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Thomson Street Events

HLF- Herbalife Ltd. at ICR XChange

Event Date/Time: Jan. 13. 2010/ 10:40PM GMT

CORPORATE PARTICIPANTS

John DeSimone

Herbalife Ltd. – CFO

CONFERENCE CALL PARTICIPANS

Rommel Dionisio

Wedbush Securities – Analyst

PRESENTATION

Rommel Dionisio- Wedbush Securities – Analyst

Good afternoon.  I’m Rommel Dionisio at Wedbush Securities and it’s a pleasure for me to introduce our next company, Herbalife, one of the largest direct selling companies in the world.  Presenting on behalf of the company is their relatively new Chief Financial Officer, John DeSimone.  He’s certainly not new to being a CFO, though, as well as someone who I think many of us know her from her years in the [South Side], their new VP of Investor Relations, Amy Greene.

 

John?

John DeSimone – Herbalife Ltd. – CFO

I’d like to thank everybody for coming.  Before we get started, I’ll point to the Safe Harbor language on the screen.  It’s also available on our website for those who are participating in the webcast.  It’s under www.herbalife.com under the Investor Relations icon.  And as Rommel said, with me today is Amy Greene, our Vice President of Investor Relations.

 

I’m going to start with an overview.  We believe that our story is misunderstood and our stock is undervalued, and it starts with growth.  We’re a growth company.  We’ve been a growth company for the last six consecutive years we’ve had growth.  The last five, I won’t include 2009 yet, our compound annual growth rate was 12.5%, and we think there’s a lot of runway left.  And the reason why there’s a lot of runway left is, one, our product line fits really well into two of the biggest megatrends in the world, right, health, and jobs.  I mean, that’s what we hear about every day, healthcare, and jobs.

 

All right, we’re a 60 – two-thirds of our products are weight management products.  That addresses obesity, which is the number one health epidemic in the world.  There’s a quote you’ll see later on that speaks to how much obesity cost Americans.  Second, I’ll point to the business model and there’s been an evolution from traditional direct selling to daily consumption, and daily consumption is the consumption of our product on a daily basis.  But more specifically, it’s a business model in which our distributors have daily servings sold at daily price points and daily touch points.

 

So we’ll get into that in a little – a little deeper in a few slides, but that’s been the number one driver of our growth over the past six years and it is the number one strategy we have over the next ten years is the expansion of that model around the world.  In addition, we have plans, we have aggressive plans to expand internationally into more countries, so we’re in 72 countries.  Our goal is to, over the next ten years, to get into 130 countries.  It’s a very aggressive goal.  It calls for five or six net countries openings a year, but this is not a very capital investive business and we have one operating system around the world, which we can leverage to open up these new markets.  So that’s an important part of our strategy.

 

Another area we think we’re misunderstood is our financial model.  Our financial model is characterized by very low capital requirements.  So we generate a lot of cash, but we don’t have to reinvest it back in the business.  It’s a high margin business and a majority of our cost structure is extremely variable.  All right, it’s payment to distributors that we don’t have to make until the distributor buys the product.  So we have a very low fixed cost base and additionally we’re very conservatively levered.  All right, our debt to EBITDA is one times.  So we’re very conservatively levered.

 

And in addition, I think we are very discipline with our use of capital.  We return a lot of capital to shareholders.  As I said, it’s – this is not a capital intensive business.  We general a lot of cash.  We invest in the business where we can and where we can exceed our hurdle rates and where we can’t, we find ways to return that money to shareholders.  And that’s been evident in our history.

 

By way of background, just for those who aren’t familiar with the Company, like I said two-thirds of our Company fall into daily nutrition/weight management category.  21% of our business falls into targeted nutrition, which is products like healthy heart or healthy digestion, things like that.  And then we round out the line with some sports and fitness products and personal care products.

 

This slide is just to further illustrate the megatrends, excuse me, that exist around the world, that our products address and our business opportunities address.   It’s health and jobs and so we put some Time Magazine covers on here.  I don’t think these are contentious points so I don’t have to spend a lot of time on there, but one of the quotes I wanted to put up is, which is really difficult to see for some reason, but it’s that the CDC says that obesity causes Americans $147 billion a year.  All right, and we know it’s a huge topic within America right now and our product line addresses it really well.

 

So daily consumption, I’m going to spend a moment o this slide so you can see on the bottom our financial results from 2003 through the guidance we’ve given for 2009 and we’ve nearly doubled our sales.  The way we’ve double our sales is the evolution of the business from traditional direct selling to daily consumption.  Traditional direct selling is characterized by medium and high price purchases done very infrequently.

 

All right, so that’s the way you think of direct selling.  It’s people buying $50, or $100, or $200 at a time once a month, once every two months.  Daily consumption is characterized by people spending very little money very frequently.  So it’s people paying $2 or $3 a day two, three, four, five days a week.  All right, and daily consumption allows a lot more consumers to participate in the product offering than traditional direct selling does.  And what we find is it penetrates deeper into a marketplace.  It has much higher retention.  It’s stickier and it’s a very efficient model for our distributors because their customer now come to them.

 

All right, so how many people here have been to a nutrition club or a commercial club with – okay, so just a couple people.  But if you’re interested in this story, that’s really the next step for you is to go visit a club and Amy Greene, if you contact her she’ll set you up with one.  But the way these clubs work is it’s either a home club or a commercial club where our distributors rent commercial space and share the cost.  And they invite potential consumers into that club and they give them a shake, which is our weight loss product, a tea and an aloe drink for around $3 a day.

 

All right, so we have a model now where the consumers can pay just that daily fee and then the consumers come back.  So instead of distributors having to go chase the consumer down, which is generally how direct selling works, you have to put up the phone, make calls every month, schedule meetings, in our model distributors – consumers come to distributors.  So it’s a much more efficient model and that’s the bullet point, the fourth bullet point on the right.

 

To help illustrate the point of daily price points, we put this slide up.  I like this slide.  It talks about coffee.  I think it’s a good analogy.  If you had to buy coffee on a monthly basis and you had to go to McDonald’s and pay $60 for your months’ supply and go pick it up every day, very few people can afford to participate in an opportunity.  There’s a lot of people that don’t have that kind of extra money.  But when you have to buy coffee for $2 a day, a lot more people participate and that’s what we’ve been able to do with our three top products, our three core products is break it down into a daily price point and that allows more consumers to participate in the product offering.

 

And then we think a big competitive advantage is we have daily touch points.  Our competitors can’t have their customers come to them every day because they can’t use the product or they can’t sell it on a daily serving basis.  We have the ability to sell it on a daily serving basis and that’s where the growth is coming from and that allows our distributors to see their customers very often.  So we call it daily price points and daily touch points and both are big competitive advantages for the company.

 

And this is another slide that illustrates the power of and how deep, deeply penetrating the daily consumption is.  So the three core products that support clubs are Formula One, Aloe, and Tea, and since 2003 those three products have grown 151% while the Company, this is on a volume basis, while the Company has grown 84%.  So those three products have grown almost twice as fast as the Company and the Company has had great growth.  Why?  Because those three products have been able to penetrate deeper into the marketplace.  So instead of skimming the service of consumers that can afford to buy the product, this daily fee allows it to go deep into a marketplace and this is just to illustrate that point.

 

So this is a little buys slide.  Okay, daily – the daily consumption concept, the daily fee concept started in Mexico it didn’t spread very quickly around Herbalife because a lot of distributors thought it was specific to Mexico.  But then the US-Latino community adopted daily consumption and their penetration rates went from 2.3 to over nine and in 2006, Taiwan adopted daily consumption and their penetration rates doubled, and so forth.

 

And you see Korea and then at least you’ll see India, and India doesn’t register yet, but India started – we opened India ten years ago and it had a big pop, and then it dropped.  Right, that’s pretty consistent with most direct sellers.  And then it flattened out for a long time.  And then over the last three quarters we’ve seen high double to low triple digit growth from India from clubs because now we’ll been able to go to the market in India with a daily fee, and that offers a lot more people the opportunity to participate in our product line.  So there’s a big opportunity in India if we’re at the flush point that we think we’re at.  So that’s on here.

 

And then to illustrate the opportunity around the world, we’re in 72 countries.  Only a handful have adopted this daily consumption.  The rest is still trying to [cede] the idea and get it to work, but the penetration rates for the Company in 20 were 5.6 – I mean, excuse me, .56 volume points per capita.  So you can just, you can see the opportunity because you can see the penetration rate that other markets that have adopted daily consumption could obtain and we think a lot of other markets can get to that point. And that’s really the number one strategy behind the Company is the spreading of that concept.

 

Additionally, as we said, we’re going to augment that strategy with the expansion into new countries.  We opened up two in Q4. Or those who haven’t followed the story, it took us a while to implement Oracle.  It took us about a year and a half into 71 of our 72 countries, we launched Oracle.  We completed that in the end of the second quarter and that allowed us to build a platform or gave us the platform to open up new countries.  So in Q4 we opened up two new countries.  This year our goal is six new countries and over the next ten years, it’s almost 60 new countries. So that’s an important part of our strategy too

.

 

So the countries we’re in right now represent about 75% of the world’s population.  So there’s still 25% of the world’s population we don’t address yet, and that’s what this new country strategy would look to do.  Manufacturing strategy, so prior to the middle of 2009, most of Herbalife’s products were outsourced (inaudible) of China.  We have a strategic initiative to bring most of that in-house for a couple of reasons.  There is a margin opportunity.

 

Most of our product cost is in materials and we haven’t been able to go after that bucket.  There’s also a protection opportunity to control our IP.  There’s also a – most of our products are made in the US and shipped around the world.  That’s very inefficient so we’ll look to, over time, develop manufacturing capabilities around the world where we can both reduce the freight costs, but also take advantage of trade agreements to lower duties and get our product costs into market at a lower cost.  So that’s a strategy.  We think over the next three to five years we’ll have 100 basis point improvement in gross margin from this strategy.

 

So what I’d like to add to that is so we bought our first manufacturing facility in early, excuse me, mid-2009.  It’s not a capital intensive business.  It’s not a capital intensive investment.  We bought the business for $10 million.  We have to put another $10 million to $25 million, I mean, excuse me, $10 million to $13 million in.  So we’re in the $20 million to $25 million total investment range for a facility that gives us the capacity to produce 30% of our worldwide product.  So for us to get to 80% you can see it’s not that big of an investment.  If we were to acquire five to seven more manufacturing facilities around the world over the next five to seven years, it might be, on the really conservative side, $100 million.  So that’s coming to somewhere between $10 million and 20 million a year.  It’s a very small piece of our free cash flow to implement this strategy and there’s a good payback for it.