Herbalife Nutrition Ltd. — Q2 2020 Form 10-Q
Business and period: Herbalife sells nutrition products through independent Members, with a modified operating model in China. This unaudited filing covers the quarter and six months ended June 30, 2020; amounts are in U.S. dollars unless noted.
Financial performance
| Metric | Q2 2020 | Q2 2019 | Six months 2020 | Six months 2019 |
|---|---|---|---|---|
| Net sales | $1,346.9 million | $1,240.1 million | $2,609.3 million | $2,412.3 million |
| Gross profit / margin | $1,074.1 million / 79.7% | $996.9 million / 80.4% | $2,090.8 million / 80.1% | $1,927.5 million / 79.9% |
| Operating income / margin | $189.7 million / 14.1% | $153.1 million / 12.3% | $285.3 million / 10.9% | $316.1 million / 13.1% |
| Net income | $115.1 million | $76.5 million | $160.7 million | $172.8 million |
| Diluted EPS | $0.82 | $0.54 | $1.15 | $1.20 |
| Operating cash flow | Not presented by quarter | $385.0 million | $114.8 million |
- Q2 sales increased 8.6% in reported dollars and 14.9% in local currency; first-half sales increased 8.2% and 13.3%, respectively. Worldwide Volume Points rose 12.4% in Q2 and 9.0% for the half.
- Q2 net income rose 50.5%, mainly reflecting higher contribution margin. First-half net income fell 7.0%, with higher regulatory-related expenses and lower China grant income among the offsets to sales-driven contribution growth.
- Q2 gross margin declined 65 basis points, reflecting manufacturing, sourcing, freight, currency, country mix, and inventory impacts, partly offset by price increases. First-half gross margin improved 22 basis points.
- First-half cash from operations included favorable working-capital movements, particularly in other current liabilities; it was not solely earnings-driven. Investing cash outflow was $49.4 million, primarily capital expenditures.
Balance sheet, debt, and liquidity
- At June 30, cash and cash equivalents were $1,740.0 million, versus $839.4 million at year-end 2019; reported working capital was $1,304.9 million, versus $523.8 million.
- Total debt carrying value was $2,427.1 million, versus $1,803.0 million at December 31, 2019. The increase principally reflects $600 million of 7.875% senior notes issued in May 2020, due 2025. The filing lists total scheduled principal payments of $2,549.6 million.
- The $600 million note issue carries a 7.875% coupon; the 2026 notes carry 7.250%. The $550 million 2024 convertible notes carry a 2.625% coupon. Senior unsecured notes rank effectively behind secured debt to the extent of secured assets.
- The company reported $282.5 million of available revolving-credit capacity, no revolving borrowings, and compliance with credit-facility covenants. The credit facility’s weighted-average borrowing rate was 3.86% at June 30.
- Cash growth reflects, in part, the May note offering. Management said cash on hand, operating cash flow, and available credit were expected to meet foreseeable needs for the next 12 months. The filing does not provide a specific earnings or sales forecast.
Changes, outlook, risks, and unusual items
- Regional divergence: Q2 reported sales grew 38.7% in North America, 14.2% in EMEA, and 12.0% in China, but declined 20.5% in Mexico, 22.7% in South and Central America, and 5.1% in Asia Pacific excluding China. Currency movements materially affected several regions.
- COVID-19: Restrictions disrupted in-person selling, Member events, Nutrition Clubs, and product access in some markets. The company shifted toward online ordering, home delivery, and virtual Member training. Management said demand remained at or above pre-pandemic levels overall, but warned impacts could continue through year-end and could materially adversely affect future results; duration and magnitude were uncertain. Q2 included $6.1 million of pre-tax pandemic-related expenses, and the company expected such costs to continue.
- FCPA investigations: Herbalife reported an understanding in principle with SEC staff and DOJ for resolution of alleged China-related conduct from 2006–2016. Proposed terms include approximately $123 million of penalties, disgorgement, and interest, a three-year DOJ deferred prosecution agreement, and compliance reporting. The company had accrued approximately $123 million, but final approvals and terms remained outstanding; additional loss could be material and was not estimable.
- Other contingencies: Mexico’s Supreme Court declined the company’s final petition in a tax dispute; the adverse assessment became final, and the company said it would pay. The $19 million loss had been accrued in 2019. The filing also describes ongoing tax disputes in Brazil, India, Korea, and China, among others; several are not accrued because management does not consider losses probable. Product-liability claims are also possible; the company has a $12.5 million annual deductible.
- China grants and prior-period items: China government grants contributed $3.3 million in Q2 and $12.4 million for the first half of 2020, versus $0 and $21.3 million, respectively, in 2019. The prior-year first half also included $6.0 million of insurance recoveries and $14.4 million of CVR revaluation gains; neither was recognized in first-half 2020.
- Capital allocation: First-half share repurchases totaled $26.0 million, including shares withheld for employee taxes. After quarter-end, the company announced a modified Dutch-auction tender offer for up to $750 million at $44.75–$50.00 per share, subject to its terms and conditions. The company expected to use cash for the offer.
- Investment spending: Management estimated full-year 2020 capital expenditures of approximately $130–$170 million. No formal earnings guidance was provided in the supplied filing text.
Important facts for investors to verify
- Final SEC, DOJ, and court approvals and ultimate payment terms for the proposed FCPA resolution, including any obligations beyond the accrued $123 million.
- Completion, price, share count, and cash impact of the $750 million tender offer, and resulting debt, liquidity, and covenant headroom.
- Whether strong Q2 sales and Volume Point growth persist after pandemic-related restrictions and unusual demand patterns ease, particularly in North America.
- Cash-flow quality: the extent to which elevated first-half operating cash flow depended on working-capital changes and accrued liabilities.
- Progress and potential financial exposure in unresolved tax assessments, the China customs audit, and other legal and regulatory matters.