Herbalife Ltd. — Q2 2012 Form 10-Q
Business context and reporting period. Unaudited results cover the quarter and six months ended June 30, 2012, compared with the same 2011 periods. Herbalife sells nutrition and personal-care products through network marketing; it reported 3.0 million distributors and operations in 83 countries.
Financial performance
| Metric | Q2 2012 | Q2 2011 | Six months 2012 | Six months 2011 |
|---|---|---|---|---|
| Net sales | $1,031.9m | $879.7m | $1,996.1m | $1,674.8m |
| Gross profit | $828.2m | $708.6m | $1,596.2m | $1,340.9m |
| Operating income | $186.7m | $153.2m | $340.8m | $276.6m |
| Net income | $133.4m | $111.2m | $241.5m | $199.2m |
| Diluted EPS | $1.10 | $0.88 | $1.98 | $1.57 |
- Q2 net sales rose 17.3% in reported dollars and 25.4% in local currency; six-month sales rose 19.2% and 24.9%, respectively. Q2 net income increased 20.0%; six-month net income increased 21.3%.
- Q2 gross margin was 80.3% versus 80.6%; operating margin was 18.1% versus 17.4%; net margin was 12.9% versus 12.6%. For the first half, gross margin was 80.0% versus 80.1%, operating margin 17.1% versus 16.5%, and net margin 12.1% versus 11.9%.
- Worldwide Volume Points increased 22.6% in Q2 and 23.1% for the six months. Management attributed growth principally to daily-consumption business methods, distributor engagement and recruiting. China sales grew 50.0% in Q2; Asia Pacific excluding China grew 25.1%. EMEA sales were essentially flat in reported dollars in both comparable periods.
- Six-month operating cash flow was $257.4m, versus $250.6m. Property, plant and equipment purchases were $39.7m; operating cash flow less those purchases was approximately $217.7m. Cash ended the period at $286.2m.
- At June 30, current assets were $846.1m and current liabilities $566.3m, producing working capital of $279.8m. Long-term debt was $555.1m, plus $0.8m current debt; the revolver had $139m of undrawn capacity. Debt covenants were met. The revolving facility’s weighted-average rate was 1.74%.
- Share repurchases were $505.6m and dividends paid were $70.3m in the first half. Shares outstanding at June 30 were 111.8m, compared with 115.8m at year-end.
Material changes versus prior comparable periods
- Sales growth was broad-based, but foreign exchange reduced reported growth: six-month local-currency sales growth of 24.9% exceeded reported growth of 19.2%. Gross margin edged down, partly due to inventory write-downs and other costs; operating and net margins improved.
- Net interest expense rose to $3.2m in Q2 from $0.9m, primarily reflecting higher revolving-credit borrowings. SG&A rose in dollars but declined as a share of sales to 29.7% from 30.3% in Q2.
- Revolver borrowings increased to $555.0m from $202.0m at December 31, 2011, principally supporting repurchases and dividends. Retained earnings fell to $25.5m from $305.9m, while total shareholders’ equity declined to $270.7m from $560.2m, mainly reflecting repurchases and dividends.
Outlook, risks and unusual items
- Management expected 2012 capital expenditures of approximately $110m–$120m. The filing provides no clear numerical full-year revenue or earnings guidance; management cautioned interim results are not necessarily indicative of full-year results.
- After quarter-end, Herbalife entered a $500m term loan on July 26, 2012, maturing March 9, 2016; most proceeds were intended to pay down the revolver. It completed its existing $1bn repurchase program July 27, buying 3.9m shares at a final discounted average price of $46.37, and authorized a new $1bn program on July 30. A $0.30-per-share dividend was also approved for payment in August.
- Venezuela’s currency controls constrain conversion and repatriation. The company recorded first-half foreign-exchange losses of $4.1m on alternative legal conversions, and reported $52.6m of Bolivar-denominated cash remeasured at the official SITME rate. Management warned those balances may not reflect realizable U.S. dollars; a 41%-less-favorable conversion scenario would reduce that cash by $21.6m.
- Contingencies include a Mexican tax dispute involving a previously nullified assessment of approximately $86m; the company said the assessment could be reissued and that a possible loss could not be reasonably estimated. A Belgian court had ruled against the company’s marketing plan; Herbalife appealed. The filing also describes tax matters in Spain, Brazil and Italy. Management did not consider existing product-liability claims material.
- Key risks include distributor recruitment and retention, regulation and legal challenges to network marketing, product safety and adverse publicity, foreign exchange and country risks, China licensing, and tax disputes. The company reported effective disclosure controls and no material internal-control changes in the quarter.
Important facts for investors to verify
- Whether distributor activity, retention and Volume Point growth translate into sustainable sales and earnings growth.
- How much of reported growth and margin performance is affected by currency movements, especially Venezuela, and whether Venezuelan cash can be converted and repatriated.
- Debt and covenant capacity after the post-quarter term loan, repurchases and new buyback authorization, including the resulting interest burden and liquidity.
- Developments in the Belgian appeal and the Mexican and other tax proceedings, including any change in estimated exposure.
- Whether inventory write-downs, foreign-exchange effects and rising operating costs persist or materially change margins.