Herbalife Ltd. — Q2 2014 Form 10-Q
Reporting period: Three and six months ended June 30, 2014. Unaudited results; dollar amounts below are in millions unless otherwise stated. Herbalife sells nutrition and personal-care products through a global network of 3.9 million independent members in 91 countries, including China, where it uses a distinct distribution model.
Financial performance
| Metric | Q2 2014 | Q2 2013 | First half 2014 | First half 2013 |
|---|---|---|---|---|
| Net sales | $1,306.2 | $1,219.2 | $2,568.8 | $2,342.9 |
| Operating income | $196.3 | $192.4 | $323.9 | $361.3 |
| Net income | $119.5 | $143.2 | $194.2 | $262.0 |
| Diluted EPS | $1.31 | $1.34 | $2.02 | $2.44 |
| Gross margin | 80.3% | 79.7% | 80.2% | 79.8% |
| Operating margin | 15.0% | 15.8% | 12.6% | 15.5% |
| Net margin | 9.2% | 11.7% | 7.6% | 11.2% |
- Q2 net sales increased 7.1% year over year; first-half sales rose 9.6%. On a local-currency basis, including Venezuela remeasurement, growth was 10.8% and 13.9%, respectively.
- Q2 product sales increased 13.9%, while shipping and handling revenue fell to $104.9 from $164.2, reflecting the prior-year pricing-structure changes. Worldwide Volume Points rose 4.9% in Q2 and 6.9% for the first half.
- Profitability weakened despite higher sales. Q2 SG&A rose to $461.9 (35.4% of sales, versus 32.8%); first-half SG&A was $964.0 (37.5% versus 32.6%). First-half operating income fell 10.3% and net income fell 25.9%.
- China was a major growth contributor: sales rose 44.2% in Q2 and 63.9% in the first half. EMEA sales rose 21.9% and 23.2%; South and Central America sales fell 8.6% in Q2 but grew 1.4% for the half. Asia Pacific excluding China declined 4.0% for the half.
Cash flow, debt and liquidity
- First-half operating cash flow was $347.6, compared with $351.5 a year earlier. Investing cash outflow was $113.1; financing cash outflow was $336.4. Cash declined $199.5 to $773.5 at June 30, including a $97.5 adverse effect from exchange-rate changes.
- Working capital was $552.4, down from $720.9 at year-end 2013; current assets were $1,494.8 and current liabilities $942.4.
- Debt carrying value totaled $1,838.0: $893.8 under the senior secured facility and $944.2 for the liability component of the convertible notes. The notes had $1,150.0 principal outstanding. Cash plus undrawn facility capacity of $194.6 was available for general corporate needs. The company reported compliance with debt covenants.
- In February 2014, Herbalife issued $1.15 billion of 2.00% convertible notes due 2019. It used approximately $685.8 to enter prepaid forward share repurchases and paid $123.8 for capped calls. First-half share repurchases were $1,277.9; the company also terminated its quarterly dividend in favor of repurchases. Shareholders’ equity became a $404.1 deficit, primarily reflecting repurchases and related transactions.
- The company expected 2014 capital expenditures of approximately $175–$195 million and said cash, operating cash flow and available borrowings should fund operations and foreseeable requirements for at least the next 12 months.
Outlook, commentary and material risks
- Management attributed sales growth to daily-consumption business methods, member engagement and recruiting, and geographic expansion. It identified member recruitment and retention, productivity, new products and infrastructure investment as ongoing priorities. No earnings or revenue guidance was provided in the supplied filing text.
- Venezuela is a significant uncertainty. Herbalife remeasured Bolivar balances at the SICAD I rate of 10.6 Bolivars per U.S. dollar at June 30, after moving from the prior rate in Q1. The company recorded approximately $86.1 of first-half foreign-exchange losses from the remeasurement and reported $152.6 of Bolivar-denominated cash. Using the approximately 50 Bolivars-per-dollar SICAD II rate in a sensitivity analysis would have reduced reported cash by about $120.2 and produced an additional estimated $109.5 foreign-exchange loss. Currency controls, inflation, pricing restrictions and inability to repatriate funds could further affect results and liquidity.
- Other unusual costs included $12.3 of first-half professional fees related to public allegations by a hedge fund manager, $6.0 of FTC-inquiry expenses, and $15.9 of non-cash interest expense related to the convertible notes and forward transactions. First-half results also included a $3.2 impairment loss on Venezuelan bonds. The effective tax rate rose to 31.7% for the first half from 25.2%, partly because some tax benefits related to interest expense and Venezuela foreign-exchange losses could not be fully realized.
- Legal and regulatory exposures include ongoing Bostick litigation challenging the marketing model, a separate purported shareholder class action alleging securities-law misstatements, and governmental inquiries including the FTC inquiry. The company said it could not estimate reasonably possible losses for certain proceedings. Tax matters include Mexican assessments of approximately $88 and $23; the company said losses were not probable and potential exposure could not be reasonably estimated. Product-liability claims were described as not material to date.
- Other key risks include member retention (51.8% sales-leader requalification outside China and temporarily Venezuela), regulatory interpretations of network marketing, licensing and compliance risks in China, foreign exchange exposure, competition and reliance on members and third-party manufacturers.
Most important facts for investors to verify
- Whether Venezuela can access exchange mechanisms and repatriate cash, and whether future remeasurement rates could materially reduce reported cash or earnings.
- The status and potential financial consequences of FTC, Bostick, shareholder-class-action and tax proceedings; several exposures are not quantifiable from this filing.
- Debt terms, covenant headroom, cash needs upon any convertible-note conversion, and potential dilution beyond the capped-call protection.
- Whether sales growth and member engagement can continue while SG&A, interest expense and other costs pressure margins and earnings.
- Execution of the planned capital expenditures and the distinction between reported cash balances and cash held in countries with currency restrictions.