e424a
The information
in this prospectus is not complete and may be changed. We may
not sell these securities until the registration statement filed
with the Securities and Exchange Commission is effective.
This prospectus is not an offer to sell these securities and it
is not soliciting an offer to buy these securities in any state
where the offer or sale is not
permitted.
|
As filed pursuant to Rule 424(a)
Under the Securities Act of 1933.
Registration No. 333-129683
Subject to Completion
Preliminary Prospectus dated
November 28, 2005
PROSPECTUS
10,000,000 Shares
Common Shares
Herbalife Ltd. shareholders are selling all of the shares.
The shares trade on the New York Stock Exchange under the symbol
HLF. On November 28, 2005, the last sale price
of the shares as reported on the New York Stock Exchange was
$29.84 per share.
Investing in our common shares involves risks that are
described in the Risk Factors section beginning on
page 7 of this prospectus.
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Underwriting | |
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Proceeds to | |
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Discounts and | |
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Selling | |
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Price to Public | |
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Commissions | |
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Shareholders | |
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Per Share
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$ |
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$ |
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$ |
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Total
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$ |
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$ |
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$ |
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The underwriters may also purchase up to an additional
1,500,000 shares from the selling shareholders, at the
public offering price, less the underwriting discount, within
30 days from the date of this prospectus to cover
over-allotments.
Neither the Securities and Exchange Commission nor any state
securities commission has approved or disapproved of these
securities or determined if this prospectus is truthful or
complete. Any representation to the contrary is a criminal
offense.
The shares will be ready for delivery on or
about ,
2005.
|
|
Merrill Lynch & Co. |
Morgan Stanley |
Banc of America Securities
LLC
|
|
|
Credit Suisse First
Boston |
,
2005.
TABLE OF CONTENTS
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F-1 |
|
You should rely only on the information contained in this
document or to which we have referred you. We have not
authorized anyone to provide you with information that is
different. This document may only be used where it is legal to
sell these securities. The information in this document may only
be accurate on the date of this document.
i
PROSPECTUS SUMMARY
The following summary should be read in conjunction with, and
is qualified in its entirety by, the more detailed information
and financial statements (including the accompanying notes)
appearing elsewhere in this prospectus. We amended our
Memorandum and Articles of Association to change our name from
WH Holdings (Cayman Islands) Ltd. to Herbalife Ltd. Unless
otherwise noted, the terms we, our,
us, Company and Successor
refer to Herbalife Ltd. (Herbalife) and its
subsidiaries, including WH Capital Corporation (WH Capital
Corp.) and Herbalife International, Inc. (Herbalife
International) and its subsidiaries for periods subsequent
to Herbalife Internationals acquisition on July 31,
2002, by an investment group led by Whitney & Co., LLC
and Golden Gate Private Equity, Inc. (the
Acquisition), and the terms we,
our, us, Company and
Predecessor refer to Herbalife International before
the Acquisition for periods through July 31, 2002.
Herbalife is a holding company, with substantially all of its
assets consisting of the capital stock of its indirect,
wholly-owned subsidiary, Herbalife International. See
Corporate Structure and Information. You
should carefully consider the information set forth under
Risk Factors. In addition, certain statements in
this prospectus are forward-looking statements which involve
risks and uncertainties. See Disclosure Regarding
Forward-Looking Statements.
HERBALIFE
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 $1.3 billion for the year ended
December 31, 2004. We sell our products in 60 countries
through a network of over one million independent distributors.
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
25-year operating history.
We offer products in three principal categories: weight
management, nutritional supplements which we refer to as
inner nutrition and personal care 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, nutrition and
personal care for our consumers and maximize our
distributors cross-selling opportunities. We also sell
literature and promotional materials designed to support our
distributors business. The following table illustrates our
principal product categories:
|
|
|
|
|
Product Category |
|
Description |
|
Representative Products |
|
|
|
|
|
Weight Management
(42.8% of 2004 Net Sales) |
|
Meal replacements, weight-loss accelerators and a variety of
healthy snacks |
|
Formula 1
Personalized Protein Powder
Total Control®
High Protein Bars and Snacks |
Inner Nutrition
(42.9% of 2004 Net Sales) |
|
Dietary and nutritional supplements containing herbs, vitamins,
minerals and other natural ingredients |
|
Niteworkstm
Garden
7tm
Aloe Concentrate
Liftoff tm |
Outer Nutrition®
(9.4% of 2004 Net Sales) |
|
Skin cleansers, moisturizers, lotions, shampoos and conditioners |
|
Skin Activator® Cream
Radiant
Ctm
Body Lotion
Herbal Aloe Everyday Shampoo
NouriFusiontm |
We are committed to providing products with scientific
substantiation. We have significantly increased our emphasis on
scientific research in the fields of weight management and
nutrition over the past three years. We believe that our focus
on nutrition science will continue to result in meaningful
product enhancements that differentiate our products in the
marketplace. Our research and development organization combines
the
1
experience of product development scientists within our company
with an external team including world-renowned scientists.
Additionally, we contributed to the establishment of the Mark
Hughes Cellular and Molecular Nutritional Lab at UCLA (the
UCLA Lab), which is an independent lab devoted to
the advancement of nutrition science. In 2003, we also
introduced
Niteworkstm,
a cardiovascular product developed in conjunction with Louis
Ignarro, Ph.D., a Nobel Laureate in Medicine and, in March
2004, we introduced
ShapeWorkstm,
a comprehensive weight management program based on the clinical
experience and the 16 years of meal replacement research of
David Heber, M.D., Ph.D., professor, and Director of
the UCLA Center for Human Nutrition.
We have a 16-member Scientific Advisory Board, comprised of
world-renowned scientists, and a Medical Advisory Board
consisting of leading medical doctors. We consult with members
of our Scientific Advisory Board on the advancements in the
field of nutrition science, while our Medical Advisory Board
provides training on product usage and gives health-news updates
through Herbalife literature, the internet and live training
events around the world. The boards, both chaired by
Dr. David Heber, support our internal product development
team by providing expertise on obesity and human nutrition,
conducting product research and advising on product concepts.
We believe that the direct selling channel is ideally suited to
marketing our products. Through education, ongoing personalized
customer care and first-hand testimonials of product
effectiveness, distributors can motivate their customers to
begin and maintain their wellness and weight management
programs. We are focused on building and maintaining our
distributor network by offering financially rewarding and
flexible career opportunities through sales of quality,
innovative products to health conscious consumers. We believe
the income opportunity provided by our network marketing program
appeals to a broad cross-section of people throughout the world,
particularly those seeking to supplement family income, start a
home business or pursue entrepreneurial, full and part-time
employment opportunities. Our distributors, who are all
independent contractors, can profit from selling our products
and can also earn royalties and bonuses on sales made by the
distributors whom they recruit to join their sales
organizations. We actively support our distributors through a
broad array of motivational, educational, technical and support
services, including individual recognition, reward programs and
promotions, and participation in local, national and
international Company-sponsored World Team School events and
Extravaganzas.
Our Competitive Strengths
We believe that our success stems from our ability to motivate
our distributor network with a range of quality, innovative and
efficacious products that appeal to consumer preferences for
healthy living. We have been able to achieve sustained and
profitable growth by capitalizing on the following competitive
strengths:
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our large and highly motivated distributor base; |
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our diverse and well-established product portfolio; |
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our nutrition science-based product development approach; |
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|
our scalable business model; |
|
|
|
our geographic diversification; and |
|
|
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our experienced management team. |
2
Our Business Strategy
We believe that our network marketing model is the most
effective way to sell our products. Our objective is to increase
the recruitment, retention, retailing and productivity of our
distributor base by pursuing the following strategic initiatives:
|
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|
|
Distributor Strategy: to invest in events, promotions,
systems and tools and Company branding initiatives, as well as
globalize successful programs to help distributors build their
businesses; |
|
|
|
Direct to Consumer Strategy: to provide a platform for
consumers to purchase directly from us via the Internet while
maintaining their relationships with distributors; |
|
|
|
Product Strategy: to continue introducing science-based
products that help our distributors increase product retailing
and recruit and retain distributors; |
|
|
|
China Strategy: to expand our business in China under the
newly issued Direct Selling Regulations; and |
|
|
|
Infrastructure Strategy: to improve and strengthen our
technology infrastructure and distribution network and invest in
our employees through an organizational development program. |
Our Sponsors
We acquired Herbalife International on July 31, 2002, which
we refer to herein as the Acquisition. We were
formed by and on behalf of an investment group led by
Whitney & Co., LLC (Whitney) and Golden
Gate Private Equity, Inc. (Golden Gate Capital),
which we refer to collectively herein as the Equity
Sponsors, to consummate the Acquisition.
Whitney was established in 1946 by John Hay Whitney as one of
the first U.S. firms involved in the development of the
private equity industry. Today, Whitney remains a private firm
owned by investing professionals and its main activities are to
provide private equity and debt capital for middle market growth
companies. Whitney manages approximately $5 billion of
assets for endowments, foundations and pension plans and is
currently investing its fifth outside equity fund,
Whitney V, L.P., a fund with committed capital of
$1.1 billion.
Golden Gate Capital is a San Francisco-based private equity
investment firm with $2.6 billion of capital under
management from leading endowments and a number of Fortune 500
CEOs. The firms charter is to partner with world-class
management teams to invest in change-intensive, growth
businesses. The principals of Golden Gate Capital have a long
and successful history of investing with management partners
across a wide range of industries and transaction types,
including leveraged buyouts and recapitalizations, corporate
divestitures and spin-offs, build-ups and venture stage
investing. Additionally, the principals of Golden Gate Capital
draw on their strong consulting heritage at Bain &
Company in their investment approach.
Corporate Structure and Information
We were incorporated under the laws of the Cayman Islands in
April 2002 and have a foreign holding and operating company
structure. Our first and second tier subsidiaries are organized
either in the United States, Luxembourg or the Cayman Islands.
We believe that this foreign holding and operating company
structure provides us with an effective platform to organize our
international business activities and to take advantage of
favorable environments to implement our international business,
operating and financial strategies. International activities are
an important part of our business. For the fiscal year ended
December 31, 2004, approximately 81% of our net sales were
generated outside the U.S.
Our principal executive offices are located c/o Herbalife
International at 1800 Century Park East, Los Angeles,
California, 90067, and our telephone number is
c/o Herbalife International at (310) 410-9600. Our
website address is www.herbalife.com. The information on
our website is not a part of this prospectus. We have included
our website address in this document as an inactive textual
reference only.
3
THE OFFERING
|
|
|
Common shares offered by the selling shareholders |
|
10,000,000 shares |
|
Common shares outstanding after this offering |
|
69,400,666 shares |
|
Use of proceeds |
|
The selling shareholders will receive all net proceeds from the
sale of common shares to be sold in this offering. Accordingly,
we will not receive any proceeds from the sale of common shares
by the selling shareholders. |
|
Risk factors |
|
See Risk Factors beginning on page 7 of this
prospectus for a discussion of factors you should carefully
consider before deciding to invest in our common shares. |
|
New York Stock Exchange symbol |
|
HLF |
|
Over-allotment option |
|
Affiliates of the Equity Sponsors have granted the underwriters
an option to purchase up to an additional 1,500,000 common
shares to cover over-allotments, if any. |
Unless we specifically state otherwise, all information in this
prospectus:
|
|
|
|
|
assumes no exercise of the over-allotment option granted by the
selling shareholders in favor of the underwriters; |
|
|
|
is based upon 69,400,666 shares outstanding as of
November 3, 2005; |
|
|
|
assumes no exercise of options and warrants to purchase
11.4 million of our common shares outstanding as of
November 3, 2005 with a weighted average exercise price of
$12.00 per share; and |
|
|
|
assumes no issuance of additional options to purchase our common
shares under our existing stock incentive plans. |
4
SUMMARY CONSOLIDATED FINANCIAL DATA
The following table sets forth certain of our historical
financial data for the periods and as of the dates indicated. We
derived the summary consolidated financial data for the seven
month period ended July 31, 2002, the five month period
ended December 31, 2002, and the years ended
December 31, 2003 and 2004, from our audited consolidated
financial statements and the related notes included elsewhere in
this prospectus. We have derived the summary consolidated
financial data as of and for the nine months ended
September 30, 2004 and 2005, from the unaudited
consolidated financial statements and related notes included
elsewhere in this prospectus. The summary financial data set
forth below are not necessarily indicative of the results of
future operations.
The summary financial data should be read in conjunction with
our audited consolidated financial statements, the selected
consolidated historical financial data and the unaudited
financial statements, and, in each case, the related notes
included elsewhere in this prospectus, in addition to the
discussion under the heading Managements Discussion
and Analysis of Financial Condition and Results of
Operations. All common share and earnings per share data
for the Company gives effect to a 1:2 reverse stock split of our
common shares, which took effect December 1, 2004.
|
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|
|
Predecessor | |
|
Company | |
|
|
| |
|
| |
|
|
|
|
|
|
Year Ended | |
|
Nine Months Ended | |
|
|
January 1 to | |
|
August 1 to | |
|
December 31, | |
|
September 30, | |
|
|
July 31, | |
|
December 31, | |
|
| |
|
| |
|
|
2002 | |
|
2002 | |
|
2003 | |
|
2004 | |
|
2004 | |
|
2005 | |
|
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
|
(In thousands, except per share amounts) | |
Statement of Income Data:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net sales
|
|
$ |
644,188 |
|
|
$ |
449,524 |
|
|
$ |
1,159,433 |
|
|
$ |
1,309,663 |
|
|
$ |
968,021 |
|
|
$ |
1,157,724 |
|
Gross profit
|
|
|
503,635 |
|
|
|
354,523 |
|
|
|
923,648 |
|
|
|
1,039,750 |
|
|
|
769,197 |
|
|
|
925,132 |
|
Operating
income(1)
|
|
|
14,304 |
|
|
|
52,889 |
|
|
|
107,036 |
|
|
|
138,719 |
|
|
|
111,020 |
|
|
|
164,827 |
|
Net income (loss)
|
|
|
9,212 |
|
|
|
14,005 |
|
|
|
36,847 |
|
|
|
(14,311 |
) |
|
|
23,094 |
|
|
|
63,187 |
|
Earnings (loss) per share:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
$ |
0.28 |
|
|
$ |
|
|
|
$ |
|
|
|
$ |
(0.27 |
) |
|
$ |
0.44 |
|
|
$ |
0.92 |
|
|
Diluted
|
|
$ |
0.27 |
|
|
$ |
0.27 |
|
|
$ |
0.69 |
|
|
$ |
(0.27 |
) |
|
$ |
0.42 |
|
|
$ |
0.87 |
|
Weighted average shares outstanding:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
|
32,387 |
|
|
|
|
|
|
|
|
|
|
|
52,911 |
|
|
|
52,121 |
|
|
|
68,800 |
|
|
Diluted
|
|
|
33,800 |
|
|
|
51,021 |
|
|
|
53,446 |
|
|
|
52,911 |
|
|
|
55,246 |
|
|
|
72,373 |
|
Other Financial Data:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Retail sales (unaudited)
(2)
|
|
|
1,047,690 |
|
|
|
731,505 |
|
|
|
1,894,384 |
|
|
|
2,146,241 |
|
|
|
1,584,011 |
|
|
|
1,904,560 |
|
Acquisition transaction expenses
|
|
|
54,708 |
|
|
|
6,183 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Depreciation and amortization
|
|
|
11,722 |
|
|
|
11,424 |
|
|
|
55,605 |
|
|
|
43,896 |
|
|
|
34,287 |
|
|
|
27,749 |
|
Capital
expenditures(3)
|
|
|
6,799 |
|
|
|
3,599 |
|
|
|
20,435 |
|
|
|
30,279 |
|
|
|
20,681 |
|
|
|
22,301 |
|
5
|
|
|
|
|
|
|
As of | |
|
|
September 30, | |
|
|
2005 | |
|
|
| |
|
|
(In thousands) | |
Balance Sheet Data:
|
|
|
|
|
Cash and cash equivalents
|
|
$ |
105,180 |
|
Total working
capital(4)
|
|
|
9,398 |
|
Total assets
|
|
|
827,402 |
|
Total debt
|
|
|
288,328 |
|
Other long-term liabilities
|
|
|
144,038 |
|
Shareholders equity
|
|
|
130,816 |
|
|
|
(1) |
Operating income for the seven months ended July 31, 2002,
and the five months ended December 31, 2002, includes
pre-tax charges of $54.7 million and $6.2 million,
respectively, relating to fees and expenses in connection with
the Acquisition and, for the year ended 2003, includes a
$5.1 million charge for legal and related costs associated
with litigation resulting from the Acquisition. |
|
(2) |
In previous years, we reported retail sales on the face of our
income statement in addition to the required disclosure of net
sales. Retail sales represent the gross sales amount reflected
on our invoices to our distributors. We do not receive the
retail sales amount. Product sales represent the
actual product purchase price paid to us by our distributors,
after giving effect to distributor discounts referred to as
distributor allowances, which total approximately
50% of suggested 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. Net sales represent product
sales and including handling and freight income. |
|
|
|
Retail sales data is referred to in Managements
Discussion and Analysis of Financial Condition and Results of
Operations. Our use of retail sales reflect the
fundamental role of retail sales in our accounting
systems, internal controls and operations, including the basis
upon which our distributors are paid. In addition, information
in daily and monthly reports reviewed by our management relies
on retail sales data. |
|
|
The following represents the reconciliation of retail sales to
net sales for each of the periods set forth above: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Predecessor | |
|
Company | |
|
|
| |
|
| |
|
|
|
|
|
|
Year Ended | |
|
Nine Months Ended | |
|
|
January 1 to | |
|
August 1 to | |
|
December 31, | |
|
September 30, | |
|
|
July 31, | |
|
December 31, | |
|
| |
|
| |
|
|
2002 | |
|
2002 | |
|
2003 | |
|
2004 | |
|
2004 | |
|
2005 | |
|
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
|
(In thousands) | |
Retail sales (unaudited)
|
|
$ |
1,047,690 |
|
|
$ |
731,505 |
|
|
$ |
1,894,384 |
|
|
$ |
2,146,241 |
|
|
$ |
1,584,011 |
|
|
$ |
1,904,560 |
|
Distributor allowance (unaudited)
|
|
|
(492,997 |
) |
|
|
(345,145 |
) |
|
|
(899,264 |
) |
|
|
(1,021,196 |
) |
|
|
(752,682 |
) |
|
|
(907,176 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Product sales
|
|
|
554,693 |
|
|
|
386,360 |
|
|
|
995,120 |
|
|
|
1,125,045 |
|
|
|
831,329 |
|
|
|
997,384 |
|
Handling and freight income
|
|
|
89,495 |
|
|
|
63,164 |
|
|
|
164,313 |
|
|
|
184,618 |
|
|
|
136,692 |
|
|
|
160,340 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net sales
|
|
$ |
644,188 |
|
|
$ |
449,524 |
|
|
$ |
1,159,433 |
|
|
$ |
1,309,663 |
|
|
$ |
968,021 |
|
|
$ |
1,157,724 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(3) |
Includes acquisitions of property through capitalized leases of
$2.1 million for the seven months ended July 31, 2002,
$1.4 million for the five months ended December 31,
2002, $6.8 million for the year ended December 31,
2003, $7.2 million for the year ended December 31, 2004,
$3.9 million for the nine months ended September 30,
2004 and $0.5 million for the nine months ended
September 30, 2005. |
|
(4) |
Includes cash and cash equivalents. |
6
RISK FACTORS
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 approximately 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 and non-supervisor
distributors requalify annually in order to help us maintain a
more accurate count of their numbers. For the latest twelve
month re-qualification period ending January 2005, 60% of our
supervisors did not re-qualify and more than 90% of our
distributors that are not supervisors turned over. 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.
We estimate that, of our over one million independent
distributors, we had approximately 201,000 supervisors after
requalifications in February 2005. 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 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
7
independent distributors. If any of these events occur, the
value of an investment in our common shares could be impaired.
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. |
Adverse publicity concerning any actual or purported failure of
our Company or our 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 affect 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 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 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
8
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. |
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, 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.
9
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. For example,
the Food and Drug Administration, or the FDA, has announced
plans to issue new guidance or regulations relating to low
carbohydrate claims for foods, which could negatively impact our
sales of such products.
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. Further, 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 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 manufacturer 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. This will mean that some of our contract
manufacturers will not be fully impacted by the proposed
regulation until at least 2008. 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
10
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 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 $31,000 as of September 30, 2005) per
purported violation as well as costs of the trial. For the year
ended December 31, 2004, our net sales in Belgium were
approximately $19.7 million. Currently, the lawsuit is in
the pleading stage. The plaintiffs filed their initial brief on
September 27, 2005. 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 81% of our net sales for the nine months ended
September 30, 2005, 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 risk 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.
11
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 proposal form in September 2005. When final, effective
and applicable to us, these regulations will require us to use a
business model different from that which we offer in other
markets. To allow us to operate in advance of the effectiveness
of these new regulations, as well as to operate once those
regulations are implemented, 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. Once the regulations are effective, we also expect to
sell through independent direct sellers. These features are not
common to the business model we employ elsewhere in the world.
The direct selling regulations require us to apply for approval
to conduct a direct selling enterprise in China. There can be no
assurance that we will be able to obtain that license.
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.
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
12
which we compete or to successfully expand our business into
additional countries in Eastern Europe, Southeast Asia, South
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. We cannot
assure you that our 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, 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. As part of this
upgrade, we have invested approximately $38.4 million as of
September 30, 2005. We intend to invest an additional
$25.0 million through December 31, 2006. We are
implementing an Oracle enterprise-wide technology solution, a
scalable and stable open architecture platform, to enhance our
and our distributors efficiency and
13
productivity. In addition, we are upgrading our internet-based
marketing and distributor services platform,
MyHerbalife.com. We expect these initiatives to be
substantially complete by 2007.
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 cGMPs 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
tradename rights used in connection with the packaging,
marketing and distribution of our products in the markets where
those products are sold. Therefore, trademark and tradename
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 tradename 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
14
legal recourse in the event we 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
non-compliant advertising practice, there can be no assurance
that we could not be held 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 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.
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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%, 23% and 21% of retail sales for the nine months ended
September 30, 2005, and the fiscal years ended
December 31, 2004, 2003 and 2002, 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 re-establish 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 such key personnel could
negatively impact our ability to implement our business
strategy, and our continued success will also be dependent upon
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
91/2% Notes
and senior credit facility contain 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. |
In addition, our senior 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 outstanding notes and/or the senior credit
facility, which is secured by substantially all of our assets,
which the lenders thereunder could proceed to foreclose against.
16
If we do not comply with transfer pricing and similar tax
regulations, then we may be subjected to additional taxes,
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 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, 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.
17
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.
A few of our shareholders will 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 November 3, 2005, affiliates of Whitney and Golden
Gate Capital own approximately 60.4% of the voting power of our
share capital. After this offering, affiliates of Whitney and
Golden Gate Capital will own approximately 46.6% of the voting
power of our share capital. Accordingly, the Equity Sponsors
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 and they will
have significant control over 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, the Equity Sponsors may have interests that conflict
with yours.
We are subject to, among other things, the attestation
requirements regarding the effectiveness of internal control
over financial reporting. These requirements have increased our
compliance costs, and failure to comply in a timely manner could
adversely affect the value of our securities.
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
Commission, the Public Company Accounting Oversight Board and
the NYSE. In particular, we are required to include management
and auditor reports on the effectiveness of internal control
over financial reporting as part of our annual report on
Form 10-K for the year ended December 31, 2005,
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.
Risks Related to This Offering and Your Investment in Our
Common Shares
Future sales of shares by existing shareholders could
cause our stock price to decline.
If our existing shareholders sell, or indicate an intention to
sell, substantial amounts of our common shares in the public
market after the 90-day contractual lock-up, which is subject to
adjustment, and other legal restrictions on resale discussed in
this prospectus lapse, the trading price of our common shares
could decline below the offering price. Based on the number of
shares outstanding as of November 3, 2005, upon completion
of this offering, we will have 69,400,666 outstanding common
shares. Merrill Lynch, Pierce, Fenner & Smith
Incorporated and Morgan Stanley & Co. Incorporated, on
behalf of the underwriters, may, in their sole discretion,
permit those who have entered into lock-up agreements with the
underwriters to sell shares prior to the expiration of the
lock-up agreements.
After the lock-up agreements pertaining to this offering expire
(90 days or more from the date of this prospectus, subject
to adjustment), all of our outstanding shares will be eligible
for sale in the public market, but they will be subject to
volume limitations under Rule 144 under the Securities Act.
In addition, the 11.4 million shares subject to outstanding
options and rights under our various incentive plans and
warrants are eligible for sale in the public market to the
extent permitted by the provisions of various vesting
agreements, the lock-up agreements and Rules 144 and 701
under the Securities Act. If these additional shares are sold, or
18
if it is perceived that they will be sold in the public market,
the trading price of our common shares could decline.
The trading price of our common shares is likely to be
volatile, and you might not be able to sell your shares at or
above the offering price.
The trading price of our common shares is likely to be subject
to fluctuations. Factors affecting the trading price of our
common shares may include:
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variations in our financial results; |
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announcements of new business initiatives by us or by our
competitors; |
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recruitment or departure of key personnel and key distributors; |
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changes in the estimates of our financial results or changes in
the recommendations of any securities analysts that elect to
follow our common shares or the common shares of our competitors; |
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our failure to timely address changing customer or distributor
preferences; |
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announcements of regulatory or third party claims; and |
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market conditions in our industry and the economy as a whole. |
In addition, if the market for weight management, nutrition, or
network marketing stocks or the stock market in general
experiences loss of investor confidence, the trading price of
our common shares could decline for reasons unrelated to our
business or financial results. The trading price of our common
shares might also decline in reaction to events that affect
other companies in our industry even if these events do not
directly affect us.
If securities analysts do not publish research or reports
about our business or if they downgrade our stock, the price of
our stock could decline.
The trading market for our common shares relies in part on the
research and reports that industry or financial analysts publish
about us or our business. We do not control these analysts.
Furthermore, if one or more of the analysts who do cover us
downgrades our stock, the price of our stock could decline. If
one or more of these analysts ceases coverage of our Company, we
could lose visibility in the market.
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, 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
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
19
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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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 of arrangement is not one that would more properly be
sanctioned under some other provision of the Companies Law. |
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
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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.
DISCLOSURE REGARDING FORWARD-LOOKING STATEMENTS
This prospectus contains forward-looking statements
within the meaning of Section 27A of 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 prospectus. 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:
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our relationship with, and our ability to influence the actions
of, our distributors; |
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adverse publicity associated with our products or network
marketing organization; |
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uncertainties relating to interpretation and enforcement of
recently enacted legislation in China governing direct selling; |
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adverse changes in the Chinese economy, Chinese legal system or
Chinese governmental policies; |
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risk of improper action by Chinese employees or international
distributors in violation of Chinese law; |
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changing consumer preferences and demands; |
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the competitive nature of our business; |
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regulatory matters governing our products, including potential
governmental or regulatory actions concerning the safety or
efficacy of our products, and network marketing program; |
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risks associated with operating internationally, including
foreign exchange risks; |
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our dependence on increased penetration of existing markets; |
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contractual limitations on our ability to expand our business; |
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our reliance on our information technology infrastructure and
outside manufacturers; |
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the sufficiency of trademarks and other intellectual property
rights; |
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product concentration; |
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our reliance on our management team; |
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uncertainties relating to the application of transfer pricing
and similar tax regulations; |
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taxation relating to our distributors; and |
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product liability claims. |
Additional factors that could cause actual results to differ
materially from our forward-looking statements are set forth in
this prospectus, including under the headings Prospectus
Summary, Risk Factors, Managements
Discussion and Analysis of Financial Condition and Results of
Operations, Business and in our
Prospectus Summary-Summary Consolidated Financial
Data and the related notes. We do not intend, and
undertake no obligation, to update any forward-looking
statement. The Private Securities Litigation Reform Act of 1995
and Section 27A of the Securities Act do not protect
forward-looking statements we make in connection with this
offering.
Before deciding whether to invest in our common shares, you
should carefully consider the matters set forth under the
heading Risk Factors and all other information
contained in this prospectus. All subsequent written and oral
forward-looking statements attributable to us, or persons acting
on our behalf, are expressly qualified in their entirety by the
cautionary statements.
Forward-looking statements in this prospectus 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. We do 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.
MARKET DATA
Market data and other statistical information used throughout
this prospectus are based on independent industry publications,
government publications and reports by market research firms or
other published independent sources. Some data are also based on
our good faith estimates, which are derived from our review of
internal surveys, as well as the independent sources listed
above. We believe that these sources are reliable.
USE OF PROCEEDS
The selling shareholders will receive all net proceeds from the
sale of common shares to be sold in this offering. Accordingly,
we will not receive any proceeds from the sale of common shares
by the selling shareholders.
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PRICE RANGE OF OUR COMMON SHARES
Herbalifes common shares are listed on the New York Stock
Exchange (NYSE). The common shares trade on the NYSE under the
symbol HLF.
The following table sets forth, for the period indicated, the
high and low sales prices per share for our common shares as
reported by NYSE consolidated tape.
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2004
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Fourth Quarter
|
|
$ |
16.85 |
|
|
$ |
14.00 |
|
2005
|
|
|
|
|
|
|
|
|
|
First Quarter
|
|
$ |
16.70 |
|
|
$ |
15.10 |
|
|
Second Quarter
|
|
$ |
21.86 |
|
|
$ |
14.52 |
|
|
Third Quarter
|
|
$ |
30.50 |
|
|
$ |
21.00 |
|
|
Fourth Quarter (through November 28, 2005)
|
|
$ |
33.75 |
|
|
$ |
25.25 |
|
The closing sale price of our common shares, as reported by the
NYSE on November 28, 2005, was $29.84. As of
November 3, 2005, there were 1,336 holders of record of our
common shares, not including beneficial owners of shares
registered in nominee or street name.
DIVIDEND POLICY
We have not paid any dividends since becoming a publicly traded
company in December 2004, except as described under
Certain Relationships and Related Transactions
Special Cash Dividend, and we do not currently intend to
pay any dividends. From time to time management may evaluate our
dividend policies. However, the declaration and payment of
dividends to holders of our common shares will be entirely at
the discretion of our board of directors and will depend upon
many factors, including our financial condition, earnings, legal
requirements and other factors our board of directors deems
relevant. The terms of our current and future indebtedness may
also restrict us from paying cash dividends.
23
CAPITALIZATION
The following table sets forth our cash and cash equivalents and
capitalization as of September 30, 2005. You should read
this table in conjunction with Selected Consolidated
Historical Financial Data, Managements
Discussion and Analysis of Financial Condition and Results of
Operations and our consolidated financial statements, and
in each case, the related notes included elsewhere in this
prospectus.
|
|
|
|
|
|
|
|
|
|
As of | |
|
|
September 30, 2005 | |
|
|
| |
|
|
(In thousands) | |
Cash and cash equivalents
|
|
$ |
105,180 |
|
|
|
|
|
Debt (including current portion):
|
|
|
|
|
|
Borrowings under our senior credit facility
|
|
|
119,137 |
|
|
91/2% Notes,
net
|
|
|
161,212 |
|
|
Capitalized leases and other debt
|
|
|
7,979 |
|
|
|
|
|
|
|
Total debt
|
|
|
288,328 |
|
|
|
|
|
Shareholders equity:
|
|
|
|
|
|
Common shares, par value $0.002 per share,
175,000,000 shares authorized, 69,347,198 shares outstanding
|
|
|
139 |
|
|
Paid-in capital in excess of par
|
|
|
78,836 |
|
|
Accumulated other comprehensive income
|
|
|
2,965 |
|
|
Retained earnings
|
|
|
48,876 |
|
|
|
|
|
|
|
Total shareholders equity
|
|
|
130,816 |
|
|
|
|
Total capitalization
|
|
$ |
419,144 |
|
|
|
|
|
24
SELECTED CONSOLIDATED HISTORICAL FINANCIAL DATA
The following table sets forth certain of our historical
financial data for the periods and as of the dates indicated. We
have derived the selected historical consolidated financial data
for the seven month period ended July 31, 2002, the five
month period ended December 31, 2002, and as of and for the
years ended December 31, 2003 and 2004, from our audited
financial statements and the related notes included elsewhere in
this prospectus. The selected historical consolidated financial
data as of December 31, 2000, 2001, 2002 and for the years
ended December 31, 2000 and 2001, have been derived from
our audited financial statements for such years, which are not
included in this prospectus. We have derived the selected
historical consolidated financial data as of and for the nine
months ended September 30, 2004 and 2005, from our
unaudited consolidated financial statements and the related
notes included elsewhere in this prospectus. The selected
consolidated historical financial data set forth below are not
necessarily indicative of the results of future operations and
should be read in conjunction with the discussion under the
heading Managements Discussion and Analysis of
Financial Condition and Results of Operations, and the
historical consolidated financial statements and accompanying
notes included elsewhere in this prospectus. All common share
and earnings per share data for the Company gives effect to a
1:2 reverse stock split, which took effect December 1, 2004.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Predecessor | |
|
Company | |
|
|
| |
|
| |
|
|
Year Ended | |
|
January 1 | |
|
|
|
Year Ended | |
|
Nine Months Ended | |
|
|
December 31, | |
|
to | |
|
August 1 to | |
|
December 31, | |
|
September 30, | |
|
|
| |
|
July 31, | |
|
December 31, | |
|
| |
|
| |
|
|
2000 | |
|
2001 | |
|
2002 | |
|
2002 | |
|
2003 | |
|
2004 | |
|
2004 | |
|
2005 | |
|
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
|
(In thousands, except per share amounts) | |
Income Statement Data:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net sales
|
|
$ |
1,085,484 |
|
|
$ |
1,020,130 |
|
|
$ |
644,188 |
|
|
$ |
449,524 |
|
|
$ |
1,159,433 |
|
|
$ |
1,309,663 |
|
|
$ |
968,021 |
|
|
$ |
1,157,724 |
|
Cost of sales
|
|
|
268,992 |
|
|
|
241,522 |
|
|
|
140,553 |
|
|
|
95,001 |
|
|
|
235,785 |
|
|
|
269,913 |
|
|
|
198,824 |
|
|
|
232,592 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross profit
|
|
|
816,492 |
|
|
|
778,608 |
|
|
|
503,635 |
|
|
|
354,523 |
|
|
|
923,648 |
|
|
|
1,039,750 |
|
|
|
769,197 |
|
|
|
925,132 |
|
Royalty overrides
|
|
|
382,322 |
|
|
|
355,225 |
|
|
|
227,233 |
|
|
|
159,915 |
|
|
|
415,351 |
|
|
|
464,892 |
|
|
|
342,366 |
|
|
|
410,875 |
|
Selling, general and administrative
expenses(1)
|
|
|
363,731 |
|
|
|
354,608 |
|
|
|
207,390 |
|
|
|
135,536 |
|
|
|
401,261 |
|
|
|
436,139 |
|
|
|
315,811 |
|
|
|
349,430 |
|
Acquisition transaction
expenses(2)
|
|
|
9,498 |
|
|
|
|
|
|
|
54,708 |
|
|
|
6,183 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating
income(1)
|
|
|
60,941 |
|
|
|
68,775 |
|
|
|
14,304 |
|
|
|
52,889 |
|
|
|
107,036 |
|
|
|
138,719 |
|
|
|
111,020 |
|
|
|
164,827 |
|
Interest income (expense), net
|
|
|
2,354 |
|
|
|
3,413 |
|
|
|
1,364 |
|
|
|
(23,898 |
) |
|
|
(41,468 |
) |
|
|
(123,305 |
) |
|
|
(55,233 |
) |
|
|
(37,598 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income before income taxes and minority interest
|
|
|
63,295 |
|
|
|
72,188 |
|
|
|
15,668 |
|
|
|
28,991 |
|
|
|
65,568 |
|
|
|
15,414 |
|
|
|
55,787 |
|
|
|
127,229 |
|
Income taxes
|
|
|
25,318 |
|
|
|
28,875 |
|
|
|
6,267 |
|
|
|
14,986 |
|
|
|
28,721 |
|
|
|
29,725 |
|
|
|
32,693 |
|
|
|
64,042 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income (loss) before minority interest
|
|
|
37,977 |
|
|
|
43,313 |
|
|
|
9,401 |
|
|
|
14,005 |
|
|
|
36,847 |
|
|
|
(14,311 |
) |
|
|
23,094 |
|
|
|
63,187 |
|
Minority interest
|
|
|
1,058 |
|
|
|
725 |
|
|
|
189 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income (loss)
|
|
$ |
36,919 |
|
|
$ |
42,588 |
|
|
$ |
9,212 |
|
|
$ |
14,005 |
|
|
$ |
36,847 |
|
|
$ |
(14,311 |
) |
|
$ |
23,094 |
|
|
$ |
63,187 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Earnings (loss) per share:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
$ |
1.28 |
|
|
$ |
1.40 |
|
|
$ |
0.28 |
|
|
$ |
|
|
|
$ |
|
|
|
$ |
(0.27 |
) |
|
$ |
0.44 |
|
|
$ |
0.92 |
|
|
Diluted
|
|
$ |
1.22 |
|
|
$ |
1.36 |
|
|
$ |
0.27 |
|
|
$ |
0.27 |
|
|
$ |
0.69 |
|
|
$ |
(0.27 |
) |
|
$ |
0.42 |
|
|
$ |
0.87 |
|
Weighted average shares outstanding:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
|
28,827 |
|
|
|
30,422 |
|
|
|
32,387 |
|
|
|
|
|
|
|
|
|
|
|
52,911 |
|
|
|
52,121 |
|
|
|
68,800 |
|
|
Diluted
|
|
|
30,353 |
|
|
|
31,250 |
|
|
|
33,800 |
|
|
|
51,021 |
|
|
|
53,446 |
|
|
|
52,911 |
|
|
|
55,246 |
|
|
|
72,373 |
|
25
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Predecessor | |
|
Company | |
|
|
| |
|
| |
|
|
Year Ended | |
|
January 1 | |
|
|
|
Year Ended | |
|
Nine Months Ended | |
|
|
December 31, | |
|
to | |
|
August 1 to | |
|
December 31, | |
|
September 30, | |
|
|
| |
|
July 31, | |
|
December 31, | |
|
| |
|
| |
|
|
2000 | |
|
2001 | |
|
2002 | |
|
2002 | |
|
2003 | |
|
2004 | |
|
2004 | |
|
2005 | |
|
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
|
(In thousands) | |
Other Financial Data:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Retail sales
(unaudited)(3)
|
|
$ |
1,764,851 |
|
|
$ |
1,656,168 |
|
|
$ |
1,047,690 |
|
|
$ |
731,505 |
|
|
$ |
1,894,384 |
|
|
$ |
2,146,241 |
|
|
$ |
1,584,011 |
|
|
$ |
1,904,560 |
|
Net cash provided by (used in):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating activities
|
|
|
46,141 |
|
|
|
95,465 |
|
|
|
37,901 |
|
|
|
28,039 |
|
|
|
94,648 |
|
|
|
80,223 |
|
|
|
80,981 |
|
|
|
130,878 |
|
|
Investing activities
|
|
|
(49,968 |
) |
|
|
(16,366 |
) |
|
|
18,995 |
|
|
|
(456,046 |
) |
|
|
2,854 |
|
|
|
(9,378 |
) |
|
|
(13,029 |
) |
|
|
(22,748 |
) |
|
Financing activities
|
|
|
(14,079 |
) |
|
|
(3,456 |
) |
|
|
(35,292 |
) |
|
|
491,519 |
|
|
|
(18,831 |
) |
|
|
(21,981 |
) |
|
|
(50,424 |
) |
|
|
(200,303 |
) |
|
Depreciation and amortization
|
|
|
15,693 |
|
|
|
18,056 |
|
|
|
11,722 |
|
|
|
11,424 |
|
|
|
55,605 |
|
|
|
43,896 |
|
|
|
34,287 |
|
|
|
27,749 |
|
Capital
expenditures(4)
|
|
|
25,383 |
|
|
|
14,751 |
|
|
|
6,799 |
|
|
|
3,599 |
|
|
|
20,435 |
|
|
|
30,279 |
|
|
|
20,681 |
|
|
|
22,301 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Predecessor | |
|
Company | |
|
|
| |
|
| |
|
|
As of December 31, | |
|
As of December 31, | |
|
As of | |
|
|
| |
|
| |
|
September 30, | |
|
|
2000 | |
|
2001 | |
|
2002 | |
|
2003 | |
|
2004 | |
|
2005 | |
|
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
|
(In thousands) | |
Balance Sheet Data:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash and cash
equivalents(5)
|
|
$ |
140,250 |
|
|
$ |
201,181 |
|
|
$ |
76,024 |
|
|
$ |
156,380 |
|
|
$ |
201,577 |
|
|
$ |
105,180 |
|
Receivables, net
|
|
|
24,600 |
|
|
|
27,609 |
|
|
|
29,026 |
|
|
|
31,977 |
|
|
|
29,546 |
|
|
|
40,787 |
|
Inventories
|
|
|
99,332 |
|
|
|
72,208 |
|
|
|
56,868 |
|
|
|
59,397 |
|
|
|
71,092 |
|
|
|
86,376 |
|
Total working capital
|
|
|
145,211 |
|
|
|
177,813 |
|
|
|
7,186 |
|
|
|
1,521 |
|
|
|
(1,556 |
) |
|
|
9,398 |
|
Total assets
|
|
|
416,937 |
|
|
|
470,335 |
|
|
|
855,705 |
|
|
|
903,964 |
|
|
|
948,701 |
|
|
|
827,402 |
|
Total debt
|
|
|
8,417 |
|
|
|
10,612 |
|
|
|
340,759 |
|
|
|
325,294 |
|
|
|
486,217 |
|
|
|
288,328 |
|
Shareholders equity
|
|
|
222,401 |
|
|
|
260,916 |
|
|
|
191,274 |
|
|
|
237,788 |
|
|
|
64,342 |
|
|
|
130,816 |
|
|
|
(1) |
The year ended December 31, 2003, includes
$5.1 million in legal and related costs associated with
litigation resulting from the Acquisition. |
|
(2) |
The year ended December 31, 2000, includes fees and
expenses in connection with a proposed acquisition transaction
by our founder, Mark Hughes. The seven months ended
July 31, 2002, and the five months ended December 31,
2002, include fees and expenses related to the Acquisition. |
|
(3) |
In previous years, we reported retail sales on the face of our
income statement in addition to the required disclosure of net
sales. Retail sales represent the gross sales amount reflected
on our invoices to our distributors. We do not receive the
retail sales amount. Product sales represent the
actual product purchase price paid to us by our distributors,
after giving effect to distributor discounts referred to as
distributor allowances, which total approximately
50% of suggested 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. Net sales represents product
sales and handling and freight income. |
|
|
|
Retail sales data is referred to in Managements
Discussion and Analysis of Financial Condition and Results of
Operations. Our use of retail sales reflect the
fundamental role of retail sales in our accounting
systems, internal controls and operations, including the basis
upon which the distributors are being paid. In addition,
information in daily and monthly reports reviewed by our
management relies on retail sales data. |
26
|
|
|
The following represents the reconciliation of retail sales to
net sales for each of the periods set forth above: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Predecessor | |
|
Company | |
|
|
| |
|
| |
|
|
Year Ended | |
|
|
|
|
|
Year Ended | |
|
Nine Months Ended | |
|
|
December 31, | |
|
January 1 | |
|
August 1 to | |
|
December 31, | |
|
September 30, | |
|
|
| |
|
to July 31, | |
|
December 31, | |
|
| |
|
| |
|
|
2000 | |
|
2001 | |
|
2002 | |
|
2002 | |
|
2003 | |
|
2004 | |
|
2004 | |
|
2005 | |
|
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
|
(In thousands) | |
Retail sales (unaudited)
|
|
$ |
1,764,851 |
|
|
$ |
1,656,168 |
|
|
$ |
1,047,690 |
|
|
$ |
731,505 |
|
|
$ |
1,894,384 |
|
|
$ |
2,146,241 |
|
|
$ |
1,584,011 |
|
|
$ |
1,904,560 |
|
Distributor allowance (unaudited)
|
|
|
(820,723 |
) |
|
|
(774,513 |
) |
|
|
(492,997 |
) |
|
|
(345,145 |
) |
|
|
(899,264 |
) |
|
|
(1,021,196 |
) |
|
|
(752,682 |
) |
|
|
(907,176 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Product sales
|
|
|
944,128 |
|
|
|
881,655 |
|
|
|
554,693 |
|
|
|
386,360 |
|
|
|
995,120 |
|
|
|
1,125,045 |
|
|
|
831,329 |
|
|
|
997,384 |
|
Handling and freight income
|
|
|
141,356 |
|
|
|
138,475 |
|
|
|
89,495 |
|
|
|
63,164 |
|
|
|
164,313 |
|
|
|
186,618 |
|
|
|
136,692 |
|
|
|
160,340 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net sales
|
|
$ |
1,085,484 |
|
|
$ |
1,020,130 |
|
|
$ |
644,188 |
|
|
$ |
449,524 |
|
|
$ |
1,159,433 |
|
|
$ |
1,309,663 |
|
|
$ |
968,021 |
|
|
$ |
1,157,724 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(4) |
Includes acquisition of property from capitalized leases of
$0.4 million, $3.8 million, $2.1 million,
$1.4 million, $6.8 million, $7.2 million,
$3.9 million and $0.5 million for 2000, 2001, the
seven months ended July 31, 2002, the five months ended
December 31, 2002, the year ended December 31, 2003
and 2004 and the nine months ended September 30, 2004 and
2005, respectively. |
|
(5) |
Includes restricted cash of $10.6 million and
$5.7 million as of December 31, 2002 and
December 31, 2003, respectively, and $1.3 million of
marketable securities at December 31, 2002. |
27
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION
AND RESULTS OF OPERATIONS
You should read the following discussion and analysis in
conjunction with Selected Consolidated Historical
Financial Data and the related notes and our consolidated
financial statements and related notes, each included elsewhere
in this prospectus.
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 $1.3 billion for the year ended
December 31, 2004. We sell our products in 60 countries
through a network of over one million independent distributors.
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 25-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 recruitment, retention, and retailing, and improving
distributor productivity by entering new markets, including
China, further penetrating existing markets, pursuing local
distributor initiatives, introducing new products, developing
niche market segments and further investing in our
infrastructure. We are continuing to strengthen the cooperation
between senior management and distributor leadership to focus on
these key initiatives.
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 region
or country directionally indicates an increase in local currency
net sales.
Volume Points by Geographic Region
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nine Months | |
|
|
Year Ended December 31, | |
|
Ended September 30, | |
|
|
| |
|
| |
|
|
2002 | |
|
2003 | |
|
% Change | |
|
2004 | |
|
% Change | |
|
2004 | |
|
2005 | |
|
% Change | |
|
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
|
(In millions) | |
The Americas
|
|
|
679.6 |
|
|
|
688.1 |
|
|
|
1.3 |
% |
|
|
761.7 |
|
|
|
10.7 |
% |
|
|
556.3 |
|
|
|
771.5 |
|
|
|
38.7 |
% |
Europe
|
|
|
472.3 |
|
|
|
525.0 |
|
|
|
11.2 |
|
|
|
574.5 |
|
|
|
9.4 |
|
|
|
437.3 |
|
|
|
432.8 |
|
|
|
(1.0 |
) |
Asia/ Pacific Rim
|
|
|
272.0 |
|
|
|
229.4 |
|
|
|
(15.7 |
) |
|
|
269.2 |
|
|
|
17.3 |
|
|
|
196.2 |
|
|
|
225.6 |
|
|
|
15.0 |
|
Japan
|
|
|
124.5 |
|
|
|
102.5 |
|
|
|
(17.8 |
) |
|
|
72.8 |
|
|
|
(29.0 |
) |
|
|
55.0 |
|
|
|
52.5 |
|
|
|
(4.5 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Worldwide
|
|
|
1,548.4 |
|
|
|
1,545.0 |
|
|
|
(0.2 |
)% |
|
|
1,678.2 |
|
|
|
8.6 |
% |
|
|
1,244.8 |
|
|
|
1,482.4 |
|
|
|
19.1 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Another key non-financial measure we focus on is the number of
distributors qualified as supervisors under our compensation
system. Distributors qualify for supervisor status based on
their Volume Points. 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
region. Our compensation system requires each supervisor
28
to re-qualify for such status each year, prior to February.
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, does not reflect a dramatic underlying
change in the business in comparing these two sequential
quarters, and will become more meaningful period to period
throughout the year.
The following tables show trends in the number of supervisors
over the reporting period by region, and fluctuations within
each notable country are discussed in the appropriate net sales
section below where pertinent. In February of each year, we
delete from the rank of supervisor those supervisors who did not
satisfy the supervisor qualification requirements during the
preceding twelve months. Distributors who meet the supervisor
requirements at any time during the year are promoted to
supervisor status at that time, including any supervisors who
were deleted, but who subsequently requalified.
Number of Supervisors by Geographic Region as of Reporting
Period
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As of December 31, | |
|
As of September 30, | |
|
|
| |
|
| |
|
|
2002 | |
|
2003 | |
|
% Change | |
|
2004 | |
|
% Change | |
|
2004 | |
|
2005 | |
|
% Change | |
|
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
The Americas
|
|
|
105,474 |
|
|
|
110,165 |
|
|
|
4.4 |
% |
|
|
124,605 |
|
|
|
13.1 |
% |
|
|
108,024 |
|
|
|
136,536 |
|
|
|
26.4 |
% |
Europe
|
|
|
76,587 |
|
|
|
84,665 |
|
|
|
10.5 |
|
|
|
102,203 |
|
|
|
20.7 |
|
|
|
94,064 |
|
|
|
86,364 |
|
|
|
(8.2 |
) |
Asia/Pacific Rim
|
|
|
65,111 |
|
|
|
55,564 |
|
|
|
(14.7 |
) |
|
|
55,460 |
|
|
|
(0.2 |
) |
|
|
48,308 |
|
|
|
54,804 |
|
|
|
13.4 |
|
Japan
|
|
|
31,906 |
|
|
|
24,485 |
|
|
|
(23.3 |
) |
|
|
16,860 |
|
|
|
(31.1 |
) |
|
|
16,056 |
|
|
|
12,327 |
|
|
|
(23.2 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Worldwide
|
|
|
279,078 |
|
|
|
274,879 |
|
|
|
(1.5 |
)% |
|
|
299,128 |
|
|
|
8.8 |
% |
|
|
266,452 |
|
|
|
290,031 |
|
|
|
8.8 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Number of Supervisors by Geographic Region as of
Requalification Period
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As of February, | |
|
|
| |
|
|
2002 | |
|
2003 | |
|
2004* | |
|
2005 | |
|
|
| |
|
| |
|
| |
|
| |
The Americas
|
|
|
62,737 |
|
|
|
67,921 |
|
|
|
75,359 |
|
|
|
87,925 |
|
Europe
|
|
|
47,230 |
|
|
|
51,290 |
|
|
|
70,239 |
|
|
|
65,104 |
|
Asia/Pacific Rim
|
|
|
40,423 |
|
|
|
35,637 |
|
|
|
31,790 |
|
|
|
38,524 |
|
Japan
|
|
|
22,013 |
|
|
|
18,287 |
|
|
|
13,946 |
|
|
|
9,547 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Worldwide
|
|
|
172,403 |
|
|
|
173,135 |
|
|
|
191,334 |
|
|
|
201,100 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
* |
In 2004 certain modifications were made to the requalifications
resulting in approximately 19,000 additional supervisors
including approximately 9,000 relating to a change in the
business model in Russia. |
Supervisors must re-qualify annually. The requalification period
covers the twelve months starting in February and ending the
following January. The number of supervisors by geographic
region as of the reporting dates will normally be higher than
the number of supervisors by geographic region as of the
requalification 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 recruiting and retention
efforts in different geographic regions.
The value of the average monthly purchase of Herbalife products
by our supervisors has remained relatively constant over time.
Consequently, increases in our sales are driven primarily by our
retention of supervisors and by our recruitment and retention of
distributors, rather than through increases in the productivity
of our overall supervisor base.
The modification in 2004 to the distributor re-qualification
criteria was a limited test. This modification allowed
distributors who otherwise would have failed to requalify as
supervisors to continue to receive the benefit of product
discounts, while forfeiting their down-line royalties. We
believe this test was successful
29
because the test group generated approximately, 12 million
additional Volume Points on an annualized basis, which would
represent approximately $9.4 million in net sales,
$5.2 million in operating margin and an immaterial impact
to marketing, distribution and administrative expenses. As a
result of the test, the Company has modified the supervisor
re-qualification criteria for all distributors in 2005.
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, weight management program, healthy lifestyle and/or
business opportunity; 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 the product 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), and net sales, which reflects
distribution allowances and handling and freight income, is 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. (GAAP). You should not
consider Retail Sales in isolation from, nor as 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 under Results of
Operations. Product sales represent the actual
product purchase price 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:
|
|
|
|
|
royalty overrides, or commissions, and bonuses, which total
approximately 15% and 7%, respectively, of the Retail Sales of
weight management, inner nutrition, Outer Nutrition® and
promotional products; |
|
|
|
the Mark Hughes Bonus payable to some of our most senior
distributors in the aggregate amount of approximately 1% of
Retail Sales of weight management, inner nutrition, Outer
Nutrition® and promotional products; and |
|
|
|
other discretionary incentive cash bonuses to qualifying
distributors. |
Royalty Overrides are generally earned based on Retail Sales,
and approximate in the aggregate about 23% 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. 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. Non-U.S. royalty
checks that have aged, for a variety of reasons, beyond a
certainty of being paid, are taken back into income.
30
Management has calculated this period of certainty to be three
years worldwide, whereas previously this period varied by
country, ranging from 12 months to 30 years. In order
to achieve consistency among all countries, the Company adjusted
the period over which such amounts would be taken into income to
three years on a Company-wide basis beginning with the third
quarter of 2004.
Our operating margins consist of net sales less cost
of sales and royalty overrides.
Selling, General and 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.
113/4% Notes
refers to Herbalife Internationals
113/4% senior
subordinated notes due 2010.
91/2% Notes
refers to our
91/2% notes
due 2011.
Most of our sales to distributors outside the United States are
made in the respective local currencies. In preparing our
financial statements, we translate revenues into
U.S. dollars using average exchange rates. Additionally,
the majority of our purchases from our suppliers generally are
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 nine months ended September 30, 2005, net sales
increased by 19.6%, as compared to the same period in 2004. The
combination of continued strong recruitment and retention of
distributors and retailing of our products in our key markets,
various promotions leading up to the 25th Anniversary
Extravaganza in Atlanta in April 2005 and the Worldwide Cup
promotions during 2005, generally favorable foreign currency
exchange rates, the launch of new products such as
Liftoff tm
and
NouriFusiontm
coupled with the ongoing roll-out of
ShapeWorkstm
and
Niteworkstm
to more countries, contributed to the sales increase. For the
three months ended September 30, 2005, net sales increased
in all regions for the first time in seven years. Also, after
24 quarters of sales declines in Japan, sales increased in
the third quarter of 2005 as compared to the third quarter of
2004. The sales growth in the U.S. and South Korea was an
encouraging result of our effort and commitment to turn around
these countries. Continued strong sales growth in Mexico was
primarily attributable to the growth in Nutrition Clubs, a party
plan concept. For the nine months ended September 30, 2005,
net sales increased in all regions except for Japan.
For the nine months ended September 30, 2005, net income
was $63.2 million, or 87 cents per diluted share compared
to net income of $23.1 million, or 42 cents per diluted
share reported for the same period in 2004. Net income as
reported includes the effect of recapitalization transaction
expenses of $14.2 million and $15.4 million in the
first quarters of 2005 and 2004, respectively, a non-cash tax
charge of $5.5 million associated with moving our China
subsidiary within the global corporate structure in the second
quarter of 2005, and the favorable post-tax 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, partially offset by the
$1.5 million favorable post-tax impact of aged royalties in
the third quarter of 2004. The improvement in net income was a
result of a 19.6% increase in net sales, the continued favorable
impact from appreciation of foreign currencies, lower interest
and income tax expense partially offset by higher operating
expenses primarily from increased labor, benefits, incentive
compensation and promotion expense. Overall, the appreciation of
foreign currencies had a $10.6 million favorable impact on
net income for the nine months ended September 30, 2005.
31
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.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Company | |
|
|
|
|
|
|
|
|
| |
|
|
Predecessor | |
|
Company | |
|
Combined | |
|
|
|
|
|
|
| |
|
| |
|
| |
|
Year Ended | |
|
Nine Months Ended | |
|
|
January 1 to | |
|
August 1 to | |
|
Year Ended | |
|
December 31, | |
|
September 30, | |
|
|
July 31, | |
|
December 31, | |
|
December 31, | |
|
| |
|
| |
|
|
2002 | |
|
2002 | |
|
2002 | |
|
2003 | |
|
2004 | |
|
2004 | |
|
2005 | |
|
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
Operations:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net sales
|
|
|
100.0 |
% |
|
|
100.0 |
% |
|
|
100.0 |
% |
|
|
100.0 |
% |
|
|
100.0 |
% |
|
|
100.0 |
% |
|
|
100.0 |
% |
Cost of sales
|
|
|
21.8 |
|
|
|
21.1 |
|
|
|
21.5 |
|
|
|
20.3 |
|
|
|
20.6 |
|
|
|
20.5 |
|
|
|
20.1 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross profit
|
|
|
78.2 |
|
|
|
78.9 |
|
|
|
78.5 |
|
|
|
79.7 |
|
|
|
79.4 |
|
|
|
79.5 |
|
|
|
79.9 |
|
Royalty overrides
|
|
|
35.3 |
|
|
|
35.6 |
|
|
|
35.4 |
|
|
|
35.8 |
|
|
|
35.5 |
|
|
|
35.4 |
|
|
|
35.5 |
|
Selling, general & administrative expenses
|
|
|
32.2 |
|
|
|
30.1 |
|
|
|
31.4 |
|
|
|
34.7 |
|
|
|
33.3 |
|
|
|
32.6 |
|
|
|
30.2 |
|
Acquisition transaction expenses
|
|
|
8.5 |
|
|
|
1.4 |
|
|
|
5.6 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating income
|
|
|
2.2 |
|
|
|
11.8 |
|
|
|
6.1 |
|
|
|
9.2 |
|
|
|
10.6 |
|
|
|
11.5 |
|
|
|
14.2 |
|
Interest income (expense), net
|
|
|
0.2 |
|
|
|
(5.4 |
) |
|
|
(2.0 |
) |
|
|
(3.5 |
) |
|
|
(9.4 |
) |
|
|
(5.7 |
) |
|
|
(3.2 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income before income taxes and minority interest
|
|
|
2.4 |
|
|
|
6.4 |
|
|
|
4.1 |
|
|
|
5.7 |
|
|
|
1.2 |
|
|
|
5.8 |
|
|
|
11.0 |
|
Income taxes
|
|
|
1.0 |
|
|
|
3.3 |
|
|
|
2.0 |
|
|
|
2.5 |
|
|
|
2.3 |
|
|
|
3.4 |
|
|
|
5.5 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income (loss)
|
|
|
1.4 |
|
|
|
3.1 |
|
|
|
2.1 |
|
|
|
3.2 |
|
|
|
(1.1 |
) |
|
|
2.4 |
|
|
|
5.5 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nine months ended September 30, 2005 compared to nine
months ended September 30, 2004 |
Net Sales
The following chart reconciles Retail Sales to net sales:
Sales by Geographic Region
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nine Months Ended September 30, | |
|
|
| |
|
|
2004 | |
|
2005 | |
|
|
| |
|
| |
|
|
|
|
Handling & | |
|
|
|
|
|
Handling & | |
|
|
|
Change | |
|
|
Retail | |
|
Distributor | |
|
Product | |
|
Freight | |
|
Net | |
|
Retail | |
|
Distributor | |
|
Product | |
|
Freight | |
|
Net | |
|
in Net | |
|
|
Sales | |
|
Allowance | |
|
Sales | |
|
Income | |
|
Sales | |
|
Sales | |
|
Allowance | |
|
Sales | |
|
Income | |
|
Sales | |
|
Sales | |
|
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
|
(In millions) | |
The Americas
|
|
$ |
557.9 |
|
|
$ |
(266.0 |
) |
|
$ |
291.9 |
|
|
$ |
51.6 |
|
|
$ |
343.5 |
|
|
$ |
803.8 |
|
|
$ |
(386.3 |
) |
|
$ |
417.5 |
|
|
$ |
70.6 |
|
|
$ |
488.1 |
|
|
|
42.1 |
% |
Europe
|
|
|
655.8 |
|
|
|
(313.0 |
) |
|
|
342.8 |
|
|
|
58.8 |
|
|
|
401.6 |
|
|
|
682.0 |
|
|
|
(324.8 |
) |
|
|
357.2 |
|
|
|
60.4 |
|
|
|
417.6 |
|
|
|
4.0 |
% |
Asia/ Pacific Rim
|
|
|
243.7 |
|
|
|
(112.1 |
) |
|
|
131.6 |
|
|
|
17.4 |
|
|
|
149.0 |
|
|
|
296.7 |
|
|
|
(136.9 |
) |
|
|
159.8 |
|
|
|
21.0 |
|
|
|
180.8 |
|
|
|
21.3 |
% |
Japan
|
|
|
126.6 |
|
|
|
(61.6 |
) |
|
|
65.0 |
|
|
|
8.9 |
|
|
|
73.9 |
|
|
|
122.1 |
|
|
|
(59.3 |
) |
|
|
62.8 |
|
|
|
8.4 |
|
|
|
71.2 |
|
|
|
(3.7 |
)% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$ |
1,584.0 |
|
|
$ |
(752.7 |
) |
|
$ |
831.3 |
|
|
$ |
136.7 |
|
|
$ |
968.0 |
|
|
$ |
1,904.6 |
|
|
$ |
(907.3 |
) |
|
$ |
997.3 |
|
|
$ |
160.4 |
|
|
$ |
1,157.7 |
|
|
|
19.6 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Changes in net sales are directly associated with the recruiting
and retention of our distributor force, retailing of our
products, 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 the distributor marketing program coupled with
educational and motivational tools to incent distributors to
drive recruiting, retention and
32
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 supervisors who continually build, educate and
motivate their respective distribution and sales organizations.
We also use event and non-event product promotions to motivate
distributors to increase recruiting, retention and retailing
activities. These promotions have prizes ranging from qualifying
for events to vacations and qualification parties 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 region discussion further
details some of the above factors and describes unique growth
factors specific to certain major countries. We believe that the
correct business foundation, coupled with ongoing training and
promotional initiatives, is required to increase recruiting and
retention of distributors and retailing of the product. The
correct business foundation includes strong country management
that works closely with the distributor leadership, unified
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
distributor 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 creating and maintaining
growth within existing markets. We expect to increase our
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 GenH in
the U.S., as described in the net sales discussion below.
Managements strategy is to review the applicability of
expanding successful country initiatives throughout a region
and/or globally and where appropriate, financially support the
globalization of these initiatives.
Net sales in the Americas increased $144.7 million, or
42.1%, for the nine months ended September 30, 2005, as
compared to the same period in 2004. In local currency, net
sales increased by 36.6% for the nine months ended
September 30, 2005, as compared to the same period in 2004.
The fluctuation of foreign currency rates had a positive impact
on net sales of $19.0 million for the nine months ended
September 30, 2005. The overall increase was a result of
net sales growth in Mexico, Brazil and the U.S. of
$78.7 million, $30.4 million and $21.0 million
for the nine months ended September 30, 2005 compared to
the same period in 2004.
The net sales growth in Mexico is a result of the continued
success of the Nutrition Clubs, strong country management, and
highly engaged distributor leadership. The costs to set up a
Nutrition Club are generally nominal, and are borne solely by
the distributor. We believe our distributors currently operate
over 15,000 Nutrition Clubs in Mexico, which have led to an
increased number of supervisors, up 69.7% at September 30,
2005 compared to September 30, 2004.
The net sales growth in Brazil is a result of the continued
success of the Total Plan, strong country distributor
leadership, a highly effective country management team and a
solid product portfolio. The Total Plan is a low-cost lead
generating method where distributors use our personal care line
of products and offer consultations to obtain referrals and has
led to an increased number of supervisors, up 37.0% at
September 30, 2005 compared to September 30, 2004.
This concept specifically supports our retailing and recruiting
33
initiatives and has been a catalyst for growth in Brazil.
Additionally, the
ShapeWorkstm
program was introduced at the Brazilian World Team School in
July 2005.
As a result of the numerous steps taken in 2004 and 2005 to
improve the business in the U.S., including the establishment of
a U.S. country management team, branding efforts such as
sponsorship of the JP Morgan Chase tennis tournament, the AVP
Volleyball Tour and the Nautica Malibu Triathlon; and various
promotions such as the 2005 Presidents Team Challenge, the
World Team Bonus, the Atlanta Challenge in connection with the
25th Anniversary Extravaganza and the Worldwide Cup
promotion, net sales have exceeded the corresponding quarterly
results of 2004. At the 25th Anniversary Extravaganza two
new products were introduced,
Liftoff tm
and
NouriFusiontm.
The number of supervisors increased by 3.2% at
September 30, 2005 compared to September 30, 2004,
after approximately two consecutive years of year-over-year
declines.
We expect 2005 net sales in the Americas region to continue
its growth primarily as a result of the expected continuation of
the solid performance in Mexico, Brazil and the U.S.
Net sales in Europe increased $16.0 million, or 4.0%, for
the nine months ended September 30, 2005, as compared to
the same period in 2004. In local currency, net sales increased
by 0.9%, for the nine months ended September 30, 2005, as
compared to the same period in 2004. The fluctuation of foreign
currency rates had a positive impact on net sales of
$12.5 million, for the nine months ended September 30,
2005. Throughout 2004, Europe experienced sales growth when
compared to 2003, partly due to the Billion Dollar promotion in
the first and second quarters of 2004. Such sales growth was not
expected to be sustainable in 2005. While some markets did
sustain growth such as France, South Africa and Spain, two key
markets, Germany and the Netherlands, experienced sales declines
of 19.9% and 13.3%, respectively, for the nine months ended
September 30, 2005 when compared to the same period in 2004.
We have recently appointed a new country manager in Germany and
the new management team is developing a turnaround plan for 2006
to re-engage the local distributor leadership and to rebuild the
confidence among distributors to improve recruiting and
retention. Similar to Germany, we have recently appointed a new
country manager in the Netherlands and have taken steps to
re-engage the local distributor leadership in the Netherlands.
Several new initiatives are planned in the second half of 2005,
including a new recruiting program, and we expect this will
contribute to improved performance beginning in 2006.
Net sales in Spain were up $7.4 million, or 31.8%, for the
nine months ended September 30, 2005, as compared to the
same period in 2004. The increase in sales is primarily due to
unified distributor leadership, an increasing emphasis locally
on health and nutrition and the continuing positive impact of
certain promotions in 2005. Net sales in France were up
$5.7 million, or 30.9%, for the nine months ended
September 30, 2005, as compared to the same period in 2004,
partly due to adoption of a new nutritional distributor training
program and a special vacation promotion. In South Africa, net
sales increased $5.6 million, or 59.9%, for the nine months
ended September 30, 2005 when compared to the same period
in 2004, primarily due to a unified distributor leadership.
Additionally, in South Africa, we celebrated our
10th anniversary of doing business in the country with a
major sales event during the third quarter.
We believe that 2005 net sales in Europe will finish flat
to slightly positive year over year partly due to sales
increases we expect to generate from the ongoing Worldwide Cup
promotion and new product introductions.
Net sales in Asia/ Pacific Rim increased $31.8 million, or
21.3%, for the nine months ended September 30, 2005, as
compared to the same period in 2004. In local currency, net
sales increased by 14.9% for the nine months ended
September 30, 2005, as compared to the same period in 2004.
The fluctuation of foreign currency rates had a positive impact
on net sales of and $9.6 million for the nine months ended
September 30, 2005. The overall sales increase was
attributable mainly to an increase in Taiwan and South Korea.
34
Net sales in Taiwan increased $16.8 million, or 32.8%, for
the nine months ended September 30, 2005, as compared to
the same period in 2004, due primarily to effective local
training and recognition initiatives, unified leadership, and
promotion of the 10th year anniversary of doing business in
Taiwan held in the third quarter. Net sales in South Korea
increased $9.9 million, or 38.4%, for the nine months ended
September 30, 2005, as compared to the same period in 2004.
Continued successful sales of
Niteworkstm,
unified leadership, coupled with other recruiting initiatives
have now established an eight quarter trend of a positive
year-over-year sales growth. New distributors and supervisors in
the third quarter increased by 45% and 55%, respectively,
compared to the same period in 2004.
Overall, we believe that unified distributor leadership, new
product launches, continued local distributor training and
recognition, and effective promotions will contribute to ongoing
sales increases in the Asia/ Pacific Rim region in 2005.
Net sales in Japan decreased $2.7 million or 3.7% for the
nine months ended September 30, 2005, as compared to the
same period in 2004. In local currency, net sales decreased by
4.9% for the nine months ended September 30, 2005, as
compared to the same periods in 2004. The fluctuation of foreign
currency rates had a positive impact on net sales of
$0.8 million for the nine months ended September 30,
2005. We believe that the numerous initiatives to stimulate
sales in Japan are beginning to make a positive impact and
contributing to the third quarter net sales increase, the first
quarterly net sales increase in six years. The initiatives
include a new sales center in a more attractive area in Tokyo,
local management implementing initiatives to re-engage and
motivate the local distributor leadership to improve recruiting
and retention of distributors, expanding our product line to
address local country demographic needs and the creation of
increased brand awareness through sporting event sponsorships.
In the third quarter
NiteworksTM
was introduced in Japan, and a special vacation promotion was
launched. We believe the above initiatives in combination with
the implementation of new brand and volume incentive promotional
programs, should continue to improve sales trends for the
balance of 2005.
Sales by Product Category
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nine Months Ended September 30, | |
|
|
| |
|
|
2004 | |
|
2005 | |
|
|
| |
|
| |
|
|
|
|
Handling & | |
|
|
|
|
|
Handling & | |
|
|
|
% Change | |
|
|
Retail | |
|
Distributor | |
|
Product | |
|
Freight | |
|
Net | |
|
Retail | |
|
Distributor | |
|
Product | |
|
Freight | |
|
Net | |
|
In Net | |
|
|
Sales | |
|
Allowance | |
|
Sales | |
|
Income | |
|
Sales | |
|
Sales | |
|
Allowance | |
|
Sales | |
|
Income | |
|
Sales | |
|
Sales | |
|
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
|
(In millions) | |
Weight Management
|
|
$ |
705.7 |
|
|
$ |
(347.1 |
) |
|
$ |
358.6 |
|
|
$ |
60.9 |
|
|
$ |
419.5 |
|
|
$ |
848.2 |
|
|
$ |
(417.7 |
) |
|
$ |
430.5 |
|
|
$ |
71.5 |
|
|
$ |
502.0 |
|
|
|
19.7 |
% |
Inner Nutrition
|
|
|
699.6 |
|
|
|
(344.1 |
) |
|
|
355.5 |
|
|
|
60.4 |
|
|
|
415.9 |
|
|
|
805.2 |
|
|
|
(396.5 |
) |
|
|
408.7 |
|
|
|
67.9 |
|
|
|
476.6 |
|
|
|
14.6 |
% |
Outer Nutrition®
|
|
|
144.6 |
|
|
|
(71.1 |
) |
|
|
73.5 |
|
|
|
12.5 |
|
|
|
86.0 |
|
|
|
208.1 |
|
|
|
(102.5 |
) |
|
|
105.6 |
|
|
|
17.4 |
|
|
|
123.0 |
|
|
|
43.0 |
% |
Literature, Promotional and Other
|
|
|
34.1 |
|
|
|
9.6 |
|
|
|
43.7 |
|
|
|
2.9 |
|
|
|
46.6 |
|
|
|
43.1 |
|
|
|
9.4 |
|
|
|
52.5 |
|
|
|
3.6 |
|
|
|
56.1 |
|
|
|
20.4 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$ |
1,584.0 |
|
|
$ |
(752.7 |
) |
|
$ |
831.3 |
|
|
$ |
136.7 |
|
|
$ |
968.0 |
|
|
$ |
1,904.6 |
|
|
$ |
(907.3 |
) |
|
$ |
997.3 |
|
|
$ |
160.4 |
|
|
$ |
1,157.7 |
|
|
|
19.6 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Our increased emphasis on the science of weight management and
nutrition during the past two years has resulted in product
introductions such as
Niteworkstm
and Garden
7 tm
and the introduction of
ShapeWorkstm,
a personalized meal replacement program. Due to the launch of
ShapeWorkstm
in March 2004 in the United States and the ongoing roll-out to
other countries, the introduction of new Outer Nutrition®
products like
NouriFusiontm,
and the increased use of the Total Plan by distributors in
Brazil and worldwide, which uses Outer Nutrition products as its
foundation, net sales of weight management products and Outer
Nutrition® products increased at a higher rate than net
sales of inner nutrition products. Sales of Outer Nutrition
products increased 43.0%, for the nine months ended
September 30, 2005, which is a greater rate than those for
any other categories. Literature, Promotional and Other, which
is net of product buy-backs and returns in all product
categories, increased primarily due to an increase in literature
sales from selling starter kits to new
35
distributors and from a decrease in returns and refunds. We
expect growth rates within these categories will vary, from time
to time, as we launch new products.
Gross Profit
Gross profit was $925.1 million for the nine months ended
September 30, 2005, as compared to $769.2 million for
the same period in 2004.
As a percentage of net sales, gross profit for the nine months
ended September 30, 2005, increased from 79.5% to 79.9% as
compared to the same period in 2004. Generally, gross profit
percentages do not vary significantly as a percentage of sales
other than due to ongoing cost reduction initiatives and
provisions for slow moving and obsolete inventory or due to
product and/or country mix. 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 was 35.5% for the
nine months ended September 30, 2005, as compared to 35.4%
for the same period in 2004. The nine months ended
September 30, 2005, included a favorable pre-tax impact of
$4.0 million relating to the change in the allowance for
uncollectible royalty overrides receivables from distributors
and the nine months ended September 30, 2004, included a
favorable pre-tax impact of $2.4 million of aged royalty
checks. Generally, royalty overrides as a percentage of net
sales varies slightly from period to period due to changes in
the mix of products and countries because varying Royalty
Overrides are paid on certain products and in certain countries.
Due to the structure of our global compensation plan coupled
with the current country mix of our business, we do not expect
to see significant fluctuations in Royalty Overrides as a
percent of net sales.
Selling, General & Administrative Expenses
Selling, General & Administrative expenses as a
percentage of net sales was 30.2%, for the nine months ended
September 30, 2005, as compared to 32.6% for the same
period in 2004. For the nine months ended September 30,
2005, Selling, General & Administrative expenses
increased $18.8 million and $33.6 million,
respectively, to $121.6 million and $349.4 million,
respectively. The unfavorable impact of foreign currency
fluctuations was $2.4 million and $7.5 million for the
three and nine months ended September 30, 2005,
respectively.
The increase in Selling, General & Administrative
expenses for the nine months ended September 30, 2005
included $22.2 million in higher salaries and benefits, due
to normal merit increases, increased staffing, and higher
incentive compensation; $6.9 million relating to legal and
litigation expenses and additional professional fees primarily
associated with strengthening our technology infrastructure and
$9.9 million in additional advertising and promotion
expenses related primarily to our 2005 Worldwide Cup promotion.
The increases were partially offset by $5.2 million lower
amortization expense of intangibles; $4.9 million lower
monitoring fees and other expenses due to the termination of the
related agreement with Whitney and Golden Gate Capital and a
$0.1 million foreign exchange gain in 2005 versus a
$2.1 million loss in 2004.
We expect 2005 Selling, General & Administrative
expenses to increase over 2004 levels, reflecting general salary
merit increases, moderate staffing additions, further expansion
in China and increased sales events activities, although as a
percentage of net sales, these expenses should be slightly down
from 2004 levels.
Net Interest Expense
Net interest expense was $37.6 million for the nine months
ended September 30, 2005, as compared to and
$55.2 million for the same period in 2004. This includes
$14.2 million and $15.4 million of recapitalization
expenses for the three months ended March 31, 2005 and
2004, respectively. The recapitalization expenses were due to
the redemption of 40%, or $110 million principal amount, of
the
91/2% Notes
completed in
36
February 2005 and the redemption of the
151/2% senior
notes, completed in March 2004. During the second and third
quarters of 2005 we prepaid $35.0 million and
$44.7 million under our senior credit facility,
respectively, resulting in approximately $0.7 million and
$0.9 million additional interest expense from write-off of
deferred financing fees.
Income Taxes
Income taxes were $64.0 million for the nine months ended
September 30, 2005, as compared to $32.7 million for
the same period in 2004. As a percentage of pre-tax income, the
effective income tax rate was 50.3% for the nine months ended
September 30, 2005, as compared to 58.6% for the same
period in 2004. The decrease in the effective tax rate for the
nine months ended September 30, 2005 as compared to 2004
was caused primarily by the impact of less non-deductible
interest including the aforementioned non-deductible
recapitalization charges in each period. Offsetting these
benefits was a $5.5 million non-cash tax charge associated
with moving our China subsidiary within our global corporate
structure in the second quarter of 2005 and an increase in taxes
due to the impact on our worldwide transfer pricing and tax
structure as a result of stronger than expected revenue growth
during the past several quarters and managements outlook
that a mid-teens revenue growth rate will continue throughout
2006. Excluding the impact of the recapitalization expenses of
$14.2 million and $15.4 million during the first
quarter of 2005 and 2004, respectively, and the
$5.5 million non-cash tax charge associated with China, the
effective tax rate would have been approximately 41.4% and 37.3%
for the nine months ended September 30, 2005 and 2004,
respectively.
Foreign Currency Fluctuations
Currency fluctuations had a favorable impact of
$3.5 million and $10.6 million on net results for the
three and nine months ended September 30, 2005, when
compared to what current year net results would have been using
last years foreign exchange rates. For the three months
ended September 30, 2005, the regional effects were an
unfavorable $0.2 million in Europe, a favorable
$0.9 million in Asia/ Pacific Rim, a favorable
$2.7 million in the Americas, and a favorable
$0.1 million in Japan. For the nine months ended
September 30, 2005, the regional effects were a favorable
$2.2 million in Europe, a favorable $2.7 million in
Asia/ Pacific Rim, a favorable $4.5 million in the
Americas, and a favorable $1.1 million in Japan.
Net Income
For the nine months ended September 30, 2005, net income
was $63.2 million, or 87 cents per diluted share
compared to a net income of $23.1 million, or 42 cents per
diluted share reported for the same period in 2004. Net income
as reported includes the effect of recapitalization transaction
expenses of $14.2 million and $15.4 million in the
first quarters of 2005 and 2004, respectively, and a non-cash
tax charge of $5.5 million associated with moving our China
subsidiary within the global corporate structure in the second
quarter of 2005, and the favorable post-tax 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, partially offset by the
$1.5 million post-tax favorable impact of aged royalties in
the third quarter of 2004. The improvement in net income was the
result of a 19.6% increase in net sales, the continued favorable
impact from appreciation of foreign currencies, lower interest
and income tax expense partially offset by higher operating
expenses primarily from increased labor, benefits and incentive
compensation. Overall, the appreciation of foreign currencies
had a $10.6 million favorable impact on net results for the
nine months ended September 30, 2005.
37
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Year ended December 31, 2004 compared to year ended
December 31, 2003 |
Net Sales
The following chart reconciles Retail Sales to net sales:
Sales by Geographic Region
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2003 | |
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2004 | |
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Handling | |
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Handling | |
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Change | |
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Retail | |
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Distributor | |
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Product | |
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Freight | |
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Net | |
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Retail | |
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Distributor | |
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Product | |
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Freight | |
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Net | |
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in Net | |
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Sales | |
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Allowance | |
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Sales | |
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Income | |
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Sales | |
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Sales | |
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Allowance | |
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Sales | |
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Income | |
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Sales | |
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Sales | |
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(In millions) | |
The Americas
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$ |
687.9 |
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$ |
(328.9 |
) |
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$ |
359.0 |
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$ |
65.4 |
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$ |
424.4 |
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$ |
762.6 |
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$ |
(364.4 |
) |
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$ |
398.2 |
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$ |
70.0 |
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$ |
468.2 |
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10.3 |
% |
Europe
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733.4 |
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(349.4 |
) |
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384.0 |
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64.2 |
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448.2 |
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875.5 |
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(418.0 |
) |
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457.5 |
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78.7 |
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536.2 |
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19.6 |
% |
Asia/ Pacific Rim
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271.6 |
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(123.6 |
) |
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148.0 |
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19.5 |
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167.5 |
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338.7 |
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(156.3 |
) |
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182.4 |
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24.1 |
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206.5 |
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23.3 |
% |
Japan
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201.5 |
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(97.4 |
) |
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104.1 |
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15.2 |
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119.3 |
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169.4 |
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(82.5 |
) |
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86.9 |
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11.9 |
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98.8 |
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(17.2 |
)% |
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Total
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$ |
1,894.4 |
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$ |
(899.3 |
) |
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$ |
995.1 |
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$ |
164.3 |
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$ |
1,159.4 |
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$ |
2,146.2 |
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$ |
(1,021.2 |
) |
|
$ |
1,125.0 |
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|
$ |
184.7 |
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|
$ |
1,309.7 |
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13.0 |
% |
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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, ensure 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 the
marketing program coupled with educational and motivational
tools to incent 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. An example is the
Barcelona Extravaganza held in August of 2004 and mentioned
below. 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 2003 laptop computer 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 & administration expenses. A current
example is the Atlanta Challenge discussed below.
Similar to sales events, it is not possible for us to draw a
precise quantitative correlation between a successful promotion
and a resultant long-term effect on net sales.
The factors described above have driven growth in our business.
The following net sales by geographic region discussion further
details some of the above factors and describes unique growth
factors specific to certain major countries. We believe that the
correct foundation, coupled with ongoing training and
promotional initiatives is required to increase recruiting and
retention of distributors and retailing of the product. 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 has included and will continue to include
generating and maintaining growth within existing markets. We
generally expect to continue to spend the current level of
selling, general & administrative expenses (as a
percent of net sales) to maintain or stimulate sales growth,
while making strategic investments
38
in new initiatives as discussed in the business strategy
section. 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
and the Total Plan in Brazil, as described in the net sales
discussion below. Managements strategy is to review the
applicability of expanding successful country initiatives
throughout a region and/or globally where appropriate.
Net sales in the Americas increased $43.8 million, or
10.3%, for the year ended December 31, 2004, as compared to
2003. In local currency, net sales increased by 10.7% for the
year ended December 31, 2004, as compared to 2003. The
fluctuation of foreign currency rates had a negative impact of
$1.6 million on net sales for the year ended
December 31, 2004. The overall increase was a result of net
sales growth in Brazil and Mexico of $29.2 million and
$28.8 million, or 74.4% and 39.1%, respectively, for the
year ended December 31, 2004. These countries continue to
benefit from strong country and distributor leadership that
focuses on recruiting and retention of the distributor force
that retails our product, and a product line and business
opportunity that is attractive to the demographics in those
countries. The net sales growth in Brazil and Mexico was
partially offset by a net sales decrease in the U.S. of
$22.0 million, or 8.0%.
The continued net sales growth in Brazil is evidenced by the
increased number of supervisors, up 54.6% at December 31,
2004 compared to 2003, the expansion of the Total Plan, strong
distributor leadership, a highly effective country management
team and a good product portfolio. The Total Plan is a low-cost
lead-generating method where distributors use our personal care
line of products and offer consultations to obtain referrals.
This concept specifically supports our retailing and recruiting
initiatives and has been a catalyst for growth in Brazil.
The continued net sales growth in Mexico is evidenced by the
increased number of supervisors, up 33.0% at December 31,
2004 compared to December 31, 2003, which reflects the
renewed emphasis on distributor and customer retention programs
such as the Nutrition Clubs, which are new and innovative means
by which distributors are retailing our products to new
customers, some of whom may eventually become distributors of
our products. The costs to set up a Nutrition Club are generally
nominal, and are borne solely by the distributor. Our
distributors have opened over 2000 Nutrition Clubs to date.
Growth in Brazil and Mexico was partly offset by a decline in
net sales in the U.S., of $22.0 million, or 8.0%, for the
year ended December 31, 2004, as compared to
December 31, 2003. This was evidenced by a 6.1% decrease in
the number of supervisors at December 31, 2004, as compared
to 2003, with a similar volume point decrease when compared to
the prior year. This is a continuation of a downward trend in
the U.S., although the decrease in 2004 is lower than the
decrease experienced in 2003. Contributing factors to this
continued decline include distraction among senior distributor
leadership related to the transition of our new senior
management team, strong competition from other direct selling
companies and marketing difficulties experienced during the
transition to the new
ShapeWorkstm
product line launched in March 2004. The transition to the new
ShapeWorkstm
product line in the U.S. cost approximately
$4.2 million, which was primarily recorded in selling,
general & administrative expenses. Of this,
approximately $0.6 million was related to several previous
versions of the package design, labels and related promotional
materials, a cost that is not expected to be incurred in future
transitions of this product in other regions. We believe the
U.S. continues to be a viable market and therefore we have
taken numerous steps to turn the business around. For example,
we have organized regional mini-extravaganza sales
events, the opening of a regional sales center in Dallas,
created a U.S. country management team, where previously
the U.S. was managed from the Americas Region, and
introduced retailing and recruiting programs used successfully
in Brazil and Mexico such as the Total Plan and Nutrition Clubs.
The multiple regional mini-extravaganzas cost approximately
$1.9 million in 2004, which was recorded in selling,
general & administrative expenses. We expect a similar
level of spending in 2005 to help stimulate growth in the
U.S. market. Regional sales centers are small, walk-up
distribution centers that we are opening in key areas of the
U.S. where we feel we are underdeveloped. The walk up
centers allow distributors to interact with us on a more
personal basis and we believe they will assist distributors with
their recruiting and retention efforts. To set up the regional
sales center in Dallas, we incurred $0.4 million in capital
expenditures and we will spend approximately $0.6 million
in annual operating
39
expenses. To the extent that management chooses to continue to
expand this model throughout the U.S. based upon a thorough
financial review, we would expect a similar level of expenditure
for each regional sales center that the Company may potentially
open. Managements evaluation in this area has not yet been
completed. Management and senior distributor leadership will
continue to target promotions, events and products to specific
key U.S. metro areas. We believe this should increase the
efficiency of our spending, while increasing market penetration.
We expect 2005 sales in the Americas region to continue
its positive year over year growth primarily as a result of the
expected continuation of the strong momentum in Mexico and
Brazil and a leveling of the decline in the U.S.
Net sales in Europe increased $87.9 million, or 19.6%, for
the year ended December 31, 2004, as compared to 2003. In
local currency net sales increased 8.6% for the year ended
December 31, 2004, as compared to 2003. The fluctuation of
foreign currency rates had a positive impact on net sales of
$49.4 million for the year ended December 31, 2004.
Most European markets recorded net sales growth partly as a
result of an eight-month promotion ending in June 2004 that
helped our distributors increase recruiting and retention and
was further supported by the motivation and training at the
Barcelona Extravaganza in July 2004. We spent $3.9 million,
recorded in Selling, General & Administrative Expenses,
on this eight month incremental sales promotion, called the
Billion Dollar Challenge. The Barcelona Extravaganza
had a net cost of $1.8 million and was recorded in the
selling, general & administrative expenses. The
November 2004 launch of
ShapeWorkstm
in Europe at the Bologna World Team School has been well
received by distributors, reflecting a smoother launch than in
the U.S. earlier this year.
Net sales in Spain were up $13.8 million, or 72.5%, for the
year ended December 31, 2004, as compared to 2003, due to a
cohesive, renewed focus by distributor leadership, an increasing
emphasis locally on health and nutrition and the success of the
Billion Dollar Challenge and the Barcelona Extravaganza. Net
sales in Turkey were up $11.4 million, or 85.7%, for the
year ended December 31, 2004, as compared to 2003, due to
increasing acceptance of the direct selling concept in Turkey as
well as an energetic distributor leadership group. In Italy, one
of our largest European markets, net sales were up
$7.1 million, or 11.2%, for the year ended
December 31, 2004, as compared to 2003, driven by strong
country management and distributor leadership collaboration on
recruiting and retention programs. In the Netherlands, another
of our larger European markets, net sales were up
$8.3 million, or 17.8%, for the year ended
December 31, 2004, as compared to 2003, partly due to the
Corporate/ Distributor co-sponsored TV program, Fitness
Challenge, which increased the visibility of the Herbalife
name. The Companys cost related to the Fitness Challenge
was less than $0.1 million, and was recorded in Selling,
General & Administrative Expenses. We are currently
reviewing whether to repeat this sponsorship in 2005. In
addition, we initiated a new worldwide promotion, The Atlanta
Challenge, at the Barcelona Extravaganza in July, as a means to
incent distributors to qualify for our 25th Anniversary
Extravaganza in April 2005 in Atlanta. The 25th Anniversary
Cruise is a special worldwide vacation promotion, separate from,
but occurring in connection with the 25th Anniversary
Extravaganza in Atlanta, and is expected to cost approximately
$6.0 million. This is an event that distributors qualified
for during 2004. Accordingly, we have accrued the expense in
selling, general & administrative expenses. We do not
expect a similar promotion in 2005. The 25th Anniversary
Extravaganza will replace the major regional extravaganzas in
2005, although we may still hold smaller regional events to
carry the excitement and momentum of this event. We expect the
net cost of the 25th Anniversary Extravaganza in Atlanta to
be approximately $6.4 million.
In the first quarter of 2004, we took over the management of
product distribution in Russia and Greece. Prior to this, we
used a third-party importer to manage and distribute our product
to distributors in these countries. We have now opened an
administrative office and a company-operated distribution center
in these countries to more closely align with our business model
in most other countries around the world. This will allow more
direct interaction with our distributors, which we feel will
improve communication and ultimately enhance recruiting and
retention of distributors in those countries. The cost of the
change in business model in these countries was
$1.0 million in capital expenditures, $4.4 million in
transition costs that we do not expect
40
to incur in the future and $5.9 million in net additional
annual operating expenses. The transition costs and operating
expenses were recorded in selling, general &
administrative expenses.
We believe that 2005 sales should continue the positive year
over year volume growth partly due to the European introduction
of
ShapeWorkstm,
the momentum we expect to generate from the Extravaganza, and
new products and business tools being launched at the
Extravaganza.
Net sales in Asia/ Pacific Rim increased $39.0 million, or
23.3%, for the year ended December 31, 2004, as compared to
2003. In local currency, net sales increased 19.2% for the year
ended December 31, 2004, as compared to 2003. The
fluctuation of foreign currency rates had a $6.8 million
positive impact on net sales for the year ended
December 31, 2004. The overall increase was attributable
mainly to an increase in Taiwan, partly offset by a decrease in
South Korea.
Net sales in Taiwan increased $23.8 million, or 49.6%, for
the year ended December 31, 2004, over 2003, due primarily
to an increase in the number of supervisors by 34.0% at
December 31, 2004, as compared to the same time last year,
highly engaged distributor leadership, strong country
management, increased local distributor trainings and
initiatives to promote individual recognition of well performing
distributors, new product launches, positive momentum from the
Bangkok Extravaganza held in September and various other
regional promotions. The Bangkok Extravaganza had a net cost of
$1.7 million and was recorded in selling,
general & administrative expenses. In 2005, this and
other regional extravaganzas will be replaced by the 25th
Anniversary Atlanta Extravaganza. Management will evaluate the
need for smaller regional events to carry the excitement and
momentum of the 25th Anniversary Atlanta Extravaganza to those
around the world who are unable to attend. Net sales in South
Korea decreased $8.0 million, or 18.3%, for the year ended
December 31, 2004, as compared to 2003. It appears that
numerous initiatives begun in the fourth quarter of 2003, are
making an impact. To illustrate this improvement, while volume
was flat (an improvement over prior years trend), net
sales increased 11.0% in the fourth quarter as compared to the
same period last year. We expect South Korea will report
positive year over year sales growth in 2005. In late 2004 we
introduced
ShapeWorkstm
in South Korea, at a cost of less than $0.1 million, which
was recorded in selling, general & administrative
expenses, and which we believe should help with recruiting and
retailing initiatives.
Overall, we believe that continued local distributor training
and the positive momentum from the Bangkok Extravaganza, along
with the launch of
ShapeWorkstm,
the momentum we expect to generate from the 25th
Anniversary Extravaganza, and new products and business tools
being launched at the 25th Anniversary Extravaganza. should
contribute to ongoing sales increases in the Asia/ Pacific Rim
region in 2005.
Net sales in Japan decreased $20.5 million, or 17.2%, for
the year ended December 31, 2004, as compared to 2003. In
local currency, net sales in Japan decreased 22.9% for the year
ended December 31, 2004, as compared to 2003. The
fluctuation of foreign currency rates had a $6.8 million
favorable impact on net sales for the year ended
December 31, 2004. The net sales decline in 2004, which is
a continuation of a five-year downward trend in Japan, albeit at
a slower rate for this reporting period, had been driven
primarily by ineffective prior country management, which had not
properly motivated distributor leadership or introduced new
products in a timely manner to meet distributor expectations.
This weakness has been exacerbated by strong competition from
other direct selling companies and a general deterioration of
the Japanese economy. In the third quarter of 2004, we appointed
a new country manager who is currently focusing on uniting and
motivating distributor leadership to improve recruiting and
retention of distributors, and we are in the process of
expanding our product line to address local country demographic
needs. For example in late 2004 we introduced a green tea
flavored Formula 1 and we created individual serving
packets for our Formula 1 product. In 2005 we will
be opening a new sales office in a central location of Tokyo, a
significant improvement over the existing location that we
believe should give us greater visibility in a
41
key population center. In combination with implementing new
brand and volume incentive promotional programs, we believe the
above initiatives should help improve financial performance in
2005.
Sales by Product Category
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2003 | |
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2004 | |
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Handling | |
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Handling | |
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& | |
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& | |
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Change | |
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Retail | |
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Distributor | |
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Product | |
|
Freight | |
|
Net | |
|
Retail | |
|
Distributor | |
|
Product | |
|
Freight | |
|
Net | |
|
in Net | |
|
|
Sales | |
|
Allowance | |
|
Sales | |
|
Income | |
|
Sales | |
|
Sales | |
|
Allowance | |
|
Sales | |
|
Income | |
|
Sales | |
|
Sales | |
|
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
|
(Dollars in millions) | |
Weight Management
|
|
$ |
840.4 |
|
|
$ |
(413.2 |
) |
|
$ |
427.2 |
|
|
$ |
72.9 |
|
|
$ |
500.1 |
|
|
$ |
945.1 |
|
|
$ |
(465.3 |
) |
|
$ |
479.8 |
|
|
$ |
81.3 |
|
|
$ |
561.1 |
|
|
|
12.2 |
% |
Inner Nutrition
|
|
|
849.0 |
|
|
|
(417.5 |
) |
|
|
431.5 |
|
|
|
73.6 |
|
|
|
505.1 |
|
|
|
946.5 |
|
|
|
(466.0 |
) |
|
|
480.5 |
|
|
|
81.5 |
|
|
|
562.0 |
|
|
|
11.3 |
% |
Outer Nutrition®
|
|
|
177.6 |
|
|
|
(87.3 |
) |
|
|
90.3 |
|
|
|
15.4 |
|
|
|
105.7 |
|
|
|
207.3 |
|
|
|
(102.1 |
) |
|
|
105.2 |
|
|
|
17.9 |
|
|
|
123.1 |
|
|
|
16.5 |
% |
Literature, Promotional and Other
|
|
|
27.4 |
|
|
|
18.7 |
|
|
|
46.1 |
|
|
|
2.4 |
|
|
|
48.5 |
|
|
|
47.3 |
|
|
|
(12.2 |
) |
|
|
59.5 |
|
|
|
4.0 |
|
|
|
63.5 |
|
|
|
30.9 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$ |
1,894.4 |
|
|
$ |
(899.3 |
) |
|
$ |
995.1 |
|
|
$ |
164.3 |
|
|
$ |
1,159.4 |
|
|
$ |
2,146.2 |
|
|
$ |
(1,021.2 |
) |
|
$ |
1,125.0 |
|
|
$ |
184.7 |
|
|
$ |
1,309.7 |
|
|
|
13.0 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Our increased emphasis on the science of weight management and
nutrition during the past two years, illustrated by our assembly
of the Scientific Advisory Board and the Medical Advisory Board,
has resulted in numerous product introductions like
Niteworkstm
and Garden
7tm
and the introduction of
ShapeWorkstm
, a personalized meal replacement program. Due to the launch of
our
ShapeWorkstm
product line in March 2004, and the introduction of new personal
care products, net sales of weight management products and Outer
Nutrition® products increased at a higher rate than net
sales of inner nutrition products. The rationalization of our
Outer Nutrition® product line in 2002 resulted in an
initial decrease in sales, but since then the line has
represented approximately 9% of our net sales. The product line
today is designed to complement the weight management and inner
nutrition product lines with products for improving the
appearance of the body, skin and hair. Literature, Promotional
and Other, which includes product buy-backs and returns in all
product categories, increased due to a decrease in returns and
refunds. We expect shifts within these categories from time to
time as we launch new products.
Gross Profit
Gross profit was $1,039.8 million for the year ended
December 31, 2004, as compared to $923.6 million in
2003. As a percentage of net sales, gross profit for the year
ended December 31, 2004, decreased from 79.7% to 79.4%, as
compared to 2003. The decrease in gross profit as a percentage
of net sales for the year ended December 31, 2004, was
attributable mainly to an increase in provisions made for slow
moving and obsolete inventory of $4.8 million as well as a
small sales mix variance, which was partially offset by lower
raw material and vendor costs. Generally, gross profit
percentages do not vary significantly as a percentage of sales
other than due to ongoing cost reduction initiatives 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 35.5% for
the year ended December 31, 2004, as compared to 35.8% in
2003. As a percentage of net sales, Royalty Overrides decreased
by 0.3% for the year ended December 31, 2004, as compared
to 2003, due primarily to the $2.4 million favorable impact
of aged royalties. 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 percent of net sales.
42
Selling, General & Administrative Expenses
Selling, general and administrative expenses as a percentage of
net sales were 33.3% for the year ended December 31, 2004,
as compared to 34.6% in 2003.
For the year ended December 31, 2004, selling,
general & administrative expenses increased
$34.8 million to $436.1 million from
$401.3 million in 2003. The increase included
$15.4 million in higher salaries and benefits, due
primarily to normal merit increases, the impact of foreign
currency fluctuations, a lower bonus expense in 2003 based on
not fully achieving targets that year and increases related to
the strengthening of the management team regionally and in the
U.S.; $13.8 million in additional professional fees
associated with higher legal and accounting expenses, including
Sarbanes-Oxley compliance, technology expenses, and higher
manufacturing consulting expenses related to the start-up of our
facility in China; $4.5 million in additional promotional
expenses related primarily to the
ShapeWorkstm
launch, the eight-month European promotion program noted above
which ended in June 2004 and expenses related to our 25th
Anniversary promotions, all of which were detailed in the
discussion of net sales by region; $12.2 million in higher
non-income taxes due primarily to higher sales in certain
jurisdictions; $2.6 million relating to the
recapitalization in March, which we do not expect to recur in
2005; and $3.0 million in higher provisions made for
doubtful accounts. The changes discussed above include the
unfavorable impact of foreign currency fluctuations on operating
expenses of $9.3 million The increases were partially
offset by $8.7 million lower litigation expenses,
$4.6 million lower foreign exchange transaction losses and
$11.7 million lower amortization expense of intangibles for
the year ended December 31, 2004, as compared to 2003, due
to the final allocation in the third quarter of 2003 of the
purchase price in connection with the Acquisition.
In December 2004, we reached an agreement with the Equity
Sponsors to terminate a monitoring fee agreement in exchange for
the issuance of 700,000 warrants. Using the Black-Scholes model
we have calculated the fair value of this consideration to be
approximately $2.9 million, which is included in 2004
expenses.
We target a product gross profit of approximately 80% of net
sales, which allows us to economically remit royalties to our
distributor organization, pay our vendors for product and cover
operating costs associated with product development and
licensing, warehousing, distribution and transportation. We
generally do not target promotions or advertising at any
particular product or brand. Our significant promotions are
generally aimed at generating increased levels of recruiting and
retention of distributors. An example is the European Billion
Dollar Challenge in the first half of 2004. Under this
promotion, distributors qualified for various levels of award,
based on the incremental sales volume they achieved. Generally,
when a major new product is launched, there will be expenditures
related to the roll-out and promotion of such products. Based on
the breadth and manner of a product launch, these costs could be
material or immaterial. For example, as detailed previously in
the net sales discussion, we introduced
ShapeWorkstm
in the United States in 2004 at an extravaganza, at a cost of
approximately $3.7 million, net of costs of labeling and
packaging revisions prior to introduction. The same product was
launched in Europe at the Bologna event (a
mini-extravaganza) at a cost of $0.5 million,
and in South Korea, not tied to any major event, at a cost of
less than $0.1 million. Product or brand advertising is
generally handled by our distributors, although in 2005, we
anticipate participating in sponsoring certain sporting events
that will raise awareness and recognition of the Herbalife
brand. We have not finalized these plans, but we expect that
spending on such events would not be material in 2005.
We expect 2005 selling, general & administrative
expenses to increase approximately 7% to 8% over 2004 levels
reflecting general salary merit increases and further
investments in China and sales events, although we expect that
as a percentage of net sales, these expenses should remain flat
with 2004 levels.
Net Interest Expense
Net interest expense was $123.3 million for the year ended
December 31, 2004, as compared to $41.5 million in
2003. The higher interest expense in 2004 was primarily due to
the two recapitalizations in
43
2004 as noted in the table below and $8.2 million
additional interest expense associated with the
$275.0 million principal amount of our
91/2% Notes
issued in March 2004:
|
|
|
|
|
|
|
|
|
|
|
Year Ended | |
|
Year Ended | |
|
|
December 31, | |
|
December 31, | |
Interest Expense (dollars in millions) |
|
2004 | |
|
2003 | |
|
|
| |
|
| |
113/4% Notes-Redemption Premium
and write-off of deferred financing fees
|
|
$ |
49.9 |
|
|
$ |
1.4 |
|
151/2% Senior
Notes-Redemption Premium and write-off of deferred
financing fees
|
|
|
15.4 |
|
|
|
|
|
Term Loan-Write-off of deferred financing fees
|
|
|
4.5 |
|
|
|
|
|
Revolver-Write-off of deferred finance fees
|
|
|
1.7 |
|
|
|
|
|
|
|
|
|
|
|
|
Recapitalization expenses included in Interest Expense
|
|
$ |
71.5 |
|
|
$ |
1.4 |
|
Interest Expense
|
|
|
51.8 |
|
|
|
40.1 |
|
|
|
|
|
|
|
|
Total Interest Expense
|
|
$ |
123.3 |
|
|
$ |
41.5 |
|
|
|
|
|
|
|
|
As part of the continuation of the fourth quarter 2004
recapitalization, we exercised a contract provision to redeem
40%, or $110 million, of the
91/2% Notes.
After the required notice period, this redemption was completed
on February 4, 2005. The premium and the write-off of
deferred financing fees of $14.2 million associated with
this redemption will be included in interest expense in the
first quarter of 2005.
Income Taxes
Income taxes were $29.7 million for the year ended
December 31, 2004, as compared to $28.7 million in
2003. As a percentage of pre-tax income, the estimated effective
income tax rate was 192.8% for the year ended December 31,
2004, as compared to 43.8% in 2003. The increase in the
effective tax rate for the year ended December 31, 2004 as
compared to 2003 was caused primarily by the expenses related to
the recapitalizations, a significant portion of which are
non-deductible, and the non-deductible interest expense
associated with the
91/2% Notes.
Excluding the impact of the recapitalization expenses of
$71.5 million, the 2004 effective tax rate would have been
approximately 47%. In 2005, we believe the effective tax rate
should decrease to 43%, reflecting the lower level of non
deductible interest, and before the impact of the
$14.2 million of premium and write-off of deferred
financing fees noted in interest expense above. We estimate the
unfavorable impact to the effective tax rate of including these
expenses could be as high as 4%.
Foreign Currency Fluctuations
Currency fluctuations had a favorable impact of
$12.9 million on net results for the year ended
December 31, 2004, when compared to what current year net
results would have been using last years foreign exchange
rates. For the year ended December 31, 2004, the regional
effects were a favorable $7.5 million in Europe, a
favorable $2.7 million in Asia/ Pacific Rim, a favorable
$0.2 million in the Americas, and a favorable
$2.5 million in Japan.
Net Results
Net results for the year ended December 31, 2004, including
$71.5 million of pre-tax recapitalization expenses
(approximately $60.5 million net of tax), was a loss of
$14.3 million, or a loss of $0.27 per diluted share,
which was $51.2 million lower than the prior-year net
income of $36.8 million or earnings of $0.69 per
diluted share. The recapitalization expenses in the first and
fourth quarters of 2004 of $71.5 million pre-tax resulted
from the repurchase our
151/2% senior
notes, and the
113/4
Notes, and the refinancing of Herbalife Internationals
term loan. Net results were also impacted by the interest
expense associated with the
91/2% Notes,
higher promotional expenses and labor costs, partially offset by
the 13.0% increase in net sales, the favorable impact of aged
royalties and the favorable impact of the appreciation of
foreign currencies. Overall, the appreciation of foreign
currencies had a $12.9 million favorable impact on net
results for 2004.
44
|
|
|
Year ended December 31, 2003 compared to year ended
December 31, 2002 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Predecessor | |
|
Company | |
|
Combined | |
|
Company | |
|
|
| |
|
| |
|
| |
|
| |
|
|
January 1 to | |
|
August 1 to | |
|
Year Ended | |
|
Year Ended | |
|
|
July 31, 2002 | |
|
December 31, 2002 | |
|
December 31, 2002 | |
|
December 31, 2003 | |
|
|
| |
|
| |
|
| |
|
| |
|
|
(In millions) | |
Operations:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net sales
|
|
$ |
644.2 |
|
|
$ |
449.5 |
|
|
$ |
1,093.7 |
|
|
$ |
1,159.4 |
|
Cost of sales
|
|
|
140.6 |
|
|
|
95.0 |
|
|
|
235.6 |
|
|
|
235.8 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross profit
|
|
|
503.6 |
|
|
|
354.5 |
|
|
|
858.1 |
|
|
|
923.6 |
|
Royalty overrides
|
|
|
227.2 |
|
|
|
159.9 |
|
|
|
387.1 |
|
|
|
415.4 |
|
Selling, general & administrative expenses
|
|
|
207.4 |
|
|
|
135.5 |
|
|
|
342.9 |
|
|
|
401.3 |
|
Acquisition transaction expenses
|
|
|
54.7 |
|
|
|
6.2 |
|
|
|
60.9 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating income
|
|
|
14.3 |
|
|
|
52.9 |
|
|
|
67.2 |
|
|
|
107.0 |
|
Interest income (expense), net
|
|
|
1.4 |
|
|
|
(23.9 |
) |
|
|
(22.5 |
) |
|
|
(41.5 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Income before income taxes and minority interest
|
|
|
15.7 |
|
|
|
29.0 |
|
|
|
44.7 |
|
|
|
65.6 |
|
Income taxes
|
|
|
6.3 |
|
|
|
15.0 |
|
|
|
21.3 |
|
|
|
28.7 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income before minority interest
|
|
|
9.4 |
|
|
|
14.0 |
|
|
|
23.4 |
|
|
|
36.8 |
|
Minority interest
|
|
|
0.2 |
|
|
|
|
|
|
|
0.2 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income
|
|
$ |
9.2 |
|
|
$ |
14.0 |
|
|
$ |
23.2 |
|
|
$ |
36.8 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the year ended December 31, 2003, net income increased
to $36.8 million from $23.2 million in 2002. Net sales
for the year ended December 31, 2003 increased 6.0% to
$1,159.4 million from $1,093.7 million in 2002, helped
by the appreciation of foreign currencies, primarily the euro.
Excluding the impact of pre-tax amortization expense of
intangibles resulting from the Acquisition of $34.5 million
and $1.5 million in 2003 and 2002, respectively,
transaction expenses of $60.9 million in 2002 relating to
the Acquisition, 2003 legal and related costs associated with
litigation resulting from the Acquisition of $5.1 million,
$6.2 million in incremental fees and expenses paid to our
Equity Sponsors in 2003, and the favorable impact of foreign
currency appreciation of approximately $15.8 million in
2003, operating income increased 5.7% to $137.0 million in
2003 from $129.6 million in 2002. The improved result was
attributed to increased sales throughout Europe, Brazil and
Mexico, partly offset by the decreased sales in the U.S., Japan
and South Korea. We expect that sales in the U.S., Japan and
South Korea will improve following the execution of our
revitalization initiatives for 2004, which are described below.
We anticipate some impact associated with the discovery of BSE
in the United States, but do not expect this issue to have a
material effect on our business.
45
Net Sales
The following chart reconciles Retail Sales to net sales:
Sales by Geographic Regions
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31, | |
|
|
|
|
| |
|
|
|
|
2002 | |
|
2003 | |
|
|
|
|
| |
|
| |
|
|
|
|
|
|
Handling | |
|
|
|
|
|
Handling | |
|
|
|
|
|
|
|
|
& | |
|
|
|
|
|
& | |
|
|
|
Change | |
|
|
Retail | |
|
Distributor | |
|
Product | |
|
Freight | |
|
Net | |
|
Retail | |
|
Distributor | |
|
Product | |
|
Freight | |
|
Net | |
|
in Net | |
|
|
Sales | |
|
Allowance | |
|
Sales | |
|
Income | |
|
Sales | |
|
Sales | |
|
Allowance | |
|
Sales | |
|
Income | |
|
Sales | |
|
Sales | |
|
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
|
(In millions) | |
The Americas
|
|
$ |
683.1 |
|
|
$ |
(324.7 |
) |
|
$ |
358.4 |
|
|
$ |
65.9 |
|
|
$ |
424.3 |
|
|
$ |
687.9 |
|
|
$ |
(328.9 |
) |
|
$ |
359.0 |
|
|
$ |
65.4 |
|
|
$ |
424.4 |
|
|
|
0.0 |
% |
Europe
|
|
|
560.3 |
|
|
|
(266.3 |
) |
|
|
294.0 |
|
|
|
48.7 |
|
|
|
342.7 |
|
|
|
733.4 |
|
|
|
(349.4 |
) |
|
|
384.0 |
|
|
|
64.2 |
|
|
|
448.2 |
|
|
|
30.8 |
|
Asia/ Pacific Rim
|
|
|
294.7 |
|
|
|
(130.0 |
) |
|
|
164.7 |
|
|
|
20.8 |
|
|
|
185.5 |
|
|
|
271.6 |
|
|
|
(123.6 |
) |
|
|
148.0 |
|
|
|
19.5 |
|
|
|
167.5 |
|
|
|
(9.7 |
) |
Japan
|
|
|
241.1 |
|
|
|
(117.1 |
) |
|
|
124.0 |
|
|
|
17.2 |
|
|
|
141.2 |
|
|
|
201.5 |
|
|
|
(97.4 |
) |
|
|
104.1 |
|
|
|
15.2 |
|
|
|
119.3 |
|
|
|
(15.5 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$ |
1,779.2 |
|
|
$ |
(838.1 |
) |
|
$ |
941.1 |
|
|
$ |
152.6 |
|
|
$ |
1,093.7 |
|
|
$ |
1,894.4 |
|
|
$ |
(899.3 |
) |
|
$ |
995.1 |
|
|
$ |
164.3 |
|
|
$ |
1,159.4 |
|
|
|
6.0 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net sales growth in the Americas was flat with 2002. In local
currency, net sales increased by 1.9%. The slight increase was a
result of increases in both Brazil and Mexico, which were mostly
offset by declining sales in the U.S. Net sales in Brazil
and Mexico increased 71.4% and 13.3%, respectively, while net
sales in the U.S. declined 10.3% in 2003. In the fourth
quarter of 2003, the rate of net sales decline in the
U.S. slowed in connection with the introduction of a new
sales promotion. In 2004, it is our goal to revitalize the
U.S. market through new product introductions, the enhanced
use of internet tools, the opening of strategically located
sales centers and the implementation of distributor leadership
initiatives.
Net sales in Europe increased $105.5 million or 30.8% in
2003, as compared to the prior year. In local currency, net
sales increased 14.7% as compared to 2002. The appreciation of
the euro and other European currencies was a primary reason for
the overall sales increase. Net sales in many of the established
countries like Belgium (up 115.1%), France (up 59.9%),
Netherlands (up 33.2%), Spain (up 72.2%), Switzerland
(up 54.9%) and Turkey (up 371.5%) showed notable
growth as reported in U.S. dollars. In 2004, it is our goal
to increase sales by strengthening our presence in Europe and in
particular in Russia and Greece by expanding our distributor
services and taking over the management of product distribution,
which in the past has been handled through third party importers.
Net sales in Asia/ Pacific Rim decreased $18.0 million or
9.7% in 2003, as compared to the prior year. In local currency,
net sales decreased 13.3%. The sales decrease was due to a
$32.5 million or 42.5% decline in South Korea partly offset
by a $9.6 million or 25.0% increase in Taiwan. During 2003,
we implemented several new initiatives to help the distributors
in South Korea regain momentum, including improving their
incentive arrangements and introducing new internet tools and
several new products. We believe that these initiatives have
helped stabilize sales during the second half of 2003.
Net sales in Japan decreased $21.9 million or 15.5% during
2003, as compared to the prior year. In local currency, net
sales in Japan decreased 22.8%. The decline in the Japanese
market over the last year has continued due to strong
competition and the general deterioration in economic conditions
in Japan. In 2004, it is our goal to revitalize the Japanese
market through new product introductions, enhanced use of
internet tools, and the implementation of distributor leadership
initiatives.
46
Sales by Product Category
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|
Year Ended December 31, | |
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| |
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2002 | |
|
2003 | |
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| |
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| |
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Handling | |
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Handling | |
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& | |
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& | |
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Change | |
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Retail | |
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Distributor | |
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Product | |
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Freight | |
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Net | |
|
Retail | |
|
Distributor | |
|
Product | |
|
Freight | |
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Net | |
|
in Net | |
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|
Sales | |
|
Allowance | |
|
Sales | |
|
Income | |
|
Sales | |
|
Sales | |
|
Allowance | |
|
Sales | |
|
Income | |
|
Sales | |
|
Sales | |
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| |
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| |
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| |
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| |
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| |
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| |
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| |
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| |
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| |
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| |
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| |
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|
(In millions) | |
Weight Management
|
|
$ |
779.8 |
|
|
$ |
(381.1 |
) |
|
$ |
398.7 |
|
|
$ |
66.9 |
|
|
$ |
465.6 |
|
|
$ |
840.4 |
|
|
$ |
(413.2 |
) |
|
$ |
427.2 |
|
|
$ |
72.9 |
|
|
$ |
500.1 |
|
|
|
7.4 |
% |
Inner Nutrition
|
|
|
797.7 |
|
|
|
(389.8 |
) |
|
|
407.9 |
|
|
|
68.4 |
|
|
|
476.3 |
|
|
|
849.0 |
|
|
|
(417.5 |
) |
|
|
431.5 |
|
|
|
73.6 |
|
|
|
505.1 |
|
|
|
6.0 |
|
Outer Nutrition®
|
|
|
182.0 |
|
|
|
(88.9 |
) |
|
|
93.1 |
|
|
|
15.6 |
|
|
|
108.7 |
|
|
|
177.6 |
|
|
|
(87.3 |
) |
|
|
90.3 |
|
|
|
15.4 |
|
|
|
105.7 |
|
|
|
(2.8 |
) |
Literature, Promotional and Other
|
|
|
19.7 |
|
|
|
21.7 |
|
|
|
41.4 |
|
|
|
1.7 |
|
|
|
43.1 |
|
|
|
27.4 |
|
|
|
18.7 |
|
|
|
46.1 |
|
|
|
2.4 |
|
|
|
48.5 |
|
|
|
12.5 |
|
|
|
|
|
|
|
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|
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|
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Total
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|
$ |
1,779.2 |
|
|
$ |
(838.1 |
) |
|
$ |
941.1 |
|
|
$ |
152.6 |
|
|
$ |
1,093.7 |
|
|
$ |
1,894.4 |
|
|
$ |
(899.3 |
) |
|
$ |
995.1 |
|
|
$ |
164.3 |
|
|
$ |
1,159.4 |
|
|
|
6.0 |
% |
|
|
|
|
|
|
|
|
|
|
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|
|
|
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|
|
The increase in net sales for weight management and inner
nutrition products was due to our increased emphasis on
science-based products. In addition, during 2002 we rationalized
our Outer Nutrition® line by eliminating color cosmetics,
resulting in decreased net sales in 2003. We believe that our
Outer Nutrition® product line is now better aligned with
our other product categories.
Gross Profit
Gross profit was $923.6 million for the year ended
December 31, 2003, as compared to $858.2 million in
the prior year. As a percentage of net sales, gross profit for
the year ended December 31, 2003 increased from 78.5% to
79.7% as compared to the prior year. The increase in gross
profit reflected inventory management initiatives which have
reduced obsolescence by $3.5 million, a decrease in freight
and duty expenses of $3.2 million, and the favorable impact
of stronger foreign currencies.
Royalty Overrides
Royalty Overrides as a percentage of net sales were 35.8% for
the year ended December 31, 2003, as compared to 35.4% in
the prior year. The ratio varies slightly from period to period
primarily due to a change 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
compensation plan, we do not expect to see significant
fluctuations in Royalty Overrides as a percent of sales.
Selling, General and Administrative Expenses
Selling, general and administrative expenses as a percentage of
net sales were 34.6% for the year ended December 31, 2003,
as compared to 31.4% in the prior year. For the year ended
December 31, 2003, these expenses increased
$58.4 million to $401.3 million from
$342.9 million in the prior year. The increase included
$34.5 million amortization expense of intangibles in 2003
compared to $1.5 million in 2002. In addition, selling,
general and administrative expenses were unfavorably impacted by
approximately $10.9 million due to the appreciation of
foreign currencies, by approximately $6.9 million due to
increased promotional expenses, by approximately
$9.1 million due to litigation costs and related legal
expenses, and by approximately $6.2 million due to fees and
expenses paid to our Equity Sponsors subsequent to the
Acquisition. Lower salaries and wages expense partly offset the
increased expense reflecting efficiencies realized from various
cost savings initiatives.
Acquisition Transaction Expenses
In 2002, we recorded $21.9 million relating to fees and
$39.0 million of stock option expenses in connection with
the Acquisition.
47
Net Interest Expense
Net interest expense was $41.5 million for the year ended
December 31, 2003, as compared to $22.5 million in the
prior year. The increase was mainly due to a full years
interest expense relating to the term loan, the
113/4% Notes
and the 15.5% senior notes in 2003, as compared to only
five months of interest expense for those same items in 2002.
Income Taxes
Income taxes were $28.7 million for the year ended
December 31, 2003, as compared to $21.3 million for
the prior year. As a percentage of pre-tax income, the annual
effective income tax rate was 43.8% for 2003 and 47.6% for 2002.
The higher effective tax rate in 2002 reflected primarily the
non-deductibility of certain acquisition-related expenses
incurred in 2002.
Foreign Currency Fluctuations
Currency fluctuations had a favorable impact of
$9.5 million on net income for the year ended
December 31, 2003, when compared to what current year net
income would have been using 2002 foreign exchange rates. For
the year ended December 31, 2003, the regional effects were
an unfavorable impact of $3.2 million in the Americas, a
favorable impact of $1.5 million in Asia/ Pacific Rim, a
favorable impact of $11.2 million in Europe, and no
material impact in Japan.
Net Income
Net income for the year ended December 31, 2003, was
$36.8 million compared to net income of $23.2 million
for the prior year. Net income increased primarily because of
the factors noted above.
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, 2005, we generated
$130.9 million from operating cash flows, as compared to
$81.0 million in 2004. The improved operating cash flow was
primarily due to the 19.6% increase in net sales, partially
offset by higher receivables resulting from higher sales volume
and higher operating expenses primarily from increased labor,
benefit and incentive compensation.
Capital expenditures, including capital leases, for the nine
months ended September 30, 2005, were $22.3 million,
as compared to $20.7 million in 2004. The majority of these
expenditures represented investments in management information
systems, internet tools for distributors, the relocation of our
facility in Japan and the expansion of our facilities in China.
We expect to incur total capital expenditures of up to
$35.0 million in 2005 primarily related to investments in
management information systems, internet tools for distributors,
office facilities and our expansion in China.
2005 and 2006 are investment years for us in China as we expand
our business there. We currently anticipate to fund an operating
loss of approximately $5.0 million and $10.0 million
in 2005 and 2006, respectively, in addition to total capital
expenditures and working capital of up to $15.0 million for
the planned build-out of retail stores, our offices and the
expansion of the capabilities of our manufacturing facility. As
of September 30, 2005, we have invested approximately
$2.0 million in capital expenditures.
In December 2004, Herbalife completed an initial public offering
in connection with which several recapitalization transactions
were completed, including the tender for all of the outstanding
113/4% Notes,
of which 99.9% accepted the tender offer, and a replacement of
the existing term loan and revolving credit facility with a new
$225.0 million senior credit facility. In addition, we
redeemed $110 million principal
48
amount excluding discounts or 40% of our outstanding
91/2% Notes
in February of 2005 for the cash amount of $124.1 million,
including a premium of $10.5 million and accrued interest
of $3.6 million. Interest expense for the first six months
of 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.
The $225.0 million senior credit facility consists 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. The revolver is available until
December 21, 2009. The revolver bears interest at LIBOR
plus 2%. In April 2005 the senior credit facility was amended
whereby the interest rate was reduced from LIBOR plus
21/4%
to LIBOR plus
13/4%.
In addition, the amount payable in connection with a partial or
full refinancing of the loan within the first year of the
amendment shall equal 101% of the principal amount. During the
second quarter of 2005 we prepaid $35.0 million of our
senior credit facility resulting in approximately
$0.7 million additional interest expense from write-off of
deferred financing fees.
In August 2005, the senior credit facility was amended to permit
the purchase, repurchase or redemption of up to
$50.0 million aggregate principal amount of the
91/2% Notes
due 2011. There were no repurchases during the third quarter.
During the third quarter of 2005 we prepaid an additional
$44.7 million of our senior credit facility resulting in
approximately $0.9 million additional interest expense from
write-off of deferred financing fees. With regard to the term
loan we are obligated to pay $0.3 million every quarter
until September 30, 2010 and the remaining principal amount
on December 21, 2010. As of September 30, 2005, no
amounts had been borrowed under the revolving credit facility.
The senior credit facility and the
91/2% Notes
include customary covenants that restrict, among other things,
the ability to incur additional debt, pay dividends or make
certain other restricted payments, incur liens, merge or sell
all or substantially all of our assets, or enter into various
transactions with affiliates. Additionally, the senior credit
facility includes covenants relating to the maintenance of
certain leverage, fixed charge coverage, and interest coverage
ratios, and requirements to make early payments to the extent of
excess cash flow, as defined therein.
The following summarizes our contractual obligations including
interest at September 30, 2005 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 | |
|
|
| |
|
|
|
|
2010 & | |
|
|
Total | |
|
2005 | |
|
2006 | |
|
2007 | |
|
2008 | |
|
2009 | |
|
Thereafter | |
|
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
|
(In millions) | |
Borrowings under our senior credit facility
|
|
$ |
152.3 |
|
|
$ |
1.9 |
|
|
$ |
7.7 |
|
|
$ |
7.6 |
|
|
$ |
7.6 |
|
|
$ |
7.5 |
|
|
$ |
120.0 |
|
113/4% Notes
|
|
|
0.2 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
0.2 |
|
91/2% Notes
|
|
|
259.0 |
|
|
|
7.8 |
|
|
|
15.7 |
|
|
|
15.7 |
|
|
|
15.7 |
|
|
|
15.7 |
|
|
|
188.4 |
|
Capitalized leases
|
|
|
5.2 |
|
|
|
0.5 |
|
|
|
3.1 |
|
|
|
1.6 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Other debt
|
|
|
2.7 |
|
|
|
0.3 |
|
|
|
1.5 |
|
|
|
0.9 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating leases
|
|
|
24.9 |
|
|
|
4.0 |
|
|
|
12.5 |
|
|
|
3.3 |
|
|
|
1.7 |
|
|
|
1.1 |
|
|
|
2.3 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$ |
444.3 |
|
|
$ |
14.5 |
|
|
$ |
40.5 |
|
|
$ |
29.1 |
|
|
$ |
25.0 |
|
|
$ |
24.3 |
|
|
$ |
310.9 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Whitney and Golden Gate Capital (and/or their affiliates) were
parties to a Share Purchase Agreement (the Share Purchase
Agreement) pursuant to which they originally purchased our
Preferred Shares. Under the terms of the Share Purchase
Agreement, Whitney and Golden Gate Capital could, subject to
approval by our board of directors and 75% of our shareholders,
require us to pay a dividend to all of our shareholders related
to certain income that may be taxable to them resulting from
their ownership of our shares. We completed our analysis with
regard to this payment and based on this analysis, we made
$1.4 million and $4.9 million dividend payments to our
shareholders in the fourth quarter of 2004, related to certain
income that may be taxable to them for the years ended
December 31, 2003 and December 31, 2004, respectively.
49
In December 2004, we entered into a termination agreement with
the parties to the Share Purchase Agreement. Pursuant to the
termination agreement, the Share Purchase Agreement and all
obligations and liabilities of the parties under the Share
Purchase Agreement were terminated. As consideration for the
termination of the Share Purchase Agreement, we have entered
into a Tax Indemnification Agreement with Whitney and Golden
Gate Capital (and/or their affiliates) pursuant to which we have
agreed to indemnify each of those parties for the Federal income
tax liability and any related losses they incur in respect of
income of Herbalife that is (or would be) includible in the
gross income of that party for any taxable period under
Section 951(a) of the Internal Revenue Code of 1986, as
amended (the Code). Under the terms of the Tax
Indemnification Agreement, we assume, for this purpose, that
each indemnified party is a United States
shareholder as defined in Section 951(b) of the Code.
We do not, however, have any obligation to provide an indemnity
with respect to any taxes or related losses incurred that have
been reimbursed under the Share Purchase Agreement. Our senior
credit facility permits us to pay these tax indemnity payments,
but restricts the aggregate amount that we can pay in any given
year to no more than $15 million. We currently anticipate
that any amounts that we are required to pay under this
agreement in the future will be immaterial to our financial
condition and operating results.
In connection with the initial public offering we paid a special
cash dividend to shareholders of record prior to the offering in
the amount of $139.7 million.
The declaration of future dividends is subject to the discretion
of our board of directors and will depend upon various factors,
including our earnings, financial condition, restrictions
imposed by our credit agreement, cash requirements, future
prospects and other factors deemed relevant by our board of
directors. Our credit agreement permits payments of dividends as
long as no default exists and the amount does not exceed
$20.0 million per fiscal year provided that the amount of
dividends may be increased by 25% of the consolidated net income
for the prior fiscal year if the Leverage Ratio (as defined in
our credit agreement) for the four fiscal quarters of such
fiscal year is less than or equal to 2.00:1.00.
As of September 30, 2005, we had working capital of
$9.4 million compared to negative $1.6 million at
December 31, 2004. Cash and cash equivalents were
$105.2 million at September 30, 2005, compared to
$201.6 million at December 31, 2004.
We expect that cash and funds provided from operations and
available borrowings under our revolving credit facility will
provide sufficient working capital to operate our business, to
make expected capital expenditures and to meet foreseeable
liquidity requirements, including debt service on the
91/2% Notes
and the senior credit facility. There can be no assurance,
however, that our business will service our debt, including our
outstanding notes, 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.
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 distributors have
been named as defendants in a purported 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). 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 its
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
50
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. We believe that we have
meritorious defenses to the suit.
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
we have meritorious defenses to the suit.
In February 2005, Herbalife voluntarily elected to temporarily
withdraw its Sesame & Herb tablet product from the
Israeli market. This product, which has been on the market since
1989, is sold only in Israel. Herbalifes voluntary
decision to temporarily withdraw this product accompanied the
initiation of a review by the Israeli Ministry of Health (the
Israel MOH) of a small number of anecdotal case
reports of individuals having liver dysfunction who had also
consumed Herbalife products. Herbalife scientists and medical
doctors are closely cooperating with the Israel MOH to
facilitate this ongoing review. In May 2005, the Israel MOH
issued a press release stating that although their investigation
was continuing, no causal link has been shown between the
consumption of Herbalife products and liver function
abnormalities. In addition, the Israel MOH requested that
individuals consuming or intending to consume Herbalife products
obtain liver function tests before and one month after beginning
their use, and that persons with liver function disorders
refrain from consuming dietary supplements. Independent analysis
of Herbalifes Israeli products has confirmed that
Herbalife products do not contain any substances indicated by
the Israel MOH as being of concern in relation to this small
number of reported cases of liver dysfunction. Herbalife
believes that Herbalife products are not the cause of these few
reported anecdotal cases of liver dysfunction.
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 a self insured retention 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 in excess of amounts reserved 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.
51
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
involved in preparing the 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 60 countries throughout the world and
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 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.
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 as a percentage of Retail Sales were
approximately 0.99%, and 1.0%, for the three and nine months
ended September 30, 2004 and 2005, respectively. No
material changes in estimates have been recognized for the nine
months ended September 30, 2004 and 2005.
Royalty overrides receivables and the related allowances for
estimated uncollectible royalty overrides receivables are
calculated and recorded as contra-liabilities to the royalty
overrides liabilities on the balance sheet. During the third
quarter of 2005, we changed the way we estimate the allowances
based on new information that allows us to analyze royalty
overrides receivables and offsetting royalty payable balances.
Consequently, the change in estimate to the allowance for
uncollectible royalty overrides receivable was reduced by
$4.0 million during the quarter ended September 30,
2005.
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 $6.2 million
and $8.1 million as of December 31, 2004 and
September 30, 2005, respectively.
In accordance with Statement of Financial Accounting Standards
(SFAS) 144, 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
52
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 unit
goodwill and other intangibles. As of September 30, 2005,
we had goodwill of approximately $144.6 million, and
marketing franchise of $310.0 million. Goodwill was reduced
in the third quarter by approximately $16.0 million to
reflect a reduction in the valuation allowance established at
the time of the Acquisition against pre-Acquisition tax benefits.
Contingencies are accounted for in accordance with SFAS 5,
Accounting for Contingencies. SFAS 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.
New Accounting Pronouncements
In December 2004, the Financial Accounting Standards Board
(FASB) enacted Statement of Financial Accounting
Standards 123 revised 2004
(SFAS 123R), Share-Based Payment
which replaces Statement of Financial Accounting Standards
No. 123 (SFAS 123), Accounting for
Stock-Based Compensation and supersedes Accounting
Principles Board (APB) Opinion No. 25,
Accounting for Stock Issued to Employees.
SFAS 123R requires the measurement of all employee
share-based payments to employees, including grants of employee
stock options, using a fair-value-based method and the recording
of such expense in our consolidated statements of income. The
accounting provisions of SFAS 123R are effective for
reporting periods beginning after December 15, 2005.
We are required to adopt SFAS 123R in the first quarter of
fiscal 2006. The pro forma disclosures previously permitted
under SFAS 123 no longer will be an alternative to
financial statement recognition. See Note 8 in our Notes to
Consolidated Financial Statements for the pro forma net income
and net income per share amounts, for the three and nine months
ended September 30, 2004 and 2005, respectively, as if we
had used a fair-value-based method similar to the methods
required under SFAS 123R to measure compensation expense
for employee stock incentive awards. Although we have not yet
determined whether the adoption of SFAS 123R will result in
amounts that are similar to the current pro forma disclosures
under SFAS 123, we
53
are evaluating the requirements under SFAS 123R and on a
preliminary basis we expect the adoption will not have a
material impact on our consolidated statements of income,
relative to currently existing options.
In December 2004, the FASB issued FASB Staff Position
No. FAS 109-2 (FAS 109-2),
Accounting and Disclosure Guidance for the Foreign
Earnings Repatriation Provision within the American Jobs
Creations Act of 2004 (AJCA). The AJCA
introduces a limited time 85% dividends received deduction on
the repatriation of certain foreign earnings to a
U.S. taxpayer (repatriation provision),
provided certain criteria are met. FAS 109-2 provides
accounting and disclosure guidance for the repatriation
provision. This provision will not provide a material benefit to
the Company.
In December 2004, the FASB issued SFAS No. 151,
Inventory Costs, an amendment of ARB No. 43,
Chapter 4, which requires that abnormal amounts of
idle facility expense, freight, handling costs and wasted
material (spoilage) be recognized as current-period charges. In
addition, the statement requires that allocation of fixed
production overheads to the costs of conversion be based on the
normal capacity of the production facilities.
SFAS No. 151 is effective for fiscal years beginning
after June 15, 2005. We will adopt this statement as
required, and we do not believe the adoption will have a
material effect on our results of operations, financial
condition or liquidity.
In May 2005, the FASB issued Statement of Financial Accounting
Standards (SFAS) No. 154, Accounting
Changes and Error Corrections. SFAS No. 154
requires restatement of prior periods financial statements
for changes in accounting principle, unless it is impracticable
to determine either the period-specific effects or the
cumulative effect of the change. Also, SFAS No. 154
requires that retrospective application of a change in
accounting principle be limited to the direct effects of the
change. SFAS No. 154 is effective for accounting
changes and corrections of errors made in fiscal years beginning
after December 15, 2005.
54
BUSINESS
Herbalife
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 $1.3 billion for the fiscal year ended
December 31, 2004. We sell our products in 60 countries
through a network of over one million independent distributors.
In China, in order to comply with recently enacted legislation,
we sell our products through retail stores and an employed sales
force. 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 25-year operating history.
We offer products in three primary categories: weight
management, inner nutrition and Outer Nutrition®. Our
weight management product portfolio includes meal replacements,
weight-loss accelerators and a variety of healthy snacks. In
March 2004, we launched the
ShapeWorkstm
weight management program, an enhancement to our best-selling
Formula 1 weight management product, which personalizes
protein intake and includes a customized meal plan. Our
collection of inner nutrition products consists of dietary and
nutritional supplements, each containing quality herbs,
vitamins, minerals and natural ingredients in support of total
well-being and long-term good health. In 2003, we introduced
Niteworkstm,
which supports energy, vascular and circulatory health. In 2005
we entered into the high growth energy drink category in the
U.S. and Canada with the introduction of
Liftoff tm
an innovative, effervescent energy product. Our Outer
Nutrition® products include skin cleansers, moisturizers,
lotions, shampoos and conditioners, each based on botanical
formulas to revitalize, soothe and smooth body, skin and hair.
In 2005 we upgraded and expanded our personal care line with the
introduction of
NouriFusiontm.
This product line utilizes vitamin A, C and E to provide
benefits to the skin. Weight management, inner nutrition and
Outer Nutrition® accounted for 42.8%, 42.9% and 9.4% of our
net sales in fiscal year 2004, respectively.
We have significantly increased our emphasis on scientific
research in the fields of weight management and nutrition over
the past three years. We believe that our focus on nutrition
science will continue to result in meaningful product
enhancements that differentiate our products in the marketplace.
Our research and development organization combines the
experience of product development scientists within our Company
with an external team including world-renowned scientists.
Additionally, we contributed to the establishment of the Mark
Hughes Cellular and Molecular Nutrition Lab at UCLA (the
UCLA Lab), which is an independent lab devoted to
the advancement of nutrition science. We introduced
Niteworkstm,
a cardiovascular product developed in conjunction with Louis
Ignarro, Ph.D., a Nobel Laureate in Medicine in 2003 and,
in March 2004, we introduced
ShapeWorkstm,
a comprehensive weight management program based on the clinical
experience and the 15 years of meal replacement research of
David Heber, M.D., Ph.D., Professor of Medicine and
Public Health at the UCLA School of Medicine, Director of the
UCLA Center for Human Nutrition and Director of the UCLA Center
for Dietary Supplement Research in Botanicals.
We have a 16-member Scientific Advisory Board, comprised of
world-renowned scientists, and a Medical Advisory Board
consisting of leading scientists and medical doctors. We consult
with members of our Scientific Advisory Board on the
advancements in the field of nutrition science, while our
Medical Advisory Board provides training on product usage and
gives health-news updates through Herbalife literature, the
internet and live training events around the world. The boards,
both chaired by Dr. David Heber, support our internal
product development team by providing expertise on obesity and
human nutrition, conducting product research and advising on
product concepts.
We believe that the direct-selling channel is ideally suited to
marketing our products, because sales of weight management,
nutrition and personal care products are strengthened by ongoing
personal contact between retail consumers and distributors. This
personal contact may enhance consumers nutritional and
health education and motivate consumers to begin and maintain
wellness and weight management programs.
55
In addition, by using our products themselves, distributors can
provide first-hand testimonials of product effectiveness, which
can serve as a powerful sales tool.
We are focused on building and maintaining our distributor
network by offering financially rewarding and flexible career
opportunities through sales of quality, innovative products to
health conscious consumers. We believe the income opportunity
provided by our network marketing program appeals to a broad
cross-section of people throughout the world, particularly those
seeking to supplement family income, start a home business or
pursue entrepreneurial, full and part-time, employment
opportunities. Our distributors, who are all independent
contractors, can profit from selling our products and can also
earn royalties and bonuses on sales made by the distributors
whom they recruit to join their sales organizations.
We enable distributors to maximize their potential by providing
a broad array of motivational, educational and support services.
We motivate our distributors through our performance-based
compensation plan, individual recognition, reward programs and
promotions, and participation in local, national and
international Company-sponsored sales events and Extravaganzas.
We are committed to providing professionally designed
educational training materials that our distributors can use to
enhance recruitment and to maximize their sales. We and our
distributor leadership conduct thousands of training sessions
annually throughout the world to educate and motivate our
distributors. These training events teach our distributors not
only how to develop invaluable business-building and leadership
skills, but also how to differentiate our products with their
consumers. Our corporate-sponsored training events provide a
forum for distributors, who otherwise operate independently, to
share ideas with us and each other. In addition, our
internet-based Herbalife Broadcasting Network delivers, on a
24-hour basis worldwide, educational, motivational and
inspirational content, including addresses from our CEO. Our
efficient and effective distribution, logistics and customer
care support system assists our distributors by providing
next-day sales capabilities and support services. We further aid
our distributors by generating additional demand for our
products through traditional marketing and public relations
methods, such as through television ads, sporting event
sponsorships and endorsements.
We were founded in 1980 by Mark Hughes. In 2002, we were
acquired by an investment group led by Whitney & Co.
LLC (Whitney) and Golden Gate Private Equity, Inc.
(Golden Gate Capital) (together, the Equity
Sponsors). To consummate this acquisition, Whitney and
Golden Gate Capital and their affiliates formed a new holding
company called WH Holdings (Cayman Islands) Ltd., a Cayman
Islands exempted limited liability company (which has since been
renamed Herbalife Ltd.), and several new direct and indirect
wholly owned subsidiaries of that holding company, including an
acquisition vehicle called WH Acquisition Corp., a Nevada
corporation, in order to acquire us. On July 31, 2002, WH
Acquisition Corp. acquired us pursuant to an Agreement and Plan
of Merger we entered into on April 10, 2002. As a result of
the acquisition, we became a privately held company and were
delisted from the NASDAQ National Market at that time.
In December 2004, we and certain shareholders sold a total of
16.7 million of our common shares in our initial public
offering, and our common shares have since been listed on the
New York Stock Exchange (the NYSE) under the symbol
HLF.
Our Competitive Strengths
We believe that our success stems from our ability to motivate
our distributor network with a range of quality, innovative and
efficacious products that appeal to consumer preferences for
healthy living. We have been able to achieve sustained and
profitable growth by capitalizing on the following competitive
strengths:
Large, Highly-Motivated Distributor Base. We have
over one million distributors, including over
290,000 supervisors as of September 2005. Our compensation
system encourages distributors to remain active in the business
and to build down-line sales organizations of their own, which
can serve to increase their income and to increase our product
sales. Supervisors contribute significantly to our sales and
some key supervisors who have attained the highest levels within
our distributor network are responsible for their
organizations generation of a substantial portion of our
sales and for recruiting a substantial number of our
distributors.
56
Diverse and Well-Established Product Portfolio. We
are committed to building distributor, customer and brand
loyalty by providing a diverse portfolio of health-oriented and
wellness products. As of December 31, 2004, we had 130
products encompassing over 3,100 SKUs across our three primary
product categories. The breadth of our product offerings enables
our distributors to sell a comprehensive package of products
designed to simplify weight management and nutrition. We
continually review and if necessary improve upon our product
formulations, many of which have been in existence for years,
based upon developments in nutrition science. We believe that
the longevity and variety in our product portfolio significantly
enhances our distributors abilities to build their
businesses.
Nutrition Science-Based Product Development. We
have significantly increased our emphasis on science-based
product development in the fields of weight management and
nutrition during the past three years. We have an internal team
of scientists dedicated to continually evaluating opportunities
to enhance our existing products and to develop new
science-based products. These new product development efforts
are reviewed by prominent doctors and scientists who constitute
our Scientific Advisory Board and Medical Advisory Board. In
addition, in the past two years we provided donations to assist
in the establishment of the UCLA Lab. We believe that the UCLA
Lab provides opportunities for Herbalife to access cutting-edge
science in herbal research and nutrition.
Scalable Business Model. Our business model
enables us to grow our business with minimal investment in our
infrastructure and other fixed costs. Except in China, we
require no company-employed sales force to market and sell our
products, we incur no direct incremental cost to add a new
distributor in our existing markets, and our distributor
compensation varies directly with sales. In addition, our
distributors bear the majority of our consumer marketing
expenses, and supervisors sponsor and coordinate a large share
of distributor recruiting and training initiatives. Furthermore,
we can readily increase production and distribution of our
products as a result of our multiple third party manufacturing
relationships and our global footprint of in-house distribution
centers.
Geographic Diversification. We have a proven
ability to establish our network marketing organization in new
markets. Since our founding 25 years ago, we have expanded
into 60 countries, including 23 countries in the last seven
years. While sales within our local markets may fluctuate due to
economic, market and regulatory conditions, competitive
pressures, political or social instability or for other reasons,
we believe that our geographic diversity mitigates our financial
exposure to any particular market.
Experienced Management Team. The management team
is led by Michael O. Johnson who became our Chief Executive
Officer after spending 17 years with The Walt Disney
Company, where he most recently served as President of Walt
Disney International. Since joining our Company,
Mr. Johnson has assembled a team of experienced executives,
including Gregory Probert, President and Chief Operating Officer
and formerly Chief Executive Officer of DMX Music and Chief
Operating Officer of The Walt Disney Companys Buena Vista
Home Entertainment division; Richard Goudis, Chief Financial
Officer and formerly Chief Operating Officer of Rexall Sundown;
and Brett R. Chapman, General Counsel and formerly Senior Vice
President and Deputy General Counsel at The Walt Disney Company.
In addition, Steve Henig, Ph.D., formerly Senior Vice
President of Ocean Spray Cranberries, Inc., joined the Company
in 2005 as Chief Scientific Officer with responsibility for our
product research and development.
Our Business Strategy
We believe that our network marketing model is the most
effective way to sell our products. Our objective is to increase
the recruitment, retention, retailing and productivity of our
distributor base by pursuing the following strategic initiatives:
Distributor Strategy. We continue to increase our
investment in events and promotions as a catalyst to help our
distributors improve the effectiveness and productivity of their
businesses. We will attempt to globalize best-practice business
methods, such as Nutrition Clubs and the Total Plan, to enable
our distributors to improve their penetration in existing
markets. Additionally, we are creating new distributor business
systems and tools that will assist our distributors in building
their businesses more efficiently while better servicing their
existing customers. And finally, to increase brand awareness
among potential customers
57
and distributors, we created Team Herbalife and began allowing
our distributors to utilize the Herbalife brand logo in their
marketing efforts.
Direct-to-Consumer Strategy. We believe this
strategy complements our distributors existing business
opportunities and it should build a longer-term, more
sustainable customer base. We believe that providing direct
sales of our science-based products to end customers via the
Internet, while maintaining the financial and business
relationship between the customer and distributor, should allow
distributors to increase retailing, improve recruiting and
leverage our order taking, distribution, shipping, and
collections resources. In consultation with distributor
leadership, we are developing and will implement an e-commerce
direct-to-consumer platform in 2006.
Product Strategy. We are committed to providing
our distributors with unique, innovative products to help them
increase sales and recruit new distributors. On an ongoing basis
we will augment our product portfolio with additional
science-based products and, as appropriate, will bundle products
addressing similar health concerns into packages. We are
establishing a core set of products that will be available in
all markets. We are also empowering regional and country
managers to develop unique products that are specific to their
markets which should ensure that local consumer needs can be
met. Additionally, each year we plan to have mega
launches of products and/or programs which should generate
continual excitement among our distributors, and which could add
to the core set of products. These mega launches
will generally target specific market segments deemed strategic
to us, such as a childrens line to target stay-at-home
moms and a sports and fitness line to target consumers who have
active lifestyles.
China Strategy. While we plan to expand into new
markets each year, expanding in China represents a significant
growth opportunity for us. In August 2005, China published
direct sales and anti-pyramiding regulations to become effective
in November and December 2005. We believe that China could
become one of the largest direct-selling markets in the world
over the next several years. To address this opportunity, we
have assembled a management team with direct selling experience,
secured a headquarters location, and are in the process of
opening retail locations and registering additional products. In
the third quarter of 2005, we opened flagship stores in four key
provinces: Fujian, Tiangsu, Liaong and Shandong. We believe our
manufacturing facility in Suzhou has sufficient capacity to
support the anticipated growth in the Chinese market. We
anticipate officially applying for our direct selling license in
December of this year and remain optimistic that we will receive
our license in early 2006.
Infrastructure Strategy. In 2003, we embarked upon
a strategic initiative to significantly upgrade our technology
infrastructure globally. We are implementing an Oracle
enterprise-wide technology solution, with a scalable and stable
open architecture platform, to enhance our efficiency and
productivity as well as that of our distributors. In addition,
we are upgrading our internet-based marketing and distributor
services platform with tools such as Bizworks and
MyHerbalife.comtm.
We expect these initiatives to be substantially complete by
2007. Additionally, we are investing in our employees through a
comprehensive and global organizational development program
which was initiated in 2005.
Product Overview
For 25 years, our products have been designed to help
distributors and customers from around the world lose weight,
improve their health, and experience life-changing results. We
have built our heritage on developing formulas that blend the
best of nature with innovative techniques from nutrition
science, appealing to the growing base of consumers seeking to
live a healthier lifestyle.
As of December 31, 2004, we marketed and sold 130 products
encompassing over 3,100 SKUs through our distributors and had
approximately 1,600 trademarks globally. We group our products
into three categories: weight management, inner nutrition, and
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.
These programs target specific consumer market segments, such as
women, men, mature adults, sports enthusiasts, as well as
weight-loss and weight-management customers and individuals
looking to enhance their overall well-being.
58
The following table summarizes our products by product category.
The net sales figures are for the year ended December 31,
2004.
|
|
|
|
|
Product Category |
|
Description |
|
Representative Products |
|
|
|
|
|
Weight Management
(42.8% of 2004 net sales) |
|
Meal replacements, weight-loss accelerators and a variety of
healthy snacks |
|
Formula 1
Personalized Protein Powder Total Control®
High Protein Bars and Snacks |
Inner Nutrition
(42.9% of 2004 net sales) |
|
Dietary and nutritional supplements containing quality herbs,
vitamins, minerals and other natural ingredients |
|
Niteworkstm
Garden
7 tm
Aloe Concentrate
Liftoff tm |
Outer Nutrition®
(9.4% of 2004 net sales) |
|
Skin cleansers, moisturizers, lotions, shampoos and conditioners |
|
Skin Activator® Cream
Radiant
C tm
Body Lotion
Herbal Aloe Everyday Shampoo
NouriFusiontm |
Our weight-management products include the following:
|
|
|
|
|
Formula 1 Protein Drink Mix, a meal-replacement protein powder
available in five different flavors; |
|
|
|
Formula 2 Multivitamin-Mineral & Herbal Tablets, which
provide essential vitamins and nutrients and are part of our
weight-management programs; |
|
|
|
Personalized Protein Powder, a soy and whey protein source
developed to be added to our meal replacements to boost protein
intake and decrease hunger; |
|
|
|
weight-loss accelerators, including Total Control®,
which address specific challenges associated with dieting, such
as lack of energy, hunger and food craving, fluid retention,
decreased metabolism and digestive challenges, by building
energy, boosting metabolism, curbing appetite and helping to
promote weight loss; and |
|
|
|
healthy snacks, formulated to provide between-meal nutrition and
satisfaction. |
Our best-selling Formula 1 meal replacement product has been
part of our basic weight management program for 25 years
and generated approximately 22% of our net sales in 2004. In
March 2004, we introduced
ShapeWorkstm,
a personalized protein-based meal replacement program based on
the clinical experience and 15 years of meal replacement
research of Dr. David Heber, Director of the UCLA Center
for Human Nutrition. The
ShapeWorkstm
program incorporates several of our leading weight management
products, including the products listed above. Our distributors
help identify body type, analyze lean body mass, and customize a
ShapeWorkstm
program that can help increase metabolism and control hunger.
We market numerous dietary and nutritional supplements designed
to meet our customers specific nutritional needs. Each of
these supplements contains quality herbs, vitamins, minerals and
other natural ingredients and focuses on specific lifestages and
lifestyles of our customers, including women, men, children,
mature adults, and athletes. For example, in 2003, we introduced
Niteworkstm,
a product developed in conjunction with Nobel Laureate in
Medicine, Dr. Louis Ignarro.
Niteworkstm
supports energy, circulatory and vascular health and enhances
blood flow to the heart, brain and other vital organs. Another
new product,
Garden 7 tm,
is designed to provide the phytonutrient benefits of seven
servings of fruits and vegetables, has anti-oxidant and
health-boosting properties, and comes in convenient daily packs
which can make nutrition simple. In 2005, we entered into the
high growth energy drink category in the U.S. and Canada with
the introduction of
Liftoff tm
an innovative, effervescent energy product.
59
Our Outer Nutrition® products complement our
weight-management and inner nutrition products and improve the
appearance of the body, skin and hair. These products include
skin cleansers, toners, moisturizers and facial masks, shampoos
and conditioners, body-wash items and a selection of fragrances
for men and women under the brand names
Radiant C tm
and Skin Activator®, among others. For example, our
Radiant C tm
Daily Skin Booster is designed to harness the antioxidant
power of vitamin C in a light gel-cream to help seal in moisture
and minimize the appearance of fine lines and wrinkles. In
addition, we offer Skin Activator®, an advanced
cream based on glucosamine, almond oil, green tea and sugar that
is also designed to reduce the appearance of fine lines and
wrinkles, help skin regain a smoother, firmer appearance, and
protect from dryness. In 2005 we upgraded and expanded our
personal care line with the introduction of
NouriFusiontm.
This product line utilizes vitamin A, C and E to provide
benefits to the skin.
|
|
|
Literature, promotional and other products |
We also sell literature and promotional materials, including
sales aids, informational audiotapes, videotapes, CDs and DVDs
designed to support our distributors marketing efforts, as
well as start-up kits called International Business
Packs for new distributors. For the year ended
December 31, 2004, $63.5 million or 4.8% of our net
sales were derived from literature and promotional materials. In
2005 we introduced
Bizworkstm,
an internet based subscription toolset for distributors that
enhances the on-line experience and improves their productivity.
Product Development
We are committed to providing our distributors with unique,
innovative science-based products to help them increase retail
sales, and recruit and retain additional distributors. We
believe this is accomplished by introducing new products and by
upgrading, reformulating and repackaging existing product lines.
Our internal team of scientists collaborate with the
Companys Scientific Advisory Board and Medical Advisory
Board to formulate, review and evaluate new product ideas. Once
a particular market opportunity has been identified, our
scientists along with our marketing and sales teams work closely
with distributors to effect a successful development and launch
of the product.
We are focused on improving and enhancing our products through
our product development efforts. With regard to the weight
management and inner nutrition categories, new product
development involves all of our product strategies groups
including the product marketing, licensing, manufacturing,
medical affairs, scientific affairs, technical services and
quality control groups. Product development generally begins
with the scientific affairs group overseeing product design and
feasibility research, and the technical services group
overseeing scientific substantiation (evaluation of safety and
efficacy), expert reviews and related product research. Product
designs are transferred to technical services for development at
the pre-prototype phase, but technically complex products are
often taken to prototype phase by scientific affairs before
transfer. The technical services group then develops the
manufacturing specifications/technology transfer package, which
often requires development of a prototype, and tests product
stability. Prototypes are developed using contract facilities,
with oversight by either scientific affairs or technical
services, as appropriate. The quality control group, with
support from the technical services group, is responsible for
analytical methods development for ingredient label claims and
manufacturing product release. Manufacturing is generally
out-sourced to qualified vendors, although some products are
manufactured at our China manufacturing facility. Product
quality assurance is the responsibility of our quality control
group.
With regard to the Outer Nutrition® category, new product
development involves undertaking market trend and competitor
assessment. We then undertake ideation, which involves creating
ideas that fill our needs or our gaps but that conform with our
overall business strategy. We test final ideas with our
distributors via global quantitative testing. Those ideas that
have high retail potential and high personal use potential are
considered for development. We then initiate development and
undertake sensory tests and home use tests to determine if we
need to make any aesthetic improvements. Next, we test products
in clinical trials or with
60
expert panels for efficacy, safety and claim substantiation.
Finally, we scale up for launch, complete stability and launch.
During the past three years, we have significantly
increased our emphasis on the science of weight management and
nutrition. This is illustrated by our assembly of a dedicated
internal product development team composed of leading scientists
as well as our recent establishment of a Scientific Advisory
Board and Medical Advisory Board. Our Scientific Advisory Board
is comprised of 16 renowned international scientists who
are experts in the fields of obesity and human nutrition, and
who conduct product research and advise on product concepts.
Members of this board include David
Heber, M.D., Ph.D., Professor of Medicine and Public
Health at the UCLA School of Medicine, Director of the UCLA
Center for Human Nutrition and Director of the UCLA Center for
Dietary Supplement Research in Botanicals, and Louis
Ignarro, Ph.D., Distinguished Professor of Pharmacology at
the UCLA School of Medicine and Nobel Laureate in Medicine. In
addition, our Medical Advisory Board is comprised of three
leading scientists and medical doctors, who provide training on
product usage and give health-news updates through Herbalife
literature, the internet, and live training events around the
world.
We believe that it is important to maintain our relationships
with the members of our Scientific Advisory Board and Medical
Advisory Board and to recognize the time and effort that they
expend on our behalf. As a result, we have agreed to compensate
the members of these advisory boards as follows. A consulting
firm with which Dr. Ignarro is affiliated is entitled to
receive a royalty on sales of
(a) Niteworkstm,
(b) certain healthy heart products, and
(c) other products that we may mutually designate in the
future that are, in each case, sold with the aid of
Dr. Ignarros consulting, promotional or endorsement
services. From June 1, 2003 through December 31, 2004,
we paid approximately $1.3 million to the consulting firm.
In addition, we have made donations from time to time to UCLA to
fund research and educational programs. We contributed $50,000
in 2003 and contributed $100,000 in 2004 as part of this
arrangement. Dr. Heber receives no direct compensation from
us although we do reimburse him for travel expenses. Members of
our Scientific Advisory Board are compensated for their time and
efforts in the following manner: (a) one member is a
consultant to us whose compensation for service on the board is
reflected in their consulting fees, and (b) ten members are
paid an annual retainer of $5,000 plus travel expenses. In
addition, each member of our Medical Advisory Board other than
Dr. Heber (whose compensation is described above) receives
a monthly retainer of $5,000, plus $3,000 for every day that he
appears at a non-southern California distributor event and
$2,000 for every day that he needs to travel to such events.
From 2002 through 2004, we contributed to the establishment of
the Mark Hughes Lab For Cellular Nutrition, at UCLA (the
UCLA Lab) through a grant aggregating $500,000.
Additionally, in 2004 we donated lab equipment and software to
the UCLA Lab. UCLA agreed that the donations would be used to
further research and education in the fields of weight
management and botanical dietary supplements. While our direct
relationship with UCLA is currently limited to conducting two
ongoing clinical studies, we intend to take full advantage of
the expertise at UCLA by committing to support research that
will further our understanding of the benefits of phytochemicals.
In August 2005, we appointed Steve Henig, Ph.D. to the newly
created post of Chief Scientific Officer, with responsibility
for our product research and development function.
Mr. Henigs specific responsibilities include setting
Herbalifes R&D direction; product innovation and
development; scientific and medical affairs; product safety and
efficacy; and leadership of Herbalifes Scientific Advisory
Board, which is chaired by David Heber, M.D., Ph.D.
Mr. Henig is a product innovator who brings more than two
decades of experience in the development and marketing of
nutrition products to Herbalife. He most recently served as
Senior Vice President at Ocean Spray Cranberries, Inc. where he
revitalized the companys new products program and medical
research program for Ocean Spray. He has also consulted with a
number of leading companies, including POM Wonderful.
We believe our focus on nutrition science and our efforts at
combining our internal research and development efforts with the
scientific expertise of our Scientific Advisory Board, the
educational skills of the Medical Advisory Board, and the
resources of the UCLA Lab should result in meaningful product
introductions and give our distributors and consumers increased
confidence in our products.
61
Network Marketing Program
Our products are distributed through a global network marketing
organization comprised of over one million independent
distributors in 60 countries, except in China where, due to
regulations, our sales are conducted through company operated
retail stores, preferred customers, and employed sales
management personnel and, once the newly promulgated direct
selling and anti-pyramiding regulations become effective,
independent direct sellers. In addition to helping them achieve
physical health and wellness through use of our products, we
offer our distributors, who are independent contractors, what we
believe is one of the most attractive income opportunities in
the direct selling industry. Distributors may earn income on
their own sales and can also earn royalties and bonuses on sales
made by the distributors in their sales organizations. We
believe that our products are particularly well-suited to the
network marketing distribution channel because sales of weight
management and health and wellness products are strengthened by
ongoing personal contact between retail consumers and
distributors. We believe our continued commitment to developing
innovative, science-based products will enhance our ability to
attract new distributors as well as increase the productivity
and retention of existing distributors. Furthermore, our
international sponsorship program, which permits distributors to
sponsor distributors in other countries where we are licensed to
do business and where we have obtained required product
approvals, provides a significant advantage to our distributors
as compared with distributors in some other network marketing
organizations.
In connection with the Acquisition, we entered into an agreement
with our distributors on July 18, 2002 that no material
changes adverse to the distributors will be made to the existing
marketing plan and that we will continue to distribute Herbalife
products exclusively through our independent distributors. We
believe that this agreement has strengthened our relationship
with our existing distributors, improved our ability to recruit
new distributors and generally increased the long-term stability
of our business.
|
|
|
Structure of the network marketing program |
To become a distributor, a person must be sponsored by an
existing distributor, except in China where no sponsorship is
allowed, and must purchase an International Business Pack from
us, except in South Korea, where there is no charge for a
distributor kit. The International Business Pack is a
distributor kit available in local languages. The kit comes in
two sizes. The larger kit costs the local currency equivalent of
about $75 and includes a can of
ShapeWorkstm/
Formula 1, several bottles of different nutritional
supplements, booklets describing us, our compensation plan and
rules of conduct, various training and promotional materials,
distributor applications and a product catalog. The smaller
version costs the local currency equivalent of about $50 and
includes sample products and essentially the same print and
promotional materials as included in the larger kit version. To
become a supervisor or qualify for a higher level, distributors
must achieve specified volumes of product purchases or earn
certain amounts of royalty overrides during specified time
periods and must re-qualify for the levels once each year. To
attain supervisor status, a distributor generally must purchase
products representing at least 4,000 volume points in one month
or 2,500 volume points in two consecutive months. China has its
own unique qualifying program. Volume points are point values
assigned to each of our products that are equal in all countries
and are based on the suggested retail price of
U.S. products (one volume point equates to one
U.S. dollar). Supervisors may then attain higher levels,
(consisting of the World Team, the Global Expansion Team, the
Millionaire Team, the Presidents Team, the Chairmans
Club and the Founders Circle) and earn increasing amounts of
royalty overrides based on purchases by distributors within
their organizations and, for members of our Global Expansion
Team and above, earn production bonuses on sales in their
downline sales organizations. Supervisors contribute
significantly to our sales and some key supervisors who have
attained the highest levels within our distributor network are
responsible for their organizations generation of a
substantial portion of our sales and for recruiting a
substantial number of our distributors.
62
The following table sets forth the number of our supervisors at
the dates indicated:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
February* | |
|
|
| |
|
|
2001 | |
|
2002 | |
|
2003 | |
|
2004** | |
|
2005 | |
|
|
| |
|
| |
|
| |
|
| |
|
| |
The Americas
|
|
|
55,465 |
|
|
|
62,737 |
|
|
|
67,921 |
|
|
|
75,359 |
|
|
|
87,925 |
|
Europe
|
|
|
42,419 |
|
|
|
47,230 |
|
|
|
51,290 |
|
|
|
70,239 |
|
|
|
65,104 |
|
Asia/Pacific Rim
|
|
|
43,230 |
|
|
|
40,423 |
|
|
|
35,637 |
|
|
|
31,790 |
|
|
|
38,524 |
|
Japan
|
|
|
23,589 |
|
|
|
22,013 |
|
|
|
18,287 |
|
|
|
13,946 |
|
|
|
9,547 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Worldwide
|
|
|
164,703 |
|
|
|
172,403 |
|
|
|
173,135 |
|
|
|
191,334 |
|
|
|
201,100 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
* |
In February of each year, we delete from the rank of supervisor
those supervisors who did not satisfy the supervisor
qualification requirements during the preceding twelve months.
Distributors who meet the supervisor requirements at any time
during the year are promoted to supervisor status at that time,
including any supervisors who were deleted, but who subsequently
requalified. For the latest twelve month re-qualification period
ending January 2005, approximately 60 percent of our
supervisors did not re-qualify and more than 90% of our
distributors that are not supervisors turned over. Distributors
who purchase our product for personal consumption or for short
term weight loss or income goals may stay with us for several
months to one year. Supervisors who have committed time and
effort to build a sales organization generally stay for longer
periods. We rely on certifications from the selling distributors
as to the amount and source of product sales to other
distributors which are not directly verifiable by us. In order
to increase retailing of our products, we have modified our
requalification criteria to provide that any distributor that
earns at least 4,000 volume points in any 12-month period can
requalify as a supervisor and retain a discount of 50% from
suggested retail prices, but will forfeit their distributor
organization and associated earnings. For a supervisor to
requalify and retain their distributor organization and
associated earnings, they need to earn 4,000 volume points in
one month or 2,500 volume points in two consecutive months. |
|
|
** |
In 2004 certain modifications were made to the re-qualification
criteria resulting in approximately 19,000 additional
supervisors, including approximately 9,000 related to a change
in the business model in Russia. |
Distributor earnings are derived from several sources. First,
distributors may earn profits by purchasing our products at
wholesale prices, which are discounted 25% to 50% from suggested
retail prices, depending on the distributors level within
our distributor network, and selling our products to retail
customers or to other distributors. Second, distributors who
sponsor other distributors and establish their own sales
organizations may earn (a) royalty overrides, 15% of
product retail sales in the aggregate, (b) production
bonuses, 7% of product retail sales in the aggregate and
(c) the Mark Hughes bonus, 1% of product retail sales in
the aggregate. Royalty overrides together with the distributor
allowances represent the potential earnings to distributors of
up to approximately 73% of retail sales.
Under the regulations recently published by the Government of
China, direct selling companies will be limited to the payment
of gross compensation to direct sellers of 30% of the revenue
they generate through their own sales of products to consumers.
The Company will incur substantial ongoing additional costs
relating to the inclusion in the China business model of company
operated retail stores, employed sales management personnel and
company provided training and certification procedures for sales
personnel, features not common elsewhere in our business model.
Distributors earn the right to receive royalty overrides upon
attaining the level of supervisor and above, and production
bonuses upon attaining the level of Global Expansion Team and
above. Once a distributor becomes a supervisor, he or she has an
incentive to qualify, by earning specified amounts of royalty
overrides, as a member of the Global Expansion Team, the
Millionaire Team or the Presidents Team, and thereby
receive production bonuses of up to 7%. We believe that the
right of distributors to earn royalty overrides and production
bonuses contributes significantly to our ability to retain our
most productive distributors.
63
As noted above, our compensation plan offers distributors
opportunities to achieve higher levels of potential earnings up
to ultimately 73% of retail sales, through a combination of
royalty overrides and distributor allowances. Each
distributors success is dependent on two primary factors:
the time, effort and commitment a distributor puts into his or
her Herbalife business and the product sales made by a
distributor and his or her sales organization.
The following table summarizes supervisor payouts in 2004:
|
|
|
|
|
|
|
|
|
|
|
Number of | |
|
Estimated Average Annual | |
|
|
Individuals | |
|
Earnings in 2004 | |
|
|
| |
|
| |
Chairmans Club
|
|
|
24 |
|
|
$ |
1,970,000 |
|
Presidents Team
|
|
|
762 |
|
|
|
313,000 |
|
All Supervisors
|
|
|
201,100 |
|
|
|
6,500 |
|
Many of our non-supervisor distributors join Herbalife to obtain
a 25% discount on our products and become a discount consumer or
merely have a part-time income goal in mind. Consequently,
non-supervisor earnings tend to be relatively low and are not
tracked by the Company.
|
|
|
Distributor motivation and training |
We believe that motivation and training are key elements in
distributor success and that we and our distributor supervisors
have established a consistent schedule of events to support
these needs. We and our distributor leadership conduct thousands
of training sessions annually on local, regional and global
levels to educate and motivate our distributors. Every month,
there are hundreds of one-day Success Training Seminars held
throughout the world. Twice a year, in each major territory or
region, there is a three-day World Team School typically
attended by 2,000 to 10,000 distributors. In addition, once a
year in each region, we host an Extravaganza at which our
distributors from around the world can come to learn about new
products, expand their skills and celebrate their success. In
2004 we held Extravaganzas in Nashville, Barcelona, Bangkok,
Mexico City and Sao Paulo, attended by more than 61,000 of
our distributors. In 2005 we conducted a worldwide extravaganza,
in celebration of the Companys 25th anniversary, in
Atlanta where more than 34,000 distributors attended.
Additional regional events will be held in 2005 in Mexico City,
Sao Paulo and Japan.
In addition to these training sessions, we have our own
Herbalife Broadcast Network that we use to provide
distributors continual training and the most current product and
marketing information. The Herbalife Broadcast Network can be
seen on the internet.
Distributor reward and recognition is a significant factor in
motivating our distributors. Each year, we invest over
$40 million in regional and worldwide promotions to
motivate our distributors to achieve and exceed both sales and
recruiting goals. Examples of our worldwide promotions are our
25th Anniversary Cruise that will took place in April 2005,
under which distributors qualified to receive a cruise vacation,
and our Atlanta Challenge, under which distributors earned
rewards for exceeding their prior year base-line performance. In
Atlanta the Company introduced a Worldwide Cup Promotion that is
the primary promotion for 2005.
64
Geographic Presence
As of September 30, 2005, we conducted business in 60
countries located in the Americas, Europe, Asia/Pacific Rim
(excluding Japan) and Japan. The following charts sets forth the
countries we have opened and currently operate in as of
September 30, 2005, the year in which we commenced
operations in those countries and net sales information by
region for the past three fiscal years.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year | |
|
|
|
Year | |
|
|
|
Year | |
Country |
|
Entered | |
|
Country |
|
Entered | |
|
Country |
|
Entered | |
|
|
| |
|
|
|
| |
|
|
|
| |
Europe*
|
|
|
|
|
|
The Americas |
|
|
|
|
|
Asia/Pacific Rim and Japan |
United Kingdom
|
|
|
1984 |
|
|
USA |
|
|
1980 |
|
|
Australia |
|
|
1983 |
|
Spain
|
|
|
1989 |
|
|
Canada |
|
|
1982 |
|
|
New Zealand |
|
|
1988 |
|
Israel
|
|
|
1989 |
|
|
Mexico |
|
|
1989 |
|
|
Japan |
|
|
1989 |
|
France
|
|
|
1990 |
|
|
Venezuela |
|
|
1994 |
|
|
Hong Kong |
|
|
1992 |
|
Germany
|
|
|
1990 |
|
|
Dominican Republic |
|
|
1994 |
|
|
Philippines |
|
|
1994 |
|
Portugal
|
|
|
1992 |
|
|
Argentina |
|
|
1994 |
|
|
Taiwan |
|
|
1995 |
|
Czech Republic
|
|
|
1992 |
|
|
Brazil |
|
|
1995 |
|
|
Korea (South) |
|
|
1996 |
|
Italy
|
|
|
1992 |
|
|
Chile |
|
|
1997 |
|
|
Thailand |
|
|
1997 |
|
Netherlands
|
|
|
1993 |
|
|
Jamaica |
|
|
1999 |
|
|
Indonesia |
|
|
1998 |
|
Belgium
|
|
|
1994 |
|
|
Panama |
|
|
2000 |
|
|
India |
|
|
1999 |
|
Poland
|
|
|
1994 |
|
|
Colombia |
|
|
2001 |
|
|
China |
|
|
2001 |
|
Denmark
|
|
|
1994 |
|
|
Bolivia |
|
|
2004 |
|
|
Macau |
|
|
2002 |
|
Sweden
|
|
|
1994 |
|
|
|
|
|
|
|
|
Singapore |
|
|
2003 |
|
Russia
|
|
|
1995 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Austria
|
|
|
1995 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Switzerland
|
|
|
1995 |
|
|
|
|
|
|
|
|
|
|
|
|
|
South Africa
|
|
|
1995 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Norway
|
|
|
1995 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Finland
|
|
|
1995 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Greece
|
|
|
1996 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Turkey
|
|
|
1998 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Botswana
|
|
|
1998 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Lesotho
|
|
|
1998 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Namibia
|
|
|
1998 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Swaziland
|
|
|
1998 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Iceland
|
|
|
1999 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Slovak Republic
|
|
|
1999 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Cyprus
|
|
|
2000 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Ireland
|
|
|
2000 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Croatia
|
|
|
2001 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Latvia
|
|
|
2002 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Ukraine
|
|
|
2002 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Estonia
|
|
|
2003 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Lithuania
|
|
|
2003 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Hungary
|
|
|
2005 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
* |
Europe includes Africa and Middle Eastern countries. |
65
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31 | |
|
Percent of | |
|
Number of Countries | |
|
|
| |
|
Total Net Sales | |
|
Open as of | |
Geographic region |
|
2002 | |
|
2003 | |
|
2004 | |
|
2004 | |
|
September 30, 2005 | |
|
|
| |
|
| |
|
| |
|
| |
|
| |
|
|
(In millions) | |
|
|
|
|
The Americas
|
|
$ |
424.3 |
|
|
$ |
424.4 |
|
|
$ |
468.2 |
|
|
|
35.8 |
% |
|
|
12 |
|
Europe
|
|
|
342.7 |
|
|
|
448.2 |
|
|
|
536.2 |
|
|
|
40.9 |
|
|
|
35 |
|
Asia/Pacific Rim (excluding Japan)
|
|
|
185.5 |
|
|
|
167.5 |
|
|
|
206.5 |
|
|
|
15.8 |
|
|
|
12 |
|
Japan
|
|
|
141.2 |
|
|
|
119.3 |
|
|
|
98.8 |
|
|
|
7.5 |
|
|
|
1 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$ |
1,093.7 |
|
|
$ |
1,159.4 |
|
|
$ |
1,309.7 |
|
|
|
100.0 |
% |
|
|
60 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Over the most recent five years, the top six countries of each
year have gone from representing approximately 69.9% of net
sales in 2000 to 51.4% of net sales in 2004.
After entering a new country, we in many instances experience an
initial period of rapid growth in sales as new distributors are
recruited, followed by a decline in sales. We believe that a
significant factor affecting these markets is the opening of
other new markets within the same geographic region or with the
same or similar language or cultural bases. Some distributors
then tend to focus their attention on the business opportunities
provided by these newer markets instead of developing their
established sales organizations in existing markets.
Additionally, in some instances, we have become aware that
certain sales in certain existing markets were attributable to
purchasers who distributed our products in countries that had
not yet been opened. When these countries were opened, the sales
in existing markets shifted to the newly opened markets,
resulting in a decline in sales in the existing markets. To the
extent we decide to open new markets in the future, we will
continue to seek to minimize the impact on distributor focus in
existing markets and to ensure that adequate distributor support
services and other Herbalife systems are in place to support
growth.
Manufacturing and Distribution
All of our weight management, nutritional and personal care
products are manufactured for us by third party manufacturing
companies, with the exception of products distributed in and
sourced from China where we have our own manufacturing facility.
We source our products from multiple manufacturers, with our top
three suppliers accounting for approximately 37% of our product
purchases for the nine months ended September 30, 2005. In
addition, each of our products can be made available from a
secondary vendor if necessary. We work closely with our vendors
in an effort to achieve the highest quality standards and
product availability. We also have our own quality control lab
in which we routinely test products received from vendors. We
have established excellent relationships with our manufacturers
and have obtained improvements in supply services, product
quality and product delivery. Historically, we have not been
subject to material price increases by our suppliers, and we
believe that in the event of price increases, we have the
ability to respond to a portion of the price increases by
raising the prices of our products. We own the proprietary
formulations for substantially all of our weight management
products and dietary and nutritional supplements.
In order to coordinate and manage the manufacturing of our
products, we utilize a significant demand planning and
forecasting process that is directly tied to our production
planning and purchasing systems. Using this sophisticated
planning software and process allows us to balance our inventory
levels to provide exceptional service to distributors while
minimizing working capital and inventory obsolescence. We
maintain a monthly forecast accuracy of better than 80%, which
facilitates the above planning process.
Our global distribution system features centralized distribution
and telephone ordering systems coupled with storefront
distributor service centers. Our major distribution warehouses
have been automated with pick-to-light picking
systems which consistently deliver over 99.5% order accuracy and
handling systems that provide for inspection of every shipment
before it is sent to delivery. Shipping and processing standards
for orders placed are either the same day or the following
business day. We have central sales ordering facilities for
answering and processing telephone orders. Operators at such
centers are capable of conversing in multiple languages.
66
Our products are distributed to foreign markets either from the
facilities of our manufacturers or from our Los Angeles and
Venray, Netherlands distribution centers. Products are
distributed in the United States market from our Los Angeles
distribution center, our Memphis distribution center or from our
Dallas sales center. Nutrition products manufactured in
countries globally are generally transported by truck, cargo
ship or plane to our international markets and are warehoused in
either one of our foreign distribution centers or a contracted
third party warehouse and distribution center. After arrival of
the products in a foreign market, distributors purchase the
products from the local distribution center or the associated
sales center. Our Outer Nutrition® products are
predominantly manufactured in Europe and the United States. The
products manufactured in Europe are shipped to a centralized
warehouse facility, from which delivery by truck, ship or plane
to other international markets occurs.
Product Return and Buy-Back Policies
In most markets, our products include a customer satisfaction
guarantee. Under this guarantee, within 30 days of
purchase, any customer who is not satisfied with an Herbalife
product for any reason may return it or any unused portion of it
to the distributor from whom it was purchased for a full refund
from the distributor or credit toward the purchase of another
Herbalife product. If they return the products to us on a timely
basis, distributors may obtain replacements from us for such
returned products. In addition, in most jurisdictions, we
maintain a buy-back program, pursuant to which we will
repurchase products sold to a distributor provided that the
distributor resigns as an Herbalife distributor, returns the
product in marketable condition generally within twelve months
of original purchase and meets certain documentation and other
requirements. We believe this buy-back policy addresses a number
of the regulatory compliance issues pertaining to network
marketing, in that it offers monetary protection to distributors
who want to exit the business.
Historically, product returns and buy-backs have not been
significant and have been steadily declining over these
reporting periods. Product returns, refunds and buy-back
expenses approximated 2.4%, 1.9%, 1.1%, 0.9% of retail sales in
2002, 2003, 2004 and for the nine months ended
September 30, 2005, respectively.
Management Information, Internet and Telecommunication
Systems
In order to facilitate our continued growth and support
distributor activities, we continually upgrade our management
information, internet and telecommunication systems. These
systems include: (1) a centralized host computer managed by
Hewlett Packard in Colorado, which is linked to our
international markets through a dedicated wide area network that
provides on-line, real-time computer connectivity and access;
(2) local area networks of personal computers within our
markets, serving our regional administrative staffs; (3) an
international e-mail system through which our employees
communicate; (4) a standardized Northern Telecom Meridian
telecommunication system in most of our markets; (5) a
fully integrated Oracle supply chain management system that has
been installed in our distribution centers; and
(6) internet websites to provide a variety of online
services for distributors (status of qualifications, meeting
announcements, product information, application forms,
educational materials and, in the United States, sales ordering
capabilities). These systems are designed to provide financial
and operating data for management, timely and accurate product
ordering, royalty override payment processing, inventory
management and detailed distributor records. We intend to
continue to invest in our systems in order to strengthen our
operating platform.
Regulation
General. In both our United States and foreign markets,
we are affected by extensive laws, governmental regulations,
administrative determinations, court decisions and similar
constraints. Such laws, regulations and other constraints exist
at the federal, state or local levels in the United States and
at all levels of government in foreign jurisdictions, including
regulations pertaining to: (1) the formulation,
manufacturing, packaging, labeling, distribution, importation,
sale and storage of our products; (2) product claims and
advertising, including direct claims and advertising by us, as
well as claims and advertising by distributors, for which we may
be held responsible; (3) our network marketing program;
(4) transfer pricing and similar regulations that affect
the level of U.S. and foreign taxable income and customs duties;
and (5) taxation of
67
distributors (which in some instances may impose an obligation
on us to collect the taxes and maintain appropriate records).
Products. In the United States, the formulation,
manufacturing, packaging, storing, labeling, promotion,
advertising, distribution and sale of our products are subject
to regulation by various governmental agencies, including
(1) the FDA, (2) the Federal Trade Commission
(FTC), (3) the Consumer Product Safety
Commission (CPSC), (4) the United States
Department of Agriculture (USDA), (5) the
Environmental Protection Agency (EPA), (6) the
United States Postal Service, (7) United States Customs and
Border Protection, and (8) the Drug Enforcement
Administration. Our activities also are regulated by various
agencies of the states, localities and foreign countries in
which our products are manufactured, distributed and sold. The
FDA, in particular, regulates the formulation, manufacture and
labeling of conventional foods, dietary supplements, cosmetics
and over-the-counter (OTC) drugs, such as those
distributed by us. FDA regulations require us and our suppliers
to meet relevant current good manufacturing practice
(cGMP) regulations for the preparation, packing and
storage of foods and OTC drugs. On March 7, 2003, the FDA
released for comment its proposed cGMPs for dietary
supplements. If the FDA issues the final cGMPs for dietary
supplements in 2005, as the FDAs former Commissioner now
expects, we will have up to one year to ensure compliance. We
expect to see an increase in certain manufacturing costs as a
result of the necessary increase in testing of raw ingredients
and finished products and compliance with higher quality
standards.
Most OTC drugs are subject to FDA Monographs that establish
labeling and composition for these products. Our products must
comply with these Monographs, and our manufacturers must list
all products with the FDA and follow cGMP. Our cosmetic products
are regulated for safety by the FDA, which requires that
ingredients meet industry standards for non-allergenicity and
non-toxicity. Performance claims for cosmetics may not be
therapeutic.
The U.S. 1994 Dietary Supplement Health and Education Act
(DSHEA) revised the provisions of the Federal Food,
Drug and Cosmetic Act (FFDCA) concerning the
composition and labeling of dietary supplements and, we believe,
is generally favorable to the dietary supplement industry. The
legislation created a new statutory class of dietary
supplements. This new class includes vitamins, minerals, herbs,
amino acids and other dietary substances for human use to
supplement the diet, and the legislation grandfathers, with some
limitations, dietary ingredients that were on the market before
October 15, 1994. A dietary supplement that contains a
dietary ingredient that was not on the market before
October 15, 1994 will require evidence of a history of use
or other evidence of safety establishing that it is reasonably
expected to be safe. Manufacturers or marketers of dietary
supplements in the United States and certain other jurisdictions
that make product performance claims, including structure or
function claims, must have substantiation in their possession
that the statements are truthful and not misleading. The
majority of the products marketed by us in the United States are
classified as conventional foods or dietary supplements under
the FFDCA. Internationally, the majority of products marketed by
us are classified as foods or food supplements.
In January 2000, the FDA a issued a regulation that defines the
types of statements that can be made concerning the effect of a
dietary supplement on the structure or function of the body
pursuant to DSHEA. Under DSHEA, dietary supplement labeling may
bear structure or function claims, which are claims that the
products affect the structure or function of the body, without
prior FDA approval, but with notification to the FDA. They may
not bear a claim that they can prevent, treat, cure, mitigate or
diagnose disease (a disease claim). The regulation describes how
the FDA distinguishes disease claims from structure or function
claims. During 2004 the FDA issued a guidance, paralleling an
earlier guidance from the FTC, defining a manufacturers
obligations to substantiate structure/function claims. The FDA
also issued a Structure/Function Claims Small Entity Compliance
Guide. In addition, the agency permits companies to use
FDA-approved full and qualified health claims for products
containing specific ingredients that meet stated requirements.
As a marketer of dietary and nutritional supplements and other
products that are ingested by consumers, we are subject to the
risk that one or more of the ingredients in our products may
become the subject of regulatory action. A number of states
restricted the sale of dietary supplements containing botanical
sources of ephedrine alkaloids. As a result of these state
regulations, we stopped sales of its dietary supplements
68
containing botanical sources of ephedrine alkaloids due to a
shift in consumer preference for ephedra free
products and a significant increase in products liability
insurance premiums for products containing botanical sources of
ephedrine group alkaloids. On December 31, 2002, we ceased
sales of Thermojetics® original green herbal tablets
containing ephedrine alkaloids derived from Chinese Ma huang, as
well as Thermojetics® green herbal tablets and
Thermojetics® gold herbal tablets (the latter two
containing the herb Sida cordifolia which is another botanical
source of ephedrine alkaloids). On February 6, 2004, the
FDA published a rule finding that dietary supplements containing
ephedrine alkaloids present an unreasonable risk of illness or
injury under conditions of use recommended or suggested in the
labeling of the product, or, if no conditions of use are
suggested in the labeling, under ordinary conditions of use, and
are therefore adulterated.
The FDA has on record a small number of reports of adverse
reactions allegedly resulting from the ingestion of our
Thermojetics® original green tablet. These reports
are among thousands of reports of adverse reactions to these
products sold by other companies.
As a further outgrowth of the FDA ephedra safety review, the
FDA, in January 2004, announced that it would undertake a review
of the safety of the herb Citrus aurantium. We had
previously used Citrus aurantium in the
ShapeWorkstm
total control and Thermojetics® green ephedra free
dietary supplements sold in the United States and in a number of
international markets. Unconfirmed reports of
serious adverse events, reportedly associated with
Citrus aurantium, were disclosed by the FDA to the New
York Times during April 2004. Under the Freedom of Information
Act, we obtained a copy of those anecdotal serious adverse event
reports. No Herbalife dietary supplement containing Citrus
aurantium was cited by the FDA. Indeed, many cited products
from other companies did not even contain Citrus
aurantium. Nonetheless, we decided to reformulate our
products and within the United States no longer market dietary
supplements containing Citrus aurantium. Internationally,
due to longer product registration lead times, we are in the
process of reformulating our foreign products containing
Citrus aurantium and expect to complete such
reformulation by the end of 2006.
The FDAs decision to ban ephedra triggered a significant
reaction by the national media, some of whom are calling for the
repeal or amendment of DSHEA. These media view supposed
weaknesses within DSHEA as the underlying reason why
ephedra was allowed to remain on the market. We have been
advised that DSHEA opponents in Congress may use this anti-DSHEA
momentum to advance existing or new legislation during the 109th
Congress to amend or repeal DSHEA. We currently expect to see
the following: (1) calls for mandatory reporting of serious
adverse event reports for supplements; (2) premarket
approval for safety and effectiveness of dietary ingredients;
(3) specific premarket review of dietary ingredient
stimulants that are and will be used to replace ephedra;
(4) reversal of the burden of proof standard which now
rests on the FDA; and (5) a redefining of dietary
ingredient to remove either botanicals or selected classes
of ingredients now treated as dietary ingredients.
On September 16, 2002, the FDA changed its policies for
notifying companies of anecdotal adverse event reports for
dietary supplements. Since then, to date we have received seven
anecdotal special nutritional adverse events reports from the
FDA. These anecdotal special nutritional adverse events
consisted of an allegation of behavioral change, a reported
seizure, two cases of unspecified medical problems, two cardiac
problems, and an allegation of death. These adverse events
occurred following the use of varying, sometimes unspecified,
Herbalife products, including two products no longer sold by
Herbalife, Thermojetics Original Green and Thermojetics Gold
dietary supplements, both of which contained ephedrine
alkaloids. The incidents occurred within varying intervals of
time following the reported use of Herbalife products. In one
case of a reported unspecified medical problem, the Herbalife
products were taken in combination with a drug known as
warfarin. The single alleged death occurred six weeks after the
reported consumption of Herbalife Relax Now and Total
Control® dietary supplements. Two of the adverse events
involved women in their fifties who suffered cardiac incidents,
one of whom reportedly suffered a heart attack after claiming to
have ingested a daily intake of approximately 2-3 tablets a
day of the now discontinued Thermojetics Gold dietary supplement
for more than a year. As a result of our receipt of adverse
event reports we may from time to time elect or be required to
remove a product from a market, either permanently or
temporarily. We are in the process of refining our processes for
gathering and reporting serious dietary supplement
adverse event
69
reports in those markets where such reporting is required.
Currently, this process is managed by our Medical Affairs
department in collaboration with Distributor Relations Call
Centers.
On March 7, 2003, the FDA proposed a new regulation to
require current good manufacturing practices 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. This will mean that some of our contract
manufacturers will not be fully impacted by the proposed
regulation until at least 2008. However, the proposed regulation
can be expected to result in additional costs and possibly the
need to seek alternate suppliers.
In December 1999, we introduced a new line of weight management
products that are suitable for diets that are high in protein
and low in carbohydrates. The line, which consists of eight
nutritionally balanced high-protein products that are also low
in carbohydrates, is called the HPLC Program. To date the FDA
has not authorized the use of a low carbohydrate claim on the
label of individual food products, and therefore, we have not
made such a claim on the label of any of the eight products that
together comprise our HPLC Program. We believe, however, that it
is permissible to accurately describe the entire program as one
that is suitable for a diet that is high in protein and low in
carbohydrates, and we have elected to do so by virtue of the
name that we have selected for this weight management program.
Some of the products marketed by us are considered conventional
foods and are currently labeled as such. Within the United
States, this category of products is subject to the Nutrition,
Labeling and Education Act (NLEA), and regulations
promulgated under the NLEA. The NLEA regulates health claims,
ingredient labeling and nutrient content claims characterizing
the level of a nutrient in the product. The ingredients added to
conventional foods must either be generally recognized as safe
by experts (GRAS) or be approved as food additives
under FDA regulations.
In foreign markets, prior to commencing operations and prior to
making or permitting sales of our products in the market, we may
be required to obtain an approval, license or certification from
the relevant countrys ministry of health or comparable
agency. Where a formal approval, license or certification is not
required, we nonetheless seek a favorable opinion of counsel
regarding our compliance with applicable laws. Prior to entering
a new market in which a formal approval, license or certificate
is required, we work extensively with local authorities in order
to obtain the requisite approvals. The approval process
generally requires us to present each product and product
ingredient to appropriate regulators and, in some instances,
arrange for testing of products by local technicians for
ingredient analysis. The approvals may be conditioned on
reformulation of our products, or may be unavailable with
respect to some products or some ingredients. Product
reformulation or the inability to introduce some products or
ingredients into a particular market may have an adverse effect
on sales. We must also comply with product labeling and
packaging regulations that vary from country to country. Our
failure to comply with these regulations can result in a product
being removed from sale in a particular market, either
temporarily or permanently.
In 2005, Herbalife voluntarily elected to temporarily withdraw
its Sesame & Herb tablet product from the Israeli
market. This product, which has been on the market since 1989,
is sold only in Israel. Herbalifes voluntary decision to
temporarily withdraw this product accompanied the initiation of
a review by the Israeli Ministry of Health of anecdotal case
reports of individuals having varying liver conditions when it
was reported that a small number of these individuals had
consumed Herbalife products. Herbalife scientists and medical
doctors are closely cooperating with the Ministry of Health to
facilitate this review.
The FTC, which exercises jurisdiction over the advertising of
all of our products, has in the past several years instituted
enforcement actions against several dietary supplement companies
and against manufacturers
70
of weight loss products generally for false and misleading
advertising of some of their products. These enforcement actions
have often resulted in consent decrees and monetary payments by
the companies involved. In addition, the FTC has increased its
scrutiny of the use of testimonials, which we also utilize, as
well as the role of expert endorsers and product clinical
studies. Although we have not been the target of FTC enforcement
action for the advertising of our products, we cannot be sure
that the FTC, or comparable foreign agencies, will not question
our advertising or other operations in the future. It is unclear
whether the FTC will subject our advertisements to increased
surveillance to ensure compliance with the principles set forth
in the guide.
In Europe, a pending EU Health Claim regulation, now being
discussed within the European Parliament, could, if enacted,
have an adverse effect on existing product wellness,
well-being and good for you claims
presently made on existing product labeling, literature and
advertising. We and our industry allies are vigorously working
to address this pending debate in ongoing discussion with
Parliamentarians and the European Commission.
In some countries, regulations applicable to the activities of
our distributors also may affect our business because in some
countries we are, or regulators may assert that we are,
responsible for our distributors conduct. In these
countries, regulators may request or require that we take steps
to ensure that our distributors comply with local regulations.
The types of regulated conduct include: (1) representations
concerning our products; (2) income representations made by
us and/or distributors; (3) public media advertisements,
which in foreign markets may require prior approval by
regulators; and (4) sales of products in markets in which
the products have not been approved, licensed or certified for
sale.
In some markets, it is possible that improper product claims by
distributors could result in our products being reviewed by
regulatory authorities and, as a result, being classified or
placed into another category as to which stricter regulations
are applicable. In addition, we might be required to make
labeling changes.
We are unable to predict the nature of any future laws,
regulations, interpretations or applications, nor can we predict
what effect additional governmental regulations or
administrative orders, when and if promulgated, would have on
our business in the future. They could, however, require:
(1) the reformulation of some products not capable of being
reformulated; (2) imposition of additional record keeping
requirements; (3) expanded documentation of the properties
of some products; (4) expanded or different labeling;
(5) additional scientific substantiation regarding product
ingredients, safety or usefulness; and/or (6) additional
distributor compliance surveillance and enforcement action by us.
Any or all of these requirements could have a material adverse
effect on our results of operations and financial condition. All
of our officers and directors are subject to a permanent
injunction issued in October 1986 pursuant to the settlement of
an action instituted by the California Attorney General, the
State Health Director and the Santa Cruz County District
Attorney. We consented to the entry of this injunction without
in any way admitting the allegations of the complaint. The
injunction prevents us and our officers and directors from
making specified claims in future advertising of our products
and required us to implement some documentation systems with
respect to payments to our distributors. At the same time, the
injunction does not prevent us from continuing to make specified
claims concerning our products that have been made and are being
made, provided that we have a reasonable basis for making the
claims.
We are aware that, in some of our international markets, there
has been recent adverse publicity concerning products that
contain ingredients that have been genetically modified
(GM). In some markets, the possibility of health
risks or perceived consumer preference thought to be associated
with GM ingredients has prompted proposed or actual governmental
regulation. For example, the European Union has adopted a EC
Regulation 1829/2003 affecting the labeling of products
containing ingredients that have been genetically modified, and
the documents manufacturers and marketers will need to possess
to ensure traceability at all steps in the chain of
production and distribution. This new regulation, which took
effect in 2004, has been implemented by us and our contract
manufacturers, resulting in modifications to our labeling, and
in some instances, to some of our foods and food supplements
sold in Europe. Differing GM regulations affecting us also have
been adopted in Brazil, Japan, Korea, Taiwan and Thailand. We
cannot anticipate the extent to which future regulations in our
markets will restrict the use of GM ingredients in our products
or the impact of
71
any regulations on our business in those markets. In response to
any applicable regulations, we would, where practicable, attempt
to reformulate our products to satisfy the regulations. We
believe, based upon currently available information, that
compliance with regulatory requirements in this area should not
have a material adverse effect on us or our business. However,
because publicity and governmental scrutiny of GM ingredients is
a relatively new and evolving area, there can be no assurance in
this regard. If a significant number of our products were found
to be genetically modified and regulations in our markets
significantly restricted the use of GM ingredients in our
products, our business could be materially adversely affected.
In addition, in certain of our markets, there has been recent
adverse regulatory and press attention to ingredients that may
cause what is commonly referred to as mad cow disease
(BSE). Certain of our products contain ingredients
derived from bovine sources. We are not aware of any infection
or contamination of any of our products by BSE. Should any such
infection or contamination be detected, it could have a material
adverse effect on our business. Additionally, if governments
preclude importation of products from the U.S. containing
bovine-derived ingredients, it could adversely impact product
availability and/or future price. Further, even if no such
infection or contamination is detected, adverse publicity
concerning the BSE risk, or governmental or regulatory
developments aimed at combating the risk of BSE contamination by
regulating bovine products and/or by-products, could have a
material adverse effect on our business.
We are also in the process of complying with recent regulations
within the European Union, Australia, Brazil, Canada, China,
Hong Kong, Japan, Taiwan and Thailand affecting the use and/or
labeling of irradiated raw ingredients. To date, we have dealt
with irradiation compliance questions involving three products
sold in the Netherlands and one product sold in Switzerland.
Compliance with GM, BSE and irradiation regulations can be
expected to increase the cost of manufacturing certain of our
products.
Network marketing program. Our network marketing program
is subject to a number of federal and state regulations
administered by the FTC and various state agencies as well as
regulations in foreign markets administered by foreign agencies.
Regulations applicable to network marketing organizations
generally are directed at ensuring that product sales ultimately
are made to consumers and that advancement within our
organization is based on sales of the organizations
products rather than investments in the organizations or
other non-retail sales related criteria. For instance, in some
markets, there are limits on the extent to which distributors
may earn royalty overrides on sales generated by distributors
that were not directly sponsored by the distributor. When
required by law, we obtain regulatory approval of our network
marketing program or, when this approval is not required, the
favorable opinion of local counsel as to regulatory compliance.
Nevertheless, we remain subject to the risk that, in one or more
markets, our marketing system could be found not to be in
compliance with applicable regulations. Failure by us to comply
with these regulations could have a material adverse effect on
our business in a particular market or in general.
We also are subject to the risk of private party challenges to
the legality of our network marketing program. For example, in
Webster v. Omnitrition International, Inc., 79 F.3d
776 (9th Cir. 1996), the multi-level marketing program of
Omnitrition International, Inc. (Omnitrition) was
successfully challenged in a class action by Omnitrition
distributors who alleged that Omnitrition was operating an
illegal pyramid scheme in violation of federal and
state laws. We believe that our network marketing program
satisfies the standards set forth in the Omnitrition case and
other applicable statutes and case law defining a legal
marketing system, in part based upon significant differences
between our marketing system and that described in the
Omnitrition case.
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
72
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
we have meritorious defenses to the suit.
Herbalife International and certain of its distributors have
been named as defendants in a purported 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). Herbalife International
had removed the lawsuit to federal court and the court remanded
the lawsuit to state court. The complaint alleges that certain
telemarketing practices of certain Herbalife International
distributors violate the Telephone Consumer Protection Act (the
TCPA) and seeks to hold Herbalife International
liable for the practices of its distributors. More specifically,
the plaintiffs complaint alleges that several of
Herbalifes distributors used pre-recorded telephone
messages and autodialers to contact prospective customers in
violation of the TCPAs prohibition of such practices.
Herbalifes 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. We believe that we have meritorious defenses to the
suit.
We are also subject to the risk of private party challenges to
the legality of our network marketing program outside of the
United States. Non-U.S. 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. (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. Currently, the lawsuit is in
the pleading stage, and the plaintiffs filed their initial brief
on September 27, 2005. 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.
It is an ongoing part of our business to monitor and respond to
regulatory and legal developments, including those that may
affect our network marketing program. However, the regulatory
requirements concerning network marketing programs do not
include bright line rules and are inherently fact-based. An
adverse judicial determination with respect to our network
marketing program could have a material adverse effect on our
business. An adverse determination could: (1) require us to
make modifications to our network marketing program,
(2) result in negative publicity or (3) have a
negative impact on distributor morale. In addition, adverse
rulings by courts in any proceedings challenging the legality of
multi-level marketing systems, even in those not involving us
directly, could have a material adverse effect on our operations.
Transfer pricing and similar regulations. In many
countries, including the United States, we are subject to
transfer pricing and other tax regulations designed to ensure
that appropriate levels of income are reported as earned by our
U.S. or local entities and are taxed accordingly. 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.
Although we believe that we are in substantial compliance with
all applicable regulations and restrictions, we are subject to
the risk that governmental authorities could audit our transfer
pricing and related practices and assert that additional taxes
are owed. For example, 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, duties, value added taxes,
withholding 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 appeal
or litigate to reverse the assessments. We have taken advice
from our tax advisors, and the company believes that there are
substantial defenses to the allegations that additional taxes
are owing, and we
73
are vigorously defending against the imposition of additional
proposed taxes. The ultimate resolution of these matters may
take several years, and the outcome is uncertain.
In the event that the audits or assessments are concluded
adversely to us, we may or may not be able to offset or mitigate
the consolidated effect of foreign income tax assessments
through the use of U.S. foreign tax credits. Currently, we
anticipate utilizing the majority of our foreign tax credits in
the year in which they arise with the unused amount carried
forward. Because the laws and regulations governing
U.S. foreign tax credits are complex and subject to
periodic legislative amendment, we cannot be sure that we would
in fact be able to take advantage of any foreign tax credits in
the future. As a result, adverse outcomes in these matters could
have a material impact on our financial condition and operating
results.
Other regulations. We also are subject to a variety of
other regulations in various foreign markets, including
regulations pertaining to social security assessments,
employment and severance pay requirements, import/export
regulations and antitrust issues. As an example, in many
markets, we are substantially restricted in the amount and types
of rules and termination criteria that we can impose on
distributors without having to pay social security assessments
on behalf of the distributors and without incurring severance
obligations to terminated distributors. In some countries, we
may be subject to these obligations in any event.
Our failure to comply with these regulations could have a
material adverse effect on our business in a particular market
or in general. Assertions that we failed to comply with
regulations or the effect of adverse regulations in one market
could adversely affect us in other markets as well by causing
increased regulatory scrutiny in those other markets or as a
result of the negative publicity generated in those other
markets.
Compliance procedures. As indicated above, Herbalife, our
products and our network marketing program are subject, both
directly and indirectly through distributors conduct, to
numerous federal, state and local regulations, both in the
United States and foreign markets. Beginning in 1985, we began
to institute formal regulatory compliance measures by developing
a system to identify specific complaints against distributors
and to remedy any violations by distributors through appropriate
sanctions, including warnings, suspensions and, when necessary,
terminations. In our manuals, seminars and other training
programs and materials, we emphasize that distributors are
prohibited from making therapeutic claims for our products.
Our general policy regarding acceptance of distributor
applications from individuals who do not reside in one of our
markets is to refuse to accept the individuals distributor
application. From time to time, exceptions to the policy are
made on a country-by-country basis.
In order to comply with regulations that apply to both us and
our distributors, we conduct considerable research into the
applicable regulatory framework prior to entering any new market
to identify all necessary licenses and approvals and applicable
limitations on our operations in that market. Typically, we
conduct this research with the assistance of local legal counsel
and other representatives. We devote substantial resources to
obtaining the necessary licenses and approvals and bringing our
operations into compliance with the applicable limitations. We
also research laws applicable to distributor operations and
revise or alter our distributor manuals and other training
materials and programs to provide distributors with guidelines
for operating a business, marketing and distributing our
products and similar matters, as required by applicable
regulations in each market. We, however, are unable to monitor
our supervisors and distributors effectively to ensure that they
refrain from distributing our products in countries where we
have not commenced operations, and we do not devote significant
resources to this type of monitoring.
In addition, regulations in existing and new markets often are
ambiguous and subject to considerable interpretive and
enforcement discretion by the responsible regulators. Moreover,
even when we believe that we and our distributors are initially
in compliance with all applicable regulations, new regulations
regularly are being added and the interpretation of existing
regulations is subject to change. Further, the content and
impact of regulations to which we are subject may be influenced
by public attention directed at us, our products or our network
marketing program, so that extensive adverse publicity about us,
our products or our network marketing program may result in
increased regulatory scrutiny.
It is an ongoing part of our business to anticipate and respond
to new and changing regulations and to make corresponding
changes in our operations to the extent practicable. Although we
devote considerable
74
resources to maintaining our compliance with regulatory
constraints in each of our markets, we cannot be sure that
(1) we would be found to be in full compliance with
applicable regulations in all of our markets at any given time
or (2) the regulatory authorities in one or more markets
will not assert, either retroactively or prospectively or both,
that our operations are not in full compliance. These assertions
or the effect of adverse regulations in one market could
negatively affect us in other markets as well by causing
increased regulatory scrutiny in those other markets or as a
result of the negative publicity generated in those other
markets. These assertions could have a material adverse effect
on us in a particular market or in general. Furthermore,
depending upon the severity of regulatory changes in a
particular market and the changes in our operations that would
be necessitated to maintain compliance, these changes could
result in our experiencing a material reduction in sales in the
market or determining to exit the market altogether. In this
event, we would attempt to devote the resources previously
devoted to the market to a new market or markets or other
existing markets. However, we cannot be sure that this
transition would not have an adverse effect on our business and
results of operations either in the short or long-term.
Trademarks and Proprietary Formulas
We use the umbrella trademarks Herbalife, Thermojetics,
Dermajetics, and have several other trademarks and trade names
registered in connection with our products and operations. Our
trademark registrations are issued through the United States
Patent and Trademark Office and in comparable agencies in the
foreign countries. We consider our trademarks and trade names to
be an important factor in our business. We also take care in
protecting the intellectual property rights of our proprietary
formulas by restricting access to our formulas within our
Company to those persons or departments that require access to
them to perform their functions, and by requiring our finished
goods-suppliers and consultants to execute supply and
non-disclosure agreements that seek to contractually protect our
intellectual property rights in our proprietary products. For
example, we are currently developing a new product in the energy
supplement category for which we may seek (through our employees
who invented this product) one or more patents for technological
innovations inherent in the product, including the formulation
as a whole. At the moment, this project and its elements remain
the confidential trade secrets of us and our inventor-employees.
However, despite our efforts, we may be unable to prevent third
parties from infringing upon or misappropriating our proprietary
rights.
Competition
The business of marketing weight management and nutrition
products is highly competitive. This market segment includes
numerous manufacturers, distributors, marketers, retailers and
physicians that actively compete for the business of consumers
both in the United States and abroad. The market is highly
sensitive to the introduction of new products or weight
management plans, including various prescription drugs that may
rapidly capture a significant share of the market. As a result,
our ability to remain competitive depends in part upon the
successful introduction of new products. In addition, we
anticipate that we will be subject to increasing competition in
the future from sellers that utilize electronic commerce. We
cannot be sure of the impact of electronic commerce or that it
will not adversely affect our business.
We are subject to significant competition for the recruitment of
distributors from other network marketing organizations,
including those that market weight management products,
nutritional supplements, and personal care products, as well as
other types of products. Some of our competitors are
substantially larger than we are, and have available
considerably greater financial resources than we have. Our
ability to remain competitive depends, in significant part, on
our success in recruiting and retaining distributors through an
attractive compensation plan and other incentives. We believe
that our production bonus program, international sponsorship
program and other compensation and incentive programs provide
our distributors with significant earning potential. However, we
cannot be sure that our programs for recruitment and retention
of distributors will be successful.
75
Employees
As of September 30, 2005, we had 2,667 full-time employees.
These numbers do not include our distributors, who are
independent contractors rather than our employees. Except for
some employees in Mexico and in some European countries, none of
our employees are members of any labor union, and we have never
experienced any business interruption as a result of any labor
disputes.
Properties
We lease all of our physical properties located in the United
States. Our executive offices, located in Century City,
California, include approximately 115,000 square feet of
general office space under lease arrangements expiring in August
2007. We lease an aggregate of approximately 144,000 square
feet of office space, computer facilities and conference rooms
at the Operations Center in Inglewood, California, under a lease
that expires in October 2006, and approximately
150,000 square feet of warehouse space in two separate
facilities located in Los Angeles and Memphis. The Los Angeles
and Memphis lease agreements have terms through June 2006 and
August 2006, respectively. In Venray, Netherlands, we lease our
European centralized warehouse of approximately
175,000 square feet. The lease expires in June 2007. We
also lease warehouse, manufacturing plant and office space in a
majority of our other geographic areas of operation. We believe
that our existing facilities are adequate to meet our current
requirements and that comparable space is readily available at
each of these locations.
Legal Proceedings
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. The Company believes that
we have meritorious defenses to the suit.
Herbalife International and certain of its distributors have
been named as defendants in a purported 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). 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 liable for the practices of its 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. 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
76
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 owing, 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 pay the full amount assessed.
77
MANAGEMENT
Biographical information follows for each person who serves as a
director and/or an executive officer of the Company. The table
sets forth certain information regarding these individuals. Ages
are as of November 3, 2005.
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Director/ | |
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|
Officer | |
Name |
|
Age |
|
Position with the Company |
|
Since | |
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|
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|
| |
Peter M. Castleman
|
|
49 |
|
Chairman of the Board |
|
|
2002 |
|
Michael O. Johnson
|
|
51 |
|
Chief Executive Officer, Director |
|
|
2003 |
|
Gregory Probert
|
|
49 |
|
President, Chief Operating Officer |
|
|
2003 |
|
Richard Goudis
|
|
44 |
|
Chief Financial Officer |
|
|
2004 |
|
Brett R. Chapman
|
|
50 |
|
General Counsel |
|
|
2003 |
|
Leroy T. Barnes, Jr.
|
|
53 |
|
Director |
|
|
2004 |
|
Richard P. Bermingham
|
|
66 |
|
Director |
|
|
2004 |
|
Kenneth J. Diekroeger
|
|
43 |
|
Director |
|
|
2002 |
|
James H. Fordyce
|
|
46 |
|
Director |
|
|
2002 |
|
Peter Maslen
|
|
53 |
|
Director |
|
|
2004 |
|
Charles L. Orr
|
|
62 |
|
Director |
|
|
2002 |
|
Jesse T. Rogers
|
|
48 |
|
Director |
|
|
2002 |
|
John Tartol
|
|
54 |
|
Director |
|
|
2005 |
|
Leon Waisbein
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|
38 |
|
Director |
|
|
2005 |
|
Peter M. Castleman is the Chairman of our Board of
Directors. Mr. Castleman is Managing Partner of Whitney, a
position that he has held for more than a decade. Prior to
joining Whitney over fifteen years ago, Mr. Castleman was
with Morgan Stanley & Co. and prior to that with
J.P. Morgan & Co., Inc. Mr. Castleman
received his MBA from Harvard Business School and his
undergraduate degree from Duke University. Mr. Castleman is
currently a director of several private companies. He was
previously a director of numerous other companies, including The
North Face, Inc., Advance Paradigm, Eon Labs Inc., and
Pharmanex, Inc.
Michael O. Johnson is Chief Executive Officer of
the Company. Mr. Johnson joined the Company in April 2003
after 17 years with The Walt Disney Company, where he most
recently served as President of Walt Disney International, and
also served as President of Asia Pacific for The Walt Disney
Company and President of Buena Vista Home Entertainment.
Mr. Johnson has also previously served as a publisher of
Audio Times magazine, and has directed the regional sales
efforts of Warner Amex Satellite Entertainment Company for three
of its television channels, including MTV, Nickelodeon and The
Movie Channel. Mr. Johnson is currently a director of
Univision Communications, Inc., a television company serving
Spanish-speaking Americans. Mr. Johnson received his
Bachelor of Arts in Political Science from Western State College.
Gregory Probert is President and Chief Operating
Officer of the Company. Mr. Probert joined the Company in
August 2003, after serving as President and CEO of DMX MUSIC for
over 2 years. Mr. Probert joined DMX MUSIC after
serving as Chief Operating Officer of planetLingo from January
2000 to November 2000, where he led the team that designed and
built the companys first product, an online conversational
system for the $20 billion ESL market in Japan. Immediately
prior to planetLingo, Mr. Probert spent 12 years with
The Walt Disney Company, where he most recently served as
Executive Vice President and Chief Operating Officer for the
$3.5 billion Buena Vista Home Entertainment worldwide
business. Mr. Proberts positions with The Walt Disney
Company also included service as Executive Vice President and
Managing Director of the International Home Video Division,
Senior Vice President and Managing Director of Buena Vista Home
Entertainment, Asia Pacific Region, based in Hong Kong, and
Chief Financial Officer of Buena Vista International,
Disneys theatrical distribution arm, among others.
Mr. Probert received his Bachelor of Science from the
University of Southern California and his MBA from California
State University, Los Angeles.
78
Richard Goudis joined the Company in June 2004, as
Chief Financial Officer. From 1998 to 2001, Mr. Goudis was
the Chief Operating Officer of Rexall Sundown, a Nasdaq
100 company that was sold to Royal Numico in 2000. After
the sale to Royal Numico, Mr. Goudis had operations
responsibility for all of Royal Numicos
U.S. investments, including General Nutrition Centers, or
GNC, Unicity International and Rexall Sundown. From 2002 to May
2004, Mr. Goudis was a partner at Flamingo Capital
Partners, a firm he founded with several retired executives from
Rexall Sundown. Prior to working at Rexall Sundown,
Mr. Goudis worked at Sunbeam Corporation and
Pratt & Whitney.
Brett R. Chapman joined the Company in October
2003, as General Counsel and Secretary. Prior to joining the
Company, Mr. Chapman spent thirteen years at The Walt
Disney Company, most recently as Senior Vice President and
Deputy General Counsel, with responsibility for all legal
matters relating to Disneys Media Networks Group,
including the ABC Television Network, the companys cable
properties including The Disney Channel and ESPN, and
Disneys radio and internet businesses. Prior to working at
The Walt Disney Company, Mr. Chapman was an associate at
the law firm of Skadden, Arps, Slate, Meagher & Flom
LLP. Mr. Chapman received his Bachelor of Science and
Master of Science in Business Administration from California
State University, Northridge and his Juris Doctorate from
Southwestern University School of Law.
Leroy T. Barnes, Jr. is the retired Vice
President and Treasurer of PG&E Corporation, a position he
held from 2001 to 2005. From 1997 to 2001, Mr. Barnes was
Vice President and Treasurer of Gap, Inc. Prior to that,
Mr. Barnes was with Pacific Telesis Group/ SBC
Communications and prior to that with UC Press. Earlier in his
career, Mr. Barnes was a consultant at Deloitte &
Touche. Mr. Barnes received his Bachelors and Masters
degrees from Stanford University, and his MBA in Finance from
Stanford Business School. Mr. Barnes is a member of the
boards of directors of Longs Drug Stores, Inc., a retail drug
store chain, the McClatchy Newspaper Company, Inc., a newspaper
and Internet publisher, and Citizens Communications, Inc., a
telecommunications-focused company.
Richard P. Bermingham Mr. Bermingham,
currently retired, has over 40 years of business
experience. Mr. Bermingham was engaged in real estate
development and investing activities as a private investor
during the past several years. Mr. Bermingham was Chairman
of the Board of Bermingham Investment Company from 1997 to 2004.
From 1994 to 1997, Mr. Bermingham was the Vice Chairman of
the Board of American Golf. Mr. Bermingham worked for
Collins Food International, which was acquired by Sizzler
International, Inc., from 1967 to 1994. He served as the Chief
Executive Officer and a member of the board of directors of the
publicly traded company for the period from 1987 to 1994.
Mr. Bermingham currently serves on the boards of
Jordanos, Inc., Special Value Expansion Fund, LLC,
Interactive Health, Inc. and Encanto Restaurants LLC, the latter
two of which are companies controlled by Whitney or affiliates
thereof. Additionally, Mr. Bermingham serves on the
Advisory Board of Missouri River Plastics. Mr. Bermingham
was a certified public accountant and received his Bachelor of
Science from the University of Colorado.
Kenneth J. Diekroeger is a Managing Director of
Golden Gate Capital, a position he has held since its inception
in 2000. From 1996 to 2000, Mr. Diekroeger was a managing
director and partner with American Industrial Partners. Earlier
in his career, Mr. Diekroeger was a consultant at
Bain & Company. Mr. Diekroeger received his MBA
from Stanford University and his Bachelor of Science in
Industrial Engineering from Stanford University. He is currently
a director of several private companies.
James H. Fordyce is a partner with certain
Whitney-affiliated entities and has been with Whitney since July
1996. Prior to joining Whitney, Mr. Fordyce was with Heller
Financial and prior to that with Chemical Bank. Mr. Fordyce
received his MBA from Fordham University and his undergraduate
degree from Lake Forest College. Mr. Fordyce currently is a
director of several private companies.
Peter Maslen is CEO of The Hanson Maslen Group,
LLC, which he co-founded in 2003. From 1999 to 2003, he served
as President of Starbucks Coffee International. Prior to that,
he was President of Tricon Restaurants Central Europe, a
spin-off from PepsiCo where he held senior management positions
in Asia and Europe. Earlier, with Mars, Inc., Mr. Maslen
held various leadership roles around the world.
79
Charles L. Orr is self-employed as an independent
director and advisor to companies operating in the e-commerce,
financial services and direct selling industries. From 1993
through 2000, Mr. Orr was President and CEO of Shaklee
Corporation which included the brand names of Harry and David,
Jackson and Perkins and Shaklee. From 2003 through 2005,
Mr. Orr has served as the Chairman of the Scientific
Advisory Board for Swiss Medica, Inc., a Toronto-based
bio-science marketing and distribution company. Mr. Orr
served as a director of Provident Mutual Life Insurance Company
from 1995 through 2002. His prior business affiliations include
CIGNA, Continental Insurance, Federated Investors, RCA Computer
Systems, Southwestern Life and Xerox. Mr. Orr received his
MBA from the University of Connecticut and his Bachelor of Arts
from Wesleyan University. He is an advisor to several private
companies and currently serves as a board member of the Direct
Selling Education Foundation, a position he has held since 2001,
and of Swiss Medica, Inc., a position he has held since 2005.
Jesse T. Rogers is a Managing Director of Golden
Gate Capital, a position he has held since its inception in
2000. Prior to joining Golden Gate Capital, Mr. Rogers was
a partner at Bain & Company for over ten years, where
he served as the West Coast head of the consumer products
practice and founded Bain & Companys worldwide
Private Equity Group. Mr. Rogers received his MBA from
Harvard Business School and his Bachelor of Arts from Stanford
University. He is currently a director of several private
companies and previously served as a director of Beringer Wine
Estates and Bain & Company.
John Tartol has been an independent Herbalife
distributor for 24 years and a member of the
Chairmans Club since 2000. He is active in training other
Herbalife distributors all over the world and has served on
various strategy and planning groups for Herbalife. He is also
active on behalf of various charities in his community and
worldwide on behalf of the Herbalife Family Foundation. He has a
bachelors degree in finance from the University of
Illinois.
Leon Waisbein has been an independent Herbalife
distributor for 14 years. A member of the Chairmans
Club since 1995, Mr. Waisbein has built a successful
organization in more than 30 countries. He has been active in
training Herbalife distributors around the world, and is a
member of various strategy and planning groups for Herbalife. He
is Chairman of a charity foundation supporting disabled children
and an active volunteer for the Herbalife Family Foundation. He
has a bachelors degree in life science.
Director Independence
Our Board of Directors has affirmatively determined that
Messrs. Barnes, Bermingham, Maslen and Orr are independent
under section 303A.02 of the NYSE listing standards and the
Companys Categorical Standards of Independence. The
NYSEs independence guidelines include a series of
objective tests, such as that the director is not an employee of
the Company and has not engaged in various types of business
dealings involving the Company, which would prevent a director
from being independent. None of the Companys independent
directors had any relationships that violated these tests. We
currently expect that over the course of approximately three
years the number of our directors will decrease to nine. We
anticipate that the percentage of independent directors on our
board will increase over such time.
As a result of the disposition agreement and voting agreement by
and among certain affiliates of our Equity Sponsors described
under Certain Relationships and Related
Transactions Disposition Agreement and
Certain Relationships and Related Transactions
Voting Agreement we are deemed to be a controlled
company within the meaning of the NYSE listing standards.
Among other things, our status as a controlled company means
that we are not subject to all of the NYSE corporate governance
requirements that would otherwise be applicable, such as certain
requirements set forth in Sections 303A.01 (regarding
independent directors), 303A.04 (regarding the nominating and
corporate governance committee), and 303A.05 (regarding the
compensation committee). For example, as a controlled company we
are not required to have independent directors comprise a
majority of the members of our Board of Directors. As a result
of the consummation of this offering, we will cease to be a
controlled company, and we will comply with the additional
requirements within the time frames prescribed by the NYSE
listing standards.
80
Codes of Business Conduct and Ethics and Corporate Governance
Guidelines
Our Board of Directors has adopted a corporate code of business
conduct and ethics applicable to our directors, officers,
including our principal executive officer, principal financial
officer, and principal accounting officer and employees, as well
as corporate governance guidelines, in accordance with
applicable rules and regulations of the SEC and the NYSE. Each
of our code of business conduct and ethics and corporate
governance guidelines are available on our website at
www.herbalife.com/index.cfm by following the links to
Investor Relations and Corporate
Governance, or in print to any shareholders who requests
it.
Committees of the Board
Our Board of Directors has a standing audit committee,
nominating and corporate governance committee and compensation
committee.
Our audit committee consists of Messrs. Barnes, Bermingham
and Maslen, each of whom are independent as defined in
Section 303A.02 of the NYSE listing standards. As required
by Section 303A.07 of the NYSE listing standards, the Board
of Directors has determined that each of Messrs. Barnes,
Bermingham and Maslen are financially literate, and that
Mr. Bermingham is an audit committee financial
expert, as defined in Item 401(h) of
Regulation S-K. Mr. Barnes currently serves on the
audit committee of three public companies in addition to that of
the Company. However, as required by Section 303A.07 of the
NYSE listing standards, the Board of Directors has determined
that such simultaneous service would not impair his ability to
effectively serve on the Companys audit committee.
The principal duties of the audit committee are as follows:
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to monitor the integrity of the Companys financial
reporting process and systems of internal controls regarding
finance, accounting and reporting; |
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to monitor the independence and performance of the
Companys independent auditors and internal auditing
department; and |
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to provide an avenue of communication among the independent
auditors, management, the internal auditing department and the
Board of Directors. |
|
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Nominating and Corporate Governance Committee |
Our nominating and corporate governance committee consists of
Messrs. Castleman, Barnes, Diekroger and Johnson, of whom
Mr. Barnes is independent as defined in
Section 303A.02 of the NYSE listing standards.
The principal duties of the nominating and corporate governance
committee are as follows:
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to recommend to our Board of Directors proposed nominees for
election to the Board of Directors by the shareholders at annual
general meetings, based on an annual review as to the
renominations of incumbents, as well as to recommend proposed
nominees for election by the Board of Directors to fill
vacancies that occur between annual general meetings of
shareholders; and |
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|
to make recommendations to the Board of Directors regarding
corporate governance matters and practices. |
Working closely with the full Board of Directors, the nominating
and corporate governance committee develops criteria for open
board positions, taking into account such factors as it deems
appropriate, including, among others, the current composition of
the Board of Directors, the range of talents, experiences and
skills that would best complement those already represented on
the Board of Directors, the balance of management and
independent directors and the need for financial or other
specialized expertise. Applying these criteria, the nominating
and corporate governance committee considers candidates for
director suggested by its members and other directors, as well
as management and shareholders. The nominating and corporate
governance
81
committee also retains a third-party executive search firm on an
ad-hoc basis to identify and review candidates upon request of
the committee from time to time.
Once the nominating and corporate governance committee has
identified a prospective nominee, whether the prospective
nominee is recommended by a shareholder or otherwise, it makes
an initial determination as to whether to conduct a full
evaluation, taking into account the information provided to the
nominating and corporate governance committee with the
recommendation of the candidate as well as the nominating and
corporate governance committees own knowledge,
supplemented as appropriate by inquiries to third parties. The
preliminary determination is based primarily on the need for
additional directors and the likelihood that the prospective
nominee can satisfy the criteria that the nominating and
corporate governance committee has established. If the committee
determines, in consultation with the Chairman of the Board of
Directors and other directors as appropriate, that additional
consideration is warranted, it may request the third-party
search firm to gather additional information about the
prospective nominees background and experience and to
report its findings to the nominating and corporate governance
committee. The committee then evaluates the prospective nominee
against the specific criteria that it has established for the
position, as well as the standards and qualifications set out in
the Companys Principles of Corporate Governance,
including:
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business experience and skills; |
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independence; |
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judgment; |
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integrity; |
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the ability to commit sufficient time and attention to board
activities; and |
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the absence of potential conflicts with the Companys
interests. |
If the nominating and corporate governance committee decides, on
the basis of its preliminary review, to proceed with further
consideration, the committee members, as well as other directors
as appropriate, interview the nominee. After completing this
evaluation and interview, the nominating and corporate
governance committee makes a recommendation to the full Board of
Directors, which makes the final determination whether to
nominate the candidate after considering the nominating and
corporate governance committees report.
Our compensation committee currently consists of
Messrs. Rogers, Bermingham, Fordyce and Maslen, of whom
Messrs. Bermingham and Maslen are independent
as defined in Section 303A.02 of the NYSE listing standards.
The principal duties of the compensation committee are as
follows:
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reviewing and approving corporate goals and objectives relevant
to the compensation of the Companys Chief Executive
Officer; |
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evaluating the performance of the Chief Executive Officer and,
either as a committee or together with the other independent
directors, determining and approving the compensation level for
the Chief Executive Officer; and |
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making recommendations to the Board of Directors regarding
compensation of other executive officers and certain
compensation plans. |
Our Board of Directors has adopted a written charter for the
compensation committee which is available on the Companys
Investor Relations website at www.herbalife.com/index.cfm
by following the links to Investor Relations and
Corporate Governance or in print to any shareholder
who requests it. In fiscal 2004, the compensation committee met
six times.
82
PRINCIPAL AND SELLING SHAREHOLDERS
The following table shows the beneficial ownership of Common
Shares of Herbalife as of November 3, 2005, and thus the
indirect beneficial ownership of the equity interest of
Herbalife as of that date, of (1) each of Herbalifes
directors, (2) each of the Named Executive officers,
(3) all directors and executive officers as a group and
(4) each person or entity known to Herbalife to
beneficially own more than five percent (5%) of the outstanding
Common Shares of Herbalife. The information set forth in the
table below regarding the beneficial ownership of the referenced
investment partnerships sponsored by Whitney and Golden Gate
Capital and their applicable affiliates is based on the
Schedule 13G/ A filed with the SEC by such entities and
their affiliates on February 14, 2005 and which indicates
shared voting and dispositive power over such shares pursuant to
the disposition agreement and voting agreement referenced above.
In the absence of these agreements, affiliates of Whitney and
Golden Gate Capital would own approximately 38.8% and 21.9%,
respectively, of our share capital prior to the offering and
approximately 30.0% and 16.8%, respectively, of our share
capital after the offering.
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|
Beneficial Ownership of Herbalife | |
|
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| |
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|
Shares Beneficially | |
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|
Shares Beneficially | |
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|
Owned Prior to | |
|
Shares | |
|
Owned After This | |
|
|
This Offering(1) | |
|
Being Sold | |
|
Offering(1) | |
|
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| |
|
In This | |
|
| |
Directors, Officers and 5% Shareholders |
|
Number | |
|
Percent | |
|
Offering | |
|
Number | |
|
Percent | |
|
|
| |
|
| |
|
| |
|
| |
|
| |
Greater than 5% beneficial owners and other selling
shareholders
|
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|
|
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|
|
|
|
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|
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|
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|
|
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|
|
Whitney V,
L.P.(2)**
|
|
|
42,320,155 |
|
|
|
60.4 |
% |
|
|
6,075,748 |
|
|
|
32,670,155 |
|
|
|
46.6 |
% |
Whitney Strategic Partners V,
L.P.(2)**
|
|
|
42,320,155 |
|
|
|
60.4 |
% |
|
|
53,300 |
|
|
|
32,670,155 |
|
|
|
46.6 |
% |
Whitney Private Debt Fund,
L.P.(2)**
|
|
|
42,320,155 |
|
|
|
60.4 |
% |
|
|
23,810 |
|
|
|
32,670,155 |
|
|
|
46.6 |
% |
Prairie Fire Capital,
LLC(2)(3)**
|
|
|
42,320,155 |
|
|
|
60.4 |
% |
|
|
|
|
|
|
32,670,155 |
|
|
|
46.6 |
% |
Michael R.
Stone(2)(3)**
|
|
|
42,320,155 |
|
|
|
60.4 |
% |
|
|
|
|
|
|
32,670,155 |
|
|
|
46.6 |
% |
Daniel J.
OBrien(2)(3)**
|
|
|
42,320,155 |
|
|
|
60.4 |
% |
|
|
|
|
|
|
32,670,155 |
|
|
|
46.6 |
% |
Total
|
|
|
42,320,155 |
|
|
|
60.4 |
% |
|
|
6,152,858 |
|
|
|
32,670,155 |
|
|
|
46.6 |
% |
CCG Investments (BVI),
L.P.(4)***
|
|
|
42,320,155 |
|
|
|
60.4 |
% |
|
|
3,053,667 |
|
|
|
32,670,155 |
|
|
|
46.6 |
% |
CCG Associates QP,
LLC(4)***
|
|
|
42,320,155 |
|
|
|
60.4 |
% |
|
|
153,505 |
|
|
|
32,670,155 |
|
|
|
46.6 |
% |
CCG Associates AI,
LLC(4)***
|
|
|
42,320,155 |
|
|
|
60.4 |
% |
|
|
14,273 |
|
|
|
32,670,155 |
|
|
|
46.6 |
% |
CCG Investment Fund AI,
LP(4)***
|
|
|
42,320,155 |
|
|
|
60.4 |
% |
|
|
40,909 |
|
|
|
32,670,155 |
|
|
|
46.6 |
% |
CCG AV, LLC
Series C(4)***
|
|
|
42,320,155 |
|
|
|
60.4 |
% |
|
|
100,737 |
|
|
|
32,670,155 |
|
|
|
46.6 |
% |
CCG AV, LLC
Series E(4)***
|
|
|
42,320,155 |
|
|
|
60.4 |
% |
|
|
81,821 |
|
|
|
32,670,155 |
|
|
|
46.6 |
% |
CCG CI,
LLC(4)
***
|
|
|
42,320,155 |
|
|
|
60.4 |
% |
|
|
52,230 |
|
|
|
32,670,155 |
|
|
|
46.6 |
% |
Golden Gate Capital Administration,
LLC(4)
***
|
|
|
42,320,155 |
|
|
|
60.4 |
% |
|
|
|
|
|
|
32,670,155 |
|
|
|
46.6 |
% |
David C.
Dominik(4)***
|
|
|
42,320,155 |
|
|
|
60.4 |
% |
|
|
|
|
|
|
32,670,155 |
|
|
|
46.6 |
% |
Total
|
|
|
42,320,155 |
|
|
|
60.4 |
% |
|
|
3,497,142 |
|
|
|
32,670,155 |
|
|
|
46.6 |
% |
Directors and named executive officers
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|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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|
|
Peter M.
Castleman(2)(3)**
|
|
|
42,320,155 |
|
|
|
60.4 |
% |
|
|
|
|
|
|
32,670,155 |
|
|
|
46.6 |
% |
James H. Fordyce**
|
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|
|
|
|
* |
|
|
|
|
|
|
|
|
|
|
|
* |
|
Jesse T.
Rogers(4)***
|
|
|
42,320,155 |
|
|
|
60.4 |
% |
|
|
|
|
|
|
32,670,155 |
|
|
|
46.6 |
% |
Kenneth J.
Diekroeger(4)***
|
|
|
42,320,155 |
|
|
|
60.4 |
% |
|
|
|
|
|
|
32,670,155 |
|
|
|
46.6 |
% |
John
Tartol(5)****
|
|
|
231,716 |
|
|
|
* |
|
|
|
|
|
|
|
231,716 |
|
|
|
* |
|
Leon Waisbein****
|
|
|
319,091 |
|
|
|
* |
|
|
|
|
|
|
|
319,091 |
|
|
|
* |
|
Charles L.
Orr(6)****
|
|
|
60,000 |
|
|
|
* |
|
|
|
|
|
|
|
60,000 |
|
|
|
* |
|
Leroy T. Barnes,
Jr.(7)****
|
|
|
20,833 |
|
|
|
* |
|
|
|
|
|
|
|
20,833 |
|
|
|
* |
|
Peter
Maslen(8)****
|
|
|
20,833 |
|
|
|
* |
|
|
|
|
|
|
|
20,833 |
|
|
|
* |
|
Richard
Bermingham(9)****
|
|
|
24,833 |
|
|
|
* |
|
|
|
|
|
|
|
24,833 |
|
|
|
* |
|
Michael O.
Johnson(10)****
|
|
|
1,894,217 |
|
|
|
2.7 |
% |
|
|
350,000 |
|
|
|
1,544,217 |
|
|
|
2.2 |
% |
Gregory
Probert(11)****
|
|
|
275,000 |
|
|
|
* |
|
|
|
|
|
|
|
275,000 |
|
|
|
* |
|
Brett R.
Chapman(12)****
|
|
|
106,872 |
|
|
|
* |
|
|
|
|
|
|
|
166,872 |
|
|
|
* |
|
Richard
Goudis(13)****
|
|
|
92,500 |
|
|
|
* |
|
|
|
|
|
|
|
92,500 |
|
|
|
* |
|
All Directors and Executive Officers as a Group
(15 persons)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
|
45,373,152 |
|
|
|
62.6 |
% |
|
|
10,000,000 |
|
|
|
35,373,152 |
|
|
|
48.8 |
% |
83
|
|
** |
c/o Whitney & Co. LLC, 177 Broad Street, Stamford,
Connecticut 06901. |
|
|
*** |
c/o Golden Gate Private Equity, Inc., One Embarcadero Center,
33rd Floor, San Francisco, California 94111. |
|
|
**** |
c/o Herbalife International, Inc., 1800 Century Park East, Los
Angeles, California 90067. |
|
|
(1) |
Applicable percentage of ownership is based upon 69,400,666
Common Shares outstanding as of November 3, 2005, and the
relevant number of Common Shares issuable upon exercise of stock
options or warrants which are exercisable presently or within
60 days of November 3, 2005. Beneficial ownership is
determined in accordance with the rules of the Securities and
Exchange Commission, and includes voting and investment power
with respect to shares. Except with respect to the disposition
agreement and voting agreement described under Certain
Relationships and Related Party Transactions and unless
otherwise indicated below, to our knowledge, all persons listed
above have sole voting and investment power with respect to
their Common Shares, except to the extent authority is shared by
spouses under applicable law. |
|
(2) |
Represents shares of Herbalife beneficially owned by
Whitney V, L.P., Whitney Strategic Partners V, L.P.,
Whitney Private Debt Fund, L.P., Prairie Fire Capital LLC,
Michael R. Stone, Daniel J. OBrien, 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 Golden Gate
Capital Management, LLC as a result of shared dispositive power
pursuant to the disposition agreement and shared voting power
pursuant to the voting agreement, each as described under
Certain Relationships and Related Party
Transactions. On December 1, 2004, Whitney entities
were granted 455,000 warrants at a strike price of
$15.50 per share in connection with the termination of a
monitoring agreement. In August 2005, the warrants were assigned
to Prairie Fire Capital, LLC, Michael R. Stone and Daniel J.
OBrien, in the amount of 242,718, 198,611 and 13,671
underlying Common Shares, respectively. On December 1,
2004, GGC Administration, L.L.C. was granted a warrant to
acquire 245,000 shares at a strike price of $15.50 per
share in connection with the termination of a monitoring fee
agreement. All of the warrants are exercisable within
60 days of the date of November 3, 2005. |
|
(3) |
Represents shares beneficially owned by Whitney V, L.P.,
Whitney Strategic Partners V, L.P., Whitney Private Debt
Fund, L.P., Prairie Fire Capital LLC, Michael R. Stone and
Daniel J. OBrien. Messrs. Castleman, Stone and
OBrien are managing members of the entities that are the
general partners of Whitney V, L.P., Whitney Strategic
Partners V, L.P., and Whitney Private Debt Fund, L.P., and
accordingly they may be deemed to share beneficial ownership of
any such shares. Each of Messrs. Castleman, Stone and
OBrien disclaims beneficial ownership of all shares owned
by Whitney V, L.P., Whitney Strategic Partners V,
L.P., Whitney Private Debt Fund, L.P. and Prairie Fire Capital,
LLC, except to the extent of his pecuniary interest in each such
entity. |
|
(4) |
Represents shares beneficially owned by 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.
Messrs. Rogers and Diekroeger are managing members of the
entities that are general partners of 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 Golden Gate
Capital Management LLC , and accordingly, they may be deemed to
share beneficial ownership of any such shares. Each of
Messrs. Rogers and Diekroeger disclaim beneficial ownership
of all shares owned by 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 Golden Gate Capital Management LLC,
except to the extent of his pecuniary interest in the Golden
Gate Capital entities. |
|
(5) |
Represents (i) 225 shares held in custodial accounts
for the benefit of Mr. Tartols three children.
Mr. Tartol disclaims beneficial ownership of 75 of these
shares except to the extent of his pecuniary interest therein;
(ii) 53,130 shares held by the Tartol Enterprises
Profit Sharing Plan, for which Mr. Tartol is the trustee;
and (iii) 178,361 shares held by Carhill Holdings, Inc., a
corporation for which Mr. Tartol acts as only a consultant,
and accordingly, Mr. Tartol disclaims beneficial ownership
of such shares held by Carhill Holdings, Inc. |
84
|
|
(6) |
Mr. Orr was granted 25,000 options to purchase Common
Shares at an exercise price of $0.88 per share and 25,000
options to purchase Common Shares at an exercise price of
$3.52 per share, and 41,667 options to purchase Common
Shares at an exercise plan of $14.93 per share, of which
60,000 are exercisable within 60 days of November 3,
2005. |
|
(7) |
Mr. Barnes was granted 62,500 options to purchase Common
Shares at an exercise price of $14.00 per share of which
20,833 are exercisable within 60 days of November 3,
2005. |
|
(8) |
Mr. Maslen was granted 62,500 options to purchase Common
Shares at an exercise price of $14.00 per share of which
20,833 are exercisable within 60 days of November 3,
2005. |
|
(9) |
Mr. Bermingham was granted 62,500 options to purchase
Common Shares at an exercise price of $14.00 per share of
which 20,833 are exercisable within 60 days of
November 3, 2005. |
|
|
(10) |
Mr. Johnson was granted 591,185 options to purchase Common
Shares at an exercise price of $0.88 per share, 591,185
options to purchase Common Shares at an exercise price of
$3.52 per share, 591,185 options to purchase Common Shares
at an exercise price of $10.56 per share, 125,000 options
to purchase Common Shares at an exercise price of
$15.00 per share, 500,000 options to purchase Common Shares
at an exercise price of $15.50 per share, 591,185 options
to purchase Common Shares at an exercise price of
$17.60 per share and 591,185 options to purchase Common
Shares at an exercise price of $24.64 per share. Of Mr.
Johnsons 3,580,925 total options, 1,792,307 are
exercisable within 60 days of November 3, 2005 and
1,788,618 are not exercisable within 60 days of
November 3, 2005. |
|
(11) |
Mr. Probert was granted 125,000 options to purchase Common
Shares at an exercise price of $5.00 per share, 75,000
options to purchase Common Shares at an exercise price of
$7.00 per share, 40,000 options to purchase Common Shares
at an exercise price of $9.00 per share, 75,000 options to
purchase Common Shares at an exercise price of $11.00 per
share, 40,000 options to purchase Common Shares at an exercise
price of $13.00 per share, 100,000 options to purchase
Common Shares at an exercise price of $15.00 per share,
375,000 options to purchase Common Shares at an exercise price
of $15.50 per share, 115,000 options to purchase Common
Shares at an exercise price of $17.00 per share, 40,000
options to purchase Common Shares at an exercise price of
$21.00 per share, 75,000 options to purchase Common Shares
at an exercise price of $23.00 per share, and 40,000
options to purchase Common Shares at an exercise price of
$25.00 per share, of which 275,000 are exercisable within
60 days of November 3, 2005. |
|
(12) |
Mr. Chapman was granted 75,000 options to purchase Common
Shares at an exercise price of $5.00 per share, 21,875
options to purchase Common Shares at an exercise price of
$7.00 per share, 15,000 options to purchase Common Shares
at an exercise price of $9.00 per share, 21,875 options to
purchase Common Shares at an exercise price of $11.00 per
share, 15,000 options to purchase Common Shares at an exercise
price at $13.00 per share, 137,500 options to purchase
Common Shares at an exercise price of $15.50 per share,
75,000 options to purchase Common Shares at an exercise price of
$15.00 per share, 36,875 options to purchase Common Shares
at an exercise price of $17.00 per share, 15,000 options to
purchase Common Shares at an exercise price of $21.00 per
share, 21,875 options to purchase Common Shares at an exercise
price of $23.00 per share, and 15,000 options to purchase
Common Shares at an exercise price of $25.00 per share, of
which 106,872 are exercisable within 60 days of
November 3, 2005. |
|
(13) |
Mr. Goudis was granted 40,000 options to purchase Common
Shares at an exercise price of $8.02 per share, 7,500
options to purchase Common Shares at an exercise price of
$9.00 per share, 40,000 options to purchase Common Shares
at an exercise price of $12.00 per share, 7,500 options to
purchase Common Shares at an exercise price of $13.00 per
share, 150,000 options to purchase Common Shares at an exercise
price of $15.50 per share, 75,000 options to purchase
Common Shares at an exercise price of $15.00 per share,
40,000 options to purchase Common Shares at an exercise price at
$16.00 per share, 7,500 options to purchase Common Shares
at an exercise price of $17.00 per share, 40,000 options to
purchase Common Shares at an exercise price of $20.00 per
share, 7,500 options to purchase Common Shares at an exercise
price of $21.00 per share, 40,000 options to purchase
Common Shares at an exercise price of $24.00 per share,
7,500 options to purchase Common Shares at an exercise price of
$25.00 per share, of which 92,500 are exercisable within
60 days of November 3, 2005. |
85
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Conversion of Preferred Shares
A portion of the proceeds from the offering of the
91/2%
Notes was applied to pay the original issue price for all of our
outstanding 12% Series A Cumulative Convertible Preferred
Shares (the Preferred Shares). To permit us to
convert the Preferred Shares, we amended our Memorandum and
Articles of Association to permit our Board of Directors to
elect to convert all of the outstanding Preferred Shares into
the right to receive a cash payment, for each Preferred Share
converted, equal to the original issue price for the Preferred
Shares ($1.76 per share), and all accrued and unpaid dividends,
plus one Common Share of the Company. In connection with the
consummation of this conversion, all of the 2.0 million
outstanding warrants to purchase our Preferred Shares were
exercised in exchange for our Preferred Shares, and all of our
Preferred Shares (including the Preferred Shares issuable upon
the exercise of the warrants) were then converted into an
aggregate of approximately 52.1 million of our Common
Shares.
All of the outstanding Preferred Shares, immediately prior to
their conversion into Common Shares, were held by the Equity
Sponsors and their affiliates, certain members of our
management, and selected distributors. In addition, affiliates
of the Equity Sponsors and GarMark Partners, L.P.
(GarMark) held warrants to purchase an aggregate of
2,040,816 of the Preferred Shares. These parties held certain
rights that may have presented an actual or potential conflict
of interest in connection with our proposal to convert the
Preferred Shares.
Certain Equity Sponsors (and/or their affiliates) and the
selected distributors holding Preferred Shares were and are
parties to a shareholders agreement pursuant to which they
have certain rights to determine the composition of our Board of
Directors.
In addition, an affiliate of Whitney, one of the Equity
Sponsors, was a party to a securities purchase agreement
providing that affiliate with the right to designate one
observer to our board of directors to attend each meeting of the
board and each meeting of the committees of the board for so
long as that party holds at least $10 million of our 15.5%
senior notes (the Senior Notes) (subject to certain
exceptions). We purchased all of the Senior Notes on
March 8, 2004. See Purchase of Senior
Notes.
Purchase of Senior Notes
A portion of the proceeds from the offering of the
91/2%
Notes was applied to purchase our Senior Notes (face value
$38.0 million) at a negotiated price.
All of the Senior Notes, immediately prior to the closing of
their repurchase, were held by GarMark, Whitney Private Debt
Fund, L.P. (Whitney Private Debt), and Green River
Offshore Fund Ltd. (Green River). Whitney
Private Debt and Green River are affiliates of Whitney. GarMark
purchased $23.0 million in principal amount of the Senior
Notes and received warrants for 1,235,231 of the Preferred
Shares and Whitney Private Debt purchased $15.0 million in
principal amount of the Senior Notes and received warrants for
805,585 of the Preferred Shares on July 31, 2002, pursuant
to a Securities Purchase Agreement (the Securities
Purchase Agreement) among the Company, as issuer, and
GarMark and Whitney Private Debt, as purchasers. On
November 27, 2002, Green River purchased $1.6 million
in principal amount of the Senior Notes from GarMark and
received warrants for 85,929 of the Preferred Shares from
GarMark.
The holders of the Senior Notes held certain rights that may
have presented an actual or potential conflict of interest in
connection with our proposal to purchase the Senior Notes. The
Securities Purchase Agreement provided that each holder of
$10.0 million or more of the Senior Notes (subject to
certain exceptions) could designate one observer to our Board of
Directors to attend each meeting of the Board of Directors and
each meeting of the committees of the Board of Directors. Each
of Whitney Private Debt and GarMark held $10.0 million or
more of the Senior Notes. In addition, certain affiliates of
Whitney were parties to a shareholders agreement with
certain of our other shareholders pursuant to which Whitney V,
L.P., an affiliate of Whitney, was permitted to nominate four
individuals to our Board of Directors, and two additional
nominees to our Board of Directors were required to be
acceptable to Whitney V, L.P. and CCG
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Investments (BVI), L.P., an affiliate of Golden Gate Private
Equity, Inc. This agreement terminated upon the consummation of
the initial public offering.
On February 3, 2004, the Board of Directors approved the
offering of the
91/2%
Notes, the repurchase of our Senior Notes and the related
transactions, subject to development of the final terms and the
approval of those terms by a special offering committee of the
Board of Directors established to determine and approve on our
behalf the final terms of the
91/2%
Notes and the related transactions. During that portion of the
meeting relating to the discussion and approval of the purchase
of the Senior Notes (a portion of which were owned by Whitney
and its affiliates), Messrs. Peter M. Castleman, James H.
Fordyce, John C. Hockin and Steven E. Rodgers, members of our
Board of Directors at the time of the offering of the
91/2%
Notes who are also partners of Whitney and various of its
affiliates, abstained from the discussion and vote. The
remaining members of the board, after considering relevant
factors, determined that the purchase of our Senior Notes was
desirable and in the best interests of the Company, and approved
the purchase of the Senior Notes at such price and on such terms
as the special offering committee deemed appropriate in
connection with the sale of the
91/2%
Notes.
On March 3, 2004, the special offering committee approved
the final terms of the
91/2%
Notes and the related transactions, with those of its members
who are affiliated with Whitney abstaining from the discussion
and vote concerning the purchase of the Senior Notes.
Certain Transactions Relating to Herbalife
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 nine months ended September 30, 2005,
total purchases from Shuster were $0.02 million. For the
three and nine months ended September 30, 2004, 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. While there were no services
performed in 2004 by TBA for Herbalife, for the nine months
ended September 30, 2005 payments of $5.71 million
were made to TBA for services relating to the
25th Anniversary Extravaganza, the majority of which were
reimbursements of Extravaganza expenses paid to third parties.
In 2004, Golden Gate Capital acquired a 47 percent
ownership interest in Leiner Health Products Inc.
(Leiner), a nutritional manufacturer and supplier of
certain Herbalife products. For the nine months ended
September 30, 2005, total purchases from Leiner were
$0.14 million. For the nine months ended September 30,
2004, total purchases from Leiner were $0.35 million.
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 nine months
ended September 30, 2005, total purchases from Stauber were
$0.85 million.
The Company believes that the transactions with the above
entities are done on an arms length basis with
fair market pricing.
Share Purchase Agreement
Certain Equity Sponsors (and/or their affiliates) were parties
to a Share Purchase Agreement (the Share Purchase
Agreement) pursuant to which they originally purchased our
Preferred Shares. Under the terms of the Share Purchase
Agreement, the Equity Sponsors could, subject to approval by our
Board of Directors and 75% of our shareholders, require us to
pay a dividend to all of our shareholders related to certain
income that may be taxable to them resulting from their
ownership of our shares. We completed our analysis with regard
to this payment and based on this analysis, we made
$1.4 million and $4.9 million payments to our
shareholders related to certain income that may be taxable to
them for the years ended December 31, 2003 and
December 31, 2004, respectively. On December 13, 2004,
our Board of Directors approved the payment of these
distributions to shareholders of record as of December 13,
2004, subject to the approval of 75% of our shareholders. On
December 14, 2004, 75% of our shareholders approved these
distributions and we distributed
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these payments as a dividend. The approval and making of these
payments was not contingent upon the consummation of the initial
public offering.
We have entered into a termination agreement with the parties to
the Share Purchase Agreement. Pursuant to the termination
agreement, the Share Purchase Agreement and all obligations and
liabilities of the parties under the Share Purchase Agreement
were terminated, except for our obligation to pay dividends of
approximately $1.4 million and $4.9 million to all of
our current shareholders in respect of certain income that may
be taxable to them for the year ended December 31, 2003 and
the period from January 1, 2004 through December 13,
2004, respectively, which we paid as a dividend on
December 14, 2004 to shareholders of record on
December 13, 2004. In consideration for the termination of
the Share Purchase Agreement, we entered into a Tax
Indemnification Agreement with certain Equity Sponsors (and/or
their affiliates). See Tax Indemnification
Agreement below.
Tax Indemnification Agreement
As consideration for the termination of the Share Purchase
Agreement, we have entered into a Tax Indemnification Agreement
with certain Equity Sponsors (and/or their affiliates) pursuant
to which we have agreed to indemnify each of those parties for
the Federal income tax liability and any related losses they
incur in respect of income of the Company that is (or would be)
includible in the gross income of that party for any taxable
period under Section 951(a) of the Code. Under the terms of
the Tax Indemnification Agreement, we assume, for this purpose,
that each indemnified party is a United States
shareholder as defined in Section 951(b) of the Code.
We do not, however, have any obligation to provide an indemnity
with respect to any taxes or related losses incurred that have
been reimbursed under the Share Purchase Agreement. Our credit
agreement will permit us to pay these tax indemnity payments,
but it will restrict the aggregate amount that we can pay in any
given year to no more than $15 million in the aggregate. We
currently anticipate that any amounts that we are required to
pay under this agreement in the future will be immaterial to us.
Registration Rights Agreement
Members of our distributor organization holding our equity
securities are also party to a registration rights agreement
between the Equity Sponsors and the Company (the
registration rights agreement). Under this
registration rights agreement, the Equity Sponsors have
unlimited demand registration rights permitting them
to cause us, subject to certain restrictions, to register
certain equity securities and to participate in registrations by
us of our equity securities, subject to certain restrictions.
If we at any time propose to register any of our securities
under the Securities Act for sale to the public, in certain
circumstances holders of Preferred Shares or Common Shares
issued upon conversion of the Preferred Shares (including
distributor shareholders) may require us to include their shares
in the securities to be covered by the registration statement.
Such registration rights are subject to customary limitations
specified in the registration rights agreement.
Indemnity Agreement
In connection with the purchase of the Preferred Shares,
Herbalife and WH Acquisition Corp. entered into an indemnity
agreement with the Equity Sponsors pursuant to which the Company
and Herbalife International (as successor-in-interest to WH
Acquisition Corp.) agreed to indemnify the Equity Sponsors for
losses and claims resulting from, arising out of or in any way
related to the Acquisition, including existing litigation.
Whitney had been sued in San Francisco by Rosemont Associates
and Joseph Urso for $20 million in a suit alleging breach
of contract, breach of covenants of good faith and fair dealing,
quantum meruit and other causes of action arising out of
the sale of Herbalife International to Whitney and others. This
lawsuit was settled for an undisclosed sum that was not material
to us or our financial condition.
Monitoring Fee Agreements
In connection with the Acquisition, we entered into various
agreements with the Equity Sponsors. Pursuant to the monitoring
fee agreements entered into in connection with the Acquisition,
Whitney and
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GGC Administration, LLC, an affiliate of CCG Investments (BVI),
L.P., conducted certain activities related to such parties
and its affiliates investments in the Company. These
activities included activities related to the general management
of the Company and its subsidiaries, identification and analysis
of potential acquisitions and dispositions by the Company and
its subsidiaries, support, negotiation and analysis of financing
alternatives for the Company and its subsidiaries, and other
activities necessary or advisable with respect to the monitoring
of the Company.
In consideration of these services, Herbalife International paid
to Whitney and GGC Administration, LLC, quarterly, fees for
monitoring services rendered (determined on an hourly basis),
and such obligations were guaranteed by us. Such monitoring fees
were paid quarterly at a rate of $5.0 million per annum,
divided between Whitney and GGC Administration, LLC at a ratio
of 65% to 35%, respectively. Herbalife International also agreed
to reimburse Whitney and GGC Administration, LLC for their
reasonable out-of-pocket expenses and to pay additional
transaction fees to them in the event the Company and/or any of
its subsidiaries completed add-on acquisitions, divestitures, a
transaction resulting in a change of control (as defined
therein) or financing involving the Company and/or any of its
subsidiaries, and that such obligations would be guaranteed by
the Company. In fiscal 2004, Herbalife International reimbursed
Whitney and GGC Administration, LLC approximately
$1.8 million for their reasonable out-of-pocket expenses
incurred since the date of the Acquisition through the payment
date, which were invoiced during fiscal 2003. We have entered
into a termination agreement with Whitney and GGC
Administration, LLC to terminate the monitoring fee agreements
in consideration for an aggregate of 0.7 million warrants.
Each warrant gives the holder the ability to purchase one share
of the Companys Common Shares at a price of $15.50 per
share. This agreement was not contingent on the consummation of
the initial public offering. We calculated the fair market value
of these warrants utilizing a Black-Scholes Option Pricing
Model. We recorded the related $2.9 million amount as a
charge against earnings in the fourth quarter of 2004.
We have also agreed to provide customary joint and several
indemnification to Whitney and GGC Administration, LLC. See
Indemnity Agreement.
WH Holdings (Cayman Islands) Ltd. Stock Incentive Plan
We have established a stock incentive plan that provides for the
grant of options to purchase our Common Shares and stock
appreciation rights to employees and consultants of Herbalife
International. The incentive plan is administered by a committee
appointed by the Board of Directors of the Company. In addition,
we have established the 2004 Plan that provides for grants of
awards to our directors, officers, employees and consultants.
WH Holdings (Cayman Islands) Ltd. Independent Directors Stock
Option Plan
We have established an independent directors stock option plan
that provides for the grant of options to purchase our Common
Shares to our independent directors. Directors who are our
employees or employees of any of our affiliates or have been
designated as directors by our affiliates or our distributors
are not independent directors for purposes of director
compensation. We have granted options to Henry Burdick and
Charles Orr under this plan.
2004 Stock Incentive Plan
We have established the 2004 Plan that provides for the grant of
stock options and stock appreciation rights, as well as awards
of restricted stock, restricted stock units and performance
units to our directors, officers, employees and consultants. The
2004 Plan is administered by the compensation committee of the
Board of Directors.
2005 Stock Incentive Plan
We have established the Herbalife Ltd. 2005 Stock Incentive Plan
that provides for the grant of stock options and stock
appreciation rights, as well as awards of restricted stock,
stock units, performance units and dividend equivalents to our
current or prospective directors, officers, employees and
consultants. The 2005
89
Stock Incentive Plan authorizes the issuance of 4,000,000 common
shares pursuant to awards, plus any shares that remain available
for issuance under the 2004 Plan. The 2005 Stock Incentive Plan
is administered by the compensation committee of the Board of
Directors.
Executive Incentive Plan
We have established the Herbalife Ltd. Executive Incentive Plan
that governs the award and payment of annual bonuses to our
Chief Executive Officer and such other executives as selected by
the compensation committee. Pursuant to the Executive Incentive
Plan, the compensation committee may establish an incentive
program for the current year by determining the performance
criteria to be used to determine any amounts payable to
participants under the Incentive Plan and the performance bonus
amount payable to each participant, which amount will be based
upon one or more performance criteria and/or the level of
achievement with respect thereto. The Incentive Executive
Incentive Plan is intended to satisfy the requirements for
performance-based compensation within the meaning of
Section 162(m) of the Internal Revenue Code.
Indemnification of Directors and Officers
The Memorandum and Articles of Association provide that, to the
fullest extent permitted by the Companies Law (2004 Revision),
every director, agent or officer of the Company shall be
indemnified out of the assets of the Company against any
liability incurred by him as a result of any act or failure to
act in carrying out his functions other than such liability (if
any) that he may incur by his own willful misconduct. To the
fullest extent permitted by the Statute, such director, or
officer shall not be liable to the Company for any loss or
damage in carrying out his functions unless the liability arises
through the willful misconduct of such director, agent or
officer.
The Company is a Cayman Islands exempted limited liability
company. As such, it is governed by the laws of the Cayman
Islands with respect to the indemnification provisions. Cayman
Islands law does not limit the extent to which a companys
articles of association may provide for indemnification of
officers and directors, except to the extent any such provision
may be held by the Cayman Islands courts to be contrary to
public policy, such as to provide indemnification against civil
fraud or the consequences of committing a crime. Our articles of
association provide for indemnification of officers and
directors for losses, damages, costs and expenses incurred in
their capacities as such, except in the case of (a) any
fraud or dishonesty of such director or officer, (b) such
directors or officers conscious, intentional or
willful breach of his obligation to act honestly, lawfully and
in good faith with a view to the best interests of the Company,
or (c) any claims or rights of action to recover any gain,
personal profit, or other advantage to which the director or
officer is not legally entitled.
The Company has entered into an indemnification agreement with
each of its directors and certain of its officers to supplement
the indemnification protection available under its articles of
association. These indemnity agreements generally provide that
we will indemnify the parties thereto to the fullest extent
permitted by law.
The foregoing summaries are necessarily subject to the complete
text of the Companys articles of association and the
indemnification agreements referred to above and are qualified
in their entirety by reference thereto.
In addition to the indemnification provisions set forth above,
the Company maintains insurance policies that indemnify its
directors and officers against various liabilities arising under
the Securities Act of 1933 and the Securities Exchange Act of
1934 that might be incurred by any director or officer in his
capacity as such.
Insofar as indemnification for liabilities arising under the
Securities Act of 1933 may be permitted to managers, officers,
or persons controlling us pursuant to the foregoing, we have
been informed that, in the opinion of the Securities and
Exchange Commission, such indemnification is against public
policy as expressed in the Securities Act and is, therefore,
unenforceable.
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Special Cash Dividend
We used a portion of the net proceeds from the initial public
offering and the related transactions to pay a
$139.7 million special cash dividend to our then current
shareholders. Whitney and Golden Gate received approximately
$70.5 million and $40.0 million, respectively, based
on the number of shares they then beneficially owned.
In March 2004, we completed the $275.0 million offering of
the
91/2%
Notes. The proceeds of the offering together with available cash
were partly used to pay $183.1 million for the original
issue price of 104.1 million Preferred Shares and to pay
all accrued and unpaid dividends of $38.5 million. Whitney
and Golden Gate received cash dividends of approximately
$19.8 million and $11.2 million, respectively, based
on the shares they then beneficially owned.
Disposition Agreement
The investment partnerships sponsored by Whitney and Golden Gate
and their applicable affiliates have entered into an agreement
pursuant to which sales or other dispositions of our Common
Shares or other voting securities held by one Equity Sponsor, or
their respective affiliates, would be subject to the prior
approval of the other Equity Sponsor during an initial 12-month
veto period. The agreement further provides that, for an
additional 6-month period commencing at the expiration of the
veto period, the parties will discuss proposed dispositions of
our Common Shares with the intent of cooperating in good faith
to permit the disposing party to achieve as many of its business
and/or economic objectives with respect to the proposed
disposition as possible. However, neither party is required to
obtain the consent of the other party to dispose of any of our
Common Shares following the expiration of the initial 12-month
veto period. The agreement covers sales or dispositions only and
does not relate to voting, acquisitions, dividends or any other
matters relating to ownership of our Common Shares or other
voting securities. This agreement will terminate upon the
earlier of (1) eighteen months from December 15, 2004
and (2) such time as the aggregate ownership of the
Companys Common Shares by Whitney and Golden Gate falls
below 25% of our voting securities.
Voting Agreement
The investment partnerships sponsored by Whitney and Golden Gate
and their applicable affiliates have entered into a voting
agreement pursuant to which during the term of the agreement, on
all matters relating to the election of one or more directors of
the Company to serve on the Companys Board of Directors,
whether at an annual general or special meeting of shareholders,
each of Whitney and Golden Gate agree to vote all of the Common
Shares beneficially owned by Whitney and Golden Gate,
respectively, as may be necessary to elect the director
nominee(s) designated by Whitney, if one or more affiliates of
Whitney have been nominated for director, and the director
nominee(s) designated by Golden Gate, if one or more affiliates
of Golden Gate have been nominated for director, to serve on the
Board of Directors. The voting agreement terminates upon the
termination of the disposition agreement described immediately
above.
DESCRIPTION OF SHARE CAPITAL
The following description of our share capital is based on our
amended and restated memorandum and articles of association,
which have been recently adopted. Throughout this description,
we refer to our amended and restated memorandum and articles of
association as simply our memorandum and articles of
association. Our authorized share capital consists of
500,000,000 common shares and 7,500,000 preference shares, each
with a par value of $0.002 per share. Upon completion of
this offering, we will have 69,400,666 outstanding common
shares, assuming that there are no exercises of outstanding
options or warrants after the date of this prospectus.
We are a Cayman Islands exempted company and our affairs are
governed by our memorandum and articles of association, the
Companies Law (2004 Revision) and the common law of the Cayman
Islands. The following are summaries of material provisions of
our memorandum and articles of association and the
91
Companies Law insofar as they relate to the material terms of
our common shares. Complete copies of our memorandum and
articles of association are filed as exhibits to our public
filings.
Common Shares
General. All the issued and outstanding common shares are
fully paid and nonassessable. Certificates representing the
common shares are issued in registered form. The common shares
are issued when registered in the register of shareholders of
Herbalife. The common shares are not entitled to any sinking
fund or pre-emptive or redemption rights. Our shareholders may
freely hold and vote their shares.
Voting Rights. Each common share is entitled to one vote
on all matters upon which the common shares are entitled to
vote, including the election of directors. Voting at any meeting
of shareholders is by a poll. Our articles of association do not
provide for actions by written consent of shareholders.
The required quorum for a meeting of our shareholders consists
of a number of shareholders present in person or by proxy and
entitled to vote that represents the holders of not less than a
majority of our issued voting share capital. We will hold an
annual general meeting of shareholders at such time and place as
the Board of Directors may determine. In addition, the Board of
Directors may convene a general meeting of shareholders at any
time upon five days notice. Further, general meetings
(other than the annual general meeting) may also be convened
upon written requisition of shareholders holding in aggregate
30% or more of issued voting share capital, which requisition
must state the object for the general meeting.
Subject to the quorum requirements referred to in the paragraph
above, any ordinary resolution to be made by the shareholders
requires the affirmative vote of a simple majority of the votes
attaching to the common shares cast in a general meeting of the
Company, while a special resolution requires the affirmative
vote of
662/3%
of the votes cast attaching to the common shares. A special
resolution is required for matters such as a change of name,
amending our memorandum and articles of association and placing
us into voluntary liquidation. Holders of common shares, which
are currently the only shares carrying the right to vote at our
general meetings, have the power, among other things, to elect
directors, ratify the appointment of auditors and make changes
in the amount of our authorized share capital. To the extent
that the Equity Sponsors ownership of our common shares is
less than
662/3%,
the Equity Sponsors will not be able to unilaterally approve
corporate actions that require special resolutions.
Dividends. The holders of our common shares are entitled
to receive such dividends as may be declared by our board of
directors. Dividends may be paid only out of profits, which
include net earnings and retained earnings undistributed in
prior years, and out of share premium, a concept analogous to
paid-in surplus in the United States, subject to a statutory
solvency test.
Liquidation. If we are to be liquidated, the liquidator
may, with the approval of the shareholders, divide among the
shareholders in cash or in kind the whole or any part of our
assets, may determine how such division shall be carried out as
between the shareholders or different classes of shareholders,
and may vest the whole or any part of such assets in trustees
upon such trusts for the benefit of the shareholders as the
liquidator, with the approval of the shareholders, sees fit,
provided that a shareholder shall not be compelled to accept any
shares or other assets which would subject the shareholder to
liability.
Miscellaneous. Share certificates registered in the names
of two or more persons are deliverable to any one of them named
in the share register, and if two or more such persons tender a
vote, the vote of the person whose name first appears in the
share register will be accepted to the exclusion of any other.
Anti-Takeover Provisions
General. Our articles of association have provisions that
could have an anti-takeover effect. These provisions are
intended to enhance the ability of the board of directors to
deal with unsolicited takeover attempts by increasing the
likelihood of continuity and stability in the composition of the
board of directors. These provisions could have the effect of
discouraging transactions that may involve an actual or
threatened change of control of Herbalife.
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Classified Board. The articles provide that our board of
directors will be divided into three classes serving staggered
three-year terms. The board of directors does not have the power
to remove directors. Vacancies on the board of directors may be
filled only by the remaining directors and not by the
shareholders. These provisions could have the effect of
precluding an acquiror from removing incumbent directors and
simultaneously gaining control of the board of directors by
filling the vacancies created by the removal of directors with
its own nominees, unless the acquiror controls at least
two-thirds of the combined voting power of the common shares
(the percentage necessary to adopt a special resolution to amend
these provisions). This could result in delaying a shareholder
from obtaining majority representation on the board of directors.
Number of Directors. The articles provide that the board
of directors will consist of not less than one director or more
than fifteen directors, the exact number to be set from time to
time by a majority of the whole board of directors. Accordingly,
the board of directors, and not the shareholders, has the
authority to determine the number of directors and could delay
any shareholder from obtaining majority representation on the
board of directors by enlarging the board of directors and
filling the new vacancies with its own nominees until a general
meeting at which directors are to be appointed.
Advance Notice Provisions. The articles establish an
advance notice procedure that must be followed by shareholders
if they wish to nominate candidates for election as directors at
an annual or extraordinary general meeting of shareholders or to
submit a proposal for consideration at a general or
extraordinary meeting of shareholders. The articles provide
generally that, if you desire to nominate a candidate for
election as a director at an annual general meeting or to submit
a proposal for consideration at a general meeting of
shareholders (including an annual general meeting), you must
give us notice not earlier than the 120th day prior to such
general meeting and not later than the 90th day prior to
such general meeting or the 10th day following the day on
which public announcement is first made of the date of the
general meeting, whichever is later.
Action Only by General Meeting and not by Written
Consent. Subject to the terms of any other class of shares
in issue, any action required or permitted to be taken by the
holders of common shares must be taken at a duly called annual
or extraordinary general meeting of shareholders and not by
written consent of the holders of the common shares. General
meetings may be called by the board or, with respect to an
extraordinary general meeting, upon written requisition of
shareholders holding in aggregate, 30% or more of issued voting
capital, which requisition must state the objects for the
general meeting.
Undesignated Preference Shares. Pursuant to our articles
of association, our board of directors has the authority,
without further action by the shareholders, to issue up to
7.5 million preference shares in one or more series and to
fix the designations, powers, preferences, privileges, and
relative participating, optional or special rights and the
qualifications, limitations or restrictions thereof, including
dividend rights, conversion rights, voting rights, terms of
redemption and liquidation preferences, any or all of which may
be greater than the rights of the common shares. Our board of
directors, without shareholder approval, may issue preference
shares with voting, conversion or other rights that could
adversely affect the voting power and other rights of holders of
our common shares. Subject to the directors duty of acting
in the best interest of Herbalife, preference shares can be
issued quickly with terms calculated to delay or prevent a
change in control of us or make removal of management more
difficult. Additionally, the issuance of preference shares may
have the effect of decreasing the market price of the common
shares, and may adversely affect the voting and other rights of
the holders of common shares. No preference shares have been
issued and we have no present plans to issue any preference
shares.
Restrictions on Business Combinations. As a Cayman
Islands company, Herbalife is not subject to Section 203 of
the Delaware General Corporation Law, which restricts business
combinations with interested shareholders. However,
Articles 109-111 of our articles contains provisions that
largely mirror the intention of Section 203 and generally
prohibit business combinations between Herbalife and
an interested share-
93
holder. Specifically, business combinations
between an interested shareholder and Herbalife are
prohibited for a period of three years after the time the
interested shareholder acquired its shares, unless:
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the business combination or the transaction resulting in the
person becoming an interested shareholder is approved by the
board of directors prior to the date the interested shareholder
acquired Herbalifes shares; |
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the interested shareholder acquired at least 85% of
Herbalifes shares in the transaction in which it became an
interested shareholder; or |
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the business combination is approved by a majority of the board
of directors and by the affirmative |
For purposes of this provision, business
combinations is defined broadly to include mergers,
consolidations of majority owned subsidiaries, sales or other
dispositions of assets having an aggregate value in excess of
10% of the consolidated assets of Herbalife, and most
transactions that would increase the interested
shareholders proportionate share ownership in Herbalife.
Interested shareholder is defined as a person who,
together with any affiliates and/or associates of that person,
beneficially owns, directly or indirectly, 15% or more of the
issued voting shares of Herbalife. Our Equity Sponsors and their
affiliates are not deemed to be interested shareholders for
these purposes.
Differences in Corporate Law
The Companies Law is modeled after that of England but does not
follow recent United Kingdom statutory enactments and differs
from laws applicable to U.S. corporations and their
shareholders. Set forth below is a summary of the significant
differences between the provisions of the Companies Law
applicable to us and the laws applicable to companies
incorporated in the United States and their shareholders.
Mergers and Similar Arrangements. Cayman Islands law does
not provide for mergers as that expression is understood under
U.S. corporate law. While 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 a scheme 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 a majority
of the companys shareholders who are present and voting
(either in person or by proxy) at such meeting. The shares voted
in favor of the scheme of arrangement must also represent at
least 75% of the value of each class of the companys
shareholders (excluding the shares owned by the parties to the
scheme of arrangement) present and voting at the meeting. 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 materially adversely affect creditors interests.
Furthermore, the 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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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 of arrangement is not one that would more properly be
sanctioned under some other provision of the Companies Law. |
If the scheme of arrangement is approved, the dissenting
shareholder would have no rights comparable to appraisal rights,
which would otherwise ordinarily be available to dissenting
shareholders of U.S. corporations, providing rights to
receive payment in cash for the judicially determined value of
the shares.
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In addition, if a third party purchases at least 90% of our
outstanding shares pursuant to an offer within a four-month
period of making such an offer, the purchaser may, during the
two months following expiration of the four-month period,
require the holders of the remaining shares to transfer their
shares on the same terms on which the purchaser acquired the
first 90% of our outstanding shares. An objection can be made to
the Grand Court of the Cayman Islands, but this is unlikely to
succeed unless there is evidence of fraud, bad faith, collusion
or inequitable treatment of the shareholders.
Shareholders Suits. Our Cayman Islands counsel is
not aware of any reported class action or derivative action
having been brought in a Cayman Islands court. In principle, we
would normally be the proper plaintiff in any action brought on
behalf of the company, and a derivative action may not be
brought by a minority shareholder. However, based on English
authorities, which would in all likelihood be of persuasive
authority in the Cayman Islands, exceptions to the foregoing
principle apply in circumstances in which:
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a company is acting or proposing to act illegally or outside the
scope of its corporate authority; |
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the act complained of, although not acting outside the scope of
its corporate authority, could be effected only if authorized by
more than a simple majority vote; |
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the individual rights of the plaintiff shareholder have been
infringed or are about to be infringed; or |
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those who control the company are perpetrating a fraud on
the minority. |
Indemnification
Cayman Islands law does not limit the extent to which a
companys articles of association may provide for
indemnification of officers and directors, except to the extent
any such provision may be held by the Cayman Islands courts to
be contrary to public policy, such as to provide indemnification
against civil fraud or the consequences of committing a crime.
Our articles of association provide for indemnification of
officers and directors for losses, damages, costs and expenses
incurred in their capacities as such, except in the case of
(a) any fraud or dishonesty of such director or officer,
(b) such directors or officers conscious,
intentional or wilful breach of his obligation to act honestly,
lawfully and in good faith with a view to the best interests of
the Company, or (c) any claims or rights of action to
recover any gain, personal profit, or other advantage to which
the director or officer is not legally entitled.
We have entered into an indemnification agreement with each of
our directors and certain of our officers to supplement the
indemnification protection available under our articles of
association. These indemnity agreements generally provide that
we will indemnify the parties thereto to the fullest extent
permitted by law. Such indemnification shall include, without
limitation, indemnity in third party proceedings and indemnity
in derivative actions. No indemnification shall be made for any
claim, issue or matter as to which an indemnitee has been
adjudged by a court of competent jurisdiction, after the
exhaustion of all appeals therefrom, to be liable to Herbalife,
unless and only to the extent that any court in which such
proceeding is brought or other court of competent jurisdiction
determines upon application that, in view of all the
circumstances of the case, the indemnitee is fairly and
reasonably entitled to indemnity for such amounts as the court
shall deem proper. The agreement will also provide for, under
certain circumstances, indemnification of expenses of successful
parties, and indemnification for expenses of a witness. The
agreement will further provide that if the indemnification
provided for in the agreement is unavailable and may not be paid
to an indemnitee for any reason other than statutory or common
law limitations set forth in applicable law, then in respect of
any threatened, pending or completed proceeding in which
Herbalife is jointly liable with the indemnitee (or would be if
joined in such action, suit, arbitration, proceeding, inquiry or
investigation), Herbalife shall contribute to the amount of
expenses or liabilities of any type whatsoever actually and
reasonably incurred and paid or payable by the indemnitee in
such proportion as is appropriate to reflect relative benefits
and relative fault, as further described in the agreement.
We also intend to maintain insurance to protect ourselves and
our directors, officers, employees and agents against expenses,
liabilities and losses incurred by such persons in connection
with their services in the foregoing capacities.
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The foregoing summaries are necessarily subject to the complete
text of our articles of association and the indemnification
agreements referred to above and are qualified in their entirety
by reference thereto.
Inspection of Books and Records
Holders of our shares will have no general right under Cayman
Islands law to inspect or obtain copies of our list of
shareholders or our corporate records. However, we will provide
our shareholders with annual audited consolidated financial
statements.
Transfer Agent
Mellon Investor Services LLC is the transfer agent for our
common shares.
Listing
Our common shares are listed on the New York Stock Exchange
under the trading symbol HLF.
Prohibited Sale of Securities under Cayman Islands Law
An exempted company such as us that is not listed on the Cayman
Islands Stock Exchange is prohibited from making any invitations
to the public in the Cayman Islands to subscribe for any of its
securities.
SHARES ELIGIBLE FOR FUTURE SALE
Future sales of substantial amounts of common shares in the
public market, or the perception that these sales may occur,
could adversely affect the prevailing market price of the common
shares. Upon the completion of this offering, we will have
69,400,666 shares of our common shares outstanding not
including, as of November 3, 2005:
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10,688,183 shares of our common shares issuable upon the
exercise of outstanding options under our option plans and
individual option agreements with certain of our executive
officers; |
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700,000 shares of our common shares issuable pursuant to
outstanding warrants; and |
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5,968,261 shares of common shares reserved and available
for grant under our option plans. |
All of the shares sold in this offering will be freely tradable
without restriction or the requirement of further registration
under the Securities Act unless they are acquired by our
affiliates, as that term is defined in Rule 144
of the Securities Act. In addition, all of our other outstanding
shares of common shares will be freely tradable without
restriction or the requirement of further registration under the
Securities Act immediately following the completion of this
offering, subject to restrictions applicable to our affiliates,
the Rule 144 trading volume limitations discussed below
and, in some cases, the 90-day lock-up restrictions
described below.
Rule 144
In general, under Rule 144 as currently in effect, a person
(or persons whose shares are aggregated together), including an
affiliate, who has beneficially owned restricted shares for at
least one year is entitled to sell, within any three-month
period, a number of these shares that does not exceed the
greater of:
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one percent of the then outstanding shares of our common shares
(approximately 694,007 shares immediately after this
offering); or |
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the average weekly trading volume in our common shares on the
New York Stock Exchange during the four calendar weeks preceding
the date on which notice of this sale is filed, provided that
requirements concerning availability of public information,
manner of sale and notice of sale are satisfied. |
In addition, affiliates must comply with the restrictions and
requirements of Rule 144 other than the one-year holding
period requirement in order to sell shares of our common shares
which are not restricted securities.
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Under Rule 144(k), a person who is not an affiliate of ours
and has not been an affiliate of ours for at least three months
prior to the sale and who has beneficially owned restricted
shares for at least two years may resell these shares without
compliance with