Herbalife Nutrition Ltd. — Q1 2018 Form 10-Q
Reporting period: Three months ended March 31, 2018; unaudited. Herbalife sells nutrition and wellness products through independent members globally, with a distinct China distribution model. The company changed its name from Herbalife Ltd. on April 24, 2018.
Financial performance
| Metric | Q1 2018 | Q1 2017 |
|---|---|---|
| Net sales | $1,176.9 million | $1,102.1 million |
| Gross profit / margin | $937.0 million / 79.6% | $897.5 million / 81.4% |
| Operating income | $155.8 million | $143.8 million |
| Income before taxes | $91.5 million | $113.6 million |
| Net income | $82.1 million | $85.2 million |
| Diluted EPS | $1.08 | $0.98 |
| Operating cash flow | $156.2 million | $175.5 million |
- Sales increased 6.8% in U.S. dollars and 7.5% in local currency; excluding Venezuela, local-currency sales rose 1.4%. Price increases were the principal reported driver. Worldwide Volume Points, a company sales-volume indicator, declined 0.2%.
- Gross margin fell 1.8 percentage points, reflecting foreign exchange, manufacturing and sourcing costs, inventory write-downs, and mix, partly offset by price increases. Net margin was 7.0%, versus 7.7%.
- Interest expense, net rose to $39.9 million from $30.2 million. The effective tax rate declined to 10.3% from 25.0%, primarily due to discrete tax benefits and geographic income mix.
- Diluted EPS rose despite lower net income, alongside a reduction in diluted weighted-average shares to 76.3 million from 86.7 million.
Liquidity, debt, and capital allocation
- Cash and cash equivalents were $1,330.2 million at March 31, 2018; cash, cash equivalents, and restricted cash totaled $1,347.0 million for cash-flow reporting. Working capital was $1,040.2 million.
- Debt carrying value was $2,211.4 million, including $102.3 million current debt; scheduled principal payments totaled $2,435.2 million. The $1.3 billion term loan carried a 7.15% weighted-average rate; no revolving-facility borrowings were outstanding. The company reported compliance with debt covenants and a $200 million minimum cash requirement.
- Q1 financing included issuing $550 million of 2.625% convertible notes due 2024 and repurchasing $475 million principal of 2.00% convertible notes due 2019 for $583.5 million, including accrued interest. The transactions generated a $13.1 million debt-extinguishment loss. The 2019 notes had $675 million principal remaining.
- Operating cash flow declined year over year. Capital expenditures were $14.6 million in the quarter; management expected full-year 2018 capital expenditures of approximately $110–$140 million. This is the filing’s stated expenditure expectation, not earnings guidance.
Material changes and operating trends
- Primary Reporting Segment sales increased 8.8% to $964.7 million; China sales declined 1.6% to $212.2 million. China Volume Points fell 22.5%, primarily compared with unusually high March 2017 orders ahead of a price increase. EMEA and Asia Pacific sales grew 18.3% and 11.8%, respectively; South Korea, Taiwan, and Brazil were weaker markets.
- China government grants contributed $16.2 million of other operating income, versus none in Q1 2017. Management said future grants are not assured.
- Other expense of $24.4 million included an $11.3 million loss from revaluing the contingent value right (CVR) issued in the 2017 tender offer and the $13.1 million debt-extinguishment loss.
- Herbalife adopted revenue recognition Topic 606 in 2018 using the modified retrospective method. Opening retained earnings decreased $2.3 million; adoption reduced Q1 reported sales by $8.0 million and net income by $0.6 million versus the stated “without adoption” presentation. Prior-period figures were not restated.
Outlook, risks, and contingencies
- Management said it expected operating cash flows, cash, available credit, and capital-market access to provide sufficient working capital for the next twelve months and thereafter. It also noted that results for the quarter are not necessarily indicative of full-year results.
- The FTC Consent Order requires U.S. business and compensation controls and independent compliance audits for seven years. Management did not expect a long-term material adverse impact, but warned that sales, member activity, costs, or results could be harmed if compliance is inadequate or the business adjusts adversely.
- The SEC and Department of Justice investigation into China anti-corruption compliance remained ongoing; the company could not predict its scope, duration, or outcome. A China customs audit covering 2015–2017 also remained ongoing, with possible loss not reasonably estimable.
- Significant unresolved tax disputes include Mexican VAT assessments, Brazilian tax assessments, Indian VAT matters, and a Korean customs assessment already paid and under appeal. The company generally stated it did not consider losses probable; for several matters it could not reasonably estimate a possible loss range. Mexico VAT-related assets totaled $39.9 million, whose recovery depends on refunds or offsets.
- Other risks include the direct-selling regulatory environment and member retention, China licensing and regulatory uncertainty, foreign exchange and Venezuela restrictions, product liability, and the company’s substantial debt and convertible-note obligations. The company reported no material off-balance-sheet arrangements.
- After quarter-end, the company announced a modified Dutch auction tender offer for up to $600 million of shares at $98–$108 per share. Shareholders approved a two-for-one stock split; reported per-share figures had not been restated.
Important facts for investors to verify
- Whether sales and member activity stabilize, particularly in China and regions affected by regulatory or marketing-plan transitions; assess Volume Points alongside reported sales and pricing effects.
- Whether gross-margin pressure, inventory write-downs, and foreign-exchange effects persist, and how much earnings depend on China grants and other non-recurring or valuation items.
- Debt repayment and refinancing capacity, including the 2019 convertible-note maturity, variable-rate exposure, covenant headroom, and cash held by foreign subsidiaries.
- Developments in FTC Consent Order compliance, the China anti-corruption investigation, customs review, and material tax disputes; potential outcomes are uncertain and several loss ranges are not estimable from the filing.
- Completion and funding of the announced tender offer, the effects of the stock split, and any resulting change in share count, leverage, or liquidity.