Herbalife Ltd. — Q2 2011 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2011. Unaudited results; comparisons are with the corresponding 2010 periods. Herbalife sells nutrition, weight-management, energy, fitness and personal-care products, primarily through a global network of about 2.3 million independent distributors. China uses a different, regulated sales model.
Key financial results
Amounts below are in millions of dollars except per-share data. Net sales include shipping and handling revenues.
| Metric | Q2 2011 | Q2 2010 | Six months 2011 | Six months 2010 |
|---|---|---|---|---|
| Net sales | $879.7 | $688.8 | $1,674.8 | $1,307.4 |
| Gross profit | $708.6 | $552.2 | $1,340.9 | $1,030.4 |
| Operating income | $153.2 | $116.4 | $276.6 | $180.3 |
| Net income | $111.2 | $82.2 | $199.2 | $134.0 |
| Diluted EPS | $0.88 | $0.65 | $1.57 | $1.06 |
| Operating cash flow | Not separately provided | Not separately provided | $250.6 | $170.6 |
- Growth: Net sales rose 27.7% in Q2 and 28.1% for the first half; management reported local-currency growth of 19.9% and 22.1%, respectively. Net income increased 35.3% and 48.6%.
- Margins: Gross margin was 80.6% in Q2 and 80.1% for the first half, versus 80.2% and 78.8%. Operating margin was 17.4% and 16.5%, versus 16.9% and 13.8%; net margin was 12.6% and 11.9%, versus 11.9% and 10.3%.
- Cash flow and investment: First-half capital expenditures were $44.4 million, compared with $23.9 million. Cash flow from operations less reported property purchases was approximately $206.2 million, versus $146.7 million.
- Liquidity: At June 30, cash was $254.5 million, current assets $738.6 million and current liabilities $542.7 million; working capital was $196.0 million, up from $124.8 million at year-end 2010.
- Debt: Total debt was $160.6 million, including $158.0 million outstanding on the new revolving credit facility. The $700 million facility matures in March 2016, with $540.7 million of undrawn capacity. The company reported compliance with its covenants.
Material changes and operating trends
- Growth was broad-based. Q2 net sales increased 40.8% in Mexico, 57.1% in South and Central America, 19.5% in EMEA and 37.9% in Asia Pacific excluding China; China sales rose 0.4% in U.S. dollars but declined 4.6% in local currency. Worldwide Volume Points rose 17.1% in Q2 and 19.2% for the first half.
- Management attributed growth to adoption of daily-consumption distributor methods, distributor engagement and recruiting, branding, and expansion of distribution access. Average active sales leaders increased 21.1% worldwide in Q2.
- Weight Management remained the largest product category, with Q2 net sales of $552.3 million, up 28.3%. All listed product categories grew.
- Gross-margin improvement reflected sourcing savings in Q2 and, for the first half, comparisons involving Venezuela. Selling, general and administrative expense rose in dollars, including higher compensation, distributor events and promotion, professional fees, foreign-exchange losses and non-income taxes.
- The company refinanced its prior debt facility in March 2011. It also repurchased 1.8 million shares for approximately $98.8 million in Q2. First-half dividends paid were $38.7 million and share repurchases used $115.3 million of cash.
Outlook, risks and unusual items
- Outlook: Management expected 2011 capital expenditures of approximately $90–$100 million and stated that cash, operating cash flow and available facility borrowings should meet foreseeable liquidity needs. The filing provides no specific earnings or revenue guidance.
- Venezuela: Currency controls constrain conversion and repatriation of cash. A February bond conversion generated a $1.3 million pretax loss. Venezuelan operations were less than 2% of consolidated net sales, but exchange access and accounting rates remain uncertain.
- Tax contingency: A Mexican tax assessment of approximately $97 million, largely related to VAT, was nullified in May 2011; authorities may re-issue some or all of it. The company recorded no provision and said it could not reasonably estimate a possible loss range. The filing also reports international tax audits and $32.1 million of unrecognized tax benefits, plus related interest and penalties.
- Legal and regulatory exposure: Routine product-liability claims were described as not material, with a $10 million annual insurance deductible. The filing discusses a Belgian challenge to the legality of the marketing program, an adidas trademark/contract dispute, product and advertising regulation, and risks to direct-selling licenses and operations in China. The former-distributor litigation in California was dismissed by joint stipulation in May 2011.
- Accounting and other items: Herbalife changed its accounting method for excess share-based compensation tax benefits to the with-and-without method, applied to periods presented; the company said the change did not affect taxes payable. A two-for-one stock split was approved and prior share and per-share data were retrospectively adjusted. First-half 2011 results included a $0.9 million pretax financing-cost write-off.
- Other risks: Distributor recruitment and retention, product and network-marketing reputation, competition, foreign exchange, supplier dependence, tax and regulatory changes, and economic conditions could affect results. Management stated disclosure controls were effective and reported no material second-quarter change in internal control over financial reporting.
Important facts for investors to verify
- Whether reported sales growth persists after separating local-currency growth from favorable exchange-rate effects, and whether distributor engagement translates into sustained consumer demand.
- Whether Venezuela’s currency restrictions affect cash access, product imports, reported earnings or the ability to continue consolidating the subsidiary.
- The potential outcome and financial exposure from the Mexican tax matter, other tax audits, and the Belgian and adidas proceedings.
- Progress in China, including licensing, regulatory compliance and the transition to daily-consumption distribution methods.
- Cash use for repurchases and dividends relative to capital spending, debt levels, facility covenants and remaining borrowing capacity.
- Exposure to product concentration: Formula 1 represented approximately 28% of 2010 net sales, according to the filing.