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HLF- HERBALIFE LTD at Citi Global Consumer Conference

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EVENT DATE/TIME: MAY 23, 2012/ 2:15PM GMT

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CORPORATE PARTICIPANTS
John DeSimone Herbalife Ltd. –CFO

CONFERENCE CALL PARTICIPANTS
Wendy Nicholson Citigroup- Analyst

PRESENTATION
Wendy Nicholson Citigroup- Analyst

I am Wendy Nicholson, Citigroup Home and Personal Care Products analyst. It’s my pleasure to introduce Herbalife to you this morning. I know it’s been a very controversial stock. We are thrilled to have them here. The speaker is going to be John DeSimone, the CFO of the Company. Also, we have got Amy Greene from Investor Relations. So we will turn it over to John.

John DeSimone- Herbalife Ltd. CFO

Thank you. Good morning. Start with the – our Safe Harbor statement. The details of this is on our website – and the slides are not moving. Here we go.

As Wendy said, it has been a unique couple of weeks for us. I think the key learning for us is that there is enough insecurity in our business model that we need to do a better job educating Wall Street as to how it works and why it works with substantive facts and data behind it. And that is what we’re going to attempt to do today.

We have added a number of new slides and a number of new statistics in an attempt to do just that. We are calling that section Herbalife `0`, so it is how the model works. We will move on to what is driving growth, what has been driving growth, what is expected to continue driving growth, which is really a new way our distributors go to the marketplace.

We’re going to provide some key consumption-related metrics. So what has been identified over the last couple of weeks is we don’t have visibility into – direct visibility into consumption, but we have a lot of indirect visibility into consumption. And we are gong to provide some new stats for that. And then we will get into our financial performance.

So, I will start with how the model works. We have just under 3 million – we call them distributors – and I think that has been a confusing term that has been misunderstood by the Street and by media. So we are going to bifurcate that into two groups. We call them sales leaders and non-sales leaders. And they are very different groups.

They are still distributors in our vernacular, but the way people outside of the Company need to look at these two groups is that the non-sales leaders are nothing more than single-level distributors. They’re single-level, eligible earnings only; there is no multilevel component to those individuals. They derive all of their income just from the retail/wholesale profit, meaning they buy it at discount and they can sell at a markup. There is no royalty system. They are not eligible for royalties or bonus at all.

And I think the fourth bullet point in that right box, the upper right box, is a really important bullet point. There are no buying requirements by non-sales leaders. So if a distributor is in the business and buying product, they are buying it because they have consumption-based needs, whether it is their consumption or their customers’ consumption, but for no other reason.

And again, the message is when the media or the press think of single-level nobody questions that distributors are in the business for self-consumption. Right? That was a question raised a couple of weeks ago, about how much of our business is consumed inside the distributor network and outside. And the reality is as long as it is consumed, it doesn’t matter whether it is in or out.

Then there is second group, which is 18% of our distributors, so it is a smaller group, which are multilevel earnings eligible. With that group, to become a sales leader, you sign up as a distributor, the first-level group, and you can accumulate volume to move into that sales leader category. So there are volume accumulation requirements to qualify for a sales leader and to qualify for royalties. And we will talk about that in a few minutes.

This slide depicts in these two horizontal green bars the earning opportunity for our distributors. And that left green bar, the bigger one, is the single-level earnings opportunity; that is, you buy at a discount and you sell at a markup. Okay? And on the far – on the right side, it is the royalty, it is the multilevel earnings bucket, which is less than half the size of the single-level.

Now why is that important? Because when media and investors over the last couple of weeks have determined the earnings opportunities for distributors, that left bar, the bigger bar has been left off. Yet on the prior page, that 82% of the distributors who are single-level are only eligible for that left bar, not for the right bar. So the numerator that is being used has been wrong and the denominator that is being used has been wrong. So it comes up with a distorted calculation.

And then I think most important on this slide is that bottom bullet point, which is no distributor, whether they are a sales leader or a non-sales leader, can earn both royalties and retail profit on the same sale. So how does – what do I mean by that?

If Amy is a sales leader and she can buy the product at a 50% off, and I am a distributor under her, and I buy it at 35% off, she makes 15 points. She makes that retail profit. And that is all she makes; she makes no royalties. The only time she can make a royalty is if I also have qualified for a sales leader and can buy the product at 50% off. Now, she’s making no royalty- I mean no retail profit, because she is buying it at the same price that I am buying it on. There is no markup for her, but she makes a royalty. So she gives up the retail profit in exchange for the royalty.

Why would you do that, because the royalty is less? Well, the retail profit is on a smaller base, the royalty is on a bigger base. Right? So you make smaller dollars on a bigger base. So that is another important element of our business plan I think is misunderstood.

Before I get to some stats behind consumption, I will talk a little bit about our product category and what is driving our growth. So our product categories fall into – we break them into four buckets and then all other. The biggest bucket is Weight Management; it represents a little less than two thirds of our sales. Half of that comes from the meal replacement product, Formula 1. Targeted nutrition, which is more traditional supplements, is 23% of our business. We have a small Sports & Energy, but growing category, at 5% of our business. Outer Nutrition, which is skin care, is 4% of our business. And All Other, which includes IBP sales, which is the pack people buy to become distributors, literature clothing, and everything else we sell to support our distributors, is 5.5% of sales.

How our product is positioned has been a key element of growth over the last – I will give it nine years, or starting in 2003, which is the product is positioned as a meal replacement, which makes it a replacement spend, not a discretionary spend. All right? So that is an umbrella statement.

How the distributors go to market with that selling proposition is through something we call daily consumption. Daily consumption is defined internally, within Herbalife, as any business method our distributors use to create frequent interaction with their customer. Okay? Traditional direct distributors are attempting to do is drive more frequent interaction, because that is more frequent interaction, especially in a weight management type product, drives product usage, drives consumption. That consumption drives the product benefit. Okay? So we will talk a little bit about that in the next slide.

Three of the models that our distributors use to create that frequent interaction are weight loss challenges – kind of think of the Biggest Loser, where people weigh in once a week, and if you gain weight, you pay a dollar, if you lose weight, you can win money, that kind of thing. And then all the way to the right is the most prevalent model, which is a Nutrition Club. A nutrition Club is a fixed location operated by distributors that operates as a social club, where the customers can come in, pay an entry fee to the social club for the day and get three core Herbalife products, Formula 1, tea, Herbalife tea, which is the caffeine drink, and aloe for digestion. And it is positioned as a replacement meal. And the objective of that selling proposition is to take somebody who is already spending their $4 or $5 at fast food and bring them over to Herbalife for a meal, and actually save money and get better nutrition.

Why that model works so well? Again, we talked a little bit a minute ago about frequent interaction. But that frequent interaction creates a socialization or sense of community when the people get together often. And that creates a – we will call it consumer discipline. And weight management products, a lot of people in weight management, it is a big category, a lot of people get in for – to lose weight and don’t have discipline to succeed. That interaction helps create that discipline. It creates a socialization, a network of people helping support your goals, and that drives the product usage and the product compliance.

Product compliance will drive a product result. Because a meal replacement shake is a low-calorie delivery form of proteins, carbohydrates, vitamins, minerals, nutrients. And low-calorie – it is- caloric switch is how people lose weight and meal replacement. You replace a 600 to 800 calorie breakfast or lunch with a 200 calorie shake and you will lose weight.

That product result is very objective. When you lose weight, it is not a multivitamin where you think it works because somebody told you it works. If you lost weight, you know you lost weight, and everybody around you knows you lost weight and that creates a good person-to-person selling opportunity and long-term customers

That daily consumption, which is, again, that frequent interaction, we believe that around –from different types of analysis we have done on it, between 34% and 41% of our business is transacted through that model. That is not just the three core products that are sold as part of the social membership, but it is take-home product sales that happen through that forum.

This is a little dated – this is a 2010 survey we did for Nutrition Clubs in three key countries. We are redoing it this year. The first two green bars on the top are frequency of visits and how long they have been coming – consumers have been going to clubs. In the US, 55% of the consumers go every day the club is open, and 55% had been attending for longer than six months. In Mexico it was 50% and 45%. And then in Korea, which was pretty newer clubs – clubs in Korea started in 2009; this was done in 2010 – 30% attend every day and 30% attended for longer than six months.

So these next few slides are new slide to the presentation, to provide data that is indicative of consumption, not just daily consumption, but consumption. So the first row are the core three products that are sold in Nutrition Clubs. Those core three products in 2002, the first column, represented 35% of our overall Company’s volume. In 2012 – excuse me – in Q1 of 2012 and in 2011, those products represented 52% of overall volume. So the volume done through clubs, which is all consumption-based, has grown at 50% greater rate than the Company has grown.

The next stat is not a new stat, but I am not sure we have given out the 2002 data and looked at the trend, but that is the retention of the sales leaders. The sales leaders are those 18% of our distributors that have multilevel earnings eligibility. The retention rate in 2002 was 27%. In 2001, it is 52%.

Sales leader activity rate. So of that sales leader group, that multilevel earnings opportunity group, the average number of the entire population that ordered in a given month in 2002 was 37%. It is up to 56% this year.

5K sales leader qualifications. So there are two – in the past, prior to 2009, there were two ways to qualify to become a sales leader. So you’re a distributor, you have no volume purchase requirements. To become a sales leader, you had to buy 4000 volume points in one month or 2500 volume points in two consecutive months.

In 2009, we introduced the third pathway, which is doing 5000 volume points over any 12-month period. So the purpose of that change was to drive smaller purchases more frequently over a longer period of time and allow people to build their way into becoming a sales leader. All right? That’s in the direction of daily consumption, support of the daily consumption. That represented 24% of our new sales leader growth, total sales leaders in Q1 of 2012.

And I think the next two stats are the most telling. The new sales qualification volume – so again, to become a sales leader, you have to qualify through volume purchases. Those volume purchases – think of it as recruiting volume – new sales leader qualification volume as a percent of overall Company volume in 2002 was 27% of our overall volume. In Q1 of this year, 14%, all of last year, 16%. So there is a recruiting element to any business, as there is ours, but it is a small part of the overall volume, not a big part. That has been, I think, misunderstood over the last couple of weeks.