HLF

Business Context and Reporting Period

Company: Herbalife Ltd.
Filing Type: Form 10-Q (Unaudited)
Period Ended: June 30, 2009
Business Overview: Herbalife is a global network marketing company selling weight management, nutritional supplements, and personal care products through approximately 1.9 million independent distributors in 70 countries. In China, the company utilizes a retail store and employed sales force model due to regulatory restrictions.

Key Financial Metrics

Margins (Six Months 2009): Gross Margin was 79.4%; Operating Margin was 12.3%; Net Income Margin was 8.2%.

Material Changes vs. Prior Period

• Revenue Decline: Net sales decreased 10.6% for the quarter and 12.1% for the six months compared to 2008. The decline was primarily driven by unfavorable foreign currency fluctuations ($68.0M and $145.2M impact, respectively). In local currency, sales were relatively flat.
• Profitability: Net income decreased 28.1% (quarter) and 30.6% (six months) year-over-year. This was driven by revenue declines, a higher effective tax rate due to country mix changes, and higher depreciation expenses.
• Regional Performance:
  • Declines: Mexico (-35.3% QoQ) due to new Value Added Tax (VAT) on nutrition products; EMEA (-20.8% QoQ) impacted by currency and negative media in Spain; South & Central America (-13.5% QoQ) due to Venezuela currency controls and inflation.
  • Growth: Asia Pacific (excluding China) grew 7.6% (QoQ) and 8.8% (6-month), driven by strong performance in Taiwan, South Korea, and Malaysia. North America grew 3.8% (QoQ) due to a shift to daily consumption models and a 5% price increase in the U.S.
• Distributor Metrics: Worldwide new sales leaders decreased 16.9% (quarter) and 17.2% (six months). Supervisor retention rate was 40.3% for the 2009 re-qualification period.

Guidance, Outlook, and Risks

• Outlook: Management expects fiscal year 2009 net sales to increase in North America and Asia Pacific but decrease in Mexico, South & Central America, and EMEA due to currency headwinds and specific regional challenges (VAT in Mexico, inflation in Venezuela).
• Capital Allocation: A new share repurchase program of up to $300 million was authorized in April 2009. No shares were repurchased in the first half of 2009. Quarterly dividends of $0.20 per share were maintained.
• Liquidity: The company maintains a $300 million senior secured credit facility with $98 million undrawn capacity as of June 30, 2009. Management believes operating cash flows are sufficient to meet debt obligations.
• Key Risks:
  • Venezuela: Currency restrictions and high inflation pose risks to repatriating cash and earnings. The company holds approximately $51 million in cash in Venezuela.
  • China: Expansion is subject to obtaining provincial direct-selling licenses. The company recently received licenses for five additional provinces.
  • Regulatory/Litigation: Ongoing tax audits in various jurisdictions and product liability claims. A lawsuit in Belgium challenges the legality of the network marketing program.
  • Foreign Exchange: Significant exposure to currency fluctuations, particularly the strengthening U.S. dollar.

Investor Verification Checklist

• Currency Impact: Verify the extent to which reported revenue declines are due to foreign exchange rates versus actual volume drops in key markets like Mexico and EMEA.
• Venezuela Exposure: Assess the risk of the $51 million cash balance in Venezuela and the potential for write-downs if the country is designated as highly inflationary or if currency repatriation fails.
• China Expansion: Monitor the progress of obtaining direct-selling licenses in new provinces and the adoption of the "Nutrition Club" model.
• Distributor Retention: Review the 40.3% supervisor retention rate and the decline in new sales leaders to gauge the health of the distribution network.
• Tax Contingencies: Review the $43 million in unrecognized tax benefits and the status of ongoing audits in Spain and Mexico.