Herbalife Nutrition Ltd. — Q1 2020 Form 10-Q
Reporting period: Three months ended March 31, 2020. Unaudited results are compared with the three months ended March 31, 2019 unless otherwise noted. Herbalife sells nutrition products globally primarily through independent Members; China operates under a modified sales model.
Key financial results
| Metric | Q1 2020 | Q1 2019 / comparison |
|---|---|---|
| Net sales | $1,262.4 million | $1,172.2 million; up 7.7% reported and 11.6% in local currency |
| Gross profit / margin | $1,016.7 million / 80.5% | $930.6 million / 79.4% |
| Operating income / margin | $95.6 million / 7.6% | $163.0 million / 13.9% |
| Net income | $45.6 million | $96.3 million; down 52.6% |
| Diluted EPS | $0.32 | $0.66 |
| Operating cash flow | $141.7 million | $38.5 million |
| Cash and cash equivalents | $944.2 million at March 31 | $839.4 million at December 31, 2019 |
| Debt, carrying value | $1,833.8 million, including $23.1 million current | $1,803.0 million at December 31, 2019 |
| Working capital | $587.3 million | $523.8 million at December 31, 2019 |
Cash used in investing activities was $24.3 million, primarily for property and equipment. Cash provided by financing activities was $21.0 million, including $30.2 million of net borrowings from the senior secured facility. The cash-flow statement reports a $104.6 million increase in cash, cash equivalents and restricted cash for the quarter. The filing attributes much of the year-over-year operating cash flow increase to working-capital movements, including a $92.9 million source from other current liabilities.
Changes and operating performance
- Net sales growth reflected higher volume, price increases and favorable sales mix, partly offset by a 3.9% unfavorable currency impact. Worldwide Volume Points rose 5.6%.
- Profitability weakened despite higher sales: SG&A rose $113.6 million to $549.0 million, principally including $83.0 million of FCPA-related investigation expenses, higher China service fees and labor costs. Lower China government grants and the absence of 2019 CVR revaluation income also weighed on comparison.
- Interest expense, net fell to $25.0 million from $36.1 million. The effective tax rate rose to 35.4% from 28.9%.
- Regional net sales increased in China (26.3%), Asia Pacific (12.0%), North America (8.3%) and EMEA (2.8%); declined in Mexico (3.7%) and South and Central America (8.3%).
- China government grant income was $9.1 million, compared with $21.3 million in Q1 2019. Gross margin improved by 115 basis points, mainly from pricing and lower inventory write-downs.
Liquidity, debt and capital allocation
- Total debt principal was $1,954.9 million at March 31, 2020. The debt schedule includes $584.0 million due in 2024, principally the $550 million convertible notes due March 2024. The 2026 senior notes carry a 7.25% coupon.
- The March 2020 credit-facility amendment extended the Term Loan A and revolving-facility maturity to March 2025, subject to an earlier maturity condition tied to the 2024 convertible notes and leverage. It increased revolving capacity to $282.5 million and reduced applicable Term Loan A and revolver margins. No revolver borrowings were outstanding, and the company reported compliance with debt covenants.
- The company reported $944.2 million of cash and access to the undrawn revolver; management said these resources and operating cash flow were sufficient for foreseeable needs over the next 12 months. Management expected 2020 capital expenditures of approximately $130 million to $170 million.
- No open-market share repurchases occurred during the quarter. The $1.5 billion repurchase authorization remained available, subject to facility covenants and other restrictions. The company has not paid cash dividends since 2014.
Outlook, risks and unusual items
- COVID-19: The pandemic disrupted distribution, Member access, in-person selling and training, and some manufacturing and logistics. Sales were higher in Q1, but management expected adverse effects in coming quarters, potentially through year-end in some markets. It cited a recent decline in new Members in certain markets and said the duration and magnitude of impacts could not be predicted. No numerical earnings guidance was provided.
- FCPA investigations: Herbalife reported an understanding in principle with SEC staff and DOJ for a proposed total payment of approximately $123 million, including an $83 million additional accrual in Q1 on top of $40 million previously accrued. Proposed terms include an SEC administrative resolution and a three-year DOJ deferred prosecution agreement with compliance reporting. Documentation and approvals remained outstanding; final terms were uncertain, and additional loss could be material.
- Mexico tax dispute: On April 29, 2020, Mexico’s Supreme Court declined a further petition, making adverse lower-court decisions final. The company said it would pay the assessment; a $19 million loss had been accrued in 2019. Mexico VAT-related assets totaled $19.3 million, and the company believed they were recoverable.
- Other disclosed tax matters include Brazilian, Indian and Korean assessments and an ongoing Chinese customs audit. The company generally had not accrued losses where it did not consider loss probable or could not reasonably estimate it.
- The U.S. FTC Consent Order requires ongoing compliance controls and independent audits. Failure to comply, or resulting changes to Member activity or compensation, could materially affect the business. The filing also identifies foreign exchange, regulatory, product-liability, supply-chain, Member-retention and leverage risks.
- Shareholders’ deficit was $388.5 million at March 31. Foreign currency translation reduced comprehensive income by $57.1 million during the quarter; total comprehensive loss was $4.9 million.
Important facts for investors to verify
- Progress, final documentation, approvals, payment timing and any change in the approximately $123 million proposed FCPA settlement.
- Subsequent-quarter sales, Volume Points, new-Member trends and fulfillment conditions as COVID-19 restrictions evolved across regions.
- Debt covenant headroom, the terms and availability of the $282.5 million revolver, and liquidity needs around the $550 million 2024 note maturity.
- Cash-flow sustainability: Q1 operating cash flow benefited materially from working-capital changes, particularly other current liabilities.
- Resolution and recoverability of material tax disputes and Mexico VAT assets, alongside the final Mexico assessment payment.