UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

 

 

 

Form 10-Q

 

 

 

 

Commission file number: 1-32381

 

 

 

 

HERBALIFE LTD.

(Exact name of registrant as specified in its charter)

 

 

 

P.O. Box 309GT
Ugland House, South Church Street
Grand Cayman, Cayman Islands
(Address of principal executive offices) (Zip code)

 

(310) 410-9600

(Registrant’s telephone number, including area code)

 

 

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes þ     No o

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes o     No o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

(Do not check if a smaller reporting company)

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o     No þ

 

Number of shares of registrant’s common shares outstanding as of April 30, 2009 was 61,548,112

 

 

HERBALIFE LTD.

 

 

 

HERBALIFE LTD.

 

CONSOLIDATED BALANCE SHEETS

(Unaudited)

 

 

See the accompanying notes to consolidated financial statements

HERBALIFE LTD.

 

CONSOLIDATED STATEMENTS OF INCOME

 

 

See the accompanying notes to consolidated financial statements

HERBALIFE, LTD.

 

CONSOLIDATED STATEMENTS OF CASH FLOWS

 

 

See the accompanying notes to consolidated financial statements

HERBALIFE LTD.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

 

Herbalife Ltd., a Cayman Islands exempted limited liability company, or Herbalife, incorporated on April 4, 2002. Herbalife Ltd. (and together with its subsidiaries, the “Company”) is a leading global network marketing company that sells weight management, nutritional supplement, energy, sports & fitness products and personal care products through a network of over 1.9 million independent distributors, except in China, where the Company currently sells its products through retail stores and an employed sales force. The Company reports revenue in six geographic regions: North America, which consists of the U.S., Canada and Jamaica; Mexico; South and Central America; EMEA, which consists of Europe, the Middle East and Africa; Asia Pacific (excluding China) which consists of Asia, New Zealand and Australia; and China.

 

 

The unaudited interim financial information of the Company has been prepared in accordance with Article 10 of the Securities and Exchange Commission’s Regulation S-X. Accordingly, it does not include all of the information required by generally accepted accounting principles, or GAAP, in the U.S. for complete financial statements. The Company’s unaudited consolidated financial statements as of March 31, 2009, and for the three months ended March 31, 2009 and 2008, include Herbalife 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 consolidated financial statements as of March 31, 2009, and for the three months ended March 31, 2009 and 2008. These unaudited consolidated financial statements should be read in conjunction with the Company’s Annual Report on Form 10-K for the year ended December 31, 2008, or the 2008 10-K. Operating results for the three months ended March 31, 2009, are not necessarily indicative of the results that may be expected for the year ending December 31, 2009.

 

Recently Adopted Accounting Pronouncements

 

In March 2008, the Financial Accounting Standards Board, or FASB, issued Statement of Financial Accounting Standards, or SFAS, No. 161, Disclosures about Derivative Instruments and Hedging Activities — An Amendment of FASB Statement No. 133, or SFAS 161. SFAS 161 expands the disclosure requirements for derivative instruments and hedging activities. SFAS 161 specifically requires entities to provide enhanced disclosures addressing the following: (a) how and why an entity uses derivative instruments, (b) how derivative instruments and related hedged items are accounted for under SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, or SFAS 133, and its related interpretations, and (c) how derivative instruments and related hedged items affect an entity’s financial position, financial performance, and cash flows. SFAS 161 is effective for fiscal years and interim periods beginning after November 15, 2008. The Company adopted SFAS 161 on January 1, 2009. The adoption had no financial impact on the Company’s consolidated financial statements and only required additional financial statement disclosures. The Company has applied the requirements of SFAS 161 on a prospective basis. Accordingly, disclosures related to interim and annual periods prior to the date of adoption have not been presented.

 

In February 2008, the FASB issued FASB Staff Position FAS 157-2, or FSP FAS 157-2. FSP FAS 157-2 delayed the effective date of SFAS No. 157, Fair Value Measurements, or SFAS 157, for all nonfinancial assets and nonfinancial liabilities, except those that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually). FSP FAS 157-2 partially defers the effective date of SFAS 157 to fiscal years beginning after November 15, 2008, and interim periods within those fiscal years for items within the scope of FSP FAS 157-2. On January 1, 2009, the Company adopted the provisions of SFAS 157 for nonfinancial assets and nonfinancial liabilities and the adoption did not have a material impact on its consolidated financial statements.

 

In December 2007, the FASB issued SFAS, No. 141 (revised 2007), Business Combinations, or SFAS 141R, which replaces SFAS 141, Business Combinations. SFAS 141R establishes principles and requirements for how an

 

HERBALIFE LTD.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

acquirer recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, any non controlling interest in the acquiree and the goodwill acquired. SFAS 141R also modifies the recognition for preacquisition contingencies, such as environmental or legal issues, restructuring plans and acquired research and development value in purchase accounting. SFAS 141R amends SFAS No. 109, Accounting for Income Taxes, to require the acquirer to recognize changes in the amount of its deferred tax benefits that are recognizable because of a business combination either in income from continuing operations in the period of the combination or directly in contributed capital, depending on the circumstances. SFAS 141R also establishes disclosure requirements which will enable users to evaluate the nature and financial effects of the business combination. SFAS 141R is effective for fiscal years beginning after December 15, 2008. The Company adopted SFAS 141R on January 1, 2009 and the adoption did not have a material impact on its consolidated financial statements.

 

New Accounting Pronouncements

 

In April 2009, the FASB issued FASB Staff Position No. FAS 107-1 and Accounting Principles Board Opinion No. 28-1, Interim Disclosures about Fair Value of Financial Instruments, or FSP FAS 107-1. FSP FAS 107-1 amends FASB Statement No. 107, Disclosures about Fair Value of Financial Instruments, to require disclosures about fair value of financial instruments for interim reporting periods of publicly traded companies as well as in annual financial statements. FSP FAS 107-1 also amends Accounting Principles Board Opinion No. 28, Interim Financial Reporting, to require those disclosures in summarized financial information at interim reporting periods. FSP FAS 107-1 shall be effective for interim reporting periods ending after June 15, 2009, with early adoption permitted for periods ending after March 15, 2009. The Company has elected to adopt FSP FAS 107-1 for its interim period ending June 30, 2009, and believes the adoption of FSP FAS 107-1 will not have a material impact to its consolidated financial statements.

 

 

Long-term debt consists of the following:

 

 

Interest expense was $3.3 million and $5.5 million for the three months ended March 31, 2009 and 2008, respectively.

 

On July 21, 2006, the Company entered into a $300.0 million senior secured credit facility, comprised of a $200.0 million term loan and a $100.0 million revolving credit facility, with a syndicate of financial institutions as lenders and replaced a $225.0 million senior secured credit facility, originally entered into on December 21, 2004. In September 2007, the Company and its lenders amended the senior secured credit facility, increasing the amount of the revolving credit facility by an aggregate principal amount of $150.0 million to $250.0 million. The term loan bears interest at LIBOR plus a margin of 1.5%, or the base rate plus a margin of 0.50%, and matures on July 21, 2013. The revolving credit facility bears interest at LIBOR plus a margin of 1.25%, or the base rate plus a margin of 0.25%, and is available until July 21, 2012. On March 31, 2009 and December 31, 2008, the weighted average interest rate for the senior secured credit facility was 2.20% and 3.04%, respectively.

 

HERBALIFE LTD.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

The senior secured credit facility requires the Company to comply with a leverage ratio and an interest coverage ratio. In addition, the senior secured 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, merge or consolidate and enter into certain transactions with affiliates.

 

As of March 31, 2009, the Company is obligated to pay approximately $0.4 million of the term loan every quarter until June 30, 2013, and the remaining principal on July 21, 2013. As of March 31, 2009 and December 31, 2008, the amounts outstanding under the term loan were $146.5 million and $146.8 million, respectively.

 

During the first quarter of 2009, the Company borrowed an additional $19.0 million under the revolving credit facility and paid $14.7 million of the revolving credit facility. As of March 31, 2009 and December 31, 2008, the amounts outstanding under the revolving credit facility were $182.0 million and $177.7 million, respectively.

 

Through the course of conducting regular business operations, certain vendors and government agencies may require letters of credit to be issued. As of March 31, 2009 and December 31, 2008, the Company had $2.6 million and $2.8 million, respectively, of issued but undrawn letters of credit.

 

 

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 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 lawsuits. The Company currently maintains product liability insurance with an annual deductible of $10 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 their allegations that additional taxes are owed, and the Company is vigorously contesting the additional proposed taxes and related charges.

 

These matters may take several years to resolve, and the Company cannot be sure of their ultimate resolution. However, it is the opinion of management that adverse outcomes, if any, will not likely result in a material adverse effect on the Company’s financial condition and operating results. This opinion is based on the belief that any losses suffered in excess of amounts reserved would not be material, and that the Company has meritorious defenses. Although the Company has reserved an amount that the Company believes represents the most likely outcome of the resolution of these disputes, if the Company is incorrect in the assessment the Company may have to record additional expenses.

 

HERBALIFE LTD.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

 

Total comprehensive income consisted of the following:

 

 

 

The Company is a network marketing company that sells a wide range of weight management products, nutritional supplements and personal care products within one industry segment as defined under SFAS No. 131, Disclosures about Segments of an Enterprise and Related Information. The Company’s products are manufactured by third party providers and then sold to independent distributors who sell Herbalife products to retail consumers or other distributors.

 

The Company sells products in 70 countries throughout the world and is organized and managed by geographic regions. The Company aggregates its operating segments, excluding China, into one 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, and the nature of the regulatory environment. China has been identified as a separate reportable segment as it does not meet the criteria for aggregation.

 

Revenues reflect sales of products to distributors based on the distributors’ geographic location.

 

HERBALIFE LTD.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

During the first quarter of 2009, the Company changed its geographic regions as part of the Company’s restructuring program by designating Mexico as its own region and combining South America and Central America into one region. These changes in geographic regions were implemented to create growth opportunities for distributors, support faster decision making across the organization by reducing the number of layers of management, improve the sharing of ideas and tools and accelerate growth in its high potential markets. Historical information presented related to the Company’s geographic regions has been reclassified to conform with the current geographic presentation. The operating information for the Company’s reporting segment and China, and sales by product line are as follows:

 

 

 

 

 

HERBALIFE LTD.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

 

 

As of March 31, 2009 and December 31, 2008, total assets for the Company’s reporting segment, excluding China, was $1,096.1 million and $1,074.3 million, respectively. Total assets for China were $44.4 million and $47.0 million as of March 31, 2009 and December 31, 2008, respectively.

 

 

The Company has five stock-based compensation plans, which are more fully described in Note 9 to the Consolidated Financial Statements in the 2008 10-K. During the three months ended March 31, 2009, the Company granted stock awards subject to continued service, consisting of stock units and stock appreciation rights, with vesting terms fully described in the 2008 10-K. During the three months ended March 31, 2009, the Company also granted stock units and stock appreciation rights, subject to continued service, one-third of which vest on the third anniversary of the date of grant, one-third of which vest on the fourth anniversary of the date of grant, and the remaining one-third of which vest on the fifth anniversary of the date of grant.

 

For the three months ended March 31, 2009 and 2008, stock-based compensation expense amounted to $4.9 million and $5.1 million, respectively. As of March 31, 2009, the total unrecognized compensation cost related to all non-vested stock awards was $48.7 million and the related weighted-average period over which it is expected to be recognized is approximately 2.5 years.

 

The following tables summarize the activity under all stock-based compensation plans for the three months ended March 31, 2009:

 

 

 

HERBALIFE LTD.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

 

The weighted-average grant date fair value of stock awards granted during the three months ended March 31, 2009 and 2008 was $5.85 and $21.58, respectively. The total intrinsic value of stock awards exercised during the three months ended March 31, 2009 and 2008 was $1.2 million and $32.9 million, respectively.

 

 

As of March 31, 2009, the total amount of unrecognized tax benefits, related interest and penalties was $41.1 million, $8.7 million and $3.2 million, respectively. During the three months ended March 31, 2009, the Company recorded tax and interest related to uncertain tax positions of $0.1 million and $0.2 million, respectively. The unrecognized tax benefits relate primarily to uncertainties from international transfer pricing issues and the deductibility of certain operating expenses in various jurisdictions. If the total amount of unrecognized tax benefits were recognized, $41.1 million of unrecognized tax benefits, $8.7 million of interest and $3.2 million of penalties, would impact the effective tax rate.

 

During the three months ended March 31, 2009, the Company benefited from the terms of a tax holiday in the People’s Republic of China. The tax holiday commenced on January 1, 2008 and will conclude on December 31, 2012. Under the terms of the holiday, the Company is subject to a zero tax rate in China during 2008 and 2009 and a concessionary tax rate in China for the remaining years included in the holiday period.

 

 

Interest Rate Risk Management

 

The Company engages in an interest rate hedging strategy for which the hedged transactions are forecasted interest payments on the Company’s variable rate term loan. The hedged risk is the variability of forecasted interest rate cash flows, where the hedging strategy involves the purchase of interest rate swaps. For the outstanding cash flow hedges on interest rate exposures at March 31, 2009 the maximum length of time over which the Company is hedging these exposures is approximately six months.

 

Under its senior secured credit facility, the Company is obligated to enter into interest rate hedges for up to 25% of the aggregate principal amount of the term loan for a minimum of three years. On August 23, 2006, the Company entered into an interest rate swap agreement. The agreement provides for the Company to pay interest for a three-year period at a fixed rate of 5.26% on various notional amounts while receiving interest for the same period at the LIBOR rate on the same notional principal amounts. The swap has been designated as a cash flow hedge against the variability in LIBOR interest rate on the new term loan at LIBOR plus 1.50%, thereby fixing the Company’s effective rate on the notional amounts at 6.76%. The Company formally assesses, both at inception and at least quarterly thereafter, whether the derivatives used in hedging transactions are effective in offsetting changes in cash flows of the hedged item. As of March 31, 2009 and December 31, 2008, the hedge relationship qualified as an effective hedge under SFAS No. 133. Consequently, all changes in the fair value of the derivative are deferred and recorded in other comprehensive income (loss) until the related forecasted transaction is recognized in the consolidated statements of income. The fair value of the interest rate swap agreement is based on third-party bank quotes and the Company recorded the interest rate swap as a liability at fair value of $0.6 million and $1.0 million as of March 31, 2009 and December 31, 2008, respectively.

 

Foreign Currency Instruments

 

The Company also designates certain derivatives, such as certain foreign currency forward and option contracts, as freestanding derivatives for which hedge accounting does not apply. The changes in the fair market value of the derivatives are included in selling, general and administrative expenses in the Company’s consolidated statements of income. The Company uses foreign currency forward contracts to hedge foreign-currency-denominated intercompany transactions and to partially mitigate the impact of foreign currency fluctuations. The Company also uses foreign currency option contracts to partially mitigate the impact of foreign currency fluctuations. The fair value of the forward and option contracts are based on third-party bank quotes. As of March 31, 2009, all of the Company’s outstanding foreign currency forward contracts have maturity dates of less

 

HERBALIFE LTD.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

than one year, with the majority maturing within 90 days. There were no foreign currency option contracts outstanding as of March 31, 2009. See Part I, Item 3 — Quantitative and Qualitative Disclosures About Market Risk in this Quarterly Report on Form 10-Q for foreign currency instruments outstanding as of March 31, 2009.

 

The Company also purchases forward contracts in order to hedge forecasted inventory purchases that are designated as cash-flow hedges and are subject to foreign currency exposures. The Company applied the hedge accounting rules as required by SFAS 133 for these hedges. These contracts allow the Company to sell Euros in exchange for US dollars at specified contract rates. As of March 31, 2009, approximately $36.0 million of these contracts were outstanding and are expected to mature over the next nine months. The Company’s derivative financial instruments are recorded on the consolidated balance sheet at fair value based on quoted market rates. These forward contracts are used to hedge forecasted inventory purchases over specific months. Changes in the fair value of forward contracts, excluding forward points, designated as cash-flow hedges are recorded in other comprehensive income (loss), and are recognized in cost of sales in the period which approximates the time the hedged inventory is sold. As of March 31, 2009 and December 31, 2008, the Company recorded an asset at fair value of $1.5 million and a liability of $0.1 million, respectively, relating to outstanding contracts. The Company assesses hedge effectiveness and measures hedge ineffectiveness at least quarterly. During the three months ended March 31, 2009, the ineffective portion relating to these hedges was immaterial and the hedges remained effective as of March 31, 2009.

 

Gains and Losses on Derivative Instruments

 

The following gains (losses) relating to derivative instruments were recorded in other comprehensive income (loss) during the three months ended March 31, 2009:

 

 

The following gains (losses) relating to derivative instruments were recorded to income during the three months ended March 31, 2009:

 

 

 

 

HERBALIFE LTD.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

 

The following gains (losses) relating to derivative instruments were reclassified from accumulated other comprehensive loss into income during the three months ended March 31, 2009:

 

 

SFAS 133 requires companies to recognize all derivative instruments as either assets or liabilities at fair value in the statement of financial position. See Note 13, Fair Value Measurements, for information on derivative fair values in the Company’s consolidated balance sheet as of March 31, 2009.

 

 

The Company recorded $0.6 million and $0.4 million of professional fees, severance and related costs for the three months ended March 31, 2009 and 2008, respectively, related to restructurings. All such amounts were included in selling, general and administrative expenses. The Company expects to complete in 2009 the restructuring program initiated in the fourth quarter of 2008.

 

The following table summarizes the components of this reserve as of March 31, 2009:

 

 

 

Dividends

 

On February 20, 2009, the Company’s board of directors approved a quarterly cash dividend of $0.20 per common share in an aggregate amount of $12.3 million, for the fourth quarter of 2008 that was paid to shareholders of record on March 17, 2009. The aggregate amount of dividends declared and paid during the three months ended March 31, 2009 and 2008 were $12.3 million and $12.9 million, respectively.

 

Share Repurchases

 

During the three months ended March 31, 2009, the Company did not repurchase any of its common shares. As of March 31, 2009, since the inception of the share repurchase program, the Company has repurchased approximately 13.7 million of its common shares at an aggregate cost of $502.8 million or an average cost of $36.76 per share. As of March 31, 2009, the approximate dollar value of shares that could be purchased under the Company’s share repurchase program was approximately $97.2 million. The Company’s share repurchase program in effect on March 31, 2009 expired on April 17, 2009 pursuant to its terms.

 

 

Basic earnings per share represents net income for the period common shares were outstanding, divided by the weighted average number of common shares outstanding for the period. Diluted earnings per share represents net

 

HERBALIFE LTD.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

income divided by the weighted average number of common shares outstanding, inclusive of the effect of dilutive securities such as outstanding stock options, stock appreciation rights, stock units and warrants.

 

The following are the common share amounts used to compute the basic and diluted earnings per share for each period:

 

 

Equity grants, such as stock options, stock appreciation rights, or stock units, to purchase or acquire 3.7 million and 1.5 million common shares were outstanding during the three months ended March 31, 2009 and 2008, respectively, but were not included in the computation of diluted earnings per share because the exercise prices were greater than the average market price of a common share and therefore such equity grants would be anti-dilutive.

 

 

The Company currently applies the provisions of SFAS 157 for its financial and non-financial assets and liabilities. SFAS 157 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. SFAS 157 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.

 

The Company measures certain assets and liabilities at fair value consisting of derivative instruments. All derivative assets are recorded as prepaid expenses and other current assets, and all derivative liabilities are recorded as accrued expenses. Assets or liabilities that have recurring measurements are shown below:

 

Fair Value Measurements at Reporting Date Using

 

 

HERBALIFE LTD.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

 

 

On April 30, 2009, the Company announced that its board of directors has authorized a $0.20 per common share cash dividend for the first quarter of 2009, payable on June 5, 2009 to shareholders of record on May 22, 2009.

 

The Company’s share repurchase program in effect on March 31, 2009 expired on April 17, 2009 pursuant to its terms. On April 30, 2009, the Company announced that its board of directors authorized a new program for the Company to repurchase up to $300 million of Herbalife common shares during the next two years, at such times and prices as determined by the Company’s management.

 

 

Overview

 

We are a global network marketing company that sells weight management products, nutritional supplements, energy, sports & fitness products and personal care products. We pursue our mission of “changing people’s lives” by providing a financially rewarding business opportunity to distributors and quality products to distributors and their customers who seek a healthy lifestyle. We are one of the largest network marketing companies in the world with net sales of approximately $2.4 billion for the year ended December 31, 2008. As of March 31, 2009, we sold our products in 70 countries through a network of over 1.9 million independent distributors. In China, we sell our products through retail stores and an employed sales force. We believe the quality of our products and the effectiveness of our distribution network, coupled with geographic expansion, have been the primary reasons for our success throughout our 29-year operating history.

 

Our products are grouped in four principal categories: weight management, targeted nutrition, energy, sports & fitness and Outer Nutrition. Our products are often sold in programs that are comprised of a series of related products designed to simplify weight management and nutrition for consumers and maximize our distributors’ cross-selling opportunities.

 

Industry-wide factors that affect us and our competitors include the increasing prevalence of obesity and the aging of the worldwide population, which are driving demand for nutrition and wellness-related products and the recruitment and retention of distributors.

 

While we are closely monitoring the current global economic crisis, the Company remains focused on the opportunities and challenges in retailing of our products, recruiting and retaining distributors, improving distributor productivity, opening new markets, further penetrating existing markets including China, the U.S., Brazil, Mexico and Russia, globalizing successful distributor methods of operation such as Nutrition Clubs, introducing new products, developing niche market segments and further investing in our infrastructure. Management remains intently focused on the Venezuela market and especially the limited ability to repatriate cash at the official exchange rate.

 

During the first quarter of 2009, we changed our geographic regions, designating Mexico as its own region and combining South America and Central America into a single region. These changes in geographic regions were implemented to create growth opportunities for distributors, support faster decision making across the organization by reducing the number of layers of management, improve the sharing of ideas and tools and accelerate growth in high potential markets. Under the new geographic regions, we report revenue from:

 

 

Historical information presented in this Quarterly Report on Form 10-Q relating to our geographic regions has been reclassified to conform with our current geographic presentation

 

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 unit measure of product sales volume. It is a useful measure that we rely on as it excludes the impact of foreign currency fluctuations and ignores the differences generated by varying retail pricing across geographic markets. The Volume Point measure, in the aggregate and in each region, can be a measure of our sales volume as well as of sales volume trends. In general, an increase in Volume Points in a particular geographic region

or country indicates an increase in our sales volume which results in an increase in our local currency net sales and a decrease in Volume Points in a particular geographic region or country indicates a decrease in our sales volume, which results in decreasing local currency net sales.

 

 

Number of New Sales Leaders by Geographic Region during the Reporting Period

 

Another key non-financial measure on which we focus is the number of distributors qualified as new sales leaders under our compensation system. Excluding China, distributors qualify for supervisor status based on their Volume Points. The changes in the total number of sales leaders or changes in the productivity of sales leaders may cause Volume Points to increase or decrease. The fluctuation in the number of new sales leaders is a general indicator of the level of distributor recruitment.

 

 

Number of Supervisors and Retention Rates by Geographic Region as of Re-qualification Period

 

Our compensation system requires each supervisor to re-qualify for such status each year, prior to February, in order to maintain their 50% discount on product and be eligible to receive royalty payments. In February of each year, we demote from the rank of supervisor those distributors who did not satisfy the supervisor re-qualification requirements during the preceding twelve months. The re-qualification requirement does not apply to new supervisors (i.e. those who became supervisors subsequent to the January re-qualification of the prior year).

 

The distributor statistics below further highlight the calculation for retention.

 

 

The table below reflects the number of sales leaders as of February (subsequent to the annual re-qualification date) and supervisor retention rate by year and by region.

 

 

The number of supervisors by geographic region as of the quarterly reporting dates will normally be higher than the number of supervisors by geographic region as of the re-qualification period because supervisors who do not re-qualify during the relevant twelve-month period will be dropped from the rank of supervisor the following February. Since supervisors purchase most of our products for resale to other distributors and consumers, comparisons of supervisor totals on a year-to-year basis are good indicators of our recruitment and retention efforts in different geographic regions.

 

The value of the average monthly purchase of Herbalife products by our sales leaders has remained relatively constant over time. Consequently, increases in our sales are driven primarily by our retention of supervisors and by our recruitment and retention of distributors, rather than through increases in the productivity of our overall supervisor base.

 

We provide distributors with products, support materials, training, special events and a competitive compensation program. If a distributor wants to pursue the Herbalife business opportunity, the distributor is responsible for growing his or her business and personally pays for the sales activities related to attracting new customers and recruiting distributors by hosting events such as Herbalife Opportunity Meetings or Success Training Seminars; by advertising Herbalife’s products; by purchasing and using promotional materials such as t-shirts, buttons and caps; by utilizing and paying for direct mail and print material such as brochures, flyers, catalogs, business cards, posters and banners and telephone book listings; by purchasing inventory for sale or use as samples; and by training, mentoring and following up (in person or via the phone or internet) with customers and recruits on how to use Herbalife products and/or pursue the Herbalife business opportunity.

 

Presentation

 

“Retail sales” represent the gross sales amounts on our invoices to distributors before distributor allowances, as defined below, and “net sales,” which reflect distribution allowances and handling and freight income, represent what we collect and recognize as net sales in our financial statements. We discuss retail sales because of its fundamental role in our compensation systems, internal controls and operations, including its role as the basis upon which distributor discounts, royalties and bonuses are awarded. In addition, it is used as the basis for certain

information included in daily and monthly reports reviewed by our management. However, such a measure is not in accordance with Generally Accepted Accounting Principles in the U.S., or GAAP. You should not consider retail sales in isolation from, nor as a substitute for, net sales and other consolidated income or cash flow statement data prepared in accordance with GAAP, or as a measure of profitability or liquidity. A reconciliation of net sales to retail sales is presented below under “Results of Operations.” “Product sales” represent the actual product purchase price paid to us by our distributors, after giving effect to distributor discounts referred to as “distributor allowances,” which approximate 50% of retail sales prices. Distributor allowances as a percentage of retail sales may vary by country depending upon regulatory restrictions that limit or otherwise restrict distributor allowances.

 

Our “gross profit” consists of net sales less “cost of sales,” which represents the prices we pay to our raw material suppliers and manufacturers of our products as well as costs related to product shipments, duties and tariffs, freight expenses relating to shipment of products to distributors and importers and similar expenses.

 

“Royalty overrides” are our most significant expense and consist of:

 

 

Royalty overrides are generally earned based on retail sales and approximate in the aggregate about 21% of retail sales or approximately 34% of our net sales. Royalty overrides together with distributor allowances represent the potential earnings to distributors of up to approximately 73% of retail sales. The compensation to distributors is generally for the development, retention and improved productivity of their distributor sales organizations and is paid to several levels of distributors on each sale. Due to restrictions on direct selling in China, our full-time employed sales representatives in China are compensated with wages, bonuses and benefits instead of the distributor allowances and royalty overrides utilized in our traditional marketing program used in our other five regions. Because of local country regulatory constraints, we may be required to modify our typical distributor incentive plans as described above. Consequently, the total distributor discount percentage may vary over time. We also offer reduced distributor allowances and pay reduced royalty overrides with respect to certain products worldwide.

 

Our “operating margins” consist of net sales less cost of sales and royalty overrides.

 

“Selling, general and administrative expenses” represent our operating expenses, components of which include labor and benefits, sales events, professional fees, travel and entertainment, distributor marketing, occupancy costs, communication costs, bank fees, depreciation and amortization, foreign exchange gains and losses and other miscellaneous operating expenses.

 

Most of our sales to distributors 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 operating margins and can generate transaction losses on intercompany transactions. Throughout the last five years, foreign currency exchange rates have fluctuated significantly. From time to time, we enter into foreign exchange forward and option contracts to 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 months ended March 31, 2009 decreased 13.7% to $521.7 million compared to the same period in 2008, primarily reflecting the adverse effect of currency fluctuations which had an adverse impact of 12.8% or $77.2 million. In local currency, net sales declined 0.9% compared to the same period in 2008. For the three months ended March 31, 2009 net sales in some of our top countries including Mexico, Venezuela, Japan and

Brazil decreased 36.8%, 30.7%, 28.0% and 7.6%, respectively, as compared to the same period in 2008, while other top countries including Taiwan, the U.S. and China increased 41.7%, 4.5% and 9.4%, respectively, as compared to the same period in 2008. A decline in distributor and sales leader recruiting and the negative impact of the Value Added Tax, or VAT, in Mexico and 2008 price increases in Venezuela also contributed to the decline in net sales for the period. The increase in other top markets was mainly due to the continued success of our distributors as they continued their conversion to a daily consumption business model and an increase in the number of sales employees in China compared to the prior year period.

 

Net income for the three months ended March 31, 2009 decreased 33.4% to $41.5 million, or $0.67 per diluted share, compared to $62.4 million, or $0.93 per diluted share, for the same period in 2008. The decrease was driven by revenue declines, higher effective tax rate reflecting changes in country mix, higher depreciation expense and foreign currency losses, partially offset by lower interest expense, lower labor costs resulting from our restructuring initiative and lower sales events costs. Net income for the three months ended March 31, 2009 included a $0.4 million unfavorable after tax impact in connection with our restructuring activities.

 

Results of Operations

 

Our results of operations for the periods described below are not necessarily indicative of results of operations for future periods, which depend upon numerous factors, including our ability to recruit new distributors and retain existing distributors, open new markets, further penetrate existing markets, introduce new products and programs that will help our distributors 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.

 

 

 

 

Net Sales

 

The following chart reconciles retail sales to net sales:

 

Sales by Geographic Region

 

 

Changes in net sales are directly associated with the recruiting and retention of our distributor force, retailing of our products, the quality and completeness of our product offerings that the distributor force has to sell and the number of countries in which we operate. Management’s role, both in-country and at the corporate level is to provide distributors with a competitive and broad product line, encourage strong teamwork and leadership among the Chairman’s Club and President’s Team distributors and offer leading edge business tools to make doing business with Herbalife simple. Management uses the distributor marketing program coupled with educational and motivational tools and promotions to incentivize distributors to increase recruiting, retention and retailing, which in turn affect net sales. Such tools include Company sponsored sales events such as Extravaganzas and World Team Schools where large groups of distributors gather, thus allowing them to network with other distributors, learn recruiting, retention and retailing techniques from our leading distributors 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 productivity of the supervisor network. The expenses for such programs are included in selling, general and administrative expenses. Sales are driven by several factors, including the number and productivity of distributors and sales leaders who continually build, educate and motivate their respective distribution and sales organizations. We also use event and non-event product promotions to motivate distributors to increase recruiting, retention and retailing 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.

 

The factors described above have helped distributors increase their business, which in turn helps drive sales in our business. The discussion below of net sales by geographic region further details some of the specific drivers of growth of our business and causes of sales reductions during the three months ended March 31, 2009, as well as the unique growth or contraction factors specific to certain geographic regions or major countries. We believe that the correct business foundation, coupled with ongoing training and promotional initiatives, is required to increase recruiting and retention of distributors and retailing our products. The correct business foundation includes strong country management that works closely with the distributor leadership, unified distributor leadership, a broad product line that appeals to local consumer needs, a favorable regulatory environment, a scalable and stable technology platform and an attractive distributor marketing plan. Initiatives, such as Success Training Seminars, World Team Schools, Promotional Events and regional Extravaganzas are integral components of developing a highly motivated and educated distributor sales organization that will work toward increasing the recruitment and retention of distributors.

 

Our strategy will continue to include creating and maintaining growth within existing markets, while expanding into new markets. In addition, new ideas and Daily Method of Operations, or DMOs, are being generated in our regional markets and globalized where applicable, either by distributors, country management or

corporate management. Examples of DMOs include the Club concept in Mexico, the Total Plan in Brazil, the Wellness Coach in France, 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.

 

North America

 

The North America region reported net sales of $123.1 million for the three months ended March 31, 2009. Net sales increased $4.5 million, or 3.8%, for the three months ended March 31, 2009, as compared to the same period in 2008. In local currency, net sales increased by 4.4% for the three months ended March 31, 2009, as compared to the same period in 2008. The overall increase was a result of net sales growth in the U.S. of $5.1 million, or 4.5%, for the three months ended March 31, 2009, as compared to the same period in 2008.

 

The increase in net sales in North America was primarily due to the continued success of our distributors converting their business focus toward a daily consumption business model, especially the Nutrition Club DMO, and its extension into Commercial Clubs and Central Clubs, along with the recent development of the Weight Loss Challenge DMO. In terms of volume, the mix of business in the U.S. was 63% Spanish speaking and 37% Non-Spanish speaking for the three months ended March 31, 2009.

 

In January 2009, the U.S. hosted a “Why Herbalife, Why Now?” tour in seven cities featuring our Chief Executive Officer, or CEO, Michael O. Johnson. In total over 14,500 distributors attended the tour.

 

New supervisors in the region decreased 12.4% for the three months ended Mach 31, 2009, as compared to the same period in 2008. Total supervisors in the region decreased 1.0%. New supervisors in the U.S. decreased 12.6% for the three months ended March 31, 2009, as compared to the same period in 2008.

 

In March 2009, Herbalife hosted its annual global Herbalife Honors event in Los Angeles, where President Team members from around the world met and shared best practices, conducted leadership training and Herbalife management awarded distributors $36.4 million in Mark Hughes bonus payments related to 2008 performance.

 

We believe the fiscal year 2009 net sales in North America should increase year over year primarily as a result of the successful transformation of our distributor business focus to a daily consumption model as well as a 5% price increase which was instituted in the U.S. during February 2009.

 

Mexico

 

Net sales in Mexico were $59.2 million for the three months ended March 31, 2009. Net sales for the three months ended March 31, 2009 decreased $34.4 million, or 36.8%, as compared to the same period in 2008. In local currency, net sales for the three months ended March 31, 2009 decreased by 15.9%, as compared to the same period in 2008. The fluctuation of foreign currency rates had an unfavorable impact of $19.4 million on net sales for the three months ended March 31, 2009.

 

During the third quarter of 2008 we began collecting a VAT from our distributors that has been levied by the Mexican government on the import and resale of certain nutrition products. Distributors previously paid 0% VAT on purchases of most of our nutrition products. In the first quarter of 2009, this VAT increase affected approximately 56% of our sales volume in the region and because Nutrition Clubs are the predominant DMO in Mexico, which are retail price-sensitive, the VAT increase has caused our volumes to decline. We are in the process of challenging this assessment on several fronts, however in the near-term while the products continue to be subject to VAT, we expect volume growth to be constrained in Mexico. We are also exploring product re-formulations that would enable us to sell nutrition products in Mexico which would not be subject to the VAT charge.

 

New supervisors in Mexico decreased 40.8% for the year ended March 31, 2009, as compared to the same period in 2008. Total supervisors in Mexico decreased 17.6%.

 

In January 2009, Mexico hosted a President’s Tour in 15 cities which was attended by over 16,000 distributors. In March 2009, Mexico hosted a “Why Herbalife, Why Now?” tour in four cities featuring CEO Michael O. Johnson with a combined total attendance of over 16,000 distributors.

We believe the fiscal year 2009 net sales in Mexico should decrease reflecting lower volumes due to the VAT charge coupled with assumed unfavorable currency fluctuations.

 

South and Central America

 

The South and Central America region reported net sales of $75.3 million for the three months ended March 31, 2009. Net sales decreased $30.7 million or 29.0% for the three months ended March 31, 2009, as compared to the same period in 2008. In local currency, net sales decreased 16.5% for the three months ended March 31, 2009, as compared to the same period in 2008. The fluctuation of foreign currency rates had a $13.3 million unfavorable impact on net sales for the three months ended March 31, 2009. The decrease in local currency net sales in the region was attributable to net sales decreases in most of the markets in the region partially offset by sales in Ecuador which was opened in the fourth quarter of 2008.

 

In Brazil, the region’s largest market, net sales decreased $2.7 million, or 7.6%, for the three months ended March 31, 2009, as compared to the same period in 2008. In local currency, net sales increased 23.0% for the three months ended March 31, 2009, as compared to the same period in 2008. The increase in local currency net sales was a result of distributors successfully transforming this market into a more balanced mix of recruiting, retailing and retention via the Nutrition Club and daily consumption based DMOs. The fluctuation of foreign currency rates had a $10.9 million unfavorable impact on net sales for the three months ended March 31, 2009.

 

Venezuela, the region’s second largest market, experienced a net sales decrease of $7.7 million or 30.7%, for the three months ended March 31, 2009 as compared to the same period in 2008. On a sequential quarter basis, Venezuela appears to have stabilized following a slowdown in volume during the second half of 2008 as a result of price increases of 20% and 25% in January and May 2008, respectively.

 

In February 2009, the region hosted three Extravaganzas in Chile, Colombia, and Panama with collectively over 18,300 distributors in attendance. In addition, Brazil hosted an Extravaganza in April 2009 with attendance of over 12,000 distributors.

 

New supervisors in the region decreased 39.6% for the three months ended March 31, 2009, as compared to the same period in 2008. For the three months ended March 31, 2009, the decrease was driven by declines in Argentina, Venezuela, Bolivia and Peru of 84.3%, 72.1%, 59.8%, and 57.5%, respectively, as compared to the same period in 2008. These declines were partially offset by increases in new supervisor growth in Brazil which increased 11.8% for the three months ended March 31, 2009 as compared to the same period in 2008. Total supervisors in the region decreased 1.9%.

 

We believe the fiscal year 2009 net sales in South and Central America should show a decline primarily due to challenging volume comparisons in Venezuela, Argentina and Peru and assumed unfavorable currency fluctuations partially offset by the success of daily consumption DMOs, primarily in Brazil, as well as product price increases.

 

EMEA

 

The EMEA region reported net sales of $123.3 million for the three months ended March 31, 2009. Net sales decreased $34.7 million, or 22.0%, for the three months ended March 31, 2009, as compared to 2008. In local currency, net sales decreased 6.6% for the three months ended March 31, 2009, as compared to 2008. The fluctuation of foreign currency rates had an unfavorable impact on net sales of $24.3 million for the three months ended March 31, 2009.

 

Among the largest markets in the region, Italy, France and Spain net sales decreased 3.9%, 22.5% and 48.3%, respectively, for the three months ended March 31, 2009, as compared to the same period in 2008. In local currency, Italy reported a net sales increase of 10.5% while France and Spain reported net sales decreases of 10.8% and 40.8%, respectively, for the three months ended March 31, 2009, as compared to the same period in 2008. The decrease in net sales for Spain reflects the impact of negative media reports in April 2008 relating to the Spanish Ministry of Health alert regarding Herbalife products. In Russia, net sales decreased by 21.0% for the three months ended March 31, 2009, as compared to the same period in 2008. In local currency, however, net sales increased by 11.6% for the three months ended March 31, 2009, as compared to the same period in 2008. The increase in local currency net sales was primarily driven by the continued adoption of the Nutrition Club concept in the form of a

Breakfast Club DMO. Net sales in the Netherlands decreased 11.9% for the three months ended March 31, 2009, as compared to the same period in 2008. In local currency, however, net sales increased 1.1% over the same period compared to the prior year period reflecting a re-activated distributor base that is utilizing the Wellness Evaluation and Healthy Breakfast DMOs. Portugal net sales declined 61.8% for the three months ended March 31, 2009, as it continues to transition towards a daily consumption model.

 

For the three months ended March 31, 2009, new supervisors for the region decreased 19.9%, with declines in Portugal, Spain and the CIS countries of 78.7%, 62.6% and 35.4%, respectively. These declines were partially offset by increases in Russia and Italy, where new supervisors increased 26.4% and 10.5%, respectively, for the three months ended March 31, 2009. Total supervisors in the region decreased 10.3%.

 

We believe fiscal year 2009 net sales in EMEA should show a decrease due primarily to assumed unfavorable currency fluctuations and soft volume point trends.

 

Asia Pacific

 

The Asia Pacific region, which excludes China, reported net sales of $114.0 million for the three months ended March 31, 2009. Net sales increased $10.3 million, or 9.9%, for the three months ended March 31, 2009, as compared to the same period in 2008. In local currency, net sales increased 29.8% for the three months ended March 31, 2009, as compared to the same period in 2008. The fluctuation of foreign currency rates had an unfavorable impact of $20.6 million on net sales for the three months ended March 31, 2009. The increase in net sales in Asia Pacific was primarily attributable to increases in three of our largest markets in the region, Taiwan, South Korea and Malaysia, partially offset by a decrease in Japan.

 

Net sales in Taiwan, our largest market in the region, increased $12.7 million, or 41.7%, for the three months ended March 31, 2009, as compared to the same period in 2008. In local currency, net sales increased 54.3% for the three months ended March 31, 2009, as compared to the same period in 2008. Adoption of the Nutrition Club DMO, in the form of Commercial Clubs, has been a positive catalyst for growth in this country. Sales were further bolstered in the first quarter of 2009 by a promotion which was done in conjunction with a government sponsored Consumption Voucher project. This promotion was in place for both February and March.

 

Net sales in South Korea, our second largest market in the region, increased $0.8 million, or 5.0%, for the three months ended March 31, 2009, as compared to the same period in 2008. In local currency, net sales increased 55.9% for the three months ended March 31, 2009, as compared to the same period in 2008. The increase in local currency net sales was driven by branding activities and the adoption of the Nutrition Club DMO, in the form of Commercial Clubs. The fluctuation of foreign currency rates had an unfavorable impact on net sales of $8.3 million or 50.9% for the three months ended March 31, 2009, as compared to the same period in 2008.

 

Net sales in Japan, our third largest market in the region, decreased $6.0 million, or 28.0%, for the three months ended March 31, 2009, as compared to the same period in 2008. In local currency, net sales decreased 18.0% for the three months ended March 31, 2009, as compared to the same period in 2008. The decrease in local currency net sales was driven by a continuing decline in distributor recruiting. The fluctuation of foreign currency rates had an unfavorable impact on net sales of $2.1 million or 10.0% for the three months ended March 31, 2009, as compared to the same period in 2008.

 

Net sales in Malaysia, our fourth largest market in the region, increased $2.9 million, or 34.7%, for the three months ended March 31, 2009, as compared to the same period in 2008, reflecting the continued success of the Road Show DMO, which has generated positive distributor momentum and increased recruiting. In local currency, net sales increased 51.6% for the three months ended March 31, 2009, as compared to the same period in 2008.

 

New supervisors in the region increased 22.3% for the three months ended March 31, 2009, as compared to the same period in 2008. New supervisors for India, Korea and Taiwan increased 83.8%, 56.4% and 29.2%, respectively, for the three months ended March 31, 2009. These increases were offset by declines in Japan and Australia of 71.5% and 39.7%, respectively, for the three months ended March 31, 2009. Total supervisor growth in the region increased 7.0%.

We believe the fiscal year 2009 net sales in Asia Pacific should be approximately flat compared to prior year as projected volume increases will be offset by assumed unfavorable foreign currency fluctuations.

 

China

 

Net sales in China were $26.8 million for the three months ended March 31, 2009. Net sales increased $2.3 million, or 9.4%, for three months ended March 31, 2009, compared to the same period in 2008. In local currency, net sales increased 4.8% for the three months ended March 31, 2009, as compared to the same period in 2008. The fluctuation of foreign currency rates had a favorable impact of $1.2 million on net sales for the three months ended March 31, 2009.

 

The current focus in China is to transition to a more retail based environment led by the introduction of nutrition clubs to increase the emphasis on daily consumption methods of operation. As experienced in other markets which have gone through a similar transition, China is experiencing a slow-down in sales growth as distributors begin to build their nutrition club business. As of March 31, 2009, there were currently over 100 clubs operating within major cities throughout China. We believe the recent success of the club DMO in Taiwan could be achieved over the next few years throughout China.

 

In March 2009, China held a Spectacular in the city of Nanjing with over 9,000 attendees.

 

As of March 31, 2009, we had 84 stores in China across 30 provinces. We currently have direct selling licenses in six provinces: JiangSu, Beijing, Guangdong, Shandong, Zhejiang (excluding Ningbo) and Guizhou. In Beijing, our direct selling license will permit us to sell away from fixed retail locations once our Beijing outlet is inspected and confirmed by the relevant authority. In addition, we have submitted applications for five additional direct selling licenses in China.

 

New sales employees in China decreased 0.5% for the three months ended March 31, 2009, as compared to the same period in 2008. Overall, sales employees in China increased 17.2%.

 

We believe the fiscal year 2009 net sales in China should increase slightly year over year, primarily as a result of improved store productivity and continuing growth of nutrition clubs.

 

Sales by Product Category

 

 

Net sales of all product categories decreased for the three months ended March 31, 2009, as compared to the same period in 2008, mainly due to the changes in net sales in the geographic regions discussed above.

 

Gross Profit

 

Gross profit was $419.3 million for the three months ended March 31, 2009, as compared to $486.8 million for the same period in 2008. As a percentage of net sales, gross profit for the three months ended March 31, 2009 decreased slightly to 80.4% as compared to 80.5% for the same period in 2008. Generally, gross profit percentages do not vary significantly as a percentage of net sales. We are experiencing ingredient and product price pressure in

the areas of soy and dairy products along with currency fluctuations reflecting current global economic trends. We believe that we have the ability to mitigate some of these cost increases through improved optimization of our supply chain coupled with select increases in the retail prices of our products.

 

Royalty Overrides

 

Royalty overrides as a percentage of net sales was 33.7% for the three months ended March 31, 2009, as compared to 35.2% for the same period in 2008. The decrease for the three months ended March 31, 2009, was primarily due to changes in country mix and the increase in net sales in China where compensation to our full-time employee sales representatives is included in selling, general and administrative expenses as opposed to royalty overrides where it is included for all other distributors under our worldwide marketing plan. Generally, this ratio varies slightly from period to period due to changes in the mix of products and countries because full royalty overrides are not paid on certain products and in certain countries. We anticipate fluctuations in royalty overrides as a percent of net sales reflecting the growth prospect of our China business relative to that of our worldwide business.

 

Selling, General and Administrative Expenses

 

Selling, general and administrative expenses as a percentage of net sales was 34.8% for the three months ended March 31, 2009, as compared to 30.5% for the same period in 2008.

 

For the three months ended March 31, 2009, selling, general and administrative expenses decreased $2.9 million to $181.5 million from $184.4 million for the same period in 2008. The decrease for the three months ended March 31, 2009 included $1.7 million in lower salaries and benefits mainly resulting from our restructuring initiatives; $4.3 million in lower distributor sales events costs; and $4.1 million in lower non-income tax expenses. These decreases were partially offset by $4.5 million in higher depreciation and amortization expenses, related mostly to the development of our technology infrastructure and the expansion and relocation of certain of our operations to new facilities; and $3.9 million in higher foreign currency exchange losses during the three months ended March 31, 2009 as compared to the same period in 2008.

 

We expect 2009 selling, general and administrative expenses to increase slightly in absolute dollars over 2008 levels reflecting higher China sales employee costs, increased depreciation, primarily related to our global Oracle implementation, and various sales growth initiatives, including distributor promotions. As a result of these factors, selling, general and administrative expenses as a percentage of net sales is expected to be above 2008 levels. Excluding China sales employee costs, we also expect selling, general and administrative expenses as a percentage of net sales to be higher than 2008 levels.

 

Net Interest Expense

 

Net interest expense is as follows: