Herbalife Ltd. — Q1 2015 Form 10-Q
Reporting period: Three months ended March 31, 2015; comparisons are with Q1 2014 unless otherwise noted. Herbalife sells nutrition and wellness products through a global network of 4.1 million independent Members across 91 countries. The interim financial statements are unaudited.
Financial performance
| Metric | Q1 2015 | Q1 2014 | Change |
|---|---|---|---|
| Net sales | $1,105.4 million | $1,262.6 million | Down 12.5% |
| Gross profit / margin | $890.0 million / 80.5% | $1,011.4 million / 80.1% | Profit down 12.0%; margin up 0.4 percentage points |
| Operating income / margin | $135.6 million / 12.3% | $127.5 million / 10.1% | Income up 6.4% |
| Net income | $78.2 million | $74.6 million | Up 4.8% |
| Diluted EPS | $0.92 | $0.74 | Up 24.3% |
| Operating cash flow | $161.1 million | $190.6 million | Down $29.5 million |
Net interest expense rose to $21.5 million from $14.9 million, principally reflecting the 2014 convertible-note issuance. Effective tax rate declined to 30.1% from 31.8%. Reported diluted EPS also reflects a lower diluted weighted-average share count (84.6 million versus 100.8 million).
Balance sheet and liquidity
- Cash and cash equivalents were $715.5 million at March 31, versus $645.4 million at year-end 2014. Total assets were $2.39 billion; shareholders’ deficit was $301.2 million.
- Total debt was $1.81 billion, including $825.0 million under the secured credit facility and $1.15 billion principal of 2.00% convertible notes due 2019. The balance sheet classified $419.4 million of debt as current, up from $100.0 million at year-end, primarily reflecting scheduled credit-facility maturities.
- Working capital was positive at $259.3 million, down from $518.6 million at year-end. Management said cash, operating cash flow, available borrowing capacity and capital-market access should meet expected working-capital, investment and debt-service needs.
- Q1 investing cash outflow was $16.7 million; financing cash outflow was $31.1 million. Capital expenditures were $15.4 million on an accrued basis. Management expected full-year 2015 capital expenditures of approximately $120–$140 million.
Material changes and operating trends
- Worldwide Volume Points, a company-defined sales-volume indicator, declined 4.4%. Net sales in local currency were essentially flat excluding the Venezuela remeasurement impact. Management attributed the reported sales decline mainly to currency translation (approximately 16.3% negative) and lower volume (4.4% negative), partly offset by price increases and country mix.
- China was a growth standout: sales increased 20.9% to $164.2 million and Volume Points rose 24.8%. Sales declined in the Primary Reporting Segment by 16.5% reported, with local-currency results affected by Venezuela; excluding Venezuela’s remeasurement impact, local-currency sales declined 3.1%.
- Sales declined across North America (8.5%), Mexico (13.4%), South and Central America (33.9%), EMEA (11.7%) and Asia Pacific excluding China (13.4%). EMEA Volume Points increased 13.0% despite the reported sales decline, reflecting currency effects. South Korea, Brazil and Venezuela were notable sources of weakness.
- Management said changes to the Marketing Plan—including longer-term Sales Leader qualification, first-order limits and, in Mexico, restricting field sales for qualification—temporarily disrupted purchasing and sales activity, while intended to improve training, retention and business sustainability. Average Active Sales Leaders increased 8.4% worldwide; the reported re-qualification retention rate was 54.2%, excluding China, Venezuela and Argentina.
- Gross margin improved 0.4 percentage points, while royalty overrides fell to 29.2% of sales from 30.2%. SG&A declined to $431.4 million from $502.1 million, largely because foreign-exchange losses were lower year over year, including a smaller Venezuela-related loss.
Outlook, risks and unusual items
- No earnings or revenue guidance was provided. Management noted that quarterly results are not necessarily indicative of full-year results and identified recruiting and retaining Members, sales-leader activity, market penetration, new products and currency movements as important drivers.
- Venezuela moved to the SIMADI exchange rate for remeasurement, 192 Bolivars per U.S. dollar at quarter-end. Q1 included a $32.6 million foreign-exchange loss, $1.4 million of inventory write-downs and a $2.3 million impairment of Venezuelan bonds. The company had limited ability to exchange or repatriate Bolivars; further devaluation or use of less favorable exchange mechanisms could materially affect results. Venezuela represented about 1% of Q1 sales.
- Other identified Q1 items included a $12.8 million foreign-exchange gain associated mainly with Euro/U.S. dollar exposure, $4.3 million of professional and advisory expenses related to public allegations, and $3.4 million of FTC investigation-related expenses. Management also cited $10.5 million of unfavorable non-cash interest expense related to the convertible notes and forward transactions.
- Regulatory and legal matters include the FTC’s ongoing Civil Investigative Demand and a Department of Justice request for information. The company said it is cooperating and cannot predict the scope, duration or outcome. A proposed settlement in the Bostick matter included $15 million cash and up to $2.5 million of product returns; final court approval was pending. A securities class action had been dismissed with leave to amend; the company intended to defend it. Mexican tax/VAT disputes and delayed VAT refunds also remain relevant; the company reported $54.1 million of Mexico VAT-related assets.
- After quarter-end, on May 4, the credit facility was amended: the revolving facility maturity was extended to March 2017, borrowing capacity was reduced (to an expected $425 million by September 30, 2015), and interest margins and restrictions on dividends and repurchases increased. The term loan still matures in March 2016. The amendment requires additional security and approximately $7 million of issuance costs.
- Other principal risks include Member recruitment and retention, scrutiny of the network-marketing model, product and advertising regulation, international currency and tax exposure, China licensing and regulatory uncertainty, competition, and product-liability or supply-chain issues. Management concluded disclosure controls were effective as of March 31, 2015, with no material change in internal control reported during the quarter.
Key facts for investors to verify
- Whether sales-volume trends and Member activity recover as Marketing Plan changes are absorbed, particularly in North America, Mexico, South Korea and Brazil, and whether China’s growth persists.
- The extent of future Venezuela currency losses, access to exchange mechanisms, ability to repatriate cash and progress toward local manufacturing.
- Available liquidity and refinancing capacity after the May 4 credit amendment, including the reduced revolver availability, higher future borrowing costs, covenant compliance and 2016 term-loan maturity.
- Developments in the FTC and DOJ inquiries, the Bostick settlement approval, securities litigation and Mexican tax/VAT matters, including potential cash or earnings effects.
- Whether projected 2015 capital expenditures of $120–$140 million and management’s liquidity expectations remain achievable amid sales, foreign-exchange and financing risks.