Herbalife Ltd. — Q2 2016 Form 10-Q
Business context and period. Herbalife sells nutrition and wellness products through independent Members in 94 countries. This unaudited filing covers the quarter and six months ended June 30, 2016; comparisons are with the same 2015 periods. Amounts are in U.S. dollars unless noted.
Financial performance
| Metric | Q2 2016 | Q2 2015 | Six months 2016 | Six months 2015 |
|---|---|---|---|---|
| Net sales | $1,201.8 million | $1,162.3 million | $2,321.4 million | $2,267.7 million |
| Gross profit / margin | $965.5 million / 80.3% | $933.0 million / 80.3% | $1,872.0 million / 80.6% | $1,823.0 million / 80.4% |
| Operating income (loss) | $(19.9) million | $143.8 million | $148.4 million | $279.4 million |
| Net income (loss) | $(22.9) million | $82.8 million | $72.9 million | $161.0 million |
| Diluted EPS | $(0.28) | $0.97 | $0.85 | $1.90 |
| Operating cash flow | Not separately provided for the quarter | Not separately provided for the quarter | $368.0 million | $358.7 million |
Q2 net sales rose 3.4% in reported dollars and 10.0% in local currency; six-month sales rose 2.4% and 10.4%, respectively. Worldwide Volume Points increased 9.0% in Q2 and 6.8% year to date. The stronger U.S. dollar reduced reported sales growth. Gross margin was broadly stable, with sourcing and manufacturing savings, price increases and lower inventory write-downs offset by currency effects.
Q2 operating margin was negative 1.7%, versus 12.4% a year earlier; six-month operating margin was 6.4%, versus 12.3%. Net margin was negative 1.9% in Q2 and 3.1% for the first half, compared with 7.1% in both prior-year periods. Selling, general and administrative expense was $676.8 million in Q2 and $1,103.9 million year to date, including $203.0 million of regulatory settlement expense.
Liquidity, debt and cash flow
- Cash and cash equivalents were $936.7 million at June 30, up from $889.8 million at year-end 2015. Operating cash flow was $368.0 million; investing cash flow was $(82.4) million and financing cash flow was $(233.5) million for the first half.
- Capital expenditures were $82.2 million for the first half. Management expected full-year 2016 capital expenditures of approximately $160 million to $180 million.
- Total debt carrying value was $1,426.6 million: $410.0 million outstanding on the revolving credit facility, $1,003.3 million carrying value of convertible notes, and $13.3 million other debt. The notes have $1.15 billion principal due in 2019. The revolving facility had $425.0 million available and matures March 9, 2017.
- The facility requires at least $200.0 million of consolidated cash. The company reported compliance with debt covenants at June 30. Working capital fell to $203.6 million from $541.9 million at year-end, mainly because $410.0 million of revolving debt became current and a $203.0 million settlement accrual was recorded.
- The $200 million FTC settlement payment was made in July 2016. Management said cash, operating cash flow, available facility borrowings and capital-market access were expected to support operations, planned capital spending and foreseeable obligations for the next twelve months and thereafter.
Material changes and management commentary
- Regulatory settlements: The FTC settlement became effective July 25, 2016, after quarter-end, but its $200 million charge was recognized in Q2. A separate $3 million Illinois Attorney General settlement was also included in the $203 million total. The FTC settlement requires U.S. Member classification, distributor compensation tied to documented retail sales, restrictions on Nutrition Clubs, enhanced compliance procedures and independent audits for seven years.
- Regional trends: Q2 sales increased in North America (15.9%), EMEA (13.0%) and China (2.5%), but declined in Mexico (7.7%), South and Central America (10.2%) and Asia Pacific excluding China (1.9%). South Korea and Brazil were notable sources of weakness. China sales increased 14.7% for the first half.
- Business model transition: Management attributed improving worldwide Volume Points partly to Members adapting to Marketing Plan changes and customer-focused, daily-consumption approaches. It cautioned that transition effects vary by market and can weigh on near-term sales.
- China grants: Government grant income was $28.1 million in Q2 and $28.9 million year to date. The company intends to apply for future grants but gave no assurance they will recur.
- Foreign exchange and Venezuela: Venezuela remained affected by inflation, pricing and import restrictions, and limits on repatriating earnings and settling intercompany obligations. Venezuela represented less than 1% of sales; related foreign exchange losses and charges were $7.1 million for the first half, down from $36.9 million a year earlier.
- Tax and legal contingencies: The filing describes pending tax disputes and assessments in Mexico, Brazil, India and South Korea, among others. Management generally stated it believed losses were not probable; some potential losses could not be reasonably estimated. Mexico VAT-related assets were $50.8 million. A Brazil tax assessment of approximately $49 million was received in July, after quarter-end.
- Outlook and risks: No earnings or revenue guidance was provided in the supplied filing text. Management warned that FTC compliance costs or business changes could affect U.S. sales, Member activity and results; failure to comply could have a material adverse effect. Other stated risks include foreign exchange, Member retention, regulation of direct selling and products, tax disputes, China licensing and the 2017 revolving facility maturity.
Key facts investors should verify
- Reconcile Q2 and first-half operating results excluding the $203 million regulatory settlement, while recognizing that such adjustments are not a substitute for reported GAAP results.
- Track implementation of the FTC order, related compliance costs, documented U.S. retail sales, Member retention and any effect on U.S. revenue.
- Assess refinancing or repayment plans for the $410 million revolving facility due in March 2017 and the company’s covenant headroom and cash requirements.
- Monitor whether China government grants recur and whether China sales growth and Member activity remain sustainable.
- Follow developments in material tax matters, including Mexico VAT assets, Brazilian assessments and South Korean customs assessments, and compare outcomes with management’s loss assessments.
- Review foreign-exchange exposure and market-level operating trends, especially South Korea, Brazil and Venezuela.