<PAGE> 1
================================================================================
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT UNDER SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE
ACT OF 1934 (FEE REQUIRED)
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934 (NO FEE REQUIRED)
For the transition period from ___________________ to ____________________
Commission file number 0-15712
HERBALIFE INTERNATIONAL, INC.
--------------------------------------------------------
(Exact name of Registrant as specified in its charter)
Nevada 22-2695420
--------------------------------- ------------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
1800 Century Park East, Los Angeles, California 90067
------------------------------------------------- ------------
(Address of principal executive offices) (Zip Code)
(310) 410-9600
(Registrant's telephone number, including area code)
- --------------------------------------------------------------------------------
Former Name, Former Address and Former Fiscal Year, 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 [X] No [ ]
APPLICABLE ONLY TO REGISTRANTS INVOLVED IN BANKRUPTCY
PROCEEDINGS DURING THE PRECEDING FIVE YEARS:
Indicate by check mark whether the registrant has filed all documents and
reports required to be filed by Sections 12, 13, or 15(d) of the Securities
Exchange Act of 1934 subsequent to the distribution of securities under a plan
confirmed by a court.
Yes [ ] No [ ]
APPLICABLE ONLY TO CORPORATE ISSUERS:
The number of shares outstanding of each of the registrant's classes of Common
Stock, as of October 31, 1998: Class A Common Stock - 9,978,506
Class B Common Stock - 18,599,068
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<PAGE> 2
HERBALIFE INTERNATIONAL, INC.
Index to Financial Statements and Exhibits
Filed with the Quarterly Report of the Company on Form 10-Q
For the Quarter Ended September 30, 1998
PART I. FINANCIAL INFORMATION
<TABLE>
<CAPTION>
Item 1. Financial Statements: Page No.
--------
<S> <C> <C>
Consolidated Balance Sheets 2 - 3
Consolidated Statements of Income 4
Consolidated Statements of Cash Flows 5
Notes to Consolidated Financial Statements 6 - 7
Item 2. Management's Discussion and Analysis of Financial 8 - 12
Condition and Results of Operations
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 13
Item 2. Changes in Securities and Use of Proceeds 13
Item 3. Defaults Upon Senior Securities 13
Item 4. Submission of Matters to a Vote of Security Holders 13
Item 5. Other Information 13
Item 6. Exhibits and Reports on Form 8-K 14 - 15
Signature 16
</TABLE>
<PAGE> 3
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
HERBALIFE INTERNATIONAL, INC.
CONSOLIDATED BALANCE SHEETS
(Unaudited)
ASSETS
<TABLE>
<CAPTION>
September 30, December 31,
1998 1997
------------- -------------
<S> <C> <C>
CURRENT ASSETS:
Cash and cash equivalents $ 66,673,000 $ 78,913,000
Marketable securities 9,037,000 43,794,000
Receivables 37,638,000 46,021,000
Inventories 92,709,000 71,583,000
Prepaid income taxes 1,932,000 695,000
Prepaid expenses and other current assets 12,368,000 7,466,000
Deferred income taxes 18,652,000 19,502,000
------------ ------------
Total current assets 239,009,000 267,974,000
Property, at cost, net of accumulated depreciation
and amortization of $41,514,000(1998) and
$34,255,000(1997) 30,066,000 29,738,000
Deferred compensation plan 16,962,000 6,464,000
Other assets 10,207,000 6,945,000
Goodwill, net of accumulated amortization of
$1,558,000(1998) and $1,428,000(1997) 3,330,000 3,459,000
------------ ------------
TOTAL $299,574,000 $314,580,000
============ ============
</TABLE>
See the accompanying notes to consolidated financial statements
2
<PAGE> 4
HERBALIFE INTERNATIONAL, INC.
CONSOLIDATED BALANCE SHEETS
(Unaudited)
LIABILITIES AND STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
September 30, December 31,
1998 1997
-------------- -------------
<S> <C> <C>
CURRENT LIABILITIES:
Accounts payable $ 10,431,000 $ 12,654,000
Royalty overrides 52,168,000 56,643,000
Accrued compensation 19,574,000 19,516,000
Accrued expenses 18,984,000 19,137,000
Dividends payable 4,351,000 4,634,000
Current portion of contracts payable and bank loans 1,716,000 1,449,000
Advance sales deposits 11,006,000 18,375,000
Income taxes payable 4,280,000 9,580,000
------------- -------------
Total current liabilities 122,510,000 141,988,000
NON-CURRENT LIABILITIES:
Contracts payable, net of current portion 2,033,000 2,666,000
Deferred income taxes 1,130,000 1,739,000
Deferred compensation liability 14,816,000 7,767,000
Other non-current liabilities and deferred credits 4,535,000 3,819,000
------------- -------------
Total liabilities 145,024,000 157,979,000
------------- -------------
MINORITY INTEREST 2,205,000 1,868,000
------------- -------------
STOCKHOLDERS' EQUITY:
Common Stock A, $0.01 par value; 33,333,333 shares
authorized 9,978,509(1998) and 9,811,623(1997) shares
issued and outstanding 100,000 98,000
Common Stock B, $0.01 par value; 66,666,667 shares
authorized, 18,603,672(1998) and 19,818,248(1997) shares
issued and outstanding 186,000 198,000
Paid-in-capital in excess of par value 54,778,000 50,319,000
Retained earnings 103,772,000 109,106,000
Cumulative translation adjustment (6,518,000) (4,858,000)
Unearned compensation -- (152,000)
Unrealized gain on marketable securities 27,000 22,000
------------- -------------
Total stockholders' equity 152,345,000 154,733,000
------------- -------------
TOTAL $ 299,574,000 $ 314,580,000
============= =============
</TABLE>
See the accompanying notes to consolidated financial statements
3
<PAGE> 5
HERBALIFE INTERNATIONAL, INC.
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
--------------------------------------- ----------------------------------------
September 30, 1998 September 30, 1997 September 30, 1998 September 30, 1997
------------------ ------------------ ------------------ -------------------
<S> <C> <C> <C> <C>
Retail sales $402,704,000 $393,894,000 $1,199,293,000 $1,067,858,000
Less: Distributor allowances on product
purchases 189,672,000 186,667,000 566,541,000 505,764,000
------------ ------------ -------------- --------------
Net sales 213,032,000 207,227,000 632,752,000 562,094,000
Cost of sales 57,738,000 53,676,000 165,884,000 147,527,000
Royalty overrides 61,253,000 61,437,000 183,929,000 167,466,000
Marketing, distribution & administrative
expenses 82,559,000 70,204,000 223,205,000 185,302,000
Interest income - net (396,000) (1,402,000) (2,072,000) (3,550,000)
------------ ------------ -------------- --------------
Income before income taxes and minority interest 11,878,000 23,312,000 61,806,000 65,349,000
Income taxes 4,573,000 8,975,000 23,795,000 25,159,000
------------ ------------ -------------- --------------
Income before minority interest 7,305,000 14,337,000 38,011,000 40,190,000
Minority interest 253,000 83,000 842,000 321,000
------------ ------------ -------------- --------------
NET INCOME $ 7,052,000 $ 14,254,000 $ 37,169,000 $ 39,869,000
============ ============ ============== ==============
EARNINGS PER SHARE
Basic $ 0.25 $ 0.47 $ 1.28 $ 1.32
Diluted 0.24 0.45 1.24 1.26
WEIGHTED AVERAGE SHARES OUTSTANDING
Basic 28,764,000 30,108,000 29,004,000 30,184,000
Diluted 29,240,000 31,468,000 30,086,000 31,560,000
CASH DIVIDENDS PER COMMON SHARE $ 0.15 $ 0.15 $ 0.45 $ 0.45
</TABLE>
See the accompanying notes to consolidated financial statements
4
<PAGE> 6
HERBALIFE INTERNATIONAL, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
<TABLE>
<CAPTION>
NINE MONTHS ENDED
---------------------------------------
September 30, 1998 September 30, 1997
------------------ -------------------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 37,169,000 $ 39,869,000
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 9,304,000 7,385,000
Deferred income taxes 12,000 468,000
Amortization of unearned compensation 152,000 195,000
Stock Grant -- 582,000
Unrealized foreign exchange (gain) loss 952,000 761,000
Minority interest in earnings 842,000 321,000
Other 340,000 151,000
Changes in operating assets and liabilities:
Receivables 7,415,000 (10,978,000)
Inventories (22,612,000) (17,836,000)
Prepaid expenses and other current assets (5,899,000) (6,415,000)
Other assets (4,291,000) (924,000)
Accounts payable (2,270,000) 68,000
Royalty overrides (3,993,000) 11,865,000
Accrued expenses and accrued compensation 1,957,000 2,950,000
Advance sales deposits (7,056,000) 5,180,000
Income taxes payable (2,908,000) (3,466,000)
Deferred compensation liability 7,048,000 3,049,000
------------ ------------
16,162,000 33,225,000
------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES
Purchases of property (9,024,000) (10,518,000)
Proceeds from sale of property 70,000 89,000
Changes in marketable securities 34,761,000 (4,760,000)
Deferred compensation plan investments (10,498,000) (4,009,000)
------------ ------------
15,309,000 (19,198,000)
------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES
Dividends paid (13,192,000) (13,635,000)
Distribution to minority interest (505,000) --
Additions to loans payable 858,000 180,000
Principal payments on loans payable (1,053,000) (2,328,000)
Exercise of stock options 4,932,000 3,134,000
Stock repurchases (32,343,000) (9,395,000)
Recapitalization costs (616,000) --
------------ ------------
(41,919,000) (22,044,000)
------------ ------------
EFFECT OF EXCHANGE RATE CHANGES ON CASH (1,792,000) (2,631,000)
------------ ------------
NET CHANGE IN CASH AND CASH EQUIVALENTS (12,240,000) (10,648,000)
CASH AND CASH EQUIVALENTS AT JANUARY 1 78,913,000 87,481,000
------------ ------------
CASH AND CASH EQUIVALENTS AT SEPTEMBER 30 $ 66,673,000 $ 76,833,000
============ ============
</TABLE>
See the accompanying notes to consolidated financial statements
5
<PAGE> 7
HERBALIFE INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. INTERIM FINANCIAL INFORMATION
The unaudited interim financial information of Herbalife International, Inc.
(the "Company") has been prepared in accordance with Article 10 of the
Securities and Exchange Commission's Regulation S-X. In the opinion of
management, the accompanying interim financial information contains all
adjustments, consisting of normal recurring adjustments, necessary to present
fairly the Company's financial statements as of September 30, 1998 and for the
three and nine month periods ended September 30, 1997 and 1998. Certain
reclassifications have been made in the 1997 consolidated financial statements
to conform to the 1998 presentation.
In June 1997, the Financial Accounting Standards Board ("FASB") issued Statement
of Financial Accounting Standards ("SFAS") No. 131, "Disclosures about Segments
of an Enterprise and Related Information." This statement is effective for the
Company's annual financial statements for fiscal year 1998.
In February 1998, the FASB issued SFAS No. 132, "Employers' Disclosures about
Pensions and Other Post Retirement Benefits". SFAS No. 132 is effective for the
Company's annual financial statements for fiscal year 1998.
In March 1998, the American Institute of Certified Public Accountants (AICPA)
Accounting Standards Executive Committee issued Statement of Position (SOP)
98-1, "Accounting for the Costs of Computer Software Developed or Obtained for
Internal Use". SOP 98-1 provides guidance on the capitalization of software for
internal use. The Company will adopt SOP 98-1 no later than January 1, 1999.
Management is currently assessing the impact of this SOP on the financial
statements of the Company.
In April 1998, the AICPA's Accounting Standards Executive Committee issued SOP
98-5, "Reporting on the cost of start-up activities". SOP 98-5 requires that all
the costs of start-up activities, including organizational costs, be expensed as
incurred. The Company will adopt SOP 98-5 on January 1, 1999, as required. The
effects of adopting this SOP will not be material to the Company's consolidated
financial statements.
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities". This statement is effective January 1,
2000. The Company has not yet analyzed the impact of adopting the statement.
2. EARNINGS PER SHARE
Basic earnings per share is computed by dividing net income by the weighted
average number of common shares outstanding during the period. Diluted earnings
per share includes the dilutive effect of stock options. A reconciliation of the
basic and diluted weighted average shares is as follows:
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
-------------------------------- ------------------------------
September 30, September 30, September 30, September 30,
1998 1997 1998 1997
------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
Basic 28,764,000 30,108,000 29,004,000 30,184,000
Effect of Stock Options 476,000 1,360,000 1,082,000 1,376,000
---------- ------------ ------------ ------------
Diluted 29,240,000 31,468,000 30,086,000 31,560,000
========== ============ ============ ============
</TABLE>
Net income as presented in the consolidated statements of income is used as the
numerator in both the basic and diluted computation.
6
<PAGE> 8
HERBALIFE INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
3. CONTINGENCIES
The Company's French and Italian subsidiaries have been subject to tax audits by
governmental authorities in those countries, each of whom are proposing that
material value added and income taxes are due. The Company and its tax advisors
believe that the Company has substantial defenses and the Company is vigorously
contesting the additional proposed taxes and related charges. However, the
ultimate resolution of these matters is unknown and may take several years.
Furthermore, the Company is from time to time engaged in routine litigation
incidental to the conduct of its business. The Company regularly reviews all
pending litigation matters in which it is involved and, estimating the impact of
such litigation matters, establishes reserves considered appropriate by
management. The Company's estimates of the impact of these matters may change as
the matters progress and are ultimately resolved.
4. COMPREHENSIVE INCOME
In June of 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 130 "Reporting Comprehensive Income." The
statement, which the Company adopted in 1998, establishes standards for
reporting and displaying comprehensive income and its components in a full set
of general-purpose financial statements. Comprehensive income is summarized as
follows:
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
------------------------------- ---------------------------------
September 30, September 30, September 30, September 30,
1998 1997 1998 1997
------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
Net Income $7,052,000 $14,254,000 $37,169,000 $39,869,000
Foreign currency translation
adjustment 474,000 (1,135,000) (1,660,000) (1,969,000)
Unrealized gain/(loss) on marketable
securities (70,000) 28,000 5,000 (92,000)
---------- ----------- ----------- -----------
Comprehensive income $7,456,000 $13,147,000 $35,514,000 $37,808,000
========== =========== =========== ===========
</TABLE>
5. TRANSACTIONS WITH RELATED PARTIES.
On April 23, 1998, Raven Industries ("Raven") and D&F Industries ("D&F"), two of
the significant suppliers of the Company's products, and Dynamic Products, Inc.
("Dynamic") another supplier to the Company, concluded a bond offering. Part of
the proceeds from the offering were used to repurchase certain ownership
interests in such entities, including the entire ownership interest of Mr.
Hughes, CEO and President of the Company, in Raven and Dynamic (representing 1/3
and 1/5 of the formerly outstanding ownership, respectively), as well as the
entire ownership interest of an employee (formerly a Director and Executive
Officer) of the Company in Dynamic (representing 5% of the formerly outstanding
ownership). As a result, Mr. Hughes and such employee cease to have any
ownership interest in those suppliers to the Company.
6. SUBSEQUENT EVENT
On October 14, 1998, the Stock Option Committee of the Company's Board of
Directors determined to reprice currently outstanding stock options to current
fair market values. The Committee took such action because, among other things,
a comparison of recent trading values with the existing prices of outstanding
stock options indicated that such options had ceased to provide appropriate
levels of incentivization to the holders of such options, thereby undermining
the purpose that they were originally intended to serve. Stock options to
acquire a total of 1.9 million shares of Class A Common Stock were repriced to
$8.00 per share, and stock options to acquire a total of 4.9 million shares of
Class B Common Stock were repriced to $6-5/8 per share. In both cases, the new
option prices are equal to the closing market price of the Company's shares on
the date of repricing.
7
<PAGE> 9
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
RESULTS OF OPERATIONS
Throughout this report "retail sales" are determined as the gross sales amounts
reflected on the Company's invoices to its distributors. The Company does not
receive the amount reported as "retail sales", and the Company does not monitor
the actual retail prices charged for the Company's products. "Net sales"
represents the actual purchase prices paid to the Company by its distributors,
after giving effect to distributor discounts (referred to as "distributor
allowances"), which have approximated 50% of suggested retail sales prices. The
Company receives its net sales price in cash or through credit card payments
upon receipt of orders from distributors. Importers are utilized by the Company
in some markets and, under certain circumstances, credit terms are extended. The
Company's "gross profit" consists of net sales less (i) "cost of sales,"
consisting of the prices paid by the Company to its manufacturers for products
and costs related to product shipments, foreign duties and tariffs and similar
expenses, and (ii) "royalty overrides," currently consisting of (a) royalties
and bonuses, which have approximated 15% and 6%, respectively, on the suggested
retail sales prices of products earned by qualifying distributors on the sales
of other distributors within their distributor organizations, (b) the
President's Team Bonus payable to certain of the Company's most senior
distributors in the aggregate amount of up to an additional 1% of product retail
sales and (c) other one time incentive cash bonuses to qualifying distributors.
Royalty overrides as reported in the Consolidated Statements of Income are net
of a handling fee (6% of retail sales) charged by the Company to its
distributors on purchases of products from the Company.
The Company's use of "retail sales" in reporting financial and operating data
reflects the fundamental role of "retail sales" in the Company's accounting
systems, internal controls and operations, including the basis upon which
distributor bonuses are paid. The retail sales price of the Company's products
is reflected in distributor invoices as the price charged to distributors
together with, in most cases, a deduction for the corresponding distributor
allowance. The retail sales price is used by the Company to calculate, among
other things, royalty overrides and "volume points" earned by distributors.
Volume points are point values assigned to each of the Company's products that
are equal in all countries, and are used as a supervisor qualification criteria.
In addition, management relies upon "retail sales" data reflected in daily sales
reports to monitor results of operations in each of the Company's markets.
The ratio of the Company's "retail sales" to "net sales" is relatively constant
because distributor allowances historically total approximately 50% of suggested
retail sales prices. Accordingly, factors that affect "retail sales" generally
have a corresponding and proportionate effect on "net sales." To the extent the
ratio of "retail sales" to "net sales" varies from period to period, such
variances have resulted principally from sales of the Company's distributor kits
and other educational and promotional materials, for which there are no
distributor allowances.
The Company's 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 the Company's ability in the future to introduce
additional and new products into its markets, increase penetration in existing
markets, and enter new markets.
COMPARISON OF OPERATING RESULTS FOR 1998 TO 1997
RETAIL SALES BY GEOGRAPHICAL SEGMENTS (DOLLARS IN MILLIONS):
<TABLE>
<CAPTION>
Three Months Ended September 30 Nine Months Ended September 30
--------------------------------- ------------------------------------
% %
1998 1997 Change 1998 1997 Change
----- ------ ------ -------- -------- ------
<S> <C> <C> <C> <C> <C> <C>
Asia/Pacific Rim $174.1 $182.4 -4.5 $ 480.4 $ 448.5 7.1
Europe 108.9 109.6 -0.7 370.2 329.2 12.5
The Americas 119.7 101.9 17.4 348.7 290.2 20.2
------ ------ ---- -------- -------- ----
Total Retail Sales $402.7 $393.9 2.2 $1,199.3 $1,067.9 12.3
====== ====== ==== ======== ======== ====
</TABLE>
In the Asia/Pacific Rim region, sales in Japan declined $12.9 million, or 8.7%,
for the three months ended September 30, 1998; however, retail sales increased
$22.7 million, or 6.3%, for the nine months ended September 30, 1998. The
decline in sales for the quarter was directly attributable to the strengthening
of the dollar in 1998. In local currency, retail sales in Japan increased 8.0%
and 20.0% for the three months and nine months ended September 30, 1998. Hong
Kong and South Korea both contributed retail sales increases in dollars for the
three and nine-month periods.
8
<PAGE> 10
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
RESULTS OF OPERATIONS (CONTINUED)
RETAIL SALES BY GEOGRAPHIC SEGMENTS (CONTINUED)
In Europe, most countries continued to post retail sales increases with
significant contributions from Italy, Germany and Switzerland for the three and
nine-month periods. Continued economic and political uncertainty in Russia
resulted in sales declines of $23.0 million, or 61.1%, and $26.4 million, or
22.4% for the three months and nine months ended September 30, 1998. Due to
these uncertainties, the Company is unable to reliably predict the future
outlook for the Russian market. Excluding Russia, sales in Europe increased
31.0% and 31.9% for the three and nine-month periods, respectively.
In the Americas, retail sales increases resulted primarily from the continued
growth in the United States. For the three months and nine months ended
September 30, 1998, retail sales in the U.S. increased $16.8 million, or 22.0%,
and $47.7 million, or 21.3% respectively. Mexico also achieved higher sales,
while Brazil reflected sales decreases.
Eliminating the effect of currency fluctuations, retail sales for the quarter
increased 12.0% in total (14.2% Asia/Pacific Rim; 0% Europe; 20.5% the
Americas). For the nine months, retail sales increased 21.2% in total (23.5%
Asia/Pacific Rim; 16.8% Europe; 22.4% the Americas).
RETAIL SALES BY PRODUCT SEGMENTS (DOLLARS IN MILLIONS):
<TABLE>
<CAPTION>
Three Months Ended September 30 Nine Months Ended September 30
--------------------------------- -----------------------------------
% %
1998 1997 Change 1998 1997 Change
------ ------ ------ -------- -------- ------
<S> <C> <C> <C> <C> <C> <C>
Food & Dietary Supplements $214.0 $210.7 1.6 $626.4 $577.2 8.5
Weight Management 132.3 126.4 4.7 382.6 323.3 18.3
Personal Care 41.0 36.8 11.4 142.1 116.2 22.3
Literature/ Promotional/ Other 15.4 20.0 -23.0 48.2 51.2 -5.9
------ ------ ----- -------- -------- ------
Total Retail Sales $402.7 $393.9 2.2 $1,199.3 $1,067.9 12.3
====== ====== ===== ======== ======== ======
</TABLE>
Certain products that were previously classified as Weight Management have now
been classified as Food & Dietary Supplements, such as multi-vitamin herbal and
mineral products. The variances in these product segments were impacted by the
factors identified in the geographical segments discussed above. For the
quarter, Literature/Promotional product sales declined principally in Europe,
including a significant decrease in Russian distributor kits.
OPERATING INFORMATION:
Gross profit of $94.0 and $282.9 million for the three and nine months ended
September 30, 1998 was $1.9 million, or 2.1%, and $35.8 million, or 14.5%,
higher than in the prior year, respectively. Gross margin (defined as gross
profit as a percentage of retail sales) was 23.4% and 23.6% for the three and
nine months ended September 30, 1998, respectively, as compared to 23.4% and
23.1% for the same periods in the prior year. Strategic price increases
effective January 1, 1998 in the majority of the Company's markets and cost
savings from previously negotiated agreements with the Company's largest
contract manufacturers of nutritional and weight management products were partly
offset by (i) continued pressure on the gross margin from weakened currencies
mainly in the Company's Asia/Pac Rim markets; and (ii) a charge made in the
third quarter of 1998 of $3.5 million, primarily related to Russia.
Marketing, distribution and administrative expenses, as a percentage of retail
sales, were 20.5% and 18.6% for the three and nine months ended September 30,
1998, respectively, as compared to 17.8% and 17.4% for the same periods in 1997.
These expenses have increased to support the Company's defined growth strategies
(expand product offerings and develop new products, revitalize sales in certain
existing markets, expand into new markets and enhance sales and motivational
training). The increase in expenses was primarily due to additional salaries and
related expenses in administration and foreign distribution facilities, and
reserves of $3 million against accounts receivables in Russia during the third
quarter.
9
<PAGE> 11
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
RESULTS OF OPERATIONS (CONTINUED)
OPERATING INFORMATION (CONTINUED)
The continued weakening of the Japanese Yen against the U.S. Dollar resulted in
proportionately lower revenues, expenses, and ultimately income when translated
into the U.S. Dollar reporting currency. The effect of the weaker Japanese Yen
on the Company's net income per diluted share for the three and nine months
ended September 30, 1998 was approximately $0.13 and $0.26, respectively, as
compared to the exchange rates in effect for the same periods of 1997. The
effect of foreign currency changes in any country other than Japan was not
individually material to the operations of the Company. However, the
strengthening of the U.S. Dollar in relation to the currencies of other
countries in which the Company operates, excluding Japan, amounted to
approximately $0.04 and $0.20 per diluted share for the three and nine months
ended September 30, 1998 as compared to the exchange rates in effect for the
same periods in the prior year.
LIQUIDITY AND CAPITAL RESOURCES
The Company has historically met its working capital and capital expenditure
requirements, including funding for expansion of operations, through net cash
provided by operating activities. For the nine months ended September 30, 1998,
net cash provided by operating activities was $16.2 million, compared to $33.2
million for the same period in 1997. The decrease primarily resulted from normal
timing changes of operating assets and liabilities, and increased inventory
levels resulting from the introduction of new products and the establishment of
higher minimum stock levels.
At September 30, 1998, the Company's cash, cash equivalents and marketable
securities aggregate balance was $75.7 million, compared to $122.7 million at
December 31, 1997. The decrease is primarily the result of stock repurchases and
increased inventory levels.
Capital expenditures for the nine months ended September 30, 1998 were $9.0
million compared to $10.5 million for the same period in the prior year. The
majority of the 1998 expenditures resulted from the expansion of office
facilities and equipment in the U.S., the U.K. and Japan. For 1998 and 1999, the
Company is planning to invest approximately $15 million annually in the
continued development of management information systems and expansion of new and
existing facilities. In connection with its entry into each new market, the
Company funds inventory requirements and typically establishes either a
full-service distribution center, sales office, a fulfillment center or
compliance office, or a combination of the foregoing. While the capital
requirements associated with entry into new markets vary, the Company estimates
that an additional $1.6 million will be required for pre-opening expenses,
capital expenditures and other operating cash flow needs associated with its
1998 new market expansion activities.
In 1998, the Company declared quarterly dividends of $0.15 per share,
aggregating $13.0 million. The payment of dividends is determined by the Board
of Directors at its discretion and the amounts of dividends declared and paid in
future quarters will depend, among other factors, on profitability, as well as
other planned uses of the Company's cash resources.
The Company has not been subjected to material price increases by its suppliers
for several years. The Company believes that it has the ability to respond to a
portion or possibly all of any price increases by raising the price of its
products. Purchases by the Company from its suppliers are generally made in U.S.
Dollars, while sales to distributors are generally 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 losses on
intercompany transactions. The Company from time to time enters into forward
exchange contracts and other hedging arrangements to manage its foreign exchange
risk on intercompany transactions. As of November 13, 1998, the Company had $117
million in notional amounts of Yen put options with short-term maturities
through December 31, 1999.
Year 2000 compliance refers to the inability of certain computer systems to
recognize dates commencing on January 1, 2000. Such inability has the potential
to materially adversely affect the operation of the Company. The Company has
completed a review of its computer systems worldwide relating to order
processing, distribution, disbursements, and other financial systems. Currently,
the Company believes that by remediating existing software and converting to new
software for certain applications, Year 2000 compliance will not pose
significant operational problems and is not anticipated to be material to its
financial position or results of operations of any given year. Remediation and
replacement has begun and is targeted to be completed during the first and
second quarters of 1999. Testing and certification of these systems and
applications is targeted for completion by mid 1999. Also, contingency plans are
being developed for those applications selected for replacement
10
<PAGE> 12
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
LIQUIDITY AND CAPITAL RESOURCES (CONTINUED)
which will allow sufficient time for remediation and development of manual
processes. As of September 30, 1998, the Company had incurred approximately $8.5
million for year 2000 efforts. Future costs are estimated to be up to $15
million, which are expected to be funded through operating cash flows. Such
expenditures are expensed or capitalized, as appropriate. In addition, the
Company is planning to contact its major vendors, telecommunication providers
and others on whom it relies to assure that their systems will be converted in a
timely fashion. While the Company believes it will be able to resolve the Year
2000 issue in a timely manner, if it is unable to complete the installation of
replacement systems and the required changes to existing critical systems, or if
those with whom it conducts business are unsuccessful in implementing timely
solutions, the Year 2000 issue could have a material adverse effect on the
Company's results of operations including its ability to process and distribute
orders. The Company's Year 2000 efforts are ongoing and its overall plan will
continue to evolve as new information becomes available.
On January 1, 1999, eleven of the fifteen member countries of the European Union
will adopt a single European Currency - the euro. The conversion rates between
the existing sovereign currencies ("legacy currencies") and the euro will be
fixed. The euro will then be traded on currency exchanges and may be used in
business transactions. Beginning in January 2002, new euro-denominated bills and
coins will be issued, and legacy currencies will be withdrawn from circulation.
The Company has conducted a review of its information and business systems, and
those of its European affiliates, to address the impact of the euro conversion.
The Company initially plans to offer both the legacy currencies and the euro to
settle distributor sales and ultimately to process orders in the euro currency.
To prepare for this transition, certain computer systems will require
modifications or replacement. The remediation and testing process is targeted to
be completed by December 1998 and will cost approximately $500,000. These costs
will be expensed or capitalized as appropriate. The Company is still evaluating
subsequent phases to the euro conversion, which may include, among other things,
system modifications to allow payment of distributor royalties in euro. The
incremental costs associated with these subsequent phases will not be
significant as the system modifications will be incorporated into the Company's
year 2000 efforts. In connection with the common currency, the Company is also
currently evaluating the effects on pricing.
In January 1996, the Company's Board of Directors approved a one million share
stock repurchase program, which was completed in April 1997. In addition, in
April 1997, the Board of Directors authorized a $30 million stock repurchase
program, which was completed in February 1998. In February 1998 and again in
July 1998, the Board authorized two additional $20 million stock repurchase
programs, the first of which was completed in September, 1998. Pursuant to these
stock repurchase programs, for the year to date through September 30, 1998, the
Company had expended $32.3 million in the aggregate to repurchase 1.6 million
shares.
The Company has pledged cash and cash equivalents to secure bank financing
primarily for the benefit of its foreign subsidiaries, including letters of
credit, lines of credit, leases, and other obligations. As of September 30,
1998, an aggregate of $5.6 million had been pledged against $6.3 million of
commitments for debt obligations and contingent guarantees. Generally, these
debt arrangements expire in less than one year. The Company also enters into
other unsecured guarantees related mainly to short-term currency hedge
arrangements.
In September 30, 1998, the Company had $3.2 million of credit facilities of
which $0.8 million is outstanding. The majority of these facilities expire in
1998. These facilities are subject to normal banking terms and conditions and do
not materially restrict the Company's activities.
11
<PAGE> 13
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
FORWARD LOOKING STATEMENTS
With the exception of the actual reported financial results and other historical
information, the statements made in the Management's Discussion and Analysis of
Financial Condition and Results of Operations and elsewhere in this report are
forward looking statements that involve risks and uncertainties that could
affect actual future results. Such risks and uncertainties include, but are not
limited to: the regulatory environment, consumer acceptance of network
marketing, economic conditions in the countries the Company operates, the
presence of possible competitors, adverse publicity and in-region cultural or
demographic factors and other risks indicated in the Company's filings with the
Securities and Exchange Commission, including the Company's filing of a
registration statement on Form S-3 in March 1998.
12
<PAGE> 14
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
See discussion under "Legal Proceedings" in the Company's Annual Report
on Form 10-K for the fiscal year ended December 31, 1997 and in footnote
three to the Financial Statements included in Item 1 of this document.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
None.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
ITEM 5. OTHER INFORMATION
None.
13
<PAGE> 15
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) EXHIBITS
HERBALIFE INTERNATIONAL, INC.
EXHIBIT INDEX
<TABLE>
<CAPTION>
- ---------------- --------------------------------------------------------------------- --------------------
Exhibit Number Description Page No./(Footnote)
- ---------------- --------------------------------------------------------------------- --------------------
<S> <C> <C>
3.1 Amended and Restated Articles of Incorporation (10)
3.2 Amended and Restated Bylaws (2)
4.1 Form of Class A Common Stock and Class B Common Stock Certificates (12)
10.1 Final Judgment and Permanent Injunction, entered into on October,
1986 by the parties to that action entitled People of the State of
California, et al., v Herbalife International, Inc. et al., Case No.
92767 in the Superior Court of the State of California for the County (1)
of Santa Cruz
10.2 The Company's 1991 Stock Option Plan, as amended (7), (13)
10.3 The Company's 1992 Executive Incentive Compensation Plan, as amended (2), (7)
10.4 Form of Individual Participation Agreement relating to the Company's
Executive Compensation Plan (2)
10.5 Form of Letter Agreement between the Compensation Committee of the
Board of Directors of the Company and Mark Hughes (2)
10.6 Form of Indemnity Agreement between the Company and certain officers
and directors of the Company (2)
10.7 Trust Agreement among the Company, Citicorp Trust, N.A. and certain
officers and directors of the Company (2)
10.8 Form of Stock Appreciation Rights Agreement between the Company and
certain directors of the Company (2)
10.9 1994 Performance Based Annual Incentive Compensation Plan (4), (7), (11)
10.10 Form of Promissory Note for Advances under the Company's 1994
Performance Based Annual Incentive Compensation Plan (5)
10.11 Employment Agreement between the Company and Chris Pair dated April
3, 1994 (3)
10.12 Deferred Compensation Agreement between the Company and Michael Rosen (5)
10.13 Office lease agreement between the Company and State Teacher's
Retirement System, dated July 20, 1995 (6)
10.14 Form of stock appreciation rights agreements between the Company and
certain directors of the Company (6)
10.15 The Company's Senior Executive Deferred Compensation Plan, effective
January 1, 1996 (6)
10.16 The Company's Management Deferred Compensation Plan, effective
January 1, 1996 (6)
10.17 Master Trust Agreement between the company and Imperial Trust
Company, Inc., effective January 1, 1996 (6)
10.18 The Company's 401K Plan (6)
10.19 Agreement Concerning Share Allocation Plan for Specific Directors of
Herbalife of Japan K.K. dated December 30, 1996. (8)
10.20 Consulting Agreement between David Addis and Herbalife of America,
Inc. Dated January 27, 1997. (8)
10.21 Agreement between Herbalife International of America, Inc. and D&F
Industries, Inc. dated September 2, 1997 (9)
10.22 Agreement between Herbalife International of America, Inc. and
Dynamic Products, Inc. dated September 2, 1997 (9)
10.23 Agreement between Herbalife International of America, Inc. and Raven
Industries, Inc. d/b/a Omni-Pak Industries, dated September 2, 1997 (9)
10.24 The Company's Supplemental Executive Retirement Plan (12)
10.25 Form of Underwriting Agreement (14)
10.26 Form of Purchase Contract Between the Selling Stockholder and the (14)
Trust
21 List of subsidiaries of the Company (12)
27 Financial Data Schedule (15)
- ---------------------------------------------------------------------------------------------------------------
</TABLE>
14
<PAGE> 16
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (CONTINUED)
(a) EXHIBITS (CONTINUED)
(1) Incorporated by reference to the Company's Annual Report on Form
10-K for the year ended December 31, 1987.
(2) Incorporated by reference to the Company's Registration Statement
on Form S-1 (No. 33-66576) declared effective by the Securities and
Exchange Commission on October 8, 1993.
(3) Incorporated by reference to the Company's Quarterly Report on Form
10-Q for the three months ended June 30, 1994.
(4) Incorporated by reference to the Company's Definitive Proxy
Statement relating to its 1994 Annual Meeting of Stockholders.
(5) Incorporated by reference to the Company's Annual Report on Form
10-K for the year ended December 31, 1994.
(6) Incorporated by reference to the Company's Annual Report on Form
10-K for the year ended December 31, 1995.
(7) Incorporated by reference to the Company's Definitive Proxy
Statement relating to its 1996 Annual Meeting of Stockholders.
(8) Incorporated by reference to the Company's Annual Report on Form
10-K for the year ended December 31, 1996.
(9) Incorporated by reference to the Company's Quarterly Report on Form
10-Q for the three months ended September 30, 1997.
(10) Incorporated by reference to the Company's Registration Statement
on Form 8-K declared effective by the Security and Exchange
Commission on December 12, 1997.
(11) Incorporated by reference to the Company's Definitive Proxy
Statement relating to the Special Shareholder Meeting held on
December 11, 1997.
(12) Incorporated by reference to the Company's Annual Report on Form
10-K for the year ended December 31, 1997.
(13) Incorporated by reference to the Company's Definitive Proxy
Statement relating to its 1998 Annual Meeting of Stockholders.
(14) Incorporated by reference to the Company's Registration Statement
on Form S-3 (No 333-46201) declared effective by the Securities and
Exchange Commission on March 23, 1998.
(15) Filed herewith.
(b) REPORTS ON FORM 8-K:
None.
15
<PAGE> 17
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.
Date: November 13, 1998
HERBALIFE INTERNATIONAL, INC.
(Registrant)
By: /s/ TIMOTHY GERRITY
----------------------------------
Timothy Gerrity
Executive Vice President and
Chief Financial Officer
16
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<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-END> SEP-30-1998
<CASH> 66,673,000
<SECURITIES> 9,037,000
<RECEIVABLES> 37,638,000
<ALLOWANCES> 0
<INVENTORY> 92,709,000
<CURRENT-ASSETS> 239,009,000
<PP&E> 71,580,000
<DEPRECIATION> 41,514,000
<TOTAL-ASSETS> 299,574,000
<CURRENT-LIABILITIES> 122,510,000
<BONDS> 2,033,000
0
0
<COMMON> 286,000
<OTHER-SE> 152,059,000
<TOTAL-LIABILITY-AND-EQUITY> 299,574,000
<SALES> 632,752,000
<TOTAL-REVENUES> 1,199,293,000
<CGS> 165,884,000
<TOTAL-COSTS> 349,813,000
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> 61,806,000
<INCOME-TAX> 23,795,000
<INCOME-CONTINUING> 37,169,000
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 37,169,000
<EPS-PRIMARY> 1.28
<EPS-DILUTED> 1.24
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