e10vq
UNITED STATES SECURITIES AND
EXCHANGE COMMISSION
Washington, D.C.
20549
Form 10-Q
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(Mark One)
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þ
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QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
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For the quarterly period ended
September 30, 2006
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OR
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o
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TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
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Commission file number: 1-32381
HERBALIFE LTD.
(Exact name of registrant as
specified in its charter)
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Cayman Islands
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98-0377871
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(State or other jurisdiction
of
incorporation or organization)
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(I.R.S. Employer
Identification No.)
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c/o Herbalife International, Inc.
1800 Century Park East
Los Angeles, CA 90067
(Address of principal executive
offices) (Zip code)
(310) 410-9600
(Registrants telephone number, including area code)
P.O. Box 309GT
Ugland House, South Church Street
Grand Cayman, Cayman Islands
(Former Address if changed since
last report)
Indicate by check mark whether the registrant (1) has filed
all reports required to be filed by Section 13 or 15(d) of
the Securities Exchange Act of 1934 during the preceding
12 months (or for such shorter period that the registrant
was required to file such reports), and (2) has been
subject to such filing requirements for the past
90 days. Yes þ No o
Indicate by check mark whether the registrant is a large
accelerated filer, an accelerated filer, or a non-accelerated
filer. See definition of accelerated filer and large
accelerated filer in
Rule 12b-2
of the Exchange Act. (Check one):
Large accelerated
filer o Accelerated
filer þ Non-accelerated
filer o
Indicate by check mark whether the registrant is a shell company
(as defined in
Rule 12b-2
of the Exchange
Act). Yes o No þ
Number of shares of registrants common shares outstanding
as of November 7, 2006 was 71,273,602.
HERBALIFE
LTD.
Index to
Financial Statements and Exhibits
Filed with the Quarterly Report of the Company on
Form 10-Q
For the Three and Nine Months ended September 30,
2006
2
PART I.
FINANCIAL INFORMATION
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Item 1.
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FINANCIAL
STATEMENTS
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HERBALIFE
LTD.
CONSOLIDATED
BALANCE SHEETS
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December 31,
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September 30,
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2005
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2006
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(Unaudited)
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(In thousands, except
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share amounts)
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ASSETS
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CURRENT ASSETS:
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Cash and cash equivalents
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$
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88,248
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$
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123,273
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Receivables, net of allowance for
doubtful accounts of $4,678 (2005) and $5,125 (2006)
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37,266
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47,932
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Inventories
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109,785
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124,230
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Prepaid expenses and other current
assets
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40,667
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44,813
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Deferred income taxes
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23,585
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35,550
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Total current assets
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299,551
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375,798
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Property, at cost, net of
accumulated depreciation and amortization of $30,819
(2005) and $50,312 (2006)
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64,946
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94,606
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Deferred compensation plan assets
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13,149
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16,758
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Other assets
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7,510
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10,714
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Deferred financing costs, net of
accumulated amortization of $3,749 (2005) and $188 (2006)
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3,531
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2,089
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Marketing related intangibles
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310,000
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310,000
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Product certification, product
formulas and other intangible assets, net of accumulated
amortization of $17,792 (2005) and $20,117 (2006)
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4,908
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2,583
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Goodwill
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134,206
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125,096
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TOTAL
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$
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837,801
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$
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937,644
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LIABILITIES AND
SHAREHOLDERS EQUITY
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CURRENT LIABILITIES:
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Accounts payable
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$
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39,156
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$
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41,830
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Royalty overrides
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87,401
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108,903
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Accrued compensation
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32,570
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42,309
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Accrued expenses
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93,597
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102,009
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Current portion of long term debt
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9,816
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7,098
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Advance sales deposits
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10,874
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7,450
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Income taxes payable
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12,043
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21,816
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Total current liabilities
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285,457
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331,415
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NON-CURRENT LIABILITIES:
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Long term debt, net of current
portion
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253,276
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180,693
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Deferred compensation
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15,145
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16,561
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Deferred income taxes
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112,714
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102,230
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Other non-current liabilities
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2,321
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7,400
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Total liabilities
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668,913
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638,299
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COMMITMENTS AND CONTINGENCIES
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SHAREHOLDERS EQUITY:
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Preference shares, $0.002 par
value, 7.5 million shares authorized and unissued
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Common shares, $0.002 par
value, 175 million shares authorized, 69.9 million
(2005) and 71.3 million (2006) shares issued and
outstanding
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140
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142
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Additional paid in capital
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89,508
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120,625
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Accumulated other comprehensive
income (loss)
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605
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(1,546
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Retained earnings
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78,635
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180,124
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Total shareholders equity
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168,888
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299,345
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TOTAL
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$
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837,801
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$
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937,644
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See the accompanying notes to consolidated financial statements
3
HERBALIFE
LTD.
CONSOLIDATED
STATEMENTS OF INCOME
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Three Months Ended
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Nine Months Ended
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September 30, 2005
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September 30, 2006
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September 30, 2005
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September 30, 2006
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(Unaudited)
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(In thousands, except per share amounts)
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Product sales
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$
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345,761
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$
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412,788
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$
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997,384
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$
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1,209,233
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Handling & freight income
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55,236
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63,586
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160,340
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188,916
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Net sales
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400,997
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476,374
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1,157,724
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1,398,149
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Cost of sales
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79,482
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97,159
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232,592
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281,165
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Gross profit
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321,515
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379,215
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925,132
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1,116,984
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Royalty overrides
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138,618
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168,658
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410,875
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501,307
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Selling, general &
administrative expenses
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121,584
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146,070
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349,430
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421,995
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Operating income
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61,313
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64,487
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164,827
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193,682
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Interest expense, net
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7,950
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25,869
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37,598
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36,839
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Income before income taxes
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53,363
|
|
|
|
38,618
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127,229
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|
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156,843
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Income taxes
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|
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26,226
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|
|
|
12,151
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64,042
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55,354
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NET INCOME
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$
|
27,137
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$
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26,467
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$
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63,187
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$
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101,489
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Earnings per share:
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Basic
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$
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0.39
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$
|
0.37
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$
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0.92
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$
|
1.44
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Diluted
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$
|
0.37
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$
|
0.36
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$
|
0.87
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$
|
1.37
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Weighted average shares
outstanding:
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|
|
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Basic
|
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69,077
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71,179
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68,800
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70,593
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Diluted
|
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73,455
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74,257
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|
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72,373
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|
|
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74,173
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See the accompanying notes to consolidated financial statements
4
HERBALIFE,
LTD.
CONSOLIDATED
STATEMENTS OF CASH FLOWS
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Nine Months Ended
|
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September 30,
|
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September 30,
|
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|
|
2005
|
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2006
|
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(Unaudited)
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(In thousands)
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CASH FLOWS FROM OPERATING
ACTIVITIES:
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Net income
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$
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63,187
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$
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101,489
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Adjustments to reconcile net income
to net cash provided by operating activities:
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|
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Depreciation and amortization
|
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27,749
|
|
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21,857
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Stock-based compensation expenses
|
|
|
2,567
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|
|
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8,340
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Excess tax benefits from
share-based payment arrangements
|
|
|
|
|
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(15,558
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)
|
Amortization of discount and
deferred financing costs
|
|
|
1,098
|
|
|
|
755
|
|
Deferred income taxes
|
|
|
6,397
|
|
|
|
(21,399
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)
|
Unrealized foreign exchange gain
|
|
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(2,303
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)
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|
|
(952
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)
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Write-off of deferred financing
costs and unamortized discounts
|
|
|
5,388
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|
|
|
6,621
|
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Other
|
|
|
511
|
|
|
|
284
|
|
Changes in operating assets and
liabilities:
|
|
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Receivables
|
|
|
(11,185
|
)
|
|
|
(9,223
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)
|
Inventories
|
|
|
(17,703
|
)
|
|
|
(13,045
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)
|
Prepaid expenses and other current
assets
|
|
|
11,102
|
|
|
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(4,255
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)
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Changes in other assets
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|
7
|
|
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|
(2,836
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)
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Accounts payable
|
|
|
4,638
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|
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|
821
|
|
Royalty overrides
|
|
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(957
|
)
|
|
|
20,085
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|
Accrued expenses and accrued
compensation
|
|
|
12,281
|
|
|
|
20,056
|
|
Advance sales deposits
|
|
|
8,578
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|
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(3,708
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)
|
Income taxes payable
|
|
|
19,066
|
|
|
|
34,262
|
|
Deferred compensation liability
|
|
|
464
|
|
|
|
1,415
|
|
|
|
|
|
|
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NET CASH PROVIDED BY OPERATING
ACTIVITIES
|
|
$
|
130,885
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$
|
145,009
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CASH FLOWS FROM INVESTING
ACTIVITIES:
|
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|
|
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|
Purchases of property
|
|
|
(21,761
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)
|
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(45,526
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)
|
Proceeds from sale of property
|
|
|
33
|
|
|
|
63
|
|
Deferred compensation plan assets
|
|
|
(1,027
|
)
|
|
|
(3,609
|
)
|
Other
|
|
|
|
|
|
|
(38
|
)
|
|
|
|
|
|
|
|
|
|
NET CASH USED IN INVESTING
ACTIVITIES
|
|
$
|
(22,755
|
)
|
|
$
|
(49,110
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)
|
|
|
|
|
|
|
|
|
|
CASH FLOWS FROM FINANCING
ACTIVITIES:
|
|
|
|
|
|
|
|
|
Borrowings from long term debt
|
|
|
172
|
|
|
|
215,000
|
|
Principal payments on long term debt
|
|
|
(91,700
|
)
|
|
|
(132,020
|
)
|
Repurchases of
91/2% Notes
and
113/4% Notes
|
|
|
(110,000
|
)
|
|
|
(165,137
|
)
|
Increase in deferred financing costs
|
|
|
|
|
|
|
(2,277
|
)
|
Exercise of stock options
|
|
|
1,599
|
|
|
|
7,178
|
|
Excess tax benefits from
share-based payment arrangements
|
|
|
|
|
|
|
15,558
|
|
Other
|
|
|
(374
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
NET CASH USED IN FINANCING
ACTIVITIES
|
|
$
|
(200,303
|
)
|
|
$
|
(61,698
|
)
|
|
|
|
|
|
|
|
|
|
EFFECT OF EXCHANGE RATE CHANGES ON
CASH
|
|
|
(4,224
|
)
|
|
|
824
|
|
|
|
|
|
|
|
|
|
|
NET CHANGE IN CASH AND CASH
EQUIVALENTS
|
|
|
(96,397
|
)
|
|
|
35,025
|
|
CASH AND CASH EQUIVALENTS,
BEGINNING OF PERIOD
|
|
|
201,577
|
|
|
|
88,248
|
|
|
|
|
|
|
|
|
|
|
CASH AND CASH EQUIVALENTS, END OF
PERIOD
|
|
$
|
105,180
|
|
|
$
|
123,273
|
|
|
|
|
|
|
|
|
|
|
CASH PAID FOR:
|
|
|
|
|
|
|
|
|
Interest
|
|
$
|
28,003
|
|
|
$
|
36,469
|
|
|
|
|
|
|
|
|
|
|
Income taxes
|
|
$
|
35,846
|
|
|
$
|
42,481
|
|
|
|
|
|
|
|
|
|
|
NON-CASH ACTIVITIES:
|
|
|
|
|
|
|
|
|
Accrued capital expenditures
|
|
$
|
540
|
|
|
$
|
3,569
|
|
|
|
|
|
|
|
|
|
|
See the accompanying notes to consolidated financial statements
5
HERBALIFE
LTD.
Herbalife Ltd., a Cayman Islands exempted limited liability
company (Herbalife or the Company),
incorporated on April 4, 2002, and its direct and indirect
wholly-owned subsidiaries, WH Intermediate Holdings Ltd., a
Cayman Islands company (WH Intermediate), WH
Luxembourg Holdings S.à.R.L., a Luxembourg unipersonal
limited liability company (Lux Holdings), WH
Luxembourg CM S.à.R.L., a Luxembourg unipersonal limited
liability company, and WH Acquisition Corp., a Nevada
corporation (WH Acquisition), were formed on behalf
of Whitney & Co., LLC (Whitney) and Golden
Gate Private Equity, Inc. (Golden Gate), in order to
acquire Herbalife International, Inc., a Nevada corporation, and
its subsidiaries (collectively, Herbalife
International) on July 31, 2002 (the
Acquisition). Herbalife and its subsidiaries are
referred to collectively herein as the Company.
IPO
Recapitalization
On December 16, 2004, Herbalife completed an initial public
offering of its common shares (the IPO), as part of
a series of recapitalization transactions, including:
|
|
|
|
|
a tender offer for $159.8 million of the outstanding
113/4% senior
subordinated notes due 2010 (the
113/4% Notes),
issued by Herbalife International;
|
|
|
|
the replacement of Herbalife Internationals existing
$205.0 million senior credit facility with a new
$225.0 million senior credit facility;
|
|
|
|
the payment of a $139.8 million special cash dividend to
the pre-IPO shareholders of Herbalife; and
|
|
|
|
the amendment of Herbalifes Memorandum and Articles of
Association to: (1) effect a 1:2 reverse stock split of
Herbalifes common shares; (2) increase
Herbalifes authorized common shares to 500 million
shares; and (3) increase Herbalifes authorized
preference shares to 7.5 million shares, all of which took
effect on December 1, 2004.
|
As a planned continuation of the IPO and the recapitalization,
Herbalife exercised a contract provision in December 2004 to
redeem 40%, or $110.0 million principal value (excluding a
premium of $10.5 million), of the
91/2%
notes due 2011, (the
91/2% Notes).
After the required notice period, this redemption was completed
on February 4, 2005. The redemption premium of
$10.5 million and the write-off of deferred financing fees
of $3.7 million associated with this redemption are
included in interest expense in the first quarter of 2005.
In connection with the IPO and the recapitalization, the Company
incurred $24.7 million in fees and expenses of which
$19.8 million were associated with the IPO (included in
equity) and $4.9 million were associated with the
establishment of a credit facility, all of which were included
in deferred financing cost. This credit facility was fully
repaid in the third quarter of 2006 and the associated deferred
financing costs were written off. See note 4 for discussion.
Secondary
Offering
On December 19, 2005, Herbalife completed a secondary
public offering of 13 million common shares held by certain
existing shareholders. The selling shareholders received all net
proceeds from the sale of common shares sold in this offering.
Accordingly, Herbalife did not receive any proceeds from the
sale of common shares.
The unaudited interim financial information of the Company has
been prepared in accordance with Article 10 of the
Securities and Exchange Commissions
Regulation S-X.
Accordingly, it does not include all of the information required
by generally accepted accounting principals in the
U.S. (GAAP) for complete financial statements.
The Companys consolidated financial statements as of and
for the three and nine months ended September 30, 2005 and
September 30, 2006 include Herbalife and all of its direct
and indirect subsidiaries. In the
6
HERBALIFE
LTD.
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
opinion of management, the accompanying financial information
contains all adjustments, consisting of normal recurring
adjustments, necessary to present fairly the Companys
consolidated financial statements as of and for the three and
nine months ended September 30, 2005 and September 30,
2006. Operating results for the three and nine months ended
September 30, 2006 are not necessarily indicative of the
results that may be expected for the year ending
December 31, 2006.
New
Accounting Pronouncements
Effective January 1, 2006, the Company adopted the fair
value recognition provisions of Statement of Financial
Accounting Standards (SFAS) No. 123R,
Share-Based Payment (SFAS No. 123R), which
generally requires, among other things, that all employee
share-based compensation be measured using a fair value method
and that the resulting compensation cost be recognized in the
financial statements. The Company selected the modified
prospective method of adoption. Under this method, compensation
expense that the Company recognized for the three and nine
months ended September 30, 2006 included:
(a) compensation expense for all share-based payments
granted prior to, but not yet vested as of January 1, 2006,
based on the grant date fair value estimated in accordance with
the original provisions of SFAS No. 123, Accounting
for Stock-Based Compensation
(SFAS No. 123), and (b) compensation
expense for all share-based payments granted on or after
January 1, 2006, based on the grant date fair value
estimated in accordance with the provisions of
SFAS No. 123R. Results for prior periods were not
restated. See Note 8 to the consolidated financial
statements for more details on stock based compensation.
In June 2006, Financial Accounting Standards Board
(FASB) Interpretation No. 48
(FIN 48), Accounting for Uncertainty in Income
Taxes was issued in its final version. FIN 48 clarifies the
accounting for uncertainty in income taxes recognized in an
enterprises financial statements in accordance with FASB
Statement No. 109, Accounting for Income Taxes. FIN 48
provides guidance on derecognition, classification, interest and
penalties, accounting in interim periods, disclosure, and
transition effective for fiscal years beginning after
December 15, 2006. Earlier application of the provisions of
FIN 48 is encouraged if the enterprise has not yet issued
financial statements, including interim financial statements, in
the period FIN 48 is adopted. The Company is currently
evaluating the impact of adopting FIN 48.
In June 2006, the FASB ratified the consensuses of Emerging
Issues Task Force (EITF) Issue
No. 06-3,
How Taxes Collected from Customers and Remitted to Governmental
Authorities Should Be Presented in the Income Statement (That
Is, Gross versus Net Presentation)
(EITF 06-3).
EITF 06-3
clarifies that the scope of this issue includes any tax assessed
by a governmental authority that is directly imposed on a
revenue-producing transaction between a seller and a customer
and indicates that the income statement presentation on either a
gross basis or a net basis of the taxes within the scope of the
issue is an accounting policy decision that should be disclosed.
Furthermore, for taxes reported on a gross basis, an enterprise
should disclose the amounts of those taxes in interim and annual
financial statements for each period for which an income
statement is presented. The consensus is effective, through
retrospective application, for periods beginning after
December 15, 2006. The Company is currently evaluating the
presentation basis to be utilized in accordance with
EITF 06-3.
In September 2006, the FASB issued No. 157, Fair Value
Measurement, (SFAS No. 157), which defines
fair value, establishes a framework for measuring fair value in
accordance with GAAP and expands disclosures about fair value
measurements. The provisions of SFAS No. 157 are
effective for fiscal years beginning after November 15,
2007. The Company is currently evaluating the impact, if any, of
adopting SFAS No. 157.
In September 2006, the Securities and Exchange Commission issued
Staff Accounting Bulletin No. 108, Considering the
Effects of Prior Year Misstatements when Quantifying
Misstatements in Current year Financial Statements
(SAB 108), which provides interpretive guidance
on how the effects of the carryover or reversal of prior year
misstatements should be considered in quantifying a current year
misstatement. The guidance is effective for fiscal years
beginning after November 15, 2006 and it allows a one-time
transitional cumulative effect adjustment to
beginning-of-year
retained earnings at the first fiscal year ending after
November 15, 2006 for errors
7
HERBALIFE
LTD.
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
that were not previously deemed material, but are material under
the guidance in SAB 108. The Company is currently
evaluating the impact, if any, of adopting SAB 108 on its
consolidated financial statements.
Reclassifications
Certain reclassifications were made to the prior period
consolidated financial statements to conform to current period
presentation.
|
|
3.
|
Transactions
with related parties
|
In 2004, Whitney acquired a 50 percent indirect ownership
interest in Shuster Laboratories, Inc. (Shuster), a
provider of product testing and formula development for
Herbalife. For the three and nine months ended
September 30, 2005, total purchases from Shuster were zero
and $0.02 million, respectively. For the three and nine
months ended September 30, 2006, there were no purchases
from Shuster.
In 2004, Whitney acquired a 50 percent indirect ownership
interest in TBA Entertainment (TBA), a provider of
creative services to Herbalife. For the three and nine months
ended September 30, 2005, payments of $0.02 million
and $5.71 million were made to TBA for services relating to
the 25th Anniversary Extravaganza, of which the majority
were reimbursements of extravaganza expenses paid to third
parties. For the three and nine months ended September 30,
2006, payments to TBA were $0.51 million and
$0.61 million, respectively.
In 2004, Golden Gate acquired a 47 percent ownership
interest in Leiner Health Products Inc. (Leiner), a
nutritional manufacturer and supplier of certain Herbalife
products. For the three and nine months ended September 30,
2005, total purchases from Leiner were zero and
$0.14 million, respectively. For the three and nine months
ended September 30, 2006, there were no purchases from
Leiner.
In January 2005, Whitney, together with its affiliates, acquired
a 77 percent ownership interest in Stauber Performance
Ingredients (Stauber), a value-added distributor of
bulk specialty nutraceutical ingredients. For the three and nine
months ended September 30, 2005, total purchases from
Stauber were $0.40 million and $0.85 million,
respectively. For the three and nine months ended
September 30, 2006, total purchases from Stauber were
$0.06 million and $0.25 million, respectively.
Long term debt consists of the following:
|
|
|
|
|
|
|
|
|
|
|
As of
|
|
|
|
December 31,
|
|
|
September 30,
|
|
|
|
2005
|
|
|
2006
|
|
|
|
(In millions)
|
|
|
113/4% Notes
|
|
$
|
0.1
|
|
|
$
|
|
|
Borrowings under Prior Credit
Facility (see below)
|
|
|
89.8
|
|
|
|
|
|
Borrowings under New Credit
Facility (see below)
|
|
|
|
|
|
|
180.0
|
|
91/2% Notes,
net of unamortized discounts of $3.7 million (2005)
|
|
|
161.3
|
|
|
|
|
|
Capital leases
|
|
|
5.4
|
|
|
|
6.2
|
|
Other debt
|
|
|
6.5
|
|
|
|
1.6
|
|
|
|
|
|
|
|
|
|
|
|
|
|
263.1
|
|
|
|
187.8
|
|
Less: current portion
|
|
|
9.8
|
|
|
|
7.1
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
253.3
|
|
|
$
|
180.7
|
|
|
|
|
|
|
|
|
|
|
During 2005 the Company prepaid approximately
$109.0 million of its term loan under the
$225.0 million senior secured credit facility, originally
entered into on December 21, 2004 (the Prior Credit
Facility), resulting in
8
HERBALIFE
LTD.
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
approximately $2.2 million of additional interest expense
from the write-off of unamortized deferred financing costs. In
March 2006, the Company made a prepayment on its term loan under
the Prior Credit Facility of $9.8 million. Consequently,
the Company expensed $0.2 million of related unamortized
deferred financing costs in the first quarter of 2006.
On July 21, 2006, the Company entered into a
$300.0 million senior secured credit facility (the
New Credit Facility) with a syndicate of financial
institutions as lenders. The New Credit Facility is comprised of
a $200.0 million term loan and a $100.0 million
revolving credit facility and replaced the Prior Credit
Facility. The new term loan bears interest at LIBOR rate plus a
margin of 1.5%, or the base rate plus a margin of 0.50% and
matures on July 21, 2013. The new revolver bears interest
at LIBOR rate plus a margin of 1.25%, or the base rate plus a
margin of 0.25% and is available until July 21, 2012. The
Company incurred approximately $2.3 million of debt
issuance costs which are being amortized over the term of the
debt. The Company is obligated to pay $0.5 million each
quarter from December 31, 2006 until June 30, 2013 and
the remaining principal on July 21, 2013 for the new term
loan. The Company used $65.0 million in available cash and
$15.0 million in borrowings under the new revolving credit
facility to repay all amounts outstanding under the Prior Credit
Facility amounting to $79.6 million. Consequently, the
Company expensed $1.7 million of unamortized deferred
financing costs related to the Prior Credit Facility. Also in
July 2006, the Company redeemed the outstanding
$0.1 million aggregate principal amount of its
113/4% Notes.
On August 23, 2006, the Company borrowed
$200.0 million pursuant to the term loan under the New
Credit Facility to repay the borrowings under the new revolver
and to fund the redemption of its
91/2% Notes.
The total redemption price of the
91/2% Notes
was $187.8 million and consisted of $165.0 million
aggregate principal amount, $16.6 million purchase premium
and $6.2 million accrued interest. The redemption premium
of $16.6 million and the write-off of unamortized deferred
financing costs and discounts of $4.6 million associated with
the
91/2% Notes
are included in interest expense in the third quarter of 2006.
In September 2006, the Company made a prepayment on the term
loan under the New Credit Facility of $20.0 million
resulting in $0.1 million additional interest expense from
the write-off of unamortized deferred financing costs.
No borrowings were outstanding under the new revolver at
September 30, 2006.
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.
Herbalife International and certain of its independent
distributors have been named as defendants in a purported class
action lawsuit filed February 17, 2005, in the Superior
Court of California, County of San Francisco, and served on
Herbalife International on March 14, 2005
(Minton v. Herbalife International, et al). The
case has been transferred to the Los Angeles County Superior
Court. The plaintiff is challenging the marketing practices of
certain Herbalife International independent distributors and
Herbalife International under various state laws prohibiting
endless chain schemes, insufficient disclosure in
assisted marketing plans, unfair and deceptive business
practices, and fraud and deceit. The plaintiff alleges that the
Freedom Group system operated by certain independent
distributors of Herbalife International products places too much
emphasis on recruiting and encourages excessively large
purchases of product and promotional materials by distributors.
The plaintiff also alleges that Freedom Group pressured
distributors to disseminate misleading promotional materials.
The plaintiff seeks to hold Herbalife International vicariously
liable for the actions of its independent distributors and is
seeking damages and injunctive relief. The Company believes that
it has meritorious defenses to the suit.
Herbalife International and certain of its distributors have
been named as defendants in a class action lawsuit filed
July 16, 2003, in the Circuit Court of Ohio County in the
State of West Virginia (Mey v. Herbalife
9
HERBALIFE
LTD.
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
International, Inc., et al). On April 21, 2006,
the court granted plaintiffs motion for class
certification in West Virginia. The complaint alleges that
certain telemarketing practices of certain Herbalife
International distributors violate the Telephone Consumer
Protection Act, or TCPA, and seeks to hold Herbalife
International vicariously liable for the practices of these
distributors. More specifically, the plaintiffs complaint
alleges that several of Herbalife Internationals
distributors used pre-recorded telephone messages and
autodialers to contact prospective customers in violation of the
TCPAs prohibition of such practices. Herbalife
Internationals distributors are independent contractors
and if any such distributors in fact violated the TCPA they also
violated Herbalifes policies, which require its
distributors to comply with all applicable federal, state and
local laws. The Company believes that it has meritorious
defenses to the suit.
As a marketer of dietary and nutritional supplements and other
products that are ingested by consumers or applied to their
bodies, the Company has been and is currently subjected to
various product liability claims. The effects of these claims to
date have not been material to the Company, and the reasonably
possible range of exposure on currently existing claims is not
material to the Company. The Company believes that it has
meritorious defenses to the allegations contained in the
lawsuits. The Company currently maintain product liability
insurance with an annual deductible of $10 million.
Certain of the Companys subsidiaries have been subject to
tax audits by governmental authorities in their respective
countries. In certain of these tax audits, governmental
authorities are proposing that significant amounts of additional
taxes and related interest and penalties are due. The Company
and its tax advisors believe that there are substantial defenses
to their allegations that additional taxes are owed, and the
Company is vigorously contesting the additional proposed taxes
and related charges.
These matters may take several years to resolve, and the Company
cannot be sure of their ultimate resolution. However, it is the
opinion of management that adverse outcomes, if any, will not
likely result in a material effect on the Companys
financial condition and operating results. This opinion is based
on the Companys belief that any losses it suffers would
not be material and that it has meritorious defenses. Although
the Company has reserved an amount that it believes represents
the likely outcome of the resolution of these disputes, if the
Company is incorrect in its assessment it may have to record
additional expenses.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
|
Nine Months Ended
|
|
|
|
September 30,
|
|
|
September 30,
|
|
|
September 30,
|
|
|
September 30,
|
|
|
|
2005
|
|
|
2006
|
|
|
2005
|
|
|
2006
|
|
|
|
(In millions)
|
|
|
Net income
|
|
$
|
27.1
|
|
|
$
|
26.5
|
|
|
$
|
63.2
|
|
|
$
|
101.5
|
|
Unrealized gain (loss) on
derivative instruments
|
|
$
|
0.4
|
|
|
$
|
(0.6
|
)
|
|
$
|
0.3
|
|
|
$
|
(0.6
|
)
|
Foreign currency translation
adjustment
|
|
$
|
(0.6
|
)
|
|
$
|
(0.1
|
)
|
|
$
|
(1.9
|
)
|
|
$
|
(1.6
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Comprehensive income
|
|
$
|
26.9
|
|
|
$
|
25.8
|
|
|
$
|
61.6
|
|
|
$
|
99.3
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The Company is a network marketing company that sells a wide
range of weight management products, nutritional supplements and
personal care products within one industry segment as defined
under SFAS 131, Disclosures about Segments of an
Enterprise and Related Information. The Companys
products are manufactured by third party providers and then sold
to independent distributors who sell Herbalife products to
retail consumers or other distributors.
10
HERBALIFE
LTD.
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
The Company sells products in 62 countries throughout the world
and is organized and managed by geographic unit. The Company
elected to aggregate its operating segments into one reporting
segment, as management believes that the Companys
operating segments have similar operating characteristics and
similar long term operating performance. In making this
determination, management believes that the operating segments
are similar with regard to the nature of the products sold, the
product acquisition process, the types of customers products are
sold to, the methods used to distribute the products, and the
nature of the regulatory environment.
Revenues reflect sales of products to distributors based on the
distributors geographic location.
In July 2006, the Company changed its geographic unit from four
to seven units as part of the Companys on-going
realignment for growth efforts. These changes are intended to
create growth opportunities for distributors, support faster
decision making across the organization due to reduced
management layers, and improve the sharing of ideas and tools to
accelerate growth in its high potential markets. The
Companys reporting segments operating information
and sales by product line are as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
|
Nine Months Ended
|
|
|
|
September 30,
|
|
|
September 30,
|
|
|
September 30,
|
|
|
September 30,
|
|
|
|
2005
|
|
|
2006
|
|
|
2005
|
|
|
2006
|
|
|
|
(In millions)
|
|
|
Net sales:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
United States
|
|
$
|
70.7
|
|
|
$
|
88.1
|
|
|
$
|
215.9
|
|
|
$
|
252.3
|
|
Mexico
|
|
|
61.5
|
|
|
|
102.1
|
|
|
|
149.0
|
|
|
|
278.8
|
|
Others
|
|
|
268.8
|
|
|
|
286.2
|
|
|
|
792.8
|
|
|
|
867.1
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total net sales
|
|
$
|
401.0
|
|
|
$
|
476.4
|
|
|
$
|
1,157.7
|
|
|
$
|
1,398.2
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating margin(1):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
United States
|
|
$
|
32.9
|
|
|
|
39.9
|
|
|
$
|
92.2
|
|
|
$
|
105.4
|
|
Mexico
|
|
|
27.4
|
|
|
|
43.3
|
|
|
|
64.8
|
|
|
|
122.3
|
|
Others
|
|
|
122.6
|
|
|
|
127.4
|
|
|
|
357.2
|
|
|
|
388.0
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total operating margin
|
|
$
|
182.9
|
|
|
$
|
210.6
|
|
|
$
|
514.2
|
|
|
$
|
615.7
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Selling, general and
administrative expense
|
|
|
121.6
|
|
|
|
146.1
|
|
|
|
349.4
|
|
|
|
422.0
|
|
Interest expense, net
|
|
|
8.0
|
|
|
|
25.8
|
|
|
|
37.6
|
|
|
|
36.9
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income before income taxes
|
|
|
53.3
|
|
|
|
38.7
|
|
|
|
127.2
|
|
|
|
156.8
|
|
Income taxes
|
|
|
26.2
|
|
|
|
12.2
|
|
|
|
64.0
|
|
|
|
55.3
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income
|
|
$
|
27.1
|
|
|
$
|
26.5
|
|
|
$
|
63.2
|
|
|
$
|
101.5
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net sales by product line:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weight management
|
|
$
|
167.1
|
|
|
$
|
202.1
|
|
|
$
|
476.6
|
|
|
$
|
591.2
|
|
Inner Nutrition
|
|
|
176.9
|
|
|
|
209.9
|
|
|
|
502.0
|
|
|
|
617.3
|
|
Outer
Nutrition®
|
|
|
37.0
|
|
|
|
33.7
|
|
|
|
123.0
|
|
|
|
112.9
|
|
Literature, promotional and
other(2)
|
|
|
20.0
|
|
|
|
30.7
|
|
|
|
56.1
|
|
|
|
76.8
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total net sales
|
|
$
|
401.0
|
|
|
$
|
476.4
|
|
|
$
|
1,157.7
|
|
|
$
|
1,398.2
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net sales by geographic unit:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
North America(3)
|
|
$
|
75.1
|
|
|
$
|
92.1
|
|
|
$
|
230.1
|
|
|
$
|
266.8
|
|
Mexico and Central America
|
|
|
61.7
|
|
|
|
103.0
|
|
|
|
149.7
|
|
|
|
281.1
|
|
Brazil
|
|
|
28.9
|
|
|
|
32.8
|
|
|
|
76.8
|
|
|
|
99.4
|
|
South America and Southeast Asia(4)
|
|
|
37.0
|
|
|
|
51.6
|
|
|
|
94.3
|
|
|
|
142.3
|
|
EMEA(5)
|
|
|
131.2
|
|
|
|
127.4
|
|
|
|
417.6
|
|
|
|
414.1
|
|
Greater China(6)
|
|
|
29.2
|
|
|
|
36.2
|
|
|
|
82.4
|
|
|
|
92.5
|
|
North Asia(7)
|
|
|
37.9
|
|
|
|
33.3
|
|
|
|
106.8
|
|
|
|
102.0
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total net sales
|
|
$
|
401.0
|
|
|
$
|
476.4
|
|
|
$
|
1,157.7
|
|
|
$
|
1,398.2
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
11
HERBALIFE
LTD.
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
|
|
|
(1) |
|
Operating margin consists of net sales less cost of sales and
royalty overrides. |
|
(2) |
|
Product buybacks and returns in all product categories are
included in the literature, promotional and other category. |
|
(3) |
|
Consists of the U.S., Canada, Jamaica and Dominican Republic. |
|
(4) |
|
Includes New Zealand and Australia and excludes Brazil, Taiwan
and Hong Kong. |
|
(5) |
|
Consists of Europe, Middle East and Africa. |
|
(6) |
|
Consists of China, Hong Kong and Taiwan. |
|
(7) |
|
Consists of Japan and Korea. |
|
|
|
|
|
|
|
|
|
|
|
As of
|
|
|
|
December 31,
|
|
|
September 30,
|
|
|
|
2005
|
|
|
2006
|
|
|
|
(In millions)
|
|
|
Total Assets:
|
|
|
|
|
|
|
|
|
United States
|
|
$
|
520.1
|
|
|
$
|
620.7
|
|
Mexico
|
|
|
52.5
|
|
|
|
64.5
|
|
Others
|
|
|
265.2
|
|
|
|
252.4
|
|
|
|
|
|
|
|
|
|
|
Total assets
|
|
$
|
837.8
|
|
|
$
|
937.6
|
|
|
|
|
|
|
|
|
|
|
|
|
8.
|
Stock
Based Compensation
|
The Company has six stock-based compensation plans, the WH
Holdings (Cayman Islands) Ltd. Stock Incentive Plan
(Management Plan), the WH Holdings (Cayman Islands)
Ltd. Independent Directors Stock Incentive Plan
(Independent Directors Plan), the Herbalife Ltd.
2004 Incentive Plan (2004 Stock Incentive Plan), the
Herbalife Ltd. 2005 Stock Incentive Plan (2005 Stock
Incentive Plan), the Herbalife Ltd. Executive Incentive
Plan (Executive Incentive Plan) and the Herbalife
Ltd. Independent Directors Deferred Compensation and Stock Unit
Plan (Independent Director Stock Unit Plan). The
Management Plan provides for the grant of options to purchase
common shares of Herbalife to members of the Companys
management. The Independent Directors Plan provides for the
grant of options to purchase common shares of Herbalife to the
Companys independent directors. The 2004 Stock Incentive
Plan replaced the Management Plan and the Independent Directors
Plan and after the adoption thereof, no additional awards were
made under either the Management Plan or the Independent
Directors Plan. However, the shares remaining available for
issuance under these plans were absorbed by and became available
for issuance under the 2004 Stock Incentive Plan. The 2005 Stock
Incentive Plan authorizes the issuance of 4,000,000 common
shares pursuant to awards, plus any shares that remained
available for issuance under the 2004 Stock Incentive Plan at
the time of the adoption of the 2005 Stock Incentive Plan. The
terms of the 2005 Stock Incentive Plan are substantially similar
to the terms of the 2004 Stock Incentive Plan. The purpose of
the Executive Incentive Plan is to govern the award and payment
of annual bonuses to certain company executives. The purpose of
the Independent Directors Stock Unit Plan is to facilitate
equity ownership in the Company by its independent directors
through the award of stock units and to allow for deferral by
the independent directors of compensation realized in connection
with such stock units. The Companys stock compensation
awards outstanding as of September 30, 2006 include stock
options, stock appreciation rights (SARS) and stock
units.
Prior to January 1, 2006, the Company applied the intrinsic
value method as outlined in Accounting Principles Board
(APB) Opinion No. 25, Accounting for Stock
Issued to Employees (APB 25), and related
interpretations, in accounting for share-based awards made under
these plans. Under the intrinsic value method, compensation
expense is recorded on the date of grant to the extent that the
current market price of the underlying stock exceeds the
exercise price. On January 1, 2006, the Company adopted
SFAS No. 123R. This statement replaces
SFAS No. 123 and supersedes APB 25.
SFAS No. 123R requires that all share-based
compensation be recognized
12
HERBALIFE
LTD.
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
as an expense in the financial statements and that such cost be
measured based on the fair value of the awards granted. The
Company adopted SFAS No. 123R using the modified
prospective transition method which requires the recognition of
compensation expense on a prospective basis only. Accordingly,
prior period financial statements have not been restated. Under
this transition method, stock-based compensation cost for the
first three quarters of 2006 include (a) compensation cost
for all share-based awards granted prior to, but not yet vested
as of, January 1, 2006, based on the grant date fair value
estimated in accordance with the original provisions of
SFAS No. 123; and (b) compensation cost for all
share-based awards granted subsequent to January 1, 2006
based on the grant-date fair value estimated in accordance with
the provisions of SFAS No. 123R.
SFAS No. 123R also requires the Company to estimate
forfeitures in calculating the expense relating to share-based
compensation as opposed to recognizing forfeitures as an expense
reduction as they occur. The adjustment to apply estimated
forfeitures to previously recognized share-based compensation
was considered immaterial and as such was not classified as a
cumulative effect of a change in accounting principle.
The Company records compensation expense over the requisite
service period which is equal to the vesting period. For awards
granted prior to January 1, 2006, compensation expense is
recognized on a graded-vesting basis over the vesting term. For
awards granted on or after January 1, 2006, compensation
expense is recognized on a straight-line basis over the vesting
term. For the three and nine months ended September 30,
2006, stock-based compensation expense was included in Selling,
General & Administrative Expenses in the amount of
$2.8 million and $8.3 million, respectively, as well
as related income tax benefits recognized in earnings in the
amount of $1.1 million and $3.3 million, respectively.
As of September 30, 2006, the total unrecognized
compensation cost related to nonvested stock awards was
$28.4 million and the related weighted-average period over
which it is expected to be recognized is approximately
2.3 years.
As a result of the adoption of SFAS No. 123R, the
Companys net income for the three and nine months ended
September 30, 2006 was $1.3 million and
$4.1 million lower, respectively, than it would have been
under the Companys previous accounting method for
share-based compensation. Basic and diluted net earnings per
common share for the three months ended September 30, 2006
were both negatively impacted by the change in accounting method
by $0.02 per share. The negative impact on both basic and
diluted net earnings per common share for the nine months ended
September 30, 2006 was $0.06 per share. Prior to the
Companys adoption of SFAS No. 123R, benefits of
tax deductions in excess of recognized compensation costs were
reported as operating cash inflows. SFAS No. 123R
requires that these excess tax benefits be recorded as a
financing cash inflow rather than as a reduction of taxes paid.
For the three and nine months ended September 30, 2006, tax
benefits of $1.4 million and $15.6 million,
respectively, were generated from option exercises.
13
HERBALIFE
LTD.
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
The following table illustrates the effect on net income and
earnings per share if the Company had applied the fair value
recognition provision of SFAS No. 123 to options
granted under the Companys stock-based compensation plans
for the three and nine months ended September 30, 2005. For
purposes of this pro forma disclosure, the value of the options
is estimated using the Black-Scholes-Merton option-pricing model
and amortized to expense using a graded vesting schedule with
forfeitures recognized as they occur.
|
|
|
|
|
|
|
|
|
|
|
Three Months
|
|
|
Nine Months
|
|
|
|
Ended
|
|
|
Ended
|
|
|
|
September 30,
|
|
|
September 30,
|
|
|
|
2005
|
|
|
2005
|
|
|
|
(In millions)
|
|
|
Net income as reported
|
|
$
|
27.1
|
|
|
$
|
63.2
|
|
Add: Stock-based employee
compensation expense included in reported net income, net of tax
|
|
|
0.2
|
|
|
|
1.5
|
|
Less: Stock-based employee
compensation expense determined under fair value based methods
for all awards, net of tax
|
|
|
(1.4
|
)
|
|
|
(5.3
|
)
|
|
|
|
|
|
|
|
|
|
Pro forma net income
|
|
$
|
25.9
|
|
|
$
|
59.4
|
|
|
|
|
|
|
|
|
|
|
Basic earnings per share
|
|
|
|
|
|
|
|
|
As reported
|
|
$
|
0.39
|
|
|
$
|
0.92
|
|
Pro forma
|
|
$
|
0.38
|
|
|
$
|
0.86
|
|
Diluted earnings per share
|
|
|
|
|
|
|
|
|
As reported
|
|
$
|
0.37
|
|
|
$
|
0.87
|
|
Pro forma
|
|
$
|
0.35
|
|
|
$
|
0.82
|
|
The Companys stock-based compensation plans provide for
grants of stock options, SARS, restricted stock and stock units
(collectively called the awards). Stock options
typically vest quarterly over a five-year period beginning on
the grant date, and certain stock option grants vest over a
period of less than five years. SARS vest quarterly over a
five-year period beginning on the grant date. The contractual
term of stock options and SARS is ten years. Stock unit awards
under the 2005 Incentive Plan (Incentive Plan Stock
Units) vest annually over a three year period which is
equal to the contractual term.
Stock unit awards under the Independent Directors Stock Unit
Plan (Independent Director Stock Units) vest at a
25% rate on each of April 15, July 15 and October 15 of the
calendar year in which the award is granted and January 15 of
the calendar year following the year in which the award is
granted. Unless otherwise determined at the time of grant, the
value of each stock unit shall be equal to one common share of
Herbalife.
The fair value of each award is estimated on the date of grant
using the Black-Scholes-Merton option-pricing model based on the
assumptions in the following tables. The expected term of the
award is based on observed historical exercise patterns. Because
of the very limited historical data, all groups of employees
have been determined to have similar historical exercise
patterns for valuation purposes. The expected volatility of
stock awards is primarily based upon on the historical
volatility of the Companys common stock and, due to the
limited period of public trading data for its common stock, it
is also validated against the volatility rates of a peer group
of companies. The risk free interest rate is based on the
implied yield on a U.S. Treasury zero-coupon issue with a
remaining term equal to the expected term of the award. The
dividend yield reflects that the Company has not paid
14
HERBALIFE
LTD.
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
any cash dividends since inception. The following table
summarizes the weighted average assumptions used in the
calculation of fair market value for the three and nine months
ended September 30, 2005 and 2006.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Incentive Plan
|
|
|
Independent Directors
|
|
|
|
Stock Options
|
|
|
SARS
|
|
|
Stock Units
|
|
|
Stock Units
|
|
|
|
Three Months
|
|
|
Three Months
|
|
|
Three Months
|
|
|
Three Months
|
|
|
|
Ended
|
|
|
Ended
|
|
|
Ended
|
|
|
Ended
|
|
|
|
September 30,
|
|
|
September 30,
|
|
|
September 30,
|
|
|
September 30,
|
|
|
|
2005
|
|
|
2006
|
|
|
2005
|
|
|
2006
|
|
|
2005
|
|
|
2006
|
|
|
2005
|
|
|
2006
|
|
|
Expected volatility
|
|
|
32.75
|
%
|
|
|
|
|
|
|
|
|
|
|
38.08
|
%
|
|
|
|
|
|
|
37.75
|
%
|
|
|
|
|
|
|
|
|
Dividends yield
|
|
|
zero
|
|
|
|
|
|
|
|
|
|
|
|
zero
|
|
|
|
|
|
|
|
zero
|
|
|
|
|
|
|
|
|
|
Expected term
|
|
|
6.3 years
|
|
|
|
|
|
|
|
|
|
|
|
6.3 years
|
|
|
|
|
|
|
|
2.5 years
|
|
|
|
|
|
|
|
|
|
Risk-free interest rate
|
|
|
4.01
|
%
|
|
|
|
|
|
|
|
|
|
|
4.70
|
%
|
|
|
|
|
|
|
4.71
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Incentive Plan
|
|
|
Independent Directors
|
|
|
|
Stock Options
|
|
|
SARS
|
|
|
Stock Units
|
|
|
Stock Units
|
|
|
|
Nine Months
|
|
|
Nine Months
|
|
|
Nine Months
|
|
|
Nine Months
|
|
|
|
Ended
|
|
|
Ended
|
|
|
Ended
|
|
|
Ended
|
|
|
|
September 30,
|
|
|
September 30,
|
|
|
September 30,
|
|
|
September 30,
|
|
|
|
2005
|
|
|
2006
|
|
|
2005
|
|
|
2006
|
|
|
2005
|
|
|
2006
|
|
|
2005
|
|
|
2006
|
|
|
Expected volatility
|
|
|
32.75
|
%
|
|
|
37.03
|
%
|
|
|
|
|
|
|
38.43
|
%
|
|
|
|
|
|
|
38.40
|
%
|
|
|
|
|
|
|
37.29
|
%
|
Dividends yield
|
|
|
zero
|
|
|
|
zero
|
|
|
|
|
|
|
|
zero
|
|
|
|
|
|
|
|
zero
|
|
|
|
|
|
|
|
zero
|
|
Expected term
|
|
|
6.3 years
|
|
|
|
6.3 years
|
|
|
|
|
|
|
|
6.3 years
|
|
|
|
|
|
|
|
2.5 years
|
|
|
|
|
|
|
|
3.0 years
|
|
Risk-free interest rate
|
|
|
3.91
|
%
|
|
|
3.94
|
%
|
|
|
|
|
|
|
4.59
|
%
|
|
|
|
|
|
|
4.10
|
%
|
|
|
|
|
|
|
3.56
|
%
|
The following tables summarize the activity under the
stock-based compensation plans for the nine months ended
September 30, 2006:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted
|
|
|
|
|
|
|
|
|
|
Weighted
|
|
|
Average
|
|
|
Aggregate
|
|
|
|
|
|
|
Average
|
|
|
Remaining
|
|
|
Intrinsic
|
|
Stock Options & SARS
|
|
Shares
|
|
|
Exercise Price
|
|
|
Contractual Term
|
|
|
Value
|
|
|
|
(In thousands)
|
|
|
|
|
|
|
|
|
(In millions)
|
|
|
Outstanding at December 31,
2005
|
|
|
10,197
|
|
|
$
|
12.30
|
|
|
|
|
|
|
|
|
|
Granted
|
|
|
1,130
|
|
|
|
33.78
|
|
|
|
|
|
|
|
|
|
Exercised
|
|
|
(1,406
|
)
|
|
|
5.11
|
|
|
|
|
|
|
|
|
|
Forfeited
|
|
|
(151
|
)
|
|
|
9.98
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding at September 30,
2006
|
|
|
9,770
|
|
|
$
|
15.86
|
|
|
|
7.6 years
|
|
|
$
|
215.3
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Exercisable at September 30,
2006
|
|
|
3,896
|
|
|
$
|
12.58
|
|
|
|
7.6 years
|
|
|
$
|
98.6
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted Average
|
|
|
Aggregate
|
|
Incentive Plan and Independent Directors Stock Units
|
|
Shares
|
|
|
Grant Date Fair Value
|
|
|
Fair Value
|
|
|
|
(In thousands)
|
|
|
|
|
|
(In millions)
|
|
|
Outstanding and nonvested at
December 31, 2005
|
|
|
|
|
|
$
|
|
|
|
$
|
|
|
Granted
|
|
|
132.4
|
|
|
|
33.25
|
|
|
|
4.4
|
|
Vested
|
|
|
(9.3
|
)
|
|
|
32.19
|
|
|
|
(0.3
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding and nonvested at
September 30, 2006
|
|
|
123.1
|
|
|
$
|
33.33
|
|
|
$
|
4.1
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
15
HERBALIFE
LTD.
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
The weighted-average grant date per share fair value of stock
awards granted during the three and nine months ended
September 30, 2006 was $18.49 and $17.44, respectively. The
total intrinsic value of stock awards exercised during the three
and nine months ended September 30, 2006 was
$3.8 million and $45.0 million, respectively.
|
|
9.
|
Derivative
Instruments and Hedging Activities
|
The Company designates certain derivatives as cash flow hedges.
The Company engages in a foreign exchange hedging strategy for
which the hedged transactions are forecasted foreign currency
denominated intercompany transactions. The hedged risk is the
variability of the forecasted foreign currency cash flows where
the hedging strategy involves the purchase of average rate
options. The Company also engages in an interest rate hedging
strategy for which the hedged transactions are forecasted
interest payments on the Companys variable rate term loan.
The hedged risk is the variability of forecasted interest rate
cash flows, where the hedging strategy involves the purchase of
interest rate swaps. As of December 31, 2005 and
September 30, 2006, the Company did not have any
outstanding cash flow hedges on foreign exchange exposure. For
the outstanding cash flow hedges on interest rate exposures at
December 31, 2005, the maximum length of time over which
the Company is hedging these exposures is approximately three
years. The interest rate swap outstanding as of
December 31, 2005, was accounted for under the shortcut
method, as defined by SFAS No. 133, Accounting
for Derivative Investments and Hedging Activities, which
assumes the hedge to be perfectly effective. Consequently, all
changes in the fair value of the derivative are deferred and
recorded in other comprehensive income (OCI) until
the related forecasted transaction is recognized in the
consolidated statements of income.
On July 21, 2006 the interest rate swap, originally entered
into on February 21, 2005, was terminated due to the debt
refinancing and income of approximately $0.8 million was
recorded as interest income in the Companys consolidated
statements of income for the quarter ended September 30,
2006. On August 23, 2006, the Company entered into a new
interest rate swap agreement. The agreement provides for the
Company to pay interest for a three-year period at a fixed rate
of 5.26% on various notional amounts while receiving interest
for the same period at the LIBOR rate on the same notional
principal amounts. The swap was entered into as a cash flow
hedge against LIBOR interest rate movements on the new term
loan. The Company assesses the effectiveness of the hedge based
on the hypothetical derivative method. Under the hypothetical
derivative method, the cumulative change in fair value of the
actual swap is compared to the cumulative change in fair value
of a hypothetical swap, which has terms that identically match
the critical terms of the hedged transaction. Thus, the
hypothetical swap is presumed to perfectly offset the hedged
cash flows. The change in fair value of the perfect hypothetical
swap will then be regarded as a proxy for the present value of
the cumulative change in the expected future cash flows from the
hedged transactions. As of September 30, 2006, the hedge
relationship qualified as an effective hedge under
SFAS No. 133. Consequently, all changes in the fair
value of the derivative are deferred and recorded in OCI until
the related forecasted transaction is recognized in the
consolidated statements of income. The estimated net amount of
existing loss expected to be reclassified into earnings over the
next three years, which related to cash flow hedge, is
$0.6 million.
The Company designates certain derivatives as free standing
derivatives for which hedge accounting does not apply. The
changes in the fair market value of the derivatives are recorded
in the Companys consolidated statements of income. The
Company purchases average rate put options, which give the
Company the right, but not the obligation, to sell foreign
currency at a specified exchange rate (strike rate).
These contracts provide protection in the event the foreign
currency weakens beyond the strike rate. The Company also uses
foreign currency forward contracts, which give the Company the
obligation to buy or sell foreign currency at a specified time
and rate. The contracts are used to protect against changes in
the functional currency equivalent value of inter-company or
third party nonfunctional currency payables and receivables. The
fair values of the option and forward contracts are based on
third-party bank quotes. In December 2005, the Company entered
into a short term interest rate cap agreement, which was not
designated under hedge accounting. The interest rate cap
agreement expired in the first quarter of 2006.
16
HERBALIFE
LTD.
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
In November 2006, the Company announced a realignment of its
employee base as part of its realignment for growth plan. Under
this plan, the Company expects to incur severance and other
employee related costs of approximately $8 to $10 million.
Such costs are expected to be recognized within the next twelve
months.
17
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|
Item 2.
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Managements
Discussion And Analysis Of Financial Condition and Results Of
Operations
|
Overview
We are a global network marketing company that sells weight
management, nutritional supplement and personal care products.
We pursue our mission of changing peoples
lives by providing a financially rewarding business
opportunity to distributors and quality products to distributors
and customers who seek a healthy lifestyle. We are one of the
largest network marketing companies in the world with net sales
of approximately $1.6 billion for the year ended
December 31, 2005. We sell our products in 62 countries
through a network of over one million independent distributors,
except in China, where we currently use a retail business model
with employed sales representatives because of regulatory
restrictions on direct selling. We believe the quality of our
products and the effectiveness of our distribution network,
coupled with geographic expansion, have been the primary reasons
for our success throughout our
26-year
operating history.
We offer products in three principal categories: weight
management products, nutritional supplements which we refer to
as Inner Nutrition and personal care products which
we refer to as Outer
Nutrition.®
Our products are often sold in programs, which are comprised of
a series of related products designed to simplify weight
management and nutrition for our consumers and maximize our
distributors cross-selling opportunities.
Industry-wide factors that affect us and our competitors include
the increasing prevalence of obesity and the aging of the
worldwide population, which are driving demand for nutrition and
wellness-related products and the recruitment and retention of
distributors.
The opportunities and challenges upon which we are most focused
are driving retailing of our product, recruitment and retention
of distributors and improving distributor productivity, entering
new markets, further penetrating existing markets, pursuing
local distributor initiatives, introducing new products,
developing niche market segments and further investing in our
infrastructure.
In July 2006, we changed our geographic unit from four to seven
units as part of our on-going realignment for growth efforts.
These changes are intended to create growth opportunities for
our distributors, to support faster decision making across the
organization by reducing the number of management layers, and to
improve the sharing of ideas and tools to accelerate growth in
our high potential markets. Under the new geographic units we
report revenue from:
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North America, which consists of the U.S., Canada, Jamaica and
the Dominican Republic;
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Mexico and Central America, which consists of Mexico, Costs Rica
and Panama;
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Brazil;
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South America and Southeast Asia, which includes New Zealand and
Australia and excludes Brazil, Taiwan and Hong Kong;
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EMEA, which consists of Europe, the Middle East and Africa;
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|
Greater China, which consists of China, Taiwan and Hong
Kong; and
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North Asia, which consists of Japan and Korea.
|
A key non-financial measure we focus on is Volume Points on a
Royalty Basis (hereafter Volume Points), which is
essentially our weighted unit measure of product sales volume.
It is a useful measure for us, as it excludes the impact of
foreign currency fluctuations and ignores the differences
generated by varying retail pricing across geographic markets.
In general, an increase in Volume Points in a particular group
or country directionally indicates an increase in local currency
net sales.
18
Volume
Points by Geographic Unit
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Three Months Ended
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Nine Months Ended
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September 30,
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September 30,
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September 30,
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September 30,
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2005
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2006
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% Change
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2005
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2006
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% Change
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(Volume points in millions)
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North America
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118.3
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145.8
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23.2
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%
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356.9
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408.2
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14.4
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%
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Mexico & Central America
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100.4
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170.2
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69.5
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%
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247.3
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467.5
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89.0
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%
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Brazil
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40.5
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41.0
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1.2
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%
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115.3
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126.3
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9.5
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%
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South America and Southeast Asia
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52.3
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73.9
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41.3
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%
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133.0
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191.5
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44.0
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%
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EMEA
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140.6
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129.7
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(7.8
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)%
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432.8
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426.7
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(1.4
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)%
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Greater China
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38.1
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40.3
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5.8
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%
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104.7
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105.7
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1.0
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%
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North Asia
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33.7
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29.6
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(12.2
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)%
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92.4
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89.5
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|
(3.1
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%)
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Worldwide
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523.9
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630.5
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20.3
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%
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1,482.4
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|
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|
1,815.4
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|
22.5
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%
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|
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|
|
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Another key non-financial measure on which we focus is the
number of distributors qualified as supervisors under our
compensation system. Distributors qualify for supervisor status
based on their Volume Points.
Our compensation system requires supervisors to re-qualify
annually. The re-qualification period covers the twelve months
starting in February and ending the following January. There is
significant variation in the number of supervisors from the
fourth quarter to the first quarter of any given year due to the
timing of the re-qualification process. This fluctuation is
normal and consistent, and does not reflect a dramatic
underlying change in the business in comparing these two
sequential quarters. The growth in the number of supervisors is
a general indicator of the level of distributor recruitment,
which generally drives net sales in a particular country or
group.
The following tables show trends in the number of supervisors
over the reporting period by geographic unit, and fluctuations
within notable countries are discussed below in the appropriate
net sales section below where pertinent.
Number of
Supervisors by Geographic Unit as of Reporting Period
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As of September 30,
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|
2005
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|
|
2006
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|
|
% Change
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|
North America
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57,993
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66,640
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14.9
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%
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Mexico & Central America
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|
33,434
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|
66,097
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97.7
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%
|
Brazil
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|
33,267
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|
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|
38,857
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16.8
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%
|
South America and Southeast Asia
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|
36,409
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50,723
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39.3
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%
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EMEA
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|
86,364
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|
87,762
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1.6
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%
|
Greater China
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|
23,597
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|
28,176
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|
19.4
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%
|
North Asia
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|
18,967
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|
20,913
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|
10.3
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%
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|
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|
|
|
|
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|
Worldwide
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|
290,031
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|
359,168
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23.8
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%
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|
19
Number of
Supervisors by Geographic Unit as of Re-qualification
Period
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As of February,
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2005
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|
|
2006
|
|
|
% Change
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|
|
North America
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40,818
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|
45,778
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|
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|
12.2
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%
|
Mexico & Central America
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|
|
19,045
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|
38,344
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|
101.3
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%
|
Brazil
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|
21,605
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|
27,318
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|
26.4
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%
|
South America and Southeast Asia
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|
23,983
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|
30,846
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28.6
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%
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EMEA
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|
65,104
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66,103
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1.5
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%
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Greater China
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|
16,673
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|
19,447
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16.6
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%
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North Asia
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|
13,872
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|
15,736
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|
13.4
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%
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|
|
|
|
|
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|
Worldwide
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|
201,100
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243,572
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21.1
|
%
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|
|
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|
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|
For the twelve month re-qualification period ended January 2006,
41.5% of our supervisors re-qualified, up from 39.7% a year ago.
The number of supervisors by geographic unit as of the reporting
dates will normally be higher than the number of supervisors by
geographic unit as of the re-qualification period because
supervisors who do not re-qualify during the relevant
twelve-month period will be dropped from the rank of supervisor
in February. Since supervisors purchase most of our products for
resale to other distributors and consumers, comparisons of
supervisor totals on a
year-to-year,
same period basis are good indicators of our recruitment and
retention efforts in different geographic units.
We provide distributors with products, support material,
training, special events and a competitive compensation program.
If a distributor wants to pursue the Herbalife business
opportunity, the distributor is responsible for growing his or
her business and personally pays for the sales activities
related to attracting new customers and recruiting distributors
by hosting events such as Herbalife Opportunity Meetings or
Success Training Seminars; by advertising Herbalifes
products, by purchasing and using promotional materials such as
t-shirts, buttons and caps; by utilizing and paying for direct
mail and print material such as brochures, flyers, catalogs,
business cards, posters and banners and telephone book listings;
by purchasing inventory for sale or use as samples; and by
training, mentoring and following up, in person or via the phone
or internet, with customers and recruits on how to use Herbalife
products
and/or
pursue the Herbalife business opportunity.
Presentation
Retail Sales represent the gross sales amounts on
our invoices to distributors before distributor allowances (as
defined below). Net Sales which reflects distributor
allowances and handling and freight income, represent what the
Company collects and recognizes as net sales in its financial
statements. We discuss Retail Sales because of its fundamental
role in our compensation systems, internal controls and
operations, including its role as the basis upon which
distributor discounts, royalties and bonuses are awarded. In
addition, information in daily and monthly reports reviewed by
our management relies on Retail Sales data. However, such a
measure is not in accordance with Generally Accepted Accounting
Principles in the U.S., or GAAP. You should not consider Retail
Sales in isolation from, nor is it a substitute for, net sales
and other consolidated income or cash flow statement data
prepared in accordance with GAAP, or as a measure of
profitability or liquidity. A reconciliation of net sales to
Retail Sales is presented below. Product sales
represent the actual product purchase prices paid to us by our
distributors, after giving effect to distributor discounts
referred to as distributor allowances, which
approximate 50% of retail sales prices. Distributor allowances
as a percentage of sales may vary by country depending upon
regulatory restrictions that limit or otherwise restrict
distributor allowances.
Our gross profit consists of net sales less
cost of sales, which represents the prices we pay to
our raw material suppliers and manufacturers of our products as
well as costs related to product shipments, duties and tariffs,
freight expenses relating to shipment of products to
distributors and importers and similar expenses.
Royalty Overrides are our most significant expense
and consist of:
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|
royalty overrides and production bonuses, which total
approximately 15% and 7%, respectively, of the Retail Sales of
Weight management, Inner nutrition, Outer
nutrition®
and promotional products;
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20
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the Mark Hughes Bonus payable to some of our most senior
distributors in the aggregate amount of up to 1% of Retail Sales
of Weight management, Inner nutrition, Outer
nutrition®
and promotional products; and
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|
other discretionary incentive cash bonuses payable to qualifying
distributors.
|
Royalty Overrides are generally earned based on Retail Sales,
and approximate, in the aggregate, about 22% of Retail Sales or
approximately 35% of our net sales. Royalty Overrides, together
with distributor allowances, represent the potential earnings to
distributors of up to approximately 73% of Retail Sales. The
compensation to distributors is generally for the development,
retention and improved productivity of their distributor sales
organizations and is paid to several levels of distributors on
each sale. Because of local country regulatory constraints, we
may be required to modify our typical distributor incentive
plans as described above. Because of restrictions on direct
selling in China, our full-time employed sales representatives
in China are compensated with wages, bonuses and benefits
instead of the distributors earnings
distributor allowances and royalty overrides. Consequently, the
total distributor discount percentage may vary over time. We
also offer reduced distributor allowances and pay reduced
royalty overrides with respect to certain products worldwide.
Our operating margins consist of net sales less cost
of sales and royalty overrides.
Selling, General & Administrative Expenses
represent our operating expenses, components of which include
labor and benefits, sales events, professional fees, travel and
entertainment, distributor marketing, occupancy costs,
communication costs, bank fees, depreciation and amortization,
foreign exchange gains and losses and other miscellaneous
operating expenses.
Most of our sales to distributors outside the United States are
made in the respective local currencies. In preparing our
consolidated financial statements, we translate revenues into
U.S. dollars using average exchange rates. Additionally,
the majority of our purchases from our suppliers are generally
made in U.S. dollars. Consequently, a strengthening of the
U.S. dollar versus a foreign currency can have a negative
impact on our reported sales and operating margins and can
generate transaction losses on intercompany transactions.
Throughout the last five years, foreign currency exchange rates
have fluctuated significantly. From time to time, we enter into
foreign exchange forward contracts and option contracts to
mitigate our foreign currency exchange risk.
Summary
Financial Results
For the three and nine months ended September 30, 2006, net
sales increased by 18.8% and 20.8%, respectively, as compared to
the same periods in 2005, primarily due to increases in North
America, Mexico and Central America, and Brazil. Net sales in
EMEA and North Asia decreased for the three and nine months
ended September 30, 2006 when compared to the same periods
of 2005. The overall increase in net sales for the three and
nine months ended September 30, 2006 reflects the continued
sales momentum generated from the successful promotions in 2005
and 2006 and the enthusiasm and unity within our distributor
organization.
Net income decreased for the three months ended
September 30, 2006 to $26.5 million, or $0.36 per
diluted share, from $27.1 million or $0.37 per diluted
share, for the same period in 2005. Net income includes the
impact of $14.3 million recapitalization expenses in
connection with the repayment of the $225.0 million senior
secured credit facility, originally entered into on
December 21, 2004 (the Prior Credit Facility)
and our
91/2% Notes
due 2011 (the
91/2%
Notes) and a $2.7 million additional tax benefit
from refinancing transactions in the third quarter of 2006 and a
favorable impact of $2.5 million relating to a change in
the allowance for uncollectible royalty overrides receivables
from distributors in the third quarter of 2005. For the three
months ended September 30, 2006 as compared to the same
period in 2005, net sales growth and a lower effective tax rate,
partially offset by higher labor costs, promotional expenses and
professional fees had a net favorable impact to net income.
Foreign currencies had an unfavorable impact of
$0.1 million on net results for the three months ended
September 30, 2006.
Net income increased for the nine months ended
September 30, 2006 to $101.5 million, or
$1.37 per diluted share, from $63.2 million or
$0.87 per diluted share, for the same period in 2005. Net
income includes the impact of a $3.7 million tax benefit
resulting from an international income tax settlement in the
first quarter of 2006, $14.3 million recapitalization
expenses incurred in connection with the repayment of our Prior
Credit Facility and our
91/2%
Notes and a $2.7 million additional tax benefit from
refinancing transactions, in the third quarter of 2006, and
$14.2 million of recapitalization expenses incurred in the
first quarter of 2005 associated with the $110.0 million
21
clawback of our
91/2% Notes
and a favorable impact of $2.5 million relating to a change
in the allowance for uncollectible royalty overrides receivables
from distributors in the third quarter of 2005. For the nine
months ended September 30, 2006 as compared to the same
period in 2005, net sales growth, lower interest expense and a
lower effective tax rate, partially offset by higher labor
costs, promotional expenses and professional fees, had a net
favorable impact to net income. Foreign currencies had a
favorable impact of $2.6 million on net results for the
nine months ended September 30, 2006.
Results
of Operations
Our results of operations for the periods described below are
not necessarily indicative of results of operations for future
periods, which depend upon numerous factors, including our
ability to recruit and retain new distributors, open new markets
and further penetrate existing markets and introduce new
products and develop niche market segments.
The following table sets forth selected results of our
operations expressed as a percentage of net sales for the
periods indicated.
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|
|
|
|
|
Three Months Ended
|
|
|
Nine Months Ended
|
|
|
|
September 30,
|
|
|
September 30,
|
|
|
September 30,
|
|
|
September 30,
|
|
|
|
2005
|
|
|
2006
|
|
|
2005
|
|
|
2006
|
|
|
Operations:
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|
|
|
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|
|
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|
|
|
|
|
|
Net sales
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|
|
100.0
|
%
|
|
|
100.0
|
%
|
|
|
100.0
|
%
|
|
|
100.0
|
%
|
Cost of sales
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|
|
19.8
|
|
|
|
20.4
|
|
|
|
20.1
|
|
|
|
20.1
|
|
|
|
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|
|
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|
|
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|
Gross profit
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|
|
80.2
|
|
|
|
79.6
|
|
|
|
79.9
|
|
|
|
79.9
|
|
Royalty overrides
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|
|
34.6
|
|
|
|
35.4
|
|
|
|
35.5
|
|
|
|
35.9
|
|
Selling, general &
administrative expenses
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|
|
30.3
|
|
|
|
30.7
|
|
|
|
30.2
|
|
|
|
30.2
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating income
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|
|
15.3
|
|
|
|
13.5
|
|
|
|
14.2
|
|
|
|
13.8
|
|
Interest expense
|
|
|
2.0
|
|
|
|
5.4
|
|
|
|
3.2
|
|
|
|
2.6
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income before income taxes
|
|
|
13.3
|
|
|
|
8.1
|
|
|
|
11.0
|
|
|
|
11.2
|
|
Income taxes
|
|
|
6.5
|
|
|
|
2.6
|
|
|
|
5.5
|
|
|
|
4.0
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income
|
|
|
6.8
|
|
|
|
5.5
|
|
|
|
5.5
|
|
|
|
7.2
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
Sales
The following chart reconciles Retail Sales to net sales:
Sales by
Geographic Unit
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended September 30,
|
|
|
|
2005
|
|
|
2006
|
|
|
|
|
|
|
|
|
|
|
|
|
Handling
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Handling
|
|
|
|
|
|
Change
|
|
|
|
Gross
|
|
|
Distributor
|
|
|
Product
|
|
|
& Freight
|
|
|
Net
|
|
|
Gross
|
|
|
Distributor
|
|
|
Product
|
|
|
& Freight
|
|
|
Net
|
|
|
in Net
|
|
|
|
Sales
|
|
|
Allowance
|
|
|
Sales
|
|
|
Income
|
|
|
Sales
|
|
|
Sales
|
|
|
Allowance
|
|
|
Sales
|
|
|
Income
|
|
|
Sales
|
|
|
Sales
|
|
|
|
(In millions)
|
|
|
North America
|
|
$
|
120.9
|
|
|
$
|
(57.7
|
)
|
|
$
|
63.2
|
|
|
$
|
11.9
|
|
|
$
|
75.1
|
|
|
$
|
148.0
|
|
|
$
|
(70.5
|
)
|
|
$
|
77.5
|
|
|
$
|
14.6
|
|
|
$
|
92.1
|
|
|
|
22.6
|
%
|
Mexico and Central America
|
|
$
|
103.5
|
|
|
$
|
(50.1
|
)
|
|
$
|
53.4
|
|
|
$
|
8.3
|
|
|
$
|
61.7
|
|
|
|
173.5
|
|
|
|
(84.4
|
)
|
|
|
89.1
|
|
|
|
13.9
|
|
|
|
103.0
|
|
|
|
66.9
|
%
|
Brazil
|
|
|
47.9
|
|
|
|
(22.9
|
)
|
|
|
25.0
|
|
|
|
3.9
|
|
|
|
28.9
|
|
|
|
53.8
|
|
|
|
(25.7
|
)
|
|
|
28.1
|
|
|
|
4.7
|
|
|
|
32.8
|
|
|
|
13.5
|
%
|
South America and Southeast Asia
|
|
|
60.9
|
|
|
|
(28.6
|
)
|
|
|
32.3
|
|
|
|
4.7
|
|
|
|
37.0
|
|
|
|
88.3
|
|
|
|
(42.1
|
)
|
|
|
46.2
|
|
|
|
5.4
|
|
|
|
51.6
|
|
|
|
39.5
|
%
|
EMEA
|
|
|
214.1
|
|
|
|
(101.7
|
)
|
|
|
112.4
|
|
|
|
18.8
|
|
|
|
131.2
|
|
|
|
209.0
|
|
|
|
(99.9
|
)
|
|
|
109.1
|
|
|
|
18.3
|
|
|
|
127.4
|
|
|
|
(2.9
|
)%
|
Greater China
|
|
|
50.5
|
|
|
|
(24.7
|
)
|
|
|
25.8
|
|
|
|
3.4
|
|
|
|
29.2
|
|
|
|
54.8
|
|
|
|
(21.5
|
)
|
|
|
33.3
|
|
|
|
2.9
|
|
|
|
36.2
|
|
|
|
24.0
|
%
|
North Asia
|
|
|
61.8
|
|
|
|
(28.2
|
)
|
|
|
33.6
|
|
|
|
4.3
|
|
|
|
37.9
|
|
|
|
53.5
|
|
|
|
(24.0
|
)
|
|
|
29.5
|
|
|
|
3.8
|
|
|
|
33.3
|
|
|
|
(12.1
|
%)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
659.6
|
|
|
$
|
(313.9
|
)
|
|
$
|
345.7
|
|
|
$
|
55.3
|
|
|
$
|
401.0
|
|
|
$
|
780.9
|
|
|
$
|
(368.1
|
)
|
|
$
|
412.8
|
|
|
$
|
63.6
|
|
|
$
|
476.4
|
|
|
|
18.8
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
22
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nine Months Ended September 30,
|
|
|
|
2005
|
|
|
2006
|
|
|
|
|
|
|
|
|
|
|
|
|
Handling
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Handling
|
|
|
|
|
|
Change
|
|
|
|
Gross
|
|
|
Distributor
|
|
|
Product
|
|
|
& Freight
|
|
|
Net
|
|
|
Gross
|
|
|
Distributor
|
|
|
Product
|
|
|
& Freight
|
|
|
Net
|
|
|
in Net
|
|
|
|
Sales
|
|
|
Allowance
|
|
|
Sales
|
|
|
Income
|
|
|
Sales
|
|
|
Sales
|
|
|
Allowance
|
|
|
Sales
|
|
|
Income
|
|
|
Sales
|
|
|
Sales
|
|
|
|
(In millions)
|
|
|
North America
|
|
$
|
370.8
|
|
|
$
|
(177.2
|
)
|
|
$
|
193.6
|
|
|
$
|
36.5
|
|
|
$
|
230.1
|
|
|
$
|
429.1
|
|
|
$
|
(204.7
|
)
|
|
$
|
224.4
|
|
|
$
|
42.4
|
|
|
$
|
266.8
|
|
|
|
15.9
|
%
|
Mexico & Central America
|
|
$
|
251.1
|
|
|
$
|
(121.6
|
)
|
|
$
|
129.5
|
|
|
$
|
20.2
|
|
|
$
|
149.7
|
|
|
|
473.1
|
|
|
|
(229.8
|
)
|
|
|
243.3
|
|
|
|
37.8
|
|
|
|
281.1
|
|
|
|
87.8
|
%
|
Brazil
|
|
|
127.2
|
|
|
|
(60.8
|
)
|
|
|
66.4
|
|
|
|
10.4
|
|
|
|
76.8
|
|
|
|
164.1
|
|
|
|
(78.5
|
)
|
|
|
85.6
|
|
|
|
13.8
|
|
|
|
99.4
|
|
|
|
29.4
|
%
|
South America and Southeast Asia
|
|
|
155.6
|
|
|
|
(72.5
|
)
|
|
|
83.1
|
|
|
|
11.2
|
|
|
|
94.3
|
|
|
|
245.2
|
|
|
|
(118.1
|
)
|
|
|
127.1
|
|
|
|
15.2
|
|
|
|
142.3
|
|
|
|
50.9
|
%
|
EMEA
|
|
|
682.0
|
|
|
|
(324.8
|
)
|
|
|
357.2
|
|
|
|
60.4
|
|
|
|
417.6
|
|
|
|
681.1
|
|
|
|
(326.9
|
)
|
|
|
354.2
|
|
|
|
59.9
|
|
|
|
414.1
|
|
|
|
(0.8
|
)%
|
Greater China
|
|
|
142.7
|
|
|
|
(69.9
|
)
|
|
|
72.8
|
|
|
|
9.6
|
|
|
|
82.4
|
|
|
|
145.2
|
|
|
|
(61.0
|
)
|
|
|
84.2
|
|
|
|
8.3
|
|
|
|
92.5
|
|
|
|
12.3
|
%
|
North Asia
|
|
|
175.2
|
|
|
|
(80.5
|
)
|
|
|
94.7
|
|
|
|
12.1
|
|
|
|
106.8
|
|
|
|
165.3
|
|
|
|
(74.9
|
)
|
|
|
90.4
|
|
|
|
11.6
|
|
|
|
102.0
|
|
|
|
(4.5
|
%)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
1,904.6
|
|
|
$
|
(907.3
|
)
|
|
$
|
997.3
|
|
|
$
|
160.4
|
|
|
$
|
1,157.7
|
|
|
$
|
2,303.1
|
|
|
$
|
(1,093.9
|
)
|
|
$
|
1,209.2
|
|
|
$
|
189.0
|
|
|
$
|
1,398.2
|
|
|
|
20.8
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Changes in net sales are directly associated with the
recruiting, retention and retailing of our distributor force,
the quality and completeness of the product offerings that the
distributor force has to sell and the number of countries in
which we operate. Managements role, both in-country and at
the corporate level is to provide distributors with a
competitive and broad product line, encourage strong teamwork
and leadership among the Chairmans Club and
Presidents Team distributors and offer leading edge
business tools to make doing business with Herbalife simple.
Management uses our marketing program coupled with educational
and motivational tools to incentivize distributors to drive
recruiting, retention and retailing which in turn affect net
sales. Such tools include corporate sales events
Extravaganzas and World Team Schools where large
groups of distributors gather, thus allowing them to network
with other distributors, learn recruiting, retention and
retailing techniques from our leading distributors and become
more familiar with how to market and sell our products and
business opportunities. Accordingly, management believes that
these development and motivation programs can increase the
productivity of the supervisor network. The expenses for such
programs are included in Selling, General &
Administrative expenses. Sales are driven by several factors
including the number and productivity of distributor leaders who
continually build, educate and motivate their respective
distribution and sales organizations. We also use product event
and non-event promotions to motivate distributors to increase
recruiting, retention and retailing activities. These promotions
have ranged from our 2005 Worldwide Cup promotion to vacations
or other qualifying events for distributors that meet certain
selling and recruiting goals. The costs of these promotions are
included in Selling, General & Administrative expenses.
The factors described above have driven growth in our business.
The following net sales by geographic unit discussion provides
further details regarding some of the above factors and
describes unique growth factors specific to certain groups,
including major countries within such groups. The Company
believes that the correct foundation, coupled with ongoing
training and promotional initiatives is required to increase
recruiting and retention of distributors and retailing of our
products. The correct foundation includes strong country
management that works closely with the distributor leadership, a
broad product line that appeals to local consumer needs, a
favorable regulatory environment, a scalable and stable
technology platform and an attractive marketing plan.
Initiatives such as Success Training Seminars, World Team
Schools, Promotional Events and regional Extravaganzas are
integral components of developing a highly motivated and
educated distributor sales organization that will work toward
increasing the recruitment and retention of distributors.
Our strategy will continue to include generating and maintaining
growth within existing markets and increased focus on the
support and acculturation of successful distributor daily
methods of operations (DMOs). We expect to increase
spending in Selling, General & Administrative expenses
to maintain or stimulate sales growth, while making strategic
investments in new initiatives. In addition, new ideas are being
generated in our regional markets, either by distributors,
country management or corporate management. Examples are the
Nutrition Clubs in Mexico, the Total Plan in Brazil and
GenerationH, or GenH in the U.S., each as described
below in the net sales discussion below. Managements
strategy is to review the feasibility of expanding successful
country initiatives throughout a region
and/or
globally where appropriate and financially support the expansion
of these initiatives.
23
North
America
Net sales in North America increased $17.0 million and
$36.7 million, or 22.6% and 15.9%, respectively, for the
three and nine months ended September 30, 2006, as compared
to the same periods of 2005. In local currency, net sales
increased by 22.5% and 15.5%, respectively, for the three and
nine months ended September 30, 2006, as compared to the
same periods of 2005. The fluctuation of foreign currency rates
had a favorable impact of $0.2 million and
$0.9 million, respectively on net sales for the three and
nine months ended September 30, 2006. The overall increase
in net sales in North America was a result of net sales growth
in the U.S. of $17.4 million and $36.3 million or
24.7% and 16.8% for the three and nine months ended
September 30, 2006, respectively, as compared to the same
periods of 2005.
Net sales in the U.S. increased as a result of a number of
factors, including strong supervisor growth, up 16.1% at
September 30, 2006, as compared to September 30, 2005;
the establishment of a dedicated U.S. country management
team; continued branding efforts such as sponsorship of the AVP
Volleyball Tour, the Bay to Breakers Run, the 2006 Amgen Tour of
California bicycle race and the 2006 Nautica Triathlon; and
various new promotions including the 2006 Active World Team
promotion and the 2006 President Team Challenge. To further
support the retailing and recruiting efforts of our
distributors, we plan to open a new sales centers in the
U.S. during the fourth quarter of 2006 and, in particular,
to stimulate sales within the vicinity of the new sales centers.
Additionally, in July 2006 at our North American Extravaganza,
we introduced a water mixable version of our top selling Formula
1 shake, a reformulated version of our Garden
7tm
product and NouriFusion in individual use packets.
We believe that 2006 sales in North America should continue its
positive year over year growth primarily as a result of the
expected continuation of the strong momentum in key markets, the
rapid success and expansion of the Nutrition Club DMO and
increased distribution focus on providing samples of product in
individual use packets.
Mexico
and Central America
Net sales in Mexico and Central America for the three and nine
months ended September 30, 2006, increased
$41.3 million and $131.4 million, or 66.9% and 87.8%,
respectively, as compared to the same periods of 2005. In local
currency, net sales for the three and nine months ended
September 30, 2006, increased by 70.5% and 87.7%,
respectively, as compared to the same periods of 2005. The
fluctuation of foreign currency rates had an unfavorable impact
of $2.3 million on net sales for the three months ended
September 30, 2006 and a favorable impact of
$0.2 million on net sales for the nine months ended
September 30, 2006. The overall increase was a result of
net sales growth in Mexico of $40.6 million and
$129.8 million or 66.0% and 87.1% for the three and nine
months ended September 30, 2006, respectively, as compared
to the same periods of 2005.
The net sales growth trend in Mexico reflects strong supervisor
growth, up 97.9% at September 30, 2006, as compared to
September 30, 2005, and the continued expansion of our
Nutrition Clubs. We estimate that distributors are operating
approximately 36,000 Nutrition Clubs in Mexico. During the first
nine months of 2006 we opened an additional sales center in
Mexico City, held a Presidents Team Tour attended by
approximately 9,000 distributors, hosted the Mexico Extravaganza
in Mexico City, which was attended by over 11,000 distributors
and held two Active Supervisor Schools, which approximately
4,300 distributors attended. Additionally, we relocated our
Mexico headquarters and main warehouse in Guadalajara and plan
to open a new sales center in the Mexico City area to better
support our expansion efforts.
We believe that the 2006 sales in Mexico and Central America
should continue its positive year over year growth primarily as
a result of the strong supervisor growth, increased development
of products, literature and promotions to support and leverage
the success of the Nutrition Clubs and building upon the
momentum within our distributor organization. As sales have
continued to increase primarily in Mexico, resulting in a
corresponding higher sales base, the rate of increase in net
sales, when measured as a percent of net sales for the
corresponding quarter last year, has declined for Mexico and
Central America. This trend is expected to continue in the
fourth quarter of 2006.
24
Brazil
Net sales in Brazil increased $3.9 million and
$22.6 million, or 13.5% and 29.4%, respectively, for the
three and nine months ended September 30, 2006, as compared
to the same periods of 2005. In local currency, net sales
increased by 5.2% and 13.3%, respectively, for the three and
nine months ended September 30, 2006, as compared to the
same periods of 2005. The fluctuation of foreign currency rates
had a favorable impact of $2.4 million and
$12.5 million on net sales for the three and nine months
ended September 30, 2006, respectively.
The net sales growth trend in Brazil is a result of strong
supervisor growth, up 16.8% at September 30, 2006, as
compared to September 30, 2005, strong distributor
leadership, a highly effective country management team and the
introduction of a new distributor promotion launched in the
third quarter of 2006. In addition, expansion of the Total Plan
lead generation method and the introduction of the Nutrition
Club concept in this market have been key catalysts for growth.
During the year we held a World Team School attended by over
4,500 distributors and launched the NouriFusion basic line in
individual use packets.
We believe the 2006 sales in Brazil should continue its positive
year over year growth primarily as a result of the increase in
the Nutrition Club DMOs and plans to refine our product
portfolio to help us compete more aggressively in the personal
care industry by leveraging our product knowledge and the Total
Plan. Although net sales in Brazil is expected to increase in
2006 on a year over year basis and we expect fourth quarter net
sales to be slightly higher than in the fourth quarter of 2005,
we have experienced a leveling sales in the last nine months.
South
America and Southeast Asia
Net sales in South America and Southeast Asia increased
$14.6 million and $48.0 million, or 39.5% and 50.9%,
for the three and nine months ended September 30, 2006,
respectively, as compared to the same periods of 2005. In local
currency, net sales increased 37.6% and 50.6%, respectively for
the three and nine months ended September 30, 2006, as
compared to the same periods of 2005. The fluctuation of foreign
currency rates had a $0.6 million and $0.4 million
favorable impact, respectively on net sales for the three and
nine months ended September 30, 2006. The overall increase
was attributable mainly to net sales increases in Colombia,
Argentina, Venezuela and Bolivia and the opening of Malaysia in
February 2006 as a new market. During the quarter ended
September 30, 2006, we held an extravaganza for the region
in Bangkok, Thailand, which was attended by over 15,000
distributors from 13 countries.
Colombia, Argentina, Venezuela and Bolivia experienced sales
increases of 80.3%, 54.5%, 71.9% and 63.4%, respectively, for
the quarter ended September 30, 2006. For the nine months
ended September 30, 2006, Colombia, Argentina, Venezuela
and Bolivia experienced continued sales increases of 214.4%,
78.2%, 43.6% and 123.1%, respectively. This growth was the
result of positive momentum from the local events, including
Millionaires Retreats held in Panama and Pucon, Chile,
sponsored activities such as the Bogota, Colombia Marathon
during the third quarter of 2006.
We opened our Malaysia market in February 2006. Over 10,000
people attended the various opening events. Net sales for the
three and nine months ended September 30, 2006 were
$7.8 million and $19.1 million, respectively. During
the quarter ended September 30, 2006, several workshops and
trainings were conducted to support the continued growth of
sales in Malaysia.
We believe the 2006 sales in South America and Southeast Asia
should continue its positive year over year growth primarily as
a result of the opening of Peru and the ability to respond more
quickly to challenges as a result of the realignment.
EMEA
EMEA net sales decreased $3.8 million and
$3.5 million, or 2.9% and 0.8%, respectively, for the three
and nine months ended September 30, 2006, as compared to
the same periods of 2005. In local currency, net sales decreased
5.7% for the three months ended September 30, 2006, as
compared to the same period of 2005 and increased 1.0% for the
nine months ended September 30, 2006, as compared to the
same period of 2005. The fluctuation of foreign currency rates
had a favorable impact on net sales of $3.7 million for the
three months ended September 30, 2006 and an unfavorable
impact on net sales of $7.9 million for the nine months
ended September 30, 2006. Portugal,
25
France and Spain continue to grow and experienced sales
increases of 32.5%, 13.2% and 15.6%, respectively, while Germany
and the Netherlands experienced decreases in net sales of 25.7%
and 21.2%, respectively for the quarter ended September 30,
2006, as compared to the same period of 2005. For the nine
months ended September 30, 2006, Portugal, France, and
Spain sales increased 36.1%, 26.2%, and 13.1%, respectively,
while Germany and the Netherlands experienced decreased net
sales of 20.4% and 22.1%, respectively. During the first quarter
of 2006 we relocated our call centers to Italy, France and the
Netherlands in an effort to improve service and support to
distributors who previously were serviced out of the United
Kingdom. During this process we also opened our first sales
center in the Netherlands. Additionally, during the third
quarter an Extravaganza was held in Athens, Greece and was
attended by over 15,000 distributors from over 40 countries.
The net sales increases in Portugal, France, and Spain
continued, primarily due to a well balanced performance across
distributor retailing, recruiting and retention efforts, a
united distributor leadership working closely with the local
management, and a program focus on the Total Plan. In addition,
there has been an increasing emphasis on good health and
nutrition in France, which is supported and promoted by local
nutritionists. Two Nutrition Advisory Board members were
appointed in France and Spain during the third quarter of 2006.
The decline in Germany was primarily driven by a decrease in
supervisors, down 22.4% at September 30, 2006, as compared
to September 30, 2005. In Germany, a recently constituted
strategy group has focused on turnaround initiatives, both in
business activity as well as brand building. Significant
distributor training has been undertaken, concentrating on long
term customers, Nutrition Clubs and wellness coaching. In
addition, improved distributor communications has been a key
focus and new online tools are being provided.
The net sales decline in the Netherlands was primarily driven by
lower recruiting of new distributors. A reconstituted
distributor strategy group, working closely with regional
management is focused on initiatives to reverse that trend.
These included a National Supervisor recruitment drive, the
launch of
Liftofftm
in June 2006, a highly successful Spring Spectacular
event and the appointment of a member of the Global Nutritional
Advisory Board.
While progress is being made, the turnaround is expected to be
slow in Germany and the Netherlands and net sales for 2006 are
expected to be below the level of 2005 for these countries.
We expect 2006 net sales in EMEA to be slightly lower when
compared to 2005 and measured in US dollars, while flat when
measured in local currency. We have identified several
high-potential markets for which we are developing strategic
plans to grow sales in these emerging markets. We plan to
continue to support these markets through our global and local
branding initiatives. This includes sponsoring the London
Triathlon, the Italian Beach Volleyball Championship, the Nice
Ironman Triathlon and the Madrid Triathlon, which are intended
to continually improve our corporate and brand reputation in the
market. We are also enhancing distributor communication
processes and training, and, in addition, we have the
introduction of some new products into the region, most notably
Liftofftm.
Liftofftm
was introduced in ten markets in the EMEA group in the
third quarter of 2006, and is scheduled for launch during the
fourth quarter of 2006 in several additional markets.
Greater
China
Greater China net sales increased $7.0 million and
$10.1 million, or 24.0% and 12.3%, for the three and nine
months ended September 30, 2006, respectively, as compared
to the same periods of 2005. In local currency, net sales
increased 24.2% and 13.0%, respectively for the three and nine
months ended September 30, 2006, as compared to the same
periods of 2005. The fluctuation of foreign currency rates had
an unfavorable impact of $0.1 million and
$0.7 million, respectively, on net sales for the three and
nine months ended September 30, 2006. The overall increase
in net sales was attributable mainly to an increase in China,
while Taiwan and Hong Kong continued to experience a decline in
sales.
Net sales in China increased by $10.9 million to
$11.6 million and by $20.5 million to
$21.9 million, respectively, for the three and nine months
ended September 30, 2006, as compared to the same periods
of 2005. Since March of 2005 we have opened 33 retail stores in
20 provinces throughout China. During the fourth quarter of
2006, we plan to hold a World Team School and open an additional
9 stores.
26
Net sales in Taiwan decreased $2.2 million and
$6.7 million, or 9.3% and 9.8%, respectively, for the three
and nine months ended September 30, 2006, as compared to
the same periods of 2005. In local currency, net sales in Taiwan
decreased 7.9% and 7.9%, respectively, for the three and nine
months ended September 30, 2006, as compared to the same
periods of 2005. The fluctuation of foreign currency rates had
an unfavorable impact on net sales of $0.3 million and
$1.3 million for the three and nine months ended
September 30, 2006, respectively. The decrease in net sales
was primarily attributable to the focus of local distributor
leadership and some of their key members, whose attention was
temporarily shifted, in net sales on the opening of Malaysia and
the emerging business opportunity in China. During the fourth
quarter of 2006, we plan to hold a World Training School and as
well as a special training event in November.
Net sales in Hong Kong decreased $1.7 million and
$3.8 million, or 38.8% and 29.4%, respectively, for the
three and nine months ended September 30, 2006, as compared
to the same periods of 2005. The decline in net sales is
primarily the result of a decrease in supervisors, down 22.2% at
September 30, 2006, as compared to September 30, 2005.
We believe the 2006 sales in Greater China should continue its
positive year over year growth primarily as a result of the
continued expansion of our retail presence and continued efforts
to enhance our product portfolio.
North
Asia
North Asia net sales decreased $4.6 million and
$4.8 million, or 12.1% and 4.5%, respectively, for the
three and nine months ended September 30, 2006, as compared
to the same periods of 2005. In local currency, net sales
decreased 13.1% and 2.5% for the three and nine months ended
September 30, 2006, as compared to the same periods of
2005. The fluctuation of foreign currency rates had a favorable
impact of $0.3 million and an unfavorable impact of
$2.2 million on net sales for the three and nine months
ended September 30, 2006, respectively. The decrease was
mainly attributable to Japan.
Net sales in Japan decreased $5.8 million and
$11.8 million, or 24.3% and 16.5%, respectively, for the
three and nine months ended September 30, 2006, as compared
to the same periods of 2005. In spite of the decrease in net
sales, the number of new distributors and the supervisor
retention rate are improving when compared to the same periods
last year. The improved retention rate was caused by an increase
in the number of distributors taking advantage of the modified
re-qualification criteria. We believe the modified
re-qualification criteria will lead to increased future sales.
During the three months ended September 30, 2006,
NouriFusiontm
skin whitening foundation was launched, and a new Nutrition
Center showroom and sales center, which will operate seven days
a week, were opened in Osaka and a recruiting promotion was
launched. During the fourth quarter of 2006, we will be
launching several new products and promotions, which are
expected to generate excitement among our distributors.
We believe the 2006 sales in North Asia should remain flat year
over year. We plan to remain focused on reinvigorating our
distributor leadership and exporting successful DMOs into this
market.
Sales by
Product Category
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended September 30,
|
|
|
|
2005
|
|
|
2006
|
|
|
|
|
|
|
|
|
|
|
|
|
Handling
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Handling
|
|
|
|
|
|
|
|
|
|
Retail
|
|
|
Distributor
|
|
|
Product
|
|
|
& Freight
|
|
|
Net
|
|
|
Retail
|
|
|
Distributor
|
|
|
Product
|
|
|
& Freight
|
|
|
Net
|
|
|
%Change in
|
|
|
|
Sales
|
|
|
Allowance
|
|
|
Sales
|
|
|
Income
|
|
|
Sales
|
|
|
Sales
|
|
|
Allowance
|
|
|
Sales
|
|
|
Income
|
|
|
Sales
|
|
|
Net Sales
|
|
|
|
(In millions)
|
|
|
Weight Management
|
|
$
|
282.4
|
|
|
$
|
(139.0
|
)
|
|
$
|
143.4
|
|
|
$
|
23.7
|
|
|
$
|
167.1
|
|
|
$
|
344.6
|
|
|
$
|
(170.6
|
)
|
|
$
|
174.0
|
|
|
$
|
28.1
|
|
|
$
|
202.1
|
|
|
|
20.9
|
%
|
Inner Nutrition
|
|
|
299.0
|
|
|
|
(147.2
|
)
|
|
|
151.8
|
|
|
|
25.1
|
|
|
|
176.9
|
|
|
|
358.0
|
|
|
|
(177.2
|
)
|
|
|
180.8
|
|
|
|
29.1
|
|
|
|
209.9
|
|
|
|
18.7
|
%
|
Outer
Nutrition®
|
|
|
62.8
|
|
|
|
(31.0
|
)
|
|
|
31.8
|
|
|
|
5.2
|
|
|
|
37.0
|
|
|
|
57.5
|
|
|
|
(28.5
|
)
|
|
|
29.0
|
|
|
|
4.7
|
|
|
|
33.7
|
|
|
|
(8.9
|
)%
|
Literature, Promotional and Other
|
|
|
15.4
|
|
|
|
3.3
|
|
|
|
18.7
|
|
|
|
1.3
|
|
|
|
20.0
|
|
|
|
20.8
|
|
|
|
8.2
|
|
|
|
29.0
|
|
|
|
1.7
|
|
|
|
30.7
|
|
|
|
53.5
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
659.6
|
|
|
$
|
(313.9
|
)
|
|
$
|
345.7
|
|
|
$
|
55.3
|
|
|
$
|
401.0
|
|
|
$
|
780.9
|
|
|
$
|
(368.1
|
)
|
|
$
|
412.8
|
|
|
$
|
63.6
|
|
|
$
|
476.4
|
|
|
|
18.8
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
27
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nine Months Ended September 30,
|
|
|
|
2005
|
|
|
2006
|
|
|
|
|
|
|
|
|
|
|
|
|
Handling
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Handling
|
|
|
|
|
|
|
|
|
|
Retail
|
|
|
Distributor
|
|
|
Product
|
|
|
& Freight
|
|
|
Net
|
|
|
Retail
|
|
|
Distributor
|
|
|
Product
|
|
|
& Freight
|
|
|
Net
|
|
|
%Change in
|
|
|
|
Sales
|
|
|
Allowance
|
|
|
Sales
|
|
|
Income
|
|
|
Sales
|
|
|
Sales
|
|
|
Allowance
|
|
|
Sales
|
|
|
Income
|
|
|
Sales
|
|
|
Net Sales
|
|
|
|
(In millions)
|
|
|
Weight Management
|
|
$
|
805.2
|
|
|
$
|
(396.5
|
)
|
|
$
|
408.7
|
|
|
$
|
67.9
|
|
|
$
|
476.6
|
|
|
$
|
1,003.4
|
|
|
$
|
(494.6
|
)
|
|
$
|
508.8
|
|
|
$
|
82.4
|
|
|
$
|
591.2
|
|
|
|
24.0
|
%
|
Inner Nutrition
|
|
|
848.2
|
|
|
|
(417.7
|
)
|
|
|
430.5
|
|
|
|
71.5
|
|
|
|
502.0
|
|
|
|
1,047.8
|
|
|
|
(516.4
|
)
|
|
|
531.4
|
|
|
|
85.9
|
|
|
|
617.3
|
|
|
|
23.0
|
%
|
Outer
Nutrition®
|
|
|
208.1
|
|
|
|
(102.5
|
)
|
|
|
105.6
|
|
|
|
17.4
|
|
|
|
123.0
|
|
|
|
191.7
|
|
|
|
(94.5
|
)
|
|
|
97.2
|
|
|
|
15.7
|
|
|
|
112.9
|
|
|
|
(8.2
|
)%
|
Literature, Promotional and Other
|
|
|
43.1
|
|
|
|
9.4
|
|
|
|
52.5
|
|
|
|
3.6
|
|
|
|
56.1
|
|
|
|
60.2
|
|
|
|
11.6
|
|
|
|
71.8
|
|
|
|
5.0
|
|
|
|
76.8
|
|
|
|
36.9
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
1,904.6
|
|
|
$
|
(907.3
|
)
|
|
$
|
997.3
|
|
|
$
|
160.4
|
|
|
$
|
1,157.7
|
|
|
$
|
2,303.1
|
|
|
$
|
(1,093.9
|
)
|
|
$
|
1,209.2
|
|
|
$
|
189.0
|
|
|
$
|
1,398.2
|
|
|
|
20.8
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Our increased emphasis on the science of weight management and
nutrition during the recent years, illustrated by our assembly
of the Scientific Advisory Board and the Medical Advisory Board,
has resulted in product introductions such as
Niteworkstm,,
Garden
7tm
and Formula I Instant Nutritional Snack Mix and the introduction
of
ShapeWorkstm,
a personalized meal replacement program. Due to the launch of
these new products together with the continued positive sales
momentum discussed above, net sales of weight management
products and inner nutrition products increased at a higher rate
than net sales of outer
nutrition®
products. We expect shifts within these categories from time to
time as we launch new products.
Gross
Profit
Gross profit was $379.2 million and $1,117.0 million
for the three and nine months ended September 30, 2006, as
compared to $321.5 million and $925.1 million in the
same periods of 2005. As a percentage of net sales, gross profit
for the three months ended September 30, 2006 decreased
slightly from 80.2% to 79.6%, as compared to the same period of
2005. The gross profit for the nine months ended
September 30, 2006 remained flat at approximately 79.9% of
net sales, as compared to the same period of 2005. Generally,
gross profit percentages do not vary significantly as a
percentage of net sales other than due to product and country
mix, currency fluctuations, importation cost and provisions for
slow moving and obsolete inventory. Additionally, we believe
that we have the ability to mitigate price increases by raising
the prices of our products or shifting product sourcing to
alternative manufacturers.
Royalty
Overrides
Royalty Overrides as a percentage of net sales were 35.4% and
35.9% for the three and nine months ended September 30,
2006, as compared to 34.6% and 35.5% in the same periods of
2005. The increase for the three and nine months ended
September 30, 2006, as compared to the same periods of
2005, was primarily due to a favorable pre-tax impact of
$4.0 million relating to a change in the allowance for
uncollectible royalty overrides receivables from distributors in
the third quarter of 2005. Generally, this ratio varies slightly
from period to period due to changes in the mix of products and
countries because full Royalty Overrides are not paid on certain
products or in certain countries. Due to the structure of our
global compensation plan, we do not expect to see significant
fluctuations in Royalty Overrides as a percentage of net sales.
Selling,
General & Administrative Expenses
Selling, General & Administrative expenses as a
percentage of net sales were 30.7% and 30.2% for the three and
nine months ended September 30, 2006, as compared to 30.3%
and 30.2% in the same periods of 2005. For the three and nine
months ended September 30, 2006, Selling,
General & Administrative expenses increased
$24.5 million and $72.6 million to $146.1 million
and $422.0 million, respectively, as compared to the same
periods of 2005. The unfavorable impact of foreign currency
fluctuations was $1.8 million and $2.0 million for the
three and nine months ended September 30, 2006,
respectively.
The increases in Selling, General, & Administrative
expenses for the three and nine months ended September 30,
2006 included $10.5 million and $32.6 million in
higher salaries and benefits, due primarily to normal merit
increases, higher employee bonuses, higher stock based
compensation expenses, and increases related to the
strengthening of the management team regionally and in the U.S;
higher compensation costs associated with
28
employee sales representatives in China; $3.6 million and
$12.8 million in higher professional fees primarily
associated with our technology infrastructure and legal
expenses; and $4.0 million and $8.5 million in higher
occupancy expenses due to new facilities, respectively.
We expect 2006 Selling, General & Administrative
expenses to increase over 2005 levels, reflecting general salary
merit increases and the ongoing investments in our five key
strategies distributor,
direct-to-consumer,
product development, China, and infrastructure.
Net
Interest Expense
Net interest expense was $25.9 million and
$36.8 million for the three and nine months ended
September 30, 2006, as compared to $8.0 million and
$37.6 million for the same periods of 2005. Interest
expense for the three months ended September 30, 2006
includes recapitalization expenses of $22.9 million due to
the repayment of our Prior Credit Facility of $79.6 million
in July 2006 and the redemption of the $165.0 million
aggregate principal amount of our
91/2% Notes
due 2011 in August 2006. The recapitalization expenses include
$1.7 million of write-off of unamortized deferred financing
cost for the Prior Credit Facility, $16.6 million of
purchase premium and $4.6 million of write-off of discount
and deferred financing cost in respect of our
91/2% Notes.
The Company entered into a new credit agreement in July 2006
which provides for a term loan of $200.0 million and a
revolving credit facility of $100.0 million (the New
Credit Facility). In August 2006, the Company borrowed
$200.0 million of term loan under the New Credit Facility,
and in September 2006, we prepaid $20.0 million of the term
loan borrowing, resulting in approximately $0.1 million
additional interest expense from the write-off of deferred
financing fees.
Income
Taxes
Income taxes were $12.2 million and $55.4 million for
the three and nine months ended September 30, 2006
respectively, as compared to $26.2 million and
$64.0 million in the same periods of 2005. As a percentage
of pre-tax income, the effective income tax rate was 31.5% and
35.3% for the three and nine months ended September 30,
2006, respectively, as compared to 49.1% and 50.3% in the same
periods of 2005. The decrease in the effective tax rate for the
three and nine months ended September 30, 2006 as compared
to 2005 was caused primarily by higher pre-tax income in lower
taxed jurisdictions and the impact of recapitalization charges
in the three and nine months ended September 30, 2005 as
well as the settlement of an international tax audit and the
additional tax benefit from refinancing transactions in the
three and nine months ended September 30, 2006. Excluding
the effect of the settlement related to the international tax
audit and the tax benefit of the bond redemption, the effective
tax rate would have been approximately 37.5% and 39.1% for the
three and nine months ended September 30, 2006,
respectively.
Foreign
Currency Fluctuations
Currency fluctuations had an unfavorable impact of
$0.1 million and a favorable impact of $2.6 million on
net results for the three and nine months ended
September 30, 2006, when compared to what current year net
results would have been using last years foreign exchange
rates. For the three months ended September 30, 2006, the
regional effects of currency fluctuations were zero impact in
North America, an unfavorable impact of $0.7 million in
Mexico and Central America, a favorable impact of
$0.6 million in Brazil, a favorable impact of
$0.2 million in South America and Southeast Asia, a
favorable impact of $0.4 million in EMEA, an unfavorable
impact of $0.1 million in Greater China and an unfavorable
impact of $0.5 million in North Asia. For the nine months
ended September 30, 2006, the regional effects of currency
fluctuation were a favorable impact of $0.3 million in
North America, a favorable impact of $0.4 million in Mexico
and Central America, a favorable impact of $2.6 million in
Brazil, a favorable impact of $0.3 million in South America
and Southeast Asia, an unfavorable impact of $0.9 million
in EMEA, an unfavorable impact of $0.4 million in Greater
China and a favorable impact of $0.3 million in North Asia.
29
Net
Results
Net income decreased for the three months ended
September 30, 2006 to $26.5 million, or $0.36 per
diluted share, from $27.1 million or $0.37 per diluted
share, for the same period in 2005. Net income includes the
impact of $14.3 million recapitalization expenses in
connection with the repayment to the Prior Credit Facility and
our
91/2% Notes
and a $2.7 million additional tax benefit from refinancing
transactions in the third quarter of 2006 and a favorable impact
of $2.5 million relating to a change in the allowance for
uncollectible royalty overrides receivables from distributors in
the third quarter of 2005. For the three months ended
September 30, 2006 as compared to the same period in 2005,
net sales growth and a lower effective tax rate, partially
offset by higher labor costs, promotional expenses and
professional fees, had a net favorable impact to net income.
Foreign currencies had an unfavorable impact of
$0.1 million on net results for the three months ended
September 30, 2006.
Net income increased for the nine months ended
September 30, 2006 to $101.5 million, or
$1.37 per diluted share, from $63.2 million or
$0.87 per diluted share, for the same period in 2005. Net
income includes the impact of a $3.7 million tax benefit
resulting from an international income tax settlement in the
first quarter of 2006, $14.3 million recapitalization
expenses incurred in connection with the repayment of our Prior
Credit Facility and our
91/2%
Notes and a $2.7 million additional tax benefit from
refinancing transactions in the third quarter of 2006, and
$14.2 million of recapitalization expenses incurred in the
first quarter of 2005 associated with the $110.0 million
clawback of our
91/2% Notes
and a favorable impact of $2.5 million relating to a change
in the allowance for uncollectible royalty overrides receivables
from distributors in the third quarter of 2005. For the nine
months ended September 30, 3006 as compared to the same
period in 2005, net sales growth, lower interest expense and a
lower effective tax rate, partially offset by higher labor
costs, promotional expenses and professional fees, had a net
favorable impact to net income. Foreign currencies had a
favorable impact of $2.6 million on net results for the
nine months ended September 30, 2006.
Liquidity
and Capital Resources
We have historically met our working capital and capital
expenditure requirements, including funding for expansion of
operations, through net cash flows provided by operating
activities. Our principal source of liquidity is our operating
cash flows. Variations in sales of our products would directly
affect the availability of funds. There are no material
restrictions on the ability to transfer and remit funds among
our international affiliated companies.
For the nine months ended September 30, 2006, we generated
$145.0 million from operating cash flows, as compared to
$130.9 million in the same period of 2005. The increase in
cash generated from operations reflected an increase in net
income of $38.3 million, which was primarily driven by a
20.8% growth in net sales, partially offset by higher royalty
overrides and selling, general & administrative
expenses.
Capital expenditures, including capital leases, for the three
and nine months ended September 30, 2006 were
$23.5 million and $49.1 million, respectively, as
compared to $9.5 million and $22.3 million, for the
same periods in 2005. We expect to incur capital expenditures of
approximately $55 million in 2006. The majority of these
expenditures represent investments in management information
systems, the development of the Companys
direct-to-consumer
platform, the expansion of our facilities in China and for the
build-out and construction of new U.S. facilities.
2005 and 2006 are investment years for us in China as we expand
our business there. The operating loss in China for 2005 was
$2.2 million and we currently anticipate funding an
operating loss of less than $1.0 million in 2006, in
addition to total capital expenditures and working capital of up
to $4.0 million for the planned build-out of retail stores,
our offices and the expansion of the capabilities of our
manufacturing facility. In 2005, we invested approximately
$4.5 million in capital expenditures in China.
In February 2005, we redeemed a $110 million principal
amount, excluding discounts, or 40% of our
91/2% Notes
for the cash amount of $124.1 million, including a premium
of $10.5 million and accrued interest of $3.6 million.
Interest expense in 2005 includes the redemption amount of
$14.2 million, which represents $10.5 million of
premium and $3.7 million of write-off of deferred financing
cost and discount. In August 2006, we redeemed the
$165.0 million principal amount of our
91/2% Notes
for a total amount of $187.8 million, including a premium
of $16.6 million and accrued interest of $6.2 million.
Interest expense in the third quarter of
30
2006 includes the call premium of $16.6 million and
$4.6 million of write-off of discounts and deferred
financing costs.
Our Prior Credit Facility consisted of a senior secured
revolving credit facility with total availability of up to
$25.0 million and a senior secured term loan facility in an
aggregate principal amount of $200.0 million. In July 2006,
we prepaid all amounts outstanding under the Prior Credit
Facility amounting to $79.6 million. Interest expense in
the third quarter of 2006 includes $1.7 million of
write-off of deferred financing cost.
In July 2006, we entered into the New Credit Facility, a
$300.0 million senior secured credit facility, with a
syndicate of financial institutions as lenders. The New Credit
Facility replaced the Prior Credit Facility. The New Credit
Facility provides for a $200.0 million term loan and a
revolving credit facility of $100.0 million. The term loan
matures on July 21, 2013 and the revolving credit facility
is available until July 21, 2012. The term loan bears
interest at LIBOR plus a margin of 1.5%, and the revolver bears
interest at LIBOR rate plus a margin of 1.25%. The Company is
obligated to pay $0.5 million of the term loan every
quarter from December 31, 2006 until June 30, 2013 and
the remaining principal on July 21, 2013. In September
2006, the Company made a prepayment of the new term loan
borrowings of $20.0 million resulting in $0.1 million
additional interest expense from write-off of unamortized
deferred financing costs.
In July 2006, we redeemed the outstanding $0.1 million
principal balance of the
113/4% Notes
due 2010.
The following summarizes our contractual obligations including
interest at September 30, 2006 and the effect such
obligations are expected to have on our liquidity and cash flows
in future periods:
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Payments Due by Period
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2011 &
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Total
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2006
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2007
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2008
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2009
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2010
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Thereafter
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(In millions)
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Senior secured term loan
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$
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262.3
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$
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3.7
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$
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14.5
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$
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14.3
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$
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14.2
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$
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14.0
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$
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201.6
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Capital leases
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6.4
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1.4
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3.1
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1.2
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0.7
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Other debt
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1.6
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0.7
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0.9
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Operating leases
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91.8
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5.2
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16.0
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11.7
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10.0
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8.9
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40.0
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Total
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$
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362.1
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$
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11.0
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$
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34.5
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$
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27.2
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$
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24.9
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$
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22.9
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$
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241.6
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As of September 30, 2006, we had positive working capital
of $44.4 million. Cash and cash equivalents were
$123.3 million at September 30, 2006, compared to
$88.2 million at December 31, 2005.
We expect that cash and funds provided from operations and
available borrowings under our existing revolving credit
facility will provide sufficient working capital to operate our
business, to make expected capital expenditures and to meet
foreseeable liquidity requirements. There can be no assurance,
however, that our business will service our debt, or fund our
other liquidity needs.
The majority of our purchases from suppliers are generally made
in U.S. dollars while sales to Herbalife distributors
generally are made in local currencies. Consequently,
strengthening of the U.S. dollar versus a foreign currency
can have a negative impact on operating margins and can generate
transaction losses on intercompany transactions. For discussion
of our foreign exchange contracts and other hedging
arrangements, see the quantitative and qualitative disclosures
about market risks described below.
Subsequent
Events
In November 2006, we announced a realignment of our employee
base as part of our realignment for growth plan. Under this
plan, we expect to incur employee related costs of approximately
$8 to $10 million. Such costs are expected to be recognized
within the next twelve months.
31
Contingencies
We are from time to time engaged in routine litigation. We
regularly review all pending litigation matters in which we are
involved and establish reserves deemed appropriate by management
for these litigation matters when a probable loss estimate can
be made.
Herbalife International and certain of its independent
distributors have been named as defendants in a purported class
action lawsuit filed February 17, 2005, in the Superior
Court of California, County of San Francisco, and served on
Herbalife International on March 14, 2005
(Minton v. Herbalife International, et al). The
case has been transferred to the Los Angeles County Superior
Court. The plaintiff is challenging the marketing practices of
certain Herbalife International independent distributors and
Herbalife International under various state laws prohibiting
endless chain schemes, insufficient disclosure in
assisted marketing plans, unfair and deceptive business
practices, and fraud and deceit. The plaintiff alleges that the
Freedom Group system operated by certain independent
distributors of Herbalife International products places too much
emphasis on recruiting and encourages excessively large
purchases of product and promotional materials by distributors.
The plaintiff also alleges that Freedom Group pressured
distributors to disseminate misleading promotional materials.
The plaintiff seeks to hold Herbalife International vicariously
liable for the actions of its independent distributors and is
seeking damages and injunctive relief. We believe that we have
meritorious defenses to the suit.
Herbalife International and certain of its distributors have
been named as defendants in a class action lawsuit filed
July 16, 2003, in the Circuit Court of Ohio County in the
State of West Virginia (Mey v. Herbalife International,
Inc., et al). On April 21, 2006, the court granted
plaintiffs motion for class certification in West
Virginia. The complaint alleges that certain telemarketing
practices of certain Herbalife International distributors
violate the Telephone Consumer Protection Act, or TCPA, and
seeks to hold Herbalife International vicariously liable for the
practices of these distributors. More specifically, the
plaintiffs complaint alleges that several of Herbalife
Internationals distributors used pre-recorded telephone
messages and autodialers to contact prospective customers in
violation of the TCPAs prohibition of such practices.
Herbalife Internationals distributors are independent
contractors and if any such distributors in fact violated the
TCPA they also violated Herbalifes policies, which require
our distributors to comply with all applicable federal, state
and local laws. We believe that we have meritorious defenses to
the suit.
As a marketer of dietary and nutritional supplements and other
products that are ingested by consumers or applied to their
bodies, we have been and are currently subjected to various
product liability claims. The effects of these claims to date
have not been material to us, and the reasonably possible range
of exposure on currently existing claims is not material to us.
We believe that we have meritorious defenses to the allegations
contained in the lawsuits. We currently maintain product
liability insurance with an annual deductible of
$10 million.
Certain of our subsidiaries have been subject to tax audits by
governmental authorities in their respective countries. In
certain of these tax audits, governmental authorities are
proposing that significant amounts of additional taxes and
related interest and penalties are due. We and our tax advisors
believe that there are substantial defenses to their allegations
that additional taxes are owed, and we are vigorously contesting
the additional proposed taxes and related charges.
These matters may take several years to resolve, and we cannot
be sure of their ultimate resolution. However, it is the opinion
of management that adverse outcomes, if any, will not likely
result in a material effect on our financial condition and
operating results. This opinion is based on our belief that any
losses we suffer would not be material and that we have
meritorious defenses. Although we have reserved an amount that
we believe represents the likely outcome of the resolution of
these disputes, if we are incorrect in our assessment we may
have to record additional expenses.
Critical
Accounting Policies
Our Consolidated Financial Statements are prepared in conformity
with accounting principles generally accepted in the United
States of America, which require us to make estimates and
assumptions that affect the reported amounts of assets and
liabilities and disclosures of contingent assets and liabilities
at the date of the financial statements and the reported amounts
of revenue and expenses during the year. Actual results could
differ from those estimates. We consider the following policies
to be most critical in understanding the judgments that are
32
involved in preparing the consolidated financial statements and
the uncertainties that could impact our results of operations,
financial condition and cash flows.
We are a network marketing company that sells a wide range of
weight management products, nutritional supplements and personal
care products within one industry segment as defined under
SFAS 131, Disclosures about Segments of an Enterprise and
Related Information. Our products are manufactured by third
party providers and then sold to independent distributors who
sell Herbalife products to retail consumers or other
distributors.
We sell products in 62 countries throughout the world which are
organized and managed by geographic region. In the first quarter
of 2003, we elected to aggregate our operating segments into one
reporting segment, as management believes that our 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 products are sold to, the
methods used to distribute the products and the nature of the
regulatory environment.
Revenue is recognized when products are shipped and title passes
to the independent distributor or importer. Amounts billed for
freight and handling costs are included in net sales. We
generally receive the net sales price in cash or through credit
card payments at the point of sale. Related royalty overrides
and allowances for product returns are recorded when the
merchandise is shipped.
Allowances for product returns primarily in connection with our
buyback program are provided at the time the product is shipped.
This accrual is based upon historic return rates for each
country, which vary from zero to approximately 5.0% of retail
sales, and the relevant return pattern, which reflects
anticipated returns to be received over a period of up to
12 months following the original sale. Historically,
product returns and buybacks have not been significant. Product
returns and buybacks were approximately 1.2%, 1.0% and 1.0%,
1.0%, for the three and nine months ended September 30,
2005 and 2006, respectively. No material changes in estimates
have been recognized for the nine months ended
September 30, 2005 and 2006.
We record reserves against our inventory to provide for
estimated obsolete or unsalable inventory based on assumptions
about future demand for our products and market conditions. If
future demand and market conditions are less favorable than
managements assumptions, additional reserves could be
required. Likewise, favorable future demand and market
conditions could positively impact future operating results if
previously reserved for inventory is sold. We reserved for
obsolete and slow moving inventory totaling $8.0 million
and $9.8 million as of December 31, 2005 and
September 30, 2006, respectively.
In accordance with SFAS No. 144, Accounting for the
Impairment or Disposal of Long-Lived Assets, long-lived assets,
such as property, plant, and equipment, and purchased
intangibles subject to amortization, are reviewed for impairment
whenever events or changes in circumstances indicate that the
carrying amount of an asset may not be recoverable.
Recoverability of assets to be held and used is measured by a
comparison of the carrying amount of an asset to estimated
undiscounted future cash flows expected to be generated by the
asset. If the carrying amount of an asset exceeds its estimated
future cash flows, an impairment charge is recognized by the
amount by which the carrying amount of the asset exceeds the
fair value of the asset. Assets to be disposed of would be
separately presented in the balance sheet and reported at the
lower of the carrying amount or fair value less costs to sell,
and are no longer depreciated. The assets and liabilities of a
disposed group classified as held for sale would be presented
separately in the appropriate asset and liability sections of
the balance sheet.
Goodwill and other intangibles not subject to amortization are
tested annually for impairment and are tested for impairment
more frequently if events and circumstances indicate that the
asset might be impaired. An impairment loss is recognized to the
extent that the carrying amount exceeds the assets fair
value. This determination is made at the reporting unit level
and consists of two steps. First, the Company determines the
fair value of a reporting unit and compares it to its carrying
amount. Second, if the carrying amount of a reporting unit
exceeds its fair value, an impairment loss is recognized for any
excess of the carrying amount of the reporting units
goodwill and other intangibles over the implied fair value. The
implied fair value is determined by allocating the fair value of
the reporting unit in a manner similar to a purchase price
allocation, in accordance with SFAS No. 141, Business
Combinations. The residual fair value after this allocation is
the implied fair value of the reporting units goodwill and
other intangibles. As of September 30, 2006, we had
goodwill of approximately $125.1 million, and marketing
33
franchise of $310.0 million. Goodwill was reduced in the
first three quarters of 2006 by approximately $4.7 million,
$2.0 million and $2.4 million, respectively, due
primarily to the effect of the settlement of an international
tax audit related to the pre-acquisition period, the use of net
operating losses and the reduction of certain pre-acquisition
income tax reserves.
Contingencies are accounted for in accordance with
SFAS No. 5, Accounting for Contingencies
(SFAS No. 5). SFAS No. 5
requires that we record an estimated loss from a loss
contingency when information available prior to issuance of our
financial statements indicates that it is probable that an asset
has been impaired or a liability has been incurred at the date
of the financial statements and the amount of the loss can be
reasonably estimated. Accounting for contingencies such as legal
and income tax matters requires us to use judgment. Many of
these legal and tax contingencies can take years to be resolved.
Generally, as the time period increases over which the
uncertainties are resolved, the likelihood of changes to the
estimate of the ultimate outcome increases.
Deferred income tax assets have been established for net
operating loss carryforwards of certain foreign subsidiaries and
have been reduced by a valuation allowance to reflect them at
amounts estimated to be ultimately recognized. The net operating
loss carryforwards expire in varying amounts over a future
period of time. Realization of the income tax carryforwards is
dependent on generating sufficient taxable income prior to
expiration of the carryforwards. Although realization is not
assured, we believe it is more likely than not that the net
carrying value of the income tax carryforwards will be realized.
The amount of the income tax carryforwards that is considered
realizable, however, could change if estimates of future taxable
income during the carryforward period are adjusted.
We account for stock-based compensation in accordance with
SFAS No. 123R, Share-Based Payment
(SFAS No. 123R). Under the fair value
recognition provisions of this statement, share-based
compensation cost is measured at the grant date based on the
value of the award and is recognized as expense over the vesting
period. Determining the fair value of share-based awards at the
grant date requires judgment, including estimating our stock
price volatility and employee stock award exercise behaviors.
Our expected volatility is primarily based upon the historical
volatility of Herbalifes common stock and, due to the
limited period of public trading data for its common stock, it
is also validated against the volatility of a company peer
group. The expected life of awards is based on observed
historical exercise patterns, which can vary over time. As
stock-based compensation expense recognized in the Consolidated
Statements of Income is based on awards ultimately expected to
vest, the amount of expense has been reduced for estimated
forfeitures. SFAS No. 123R requires forfeitures to be
estimated at the time of grant and revised, if necessary, in
subsequent periods if actual forfeitures differ from those
estimates. Forfeitures were estimated based on historical
experience.
New
Accounting Pronouncements
Effective January 1, 2006, we adopted the fair value
recognition provisions of SFAS No. 123R, which
generally requires, among other things, that all employee
share-based compensation be measured using a fair value method
and that the resulting compensation cost be recognized in the
financial statements. We selected the modified prospective
method of adoption. Under this method, compensation expense that
we recognized for the three and nine months ended
September 30, 2006 included: (a) compensation expense
for all share-based payments granted prior to, but not yet
vested as of January 1, 2006, based on the grant date fair
value estimated in accordance with the original provisions of
SFAS No. 123, Accounting for Stock-Based Compensation,
and (b) compensation expense for all share-based payments
granted on or after January 1, 2006, based on the grant
date fair value estimated in accordance with the provisions of
SFAS No. 123R. Results for prior periods were not
restated. See Note 8 to the consolidated financial
statements for more details on stock based compensation.
In June 2006, FASB Interpretation No. 48, Accounting for
Uncertainty in Income Taxes (FIN 48) was issued
in its final version. The Interpretation clarifies the
accounting for uncertainty in income taxes recognized in an
enterprises financial statements in accordance with FASB
Statement No. 109, Accounting for Income Taxes. FIN 48
provides guidance on derecognition, classification, interest and
penalties, accounting in interim periods, disclosure, and
transition effective for fiscal years beginning after
December 15, 2006. Earlier application of the provisions of
FIN 48 is encouraged if the enterprise has not yet issued
financial statements, including interim financial statements, in
the period FIN 48 is adopted. We are currently evaluating
the impact of adopting FIN 48.
34
In June 2006, the FASB ratified the consensuses of Emerging
Issues Task Force (EITF) Issue
No. 06-3,
How Taxes Collected from Customers and Remitted to Governmental
Authorities Should Be Presented in the Income Statement (That
Is, Gross versus Net Presentation)
(EITF 06-3).
EITF 06-3
clarifies that the scope of this issue includes any tax assessed
by a governmental authority that is directly imposed on a
revenue-producing transaction between a seller and a customer
and indicates that the income statement presentation on either a
gross basis or a net basis of the taxes within the scope of the
issue is an accounting policy decision that should be disclosed.
Furthermore, for taxes reported on a gross basis, an enterprise
should disclose the amounts of those taxes in interim and annual
financial statements for each period for which an income
statement is presented. The consensus is effective, through
retrospective application, for periods beginning after
December 15, 2006. We are currently evaluating the
presentation basis to be utilized in accordance with
EITF 06-3.
In September 2006, the FASB issued SFAS No. 157, Fair
Value Measurement, which defines fair value, establishes a
framework for measuring fair value in accordance with GAAP, and
expands disclosures about fair value measurements. The
provisions of SFAS No. 157 are effective for fiscal
years beginning after November 15, 2007. We are currently
evaluating the impact, if any, of adopting
SFAS No. 157.
In September 2006, the Securities and Exchange Commission issued
Staff Accounting Bulletin No. 108, Considering the
Effects of Prior Year Misstatements when Quantifying
Misstatements in Current year Financial Statements
(SAB 108), which provides interpretive guidance
on how the effects of the carryover or reversal of prior year
misstatements should be considered in quantifying a current year
misstatement. The guidance is effective for fiscal years
beginning after November 15, 2006 and it allows a one-time
transitional cumulative effect adjustment to
beginning-of-year
retained earnings at the first fiscal year ending after
November 15, 2006 for errors that were not previously
deemed material, but are material under the guidance in
SAB 108. We are currently evaluating the impact, if any, of
adopting SAB 108 on our consolidated financial statements.
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Item 3.
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Quantitative
and Qualitative Disclosures About Market Risk
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We are exposed to market risks, which arise during the normal
course of business from changes in interest rates and foreign
currency exchange rates. On a selected basis, we use derivative
financial instruments to manage or hedge these risks. All
hedging transactions are authorized and executed pursuant to
written guidelines and procedures.
We have adopted SFAS No. 133, Accounting for
Derivative Instruments and Hedging Activities.
SFAS No. 133, as amended and interpreted, established
accounting and reporting standards for derivative instruments,
including certain derivative instruments embedded in other
contracts, and for hedging activities. All derivatives, whether
designated in hedging relationships or not, are required to be
recorded on the balance sheet at fair value. If the derivative
is designated as a fair-value hedge, the changes in the fair
value of the derivative and the underlying hedged item are
recognized concurrently in earnings. If the derivative is
designated as a cash-flow hedge, changes in the fair value of
the derivative are recorded in other comprehensive income
(OCI) and are recognized in the statement of
operations when the hedged item affects earnings.
SFAS No. 133 defined new requirements for designation
and documentation of hedging relationships as well as ongoing
effectiveness assessments in order to use hedge accounting. For
a derivative that does not qualify as a hedge, changes in fair
value are recognized concurrently in earnings.
A discussion of our primary market risk exposures and
derivatives is presented below.
Foreign
Exchange Risk
We enter into foreign exchange derivatives in the ordinary
course of business primarily to reduce exposure to currency
fluctuations attributable to inter-company transactions and
translation of local currency revenue. Most of these foreign
exchange contracts are designated as free standing derivatives
for which hedge accounting does not apply.
We purchase average rate put options, which give us the right,
but not the obligation, to sell foreign currency at a specified
exchange rate (strike rate). These contracts provide
protection in the event that the foreign currency weakens beyond
the option strike rate.
35
The following table provides information about the details of
our option contracts:
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|
|
|
|
|
|
|
|
|
|
Average
|
|
|
Fair
|
|
|
Maturity
|
|
Foreign Currency
|
|
Coverage
|
|
|
Strike Price
|
|
|
Value
|
|
|
Date
|
|
|
|
(In millions)
|
|
|
|
|
|
(In millions)
|
|
|
|
|
|
Purchase Puts (Company may sell
peso/buy USD)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Mexican peso
|
|
$
|
18.5
|
|
|
|
10.69 10.94
|
|
|
$
|
0.4
|
|
|
|
Oct-Dec 2006
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
18.5
|
|
|
|
|
|
|
$
|
0.4
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Purchase Puts (Company may sell
real/buy USD)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Brazilian real
|
|
$
|
5.0
|
|
|
|
2.28 2.37
|
|
|
$
|
0.0
|
|
|
|
Oct-Dec 2006
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
5.0
|
|
|
|
|
|
|
$
|
0.0
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Purchase Puts (Company may sell
won/buy USD)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Korean won
|
|
$
|
3.8
|
|
|
|
980.75 992.25
|
|
|
$
|
0.0
|
|
|
|
Oct-Dec 2006
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
3.8
|
|
|
|
|
|
|
$
|
0.0
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Purchase Puts (Company may sell
pounds/buy USD)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
British pound
|
|
$
|
3.0
|
|
|
|
1.89 1.91
|
|
|
$
|
0.1
|
|
|
|
Oct-Dec 2006
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
3.0
|
|
|
|
|
|
|
$
|
0.1
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Purchase Puts (Company may sell
rand/buy USD)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
South African rand
|
|
$
|
0.3
|
|
|
|
6.10 6.10
|
|
|
$
|
0.1
|
|
|
|
Oct-Dec 2006
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
0.3
|
|
|
|
|
|
|
$
|
0.1
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Purchase Puts (Company may sell
Taiwan dollar/buy USD)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Taiwan Dollar
|
|
$
|
3.0
|
|
|
|
30.98 31.25
|
|
|
$
|
0.2
|
|
|
|
Oct-Dec 2006
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
3.0
|
|
|
|
|
|
|
$
|
0.2
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Purchase Puts (Company may sell
Euro/buy USD)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Euro
|
|
$
|
4.5
|
|
|
|
1.29 1.30
|
|
|
$
|
0.1
|
|
|
|
Oct-Dec 2006
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
4.5
|
|
|
|
|
|
|
$
|
0.1
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Foreign exchange forward contracts are used to hedge advances
between subsidiaries. The objective of these contracts is to
neutralize the impact of foreign currency movements on the
subsidiarys operating results. The fair value of forward
contracts is based on third-party bank quotes.
36
The following table provides information about the details of
our forward contracts:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Contract
|
|
|
Forward
|
|
|
Maturity
|
|
|
Contract
|
|
|
Fair
|
|
Foreign Currency
|
|
Date
|
|
|
Position
|
|
|
Date
|
|
|
Rate
|
|
|
Value
|
|
|
|
|
|
|
(In millions)
|
|
|
|
|
|
|
|
|
(In millions)
|
|
|
At September 30,
2006
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Buy SEK sell USD
|
|
|
09/29/06
|
|
|
$
|
2.5
|
|
|
|
10/31/06
|
|
|
|
7.28
|
|
|
$
|
2.5
|
|
Buy EUR sell USD
|
|
|
09/29/06
|
|
|
$
|
1.0
|
|
|
|
10/31/06
|
|
|
|
1.27
|
|
|
$
|
1.0
|
|
Buy GBP sell USD
|
|
|
09/29/06
|
|
|
$
|
3.4
|
|
|
|
10/31/06
|
|
|
|
1.88
|
|
|
$
|
3.4
|
|
Buy USD sell TRY
|
|
|
09/29/06
|
|
|
$
|
2.3
|
|
|
|
10/31/06
|
|
|
|
1.53
|
|
|
$
|
2.3
|
|
Buy USD sell KRW
|
|
|
09/27/06
|
|
|
$
|
7.4
|
|
|
|
10/31/06
|
|
|
|
943.40
|
|
|
$
|
7.4
|
|
Buy YEN sell USD
|
|
|
09/28/06
|
|
|
$
|
5.0
|
|
|
|
10/31/06
|
|
|
|
117.33
|
|
|
$
|
5.0
|
|
Buy KRW sell USD
|
|
|
09/27/06
|
|
|
$
|
3.0
|
|
|
|
10/31/06
|
|
|
|
943.40
|
|
|
$
|
3.0
|
|
Buy INR sell USD
|
|
|
09/27/06
|
|
|
$
|
5.3
|
|
|
|
10/31/06
|
|
|
|
45.96
|
|
|
$
|
5.3
|
|
Buy EUR sell USD
|
|
|
09/29/06
|
|
|
$
|
20.5
|
|
|
|
10/31/06
|
|
|
|
1.27
|
|
|
$
|
20.5
|
|
Buy USD sell EUR
|
|
|
09/28/06
|
|
|
$
|
34.1
|
|
|
|
10/31/06
|
|
|
|
1.27
|
|
|
$
|
34.0
|
|
Buy USD sell EUR
|
|
|
09/29/06
|
|
|
$
|
33.3
|
|
|
|
10/31/06
|
|
|
|
1.27
|
|
|
$
|
33.3
|
|
Buy EUR sell USD
|
|
|
09/28/06
|
|
|
$
|
18.2
|
|
|
|
10/31/06
|
|
|
|
1.27
|
|
|
$
|
18.1
|
|
Buy NZD sell EUR
|
|
|
09/29/06
|
|
|
$
|
0.7
|
|
|
|
10/31/06
|
|
|
|
1.94
|
|
|
$
|
0.7
|
|
Buy TWD sell EUR
|
|
|
09/27/06
|
|
|
$
|
4.9
|
|
|
|
10/31/06
|
|
|
|
41.78
|
|
|
$
|
4.9
|
|
Buy NOK sell EUR
|
|
|
09/29/06
|
|
|
$
|
1.7
|
|
|
|
10/31/06
|
|
|
|
8.20
|
|
|
$
|
1.7
|
|
Buy DKK sell EUR
|
|
|
09/29/06
|
|
|
$
|
1.4
|
|
|
|
10/31/06
|
|
|
|
7.46
|
|
|
$
|
1.4
|
|
Buy PLN sell EUR
|
|
|
09/29/06
|
|
|
$
|
0.8
|
|
|
|
10/31/06
|
|
|
|
3.99
|
|
|
$
|
0.8
|
|
Buy USD sell EUR
|
|
|
09/29/06
|
|
|
$
|
0.8
|
|
|
|
10/31/06
|
|
|
|
1.27
|
|
|
$
|
0.8
|
|
Buy EUR sell HUF
|
|
|
09/29/06
|
|
|
$
|
0.1
|
|
|
|
10/31/06
|
|
|
|
274.18
|
|
|
$
|
0.1
|
|
Buy EUR sell SEK
|
|
|
09/29/06
|
|
|
$
|
0.6
|
|
|
|
10/31/06
|
|
|
|
9.25
|
|
|
$
|
0.6
|
|
Buy YEN sell CHF
|
|
|
09/29/06
|
|
|
$
|
17.6
|
|
|
|
10/31/06
|
|
|
|
94.40
|
|
|
$
|
17.6
|
|
Buy EUR sell GBP
|
|
|
09/29/06
|
|
|
$
|
0.9
|
|
|
|
10/31/06
|
|
|
|
0.68
|
|
|
$
|
0.9
|
|
All our foreign subsidiaries, excluding those operating in
hyper-inflationary environments, designate their local
currencies as their functional currency. At September 30,
2006, the total amount of our foreign subsidiary cash was
$105.1 million, of which $8.7 million was invested in
U.S. dollars.
Interest
Rate Risk
On July 21, 2006, the interest rate swap associated with
the Prior Credit Facility, originally entered into on
February 21, 2005, was terminated due to the debt
refinancing and income of $0.8 million was recorded in
interest income in our consolidated statements of income for the
quarter ended September 30, 2006. On August 23, we
entered into a new interest rate swap agreement. This agreement
provides for us to pay interest for a three-year period at a
fixed rate of 5.26% on initial notional principal amount of
$180.0 million while receiving interest for the same period
at the LIBOR rate on the same notional principal amount.
Subsequently, the notional amount will be reduced by
$20 million in the second, third and fourth quarters of
each year commencing January 1, 2007, throughout the term
of the swap. The swap has been entered into as a cash flow hedge
against LIBOR interest rate movements on new term loan totaling
$200.0 million at LIBOR plus 1.50%, thereby fixing our
effective rate on the notional amount at 6.76%. At
September 30, 2006, the Company recorded the interest rate
swap as a liability at fair value of $0.6 million with the
offsetting amount recorded in other comprehensive income
(OCI).
As of September 30, 2006, the aggregate annual maturities
of the term loan obtained in July 2006 are:
2006-$0.5 million; 2007-$2.0 million;
2008-$2.0 million; 2009-$2.0 million;
2010-$2.0 million; and $171.5 million thereafter. The
fair value of this loan approximates its carrying value of
$180.0 million as of September 30, 2006. The term loan
bears a variable interest rate, and on September 30, 2006
the average interest rate was 6.86%.
37
Under the Companys new term loan in effect as of
September 30, 2006, we are obligated to enter into (for a
minimum of three years) an interest rate hedge for up to 25% of
the aggregate principal amount of the new term loan. On
August 23, 2006, we entered into an interest rate swap, as
discussed above, to fulfill this obligation.
|
|
Item 4.
|
Controls
And Procedures
|
Evaluation of Disclosure Controls and
Procedures. Our management, including our Chief
Executive Officer and Chief Financial Officer, has evaluated the
effectiveness of our disclosure controls and procedures (as such
term is defined in
Rules 13a-15(e)
and
15d-15(e)
under the Securities Exchange Act of 1934, as amended (the
Exchange Act)), as of the end of the period covered
by this report. Based on such evaluation, our Chief Executive
Officer and Chief Financial Officer have concluded that our
disclosure controls and procedures were effective as of the end
of the period covered by this report.
Changes in Internal Control Over Financial
Reporting. There were no changes in our internal
control over financial reporting (as such term is defined in
Rules 13a-15(f)
and
15d-15(f)
under the Exchange Act) that occurred during the last fiscal
quarter that have materially affected, or are reasonably likely
to materially affect, our internal control over financial
reporting.
FORWARD
LOOKING STATEMENTS
This document contains forward-looking statements
within the meaning of Section 27A of the Securities Act of
1933, as amended (the Securities Act), and
Section 21E of the Exchange Act. All statements other than
statements of historical fact are forward-looking
statements for purposes of federal and state securities
laws, including any projections of earnings, revenue or other
financial items; any statements of the plans, strategies and
objectives of management for future operations; any statements
concerning proposed new services or developments; any statements
regarding future economic conditions or performance; any
statements of belief; and any statements of assumptions
underlying any of the foregoing. Forward-looking statements may
include the words may, will,
estimate, intend, continue,
believe, expect or
anticipate and other similar words.
Although we believe that the expectations reflected in any of
our forward-looking statements are reasonable, actual results
could differ materially from those projected or assumed in any
of our forward-looking statements. Our future financial
condition and results of operations, as well as any
forward-looking statements, are subject to change and to
inherent risks and uncertainties, such as those disclosed in
this document. Important factors that could cause our actual
results, performance and achievements, or industry results to
differ materially from estimates or projections contained in our
forward-looking statements include, among others, the
following:
|
|
|
|
|
our relationships with, and our ability to influence the actions
of, our distributors;
|
|
|
|
adverse publicity associated with our products or network
marketing organization;
|
|
|
|
uncertainties relating to interpretation and enforcement of
recently enacted legislation in China governing direct selling;
|
|
|
|
adverse changes in the Chinese economy, Chinese legal system or
Chinese governmental policies;
|
|
|
|
risk of improper action by our employees or international
distributors in violation of applicable law;
|
|
|
|
changing consumer preferences and demands;
|
|
|
|
the competitive nature of our business;
|
|
|
|
regulatory matters governing our products, including potential
governmental or regulatory actions concerning the safety or
efficacy of our products, and our network marketing program,
including the direct selling market within which we operate;
|
|
|
|
risks associated with operating internationally, including
foreign exchange risks;
|
|
|
|
our dependence on increased penetration of existing markets;
|
|
|
|
contractual limitations on our ability to expand our business;
|
38
|
|
|
|
|
our reliance on our information technology infrastructure and
outside manufacturers;
|
|
|
|
the sufficiency of trademarks and other intellectual property
rights;
|
|
|
|
product concentration;
|
|
|
|
our reliance on our management team;
|
|
|
|
uncertainties relating to the application of transfer pricing,
duties and similar tax regulations;
|
|
|
|
taxation relating to our distributors; and
|
|
|
|
product liability claims.
|
Additional factors that could cause actual results to differ
materially from our forward-looking statements are set forth in
this Quarterly Report on
Form 10-Q,
including under the heading Risk Factors,
Managements Discussion and Analysis of Financial
Condition and Results of Operations and in our Financial
Statements and the related notes.
Forward-looking statements in this Quarterly Report on
Form 10-Q
speak only as of the date hereof, and forward looking statements
in documents attached are incorporated by reference and speak
only as of the date of those documents. The Company does not
undertake any obligation to update or release any revisions to
any forward-looking statement or to report any events or
circumstances after the date hereof or to reflect the occurrence
of unanticipated events, except as required by law.
PART II.
OTHER INFORMATION
|
|
Item 1.
|
LEGAL
PROCEEDINGS
|
See discussion under Note 5 in the Notes to the Condensed
Consolidated Financial Statements included in Item 1 of
this report.
Our
failure to establish and maintain distributor relationships for
any reason could negatively impact sales of our products and
harm our financial condition and operating
results.
We distribute our products exclusively through over one million
independent distributors, and we depend upon them directly for
substantially all of our sales. To increase our revenue, we must
increase the number of, or the productivity of, our
distributors. Accordingly, our success depends in significant
part upon our ability to recruit, retain and motivate a large
base of distributors. There is a high rate of turnover among our
distributors, a characteristic of the network marketing
business. The loss of a significant number of distributors for
any reason could negatively impact sales of our products and
could impair our ability to attract new distributors. In our
efforts to attract and retain distributors, we compete with
other network marketing organizations, including those in the
weight management product, dietary and nutritional supplement
and personal care and cosmetic product industries. Our operating
results could be harmed if our existing and new business
opportunities and products do not generate sufficient interest
to retain existing distributors and attract new distributors.
In light of the high
year-over-year
rate of turnover in our distributor base, we have our
supervisors re-qualify annually in order to help us maintain a
more accurate count of their numbers. For the latest twelve
month re-qualification period ending January 2006, 41.5% of our
supervisors re-qualified. Distributors who purchase our product
for personal consumption or for short-term income goals may stay
with us for several months to one year. Supervisors who have
committed time and effort to build a sales organization will
generally stay for longer periods. Distributors have highly
variable levels of training, skills and capabilities. The
turnover rate of our distributors, and our operating results,
can be adversely impacted if we, and our senior distributor
leadership, do not provide the necessary mentoring, training and
business support tools for new distributors to become successful
sales people in a short period of time.
39
We estimate that, of our over one million independent
distributors, we had approximately 244,000 supervisors after
re-qualifications for the twelve months period ended January
2006. These supervisors, together with their downline sales
organizations, account for substantially all of our revenues.
Our distributors, including our supervisors, may voluntarily
terminate their distributor agreements with us at any time. The
loss of a group of leading supervisors, together with their
downline sales organizations, or the loss of a significant
number of distributors for any reason, could negatively impact
sales of our products, impair our ability to attract new
distributors and harm our financial condition and operating
results.
Since
we cannot exert the same level of influence or control over our
independent distributors as we could were they our own
employees, our distributors could fail to comply with our
distributor policies and procedures, which could result in
claims against us that could harm our financial condition and
operating results.
Our distributors are independent contractors and, accordingly,
we are not in a position to directly provide the same direction,
motivation and oversight as we would if distributors were our
own employees. As a result, there can be no assurance that our
distributors will participate in our marketing strategies or
plans, accept our introduction of new products, or comply with
our distributor policies and procedures.
Extensive federal, state and local laws regulate our business,
our products and our network marketing program. Because we have
expanded into foreign countries, our policies and procedures for
our independent distributors differ due to the different legal
requirements of each country in which we do business. While we
have implemented distributor policies and procedures designed to
govern distributor conduct and to protect the goodwill
associated with Herbalife trademarks and tradenames, it can be
difficult to enforce these policies and procedures because of
the large number of distributors and their independent status.
Violations by our independent distributors of applicable law or
of our policies and procedures in dealing with customers could
reflect negatively on our products and operations and harm our
business reputation. In addition, it is possible that a court
could hold us civilly or criminally accountable based on
vicarious liability because of the actions of our independent
distributors. If any of these events occur, the value of an
investment in our common shares could be impaired. For example,
in Mey v. Herbalife International, et al, the
plaintiff seeks to hold the Company vicariously liable for
actions of certain of its distributors, each of whom is an
independent contractor. While the Company vigorously denies such
distributors were acting as agents of the Company, and although
the court specifically did not rule on the question of vicarious
liability, on April 21, 2006 it did grant the
plaintiffs motion to certify the case as a class action.
We believe that we have meritorious defenses and will continue
to vigorously defend this lawsuit.
Adverse
publicity associated with our products, ingredients or network
marketing program, or those of similar companies, could harm our
financial condition and operating results.
The size of our distribution force and the results of our
operations may be significantly affected by the publics
perception of our Company and similar companies. This perception
is dependent upon opinions concerning:
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the safety and quality of our products and ingredients;
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the safety and quality of similar products and ingredients
distributed by other companies;
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our distributors;
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our network marketing program; and
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the direct selling business generally.
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Adverse publicity concerning any actual or purported failure of
our Company or our independent distributors to comply with
applicable laws and regulations regarding product claims and
advertising, good manufacturing practices, the regulation of our
network marketing program, the licensing of our products for
sale in our target markets or other aspects of our business,
whether or not resulting in enforcement actions or the
imposition of penalties, could have an adverse effect on the
goodwill of our Company and could negatively affect our ability
to attract, motivate and retain distributors, which would
negatively impact our ability to generate revenue. We cannot
40
ensure that all distributors will comply with applicable legal
requirements relating to the advertising, labeling, licensing or
distribution of our products.
In addition, our distributors and consumers
perception of the safety and quality of our products and
ingredients as well as similar products and ingredients
distributed by other companies can be significantly influenced
by national media attention, publicized scientific research or
findings, widespread product liability claims and other
publicity concerning our products or ingredients or similar
products and ingredients distributed by other companies. Adverse
publicity, whether or not accurate or resulting from
consumers use or misuse of our products, that associates
consumption of our products or ingredients or any similar
products or ingredients with illness or other adverse effects,
questions the benefits of our or similar products or claims that
any such products are ineffective, inappropriately labeled or
have inaccurate instructions as to their use, could negatively
impact our reputation or the market demand for our products.
Adverse publicity relating to us, our products or our
operations, including our network marketing program or the
attractiveness or viability of the financial opportunities
provided thereby, has had, and could again have, a negative
effect on our ability to attract, motivate and retain
distributors. In the mid-1980s, our products and marketing
program became the subject of regulatory scrutiny in the United
States, resulting in large part from claims and representations
made about our products by our independent distributors,
including impermissible therapeutic claims. The resulting
adverse publicity caused a rapid, substantial loss of
distributors in the United States and a corresponding reduction
in sales beginning in 1985. We expect that negative publicity
will, from time to time, continue to negatively impact our
business in particular markets.
Our
failure to appropriately respond to changing consumer
preferences and demand for new products or product enhancements
could significantly harm our distributor and customer
relationships and product sales and harm our financial condition
and operating results and cause the loss or reduction in the
value of your investment in our common shares.
Our business is subject to changing consumer trends and
preferences, especially with respect to weight management
products. Our continued success depends in part on our ability
to anticipate and respond to these changes, and we may not
respond in a timely or commercially appropriate manner to such
changes. Furthermore, the nutritional supplement industry is
characterized by rapid and frequent changes in demand for
products and new product introductions and enhancements. Our
failure to accurately predict these trends could negatively
impact consumer opinion of our products, which in turn could
harm our customer and distributor relationships and cause the
loss of sales. The success of our new product offerings and
enhancements depends upon a number of factors, including our
ability to:
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accurately anticipate customer needs;
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innovate and develop new products or product enhancements that
meet these needs;
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successfully commercialize new products or product enhancements
in a timely manner;
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price our products competitively;
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manufacture and deliver our products in sufficient volumes and
in a timely manner; and
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differentiate our product offerings from those of our
competitors.
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If we do not introduce new products or make enhancements to meet
the changing needs of our customers in a timely manner, some of
our products could be rendered obsolete, which could negatively
impact our revenues, financial condition and operating results.
Due to
the high level of competition in our industry, we might fail to
retain our customers and distributors, which would harm our
financial condition and operating results.
The business of marketing weight management and nutrition
products is highly competitive and sensitive to the introduction
of new products or weight management plans, including various
prescription drugs, which may rapidly capture a significant
share of the market. These market segments include numerous
manufacturers,
41
distributors, marketers, retailers and physicians that actively
compete for the business of consumers both in the United States
and abroad. In addition, we anticipate that we will be subject
to increasing competition in the future from sellers that
utilize electronic commerce. Some of these competitors have
longer operating histories, significantly greater financial,
technical, product development, marketing and sales resources,
greater name recognition, larger established customer bases and
better-developed distribution channels than we do. Our present
or future competitors may be able to develop products that are
comparable or superior to those we offer, adapt more quickly
than we do to new technologies, evolving industry trends and
standards or customer requirements, or devote greater resources
to the development, promotion and sale of their products than we
do. For example, if our competitors develop other diet or weight
loss treatments that prove to be more effective than our
products, demand for our products could be reduced. Accordingly,
we may not be able to compete effectively in our markets and
competition may intensify.
We are also subject to significant competition for the
recruitment of distributors from other network marketing
organizations, including those that market weight management
products, dietary and nutritional supplements and personal care
products as well as other types of products. We compete for
global customers and distributors with regard to weight
management, nutritional supplement and personal care products.
Our competitors include both direct selling companies such as
NuSkin Enterprises, Natures Sunshine, Alticor/Amway,
Melaleuca, Avon Products, Oriflame and Mary Kay, as well as
retail establishments such as Weight Watchers, Jenny Craig,
General Nutrition Centers, Wal-Mart and retail pharmacies. In
addition, because the industry in which we operate is not
particularly capital intensive or otherwise subject to high
barriers to entry, it is relatively easy for new competitors to
emerge who will compete with us for our distributors and
customers. In addition, the fact that our distributors may
easily enter and exit our network marketing program contributes
to the level of competition that we face. For example, a
distributor can enter or exit our network marketing system with
relative ease at any time without facing a significant
investment or loss of capital because (1) we have a low
upfront financial cost (generally $50 to $75) to become a
Herbalife distributor, (2) we do not require any specific
amount of time to work as a distributor, (3) we do not
insist on any special training to be a distributor and
(4) we do not prohibit a new distributor from working with
another company. Our ability to remain competitive therefore
depends, in significant part, on our success in recruiting and
retaining distributors through an attractive compensation plan,
the maintenance of an attractive product portfolio and other
incentives. We cannot ensure that our programs for recruitment
and retention of distributors will be successful, and if they
are not, our financial condition and operating results would be
harmed.
We are
affected by extensive laws, governmental regulations,
administrative determinations, court decisions and similar
constraints both domestically and abroad and our failure or our
distributors failure to comply with these restraints could
lead to the imposition of significant penalties or claims, which
could harm our financial condition and operating
results.
In both domestic and foreign markets, the formulation,
manufacturing, packaging, labeling, distribution, importation,
exportation, licensing, sale and storage of our products are
affected by extensive laws, governmental regulations,
administrative determinations, court decisions and similar
constraints. Such laws, regulations and other constraints may
exist at the federal, state or local levels in the United States
and at all levels of government in foreign jurisdictions. There
can be no assurance that we or our distributors are in
compliance with all of these regulations. Our failure or our
distributors failure to comply with these regulations or
new regulations could lead to the imposition of significant
penalties or claims and could negatively impact our business. In
addition, the adoption of new regulations or changes in the
interpretations of existing regulations may result in
significant compliance costs or discontinuation of product sales
and may negatively impact the marketing of our products,
resulting in significant loss of sales revenues.
On April 12, 2006 the Federal Trade Commission issued a
notice of proposed rulemaking which, if implemented, will
regulate all sellers of business opportunities in
the United States. The proposed rule would, among other things,
require all sellers of business opportunities, which would
likely include the Company, to (i) implement a seven day
waiting period before entering into an agreement with a
prospective business opportunity purchaser, (ii) provide
all prospective business opportunity purchasers with substantial
information in writing at the beginning of the waiting period
regarding the business opportunity, including information
relating to: representations made as to the earnings experience
of other business opportunity purchasers, the names and
telephone
42
numbers of recent purchasers in their geographic area,
cancellation or refund policies and requests within the prior
two years, certain legal actions against the company, its
affiliated companies and company officers, directors, sales
managers and certain others. The Company, other direct selling
companies, the Direct Selling Association, and other interested
parties have filed over 17,000 comments with the FTC that are
publicly available regarding the proposed rule through the
FTCs website at
http://www.ftc.gov/os/comments/businessopprule/index.htm.
The Company, the DSA, other direct selling companies, and other
interested parties also filed rebuttal comments with
the FTC in September, 2006. Based on information currently
available, we anticipate that the final rule may require several
years to become final and effective, and may differ
substantially from the rule as originally proposed. Nevertheless
the proposed rule, if implemented in its original form, would
negatively impact our U.S. business.
Governmental regulations in countries where we plan to commence
or expand operations may prevent or delay entry into those
markets. In addition, our ability to sustain satisfactory levels
of sales in our markets is dependent in significant part on our
ability to introduce additional products into such markets.
However, governmental regulations in our markets, both domestic
and international, can delay or prevent the introduction, or
require the reformulation or withdrawal, of certain of our
products. For example, during the third quarter of 1995, we
received inquiries from certain governmental agencies within
Germany and Portugal regarding our product,
Thermojetics®
Instant Herbal Beverage, relating to the caffeine content
of the product and the status of the product as an instant
tea, which was disfavored by regulators, versus a
beverage. Although we initially suspended the
product sale in Germany and Portugal at the request of the
regulators, we successfully reintroduced it once regulatory
issues were satisfactorily resolved. Any such regulatory action,
whether or not it results in a final determination adverse to
us, could create negative publicity, with detrimental effects on
the motivation and recruitment of distributors and,
consequently, on sales.
On March 7, 2003, the FDA proposed a new regulation to
require current Good Manufacturing Practices (cGMPs) affecting
the manufacture, packing, and holding of dietary supplements.
The proposed regulation would establish standards to ensure that
dietary supplements and dietary ingredients are not adulterated
with contaminants or impurities, and are labeled to accurately
reflect the active ingredients and other ingredients in the
products. It also includes proposed requirements for designing
and constructing physical plants, establishing quality control
procedures, and testing manufactured dietary ingredients and
dietary supplements, as well as proposed requirements for
maintaining records and for handling consumer complaints related
to cGMPs. We are evaluating this proposal with respect to its
potential impact upon the various contract manufacturers that we
use to manufacture our products, some of whom might not meet the
new standards. It is important to note that the proposed
regulation, in an effort to limit disruption, includes a
three-year phase-in for small businesses of any final regulation
that is issued. At such time as the FDA issues the final cGMP
regulation we expect that some of our smaller contract
manufacturers will not be fully impacted by the proposed
regulation for up to three years. However, the proposed
regulation can be expected to result in additional costs and
possibly the need to seek alternate suppliers.
Our
network marketing program could be found to be not in compliance
with current or newly adopted laws or regulations in one or more
markets, which could prevent us from conducting our business in
these markets and harm our financial condition and operating
results.
Our network marketing program is subject to a number of federal
and state regulations administered by the Federal Trade
Commission and various state agencies in the United States as
well as regulations on direct selling in foreign markets
administered by foreign agencies. We are subject to the risk
that, in one or more markets, our network marketing program
could be found not to be in compliance with applicable law or
regulations. Regulations applicable to network marketing
organizations generally are directed at preventing fraudulent or
deceptive schemes, often referred to as pyramid or
chain sales schemes, by ensuring that product sales
ultimately are made to consumers and that advancement within an
organization is based on sales of the organizations
products rather than investments in the organization or other
non-retail sales-related criteria. The regulatory requirements
concerning network marketing programs do not include
bright line rules and are inherently fact-based, and
thus, even in jurisdictions where we believe that our network
marketing program is in full compliance with applicable laws or
regulations governing network marketing systems, we are subject
to the risk that these laws or regulations or the enforcement or
interpretation of these laws and regulations by governmental
agencies or courts can change. The
43
failure of our network marketing program to comply with current
or newly adopted regulations could negatively impact our
business in a particular market or in general.
We are also subject to the risk of private party challenges to
the legality of our network marketing program. The multi-level
marketing programs of other companies have been successfully
challenged in the past, and in a current lawsuit, allegations
have been made challenging the legality of our network marketing
program in Belgium. Test Ankoop-Test Achat, a Belgian consumer
protection organization, sued Herbalife International Belgium,
S.V., or HIB, on August 26, 2004, alleging that HIB
violated Article 84 of the Belgian Fair Trade Practices Act
by engaging in pyramid selling, i.e., establishing a
network of professional or non-professional sales people who
hope to make a profit more through the expansion of that network
rather than through the sale of products to end-consumers. The
plaintiff is seeking a payment of 25,000 (equal to
approximately $32,000 as of September 30, 2006) per
purported violation as well as costs of the trial. For the year
ended December 31, 2005, our net sales in Belgium were
approximately $15.9 million. Currently, the lawsuit is in
the pleading stage. The plaintiffs filed their initial brief on
September 27, 2005. We filed a reply brief on May 9,
2006. There is no date yet for the oral hearings. An adverse
judicial determination with respect to our network marketing
program, or in proceedings not involving us directly but which
challenge the legality of multi-level marketing systems, in
Belgium or in any other market in which we operate, could
negatively impact our business.
A
substantial portion of our business is conducted in foreign
markets, exposing us to the risks of trade or foreign exchange
restrictions, increased tariffs, foreign currency fluctuations
and similar risks associated with foreign
operations.
Approximately 82% of our net sales for the three and nine months
ended September 30, 2006, were generated outside the United
States, exposing our business to risks associated with foreign
operations. For example, a foreign government may impose trade
or foreign exchange restrictions or increased tariffs, which
could negatively impact our operations. We are also exposed to
risks associated with foreign currency fluctuations. For
instance, purchases from suppliers are generally made in
U.S. dollars while sales to distributors are generally made
in local currencies. Accordingly, strengthening of the
U.S. dollar versus a foreign currency could have a negative
impact on us. Although we engage in transactions to protect
against risks associated with foreign currency fluctuations, we
cannot be certain any hedging activity will effectively reduce
our exchange rate exposure. Our operations in some markets also
may be adversely affected by political, economic and social
instability in foreign countries. As we continue to focus on
expanding our existing international operations, these and other
risks associated with international operations may increase,
which could harm our financial condition and operating results.
Our
expansion in China is subject to general, as well as
industry-specific, economic, political and legal developments in
China, and requires that we utilize a different business model
from that we use elsewhere in the world.
Our expansion of operations into China is subject to risks and
uncertainties related to general economic, political and legal
developments in China, among other things. The Chinese
government exercises significant control over the Chinese
economy, including but not limited to controlling capital
investments, allocating resources, setting monetary policy,
controlling foreign exchange and monitoring foreign exchange
rates, implementing and overseeing tax regulations and providing
preferential treatment to certain industry segments or
companies. Accordingly, any adverse change in the Chinese
economy, the Chinese legal system or Chinese governmental,
economic or other policies could have a material adverse effect
on our business in China.
In August 2005, China published regulations governing direct
selling (effective December 1, 2005) and prohibiting
pyramid promotional schemes (effective November 1,
2005) and a number of administrative methods and
proclamations were issued in September 2005 and in September
2006. These regulations will require us to use a business model
different from that which we offer in other markets. To allow us
to operate under these regulations, we have created and
introduced a model specifically for China. In China, we have
Company-operated retail stores that sell through employed sales
management personnel to customers and preferred customers. We
provide training and certification procedures for sales
personnel in China. We also have non-employee sales
representatives who sell through our retail stores. These
features are not common to the business model we employ
elsewhere in the world. The direct selling regulations require
us to apply for various approvals to conduct a direct selling
enterprise in
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China. While direct selling licenses are centrally issued, such
licenses are generally valid only in the jurisdictions within
which related approvals have been obtained. Such approvals are
generally awarded on local and provincial bases, and the
approval process requires involvement with multiple ministries
at each level. Our participation and conduct during the approval
process is guided not only by distinct Chinese practices and
customs, but by the applicable laws of the other jurisdictions
in which we operate our business, including the U.S., and our
internal code of ethics. Furthermore, we rely on certain key
personnel in China to assist us during the approval process, and
the loss of any such key personnel could delay or hinder our
ability to obtain licenses or related approvals. As such, there
can be no assurance that we will be able to obtain
direct-selling licenses, or obtain related approvals from any or
all of the localities or provinces in China that are important
to our business. Our inability to obtain or renew any or all of
the licenses or related approvals that are required for us to
operate in China would negatively impact our business.
Additionally, although certain regulations have been published,
others are pending, and there is uncertainty regarding the
interpretation and enforcement of such regulations. The
regulatory environment in China is evolving, and officials in
the Chinese government often exercise discretion in deciding how
to interpret and apply regulations. As such, we have worked
closely with governmental agencies and advisors in interpreting
both the existing regulations and the new regulations. However,
we cannot be certain that our business model will be deemed by
national or local Chinese regulatory authorities to be compliant
with these or other more general regulations. In the past, the
Chinese government has rigorously monitored the direct selling
market in China, and has taken serious action against companies
that the government believed were engaging in activities they
regarded to be in violation of applicable law, including
shutting down their businesses and imposing substantial fines.
As a result, there can be no guarantee that the Chinese
governments interpretation and application of the existing
and new regulations will not negatively impact our business in
China, result in regulatory investigations or lead to fines or
penalties.
Chinese regulations prevent persons who are not Chinese
nationals from engaging in direct selling in China. We cannot
guarantee that any of our distributors living outside of China
or any of our independent sales representatives or employed
sales management personnel in China will not engage in
activities that violate our policies in this market and
therefore result in regulatory action and adverse publicity.
As we expand operations in China, we anticipate that certain
distributors will switch their focus from their home markets to
that of China. As a result, we may see reduced distributor focus
in Hong Kong, Taiwan and possibly other of our markets as
Chinese nationals that are distributors shift their attention to
China, and a resultant reduction in distributor growth,
leadership and revenue in these other countries.
If our operations in China are successful, we may experience
rapid growth in China, and there can be no assurances that we
will be able to successfully manage rapid expansion of
manufacturing operations and a rapidly growing and dynamic sales
force. There also can be no assurances that we will not
experience difficulties in dealing with or taking employment
related actions (such as hiring, terminations and salary
administration, including social benefit payments) with respect
to our employed sales representatives, particularly given the
highly regulated nature of the employment relationship in China.
If we are unable to effectively manage such growth and expansion
of our retail stores, manufacturing operations or our employees,
our government relations may be compromised and our operations
in China may be harmed.
Our China business model, particularly with regard to sales
management responsibilities and remuneration, differs from our
traditional business model. There is a risk that such changes
and transitions may not be understood by our distributors or
employees, may be viewed negatively by our distributors or
employees, or may not be correctly utilized by our distributors
or employees. If that is the case, our business could be
negatively impacted.
If we
fail to further penetrate existing markets or successfully
expand our business into new markets, then the growth in sales
of our products, along with our operating results, could be
negatively impacted and investors could lose all or part of
their investment in our common shares.
The success of our business is to a large extent contingent on
our ability to continue to grow by entering new markets and
further penetrating existing markets. Our ability to further
penetrate existing markets in which we compete or to
successfully expand our business into additional countries in
Eastern Europe, Southeast Asia, South
45
America or elsewhere, to the extent we believe that we have
identified attractive geographic expansion opportunities in the
future, is subject to numerous factors, many of which are out of
our control.
In addition, government regulations in both our domestic and
international markets can delay or prevent the introduction, or
require the reformulation or withdrawal, of some of our
products, which could negatively impact our business, financial
condition and results of operations. Also, our ability to
increase market penetration in certain countries may be limited
by the finite number of persons in a given country inclined to
pursue a direct selling business opportunity. Moreover, our
growth will depend upon improved training and other activities
that enhance distributor retention in our markets. While we have
recently experienced significant growth in certain of our
international markets, such as Mexico, we cannot assure you that
such growth levels will continue in the immediate or long term
future. Furthermore, our efforts to support growth in such
international markets could be hampered to the extent that our
infrastructure in such markets is deficient when compared to our
more developed markets, such as the U.S. Therefore, we cannot
assure you that our general efforts to increase our market
penetration and distributor retention in existing markets will
be successful. Thus, if we are unable to continue to expand into
new markets or further penetrate existing markets, our operating
results would suffer and the market value of our common shares
could decline.
Our
contractual obligation to sell our products only through our
Herbalife distributor network and to refrain from changing
certain aspects of our marketing plan may limit our
growth.
In connection with the Acquisition, we entered into an agreement
with our distributors that provided assurances that the change
in ownership of our Company would not negatively affect certain
aspects of their business. Through this agreement, we have
committed to our distributors that we will not sell Herbalife
products through any distribution channel other than our network
of independent Herbalife distributors. Thus, we are
contractually prohibited from expanding our business by selling
Herbalife products through other distribution channels that may
be available to our competitors, such as over the internet,
through wholesale sales, by establishing retail stores or
through mail order systems. Since this is an ongoing or
open-ended commitment, there can be no assurance that we will be
able to take advantage of innovative new distribution channels
that are developed in the future.
In addition, our agreement with our distributors provides that
we will not change certain aspects of our marketing plan without
the consent of a specified percentage of our distributors. For
example, our agreement with our distributors provides that we
may increase, but not decrease, the discount percentages
available to our distributors for the purchase of products or
the applicable royalty override percentages, including roll-ups,
and production and other bonus percentages available to our
distributors at various qualification levels within our
distributor hierarchy. We may not modify the eligibility or
qualification criteria for these discounts, royalty overrides
and production and other bonuses unless we do so in a manner to
make eligibility
and/or
qualification easier than under the applicable criteria in
effect as of the date of the agreement. Our agreement with our
distributors further provides that we may not vary the criteria
for qualification for each distributor tier within our
distributor hierarchy, unless we do so in such a way so as to
make qualification easier.
Although we reserved the right to make these changes to our
marketing plan without the consent of our distributors in the
event that changes are required by applicable law or are
necessary in our reasonable business judgment to account for
specific local market or currency conditions to achieve a
reasonable profit on operations, there can be no assurance that
our agreement with our distributors will not restrict our
ability to adapt our marketing plan to the evolving requirements
of the markets in which we operate. As a result, our growth, and
the potential of growth in the value of your investment in our
common shares, may be limited.
We
depend on the integrity and reliability of our information
technology infrastructure, and any related inadequacies may
result in substantial interruptions to our
business.
Our ability to timely provide products to our distributors and
their customers, and services to our distributors, depends on
the integrity of our information technology system, which we are
in the process of upgrading, including the reliability of
software and services supplied by our vendors. We are
implementing an Oracle enterprise-wide technology solution, a
scalable and stable open architecture platform, to enhance our
and our distributors efficiency
46
and productivity. In addition, we are upgrading our
internet-based marketing and distributor services platform,
MyHerbalife.com.
The most important aspect of our information technology
infrastructure is the system through which we record and track
distributor sales, volume points, royalty overrides, bonuses and
other incentives. We have encountered, and may encounter in the
future, errors in our software or our enterprise network, or
inadequacies in the software and services supplied by our
vendors, although to date none of these errors or inadequacies
has had a meaningful negative impact on our business. Any such
errors or inadequacies that we may encounter in the future may
result in substantial interruptions to our services and may
damage our relationships with, or cause us to lose, our
distributors if the errors or inadequacies impair our ability to
track sales and pay royalty overrides, bonuses and other
incentives, which would harm our financial condition and
operating results. Such errors may be expensive or difficult to
correct in a timely manner, and we may have little or no control
over whether any inadequacies in software or services supplied
to us by third parties are corrected, if at all.
Since
we rely on independent third parties for the manufacture and
supply of our products, if these third parties fail to reliably
supply products to us at required levels of quality, then our
financial condition and operating results would be
harmed.
All of our products are manufactured by outside companies,
except for a small amount of products manufactured in our own
manufacturing facility in China. We cannot assure you that our
outside manufacturers will continue to reliably supply products
to us at the levels of quality, or the quantities, we require,
especially after the FDA imposes cGMP regulations.
Our supply contracts generally have a two-year term. Except for
force majeure events, such as natural disasters and other acts
of God, and non-performance by Herbalife, our manufacturers
generally cannot unilaterally terminate these contracts. These
contracts can generally be extended by us at the end of the
relevant time period and we have exercised this right in the
past. Globally we have over 40 suppliers of our products. For
our major products, we have both primary and secondary
suppliers. Our major suppliers include Natures Bounty for
protein powders, Fine Foods (Italy) for protein powders and
nutritional supplements, PharmaChem Labs for teas and
Niteworkstm
and JB Labs for fiber. In the event any of our
third-party manufacturers were to become unable or unwilling to
continue to provide us with products in required volumes and at
suitable quality levels, we would be required to identify and
obtain acceptable replacement manufacturing sources. There is no
assurance that we would be able to obtain alternative
manufacturing sources on a timely basis. An extended
interruption in the supply of products would result in the loss
of sales. In addition, any actual or perceived degradation of
product quality as a result of reliance on third party
manufacturers may have an adverse effect on sales or result in
increased product returns and buybacks.
If we
fail to protect our trademarks and tradenames, then our ability
to compete could be negatively affected, which would harm our
financial condition and operating results.
The market for our products depends to a significant extent upon
the goodwill associated with our trademark and tradenames. We
own, or have licenses to use, the material trademark and trade
name rights used in connection with the packaging, marketing and
distribution of our products in the markets where those products
are sold. Therefore, trademark and trade name protection is
important to our business. Although most of our trademarks are
registered in the United States and in certain foreign countries
in which we operate, we may not be successful in asserting
trademark or trade name protection. In addition, the laws of
certain foreign countries may not protect our intellectual
property rights to the same extent as the laws of the United
States. The loss or infringement of our trademarks or tradenames
could impair the goodwill associated with our brands and harm
our reputation, which would harm our financial condition and
operating results.
Unlike in most of the other markets in which we operate, limited
protection of intellectual property is available under Chinese
law. Accordingly, we face an increased risk in China that
unauthorized parties may attempt to copy or otherwise obtain or
use our trademarks, copyrights, product formulations or other
intellectual property. Further, since Chinese commercial law is
relatively undeveloped, we may have limited legal recourse in
the event we
47
encounter significant difficulties with intellectual property
theft or infringement. As a result, we cannot assure you that we
will be able to adequately protect our product formulations or
other intellectual property.
If our
distributors fail to comply with labeling laws, then our
financial condition and operating results would be
harmed.
Although the physical labeling of our products is not within the
control of our independent distributors, our distributors must
nevertheless advertise our products in compliance with the
extensive regulations that exist in certain jurisdictions, such
as the United States, which considers product advertising to be
labeling for regulatory purposes.
Our products are sold principally as foods, dietary supplements
and cosmetics and are subject to rigorous FDA and related legal
regimens limiting the types of therapeutic claims that can be
made for our products. The treatment or cure of disease, for
example, is not a permitted claim for these products. While we
train and attempt to monitor our distributors marketing
materials, we cannot ensure that all such materials comply with
bans on therapeutic claims. If our distributors fail to comply
with these restrictions, then we and our distributors could be
subjected to claims, financial penalties, mandatory product
recalls or relabeling requirements, which could harm our
financial condition and operating results. Although we expect
that our responsibility for the actions of our independent
distributors in such an instance would be dependent on a
determination that we either controlled or condoned a
noncompliant advertising practice, there can be no assurance
that we could not be held vicariously responsible for the
actions of our independent distributors.
If our
intellectual property is not adequate to provide us with a
competitive advantage or to prevent competitors from replicating
our products, or if we infringe the intellectual property rights
of others, then our financial condition and operating results
would be harmed.
Our future success and ability to compete depend upon our
ability to timely produce innovative products and product
enhancements that motivate our distributors and customers, which
we attempt to protect under a combination of copyright,
trademark and trade secret laws, confidentiality procedures and
contractual provisions. However, our products are generally not
patented domestically or abroad, and the legal protections
afforded by our common law and contractual proprietary rights in
our products provide only limited protection and may be
time-consuming and expensive to enforce
and/or
maintain. Further, despite our efforts, we may be unable to
prevent third parties from infringing upon or misappropriating
our proprietary rights or from independently developing
non-infringing products that are competitive with, equivalent to
and/or
superior to our products.
Additionally, third parties may claim that products we have
independently developed infringe upon their intellectual
property rights. For example, in two related lawsuits that are
currently pending in California, Unither Pharma, Inc. and others
are alleging that sales by Herbalife International of
(1) its
Niteworkstm
and Prelox Blue products and (2) its former products
Womans Advantage with DHEA and Optimum Performance
infringe on patents that are licensed to or owned by those
parties, and are seeking unspecified damages, attorneys
fees and injunctive relief from the Company. Although we believe
that we have meritorious defenses to, and are vigorously
defending against, these allegations, there can be no assurance
that one or more of our products will not be found to infringe
upon the intellectual property rights of these parties or others.
Monitoring infringement
and/or
misappropriation of intellectual property can be difficult and
expensive, and we may not be able to detect any infringement or
misappropriation of our proprietary rights. Even if we do detect
infringement or misappropriation of our proprietary rights,
litigation to enforce these rights could cause us to divert
financial and other resources away from our business operations.
Further, the laws of some foreign countries do not protect our
proprietary rights to the same extent as do the laws of the
United States.
Since
one of our products constitutes a significant portion of our
retail sales, significant decreases in consumer demand for this
product or our failure to produce a suitable replacement should
we cease offering it would harm our financial condition and
operating results.
Our Formula 1 meal replacement product constitutes a significant
portion of our sales, accounting for approximately 27%, 22%, and
23% of retail sales for the fiscal years ended December 31,
2005, 2004 and 2003,
48
respectively. If consumer demand for this product decreases
significantly or we cease offering this product without a
suitable replacement, then our financial condition and operating
results would be harmed.
If we
lose the services of members of our senior management team, then
our financial condition and operating results would be
harmed.
We depend on the continued services of our Chief Executive
Officer, Michael O. Johnson, and our current senior management
team and the relationships that they have developed with our
senior distributor leadership, especially in light of the high
level of turnover in our former senior management team, and the
resulting need to reestablish good working relationships with
our senior distributor leadership, after the death of our
founder in May of 2000. Although we have entered into employment
agreements with many members of our senior management team, and
do not believe that any of them are planning to leave or retire
in the near term, we cannot assure you that our senior managers
will remain with us. The loss or departure of any member of our
senior management team could negatively impact our distributor
relations and operating results. If any of these executives do
not remain with us, our business could suffer. The loss of key
personnel, including our regional managers in Mexico and Central
America, Greater China, Brazil, North America, South America and
Southeast Asia, EMEA, and North Asia, could negatively impact
our ability to implement our business strategy, and our
continued success will also be dependent on our ability to
retain existing, and attract additional, qualified personnel to
meet our needs. We currently do not maintain key
person life insurance with respect to our senior
management team.
The
covenants in our existing indebtedness limit our discretion with
respect to certain business matters, which could limit our
ability to pursue certain strategic objectives and in turn harm
our financial condition and operating results.
Our credit facility contains numerous financial and operating
covenants that restrict our and our subsidiaries ability
to, among other things:
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pay dividends, redeem share capital or capital stock and make
other restricted payments and investments;
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incur additional debt or issue preferred shares;
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allow the imposition of dividend or other distribution
restrictions on our subsidiaries;
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create liens on our and our subsidiaries assets;
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engage in transactions with affiliates;
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guarantee other indebtedness; and
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merge, consolidate or sell all or substantially all of our
assets and the assets of our subsidiaries.
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In addition, our credit facility requires us to meet certain
financial ratios and financial conditions. Our ability to comply
with these covenants may be affected by events beyond our
control, including prevailing economic, financial and industry
conditions. Failure to comply with these covenants could result
in a default causing all amounts to become due and payable under
our credit facility, which is secured by substantially all of
our assets, which the lenders thereunder could proceed to
foreclose against.
If we
do not comply with transfer pricing, customs duties, and similar
regulations, then we may be subjected to additional taxes,
duties, interest, and penalties in material amounts, which could
harm our financial condition and operating
results.
As a multinational corporation, in many countries including the
United States, we are subject to transfer pricing and other tax
regulations designed to ensure that our intercompany
transactions are consummated at prices that have not been
manipulated to produce a desired tax result, that appropriate
levels of income are reported as earned by our United States or
local entities, and that we are taxed appropriately on such
transactions. In addition, our operations are subject to
regulations designed to ensure that appropriate levels of
customs duties are assessed on the importation of our products.
We are currently subject to pending or proposed audits that are
at various levels of review, assessment or appeal in a number of
jurisdictions involving transfer pricing issues, income taxes,
customs
49
duties, value added taxes, withholding taxes, sales and use and
other taxes and related interest and penalties in material
amounts. In some circumstances, additional taxes, interest and
penalties have been assessed and we will be required to pay the
assessments or litigate to reverse the assessments. We have
reserved in the consolidated financial statements an amount that
we believe represents the most likely outcome of the resolution
of these disputes, but if we are incorrect in our assessment we
may have to pay the full amount asserted. Ultimate resolution of
these matters may take several years, and the outcome is
uncertain. If the United States Internal Revenue Service or the
taxing authorities of any other jurisdiction were to
successfully challenge our transfer pricing practices or our
positions regarding the payment of income taxes, customs duties,
value added taxes, withholding taxes, sales and use, and other
taxes, we could become subject to higher taxes and our earnings
would be adversely affected.
We may
be held responsible for certain taxes or assessments relating to
the activities of our distributors, which could harm our
financial condition and operating results.
Our distributors are subject to taxation, and in some instances,
legislation or governmental agencies impose an obligation on us
to collect taxes, such as value added taxes, and to maintain
appropriate records. In addition, we are subject to the risk in
some jurisdictions of being responsible for social security and
similar taxes with respect to our distributors. In the event
that local laws and regulations or the interpretation of local
laws and regulations change to require us to treat our
independent distributors as employees, or that our distributors
are deemed by local regulatory authorities in one or more of the
jurisdictions in which we operate to be our employees rather
than independent contractors under existing laws and
interpretations, we may be held responsible for social security
and related taxes in those jurisdictions, plus any related
assessments and penalties, which could harm our financial
condition and operating results.
We may
incur material product liability claims, which could increase
our costs and harm our financial condition and operating
results.
Our products consist of herbs, vitamins and minerals and other
ingredients that are classified as foods or dietary supplements
and are not subject to pre-market regulatory approval in the
United States. Our products could contain contaminated
substances, and some of our products contain innovative
ingredients that do not have long histories of human
consumption. We generally do not conduct or sponsor clinical
studies for our products and previously unknown adverse
reactions resulting from human consumption of these ingredients
could occur. As a marketer of dietary and nutritional
supplements and other products that are ingested by consumers or
applied to their bodies, we have been, and may again be,
subjected to various product liability claims, including that
the products contain contaminants, the products include
inadequate instructions as to their uses, or the products
include inadequate warnings concerning side effects and
interactions with other substances. It is possible that
widespread product liability claims could increase our costs,
and adversely affect our revenues and operating income.
Moreover, liability claims arising from a serious adverse event
may increase our costs through higher insurance premiums and
deductibles, and may make it more difficult to secure adequate
insurance coverage in the future. In addition, our product
liability insurance may fail to cover future product liability
claims, thereby requiring us to pay substantial monetary damages
and adversely affecting our business. Finally, given the higher
level of self-insured retentions that we have accepted under our
current product liability insurance policies, which are as high
as approximately $10 million, in certain cases we may be
subject to the full amount of liability associated with any
injuries, which could be substantial.
Several years ago, a number of states restricted the sale of
dietary supplements containing botanical sources of ephedrine
alkaloids and on February 6, 2004 the FDA banned the use of
such ephedrine alkaloids. Until late 2002 we had sold
Thermojetics®
original green herbal tablets,
Thermojetics®
green herbal tablets and
Thermojetics®
gold herbal tablets, all of which contained ephedrine alkaloids.
Accordingly, we run the risk of product liability claims related
to the ingestion of ephedrine alkaloids contained in those
products. Currently, we have been named as a defendant in
product liability lawsuits seeking to link the ingestion of
certain of the aforementioned products to subsequent alleged
medical problems suffered by plaintiffs. Although we believe
that we have meritorious defenses to the allegations contained
in these lawsuits, and are vigorously defending these claims,
there can be no assurance that we will prevail in our defense of
any or all of these matters.
50
A few
of our shareholders collectively exert significant influence
over us and have the power to cause the approval or rejection of
all shareholder actions and may take actions that conflict with
your interests.
As of February 1, 2006, affiliates of Whitney &
Co., LLC and Golden Gate Capital own approximately 41.5% of the
voting power of our share capital. Accordingly,
Whitney & Co., LLC and Golden Gate Capital collectively
will have the power to exert significant influence over us and
the approval or rejection of any matter on which the
shareholders may vote, including the election of directors,
amendment of our memorandum and articles of association and
approval of significant corporate transactions as well as our
management and policies. This influence over corporate actions
may also delay, deter or prevent transactions that would result
in a change of control. Moreover, Whitney & Co., LLC
and Golden Gate Capital may have interests that conflict with
yours.
We are
subject to, among other things, requirements regarding the
effectiveness of internal control over financial reporting. In
connection with these requirements, we conduct regular audits of
our business and operations. Our failure to identify or correct
deficiencies and areas of weakness in the course of these audits
could adversely affect our financial condition and results of
operations.
We are required to comply with various corporate governance and
financial reporting requirements under the Sarbanes-Oxley Act of
2002, as well as new rules and regulations adopted by the
Securities and Exchange Commission, the Public Company
Accounting Oversight Board and the New York Stock Exchange. In
particular, we are required to include management and auditor
reports on the effectiveness of internal controls over financial
reporting as part of our annual report on
Form 10-K
for the year ended December 31, 2006, pursuant to
Section 404 of the Sarbanes-Oxley Act. We expect to
continue to spend significant amounts of time and money on
compliance with these rules. Our failure to correct any noted
weaknesses in internal controls over financial reporting could
result in the disclosure of material weaknesses which could have
a material adverse effect upon the market value of our stock.
On a regular and on-going basis, we conduct audits through our
internal audit department of various aspects of our business and
operations. These internal audits are conducted to insure
compliance with our policies and to strengthen our operations
and related internal controls. The Audit Committee of our Board
of Directors regularly reviews the results of these internal
audits and, when appropriate, suggests remedial measures and
actions to correct noted deficiencies or strengthen areas of
weakness. There can be no assurance that these internal audits
will uncover all material deficiencies or areas of weakness in
our operations or internal controls. If left undetected and
uncorrected, such deficiencies and weaknesses could have a
material adverse effect on our financial condition and results
of operations.
From time to time, the results of these internal audits may
necessitate that we conduct further investigations into aspects
of our business or operations. At the time of the filing of this
Quarterly Report on
Form 10-Q,
one such investigation was pending. This investigation concerns
certain activities related to one of our foreign subsidiaries
and related matters, and may involve violations of applicable
law. The then pending review of this investigation necessitated
our filing of a request for extension on Form 12b-25 with the
Securities and Exchange Commission. While we currently believe
the likelihood is remote that the results of this investigation
will have a material adverse effect on our financial condition
or results of operations, no such assurances can be given at
this time. In addition, our business practices and operations
may periodically be investigated by one or more of the many
governmental authorities with jurisdiction over our worldwide
operations. In the event that these investigations produce
unfavorable results, we may be subjected to fines, penalties or
loss of licenses or permits needed to operate in certain
jurisdictions, any one of which could have a material adverse
effect on our financial condition or results of operations.
Holders
of our common shares may face difficulties in protecting their
interests because we are incorporated under Cayman Islands
law.
Our corporate affairs are governed by our amended and restated
memorandum and articles of association, and by the Companies Law
(2004 Revision) and the common law of the Cayman Islands. The
rights of our shareholders and the fiduciary responsibilities of
our directors under Cayman Islands law are not as clearly
established as under statutes or judicial precedent in existence
in jurisdictions in the United States. Therefore, shareholders
may have more difficulty in protecting their interests in the
face of actions by our management, directors or controlling
51
shareholders than would shareholders of a corporation
incorporated in a jurisdiction in the United States, due to the
comparatively less developed nature of Cayman Islands law in
this area.
Unlike many jurisdictions in the United States, Cayman Islands
law does not specifically provide for shareholder appraisal
rights on a merger or consolidation of a company. This may make
it more difficult for shareholders to assess the value of any
consideration they may receive in a merger or consolidation or
to require that the offer give shareholders additional
consideration if they believe the consideration offered is
insufficient.
Shareholders of Cayman Islands exempted companies such as
ourselves have no general rights under Cayman Islands law to
inspect corporate records and accounts or to obtain copies of
lists of our shareholders. Our directors have discretion under
our articles of association to determine whether or not, and
under what conditions, our corporate records may be inspected by
our shareholders, but are not obliged to make them available to
our shareholders. This may make it more difficult for you to
obtain the information needed to establish any facts necessary
for a shareholder motion or to solicit proxies from other
shareholders in connection with a proxy contest.
Subject to limited exceptions, under Cayman Islands law, a
minority shareholder may not bring a derivative action against
the board of directors. Maples and Calder, our Cayman Islands
counsel, has informed us that they are not aware of any reported
class action or derivative action having been brought in a
Cayman Islands court.
Provisions
of our articles of association and Cayman Islands corporate law
may impede a takeover or make it more difficult for shareholders
to change the direction or management of the Company, which
could adversely affect the value of our common shares and
provide shareholders with less input into the management of the
Company than they might otherwise have.
Our articles of association permit our board of directors to
issue preference shares from time to time, with such rights and
preferences as they consider appropriate. Our board of directors
could authorize the issuance of preference shares with terms and
conditions and under circumstances that could have an effect of
discouraging a takeover or other transaction.
In addition, our articles of association contain certain other
provisions which could have an effect of discouraging a takeover
or other transaction or preventing or making it more difficult
for shareholders to change the direction or management of our
Company, including a classified board, the inability of
shareholders to act by written consent, a limitation on the
ability of shareholders to call special meetings of shareholders
and advance notice provisions. As a result, our shareholders may
have less input into the management of our Company than they
might otherwise have if these provisions were not included in
our articles of association.
Unlike many jurisdictions in the United States, Cayman Islands
law does not provide for mergers as that expression is
understood under corporate law in the United States. However,
Cayman Islands law does have statutory provisions that provide
for the reconstruction and amalgamation of companies, which are
commonly referred to in the Cayman Islands as schemes of
arrangement. The procedural and legal requirements
necessary to consummate these transactions are more rigorous and
take longer to complete than the procedures typically required
to consummate a merger in the United States. Under Cayman
Islands law and practice, a scheme of arrangement in relation to
a solvent Cayman Islands company must be approved at a
shareholders meeting by each class of shareholders, in
each case, by a majority of the number of holders of each class
of a companys shares that are present and voting (either
in person or by proxy) at such a meeting, which holders must
also represent 75% in value of such class issued that are
present and voting (either in person or by proxy) at such
meeting (excluding the shares owned by the parties to the scheme
of arrangement).
The convening of these meetings and the terms of the
amalgamation must also be sanctioned by the Grand Court of the
Cayman Islands. Although there is no requirement to seek the
consent of the creditors of the parties involved in the scheme
of arrangement, the Grand Court typically seeks to ensure that
the creditors have consented to the transfer of their
liabilities to the surviving entity or that the scheme of
arrangement does not otherwise have a material adverse effect on
the creditors interests. Furthermore, the Grand Court will
only approve a scheme of arrangement if it is satisfied that:
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the statutory provisions as to majority vote have been complied
with;
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52
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the shareholders have been fairly represented at the meeting in
question;
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the scheme of arrangement is such as a businessman would
reasonably approve; and
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the scheme or arrangement is not one that would more properly be
sanctioned under some other provision of the Companies Law.
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There
is uncertainty as to shareholders ability to enforce
certain foreign civil liabilities in the Cayman
Islands.
We are incorporated as an exempted company with limited
liability under the laws of the Cayman Islands. A material
portion of our assets are located outside of the United States.
As a result, it may be difficult for our shareholders to enforce
judgments against us or judgments obtained in U.S. courts
predicated upon the civil liability provisions of the federal
securities laws of the United States or any state of the United
States.
We have been advised by our Cayman Islands counsel, Maples and
Calder, that although there is no statutory enforcement in the
Cayman Islands of judgments obtained in the United States, the
courts of the Cayman Islands will based on the
principle that a judgment by a competent foreign court imposes
upon the judgment debtor an obligation to pay the sum for which
judgment has been given recognize and enforce a
foreign judgment of a court of competent jurisdiction if such
judgment is final, for a liquidated sum, not in respect of taxes
or a fine or penalty, is not inconsistent with a Cayman Islands
judgment in respect of the same matters, and was not obtained in
a manner, and is not of a kind, the enforcement of which is
contrary to the public policy of the Cayman Islands. There is
doubt, however, as to whether the Grand Court of the Cayman
Islands will (a) recognize or enforce judgments of
U.S. courts predicated upon the civil liability provisions
of the federal securities laws of the United States or any
state of the United States, or (b) in original actions
brought in the Cayman Islands, impose liabilities predicated
upon the civil liability provisions of the federal securities
laws of the United States or any state of the United States, on
the grounds that such provisions are penal in nature.
The Grand Court of the Cayman Islands may stay proceedings if
concurrent proceedings are being brought elsewhere.
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Item 2.
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UNREGISTERED
SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
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None.
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Item 3.
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DEFAULTS
UPON SENIOR SECURITIES
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None.
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Item 4.
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SUBMISSION
OF MATTERS TO A VOTE OF SECURITY HOLDERS
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None.
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Item 5.
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OTHER
INFORMATION
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(a) None.
(b) None.
53
(a) Exhibit Index:
EXHIBIT INDEX
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Exhibit
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Number
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Description
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Reference
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2
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.1
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Agreement and Plan of Merger,
dated April 10, 2002, by and among Herbalife International,
Inc., WH Holdings (Cayman Islands) Ltd. and WH Acquisition Corp.
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(a)
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3
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.1
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Form of Amended and Restated
Memorandum and Articles of Association of Herbalife Ltd.
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(d)
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4
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.1
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Indenture, dated as of
June 27, 2002 between WH Acquisition Corp., WH Intermediate
Holdings Ltd., WH Luxembourg Holdings SàRL, WH Luxembourg
Intermediate Holdings SàRL, WH Luxembourg CM SàRL and
The Bank of New York as Trustee governing
113/4%
Senior Subordinated Notes due 2010
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(a)
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4
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.2
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Indenture, dated as of
March 8, 2004 between WH Holdings (Cayman Islands) Ltd., WH
Capital Corporation and The Bank of New York as trustee
governing
91/2% Notes
due 2011
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(a)
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4
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.3
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Form of Share Certificate
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(d)
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9
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.1
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Shareholders Agreement dated
as of July 31, 2002, by and among WH Holdings (Cayman
Islands) Ltd., Whitney V, L.P., Whitney Strategic
Partners V, L.P., WH Investments Ltd., CCG Investments
(BVI), L.P., CCG Associates-QP, LLC, CCG Associates-AI, LLC, CCG
Investment Fund-AI, L.P., CCG AV, LLC-Series C, CCG AV,
LLC-Series E, and certain other persons
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(a)
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10
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.1
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Form of Indemnity Agreement
between Herbalife International Inc. and certain officers and
directors of Herbalife International Inc.
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(a)
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10
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.2
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Office lease agreement between
Herbalife International of America Inc. and State Teachers
Retirement System, dated July 11, 1995
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(a)
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10
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.3#
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Herbalife International of
America, Inc.s Senior Executive Deferred Compensation
Plan, effectivex January 1, 1996, as amended
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(a)
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10
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.4#
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Herbalife International of
America, Inc.s Management Deferred Compensation Plan,
effective January 1, 1996, as amended
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(a)
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10
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.5
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Master Trust Agreement
between Herbalife International of America, Inc. and Imperial
Trust Company, Inc., effective January 1, 1996
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(a)
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10
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.6#
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Herbalife International Inc. 401K
Profit Sharing Plan and Trust, as amended
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(a)
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10
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.7
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Trust Agreement for Herbalife
2001 Executive Retention Plan, effective March 15, 2001
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(a)
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10
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.8#
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Herbalife 2001 Executive Retention
Plan, effective March 15, 2001
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(a)
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10
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.9#
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Separation Agreement and General
Release, dated as of May 17, 2002, between Robert Sandler
and Herbalife International, Inc. and Herbalife International of
America, Inc. and Clarification
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(a)
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10
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.10
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Agreement for Retention of Legal
Services, dated as of May 20, 2002, by and among Herbalife
International, Inc., Herbalife International of America, Inc.
and Robert A. Sandler
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(a)
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10
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.11
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Purchase Agreement, dated as of
June 21, 2002, by and among WH Acquisition Corp., Herbalife
International, Inc., WH Intermediate Holdings Ltd., WH
Luxembourg Holdings SàRL, WH Luxembourg Intermediate
Holdings SàRL, WH Luxembourg CM SàRL and UBS Warburg
LLC
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(a)
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10
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.12
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Registration Rights Agreement,
dated as of June 27, 2002, by and among WH Acquisition
Corp., WH Intermediate Holdings Ltd., WH Luxembourg Holdings
SàRL, WH Luxembourg Intermediate Holdings SàRL, WH
Luxembourg CM SàRL and UBS Warburg LLC
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(a)
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10
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.13
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Notice to Distributors regarding
Amendment to Agreements of Distributorship, dated as of
July 18, 2002 between Herbalife International, Inc. and
each Herbalife Distributor
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(a)
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10
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.14
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Indemnity Agreement dated as of
July 31, 2002, by and among WH Holdings (Cayman Islands)
Ltd., WH Acquisition Corp., Whitney & Co., LLC,
Whitney V, L.P., Whitney Strategic Partners V, L.P.,
GGC Administration, L.L.C., Golden Gate Private Equity, Inc.,
CCG Investments (BVI), L.P., CCG Associates-AI, LLC, CCG
Investment Fund-AI, LP, CCG AV, LLC-Series C, CCG AV,
LLC-Series C, CCG AV, LLC-Series E, CCG Associates-QP,
LLC and WH Investments Ltd.
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(a)
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54
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Exhibit
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Number
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Description
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Reference
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10
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.15#
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Independent Directors Stock
Option Plan of WH Holdings (Cayman Islands) Ltd.
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(a)
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10
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.16#
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Employment Agreement, dated as of
March 10, 2003 between Brian Kane and Herbalife
International, Inc. and Herbalife International of America, Inc.
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(a)
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10
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.17#
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Employment Agreement dated as of
March 10, 2003 between Carol Hannah and Herbalife
International, Inc. and Herbalife International of America, Inc.
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(a)
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10
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.18#
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Non-Statutory Stock Option
Agreement, dated as of March 10, 2003 between WH Holdings
(Cayman Islands) Ltd. and Brian Kane
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|
(a)
|
|
10
|
.19#
|
|
Non-Statutory Stock Option
Agreement, dated as of March 10, 2003 between WH Holdings
(Cayman Islands) Ltd. and Carol Hannah
|
|
(a)
|
|
10
|
.20#
|
|
WH Holdings (Cayman Islands) Ltd.
Stock Incentive Plan, as restated, dated as of November 5,
2003
|
|
(a)
|
|
10
|
.21#
|
|
Side Letter Agreement dated as of
March 10, 2003 by and among WH Holdings (Cayman Islands)
Ltd., Brian Kane and Carol Hannah and the Shareholders listed
therein
|
|
(a)
|
|
10
|
.22#
|
|
Employment Agreement dated as of
April 3, 2003 between Michael O. Johnson and Herbalife
International, Inc. and Herbalife International of America, Inc.
|
|
(a)
|
|
10
|
.23#
|
|
Non-Statutory Stock Option
Agreement, dated as of April 3, 2003 between WH Holdings
(Cayman Islands) Ltd. and Michael O. Johnson
|
|
(a)
|
|
10
|
.24#
|
|
Side Letter Agreement dated as of
April 3, 2003 by and among WH Holdings (Cayman Islands)
Ltd., Michael O. Johnson and the Shareholders listed therein
|
|
(a)
|
|
10
|
.25#
|
|
Employment Agreement dated as of
July 14, 2003 between Matt Wisk and Herbalife International
of America, Inc.
|
|
(a)
|
|
10
|
.26#
|
|
Employment Agreement dated as of
July 31, 2003 between Gregory L. Probert and Herbalife
International of America, Inc.
|
|
(a)
|
|
10
|
.27#
|
|
Employment Agreement dated
October 6, 2003 between Brett R. Chapman and Herbalife
International of America, Inc.
|
|
(a)
|
|
10
|
.28#
|
|
Form of Non-Statutory Stock Option
Agreement (Non-Executive Agreement)
|
|
(a)
|
|
10
|
.29#
|
|
Form of Non-Statutory Stock Option
Agreement (Executive Agreement)
|
|
(a)
|
|
10
|
.30
|
|
Registration Rights Agreement,
dated as of March 8, 2004, by and among WH Holdings (Cayman
Islands) Ltd., WH Capital Corporation and UBS Securities, LLC
|
|
(a)
|
|
10
|
.31
|
|
Indemnity Agreement, dated as of
February 9, 2004, among WH Capital Corporation and Gregory
Probert
|
|
(a)
|
|
10
|
.32
|
|
Indemnity Agreement, dated as of
February 9, 2004, among WH Capital Corporation and Brett R.
Chapman
|
|
(a)
|
|
10
|
.33
|
|
Stock Subscription Agreement of WH
Capital Corporation, dated as of February 9, 2004, between
WH Capital Corporation and WH Holdings (Cayman Islands)
Ltd.
|
|
(a)
|
|
10
|
.34
|
|
First Amendment to Amended and
Restated WH Holdings (Cayman Islands) Ltd. Stock Incentive Plan,
dated November 5, 2003
|
|
(a)
|
|
10
|
.35#
|
|
Separation Agreement and General
Release dated May 1, 2004, among Herbalife International,
Inc., Herbalife International of America, Inc. and Carol Hannah
|
|
(a)
|
|
10
|
.36#
|
|
Consulting Agreement dated
May 1, 2004 among Herbalife International of America, Inc.
and Carol Hannah
|
|
(a)
|
|
10
|
.37#
|
|
Employment Agreement dated
June 1, 2004 among Herbalife International of America, Inc.
and Richard Goudis
|
|
(a)
|
|
10
|
.38
|
|
Purchase Agreement, dated
March 3, 2004, by and among WH Holdings (Cayman Islands)
Ltd., WH Capital Corporation and UBS Securities LLC
|
|
(a)
|
|
10
|
.39
|
|
Registration Rights Agreement,
dated as of July 31, 2002, by and among WH Holdings (Cayman
Islands) Ltd., Whitney V, L.P., Whitney Strategic
Partners V, L.P., WH Investments Ltd., CCG Investments
(BVI), L.P., CCG Associates-QP, LLC, CCG Associates-AI, LLC, CCG
Investment Fund-AI, L.P., CCG AV, LLC-Series C and CCG AV,
LLC-Series E.
|
|
(b)
|
55
|
|
|
|
|
|
|
Exhibit
|
|
|
|
|
Number
|
|
Description
|
|
Reference
|
|
|
10
|
.40
|
|
Share Purchase Agreement, dated as
of July 31, 2002, by and among WH Holdings (Cayman Islands)
Ltd., Whitney Strategic Partners V, L.P., WH Investments
Ltd., Whitney V, L.P., CCG Investments (BVI), L.P., CCG
Associates-QP, LLC, CCG Associates-AI, LLC, CCG Investment
Fund-AI, LP, CCG AV, LLC-Series C and CCG AV,
LLC-Series E.
|
|
(b)
|
|
10
|
.41
|
|
Form of Indemnification Agreement
between Herbalife Ltd. and the directors and certain officers of
Herbalife Ltd.
|
|
(c)
|
|
10
|
.42#
|
|
Herbalife Ltd. 2004 Stock
Incentive Plan
|
|
(c)
|
|
10
|
.43
|
|
Termination Agreement, dated as of
December 1, 2004, between Herbalife Ltd., Herbalife
International, Inc. and Whitney & Co., LLC.
|
|
(d)
|
|
10
|
.44
|
|
Termination Agreement, dated as of
December 1, 2004, between Herbalife Ltd., Herbalife
International Inc. and GGC Administration, L.L.C.
|
|
(d)
|
|
10
|
.45
|
|
Termination Agreement, dated as of
December 13, 2004, by and among Herbalife Ltd.,
Whitney V, L.P., Whitney Strategic Partners V, L.P.,
CCG Investments (BVI), L.P., CCG Associates-QP, LLC, CCG
Associates-AI, LLC, CCG Investment Fund-AI, LP, CCG AV,
LLC-Series C, CCG AV, LLC-Series E and CCG CI, LLC.
|
|
(d)
|
|
10
|
.46
|
|
Indemnification Agreement, dated
as of December 13, 2004, by and among Herbalife Ltd.,
Herbalife International, Inc., Whitney V, L.P., Whitney
Strategic Partners V, L.P., CCG Investments (BVI), L.P.,
CCG Associates-QP, LLC, CCG Associates-AI, LLC, CCG Investment
Fund-AI, LP, CCG AV, LLC-Series C, CCG AV,
LLC-Series E, CCG CI, LLC and GGC Administration, LLC.
|
|
(d)
|
|
10
|
.47#
|
|
Amendment No. 1 to Herbalife
Ltd. 2004 Stock Incentive Plan
|
|
(e)
|
|
10
|
.48#
|
|
Form of Stock Bonus Award Agreement
|
|
(e)
|
|
10
|
.49#
|
|
Contract for Services of a
Consultant between Herbalife International Luxembourg
S.á.R.L. and Brian Kane dated as of October 18, 2004
|
|
(f)
|
|
10
|
.50#
|
|
Compromise Agreement between
Herbalife International Luxembourg S.á.R.L. and Brian Kane
dated as of October 18, 2004
|
|
(f)
|
|
10
|
.51
|
|
Credit Agreement, dated as of
December 21, 2004, by and among Herbalife International
Inc., Herbalife Ltd., WH Intermediate Holdings Ltd., HBL Ltd.,
WH Luxembourg Holdings S.á.R.L., HLF Luxembourg Holdings,
S.á.R.L., WH Capital Corporation, WH Luxembourg
Intermediate Holdings S.á.R.L. and the Subsidiary
Guarantors party hereto, and certain lenders and agents named
therein.
|
|
(g)
|
|
10
|
.52
|
|
Security Agreement, dated as of
December 21, 2004, by and among Herbalife International,
Inc., Herbalife Ltd., WH Intermediate Holdings Ltd., HBL Ltd.,
WH Luxembourg Holdings S.á.R.L., HLF Luxembourg Holdings,
S.á.R.L., WH Capital Corporation, WH Luxembourg
Intermediate Holdings S.á.R.L., and the Subsidiary
Guarantors party thereto in favor of Morgan Stanley &
Co. Incorporated, as Collateral Agent.
|
|
(g)
|
|
10
|
.53
|
|
First Amendment to Credit
Agreement, dated as of April 12, 2005, by and among
Herbalife International Inc., Herbalife Ltd., WH Intermediate
Holdings Ltd., HBL Ltd., WH Luxembourg Holdings S.á.R.L.,
HLF Luxembourg Holdings, S.á.R.L., WH Capital Corporation,
WH Luxembourg Intermediate Holdings S.á.R.L. and the
Subsidiary Guarantors party thereto, and certain lenders and
agents named therein.
|
|
(g)
|
|
10
|
.54#
|
|
Employment Agreement Effective as
of January 1, 2005 between Herbalife Ltd. and Henry Burdick
|
|
(h)
|
|
10
|
.55#
|
|
Form of 2004 Herbalife Ltd. 2004
Stock Incentive Plan Stock Option Agreement
|
|
(i)
|
|
10
|
.56#
|
|
Form of 2004 Herbalife Ltd. 2004
Stock Incentive Plan Non-Employee Director Stock Option Agreement
|
|
(i)
|
|
10
|
.57
|
|
Second Amendment to Credit
Agreement, dated as of August 19, 2005, by and among
Herbalife International, Inc., Herbalife Ltd., WH Intermediate
Holdings Ltd., HBL Ltd., WH Luxembourg Holdings S.á.R.L.,
HLF Luxembourg Holdings, S.á.R.L., WH Capital Corporation,
WH Luxembourg Intermediate Holdings S.á.R.L. and the
Subsidiary Guarantors party thereto, and certain lenders and
agents named therein.
|
|
(i)
|
56
|
|
|
|
|
|
|
Exhibit
|
|
|
|
|
Number
|
|
Description
|
|
Reference
|
|
|
10
|
.58
|
|
Service Agreement by and between
Herbalife Europe Limited and Wynne Roberts ESQ, dated as of
September 6, 2005.
|
|
(k)
|
|
10
|
.59#
|
|
Amendment to employment agreement
between Michael O. Johnson and Herbalife International, Inc. and
Herbalife International of America, Inc., dated May 15,
2005.
|
|
(l)
|
|
10
|
.60#
|
|
Herbalife Ltd. 2005 Stock
Incentive Plan
|
|
(m)
|
|
10
|
.61#
|
|
Herbalife Ltd. Independent
Directors Deferred Compensation and Stock Unit Plan
|
|
(n)
|
|
10
|
.62#
|
|
Herbalife Ltd. Independent
Directors Deferred Compensation and Stock Unit Plan Independent
Directors Stock Unit Award Agreement
|
|
(n)
|
|
10
|
.63#
|
|
Form of Herbalife Ltd. 2005 Stock
Incentive Plan Stock Unit Award Agreement
|
|
(o)
|
|
10
|
.64#
|
|
Form of Herbalife Ltd. 2005 Stock
Incentive Plan Stock Appreciation Right Award Agreement
|
|
(o)
|
|
10
|
.65#
|
|
Form of Herbalife Ltd. 2005 Stock
Incentive Plan Stock Unit Award Agreement applicable to
Mr. Michael O. Johnson
|
|
(p)
|
|
10
|
.66#
|
|
Form of Herbalife Ltd. 2005 Stock
Incentive Plan Stock Appreciation Right Award Agreement
applicable to Mr. Michael O. Johnson
|
|
(p)
|
|
10
|
.67#
|
|
Amendment to Herbalife Ltd.
Independent Directors Deferred Compensation and Stock Unit Plan
|
|
(q)
|
|
10
|
.68#
|
|
Form of Herbalife Ltd. 2005 Stock
Incentive Plan Stock Unit Award Agreement applicable to
Messrs. Gregory Probert, Brett R. Chapman and Richard Goudis
|
|
(r)
|
|
10
|
.69#
|
|
Form of Herbalife Ltd. 2005 Stock
Incentive Plan Stock Appreciation Right Award Agreement
applicable to Messrs. Gregory Probert, Brett R. Chapman and
Richard Goudis
|
|
(r)
|
|
10
|
.70#
|
|
Amended and restated employment
agreement effective April 17, 2006 between Herbalife
International of America, Inc. and Paul Noack
|
|
(s)
|
|
10
|
.71
|
|
Form of Credit Agreement, dated as
of July 21, 2006, by and among Herbalife International
Inc., Herbalife Ltd., WH Intermediate Holdings Ltd., HBL Ltd.,
WH Luxembourg Holdings S.á.R.L., Herbalife International
Luxembourg S.á.R.L., HLF Luxembourg Holdings,
S.á.R.L., WH Capital Corporation, WH Luxembourg
Intermediate Holdings S.á.R.L., HV Holdings Ltd., Herbalife
Distribution Ltd., Herbalife Luxembourg Distribution
S.á.R.L., and the Subsidiary Guarantors party thereto, and
certain lenders and agents named therein.
|
|
*
|
|
10
|
.72
|
|
Form of Security Agreement, dated
as of July 21, 2006, by and among Herbalife International,
Inc., Herbalife Ltd., WH Intermediate Holdings Ltd., HBL Ltd.,
WH Luxembourg Holdings S.á.R.L., Herbalife International
Luxembourg S.á.R.L. HLF Luxembourg Holdings, S.á.R.L.,
WH Capital Corporation, WH Luxembourg Intermediate Holdings
S.á.R.L., HV Holdings Ltd., Herbalife Distribution Ltd.,
Herbalife Luxembourg Distribution S.á.R.L., and the
Subsidiary Guarantors party thereto in favor of Merrill Lynch
Capital Corporation, as Collateral Agent.
|
|
*
|
|
10
|
.73#
|
|
Amended and Restated Independent
Directors Deferred Compensation and Stock Unit Plan
|
|
*
|
|
31
|
.1
|
|
Rule 13a-14(a)
Certification of Chief Executive Officer
|
|
*
|
|
31
|
.2
|
|
Rule 13a-14(a)
Certification of Chief Financial Officer
|
|
*
|
|
32
|
.1
|
|
Section 1350 Certification of
Chief Executive Officer and Chief Financial Officer
|
|
*
|
|
|
|
* |
|
Filed herewith. |
|
# |
|
Management contract or compensatory plan or arrangement. |
|
(a) |
|
Previously filed on October 1, 2004 as an Exhibit to the
Companys registration statement on
Form S-1
(File
No. 333-119485)
and is incorporated herein by reference. |
|
(b) |
|
Previously filed on November 9, 2004 as an Exhibit to
Amendment No. 2 to the Companys registration
statement on
Form S-1
(File No.
333-119485)
and is incorporated herein by reference. |
|
(c) |
|
Previously filed on December 2, 2004 as an Exhibit to
Amendment No. 4 to the Companys registration
statement on
Form S-1
(File No.
333-119485)
and is incorporated herein by reference. |
57
|
|
|
(d) |
|
Previously filed on December 14, 2004 as an Exhibit to
Amendment No. 5 to the Companys registration
statement on
Form S-1
(File No.
333-119485)
and is incorporated herein by reference. |
|
(e) |
|
Previously filed on February 17, 2005 as an Exhibit to the
Companys registration statement on
Form S-8
(File
No. 333-122871)
and is incorporated herein by reference. |
|
(f) |
|
Previously filed on March 14, 2005 as an Exhibit to the
Companys Annual Report on
Form 10-K
for the year ended December 31, 2004 and is incorporated
herein by reference. |
|
(g) |
|
Previously filed on May 9, 2005 as an Exhibit to the
Companys Quarterly Report on
Form 10-Q
for the quarter ended March 31, 2005 and is incorporated
herein by reference. |
|
(h) |
|
Previously filed on May 13, 2005 as an Exhibit to the
Companys Current Report on
Form 8-K
and is incorporated herein by reference. |
|
(i) |
|
Previously filed on June 14, 2005 as an Exhibit to the
Companys Current Report on
Form 8-K
and is incorporated herein by reference. |
|
(j) |
|
Previously filed on August 23, 2005 as an Exhibit to the
Companys Current Report on
Form 8-K
and is incorporated herein by reference. |
|
(k) |
|
Previously filed on September 23, 2005 as an Exhibit to the
Companys Current Report on
Form 8-K
and is incorporated herein by reference. |
|
(l) |
|
Previously filed on August 3, 2005 as an Exhibit to the
Companys Quarterly Report on
Form 10-Q
for the quarter ended June 30, 2005 and is incorporated
herein by reference. |
|
(m) |
|
Previously filed on November 22, 2005 as an Exhibit to the
Companys Registration Statement on
Form S-8
and is incorporated herein by reference. |
|
(n) |
|
Previously filed on February 28, 2006 as an Exhibit to the
Companys Annual Report on
Form 10-K
for the year ended December 31, 2005 and is incorporated
herein by reference. |
|
(o) |
|
Previously filed on March 29, 2006 as an Exhibit to the
Companys Current Report on
Form 8-K
and is incorporated herein by reference. |
|
(p) |
|
Previously filed on March 29, 2006 as an Exhibit to the
Companys Current Report on
Form 8-K
and is incorporated herein by reference. |
|
(q) |
|
Previously filed on March 30, 2006 as an Exhibit to the
Companys Current Report on
Form 8-K
and is incorporated herein by reference. |
|
(r) |
|
Previously filed on March 31, 2006 as an Exhibit to the
Companys Current Report on
Form 8-K
and is incorporated herein by reference. |
|
(s) |
|
Previously filed on May 3, 2006 as an Exhibit to the
Companys Quarterly Report on
Form 10-Q
for the quarter ended March 31, 2006 and is incorporated
herein by reference. |
58
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of
1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
HERBALIFE LTD.
(Registrant)
Richard Goudis
Chief Financial Officer
Date: November 13, 2006
59