Herbalife Ltd. — Q1 2014 Form 10-Q
Reporting period: Three months ended March 31, 2014; unaudited. Financial amounts below are in U.S. dollars. The company sells nutrition and personal-care products through a global network of independent Members and reported operations in 91 countries.
Financial performance
| Metric | Q1 2014 | Q1 2013 | Change |
|---|---|---|---|
| Net sales | $1,262.6 million | $1,123.6 million | +12.4%; +16.9% in local currency |
| Gross profit / margin | $1,011.5 million / 80.1% | $897.7 million / 79.9% | Margin +0.2 percentage points |
| Operating income / margin | $127.6 million / 10.1% | $168.9 million / 15.0% | Declined |
| Net income / diluted EPS | $74.6 million / $0.74 | $118.9 million / $1.10 | Net income -37.2% |
| Net interest expense | $15.0 million | $5.4 million | Higher, primarily from increased borrowings and the convertible notes |
| Operating cash flow | $190.6 million | $137.6 million | Increased |
| Capital expenditures, including accrued amounts and capital leases | $49.7 million | $24.9 million | Increased |
Net sales growth reflected higher Member engagement, recruiting, and adoption of daily-consumption distribution methods. Worldwide Volume Points rose 9.2%. China sales grew 98.2% and EMEA grew 24.6%; Asia Pacific excluding China declined 10.1%. Shipping and handling revenue fell to $106.5 million from $172.1 million, following a pricing-structure change; management said the change did not materially affect net sales or profitability.
Financial position and capital allocation
- At March 31, cash and cash equivalents were $1.262 billion, versus $973.0 million at year-end 2013. Working capital was $1.034 billion, up from $720.9 million.
- Total debt was $1.848 billion, comprising $912.5 million under the senior secured credit facility and $935.8 million carrying value for convertible notes. Cash exceeded current debt; the company reported $196.6 million of undrawn credit-facility capacity and compliance with its debt covenants.
- The company issued $1.15 billion of 2.00% convertible notes due 2019, with an initial conversion price of approximately $86.28 per share. The notes’ effective interest rate was approximately 6.2% because of the accounting discount.
- Q1 financing included $1.15 billion of note proceeds, $694.5 million of share repurchases, and $123.8 million paid for capped calls. The prepaid forward transaction covered approximately 9.9 million shares for settlement around the notes’ 2019 maturity and reduced shareholders’ equity. Equity fell to $42.1 million from $551.4 million at year-end.
- The company paid a $0.30-per-share quarterly dividend in March. On April 28, after quarter-end, the board announced termination of the quarterly dividend and a plan to use the cash for additional share repurchases. Through April 25, the company had repurchased approximately 4.5 million shares for about $255 million under trading plans.
Material changes and unusual items
- Venezuela foreign exchange: The company remeasured Bolivar-denominated balances at the SICAD I rate of 10.7 Bolivars per U.S. dollar, recording an $86.1 million foreign-exchange loss and reducing reported cash by approximately $96 million. A further $3.2 million impairment was recorded on Venezuelan bonds. Together, these items had an $89.3 million pretax adverse effect ($66.6 million after tax). Management said that applying the SICAD II rate of about 50 at quarter-end would have added approximately $99.3 million of foreign-exchange losses and reduced reported Venezuelan cash by a further $108 million.
- Expense growth: SG&A rose to $502.1 million from $364.7 million and increased to 39.8% of sales from 32.5%. The increase included higher Venezuela foreign-exchange losses, $30.2 million of higher China independent-service-provider expenses, and $12.7 million of higher salaries, bonuses, and benefits.
- Other specified costs: The company reported $4.3 million of legal, advisory, and other costs related to a hedge fund manager’s allegations, $0.9 million related to the FTC inquiry, and $5.8 million of unfavorable non-cash interest expense related to the convertible notes and forward transactions.
- The effective tax rate rose to 31.8% from 27.3%, partly because the company could not fully realize a tax benefit on Venezuela foreign-exchange losses and because of geographic income mix and fewer discrete tax benefits.
Management outlook, risks, and contingencies
- Management expected 2014 capital expenditures of approximately $175 million to $195 million. It expected the Winston-Salem manufacturing facility to become operational in June 2014; management noted that a delay could affect supply. No full-year earnings or revenue guidance is provided in the supplied filing text.
- Management expected cash, operating cash flow, and available credit to fund operations, planned capital spending, debt service, and foreseeable liquidity needs. It also described possible Venezuelan operating responses, including local sourcing, reduced imports, and limits on operating hours, order sizes, promotions, or events.
- Venezuela remained exposed to currency controls, restricted repatriation, inflation, price controls, possible further devaluation, product-supply constraints, and uncertainty over which exchange rate would apply. Bolivar-denominated cash may not be convertible at the reported rate.
- Legal and regulatory exposures include governmental inquiries into the network-marketing program, the ongoing Bostick litigation (the federal RICO claim was dismissed; remaining claims continue), and a securities class action filed April 14, 2014. The company said it intended to defend the actions. It also reported a $22 million Mexican tax assessment under appeal, an earlier Mexican assessment of approximately $88 million that was nullified but could be reissued, and other international tax matters. Management did not consider losses probable for the described tax matters and said possible losses could not be reasonably estimated.
- Other principal risks cited include Member recruitment and retention, product and network-marketing regulation, adverse publicity and share-price volatility, competition, China licensing and regulatory uncertainty, foreign exchange exposure, and dependence on third-party manufacturers. The company reported effective disclosure controls as of March 31, 2014 and no material internal-control changes during the quarter.
Important facts for investors to verify
- Whether Herbalife can access Venezuelan foreign-exchange mechanisms and whether future remeasurement rates trigger further losses or cash reductions.
- Underlying sales and Member trends by market, especially the Asia Pacific decline and the sustainability of China’s rapid growth; note that Venezuelan sales leaders were temporarily exempted from requalification.
- The effect of the new debt, share repurchases, and dividend termination on leverage, liquidity, interest expense, and per-share results.
- Developments in the FTC and other regulatory inquiries, Bostick and Awad litigation, and outstanding tax audits or assessments.
- Execution of the manufacturing expansion and the company’s projected $175 million to $195 million of 2014 capital expenditures.