Herbalife Ltd. — Form 10-Q Summary
Reporting period: Quarter and six months ended June 30, 2017. Amounts are in U.S. dollars; financial statements are unaudited. Herbalife sells nutrition products through independent Members and, in China, through service providers and other channels.
Financial results and position
| Metric | Q2 2017 | Q2 2016 | Six months 2017 | Six months 2016 |
|---|---|---|---|---|
| Net sales | $1,146.9 million | $1,201.8 million | $2,249.0 million | $2,321.4 million |
| Operating income (loss) | $204.9 million | $(19.9) million | $348.7 million | $148.4 million |
| Net income (loss) | $137.6 million | $(22.9) million | $222.8 million | $72.9 million |
| Diluted EPS | $1.61 | $(0.28) | $2.59 | $0.85 |
| Operating cash flow | Not provided for quarter | Not provided for quarter | $277.1 million | $368.0 million |
- Margins: Q2 gross margin was 80.9%, versus 80.3%; operating margin was 17.9%, versus (1.7%); net margin was 12.0%, versus (1.9%). First-half gross margin was 81.2%, versus 80.6%; operating margin was 15.5%, versus 6.4%; net margin was 9.9%, versus 3.1%.
- Cash and liquidity: Cash and equivalents were $1,624.1 million at June 30, compared with $844.0 million at year-end 2016. Working capital was $1,406.6 million. The credit facility requires at least $200 million of consolidated cash; the company reported covenant compliance.
- Debt: Balance-sheet debt was $2,288.4 million, comprising $1,235.0 million under the new term loan, $1,047.0 million carrying value of convertible notes, and $6.4 million other debt. Cash less balance-sheet debt was approximately $664 million net cash. The term loan’s weighted-average borrowing rate was 6.53% at June 30; a 1 percentage-point rate move was estimated to change annual interest expense by about $13 million.
- Capital allocation: First-half investing cash outflow was $47.5 million. Financing cash inflow was $537.5 million, including $1,274.0 million of new-facility borrowings, offset by debt repayments and share repurchases. The company repurchased about $240.5 million of shares under its program during the first half; $1,259.5 million of authorization remained at June 30.
Changes and drivers
- Net sales declined 4.6% in Q2 and 3.1% in the first half year over year; in local currency, they declined 3.4% and 1.8%, respectively. Worldwide Volume Points, management’s sales-volume indicator, fell 8.1% in Q2 and 3.5% in the first half.
- The sales decline reflected weaker volume and unfavorable currency effects, partly offset by price increases. Q2 volume weakness was pronounced in North America (Volume Points down 18.1%), South and Central America (down 14.2%), and China (down 14.4%). EMEA Volume Points rose 2.4%.
- Net income improved substantially from the prior-year Q2 loss, primarily because prior-year SG&A included $203.0 million of regulatory-settlement expense. 2017 results also included $38.9 million of China government-grant income and tax benefits from adoption of a share-based compensation accounting standard. Higher interest expense and lower contribution margin partly offset these benefits.
- Gross-margin improvement reflected sourcing and self-manufacturing savings and price increases, partly offset by foreign exchange and higher inventory write-downs. First-half operating cash flow fell from $368.0 million to $277.1 million, mainly due to less favorable working-capital movements.
Outlook, risks and unusual items
- Management said U.S. sales could remain pressured during the rest of 2017 as Members adapt to FTC Consent Order procedures, but did not expect a long-term material adverse effect. No quantified revenue or earnings guidance is provided in the filing text. Expected 2017 capital expenditures were approximately $115–$135 million.
- The FTC Consent Order, effective July 2016, followed a $200 million payment and requires changes to U.S. Member classification, sales documentation and compensation, plus independent compliance audits for seven years. Management identified potential sales and compliance impacts; failure to comply could materially harm results.
- The SEC and Department of Justice requested information concerning China anti-corruption compliance. The company said it was cooperating and could not predict the matter’s scope or outcome.
- Material disclosed tax disputes include Mexican VAT and income-tax matters, Brazilian tax assessments, Indian VAT assessments, and a Korean customs assessment. Management generally said losses were not probable; some matters are being appealed, and possible losses could not be reasonably estimated. The company also reported $47.6 million of Mexico VAT-related assets and $17.0 million of Brazil ICMS-ST credits, which it believes are recoverable or usable.
- China government grants contributed $38.9 million of Q2 and first-half operating income; future grants are not assured. Other notable items included FTC implementation costs, regulatory inquiry expenses, and expenses related to responding to short-seller allegations.
- Management identified foreign exchange, variable-rate debt, Member retention, direct-selling regulation, China licensing and compliance, product liability, and legal and tax proceedings among key risks. Disclosure controls were reported effective at June 30, 2017; no material change in internal control over financial reporting was reported for the quarter.
Investor verification priorities
- Assess whether the sales and Volume Point declines, particularly in North America and South and Central America, continued after Q2, and distinguish underlying demand from currency, pricing, and timing effects.
- Separate recurring operating performance from the prior-year FTC settlement comparison, China grant income, and 2017 share-based compensation tax benefits.
- Review the new credit facility’s leverage covenant, minimum-cash requirement, amortization schedule, variable-rate exposure, and capacity for further repurchases.
- Track execution of FTC Consent Order controls and audits, including the effect on Member activity, eligible U.S. sales, and compensation.
- Monitor developments in the disclosed tax disputes and China anti-corruption inquiry, including any changes in loss assessments or recoverability of tax-related assets.