WW International, Inc. — Q2 2012 Form 10-Q
Reporting period: Three and six months ended June 30, 2012, compared with the corresponding periods ended July 2, 2011. Amounts below are in U.S. dollars; financial statement amounts are shown in millions unless stated otherwise.
Business context and results
Weight Watchers operates through its WWI meetings and products business and WW.com Internet business. Results faced tough comparisons with fiscal 2011, when new program launches and marketing had driven unusually strong enrollment growth. In the second quarter, online growth largely offset weakness in meetings; for the first half, online and Continental European growth were offset by declines in North American and UK meetings.
Key financial metrics
| Metric | Q2 2012 | Q2 2011 | First half 2012 | First half 2011 |
|---|---|---|---|---|
| Revenue | $484.8 | $486.0 | $988.3 | $989.4 |
| Gross profit / margin | $293.5 / 60.6% | $287.2 / 59.1% | $581.9 / 58.9% | $570.3 / 57.6% |
| Operating income / margin | $153.5 / 31.7% | $155.3 / 32.0% | $256.3 / 25.9% | $291.1 / 29.4% |
| Net income attributable to WW International | $77.5 | $87.0 | $132.1 | $160.6 |
| Diluted EPS | $1.36 | $1.17 | $2.01 | $2.17 |
- Revenue mix and volumes: Q2 Internet revenue rose 28.3% to $135.6 million; online paid weeks increased 30.2%, and period-end active subscribers rose 26.4% to 2.3 million. Global meeting fees fell 7.8%, with meeting paid weeks down 4.7% and attendance down 9.6%. First-half Internet revenue rose 32.8% to $262.5 million, while meeting fees fell 7.0%.
- Margins and expenses: Higher-margin online revenue mix helped lift gross margin. Marketing expense increased 11.5% in Q2 and 25.3% in the first half, reflecting growth initiatives; SG&A was nearly flat in Q2 and up 2.9% in the first half. First-half operating margin declined 3.5 percentage points.
- Interest, taxes and unusual items: Q2 interest expense increased 58.2% to $23.8 million, mainly because of debt taken on to fund share repurchases and higher borrowing costs. Other expense included an investment write-off and foreign-currency effects. First-half results also included a $1.3 million debt-extinguishment charge. The effective tax rate was 38.5%, versus 38.0%.
- Cash flow and liquidity: First-half operating cash flow was $180.3 million, down 29.3% from $255.0 million. Capital expenditures were $25.8 million and capitalized software expenditures $12.2 million. Cash increased to $90.9 million from $47.5 million at year-end 2011. The company reported a $259.9 million working-capital deficit, including $152.9 million of current debt.
- Debt and capital structure: Total debt was $2.494 billion, compared with $1.052 billion at December 31, 2011; long-term debt was $2.341 billion. Debt was variable-rate, with a 2.84% average effective rate at June 30, excluding swaps. Interest-rate swaps hedged $697.8 million, leaving $1.796 billion of variable-rate debt unhedged. A 50-basis-point rate move was estimated to change annual interest expense by approximately $9 million. The company had $290.6 million of unused revolving commitments, net of letters of credit.
Material changes and capital transactions
- In March 2012, the company amended and extended its credit facility and borrowed approximately $1.449 billion in new term loans.
- It repurchased approximately 8.78 million shares in a tender offer and 9.50 million shares from Artal Holdings, both at $82 per share, for total repurchases of approximately $1.5 billion. The transactions were primarily debt-financed and reduced weighted-average diluted shares by 23.1% in Q2.
- Despite the lower share count, diluted EPS rose in Q2 to $1.36 from $1.17; first-half diluted EPS fell to $2.01 from $2.17 as lower earnings outweighed the buyback benefit.
- Reported revenue was nearly flat year over year, but excluding foreign exchange, revenue increased 2.3% in Q2 and 1.4% in the first half.
Outlook, risks and contingencies
- Management gave no specific numerical earnings or revenue guidance in the provided filing text. It stated that operating cash flow and revolving-credit availability should be sufficient for anticipated capital spending, debt service and working-capital needs over the next 12 months, and expected continued compliance with debt covenants.
- Management cited weaker enrollment and consumer confidence, ineffective UK meeting advertising, and execution challenges introducing Monthly Pass to part of the North American corporate business. It also described strategic marketing and technology investments intended to support growth.
- The UK self-employment tax dispute remained unresolved. The UK Court of Appeal granted permission to appeal, but no hearing date had been set. The company had paid HMRC approximately $30.0 million without prejudice and reported a remaining reserve of approximately $14.3 million; additional claims were being appealed.
- Other identified risks include competition and product appeal, marketing effectiveness, seasonality, foreign exchange and international operations, technology and privacy, franchise relationships, debt service and restrictive covenants, and possible conflicts with the majority owner. The company said it was in compliance with required debt tests at quarter-end.
Important facts for investors to verify
- Whether online subscriber and paid-week growth can continue and compensate for declining meeting enrollment, attendance and fees.
- Whether increased marketing and technology spending produces sustainable growth and improved operating margins.
- Debt repayment capacity, refinancing needs, covenant headroom and sensitivity to higher variable interest rates.
- Developments and potential financial exposure in the UK HMRC tax dispute, including whether the reported reserve remains adequate.
- The terms and effects of the large share repurchases, dividend capacity, and any implications of Artal Holdings’ position as majority owner.