Herbalife Ltd. — Q3 2012 Form 10-Q
Reporting period: Three and nine months ended September 30, 2012; unaudited. Herbalife sells nutrition and personal-care products through a global network-marketing distributor organization. At quarter-end it operated in 84 countries and had 3.1 million independent distributors, including 0.2 million in China.
Financial results
| Metric | Q3 2012 | Q3 2011 | Nine months 2012 | Nine months 2011 |
|---|---|---|---|---|
| Net sales | $1,016.9 million | $895.2 million | $3,013.0 million | $2,570.0 million |
| Operating income | $160.8 million | $151.3 million | $501.7 million | $427.9 million |
| Net income | $117.8 million | $108.0 million | $359.3 million | $307.2 million |
| Diluted EPS | $1.04 | $0.87 | $3.01 | $2.44 |
| Operating cash flow | Not separately stated | Not separately stated | $399.9 million | $393.6 million |
- Q3 net sales rose 13.6% in reported dollars and 20.6% in local currency; nine-month sales increased 17.2% and 23.4%, respectively. Management attributed growth mainly to daily-consumption distributor methods, greater distributor engagement, more active sales leaders, recruiting and branding.
- Gross margin was 80.2% in Q3 versus 80.4%; operating margin was 15.8% versus 16.9%, and net margin was 11.6% versus 12.1%. For nine months, gross margin was 80.0% versus 80.2%, operating margin 16.7% versus 16.6%, and net margin 11.9% in both periods.
- Q3 net income increased 9.0%; higher contribution margin and lower taxes were partly offset by increased SG&A and interest expense. Nine-month net income rose 17.0%, with higher SG&A, interest and taxes partly offsetting sales-driven contribution-margin gains.
- At September 30, cash was $321.7 million, current assets $925.2 million and current liabilities $663.9 million; working capital was $261.2 million. Current ratio was approximately 1.39.
- Total debt was $500.4 million, including $50.4 million current and $450.0 million long-term, compared with $203.6 million at December 31, 2011. Cash less total debt was approximately $178.7 million. The company reported $695.3 million of undrawn credit capacity and compliance with debt covenants.
- Nine-month investing cash outflow was $62.5 million, including $59.2 million of property and equipment purchases. Financing cash outflow was $277.8 million, including $506.3 million of share repurchases and $102.7 million of dividends. Cash increased $62.9 million during the period.
Material changes and capital allocation
- In July, Herbalife added a $500 million term loan to its $700 million senior secured revolving facility. Proceeds were used to repay revolver borrowings; the combined facility matures in March 2016 and bears variable rates. Weighted-average borrowing rate was 1.97% at quarter-end.
- Share repurchases and dividends materially reduced equity: shareholders’ equity declined to $371.4 million from $560.2 million at year-end 2011. A new $1 billion repurchase authorization was approved in July, with the full amount remaining available at quarter-end.
- Inventory increased to $313.6 million from $247.7 million, primarily finished goods to support growth and sourcing initiatives. The filing reports $20.7 million of obsolete and slow-moving inventory adjustments.
Outlook, risks and contingencies
- No specific earnings or revenue guidance was provided. Management expected full-year 2012 capital expenditures of approximately $110–$120 million and said operating cash flow and available borrowings should meet foreseeable liquidity needs.
- Management identified distributor recruiting, retention and productivity, market penetration, product launches, regulation and currency movements as important drivers and risks. Sales leaders’ annual retention outside China was 52.0%, versus 48.9% in 2011; reported average active sales leaders increased 22.1% worldwide in Q3.
- Venezuelan exchange restrictions limit access to U.S. dollars and timely repatriation. Herbalife reported $71.6 million of Bolivar-denominated cash, largely remeasured at the SITME rate; management cautioned reported values may not equal realizable U.S. dollars. A hypothetical 41% less favorable rate would reduce that cash balance by $29.4 million. Nine-month alternative exchanges generated $4.1 million of foreign-exchange losses.
- Tax matters include a Mexican assessment of approximately $89 million for 2005–2006 that was nullified but could be reissued; litigation continues, and a separate 2007 audit was underway. The company had not recognized a loss and could not estimate a possible loss range. Spanish and Brazilian tax assessments and an Italian social-contribution order were also being contested; the Italian authority stated it intended to withdraw its claim, with a further hearing scheduled for February 2013.
- A Belgian court ruled in 2011 that the company’s Belgian network-marketing program violated local law concerning pyramid schemes. Herbalife appealed; briefing continued, and the company said it had made clarifications and changes pending appeal.
- Other stated risks include direct-selling and product regulation, distributor conduct and turnover, adverse publicity, competition, China licensing and regulatory uncertainty, foreign-exchange exposure, supplier dependence, product liability, and debt-covenant restrictions. Product-liability claims to date and the reasonably possible range of exposure on existing claims were described as not material; insurance has a $10 million annual deductible.
- Management concluded disclosure controls were effective as of September 30, 2012, with no material change in internal control over financial reporting during the quarter.
Key investor verification points
- Assess whether distributor activity and daily-consumption methods can sustain volume growth, particularly in China and other fast-growing regions, and monitor distributor retention and sales-leader trends.
- Reconcile reported-dollar and local-currency growth, foreign-exchange impacts, and the effects of Venezuela’s exchange restrictions on cash and earnings.
- Review debt and covenant capacity alongside continued repurchases and dividends, capital spending, and the company’s variable-rate exposure.
- Track outcomes and potential financial exposure from the Belgian appeal and tax disputes, especially the Mexican assessments and audits.
- Monitor inventory growth, product demand and returns, and whether SG&A growth and currency pressures affect margins.