HERBALIFE LTD. annual report, FY2020

Herbalife Nutrition Ltd. — FY2020 Form 10-K

Reporting period: Fiscal year ended December 31, 2020. Although the request references Q4, this filing is an annual report; fourth-quarter results are noted separately below. Financial figures are in U.S. dollars unless stated otherwise.

Business context

Herbalife sells nutrition, weight-management, sports and wellness products in 95 markets, primarily through independent Members using a direct-selling model. It reported approximately 6.2 million Members at year-end. Formula 1 shake products accounted for about 28% of annual net sales; weight management products represented 59.8% of sales.

Financial performance and liquidity

MetricFY2020FY2019Change
Net sales$5,541.8 million$4,877.1 million+13.6%
Gross profit / gross margin$4,391.2 million / 79.2%$3,919.1 million / 80.4%Margin down 112 bps
Operating income / margin$640.6 million / 11.6%$568.1 million / 11.7%Income +12.8%
Net income / diluted EPS$372.6 million / $2.77$311.0 million / $2.20Income +19.8%
Operating cash flow$628.6 million$457.5 million+37.4%
Capital expenditures$116.8 million$110.2 million+6.0%
Cash and cash equivalents$1,045.4 million$839.4 million+$206.0 million
Total debt$2,428.4 million$1,803.0 million+$625.4 million
Working capital$648.5 million$523.8 million+$124.7 million

Net sales growth reflected a 14.1% increase in Volume Points and a favorable 3.6% price impact, partly offset by a 3.8% adverse foreign-exchange impact. Operating cash flow increased on higher earnings and favorable working-capital movements. The company said cash, operating cash flow and available credit were sufficient for foreseeable needs. It had a $282.5 million revolving facility, with no revolving borrowings outstanding at year-end.

Debt increased largely following the May 2020 issuance of $600 million of 7.875% senior notes. The company also had $550 million principal amount of 2.625% convertible notes due 2024 and $400 million principal amount of 7.25% notes due 2026. Shareholders’ deficit widened to $856.1 million from $390.0 million, reflecting substantial share repurchases among other items.

Changes and fourth-quarter results

  • FY2020 net sales rose from $4.88 billion to $5.54 billion, while net income increased from $311.0 million to $372.6 million. Diluted EPS increased to $2.77 from $2.20.
  • Gross margin declined to 79.2%, primarily due to higher freight costs from home delivery, foreign exchange, self-manufacturing and sourcing costs, country mix and inventory write-downs; price increases partly offset these pressures. Royalty overrides increased to 30.5% of sales from 29.7%.
  • SG&A rose $134.7 million to $2.08 billion, including higher labor and benefits and increased FCPA-investigation expenses; lower travel and Member-event costs partly offset the increases.
  • Fourth-quarter net sales were $1,410.7 million versus $1,220.3 million a year earlier; net income was $73.8 million versus $56.7 million, and diluted EPS was $0.59 versus $0.40. Sales and earnings were below the third quarter’s $1,521.8 million and $138.1 million, respectively.
  • Regional results were mixed: North America sales grew 33.9% and EMEA 21.1%; Mexico sales fell 7.7% and South and Central America fell 3.3%. China sales increased 7.7% for the year, but declined year over year in Q4, according to management.

Outlook, risks and unusual items

  • Management expected Volume Point and net sales growth in 2021 but cautioned it might not sustain 2020’s growth rate. It forecast 2021 capital expenditures of approximately $175 million to $225 million; no specific earnings or revenue guidance is provided in the supplied filing text.
  • COVID-19 disrupted Member access to products, in-person meetings and Nutrition Clubs, and affected supply chains and operations. The company shifted toward online ordering, home delivery and virtual training; management said demand was at or above pre-pandemic levels overall but future impacts remained uncertain.
  • In August 2020, the company resolved U.S. SEC and DOJ FCPA matters concerning China. It paid approximately $123 million in penalties, disgorgement and interest in September, and agreed to a three-year deferred prosecution agreement and compliance self-reporting. The SEC order found violations of FCPA books-and-records and internal-control provisions; failure to comply could lead to further action.
  • The FTC Consent Order remains a material compliance obligation, including U.S. sales documentation, Member classification and independent audits through a seven-year period. The company said it believed it was complying, while acknowledging associated costs and potential business effects.
  • Material tax exposures include ongoing audits and disputes in multiple jurisdictions. The company disclosed a final adverse Mexican tax verdict related to 2007 and an accrued $19 million loss; other assessments and proceedings have uncertain outcomes. The auditor identified loss contingencies as a critical audit matter.
  • Other unusual items include $21.2 million of pre-tax COVID-related expenses and $21.8 million of non-cash interest expense on convertible notes in 2020. China government grant income was $14.5 million, down from $31.5 million in 2019.
  • The company repurchased approximately 18.4 million shares for about $892.1 million under its repurchase program in 2020 and paid no cash dividends. In January 2021, it completed a separate $600 million purchase of 12.49 million shares from Carl Icahn and affiliates, funded with cash and approximately $150 million of revolving-credit borrowings.

Key investor verification points

  • Review the cash-flow statement and debt notes to assess the sustainability of operating cash flow, increased debt and the effects of the 2020 and January 2021 repurchases.
  • Track gross-margin trends, freight and sourcing costs, foreign-exchange exposure, and the concentration of sales in Formula 1 products.
  • Monitor U.S. FTC Consent Order compliance and the three-year FCPA deferred prosecution agreement, including any additional costs, findings or enforcement actions.
  • Follow developments in tax audits and assessments, particularly Mexico, Brazil, India, Korea and China, and compare potential exposures with recorded reserves.
  • Assess whether 2021 sales and Volume Point growth can be maintained as pandemic restrictions ease, and monitor China’s Q4 sales decline and regional Member activity.