Herbalife(HLF) - 2021 Q4 - Annual Report

PART I Business Herbalife Nutrition is a global direct-selling nutrition company with 6.3 million members, focused on weight management and subject to extensive regulation Product Sales Weight Management dominates product sales at 58.1% in 2021, with Formula 1 as the top-selling line and consistently low returns Net Sales by Product Category (% of Total) | Product Category | 2021 | 2020 | 2019 | | :--- | :--- | :--- | :--- | | Weight Management | 58.1% | 59.8% | 61.8% | | Targeted Nutrition | 28.2% | 27.6% | 26.2% | | Energy, Sports, and Fitness | 9.5% | 7.9% | 7.2% | | Outer Nutrition | 1.9% | 2.0% | 2.0% | | Literature, Promotional, and Other | 2.3% | 2.7% | 2.8% | - The company's best-selling product line, Formula 1 Nutritional Shake Mix, accounted for approximately 27% of net sales for the year ended December 31, 2021[18] - Product returns and buybacks were consistently low, representing approximately 0.1% of net sales for each of the years ended December 31, 2021, 2020, and 2019[22] Our Network Marketing Program The company operates a direct-selling model with 6.3 million members, including 2.5 million preferred members and 2.3 million distributors - As of December 31, 2021, the company had approximately 6.3 million Members, including 2.5 million preferred members and 2.3 million distributors in segmented markets[32] Sales Leader Retention Rate (excluding China) | Re-qualification Period Ending | Retention Rate | | :--- | :--- | | January 2022 | 68.9% | | January 2021 | 67.9% | | January 2020 | 66.5% | Number of Sales Leaders (as of end of February) | Region | 2021 | 2020 | 2019 | | :--- | :--- | :--- | :--- | | North America | 95,402 | 71,202 | 66,264 | | Mexico | 73,043 | 72,866 | 75,475 | | South and Central America | 58,316 | 61,535 | 64,929 | | EMEA | 158,153 | 130,438 | 121,297 | | Asia Pacific | 173,582 | 158,815 | 133,817 | | Total (ex-China) | 558,496 | 494,856 | 461,782 | | China | 68,301 | 70,701 | 89,077 | | Worldwide Total | 626,797 | 565,557 | 550,859 | Business in China Herbalife's China business model adapts to local regulations, prohibiting multi-level marketing but permitting direct selling through independent service providers - The business model in China differs from other markets due to local regulations; multi-level marketing is not permitted, but direct selling is[50][51] - Independent service providers in China are compensated for marketing and sales support services, not through the royalty override system used globally, with compensation based on sales and service quality[53] Resources The company's "seed to feed" strategy emphasizes supply chain control, with 60% of inner nutrition products manufactured in-house and a global distribution network - The company's four manufacturing facilities (HIMs) produce approximately 60% of its inner nutrition products sold worldwide[57] - In 2021, approximately 19% of products were purchased from the top three third-party manufacturers[59] - The company's distribution network includes over 1,600 distribution points and partner retail locations globally[61] Regulation Herbalife is extensively regulated by agencies like the FDA and FTC, notably under a 2016 Consent Order dictating U.S. business practices - The company's products and business are regulated by numerous agencies, including the FDA and FTC in the United States[68][70] - A 2016 Consent Order with the FTC requires the company to segment its U.S. members into 'preferred members' and 'distributors' and to base distributor compensation on documented retail sales[82] - The company is subject to a 1986 permanent injunction in California that prevents specified advertising claims and mandates that payments to Members be based on retail value[80] Human Capital As of December 31, 2021, Herbalife Nutrition had approximately 10,800 employees and is focused on diversity, equity, and inclusion initiatives - As of December 31, 2021, the company had approximately 10,800 employees, with 3,100 in the United States[102] - In 2021, the company established diversity goals for women in global leadership and for racial/ethnic minorities in U.S. leadership roles[105] Risk Factors The company faces significant risks related to its business model, regulatory environment, and international operations, including dependence on members and currency fluctuations Risks Related to Our Business and Industry The business is highly dependent on member retention, vulnerable to adverse publicity, intense competition, and concentration risk from its Formula 1 product line - The business depends on recruiting and retaining a large base of independent Members, who can easily leave the network due to low entry/exit costs[126] - The Formula 1 product line constitutes a significant portion of net sales (27% in 2021), creating a product concentration risk[147] - The COVID-19 pandemic has disrupted global supply chains and may continue to adversely affect business operations, including manufacturing and distribution[150] Risks Related to Regulatory and Legal Matters The company operates under extensive and complex regulations, with significant risks from the 2016 FTC Consent Order and potential challenges to its network marketing program - The company is subject to a Consent Order with the FTC, and any failure to comply could materially harm its business, financial condition, and operating results[121][180] - The network marketing program is subject to extensive regulation aimed at preventing pyramid schemes, and any adverse legal or regulatory determination could require changes to the compensation plan[176][178] - The company faces material product liability risks for its ingestible products, which are not subject to pre-market regulatory approval in the U.S[190] Risks Related to Our International Operations With 76% of 2021 net sales from outside the U.S., the company faces significant international risks including currency fluctuations, political instability, and complex regulations in China - Approximately 76% of net sales for the year ended December 31, 2021, were generated outside the United States, exposing the business to international risks[199] - The business in China (11% of 2021 net sales) is subject to unique risks due to its modified business model and significant government control over the economy and regulations[214] - In August 2020, the company reached resolutions with the SEC and DOJ regarding FCPA violations in China, resulting in a deferred prosecution agreement and aggregate payments of approximately $123 million[209] Risks Related to Our Indebtedness and Common Shares The company's debt instruments contain restrictive covenants, and the potential conversion of convertible notes could cause dilution, while Cayman Islands incorporation may limit shareholder protections - Covenants in the 2018 Credit Facility and other debt agreements limit the ability to pay dividends, sell assets, and incur additional debt[221] - The conversion of the 2024 Convertible Notes could require significant cash payments or result in the dilution of existing common shares[226][227][228] - Incorporation under Cayman Islands law means shareholder rights and director fiduciary responsibilities are not as clearly defined as in the U.S., potentially making it harder for shareholders to protect their interests[229] Unresolved Staff Comments The company reports no unresolved staff comments - None[247] Properties The company primarily leases its properties, including corporate offices and distribution centers, while owning a large manufacturing facility in Winston-Salem, NC - The company owns a large manufacturing facility in Winston-Salem, North Carolina, containing approximately 800,000 square feet[248] - Major leased properties include corporate offices in Los Angeles, regional headquarters in Torrance, distribution centers in California and Tennessee, and manufacturing facilities in China and California[247] Legal Proceedings Information regarding legal proceedings is incorporated by reference from Note 7, Contingencies, of the Consolidated Financial Statements - Information regarding legal proceedings is detailed in Note 7, Contingencies, to the Consolidated Financial Statements[249] Mine Safety Disclosures This item is not applicable to the company - Not applicable[249] PART II Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities Herbalife's common shares trade on the NYSE, with no cash dividends since 2014, and a $1.5 billion share repurchase program authorized in 2021 - The company has not declared or paid cash dividends since 2014, and future dividends are at the discretion of the board[256] - On February 9, 2021, a new three-year, $1.5 billion share repurchase program was authorized, replacing a prior program, with approximately $1.1 billion remaining available as of December 31, 2021[257] Share Repurchases (Q4 2021) | Period | Total Shares Purchased | Average Price Paid per Share | | :--- | :--- | :--- | | Oct 1 – Oct 31 | 1,859,392 | $46.04 | | Nov 1 – Nov 30 | 380,000 | $42.07 | | Dec 1 – Dec 31 | 0 | N/A | | Total Q4 | 2,239,392 | $45.36 | Management's Discussion and Analysis of Financial Condition and Results of Operations For fiscal year 2021, net sales increased 4.7% to $5.8 billion, net income rose 20.0% to $447.2 million, and operating cash flow decreased to $460.3 million, with a global transformation program initiated Key Financial Results (Year Ended Dec 31) | Metric | 2021 | 2020 | % Change | | :--- | :--- | :--- | :--- | | Net Sales | $5,802.8 M | $5,541.8 M | 4.7% | | Net Income | $447.2 M | $372.6 M | 20.0% | | Diluted EPS | $4.13 | $2.77 | 49.1% | | Operating Cash Flow | $460.3 M | $628.6 M | (26.8)% | Volume Points by Region (in millions) | Region | 2021 | 2020 | % Change | | :--- | :--- | :--- | :--- | | North America | 1,783.8 | 1,735.0 | 2.8% | | Mexico | 851.0 | 879.7 | (3.3)% | | South & Central America | 497.8 | 535.2 | (7.0)% | | EMEA | 1,629.3 | 1,562.5 | 4.3% | | Asia Pacific | 1,960.1 | 1,690.2 | 16.0% | | China | 375.8 | 523.8 | (28.3)% | | Worldwide | 7,097.8 | 6,926.4 | 2.5% | - In Q4 2021, the company launched a global Transformation Program to optimize processes, expecting $25-$30 million in pre-tax expenses through 2023, with $12.9 million recognized in 2021[362] Quantitative and Qualitative Disclosures About Market Risk The company manages foreign currency and interest rate risks using derivatives, with a hypothetical 1% interest rate change impacting annual interest expense by approximately $9.9 million - The company uses foreign exchange derivatives to hedge currency fluctuations on intercompany transactions and inventory purchases, with a notional amount of outstanding cash flow hedges of approximately $54.5 million as of December 31, 2021[422][425] - The company is exposed to interest rate risk from its variable-rate 2018 Credit Facility, where a 1% change in interest rates could alter annual interest expense by approximately +$9.9 million or -$1.0 million[430] Financial Statements and Supplementary Data This section includes the consolidated financial statements and an unqualified auditor's report, with loss contingencies identified as a critical audit matter - The independent auditor, PricewaterhouseCoopers LLP, issued an unqualified opinion on the consolidated financial statements and the effectiveness of internal control over financial reporting as of December 31, 2021[469] - The auditor identified 'Loss Contingencies' as a critical audit matter due to the significant management judgment required to assess the likelihood and estimate the amount of potential losses from legal and tax matters[477][478] Controls and Procedures Management concluded that the company's disclosure controls and internal control over financial reporting were effective as of December 31, 2021 - Management concluded that the company's disclosure controls and procedures were effective as of December 31, 2021[435] - Based on the COSO framework, management concluded that internal control over financial reporting was effective as of December 31, 2021[439] PART III Directors, Executive Officers, Corporate Governance, Compensation, and Principal Accountant Fees Information for Items 10 through 14 is incorporated by reference from the company's forthcoming definitive proxy statement - Information for Items 10, 11, 12, 13, and 14 is incorporated by reference from the company's forthcoming definitive proxy statement[442][443][444][445][446] PART IV Exhibits, Financial Statement Schedules This section includes consolidated financial statements, the auditor's report, and an index of exhibits detailing debt, contingencies, and segment information Note 5. Long-Term Debt As of December 31, 2021, total long-term debt was $2.73 billion, comprising various senior notes and a credit facility, with a $24.6 million loss on extinguishment from a 2021 redemption Long-Term Debt Components (Carrying Value, Dec 31, 2021) | Debt Instrument | Amount (in millions) | | :--- | :--- | | Senior Secured Credit Facility | $1,088.6 | | 2.625% Convertible Notes due 2024 | $486.0 | | 7.875% Senior Notes due 2025 | $594.2 | | 4.875% Senior Notes due 2029 | $592.8 | | Total (net of current portion) | $2,733.2 | - In May 2021, the company redeemed all $400.0 million of its 7.250% Senior Notes due 2026, recognizing a loss on extinguishment of $24.6 million[608] Note 7. Contingencies The company is involved in numerous global tax and legal matters, including ongoing tax disputes, a 2020 FCPA settlement of $123 million, and a $12.5 million class action lawsuit settlement - The company is litigating tax assessments in multiple jurisdictions, including Brazil (approx. $9.9 million withholding, $45.8 million ICMS), India (approx. $14.1 million VAT/Service Tax, $27.1 million income tax), and Korea (approx. $66.9 million customs duties)[628][629][630][632] - In August 2020, the company entered into a deferred prosecution agreement with the DOJ and a settlement with the SEC to resolve an FCPA investigation, paying approximately $123 million in penalties and disgorgement[639] - The company has agreed to the principal terms of a settlement for the Rodgers, et al. class action lawsuit, which involves a payment of $12.5 million into a fund, accrued as of December 31, 2021[640] Note 10. Segment Information The company manages its business through two reportable segments, Primary Reporting and China, with the U.S. being the largest single country by net sales Net Sales by Reportable Segment (in millions) | Segment | 2021 | 2020 | 2019 | | :--- | :--- | :--- | :--- | | Primary Reporting Segment | $5,173.3 | $4,732.2 | $4,125.1 | | China | $629.5 | $809.6 | $752.0 | | Total Net Sales | $5,802.8 | $5,541.8 | $4,877.1 | Contribution Margin by Reportable Segment (in millions) | Segment | 2021 | 2020 | 2019 | | :--- | :--- | :--- | :--- | | Primary Reporting Segment | $2,175.6 | $1,983.6 | $1,793.6 | | China | $554.2 | $717.5 | $677.3 | | Total Contribution Margin | $2,729.8 | $2,701.1 | $2,470.9 |