Herbalife Ltd. — Q1 2013 Form 10-Q
Reporting period: Three months ended March 31, 2013; comparisons are with Q1 2012 unless noted. Herbalife sells nutrition, weight-management, fitness and personal-care products through a global network-marketing business. It reported 3.6 million distributors and operations in 88 countries.
Financial results and liquidity
| Metric | Q1 2013 | Q1 2012 / prior date |
|---|---|---|
| Net sales | $1,123.6 million | $964.2 million; up 16.5% (17.5% in local currency) |
| Gross profit / margin | $897.7 million / 79.9% | $768.0 million / 79.7% |
| Operating income / margin | $168.9 million / 15.0% | $154.1 million / 16.0% |
| Net income / diluted EPS | $118.9 million / $1.10 | $108.2 million / $0.88 |
| Net interest expense | $5.4 million | $1.4 million |
| Operating cash flow | $137.6 million | $120.4 million |
| Capital expenditures | $24.9 million | $24.7 million |
| Cash and cash equivalents | $722.5 million at March 31 | $333.5 million at December 31, 2012 |
| Total debt | $975.3 million at March 31 | $487.6 million at December 31, 2012 |
| Working capital | $649.1 million at March 31 | $247.0 million at December 31, 2012 |
Revenue growth was broad-based. Net sales rose across all reported geographic regions and product categories; South and Central America grew 32.6%, Asia Pacific 19.9%, and China 20.4%. Weight Management remained the largest product category, with sales of $711.6 million, up 18.2%.
Gross margin improved 20 basis points, reflecting price increases and product-cost savings, partly offset by foreign exchange and inventory write-downs. Operating margin declined one percentage point as SG&A rose faster than sales. Diluted EPS increased 25%, helped in part by fewer weighted-average shares following repurchases.
Material changes and capital allocation
- SG&A increased to $364.7 million from $296.4 million, including higher compensation and growth-related selling costs, as well as $9.5 million of costs tied to the company’s response to a short seller’s allegations and related market scrutiny.
- Q1 included a $15.1 million pre-tax foreign-exchange loss from Venezuela’s bolivar devaluation. Together, this item and the hedge-fund-related costs reduced reported net income by approximately $18.5 million after tax, according to management.
- Herbalife borrowed $513.2 million and repaid $25.5 million of long-term debt during the quarter. The higher borrowings supported, among other uses, approximately $162.4 million of share repurchases. The company repurchased about 4.0 million shares at an average $40.61 and paid $30.9 million in dividends.
- Cash increased substantially, but debt also rose; the credit facility had $195.2 million of undrawn capacity at March 31. The company reported compliance with its debt covenants.
Outlook, risks and unusual matters
- Outlook: No specific revenue or earnings guidance is provided. Management expected 2013 capital expenditures of approximately $165 million to $185 million and said operating cash flow and available credit were expected to cover working capital, planned investment and foreseeable liquidity needs.
- Auditor and filing status: KPMG resigned on April 8, 2013 after concluding its independence was impaired by alleged insider trading by a former engagement partner. KPMG withdrew its audit reports for 2010–2012 and said they should no longer be relied upon because of the independence issue—not because of Herbalife’s financial statements or accounting. The Q1 interim statements were not reviewed by an independent accountant; the company said the filing was deficient and it was no longer timely/current in Exchange Act filings. Herbalife planned to engage a successor and amend the filing after review. Management and the Audit Committee said they believed the information was fairly presented.
- Venezuela: The official exchange rate moved to 6.3 bolivars per U.S. dollar, and access to dollars remained uncertain. The company held approximately $102.3 million of bolivar-denominated cash, remeasured at the official rate; management cautioned that reported balances may not reflect realizable U.S. dollars. A sensitivity scenario using an exchange rate 75% less favorable would reduce that cash balance by $76.5 million. Venezuela generated about 4% of Q1 sales.
- Legal and regulatory: The filing describes tax disputes, including Mexican VAT matters, and litigation challenging the network-marketing model. Herbalife said it believed it had defenses and had not recorded losses where it judged losses were not probable; several potential outcomes could not be reasonably estimated. It also anticipated possible regulatory inquiries following public allegations and said it would cooperate.
- Other exposures: Risks include distributor recruitment and retention, regulation of products and network marketing, China licensing and regulatory interpretation, foreign exchange and international operations, product liability, and stock-price volatility. Management cited intense public scrutiny and substantial short interest.
- Accounting controls: Management concluded disclosure controls were effective as of March 31 and reported no material quarter changes in internal control over financial reporting. The lack of an independent interim review remains a separate reporting limitation.
Most important facts for investors to verify
- Whether a successor auditor was engaged, completed the required Q1 review and historical audits, and whether the company filed the promised amendment and restored timely filing status.
- Whether historical financial statements and internal-control reports remain supportable after the withdrawn audit opinions, and any resulting effects on registrations, financing access, exchange listing or credit-facility compliance.
- Whether Venezuela can convert and repatriate bolivars, and how any further devaluation or use of less favorable exchange mechanisms affects cash, earnings and continued consolidation.
- Whether sales and distributor engagement growth persist, particularly given the distributor retention and regulatory risks, and whether margins recover as SG&A and other expenses evolve.
- The progress and potential financial exposure of Mexican and other tax matters, network-marketing litigation or inquiries, and ongoing hedge-fund-related legal and advisory costs.
- How the company funds repurchases, dividends and planned capital expenditures while debt is higher, and whether liquidity and covenant headroom remain adequate.