WW International, Inc. — Q3 2014 Form 10-Q
Reporting period: Fiscal quarter ended September 27, 2014; comparisons are with the quarter ended September 28, 2013. Nine-month figures cover the corresponding year-to-date periods. Amounts are in U.S. dollars.
Business context and reporting period
Weight Watchers provides in-person meetings, online subscriptions and related products. From fiscal 2014, it reported four geographic segments: North America, United Kingdom, Continental Europe and Other. Management attributed continuing weakness to lower starting subscriber bases, weaker recruitment and a challenging competitive environment, including mobile apps and activity trackers.
Financial performance
| Metric | Q3 2014 | Q3 2013 | Nine months 2014 | Nine months 2013 |
|---|---|---|---|---|
| Revenue | $345.2 million | $396.3 million | $1,152.1 million | $1,358.0 million |
| Operating income | $91.4 million | $124.5 million | $257.0 million | $381.6 million |
| Net income attributable to WW International | $37.9 million | $60.3 million | $113.4 million | $173.9 million |
| Diluted EPS | $0.67 | $1.07 | $2.00 | $3.09 |
| Gross margin | 54.3% | 58.5% | 55.2% | 58.9% |
| Operating margin | 26.5% | 31.4% | 22.3% | 28.1% |
Q3 revenue fell 12.9% reported and 13.5% excluding currency effects; year-to-date revenue declined 15.2% reported and 15.9% on a constant-currency basis. Service revenue and product sales both declined. In Q3, total paid weeks were down 12.4%, ending active bases were down 12.5%, and global attendance fell 10.1% year over year. North America was the principal source of revenue and operating-income pressure; Continental Europe was comparatively resilient.
Lower gross margin reflected North American fixed-cost deleverage, promotional activity and compensation changes, as well as weaker Online revenue mix. Marketing expense declined 23.6% in Q3 and 17.7% year to date, while SG&A was nearly flat in Q3 and up 2.4% year to date. Interest expense rose 22.6% in Q3 and 17.2% year to date, reflecting higher borrowing costs, swap exposure and a $1.6 million financing-fee write-off.
For the first nine months, cash from operations was $221.3 million, down from $301.4 million; investing used $47.4 million and financing used $17.8 million. Cash increased $152.8 million to $327.4 million from fiscal year-end. Current assets were $439.0 million and current liabilities $378.4 million, yielding reported working-capital surplus of $60.6 million. The company noted it generally operates with negative working capital due in part to customer prepayments.
Total debt was $2.370 billion, including $30 million current, versus $2.388 billion at December 28, 2013. The revolving facility was reduced from $250 million to $50 million; $48.7 million remained available, with no revolver borrowings. Debt was variable-rate, substantially secured by company assets, and the reported consolidated leverage ratio was 4.96:1.00. Total deficit was $1.364 billion.
Material changes and unusual items
- Revenue declines persisted across meetings and Online, with lower active bases and recruitment particularly affecting North America. Q3 UK recruitment improved and turned positive year over year; Continental Europe Online activity helped offset meeting weakness.
- The company recorded $10.9 million of restructuring charges in the first nine months, with approximately $0.3 million of additional charges anticipated for the remainder of fiscal 2014. $3.0 million remained accrued at quarter-end.
- Acquiring an additional 45% of its Brazilian business in March brought ownership to 80% and produced a $10.5 million pretax gain. The company also acquired online fitness company Wello in April for approximately $9.0 million.
- The September credit-agreement amendment eliminated the revolver’s financial covenant and reduced its commitment to $50 million. Financing-fee write-off associated with the amendment increased Q3 interest expense by approximately $1.6 million.
- The quarterly dividend had been suspended in October 2013. No shares were repurchased under the company’s program during the reported nine-month period.
Outlook, risks and contingencies
Management expected fiscal 2015 to begin with lower active bases in meetings and Online than fiscal 2014. It estimated that this starting-base effect alone could reduce fiscal 2015 diluted EPS by approximately $0.55, and that continued healthcare and new-technology investment, while maintaining legacy systems, could affect EPS by a further approximately $0.26. The filing does not provide a full-year revenue or EPS forecast.
Management said operating cash flow and revolver availability should be sufficient for the next 12 months to fund anticipated capital expenditure, debt service and working-capital needs. Key risks identified include competitive pressure, ability to attract and retain members, execution of strategic initiatives, debt service and covenants, international and currency exposure, technology and privacy risks, seasonality, and acquisition integration.
A California wage-and-hour class action settlement of approximately $1.7 million had preliminary court approval; final approval was pending. A securities class action remained pending, with defendants’ motion to dismiss filed in October 2014; the company said it considered the claims meritless. Shareholder demand letters concerning related fiduciary-duty allegations were under review by a special committee. The company stated other ordinary-course litigation was not expected to have a material effect, while noting outcomes cannot be predicted with certainty.
Most important facts for investors to verify
- Whether recruitment, paid weeks and active subscriber bases stabilize, particularly in North America, and whether UK improvement continues.
- Whether FY2015 EPS headwinds of approximately $0.55 from lower starting bases and $0.26 from healthcare and technology spending are borne out.
- Debt repayment capacity, variable-rate exposure, the 4.96:1.00 leverage ratio, and refinancing needs, including the $296.3 million Tranche B-1 maturity in 2016.
- Progress and costs from restructuring, technology and healthcare initiatives, and the benefits of the Brazil and Wello acquisitions.
- Developments in the securities litigation, California settlement and shareholder demands.
- The filing’s non-GAAP reconciliation reports adjusted nine-month 2014 diluted EPS of $1.96, while the MD&A narrative states $1.97; verify the intended adjusted figure.