Herbalife Nutrition Ltd. — Form 10-Q Summary
Reporting period: Quarter and nine months ended September 30, 2019. Amounts are in U.S. dollars; financial statement amounts are generally in millions, except per-share data. The interim financial statements are unaudited.
Business context
Herbalife sells nutrition and personal-care products in 94 countries primarily through independent Members. China uses a modified business model involving independent service providers, sales representatives and company-operated retail platforms. China is reported separately from the company’s other geographic regions.
Financial performance
| Metric | Q3 2019 | Q3 2018 | Nine months 2019 | Nine months 2018 |
|---|---|---|---|---|
| Net sales | $1,244.5 | $1,242.8 | $3,656.8 | $3,705.2 |
| Gross profit | $1,001.1 | $1,024.7 | $2,928.6 | $3,011.8 |
| Operating income | $143.6 | $187.3 | $459.7 | $534.9 |
| Net income | $81.5 | $71.2 | $254.3 | $247.7 |
| Diluted EPS | $0.58 | $0.49 | $1.79 | $1.64 |
| Operating cash flow | Not separately stated | Not separately stated | $300.9 | $509.7 |
Q3 net sales increased 0.1% year over year; nine-month sales declined 1.3%. Management said sales excluding Venezuela increased 0.4% in Q3 and declined 1.0% year to date. Q3 gross, operating and net margins were 80.4%, 11.5% and 6.5%, respectively, compared with 82.5%, 15.1% and 5.7% a year earlier. For the nine months, those margins were 80.1%, 12.6% and 7.0%, versus 81.3%, 14.4% and 6.7%.
Net income rose despite weaker operating income. Q3 results benefited from lower interest expense and a more favorable comparison for other income/expense than in 2018, partly offset by lower contribution margin, particularly in China. Nine-month results benefited from lower SG&A and interest expense and favorable other income/expense, partly offset by lower contribution margin and higher taxes. Effective tax rates were 28.1% in Q3 and 31.5% year to date, compared with 38.9% and 29.4% in the prior-year periods.
Cash, debt and liquidity
- At September 30, 2019, cash and cash equivalents were $715.2, down from $1,198.9 at December 31, 2018. Cash, cash equivalents and restricted cash totaled $723.2.
- Operating cash flow for the first nine months was $300.9, compared with $509.7 a year earlier. Capital expenditures paid were $79.5; operating cash flow less those purchases was approximately $221.4, a simple derived measure.
- Working capital was $468.7, up from $216.2 at year-end 2018. Current assets were $1,389.3 and current liabilities $920.6.
- Debt carrying value totaled $1,803.8, including $24.5 current and $1,779.3 long-term. Scheduled principal payments totaled $1,936.8. The company repaid $675.0 of 2.00% convertible notes at maturity in August 2019. The $250.0 revolving facility had no borrowings outstanding.
- The senior secured credit facility had a 5.67% weighted-average interest rate at quarter-end; the company reported compliance with its covenants. A 1 percentage-point rate change, with borrowings unchanged, would change annual interest expense by approximately $9.8.
- Shareholders’ deficit was $467.5. The company made no open-market share repurchases in the first nine months; $1.5 billion remained available under its authorization.
Material changes and operating trends
- China sales fell 21.7% in Q3 and 28.7% for the nine months; China Volume Points declined 19.5% and 29.6%, respectively. Management attributed weakness to reduced Member activity and meetings following the Chinese government’s 100-day health-products review, and expected the review’s effects to continue through 2019.
- The Primary Reporting Segment, comprising regions other than China, grew sales 6.1% in Q3 and 5.8% year to date. Asia Pacific was a notable growth driver, with sales up 18.3% and 18.9%; South and Central America declined 9.1% and 14.7%.
- Worldwide Volume Points increased 2.3% in Q3 and 2.7% year to date, while China’s declines weighed on the overall result. Volume Points are a company-defined sales-volume indicator, not a GAAP revenue measure.
- Gross margin contracted year over year, reflecting currency effects, country mix, sourcing and manufacturing costs, and inventory write-downs. Royalty overrides rose to 29.2% of sales in Q3 and 29.8% year to date, partly because China represented a smaller share of total sales.
- The company adopted lease accounting in 2019 and recognized $181.9 of operating lease right-of-use assets and $198.8 of operating lease liabilities at September 30.
Outlook, unusual items and risks
- No specific revenue or earnings guidance is provided in the supplied filing text. Management expected 2019 capital expenditures of approximately $105–$115; $76.0 had been spent, including accrued expenditures, in the first nine months.
- Q3 included a $19.0 accrual for a Mexican VAT assessment. The Mexican Supreme Court declined to hear the company’s appeal on October 16, 2019; the company petitioned for reconsideration on October 21. The assessment is guaranteed by an undrawn letter of credit.
- The company and SEC settled an investigation concerning disclosures about the China marketing plan on September 27, 2019. Herbalife agreed to cease and desist from specified violations and pay a $20.0 million civil penalty, which was paid in October. The company neither admitted nor denied the SEC’s allegations, except as to jurisdiction.
- Separate SEC and Department of Justice FCPA investigations concerning China external-affairs expenditures and related controls remained ongoing. The company said it could not reasonably estimate a potential loss; outcomes could materially affect operations and financial results.
- China government grants contributed $6.4 in Q3 and $27.7 in the first nine months to other operating income. A further $6.0 of year-to-date income reflected finalized insurance recoveries relating to a 2017 Mexico warehouse flood. Future grant income is not assured.
- The $675.0 million 2019 convertible-note repayment reduced cash. Other notable earnings items included a $15.7 year-to-date gain from the CVR’s expiration and non-cash interest expense associated with convertible notes and forward transactions.
- Management identified continuing exposure to foreign exchange movements, tariffs, regulatory and direct-selling restrictions, Member recruitment and retention, product liability, and debt covenants. The FTC Consent Order imposes U.S. business and compliance requirements, including independent audits; the company noted that noncompliance could have a material adverse effect.
- Management stated that cash, operating cash flow, available credit and capital-market access should be sufficient for expected needs. Disclosure controls were assessed as effective at September 30, 2019; no material change in internal control over financial reporting was reported for the quarter.
Important facts for investors to verify
- Whether China Member activity, sales and Volume Points recover after the government review, and how much of any recovery is reflected in revenue and cash flow.
- The final outcome and payment requirements for the Mexican VAT assessment, plus recoverability and timing of the company’s Mexican VAT assets.
- The eventual scope, resolution and financial consequences of the ongoing FCPA investigations.
- Cash generation, capital spending and debt-service capacity following the $675.0 million note repayment, including exposure to variable interest rates and debt covenants.
- How much reported earnings depend on nonrecurring items such as government grants, insurance recoveries and the CVR revaluation gain.
- Whether regional sales trends and the company’s non-GAAP Volume Points measure remain comparable, given timing differences and prior-period adjustments.