HLF- Herbalife Ltd. at Bank of America Merrill Lynch INVESTMENT CONFERENCE
Event Date/Time: Sep/ 14. 2010/ 9:00PM GMT
Herbalife International of America, Inc. – CFO
CONFERENCE CALL PARTICIPANTS
Merrill Lynch – Analyst
Chris Ferrara- Merrill Lynch- Analyst
Next up, we are pleased to have Herbalife. Herbalife is a direct marketing Company selling mainly nutritional products through about 2.1 million distributors, through 73 countries. With us here is CFO, John DeSimone. John joined herbalife in 2007 after 17 years in corporate finance elsewhere including runs at Rexall Sundown, Precision Response and Sunbeam and I know he is going to walk you through interesting story. I appreciate you being here. Thank you very much.
John DeSimone – Herbalife International of America, Inc. – CFO
Thank you Chris. Can everybody hear me? Okay. I’ll start with the Safe Harbor statement, if you want to get to it in detail, the details are on our website, if somebody wants to read about the Safe Harbor statement. We are going to start the presentation off a little differently than we have in the past. We generally tell the story, it’s a unique story and then we show the results. But we’re going to start off with the results. Our second quarter was a great quarter. I think it’s an eye-opener and it hopefully gives an indication of the opportunity that’s in front of us. In the second quarter, we had volume point growth, now volume point is essentially a proxy for retail sales, that’s the way to think about it, in US dollar terms and it’s constant currency.
So we had volume point growth of 19.9% worldwide, very broad-based growth. You will see as I go through the various regions that almost all our regions had growth in 80% of our countries, we are in 73 countries, 80% of those countries had growth in the second quarter. And then we’re talking to what’s driving growth in a few slides.
North America, which is almost entirely—so we break out Mexico separately from North America. So, North America is almost entirely the US, there is a little bit of Canada, a little bit of Jamaica, but it’s almost entirely the US. And the US was the Company’s first market. It opened up in 1980, 30 years ago and in the second quarter this year we had 21.1% growth. I point this out, because I think it’s unique to Herbalife in its oldest, most mature markets it’s having strong double-digit growth, where a lot of competitors of ours are having growth in emerging markets, you’ll find our story is both emerging and established markets and we’ll talk about why in a few slides.
Mexico is a 20-year old market, they had almost 11% volume point growth in the second quarter. This is really a country that was the genesis of the new business model, back a few years ago, daily consumption that we’ll talk about again in a couple of slides.
South America was the one weak region in the quarter, it was down 1.9%. There is two countries that drive South America for Herbalife, Venezuela, which as lot of noise around Venezuela, and Brazil and Brazil is adopting daily consumption and it’s having – the component of Brazil that’s adopting daily consumption is having double-digit growth and that’s being dragged down by the two-thirds that’s not adopted daily consumption yet.
EMEA, EMEA stands for Europe, Middle East and Africa. It had 8.6% growth in the second quarter, that’s the strongest growth it’s had over five years in EMEA. China had almost 26% growth and it is a fairly new market for us, only 41 million volume points, but a lot of opportunity. And then Asia Pacific had 52.8% volume growth in the quarter that’s led by Korea, which had 92% growth. India had 115% growth, Taiwan had, I think it’s 30% growth, but the key and you will see that this is going to be readout throughout the presentation, the key is that there has been a new evolution of our business model, the way distributors go to market that allows them to reach a whole new consumer base that traditional direct-selling couldn’t reach.
From a net sales –last page was volume points, this page is net sales, we had 20.5% net sales growth in the second quarter, almost equivalent to the 19.9% volume growth. So, a little bit of currency but not much. 420 basis point operating margin improvement. We had a great operating margins in the second quarter, that 16.9% was a record for the Company. That’s not what we expect going forward, that’s somewhat inflated, because the contribution margin in the short term in our business model, 35% to 40% of net sales. So, when we have a [blow eight ball quarterly] if we did, we have so much revenue in the quarter, a lot falls to the bottom line. Longer term we have to invest behind that growth to maintain it. And from an EPS standpoint, 70% earnings growth in second quarter up to $1.32.
We provided guidance, it’s the same guidance we provided at the end of the second quarter results; I just want to read – just put it up here. We have third quarter guidance of 13% to 15% volume point growth, full-year 12% to 14% volume growth. Net sales also 13% to 15% in Q3, 15% to 17% full year, so there is some currency benefit for the full-year. And EPS for the third quarter of $0.99 to $1.03, and for the full-year $4.30 to $4.40, on a full-year basis that represents little over 30% EPS growth. We had great Q1, record Q2 and we expect strong results for the rest of the year.
So why? So provided the results, now this is the story behind it. So first and we don’t talk enough about this. But our products are the real need, right. We sell nutrition-based products and we are in a world where there is more need than an ever for nutrition-based products or products like ours and the awareness of that need has never been greater and it’s accelerating and maybe it was at some point in time, but it’s [spread east’ pretty quickly. In China, 24% of the adult population in China is overweight, they are not obese but they are overweight. That’s 220 million people overweight in China, that’s more overweight people in China than the US. Two-thirds of the adult population in the US is overweight.
So India for example, ten of the – 18 states in India have at least 10% of their population overweight. So, even though we don’t think of the eastern culture is having a weight problem they are starting to have obesity and overweight problem as western diners move to east, right. We tend to follow fast food, right. So, McDonalds, Burger King, those types of fast food chains when they go into countries they create a problem that we have a solution for. So, we don’t talk about that enough but that’s an important element of the story.
More importantly is that those products are under traditional direct selling, traditional direct selling is you sell basically a monthly price point. So our view, you find medium to high price purchase done infrequently. So, somebody would buy a month supply of product for $30, $50, $100. That worked well for a certain segment of the population that can afford to take that kind of money out of the pocket at one time and purchase their product. But there was a whole another segment of the consumer that couldn’t afford to participate in that monthly price point.
And the new model, the evolution, the daily consumption model offers the consumer an opportunity to buy just the products they need for that day, just one use at a time, one serving at a time. You’ll see a slide in a few pages that compares this to coffee, right. So the coffee at $2 a day, very affordable. Lot of people reaching their pocket, pull out $2 and buy coffee. If you had to buy that, [month supply], you have to go to Starbucks and spend $60 at the beginning of each month. Some people could do it, but far fewer people could afford do it and can afford to participate at $2 a day and that’s been the evolution of the model within Herbalife.
It started in Mexico and will get into little detail. It started in Mexico in 2003, spread to the – a segment of the US in 2006. But it’s just now starting to become popular in the general market in the US and many other countries that didn’t adopt that model (inaudible) and then this is called strengthening brand, right. So our products are relevant, our business model reaches more people than it ever had and our brand is strengthening. We sponsor 150 teams around the world. We tend to brand through sports. Because it supports a healthy active life style, which is our message and we do a lot of branding through soccer because it’s a global sport and we are a global Company.
From a product line standpoint, almost 63% of our product is in weight management. I think it is important to note that that’s not the magic pill that’s chasing supplement. This is the life style oriented, food oriented weight management product. Our number 1 product is that Formula 1, it’s a meal replacement shake. It represents half of that 63% of sales. So it’s not a contentious product, it’s 30 years old. It’s food oriented and you will see that in the next slide. 23% of our sales was targeted nutrition, that’s condition specific products like health or brain healthy. Little under 5% of our sales are in energy and sports nutrition, and another 5% in personal care, which both offer an opportunity for us.
Purpose of this slide is again to just get you mind on who we are as a company, we are a much more functional food company than a supplement company. Four of our top five products are functional food products and our top five products as a group represent 61% of our sales. So again just to kind of give you a vision of who we are. This again –this is the new model, the traditional model versus the daily consumption model, traditional model. In direct selling, you pick up a phone, you’d call your customer once a month or once every two weeks whatever the cycle is then you try to get an order from that customer. Does it penetrate, it’s a very low penetration model, very inefficient model for distributors, right. Distributors have to call their customers up once a month, there is way to reach their customers in a group.
Other than you can schedule a meeting, but you still have to call or schedule a party or a meeting or whatever it may be. And the turnover is pretty high in that model. In daily consumption, nutrition clubs, people, consumers purchase just what they need for that day so instead of getting a lot of – a few people to purchase a lot, you get a lot of people to purchase a little. It penetrates much deeper in to the marketplace as people can afford to buy the products on the daily price point, but customer turnover is much lower, the retention of the consumer is much higher, and it’s a much more efficient model for distributors because now customers are coming to them, instead of them going to customers.
I will spend a minute and tell you what a club is. So how many people have been to clubs? You really should go to clubs. Amy, who is our Vice President of Investor Relations, will be happy to get you some addresses. But the genesis of a club, I would say the genesis, and will give you a feel for what a club is. We had a (inaudible) who was a distributor in Mexico in 2003. He saw the value in our products-based community, right. People in his community have very poor diets, he wanted to give them Herbalife, but they couldn’t afford to participate in that monthly price point.
So, he opened up his house with a home club. He invited consumers to come into his house, pay a few to get in and they would get the meal replacement shake, they would get a cup of tea and a aloe drink, which is for digestion. So they get three drinks for a nominal fee and that would be breakfast. And it was a trade off in dollars, non-incremental spend it’s another important point, right. So the idea was to sell these three products as a meal, if you find somebody who was buying a meal somewhere else they come to an Herbalife club, they spend a few dollars, they get their meal, it’s replacement spend, it’s better nutritionally, but cheaper on what they might spend at McDonalds. That model in Mexico worked really well and had tremendous growth for a number of years.
But it didn’t extend beyond – extend to Latin America, but it didn’t extend beyond Latin America because it’s a model that most of our distributors felt couldn’t work in their culture. So in Mexico, they are very social, they are accustomed to having people come over their house, they worked very well, didn’t extend beyond Mexico and Latin America.
In 2006, [Brazil is right] and they really evolved the model to more a commercial club, which is the same concept as a home club is expect it is done in a rented commercial space and that model fits in much better than most culture, [get the coffee slide]. But let me put some numbers around it, what I think the opportunity is or what we think the opportunity is. So I guess this slide requires a little bit of set up. So the blue bars are the penetration rates for our top five countries back in 2003, which is before clubs were started.
The green bars are the penetration rates in 2009. So in Mexico 1.2 volume points for capital, again volume points is about retail – equal to retail sales with the penetration rate in Mexico in 2003. As the club started growing in 2009, that was the 4x growth and was 4.4 volume points per capita.
In the US Latino business, it went from 2.3 to 10.8, in Taiwan 2.9 to 8.7, Korea 1.2 to 3.0, Brazil has doubled. And the message is that this deeper model, the model where people can now buy the product they need at a daily price points, reaches a lot more consumers and we’ve seen it work in a lot of countries and now it’s time to spread outside of these Top 5. I think Top 5 were the first five, but now the general market in the US has 33%. General market is the non-Spanish speaking market in the US that had 33% growth in the second quarter driven by the daily consumption model.
So this model is now just starting again to most of our countries. One of the things I said earlier that what’s unique to Herbalife is our growth is coming from both established and emerging markets. Established market is not all established markets, but established markets as defined by the World Bank, were up 23.8% in the second quarter and emerging markets were up 16.2%.