WW International, Inc. — Q2 2014 Form 10-Q
Reporting period: Second quarter and six months ended June 28, 2014; comparisons are with periods ended June 29, 2013. Amounts are in U.S. dollars; financial statement amounts below are in millions unless noted.
Business context
Weight Watchers provides meetings, Online subscriptions and related products through company-owned operations, franchisees and licensees. Management attributed the period’s weaker results to lower starting member bases, recruitment pressure and a challenging competitive environment, particularly in North America. The company reorganized reporting into North America, United Kingdom, Continental Europe and Other segments.
Financial performance
| Metric | Q2 2014 | Q2 2013 | Six months 2014 | Six months 2013 |
|---|---|---|---|---|
| Revenue | $397.5 | $470.9 | $806.9 | $961.7 |
| Gross profit / margin | $225.8 / 56.8% | $283.7 / 60.3% | $448.7 / 55.6% | $567.4 / 59.0% |
| Operating income / margin | $114.6 / 28.8% | $154.0 / 32.7% | $165.6 / 20.5% | $257.1 / 26.7% |
| Net income attributable to WWI | $54.0 | $64.9 | $75.5 | $113.7 |
| Diluted EPS | $0.95 | $1.15 | $1.33 | $2.02 |
- Q2 revenue fell 15.6% reported and 16.8% at constant currency; first-half revenue fell 16.1% reported and 16.9% at constant currency. Service revenue declined 14.4% in Q2, while product sales and other fell 19.9%.
- Q2 total paid weeks declined 14.4%; period-end active Monthly Pass subscribers fell 10.7% to 1.4 million and Online subscribers fell 14.1% to 2.0 million. Global attendance was down 12.9% to 10.3 million.
- Q2 marketing expense declined 34.7%, but SG&A rose 10.2%. Lower revenue, compressed gross margin and higher SG&A as a share of revenue drove lower operating income. First-half operating income declined 35.6%.
- Interest expense increased 16.1% in Q2 and 14.3% in the first half. Reported first-half results included a $10.5 million pre-tax gain on the Brazil acquisition; the prior-year comparison included a $21.7 million debt-extinguishment charge.
- Management’s non-GAAP adjusted diluted EPS was $0.98 for Q2 versus $1.39 a year earlier, and $1.29 for the first half versus $2.26. Adjustments include restructuring, specified tax items, the Brazil gain and, for 2013, the debt-extinguishment charge.
Cash, debt and liquidity
- Cash was $276.5 million at June 28, 2014, up from $174.6 million at fiscal year-end. First-half operating cash flow was $145.5 million (versus $178.0 million); investing cash outflow was $32.0 million and financing cash outflow was $11.9 million. Cash increased $101.9 million.
- Total debt was $2.376 billion, down $12 million from year-end; $30 million was current. The company had no revolving-facility borrowings, $248.4 million of unused commitments and $1.6 million in outstanding letters of credit. Reported consolidated leverage ratio was 4.73:1.00.
- Debt is variable-rate; $1.5 billion of interest-rate swaps hedge a portion. The effective average rate including swaps was approximately 4.92% at quarter-end. A 50-basis-point rate change was estimated to affect annual interest expense by about $4.4 million.
- Working capital was a $13.8 million surplus, compared with a $30.1 million deficit at year-end; excluding cash and current debt, the working capital deficit was $232.7 million. Management said operating cash flow and revolver availability should cover anticipated needs for the next 12 months.
Outlook, commentary and notable items
- Management expected to enter fiscal 2015 with lower starting active bases in meetings and Online than at the beginning of fiscal 2014. It estimated this lower base alone could reduce fiscal 2015 EPS by approximately $0.60, irrespective of recruitment trends. Continued healthcare and technology-platform investment was also expected to weigh on fiscal 2015 results. No overall fiscal 2015 EPS forecast was provided.
- The company recorded $10.2 million of first-half restructuring charges and expected approximately $1.8 million of additional charges in the remainder of fiscal 2014. It expected $4.3 million of the June-quarter restructuring liability to be paid in fiscal 2014, with the balance in fiscal 2015.
- In March, WWI increased its ownership of Brazilian VPM from 35% to 80%, began consolidating it and recorded the $10.5 million acquisition-related gain. In April it acquired Wello for $9.1 million, partly using $4.3 million of stock consideration.
- The quarterly dividend had been suspended in October 2013; no dividends were declared in the reported 2014 periods. Credit agreements include restrictive covenants; the leverage test on the revolver applies when borrowings exceed the specified threshold, and the company said leverage was expected to remain above 3.25:1.00 for the foreseeable future.
- Key risks cited include competition and recruitment weakness, ability to develop appealing products and execute initiatives, debt service and covenants, technology and privacy/security risks, foreign exchange and international operations, and acquisition integration. The securities class action remained pending; the company said it believed the claims were without merit. A California wage-and-hour class settlement was preliminarily approved, with final approval hearing scheduled for December 2014.
Important facts for investors to verify
- Whether recruitment, paid weeks and active subscriber trends improve, especially in North America, and whether the new marketing and promotional initiatives are effective.
- Whether the estimated fiscal 2015 EPS headwind of approximately $0.60 from lower starting active bases is borne out, and the scale and returns of planned healthcare and technology investment.
- Debt-service capacity, variable-rate exposure, leverage and covenant headroom, including the terms and availability of the revolving facility.
- Final purchase accounting and performance for the Brazil and Wello acquisitions, and the timing and total cost of restructuring.
- Developments in the securities litigation and final approval and payment of the California settlement; also monitor the effect of New York sales tax on Online products.