Herbalife Ltd. — Q1 2012 Form 10-Q
Reporting period: Three months ended March 31, 2012; unaudited. Herbalife sells nutrition and personal-care products primarily through independent distributors. It reported 2.8 million distributors and operations in 81 countries. Comparisons below are against Q1 2011 unless otherwise stated.
Financial and operating performance
| Metric | Q1 2012 | Q1 2011 | Change |
|---|---|---|---|
| Net sales | $964.2 million | $795.1 million | +21.3%; +24.3% in local currency |
| Gross profit / margin | $768.0 million / 79.7% | $632.3 million / 79.5% | Margin +0.2 percentage points |
| Operating income / margin | $154.1 million / 16.0% | $123.4 million / 15.5% | Income +24.9% |
| Net income | $108.2 million | $88.0 million | +22.9% |
| Diluted EPS | $0.88 | $0.70 | +25.7% |
| Operating cash flow | $120.4 million | $108.0 million | +$12.4 million |
| Capital expenditures | $24.9 million | $28.3 million | -$3.4 million |
Net sales growth was broad-based: Asia Pacific excluding China rose 30.5%, South and Central America 32.1%, North America 26.2%, China 24.5%, and Mexico 12.7%; EMEA was essentially flat. Weight Management remained the largest product category at $601.8 million, up 20.7%. Worldwide Volume Points increased 23.6%, and average active sales leaders rose 23.1%.
Royalty overrides were $317.5 million, or 32.9% of sales, versus 33.2%. SG&A was $296.4 million, or 30.8% of sales in both periods. The effective tax rate rose to 29.2% from 27.1%. Management attributed growth principally to daily-consumption distribution methods, distributor engagement and recruiting; higher operating expenses and taxes partly offset the resulting contribution-margin growth.
Balance sheet, liquidity and capital allocation
- At March 31, cash and cash equivalents were $305.9 million; current assets $845.0 million and current liabilities $565.8 million. Working capital was $279.1 million, up from $220.1 million at December 31, 2011.
- Total debt was approximately $231.8 million, including $228.0 million drawn on the $700 million revolving credit facility. Undrawn facility capacity was $466.3 million. The facility matures March 2016; its weighted-average borrowing rate was 1.72%. The company reported compliance with covenants.
- Financing cash outflows included $35.2 million of dividends and $72.9 million of share repurchases. The company repurchased approximately 743,300 shares for about $50.0 million at an average $67.24 per share; $427.9 million remained authorized under the repurchase program.
- Management said operating cash flow and available facility borrowings should meet working-capital, capital-spending and foreseeable liquidity needs for the next 12 months and thereafter.
Outlook, risks and unusual items
- Management expected 2012 capital expenditures of approximately $110–$120 million. It gave no specific revenue or earnings guidance in the supplied filing text and cautioned that first-quarter results are not necessarily indicative of full-year results.
- Venezuelan currency access remains restricted and uncertain. Herbalife recorded $2.1 million of Q1 foreign-exchange losses using an alternative legal exchange mechanism. Its approximately $40.8 million of Bolivar cash was largely remeasured at the SITME rate; management warned that a 40% less favorable exchange rate applied to that cash could reduce its reported value by $16.5 million and produce a corresponding operating-profit loss. Repatriation and realizable U.S.-dollar value remain uncertain.
- Tax disputes include a Mexican assessment of approximately $90 million, previously nullified but potentially subject to re-issuance and under litigation; a Spanish assessment of approximately $4.3 million; a Brazilian assessment of approximately $4.7 million; and an Italian court order of approximately $7.1 million, which Herbalife appealed. The company had not accrued losses for these matters, citing its assessment that loss was not probable; it said possible losses could not be reasonably estimated in key cases.
- A Belgian court ruled in November 2011 that Herbalife’s Belgian operation violated local law concerning pyramid schemes. The company appealed in March 2012 and said it believed the ruling was flawed; it was also considering changes pending appeal. An adverse outcome could affect its network-marketing model.
- Key risks include distributor recruitment and retention, regulation and legal challenges to network marketing, product safety and adverse publicity, foreign-exchange exposure, China licensing and regulatory uncertainty, supplier reliance, and tax and product-liability claims. The filing also identifies a pending adidas dispute concerning use of Herbalife’s Tri-Leaf mark on sports-related goods.
- Other notable items: the company declared a further $0.30-per-share dividend on April 30, payable May 30, 2012; it extended its LA Galaxy sponsorship through 2022, with estimated remaining commitments of approximately $44 million for 2013–2022. Management concluded disclosure controls were effective and reported no material change in internal control over financial reporting during the quarter.
Most important facts for investors to verify
- Whether distributor engagement and daily-consumption methods sustain sales growth, particularly given regional weakness in EMEA and Taiwan and the lower China sales-leader count.
- Whether Venezuelan currency restrictions, exchange rates and cash convertibility materially affect earnings, reported cash or the ability to repatriate funds.
- Developments and potential exposure in the Mexican, Spanish, Brazilian and Italian tax disputes, and the Belgian network-marketing appeal.
- Cash generation relative to dividends, repurchases, planned capital expenditures and facility borrowing; confirm covenant headroom and the continuing cost of variable-rate debt.
- Whether margin improvement persists as product mix, pricing, inventory write-downs, foreign exchange and distributor-related expenses change.