Herbalife Ltd. — Form 10-Q Summary
Reporting period: Three and nine months ended September 30, 2013. The financial statements are unaudited and were not reviewed by an independent accountant; the filing states it is deficient and the company was not current in its SEC filings when filed.
Business context and performance
Herbalife sells nutrition and personal-care products through a global network-marketing organization. It reported 3.6 million distributors and sales in 88 countries. Management attributed growth principally to daily-consumption programs, greater distributor engagement and recruiting, and expansion in China and South and Central America.
| Metric | Q3 2013 | Q3 2012 | Nine months 2013 | Nine months 2012 |
|---|---|---|---|---|
| Net sales | $1,213.5m | $1,016.9m | $3,556.4m | $3,013.0m |
| Operating income | $192.1m | $160.8m | $553.4m | $501.7m |
| Net income | $142.0m | $111.9m | $404.0m | $351.8m |
| Diluted EPS | $1.32 | $0.98 | $3.75 | $2.95 |
| Gross margin | 80.4% | 80.2% | 80.0% | 80.0% |
| Operating margin | 15.8% | 15.8% | 15.6% | 16.7% |
| Net margin | 11.7% | 11.0% | 11.4% | 11.7% |
Financial position, cash flow and capital allocation
- Net sales increased 19.3% in Q3 and 18.0% for the nine months; management reported local-currency growth of 20.5% and 18.5%, respectively. Nine-month volume points grew 13.2% worldwide.
- Operating cash flow was $577.0m for nine months, compared with $399.9m. Cash purchases of property and equipment were $91.8m; operating cash flow less those purchases was approximately $485m.
- At September 30, cash was $892.5m, current assets $1,578.8m and current liabilities $868.0m; working capital was $710.9m. Cash includes approximately $150.1m of Venezuelan bolivar-denominated cash reported at the official exchange rate.
- Total debt was $950.1m, versus $487.6m at year-end 2012; cash less debt therefore indicated net debt of approximately $57.6m. The weighted-average borrowing rate was 2.18%, and the company reported covenant compliance. Undrawn credit-facility capacity was $198.1m.
- Nine-month share repurchases were approximately $272.4m, dividends paid were $92.7m, and the company declared $0.30 per share quarterly dividends. Remaining authorization under the $1bn repurchase program was $677.6m.
- Management expected full-year 2013 capital expenditures of approximately $170m–$180m. The filing provides no specific earnings or revenue guidance.
Changes versus prior comparable periods
- Q3 net income rose 26.9%; nine-month net income rose 14.8%. Higher contribution margin from sales growth was partly offset by higher SG&A and interest expense.
- SG&A increased to 33.8% of sales in Q3 and 33.0% for nine months, from 31.9% and 30.7%. Nine-month operating margin declined to 15.6% from 16.7%.
- China sales rose 76.6% in Q3 and 52.9% for nine months; South and Central America sales rose 44.0% and 40.7%. Asia Pacific excluding China declined 1.5% in Q3, while growing 6.0% for nine months.
- Debt increased substantially, while cash also rose. Management said borrowings primarily related to repurchases; the remaining proceeds increased cash and financial flexibility.
- The company revised prior-period statements for income-tax errors. It said the errors were not material to prior periods; the adjustment reduced Q3 2012 net income by $5.9m and nine-month 2012 net income by $7.6m, with diluted EPS reduced by $0.06 and $0.06, respectively.
Outlook, unusual items and principal risks
- The filing records $23.8m of nine-month pre-tax legal/advisory and related expenses responding to a hedge fund manager’s allegations about the network-marketing program, and $9.6m of re-audit expenses. These costs are expected to continue and may vary.
- Venezuela’s currency restrictions and devaluation produced a $15.1m pre-tax remeasurement loss in Q1. The company could not assure timely conversion of bolivars into U.S. dollars; it warned that a 75%-less-favorable rate applied to Venezuelan cash would reduce its reported value by $112.3m. Venezuelan sales were about 5% of nine-month consolidated sales.
- Key reporting risk: KPMG resigned after its former engagement partner’s alleged insider trading, withdrew audit opinions for 2010–2012, and the company’s interim statements had no required independent-accountant review. PwC was engaged to re-audit those years and review interim periods. The company said it would amend filings after completion; it also warned of possible financing and listing consequences if audits were not completed.
- Network-marketing legality remained under scrutiny, including a U.S. class action, regulatory inquiries and a Belgian proceeding on appeal. The company disputed the allegations and said it would defend the matters; outcomes are uncertain.
- Other contingencies include Mexican tax assessments of approximately $87m for 2005–2006 (a prior assessment was nullified but could be reissued) and approximately $22m for 2007, which the company appealed. The company recorded no loss for these matters, stating loss was not probable; it could not estimate a possible loss range.
- Additional risks include distributor recruitment and retention, product and direct-selling regulation, foreign exchange exposure, China licensing and regulatory uncertainty, and variable-rate debt. Management stated that operating cash flow and available credit were expected to meet foreseeable liquidity needs.
Important facts for investors to verify
- PwC’s progress and conclusions on the 2010–2012 re-audits and interim reviews, and any resulting restatements or amendments.
- Whether reported Venezuelan cash can be converted and repatriated at the stated rate, and the effect of further exchange restrictions or devaluation.
- Debt levels, covenant headroom, liquidity available under the credit facility, and the extent to which repurchases and dividends rely on borrowing.
- Developments in network-marketing investigations and litigation, and the eventual outcome of the Mexican tax disputes.
- Whether distributor engagement, retention and regional sales growth continue, especially given Q3 weakness in Asia Pacific excluding China and higher SG&A as a share of sales.