UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form
(Mark One)
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from to
Commission file number:
(Exact name of registrant as specified in its charter)
(State or other jurisdiction of incorporation or organization) |
(I.R.S. Employer Identification No.) |
(Address of principal executive offices) |
(Zip code) |
(
(Registrant’s telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
Title of each class: |
Trading Symbol(s): |
Name of each exchange on which registered: |
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.
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted 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 such files).
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
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Accelerated filer |
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Non-accelerated filer |
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Smaller reporting company |
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Emerging growth company |
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If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No
Number of shares of registrant’s common shares outstanding as of April 27, 2021 was
TABLE OF CONTENTS
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Page No. |
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PART I. FINANCIAL INFORMATION |
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Item 1. |
3 |
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3 |
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4 |
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Unaudited Condensed Consolidated Statements of Comprehensive Income |
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6 |
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Notes to Unaudited Condensed Consolidated Financial Statements |
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Item 2. |
Management’s Discussion and Analysis of Financial Condition and Results of Operations |
31 |
Item 3. |
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Item 4. |
53 |
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PART II. OTHER INFORMATION |
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Item 1. |
56 |
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Item 1A. |
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Item 2. |
78 |
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Item 3. |
78 |
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Item 4. |
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Item 5. |
78 |
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Item 6. |
78 |
2
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
HERBALIFE NUTRITION LTD. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
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March 31, |
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December 31, |
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(in millions, except share and par value amounts) |
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ASSETS |
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Current assets: |
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Cash and cash equivalents |
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$ |
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$ |
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Receivables, net of allowance for doubtful accounts |
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Inventories |
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Prepaid expenses and other current assets |
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Total current assets |
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Property, plant, and equipment, at cost, net of accumulated depreciation and amortization |
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Operating lease right-of-use assets |
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Marketing-related intangibles and other intangible assets, net |
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Goodwill |
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Other assets |
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Total assets |
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$ |
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$ |
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LIABILITIES AND SHAREHOLDERS’ DEFICIT |
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Current liabilities: |
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Accounts payable |
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$ |
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$ |
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Royalty overrides |
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Current portion of long-term debt |
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Other current liabilities |
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Total current liabilities |
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Long-term debt, net of current portion |
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Non-current operating lease liabilities |
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Other non-current liabilities |
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Total liabilities |
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Commitments and contingencies |
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Shareholders’ deficit: |
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Common shares, $ |
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Paid-in capital in excess of par value |
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Accumulated other comprehensive loss |
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( |
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Accumulated deficit |
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( |
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( |
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Treasury stock, at cost, |
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( |
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Total shareholders’ deficit |
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Total liabilities and shareholders’ deficit |
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$ |
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$ |
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See the accompanying notes to unaudited condensed consolidated financial statements.
3
HERBALIFE NUTRITION LTD. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
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Three Months Ended |
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March 31, |
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March 31, |
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(in millions, except per share amounts) |
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Net sales |
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$ |
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$ |
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Cost of sales |
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Gross profit |
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Royalty overrides |
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Selling, general, and administrative expenses |
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Other operating income |
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Operating income |
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Interest expense, net |
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Income before income taxes |
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Income taxes |
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Net income |
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$ |
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$ |
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Earnings per share: |
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Basic |
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$ |
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$ |
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Diluted |
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$ |
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$ |
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Weighted-average shares outstanding: |
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Basic |
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Diluted |
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See the accompanying notes to unaudited condensed consolidated financial statements.
4
HERBALIFE NUTRITION LTD. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Unaudited)
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Three Months Ended |
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March 31, |
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March 31, |
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(in millions) |
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Net income |
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$ |
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$ |
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Other comprehensive loss: |
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Foreign currency translation adjustment, net of income taxes of $ |
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Unrealized gain on derivatives, net of income taxes of $ |
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Total other comprehensive loss |
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( |
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Total comprehensive income (loss) |
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$ |
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$ |
( |
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See the accompanying notes to unaudited condensed consolidated financial statements.
5
HERBALIFE NUTRITION LTD. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
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Three Months Ended |
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March 31, |
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March 31, |
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(in millions) |
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Cash flows from operating activities: |
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Net income |
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$ |
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$ |
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Adjustments to reconcile net income to net cash provided by operating activities: |
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Depreciation and amortization |
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Share-based compensation expenses |
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Non-cash interest expense |
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Deferred income taxes |
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Inventory write-downs |
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Foreign exchange transaction loss |
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Other |
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( |
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( |
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Changes in operating assets and liabilities: |
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Receivables |
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( |
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( |
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Inventories |
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( |
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Prepaid expenses and other current assets |
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Accounts payable |
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Royalty overrides |
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Other current liabilities |
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Other |
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Net cash provided by operating activities |
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Cash flows from investing activities: |
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Purchases of property, plant, and equipment |
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( |
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Other |
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Net cash used in investing activities |
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Cash flows from financing activities: |
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Borrowings from senior secured credit facility, net of discount |
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Principal payments on senior secured credit facility and other debt |
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( |
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Share repurchases |
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Other |
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Net cash (used in) provided by financing activities |
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Effect of exchange rate changes on cash, cash equivalents, and restricted cash |
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Net change in cash, cash equivalents, and restricted cash |
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Cash, cash equivalents, and restricted cash, beginning of period |
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Cash, cash equivalents, and restricted cash, end of period |
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$ |
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$ |
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See the accompanying notes to unaudited condensed consolidated financial statements.
6
HERBALIFE NUTRITION LTD. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. Organization
Herbalife Nutrition Ltd., a Cayman Islands exempted company with limited liability, was incorporated on April 4, 2002. Herbalife Nutrition Ltd. (and together with its subsidiaries, the “Company” or “Herbalife”) is a global nutrition company that sells weight management; targeted nutrition; energy, sports, and fitness; and outer nutrition products to and through a network of independent members, or Members. In China, the Company sells its products to and through independent service providers and sales representatives to customers and preferred customers, as well as through Company-operated retail platforms when necessary. The Company sells its products in
2. Significant Accounting Policies
Basis of Presentation
The unaudited condensed consolidated interim financial information of the Company has been prepared in accordance with Article 10 of the Securities and Exchange Commission’s, or SEC, Regulation S-X. Accordingly, as permitted by Article 10 of the SEC’s Regulation S-X, it does not include all of the information required by generally accepted accounting principles in the U.S., or U.S. GAAP, for complete financial statements. The condensed consolidated balance sheet as of December 31, 2020 was derived from the audited financial statements at that date and does not include all the disclosures required by U.S. GAAP, as permitted by Article 10 of the SEC’s Regulation S-X. The Company’s unaudited condensed consolidated financial statements as of March 31, 2021 and for the three months ended March 31, 2021 and 2020 include Herbalife Nutrition Ltd. and all of its direct and indirect subsidiaries. In the opinion of management, the accompanying financial information contains all adjustments, consisting of normal recurring adjustments, necessary to present fairly the Company’s unaudited condensed consolidated financial statements as of March 31, 2021 and for the three months ended March 31, 2021 and 2020. These unaudited condensed consolidated financial statements should be read in conjunction with the Company’s Annual Report on Form 10-K for the year ended December 31, 2020, or the 2020 10-K. Operating results for the three months ended March 31, 2021 are not necessarily indicative of the results that may be expected for the year ending December 31, 2021.
Recently Adopted Pronouncements
In August 2018, the Financial Accounting Standards Board, or FASB, issued Accounting Standards Update, or ASU, No. 2018-14, Compensation — Retirement Benefits — Defined Benefit Plans — General (Subtopic 715-20): Disclosure Framework — Changes to the Disclosure Requirements for Defined Benefit Plans. This ASU removes disclosures that are no longer considered cost beneficial, clarifies the specific requirements of disclosures, and adds disclosure requirements identified as relevant. The amendments in this update are effective for reporting periods beginning after December 15, 2020, with early adoption permitted. The adoption of this guidance during the first quarter of 2021 did not have a material impact on the Company’s condensed consolidated financial statements.
In December 2019, the FASB issued ASU No. 2019-12, Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes. This ASU simplifies the accounting for income taxes by eliminating some exceptions to the general approach in the FASB Accounting Standards Codification, or ASC, Topic 740, Income Taxes, and clarifies certain aspects of the existing guidance to promote more consistent application, among other things. The amendments in this update are effective for reporting periods beginning after December 15, 2020, with early adoption permitted. The adoption of this guidance during the first quarter of 2021 did not have a material impact on the Company’s condensed consolidated financial statements.
New Accounting Pronouncements
In August 2020, the FASB issued ASU No. 2020-06, Debt — Debt with Conversion and Other Options (Subtopic 470-20) and Derivatives and Hedging — Contracts in Entity’s Own Equity (Subtopic 815-40): Accounting for Convertible Instruments and Contracts in an Entity’s Own Equity. This ASU simplifies the accounting for convertible instruments by eliminating certain accounting models, resulting in fewer embedded conversion features being separately recognized from the host contract, and also amends the guidance for derivatives scope exception for contracts in an entity’s own equity to reduce form-over-substance-based accounting conclusions. Additionally, the amendments in this ASU affect the diluted EPS calculation for convertible instruments. It will require that the effect of potential share settlement be included in the diluted EPS calculation when a convertible instrument may be settled in cash or shares; the if-converted method as opposed to the treasury stock method would be required to calculate diluted EPS for these types of convertible instruments. The amendments in this update are effective for reporting periods beginning after December 15, 2021, with early adoption permitted. The Company is evaluating the potential impact of this adoption on its condensed consolidated financial statements.
7
Revenue Recognition
The Company’s net sales consist of product sales. In general, the Company's performance obligation is to transfer its products to its Members. The Company generally recognizes revenue when product is delivered to its Members. For China independent service providers and for third-party importers utilized in certain other countries where sales historically have not been material, the Company recognizes revenue based on the Company’s estimate of when the service provider or third-party importer sells the products because the Company is deemed to be the principal party of these product sales due to the additional selling and operating requirements relating to pricing of products, conducting business with physical locations, and other selling and marketing activities required of the service providers and third-party importers.
The Company’s Members, excluding its China independent service providers, may receive distributor allowances, which are comprised of discounts, rebates, and wholesale commission payments from the Company. Distributor allowances resulting from the Company’s sales of its products to its Members are recorded against net sales because the distributor allowances represent discounts from the suggested retail price.
The Company compensates its sales leader Members with royalty overrides for services rendered relating to the development, retention, and management of their sales organizations. Royalty overrides are payable based on achieved sales volume. Royalty overrides are classified as an operating expense reflecting the services provided to the Company. The Company compensates its China independent service providers and third-party importers utilized in certain other countries for providing marketing, selling, and customer support services. As the Company is the principal party of the product sales as described above, the service fees payable to China independent service providers and the compensation received by third-party importers for the services they provide, which represents the discount provided to them, are recorded in selling, general, and administrative expenses within the Company’s condensed consolidated statements of income.
The Company recognizes revenue when it delivers products to its United States Members; distributor allowances, inclusive of discounts and wholesale commissions, are recorded as a reduction to net sales; and royalty overrides are classified as an operating expense.
Shipping and handling services relating to product sales are recognized as fulfillment activities on the Company’s performance obligation to transfer products and are therefore recorded within net sales as part of product sales and are not considered as separate revenues. Shipping and handling costs paid by the Company are included in cost of sales.
The Company presents sales taxes collected from customers on a net basis.
The Company generally receives the net sales price in cash or through credit card payments at the point of sale. Accounts receivable consist principally of credit card receivables arising from the sale of products to the Company’s Members, and its collection risk is reduced due to geographic dispersion. Credit card receivables were $
The Company records advance sales deposits when payment is received but revenue has not yet been recognized. In the majority of the Company’s markets, advance sales deposits are generally recorded to income when the product is delivered to its Members. Additionally, advance sales deposits also include deferred revenues due to the timing of revenue recognition for products sold through China independent service providers. The estimated deferral period for advance sales deposits is generally within one week. During the three months ended March 31, 2021, the Company recognized substantially all of the revenues that were included within advance sales deposits as of December 31, 2020 and any remaining such balance was not material as of March 31, 2021. Advance sales deposits are included in other current liabilities within the Company’s condensed consolidated balance sheets. See Note 13, Detail of Certain Balance Sheet Accounts, for further information.
In general, if a Member returns product to the Company on a timely basis, they may obtain replacement product from the Company for such returned products. In addition, in general the Company maintains a buyback program pursuant to which it will repurchase products sold to a Member who has decided to leave the business. Allowances for product returns, primarily in connection with the Company’s buyback program, are provided at the time the sale is recorded. This accrual is based upon historical return rates for each country and the relevant return pattern, which reflects anticipated returns to be received over a period of up to 12 months following the original sale. Allowances for product returns were $
8
The Company’s products are grouped in
Distributor Compensation – U.S.
In the U.S., distributor compensation, including Royalty overrides, is capped if the Company does not meet an annual requirement as described in the consent order discussed in more detail in Note 5, Contingencies. On a periodic basis, the Company evaluates if this requirement will be achieved by year end to determine if a cap on distributor compensation will be required, and then determines the appropriate amount of distributor compensation expense, which may vary in each reporting period. As of March 31, 2021, the Company believes that the cap to distributor compensation will not be applicable for the current year.
Other Operating Income
To encourage local investment and operations, governments in various China provinces conduct grant programs. The Company applied for and received several such grants in China. Government grants are recorded into income when a legal right to the grant exists, there is a reasonable assurance that the grant proceeds will be received, and the substantive conditions under which the grants were provided have been met. Generally, these substantive conditions are the Company maintaining operations and paying certain taxes in the relevant province and obtaining government approval by completing an annual application process. The Company believes the continuing obligation with respect to the funds is a general requirement that they are used only for its business in China. The Company recognized government grant income related to its regional headquarters and distribution centers within China of approximately $
Restricted Cash
The following table provides a reconciliation of cash, cash equivalents, and restricted cash reported within the Company’s condensed consolidated balance sheets that sum to the total of the same such amounts shown in the Company’s condensed consolidated statements of cash flows:
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March 31, |
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December 31, |
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(in millions) |
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Cash and cash equivalents |
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$ |
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$ |
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Restricted cash included in Prepaid expenses and other current assets |
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Restricted cash included in Other assets |
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Total cash, cash equivalents, and restricted cash shown in the statement of cash flows |
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$ |
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$ |
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The majority of the Company’s consolidated restricted cash is held by certain of its foreign entities and consists of cash deposits that are required due to the business operating requirements in those jurisdictions.
COVID-19 Pandemic
During March 2020, the World Health Organization characterized the outbreak of coronavirus disease 2019, or COVID-19, as a pandemic. In response to the spread of COVID-19, certain government agencies and the Company itself have mandated various measures and recommended others, in each to protect the public and the Company’s employees, which have disrupted certain areas of the Company’s business including, but not limited to, distribution and selling activities. Despite the pandemic having a negative impact in certain of the Company’s markets, the Company’s consolidated net sales was higher for the three months ended March 31, 2021 as compared to the same period in 2020. The ultimate extent and magnitude of the impact of COVID-19 is not known and could have a material adverse impact to the Company’s business and future financial condition and results of operations. Management has been and continues to actively monitor the impact of COVID-19 generally and on the Company.
9
The Company’s condensed consolidated financial statements presented herein reflect the latest estimates and assumptions made by management that affect the reported amounts of assets and liabilities and related disclosures as of the date of the condensed consolidated financial statements and reported amounts of revenue and expenses during the reporting periods presented. The Company believes it has used reasonable estimates and assumptions to assess the fair values of its goodwill, marketing-related intangible assets, and long-lived assets; assessment of the annual effective tax rate; valuation of deferred income taxes; and the allowance for doubtful accounts. After reviewing historical and forward-looking information, the Company determined there were no impairments required relating to its goodwill, marketing-related intangible assets, and long-lived assets during the three months ended March 31, 2021.
3. Inventories
Inventories consist primarily of finished goods available for resale. Inventories are stated at lower of cost (primarily on the first-in, first-out basis) and net realizable value.
The following are the major classes of inventory:
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March 31, |
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December 31, |
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(in millions) |
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Raw materials |
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$ |
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$ |
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Work in process |
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Finished goods |
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Total |
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$ |
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$ |
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4. Long-Term Debt
Long-term debt consists of the following:
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March 31, |
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December 31, |
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(in millions) |
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Borrowings under senior secured credit facility, carrying value |
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$ |
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$ |
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Other |
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Total |
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Less: current portion |
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Long-term portion |
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$ |
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$ |
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Senior Secured Credit Facility
On August 16, 2018, the Company entered into a $
The 2018 Term Loan B was issued to the lenders at a
10
On December 12, 2019, the Company amended the 2018 Credit Facility which, among other things, reduced the interest rate for borrowings under the 2018 Term Loan B from either the eurocurrency rate plus a margin of
On
On February 10, 2021, the Company amended the 2018 Credit Facility which, among other things, reduced the interest rate for borrowings under the 2018 Term Loan B from either the eurocurrency rate plus a margin of 2.75% or the base rate plus a margin of 1.75% to either the eurocurrency rate plus a margin of
Under the 2018 Credit Facility, borrowings under the 2018 Term Loan A, 2018 Term Loan B, and 2018 Revolving Credit Facility all bear interest at either the eurocurrency rate plus a margin of
The 2018 Credit Facility requires the Company to comply with a leverage ratio. The 2018 Credit Facility also contains affirmative and negative covenants customary for financings of this type, including, among other things, limitations or prohibitions on repurchasing common shares, declaring and paying dividends and other distributions, redeeming and repurchasing certain other indebtedness, loans and investments, additional indebtedness, liens, mergers, asset sales and transactions with affiliates. In addition, the 2018 Credit Facility contains customary events of default. As of March 31, 2021 and December 31, 2020, the Company was in compliance with its debt covenants under the 2018 Credit Facility.
The 2018 Term Loan A and 2018 Term Loan B are payable in consecutive quarterly installments which began on December 31, 2018. In addition, beginning in 2020, the Company may be required to make mandatory prepayments towards the 2018 Term Loan B based on the Company’s consolidated leverage ratio and annual excess cash flows as defined under the terms of the 2018 Credit Facility. The Company is also permitted to make voluntary prepayments. Amounts outstanding under the 2018 Term Loan A may be voluntarily prepaid without premium or penalty, subject to customary breakage fees in connection with the prepayment of a eurocurrency loan. Under the amended 2018 Credit Facility, amounts voluntarily prepaid under the 2018 Term Loan B on or before August 10, 2021 will incur a prepayment premium of 1%; thereafter, amounts outstanding under the 2018 Term Loan B may be voluntarily prepaid without premium or penalty, subject to customary breakage fees in connection with the prepayment of a eurocurrency loan. These prepayments, if any, will be applied against remaining quarterly installments owed under the 2018 Term Loan A and 2018 Term Loan B in order of maturity with the remaining principal due upon maturity, unless directed otherwise by the Company. Based on the 2020 consolidated leverage ratio and excess cash flow calculation, both as defined under the terms of the 2018 Credit Facility, the Company will not be required to make a mandatory prepayment in 2021 toward the 2018 Term Loan B.
As of March 31, 2021 and December 31, 2020, the weighted-average interest rate for borrowings under the 2018 Credit Facility was
11
During the three months ended March 31, 2021, the Company borrowed an aggregate amount of $
During the three months ended March 31, 2021 and 2020, the Company recognized $
The fair value of the outstanding borrowings on the 2018 Term Loan A is determined by utilizing over-the-counter market quotes for similar instruments, which are considered Level 2 inputs as described in Note 12, Fair Value Measurements. As of March 31, 2021 and December 31, 2020, the carrying value of the 2018 Term Loan A was $
Convertible Senior Notes due 2024
In March 2018, the Company issued $
The Company incurred approximately $
12
In March 2018, the $
As of March 31, 2021, the outstanding principal on the 2024 Convertible Notes was $
During the three months ended March 31, 2021 and 2020, the Company recognized $
Senior Notes due 2025
In May 2020, the Company issued $
At any time prior to September 1, 2022, the Company may redeem all or part of the 2025 Notes at a redemption price equal to
|
|
Percentage |
|
||
2022 |
|
|
% |
||
2023 |
|
|
% |
||
2024 and thereafter |
|
|
% |
The 2025 Notes contain customary negative covenants, including, among other things, limitations or prohibitions on restricted payments, incurrence of additional indebtedness, liens, mergers, asset sales and transactions with affiliates. In addition, the 2025 Notes contain customary events of default.
The Company incurred approximately $
13
As of March 31, 2021, the outstanding principal on the 2025 Notes was $
During the three months ended March 31, 2021, the Company recognized $
Senior Notes due 2026
In August 2018, the Company issued $
At any time prior to August 15, 2021, the Company may redeem all or part of the 2026 Notes at a redemption price equal to
|
|
Percentage |
|
||
2021 |
|
|
% |
||
2022 |
|
|
% |
||
2023 and thereafter |
|
|
% |
The 2026 Notes contain customary negative covenants, including, among other things, limitations or prohibitions on restricted payments, incurrence of additional indebtedness, liens, mergers, asset sales and transactions with affiliates. In addition, the 2026 Notes contain customary events of default.
The Company incurred approximately $
As of March 31, 2021, the outstanding principal on the 2026 Notes was $
During the three months ended March 31, 2021 and 2020, the Company recognized $
14
Valuation of 2024 Convertible Notes – Level 2 and Level 3 Inputs
In order to determine the initial value of the 2024 Convertible Notes, the Company determined the fair value of the liability component of the 2024 Convertible Notes using two valuation methods. The Company reviewed market data that was available for publicly traded, senior, unsecured nonconvertible corporate bonds issued by companies with similar credit ratings. Assumptions used in the estimate represent what market participants would use in pricing the liability component, including market yields and credit standing to develop the straight debt yield estimate. The Company also used a lattice model, which included inputs such as stock price, the Convertible Note trading price, volatility and dividend yield to estimate the straight debt yield. The Company combined the results of the two valuation methods to determine the fair value of the liability component of the 2024 Convertible Notes. Most of these inputs are primarily considered Level 2 and Level 3 inputs. The Company used similar valuation approaches to determine the subsequent fair value of the liability component only for disclosure purposes, which includes using a lattice model and (1) reviewing market data relating to its 2025 Notes and 2026 Notes and comparable yield curves to determine its straight debt yield estimate, or (2) reviewing market data relating to publicly traded, senior, unsecured nonconvertible corporate bonds issued by companies with similar credit ratings in order to determine its straight debt yield estimate.
Total Debt
The Company’s total interest expense was $
As of March 31, 2021, annual scheduled principal payments of debt were as follows:
|
|
Principal Payments |
|
|
|
|
(in millions) |
|
|
2021 |
|
$ |
|
|
2022 |
|
|
|
|
2023 |
|
|
|
|
2024 |
|
|
|
|
2025 |
|
|
|
|
Thereafter |
|
|
|
|
Total |
|
$ |
|
5. Contingencies
The Company is from time to time engaged in routine litigation. The Company regularly reviews all pending litigation matters in which it is involved and establishes reserves deemed appropriate by management for these litigation matters when a probable loss estimate can be made.
The matters described in this Note may take several years to resolve. While the Company believes it has meritorious defenses, it cannot be sure of their ultimate resolution. Although the Company may reserve amounts for certain matters that the Company believes represent the most likely outcome of the resolution of these related disputes, if the Company is incorrect in its assessment, the Company may have to record additional expenses, when it becomes probable that an increased potential liability is warranted.
15
Tax Matters
The Mexican Tax Administration Service commenced audits of the Company’s Mexican subsidiaries for the period from January to September 2007 and on May 10, 2013, the Company received an assessment related to that period. This assessment is subject to interest and inflationary adjustments. On July 11, 2013, the Company filed an administrative appeal disputing the assessment. On September 22, 2014, the Mexican Tax Administration Service denied the Company’s administrative appeal. The Company commenced litigation in the Tax Court of Mexico in November 2014 to dispute the assertions made by the Mexican Tax Administration Service in the case. On January 16, 2018, the Tax Court of Mexico issued a verdict upholding the assessment issued by the Mexican Tax Administration Service. On April 16, 2018, the Company filed an appeal of this verdict, and in July 2019, the Circuit Court issued a written verdict upholding the assessment and the judgment of the Tax Court of Mexico. On August 12, 2019, the Company filed an appeal with the Supreme Court of Mexico. On October 16, 2019, the Supreme Court of Mexico refused to hear the Company’s appeal. On October 21, 2019, the Company filed a petition with the Supreme Court of Mexico, asking them to reconsider their previous decision. On April 29, 2020, the Supreme Court of Mexico declined the Company’s second petition and the adverse verdicts of the lower courts became final. The Company will pay the assessed amount in due course. The Company previously recognized a loss of $
The Mexican Tax Administration Service has delayed processing VAT refunds for companies operating in Mexico and the Company believes that the process for its Mexico subsidiary to receive VAT refunds may be delayed. As of March 31, 2021, the Company had $
The Company has received tax assessments for multiple years from the Federal Revenue Office of Brazil related to withholding/contributions based on payments to the Company’s Members. The aggregate combined amount of all these assessments is equivalent to approximately $
The Company is under examination in several Brazilian states related to ICMS and ICMS-ST taxation. Some of these examinations have resulted in assessments for underpaid tax that the Company has appealed. The State of São Paulo has audited the Company for the 2013 and 2014 tax years. During July 2016, for the State of São Paulo, the Company received an assessment in the aggregate amount of approximately $
16
The Company has received various tax assessments in multiple jurisdictions in India for multiple years from the Indian VAT and Service Tax authorities in an amount equivalent to approximately $
The Korea Customs Service audited the importation activities of Herbalife Korea for the period January 2011 through May 2013. The total assessment for the audit period is $
During the course of 2016, the Company received various questions from the Greek Social Security Agency and on December 29, 2016, the Greek Social Security Agency issued an assessment with respect to Social Security Contributions on Member earnings for the 2006 year. For Social Security issues, the statute of limitations is open for 2007 and later years in Greece. Despite the assessment amount being immaterial, the Company could receive similar assessments covering other years. The Company continues to litigate the assessment. The Company has not recognized a loss as it does not believe a loss is probable. The Company is currently unable to reasonably estimate the amount of the loss that may result from an unfavorable outcome if additional assessments for other periods were to be issued.
During March 2018, the Chinese Customs Service began an audit of the Company’s Chinese importations initially covering the periods 2015 through 2017 and has subsequently expanded its audit. The Company has responded to the initial questions from the Customs Service and the audit is ongoing. The Company believes that it has accrued the appropriate amounts, and at the present time the Company is unable to reasonably estimate the amount of any potential loss in excess of the amount already accrued relating to these matters.
U.S. Federal Trade Commission Consent Order
On July 15, 2016, the Company and the Federal Trade Commission, or the FTC, entered into a proposed Stipulation to Entry of Order for Permanent Injunction and Monetary Judgment, or the Consent Order. The Consent Order was lodged with the U.S. District Court for the Central District of California on July 15, 2016 and became effective on July 25, 2016, or the Effective Date. The Consent Order resolved the FTC’s multi-year investigation of the Company.
17
Pursuant to the Consent Order, under which the Company neither admitted nor denied the FTC’s allegations (except as to the Court having jurisdiction over the matter), the Company made, through its wholly-owned subsidiary Herbalife International of America, Inc., a $
Other Matters
As a marketer of foods, dietary and nutritional supplements, and other products that are ingested by consumers or applied to their bodies, the Company has been and is currently subjected to various product liability claims. The effects of these claims to date have not been material to the Company. The Company currently maintains product liability insurance with an annual deductible of $
As previously disclosed, the SEC and the Department of Justice, or DOJ, conducted investigations into the Company’s compliance with the Foreign Corrupt Practices Act, or FCPA, in China. Also, as previously disclosed, the Company conducted its own review and implemented remedial and improvement measures based upon this review, including replacement of certain employees and enhancements of Company policies and procedures in China. The Company cooperated with the SEC and the DOJ and has now reached separate resolutions with each of them.
On August 28, 2020, the SEC accepted the Offer of Settlement and issued an administrative order finding that the Company violated the books and records and internal controls provisions of the FCPA. In addition, on August 28, 2020, the Company and the DOJ separately entered into a court-approved deferred prosecution agreement, or DPA, under which the DOJ deferred criminal prosecution of the Company for a period of three years related to a conspiracy to violate the books and records provisions of the FCPA. Among other things, the Company is required to undertake compliance self-reporting obligations for the
On September 18, 2017, the Company and certain of its subsidiaries and Members were named as defendants in a purported class action lawsuit, titled Rodgers, et al. v Herbalife Ltd., et al. and filed in the U.S. District Court for the Southern District of Florida, which alleges violations of Florida’s Deceptive and Unfair Trade Practices statute and federal Racketeer Influenced and Corrupt Organizations statutes, unjust enrichment, and negligent misrepresentation. On August 23, 2018, the Court issued an order transferring the action to the U.S. District Court for the Central District of California as to
18
6. Segment Information
The Company is a nutrition company that sells a wide range of weight management; targeted nutrition; energy, sports, and fitness; and outer nutrition products. The Company’s products are manufactured by the Company in its Changsha, Hunan, China extraction facility; Suzhou, China facility; Nanjing, China facility; Lake Forest, California facility; and Winston-Salem, North Carolina facility, as well as by third-party providers, and then are sold to Members who consume and sell Herbalife products to retail consumers or other Members. Revenues reflect sales of products by the Company to its Members and are categorized based on geographic location.
As of March 31, 2021, the Company sold products in
Operating information for the
|
|
Three Months Ended |
|
|||||
|
|
March 31, |
|
|
March 31, |
|
||
|
|
(in millions) |
|
|||||
Net sales: |
|
|
|
|
|
|
||
Primary Reporting Segment |
|
$ |
|
|
$ |
|
||
China |
|
|
|
|
|
|
||
Total net sales |
|
$ |
|
|
$ |
|
||
Contribution margin(1): |
|
|
|
|
|
|
||
Primary Reporting Segment |
|
$ |
|
|
$ |
|
||
China(2) |
|
|
|
|
|
|
||
Total contribution margin |
|
$ |
|
|
$ |
|
||
Selling, general, and administrative expenses(2) |
|
|
|
|
|
|
||
Other operating income |
|
|
( |
) |
|
|
( |
) |
Interest expense, net |
|
|
|
|
|
|
||
Income before income taxes |
|
|
|
|
|
|
||
Income taxes |
|
|
|
|
|
|
||
Net income |
|
$ |
|
|
$ |
|
(1) Contribution margin consists of net sales less cost of sales and Royalty overrides. For the China segment, contribution margin does not include service fees to China independent service providers.
(2) Service fees to China independent service providers totaling $
The following table sets forth net sales by geographic area:
|
|
Three Months Ended |
|
|||||
|
|
March 31, |
|
|
March 31, |
|
||
|
|
(in millions) |
|
|||||
Net sales: |
|
|
|
|
|
|
||
United States |
|
$ |
|
|
$ |
|
||
China |
|
|
|
|
|
|
||
Mexico |
|
|
|
|
|
|
||
Others |
|
|
|
|
|
|
||
Total net sales |
|
$ |
|
|
$ |
|
19
7. Share-Based Compensation
The Company has share-based compensation plans, which are more fully described in Note 9, Share-Based Compensation, to the Consolidated Financial Statements included in the 2020 10-K. During the three months ended March 31, 2021, the Company granted restricted stock units subject to service conditions and restricted stock units subject to service and performance conditions.
Share-based compensation expense amounted to $
The following table summarizes the activity for stock appreciation rights, or SARs, under all share-based compensation plans for the three months ended March 31, 2021:
|
|
Number of Awards |
|
|
Weighted-Average Exercise Price Per Award |
|
|
Weighted-Average Remaining Contractual Term |
|
Aggregate Intrinsic Value(1) |
|
|||
|
|
(in thousands) |
|
|
|
|
|
|
|
(in millions) |
|
|||
Outstanding as of December 31, 2020(2)(3) |
|
|
|
|
$ |
|
|
|
$ |
|
||||
Granted |
|
|
|
|
$ |
|
|
|
|
|
|
|||
Exercised(4) |
|
|
( |
) |
|
$ |
|
|
|
|
|
|
||
Forfeited |
|
|
|
|
$ |
|
|
|
|
|
|
|||
Outstanding as of March 31, 2021(2)(3) |
|
|
|
|
$ |
|
|
|
$ |
|
||||
Exercisable as of March 31, 2021(5) |
|
|
|
|
$ |
|
|
|
$ |
|
||||
Vested and expected to vest as of March 31, 2021 |
|
|
|
|
$ |
|
|
|
$ |
|
(1) The intrinsic value is the amount by which the current market value of the underlying stock exceeds the exercise price of the SARs.
(2) Includes less than
(3) Includes
(4) Includes
(5) Includes less than
There were
The following table summarizes the activities for stock units under all share-based compensation plans for the three months ended March 31, 2021:
|
|
Number of Shares |
|
|
Weighted-Average Grant Date Fair Value Per Share |
|
||||||
|
|
(in thousands) |
|
|
|
|
||||||
Outstanding and nonvested as of December 31, 2020(1) |
|
|
|
|
$ |
|
||||||
Granted(2) |
|
|
|
|
$ |
|
||||||
Vested |
|
|
( |
) |
|
$ |
|
|||||
Forfeited |
|
|
( |
) |
|
$ |
|
|||||
Outstanding and nonvested as of March 31, 2021(1) |
|
|
|
|
$ |
|
||||||
Expected to vest as of March 31, 2021(3) |
|
|
|
|
$ |
|
(1) Includes
(2) Includes
(3) Includes
The total vesting date fair value of stock units which vested during the three months ended March 31, 2021 and 2020 was $
20
8. Income Taxes
Income taxes were $
As of March 31, 2021, the total amount of unrecognized tax benefits, including related interest and penalties, was $
The Company believes that it is reasonably possible that the amount of unrecognized tax benefits could decrease by up to approximately $
9. Derivative Instruments and Hedging Activities
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 2018 Credit Facility, which are based on variable rates.
During the first quarter of 2020, the Company entered into various interest rate swap agreements with effective dates ranging between and . These agreements collectively provide for the Company to pay interest at a weighted-average fixed rate of
Foreign Currency Instruments
The Company designates certain foreign currency derivatives, primarily comprised of foreign currency forward contracts and option contracts, as freestanding derivatives for which hedge accounting does not apply. The changes in the fair market value of these freestanding derivatives are included in selling, general, and administrative expenses within the Company’s condensed consolidated statements of income. The Company primarily uses freestanding foreign currency derivatives to hedge foreign currency-denominated intercompany transactions and to partially mitigate the impact of foreign currency fluctuations. The fair value of the freestanding foreign currency derivatives is based on third-party quotes. The Company’s foreign currency derivative contracts are generally executed on a monthly basis.
The Company designates as cash flow hedges those foreign currency forward contracts it enters into to hedge forecasted inventory purchases and intercompany management fees that are subject to foreign currency exposures. Forward contracts are used to hedge forecasted inventory purchases over specific months. Changes in the fair value of these forward contracts designated as cash flow hedges, excluding forward points, are recorded as a component of accumulated other comprehensive loss within shareholders’ deficit, and are recognized in cost of sales within the Company's condensed consolidated statement of income during the period which approximates the time the hedged inventory is sold. The Company also hedges forecasted intercompany management fees over specific months. These contracts allow the Company to sell Euros in exchange for U.S. dollars at specified contract rates. Changes in the fair value of these forward contracts designated as cash flow hedges, excluding forward points, are recorded as a component of accumulated other comprehensive loss within shareholders’ deficit, and are recognized in selling, general, and administrative expenses within the Company’s condensed consolidated statement of income during the period when the hedged item and underlying transaction affect earnings. The Company has elected to record changes in the fair value of amounts excluded from the assessment of effectiveness currently in earnings.
21
As of March 31, 2021 and December 31, 2020, the aggregate notional amounts of all foreign currency contracts outstanding designated as cash flow hedges were approximately $
As of both March 31, 2021 and December 31, 2020, the majority of the Company’s outstanding foreign currency forward contracts had maturity dates of less than with the majority of freestanding derivatives expiring within . As of March 31, 2021, the Company had aggregate notional amounts of approximately $
The following tables summarize the derivative activity during the three months ended March 31, 2021 and 2020 relating to all the Company’s derivatives.
Gains and Losses on Derivative Instruments
The following table summarizes gains (losses) relating to derivative instruments recorded in other comprehensive loss during the three months ended March 31, 2021 and 2020:
|
|
Amount of Gain (Loss) Recognized in Other Comprehensive Loss |
|
|||||
|
|
Three Months Ended |
|
|||||
|
|
March 31, |
|
|
March 31, |
|
||
|
|
(in millions) |
|
|||||
Derivatives designated as hedging instruments: |
|
|
|
|
|
|
||
Foreign exchange currency contracts relating to inventory and intercompany management fee hedges |
|
$ |
|
|
$ |
|
||
Interest rate swaps |
|
|
— |
|
|
|
( |
) |
As of March 31, 2021, the estimated amount of existing net losses related to cash flow hedges recorded in accumulated other comprehensive loss that are expected to be reclassified into earnings over the next twelve months was $
22
The effect of cash flow hedging relationships on the Company’s condensed consolidated statements of income for the three months ended March 31, 2021 and 2020 was as follows:
|
|
Location and Amount of Gain (Loss) Recognized in Income on Cash Flow Hedging Relationships |
|
|||||||||||||||||||||
|
|
Three Months Ended |
|
|||||||||||||||||||||
|
|
March 31, |
|
|
March 31, |
|
||||||||||||||||||
|
|
Cost of sales |
|
|
Selling, general, and administrative expenses |
|
|
Interest expense, net |
|
|
Cost of sales |
|
|
Selling, general, and administrative expenses |
|
|
Interest expense, net |
|
||||||
|
|
(in millions) |
|
|||||||||||||||||||||
Total amounts presented in the condensed consolidated statements of income |
|
$ |
|
|
$ |
|
|
$ |
|
|
$ |
|
|
$ |
|
|
$ |
|
||||||
|
|
|
|
|
|