UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 


 

FORM 10-Q

 


 

(Mark One)

 

ý

 

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934

 

 

 

 

 

 

For the quarterly period ended June 30, 2004

 

 

 

 

 

 

OR

 

 

 

 

 

o

 

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934

 

 

 

 

 

 

Commission file number:  333-115363

 

 


 

WH HOLDINGS (CAYMAN ISLANDS) LTD.

(Exact name of registrant as specified in its charter)

 

Cayman Islands

 

N/A

(State or other jurisdiction of incorporation or organization)

 

(I.R.S. Employer Identification No.)

 

P.O. Box 309GT
Ugland House, South Church Street
Grand Cayman, Cayman Island

(Address of principal executive offices) (Zip code)

 

(310) 410-9600*

(Registrant’s telephone number, including area code)

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes ý   No o

 

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).

Yes o   No ý

 

Number of shares of registrant’s common shares outstanding as of June 30, 2004 was 104,164,038.

 


* C/O Chief Financial Officer of Herbalife International, Inc.

 

 



 

WH HOLDINGS (CAYMAN ISLANDS) LTD.

 

Index to Financial Statements and Exhibits

 

Filed with the Quarterly Report of the Company on Form 10-Q

 

For the Three and Six Months ended June 30, 2004

 

 

PART I.  FINANCIAL INFORMATION

 

 

 

 

Item 1.

Financial Statements:

 

 

 

 

 

Unaudited Consolidated Balance Sheets

 

 

 

 

 

Unaudited Consolidated Statements of Income

 

 

 

 

 

Unaudited Statements of Changes in Stockholder’s Equity

 

 

 

 

 

Unaudited Consolidated Statements of Cash Flows

 

 

 

 

 

Notes to Unaudited Consolidated Financial Statements

 

 

 

 

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

 

 

 

Item 3.

Quantitative and Qualitative Disclosures About Market Risks

 

 

 

 

Item 4.

Controls and Procedures

 

 

 

 

 

PART II.  OTHER INFORMATION

 

 

 

 

Item 1.

Legal Proceedings

 

 

 

 

Item 2.

Changes in Securities and Use of Proceeds

 

 

 

Item 3.

Defaults Upon Senior Securities

 

 

 

Item 4.

Submission of Matters to a Vote of Security Holders

 

 

 

Item 5.

Other Information

 

 

 

Item 6.

Exhibits and Reports on Form 8-K

 

 

 

 

Signature and Certifications

 

 

1



 

PART I.  FINANCIAL INFORMATION

 

Item 1.  FINANCIAL STATEMENTS

 

WH HOLDINGS (CAYMAN ISLANDS) LTD.

CONSOLIDATED BALANCE SHEETS

(Unaudited)

 

 

 

December 31, 2003

 

June 30, 2004

 

 

 

 

 

 

 

ASSETS

 

 

 

 

 

 

 

CURRENT ASSETS:

 

 

 

 

 

Cash and cash equivalents

 

$

150,679,000

 

$

157,132,000

 

Restricted cash

 

5,701,000

 

 

Receivables net of allowance for doubtful accounts of  $2,527,000 (2003) and $4,731,000 (2004), and including related party receivables of $323,000 (2003)

 

31,977,000

 

33,155,000

 

Inventories

 

59,397,000

 

70,503,000

 

Prepaid expenses and other current assets

 

20,825,000

 

25,521,000

 

Deferred income taxes

 

9,164,000

 

8,963,000

 

Total current assets

 

277,743,000

 

295,274,000

 

 

 

 

 

 

 

Property, at cost, net of accumulated depreciation and amortization of $17,607,000 (2003) and  $22,292,000 (2004)

 

45,411,000

 

46,524,000

 

Deferred compensation plan assets

 

21,340,000

 

21,420,000

 

Other assets

 

5,795,000

 

6,279,000

 

Deferred financing costs, net of accumulated amortization of  $10,266,000 (2003) and $13,295,000 (2004)

 

33,278,000

 

30,625,000

 

Marketing franchise

 

310,000,000

 

310,000,000

 

Distributor network, net of accumulated amortization of  $26,539,000 (2003) and $35,906,000 (2004)

 

29,661,000

 

20,294,000

 

Product certification, product formulae and other intangible assets, net of accumulated amortization of  $9,491,000 (2003) and $12,841,000 (2004)

 

13,219,000

 

9,935,000

 

Goodwill

 

167,517,000

 

167,517,000

 

TOTAL

 

$

903,964,000

 

$

907,868,000

 

 

 

 

 

 

 

LIABILITIES AND STOCKHOLDERS’ EQUITY

 

 

 

 

 

 

 

CURRENT LIABILITIES:

 

 

 

 

 

Accounts payable

 

$

22,526,000

 

$

23,639,000

 

Royalty overrides

 

76,522,000

 

73,922,000

 

Accrued compensation

 

19,127,000

 

21,125,000

 

Accrued expenses

 

59,669,000

 

83,471,000

 

Current portion of long term debt

 

72,377,000

 

22,213,000

 

Advance sales deposits

 

6,574,000

 

11,698,000

 

Income taxes payable

 

19,427,000

 

43,062,000

 

Total current liabilities

 

$

276,222,000

 

$

279,130,000

 

 

 

 

 

 

 

NON-CURRENT LIABILITIES:

 

 

 

 

 

Long term debt, net of current portion, including related party debt of $23,700,000 (2003) and $5,808,000 (2004)

 

252,917,000

 

482,114,000

 

Deferred compensation

 

22,442,000

 

18,932,000

 

Deferred income taxes

 

111,910,000

 

96,863,000

 

Other non-current liabilities

 

2,685,000

 

2,721,000

 

Total liabilities

 

$

666,176,000

 

$

879,760,000

 

 

 

 

 

 

 

COMMITMENTS AND CONTINGENCIES

 

 

 

 

 

 

 

 

 

 

 

STOCKHOLDERS’ EQUITY:

 

 

 

 

 

Preferred shares, $0.001 par value (aggregate liquidation preference $446,241,000 (2003)), 12% Series A Cumulative and Convertible, 106,000,000 (2003) shares authorized, 102,013,572 (2003) shares issued and outstanding

 

$

102,000

 

 

Common shares, $0.001 par value, 250,000,000 shares authorized, 104,164,038 (2004) shares issued and outstanding

 

 

$

104,000

 

Paid-in-capital in excess of par value

 

183,407,000

 

1,330,000

 

Accumulated other comprehensive income

 

3,427,000

 

2,718,000

 

Retained earnings

 

50,852,000

 

23,956,000

 

Total stockholders’ equity

 

$

237,788,000

 

$

28,108,000

 

 

 

 

 

 

 

TOTAL

 

$

903,964,000

 

$

907,868,000

 

 

See the accompanying notes to consolidated financial statements

 

2



 

WH HOLDINGS (CAYMAN ISLANDS) LTD.

CONSOLIDATED STATEMENTS OF INCOME

 

(Unaudited)

 

 

 

Three Months Ended

 

Six Months Ended

 

 

 

June 30,
2003

 

June 30,
2004

 

June 30,
2003

 

June 30
2004

 

 

 

 

 

 

 

 

 

 

 

Product sales

 

$

248,310,000

 

$

278,519,000

 

$

488,708,000

 

$

556,658,000

 

Handling & freight income

 

40,568,000

 

45,641,000

 

80,209,000

 

91,554,000

 

Net sales

 

288,878,000

 

324,160,000

 

568,917,000

 

648,212,000

 

Cost of sales

 

58,401,000

 

66,245,000

 

115,362,000

 

129,863,000

 

Gross profit

 

230,477,000

 

257,915,000

 

453,555,000

 

518,349,000

 

Royalty overrides

 

103,481,000

 

114,532,000

 

202,991,000

 

230,388,000

 

Marketing, distribution & administrative expenses (including $1,850,000, $1,721,000, $4,929,000 and $3,519,000 of related party expenses for the three and six months ended June 30, 2003 and 2004, respectively)

 

86,724,000

 

105,199,000

 

171,100,000

 

213,039,000

 

Interest expense - net

 

10,255,000

 

14,256,000

 

20,202,000

 

41,629,000

 

Income before income taxes

 

30,017,000

 

23,928,000

 

59,262,000

 

33,293,000

 

Income taxes

 

12,803,000

 

11,840,000

 

25,177,000

 

21,689,000

 

NET INCOME

 

$

17,214,000

 

$

12,088,000

 

$

34,085,000

 

$

11,604,000

 

 

See the accompanying notes to consolidated financial statements

 

3



 

WH HOLDINGS (CAYMAN ISLANDS) LTD.

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY

(Unaudited)

 

 

 

Preferred
Stock

 

Common
Stock

 

Paid in Capital
in Excess of
Par Value

 

Accumulated
Other
Comprehensive
Income

 

Retained
Earnings

 

Total
Stockholders’
Equity

 

Comprehensive
Income

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance at December 31, 2003

 

$

102,000

 

$

 

$

183,407,000

 

$

3,427,000

 

$

50,852,000

 

$

237,788,000

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Redemption of 102,013,572 preferred shares

 

(102,000

)

 

 

(183,013,000

)

 

 

 

 

(183,115,000

)

 

 

Issuance of 104,054,388 common shares

 

 

 

104,000

 

(104,000

)

 

 

 

 

 

 

 

Issuance of 109,650 common shares from the exercise of stock options

 

 

 

 

124,000

 

 

 

 

 

124,000

 

 

 

Additional capital from stock options

 

 

 

 

 

916,000

 

 

 

 

 

916,000

 

 

 

Dividends declared

 

 

 

 

 

 

 

 

 

(38,500,000

)

(38,500,000

)

 

 

Net income

 

 

 

 

 

 

 

 

 

11,604,000

 

11,604,000

 

$

11,604,000

 

Translation adjustments

 

 

 

 

 

 

 

(2,124,000

)

 

 

(2,124,,000

)

(2,124,000

)

Unrealized gain on derivatives

 

 

 

 

 

 

 

3,179,000

 

 

 

3,179,000

 

3,179,000

 

Reclassification adjustments for loss on derivative instruments

 

 

 

 

 

 

 

(1,764,000

)

 

 

(1,764,000

)

(1,764,000

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total comprehensive income

 

 

 

 

 

 

 

 

 

 

 

 

 

$

10,895,000

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance at June 30, 2004

 

$

 

$

104,000

 

$

1,330,000

 

$

2,718,000

 

$

23,956,000

 

$

28,108,000

 

 

 

 

See the accompanying notes to consolidated financial statements.

 

4



 

WH HOLDINGS (CAYMAN ISLANDS) LTD.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

 

 

 

Six Months Ended

 

 

 

June 30,
2003

 

June 30,
2004

 

CASH FLOWS FROM OPERATING ACTIVITIES

 

 

 

 

 

Net income

 

$

34,085,000

 

$

11,605,000

 

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

 

 

 

 

 

Depreciation and amortization

 

12,591,000

 

23,018,000

 

Amortization and discount of deferred financing costs

 

4,089,000

 

3,397,000

 

Deferred income taxes

 

(994,000

)

(14,746,000

)

Unrealized foreign exchange loss

 

888,000

 

1,656,000

 

Write-off of deferred financing costs and unamortized discount

 

 

4,077,000

 

Other

 

364,000

 

1,095,000

 

Changes in operating assets and liabilities:

 

 

 

 

 

Receivables

 

(5,032,000

)

(1,673,000

)

Inventories

 

5,552,000

 

(13,126,000

)

Prepaid expenses and other current assets

 

926,000

 

(2,689,000

)

Accounts payable

 

(3,356,000

)

1,532,000

 

Royalty overrides

 

(4,911,000

)

(1,246,000

)

Accrued expenses and accrued compensation

 

(5,591,000

)

27,079,000

 

Advance sales deposits

 

3,626,000

 

5,324,000

 

Income taxes payable

 

5,389,000

 

23,796,000

 

Deferred compensation liability

 

(10,422,000

)

(3,510,000

)

NET CASH PROVIDED BY OPERATING ACTIVITIES

 

37,204,000

 

65,589,000

 

 

 

 

 

 

 

CASH FLOWS FROM INVESTING ACTIVITIES:

 

 

 

 

 

Purchases of property

 

(4,821,000

)

(10,320,000

)

Proceeds from sale of property

 

19,000

 

5,000

 

Changes in marketable securities, net

 

1,268,000

 

 

Net change in restricted cash

 

2,402,000

 

5,701,000

 

Changes in other assets

 

(27,000

)

(3,324,000

)

Deferred compensation plan assets

 

10,964,000

 

(80,000

)

NET CASH PROVIDED BY (USED IN) INVESTING ACTIVITIES

 

9,805,000

 

(8,018,000

)

 

 

 

 

 

 

CASH FLOWS FROM FINANCING ACTIVITIES:

 

 

 

 

 

Dividends paid on Preferred Shares

 

 

(38,500,000

)

Issuance of 15.5% Senior Notes and 9.5% Notes

 

579,000

 

267,438,000

 

Borrowings from long-term debt

 

2,613,000

 

217,000

 

Principal payments on long-term debt

 

(6,486,000

)

(52,397,000

)

Redemption of Preferred Shares

 

 

(183,115,000

)

Proceeds from issuance of Common Shares

 

4,000,000

 

 

Repurchase of  15.5% Senior Notes

 

 

(39,644,000

)

Exercise of Stock Options

 

 

86,000

 

NET CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES

 

706,000

 

(45,915,000

)

 

 

 

 

 

 

EFFECT OF EXCHANGE RATE CHANGES ON CASH

 

2,582,000

 

(5,203,000

)

 

 

 

 

 

 

NET CHANGE IN CASH AND CASH EQUIVALENTS

 

50,297,000

 

6,453,000

 

CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD

 

64,201,000

 

150,679,000

 

CASH AND CASH EQUIVALENTS, END OF PERIOD

 

$

114,498,000

 

$

157,132,000

 

 

 

 

 

 

 

CASH PAID FOR:

 

 

 

 

 

Interest

 

$

16,745,000

 

$

28,402,000

 

Income taxes

 

$

19,268,000

 

$

14,139,000

 

 

 

 

 

 

 

NON-CASH ACTIVITIES:

 

 

 

 

 

Acquisitions of property from capital leases

 

$

5,148,000

 

$

1,510,000

 

 

See the accompanying notes to consolidated financial statements

 

5



 

WH HOLDINGS (CAYMAN ISLANDS) LTD.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

1.                                      ORGANIZATION

 

WH Holdings (Cayman Islands) Ltd., a Cayman Islands exempted limited liability company (“Holdings”), incorporated on April 4, 2002, and its direct and indirect wholly owned subsidiaries, WH Intermediate Holdings Ltd., a Cayman Islands company (“WH Intermediate”), WH Luxembourg Holdings S.à.R.L., a Luxembourg unipersonal limited liability company (“Lux Holdings”), WH Luxembourg Intermediate Holdings S.à.R.L. (“Herbalife Lux”), formerly known as WH Luxembourg CM S.à.R.L, a Luxembourg unipersonal limited liability company, and WH Acquisition Corp., a Nevada corporation (“WH Acquisition”), were formed on behalf of Whitney & Co., LLC (“Whitney”) and Golden Gate Private Equity, Inc. (“Golden Gate”), in order to acquire Herbalife International, Inc., a Nevada corporation, and its subsidiaries (“Herbalife” or “Predecessor”) on July 31, 2002 (the “Merger”).  Holdings and its subsidiaries are referred to collectively herein as the Company.  Holdings’ 12% Series A Cumulative Convertible Preferred Shares are referred to as “preferred shares” and Holdings’ Common Shares are referred to as “common shares.”

 

2.                                      BASIS OF PRESENTATION

 

The unaudited interim financial information of the Company has been prepared in accordance with Article 10 of the Securities and Exchange Commission’s Regulation S-X.  Accordingly, they do not include all of the information required by generally accepted accounting principles for complete financial statements. The Company’s financial statements as of and for the three and six months ended June 30, 2004 include WH Intermediate and all of its direct and indirect subsidiaries.  In the opinion of management, the accompanying financial information contains all adjustments, consisting of normal recurring adjustments, considered necessary to present fairly the Company’s financial statements as of June 30, 2004 and for the three months and six months ended June 30, 2003 and June 30, 2004. Operating results for the three and six months ended June 30, 2004, are not necessarily indicative of the results that may be expected for the year ending December 31, 2204.

 

Reclassifications

 

Certain reclassifications were made to the prior period financial statements to conform to current period presentation.

 

3.                                      TRANSACTIONS WITH RELATED PARTIES

 

The Company has entered into agreements with Whitney and Golden Gate to pay monitoring fees for their management and other services and to pay certain other expenses.  Under the monitoring fee agreements, the Company is obligated to pay an annual aggregate amount of up to $5.0 million, but not less than $2.5 million, to Whitney and Golden Gate, for an initial period of ten years subject to the provisions in Herbalife’s amended and restated credit agreement (the “Credit Agreement”).  For the three months ended June 30, 2003 and June 30, 2004, the Company expensed monitoring fees in the amount of $1.3 million for both periods and other expenses of $0.6 million and $0.4 million, respectively.  For the six months ended June 20, 2003, and June 30, 2004, the Company expensed monitoring fees in the amount of $2.5 million for both periods and other expenses of $2.4 million and $1.0 million, respectively.  As of June 30, 2004, Whitney affiliated companies held $4.8 million of the outstanding term loan balance and senior executives of Whitney held $1.0 million of Herbalife’s 11 ¾% Senior Subordinated Notes due 2010 (the “11 ¾% Notes”).  Also, in March 2004, Holdings redeemed $17.3 million of the 15.5% Senior Notes held by certain Whitney affiliated companies and paid an additional $5.0 million repurchase premium and $0.5 million accrued interest.

 

4.                                      LONG TERM DEBT

 

Long term debt consisted of the following (in millions):

 

 

 

December 31,
2003

 

June 30,
2004

 

11 ¾% Notes

 

$

158.2

 

$

158.3

 

Borrowing under senior credit facility

 

119.8

 

71.1

 

15.5% Senior Notes

 

39.6

 

 

Discount - 15.5% Senior Notes warrant

 

(1.6

)

 

9.5% Notes

 

 

267.7

 

Capital leases

 

5.5

 

5.5

 

Other debt

 

3.8

 

1.7

 

 

 

325.3

 

504.3

 

Less: current portion

 

72.4

 

22.2

 

 

 

$

252.9

 

$

482.1

 

 

6



 

In March 2004, the Company and its lenders amended the Credit Agreement.  Under the terms of the amendment, the Company made a prepayment of $40.0 million to reduce outstanding amounts under Herbalife’s senior credit facility. In connection with this prepayment, the lenders under Herbalife’s Senior Credit Facility waived the March 31, 2004 mandatory amortization payment of $6.5 million along with a mandatory 50% excess cash flow payment for the year ended December 31, 2003.The amendment also lowered the interest rate to LIBOR plus a 2.5% margin and increased the capital spending allowance under the Credit Agreement and permitted Holdings to complete a recapitalization. The schedule of the principal payments was also modified so that the Company was obligated to pay approximately $4.4 million on March 31, 2004, and in each subsequent quarter through June 30, 2008.

 

In March 2004, Holdings and its wholly-owned subsidiary WH Capital Corporation completed a $275 million offering of 9.5% Notes due 2011 (the “9.5% Notes”).  The proceeds of the offering together with available cash were used to pay the cash redemption price due upon redemption of all outstanding Holdings 12% Series A Cumulative Convertible preferred shares, including all accrued and unpaid dividends, to redeem Holdings’ 15.5% Senior Notes and to pay related fees and expenses.  Interest on the 9.5% Notes will be paid in cash semi-annually in arrear on April 1 and October 1 of each year, starting on October 1, 2004.  The Notes are Holdings’ general unsecured obligations, ranking equally with any of the existing and future senior indebtedness and senior to all of Holdings’ future subordinated indebtedness.  Also, the 9.5% Notes are effectively subordinated to all existing and future indebtedness and other liabilities of Holdings’ subsidiaries.

 

5.                                      CONTINGENCIES

 

The Company is from time to time engaged in routine litigation. The Company regularly reviews all pending litigation matters in which it is involved and establishes reserves deemed appropriate by management for these litigation matters when a probable loss estimate can be made.

 

Herbalife is a defendant in a purported class action lawsuit pending in the U.S. District Court of California (Jacobs v. Herbalife International, Inc., et al) originally filed on February 19, 2002 challenging marketing practices of several distributors and Herbalife under various state and federal laws.  Without in any way admitting liability or wrongdoing, the Company has reached a binding settlement with the plaintiffs, subject to final court approval.  Under the terms of the settlement, the Company will (i) pay $3 million into a fund to be distributed to former Supervisor-level distributors who had purchased Newest Way to Wealth materials from the other defendants in this matter, (ii) up to a maximum aggregate amount of $1 million, refund to former Supervisor-level distributors the amounts they had paid to purchase such Newest Way to Wealth materials from the other defendants in this matter, and (iii)  up to a maximum aggregate amount of $2 million, offer rebates on certain new purchases of Herbalife products to those current Supervisor-level distributors who had purchased Newest Way to Wealth materials from the other defendants in this matter.

 

Herbalife and certain of its distributors have been named as defendants in a purported class action lawsuit filed July 16, 2003 in the Circuit Court of Ohio County in the State of West Virginia (Mey v. Herbalife International, Inc., et al). Herbalife removed the lawsuit to federal court and the plaintiff sought to remand the lawsuit to state court. The plaintiff’s motion was denied. The complaint alleges that certain telemarketing practices of certain Herbalife distributors violate the Telephone Consumer Protection Act and seek to hold Herbalife liable for the practices of its distributors. The Company believes that it has meritorious defenses to the suit.

 

As a marketer of dietary and nutritional supplements and other products that are ingested by consumers or applied to their bodies, the Company has been subjected to various product liability claims.  The effects of these claims to date have not been material to the Company, and the reasonably possible range of exposure on currently existing claims is not material. The Company believes that it has meritorious defenses to the allegations contained in the lawsuits. The Company currently maintains product liability insurance with an annual deductible of $10.0 million.

 

Certain of the Company’s subsidiaries have been subject to tax audits by governmental authorities in their respective countries.  In certain of these tax audits, governmental authorities are proposing that significant amounts of additional taxes and related interest and penalties are due. The Company and its tax advisors believe that there are meritorious defenses to the allegations that additional taxes are owing, and the Company is vigorously contesting the additional proposed taxes and related charges.

 

These matters may take several years to resolve, and the Company cannot be sure of their ultimate resolution. However, it is the opinion of management that adverse outcomes, if any, will not likely result in a material adverse effect on our financial condition and operating results.

 

7



 

6.                                      COMPREHENSIVE INCOME

 

Comprehensive income is summarized as follows (in millions):

 

 

 

Three Months Ended

 

Six Months Ended

 

 

 

June 30, 2003

 

June 30, 2004

 

June 30, 2003

 

June 30, 2004

 

Net income

 

$

17.2

 

$

12.1

 

$

34.1

 

$

11.6

 

Unrealized gain (loss) on derivatives, net of tax

 

 

1.3

 

(2.9

)

3.2

 

Reclassification adjustments for gain (loss) on derivatives, net of tax

 

 

(0.6

)

2.7

 

(1.8

)

Foreign currency translation adjustment, net of tax

 

1.5

 

(2.0

)

1.7

 

(2.1

)

Comprehensive income

 

$

18.7

 

$

10.8

 

$

35.6

 

$

10.9

 

 

The net change on derivative instruments represents the fair value of changes caused by marking to market these instruments on June 30, 2004. Foreign currency translation adjustment measures the impact of converting primarily foreign currency assets and liabilities of foreign subsidiaries into US dollars.

 

7.                                      SEGMENT INFORMATION

 

The Company is a network marketing company that sells a wide range of weight management products, nutritional supplements and personal care products within one reportable segment as defined under Statement of Financial Accounting Standards No (“SFAS”) 131, “Disclosures about Segments of an Enterprise and Related Information.”  The Company’s products are primarily manufactured by third party providers and then sold to independent distributors who sell Herbalife products to retail consumers or other distributors.

 

The Company has operations in 58 countries throughout the world and is organized and managed by geographic area.  In the first quarter of 2003, the Company elected to aggregate its operating segments into one reporting segment, as management believes that the 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 sold to, the methods used to distribute the products, and the nature of the regulatory environment.  However, the Company does recognize revenue from sales to distributors in four geographic regions: The Americas, Europe, Asia/Pacific Rim and Japan.

 

 

 

Three Months Ended

 

Six Months Ended

 

(in millions)

 

June 30, 2003

 

June 30, 2004

 

June 30, 2003

 

June 30, 2004

 

Net Sales:

 

 

 

 

 

 

 

 

 

United States

 

$

69.7

 

$

69.3

 

$

136.6

 

$

133.4

 

Japan

 

26.8

 

21.6

 

62.3

 

51.5

 

Others

 

192.4

 

233.3

 

370.0

 

463.3

 

Total Net Sales

 

$

288.9

 

$

324.2

 

$

568.9

 

$

648.2

 

 

 

 

 

 

 

 

 

 

 

Operating Margin:

 

 

 

 

 

 

 

 

 

United States

 

$

27.9

 

$

24.9

 

$

57.5

 

$

52.5

 

Japan

 

12.9

 

11.6

 

30.2

 

26.9

 

Others

 

86.2

 

106.8

 

162.9

 

208.5

 

Total Operating Margin

 

$

127.0

 

$

143.3

 

$

250.6

 

$

287.9

 

 

 

 

 

 

 

 

 

 

 

Marketing, distribution, and administrative expense

 

$

86.7

 

$

105.1

 

$

171.1

 

$

213.0

 

Interest expense (income), net

 

10.3

 

14.3

 

20.2

 

41.6

 

Income before income taxes

 

30.0

 

23.9

 

59.3

 

33.3

 

Income taxes

 

12.8

 

11.8

 

25.2

 

21.7

 

Net Income

 

$

17.2

 

$

12.1

 

$

34.1

 

$

11.6

 

 

 

 

 

 

 

 

 

 

 

Net sales by product line:

 

 

 

 

 

 

 

 

 

Weight management

 

$

125.0

 

$

140.0

 

$

244.7

 

$

282.1

 

Inner nutrition

 

125.5

 

138.0

 

248.8

 

277.3

 

Outer Nutrition®

 

25.7

 

28.0

 

51.9

 

57.7

 

Literature, promotional and other

 

12.7

 

18.2

 

23.5

 

31.1

 

Total Net Sales

 

$

288.9

 

$

324.2

 

$

568.9

 

$

648.2

 

 

8



 

 

 

Three Months Ended

 

Six Months Ended

 

 

 

June 30, 2003

 

June 30, 2004

 

June 30, 2003

 

June 30, 2004

 

 

 

 

 

 

 

 

 

 

 

Net sales by geographic region:

 

 

 

 

 

 

 

 

 

The Americas

 

$

104.6

 

$

116.1

 

$

205.0

 

$

227.3

 

Europe

 

117.0

 

137.4

 

223.0

 

274.0

 

Asia/Pacific Rim

 

40.5

 

49.1

 

78.9

 

95.2

 

Japan

 

26.8

 

21.6

 

62.0

 

51.7

 

Total Net Sales

 

$

288.9

 

$

324.2

 

$

568.9

 

$

648.2

 

 

 

 

December 31, 2003

 

June 30, 2004

 

 

 

 

 

Total Assets:

 

 

 

 

 

 

 

 

 

United States

 

$

601.0

 

$

582.4

 

 

 

 

 

Japan

 

62.9

 

55.4

 

 

 

 

 

Others

 

240.1

 

270.1

 

 

 

 

 

Total Assets

 

$

904.0

 

$

907.9

 

 

 

 

 

 

8.                                      STOCK BASED COMPENSATION

 

The Company has two stock based employee compensation plans which are the WH Holdings (Cayman Islands) Ltd. Stock Incentive Plan (“The Management Plan”) and WH Holdings (Cayman Islands) Ltd. Independent Directors Stock Incentive Plan (“The Independent Directors Plan”).  The Management Plan provides for the grant of options to purchase common shares of WH Holdings to members of management of the Company.  The Independent Directors Plan provides for the grant of options to purchase common shares of WH Holdings to independent directors of the Company.

 

The Company applies the intrinsic-value-based method of accounting prescribed by Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations including the Financial Accounting Standards Board (“FASB”) Interpretation No. 44, Accounting for Certain Transactions involving Stock Compensation, an interpretation of APB Opinion No. 25, issued in March 2000, to account for its stock option plans. Under this method, compensation expense is recorded on the date of grant only if the then current market price of the underlying stock exceeded the exercise price. SFAS 123, Accounting for Stock Based Compensation, established accounting and disclosure requirements using a fair-value-based method of accounting for stock based employee compensation plans. As allowed by SFAS 123, the Company has elected to continue to apply the intrinsic-value-based method of accounting described above, and has adopted only the disclosure requirements of SFAS 123.

 

The following table illustrates the effect on net income if the fair-value-based method had been applied to all outstanding and unvested awards in each period:

 

 

 

Three Months Ended

 

Six Months Ended

 

(in millions)

 

June 30, 2003

 

June 30, 2004

 

June 30, 2003

 

June 30, 2004

 

 

 

 

 

 

 

 

 

 

 

Net income as reported

 

$

17.2

 

$

12.1

 

$

34.1

 

$

11.6

 

Add:  Stock-based employee compensation expense included in reported net income, net of tax

 

0.2

 

0.3

 

0.2

 

0.6

 

Deduct:Stock-based employee compensation expense determined under fair value based methods for all awards, net of tax

 

(0.4

)

(0.6

)

(0.7

)

(1.4

)

Pro forma net income

 

$

17.0

 

$

11.8

 

$

33.6

 

$

10.8

 

 

9.                                      DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES

 

The Company designates certain derivatives as fair value hedges.  For all qualifying and highly effective fair value hedges, the changes in the fair value of a derivative and the gain or loss on the hedged asset or liability relating to the risk being hedged are recorded currently in earnings. These amounts are recorded in marketing, distribution and administrative expenses and provide offsets to one another.

 

9



 

The Company designates certain derivatives as cash flow hedges.  The Company engages in a foreign exchange hedging strategy for which the hedged transactions are forecasted foreign currency denominated intercompany transactions.  The hedged risk is the variability of the foreign currency where the hedging strategy involves the purchase and sale of average rate options.  For the outstanding cash flow hedges on foreign exchange exposures at June 30, 2003 and June 30, 2004, the maximum length of time over which the Company is hedging these exposures is approximately one year.  The Company also engages in an interest rate hedging strategy for which the hedged transactions are forecasted interest payments on the variable rate term loan.  The hedged risk is the variability of interest rate where the hedging strategy involves the purchase of interest rate caps.  There is no ineffective portion for the three and six months ended June 30, 2003 and June 30, 2004.  For all qualifying and highly effective cash flow hedges, the changes in the effective portion of the fair value of the derivative are recorded in other comprehensive income (“OCI”).  At June 30, 2004, the net gain in OCI was $0.02 million.  Substantially, all of the OCI amounts will be reclassified to earnings within 12 months.

 

10.                               RESTRUCTURING RESERVE

 

As of the date of the Merger, the Company implemented a plan to reduce costs of the business and recorded a severance and restructuring accrual as part of the cost of the Merger.  The accrued severance is for identified employees including executives, corporate functions and administrative support.

 

The following table summarizes the activity in the Company’s restructuring accrual (in millions):

 

Balance at December 31, 2003

 

$

2.5

 

Additional accrual

 

 

Cash payments

 

(0.6

)

Balance at June 30, 2004

 

$

1.9

 

 

The Company expects to pay these restructuring costs through 2005.

 

11.                               SUPPLEMENTAL INFORMATION

 

The consolidated financial statement data as of June 30, 2004 and for the three and six months ended June 30, 2003 and June 30, 2004, have been aggregated by entities that guarantee the 11 ¾% Notes (the “Guarantors”) and entities that do not guarantee the 11 ¾% Notes (the “Non-Guarantors”).  The Guarantors include WH Intermediate, Lux Holdings, Lux Intermediate, Herbalife Lux (collectively, the “Parent Guarantors”) and Herbalife’s operating subsidiaries in Brazil, Finland, Israel, Japan, Mexico, United Kingdom, U.S. (except for Herbalife Investment Co., LLC), Sweden, Taiwan and Thailand (collectively, the “Subsidiary Guarantors”).  All other subsidiaries are Non-Guarantors.  Herbalife is the borrower of the 11 ¾% Notes.

 

Holdings is the borrower of the 9.5% Notes but is not a guarantor of the 11 ¾% Notes.  Obligations under the 9.5% Notes are generally not guaranteed by any of the subsidiaries.  Under certain circumstances, however, the subsidiaries may be required to guarantee the obligation.

 

Consolidating condensed unaudited statements of income for guarantors and non-guarantors for the three and six months ended June 30, 2003 and June 30, 2004 are summarized as follows (in millions):

 

 

 

Three Months Ended June 30, 2003

 

 

 

WH Holdings
(Cayman
Islands) Ltd.

 

Parent
Guarantors

 

Herbalife
International,
Inc.

 

Subsidiary
Guarantors

 

Non-
Guarantors

 

Eliminations

 

Total
Consolidated

 

Net sales

 

$

 

$

 

$

 

$

249.7

 

$

68.4

 

$

(29.2

)

$

288.9

 

Cost of sales

 

 

 

 

54.5

 

33.8

 

(29.9

)

58.4

 

Royalty overrides

 

 

 

 

62.5

 

41.0

 

 

103.5

 

Marketing, distribution & administrative expenses

 

0.2.

 

0.4

 

2.3

 

63.5

 

20.3

 

 

86.7

 

Equity in subsidiary (income) loss

 

(19.2

)

(19.6

)

(25.1

)

(0.7

)

(0.1

)

64.7

 

 

Interest expense - net

 

1.8

 

 

8.7

 

(0.2

)

 

 

10.3

 

Intercompany charges

 

 

 

(2.8

)

36.6

 

(33.8

)

 

 

Income before income taxes

 

17.2

 

19.2

 

16.9

 

33.5

 

7.2

 

(64.0

)

30.0

 

Income tax expense (benefit)

 

 

 

(2.7

)

13.5

 

2.0

 

 

12.8

 

NET INCOME (LOSS)

 

$

17.2

 

$

19.2

 

$

19.6

 

$

20.0

 

$

5.2

 

$

(64.0

)

$

17.2

 

 

10



 

 

 

Three Months Ended June 30, 2004

 

 

 

WH Holdings
(Cayman
Islands) Ltd.

 

Parent
Guarantors

 

Herbalife
International,
Inc.

 

Subsidiary
Guarantors

 

Non-
Guarantors

 

Eliminations

 

Total
Consolidated

 

Net sales

 

$

 

$

143.5

 

$

 

$

152.2

 

$

93.5

 

$

(65.0

)

$

324.2

 

Cost of sales

 

 

27.8

 

 

52.0

 

48.6

 

(62.1

)

66.3

 

Royalty overrides

 

 

3.6

 

 

60.0

 

50.9

 

 

114.5

 

Marketing, distribution & administrative expenses

 

0.1

 

2.1

 

7.7

 

73.4

 

22.1

 

(0.2

)

105.2

 

Equity in subsidiary (income) loss

 

(19.6

)

(27.1

)

(11.2

)

(0.9

)

 

58.8

 

 

Interest expense - net

 

7.1

 

0.3

 

6.5

 

0.7

 

(0.3

)

 

14.3

 

Intercompany charges

 

 

117.2

 

(41.7

)

(39.5

)

(36.0

)

 

 

Income before income taxes

 

12.4

 

19.6

 

38.7

 

6.5

 

8.2

 

(61.5

)

23.9

 

Income tax expense (benefit)

 

0.3

 

 

11.6

 

(2.4

)

2.3

 

 

11.8

 

NET INCOME  (LOSS)

 

$

12.1

 

$

19.6

 

$

27.1

 

$

8.9

 

$

5.9

 

$

(61.5

)

$

12.1

 

 

 

 

Six Months Ended June 30, 2003

 

 

 

WH Holdings
(Cayman
Islands) Ltd.

 

Parent
Guarantors

 

Herbalife
International,
Inc.

 

Subsidiary
Guarantors

 

Non-
Guarantors

 

Eliminations

 

Total
Consolidated

 

Net sales

 

$

 

$

 

$

 

$

496.3

 

$

128.8

 

$

(56.2

)

$

568.9

 

Cost of sales

 

 

 

 

109.5

 

62.4

 

(56.5

)

115.4

 

Royalty overrides

 

 

 

 

125.6

 

77.4

 

 

203.0

 

Marketing, distribution & administrative expenses

 

0.2

 

0.5

 

4.7

 

126.8

 

38.8

 

 

171.0

 

Equity in subsidiary (income) loss

 

(37.7

)

(38.2

)

(49.5

)

(1.0

)

 

126.4

 

 

Interest expense - net

 

3.4

 

 

17.3

 

(0.4

)

(0.1

)

 

20.2

 

Intercompany charges

 

 

 

(5.0

)

68.1

 

(63.1

)

 

 

Income before income taxes

 

34.1

 

37.7

 

32.5

 

67.7

 

13.4

 

(126.1

)

59.3

 

Income tax expense (benefit)

 

 

 

(5.7

)

27.1

 

3.8

 

 

25.2

 

NET INCOME (LOSS)

 

$

34.1

 

$

37.7

 

$

38.2

 

$

40.6

 

$

9.6

 

$

(126.1

)

$

34.1

 

 

 

 

Six Months Ended June 30, 2004

 

 

 

WH Holdings
(Cayman
Islands) Ltd.

 

Parent
Guarantors

 

Herbalife
International,
Inc.

 

Subsidiary
Guarantors

 

Non-
Guarantors

 

Eliminations

 

Total
Consolidated

 

Net sales

 

$

 

$

294.0

 

$

 

$

297.1

 

$

177.4

 

$

(120.3

)

$

648.2

 

Cost of sales

 

 

58.4

 

 

96.2

 

91.7

 

(116.4

)

129.9

 

Royalty overrides

 

 

7.8

 

 

123.2

 

99.4

 

 

230.4

 

Marketing, distribution & administrative expenses

 

 

5.2

 

14.9

 

150.5

 

42.4

 

 

213.0

 

Equity in subsidiary (income) loss

 

(36.9

)

(29.1

)

(10.5

)

(1.7

)

 

78.2

 

 

Interest expense - net

 

25.3

 

0.5

 

15.0

 

2.4

 

(1.6

)

 

41.6

 

Intercompany charges

 

 

214.2

 

(63.6

)

(76.4

)

(74.2

)

 

 

Income before income taxes

 

11.6

 

37.0

 

44.2

 

2.9

 

19.7

 

(82.1

)

33.3

 

Income tax expense (benefit)

 

 

0.1

 

15.0

 

0.5

 

6.1

 

 

21.7

 

NET INCOME(LOSS)

 

$

11.6

 

$

36.9

 

$

29.2

 

$

2.4

 

$

13.6

 

$

(82.1

)

$

11.6

 

 

11



 

Consolidating condensed unaudited balance sheet data for guarantors and non-guarantors as of June 30, 2004 and December 31, 2003 are summarized as follows (in millions):

 

 

 

June 30, 2004

 

 

 

WH Holdings
(Cayman
Islands) Ltd.

 

Parent
Guarantors

 

Herbalife
International,
Inc.

 

Subsidiary
Guarantors

 

Non-
Guarantors

 

Eliminations

 

Total
Consolidated

 

CURRENT ASSETS:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash and marketable securities

 

$

2.7

 

$

16.3

 

$

1.6

 

$

87.2

 

$

49.3

 

$

 

$

157.1

 

Receivables

 

 

0.1

 

6.5

 

20.7

 

12.3

 

(6.5

)

33.1

 

Intercompany receivables (payables)

 

 

(24.6

)

199.7

 

(95.4

)

(79.7

)

 

 

Inventories

 

 

32.8

 

 

28.7

 

18.3

 

(9.3

)

70.5

 

Other current assets

 

 

11.0

 

1.3

 

19.9

 

2.3

 

 

34.5

 

Total current assets

 

2.7

 

35.6

 

209.1

 

61.1

 

2.5

 

(15.8

)

295.2

 

Property net

 

 

1.8

 

0.5

 

39.1

 

5.1

 

 

46.5

 

OTHER NON-CURRENT ASSETS

 

232.3

 

94.9

 

432.8

 

131.8

 

68.9

 

(394.5

)

566.2

 

TOTAL ASSETS

 

$

235.0

 

$

132.3

 

$

642.4

 

$

232.0

 

$

76.5

 

$

(410.3

)

$

907.9

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

CURRENT LIABILITIES:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Accounts payable

 

$

 

$

9.1

 

$

 

$

10.4

 

$

4.1

 

$

 

$

23.6

 

Royalties overrides

 

 

1.1

 

 

40.8

 

32.0

 

 

73.9

 

Accrued compensation and expenses

 

8.5

 

15.3

 

8.6

 

54.1

 

18.1

 

 

104.6

 

Other current liabilities

 

 

3.9

 

25.1

 

47.6

 

6.9

 

(6.4

)

77.1

 

Total current liabilities

 

8.5

 

29.4

 

33.7

 

152.9

 

61.1

 

(6.4

)

279.2

 

NON-CURRENT LIABILITIES

 

267.7

 

(0.6

)

337.8

 

(4.7

)

0.4

 

 

600.6

 

STOCKHOLDER’S EQUITY

 

(41.2

)

103.5

 

270.9

 

83.8

 

15.0

 

(403.9

)

28.1

 

TOTAL LIABILITIES & STOCKHOLDER’S EQUITY

 

$

235.0

 

$

132.3

 

$

642.4

 

$

232.0

 

$

76.5

 

$

(410.3

)

$

907.9

 

 

 

 

December 31, 2003

 

 

 

WH Holdings
(Cayman
Islands) Ltd.

 

Parent
Guarantors

 

Herbalife
International
Inc.

 

Subsidiary
Guarantors

 

Non-
Guarantors

 

Eliminations

 

Total
Consolidated

 

CURRENT ASSETS:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash and marketable securities

 

$

9.4

 

$

13.8

 

$

0.1

 

$

92.5

 

$

40.6

 

$

 

$

156.4

 

Receivables

 

1.5

 

 

 

23.0

 

7.5

 

 

32.0

 

Intercompany receivables (payables)

 

 

(23.3

)

196.7

 

(89.4

)

(84.0

)

 

 

Inventories

 

 

26.0

 

 

23.9

 

15.0

 

(5.5

)

59.4

 

Other current assets

 

 

2.2

 

(2.5

)

26.9

 

3.4

 

 

30.0

 

Total current assets

 

10.9

 

18.7

 

194.3

 

76.9

 

(17.5

)

(5.5

)

277.8

 

Property, net

 

 

2.1

 

0.3

 

37.7

 

5.3

 

 

45.4

 

OTHER NON-CURRENT ASSETS

 

238.7

 

65.8

 

448.9

 

129.8

 

68.5

 

(370.9

)

580.8

 

TOTAL ASSETS

 

$

249.6

 

$

86.6

 

$

643.5

 

$

244.4

 

$

56.3

 

$

(376.4

)

$

904.0

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

CURRENT LIABILITIES:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Accounts payable

 

$

0.1

 

$

8.2

 

$

 

$

10.4

 

$

3.8

 

$

 

$

22.5

 

Royalties overrides

 

 

0.7

 

 

45.7

 

30.1

 

 

76.5

 

Accrued compensation and expenses

 

 

10.2

 

8.7

 

44.7

 

15.2

 

 

78.8

 

Other current liabilities

 

(0.2

)

0.4

 

41.1

 

55.6

 

1.5

 

 

98.4

 

Total current liabilities

 

(0.1

)

19.5

 

49.8

 

156.4

 

50.6

 

 

276.2

 

NON-CURRENT LIABILITIES

 

38.0

 

0.3

 

351.9

 

(0.9

)

0.7

 

 

390.0

 

STOCKHOLDER’S EQUITY

 

211.7

 

66.8

 

241.8

 

88.9

 

5.0

 

(376.4

)

237.8

 

TOTAL LIABILITIES & STOCKHOLDER’S EQUITY

 

$

249.6

 

$

86.6

 

$

643.5

 

$

244.4

 

$

56.3

 

$

(376.4

)

$

904.0

 

 

12



 

Consolidating condensed unaudited statement of cash flows data for guarantors and non-guarantors for the six months ended June 30, 2004 and June 30, 2003 is summarized as follows (in millions):

 

 

 

Six Months Ended June 30, 2003

 

 

 

WH Holdings
(Cayman
Islands) Ltd.

 

Parent
Guarantors

 

Herbalife
International,
Inc.

 

Subsidiary
Guarantors

 

Non-
Guarantors

 

Eliminations

 

Total
Consolidated

 

Net cash provided by (used in) operating activities

 

35.1

 

$

38.3

 

$

27.0

 

$

55.3

 

$

24.8

 

$

(143.3

)

$

37.2

 

Net cash provided by (used in) investing activities

 

(35.4

)

(38.3

)

(25.3

)

3.2

 

(0.3

)

105.9

 

9.8

 

Net cash provided by (used in) financing activities

 

4.6

 

 

(1.9

)

(24.4

)

(15.0

)

37.4

 

0.7

 

Effect of exchange rate changes on cash

 

 

 

 

1.0

 

1.6

 

 

2.6

 

Cash at beginning of period

 

 

 

0.3

 

38.4

 

25.5

 

 

64.2

 

Cash at end of period

 

4.3.

 

$

 

$

0.1

 

$

73.5

 

$

36.6

 

$

 

$

114.5

 

 

 

 

Six Months Ended June 30, 2004

 

 

 

WH Holdings
(Cayman
Islands) Ltd.

 

Parent
Guarantors

 

Herbalife
International,
Inc.

 

Subsidiary
Guarantors

 

Non-
Guarantors

 

Eliminations

 

Total
Consolidated

 

Net cash provided by (used in) operating activities

 

$

(17.2

)

$

32.7

 

$

49.2

 

$

29.3

 

$

15.9

 

$

(44.3

)

$

65.6

 

Net cash provided by (used in) investing activities

 

9.9

 

(27.1

)

0.8

 

(17.4

)

(3.9

)

29.7

 

(8.0

)

Net cash provided by (used in) financing activities

 

6.3

 

 

(48.6

)

(16.4

)

(1.9

)

14.6

 

(46.0

)

Effect of exchange rate changes on cash

 

 

(3.0

)

 

(0.8

)

(1.4

)

 

(5.2

)

Cash at beginning of period

 

3.7

 

13.7

 

0.2

 

92.5

 

40.6

 

 

150.7

 

Cash at end of period

 

$

2.7

 

$

16.3

 

$

1.6

 

$

87.2

 

$

49.3

 

$

 

$

157.1

 

 

Item 2.  MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

Organization

 

WH Holdings (Cayman Islands) Ltd., a Cayman Islands exempted limited liability company (“Holdings”), incorporated on April 4, 2002, and its direct and indirect wholly owned subsidiaries, WH Intermediate Holdings Ltd., a Cayman Islands company (“WH Intermediate”), WH Luxembourg Holdings S.à.R.L., a Luxembourg unipersonal limited liability company (“Lux Holdings”), WH Luxembourg Intermediate Holdings S.à.R.L. (“Herbalife Lux”), formerly known as WH Luxembourg CM S.à.R.L, a Luxembourg unipersonal limited liability company, and WH Acquisition Corp., a Nevada corporation (“WH Acquisition”), were formed on behalf of Whitney & Co., LLC (“Whitney”) and Golden Gate Private Equity, Inc. (“Golden Gate”), in order to acquire Herbalife International, Inc., a Nevada corporation, and its subsidiaries (“Herbalife” or “Predecessor”) on July 31, 2002 (the “Merger”).  Holdings and its subsidiaries are referred to collectively herein as the Company.

 

Critical Accounting Policies

 

Our financial statements contain all adjustments, consisting of normal recurring adjustments necessary to present fairly our financial statements.  Our unaudited interim consolidated financial statements are prepared in conformity with Article 10 of Securities and Exchange Commission’s Regulation S-X, which require us to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the year.  Actual results could differ from those estimates.  We consider the following policies to be most critical in understanding the judgments that are involved in preparing the financial statements and the uncertainties that could impact our results of operations, financial condition and cash flows.

 

13



 

Allowances for product returns are provided at the time the product is shipped.  This accrual is based upon historic trends and experience.  If the actual product returns differ from past experience, changes in the allowances are made.

 

We write down our inventory to provide for estimated obsolete or unsalable inventory based on assumptions about future demand for our products and market conditions.  If future demand and market conditions are less favorable than management’s assumptions, additional inventory write-downs could be required.  Likewise, favorable future demand and market conditions could positively impact future operating results if written-off inventory is sold.

 

We perform goodwill impairment tests on an annual basis and on an interim basis if an event or circumstance indicates that impairment may have occurred.  We assess the impairment of other amortizable intangible assets and long-lived assets whenever events or changes in circumstances indicate that the carrying value may not be recoverable.  Factors we consider important that could trigger an impairment review include significant underperformance compared to historical or projected operating results, substantial changes in our business strategy and significant negative industry or economic trends.  If such indicators are present, we evaluate the fair value of the goodwill of the reporting unit compared to its carrying value.  For other intangible assets and long-lived assets we determine whether the sum of the estimated undiscounted cash flows attributable to the assets in question is less than their carrying value.  If less, we recognize an impairment loss based on the excess of the carrying amount of the assets over their respective fair values.  Fair value of goodwill, other intangible assets and long-lived assets is determined by discounted future cash flows, appraisals or other methods.  If the long-lived asset determined to be impaired is to be held and used, we recognize an impairment charge to the extent the present value of anticipated net cash flows attributable to the asset are less than the asset’s carrying value.  The fair value of the long-lived asset then becomes the asset’s new carrying value, which we depreciate over the remaining estimated useful life of the asset.  To the extent we determine there are indicators of impairment in future periods, additional write-downs may be required.

 

Contingencies are accounted for in accordance with SFAS 5, “Accounting for Contingencies.”  SFAS 5 requires that we record an estimated loss from a loss contingency when information available prior to issuance of our financial statements indicates that it is probable that an asset has been impaired or a liability has been incurred at the date of the financial statements and the amount of the loss can be reasonably estimated.  Accounting for contingencies such as legal and income tax matters requires us to use judgment.  Many of these legal and tax contingencies can take years to be resolved.  Generally, as the time period increases over which the uncertainties are resolved, the likelihood of changes to the estimate of the ultimate outcome increases.

 

Deferred income tax assets have been established for net operating loss carryforwards of certain foreign subsidiaries and have been reduced by a valuation allowance to reflect them at amounts estimated to be ultimately recognized.  The net operating loss carryforwards expire in varying amounts over a future period of time.  Realization of the income tax carryforwards is dependent on generating sufficient taxable income prior to expiration of the carryforwards.  Although realization is not assured, we believe it is more likely than not that the net carrying value of the income tax carryforwards will be realized.  The amount of the income tax carryforwards that is considered realizable, however, could change if estimates of future taxable income during the carryforward period are adjusted.

 

New Accounting Pronouncements
 

In December 2003, the SEC issued Staff Accounting Bulletin (“SAB”) No. 104, “Revenue Recognition,” which codifies, revises, and rescinds certain sections of SAB No. 101, “Revenue Recognition,” in order to make this interpretive guidance consistent with current authoritative accounting and auditing guidance and SEC rules and regulations. The changes noted in SAB No. 104 did not have a material effect on our consolidated results of operations, consolidated financial position, or consolidated cash flows.

 

In May 2003, the FASB issued SFAS 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity.” SFAS 150 establishes standards on the classification and measurement of certain instruments with characteristics of both liabilities and equity. SFAS 150 is effective for financial instruments entered into or modified after May 31, 2003, and otherwise effective at the beginning of the first interim period beginning after June 15, 2003. SFAS 150 requires the classification of any financial instruments with a mandatory redemption feature, an obligation to repurchase equity shares, or a conditional obligation based on the issuance of a variable number of its equity shares, as a liability. The adoption of SFAS 150 did not have a material effect on our consolidated financial returns.

 

In April 2003, the FASB issued SFAS 149, “Amendment of Statement 133 on Derivative Instruments and Hedging Activities,” effective for contracts entered into or modified after June 30, 2003. This amendment clarifies when a contract meets the characteristics of a derivative, clarifies when a derivative contains a financing component, and amends certain other existing pronouncements. The adoption of SFAS 149 did not have a material effect on our consolidated financial statements.

 

The FASB issued Interpretation 46 (“FIN 46”), “Consolidation of Variable Interest Entities” in January 2003, and a revised interpretation of FIN 46 (“FIN 46-R”). FIN 46 requires certain variable interest entities (“VIEs”) to be consolidated by the primary beneficiary of the entity if the equity investors in the entity do not have the characteristics of a controlling financial interest or sufficient equity to finance its

 

14



 

activities without additional subordinated financial support from other parties. The provisions of FIN 46 are effective immediately for all arrangements entered into after January 31, 2003. We have not invested in any entities that we believe are VIEs for which we are the primary beneficiary. The adoption of FIN 46 and FIN 46-R had no impact on our financial position, results of operations, or cash flows.

 

In November 2002, the FASB issued Interpretation No. 45 (“FIN 45”), Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others, which addresses the disclosure to be made by a guarantor in its interim and annual financial statements about its obligations under guarantees. The disclosure requirements are effective for interim and annual financial statements ending after December 15, 2002.  We do not have any material guarantees that require disclosure under FIN 45.

 

FIN 45 also requires the recognition of a liability by a guarantor at the inception of certain guarantees. FIN 45 requires the guarantor to recognize a liability for the non-contingent component of a guarantee, which is the obligation to stand ready to perform in the event that specified triggering events or conditions occur. The initial measurement of this liability is the fair value of the guarantee at inception. The recognition of the liability is required even if it is not probable that payments will be required under the guarantee or if the guarantee was issued with a premium payment or as part of a transaction with multiple elements. The initial recognition and measurement provisions are effective for all guarantees within the scope of FIN 45 issued or modified after December 31, 2002. We have adopted the disclosure requirements of FIN 45 and will apply the recognition and measurement provisions for all guarantees entered into or modified after December 31, 2002

 

For the year ended December 31, 2003 and the six months ended June 30, 2004, we have not entered into any guarantees within the scope of FIN 45.

 

General

 

We are a worldwide marketer of weight management, inner nutrition and Outer Nutrition® products that support our customers’ wellness and healthy lifestyles. We market and sell these products through a global network marketing organization comprised of over one million independent distributors in 58 countries.

 

“Retail sales” represent the gross sales amounts reflected on our invoices to our distributors.  We do not receive the amount reported as “retail sales,” and we do not monitor the actual retail prices charged for our products.  “Product sales” represent the actual product purchase price paid to us by our distributors, after giving effect to distributor discounts, referred to as “distributor allowances”, which total approximately 50% of suggested retail sales prices.  Distributor allowances as a percentage of sales may vary by country depending upon regulatory restrictions that limit or otherwise restrict distributor allowances.  “Net Sales” represent product sales including handling and freight income.  We utilize importers in a limited number of markets and, under some circumstances, we extend credit terms to these importers. Our “gross profit” consists of net sales less “cost of sales,” consisting of the cost to manufacture products in our China factory, the prices we pay to our third party manufacturers for products and costs related to product shipments, duties and tariffs, freight expenses relating to shipment of products to distributors and importers and similar expenses.

 

“Royalty overrides” consist of (i) royalty overrides and bonuses, which total approximately 15% and 7%, respectively, of the suggested retail sales prices of products earned by qualifying distributors on sales within their distributor organizations, (ii) the President’s Team Bonus payable to some of our most senior distributors in the aggregate amount of approximately an additional 1% of product retail sales, and (iii) other one-time incentive cash bonuses to qualifying distributors. These payments generally represent compensation to distributors for the development, retention and improved productivity of their distributor sales organizations.  Because of local country regulatory constraints, we may be required to modify our typical distributor incentive plans. Consequently, the total distributor discount percentage may vary over time. We also offer reduced distributor allowances and pay reduced royalty overrides with respect to certain products worldwide.

 

Sales, related royalty overrides, and allowances for product returns are recorded when the merchandise is shipped in accordance with our shipping terms when title passes. Advance sales deposits represent prepaid orders for which we have not shipped the merchandise.

 

Marketing, distribution and administrative expenses represent our operating expenses, components of which include labor and benefits, sales, training and marketing events, professional fees, travel and entertainment, advertising, occupancy costs, communication costs, bank fees, depreciation and amortization, foreign exchange fees and other miscellaneous operating expenses.

 

Most of our sales outside the United States are made in the respective local currencies.  In preparing our financial statements, we translate revenues into U.S. Dollars using average exchange rates.  Additionally, the majority of our purchases from our suppliers generally are made in U.S. Dollars, while sales to distributors generally are made in local currencies.  Consequently, a strengthening of the U.S. Dollar versus a foreign currency can have a negative impact on our reported sales and operating margins and can generate transaction losses on

 

15



 

intercompany transactions.  Throughout the last five years, foreign currency exchange rates have fluctuated significantly.  From time to time, we enter into foreign exchange forward contracts and option contracts to mitigate our foreign currency exchange risk.

 

Results of Operations

 

The growing consumer focus on good health and increasing obesity rates throughout the world continue to provide an excellent opportunity for us to grow our business selling weight management products and inner and outer nutritional products

 

Our results of operations for the periods described below are not necessarily indicative of results of operations for future periods, which depend upon numerous factors, including our ability to attract and retain new distributors, further penetrate existing markets, open new markets and introduce additional and new products into our markets.

 

Comparison of Second Quarter 2004 to 2003

 

Three Months Results

 

Net income for the three months ended June 30, 2004,  was $12.1 million, which was $5.1 million lower than the prior-year same period. The decrease in net income for the three months was primarily due to amortization of intangibles, higher labor costs and promotional expenses, and higher interest expenses, partially offset by increased net sales in all geographic regions except for Japan and the favorable impact of the appreciation of foreign currencies.  Overall the appreciation of foreign currencies had a $2.8 million favorable impact on net income.

 

Six Months Results

 

Net income for the six months ended June 30, 2004, was $11.6 million, which was $22.5 million lower than the prior-year same period. The decrease in net income for the six months was primarily due to increased operating expenses and higher interest expenses, offset by increased net sales in all geographic regions, except for Japan. Operating expenses increased due to additional amortization of intangibles, the unfavorable impact by the appreciation of foreign currencies, higher labor and promotional costs and provisions made for various tax matters.  Overall the appreciation of foreign currencies had a $5.7 million favorable impact on net income.

 

Excluding the impact of the additional amortization of intangibles relating to the Merger and the positive impact from appreciation of foreign currencies, net income for the current three and six-month period would have been $4.4 million and $21.3 million, respectively, lower than the prior year same periods, which was due to higher interest expense resulted from the refinancing transaction in March 2004.

 

Sales by Geographic Regions

 

 

 

Three Months Ended June 30

 

 

 

2003

 

2004

 

(in millions)

 

Retail
Sales

 

Distributor
Allowance

 

Product
Sales

 

Handling
& Freight
Income

 

Net Sales

 

Retail
Sales

 

Distributor
Allowance

 

Product
Sales

 

Handling
& Freight
Income

 

Net
Sales

 

% Change
In
Net Sales

 

The Americas