Herbalife Ltd. — Q1 2016 Form 10-Q
Business context and reporting period. Unaudited results for the three months ended March 31, 2016, compared with Q1 2015. Herbalife sells nutrition and wellness products in 94 countries through approximately 4.0 million independent Members, including 0.3 million in China.
Key financial results
| Metric | Q1 2016 | Q1 2015 | Change |
|---|---|---|---|
| Net sales | $1,119.6 million | $1,105.4 million | +1.3% reported; +10.9% in local currency |
| Gross profit / margin | $906.5 million / 81.0% | $890.0 million / 80.5% | Margin +0.5 percentage points |
| Operating income / margin | $168.3 million / 15.0% | $135.6 million / 12.3% | Operating income +24.1% |
| Net income | $95.8 million | $78.2 million | +22.5% |
| Diluted EPS | $1.12 | $0.92 | +21.7% |
| Operating cash flow | $141.1 million | $161.1 million | Down $20.0 million |
Royalty overrides were $311.9 million, or 27.9% of sales, versus $323.0 million, or 29.2%. SG&A was $426.3 million, or 38.1% of sales, compared with $431.4 million, or 39.0%. Net interest expense increased to $24.9 million from $21.5 million. The effective tax rate rose to 33.2% from 30.1%.
Cash and cash equivalents were $774.2 million at March 31, down from $889.8 million at year-end. Net cash used in investing was $25.6 million; net cash used in financing was $233.7 million, including $229.7 million of debt repayments. Working capital was $266.2 million, versus $541.9 million at year-end.
Total debt carrying value was $1,402.8 million: $410.0 million under the revolving credit facility and $992.8 million for the convertible notes. The $410.0 million revolving balance is classified as current and the facility matures March 9, 2017; $425.0 million of borrowing capacity was available. The $1.15 billion convertible notes mature in 2019 and bear 2.00% stated interest. The company reported compliance with debt covenants and is required to maintain at least $200 million of consolidated cash.
Material changes and operating trends
- Worldwide Volume Points increased 4.5%. China sales rose 32.4% to $217.4 million, while the primary reporting segment’s sales fell 4.1% to $902.2 million in reported dollars. A strong U.S. dollar reduced consolidated sales by approximately 9.6%; local-currency growth was 10.9%.
- Regional sales were mixed: North America +8.5%, EMEA +6.4%, and China +32.4%; Mexico declined 11.2%, South and Central America declined 21.5%, and Asia Pacific excluding China declined 8.9%. Currency translation was a substantial drag in several regions.
- Management attributed improvement in sales volume to Member execution, customer-focused and daily-consumption programs, and progress adapting to Marketing Plan changes. Average active sales leaders were nearly flat worldwide (+0.4%), with growth in China and EMEA offset by declines elsewhere.
- Gross margin improved due to country mix, price increases, and sourcing/manufacturing savings, partly offset by currency effects. Lower royalty overrides primarily reflected faster China growth, where service-provider fees are recorded in SG&A instead.
- Net income benefited from higher contribution margin and lower Venezuela-related foreign-exchange losses than in Q1 2015. Q1 2015 included $36.3 million of Venezuela-related foreign-exchange losses and other charges; Q1 2016 recorded $4.7 million.
Outlook, risks, and unusual items
- Management expected full-year 2016 capital expenditures of approximately $145 million to $175 million. It stated that operating cash flow, available credit, and capital-market access should be sufficient for expected needs and obligations over the next 12 months and thereafter; this is management’s assessment, not a guarantee.
- The FTC investigation into the company’s marketing and business-opportunity practices remained in advanced discussions, with material issues unresolved. Herbalife’s best estimate of a payment in a negotiated resolution was $200 million; no amount was accrued. The company warned that resolution or litigation could materially adversely affect operations, results, or financial condition.
- Tax and customs disputes remain outstanding, especially in Mexico, Brazil, India, and Korea. The company generally stated losses were not probable, but some exposures could not be reasonably estimated. Mexico VAT-related assets totaled $56.2 million; recovery timing and outcomes are uncertain.
- Venezuela remained affected by inflation, pricing and import restrictions, and foreign-exchange controls that limit repatriation and access to U.S. dollars. Venezuela represented less than 1% of Q1 2016 sales and held approximately $5.1 million of Bolivar-denominated cash.
- Foreign currency risk remains significant; the company used $438.1 million of foreign-exchange contracts. A 1 percentage-point interest-rate change, with borrowings constant, was estimated to change annual interest expense by about $4.1 million.
- Q1 2016 net income included $7.6 million of pre-tax expenses related to regulatory inquiries, $2.9 million for legal and advisory response to market allegations, and $1.4 million of re-audit cost recovery expenses. On April 21, 2016, the company bought a previously leased Torrance office building for approximately $30 million.
Most important facts for investors to verify
- Progress and potential financial impact of the FTC matter, including whether a settlement is reached and how any payment is funded.
- Liquidity and refinancing plans for the $410 million revolving facility due in March 2017, and compliance with the facility’s covenants and minimum-cash requirement.
- Whether China’s rapid growth and broader Volume Point trends can persist, and whether Member and sales-leader activity improves in weaker regions.
- Foreign-exchange exposure, Venezuela restrictions, and the recoverability and timing of VAT and other tax-related assets.
- Actual 2016 capital expenditures versus the $145 million–$175 million estimate and resulting cash-flow trends.