Herbalife Nutrition Ltd.
Q3 2012 Earnings Call Transcript

Published: 30 Oct 2012

[Operator:]

Good morning, and thank you for joining the Third Quarter 2012 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:]

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're referring to volume points. I'll now turn the call over to Michael.

[Michael O. Johnson:]

Thanks, Brett, and good morning, everyone, and welcome to our Third Quarter 2012 Earnings Conference Call. We have another record quarter with net sales up 14% to $1 billion. Volume points of 1.2 billion increased by 17% over the prior year's third quarter, and EPS is $1.04, a 20% increase. Our growth continues to be broad based. Each of our 6 regions experienced strong double-digit volume point growth in the quarter. Four of our regions, Asia, Mexico, China and South and Central America exceeded 15% volume point growth. North America had a 14% increase in volume points, and EMEA experienced a 10% volume point growth in the quarter. And our Average Active Sales Leaders increased 22% in the quarter. Des will provide more color around these regional results in just a minute. The consistency of our growth and financial results reflect the dedication and hard work of everyone on Team Herbalife. So thank you to our independent distributors and employees around the world for another record performance. For more than 32 years, Herbalife products' independent distributors and employees have been helping millions of people achieve their weight management and daily nutrition goals. This has always been the culture at Herbalife, and the need for good nutrition, it's never been more important than it is right now. The fundamental change in our business began 10 years ago with the development of Nutrition Clubs in Mexico. This increased our addressable audience by making our products more affordable to more consumers. Over the last several years, a substantial portion of our growth has come from our distributors around the world moving to daily consumption business methods, built on the creation of lifelong customers consuming Herbalife product everyday. We believe that these business methods now generate approximately 40% of our volume. With approximately 43,000 nonresidential clubs at the end of the third quarter, Herbalife products are now more accessible to more customers than ever before. The success that our Distributors are having throughout our 85 markets continues to be driven by the high-touch, frequent-contact business methods that are the hallmark of daily consumption business methods. Mexico, our oldest daily consumption market, has continued to experience double-digit volume point growth. The sustainable growth in Mexico highlights to us similar results that are possible in many other markets that are continuing their adoption and expansion of direct selling methods. Yesterday, we introduced guidance for 2013 volume growth, earnings growth and capital expenditures. This guidance reflects our outlook for continued growth in net sales, volume points and EPS. Additionally, we provided guidance for our capital spending needs. The increase in our CapEx in 2013 primarily reflects our ongoing investment in the manufacturing of our top products, expanding tools for our distributors and creating more product access points. In 2010, as part of our 10-year planning process, we set an aspirational goal of 10 billion volume points by 2020, basically tripling our volume from our 2009 base. When we discussed the goal, we were cautious to always use the term aspirational because it was just at a stretch. Every year, we update our 5-year plan and layering in growth we've experienced since late 2009, our aspirational goal of 10 billion volume points by 2020 is now a number we believe we can achieve and a goal we are implementing plans and the infrastructure to support. Investments in our Seed to Feed strategy reflect our high degree of confidence in our business and are crucial to supporting our growth. In August 2009, we announced the acquisition of Lake Forest, California Herbalife manufacturing and innovation facility. Based on our growth expectations in 2009, Lake Forest was designed to produce about 40% of our global and our nutrition product. Our growth has continued to exceed our expectations, and therefore, the facility is now approaching full utilization. Recently, our Board of Directors approved the creation of a manufacturing facility in the U.S. on the East Coast that will have approximately 4x the manufacturing capacity of our Lake Forest facility. We anticipate that this facility will be online producing Herbalife product in 2014. The self-manufacturing component of our Seed to Feed strategy has enabled us to have faster speed to market and more regionalized product ideation. The seasonal flavors of our Formula 1 shakes are an example. We recently launched the dulce de leche in the U.S. and sweet corn in Brazil. In 2013, we plan to accelerate these new flavors, both seasonally and by region, as well as to introduce additional delivery form such as GMO-free shake and a meal replacement soup in certain markets. Our Formula 1 shakes, which comprised 32% of our sales, are designed to be the most complete, well-balanced meal you can have any time of the day. With the right balance of proteins, fibers and carbohydrates and the appropriate amount of vitamins and minerals, our Formula 1 shake is designed to do more than help you reach and maintain a healthy weight, it's a nutritious meal. As we discussed last quarter, we've engaged Lieberman Research to conduct consumer research over the next 3 years. This quarter's results were very similar to those of the second quarter. Approximately 5% of U.S. households reported having purchased Herbalife product in the past 3 months, which translates into more than 5.5 million households. Those consumers who purchased Herbalife product, more than 90% were outside our distribution network. According to Lieberman Research, the consumers' intent to repurchase was very strong, with 2/3 of those having purchased Herbalife product in the past 3 months, indicating that they would definitely repurchase Herbalife products. In the third quarter, Lieberman also conducted research for us in Korea, and their findings were very similar to those of the U.S. market. We also continued to build our brand and our image. This is a process which our product, our distributors, employees and vendors all participate. Through many sponsorships around the world, we continue to activate and authenticate our brand with a healthy, active lifestyle, both through athletes and sports teams. We received tremendous positive recognition for our brand this summer through our sponsorship of the Herbalife World Football Challenge, one of the largest and most successful soccer exhibitions ever staged in North America. It's brought together many of the world's most accomplished and celebrated soccer clubs to play in major sports venues across the U.S. This year, there were approximately 350,000 people at 9 games. The games were broadcast on ESPN, Fox Sports, Univision and in over 20 key markets and territories throughout the world. We also are proud to have more than 50 Herbalife-sponsored athletes competing in the London Olympics, with 8 of our sponsored athletes taking home medals. Here in Los Angeles, in September, we are the proud sponsor of the Herbalife Triathlon Los Angeles where approximately 2,500 athletes participated, including 400 Herbalife distributors and employees. Spending time with our distributors around the world is crucial to our ongoing success. Company-sponsored events are an important aspect of our business as they provide a platform for us to facilitate leadership development among distributors, train on business methods that drive sustainable growth, train on new product launches and foster an environment for distributors to collaborate among themselves. The summer was filled with regional extravaganzas, offering the opportunity to spend time with thousands of distributors. This quarter, we saw 22,000 distributors at our 3 EMEA Extravaganzas in Kiev, Ukraine; Barcelona and Istanbul, Turkey. From there, we headed to Macau for events with 12,000 distributors in 12 Asian countries. Not to be outdone, Mexico held 2 simultaneous extravaganzas, a first for Herbalife. We had 20,000 distributors in Mexico City and 13,000 distributors in Guadalajara. As we continue to foster the transformation of our business, our distributors are creating loyal customers and also building solid distributor organizations through daily consumption business methods and systemized training. They're selling deeper into the communities. They're going city by city, and they're living and activating and wearing the brand. We will continue to make necessary investments to stay ahead of our growth, improve upon our recent success. And as we say here, build it better every day. Herbalife is built on a strong successful 32-year foundation. The global mega trend of obesity, coupled with our weight management, nutrition products and, of course, our dedicated distributor activity, puts us in a great position to extend our financial success well into the future. I thank you for your time, and now let me turn the call over to Des.

[Desmond Walsh:]

Thank you, Michael. The third quarter is our fifth consecutive quarter of more than 1 billion volume points and was 17% higher than last year's third quarter results. As Michael mentioned, we continue to be very pleased with the momentum we see in the underlying trends in our business, as all 6 regions posted strong double-digit volume point growth. The main driver of our growth continues to be the consistent execution of the business methods that we have been discussing with you all for the past several years

[John DeSimone:]

Thank you, Des. I'll start my prepared comments with a review of the third quarter results, followed by commentary regarding our guidance. For the third quarter, we reported net sales of $1 billion, an increase of 13.6% compared to the third quarter of 2011. And as you all know, we faced a pretty big foreign currency headwind in the quarter, which had an approximate 700-basis-point drag on net sales. Some of the more significant currency headwinds include the Brazilian real, negative 25% versus the third quarter of last year; the Indian rupee, negative 20%; the Mexican peso, negative 7%; the Korean won, negative 4%; and FX rates in the EMEA region, collectively, were negative 11% versus the third quarter of last year. Looking to the fourth quarter, the headwind is behind us as currency is effectively neutral versus the fourth quarter last year. Gross profit margin in the quarter was slightly below last year. The approximately 20 basis point decline on a year-over-year basis was due mostly to the unfavorable impact of FX and country mix, which was partially offset by savings associated with our Seed to Feed initiatives and lower inventory write-downs. Third quarter operating margin of 15.8% represents approximately 100 basis point decline compared to the prior year. The decline in operating profit, as a percent of sales, is due to the negative impact of FX. On a constant currency basis, operating margin would have been slightly above the third quarter of last year. On a year-over-year basis, SG&A was negatively impacted by approximately $5 million from the timing of events. One of our larger events that occurred in the fourth quarter last year took place in the third quarter this year. Excluding this timing item, internal service provider payments, SG&A, as a percent of sales, improved slightly compared to last year's third quarter. Turning to EPS, third quarter earnings per share of $1.04 was $0.17 better than results from a year ago. This 20% improvement in EPS was achieved despite a $0.15 headwind from currency. On a constant currency basis, EPS would have increased by more than 36%. Compared to guidance, third quarter EPS was $0.05 higher than the midpoint of the guidance range provided in July. This speed was primarily caused by higher volumes as we exceeded the midpoint of guidance range by 33 million volume points. The benefit of higher volume was partially offset by a higher-than-expected tax rate. With respect to guidance for the remainder of 2012, we are raising both our revenue and earnings ranges compared to our previous guidance. Volume for the year is now expected to increase by 18% to 20%, with net sales expected to increase by 16% to 18%. We are raising our fully diluted EPS guidance range, adding $0.11 and $0.05 to the low end and the high end of the previous range, respectively, resulting in a new 2012 EPS guidance range of $3.99 to $4.03. As I noted earlier, fourth quarter EPS guidance assumes relatively no overall impact from FX compared to last year's fourth quarter, while this year's full year 2012 EPS guidance range includes an approximate $0.37 headwind from currency compared to 2011. Moving to our 2013 guidance. We expect volume points to grow in the high-single to low double-digit range. Accordingly, we are initiating fiscal 2013 guidance for volume points and net sales growth of 8.5% to 10.5%, and 10% to 12%, respectively. We expect full year EPS to be in the range of $4.40 to $4.55 per share. With respect to our initial 2013 guidance, please take note of our assumptions with respect to Venezuela. As I mentioned in April, some time following the October elections, we expect the formal devaluation of the bolivar. We believe it could happen in the first quarter of 2013 and have incorporated a change in the FX rate in our initial 2013 guidance. While the timing and value of the devaluation is not known, our guidance assumes a 10 to 1 exchange rate beginning January 1, 2013. Also note that while we assume the higher Venezuelan FX rate for our ongoing performance next year, our guidance does not include any onetime impact from the likely devaluation. Overall, foreign currency, including this impact from Venezuela, which I just noted, has an approximate $0.10 drag on next year's guidance. Moving to capital expenditure guidance, next year's range of $165 million to $185 million reflects the next major expansion in our Seed to Feed strategy. Our board approved a new East Coast manufacturing facility that will cost approximately $130 million. We anticipate that this facility will be complete and operational by the middle of 2014. We are currently negotiating with multiple sites and/or building locations, and we'll update investors further when we have a definitive agreement. The majority of the facility capital is expected to be spent in 2013. This new facility is necessary in order to meet product supply needs and to in-source products currently made at third-party contract manufacturers. In addition to ensuring quality production, this should help improve inventory turns. Approximately 85% of our increasing inventory since last year's third quarter and year end and sequential inventory growth since Q2 have come from product made at third parties. This investment in inventory has been necessary given the significant growth we are experiencing in markets with very long supply chain lead times, plus buffer inventory, necessitated by the execution of our vendor consolidation strategy to reduce the number of vendor partners to those that are capable of scaling with our growth. With respect to this new facility, we believe that self-manufacturing will reduce lead times in those markets and allow more flexibility with the registration of products in foreign markets. Additionally, this new facility will be approximately 4x the size with a comparable increasing capacity over our current facility in Southern California, including additional room for expansion. Moving to share repurchase, during the quarter, we repurchased $181.9 million of stock in the open market. This completed the repurchase agreement announced in May. Two comments with respect to share repurchase. Q4 and full year 2013 guidance assumes $50 million of share repurchase per quarter. And second, as noted during last quarter's earnings call, the board authorized a new $1 billion share repurchase program expiring in 2017. The entire $1 billion is outstanding as of the end of the third quarter. Also noted during our last earnings call, was our belief that we have identified a strategy that would allow us to accelerate the repurchases beyond our consolidated U.S. GAAP equity position. This process is complete, and we now have the ability to repurchase stock beyond our consolidated equity position, should we decide to do so. Thank you. That ends our prepared comments. We will now open up the call for your questions.

[Operator:]

[Operator Instructions] Your first question comes from the line of John San Marco with Janney Montgomery Scott.

[John P. San Marco:]

Did you say -- just double checking, you said there were 43,000 clubs at quarter end in total? And is that calculated the same way as the 36,000 number you gave us last quarter?

[John DeSimone:]

Yes, it's calculated the same way. And yes, it's just under 43,000.

[John P. San Marco:]

Okay. In that context, I was hoping you could address product mix. The Weight Management product line is growing a little slower than targeted nutrition and energy. Just surprising, given the -- all the data we have in daily consumption's growth, can you help what's driving the product mix here for me?

[Desmond Walsh:]

Yes, John, this is Des. So I think what you're seeing, John, is that through the Herbalife Fit Club concept, we obviously have increased adoption of other products beyond the core Nutrition Club products range. It also speaks to the fact that our Nutrition Club customers are, obviously, are coming every day to enjoy a shake, a tea, an aloe. But in addition, that they're purchasing other products. So I think what you see is that it's just a broader reflection of more consumer activity, but across a broader product range.

[John P. San Marco:]

So it's different products going through the same clubs, or these new clubs that are opening up that are just focused on products outside of the...

[Desmond Walsh:]

It's probably both, John. But what we have, obviously, is that we've got a whole group of new distributors who are combining the Herbalife Fit Club concept with Nutrition Club concept. And so in those clubs, you actually have a broader product range. But also I think you have maturing of existing clubs with greater focus now on consumption of other products outside the clubs.

[John DeSimone:]

And John, this is John. Let me add that 51.4% of our volume this quarter came from Nutrition Club SKUs, which compares to 51.1% last year. So it is slightly up.

[John P. San Marco:]

51.1% for that ELO Formula 1?

[Michael O. Johnson:]

Right.

[John P. San Marco:]

Okay, very helpful. And then last question, I was just hoping you could address Western Europe. It seems that of the few soft spots that you have globally, they tend to be in these markets where the economies are the weakest. Did this make you rethink the economic sensitivity of the business model? Is there something unique about 2012, or do I have it all wrong, and you don't view your businesses as economically insensitive?

[Desmond Walsh:]

Yes. So, no, John. What we see is this. Obviously, Western Europe continues to be a focus for us. But here's what we're really excited about in Western Europe. Our distributors are entrepreneurs, and so they follow success. If you look at Western Europe, and you look at what's happening in the U.K, what you see is that our distributor leadership there, 2 or 3 years ago, began to focus significantly on daily consumption business methods and specifically the Weight Loss Challenge concept. And that concept, obviously, combined with clubs, combined now with Herbalife Fit Club, has really resulted in tremendous growth in the U.K. You see that 56% increase in volume points in the third quarter, 70% increase in new distributors. So because of that, that concept is, obviously, now being looked at and adopted by leadership throughout Western Europe. So we believe that what's happening in the U.K. is a leading indicator of what can happen in the other countries in Western Europe. And so that's why we're confident that the model is just as productive as ever, and that we're on the right strategy as far as all of Western Europe is concerned.

[Operator:]

[Operator Instructions] Your next question comes from line of Michael Swartz with SunTrust Robinson Humphrey.

[Michael A. Swartz:]

I guess this question is directed to John. With regards to the 2013 guidance, I mean, if I kind of do the math, it looks like you're guiding for some margin pressure year-over-year. Could you maybe give us some more color on the moving parts there? Are there any onetime costs from the new manufacturing facility, et cetera?

[John DeSimone:]

The major impact to margins next year is FX, and the major FX contributor is Venezuela and the assumptions we are making with respect to that market, which is a 10 to 1 exchange rate. Once you get beyond FX, we have pretty close to margin neutral expectations for next year. There is -- I think you have a second question, which was some costs that may be in the model next year for the new manufacturing operation. There are some, it's not vary material, so I wouldn't be too concerned about that.

[Michael A. Swartz:]

Okay, great. And then kind of longer term, I guess, with the whole Seed to Feed initiative and then this new facility that you're bringing online by 2014, I mean, is that facility included or the savings, potential savings from that facility included in that kind of 100 to 200 basis points outlook you gave, I think, in 2010 regarding Seed to Feed, or is this incremental?

[John DeSimone:]

No, no, it's included. That basis point benefit expectation included in the entire Seed to Feed strategy that was multiple years. At that point in time, we knew we needed additional facilities. We didn't know where. We have evolved that strategy to a 1 large facility on the East Coast. The primary objective of that facility is to stay in stock on high-quality products. We feel that the capacity is necessary given our growth profile. So that is still the primary objective of that facility. The secondary objective is the financial opportunity.

[Michael A. Swartz:]

And I'm assuming that facility starts some time in mid-year 2014, when would you expect any kind of cost savings from vendor consolidation to show up?

[John DeSimone:]

Well, vendor consolidation is partially a result of manufacturing, self-manufacturing. But it was a part of an overall consolidation that took place regardless and independent of self-manufacturing. But to answer your first question, we're not going to see a benefit from that factory in -- until 2015. This is going to come up in mid-2014, and then you've got to ramp it up and then have one inventory turn before we see the benefit.

[Operator:]

There are no further questions at this time, I would like to turn the conference over back to Michael Johnson for any closing remarks.

[Michael O. Johnson:]

Thank you, all, very much. We realize for all of you, this is probably a pretty tough time, tough time for a call, of course. We hope you and your families are getting through the storm without too much disruption. Our thoughts, of course, are with all of you. And, of course, with our distributors who are in the Mid-west and the Eastern U.S., we're hoping that everybody is safe, dry and getting through this really unprecedented storm without too much harm. Our business is incredibly strong. Our momentum continues, our leaders are engaged, our management team has never been more motivated or focused than we are today. We know this is a tough time to have a call, but we want to thank you all for being on it. We're continuing our momentum, our progression forward. We're looking forward to seeing you next quarter to give you even a better report. So thank you very much. Have a great and dry day ahead.

[Operator:]

This concludes today's conference. You may now disconnect.