Herbalife Nutrition Ltd. — Q1 2019 Form 10-Q
Business context and reporting period. Unaudited results for the three months ended March 31, 2019, compared with Q1 2018. Herbalife sells nutrition and personal-care products primarily through independent Members; China uses a distinct sales and service-provider model. Figures are in U.S. dollars unless noted.
Key financial results
| Metric | Q1 2019 | Q1 2018 | Change / context |
|---|---|---|---|
| Net sales | $1,172.2 million | $1,176.9 million | Down 0.4% reported; company cited foreign-exchange headwinds. Volume Points rose 6.1%. |
| Gross profit / margin | $930.6 million / 79.4% | $937.0 million / 79.6% | Margin down 0.2 percentage points. |
| Operating income / margin | $163.0 million / 13.9% | $155.8 million / 13.2% | Operating income rose 4.6%. |
| Net income | $96.3 million | $82.1 million | Up 17.3%; diluted EPS was $0.66 versus $0.54. |
| Interest expense, net | $36.1 million | $39.9 million | Lower weighted-average borrowing rate and higher interest income contributed to the decrease. |
| Cash from operations | $38.5 million | $156.2 million | Down substantially, mainly from less favorable working-capital movements and higher cash taxes. |
| Capital expenditures | $27.0 million cash purchases | $15.6 million | Management expects $130–$170 million for full-year 2019. |
| Cash and cash equivalents | $1,209.0 million | $1,198.9 million at Dec. 31, 2018 | Cash, cash equivalents and restricted cash totaled $1,219.0 million at quarter-end. |
| Debt | $2,461.7 million carrying value | $2,453.8 million at Dec. 31, 2018 | Includes $686.2 million current debt; $675 million principal of 2.00% convertible notes matures Aug. 15, 2019. |
| Working capital | $304.0 million | $216.2 million at Dec. 31, 2018 | Up $87.8 million. |
| Income tax rate | 28.9% | 10.3% | Higher primarily because of fewer discrete tax benefits. |
Material changes versus Q1 2018
- Regional results diverged: Primary Reporting Segment sales increased 5.9% to $1,021.8 million, while China sales fell 29.1% to $150.4 million. China contribution margin declined 28.2% to $133.1 million.
- Sales growth was strongest in Asia Pacific excluding China (+19.9%), North America (+10.9%), and Mexico (+4.6%). South and Central America fell 20.6% reported; EMEA increased 1.4% reported.
- Worldwide Volume Points increased 6.1%, with growth in five of six regions; China declined 31.8% and South and Central America declined 9.9%.
- SG&A fell $24.7 million to $435.4 million, partly reflecting lower China service fees, but royalty overrides rose $22.2 million to $359.5 million. The royalty-override rate increased to 30.7% of sales from 28.7%, partly because China represented a smaller share of revenue.
- Net income benefited from lower SG&A, an $8.5 million CVR revaluation gain versus an $11.3 million loss in 2018, and the prior-year $13.1 million debt-extinguishment loss. Higher income taxes and lower China contribution margin partly offset these benefits.
Liquidity, debt and other financial matters
- Long-term debt included approximately $990 million outstanding under the 2018 secured credit facility, $675 million principal of 2019 convertible notes, $550 million principal of 2024 convertible notes, and $400 million principal of 2026 senior notes. The revolving credit facility had no borrowings; the company reported compliance with credit-facility covenants.
- The 2018 credit facility is variable-rate debt. Management estimated a 1 percentage-point rate change, with borrowings held constant, could change annual interest expense by approximately $9.9 million.
- Operating cash flow was $38.5 million and cash capital expenditures were $27.0 million. Cash generation was affected by working-capital outflows, including inventory and other current liabilities. The company said cash, operating cash flow, available facility borrowings and capital-market access should meet foreseeable needs.
- Herbalife adopted lease accounting on Jan. 1, 2019, recognizing operating lease right-of-use assets and liabilities; adoption did not adjust opening retained earnings.
Outlook, management commentary and risks
- No full-year revenue or earnings guidance is provided in the supplied filing text. Management forecasts 2019 capital expenditures of approximately $130–$170 million.
- Management attributed China’s sharp Q1 decline to a government 100-day review of the health-products industry and related negative media coverage, which reduced Member activity and sales meetings. The review concluded in April, but management expected adverse effects to continue further into 2019.
- Management cited Member segmentation, customer-focused selling, Nutrition Clubs, product expansion and technology tools as growth initiatives. It also noted ongoing challenges in Brazil, including slower adoption of customer-oriented practices, economic uncertainty and competitive pressure.
- In April 2019, a fire at a third-party warehouse in Vietnam destroyed a significant amount of inventory; management said this could adversely affect Q2 sales despite a recovery plan. This is a subsequent event, not a Q1 operating result.
- Unusual Q1 income items included $21.3 million of China government grants and $6.0 million of finalized insurance recoveries related to the 2017 Mexico warehouse flood. The filing states there is no assurance that China grants will continue.
- Regulatory and legal exposures include the FTC Consent Order and its compliance requirements; SEC discussions concerning China marketing-plan disclosures, for which an $8 million liability was accrued; and ongoing SEC/DOJ FCPA investigations concerning China expenditures, with potential losses not reasonably estimable. The company reported no material change in internal control and concluded disclosure controls were effective.
- Other contingencies include tax disputes and assessments in Mexico, Brazil, India and Korea, among other jurisdictions. The company generally stated it did not consider losses probable; it could not reasonably estimate potential losses for several matters. Mexico VAT-related assets totaled $32.3 million, with possible refund delays and changed offset rules.
- Additional risks include Member retention and conduct, compliance with direct-selling and product regulations, foreign-exchange and tariff exposure, dependence on China, debt and convertible-note refinancing or conversion, and potential dilution. The 2019 notes were convertible at holders’ option at quarter-end and mature in August 2019.
Important facts for investors to verify
- How Herbalife addressed the $675 million 2019 convertible-note maturity, including any repayment, refinancing or conversion and the resulting liquidity and dilution effects.
- Whether China sales and Member activity recovered after the government review, and how the SEC matter and FCPA investigation were resolved or progressed.
- Whether operating cash flow improved after the Q1 working-capital outflows and whether full-year capital expenditures remained within the stated $130–$170 million range.
- Whether the Vietnam warehouse fire affected Q2 product availability and sales, and whether insurance or other recoveries were available.
- The sustainability of earnings excluding China grants, insurance recoveries, and the non-cash CVR revaluation gain; also monitor the higher effective tax rate.
- Whether tax assessments, Mexico VAT recoverability, FTC Consent Order compliance costs, or other contingencies resulted in additional accruals or cash payments.