WW International, Inc. — Q3 2017 Form 10-Q
Business context and reporting period. The company provides weight-management services through meetings and digital subscriptions, plus product sales and other activities. This unaudited report covers the three and nine months ended September 30, 2017; comparatives are the periods ended October 1, 2016.
Financial performance
| Metric | Q3 2017 | Q3 2016 | First 9 months 2017 | First 9 months 2016 |
|---|---|---|---|---|
| Revenue | $323.7M | $280.8M | $994.4M | $897.5M |
| Gross profit / margin | $177.1M / 54.7% | $144.3M / 51.4% | $530.2M / 53.3% | $455.0M / 50.7% |
| Operating income / margin | $91.4M / 28.2% | $66.8M / 23.8% | $217.8M / 21.9% | $154.1M / 17.2% |
| Net income attributable to WWI | $44.7M | $34.7M | $100.5M | $54.4M |
| Diluted EPS | $0.65 | $0.53 | $1.48 | $0.83 |
| Interest expense | $27.0M | $28.3M | $82.2M | $87.0M |
Revenue grew 15.3% in Q3 and 10.8% year to date; on a constant-currency basis, growth was 13.9% and 11.5%, respectively. Management attributed growth to higher service revenue across major markets. Online subscription revenue increased 27.1% in Q3 and 18.6% in the first nine months. Gross-margin expansion reflected improved leverage in meetings and Online and a mix shift toward Online, partly offset by lower high-margin licensing revenue.
Marketing expense was $30.3M in Q3 and $158.7M year to date; as a share of revenue it declined to 9.4% and 16.0%, respectively. SG&A was $55.4M and $153.7M, with increases primarily attributed to compensation and incentive costs. The effective tax rate was 30.5% in Q3 and 26.6% year to date, versus 10.3% and 18.6% in the comparative periods.
Cash flow, debt, and liquidity
- Operating cash flow for the first nine months was $184.8M, versus $93.9M a year earlier. Investing used $31.1M; financing used $88.4M, including a $73.0M cash payment to retire $75.5M of term-loan principal.
- Cash and equivalents were $178.2M at September 30, 2017, up from $108.7M at December 31, 2016. Current assets were $280.5M and current liabilities $293.2M, a $12.7M working-capital deficit. The company says negative working capital is characteristic of its subscription and commitment-plan model, with customer prepayments recorded as deferred revenue.
- Term-loan principal totaled $1,930.4M, all under the Tranche B-2 facility due April 2020; the balance-sheet current portion was $31.4M. Net debt, as defined by the company, was $1,738.1M. The revolving facility had no borrowings and $47.8M of available commitments, net of letters of credit.
- Debt is variable-rate; the term loan carried LIBOR plus a 3.25% margin. A $1.25B interest-rate swap hedged part of the exposure. Management estimated a hypothetical 50-basis-point rate increase would raise annual interest expense by about $3.4M.
- The company expected an approximately $11.2M cash-flow-sweep payment in Q2 2018. Its credit agreement has customary restrictions but no financial maintenance covenants; substantially all assets secure the facility.
Changes, outlook, and notable items
- For the first nine months, operating income increased 41.4% and attributable net income increased 84.8% year over year. Growth and margin gains were partly offset by higher SG&A and a higher effective tax rate.
- Management identified deleveraging as a capital-structure priority and targeted year-end 2018 net debt/EBITDAS below 4.5x, relying on improved operating performance and cash generation. At September 30, trailing-twelve-month EBITDAS was $328.3M and net debt/EBITDAS was 5.3x. These are non-GAAP measures.
- Year-to-date results included an $11.6M tax benefit related to cessation of the Spanish subsidiary’s operations, a $2.3M benefit from reversal of tax reserves following an updated transfer-pricing study, and a $1.6M gain on early extinguishment of debt. The prior-year comparison included substantial R&D and Section 199 tax benefits, making tax-rate and earnings comparisons less like-for-like.
- The annual impairment test found no impairment, but Brazil goodwill had only about 10% fair-value headroom; management cautioned that relatively small assumption changes could result in impairment.
- Mindy Grossman became President and CEO effective July 5, 2017. The filing identifies the CEO transition, competition, customer appeal and retention, marketing effectiveness, technology and privacy, debt and refinancing, international operations, foreign exchange, and litigation as risks.
- After quarter-end, on November 2, 2017, the Second Circuit affirmed dismissal of the Online Plus class action; the plaintiff could still seek rehearing or Supreme Court review within the stated deadlines. Management said other ordinary-course matters were not expected to have a material effect, while noting outcomes cannot be predicted with certainty.
- Management reported disclosure controls were effective at the reasonable-assurance level and no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether revenue, subscriber recruitment and retention gains—particularly in Online—persist, and how segment performance develops.
- Progress toward the 2018 leverage target, debt repayment capacity, the expected cash-flow sweep, and exposure to variable rates and refinancing needs.
- Underlying earnings and cash generation after considering discrete tax benefits, the debt-extinguishment gain, and working-capital movements.
- Brazil goodwill valuation assumptions and impairment headroom, as well as the execution and financial effects of the Spanish operations cessation.
- Potential effects of the CEO transition, customer-facing technology and privacy risks, and any further developments in litigation.