WEIGHT WATCHERS INTERNATIONAL INC - 10-Q Quarterly Report

ý QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934

WEIGHT WATCHERS INTERNATIONAL, INC.
(Exact name of Registrant as specified in its charter)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ý No o

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act). Yes ý No o

		Page No.
PART I. FINANCIAL INFORMATION
Item 1.	Financial Statements
Unaudited Consolidated Balance Sheets as of April 3, 2004 and January 3, 2004	3
Unaudited Consolidated Statements of Operations for the three months ended April 3, 2004 and March 29, 2003	4
Unaudited Consolidated Statement of Changes in Shareholders' Equity for the three months ended April 3, 2004, and for the fiscal year ended January 3, 2004	5
Unaudited Consolidated Statements of Cash Flows for the three months ended April 3, 2004 and March 29, 2003	6
Notes to Unaudited Consolidated Financial Statements	7–20
Item 2.	Management's Discussion and Analysis of Financial Condition and Results of Operations	21
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	28
Item 4.	Controls and Procedures	28
PART II. OTHER INFORMATION
Item 1.	Legal Proceedings	30
Item 2.	Changes in Securities and Use of Proceeds and Issuer Purchases of Equity Securities	30
Item 3.	Defaults Upon Senior Securities	30
Item 4.	Submission of Matters to a Vote of Security Holders	30
Item 5.	Other Information	30
Item 6.	Exhibits and Reports on Form 8-K	30
Signatures	31
Exhibits

WEIGHT WATCHERS INTERNATIONAL, INC. AND SUBSIDIARIES
UNAUDITED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)

The accompanying notes are an integral part of the consolidated financial statements.

WEIGHT WATCHERS INTERNATIONAL, INC. AND SUBSIDIARIES
UNAUDITED CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)

		Three Months Ended
		April 3, 2004			March 29, 2003
Meeting fees, net		$	180,475		$	153,485
Product sales and other, net			100,892			97,994

	Revenues, net		281,367			251,479
Cost of revenues			130,956			113,278

	Gross profit		150,411			138,201
Marketing expenses			46,538			41,494
Selling, general and administrative expenses			21,657			17,293

	Operating income		82,216			79,414
Interest expense, net			4,400			10,086
Other (income)/expense, net			(3,733	)		3,113
Early extinguishment of debt			3,254			—

	Income before income taxes and cumulative effect of accounting change		78,295			66,215
Provision for income taxes			29,597			25,634

	Income before cumulative effect of accounting change		48,698			40,581
Cumulative effect of accounting change, net of tax			(11,941	)		—

	Net income	$	36,757		$	40,581

Basic Earnings Per Share:
	Income before cumulative effect of accounting change	$	0.46		$	0.38
	Cumulative effect of accounting change		(0.11	)		—

	Net income	$	0.35		$	0.38

Diluted Earnings Per Share:
	Income before cumulative effect of accounting change	$	0.45		$	0.37
	Cumulative effect of accounting change		(0.11	)		—

	Net income	$	0.34		$	0.37

Weighted average common shares outstanding:
	Basic		106,013			106,440

	Diluted		108,563			109,686

The accompanying notes are an integral part of the consolidated financial statements.

WEIGHT WATCHERS INTERNATIONAL, INC. AND SUBSIDIARIES
UNAUDITED CONSOLIDATED STATEMENTS OF CHANGES
IN SHAREHOLDERS' EQUITY
(IN THOUSANDS)

The accompanying notes are an integral part of the consolidated financial statements.

WEIGHT WATCHERS INTERNATIONAL, INC. AND SUBSIDIARIES
UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)

The accompanying notes are an integral part of the consolidated financial statements.

WEIGHT WATCHERS INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)

The accompanying consolidated financial statements include the accounts of Weight Watchers International, Inc., its majority-owned subsidiaries and entities required to be consolidated pursuant to Financial Accounting Standards Board Interpretation No. 46R, "Consolidation of Variable Interest Entities," ("FIN 46R"). The term "WWI" as used throughout this document is used to indicate Weight Watchers International and its majority-owned subsidiaries. The term "the Company" as used throughout this document is used to indicate WWI as well as entities required to be consolidated under FIN 46R. The consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America and include amounts that are based on management's best estimates and judgments. While all available information has been considered, actual amounts could differ from those estimates. The consolidated financial statements are unaudited but, in the opinion of management, reflect all adjustments (consisting of normal recurring adjustments and adjustments required upon adoption of FIN 46R) necessary for a fair presentation.

Management's Discussion and Analysis of Financial Condition and Results of Operation, which follows these notes, contains additional information on the results of operations, the financial position and cash flows of the Company. Those comments should be read in conjunction with these notes. The Company's Annual Report on Form 10-K for the fiscal year ended January 3, 2004 includes additional information about the Company, its results of operations, its financial position and its cash flows, and should be read in conjunction with this Quarterly Report on Form 10-Q.

On January 17, 2003, the Financial Accounting Standards Board ("FASB") issued Interpretation No. 46 ("FIN 46"), to clarify when an entity should consolidate another entity known as a variable interest entity ("VIE"). This standard required that, under certain circumstances, separate businesses with some common ownership be consolidated for financial reporting purposes. Upon adoption of the original FIN 46, we would not have met those circumstances, and we therefore would not have consolidated WeightWatchers.com's financial statements.

On December 24, 2003, the FASB issued FIN 46R, which completely replaced FIN 46. FIN 46R is applicable for financial statements issued for reporting periods after March 15, 2004. FIN 46R requires that an entity consolidate a VIE if that enterprise has a variable interest that will absorb a majority of the VIE's expected losses, will receive a majority of the VIE's expected residual returns, or both.

Based on the revisions in this regulation, the Company was required to reevaluate its relationship with its affiliate and licensee, WeightWatchers.com. The Company determined this entity was a variable interest entity and that the Company was its primary beneficiary. Accordingly, the Company has consolidated WeightWatchers.com effective April 3, 2004. Therefore, the Company's consolidated balance sheet at April 3, 2004 includes the balance sheet of WeightWatchers.com. All intercompany balances have been eliminated in consolidation. In accordance with the provisions of FIN 46R, the Company recorded a charge for the cumulative effect of this accounting change of $11,941 net of taxes for the quarter ended April 3, 2004. This charge reflects the cumulative impact to the Company's results of operations had WeightWatchers.com been consolidated since inception, September 1999. Effective at the beginning of the second fiscal quarter of 2004, the Company's consolidated statement of operations will include the results of WeightWatchers.com. See Notes 9 and 12 for further information regarding WeightWatchers.com.

Certain prior year amounts have been reclassified to conform to the current year presentation.

All acquisitions have been accounted for under the purchase method of accounting and, accordingly, earnings have been included in the consolidated operating results of the Company since the date of acquisition. During the first quarter of fiscal 2004 and the full year fiscal 2003, the Company acquired certain assets of its franchises as outlined below.

On November 30, 2003, the Company completed the acquisition of certain assets of its franchisees, Weight Watchers of Dallas, Inc. and Pedebud, Inc. (d/b/a Weight Watchers of Northern New Mexico), pursuant to the terms of a combined asset purchase agreement with these two entities (collectively "Dallas/New Mexico") and the Company. The purchase price was $27,200 plus assumed liabilities of $300, and was allocated to franchise rights ($26,874), property and equipment ($412), and inventory ($214). The acquisition was financed through cash from operations. Pro forma results of operations, assuming this acquisition had been completed at the beginning of each period presented, would not differ materially from the reported results.

Effective March 30, 2003, the Company completed the acquisition of certain assets of eight of the fifteen franchises of The WW Group, Inc. and its affiliates (the "WW Group") pursuant to the terms of an Asset Purchase Agreement executed on March 31, 2003 among the WW Group, The WW Group East L.L.C., The WW Group West L.L.C., Cuida Kilos, S.A. de C.V., Weight Watchers North America, Inc. and the Company. The purchase price for the acquisition was $180,700 plus assumed liabilities of $448 and acquisition costs of $866. The Company completed the purchase price allocation in the fourth quarter of 2003 as follows: franchise rights ($177,128), inventory ($2,741), prepaid expenses ($36) and property and equipment ($2,109). The acquisition was financed through cash and additional borrowings of $85,000 under a new Term Loan D under the Company's Credit Facility, as amended on April 1, 2003 (as defined in Note 4).

The following table presents unaudited pro forma financial information that reflects the consolidated operations of the Company and the acquired franchises of the WW Group as if the acquisition had occurred as of the beginning of fiscal 2003. The pro forma financial information does not give effect to any synergies that might have resulted nor any discontinued expenses from the acquisition of the WW Group. Such discontinued expenses are estimated by management to be approximately $3,100 for the three months ended March 29, 2003. These expenses relate to corporate expenses of the owners of the WW Group and other indirect expenses of non-acquired franchises for this period. This pro forma information does not necessarily reflect the actual results that would have occurred, nor is it necessarily indicative of future results of operations of the consolidated companies.

	Pro Forma
	For the three months ended March 29, 2003
Revenue	$	267,797
Net income	$	39,333
Diluted earnings per share	$	0.37

During fiscal 2003, the Company also completed the acquisition of franchises in Mexico and Hong Kong, as well as a third party entity, Easy Slim, for a total purchase price of $1,271, which was paid with cash from operations. As a result of these three acquisitions, the Company recorded goodwill of $395 and franchise rights acquired of $1,326. Pro forma results of operations, assuming these

acquisitions had been completed at the beginning of each period presented, would not differ materially from the reported results.

In accordance with SFAS No. 142, "Goodwill and Other Intangible Assets," the Company no longer amortizes goodwill or other indefinite lived intangible assets. The Company performed a fair value impairment test as of January 3, 2004 on its goodwill and other indefinite lived intangible assets and determined that no impairment was evident. Unamortized goodwill is due mainly to the acquisition of the Company by the H.J. Heinz Company in 1978. The balance in goodwill increased from January 3, 2004 to April 3, 2004, primarily due to additional transaction costs. Franchise rights acquired are due mainly to acquisitions of the Company's franchised territories. For the three months ended April 3, 2004, franchise acquisition costs decreased due to the impact of foreign currency fluctuations.

Also, in accordance with SFAS No. 142, aggregate amortization expense for finite lived intangible assets was recorded in the amounts of $273 and $213 for the three months ended April 3, 2004 and March 29, 2003, respectively.

The carrying amount of the Company's finite-lived intangible assets was as follows:

Estimated amortization expense on the Company's finite lived intangible assets for the next five fiscal years is as follows:

The Company's Credit Agreement, as amended on January 16, 2001, December 21, 2001, April 1, 2003 and August 21, 2003 (the "Credit Facility") consists of Term Loans, a Revolver and transferable loan certificate ("TLC").

In January 2004, the Company refinanced its Credit Facility as follows: the Term Loan A, Term Loan B, and the TLC in the aggregate amount of $454,180 were repaid and replaced with a new Term Loan B in the amount of $150,000 and borrowings under the Revolver of $310,000. In connection with this refinancing, available borrowings under the Revolver were increased from $45,000 to $350,000.

Due to the early extinguishment of the Term Loans resulting from this refinancing, we recognized expenses of $3,254 for the three months ended April 3, 2004, which included the write-off of unamortized debt issuance costs of $2,933 and $321 of fees associated with the transaction.

Virginia (State or other jurisdiction of incorporation or organization		11-6040273 (I.R.S. Employer Identification No.)
175 Crossways Park West, Woodbury, New York 11797-2055 (Address of principal executive offices) (Zip code)
Registrant's telephone number, including area code:		(516) 390-1400

			April 3, 2004			January 3, 2004
ASSETS
CURRENT ASSETS
	Cash and cash equivalents		$	37,367		$	23,442
	Receivables, net			21,024			18,545
	Inventories, net			30,854			39,110
	Prepaid expenses and other current assets			27,016			33,528

		TOTAL CURRENT ASSETS		116,261			114,625
Property and equipment, net				17,992			15,747
Franchise rights acquired				496,196			496,261
Goodwill				23,797			23,779
Trademarks and other intangible assets, net				4,703			2,454
Deferred income taxes				96,228			109,799
Deferred financing costs and other noncurrent assets				6,822			7,023

		TOTAL ASSETS	$	761,999		$	769,688

LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES
	Portion of long-term debt due within one year		$	1,500		$	15,554
	Accounts payable			21,807			22,287
	Accrued interest			1,758			2,358
	Accrued liabilities			57,374			52,820
	Income taxes payable			37,462			24,624
	Deferred revenue			30,900			16,527

		TOTAL CURRENT LIABILITIES		150,801			134,170
Long-term debt				433,433			454,320
Other				—			10

		TOTAL LIABILITIES		584,234			588,500
SHAREHOLDERS' EQUITY
	Common stock, $0 par; 1,000,000 shares authorized; 111,988 shares issued and outstanding			—			—
	Treasury stock, at cost, 6,409 shares at April 3, 2004 and 5,639 shares at January 3, 2004			(89,064	)		(48,421	)
	Deferred compensation			(341	)		(214	)
	Retained earnings			261,928			223,557
	Accumulated other comprehensive income			5,242			6,266

		TOTAL SHAREHOLDERS' EQUITY		177,765			181,188

		TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY	$	761,999		$	769,688

		Common Stock
					Treasury Stock								Accumulated Other Comprehensive Income (Loss)
					Treasury Stock					Deferred Compensation						Retained Earnings
		Shares	Amount		Shares		Amount			Deferred Compensation						Retained Earnings			Total
Balance at December 28, 2002		111,988	$	—	5,711		$	(23,061	)				$	(3,873	)	$	73,482		$	46,548
Comprehensive Income:
	Net income																143,941			143,941
	Translation adjustment, net of taxes of $4,116													7,733						7,733
	Change in fair value of derivatives accounted for as hedges, net of taxes of $1,687													2,406						2,406

Total Comprehensive Income																				154,080

Stock options exercised					(856	)		3,455									(1,452	)		2,003
Tax benefit of stock options exercised																	7,319			7,319
Purchase of treasury stock					784			(28,815	)											(28,815	)
Restricted stock issued to employees											(267	)					267			—
Compensation expense on restricted stock awards											53									53

Balance at January 3, 2004		111,988	$	—	5,639		$	(48,421	)	$	(214	)	$	6,266		$	223,557		$	181,188
Comprehensive Income:
	Net income																36,757			36,757
	Translation adjustment, net of taxes													(1,122	)					(1,122	)
	Change in fair value of derivatives accounted for as hedges, net of taxes													98						98

Total Comprehensive Income																				35,733

Stock options exercised					(346	)		1,397									(514	)		883
Tax benefit of stock options exercised																	1,945			1,945
Purchase of treasury stock					1,116			(42,040	)											(42,040	)
Restricted stock issued to employees											(163	)					163			—
Compensation expense for restricted stock issued to employees											36									36
Cumulative effect of accounting change																	20			20

Balance at April 3, 2004		111,988	$	—	6,409		$	(89,064	)	$	(341	)	$	5,242		$	261,928		$	177,765

			Three Months Ended
			April 3, 2004			March 29, 2003
Cash provided by operating activities			$	85,174		$	101,471

Investing activities:
	Capital expenditures			(1,017	)		(1,332	)
	Repayments from equity investment			4,917			—
	Other items, net			(100	)		(246	)

		Cash provided by/(used for) investing activities		3,800			(1,578	)

Financing activities:
	Net decrease in short-term borrowings			(1,209	)		(1,415	)
	Net proceeds from revolver			270,000			—
	Payments of long-term debt			(454,555	)		(3,672	)
	Proceeds from new term loan			150,000			—
	Premium paid on extinguishment of debt and other costs			(321	)		—
	Proceeds from stock options exercised			883			840
	Repurchase of treasury stock			(42,040	)		—
	Deferred financing costs			(2,534	)		—

		Cash used for financing activities		(79,776	)		(4,247	)

Effect of exchange rate changes on cash/cash equivalents and other				(966	)		(160	)

Net increase in cash and cash equivalents				8,232			95,486
Cumulative effect of accounting change				5,693			—
Cash and cash equivalents, beginning of period				23,442			57,530

Cash and cash equivalents, end of period			$	37,367		$	153,016

	April 3, 2004				January 3, 2004
	Gross Carrying Amount		Accumulated Amortization		Gross Carrying Amount		Accumulated Amortization
Deferred software cost	$	3,950	$	2,318	$	1,879	$	1,206
Trademarks		7,705		6,935		7,600		6,879
Non-compete agreement		1,200		900		1,200		875
Website development costs		10,666		9,336		—		—
Other		4,003		3,332		4,003		3,268

	$	27,524	$	22,821	$	14,682	$	12,228

Remainder of 2004	$	1,681
2005	$	1,556
2006	$	683
2007	$	198
2008	$	119