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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, 2019

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 NUTRITION 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)

Securities registered pursuant to Section 12(b) of the Act:

 

Title of each class:

Trading Symbol(s):

Name of each exchange on which registered:

Common Shares, par value $0.0005 per share

HLF

New York Stock Exchange

 

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 every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).    Yes      No  

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

 

Large accelerated filer

Accelerated filer

 

 

 

 

Non-accelerated filer

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 22, 2019 was 147,292,579.

 

 

 

 


 

TABLE OF CONTENTS

 

 

 

Page No.

 

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

39

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

62

Item 4.

Controls and Procedures

65

 

 

 

 

PART II. OTHER INFORMATION

 

 

 

 

Item 1.

Legal Proceedings

68

Item 1A.

Risk Factors

68

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

88

Item 3.

Defaults Upon Senior Securities

88

Item 4.

Mine Safety Disclosures

88

Item 5.

Other Information

88

Item 6.

Exhibits

88

 

 

 


 

PART I. FINANCIAL INFORMATION

Item 1.

Financial Statements

HERBALIFE NUTRITION LTD. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(Unaudited)

 

 

 

September 30,

2019

 

 

December 31,

2018

 

 

 

(in millions, except share and par value amounts)

 

ASSETS

 

Current assets:

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

715.2

 

 

$

1,198.9

 

Receivables, net of allowance for doubtful accounts

 

 

100.4

 

 

 

70.5

 

Inventories

 

 

420.1

 

 

 

381.8

 

Prepaid expenses and other current assets

 

 

153.6

 

 

 

153.8

 

Total current assets

 

 

1,389.3

 

 

 

1,805.0

 

Property, plant, and equipment, at cost, net of accumulated depreciation and amortization

 

 

360.6

 

 

 

360.0

 

Operating lease right-of-use assets

 

 

181.9

 

 

 

 

Marketing-related intangibles and other intangible assets, net

 

 

310.1

 

 

 

310.1

 

Goodwill

 

 

89.3

 

 

 

92.9

 

Other assets

 

 

214.4

 

 

 

221.8

 

Total assets

 

$

2,545.6

 

 

$

2,789.8

 

LIABILITIES AND SHAREHOLDERS’ DEFICIT

 

Current liabilities:

 

 

 

 

 

 

 

 

Accounts payable

 

$

75.8

 

 

$

81.1

 

Royalty overrides

 

 

283.9

 

 

 

281.4

 

Current portion of long-term debt

 

 

24.5

 

 

 

678.9

 

Other current liabilities

 

 

536.4

 

 

 

547.4

 

Total current liabilities

 

 

920.6

 

 

 

1,588.8

 

Long-term debt, net of current portion

 

 

1,779.3

 

 

 

1,774.9

 

Non-current operating lease liabilities

 

 

165.4

 

 

 

 

Other non-current liabilities

 

 

147.8

 

 

 

149.5

 

Total liabilities

 

 

3,013.1

 

 

 

3,513.2

 

Commitments and contingencies

 

 

 

 

 

 

 

 

Shareholders’ deficit:

 

 

 

 

 

 

 

 

Common shares, $0.0005 par value; 2.0 billion shares authorized; 137.2 million (2019) and 142.8 million (2018) shares outstanding

 

 

0.1

 

 

 

0.1

 

Paid-in capital in excess of par value

 

 

363.7

 

 

 

341.5

 

Accumulated other comprehensive loss

 

 

(230.4

)

 

 

(209.8

)

Accumulated deficit

 

 

(272.0

)

 

 

(526.3

)

Treasury stock, at cost, 10.0 million (2019) and 10.0 million (2018) shares

 

 

(328.9

)

 

 

(328.9

)

Total shareholders’ deficit

 

 

(467.5

)

 

 

(723.4

)

Total liabilities and shareholders’ deficit

 

$

2,545.6

 

 

$

2,789.8

 

 

See the accompanying notes to unaudited condensed consolidated financial statements.

 

 

3


 

HERBALIFE NUTRITION LTD. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF INCOME

(Unaudited)

 

 

 

Three Months Ended

 

 

Nine Months Ended

 

 

 

September 30,

2019

 

 

September 30,

2018

 

 

September 30,

2019

 

 

September 30,

2018

 

 

 

(in millions, except per share amounts)

 

Net sales

 

$

1,244.5

 

 

$

1,242.8

 

 

$

3,656.8

 

 

$

3,705.2

 

Cost of sales

 

 

243.4

 

 

 

218.1

 

 

 

728.2

 

 

 

693.4

 

Gross profit

 

 

1,001.1

 

 

 

1,024.7

 

 

 

2,928.6

 

 

 

3,011.8

 

Royalty overrides

 

 

363.8

 

 

 

344.0

 

 

 

1,090.1

 

 

 

1,031.1

 

Selling, general, and administrative expenses

 

 

500.1

 

 

 

499.4

 

 

 

1,412.5

 

 

 

1,469.7

 

Other operating income

 

 

(6.4

)

 

 

(6.0

)

 

 

(33.7

)

 

 

(23.9

)

Operating income

 

 

143.6

 

 

 

187.3

 

 

 

459.7

 

 

 

534.9

 

Interest expense, net

 

 

31.6

 

 

 

39.9

 

 

 

104.0

 

 

 

124.1

 

Other (income) expense, net

 

 

(1.3

)

 

 

30.9

 

 

 

(15.7

)

 

 

60.0

 

Income before income taxes

 

 

113.3

 

 

 

116.5

 

 

 

371.4

 

 

 

350.8

 

Income taxes

 

 

31.8

 

 

 

45.3

 

 

 

117.1

 

 

 

103.1

 

Net income

 

$

81.5

 

 

$

71.2

 

 

$

254.3

 

 

$

247.7

 

Earnings per share:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic

 

$

0.59

 

 

$

0.52

 

 

$

1.85

 

 

$

1.75

 

Diluted

 

$

0.58

 

 

$

0.49

 

 

$

1.79

 

 

$

1.64

 

Weighted-average shares outstanding:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic

 

 

137.4

 

 

 

136.2

 

 

 

137.3

 

 

 

141.3

 

Diluted

 

 

140.0

 

 

 

145.6

 

 

 

142.3

 

 

 

150.8

 

 

See the accompanying notes to unaudited condensed consolidated financial statements.

 

 

4


 

HERBALIFE NUTRITION LTD. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(Unaudited)

 

 

 

Three Months Ended

 

 

Nine Months Ended

 

 

 

September 30,

2019

 

 

September 30,

2018

 

 

September 30,

2019

 

 

September 30,

2018

 

 

 

(in millions)

 

Net income

 

$

81.5

 

 

$

71.2

 

 

$

254.3

 

 

$

247.7

 

Other comprehensive loss:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Foreign currency translation adjustment, net of income taxes of $(0.1) and $(2.4) for the three months ended September 30, 2019 and 2018, respectively, and $(1.1) and $(4.4) for the nine months ended September 30, 2019 and 2018, respectively

 

 

(24.0

)

 

 

(4.6

)

 

 

(18.7

)

 

 

(34.2

)

Unrealized loss on derivatives, net of income taxes of $— for both the three months ended September 30, 2019 and 2018 and $— for both the nine months ended September 30, 2019 and 2018

 

 

 

 

 

(5.7

)

 

 

(1.9

)

 

 

(4.3

)

Total other comprehensive loss

 

 

(24.0

)

 

 

(10.3

)

 

 

(20.6

)

 

 

(38.5

)

Total comprehensive income

 

$

57.5

 

 

$

60.9

 

 

$

233.7

 

 

$

209.2

 

 

See the accompanying notes to unaudited condensed consolidated financial statements.

 

 

5


 

HERBALIFE NUTRITION LTD. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

 

 

 

Nine Months Ended

 

 

 

September 30,

2019

 

 

September 30,

2018

 

 

 

(in millions)

 

Cash flows from operating activities:

 

 

 

 

 

 

 

 

Net income

 

$

254.3

 

 

$

247.7

 

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

 

 

 

 

 

 

 

 

Depreciation and amortization

 

 

73.4

 

 

 

76.0

 

Share-based compensation expenses

 

 

29.7

 

 

 

31.8

 

Non-cash interest expense

 

 

37.5

 

 

 

49.4

 

Deferred income taxes

 

 

8.0

 

 

 

6.0

 

Inventory write-downs

 

 

17.9

 

 

 

13.9

 

Foreign exchange transaction loss

 

 

4.0

 

 

 

10.4

 

Loss on extinguishment of debt

 

 

 

 

 

48.5

 

Other

 

 

(10.4

)

 

 

11.3

 

Changes in operating assets and liabilities:

 

 

 

 

 

 

 

 

Receivables

 

 

(35.7

)

 

 

(25.9

)

Inventories

 

 

(63.5

)

 

 

(40.5

)

Prepaid expenses and other current assets

 

 

2.7

 

 

 

(52.2

)

Accounts payable

 

 

(2.9

)

 

 

25.2

 

Royalty overrides

 

 

5.9

 

 

 

14.2

 

Other current liabilities

 

 

(18.0

)

 

 

82.3

 

Other

 

 

(2.0

)

 

 

11.6

 

Net cash provided by operating activities

 

 

300.9

 

 

 

509.7

 

Cash flows from investing activities:

 

 

 

 

 

 

 

 

Purchases of property, plant, and equipment

 

 

(79.5

)

 

 

(55.7

)

Net cash used in investing activities

 

 

(79.5

)

 

 

(55.7

)

Cash flows from financing activities:

 

 

 

 

 

 

 

 

Borrowings from senior secured credit facility, net of discount

 

 

 

 

 

998.1

 

Principal payments on senior secured credit facility and other debt

 

 

(17.4

)

 

 

(1,231.7

)

Proceeds from convertible senior notes

 

 

 

 

 

550.0

 

Repayment of convertible senior notes

 

 

(675.0

)

 

 

(582.5

)

Proceeds from senior notes

 

 

 

 

 

400.0

 

Debt issuance costs

 

 

 

 

 

(26.8

)

Share repurchases

 

 

(9.9

)

 

 

(740.6

)

Proceeds from settlement of capped call transactions

 

 

 

 

 

55.9

 

Other

 

 

2.5

 

 

 

2.4

 

Net cash used in financing activities

 

 

(699.8

)

 

 

(575.2

)

Effect of exchange rate changes on cash, cash equivalents, and restricted cash

 

 

(13.4

)

 

 

(48.0

)

Net change in cash, cash equivalents, and restricted cash

 

 

(491.8

)

 

 

(169.2

)

Cash, cash equivalents, and restricted cash, beginning of period

 

 

1,215.0

 

 

 

1,295.5

 

Cash, cash equivalents, and restricted cash, end of period

 

$

723.2

 

 

$

1,126.3

 

 

See the accompanying notes to unaudited condensed consolidated financial statements.

6


 

HERBALIFE NUTRITION LTD. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

1. Organization

Herbalife Nutrition Ltd., a Cayman Islands exempted company with limited liability, was incorporated on April 4, 2002. Herbalife Nutrition Ltd. (and together with its subsidiaries, the “Company” or “Herbalife”) is a global nutrition company that sells weight management; targeted nutrition; energy, sports, and fitness; and outer nutrition products to and through a network of independent members, or Members. In China, the Company sells its products to and through independent service providers, sales representatives, and sales officers to customers and preferred customers, as well as through Company-operated retail platforms when necessary. The Company sells its products 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 as of December 31, 2018 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, 2019 and for the three and nine months ended September 30, 2019 and 2018 include Herbalife Nutrition Ltd. and all of its direct and indirect subsidiaries. In the opinion of management, the accompanying financial information contains all adjustments, consisting of normal recurring adjustments, necessary to present fairly the Company’s unaudited condensed consolidated financial statements as of September 30, 2019 and for the three and nine months ended September 30, 2019 and 2018. 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, 2018, or the 2018 10-K. Operating results for the three and nine months ended September 30, 2019 are not necessarily indicative of the results that may be expected for the year ending December 31, 2019.

Recently Adopted Pronouncements

In February 2016, the Financial Accounting Standards Board, or FASB, issued Accounting Standards Update, or ASU, No. 2016-02, Leases (Topic 842), and subsequently issued additional updates to Accounting Standards Codification, or ASC, Topic 842, or ASC 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. 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. The update requires entities to recognize and measure leases at the beginning of the earliest period presented using a modified retrospective approach or allows entities to initially apply the new lease standard at the adoption date and recognize a cumulative-effect adjustment to the opening balance of retained earnings in the period of adoption. The Company adopted ASC 842 at the adoption date with the initial application date as of January 1, 2019. Under this adoption method, prior period amounts have not been adjusted. The Company elected to apply the package of practical expedients which allows entities to not reassess whether expired or existing contracts contain leases, not reassess the classification of existing leases, and not reassess initial direct costs for existing leases. Additionally, the Company did not apply hindsight in the determination of the lease term and assessing impairment of right-of-use assets for existing leases. As a result, the Company did not make any adjustments to beginning retained earnings. As part of the Company’s updated lease accounting policies, leases with an initial term of twelve months or less are not recorded on the balance sheet. Additionally, the Company elected to account for lease and non-lease components as a single lease component in the measurement of its lease liabilities and right-of-use assets. On January 1, 2019, the Company recorded total operating lease liabilities of $189.1 million and total operating lease right-of-use assets of $176.9 million, net of certain deferred rent liabilities and prepaid rent, which had no impact to the Company’s condensed consolidated statements of cash flows. See Note 4, Leases, for additional information.

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 Company has elected to record changes in the fair value of amounts excluded from the assessment of effectiveness currently in earnings. The adoption of this guidance during the first quarter of 2019 did not have a material impact on the Company’s condensed consolidated financial statements.

7


 

In February 2018, the FASB issued ASU No. 2018-02, Income Statement — Reporting Comprehensive Income (Topic 220). This ASU allows a reclassification from accumulated other comprehensive income to retained earnings for tax effects of items within accumulated other comprehensive income, or stranded tax effects, resulting from the Tax Cuts and Jobs Act and requires certain disclosures about those stranded tax effects. The Company has elected to not reclassify the income tax effects of the Tax Cuts and Jobs Act from accumulated other comprehensive income to retained earnings. The adoption of this guidance during the first quarter of 2019 did not have a material impact on the Company’s condensed consolidated financial statements.

In June 2018, the FASB issued ASU No. 2018-07, Compensation — Stock Compensation (Topic 718): Improvements to Nonemployee Share-Based Payment Accounting. This ASU expands the scope of Topic 718 to include share-based payment transactions for acquiring goods and services from nonemployees. The adoption of this guidance during the first quarter of 2019 did not have a material impact on the Company’s condensed consolidated financial statements.

In November 2018, SEC Release No. 33-10532, Disclosure Update and Simplification, which amended and simplified certain disclosure requirements including the requirement to present an analysis of changes in shareholders’ equity for interim periods, became effective. The Company has included a reconciliation of the changes in its shareholders' deficit in Note 11, Shareholders’ Deficit.

New Accounting Pronouncements

In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments — 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 condensed 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 adoption of this guidance will not have a material impact on the Company’s consolidated financial statements.

In August 2018, the FASB issued ASU No. 2018-13, Fair Value Measurement (Topic 820): Disclosure Framework — Changes to the Disclosure Requirements for Fair Value Measurement. This ASU modifies the disclosure requirements on fair value measurements in Topic 820 based on the consideration of costs and benefits to promote the appropriate exercise and discretion by entities when considering fair value measurement disclosures and to clarify that materiality is an appropriate consideration of entities and their auditors when evaluating disclosure requirements. The amendments in this update are effective for reporting periods beginning after December 15, 2019, with early adoption permitted. The adoption of this guidance will not have a material impact on the Company’s consolidated financial statements.

In August 2018, the FASB issued ASU No. 2018-14, Compensation — Retirement Benefits — Defined Benefit Plans — General (Subtopic 715-20): Disclosure Framework — Changes to the Disclosure Requirements for Defined Benefit Plans. This ASU removes disclosures that are no longer considered cost beneficial, clarifies the specific requirements of disclosures, and adds disclosure requirements identified as relevant. The amendments in this update are effective for reporting periods beginning after December 15, 2020, with early adoption permitted. The Company is evaluating the potential impact of this adoption on its condensed consolidated financial statements.

In August 2018, the FASB issued ASU No. 2018-15, Intangibles — Goodwill and Other — Internal-Use Software (Subtopic 350-40): Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract. This ASU clarifies the accounting for implementation costs of a hosting arrangement that is a service contract and aligns that accounting, regardless of whether the arrangement conveys a license to the hosted software. The amendments in this update are effective for reporting periods beginning after December 15, 2019, with early adoption permitted. The Company is evaluating the potential impact of this adoption on its condensed consolidated financial statements.

8


 

Revenue Recognition

The Company’s net sales consist of product sales. In general, the Company's performance obligation is to transfer its products to its Members. The Company generally recognizes revenue when product is delivered to its Members. For China independent service providers and for third-party importers utilized in certain other countries where sales historically have not been material, the Company recognizes revenue based on the Company’s estimate of when the service provider or third-party importer sells the products because the Company is deemed to be the principal party of these product sales due to the additional selling and operating requirements relating to pricing of products, conducting business with physical locations, and other selling and marketing activities required of the service providers and third-party importers.

The Company’s Members, excluding its China independent service providers, may receive distributor allowances, which are comprised of discounts, rebates, and wholesale commission payments from the Company. Distributor allowances resulting from the Company’s sales of its products to its Members are recorded against net sales because the distributor allowances represent discounts from the suggested retail price.

The Company compensates its sales leader Members with royalty overrides for services rendered, relating to the development, retention, and management of their sales organizations. Royalty overrides are payable based on achieved sales volume. Royalty overrides are classified as an operating expense reflecting the services provided to the Company. The Company compensates its China independent service providers and third-party importers utilized in certain other countries for providing marketing, selling, and customer support services. As the Company is the principal party of the product sales as described above, the service fees payable to China independent service providers and the compensation received by third-party importers for the services they provide are recorded in selling, general, and administrative expenses within the Company’s condensed consolidated statements of income.

The Company recognizes revenue when it delivers products to its United States Members; distributor allowances, inclusive of discounts and wholesale commissions, are recorded as a reduction to net sales; and royalty overrides are classified as an operating expense.

Shipping and handling services relating to product sales are recognized as fulfillment activities on the Company’s performance obligation to transfer products and are therefore recorded within net sales as part of product sales and are not considered as separate revenues. Shipping and handling costs paid by the Company are included in cost of sales.

The Company presents sales taxes collected from customers on a net basis.

The Company generally receives the net sales price in cash or through credit card payments at the point of sale. Accounts receivable consist principally of credit card receivables arising from the sale of products to the Company’s Members, and its collection risk is reduced due to geographic dispersion. Credit card receivables were $76.7 million and $52.7 million as of September 30, 2019 and December 31, 2018, respectively. Substantially all credit card receivables were current as of September 30, 2019 and December 31, 2018. The Company recorded $1.2 million and $0.2 million during the three months ended September 30, 2019 and 2018, respectively, and $2.3 million and $0.7 million during the nine months ended September 30, 2019 and 2018, respectively, in bad-debt expense related to allowances for the Company’s receivables. As of September 30, 2019 and December 31, 2018, the Company’s allowance for doubtful accounts was $2.4 million and $1.5 million, respectively. As of September 30, 2019 and December 31, 2018, the majority of the Company’s total outstanding accounts receivable were current.

The Company records advance sales deposits when payment is received but revenue has not yet been recognized. In the majority of the Company’s markets, advance sales deposits are generally recorded to income when the product is delivered to its Members. Additionally, advance sales deposits also include deferred revenues due to the timing of revenue recognition for products sold through China independent service providers. The estimated deferral period for advance sales deposits is generally within one week. During the nine months ended September 30, 2019, the Company recognized substantially all of the revenues that were included within advance sales deposits as of December 31, 2018 and any remaining such balance was not material as of September 30, 2019. Advance sales deposits are included in Other current liabilities on the Company’s condensed consolidated balance sheets. See Note 14, Detail of Certain Balance Sheet Accounts, for further information.

In general, if a Member returns product to the Company on a timely basis, they may obtain replacement product from the Company for such returned products. In addition, in general the Company maintains a buyback program pursuant to which it will repurchase products sold to a Member who has decided to leave the business. Allowances for product returns, primarily in connection with the Company’s buyback program, are provided at the time the sale is recorded. This accrual is based upon historical return rates for each country and the relevant return pattern, which reflects anticipated returns to be received over a period of up to 12 months following the original sale. Allowances for product returns were $4.7 million and $4.9 million as of September 30, 2019 and December 31, 2018, respectively.

9


 

The Company’s products are grouped in five principal categories: weight management; targeted nutrition; energy, sports, and fitness; outer nutrition; and literature and promotional items. However, the effect of economic factors on the nature, amount, timing, and uncertainty of revenue recognition and cash flows are similar among all five product categories. The Company defines its operating segments through six geographic regions. The effect of economic factors on the nature, amount, timing, and uncertainty of revenue recognition and cash flows are similar among the regions with the Company’s Primary Reporting Segment. See Note 7, Segment Information, for further information on the Company’s reportable segments and the Company’s presentation of disaggregated revenue by reportable segment.

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 6, 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, 2019, the Company believes that the cap to distributor compensation will not be applicable for the current year.

Other Operating Income

To encourage local investment and operations, governments in various China provinces conduct grant programs. The Company applied for and received several such grants in China. Government grants are recorded into income when a legal right to the grant exists, there is a reasonable assurance that the grant proceeds will be received, and the substantive conditions under which the grants were provided have been met. Generally, these substantive conditions are the Company maintaining operations and paying certain taxes in the relevant province and obtaining government approval by completing an annual application process. The Company believes the continuing obligation with respect to the funds is a general requirement that they are used only for its business in China. The Company recognized government grant income related to its regional headquarters and distribution centers within China of approximately $6.4 million and $6.0 million during the three months ended September 30, 2019 and 2018, respectively, and $27.7 million and $23.9 million during the nine months ended September 30, 2019 and 2018, respectively, in other operating income within its condensed consolidated statements of income. 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.

During the nine months ended September 30, 2019, the Company also recognized $6.0 million in other operating income related to the finalization of insurance recoveries in connection with the flooding at one of its warehouses in Mexico during September 2017, which damaged certain of the Company’s inventory stored within the warehouse. See Note 7, Contingencies, to the Consolidated Financial Statements included in the 2018 10-K for further discussion.

Other (Income) Expense, Net

During the three months ended September 30, 2019, the Company recognized a gain of $1.3 million on the revaluation of the non-transferable contractual contingent value right, or CVR, provided for each share tendered in the October 2017 modified Dutch auction tender offer (See Note 11, Shareholders’ Deficit, for further information on the CVR) in other (income) expense, net within its condensed consolidated statements of income. During the three months ended September 30, 2018, the Company recognized a gain of $4.6 million on the revaluation of the CVR and a $35.4 million loss on extinguishment of the Company’s 2017 senior secured credit facility (See Note 5, Long-Term Debt) in other (income) expense, net within its condensed consolidated statements of income.

During the nine months ended September 30, 2019, the Company recognized a gain of $15.7 million on the revaluation of the CVR in other (income) expense, net within its condensed consolidated statements of income. During the nine months ended September 30, 2018, the Company recognized a loss of $11.4 million on the revaluation of the CVR, a $13.1 million loss on extinguishment of $475.0 million aggregate principal amount of the Company’s convertible senior notes due 2019 (See Note 5, Long-Term Debt), and a $35.4 million loss on extinguishment of the Company’s 2017 senior secured credit facility (See Note 5, Long-Term Debt) in other (income) expense, net within its condensed consolidated statements of income.

These non-cash expenses are included as non-cash adjustments to net income in the Company’s cash flows from operating activities within its condensed consolidated statements of cash flows.

10


 

Restricted Cash

The following table provides a reconciliation of cash, cash equivalents, and restricted cash reported within the Company’s condensed consolidated balance sheets that sum to the total of the same such amounts shown in the Company’s condensed consolidated statements of cash flows:

 

 

 

September 30,

2019

 

 

December 31,

2018

 

 

 

(in millions)

 

Cash and cash equivalents

 

$

715.2

 

 

$

1,198.9

 

Restricted cash included in Prepaid expenses and other current assets

 

 

2.5

 

 

 

3.3

 

Restricted cash included in Other assets

 

 

5.5

 

 

 

12.8

 

Total cash, cash equivalents, and restricted cash shown in the statement of cash flows

 

$

723.2

 

 

$

1,215.0

 

 

The majority of the Company’s consolidated restricted cash is held by certain of its foreign entities and consists of cash deposits that are required due to the business operating requirements in those jurisdictions.

 

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,

2019

 

 

December 31,

2018

 

 

 

(in millions)

 

Raw materials

 

$

51.1

 

 

$

51.9

 

Work in process

 

 

6.4

 

 

 

7.1

 

Finished goods

 

 

362.6

 

 

 

322.8

 

Total

 

$

420.1

 

 

$

381.8

 

 

 

4. Leases

Generally, the Company leases certain office space, warehouses, distribution centers, manufacturing centers, and equipment. A contract is or contains a lease if the contract conveys the right to control the use of identified property, plant, or equipment (an identified asset) for a period of time in exchange for consideration. The Company also rents or subleases certain real estate to third parties. Sublease income was not material for the three and nine months ended September 30, 2019 and 2018.

In general, the Company’s leases include one or more options to renew, with renewal terms that generally vary from one to ten years. The exercise of lease renewal options is generally at the Company’s sole discretion. Certain leases also include options to purchase the leased property. The depreciable life of assets and leasehold improvements are limited by the expected lease term, unless there is a transfer of title or purchase option reasonably certain of exercise.

The Company’s lease agreements do not contain any material residual value guarantees or material restrictive covenants.

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Leases with an initial term of twelve months or less are not recorded on the Company’s condensed consolidated balance sheets, and the Company does not separate nonlease components from lease components. The Company’s lease assets and liabilities recognized within its condensed consolidated balance sheets were as follows:

 

 

 

September 30,

2019

 

 

Balance Sheet Location

 

 

(in millions)

 

 

 

ASSETS:

 

 

 

 

 

 

Operating lease right-of-use assets

 

$

181.9

 

 

Operating lease right-of-use assets

Finance lease right-of-use assets

 

 

1.0

 

 

Property, plant, and equipment, at cost, net of accumulated depreciation and amortization(1)

Total lease assets

 

$

182.9

 

 

 

LIABILITIES:

 

 

 

 

 

 

Current:

 

 

 

 

 

 

Operating lease liabilities

 

$

33.4

 

 

Other current liabilities

Finance lease liabilities

 

 

0.5

 

 

Current portion of long-term debt

Non-current:

 

 

 

 

 

 

Operating lease liabilities

 

 

165.4

 

 

Non-current operating lease liabilities

Finance lease liabilities

 

 

0.5

 

 

Long-term debt, net of current portion

Total lease liabilities

 

$

199.8

 

 

 

 

(1)

Finance lease assets are recorded net of accumulated amortization of $1.2 million as of September 30, 2019.

Lease cost is recognized on a straight-line basis over the lease term. The components of lease cost are as follows:

 

 

 

Three Months Ended

 

 

Nine Months Ended

 

 

 

September 30,

2019

 

 

September 30,

2019

 

 

 

(in millions)

 

Operating lease cost(1)(2)

 

$

17.0

 

 

$

49.3

 

Finance lease cost

 

 

 

 

 

 

 

 

Amortization of right-of-use assets

 

 

0.1

 

 

 

0.3

 

Interest on lease liabilities

 

 

 

 

 

 

Net lease cost

 

$

17.1

 

 

$

49.6

 

 

(1)

Includes short-term leases and variable lease costs, which were $3.0 million and $0.5 million, respectively, for the three months ended September 30, 2019 and $8.9 million and $1.1 million, respectively, for the nine months ended September 30, 2019. Variable lease costs, which include items such as real estate taxes, common area maintenance, and changes based on an index or rate, are not included in the calculation of the right-of-use assets and are recognized as incurred.

(2)

Amounts include $16.1 million and $46.7 million for the three and nine months ended September 30, 2019, respectively, recorded to selling, general, and administrative expenses within the Company’s condensed consolidated statements of income and $0.9 million and $2.6 million for the three and nine months ended September 30, 2019, respectively, capitalized as part of the cost of another asset, which includes inventories. During the three and nine months ended September 30, 2018, the Company recognized rental expense of $15.3 million and $46.2 million, respectively, in selling, general, and administrative expenses within the Company’s condensed consolidated statements of income pursuant to FASB ASC Topic 840, Leases.

12


 

As of September 30, 2019, annual scheduled lease payments were as follows:

 

 

 

Operating Leases(1)

 

 

Finance Leases

 

 

 

(in millions)

 

2019

 

$

5.2

 

 

$

0.2

 

2020

 

 

45.7

 

 

 

0.5

 

2021

 

 

36.8

 

 

 

0.2

 

2022

 

 

30.2

 

 

 

0.2

 

2023

 

 

17.0

 

 

 

0.1

 

Thereafter

 

 

128.7

 

 

 

 

Total lease payments

 

 

263.6

 

 

 

1.2

 

Less: imputed interest

 

 

64.8

 

 

 

0.2

 

Present value of lease liabilities

 

$

198.8

 

 

$

1.0

 

 

(1)

Operating lease payments exclude $3.7 million of legally binding minimum lease payments for leases signed but not yet commenced.

In general, for the majority of the Company’s material leases, the renewal options are not included in the calculation of its right-of-use assets and lease liabilities, as the Company does not believe that it is reasonably certain that these renewal options will be exercised. Periodically, the Company assesses its leases to determine whether it is reasonably certain that these renewal options will be exercised.

As of December 31, 2018, future minimum rental commitments for non-cancelable operating leases were as follows:

 

 

 

Operating Leases

 

 

 

(in millions)

 

2019

 

$

43.1

 

2020

 

 

36.3

 

2021

 

 

27.4

 

2022

 

 

23.0

 

2023

 

 

12.5

 

Thereafter

 

 

111.4

 

Total

 

$

253.7

 

 

The majority of the Company’s leases are for real estate and in general, the individual lease contracts do not provide information about the rate implicit in the lease. Because the Company is not able to determine the rate implicit in its leases, it instead generally uses its incremental borrowing rate to determine the present value of lease liabilities. In determining its incremental borrowing rate, the Company reviewed the terms of its leases, its senior secured credit facility, swap rates, and other factors. The weighted-average remaining lease term and weighted-average discount rate used to calculate the present value of lease liabilities are as follows:

 

 

 

September 30,

2019

 

Weighted-average remaining lease term:

 

 

 

 

Operating leases

 

8.7 years

 

Finance leases

 

2.9 years

 

Weighted-average discount rate:

 

 

 

 

Operating leases

 

 

5.8

%

Finance leases

 

 

5.4

%

 

13


 

Supplemental cash flow information related to leases is as follows:

 

 

 

Nine Months Ended

 

 

 

September 30,

2019

 

 

 

(in millions)

 

Cash paid for amounts included in the measurement of lease liabilities:

 

 

 

 

Operating cash flows for operating leases

 

$

33.8

 

Operating cash flows for finance leases

 

 

 

Financing cash flows for finance leases

 

 

0.4

 

Right-of-use assets obtained in exchange for new lease liabilities:

 

 

 

 

Operating leases

 

 

39.1

 

Finance leases

 

 

0.4

 

 

 

5. Long-Term Debt

Long-term debt consists of the following:

 

 

 

September 30,

2019

 

 

December 31,

2018

 

 

 

(in millions)

 

Borrowings under senior secured credit facility, carrying value

 

$

969.9

 

 

$

983.6

 

2.00% convertible senior notes due 2019, carrying value of liability component