WW International, Inc. — Q2 2016 Form 10-Q
Reporting period: Three and six months ended July 2, 2016; comparisons are to the periods ended July 4, 2015. Amounts are in U.S. dollars; financial statement figures below are in millions except per-share data.
Business context and results
WWI operates meetings, digital subscription and related product businesses across North America, the United Kingdom, Continental Europe and other markets. Management’s transformation centers on cost discipline, repositioning the brand and offerings—including the Beyond the Scale program and SmartPoints—healthcare-channel growth and technology upgrades. The company said subscriber growth continued, with total end-of-period subscribers up 5.0% year over year in Q2.
| Metric | Q2 2016 | Q2 2015 | First half 2016 | First half 2015 |
|---|---|---|---|---|
| Revenue | $309.8 | $309.8 | $616.7 | $631.9 |
| Gross profit | $161.0 | $159.4 | $310.7 | $316.7 |
| Gross margin | 52.0% | 51.4% | 50.4% | 50.1% |
| Operating income | $73.7 | $70.6 | $87.3 | $88.6 |
| Operating margin | 23.8% | 22.8% | 14.2% | 14.0% |
| Net income attributable to WWI | $30.5 | $27.9 | $19.7 | $22.4 |
| Diluted EPS | $0.46 | $0.49 | $0.30 | $0.39 |
| Interest expense | $28.6 | $30.5 | $58.6 | $61.6 |
Financial position, cash flow and debt
- Six-month operating cash flow was $46.4 million, versus $26.3 million a year earlier. Investing activities used $19.9 million, including $15.2 million of capitalized software costs; financing activities used $153.9 million, mainly for debt repayment.
- Cash was $114.5 million at July 2, down $127.0 million from fiscal year-end. Current assets were $216.2 million and current liabilities $362.3 million, a $146.1 million working-capital deficit. WWI says subscription prepayments contribute to its customary negative working capital.
- Total debt principal was $2.080 billion: $2.032 billion under the Tranche B-2 term facility and $48 million drawn on the revolver. The company repaid the $144.3 million B-1 maturity on April 1. After quarter-end, it paid down $25 million of the revolver. The term loan matures in 2020; the revolver matures in 2018.
- Debt is variable-rate, substantially all assets secure the credit facility, and the credit agreement has customary restrictive covenants but no financial maintenance covenant. The reported net debt/EBITDAS ratio was 8.2x, against a management target below 4.5x by year-end 2018. The company reported trailing-twelve-month EBITDA of $240.8 million.
- A $1.5 billion interest-rate swap hedges part of variable-rate exposure. The swap liability was $62.2 million at quarter-end. Management estimated a 50-basis-point rate increase would raise annual interest expense by about $2.6 million; a 50-basis-point decrease would reduce it by about $0.2 million.
Material changes and management commentary
- Q2 revenue was flat as reported and up 0.7% on a constant-currency basis; first-half revenue fell 2.4% reported and 1.2% constant currency. Foreign exchange reduced revenue by $2.3 million in Q2 and $7.7 million in the first half.
- North America led Q2 growth: segment revenue rose 5.4% reported, while end-of-period subscribers increased 8.6%. UK and Continental Europe revenues fell 15.5% and 8.3%, respectively, as reported. Management attributed international weakness to lower subscriber bases, recruitment pressure and competition; it said revised advertising in key Continental European markets improved trends.
- Q2 operating income improved 4.5%, with lower SG&A and higher gross margin; first-half operating income declined 1.5%. First-half margin comparisons reflect increased marketing and SG&A as a share of revenue and weaker European performance.
- Q2 net income benefited from a $2.5 million reversal of a valuation allowance for foreign-loss tax benefits. The prior-year comparison included a $6.7 million Q2 debt-extinguishment gain; the first-half 2015 comparison included an $11.5 million gain and $6.0 million of restructuring charges. Diluted share count rose about 15% year over year, primarily following the Winfrey transaction, contributing to lower EPS despite higher Q2 net income.
- Fiscal 2016 revenue was forecast to be slightly below $1.2 billion. Management cited expected higher recruitments and stable retention, while estimating negative revenue impacts of about $20 million from lower incoming subscribers versus the prior year and $15 million from foreign exchange at then-current rates. It stated that cash, forecast revenue and cost controls should provide liquidity for obligations over the next 12 months.
Risks, contingencies and unusual items
- Management reported no impairment in its fiscal 2016 annual goodwill and indefinite-lived franchise-rights review. Brazil goodwill had only about 10% estimated fair-value headroom; its carrying amount was approximately $18.0 million, and management warned that relatively small assumption changes could trigger impairment.
- Risks identified include intense competition, ability to sustain recruitment and product appeal, execution of the transformation plan, substantial debt service and refinancing risk, foreign-exchange and international-market exposure, technology and privacy issues, seasonality, and litigation.
- The federal securities class action was dismissed in May 2016 and not appealed. A shareholder derivative suit and a putative class action alleging issues related to website and app disruptions remained pending; the company said it would defend them. Management did not expect ordinary-course legal matters to have a material effect, while noting outcomes cannot be predicted with certainty.
- The company’s quarterly dividend remains suspended. Management said it expects leverage to remain above the 3.25x threshold relevant to certain dividend and share-repurchase limits for the foreseeable future.
- Management concluded disclosure controls were effective at the reasonable-assurance level and reported no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether subscriber and recruitment momentum—particularly in North America—can offset ongoing weakness in the UK and Continental Europe and deliver the forecast revenue level.
- Debt reduction progress, cash generation, the 8.2x leverage position and the feasibility of the year-end 2018 leverage target; also verify the effect of variable rates and the limited remaining revolver availability at quarter-end.
- How much reported earnings and EPS depend on the one-time tax valuation-allowance release, prior-year debt gains and the higher share count.
- Brazil reporting-unit assumptions and impairment headroom, along with the status and potential exposure of the pending litigation.