Herbalife Ltd. — Q1 2011 Form 10-Q
Reporting period: Three months ended March 31, 2011; comparative period is Q1 2010. Unaudited results. Herbalife sells nutrition, weight-management and personal-care products through a global distributor network of approximately 2.3 million, operating in 75 countries. China uses a distinct sales model.
Financial results and liquidity
- Net sales: $795.1 million, up 28.5% year over year; local-currency growth was 24.7%. Product sales were $676.8 million and shipping and handling revenue was $118.3 million.
- Profitability: Gross profit was $632.3 million, with gross margin of 79.5% versus 77.3%. Operating income was $123.4 million, up from $64.0 million; operating margin rose to 15.5% from 10.4%. Net income was $87.6 million, up 68.8%; diluted EPS was $1.41 versus $0.83. The reported EPS is before the subsequent two-for-one share split.
- Expenses and tax: Royalty overrides were $264.4 million (33.2% of sales versus 33.5%). SG&A was $244.5 million (30.8% of sales versus 33.4%). The effective income tax rate was 27.5%, compared with 16.3%.
- Cash flow: Operating cash flow was $107.5 million versus $87.4 million. Investing cash outflow was $28.5 million, including $28.3 million of property purchases. Financing cash outflow was $16.0 million; dividends paid were $14.8 million and share repurchases were $9.0 million. Cash increased $70.2 million to $260.8 million.
- Balance sheet and liquidity: Working capital was $210.9 million, up from $124.8 million at year-end 2010. Total debt was $182.9 million; cash exceeded total debt by approximately $77.9 million. The company reported $520 million of undrawn capacity on its new revolving facility.
- Capital returns: A quarterly dividend of $0.25 per pre-split share was paid. No open-market share repurchases occurred during the quarter; remaining authorization was approximately $776.7 million.
Material changes versus Q1 2010
- Sales growth was broad-based; reported revenue rose 28.5%, with Volume Points up 21.5% worldwide and average active sales leaders up 20.8%.
- Net sales increased in every reported geographic region. Asia Pacific excluding China grew 41.3%, Mexico 44.7%, South and Central America 37.2%, China 41.0%, EMEA 17.7%, and North America 10.4%.
- Management attributed growth mainly to adoption of daily-consumption distributor methods, distributor engagement and recruiting. China sales rose 41.0%; management said its Nutrition Club approach remained at an early stage.
- Margin comparisons were materially affected by Venezuela-related items in Q1 2010, including a $12.7 million unfavorable cost-of-sales impact and a $14.5 million favorable tax impact. Q1 2011 included a $1.3 million pretax loss from a Venezuelan currency conversion and a $0.9 million pretax debt-financing-cost write-off.
- On March 9, 2011, Herbalife replaced its prior facility with a $700 million, five-year senior secured revolving credit facility, expiring in March 2016. It reported covenant compliance at quarter-end.
Outlook, commentary, risks and contingencies
- Management expects cash, operating cash flows and available revolver borrowings to be sufficient for the next 12 months. It forecast 2011 capital expenditures of approximately $80–$90 million; no specific revenue or earnings guidance was provided.
- Management said supply-chain optimization and selective product price increases may help offset cost pressures. It cited distributor recruitment and retention, existing-market penetration, new markets, product launches and daily-consumption methods as priorities.
- Venezuela: Currency controls and delays in converting Bolivars limit cash repatriation. The company used the SITME rate of 5.3 Bolivars per U.S. dollar for remeasurement and warned that future access to exchange mechanisms could affect results and operations.
- Tax contingencies: A Mexican tax assessment of approximately $96 million, mostly relating to VAT on 2005–2006 imports, is under appeal. No provision was recorded because management did not consider a loss probable; the possible loss range could not be reasonably estimated. The company noted other international tax audits and uncertain tax positions.
- Other risks include regulation and legal challenges to the network-marketing model, product safety and liability, distributor retention and conduct, foreign-exchange exposure, China licensing and regulatory uncertainty, competition, and reliance on third-party manufacturers. A Belgian challenge to the marketing model and an adidas trademark dispute were also described in the filing.
- The company said product-liability claims had not been material to date and maintained insurance with a $10 million annual deductible. A settlement of litigation with former distributors was being documented and was expected to involve no financial liability to Herbalife.
- Shareholders approved a two-for-one share split on April 28, 2011. The company subsequently announced a post-split dividend of $0.20 per share, payable June 7, 2011.
Important facts for investors to verify
- Whether distributor engagement, retention and Volume Point growth persist, and how those non-financial measures translate into retail demand and reported sales.
- How much of reported growth and margin improvement reflects underlying operations versus currency movements and the unusual Venezuela comparisons.
- The status and potential financial or liquidity impact of the approximately $96 million Mexican tax assessment and other tax disputes.
- Venezuela’s ability to access currency, repatriate cash and maintain product supply, and the effect of any change in exchange rates or restrictions.
- Debt-facility covenant headroom, variable-rate exposure, cash deployment and planned capital expenditures, including the effect of dividends and repurchases.
- Progress in China licensing and the Nutrition Club strategy, and any regulatory or legal developments affecting Herbalife’s distribution model or products.