Herbalife Ltd. — Q2 2010 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2010. Unaudited results; comparisons are with the corresponding 2009 periods. Herbalife sells nutrition, weight-management, fitness and personal-care products through a global distributor network of approximately 2.1 million, with a distinct China sales model.
Financial performance
| Metric | Q2 2010 | Change vs. Q2 2009 | Six months 2010 | Change vs. 2009 |
|---|---|---|---|---|
| Net sales | $688.8 million | +20.5% (local currency +20.0%) | $1,307.4 million | +19.6% (local currency +16.8%) |
| Gross profit / margin | $552.2 million / 80.2% | Margin +1.6 percentage points | $1,030.4 million / 78.8% | Margin -0.6 points |
| Operating income / margin | $116.4 million / 16.9% | $71.8 million / 12.6% in 2009 | $180.3 million / 13.8% | $134.1 million / 12.3% in 2009 |
| Net income | $81.9 million | +69.8% | $133.8 million | +49.0% |
| Diluted EPS | $1.32 | $0.77 in 2009 | $2.14 | $1.44 in 2009 |
| Net interest expense | $2.1 million | $1.3 million in 2009 | $4.1 million | $3.0 million in 2009 |
Management attributed sales growth principally to adoption of daily-consumption business models, more active sales leaders, branding and distributor recruiting. Asia Pacific (excluding China) was the strongest growth region: sales rose 50.1% in Q2 and 36.9% in the first half; South Korea was a major contributor. South and Central America sales fell 3.0% in Q2, primarily reflecting Venezuela’s accounting and exchange-rate changes. Weight Management remained the largest product category.
Q2 SG&A was $211.1 million, or 30.6% of sales, versus 33.4% a year earlier. First-half SG&A was $418.0 million, or 32.0% of sales, versus 34.0%. Royalty overrides were 32.7% of Q2 sales and 33.0% for the half. First-half gross margin was pressured by Venezuela-related inventory costs and exchange-rate effects.
Cash, liquidity and capital allocation
- First-half operating cash flow was $170.4 million, compared with $122.3 million in 2009. Investing cash flow was negative $23.2 million; financing cash flow was negative $100.9 million, including $79.2 million of share repurchases and $24.1 million of dividends. Cash increased $19.4 million to $170.2 million, after a $26.9 million negative foreign-exchange effect.
- At June 30, cash was $170.2 million, working capital $132.8 million, and total current liabilities $442.5 million. Total debt was $243.4 million, including $239.6 million under the senior secured credit facility; net debt including other debt and leases was approximately $73 million. The company reported $155 million of undrawn revolving-credit capacity and compliance with debt covenants.
- Capital expenditures were $23.9 million in the first half; management expected approximately $80 million for full-year 2010. The board increased the repurchase authorization to $1 billion and extended it through December 2014. First-half repurchases totaled approximately $75.2 million; $851.6 million remained authorized at June 30.
- The quarterly dividend was $0.20 per share during the period. On August 2, 2010, the board announced an increase to $0.25 per share.
Outlook, unusual items and material risks
- Management expected 2010 sales to increase year over year in North America, Mexico, EMEA, Asia Pacific and China, but expected a decline in South and Central America, principally due to Venezuela. These are directional regional expectations; the filing provides no consolidated numerical revenue or earnings guidance.
- Management expected 2010 SG&A to rise in absolute dollars, reflecting compensation, China-related costs, depreciation and sales-growth initiatives. The company cited supply-chain optimization and selective product price increases as possible offsets to cost pressures.
- Venezuela became highly inflationary for accounting purposes on January 1, 2010, and the subsidiary changed its functional currency to the U.S. dollar. First-half results included a $15.1 million non-tax-deductible remeasurement loss, $12.7 million of incremental costs on previously imported products, a $3.8 million gain from CADIVI-approved currency exchanges and a one-time $14.5 million deferred tax benefit. Q2 also included a $4.0 million pre-tax foreign-exchange gain from remeasurement at the new SITME rate. Management cautioned that exchange restrictions mean reported Venezuelan cash and other remeasured balances may not reflect realizable U.S. dollars; Venezuela was less than 2% of first-half sales and less than 3% of assets.
- Herbalife disclosed an $89 million Mexican tax assessment, mostly relating to alleged VAT on imported products. It recorded no provision because management did not consider a loss probable and could not reasonably estimate a potential loss range; it was appealing the assessment. Surety bonds might be required. Resolution could take several years.
- A dispute with former distributors ended in a May 2010 final judgment dismissing all parties’ claims; both sides appealed. Other stated risks include distributor recruitment and retention, product and network-marketing regulation, foreign exchange and currency controls, tax disputes, China licensing and regulatory uncertainty, product liability, competition and reliance on third-party manufacturers. Management said disclosure controls were effective and reported no material second-quarter change in internal control over financial reporting.
Important facts for investors to verify
- Whether sales and distributor engagement growth, particularly in Asia Pacific, can be sustained and translated into cash generation.
- How Venezuela’s currency-access restrictions and exchange rates affect earnings, reported cash, product imports and potential operations.
- The progress and ultimate exposure in the $89 million Mexican tax assessment and other international tax disputes.
- Whether planned capital spending and expanded buybacks and dividends remain supportable alongside debt service and the $155 million undrawn revolver.
- Whether distributor retention and regional weaknesses—especially South and Central America—affect management’s 2010 regional outlook.