Herbalife Ltd. — Q3 2016 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2016. Unaudited consolidated results. Herbalife sells nutrition and personal-care products through independent Members in 94 countries; it reported 4.1 million Members, including approximately 0.3 million in China.
Financial performance
| Metric | Q3 2016 | Q3 2015 | Nine months 2016 | Nine months 2015 |
|---|---|---|---|---|
| Net sales | $1,122.0 million | $1,102.9 million | $3,443.4 million | $3,370.6 million |
| Operating income | $151.5 million | $161.6 million | $299.9 million | $441.0 million |
| Net income | $87.7 million | $93.6 million | $160.6 million | $254.6 million |
| Diluted EPS | $1.01 | $1.09 | $1.87 | $2.99 |
| Operating cash flow | Not separately provided | Not separately provided | $249.9 million | $493.2 million |
- Net sales rose 1.7% in Q3 and 2.2% year to date; in local currency, they increased 5.2% and 8.7%, respectively. Worldwide Volume Points increased 6.2% in Q3 and 6.6% year to date.
- Gross margin was 81.4% in Q3 and 80.9% year to date, up 0.2 percentage points in both comparable periods. Operating margin was 13.5% in Q3 versus 14.7%, and 8.7% year to date versus 13.1%.
- Net income declined 6.3% in Q3 and 36.9% year to date. Year-to-date results included $203.0 million of regulatory settlements, partly offset by higher China government grants, sales growth, and lower Venezuela-related foreign-exchange losses.
- Cash from operations fell to $249.9 million from $493.2 million. Investing activities used $107.5 million, including $111.9 million for property and equipment; financing activities used $241.3 million, mainly for debt principal payments. Cash declined $101.5 million to $788.3 million.
Balance sheet and liquidity
- At September 30, cash was $788.3 million; current assets were $1,559.4 million and current liabilities $1,263.3 million. Working capital was $296.1 million, down from $541.9 million at year-end 2015.
- Total debt was $1,442.9 million, compared with $1,622.0 million at December 31, 2015. The current portion was $425.3 million; the company’s $410.0 million revolver matures March 9, 2017, with $425.0 million of total borrowing capacity available. The $1.15 billion convertible notes mature in August 2019.
- The credit facility requires at least $200 million of consolidated cash; Herbalife reported covenant compliance. Management said cash, operating cash flow, available borrowings, and capital-market access should cover working capital, planned capital expenditures, debt service, and other needs for the next 12 months.
- Shareholders’ equity was positive $123.7 million, compared with a $53.5 million deficit at year-end 2015.
Material changes and management commentary
- Q3 sales growth reflected volume, while a strong U.S. dollar reduced reported results. Year-to-date sales also benefited from price increases. Management attributed worldwide volume growth to Member training and retention initiatives, daily-consumption programs, improved product access, and continued promotion.
- Regional performance was uneven: Q3 net sales increased in North America and EMEA, but declined in South and Central America and China. South and Central America remained pressured, particularly Brazil; South Korean sales also fell sharply amid changes to the Marketing Plan and product discount structure.
- The $200 million FTC settlement was paid in July 2016. The Consent Order requires U.S. Member classification, compensation tied to documented retail sales and permitted personal consumption, restrictions on Nutrition Clubs, and independent compliance audits for seven years. The company is implementing requirements and cautioned that U.S. business and Member activity could be affected during the transition.
- Management expected 2016 capital expenditures of approximately $145 million to $155 million. The filing provides no specific full-year revenue or earnings guidance.
Risks, contingencies, and unusual items
- Material risks include compliance with the FTC Consent Order, Member recruitment and retention, regulatory scrutiny of network marketing, foreign-exchange exposure, and operating restrictions in Venezuela and China. The company stated that Consent Order noncompliance or implementation costs could materially harm results.
- Tax disputes remain pending in Mexico, Brazil, India, and South Korea. The company generally said losses were not considered probable and some exposures could not be reasonably estimated. Disclosed matters include a Mexico assessment of approximately $59 million, a Brazil São Paulo assessment of approximately $49.5 million, and a Korea preliminary assessment of $32.6 million; the company had paid $13.0 million of Korea assessments and expected to pay the remaining assessed amount while appealing.
- Venezuela’s currency, pricing, and import restrictions continued to constrain operations and repatriation. Venezuela generated less than 1% of consolidated sales in the nine-month periods shown.
- On October 30, 2016, an arbitration tribunal awarded the company approximately $30 million related to the re-audit of 2010–2012 financial statements. The award was not recognized in the September 30 statements and could be challenged.
- The company reported effective disclosure controls as of September 30, 2016, and no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Progress and costs of FTC Consent Order implementation, including documented U.S. retail sales, Member classification, Nutrition Club restrictions, and audit findings.
- Plans to refinance or repay the $410 million revolver due March 2017, covenant headroom, and the effect of elevated borrowing rates on interest expense.
- Whether operating cash flow recovers after the year-to-date decline and whether planned capital spending remains within the $145–$155 million range.
- Developments in Brazil, South Korea, and other weak markets, alongside the sustainability of growth in North America, EMEA, and China.
- Outcomes and potential cash impacts of tax disputes and the post-period arbitration award, which was not included in reported results.