Herbalife Ltd. — 2014 Form 10-K
Reporting period: Fiscal year ended December 31, 2014; quarterly figures below include the fourth quarter. Amounts are in U.S. dollars unless noted. Herbalife sells nutrition and personal-care products primarily through independent Members in 91 countries.
Business context and key metrics
- Approximately 4.0 million Members at year-end; Formula 1 Healthy Meal represented about 30% of net sales. Weight management products accounted for 64.1% of 2014 net sales.
- Worldwide Volume Points rose 2.0%, slowing from 13.1% growth in 2013. Management identifies this as a measure of sales volume, not product mix.
- China was the strongest major growth market: sales increased 40.9% to $664.3 million. China operated under a distinct regulatory and compensation model.
Financial performance
| Metric | FY 2014 | FY 2013 |
|---|---|---|
| Net sales | $4,958.6 million | $4,825.3 million |
| Gross profit / gross margin | $3,975.7 million / 80.2% | $3,861.9 million / 80.0% |
| Operating income / margin | $513.5 million / 10.3% | $735.3 million / 15.2% |
| Net income / diluted EPS | $308.7 million / $3.40 | $527.5 million / $4.91 |
| Operating cash flow | $511.4 million | $772.9 million |
| Cash and cash equivalents at year-end | $645.4 million | $973.0 million |
| Total debt at year-end | $1,811.7 million | $931.3 million |
| Working capital at year-end | $518.6 million | $720.8 million |
Net sales grew 2.8% reported and 8.3% in local currency, with the latter including the remeasurement impact of Venezuela sales. Royalty overrides declined to 29.7% of sales from 31.0%, while SG&A rose to 40.2% from 33.8%. Capital expenditures, including accruals, were $156.7 million. Operating cash flow fell substantially, reflecting lower net income and working-capital movements, including higher inventory.
Fourth-quarter net sales were $1,133.6 million versus $1,268.9 million a year earlier; net income was $103.3 million versus $123.5 million. Fourth-quarter 2014 net income included a $12.0 million after-tax benefit from a cumulative employee bonus accrual estimate adjustment.
Material changes and unusual items
- Reported net income declined 41.5%. The filing cites higher SG&A, interest expense and Venezuela-related foreign exchange losses, partly offset by improved contribution margin and lower income taxes.
- Venezuela-related items had a stated $229.0 million pre-tax unfavorable impact in 2014, including currency remeasurement losses, inventory and long-lived asset write-downs, and impairment of Venezuelan bonds. The company recognized $219.0 million in net foreign currency transaction losses overall.
- Other 2014 costs included $25.1 million related to responses to short-seller allegations, $15.0 million related to the FTC Civil Investigative Demand, and a $17.5 million legal reserve for the Bostick matter. Convertible-note and forward-transaction accounting also contributed significant non-cash interest expense.
- Herbalife issued $1.15 billion of 2.00% convertible notes due 2019. It spent approximately $1.267 billion on share repurchases and related transactions in 2014, including prepaid forward transactions; shareholders’ equity moved from $551.4 million to a deficit of $334.4 million. The quarterly dividend was discontinued in April 2014 in favor of share repurchases.
Liquidity, outlook, risks and contingencies
- Debt comprised $850.0 million under the senior secured credit facility and $961.7 million carrying value for the convertible notes. The company reported $195.8 million of undrawn credit-facility capacity and compliance with debt covenants at year-end. Management expected cash, operating cash flow, available borrowings and capital-market access to meet foreseeable needs.
- Management forecast 2015 capital expenditures of approximately $120–$140 million. The filing provides no specific earnings or revenue guidance.
- Venezuelan currency controls restrict conversion and repatriation of funds. In February 2015, Venezuela introduced the SIMADI exchange mechanism; if Herbalife used that rate for remeasurement, it estimated an initial approximately $35 million of foreign-exchange losses and asset impairment charges. The actual effect remained subject to facts available at March 31, 2015.
- The FTC was investigating whether the company complied with federal law in advertising, marketing or selling business opportunities; the company said it was cooperating and could not predict the outcome. A securities class action was pending. The Bostick settlement contemplated $15 million in cash and up to $2.5 million in product returns, subject to final court approval.
- Tax authorities in multiple jurisdictions had audits, assessments or disputes outstanding. A Mexican assessment related to 2005–2006 was substantially nullified by the tax court in February 2015, subject to possible appeal; a separate Mexican assessment remained under litigation.
- Principal business risks include legal and regulatory scrutiny of the network-marketing model and Member claims, Member recruitment and retention, foreign exchange and currency restrictions, China licensing and regulation, product liability, reliance on third-party manufacturers, and concentration in Formula 1.
- PwC issued an unqualified opinion on the financial statements and internal control over financial reporting; management also concluded controls were effective. The filing notes the prior auditor’s resignation and withdrawal of earlier audit opinions, and related re-audit expenses incurred in 2013.
Important facts for investors to verify
- Whether reported sales trends and Member productivity stabilize, particularly in North America, Asia Pacific and South & Central America, and whether China growth continues.
- The cash, earnings and asset consequences of Venezuela’s exchange-rate system, including the SIMADI remeasurement and the ability to access or repatriate funds.
- The status and potential financial impact of the FTC inquiry, securities litigation, Bostick settlement approval and material tax disputes.
- Debt-service capacity, covenant headroom and the effects of the 2019 convertible notes, including potential cash settlement, dilution and non-cash interest.
- Whether operating cash flow recovers and inventory levels normalize as manufacturing capacity expands; compare future capital spending with the stated 2015 range.