Herbalife Nutrition Ltd. — 2019 Form 10-K
Reporting period: Fiscal year ended December 31, 2019. The filing also reports fourth-quarter results. Unless stated otherwise, amounts are U.S. dollars.
Business context
Herbalife sells nutrition and personal-care products through independent Members in 94 countries. Its direct-selling model relies on Member recruitment, retention, product retailing and coaching. Formula 1, its leading product line, represented approximately 30% of net sales. The company had approximately 4.7 million Members at year-end.
Financial results and liquidity
| Metric | FY 2019 | FY 2018 |
|---|---|---|
| Net sales | $4,877.1 million | $4,891.8 million |
| Gross profit / gross margin | $3,919.1 million / 80.4% | $3,972.5 million / 81.2% |
| Operating income / operating margin | $568.1 million / 11.7% | $683.1 million / 14.0% |
| Net income / diluted EPS | $311.0 million / $2.20 | $296.6 million / $1.98 |
| Operating cash flow | $457.5 million | $648.4 million |
| Capital expenditures | $110.2 million | $88.2 million |
| Cash and cash equivalents at year-end | $839.4 million | $1,198.9 million |
| Total debt at year-end | $1,803.0 million | $2,453.8 million |
| Working capital at year-end | $523.8 million | $216.2 million |
Net sales declined 0.3% year over year; management reported a 3.1% local-currency increase excluding Venezuela. Worldwide Volume Points, a company sales-volume indicator, rose 3.0%. Higher sales in the primary reporting segment were offset by a sharp decline in China. Net income increased 4.9%, despite lower operating income, reflecting lower interest expense, lower taxes and favorable year-over-year non-operating comparisons. Gross margin fell 0.8 percentage point.
Fourth-quarter net sales were $1,220.3 million, versus $1,186.6 million a year earlier; net income was $56.7 million versus $48.9 million, and diluted EPS was $0.40 versus $0.34.
Cash from operations fell by $190.9 million, driven mainly by unfavorable working-capital movements and lower net income excluding non-cash items. Financing activities used $713.0 million, while cash declined $359.5 million year over year. The company reported no material off-balance-sheet arrangements. Its shareholders’ deficit was $390.0 million at year-end.
Material changes and operating developments
- China: Net sales decreased 25.4% to $752.0 million and Volume Points fell 25.7%. Management attributed the weakness largely to the Chinese government’s 100-day health-products review, which curtailed Member activities and meetings.
- Growth elsewhere: Asia Pacific net sales rose 18.6%, North America 8.1%, and EMEA 2.1%. South and Central America declined 13.4%, including substantial currency effects; Mexico sales increased 1.2% while Volume Points declined 4.1%.
- Debt and capital allocation: The company repaid $675 million of 2019 convertible notes at maturity in August 2019 and amended its secured term loan in December, reducing the Term Loan B interest-rate margin. It made no open-market share repurchases in 2019 and has not paid cash dividends since 2014.
- Manufacturing and investment: Company facilities produced approximately 60%–65% of worldwide inner-nutrition products. Management expected 2020 capital expenditures of approximately $130 million to $170 million.
Outlook, risks and unusual items
- The filing gives no quantified earnings or revenue guidance. Management said the coronavirus outbreak in China could materially affect first-quarter and full-year 2020 results, but its extent and duration could not be reasonably estimated at the filing date.
- The company recorded $40 million of accrued liability for ongoing SEC and DOJ FCPA investigations concerning China. It said the investigations’ scope and outcome, and any loss beyond the accrual, could not be estimated reliably.
- A separate SEC settlement over disclosures concerning the China marketing plan was reached in September 2019. Herbalife neither admitted nor denied the allegations and paid a $20 million civil penalty in October.
- The company accrued a $19 million loss for a Mexican VAT assessment after unfavorable court decisions; it continued to challenge the matter. It also disclosed significant pending tax assessments and audits in several jurisdictions, with outcomes uncertain.
- The FTC Consent Order requires extensive U.S. compliance measures, an independent compliance auditor for seven years, and restrictions on claims and certain Nutrition Club activities. The company said it believed it was compliant, but warned that compliance costs or effects on Member activity and sales could be adverse.
- Other principal risks include direct-selling and product regulation, Member retention and conduct, reliance on China and other international markets, foreign-exchange movements, product concentration, variable-rate debt and covenants, and supply-chain or cybersecurity disruption.
The company reported that its independent auditor issued an unqualified opinion on the financial statements and internal control over financial reporting; management also concluded controls were effective at December 31, 2019.
Important facts for investors to verify
- Whether China sales and Member activity recover after the government review, and the effect of coronavirus-related restrictions.
- The reconciliation of reported sales and currency effects, particularly Venezuela’s disproportionate impact on consolidated comparisons.
- The status and potential financial exposure of the FCPA investigations, tax audits and assessments, including the Mexico VAT dispute.
- Debt maturities, leverage-covenant headroom, variable-rate exposure and the company’s ability to sustain cash generation while meeting capital needs.
- The durability of growth in Asia Pacific and North America, and the ongoing declines or transitions in China and parts of South and Central America.
- Member retention, retail demand and the effect of FTC Consent Order compliance on compensation, sales practices and operating costs.