Herbalife Ltd HLF
Q3 2010 Earnings Call Transcript
Transcript Call Date 11/02/2010

Operator: Good morning and thank you for joining the Third Quarter 2010 Earnings Conference Call for Herbalife Ltd. On the call today is Michael Johnson, the Company’s Chairman and CEO; the Company’s president, Des Walsh; John DeSimone, the Company’s CFO; and Brett Chapman, the Company’s General Counsel.

I would now like to turn the call over to Brett Chapman, to read the Company’s safe harbor language.

Brett R. Chapman - General Counsel: Before we begin, as a reminder, during this conference call, comments may be made that include some forward-looking statements. These statements involve risk and uncertainty, and as you know, actual results may differ materially from those discussed or anticipated. We encourage you to refer to yesterday’s earnings release and our SEC filings for a complete discussion of risks associated with these forward-looking statements and our business.

In addition, during this call, certain financial performance measures may be discussed that differ from comparable measures contained in our financial statements, prepared in accordance with U.S. generally accepted accounting principles, referred to by the Securities and Exchange Commission as non-GAAP financial measures.

We believe these non-GAAP financial measures assist management and investors in evaluating and comparing period to period results of operations in a more meaningful and consistent manner. Please refer to the Investor Relations section of our website, Herbalife.com, to find our press release for this quarter, which contains a reconciliation of these measures.

Additionally, when management makes reference to volume during this conference call, they are referring to volume points.

I’ll now turn the call over to Michael.

Michael O. Johnson - Chairman and CEO: Good morning, everyone, everywhere in around the world and welcome to our third quarter 2010 earnings call and analyst day. I just wanted to open that way, because we have so many distributors in 73 different countries, who speak so many different languages and so many different investors and analysts, who are following us from all over the world.

The positive momentum we've been experiencing in our business continued as we had another very strong quarter driven by net sales growth of 14.7% and volume point growth of 13.5%. Underscoring the broad strength in our business, we experienced both volume point growth and increases in average active sales leaders in all six of our regions during the quarter.

Average active sales leader, our measurement of distributor engagement, increased 12% in the quarter, which we believe reflects positive momentum. By the way of comparison, it's been more than four years since we've experienced simultaneous volume growth in all of our regions. The ongoing transition to daily consumption focused DMOs continues to have a positive impact on our business.

For the third quarter, we announced suggested earnings per share of $1.17 which is 38% above Q3 2009 adjusted EPS. This strong growth in bottom line performance is driven primarily by a double-digit volume growth and our margin improvement. Our distributors' successful use of sustainable business methods, creating long-term customers, who are consuming Herbalife products daily, continues to be the primary driver of our growth.

We continue to believe that there are three primary reasons why our results outperform our peers in the industry. First, Herbalife's products and our business opportunity address three macro trends, obesity, the aging of the population, and the need for additional income. Every piece of media today is focused on these topics and sadly for the world, these trends do not appear to be declining.

Unlike a typical consumer product company, Herbalife offers an opportunity to help the consumer address both health and income needs. We're uniquely positioned at the intersection of health and wealth, what an enviable position for our distributors and our Company.

Second, our distributors continue to build sustainable businesses focused on long-term customers who are consuming our products on a daily basis. This focus on daily consumption is attracting more consumers to Herbalife than any time in our history, allowing more distributors to access the business opportunity than ever before and enabling more distributors to be successful with Herbalife.

We have more distributors moving up the marketing plan, committed to growing successful businesses while retaining more distributors than ever before.

Third, our brand and image keep growing stronger. Herbalife is more visible and better recognized around the world than ever before. Together with our distributors we sponsor more than a 150 teams, athletes and events worldwide. We strive to make Herbalife brand both recognizable and synonymous with the healthy active lifestyle.

We continue to believe that we have a competitive advantage in these three areas – relevant products, the potential for individuals to build a sustainable business in an increasingly brand and image. This gives us confidence and the belief that the momentum in our business will continue.

Accordingly, we are raising our full year 2010 earnings per share guidance to a range of $4.54 to $4.58 and 12.5% to 13.5% volume growth and 16.5% to 17% net sales growth. This new full year 2010 guidance range represents an $0.18 increase from the high-end of the guidance provided last quarter.

We are also providing initial 2011 guidance, which reflects a volume growth of 8% to 10% and earnings per share of $5 to $5.25.

Turning to the results we reported yesterday, we are pleased to announce record third quarter adjusted earnings per share of $1.17, which is $0.32 or 38% better than our third quarter 2009 performance. It is important to note that the improvement in earnings was largely driven by revenue growth, as was the case with our results in the first half of the year.

Our reported net sales in the quarter increased almost 15% compared to the same period in 2009. Our growth was very broad, with all of our regions achieving local currency sales growth during the quarter. Des will provide additional detail regarding our top line results in just a few minutes.

Another indicator of the broad health of our business is that we experienced growth in new distributors in each of our regions again during the third quarter. In total, we had approximately 16% growth in new distributors worldwide. Distributor growth by region is available on the Investor Relations section of our website.

Returning to the financials, we generated approximately $100 million in cash flow from operations in the quarter. During the quarter, we repurchased approximately $25 million in shares and paid $15 million in dividends.

Before I pass it over to Des, I’d like to recap some of the key events in the past few months. We began the third quarter with three European extravaganzas in (indiscernible), Torino, and Stockholm, where we had approximately 17,000 enthusiastic distributors in attendance. In September, Mexico hosted its extravaganza for more than 18,000 distributors. Most recently, North America hosted extravaganzas in Atlanta and Los Angeles, where we saw 20,000 distributors.

On the infrastructure front, as we’ve been discussing with you for the past year, we continue to vertically integrate our business, which we view as a competitive advantage that will greatly benefit our distributors. We are pleased with the progress of this seed-to-feed initiative. The facility we purchased last year in Lake Forest, California is now ramping up the amount of product that it is manufacturing for us. In addition, we recently announced a joint venture in China for a botanical ingredients extraction facility that will enable us to have greater traceability of the ingredients that go in to our Herbalife products.

For those joining us on the Analyst Day presentation, you will hear our Chief Operating Officer, Rich Goudis, walk through the details of this key strategy and our process.

While we are talking about products, (indiscernible) that we have never been more excited about our products than we are right now. At our North America extravaganzas in October we launched three new U.S. products, the seasonal Pumpkin Spice Formula 1 and allergen-free version of Formula 1, which is free of soy and gluten. We also announced the proprietary CoQ10 product for heart health, led by Nobel Laureate Dr. Louis Ignarro. The progress we've made in our manufacturing supply-chain capabilities increased our flexibility and speed to market. These three new products are result of that progress.

Now, let me turn it over to Des for specific market updates. Des?

Des Walsh - President: Thank you, Michael. The momentum that continues to drive our business is two key elements, the ongoing successful expansion of daily consumption business methods, focused on creating long-term customers and the increased level of distributor engagement in hosting Herbalife opportunity meetings, success training seminars, and other training sessions throughout the world.

We continue to see the expansion in daily consumption business methods as a primary driver of our distributors businesses and Herbalife's growth. We believe that the momentum behind this evolution will continue to accelerate as more distributors in more markets have success acculturating daily consumption business methods in their markets.

Examining the markets that have thus far integrated elements of daily consumption into their business methods, we have identified what we believe to be a three stage life-cycle. Let me preface my comments by saying that we believe that we are still so early in the growth of daily consumption, some characteristics of the life-cycle are relatively assumptive as we do not have a large number of countries or markets in the more fully developed laser stages.

We have turned the first stage of the life-cycle acculturation, typically a two to three-year period, where a country or market segment identifies which elements of daily consumption work best in their market. Stage two, the expansion stage, is where we begin to see the acculturated business model take root and grow.

During this period, we see rapid growth in the number of distributors growing their businesses, recruiting metrics that are higher than historical averages and distributors begin to put into place systems to train and successfully develop the new business methods. In the third stage, the enhancement stage, we are seeing distributors focus on driving sales within the clubs that were opened during the prior stage, increasing members and sales per member.

We will go into more detail about the lifecycle of daily consumption later this morning during our Analyst Day.

Now, let me provide regional highlights and color on some key markets. North America had a strong quarter posting strong growth compared to the prior year period in both local currency net sales and volume points with increases of 10% and 9%, respectively.

One of the measurements that we use to gauge distributor engagement, average active sales leaders increased 14% in North America compared to last year’s third quarter results. U.S. net sales grew 10% and volume points increased 9% versus the same quarter last year, well ahead of our expectations.

Volume within our Latino division increased by 1% for the quarter while average active sales leaders increased 14%. We believe that this apparent discrepancy between the two metrics is the results of the following; one a greater focus on retailing and higher utilization of the 5K sales leader qualification; and two, the blurring of the lines between the Latino and general markets, a trend we have recently observed, where the new generation of fully acculturated Latino distributors is sponsoring English speaking distributors, and therefore blurring the lines between our general market and Latino statistics.

Based on the record attendance by Latino distributors at this month’s extravaganzas, which was up approximately 60% compared to last year, we continue to believe that the Latino market is one in which we will see meaningful growth. We will go into more detail about our plans for the market when Ibi Fleming, Vice President, U.S. Latino market, speaks later this morning at our Analyst Day.

Sales in the general market of the U.S. market were up 26% versus the third quarter in 2009. Both new distributors and average active sales leaders increased in the quarter by 48% and 16%, respectively. This is the third consecutive quarter of greater than 20% new distributor growth for the general market and we are excited about this metric as we believe it is indicative of a pipeline for future sales leader development in the market.

We believe that distributor engagement is a critical element to driving growth, and are experiencing an engagement level within the general market that is the highest we had seen in several years.

Moving on to Mexico, local currency net sales for the quarter increased 18% and volume points increased 16%. New distributors increased 9% year-over-year in the quarter. We are pleased to see average active sales leaders increase by 11% compared to the prior year period. This is the fourth consecutive quarter of growth and we are pleased to see the market returned to the size it was prior to 2008.

As the origin of home-based nutrition clubs, we consider Mexico to be our most developed daily consumption market. Despite being the most developed are furthest along the life cycle, we believe that there remained significant growth opportunities in Mexico.

Miguel Fernandez, Senior Vice President, Mexico will be presenting some of his thoughts about the market later this morning at our Analyst Day.

The Asia Pacific region continues to be a key growth driver for the Company. During the third quarter, local currency net sales increased 35% and volume points grew 29% compared to the prior year period. New distributors in the region increased 31%.

Of the 13 countries in the region, four posted more than 50% growth in local currency sales, South Korea, India, Indonesia, and Hong Kong. We believe that the growth within the region continues to be driven by the expansion of daily consumption business methods and the high degree of distributor engagement. Average active sales leaders increased 27% in the quarter.

Looking at key markets within the region, let me spend a few minutes discussing South Korea and India. These two markets have had continued success with daily consumption business methods and are key drivers of this region. In Korea, for the third quarter, local currency sales and volume points were up 58% and 57%, respectively. Average active sales leaders in Korea increased 69% in the third quarter compared to the prior year period.

India is a market in which we see tremendous opportunity. Bill Rahn, Senior Vice President, Asia Pacific, will be discussing both the region and India, in particular, later this morning. But let me give you a little color about third quarter results in the market. India is benefiting greatly from the increase in the addressable audience who can partake in the daily price point made available by our independent distributors through the nutrition club model.

Local currency net sales and volume points increased 102% and 96%, respectively, in the quarter. Distributor engagement continued to grow as well with a 98% increase in average active sales leaders. Daily consumption and the replication of nutrition clubs continue to be the drivers of growth in India.

Local currency net sales in the South and Central America region increased 17% and volume points in the region were up 5% in the quarter. Average active sales leaders in the region increased 4% over last year’s third quarter.

New distributor increased 2% compared to the prior year period. Regionally, we believe that the distributor leadership has begun to see the benefits the daily consumption models bring to their markets. Corporately, we focus a large portion of our energies on helping the various markets around the world share best practices among themselves and the South American region is the great example of that principle. Leadership within that region has been studying the business methods used by other markets and are now working to integrate more elements of daily consumption into their markets.

Turning to EMEA, this is the region where we are now seeing the growth of sustainable business models focus on the creation of long-term customers. During the third quarter, local currency net sales increased 5% and volume points in the region grew almost 4% compared to the prior year. We are pleased to see the U.K. gain traction with the weight loss challenge concept and the Nordic countries are seeing growth with distributor offices called lifestyle centers. New distributors increased 18% and average active sales leaders in the region were up 3% in the quarter compared to the prior year.

As we have previously told you, Russia was the market where we initially tested the marketing plan changes that eventually we rolled out globally last October. As this market has had the 5K 12-month sales leader qualification in place for longest, we continue to be very pleased with the changes we are seeing in the business there.

The Russian sales leaders that qualified on to the longer 12-month process are over 50% more active following qualifications than those that qualify under the traditional one or two-month plan.

Now, let’s turn to China, where our local currency net sales increased 12% and volume points increased 22% in the third quarter compared to the prior year period. It was almost two years ago when we began to introduce the club concept into this unique market because of the strong success that clubs were demonstrating in neighboring countries.

As we have seen in other markets, the acculturation process typically takes up to 24 months before we begin to see what we believe to be strong, sustainable growth.

We believe that our sales leaders in China are making progress acculturating the concept to daily consumption, and we are now seeing clubs opening in locations that are more like those which have been successful and duplicable in other markets.

During the third quarter, we also saw positive momentum behind the television ad campaign in China. As we have been discussing with you for the past several quarters, we believe that there is an ongoing transformation within our business.

The daily consumption model has taken hold in some of our largest markets and it continues to expand into more of our existing markets every day. A fascinating aspect of the growth in daily consumption is the various forms that are just taking on around the world. Nutrition clubs are now just one iteration of daily consumer business methods being successfully leveraged by Herbalife distributors around the world.

While we talk about the localization of daily consumption across the globe, it is important to understand that we believe we are in the early stages of their growth in most of our markets.

Rob Levy, our Senior Vice President, Worldwide Sales and Marketing, will be discussing with you the elements, we believe, that are key to driving further growth and success within the daily consumption business models around the world.

In closing, let me congratulate our distributor leadership for the success that they have achieved in the third quarter through increased focus on creating long-term customers with sustainable business methods and increased meeting activity to welcome, train, and activate new distributors around the world.

Now, let me pass the call over to John to review the financials.

John DeSimone - CFO: Thank you, Des. We'll start the financial review with commentary on this year's third quarter results compared to last year's third quarter and then we'll compare them to the guidance we provided in August.

Volume points grew 13.5% in the quarter while net sales grew 14.7%. The net sales growth was negatively impacted by 200 basis points from changes in foreign currency rates. On a local currency basis, net sales increased 16.7% compared to the third quarter last year. Similar to a quarter ago, our volume and net sales results were very broad based. However, whereas a quarter ago, five of six regions experienced growth, this quarter all six regions experienced growth.

Turning to gross margins, we experienced a 260 basis point improvement compared to the same quarter last year. About 40% of the difference or a little over 100 basis points was the result of how we accounted for Venezuela a year ago. If you recall, during last year's third quarter, the Company recorded a loss in cost of goods sold of over $6 million relating to non-CADIVI shipments. This loss in cost of goods sold was offset by a similar gain recorded in SG&A last year.

In addition to Venezuela, other currency related items benefited gross margin by approximately 50 basis points. Just a reminder, the currency impact on gross margin lagged with inventory turns.

In comparison, there is no such lag for currency impact on net sales or SG&A. In addition to currency, price increases had a 50 basis point positive impact during the quarter.

Turning to SG&A, adjusted SG&A as a percentage of sales was 90 basis points higher than the year ago quarter, but the change is primarily a result of the $6 million Venezuela currency swing between cost of goods sold and SG&A that was booked in the third quarter of last year and that I just noted. Also, impacting SG&A for the quarter was $3.8 million of additional recorded foreign currency losses. This is approximately $3 million higher than last year’s quarter.

As a reminder, during the second quarter of this year, we recorded $8.2 million of foreign currency gains in SG&A. This represents a $12 million shift sequentially. As a result of the gross margin and SG&A changes just described, adjusted operating margins in the quarter improved by 160 basis points versus last year’s third quarter.

Our adjusted effective tax rate improved in the quarter by approximately 365 basis points, which was mostly a result of country mix and tax planning strategies.

Our reported EPS on a GAAP basis was $1.22, but these reported results included a one-time tax benefit of $3.2 million relating to a refund in Korea for tax years 2001 to 2004. On an adjusted basis, excluding this one-time item, our EPS for the quarter was $1.17, 38% higher than the adjusted results from a quarter ago.

This adjusted earnings per share of $1.17 was also $0.14 higher than the high end of the guidance range provided in August. Much of the upside was a result of above the line performance with an additional $0.06 benefit from the lower than projected effective tax rate. With respect to cash flow for the third quarter, our Company produced $97.3 million from operations.

Also during the quarter, we returned cash to investors of $39.8 million through a quarterly dividend of $14.9 million and share repurchases of $24.9 million. We also invested $18.3 million in capital expenditures during the quarter. Our net debt as of September 30, 2010, was $15.6 million, an $83.9 million improvement compared to year end 2009.

Now let me discuss our guidance that was provided in yesterday’s earnings release. For the full year 2010, we are raising our EPS guidance to a range of $4.54 to $4.58 compared to the previously announced guidance range of $4.30 to $4.40. This increase of $0.18 to the high end of the guidance range is a result of the $0.14 being in Q3 plus $0.04 improvement in Q4, which is due mostly to foreign currency rates.

Our volume guidance for the fourth quarter remains unchanged from what was implicit in the guidance provided in August. The resulting full year guidance for volume growth is projected to be in the range of 12.5% to 13.5% above our record 2009 performance.

Net sales guidance is in the range of 16.5% to 17%. We expect our effective tax rate to be in the range of 28% to 29% for the full year, a 100 basis point reduction from the guidance provided in August.

From a capital spending standpoint, we are slightly decreasing our guidance by $5 million due to timing. Our new full year 2010 guidance is $65 million to $75 million.

Turning to 2011, we provided initial EPS guidance of $5 to $5.25. This guidance reflects end of September FX spot rates and our expectations of continued positive sales momentum. Guidance includes volume point growth of 8% to 10% and net sales growth of 11% to 13% above fiscal 2010.

We expect our effective tax rate to be in the 29% to 30% range and capital expenditures to be between $80 million and $90 million. Included in both 2010 and 2011 guidance is approximately $0.02 benefit per quarter from using the new parallel rate in Venezuela of 5.3 bolivars to $1 compared to utilizing the last free-market rate of 8.1. This is consistent with previous guidance.

This concludes our prepared remarks. We will now open up the call for your questions.

Transcript Call Date 11/02/2010

Unidentified Analyst: Do you have any sense of how much of this year's mid-teens (indiscernible) growth is channel build versus actual consumption?

Des Walsh - President: It's tough to actually break it down in that particular way. I would say it's a combination of both, but primarily driven by increase in daily consumption around the world.

Brett R. Chapman - General Counsel: For those who are listening on the call, not here at Investor Day we have people asking questions in another room. We have a mic being passed around so if could just bear with us for a moment. Is there a question?

Unidentified Analyst: John, question on the 2011 tax rate. It looks like you’ve got it about point higher than the 2010 assumption. I am wondering if there is anything specific in there that might move that higher or the reason for moving higher, given that all else being equal, the bias seems to be at lower rate because of country mix and that sort of thing?

John DeSimone - CFO: It’s based on country mix of our projections, that’s really driving the tax rate increase for next year.

Unidentified Analyst: I just wanted to know what’s fueling the growth in Malaysia and Korea? You’re doing very well over there, but now I mean what is the real – Mr. Walsh if you can answer that please?

Des Walsh - President: So it’s driven by combination of two things. First of all, the increased adoption of daily consumption is driving both markets and then coupled with that the super and premium HOM concept, which you are going to hear more about at Inventor Day. Essentially, it’s a way of introducing more people into the business and then once they come into the business then the distributor leadership get them engaged in all aspects of daily consumption. So it’s that unique combination that’s driving, not just those two markets, but obviously, many of our markets in Asia Pacific region and elsewhere.

Josef Jung - Eminence Capital: (Josef Jung) with (Eminence Capital). I had a quick question on inventory balance at the end of the third quarter. It looks like it was up about $50 million year-over-year, even though COGS was flat. I just wanted to get a sense for what the ramp was?

Michael O. Johnson - Chairman and CEO: There’s two reasons for the increase in inventory. First is sales growth, and second is it’s buffer inventory as we transition manufacturing into our own facility.

Unidentified Company Speaker: We’ll open the questions now to people on the audio.

Operator: Brett Jordan, Avondale Partners.

Onadin - Avondale Partners: This is (Onadin) for Brett. Just a quick question on the extraction facility. Just wondering if you have a timetable for the buildout of that?

Michael O. Johnson - Chairman and CEO: It’s sometime around September is the plan. So about a little less than a year from now it should be operational.

Onadin - Avondale Partners: As you further on the vertical integration, you mentioned on the call that Lake Forest was ramping, and it’s in the role that it’s playing. I am just wondering what percent of product is being produced through the Lake Forest facility now?

Michael O. Johnson - Chairman and CEO: About 20% of the U.S. product, and it’s going to be up over the next 12 months.

Operator: Tim Ramey, D.A. Davidson.

Tim Ramey - D.A. Davidson: John, maybe dig a little deeper on the drivers of the tax rate assumption? In other words, let's say, that China grew 50%. Can you talk about the incremental tax rate there? Do you have large NOLs there? What should we be thinking about as we project our own sales growth for these various countries?

John DeSimone - CFO: We don't get into effective tax rate by country for obvious reasons, and I know that's not necessarily helpful to you, but it's the appropriate thing to do from a company standpoint. It's not an NOL issue because we don’t have NOLs. It's really just country mix. Certain countries have lower effective tax rates, certain have higher effective tax rate depending on where the growth comes from that has a mixed issue on our tax rate.

Tim Ramey - D.A. Davidson: It's hard to think of the thing that would drive the tax rate mix higher for next year. Maybe I'm being slow on that, but could you give us some sense of what could drive the tax rate higher next year?

John DeSimone - CFO: It's for country mix, right. So, we don't like to get into, as a company, which countries have high effective tax rates and which ones have low effective tax rate. So, that's one of the reasons we give guidance on the tax rate line is, because you don't have that kind of visibility. So, we run our models and we run our projections into our models and (indiscernible) the effective tax rate and then we use that to guide the Street.

Tim Ramey - D.A. Davidson: Also, do you have anything further on currency hedges for next year?

John DeSimone - CFO: The only currency that’s hedged for next year right now is the euro. We are 41% hedged on our exposure at $1.31.

Operator: At this time, there are no further audio questions.

Michael O. Johnson - Chairman and CEO: Well, then, we want to thank you everyone. We are about to head next door to present to our investors and analysts our story and the story of continued growth and expanded product line, one of product excellence and an enhanced supply chain, our business opportunity that’s working better than ever by going wider and deeper with engaged distributors who are the brand of Herbalife everyday to their thousands of customers and (indiscernible). We just want to thank everybody for your continued support. We look forward to your continued success as an investor of Herbalife and to our distributors in your continued success as members of a wonderful team Herbalife. Thank you very much.