Herbalife Ltd. — Q3 2017 Form 10-Q
Reporting period: Three and nine months ended September 30, 2017; unaudited. Herbalife sells nutrition and personal-care products through independent Members, with a modified sales model in China. Comparisons below are against the corresponding 2016 periods unless stated otherwise. Amounts are in U.S. dollars.
Financial performance
| Metric | Q3 2017 | Q3 2016 | Nine months 2017 | Nine months 2016 |
|---|---|---|---|---|
| Net sales | $1,085.4 million | $1,122.0 million | $3,334.4 million | $3,443.4 million |
| Gross profit / margin | $870.0 million / 80.2% | $912.9 million / 81.4% | $2,695.6 million / 80.8% | $2,784.9 million / 80.9% |
| Operating income / margin | $119.3 million / 11.0% | $151.5 million / 13.5% | $468.0 million / 14.0% | $299.9 million / 8.7% |
| Net income | $54.5 million | $87.7 million | $277.3 million | $160.6 million |
| Diluted EPS | $0.66 | $1.01 | $3.26 | $1.87 |
| Operating cash flow | Not stated for quarter | Not stated for quarter | $404.4 million | $249.9 million |
- Q3 sales fell 3.3% (4.0% in local currency); worldwide Volume Points, a company sales-volume measure, declined 5.6%. Price increases partly offset lower volume. Nine-month sales fell 3.2% (2.5% in local currency), while Volume Points declined 4.2%.
- Q3 net income declined 37.9%; nine-month net income increased 72.7%. The nine-month comparison benefited from lower SG&A after $203.0 million of regulatory settlements in 2016, as well as tax benefits and higher China government grants.
- Q3 net interest expense rose to $38.4 million from $22.1 million; nine-month net interest expense rose to $106.5 million from $70.1 million. The company attributed the increase primarily to higher rates and borrowing under its new credit facility.
- Nine-month capital expenditures were $67.9 million, compared with $111.9 million. Management expected full-year 2017 capital expenditures of approximately $88–$108 million. Operating cash flow less reported cash purchases of property and equipment was approximately $333.7 million.
Liquidity, debt and capital allocation
- At September 30, cash and cash equivalents were $1,636.3 million, total debt carrying value was $2,280.7 million, and working capital was $1,415.3 million. Cash less debt was approximately negative $644 million.
- Cash increased from $844.0 million at year-end 2016, substantially alongside financing activity. The company reported $438.6 million net cash provided by financing for the first nine months, including $1,274.0 million of credit-facility borrowings, debt repayments, and $346.2 million of share repurchases.
- A February 2017 facility comprises a $1.3 billion term loan and a $150 million revolver. The term loan carried a 6.71% weighted-average facility rate at September 30; no revolver borrowings were outstanding. The facility requires a minimum $200 million consolidated cash balance and compliance with covenants; the company reported compliance. Management estimated a 1 percentage-point interest-rate change would affect annual interest expense by approximately $12.5 million.
- In October, after quarter-end, the company repurchased approximately 6.7 million shares for $457.8 million in a tender offer. Pro forma September 30 cash would have been $1,178.5 million; shareholders’ equity would have become a $246.1 million deficit. A contingent value right created a $7.3 million liability, subject to future fair-value changes.
Material changes and management commentary
- Results weakened in North America: Q3 regional sales declined 17.1%, and U.S. sales fell 18.0%. Management linked the decline to Members’ training and documentation work implementing the FTC settlement. The company said sales could remain pressured during the rest of 2017, while not expecting a long-term material adverse effect.
- Regional trends were mixed. Q3 sales grew 6.1% in EMEA, but declined 3.6% in South and Central America and 2.1% in China; Asia Pacific excluding China was nearly flat. South Korea was particularly weak, with sales down 19.8%; Russia and Indonesia reported growth.
- Gross margin fell 1.2 percentage points in Q3, reflecting foreign exchange, cost changes and country mix, partly offset by price increases and lower inventory write-downs. Nine-month margin was nearly unchanged.
- China government grants contributed $4.6 million in Q3 and $43.5 million year to date; future grants are not assured. Q3 results also included $3.0 million of FTC-order implementation costs, $3.3 million of regulatory inquiry expenses, and $1.1 million of costs related to public allegations. The filing identifies other unusual and non-cash items, including convertible-note and forward-transaction interest expense.
Risks, contingencies and outlook
- The 2016 FTC Consent Order requires U.S. sales documentation and other operational controls, imposes restrictions on Member practices, and provides for independent compliance audits for seven years. Failure to comply, or reduced eligible sales, could restrict distributor compensation and materially affect operations.
- The company reported ongoing tax disputes and assessments in Mexico, Brazil, India, Korea and other jurisdictions. It generally stated that losses were not probable; for certain Mexican matters it could not reasonably estimate a possible loss. Mexico VAT-related assets totaled $46.3 million, with refunds potentially delayed.
- The SEC and Department of Justice requested information about anti-corruption compliance in China; the company said it was cooperating and could not predict the outcome. A September 2017 purported class action alleged statutory and other violations; the company said it would defend the claims.
- Flooding damaged inventory at a Mexican warehouse. The company recorded an estimated loss and an equal insurance receivable for the portion it could estimate; additional loss, if any, was not reasonably estimable at quarter-end.
- No specific revenue or earnings guidance is provided in the supplied filing text. Management cited Member recruitment and retention, sales-volume trends, foreign exchange, regulation, and market penetration as important uncertainties.
Investor verification priorities
- Track whether U.S. sales and Volume Points stabilize as Members adapt to FTC-order processes, and review compliance-auditor findings and eligible-sales calculations.
- Reconcile cash growth to borrowings and subsequent tender-offer spending; assess remaining liquidity against the $200 million covenant and upcoming debt maturities.
- Evaluate the sustainability of nine-month earnings, including China grants, discrete tax benefits, and the comparison with 2016 regulatory settlements.
- Monitor debt costs, variable-rate exposure, and the $1.15 billion convertible notes due in 2019, including potential cash-settlement and dilution implications.
- Follow the status and potential exposure of tax disputes, the China anti-corruption inquiry, the class action, and the Mexican warehouse insurance recovery.