Item 1.
Financial Statements
HERBALIFE LTD. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
|
|
September 30,
2016
|
|
|
December 31,
2015
|
|
|
|
(In millions, except share and
par value amounts)
|
|
ASSETS
|
|
|
|
|
|
|
|
|
CURRENT ASSETS:
|
|
|
|
|
|
|
|
|
Cash and cash equivalents
|
|
$
|
788.3
|
|
|
$
|
889.8
|
|
Receivables, net of allowance for doubtful accounts
|
|
|
87.9
|
|
|
|
69.9
|
|
Inventories
|
|
|
371.7
|
|
|
|
332.0
|
|
Prepaid expenses and other current assets
|
|
|
198.0
|
|
|
|
161.1
|
|
Deferred income tax assets
|
|
|
113.5
|
|
|
|
113.5
|
|
Total current assets
|
|
|
1,559.4
|
|
|
|
1,566.3
|
|
Property, at cost, net of accumulated depreciation and amortization
|
|
|
376.2
|
|
|
|
339.2
|
|
Deferred compensation plan assets
|
|
|
30.2
|
|
|
|
29.3
|
|
Other assets
|
|
|
162.2
|
|
|
|
141.1
|
|
Marketing related intangibles and other intangible assets, net
|
|
|
310.1
|
|
|
|
310.2
|
|
Goodwill
|
|
|
94.5
|
|
|
|
91.8
|
|
Total assets
|
|
$
|
2,532.6
|
|
|
$
|
2,477.9
|
|
LIABILITIES AND SHAREHOLDERS’ EQUITY (DEFICIT)
|
|
|
|
|
|
|
|
|
CURRENT LIABILITIES:
|
|
|
|
|
|
|
|
|
Accounts payable
|
|
$
|
86.4
|
|
|
$
|
71.1
|
|
Royalty overrides
|
|
|
261.5
|
|
|
|
249.9
|
|
Accrued compensation
|
|
|
126.9
|
|
|
|
128.8
|
|
Accrued expenses
|
|
|
239.3
|
|
|
|
228.7
|
|
Current portion of long-term debt
|
|
|
425.3
|
|
|
|
229.5
|
|
Advance sales deposits
|
|
|
85.0
|
|
|
|
63.8
|
|
Income taxes payable
|
|
|
38.9
|
|
|
|
52.6
|
|
Total current liabilities
|
|
|
1,263.3
|
|
|
|
1,024.4
|
|
NON-CURRENT LIABILITIES:
|
|
|
|
|
|
|
|
|
Long-term debt, net of current portion
|
|
|
1,017.6
|
|
|
|
1,392.5
|
|
Deferred compensation plan liability
|
|
|
48.9
|
|
|
|
43.6
|
|
Deferred income tax liabilities
|
|
|
2.6
|
|
|
|
0.4
|
|
Other non-current liabilities
|
|
|
76.5
|
|
|
|
70.5
|
|
Total liabilities
|
|
|
2,408.9
|
|
|
|
2,531.4
|
|
CONTINGENCIES
|
|
|
|
|
|
|
|
|
SHAREHOLDERS’ EQUITY (DEFICIT):
|
|
|
|
|
|
|
|
|
Common shares, $0.001 par value; 1.0 billion shares authorized; 93.1 million (2016)
and 92.7 million (2015) shares outstanding
|
|
|
0.1
|
|
|
|
0.1
|
|
Paid-in capital in excess of par value
|
|
|
462.6
|
|
|
|
438.2
|
|
Accumulated other comprehensive loss
|
|
|
(173.3
|
)
|
|
|
(165.5
|
)
|
Accumulated deficit
|
|
|
(165.7
|
)
|
|
|
(326.3
|
)
|
Total shareholders’ equity (deficit)
|
|
|
123.7
|
|
|
|
(53.5
|
)
|
Total liabilities and shareholders’ equity (deficit)
|
|
$
|
2,532.6
|
|
|
$
|
2,477.9
|
|
See the accompanying notes to unaudited condensed consolidated financial statements.
3
HERBALIFE LTD. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
|
|
Three Months Ended
|
|
|
Nine Months Ended
|
|
|
|
September 30,
2016
|
|
|
September 30,
2015
|
|
|
September 30,
2016
|
|
|
September 30,
2015
|
|
|
|
(In millions, except per share amounts)
|
|
Product sales
|
|
$
|
1,063.2
|
|
|
$
|
1,036.4
|
|
|
$
|
3,253.1
|
|
|
$
|
3,154.7
|
|
Shipping & handling revenues
|
|
|
58.8
|
|
|
|
66.5
|
|
|
|
190.3
|
|
|
|
215.9
|
|
Net sales
|
|
|
1,122.0
|
|
|
|
1,102.9
|
|
|
|
3,443.4
|
|
|
|
3,370.6
|
|
Cost of sales
|
|
|
209.1
|
|
|
|
206.9
|
|
|
|
658.5
|
|
|
|
651.6
|
|
Gross profit
|
|
|
912.9
|
|
|
|
896.0
|
|
|
|
2,784.9
|
|
|
|
2,719.0
|
|
Royalty overrides
|
|
|
320.3
|
|
|
|
304.7
|
|
|
|
968.9
|
|
|
|
946.4
|
|
Selling, general & administrative expenses
|
|
|
441.3
|
|
|
|
433.1
|
|
|
|
1,545.2
|
|
|
|
1,335.0
|
|
Other operating income
|
|
|
(0.2
|
)
|
|
|
(3.4
|
)
|
|
|
(29.1
|
)
|
|
|
(3.4
|
)
|
Operating income
|
|
|
151.5
|
|
|
|
161.6
|
|
|
|
299.9
|
|
|
|
441.0
|
|
Interest expense, net
|
|
|
22.1
|
|
|
|
24.1
|
|
|
|
70.1
|
|
|
|
69.3
|
|
Other expense, net
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
2.3
|
|
Income before income taxes
|
|
|
129.4
|
|
|
|
137.5
|
|
|
|
229.8
|
|
|
|
369.4
|
|
Income taxes
|
|
|
41.7
|
|
|
|
43.9
|
|
|
|
69.2
|
|
|
|
114.8
|
|
NET INCOME
|
|
$
|
87.7
|
|
|
$
|
93.6
|
|
|
$
|
160.6
|
|
|
$
|
254.6
|
|
Earnings per share:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
$
|
1.06
|
|
|
$
|
1.13
|
|
|
$
|
1.94
|
|
|
$
|
3.09
|
|
Diluted
|
|
$
|
1.01
|
|
|
$
|
1.09
|
|
|
$
|
1.87
|
|
|
$
|
2.99
|
|
Weighted average shares outstanding:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
|
83.1
|
|
|
|
82.6
|
|
|
|
83.0
|
|
|
|
82.5
|
|
Diluted
|
|
|
86.4
|
|
|
|
85.7
|
|
|
|
86.1
|
|
|
|
85.1
|
|
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,
2016
|
|
|
September 30,
2015
|
|
|
September 30,
2016
|
|
|
September 30,
2015
|
|
|
|
(In millions)
|
|
Net income
|
|
$
|
87.7
|
|
|
$
|
93.6
|
|
|
$
|
160.6
|
|
|
$
|
254.6
|
|
Other comprehensive loss:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Foreign currency translation adjustment, net of income taxes of
$5.8 and $(2.7) for the three months ended September 30, 2016 and 2015, respectively, and $7.3 and $(7.0) for the nine months ended September 30, 2016 and 2015, respectively
|
|
|
(2.6
|
)
|
|
|
(37.0
|
)
|
|
|
1.6
|
|
|
|
(81.4
|
)
|
Unrealized (loss) gain on derivatives, net of income taxes of $— and $(0.2) for the three months ended September 30, 2016 and 2015, respectively, and $(0.3) and $0.1 for the nine months ended September 30, 2016 and 2015, respectively
|
|
|
(2.2
|
)
|
|
|
(0.9
|
)
|
|
|
(9.3
|
)
|
|
|
3.6
|
|
Unrealized loss on available-for-sale investments, net of income
taxes of $0.1 and $(0.2) for the nine months ended September 30, 2016 and 2015, respectively
|
|
|
—
|
|
|
|
—
|
|
|
|
(0.1
|
)
|
|
|
(0.3
|
)
|
Total other comprehensive loss
|
|
|
(4.8
|
)
|
|
|
(37.9
|
)
|
|
|
(7.8
|
)
|
|
|
(78.1
|
)
|
Total comprehensive income
|
|
$
|
82.9
|
|
|
$
|
55.7
|
|
|
$
|
152.8
|
|
|
$
|
176.5
|
|
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,
2016
|
|
|
September 30,
2015
|
|
|
|
(In millions)
|
|
CASH FLOWS FROM OPERATING ACTIVITIES
|
|
|
|
|
|
|
|
|
Net income
|
|
$
|
160.6
|
|
|
$
|
254.6
|
|
Adjustments to reconcile net income to net cash provided by operating activities:
|
|
|
|
|
|
|
|
|
Depreciation and amortization
|
|
|
72.6
|
|
|
|
72.6
|
|
Excess tax benefits from share-based payment arrangements
|
|
|
(5.1
|
)
|
|
|
(1.5
|
)
|
Share-based compensation expenses
|
|
|
30.3
|
|
|
|
34.2
|
|
Non-cash interest expense
|
|
|
42.0
|
|
|
|
39.8
|
|
Deferred income taxes
|
|
|
(38.4
|
)
|
|
|
(1.5
|
)
|
Inventory write-downs
|
|
|
16.7
|
|
|
|
22.3
|
|
Foreign exchange transaction gain
|
|
|
(1.4
|
)
|
|
|
(11.9
|
)
|
Foreign exchange loss and other charges relating to Venezuela
|
|
|
4.4
|
|
|
|
37.2
|
|
Other
|
|
|
(8.2
|
)
|
|
|
8.9
|
|
Changes in operating assets and liabilities:
|
|
|
|
|
|
|
|
|
Receivables
|
|
|
(14.6
|
)
|
|
|
(25.1
|
)
|
Inventories
|
|
|
(56.7
|
)
|
|
|
(3.2
|
)
|
Prepaid expenses and other current assets
|
|
|
7.0
|
|
|
|
0.4
|
|
Other assets
|
|
|
(1.9
|
)
|
|
|
(16.8
|
)
|
Accounts payable
|
|
|
17.5
|
|
|
|
18.3
|
|
Royalty overrides
|
|
|
14.1
|
|
|
|
5.6
|
|
Accrued expenses and accrued compensation
|
|
|
11.9
|
|
|
|
61.7
|
|
Advance sales deposits
|
|
|
21.2
|
|
|
|
23.3
|
|
Income taxes
|
|
|
(24.8
|
)
|
|
|
(26.6
|
)
|
Deferred compensation plan liability
|
|
|
2.7
|
|
|
|
0.9
|
|
NET CASH PROVIDED BY OPERATING ACTIVITIES
|
|
|
249.9
|
|
|
|
493.2
|
|
CASH FLOWS FROM INVESTING ACTIVITIES
|
|
|
|
|
|
|
|
|
Purchases of property, plant and equipment
|
|
|
(111.9
|
)
|
|
|
(57.5
|
)
|
Other
|
|
|
4.4
|
|
|
|
6.2
|
|
NET CASH USED IN INVESTING ACTIVITIES
|
|
|
(107.5
|
)
|
|
|
(51.3
|
)
|
CASH FLOWS FROM FINANCING ACTIVITIES
|
|
|
|
|
|
|
|
|
Principal payments on senior secured credit facility and other debt
|
|
|
(233.0
|
)
|
|
|
(202.6
|
)
|
Issuance costs relating to long-term debt
|
|
|
—
|
|
|
|
(6.2
|
)
|
Share repurchases
|
|
|
(12.5
|
)
|
|
|
(10.7
|
)
|
Excess tax benefits from share-based payment arrangements
|
|
|
5.1
|
|
|
|
1.5
|
|
Other
|
|
|
(0.9
|
)
|
|
|
0.1
|
|
NET CASH USED IN FINANCING ACTIVITIES
|
|
|
(241.3
|
)
|
|
|
(217.9
|
)
|
EFFECT OF EXCHANGE RATE CHANGES ON CASH
|
|
|
(2.6
|
)
|
|
|
(56.2
|
)
|
NET CHANGE IN CASH AND CASH EQUIVALENTS
|
|
|
(101.5
|
)
|
|
|
167.8
|
|
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD
|
|
|
889.8
|
|
|
|
645.4
|
|
CASH AND CASH EQUIVALENTS, END OF PERIOD
|
|
$
|
788.3
|
|
|
$
|
813.2
|
|
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. As of September 30, 2016, the Company sold its products to and through a network of 4.1 million independent members, or Members, which included 0.3 million in China. 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, 2015 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, 2016, and for the three and nine months ended September 30, 2016 and 2015, 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, 2016, and for the three and nine months ended September 30, 2016 and 2015. 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, 2015, or the 2015 10-K. Operating results for the three and nine months ended September 30, 2016, are not necessarily indicative of the results that may be expected for the year ending December 31, 2016.
New Accounting Pronouncements
In May 2014, the Financial Accounting Standards Board, or FASB, issued Accounting Standards Update, or 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 issued ASU No. 2015-14,
Revenue from Contracts with Customers (Topic 606): Deferral of the Effective Date
, which deferred the effective date of ASU No. 2014-09 for all entities by one year to annual reporting periods beginning after December 15, 2017.
In March 2016, the FASB issued ASU 2016-08,
Revenue from Contracts with Customers (Topic 606), Principal versus Agent Considerations (Reporting Revenue versus Net)
, which clarifies the implementation guidance on principal versus agent considerations in the new revenue recognition standard. ASU 2016-08 clarifies how an entity should identify the unit of accounting (i.e. the specified good or service) for the principal versus agent evaluation and how it should apply the control principle to certain types of arrangements.
In April 2016, the FASB issued ASU 2016-10,
Revenue from Contracts with Customers (Topic 606), Identifying Performance Obligations and Licensing
, which clarifies the implementation guidance on how an entity should identify performance obligations in contracts with customers, and how it should account for licensing arrangements with customers.
In May 2016, the FASB issued ASU 2016-12,
Narrow-Scope Improvements and Practical Expedients
,
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 as of the original effective date of December 15, 2016. The Company is evaluating the potential impact of this adoption on its consolidated financial statements.
7
In August 2014, the FASB issued ASU No. 2014-15,
Presentation of Financial Statements — Going Concern (Subtopic 205-40)
. The purpose of this ASU is to incorporate
into U.S. GAAP management’s responsibility to evaluate whether there is substantial doubt about an entity’s ability to continue as a going concern within one year after the date that the financial statements are issued (or within one year after the date th
at the financial statements are available to be issued when applicable), and to provide related footnote disclosures. This update is effective for the annual period ending after December 15, 2016, and for annual periods and interim periods thereafter. Earl
y application is permitted. The adoption of this guidance will not have a material impact on the Company’s consolidated financial statements.
In July 2015, the FASB issued ASU No. 2015-11,
Inventory (Topic 330): Simplifying the Measurement of Inventory
. This ASU does not apply to inventory that is measured using last-in, first-out (LIFO) or the retail inventory method. The amendments apply to all other inventory, which includes inventory that is measured using first-in, first-out (FIFO) or average cost. This ASU eliminates from U.S. GAAP the requirement to measure inventory at the lower of cost or market. Market under the previous requirement could be replacement cost, net realizable value, or net realizable value less an approximately normal profit margin. Entities within scope of this update will now be required to measure inventory at the lower of cost and net realizable value. Net realizable value is the estimated selling prices in the ordinary course of business, less reasonably predictable costs of completion, disposal, and transportation. Subsequent measurement is unchanged for inventory using LIFO or the retail inventory method. The amendments in this update are effective for fiscal years beginning after December 15, 2016, with early adoption permitted, and should be applied prospectively. The Company early adopted ASU 2015-11 as of January 1, 2016.
The adoption of this guidance did not have a material impact on the Company’s consolidated financial statements.
In November 2015, the FASB issued ASU No. 2015-17,
Income Taxes (Topic 740):
Balance Sheet Classification of Deferred Taxes
. This ASU simplifies the presentation of deferred taxes by requiring that deferred tax assets and liabilities be presented as noncurrent on the balance sheet. ASU 2015-17 is effective for annual reporting periods, and interim periods therein, beginning after December 15, 2016, with early adoption permitted. The amendments may be applied either prospectively to all deferred tax liabilities and assets or retrospectively to all periods presented. The Company is evaluating the potential impact of this adoption on its consolidated financial statements.
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.
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 Company is evaluating the potential impact of this adoption on its consolidated financial statements.
8
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 provid
es guidance clarifying that the novation of a derivative contract (i.e. a change in counterparty) in a hedge accounting relationship does not, in and of itself, require dedesignation of that hedge accounting relationship. If all of the other hedge accounti
ng 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 amendments in this u
pdate are effective for reporting periods beginning after December 15, 2016, with early adoption permitted. Entities may adopt the guidance prospectively or use a modified retrospective approach. The Company is evaluating the potential impact of this adopt
ion on its consolidated financial statements.
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 clarifies 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. The amendments in this update are effective for reporting periods beginning after December 15, 2016, with early adoption permitted. Entities are required to apply the guidance to existing debt instruments using a modified retrospective transition method as of the period of adoption. The Company is evaluating the potential impact of this adoption on its consolidated financial statements.
In March 2016, the FASB issued 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 are effective for reporting periods beginning after December 15, 2016, with early adoption permitted. The Company is evaluating the potential impact of this adoption on its 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.
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 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 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 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.
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, 2016, the Company recognized government grant income of approximately $0.2 million and $29.1 million, respectively, in other operating income within its condensed consolidated statements of income, related to its regional headquarters and distribution centers within China. To conform with the current period presentation, for the three and nine months ended September 30, 2015, $3.4 million in government grant income in China has been reclassified from selling, general, and administrative expenses to other operating income within its condensed consolidated statements of income. 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.
Purchase of Previously Leased Office Building
On April
21, 2016, the Company purchased one of its office buildings in Torrance, California, which it had previously leased, for approximately $29.6 million. The Company allocated $16.9 million and $11.6 million, which was net of the deferred rent liability of $1.1 million, between buildings and land, respectively, based on their relative fair values.
Venezuela
The adverse operating environment in Venezuela continues to be challenging for the Company’s Venezuela business, with high inflation, pricing limitations, importation restrictions, and foreign exchange restrictions. Foreign exchange controls in Venezuela continue to limit Herbalife Venezuela’s ability to repatriate earnings and settle its intercompany shipment obligations at any official rate. As a result, this has continued to significantly limit Herbalife Venezuela’s ability to acquire its U.S. dollar denominated raw materials and finished good inventory.
During the three and nine months ended September 30, 2016, the Company recognized foreign exchange losses and other related charges of $0.1 million and $7.2 million, respectively, as compared to $1.5 million and $38.4 million for the same periods in 2015, within its condensed consolidated statements of income related to its Venezuelan operations. During both the nine months ended September 30, 2016 and 2015, Herbalife Venezuela’s net sales represented less than 1% of the Company’s consolidated net sales. As of September 30, 2016, Herbalife Venezuela’s cash and cash equivalents primarily consisted of Bolivar-denominated cash of approximately $1.4 million. See the Company’s consolidated financial statements and related notes in the 2015 10-K for further information on Herbalife Venezuela and Venezuela’s highly inflationary economy.
3. Inventories
Inventories consist primarily of finished goods available for resale. Inventories are currently 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,
2016
|
|
|
December 31,
2015
|
|
|
|
(In millions)
|
|
Raw materials
|
|
$
|
50.9
|
|
|
$
|
41.5
|
|
Work in process
|
|
|
4.6
|
|
|
|
3.8
|
|
Finished goods
|
|
|
316.2
|
|
|
|
286.7
|
|
Total
|
|
$
|
371.7
|
|
|
$
|
332.0
|
|
10
4. Long-Term Debt
Long-term debt consists of the following:
|
|
September 30,
2016
|
|
|
December 31,
2015
|
|
|
|
(In millions)
|
|
Senior secured credit facility, carrying value
|
|
$
|
410.0
|
|
|
$
|
639.5
|
|
Convertible senior notes, carrying value of liability
component
|
|
|
1,014.0
|
|
|
|
982.5
|
|
Other debt
|
|
|
18.9
|
|
|
|
—
|
|
Total
|
|
|
1,442.9
|
|
|
|
1,622.0
|
|
Less: current portion
|
|
|
425.3
|
|
|
|
229.5
|
|
Long-term portion
|
|
$
|
1,017.6
|
|
|
$
|
1,392.5
|
|
Senior Secured Credit Facility
On March 9, 2011, the Company entered into a $700.0 million senior secured revolving credit facility, or the Credit Facility, with a syndicate of financial institutions as lenders and terminated its prior senior secured credit facility, or the Prior Credit Facility.
In March 2011, the Company used $196.0 million in U.S. dollar borrowings under the Credit Facility to repay all amounts outstanding under the Prior Credit Facility. The Company incurred approximately $5.7 million of debt issuance costs in connection with the Credit Facility. These debt issuance costs were recorded on the Company’s condensed consolidated balance sheet and are being amortized over the term of the Credit Facility.
On July 26, 2012, the Company amended the Credit Facility to include a $500.0 million term loan with a syndicate of financial institutions as lenders, or the Term Loan. The Term Loan was a part of the Credit Facility and was in addition to the Company’s current revolving credit facility.
In July 2012, the Company used all $500.0 million of the borrowings under the Term Loan to pay down amounts outstanding under the Company’s revolving credit facility. The Company incurred approximately $4.5 million of debt issuance costs in connection with the Term Loan. These debt issuance costs were recorded on the Company’s condensed consolidated balance sheet and amortized over the life of the Term Loan. The Term Loan matured on March 9, 2016 and was repaid in full.
In February 2014, in connection with issuing the $1.15 billion Convertible Notes described below, the Company amended the Credit Facility. Pursuant to this amendment, the Company amended the terms of the Credit Facility to provide for technical amendments to the indebtedness, asset sale and dividend covenants and the cross-default event of default to accommodate the issuance of the convertible senior notes described below and the capped call and prepaid forward share repurchase transactions described in greater detail in Note 10,
Shareholders’ Equity (Deficit)
. The amendment also increased by 0.50% the highest applicable margin payable by Herbalife in the event that Herbalife’s consolidated total leverage ratio is equal to or exceeds 2.50 to 1.00 and increased the permitted consolidated total leverage ratio of Herbalife under the Credit Facility. The Company incurred approximately $2.3 million of debt issuance costs in connection with the amendment. The debt issuance costs are recorded on the Company’s condensed consolidated balance sheet and are being amortized over the life of the Credit Facility.
On May 4, 2015, the Company amended its Credit Facility to extend the maturity date of its 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 the Term Loan and revolving credit facility, respectively. Additionally, the Company’s $700 million borrowing capacity on its 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 total available borrowing capacity under the revolving credit facility was $425.0 million as of September 30, 2016. Prior to March 9, 2016, the interest rates on the Company’s borrowings under the 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 Credit Facility increased by 2.00% such that borrowings under the Credit Facility now bear 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. The debt issuance costs are recorded on the Company’s condensed consolidated balance sheet and are being amortized over the life of the revolving credit facility.
11
The base rate under the Credit Facility represents the highest of the Federal Funds Rate plus 0.50%, the one-month LIBOR plus 1.00%, and the prime rate offered by Bank of America. The Company, based on its consolid
ated leverage ratio, pays a commitment fee between 0.40% and 0.50% per annum on the unused portion of the Credit Facility. The Credit Facility also permits the Company to borrow limited amounts in Mexican Peso and Euro currencies based on variable rates. A
ll obligations under the Credit Facility are unconditionally guaranteed by certain of the Company’s subsidiaries and are secured by substantially all of the assets of the U.S. subsidiaries of the parent company, Herbalife Ltd. and by certain assets of cert
ain foreign subsidiaries of Herbalife Ltd.
The Credit Facility requires the Company to comply with a leverage ratio and a coverage ratio. In addition, the Credit Facility contains customary 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 Credit Facility restricts the Company’s ability to pay dividends or repurchase its common shares to a maximum of $233.0 million until maturity and for every one dollar of share repurchase or dividend paid, the revolving credit facility’s borrowing capacity is permanently decreased by two dollars. The Credit Facility also provides for the grant of security interest on certain additional assets of the Company and its subsidiaries. The Company is also required to maintain a minimum balance of $200.0 million of consolidated cash and cash equivalents. As of September 30, 2016 and December 31, 2015, the Company was compliant with its debt covenants under the Credit Facility.
On September 30, 2016 and December 31, 2015, the weighted average interest rate for borrowings under the Credit Facility, including borrowings under the Term Loan as of December 31, 2015, was 4.13% and 2.78%, respectively.
During the three months ended March 31, 2016, the Company repaid a total amount of $229.7 million to repay in full the Term Loan. The Company did not repay any amounts under the revolving credit facility during the three months ended June 30, 2016 and September 30, 2016. As of September 30, 2016, the U.S. dollar amount outstanding under the revolving credit facility was $410.0 million. As of December 31, 2015, the U.S. dollar amount outstanding under the Credit Facility was $639.7 million, which consisted of $229.7 million outstanding on the Term Loan and $410.0 million outstanding on the revolving credit facility. There were no outstanding foreign currency borrowings as of September 30, 2016 and December 31, 2015 under the Credit Facility.
The fair value of the outstanding borrowings on the Company’s revolving credit facility approximated its carrying value as of September 30, 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 Company’s revolving credit facility is 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).
12
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 we
re 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 shee
t is being amortized over the contractual term of the Convertible Notes using the effective interest method.
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 condensed 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 determined 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, 2016, the outstanding principal on the Convertible Notes was $1.15 billion, the unamortized debt discount and debt issuance cost was $136.0 million, and the carrying amount of the liability component was $1,014.0 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 September 30, 2016, the fair value of the liability component relating to the Convertible Notes was approximately $950.8 million.
As of December 31, 2015, the outstanding principal on the Convertible Notes was $1.15
billion, the unamortized debt discount
and debt issuance costs
was $167.6
million, and the carrying amount of the liability component was $982.5
million, which was recorded to long-term debt within the Company’s consolidated balance sheet as reflected in the table above within this Note. As of
December 31, 2015, the fair value of the liability component relating to the Convertible Notes was approximately $795.9
million.
At September 30, 2016 and December 31, 2015, 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 (Deficit)
, 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, 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.
During the three and nine months ended September 30, 2015, the Company recognized $16.0 million and $46.8 million, respectively, of interest expense relating to the Convertible Notes, which included $9.3 million and $27.0 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.
The Company’s total interest expense, including the Credit Facility, was $24.0 million and $25.5 million for the three months ended September 30, 2016 and 2015, respectively, and $74.6 million and $73.7 million for the nine months ended September 30, 2016 and 2015, respectively, which was recognized within its condensed consolidated statements of income.
As of September 30, 2016, the aggregate annual maturity of the Credit Facility was expected to be $410.0 million for 2017. The $1.15 billion Convertible Notes are due in 2019.
Certain vendors and government agencies may require letters of credit or similar guaranteeing arrangements to be issued or executed. As of September 30, 2016, the Company had $39.7 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.
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, and the reasonably possible range of exposure on currently existing claims is not material to the Company. The Company believes that it has meritorious defenses to the allegations contained in the claims. The Company currently maintains product liability insurance with an annual deductible of $15 million.
Certain of the Company’s subsidiaries have been subject to tax audits by governmental authorities in their respective countries. In certain of these tax audits, governmental authorities are proposing that significant amounts of additional taxes and related interest and penalties are due. The Company and its tax advisors believe that there are substantial defenses to governmental allegations that significant additional taxes are owed, and the Company is vigorously contesting the additional proposed taxes and related charges.
On May 7, 2010, the Company received an assessment from the Mexican Tax Administration Service in an amount equivalent to approximately $59 million, translated at the September 30, 2016 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. Litigation of the appeal is ongoing. 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 $15.1 million, translated at the September 30, 2016 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 $16.4 million, translated at the September 30, 2016 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 audited the Company’s Mexican subsidiaries for the 2011 year. The audit focused on importation and VAT issues. On June 25, 2013, the Mexican Tax Administration Service closed the audit of the 2011 year without any assessment.
The Mexican Customs Service has challenged the customs classification codes used by the Company for certain importations. A change in the customs classification codes would require the payment of additional VAT and other taxes for those importations. The Company believes that the customs classification codes used for the importation of these products were correct and has generally prevailed in such cases through an administrative appeal. The Company expects to challenge any further assessments as they are received. Most of the products that were the subject of the dispute have since been reformulated to avoid potential additional assessments related to future importations of product.
14
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. In March 2015, the Company commenced litigation in the Tax Court of Mexico to reclaim the VAT refund pertaining specifically to the July 2013 period. In July 2016, the Company withdrew its V
AT refund claim as it has elected to apply this immaterial amount against certain future tax liabilities. As of September 30, 2016, the Company had $46.9 million of Mexico VAT related assets, of which $36.8 million was within non-current other assets and $
10.1 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 again
st 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, 2016, 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.
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 issued for these or other periods. The Company believes that it has meritorious defenses if the 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 Mexican Tax Administration Service has also requested information related to the Company’s 2012 year. This information has been provided. The Mexican Tax Administration Service may request additional information or audit additional periods.
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, 2016 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 $5.4 million, translated at the September 30, 2016 spot rate, related to contributions based on payments to the Company’s Members during 2011. 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 filed a first level administrative appeal against most of the assessment on February 23, 2016.
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. The Company believes it will be able to utilize or recover these ICMS-ST credits in the future. The Company had $16.4 million, translated at the September 30, 2016 spot rate, of Brazil ICMS-ST related assets within other assets on its consolidated balance sheet.
15
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 $49.5 million, translat
ed at the September 30, 2016 spot rate, relating to various ICMS issues for its 2013 tax year and it is possible the Company could receive a similar assessment for its 2014 tax year. In August 2016, the Company filed a first level administrative appeal and
plans to appeal future possible assessments. The Company has not recognized a loss as the Company does not believe a loss is probable. The Company has also received assessments from other states in Brazil. During the fourth quarter of 2015, the Company fi
led appeals with state judicial courts against three of the assessments relating to other states in Brazil. The Company had issued surety bonds in the aggregate amount of $10.8 million, translated at the September 30, 2016 spot rate, through an insurance c
ompany to guarantee payment of the three 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 $8.9 million, translated at the September 30, 2016 spo
t rate, from several 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 $3.6 million, translated at the September 30, 2016 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.
The Korea Customs Service audited the importation activities of Herbalife Korea for the period January 2011 through May 2013. The total preliminary assessment for the audit period is $32.6 million translated at the September 30, 2016 spot rate. From January 2016 to October 2016, the Company received and paid four quarterly tax assessments that total $13.0 million, translated at the September 30, 2016 spot rate, covering the first four quarters of the audit period, January 12, 2011 through January 6, 2012. The Company has recognized these payments within other assets on its condensed consolidated balance sheet. The Company expects to pay the remaining assessed amount and to file an appeal to the National Tax Tribunal during the fourth quarter of 2016. The Company disagrees with the assertions made in the assessments, as well as the calculation methodology used in the assessments. The Company has not recognized a loss as the Company 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.
16
Pursuant to the Consent Order, under which the Company ne
ither admitted nor denied the FTC’s allegations (except as to the Court having jurisdiction over the matter), the Company agreed to make, through its wholly owned subsidiary Herbalife International of America, Inc., a $200 million payment to the FTC within
seven days of entry of the Consent Order. The $200 million settlement amount is recognized in selling, general and administrative expenses within the Company’s condensed consolidated statements of income for the nine months ended September 30, 2016 and wa
s paid in July 2016. Additionally, pursuant to the Consent Order, the Company has agreed to implement certain new procedures and enhance certain existing procedures in the U.S., most of which the Company will have 10 months from the Effective Date to imple
ment.
The Consent Order requires the Company to categorize all existing and future Members in the U.S. as either “preferred members” – those members who only purchase products at a discount, or “distributors” – those members who choose to resell the produc
ts or build a sales organization. Although not required until May 2017, in October 2016 the Company initiated the process of allowing existing Members in the U.S. to affirmatively elect to be classified as either preferred members or as independent distrib
utors. The Company also agreed to compensate distributors based on documented U.S. retail sales, which may include sales to preferred members and purchases for a distributor’s personal consumption within allowable limits. The Consent Order also imposes res
trictions on distributors’ 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 compli
ance 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 an independ
ent compliance auditor will 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 Monitor
s, Inc. to serve as the independent compliance auditor. The Company intends to monitor the impact of the Consent Order regularly and, while the Company currently does not expect the settlement to have a long-term and materially adverse impact on its busine
ss 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.
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, Securities and Exchange Commission and other governmental authorities. In the future, governmental authorities may determine to seek information from the Company 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 cooperated and will continue to fully cooperate with any governmental or regulatory inquiries or investigations.
These matters 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.
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 third party providers and by the Company in its Changsha, Hunan, China extraction facility, Suzhou, China facility, Nanjing, China facility, Lake Forest, California facility, and in its Winston-Salem, North Carolina facility, 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.
17
As of September 30, 2016, the Company sold products in 94 countries throughout the world and was organized and managed by 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 on a consolidated basis and
not by operating segment. Therefore, net sales and contribution margin are presented by reportable segment and assets by segment are not presented.
The operating information for the two reportable segments are as follows:
|
|
Three Months Ended
|
|
|
Nine Months Ended
|
|
|
|
September 30,
2016
|
|
|
September 30,
2015
|
|
|
September 30,
2016
|
|
|
September 30,
2015
|
|
|
|
(In millions)
|
|
Net Sales:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Primary Reporting Segment
|
|
$
|
907.8
|
|
|
$
|
878.0
|
|
|
$
|
2,769.3
|
|
|
$
|
2,744.8
|
|
China
|
|
|
214.2
|
|
|
|
224.9
|
|
|
|
674.1
|
|
|
|
625.8
|
|
Total Net Sales
|
|
$
|
1,122.0
|
|
|
$
|
1,102.9
|
|
|
$
|
3,443.4
|
|
|
$
|
3,370.6
|
|
Contribution Margin(1):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Primary Reporting Segment
|
|
$
|
398.8
|
|
|
$
|
390.5
|
|
|
$
|
1,201.5
|
|
|
$
|
1,209.3
|
|
China(2)
|
|
|
193.8
|
|
|
|
200.8
|
|
|
|
614.5
|
|
|
|
563.3
|
|
Total Contribution Margin
|
|
|
592.6
|
|
|
|
591.3
|
|
|
|
1,816.0
|
|
|
|
1,772.6
|
|
Selling, general and administrative expenses(2)
|
|
|
441.3
|
|
|
|
433.1
|
|
|
|
1,545.2
|
|
|
|
1,335.0
|
|
Other operating income
|
|
|
(0.2
|
)
|
|
|
(3.4
|
)
|
|
|
(29.1
|
)
|
|
|
(3.4
|
)
|
Interest expense, net
|
|
|
22.1
|
|
|
|
24.1
|
|
|
|
70.1
|
|
|
|
69.3
|
|
Other expense, net
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
2.3
|
|
Income before income taxes
|
|
|
129.4
|
|
|
|
137.5
|
|
|
|
229.8
|
|
|
|
369.4
|
|
Income taxes
|
|
|
41.7
|
|
|
|
43.9
|
|
|
|
69.2
|
|
|
|
114.8
|
|
Net income
|
|
$
|
87.7
|
|
|
$
|
93.6
|
|
|
$
|
160.6
|
|
|
$
|
254.6
|
|
(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 $100.2 million and $105.9 million for the three months ended September 30, 2016 and 2015, respectively, and $318.4 million and $299.0 million for the nine months ended September 30, 2016 and 2015, 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,
2016
|
|
|
September 30,
2015
|
|
|
September 30,
2016
|
|
|
September 30,
2015
|
|
|
|
(In millions)
|
|
Net Sales:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
United States
|
|
$
|
236.0
|
|
|
$
|
214.7
|
|
|
$
|
737.7
|
|
|
$
|
661.5
|
|
Mexico
|
|
|
112.8
|
|
|
|
113.4
|
|
|
|
341.8
|
|
|
|
366.2
|
|
China
|
|
|
214.2
|
|
|
|
224.9
|
|
|
|
674.1
|
|
|
|
625.8
|
|
Others
|
|
|
559.0
|
|
|
|
549.9
|
|
|
|
1,689.8
|
|
|
|
1,717.1
|
|
Total Net Sales
|
|
$
|
1,122.0
|
|
|
$
|
1,102.9
|
|
|
$
|
3,443.4
|
|
|
$
|
3,370.6
|
|
18
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 2015 10-K. During the nine months ended September 30, 2016, the Company granted stock appreciation rights, or SARs, subject to service conditions and service and performance conditions, and stock units subject to service conditions.
For the three months ended September 30, 2016 and 2015, share-based compensation expense amounted to $9.8 million and $10.3 million, respectively. For the nine months ended September 30, 2016 and 2015, share-based compensation expense amounted to $30.3 million and $34.2 million, respectively. As of September 30, 2016, the total unrecognized compensation cost related to all non-vested stock awards was $59.5 million and the related weighted-average period over which it is expected to be recognized is approximately 1.5 years.
The following tables summarize the activity under all share-based compensation plans for the nine months ended September 30, 2016:
Stock Options & SARs
|
|
Awards
|
|
|
Weighted
Average
Exercise
Price
|
|
|
Weighted
Average
Remaining
Contractual
Term
|
|
Aggregate
Intrinsic
Value(1)
|
|
|
|
(In thousands)
|
|
|
|
|
|
|
|
|
(In millions)
|
|
Outstanding at December 31, 2015(2)(3)
|
|
|
12,076
|
|
|
$
|
38.70
|
|
|
6.6 years
|
|
$
|
216.4
|
|
Granted
|
|
|
1,387
|
|
|
$
|
62.27
|
|
|
|
|
|
|
|
Exercised
|
|
|
(1,076
|
)
|
|
$
|
33.44
|
|
|
|
|
|
|
|
Forfeited
|
|
|
(256
|
)
|
|
$
|
49.97
|
|
|
|
|
|
|
|
Outstanding at September 30, 2016(2)(3)
|
|
|
12,131
|
|
|
$
|
41.62
|
|
|
6.3 years
|
|
$
|
265.3
|
|
Exercisable at September 30, 2016(4)
|
|
|
7,223
|
|
|
$
|
39.00
|
|
|
4.7 years
|
|
$
|
183.4
|
|
(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 2.9 million and 2.5 million performance condition SARs as of September 30, 2016 and December 31, 2015, respectively.
|
(3)
|
Includes 0.1 million market condition SARs.
|
(4)
|
Includes 0.9 million performance condition SARs.
|
The weighted-average grant date fair value of SARs granted during the three months ended September 30, 2016 and 2015 was $32.06 and $24.11, respectively. The weighted-average grant date fair value of SARs granted during the nine months ended September 30, 2016 and 2015 was $29.49 and $12.88, respectively. The total intrinsic value of stock options and SARs exercised during the three months ended September 30, 2016 and 2015 was $17.9 million and $4.2 million, respectively. The total intrinsic value of stock options and SARs exercised during the nine months ended September 30, 2016 and 2015 was $32.0 million and $23.8 million, respectively.
Incentive Plan and Independent Directors Stock Units
|
|
Shares
|
|
|
Weighted
Average
Grant Date
Fair Value
|
|
|
|
(In thousands)
|
|
|
|
|
|
Outstanding and nonvested December 31, 2015
|
|
|
34
|
|
|
$
|
51.08
|
|
Granted
|
|
|
27
|
|
|
$
|
62.51
|
|
Vested
|
|
|
(34
|
)
|
|
$
|
51.25
|
|
Forfeited
|
|
—
|
|
|
$
|
—
|
|
Outstanding and nonvested September 30, 2016
|
|
|
27
|
|
|
$
|
62.51
|
|
The total vesting date fair value of stock units which vested during the three months ended September 30, 2016 and 2015 was $0.2 million and $0.3 million, respectively. The total vesting date fair value of stock units which vested during the nine months ended September 30, 2016 and 2015 was $2.0 million and $1.3 million, respectively.
19
The Company recognizes excess tax benefits
associated with share-based compensation to shareholders’ equity (deficit) only when realized. When assessing whether excess tax benefits relating to share-based compensation have been realized, the Company follows the with-and-without approach. Under this
approach, excess tax benefits related to share-based compensation are not deemed to be realized until after the utilization of all other tax benefits available to the Company, which are also subject to applicable limitations. As of both September 30, 2016
and December 31, 2015, the Company had $25.4 million of unrealized excess tax benefits.
8. Income Taxes
Income taxes were $41.7 million and $69.2 million for the three and nine months ended September 30, 2016, respectively, as compared to $43.9 million and $114.8 million for the same periods in 2015. The effective income tax rate was 32.2% and 30.1% for the three and nine months ended September 30, 2016, respectively, as compared to 31.9% and 31.1% for the same periods in 2015. The increase in the effective tax rate for the three months ended September 30, 2016, as compared to the same period in 2015, was primarily due to the impact of changes in the geographic mix of the Company’s income, partially offset by an increase in net benefits from discrete events. The decrease in the effective tax rate for the nine months ended September 30, 2016, as compared to the same period in 2015, was primarily due to an increase in net benefits from discrete events.
As of September 30, 2016, the total amount of unrecognized tax benefits, including related interest and penalties was $63.8 million. If the total amount of unrecognized tax benefits was recognized, $46.8 million of unrecognized tax benefits, $9.0 million of interest and $2.3 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 $10.2 million within the next twelve months. Of this possible decrease, $5.4 million would be due to the settlement of audits or resolution of administrative or judicial proceedings. The remaining possible decrease of $4.8 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 also 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 (deficit), 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 (deficit), 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.
20
As of September 30, 2016 and December 31, 2015, the aggregate notional amounts of all foreign c
urrency contracts outstanding designated as cash flow hedges were approximately $92.7 million and $112.8 million, respectively. At September 30, 2016, these outstanding contracts were expected to mature over the next fifteen months. The Company’s derivativ
e financial instruments are recorded on the condensed consolidated balance sheet at fair value based on third-party quotes. As of September 30, 2016, the Company recorded assets at fair value of $2.5 million and liabilities at fair value of $0.8 million re
lating to all outstanding foreign currency contracts designated as cash-flow hedges. As of December 31, 2015, the Company recorded assets at fair value of $4.2 million and liabilities at fair value of $0.5 million relating to all outstanding foreign curren
cy contracts designated as cash-flow hedges. The Company assesses hedge effectiveness and measures hedge ineffectiveness at least quarterly. During the three and nine months ended September 30, 2016 and 2015, the ineffective portion relating to these hedge
s was immaterial and the hedges remained effective as of September 30, 2016 and December 31, 2015.
As of September 30, 2016 and December 31, 2015, 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 and two months as of September 30, 2016 and December 31, 2015, respectively. As of September 30, 2016, the Company had aggregate notional amounts of approximately $299.1 million of foreign currency contracts, inclusive of freestanding contracts and contracts designated as cash flow hedges.
Gains and Losses on Derivative Instruments
The following table summarizes gains (losses) relating to derivative instruments recorded in other comprehensive income during the three and nine months ended September 30, 2016 and 2015:
|
|
Amount of Gain (Loss) Recognized
in Other Comprehensive Income
|
|
|
|
For the Three Months Ended
|
|
|
For the Nine Months Ended
|
|
|
|
September 30, 2016
|
|
|
September 30, 2015
|
|
|
September 30, 2016
|
|
|
September 30, 2015
|
|
|
|
(In millions)
|
|
Derivatives designated as hedging instruments:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Foreign exchange currency contracts relating to inventory
and intercompany management fee hedges
|
|
$
|
0.8
|
|
|
$
|
4.2
|
|
|
$
|
3.1
|
|
|
$
|
13.8
|
|
The following table summarizes gains (losses) relating to derivative instruments recorded to income during the three and nine months ended September 30, 2016 and 2015:
|
|
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, 2016
|
|
|
September 30, 2015
|
|
|
September 30, 2016
|
|
|
September 30, 2015
|
|
|
|
|
|
(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
|
|
$
|
—
|
|
|
$
|
(0.1
|
)
|
|
$
|
0.1
|
|
|
$
|
(0.4
|
)
|
Derivatives not designated as hedging instruments:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Foreign exchange currency contracts
|
|
Selling, general and
administrative
expenses
|
|
$
|
0.6
|
|
|
$
|
5.6
|
|
|
$
|
(2.6
|
)
|
|
$
|
(0.3
|
)
|
(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.
|
21
The following table summarizes gains (losses) relating to derivative instruments reclassified from accumulated other comprehensive loss into income during the th
ree and nine months ended September 30, 2016 and 2015:
|
|
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, 2016
|
|
|
September 30, 2015
|
|
|
September 30, 2016
|
|
|
September 30, 2015
|
|
|
|
|
|
(In millions)
|
|
Derivatives designated as hedging instruments:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Foreign exchange currency contracts relating to
inventory hedges
|
|
Cost of sales
|
|
$
|
3.2
|
|
|
$
|
5.2
|
|
|
$
|
12.9
|
|
|
$
|
10.0
|
|
Foreign exchange currency contracts relating to
intercompany management fee hedges
|
|
Selling, general and
administrative expenses
|
|
$
|
(0.2
|
)
|
|
$
|
0.1
|
|
|
$
|
(0.8
|
)
|
|
$
|
0.1
|
|
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 derivative fair values and their condensed consolidated balance sheet location as of September 30, 2016 and December 31, 2015.
10. Shareholders’ Equity (Deficit)
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. The Credit Facility permits payments of dividends up to a specified cap as long as no default or event of default exists and the consolidated leverage ratio specified in the Credit Facility is not exceeded. See Note 4,
Long-Term Debt
, for further information on restrictions concerning the Company’s ability to declare dividends.
Share Repurchases
On July 30, 2012, the Company announced that its board of directors authorized a new $1 billion share repurchase program that will expire on June 30, 2017. On February 3, 2014, the Company announced that its board of directors authorized an increase in the existing share repurchase authorization to an available balance of $1.5 billion. This share repurchase program allows the Company to repurchase its 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 up to a specified cap as long as no default or event of default exists and the consolidated leverage ratio specified in the Credit Facility is not exceeded. See Note 4,
Long-Term Debt
, for further information on restrictions concerning the Company’s ability to repurchase its common shares.
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, 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.
22
As a result of the Forward Transactions, the Company’s total shareholders’ equity (deficit) 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 (deficit). 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, 2016 and 2015, 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.
During the three and nine months ended September 30, 2016 and 2015, the Company did not repurchase any of its common shares through open market purchases. As of September 30, 2016, the remaining authorized capacity under the Company’s $1.5 billion share repurchase program was $232.9 million inclusive of reductions for the Forward Transactions.
The Company reflects the aggregate purchase price of its common shares repurchased as a reduction to shareholders’ equity (deficit). The Company allocates the purchase price of the repurchased shares to accumulated deficit, common shares
and additional paid-in-capital.
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 minimum 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, 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.
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 respect to its 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. 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 (deficit) on its condensed consolidated balance sheet was reduced by $123.8 million during the first quarter of 2014.
23
Accumulated Other C
omprehensive Income (Loss)
The following table summarizes changes in accumulated other comprehensive income (loss) during the three months ended September 30, 2016 and 2015:
|
|
Changes in Accumulated Other Comprehensive
|
|
|
|
Income (Loss) by Component
|
|
|
|
Three Months Ended September 30,
|
|
|
|
2016
|
|
|
2015
|
|
|
|
Foreign
Currency
Translation
Adjustments
|
|
|
Unrealized
Gain
(Loss)
on
Derivatives
|
|
|
Unrealized Gain
(Loss) on
Available-For-
Sale
Investments
|
|
|
Total
|
|
|
Foreign
Currency
Translation
Adjustments
|
|
|
Unrealized
Gain (Loss)
on
Derivatives
|
|
|
Unrealized
Gain
(Loss) on
Available-For-
Sale
Investments
|
|
|
Total
|
|
|
|
(In millions)
|
|
Beginning Balance
|
|
$
|
(178.8
|
)
|
|
$
|
10.3
|
|
|
$
|
—
|
|
|
$
|
(168.5
|
)
|
|
$
|
(140.8
|
)
|
|
$
|
22.5
|
|
|
$
|
(0.1
|
)
|
|
$
|
(118.4
|
)
|
Other comprehensive income (loss)
before reclassifications, net of tax
|
|
|
(2.6
|
)
|
|
|
0.8
|
|
|
|
—
|
|
|
|
(1.8
|
)
|
|
|
(37.0
|
)
|
|
|
4.5
|
|
|
|
—
|
|
|
|
(32.5
|
)
|
Amounts reclassified from
accumulated other comprehensive
income (loss) to income, net of
tax(1)
|
|
|
—
|
|
|
|
(3.0
|
)
|
|
|
—
|
|
|
|
(3.0
|
)
|
|
|
—
|
|
|
|
(5.4
|
)
|
|
|
—
|
|
|
|
(5.4
|
)
|
Total other comprehensive income
(loss), net of reclassifications
|
|
|
(2.6
|
)
|
|
|
(2.2
|
)
|
|
|
—
|
|
|
|
(4.8
|
)
|
|
|
(37.0
|
)
|
|
|
(0.9
|
)
|
|
|
—
|
|
|
|
(37.9
|
)
|
Ending balance
|
|
$
|
(181.4
|
)
|
|
$
|
8.1
|
|
|
$
|
—
|
|
|
$
|
(173.3
|
)
|
|
$
|
(177.8
|
)
|
|
$
|
21.6
|
|
|
$
|
(0.1
|
)
|
|
$
|
(156.3
|
)
|
(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, 2016 and 2015.
|
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.
Other comprehensive income (loss) before reclassifications was net of tax benefits of $2.7 million and $0.3 million for foreign currency translation adjustment and unrealized gain (loss) on derivatives, respectively, for the three months ended September 30, 2015. Amounts reclassified from accumulated other comprehensive income (loss) to income was net of tax expense of $0.1 million for unrealized gain (loss) on derivatives for the three months ended September 30, 2015.
24
The following table summarizes changes in accumulated other comprehensive income (loss) during the nine months ended September 30, 2016 and 2015:
|
|
Changes in Accumulated Other Comprehensive
|
|
|
|
Income (Loss) by Component
|
|
|
|
Nine Months Ended September 30,
|
|
|
|
2016
|
|
|
2015
|
|
|
|
Foreign
Currency
Translation
Adjustments
|
|
|
Unrealized
Gain
(Loss)
on
Derivatives
|
|
|
Unrealized Gain
(Loss) on
Available-For-
Sale
Investments
|
|
|
Total
|
|
|
Foreign
Currency
Translation
Adjustments
|
|
|
Unrealized
Gain (Loss)
on
Derivatives
|
|
|
Unrealized Gain
(Loss) on
Available-For-
Sale
Investments
|
|
|
Total
|
|
|
|
(In millions)
|
|
Beginning Balance
|
|
$
|
(183.0
|
)
|
|
$
|
17.4
|
|
|
$
|
0.1
|
|
|
$
|
(165.5
|
)
|
|
$
|
(96.4
|
)
|
|
$
|
18.0
|
|
|
$
|
0.2
|
|
|
$
|
(78.2
|
)
|
Other comprehensive income (loss)
before reclassifications, net of tax
|
|
|
1.6
|
|
|
|
3.4
|
|
|
|
—
|
|
|
|
5.0
|
|
|
|
(81.4
|
)
|
|
|
13.6
|
|
|
|
(1.8
|
)
|
|
|
(69.6
|
)
|
Amounts reclassified from
accumulated other comprehensive
income (loss) to income, net of
tax(1)
|
|
|
—
|
|
|
|
(12.7
|
)
|
|
|
(0.1
|
)
|
|
|
(12.8
|
)
|
|
|
—
|
|
|
|
(10.0
|
)
|
|
|
1.5
|
|
|
|
(8.5
|
)
|
Total other comprehensive income
(loss), net of reclassifications
|
|
|
1.6
|
|
|
|
(9.3
|
)
|
|
|
(0.1
|
)
|
|
|
(7.8
|
)
|
|
|
(81.4
|
)
|
|
|
3.6
|
|
|
|
(0.3
|
)
|
|
|
(78.1
|
)
|
Ending balance
|
|
$
|
(181.4
|
)
|
|
$
|
8.1
|
|
|
$
|
—
|
|
|
$
|
(173.3
|
)
|
|
$
|
(177.8
|
)
|
|
$
|
21.6
|
|
|
$
|
(0.1
|
)
|
|
$
|
(156.3
|
)
|
(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 nine months ended September 30, 2016 and 2015.
|
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 unrealized gain (loss) on available-for-sale investments for the nine months ended September 30, 2016.
Other comprehensive income (loss) before reclassifications was net of tax benefits of $7.0 million, tax expense of $0.2 million, and tax benefits of $1.0 million for foreign currency translation adjustments, unrealized gain (loss) on derivatives, and unrealized gain (loss) on available-for-sale investments, respectively, for the nine months ended September 30, 2015. Amounts reclassified from accumulated other comprehensive income (loss) to income was net of tax benefits of $0.1 million and tax expense of $0.8 million for unrealized gain (loss) on derivatives and unrealized gain (loss) on available-for-sale investments, respectively, for the nine months ended September 30, 2015.
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 stock options, SARs, stock units and warrants.
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,
|
|
|
|
2016
|
|
|
2015
|
|
|
2016
|
|
|
2015
|
|
|
|
(in millions)
|
|
Weighted average shares used in basic computations
|
|
|
83.1
|
|
|
|
82.6
|
|
|
|
83.0
|
|
|
|
82.5
|
|
Dilutive effect of exercise of equity grants outstanding
|
|
|
3.3
|
|
|
|
3.1
|
|
|
|
3.1
|
|
|
|
2.6
|
|
Weighted average shares used in diluted computations
|
|
|
86.4
|
|
|
|
85.7
|
|
|
|
86.1
|
|
|
|
85.1
|
|
25
There were an aggregate of 3.9 million and 4.8 million of equity grants, consisting of stock options, SARs, and stock units that were outstanding during the three
and nine months ended September 30, 2016, respectively, and
an aggregate of 4.2 million and 5.5 million of equity grants that were outstanding during the three and nine months ended
September
30, 2015, respectively,
but were not included in the computatio
n 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, 2016 and 2015, 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, 2016 and 2015. 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.
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.
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 inputs 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.
26
The Company measures ce
rtain 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 observa
ble 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 gros
s values at September 30, 2016 and December 31, 2015:
Fair Value Measurements at Reporting Date
|
|
Derivative Balance
Sheet
Location
|
|
Significant Other
Observable
Inputs
(Level 2)
Fair Value at
September 30,
2016
|
|
|
Significant Other
Observable
Inputs
(Level 2)
Fair Value at
December 31,
2015
|
|
|
|
|
|
(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
|
|
$
|
2.5
|
|
|
$
|
4.2
|
|
Derivatives not designated as hedging
instruments:
|
|
|
|
|
|
|
|
|
|
|
Foreign exchange currency contracts
|
|
Prepaid expenses and
other current assets
|
|
$
|
1.5
|
|
|
$
|
2.6
|
|
|
|
|
|
$
|
4.0
|
|
|
$
|
6.8
|
|
LIABILITIES:
|
|
|
|
|
|
|
|
|
|
|
Derivatives designated as hedging
instruments:
|
|
|
|
|
|
|
|
|
|
|
Foreign exchange currency contracts relating to
inventory and intercompany management fee
hedges
|
|
Accrued expenses
|
|
$
|
0.8
|
|
|
$
|
0.5
|
|
Derivatives not designated as hedging
instruments:
|
|
|
|
|
|
|
|
|
|
|
Foreign exchange currency contracts
|
|
Accrued expenses
|
|
$
|
1.5
|
|
|
$
|
6.2
|
|
|
|
|
|
$
|
2.3
|
|
|
$
|
6.7
|
|
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 Company’s 2015 10-K for a further description of its deferred compensation plan assets.
27
The following tables summarize the offsetting of the fair values of the Company’s derivative assets and derivative liabilities for presentation in t
he Company’s condensed consolidated balance sheet at September 30, 2016 and December 31, 2015:
|
|
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, 2016
|
|
|
|
|
|
|
|
|
|
|
|
|
Foreign exchange currency contracts
|
|
$
|
4.0
|
|
|
$
|
(2.2
|
)
|
|
$
|
1.8
|
|
Total
|
|
$
|
4.0
|
|
|
$
|
(2.2
|
)
|
|
$
|
1.8
|
|
December 31, 2015
|
|
|
|
|
|
|
|
|
|
|
|
|
Foreign exchange currency contracts
|
|
$
|
6.8
|
|
|
$
|
(4.5
|
)
|
|
$
|
2.3
|
|
Total
|
|
$
|
6.8
|
|
|
$
|
(4.5
|
)
|
|
$
|
2.3
|
|
|
|
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, 2016
|
|
|
|
|
|
|
|
|
|
|
|
|
Foreign exchange currency contracts
|
|
$
|
2.3
|
|
|
$
|
(2.2
|
)
|
|
$
|
0.1
|
|
Total
|
|
$
|
2.3
|
|
|
$
|
(2.2
|
)
|
|
$
|
0.1
|
|
December 31, 2015
|
|
|
|
|
|
|
|
|
|
|
|
|
Foreign exchange currency contracts
|
|
$
|
6.7
|
|
|
$
|
(4.5
|
)
|
|
$
|
2.2
|
|
Total
|
|
$
|
6.7
|
|
|
$
|
(4.5
|
)
|
|
$
|
2.2
|
|
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, 2016, and December 31, 2015, 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. Professional Fees and Other Expenses
In late 2012, a hedge fund manager publicly raised allegations regarding the legality of the Company’s network marketing program and announced that the hedge fund manager had taken a significant short position regarding the Company’s common shares, leading to intense public scrutiny and significant stock price volatility. The Company believes that the hedge fund manager’s allegations are inaccurate and misleading. The Company has engaged legal and advisory 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, 2016 and 2015, the Company recorded approximately $3.1 million and $3.6 million, respectively, and for the nine months ended September 30, 2016 and 2015, the Company recorded approximately $10.7 million and $15.0 million, respectively, of professional fees and other expenses related to this matter.
14. Subsequent Events
On October 30, 2016, an arbitration tribunal awarded the Company approximately $30 million in connection with the re-audit of the Company’s 2010 to 2012 financial statements after the resignation of KPMG as the Company’s independent registered public accounting firm. Either party may file a motion to vacate, modify or correct the award.
This amount has not been recognized within the Company’s condensed consolidated financial statements as of September 30, 2016.
28
Item 2.
Management’s Discussion and Analysis of
Financial Condition and Resul
ts 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, 2015, or the 2015 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. As of September 30, 2016, we sold our products in 94 countries to and through a network of 4.1 million independent members, or Members, which included approximately 0.3 million in China. 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 36-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, recruiting 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. Management also continues to monitor the Venezuelan market and especially the limited ability to repatriate cash.
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 Judgment, or the Consent Order, which resolved the FTC’s multi-yea
r 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 will have 10 months from the Effective Date to implement.
The Consent Order requires us to categorize all existing and future Members in the U.S. as either “preferred mem
bers” – those members who only purchase products at a discount, or “distributors” – those members who choose to resell the products or build a sales organization. Although not required until May 2017, in October 2016 we initiated the process of allowing ex
isting Members in the U.S. to affirmatively elect to be classified as either preferred members or as independent distributors.
We also agreed to compensate distributors based on documented U.S. retail sales, which may include sales to preferred members and
purchases for a distributor’s personal consumption within allowable limits. The Consent Order also imposes restrictions on distributors’ ability to open Nutrition Clubs in the United States. We intend to monitor the impact of the Consent Order regularly a
nd 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 cur
rently 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 term
s of the settlement do not change our business model as a direct selling company and we were at the time of the settlement, and are now, in the process of implementing many of the new and enhanced procedures
; however, the terms of the settlement and the co
sts to comply therewith could adversely affect our business operations, our results of operations and our financial condition. See Part II, Item 1A – Risk Factors of this Quarterly Report on Form 10-Q for a discussion of risks related to the settlement wit
h 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.
We assign a Volume Point value to a product when it is first introduced into a market and the value is unaffected by subsequent 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 different 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 described 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 of more expensive products.
|
|
Three Months Ended September 30,
|
|
|
Nine Months Ended September 30,
|
|
|
|
2016
|
|
|
2015
|
|
|
% Change
|
|
|
2016
|
|
|
2015
|
|
|
% Change
|
|
|
|
(Volume Points in millions)
|
|
North America
|
|
|
311.6
|
|
|
|
285.0
|
|
|
|
9.3
|
%
|
|
|
978.1
|
|
|
|
888.3
|
|
|
|
10.1
|
%
|
Mexico
|
|
|
234.5
|
|
|
|
207.2
|
|
|
|
13.2
|
%
|
|
|
693.1
|
|
|
|
630.6
|
|
|
|
9.9
|
%
|
South & Central America
|
|
|
161.1
|
|
|
|
188.7
|
|
|
|
(14.6
|
)%
|
|
|
499.2
|
|
|
|
572.3
|
|
|
|
(12.8
|
)%
|
EMEA
|
|
|
252.0
|
|
|
|
219.0
|
|
|
|
15.1
|
%
|
|
|
789.6
|
|
|
|
675.7
|
|
|
|
16.9
|
%
|
Asia Pacific (excluding China)
|
|
|
275.9
|
|
|
|
258.0
|
|
|
|
6.9
|
%
|
|
|
803.2
|
|
|
|
795.1
|
|
|
|
1.0
|
%
|
China
|
|
|
153.2
|
|
|
|
149.8
|
|
|
|
2.3
|
%
|
|
|
488.1
|
|
|
|
427.4
|
|
|
|
14.2
|
%
|
Worldwide
|
|
|
1,388.3
|
|
|
|
1,307.7
|
|
|
|
6.2
|
%
|
|
|
4,251.3
|
|
|
|
3,989.4
|
|
|
|
6.6
|
%
|
30
We believe the increase in worldwide Volume Points for the
three and nine months ended September 30, 2016 of 6.2% and 6.6%, respectively, after a decline for the prior year periods, and a general trend of decreasing rates of increase in the preceding year periods, is attributable to our facilitation of sales lead
er success and customer satisfaction by providing quality products and emphasizing sustainable business; improved DMOs, including daily consumption approaches such as Nutrition Clubs; easier access to product; systemized training for Members on our product
s and methods; and continued promotion and branding of Herbalife products. The increases for North America, Mexico and Asia Pacific (excluding China) for the three and nine months ended September 30, 2016, after decreases in the prior year periods, primari
ly reflects our Members transitioning through a period of adjustment to certain revisions to our operations and Marketing Plan designed to improve the training and retention of sales leaders. We continue to see declines in the South & Central America regio
n primarily as a result of regional specific challenges discussed in greater detail in Sales by Geographic Region. Certain of the revisions and their impact on our results are discussed further below in the applicable sections of Sales by Geographic Region
. We believe the changes to our Marketing Plan, as well as our competitive strengths and business strategies discussed in greater detail in Item 1 — Business of the 2015 10-K, will contribute to achieving our long-term objective of sustainable sales growth
through retailing, recruiting and retention.
Average Active Sales Leaders by Geographic Region
Average Active Sales Leaders represents the monthly average number of sales leaders that place an order, including orders of non-sales leader Members in their downline sales organization, during a given period. We utilize this metric as an indication of the engagement level of sales leaders and the success of our strategies and execution.
|
|
Three Months Ended September 30,
|
|
|
Nine Months Ended September 30,
|
|
|
|
2016
|
|
|
2015
|
|
|
% Change
|
|
|
2016
|
|
|
2015
|
|
|
% Change
|
|
North America
|
|
|
81,035
|
|
|
|
77,066
|
|
|
|
5.2
|
%
|
|
|
77,754
|
|
|
|
76,801
|
|
|
|
1.2
|
%
|
Mexico
|
|
|
68,380
|
|
|
|
64,640
|
|
|
|
5.8
|
%
|
|
|
65,648
|
|
|
|
64,860
|
|
|
|
1.2
|
%
|
South & Central America
|
|
|
56,025
|
|
|
|
60,726
|
|
|
|
(7.7
|
)%
|
|
|
55,795
|
|
|
|
60,522
|
|
|
|
(7.8
|
)%
|
EMEA
|
|
|
84,125
|
|
|
|
74,741
|
|
|
|
12.6
|
%
|
|
|
80,591
|
|
|
|
71,739
|
|
|
|
12.3
|
%
|
Asia Pacific (excluding China)
|
|
|
76,315
|
|
|
|
77,130
|
|
|
|
(1.1
|
)%
|
|
|
73,607
|
|
|
|
75,649
|
|
|
|
(2.7
|
)%
|
China
|
|
|
31,719
|
|
|
|
25,696
|
|
|
|
23.4
|
%
|
|
|
30,467
|
|
|
|
23,293
|
|
|
|
30.8
|
%
|
Worldwide(1)
|
|
|
383,274
|
|
|
|
367,557
|
|
|
|
4.3
|
%
|
|
|
369,969
|
|
|
|
360,460
|
|
|
|
2.6
|
%
|
(1)
|
Worldwide average active sales leaders may not equal the sum of the average active sales leaders in each region due to the calculation being an average of sales leaders active in a period, not a summation, and the fact that some sales leaders are active in more than one region but are counted only once in the worldwide amount.
|
We believe the increase in Average Active Sales Leaders worldwide and within each region other than South & Central America and Asia Pacific generally reflects the same success factors discussed above for Volume Points. However, given the long term and qualitative nature of our strategies, the magnitude of the impact of each such strategy on sales leaders’ engagement cannot be quantified and may vary over time and by market.
Management is currently evaluating this metric’s continued usefulness as a result of the Marketing Plan changes described below and the more general transition of our business to a daily consumption model.
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).
31
For the latest twelve month re-qualific
ation period ending January 2016, approximately 54.2% of our sales leaders, excluding China, Venezuela, and Argentina, re-qualified. For the twelve month re-qualification period ended January 2015, approximately 54.2% of our sales leaders, excluding China,
Venezuela and Argentina, re-qualified. During the twelve-month period ended January 2014 and 2016, Venezuelan sales leaders, and during the twelve-month period ended January 2015, Argentinian sales leaders, were not required to re-qualify due to product s
upply limitations resulting from currency restrictions and other economic conditions. The impacted sales leaders were excluded from the retention rate calculations for the affected years to avoid an overstated positive impact on the rate of essentially hav
ing all those sales leaders re-qualified. Venezuelan and Argentinian sales leaders were also excluded from the January 2015 and January 2016 retention rate calculations, respectively, even though they were required to re-qualify in those years, to similarl
y avoid an overstated negative impact of including some sales leaders in the calculation that would have been demoted in the respective preceding years if required to re-qualify. If Venezuela and Argentina were included on a normalized basis, the 2016 and
2015 retention rates would have been 53.7% and 53.4%, respectively.
Sales Leaders Statistics (Excluding China)
|
|
2016
|
|
|
2015
|
|
|
|
(In thousands)
|
|
January 1 total sales leaders
|
|
|
603.3
|
|
|
|
650.1
|
|
January & February new sales leaders
|
|
|
27.7
|
|
|
|
31.6
|
|
Demoted sales leaders (did not re-qualify)(1)
|
|
|
(207.6
|
)
|
|
|
(205.2
|
)
|
Other sales leaders (resigned, etc)
|
|
|
(3.9
|
)
|
|
|
(6.8
|
)
|
End of February total sales leaders
|
|
|
419.5
|
|
|
|
469.7
|
|
The statistics below further highlight the calculation for retention.
Sales Leaders Retention (Excluding China)
|
|
2016
|
|
|
2015
|
|
|
|
(In thousands)
|
|
Sales leaders needed to re-qualify
|
|
|
450.2
|
|
|
|
426.5
|
|
Demoted sales leaders (did not re-qualify)(1)
|
|
|
(206.4
|
)
|
|
|
(195.2
|
)
|
Total re-qualified
|
|
|
243.8
|
|
|
|
231.3
|
|
Retention rate
|
|
|
54.2
|
%
|
|
|
54.2
|
%
|
(1)
|
Although sales leaders in Argentina and Venezuela were required to re-qualify for the twelve-month periods ended January 2016 and 2015, respectively, as described above, Argentina and Venezuela sales leaders are excluded from the Sales Leader Retention table calculations for those re-qualification periods for comparative purposes. Argentina and Venezuela sales leaders figures are included in the Sales Leaders Statistics table for 2016 and 2015, respectively.
|
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
|
|
|
|
2016
|
|
|
2015
|
|
|
2016
|
|
|
2015
|
|
North America
|
|
|
79,305
|
|
|
|
88,866
|
|
|
|
58.3
|
%
|
|
|
58.4
|
%
|
Mexico
|
|
|
67,294
|
|
|
|
83,137
|
|
|
|
57.1
|
%
|
|
|
56.7
|
%
|
South & Central America
|
|
|
77,523
|
|
|
|
88,392
|
|
|
|
53.0
|
%
|
|
|
52.0
|
%
|
EMEA
|
|
|
87,500
|
|
|
|
82,025
|
|
|
|
63.6
|
%
|
|
|
68.4
|
%
|
Asia Pacific (excluding China)
|
|
|
107,871
|
|
|
|
127,252
|
|
|
|
43.8
|
%
|
|
|
43.9
|
%
|
Total Sales Leaders
|
|
|
419,493
|
|
|
|
469,672
|
|
|
|
54.2
|
%
|
|
|
54.2
|
%
|
China
|
|
|
41,890
|
|
|
|
32,222
|
|
|
|
|
|
|
|
|
|
Worldwide Total Sales Leaders
|
|
|
461,383
|
|
|
|
501,894
|
|
|
|
|
|
|
|
|
|
Sales leaders generally purchase our products for resale to other Members and retail consumers and self-consumption. 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 2016 remained consistent v
ersus the prior year at a historically high level for us, despite there being a significant number of sales leaders having to re-qualify for the first time, due to the revision to our qualification requirements made in November 2014. We believe the perform
ance for the period ended January 2016 is the result of efforts we have made to improve the sustainability of sales leaders’ businesses.
Presentation
“Retail sales”
represent the suggested retail price of products we sell to our Members and is the gross sales amount reflected on our invoices. Retail sales 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 sales less distributor allowances as
“product sales”
.
Total distributor allowances for the three months ended September 30, 2016 and 2015 were 40.5% and 39.7% of retail sales, respectively. Total distributor allowances for both the nine months ended September 30, 2016 and 2015 was 40.2% of retail sales. 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 sales 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 sales” 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 sales because of its fundamental role in our systems, internal controls and operations, and its correlation to Member discounts and Royalty overrides. In addition, retail sales is a component of the financial reports we use to analyze our financial results. However, such a measure is not in accordance with U.S. generally accepted accounting principles, or U.S. GAAP. Retail sales 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 sales 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 all Mem
bers can potentially 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 can earn additional compensation for those activities, which we refer to as
“Royalty overrides.
” Royalty overrides are our most significant operating expense 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.
|
During the three months ended September 30, 2016 and 2015, total Royalty overrides were 28.6% and 27.6% of our net sales, respectively. During both the nine months ended September 30, 2016 and 2015, total Royalty overrides were 28.1% of our net sales. 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.
Due to restrictions on direct selling in China, our independent service providers in China are compensated for marketing, sales, and support services with fees reflecting the quality of their service, sales contributions and other factors instead of the distributor allowances and royalty overrides utilized in our traditional marketing program. Compensation to China independent service providers is 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.
Our “
other expense, net
” consists of non-operating expenses such as impairments of available-for-sale investments.
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 gains or 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, 2016 were $1,122.0 million and $3,443.4 million, respectively. Net sales increased $19.1 million, or 1.7%, and $72.8 million, or 2.2%, for the three and nine months ended September 30, 2016, as compared to the same periods in 2015. In local currency, net sales increased 5.2% and 8.7% for the three and nine months ended September 30, 2016, respectively, as compared to the same periods in 2015. The increase in net sales of 1.7% for the three months ended September 30, 2016 was primarily driven by an increase in sales volume, as measured by an increase in Volume Points, which increased net sales by approximately 6.2%, partially offset by the effect of a strong U.S. dollar and the resulting fluctuation in foreign currency rates, which reduced net sales by approximately 3.4%. The increase in net sales of 2.2% for the nine months ended September 30, 2016 was primarily driven by an increase in sales volume, as measured by an increase in Volume Points and the impact of price increases, which increased net sales by approximately 6.6% and 2.4%, respectively. These increases were partially offset by the effect of a strong U.S. dollar and the resulting fluctuation in foreign currency rates, which reduced net sales by approximately 6.6%.
34
Net income for the three and nine months ended September 30, 2016 was $87.7 million, or $1.01 per diluted share, and $160.6
million, or $1.87 per diluted share, respectively. Net income decreased $5.9 million, or 6.3%, and $94.0 million, or 36.9 %, for the three and nine months ended September 30, 2016, respectively, as compared to the same periods in 2015. The decrease in net
income for the nine months ended September 30, 2016 was primarily due to the $203.0 million regulatory settlements and $19.4 million in higher service fees to China service providers due to sales growth in China; partially offset by the net sales growth a
s discussed above; $25.7 million in higher government grant income in China; and $19.6 million in lower foreign exchange losses primarily related to the remeasurement of our Venezuela Bolivar-denominated assets and liabilities described below.
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); 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); 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.
The income tax impact of the expenses discussed above is based on forecasted items affecting our 2016 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, 2015 included a
$3.4 million pre-tax favorable impact ($2.4 million post-tax) of government grant income in China;
$0.5 million post-tax favorable impact related to Venezuela; a $1.3 million pre-tax unfavorable impact ($0.9 million post-tax) of interest expense resulting from a transaction related to Venezuela; a $0.8 million post-tax favorable impact of foreign exchange losses resulting from Euro/U.S. dollar exposure primarily related to intercompany balances; a $3.6 million pre-tax unfavorable impact ($2.8 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 $7.6 million pre-tax unfavorable impact ($4.7 million post-tax) from expenses related to regulatory inquiries; a $11.2 million unfavorable impact of non-cash interest expense related to the Convertible Notes and the Forward Transactions (See
Liquidity and Capital Resources — Convertible Senior Notes
below for further discussion); a $0.7 million pre-tax unfavorable impact ($0.4 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 $3.1 million pre-tax favorable impact ($2.0 million post-tax) related to recovery of losses associated with defective manufacturing equipment.
35
Net income for the nine months ended September 30, 2015 included a $36.9 million pre-tax unfavorable impact ($24.3 million post-tax), comprised of a $32.9 million foreign exchange loss related to the remeasurement of Venezuela Bolivar-denominated
assets and liabilities, $1.7 million of inventory write downs
related to Venezuela, and a $2.3 million impairment loss on Venezuela bonds (See
Liquidity and Capital Resources — Venezuela
below for further discussion of currency exchange rate issues in
Venezuela and
Other Expense, net
below for further discussion of
Venezuela bonds); a $1.3 million pre-tax unfavorable impact ($0.9 million post-tax) of interest expense resulting from
a transaction
related to Venezuela; $7.5 million pre-tax favorable impac
t from foreign exchange gain ($7.7 million post-tax) resulting from Euro/U.S. dollar exposure primarily related to intercompany balances; a $15.0 million pre-tax unfavorable impact ($10.5 million post-tax) related to legal, advisory services and other expe
nses 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 $16.8 million pre-tax u
nfavorable impact ($10.4 million post-tax) from expenses related
to regulatory inquiries; a $32.8 million unfavorable impact of non-cash interest expense related to the Convertible Notes and the Forward Transactions (See
Liquidity and Capital Resources — C
onvertible Senior Notes
below for further discussion); a $1.2 million pre-tax unfavorable impact ($0.8 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 $3.1 million pre-tax favorable impact ($2.0 million post-tax) related to recovery of losses associated with defective manufacturing equipment.
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 recruit new 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.
The following table sets forth selected results of our operations expressed as a percentage of net sales for the periods indicated:
|
|
Three Months Ended
|
|
|
Nine Months Ended
|
|
|
|
September 30,
2016
|
|
|
September 30,
2015
|
|
|
September 30,
2016
|
|
|
September 30,
2015
|
|
Operations:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net sales
|
|
|
100.0
|
%
|
|
|
100.0
|
%
|
|
|
100.0
|
%
|
|
|
100.0
|
%
|
Cost of sales
|
|
|
18.6
|
|
|
|
18.8
|
|
|
|
19.1
|
|
|
|
19.3
|
|
Gross profit
|
|
|
81.4
|
|
|
|
81.2
|
|
|
|
80.9
|
|
|
|
80.7
|
|
Royalty overrides(1)
|
|
|
28.6
|
|
|
|
27.6
|
|
|
|
28.1
|
|
|
|
28.1
|
|
Selling, general and administrative expenses(1)
|
|
|
39.3
|
|
|
|
39.2
|
|
|
|
44.9
|
|
|
|
39.6
|
|
Other operating income
|
|
|
—
|
|
|
|
(0.3
|
)
|
|
|
(0.8
|
)
|
|
|
(0.1
|
)
|
Operating income
|
|
|
13.5
|
|
|
|
14.7
|
|
|
|
8.7
|
|
|
|
13.1
|
|
Interest expense, net
|
|
|
2.0
|
|
|
|
2.2
|
|
|
|
2.0
|
|
|
|
2.0
|
|
Other expense, net
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
0.1
|
|
Income before income taxes
|
|
|
11.5
|
|
|
|
12.5
|
|
|
|
6.7
|
|
|
|
11.0
|
|
Income taxes
|
|
|
3.7
|
|
|
|
4.0
|
|
|
|
2.0
|
|
|
|
3.4
|
|
Net income
|
|
|
7.8
|
%
|
|
|
8.5
|
%
|
|
|
4.7
|
%
|
|
|
7.6
|
%
|
(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 primarily due to the regulatory environment in China. See Note 6,
Segment Information
, to the Condensed Consolidated Financial Statements for further discussion of our reporting segments. See below for discussions of net sales and contribution margin by our reporting segments.
36
Net Sales by Reporting Segment
The Primary Reporting Segment reported net sales of $907.8 million and $2,769.3 million for the three and nine months ended September 30, 2016, respectively, representing an increase of $29.8 million, or 3.4%, and $24.5 million, or 0.9%, for the three and nine months ended September 30, 2016, respectively, as compared to the same periods in 2015. In local currency, net sales increased 6.3% and 7.6% for the three and nine months ended September 30, 2016, respectively, as compared to the same periods in 2015 for the Primary Reporting Segment. The 3.4% increase in net sales for the three months ended September 30, 2016 was primarily due to an increase in sales volume, as measured by an increase in Volume Points, which increased net sales by approximately 6.7%, partially offset by the effect of the strong U.S. dollar and the resulting impact of fluctuations in foreign currency rates which reduced net sales by approximately 2.9%. The 0.9% increase in net sales for the nine months ended September 30, 2016 was primarily due to an increase in sales volume, as measured by an increase in Volume Points, and price increases which increased net sales by approximately 5.6% and 3.0%, respectively, partially offset by the effect of the strong U.S. dollar and the resulting impact of fluctuations in foreign currency rates which reduced net sales by approximately 6.7%.
China reported net sales of $214.2 million and $674.1 million for the three and nine months ended September 30, 2016, respectively, representing a decrease of $10.7 million, or 4.8%, and an increase of $48.3 million, or 7.7%, for the three and nine months ended September 30, 2016, respectively, as compared to the same periods in 2015. In local currency, net sales increased 0.9% and 13.4% for the three and nine months ended September 30, 2016, respectively, as compared to the same periods in 2015 for China. The 4.8% decrease in China net sales for the three months ended September 30, 2016 was primarily due to the impact of foreign currency fluctuation, which reduced net sales by approximately 5.6%, partially offset by an increase in sales volume, as measured by an increase in Volume Points, which increased net sales by approximately 2.3%. The 7.7% increase in China net sales for the nine months ended September 30, 2016 was primarily due to an increase in sales volume, as measured by an increase in Volume Points, which increased net sales by approximately 14.2%, partially offset by the impact of foreign currency fluctuation, which reduced net sales by approximately 5.7%.
Contribution Margin by Reporting Segment
As discussed above under “Presentation,” contribution margin consists of net sales less cost of sales and Royalty overrides.
The Primary Reporting Segment reported contribution margin of $398.8 million, or 43.9% of net sales, and $1,201.5 million, or 43.4% of net sales, representing an increase of $8.3 million, or 2.1%, and a decrease of $7.8 million, or 0.6%, for the three and nine months ended September 30, 2016, respectively, as compared to the same periods in 2015. The 2.1% increase for the three months ended September 30, 2016 was primarily the result of the favorable impact of volume increase, as measured by an increase in Volume Points, which increased contribution margin by approximately 7.9%, partially offset by the impact of fluctuations in the foreign currency rates which reduced contribution margin by approximately 6.7%. The 0.6% decrease for the nine months ended September 30, 2016 was primarily the result of fluctuations in the foreign currency rates which reduced contribution margin by approximately 11.6%, partially offset by the favorable impact of volume increase, as measured by an increase in Volume Points, and price increases which increased contribution margin by approximately 6.2% and 4.8%, respectively.
China reported contribution margin of $193.8 million and $614.5 million for the three and nine months ended September 30, 2016, respectively, representing a decrease of $7.0 million, or 3.5%, and an increase of $51.2 million, or 9.1%, for the three and nine months ended September 30, 2016, respectively, as compared to the same periods in 2015. The decrease for the three months ended September 30, 2016 was primarily due to the impact of fluctuations in foreign currency rates which reduced contribution margin by approximately 5.6%, partially offset by the impact of volume increase, as measured by an increase in Volume Points, which increased contribution margin by approximately 2.4%. The increase for the nine months ended September 30, 2016 was primarily the result of a volume increase, as measured by an increase in Volume Points, which increased contribution margin by approximately 14.2%, partially offset by the impact of fluctuations in foreign currency rates which reduced contribution margin by approximately 5.7%.
37
Sales by Geographic Region
The following chart reconciles retail sales to net sales by geographic region:
|
|
Three Months Ended September 30,
|
|
|
|
2016
|
|
|
2015
|
|
|
|
Retail
Sales(1)
|
|
|
Distributor
Allowance
|
|
|
Product
Sales
|
|
|
Shipping &
Handling
Revenues
|
|
|
Net
Sales
|
|
|
Retail
Sales(1)
|
|
|
Distributor
Allowance
|
|
|
Product
Sales
|
|
|
Shipping &
Handling
Revenues
|
|
|
Net
Sales
|
|
|
Change in
Net Sales
|
|
|
|
(In millions)
|
|
North America
|
|
$
|
399.8
|
|
|
$
|
(181.5
|
)
|
|
$
|
218.3
|
|
|
$
|
22.7
|
|
|
$
|
241.0
|
|
|
$
|
363.5
|
|
|
$
|
(164.7
|
)
|
|
$
|
198.8
|
|
|
$
|
20.6
|
|
|
$
|
219.4
|
|
|
|
9.8
|
%
|
Mexico
|
|
|
193.9
|
|
|
|
(87.9
|
)
|
|
|
106.0
|
|
|
|
6.8
|
|
|
|
112.8
|
|
|
|
193.6
|
|
|
|
(86.6
|
)
|
|
|
107.0
|
|
|
|
6.4
|
|
|
|
113.4
|
|
|
|
(0.5
|
)%
|
South & Central America
|
|
|
211.2
|
|
|
|
(98.5
|
)
|
|
|
112.7
|
|
|
|
8.3
|
|
|
|
121.0
|
|
|
|
234.2
|
|
|
|
(106.8
|
)
|
|
|
127.4
|
|
|
|
10.7
|
|
|
|
138.1
|
|
|
|
(12.4
|
)%
|
EMEA
|
|
|
346.6
|
|
|
|
(157.6
|
)
|
|
|
189.0
|
|
|
|
12.6
|
|
|
|
201.6
|
|
|
|
312.9
|
|
|
|
(141.7
|
)
|
|
|
171.2
|
|
|
|
11.3
|
|
|
|
182.5
|
|
|
|
10.5
|
%
|
Asia Pacific
|
|
|
392.0
|
|
|
|
(167.8
|
)
|
|
|
224.2
|
|
|
|
7.2
|
|
|
|
231.4
|
|
|
|
360.4
|
|
|
|
(152.1
|
)
|
|
|
208.3
|
|
|
|
16.3
|
|
|
|
224.6
|
|
|
|
3.0
|
%
|
China
|
|
|
242.8
|
|
|
|
(29.8
|
)
|
|
|
213.0
|
|
|
|
1.2
|
|
|
|
214.2
|
|
|
|
253.7
|
|
|
|
(30.0
|
)
|
|
|
223.7
|
|
|
|
1.2
|
|
|
|
224.9
|
|
|
|
(4.8
|
)%
|
Worldwide
|
|
$
|
1,786.3
|
|
|
$
|
(723.1
|
)
|
|
$
|
1,063.2
|
|
|
$
|
58.8
|
|
|
$
|
1,122.0
|
|
|
$
|
1,718.3
|
|
|
$
|
(681.9
|
)
|
|
$
|
1,036.4
|
|
|
$
|
66.5
|
|
|
$
|
1,102.9
|
|
|
|
1.7
|
%
|
|
|
Nine Months Ended September 30,
|
|
|
|
2016
|
|
|
2015
|
|
|
|
Retail
Sales(1)
|
|
|
Distributor
Allowance
|
|
|
Product
Sales
|
|
|
Shipping &
Handling
Revenues
|
|
|
Net
Sales
|
|
|
Retail
Sales(1)
|
|
|
Distributor
Allowance
|
|
|
Product
Sales
|
|
|
Shipping &
Handling
Revenues
|
|
|
Net
Sales
|
|
|
Change in
Net Sales
|
|
|
|
(In millions)
|
|
North America
|
|
$
|
1,246.8
|
|
|
$
|
(564.1
|
)
|
|
$
|
682.7
|
|
|
$
|
70.8
|
|
|
$
|
753.5
|
|
|
$
|
1,116.8
|
|
|
$
|
(504.4
|
)
|
|
$
|
612.4
|
|
|
$
|
63.7
|
|
|
$
|
676.1
|
|
|
|
11.4
|
%
|
Mexico
|
|
|
587.0
|
|
|
|
(265.8
|
)
|
|
|
321.2
|
|
|
|
20.6
|
|
|
|
341.8
|
|
|
|
626.5
|
|
|
|
(281.4
|
)
|
|
|
345.1
|
|
|
|
21.1
|
|
|
|
366.2
|
|
|
|
(6.7
|
)%
|
South & Central America
|
|
|
637.3
|
|
|
|
(295.2
|
)
|
|
|
342.1
|
|
|
|
25.8
|
|
|
|
367.9
|
|
|
|
722.2
|
|
|
|
(333.3
|
)
|
|
|
388.9
|
|
|
|
44.4
|
|
|
|
433.3
|
|
|
|
(15.1
|
)%
|
EMEA
|
|
|
1,060.5
|
|
|
|
(480.1
|
)
|
|
|
580.4
|
|
|
|
38.6
|
|
|
|
619.0
|
|
|
|
966.0
|
|
|
|
(438.1
|
)
|
|
|
527.9
|
|
|
|
34.8
|
|
|
|
562.7
|
|
|
|
10.0
|
%
|
Asia Pacific
|
|
|
1,145.6
|
|
|
|
(489.3
|
)
|
|
|
656.3
|
|
|
|
30.8
|
|
|
|
687.1
|
|
|
|
1,134.1
|
|
|
|
(476.4
|
)
|
|
|
657.7
|
|
|
|
48.8
|
|
|
|
706.5
|
|
|
|
(2.7
|
)%
|
China
|
|
|
767.3
|
|
|
|
(96.9
|
)
|
|
|
670.4
|
|
|
|
3.7
|
|
|
|
674.1
|
|
|
|
706.7
|
|
|
|
(84.0
|
)
|
|
|
622.7
|
|
|
|
3.1
|
|
|
|
625.8
|
|
|
|
7.7
|
%
|
Worldwide
|
|
$
|
5,444.5
|
|
|
$
|
(2,191.4
|
)
|
|
$
|
3,253.1
|
|
|
$
|
190.3
|
|
|
$
|
3,443.4
|
|
|
$
|
5,272.3
|
|
|
$
|
(2,117.6
|
)
|
|
$
|
3,154.7
|
|
|
$
|
215.9
|
|
|
$
|
3,370.6
|
|
|
|
2.2
|
%
|
(1)
|
Retail sales is a Non-GAAP measure which may not be comparable to similarly-titled measures used by other companies.
|
Changes in net sales are directly associated with the retailing of our products, recruitment of Members, and retention of sales leaders. Our strategies include providing quality products, improved DMOs, including daily consumption approaches such as Nutrition Clubs, easier access to product, systemized training of Members on our products and methods, and continued promotion and branding of Herbalife products.
Management’s role, both in-country and at the regional 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 Member 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 increase retailing, retention, and recruiting, which in turn affect net sales. Such tools include Company-sponsored 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 motivation programs increase the engagement 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, retention, and recruiting activities. These promotions have prizes ranging from qualifying for events to product prizes and vacations. The costs of these promotions are included in selling, general and administrative expenses.
38
DMOs are being generated in many of our markets and are globalized where applicable through the combined efforts of Members and country, regional and corpora
te management. While we support a number of different DMOs, one of the most popular DMOs is daily consumption. Under our traditional DMO, a Member typically sells to its customers on a somewhat infrequent basis (e.g., monthly) which provides fewer opportun
ities for interaction with their customers. Under a daily consumption DMO, a Member interacts with its customers on a more frequent basis 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 Club concept in Mexico, the Healthy Breakfast concept in Russia, and the Internet/Sampling and Weight Loss Challenge in the U.S.
Management’s strategy is to review the applicability of expanding successful country initiatives throughout a region, and where appropriate, financially support the globalization of these initiatives.
The factors described above have helped 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 our business and causes of sales fluctuations during the three and nine months ended September 30, 2016 as compared to the same periods in 2015, 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.
We believe Volume Point increases for the three and nine months ended September 30, 2016 reflect, among other qualitative factors, many but not all of our markets having come through a transition period as Members adjust to certain revisions to our Marketing Plan designed to improve the training and retention of sales leaders.
While most Members are not sales leaders, those wishing to become sales leaders have three qualification methods to do so. Prior to global rollout in 2009, there was only the one-month sales leader qualification method or the two-month sales leader qualification method. However, in 2009 we revised our Marketing Plan to enable Members to also qualify for sales leader status over a 12-month period. Since implementation in 2009, sales leaders who utilized the 12-month qualification method have typically performed better in terms of activity and retention rates. To further promote the 12-month sales leader qualification method, during 2014 we announced the implementation, effective globally in February 2015, of a first-order limit for new Members and in November 2014 we reduced the number of Volume Points required to be accumulated over the 12-month period from 5,000 to 4,000. See
Item 1 —
Business
in the 2015 10-K
for additional information.
We believe that the changes, while good for our business in the long-term, take time to incorporate into Members’ individual business practices, and in the near term have created distractions which can impact, and in certain markets has slowed, net sales. We believe these Marketing Plan changes can negatively impact net sales in the short term for several reasons. Sponsoring sales leaders must take the time to guide downline Members through the adjustment and acclimation process, diverting them from other sales efforts. Additionally, the changes can lead to a temporary slowdown in sales because some sales that previously would have taken place over a shorter one to two month period are deferred up to twelve months as a Member works towards possible sales leader qualification. Members within different regions and countries are adopting these changes to varying degrees and on varying timelines with such variances leading to differences in how the Marketing Plan changes impact our business in different regions or countries. To the extent we discuss a region or country is still adapting to the changes below, we believe net sales within that region or country are being negatively impacted by the factors described above. Additionally, each region and many countries are also impacted by individual internal and external factors beyond the Marketing Plan changes that impact net sales trends, such as the economic and regulatory environment, changes in product offering, strength and engagement of Member leadership, and level of brand awareness.
North America
The North America region reported net sales of $241.0 million and $753.5 million for the three and nine months ended September 30, 2016, respectively. Net sales increased $21.6 million, or 9.8%, and $77.4 million, or 11.4% for the three and nine months ended September 30, 2016, respectively, as compared to the same periods in 2015. In local currency, net sales increased 9.8% and 11.5% for the three and nine months ended September 30, 2016, respectively, as compared to the same periods in 2015. The increase in net sales in the region for the three and nine months ended September 30, 2016, as compared to the same periods in 2015, was a result of net sales increase in the U.S. of $21.3 million, or 9.9%, and $76.2 million, or 11.5%, respectively. The 9.8% increase in net sales for the North America region for the three months ended September 30, 2016 was primarily the result of an increase in sales volume, as measured by an increase in Volume Points, which increased net sales by approximately 9.3%. The 11.4% increase in net sales for the North America region for the nine months ended September 30, 2016 was primarily the result of an increase in sales volume, as measured by an increase in Volume Points, which increased net sales by approximately 10.1%, as well as price increases which increased net sales by approximately 1.1%.
39
We believe North America’s Volume Point increases for the quarter and year-to-date, versus decreases for the prior year periods, reflect the positive results of Members having adjusted to the
revisions in our Marketing Plan described above. The revisions are intended to enhance and reward a customer-centric business focus where we encourage Members to achieve product results and gain experience in the Herbalife business prior to attempting to q
ualify for sales leader. We are also seeing a positive impact from a program which encourages the establishment of a solid customer base and consistent low volume orders from new Members.
As discussed above, in July 2016 we reached a settlement with the FTC. As part of the settlement, we agreed to implement certain new procedures and enhance certain existing procedures in the United States, most of which we will have ten months from the Effective Date to implement. While we do not expect the settlement to have a long-term material adverse impact on our net sales in the North America region or on our Member base, we believe they may be negatively impacted as we and our Members implement and adjust to the changes.
Mexico
The Mexico region reported net sales of $112.8 million and $341.8 million for the three and nine months ended September 30, 2016, respectively. Net sales decreased $0.6 million, or 0.5%, and $24.4 million, or 6.7%, for the three and nine months ended September 30, 2016, respectively, as compared to the same periods in 2015. In local currency, net sales increased 13.6% and 9.7% for the three and nine months ended September 30, 2016, respectively, as compared to the same periods in 2015. The 0.5% decrease in net sales for the three months ended September 30, 2016 was primarily the result of the strong U.S. dollar and the resulting impact of fluctuations in foreign currency rates which reduced net sales by approximately 14.1%. This reduction to net sales was partially offset by an increase in sales volume, as measured by an increase in Volume Points, which increased net sales by approximately 13.2%. The 6.7% decrease in net sales for the nine months ended September 30, 2016 was primarily the result of the strong U.S. dollar and the resulting impact of fluctuations in foreign currency rates which reduced net sales by approximately 16.4%. This reduction to net sales was partially offset by an increase in sales volume, as measured by an increase in Volume Points, which increased net sales by approximately 9.9%.
We believe Mexico’s Volume Point increases for the quarter and year-to-date, versus decreases for the prior year periods, reflect the positive results of Members having adjusted to the revisions in our Marketing Plan described above, which include rules that require Members attempting to qualify for sales leader status to purchase directly from Herbalife rather than from their sponsor Member (these transactions with the sponsor Member are known as “field sales”). Also significantly, Mexico has instituted a program which encourages immediate focus on customers and consistent low volume orders from new Members. The Mexico market has also improved service to Members by expanding the number of locations at which Members can pay for and pick up orders.
South and Central America
The South and Central America region reported net sales of $121.0 million and $367.9 million for the three and nine months ended September 30, 2016, respectively. Net sales decreased $17.1 million, or 12.4%, and $65.4 million, or 15.1%, for the three and nine months ended September 30, 2016, respectively, as compared to the same periods in 2015. In local currency, net sales decreased 8.7% and 0.9% for the three and nine months ended September 30, 2016, respectively, as compared to the same periods in 2015. The 12.4% decrease in net sales for the three months ended September 30, 2016 was primarily the result of a decline in sales volume, as measured by a decrease in Volume Points, and fluctuations in foreign currency rates, which reduced net sales by approximately 14.6% and 3.7%, respectively. These reductions to net sales were partially offset by price increases which increased net sales by approximately 10.0%. The 15.1% decrease in net sales for the nine months ended September 30, 2016 was primarily the result of fluctuations in foreign currency rates, and a decline in sales volume, as measured by a decrease in Volume Points, which reduced net sales by approximately 14.2% and 12.8%, respectively. These reductions to net sales were partially offset by price increases which increased net sales by approximately 12.1%.
We believe the decline in Volume Points for the region for the quarter and year-to-date, most significantly in the Brazil market and continuing a trend of declines in prior comparable periods, was a result of certain country-specific challenges in the markets making up the region discussed below, and more generally distractions to Member operations as they adjust to the revisions to our Marketing Plan described above.
40
In Brazi
l, the region’s largest market, net sales were $46.4 million and $142.1 million for the three and nine months ended September 30, 2016, respectively. Net sales decreased $12.8 million, or 21.6%, and $58.8 million, or 29.3% for the three and nine months end
ed September 30, 2016, respectively, as compared to the same periods in 2015. In local currency, net sales decreased 27.7% and 18.8% for the three and nine months ended September 30, 2016, respectively, as compared to the same periods in 2015. The fluctuat
ion of foreign currency rates had a favorable impact of $3.6 million and an unfavorable impact of $21.1 million on net sales for the three and nine months ended September 30, 2016, respectively. Brazil’s net sales decrease for the three and nine months end
ed September 30, 2016 was attributable to adverse economic and political conditions in the market and, for the nine month period, foreign currency fluctuations. We believe this challenging business environment has contributed to Members in Brazil transitio
ning more slowly through the Marketing Plan changes implemented as described above compared with other major markets. We have introduced programs in Brazil that have been successful in other regions to improve member activity and productivity. Changes in I
CMS tax legislation, effective for 2016, reduced third quarter net sales by approximately $5 million and year-to-date net sales by approximately $10 million.
Net sales in Peru were $16.2 million and $48.2 million for the three and nine months ended September 30, 2016, respectively. Net sales did not change materially for the quarter and increased $0.7 million, or 1.5%, for the nine months ended September 30, 2016 as compared to the same periods in 2015. In local currency, net sales increased 3.9% and 9.2% for the three and nine months ended September 30, 2016, respectively, as compared to the same periods in 2015. The fluctuation of foreign currency rates had an unfavorable impact of $0.6 million and $3.6 million on net sales for the three and nine months ended September 30, 2016, respectively. The market has seen success with strategies such as Nutrition Clubs and a program which encourages consistent low volume orders from new Members.
Net sales in Venezuela were $1.1 million and $9.5 million for the three and nine months ended September 30, 2016, respectively. Net sales decreased $2.5 million, or 68.7%, and $3.2 million, or 25.1%, for the three and nine months ended September 30, 2016, respectively, as compared to the same periods in 2015. Significant Bolivar-to-dollar exchange rate deterioration and sales volume declines were somewhat offset by the impact of significant price increases in the market due to an inflationary environment. Venezuela net sales represent less than 1% of our consolidated net sales.
EMEA
The EMEA region reported net sales of $201.6 million and $619.0 million for the three and nine months ended September 30, 2016, respectively. Net sales increased $19.1 million, or 10.5%, and $56.3 million, or 10.0%, for the three and nine months ended September 30, 2016, respectively, as compared to the same periods in 2015. In local currency, net sales increased 14.9% and 17.4% for the three and nine months ended September 30, 2016, respectively, as compared to the same periods in 2015. The 10.5% increase in net sales for the three months ended September 30, 2016 was primarily the result of an increase in sales volume, as measured by an increase in Volume Points, and price increases which increased net sales by approximately 15.1% and 1.8%, respectively. This increase in net sales was partially offset by the effect of the strong U.S. dollar and the resulting impact of fluctuations in foreign currency rates, which reduced net sales by approximately 4.4%. The 10.0% increase in net sales for the nine months ended September 30, 2016 was primarily the result of an increase in sales volume, as measured by an increase in Volume Points, and price increases which increased net sales by approximately 16.9% and 2.3%, respectively. This increase in net sales was partially offset by the effect of the strong U.S. dollar and the resulting impact of fluctuations in foreign currency rates, which reduced net sales by approximately 7.4%.
The EMEA region has had several years of strong growth in sales volume. 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 $34.3 million and $106.7 million for the three and nine months ended September 30, 2016, respectively. Net sales increased $3.9 million, or 12.6%, and $11.0 million, or 11.5%, for the three and nine months ended September 30, 2016, respectively, as compared to the same periods in 2015. In local currency, net sales increased 12.3% and 11.3% for the three and nine months ended September 30, 2016, respectively, as compared to the same periods in 2015. The fluctuation of foreign currency rates had a favorable impact of $0.1 million on net sales for both the three and nine months ended September 30, 2016. Italy continues to benefit from an organized training approach, events such as city-by-city tours, and efforts to increase brand awareness.
41
Net sales in Spain were $25.1 million and $76.4 million for the three and nine months ended September 30, 2016, respectively. Net sales increased $1.8 million, or 7.8%, and $12.1 million, or 18.7%, for the thre
e and nine months ended September 30, 2016, respectively, as compared to the same periods in 2015. In local currency, net sales increased 7.5% and 18.6% for the three and nine months ended September 30, 2016, respectively, as compared to the same periods i
n 2015. The fluctuation of foreign currency rates had a favorable impact of $0.1 million on net sales for both the three and nine months ended September 30, 2016. Spain has seen continued growth in the number of Member locations such as Nutrition Clubs, an
d utilized local marketing strategies to increase national brand awareness.
Net sales in Russia were $25.2 million and $76.2 million for the three and nine months ended September 30, 2016, respectively. Net sales increased $2.9 million, or 13.2%, and $1.8 million, or 2.5%, for the three and nine months ended September 30, 2016, respectively, as compared to the same periods in 2015. In local currency, net sales increased 16.3% and 18.4% for the three and nine months ended September 30, 2016, respectively, as compared to the same periods in 2015. The fluctuation of foreign currency rates had an unfavorable impact of $0.7 million and $11.9 million on net sales for the three and nine months ended September 30, 2016, respectively. Product prices in Russia were increased 5% in March 2016 and 14% in March 2015. Russia continues to emphasize the strategy of building a sustainable business through customer focus and daily consumption.
Net sales in the United Kingdom were $10.3 million and $36.2 million for the three and nine months ended September 30, 2016, respectively. Net sales decreased $3.7 million, or 26.5%, and $5.5 million, or 13.3%, for the three and nine months ended September 30, 2016, respectively, as compared to the same periods in 2015. In local currency, net sales decreased 13.2% and 4.9% for the three and nine months ended September 30, 2016, respectively, as compared to the same periods in 2015. The fluctuation of foreign currency rates had an unfavorable impact of $1.9 million and $3.5 million on net sales for the three and nine months ended September 30, 2016, respectively.
Asia Pacific
The Asia Pacific region, which excludes China, reported net sales of $231.4 million and $687.1 million for the three and nine months ended September 30, 2016, respectively. Net sales increased $6.8 million, or 3.0%, and decreased $19.4 million, or 2.7%, for the three and nine months ended September 30, 2016, respectively, as compared to the same periods in 2015. In local currency, net sales increased 1.3% and 0.3% for the three and nine months ended September 30, 2016, respectively, as compared to the same periods in 2015. The 3.0% increase in net sales for the three months ended September 30, 2016 was primarily the result of an increase in sales volume, as measured by an increase in Volume Points, the impact of fluctuations in foreign currency rates, and price increases which increased net sales by approximately 6.9%, 1.7%, and 0.4%, respectively. These factors were significantly offset by an unfavorable change in the region’s sales mix resulting from a greater percentage of our sales volume coming from markets with lower prices. The 2.7% decrease in net sales for the nine months ended September 30, 2016 was primarily the result of the impact of fluctuations in foreign currency rates, which reduced net sales by approximately 3.0%. This reduction to net sales was partially offset by an increase in sales volume, as measured by an increase in Volume Points, and price increases which contributed approximately 1.0% and 1.3%, respectively, to net sales.
We believe the increases in Volume Points for the region for the quarter and year-to-date periods after declines in prior comparable periods were driven by country-specific factors including those discussed below.
Net sales in South Korea were $45.0 million and $142.6 million for the three and nine months ended September 30, 2016, respectively. Net sales decreased $20.1 million, or 30.9%, and $71.7 million, or 33.5%, for the three and nine months ended September 30, 2016, respectively, as compared to the same periods in 2015. In local currency, net sales decreased 33.7% and 30.9% for the three and nine months ended September 30, 2016, respectively, as compared to the same periods in 2015. The fluctuation of foreign currency rates had a favorable impact of $1.8 million and an unfavorable impact of $5.5 million on net sales for the three and nine months ended September 30, 2016, respectively. South Korea has been negatively impacted by a number of changes in the Marketing Plan, some of which are unique to South Korea. In addition to the shift in emphasis toward the longer-term sales leader qualification method described above, we also changed the product discount structure in South Korea and began charging a fee for the Member kit this year. Previously, the Member kit in South Korea was free. While we believe these changes will benefit the market in the long term, they have resulted in sales declines as sales leaders continue to adapt to these new methods of operation.
Net sales in India were $44.9 million and $121.4 million for the three and nine months ended September 30, 2016, respectively. Net sales increased $3.8 million, or 9.2%, and $0.2 million, or 0.2%, for the three and nine months ended September 30, 2016, respectively, as compared to the same periods in 2015. In local currency, net sales increased 12.6% and 5.7% for the three and nine months ended September 30, 2016, respectively, as compared to the same periods in 2015. The fluctuation of foreign currency rates had an unfavorable impact of $1.4 million and $6.7 million on net sales for the three and nine months ended September 30, 2016, respectively. In May, we launched a program that emphasizes consistent low-volume orders which we believe has contributed to higher sales leader activity and productivity compared with the same period last year.
42
Net sales in Taiwan were $28.7 million and $95.2 million for the three and nine months ended September 30, 2016, respectively. Net sales decreased $1.8 million, or 6.0%, and increased
$1.5 million, or 1.6%, for the three and nine months ended September 30, 2016, respectively, as compared to the same periods in 2015. In local currency, net sales decreased 6.8% and increased 4.9% for the three and nine months ended September 30, 2016, re
spectively, as compared to the same periods in 2015. The fluctuation of foreign currency rates had a favorable impact of $0.2 million and an unfavorable impact of $3.1 million on net sales for the three and nine months ended September 30, 2016, respectivel
y. Taiwan had a price increase of 2.75% in June 2016. We believe product volume purchased ahead of this price increase drove sales in the second quarter of 2016 and had an adverse impact on third quarter sales.
Net sales in Indonesia were $29.0 million and $83.5 million for the three and nine months ended September 30, 2016, respectively. Net sales increased $11.1 million, or 62.1%, and $20.6 million, or 32.8%, for the three and nine months ended September 30, 2016, respectively, as compared to the same periods in 2015. In local currency, net sales increased 53.1% and 33.3% for the three and nine months ended September 30, 2016, respectively, as compared to the same periods in 2015. The fluctuation of foreign currency rates had a favorable impact of $1.6 million and an unfavorable impact of $0.3 million on net sales for the three and nine months ended September 30, 2016, respectively. Indonesia had price increases of 3% in September 2016 and 6% in October 2015. 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.
China
Net sales in China were $214.2 million and $674.1 million for the three and nine months ended September 30, 2016, respectively. Net sales decreased $10.7 million, or 4.8%, and increased $48.3 million, or 7.7%, for the three and nine months ended September 30, 2016, respectively, as compared to the same periods in 2015. In local currency, net sales increased 0.9% and 13.4% for the three and nine months ended September 30, 2016, respectively, as compared to the same periods in 2015. The net sales decrease for the three months ended September 30, 2016 was primarily the result of the impact of fluctuations in foreign currency rates, which reduced net sales by approximately 5.6%, partially offset by an increase in sales volume, as measured by an increase in Volume Points, which increased net sales by approximately 2.3%. The net sales increase for the nine months ended September 30, 2016 were primarily the result of increases in sales volume, as measured by an increase in Volume Points, which increased net sales by approximately 14.2%, partially offset by the impact of fluctuations in foreign currency rates, which reduced net sales by approximately 5.7%
We have seen continued adoption and acculturation of daily consumption DMOs in the China market, including Nutrition Clubs, aided by a Preferred Customer program, a Healthy Active Lifestyle program and supported by ongoing investments in advertising, corporate
social responsibility and brand awareness. We continue to enhance service provider support and product access in China through online and mobile platforms. We believe the lower rate of sales volume increase compared with recent periods is attributed to factors such as Members testing new business methods that did not prove to be as sustainable as traditional methods. Members are now re-focusing on their proven business methods.
Sales by Product Category
|
|
Three Months Ended September 30,
|
|
|
|
2016
|
|
|
2015
|
|
|
|
Retail
Sales(2)
|
|
|
Distributor
Allowance
|
|
|
Product
Sales
|
|
|
Shipping &
Handling
Revenues
|
|
|
Net
Sales
|
|
|
Retail
Sales(2)
|
|
|
Distributor
Allowance
|
|
|
Product
Sales
|
|
|
Shipping &
Handling
Revenues
|
|
|
Net
Sales
|
|
|
% Change in
Net Sales
|
|
|
|
(In millions)
|
|
Weight Management
|
|
$
|
1,156.9
|
|
|
$
|
(480.3
|
)
|
|
$
|
676.6
|
|
|
$
|
38.1
|
|
|
$
|
714.7
|
|
|
$
|
1,128.3
|
|
|
$
|
(461.3
|
)
|
|
$
|
667.0
|
|
|
$
|
43.6
|
|
|
$
|
710.6
|
|
|
|
0.6
|
%
|
Targeted Nutrition
|
|
|
432.6
|
|
|
|
(179.6
|
)
|
|
|
253.0
|
|
|
|
14.3
|
|
|
|
267.3
|
|
|
|
386.5
|
|
|
|
(157.9
|
)
|
|
|
228.6
|
|
|
|
14.9
|
|
|
|
243.5
|
|
|
|
9.8
|
%
|
Energy, Sports and Fitness
|
|
|
113.5
|
|
|
|
(47.1
|
)
|
|
|
66.4
|
|
|
|
3.7
|
|
|
|
70.1
|
|
|
|
106.3
|
|
|
|
(43.6
|
)
|
|
|
62.7
|
|
|
|
4.2
|
|
|
|
66.9
|
|
|
|
4.8
|
%
|
Outer Nutrition
|
|
|
41.0
|
|
|
|
(17.1
|
)
|
|
|
23.9
|
|
|
|
1.3
|
|
|
|
25.2
|
|
|
|
49.4
|
|
|
|
(20.1
|
)
|
|
|
29.3
|
|
|
|
1.9
|
|
|
|
31.2
|
|
|
|
(19.2
|
)%
|
Literature, Promotional
and Other(1)
|
|
|
42.3
|
|
|
|
1.0
|
|
|
|
43.3
|
|
|
|
1.4
|
|
|
|
44.7
|
|
|
|
47.8
|
|
|
|
1.0
|
|
|
|
48.8
|
|
|
|
1.9
|
|
|
|
50.7
|
|
|
|
(11.8
|
)%
|
Total
|
|
$
|
1,786.3
|
|
|
$
|
(723.1
|
)
|
|
$
|
1,063.2
|
|
|
$
|
58.8
|
|
|
$
|
1,122.0
|
|
|
$
|
1,718.3
|
|
|
$
|
(681.9
|
)
|
|
$
|
1,036.4
|
|
|
$
|
66.5
|
|
|
$
|
1,102.9
|
|
|
|
1.7
|
%
|
43
|
|
Nine Months Ended September 30,
|
|
|
|
2016
|
|
|
2015
|
|
|
|
Retail
Sales(2)
|
|
|
Distributor
Allowance
|
|
|
Product
Sales
|
|
|
Shipping &
Handling
Revenues
|
|
|
Net
Sales
|
|
|
Retail
Sales(2)
|
|
|
Distributor
Allowance
|
|
|
Product
Sales
|
|
|
Shipping &
Handling
Revenues
|
|
|
Net
Sales
|
|
|
% Change in
Net Sales
|
|
|
|
(In millions)
|
|
Weight Management
|
|
$
|
3,538.4
|
|
|
$
|
(1,463.2
|
)
|
|
$
|
2,075.2
|
|
|
$
|
123.7
|
|
|
$
|
2,198.9
|
|
|
$
|
3,456.2
|
|
|
$
|
(1,431.1
|
)
|
|
$
|
2,025.1
|
|
|
$
|
141.5
|
|
|
$
|
2,166.6
|
|
|
|
1.5
|
%
|
Targeted Nutrition
|
|
|
1,300.7
|
|
|
|
(537.8
|
)
|
|
|
762.9
|
|
|
|
45.5
|
|
|
|
808.4
|
|
|
|
1,206.6
|
|
|
|
(499.6
|
)
|
|
|
707.0
|
|
|
|
49.4
|
|
|
|
756.4
|
|
|
|
6.9
|
%
|
Energy, Sports and Fitness
|
|
|
332.5
|
|
|
|
(137.5
|
)
|
|
|
195.0
|
|
|
|
11.6
|
|
|
|
206.6
|
|
|
|
302.5
|
|
|
|
(125.3
|
)
|
|
|
177.2
|
|
|
|
12.4
|
|
|
|
189.6
|
|
|
|
9.0
|
%
|
Outer Nutrition
|
|
|
134.9
|
|
|
|
(55.8
|
)
|
|
|
79.1
|
|
|
|
4.7
|
|
|
|
83.8
|
|
|
|
157.3
|
|
|
|
(65.1
|
)
|
|
|
92.2
|
|
|
|
6.4
|
|
|
|
98.6
|
|
|
|
(15.0
|
)%
|
Literature, Promotional
and Other(1)
|
|
|
138.0
|
|
|
|
2.9
|
|
|
|
140.9
|
|
|
|
4.8
|
|
|
|
145.7
|
|
|
|
149.7
|
|
|
|
3.5
|
|
|
|
153.2
|
|
|
|
6.2
|
|
|
|
159.4
|
|
|
|
(8.6
|
)%
|
Total
|
|
$
|
5,444.5
|
|
|
$
|
(2,191.4
|
)
|
|
$
|
3,253.1
|
|
|
$
|
190.3
|
|
|
$
|
3,443.4
|
|
|
$
|
5,272.3
|
|
|
$
|
(2,117.6
|
)
|
|
$
|
3,154.7
|
|
|
$
|
215.9
|
|
|
$
|
3,370.6
|
|
|
|
2.2
|
%
|
(1)
|
Product buy backs and returns in all product categories are included in literature, promotional and other category
|
(2)
|
Retail sales is a Non-GAAP measure which may not be comparable to similarly-titled measures used by other companies.
|
Net sales for the Weight Management, Targeted Nutrition, and Energy, Sports and Fitness product categories increased for the three and nine months ended September 30, 2016 as compared to the same periods in 2015. Net sales for the Outer Nutrition and Literature, Promotional, and Other product categories decreased for the three and nine months ended September 30, 2016 as compared to the same periods in 2015. The trend and business factors described in the above discussions of the individual geographic regions apply generally to all product categories.
Gross Profit
Gross profit was $912.9 million and $2,784.9 million for the three and nine months ended September 30, 2016, respectively, as compared to $896.0 million and $2,719.0 million for the same periods in 2015. As a percentage of net sales, gross profit for the three months ended September 30, 2016 was 81.4% as compared to 81.2% for the same period in 2015, or a favorable net increase of 20 basis points and for the nine months ended September 30, 2016 was 80.9% as compared to 80.7% for the same period in 2015, or a favorable net increase of 20 basis points. The gross profit rate for the three months ended September 30, 2016 included the favorable impact of cost savings through strategic sourcing and self-manufacturing of 114 basis points, retail price increases of 29 basis points, and other cost changes of 25 basis points, partially offset by the unfavorable impact of foreign currency fluctuations of 143 basis points, higher inventory write-downs of 4 basis points, and country mix of 1 basis point. The 20 basis point net increase for the nine months ended September 30, 2016 included the favorable impact of cost savings through strategic sourcing and self-manufacturing of 83 basis points, retail price increases of 44 basis points, lower inventory write-downs of 26 basis points, country mix of 25 basis points, and other cost changes of 5 basis points, partially offset by the unfavorable impact of foreign currency fluctuations of 163 basis points. Generally, the gross profit as a percentage of net sales may vary from period to period due to the impact from 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 $320.3 million and $968.9 million for the three and nine months ended September 30, 2016, respectively, as compared to $304.7 million and $946.4 million for the same periods in 2015. Royalty overrides as a percentage of net sales were 28.6% and 28.1% for the three and nine months ended September 30, 2016, respectively, as compared to 27.6% and 28.1% for the same periods in 2015. The changes in royalty overrides as a percentage of net sales were primarily due to the sales in our China business relative to that of our worldwide business. 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 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 $441.3 million and $1,545.2 million for the three and nine months ended September 30, 2016, respectively, as compared to $433.1 million and $1,335.0 million for the same periods in 2015. Selling, general and administrative expenses as a percentage of net sales were 39.3% and 44.9% for the three and nine months ended September 30, 2016, respectively, as compared to 39.2% and 39.6% for the same periods in 2015.
44
The increase in selling, general and administrative expenses for the nine months ended September 30, 2016 was primarily due to the $203.0 million regulatory settlements and $19.4 million in higher service fees to China i
ndependent service providers related to sales growth in China; partially offset by $19.6 million in lower net foreign exchange losses, which included $28.5 million lower net foreign exchange losses from the remeasurement of our Bolivar-denominated monetary
assets and liabilities (See
Liquidity and Capital Resources — Venezuela
, for further discussion of currency exchange rate issues in Venezuela).
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, 2016 and 2015, we recorded approximately $3.2 million and $3.6 million, respectively, of expenses related to this matter, which includes approximately $2.7 million and $3.3 million, respectively, of legal, advisory and other professional service fees. For the nine months ended September 30, 2016 and 2015, we recorded approximately $10.7 million and $15.0 million, respectively, of expenses related to this matter, which includes approximately $8.5 million and $13.7 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.
Other Operating Income
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 other operating income during the three and nine months ended September 30, 2016 and 2015.
Net Interest Expense
Net interest expense is as follows:
|
|
Three Months Ended
|
|
|
Nine Months Ended
|
|
|
|
September 30,
2016
|
|
|
September 30,
2015
|
|
|
September 30,
2016
|
|
|
September 30,
2015
|
|
|
|
(Dollars in millions)
|
|
Interest expense
|
|
$
|
24.0
|
|
|
$
|
25.5
|
|
|
$
|
74.6
|
|
|
$
|
73.7
|
|
Interest income
|
|
|
(1.9
|
)
|
|
|
(1.4
|
)
|
|
|
(4.5
|
)
|
|
|
(4.4
|
)
|
Net interest expense
|
|
$
|
22.1
|
|
|
$
|
24.1
|
|
|
$
|
70.1
|
|
|
$
|
69.3
|
|
The decrease in net interest expense for the three months ended September 30, 2016, as compared to the same period in 2015, was primarily due to transactions to convert our Bolivars to U.S. dollars for 2015 that were financing in nature and the payoff of our Term Loan in March 2016. These decreases were partially offset by an increase in interest expense from our revolving credit facility as a result of increased interest rates.
Other expense, net
There was no other expense, net for the nine months ended September 30, 2016 as compared to $2.3 million for the same period in 2015. Other expense, net as a percentage of net sales was 0.1% for the nine months ended September 30, 2015. The decrease in other expense, net, for the nine months ended September 30, 2016, as compared to the same period in 2015, was due to no other-than-temporary impairment losses recognized during the nine months ended September 30, 2016 as compared to the same period in 2015 in which losses were incurred in connection with our investments in Bolivar-denominated bonds.
Income Taxes
Income taxes were $41.7 million and $69.2 million for the three and nine months ended September 30, 2016, respectively, as compared to $43.9 million and $114.8 million for the same periods in 2015. The effective income tax rate was 32.2% and 30.1% for the three and nine months ended September 30, 2016, respectively, as compared to 31.9% and 31.1% for the same periods in 2015. The increase in the effective tax rate for the three months ended September 30, 2016, as compared to the same period in 2015, was primarily due to the impact of changes in the geographic mix of our income, partially offset by an increase in net benefits from discrete events. The decrease in the effective tax rate for the nine months ended September 30, 2016, as compared to the same period in 2015, was primarily due to an increase in net benefits from discrete events.
45
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, such as Venezuela as discussed below, 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.
Our existing debt has not resulted from the need to fund our normal operations, but instead has resulted primarily from our share repurchase program. Since inception in 2007, total share repurchases amounted to approximately $3.1 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 $788.3 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, capital expenditures, share repurchases, 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, 2016 and December 31, 2015.
For the nine months ended September 30, 2016, we generated $249.9 million of operating cash flow, as compared to $493.2 million for the same period in 2015. The decrease in our operating cash flow was the result of lower net income, lower non-cash items, and net unfavorable changes in operating assets and liabilities. The decrease in net income was primarily the result of the $203.0 million regulatory settlements, partially offset by higher contribution margin of $43.4 million driven by net sales growth; lower income taxes; and higher other operating income primarily related to government grants in China. The change in operating assets and liabilities was primarily the result of changes in inventories; and accrued expenses and accrued compensation primarily related to the higher employee bonus payments. The lower non-cash items were primarily the result of the decrease in foreign exchange losses related to Venezuela, and a decrease in deferred income taxes.
Capital expenditures, including accrued capital expenditures, for the nine months ended September 30, 2016 and 2015 were $111.5 million and $48.7 million, respectively. The majority of these expenditures represented investments in manufacturing facilities domestically and internationally, specifically the build-out of our Nanjing manufacturing facility which commenced operations in July 2016, management information systems including the upgrade of our Oracle enterprise wide systems which is expected to go live in the summer of 2017, initiatives to develop web-based Member tools, the expansion of our warehouse and sales centers, and the purchase of one of our office buildings in Torrance, California. We expect to incur total capital expenditures of approximately $145 million to $155 million for the full year of 2016.
In March 2016, Herbalife hosted its annual global Herbalife Summit event in Cancun, Mexico, where President Team members from around the world met and shared best practices, conducted leadership training and Herbalife management awarded Members $64.3 million of Mark Hughes bonus payments related to their 2015 performance. In March 2015, Herbalife management awarded Members $72.4 million of Mark Hughes bonus payments related to their 2014 performance.
46
Senior Secured Credit Facility
We currently have a senior secured credit facility, or the Credit Facility, with a syndicate of financial institutions as lenders which consists of a revolving credit facility. The Credit Facility previously included a term loan, or the Term Loan, which matured and was repaid in full in March 2016. In May 2015, we amended our Credit Facility and our $700 million borrowing capacity on our 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 on our revolving credit facility to $425.0 million as of September 30, 2016. Our revolving credit facility matures on March 9, 2017. During May 2015, pursuant to the amendment and upon execution, we made prepayments of approximately $20.3 million and $50.9 million on the Term Loan and revolving credit facility, respectively. The Credit Facility requires us to comply with a leverage ratio and a coverage 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. The Credit Facility also restricts our ability to pay dividends or repurchase our common shares to a maximum of $233.0 million until maturity and for every one dollar of share repurchase or dividend paid, the revolving credit facility’s borrowing capacity is permanently decreased by two dollars. The Credit Facility also provides for the grant of security interest on certain additional assets of the Company and its subsidiaries. We are also required to maintain a minimum balance of $200.0 million of consolidated cash and cash equivalents. As of September 30, 2016 and December 31, 2015, we were compliant with our debt covenants under the Credit Facility.
During the three months ended March 31, 2016, we repaid a total amount of $229.7 million to repay in full our Term Loan. We did not repay any amounts under the revolving credit facility during the three months ended June 30, 2016 and September 30, 2016. As of September 30, 2016, the U.S. dollar amount outstanding under the revolving credit facility was $410.0 million. As of December 31, 2015, the U.S. dollar amount outstanding under the Credit Facility was $639.7 million, which consisted of $229.7 million outstanding on the Term Loan and $410.0 million outstanding on the revolving credit facility. There were no outstanding foreign currency borrowings as of September 30, 2016 and December 31, 2015 under the Credit Facility. On September 30, 2016 and December 31, 2015, the weighted average interest rate for borrowings under the Credit Facility, including borrowings under the Term Loan as of December 31, 2015, was 4.13% and 2.78%, respectively.
See Note 4,
Long-Term Debt
, to the Condensed Consolidated Financial Statements for a further discussion on our Credit Facility.
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 for a further discussion on our Convertible Notes.
Off-Balance Sheet Arrangements
At September 30, 2016 and December 31, 2015, 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. The Credit Facility permits payments of dividends up to a specified cap as long as no default or event of default exists and the consolidated leverage ratio specified in the Credit Facility is not exceeded. See Note 4,
Long-Term Debt
, to the Condensed Consolidated Financial Statements for a further discussion on dividend restrictions.
47
Share Repurchases
Our board of directors has authorized a $1.5 billion share repurchase program that will expire on June 30, 2017. This share repurchase program allows us to repurchase our common shares, at such times and prices as determined by us as market conditions warrant, and to the extent Herbalife Ltd.’s distributable reserves are available under Cayman Islands law. The Credit Facility permits us to repurchase our common shares up to a specified cap as long as no default or event of default exists and the consolidated leverage ratio specified in the Credit Facility is not exceeded. See Note 4,
Long-Term Debt
, to the Condensed Consolidated Financial Statements for a further discussion on share repurchase restrictions.
In conjunction with the issuance of the Convertible Notes during February 2014, we paid approximately $685.8 million to 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 $69.02 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. The shares are treated as retired shares for basic and diluted EPS purposes although they remain legally outstanding. See Note 10,
Shareholders’ Equity (Deficit)
, to the Condensed Consolidated Financial Statements for a further discussion on the Forward Transactions.
During the nine months ended September 30, 2016 and 2015, we did not repurchase any of our common shares through open market purchases. As of September 30, 2016, the remaining authorized capacity under our $1.5 billion share repurchase program was $232.9 million inclusive of reductions for the Forward Transactions.
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 (Deficit)
, to the Condensed Consolidated Financial Statements for a further discussion of the Capped Call Transactions.
Working Capital and Operating Activities
As of September 30, 2016 and December 31, 2015, we had positive working capital of $296.1 million and $541.9 million, respectively, or a decrease of $245.8 million. This decrease was primarily due to the decrease in cash and cash equivalents and the increase in the current portion of long-term debt as $410.0 million of the Credit Facility relating to the revolving credit facility will be paid by March 9, 2017; partially offset by increases in inventories and prepaid expenses and other current assets, and the $229.7 million payment of the Credit Facility relating to the Term Loan.
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. In May 2015, we amended the Credit Facility as described further in Note 4,
Long-Term Debt
.
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 —
Quantitative and Qualitative Disclosures about Market Risk.
Venezuela
The adverse operating environment in Venezuela continues to be challenging for our Venezuela business, with high inflation, pricing limitations, importation restrictions, and foreign exchange restrictions. Foreign exchange controls in Venezuela continue to limit Herbalife Venezuela’s ability to repatriate earnings and settle its intercompany shipment obligations at any official rate. As a result, this has continued to significantly limit Herbalife Venezuela’s ability to acquire its U.S. dollar denominated raw materials and finished good inventory.
48
During the three and nine months ended September 30, 2016, we recognized foreign exchange losses and other related charges of
$0.1 million and $7.2 million, respectively, as compared to $1.5 million and $38.4 million
for the same periods in 2015 within our condensed consolidated statements of income related to our Venezuelan operations. During both the nine months ended
September
30, 2016 and 2015, Herbalife Venezuela’s net sales represented less than 1% of our consolidated net sales. As of
September
30, 2016, Herbalife Venezuela’s cash and cash equivalents primarily consisted of Bolivar-denominated cash of approximately $1.4 mill
ion. See our consolidated financial statements and related notes in the 2015 10-K for further information on Herbalife Venezuela and Venezuela’s highly inflationary economy.
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, 2016.
Subsequent Events
See Note 14,
Subsequent Events,
to the Condensed Consolidated Financial Statements 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 third party providers and 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 then are sold to Members who consume and sell Herbalife products to retail consumers or other Members. As of September 30, 2016, 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. Net sales include product sales and shipping and handling revenues. 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. Related royalty overrides are recorded when revenue is recognized.
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% of product sales for both the three and nine months ended September 30, 2016 and 2015.
49
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 condit
ions 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 $33.3 million and $39.4 million to present them at their lower of cost and
net realizable value, and lower of cost or market, in our condensed consolidated balance sheets as of September 30, 2016 and December 31, 2015, respectively.
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 recognized 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 value 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 use 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 assets, 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, 2016 and December 31, 2015, we had goodwill of approximately $94.5 million and $91.8 million, respectively. As of both September 30, 2016 and December 31, 2015, we had marketing related intangible assets of approximately $310.0 million. The increase in goodwill during the nine months ended September 30, 2016 was due to cumulative translation adjustments. No marketing related intangibles or goodwill impairment was recorded during the three and nine months ended September 30, 2016 and 2015.
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.
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The Company evaluates the realizability of its deferred tax assets by assessing the valuation allowance and by adjusting the amount of such allowanc
e, 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 in
come 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 require
d 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 lo
cation 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 inter
pretations 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.
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 return 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.