Herbalife Ltd. — Form 10-Q Summary
Reporting period: Quarter and nine months ended September 30, 2015; comparisons are with the corresponding 2014 periods. Unaudited consolidated financial statements. Herbalife sells nutrition products through an independent Member network; it reported 4.0 million Members and operations in 93 countries.
Financial performance
| Metric | Q3 2015 | Q3 2014 | Nine months 2015 | Nine months 2014 |
|---|---|---|---|---|
| Net sales | $1,102.9 million | $1,256.2 million | $3,370.6 million | $3,825.0 million |
| Operating income | $161.6 million | $27.6 million | $441.0 million | $351.5 million |
| Net income | $93.6 million | $11.2 million | $254.6 million | $205.4 million |
| Diluted EPS | $1.09 | $0.13 | $2.99 | $2.22 |
| Gross margin | 81.2% | 79.7% | 80.7% | 80.0% |
| Operating margin | 14.7% | 2.2% | 13.1% | 9.2% |
- Reported net sales fell 12.2% in Q3 and 11.9% year to date. Management attributed the decline chiefly to currency translation and lower sales volume. In local currency, sales rose 2.8% in Q3 and 1.2% year to date excluding Venezuela.
- Worldwide Volume Points, a company-defined sales-volume indicator, declined 3.2% in Q3 and 4.1% year to date. Average active sales leaders increased 4.3% and 5.7%, respectively.
- Performance varied substantially by region: China sales grew 24.0% in Q3 and 28.4% year to date; the Primary Reporting Segment declined 18.3% and 17.8%. China growth also increased service fees recorded in SG&A.
- Q3 net income improved sharply from the prior-year quarter, which included significant Venezuela currency remeasurement losses, a Bostick litigation reserve and asset impairments. Lower SG&A was the main driver of improved operating income; sales and contribution margin were lower. Year-to-date net income rose 24.0%.
- Operating cash flow for the first nine months was $493.2 million, compared with $449.5 million. Cash and cash equivalents were $813.2 million at September 30, 2015, up from $645.4 million at year-end 2014. Capital expenditures, including accrued amounts, were $48.7 million versus $121.6 million.
- Working capital was $461.6 million, down from $518.6 million at year-end, primarily reflecting more debt classified as current. Total debt was $1,653.4 million, including $254.7 million current debt; the balance-sheet shareholders’ deficit was $130.7 million.
Material changes, liquidity and capital allocation
- Debt declined from $1,811.7 million at December 31, 2014. The senior secured credit facility balance was $664.7 million; $425.0 million of revolving capacity remained available. The term loan matures March 9, 2016 and the revolver March 9, 2017. The $1.15 billion convertible notes carry a 2.00% stated coupon and mature in 2019.
- The credit facility requires at least $200 million of consolidated cash, includes financial covenants and restricts dividends and repurchases. The company reported compliance at September 30, 2015. No open-market share repurchases or dividends were reported in the first nine months of 2015.
- Management said operating cash flow, available credit and capital-market access should be sufficient for working capital, expected capital expenditures and foreseeable liquidity requirements. It forecast full-year 2015 capital expenditures of approximately $80–$90 million.
- Q3 gross margin improved 150 basis points, with price increases, lower inventory write-downs, country mix and cost savings partly offset by foreign-exchange effects. Royalty overrides fell as a share of sales, partly because China’s faster growth shifts more compensation into SG&A.
Outlook, commentary and key risks
- Management described changes to the Marketing Plan and operating practices as intended to improve sales-leader training and retention, while acknowledging that Member adaptation has weighed on volume and near-term sales in several markets. The filing provides no specific earnings or revenue guidance.
- Venezuela remains exposed to foreign-exchange controls, high inflation, price controls and potential further devaluation. The company used the SIMADI rate of 198 bolivars per U.S. dollar at quarter-end; access to exchange mechanisms is limited, and reported Venezuelan asset values may not reflect realizable U.S. dollars. Year-to-date Venezuela remeasurement and related items reduced pretax income by $36.9 million. Local manufacturing was expected to begin in the first half of 2016, but depends on access to foreign currency for inputs.
- Regulatory and legal matters include an ongoing FTC investigation, information requests from the Department of Justice, and a securities class action the company is defending. The company said it could not predict the scope or outcome of regulatory inquiries and had not recorded a loss for the securities case because loss was not considered probable.
- Tax disputes and VAT matters include Mexican assessments and delayed VAT refunds; the company reported $56.4 million in Mexico VAT-related assets and said it had not recognized losses because it did not consider them probable. It also disclosed ongoing Brazilian and Korean tax or customs matters. Outcomes and potential losses are uncertain.
- The Bostick class settlement received final approval and became final; its $15 million fund payment and up to $2.5 million in product returns were adequately reserved. Professional and advisory expenses related to public allegations remained ongoing.
- Management concluded disclosure controls and procedures were effective as of September 30, 2015; no material change in internal control over financial reporting was reported for the quarter.
Investor verification priorities
- Track reported sales and local-currency sales separately, especially Volume Points and trends in South Korea, Mexico, South and Central America, and China.
- Assess whether lower SG&A and higher earnings are sustainable apart from prior-year Venezuela foreign-exchange losses and other unusual costs.
- Verify liquidity and covenant headroom, the 2016 term-loan maturity, the $200 million minimum cash requirement, and remaining revolver availability.
- Monitor Venezuela’s exchange-rate access, cash repatriation, local-manufacturing progress and potential effects on earnings and cash realization.
- Follow developments in FTC and DOJ inquiries, the securities litigation, and tax/VAT disputes, including any change in loss estimates or reserves.