WW INTERNATIONAL, INC. quarterly report, Q3 FY2018

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WW International, Inc. — Q3 2018 Form 10-Q

Reporting period: Three and nine months ended September 29, 2018. Amounts below are in U.S. dollars; financial figures are generally in millions unless noted. The company’s interim financial statements are unaudited.

Business context and performance

WW provides digital subscriptions, in-person workshops combined with digital services, and related products. Management attributed growth to higher digital recruitment and retention, including continued success of the WW Freestyle program. Revenue is reported across North America, Continental Europe, the United Kingdom, and Other.

Financial results and key metrics

  • Q3 revenue: $365.8, up 13.0% year over year (14.0% in constant currency). Service revenue rose to $312.0; product sales and other revenue were $53.8.
  • Q3 profit and margins: Gross profit was $215.4, up 21.6%; gross margin increased to 58.9% from 54.7%. Operating income was $118.9, up 30.1%, and operating margin rose to 32.5% from 28.2%. Net income attributable to WW was $70.1 versus $44.7; diluted EPS was $1.00 versus $0.65.
  • First nine months: Revenue was $1,183.7, up 19.0% reported and 17.1% in constant currency. Gross profit was $681.2, up 28.5%, with a 57.5% margin versus 53.3%. Operating income was $308.6, up 41.7%, with a 26.1% margin versus 21.9%. Net income attributable to WW was $180.0 versus $100.5; diluted EPS was $2.57 versus $1.48.
  • Digital and membership indicators: Q3 digital subscription revenue increased 33.2% to $143.3, while Digital + Studio fees increased 1.8% to $168.7. End-of-period subscribers totaled 4.19 million, up 24.9% year over year; digital subscribers were 2.74 million.
  • Cash flow: Nine-month operating cash flow was $254.6, compared with $184.8. Investing used $45.0, including $11.9 of capital expenditures, $20.1 of capitalized software spending, and $3.1 for the Kurbo acquisition. Financing used $70.7, including scheduled debt payments and revolver repayments. Cash increased $136.7 to $219.8.
  • Liquidity: Current assets were $336.1 and current liabilities $312.0, producing working capital of $24.1, versus a $134.0 deficit at fiscal 2017 year-end. Cash was $219.8, and the revolving facility had $148.7 available, net of $1.3 in undrawn letters of credit. Management said these resources and expected operating cash flows should cover obligations for the next 12 months.
  • Debt: Principal debt totaled $1,782.3: $1,482.3 under the term loan and $300.0 of 8.625% senior notes; the revolver was undrawn. Net debt was $1,525.5 and net debt/Adjusted EBITDAS was 3.6x, both company-reported non-GAAP measures. The weighted average debt rate including swaps was 7.42% at quarter-end, versus 7.34% at fiscal 2017 year-end. The company reported covenant compliance.

Material changes versus comparable periods

  • Q3 growth was led by North America and Continental Europe. Q3 North America revenue rose 14.1% and Continental Europe 19.3%; UK revenue was essentially flat, while Other declined 8.2% reported.
  • Management attributed margin expansion primarily to operating leverage and a mix shift toward the higher-margin Digital business. Marketing spending increased 17.2% in Q3, reflecting digital marketing and brand investment; SG&A increased 10.1%, partly due to compensation and strategic initiatives.
  • Interest expense rose 31.5% in Q3 and 30.4% year to date, primarily reflecting the higher-cost debt structure following the November 2017 refinancing. The refinancing replaced prior facilities with new term debt and $300 million of 8.625% notes.
  • The effective tax rate declined to 15.0% in Q3 from 30.5%, and to 9.8% year to date from 26.6%. Current-year results included tax benefits from stock-based compensation, audit reserve reversals, favorable return adjustments, and the cessation of Mexican operations.

Outlook, risks, contingencies, and unusual items

  • The filing provides no specific revenue, earnings, or subscriber guidance. Management described winter as the business’s most important recruitment season and said advertising spending is generally concentrated in winter.
  • Management highlighted competition, execution of new initiatives and marketing, technology and privacy risks, international and foreign-exchange exposure, seasonality, and substantial debt and debt-service obligations. The company estimated that a hypothetical 75-basis-point rate increase would raise annual interest expense by approximately $1.7 million, after considering its swap and LIBOR floor.
  • Brazil remains a goodwill impairment sensitivity: its reporting-unit fair value exceeded carrying value by approximately 10%, and a relatively small assumption change could trigger further impairment. The company recorded a $13.3 million Brazil goodwill impairment in fiscal 2017; no impairment was recorded in the first nine months of 2018.
  • The company acquired substantially all assets of Kurbo Health for $3.1 million in August 2018. It also recorded a $48.6 million opening-retained-earnings reduction on adopting intra-entity tax guidance, related to an intellectual-property transfer, and a $2.5 million increase to retained earnings from an accounting election for Tax Act effects.
  • Accounting for the Tax Act transition tax remained provisional; WW reduced its estimate by $0.7 million in Q3 and continued evaluating GILTI tax treatment. Adoption of the new lease standard is expected to materially affect the balance sheet, but the impact was still being evaluated.
  • Management said pending and threatened ordinary-course legal matters were not expected to have a material adverse effect, while noting outcomes cannot be predicted with certainty. Artal owned approximately 22.2% of outstanding shares and may significantly influence company matters. WW paid no dividend and reported no open-market repurchases under its authorization during the nine-month period.

Most important facts for investors to verify

  • Whether digital subscriber growth and recruitment translate into durable retention, revenue, and operating cash flow, particularly through the winter season.
  • Debt reduction, interest expense, the 3.6x net leverage measure, revolver availability, and ongoing compliance with debt covenants and cash-flow-sweep terms.
  • The sustainability of margin gains amid higher marketing and strategic spending, and the extent to which tax benefits contributed to reported earnings and EPS growth.
  • Brazil reporting-unit assumptions and headroom, and the balance-sheet impact of adopting the lease standard in fiscal 2019.
  • Completion of the Tax Act accounting, including transition-tax and GILTI assessments, and any material developments in legal matters or other disclosed risks.