TMCnet News
HERBALIFE LTD. - 10-K - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS(Edgar Glimpses Via Acquire Media NewsEdge) You should read the following discussion and analysis in conjunction with Item 6 - Selected Financial Data and our consolidated financial statements and related notes, each included elsewhere in this Annual Report on Form 10-K. We are a leading global nutrition company that sells weight management products, nutritional supplements, energy, sports & fitness products and personal care products utilizing network marketing distribution. As of December 31, 2013, we sold our products to and through a network of 3.7 million independent members, or Members, which include approximately 0.2 million China sales representatives, sales officers, and independent service providers, many of whom are simply discount customers. In China, we currently sell our products through retail stores, sales representatives, sales officers and independent service providers. We are in the process of changing our terminology to identify "distributors" as "Members." Those Members who participate in the business opportunity that our network marketing program presents are referred to as "sales leaders." We pursue our mission of "changing people's lives" by providing high quality, science-based products to Members and their customers who seek a healthy lifestyle and we also offer a financially rewarding business opportunity to those Members who seek part time or full time income. We believe the global obesity epidemic has made our quality products more relevant and the effectiveness of our distribution network, coupled with geographic expansion, have been the primary reasons for our success throughout our 34-year operating history. As of December 31, 2013, we sold our products in 91 countries. Our products are grouped in four principal categories: weight management; targeted nutrition; energy, sports & fitness; and outer nutrition, along with literature and promotional items. Our products are often sold through a series of related products and literature designed to simplify weight management and nutrition for consumers and maximize our Members' cross-selling opportunities. Industry-wide factors that affect us and our competitors include the global obesity epidemic and the aging of the worldwide population, which are driving demand for weight management, nutrition and wellness-related products along with the global increase in under employment and unemployment which can affect the recruitment and retention of Members seeking part time or full time income opportunities. While we continue to monitor the current global financial environment, we remain focused on the opportunities and challenges in retailing of our products, recruiting and retaining Members, improving Member productivity, opening new markets, further penetrating existing markets, globalizing successful Distributor Methods of Operation, or DMOs, such as Nutrition Clubs and Weight Loss Challenges, introducing new products and globalizing existing products, developing niche market segments and further investing in our infrastructure. Management also continues to monitor the Venezuelan market and especially the limited ability to repatriate cash. We report revenue from our six regions: • North America; • Mexico; • South and Central America; • EMEA, which consists of Europe, the Middle East and Africa; • Asia Pacific (excluding China); and • China. 52 -------------------------------------------------------------------------------- Table of Contents Volume Points by Geographic Region A key non-financial measure we focus on is Volume Points on a Royalty Basis, or Volume Points, which is essentially our weighted average measure of product sales volume. Volume Points, which are unaffected by exchange rates or price changes, are used by management as a proxy for sales trends because in general, an increase in Volume Points in a particular geographic region or country indicates an increase in our local currency net sales while a decrease in Volume Points in a particular geographic region or country indicates a decrease in our local currency net sales. We assign a Volume Point value to a product when it is first introduced into a market and the value is unaffected by subsequent exchange rate and price changes. The specific number of Volume Points assigned to a product, and generally consistent across all markets, is based on a Volume Point to suggested retail price ratio for similar products. If a product is available in different quantities, the various sizes will have different Volume Point values. In general, once assigned, a Volume Point value is consistent in each region and country and does not change from year to year. The reason Volume Points are used in the manner described above is that we use Volume Points for Member qualification and recognition purposes and therefore we attempt to keep Volume Points for a similar or like product consistent on a global basis. However, because Volume Points are a function of value rather than product type or size, they are not a reliable measure for product mix. As an example, an increase in Volume Points in a specific country or region could mean a significant increase in sales of less expensive products or a marginal increase in sales of more expensive products. For the Year Ended December 31, 2013 2012 % Change 2012 2011 % Change (Volume points in millions) North America 1,249.9 1,157.8 8.0 % 1,157.8 987.1 17.3 % Mexico 864.3 815.4 6.0 % 815.4 704.5 15.7 % South & Central America 966.2 740.4 30.5 % 740.4 569.9 29.9 % EMEA 698.0 602.5 15.9 % 602.5 545.0 10.6 % Asia Pacific (excluding China) 1,225.4 1,197.8 2.3 % 1,197.8 961.6 24.6 % China 333.6 206.5 61.5 % 206.5 153.8 34.3 % Worldwide 5,337.4 4,720.4 13.1 % 4,720.4 3,921.9 20.4 % Average Active Sales Leaders by Geographic Region With the continued expansion of daily consumption DMOs in our different markets and our objective to improve Member retention, we believe the Average Active Sales Leader is a useful metric. It represents the monthly average number of sales leaders that place an order, including orders of non-sales leader Members in their downline sales organization, during a given period. We rely on this metric as an indication of the engagement level of sales leaders in a given region. Changes in the Average Active Sales Leader metric may be indicative of potential for changes in annual retention levels and future sales growth. For the Year Ended December 31, For the Year Ended December 31, 2013 2012 % Change 2012 2011 % Change North America 72,058 66,054 9.1 % 66,054 56,741 16.4 % Mexico 63,581 57,651 10.3 % 57,651 47,697 20.9 % South & Central America 58,090 44,980 29.1 % 44,980 34,938 28.7 % EMEA 49,650 44,098 12.6 % 44,098 38,607 14.2 % Asia Pacific (excluding China) 71,542 63,255 13.1 % 63,255 48,195 31.2 % China 14,808 11,683 26.7 % 11,683 8,814 32.6 % Worldwide(1) 318,740 277,803 14.7 % 277,803 227,308 22.2 % 53 -------------------------------------------------------------------------------- Table of Contents (1) Worldwide average active sales leaders may not equal the sum of the average active sales leaders in each region due to the calculation being an average of sales leaders active in a period, not a summation, and the fact that some sales leaders are active in more than one region but are counted only once in the worldwide amount. Number of Sales Leaders and Retention Rates by Geographic Region as of Re-qualification Period Our compensation system requires each sales leader to re-qualify for such status each year, prior to February, in order to maintain their 50% discount on products and be eligible to receive royalty payments. In February of each year, we demote from the rank of sales leader those Members who did not satisfy the re-qualification requirements during the preceding twelve months. The re-qualification requirement does not apply to new sales leaders (i.e. those who became sales leaders subsequent to the January re-qualification of the prior year). Sales Leaders Statistics (Excluding China) 2013 2012 2011 (In thousands) January 1 total sales leaders 583.1 501.3 434.2 January & February new sales leaders 37.1 34.8 28.9 Demoted sales leaders (did not re-qualify) (182.8 ) (151.3 ) (144.8 ) Other sales leaders (resigned, etc) (1.3 ) (0.8 ) (0.8 ) End of February total sales leaders 436.1 384.0 317.5 The Member statistics below further highlight the calculation for retention. Sales Leaders Retention (Excluding China) 2013 2012 2011 (In thousands) Sales leaders needed to re-qualify 379.6 314.9 283.2 Demoted sales leaders (did not re-qualify) (182.8 ) (151.3 ) (144.8 ) Total re-qualified 196.8 163.6 138.4 Retention rate 51.8 % 52.0 % 48.9 % The table below reflects the number of sales leaders as of the end of February of the year indicated (subsequent to the annual re-qualification date) and sales leader retention rate by year and by region. Number of Sales Leaders Sales Leaders Retention Rate 2013 2012 2011 2013 2012 2011 North America 86,469 79,150 72,152 54.7 % 51.1 % 48.6 % Mexico 78,453 67,959 54,526 57.6 % 59.2 % 57.9 % South & Central America 79,351 65,653 50,288 53.6 % 55.7 % 47.3 % EMEA 57,071 55,121 49,696 60.7 % 61.5 % 58.6 % Asia Pacific (excluding China) 134,714 116,158 90,822 40.1 % 40.2 % 38.4 % Total Sales leaders 436,058 384,041 317,484 51.8 % 52.0 % 48.9 % China 30,304 26,262 30,543 Worldwide Total Sales Leaders 466,362 410,303 348,027 Sales leaders purchase most of our products for resale to other Members and consumers. The number of sales leaders by geographic region as of the quarterly reporting dates will normally be higher than the number of sales leaders by geographic region as of the re-qualification period because sales leaders who do not re-qualify 54 -------------------------------------------------------------------------------- Table of Contents during the relevant twelve-month period will be removed from the rank of sales leader the following February. Comparisons of sales leader totals on a year-to-year basis are indicators of our recruitment and retention efforts in different geographic regions. We provide Members with products, support materials, training, special events and a competitive compensation program. If a Member wants to pursue the Herbalife business opportunity, the Member is responsible for growing his or her business and personally pays for the sales activities related to attracting new customers and recruiting Members. Activities may include hosting events such as Herbalife Opportunity Meetings or Success Training Seminars; advertising Herbalife's products; purchasing and using promotional materials such as t-shirts, buttons and caps; utilizing and paying for direct mail and print material such as brochures, flyers, catalogs, business cards, posters and banners and telephone book listings; purchasing inventory for sale or use as samples; and training and mentoring customers and recruits on how to use Herbalife products and/or pursue the Herbalife business opportunity. Presentation "Retail sales" represent the suggested retail price of products we sell to our Members and is the gross sales amount reflected on our invoices. This is not the price paid to us by our Members. Our Members purchase product from us at a discount from the suggested retail price. We refer to these discounts as "Distributor Allowance", and we refer to retail sales less distributor allowances as "Product Sales". Total distributor allowances for 2013, 2012 and 2011 were 44.1%, 45.7% and 45.7% of Retail Sales, respectively. Distributor allowances as a percentage of retail sales may vary by country depending upon regulatory restrictions that limit or otherwise restrict distributor allowances. We also offer reduced distributor allowances with respect to certain products worldwide. Each Member's level of discount is determined by qualification based on volume of purchases. In cases where a Member has qualified for less than the maximum discount, the remaining discount, which we also refer to as a wholesale commission, is received by their sponsoring Members. Therefore, product sales are recognized net of product returns and distributor allowances. "Net Sales" equal product sales plus "shipping and handling revenues", and generally represents what we collect. During 2013 we simplified our pricing structure for most markets, increasing suggested retail prices and reducing total shipping and handling fees, eliminating a "packaging and handling" line item from our invoices to Members, with no impact on total Member cost. In conjunction, the method for Distributor Allowances and Marketing Plan payouts now generally utilizes 90% to 95% of suggested retail price, depending on the product and market, to which we apply discounts of up to 50% for Distributor Allowances and payout rates of up to 15% for royalty overrides, up to 7% for production bonuses, and approximately 1% for the Mark Hughes bonus. Consequently, the revision to our pricing structure did not have a meaningful impact on the amounts of Distributor Allowance or payouts under our Marketing Plan and did not materially impact our consolidated Net Sales and profitability. We do not have visibility to all of the sales from our Members to their customers, but such a figure would differ from our reported "retail sales" by factors including (a) the amount of product purchased by our Members for their own personal consumption and (b) prices charged by our Members to their customers other than our suggested retail prices. We discuss retail sales because of its fundamental role in our systems, internal controls and operations, and its correlation to Member discounts and Royalty Overrides. In addition, it is used as the basis for certain information included in daily and monthly reports reviewed by our management. However, such a measure is not in accordance with U.S. generally accepted accounting principles, or U.S. GAAP. Retail sales should not be considered in isolation from, nor as a substitute for, net sales and other consolidated income or cash flow statement data prepared in accordance with U.S. GAAP, or as a measure of profitability or liquidity. A reconciliation of retail sales to net sales is presented below under Results of Operations. Our international operations have provided and will continue to provide a significant portion of our total net sales. As a result, total net sales will continue to be affected by fluctuations in the U.S. dollar against foreign 55-------------------------------------------------------------------------------- Table of Contents currencies. In order to provide a framework for assessing how our underlying businesses performed excluding the effect of foreign currency fluctuations, in addition to comparing the percent change in net sales from one period to another in U.S. dollars, we also compare the percent change in net sales from one period to another period using "net sales in local currency". Net sales in local currency is not a U.S. GAAP financial measure. Net sales in local currency removes from net sales in U.S. dollars the impact of changes in exchange rates between the U.S. dollar and the functional currencies of our foreign subsidiaries, by translating the current period net sales into U.S. dollars using the same foreign currency exchange rates that were used to translate the net sales for the previous comparable period. We believe presenting net sales in local currency is useful to investors because it allows a meaningful comparison of net sales of our foreign operations from period to period. However, net sales in local currency measures should not be considered in isolation or as an alternative to net sales in U.S. dollar measures that reflect current period exchange rates, or to other financial measures calculated and presented in accordance with U.S. GAAP. Our "gross profit" consists of net sales less "cost of sales," which represents our manufacturing costs, the price we pay to our raw material suppliers and manufacturers of our products as well as shipping and handling costs including duties, tariffs, and similar expenses. While all Members can potentially profit from their activities by reselling our products for amounts greater than the prices they pay us, Members that develop, retain, and manage other Members can earn additional compensation for those activities, which we refer to as "Royalty overrides." Royalty overrides are our most significant operating expense and consist of: • royalty overrides and production bonuses; • the Mark Hughes bonus payable to some of our most senior Members; and • other discretionary incentive cash bonuses to qualifying Members. During 2013, 2012 and 2011, total Royalty overrides were 31.0%, 32.9% and 32.9% of our net sales, respectively. Royalty overrides are compensation to Members for the development, retention and improved productivity of their sales organizations and are paid to several levels of Members on each sale. Royalty overrides are compensation for services rendered to the Company and as such are recorded as an operating expense. Due to restrictions on direct selling in China, our independent service providers in China are compensated with service fees instead of the distributor allowances and royalty overrides utilized in our traditional marketing program. Compensation to China independent service providers is included in selling, general and administrative expenses. Because of local country regulatory constraints, we may be required to modify our Member incentive plans as described above. We also pay reduced royalty overrides with respect to certain products worldwide. Consequently, the total royalty override percentage may vary over time and from the percentages noted above. Our "contribution margins" consist of net sales less cost of sales and royalty overrides. "Selling, general and administrative expenses" represent our operating expenses, which include labor and benefits, sales events, professional fees, travel and entertainment, Member promotions, occupancy costs, communication costs, bank fees, depreciation and amortization, foreign exchange gains and losses and other miscellaneous operating expenses. Most of our sales to Members outside the United States are made in the respective local currencies. In preparing our financial statements, we translate revenues into U.S. dollars using average exchange rates. Additionally, the majority of our purchases from our suppliers generally are made in U.S. dollars. Consequently, a strengthening of the U.S. dollar versus a foreign currency can have a negative impact on our reported sales and contribution margins and can generate foreign currency losses on intercompany transactions. Foreign currency exchange rates can fluctuate significantly. From time to time, we enter into foreign exchange forward and option contracts to partially mitigate our foreign currency exchange risk as discussed in further detail in Item 7A - Quantitative and Qualitative Disclosures about Market Risk. 56-------------------------------------------------------------------------------- Table of Contents Results of Operations Our results of operations for the periods below are not necessarily indicative of results of operations for future periods, which depend upon numerous factors, including our ability to recruit new Members and retain existing Members, open new markets, further penetrate existing markets, introduce new products and programs that will help our Members increase their retail efforts and develop niche market segments. The following table sets forth selected results of our operations expressed as a percentage of net sales for the periods indicated: Year Ended Year Ended Year Ended December 31, December 31, December 31, 2013 2012 2011 Operations: Net sales 100.0 % 100.0 % 100.0 % Cost of sales 20.0 19.9 19.7 Gross profit 80.0 80.1 80.3 Royalty overrides(1) 31.0 32.9 32.9 Selling, general and administrative expenses(1) 33.8 30.9 31.1 Operating income 15.2 16.3 16.3 Interest expense 0.6 0.4 0.3 Interest income 0.2 0.1 0.2 Income before income taxes 14.8 16.0 16.2 Income taxes 3.9 4.6 4.2 Net income 10.9 11.4 12.0 (1) Compensation to our China sales employees and service fees to our independent service providers in China are included in selling, general and administrative expenses while Member compensation for all other countries is included in royalty overrides. Changes in net sales are directly associated with the recruiting and retention of our Member force, retailing of our products, the quality and completeness of our product offerings that the Member force has to sell and the number of countries in which we operate. Management's role, both in-country and at the region and corporate level, is to provide Members with a competitive and broad product line, encourage strong teamwork and Member leadership and offer leading edge business tools and technology services to make doing business with Herbalife simple. Management uses the Member marketing program coupled with educational and motivational tools and promotions to encourage Members to increase recruiting, retention and retailing, which in turn affect net sales. Such tools include Company sponsored sales events such as Extravaganzas, Leadership Development Weekends and World Team Schools where large groups of Members gather, thus allowing them to network with other Members, learn recruiting, retention and retailing techniques from our leading Members and become more familiar with how to market and sell our products and business opportunities. Accordingly, management believes that these development and motivation programs increase the productivity of the sales leader network. The expenses for such programs are included in selling, general and administrative expenses. Sales are driven by several factors, including the number and productivity of Members and sales leaders who continually build, educate and motivate their respective distribution and sales organizations. We also use event and non-event product promotions to motivate Members to increase recruiting, retention and retailing activities. These promotions have prizes ranging from qualifying for events to product prizes and vacations. The costs of these promotions are included in selling, general and administrative expenses. The factors described above have helped Members increase their business, which in turn helps drive Volume Point growth in our business, and thus, net sales growth. The discussion below of net sales by geographic 57-------------------------------------------------------------------------------- Table of Contents region further details some of the specific drivers of growth of our business and causes of sales fluctuations during the year ended December 31, 2013 as compared to the same period in 2012 and during the year ended December 31, 2012 as compared to the same period in 2011, as well as the unique growth or contraction factors specific to certain geographic regions or significant countries within a region during these periods. We believe that the correct business foundation, coupled with ongoing training and promotional initiatives, is required to increase recruiting and retention of Members and retailing of our products. The correct business foundation includes strong country management that works closely with the Member leadership, actively engaged and unified Member leadership, a broad product line that appeals to local consumer needs, a favorable regulatory environment, a scalable and stable technology platform and an attractive Member marketing plan. Initiatives, such as Success Training Seminars, Leadership Development Weekends, Promotional Events and regional Extravaganzas are integral components of developing a highly motivated and educated Member sales organization that will work toward increasing the recruitment and retention of Members. We anticipate that our strategy will continue to include creating and maintaining growth within existing markets while expanding into new markets. In addition, new ideas and DMOs are being generated in many of our markets and are globalized where applicable through the combined efforts of Members, country management or regional and corporate management. While we support a number of different DMOs, one of the more popular DMOs is the daily consumption DMO. Under our traditional DMO, a Member typically sells to its customers on a somewhat infrequent basis (e.g., monthly) which provides fewer opportunities for interaction with their customers. Under a daily consumption DMO, a Member interacts with its customers on a more frequent basis which enables the Member to better educate and advise customers about nutrition and the proper use of the products and helps promote daily usage as well, thereby helping the Member grow his or her business. Specific examples of DMOs include the Club concept in Mexico, Premium Herbalife Opportunity Meetings in Korea, the Healthy Breakfast concept in Russia, and the Internet/Sampling and Weight Loss Challenge in the U.S. Management's strategy is to review the applicability of expanding successful country initiatives throughout a region, and where appropriate, financially support the globalization of these initiatives. Financial Results for the year ended December 31, 2013 compared to the year ended December 31, 2012 Net sales for the year ended December 31, 2013 increased 18.5% to $4,825.3 million as compared to $4,072.3 million in 2012. In local currency, net sales for the year ended December 31, 2013 increased 19.4% as compared to the same period in 2012. The increase in net sales was primarily due to the continued successful adoption and operation of daily consumption DMOs; increased Member engagement and an increase in average active sales leaders; branding activities and increased Member recruiting. Net income for the year ended December 31, 2013 increased 13.7% to $527.5 million, or $4.91 per diluted share, compared to $464.0 million, or $3.94 per diluted share, for the same period in 2012. The increase was primarily due to higher contribution margin driven by net sales growth discussed above, partially offset by higher selling, general and administrative expenses to support the growth of our business and for the legal and advisory services described below, higher interest expense and higher income taxes. Net income for the year ended December 31, 2013 included approximately $29.1 million pre-tax unfavorable impact ($24.5 million post-tax) related to legal and advisory services and other expenses for the Company's response to allegations and other negative information put forward in the marketplace by a hedge fund manager which started in late 2012 and approximately $20.4 million pre-tax unfavorable impact ($15.6 million post-tax) related to expenses for the re-audit of the Company's 2010 to 2012 financial statements (See Selling, General and Administrative Expenses below for further discussion). Net income for year ended December 31, 2013 also included a $15.1 million pre-tax unfavorable impact ($9.8 million post-tax) related to the Venezuela Bolivar devaluation (See Liquidity and Capital Resources - Currency Restrictions in Venezuela below for further discussion of currency exchange rate issues in Venezuela). 58-------------------------------------------------------------------------------- Table of Contents Net Sales The following chart reconciles retail sales to net sales: Sales by Geographic Region Year Ended December 31, 2013 2012 Shipping & Shipping & Change Retail Distributor Product Handling Net Retail Distributor Product Handling Net in Net Sales(1) Allowance Sales Revenues(1) Sales Sales Allowance Sales Revenues Sales Sales (Dollars in millions) North America $ 1,485.6 $ (685.4 ) $ 800.2 $ 107.8 $ 908.0 $ 1,334.2 $ (635.8 ) $ 698.4 $ 142.8 $ 841.2 7.9 % Mexico 937.6 (444.8 ) 492.8 69.6 562.4 802.1 (391.7 ) 410.4 85.7 496.1 13.4 % South & Central America 1,519.6 (718.8 ) 800.8 172.7 973.5 1,134.2 (544.5 ) 589.7 99.1 688.8 41.3 % EMEA 1,198.4 (572.1 ) 626.3 108.9 735.2 1,018.3 (492.7 ) 525.6 102.2 627.8 17.1 % Asia Pacific 1,815.3 (805.8 ) 1,009.5 165.1 1,174.6 1,780.6 (806.2 ) 974.4 165.5 1,139.9 3.0 % China 557.5 (86.4 ) 471.1 0.5 471.6 334.9 (56.5 ) 278.4 0.1 278.5 69.3 % Worldwide $ 7,514.0 $ (3,313.3 ) $ 4,200.7 $ 624.6 $ 4,825.3 $ 6,404.3 $ (2,927.4 ) $ 3,476.9 $ 595.4 $ 4,072.3 18.5 % (1) During 2013 we simplified our pricing structure for most markets by increasing suggested retail prices and reducing total shipping and handling revenues by a similar amount, eliminating a "packaging and handling" line item from our invoices to Members. These changes did not materially impact our consolidated Net Sales and profitability. North America The North America region reported net sales of $908.0 million for the year ended December 31, 2013. Net sales increased $66.8 million, or 7.9%, for the year ended December 31, 2013, as compared to the same period in 2012. In local currency, net sales increased 8.0% for the year ended December 31, 2013, as compared to the same period in 2012. The overall increase in net sales in the region was a result of net sales growth in the U.S. of $64.0 million, or 7.8%, for the year ended December 31, 2013, as compared to the same period in 2012. In the U.S. we continue to see the success of our Members converting their business strategy toward daily consumption DMOs, especially the Nutrition Club. Average active sales leaders in the region increased 9.1% for the year ended December 31, 2013, as compared to the same period in 2012. In February 2013, the region hosted a series of trainings in nine cities with approximately 8,500 attendees. In April, the region hosted a series of General market trainings in thirteen cities with approximately 7,200 attendees. In June, the region hosted a series of Latin market trainings in nine cities with approximately 12,400 attendees. In July, the region hosted a series of General Market trainings in thirteen cities with a total of approximately 7,800 attendees. In October, the region hosted a General market Extravaganza in Las Vegas and a Latin market Extravaganza in Los Angeles with attendance of approximately 11,600 and 13,000, respectively. Mexico The Mexico region reported net sales of $562.4 million for the year ended December 31, 2013. Net sales for the year ended December 31, 2013 increased $66.3 million, or 13.4%, as compared to the same period in 2012. In local currency, net sales for the year ended December 31, 2013 increased 10.0% as compared to the same period in 2012. The fluctuation of foreign currency rates had a favorable impact of $16.8 million on net sales for the year ended December 31, 2013. 59 -------------------------------------------------------------------------------- Table of Contents The growth in net sales is primarily the result of increased Member engagement as well as the continued success of the Nutrition Club DMO. One of the recent growth drivers in Mexico has been the ongoing transition from home clubs to commercial clubs by many Members, which are able to generate higher volumes of sales through the servicing of more customers and longer operating hours. Average active sales leaders in Mexico increased 10.3% for the year ended December 31, 2013, as compared to the same period in 2012. In May, the region hosted two Leadership trainings in Puerto Vallarta and Acapulco with a total of approximately 16,200 attendees. In September, the region hosted an Extravaganza in Mexico City and in Guadalajara with a total of approximately 28,300 attendees. South and Central America The South and Central America region reported net sales of $973.5 million for the year ended December 31, 2013. Net sales increased $284.7 million, or 41.3%, for the year ended December 31, 2013, as compared to the same period in 2012. In local currency, net sales increased 49.0% for the year ended December 31, 2013, as compared to the same period in 2012. The fluctuation of foreign currency rates had a $52.7 million unfavorable impact on net sales for the year ended December 31, 2013. The increase in net sales for the year ended December 31, 2013, as compared to the same period in 2012, was due to an increase in net sales in almost every country in the region led by Brazil, Venezuela and Colombia. This growth was primarily driven by the adoption and expansion of daily consumption DMOs throughout the region. In Brazil, the region's largest market, net sales increased $66.3 million, or 21.0%, for the year ended December 31, 2013, as compared to the same period in 2012. In local currency, net sales increased 33.8% for the year ended December 31, 2013, as compared to the same period in 2012. The fluctuation of foreign currency rates had a $40.2 million unfavorable impact on net sales in Brazil for the year ended December 31, 2013. The increase in net sales continues to be driven by the successful adoption of Nutrition Clubs and other daily consumption DMOs. Venezuela, the region's second largest market, experienced a net sales increase of $124.4 million, or 87.6%, for the year ended December 31, 2013, as compared to the same period in 2012. In local currency, net sales increased 87.6% for the year ended December 31, 2013, as compared to the same period in 2012. The overall sales growth was primarily due to increased Member engagement and growth in the Nutrition Club DMO. Venezuela also had price increases of 15% in December 2012, 17% in April 2013, and 19% in July 2013, all of which contributed to the increase in sales. The Company initiated price increases in Venezuela of 30% and 23% during December 2013 in order to better align product prices with the economic conditions of the market. The overall impact of these price increases could decrease volume in 2014. During January 2014, an additional price increase was planned but not allowed after a review by local governmental agencies. Commencing in 2014, the Company has taken numerous initiatives to reduce its economic exposure to this market, including limiting product imports. The rate for which we remeasure sales in Venezuela was officially devalued from 5.3 Venezuelan Bolivars per U.S. dollar to 6.3 Venezuelan Bolivars per U.S. dollar during February 2013, and had a $46.6 million unfavorable impact on net sales in Venezuela for the year ended December 31, 2013. See Liquidity and Capital Resources - Working Capital and Operating Activities below for further discussion of currency exchange rate issues in Venezuela. Average active sales leaders in the region increased 29.1% for the year ended December 31, 2013, as compared to the same period in 2012. In February 2013, the region hosted a regional Extravaganza in Bogota, Colombia with approximately 20,200 attendees. In May, the region held three Brazil Extravaganzas with approximately 15,000 attendees. In October, Brazil hosted a World Team School event with approximately 5,500 attendees. 60-------------------------------------------------------------------------------- Table of Contents EMEA The EMEA region reported net sales of $735.2 million for the year ended December 31, 2013. Net sales increased $107.4 million, or 17.1%, for the year ended December 31, 2013, as compared to the same period in 2012. In local currency, net sales increased 16.3% for the year ended December 31, 2013, as compared to the same period in 2012. The fluctuation of foreign currency rates had a favorable impact on net sales of $5.0 million for the year ended December 31, 2013. The increase in net sales for the year ended December 31, 2013 was primarily driven by increases in Russia, the United Kingdom, Spain, and Italy. Net sales in Russia, our largest market in the region, increased $25.0 million, or 24.7%, for the year ended December 31, 2013, as compared to the same period in 2012. In local currency, net sales increased 28.2% for the year ended December 31, 2013, as compared to the same period in 2012. The fluctuation of foreign currency rates had a $3.6 million unfavorable impact on net sales in Russia for the year ended December 31, 2013. The increase in Russia was driven by the ongoing adoption of the Commercial Nutrition Club, additional sales centers which have increased access to our products and branding including the sponsorship of FC Spartak Moscow football club. Net sales in Italy, our second largest market in the region, increased $13.4 million, or 13.7%, for the year ended December 31, 2013, as compared to the same period in 2012. In local currency, net sales increased 10.1% for the year ended December 31, 2013, as compared to the same period in 2012. The fluctuation of foreign currency rates had a $3.6 million favorable impact on net sales in Italy for the year ended December 31, 2013. Italy has now had three consecutive quarters of positive year-over-year sales growth. Management believes this is a strong indication that the market is embracing the daily consumption DMO. Net sales in Spain, our third largest market in the region, increased $15.4 million, or 29.1%, for the year ended December 31, 2013, as compared to the same period in 2012. In local currency, net sales in Spain increased 24.7% for the year ended December 31, 2013, as compared to the same period in 2012. The fluctuation of foreign currency rates had a $2.3 million favorable impact on net sales in Spain for the year ended December 31, 2013. The increase in Spain was mainly due to the positive effect of increased Member engagement and recruitment. Net sales in the United Kingdom increased $25.5 million, or 80.5%, for the year ended December 31, 2013, as compared to the same period in 2012. In local currency, net sales in the United Kingdom increased 83.0% for the year ended December 31, 2013, as compared to the same period in 2012. The fluctuation of foreign currency rates had a $0.8 million unfavorable impact on net sales in the United Kingdom for the year ended December 31, 2013. The increase in the United Kingdom was primarily due to the successful adoption of Nutrition Clubs and Weight Loss Challenge DMO. Average active sales leaders in the region increased 12.6% for the year ended December 31, 2013, as compared to the same period in 2012. In September, the region hosted four Extravaganzas including two in Russia (St. Petersburg and Krasnoyarsk), one in Istanbul, Turkey, and one in Cologne, Germany. The Germany and Turkey events had approximately 15,000 and 3,900 attendees, respectively, while the Russia events had a total of approximately 8,100 attendees. In November, South Africa hosted an Extravaganza with approximately 1,750 attendees. Also in November, Russia hosted an Extravaganza in Mongolia with approximately 1,500 attendees. Asia Pacific The Asia Pacific region, which excludes China, reported net sales of $1,174.6 million for the year ended December 31, 2013. Net sales increased $34.7 million, or 3.0%, for the year ended December 31, 2013, as compared to the same period in 2012. In local currency, net sales increased 4.7% for the year ended December 31, 2013, as compared to the same period in 2012. The fluctuation of foreign currency rates had an unfavorable impact of $18.6 million on net sales for the year ended December 31, 2013. The increase in net sales for the year ended December 31, 2013 was driven primarily by growth in Indonesia, South Korea, and Vietnam, partially offset by Japan and Malaysia. 61-------------------------------------------------------------------------------- Table of Contents Net sales in South Korea, our largest market in the region, increased $12.3 million, or 2.9%, for the year ended December 31, 2013, as compared to the same period in 2012. In local currency, net sales for the year ended December 31, 2013 were comparable to the same period in 2012. The fluctuation of foreign currency rates had a favorable impact on net sales of $12.2 million for the year ended December 31, 2013. South Korea continues to be impacted by a modest slowdown in the number of new Nutrition Clubs as well as a decline in productivity in certain Nutrition Clubs compared to the prior year period. Net sales in Taiwan, our second largest market in the region, decreased $6.9 million, or 4.5%, for the year ended December 31, 2013, as compared to the same period in 2012. In local currency, net sales decreased 4.2% for the year ended December 31, 2013, as compared to the same period in 2012. The fluctuation of foreign currency rates had an unfavorable impact on net sales of $0.5 million for the year ended December 31, 2013. Taiwan had their first price increase in almost three years in April and volume in subsequent months was lower than normal as a result. Volume has recently begun to recover although it is still below levels from a year ago. Despite the decrease in net sales for the twelve months ended December 31, 2013 as compared to the prior twelve month period, we believe the overall trend is favorable indicating that the strategic steps taken to address Member business training practices around Nutrition Clubs since fourth quarter 2010 are proving successful. Net sales in India, our third largest market in the region, increased $1.0 million, or 0.7%, for the year ended December 31, 2013, as compared to the same period in 2012. In local currency, net sales increased 10.4% for the year ended December 31, 2013, as compared to the same period in 2012. The fluctuation of foreign currency rates had an unfavorable impact on net sales of $14.0 million for the year ended December 31, 2013. The increase in net sales for the year ended December 31, 2013 was primarily driven by increased product access and the successful adoption of the daily consumption DMOs, especially the Nutrition Club. Net sales in Indonesia, our fourth largest market in the region, increased $32.9 million, or 35.6%, for the year ended December 31, 2013, as compared to the same period in 2012. In local currency, net sales increased 49.6% for the year ended December 31, 2013, as compared to the same period in 2012. The fluctuation of foreign currency rates had an unfavorable impact on net sales of $13.0 million for the year ended December 31, 2013. The primary catalyst driving the sales increase in Indonesia was the growth in Nutrition Clubs. Net sales in Malaysia, our fifth largest market in the region, decreased $11.5 million, or 9.7%, for the year ended December 31, 2013, as compared to the same period in 2012. In local currency, net sales decreased 8.2% for the year ended December 31, 2013, as compared to the same period in 2012. The fluctuation of foreign currency rates had an unfavorable impact on net sales of $1.7 million for the year ended December 31, 2013. The decrease in net sales for the twelve months ended December 31, 2013 reflects, in part, the opening of a competitor in the country on October 1st and the move of several Members to the new company. We believe this is a short term issue and that the impact will not be an issue going forward into 2014. In addition, during 2012 we saw tremendous growth in Nutrition Home Clubs and some of these clubs suffered from a lack of proper training and have declined in number and activity levels as a result. We are working with Member leadership in Malaysia to address these training issues. We believe that the underlying DMO's currently used by Members in the country (Nutrition Clubs, Road Shows, and Mega Herbalife Opportunity Meetings) provide for a solid base of growth going forward. Average active sales leaders in the region increased 13.1% for the year ended December 31, 2013, as compared to the same period in 2012. In June, the region hosted three regional extravaganzas, in South Korea, India and Thailand, with approximately 13,800, 13,500 and 19,000 attendees, respectively. In October, the region hosted an AWT University event in Thailand with approximately 7,300 attendees. China Net sales in China were $471.6 million for the year ended December 31, 2013. Net sales increased $193.1 million, or 69.3%, for the year ended December 31, 2013, as compared to the same period in 2012. In local currency, 62-------------------------------------------------------------------------------- Table of Contents net sales increased 64.7% for the year ended December 31, 2013, as compared to the same period in 2012. The fluctuation of foreign currency rates had a favorable impact of $12.8 million on net sales for the year ended December 31, 2013. The increase in net sales was driven by the continuing adoption and acculturation of daily consumption DMOs. In addition, sales have benefited from Member acceptance of a trial Preferred Customer program which was launched earlier this year as well as on-line ordering. Average active sales leaders in China increased 26.7% for the year ended December 31, 2013, as compared to the same period in 2012. We believe that the increase in Member engagement as reflected in the average active sales leader numbers is indicative of the market transitioning to daily consumption DMOs. As of December 31, 2013, we were operating 66 retail stores in 29 provinces in China and had direct selling licenses to 25 out of the 29 provinces in which we operated. We continue to seek additional provincial licenses where appropriate. In April the region hosted its annual China Extraordinary Tour (Honors) with approximately 8,600 attendees. In July, a Healthy & Activity Tour was held in five cities with a total of approximately 7,500 attendees. In October, the region hosted an Anniversary Rally with approximately 11,200 attendees. Sales by Product Category Year Ended December 31, 2013 2012 Shipping & Shipping & % Change Retail Distributor Product Handling Net Retail Distributor Product Handling Net in Net Sales Allowance Sales Revenues Sales Sales Allowance Sales Revenues Sales Sales (Dollars in millions) Weight Management $ 4,878.5 $ (2,220.3 ) $ 2,658.2 $ 405.5 $ 3,063.7 $ 4,118.8 $ (1,946.8 ) $ 2,172.0 $ 382.9 $ 2,554.9 19.9 % Targeted Nutrition 1,767.4 (804.4 ) 963.0 146.9 1,109.9 1,523.1 (719.9 ) 803.2 141.6 944.8 17.5 % Energy, Sports and Fitness 405.2 (184.4 ) 220.8 33.7 254.5 337.5 (159.5 ) 178.0 31.4 209.4 21.5 % Outer Nutrition 250.4 (114.0 ) 136.4 20.8 157.2 235.9 (111.5 ) 124.4 21.9 146.3 7.5 % Literature, Promotional and Other(1) 212.5 9.8 222.3 17.7 240.0 189.0 10.3 199.3 17.6 216.9 10.7 % Total $ 7,514.0 $ (3,313.3 ) $ 4,200.7 $ 624.6 $ 4,825.3 $ 6,404.3 $ (2,927.4 ) $ 3,476.9 $ 595.4 $ 4,072.3 18.5 % (1) Product buybacks and returns in all product categories are included in the literature, promotional and other category. Net sales for all product categories increased for the year ended December 31, 2013 as compared to the same period in 2012. The growth factors described in the above discussions of the individual geographic regions apply generally to all product categories. Gross Profit Gross profit was $3,861.9 million for the year ended December 31, 2013, as compared to $3,259.7 million for the same period in 2012. As a percentage of net sales, gross profit for the year ended December 31, 2013 was 80.0%, comparable to 80.1% for the same period in 2012. For the year ended December 31, 2013 the favorable impact from retail price increases was primarily offset by the unfavorable impact of inventory write-downs. Royalty Overrides Royalty Overrides were $1,497.6 million for the year ended December 31, 2013, as compared to $1,338.6 million for the same period in 2012. Royalty Overrides as a percentage of net sales was 31.0% for the year ended December 31, 2013 as compared to 32.9% for the same period in 2012. Generally, this ratio varies slightly from 63 -------------------------------------------------------------------------------- Table of Contents period to period due to changes in the mix of products and countries because full royalty overrides are not paid on certain products and in certain countries. Compensation to our sales employees and independent service providers in China is included in selling, general and administrative expenses as opposed to Royalty Overrides where it is included for all other Members under our worldwide marketing plan. We anticipate fluctuations in Royalty Overrides as a percentage of net sales reflecting the growth prospect of our China business relative to that of our worldwide business. Selling, General and Administrative Expenses Selling, general and administrative expenses were $1,629.1 million for the year ended December 31, 2013, as compared to $1,259.7 million for the same period in 2012. Selling, general and administrative expenses as a percentage of net sales were 33.8% for the year ended December 31, 2013, as compared to 30.9% for the same period in 2012. The increase in selling, general and administrative expenses for the year ended December 31, 2013 included $72.8 million in higher salaries, bonuses and benefits; $29.1 million in expenses associated with our response to allegations and other negative information put forward by a hedge fund manager, as further discussed below; $20.4 million in expenses for the re-audit of our 2010 to 2012 financial statements; higher variable expenses related to sales growth including $31.5 million in higher Member promotion and event costs; $92.1 million in higher expenses related to China independent service providers; $17.4 million in higher non-income tax expenses such as value added tax and sales tax and $21.3 million in higher net foreign exchange loss, which included a $15.1 million net foreign exchange loss related to the remeasurement of the Company's Bolivar denominated monetary assets and liabilities resulting from the Venezuela Bolivar devaluation (See Liquidity and Capital Resources - Currency Restrictions in Venezuela, for further discussion of currency exchange rate issues in Venezuela). In late 2012, a hedge fund manager publicly raised allegations regarding the legality of the Company's network marketing program and announced that the hedge fund manager had taken a significant short position regarding our common shares, leading to intense public scrutiny and significant stock price volatility. We have engaged legal and advisory services firms to assist with responding to the allegations and to perform other related services in connection to these events. For the year ended December 31, 2013, we recorded approximately $29.1 million of expenses related to this matter, of which approximately $25.7 million was related to legal, advisory and other professional service fees. We expect to continue to incur expenses related to this matter over the next several periods and the expenses are expected to vary from period to period. As previously disclosed, on April 8, 2013, our former independent registered public accounting firm, KPMG LLP, resigned and withdrew their audit opinions for the years ended December 31, 2012, 2011, and 2010. The Company engaged PricewaterhouseCoopers LLP, or PwC, as its new independent registered public accounting firm and performed a re-audit of its prior years' financial statements. For the year ended December 31, 2013, we recorded approximately $20.4 million in re-audit fees and other related expenses. Net Interest Expense Net interest expense is as follows: Year Ended Year Ended December 31, December 31, Net Interest Expense 2013 2012 (Dollars in millions) Interest expense $ 26.6 $ 16.7 Interest income (8.0 ) (6.2 ) Net Interest Expense $ 18.6 $ 10.5 64 -------------------------------------------------------------------------------- Table of Contents The increase in net interest expense for the year ended December 31, 2013, as compared to the same period in 2012, was primarily due to higher outstanding balances on the Credit Facility. Due to the issuance of the convertible notes discussed in Note 15, Subsequent Events, interest expense will increase in future periods. Income Taxes Income taxes were $189.2 million for the year ended December 31, 2013, as compared to $186.9 million for the same period in 2012. As a percentage of pre-tax income, the effective income tax rate was 26.4% for the year ended December 31, 2013, as compared to 28.7% for the same period in 2012. The decrease in the effective tax rate for the year ended December 31, 2013, as compared to the same period in 2012, was primarily due to an increase of net benefits from discrete events, principally related to the expiration of statute of limitations related to certain tax contingencies and tax planning items related to certain income tax return filings, partially offset by the impact of changes in the geographic mix of the Company's income. See Note 12, Income Taxes, to the Consolidated Financial Statements for additional discussion. Financial Results for the year ended December 31, 2012 compared to the year ended December 31, 2011 Net sales for the year ended December 31, 2012 increased 17.9% to $4,072.3 million as compared to $3,454.5 million in 2011. In local currency, net sales for the year ended December 31, 2012 increased 22.6% as compared to the same period in 2011. The increase in net sales was primarily due to the continued successful adoption and operation of daily consumption DMOs; increased Member engagement and an increase in average active sales leaders; branding activities and increased Member recruiting. Net income for the year ended December 31, 2012 increased 11.8% to $464.0 million, or $3.94 per diluted share, compared to $415.0 million, or $3.32 per diluted share, for the same period in 2011. The increase was primarily due to higher contribution margin driven by net sales growth discussed above, partially offset by higher selling, general and administrative expenses to support the growth of our business, higher interest expense and higher income taxes. Net income for the year ended December 31, 2011 included a $0.9 million pre-tax ($0.7 million post-tax) additional interest expense from the write-off of unamortized deferred financing costs resulting from the debt refinancing arrangement in March 2011. See Note 4, Long Term Debt, to the Consolidated Financial Statements for further information on our debt refinancing. Net Sales The following chart reconciles retail sales to net sales: Sales by Geographic Region Year Ended December 31, 2012 2011 Shipping & Shipping & Change Retail Distributor Product Handling Net Retail Distributor Product Handling Net in Net Sales Allowance Sales Revenues Sales Sales Allowance Sales Revenues Sales Sales (Dollars in millions) North America $ 1,334.2 $ (635.8 ) $ 698.4 $ 142.8 $ 841.2 $ 1,111.4 $ (530.5 ) $ 580.9 $ 117.7 $ 698.6 20.4 % Mexico 802.1 (391.7 ) 410.4 85.7 496.1 706.0 (344.4 ) 361.6 75.3 436.9 13.6 % South & Central America 1,134.2 (544.5 ) 589.7 99.1 688.8 904.9 (430.8 ) 474.1 80.3 554.4 24.2 % EMEA 1,018.3 (492.7 ) 525.6 102.2 627.8 991.0 (476.4 ) 514.6 100.6 615.2 2.0 % Asia Pacific 1,780.6 (806.2 ) 974.4 165.5 1,139.9 1,469.4 (666.7 ) 802.7 135.9 938.6 21.4 % China 334.9 (56.5 ) 278.4 0.1 278.5 245.1 (34.3 ) 210.8 - 210.8 32.1 % Worldwide $ 6,404.3 $ (2,927.4 ) $ 3,476.9 $ 595.4 $ 4,072.3 $ 5,427.8 $ (2,483.1 ) $ 2,944.7 $ 509.8 $ 3,454.5 17.9 % 65 -------------------------------------------------------------------------------- Table of Contents North America The North America region reported net sales of $841.2 million for the year ended December 31, 2012. Net sales increased $142.6 million, or 20.4%, for the year ended December 31, 2012, as compared to the same period in 2011. In local currency, net sales increased 20.5% for the year ended December 31, 2012, as compared to the same period in 2011. The overall increase in net sales in the region was a result of net sales growth in the U.S. of $140.0 million, or 20.7%, for the year ended December 31, 2012, as compared to the same period in 2011. In the U.S. we continue to see the success of our Members converting their business focus toward daily consumption DMOs, especially the Nutrition Club. Average active sales leaders in the region increased 16.4% for the year ended December 31, 2012, as compared to the same period in 2011. In January 2012, the region hosted a U.S. Latin market Future President's Team Retreat with over 900 attendees. The region also hosted Latin market Leadership Development Weekends in February with approximately 9,400 attendees. In March 2012, we hosted our annual global Herbalife Summit event in Los Angeles, California where President Team members from around the world met and shared best practices, conducted leadership training and management awarded Members $52.3 million of Mark Hughes bonus payments related to 2011 performance. In April 2012, the region hosted General Market Leadership Development Weekends with approximately 5,000 attendees and Latin Market Leadership Development Weekends in June 2012 with approximately 13,000 attendees. In July 2012, the region hosted a series of Leadership Development Weekends with approximately 5,800 attendees. During the fourth quarter the region hosted two regional extravaganzas (one Latin Market and one General Market) with a total of approximately 20,800 attendees. The region also hosted two Future President Team Retreats (one Latin Market and one General Market) with a total of over 1,600 attendees. Mexico The Mexico region reported net sales of $496.1 million for the year ended December 31, 2012. Net sales for the year ended December 31, 2012 increased $59.2 million, or 13.6%, as compared to the same period in 2011. In local currency, net sales for the year ended December 31, 2012 increased 20.4% as compared to the same period in 2011. The fluctuation of foreign currency rates had an unfavorable impact of $30.1 million on net sales for the year ended December 31, 2012. The growth in net sales is primarily the result of increased Member engagement as well as the continued success of the Nutrition Club DMO. One of the recent growth drivers in Mexico has been the ongoing transition from home clubs to commercial clubs by many Members, which are able to generate higher volumes of sales through the servicing of more customers and longer operating hours. Average active sales leaders in Mexico increased 20.9% for the year ended December 31, 2012, as compared to the same period in 2011. In January 2012, the region hosted a Future President's Team Retreat and Future Millionaire's Team Retreat in Cancun, Mexico with approximately 600 and 1,525 attendees, respectively. In May 2012, the region hosted Leadership Weekends in two cities with a total of approximately 15,000 attendees. In September 2012, the region hosted Extravaganzas in Mexico City and Guadalajara with approximately 21,200 and 12,200 attendees, respectively. South and Central America The South and Central America region reported net sales of $688.8 million for the year ended December 31, 2012. Net sales increased $134.4 million, or 24.2%, for the year ended December 31, 2012, as compared to the same period in 2011. In local currency, net sales increased 33.4% for the year ended December 31, 2012, as compared to the same period in 2011. The fluctuation of foreign currency rates had a $50.9 million unfavorable 66-------------------------------------------------------------------------------- Table of Contents impact on net sales for the year ended December 31, 2012. The increase in net sales for the year ended December 31, 2012, as compared to the same period in 2011, was due to an increase in net sales in almost every country in the region led by Brazil, Venezuela and Peru. This growth was primarily driven by the adoption and expansion of daily consumption DMOs throughout the region. In Brazil, the region's largest market, net sales increased $9.2 million, or 3.0%, for the year ended December 31, 2012, as compared to the same period in 2011. In local currency, net sales increased 19.8% for the year ended December 31, 2012, as compared to the same period in 2011. The fluctuation of foreign currency rates had a $51.4 million unfavorable impact on net sales in Brazil for the year ended December 31, 2012. The increase in net sales was primarily the result of the successful adoption of Nutrition Clubs and other daily consumption DMOs. Venezuela, the region's second largest market, experienced a net sales increase of $76.8 million, or 117.7%, for the year ended December 31, 2012, as compared to the same period in 2011. In local currency, net sales increased 117.7% for the year ended December 31, 2012, as compared to the same period in 2011. The sales growth was primarily due to increased Member engagement and growth in the Nutrition Club DMO. We also had price increases of 9.5% in January 2012 and of 15.0% in December 2012 which contributed to the increase in sales. There was no exchange rate impact to sales for the year ended December 31, 2012 as compared to the same period in 2011 as the 5.3 Venezuelan Bolivars to U.S. dollar exchange rate for which we remeasure sales in Venezuela did not change during the comparative period. See Liquidity and Capital Resources - Working Capital and Operating Activities below for further discussion of currency exchange rate issues in Venezuela. Average active sales leaders in the region increased 28.7% for the year ended December 31, 2012, as compared to the same period in 2011. In February 2012, the region hosted two Extravaganzas in Panama City, Panama and Santiago, Chile with 8,700 and 9,000 attendees, respectively. In May 2012, the region held three Extravaganzas in Brazil with a total of approximately 13,000 attendees. During the fourth quarter Brazil held a World Team School with over 4,700 attendees. EMEA The EMEA region reported net sales of $627.8 million for the year ended December 31, 2012. Net sales increased $12.6 million, or 2.0%, for the year ended December 31, 2012, as compared to the same period in 2011. In local currency, net sales increased 9.6% for the year ended December 31, 2012, as compared to the same period in 2011. The fluctuation of foreign currency rates had an unfavorable impact on net sales of $46.2 million for the year ended December 31, 2012. The increase in net sales for the year ended December 31, 2012 was primarily driven by increases in Russia and the United Kingdom, partially offset by a decrease in Italy. Net sales in Russia, our largest market in the region, increased $27.9 million, or 38.0%, for the year ended December 31, 2012, as compared to the same period in 2011. In local currency, net sales increased 45.5% for the year ended December 31, 2012, as compared to the same period in 2011. The fluctuation of foreign currency rates had a $5.5 million unfavorable impact on net sales in Russia for the year ended December 31, 2012. The increase in Russia was driven by the ongoing adoption of the Commercial Nutrition Club, additional sales centers which have increased access to our products and improving brand image including the sponsorship of FC Spartak Moscow football club. Net sales in Italy, our second largest market in the region, decreased $20.8 million, or 17.5%, for the year ended December 31, 2012, as compared to the same period in 2011. In local currency, net sales decreased 10.6% for the year ended December 31, 2012, as compared to the same period in 2011. The fluctuation of foreign currency rates had an $8.2 million unfavorable impact on net sales in Italy for the year ended December 31, 2012. The decline in Italy was driven by a decrease in Member activity. Net sales in Spain, our third largest market in the region, increased $1.4 million, or 2.7%, for the year ended December 31, 2012, as compared to the same period in 2011. In local currency, net sales in Spain increased 67-------------------------------------------------------------------------------- Table of Contents 11.6% for the year ended December 31, 2012, as compared to the same period in 2011. The fluctuation of foreign currency rates had a $4.6 million unfavorable impact on net sales in Spain for the year ended December 31, 2012. The increase in Spain was mainly due to the positive effect of increased Member activity which was aided by our sponsorship of FC Barcelona. Average active sales leaders in the region increased 14.2% for the year ended December 31, 2012, as compared to the same period in 2011. In September 2012, the region hosted three Extravaganzas in Spain, Ukraine, and Turkey with a total of over 23,200 total attendees. Asia Pacific The Asia Pacific region, which excludes China, reported net sales of $1,139.9 million for the year ended December 31, 2012. Net sales increased $201.3 million, or 21.4%, for the year ended December 31, 2012, as compared to the same period in 2011. In local currency, net sales increased 26.0% for the year ended December 31, 2012, as compared to the same period in 2011. The fluctuation of foreign currency rates had an unfavorable impact of $42.5 million on net sales for the year ended December 31, 2012. The increase in net sales for the year ended December 31, 2012 reflected growth in almost all the countries in the region led by South Korea, Indonesia, Malaysia and India. Net sales in South Korea, our largest market in the region, increased $77.8 million, or 22.7%, for the year ended December 31, 2012, as compared to the same period in 2011. In local currency, net sales increased 25.2% for the year ended December 31, 2012, as compared to the same period in 2011. The fluctuation of foreign currency rates had an unfavorable impact on net sales of $8.7 million for the year ended December 31, 2012. The increase in net sales was primarily driven by the successful adoption and operation of the Nutrition Club and other daily consumption DMOs along with the Mega and Premium Herbalife Opportunity Meetings. Net sales in Taiwan, our second largest market in the region, decreased $1.7 million, or 1.1%, for the year ended December 31, 2012, as compared to the same period in 2011. In local currency, net sales decreased 0.4% for the year ended December 31, 2012, as compared to the same period in 2011. The fluctuation of foreign currency rates had an unfavorable impact on net sales of $1.1 million for the year ended December 31, 2012. The modest decline in net sales reflects the formation of a stable platform for future growth following strategic actions taken to address certain Member business training practices around nutrition clubs, resulting in the closure of a significant number of clubs. Net sales in India, our third largest market in the region, increased $26.8 million, or 22.9%, for the year ended December 31, 2012, as compared to the same period in 2011. In local currency, net sales increased 40.7% for the year ended December 31, 2012, as compared to the same period in 2011. The fluctuation of foreign currency rates had an unfavorable impact on net sales of $20.8 million for the year ended December 31, 2012. The increase in net sales for the year ended December 31, 2012 was primarily driven by increased product access and the successful adoption of the daily consumption DMOs, especially the Nutrition Club. Net sales in Malaysia, our fourth largest market in the region, increased $34.2 million, or 40.6%, for the year ended December 31, 2012, as compared to the same period in 2011. In local currency, net sales increased 42.1% for the year ended December 31, 2012, as compared to the same period in 2011. The fluctuation of foreign currency rates had an unfavorable impact on net sales of $1.3 million for the year ended December 31, 2012. The increase in net sales was primarily driven by the continued success of the Road Show DMO and Mega Herbalife Opportunity Meetings which generated positive Member momentum. Also contributing to growth for the period was increased Member activity including increased activity in Nutrition Clubs. Net sales in Indonesia, our fifth largest market in the region, increased $42.1 million, or 83.7%, for the year ended December 31, 2012, as compared to the same period in 2011. In local currency, net sales increased 96.7% for 68-------------------------------------------------------------------------------- Table of Contents the year ended December 31, 2012, as compared to the same period in 2011. The fluctuation of foreign currency rates had an unfavorable impact on net sales of $6.5 million for the year ended December 31, 2012. The primary catalyst driving the sales increase in Indonesia was the growth in Nutrition Clubs. Average active sales leaders in the region increased 31.2% for the year ended December 31, 2012, as compared to the same period in 2011. During the first quarter the region hosted a series of Spectaculars in eight countries with a total of approximately 43,000 attendees. In May 2012, the region hosted two regional extravaganzas, in South Korea and Singapore, with approximately 19,800 and 24,800 attendees, respectively. In September 2012, the region hosted an Asia Pacific University training in Macau with 11,300 attendees and a World Team School in India with 3,500 attendees. China Net sales in China were $278.5 million for the year ended December 31, 2012. Net sales increased $67.7 million, or 32.1%, for the year ended December 31, 2012, as compared to the same period in 2011. In local currency, net sales increased 29.1% for the year ended December 31, 2012, as compared to the same period in 2011. The fluctuation of foreign currency rates had a favorable impact of $6.4 million on net sales for the year ended December 31, 2012. Average active sales leaders in China increased 32.6% for the year ended December 31, 2012, as compared to the same period in 2011. As of December 31, 2012, we were operating 67 retail stores in 29 provinces in China. During May 2012, we received direct selling licenses for 8 additional provinces in China, bringing the total provinces covered by our direct selling licenses to 24 out of the 29 provinces in which we operated as of December 31, 2012. In April 2012, the region hosted its annual China Extraordinary Tour (Honors) with approximately 12,800 attendees. During the fourth quarter China held an Anniversary Rally in Xiamen with approximately 13,400 attendees. Sales by Product Category Year Ended December 31, 2012 2011 Shipping & Shipping & % Change Retail Distributor Product Handling Net Retail Distributor Product Handling Net in Net Sales Allowance Sales Revenues Sales Sales Allowance Sales Revenues Sales Sales (Dollars in millions) Weight Management $ 4,118.8 $ (1,946.8 ) $ 2,172.0 $ 382.9 $ 2,554.9 $ 3,479.4 $ (1,647.5 ) $ 1,831.9 $ 326.8 $ 2,158.7 18.4 % Targeted Nutrition 1,523.1 (719.9 ) 803.2 141.6 944.8 1,272.7 (602.6 ) 670.1 119.5 789.6 19.7 % Energy, Sports and Fitness 337.5 (159.5 ) 178.0 31.4 209.4 273.6 (129.5 ) 144.1 25.7 169.8 23.3 % Outer Nutrition 235.9 (111.5 ) 124.4 21.9 146.3 238.1 (112.7 ) 125.4 22.4 147.8 (1.0 )% Literature, Promotional and Other(1) 189.0 10.3 199.3 17.6 216.9 164.0 9.2 173.2 15.4 188.6 15.0 % Total $ 6,404.3 $ (2,927.4 ) $ 3,476.9 $ 595.4 $ 4,072.3 $ 5,427.8 $ (2,483.1 ) $ 2,944.7 $ 509.8 $ 3,454.5 17.9 % (1) Product buybacks and returns in all product categories are included in the literature, promotional and other category. Net sales for all product categories increased for the year ended December 31, 2012 as compared to the same period in 2011, except for a slight decrease in Outer Nutrition. The growth factors described in the above discussions of the individual geographic regions apply generally to all product categories. 69-------------------------------------------------------------------------------- Table of Contents Gross Profit Gross profit was $3,259.7 million for the year ended December 31, 2012, as compared to $2,774.4 million for the same period in 2011. As a percentage of net sales, gross profit for the year ended December 31, 2012 decreased to 80.1%, as compared to 80.3% for the same period in 2011, or an unfavorable net decrease of 20 basis points. The net 20 basis point decrease for the year ended December 31, 2012, as compared to the same period in 2011, was primarily due to the unfavorable impact of foreign currency fluctuations, country mix and other costs partially offset by the benefit from our net source savings initiatives and favorable changes in inventory write-downs. Royalty Overrides Royalty Overrides were $1,338.6 million for the year ended December 31, 2012, as compared to $1,137.6 million for the same period in 2011. Royalty Overrides as a percentage of net sales was 32.9% for both the years ended December 31, 2012 and 2011. Generally, this ratio varies slightly from period to period due to changes in the mix of products and countries because full Royalty Overrides are not paid on certain products and in certain countries. Compensation to our sales employees and independent service providers in China is included in selling, general and administrative expenses as opposed to Royalty Overrides where it is included for all other Members under our worldwide marketing plan. We anticipate fluctuations in Royalty Overrides as a percentage of net sales reflecting the growth prospect of our China business relative to that of our worldwide business. Selling, General and Administrative Expenses Selling, general and administrative expenses were $1,259.7 million for the year ended December 31, 2012, as compared to $1,074.6 million for the same period in 2011. Selling, general and administrative expenses as a percentage of net sales were 30.9% for the year ended December 31, 2012, as compared to 31.1% for the same period in 2011. The increase in selling, general and administrative expenses for the year ended December 31, 2012 included $59.7 million in higher salaries, bonuses and benefits, excluding China sales employees, $20.2 million in higher professional fees, excluding China independent service providers, higher variable expenses related to sales growth including $24.7 million in higher Member promotion and event costs, $3.9 million in higher advertising expenses, $26.7 million in higher expenses related to China sales employees and independent service providers, $10.9 million in higher non-income tax expenses such as value added tax and sales tax and $5.2 million in higher foreign exchange loss. Net Interest Expense Net interest expense is as follows: Year Ended Year Ended December 31, December 31, Net Interest Expense 2012 2011 (Dollars in millions) Interest expense $ 16.7 $ 9.9 Interest income (6.2 ) (7.4 ) Net Interest Expense $ 10.5 $ 2.5 The increase in net interest expense for the year ended December 31, 2012, as compared to the same period in 2011, was primarily due to higher outstanding balances on the Credit Facility, and lower interest received related to non-income tax refunds. 70 -------------------------------------------------------------------------------- Table of Contents Income Taxes Income taxes were $186.9 million for the year ended December 31, 2012, as compared to $144.8 million for the same period in 2011. As a percentage of pre-tax income, the effective income tax rate was 28.7% for the year ended December 31, 2012, as compared to 25.9% for the same period in 2011. The increase in the effective tax rate for the year ended December 31, 2012, as compared to the same period in 2011, was primarily due to lower net benefits from discrete events, changes in the geographic mix of the Company's income, and increased accruals for tax contingencies. See Note 12, Income Taxes, to the Consolidated Financial Statements for additional discussion. Liquidity and Capital Resources for fiscal years 2013, 2012, and 2011 We have historically met our working capital and capital expenditure requirements, including funding for expansion of operations, through net cash flows provided by operating activities. Variations in sales of our products directly affect the availability of funds. There are no material contractual restrictions on our ability to transfer and remit funds among our international affiliated companies. However, there are foreign currency restrictions in certain countries, such as Venezuela as discussed below, which could reduce our ability to timely obtain U.S. dollars. Even with these restrictions, we believe we will have sufficient resources, including cash flow from operating activities, to meet debt service obligations in a timely manner and be able to continue to meet our objectives. Our existing debt has not resulted from the need to fund our normal operations, but instead has resulted from our previous and ongoing share repurchase program. Since inception in 2007, total share repurchases amounted to approximately $1.9 billion. While a significant net sales decline could potentially affect the availability of funds, many of our largest expenses are variable in nature, which we believe protects our funding in all but a dramatic net sales downturn. Further, as discussed in greater detail below, we maintain the Credit Facility, executed on March 9, 2011 and amended on July 26, 2012, which had $196.4 million of undrawn capacity as of December 31, 2013. As discussed further below, on July 26, 2012, we amended the Credit Facility and entered into a $500.0 million term loan with a syndicate of financial institutions which matures in March 2016, or the Term Loan. We utilized the majority of the proceeds from the Term Loan to pay down our outstanding balance on our revolving credit facility, which then provided us with additional undrawn capacity. This available undrawn capacity, in addition to cash flow from operations, can be used to support general corporate purposes, including, our future share repurchase programs, dividends, and strategic investment opportunities. We also have a cash pooling arrangement with a financial institution for cash management purposes. This cash pooling arrangement allows certain of our participating subsidiaries to withdraw cash from this financial institution based upon our aggregate cash deposits held by subsidiaries who participate in the cash pooling arrangement. We did not owe any amounts to this financial institution under the pooling arrangement as of December 31, 2013 and 2012. For the year ended December 31, 2013, we generated $772.9 million of operating cash flow, as compared to $567.8 million for the same period in 2012. The increase in cash generated from operations was primarily due to an increase in operating income of $73.8 million driven by an 18.5% growth in net sales for the year ended December 31, 2013 as compared to the same period in 2012 and changes in accrued expenses and accrued compensation, inventories and receivables during the year ended December 31, 2013 as compared to the same period in 2012. For the year ended December 31, 2012, we generated $567.8 million of operating cash flow, as compared to $510.5 million for the same period in 2011. The increase in cash generated from operations was primarily due to an increase in operating income of $99.2 million driven by a 17.9% growth in net sales for the year ended December 31, 2012 as compared to the same period in 2011. Capital expenditures, including accrued capital expenditures, for the years ended December 31, 2013, 2012, and 2011 were $162.5 million $122.8 million, and $90.9 million, respectively. The majority of these expenditures 71-------------------------------------------------------------------------------- Table of Contents represented investments in management information systems, the development of our Member internet initiatives, and the expansion of our warehouse, sales centers and manufacturing facilities domestically and internationally. We expect to incur total capital expenditures of approximately $175 million to $195 million for the full year of 2014, which includes capital expenditures associated with the Winston-Salem, North Carolina facility that was acquired December 2012. See Note 2, Basis of Presentation, to the Consolidated Financial Statements for further discussion of the purchase of the Winston-Salem, North Carolina facility. We entered into a $300.0 million senior secured credit facility, or the Prior Credit Facility, comprised of a $200.0 million term loan and a revolving credit facility of $100.0 million, with a syndicate of financial institutions as lenders in July 2006. In September 2007, we amended the Prior Credit Facility, increasing the revolving credit facility by $150.0 million to $250.0 million to fund the increase in our share repurchase program. The term loan was to mature on July 21, 2013 and the revolving credit facility was to be available until July 21, 2012. The term loan bore interest at LIBOR plus a margin of 1.5%, or the base rate, which represented the prime rate offered by major U.S. banks, plus a margin of 0.50%. The revolving credit facility bore interest at LIBOR plus a margin of 1.25%, or the base rate, which represented the prime rate offered by major U.S. banks, plus a margin of 0.25%. On March 9, 2011, we 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 the Prior Credit Facility. The Credit Facility has a five year maturity and expires on March 9, 2016. Based on our consolidated leverage ratio, U.S. dollar borrowings under the Credit Facility bear interest at either LIBOR plus the applicable margin between 1.50% and 2.50% or the base rate plus the applicable margin between 0.50% and 1.50%. The base rate under the Credit Facility represents the highest of the Federal Funds Rate plus 0.50%, one-month LIBOR plus 1.00%, and the prime rate offered by Bank of America. We, based on our consolidated leverage ratio, pay a commitment fee between 0.25% and 0.50% per annum on the unused portion of the Credit Facility. The Credit Facility also permits us 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 our subsidiaries and are secured by substantially all of the assets of the U.S. subsidiaries of our parent, Herbalife Ltd. In March 2011, we used $196.0 million in U.S. dollar borrowings under the Credit Facility to repay all amounts outstanding under the Prior Credit Facility. We 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 our consolidated balance sheet and are being amortized over the term of the Credit Facility. On July 26, 2012, we amended the Credit Facility to include the Term Loan. The Term Loan is a part of the Credit Facility and is in addition to our current revolving credit facility. The Term Loan matures on March 9, 2016. We will make regular scheduled payments for the Term Loan consisting of both principal and interest components. Based on our consolidated leverage ratio, the Term Loan bears interest at either LIBOR plus the applicable margin between 1.50% and 2.50% or the base rate plus the applicable margin between 0.50% and 1.50%, which are the same terms as our revolving credit facility. In July 2012, we used all $500.0 million of the borrowings under the Term Loan to pay down amounts outstanding under our revolving credit facility. We 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 our consolidated balance sheet and will be amortized over the life of the Term Loan. On December 31, 2013, 2012, and 2011, the weighted average interest rate for borrowings under the Credit Facility, which included borrowings under the Term Loan as of December 31, 2013 and 2012, was 2.17%, 1.96% and 1.89%, respectively. The Credit Facility requires us to comply with a leverage ratio and a coverage ratio. In addition, the Credit Facility contains customary covenants, including covenants that limit or restrict our 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. As of December 31, 2013 and 2012, we were in compliance with the debt covenants under the Credit Facility. 72-------------------------------------------------------------------------------- Table of Contents During the year ended December 31, 2013, we borrowed $763.0 million and paid a total of $319.2 million under the Credit Facility. During the year ended December 31, 2012, we borrowed $1,428.0 million and paid a total of $1,142.5 million under the Credit Facility. During the year ended December 31, 2011, we borrowed $859.7 million and $54.0 million under the Credit Facility and the Prior Credit Facility, respectively, and paid a total of $657.7 million and $228.9 million of the Credit Facility and Prior Credit Facility, respectively. As of December 31, 2013 and 2012, the U.S. dollar amount outstanding under the Credit Facility was $931.3 million and $487.5 million, respectively. Of the $931.3 million U.S. dollar amount outstanding under the Credit Facility as of December 31, 2013, $431.3 million was outstanding on the Term Loan and $500.0 million was outstanding on the revolving credit facility. The $487.5 million U.S. dollar amount outstanding under the Credit Facility as of December 31, 2012, was related to the Term Loan and there were no amounts outstanding on the revolving credit facility. There were no outstanding foreign currency borrowings as of December 31, 2013 and 2012 under the Credit Facility. We use our revolving credit facility to manage normal variations in cash created by significant cash items such as taxes, dividends, share repurchases, capital expenditures and other large cash flow items. Our revolving credit facility provides us with the ability to access significant funds on a timely basis. We repay outstanding balances from cash from operations. See Note 15, Subsequent Events, for discussion of the issuance of convertible senior notes during February 2014. The following summarizes our contractual obligations including interest at December 31, 2013, and the effect such obligations are expected to have on our liquidity and cash flows in future periods: Payments Due by Period 2019 & Total 2014 2015 - 2016 2017 - 2018 Thereafter (Dollars in millions) Borrowings under the senior secured credit facility(1) $ 972.1 $ 101.1 $ 871.0 $ - $ - Operating leases 179.7 54.0 75.4 33.7 16.6 Other 86.3 22.2 29.5 16.9 17.7 Total(2) $ 1,238.1 $ 177.3 $ 975.9 $ 50.6 $ 34.3 (1) The estimated interest payments on our Credit Facility are based on interest rates effective at December 31, 2013. (2) Our consolidated balance sheet as of December 31, 2013 included $32.9 million in unrecognized tax benefits. The future payments related to these unrecognized tax benefits have not been presented in the table above due to the uncertainty of the amounts and potential timing of cash settlements with the tax authorities, and whether any settlement would occur. At December 31, 2013 and December 31, 2012, the total amount of our foreign subsidiary cash and cash equivalents was $567.4 million and $321.3 million, respectively, of which $6.8 million and $6.9 million was invested in U.S. dollars as of December 31, 2013 and December 31, 2012, respectively. At December 31, 2013 and December 31, 2012, the total amount of cash and cash equivalents held by U.S. entities was $405.6 million and $12.2 million, respectively. For earnings not considered to be indefinitely reinvested, deferred taxes have been provided. For earnings considered to be indefinitely reinvested, deferred taxes have not been provided. Should we make a determination to remit the cash and cash equivalents from our foreign subsidiaries to our U.S. consolidated group for the purpose of repatriation of undistributed earnings, we would need to accrue and pay taxes. As of December 31, 2013, our U.S. consolidated group had approximately $88.1 million of permanently reinvested unremitted earnings from its subsidiaries, and if these monies were ever needed to be remitted, the impact of any tax consequences on our overall liquidity position would not be material. As of December 31, 2013, our parent had $2.0 billion of permanently reinvested unremitted earnings relating to its operating subsidiaries. We do not have any plans to repatriate these unremitted earnings to our parent; therefore, we do not have any liquidity concerns relating to these unremitted earnings and related cash and cash equivalents. See Note 12, Income Taxes, to the Consolidated Financial Statements for additional discussion. 73 -------------------------------------------------------------------------------- Table of Contents Off-Balance Sheet Arrangements At December 31, 2013 and December 31, 2012, we had no material off-balance sheet arrangements as defined in Item 303(a)(4)(ii) of Regulation S-K. Share Repurchases On April 17, 2009, our share repurchase program adopted on April 18, 2007 expired pursuant to its terms. On April 30, 2009, our board of directors authorized a new program for us to repurchase up to $300 million of our common shares during the following two years, at such times and prices as determined by management, as market conditions warrant. On May 3, 2010, our board of directors approved an increase to the repurchase program from $300 million to $1 billion. In addition, our board of directors approved the extension of the expiration date from April 2011 to December 2014. On May 2, 2012, we entered into an agreement with Merrill Lynch International to repurchase $427.9 million of our common shares, which was the remaining authorized capacity under existing repurchase program at that time. Under the terms of the repurchase agreement, we paid $427.9 million on May 4, 2012 and the agreement expired on July 27, 2012. We received 5.3 million and 3.9 million of our common shares under the repurchase agreement during June 2012 and July 2012, respectively. The total number of common shares repurchased under the agreement was determined generally upon a discounted volume-weighted average share price of our common shares over the course of the agreement. On July 27, 2012, we completed the repurchase program upon the final delivery of common shares repurchased under the repurchase agreement. On July 30, 2012, we announced that our board of directors authorized a new $1 billion share repurchase program that will expire on June 30, 2017. This repurchase program allows us to repurchase our common shares, at such times and prices as determined by us as market conditions warrant. The Credit Facility permits us to repurchase our common shares as long as no default or event of default exists and the consolidated leverage ratio specified in the Credit Facility is not exceeded. As of December 31, 2013, the remaining authorized capacity under the repurchase program was $652.6 million. During the year ended December 31, 2013, we repurchased 6.1 million of our common shares through open market purchases at an aggregate cost of approximately $297.4 million, or an average cost of $49.08 per share. During the year ended December 31, 2012, we repurchased 11.0 million of our common shares through open market purchases at an aggregate cost of approximately $527.8 million, or an average cost of $47.78 per share. During the year ended December 31, 2011, we repurchased 5.5 million of our common shares through open market purchases at an aggregate cost of approximately $298.8 million, or an average cost of $54.27 per share. The number of shares issued upon vesting or exercise for certain restricted stock units and SARs granted, pursuant to our share-based compensation plans, is net of the minimum statutory withholding requirements that we pay on behalf of our employees. Although shares withheld are not issued, they are treated as common share repurchases for accounting purposes, as they reduce the number of shares that would have been issued upon vesting. These shares do not count against the authorized capacity under the repurchase program described above. Dividends The declaration of future dividends is subject to the discretion of our board of directors and will depend upon various factors, including our earnings, financial condition, restrictions imposed by the Credit Facility and the terms of any other indebtedness that may be outstanding, cash requirements, future prospects and other factors deemed relevant by our board of directors. The Credit Facility permits payments of dividends as long as no default or event of default exists and the consolidated leverage ratio specified in the Credit Facility is not exceeded. During the second quarter of 2007, our board of directors adopted a regular quarterly cash dividend program. Our board of directors authorized a $0.10 per common share cash dividend each quarter from the adoption of the program through the second quarter of 2010. On August 2, 2010, we announced that our board of directors 74 -------------------------------------------------------------------------------- Table of Contents approved an increase in the quarterly cash dividend to $0.13 per common share, an increase of $0.03 per common share from prior quarters. On May 2, 2011, we announced that our board of directors approved an increase in the quarterly cash dividend to $0.20 per common share, an increase of $0.07 per common share from prior quarters. On February 21, 2012, we announced that our board of directors approved an increase in the quarterly cash dividend to $0.30 per common share, an increase of $0.10 per common share from prior quarters. The aggregate amount of dividends paid and declared during fiscal year 2013, 2012, and 2011, was approximately $123.1 million, $135.1 million, and $85.5 million, respectively. Working Capital and Operating Activities As of December 31, 2013 and December 31, 2012, we had positive working capital of $720.9 million and $221.7 million, respectively, or an increase of $499.2 million. This increase was primarily related to the increase in our cash and cash equivalents, prepaid expenses and other current assets, and inventories, partially offset by the increases in our current liabilities primarily related to our accounts payables, royalty overrides, accrued expenses, and current portion of long-term debt. The increase in inventory primarily relates to increases in finished goods to support sales growth and strategic sourcing initiatives. We expect that cash and funds provided from operations and available borrowings under the Credit Facility will provide sufficient working capital to operate our business, to make expected capital expenditures and to meet foreseeable liquidity requirements, including payment of amounts outstanding under the Credit Facility, for the next twelve months and thereafter. The majority of our purchases from suppliers are generally made in U.S. dollars, while sales to our Members generally are made in local currencies. Consequently, strengthening of the U.S. dollar versus a foreign currency can have a negative impact on net sales and contribution margins and can generate transaction losses on intercompany transactions. For discussion of our foreign exchange contracts and other hedging arrangements, see Item 7A - Quantitative and Qualitative Disclosures about Market Risk. Currency Restrictions in Venezuela Currency restrictions enacted by the Venezuelan government have become more restrictive and have impacted the ability our subsidiary in Venezuela, Herbalife Venezuela, to timely obtain U.S. dollars in exchange for Venezuelan Bolivars, or Bolivars, at the official foreign exchange rate from the Venezuelan government. The application and approval process continue to be delayed and our ability to timely obtain U.S. dollars at the official exchange rate remains uncertain. In recent instances, we have been unsuccessful in obtaining U.S. dollars at the official rate and it remains uncertain whether our current pending applications and future anticipated applications will be approved. In June 2010, the Venezuelan government introduced additional regulations under a new regulated system, SITME, which was controlled by the Central Bank of Venezuela. SITME provided a mechanism to exchange Bolivars into U.S. dollars through the purchase and sale of U.S. dollar denominated bonds issued in Venezuela. However, SITME was only available in certain limited circumstances. Specifically, SITME could only be used for product purchases and was not available for other matters such as the payment of dividends. Also, SITME could only be used for amounts of up to $50,000 per day and $350,000 per month and was generally only available to the extent the applicant had not exchanged and received U.S. dollars via the CADIVI process within the previous 90 days. Effective January 1, 2012, additional laws were enacted that required companies to register with the Registry of Users of the System of Transactions with Securities in Foreign Currency, or RUSITME, prior to transacting with the SITME, the regulated system, which was controlled by the Central Bank of Venezuela. In February 2013, the Venezuela government announced that it devalued its Bolivar currency and will eliminate the SITME regulated system. The SITME 5.3 Bolivars per U.S. dollar rate was eliminated and the CADIVI rate has been devalued from 4.3 Bolivars to 6.3 Bolivars per U.S. dollar. In March 2013, the Venezuelan 75 -------------------------------------------------------------------------------- Table of Contents government also announced they will introduce an additional complimentary exchange mechanism known as SICAD. It is currently unknown whether Herbalife Venezuela will be able to timely access this new exchange mechanism and we are currently assessing and monitoring the restrictions and exchange rates relating to this alternative mechanism. As an alternative exchange mechanism, we have also participated in certain bond offerings from the Venezuelan government and from Petróleos de Venezuela, S.A. or PDVSA, a Venezuelan state-owned petroleum company, where we effectively purchased bonds with our Bolivars and then sold the bonds for U.S. dollars. In other instances, we have also used other alternative legal exchange mechanisms for currency exchanges. Highly Inflationary Economy and Accounting in Venezuela Venezuela's inflation rate as measured using the blended National Consumer Price Index and Consumer Price Index rate exceeded a three-year cumulative inflation rate of 100% as of December 31, 2009. Accordingly, effective January 1, 2010, Venezuela was considered a highly inflationary economy. Pursuant to the highly inflationary basis of accounting under U.S. GAAP, Herbalife Venezuela changed its functional currency from the Bolivar to the U.S. dollar. Subsequent movements in the Bolivar to U.S. dollar exchange rate will impact the Company's consolidated earnings. Prior to January 1, 2010 when the Bolivar was the functional currency, movements in the Bolivar to U.S. dollar were recorded as a component of equity through other comprehensive income. Pursuant to highly inflationary accounting rules, we no longer translate Herbalife Venezuela's financial statements as its functional currency is the U.S. dollar. Remeasurement of Herbalife Venezuela's Monetary Assets and Liabilities Prior to February 2013, we used the SITME rate of 5.3 Bolivars per U.S. dollar to remeasure our Bolivar denominated transactions. In February 2011, Herbalife Venezuela purchased U.S. dollar denominated bonds with a face value of $20 million U.S. dollars in a bond offering from PDVSA for 86 million Bolivars and then immediately sold the bonds for $15 million U.S. dollars, resulting in an average effective conversion rate of 5.7 Bolivars per U.S. dollar. This Bolivar to U.S. dollar conversion resulted in us recording a net pre-tax loss of $1.3 million U.S. dollars during the first quarter of 2011 which is included in its consolidated statement of income for the year ended December 31, 2011. We were unsuccessful in accessing any subsequent PDVSA bond offerings and the frequency of future bond offerings is unknown. During 2011, we also accessed the SITME market in order to exchange its Bolivars to U.S. dollars. In less frequent instances, we have also accessed alternative legal exchange mechanisms, to exchange Bolivars for U.S. dollars, at less favorable rates than the SITME rate, which resulted in us recognizing $1.2 million of losses in selling, general and administration expenses included within our consolidated statement of income for the year ended December 31, 2011. During the year ended December 31, 2012, we continued accessing the SITME market in order to exchange our Bolivars to U.S. dollars and the daily and monthly restrictions continued. In other instances, we recognized an aggregate of $4.8 million of foreign exchange losses as a result of exchanging Bolivars for U.S. dollars using alternative legal exchange mechanisms that were on average approximately 43% less favorable than the 5.3 Bolivars per U.S. dollar published SITME rate. During the year ended December 31, 2012, we have exchanged 59.2 million Bolivars for $6.4 million U.S. dollars using these alternative legal exchange mechanisms. Following the Venezuelan government's devaluation of the Bolivar against the U.S. dollar and elimination of the SITME regulated system in February 2013, we used the new CADIVI rate of 6.3 Bolivars per U.S. dollar to remeasure our Bolivar denominated transactions. This new CADIVI rate is approximately 16% less favorable than the previously published 5.3 SITME rate. We recognized approximately $15.1 million of net foreign exchange losses within our consolidated statement of income during the first quarter of 2013, as a result of remeasuring our Bolivar denominated monetary assets and liabilities at this new CADIVI rate of 6.3 Bolivars per U.S. dollar. The majority of these foreign exchange losses related to the approximately $16.9 million devaluation of Herbalife Venezuela's Bolivar denominated cash and cash equivalents. During the year ended December 31, 2013, we also recognized $0.7 million of foreign exchange losses as a result of exchanging Bolivars for 76-------------------------------------------------------------------------------- Table of Contents U.S. dollars using alternative legal exchange mechanisms that were approximately 75% less favorable than the new CADIVI rate. During the year ended December 31, 2013, we exchanged 5.6 million Bolivars for $0.2 million U.S. dollars using these alternative legal exchange mechanisms. During the fourth quarter of 2013, we also submitted a bid of approximately 6.8 million Bolivars, or approximately $1.1 million U.S. dollars remeasured at the CADIVI rate, through the SICAD mechanism. We received notification from the central bank of Venezuela that the bid was approved and we are to receive a distribution of approximately $0.6 million in U.S. dollars, resulting in a foreign exchange loss of approximately $0.5 million, or an effective exchange rate of 11.3 Bolivars per U.S. dollar. As of December 31, 2013, we have not received the U.S. dollars related to this approved bid. As of December 31, 2013 and December 31, 2012, Herbalife Venezuela's net monetary assets and liabilities denominated in Bolivars was approximately $186.9 million and $82.9 million, respectively, and included approximately $215.9 million and $99.2 million, respectively, in Bolivar denominated cash and cash equivalents. As noted above, these Bolivar denominated assets and liabilities were remeasured at the CADIVI rate as of December 31, 2013 and at the SITME rate as of December 31, 2012. We remeasured our Bolivars at the official published CADIVI rate as of December 31, 2013 given the limited availability of alternative exchange mechanisms and the uncertainty in the effective exchange rate for alternative exchange mechanisms. These remeasured amounts, including cash and cash equivalents, being reported on our consolidated balance sheet using the published CADIVI rate may not accurately represent the amount of U.S. dollars that we could ultimately realize. While we continue 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 we will be able to exchange Bolivars into U.S. dollars on a timely basis. Investments in Bolivar-Denominated Bonds During the fourth quarter of 2013, we invested in Bolivar denominated bonds, or bonds, issued by the Venezuelan government. The purchase price of the bonds was approximately 25.5 million Bolivars, or approximately $4.1 million using the CADIVI rate. Although the bonds are rated below investment grade, we invested in these bonds to partially mitigate the risk of inflation on our Bolivar denominated cash and cash equivalents held by Herbalife Venezuela. We classify 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 are 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. During 2013, the Company did not sell any of its bonds. See Note 2, Basis of Presentation, to the Consolidated Financial Statements for further information on our purchases of bonds during the year ended December 31, 2013. Consolidation of Herbalife Venezuela and Foreign Exchange Risk We plan to continue our operation in Venezuela and to import products into Venezuela despite the foreign currency constraints that exist in the country. Herbalife Venezuela will continue to apply for legal exchange mechanisms to convert its Bolivars to U.S. dollars. Despite the currency exchange restrictions in Venezuela, we continue to control Herbalife Venezuela and its operations. The mere existence of the exchange restrictions discussed above does not in and of itself create a presumption that this lack of exchangeability is other-than-temporary, nor does it create a presumption that an entity should deconsolidate its Venezuelan operations. Therefore, we continue to consolidate Herbalife Venezuela in our consolidated financial statements for U.S. GAAP purposes. We plan to utilize the CADIVI or other official rates to the extent allowable under current restrictions in order to exchange Bolivars for U.S. dollars. We also plan to access government, PDVSA bond offerings, SICAD, and alternative legal exchange mechanisms when they are made available. As discussed above, these alternative legal exchange mechanisms could cause us to recognize significant foreign exchange losses if they are less favorable than the official rate, which could also result in our Bolivar denominated cash and cash equivalents 77 -------------------------------------------------------------------------------- Table of Contents reported on our consolidated balance sheet being significantly reduced. To illustrate our sensitivity to potential future changes in the official rate or using unfavorable alternative legal exchange mechanisms to exchange Bolivars to U.S. dollars, if the exchange rate was approximately 75% less favorable than the current 6.3 official rate and this unfavorable exchange rate was used to convert our Bolivar denominated cash and cash equivalents as of December 31, 2013, our $215.9 million in Bolivar denominated cash and cash equivalents as of December 31, 2013 would be reduced by $161.5 million and result in a corresponding foreign exchange loss to our operating profit. This 75% less favorable exchange rate is not necessarily representative of exchange rates which could be available to us for future exchanges and represents the weighted average rate that we received when using alternative exchange mechanisms during fiscal year 2013. Our ability to access the official exchange rate could impact what exchange rates will be used for remeasurement purposes in future periods. We continue to assess and monitor the current economic and political environment in Venezuela. Although Venezuela is an important market in our South and Central America Region, Herbalife Venezuela's net sales represented approximately 6%, 4%, and 2% of our consolidated net sales for the years ended December 31, 2013, 2012, and 2011, respectively, and its total assets represented approximately 10% and 7% of our consolidated total assets as of December 31, 2013 and 2012, respectively. Quarterly Results of Operations Quarter Ended December 31, September 30, June 30, March 31, December 31, September 30, June 30, March 31, 2013 2013 2013 2013 2012 2012 2012 2012 (In thousands except per share data) Operations: Net sales $ 1,268,879 $ 1,213,543 $ 1,219,239 $ 1,123,647 $ 1,059,320 $ 1,016,887 $ 1,031,948 $ 964,175 Cost of sales 251,807 238,415 247,224 225,977 211,105 201,597 203,737 196,144 Gross profit 1,017,072 975,128 972,015 897,670 848,215 815,290 828,211 768,031 Royalty overrides 380,735 373,241 379,551 364,029 355,658 330,247 335,195 317,533 Selling, general and administrative expenses 454,478 409,747 400,107 364,720 332,764 324,200 306,310 296,393 Operating income 181,859 192,140 192,357 168,921 159,793 160,843 186,706 154,105 Interest expense, net 2,902 4,726 5,559 5,373 2,453 3,546 3,169 1,373 Income before income taxes 178,957 187,414 186,798 163,548 157,340 157,297 183,537 152,732 Income taxes 55,417 45,464 43,636 44,675 45,133 45,424 51,586 44,801 Net income $ 123,540 $ 141,950 $ 143,162 $ 118,873 $ 112,207 $ 111,873 $ 131,951 $ 107,931 Earnings per share Basic $ 1.22 $ 1.39 $ 1.39 $ 1.14 $ 1.04 $ 1.03 $ 1.13 $ 0.93 Diluted $ 1.15 $ 1.32 $ 1.34 $ 1.10 $ 1.00 $ 0.98 $ 1.09 $ 0.88 Weighted average shares outstanding Basic 101,211 102,200 102,993 104,121 107,444 108,816 116,557 116,191 Diluted 107,234 107,777 107,083 108,068 112,230 113,646 121,482 122,373 Contingencies See Note 7, Contingencies, to the Consolidated Financial Statements for information on our contingencies as of December 31, 2013. 78-------------------------------------------------------------------------------- Table of Contents Subsequent Events See Note 15, Subsequent Events, to the Consolidated Financial Statements for information regarding subsequent events. Critical Accounting Policies U.S. GAAP requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the year. We regularly evaluate our estimates and assumptions related to revenue recognition, allowance for product returns, inventory, goodwill and purchased intangible asset valuations, deferred income tax asset valuation allowances, uncertain tax positions, tax contingencies, and other loss contingencies. We base our estimates and assumptions on current facts, historical experience and various other factors that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities and the recording of revenue, costs and expenses. Actual results could differ from those estimates. We consider the following policies to be most critical in understanding the judgments that are involved in preparing the financial statements and the uncertainties that could impact our operating results, financial condition and cash flows. We are a nutrition company that sells a wide range of weight management products, nutritional supplements, energy, sports & fitness products and personal care products. Our products are manufactured by third party providers and manufactured in our Suzhou, China facility, and in our manufacturing facility located in Lake Forest, California, and then are sold to Members who sell Herbalife products to retail consumers or other Members. As of December 31, 2013, we sold products in 91 countries throughout the world and we are organized and managed by geographic region. We have elected to aggregate our operating segments into one reporting segment, except China, as management believes that our operating segments have similar operating characteristics and similar long term operating performance. In making this determination, management believes that the operating segments are similar in the nature of the products sold, the product acquisition process, the types of customers to whom products are sold, the methods used to distribute the products, and the nature of the regulatory environment. We generally recognize revenue upon delivery and when both the title and risk and rewards pass to the Member or importer, or as products are sold in our retail stores in China or through our independent service providers in China. Net sales include product sales and shipping and handling revenues. Product sales are recognized net of product returns, and discounts referred to as "distributor allowances." We generally receive the net sales price in cash or through credit card payments at the point of sale. Related royalty overrides are recorded when revenue is recognized. Allowances for product returns, primarily in connection with our buyback program, are provided at the time the sale is recorded. This accrual is based upon historical return rates for each country and the relevant return pattern, which reflects anticipated returns to be received over a period of up to 12 months following the original sale. Historically, product returns and buybacks have not been significant. Product returns and buybacks were approximately 0.2%, 0.3%, and 0.4% of product sales for the years ended December 31, 2013, 2012, and 2011, respectively. We adjust our inventories to lower of cost or market. Additionally we adjust the carrying value of our inventory based on assumptions regarding future demand for our products and market conditions. If future demand and market conditions are less favorable than management's assumptions, additional inventory write-downs could be required. Likewise, favorable future demand and market conditions could positively impact future operating results if previously written down inventories are sold. We have obsolete and slow moving inventories which have been adjusted downward $32.4 million and $18.0 million to present them at their lower of cost or market in our consolidated balance sheets as of December 31, 2013 and December 31, 2012, respectively. 79-------------------------------------------------------------------------------- Table of Contents Goodwill and marketing related intangible assets not subject to amortization are tested annually for impairment, and are tested for impairment more frequently if events and circumstances indicate that the asset might be impaired. An impairment loss is recognized to the extent that the carrying amount exceeds the asset's fair value. As discussed below, for goodwill impairment testing, we have the option to perform a qualitative assessment of whether it is more likely than not that a reporting unit's fair value is less than its carrying amount before applying the two-step goodwill impairment test. If we conclude it is not more likely than not that the fair value of a reporting unit is less than its carrying amount, then there is no need to perform the two-step impairment test. Currently, we do not use this qualitative assessment option but we could in the future elect to use this option. For our marketing related intangible assets a similar qualitative option is also currently available. However, we currently use a discounted cash flow model, or the income approach, under the relief-from-royalty method to determine the fair value of our marketing related intangible assets in order to confirm there is no impairment required. For our marketing related intangible assets, if we do not use this qualitative assessment option, we could still in the future elect to use this option. In order to estimate the fair value of goodwill, we also primarily use an income approach. The determination of impairment is made at the reporting unit level and consists of two steps. First, we determine the fair value of a reporting unit and compare it to its carrying amount. The determination of the fair value of the reporting units requires us to make significant estimates and assumptions. These estimates and assumptions include estimates of future revenues and expense growth rates, capital expenditures and the depreciation and amortization related to these capital expenditures, discount rates, and other inputs. Due to the inherent uncertainty involved in making these estimates, actual future results could differ. Changes in assumptions regarding future results or other underlying assumptions could have a significant impact on the fair value of the reporting unit. Second, if the carrying amount of a reporting unit exceeds its fair value, an impairment loss is recognized for any excess of the carrying amount of the reporting unit's goodwill and other intangibles over the implied fair value as determined in Step 2 of the goodwill impairment test. Also, if during Step 1 of a goodwill impairment test we determine we have reporting units with zero or negative carrying amounts, then we perform Step 2 of the goodwill impairment test if it is more likely than not that a goodwill impairment exists. During Step 2 of a goodwill impairment test, the implied fair value of goodwill is determined in a similar manner as how the amount of goodwill recognized in a business combination is determined, in accordance with FASB ASC Topic 805, Business Combinations. We would assign the fair value of a reporting unit to all of the assets and liabilities of that reporting unit as if the reporting unit had been acquired in a business combination and the fair value of the reporting unit was the price paid to acquire the reporting unit. The excess of the fair value of a reporting unit over the amounts assigned to its assets and liabilities is the implied fair value of goodwill. As of both December 31, 2013 and December 31, 2012, we had goodwill of approximately $105.5 million and marketing related intangible assets of approximately $310.0 million. No marketing related intangibles or goodwill impairment was recorded during the years ended December 31, 2013, 2012, and 2011, as their estimated fair value significantly exceeded their carrying amounts. Contingencies are accounted for in accordance with the FASB ASC Topic 450, Contingencies, or ASC 450. ASC 450 requires that we record an estimated loss from a loss contingency when information available prior to issuance of our financial statements indicates that it is probable that an asset has been impaired or a liability has been incurred at the date of the financial statements and the amount of the loss can be reasonably estimated. We also disclose material contingencies when we believe a loss is not probable but reasonably possible as required by ASC 450. Accounting for contingencies such as legal and non-income tax matters requires us to use judgment related to both the likelihood of a loss and the estimate of the amount or range of loss. Many of these legal and tax contingencies can take years to be resolved. Generally, as the time period increases over which the uncertainties are resolved, the likelihood of changes to the estimate of the ultimate outcome increases. Deferred income tax assets have been established for net operating loss and interest carryforwards of certain foreign subsidiaries and have been reduced by a valuation allowance to reflect them at amounts estimated to be ultimately realized. Although realization is not assured, we believe it is more likely than not that the net carrying value will be realized. The amount of the carryforwards that is considered realizable, however, could change if estimates of future taxable income are adjusted. In the ordinary course of our business, there are many transactions and calculations where the tax law and ultimate tax determination is uncertain. As part of the process of 80-------------------------------------------------------------------------------- Table of Contents preparing our consolidated financial statements, we are required to estimate our income taxes in each of the jurisdictions in which we operate prior to the completion and filing of tax returns for such periods. These estimates involve complex issues and require us to make judgments about the likely application of the tax law to our situation, as well as with respect to other matters, such as anticipating the positions that we will take on tax returns prior to us actually preparing the returns and the outcomes of disputes with tax authorities. The ultimate resolution of these issues may take extended periods of time due to examinations by tax authorities and statutes of limitations. In addition, changes in our business, including acquisitions, changes in our international corporate structure, changes in the geographic location of business functions or assets, changes in the geographic mix and amount of income, as well as changes in our agreements with tax authorities, valuation allowances, applicable accounting rules, applicable tax laws and regulations, rulings and interpretations thereof, developments in tax audit and other matters, and variations in the estimated and actual level of annual pre-tax income can affect the overall effective income tax rate. We account for uncertain tax positions in accordance with the FASB ASC Topic 740, Income Taxes, or ASC 740, which provides guidance on the determination of how tax benefits claimed or expected to be claimed on a tax return should be recorded in the financial statements. Under ASC 740, we must recognize the tax benefit from an uncertain tax position only if it is more likely than not that the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position. The tax benefits recognized in the financial statements from such a position are measured based on the largest benefit that has a greater than fifty percent likelihood of being realized upon ultimate resolution. We account for foreign currency transactions in accordance with ASC Topic 830, Foreign Currency Matters. In a majority of the countries where we operate, the functional currency is the local currency. Our foreign subsidiaries' asset and liability accounts are translated for consolidated financial reporting purposes into U.S. dollar amounts at year-end exchange rates. Revenue and expense accounts are translated at the average rates during the year. Our foreign exchange translation adjustments are included in accumulated other comprehensive loss on our accompanying consolidated balance sheets. Foreign currency transaction gains and losses and foreign currency remeasurements are generally included in selling, general and administrative expenses in the accompanying consolidated statements of income. |