Herbalife Ltd. — FY2013 Form 10-K and Q4 results
Business and period. Herbalife sells nutrition, weight-management and personal-care products through independent Members in 91 countries. The 10-K covers the fiscal year ended December 31, 2013; fourth-quarter figures below are for the three months ended that date. The principal sales channel is Member-led direct selling, with a distinct retail and service-provider model in China.
Financial performance
| Metric | FY2013 | FY2012 | Change |
|---|---|---|---|
| Net sales | $4,825.3 million | $4,072.3 million | +18.5%; +19.4% in local currency |
| Gross profit / margin | $3,861.9 million / 80.0% | $3,259.7 million / 80.1% | Margin down 0.1 percentage point |
| Operating income / margin | $735.3 million / 15.2% | $661.4 million / 16.3% | Margin down 1.1 percentage points |
| Net income / diluted EPS | $527.5 million / $4.91 | $464.0 million / $3.94 | Net income +13.7% |
| Operating cash flow | $772.9 million | $567.8 million | +$205.1 million |
| Cash and cash equivalents at year-end | $973.0 million | $333.5 million | +$639.4 million |
| Total debt at year-end | $931.3 million | $487.6 million | +$443.7 million |
| Working capital at year-end | $720.9 million | $221.7 million | +$499.2 million |
Q4 snapshot: Net sales were $1,268.9 million versus $1,059.3 million in Q4 2012; net income was $123.5 million versus $112.2 million; diluted EPS was $1.15 versus $1.00. Q4 operating income was $181.9 million.
Weight management accounted for 63.5% of FY2013 net sales; Formula 1 alone represented approximately 28%. Worldwide Volume Points, a company-defined sales-volume measure, rose 13.1%. China sales increased 69.3%, South and Central America 41.3%, and Asia Pacific (excluding China) 3.0%.
Material changes and capital position
- SG&A rose to $1,629.1 million from $1,259.7 million, increasing from 30.9% to 33.8% of sales. Costs included $29.1 million for legal and advisory work responding to public allegations and $20.4 million for the re-audit of 2010–2012 financial statements, as well as higher growth-related and China service-provider expenses.
- Royalty overrides increased in dollars to $1,497.6 million but declined to 31.0% of sales from 32.9%. Gross margin was essentially stable; higher selling costs reduced operating margin.
- Operating cash flow was $772.9 million; cash used in investing activities was $150.8 million, including $147.0 million of cash purchases of property and equipment. Reported capital expenditures, including accrued amounts, were $162.5 million.
- At year-end, $931.3 million was outstanding under the secured credit facility, with $196.4 million of undrawn capacity; the company reported compliance with its covenants. Debt was variable-rate, with a 2.17% weighted-average rate at year-end.
- After year-end, Herbalife issued $1.15 billion of 2.00% convertible senior notes due 2019. The company also paid approximately $124 million for capped-call transactions and approximately $686 million for prepaid forward share repurchases covering about 9.9 million shares. These are subsequent events, not year-end debt or cash balances.
- FY2013 dividends paid and declared totaled approximately $123.1 million. The company repurchased 6.1 million shares for approximately $297.4 million. In February 2014, the board increased the available repurchase authorization to $1.5 billion and approved a $0.30-per-share quarterly dividend.
Outlook, commentary and risks
- Management attributed growth mainly to adoption of daily-consumption business methods, including Nutrition Clubs and Weight Loss Challenges, increased Member engagement, active sales leaders and recruiting. It planned to deepen existing markets, develop new markets, expand product access and continue investing in manufacturing and infrastructure. The filing does not provide a clear earnings or revenue forecast.
- Management expected 2014 capital expenditures of approximately $175–$195 million, including the Winston-Salem manufacturing facility, then expected to open in mid-2014.
- Venezuela’s 2013 currency devaluation generated a $15.1 million pre-tax loss; restrictions delayed or limited access to U.S. dollars. At year-end, $215.9 million of cash and cash equivalents was denominated in bolivars and reported using the official rate, which the company cautioned might not reflect realizable U.S.-dollar value. Herbalife stated that it might limit imports and that further devaluation or use of less favorable exchange mechanisms could materially affect earnings and cash flows.
- Network-marketing legality, Member and product claims, regulatory compliance, and adverse publicity remain significant risks. A Belgian appeals court reversed a lower-court pyramid-scheme ruling in December 2013; the filing said a further appeal remained possible through March 31, 2014. A U.S. putative class action challenging the marketing program was pending, and the company said it intended to defend it. The company also disclosed governmental and regulatory inquiries.
- Tax and customs contingencies include Mexican assessments of approximately $88 million for 2005–2006 and $22 million for part of 2007; the company said it disputed the matters, had not accrued a loss because it did not consider one probable, and could not estimate a possible loss range. Other country audits and claims were also ongoing.
- KPMG resigned in April 2013 and withdrew its audit opinions for 2010–2012; Herbalife engaged PwC to re-audit those years. PwC’s report on the FY2013 financial statements expressed an unqualified opinion and reported effective internal control over financial reporting as of year-end.
Important facts for investors to verify
- Whether the reported growth reflects sustained end-customer demand and repeat consumption, rather than primarily Member purchases, recruiting or inventory accumulation; the company said it lacked visibility into all Member-to-customer sales.
- Developments in regulatory inquiries and litigation concerning the network-marketing model, Member conduct and product or income claims.
- Venezuela’s exchange restrictions, the recoverability and usable value of bolivar-denominated cash, and any further currency or import-policy changes.
- The full financing and dilution implications of the 2019 convertible notes, capped calls and forward share repurchases, including how these transactions affect liquidity, debt and share count.
- Resolution of tax, VAT, customs and Member-related assessments, and whether recorded reserves remain adequate as proceedings progress.
- Whether SG&A growth, manufacturing investment and the Winston-Salem facility can be absorbed while maintaining margins and Member retention.