WW INTERNATIONAL, INC. quarterly report, Q2 FY2015

WW International, Inc. — Q2 2015 Form 10-Q

Reporting period: Quarter ended July 4, 2015; comparisons are with the quarter ended June 28, 2014. The filing also reports six-month results. Amounts below are in U.S. dollars; financial statement figures are converted from thousands to millions where appropriate.

Financial results and liquidity

Metric	Q2 2015	Q2 2014	First half 2015	First half 2014
Revenue	$309.8M	$397.5M	$631.9M	$806.9M
Gross profit / margin	$159.4M / 51.4%	$225.8M / 56.8%	$316.7M / 50.1%	$448.7M / 55.6%
Operating income / margin	$70.6M / 22.8%	$114.6M / 28.8%	$88.6M / 14.0%	$165.6M / 20.5%
Net income attributable to WWI	$27.9M	$54.0M	$22.4M	$75.5M
Diluted EPS	$0.49	$0.95	$0.39	$1.33

Q2 revenue fell 22.1% reported and 16.5% on a constant-currency basis; first-half revenue fell 21.7% reported and 16.2% constant currency. Foreign exchange reduced revenue by $22.3M in Q2 and $44.0M in the first half.
Q2 operating income declined 38.4%; first-half operating income declined 46.5%. Management attributed the deterioration primarily to lower revenue, especially in North America, and gross-margin compression. First-half gross margin was 50.1%, versus 55.6%.
Interest expense was $30.5M in Q2 and $61.6M for the first half. First-half interest expense rose 9.1% year over year despite lower average debt, reflecting higher effective rates and swap-related factors.
Cash from operations was $26.3M for the first half, down from $145.5M. Investing used $26.7M; financing used $147.6M, primarily for debt prepayments and scheduled repayments. Cash declined to $149.7M from $301.2M at fiscal year-end.
At July 4, total debt was $2.197B, including $144.3M due April 2016; the current debt portion was $165.3M. The company had a $207.2M working-capital deficit. Its debt was variable-rate, with a reported average rate of 5.06% including swaps; the revolver was undrawn at quarter-end, with $48.2M available.

Material changes and significant items

Revenue and paid weeks declined across all segments. Q2 total paid weeks fell 22.1%; North America revenue declined 19.2% on a constant-currency basis, and its active subscriber base and meeting attendance weakened. Recruitment trends in North America improved in Q2 versus Q1, but remained down year over year.
The company prepaid $63.1M of principal in March and $84.9M in June, using $57.4M and $77.2M of cash proceeds, respectively. These discounted prepayments generated $11.5M in gains on early extinguishment of debt in the first half, including $6.7M in Q2.
On July 14, after quarter-end, the company drew $48.0M from its revolving facility to increase cash and financial flexibility. This draw is subsequent to the reported quarter-end balance sheet.
The company acquired Weilos, a mobile health and weight-loss social platform, in March for a purchase price of $6.7M.
Fiscal 2014 financial statements were restated, principally to account for certain acquired franchise rights as definite-lived assets rather than indefinite-lived. The company also corrected an immaterial current-debt classification and other immaterial items. Q2 2015 included $1.65M of out-of-period pretax adjustments related to immaterial prior-period errors.

Outlook, management commentary, and risks

Management forecast fiscal 2015 revenue of approximately $1.15B, compared with $1.48B in fiscal 2014, citing lower starting active subscriber bases and weak recruitment trends.
The company established an incremental $100M annual gross cost-savings initiative, which management said was progressing on plan. Planned savings were approximately 45% from marketing, 35% from general and administrative costs, and 20% from operating costs. Management anticipated approximately $4M of additional restructuring charges in the remainder of fiscal 2015.
Management said the turnaround was taking longer than expected. It cited limited program news and insufficiently impactful marketing during the 2015 winter season, and planned substantive product and program innovation with improved marketing for the 2016 winter season.
Management expected fiscal 2015 technology investment of approximately $85M, down from $115M in fiscal 2014, and projected a $60M annual run rate exiting fiscal 2015.
Management believed cash, forecast cash generation, cost savings, the revolver draw, and the anticipated 2016 winter launch would support obligations for the next 12 months, including the April 2016 maturity. It cautioned that there was no assurance obligations would be met and cited the ability to delay investment or reduce marketing if needed.
The company did not identify an impairment trigger after reviewing declines in equity and debt trading values, but warned that a material impairment charge could arise if the 2016 winter season underperformed or depressed trading values persisted into fiscal 2016.
Risks include significant leverage and debt service, declining recruitment and competition, successful execution of product, marketing and technology initiatives, foreign exchange exposure, seasonal performance, and potential impairment. A securities class action and related shareholder demand letters remained pending; management said it intended to defend the litigation and did not expect other ordinary-course matters to have a material effect, while noting outcomes are uncertain.
Management reported disclosure controls effective at the reasonable-assurance level and said the previously identified material weakness concerning franchise-rights accounting had been remediated. The filing reports no material changes to risk factors from the fiscal 2014 10-K/A.

Most important facts for investors to verify

Whether revenue, recruitment, paid weeks, and active subscribers stabilize, particularly in North America, and whether the 2016 winter program delivers the expected improvement.
Whether the $100M cost-savings target is achieved without undermining marketing effectiveness or customer growth, and the timing and total cost of restructuring.
Cash generation and liquidity relative to the $144.3M April 2016 debt maturity, including the effect of the post-quarter $48.0M revolver draw.
Debt repayment capacity, interest-rate exposure, leverage and refinancing prospects; the filing reports a 6.69:1.00 consolidated leverage ratio and debt largely maturing in fiscal 2020.
The effects of the franchise-rights restatement and remediation, and whether the material weakness remains resolved in subsequent reporting.
Potential impairment exposure, litigation developments, and the company’s ability to sustain reported results apart from debt-extinguishment gains and other non-GAAP adjustments.