Herbalife Ltd. — Q2 2015 Form 10-Q
Reporting period: Unaudited quarter and six months ended June 30, 2015; comparisons are with the corresponding 2014 periods. Herbalife sells nutrition and wellness products through independent Members in 91 countries. At quarter-end it reported 4.1 million Members, including 0.3 million in China.
Financial performance
| Metric | Q2 2015 | Q2 2014 | Six months 2015 | Six months 2014 |
|---|---|---|---|---|
| Net sales | $1,162.3 million | $1,306.2 million | $2,267.7 million | $2,568.8 million |
| Gross profit | $933.0 million | $1,049.0 million | $1,823.0 million | $2,060.5 million |
| Operating income | $143.8 million | $196.3 million | $279.4 million | $324.0 million |
| Net income | $82.8 million | $119.5 million | $161.0 million | $194.2 million |
| Diluted EPS | $0.97 | $1.31 | $1.90 | $2.02 |
| Operating cash flow | Not separately reported | Not separately reported | $358.7 million | $347.6 million |
- Q2 net sales fell 11.0%; first-half sales fell 11.7%. In local currency, sales increased 1.1% and 0.5%, respectively, excluding Venezuela. Management attributed the reported decline mainly to U.S. dollar strength and weaker sales volume, partly offset by price increases and favorable country mix.
- Worldwide Volume Points declined 4.8% in Q2 and 4.6% in the first half. China sales rose 39.2% and 31.1%, respectively, while the Primary Reporting Segment’s sales fell 18.5% and 17.5%.
- Q2 gross margin was 80.3%, unchanged year over year; first-half gross margin was 80.4%, versus 80.2%. Net margin was 7.1% in both 2015 periods, versus 9.2% in Q2 2014 and 7.6% in the first half of 2014.
- Net interest expense was $23.7 million for Q2 and $45.2 million for the first half, compared with $21.4 million and $36.4 million, respectively, in 2014.
Balance sheet, debt and liquidity
- At June 30, 2015, cash and cash equivalents were $749.6 million, total debt was $1,683.0 million, and working capital was $363.2 million, down from $518.6 million at December 31, 2014. Shareholders’ deficit was $196.4 million.
- Current debt was $293.5 million, compared with $100.0 million at year-end, primarily reflecting amounts due under the Term Loan by March 2016. The company reported compliance with credit-facility covenants.
- The May 2015 credit-facility amendment extended the revolving facility maturity to March 2017, while the Term Loan matures in March 2016. Expected revolver capacity is $425 million as of September 30, 2015. The facility requires at least $200 million of consolidated cash and restricts dividends and repurchases.
- First-half investing cash use was $34.3 million and financing cash use was $176.7 million. Cash increased $104.2 million after a $43.5 million adverse foreign-exchange effect. Capital expenditures were $31.6 million, including accrued expenditures; management forecast full-year 2015 capital expenditures of approximately $110–$130 million.
Material changes and management outlook
- Lower sales volume across North America, Mexico, South and Central America, and Asia Pacific was attributed in part to Members adapting to marketing-plan and operating changes intended to improve sales-leader training and retention. Average active sales leaders increased 4.6% in Q2 and 6.5% year to date, while worldwide Volume Points declined.
- China growth increased service fees to independent service providers: $114.4 million in Q2 and $193.1 million in the first half, versus $80.8 million and $142.5 million in 2014. These fees are reported in SG&A.
- Management said it expects cash from operations, available credit and capital markets access to support operations and foreseeable liquidity needs. It provided no quantified earnings or revenue guidance. It expects possible near-term sales pressure in Mexico from VAT changes and import delays.
- Venezuela remains exposed to currency controls, high inflation and further devaluation. Herbalife used the SIMADI rate of 198 Bolivars per U.S. dollar at June 30. First-half results included $32.9 million of Venezuela foreign-exchange losses, $1.7 million of inventory write-downs and a $2.3 million bond impairment. The company cautioned that reported Bolivar-denominated assets may not reflect cash ultimately realizable in U.S. dollars.
Risks, contingencies and unusual items
- The FTC’s confidential investigation and Civil Investigative Demand concerning the company’s marketing and business-opportunity practices remain unresolved; the company said it could not predict the scope, duration or outcome. The Department of Justice also sought information concerning allegations about the company and its Members.
- A U.S. securities class action complaint was dismissed with leave to amend on July 28, 2015. The company stated it would continue to defend the matter. A separate Member class-action settlement was finally approved in May 2015, with a $15 million fund and up to $2.5 million in product returns; objectors sought reconsideration.
- Mexican tax matters include an approximately $73 million assessment for earlier periods, substantially nullified by the Tax Court but under appeal, and an approximately $19 million assessment for 2007 that is being litigated. The company also reported $55.4 million of Mexico VAT-related assets and said VAT refund processing may be delayed. Management did not consider losses probable for these matters.
- Professional fees and other expenses related to responses to public allegations were $7.1 million in Q2 and $11.4 million in the first half. Regulatory-inquiry expenses were $5.8 million in Q2 and $9.2 million in the first half. The filing also cites costs related to re-auditing 2010–2012 financial statements after KPMG’s resignation.
- Other principal risks include Member recruitment and retention, regulation of direct selling and product claims, China licensing and regulatory interpretation, foreign exchange exposure, tax disputes, product liability, and restrictions imposed by debt covenants. Management reported disclosure controls were effective and no material quarterly change in internal control over financial reporting.
Key facts for investors to verify
- Whether volume and sales trends outside China stabilize as Members adapt to marketing-plan changes, and whether China growth can offset weakness elsewhere.
- The cash realization and future earnings impact of Venezuela balances, exchange-rate changes and currency restrictions.
- Progress and potential financial exposure from the FTC and DOJ inquiries, securities litigation, and Mexican VAT and tax disputes.
- Debt repayment and refinancing capacity, covenant headroom, and the effects of the reduced revolving-credit availability and repurchase restrictions.
- Whether the $110–$130 million full-year capital expenditure expectation and management’s liquidity assessment remain appropriate.