Herbalife Nutrition Ltd. (NYSE: HLF) — Q2 2019 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2019. Financial statements are unaudited; amounts are in U.S. dollars unless indicated otherwise.
Business context and reporting period
Herbalife sells nutrition and personal-care products primarily through independent Members in 94 countries. China uses a distinct sales model through independent service providers and other channels. The company reports a Primary Reporting Segment (all regions except China) and China separately.
Financial performance and liquidity
| Metric | Q2 2019 | Q2 2018 | Six months 2019 | Six months 2018 |
|---|---|---|---|---|
| Net sales | $1,240.1m | $1,285.5m | $2,412.3m | $2,462.4m |
| Gross profit | $996.9m | $1,050.1m | $1,927.5m | $1,987.1m |
| Operating income | $153.1m | $191.8m | $316.1m | $347.6m |
| Net income | $76.5m | $94.4m | $172.8m | $176.5m |
| Diluted EPS | $0.54 | $0.62 | $1.20 | $1.15 |
| Operating cash flow | Not stated for quarter | Not stated for quarter | $114.8m | $344.9m |
- Q2 sales fell 3.5% year over year; six-month sales fell 2.0%. Excluding Venezuela, sales declined 3.4% and 1.7%, respectively. Local-currency growth excluding Venezuela was 0.7% for Q2 and 3.2% for the half year; reported local-currency growth rates are distorted by Venezuela’s hyperinflation and related pricing and currency effects.
- Gross margin was 80.4% in Q2 versus 81.7%; operating margin was 12.3% versus 14.9%; net margin was 6.2% versus 7.3%. For the six months, gross margin was 79.9% versus 80.7%, operating margin 13.1% versus 14.1%, and net margin 7.2% in both periods.
- Q2 diluted EPS decreased 13%; six-month diluted EPS increased from $1.15 to $1.20 despite slightly lower net income, reflecting fewer weighted-average shares.
- Operating cash flow for the first half dropped to $114.8m from $344.9m, reflecting lower income excluding non-cash items and unfavorable working-capital movements, notably inventory, accrued compensation, payables, and advance sales deposits. Cash purchases of property and equipment were $51.7m; accrued capital expenditures were $47.5m.
- At June 30, cash and cash equivalents were $1,254.9m; working capital was $393.4m, up from $216.2m at year-end 2018. Total assets were $3,078.6m and shareholders’ deficit was $534.2m.
- Debt carrying value totaled $2,469.9m, including $693.7m current and $1,776.2m long term. Outstanding principal was $2,612.7m. Cash was approximately $1,254.9m; the filing does not state a single net-debt figure. The $250m revolving facility had no borrowings, and the company was in compliance with its credit-facility covenants.
Material changes versus the prior comparable period
- China was the main weakness: Q2 sales declined 34.8% to $187.0m and six-month sales declined 32.4% to $337.4m. China Volume Points fell 37.3% in Q2 and 35.0% for the half year. Management attributed the decline to reduced Member activity and meetings during and after the government’s 100-day health-products review.
- The Primary Reporting Segment grew: Q2 sales increased 5.4% to $1,053.1m and first-half sales increased 5.7% to $2,074.9m. Asia Pacific and North America were notable sources of growth; South and Central America declined.
- Worldwide Volume Points were nearly flat in Q2 (+0.1%) and up 3.0% for the half year. Management noted Volume Points are a sales-trend proxy, not a GAAP revenue measure, and their assignment methodology is under review.
- Q2 net income fell 19.0%, driven chiefly by lower contribution margin from China, partly offset by lower SG&A and net interest expense. First-half net income declined 2.1%; lower China contribution and higher taxes were partly offset by lower SG&A, China grants, a CVR revaluation gain, and insurance recoveries.
- Operating cash flow was substantially lower than in the prior-year half, when cash generation benefited from more favorable working-capital movements. Share repurchases were $9.0m in the first half of 2019, versus $681.4m in the first half of 2018.
Outlook, management commentary, risks and unusual items
- Management expected the negative effects of China’s 100-day review to continue into the second half of 2019. The company expanded its China e-commerce platform late in Q2.
- Full-year 2019 capital expenditures were expected to be approximately $120m–$150m, mainly supporting information systems and Member-facing tools. No specific earnings or revenue guidance is provided in the supplied filing text.
- The $675m principal amount of 2.00% convertible notes due August 15, 2019 was classified as current debt. The company expected to pay the remaining principal in full at maturity; this was a significant near-term cash requirement.
- Unusual first-half items included $21.3m of China government grant income, $6.0m of insurance recoveries related to a 2017 Mexico warehouse flood, and a $14.4m non-cash gain from revaluing a contingent value right (CVR). The CVR liability was $1.3m at June 30 and was due to expire in August 2019 absent a qualifying transaction.
- The company accrued a $20m liability for a likely SEC civil penalty concerning disclosures about its China marketing plan; settlement terms and timing were not final. Separately, SEC and DOJ investigations into potential FCPA issues in China continued, with possible outcomes not reasonably estimable and potentially materially adverse.
- Other contingencies include contested tax assessments in Mexico, Brazil, India, and Korea; the company generally stated it did not consider losses probable, while several outcomes or potential losses could not be reasonably estimated. Mexico VAT-related assets totaled $31.3m, with refund timing and recovery subject to uncertainty.
- The FTC Consent Order requires ongoing compliance procedures and independent audits. Management said it did not expect a long-term material adverse effect, but acknowledged possible negative effects on U.S. business and Members and material consequences if the company fails to comply.
- Key broader risks include dependence on Member recruitment and retention, regulation and public perception of direct selling and products, foreign exchange and tariffs, China regulatory uncertainty, litigation and tax matters, and debt/covenant restrictions. Disclosure controls were deemed effective at June 30, 2019, with no material change in internal control reported during the quarter.
Most important facts for investors to verify
- Whether China sales and Member activity recovered after the 100-day review, and the impact of continued regulatory scrutiny.
- Whether the $675m 2019 convertible-note maturity was paid as expected and how it affected cash, refinancing, and capital allocation.
- Operating cash-flow trends and working-capital drivers, particularly inventory and compensation-related payments.
- Resolution and final cost of the SEC China marketing-plan matter, the ongoing FCPA investigations, and significant international tax disputes.
- Whether sales growth outside China can offset China weakness, foreign-exchange headwinds, and pressure on gross and operating margins.
- Compliance with the FTC Consent Order and credit-facility covenants, including any effect on U.S. compensation practices, Member activity, or repurchases.