Herbalife Nutrition Ltd. — Q3 2020 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2020. Unaudited results; comparisons are with the corresponding 2019 periods. Herbalife sells nutrition and personal-care products through independent Members, with a distinct operating model in China.
Financial performance
| Metric | Q3 2020 | Q3 2019 | Nine months 2020 | Nine months 2019 |
|---|---|---|---|---|
| Net sales | $1,521.8 million | $1,244.5 million | $4,131.1 million | $3,656.8 million |
| Operating income | $206.9 million | $143.6 million | $492.2 million | $459.7 million |
| Net income | $138.1 million | $81.5 million | $298.8 million | $254.3 million |
| Diluted EPS | $1.04 | $0.58 | $2.17 | $1.79 |
- Q3 sales rose 22.3%; nine-month sales rose 13.0%. Volume Points, the company’s sales-volume proxy, increased 23.2% and 13.8%, respectively. Management attributed growth principally to volume, with price increases also contributing; foreign exchange was a headwind.
- Q3 gross margin was 78.8%, down from 80.4%; operating margin was 13.6%, up from 11.5%; net margin was 9.1%, up from 6.5%. For the nine months, gross margin was 79.6% versus 80.1%, operating margin 11.9% versus 12.6%, and net margin 7.2% versus 7.0%.
- Q3 contribution margin increased to $736.0 million from $637.3 million. Royalty overrides rose to 30.4% of sales from 29.2%; SG&A declined to 34.8% of sales from 40.2%. The nine-month SG&A increase included $83.1 million of expenses related to the China FCPA investigations and settlement.
- Operating cash flow for the nine months was $516.1 million, versus $300.9 million. Capital expenditures were $75.6 million in cash-flow reporting, implying approximate operating cash flow less capital expenditures of $440.6 million. Cash and cash equivalents were $1,034.6 million at September 30, up from $839.4 million at year-end.
Balance sheet, debt and liquidity
- Total debt carrying value was $2,428.6 million, compared with $1,803.0 million at December 31, 2019. This included $989.9 million outstanding under the secured credit facility, $550 million principal of 2024 convertible notes, $600 million principal of 2025 senior notes, and $400 million principal of 2026 senior notes.
- The company issued $600 million of 7.875% senior notes due 2025 in May. The March 2020 credit-facility amendment extended certain maturities, increased revolving capacity to $282.5 million, and reduced specified borrowing rates. No revolver borrowings were outstanding; the company reported covenant compliance.
- Current assets were $1,732.1 million and current liabilities $1,092.7 million, giving working capital of $639.4 million and a current ratio of approximately 1.59. Shareholders’ deficit widened to $912.9 million from $390.0 million, principally reflecting the year-to-date share repurchases and accumulated deficit.
Changes, outlook and material matters
- Growth was broad but uneven. Q3 U.S. sales increased 53.8%; EMEA increased 38.0%; China increased 5.4%. Mexico sales fell 5.3% in reported dollars, while South and Central America rose 7.7% in Q3 but declined 7.6% for the nine months. Currency weakness materially affected several markets.
- In August, Herbalife repurchased about 15.4 million shares for approximately $750 million through a modified Dutch auction and also made open-market repurchases. Total nine-month cash-flow repurchases were $844.2 million; $682.9 million remained under the $1.5 billion authorization at quarter-end. The filing says the business historically used debt primarily to fund repurchases.
- The company paid approximately $123 million in September to resolve the SEC and DOJ China FCPA matters. The SEC order found violations of FCPA books-and-records and internal-controls provisions; the DOJ deferred prosecution for three years, subject to compliance and self-reporting obligations. Noncompliance could materially harm results and financial condition.
- COVID-19 disrupted in-person meetings, Nutrition Clubs, product access and distribution, with impacts varying by market. Management said demand remained at or above pre-pandemic levels overall, but effects could continue through 2020 and beyond and their duration and magnitude were uncertain. The company said cash, operating cash flow and available revolving credit were sufficient for foreseeable needs over the next 12 months.
- Management expected 2020 capital expenditures of approximately $110–$130 million. The filing provides no specific revenue or earnings guidance. Management noted that pandemic-related expenses were expected to continue.
- Contingencies include a final adverse Mexican tax assessment for which a $19 million loss had been accrued and payment was planned; disputed tax matters in Brazil, India and Korea; and an ongoing China customs audit for which excess loss could not be reasonably estimated. The company reported $62.5 million of unrecognized tax benefits, interest and penalties.
- Subsequent event: on November 4, the board declared warrants for shareholders at one warrant per four shares, with a $67.50 exercise price, seven-year term and exercise only on expiration. The company expected to list them on the NYSE; the distribution also requires adjustments to convertible notes and employee awards.
Key facts for investors to verify
- Whether the sharp Q3 volume growth persists as pandemic restrictions and consumer behavior change, and whether growth translates into sustainable sales and margins.
- Debt repayment capacity and covenant headroom after the 2020 debt issuance and substantial share repurchases, including the high-coupon 2025 notes and convertible-note obligations.
- Progress on the three-year DOJ deferred-prosecution agreement and ongoing SEC compliance obligations, including any further costs or consequences.
- Exposure and potential cash timing for Mexican, Brazilian, Indian, Korean and China tax/customs matters, including recovery of Mexico VAT assets.
- Effects of foreign exchange, delivery and freight costs, supply-chain constraints, direct-selling regulation, and COVID-19 on regional performance and liquidity.