Herbalife(HLF) - 2018 Q4 - Annual Report

Part I Item 1. Business Herbalife Nutrition is a global direct-selling company with a "seed to feed" quality control strategy and a unique business model in China - The company operates a direct selling business model to distribute its nutrition products across 94 countries as of December 31, 2018[15][16] - The company's best-selling product line, Formula 1 Nutritional Shake Mix, consistently represented approximately 30% of net sales for 2018, 2017, and 2016[17] - Herbalife's "seed to feed" strategy involves significant investment in traceable ingredients, scientific personnel, product testing, and self-manufacturing, with company-owned facilities producing approximately 60% to 65% of inner nutrition products sold worldwide[22][24] - As of December 31, 2018, the company had approximately 4.5 million Members, which includes 0.9 million preferred members and 0.7 million distributors[30] - The business model in China is distinct from the global model to comply with local regulations, which prohibit multi-level marketing but permit direct selling[50][51] Product Mix as a Percentage of Net Sales (2016-2018) | Product Category | 2018 | 2017 | 2016 | | :--- | :--- | :--- | :--- | | Weight Management | 63.5% | 64.2% | 63.8% | | Targeted Nutrition | 25.4% | 24.5% | 23.6% | | Energy, Sports, and Fitness | 6.3% | 6.0% | 6.1% | | Outer Nutrition | 1.9% | 2.1% | 2.4% | | Literature, Promotional, and Other | 2.9% | 3.2% | 4.1% | Item 1A. Risk Factors The company faces risks from its dependence on independent Members, compliance with the FTC Consent Order, and the complex regulatory landscape in China - The business is highly dependent on its ability to recruit, retain, and motivate a large base of independent Members, who can terminate their agreements at any time[99][100] - The 2016 Consent Order with the FTC imposes significant compliance risks and costs, and failure to comply could negatively impact business operations in the U.S[127][129][130] - Operations in China are subject to unique risks due to a modified business model required by Chinese regulations, with uncertainty regarding the interpretation and enforcement of these rules[136][138][143] - Approximately 80% of net sales for the year ended December 31, 2018, were generated outside the U.S, exposing the company to foreign exchange and geopolitical risks[134] - The company's Formula 1 product line accounted for approximately 30% of net sales in 2018, creating a concentration risk[171] - The SEC and DOJ are conducting an investigation into the company's compliance with the FCPA in China, the outcome of which is uncertain[175][633] - Changes in U.S. tax law may classify some non-U.S. subsidiaries as Controlled Foreign Corporations (CFCs), which could have adverse tax consequences for certain U.S. shareholders[191][192] Item 1B. Unresolved Staff Comments The company reports that it has no unresolved staff comments from the SEC - None[218] Item 2. Properties The company leases most of its properties but owns a large manufacturing facility in Winston-Salem, North Carolina - The company leases most of its physical properties, including its corporate executive offices and major distribution centers[219] - The company owns an approximately 800,000 square foot manufacturing facility in Winston-Salem, North Carolina[220] - Leased manufacturing facilities are located in Suzhou, Nanjing, and Changsha, China[219] Item 3. Legal Proceedings Details on legal proceedings are referenced in Note 7 of the financial statements - The report refers to Note 7, Contingencies, for details on legal proceedings, including tax disputes, an FCPA investigation, and the FTC Consent Order[221][614] Item 4. Mine Safety Disclosures This item is not applicable to the company - Not applicable[221] Part II Item 5. Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities The company's common shares trade on the NYSE, dividends were terminated in 2014, and a new $1.5 billion share repurchase program was authorized in 2018 - The company's common shares are listed on the New York Stock Exchange (NYSE) under the symbol "HLF"[223] - In April 2014, the company terminated its quarterly cash dividend to utilize cash for share repurchases instead[228] - On October 30, 2018, a new five-year, $1.5 billion share repurchase program was authorized, with the full amount available as of year-end[230] - No common shares were repurchased during the three months ended December 31, 2018[231] Item 6. Selected Financial Data This section presents a five-year summary of key historical financial data, showing net sales of $4.89 billion and a shareholders' deficit of $723.4 million for 2018 - The company provides a reconciliation from its non-GAAP measure "Retail value" to the GAAP measure "Net sales," with a 2018 Retail value of $7.71 billion reconciling to Net sales of $4.89 billion[237] Selected Financial Data (2014-2018) | (in millions, except per share data) | 2018 | 2017 | 2016 | 2015 | 2014 | | :--- | :--- | :--- | :--- | :--- | :--- | | Net sales | $4,891.8 | $4,427.7 | $4,488.4 | $4,469.0 | $4,958.6 | | Operating income | $683.1 | $617.1 | $458.1 | $583.6 | $513.5 | | Net income | $296.6 | $213.9 | $260.0 | $339.1 | $308.7 | | Diluted EPS | $1.98 | $1.29 | $1.51 | $1.99 | $1.70 | | Total assets | $2,789.8 | $2,895.1 | $2,565.4 | $2,477.9 | $2,355.0 | | Total debt | $2,453.8 | $2,268.1 | $1,447.9 | $1,622.0 | $1,791.8 | | Total shareholders' (deficit) equity | $(723.4) | $(334.7) | $196.3 | $(53.5) | $(334.4) | Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations In 2018, net sales grew 10.5% to $4.9 billion, driven by strong volume growth, while the company refinanced its debt and continued share repurchases - Net sales for 2018 increased 10.5% to $4.9 billion, while net income increased 38.7% to $296.6 million, or $1.98 per diluted share[273][274] - The company refinanced its debt in August 2018, entering a new $1.25 billion senior secured credit facility and issuing $400 million in senior notes due 2026[375][384] - As of December 31, 2018, the company had working capital of $216.2 million, a decrease of $737.3 million from 2017, primarily due to changes in cash and current debt[399] Worldwide Volume Points (2016-2018) | (in millions) | 2018 | 2017 | % Change | 2016 | % Change | | :--- | :--- | :--- | :--- | :--- | :--- | | Worldwide | 5,892.0 | 5,379.4 | 9.5% | 5,582.1 | (3.6)% | Results of Operations Net sales in 2018 increased 10.5% to $4.9 billion, driven by volume growth across most regions, leading to a net income increase to $296.6 million - Gross profit as a percentage of net sales increased to 81.2% in 2018 from 80.8% in 2017, primarily due to retail price increases[309] - Selling, general, and administrative (SG&A) expenses increased to $1,955.2 million in 2018 from $1,758.6 million in 2017, driven by higher service fees and member promotion costs[312][313] - The effective income tax rate decreased to 36.1% in 2018 from 54.6% in 2017, primarily due to a lower net tax expense related to U.S. Tax Reform[320] Net Sales by Geographic Region (2018 vs. 2017) | Region | 2018 Net Sales (in millions) | 2017 Net Sales (in millions) | % Change | | :--- | :--- | :--- | :--- | | North America | $948.3 | $840.2 | 12.9% | | Mexico | $467.9 | $442.7 | 5.7% | | South & Central America | $437.6 | $474.3 | (7.7)% | | EMEA | $977.0 | $868.7 | 12.5% | | Asia Pacific | $1,053.4 | $915.9 | 15.0% | | China | $1,007.6 | $885.9 | 13.7% | | Worldwide | $4,891.8 | $4,427.7 | 10.5% | Net Sales by Product Category (2018 vs. 2017) | Product Category | 2018 Net Sales (in millions) | 2017 Net Sales (in millions) | % Change | | :--- | :--- | :--- | :--- | | Weight Management | $3,105.8 | $2,842.5 | 9.3% | | Targeted Nutrition | $1,243.5 | $1,082.8 | 14.8% | | Energy, Sports, and Fitness | $308.4 | $263.8 | 16.9% | | Outer Nutrition | $91.9 | $93.9 | (2.1)% | | Literature, Promotional, and Other | $142.2 | $144.7 | (1.7)% | Liquidity and Capital Resources The company's liquidity is sourced from operating cash flow, with debt used for share repurchases, and a significant portion of cash held by foreign subsidiaries - Net cash provided by operating activities increased to $648.4 million in 2018 from $590.8 million in 2017[369] - In August 2018, the company entered into a new $1.25 billion senior secured credit facility and issued $400 million in senior notes due 2026 to repay its 2017 credit facility[375][384] - As of December 31, 2018, foreign subsidiaries held $870.3 million of the company's total $1.2 billion in cash and cash equivalents[387] - During 2018, the company repurchased 11.4 million common shares for approximately $600.3 million through open-market purchases and a tender offer[394] Contractual Obligations as of December 31, 2018 | Obligation (in millions) | Total | Due in 2019 | Due 2020-2021 | Due 2022-2023 | Due 2024 & Thereafter | | :--- | :--- | :--- | :--- | :--- | :--- | | Convertible senior notes due 2019 | $688.5 | $688.5 | $— | $— | $— | | Convertible senior notes due 2024 | $629.4 | $14.4 | $28.9 | $28.9 | $557.2 | | Senior notes due 2026 | $632.0 | $29.0 | $58.0 | $58.0 | $487.0 | | Senior secured credit facility | $1,329.9 | $76.7 | $157.9 | $317.3 | $778.0 | | Operating leases | $253.7 | $43.1 | $63.7 | $35.5 | $111.4 | | Total | $3,741.2 | $1,013.9 | $348.7 | $445.0 | $1,933.6 | Critical Accounting Policies Key accounting policies involve significant judgments in revenue recognition, inventory valuation, impairment testing for goodwill, and accounting for income taxes - Revenue is generally recognized upon delivery when control passes to the Member, net of product returns and distributor allowances[409] - Allowances for product returns are based on historical rates and are not significant, amounting to approximately 0.1% of product sales for 2018, 2017, and 2016[410] - Goodwill and marketing-related intangible assets are tested for impairment annually; a 2018 qualitative assessment indicated no impairment[412][413][414] - The company evaluates the realizability of deferred tax assets and recognizes tax benefits for uncertain positions only if it is more likely than not that the position will be sustained[420][421] Item 7A. Quantitative and Qualitative Disclosures About Market Risk The company is exposed to market risks from foreign currency exchange rates and interest rates, which it manages with derivative instruments and by fixing rates on certain debt - The company is exposed to foreign exchange risk and uses short-term derivatives to reduce exposure to currency fluctuations[429] - The company is exposed to interest rate risk on its variable-rate 2018 Credit Facility, where a hypothetical 1% change in interest rates would change annual interest expense by approximately $10.0 million[436] - As of December 31, 2018, the aggregate notional amount of outstanding foreign currency contracts designated as cash-flow hedges was approximately $43.8 million[432] Item 8. Financial Statements and Supplementary Data This section incorporates by reference the company's consolidated financial statements and the independent auditor's report - The consolidated financial statements, notes, and the report of PricewaterhouseCoopers LLP are incorporated by reference and located in Part IV, Item 15[440] Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure The company reports no changes in or disagreements with its accountants - None[441] Item 9A. Controls and Procedures Management concluded that the company's disclosure controls and internal control over financial reporting were effective as of December 31, 2018 - Management concluded that the company's disclosure controls and procedures were effective as of December 31, 2018[442] - Based on the COSO framework, management concluded that the company's internal control over financial reporting was effective as of December 31, 2018[446] - There were no material changes in internal control over financial reporting during the fourth quarter of 2018[448] Item 9B. Other Information The company reports no other information for this item - None[448] Part III Item 10. Directors, Executive Officers and Corporate Governance Information required for this item is incorporated by reference from the company's definitive proxy statement - Information is incorporated by reference from the definitive proxy statement[450] Item 11. Executive Compensation Information required for this item is incorporated by reference from the company's definitive proxy statement - Information is incorporated by reference from the definitive proxy statement[451] Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters Information required for this item is incorporated by reference from the company's definitive proxy statement - Information is incorporated by reference from the definitive proxy statement[452] Item 13. Certain Relationships and Related Transactions, and Director Independence Information required for this item is incorporated by reference from the company's definitive proxy statement - Information is incorporated by reference from the definitive proxy statement[453] Item 14. Principal Accountant Fees and Services Information required for this item is incorporated by reference from the company's definitive proxy statement - Information is incorporated by reference from the definitive proxy statement[454] Part IV Item 15. Exhibits, Financial Statement Schedules This section contains the company's audited consolidated financial statements, notes, the independent auditor's report, and an index of all filed exhibits Report of Independent Registered Public Accounting Firm PricewaterhouseCoopers LLP issued unqualified opinions on the company's financial statements and internal controls, noting changes in accounting principles - PricewaterhouseCoopers LLP issued an unqualified opinion, stating the financial statements present fairly, in all material respects, the financial position of the company[465] - The firm also opined that the company maintained effective internal control over financial reporting as of December 31, 2018[465] - The report notes a change in accounting principle for revenue from contracts with customers (ASC 606) in 2018[466] Consolidated Financial Statements The financial statements show total assets of $2.8 billion, a shareholders' deficit of $723.4 million, and net income of $296.6 million for 2018 Consolidated Balance Sheet Highlights (as of Dec 31) | (in millions) | 2018 | 2017 | | :--- | :--- | :--- | | Cash and cash equivalents | $1,198.9 | $1,278.8 | | Total current assets | $1,805.0 | $1,860.3 | | Total assets | $2,789.8 | $2,895.1 | | Total current liabilities | $1,588.8 | $906.8 | | Long-term debt, net | $1,774.9 | $2,165.7 | | Total liabilities | $3,513.2 | $3,229.8 | | Total shareholders' deficit | $(723.4) | $(334.7) | Consolidated Income Statement Highlights (Year Ended Dec 31) | (in millions) | 2018 | 2017 | 2016 | | :--- | :--- | :--- | :--- | | Net sales | $4,891.8 | $4,427.7 | $4,488.4 | | Gross profit | $3,972.5 | $3,579.1 | $3,633.8 | | Operating income | $683.1 | $617.1 | $458.1 | | Net income | $296.6 | $213.9 | $260.0 | Consolidated Cash Flow Highlights (Year Ended Dec 31) | (in millions) | 2018 | 2017 | 2016 | | :--- | :--- | :--- | :--- | | Net cash from operating activities | $648.4 | $590.8 | $367.3 | | Net cash used in investing activities | $(83.9) | $(95.2) | $(142.4) | | Net cash used in financing activities | $(593.1) | $(85.2) | $(252.3) | Item 16. Form 10-K Summary The company reports no summary for this item - None[721]