HERBALIFE LTD. The following discussion and analysis of our financial condition and results of operations should be read in conjunction with other information, including our condensed consolidated financial statements and related notes included in Part I, Item 1, Financial Information, and Part II, Item 1A, Risk Factors, of this Quarterly Report on Form 10-Q, and our consolidated financial statements appearing in our Annual Report on Form 10-K for the year endedDecember 31, 2019 , or the 2019 10-K. Unless the context otherwise requires, all references herein to the "Company," "we," "us" or "our," or similar terms, refer toHerbalife Nutrition Ltd. , aCayman Islands exempted company with limited liability, and its consolidated subsidiaries.
Overview
We are a global nutrition company that sells weight management; targeted nutrition; energy, sports, and fitness; and outer nutrition products to and through independent members, or Members. InChina , we sell our products to and through independent service providers, sales representatives, and sales officers to customers and preferred customers, as well as through Company-operated retail platforms when necessary. We refer to Members that distribute our products and achieve certain qualification requirements as "sales leaders." We provide high-quality, science-backed products to Members and their customerswho seek a healthy lifestyle and we also offer a business opportunity to those Memberswho seek additional income. We believe enhanced consumer awareness and demand for our products due to trends such as the global obesity epidemic, increasing healthcare costs, and aging populations, coupled with the effectiveness of personalized selling through a direct sales channel, have been the primary reasons for our continued success. Our products are grouped in four principal categories: weight management; targeted nutrition; energy, sports, and fitness; and outer nutrition, along with literature and promotional items. Our products are often sold through a series of related products and literature designed to simplify weight management and nutrition for consumers and maximize our Members' cross-selling opportunities. While we continue to monitor the current global financial environment, we remain focused on the opportunities and challenges in retailing our products and enhancing the customer experience, sponsoring and retaining Members, improving Member productivity, further penetrating existing markets, globalizing successful Distributor Methods of Operation, or DMOs, such asNutrition Clubs ,Fit Clubs , and Weight Loss Challenges, introducing new products and globalizing existing products, developing niche market segments and further investing in our infrastructure.
We sell our products in six geographic regions:
•North America ; •Mexico ; • South andCentral America ; • EMEA, which consists ofEurope , theMiddle East , andAfrica ; •Asia Pacific (excludingChina ); and •China . OnJuly 15, 2016 , we reached a settlement with theU.S. Federal Trade Commission , orFTC , and entered into the Consent Order, which resolved theFTC's multi-year investigation of the Company. We continue to monitor the impact of the Consent Order and our board of directors established theImplementation Oversight Committee in connection with the Consent Order, and more recently, our Audit Committee assumed oversight of continued compliance with the Consent Order.The Implementation Oversight Committee had met regularly with management to oversee our compliance with the terms of the Consent Order. While we currently do not expect the settlement to have a long-term and materially adverse impact on our business and our Member base, our business and our Member base, particularly in theU.S. , may be negatively impacted. The terms of the Consent Order do not change our going to market through direct selling by independent distributors, and compensating those distributors based upon the product they and their sales organization sell. See Part II, Item 1A, Risk Factors, of this Quarterly Report on Form 10-Q for a discussion of risks related to the settlement with theFTC . 38 --------------------------------------------------------------------------------
COVID-19 Pandemic
DuringMarch 2020 , theWorld Health Organization declared the outbreak of coronavirus disease 2019, or COVID-19, as a pandemic. The outbreak and subsequent global spread of the virus has impacted the general public, companies and state, local and national governments and economies worldwide, as well as global financial markets, and caused unemployment to increase. Public health organizations and international, federal, state and local governments have implemented measures to combat the spread of COVID-19, including restrictions on movement such as quarantines, "stay-at-home" orders and social distancing ordinances and restricting or prohibiting outright some or all forms of commercial and business activity. These measures, or others that may be implemented in the future, although temporary in nature, may become more restrictive or continue indefinitely. Our business and operations have been affected by the pandemic in manners and degrees that vary by market and we expect that the effects may extend through the end of 2020 and beyond. For the health and safety of our employees, our Members, and their customers, we implemented temporary access restrictions at many of our physical business locations and locations where Members conduct their business activities, some of which measures continue. Generally, we have been able to satisfy current levels of demand. While demand for our nutritional products continues to be at or above pre-pandemic levels and pandemic constraints have been lessened in most markets by the designation of our nutritional business as "essential" or other similar characterization, our operations have been and continue to be disrupted. The most significant impacts we have seen, depending on market, include:
• Constrained ability to deliver product to Members and/or have Members pick
product up from our access points due to facility closures and other
precautionary measures we have implemented;
• Restrictions or outright prohibitions on in-person training and
promotional meetings and events for Members that are a key aspect of our
business model, such as our annual regional Extravaganzas;
• Constrained ability of Members to have face-to-face contact with their
customers, including at
• Slowed office operations as many of our employees have limited access to
their regular place of employment.
We and our Members have responded to the pandemic and its impacts on our business and theirs by adapting operations and taking a number of proactive measures to mitigate those impacts. The most significant measures include:
• Adapting product access to the varying market-specific challenges,
including shifting to more home product delivery from Member pick-up, and
shifting to online or phone orders only from in-person ordering;
• Enhancing our training and promotion of technological tools offered to
support Members' online operations and accelerating the launch of certain
functionalities, such as functions that facilitate our Members' ability to
communicate and transact with
• Members continuing to or increasing the ways they leverage the Internet
and social media for customer contact including training, order-taking,
and acceptance of payment;
•
offerings of single servings to carry-out and home delivery of single
servings, as well as sales of fully packaged products;
• Instituting product purchase limitations for certain in-demand products to
help ensure as many Members and their customers have fair access to these
products and to minimize out-of-stock conditions; and
• Physical changes at our major facilities, such as our manufacturing plants
and distribution centers, including pre-entry temperature checks, face
masks for employees, and plexiglass barriers, and employees working from
home where possible rather than at company offices.
We believe our cash on hand as of September 30, 2020 and as of the date of this
filing, combined with cash flows from operating activities, is sufficient to
meet our foreseeable needs for the next twelve months. We also have access to
our $282.5 million revolving credit facility to supplement our cash-generating
ability if necessary.
Although we believe that our responsive measures have been effective in limiting
the adverse impact of the pandemic on most markets, the ongoing impact of the
COVID-19 pandemic will affect our business, financial condition, and results of
operations in future quarters, including their comparability to prior periods.
Given the unpredictable, unprecedented, and fluid nature of the pandemic and its
economic consequences, we are unable to predict the duration and extent to which
the pandemic and its related impacts will impact our business, financial
condition, and results of operations. A more detailed discussion of the
pandemic's impact on net sales for the third quarter and first nine months of
2020 and its expected impact in future periods, as well as the impacts specific
to each geographic region, are discussed further in the Sales by Geographic
Region section below. See Part II, Item 1A, Risk Factors, of this Quarterly
Report on Form 10-Q for a further discussion of risks related to the COVID-19
pandemic.
39
--------------------------------------------------------------------------------
Volume Points by
A key non-financial measure we focus on is Volume Points on a Royalty Basis, or Volume Points, which is essentially our weighted-average measure of product sales volume. Volume Points, which are unaffected by exchange rates or price changes, are used by management as a proxy for sales trends because in general, excluding the impact of price changes, an increase in Volume Points in a particular geographic region or country indicates an increase in our local currency net sales while a decrease in Volume Points in a particular geographic region or country indicates a decrease in our local currency net sales. The criteria we use to determine how and when we recognize Volume Points are not identical to our revenue recognition policies underU.S. GAAP. Unlike net sales, which are generally recognized when the product is delivered and when control passes to the Member, as discussed in greater detail in Note 2, Significant Accounting Policies, to the Condensed Consolidated Financial Statements included in Part I, Item 1 of this Quarterly Report on Form 10-Q, we recognize Volume Points when a Member pays for the order, which is generally prior to the product being delivered. Further, the periods in which Volume Points are tracked can vary slightly from the fiscal periods for which we report our results underU.S. GAAP. Therefore, there can be timing differences between the product orders for which net sales are recognized and for which Volume Points are recognized within a given period. However, historically these timing differences generally have been immaterial in the context of using changes in Volume Points as a proxy to explain volume-driven changes in net sales. The specific number of Volume Points assigned to a product, which is generally consistent across all markets, is based on aVolume Point to suggested retail price ratio for similar products. If a product is available in different quantities, the various sizes will have differentVolume Point values. In general, once assigned, aVolume Point value is consistent in each region and country and does not change from year to year. We use Volume Points for Member qualification and recognition purposes, as well as a proxy for sales trends, and therefore we generally keep Volume Points for a similar or like product consistent on a global basis. However, because Volume Points are a function of value rather than product type or size, they are not a reliable measure for product mix. As an example, an increase in Volume Points in a specific country or region could mean a significant increase in sales of less expensive products or a marginal increase in sales of more expensive products. Three Months Ended Nine Months Ended September 30, September 30, September 30, September 30, 2020 2019 % Change 2020 2019 % Change (Volume Points in millions) North America 501.0 330.8 51.5 % 1,349.4 1,017.1 32.7 % Mexico 232.3 216.4 7.3 % 655.6 663.0 (1.1 )% South and Central America 150.7 130.1 15.8 % 386.5 386.2 0.1 % EMEA 423.1 315.2 34.2 % 1,166.5 977.0 19.4 % Asia Pacific 448.9 406.6 10.4 % 1,211.3 1,147.1 5.6 % China 143.5 142.4 0.8 % 412.8 361.6 14.2 % Worldwide 1,899.5 1,541.5 23.2 % 5,182.1 4,552.0 13.8 % Volume Points increased 23.2% and 13.8% for the three and nine months endedSeptember 30, 2020 , respectively, including a mixed impact of COVID-19 pandemic conditions across our markets, after having increased 2.3% and 2.7%, respectively, for the same periods in 2019. Although pandemic conditions had adverse operational impacts across all markets, we believe our Members in certain markets are more focused on their business where we have seen increased net sales andVolume Point growth in certain markets, particularly theNorth America region and certain EMEA markets. 40 -------------------------------------------------------------------------------- We believeNorth America's Volume Point increases for the quarter and year-to-date periods, which were well above the increases for the comparable prior year periods, also reflect the continuing success of our Distributors as supported by our product line expansion and technological tools, as well as targeted communications and promotions. We believeMexico's increase for the quarter, after decreases compared to prior years for a number of quarters and despite continuing difficult economic conditions for the market, reflects the success of our program of promotions to encourage Member sponsorship and activity. After some years of declines, the South andCentral America region saw an increase in Volume Points for the third quarter versus the 2019 period, despite pandemic-related continuing declines in several key markets, as we believe efforts to build more sustainable business for our Members through a focus on daily product consumption and retailing take hold in certain markets in the region. EMEA saw increasedVolume Point growth for the quarter and year-to-date periods versus 2019, a result we believe of customer-oriented efforts including Member training, brand awareness, and product line expansion, as well as strong business momentum including new Member recruitment. TheAsia Pacific region sawVolume Point increases for the third quarter and year-to-date period, continuing favorable long-term trends seen in the region, although the growth rates were below those seen in the 2019 periods due to the adverse impact of pandemic conditions in the region, especially inIndia andSouth Korea .China achievedVolume Point increases for the quarter and year-to-date periods, compared to declines for the 2019 periods which were weakened by disruption from the Chinese government's 100-day review, concluded inApril 2019 , of the health product industry. We expect COVID-19 pandemic conditions to continue to impactVolume Point results; however, we are unable to predict the duration or magnitude of these effects. Results and more regional or country-specific impacts of the COVID-19 pandemic are discussed further below in the applicable sections of Sales byGeographic Region .
Presentation
"Retail value" represents the suggested retail price of products we sell to our Members and is the gross sales amount reflected on our invoices. Retail value is a non-GAAP measure which may not be comparable to similarly-titled measures used by other companies. This is not the price paid to us by our Members. Our Members purchase product from us at a discount from the suggested retail price. We refer to these discounts as "distributor allowance," and we refer to retail value less distributor allowances as "product sales." Total distributor allowances were 41.2% and 40.6% of retail value for the three months endedSeptember 30, 2020 and 2019, respectively, and 41.1% of retail value for both the nine months endedSeptember 30, 2020 and 2019. Depending on product and market, distributor allowances and Marketing Plan payouts for the three and nine months endedSeptember 30, 2020 utilized on a weighted-average basis approximately 90% of suggested retail price, to which we applied discounts of up to 50% for distributor allowances and payout rates of up to 15% for royalty overrides, up to 7% for production bonuses, and approximately 1% for the Mark Hughes bonus. Distributor allowances as a percentage of retail value may vary by country depending upon regulatory restrictions that limit or otherwise restrict distributor allowances. We also offer reduced distributor allowances with respect to certain products worldwide. Each Member's level of discount is determined by qualification based on volume of purchases. In cases where a Member has qualified for less than the maximum discount, the remaining discount, which we also refer to as a wholesale commission, is received by their sponsoring Members. Therefore, product sales are recognized net of product returns and distributor allowances. "Net sales" equal product sales plus shipping and handling, and generally represents what we collect. ForU.S. GAAP purposes, shipping and handling services relating to product sales are recognized as fulfillment activities on our performance obligation to transfer products and are therefore recorded within net sales as part of product sales and are not considered as separate revenues. We do not have visibility into all the sales from our Members to their customers, but such a figure would differ from our reported "retail value" by factors including: (a) the amount of product purchased by our Members for their own personal consumption, (b) prices charged by our Members to their customers other than our suggested retail prices, and (c) the discount from retail value at which preferred members purchase products from us. We discuss retail value because of its fundamental role in our systems, internal controls and operations, and its correlation to Member discounts and Royalty overrides. In addition, retail value is a component of the financial reports we use to analyze our financial results because, among other things, it can provide additional detail and visibility into our net sales results on a Company-wide and a geographic region and product category basis. Therefore, this non-GAAP measure may be useful to investors because it provides investors with the same information used by management. As this measure is not in accordance withU.S. generally accepted accounting principles, orU.S. GAAP, retail value should not be considered in isolation from, nor as a substitute for, net sales and other consolidated income or cash flow statement data prepared in accordance withU.S. GAAP, or as a measure of profitability or liquidity. A reconciliation of retail value to net sales is presented below under Results of Operations. 41 -------------------------------------------------------------------------------- In certain geographic markets, we have introduced segmentation of our Member base into two categories: "preferred members" -who are simply consumerswho wish to purchase product for their own household use, and "distributors" -who are Memberswho also wish to resell products or build a sales organization. Additionally, in certain markets we are simplifying our pricing by eliminating certain shipping and handling charges and recovering those costs within suggested retail price. As we continue to extend the segmentation of our distributors and preferred members to additional geographic markets and consider other pricing simplification efforts for our Members, we are evaluating the utility of retail value to management and investors and whether it will continue to be used in the same way in the future. Our international operations have provided and will continue to provide a significant portion of our total net sales. As a result, total net sales will continue to be affected by fluctuations in theU.S. dollar against foreign currencies. In order to provide a framework for assessing how our underlying businesses performed excluding the effect of foreign currency fluctuations, in addition to comparing the percent change in net sales from one period to another inU.S. dollars, we also compare the percent change in net sales from one period to another period using "net sales in local currency." Net sales in local currency is not aU.S. GAAP financial measure. Net sales in local currency removes from net sales inU.S. dollars the impact of changes in exchange rates between theU.S. dollar and the local currencies of our foreign subsidiaries, by translating the current period net sales intoU.S. dollars using the same foreign currency exchange rates that were used to translate the net sales for the previous comparable period. We believe presenting net sales in local currency is useful to investors because it allows a meaningful comparison of net sales of our foreign operations from period to period. However, net sales in local currency measures should not be considered in isolation or as an alternative to net sales inU.S. dollar measures that reflect current period exchange rates, or to other financial measures calculated and presented in accordance withU.S. GAAP. Additionally, the impact of foreign currency fluctuations inVenezuela and the price increases we implement as a result of the highly inflationary economy in that market can each, when considered in isolation, have a disproportionately large impact to our consolidated results despite the offsetting nature of these drivers and that net sales inVenezuela , which represent less than 1% of our consolidated net sales, are not material to our consolidated results. Therefore, in certain instances, we believe it is helpful to provide additional information with respect to these factors as reported and excluding the impact ofVenezuela to illustrate the disproportionate nature ofVenezuela's individual pricing and foreign exchange impact to our consolidated results. However, excluding the impact ofVenezuela from these measures is not in accordance withU.S. GAAP and should not be considered in isolation or as an alternative to the presentation and discussion thereof calculated in accordance withU.S. GAAP. Our "gross profit" consists of net sales less "cost of sales," which represents our manufacturing costs, the price we pay to our raw material suppliers and manufacturers of our products as well as shipping and handling costs including duties, tariffs, and similar expenses. While certain Members may profit from their activities by reselling our products for amounts greater than the prices they pay us, Members that develop, retain, and manage other Members may earn additional compensation for those activities, which we refer to as "Royalty overrides." Royalty overrides are our most significant operating expense and consist of: • royalty overrides and production bonuses; • the Mark Hughes bonus payable to some of our most senior Members; and • other discretionary incentive cash bonuses to qualifying Members. Royalty overrides are compensation to Members for the development, retention and improved productivity of their sales organizations and are paid to several levels of Members on each sale. Royalty overrides are compensation for services rendered to us and, as such, are recorded as an operating expense. InChina , our independent service providers are compensated for marketing, sales support, and other services instead of the distributor allowances and royalty overrides utilized in our global Marketing Plan. Service fees toChina independent service providers are included in selling, general, and administrative expenses. Because of local country regulatory constraints, we may be required to modify our Member incentive plans as described above. We also pay reduced royalty overrides with respect to certain products worldwide. Consequently, the total Royalty override percentage may vary over time.
Our "contribution margins" consist of net sales less cost of sales and Royalty overrides.
42
--------------------------------------------------------------------------------
"Selling, general, and administrative expenses" represent our operating
expenses, which include labor and benefits, service fees to China service
providers, sales events, professional fees, travel and entertainment, Member
promotions, occupancy costs, communication costs, bank fees, depreciation and
amortization, foreign exchange gains and losses, and other miscellaneous
operating expenses.
Our "other operating income" consists of government grant income related to
Our "other income, net" consists of non-operating income and expenses such as gains or losses due to subsequent changes in the fair value of the non-transferable contractual contingent value right, or CVR, provided for each share tendered in theOctober 2017 modified Dutch auction tender offer. See Note 8, Shareholders' Deficit, to the Consolidated Financial Statements included in the 2019 10-K for further information on the CVR. Most of our sales to Members outsidethe United States are made in the respective local currencies. In preparing our financial statements, we translate revenues intoU.S. dollars using average exchange rates. Additionally, the majority of our purchases from our suppliers generally are made inU.S. dollars. Consequently, a strengthening of theU.S. dollar versus a foreign currency can have a negative impact on our reported sales and contribution margins and can generate foreign currency losses on intercompany transactions. Foreign currency exchange rates can fluctuate significantly. From time to time, we enter into foreign currency derivatives to partially mitigate our foreign currency exchange risk as discussed in further detail in Part I, Item 3, Quantitative and Qualitative Disclosures about Market Risk, of this Quarterly Report on Form 10-Q.
Summary Financial Results
Net sales for the three and nine months endedSeptember 30, 2020 were$1,521.8 million and$4,131.1 million , respectively. Net sales increased$277.3 million , or 22.3% ($277.2 million , or 22.3% excludingVenezuela ), and$474.3 million , or 13.0% ($474.2 million , or 13.0% excludingVenezuela ), for the three and nine months endedSeptember 30, 2020 , respectively, as compared to the same periods in 2019. In local currency, net sales increased 26.1% and 17.6% (25.1% and 16.7% excludingVenezuela ) for the three and nine months endedSeptember 30, 2020 , respectively, as compared to the same periods in 2019. The 22.3% increase in net sales for the three months endedSeptember 30, 2020 was primarily driven by an increase in sales volume, as indicated by a 23.2% increase in Volume Points and, a 3.6% favorable impact of price increases (2.7% favorable impact excludingVenezuela ), partially offset by a 3.8% unfavorable impact of fluctuations in foreign currency exchange rates (2.9% unfavorable impact excludingVenezuela ), and a 0.8% unfavorable impact of country sales mix. The 13.0% increase in net sales for the nine months endedSeptember 30, 2020 was primarily driven by an increase in sales volume, as indicated by a 13.8% increase in Volume Points, and a 3.9% favorable impact of price increases (2.8% favorable impact excludingVenezuela ), partially offset by a 4.6% unfavorable impact of fluctuations in foreign currency exchange rates (3.7% unfavorable impact excludingVenezuela ). Net income for the three and nine months endedSeptember 30, 2020 was$138.1 million , or$1.04 per diluted share, and$298.8 million , or$2.17 per diluted share, respectively. Net income increased$56.6 million , or 69.4%, and$44.5 million , or 17.5%, for the three and nine months endedSeptember 30, 2020 , respectively, as compared to the same periods in 2019. The increase in net income for the three months endedSeptember 30, 2020 was mainly due to$98.7 million higher contribution margin driven by higher net sales, partially offset by$29.6 million higher selling, general, and administrative expenses. The increase in net income for the nine months endedSeptember 30, 2020 was mainly due to$200.2 million higher contribution margin driven by higher net sales;$15.0 million lower interest expense, net; and$12.7 million lower income taxes; partially offset by$147.0 million higher selling, general, and administrative expenses primarily driven by$83.1 million of expenses relating to theSEC and DOJ investigations relating to the FCPA matter inChina (See Note 5, Contingencies, to the Condensed Consolidated Financial Statements included in Part I, Item 1 of this Quarterly Report on Form 10-Q); a$15.7 million unfavorable impact from other income, net relating to CVR revaluations in 2019 as described below; and$14.7 million lowerChina government grant income. Net income for the three months endedSeptember 30, 2020 included a$5.5 million pre-tax unfavorable impact ($5.1 million post-tax) of non-cash interest expense related to the 2024 Convertible Notes (See Note 4, Long-Term Debt, to the Condensed Consolidated Financial Statements included in Part I, Item 1 of this Quarterly Report on Form 10-Q); a$4.7 million pre-tax unfavorable impact ($4.4 million post-tax) from expenses related to the COVID-19 pandemic, and such expenses are expected to continue in future periods; a$0.6 million pre-tax favorable impact ($0.3 million post-tax) of government grant income inChina ; and a$0.4 million pre-tax unfavorable impact ($4.7 million post-tax) from expenses related to regulatory inquiries. 43 -------------------------------------------------------------------------------- Net income for the nine months endedSeptember 30, 2020 included an$85.7 million unfavorable impact ($81.0 million post-tax) from expenses related to regulatory inquiries and a legal accrual, which includes$83.1 million of expenses relating to theSEC and DOJ investigations relating to the FCPA matter inChina ; a$16.6 million pre-tax unfavorable impact ($14.6 million post-tax) from expenses related to the COVID-19 pandemic, and such expenses are expected to continue in future periods; a$16.2 million pre-tax unfavorable impact ($16.4 million post-tax) of non-cash interest expense related to the 2024 Convertible Notes (See Note 4, Long-Term Debt, to the Condensed Consolidated Financial Statements included in Part I, Item 1 of this Quarterly Report on Form 10-Q); a$13.0 million pre-tax favorable impact ($9.4 million post-tax) of government grant income inChina ; and a$0.5 million pre-tax unfavorable impact ($0.4 million post-tax) of debt issuance costs related to the amendment of our 2018 Credit Facility. The income tax impact of the expenses discussed above is based on forecasted items affecting our 2020 full year effective tax rate. Adjustments to forecasted items unrelated to these expenses, as well as impacts related to interim reporting, will have an effect on the income tax impact of these items in subsequent periods. Net income for the three months endedSeptember 30, 2019 included a$19.0 million pre-tax unfavorable impact ($16.2 million post-tax) of an accrual for Mexico VAT assessments; an$8.7 million pre-tax unfavorable impact ($8.0 million post-tax) of non-cash interest expense related to the 2019 Convertible Notes, 2024 Convertible Notes, and the Forward Transactions (See Note 4, Long-Term Debt, to the Condensed Consolidated Financial Statements included in Part I, Item 1 of this Quarterly Report on Form 10-Q); a$1.9 million pre-tax unfavorable impact ($3.2 million post-tax) from expenses related to regulatory inquiries; a$6.4 million pre-tax favorable impact ($4.7 million post-tax) of government grant income inChina ; a$1.3 million pre-tax favorable impact ($1.8 million post-tax) of gain on the revaluation of the CVR (See Note 8, Shareholders' Deficit, to the Consolidated Financial Statements included in the 2019 10-K); and a$0.4 million post-tax favorable impact related to the finalization of insurance recoveries in connection with the flooding at one of our warehouses inMexico duringSeptember 2017 , which damaged certain of our inventory stored within the warehouse (See Note 7, Contingencies, to the Consolidated Financial Statements included in our Annual Report on Form 10-K for the year endedDecember 31, 2018 , or the 2018 10-K). Net income for the nine months endedSeptember 30, 2019 included a$34.1 million pre-tax unfavorable impact ($30.9 million post-tax) from expenses related to regulatory inquiries and a legal accrual related to theSEC investigation relating to our disclosures regarding our marketing plan inChina (See Note 5, Contingencies, to the Condensed Consolidated Financial Statements included in Part I, Item 1 of this Quarterly Report on Form 10-Q); a$33.0 million pre-tax unfavorable impact ($31.7 million post-tax) of non-cash interest expense related to the 2019 Convertible Notes, 2024 Convertible Notes, and the Forward Transactions (See Note 4, Long-Term Debt, to the Condensed Consolidated Financial Statements included in Part I, Item 1 of this Quarterly Report on Form 10-Q); a$19.0 million pre-tax unfavorable impact ($16.2 million post-tax) of an accrual for Mexico VAT assessments; a$27.7 million pre-tax favorable impact ($19.6 million post-tax) of government grant income inChina ; a$15.7 million pre-tax favorable impact ($14.4 million post-tax) of gain on the revaluation of the CVR (See Note 8, Shareholders' Deficit, to the Consolidated Financial Statements included in the 2019 10-K); and a$6.0 million pre-tax favorable impact ($5.5 million post-tax) related to the finalization of insurance recoveries in connection with the flooding at one of our warehouses inMexico duringSeptember 2017 , which damaged certain of our inventory stored within the warehouse (See Note 7, Contingencies, to the Consolidated Financial Statements included in the 2018 10-K).
Results of Operations
Our results of operations for the periods below are not necessarily indicative
of results of operations for future periods, which depend upon numerous factors,
including our ability to sponsor Members and retain sales leaders, further
penetrate existing markets, introduce new products and programs that will help
our Members increase their retail efforts and develop niche market segments.
44
--------------------------------------------------------------------------------The following table sets forth selected results of our operations expressed as a percentage of net sales for the periods indicated:
Three Months Ended Nine Months Ended
September 30, September 30, September 30, September 30,
2020 2019 2020 2019
Operations:
Net sales 100.0 % 100.0 % 100.0 % 100.0 %
Cost of sales 21.2 19.6 20.4 19.9
Gross profit 78.8 80.4 79.6 80.1
Royalty overrides(1) 30.4 29.2 30.3 29.8
Selling, general, and administrative
expenses(1) 34.8 40.2 37.7 38.6
Other operating income - (0.5 ) (0.3 ) (0.9 )
Operating income 13.6 11.5 11.9 12.6
Interest expense, net 2.3 2.5 2.1 2.8
Other income, net - (0.1 ) - (0.4 )
Income before income taxes 11.3 9.1 9.8 10.2
Income taxes 2.2 2.6 2.6 3.2
Net income 9.1 % 6.5 % 7.2 % 7.0 %
(1) Service fees to our independent service providers in
selling, general, and administrative expenses while Member compensation for
all other countries is included in Royalty overrides.
Reporting Segment Results
We aggregate our operating segments, excludingChina , into a reporting segment, or the Primary Reporting Segment. The Primary Reporting Segment includes theNorth America ,Mexico , South andCentral America , EMEA, andAsia Pacific regions.China has been identified as a separate reporting segment as it does not meet the criteria for aggregation. See Note 6, Segment Information, to the Condensed Consolidated Financial Statements included in Part I, Item 1 of this Quarterly Report on Form 10-Q for further discussion of our reporting segments. See below for discussions of net sales and contribution margin by our reporting segments.
The Primary Reporting Segment reported net sales of$1,301.8 million and$3,511.7 million for the three and nine months endedSeptember 30, 2020 , respectively, representing an increase of$266.0 million , or 25.7% ($265.9 million , or 25.7% excludingVenezuela ), and$401.0 million , or 12.9% ($400.9 million , or 12.9% excludingVenezuela ), for the three and nine months endedSeptember 30, 2020 and 2019, respectively, as compared to the same periods in 2019. In local currency, net sales increased 30.5% and 18.0% (29.4% and 16.8% excludingVenezuela ) for the three and nine months endedSeptember 30, 2020 , respectively, as compared to the same periods in 2019. The 25.7% increase in net sales for the three months endedSeptember 30, 2020 was primarily due to an increase in sales volume, as indicated by a 25.5% increase in Volume Points, and a 4.3% favorable impact of price increases (3.2% favorable impact excludingVenezuela ); partially offset by a 4.8% unfavorable impact of fluctuations in foreign currency exchange rates (3.7% unfavorable impact excludingVenezuela ). The 12.9% increase in net sales for the nine months endedSeptember 30, 2020 was primarily due to an increase in sales volume, as indicated by a 13.8% increase in Volume Points, and a 4.4% favorable impact of price increases (3.2% favorable impact excludingVenezuela ); partially offset by a 5.1% unfavorable impact of fluctuations in foreign currency exchange rates (4.0% unfavorable impact excludingVenezuela ).
For a discussion of
Contribution Margin by Reporting Segment
As discussed above under "Presentation," contribution margin consists of net sales less cost of sales and Royalty overrides.
45
--------------------------------------------------------------------------------
The Primary Reporting Segment reported contribution margin of $538.2 million , or
41.3% of net sales, and $1,485.4 million , or 42.3% of net sales, for the three
and nine months ended September 30, 2020 , respectively, representing an increase
of $91.5 million , or 20.5% ($91.4 million , or 20.5% excluding Venezuela ), and
$139.2 million , or 10.3% ($138.6 million , or 10.3% excluding Venezuela ), for the
three and nine months ended September 30, 2020 and 2019, respectively, as
compared to the same periods in 2019. The 20.5% increase in contribution margin
for the three months ended September 30, 2020 was primarily the result of a
25.5% favorable impact of volume increases, a 6.9% favorable impact of price
increases (5.1% favorable impact excluding Venezuela ), and a 1.5% favorable
impact of sales mix; partially offset by a 6.9% unfavorable impact of
fluctuations in foreign currency exchange rates (5.1% unfavorable impact
excluding Venezuela ) and a 4.3% unfavorable impact of other cost changes related
to self-manufacturing and sourcing and increased freight costs from orders
shifting toward home delivery versus Member pick-up. The 10.3% increase in
contribution margin for the nine months ended September 30, 2020 was primarily
the result of a 13.8% favorable impact of volume increases and a 6.9% favorable
impact of price increases (5.0% favorable impact excluding Venezuela ); partially
offset by a 6.1% unfavorable impact of fluctuations in foreign currency exchange
rates (4.2% unfavorable impact excluding Venezuela ) and a 2.8% unfavorable
impact of other cost changes related to self-manufacturing and sourcing and
increased freight costs from orders shifting toward home delivery versus Member
pick-up.
China reported contribution margin of $197.8 million and $553.3 million for the
three and nine months ended September 30, 2020 , respectively, representing an
increase of $7.2 million , or 3.8%, and $61.0 million , or 12.4%, for the three
and nine months ended September 30, 2020 and 2019, respectively, as compared to
the same periods in 2019. The 3.8% increase in contribution margin for the three
months ended September 30, 2020 was primarily the result of a 2.6% favorable
impact of sales mix and a 1.2% favorable impact of timing differences between
the recognition of net sales and sales volume. The 12.4% increase in
contribution margin for the nine months ended September 30, 2020 was primarily
the result of a 14.2% favorable impact of volume increases, a 2.7% favorable
impact of sales mix, and a 1.1% favorable impact of price increases, partially
offset by a 2.4% unfavorable impact of fluctuations in foreign currency exchange
rates and a 2.1% unfavorable impact of timing differences between the
recognition of net sales and sales volume.
Sales by
The following chart reconciles retail value to net sales by geographic region:
Three Months Ended
September 30, September 30,
2020 2019
Retail Distributor Shipping and Retail Distributor Shipping and % Change in
Value(1) Allowance Product Sales Handling Net Sales Value(1) Allowance Product Sales Handling Net Sales Net Sales
(Dollars in millions)
North America $ 662.4 $ (304.1 ) $ 358.3 $ 40.4 $ 398.7 $ 427.9 $ (195.8 ) $ 232.1 $ 25.0 $ 257.1 55.1 %
Mexico 193.1 (89.6 ) 103.5 6.8 110.3 200.4 (91.2 ) 109.2 7.3 116.5 (5.3 )%
South and Central America 175.6 (75.9 ) 99.7 3.0 102.7 162.3 (72.3 ) 90.0 5.4 95.4 7.7 %
EMEA 574.3 (255.5 ) 318.8 15.5 334.3 413.7 (185.8 ) 227.9 14.4 242.3 38.0 %
Asia Pacific 613.2 (267.6 ) 345.6 10.2 355.8 555.7 (242.7 ) 313.0 11.5 324.5 9.6 %
China 237.4 (18.7 ) 218.7 1.3 220.0 227.1 (19.6 ) 207.5 1.2 208.7 5.4 %
Worldwide $ 2,456.0 $ (1,011.4 ) $ 1,444.6 $ 77.2 $ 1,521.8 $ 1,987.1 $ (807.4 ) $ 1,179.7 $ 64.8 $ 1,244.5 22.3 %
46
--------------------------------------------------------------------------------
Nine Months Ended
September 30, September 30,
2020 2019
Retail Distributor Shipping and Retail Distributor Shipping and % Change in
Value(1) Allowance Product
Sales Handling
Product Sales Handling Net Sales Net Sales
(Dollars in millions)
North America $ 1,764.3 $ (808.2 ) $ 956.1 $ 106.3 $ 1,062.4 $ 1,315.9 $ (601.0 ) $ 714.9 $ 77.0 $ 791.9 34.2 %
Mexico 558.7 (256.8 ) 301.9 19.7 321.6 604.4 (274.4 ) 330.0 27.0 357.0 (9.9 )%
South and Central America 452.2 (198.6 ) 253.6 11.0 264.6 487.6 (217.6 ) 270.0 16.3 286.3 (7.6 )%
EMEA 1,529.1 (681.4 ) 847.7 45.6 893.3 1,291.1 (578.8 ) 712.3 44.6 756.9 18.0 %
Asia Pacific 1,673.6 (731.7 ) 941.9 27.9 969.8 1,572.4 (686.3 ) 886.1 32.5 918.6 5.6 %
China 666.4 (51.1 ) 615.3 4.1 619.4 592.8 (49.8 ) 543.0 3.1 546.1 13.4 %
Worldwide $ 6,644.3 $ (2,727.8 ) $ 3,916.5 $ 214.6 $ 4,131.1 $ 5,864.2 $ (2,407.9 ) $ 3,456.3 $ 200.5 $ 3,656.8 13.0 %
(1) Retail value is a non-GAAP measure which may not be comparable to
similarly-titled measures used by other companies. See "Presentation" above
for a discussion of how we calculate retail value and why we believe the
measure is useful to investors.
Changes in net sales are directly associated with the retailing of our products, recruitment of new Members, and retention of sales leaders. Our strategies involve providing quality products, improved DMOs, including daily consumption approaches such asNutrition Clubs , easier access to product, systemized training and education of Members on our products and methods, and continued promotion and branding of Herbalife products. Management's role, in-country and at the region and corporate level, is to provide Members with a competitive, broad, and innovative product line, offer leading-edge business tools and technology services, and encourage strong teamwork and Member leadership to make doing business with Herbalife simple. Management uses the Marketing Plan, which reflects the rules for our global network marketing organization that specify the qualification requirements and general compensation structure for Members, coupled with educational and motivational tools and promotions to encourage Members to increase retailing, retention, and recruiting, which in turn affect net sales. Such tools include sales events such as Extravaganzas, Leadership Development Weekends and World Team Schools where large groups of Members gather, thus allowing them to network with other Members, learn retailing, retention, and recruiting techniques from our leading Members and become more familiar with how to market and sell our products and business opportunities. Accordingly, management believes that these development and motivation programs increase the productivity of the sales leader network. The expenses for such programs are included in selling, general, and administrative expenses. We also use event and non-event product promotions to motivate Members to increase retailing, retention, and recruiting activities. These promotions have prizes ranging from qualifying for events to product prizes and vacations. A program that we have seen success with in many markets is the Member Activation Program, under which new Members,who order a modest number of Volume Points in each of their first three months, earn a prize. Our objective is to improve the quality of sales leaders by encouraging new Members to begin acquiring retail customers before attempting to qualify for sales leader status. Additionally, in certain markets we have begun to utilize the segmentation of our Member base into "preferred members" and "distributors" for more targeted and efficient communication and promotions for these two differently motivated types of Members. In certain other markets that have not been segmented, we have begun using Member data to similarly categorize Members for communication and promotion efforts. DMOs are being generated in many of our markets and are globalized where applicable through the combined efforts of Members and country, regional and corporate management. While we support a number of different DMOs, one of the most popular DMOs is the daily consumption DMO. Under our traditional DMO, a Member typically sells to its customers on a somewhat infrequent basis (e.g., monthly) which provides fewer opportunities for interaction with their customers. Under a daily consumption DMO, a Member interacts with its customers on a more frequent basis, including such activities as weekly weigh-ins, which enables the Member to better educate and advise customers about nutrition and the proper use of the products and helps promote daily usage as well, thereby helping the Member grow his or her business. Specific examples of DMOs include theNutrition Club concept inMexico , the Healthy Breakfast concept inRussia , and the Internet/Sampling and Weight Loss Challenge inthe United States . Management's strategy is to review the applicability of expanding successful country initiatives throughout a region, and where appropriate, support the globalization of these initiatives. As discussed further by market below, the Company has responded to COVID-19 pandemic conditions by adapting how it communicates with, services, and transacts with our Members and our Members have similarly adapted their DMOs and other activities. These responsive actions have varied by region and by market due to the differing market- and regional-specific impacts of the pandemic and the conditions and challenges unique to a particular market or region independent of the impacts of the pandemic 47 -------------------------------------------------------------------------------- The factors described above help Members increase their business, which in turn helps driveVolume Point growth in our business, and thus, net sales growth. The discussion below of net sales details some of the specific drivers of changes in our business and causes of sales fluctuations during the three and nine months endedSeptember 30, 2020 as compared to the same periods in 2019, as well as the unique growth or contraction factors specific to certain geographic regions or significant countries within a region during these periods. Net sales fluctuations, both Company-wide and within a particular geographic region or country, are primarily the result of changes in volume, changes in prices, or changes in foreign currency translation rates. The discussion of changes in net sales quantifies the impact of those drivers that are quantifiable such as changes in foreign currency translation rates, and cites the estimated impact of any significant price changes. The remaining drivers, which management believes are the primary drivers of changes in volume, are typically qualitative factors whose impact cannot be quantified. We use Volume Points as an indication for changes in sales volume. We expect the impact of the COVID-19 pandemic to impact our results of operations in future quarters and their comparability to prior periods, both on a consolidated basis and at the regional level. However, given the unpredictable, unprecedented, and fluid nature of the pandemic and its economic consequences, we are unable to predict the extent to which the pandemic and its related impacts will adversely impact our business, financial condition, and results of operations, including the impact it may have on our regions and individual markets. See below for a more detailed discussion of the pandemic's impact on net sales for the first quarter for each geographic region and individual market.
TheNorth America region reported net sales of$398.7 million and$1,062.4 million for the three and nine months endedSeptember 30, 2020 , respectively. Net sales increased$141.6 million , or 55.1%, and$270.5 million , or 34.2%, for the three and nine months endedSeptember 30, 2020 , respectively, as compared to the same periods in 2019. In local currency, net sales increased 55.1% and 34.2% for the three and nine months endedSeptember 30, 2020 , respectively, as compared to the same periods in 2019. The 55.1% increase in net sales for the three months endedSeptember 30, 2020 was primarily due to an increase in sales volume, as indicated by a 51.5% increase in Volume Points, and a 3.2% favorable impact of price increases. The 34.2% increase in net sales for the nine months endedSeptember 30, 2020 was primarily due to an increase in sales volume, as indicated by a 32.7% increase in Volume Points, and a 2.9% favorable impact of price increases. Net sales in theU.S. were$386.7 million and$1,033.9 million for the three and nine months endedSeptember 30, 2020 , respectively. Net sales increased$135.2 million , or 53.8%, and$259.7 million , or 33.5%, for the three and nine months endedSeptember 30, 2020 , respectively, as compared to the same periods in 2019. Growth in the region continues to be supported by product line expansion and deployment of enhanced technology tools to support our distributors' businesses and optimize their customers' experiences with Herbalife. The number of activeNutrition Clubs in the region has continued to grow and the Nutrition Club DMO is a focus area for training and technological support of our Members. Our communications, promotions, and other operations in the region are targeted to our distributors, or their preferred members or retail customers as appropriate. Our promotional program is designed to encourage consistency and sustainability in our Members' businesses. Strengthened momentum for the market has resulted in higher rates of growth in net sales for the region for the quarter and year-to-date periods than those for the comparable 2019 periods. In response to pandemic conditions, product distribution to our Members was altered to allow online orders only; our two majorU.S. distribution centers were shipping product only, with no in-person pick-ups permitted; and our sales centers were for pick-up only, with no orders taken on-site as of yet; however, our Members' ability to obtain product has not materially decreased. Late in the third quarter, ourMemphis distribution center began allowing pick-up orders; however, we continue to not allow in-person orders at any of our sales centers.Members' Nutrition Clubs , which represent a major DMO for the region, are operating in some areas as pick-up points for product only versus their more traditional on-site consumption approach.Nutrition Club sales volume increased for the third quarter versus the prior year, including the impact of home deliveries fromNutrition Clubs to their customers, an approach that has seen increased use as a response to the pandemic. Our Member training and promotion events, such as our Success Training Seminars and ourLeadership Development Weekends, have shifted to a "virtual" online approach. Promotional activities aimed at our Members continue, though prizes that have involved travel to events have shifted to cash and other awards. As evidenced by continuingVolume Point growth for the region, we believe that our responsive efforts to pandemic conditions have been effective to date and we believe that pandemic conditions may have been a contributing factor in the motivation and focus of our Members. Certain modified practices by us and our Members may prove to be lasting improvements, such as an increased focus on customer-direct orders, and events and trainings that are offered virtually as well as in-person. 48
--------------------------------------------------------------------------------
TheMexico region reported net sales of$110.3 million and$321.6 million for the three and nine months endedSeptember 30, 2020 , respectively. Net sales decreased$6.2 million , or 5.3%, and$35.4 million , or 9.9%, for the three and nine months endedSeptember 30, 2020 , respectively, as compared to the same periods in 2019. In local currency, net sales increased 7.6% and 1.1% for the three and nine months endedSeptember 30, 2020 , respectively, as compared to the same periods in 2019. The 5.3% decrease in net sales for the three months endedSeptember 30, 2020 was primarily due to a 12.9% unfavorable impact of fluctuations in foreign currency exchange rates and a 2.2% unfavorable impact of timing differences between the recognition of net sales and Volume Points, partially offset by an increase in sales volume, as indicated by a 7.3% increase in Volume Points, and a 3.3% favorable impact of price increases. The 9.9% decrease in net sales for the nine months endedSeptember 30, 2020 was primarily due to a 11.0% unfavorable impact of fluctuations in foreign currency exchange rates and a decrease in sales volume, as indicated by a 1.1% decrease in Volume Points, partially offset by a 2.8% favorable impact of price increases. We believe theVolume Point increase for the quarter, after decreases for a number of prior quarters including the 2019 period, reflects the success of our program of promotions to encourage Member sponsorship and activity, including additional promotions offered since the second quarter of 2020 as a response to pandemic conditions. We believe theVolume Point decrease for the year-to-date period reflects difficult economic conditions in the region and a consequent slowing of our business momentum for the market prior to the third quarter. Despite the pandemic conditions, nearly all product access points inMexico , both Company-operated and third party, have remained open.
South and
The South andCentral America region reported net sales of$102.7 million and$264.6 million for the three and nine months endedSeptember 30, 2020 , respectively. Net sales increased$7.3 million , or 7.7% ($7.2 million , or 7.6% excludingVenezuela ), and decreased$21.7 million , or 7.6% ($21.8 million , or 7.7% excludingVenezuela ), for the three and nine months endedSeptember 30, 2020 , respectively, as compared to the same periods in 2019. In local currency, net sales increased 35.4% and 17.4% (22.9% and 4.8% excludingVenezuela ) for the three and nine months endedSeptember 30, 2020 , respectively, as compared to the same periods in 2019. The 7.7% increase in net sales for the three months endedSeptember 30, 2020 was due to an increase in sales volume, as indicated by a 15.8% increase in Volume Points, and a 19.0% favorable impact of price increases (6.6% favorable impact excludingVenezuela ), partially offset by a 27.7% unfavorable impact of fluctuations in foreign currency exchange rates (15.4% unfavorable impact excludingVenezuela ). The 7.6% decrease in net sales for the nine months endedSeptember 30, 2020 was due to a 25.0% unfavorable impact of fluctuations in foreign currency exchange rates (12.5% unfavorable impact excludingVenezuela ), partially offset by an 18.2% favorable impact of price increases (5.3% favorable impact excludingVenezuela ) and a slight increase in sales volume, as indicated by a 0.1% increase in Volume Points. The region saw a sales volume increase for the quarter versus the prior year period led byColombia andChile , as markets adapted to pandemic conditions and efforts to build more sustainable business for our Members through a focus on daily product consumption and retailing take hold in certain markets in the region. The region is seeing success leveraging social media, utilizing cash prize promotions, and using the weight loss challenge DMO. COVID-19 pandemic conditions, however, have impacted the region adversely, and significantly so for certain markets in the region includingBrazil andPeru . Pandemic impacts have varied by market across the region and have begun to ease, but have included product shipping delays and widespread suspension of product access points andMembers' Nutrition Clubs , requiring reliance on shipping product to Members' and customers' homes. Net sales inBrazil were$20.8 million and$62.4 million for the three and nine months endedSeptember 30, 2020 , respectively. Net sales decreased$5.7 million , or 21.6%, and$20.9 million , or 25.2%, for the three and nine months endedSeptember 30, 2020 , respectively, as compared to the same periods in 2019. In local currency, net sales increased 6.2% and decreased 4.1% for the three and nine months endedSeptember 30, 2020 , respectively, as compared to the same periods in 2019. The fluctuation of foreign currency exchange rates had an unfavorable impact of$7.4 million and$17.6 million on net sales for the three and nine months endedSeptember 30, 2020 , respectively. InMay 2019 , we segmented our Member base in the market into distributors and preferred members; we are leveraging this segmentation for communication and promotion purposes, and have made preferred members a strategic focus in order to drive a larger base of new customers. We have expanded our product line to meet consumer demands in new product segments. However, COVID-19 pandemic conditions have constrained our business inBrazil sinceMarch 2020 . Although mostMembers' Nutrition Clubs are now permitted to be open, broader pandemic conditions in the country have adversely impacted sales volumes for this important DMO for the market. Home delivery is operating and is the primary distribution channel for the market, though the majority of other product access points are now open for pick-up.Brazil had a 4% price increase inMarch 2020 . 49 -------------------------------------------------------------------------------- Net sales inPeru were$17.1 million and$44.6 million for the three and nine months endedSeptember 30, 2020 , respectively. Net sales increased$1.4 million , or 9.1%, and decreased$3.0 million , or 6.3%, for the three and nine months endedSeptember 30, 2020 , respectively, as compared to the same periods in 2019. In local currency, net sales increased 15.7% and decreased 2.7% for the three and nine months endedSeptember 30, 2020 , respectively, as compared to the same periods in 2019. The fluctuation of foreign currency exchange rates had an unfavorable impact of$1.0 million and$1.7 million on net sales for the three and nine months endedSeptember 30, 2020 , respectively. Sales volumes that were above the volumes for the prior year through mid-March declined significantly from that time through most of the second quarter due to pandemic conditions. We are taking orders by Internet and phone and shipping product to Member homes; duringOctober 2020 , our sales centers began to open for product pick-up as well as home delivery.Members' Nutrition Clubs were also modified for home delivery only, though they are now beginning to re-open more fully with certain restrictions. These adaptations to pandemic conditions, as well as Members' success leveraging social media and using the weight loss challenge DMO, contributed to strengthened business momentum and a sales volume increase for the third quarter versus the prior year period.
EMEA
The EMEA region reported net sales of$334.3 million and$893.3 million for the three and nine months endedSeptember 30, 2020 , respectively. Net sales increased$92.0 million , or 38.0%, and$136.4 million , or 18.0%, for the three and nine months endedSeptember 30, 2020 , respectively, as compared to the same periods in 2019. In local currency, net sales increased 39.7% and 22.0% for the three and nine months endedSeptember 30, 2020 , respectively, as compared to the same periods in 2019. The 38.0% increase in net sales for the three months endedSeptember 30, 2020 was primarily due to an increase in sales volume, as indicated by a 34.2% increase in Volume Points, and a 3.6% favorable impact of price increases; partially offset by a 1.7% unfavorable impact of fluctuations in foreign currency exchange rates. The 18.0% increase in net sales for the nine months endedSeptember 30, 2020 was primarily due to an increase in sales volume, as indicated by a 19.4% increase in Volume Points, and a 3.8% favorable impact of price increases; partially offset by a 4.0% unfavorable impact of fluctuations in foreign currency exchange rates. Volume Points were generally higher across the region for the quarter and year-to-date periods.The Volume Point growth that has been seen across the EMEA region for a number of years reflects, we believe, efforts to enhance the quality and activity of sales leaders including Member training, brand awareness, and product line expansion, as well as enhanced technology tools for ordering, business performance, and customer retailing. In addition to the major markets discussed below, strong business momentum in theUnited Kingdom ,South Africa , andFrance contributed to region net sales growth for the third quarter and year to date. Due to COVID-19 pandemic conditions, our sales centers and other product access points in many markets within the region are closed or open for limited operations only, leaving shipping for home delivery as the primary distribution channel while these conditions persist. Members are turning further to social media to carry out their sales and oversight activities. These adaptations have been successful in limiting the adverse impact of the pandemic. Net sales inSpain were$48.8 million and$125.0 million for the three and nine months endedSeptember 30, 2020 , respectively. Net sales increased$16.5 million , or 50.7%, and$19.2 million , or 18.1%, for the three and nine months endedSeptember 30, 2020 , respectively, as compared to the same periods in 2019. In local currency, net sales increased 43.7% and 17.6% for the three and nine months endedSeptember 30, 2020 , respectively, as compared to the same periods in 2019. The fluctuation of foreign currency exchange rates had a favorable impact of$2.3 million and$0.5 million on net sales for the three and nine months endedSeptember 30, 2020 , respectively. In recent years,Spain has seen sales volume increases as it benefited from programs of promotions and sponsorships, as well as enhanced technology tools, that have raised brand awareness through healthy active lifestyle and contributed to broad-based success across Member sales organizations in the market. In response to pandemic conditions, we are shifting our operations to primarily online activities to mitigate the negative impacts of being unable to conduct in-person meetings, trainings, and selling activities. Home delivery continues to be our prevailing distribution channel and has not seen significant disruption. After the first quarter of 2020 saw a small sales volume decline, subsequent quarters have seen significant volume increases as our Members appear to have adapted to pandemic conditions, such as leveraging online tools to reach their customers, and business momentum has increased. 50 -------------------------------------------------------------------------------- Net sales inRussia were$36.7 million and$111.1 million for the three and nine months endedSeptember 30, 2020 , respectively. Net sales increased$1.8 million , or 5.1%, and$8.4 million , or 8.2%, for the three and nine months endedSeptember 30, 2020 , respectively, as compared to the same periods in 2019. In local currency, net sales increased 19.8% and 17.9% for the three and nine months endedSeptember 30, 2020 , respectively, as compared to the same periods in 2019. The fluctuation of foreign currency exchange rates had an unfavorable impact of$5.2 million and$9.9 million on net sales for the three and nine months endedSeptember 30, 2020 , respectively.Russia achieved sales volume increases for the third quarter and year-to-date periods versus the prior year despite some pandemic disruption commencing late in the first quarter. Our sales centers are now reopened for product pick-up, although we continue to support home delivery for the market. Due to pandemic conditions,Nutrition Clubs are operating primarily online in the market and remain a key DMO, supported by new products, training, and promotion for all levels of Membership, as well as product access expansion. During the third quarter, we introduced Member segmentation to the market by adding a preferred customer program option for new Members.Russia had an approximate 5% price increase inSeptember 2020 . Net sales inItaly were$39.5 million and$103.8 million for the three and nine months endedSeptember 30, 2020 , respectively. Net sales increased$10.2 million , or 34.3%, and$6.1 million , or 6.2%, for the three and nine months endedSeptember 30, 2020 , respectively, as compared to the same periods in 2019. In local currency, net sales increased 28.0% and 5.9% for the three and nine months endedSeptember 30, 2020 , respectively, as compared to the same periods in 2019. The fluctuation of foreign currency exchange rates had a favorable impact of$1.9 million and$0.3 million on net sales for the three and nine months endedSeptember 30, 2020 , respectively. Sales volume increased for the third quarter and year to date versus the prior year periods. After weakened momentum in our business and pandemic conditions in the country contributed to a sales volume decline for the first quarter of the year, we believe adaptation by Members to pandemic conditions, such as online communication with customers, has been a contributing factor to our sales volume increase and strengthened momentum for subsequent quarters.
TheAsia Pacific region, which excludesChina , reported net sales of$355.8 million and$969.8 million for the three and nine months endedSeptember 30, 2020 , respectively. Net sales increased$31.3 million , or 9.6%, and$51.2 million , or 5.6%, for the three and nine months endedSeptember 30, 2020 , respectively, as compared to the same periods in 2019. In local currency, net sales increased 10.9% and 7.5% for the three and nine months endedSeptember 30, 2020 , respectively, as compared to the same periods in 2019. The 9.6% increase in net sales for the three months endedSeptember 30, 2020 was primarily due to an increase in sales volume, as indicated by a 10.4% increase in Volume Points, and a 1.8% favorable impact of price increases, partially offset by a 1.3% unfavorable impact of fluctuations in foreign currency exchange rates. The 5.6% increase in net sales for the nine months endedSeptember 30, 2020 was primarily due to an increase in sales volume, as indicated by a 5.6% increase in Volume Points, and a 2.4% favorable impact of price increases, partially offset by a 1.9% unfavorable impact of fluctuations in foreign currency exchange rates.Volume Point and net sales increases in recent years for most markets in the region are a result, we believe, of a customer-focused business and daily consumption DMOs, includingNutrition Clubs , as well as product line and access point expansion. However, COVID-19 pandemic conditions, such as closed sales centers andMembers' Nutrition Clubs and an increased reliance on home delivery for product distribution, have had an adverse impact on results commencing late in the first quarter, most significantly forIndia ,South Korea , andIndonesia . The region has adapted to pandemic conditions and achieved sales volume increases for the third quarter as well as the year to date compared to the prior year periods. Volume increases were led byIndia andVietnam , and the ongoing pandemic conditions contributed to decreases forSouth Korea andIndonesia . Net sales inIndia were$96.2 million and$244.9 million for the three and nine months endedSeptember 30, 2020 , respectively. Net sales increased$10.2 million , or 12.0%, and$9.6 million , or 4.1%, for the three and nine months endedSeptember 30, 2020 , respectively, as compared to the same periods in 2019. In local currency, net sales increased 18.2% and 9.7% for the three and nine months endedSeptember 30, 2020 , respectively, as compared to the same periods in 2019. The fluctuation of foreign currency exchange rates had an unfavorable impact of$5.4 million and$13.2 million on net sales for the three and nine months endedSeptember 30, 2020 , respectively. Sales volumes have increased inIndia in recent years, including the current quarter and year-to-date periods despite some pandemic disruption, as we continued to expand our product line and make it easier for our Members to do business such as by adding product access points and payment methods. Although certain Indian states have implemented pandemic-related operating constraints, including reduced product manufacturing capacity and constrained ability to deliver product to Members, our manufacturing capacity has met demand. We continue to take Member orders and payments online. Although Company locations are now open for the taking of orders and payments and pick-up of product, home delivery volumes continue to exceed pre-pandemic levels. Disruption to our collections and expenditures of cash have eased, though we continue to move transactions to electronic collection and payment for operating efficiency purposes and for Member convenience. 51 -------------------------------------------------------------------------------- Separately, regulatory restrictions on direct selling, including registration requirements for our Members that were implemented duringFebruary 2020 , have reduced the number of new Members since that time, despite certain subsequent relaxations of regulations by the government in response to pandemic conditions. We have seen an increase in new Preferred Members, since these do not have similar registration requirements, but during a transition period, we may see some adverse impact on the net sales growth rate from these regulatory changes. Net sales inVietnam were$53.5 million and$149.9 million for the three and nine months endedSeptember 30, 2020 , respectively. Net sales increased$12.9 million , or 31.5%, and$35.8 million , or 31.3%, for the three and nine months endedSeptember 30, 2020 , respectively, as compared to the same periods in 2019. In local currency, net sales increased 31.3% and 31.4% for the three and nine months endedSeptember 30, 2020 , respectively, as compared to the same periods in 2019. The fluctuation of foreign currency exchange rates had a favorable impact of$0.1 million and an unfavorable impact of$0.1 million on net sales for the three and nine months endedSeptember 30, 2020 , respectively.Vietnam continues to have strong momentum, having adapted to increased direct-selling regulatory requirements and as sales leadership continues to focus on sustainable, consumption-oriented business practices. COVID-19 pandemic-related operating constraints that we saw in the second quarter had eased somewhat for the third quarter and we and our Members have adapted to constraints by moving events, trainings, and product ordering online. Net sales inIndonesia were$42.6 million and$131.3 million for the three and nine months endedSeptember 30, 2020 , respectively. Net sales decreased$5.7 million , or 11.8%, and$1.7 million , or 1.3%, for the three and nine months endedSeptember 30, 2020 , respectively, as compared to the same periods in 2019. In local currency, net sales decreased 8.3% and increased 1.5% for the three and nine months endedSeptember 30, 2020 , respectively, as compared to the same periods in 2019. The fluctuation of foreign currency exchange rates had an unfavorable impact of$1.7 million and$3.7 million on net sales for the three and nine months endedSeptember 30, 2020 , respectively. AlthoughIndonesia has increased sales volumes in recent years by focusing on a customer-based business and daily consumption throughNutrition Clubs and training activities, supported by increased product access, pandemic conditions have had an adverse impact on our operations and results for the third quarter and year to date. Our sales centers have continued to operate via online ordering, home delivery, and pick-up, which were already established methods for the market. ManyMembers' Nutrition Clubs , the major DMO for the market, that have continued to operate experienced pandemic-related constraints on their activities and public movement. Our responsive measures include training and promotions targeted to sales leaders, non-sales leader Members, and their customers as appropriate. Net sales inSouth Korea were$34.0 million and$97.4 million for the three and nine months endedSeptember 30, 2020 , respectively. Net sales decreased$4.8 million , or 12.3%, and$11.4 million , or 10.5%, for the three and nine months endedSeptember 30, 2020 , respectively, as compared to the same periods in 2019. In local currency, net sales decreased 12.6% and 7.6% for the three and nine months endedSeptember 30, 2020 , respectively, as compared to the same periods in 2019. The fluctuation of foreign currency exchange rates had a favorable impact of$0.1 million and an unfavorable impact of$3.2 million on net sales for the three and nine months endedSeptember 30, 2020 , respectively.South Korea achievedVolume Point and net sales growth for 2019 after several years of transitionary impact from Marketing Plan changes that led to contraction in our business in the market, and this growth continued in the early part of 2020. Pandemic conditions, however, including the suspension of our training facilities and ourMembers' Nutrition Clubs and restrictions on gatherings, have affected the market since mid-February and contributed to sales volume declines for the third quarter and year to date versus the prior year periods.Nutrition Clubs have begun to open on a limited basis, sales and training activities continue online, and delivery of product continues.
TheChina region reported net sales of$220.0 million and$619.4 million for the three and nine months endedSeptember 30, 2020 , respectively. Net sales increased$11.3 million , or 5.4%, and$73.3 million , or 13.4%, for the three and nine months endedSeptember 30, 2020 , respectively, as compared to the same periods in 2019. In local currency, net sales increased 4.2% and 15.7% for the three and nine months endedSeptember 30, 2020 , respectively, as compared to the same periods in 2019. The 5.4% increase in net sales for the three months endedSeptember 30, 2020 was primarily due to a 1.2% favorable impact of fluctuations in foreign currency exchange rates, an increase in sales volume, as indicated by a 0.8% increase in Volume Points, a 2.4% favorable impact of sales mix, and a 1.1% favorable impact of timing differences between the recognition of net sales and Volume Points. The 13.4% increase in net sales for the nine months endedSeptember 30, 2020 was primarily due to an increase in sales volume, as indicated by a 14.2% increase in Volume Points, a 2.4% favorable impact of sales mix, and a 1.0% favorable impact of price increases, partially offset by a 2.3% unfavorable impact of fluctuations in foreign currency exchange rates and a 1.9% unfavorable impact of timing differences between the recognition of net sales and Volume Points. 52
-------------------------------------------------------------------------------- The volume growth for the nine months endedSeptember 30, 2020 versus the prior year period, despite some disruption due to the COVID-19 viral outbreak, was partially attributable to comparison to a weakened 2019 period. During 2019, ourChina net sales were negatively impacted by the Chinese government's 100-day review, or Review, of the health products industry, which concluded inApril 2019 . The Review, combined with negative media coverage about the Review, impacted our business as Members significantly reduced activities and sales meetings during and following the Review. These activities and sales meetings are important to our business as they are a central channel for attracting and retaining customers, providing personal and professional development for our Members, and promoting our products. While our Members had begun conducting meetings again toward the end of 2019 and the first quarter of 2020, the COVID-19 pandemic resulted in travel restrictions and other temporary measures which commenced early in the first quarter and also negatively impacted our business, including renewed sales meeting restrictions andNutrition Club closures. We and our Members have been able to mitigate the impact of these restrictions through 2020 by taking many sales and promotional activities online. ByApril 2020 , though subject to additional changes in conditions,China operations had largely resumed on an adapted basis. Manufacturing plants and distribution centers are open and operating normally, as well asNutrition Clubs , subject to certain social distancing measures. Some in-person sales meetings have begun to be held again, based on location and size and subject to government approval, though sales meetings also continue to be successfully held online. During 2019 we expanded our e-commerce platform to provide the ability for our China Members to service their customers via personalized sites, and for their retail customers to purchase products directly from the Company. We have expanded our product line for theChina market and continue to conduct sales promotions in the region.
Sales by Product Category
Three Months Ended
September 30, September 30,
2020 2019
Retail Distributor Shipping and Retail Distributor Shipping and % Change in
Value(2) Allowance Product Sales Handling Net Sales Value(2) Allowance Product Sales Handling Net Sales Net Sales
(Dollars in millions)
Weight Management
728.1$ 40.5 $ 768.6 18.4 % Targeted Nutrition 679.1 (284.6 ) 394.5 21.3 415.8 524.1 (216.7 ) 307.4 17.1 324.5 28.1 % Energy, Sports, and Fitness 204.4 (85.7 ) 118.7 6.5 125.2 153.4 (63.5 ) 89.9 5.0 94.9 31.9 % Outer Nutrition 46.1 (19.3 ) 26.8 1.4 28.2 37.1 (15.3 ) 21.8 1.2 23.0 22.6 % Literature, Promotional, and Other(1) 40.0 0.9 40.9 1.3 42.2 31.4 1.1 32.5 1.0 33.5 26.0 % Total$ 2,456.0 $ (1,011.4 ) $ 1,444.6 $ 77.2 $ 1,521.8 $ 1,987.1 $ (807.4 ) $ 1,179.7 $ 64.8 $ 1,244.5 22.3 % Nine Months Ended September 30, September 30, 2020 2019 Retail Distributor Shipping and Retail Distributor Shipping and % Change in Value(2) Allowance Product Sales HandlingNet Sales Value(2) Allowance Product Sales HandlingNet Sales Net Sales (Dollars in millions)
Weight Management
9.1 %
Targeted Nutrition 1,834.4 (766.5 ) 1,067.9 59.2 1,127.1 1,527.4 (638.9 ) 888.5 52.2 940.7 19.8 %
Energy, Sports, and
Fitness 525.5 (219.6 ) 305.9 17.0 322.9 427.5 (178.8 ) 248.7 14.6 263.3 22.6 %
Outer Nutrition 131.0 (54.7 ) 76.3 4.2 80.5 113.1 (47.3 ) 65.8 3.9 69.7 15.5 %
Literature,
Promotional, and
Other(1) 110.5 2.2 112.7 3.6 116.3 99.6 3.5 103.1 3.4 106.5 9.2 %
Total $ 6,644.3 $ (2,727.8 ) $ 3,916.5 $ 214.6 $ 4,131.1 $ 5,864.2 $ (2,407.9 ) $ 3,456.3 $ 200.5 $ 3,656.8 13.0 %
(1) Product buybacks and returns in all product categories are included in the
Literature, Promotional, and Other category.
(2) Retail value is a non-GAAP measure which may not be comparable to
similarly-titled measures used by other companies. See "Presentation" above
for a discussion of how we calculate retail value and why we believe the
measure is useful to investors.
53
--------------------------------------------------------------------------------
Net sales for all categories increased for the three and nine months ended
Gross Profit
Gross profit was$1,199.1 million and$1,001.1 million for the three months endedSeptember 30, 2020 and 2019, respectively, and$3,289.9 million and$2,928.6 million for the nine months endedSeptember 30, 2020 and 2019, respectively. Gross profit as a percentage of net sales was 78.8% and 80.4% for the three months endedSeptember 30, 2020 and 2019, respectively, or an unfavorable net decrease of 164 basis points, and 79.6% and 80.1% for the nine months endedSeptember 30, 2020 and 2019, respectively, or an unfavorable net decrease of 45 basis points. The decrease in gross profit as a percentage of net sales for the three months endedSeptember 30, 2020 as compared to the same period in 2019 included the unfavorable impact of foreign currency fluctuations of 74 basis points (unfavorable impact of 58 basis points excludingVenezuela ), unfavorable cost changes of 59 basis points relating to increased freight costs due to orders shifting toward home delivery versus Member pick-up, unfavorable changes in country mix of 54 basis points, unfavorable other cost changes of 49 basis points, and unfavorable cost changes related to self-manufacturing and sourcing of 15 basis points, which includes decreased costs related toMexico tariffs, partially offset by the favorable impact of retail price increases of 63 basis points (favorable impact of 47 basis points excludingVenezuela ) and the favorable impact of lower inventory write-downs of 24 basis points. There was no net impact of foreign currency fluctuations and retail price increases inVenezuela for the three months endedSeptember 30, 2020 as compared to the same period in 2019. The decrease in gross profit as a percentage of net sales for the nine months endedSeptember 30, 2020 as compared to the same period in 2019 included unfavorable cost changes of 51 basis points relating to increased freight costs due to orders shifting toward home delivery versus Member pick-up, unfavorable cost changes related to self-manufacturing and sourcing of 32 basis points, which includes decreased costs related toMexico tariffs, the unfavorable impact of foreign currency fluctuations of 29 basis points (unfavorable impact of 11 basis points excludingVenezuela ), unfavorable other cost changes of 11 basis points, and unfavorable changes in country mix of 8 basis points, partially offset by the favorable impact of retail price increases of 72 basis points (favorable impact of 54 basis points excludingVenezuela ) and the favorable impact of lower inventory write-downs of 14 basis points. There was no net impact of foreign currency fluctuations and retail price increases inVenezuela for the nine months endedSeptember 30, 2020 as compared to the same period in 2019. Generally, gross profit as a percentage of net sales may vary from period to period due to the impact of foreign currency fluctuations, changes in country mix as volume changes among countries with varying margins, retail price increases, cost changes related to self-manufacturing and sourcing, and inventory write-downs.
Royalty Overrides
Royalty overrides were$463.1 million and$363.8 million for the three months endedSeptember 30, 2020 and 2019, respectively, and$1,251.2 million and$1,090.1 million for the nine months endedSeptember 30, 2020 and 2019, respectively. Royalty overrides as a percentage of net sales were 30.4% and 29.2% for the three months endedSeptember 30, 2020 and 2019, respectively, and 30.3% and 29.8% for the nine months endedSeptember 30, 2020 and 2019, respectively. Service fees to our independent service providers inChina are included in selling, general, and administrative expenses while Member compensation for all other countries is included in Royalty overrides. Generally, Royalty overrides as a percentage of net sales may vary from period to period due to changes in the mix of products and countries because full royalty overrides are not paid on certain products and in certain countries.
Selling, General, and Administrative Expenses
Selling, general, and administrative expenses were$529.7 million and$500.1 million for the three months endedSeptember 30, 2020 and 2019, respectively, and$1,559.5 million and$1,412.5 million for the nine months endedSeptember 30, 2020 and 2019, respectively. Selling, general, and administrative expenses as a percentage of net sales were 34.8% and 40.2% for the three months endedSeptember 30, 2020 and 2019, respectively, and 37.7% and 38.6% for the nine months endedSeptember 30, 2020 and 2019, respectively. 54 --------------------------------------------------------------------------------
The increase in selling, general, and administrative expenses for the three
months ended
The increase in selling, general, and administrative expenses for the nine months endedSeptember 30, 2020 as compared to the same period in 2019 was driven by$83.1 million of expenses relating to theSEC and DOJ investigations relating to the FCPA matter inChina ;$65.5 million in higher labor and benefits costs; and$47.5 million in higher service fees forChina independent service providers due to higher sales inChina ; partially offset by$19.0 million of expenses relating to theSEC investigation relating to our disclosures regarding our marketing plan inChina in 2019;$18.3 million in lower Member event and promotion costs, mostly resulting from cancellations of events and promotions due to the COVID-19 pandemic,$13.9 million in lower non-income tax expenses, primarily from the$19.0 million Mexico VAT assessment accrual recorded in 2019; and$13.7 million in lower travel and entertainment costs resulting from travel restrictions due to the COVID-19 pandemic.
Other Operating Income
The$0.6 million of other operating income for the three months endedSeptember 30, 2020 consisted of$0.6 million of government grant income forChina (See Note 2, Significant Accounting Policies, to the Condensed Consolidated Financial Statements included in Part I, Item 1 of this Quarterly Report on Form 10-Q). The$6.4 million of other operating income for the three months endedSeptember 30, 2019 consisted of$6.4 million of government grant income forChina . The$13.0 million of other operating income for the nine months endedSeptember 30, 2020 consisted of$13.0 million of government grant income forChina . The$33.7 million of other operating income for the nine months endedSeptember 30, 2019 consisted of$27.7 million of government grant income forChina and$6.0 million related to the finalization of insurance recoveries in connection with the flooding at one of our warehouses inMexico duringSeptember 2017 , which damaged certain of our inventory stored within the warehouse (See Note 7, Contingencies, to the Consolidated Financial Statements included in the 2018 10-K). Interest Expense, Net
Interest expense, net was as follows:
Three Months Ended Nine Months Ended
September 30, September 30, September 30, September 30,
2020 2019 2020 2019
(in millions)
Interest expense $ 37.0 $ 36.7 $ 96.4 $ 121.5
Interest income (1.8 ) (5.1 ) (7.4 ) (17.5 )
Interest expense, net $ 35.2 $ 31.6 $ 89.0 $ 104.0
The increase in interest expense, net for the three months ended September 30,
2020 as compared to the same period in 2019 was primarily due to lower interest
income earned as a result of lower interest rates. The decrease in interest
expense, net for the nine months ended September 30, 2020 as compared to the
same period in 2019 was primarily due to a decrease in our overall
weighted-average borrowings and weighted-average interest rate, partially offset
by lower interest income earned as a result of lower interest rates.
Other Income, Net
We did not recognize any other income, net for the three months endedSeptember 30, 2020 . The$1.3 million of other income, net for the three months endedSeptember 30, 2019 consisted of a$1.3 million gain on the revaluation of the CVR (See Note 8, Shareholders' Deficit, to the Consolidated Financial Statements included in the 2019 10-K). We did not recognize any other income, net for the nine months endedSeptember 30, 2020 . The$15.7 million of other income, net for the nine months endedSeptember 30, 2019 consisted of a$15.7 million gain on the revaluation of the CVR. 55
--------------------------------------------------------------------------------
Income Taxes
Income taxes were$33.6 million and$31.8 million for the three months endedSeptember 30, 2020 and 2019, respectively, and$104.4 million and$117.1 million for the nine months endedSeptember 30, 2020 and 2019, respectively. The effective income tax rate was 19.5% and 28.1% for the three months endedSeptember 30, 2020 and 2019, respectively, and 25.9% and 31.5% for the nine months endedSeptember 30, 2020 and 2019, respectively. The decrease in the effective tax rate for the three months endedSeptember 30, 2020 as compared to the same period in 2019 was primarily due to changes in the geographic mix of our income and an increase in net benefits from discrete events. The decrease in the effective tax rate for the nine months endedSeptember 30, 2020 as compared to the same period in 2019 was primarily due to changes in the geographic mix of our income, partially offset by a decrease in net benefits from discrete events.
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. Variations in sales of our products directly affect the availability of funds. There are no material contractual restrictions on our ability to transfer and remit funds among our international affiliated companies. However, there are foreign currency restrictions in certain countries which could reduce our ability to timely obtainU.S. dollars. Even with these restrictions and the impacts of the COVID-19 pandemic, we believe we will have sufficient resources, including cash flow from operating activities and access to capital markets, to meet debt service obligations in a timely manner and be able to continue to meet our objectives. Historically, our debt has not resulted from the need to fund our normal operations, but instead has resulted primarily from our share repurchase programs. Since inception in 2007, total share repurchases amounted to approximately$5.3 billion . While a significant net sales decline could potentially affect the availability of funds, many of our largest expenses are variable in nature, which we believe protects our funding in all but a dramatic net sales downturn. Our$1,034.6 million cash and cash equivalents as ofSeptember 30, 2020 and our senior secured credit facility, in addition to cash flow from operations, can be used to support general corporate purposes, including any future share repurchases, dividends, and strategic investment opportunities.
We have a cash pooling arrangement with a financial institution for cash
management purposes. This cash pooling arrangement allows certain of our
participating subsidiaries to withdraw cash from this financial institution
based upon our aggregate cash deposits held by subsidiaries
For the nine months endedSeptember 30, 2020 , we generated$516.1 million of operating cash flow as compared to$300.9 million for the same period in 2019. The increase in our operating cash flow was the result of$161.4 million of favorable changes in operating assets and liabilities and$53.8 million of higher net income excluding non-cash items disclosed within our condensed consolidated statement of cash flows. The$161.4 million change in operating assets and liabilities was primarily the result of favorable changes in inventories, royalty overrides, and other current liabilities, which included favorable changes in accrued compensation, income taxes payable, and advance sales deposits; partially offset by unfavorable changes in prepaid expenses and other current assets. The$53.8 million of higher net income excluding non-cash items was primarily driven by higher contribution margin driven by higher net sales (See Summary Financial Results above for further discussion), partially offset by higher selling, general, and administrative expenses primarily from the$83.1 million in expenses related to theSEC and DOJ investigations relating to the FCPA matter inChina . Capital expenditures, including accrued capital expenditures, were$74.8 million and$76.0 million for the nine months endedSeptember 30, 2020 and 2019, respectively. The majority of these expenditures represented investments in management information systems, including initiatives to develop web-based Member tools. We expect to incur total capital expenditures of approximately$110 million to$130 million for the full year of 2020. InMarch 2020 , our annual global Herbalife Honors event, where sales leaders from around the world meet and share best practices and conduct leadership training, was canceled due to the COVID-19 pandemic and our management awarded Members$71.3 million ofMark Hughes bonus payments related to their 2019 performance. InMarch 2019 , our management awarded Members$70.7 million ofMark Hughes bonus payments related to their 2018 performance. 56 --------------------------------------------------------------------------------
Senior Secured Credit Facility
OnFebruary 15, 2017 , we entered into a$1,450.0 million senior secured credit facility, or the 2017 Credit Facility, consisting of a$1,300.0 million term loan B, or the 2017 Term Loan B, and a$150.0 million revolving credit facility, or the 2017 Revolving Credit Facility, with a syndicate of financial institutions as lenders. The 2017 Revolving Credit Facility was to mature onFebruary 15, 2022 and the 2017 Term Loan B was to mature onFebruary 15, 2023 . The 2017 Credit Facility was amended, effectiveMarch 16, 2018 , to make certain technical amendments in connection with the offering of the 2024 Convertible Notes, as defined below. We terminated the 2017 Credit Facility onAugust 16, 2018 and the$1,178.1 million outstanding was repaid in full. OnAugust 16, 2018 , we entered into a$1.25 billion senior secured credit facility, or the 2018 Credit Facility, consisting of a$250.0 million term loan A, or the 2018 Term Loan A, a$750.0 million term loan B, or the 2018 Term Loan B, and a$250.0 million revolving credit facility, or the 2018 Revolving Credit Facility, with a syndicate of financial institutions as lenders. Prior to the amendment described below, the 2018 Term Loan A and 2018 Revolving Credit Facility both were to mature onAugust 16, 2023 . The 2018 Term Loan B matures upon the earlier of: (i)August 18, 2025 , or (ii)December 15, 2023 if the outstanding principal on the 2024 Convertible Notes, as defined below, exceeds$350.0 million and we exceed certain leverage ratios as of that date. All obligations under the 2018 Credit Facility are unconditionally guaranteed by certain direct and indirect wholly-owned subsidiaries ofHerbalife Nutrition Ltd. and secured by the equity interests of certain ofHerbalife Nutrition Ltd.'s subsidiaries and substantially all of the assets of the domestic loan parties. Also onAugust 16, 2018 , we issued$400 million aggregate principal amount of senior unsecured notes, or 2026 Notes as described below, and used the proceeds from the 2018 Credit Facility and the 2026 Notes to repay in full the$1,178.1 million outstanding under the 2017 Credit Facility. For accounting purposes, pursuant to FASB ASC Topic 470, Debt ("ASC 470"), these transactions were accounted for as an extinguishment of the 2017 Credit Facility. We recognized a loss on extinguishment of$35.4 million as a result, which was recorded in other (income) expense, net within our consolidated statements of income for the year endedDecember 31, 2018 . OnDecember 12, 2019 , we amended the 2018 Credit Facility which, among other things, reduced the interest rate for borrowings under the 2018 Term Loan B. We incurred approximately$1.2 million of debt issuance costs in connection with the amendment. For accounting purposes, pursuant to ASC 470, this transaction was accounted for as a modification of the 2018 Credit Facility. The debt issuance costs were recognized in interest expense within our consolidated statement of income for the year endedDecember 31, 2019 . OnMarch 19, 2020 , we amended the 2018 Credit Facility which, among other things, extended the maturity of both the 2018 Term Loan A and 2018 Revolving Credit Facility to the earlier of: (i)March 19, 2025 or (ii)September 15, 2023 if the outstanding principal on the 2024 Convertible Notes, as defined below, exceeds$350.0 million and we exceed certain leverage ratios as of that date; increased borrowings under the 2018 Term Loan A from$234.4 million to a total of$264.8 million ; increased the total available borrowing capacity under 2018 Revolving Credit Facility from$250.0 million to$282.5 million ; and reduced the interest rate for borrowings under both the 2018 Term Loan A and 2018 Revolving Credit Facility. We incurred approximately$1.6 million of debt issuance costs in connection with the amendment. For accounting purposes, pursuant to ASC 470, this transaction was accounted for as a modification of the 2018 Credit Facility. Of the$1.6 million of debt issuance costs, approximately$1.1 million was recorded on our condensed consolidated balance sheet and is being amortized over the life of the 2018 Credit Facility using the effective-interest method, and approximately$0.5 million was recognized in interest expense, net within our condensed consolidated statement of income during the three months endedMarch 31, 2020 . The 2018 Credit Facility requires us to comply with a leverage ratio. The 2018 Credit Facility also contains affirmative and negative covenants customary for financings of this type, including, among other things, limitations or prohibitions on repurchasing common shares, declaring and paying dividends and other distributions, redeeming and repurchasing certain other indebtedness, loans and investments, additional indebtedness, liens, mergers, asset sales and transactions with affiliates. In addition, the 2018 Credit Facility contains customary events of default. As ofSeptember 30, 2020 andDecember 31, 2019 , we were in compliance with our debt covenants under the 2018 Credit Facility. 57 -------------------------------------------------------------------------------- The 2018 Term Loan A and 2018 Term Loan B are payable in consecutive quarterly installments which began onDecember 31, 2018 . Interest is due at least quarterly on amounts outstanding under the 2018 Credit Facility. In addition, beginning in 2020, we may be required to make mandatory prepayments towards the 2018 Term Loan B based on our consolidated leverage ratio and annual excess cash flows as defined under the terms of the 2018 Credit Facility. We are also permitted to make voluntary prepayments. Amounts outstanding under the 2018 Term Loan A may be voluntarily prepaid without premium or penalty, subject to customary breakage fees in connection with the prepayment of a eurocurrency loan. Under the 2018 Credit Facility, as amended, amounts outstanding under the 2018 Term Loan B may be voluntarily prepaid without premium or penalty, subject to customary breakage fees in connection with the prepayment of a eurocurrency loan. These prepayments, if any, will be applied against remaining quarterly installments owed under the 2018 Term Loan A and 2018 Term Loan B in order of maturity with the remaining principal due upon maturity, unless directed otherwise by us. Based on the 2019 consolidated leverage ratio and excess cash flow calculation, both as defined under the terms of the 2018 Credit Facility, we were not required to make a mandatory prepayment in 2020 toward the 2018 Term LoanB. During the nine months endedSeptember 30, 2020 , we repaid a total amount of$15.6 million on amounts outstanding under the 2018 Credit Facility. During the nine months endedSeptember 30, 2019 , we repaid a total amount of$15.0 million on amounts outstanding under the 2018 Credit Facility. As ofSeptember 30, 2020 andDecember 31, 2019 , theU.S. dollar amount outstanding under the 2018 Credit Facility was$989.9 million and$975.0 million , respectively. Of the$989.9 million outstanding under the 2018 Credit Facility as ofSeptember 30, 2020 ,$254.9 million was outstanding under the 2018 Term Loan A and$735.0 million was outstanding under the 2018 Term Loan B. Of the$975.0 million outstanding under the 2018 Credit Facility as ofDecember 31, 2019 ,$234.4 million was outstanding under the 2018 Term Loan A and$740.6 million was outstanding under the 2018 Term Loan B. There were no borrowings outstanding under the 2018 Revolving Credit Facility as ofSeptember 30, 2020 andDecember 31, 2019 . There were no outstanding foreign currency borrowings under the 2018 Credit Facility as ofSeptember 30, 2020 andDecember 31, 2019 . As ofSeptember 30, 2020 andDecember 31, 2019 , the weighted-average interest rate for borrowings under the 2018 Credit Facility was 3.55% and 5.52%, respectively. See Note 4, Long-Term Debt, to the Condensed Consolidated Financial Statements included in Part I, Item 1 of this Quarterly Report on Form 10-Q for a further discussion on the 2018 Credit Facility.
Convertible Senior Notes due 2019
InFebruary 2014 , we issued$1.15 billion aggregate principal amount of convertible senior notes due 2019, or the 2019 Convertible Notes. The 2019 Convertible Notes were senior unsecured obligations which ranked effectively subordinate to any of our existing and future secured indebtedness, including amounts outstanding under the 2018 Credit Facility, to the extent of the value of the assets securing such indebtedness. The 2019 Convertible Notes paid interest at a rate of 2.00% per annum payable semiannually in arrears onFebruary 15 andAugust 15 of each year, beginning onAugust 15, 2014 . Unless earlier repurchased or converted, the 2019 Convertible Notes matured onAugust 15, 2019 . The primary purpose of the issuance of the 2019 Convertible Notes was for share repurchase purposes. InMarch 2018 , we issued$550 million aggregate principal of new convertible senior notes due 2024 as described below, and subsequently used the proceeds, along with cash on hand, to repurchase$475.0 million of our existing 2019 Convertible Notes from a limited number of holders in privately negotiated transactions for an aggregate purchase price of$583.5 million , which included$1.0 million of accrued interest. InAugust 2019 , we repaid a total amount of$675.0 million to repay in full amounts outstanding on the 2019 Convertible Notes upon maturity, as well as$6.7 million of accrued interest. See Note 4, Long-Term Debt, to the Condensed Consolidated Financial Statements included in Part I, Item 1 of this Quarterly Report on Form 10-Q for a further discussion on our 2019 Convertible Notes.
Convertible Senior Notes due 2024
InMarch 2018 , we issued$550.0 million aggregate principal amount of convertible senior notes due 2024, or the 2024 Convertible Notes. The 2024 Convertible Notes are senior unsecured obligations which rank effectively subordinate to any of our existing and future secured indebtedness, including amounts outstanding under the 2018 Credit Facility, to the extent of the value of the assets securing such indebtedness. The 2024 Convertible Notes pay interest at a rate of 2.625% per annum payable semiannually in arrears onMarch 15 andSeptember 15 of each year, beginning onSeptember 15, 2018 . Unless redeemed, repurchased or converted in accordance with their terms prior to such date, the 2024 Convertible Notes mature onMarch 15, 2024 . The primary purpose of the issuance of the 2024 Convertible Notes was to repurchase a portion of the 2019 Convertible Notes. See Note 4, Long-Term Debt, to the Condensed Consolidated Financial Statements included in Part I, Item 1 of this Quarterly Report on Form 10-Q for a further discussion on our 2024 Convertible Notes. 58 --------------------------------------------------------------------------------
Senior Notes due 2025
InMay 2020 , we issued$600.0 million aggregate principal amount of senior notes due 2025, or the 2025 Notes. The 2025 Notes are senior unsecured obligations which rank effectively subordinate to any of our existing and future secured indebtedness, including amounts outstanding under the 2018 Credit Facility, to the extent of the value of the assets securing such indebtedness. The 2025 Notes pay interest at a rate of 7.875% per annum payable semiannually in arrears onMarch 1 andSeptember 1 of each year, beginning onMarch 1, 2021 . The 2025 Notes mature onSeptember 1, 2025 , unless redeemed or repurchased in accordance with their terms prior to such date. The primary purpose of the issuance of the 2025 Notes was for general corporate purposes, including share repurchases and other capital investment projects. See Note 4, Long-Term Debt, to the Condensed Consolidated Financial Statements included in Part I, Item 1 of this Quarterly Report on Form 10-Q for a further discussion on our 2025 Notes.
Senior Notes due 2026
InAugust 2018 , we issued$400.0 million aggregate principal amount of senior notes due 2026, or the 2026 Notes. The 2026 Notes are senior unsecured obligations which rank effectively subordinate to any of our existing and future secured indebtedness, including amounts outstanding under the 2018 Credit Facility, to the extent of the value of the assets securing such indebtedness. The 2026 Notes pay interest at a rate of 7.250% per annum payable semiannually in arrears onFebruary 15 andAugust 15 of each year, beginning onFebruary 15, 2019 . The 2026 Notes mature onAugust 15, 2026 , unless redeemed or repurchased in accordance with their terms prior to such date. The primary purpose of the issuance of the 2026 Notes was to refinance a portion of our 2017 Credit Facility. See Note 4, Long-Term Debt, to the Condensed Consolidated Financial Statements included in Part I, Item 1 of this Quarterly Report on Form 10-Q for a further discussion on our 2026 Notes.
Cash and Cash Equivalents
The majority of our foreign subsidiaries designate their local currencies as their functional currencies. As ofSeptember 30, 2020 , the total amount of our foreign subsidiary cash and cash equivalents was$645.7 million , of which$26.8 million was invested inU.S. dollars. As ofSeptember 30, 2020 , the total amount of cash and cash equivalents held byHerbalife Nutrition Ltd. and itsU.S. entities, inclusive ofU.S. territories, was$388.9 million . For earnings not considered to be indefinitely reinvested deferred taxes have been provided. For earnings considered to be indefinitely reinvested, deferred taxes have not been provided. Should we make a determination to remit the cash and cash equivalents from our foreign subsidiaries that are considered indefinitely reinvested to ourU.S. consolidated group for the purpose of repatriation of undistributed earnings, we would need to accrue and pay taxes. As ofDecember 31, 2019 , ourU.S. consolidated group had approximately$139.6 million of permanently reinvested unremitted earnings from certain foreign subsidiaries, and if these monies were ever needed to be remitted, the impact of any tax consequences on our overall liquidity position would not be material. As ofDecember 31, 2019 ,Herbalife Nutrition Ltd. had approximately$2.4 billion of permanently reinvested unremitted earnings relating to its operating subsidiaries. As a result of our decision to invest in theChina Growth and Impact Investment Program, approximately$111.9 million of unremitted earnings were permanently reinvested as ofDecember 31, 2019 . As ofDecember 31, 2019 , we do not have any plans to repatriate these unremitted earnings toHerbalife Nutrition Ltd. ; therefore, we do not have any liquidity concerns relating to these unremitted earnings and related cash and cash equivalents. See Note 12, Income Taxes, to the Consolidated Financial Statements included in our 2019 10-K for additional discussion on our unremitted earnings.
Off-Balance Sheet Arrangements
As of
Dividends
We have not declared or paid cash dividends since 2014. 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,Herbalife Nutrition Ltd.'s available distributable reserves underCayman Islands law, restrictions imposed by the 2018 Credit Facility and the terms of any other indebtedness that may be outstanding, cash requirements, future prospects, and other factors deemed relevant by our board of directors. 59 --------------------------------------------------------------------------------
Share Repurchases
OnOctober 30, 2018 , our board of directors authorized a new five-year$1.5 billion share repurchase program that will expire onOctober 30, 2023 , which replaced our prior share repurchase authorization that was set to expire onFebruary 21, 2020 and had approximately$113.3 million of remaining authorized capacity when it was replaced. This share repurchase program allows us, which includes an indirect wholly-owned subsidiary ofHerbalife Nutrition Ltd. , to repurchase our common shares at such times and prices as determined by management, as market conditions warrant, and to the extentHerbalife Nutrition Ltd.'s distributable reserves are available underCayman Islands law. The 2018 Credit Facility permits us to repurchase our common shares as long as no default or event of default exists and other conditions, such as specified consolidated leverage ratios, are met. As ofSeptember 30, 2020 , the remaining authorized capacity under our$1.5 billion share repurchase program was$682.9 million . In conjunction with the issuance of the 2019 Convertible Notes duringFebruary 2014 , we paid approximately$685.8 million to enter into prepaid forward share repurchase transactions, or the Forward Transactions, with certain financial institutions, or the Forward Counterparties, pursuant to which we purchased approximately 19.9 million common shares, at an average cost of$34.51 per share, for settlement on or around theAugust 15, 2019 maturity date for the 2019 Convertible Notes, subject to the ability of each Forward Counterparty to elect to settle all or a portion of its Forward Transactions early. The shares are treated as retired shares for basic and diluted EPS purposes. See Note 10, Shareholders' Deficit, to the Condensed Consolidated Financial Statements included in Part I, Item 1 of this Quarterly Report on Form 10-Q, for a further discussion on the Forward Transactions. InAugust 2020 , we completed our modified Dutch auction tender offer and then subsequently paid cash to repurchase and retire a total of approximately 15.4 million of our common shares at an aggregate cost of approximately$750.0 million , or$48.75 per share. In addition, during the nine months endedSeptember 30, 2020 , we repurchased approximately 1.4 million of our common shares through open market purchases at an aggregate cost of approximately$67.1 million , or an average cost of$46.44 per share, and subsequently retired these shares. During the nine months endedSeptember 30, 2019 , we did not repurchase any of our common shares through open market purchases. As of bothSeptember 30, 2020 andDecember 31, 2019 , we held approximately 10.0 million of treasury shares forU.S. GAAP purposes. These treasury shares increased our shareholders' deficit and are reflected at cost within our accompanying condensed consolidated balance sheets. Although these shares are owned by an indirect wholly-owned subsidiary of ours and remain legally outstanding, they are reflected as treasury shares underU.S. GAAP and therefore reduce the number of common shares outstanding within our condensed consolidated financial statements and the weighted-average number of common shares outstanding used in calculating earnings per share. The common shares ofHerbalife Nutrition Ltd. held by the indirect wholly-owned subsidiary, however, remain outstanding on the books and records of our transfer agent and therefore still carry voting and other share rights related to ownership of our common shares, which may be exercised. So long as it is consistent with applicable laws, such shares will be voted by such subsidiary in the same manner, and to the maximum extent possible in the same proportion, as all other votes cast with respect to any matter properly submitted to a vote ofHerbalife Nutrition Ltd.'s shareholders.
See Note 10, Shareholders' Deficit, to the Condensed Consolidated Financial Statements included in Part I, Item 1 of this Quarterly Report on Form 10-Q, for a further discussion on our share repurchases.
Capped Call Transactions
InFebruary 2014 , in connection with the issuance of the 2019 Convertible Notes, we paid approximately$123.8 million to enter into capped call transactions with respect to our common shares, or the Capped Call Transactions, with certain financial institutions. The Capped Call Transactions were expected generally to reduce the potential dilution upon conversion of the 2019 Convertible Notes in the event that the market price of the common shares was greater than the strike price of the Capped Call Transactions, initially set at$43.14 per common share, with such reduction of potential dilution subject to a cap based on the cap price initially set at$60.39 per common share. DuringMarch 2018 , in connection with our repurchase of a portion of the 2019 Convertible Notes, we entered into partial settlement agreements with the option counterparties to the Capped Call Transactions to terminate a portion of the Capped Call Transactions, in each case, in a notional amount corresponding to the aggregate principal amount of the 2019 Convertible Notes that were repurchased. OnAugust 15, 2019 , the 2019 Convertible Notes matured and the remaining Capped Call Transactions expired unexercised. The expiration of the Capped Call Transactions did not have an impact on our condensed consolidated financial statements. See Note 10, Shareholders' Deficit, to the Condensed Consolidated Financial Statements included in Part I, Item 1 of this Quarterly Report on Form 10-Q, for a further discussion of the Capped Call Transactions. 60 --------------------------------------------------------------------------------
Working Capital and Operating Activities
As ofSeptember 30, 2020 andDecember 31, 2019 , we had working capital of$639.4 million and$523.8 million , respectively, or an increase of$115.6 million . The increase was primarily due to increases in cash and cash equivalents, receivables, and prepaid expenses and other current assets, partially offset by increases in other current liabilities, royalty overrides, and accounts payable. We expect that cash and funds provided from operations, available borrowings under the 2018 Credit Facility, and access to capital markets will provide sufficient working capital to operate our business, to make expected capital expenditures, and to meet foreseeable liquidity requirements for the next twelve months and thereafter. The majority of our purchases from suppliers are generally made inU.S. dollars, while sales to our Members generally are made in local currencies. Consequently, strengthening of theU.S. dollar versus a foreign currency can have a negative impact on net sales and contribution margins and can generate transaction gains or losses on intercompany transactions. For discussion of our foreign exchange contracts and other hedging arrangements, see Part I, Item 3, Quantitative and Qualitative Disclosures about Market Risk, of this Quarterly Report on Form 10-Q.
Contingencies
See Note 5, Contingencies, to the Condensed Consolidated Financial Statements included in Part I, Item 1 of this Quarterly Report on Form 10-Q, for a further discussion of our contingencies as ofSeptember 30, 2020 .
Subsequent Events
See Note 14, Subsequent Events, to the Condensed Consolidated Financial Statements included in Part I, Item 1 of this Quarterly Report on Form 10-Q, for information regarding subsequent events.
Critical Accounting Policies
U.S. GAAP requires 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. We regularly evaluate our estimates and assumptions related to revenue recognition, allowance for product returns, inventory, goodwill and purchased intangible asset valuations, deferred income tax asset valuation allowances, uncertain tax positions, tax contingencies, and other loss contingencies. We base our estimates and assumptions on current facts, historical experience and various other factors that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities and the recording of revenue, costs and expenses. 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 operating results, financial condition and cash flows. We are a nutrition company that sells a wide range of weight management; targeted nutrition; energy, sports, and fitness; and outer nutrition products. Our products are manufactured by us in ourChangsha ,Hunan, China extraction facility,Suzhou, China facility,Nanjing ,China facility,Lake Forest, California facility, and in ourWinston-Salem, North Carolina facility, and by third-party providers, and then are sold to Memberswho consume and sell Herbalife products to retail consumers or other Members. As ofSeptember 30, 2020 , we sold products in 95 countries throughout the world and we are organized and managed by geographic region. We aggregate our operating segments into one reporting segment, exceptChina , as management believes that our operating segments have similar operating characteristics and similar long term operating performance. In making this determination, management believes that the operating segments are similar in the nature of the products sold, the product acquisition process, the types of customers to whom products are sold, the methods used to distribute the products, the nature of the regulatory environment, and their economic characteristics. We generally recognize revenue upon delivery when control passes to the Member. Product sales are recognized net of product returns, and discounts referred to as "distributor allowances." We generally receive the net sales price in cash or through credit card payments at the point of sale. Royalty overrides are generally recorded when revenue is recognized. See Note 2, Significant Accounting Policies, to the Condensed Consolidated Financial Statements included in Part I, Item 1 of this Quarterly Report on Form 10-Q, for a further discussion of distributor compensation in theU.S. 61 -------------------------------------------------------------------------------- Allowances for product returns, primarily in connection with our buyback program, are provided at the time the sale is recorded. This accrual is based upon historical return rates for each country and the relevant return pattern, which reflects anticipated returns to be received over a period of up to 12 months following the original sale. Historically, product returns and buybacks have not been significant. Product returns and buybacks were approximately 0.1% of product sales for each of the three and nine months endedSeptember 30, 2020 and 2019. We adjust our inventories to lower of cost and net realizable value. Additionally we adjust the carrying value of our inventory based on assumptions regarding future demand for our products and market conditions. If future demand and market conditions are less favorable than management's assumptions, additional inventory write-downs could be required. Likewise, favorable future demand and market conditions could positively impact future operating results if previously written down inventories are sold. We have obsolete and slow moving inventories which have been adjusted downward$16.8 million and$15.1 million to present them at their lower of cost and net realizable value in our condensed consolidated balance sheets as ofSeptember 30, 2020 andDecember 31, 2019 , respectively.Goodwill and marketing-related intangible assets 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. As part of the annual goodwill impairment test, which is performed at the reporting unit level, we may conduct an assessment of qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount. In a qualitative assessment, we would consider the macroeconomic conditions, including any deterioration of general conditions and industry and market conditions, including any deterioration in the environment where the reporting unit operates, increased competition, changes in the products/services and regulatory and political developments, cost of doing business, overall financial performance, including any declining cash flows and performance in relation to planned revenues and earnings in past periods, other relevant reporting unit specific facts, such as changes in management or key personnel or pending litigation, and events affecting the reporting unit, including changes in the carrying value of net assets. If we determine that it is more likely than not that the fair value of the reporting unit is less than its carrying value, then we would perform the quantitative goodwill impairment test as required. If we determine that it is not more likely than not that the fair value of the reporting unit is less than the carrying value, then no further testing is required. During fiscal year 2019, we performed a qualitative assessment and determined that it is not more likely than not that the fair value of each reporting unit is less than its respective carrying value. For our marketing-related intangible assets, we may also utilize a qualitative assessment similar to the one described above, with the exception that the test is performed at the consolidated level rather than at the reporting unit level. During fiscal year 2019, we performed a qualitative assessment of our marketing-related intangible assets and determined that it is not more likely than not that the fair value of the assets is less than their carrying value. If we are required to determine the fair value of each reporting unit using the quantitative method, we primarily use an income approach in order to determine the fair value of a reporting unit and compare it to its carrying amount. The determination of the fair value of the reporting units requires us to make significant estimates and assumptions. These estimates and assumptions include estimates of future revenues and expense growth rates, capital expenditures and the depreciation and amortization related to these capital expenditures, discount rates, and other inputs. Due to the inherent uncertainty involved in making these estimates, actual future results could differ. Changes in assumptions regarding future results or other underlying assumptions could have a significant impact on the fair value of the reporting unit. 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 unit over its fair value. If we are required to determine the fair value of our marketing-related intangible assets using the quantitative method, we use a discounted cash flow model, or the income approach, under the relief-from-royalty method to determine the fair value of our marketing related intangible assets in order to confirm there is no impairment required. An impairment loss is recognized to the extent that the carrying amount of the assets exceeds their fair value. As ofSeptember 30, 2020 andDecember 31, 2019 , we had goodwill of approximately$88.7 million and$91.5 million , respectively. As of bothSeptember 30, 2020 andDecember 31, 2019 , we had marketing-related intangible assets of approximately$310.0 million . The decrease in goodwill during the nine months endedSeptember 30, 2020 was due to foreign currency translation adjustments. No marketing-related intangibles or goodwill impairment was recorded during the three and nine months endedSeptember 30, 2020 and 2019. See Note 2, Significant Accounting Policies, to the Condensed Consolidated Financial Statements included in Part I, Item 1 of this Quarterly Report on Form 10-Q for a further discussion. 62 -------------------------------------------------------------------------------- Contingencies are accounted for in accordance with FASB ASC Topic 450, Contingencies, or ASC 450. ASC 450 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. We also disclose material contingencies when we believe a loss is not probable but reasonably possible as required by ASC 450. Accounting for contingencies such as legal and non-income tax matters requires us to use judgment related to both the likelihood of a loss and the estimate of the amount or range of loss. 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. We evaluate the realizability of our deferred tax assets by assessing the valuation allowance and by adjusting the amount of such allowance, if necessary. Although realization is not assured, we believe it is more likely than not that the net carrying value will be realized. The amount of the carryforwards that is considered realizable, however, could change if estimates of future taxable income are adjusted. In the ordinary course of our business, there are many transactions and calculations where the tax law and ultimate tax determination is uncertain. As part of the process of preparing our condensed consolidated financial statements, we are required to estimate our income taxes in each of the jurisdictions in which we operate prior to the completion and filing of tax returns for such periods. These estimates involve complex issues and require us to make judgments about the likely application of the tax law to our situation, as well as with respect to other matters, such as anticipating the positions that we will take on tax returns prior to us actually preparing the returns and the outcomes of disputes with tax authorities. The ultimate resolution of these issues may take extended periods of time due to examinations by tax authorities and statutes of limitations. In addition, changes in our business, including acquisitions, changes in our international corporate structure, changes in the geographic location of business functions or assets, changes in the geographic mix and amount of income, as well as changes in our agreements with tax authorities, valuation allowances, applicable accounting rules, applicable tax laws and regulations, rulings and interpretations thereof, developments in tax audit and other matters, and variations in the estimated and actual level of annual pre-tax income can affect the overall effective income tax rate. We account for uncertain tax positions in accordance with FASB ASC Topic 740, Income Taxes, or ASC 740, which provides guidance on the determination of how tax benefits claimed or expected to be claimed on a tax return should be recorded in the financial statements. Under ASC 740, we must recognize the tax benefit from an uncertain tax position only if it is more likely than not that the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position. The tax benefits recognized in the financial statements from such a position are measured based on the largest benefit that has a greater than fifty percent likelihood of being realized upon ultimate resolution. OnDecember 22, 2017 , theU.S. enacted the Tax Cuts and Jobs Act of 2017, orU.S. Tax Reform, which contains several key tax provisions that affect us, including, but not limited to, a one-time mandatory transition tax on accumulated foreign earnings, changes in the sourcing and calculation of foreign income, and a reduction of the corporate income tax rate to 21% effectiveJanuary 1, 2018 . We are required to recognize the effect of the tax law changes in the period of enactment, such as determining the transition tax, remeasuring ourU.S. deferred tax assets and liabilities as well as reassessing the net realizability of our deferred tax assets and liabilities. InDecember 2017 , theSEC staff issued Staff Accounting Bulletin No. 118, Income Tax Accounting Implications of the Tax Cuts and Jobs Act, which allows us to record provisional amounts during a measurement period not to extend beyond one year of the enactment date. See Note 12, Income Taxes, to the Consolidated Financial Statements included in the 2019 10-K for a further discussion ofU.S. Tax Reform. We have made an accounting policy election to account for global intangible low-taxed income as a period cost if and when incurred. We account for foreign currency transactions in accordance with FASB ASC Topic 830, Foreign Currency Matters. In a majority of the countries where we operate, the functional currency is the local currency. Our foreign subsidiaries' asset and liability accounts are translated for consolidated financial reporting purposes intoU.S. dollar amounts at period-end exchange rates. Revenue and expense accounts are translated at the average rates during the year. Our foreign currency translation adjustments are included in accumulated other comprehensive loss on our accompanying condensed consolidated balance sheets. Foreign currency transaction gains and losses and foreign currency remeasurements are generally included in selling, general, and administrative expenses in the accompanying condensed consolidated statements of income.
New Accounting Pronouncements
See discussion under Note 2, Significant Accounting Policies, to the Condensed
Consolidated Financial Statements included in Part I, Item 1 of this Quarterly
Report on Form 10-Q, for information on new accounting pronouncements.
63
--------------------------------------------------------------------------------
© Edgar Online, source
