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EX-31.2 - EX-31.2 - HERBALIFE NUTRITION LTD.hlf-ex312_6.htm
EX-31.1 - EX-31.1 - HERBALIFE NUTRITION LTD.hlf-ex311_7.htm
EX-32.1 - EX-32.1 - HERBALIFE NUTRITION LTD.hlf-ex321_11.htm

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

Form 10-Q

 

(Mark One)

x

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

For the quarterly period ended September 30, 2015

OR

o

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

For the transition period from                     to                     .

Commission file number: 1-32381

 

HERBALIFE LTD.

(Exact name of registrant as specified in its charter)

 

 

Cayman Islands

98-0377871

(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 Islands

(Address of principal executive offices) (Zip code)

(213) 745-0500

(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  x    No  o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer

x

Accelerated filer

¨

 

 

 

 

Non-accelerated filer

o  (Do not check if a smaller reporting company)

Smaller reporting company

¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  o    No   x

Number of shares of registrant’s common shares outstanding as of October 29, 2015 was 92,534,552.

 

 

 

 


HERBALIFE LTD.

 

PART I. FINANCIAL INFORMATION

 

 

Item 1. Financial Statements

3

 

 

Unaudited Condensed Consolidated Balance Sheets

3

 

 

Unaudited Condensed Consolidated Statements of Income

4

 

 

Unaudited Condensed Consolidated Statements of Comprehensive Income

5

 

 

Unaudited Condensed Consolidated Statements of Cash Flows

6

 

 

Notes to Unaudited Condensed Consolidated Financial Statements

7

 

 

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

29

 

 

Item 3. Quantitative and Qualitative Disclosures About Market Risk

52

 

 

Item 4. Controls and Procedures

55

 

 

Forward Looking Statements

55

 

PART II. OTHER INFORMATION

 

 

Item 1. Legal Proceedings

56

 

 

Item 1A. Risk Factors

57

 

 

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

71

 

 

Item 3. Defaults Upon Senior Securities

71

 

 

Item 4. Mine Safety Disclosures

71

 

 

Item 5. Other Information

71

 

 

Item 6. Exhibits

72

 

 

Signatures and Certifications

75

 

 

 

 


 

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

HERBALIFE LTD. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(Unaudited)

 

 

 

September 30,

2015

 

 

December 31,

2014

 

 

 

(In millions, except share and

par value amounts)

 

ASSETS

 

 

 

 

 

 

 

 

CURRENT ASSETS:

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

813.2

 

 

$

645.4

 

Receivables, net of allowance for doubtful accounts of $1.2 (2015) and $1.9 (2014)

 

 

89.9

 

 

 

83.6

 

Inventories

 

 

315.6

 

 

 

377.7

 

Prepaid expenses and other current assets

 

 

180.0

 

 

 

186.1

 

Deferred income tax assets

 

 

93.4

 

 

 

100.6

 

Total current assets

 

 

1,492.1

 

 

 

1,393.4

 

Property, at cost, net of accumulated depreciation and amortization of $434.3 (2015)

   and $393.2 (2014)

 

 

335.8

 

 

 

366.7

 

Deferred compensation plan assets

 

 

27.3

 

 

 

27.4

 

Other assets

 

 

142.6

 

 

 

152.8

 

Deferred financing costs, net

 

 

21.5

 

 

 

22.0

 

Marketing related intangibles and other intangible assets, net

 

 

310.2

 

 

 

310.4

 

Goodwill

 

 

92.0

 

 

 

102.2

 

Total assets

 

$

2,421.5

 

 

$

2,374.9

 

LIABILITIES AND SHAREHOLDERS’ DEFICIT

 

 

 

 

 

 

 

 

CURRENT LIABILITIES:

 

 

 

 

 

 

 

 

Accounts payable

 

$

81.4

 

 

$

72.4

 

Royalty overrides

 

 

237.5

 

 

 

251.0

 

Accrued compensation

 

 

113.6

 

 

 

69.6

 

Accrued expenses

 

 

229.1

 

 

 

252.1

 

Current portion of long-term debt

 

 

254.7

 

 

 

100.0

 

Advance sales deposits

 

 

86.2

 

 

 

70.0

 

Income taxes payable

 

 

28.0

 

 

 

59.7

 

Total current liabilities

 

 

1,030.5

 

 

 

874.8

 

NON-CURRENT LIABILITIES:

 

 

 

 

 

 

 

 

Long-term debt, net of current portion

 

 

1,398.7

 

 

 

1,711.7

 

Deferred compensation plan liability

 

 

42.5

 

 

 

42.9

 

Deferred income tax liabilities

 

 

7.4

 

 

 

15.3

 

Other non-current liabilities

 

 

73.1

 

 

 

64.6

 

Total liabilities

 

 

2,552.2

 

 

 

2,709.3

 

CONTINGENCIES

 

 

 

 

 

 

 

 

SHAREHOLDERS’ DEFICIT:

 

 

 

 

 

 

 

 

Common shares, $0.001 par value; 1.0 billion shares authorized; 92.6 million (2015)

   and 92.2 million (2014) shares outstanding

 

 

0.1

 

 

 

0.1

 

Paid-in-capital in excess of par value

 

 

436.3

 

 

 

409.1

 

Accumulated other comprehensive loss

 

 

(156.3

)

 

 

(78.2

)

Accumulated deficit

 

 

(410.8

)

 

 

(665.4

)

Total shareholders’ deficit

 

 

(130.7

)

 

 

(334.4

)

Total liabilities and shareholders’ deficit

 

$

2,421.5

 

 

$

2,374.9

 

 

See the accompanying notes to unaudited condensed consolidated financial statements.

 

 

 

3


 

HERBALIFE LTD. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF INCOME

(Unaudited)

 

 

 

Three Months Ended

 

 

Nine Months Ended

 

 

 

September 30,

2015

 

 

September 30,

2014

 

 

September 30,

2015

 

 

September 30,

2014

 

 

 

(In millions, except per share amounts)

 

Product sales

 

$

1,036.4

 

 

$

1,157.0

 

 

$

3,154.7

 

 

$

3,514.4

 

Shipping & handling revenues

 

 

66.5

 

 

 

99.2

 

 

 

215.9

 

 

 

310.6

 

Net sales

 

 

1,102.9

 

 

 

1,256.2

 

 

 

3,370.6

 

 

 

3,825.0

 

Cost of sales

 

 

206.9

 

 

 

255.0

 

 

 

651.6

 

 

 

763.3

 

Gross profit

 

 

896.0

 

 

 

1,001.2

 

 

 

2,719.0

 

 

 

3,061.7

 

Royalty overrides

 

 

304.7

 

 

 

363.9

 

 

 

946.4

 

 

 

1,136.5

 

Selling, general & administrative expenses

 

 

429.7

 

 

 

609.7

 

 

 

1,331.6

 

 

 

1,573.7

 

Operating income

 

 

161.6

 

 

 

27.6

 

 

 

441.0

 

 

 

351.5

 

Interest expense, net

 

 

24.1

 

 

 

19.9

 

 

 

69.3

 

 

 

56.2

 

Other expense, net

 

 

 

 

 

9.8

 

 

 

2.3

 

 

 

13.0

 

Income (loss) before income taxes

 

 

137.5

 

 

 

(2.1

)

 

 

369.4

 

 

 

282.3

 

Income taxes

 

 

43.9

 

 

 

(13.3

)

 

 

114.8

 

 

 

76.9

 

NET INCOME

 

$

93.6

 

 

$

11.2

 

 

$

254.6

 

 

$

205.4

 

Earnings per share:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic

 

$

1.13

 

 

$

0.14

 

 

$

3.09

 

 

$

2.34

 

Diluted

 

$

1.09

 

 

$

0.13

 

 

$

2.99

 

 

$

2.22

 

Weighted average shares outstanding:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic

 

 

82.6

 

 

 

81.9

 

 

 

82.5

 

 

 

87.8

 

Diluted

 

 

85.7

 

 

 

86.2

 

 

 

85.1

 

 

 

92.6

 

Dividends declared per share

 

$

 

 

$

 

 

$

 

 

$

0.30

 

 

See the accompanying notes to unaudited condensed consolidated financial statements.

 

 

 

 

4


 

HERBALIFE LTD. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(Unaudited)

 

 

 

Three Months Ended

 

 

Nine Months Ended

 

 

 

September 30,

2015

 

 

September 30,

2014

 

 

September 30,

2015

 

 

September 30,

2014

 

 

 

(In millions)

 

Net income

 

$

93.6

 

 

$

11.2

 

 

$

254.6

 

 

$

205.4

 

Other comprehensive income (loss):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Foreign currency translation adjustment, net of income taxes

   of $(2.7) and $(0.8) for the three months ended

   September 30, 2015 and 2014, respectively, and $(7.0)

   and $0.7 for the nine months ended September 30, 2015 and

   2014, respectively

 

 

(37.0

)

 

 

(39.9

)

 

 

(81.4

)

 

 

(39.7

)

Unrealized (loss) gain on derivatives, net of income taxes

   of $(0.2) and $0.5 for the three months ended

   September 30, 2015 and 2014, respectively, and $0.1

   and $0.2 for the nine months ended September 30, 2015 and

   2014, respectively

 

 

(0.9

)

 

 

4.0

 

 

 

3.6

 

 

 

0.8

 

Unrealized gain (loss) on available-for-sale investments, net

   of income taxes of $— and $(0.1) for the three months ended

   September 30, 2015 and 2014, respectively, and $(0.2)

   and $(0.1) for the nine months ended September 30, 2015

   and 2014, respectively

 

 

 

 

 

(0.2

)

 

 

(0.3

)

 

 

(0.1

)

Total other comprehensive income (loss)

 

 

(37.9

)

 

 

(36.1

)

 

 

(78.1

)

 

 

(39.0

)

Total comprehensive income (loss)

 

$

55.7

 

 

$

(24.9

)

 

$

176.5

 

 

$

166.4

 

 

See the accompanying notes to unaudited condensed consolidated financial statements.

 

 

 

 

5


 

HERBALIFE LTD. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

 

 

 

Nine Months Ended

 

 

 

September 30,

2015

 

 

September 30,

2014

 

 

 

(In millions)

 

CASH FLOWS FROM OPERATING ACTIVITIES

 

 

 

 

 

 

 

 

Net income

 

$

254.6

 

 

$

205.4

 

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

 

 

 

 

 

 

 

 

Depreciation and amortization

 

 

72.6

 

 

 

69.2

 

Excess tax benefits from share-based payment arrangements

 

 

(1.5

)

 

 

(4.2

)

Share-based compensation expenses

 

 

34.2

 

 

 

34.4

 

Non-cash interest expense

 

 

39.8

 

 

 

31.2

 

Deferred income taxes

 

 

(1.5

)

 

 

(59.0

)

Inventory write-downs

 

 

22.3

 

 

 

17.7

 

Foreign exchange transaction (gain) loss

 

 

(11.9

)

 

 

4.0

 

Foreign exchange loss from Venezuela currency devaluation

 

 

32.9

 

 

 

200.3

 

Impairments and write-downs relating to Venezuela currency devaluation

 

 

4.3

 

 

 

27.5

 

Other

 

 

8.9

 

 

 

3.1

 

Changes in operating assets and liabilities:

 

 

 

 

 

 

 

 

Receivables

 

 

(25.1

)

 

 

(5.4

)

Inventories

 

 

(3.2

)

 

 

(58.7

)

Prepaid expenses and other current assets

 

 

0.4

 

 

 

(59.2

)

Other assets

 

 

(16.8

)

 

 

(8.8

)

Accounts payable

 

 

18.3

 

 

 

15.4

 

Royalty overrides

 

 

5.6

 

 

 

4.4

 

Accrued expenses and accrued compensation

 

 

61.7

 

 

 

11.8

 

Advance sales deposits

 

 

23.3

 

 

 

27.5

 

Income taxes

 

 

(26.6

)

 

 

(11.7

)

Deferred compensation plan liability

 

 

0.9

 

 

 

4.6

 

NET CASH PROVIDED BY OPERATING ACTIVITIES

 

 

493.2

 

 

 

449.5

 

CASH FLOWS FROM INVESTING ACTIVITIES

 

 

 

 

 

 

 

 

Purchases of property, plant and equipment

 

 

(57.5

)

 

 

(140.0

)

Proceeds from sale of property, plant and equipment

 

 

0.3

 

 

 

 

Investments in Venezuelan bonds

 

 

(0.1

)

 

 

(11.8

)

Other

 

 

6.0

 

 

 

 

NET CASH (USED IN) INVESTING ACTIVITIES

 

 

(51.3

)

 

 

(151.8

)

CASH FLOWS FROM FINANCING ACTIVITIES

 

 

 

 

 

 

 

 

Dividends paid

 

 

 

 

 

(30.4

)

Dividends received

 

 

 

 

 

3.4

 

Payments for Capped Call Transactions

 

 

 

 

 

(123.8

)

Proceeds from senior convertible notes

 

 

 

 

 

1,150.0

 

Principal payments on senior secured credit facility and other debt

 

 

(202.6

)

 

 

(56.3

)

Issuance costs relating to long-term debt and senior convertible notes

 

 

(6.2

)

 

 

(28.9

)

Share repurchases

 

 

(10.7

)

 

 

(1,278.4

)

Excess tax benefits from share-based payment arrangements

 

 

1.5

 

 

 

4.2

 

Proceeds from exercise of stock options and sale of stock under employee

   stock purchase plan

 

 

1.4

 

 

 

2.4

 

Other

 

 

(1.3

)

 

 

 

NET CASH (USED IN) FINANCING ACTIVITIES

 

 

(217.9

)

 

 

(357.8

)

EFFECT OF EXCHANGE RATE CHANGES ON CASH

 

 

(56.2

)

 

 

(234.7

)

NET CHANGE IN CASH AND CASH EQUIVALENTS

 

 

167.8

 

 

 

(294.8

)

CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD

 

 

645.4

 

 

 

973.0

 

CASH AND CASH EQUIVALENTS, END OF PERIOD

 

$

813.2

 

 

$

678.2

 

 

See the accompanying notes to unaudited condensed consolidated financial statements.

 

6


 

HERBALIFE LTD. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

1. Organization

Herbalife Ltd., a Cayman Islands exempt limited liability company, or Herbalife, was incorporated on April 4, 2002. Herbalife Ltd. (and together with its subsidiaries, the “Company”) is a global nutrition company that sells weight management, targeted nutrition, energy, sports & fitness, and outer nutrition products. As of September 30, 2015, the Company sold its products to and through a network of 4.0 million independent members, or Members, which included 0.3 million in China. In China, the Company sells its products through retail stores, sales representatives, sales officers and independent service providers. The Company reports revenue in six geographic regions: North America; Mexico; South and Central America; EMEA, which consists of Europe, the Middle East and Africa; Asia Pacific (excluding China); and China.

 

 

2. Significant Accounting Policies

Basis of Presentation

The unaudited condensed consolidated interim financial information of the Company has been prepared in accordance with Article 10 of the Securities and Exchange Commission’s, or the SEC, Regulation S-X. Accordingly, as permitted by Article 10 of the SEC’s Regulation S-X, it does not include all of the information required by generally accepted accounting principles in the U.S., or U.S. GAAP, for complete financial statements. The condensed consolidated balance sheet at December 31, 2014 was derived from the audited financial statements at that date and does not include all the disclosures required by U.S. GAAP, as permitted by Article 10 of the SEC’s Regulation S-X. The Company’s unaudited condensed consolidated financial statements as of September 30, 2015, and for the three and nine months ended September 30, 2015 and 2014, include Herbalife 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, necessary to present fairly the Company’s unaudited condensed consolidated financial statements as of September 30, 2015, and for the three and nine months ended September 30, 2015 and 2014. These unaudited condensed consolidated financial statements should be read in conjunction with the Company’s Annual Report on Form 10-K for the year ended December 31, 2014, or the 2014 10-K. Operating results for the three and nine months ended September 30, 2015, are not necessarily indicative of the results that may be expected for the year ending December 31, 2015.

New Accounting Pronouncements

In May 2014, the Financial Accounting Standards Board, or FASB, issued Accounting Standards Update, or ASU, No. 2014-09, Revenue from Contracts with Customers (Topic 606). The new revenue recognition standard provides a five-step analysis of transactions to determine when and how revenue is recognized. The core principle is that a company should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. In August 2015, the FASB issued ASU No. 2015-14, Revenue from Contracts with Customers (Topic 606): Deferral of the Effective Date, which defers the effective date of ASU No. 2014-09 for all entities by one year to annual reporting periods beginning after December 15, 2017. This ASU shall be applied either retrospectively to each period presented or as a cumulative-effect adjustment as of the date of adoption.  Early adoption is permitted as of the original effective date of December 15, 2016. The Company is evaluating the potential impact of this adoption on its consolidated financial statements.

In June 2014, the FASB issued ASU No. 2014-12, Compensation—Stock Compensation (Topic 718): Accounting for Share-Based Payments When the Terms of an Award Provide That a Performance Target Could Be Achieved after the Requisite Service Period (a consensus of the FASB Emerging Issues Task Force). This ASU clarifies that a performance target that affects vesting and that could be achieved after the requisite service period be treated as a performance condition. A reporting entity should apply existing guidance in Topic 718 as it relates to awards with performance conditions that affect vesting to account for such awards. As such, the performance target should not be reflected in estimating the grant-date fair value of the award. Compensation cost should be recognized in the period in which it becomes probable that the performance target will be achieved and should represent the compensation cost attributable to the period(s) for which the requisite service has already been rendered. This ASU is effective for annual periods, and interim periods within those years, beginning after December 15, 2015. Early adoption is permitted. This ASU may be applied either (a) prospectively to all awards granted or modified after the effective date or (b) retrospectively to all awards with performance targets that are outstanding as of the beginning of the earliest annual period presented in the financial statements and to all new or modified awards thereafter. The adoption of this guidance will not have a material impact on the Company’s consolidated financial statements.

 

7


 

In August 2014, the FASB issued ASU No. 2014-15, Presentation of Financial Statements — Going Concern (Subtopic 205-40). The purpose of this ASU is to incorporate into U.S. GAAP management’s responsibility to evaluate whether there is substantial doubt about an entity’s ability to continue as a going concern within one year after the date that the financial statements are issued (or within one year after the date that the financial statements are available to be issued when applicable), and to provide related footnote disclosures. This update is effective for the annual period ending after December 15, 2016, and for annual periods and interim periods thereafter. Early application is permitted. The adoption of this guidance will not have a material impact on the Company’s consolidated financial statements.

In January 2015, the FASB issued ASU No. 2015-01, Income Statement—Extraordinary and Unusual Items (Subtopic 225-20): Simplifying Income Statement Presentation by Eliminating the Concept of Extraordinary Items. This ASU is part of the FASB’s initiative to reduce complexity in accounting standards. This ASU eliminates from U.S. GAAP the concept of extraordinary items, which were previously required to be segregated from the results of ordinary operations and shown separately in the income statement, net of tax, after income from continuing operations. Entities were also required to disclose applicable income taxes for the extraordinary item and either present or disclose earnings-per-share data applicable to the extraordinary item. Items which are considered both unusual and infrequent will now be presented separately within income from continuing operations in the income statement or disclosed in notes to the financial statements. This update is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2015. Companies may apply the ASU prospectively, or may also apply the amendments retrospectively to all prior periods presented in the financial statements. Early adoption is permitted provided that the guidance is applied from the beginning of the fiscal year of adoption. The adoption of this guidance will not have a material impact on the Company’s consolidated financial statements.

In February 2015, the FASB issued ASU No. 2015-02, Consolidation (Topic 810): Amendments to the Consolidation Analysis. This ASU changes the analysis that reporting entities must perform to determine if certain types of legal entities should be consolidated. Specifically, the ASU focuses on 1) the variable interest entity, or VIE, evaluation of limited partnerships and similar legal entities, 2) eliminating the presumption that general partners should consolidate a limited partnership, 3) the consolidation analysis of reporting entities that are involved with VIEs, and 4) scope exceptions from consolidation guidance for reporting entities with interests in legal entities that are required to comply with or operate in accordance with requirements that are similar to those in Rule 2a-7 of the Investment Company Act of 1940 for registered money market funds. This update is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2015. Early adoption is permitted, including adoption in an interim period. If the ASU is adopted in an interim period, any adjustments should be reflected as of the beginning of the fiscal year that includes that interim period. The ASU may be applied using a modified retrospective approach by recording a cumulative-effect adjustment as of the beginning of the fiscal year of adoption. A reporting entity also may apply the amendments retrospectively. The Company is evaluating the potential impact of this adoption on its consolidated financial statements.

In April 2015, the FASB issued ASU No. 2015-03, Interest—Imputation of Interest (Subtopic 835-30): Simplifying the Presentation of Debt Issuance Costs. This ASU requires that debt issuance costs related to a recognized debt liability now be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability, consistent with debt discounts. Under current U.S. GAAP, debt issuance costs are recognized as a deferred charge asset. The recognition and measurement guidance for debt issuance costs are not affected by the amendments in this ASU. In August 2015, the FASB issued ASU No. 2015-15, Interest—Imputation of Interest (Subtopic 835-30): Presentation and Subsequent Measurement of Debt Issuance Costs Associated with Line-of-Credit Arrangements.  This ASU clarifies the presentation and subsequent measurement of debt issuance costs associated with lines of credit.  These costs may be presented as an asset and amortized ratably over the term of the line of credit arrangement. These updates are effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2015. Early adoption is permitted for financial statements that have not been previously issued. A reporting entity should apply these amendments retrospectively, wherein the balance sheet of each individual period presented should be adjusted to reflect the period-specific effects of applying the ASU. The Company is evaluating the potential impact of these adoptions on its consolidated financial statements.

In April 2015, the FASB issued ASU No. 2015-05, Intangibles—Goodwill and Other— Internal-Use Software (Subtopic 350-40): Customer’s Accounting for Fees Paid in a Cloud Computing Arrangement. This ASU adds explicit guidance into U.S. GAAP regarding a customer’s accounting for fees paid in a cloud computing arrangement. The ASU provides guidance to customers about whether a cloud computing arrangement includes a software license. If a cloud computing arrangement includes a software license, then the customer should account for the software license element of the arrangement consistent with the acquisition of other software licenses. If a cloud computing arrangement does not include a software license, the customer should account for the arrangement as a service contract. This update is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2015. Early adoption is permitted. A reporting entity should apply the amendments either (1) prospectively to all arrangements entered into or materially modified after the effective date or (2) retrospectively. The Company is evaluating the potential impact of this adoption on its consolidated financial statements.

 

8


 

In May, 2015, the FASB issued ASU No. 2015-07, Fair Value Measurement (Topic 820): Disclosures for Investment in Certain Entities That Calculate Net Asset Value per Share (or Its Equivalent). This ASU applies to reporting entities that elect to measure the fair value of an investment using the net asset value, or NAV, per share (or its equivalent) practical expedient. The ASU removes the requirement to categorize within the fair value hierarchy all investments for which fair value is measured using the NAV per share practical expedient. The amendments also remove the requirement to make certain disclosures for all investments that are eligible to be measured at fair value using the NAV per share practical expedient. Rather, those disclosures are limited to investments for which the entity has elected to measure the fair value using that practical expedient. The amendments in this ASU are effective for reporting periods beginning after December 15, 2015, with early adoption permitted. Entities should apply the amendments in this update retrospectively to all periods presented. The Company is evaluating the potential impact of this adoption on its consolidated financial statements.

In July 2015, the FASB issued ASU No. 2015-11, Inventory (Topic 330): Simplifying the Measurement of Inventory.  This ASU does not apply to inventory that is measured using last-in, first-out (LIFO) or the retail inventory method.  The amendments apply to all other inventory, which includes inventory that is measured using first-in, first-out (FIFO) or average cost.  This ASU eliminates from U.S. GAAP the requirement to measure inventory at the lower of cost or market.  Market under the previous requirement could be replacement cost, net realizable value, or net realizable value less an approximately normal profit margin.  Entities within scope of this update will now be required to measure inventory at the lower of cost and net realizable value.  Net realizable value is the estimated selling prices in the ordinary course of business, less reasonably predictable costs of completion, disposal, and transportation.  Subsequent measurement is unchanged for inventory using LIFO or the retail inventory method.  The amendments in this update are effective for fiscal years beginning after December 15, 2016, with early adoption permitted, and should be applied prospectively.  The Company is evaluating the potential impact of this adoption on its consolidated financial statements.  

Venezuela

Herbalife Venezuela, the Company’s Venezuelan subsidiary, currently imports its products into Venezuela. Foreign exchange controls in that country limit Herbalife Venezuela’s ability to repatriate earnings and settle its intercompany obligations at any official rate. As a result, the Company’s Bolivar-denominated cash and cash equivalents have continued to accumulate, increasing the potential impact of any currency devaluation. The current operating environment in Venezuela also continues to be challenging for the Company’s Venezuela business, with high inflation, price controls, and the risk that the government will further devalue the Bolivar or impose other import or currency exchange restrictions.

At December 31, 2014, the Company used the SICAD II rate of 50 Bolivars per U.S. dollar to remeasure Herbalife Venezuela’s financial statements. In February 2015, the Venezuelan government announced the introduction of a modified three-tier exchange control system which consists of CENCOEX, SICAD, and a third new mechanism called the Marginal Currency System, or SIMADI, and the SICAD II exchange mechanism was terminated. On February 12, 2015, the SIMADI exchange mechanism opened at a rate of 170 Bolivars per U.S. dollar as published by the Venezuelan government. During the first quarter of 2015, the Company was awarded approximately $0.1 million U.S. dollars through the SIMADI exchange mechanism and the Company’s ability to successfully exchange Bolivars to U.S. dollars continues to remain limited.

At March 31, 2015, the Company used the SIMADI exchange rate to remeasure its Venezuelan subsidiary’s financial statements. The Company recognized $32.6 million in foreign exchange losses in selling, general & administrative expenses and $1.4 million of inventory write downs in cost of sales within its condensed consolidated statement of income for the three months ended March 31, 2015 related to the remeasurement of its Venezuelan subsidiary’s financial statements. The Company recognized $0.3 million in foreign exchange losses in selling, general & administrative expenses and $0.3 million of inventory write downs in cost of sales within its condensed consolidated statement of income for the three months ended June 30, 2015 related to the remeasurement of its Venezuelan subsidiary’s financial statements. The Company recognized $0.2 million of inventory write downs in cost of sales within its condensed consolidated statement of income for the three months ended September 30, 2015 related to the remeasurement of its Venezuelan subsidiary’s financial statements. The Company continues to use the SIMADI exchange rate for remeasurement which was 198 Bolivars per U.S. dollar at September 30, 2015. During the three months ended September 30, 2015, the Company entered into a transaction to effectively convert 350.5 million of its Bolivars to $0.5 million U.S. dollars. Due to the financing nature of the transaction, the Company recognized a loss of $1.3 million in interest expense within its condensed statement of income.  

 

9


 

Due to the evolving foreign exchange control environment in Venezuela, it is possible that the Company’s ability to access certain foreign exchange mechanisms, including the SIMADI rate, could change in future periods which may have an impact on the rate the Company uses to remeasure Herbalife Venezuela’s Bolivar-denominated assets and liabilities. If the Company continues using the SIMADI rate for remeasurement purposes in future periods, any future U.S. dollars obtained through the SICAD or other more favorable mechanisms could have a positive impact on the Company’s consolidated net earnings. In addition, devaluations of the SIMADI rate, adoption of less favorable official rates by the Venezuelan government, or U.S. dollars obtained through less favorable alternative legal exchange mechanisms, could have a negative impact on the Company’s future consolidated net earnings. The Company is closely monitoring the CENCOEX, SICAD, and SIMADI exchange mechanisms as they continue to evolve.

As a result of using the SICAD I rate for remeasurement at March 31, 2014, the Company recognized $86.1 million of foreign exchange losses in selling, general & administrative expenses within its condensed consolidated statement of income for the three months ended March 31, 2014.  The Company recognized $0.2 million and $17.1 million in foreign exchange losses relating to unfavorable changes in the SICAD I rate during the three months ended June 30, 2014 and September 30, 2014, respectively. As a result of using the SICAD II rate for remeasurement at September 30, 2014, the Company recognized $98.0 million in foreign exchange losses in selling, general & administrative expenses within its condensed consolidated statement of income for the three months ended September 30, 2014.  In addition, as a result of using the SICAD II rate for remeasurement, the Company recognized $7.6 million of inventory write downs in cost of sales and $7.0 million of long lived asset impairments in selling, general & administrative expenses within its condensed consolidated statement of income during the three months ended September 30, 2014.

As of September 30, 2015, Herbalife Venezuela’s net monetary assets and liabilities denominated in Bolivars was approximately $10.1 million, and included approximately $9.5 million in Bolivar denominated cash and cash equivalents. As noted above, these Bolivar denominated assets and liabilities were remeasured at the SIMADI rate as of September 30, 2015. These remeasured amounts, including cash and cash equivalents, being reported on the Company’s condensed consolidated balance sheet using the published SIMADI rate may not accurately represent the amount of U.S. dollars that the Company will ultimately realize. While the Company continues to monitor the exchange mechanisms and restrictions imposed by the Venezuelan government, and assess and monitor the current economic and political environment in Venezuela, there is no assurance that the Company will be able to exchange Bolivars into U.S. dollars on a timely basis or at all, and if it does, what impact, if any, such exchanges will have on the Company’s financial statements. Herbalife Venezuela’s net sales represented less than 1% and approximately 3% of the Company’s consolidated net sales for the nine months ended September 30, 2015 and 2014, respectively, and its total assets represented approximately 1% and 2% of the Company’s consolidated total assets as of September 30, 2015 and December 31, 2014, respectively. As of September 30, 2015, the majority of Herbalife Venezuela’s total assets consisted of Bolivar-denominated cash and cash equivalents.

See the Company’s financial statements and related notes in the 2014 10-K for further information on Herbalife Venezuela and Venezuela’s highly inflationary economy.

Investments in Bolivar-Denominated Bonds

The Company did not invest in any additional Bolivar-denominated bonds during the three months ended September 30, 2015. During the nine months ended September 30, 2015, the Company invested in additional Bolivar-denominated bonds with a purchase price of 25.7 million Bolivars, or approximately $0.1 million. During the three and nine months ended September 30, 2014, the Company invested in additional Bolivar-denominated bonds with a purchase price of 48.0 million and 113.4 million Bolivars, respectively, or approximately $4.2 million and $11.8 million, respectively. The Company classifies these bonds as long-term available-for-sale investments which are carried at fair value, inclusive of unrealized gains and losses, and net of discount accretion and premium amortization. The fair value of these bonds is determined using Level 2 inputs which include prices of similar assets traded in active markets in Venezuela and observable yield curves. Net unrealized gains and losses on these bonds are included in other comprehensive income (loss) and are net of applicable income taxes. As of September 30, 2015, the amortized cost of the Company’s Venezuelan bonds was $1.2 million and the bonds had a market value of $1.1 million. As of September 30, 2015, the Company’s Venezuelan bonds had contractual maturities due after five years. Expected disposal dates of the bonds may be less than the contractual maturity dates. During the three and nine months ended September 30, 2015 and 2014, the Company did not sell any of its Venezuelan bonds.

 

10


 

The Company evaluates securities for other-than-temporary impairment on a quarterly basis. The impairment evaluation considers numerous factors, and their relative significance varies depending on the situation. Factors considered include the length of time and extent to which the market value has been less than cost; the financial condition and near-term prospects of the issuer of the securities; when applicable, the foreign exchange rates that are available to the Company; and the intent and ability of the Company to retain the security in order to allow for an anticipated recovery in fair value. If, based upon the analysis, it is determined that the impairment is other-than-temporary, the security is written-down to fair value, and a loss is recognized in other expense, net in the Company’s condensed consolidated income statement. Other-than-temporary impairments related to available-for-sale securities for the three months ended September 30, 2014 was $9.8 million, which were primarily due to unfavorable foreign exchange rates related to investments in Bolivar-denominated bonds. There were no other-than-temporary impairments related to available-for-sale securities during the three months ended September 30, 2015.  Other-than-temporary impairments related to available-for-sale securities for the nine months ended September 30, 2015 and 2014 were $2.3 million and $13.0 million, respectively, which were primarily due to unfavorable foreign exchange rates related to investments in Bolivar-denominated bonds.

 

 

3. Inventories

Inventories consist primarily of finished goods available for resale. Inventories are stated at lower of cost (primarily on the first-in, first-out basis) or market.

The following are the major classes of inventory:

 

 

 

September 30,

2015

 

 

December 31,

2014

 

 

 

(In millions)

 

Raw materials

 

$

43.6

 

 

$

39.5

 

Work in process

 

 

6.0

 

 

 

4.3

 

Finished goods

 

 

266.0

 

 

 

333.9

 

Total

 

$

315.6

 

 

$

377.7

 

 

 

4. Long-Term Debt

Long-term debt consists of the following:

 

 

 

September 30,

2015

 

 

December 31,

2014

 

 

 

(In millions)

 

Borrowings under the senior secured credit facility

 

$

664.7

 

 

$

850.0

 

Convertible senior notes, carrying value of liability

   component

 

 

988.7

 

 

 

961.7

 

Total

 

 

1,653.4

 

 

 

1,811.7

 

Less: current portion

 

 

254.7

 

 

 

100.0

 

Long-term portion

 

$

1,398.7

 

 

$

1,711.7

 

 

Senior Secured Credit Facility

On March 9, 2011, the Company entered into a $700.0 million senior secured revolving credit facility, or the Credit Facility, with a syndicate of financial institutions as lenders and terminated its prior senior secured credit facility, or the Prior Credit Facility.

In March 2011, the Company used $196.0 million in U.S. dollar borrowings under the Credit Facility to repay all amounts outstanding under the Prior Credit Facility. The Company incurred approximately $5.7 million of debt issuance costs in connection with the Credit Facility. These debt issuance costs were recorded as deferred financing costs on the Company’s condensed consolidated balance sheet and are being amortized over the term of the Credit Facility.

On July 26, 2012, the Company amended the Credit Facility to include a $500.0 million term loan with a syndicate of financial institutions as lenders, or the Term Loan. The Term Loan is a part of the Credit Facility and is in addition to the Company’s current revolving credit facility. The Term Loan matures on March 9, 2016. The Company will make regular scheduled payments for the Term Loan consisting of both principal and interest components.

 

11


 

In July 2012, the Company used all $500.0 million of the borrowings under the Term Loan to pay down amounts outstanding under the Company’s revolving credit facility. The Company incurred approximately $4.5 million of debt issuance costs in connection with the Term Loan. The debt issuance costs are recorded as deferred financing costs on the Company’s condensed consolidated balance sheet and will be amortized over the life of the Term Loan.

In February 2014, in connection with issuing the $1.15 billion Convertible Notes described below, the Company amended the Credit Facility. Pursuant to this amendment, the Company amended the terms of the Credit Facility to provide for technical amendments to the indebtedness, asset sale and dividend covenants and the cross-default event of default to accommodate the issuance of the Convertible Notes and the capped call and prepaid forward share repurchase transactions described in greater detail in Note 10, Shareholders’ Deficit. The amendment also increased by 0.50% the highest applicable margin payable by Herbalife in the event that Herbalife’s consolidated total leverage ratio is equal to or exceeds 2.50 to 1.00 and increased the permitted consolidated total leverage ratio of Herbalife under the Credit Facility. The Company incurred approximately $2.3 million of debt issuance costs in connection with the amendment. The debt issuance costs are recorded as deferred financing costs on the Company’s condensed consolidated balance sheet and will be amortized over the life of the Credit Facility.

On May 4, 2015, the Company amended its Credit Facility to extend the maturity date of its revolving credit facility by one year to March 9, 2017. The Term Loan will mature on March 9, 2016. Pursuant to this amendment and upon execution, the Company made prepayments of approximately $20.3 million and $50.9 million on the Term Loan and revolving credit facility, respectively. Additionally, the Company’s $700 million borrowing capacity on its revolving credit facility was reduced by approximately $235.9 million upon execution of this amendment, and was further reduced by approximately $39.1 million on September 30, 2015, bringing the total available borrowing capacity on its revolving credit facility to $425.0 million as of September 30, 2015. Until March 9, 2016, the interest rates on the Company’s borrowings under the Credit Facility will effectively remain unchanged except that the minimum applicable margin will be increased by 0.50% and LIBOR will have a minimum floor of 0.25%. Based on the Company’s consolidated leverage ratio, U.S. dollar borrowings under the Credit Facility now bear interest at either LIBOR plus the applicable margin between 2.00% and 3.00% or the base rate plus the applicable margin between 1.00% and 2.00%. The base rate under the Credit Facility represents the highest of the Federal Funds Rate plus 0.50%, the one-month LIBOR plus 1.00%, and the prime rate offered by Bank of America. The Company, based on its consolidated leverage ratio, pays a commitment fee between 0.40% and 0.50% per annum on the unused portion of the Credit Facility. The Credit Facility also permits the Company to borrow limited amounts in Mexican Peso and Euro currencies based on variable rates. All obligations under the Credit Facility are unconditionally guaranteed by certain of the Company’s subsidiaries and are secured by substantially all of the assets of the U.S. subsidiaries of the parent company, Herbalife Ltd. and by certain assets of certain foreign subsidiaries of Herbalife Ltd.

After March 9, 2016, the applicable interest rates on the Company’s borrowings under the Credit Facility will increase by 2.00% such that borrowings under the Credit Facility will bear interest at either LIBOR plus the applicable margin between 4.00% and 5.00% or the base rate plus the applicable margin between 3.00% and 4.00%. The Company incurred approximately $6.2 million of debt issuance costs in connection with the amendment. The debt issuance costs are recorded as deferred financing costs on the Company’s condensed consolidated balance sheet and will be amortized over the life of the revolving credit facility.

The Credit Facility requires the Company to comply with a leverage ratio and a coverage ratio. In addition, the Credit Facility contains customary covenants, including covenants that limit or restrict the Company’s ability to incur liens, incur indebtedness, make investments, dispose of assets, make certain restricted payments, pay dividends, repurchase its common shares, merge or consolidate and enter into certain transactions with affiliates. The Credit Facility restricts the Company’s ability to pay dividends or repurchase its common shares to a maximum of $233.0 million until maturity and for every one dollar of share repurchase or dividend paid, the revolving credit facility’s borrowing capacity is permanently decreased by two dollars. The Credit Facility also provides for the grant of security interest on certain additional assets of the Company and its subsidiaries. The Company is also required to maintain a minimum balance of $200.0 million of consolidated cash and cash equivalents. As of September 30, 2015 and December 31, 2014, the Company was compliant with its debt covenants under the Credit Facility.

On September 30, 2015 and December 31, 2014, the weighted average interest rate for borrowings under the Credit Facility, including borrowings under the Term Loan, was 2.76% and 3.04%, respectively.

 

12


 

During the three months ended March 31, 2015, the Company repaid a total amount of $25.0 million under the Credit Facility. During the three months ended June 30, 2015, the Company repaid a total amount of $135.3 million under the Credit Facility. During the three months ended September 30, 2015, the Company repaid a total amount of $25.0 million under the Credit Facility. As of September 30, 2015 and December 31, 2014, the U.S. dollar amount outstanding under the Credit Facility was $664.7 million and $850.0 million, respectively. Of the $664.7 million U.S. dollar amount outstanding under the Credit Facility as of September 30, 2015, $254.7 million was outstanding on the Term Loan and $410.0 million was outstanding on the revolving credit facility. Of the $850.0 million U.S. dollar amount outstanding under the Credit Facility as of December 31, 2014, $350.0 million was outstanding on the Term Loan and $500.0 million was outstanding on the revolving credit facility. There were no outstanding foreign currency borrowings as of September 30, 2015 and December 31, 2014 under the Credit Facility.

The fair value of the outstanding borrowings on the Company’s revolving credit facility and Term Loan approximated their carrying values as of September 30, 2015, due to their variable interest rates which reprice frequently and which represent floating market rates. The fair value of the outstanding borrowings on the Company’s revolving credit facility and Term Loan are determined by utilizing Level 2 inputs as defined in Note 12, Fair Value Measurements, such as observable market interest rates and yield curves.

Convertible Senior Notes

During February 2014, the Company initially issued $1 billion aggregate principal amount of convertible senior notes, or Convertible Notes, in a private offering to qualified institutional buyers, pursuant to Rule 144A under the Securities Act of 1933, as amended. The Company granted an option to the initial purchasers to purchase up to an additional $150 million aggregate principal amount of Convertible Notes which was subsequently exercised in full during February 2014, resulting in a total issuance of $1.15 billion aggregate principal amount of Convertible Notes. The Convertible Notes are senior unsecured obligations which rank effectively subordinate to any of our existing and future secured indebtedness, including amounts outstanding under the Credit Facility, to the extent of the value of the assets securing such indebtedness. The Convertible Notes pay interest at a rate of 2.00% per annum payable semiannually in arrears on February 15 and August 15 of each year, beginning on August 15, 2014. The Convertible Notes mature on August 15, 2019, unless earlier repurchased or converted. The Company may not redeem the Convertible Notes prior to their stated maturity date. Holders of the Convertible Notes may convert their notes at their option under the following circumstances: (i) during any calendar quarter commencing after the calendar quarter ending March 31, 2014, if the last reported sale price of the Company’s common shares for at least 20 trading days (whether or not consecutive) in a period of 30 consecutive trading days ending on, and including, the last trading day of the immediately preceding calendar quarter exceeds 130% of the conversion price for the Convertible Notes on each applicable trading day; (ii) during the five business-day period immediately after any five consecutive trading day period, or the measurement period, in which the trading price per $1,000 principal amount of Convertible Notes for each trading day of that measurement period was less than 98% of the product of the last reported sale price of the Company’s common shares and the conversion rate for the Convertible Notes for each such day; or (iii) upon the occurrence of specified corporate events. On and after May 15, 2019, holders may convert their Convertible Notes at any time, regardless of the foregoing circumstances. Upon conversion, the Convertible Notes will be settled in cash and, if applicable, the Company’s common shares, based on the applicable conversion rate at such time. The Convertible Notes had an initial conversion rate of 11.5908 common shares per $1,000 principal amount of the Convertible Notes (which is equal to an initial conversion price of approximately $86.28 per common share).

The Company incurred approximately $26.6 million of issuance costs during the first quarter of 2014 relating to the issuance of the Convertible Notes. Of the $26.6 million issuance costs incurred, $21.5 million and $5.1 million were recorded to deferred financing costs and additional paid-in capital, respectively, in proportion to the allocation of the proceeds of the Convertible Notes. The $21.5 million recorded to deferred financing costs on the Company’s condensed consolidated balance sheet is being amortized over the contractual term of the Convertible Notes using the effective interest method.

During February 2014, the $1.15 billion proceeds received from the issuance of the Convertible Notes were initially allocated between long-term debt, or liability component, and additional paid-in-capital, or equity component, within the Company’s condensed consolidated balance sheet at $930.9 million and $219.1 million, respectively. The liability component was measured using the nonconvertible debt interest rate. The carrying amount of the equity component representing the conversion option was determined by deducting the fair value of the liability component from the face value of the Convertible Notes as a whole. Since the Company must still settle these Convertible Notes at face value at or prior to maturity, this liability component will be accreted up to its face value resulting in additional non-cash interest expense being recognized within the Company’s condensed consolidated statements of income while the Convertible Notes remain outstanding. The effective interest rate on the Convertible Notes is approximately 6.2% per annum. The equity component is not remeasured as long as it continues to meet the conditions for equity classification.

 

13


 

As of September 30, 2015, the outstanding principal on the Convertible Notes was $1.15 billion, the unamortized debt discount was $161.3 million, and the carrying amount of the liability component was $988.7 million, which was recorded to long-term debt within the Company’s condensed consolidated balance sheet as reflected in the table above within this Note. As of September 30, 2015, the fair value of the liability component relating to the Convertible Notes was approximately $847.8 million. At September 30, 2015, the Company determined the fair value of the liability component of the Convertible Notes using two valuation methods. The Company reviewed market data that was available for publicly traded, senior, unsecured nonconvertible corporate bonds issued by companies with similar credit ratings. Assumptions used in the estimate represent what market participants would use in pricing the liability component, including market yields and credit standing to develop the straight debt yield estimate. The Company also used a lattice model, which included inputs such as stock price, the Convertible Note trading price, volatility and dividend yield as of September 30, 2015, to estimate the straight debt yield. The Company combined the results of the two valuation methods to determine the fair value of the liability component of the Convertible Notes. Most of these inputs are primarily considered Level 2 and Level 3 inputs. This valuation approach was similar to the approach the Company used to determine the initial fair value of the liability component of the Convertible Notes on the February 7, 2014 issuance date.

In conjunction with the issuance of the Convertible Notes, during February 2014, the Company paid approximately $685.8 million to enter into prepaid forward share repurchase transactions, or the Forward Transactions, with certain financial institutions, and paid approximately $123.8 million to enter into capped call transactions with respect to its common shares, or the Capped Call Transactions, with certain financial institutions. See Note 10, Shareholders’ Deficit, for additional discussion on the Forward Transactions and Capped Call Transactions entered into in conjunction with the issuance of these Convertible Notes.

During the three and nine months ended September 30, 2015, the Company recognized $16.0 million and $46.8 million, respectively, of interest expense relating to the Convertible Notes, which included $9.3 million and $27.0 million, respectively, relating to non-cash interest expense relating to the debt discount and $0.9 million and $2.8 million, respectively, relating to amortization of deferred financing costs. During the three and nine months ended September 30, 2014, the Company recognized $15.4 million and $39.4 million, respectively, of interest expense relating to the Convertible Notes, which included $8.7 million and $22.0 million, respectively, relating to non-cash interest expense relating to the debt discount and $0.9 million and $2.4 million, respectively, relating to amortization of deferred financing costs. The Company’s total interest expense, including the Credit Facility, was $25.5 million and $24.0 million for the three months ended September 30, 2015 and 2014, respectively, and $73.7 million and $66.0 million for the nine months ended September 30, 2015 and 2014, respectively, which was recognized within its condensed consolidated statement of income. Interest expense for the nine months ended September 30, 2015 included a $0.6 million write-off of unamortized deferred financing costs resulting from the amendment of the Credit Facility, as discussed above.

As of September 30, 2015, the aggregate annual maturities of the Credit Facility were expected to be $25.0 million for the remainder of 2015, $229.7 million for 2016, and $410.0 million for 2017. The $1.15 billion Convertible Notes are due in 2019.

Certain vendors and government agencies may require letters of credit or similar guaranteeing arrangements to be issued or executed. As of September 30, 2015, the Company had $33.8 million of issued but undrawn letters of credit or similar arrangements, which included the Mexico Value Added Tax, or VAT, related surety bonds described in Note 5, Contingencies.

 

 

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.

As a marketer of foods, dietary and nutritional supplements, and other products that are ingested by consumers or applied to their bodies, the Company has been and is currently subjected to various product liability claims. The effects of these claims to date have not been material to the Company, and the reasonably possible range of exposure on currently existing claims is not material to the Company. The Company believes that it has meritorious defenses to the allegations contained in the lawsuits. The Company currently maintains product liability insurance with an annual deductible of $15 million.

 

14


 

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 substantial defenses to governmental allegations that significant additional taxes are owed, and the Company is vigorously contesting the additional proposed taxes and related charges. On May 7, 2010, the Company received an assessment from the Mexican Tax Administration Service in an amount equivalent to approximately $67 million, translated at the September 30, 2015 spot rate, for various items, the majority of which was VAT allegedly owed on certain of the Company’s products imported into Mexico during the years 2005 and 2006. This assessment is subject to interest and inflationary adjustments. On July 8, 2010, the Company initiated a formal administrative appeal process. On May 13, 2011, the Mexican Tax Administration Service issued a resolution on the Company’s administrative appeal. The resolution nullified the assessment. Since the Mexican Tax Administration Service can further review the tax audit findings and re-issue some or all of the original assessment, the Company commenced litigation in the Tax Court of Mexico in August 2011 to dispute the assertions made by the Mexican Tax Administration Service in the case. The Company received notification on February 6, 2015 that the Tax Court of Mexico nullified substantially all of the assessment. On March 18, 2015, the Mexican Tax Administration Service filed an appeal against the verdict with the Circuit Court. On August 27, 2015, the Circuit Court remanded the case back to the Tax Court of Mexico to reconsider a portion of the procedural decision that was adverse to the Mexican Tax Administration. The Company believes that it has meritorious defenses if the assessment is reissued. The Company has not recognized a loss as the Company does not believe a loss is probable.

The Mexican Tax Administration Service commenced audits of the Company’s Mexican subsidiaries for the period from January to September 2007 and on May 10, 2013, the Company received an assessment of approximately $17.3 million, translated at the September 30, 2015 spot rate, related to that period. On July 11, 2013, the Company filed an administrative appeal disputing the assessment. In addition, the Mexican Tax Administration Service has requested additional information in response to Company filings for VAT refunds. On September 22, 2014, the Mexican Tax Administration Service denied the Company’s administrative appeal. The Company commenced litigation in the Tax Court of Mexico in November 2014 to dispute the assertions made by the Mexican Tax Administration Service in the case. The Company issued a surety bond in the amount of $18.7 million, translated at the September 30, 2015 spot rate, through an insurance company to guarantee payment of the tax assessment as required while the Company pursues an appeal of the assessment. Litigation in this case is currently ongoing. The Company has not recognized a loss as the Company does not believe a loss is probable.

The Mexican Tax Administration Service audited the Company’s Mexican subsidiaries for the 2011 year. The audit focused on importation and VAT issues. On June 25, 2013, the Mexican Tax Administration Service closed the audit of the 2011 year without any assessment.

The Mexican Customs Service has challenged the customs classification codes used by the Company for certain importations. A change in the customs classification codes would require the payment of additional VAT and other taxes for those importations. The Company believes that the customs classification codes used for the importation of these products were correct. The Company has received draft assessments of $6.9 million, translated at the September 30, 2015 spot rate, and is discussing the draft assessments with the Mexican Tax Administration. The Company expects to challenge assessments as they are received. Most of the products that were the subject of the dispute have since been reformulated to avoid potential additional assessments related to future importations of product. The Company has not recognized a loss as the Company does not believe a loss is probable.

The Mexican Tax Administration Service has delayed processing VAT refunds for companies operating in Mexico and the Company believes that the process for its Mexico subsidiary to receive VAT refunds may be delayed. In March 2015, the Company commenced litigation in the Tax Court of Mexico to reclaim the VAT refund pertaining specifically to the July 2013 period. As of September 30, 2015, the Company had $56.4 million of Mexico VAT related assets within other assets on its consolidated balance sheet. This amount relates to VAT payments made over various periods. The Company has not recognized any losses related to these VAT related assets as the Company does not believe a loss is probable.

On March 26, 2015, the Office of the President of Mexico issued a decree relating to the application of VAT to Nutritional Supplements. The Company continues to believe its application of the VAT law in Mexico is correct. At September 30, 2015, the Company has not recognized any losses as the Company, based on its current analysis and guidance from its advisors, does not believe a loss is probable. The Company continues to evaluate and monitor its situation as it develops, including whether it will make any changes to its operations in Mexico.

The Company has not recognized a loss with respect to any of these Mexican matters as the Company, based on its analysis and guidance from its advisors, does not believe a loss is probable. Further, the Company is currently unable to reasonably estimate a possible loss or range of loss that could result from an unfavorable outcome if an assessment was re-issued or any additional assessments were to be issued for these or other periods. The Company believes that it has meritorious defenses if the assessment is re-issued or would have meritorious defenses if any additional assessment is issued.

 

15


 

The Mexican Tax Administration Service has requested information related to the Company’s 2010 year. This information has been provided. In addition, the Mexican Tax Administration Service requested information related to the Company’s 2012 year. This information has been provided. The Mexican Tax Administration Service may request additional information or audit additional periods.

The Company received a tax assessment in September 2009 from the Federal Revenue Office of Brazil in an amount equivalent to approximately $2.1 million, translated at the September 30, 2015 spot rate, related to withholding/contributions based on payments to the Company’s Members during 2004. On December 28, 2010, the Company appealed this tax assessment to the Administrative Council of Tax Appeals (2nd level administrative appeal). The Company believes it has meritorious defenses and it has not recognized a loss as the Company does not believe a loss is probable. On March 6, 2014, the Company was notified of a similar audit of the 2011 year. This audit is ongoing. The Company is currently unable to reasonably estimate the amount of the loss that may result from an unfavorable outcome if additional assessments for other periods were to be issued.

The Company’s Brazilian subsidiary pays ICMS-ST taxes on its product purchases, similar to VAT. The Company believes it will be able to utilize or recover these ICMS-ST credits in the future. The Company had $13.3 million, translated at the September 30, 2015 spot rate, of Brazil ICMS-ST related assets within other assets on its consolidated balance sheet. At September 30, 2015, the Company has not recognized any losses related to these ICMS-ST related assets as the Company does not believe a loss is probable.

The Company is challenging assessments received from several Brazilian states related to the calculation of ICMS-ST taxes. In October 2015, the Company filed appeals with state judicial courts against two of the assessments. The Company has issued surety bonds in the aggregate amount of $7.5 million, translated at the September 30, 2015 spot rate, through an insurance company to guarantee payment of the tax assessments as required while the Company pursues the appeals. Litigation in these cases is currently ongoing. The Company has not recognized a loss as the Company does not believe a loss is probable.

The Korea Customs Service is currently auditing the importation activities of Herbalife Korea for the periods 2010 and later. If an assessment is issued, the Company would likely be required to pay the amount requested in order to appeal the assessment. Based on the Company’s analysis and guidance from its advisors, the Company does not believe a loss is probable. Further, the Company is currently unable to reasonably estimate a possible loss or range of loss.

Bostick, et al., v. Herbalife Int’l of Am., Inc., et al. On April 8, 2013, Herbalife Ltd. and certain of its subsidiaries were named as defendants in a suit filed in the U.S. District Court for the Central District of California, challenging Herbalife’s marketing practices and business structure under California laws prohibiting “endless chain schemes,” unfair and deceptive business practices, and false advertising, as well as federal RICO statutes. On July 7, 2014, the complaint was amended to add additional plaintiffs. The plaintiffs sought damages in an unspecified amount. The federal RICO claim was dismissed. While the Company continues to believe the suit was without merit, and without in any way admitting liability or wrongdoing, the Company and the plaintiffs reached a settlement. Under the terms of the settlement, the Company would (i) pay $15 million into a fund to be distributed to qualified claimants and (ii) accept up to a maximum amount of $2.5 million in product returns from qualified claimants. The court granted preliminary approval of the settlement on December 2, 2014 and conditionally certified a class. The court granted final approval of the settlement on May 14, 2015 and the final judgment was entered June 19, 2015. These amounts were adequately reserved for in the Company’s financial statements. The settlement class consists of approximately 1.5 million persons who were Members in the United States during the period from April 1, 2009 through and including December 2, 2014. The settlement amounts were more than sufficient to cover the claims. The objectors’ motion for reconsideration of the final judgment approving the settlement was denied by the court on August 18, 2015. No appeal was filed and the judgment is final.

 

16


 

In re Herbalife, Ltd. Securities Litigation (formerly captioned Awad v. Herbalife Ltd., et al.). On April 14, 2014, Herbalife Ltd. and certain of its officers were named as defendants in a purported stockholder class action, filed in the U.S. District Court for the Central District of California and asserting claims under the Securities Exchange Act of 1934. The complaint alleged that the Company and certain officers made material misstatements concerning the Company’s finances and business practices, and contended that the Company is operating a pyramid scheme. The initial complaint sought to represent a class of investors that had purchased shares of the Company’s common stock between May 4, 2010 and April 11, 2014. On July 30, 2014, the Court approved the appointment of different shareholders as lead plaintiffs and approved their selection of counsel. On September 18, 2014, these lead plaintiffs filed an Amended Class Action Complaint for Violation of the Federal Securities Laws against the Company, and certain of its officers. The Amended Complaint brings claims for unspecified damages under the Securities Exchange Act of 1934, as amended, alleges that the defendants made material misstatements that “fundamentally misrepresented the nature, scope and legality of the Company’s business and operations to consumers and investors alike,” and further alleges that the Company is one of “the most sophisticated pyramid schemes in history.” The lead plaintiffs seek to represent a class of all persons or entities that purchased shares of the Company’s common stock between February 23, 2011 and July 29, 2014. On March 16, 2015, the Court granted Defendants’ motion to dismiss all claims in the Amended Complaint with leave to file an amended complaint and dismissed one of the shareholders as lead plaintiff. On May 8, 2015, the lead plaintiff filed a Second Amended Complaint for Violation of the Federal Securities Laws against the Company and one of its officers. On July 28, 2015, the Court granted Defendants’ motion to dismiss the Second Amended Complaint with leave to file an amended complaint by August 27, 2015. On August 27, 2015, the lead plaintiff filed a Third Amended Complaint for Violation of the Federal Securities Laws against the Company and one of its officers. The lead plaintiff seeks to represent a class of all persons or entities that purchased shares of the Company’s common stock between February 23, 2011 and December 19, 2012. The defendants filed a Motion to Dismiss the third amended complaint on September 28, 2015.  A hearing is scheduled for November 9, 2015. The Company continues to vigorously defend this purported class action suit. The Company has not recognized a loss as it does not believe a loss is probable. Further, the Company is currently unable to reasonably estimate a possible loss or range of loss.

U.S. Federal Trade Commission Civil Investigative Demand. As previously disclosed, the Company received from the U.S. Federal Trade Commission, or the FTC, a Civil Investigative Demand, or a CID, relating to the FTC’s confidential investigation of whether the Company has complied with federal law in the advertising, marketing, or sale of business opportunities. Pursuant to the CID, as supplemented, the FTC has requested from the Company documents and other information for the time period commencing January 1, 2009 to the present. The Company is cooperating with the investigation and cannot predict the eventual scope, duration or outcome of the investigation at this time.

Since late 2012, a short seller has made and continues to make allegations regarding the Company and its network marketing program. The Company believes these allegations are without merit and is vigorously defending itself against such claims, including proactively reaching out to governmental authorities about what the Company believes is manipulative activity with respect to its securities. Because of these allegations, the Company and others have received and may receive additional regulatory and governmental inquiries. For example, the Company has previously disclosed inquiries from the FTC, Securities and Exchange Commission and other governmental authorities. The Department of Justice recently sought information from the Company, certain of its Members and others regarding allegations being made about the business practices of the Company and its Members. In the future, these and other governmental authorities may determine to seek information from the Company and other persons relating to these same or other allegations. If the Company believes any governmental or regulatory inquiry or investigation is or becomes material it will be disclosed individually. Consistent with its policies, the Company has cooperated and will continue to fully cooperate with any governmental or regulatory inquiries or investigations.

These matters may take several years to resolve. While the Company believes it has meritorious defenses, it cannot be sure of their ultimate resolution. Although the Company may reserve amounts for certain matters that the Company believes represent the most likely outcome of the resolution of these related disputes, if the Company is incorrect in its assessment, the Company may have to record additional expenses, when it becomes probable that an increased potential liability is warranted.

 

 

6. Segment Information

The Company is a nutrition company that sells a wide range of weight management, targeted nutrition, energy, sports & fitness, and outer nutrition products. The Company’s products are manufactured by third party providers and by the Company in its Changsha, Hunan, China extraction facility, Suzhou, China facility, Lake Forest, California facility, and in its Winston-Salem, North Carolina facility, and then are sold to Members who consume and sell Herbalife products to retail consumers or other Members. Revenues reflect sales of products by the Company to its Members and are categorized based on geographic location.

 

17


 

As of September 30, 2015, the Company sold products in 93 countries throughout the world and was organized and managed by six geographic regions: North America, Mexico, South & Central America, EMEA (Europe, Middle East, and Africa), Asia Pacific and China. The Company defines its operating segments as those geographical operations. The Company aggregates its operating segments, excluding China, into one reporting segment, or the Primary Reporting Segment, as management believes that the Company’s 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. China has been identified as a separate reporting segment as it does not meet the criteria for aggregation. The Company reviews its net sales and contribution margin by operating segment, and reviews its assets on a consolidated basis and not by operating segment. Therefore, net sales and contribution margin are presented by reportable segment and assets by segment are not presented. The operating information for the Primary Reporting Segment and China are as follows:

 

 

 

Three Months Ended

 

 

Nine Months Ended

 

 

 

September 30,

2015

 

 

September 30,

2014

 

 

September 30,

2015

 

 

September 30,

2014

 

 

 

(In millions)

 

Net Sales:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Primary Reporting Segment

 

$

878.0

 

 

$

1,074.9

 

 

$

2,744.8

 

 

$

3,337.8

 

China

 

 

224.9

 

 

 

181.3

 

 

 

625.8

 

 

 

487.2

 

Total Net Sales

 

$

1,102.9

 

 

$

1,256.2

 

 

$

3,370.6

 

 

$

3,825.0

 

 

Contribution Margin(1)(2):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Primary Reporting Segment

 

$

390.5

 

 

$

476.0

 

 

$

1,209.3

 

 

$

1,487.2

 

China

 

 

200.8

 

 

 

161.3

 

 

 

563.3

 

 

 

438.0

 

Total Contribution Margin

 

$

591.3

 

 

$

637.3

 

 

$

1,772.6

 

 

$

1,925.2

 

Selling, general and administrative expenses(2)

 

 

429.7

 

 

 

609.7

 

 

 

1,331.6

 

 

 

1,573.7

 

Interest expense, net

 

 

24.1

 

 

 

19.9

 

 

 

69.3

 

 

 

56.2

 

Other expense, net

 

 

 

 

 

9.8

 

 

 

2.3

 

 

 

13.0

 

Income before income taxes

 

 

137.5

 

 

 

(2.1

)

 

 

369.4

 

 

 

282.3

 

Income taxes

 

 

43.9

 

 

 

(13.3

)

 

 

114.8

 

 

 

76.9

 

Net Income

 

$

93.6

 

 

$

11.2

 

 

$

254.6

 

 

$

205.4

 

 

(1)

Contribution margin consists of net sales less cost of sales and royalty overrides.

(2)

Service fees to China independent service providers totaling $105.9 million and $86.6 million for the three months ended September 30, 2015 and 2014, respectively, and totaling $299.0 million and $229.1 million for the nine months ended September 30, 2015 and 2014, respectively, are included in selling, general and administrative expenses while Member compensation for all other countries is included in contribution margin.

The following table sets forth net sales by geographic area:

 

 

 

Three Months Ended

 

 

Nine Months Ended

 

 

 

September 30,

2015

 

 

September 30,

2014

 

 

September 30,

2015

 

 

September 30,

2014

 

 

 

(In millions)

 

Net Sales:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

United States

 

$

214.7

 

 

$

218.4

 

 

$

661.5

 

 

$

705.7

 

Mexico

 

 

113.4

 

 

 

143.9

 

 

 

366.2

 

 

 

435.2

 

South Korea

 

 

65.2

 

 

 

121.3

 

 

 

214.3

 

 

 

338.2

 

China

 

 

224.9

 

 

 

181.3

 

 

 

625.8

 

 

 

487.2

 

Others

 

 

484.7

 

 

 

591.3

 

 

 

1,502.8

 

 

 

1,858.7

 

Total Net Sales

 

$

1,102.9

 

 

$

1,256.2

 

 

$

3,370.6

 

 

$

3,825.0

 

 

 

 

18


 

7. Share-Based Compensation

The Company has share-based compensation plans, which are more fully described in Note 9, Share-Based Compensation, to the Consolidated Financial Statements in the 2014 10-K. During the nine months ended September 30, 2015, the Company granted stock awards subject to service conditions, service and market conditions, and service and performance conditions, consisting of stock appreciation rights, or SARs.

For the three months ended September 30, 2015 and 2014, share-based compensation expense amounted to $10.3 million and $11.0 million, respectively. For the nine months ended September 30, 2015 and 2014, share-based compensation expense amounted to $34.2 million and $34.4 million, respectively. As of September 30, 2015, the total unrecognized compensation cost related to all non-vested stock awards was $62.4 million and the related weighted-average period over which it is expected to be recognized is approximately 1.5 years.

The following tables summarize the activity under all share-based compensation plans for the nine months ended September 30, 2015:

 

Stock Options & SARs

 

Awards

 

 

Weighted

Average

Exercise

Price

 

 

Weighted

Average

Remaining

Contractual

Term

 

Aggregate

Intrinsic

Value(1)

 

 

 

(In thousands)

 

 

 

 

 

 

 

 

(In millions)

 

Outstanding at December 31, 2014(2)

 

 

11,169

 

 

$

37.46

 

 

5.4 years

 

$

110.6

 

Granted(3)

 

 

3,504

 

 

$

32.13

 

 

 

 

 

 

 

Exercised

 

 

(2,025

)

 

$

22.97

 

 

 

 

 

 

 

Forfeited

 

 

(205

)

 

$

49.84

 

 

 

 

 

 

 

Outstanding at September 30, 2015(2) (4)

 

 

12,443

 

 

$

38.11

 

 

6.7 years

 

$

238.0

 

Exercisable at September 30, 2015(5)

 

 

7,142

 

 

$

33.93

 

 

4.9 years

 

$

159.9

 

 

(1)

The intrinsic value is the amount by which the current market value of the underlying stock exceeds the exercise price of the stock awards.

(2)

Includes 2.5 million and 1.0 million performance condition SARs as of September 30, 2015 and December 31, 2014, respectively.

(3)

Includes 0.1 million market condition and 1.5 million performance condition SARs.    

(4)

Includes 0.1 million market condition SARs.

(5)

Includes 0.3 million performance condition SARs.

The weighted-average grant date fair value of SARs granted during the three months ended September 30, 2015 and 2014 was $24.11 and $20.88, respectively. The weighted-average grant date fair value of SARs granted during the nine months ended September 30, 2015 and 2014 was $12.88 and $25.71, respectively. The total intrinsic value of stock options and SARs exercised during the three months ended September 30, 2015 and 2014 was $4.2 million and $2.4 million, respectively. The total intrinsic value of stock options and SARs exercised during the nine months ended September 30, 2015 and 2014 was $23.8 million and $37.4 million, respectively.

 

Incentive Plan and Independent Directors Stock Units

 

Shares

 

 

Weighted

Average

Grant Date

Fair Value

 

 

 

(In thousands)

 

 

 

 

 

Outstanding and nonvested December 31, 2014

 

 

33

 

 

$

63.67

 

Granted

 

 

30

 

 

$

47.80

 

Vested

 

 

(26

)

 

$

62.29

 

Forfeited

 

 

(2

)

 

$

59.98

 

Outstanding and nonvested September 30, 2015

 

 

35

 

 

$

51.21

 

 

The total vesting date fair value of stock units which vested during the three months ended September 30, 2015 and 2014 was $0.3 million and $0.2 million, respectively. The total vesting date fair value of stock units which vested during the nine months ended September 30, 2015 and 2014 was $1.3 million and $8.7 million, respectively.

 

19


 

The Company recognizes excess tax benefits associated with share-based compensation to shareholders’ deficit only when realized. When assessing whether excess tax benefits relating to share-based compensation have been realized, the Company follows the with-and-without approach. Under this approach, excess tax benefits related to share-based compensation are not deemed to be realized until after the utilization of all other tax benefits available to the Company, which are also subject to applicable limitations. As of September 30, 2015 and December 31, 2014, the Company had $24.1 million and $23.6 million, respectively, of unrealized excess tax benefits.

 

 

8. Income Taxes

Income taxes were $43.9 million and $114.8 million for the three and nine months ended September 30, 2015, respectively, as compared to a benefit of $13.3 million and an expense of $76.9 million for the same periods in 2014, respectively. The effective income tax rate was 31.9% and 31.1% for the three and nine months ended September 30, 2015, respectively, as compared to 647.9% and 27.2% for the same periods in 2014, respectively. The decrease in the effective tax rate for the three months ended September 30, 2015, as compared to the same period in 2014, was due to the change in the geographic mix of the Company’s income, primarily related to the decrease in Herbalife Venezuela’s foreign exchange losses, and also due to the decrease in net benefits from discrete events.  The increase in the effective tax rate for the nine months ended September 30, 2015, as compared to the same period in 2014, was primarily due to the impact of changes in the geographic mix of the Company’s income.

During the three months ended September 30, 2015, the Company utilized $240.8 million of its deferred tax asset balance relating to intercompany deferred interest expense as of December 31, 2014 and reduced its valuation allowance for the same amount, as a result of a taxable distribution of an intercompany asset between Herbalife subsidiaries that occurred during the current period.  There was no net impact to the Company’s condensed consolidated balance sheet, condensed consolidated statement of income, or condensed consolidated statement of cash flows.

As of September 30, 2015, the total amount of unrecognized tax benefits, including related interest and penalties was $57.7 million. If the total amount of unrecognized tax benefits was recognized, $45.5 million of unrecognized tax benefits, $7.0 million of interest and $1.4 million of penalties would impact the effective tax rate.

The Company believes that it is reasonably possible that the amount of unrecognized tax benefits could decrease by up to approximately $12.7 million within the next twelve months. Of this possible decrease, $5.7 million would be due to the settlement of audits or resolution of administrative or judicial proceedings. The remaining possible decrease of $7.0 million would be due to the expiration of statute of limitations in various jurisdictions.

 

 

9. Derivative Instruments and Hedging Activities

Foreign Currency Instruments

The Company also designates certain foreign currency derivatives, primarily comprised of foreign currency forward contracts, as freestanding derivatives for which hedge accounting does not apply. The changes in the fair market value of these freestanding derivatives are included in selling, general and administrative expenses in the Company’s condensed consolidated statements of income. The Company uses freestanding foreign currency derivatives to hedge foreign-currency-denominated intercompany transactions and to partially mitigate the impact of foreign currency fluctuations. The fair value of the freestanding foreign currency derivatives is based on third-party quotes. The Company’s foreign currency derivative contracts are generally executed on a monthly basis.

The Company designates as cash-flow hedges those foreign currency forward contracts it enters into to hedge forecasted inventory purchases and intercompany management fees that are subject to foreign currency exposures. Forward contracts are used to hedge forecasted inventory purchases over specific months. Changes in the fair value of these forward contracts, excluding forward points, designated as cash-flow hedges are recorded as a component of accumulated other comprehensive income (loss) within shareholders’ deficit, and are recognized in cost of sales in the condensed consolidated statement of income during the period which approximates the time the hedged inventory is sold. The Company also hedges forecasted intercompany management fees over specific months. These contracts allow the Company to sell Euros in exchange for U.S. dollars at specified contract rates. Changes in the fair value of these forward contracts designated as cash flow hedges are recorded as a component of accumulated other comprehensive income (loss) within shareholders’ deficit, and are recognized in selling, general and administrative expenses in the condensed consolidated statement of income during the period when the hedged item and underlying transaction affect earnings.

 

20


 

As of September 30, 2015 and December 31, 2014, the aggregate notional amounts of all foreign currency contracts outstanding designated as cash flow hedges were approximately $104.3 million and $225.3 million, respectively. At September 30, 2015, these outstanding contracts were expected to mature over the next twelve months. The Company’s derivative financial instruments are recorded on the condensed consolidated balance sheet at fair value based on third-party quotes. As of September 30, 2015, the Company recorded assets at fair value of $5.7 million and liabilities at fair value of $1.1 million relating to all outstanding foreign currency contracts designated as cash-flow hedges. As of December 31, 2014, the Company recorded assets at fair value of $12.3 million and liabilities at fair value of $1.6 million relating to all outstanding foreign currency contracts designated as cash-flow hedges. The Company assesses hedge effectiveness and measures hedge ineffectiveness at least quarterly. During the three and nine months ended September 30, 2015 and 2014, the ineffective portion relating to these hedges was immaterial and the hedges remained effective as of September 30, 2015 and December 31, 2014.

As of September 30, 2015 and December 31, 2014, the majority of the Company’s outstanding foreign currency forward contracts had maturity dates of less than twelve months with the majority of freestanding derivatives expiring within one and two months as of September 30, 2015 and December 31, 2014, respectively. As of September 30, 2015, the Company had aggregate notional amounts of approximately $552.0 million of foreign currency contracts, inclusive of freestanding contracts and contracts designated as cash flow hedges.

Gains and Losses on Derivative Instruments

The following table summarizes gains (losses) relating to derivative instruments recorded in other comprehensive income (loss) during the three and nine months ended September 30, 2015 and 2014:

 

 

 

Amount of Gain (Loss) Recognized

in Other Comprehensive Loss

 

 

 

For the Three Months Ended

 

 

For the Nine Months Ended

 

 

 

September 30,

2015

 

 

September 30,

2014

 

 

September 30,

2015

 

 

September 30,

2014

 

 

 

(In millions)

 

Derivatives designated as hedging instruments:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Foreign exchange currency contracts relating to

   inventory and intercompany management fee hedges

 

$

4.2

 

 

$

6.2