways for people to engage with WW. As a technology experience company with human impact this will include new ways to engage with our qualified and motivating coaches as we provide members with a deeply human and personal experience. We are currently piloting virtual group coaching to bring the guidance and inspiration provided by our coaches, even more WW members, particularly digital members in an entirely new way integrated into our app experience.
As I talked about previously, one of our key priorities is to galvanize communities to events, activations, content, and experience. Amy Weinblum who is leading this newly created area of our business is building a talented and inspired team and our efforts kicked off this summer with a series of dynamic events tied to cultural moments, bringing people together for joyful, memorable, and shared experience. To celebrate Global Wellness Day, we partnered with Emmy award-winning choreographer and America's Got Talent judge, Julianne Hough and global dance phenomenon, Daybreaker, to kick off Global Wellness Day with a sunrise workout and dance party. The event featured live musical performances, celebrity experiences, and a high energy dance class designed and led by Huff, which was also live stream from our Facebook page. The response was fantastic with news of the events generating over 87 million impressions.
Then in July, we partnered with Essence for its 25th annual Essence Fest, the world's largest cultural entertainment and empowerment experience for black women with over a 0.5 million attendees. To celebrate health and wellness and create community around healthy living, we curated a three-day WW brand activation with a variety of community events and onsite experiences, including an interactive center stage discussion with Tamela Mann and Loni Love WW workshop and activation at the new Essence health hub and the first ever New Orleans Daybreaker dance party. Our presence at the event generated more than 24 million impressions and feedback regarding our activation has been enthusiastic, showing the potential to expand on diversification of audience through community.
In late July, we hosted our first ever global community event aboard the sixth WW Cruise and our first European sailing in the Mediterranean. With members joining us from seven countries across the globe we created immersive wellness experiences in both English and German that prove you can practice healthy habits everywhere including on vacation. On a local level in Quebec our Canadian team hosted our first wellness weekend in June, which brought together members and nonmembers alike for a weekend of positivity, fitness, healthy food, and importantly fun with the WW community.
In Germany, we are providing our coaches with the tools to curate their own events and engage small groups of local members, which events such as hiking and wellness weekend and a day tour with a special dinner event and building upon the successful WW good wellness many festivals we hosted last summer. This year we are hosting 5K healthy habit walks around the U.S. and Vancouver, Canada. All of these events are great examples of how we are thinking differently and illustrate the range of experiences WW can represent.
Community is such an important element of wellness and has been one of the most powerful parts of the WW experience since its founding. In September, we will be announcing a multipronged activation of community events including events in partnership with Oprah Winfrey, which we'll be launching early in the New Year. Harnessing the incomparable power of an in-person experience and extending it to our global community is one of the many ways WW is inspiring community is the world's partner in wellness making it accessible to all. And of course as these community events continue to gain traction next year, they should have a halo effect on our recruitment and retention trends.
We are also actively working on the complete transformation of our health solutions business, which has traditionally been working with employers to deliver WW as a covered benefit for their workforces. This is a small business today, but one where we see a significantly larger opportunity.
As we transform our health solutions business, in addition to our having built a new team, our strategic priorities, including transforming how we serve small and midsize employers, revamping our business development and growth model, streamlining the process for client and members sign up and engagement and upgrading our supporting technology systems to serve the needs of our strategic partners, representing corporations, governments, health plans and physicians. Building out these technology systems will be a priority of our new Toronto tech hub. Our work is still in development, but I look forward to sharing more about our strategies and going to market plans in 2020.
And finally as discussed on our last call, we are on track to launch our 2020 new program innovation during Q4 and look forward to introducing everyone to a new way to follow WW. We've taken the learnings from WW Freestyle, new scientific research, leverage the latest in food science, behavioral science and consumer preferences, to create the most personalized WW program yet.
We believe our 2020 innovation will appeal not only to our current members who love the flexibility of WW Freestyle, but also to potential first time and returning members who are looking for a more personalized program that provides the structure and support for sustainable results.
In addition to conducting clinical trials to verify efficacy, the innovation has undergone extensive consumer testing to ensure we're delivering a program that fits the needs of even more people.
So to close, our second quarter results have clearly demonstrated our ability to deliver steady, sustainable momentum for the remainder of the year and enter 2020 with a return to accelerated growth.
And I've been CEO of WW for more two years and I have never felt more confident that we're on the right path to broaden our appeal, attract more diverse audiences and drive long-term sustainable growth.
So thank you for joining us on the call today. And with that, we'll now turn the call to the operator for Q&A.
Thank you. We will now begin the question-and-answer session. [Operator Instructions] Our first question comes from Brian Nagel with Oppenheimer. Please go ahead.
Hi, good afternoon.
Congrats on nice quarter.
So the question I have, first off, with regard to subscriber growth, we've seen now an improving trajectory in the last couple of quarters. As we look back at the weaker trends in the start of the year, one of the key factors there was – what we think was WW not catering back to that lapsed member. And so the – as we look at this improving trend now, are you starting to see the lapsed member that they have not come back earlier in the year, start to reengage with WW? To what extent – if that's the case, to what extent that factor has been lifted your over overall subscriber growth?
Yes. We have seen a mix of both new and lapsed in the steady momentum of the recruitment growth. But I will say where that lapsed growth accelerates dramatically is when we launch new innovation. And as I mentioned on the call, but we're excited about is this innovation should appeal to both new current and lapsed. But that's where we should see an accelerated momentum of lapsed. But for now, we have been recruiting both new and lapsed in this resurgence of recruitment.
That’s right. Look, Brian, bear in mind that the kind of the scale of the turnaround since those first few weeks in January – I mean, having the digital recruitment be positive in Q2 and being able to say that we see a pathway for global recruitment and studio recruitment therefore to be positive in the back half of the year in a non-innovation year and knowing that we're lapping the banner year of Freestyle last year, I mean, I've been pleased with the scale of the turnaround. And frankly, looking at a little bit of a historical scope, I mean this year is the second best recruitment year ever returning to growth, knowing that we've got a new program coming. I've been real pleased for the first six months.
That's great. Let me have a follow-up, as a follow-up, I guess you made, as we look at these trends now – and obviously, we're – all of our eyes are on, as you mentioned, Nick, the end of the year when you're on your seasonal peak but how should we think about the predictive nature of what we're seeing in the business now in terms of what that implies for subscriber growth, recruitment in that key season? Is there a true underliner? As you look at the data, you have a better data than we do, is there a true momentum that builds in the business? Or really, are they distinct period? The member now is distinct, what we'll see later this year?
Well, I think it is important. Our best effort is really to have a tailwind of momentum going into our new 2020 innovation because as Nick mentioned, we're also seeing improvement in retention. So the bigger the tailwind we can have the more we can impact retention as well as new recruitment over that period of time.
Thank you very much.
Our next question comes from Michael Lasser with UBS. Please go ahead.
Good evening. Thanks for taking my question. Can you compare the level of discounting and promotions you did in the second quarter of this year to the second quarter of last year?
Yes. Look, I would say our marketing playbook was similar. In terms of price realization, it realization, it did have some pricing – negative pricing on the studio side of the business but not a – it wasn't a meaningful driver of our financials. Heading into the back half of the year, we've got some favorable pricing comps. So I'd expect that situation to the improved back half of the year.
But I would say, too, Michael, I want to stress that the improvement in trends – sizeable improvement in trends from a weak January but getting better month by month, I view it as driven by a multifaceted action plan and all the actions we've described. We're not buying recruits in any way, shape or form.
Okay. And Mindy you outlined a long list of accomplishments that you're proud of and the progress that the organization is making. Where do you feel you're falling short? And where do you feel the biggest opportunities for improvement are?
So, I would say less about falling short, but some of our efforts are further ahead than others. I think that the team as it relates to our marketing efforts, our digital efforts, our social efforts really have accelerated throughout the year. I think Nick talked about our efforts around studio. We're starting to see the impact of that towards end of the second quarter now going into July. So I think some of it is really timing of when these elements are seeing the impact. And so we as a team – and I think I will say that the team we have today is impressive across all areas of the business. So we measure the KPIs across to make sure that we're seeing improvement step by step because not everything is that same juncture in time.
And with that being said, Mindy, would you attribute most of the improvement to what – WW studio rather than perhaps some leveling off in interest in the competing diets that maybe have been waiting on the performance from the prior quarters?
I would tell you it's definitely our efforts. And we look at measurement, we look at competition, we look at consumer perception and what I can say is both our NPS, and more importantly, our consumer perception scores as well as our engagement scores are higher than they've ever been. So, to know that our existing base is more highly engaged than they have ever been, that tells us that what we're delivering is creating a lot of value. And that's really important to our ongoing success.
Our next question comes from Frank Camma with Sidoti. Please go ahead.
Thanks for taking the question. My question really focuses on given how well you're doing on the digital side, can you talk about your ability to convert those people that joined just as digital onto the meeting side?
Yes. So I think there is definite opportunities to engage our digital-only members in new ways to engage with the brand. So certainly there's an opportunity for studio. As Nick mentioned, we have found success with open houses, Open houses combined to Invite a Friend, articulating to our digital members. We also see an opportunity, I mentioned before, and you will hear more about this, the idea of creating another path for virtual coaching. And whether that's for existing studio members who also want the flexibility or in particular our digital members, which could ultimately create additional revenue streams are there.
And then creating new opportunities from new types of studios. We mention calls, but there are other things that we will be testing for different types of workshops in different types of environments. And the key is meeting people where they are and giving people the diversity of how they want to interface with the brand. But it's definitely important to note that that face to face interaction, community support, accountability that's still going to be an important element of what we do.
Okay. And my second question is just on royalties because I didn't hear you talk about that. Are you going away from royalties a little bit and more just totally owning the product? Can you talk at all about the update on that because that used to be a pretty significant revenue stream?
The biggest part of our revenue stream is products that we source to sell enough studios and more and more and the e-commerce channel, but pure licensing is still all about a $30 million business for us.
I think the key is we have brought on a new head of products and licensing with extensive experience. That's also my background. And we're doing a lot of work. The first thing we needed to do was make sure the products that had our brand on them or products that lived up to what we want our brand to represent. Hence all the new products in market today and the expansion of those products, which ultimately will give us the opportunity to have our products in more venues other than just our studios. We've also been working on our own ecommerce platforms with investments in technology. So we launched them in 2020. We launched our first two Amazon stores in U.S. and Canada. So as we expand our products, we want to have multiple points of distribution.
Got it. Thank you.
Our next question comes from Michael Swartz with SunTrust. Please go ahead.
Just wanted to touch on the cadence of marketing spend this year because I think, Mindy, you said you were off the air in July, and I guess some of those resources are going to kind of to hit it hard in the back half of the year. Can you talk to – I mean how much of that was a tactical shift versus something that was strategic and really planned going into 2019?
So clearly, when we had obviously some of the issues we had in January, we did a very significant debrief, we looked at the balance of the year, both in terms of our creative, our marketing strategy, our on-air spend, our digital spend. We did a tremendous amount of testing. And this is very authentic in terms of the approach for the balance of the year. What I said was, the reason I was pleased with the strong performance in July is we didn't have – we weren't on air in July, we'd been on air earlier in the spring. So some of it is just the change in cadence that was intentional, but we clearly proved that we can have stronger marketing. Now I'm not minimizing the effectiveness of being on air at strategic times.
So the fact is we will be on air starting early September for fall, which we were not last year. So that's an opportunity in multiple markets. And then really be set up to go very broad across our channels when we launch our 2020 innovation. So that was all a very conscious, planned out effort. But the thing that you should notice is that our presence and the diversity of our assets in our digital and social channels is light years from where we were and that's attributed to the new teams we've built, certainly with that expertise within the organization.
Yes, that's fine. I mean, Michael, look, we're investing behind things that are working and things that we like. And so, yes, Q3, obviously we said we'd spend about $40 million in marketing, that's up $5 million or so versus last year in Q4, within our guidance would be up by at least that same amount. And so with certainly investing behind the momentum we see and that reflects how we feel about our business right now.
Okay, great. And Nick just help me understand, I think, you said one of the drivers of the lower gross margin, the back half of the year is inventory reserves. Did I hear that right? And I guess what's that tied to if it is?
Yes this is really trying to anywhere you have program changes where you will, you get into inventory shifts. And frankly, last year, particularly in Q3 last year, we had some inventory reserve favorability because our products sales switch over on launch went much better than we could have thought. So inventory reserves in the back half of the year like using Q3, as an example, as I would say will be down 300 basis points, actual run rate of that gross margin change, probably more like 200 in Q3.
So that and investing in things to drive our launch and train our field and ramp up our contact center to be ready for our new program.
Great. Thank you.
Our next question comes from Ed Huma with KeyBanc Capital Markets. Please go ahead.
Hey, good evening guys. Just two quick ones for me. First, it seems like some of the success recently has been on the digital side. Just any changes on demographics on the new digital customers versus some of the previous ones? I think it had tended to skew younger. And I know it's still early, but any kind of initial read on their persistence?
And then as a broader question, and I know you touched upon kind of improving the modernity of the studio offer, have any of the new locations opened up? Do you have any initial insights on – or maybe quick fixes you can make for the rest of the studios have them a more modern kind of viewpoint?
Sure. So I'll answer it in two ways. On the digital side, we are definitely seeing broader diversity. And as a matter of fact, I think we mentioned on the last call that we launched Connect Groups, which is allowing individuals to self identify whether that's around identity, or whether that's around hobbies, or it's around life stage. And that's giving us a window actually into how people are interacting with our brand, so that's everything from young moms to college to men to LGBTQ.
So we now are up to a significant number of groups and that's reflecting the diversity of who is connecting with our brand. And the reality is it works across gender, age, but this is actually also getting people to share experiences together. And we are aiming ultimately to do the same within our studios. The thing to think about is our studios. Again, this is not a decorating project, this is how do we really evolve the content, the experiences coming in. We've been testing a number of things in smaller format before a bigger launch. We've done some efforts in Australia and Germany already, and are definitely seeing the more engagement we can create. So whether that's healthy cooking classes, whether it's other elements to inform or in Canada, kind of the wellness event.
So we're doing a lot of testing. But we, in the U.S., as Nick mentioned, we have about 75 locations that will have enhanced experience, studio managers, and will be doing different type of events and more always on programs there, so we will get a lot of learnings from that.
Our next question comes from Greg Badishkanian with Citi. Please go ahead.
Good afternoon this is actually Spencer Hanus on for Greg. So I just had a question on capital allocation. With your shares trading where they are today, what is your thought process on potentially doing share repurchases at these levels?
Yes, look, we're focused on investing in our future growth and in continuing to improve our balance sheet. It gets back down below our long-term leverage target. And then also, look, we'll always consider tuck-in acquisitions, particularly those that can improve our – and accelerate our tech and product capabilities.
Got it. Makes sense. And then you guys have been utilizing your partnership more with Oprah. How do you see that partnership evolving going forward?
So to be clear, it's obviously much more than a partnership. She's certainly been active Board member, and obviously, that's her in the company. And we have an incredible relationship. And as you saw from some of the campaigns and mentioned some events that we'll be activating going into 2020. But I also think it's important to note that the momentum and the improvement in our business and the acceleration is in every market. And the idea of really using both our ambassadors and our members to articulate the benefits of WW will continue to be part of our strategy, and that includes where it makes sense in the marketing cadence to partner with Oprah.
Great, thank you.
Our next question comes from Marc Wiesenberger with B. Riley FBR. Please go ahead.
Thank you. Good afternoon. I wonder if you could talk about how the digital marketing assets might resonate differently with your studio target demographic. And if the data maybe shows a little longer conversion cycle. And is that ultimately reflected in the sub growth for the back half of the year?
So let’s get back, every single one of our members is a digital asset, right. We have many, many studio members who are extremely and highly engaged within our communities, our app and social. But what we can do today is, with the team and with the data, we have the ability to do significantly more segmentation of our marketing outreach. So we're serving up at any point hundreds of different assets depending on who the individual is. Are they a current member? Are they not? Are they a studio member? What things will be interesting to them.
So I think that’s the most important part is our focus on personalization, so we can be as relevant to the audience that we're looking to appeal to, and that includes our studio audience.
Okay, great. Thank you very much.
Our next question comes from R. J. Hottovy with Morningstar. Please go ahead.
R. J. Hottovy
Thanks. Just had a quick question about retention. And Nick first of all thanks for the color on international and digital and U.S. studio customers being above 10 months in duration at this point. I was hoping we might flip at it or look at it a different way and look at what you're seeing in terms of first-time compared to legacy and lapsed users. Is there any difference in terms of retention levels that you're seeing between those two different cohort groups right now?
No that’s a great question. But yes behavior focused on our program tends to be remarkably consistent whether or not they're first time users on WW or many times before, what offer they join on. So our retention's strong and making progress across the Board.
R. J. Hottovy
And then just a quick follow-up. Nick, when you talked about some of the improvements that you're looking out for the studio, you mentioned pricing and promotion, I'm guessing that's still work in progress but any thoughts you might have in terms of driving the digital customer and converting to a studio customer, and what that might mean for pricing going forward?
Yes. Look, when I say the folks on the pricing and promotion on the studio side, it's – I want to stress, it's more about language and presentation and content than economics of the offer per se. I mean we are having some success highlighting the absolute dollars to be saved on studio versus digital. That works for us just because it's tow x the revenue, for example. So look, that's the main focus area.
Okay, I think, over time, being able to incent digital members to come to workshops and try them too, or try our digital coaching that we've said we’re implementing and testing. I think there are great opportunities there. That's why I like the open houses so much because it gives our wonderful coaches and guides a chance to talk to people who aren't as familiar with WW.
R. J. Hottovy
Our last question will come from Jason English with Goldman Sachs. Please go ahead.
Hey guys thank you. It looks like I'm the closing act. I appreciate that.
A couple of quick questions. First Mindy with the fourth quarter, right around the corner, are you in a position to give us any more color on what this new program, the personalization entails?
Just to give context, it obviously has been a long time in the development. We have done, as you can imagine, all extensive testing. As I said, it's the most personal program – personalized program we've had to date. And we're excited about the diversity of who is going to appeal to, both existing new and lapsed. And we'll obviously give you more color as we move forward on the specifics. But kind of that's how we're talking about it right now.
Okay. I look forward to that more color. And I want to come back to the gross margin question, because it's been – we've been impressed with the roughly flat gross margin year-on-year through the first half of the year. And in context, a bit surprised by the guidance for roughly 300 basis points compression in the back half. I heard you on the inventory reserves is as part of that. But can you go back and just drill down a little bit more on what's causing the compression in the other areas of investment?
Yes, look, I mentioned the inventory reserve moving parts in Q3, absent of which we'd be talking about a 200 basis point decline in the Q3. In Q4, you can imagine we're investing in our launch, so that's at least 100 basis points in Q4. So you kind of do that comparison, the gap from where we were like, 1,00, 120 constant currency in Q2 to 200 run rate in the back half of the year is much closer. And the main drivers there are investments in the business, as we discussed, investing in things to drive future revenue and growth. And then also we've been very clear today that we are doing lots of things to improve the trajectory of our studio business. So within that gross margin guidance, we're assuming we have less of a mix benefit within our gross margin year-over-year than we had in the first half of the year.
Understood, make sense, and congrats on bending the trend on recruitment. 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
Thank you everyone. And as I continue to say, it's incredible to be part of a company that deeply impacts the lives of millions. And thank you for joining us today and all the interest in WW. And we look forward to keeping you informed on this journey and we're glad to see our sustainable and positive momentum. Thank you.
The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.