Item 1.
Financial Statements
HERBALIFE LTD. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
|
|
September 30,
2017
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|
|
December 31,
2016
|
|
|
|
(In millions, except share and
par value amounts)
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|
ASSETS
|
|
|
|
|
|
|
|
|
CURRENT ASSETS:
|
|
|
|
|
|
|
|
|
Cash and cash equivalents
|
|
$
|
1,636.3
|
|
|
$
|
844.0
|
|
Receivables, net of allowance for doubtful accounts
|
|
|
95.2
|
|
|
|
70.3
|
|
Inventories
|
|
|
354.2
|
|
|
|
371.3
|
|
Prepaid expenses and other current assets
|
|
|
188.4
|
|
|
|
176.9
|
|
Total current assets
|
|
|
2,274.1
|
|
|
|
1,462.5
|
|
Property, at cost, net of accumulated depreciation and amortization
|
|
|
375.1
|
|
|
|
378.0
|
|
Marketing related intangibles and other intangible assets, net
|
|
|
310.1
|
|
|
|
310.1
|
|
Goodwill
|
|
|
95.8
|
|
|
|
89.9
|
|
Other assets
|
|
|
367.4
|
|
|
|
324.9
|
|
Total assets
|
|
$
|
3,422.5
|
|
|
$
|
2,565.4
|
|
LIABILITIES AND SHAREHOLDERS’ EQUITY
|
|
|
|
|
|
|
|
|
CURRENT LIABILITIES:
|
|
|
|
|
|
|
|
|
Accounts payable
|
|
$
|
60.6
|
|
|
$
|
66.0
|
|
Royalty overrides
|
|
|
266.7
|
|
|
|
261.2
|
|
Current portion of long-term debt
|
|
|
104.1
|
|
|
|
9.5
|
|
Other current liabilities
|
|
|
427.4
|
|
|
|
454.8
|
|
Total current liabilities
|
|
|
858.8
|
|
|
|
791.5
|
|
NON-CURRENT LIABILITIES:
|
|
|
|
|
|
|
|
|
Long-term debt, net of current portion
|
|
|
2,176.6
|
|
|
|
1,438.4
|
|
Other non-current liabilities
|
|
|
168.1
|
|
|
|
139.2
|
|
Total liabilities
|
|
|
3,203.5
|
|
|
|
2,369.1
|
|
CONTINGENCIES
|
|
|
|
|
|
|
|
|
SHAREHOLDERS’ EQUITY:
|
|
|
|
|
|
|
|
|
Common shares, $0.001 par value; 1.0 billion shares authorized; 89.3 million (2017) and 93.1 million (2016) shares outstanding
|
|
|
0.1
|
|
|
|
0.1
|
|
Paid-in capital in excess of par value
|
|
|
452.0
|
|
|
|
467.6
|
|
Accumulated other comprehensive loss
|
|
|
(174.6
|
)
|
|
|
(205.1
|
)
|
Retained earnings (accumulated deficit)
|
|
|
240.7
|
|
|
|
(66.3
|
)
|
Treasury stock, at cost, 4.6 million shares (2017)
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|
|
(299.2
|
)
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|
|
—
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|
Total shareholders’ equity
|
|
|
219.0
|
|
|
|
196.3
|
|
Total liabilities and shareholders’ equity
|
|
$
|
3,422.5
|
|
|
$
|
2,565.4
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|
See the accompanying notes to unaudited condensed consolidated financial statements.
3
HERBALIFE LTD. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
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|
Three Months Ended
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|
|
Nine Months Ended
|
|
|
|
September 30,
2017
|
|
|
September 30,
2016
|
|
|
September 30,
2017
|
|
|
September 30,
2016
|
|
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|
(In millions, except per share amounts)
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|
Product sales
|
|
$
|
1,029.7
|
|
|
$
|
1,063.2
|
|
|
$
|
3,162.8
|
|
|
$
|
3,253.1
|
|
Shipping & handling revenues
|
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|
55.7
|
|
|
|
58.8
|
|
|
|
171.6
|
|
|
|
190.3
|
|
Net sales
|
|
|
1,085.4
|
|
|
|
1,122.0
|
|
|
|
3,334.4
|
|
|
|
3,443.4
|
|
Cost of sales
|
|
|
215.4
|
|
|
|
209.1
|
|
|
|
638.8
|
|
|
|
658.5
|
|
Gross profit
|
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|
870.0
|
|
|
|
912.9
|
|
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|
2,695.6
|
|
|
|
2,784.9
|
|
Royalty overrides
|
|
|
310.1
|
|
|
|
320.3
|
|
|
|
944.1
|
|
|
|
968.9
|
|
Selling, general & administrative expenses
|
|
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445.2
|
|
|
|
441.3
|
|
|
|
1,327.0
|
|
|
|
1,545.2
|
|
Other operating income
|
|
|
(4.6
|
)
|
|
|
(0.2
|
)
|
|
|
(43.5
|
)
|
|
|
(29.1
|
)
|
Operating income
|
|
|
119.3
|
|
|
|
151.5
|
|
|
|
468.0
|
|
|
|
299.9
|
|
Interest expense, net
|
|
|
38.4
|
|
|
|
22.1
|
|
|
|
106.5
|
|
|
|
70.1
|
|
Income before income taxes
|
|
|
80.9
|
|
|
|
129.4
|
|
|
|
361.5
|
|
|
|
229.8
|
|
Income taxes
|
|
|
26.4
|
|
|
|
41.7
|
|
|
|
84.2
|
|
|
|
69.2
|
|
NET INCOME
|
|
$
|
54.5
|
|
|
$
|
87.7
|
|
|
$
|
277.3
|
|
|
$
|
160.6
|
|
Earnings per share:
|
|
|
|
|
|
|
|
|
|
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Basic
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$
|
0.69
|
|
|
$
|
1.06
|
|
|
$
|
3.41
|
|
|
$
|
1.94
|
|
Diluted
|
|
$
|
0.66
|
|
|
$
|
1.01
|
|
|
$
|
3.26
|
|
|
$
|
1.87
|
|
Weighted average shares outstanding:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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Basic
|
|
|
79.6
|
|
|
|
83.1
|
|
|
|
81.4
|
|
|
|
83.0
|
|
Diluted
|
|
|
83.0
|
|
|
|
86.4
|
|
|
|
85.0
|
|
|
|
86.1
|
|
See the accompanying notes to unaudited condensed consolidated financial statements.
4
HERBALIFE LTD. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Unaudited)
|
|
Three Months Ended
|
|
|
Nine Months Ended
|
|
|
|
September 30,
2017
|
|
|
September 30,
2016
|
|
|
September 30,
2017
|
|
|
September 30,
2016
|
|
|
|
(In millions)
|
|
Net income
|
|
$
|
54.5
|
|
|
$
|
87.7
|
|
|
$
|
277.3
|
|
|
$
|
160.6
|
|
Other comprehensive income (loss):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Foreign currency translation adjustment, net of income taxes of $(1.8) and $5.8 for the three months ended September 30, 2017 and 2016, respectively, and $3.5 and $7.3 for the nine months ended September 30, 2017 and 2016, respectively
|
|
|
11.3
|
|
|
|
(2.6
|
)
|
|
|
41.0
|
|
|
|
1.6
|
|
Unrealized (loss) gain on derivatives, net of income taxes of $— for both the three months ended September 30, 2017 and 2016 and $— and $(0.3) for the nine months ended September 30, 2017 and 2016, respectively
|
|
|
2.5
|
|
|
|
(2.2
|
)
|
|
|
(10.5
|
)
|
|
|
(9.3
|
)
|
Other, net of income taxes of $0.1 for the nine months ended September 30, 2016
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
(0.1
|
)
|
Total other comprehensive income (loss)
|
|
|
13.8
|
|
|
|
(4.8
|
)
|
|
|
30.5
|
|
|
|
(7.8
|
)
|
Total comprehensive income
|
|
$
|
68.3
|
|
|
$
|
82.9
|
|
|
$
|
307.8
|
|
|
$
|
152.8
|
|
See the accompanying notes to unaudited condensed consolidated financial statements.
5
HERBALIFE LTD. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
|
|
Nine Months Ended
|
|
|
|
September 30,
2017
|
|
|
September 30,
2016
|
|
|
|
(In millions)
|
|
CASH FLOWS FROM OPERATING ACTIVITIES
|
|
|
|
|
|
|
|
|
Net income
|
|
$
|
277.3
|
|
|
$
|
160.6
|
|
Adjustments to reconcile net income to net cash provided by operating activities:
|
|
|
|
|
|
|
|
|
Depreciation and amortization
|
|
|
73.8
|
|
|
|
72.6
|
|
Share-based compensation expenses
|
|
|
32.6
|
|
|
|
30.3
|
|
Non-cash interest expense
|
|
|
44.8
|
|
|
|
42.0
|
|
Deferred income taxes
|
|
|
(4.1
|
)
|
|
|
(38.4
|
)
|
Inventory write-downs
|
|
|
17.7
|
|
|
|
16.7
|
|
Foreign exchange transaction loss (gain)
|
|
|
4.0
|
|
|
|
(1.4
|
)
|
Other
|
|
|
(1.1
|
)
|
|
|
(3.8
|
)
|
Changes in operating assets and liabilities:
|
|
|
|
|
|
|
|
|
Receivables
|
|
|
(22.5
|
)
|
|
|
(14.6
|
)
|
Inventories
|
|
|
29.2
|
|
|
|
(56.7
|
)
|
Prepaid expenses and other current assets
|
|
|
(3.6
|
)
|
|
|
(14.9
|
)
|
Accounts payable
|
|
|
(8.2
|
)
|
|
|
17.5
|
|
Royalty overrides
|
|
|
(6.7
|
)
|
|
|
14.1
|
|
Other current liabilities
|
|
|
(45.0
|
)
|
|
|
24.3
|
|
Other
|
|
|
16.2
|
|
|
|
1.6
|
|
NET CASH PROVIDED BY OPERATING ACTIVITIES
|
|
|
404.4
|
|
|
|
249.9
|
|
CASH FLOWS FROM INVESTING ACTIVITIES
|
|
|
|
|
|
|
|
|
Purchases of property, plant and equipment
|
|
|
(67.9
|
)
|
|
|
(111.9
|
)
|
Other
|
|
|
(2.8
|
)
|
|
|
4.4
|
|
NET CASH USED IN INVESTING ACTIVITIES
|
|
|
(70.7
|
)
|
|
|
(107.5
|
)
|
CASH FLOWS FROM FINANCING ACTIVITIES
|
|
|
|
|
|
|
|
|
Borrowings from senior secured credit facility, net of discount
|
|
|
1,274.0
|
|
|
|
—
|
|
Principal payments on senior secured credit facility and other debt
|
|
|
(468.2
|
)
|
|
|
(233.0
|
)
|
Debt issuance costs
|
|
|
(22.6
|
)
|
|
|
—
|
|
Share repurchases
|
|
|
(346.2
|
)
|
|
|
(12.5
|
)
|
Other
|
|
|
1.6
|
|
|
|
4.2
|
|
NET CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES
|
|
|
438.6
|
|
|
|
(241.3
|
)
|
EFFECT OF EXCHANGE RATE CHANGES ON CASH
|
|
|
20.0
|
|
|
|
(2.6
|
)
|
NET CHANGE IN CASH AND CASH EQUIVALENTS
|
|
|
792.3
|
|
|
|
(101.5
|
)
|
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD
|
|
|
844.0
|
|
|
|
889.8
|
|
CASH AND CASH EQUIVALENTS, END OF PERIOD
|
|
$
|
1,636.3
|
|
|
$
|
788.3
|
|
See the accompanying notes to unaudited condensed consolidated financial statements.
6
HERBALIFE LTD. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. Organization
Herbalife Ltd., a Cayman Islands exempt limited liability company, was incorporated on April 4, 2002. Herbalife Ltd. (and together with its subsidiaries, the “Company” or “Herbalife”) is a global nutrition company that sells weight management, targeted nutrition, energy, sports & fitness, and outer nutrition products to and through a network of independent members, or Members. In China, the Company sells its products to and through independent service providers, sales representatives, and sales officers to customers and preferred customers, as well as through Company-operated retail stores when necessary. The Company reports revenue in six geographic regions: North America; Mexico; South and Central America; EMEA, which consists of Europe, the Middle East and Africa; Asia Pacific (excluding China); and China.
2. Significant Accounting Policies
Basis of Presentation
The unaudited condensed consolidated interim financial information of the Company has been prepared in accordance with Article 10 of the Securities and Exchange Commission’s, or the SEC, Regulation S-X. Accordingly, as permitted by Article 10 of the SEC’s Regulation S-X, it does not include all of the information required by generally accepted accounting principles in the U.S., or U.S. GAAP, for complete financial statements. The condensed consolidated balance sheet at December 31, 2016 was derived from the audited financial statements at that date and does not include all the disclosures required by U.S. GAAP, as permitted by Article 10 of the SEC’s Regulation S-X. The Company’s unaudited condensed consolidated financial statements as of September 30, 2017, and for the three and nine months ended September 30, 2017 and 2016, include Herbalife Ltd. and all of its direct and indirect subsidiaries. In the opinion of management, the accompanying financial information contains all adjustments, consisting of normal recurring adjustments, necessary to present fairly the Company’s unaudited condensed consolidated financial statements as of September 30, 2017, and for the three and nine months ended September 30, 2017 and 2016. These unaudited condensed consolidated financial statements should be read in conjunction with the Company’s Annual Report on Form 10-K for the year ended December 31, 2016, or the 2016 10-K. Operating results for the three and nine months ended September 30, 2017, are not necessarily indicative of the results that may be expected for the year ending December 31, 2017.
Recently Adopted Pronouncements
In March 2016, the Financial Accounting Standards Board, or FASB, issued Accounting Standards Update, or ASU No. 2016-09,
Compensation — Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting
. This ASU is intended to simplify various aspects related to how share-based payments are accounted for and presented in the financial statements, including the income tax effects of share-based payments and accounting for forfeitures. The amendments in this update became effective for the Company’s reporting period beginning January 1, 2017. This guidance requires the Company to recognize excess tax benefits on share-based compensation arrangements in its tax provision, instead of in shareholders’ equity as under the previous guidance. During the three and nine months ended September 30, 2017, the Company recorded $0.6 million and $26.4 million of excess tax benefits in its tax provision, respectively, as described further in Note 8,
Income Taxes
. In addition, these amounts are now required to be classified as an operating activity in the Company’s statement of cash flows rather than a financing activity. The Company has elected to present the cash flow statement using a prospective transition method and prior periods have not been adjusted. In addition, the Company has made an accounting policy election to continue to estimate the number of forfeitures expected to occur. The adoption of this guidance also increased the Company’s number of shares used in its calculation of fully diluted earnings per share due to the reduction in assumed proceeds under the treasury stock method which also impacts how the Company determines its earnings per share calculation. Upon adoption of this guidance on January 1, 2017, the Company also recognized $29.6 million of its unrealized excess tax benefits, described further in Note 12,
Income Taxes
in the 2016 10-K, as deferred tax assets on its consolidated balance sheet with a corresponding increase to its retained earnings.
In March 2016, the FASB issued ASU No. 2016-06,
Derivatives and Hedging (Topic 815): Contingent Put and Call Options in Debt Instruments
. This ASU clarified the requirements for assessing whether contingent put or call options that can accelerate the payment of principal on debt instruments are clearly and closely related (i.e. an entity is required to assess whether the economic characteristics and risks of embedded put or call options are clearly and closely related to those of their debt hosts only in accordance with the four-step decision sequence of FASB Accounting Standards Codification, or ASC 815,
Derivatives and Hedging
). An entity should no longer assess whether the event that triggers the ability to exercise a put or call option is related to interest rates or credit risk of the entity. In the first quarter of 2017, the Company adopted and applied the standard to its applicable financial instruments. The adoption of this guidance had no financial impact on the Company’s consolidated financial statements
.
7
In March 2016, the FASB issued ASU No. 2016-05,
Derivatives and
Hedging (Topic 815): Effect of Derivative Contract Novations on Existing Hedge Accounting Relationships
. This ASU provides guidance clarifying that the novation of a derivative contract (i.e. a change in counterparty) in a hedge accounting relationship do
es not, in and of itself, require dedesignation of that hedge accounting relationship. If all of the other hedge accounting criteria are met, including the expectation that the hedge will be highly effective when the creditworthiness of the new counterpart
to the derivative contract is considered, the hedging relationship will continue uninterrupted. The adoption of this guidance during the first quarter of 2017 had no financial impact on the Company’s consolidated financial statements.
New Accounting Pronouncements
In May 2014, the FASB issued ASU No. 2014-09,
Revenue from Contracts with Customers (Topic 606)
. The new revenue recognition standard provides a five-step analysis of contracts to determine when and how revenue is recognized. The core principle is that a company should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. In August 2015, the FASB deferred the effective date of ASU No. 2014-09 for all entities by one year to annual reporting periods beginning after December 15, 2017. The FASB has issued several updates subsequently including implementation guidance on principal versus agent considerations, on how an entity should account for licensing arrangements with customers, and to improve guidance on assessing collectability, presentation of sales taxes, noncash consideration, and contract modifications and completed contracts at transition. The amendments in this series of updates shall be applied either retrospectively to each period presented or as a cumulative-effect adjustment as of the date of adoption. Early adoption is permitted. The Company continues to assess the impact this ASU, and related subsequent updates, will have on its consolidated financial statements. As of September 30, 2017, the Company has not identified any material impact to its consolidated net income relating to this ASU. However, the final impact of this ASU on the Company’s financial statements will not be known until the assessment is complete. The Company expects to update its disclosure in future periods as the analysis is completed.
In January 2016, the FASB issued ASU No. 2016-01,
Financial Instruments – Overall (Subtopic 825-10):
Recognition and Measurement of Financial Assets and Financial Liabilities
. The updated guidance enhances the reporting model for financial instruments by modifying how entities measure and recognize equity investments and present changes in the fair value of financial liabilities, and by simplifying the disclosure guidance for financial instruments. The amendments in this update are effective for fiscal years beginning after December 15, 2017. The amendments in this update should be applied prospectively. The Company is evaluating the potential impact of this adoption on its consolidated financial statements.
In February 2016, the FASB issued ASU No. 2016-02,
Leases (Topic 842)
.
The updated guidance requires lessees to recognize a lease liability and a right-of-use asset, measured at the present value of the future minimum lease payments, at the lease commencement date. Recognition, measurement and presentation of expenses will depend on classification as a finance or operating lease. The amendments also require certain quantitative and qualitative disclosures. ASU 2016-02 is effective for all interim and annual reporting periods beginning after December 15, 2018, with early adoption permitted. A modified retrospective approach must be applied for leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements. The Company is evaluating the potential impact of this adoption on its consolidated financial statements, however, increases in both assets and liabilities are expected.
In March 2016, the FASB issued ASU No. 2016-04,
Liabilities — Extinguishments of Liabilities (Subtopic 405-20): Recognition of Breakage for Certain Prepaid Stored-Value Products
. This ASU requires entities that sell prepaid stored-value products redeemable for goods, services or cash at third-party merchants to recognize breakage (i.e., the value that is ultimately not redeemed by the consumer) in a way that is consistent with how it will be recognized under the new revenue recognition standard. Under current U.S. GAAP, there is diversity in practice in how entities account for breakage that results when a consumer does not redeem the entire product balance. This ASU clarifies that an entity’s liability for prepaid stored-value products within its scope meets the definition of a financial liability. The amendments in this update are effective for reporting periods beginning after December 15, 2017, with early adoption permitted. The amendment may be applied using either a modified retrospective approach or a full retrospective approach. The adoption of this guidance will not have a material impact on the Company’s consolidated financial statements.
In June 2016, the FASB issued ASU No. 2016-13,
Financial Instrument — Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments
. This ASU changes the impairment model for most financial assets, requiring the use of an expected loss model which requires entities to estimate the lifetime expected credit loss on financial assets measured at amortized cost. Such credit losses will be recorded as an allowance to offset the amortized cost of the financial asset, resulting in a net presentation of the amount expected to be collected on the financial asset. In addition,
credit losses relating to available-for-sale debt securities will now be recorded through an allowance for credit losses rather than as a direct write-down to the security.
The amendments in this update are effective for reporting periods beginning after December 15, 2019, with early adoption permitted for reporting periods beginning after December 15, 2018. The Company is evaluating the potential impact of this adoption on its consolidated financial statements.
8
In August 2016, the FASB issued ASU No. 2016-15,
Statement of Cash Flows (Topic 230): Classification of Certain Cash
Receipts and Cash Payments
. This ASU provides clarification on eight specific cash flow issues regarding presentation and classification in the statement of cash flows with the objective of reducing the existing diversity in practice. The amendments in thi
s update are effective for reporting periods beginning after December 15, 2017, with early adoption permitted.
The adoption of this guidance will not have a material impact on the Company’s consolidated financial statements.
In October 2016, the FASB issued ASU No. 2016-16,
Income Taxes (Topic 740): Intra-Entity Transfers of Assets Other Than Inventory
. This ASU requires that entities recognize the income tax consequences of an intra-entity transfer of an asset other than inventory when the transfer occurs. The amendments in this update do not change U.S. GAAP for the pre-tax effects of an intra-entity asset transfer under Topic 810,
Consolidation
, or for an intra-entity transfer of inventory. The amendments in this update are effective for reporting periods beginning after December 15, 2017, with early adoption permitted. The Company is evaluating the potential impact of this adoption on its consolidated financial statements.
In November 2016, the FASB issued ASU No. 2016-18,
Statement of Cash Flows (Topic 230): Restricted Cash
. This ASU requires that restricted cash and restricted cash equivalents be included with cash and cash equivalents when reconciling the beginning-of-period and end-of-period amounts shown on the statements of cash flows. The amendments in this update are effective for reporting periods beginning after December 15, 2017, with early adoption permitted. The Company is evaluating the potential impact of this adoption on its consolidated financial statements.
In January 2017, the FASB issued ASU No. 2017-04,
Intangibles — Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment
. This ASU simplifies the test for goodwill impairment by removing Step 2 from the goodwill impairment test. Companies will now perform the goodwill impairment test by comparing the fair value of a reporting unit with its carrying amount, recognizing an impairment charge for the amount by which the carrying amount exceeds the reporting unit’s fair value not to exceed the total amount of goodwill allocated to that reporting unit.
An entity still has the option to perform the qualitative assessment for a reporting unit to determine if the quantitative impairment test is necessary. The amendments in this update are effective for goodwill impairment tests in fiscal years beginning after December 15, 2019, with early adoption permitted for goodwill impairment tests performed after January 1, 2017. The Company is evaluating the potential impact of this adoption on its consolidated financial statements.
In May 2017, the FASB issued ASU No. 2017-09,
Compensation — Stock Compensation (Topic 718): Scope of Modification Accounting
.
This ASU provides additional guidance for when a company should apply modification accounting when there is a change in either the terms or conditions of a share-based payment award. Specifically, a company should not apply modification accounting if the fair value, vesting conditions, and classification of the award remains the same immediately before and after the modification. The amendments in this update must be applied on a prospective basis and are effective for reporting periods beginning after December 15, 2017, with early adoption permitted.
The adoption of this guidance will not have a material impact on the Company’s consolidated financial statements.
In August 2017, the FASB issued ASU No. 2017-12,
Derivatives and Hedging: Targeted Improvements to Accounting for Hedging Activities
. This ASU improves the financial reporting of hedging relationships to better portray the economic results of an entity's risk management activities in its financial statements and makes certain targeted improvements to simplify the application of existing hedge accounting guidance. The amendments in this update are effective for reporting periods beginning after December 15, 201
8, with early adoption permitted.
The Company is evaluating the potential impact of this adoption on its consolidated financial statements.
Distributor Compensation – U.S.
In the U.S., distributor compensation, including Royalty overrides, is capped if the Company does not meet an annual requirement as described in the Consent Order discussed in more detail in Note 5,
Contingencies
. On a periodic basis, the Company evaluates if this requirement will be achieved by year end to determine if a cap on distributor compensation will be required, and then determines the appropriate amount of distributor compensation expense, which may vary in each reporting period. As of September 30, 2017, the Company believes that the cap to distributor compensation will not be applicable for the current year.
9
Other Operating Income
To encourage local investment and operations, governments in various China provinces conduct grant programs. The Company applied for and received several such grants in China. Government grants are recorded into income when a legal right to the grant exists, there is a reasonable assurance that the grant proceeds will be received, and the substantive conditions under which the grants were provided have been met. During the three and nine months ended September 30, 2017, the Company recognized $4.6 million and $43.5 million in government grant income related to its regional headquarters and distribution centers within China as compared to $0.2 million and $29.1 million for the same periods in 2016. The Company intends to continue applying for government grants in China when programs are available; however, there is no assurance that the Company will receive grants in future periods.
Reclassifications
Certain reclassifications were made to the prior period condensed consolidated balance sheets, the condensed consolidated statements of comprehensive income and the condensed consolidated statements of cash flows to conform to the current period presentation.
See Note 13,
Detail of Certain Balance Sheet Accounts
, for further information on certain balance sheet items that are combined for financial statement presentation.
3. Inventories
Inventories consist primarily of finished goods available for resale. Inventories are stated at lower of cost (primarily on the first-in, first-out basis) and net realizable value.
The following are the major classes of inventory:
|
|
September 30,
2017
|
|
|
December 31,
2016
|
|
|
|
(In millions)
|
|
Raw materials
|
|
$
|
41.8
|
|
|
$
|
49.3
|
|
Work in process
|
|
|
5.0
|
|
|
|
3.9
|
|
Finished goods
|
|
|
307.4
|
|
|
|
318.1
|
|
Total
|
|
$
|
354.2
|
|
|
$
|
371.3
|
|
4. Long-Term Debt
Long-term debt consists of the following:
|
|
September 30,
2017
|
|
|
December 31,
2016
|
|
|
|
(In millions)
|
|
Borrowings under prior senior secured credit facility, carrying value
|
|
$
|
—
|
|
|
$
|
410.0
|
|
Borrowings under new senior secured credit facility, carrying value
|
|
|
1,212.6
|
|
|
|
—
|
|
Convertible senior notes, carrying value of liability
component
|
|
|
1,058.4
|
|
|
|
1,024.8
|
|
Other
|
|
|
9.7
|
|
|
|
13.1
|
|
Total
|
|
|
2,280.7
|
|
|
|
1,447.9
|
|
Less: current portion
|
|
|
104.1
|
|
|
|
9.5
|
|
Long-term portion
|
|
$
|
2,176.6
|
|
|
$
|
1,438.4
|
|
10
Senior Secured Credit Facility
On May 4, 2015, the Company amended its prior senior secured credit facility, or the Prior Credit Facility, to extend the maturity date of its revolving credit facility, or the Prior Revolving Credit Facility, by one year to March 9, 2017. Pursuant to this amendment and upon execution, the Company made prepayments of approximately $20.3 million and $50.9 million on its $500 million term loan under the Prior Credit Facility, or the Prior Term Loan, and the Prior Revolving Credit Facility, respectively. Additionally, the Company’s $700 million borrowing capacity on its Prior Revolving Credit Facility was reduced by approximately $235.9 million upon execution of this amendment, and was further reduced by approximately $39.1 million on September 30, 2015. The Prior Term Loan matured on March 9, 2016 and was repaid in full. The total available borrowing capacity under the Prior Revolving Credit Facility was $425.0 million as of December 31, 2016. Prior to March 9, 2016, the interest rates on the Company’s borrowings under the Prior Credit Facility remained effectively unchanged except that the minimum applicable margin was increased by 0.50% and LIBOR was subject to a minimum floor of 0.25%. After March 9, 2016, the applicable interest rates on the Company’s borrowings under the Prior Credit Facility increased by 2.00% such that borrowings under the Prior Credit Facility began bearing interest at either LIBOR plus the applicable margin between 4.00% and 5.00% or the base rate plus the applicable margin between 3.00% and 4.00%, based on the Company’s consolidated leverage ratio. The Company incurred approximately $6.2 million of debt issuance costs in connection with the amendment. These debt issuance costs were recorded on the Company’s condensed consolidated balance sheet and were amortized over the life of the Prior Revolving Credit Facility.
On February 15, 2017, the Company entered into a new $1,450.0 million senior secured credit facility, or the Credit Facility, consisting of a $1,300.0 million term loan B, or the Term Loan, and a $150 million revolving credit facility, or the Revolving Credit Facility, with a syndicate of financial institutions as lenders, or Lenders. The Revolving Credit Facility matures on February 15, 2022 and the Term Loan matures on February 15, 2023.
The Term Loan was issued to the Lenders at a 2% discount, or $26.0 million. In connection with the Credit Facility, the Company also repaid the $410.0 million outstanding balance on its Prior Revolving Credit Facility. The Company incurred approximately $22.6 million of debt issuance costs in connection with the Credit Facility. The debt issuance costs and the discount are recorded on the Company’s condensed consolidated balance sheet and are being amortized over the life of the Credit Facility using the effective interest method.
Borrowings under the Term Loan bear interest at either the eurocurrency rate plus a margin of 5.50% or the base rate plus a margin of 4.50%. Prior to August 15, 2017, borrowings under the Revolving Credit Facility bore interest at the eurocurrency rate plus a margin of 4.75% or the base rate plus a margin of 3.75%. After August 15, 2017, borrowings under the Revolving Credit Facility, depending on Herbalife’s consolidated leverage ratio, bear interest at either the eurocurrency rate plus a margin of either 4.50% or 4.75% or the base rate plus a margin of either 3.50% or 3.75%. The base rate represents the highest of the Federal Funds Rate plus 0.50%, one-month adjusted LIBOR plus 1.00%, and the prime rate set by Credit Suisse, and is subject to a floor of 1.75%. The eurocurrency rate is based on adjusted LIBOR and is subject to a floor of 0.75%. The Company is required to pay a commitment fee on the Revolving Facility of 0.50% per annum on the undrawn portion of the Revolving Credit Facility. Interest is due
at least
quarterly on amounts outstanding on the Credit Facility.
The Credit Facility requires the Company to comply with a leverage ratio. In addition, the Credit Facility contains customary events of default and covenants, including covenants that limit or restrict the Company’s ability to incur liens, incur indebtedness, make investments, dispose of assets, make certain restricted payments, pay dividends, repurchase its common shares, merge or consolidate and enter into certain transactions with affiliates. The Company is also required to maintain a minimum balance of $200.0 million of consolidated cash and cash equivalents. As of September 30, 2017 and December 31, 2016, the Company was in compliance with its debt covenants under the Credit Facility and the Prior Credit Facility, respectively.
The Term Loan is payable in consecutive quarterly installments each in an aggregate principal amount of $24.4 million which began on June 30, 2017
. In addition, the Company may be required to make mandatory prepayments towards the Term Loan based on the Company’s consolidated leverage ratio and annual excess cash flows as defined under the terms of the Credit Facility. The Company is also permitted to make voluntary prepayments. These prepayments, if any, will be applied against remaining quarterly installments owed under the Term Loan in order of maturity
with the remaining principal due upon maturity
.
On September 30, 2017 and December 31, 2016, the weighted average interest rate for borrowings under the Credit Facility and the Prior Credit Facility was 6.71% and 4.29%, respectively.
11
During the three months ended March 31, 2017, the Company repaid a total amount of $410.0 million to repay in full amounts outstanding on the Prior Revolv
ing Credit Facility. During both the three months ended June 30, 2017 and September 30, 2017, the Company repaid $24.4 million, respectively, on amounts outstanding under the Term Loan.
During the three months ended March 31, 2016, the Company repaid a tot
al amount of $229.7 million to repay in full the Prior Term Loan. The Company did not repay any amounts under the Prior Revolving Credit Facility during the three months ended September 30, 2016.
As of September 30, 2017, the U.S. dollar amount outstanding
under the Term Loan was $1,251.2 million. There were no borrowings outstanding on the Revolving Credit Facility as of September 30, 2017.
As of December 31, 2016, the U.S. dollar amount outstanding under the Prior Revolving Credit Facility was $410.0 mill
ion.
There were no outstanding foreign currency borrowings as of September 30, 2017 and December 31, 2016 under the Credit Facility and the Prior Credit Facility, respectively.
During the three and nine months ended September 30, 2017, the Company recognized $23.9 million and $58.5 million, respectively, of interest expense relating to the Term Loan, which included $1.2 million and $3.0 million, respectively, relating to non-cash interest expense relating to the debt discount and $0.8 million and $2.0 million, respectively, relating to amortization of debt issuance costs.
The fair value of the outstanding borrowings on the Term Loan is determined by utilizing over-the-counter market quotes, which are considered Level 2 inputs as defined in Note 12,
Fair Value Measurements
. As of September 30, 2017, the carrying amount of the Term Loan was $1,212.6 million and the fair value was approximately $1,228 million. There were no amounts outstanding on the Revolving Credit Facility as of September 30, 2017. The fair value of the outstanding borrowings on the Company’s Prior Revolving Credit Facility approximated its carrying value as of December 31, 2016 due to its variable interest rate which reprices frequently and which represents floating market rates.
The fair value of the outstanding borrowings on the Prior Revolving Credit Facility was determined by utilizing Level 2 inputs as defined in Note 12,
Fair Value Measurements
, such as observable market interest rates and yield curves
.
Convertible Senior Notes
During February 2014, the Company initially issued $1 billion aggregate principal amount of convertible senior notes, or Convertible Notes, in a private offering to qualified institutional buyers, pursuant to Rule 144A under the Securities Act of 1933, as amended. The Company granted an option to the initial purchasers to purchase up to an additional $150 million aggregate principal amount of Convertible Notes which was subsequently exercised in full during February 2014, resulting in a total issuance of $1.15 billion aggregate principal amount of Convertible Notes. The Convertible Notes are senior unsecured obligations which rank effectively subordinate to any of the Company’s existing and future secured indebtedness, including amounts outstanding under the Credit Facility, to the extent of the value of the assets securing such indebtedness. The Convertible Notes pay interest at a rate of 2.00% per annum payable semiannually in arrears on February 15 and August 15 of each year, beginning on August 15, 2014. The Convertible Notes mature on August 15, 2019, unless earlier repurchased or converted. The Company may not redeem the Convertible Notes prior to their stated maturity date. Holders of the Convertible Notes may convert their notes at their option under the following circumstances: (i) during any calendar quarter commencing after the calendar quarter ending March 31, 2014, if the last reported sale price of the Company’s common shares for at least 20 trading days (whether or not consecutive) in a period of 30 consecutive trading days ending on, and including, the last trading day of the immediately preceding calendar quarter exceeds 130% of the conversion price for the Convertible Notes on each applicable trading day; (ii) during the five business-day period immediately after any five consecutive trading day period, or the measurement period, in which the trading price per $1,000 principal amount of Convertible Notes for each trading day of that measurement period was less than 98% of the product of the last reported sale price of the Company’s common shares and the conversion rate for the Convertible Notes for each such day; or (iii) upon the occurrence of specified corporate events. On and after May 15, 2019, holders may convert their Convertible Notes at any time, regardless of the foregoing circumstances. Upon conversion, the Convertible Notes will be settled in cash and, if applicable, the Company’s common shares, based on the applicable conversion rate at such time. The Convertible Notes had an initial conversion rate of 11.5908 common shares per $1,000 principal amount of the Convertible Notes (which is equal to an initial conversion price of approximately $86.28 per common share).
The Company incurred approximately $26.6 million of issuance costs during the first quarter of 2014 relating to the issuance of the Convertible Notes. Of the $26.6 million issuance costs incurred, $21.5 million and $5.1 million were recorded as debt issuance costs and additional paid-in capital, respectively, in proportion to the allocation of the proceeds of the Convertible Notes. The $21.5 million of debt issuance cost recorded on the Company’s condensed consolidated balance sheet is being amortized over the contractual term of the Convertible Notes using the effective interest method.
12
During February 2014, the $1.15 billion proceeds received from the issuance of the Convertible Notes were initially allocated between long-term debt, or liability component, and additional paid-in-capital, or equity component, within the Company’s conden
sed consolidated balance sheet at $930.9 million and $219.1 million, respectively. The liability component was measured using the nonconvertible debt interest rate. The carrying amount of the equity component representing the conversion option was determin
ed by deducting the fair value of the liability component from the face value of the Convertible Notes as a whole. Since the Company must still settle these Convertible Notes at face value at or prior to maturity, this liability component will be accreted
up to its face value resulting in additional non-cash interest expense being recognized within the Company’s condensed consolidated statements of income while the Convertible Notes remain outstanding. The effective interest rate on the Convertible Notes is
approximately 6.2% per annum. The equity component is not remeasured as long as it continues to meet the conditions for equity classification.
As of September 30, 2017, the outstanding principal on the Convertible Notes was $1.15 billion, the unamortized debt discount and debt issuance cost was $91.6 million, and the carrying amount of the liability component was $1,058.4 million, which was recorded to long-term debt within the Company’s condensed consolidated balance sheet as reflected in the table above within this Note.
As of December 31, 2016, the outstanding principal on the Convertible Notes was $1.15 billion, the unamortized debt discount and debt issuance costs was $125.2 million, and the carrying amount of the liability component was $1,024.8 million, which was recorded to long-term debt within the Company’s consolidated balance sheet as reflected in the table above within this Note.
The fair value of the liability component relating to the Convertible Notes was approximately $1,064.6 million and $961.3 million as of September 30, 2017 and December 31, 2016, respectively. At September 30, 2017 and December 31, 2016, the Company determined the fair value of the liability component of the Convertible Notes using two valuation methods. The Company reviewed market data that was available for publicly traded, senior, unsecured nonconvertible corporate bonds issued by companies with similar credit ratings. Assumptions used in the estimate represent what market participants would use in pricing the liability component, including market yields and credit standing to develop the straight debt yield estimate. The Company also used a lattice model, which included inputs such as stock price, the Convertible Note trading price, volatility and dividend yield to estimate the straight debt yield. The Company combined the results of the two valuation methods to determine the fair value of the liability component of the Convertible Notes. Most of these inputs are primarily considered Level 2 and Level 3 inputs. This valuation approach was similar to the approach the Company used to determine the initial fair value of the liability component of the Convertible Notes on the February 7, 2014 issuance date.
In conjunction with the issuance of the Convertible Notes, during February 2014, the Company paid approximately $685.8 million to enter into prepaid forward share repurchase transactions, or the Forward Transactions, with certain financial institutions, and paid approximately $123.8 million to enter into capped call transactions with respect to its common shares, or the Capped Call Transactions, with certain financial institutions. See Note 10,
Shareholders’ Equity
, for additional discussion on the Forward Transactions and Capped Call Transactions entered into in conjunction with the issuance of these Convertible Notes.
During the three and nine months ended September 30, 2017, the Company recognized $17.2 million and $50.9 million, respectively, of interest expense relating to the Convertible Notes, which included $10.4 million and $30.6 million, respectively, relating to non-cash interest expense relating to the debt discount and $1.0 million and $3.0 million, respectively, relating to amortization of debt issuance costs.
During the three and nine months ended September 30, 2016, the Company recognized $16.4 million and $48.7 million, respectively, of interest expense relating to the Convertible Notes, which included $9.7 million and $28.7 million, respectively, relating to non-cash interest expense relating to the debt discount and $0.9 million and $2.8 million, respectively, relating to amortization of debt issuance costs.
Total Debt
The Company’s total interest expense was $43.0 million and $24.0 million for the three months ended September 30, 2017 and 2016, respectively, and $117.4 million and $74.6 million for the nine months ended September 30, 2017 and 2016, respectively, which was recognized within its condensed consolidated statements of income.
As of September 30, 2017, annual scheduled principal payments of debt were: $26.2 million for the remainder of 2017; and $102.3 million; $1,250.0 million; $97.9 million; $97.5 million; $97.5 million; and $739.4 million for the years ended December 31, 2018, 2019, 2020, 2021, 2022, and 2023, respectively.
Certain vendors and government agencies may require letters of credit or similar guaranteeing arrangements to be issued or executed. As of September 30, 2017, the Company had $37.9 million of issued but undrawn letters of credit or similar arrangements that were unsecured, which included the Mexico Value Added Tax, or VAT, related surety bonds described in Note 5,
Contingencies
.
13
5. Contingencies
The Company is from time to time engaged in routine litigation. The Company regularly reviews all pending litigation matters in which it is involved and establishes reserves deemed appropriate by management for these litigation matters when a probable loss estimate can be made.
These matters described in this Note may take several years to resolve. While the Company believes it has meritorious defenses, it cannot be sure of their ultimate resolution. Although the Company may reserve amounts for certain matters that the Company believes represent the most likely outcome of the resolution of these related disputes, if the Company is incorrect in its assessment, the Company may have to record additional expenses, when it becomes probable that an increased potential liability is warranted.
Tax Matters
On May 7, 2010, the Company received an assessment from the Mexican Tax Administration Service in an amount equivalent to approximately $63.1 million, translated at the September 30, 2017 spot rate, for various items, the majority of which was VAT allegedly owed on certain of the Company’s products imported into Mexico during the years 2005 and 2006. This assessment is subject to interest and inflationary adjustments. On July 8, 2010, the Company initiated a formal administrative appeal process. On May 13, 2011, the Mexican Tax Administration Service issued a resolution on the Company’s administrative appeal. The resolution nullified the assessment. Since the Mexican Tax Administration Service can further review the tax audit findings and re-issue some or all of the original assessment, the Company commenced litigation in the Tax Court of Mexico in August 2011 to dispute the assertions made by the Mexican Tax Administration Service in the case. The Company received notification on February 6, 2015 that the Tax Court of Mexico nullified substantially all of the assessment. On March 18, 2015, the Mexican Tax Administration Service filed an appeal against the verdict with the Circuit Court. On August 27, 2015, the Circuit Court remanded the case back to the Tax Court of Mexico to reconsider a portion of the procedural decision that was adverse to the Mexican Tax Administration Service. The Company received notification on March 18, 2016 that the Tax Court of Mexico nullified a portion of the assessment and upheld a portion of the original assessment. On August 25, 2016, the Company filed a further appeal of this decision to the Circuit Court. On April 6, 2017, the Circuit Court issued a verdict with the Company prevailing on some lesser issues and the Tax Administration Service prevailing on the core issue. On May 11, 2017, the Company filed a further appeal to the Supreme Court of Mexico. On June 14, 2017, the Supreme Court of Mexico agreed to hear the appeal. The Company believes that it has meritorious defenses if the assessment is reissued. The Company has not recognized a loss as the Company does not believe a loss is probable.
The Mexican Tax Administration Service commenced audits of the Company’s Mexican subsidiaries for the period from January to September 2007 and on May 10, 2013, the Company received an assessment of approximately $16.2 million, translated at the September 30, 2017 spot rate, related to that period. On July 11, 2013, the Company filed an administrative appeal disputing the assessment. On September 22, 2014, the Mexican Tax Administration Service denied the Company’s administrative appeal. The Company commenced litigation in the Tax Court of Mexico in November 2014 to dispute the assertions made by the Mexican Tax Administration Service in the case. The Company issued a surety bond in the amount of $17.9 million, translated at the September 30, 2017 spot rate, through an insurance company to guarantee payment of the tax assessment as required while the Company pursues an appeal of the assessment. Litigation in this case is currently ongoing. The Company has not recognized a loss as the Company does not believe a loss is probable.
The Mexican Tax Administration Service has delayed processing VAT refunds for companies operating in Mexico and the Company believes that the process for its Mexico subsidiary to receive VAT refunds may be delayed. As of September 30, 2017, the Company had $46.3 million of Mexico VAT related assets, of which $39.7 million was within non-current other assets and $6.6 million was within prepaid expenses and other current assets on its consolidated balance sheet. This amount relates to VAT payments made over various periods and the Company believes these amounts are recoverable by refund or they may be applied against certain future tax liabilities. The Company has not recognized any losses related to these VAT related assets as the Company does not believe a loss is probable.
On March 26, 2015, the Office of the President of Mexico issued a decree relating to the application of VAT to nutritional supplements. The Company continues to believe its application of the VAT law in Mexico is correct. At September 30, 2017, the Company has not recognized any losses as the Company, based on its current analysis and guidance from its advisors, does not believe a loss is probable. The Company continues to evaluate and monitor its situation as it develops, including whether it will make any changes to its operations in Mexico.
14
The Company has not recognized a loss with respect to any of these Mexican matters as the Company, based on its analysis and guidance from its advisors
, does not believe a loss is probable. Further, the Company is currently unable to reasonably estimate a possible loss or range of loss that could result from an unfavorable outcome if an assessment was re-issued or any additional assessments were to be is
sued for these or other periods. The Company believes that it
has meritorious defenses if an
assessment is re-issued or would have meritorious defenses if any additional assessment is issued.
As previously disclosed, the Mexican Tax Administration Service has requested information related to the Company’s 2010 year. This information has been provided and the Tax Administration Service has now completed its income tax audit related to the 2010 year. The Tax Administration Service is now discussing its preliminary findings with the Company. It is possible that the Company could receive a final assessment from the Tax Administration Service after these discussions are completed. The Company believes that it has recognized an appropriate amount of income tax expense with respect to its Mexican operations during the 2010 year. The Company believes that it has meritorious defenses if a formal assessment is issued by the Tax Administration Service. The Company is currently unable to reasonably estimate the amount of loss that may result from an unfavorable outcome if a formal assessment is issued by the Tax Administration Service.
The Company received a tax assessment in September 2009 from the Federal Revenue Office of Brazil in an amount equivalent to approximately $2.2 million, translated at the September 30, 2017 spot rate, related to withholding/contributions based on payments to the Company’s Members during 2004. On December 28, 2010, the Company appealed this tax assessment to the Administrative Council of Tax Appeals (2nd level administrative appeal). The Company believes it has meritorious defenses and it has not recognized a loss as the Company does not believe a loss is probable. On March 6, 2014, the Company was notified of a similar audit of the 2011 year. In January 2016, the Company received a tax assessment for an amount equivalent to approximately $5.6 million, translated at the September 30, 2017 spot rate, related to contributions based on payments to the Company’s Members during 2011.
The Company filed a first level administrative appeal against most of the assessment on February 23, 2016, which was subsequently denied.
On March 13, 2017, the Company appealed this tax assessment to the Administrative Council of Tax Appeals (2nd level administrative appeal). The Company has not accrued a loss for the majority of the assessment because the Company does not believe a loss is probable. The Company is currently unable to reasonably estimate the amount of the loss that may result from an unfavorable outcome if additional assessments for other periods were to be issued.
The Company’s Brazilian subsidiary pays ICMS-ST taxes on its product purchases, similar to VAT. As of September 30, 2017, the Company had $16.0 million of Brazil ICMS-ST, of which $7.5 million was within non-current other assets and $8.5 million was within prepaid expenses and other current assets on its condensed consolidated balance sheet. The Company believes it will be able to utilize or recover these ICMS-ST credits in the future.
The Company is under examination in several Brazilian states related to ICMS and ICMS-ST taxation. Some of these examinations have resulted in assessments for underpaid tax that the Company has appealed. The State of Sao Paulo has audited the Company for the 2013 and 2014 tax years. During July 2016, for the State of Sao Paulo, the Company received an assessment in the aggregate amount of approximately $50.8 million, translated at the September 30, 2017 spot rate, relating to various ICMS issues for its 2013 tax year. In August 2016, the Company filed a first level administrative appeal which was denied in February 2017. The Company filed a further appeal on March 9, 2017. During August 2017, for the state of Sao Paulo, the Company received an assessment in the aggregate amount of approximately $18.8 million, translated at the September 30. 2017 spot rate, relating to various ICMS issues for its 2014 tax year. In September 2017, the Company filed a first level administrative appeal for the 2014 tax year. The Company has not recognized a loss as the Company does not believe a loss is probable. The Company has also received other ICMS tax assessments in Brazil. During the fourth quarter of 2015, the Company filed appeals with state judicial courts against three of the assessments. The Company had issued surety bonds in the aggregate amount of $13.4 million, translated at the September 30, 2017 spot rate, to guarantee payment of some of the tax assessments as required while the Company pursues the appeals. In addition, the Company has received several ICMS tax assessments in the aggregate amount of $7.2 million, translated at the September 30, 2017 spot rate, from several other Brazilian states where surety bonds have not been issued. Litigation in all these cases is currently ongoing. The Company has not recognized a loss as the Company does not believe a loss is probable.
The Company has received various tax assessments in multiple states in India for multiple years from the Indian VAT authorities in an amount equivalent to approximately $8.1 million, translated at the September 30, 2017 spot rate. These assessments are for underpaid VAT. The Company is litigating these cases at the tax administrative level and the tax tribunal levels as it believes it has meritorious defenses. The Company has not recognized a loss as it does not believe a loss is probable.
15
The Korea Customs Service audited the importation activities of Herbalife Korea for the period January 2011 through May 2013. The total assessment for the audit per
iod is $
31.2
million translated at the
September
30, 2017 spot rate. The Company has paid the assessment and has recognized these payments within other assets on its condensed consolidated balance sheet. The Company lodged a first level administrative appe
al, which was denied on October 21, 2016. On January 31, 2017, the Company filed a further appeal to the National Tax Tribunal of Korea. The Company disagrees with the assertions made in the assessments, as well as the calculation methodology used in th
e a
ssessments.
The Company has not recognized a loss as the Company does not believe a loss is probable.
During the course of 2016, the Company received various questions from the Greek Social Security Agency and on December 29, 2016, the Greek Social Security Agency issued an assessment of approximately $2.4 million translated at the September 30, 2017 spot rate, with respect to Social Security Contributions on Member earnings for the 2006 year. For Social Security issues, the Statute of Limitations is open for 2007 and later years in Greece. The Company could receive similar assessments covering other years. The Company disputes the allegations raised in the assessment and has filed an administrative appeal against the assessment with the Social Security Agency. The Company has not recognized a loss as it does not believe a loss is probable.
U.S. Federal Trade Commission Consent Order
As previously disclosed, the Company received from the U.S. Federal Trade Commission, or the FTC, a Civil Investigative Demand, or a CID, relating to the FTC’s confidential investigation of whether the Company has complied with federal law in the advertising, marketing, or sale of business opportunities. On July 15, 2016, the Company and the FTC entered into a proposed Stipulation to Entry of Order for Permanent Injunction and Monetary Judgment, or the Consent Order. The Consent Order was lodged with the U.S. District Court for the Central District of California on July 15, 2016 and became effective on July 25, 2016, or the Effective Date, upon final approval by the Court.
The Consent Order resolved the FTC’s multi-year investigation of the Company.
Pursuant to the Consent Order, under which the Company neither admitted nor denied the FTC’s allegations (except as to the Court having jurisdiction over the matter), the Company made, through its wholly owned subsidiary Herbalife International of America, Inc., a $200 million payment to the FTC. Additionally, the Company agreed to implement certain new procedures and enhance certain existing procedures in the U.S., most of which the Company had 10 months from the Effective Date to implement. Among other requirements,
the Consent Order requires the Company to categorize all existing and future Members in the U.S. as either “preferred members” – who are simply consumers who only wish to purchase products for their own household use, or “distributors” – who are members who wish to resell some products or build a sales organization. The Company also agreed to compensate distributors on eligible U.S. sales within their downline organization, which include purchases by preferred members, purchases by a distributor for his or her personal consumption within allowable limits and sales of product by a distributor to his or her customers. The Consent Order also imposes restrictions on a distributor’s ability to open Nutrition Clubs in the United States. The Consent Order subjects the Company to certain audits by an independent compliance auditor for a period of seven years; imposes requirements on the Company regarding compliance certification and record creation and maintenance; and prohibits the Company, its affiliates and its distributors from making misrepresentations and misleading claims regarding, among other things, income and lavish lifestyles. The FTC and the independent compliance auditor have the right to inspect Company records and request additional compliance reports for purposes of conducting audits pursuant to the Consent Order. In September 2016, the Company and the FTC mutually selected Affiliated Monitors, Inc. to serve as the independent compliance auditor. The Company is monitoring the impact of the Consent Order and, while the Company currently does not expect the settlement to have a long-term and materially adverse impact on its business and its Member base, the Company’s business and its Member base, particularly in the United States, may be negatively impacted as the Company and the Member base adjust to the changes. If the Company is unable to comply with the Consent Order then this could result in a material and adverse impact to the Company’s results of operations and financial condition.
Other Matters
As a marketer of foods, dietary and nutritional supplements, and other products that are ingested by consumers or applied to their bodies, the Company has been and is currently subjected to various product liability claims. The effects of these claims to date have not been material to the Company. The Company currently maintains product liability insurance with an annual deductible of $15 million.
The SEC and the Department of Justice have requested from the Company documents and other information relating to the Company’s anti-corruption compliance in China and the Company is conducting its own review. The Company is cooperating with the government and cannot predict the eventual scope, duration, or outcome of the matter at this time.
16
Since late 2012, a short seller has made and continues to make allegations regarding the Company and its network marketing program. The Company believes these allegations are without merit and is vigorously defending
itself against such claims, including proactively reaching out to governmental authorities about what the Company believes is manipulative activity with respect to its securities. Because of these allegations, the Company and others have received and may
receive additional regulatory and governmental inquiries. For example, the Company has previously disclosed inquiries from the FTC, S
EC
and other governmental authorities. In the future, governmental authorities may determine to seek information from the C
ompany and other persons relating to these same or other allegations. If the Company believes any governmental or regulatory inquiry or investigation is or becomes material it will be disclosed individually. Consistent with its policies, the Company has co
operated and will continue to fully cooperate with any governmental or regulatory inquiries or investigations.
On September 18, 2017, the Company and certain of its subsidiaries and Members were named as defendants in a purported class action lawsuit, titled
Rodgers, et al. v Herbalife Ltd., et al.
and filed in the U.S. District Court for the Southern District of Florida, which alleges violations of Florida’s Deceptive and Unfair Trade Practices statute and federal Racketeer Influenced and Corrupt Organizations statutes, unjust enrichment, and negligent misrepresentation. The plaintiffs seek damages in an unspecified amount. The Company believes the lawsuit is without merit and will vigorously defend itself against the claims in the lawsuit.
In September 2017, one of the Company’s warehouses located in Mexico sustained flooding which damaged certain inventory stored within the warehouse. The Company maintains insurance coverage with third party carriers on the affected property. As of September 30, 2017, the Company has recorded a loss for the portion of its inventory balance for which the Company believes a loss is probable and estimable and has recognized an equal offsetting receivable for insurance recoveries. The Company continues to assess the remaining warehouse inventory but has not recognized any additional loss as the amount of any additional loss has not been identified and cannot be reasonably estimated. The Company believes this event will not have a material negative impact to its Mexico operations.
6. Segment Information
The Company is a nutrition company that sells a wide range of weight management, targeted nutrition, energy, sports & fitness, and outer nutrition products. The Company’s products are manufactured by the Company in its Changsha, Hunan, China extraction facility, Suzhou, China facility, Nanjing, China facility, Lake Forest, California facility, and Winston-Salem, North Carolina facility, and by third party providers, and then are sold to Members who consume and sell Herbalife products to retail consumers or other Members. Revenues reflect sales of products by the Company to its Members and are categorized based on geographic location.
As of September 30, 2017, the Company sold products in 94 countries throughout the world and was organized into and managed through six geographic regions:
North America, Mexico, South & Central America, EMEA (Europe, Middle East, and Africa), Asia Pacific and China
.
The Company defines its operating segments as those geographical operations.
The Company aggregates its operating segments, excluding China, into a reporting segment, or the Primary Reporting Segment, as management believes that the Company’s operating segments have similar operating characteristics and similar long term operating performance. In making this determination, management believes that the operating segments are similar in the nature of the products sold, the product acquisition process, the types of customers to whom products are sold, the methods used to distribute the products, the nature of the regulatory environment, and their economic characteristics. China has been identified as a separate reporting segment as it does not meet the criteria for aggregation. The Company reviews its net sales and contribution margin by operating segment, and reviews its assets and capital expenditures on a consolidated basis and not by operating segment. Therefore, net sales and contribution margin are presented by reportable segment and assets and capital expenditures by segment are not presented.
The operating information for the two reportable segments are as follows:
|
|
Three Months Ended
|
|
|
Nine Months Ended
|
|
|
|
September 30,
2017
|
|
|
September 30,
2016
|
|
|
September 30,
2017
|
|
|
September 30,
2016
|
|
|
|
(In millions)
|
|
Net Sales:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Primary Reporting Segment
|
|
$
|
875.6
|
|
|
$
|
907.8
|
|
|
$
|
2,666.4
|
|
|
$
|
2,769.3
|
|
China
|
|
|
209.8
|
|
|
|
214.2
|
|
|
|
668.0
|
|
|
|
674.1
|
|
Total Net Sales
|
|
$
|
1,085.4
|
|
|
$
|
1,122.0
|
|
|
$
|
3,334.4
|
|
|
$
|
3,443.4
|
|
17
Contribution Margin(1):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Primary Reporting Segment
|
|
$
|
375.9
|
|
|
$
|
398.8
|
|
|
$
|
1,155.7
|
|
|
$
|
1,201.5
|
|
China(2)
|
|
|
184.0
|
|
|
|
193.8
|
|
|
|
595.8
|
|
|
|
614.5
|
|
Total Contribution Margin
|
|
|
559.9
|
|
|
|
592.6
|
|
|
|
1,751.5
|
|
|
|
1,816.0
|
|
Selling, general and administrative expenses(2)
|
|
|
445.2
|
|
|
|
441.3
|
|
|
|
1,327.0
|
|
|
|
1,545.2
|
|
Other operating income
|
|
|
(4.6
|
)
|
|
|
(0.2
|
)
|
|
|
(43.5
|
)
|
|
|
(29.1
|
)
|
Interest expense, net
|
|
|
38.4
|
|
|
|
22.1
|
|
|
|
106.5
|
|
|
|
70.1
|
|
Income before income taxes
|
|
|
80.9
|
|
|
|
129.4
|
|
|
|
361.5
|
|
|
|
229.8
|
|
Income taxes
|
|
|
26.4
|
|
|
|
41.7
|
|
|
|
84.2
|
|
|
|
69.2
|
|
Net income
|
|
$
|
54.5
|
|
|
$
|
87.7
|
|
|
$
|
277.3
|
|
|
$
|
160.6
|
|
(1)
|
Contribution margin consists of net sales less cost of sales and royalty overrides. For the China segment, contribution margin does not include service fees to China independent service providers.
|
(2)
|
Service fees to China independent service providers totaling $99.5 million and $100.2 million for the three months ended September 30, 2017 and 2016, respectively, and $316.9 million and $318.4 million for the nine months ended September 30, 2017 and 2016, respectively, are included in selling, general and administrative expenses.
|
The following table sets forth net sales by geographic area:
|
|
Three Months Ended
|
|
|
Nine Months Ended
|
|
|
|
September 30,
2017
|
|
|
September 30,
2016
|
|
|
September 30,
2017
|
|
|
September 30,
2016
|
|
|
|
(In millions)
|
|
Net Sales:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
United States
|
|
$
|
193.5
|
|
|
$
|
236.0
|
|
|
$
|
631.3
|
|
|
$
|
737.7
|
|
Mexico
|
|
|
114.3
|
|
|
|
112.8
|
|
|
|
334.7
|
|
|
|
341.8
|
|
China
|
|
|
209.8
|
|
|
|
214.2
|
|
|
|
668.0
|
|
|
|
674.1
|
|
Others
|
|
|
567.8
|
|
|
|
559.0
|
|
|
|
1,700.4
|
|
|
|
1,689.8
|
|
Total Net Sales
|
|
$
|
1,085.4
|
|
|
$
|
1,122.0
|
|
|
$
|
3,334.4
|
|
|
$
|
3,443.4
|
|
7. Share-Based Compensation
The Company has share-based compensation plans, which are more fully described in Note 9,
Share-Based Compensation
, to the Consolidated Financial Statements in the 2016 10-K. During the nine months ended September 30, 2017, the Company granted stock appreciation rights, or SARs, and stock units subject to service conditions and service and performance conditions.
In the second and third quarters of 2017, the Company granted performance stock unit awards to certain executives, which will vest on December 31, 2019 subject to their continued employment through that date and the achievement of certain performance conditions. The performance conditions include targets for Volume Points, adjusted earnings before interest and taxes, and adjusted earnings per share. These performance stock unit awards can vest at between 0% and 200% of the target award based on the achievement of the performance conditions.
For the three months ended September 30, 2017 and 2016, share-based compensation expense amounted to $9.9 million and $9.8 million, respectively.
For the nine months ended September 30, 2017 and 2016, share-based compensation expense amounted to $32.6 million and $30.3 million, respectively.
As of September 30, 2017, the total unrecognized compensation cost related to all non-vested stock awards was $55.5 million and the related weighted-average period over which it is expected to be recognized is approximately 1.5 years.
18
The following tables summarize the a
ctivity under all share-based compensation plans for the
nine
months ended
September
30, 2017:
SARs
|
|
Awards
|
|
|
Weighted
Average
Exercise
Price
|
|
|
Weighted
Average
Remaining
Contractual
Term
|
|
Aggregate
Intrinsic
Value(1)
|
|
|
|
(In thousands)
|
|
|
|
|
|
|
|
|
(In millions)
|
|
Outstanding at December 31, 2016(2)(3)
|
|
|
11,998
|
|
|
$
|
41.52
|
|
|
6.0 years
|
|
$
|
148.7
|
|
Granted
|
|
|
1,358
|
|
|
$
|
57.30
|
|
|
|
|
|
|
|
Exercised
|
|
|
(2,511
|
)
|
|
$
|
28.62
|
|
|
|
|
|
|
|
Forfeited
|
|
|
(321
|
)
|
|
$
|
53.67
|
|
|
|
|
|
|
|
Outstanding at September 30, 2017(2)(3)
|
|
|
10,524
|
|
|
$
|
46.26
|
|
|
6.3 years
|
|
$
|
237.4
|
|
Exercisable at September 30, 2017(4)
|
|
|
6,308
|
|
|
$
|
45.61
|
|
|
4.9 years
|
|
$
|
150.6
|
|
(1)
|
The intrinsic value is the amount by which the current market value of the underlying stock exceeds the exercise price of the stock awards.
|
(2)
|
Includes 0.1 million market condition SARs as of both September 30, 2017 and December 31, 2016.
|
(3)
|
Includes 2.7 million and 2.9 million performance condition SARs as of September 30, 2017 and December 31, 2016, respectively.
|
(4)
|
Includes 1.5 million performance condition SARs.
|
The weighted-average grant date fair value of SARs granted during the three months ended September 30, 2017 and 2016 was $31.31 and $32.06, respectively.
The weighted-average grant date fair value of SARs granted during the nine months ended September 30, 2017 and 2016 was $28.36 and $29.49, respectively.
The total intrinsic value of SARs exercised during the three months ended September 30, 2017 and 2016 was $3.0 million and $17.9 million, respectively.
The total intrinsic value of SARs exercised during the nine months ended September 30, 2017 and 2016 was $100.0 million and $32.0 million, respectively.
Incentive Plan and Independent Directors Stock Units
|
|
Shares
|
|
|
Weighted
Average
Grant Date
Fair Value
|
|
|
|
(In thousands)
|
|
|
|
|
|
Outstanding and nonvested December 31, 2016
|
|
|
26
|
|
|
$
|
62.35
|
|
Granted(1)
|
|
|
154
|
|
|
$
|
68.84
|
|
Vested
|
|
|
(24
|
)
|
|
$
|
62.42
|
|
Forfeited
|
|
|
—
|
|
|
|
—
|
|
Outstanding and nonvested September 30, 2017
|
|
|
156
|
|
|
$
|
68.77
|
|
(1)
|
This includes 134,388 performance based stock unit awards which represents the maximum amount that can vest.
|
The total vesting date fair value of stock units which vested during the three months ended September 30, 2017 and 2016 was $0.1 million and $0.2 million, respectively.
The total vesting date fair value of stock units which vested during the nine months ended September 30, 2017 and 2016 was $1.9 million and $2.0 million, respectively.
8. Income Taxes
Income taxes were an expense of $26.4 million and $84.2 million for the three and nine months ended September 30, 2017, respectively, as compared to an expense of $41.7 million and $69.2 million for the same periods in 2016. The effective income tax rate was 32.6% and 23.3% for the three and nine months ended September 30, 2017, respectively, as compared to 32.2% and 30.1% for the same periods in 2016. The increase in the effective tax rate for the three months ended September 30, 2017, as compared to the same period in 2016, was primarily due to the impact of changes in the geographic mix of the Company’s income, offset by an increase in net benefits from discrete events. The decrease in the effective tax rate for the nine months ended September 30, 2017, as compared to the same period in 2016, was primarily due to an increase in net benefits from discrete events. Included in the discrete events for the three and nine months ended September 30, 2017 was the impact of $0.6 million and $26.4 million of excess tax benefits generated during those respective periods, relating to the Company’s application of ASU 2016-09 that was adopted on January 1, 2017.
19
As of
September
30, 2017, the total amount of unrecognized tax benefits, including related interest and penalties was $
74.2
million. If the total amount of unreco
gnized tax benefits was recognized, $
53.1
million of unrecognized tax benefits, $
12.0
million of interest and $
2.5
million of penalties would impact the effective tax rate.
The Company believes that it is reasonably possible that the amount of unrecognized tax benefits could decrease by up to approximately $8.8 million within the next twelve months. Of this possible decrease, $3.7 million would be due to the settlement of audits or resolution of administrative or judicial proceedings. The remaining possible decrease of $5.1 million would be due to the expiration of statute of limitations in various jurisdictions. For a description on contingency matters relating to income taxes see Note 5,
Contingencies
.
9. Derivative Instruments and Hedging Activities
Foreign Currency Instruments
The Company designates certain foreign currency derivatives, primarily comprised of foreign currency forward contracts, as freestanding derivatives for which hedge accounting does not apply. The changes in the fair market value of these freestanding derivatives are included in selling, general and administrative expenses in the Company’s condensed consolidated statements of income. The Company uses freestanding foreign currency derivatives to hedge foreign-currency-denominated intercompany transactions and to partially mitigate the impact of foreign currency fluctuations. The fair value of the freestanding foreign currency derivatives is based on third-party quotes. The Company’s foreign currency derivative contracts are generally executed on a monthly basis.
The Company designates as cash-flow hedges those foreign currency forward contracts it enters into to hedge forecasted inventory purchases and intercompany management fees that are subject to foreign currency exposures. Forward contracts are used to hedge forecasted inventory purchases over specific months. Changes in the fair value of these forward contracts, excluding forward points, designated as cash-flow hedges are recorded as a component of accumulated other comprehensive income (loss) within shareholders’ equity, and are recognized in cost of sales in the condensed consolidated statements of income during the period which approximates the time the hedged inventory is sold. The Company also hedges forecasted intercompany management fees over specific months. These contracts allow the Company to sell Euros in exchange for U.S. dollars at specified contract rates. Changes in the fair value of these forward contracts designated as cash flow hedges are recorded as a component of accumulated other comprehensive income (loss) within shareholders’ equity, and are recognized in selling, general and administrative expenses in the condensed consolidated statements of income during the period when the hedged item and underlying transaction affect earnings.
As of September 30, 2017 and December 31, 2016, the aggregate notional amounts of all foreign currency contracts outstanding designated as cash flow hedges were approximately $127.0 million and $90.0 million, respectively. At September 30, 2017, these outstanding contracts were expected to mature over the next fifteen months. The Company’s derivative financial instruments are recorded on the condensed consolidated balance sheet at fair value based on third-party quotes. As of September 30, 2017, the Company recorded assets at fair value of $0.8 million and liabilities at fair value of $5.5 million relating to all outstanding foreign currency contracts designated as cash-flow hedges. As of December 31, 2016, the Company recorded assets at fair value of $4.6 million. The Company assesses hedge effectiveness and measures hedge ineffectiveness at least quarterly. During the three and nine months ended September 30, 2017 and 2016, the ineffective portion relating to these hedges was immaterial and the hedges remained effective as of September 30, 2017 and December 31, 2016.
As of September 30, 2017 and December 31, 2016, the majority of the Company’s outstanding foreign currency forward contracts had maturity dates of less than twelve months with the majority of freestanding derivatives expiring within one month as of September 30, 2017 and December 31, 2016. As of September 30, 2017, the Company had aggregate notional amounts of approximately $398.6 million of foreign currency contracts, inclusive of freestanding contracts and contracts designated as cash flow hedges.
20
Gains and Losses on Derivative Instruments
The following table summarizes gains (losses) relating to derivative instruments recorded in other comprehensive income (loss) during the three and nine months ended September 30, 2017 and 2016:
|
|
Amount of Gain (Loss) Recognized
in Other Comprehensive Income (Loss)
|
|
|
|
For the Three Months Ended
|
|
|
For the Nine Months Ended
|
|
|
|
September 30, 2017
|
|
|
September 30, 2016
|
|
|
September 30, 2017
|
|
|
September 30, 2016
|
|
|
|
(In millions)
|
|
Derivatives designated as hedging instruments:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Foreign exchange currency contracts relating to inventory
and intercompany management fee hedges
|
|
$
|
(0.3
|
)
|
|
$
|
0.8
|
|
|
$
|
(10.8
|
)
|
|
$
|
3.1
|
|
As of September 30, 2017, the estimated amount of existing net losses related to cash flow hedges recorded in accumulated other comprehensive loss that are expected to be reclassified into earnings over the next twelve months was $5.4 million.
The following table summarizes gains (losses) relating to derivative instruments recorded to income during the three and nine months ended September 30, 2017 and 2016:
|
|
Location of Gain
|
|
Amount of Gain (Loss)
Recognized in Income
|
|
|
|
(Loss)
|
|
For the Three Months Ended
|
|
|
For the Nine Months Ended
|
|
|
|
Recognized in Income
|
|
September 30, 2017
|
|
|
September 30, 2016
|
|
|
September 30, 2017
|
|
|
September 30, 2016
|
|
|
|
|
|
(In millions)
|
|
Derivatives designated as hedging instruments:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Foreign exchange currency contracts relating to
inventory hedges and intercompany
management fee hedges(1)
|
|
Selling,
general and
administrative
expenses
|
|
$
|
(2.6
|
)
|
|
$
|
—
|
|
|
$
|
(1.4
|
)
|
|
$
|
0.1
|
|
Derivatives not designated as hedging instruments:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Foreign exchange currency contracts
|
|
Selling, general and
administrative
expenses
|
|
$
|
(0.5
|
)
|
|
$
|
0.6
|
|
|
$
|
(7.0
|
)
|
|
$
|
(2.6
|
)
|
(1)
|
For foreign exchange contracts designated as hedging instruments, the amounts recognized in income primarily represent the amounts excluded from the assessment of hedge effectiveness. There were no material ineffective amounts reported for derivatives designated as hedging instruments.
|
The following table summarizes gains (losses) relating to derivative instruments reclassified from accumulated other comprehensive loss into income during the three and nine months ended September 30, 2017 and 2016:
|
|
Location of Gain
(Loss)
Reclassified
from Accumulated
Other Comprehensive
|
|
Amount of Gain (Loss) Reclassified
from Accumulated
Other Comprehensive
Loss into Income
|
|
|
|
Loss into Income
|
|
For the Three Months Ended
|
|
|
For the Nine Months Ended
|
|
|
|
(Effective Portion)
|
|
September 30, 2017
|
|
|
September 30, 2016
|
|
|
September 30, 2017
|
|
|
September 30, 2016
|
|
|
|
|
|
(In millions)
|
|
Derivatives designated as hedging instruments:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Foreign exchange currency contracts relating to
inventory hedges
|
|
Cost of sales
|
|
$
|
(1.3
|
)
|
|
$
|
3.2
|
|
|
$
|
0.3
|
|
|
$
|
12.9
|
|
Foreign exchange currency contracts relating to
intercompany management fee hedges
|
|
Selling, general and
administrative expenses
|
|
$
|
(1.5
|
)
|
|
$
|
(0.2
|
)
|
|
$
|
(0.6
|
)
|
|
$
|
(0.8
|
)
|
21
The Company reports its derivatives at fair value as either assets or liabilities within its condensed consolidated balance sheet. See Note 12,
Fair Value Measurements,
for information on deriva
tive fair values and their condensed consolidated balance sheet location as of
September
30, 2017 and December 31, 2016.
10. Shareholders’ Equity
Dividends
The declaration of future dividends is subject to the discretion of the Company’s board of directors and will depend upon various factors, including its earnings, financial condition, Herbalife Ltd.’s available distributable reserves under Cayman Islands law, restrictions imposed by the Credit Facility and the terms of any other indebtedness that may be outstanding, cash requirements, future prospects and other factors deemed relevant by its board of directors.
Share Repurchases
On February 21, 2017, the Company’s board of directors authorized a new three-year $1.5 billion share repurchase program that will expire on February 21, 2020, which replaced the Company’s prior share repurchase authorization which was set to expire on June 30, 2017 which, as of December 31, 2016, had $232.9 million of remaining authorized capacity. This share repurchase program allows the Company, which includes an indirect wholly owned subsidiary of Herbalife Ltd., to repurchase the Company’s common shares, at such times and prices as determined by the Company’s management as market conditions warrant and to the extent Herbalife Ltd.’s distributable reserves are available under Cayman Islands law. The Credit Facility permits the Company to repurchase its common shares as long as no default or event of default exists and other conditions such as specified consolidated leverage ratios are met.
In conjunction with the issuance of the Convertible Notes during February 2014, the Company paid approximately $685.8 million to enter into Forward Transactions with certain financial institutions, or the Forward Counterparties, pursuant to which the Company purchased approximately 9.9 million common shares, at an average cost of $69.02 per share, for settlement on or around the August 15, 2019 maturity date for the Convertible Notes, subject to the ability of each Forward Counterparty to elect to settle all or a portion of its Forward Transactions early. S
ee Note 4
, Long-Term Debt
for further information on the conditions for which Holders of the Convertible Notes may convert their notes prior to the maturity date.
The Forward Transactions were generally expected to facilitate privately negotiated derivative transactions between the Forward Counterparties and holders of the Convertible Notes, including swaps, relating to the common shares by which holders of the Convertible Notes establish short positions relating to the common shares and otherwise hedge their investments in the Convertible Notes concurrently with, or shortly after, the pricing of the Convertible Notes. The shares are treated as retired shares for basic and diluted EPS purposes although they remain legally outstanding.
As a result of the Forward Transactions, the Company’s total shareholders’ equity within its condensed consolidated balance sheet was reduced by approximately $685.8 million during the first quarter of 2014, with amounts of $653.9 million and $31.9 million being allocated between accumulated deficit and additional paid-in-capital, respectively, within total shareholders’ equity. Also, upon executing the Forward Transactions, the Company recorded, at fair value, $35.8 million in non-cash issuance costs to other assets and a corresponding amount to additional paid-in-capital within its condensed consolidated balance sheet. These non-cash issuance costs will be amortized to interest expense over the contractual term of the Forward Transactions. For both the three and nine months ended September 30, 2017 and 2016, the Company recognized $1.6 million and $4.8 million, respectively, of non-cash interest expense within its condensed consolidated statements of income relating to amortization of these non-cash issuance costs.
22
During the three months ended
March 31
, 2017, an indirect wholly owned subsidiary of the Company purchased
approximately
1.1
million of Herbalife Ltd.’s common shares through open market purchases
at an aggregate cost of approximately $
60.7
million
,
or an average cost of $
56.10
per share
.
During the three months ended June 30, 2017, an indirect wholly owned subsidiary of the Company purchased approximately 2.7
million of Herbalife Ltd.’s common shares through open market purchases at an aggregate cost of approximately $179.8 million, or an average cost of $67.06 per share
.
During the three months ended
September
30, 2017, an indirect wholly owned subsidiary of
the Company purchased
approximately
0.8
million of Herbalife Ltd.’s common shares through open market purchases at an aggregate cost of approximately $
58.7
million, or an average cost of $
72.38
per share
.
These 2017 share repurchases
reduced the Company’s
total shareholders’ equity and
are
reflected at cost within the Company’s accompanying condensed consolidated balance sheet.
Although these shares are owned by an indirect wholly owned subsidiary of the Company, they are reflected as treasury shares under
U.S. GAAP and therefore reduce the number of common shares outstanding within the Company’s condensed consolidated financial statements and the weighted-average number of common shares outstanding used in calculating earnings per share.
The co
mmon shares
o
f Herbalife Ltd. held by the indirect wholly owned subsidiary, however, remain outstanding on the books and records of the Company’s transfer agent and therefore still carry voting and other share rights related to ownership of the Company’s common shares
,
which may be exercised
.
So long as it is consistent with
applicable laws, such shares will be voted by such subsidiary in the same manner, and to the maximum extent possible in the same proportion, as all other votes cast with respect to any matter proper
ly submitted to a vote of Herbalife Ltd.’s shareholders.
As of
September
30, 2017, the Company held approximately
4.6
million of treasury shares for U.S. GAAP purposes. The Company did not repurchase any common shares in the open market during the three an
d
nine
months ended
September
30, 2016.
As of
September
30, 2017, the remaining authorized capacity under the Company’s $1.5 billion share repurchase program was $
1,200.8
million.
The number of shares issued upon vesting or exercise for certain restricted stock units and SARs granted pursuant to the Company’s share-based compensation plans is net of the statutory withholding requirements that the Company pays on behalf of its employees. Although shares withheld are not issued, they are treated as common share repurchases in the Company’s condensed consolidated financial statements and reduce the Company’s additional paid-in-capital within total shareholders’ equity and are reflected as share repurchases on the Company’s condensed consolidated statements of cash flows as they reduce the number of shares that would have been issued upon vesting. These shares do not count against the authorized capacity under the Company’s share repurchase program described above.
For the nine months ended September 30, 2017 and 2016, the Company’s share repurchases were $299.2 million and none, respectively, under the Company’s share repurchase programs, and $47.0 million and $12.5 million, respectively, due to shares withheld for tax purposes related to the Company’s share-based compensation plans. For the nine months ended September 30, 2017 and 2016, the Company’s total share repurchases, including shares withheld for tax purposes, were $346.2 million and $12.5 million, respectively, and have been recorded as a reduction to shareholders’ equity within the Company’s condensed consolidated balance sheet as of September 30, 2017 and within financing activities on its condensed consolidated statement of cash flows for the nine months ended September 30, 2017.
Capped Call Transactions
In February 2014, in connection with the issuance of Convertible Notes, the Company paid approximately $123.8 million to enter into Capped Call Transactions with certain financial institutions. The Capped Call Transactions are expected generally to reduce the potential dilution upon conversion of the Convertible Notes in the event that the market price of the common shares is greater than the strike price of the Capped Call Transactions, initially set at $86.28 per common share, with such reduction of potential dilution subject to a cap based on the cap price initially set at $120.79 per common share. The strike price and cap price are subject to certain adjustments under the terms of the Capped Call Transactions. Therefore, as a result of executing the Capped Call Transactions, the Company in effect will only be exposed to potential net dilution once the market price of its common shares exceeds the adjusted cap price. As a result of the Capped Call Transactions, the Company’s additional paid-in capital within shareholders’ equity on its condensed consolidated balance sheet was reduced by $123.8 million during the first quarter of 2014.
23
Accumulated Other Comprehensive Income (Loss)
The following table summarizes changes in accumulated other comprehensive income (loss) during the three months ended September 30, 2017 and 2016:
|
|
Changes in Accumulated Other Comprehensive
|
|
|
|
Income (Loss) by Component
|
|
|
|
Three Months Ended September 30,
|
|
|
|
2017
|
|
|
2016
|
|
|
|
Foreign
Currency
Translation
Adjustments
|
|
|
Unrealized
Gain
(Loss)
on
Derivatives
|
|
|
Total
|
|
|
Foreign
Currency
Translation
Adjustments
|
|
|
Unrealized
Gain (Loss)
on
Derivatives
|
|
|
Total
|
|
|
|
(In millions)
|
|
Beginning Balance
|
|
$
|
(185.8
|
)
|
|
$
|
(2.6
|
)
|
|
$
|
(188.4
|
)
|
|
$
|
(178.8
|
)
|
|
$
|
10.3
|
|
|
$
|
(168.5
|
)
|
Other comprehensive income (loss)
before reclassifications, net of tax
|
|
|
11.3
|
|
|
|
(0.2
|
)
|
|
|
11.1
|
|
|
|
(2.6
|
)
|
|
|
0.8
|
|
|
|
(1.8
|
)
|
Amounts reclassified from
accumulated other comprehensive
income (loss) to income, net of
tax(1)
|
|
|
—
|
|
|
|
2.7
|
|
|
|
2.7
|
|
|
|
—
|
|
|
|
(3.0
|
)
|
|
|
(3.0
|
)
|
Total other comprehensive income
(loss), net of reclassifications
|
|
|
11.3
|
|
|
|
2.5
|
|
|
|
13.8
|
|
|
|
(2.6
|
)
|
|
|
(2.2
|
)
|
|
|
(4.8
|
)
|
Ending balance
|
|
$
|
(174.5
|
)
|
|
$
|
(0.1
|
)
|
|
$
|
(174.6
|
)
|
|
$
|
(181.4
|
)
|
|
$
|
8.1
|
|
|
$
|
(173.3
|
)
|
(1)
|
See Note 9,
Derivative Instruments and Hedging Activities
, for information regarding the location in the condensed consolidated statements of income of gains (losses) reclassified from accumulated other comprehensive income (loss) into income during the three months ended September 30, 2017 and 2016.
|
Other comprehensive income (loss) before reclassifications was net of tax benefits of $1.8 million for foreign currency translation adjustment for the three months ended September 30, 2017.
Other comprehensive income (loss) before reclassifications was net of tax expense of $5.8 million for foreign currency translation adjustment for the three months ended September 30, 2016.
The following table summarizes changes in accumulated other comprehensive income (loss) during the nine months ended September 30, 2017 and 2016:
|
|
Changes in Accumulated Other Comprehensive
|
|
|
|
Income (Loss) by Component
|
|
|
|
Nine Months Ended September 30,
|
|
|
|
2017
|
|
|
2016
|
|
|
|
Foreign
Currency
Translation
Adjustments
|
|
|
Unrealized
Gain
(Loss)
on
Derivatives
|
|
|
Total
|
|
|
Foreign
Currency
Translation
Adjustments
|
|
|
Unrealized
Gain (Loss)
on
Derivatives
|
|
|
Other
|
|
|
Total
|
|
|
|
(In millions)
|
|
Beginning Balance
|
|
$
|
(215.5
|
)
|
|
$
|
10.4
|
|
|
$
|
(205.1
|
)
|
|
$
|
(183.0
|
)
|
|
$
|
17.4
|
|
|
$
|
0.1
|
|
|
$
|
(165.5
|
)
|
Other comprehensive income (loss)
before reclassifications, net of tax
|
|
|
41.0
|
|
|
|
(10.8
|
)
|
|
|
30.2
|
|
|
|
1.6
|
|
|
|
3.4
|
|
|
|
—
|
|
|
|
5.0
|
|
Amounts reclassified from
accumulated other comprehensive
income (loss) to income, net of
tax(1)
|
|
|
—
|
|
|
|
0.3
|
|
|
|
0.3
|
|
|
|
—
|
|
|
|
(12.7
|
)
|
|
|
(0.1
|
)
|
|
|
(12.8
|
)
|
Total other comprehensive income
(loss), net of reclassifications
|
|
|
41.0
|
|
|
|
(10.5
|
)
|
|
|
30.5
|
|
|
|
1.6
|
|
|
|
(9.3
|
)
|
|
|
(0.1
|
)
|
|
|
(7.8
|
)
|
Ending balance
|
|
$
|
(174.5
|
)
|
|
$
|
(0.1
|
)
|
|
$
|
(174.6
|
)
|
|
$
|
(181.4
|
)
|
|
$
|
8.1
|
|
|
$
|
—
|
|
|
$
|
(173.3
|
)
|
(1)
|
See Note 9,
Derivative Instruments and Hedging Activities
, for information regarding the location in the condensed consolidated statements of income of gains (losses) reclassified from accumulated other comprehensive income into income during the nine months ended September 30, 2017 and 2016.
|
24
Other comprehensive income (loss) before reclassificati
ons was net of tax expense of $
3.5
million for foreign currency translation adjustment for the
nine
months ended
September
30, 2017.
Other comprehensive income (loss) before reclassifications was net of tax expense of $7.3 million and tax benefits of $0.3 million for foreign currency translation adjustment and unrealized gain (loss) on derivatives, respectively, for the nine months ended September 30, 2016. Amounts reclassified from other comprehensive income (loss) to income were net of tax expense of $0.1 million for other for the nine months ended September 30, 2016.
11. Earnings Per Share
Basic earnings per share represents net income divided by the weighted average number of common shares outstanding for the period. Diluted earnings per share represents net income divided by the weighted average number of common shares outstanding, inclusive of the effect of dilutive securities such as outstanding SARs and stock units.
The following are the common share amounts used to compute the basic and diluted earnings per share for each period:
|
|
For the Three Months
Ended September 30,
|
|
|
For the Nine Months
Ended September 30,
|
|
|
|
2017
|
|
|
2016
|
|
|
2017
|
|
|
2016
|
|
|
|
(in millions)
|
|
Weighted average shares used in basic computations
|
|
|
79.6
|
|
|
|
83.1
|
|
|
|
81.4
|
|
|
|
83.0
|
|
Dilutive effect of exercise of equity grants outstanding
|
|
|
3.4
|
|
|
|
3.3
|
|
|
|
3.6
|
|
|
|
3.1
|
|
Weighted average shares used in diluted computations
|
|
|
83.0
|
|
|
|
86.4
|
|
|
|
85.0
|
|
|
|
86.1
|
|
There were an aggregate of 3.3 million and 3.6 million of equity grants, consisting of SARs, and stock units that were outstanding during the three and nine months ended September 30, 2017, respectively
,
and an aggregate of 3.9 million and 4.8 million of equity grants, consisting of SARs and stock units, that were outstanding during the three and nine months ended September 30, 2016, respectively,
but were not included in the computation of diluted earnings per share because their effect would be anti-dilutive or the performance condition for the award had not been satisfied.
Since the Company will settle the principal amount of its Convertible Notes in cash and settle the conversion feature for the amount above the conversion price in common shares, or the conversion spread, the Company uses the treasury stock method for calculating any potential dilutive effect of the conversion spread on diluted earnings per share, if applicable. The conversion spread will have a dilutive impact on diluted earnings per share when the average market price of the Company’s common shares for a given period exceeds the initial conversion price of $86.28 per share. For the three and nine months ended September 30, 2017 and 2016, the Convertible Notes have been excluded from the computation of diluted earnings per
share as the effect would be anti-dilutive since the conversion price of the Convertible Notes exceeded the average market price of the Company’s common shares for the three and nine months ended
September 30
, 2017 and 2016. The initial conversion rate and conversion price is described further in Note 4,
Long-Term Debt
.
The Capped Call Transactions are excluded from the calculation of diluted earnings per share because their impact is always anti-dilutive.
See Note 10,
Shareholders’ Equity
, for a discussion of how common shares repurchased by the Company’s indirect wholly owned subsidiary are treated under U.S. GAAP.
12. Fair Value Measurements
The Company applies the provisions of the FASB Accounting Standards Codification, or ASC, Topic 820,
Fair Value
Measurements and Disclosures
, or ASC 820, for its financial and non-financial assets and liabilities. ASC 820 defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. ASC 820 establishes a fair value hierarchy, which prioritizes the inputs used in measuring fair value into three broad levels as follows:
Level 1 inputs are quoted prices (unadjusted) in active markets for identical assets or liabilities that the reporting entity has the ability to access at the measurement date.
25
Level 2 inputs
include quoted prices for similar assets or liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that are not active, inputs other than quoted prices that are observable for the asset or liability and input
s that are derived principally from or corroborated by observable market data by correlation or other means.
Level 3 inputs are unobservable inputs for the asset or liability.
The Company measures certain assets and liabilities at fair value as discussed throughout the notes to its condensed consolidated financial statements. Foreign exchange currency contracts are valued using standard calculations and models primarily based on inputs such as observable forward rates, spot rates and foreign currency exchange rates at the reporting period ended date. The Company’s derivative assets and liabilities are measured at fair value and consisted of Level 2 inputs and their amounts are shown below at their gross values at September 30, 2017 and December 31, 2016:
Fair Value Measurements at Reporting Date
|
|
Derivative Balance
Sheet
Location
|
|
Significant Other
Observable
Inputs
(Level 2)
Fair Value at
September 30,
2017
|
|
|
Significant Other
Observable
Inputs
(Level 2)
Fair Value at
December 31,
2016
|
|
|
|
|
|
(in millions)
|
|
ASSETS:
|
|
|
|
|
|
|
|
|
|
|
Derivatives designated as hedging
instruments:
|
|
|
|
|
|
|
|
|
|
|
Foreign exchange currency contracts relating to
inventory and intercompany management fee
hedges
|
|
Prepaid expenses and
other current assets
|
|
$
|
0.8
|
|
|
$
|
4.6
|
|
Derivatives not designated as hedging
instruments:
|
|
|
|
|
|
|
|
|
|
|
Foreign exchange currency contracts
|
|
Prepaid expenses and
other current assets
|
|
$
|
1.1
|
|
|
$
|
2.8
|
|
|
|
|
|
$
|
1.9
|
|
|
$
|
7.4
|
|
LIABILITIES:
|
|
|
|
|
|
|
|
|
|
|
Derivatives designated as hedging
instruments:
|
|
|
|
|
|
|
|
|
|
|
Foreign exchange currency contracts relating to
inventory and intercompany management fee
hedges
|
|
Other current liabilities
|
|
$
|
5.5
|
|
|
$
|
—
|
|
Derivatives not designated as hedging
instruments:
|
|
|
|
|
|
|
|
|
|
|
Foreign exchange currency contracts
|
|
Other current liabilities
|
|
$
|
1.1
|
|
|
$
|
3.5
|
|
|
|
|
|
$
|
6.6
|
|
|
$
|
3.5
|
|
The Company considers all highly liquid investments purchased with a maturity of three months or less to be cash equivalents. Cash and cash equivalents are comprised of money market funds and foreign and domestic bank accounts. These cash and cash equivalents are valued based on level 1 inputs which consist of quoted prices in active markets. To reduce its credit risk, the Company monitors the credit standing of the financial institutions that hold the Company’s cash and cash equivalents.
The Company’s deferred compensation plan assets consist of Company owned life insurance policies. As these policies are recorded at their cash surrender value, they are not required to be included in the fair value table above. See Note 6,
Employee Compensation Plans
, to the consolidated financial statements included in the 2016 10-K for a further description of the Company’s deferred compensation plan assets.
26
The following tables summarize the offsetting of the fair values of the Company’s derivative assets and derivative l
iabilities for presentation in the Company’s condensed consolidated balance sheet at
September
30, 2017 and December 31, 2016:
|
|
Offsetting of Derivative Assets
|
|
|
|
Gross
Amounts of
Recognized
Assets
|
|
|
Gross
Amounts
Offset in the
Balance Sheet
|
|
|
Net Amounts
of Assets
Presented in
the Balance
Sheet
|
|
|
|
(In millions)
|
|
September 30, 2017
|
|
|
|
|
|
|
|
|
|
|
|
|
Foreign exchange currency contracts
|
|
$
|
1.9
|
|
|
$
|
(1.6
|
)
|
|
$
|
0.3
|
|
Total
|
|
$
|
1.9
|
|
|
$
|
(1.6
|
)
|
|
$
|
0.3
|
|
December 31, 2016
|
|
|
|
|
|
|
|
|
|
|
|
|
Foreign exchange currency contracts
|
|
$
|
7.4
|
|
|
$
|
(3.0
|
)
|
|
$
|
4.4
|
|
Total
|
|
$
|
7.4
|
|
|
$
|
(3.0
|
)
|
|
$
|
4.4
|
|
|
|
Offsetting of Derivative Liabilities
|
|
|
|
Gross
Amounts of
Recognized
Liabilities
|
|
|
Gross
Amounts
Offset in the
Balance Sheet
|
|
|
Net Amounts
of Liabilities
Presented in
the Balance
Sheet
|
|
|
|
(In millions)
|
|
September 30, 2017
|
|
|
|
|
|
|
|
|
|
|
|
|
Foreign exchange currency contracts
|
|
$
|
6.6
|
|
|
$
|
(1.6
|
)
|
|
$
|
5.0
|
|
Total
|
|
$
|
6.6
|
|
|
$
|
(1.6
|
)
|
|
$
|
5.0
|
|
December 31, 2016
|
|
|
|
|
|
|
|
|
|
|
|
|
Foreign exchange currency contracts
|
|
$
|
3.5
|
|
|
$
|
(3.0
|
)
|
|
$
|
0.5
|
|
Total
|
|
$
|
3.5
|
|
|
$
|
(3.0
|
)
|
|
$
|
0.5
|
|
The Company offsets all of its derivative assets and derivative liabilities in its condensed consolidated balance sheet to the extent it maintains master netting arrangements with related financial institutions. As of September 30, 2017 and December 31, 2016, all of the Company’s derivatives were subject to master netting arrangements and no collateralization was required for the Company’s derivative assets and derivative liabilities.
13. Detail of Certain Balance Sheet Accounts
Other Assets
The Other assets on the Company’s accompanying condensed consolidated balance sheets includes deferred compensation plan assets of $32.7 million and $30.6 million and long-term deferred tax assets of $190.3 million and $155.2 million as of September 30, 2017 and December 31, 2016, respectively.
Other Current Liabilities
Other current liabilities consist of the following:
|
|
September 30,
2017
|
|
|
December 31,
2016
|
|
|
|
(In millions)
|
|
Accrued compensation
|
|
$
|
110.1
|
|
|
$
|
125.8
|
|
Accrued liabilities
|
|
|
243.1
|
|
|
|
236.9
|
|
Advance sales deposits
|
|
|
68.2
|
|
|
|
50.1
|
|
Income taxes payable
|
|
|
6.0
|
|
|
|
42.0
|
|
Total
|
|
$
|
427.4
|
|
|
$
|
454.8
|
|
27
Other Non-Current Liabilities
The Other non-current liabilities on the Company’s accompanying condensed consolidated balance sheets includes deferred compensation plan liabilities of $55.9 million and $50.0 million and deferred income tax liabilities of $15.4 million and $15.3 million as of September 30, 2017 and December 31, 2016, respectively. See Note 6,
Employee Compensation Plans
, to the consolidated financial statements in the 2016 10-K for a further description of the Company’s deferred compensation plan assets and liabilities.
14. Subsequent Events
In October 2017, the Company completed its modified Dutch auction tender offer and then subsequently paid cash to repurchase a total of approximately 6.7 million of its common shares at an aggregate cost of approximately $457.8 million, or $68.00 per share. The Company’s cash and cash equivalents and total shareholders’ equity at September 30, 2017, have been subsequently reduced by $457.8 million during the fourth quarter of 2017, as a result of this Dutch auction tender offer transaction. In connection with the tender offer, the Company also provided a non-transferable contractual contingent value right, or CVR, for each share tendered, allowing participants in the tender offer to receive a contingent cash payment in the event Herbalife is acquired in a going-private transaction (as defined in the CVR Agreement) within two years of the commencement of the tender offer. The initial fair value of the CVR was $7.3 million, which will be recorded as a liability in the fourth quarter with a corresponding decrease to shareholders’ equity. Subsequent changes in the fair value of the CVR liability are then recognized within the Company's consolidated balance sheet with corresponding gains or losses being recognized in non-operating expense (income) within the Company's condensed consolidated statements of income during each reporting period until the CVR expires in August 2019 or is terminated due to a going-private transaction.
The following table presents selected pro forma balance sheet data as if the Dutch auction tender offer transaction had been completed and the 6.7 million shares had been repurchased as of September 30, 2017:
|
|
September 30,
2017
|
|
|
Adjustments
|
|
|
September 30,
2017
|
|
|
|
As Reported
|
|
|
|
|
|
|
Pro Forma
|
|
|
|
(In millions)
|
|
ASSETS:
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash and cash equivalents
|
|
$
|
1,636.3
|
|
|
$
|
(457.8
|
)
|
|
$
|
1,178.5
|
|
Total assets
|
|
|
3,422.5
|
|
|
|
(457.8
|
)
|
|
|
2,964.7
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
LIABILITIES:
|
|
|
|
|
|
|
|
|
|
|
|
|
Other non-current liabilities
|
|
$
|
168.1
|
|
|
$
|
7.3
|
|
|
$
|
175.4
|
|
Total liabilities
|
|
|
3,203.5
|
|
|
|
7.3
|
|
|
|
3,210.8
|
|
SHAREHOLDERS’ EQUITY (DEFICIT):
|
|
|
|
|
|
|
|
|
|
|
|
|
Common shares
|
|
|
0.1
|
|
|
|
(0.0
|
)
|
|
|
0.1
|
|
Paid-in capital in excess of par value
|
|
|
452.0
|
|
|
|
(40.4
|
)
|
|
|
411.6
|
|
Retained earnings (accumulated deficit)
|
|
|
240.7
|
|
|
|
(424.7
|
)
|
|
|
(184.0
|
)
|
Total shareholders’ equity (deficit)
|
|
|
219.0
|
|
|
|
(465.1
|
)
|
|
|
(246.1
|
)
|
Total liabilities and shareholders’ equity (deficit)
|
|
$
|
3,422.5
|
|
|
$
|
(457.8
|
)
|
|
$
|
2,964.7
|
|
28
Item 2.
Management’s Discussion and Analysis of
Financial Condition and Results of Operations
The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our condensed consolidated financial statements and related notes included in Part I, Item 1 –
Financial Information
, of this Quarterly Report on Form 10-Q and our consolidated financial statements appearing in our Annual Report on Form 10-K for the year ended December 31, 2016, or the 2016 10-K. Unless the context otherwise requires, all references herein to the “Company,” “we,” “us” or “our,” or similar terms, refer to Herbalife Ltd., a Cayman Islands exempt limited liability company, and its consolidated subsidiaries.
Overview
We are a global nutrition company that sells weight management, targeted nutrition, energy, sports & fitness, and outer nutrition products to and through independent members, or Members. In China, we sell our products to and through independent service providers, sales representatives, and sales officers to customers and preferred customers, as well as through Company-operated retail stores when necessary. We refer to Members that distribute our products and achieve certain qualification requirements as “sales leaders.”
We pursue our mission of “changing people’s lives” by providing high quality, science-based products to Members and their customers who seek a healthy lifestyle and we also offer a business opportunity to those Members who seek additional income. We believe the global obesity epidemic has made our quality products more relevant and the effectiveness of our distribution network, coupled with geographic expansion, have been the primary reasons for our success throughout our 37-year operating history.
Our products are grouped in four principal categories: weight management; targeted nutrition; energy, sports & fitness; and outer nutrition, along with literature and promotional items. Our products are often sold through a series of related products and literature designed to simplify weight management and nutrition for consumers and maximize our Members’ cross-selling opportunities.
Industry-wide factors that affect us and our competitors include the global obesity epidemic, the aging of the worldwide population and rising public health care costs, which are driving demand for weight management, nutrition and wellness-related products along with the global increase in under employment and unemployment which can affect the recruitment and retention of Members seeking additional income opportunities.
While we continue to monitor the current global financial environment, we remain focused on the opportunities and challenges in retailing of our products, sponsoring and retaining Members, improving Member productivity, further penetrating existing markets, opening new markets, globalizing successful Distributor Methods of Operation, or DMOs, such as Nutrition Clubs and Weight Loss Challenges, introducing new products and globalizing existing products, developing niche market segments and further investing in our infrastructure.
We report revenue from our six regions:
|
•
|
South and Central America;
|
|
•
|
EMEA, which consists of Europe, the Middle East and Africa;
|
|
•
|
Asia Pacific (excluding China); and
|
29
On July 15, 2016, we reached a settlement with the U.S. Federal Trade Commission, or the FTC, and entered into a proposed Stipulation to Entry of Order for Permanent Injunction and Monetary Jud
gment, or the Consent Order, which resolved the FTC’s multi-year investigation of the Company. The Consent Order became effective on July 25, 2016, or the Effective Date, upon final approval by the U.S. District Court for the Central District of California
. Pursuant to the Consent Order, we agreed to implement certain new procedures and enhance certain existing procedures in the U.S., most of which we
had
10 months from the Effective Date to implement. Among other requirements, the Consent Order require
d
us
to categorize all existing and future Members in the U.S. as either “preferred members” - who are simply consumers who only wish to purchase product for their own household use, or “distributors” - who are Members who wish to resell some products or build
a sales organization. We also agreed to compensate distributors on
eligible
U.S.
sales
within their downline organizations, which include purchases by preferred members, purchases by a distributor for his or her personal consumption within allowable limit
s and sales of product by a distributor to his or her customers. The Consent Order also requires distributors to meet certain conditions before opening Nutrition Clubs and/or entering into leases for their Herbalife business in the United States. The Conse
nt Order also prohibits the Company from making expressly or by implication, any representation regarding the amount or level of income, including full-time or part-time income, that a participant can reasonably expect to earn in the Company’s network mark
eting program, unless the representation is non-misleading and the Company possesses competent and reliable evidence sufficient to substantiate that the representation is true.
We are monitoring the impact of the Consent Order and our Board of Directors has established the Implementation Oversight Committee in connection with the Consent Order. The committee has met and will meet regularly with management to oversee our compliance with the terms of the Consent Order. While we currently do not expect the settlement to have a long-term and materially adverse impact on our business and our Member base, our business and our Member base, particularly in the U.S., may be negatively impacted as we and they adjust to the changes. The terms of the settlement do not change our going to market through direct selling by independent distributors, and compensating those distributors based upon the product they and their sales organization sell. See Item 1A –
Risk Factors
of this Quarterly Report on Form 10-Q for a discussion of risks related to the settlement with the FTC.
Volume Points by Geographic Region
A key non-financial measure we focus on is Volume Points on a Royalty Basis, or Volume Points, which is essentially our weighted-average measure of product sales volume. Volume Points, which are unaffected by exchange rates or price changes, are used by management as a proxy for sales trends because in general, excluding the impact of price changes, an increase in Volume Points in a particular geographic region or country indicates an increase in our local currency net sales while a decrease in Volume Points in a particular geographic region or country indicates a decrease in our local currency net sales. The criteria we use to determine how and when we recognize Volume Points are not identical to our revenue recognition policies under U.S. GAAP. Unlike net sales, which are generally recognized when the product is delivered and both the title and risk and rewards pass to the Member, as discussed in greater detail in the 2016 10-K, we recognize Volume Points when a Member pays for the order, which is generally prior to the product being delivered. Further, the periods in which Volume Points are tracked can vary slightly from the fiscal periods for which we report our results under U.S. GAAP. Therefore, there can be timing differences between the product orders for which net sales are recognized and for which Volume Points are recognized within a given period. However, historically these timing differences generally have been immaterial in the context of using changes in Volume Points as a proxy to explain volume-driven changes in net sales.
30
We assign a Volume Point value to a product when it is first introduced into a market and the value is unaffected by subsequent
foreign
exchange rate and price changes. The specific number of Volume Points assigned to a product, and generally consistent across all markets, is based on a Volume Point to suggested retail price ratio for similar products. If a product is available in differen
t quantities, the various sizes will have different Volume Point values. In general, once assigned, a Volume Point value is consistent in each region and country and does not change from year to year. The reason Volume Points are used in the manner describ
ed above is that we use Volume Points for Member qualification and recognition purposes and therefore we attempt to keep Volume Points for a similar or like product consistent on a global basis. However, because Volume Points are a function of value rather
than product type or size, they are not a reliable measure for product mix. As an example, an increase in Volume Points in a specific country or region could mean a significant increase in sales of less expensive products or a marginal increase in sales o
f more expensive products.
|
|
Three Months Ended September 30,
|
|
|
Nine Months Ended September 30,
|
|
|
|
2017
|
|
|
2016
|
|
|
% Change
|
|
|
2017
|
|
|
2016
|
|
|
% Change
|
|
|
|
(Volume Points in millions)
|
|
North America
|
|
|
261.5
|
|
|
|
311.6
|
|
|
|
(16.1
|
)%
|
|
|
848.2
|
|
|
|
978.1
|
|
|
|
(13.3
|
)%
|
Mexico
|
|
|
213.3
|
|
|
|
234.5
|
|
|
|
(9.0
|
)%
|
|
|
667.7
|
|
|
|
693.1
|
|
|
|
(3.7
|
)%
|
South & Central America
|
|
|
150.2
|
|
|
|
161.1
|
|
|
|
(6.8
|
)%
|
|
|
440.9
|
|
|
|
499.2
|
|
|
|
(11.7
|
)%
|
EMEA
|
|
|
258.9
|
|
|
|
252.0
|
|
|
|
2.7
|
%
|
|
|
816.7
|
|
|
|
789.6
|
|
|
|
3.4
|
%
|
Asia Pacific (excluding China)
|
|
|
278.7
|
|
|
|
275.9
|
|
|
|
1.0
|
%
|
|
|
815.4
|
|
|
|
803.2
|
|
|
|
1.5
|
%
|
China
|
|
|
147.8
|
|
|
|
153.2
|
|
|
|
(3.5
|
)%
|
|
|
483.7
|
|
|
|
488.1
|
|
|
|
(0.9
|
)%
|
Worldwide
|
|
|
1,310.4
|
|
|
|
1,388.3
|
|
|
|
(5.6
|
)%
|
|
|
4,072.6
|
|
|
|
4,251.3
|
|
|
|
(4.2
|
)%
|
We believe the decrease in worldwide Volume Points for the three and nine months ended September 30, 2017 of 5.6% and 4.2%, respectively, versus increases reported for the prior year periods, were driven by regional specific factors. The decreases for North America for the three and nine months ended September 30, 2017, following increases in the prior year periods, reflect Member focus on FTC settlement implementation actions including training on new tools and methods for documenting sales, and time spent to then train their sales organizations. The decrease for Mexico for the three and nine months ended September 30, 2017, reflects difficult economic conditions in the market and, for the quarter, the adverse impact of the damaging natural disaster in the greater Mexico City area. We continue to see declines in the South & Central America region as a result of regional and country specific challenges discussed in greater detail in Sales by Geographic Region below, and as many Members transition to customer-based, sustainable business practices. Lower levels of growth for the EMEA region versus comparable prior year periods are also driven by country specific results, including declines in several countries that have followed several years of growth. Asia Pacific (excluding China) has had mixed results by country within the region, as discussed in greater detail in Sales by Geographic Region below. The Volume Point declines in China after growth in comparable year periods is attributable to factors such as Members testing new business methods that did not prove to be as sustainable as traditional methods. Sales volume results are discussed further below in the applicable sections of Sales by Geographic Region. We believe our competitive strengths and business strategies, each of which is discussed in greater detail in Item 1 —
Business
of the 2016 10-K, will contribute to achieving our long-term objective of sustainable sales growth through retailing, recruiting and retention.
Number of Sales Leaders and Retention Rates by Geographic Region as of Re-qualification Period
Our compensation system requires each sales leader to re-qualify for such status each year, prior to February, in order to maintain their 50% discount on products and be eligible to receive royalty payments. In February of each year, we demote from the rank of sales leader those Members who did not satisfy the re-qualification requirements during the preceding twelve months. The re-qualification requirement does not apply to new sales leaders (i.e. those who became sales leaders subsequent to the January re-qualification of the prior year). Volume Points are the basis for sales leader qualification, as discussed in greater detail in Item 1, Business of the 2016 10-K. Typically, a Member accumulates Volume Points for a given sale at the time the Member pays for the product. However, effective beginning in May 2017, a Member does not receive Volume Point credit for a transaction in the United States until it is documented in compliance with the Consent Order.
31
For the latest twelve month re-qualification period ending January 2017, approximately 60.9% of our sales leaders, excluding China and Venezuela, re-qualified. This figure excludes sales leaders in the United States who had converted to preferred member pr
ior to the re-qualification period-end, as those individuals were not eligible for requalification; had these individuals been included in the calculation the figure would have been 59.3%. Venezuelan Members were excluded from retention figures for the yea
r ended January 2017 due to revised requalification criteria that are not comparable to prior periods or to other markets and were excluded from 2016 as sales leaders in the market were not required to requalify that year due to product supply limitations.
Argentina is excluded from 2016
for comparability purposes
;
demotion figures for the year are amplified as the qualification requirement had been reinstated after having been waived for 2015
.
Sales Leaders Statistics (Excluding China)
|
|
2017
|
|
|
2016
|
|
|
|
(In thousands)
|
|
January 1 total sales leaders
|
|
|
572.9
|
|
|
|
603.3
|
|
January & February new sales leaders
|
|
|
26.8
|
|
|
|
27.7
|
|
Demoted sales leaders (did not re-qualify)(1)
|
|
|
(124.0
|
)
|
|
|
(207.6
|
)
|
Sales leaders who converted to preferred members
|
|
|
(38.3
|
)
|
|
|
—
|
|
Other sales leaders (resigned, etc.)
|
|
|
(2.0
|
)
|
|
|
(3.9
|
)
|
End of February total sales leaders(1)
|
|
|
435.4
|
|
|
|
419.5
|
|
The statistics below further highlight the calculation for retention.
Sales Leaders Retention (Excluding China)
|
|
2017
|
|
|
2016
|
|
|
|
(In thousands)
|
|
Sales leaders needed to re-qualify
|
|
|
379.0
|
|
|
|
450.2
|
|
Demoted sales leaders (did not re-qualify)(2)
|
|
|
(148.3
|
)
|
|
|
(206.4
|
)
|
Total re-qualified
|
|
|
230.7
|
|
|
|
243.8
|
|
Retention rate
|
|
|
60.9
|
%
|
|
|
54.2
|
%
|
(1)
|
Demoted sales leaders excludes, and the end of February total sales leaders includes, approximately 10.0 thousand South Korea sales leaders who were demoted in March 2017, under a distinct program that granted our South Korea sales leaders one additional month to re-qualify.
|
(2)
|
For historical comparison purposes the 60.9% retention rate calculation for February 2017 includes as demoted 20.3 thousand sales leaders who re-qualified, but under a pilot program for certain markets with a lower re-qualification threshold, but excludes 6.0 thousand Venezuelan sales leaders who were demoted under revised criteria that are not comparable to prior periods or other markets. The retention rate for 2017 if calculated absent these adjustments would have been 65.5%.
|
The table below reflects the number of sales leaders as of the end of February of the year indicated (subsequent to the annual re-qualification date) and sales leader retention rate by year and by region.
|
|
Number of Sales Leaders
|
|
|
Sales Leaders Retention Rate
|
|
|
|
2017
|
|
|
2016
|
|
|
2017
|
|
|
2016
|
|
North America
|
|
|
61,362
|
|
|
|
79,305
|
|
|
|
74.8
|
%
|
|
|
58.3
|
%
|
Mexico
|
|
|
74,968
|
|
|
|
67,294
|
|
|
|
71.7
|
%
|
|
|
57.1
|
%
|
South & Central America
|
|
|
73,375
|
|
|
|
77,523
|
|
|
|
55.2
|
%
|
|
|
53.0
|
%
|
EMEA
|
|
|
101,101
|
|
|
|
87,500
|
|
|
|
62.2
|
%
|
|
|
63.6
|
%
|
Asia Pacific (excluding China)
|
|
|
124,555
|
|
|
|
107,871
|
|
|
|
49.7
|
%
|
|
|
43.8
|
%
|
Total Sales Leaders
|
|
|
435,361
|
|
|
|
419,493
|
|
|
|
60.9
|
%
|
|
|
54.2
|
%
|
China
|
|
|
47,244
|
|
|
|
41,890
|
|
|
|
|
|
|
|
|
|
Worldwide Total Sales Leaders
|
|
|
482,605
|
|
|
|
461,383
|
|
|
|
|
|
|
|
|
|
Sales leaders generally purchase our products for resale to other Members and retail consumers. The number of sales leaders by geographic region as of the quarterly reporting dates will normally be higher than the number of sales leaders by geographic region as of the re-qualification period because sales leaders who do not re-qualify during the relevant twelve-month period will be removed from the rank of sales leader the following February. Comparisons of sales leader totals on a year-to-year basis are indicators of our recruitment and retention efforts in different geographic regions.
32
Retention Rate for the requalification period ended January 2017 was significantly improved compared to pr
ior year periods. We believe this performance is the result of efforts we have made to improve the sustainability of sales leaders’ businesses such as encouraging Members to obtain experience retailing Herbalife products before becoming a sales leader.
Presentation
“Retail value”
represents the suggested retail price of products we sell to our Members and is the gross sales amount reflected on our invoices. Retail value is a Non-GAAP measure which may not be comparable to similarly-titled measures used by other companies. This is not the price paid to us by our Members. Our Members purchase product from us at a discount from the suggested retail price. We refer to these discounts as
“distributor allowance”,
and we refer to retail value less distributor allowances as
“product sales”
.
Total distributor allowances for the three months ended September 30, 2017 and 2016 were 40.7% and 40.5% of retail value, respectively.
Total distributor allowances for the nine months ended September 30, 2017 and 2016 were 40.4% and 40.2% of retail value, respectively.
Distributor allowances and Marketing Plan payouts generally utilize 90% to 95% of suggested retail price, depending on the product and market, to which we apply discounts of up to 50% for distributor allowances and payout rates of up to 15% for royalty overrides, up to 7% for production bonuses, and approximately 1% for the Mark Hughes bonus. Distributor allowances as a percentage of retail value may vary by country depending upon regulatory restrictions that limit or otherwise restrict distributor allowances. We also offer reduced distributor allowances with respect to certain products worldwide. Each Member’s level of discount is determined by qualification based on volume of purchases. In cases where a Member has qualified for less than the maximum discount, the remaining discount, which we also refer to as a wholesale commission, is received by their sponsoring Members. Therefore, product sales are recognized net of product returns and distributor allowances.
“Net sales”
equal product sales plus
“shipping and handling revenues”
, and generally represents what we collect.
We do not have visibility into all of the sales from our Members to their customers, but such a figure would differ from our reported “retail value” by factors including (a) the amount of product purchased by our Members for their own personal consumption and (b) prices charged by our Members to their customers other than our suggested retail prices. We discuss retail value because of its fundamental role in our systems, internal controls and operations, and its correlation to Member discounts and Royalty Overrides. In addition, retail value is a component of the financial reports we use to analyze our financial results because, among other things, it can provide additional detail and visibility into our net sales results on a Company-wide and a geographic region and product category basis. Therefore, this non-GAAP measure may be useful to investors because it provides investors with the same information used by management. As this measure is not in accordance with U.S. generally accepted accounting principles, or U.S. GAAP, retail value should not be considered in isolation from, nor as a substitute for, net sales and other consolidated income or cash flow statement data prepared in accordance with U.S. GAAP, or as a measure of profitability or liquidity. A reconciliation of retail value to net sales is presented below under
Results of Operations.
Our international operations have provided and will continue to provide a significant portion of our total net sales. As a result, total net sales will continue to be affected by fluctuations in the U.S. dollar against foreign currencies. In order to provide a framework for assessing how our underlying businesses performed excluding the effect of foreign currency fluctuations, in addition to comparing the percent change in net sales from one period to another in U.S. dollars, we also compare the percent change in net sales from one period to another period using “
net sales in local currency
”. Net sales in local currency is not a U.S. GAAP financial measure. Net sales in local currency removes from net sales in U.S. dollars the impact of changes in exchange rates between the U.S. dollar and the local currencies of our foreign subsidiaries, by translating the current period net sales into U.S. dollars using the same foreign currency exchange rates that were used to translate the net sales for the previous comparable period. We believe presenting net sales in local currency is useful to investors because it allows a meaningful comparison of net sales of our foreign operations from period to period. However, net sales in local currency measures should not be considered in isolation or as an alternative to net sales in U.S. dollar measures that reflect current period exchange rates, or to other financial measures calculated and presented in accordance with U.S. GAAP.
Our
“gross profit”
consists of net sales less
“cost of sales,”
which represents our manufacturing costs, the price we pay to our raw material suppliers and manufacturers of our products as well as shipping and handling costs including duties, tariffs, and similar expenses.
33
While certain Members may profit from their activities by reselling our products for
amounts greater than the prices they pay us, Members that develop, retain, and manage other Members may earn additional compensation for those activities, which we refer to as
“Royalty overrides.”
Royalty overrides are our most significant operating expen
se and consist of:
|
•
|
royalty overrides and production bonuses;
|
|
•
|
the Mark Hughes bonus payable to some of our most senior Members; and
|
|
•
|
other discretionary incentive cash bonuses to qualifying Members.
|
Royalty overrides are compensation to Members for the development, retention and improved productivity of their sales organizations and are paid to several levels of Members on each sale. Royalty overrides are compensation for services rendered to us and as such are recorded as an operating expense.
In China, our independent service providers are compensated for marketing, sales support, and other services instead of the distributor allowances and royalty overrides utilized in our global marketing plan. Service fees to China independent service providers are included in selling, general and administrative expenses.
Because of local country regulatory constraints, we may be required to modify our Member incentive plans as described above. We also pay reduced royalty overrides with respect to certain products worldwide. Consequently, the total royalty override percentage may vary over time and from the percentages noted above.
Our
“contribution margins”
consist of net sales less cost of sales and royalty overrides.
“Selling, general and administrative expenses”
represent our operating expenses, which include labor and benefits, service fees to China service providers, sales events, professional fees, travel and entertainment, Member promotions, occupancy costs, communication costs, bank fees, depreciation and amortization, foreign exchange gains and losses and other miscellaneous operating expenses.
Our “
other operating income
” consists of government grant income related to China.
Most of our sales to Members outside the United States are made in the respective local currencies. In preparing our financial statements, we translate revenues into U.S. dollars using average exchange rates. Additionally, the majority of our purchases from our suppliers generally are made in U.S. dollars. Consequently, a strengthening of the U.S. dollar versus a foreign currency can have a negative impact on our reported sales and contribution margins and can generate foreign currency losses on intercompany transactions. Foreign currency exchange rates can fluctuate significantly. From time to time, we enter into foreign currency derivatives to partially mitigate our foreign currency exchange risk as discussed in further detail in Part I, Item 3 —
Quantitative and Qualitative Disclosures about Market Risk.
Summary Financial Results
Net sales for the three and nine months ended September 30, 2017 were $1,085.4 million and $3,334.4 million, respectively. Net sales decreased $36.6 million, or 3.3%, and $109.0 million or 3.2%, for the three and nine months ended September 30, 2017, as compared to the same periods in 2016. In local currency, net sales decreased 4.0% and 2.5% for the three and nine months ended September 30, 2017, respectively, as compared to the same periods in 2016. The decrease in net sales of 3.3% for the three months ended September 30, 2017 was primarily driven by a decrease in sales volume, as indicated by a 5.6% decrease in Volume Points; partially offset by price increases, which increased net sales by approximately 3.3%. The decrease in net sales of 3.2% for the nine months ended September 30, 2017 was primarily driven by a decrease in sales volume, as indicated by a 4.2% decrease in Volume Points and a 1.3% unfavorable country mix; partially offset by price increases, which increased net sales by approximately 2.5%.
Net income for the three and nine months ended September 30, 2017 was $54.5 million, or $0.66 per diluted share, and $277.3 million, or $3.26 per diluted share, respectively. Net income decreased $33.2 million, or 37.9%, for the three months ended September 30, 2017, and increased $116.7 million, or 72.7% for the nine months ended September 30, 2017. The decrease in net income for the three months ended September 30, 2017 was primarily due to a lower contribution margin driven by the decrease in net sales, and higher interest expense, partially offset by lower income tax expense. The increase in net income for the nine months ended September 30, 2017 was primarily due to a lower selling, general and administrative expense driven by the $203.0 million regulatory settlements in 2016, partially offset by a lower contribution margin driven by lower net sales, and higher interest expense.
34
Net income for the three months
ended
September
30, 2017
included a $
4.6
million favorable impact ($
3.
1
million post-tax) of government grant income in China; a
$
1
1
.
3
million unfavorable impact of non-cash interest expense related to the Convertible Notes and the Forward Transactions (See Note 4,
Long-Term Debt
,
to the Condensed Consolidated Financial Statements
included in Part I, Item 1 of this Quarterly Report on Form 10-Q
); a $
3.3
million pre-tax unfavorable impact ($
2.2
million post-tax) from expenses related to regulatory inquiries; a $
1.1
million pre-tax u
nfavorable impact ($
0.9
million post-tax) related to legal, advisory services and other expenses for our response to allegations and other negative information put forward in the marketplace by a hedge fund manager which started in late 2012 (See
Selling,
General and Administrative Expenses
below for further discussion); and a $
3.0
million pre-tax unfavorable impact ($
1.9
million post-tax) from expenses related to the implementation of the FTC Consent Order.
Net income for the nine months ended September 30, 2017 included a $43.5 million favorable impact ($30.8 million post-tax) of government grant income in China; a $36.6 million unfavorable impact of non-cash interest expense related to the Convertible Notes and the Forward Transactions (See Note 4,
Long-Term Debt
, to the Condensed Consolidated Financial Statements included in Part I, Item 1 of this Quarterly Report on Form 10-Q); a $10.0 million pre-tax unfavorable impact ($6.6 million post-tax) from expenses related to regulatory inquiries; a $4.2 million pre-tax unfavorable impact ($3.2 million post-tax) related to legal, advisory services and other expenses for our response to allegations and other negative information put forward in the marketplace by a hedge fund manager which started in late 2012 (See
Selling, General and Administrative Expenses
below for further discussion); and a $16.7 million pre-tax unfavorable impact ($11.1 million post-tax) from expenses related to the implementation of the FTC Consent Order.
The income tax impact of the expenses discussed above is based on forecasted items affecting our 2017 full year effective tax rate. Adjustments to forecasted items unrelated to these expenses, as well as impacts related to interim reporting, will have an effect on the income tax impact of these items in subsequent periods.
Net income for the three months ended September 30, 2016 included a $2.2 million post-tax favorable impact related to regulatory settlements; $0.2 million pre-tax favorable impact ($0.2 million post-tax) of government grant income in China; a $11.8 million unfavorable impact of non-cash interest expense related to the Convertible Notes and the Forward Transactions (See Note 4,
Long-Term Debt
, to the Condensed Consolidated Financial Statements included in Part I, Item 1 of this Quarterly Report on Form 10-Q); a $3.8 million pre-tax unfavorable impact ($2.2 million post-tax) from expenses related to regulatory inquiries; a $3.1 million pre-tax unfavorable impact ($2.1 million post-tax) related to legal, advisory services and other expenses for our response to allegations and other negative information put forward in the marketplace by a hedge fund manager which started in late 2012 (See
Selling, General and Administrative Expenses
below for further discussion); a $0.2 million pre-tax unfavorable impact ($0.2 million post-tax) related to expenses incurred for the recovery of costs associated with the re-audit of our 2010 to 2012 financial statements after the resignation of KPMG as our independent registered public accounting firm; and a $5.3 million pre-tax unfavorable impact ($3.1 million post-tax) from expenses related to the implementation of the FTC Consent Order.
Net income for the nine months ended September 30, 2016 included a $203.0 million pre-tax unfavorable impact ($134.3 million post-tax) related to regulatory settlements; a $29.1 million pre-tax favorable impact ($20.7 million post-tax) of government grant income in China; a $35.4 million unfavorable impact of non-cash interest expense related to the Convertible Notes and the Forward Transactions (See Note 4, Long-Term Debt, to the Condensed Consolidated Financial Statements included in Part I, Item 1 of this Quarterly Report on Form 10-Q); a $13.9 million pre-tax unfavorable impact ($8.6 million post-tax) from expenses related to regulatory inquiries; a $10.7 million pre-tax unfavorable impact ($7.8 million post-tax) related to legal, advisory services and other expenses for our response to allegations and other negative information put forward in the marketplace by a hedge fund manager which started in late 2012 (See Selling, General and Administrative Expenses below for further discussion); a $3.5 million pre-tax unfavorable impact ($2.5 million post-tax) related to expenses incurred for the recovery of costs associated with the re-audit of our 2010 to 2012 financial statements after the resignation of KPMG as our independent registered public accounting firm; and a $5.3 million pre-tax unfavorable impact ($3.1 million post-tax) from expenses related to the implementation of the FTC Consent Order.
Results of Operations
Our results of operations for the periods below are not necessarily indicative of results of operations for future periods, which depend upon numerous factors, including our ability to sponsor Members and retain sales leaders, further penetrate existing markets, introduce new products and programs that will help our Members increase their retail efforts and develop niche market segments.
35
The following table sets forth select
ed results of our operations expressed as a percentage of net sales for the periods indicated:
|
|
Three Months Ended
|
|
|
Nine Months Ended
|
|
|
|
September 30,
2017
|
|
|
September 30,
2016
|
|
|
September 30,
2017
|
|
|
September 30,
2016
|
|
Operations:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net sales
|
|
|
100.0
|
%
|
|
|
100.0
|
%
|
|
|
100.0
|
%
|
|
|
100.0
|
%
|
Cost of sales
|
|
|
19.8
|
|
|
|
18.6
|
|
|
|
19.2
|
|
|
|
19.1
|
|
Gross profit
|
|
|
80.2
|
|
|
|
81.4
|
|
|
|
80.8
|
|
|
|
80.9
|
|
Royalty overrides(1)
|
|
|
28.6
|
|
|
|
28.6
|
|
|
|
28.3
|
|
|
|
28.1
|
|
Selling, general and administrative expenses(1)
|
|
|
41.0
|
|
|
|
39.3
|
|
|
|
39.8
|
|
|
|
44.9
|
|
Other operating income
|
|
|
(0.4
|
)
|
|
|
—
|
|
|
|
(1.3
|
)
|
|
|
(0.8
|
)
|
Operating income
|
|
|
11.0
|
|
|
|
13.5
|
|
|
|
14.0
|
|
|
|
8.7
|
|
Interest expense, net
|
|
|
3.5
|
|
|
|
2.0
|
|
|
|
3.2
|
|
|
|
2.0
|
|
Income before income taxes
|
|
|
7.5
|
|
|
|
11.5
|
|
|
|
10.8
|
|
|
|
6.7
|
|
Income taxes
|
|
|
2.5
|
|
|
|
3.7
|
|
|
|
2.5
|
|
|
|
2.0
|
|
Net income
|
|
|
5.0
|
%
|
|
|
7.8
|
%
|
|
|
8.3
|
%
|
|
|
4.7
|
%
|
(1)
|
Service fees to our independent service providers in China are included in selling, general and administrative expenses while Member compensation for all other countries is included in royalty overrides.
|
Reporting Segment Results
We aggregate our operating segments, excluding China, into a reporting segment, or the Primary Reporting Segment. The Primary Reporting Segment includes the North America, Mexico, South & Central America, EMEA, and Asia Pacific regions. China has been identified as a separate reporting segment as it does not meet the criteria for aggregation. See Note 6,
Segment Information
, to the Condensed Consolidated Financial Statements included in Part I, Item 1 of this Quarterly Report on Form 10-Q for further discussion of our reporting segments. See below for discussions of net sales and contribution margin by our reporting segments.
Net Sales by Reporting Segment
The Primary Reporting Segment reported net sales of $875.6 million and $2,666.4 million for the three and nine months ended September 30, 2017, respectively, representing a decrease of $32.2 million, or 3.5%, and a decrease of $102.9 million, or 3.7%, for the three and nine months ended September 30, 2017, respectively, as compared to the same periods in 2016. In local currency, net sales decreased 4.5% and 3.8% for the three and nine months ended September 30, 2017, respectively, as compared to the same periods in 2016 for the Primary Reporting Segment. The 3.5% decrease in net sales for the three months ended September 30, 2017 was primarily due to a decrease in sales volume, as indicated by a 5.9% decrease in Volume Points; partially offset by price increases which increased net sales by approximately 3.0%. The 3.7% decrease in net sales for the nine months ended September 30, 2017 was primarily due to a decrease in sales volume, as indicated by a 4.6% decrease in Volume Points and an unfavorable change in country mix, which reduced net sales by approximately 1.9%; partially offset by price increases which increased net sales by approximately 2.4%.
For a discussion of China’s net sales for the three and nine months ended September 30, 2017 see the China section of the Sales by Geographic Region below.
Contribution Margin by Reporting Segment
As discussed above under “Presentation,” contribution margin consists of net sales less cost of sales and Royalty overrides.
36
The Primary Reporting Segment reported contribution margin of $
3
75
.
9
million, or
42
.
9
% of net sales, and $
1,1
55
.
7
million, or
43
.
3
% of net sales, representing a
de
crease of $
2
2.9
million, or
5
.
7
%, and a decrease of $
45.8
million, or
3
.
8
%, for the three and
nine
months ended
September
30, 2017, respectively, as compared to the same periods in 2016.
The 5.7% decrease for the three months ended September 30, 2017 was primarily the result of volume d
ecreases, unfavorable country mix and unfavorable fluctuations in foreign currency rates
which reduced contribution
margin by approximately 5.1%, 2
.7
% and 1.
8
%, respectively, partially offset by price increases which increased contribution margin by approx
imately 4.
7
%. The 3.8% decrease for the nine months ended September 30, 2017 was primarily the result of unfavorable country mix and volume decreases which reduced contribution margin by approximately
5.2
% and 3.9%, respectively, partially offset by price
increases which increased contribution margin by approximately 3.7%.
China reported contribution margin of $184.0 million and $595.8 million for the three and nine months ended September 30, 2017, respectively, representing a decrease of $9.8 million, or 5.1%, and $18.7 million, or 3.0%, for the three and nine months ended September 30, 2017, respectively, as compared to the same periods in 2016. The decrease of 5.1% for the three months ended September 30, 2017 was primarily due to a decline in sales volume and fluctuation in foreign currency rates, which reduced contribution margin by approximately 6.1% and 1.8%, respectively, partially offset by the favorable impact of price increases which increased contribution margin by approximately 5.0%. The decrease of 3.0% for the nine months ended September 30, 2017 was primarily due to fluctuations in foreign currency rates and volume decreases which reduced contribution margin by approximately 4.0% and 1.0%, respectively, partially offset by the favorable impact of price increases which increased contribution margin by approximately 3.1%.
Sales by Geographic Region
The following chart reconciles retail value to net sales by geographic region:
|
|
Three Months Ended September 30,
|
|
|
|
2017
|
|
|
2016
|
|
|
|
Retail
Value(1)
|
|
|
Distributor
Allowance
|
|
|
Product
Sales
|
|
|
Shipping &
Handling
Revenues
|
|
|
Net
Sales
|
|
|
Retail
Value(1)
|
|
|
Distributor
Allowance
|
|
|
Product
Sales
|
|
|
Shipping &
Handling
Revenues
|
|
|
Net
Sales
|
|
|
Change in
Net Sales
|
|
|
|
(In millions)
|
|
North America
|
|
$
|
331.1
|
|
|
$
|
(150.7
|
)
|
|
$
|
180.4
|
|
|
$
|
19.4
|
|
|
$
|
199.8
|
|
|
$
|
399.8
|
|
|
$
|
(181.5
|
)
|
|
$
|
218.3
|
|
|
$
|
22.7
|
|
|
$
|
241.0
|
|
|
|
(17.1
|
)%
|
Mexico
|
|
|
197.1
|
|
|
|
(89.7
|
)
|
|
|
107.4
|
|
|
|
6.9
|
|
|
|
114.3
|
|
|
|
193.9
|
|
|
|
(87.9
|
)
|
|
|
106.0
|
|
|
|
6.8
|
|
|
|
112.8
|
|
|
|
1.3
|
%
|
South & Central America
|
|
|
203.8
|
|
|
|
(95.0
|
)
|
|
|
108.8
|
|
|
|
7.9
|
|
|
|
116.7
|
|
|
|
211.2
|
|
|
|
(98.5
|
)
|
|
|
112.7
|
|
|
|
8.3
|
|
|
|
121.0
|
|
|
|
(3.6
|
)%
|
EMEA
|
|
|
368.6
|
|
|
|
(167.6
|
)
|
|
|
201.0
|
|
|
|
12.9
|
|
|
|
213.9
|
|
|
|
346.6
|
|
|
|
(157.6
|
)
|
|
|
189.0
|
|
|
|
12.6
|
|
|
|
201.6
|
|
|
|
6.1
|
%
|
Asia Pacific
|
|
|
395.3
|
|
|
|
(171.9
|
)
|
|
|
223.4
|
|
|
|
7.5
|
|
|
|
230.9
|
|
|
|
392.0
|
|
|
|
(167.8
|
)
|
|
|
224.2
|
|
|
|
7.2
|
|
|
|
231.4
|
|
|
|
(0.2
|
)%
|
China
|
|
|
239.3
|
|
|
|
(30.6
|
)
|
|
|
208.7
|
|
|
|
1.1
|
|
|
|
209.8
|
|
|
|
242.8
|
|
|
|
(29.8
|
)
|
|
|
213.0
|
|
|
|
1.2
|
|
|
|
214.2
|
|
|
|
(2.1
|
)%
|
Worldwide
|
|
$
|
1,735.2
|
|
|
$
|
(705.5
|
)
|
|
$
|
1,029.7
|
|
|
$
|
55.7
|
|
|
$
|
1,085.4
|
|
|
$
|
1,786.3
|
|
|
$
|
(723.1
|
)
|
|
$
|
1,063.2
|
|
|
$
|
58.8
|
|
|
$
|
1,122.0
|
|
|
|
(3.3
|
)%
|
|
|
Nine Months Ended September 30,
|
|
|
|
2017
|
|
|
2016
|
|
|
|
Retail
Value(1)
|
|
|
Distributor
Allowance
|
|
|
Product
Sales
|
|
|
Shipping &
Handling
Revenues
|
|
|
Net
Sales
|
|
|
Retail
Value(1)
|
|
|
Distributor
Allowance
|
|
|
Product
Sales
|
|
|
Shipping &
Handling
Revenues
|
|
|
Net
Sales
|
|
|
Change in
Net Sales
|
|
|
|
(In millions)
|
|
North America
|
|
$
|
1,080.9
|
|
|
$
|
(496.1
|
)
|
|
$
|
584.8
|
|
|
$
|
63.2
|
|
|
$
|
648.0
|
|
|
$
|
1,246.8
|
|
|
$
|
(564.1
|
)
|
|
$
|
682.7
|
|
|
$
|
70.8
|
|
|
$
|
753.5
|
|
|
|
(14.0
|
)%
|
Mexico
|
|
|
576.2
|
|
|
|
(261.7
|
)
|
|
|
314.5
|
|
|
|
20.2
|
|
|
|
334.7
|
|
|
|
587.0
|
|
|
|
(265.8
|
)
|
|
|
321.2
|
|
|
|
20.6
|
|
|
|
341.8
|
|
|
|
(2.1
|
)%
|
South & Central America
|
|
|
609.3
|
|
|
|
(283.8
|
)
|
|
|
325.5
|
|
|
|
23.6
|
|
|
|
349.1
|
|
|
|
637.3
|
|
|
|
(295.2
|
)
|
|
|
342.1
|
|
|
|
25.8
|
|
|
|
367.9
|
|
|
|
(5.1
|
)%
|
EMEA
|
|
|
1,117.0
|
|
|
|
(507.8
|
)
|
|
|
609.2
|
|
|
|
39.2
|
|
|
|
648.4
|
|
|
|
1,060.5
|
|
|
|
(480.1
|
)
|
|
|
580.4
|
|
|
|
38.6
|
|
|
|
619.0
|
|
|
|
4.7
|
%
|
Asia Pacific
|
|
|
1,171.1
|
|
|
|
(506.8
|
)
|
|
|
664.3
|
|
|
|
21.9
|
|
|
|
686.2
|
|
|
|
1,145.6
|
|
|
|
(489.3
|
)
|
|
|
656.3
|
|
|
|
30.8
|
|
|
|
687.1
|
|
|
|
(0.1
|
)%
|
China
|
|
|
754.0
|
|
|
|
(89.5
|
)
|
|
|
664.5
|
|
|
|
3.5
|
|
|
|
668.0
|
|
|
|
767.3
|
|
|
|
(96.9
|
)
|
|
|
670.4
|
|
|
|
3.7
|
|
|
|
674.1
|
|
|
|
(0.9
|
)%
|
Worldwide
|
|
$
|
5,308.5
|
|
|
$
|
(2,145.7
|
)
|
|
$
|
3,162.8
|
|
|
$
|
171.6
|
|
|
$
|
3,334.4
|
|
|
$
|
5,444.5
|
|
|
$
|
(2,191.4
|
)
|
|
$
|
3,253.1
|
|
|
$
|
190.3
|
|
|
$
|
3,443.4
|
|
|
|
(3.2
|
)%
|
(1)
|
Retail value is a Non-GAAP measure which may not be comparable to similarly-titled measures used by other companies. See “Presentation” above for a discussion of how we calculate retail value and why we believe the measure is useful to investors.
|
Changes in net sales are directly associated with the retailing of our products, recruitment of new Members, and retention of sales leaders. Our strategies involve providing quality products, improved DMOs, including daily consumption approaches such as Nutrition Clubs, easier access to product, systemized training and education of Members on our products and methods, and continued promotion and branding of Herbalife products.
37
Management’s role, in-country and at the region and corporate level,
is to provide Members with a competitive and broad product line, encourage strong teamwork and Member leadership and offer leading edge business tools and technology services to make doing business with Herbalife simple. Management uses the Marketing Plan,
which reflects the rules for our global network marketing organization that specify the qualification requirements and general compensation structure for Members,
coupled with educational and motivational tools and promotions to encourage Members to incre
ase retailing, retention, and
recruiting
, which in turn affect net sales. Such tools include sales events such as Extravaganzas, Leadership Development Weekends and World Team Schools where large groups of Members gather, thus allowing them to network with
other Members, learn retailing, retention, and
recruiting
techniques from our leading Members and become more familiar with how to market and sell our products and business opportunities. Accordingly, management believes that these development and motivat
ion programs increase the productivity of the sales leader network. The expenses for such programs are included in selling, general and administrative expenses. We also use event and non-event product promotions to motivate Members to increase retailing, r
etention, and recruiting activities. These promotions have prizes ranging from qualifying for events to product prizes and vacations. A program that we have seen success with and begun to use on a broad basis is the Member Activation Program, under which n
ew Members, who order a modest number of
V
olume
P
oints in each of their first three months, earn a prize. Our objective is to
improve the quality of
sales leaders
by
encourag
ing
new Members to begin acquiring retail customers before attempting to qualify f
or sales leader status. The costs of these programs are included in selling, general and administrative expenses.
DMOs are being generated in many of our markets and are globalized where applicable through the combined efforts of Members and country, regional and corporate management. While we support a number of different DMOs, one of the most popular DMOs is the daily consumption DMO. Under our traditional DMO, a Member typically sells to its customers on a somewhat infrequent basis (e.g., monthly) which provides fewer opportunities for interaction with their customers. Under a daily consumption DMO, a Member interacts with its customers on a more frequent basis, including such activities as weekly weigh-ins, which enables the Member to better educate and advise customers about nutrition and the proper use of the products and helps promote daily usage as well, thereby helping the Member grow his or her business. Specific examples of DMOs include the Nutrition Club concept in Mexico, the Healthy Breakfast concept in Russia, and the Internet/Sampling and Weight Loss Challenge in the United States. Management’s strategy is to review the applicability of expanding successful country initiatives throughout a region, and where appropriate, support the globalization of these initiatives.
The factors described above help Members increase their business, which in turn helps drive Volume Point growth in our business, and thus, net sales growth. The discussion below of net sales details some of the specific drivers of changes in our business and causes of sales fluctuations during the three and nine months ended September 30, 2017, as compared to the same periods in 2016, as well as the unique growth or contraction factors specific to certain geographic regions or significant countries within a region during these periods. Net sales fluctuations, both Company-wide and within a particular geographic region or country, are primarily the result of changes in volume, changes in prices, and/or changes in foreign currency translation rates. The discussion of changes in net sales quantifies the impact of those drivers that are quantifiable such as changes in foreign currency translation rates, and cites the estimated impact of any significant price changes. The remaining drivers, which management believes are the primary drivers of changes in volume, are typically qualitative factors whose impact cannot be quantified. The Company uses Volume Points as an indication for changes in sales volume.
North America
The North America region reported net sales of $199.8 million and $648.0 million for the three and nine months ended September 30, 2017, respectively. Net sales decreased $41.2 million, or 17.1%, and $105.5 million, or 14.0% for the three and nine months ended September 30, 2017, respectively, as compared to the same periods in 2016. In local currency, net sales decreased 17.2% and 14.0% for the three and nine months ended September 30, 2017, respectively, as compared to the same periods in 2016. The decrease in net sales for the three and nine months ended September 30, 2017, as compared to the same periods in 2016, was a result of a net sales decrease in the U.S. of $42.5 million or 18.0%, and $106.4 million, or 14.4%, respectively. The decreases in net sales for the North America region for the three and nine months ended September 30, 2017 were primarily the result of decreases in sales volume, as indicated by decreases in Volume Points.
As part of our FTC settlement, we have implemented certain new procedures and enhanced certain existing procedures in the United States. We believe North America’s Volume Point decreases for the three and nine months ended September 30, 2017, versus increases for the prior year periods, reflect a transitionary impact of Member focus on FTC settlement implementation actions including training on new tools and methods for documenting sales and time spent to then train their sales organizations. Similar to the transitionary impact that occurred as a result of Marketing Plan changes made in 2014, we do not expect the FTC settlement to have a long-term material adverse impact on our net sales in the North America region or on our Member base. However, we believe net sales for the region could continue to be negatively impacted during the remainder of 2017 as we and our Members spend time educating and training, and as our Members implement and adjust to the changes. North America has implemented programs to encourage sponsorship and increase Distributor, Preferred Member, and customer activity.
38
Mexico
The Mexico region reported net sales of $114.3 million and $334.7 million for the three and nine months ended September 30, 2017, respectively. Net sales increased $1.5 million, or 1.3%, and decreased $7.1 million, or 2.1%, for the three and nine months ended September 30, 2017, respectively, as compared to the same periods in 2016. In local currency, net sales decreased 3.6% and increased 1.0% for the three and nine months ended September 30, 2017, respectively, as compared to the same periods in 2016. The 1.3% increase in net sales for the three months ended September 30, 2017 was primarily the result of price increases and a favorable fluctuation in foreign currency exchange rates which contributed approximately 6.1% and 5.0% to net sales, respectively. These increases were partially offset by a decrease in sales volume, as indicated by a 9.0% decrease in Volume Points. The 2.1% decrease in net sales for the nine months ended September 30, 2017 was primarily the result of a decrease in sales volume, as indicated by a 3.7% decrease in Volume Points, and an unfavorable fluctuation in foreign currency exchange rates, which reduced net sales by 3.1%. These reductions to net sales were partially offset by price increases which contributed approximately 5.1% to net sales.
We believe Volume Point declines for the quarter and year-to-date after increases for the comparable periods of 2016 were attributable to a difficult economic environment marked by rising inflation and a weaker peso, as well as the adverse impact late in the quarter of the damaging natural disaster in the greater Mexico City area.
South and Central America
The South and Central America region reported net sales of $116.7 million and $349.1 million for the three and nine months ended September 30, 2017, respectively. Net sales decreased $4.3 million, or 3.6%, and $18.8 million, or 5.1%, for the three and nine months ended September 30, 2017, respectively, as compared to the same periods in 2016. In local currency, net sales increased 1.5% and decreased 5.1% for the three and nine months ended September 30, 2017, respectively, as compared to the same periods in 2016. Excluding Venezuela, which saw significant price increases in response to a highly inflationary environment, South and Central America local currency net sales decreased 4.3% and 8.5% for the three and nine months ended September 30, 2017, respectively, as compared to the same periods in 2016.
The 3.6% decrease in net sales for the three months ended September 30, 2017 was primarily the result of a decline in sales volume, as indicated by a 6.8% decrease in Volume Points and unfavorable fluctuations in foreign currency exchange rates of 5.0%. These reductions to net sales were partially offset by price increases which contributed approximately 8.7% to net sales. The 5.1% decrease in net sales for the nine months ended September 30, 2017 was primarily the result of a decline in sales volume, as indicated by an 11.7% decrease in Volume Points. This reduction to net sales was partially offset by price increases which contributed approximately 7.8% to net sales. Volume declines have been widespread across the region for both market-specific factors and as Members in many markets continue to transition to customer-based, sustainable business practices. The effect of price increases on sales for the quarter and year-to-date were led by the Venezuela market.
In Brazil, the region’s largest market, net sales were $47.3 million and $141.8 million for the three and nine months ended September 30, 2017, respectively. Net sales increased $0.9 million, or 1.9%, and decreased $0.3 million, or 0.2% for the three and nine months ended September 30, 2017, respectively, as compared to the same periods in 2016. In local currency, net sales decreased 0.7% and 10.5% for the three and nine months ended September 30, 2017, respectively, as compared to the same periods in 2016. The fluctuation of foreign currency rates had a favorable impact of $1.2 million and $14.7 million, respectively, on net sales for the three and nine months ended September 30, 2017. Marketing Plan changes intended to build more sustainable business for our Members through a focus on daily product consumption and retailing are taking hold following a lengthy transition period. In addition, we have introduced programs in Brazil that have been successful in other regions to improve Member activity. We are also increasing the number of product access points and expanding our product offering, including the recent launch of a soy milk product. Changes in ICMS tax legislation, effective April 2016, reduced net sales by approximately $4.0 million for the first quarter of 2017.
Net sales in Peru were $15.3 million and $46.0 million for the three and nine months ended September 30, 2017, respectively. Net sales decreased $0.8 million, or 5.3%, and $2.2 million, or 4.7%, for the three and nine months ended September 30, 2017, respectively, as compared to the same periods in 2016. In local currency, net sales decreased 8.0% and 7.6% for the three and nine months ended September 30, 2017, respectively, as compared to the same periods in 2016. The fluctuation of foreign currency rates had a favorable impact of $0.4 million and $1.4 million on net sales for the three and nine months ended September 30, 2017, respectively.
39
EMEA
The EMEA region reported net sales of $213.9 million and $648.4 million for the three and nine months ended September 30, 2017, respectively. Net sales increased $12.3 million, or 6.1%, and $29.4 million, or 4.7%, for the three and nine months ended September 30, 2017, respectively, as compared to the same periods in 2016. In local currency, net sales increased 2.0% and 3.8% for the three and nine months ended September 30, 2017, respectively, as compared to the same periods in 2016. The 6.1% increase in net sales for the three months ended September 30, 2017 was contributed to by an increase in sales volume, as indicated by a 2.7% increase in Volume Points, a favorable fluctuation in foreign currency exchange rates of 4.1% and price increases which contributed approximately 2.9%. These increases in net sales were partially offset by an unfavorable change in country mix resulting from a lower percentage of our sales volume coming from markets with higher prices, which reduced net sales by 1.3%. The 4.7% increase in net sales for the nine months ended September 30, 2017 was contributed to by an increase in sales volume, as indicated by a 3.4% increase in Volume Points, price increases which contributed approximately 2.0%, and a favorable fluctuation in foreign currency exchange rates which contributed approximately 0.9%. These increases in net sales were partially offset by an unfavorable change in country mix resulting from a lower percentage of our sales volume coming from markets with higher prices, which reduced net sales by 2.1%. Though the region is made up of a large number of markets with different characteristics and levels of success, generally we believe volume growth for the region is correlated with programs that have enhanced the quality and activity of sales leaders as they continue to focus on customer-oriented initiatives.
Net sales in Italy were $34.5 million and $105.8 million for the three and nine months ended September 30, 2017, respectively. Net sales increased $0.2 million, or 0.6%, and decreased $0.9 million, or 0.8%, for the three and nine months ended September 30, 2017, respectively, as compared to the same periods in 2016. In local currency, net sales decreased 4.5% and 0.4% for the three and nine months ended September 30, 2017, respectively, as compared to the same periods in 2016. The fluctuation of foreign currency rates had a favorable impact of $1.7 million net sales for the quarter and an unfavorable impact of $0.4 million for the nine months ended September 30, 2017. Italy has seen a modest decline in new Members and volumes after several years of growth as the Member Activation Program introduced earlier this year is adopted and optimized by Members and sales leaders.
Net sales in Russia were $29.8 million and $94.5 million for the three and nine months ended September 30, 2017, respectively. Net sales increased $4.7 million, or 18.5%, and $18.3 million, or 24.0%, for the three and nine months ended September 30, 2017, respectively, as compared to the same periods in 2016. In local currency, net sales increased 8.0% and 6.1% for the three and nine months ended September 30, 2017, respectively, as compared to the same periods in 2016. The fluctuation of foreign currency rates had a favorable impact of $2.6 million and $13.7 million on net sales for the three and nine months ended September 30, 2017, respectively. Product prices in Russia were increased 5% in February 2017 and 5% in March 2016. The market has continued to utilize the Member Activation Program to attract new Members.
Net sales in Spain were $27.0 million and $76.9 million for the three and nine months ended September 30, 2017, respectively. Net sales increased $1.9 million, or 7.7%, and $0.5 million, or 0.7%, for the three and nine months ended September 30, 2017, respectively, as compared to the same periods in 2016. In local currency, net sales increased 2.2% and 0.8% for the three and nine months ended September 30, 2017, respectively, as compared to the same periods in 2016. The fluctuation of foreign currency rates had a favorable impact of $1.4 million on net sales for the quarter and an unfavorable impact of $0.1 million on net sales for the nine months ended September 30, 2017. Product prices in Spain were increased 2% in July 2017.
Asia Pacific
The Asia Pacific region, which excludes China, reported net sales of $230.9 million and $686.2 million for the three and nine months ended September 30, 2017, respectively. Net sales decreased $0.5 million, or 0.2%, and $0.9 million, or 0.1%, for the three and nine months ended September 30, 2017, respectively, as compared to the same periods in 2016. In local currency, net sales decreased 0.5% and 1.1% for the three and nine months ended September 30, 2017, respectively, as compared to the same periods in 2016. The 0.2% decrease in net sales for the three months ended September 30, 2017 was primarily the result of an unfavorable change in country sales mix resulting from a lower percentage of our sales volume coming from markets with higher prices, which reduced net sales by approximately 2.8%. This reduction to net sales was partially offset by price increases which increased net sales by approximately 1.7% and an increase in sales volume as indicated by a 1.0% increase in Volume Points. The 0.1% decrease in net sales for the nine months ended September 30, 2017 was primarily the result of an unfavorable change in country sales mix resulting from a lower percentage of our sales volume coming from markets with higher prices, which decreased net sales by approximately 3.5%. This reduction to net sales was partially offset by an increase in sales volume, as indicated by a 1.5% increase in Volume Points, and fluctuations in foreign currency exchange rates and price increases, which contributed approximately 1.0% and 0.9%, respectively, to net sales. The Volume Points performance for the region has been mixed by country, with continuing increases in Indonesia and India as well as other markets, offset by declines primarily in South Korea and Taiwan.
40
Net sales in India were $47.7 million and $136.8 million for the three and nine months ended September 30, 2017, respectively. Net sales increased $2.8 million, or 6.2%, and $15.5 million, or 12.7%, for the three and nine months ended September 30, 201
7, respectively, as compared to the same periods in 2016. In local currency, net sales increased 1.9% and 9.5% for the three and nine months ended September 30, 2017, respectively, as compared to the same periods in 2016. The fluctuation of foreign currenc
y rates had a favorable impact of $1.9 million and $4.0 million on net sales for the three and nine months ended September 30, 2017, respectively. In 2016, we introduced the
Associate
Activation Program which we believe has contributed to higher sales leader activity. Additionally, we began the segmentation of our Members into preferred members and distributors as required by local regulations. India continues to expand its product lin
e and has added product pickup locations for Members.
Net sales in South Korea were $36.1 million and $107.2 million for the three and nine months ended September 30, 2017, respectively. Net sales decreased $8.9 million, or 19.8%, and $35.3 million, or 24.8%, for the three and nine months ended September 30, 2017, respectively, as compared to the same periods in 2016. In local currency, net sales decreased 18.9% and 26.2% for the three and nine months ended September 30, 2017, respectively, as compared to the same periods in 2016. The fluctuation of foreign currency rates had an unfavorable impact of $0.4 million on net sales for the quarter and a favorable impact of $2.0 million for the nine months ended September 30, 2017. The South Korea market has been impacted by Marketing Plan changes, including certain changes unique to the market. We believe these changes support improved retailing opportunity.
Net sales in Indonesia were $33.8 million and $98.8 million for the three and nine months ended September 30, 2017, respectively. Net sales increased $4.8 million, or 16.6%, and $15.3 million, or 18.3%, for the three and nine months ended September 30, 2017, respectively, as compared to the same periods in 2016. In local currency, net sales increased 18.3% and 18.4% for the three and nine months ended September 30, 2017, respectively, as compared to the same periods in 2016. The fluctuation of foreign currency rates had an unfavorable impact of $0.5 million and $0.1 million on net sales for the three and nine months ended September 30, 2017, respectively. The Indonesia market has continued to make progress by focusing on a customer-based business and daily consumption through Nutrition Clubs, training activities, and new products. We have increased the number of product access points for the market and expanded a city-by-city training and promotion approach.
Net sales in Taiwan were $26.0 million and $90.5 million for the three and nine months ended September 30, 2017, respectively. Net sales decreased $2.7 million, or 9.4%, and $4.6 million, or 4.9%, for the three and nine months ended September 30, 2017, respectively, as compared to the same periods in 2016. In local currency, net sales decreased 13.6% and 10.5% for the three and nine months ended September 30, 2017, respectively, as compared to the same periods in 2016. The fluctuation of foreign currency rates had a favorable impact of $1.2 million and $5.3 million on net sales for the three and nine months ended September 30, 2017, respectively. Taiwan sales have declined versus the prior year periods as the market adjusts to and Members optimize programs and training intended to help Members establish customer-based, sustainable business approaches.
China
Net sales in China were $209.8 million and $668.0 million for the three and nine months ended September 30, 2017, respectively. Net sales decreased $4.4 million, or 2.1%, and $6.1 million, or 0.9%, for the three and nine months ended September 30, 2017, respectively, as compared to the same periods in 2016. In local currency, net sales decreased 2.0% and increased 2.8% for the three and nine months ended September 30, 2017, respectively, as compared to the same periods in 2016. The 2.1% decrease in net sales for the three months ended September 30, 2017 was primarily the result of a decline in sales volume, as indicated by a 3.5% decrease in Volume Points plus a 2.6% decrease due to a timing difference between the recognition of net sales and Volume Points, partially offset by price increases which contributed approximately 4.6% to net sales. The 0.9% decrease in net sales for the nine months ended September 30, 2017, was primarily the result of a 3.6% unfavorable fluctuation in foreign currency exchange rates, as well as a decrease in sales volume, as indicated by a 0.9% decrease in Volume Points, partially offset by the favorable effects of price increases effective April 2017, which increased net sales by approximately 2.8%.
We believe the decrease in sales volume for the quarter and year-to-date are attributable to factors such as a reduction in the number of Nutrition Clubs as Members in some cases consolidated smaller clubs into larger, more commercialized clubs; government limitations on companies conducting commercial meetings ahead of the National Congress this fall, and for the year-to-date period, Member overemphasis on social media business methods over more traditional methods. We have introduced the Member Activation Program for new members, expanded our online ordering platform; which allow our Members and Preferred Customers in China to purchase certain new products from a wholly owned subsidiary outside China for only personal consumption, and renewed a branding campaign.
41
Sales by P
roduct Category
|
|
Three Months Ended September 30,
|
|
|
|
2017
|
|
|
2016
|
|
|
|
Retail
Value(2)
|
|
|
Distributor
Allowance
|
|
|
Product
Sales
|
|
|
Shipping &
Handling
Revenues
|
|
|
Net
Sales
|
|
|
Retail
Value(2)
|
|
|
Distributor
Allowance
|
|
|
Product
Sales
|
|
|
Shipping &
Handling
Revenues
|
|
|
Net
Sales
|
|
|
% Change in
Net Sales
|
|
|
|
(In millions)
|
|
Weight Management
|
|
$
|
1,128.7
|
|
|
$
|
(468.4
|
)
|
|
$
|
660.3
|
|
|
$
|
36.2
|
|
|
$
|
696.5
|
|
|
$
|
1,156.9
|
|
|
$
|
(480.3
|
)
|
|
$
|
676.6
|
|
|
$
|
38.1
|
|
|
$
|
714.7
|
|
|
|
(2.5
|
)%
|
Targeted Nutrition
|
|
|
431.5
|
|
|
|
(179.1
|
)
|
|
|
252.4
|
|
|
|
13.8
|
|
|
|
266.2
|
|
|
|
432.6
|
|
|
|
(179.6
|
)
|
|
|
253.0
|
|
|
|
14.3
|
|
|
|
267.3
|
|
|
|
(0.4
|
)%
|
Energy, Sports and Fitness
|
|
|
107.1
|
|
|
|
(44.5
|
)
|
|
|
62.6
|
|
|
|
3.5
|
|
|
|
66.1
|
|
|
|
113.5
|
|
|
|
(47.1
|
)
|
|
|
66.4
|
|
|
|
3.7
|
|
|
|
70.1
|
|
|
|
(5.7
|
)%
|
Outer Nutrition
|
|
|
34.2
|
|
|
|
(14.2
|
)
|
|
|
20.0
|
|
|
|
1.1
|
|
|
|
21.1
|
|
|
|
41.0
|
|
|
|
(17.1
|
)
|
|
|
23.9
|
|
|
|
1.3
|
|
|
|
25.2
|
|
|
|
(16.3
|
)%
|
Literature, Promotional
and Other(1)
|
|
|
33.7
|
|
|
|
0.7
|
|
|
|
34.4
|
|
|
|
1.1
|
|
|
|
35.5
|
|
|
|
42.3
|
|
|
|
1.0
|
|
|
|
43.3
|
|
|
|
1.4
|
|
|
|
44.7
|
|
|
|
(20.6
|
)%
|
Total
|
|
$
|
1,735.2
|
|
|
$
|
(705.5
|
)
|
|
$
|
1,029.7
|
|
|
$
|
55.7
|
|
|
$
|
1,085.4
|
|
|
$
|
1,786.3
|
|
|
$
|
(723.1
|
)
|
|
$
|
1,063.2
|
|
|
$
|
58.8
|
|
|
$
|
1,122.0
|
|
|
|
(3.3
|
)%
|
|
|
Nine Months Ended September 30,
|
|
|
|
2017
|
|
|
2016
|
|
|
|
Retail
Value(2)
|
|
|
Distributor
Allowance
|
|
|
Product
Sales
|
|
|
Shipping &
Handling
Revenues
|
|
|
Net
Sales
|
|
|
Retail
Value(2)
|
|
|
Distributor
Allowance
|
|
|
Product
Sales
|
|
|
Shipping &
Handling
Revenues
|
|
|
Net
Sales
|
|
|
% Change in
Net Sales
|
|
|
|
(In millions)
|
|
Weight Management
|
|
$
|
3,465.6
|
|
|
$
|
(1,430.8
|
)
|
|
$
|
2,034.8
|
|
|
$
|
112.0
|
|
|
$
|
2,146.8
|
|
|
$
|
3,538.4
|
|
|
$
|
(1,463.2
|
)
|
|
$
|
2,075.2
|
|
|
$
|
123.7
|
|
|
$
|
2,198.9
|
|
|
|
(2.4
|
)%
|
Targeted Nutrition
|
|
|
1,303.6
|
|
|
|
(538.2
|
)
|
|
|
765.4
|
|
|
|
42.1
|
|
|
|
807.5
|
|
|
|
1,300.7
|
|
|
|
(537.8
|
)
|
|
|
762.9
|
|
|
|
45.5
|
|
|
|
808.4
|
|
|
|
(0.1
|
)%
|
Energy, Sports and Fitness
|
|
|
321.3
|
|
|
|
(132.7
|
)
|
|
|
188.6
|
|
|
|
10.4
|
|
|
|
199.0
|
|
|
|
332.5
|
|
|
|
(137.5
|
)
|
|
|
195.0
|
|
|
|
11.6
|
|
|
|
206.6
|
|
|
|
(3.7
|
)%
|
Outer Nutrition
|
|
|
113.1
|
|
|
|
(46.7
|
)
|
|
|
66.4
|
|
|
|
3.7
|
|
|
|
70.1
|
|
|
|
134.9
|
|
|
|
(55.8
|
)
|
|
|
79.1
|
|
|
|
4.7
|
|
|
|
83.8
|
|
|
|
(16.3
|
)%
|
Literature, Promotional
and Other(1)
|
|
|
104.9
|
|
|
|
2.7
|
|
|
|
107.6
|
|
|
|
3.4
|
|
|
|
111.0
|
|
|
|
138.0
|
|
|
|
2.9
|
|
|
|
140.9
|
|
|
|
4.8
|
|
|
|
145.7
|
|
|
|
(23.8
|
)%
|
Total
|
|
$
|
5,308.5
|
|
|
$
|
(2,145.7
|
)
|
|
$
|
3,162.8
|
|
|
$
|
171.6
|
|
|
$
|
3,334.4
|
|
|
$
|
5,444.5
|
|
|
$
|
(2,191.4
|
)
|
|
$
|
3,253.1
|
|
|
$
|
190.3
|
|
|
$
|
3,443.4
|
|
|
|
(3.2
|
)%
|
(1)
|
Product buy backs and returns in all product categories are included in literature, promotional and other category.
|
(2)
|
Retail value is a Non-GAAP measure which may not be comparable to similarly-titled measures used by other companies. See “Presentation” above for a discussion of how we calculate retail value and why we believe the measure is useful to investors.
|
Net sales for all product categories decreased for the three and nine months ended September 30, 2017 as compared to the same periods in 2016. The trend and business factors described in the above discussions of the individual geographic regions apply generally to all product categories.
42
Gross Profit
Gross profit was $870.0 million and $2,695.6 million for the three and nine months ended September 30, 2017, respectively, as compared to $912.9 million and $2,784.9 million for the same periods in 2016. As a percentage of net sales, gross profit for the three months ended September 30, 2017 was 80.2% as compared to 81.4% for the same period in 2016, or an unfavorable net decrease of 122 basis points and for the nine months ended September 30, 2017 was 80.8% as compared to 80.9% for the same period in 2016, or an unfavorable net decrease of 4 basis points. The gross profit rate for the three months ended September 30, 2017 included the unfavorable impact of foreign currency fluctuations of 132 basis points, reduction in cost savings through strategic sourcing and self-manufacturing of 45 basis points, other cost changes of 38 basis points, and country mix of 23 basis points, partially offset by the favorable impact of retail price increases of 71 basis points and lower inventory write-downs of 45 basis points. The nine months ended September 30, 2017 included the unfavorable impact of foreign currency fluctuations of 77 basis points, other cost changes of 8 basis points, and country mix of 7 basis points, partially offset by the favorable impact of retail price increases of 50 basis points, cost savings through strategic sourcing and self-manufacturing of 34 basis points, and lower inventory write-downs of 4 basis points. Generally, gross profit as a percentage of net sales may vary from period to period due to the impact of foreign currency fluctuations, changes in country mix as volume changes among countries with varying margins, retail price increases, cost savings through strategic sourcing and self-manufacturing, and inventory write-downs.
Royalty Overrides
Royalty overrides were $310.1 million and $944.1 million for the three and nine months ended September 30, 2017, respectively, as compared to $320.3 million and $968.9 million for the same periods in 2016. Royalty overrides as a percentage of net sales were 28.6% and 28.3% for the three and nine months ended September 30, 2017, respectively, as compared to 28.6% and 28.1% for the same periods in 2016. Compensation to our independent service providers in China is included in selling, general and administrative expenses as opposed to royalty overrides where it is included for all other Members. Generally, royalty overrides as a percentage of net sales may vary slightly from period to period due to changes in the mix of products and countries because full royalty overrides are not paid on certain products and in certain countries.
Selling, General and Administrative Expenses
Selling, general and administrative expenses were $445.2 million and $1,327.0 million for the three and nine months ended September 30, 2017, respectively, as compared to $441.3 million and $1,545.2 million for the same periods in 2016. Selling, general and administrative expenses as a percentage of net sales were 41.0% and 39.8% for the three and nine months ended September 30, 2017, respectively, as compared to 39.3% and 44.9% for the same periods in 2016.
The increase in selling, general, and administrative expenses for the three months ended September 30, 2017 was driven by $7.3 million in higher Member promotion and event costs; $4.9 million in higher labor and employee benefit costs; $4.0 million in higher foreign exchange loss; partially offset by $4.8 million in lower professional fees primarily from lower expenses related to allegations raised by a hedge fund manager; $4.5 million in lower travel expenses due to cost control initiatives and $2.2 million in lower advertising and sponsorships. The decrease in selling, general and administrative expenses for the nine months ended September 30, 2017 was driven by the $203.0 million regulatory settlements in 2016; $13.7 million in lower advertising and sponsorships; $9.3 million in lower professional fees primarily from lower expenses related to allegations raised by a hedge fund manager; and $7.7 million in lower travel expenses due to cost control initiatives; partially offset by $14.4 million in higher labor and employee benefit costs and $8.7 million in higher Member promotion and event costs.
In late 2012, a hedge fund manager publicly raised allegations regarding the legality of our network marketing program and announced that the hedge fund manager had taken a significant short position regarding our common shares, leading to intense public scrutiny and significant stock price volatility. We have engaged legal and advisory services firms to assist with responding to the allegations and to perform other related services in connection to these events. For the three months ended September 30, 2017 and 2016, we recorded approximately $1.1 million and $3.2 million, respectively, of expenses related to this matter, which includes approximately $0.6 million and $2.7 million, respectively, of legal, advisory and other professional service fees. For the nine months ended September 30, 2017 and 2016, we recorded approximately $4.2 million and $10.7 million, respectively, of expenses related to this matter, which includes approximately $2.6 million and $8.5 million, respectively, of legal, advisory and other professional service fees. We expect to continue to incur expenses related to this matter over the next several periods and the expenses are expected to vary from period to period.
43
Other Operating Income
During the three and nine months ended September 30, 2017, the Company recognized government grant income of approximately $4.6 million and $43.5 million, respectively, as compared to $0.2 million and $29.1 million for the same periods in 2016, respectively, relating to government grant income for China. See Note 2,
Significant Accounting Policies
, to the Condensed Consolidated Financial Statements included in Part I, Item 1 of this Quarterly Report on Form 10-Q, for a further discussion.
Net Interest Expense
Net interest expense is as follows:
|
|
Three Months Ended
|
|
|
Nine Months Ended
|
|
|
|
September 30,
2017
|
|
|
September 30,
2016
|
|
|
September 30,
2017
|
|
|
September 30,
2016
|
|
|
|
(Dollars in millions)
|
|
Interest expense
|
|
$
|
43.0
|
|
|
$
|
24.0
|
|
|
$
|
117.4
|
|
|
$
|
74.6
|
|
Interest income
|
|
|
(4.6
|
)
|
|
|
(1.9
|
)
|
|
|
(10.9
|
)
|
|
|
(4.5
|
)
|
Net interest expense
|
|
$
|
38.4
|
|
|
$
|
22.1
|
|
|
$
|
106.5
|
|
|
$
|
70.1
|
|
The increase in net interest expense for the three and nine months ended September 30, 2017, as compared to the same period in 2016, was primarily due to the increase in our interest expense due to higher interest rates and increased borrowing amounts relating to our new $1.45 billion senior secured credit facility, which includes a $1.3 billion term loan B, that was entered into on February 15, 2017 as discussed further below in
Liquidity and Capital Resources
. These increases were partially offset by higher interest income related to proceeds from the $1.3 billion term loan B.
Income Taxes
Income taxes were an expense of $26.4 million and $84.2 million for the three and nine months ended September 30, 2017, respectively, as compared to expense of $41.7 million and $69.2 million for the same periods in 2016. The effective income tax rate was 32.6% and 23.3% for the three and nine months ended September 30, 2017, respectively, as compared to 32.2% and 30.1% for the same periods in 2016. The increase in the effective tax rate for the three months ended September 30, 2017, as compared to the same period in 2016, was primarily due to the impact of changes in the geographic mix of the Company’s income, offset by an increase in net benefits from discrete events. The decrease in the effective tax rate for the nine months ended September 30, 2017, as compared to the same period in 2016, was primarily due to an increase in net benefits from discrete events. Included in the discrete events for the three and nine months ended September 30, 2017 was the impact of $0.6 million and $26.4 million of excess tax benefits generated during those respective periods, relating to the Company’s application of ASU 2016-09 that was adopted on January 1, 2017.
Liquidity and Capital Resources
We have historically met our working capital and capital expenditure requirements, including funding for expansion of operations, through net cash flows provided by operating activities. Variations in sales of our products directly affect the availability of funds. There are no material contractual restrictions on our ability to transfer and remit funds among our international affiliated companies. However, there are foreign currency restrictions in certain countries which could reduce our ability to timely obtain U.S. dollars. Even with these restrictions, we believe we will have sufficient resources, including cash flow from operating activities and access to capital markets, to meet debt service obligations in a timely manner and be able to continue to meet our objectives.
Historically, our debt has not resulted from the need to fund our normal operations, but instead has resulted primarily from our share repurchase programs. Since inception in 2007, total share repurchases amounted to approximately $3.4 billion. While a significant net sales decline could potentially affect the availability of funds, many of our largest expenses are variable in nature, which we believe protects our funding in all but a dramatic net sales downturn. Our $1,636.3 million cash and cash equivalents and our senior secured credit facility, in addition to cash flow from operations, can be used to support general corporate purposes, including, any future share repurchases, dividends, and strategic investment opportunities.
We have a cash pooling arrangement with a financial institution for cash management purposes. This cash pooling arrangement allows certain of our participating subsidiaries to withdraw cash from this financial institution based upon our aggregate cash deposits held by subsidiaries who participate in the cash pooling arrangement. We did not owe any amounts to this financial institution under the pooling arrangement as of September 30, 2017 and December 31, 2016.
44
For the
nine
months ended
September
30, 201
7
, we generated $
404.4
million of operating cash flow, as compared to $
249
.
9
million for the same period in 201
6
.
The increase in our operating c
ash flow was the result of higher net income, higher non-cash items; partially offset by unfavorable changes in operating assets and liabilities. The increase in net income was primarily the result of lower selling, general and administrative expenses mai
nly due to the $203.0 million regulatory settlements in 2016, partially offset by lower contribution margin of $64.
5
million driven by lower net sales. The increase in non-cash items was primarily the result of an increase in deferred income taxes. The
unfavorable
change in operating assets and liabilities was primarily the result of
unfavorable
changes in
accounts payable; royalty overrides;
accrued compensation; and non-income and income tax payables, partially offset by favorable changes in
inventorie
s; prepaid expenses and other current assets.
Capital expenditures, including accrued capital expenditures, for the nine months ended September 30, 2017 and 2016 were $67.1 million and $111.5 million, respectively. The majority of these expenditures represented investments in management information systems including the upgrade of our Oracle enterprise wide systems which went live in August 2017, manufacturing facilities both domestically and internationally, and initiatives to develop web-based Member tools. We expect to incur total capital expenditures of approximately $88 million to $108 million for the full year of 2017.
In March 2017, Herbalife hosted its annual global Herbalife Summit event in Charlotte, North Carolina where President Team members from around the world met and shared best practices, conducted leadership training and Herbalife management awarded Members $65.2 million of Mark Hughes bonus payments related to their 2016 performance. In March 2016, Herbalife management awarded Members $64.3 million of Mark Hughes bonus payments related to their 2015 performance.
Senior Secured Credit Facility
In May 2015, we amended our prior senior secured credit facility, or the Prior Credit Facility, and our $700 million borrowing capacity on our prior revolving credit facility, or the Prior Revolving Credit Facility, was reduced by approximately $235.9 million, and was further reduced by approximately $39.1 million on September 30, 2015, bringing the total available borrowing capacity to $425.0 million as of December 31, 2016. The Company repaid in full its $500 million term loan under the Prior Credit Facility, or the Prior Term Loan, on March 9, 2016.
On February 15, 2017, we entered into a $1,450.0 million senior secured credit facility, or the Credit Facility, consisting of a $1,300.0 million term loan B, or the Term Loan, and a $150 million revolving credit facility, or the Revolving Credit Facility, with a syndicate of financial institutions as lenders, or Lenders. The Revolving Credit Facility matures on February 15, 2022 and the Term Loan matures on February 15, 2023.
The Credit Facility requires us to comply with a leverage ratio. In addition, the Credit Facility contains customary covenants, including covenants that limit or restrict our ability to incur liens, incur indebtedness, make investments, dispose of assets, make certain restricted payments, pay dividends, repurchase our common shares, merge or consolidate and enter into certain transactions with affiliates. We are also required to maintain a minimum balance of $200.0 million of consolidated cash and cash equivalents. As of September 30, 2017 and December 31, 2016, we were compliant with our debt covenants under the Credit Facility and the Prior Credit Facility, respectively.
The Term Loan is payable in consecutive quarterly installments each in an aggregate principal amount of $24.4 million, which began on June 30, 2017
.
Interest is due at least quarterly on amounts outstanding on the Credit Facility.
In addition, we may be required to make mandatory prepayments towards the Term Loan based on the Company’s consolidated leverage ratio and annual excess cash flows as defined under the terms of the credit agreement. We are also permitted to make voluntary prepayments. These prepayments, if any, will be applied against remaining quarterly installments owed under the Term Loan in order of maturity with the remaining principal due upon maturity.
During the three months ended March 31, 2017, we repaid a total amount of $410.0 million to repay in full amounts outstanding on the Prior Revolving Credit Facility.
During both the three months ended June 30, 2017 and September 30, 2017, the Company repaid $24.4 million, respectively, on amounts outstanding under the Term Loan.
During the three months ended March 31, 2016, we repaid a total amount of $229.7 million to repay in full the Prior Term Loan.
The Company did not repay any amounts under the Prior Revolving Credit Facility during the three months ended September 30, 2016.
As of September 30, 2017, the U.S. dollar amount outstanding under the Term Loan was $1,251.2 million. There were no amounts outstanding on the Revolving Credit Facility as of September 30, 2017.
As of December 31, 2016, the U.S. dollar amount outstanding under the Prior Revolving Credit Facility was $410.0 million.
There were no outstanding foreign currency borrowings as of September 30, 2017 and December 31, 2016 under the Credit Facility and the Prior Credit Facility, respectively. On September 30, 2017 and December 31, 2016, the weighted average interest rate for borrowings under the Credit Facility and the Prior Credit Facility was 6.71% and 4.29%, respectively.
See Note 4,
Long-Term Debt
, to the Condensed Consolidated Financial Statements included in Part I, Item 1 of this Quarterly Report on Form 10-Q, for a further discussion on our Credit Facility.
45
Convertible Senior Notes
During February 2014, we issued $1.15 billion aggregate principal amount of convertible senior notes, or the Convertible Notes. The Convertible Notes are senior unsecured obligations which rank effectively subordinate to any of our existing and future secured indebtedness, including amounts outstanding under the Credit Facility, to the extent of the value of the assets securing such indebtedness. The Convertible Notes pay interest at a rate of 2.00% per annum payable semiannually in arrears on February 15 and August 15 of each year, beginning on August 15, 2014. The Convertible Notes mature on August 15, 2019, unless earlier repurchased or converted. The primary purpose of the issuance of the Convertible Notes was for share repurchase purposes. See Note 4,
Long-Term Debt
, to the Condensed Consolidated Financial Statements included in Part I, Item 1 of this Quarterly Report on Form 10-Q, for a further discussion on our Convertible Notes.
Cash and cash equivalents
The majority of our foreign subsidiaries designate their local currencies as their functional currencies. At September 30, 2017 and December 31, 2016, the total amount of our foreign subsidiary cash and cash equivalents was $1,303.5 million and $316.2 million, respectively, of which $786.3 million and $28.2 million, respectively, was invested in U.S. dollars. The increase in our foreign subsidiary U.S. dollar denominated cash and cash equivalents primarily relates to our borrowings from our Credit Facility executed on February 15, 2017. At September 30, 2017 and December 31, 2016, the total amount of cash and cash equivalents held by our parent and its U.S. entities, inclusive of U.S. territories, was $332.8 million and $527.8 million, respectively.
For earnings not considered to be indefinitely reinvested, deferred taxes have been provided. For earnings considered to be indefinitely reinvested, deferred taxes have not been provided. Should we make a determination to remit the cash and cash equivalents from our foreign subsidiaries that are considered indefinitely reinvested to our U.S. consolidated group for the purpose of repatriation of undistributed earnings, we would need to accrue and pay taxes. As of December 31, 2016, our U.S. consolidated group had approximately $131.9 million of permanently reinvested unremitted earnings from certain foreign subsidiaries, and if these monies were ever needed to be remitted, the impact of any tax consequences on our overall liquidity position would not be material. As of December 31, 2016, our parent, Herbalife Ltd., had $2.5 billion of permanently reinvested unremitted earnings relating to its operating subsidiaries. As of September 30, 2017, we do not have any plans to repatriate these unremitted earnings to our parent; therefore, we do not have any liquidity concerns relating to these unremitted earnings and related cash and cash equivalents. See Note 12,
Income Taxes
, to the Consolidated Financial Statements included in our 2016 10-K for additional discussion on our unremitted earnings.
Off-Balance Sheet Arrangements
At September 30, 2017 and December 31, 2016, we had no material off-balance sheet arrangements as defined in Item 303(a)(4)(ii) of Regulation S-K.
Dividends
The declaration of future dividends is subject to the discretion of our board of directors and will depend upon various factors, including our earnings, financial condition, Herbalife Ltd.’s available distributable reserves under Cayman Islands law, restrictions imposed by the Credit Facility and the terms of any other indebtedness that may be outstanding, cash requirements, future prospects and other factors deemed relevant by our board of directors.
Share Repurchases
On February 21, 2017, our board of directors authorized a new three-year $1.5 billion share repurchase program that will expire on February 21, 2020, which replaced our prior share repurchase authorization which was set to expire on June 30, 2017 which, as of December 31, 2016, had $232.9 million of remaining authorized capacity. This share repurchase program allows us, which includes an indirect wholly subsidiary of Herbalife Ltd., to repurchase our common shares, at such times and prices as determined by management as market conditions warrant. The Credit Facility permits us to repurchase common shares as long as no default or event of default exists and other conditions such as specified consolidated leverage ratios are met.
46
In conjunction with the issuance of the Convertible Notes during February 2014, we paid approximately $685.8 million t
o enter into prepaid forward share repurchase transactions, or the Forward Transactions, with certain financial institutions, or the Forward Counterparties, pursuant to which we purchased approximately 9.9 million common shares, at an average cost of $69.0
2 per share, for settlement on or around the August 15, 2019 maturity date for the Convertible Notes, subject to the ability of each Forward Counterparty to elect to settle all or a portion of its Forward Transactions early. The shares are treated as retir
ed shares for basic and diluted EPS purposes although they remain legally outstanding. See Note 10,
Shareholders’ Equity
, to the Condensed Consolidated Financial Statements
included in Part I, Item 1 of this Quarterly Report on Form 10-Q
,
for a further dis
cussion on the Forward Transactions.
During the three months ended March 31, 2017, an indirect wholly owned subsidiary of the Company purchased approximately 1.1 million of Herbalife Ltd.’s common shares through open market purchases at an aggregate cost of approximately $60.7 million, or an average cost of $56.10 per share. During the three months ended June 30, 2017, an indirect wholly owned subsidiary of the Company purchased approximately 2.7 million of Herbalife Ltd.’s common shares through open market purchases at an aggregate cost of approximately $179.8 million, or an average cost of $67.06 per share. During the three months ended September 30, 2017, an indirect wholly owned subsidiary of the Company purchased 0.8 million of Herbalife Ltd.’s common shares through open market purchases at an aggregate cost of approximately $58.7 million, or an average cost of $72.38 per share. These 2017 share repurchases reduced the Company’s total shareholders’ equity and are reflected at cost within the Company’s accompanying condensed consolidated balance sheet.
Although these shares are owned by the Company’s indirect wholly owned subsidiary, they are reflected as treasury shares under U.S. GAAP and therefore reduce the number of common shares outstanding within our condensed consolidated financial statements and the weighted-average number of common shares outstanding used in calculating our earnings per share
. The common shares of Herbalife Ltd. held by the indirect wholly owned subsidiary, however, remain outstanding on the books and records of the Company’s transfer agent and therefore still carry voting and other share rights related to ownership of the Company’s common shares, which may be exercised. So long as it is consistent with applicable laws, such shares will be voted by such subsidiary in the same manner, and to the maximum extent possible in the same proportion, as all other votes cast with respect to any matter properly submitted to a vote of Herbalife Ltd.’s shareholders. We did not repurchase any common shares in the open market during the three and nine months ended September 30, 2016. As of September 30, 2017, the remaining authorized capacity under our $1.5 billion share repurchase program was $1,200.8 million. See Note 10,
Shareholders’ Equity
and Note 14,
Subsequent Events
, to the Condensed Consolidated Financial Statements included in Part I, Item 1 of this Quarterly Report on Form 10-Q, for a further discussion on our share repurchases.
Capped Call Transactions
In February 2014, in connection with the issuance of Convertible Notes, we paid approximately $123.8 million to enter into capped call transactions with respect to our common shares, or the Capped Call Transactions, with certain financial institutions. The Capped Call Transactions are expected generally to reduce the potential dilution upon conversion of the Convertible Notes in the event that the market price of the common shares is greater than the strike price of the Capped Call Transactions, initially set at $86.28 per common share, with such reduction of potential dilution subject to a cap based on the cap price initially set at $120.79 per common share. See Note 10,
Shareholders’ Equity
, to the Condensed Consolidated Financial Statements included in Part I, Item 1 of this Quarterly Report on Form 10-Q, for a further discussion of the Capped Call Transactions.
Working Capital and Operating Activities
As of September 30, 2017 and December 31, 2016, we had positive working capital of $1,415.3 million and $671.0 million, respectively, or an increase of $744.3 million. This increase was primarily due to the increase in cash and cash equivalents partially offset by the increase in the current portion of long-term debt primarily related to the Credit Facility entered into on February 15, 2017.
We expect that cash and funds provided from operations, available borrowings under the Credit Facility, and access to capital markets will provide sufficient working capital to operate our business, to make expected capital expenditures and to meet foreseeable liquidity requirements, including payment of amounts outstanding under the Credit Facility, for the next twelve months and thereafter.
The majority of our purchases from suppliers are generally made in U.S. dollars, while sales to our Members generally are made in local currencies. Consequently, strengthening of the U.S. dollar versus a foreign currency can have a negative impact on net sales and contribution margins and can generate transaction gains or losses on intercompany transactions. For discussion of our foreign exchange contracts and other hedging arrangements, see Part I, Item 3 of this Quarterly Report on Form 10-Q —
Quantitative and Qualitative Disclosures about Market Risk.
47
Contingencies
See Note 5,
Contingencies
, to the Condensed Consolidated Financial Statements included in Part I, Item 1 of this Quarterly Report on Form 10-Q, for a further discussion of our contingencies as of September 30, 2017.
Subsequent Events
See Note 14,
Subsequent Events,
to the Condensed Consolidated Financial Statements included in Part I, Item 1 of this Quarterly Report on Form 10-Q, for information regarding subsequent events.
Critical Accounting Policies
U.S. GAAP requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the year. We regularly evaluate our estimates and assumptions related to revenue recognition, allowance for product returns, inventory, goodwill and purchased intangible asset valuations, deferred income tax asset valuation allowances, uncertain tax positions, tax contingencies, and other loss contingencies. We base our estimates and assumptions on current facts, historical experience and various other factors that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities and the recording of revenue, costs and expenses. Actual results could differ from those estimates. We consider the following policies to be most critical in understanding the judgments that are involved in preparing the financial statements and the uncertainties that could impact our operating results, financial condition and cash flows.
We are a nutrition company that sells a wide range of weight management, targeted nutrition, energy, sports & fitness, and outer nutrition products. Our products are manufactured by us in our Changsha, Hunan, China extraction facility, Suzhou, China facility, Nanjing, China facility, Lake Forest, California facility, and in our Winston-Salem, North Carolina facility, and by third party providers, and then are sold to Members who consume and sell Herbalife products to retail consumers or other Members. As of September 30, 2017, we sold products in 94 countries throughout the world and we are organized and managed by geographic region. We aggregate our operating segments into one reporting segment, except China, as management believes that our operating segments have similar operating characteristics and similar long term operating performance. In making this determination, management believes that the operating segments are similar in the nature of the products sold, the product acquisition process, the types of customers to whom products are sold, the methods used to distribute the products, the nature of the regulatory environment, and their economic characteristics.
We generally recognize revenue upon delivery and when both the title and risk and rewards pass to the Member or importer, or as products are sold in China to and through independent service providers, sales representatives, and sales officers to customers and preferred customers, as well as through Company-operated retail stores when necessary. Product sales are recognized net of product returns, and discounts referred to as “distributor allowances.” We generally receive the net sales price in cash or through credit card payments at the point of sale. Royalty overrides are generally recorded when revenue is recognized. See Note 2,
Significant Accounting Policies
, to the Condensed Consolidated Financial Statements included in Part I, Item 1 of this Quarterly Report on Form 10-Q, for a further discussion of distributor compensation in the U.S.
Allowances for product returns, primarily in connection with our buyback program, are provided at the time the sale is recorded. This accrual is based upon historical return rates for each country and the relevant return pattern, which reflects anticipated returns to be received over a period of up to 12 months following the original sale. Historically, product returns and buybacks have not been significant. Product returns and buybacks were approximately 0.1% for both the three and nine months ended September 30, 2017 and 2016.
We adjust our inventories to lower of cost and net realizable value. Additionally we adjust the carrying value of our inventory based on assumptions regarding future demand for our products and market conditions. If future demand and market conditions are less favorable than management’s assumptions, additional inventory write-downs could be required. Likewise, favorable future demand and market conditions could positively impact future operating results if previously written down inventories are sold. We have obsolete and slow moving inventories which have been adjusted downward $33.1 million and $25.5 million to present them at their lower of cost and net realizable value in our condensed consolidated balance sheets as of September 30, 2017 and December 31, 2016, respectively.
48
Goodwill and marketing related intangible assets not subject to amortization are tested annually for impairment, and are tested for impairment more frequently if events and circumstances indicate that the asset might be impaired. An impairment loss is reco
gnized to the extent that the carrying amount exceeds the asset’s fair value. As discussed below, for goodwill impairment testing, we have the option to perform a qualitative assessment of whether it is more likely than not that a reporting unit’s fair val
ue is less than its carrying amount before applying the two-step goodwill impairment test. If we conclude it is not more likely than not that the fair value of a reporting unit is less than its carrying amount, then there is no need to perform the two-step
impairment test. Currently, we do not use this qualitative assessment option but we could in the future elect to use this option. For our marketing related intangible assets a similar qualitative option is also currently available. However, we currently u
se a discounted cash flow model, or the income approach, under the relief-from-royalty method to determine the fair value of our marketing related intangible assets in order to confirm there is no impairment required. For our marketing related intangible a
ssets, if we do not use this qualitative assessment option, we could still in the future elect to use this option.
In order to estimate the fair value of goodwill, we also primarily use an income approach. The determination of impairment is made at the reporting unit level and consists of two steps. First, we determine the fair value of a reporting unit and compare it to its carrying amount. The determination of the fair value of the reporting units requires us to make significant estimates and assumptions. These estimates and assumptions include estimates of future revenues and expense growth rates, capital expenditures and the depreciation and amortization related to these capital expenditures, discount rates, and other inputs. Due to the inherent uncertainty involved in making these estimates, actual future results could differ. Changes in assumptions regarding future results or other underlying assumptions could have a significant impact on the fair value of the reporting unit. Second, if the carrying amount of a reporting unit exceeds its fair value, an impairment loss is recognized for any excess of the carrying amount of the reporting unit’s goodwill and other intangibles over the implied fair value as determined in Step 2 of the goodwill impairment test. Also, if during Step 1 of a goodwill impairment test we determine we have reporting units with zero or negative carrying amounts, then we perform Step 2 of the goodwill impairment test if it is more likely than not that a goodwill impairment exists. During Step 2 of a goodwill impairment test, the implied fair value of goodwill is determined in a similar manner as how the amount of goodwill recognized in a business combination is determined, in accordance with the Financial Accounting Standards Board, or FASB, Accounting Standards Codification, or ASC, Topic 805, Business Combinations. We would assign the fair value of a reporting unit to all of the assets and liabilities of that reporting unit as if the reporting unit had been acquired in a business combination and the fair value of the reporting unit was the price paid to acquire the reporting unit. The excess of the fair value of a reporting unit over the amounts assigned to its assets and liabilities is the implied fair value of goodwill. As of September 30, 2017 and December 31, 2016, we had goodwill of approximately $95.8 million and $89.9 million, respectively. As of both September 30, 2017 and December 31, 2016, we had marketing related intangible assets of approximately $310 million. The increase in goodwill during the nine months ended September 30, 2017 was due to cumulative translation adjustments. No marketing related intangibles or goodwill impairment was recorded during the three and nine months ended September 30, 2017 and 2016.
Contingencies are accounted for in accordance with FASB ASC Topic 450, Contingencies, or ASC 450. ASC 450 requires that we record an estimated loss from a loss contingency when information available prior to issuance of our financial statements indicates that it is probable that an asset has been impaired or a liability has been incurred at the date of the financial statements and the amount of the loss can be reasonably estimated. We also disclose material contingencies when we believe a loss is not probable but reasonably possible as required by ASC 450. Accounting for contingencies such as legal and non-income tax matters requires us to use judgment related to both the likelihood of a loss and the estimate of the amount or range of loss. Many of these legal and tax contingencies can take years to be resolved. Generally, as the time period increases over which the uncertainties are resolved, the likelihood of changes to the estimate of the ultimate outcome increases.
The Company evaluates the realizability of its deferred tax assets by assessing the valuation allowance and by adjusting the amount of such allowance, if necessary. Although realization is not assured, we believe it is more likely than not that the net carrying value will be realized. The amount of the carryforwards that is considered realizable, however, could change if estimates of future taxable income are adjusted. In the ordinary course of our business, there are many transactions and calculations where the tax law and ultimate tax determination is uncertain. As part of the process of preparing our consolidated financial statements, we are required to estimate our income taxes in each of the jurisdictions in which we operate prior to the completion and filing of tax returns for such periods. These estimates involve complex issues and require us to make judgments about the likely application of the tax law to our situation, as well as with respect to other matters, such as anticipating the positions that we will take on tax returns prior to us actually preparing the returns and the outcomes of disputes with tax authorities. The ultimate resolution of these issues may take extended periods of time due to examinations by tax authorities and statutes of limitations. In addition, changes in our business, including acquisitions, changes in our international corporate structure, changes in the geographic location of business functions or assets, changes in the geographic mix and amount of income, as well as changes in our agreements with tax authorities, valuation allowances, applicable accounting rules, applicable tax laws and regulations, rulings and interpretations thereof, developments in tax audit and other matters, and variations in the estimated and actual level of annual pre-tax income can affect the overall effective income tax rate.
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We account for uncertain tax positions in accordance with FASB ASC Topic 740, Income Taxes, or ASC 740, which provides guidance on the determination of how tax benefits claimed or expected to be claimed on a tax r
eturn should be recorded in the financial statements. Under ASC 740, we must recognize the tax benefit from an uncertain tax position only if it is more likely than not that the tax position will be sustained on examination by the taxing authorities, based
on the technical merits of the position. The tax benefits recognized in the financial statements from such a position are measured based on the largest benefit that has a greater than fifty percent likelihood of being realized upon ultimate resolution.
We account for foreign currency transactions in accordance with FASB ASC Topic 830, Foreign Currency Matters. In a majority of the countries where we operate, the functional currency is the local currency. Our foreign subsidiaries’ asset and liability accounts are translated for consolidated financial reporting purposes into U.S. dollar amounts at period-end exchange rates. Revenue and expense accounts are translated at the average rates during the year. Our foreign exchange translation adjustments are included in accumulated other comprehensive loss on our accompanying condensed consolidated balance sheets. Foreign currency transaction gains and losses and foreign currency remeasurements are generally included in selling, general and administrative expenses in the accompanying condensed consolidated statements of income.
New Accounting Pronouncements
See discussion under Note 2,
Significant Accounting Policies
, to the Condensed Consolidated Financial Statements included in Part I, Item 1 of this Quarterly Report on Form 10-Q, for information on new accounting pronouncements.