Herbalife Nutrition Ltd. — Q2 2018 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2018. Unaudited results; amounts in U.S. dollars unless noted. Herbalife sells nutrition and personal-care products through independent Members globally, with a distinct China operating model.
Financial performance
| Metric | Q2 2018 | Q2 2017 | Six months 2018 | Six months 2017 |
|---|---|---|---|---|
| Net sales | $1,285.5M | $1,146.9M | $2,462.4M | $2,249.0M |
| Gross profit / margin | $1,050.1M / 81.7% | $928.1M / 80.9% | $1,987.1M / 80.7% | $1,825.6M / 81.2% |
| Operating income / margin | $191.8M / 14.9% | $204.9M / 17.9% | $347.6M / 14.1% | $348.7M / 15.5% |
| Net income / diluted EPS | $94.4M / $0.62 | $137.6M / $0.81 | $176.5M / $1.15 | $222.8M / $1.30 |
| Net interest expense | $44.3M | $37.9M | $84.2M | $68.1M |
| Operating cash flow | — | $344.9M | $277.1M |
Q2 sales grew 12.1% reported and 28.1% in local currency; management attributed the reported increase to higher volume and pricing, partly offset by unfavorable currency translation, China sales-timing effects, and country mix. Worldwide Volume Points rose 12.0% in Q2 and 5.9% year to date, though the company cautioned that 2018 adjustments in Mexico and parts of South and Central America affect comparability. For the six months, sales rose 9.5% reported and 18.0% in local currency.
Balance sheet, debt and liquidity
| Metric | June 30, 2018 | December 31, 2017 |
|---|---|---|
| Cash and cash equivalents | $839.4M | $1,278.8M |
| Total assets | $2,421.5M | $2,895.1M |
| Total debt, carrying value | $2,200.7M | $2,268.1M |
| Current portion of debt | $744.3M | $102.4M |
| Shareholders’ deficit | $(779.4)M | $(334.7)M |
Working capital shifted from positive $953.5M at year-end to negative $133.9M, primarily reflecting lower cash after the May tender offer and reclassification of the 2019 convertible notes as current. The company reported no revolver borrowings and was in compliance with debt covenants. Its credit facility requires at least $200M of consolidated cash; the facility’s weighted-average rate was 7.34%, up from 6.79% at year-end. A 1-percentage-point rate change, assuming borrowing balances remain constant, would change annual interest expense by approximately $11.8M.
Operating cash flow was $344.9M for the first half. Investing used $33.0M; financing used $722.6M, including $685.6M of share repurchases. Cash, cash equivalents and restricted cash ended the period at $855.1M. The company repurchased approximately 11.4M shares in its May tender offer for $600M ($52.50 per share), leaving $113.3M of authorization. It expects 2018 capital expenditures of approximately $100M–$120M.
Material changes and notable items
- Net income declined 31.4% in Q2 and 20.8% for the first half despite sales growth. Higher SG&A, lower China government grants, increased taxes, and higher interest expense were key pressures.
- China government grant income was $1.7M in Q2 and $17.9M in the first half, versus $38.9M in each comparable 2017 period. Future grants are not assured.
- SG&A increased $67.0M in Q2, including higher China service-provider fees and labor costs. SG&A was 39.7% of Q2 sales versus 38.6% a year earlier.
- Q2 gross margin improved 76 basis points, but first-half gross margin declined 48 basis points, with currency and manufacturing/sourcing costs among the cited factors.
- Other expense included a $4.7M Q2 loss on revaluation of the contingent value right (CVR). First-half other expense also included a $13.1M loss on extinguishing $475M principal of 2019 convertible notes.
- In March, the company issued $550M of 2.625% convertible notes due 2024 and used the proceeds with cash to repurchase $475M principal of 2.00% notes due 2019 for a total purchase price of $583.5M, including accrued interest. The remaining 2019 notes had $675M principal and were classified as current.
- The company adopted ASC 606 in 2018 using the modified retrospective method. It reduced opening retained earnings by $2.3M; the reported Q2 net-income effect was nil, and the first-half effect was a $0.6M reduction.
- A two-for-one stock split was approved and effected in May 2018; share and per-share amounts in the filing reflect the split.
Outlook, risks and contingencies
Management said it expects operating cash flow, available credit and capital-market access to support working capital, expected capital expenditures and foreseeable liquidity needs. It was evaluating a refinancing of the senior secured credit facility. The filing provides no earnings or revenue guidance; results to date are not necessarily indicative of full-year performance.
Management cited improving volume trends in North America, EMEA and parts of Asia, while South and Central America remained challenged and results were mixed across Asia Pacific. Mexico tariffs on U.S.-imported products could pressure sales or require price increases. Foreign exchange remains a material risk: the strong dollar weighed on reported results, and Venezuelan currency restrictions and devaluation continue to constrain operations.
Key legal and regulatory exposures include the seven-year FTC consent-order compliance program, which requires U.S. sales documentation, independent audits and restrictions on distributor practices; the company said it did not expect a long-term material adverse effect but warned noncompliance could materially harm results. The SEC and Department of Justice investigation into China anti-corruption compliance remained ongoing, with outcome and duration unknown. Tax disputes and audits include Mexico VAT assessments, Brazilian tax assessments, an Indian VAT assessment, a paid Korean customs assessment under appeal, and an ongoing China customs audit. Management generally stated it had not accrued losses where it considered loss not probable; potential outcomes could not always be reasonably estimated. A Florida purported class action and product-liability claims were also disclosed.
Management reported effective disclosure controls as of June 30, 2018, with no material change in internal control over financial reporting during the quarter.
Most important facts for investors to verify
- Whether the company can refinance or otherwise address the $675M principal of 2019 notes and the $775M of scheduled 2019 debt principal, while maintaining covenant compliance and adequate liquidity.
- Whether operating cash flow can sustain capital spending and debt service after substantial share repurchases; confirm the impact of the tender offer on cash and working capital.
- Whether sales and volume growth persist without reliance on price increases, foreign-exchange movements, China timing comparisons, or the 2018 Volume Point adjustments.
- How SG&A, China service-provider incentives, grant income and elevated interest costs affect future operating and net margins.
- Developments in the FTC consent-order audits, China anti-corruption and customs inquiries, and material tax disputes; assess any resulting penalties, operational changes or cash requirements.
- Whether foreign-exchange, tariff, direct-selling regulatory, Member-retention and product-liability risks materially change reported results or the outlook.