UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

Form 10-Q

 

(Mark One)

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2017

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: 1-32381

 

HERBALIFE LTD.

(Exact name of registrant as specified in its charter)

 

 

Cayman Islands

98-0377871

(State or other jurisdiction of

incorporation or organization)

(I.R.S. Employer

Identification No.)

P.O. Box 309GT

Ugland House, South Church Street

Grand Cayman, Cayman Islands

(Address of principal executive offices) (Zip code)

(213) 745-0500

(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      No  

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      No  

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, 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.

 

Large accelerated filer

 

  

Accelerated filer

 

 

 

 

 

Non-accelerated filer

 

  (Do not check if a smaller reporting company)

  

Smaller reporting company

 

 

 

 

 

 

 

 

Emerging growth company

 

 

 

 

 

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 October 26, 2017 was 87,197,196

 

 

 

 

 


 

HERBALIFE LTD.

 

PART I. FINANCIAL INFORMATION

 

 

Item 1. Financial Statements

3

 

 

Unaudited Condensed Consolidated Balance Sheets

3

 

 

Unaudited Condensed Consolidated Statements of Income

4

 

 

Unaudited Condensed Consolidated Statements of Comprehensive Income

5

 

 

Unaudited Condensed Consolidated Statements of Cash Flows

6

 

 

Notes to Unaudited Condensed Consolidated Financial Statements

7

 

 

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

29

 

 

Item 3. Quantitative and Qualitative Disclosures About Market Risk

50

 

 

Item 4. Controls and Procedures

53

 

 

Forward Looking Statements

54

 

PART II. OTHER INFORMATION

 

 

Item 1. Legal Proceedings

55

 

 

Item 1A. Risk Factors

55

 

 

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

74

 

 

Item 3. Defaults Upon Senior Securities

74

 

 

Item 4. Mine Safety Disclosures

74

 

 

Item 5. Other Information

74

 

 

Item 6. Exhibits

74

 

 

Signatures and Certifications

78

 

 

 

 


 

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

HERBALIFE LTD. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(Unaudited)

 

 

 

September 30,

2017

 

 

December 31,

2016

 

 

 

(In millions, except share and

par value amounts)

 

ASSETS

 

 

 

 

 

 

 

 

CURRENT ASSETS:

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

1,636.3

 

 

$

844.0

 

Receivables, net of allowance for doubtful accounts

 

 

95.2

 

 

 

70.3

 

Inventories

 

 

354.2

 

 

 

371.3

 

Prepaid expenses and other current assets

 

 

188.4

 

 

 

176.9

 

Total current assets

 

 

2,274.1

 

 

 

1,462.5

 

Property, at cost, net of accumulated depreciation and amortization

 

 

375.1

 

 

 

378.0

 

Marketing related intangibles and other intangible assets, net

 

 

310.1

 

 

 

310.1

 

Goodwill

 

 

95.8

 

 

 

89.9

 

Other assets

 

 

367.4

 

 

 

324.9

 

Total assets

 

$

3,422.5

 

 

$

2,565.4

 

LIABILITIES AND SHAREHOLDERS’ EQUITY

 

 

 

 

 

 

 

 

CURRENT LIABILITIES:

 

 

 

 

 

 

 

 

Accounts payable

 

$

60.6

 

 

$

66.0

 

Royalty overrides

 

 

266.7

 

 

 

261.2

 

Current portion of long-term debt

 

 

104.1

 

 

 

9.5

 

Other current liabilities

 

 

427.4

 

 

 

454.8

 

Total current liabilities

 

 

858.8

 

 

 

791.5

 

NON-CURRENT LIABILITIES:

 

 

 

 

 

 

 

 

Long-term debt, net of current portion

 

 

2,176.6

 

 

 

1,438.4

 

Other non-current liabilities

 

 

168.1

 

 

 

139.2

 

Total liabilities

 

 

3,203.5

 

 

 

2,369.1

 

CONTINGENCIES

 

 

 

 

 

 

 

 

SHAREHOLDERS’ EQUITY:

 

 

 

 

 

 

 

 

Common shares, $0.001 par value; 1.0 billion shares authorized; 89.3 million (2017) and 93.1 million (2016) shares outstanding

 

 

0.1

 

 

 

0.1

 

Paid-in capital in excess of par value

 

 

452.0

 

 

 

467.6

 

Accumulated other comprehensive loss

 

 

(174.6

)

 

 

(205.1

)

Retained earnings (accumulated deficit)

 

 

240.7

 

 

 

(66.3

)

Treasury stock, at cost, 4.6 million shares (2017)

 

 

(299.2

)

 

 

 

Total shareholders’ equity

 

 

219.0

 

 

 

196.3

 

Total liabilities and shareholders’ equity

 

$

3,422.5

 

 

$

2,565.4

 

 

See the accompanying notes to unaudited condensed consolidated financial statements.

 

 

 

3


 

HERBALIFE LTD. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF INCOME

(Unaudited)

 

 

 

Three Months Ended

 

 

Nine Months Ended

 

 

 

September 30,

2017

 

 

September 30,

2016

 

 

September 30,

2017

 

 

September 30,

2016

 

 

 

(In millions, except per share amounts)

 

Product sales

 

$

1,029.7

 

 

$

1,063.2

 

 

$

3,162.8

 

 

$

3,253.1

 

Shipping & handling revenues

 

 

55.7

 

 

 

58.8

 

 

 

171.6

 

 

 

190.3

 

Net sales

 

 

1,085.4

 

 

 

1,122.0

 

 

 

3,334.4

 

 

 

3,443.4

 

Cost of sales

 

 

215.4

 

 

 

209.1

 

 

 

638.8

 

 

 

658.5

 

Gross profit

 

 

870.0

 

 

 

912.9

 

 

 

2,695.6

 

 

 

2,784.9

 

Royalty overrides

 

 

310.1

 

 

 

320.3

 

 

 

944.1

 

 

 

968.9

 

Selling, general & administrative expenses

 

 

445.2

 

 

 

441.3

 

 

 

1,327.0

 

 

 

1,545.2

 

Other operating income

 

 

(4.6

)

 

 

(0.2

)

 

 

(43.5

)

 

 

(29.1

)

Operating income

 

 

119.3

 

 

 

151.5

 

 

 

468.0

 

 

 

299.9

 

Interest expense, net

 

 

38.4

 

 

 

22.1

 

 

 

106.5

 

 

 

70.1

 

Income before income taxes

 

 

80.9

 

 

 

129.4

 

 

 

361.5

 

 

 

229.8

 

Income taxes

 

 

26.4

 

 

 

41.7

 

 

 

84.2

 

 

 

69.2

 

NET INCOME

 

$

54.5

 

 

$

87.7

 

 

$

277.3

 

 

$

160.6

 

Earnings per share:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic

 

$

0.69

 

 

$

1.06

 

 

$

3.41

 

 

$

1.94

 

Diluted

 

$

0.66

 

 

$

1.01

 

 

$

3.26

 

 

$

1.87

 

Weighted average shares outstanding:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic

 

 

79.6

 

 

 

83.1

 

 

 

81.4

 

 

 

83.0

 

Diluted

 

 

83.0

 

 

 

86.4

 

 

 

85.0

 

 

 

86.1

 

 

See the accompanying notes to unaudited condensed consolidated financial statements.

 

 

 

4


 

HERBALIFE LTD. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(Unaudited)

 

 

 

Three Months Ended

 

 

Nine Months Ended

 

 

 

September 30,

2017

 

 

September 30,

2016

 

 

September 30,

2017

 

 

September 30,

2016

 

 

 

(In millions)

 

Net income

 

$

54.5

 

 

$

87.7

 

 

$

277.3

 

 

$

160.6

 

Other comprehensive income (loss):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Foreign currency translation adjustment, net of income taxes of $(1.8) and $5.8 for the three months ended September 30, 2017 and 2016, respectively, and $3.5 and $7.3 for the nine months ended September 30, 2017 and 2016, respectively

 

 

11.3

 

 

 

(2.6

)

 

 

41.0

 

 

 

1.6

 

Unrealized (loss) gain on derivatives, net of income taxes of  $— for both the three months ended September 30, 2017 and 2016 and $— and $(0.3) for the nine months ended September 30, 2017 and 2016, respectively

 

 

2.5

 

 

 

(2.2

)

 

 

(10.5

)

 

 

(9.3

)

Other, net of income taxes of $0.1 for the nine months ended September 30, 2016

 

 

 

 

 

 

 

 

 

 

 

(0.1

)

Total other comprehensive income (loss)

 

 

13.8

 

 

 

(4.8

)

 

 

30.5

 

 

 

(7.8

)

Total comprehensive income

 

$

68.3

 

 

$

82.9

 

 

$

307.8

 

 

$

152.8

 

 

See the accompanying notes to unaudited condensed consolidated financial statements.

 

 

 

5


 

HERBALIFE LTD. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

 

 

 

Nine Months Ended

 

 

 

September 30,

2017

 

 

September 30,

2016

 

 

 

(In millions)

 

CASH FLOWS FROM OPERATING ACTIVITIES

 

 

 

 

 

 

 

 

Net income

 

$

277.3

 

 

$

160.6

 

Adjustments to reconcile net income to net cash provided by operating activities:

 

 

 

 

 

 

 

 

Depreciation and amortization

 

 

73.8

 

 

 

72.6

 

Share-based compensation expenses

 

 

32.6

 

 

 

30.3

 

Non-cash interest expense

 

 

44.8

 

 

 

42.0

 

Deferred income taxes

 

 

(4.1

)

 

 

(38.4

)

Inventory write-downs

 

 

17.7

 

 

 

16.7

 

Foreign exchange transaction loss (gain)

 

 

4.0

 

 

 

(1.4

)

Other

 

 

(1.1

)

 

 

(3.8

)

Changes in operating assets and liabilities:

 

 

 

 

 

 

 

 

Receivables

 

 

(22.5

)

 

 

(14.6

)

Inventories

 

 

29.2

 

 

 

(56.7

)

Prepaid expenses and other current assets

 

 

(3.6

)

 

 

(14.9

)

Accounts payable

 

 

(8.2

)

 

 

17.5

 

Royalty overrides

 

 

(6.7

)

 

 

14.1

 

Other current liabilities

 

 

(45.0

)

 

 

24.3

 

Other

 

 

16.2

 

 

 

1.6

 

NET CASH PROVIDED BY OPERATING ACTIVITIES

 

 

404.4

 

 

 

249.9

 

CASH FLOWS FROM INVESTING ACTIVITIES

 

 

 

 

 

 

 

 

Purchases of property, plant and equipment

 

 

(67.9

)

 

 

(111.9

)

Other

 

 

(2.8

)

 

 

4.4

 

NET CASH USED IN INVESTING ACTIVITIES

 

 

(70.7

)

 

 

(107.5

)

CASH FLOWS FROM FINANCING ACTIVITIES

 

 

 

 

 

 

 

 

Borrowings from senior secured credit facility, net of discount

 

 

1,274.0

 

 

 

 

Principal payments on senior secured credit facility and other debt

 

 

(468.2

)

 

 

(233.0

)

Debt issuance costs

 

 

(22.6

)

 

 

 

Share repurchases

 

 

(346.2

)

 

 

(12.5

)

Other

 

 

1.6

 

 

 

4.2

 

NET CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES

 

 

438.6

 

 

 

(241.3

)

EFFECT OF EXCHANGE RATE CHANGES ON CASH

 

 

20.0

 

 

 

(2.6

)

NET CHANGE IN CASH AND CASH EQUIVALENTS

 

 

792.3

 

 

 

(101.5

)

CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD

 

 

844.0

 

 

 

889.8

 

CASH AND CASH EQUIVALENTS, END OF PERIOD

 

$

1,636.3

 

 

$

788.3

 

 

See the accompanying notes to unaudited condensed consolidated financial statements.

 

 

6


 

HERBALIFE LTD. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

1. Organization

Herbalife Ltd., a Cayman Islands exempt limited liability company, was incorporated on April 4, 2002. Herbalife Ltd. (and together with its subsidiaries, the “Company” or “Herbalife”) is a global nutrition company that sells weight management, targeted nutrition, energy, sports & fitness, and outer nutrition products to and through a network of independent members, or Members. In China, the Company sells its products to and through independent service providers, sales representatives, and sales officers to customers and preferred customers, as well as through Company-operated retail stores when necessary. The Company reports revenue in six geographic regions: North America; Mexico; South and Central America; EMEA, which consists of Europe, the Middle East and Africa; Asia Pacific (excluding China); and China.

 

 

2. Significant Accounting Policies

Basis of Presentation

The unaudited condensed consolidated interim financial information of the Company has been prepared in accordance with Article 10 of the Securities and Exchange Commission’s, or the SEC, Regulation S-X. Accordingly, as permitted by Article 10 of the SEC’s Regulation S-X, it does not include all of the information required by generally accepted accounting principles in the U.S., or U.S. GAAP, for complete financial statements. The condensed consolidated balance sheet at December 31, 2016 was derived from the audited financial statements at that date and does not include all the disclosures required by U.S. GAAP, as permitted by Article 10 of the SEC’s Regulation S-X. The Company’s unaudited condensed consolidated financial statements as of September 30, 2017, and for the three and nine months ended September 30, 2017 and 2016, include Herbalife Ltd. and all of its direct and indirect subsidiaries. In the opinion of management, the accompanying financial information contains all adjustments, consisting of normal recurring adjustments, necessary to present fairly the Company’s unaudited condensed consolidated financial statements as of September 30, 2017, and for the three and nine months ended September 30, 2017 and 2016. 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, 2016, or the 2016 10-K. Operating results for the three and nine months ended September 30, 2017, are not necessarily indicative of the results that may be expected for the year ending December 31, 2017.

Recently Adopted Pronouncements

In March 2016, the Financial Accounting Standards Board, or FASB, issued Accounting Standards Update, or ASU No. 2016-09, Compensation — Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting. This ASU is intended to simplify various aspects related to how share-based payments are accounted for and presented in the financial statements, including the income tax effects of share-based payments and accounting for forfeitures. The amendments in this update became effective for the Company’s reporting period beginning January 1, 2017. This guidance requires the Company to recognize excess tax benefits on share-based compensation arrangements in its tax provision, instead of in shareholders’ equity as under the previous guidance. During the three and nine months ended September 30, 2017, the Company recorded $0.6 million and $26.4 million of excess tax benefits in its tax provision, respectively, as described further in Note 8, Income Taxes. In addition, these amounts are now required to be classified as an operating activity in the Company’s statement of cash flows rather than a financing activity. The Company has elected to present the cash flow statement using a prospective transition method and prior periods have not been adjusted. In addition, the Company has made an accounting policy election to continue to estimate the number of forfeitures expected to occur. The adoption of this guidance also increased the Company’s number of shares used in its calculation of fully diluted earnings per share due to the reduction in assumed proceeds under the treasury stock method which also impacts how the Company determines its earnings per share calculation. Upon adoption of this guidance on January 1, 2017, the Company also recognized $29.6 million of its unrealized excess tax benefits, described further in Note 12, Income Taxes in the 2016 10-K, as deferred tax assets on its consolidated balance sheet with a corresponding increase to its retained earnings.

In March 2016, the FASB issued ASU No. 2016-06, Derivatives and Hedging (Topic 815): Contingent Put and Call Options in Debt Instruments. This ASU clarified the requirements for assessing whether contingent put or call options that can accelerate the payment of principal on debt instruments are clearly and closely related (i.e. an entity is required to assess whether the economic characteristics and risks of embedded put or call options are clearly and closely related to those of their debt hosts only in accordance with the four-step decision sequence of FASB Accounting Standards Codification, or ASC 815, Derivatives and Hedging). An entity should no longer assess whether the event that triggers the ability to exercise a put or call option is related to interest rates or credit risk of the entity. In the first quarter of 2017, the Company adopted and applied the standard to its applicable financial instruments. The adoption of this guidance had no financial impact on the Company’s consolidated financial statements.

7


 

In March 2016, the FASB issued ASU No. 2016-05, Derivatives and Hedging (Topic 815): Effect of Derivative Contract Novations on Existing Hedge Accounting Relationships. This ASU provides guidance clarifying that the novation of a derivative contract (i.e. a change in counterparty) in a hedge accounting relationship does not, in and of itself, require dedesignation of that hedge accounting relationship. If all of the other hedge accounting criteria are met, including the expectation that the hedge will be highly effective when the creditworthiness of the new counterpart to the derivative contract is considered, the hedging relationship will continue uninterrupted. The adoption of this guidance during the first quarter of 2017 had no financial impact on the Company’s consolidated financial statements.

New Accounting Pronouncements

In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers (Topic 606). The new revenue recognition standard provides a five-step analysis of contracts to determine when and how revenue is recognized. The core principle is that a company should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. In August 2015, the FASB deferred the effective date of ASU No. 2014-09 for all entities by one year to annual reporting periods beginning after December 15, 2017. The FASB has issued several updates subsequently including implementation guidance on principal versus agent considerations, on how an entity should account for licensing arrangements with customers, and to improve guidance on assessing collectability, presentation of sales taxes, noncash consideration, and contract modifications and completed contracts at transition. The amendments in this series of updates shall be applied either retrospectively to each period presented or as a cumulative-effect adjustment as of the date of adoption. Early adoption is permitted. The Company continues to assess the impact this ASU, and related subsequent updates, will have on its consolidated financial statements. As of September 30, 2017, the Company has not identified any material impact to its consolidated net income relating to this ASU. However, the final impact of this ASU on the Company’s financial statements will not be known until the assessment is complete. The Company expects to update its disclosure in future periods as the analysis is completed.

In January 2016, the FASB issued ASU No. 2016-01, Financial Instruments – Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities. The updated guidance enhances the reporting model for financial instruments by modifying how entities measure and recognize equity investments and present changes in the fair value of financial liabilities, and by simplifying the disclosure guidance for financial instruments. The amendments in this update are effective for fiscal years beginning after December 15, 2017. The amendments in this update should be applied prospectively. The Company is evaluating the potential impact of this adoption on its consolidated financial statements.

In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842). The updated guidance requires lessees to recognize a lease liability and a right-of-use asset, measured at the present value of the future minimum lease payments, at the lease commencement date. Recognition, measurement and presentation of expenses will depend on classification as a finance or operating lease. The amendments also require certain quantitative and qualitative disclosures. ASU 2016-02 is effective for all interim and annual reporting periods beginning after December 15, 2018, with early adoption permitted. A modified retrospective approach must be applied for leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements. The Company is evaluating the potential impact of this adoption on its consolidated financial statements, however, increases in both assets and liabilities are expected.

In March 2016, the FASB issued ASU No. 2016-04, Liabilities — Extinguishments of Liabilities (Subtopic 405-20): Recognition of Breakage for Certain Prepaid Stored-Value Products. This ASU requires entities that sell prepaid stored-value products redeemable for goods, services or cash at third-party merchants to recognize breakage (i.e., the value that is ultimately not redeemed by the consumer) in a way that is consistent with how it will be recognized under the new revenue recognition standard. Under current U.S. GAAP, there is diversity in practice in how entities account for breakage that results when a consumer does not redeem the entire product balance. This ASU clarifies that an entity’s liability for prepaid stored-value products within its scope meets the definition of a financial liability. The amendments in this update are effective for reporting periods beginning after December 15, 2017, with early adoption permitted. The amendment may be applied using either a modified retrospective approach or a full retrospective approach. The adoption of this guidance will not have a material impact on the Company’s consolidated financial statements.

In June 2016, the FASB issued ASU No. 2016-13, Financial Instrument — Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. This ASU changes the impairment model for most financial assets, requiring the use of an expected loss model which requires entities to estimate the lifetime expected credit loss on financial assets measured at amortized cost. Such credit losses will be recorded as an allowance to offset the amortized cost of the financial asset, resulting in a net presentation of the amount expected to be collected on the financial asset. In addition, credit losses relating to available-for-sale debt securities will now be recorded through an allowance for credit losses rather than as a direct write-down to the security. The amendments in this update are effective for reporting periods beginning after December 15, 2019, with early adoption permitted for reporting periods beginning after December 15, 2018. The Company is evaluating the potential impact of this adoption on its consolidated financial statements.

8


 

In August 2016, the FASB issued ASU No. 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments. This ASU provides clarification on eight specific cash flow issues regarding presentation and classification in the statement of cash flows with the objective of reducing the existing diversity in practice. The amendments in this update are effective for reporting periods beginning after December 15, 2017, with early adoption permitted. The adoption of this guidance will not have a material impact on the Company’s consolidated financial statements.

In October 2016, the FASB issued ASU No. 2016-16, Income Taxes (Topic 740): Intra-Entity Transfers of Assets Other Than Inventory. This ASU requires that entities recognize the income tax consequences of an intra-entity transfer of an asset other than inventory when the transfer occurs. The amendments in this update do not change U.S. GAAP for the pre-tax effects of an intra-entity asset transfer under Topic 810, Consolidation, or for an intra-entity transfer of inventory. The amendments in this update are effective for reporting periods beginning after December 15, 2017, with early adoption permitted. The Company is evaluating the potential impact of this adoption on its consolidated financial statements.

In November 2016, the FASB issued ASU No. 2016-18, Statement of Cash Flows (Topic 230): Restricted Cash. This ASU requires that restricted cash and restricted cash equivalents be included with cash and cash equivalents when reconciling the beginning-of-period and end-of-period amounts shown on the statements of cash flows. The amendments in this update are effective for reporting periods beginning after December 15, 2017, with early adoption permitted. The Company is evaluating the potential impact of this adoption on its consolidated financial statements.

In January 2017, the FASB issued ASU No. 2017-04, Intangibles — Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment. This ASU simplifies the test for goodwill impairment by removing Step 2 from the goodwill impairment test. Companies will now perform the goodwill impairment test by comparing the fair value of a reporting unit with its carrying amount, recognizing an impairment charge for the amount by which the carrying amount exceeds the reporting unit’s fair value not to exceed the total amount of goodwill allocated to that reporting unit. An entity still has the option to perform the qualitative assessment for a reporting unit to determine if the quantitative impairment test is necessary. The amendments in this update are effective for goodwill impairment tests in fiscal years beginning after December 15, 2019, with early adoption permitted for goodwill impairment tests performed after January 1, 2017. The Company is evaluating the potential impact of this adoption on its consolidated financial statements.

In May 2017, the FASB issued ASU No. 2017-09, Compensation — Stock Compensation (Topic 718): Scope of Modification Accounting. This ASU provides additional guidance for when a company should apply modification accounting when there is a change in either the terms or conditions of a share-based payment award. Specifically, a company should not apply modification accounting if the fair value, vesting conditions, and classification of the award remains the same immediately before and after the modification. The amendments in this update must be applied on a prospective basis and are effective for reporting periods beginning after December 15, 2017, with early adoption permitted.  The adoption of this guidance will not have a material impact on the Company’s consolidated financial statements.

In August 2017, the FASB issued ASU No. 2017-12, Derivatives and Hedging: Targeted Improvements to Accounting for Hedging Activities. This ASU improves the financial reporting of hedging relationships to better portray the economic results of an entity's risk management activities in its financial statements and makes certain targeted improvements to simplify the application of existing hedge accounting guidance. The amendments in this update are effective for reporting periods beginning after December 15, 2018, with early adoption permitted. The Company is evaluating the potential impact of this adoption on its consolidated financial statements.

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 September 30, 2017, the Company believes that the cap to distributor compensation will not be applicable for the current year.

9


 

Other Operating Income

To encourage local investment and operations, governments in various China provinces conduct grant programs. The Company applied for and received several such grants in China. Government grants are recorded into income when a legal right to the grant exists, there is a reasonable assurance that the grant proceeds will be received, and the substantive conditions under which the grants were provided have been met. During the three and nine months ended September 30, 2017, the Company recognized $4.6 million and $43.5 million in government grant income related to its regional headquarters and distribution centers within China as compared to $0.2 million and $29.1 million for the same periods in 2016. The Company intends to continue applying for government grants in China when programs are available; however, there is no assurance that the Company will receive grants in future periods.

Reclassifications

Certain reclassifications were made to the prior period condensed consolidated balance sheets, the condensed consolidated statements of comprehensive income and the condensed consolidated statements of cash flows to conform to the current period presentation. See Note 13, Detail of Certain Balance Sheet Accounts, for further information on certain balance sheet items that are combined for financial statement presentation.

 

 

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:

 

 

 

September 30,

2017

 

 

December 31,

2016

 

 

 

(In millions)

 

Raw materials

 

$

41.8

 

 

$

49.3

 

Work in process

 

 

5.0

 

 

 

3.9

 

Finished goods

 

 

307.4

 

 

 

318.1

 

Total

 

$

354.2

 

 

$

371.3

 

 

 

4. Long-Term Debt

Long-term debt consists of the following:

 

 

 

September 30,

2017

 

 

December 31,

2016

 

 

 

(In millions)

 

Borrowings under prior senior secured credit facility, carrying value

 

$

 

 

$

410.0

 

Borrowings under new senior secured credit facility, carrying value

 

 

1,212.6

 

 

 

 

Convertible senior notes, carrying value of liability

   component

 

 

1,058.4

 

 

 

1,024.8

 

Other

 

 

9.7

 

 

 

13.1

 

Total

 

 

2,280.7

 

 

 

1,447.9

 

Less: current portion

 

 

104.1

 

 

 

9.5

 

Long-term portion

 

$

2,176.6

 

 

$

1,438.4

 

 

10


 

Senior Secured Credit Facility

On May 4, 2015, the Company amended its prior senior secured credit facility, or the Prior Credit Facility, to extend the maturity date of its revolving credit facility, or the Prior Revolving Credit Facility, by one year to March 9, 2017. Pursuant to this amendment and upon execution, the Company made prepayments of approximately $20.3 million and $50.9 million on its $500 million term loan under the Prior Credit Facility, or the Prior Term Loan, and the Prior Revolving Credit Facility, respectively. Additionally, the Company’s $700 million borrowing capacity on its Prior Revolving Credit Facility was reduced by approximately $235.9 million upon execution of this amendment, and was further reduced by approximately $39.1 million on September 30, 2015. The Prior Term Loan matured on March 9, 2016 and was repaid in full. The total available borrowing capacity under the Prior Revolving Credit Facility was $425.0 million as of December 31, 2016. Prior to March 9, 2016, the interest rates on the Company’s borrowings under the Prior Credit Facility remained effectively unchanged except that the minimum applicable margin was increased by 0.50% and LIBOR was subject to a minimum floor of 0.25%. After March 9, 2016, the applicable interest rates on the Company’s borrowings under the Prior Credit Facility increased by 2.00% such that borrowings under the Prior Credit Facility began bearing interest at either LIBOR plus the applicable margin between 4.00% and 5.00% or the base rate plus the applicable margin between 3.00% and 4.00%, based on the Company’s consolidated leverage ratio. The Company incurred approximately $6.2 million of debt issuance costs in connection with the amendment. These debt issuance costs were recorded on the Company’s condensed consolidated balance sheet and were amortized over the life of the Prior Revolving Credit Facility.

On February 15, 2017, the Company entered into a new $1,450.0 million senior secured credit facility, or the Credit Facility, consisting of a $1,300.0 million term loan B, or the Term Loan, and a $150 million revolving credit facility, or the Revolving Credit Facility, with a syndicate of financial institutions as lenders, or Lenders. The Revolving Credit Facility matures on February 15, 2022 and the Term Loan matures on February 15, 2023.

The Term Loan was issued to the Lenders at a 2% discount, or $26.0 million. In connection with the Credit Facility, the Company also repaid the $410.0 million outstanding balance on its Prior Revolving Credit Facility. The Company incurred approximately $22.6 million of debt issuance costs in connection with the Credit Facility. The debt issuance costs and the discount are recorded on the Company’s condensed consolidated balance sheet and are being amortized over the life of the Credit Facility using the effective interest method.

Borrowings under the Term Loan bear interest at either the eurocurrency rate plus a margin of 5.50% or the base rate plus a margin of 4.50%. Prior to August 15, 2017, borrowings under the Revolving Credit Facility bore interest at the eurocurrency rate plus a margin of 4.75% or the base rate plus a margin of 3.75%. After August 15, 2017, borrowings under the Revolving Credit Facility, depending on Herbalife’s consolidated leverage ratio, bear interest at either the eurocurrency rate plus a margin of either 4.50% or 4.75% or the base rate plus a margin of either 3.50% or 3.75%. The base rate represents the highest of the Federal Funds Rate plus 0.50%, one-month adjusted LIBOR plus 1.00%, and the prime rate set by Credit Suisse, and is subject to a floor of 1.75%. The eurocurrency rate is based on adjusted LIBOR and is subject to a floor of 0.75%.  The Company is required to pay a commitment fee on the Revolving Facility of 0.50% per annum on the undrawn portion of the Revolving Credit Facility. Interest is due at least quarterly on amounts outstanding on the Credit Facility.  

The Credit Facility requires the Company to comply with a leverage ratio. In addition, the Credit Facility contains customary events of default and covenants, including covenants that limit or restrict the Company’s ability to incur liens, incur indebtedness, make investments, dispose of assets, make certain restricted payments, pay dividends, repurchase its common shares, merge or consolidate and enter into certain transactions with affiliates.  The Company is also required to maintain a minimum balance of $200.0 million of consolidated cash and cash equivalents. As of September 30, 2017 and December 31, 2016, the Company was in compliance with its debt covenants under the Credit Facility and the Prior Credit Facility, respectively.

The Term Loan is payable in consecutive quarterly installments each in an aggregate principal amount of $24.4 million which began on June 30, 2017. In addition, the Company may be required to make mandatory prepayments towards the Term Loan based on the Company’s consolidated leverage ratio and annual excess cash flows as defined under the terms of the Credit Facility.  The Company is also permitted to make voluntary prepayments. These prepayments, if any, will be applied against remaining quarterly installments owed under the Term Loan in order of maturity with the remaining principal due upon maturity.  

On September 30, 2017 and December 31, 2016, the weighted average interest rate for borrowings under the Credit Facility and the Prior Credit Facility was 6.71% and 4.29%, respectively.

11


 

During the three months ended March 31, 2017, the Company repaid a total amount of $410.0 million to repay in full amounts outstanding on the Prior Revolving Credit Facility. During both the three months ended June 30, 2017 and September 30, 2017, the Company repaid $24.4 million, respectively, on amounts outstanding under the Term Loan. During the three months ended March 31, 2016, the Company repaid a total amount of $229.7 million to repay in full the Prior Term Loan. The Company did not repay any amounts under the Prior Revolving Credit Facility during the three months ended September 30, 2016. As of September 30, 2017, the U.S. dollar amount outstanding under the Term Loan was $1,251.2 million. There were no borrowings outstanding on the Revolving Credit Facility as of September 30, 2017. As of December 31, 2016, the U.S. dollar amount outstanding under the Prior Revolving Credit Facility was $410.0 million. There were no outstanding foreign currency borrowings as of September 30, 2017 and December 31, 2016 under the Credit Facility and the Prior Credit Facility, respectively.

During the three and nine months ended September 30, 2017, the Company recognized $23.9 million and $58.5 million, respectively, of interest expense relating to the Term Loan, which included $1.2 million and $3.0 million, respectively, relating to non-cash interest expense relating to the debt discount and $0.8 million and $2.0 million, respectively, relating to amortization of debt issuance costs.

The fair value of the outstanding borrowings on the Term Loan is determined by utilizing over-the-counter market quotes, which are considered Level 2 inputs as defined in Note 12, Fair Value Measurements. As of September 30, 2017, the carrying amount of the Term Loan was $1,212.6 million and the fair value was approximately $1,228 million. There were no amounts outstanding on the Revolving Credit Facility as of September 30, 2017.  The fair value of the outstanding borrowings on the Company’s Prior Revolving Credit Facility approximated its carrying value as of December 31, 2016 due to its variable interest rate which reprices frequently and which represents floating market rates. The fair value of the outstanding borrowings on the Prior Revolving Credit Facility was determined by utilizing Level 2 inputs as defined in Note 12, Fair Value Measurements, such as observable market interest rates and yield curves.

Convertible Senior Notes

During February 2014, the Company initially issued $1 billion aggregate principal amount of convertible senior notes, or Convertible Notes, in a private offering to qualified institutional buyers, pursuant to Rule 144A under the Securities Act of 1933, as amended. The Company granted an option to the initial purchasers to purchase up to an additional $150 million aggregate principal amount of Convertible Notes which was subsequently exercised in full during February 2014, resulting in a total issuance of $1.15 billion aggregate principal amount of Convertible Notes. The Convertible Notes are senior unsecured obligations which rank effectively subordinate to any of the Company’s existing and future secured indebtedness, including amounts outstanding under the Credit Facility, to the extent of the value of the assets securing such indebtedness. The Convertible Notes pay interest at a rate of 2.00% per annum payable semiannually in arrears on February 15 and August 15 of each year, beginning on August 15, 2014. The Convertible Notes mature on August 15, 2019, unless earlier repurchased or converted. The Company may not redeem the Convertible Notes prior to their stated maturity date. Holders of the Convertible Notes may convert their notes at their option under the following circumstances: (i) during any calendar quarter commencing after the calendar quarter ending March 31, 2014, if the last reported sale price of the Company’s common shares for at least 20 trading days (whether or not consecutive) in a period of 30 consecutive trading days ending on, and including, the last trading day of the immediately preceding calendar quarter exceeds 130% of the conversion price for the Convertible Notes on each applicable trading day; (ii) during the five business-day period immediately after any five consecutive trading day period, or the measurement period, in which the trading price per $1,000 principal amount of Convertible Notes for each trading day of that measurement period was less than 98% of the product of the last reported sale price of the Company’s common shares and the conversion rate for the Convertible Notes for each such day; or (iii) upon the occurrence of specified corporate events. On and after May 15, 2019, holders may convert their Convertible Notes at any time, regardless of the foregoing circumstances. Upon conversion, the Convertible Notes will be settled in cash and, if applicable, the Company’s common shares, based on the applicable conversion rate at such time. The Convertible Notes had an initial conversion rate of 11.5908 common shares per $1,000 principal amount of the Convertible Notes (which is equal to an initial conversion price of approximately $86.28 per common share).

The Company incurred approximately $26.6 million of issuance costs during the first quarter of 2014 relating to the issuance of the Convertible Notes. Of the $26.6 million issuance costs incurred, $21.5 million and $5.1 million were recorded as debt issuance costs and additional paid-in capital, respectively, in proportion to the allocation of the proceeds of the Convertible Notes. The $21.5 million of debt issuance cost recorded on the Company’s condensed consolidated balance sheet is being amortized over the contractual term of the Convertible Notes using the effective interest method.

12


 

During February 2014, the $1.15 billion proceeds received from the issuance of the Convertible Notes were initially allocated between long-term debt, or liability component, and additional paid-in-capital, or equity component, within the Company’s condensed consolidated balance sheet at $930.9 million and $219.1 million, respectively. The liability component was measured using the nonconvertible debt interest rate. The carrying amount of the equity component representing the conversion option was determined by deducting the fair value of the liability component from the face value of the Convertible Notes as a whole. Since the Company must still settle these Convertible Notes at face value at or prior to maturity, this liability component will be accreted up to its face value resulting in additional non-cash interest expense being recognized within the Company’s condensed consolidated statements of income while the Convertible Notes remain outstanding. The effective interest rate on the Convertible Notes is approximately 6.2% per annum. The equity component is not remeasured as long as it continues to meet the conditions for equity classification.

As of September 30, 2017, the outstanding principal on the Convertible Notes was $1.15 billion, the unamortized debt discount and debt issuance cost was $91.6 million, and the carrying amount of the liability component was $1,058.4 million, which was recorded to long-term debt within the Company’s condensed consolidated balance sheet as reflected in the table above within this Note. As of December 31, 2016, the outstanding principal on the Convertible Notes was $1.15 billion, the unamortized debt discount and debt issuance costs was $125.2 million, and the carrying amount of the liability component was $1,024.8 million, which was recorded to long-term debt within the Company’s consolidated balance sheet as reflected in the table above within this Note.  The fair value of the liability component relating to the Convertible Notes was approximately $1,064.6 million and $961.3 million as of September 30, 2017 and December 31, 2016, respectively. At September 30, 2017 and December 31, 2016, the Company determined the fair value of the liability component of the Convertible Notes using two valuation methods. The Company reviewed market data that was available for publicly traded, senior, unsecured nonconvertible corporate bonds issued by companies with similar credit ratings. Assumptions used in the estimate represent what market participants would use in pricing the liability component, including market yields and credit standing to develop the straight debt yield estimate. The Company also used a lattice model, which included inputs such as stock price, the Convertible Note trading price, volatility and dividend yield to estimate the straight debt yield. The Company combined the results of the two valuation methods to determine the fair value of the liability component of the Convertible Notes. Most of these inputs are primarily considered Level 2 and Level 3 inputs. This valuation approach was similar to the approach the Company used to determine the initial fair value of the liability component of the Convertible Notes on the February 7, 2014 issuance date.

In conjunction with the issuance of the Convertible Notes, during February 2014, the Company paid approximately $685.8 million to enter into prepaid forward share repurchase transactions, or the Forward Transactions, with certain financial institutions, and paid approximately $123.8 million to enter into capped call transactions with respect to its common shares, or the Capped Call Transactions, with certain financial institutions. See Note 10, Shareholders’ Equity, for additional discussion on the Forward Transactions and Capped Call Transactions entered into in conjunction with the issuance of these Convertible Notes.

During the three and nine months ended September 30, 2017, the Company recognized $17.2 million and $50.9 million, respectively, of interest expense relating to the Convertible Notes, which included $10.4 million and $30.6 million, respectively, relating to non-cash interest expense relating to the debt discount and $1.0 million and $3.0 million, respectively, relating to amortization of debt issuance costs. During the three and nine months ended September 30, 2016, the Company recognized $16.4 million and $48.7 million, respectively, of interest expense relating to the Convertible Notes, which included $9.7 million and $28.7 million, respectively, relating to non-cash interest expense relating to the debt discount and $0.9 million and $2.8 million, respectively, relating to amortization of debt issuance costs. 

Total Debt

The Company’s total interest expense was $43.0 million and $24.0 million for the three months ended September 30, 2017 and 2016, respectively, and $117.4 million and $74.6 million for the nine months ended September 30, 2017 and 2016, respectively, which was recognized within its condensed consolidated statements of income.

As of September 30, 2017, annual scheduled principal payments of debt were: $26.2 million for the remainder of 2017; and $102.3 million; $1,250.0 million; $97.9 million; $97.5 million; $97.5 million; and $739.4 million for the years ended December 31, 2018, 2019, 2020, 2021, 2022, and 2023, respectively.

Certain vendors and government agencies may require letters of credit or similar guaranteeing arrangements to be issued or executed. As of September 30, 2017, the Company had $37.9 million of issued but undrawn letters of credit or similar arrangements that were unsecured, which included the Mexico Value Added Tax, or VAT, related surety bonds described in Note 5, Contingencies.

 

 

13


 

5. Contingencies

The Company is from time to time engaged in routine litigation. The Company regularly reviews all pending litigation matters in which it is involved and establishes reserves deemed appropriate by management for these litigation matters when a probable loss estimate can be made.

These 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.

Tax Matters

On May 7, 2010, the Company received an assessment from the Mexican Tax Administration Service in an amount equivalent to approximately $63.1 million, translated at the September 30, 2017 spot rate, for various items, the majority of which was VAT allegedly owed on certain of the Company’s products imported into Mexico during the years 2005 and 2006. This assessment is subject to interest and inflationary adjustments. On July 8, 2010, the Company initiated a formal administrative appeal process. On May 13, 2011, the Mexican Tax Administration Service issued a resolution on the Company’s administrative appeal. The resolution nullified the assessment. Since the Mexican Tax Administration Service can further review the tax audit findings and re-issue some or all of the original assessment, the Company commenced litigation in the Tax Court of Mexico in August 2011 to dispute the assertions made by the Mexican Tax Administration Service in the case. The Company received notification on February 6, 2015 that the Tax Court of Mexico nullified substantially all of the assessment. On March 18, 2015, the Mexican Tax Administration Service filed an appeal against the verdict with the Circuit Court. On August 27, 2015, the Circuit Court remanded the case back to the Tax Court of Mexico to reconsider a portion of the procedural decision that was adverse to the Mexican Tax Administration Service. The Company received notification on March 18, 2016 that the Tax Court of Mexico nullified a portion of the assessment and upheld a portion of the original assessment. On August 25, 2016, the Company filed a further appeal of this decision to the Circuit Court. On April 6, 2017, the Circuit Court issued a verdict with the Company prevailing on some lesser issues and the Tax Administration Service prevailing on the core issue. On May 11, 2017, the Company filed a further appeal to the Supreme Court of Mexico. On June 14, 2017, the Supreme Court of Mexico agreed to hear the appeal. The Company believes that it has meritorious defenses if the assessment is reissued. The Company has not recognized a loss as the Company does not believe a loss is probable.

The Mexican Tax Administration Service commenced audits of the Company’s Mexican subsidiaries for the period from January to September 2007 and on May 10, 2013, the Company received an assessment of approximately $16.2 million, translated at the September 30, 2017 spot rate, related to that period. On July 11, 2013, the Company filed an administrative appeal disputing the assessment. On September 22, 2014, the Mexican Tax Administration Service denied the Company’s administrative appeal. The Company commenced litigation in the Tax Court of Mexico in November 2014 to dispute the assertions made by the Mexican Tax Administration Service in the case. The Company issued a surety bond in the amount of $17.9 million, translated at the September 30, 2017 spot rate, through an insurance company to guarantee payment of the tax assessment as required while the Company pursues an appeal of the assessment. Litigation in this case is currently ongoing. The Company has not recognized a loss as the Company does not believe a loss is probable.

The Mexican Tax Administration Service 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 September 30, 2017, the Company had $46.3 million of Mexico VAT related assets, of which $39.7 million was within non-current other assets and $6.6 million was within prepaid expenses and other current assets on its consolidated balance sheet. This amount relates to VAT payments made over various periods and the Company believes these amounts are recoverable by refund or they may be applied against certain future tax liabilities. The Company has not recognized any losses related to these VAT related assets as the Company does not believe a loss is probable.

On March 26, 2015, the Office of the President of Mexico issued a decree relating to the application of VAT to nutritional supplements. The Company continues to believe its application of the VAT law in Mexico is correct. At September 30, 2017, the Company has not recognized any losses as the Company, based on its current analysis and guidance from its advisors, does not believe a loss is probable. The Company continues to evaluate and monitor its situation as it develops, including whether it will make any changes to its operations in Mexico.

14


 

The Company has not recognized a loss with respect to any of these Mexican matters as the Company, based on its analysis and guidance from its advisors, does not believe a loss is probable. Further, the Company is currently unable to reasonably estimate a possible loss or range of loss that could result from an unfavorable outcome if an assessment was re-issued or any additional assessments were to be issued for these or other periods. The Company believes that it has meritorious defenses if an assessment is re-issued or would have meritorious defenses if any additional assessment is issued.

As previously disclosed, the Mexican Tax Administration Service has requested information related to the Company’s 2010 year. This information has been provided and the Tax Administration Service has now completed its income tax audit related to the 2010 year. The Tax Administration Service is now discussing its preliminary findings with the Company. It is possible that the Company could receive a final assessment from the Tax Administration Service after these discussions are completed. The Company believes that it has recognized an appropriate amount of income tax expense with respect to its Mexican operations during the 2010 year. The Company believes that it has meritorious defenses if a formal assessment is issued by the Tax Administration Service. The Company is currently unable to reasonably estimate the amount of loss that may result from an unfavorable outcome if a formal assessment is issued by the Tax Administration Service.

The Company received a tax assessment in September 2009 from the Federal Revenue Office of Brazil in an amount equivalent to approximately $2.2 million, translated at the September 30, 2017 spot rate, related to withholding/contributions based on payments to the Company’s Members during 2004. On December 28, 2010, the Company appealed this tax assessment to the Administrative Council of Tax Appeals (2nd level administrative appeal). The Company believes it has meritorious defenses and it has not recognized a loss as the Company does not believe a loss is probable. On March 6, 2014, the Company was notified of a similar audit of the 2011 year. In January 2016, the Company received a tax assessment for an amount equivalent to approximately $5.6 million, translated at the September 30, 2017 spot rate, related to contributions based on payments to the Company’s Members during 2011. The Company filed a first level administrative appeal against most of the assessment on February 23, 2016, which was subsequently denied.  On March 13, 2017, the Company appealed this tax assessment to the Administrative Council of Tax Appeals (2nd level administrative appeal).   The Company has not accrued a loss for the majority of the assessment because the Company does not believe a loss is probable.  The Company is currently unable to reasonably estimate the amount of the loss that may result from an unfavorable outcome if additional assessments for other periods were to be issued.

The Company’s Brazilian subsidiary pays ICMS-ST taxes on its product purchases, similar to VAT. As of September 30, 2017, the Company had $16.0 million of Brazil ICMS-ST, of which $7.5 million was within non-current other assets and $8.5 million was within prepaid expenses and other current assets on its condensed consolidated balance sheet. The Company believes it will be able to utilize or recover these ICMS-ST credits in the future.

The Company is under examination in several Brazilian states related to ICMS and ICMS-ST taxation. Some of these examinations have resulted in assessments for underpaid tax that the Company has appealed. The State of Sao Paulo has audited the Company for the 2013 and 2014 tax years. During July 2016, for the State of Sao Paulo, the Company received an assessment in the aggregate amount of approximately $50.8 million, translated at the September 30, 2017 spot rate, relating to various ICMS issues for its 2013 tax year. In August 2016, the Company filed a first level administrative appeal which was denied in February 2017. The Company filed a further appeal on March 9, 2017. During August 2017, for the state of Sao Paulo, the Company received an assessment in the aggregate amount of approximately $18.8 million, translated at the September 30. 2017 spot rate, relating to various ICMS issues for its 2014 tax year.  In September 2017, the Company filed a first level administrative appeal for the 2014 tax year. The Company has not recognized a loss as the Company does not believe a loss is probable. The Company has also received other ICMS tax assessments in Brazil. During the fourth quarter of 2015, the Company filed appeals with state judicial courts against three of the assessments. The Company had issued surety bonds in the aggregate amount of $13.4 million, translated at the September 30, 2017 spot rate, to guarantee payment of some of the tax assessments as required while the Company pursues the appeals. In addition, the Company has received several ICMS tax assessments in the aggregate amount of $7.2 million, translated at the September 30, 2017 spot rate, from several other Brazilian states where surety bonds have not been issued. Litigation in all these cases is currently ongoing. The Company has not recognized a loss as the Company does not believe a loss is probable.

The Company has received various tax assessments in multiple states in India for multiple years from the Indian VAT authorities in an amount equivalent to approximately $8.1 million, translated at the September 30, 2017 spot rate. These assessments are for underpaid VAT. The Company is litigating these cases at the tax administrative level and the tax tribunal levels as it believes it has meritorious defenses. The Company has not recognized a loss as it does not believe a loss is probable.

15


 

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 $31.2 million translated at the September 30, 2017 spot rate. The Company has paid the assessment and has recognized these payments within other assets on its condensed consolidated balance sheet. The Company lodged a first level administrative appeal, which was denied on October 21, 2016. On January 31, 2017, the Company filed a further appeal to the National Tax Tribunal of Korea. The Company disagrees with the assertions made in the assessments, as well as the calculation methodology used in the assessments. The Company has not recognized a loss as the Company does not believe a loss is probable.

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 of approximately $2.4 million translated at the September 30, 2017 spot rate, 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.  The Company could receive similar assessments covering other years.  The Company disputes the allegations raised in the assessment and has filed an administrative appeal against the assessment with the Social Security Agency.  The Company has not recognized a loss as it does not believe a loss is probable.  

U.S. Federal Trade Commission Consent Order 

As previously disclosed, the Company received from the U.S. Federal Trade Commission, or the FTC, a Civil Investigative Demand, or a CID, relating to the FTC’s confidential investigation of whether the Company has complied with federal law in the advertising, marketing, or sale of business opportunities. On July 15, 2016, the Company and the FTC entered into a proposed Stipulation to Entry of Order for Permanent Injunction and Monetary Judgment, or the Consent Order. The Consent Order was lodged with the U.S. District Court for the Central District of California on July 15, 2016 and became effective on July 25, 2016, or the Effective Date, upon final approval by the Court. The Consent Order resolved the FTC’s multi-year investigation of the Company.

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 $200 million payment to the FTC. Additionally, the Company agreed to implement certain new procedures and enhance certain existing procedures in the U.S., most of which the Company had 10 months from the Effective Date to implement. Among other requirements, the Consent Order requires the Company to categorize all existing and future Members in the U.S. as either “preferred members” – who are simply consumers who only wish to purchase products for their own household use, or “distributors” – who are members who wish to resell some products or build a sales organization. The Company also agreed to compensate distributors on eligible U.S. sales within their downline organization, which include purchases by preferred members, purchases by a distributor for his or her personal consumption within allowable limits and sales of product by a distributor to his or her customers. The Consent Order also imposes restrictions on a distributor’s ability to open Nutrition Clubs in the United States. The Consent Order subjects the Company to certain audits by an independent compliance auditor for a period of seven years; imposes requirements on the Company regarding compliance certification and record creation and maintenance; and prohibits the Company, its affiliates and its distributors from making misrepresentations and misleading claims regarding, among other things, income and lavish lifestyles. The FTC and the independent compliance auditor have the right to inspect Company records and request additional compliance reports for purposes of conducting audits pursuant to the Consent Order. In September 2016, the Company and the FTC mutually selected Affiliated Monitors, Inc. to serve as the independent compliance auditor. The Company is monitoring the impact of the Consent Order and, while the Company currently does not expect the settlement to have a long-term and materially adverse impact on its business and its Member base, the Company’s business and its Member base, particularly in the United States, may be negatively impacted as the Company and the Member base adjust to the changes. If the Company is unable to comply with the Consent Order then this could result in a material and adverse impact to the Company’s results of operations and financial condition.

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 $15 million.

The SEC and the Department of Justice have requested from the Company documents and other information relating to the Company’s anti-corruption compliance in China and the Company is conducting its own review. The Company is cooperating with the government and cannot predict the eventual scope, duration, or outcome of the matter at this time.

16


 

Since late 2012, a short seller has made and continues to make allegations regarding the Company and its network marketing program. The Company believes these allegations are without merit and is vigorously defending itself against such claims, including proactively reaching out to governmental authorities about what the Company believes is manipulative activity with respect to its securities. Because of these allegations, the Company and others have received and may receive additional regulatory and governmental inquiries. For example, the Company has previously disclosed inquiries from the FTC, SEC and other governmental authorities. In the future, governmental authorities may determine to seek information from the Company and other persons relating to these same or other allegations. If the Company believes any governmental or regulatory inquiry or investigation is or becomes material it will be disclosed individually. Consistent with its policies, the Company has cooperated and will continue to fully cooperate with any governmental or regulatory inquiries or investigations.

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. The plaintiffs seek damages in an unspecified amount. The Company believes the lawsuit is without merit and will vigorously defend itself against the claims in the lawsuit.

In September 2017, one of the Company’s warehouses located in Mexico sustained flooding which damaged certain inventory stored within the warehouse. The Company maintains insurance coverage with third party carriers on the affected property. As of September 30, 2017, the Company has recorded a loss for the portion of its inventory balance for which the Company believes a loss is probable and estimable and has recognized an equal offsetting receivable for insurance recoveries. The Company continues to assess the remaining warehouse inventory but has not recognized any additional loss as the amount of any additional loss has not been identified and cannot be reasonably estimated. The Company believes this event will not have a material negative impact to its Mexico operations.

 

 

6. Segment Information

The Company is a nutrition company that sells a wide range of weight management, targeted nutrition, energy, sports & fitness, and outer nutrition products. The Company’s products are manufactured by 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, and 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 September 30, 2017, the Company sold products in 94 countries throughout the world and was organized into and managed through six geographic regions: North America, Mexico, South & Central America, EMEA (Europe, Middle East, and Africa), Asia Pacific and China. The Company defines its operating segments as those geographical operations. The Company aggregates its operating segments, excluding China, into a reporting segment, or the Primary Reporting Segment, as management believes that the Company’s operating segments have similar operating characteristics and similar long term operating performance. In making this determination, management believes that the operating segments are similar in the nature of the products sold, the product acquisition process, the types of customers to whom products are sold, the methods used to distribute the products, the nature of the regulatory environment, and their economic characteristics. China has been identified as a separate reporting segment as it does not meet the criteria for aggregation. The Company reviews its net sales and contribution margin by operating segment, and reviews its assets and capital expenditures on a consolidated basis and not by operating segment. Therefore, net sales and contribution margin are presented by reportable segment and assets and capital expenditures by segment are not presented.

The operating information for the two reportable segments are as follows:

 

 

 

Three Months Ended

 

 

Nine Months Ended

 

 

 

September 30,

2017

 

 

September 30,

2016

 

 

September 30,

2017

 

 

September 30,

2016

 

 

 

(In millions)

 

Net Sales:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Primary Reporting Segment

 

$

875.6

 

 

$

907.8

 

 

$

2,666.4

 

 

$

2,769.3

 

China

 

 

209.8

 

 

 

214.2

 

 

 

668.0

 

 

 

674.1

 

Total Net Sales

 

$

1,085.4

 

 

$

1,122.0

 

 

$

3,334.4

 

 

$

3,443.4

 

 

17


 

Contribution Margin(1):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Primary Reporting Segment

 

$

375.9

 

 

$

398.8

 

 

$

1,155.7

 

 

$

1,201.5

 

China(2)

 

 

184.0

 

 

 

193.8

 

 

 

595.8

 

 

 

614.5

 

Total Contribution Margin

 

 

559.9

 

 

 

592.6

 

 

 

1,751.5

 

 

 

1,816.0

 

Selling, general and administrative expenses(2)

 

 

445.2

 

 

 

441.3

 

 

 

1,327.0

 

 

 

1,545.2

 

Other operating income

 

 

(4.6

)

 

 

(0.2

)

 

 

(43.5

)

 

 

(29.1

)

Interest expense, net

 

 

38.4

 

 

 

22.1

 

 

 

106.5

 

 

 

70.1

 

Income before income taxes

 

 

80.9

 

 

 

129.4

 

 

 

361.5

 

 

 

229.8

 

Income taxes

 

 

26.4

 

 

 

41.7

 

 

 

84.2

 

 

 

69.2

 

Net income

 

$

54.5

 

 

$

87.7

 

 

$

277.3

 

 

$

160.6

 

 

 

(1)

Contribution margin consists of net sales less cost of sales and royalty overrides. For the China segment, contribution margin does not include service fees to China independent service providers.

(2)

Service fees to China independent service providers totaling $99.5 million and $100.2 million for the three months ended September 30, 2017 and 2016, respectively, and $316.9 million and $318.4 million for the nine months ended September 30, 2017 and 2016, respectively, are included in selling, general and administrative expenses.

The following table sets forth net sales by geographic area:

 

 

 

Three Months Ended

 

 

Nine Months Ended

 

 

 

September 30,

2017

 

 

September 30,

2016

 

 

September 30,

2017

 

 

September 30,

2016

 

 

 

(In millions)

 

Net Sales:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

United States

 

$

193.5

 

 

$

236.0

 

 

$

631.3

 

 

$

737.7

 

Mexico

 

 

114.3

 

 

 

112.8

 

 

 

334.7

 

 

 

341.8

 

China

 

 

209.8

 

 

 

214.2

 

 

 

668.0

 

 

 

674.1

 

Others

 

 

567.8

 

 

 

559.0

 

 

 

1,700.4

 

 

 

1,689.8

 

Total Net Sales

 

$

1,085.4

 

 

$

1,122.0

 

 

$

3,334.4

 

 

$

3,443.4

 

 

 

 

7. Share-Based Compensation

The Company has share-based compensation plans, which are more fully described in Note 9, Share-Based Compensation, to the Consolidated Financial Statements in the 2016 10-K. During the nine months ended September 30, 2017, the Company granted stock appreciation rights, or SARs, and stock units subject to service conditions and service and performance conditions.

In the second and third quarters of 2017, the Company granted performance stock unit awards to certain executives, which will vest on December 31, 2019 subject to their continued employment through that date and the achievement of certain performance conditions. The performance conditions include targets for Volume Points, adjusted earnings before interest and taxes, and adjusted earnings per share. These performance stock unit awards can vest at between 0% and 200% of the target award based on the achievement of the performance conditions.

For the three months ended September 30, 2017 and 2016, share-based compensation expense amounted to $9.9 million and $9.8 million, respectively. For the nine months ended September 30, 2017 and 2016, share-based compensation expense amounted to $32.6 million and $30.3 million, respectively. As of September 30, 2017, the total unrecognized compensation cost related to all non-vested stock awards was $55.5 million and the related weighted-average period over which it is expected to be recognized is approximately 1.5 years.

18


 

The following tables summarize the activity under all share-based compensation plans for the nine months ended September 30, 2017:

 

SARs

 

Awards

 

 

Weighted

Average

Exercise

Price

 

 

Weighted

Average

Remaining

Contractual

Term

 

Aggregate

Intrinsic

Value(1)

 

 

 

(In thousands)

 

 

 

 

 

 

 

 

(In millions)

 

Outstanding at December 31, 2016(2)(3)

 

 

11,998

 

 

$

41.52

 

 

6.0 years

 

$

148.7

 

Granted

 

 

1,358

 

 

$

57.30

 

 

 

 

 

 

 

Exercised

 

 

(2,511

)

 

$

28.62

 

 

 

 

 

 

 

Forfeited

 

 

(321

)

 

$

53.67

 

 

 

 

 

 

 

Outstanding at September 30, 2017(2)(3)

 

 

10,524

 

 

$

46.26

 

 

6.3 years

 

$

237.4

 

Exercisable at September 30, 2017(4)

 

 

6,308

 

 

$

45.61

 

 

4.9 years

 

$

150.6

 

 

(1)

The intrinsic value is the amount by which the current market value of the underlying stock exceeds the exercise price of the stock awards.

(2)

Includes 0.1 million market condition SARs as of both September 30, 2017 and December 31, 2016.

(3)

Includes 2.7 million and 2.9 million performance condition SARs as of September 30, 2017 and December 31, 2016, respectively.

(4)

Includes 1.5 million performance condition SARs.

The weighted-average grant date fair value of SARs granted during the three months ended September 30, 2017 and 2016 was $31.31 and $32.06, respectively. The weighted-average grant date fair value of SARs granted during the nine months ended September 30, 2017 and 2016 was $28.36 and $29.49, respectively. The total intrinsic value of SARs exercised during the three months ended September 30, 2017 and 2016 was $3.0 million and $17.9 million, respectively. The total intrinsic value of SARs exercised during the nine months ended September 30, 2017 and 2016 was $100.0 million and $32.0 million, respectively.

 

Incentive Plan and Independent Directors Stock Units

 

Shares

 

 

Weighted

Average

Grant Date

Fair Value

 

 

 

(In thousands)

 

 

 

 

 

Outstanding and nonvested December 31, 2016

 

 

26

 

 

$

62.35

 

Granted(1)

 

 

154

 

 

$

68.84

 

Vested

 

 

(24

)

 

$

62.42

 

Forfeited

 

 

 

 

 

 

Outstanding and nonvested September 30, 2017

 

 

156

 

 

$

68.77

 

 

(1)

This includes 134,388 performance based stock unit awards which represents the maximum amount that can vest.

 

The total vesting date fair value of stock units which vested during the three months ended September 30, 2017 and 2016 was $0.1 million and $0.2 million, respectively. The total vesting date fair value of stock units which vested during the nine months ended September 30, 2017 and 2016 was $1.9 million and $2.0 million, respectively.

 

 

8. Income Taxes

Income taxes were an expense of $26.4 million and $84.2 million for the three and nine months ended September 30, 2017, respectively, as compared to an expense of $41.7 million and $69.2 million for the same periods in 2016. The effective income tax rate was 32.6% and 23.3% for the three and nine months ended September 30, 2017, respectively, as compared to 32.2% and 30.1% for the same periods in 2016.  The increase in the effective tax rate for the three months ended September 30, 2017, as compared to the same period in 2016, was primarily due to the impact of changes in the geographic mix of the Company’s income, offset by an increase in net benefits from discrete events.  The decrease in the effective tax rate for the nine months ended September 30, 2017, as compared to the same period in 2016, was primarily due to an increase in net benefits from discrete events.  Included in the discrete events for the three and nine months ended September 30, 2017 was the impact of $0.6 million and $26.4 million of excess tax benefits generated during those respective periods, relating to the Company’s application of ASU 2016-09 that was adopted on January 1, 2017.

19


 

As of September 30, 2017, the total amount of unrecognized tax benefits, including related interest and penalties was $74.2 million. If the total amount of unrecognized tax benefits was recognized, $53.1 million of unrecognized tax benefits, $12.0 million of interest and $2.5 million of penalties would impact the effective tax rate.

The Company believes that it is reasonably possible that the amount of unrecognized tax benefits could decrease by up to approximately $8.8 million within the next twelve months. Of this possible decrease, $3.7 million would be due to the settlement of audits or resolution of administrative or judicial proceedings. The remaining possible decrease of $5.1 million would be due to the expiration of statute of limitations in various jurisdictions.  For a description on contingency matters relating to income taxes see Note 5, Contingencies.

 

 

9. Derivative Instruments and Hedging Activities

Foreign Currency Instruments

The Company designates certain foreign currency derivatives, primarily comprised of foreign currency forward contracts, as freestanding derivatives for which hedge accounting does not apply. The changes in the fair market value of these freestanding derivatives are included in selling, general and administrative expenses in the Company’s condensed consolidated statements of income. The Company uses freestanding foreign currency derivatives to hedge foreign-currency-denominated intercompany transactions and to partially mitigate the impact of foreign currency fluctuations. The fair value of the freestanding foreign currency derivatives is based on third-party quotes. The Company’s foreign currency derivative contracts are generally executed on a monthly basis.

The Company designates as cash-flow hedges those foreign currency forward contracts it enters into to hedge forecasted inventory purchases and intercompany management fees that are subject to foreign currency exposures. Forward contracts are used to hedge forecasted inventory purchases over specific months. Changes in the fair value of these forward contracts, excluding forward points, designated as cash-flow hedges are recorded as a component of accumulated other comprehensive income (loss) within shareholders’ equity, and are recognized in cost of sales in the condensed consolidated statements of income during the period which approximates the time the hedged inventory is sold. The Company also hedges forecasted intercompany management fees over specific months. These contracts allow the Company to sell Euros in exchange for U.S. dollars at specified contract rates. Changes in the fair value of these forward contracts designated as cash flow hedges are recorded as a component of accumulated other comprehensive income (loss) within shareholders’ equity, and are recognized in selling, general and administrative expenses in the condensed consolidated statements of income during the period when the hedged item and underlying transaction affect earnings.

As of September 30, 2017 and December 31, 2016, the aggregate notional amounts of all foreign currency contracts outstanding designated as cash flow hedges were approximately $127.0 million and $90.0 million, respectively. At September 30, 2017, these outstanding contracts were expected to mature over the next fifteen months. The Company’s derivative financial instruments are recorded on the condensed consolidated balance sheet at fair value based on third-party quotes. As of September 30, 2017, the Company recorded assets at fair value of $0.8 million and liabilities at fair value of $5.5 million relating to all outstanding foreign currency contracts designated as cash-flow hedges. As of December 31, 2016, the Company recorded assets at fair value of $4.6 million. The Company assesses hedge effectiveness and measures hedge ineffectiveness at least quarterly. During the three and nine months ended September 30, 2017 and 2016, the ineffective portion relating to these hedges was immaterial and the hedges remained effective as of September 30, 2017 and December 31, 2016.

As of September 30, 2017 and December 31, 2016, the majority of the Company’s outstanding foreign currency forward contracts had maturity dates of less than twelve months with the majority of freestanding derivatives expiring within one month as of September 30, 2017 and December 31, 2016. As of September 30, 2017, the Company had aggregate notional amounts of approximately $398.6 million of foreign currency contracts, inclusive of freestanding contracts and contracts designated as cash flow hedges.

20


 

Gains and Losses on Derivative Instruments

The following table summarizes gains (losses) relating to derivative instruments recorded in other comprehensive income (loss) during the three and nine months ended September 30, 2017 and 2016:

 

 

 

Amount of Gain (Loss) Recognized

in Other Comprehensive Income (Loss)

 

 

 

For the Three Months Ended

 

 

For the Nine Months Ended

 

 

 

September 30, 2017

 

 

September 30, 2016

 

 

September 30, 2017

 

 

September 30, 2016

 

 

 

(In millions)

 

Derivatives designated as hedging instruments:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Foreign exchange currency contracts relating to inventory

   and intercompany management fee hedges

 

$

(0.3

)

 

$

0.8

 

 

$

(10.8

)

 

$

3.1

 

 

As of September 30, 2017, 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 $5.4 million.

The following table summarizes gains (losses) relating to derivative instruments recorded to income during the three and nine months ended September 30, 2017 and 2016:

 

 

 

Location of Gain

 

Amount of Gain (Loss)

Recognized in Income

 

 

 

(Loss)

 

For the Three Months Ended

 

 

For the Nine Months Ended

 

 

 

Recognized in Income

 

September 30, 2017

 

 

September 30, 2016

 

 

September 30, 2017

 

 

September 30, 2016

 

 

 

 

 

(In millions)

 

Derivatives designated as hedging instruments:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Foreign exchange currency contracts relating to

   inventory hedges and intercompany

   management fee hedges(1)

 

Selling, general and

administrative

expenses

 

$

(2.6

)

 

$

 

 

$

(1.4

)

 

$

0.1

 

Derivatives not designated as hedging instruments:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Foreign exchange currency contracts

 

Selling, general and

administrative

expenses

 

$

(0.5

)

 

$

0.6

 

 

$

(7.0

)

 

$

(2.6

)

 

(1)

For foreign exchange contracts designated as hedging instruments, the amounts recognized in income primarily represent the amounts excluded from the assessment of hedge effectiveness. There were no material ineffective amounts reported for derivatives designated as hedging instruments.

The following table summarizes gains (losses) relating to derivative instruments reclassified from accumulated other comprehensive loss into income during the three and nine months ended September 30, 2017 and 2016:

 

 

 

Location of Gain

(Loss)

Reclassified

from Accumulated

Other Comprehensive

 

Amount of Gain (Loss) Reclassified

from Accumulated

Other Comprehensive

Loss into Income

 

 

 

Loss into Income

 

For the Three Months Ended

 

 

For the Nine Months Ended

 

 

 

(Effective Portion)

 

September 30, 2017

 

 

September 30, 2016

 

 

September 30, 2017

 

 

September 30, 2016

 

 

 

 

 

(In millions)

 

Derivatives designated as hedging instruments:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Foreign exchange currency contracts relating to

   inventory hedges

 

Cost of sales

 

$

(1.3

)

 

$

3.2

 

 

$

0.3

 

 

$

12.9

 

Foreign exchange currency contracts relating to

   intercompany management fee hedges

 

Selling, general and

administrative expenses

 

$

(1.5

)

 

$

(0.2

)

 

$

(0.6

)

 

$

(0.8

)

 

21


 

The Company reports its derivatives at fair value as either assets or liabilities within its condensed consolidated balance sheet. See Note 12, Fair Value Measurements, for information on derivative fair values and their condensed consolidated balance sheet location as of September 30, 2017 and December 31, 2016.

 

 

10. Shareholders’ Equity

Dividends

The declaration of future dividends is subject to the discretion of the Company’s board of directors and will depend upon various factors, including its earnings, financial condition, Herbalife Ltd.’s available distributable reserves under Cayman Islands law, restrictions imposed by the Credit Facility and the terms of any other indebtedness that may be outstanding, cash requirements, future prospects and other factors deemed relevant by its board of directors.

Share Repurchases

On February 21, 2017, the Company’s board of directors authorized a new three-year $1.5 billion share repurchase program that will expire on February 21, 2020, which replaced the Company’s prior share repurchase authorization which was set to expire on June 30, 2017 which, as of December 31, 2016, had $232.9 million of remaining authorized capacity. This share repurchase program allows the Company, which includes an indirect wholly owned subsidiary of Herbalife Ltd., to repurchase the Company’s common shares, at such times and prices as determined by the Company’s management as market conditions warrant and to the extent Herbalife Ltd.’s distributable reserves are available under Cayman Islands law. The Credit Facility permits the Company to repurchase its common shares as long as no default or event of default exists and other conditions such as specified consolidated leverage ratios are met.

In conjunction with the issuance of the Convertible Notes during February 2014, the Company paid approximately $685.8 million to enter into Forward Transactions with certain financial institutions, or the Forward Counterparties, pursuant to which the Company purchased approximately 9.9 million common shares, at an average cost of $69.02 per share, for settlement on or around the August 15, 2019 maturity date for the Convertible Notes, subject to the ability of each Forward Counterparty to elect to settle all or a portion of its Forward Transactions early. See Note 4, Long-Term Debt for further information on the conditions for which Holders of the Convertible Notes may convert their notes prior to the maturity date. The Forward Transactions were generally expected to facilitate privately negotiated derivative transactions between the Forward Counterparties and holders of the Convertible Notes, including swaps, relating to the common shares by which holders of the Convertible Notes establish short positions relating to the common shares and otherwise hedge their investments in the Convertible Notes concurrently with, or shortly after, the pricing of the Convertible Notes. The shares are treated as retired shares for basic and diluted EPS purposes although they remain legally outstanding.

As a result of the Forward Transactions, the Company’s total shareholders’ equity within its condensed consolidated balance sheet was reduced by approximately $685.8 million during the first quarter of 2014, with amounts of $653.9 million and $31.9 million being allocated between accumulated deficit and additional paid-in-capital, respectively, within total shareholders’ equity. Also, upon executing the Forward Transactions, the Company recorded, at fair value, $35.8 million in non-cash issuance costs to other assets and a corresponding amount to additional paid-in-capital within its condensed consolidated balance sheet. These non-cash issuance costs will be amortized to interest expense over the contractual term of the Forward Transactions. For both the three and nine months ended September 30, 2017 and 2016, the Company recognized $1.6 million and $4.8 million, respectively, of non-cash interest expense within its condensed consolidated statements of income relating to amortization of these non-cash issuance costs.

22


 

During the three months ended March 31, 2017, an indirect wholly owned subsidiary of the Company purchased approximately 1.1 million of Herbalife Ltd.’s common shares through open market purchases at an aggregate cost of approximately $60.7 million, or an average cost of $56.10 per share. During the three months ended June 30, 2017, an indirect wholly owned subsidiary of the Company purchased approximately 2.7 million of Herbalife Ltd.’s common shares through open market purchases at an aggregate cost of approximately $179.8 million, or an average cost of $67.06 per share. During the three months ended September 30, 2017, an indirect wholly owned subsidiary of the Company purchased approximately 0.8 million of Herbalife Ltd.’s common shares through open market purchases at an aggregate cost of approximately $58.7 million, or an average cost of $72.38 per share. These 2017 share repurchases reduced the Company’s total shareholders’ equity and are reflected at cost within the Company’s accompanying condensed consolidated balance sheet. Although these shares are owned by an indirect wholly owned subsidiary of the Company, they are reflected as treasury shares under U.S. GAAP and therefore reduce the number of common shares outstanding within the Company’s condensed consolidated financial statements and the weighted-average number of common shares outstanding used in calculating earnings per share. The common shares of Herbalife Ltd. held by the indirect wholly owned subsidiary, however, remain outstanding on the books and records of the Company’s transfer agent and therefore still carry voting and other share rights related to ownership of the Company’s common shares, which may be exercised. So long as it is consistent with applicable laws, such shares will be voted by such subsidiary in the same manner, and to the maximum extent possible in the same proportion, as all other votes cast with respect to any matter properly submitted to a vote of Herbalife Ltd.’s shareholders. As of September 30, 2017, the Company held approximately 4.6 million of treasury shares for U.S. GAAP purposes. The Company did not repurchase any common shares in the open market during the three and nine months ended September 30, 2016. As of September 30, 2017, the remaining authorized capacity under the Company’s $1.5 billion share repurchase program was $1,200.8 million.

The number of shares issued upon vesting or exercise for certain restricted stock units and SARs granted pursuant to the Company’s share-based compensation plans is net of the statutory withholding requirements that the Company pays on behalf of its employees. Although shares withheld are not issued, they are treated as common share repurchases in the Company’s condensed consolidated financial statements and reduce the Company’s additional paid-in-capital within total shareholders’ equity and are reflected as share repurchases on the Company’s condensed consolidated statements of cash flows as they reduce the number of shares that would have been issued upon vesting. These shares do not count against the authorized capacity under the Company’s share repurchase program described above.

For the nine months ended September 30, 2017 and 2016, the Company’s share repurchases were $299.2 million and none, respectively, under the Company’s share repurchase programs, and $47.0 million and $12.5 million, respectively, due to shares withheld for tax purposes related to the Company’s share-based compensation plans. For the nine months ended September 30, 2017 and 2016, the Company’s total share repurchases, including shares withheld for tax purposes, were $346.2 million and $12.5 million, respectively, and have been recorded as a reduction to shareholders’ equity within the Company’s condensed consolidated balance sheet as of September 30, 2017 and within financing activities on its condensed consolidated statement of cash flows for the nine months ended September 30, 2017.  

Capped Call Transactions

In February 2014, in connection with the issuance of Convertible Notes, the Company paid approximately $123.8 million to enter into Capped Call Transactions with certain financial institutions. The Capped Call Transactions are expected generally to reduce the potential dilution upon conversion of the Convertible Notes in the event that the market price of the common shares is greater than the strike price of the Capped Call Transactions, initially set at $86.28 per common share, with such reduction of potential dilution subject to a cap based on the cap price initially set at $120.79 per common share. The strike price and cap price are subject to certain adjustments under the terms of the Capped Call Transactions. Therefore, as a result of executing the Capped Call Transactions, the Company in effect will only be exposed to potential net dilution once the market price of its common shares exceeds the adjusted cap price. As a result of the Capped Call Transactions, the Company’s additional paid-in capital within shareholders’ equity on its condensed consolidated balance sheet was reduced by $123.8 million during the first quarter of 2014.

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Accumulated Other Comprehensive Income (Loss)

The following table summarizes changes in accumulated other comprehensive income (loss) during the three months ended September 30, 2017 and 2016:

 

 

 

Changes in Accumulated Other Comprehensive

 

 

 

Income (Loss) by Component

 

 

 

Three Months Ended September 30,

 

 

 

2017

 

 

2016