WW INTERNATIONAL, INC. quarterly report, Q3 FY2013

WW International, Inc. — Q3 2013 Form 10-Q

Business context and period. Weight Watchers International reported unaudited consolidated results for the 13 weeks ended September 28, 2013, and the first nine months of fiscal 2013, compared with periods ended September 29, 2012. The company operates two reportable segments: WWI, principally meetings and related businesses, and WW.com, its internet-based businesses. Dollar amounts below are in millions unless otherwise stated.

Financial performance and liquidity

Metric	Q3 2013	Q3 2012	Nine months 2013	Nine months 2012
Revenue	$393.9	$430.6	$1,346.0	$1,418.9
Gross profit / margin	$230.0 / 58.4%	$255.8 / 59.4%	$788.4 / 58.6%	$837.7 / 59.0%
Operating income / margin	$124.5 / 31.6%	$132.0 / 30.7%	$381.6 / 28.4%	$388.3 / 27.4%
Net income	$60.3	$67.4	$173.9	$199.4
Diluted EPS	$1.07	$1.20	$3.09	$3.19

For the nine months, adjusted non-GAAP net income was $187.3 million and adjusted diluted EPS was $3.32, excluding a $21.7 million pretax debt-extinguishment charge ($13.3 million after tax, or $0.24 per diluted share).
Nine-month operating cash flow was $301.4 million, versus $290.9 million; investing cash outflow was $131.4 million, including $78.4 million for franchise acquisitions; financing cash outflow was $59.1 million.
Cash and cash equivalents were $181.3 million at September 28, 2013, versus $70.2 million at fiscal 2012 year-end. Current assets were $304.4 million and current liabilities $384.2 million, leaving a working-capital deficit of $79.8 million.
Total debt was $2.394 billion, including $24.0 million current and $2.370 billion long-term. The company had no revolver borrowings and $248.8 million of unused revolving commitments. Debt was variable-rate; reported average rate excluding swaps was 3.65%.

Material changes versus prior periods

Q3 revenue declined 8.5% and operating income declined 5.7%; net income fell 10.5% and diluted EPS fell 10.8%. For the first nine months, revenue declined 5.1%, operating income 1.7%, and net income 12.8%.
Meetings were the principal source of weakness: Q3 global meeting fees fell 11.0%, global meeting paid weeks fell 11.2%, and attendance fell 15.5%. In the first nine months, global meeting fees fell 8.1% and paid weeks fell 9.9%.
Internet revenue grew 1.0% in Q3 and 6.2% for the first nine months, but Q3 Online paid weeks declined 2.6% and period-end active Online subscribers declined 5.3% year over year to 1.9 million.
Q3 marketing expense fell 29.6%, helping operating margin rise to 31.6% despite lower revenue and gross margin. Nine-month marketing expense fell 17.6%; SG&A increased 3.8%.
Interest expense rose 15.8% in Q3 and 26.8% for the first nine months, reflecting higher rates and, for the nine-month comparison, higher average debt following prior-year share repurchases. Diluted weighted-average shares for the first nine months were down 9.8% year over year, partly supporting EPS.
WWI Q3 revenue and operating income were $267.3 million and $41.9 million, versus $305.7 million and $60.5 million. WW.com revenue and operating income were $126.6 million and $82.6 million, versus $125.0 million and $71.5 million.

Outlook, management commentary, risks and unusual items

Management said recruitment weakness and competitive pressure—including activity monitors and free apps—were affecting both meetings and Online. Paid weeks declined 6.6% in Q3; management expected Online paid-week declines to continue in Q4 and anticipated equal or greater competitive pressure entering fiscal 2014.
Management warned that lower starting active bases and continued negative recruitment trends could result in lower fiscal 2014 revenue. No specific fiscal 2014 revenue or earnings guidance was provided.
Cost savings, principally marketing reductions, partly offset declining revenue. Management did not expect further marketing-spend reductions in fiscal 2014 and expected its improved U.S. service-provider compensation program to add about $23 million of annual operating expense, with approximately $8 million recognized in fiscal 2013.
On October 30, 2013, after quarter-end, the company suspended its quarterly cash dividend. It estimated annual cash savings of approximately $39 million, intended for financial flexibility, strategic initiatives and future debt repayment.
On April 2, 2013, the company refinanced its debt with $300 million of Tranche B-1 term loans, $2.1 billion of Tranche B-2 term loans and a $250 million revolver. It incurred approximately $45 million of fees and recorded a $21.7 million extinguishment charge. The facilities are secured by substantially all company assets and contain customary restrictions; the leverage covenant applies to the revolver only when borrowings exceed 20% of commitments.
Interest-rate exposure remains material. At quarter-end, $1.9265 billion of variable-rate debt was unhedged against the then-effective $467.5 million swap; a new $1.5 billion forward-starting swap was to take effect March 31, 2014. Management estimated that a 50-basis-point rate change would alter annual interest expense by approximately $9.6 million, excluding that new swap.
Franchise acquisitions totaled $78.4 million of cash paid in the first nine months. Two additional franchise acquisitions closed October 28, 2013, for stated net purchase prices of approximately $5.2 million and $0.3 million.
Management said ordinary-course legal matters were not expected to have a material effect, while noting outcomes cannot be predicted with certainty. The filing reported no material change in risk factors and no material change in internal control over financial reporting.
The company revised the prior-year cash-flow presentation for certain cash/receivable and foreign-currency items; it said the revisions were not material individually or in aggregate and did not affect previously reported balance sheets, income statements or comprehensive income.

Important facts for investors to verify

Whether meeting recruitment, paid weeks and attendance stabilize, particularly in NACO and the UK, and whether Online subscriber declines persist.
Whether marketing savings can continue to offset revenue pressure without further spend reductions, and how the service-provider compensation increase affects margins.
Debt-service capacity, variable-rate exposure, refinancing terms and covenant restrictions, especially given the company’s high leverage and suspended dividend.
Whether adjusted earnings excluding the refinancing charge provide a useful comparison with GAAP results; review the reconciliation and the charge’s cash versus noncash components.
How acquired franchise territories affect reported meeting revenue, franchise-related revenue and future cash requirements; confirm subsequent acquisition accounting and purchase-price allocations.