Herbalife Ltd. — Q2 2013 Form 10-Q Summary
Reporting period: Three and six months ended June 30, 2013. Herbalife sells nutrition, weight-management, and personal-care products through network marketing; it reported 3.4 million distributors and operations in 88 countries. Figures below are in U.S. dollars; financial statements are unaudited and unreviewed.
Financial performance
| Metric | Q2 2013 | Q2 2012 | Six months 2013 | Six months 2012 |
|---|---|---|---|---|
| Net sales | $1,219.2 million | $1,031.9 million | $2,342.9 million | $1,996.1 million |
| Gross profit | $972.0 million | $828.2 million | $1,869.7 million | $1,596.2 million |
| Operating income | $192.4 million | $186.7 million | $361.3 million | $340.8 million |
| Net income | $143.2 million | $132.0 million | $262.0 million | $239.9 million |
| Diluted EPS | $1.34 | $1.09 | $2.44 | $1.96 |
| Operating cash flow | Not provided for quarter | Not provided for quarter | $351.5 million | $257.4 million |
- Q2 net sales rose 18.2% (17.4% in local currency); first-half sales rose 17.4% (17.5% in local currency). Net income increased 8.5% and 9.2%, respectively.
- Q2 gross margin was 79.7%, down 0.6 percentage points; operating margin was 15.8%, down 2.3 points; net margin was 11.7%, down 1.1 points. First-half gross, operating, and net margins were 79.8%, 15.5%, and 11.2%, versus 80.0%, 17.1%, and 12.0%.
- SG&A rose to $400.1 million in Q2 and $764.8 million in the first half. SG&A was 32.8% and 32.6% of sales, respectively, versus 29.7% and 30.2%. Higher compensation, China service-provider fees, distributor events and promotion, foreign exchange, and legal/advisory costs contributed.
- Cash and equivalents were $849.7 million at June 30, versus $333.5 million at year-end 2012. Working capital was $711.7 million, versus $221.7 million. First-half capital expenditures were $56.2 million; cash used in investing was $56.0 million.
- Debt was $962.6 million, up from $487.6 million at year-end; $68.8 million was current and $893.8 million long-term. The weighted-average borrowing rate was 2.20%. The company had $194.6 million of undrawn credit capacity and reported compliance with debt covenants.
- First-half financing provided $248.4 million, including $513.2 million of borrowings, offset by debt payments, $165.7 million of share repurchases, and $61.8 million of dividends. Cash growth therefore reflects borrowing as well as operating cash generation.
Material changes and business trends
- Volume Points increased 13.5% in Q2 and 13.4% in the first half. China sales grew 53.0% in Q2; South and Central America grew 45.9%. Asia Pacific excluding China increased only 0.9% in Q2.
- Weight Management remained the largest product category, with Q2 sales up 20.3%; Energy, Sports and Fitness sales grew 24.0%.
- Share count declined: basic weighted-average shares were 103.0 million in Q2 versus 116.6 million a year earlier. EPS growth consequently exceeded net-income growth.
- The company recorded a $15.1 million pretax foreign-exchange loss in Q1 from Venezuela’s currency devaluation. Q2 and first-half comparisons also include higher interest expense, reflecting increased borrowings.
Outlook, risks, contingencies, and unusual items
- No earnings or revenue guidance was provided. Management expected 2013 capital expenditures of approximately $165–185 million and said it expected to continue incurring costs related to the market allegations and auditor transition.
- Management attributed sales growth to daily-consumption distributor methods, distributor engagement and recruiting, and market expansion. It cautioned that interim results are not necessarily indicative of full-year results.
- Audit and filing qualification: KPMG resigned after determining its independence was impaired by alleged insider trading by a former engagement partner, and withdrew its audit reports for 2010–2012. KPMG said the resignation was not related to Herbalife’s financial statements or accounting. PwC was engaged to re-audit those years and review interim periods. This 10-Q had not received the required independent accountant review, was described as deficient and not timely/current, and omitted the SOX Section 906 certification pending PwC’s review. Management said it believed the information fairly presented results.
- Prior-period revisions: Income-tax errors related primarily to intercompany inventory transactions and application of accounting guidance were corrected in comparative information. Management judged them not material to the affected prior periods. Adjusted 2012 Q2 net income was $132.0 million versus $133.4 million previously reported; adjusted first-half 2012 net income was $239.9 million versus $241.5 million previously reported. Adjustments also affected prior balance-sheet captions and full-year 2010–2012 results.
- Venezuela: Currency-conversion approvals were delayed and access to U.S. dollars remained uncertain. At June 30, the subsidiary held approximately $124.6 million of Bolivar cash, remeasured at the official rate; that carrying value might not represent realizable U.S. dollars. Management’s sensitivity analysis said a rate 75% less favorable could reduce that cash value by $93.2 million. Venezuela represented about 4% of first-half sales and 7% of total assets.
- Legal and tax matters: The company disclosed an approximately $23 million Mexican tax assessment for 2007, which it appealed after quarter-end, and ongoing litigation concerning a previously nullified approximately $89 million Mexican assessment. It said losses were not considered probable and could not be reasonably estimated. Other matters include a Belgian network-marketing judgment under appeal, a U.S. class action challenging the marketing program, and possible regulatory inquiries, including a previously disclosed SEC inquiry. Management said it intended to defend the matters.
- Product-liability claims and routine litigation were described as not material to date. A $10 million annual deductible applies to product-liability insurance. The company also reported $17.6 million of first-half professional and other expenses related to responding to a hedge-fund manager’s allegations and $3.5 million of re-audit fees.
- Other significant risks include distributor recruitment and retention, regulation of products and network marketing, China licensing and compliance, foreign exchange, tax audits, supplier dependence, and stock-price volatility. Management concluded disclosure controls were effective as of June 30 despite the disclosed accounting errors.
Important facts for investors to verify
- Completion and findings of PwC’s re-audits and interim reviews, any resulting financial-statement changes, and the timing of corrected filings and certifications.
- Whether reported cash—especially Bolivar-denominated balances—is accessible and realizable, and the effect of further currency restrictions or devaluations.
- Debt levels, covenant compliance, financing availability, and the extent to which repurchases and dividends are supported by operating cash flow rather than additional borrowing.
- Developments in Mexican tax disputes, the Belgian appeal, the U.S. class action, and any regulatory inquiries into the network-marketing model.
- Whether distributor engagement and sales growth persist, particularly in regions showing weaker quarterly growth, and whether operating expenses and margins stabilize.