Business context and reporting period
WW International, Inc. (then Weight Watchers International, Inc.) filed this unaudited Form 10-Q for the quarter ended October 1, 2016, the third quarter of fiscal 2016. Comparisons are with the quarter ended October 3, 2015; nine-month comparisons cover the corresponding periods. The company sells meeting-based and digital weight-management subscriptions, products and related services.
Financial results and key metrics
Amounts below are in millions of dollars except per-share data and where noted.
| Metric | Q3 2016 | Q3 2015 | Nine months 2016 | Nine months 2015 |
|---|---|---|---|---|
| Revenue | $280.8 | $273.3 | $897.5 | $905.2 |
| Gross profit | $144.3 | $136.6 | $455.0 | $453.3 |
| Gross margin | 51.4% | 50.0% | 50.7% | 50.1% |
| Operating income | $66.8 | $63.1 | $154.1 | $151.7 |
| Net income attributable to WWI | $34.7 | $21.8 | $54.4 | $44.2 |
| Diluted EPS | $0.53 | $0.38 | $0.83 | $0.77 |
- Quarterly performance: Revenue rose 2.7% reported and 4.0% at constant currency. Operating margin increased to 23.8% from 23.1%. Net income attributable to WWI rose 59.1%, but included a substantial discrete tax benefit.
- Nine-month performance: Revenue declined 0.8% reported but rose 0.4% at constant currency. Operating margin was 17.2%, compared with 16.8% reported in the prior period; excluding prior-year restructuring charges, the comparable prior margin was 17.5%.
- Cash flow: For the first nine months, operating cash flow was $93.9 versus $52.9; investing cash use was $29.5 versus $32.8; financing cash use was $207.1 versus $104.9. Cash declined $142.5 from year-end 2015 to $99.0, principally reflecting debt repayments.
- Debt and liquidity: At October 1, principal debt was $2,026.5, entirely the variable-rate Tranche B-2 term loan due in 2020. The revolving facility had no borrowings, $48.2 of unused commitments and $1.8 of undrawn letters of credit. Current assets were $215.1 and current liabilities $313.7, a $98.6 working-capital deficit. Management said cash, forecast revenue and cost controls should provide sufficient liquidity for the next 12 months.
- Leverage and interest: Trailing-12-month EBITDAS was $242.5 and net debt/EBITDAS was 7.9x. Management targets a ratio below 4.5x by year-end 2018. Nine-month interest expense fell 5.2% to $87.0 as average debt declined. A 50-basis-point rate increase would add approximately $3.1 of annual interest expense; a comparable decrease was not expected to reduce interest expense due to the LIBOR floor.
Material changes versus the prior period
- North America drove quarterly growth: segment revenue increased 7.7%, and quarter-end subscribers rose 14.5%. Total quarter-end subscribers increased 10.1% company-wide. Management attributed momentum to the Beyond the Scale/SmartPoints program, promotions and the collaboration with Oprah Winfrey.
- International performance was weaker. Q3 UK revenue declined 21.1% and Continental Europe revenue declined 2.5%; UK meeting business faced direct competition. Nine-month revenue fell 17.4% in the UK and 9.7% in Continental Europe.
- Quarterly gross profit improved with North American efficiencies and meeting-volume leverage, partly offset by promotions and reduced contribution from high-margin licensing. Marketing expense rose 10.8% in Q3; nine-month marketing expense rose 2.0%.
- Debt repayments included $144.3 to retire the remaining B-1 term loan and $48.0 to repay revolver borrowings. The prior-year nine-month comparison included an $11.4 gain on early debt extinguishment and $7.1 of restructuring charges.
- Weighted-average diluted shares increased about 15% year over year, primarily reflecting the Winfrey transaction, which management said reduced Q3 EPS by $0.08 and nine-month EPS by $0.13.
Outlook, management commentary and risks
- Management forecast fiscal 2016 revenue of approximately $1.17 billion, supported by higher recruitments and stable retention, and estimated a $15 million negative foreign-exchange impact. Revenue growth may lag recruitment growth because of the subscription model.
- The multi-year transformation plan focuses on near-term performance and cost discipline, brand and product repositioning, healthcare-channel growth and organizational capabilities. The company reported $250 million of gross annualized expense reductions versus its fiscal 2012 cost base by the end of fiscal 2015.
- The company reported four consecutive quarters of recruitment growth and said quarter-end subscribers grew year over year in each quarter of fiscal 2016. Management noted that healthcare investment strategy had evolved toward demonstrating internal capabilities.
- CEO James R. Chambers resigned in September 2016. An interim office of the CEO was appointed while the company searched for a successor; the filing warns that a prolonged or disruptive transition could adversely affect operations and strategy.
- Interest-rate and foreign-currency exposure, heavy debt service, refinancing risk, competition, execution of the transformation, technology and privacy risks, seasonal demand, and potential asset impairment remain relevant risks. The annual impairment test found no impairment, but Brazil goodwill had only about 10% fair-value headroom, making results sensitive to assumptions.
- A $2.7 million out-of-period tax expense was recorded in Q3 to correct an old foreign-tax receivable; management said the prior-period error was immaterial. Q3 and nine-month tax benefits also included an $11.4 million research-credit and Section 199 benefit; the nine-month period included a $2.5 million valuation-allowance reversal.
- Legal matters included a derivative action with an agreement in principle to resolve and a putative class action concerning website and app glitches; the company intended to defend the latter. Management did not expect ordinary-course litigation to materially affect results, while noting outcomes cannot be predicted with certainty.
Most important facts for investors to verify
- Whether fiscal 2016 revenue approached the approximately $1.17 billion forecast, and how recruitment, retention and foreign exchange affected results.
- Whether North American subscriber gains and the transformation program offset continued weakness in the UK and Continental Europe.
- Cash generation, liquidity and debt-reduction progress against the 7.9x net debt/EBITDAS ratio and the 2018 target below 4.5x.
- The sustainability of earnings after separating discrete tax benefits, out-of-period tax adjustments, prior-year restructuring charges and debt-extinguishment gains.
- CEO succession, Brazil impairment headroom, interest-rate exposure and the status or potential financial effects of disclosed litigation.