Herbalife Ltd. — Q3 2010 Form 10-Q
Reporting period: Three and nine months ended September 30, 2010; unaudited. Herbalife sells nutrition, weight-management, fitness, and personal-care products through approximately 2.0 million independent distributors in 73 countries. In China, it uses retail stores, sales employees, sales representatives, and licensed business providers.
Financial performance
| Metric | Q3 2010 | Q3 2009 | First nine months 2010 | First nine months 2009 |
|---|---|---|---|---|
| Net sales | $688.4 million | $600.2 million | $1,995.9 million | $1,693.7 million |
| Operating income | $101.0 million | $77.8 million | $281.3 million | $211.9 million |
| Net income | $75.7 million | $57.9 million | $209.5 million | $147.7 million |
| Diluted EPS | $1.22 | $0.91 | $3.37 | $2.34 |
- Sales rose 14.7% in Q3 and 17.8% year to date; management reported local-currency growth of 16.7% and 16.8%, respectively. Worldwide volume points increased 13.6% and 13.2%.
- Q3 gross margin was 80.6% versus 78.0%; operating margin was 14.7% versus 13.0%; net margin was 11.0% versus 9.7%. Nine-month gross, operating, and net margins were 79.4%, 14.1%, and 10.5%, respectively, compared with 78.9%, 12.5%, and 8.7%.
- Net income increased 30.8% in Q3 and 41.9% year to date. Management attributed growth mainly to higher operating margin and lower effective tax rates, partly offset by higher compensation and distributor promotion costs.
- Q3 sales growth was strongest in Asia Pacific excluding China (+40.6%), Mexico (+22.3%), and China (+13.4%); EMEA declined 1.7%. For the first nine months, Asia Pacific excluding China grew 38.2%; South and Central America grew 6.1%, with currency movements weighing on reported growth.
Cash flow, liquidity, and debt
- Nine-month operating cash flow was $267.7 million, up from $227.3 million. Investing cash outflow was $42.5 million, including $42.2 million of property purchases; financing cash outflow was $165.1 million. Cash increased $42.7 million to $193.5 million.
- At September 30, cash was $193.5 million and working capital was $158.5 million, compared with $150.8 million and $83.5 million at December 31, 2009. Management expected operating cash flow and available credit to cover operations, planned capital spending, and foreseeable obligations for at least twelve months.
- Total debt was $209.1 million, down from $250.3 million at year-end 2009; $3.2 million was current and $205.9 million long-term. The $250 million revolving facility had $61 million drawn and $189 million undrawn. The company reported compliance with debt covenants.
- Herbalife repurchased approximately $100.1 million of shares during the first nine months and paid $38.9 million of dividends. The board raised the repurchase authorization to $1 billion and extended it through December 2014; remaining authorization was approximately $826.7 million. The quarterly dividend increased to $0.25 per share. A further $0.25 dividend was announced November 1, payable November 29.
Changes, outlook, and notable items
- Distributor adoption of daily-consumption business methods, including Nutrition Clubs and Weight Loss Challenges, and growth in active sales leaders were cited as key sales drivers. Average active sales leaders rose 11.8% worldwide in Q3. Management highlighted market expansion, distributor productivity, new products, and infrastructure investment as priorities.
- Management expected 2010 SG&A to increase in absolute dollars, reflecting compensation, China-related costs, depreciation, and growth initiatives. Full-year 2010 capital expenditures were expected to be up to approximately $75 million. The filing provides no specific earnings or revenue guidance.
- Venezuela became highly inflationary for accounting purposes effective January 1, 2010, and its functional currency changed to the U.S. dollar. Nine-month results included a $15.1 million non-tax-deductible remeasurement loss, $12.7 million of additional costs on previously imported inventory, a $14.5 million one-time deferred tax benefit, and foreign-exchange gains including a $4.0 million pretax SITME remeasurement gain. Currency controls and limits on dollar conversions make the realizable value and repatriation timing of Venezuelan cash uncertain. Venezuela represented less than 2% of nine-month sales and less than 3% of total assets.
- Other tax benefits included a $3.2 million benefit from an international audit settlement. The effective tax rate was 23.3% in Q3 and 23.8% year to date, versus 24.6% and 28.9% in 2009.
- Mexico’s tax authority assessed approximately $92 million, primarily for alleged value-added tax on imported products. Herbalife appealed, recorded no provision because management did not consider a loss probable, and said it could not reasonably estimate a possible loss. Resolution may take several years; surety bonds may be required.
- Risks include distributor recruitment and retention, network-marketing and product regulation, adverse publicity and product-liability claims, foreign exchange and currency restrictions, China licensing and regulatory uncertainty, and tax disputes. A separate Belgian challenge to the legality of the company’s marketing model was pending, with hearings scheduled for November 2010. Management reported effective disclosure controls and no material quarterly change in internal control over financial reporting.
Key facts for investors to verify
- How much reported sales and earnings growth reflects volume and local-currency performance versus exchange rates, pricing, and one-time tax or Venezuela items.
- Whether distributor activity, retention, and daily-consumption business methods sustain growth; South and Central America and EMEA had regional weaknesses in sales-leader counts or sales.
- Venezuela’s ability to obtain and repatriate U.S. dollars through CADIVI or SITME, and the potential effects on reported cash, sales, and earnings.
- Developments in the $92 million Mexican tax appeal and other tax and legal contingencies, including any bonding or cash requirements.
- Cash generation and debt capacity as the company continues share repurchases and dividends, including compliance with credit-facility covenants.