FINAL TRANSCRIPT
Thomson StreetEvents
HLF-Herbalife Ltd. at Wedbush Morgan Securities California Dreamin Management Access Conference
Event Date/Time: Dec. 09. 2009/ 7:15PM GMT
CORPORATE PARTICIPANTS
John DeSimone
Herbalife Ltd. –SVP Finance
PRESENTATION
Unidentified Participant
Let’s get started. It’s my pleasure to introduce our next presenter. It is going to be John DeSimone, SVP of Finance for Herbalife. John?
John De Simone- Herbalife Ltd. – SVP Finance
Thank you, good morning. With me today is Amy Greene, our Vice President of Investor Relations. Before we get started, I would like point everybody to the Safe Harbor language in the presentation, which is also available on our website at www.herbalife.com, underneath the Investor Relations icon.
Why Herbalife? Why now? It is a theme we have used all year with our distributors around the world, and it’s a theme that I think fits really well into the investment opportunity for Herbalife. This first page is a summary. There’s four key takeaways.
The first key takeaway, and really if you take nothing else away, it is the growth opportunity that is in front of this company. This is a growth story. It has been a growth story for the last five years, and we think there is a lot of runway left.
The growth will come in a number of ways, but the number one strategy is to go deeper into markets we’re currently in, with a distributor model that has evolved, that penetrates to more consumers, increases the addressable population within a given marketplace. I’ll spend most of the time of this presentation on that topic.
Additionally, we’ll look to go wider. We’ll look to open up new markets. We spent a significant amount of money to build a worldwide platform, system platform. We are on Oracle in every country but China. That provides a great scalable platform for us to launch new countries.
Additionally we have a product line that fits really well into the global obesity epidemic and we’ll talk a little bit about that, and it also fits very well into direct selling. So that’s the first point.
The second point, we have a strong financial record. We have a financial model that’s very low capital, all right? So there’s not a lot of capital required for us to grow our business. It’s very high margin, and generates a lot of cash flow.
And our company has been very disciplined in the use of that cash, so Return on invested capital in 2008 was in excess of 44%. Five times the average of the S&P.
And then we have an operation model where – or an MO within the company that if we can’t invest the money and exceed our hurdle rates, we look to return it to the shareholders. All right? We have a history of doing that. We returned over $650 million to shareholders over the last three years, and that will continue to be a part of our strategy, cash-use strategy.
Additionally, we have a proven management team. We have a management team that came in essentially in 2003, doubled the business on the top line in the last five years, and more than doubled the bottom line, and that far exceeds what our competitors have been able to do.
I’ll start the presentation off by speaking a little bit about our recent results and then we’ll get into the story. What you see in front on this slide are our reported net sales, operating margin, and EPS numbers for the third quarter of 2009. The second column is the reported number in 2009 versus 2008, and the third number is currency adjusted. We have 80% of our volume, our business, is done outside of the US, and accordingly the strength of the dollar, the headwinds we faced over the last nine months has an impact on our results.
Our third quarter 2008 net sales number was $602 million. And on a constant currency or local currency basis, that increased 750 basis points. 7.5%. Okay. On a reported basis, it decreased 0.3%. So it was a 780 basis point impact from currency headwinds.
That has changed, right? So our net sales lagged our volume growth; over the next 12 months we think our net sales will exceed our volume growth, because now we’re facing a currency tailwind.
On the operating margin side, we have a 14.7% operating profit margin in 2008 third quarter. On a reported basis it dropped to 13%, but that was currency impacted. On a constant currency basis, it was up to 15.3%, and the biggest impact on our margins on currency is that fact that most of our product is manufactured in the US. So it’s a US dollar denominated cost structure on revenue that is mostly generated outside the US.
On EPS, we had $0.89 last year. We were down slightly this year on a reported basis, but we would have been up 21% on a constant dollar basis.
Now the growth story. I am going to start with a few foundational slides. And the foundational slide is the slides of the product. 63% of our product is in weight management. Weight management addresses the global obesity problem. You can see some magazine covers, some well publicized issues around the world that weight management products address. So one is, there’s a megatrend out there, and our products fit that megatrend very well.
Two, weight loss products work really well for direct selling, and I’ll tell you my own personal experience, okay? And I tell you this because I learned a lot from it. So when I joined Herbalife, I was 30 pounds heavier than I am now. And I lost the weight on the product, and what I found is I didn’t have to tell my story. I have people coming –everybody who knew me came up to me and asked me what I did. Right?
So it’s a great person-to-person product, selling proposition, right? It’s very testimonial based, very before and after. It’s not faith. It’s you can see it, you can feel it, you know it works. It works very well within the direct selling category.
The selling proposition. We’re calling it – we speak to it as trading up in nutrition, trading down in calories, and trading down in cost. Okay? So a traditional muffin and coffee breakfast, 1000 calories. An Herbalife shake, under 250 calories. Okay? So you’re trading down in calories, you’re getting better protein, better nutrition. Okay?
And most importantly, you can see on the bottom, the cost per serving is a lot cheaper than a traditional breakfast. This is a US example. This differs a little bit by country. But this is the selling proposition. Trade down economically, trade down in calories, trade up in nutrition, and that’s what our distributors use when they go to market. Okay?
This is all foundational, like I said. The key to our growth strategy was getting this product offering from a traditional direct selling model to a model that people can buy on a per-serving basis. All right?
So traditional direct sales is categorized by medium to large purchases made very infrequently. Okay. So it’s $50. It’s $100. It’s $250, done once a month, once every other month. Okay? That skims the surface of the addressable population, because not a lot of people can afford to pay for a month’s supply of product at a time.
The evolution that is taking place within Herbalife – and we’ll talk about the genesis of it and where we are in this cycle – is that our distributors are going to market was is called a daily consumption or club model where they found a way to sell our product on a daily fee basis. Okay?
So what does that do? That allows us to go deep in a population. A lot more people, a lot more potential consumers can afford to pay $3 a day for the product versus $90 a month for the product. So they have been able to increase the addressable population by coming up with a daily fee model.
Now what’s that model? The genesis of the model was in Mexico, and it started with home clubs. A home club was a distributor who invited their customers to their home in the morning, and for 20 pesos, you could get a shake, a tea, and an aloe. Very affordable, you didn’t have to come every day. But a very effective model.
Effective for a couple reason, right? Less expensive, and I have a slide to illustrate this. But it’s less expensive. It’s also much more efficient for distributors. Okay? The tradition direct-selling model had distributors calling up their customers every month. All right? So you had to get on the phone, call your customers, find out where the order is, or call up and schedule an event to bring your customers to you.
Our distributors now have a platform where their customers come to them every day for the product. So they can service far more customers much more effectively, much more efficiently. So it’s more profitable model for our distributors.
So the two benefits of daily consumption – increases addressable population and much more efficient for our distributors.
To illustrate it a little better on a slide, we use an example of coffee. Right? And I think coffee is actually a perfect analogy. Okay? So McDonald’s sells coffee. Let’s say it’s $2 a cup. If McDonald’s required you to purchase coffee one month at a time in advance, so you had to pay $60, you got a card, and that was your coffee for the month, the amount of people that could participate in that opportunity is much smaller than people who can pay $2 a day.
And that’s what we have done with our product. And our product line fits really well into daily consumption. Our competitors don’t have products that can be consumed every day. They don’t have products they can sell on a daily basis. We have that. Okay?
I’m going to start with the Mexico story. Mexico is where the club started. And prior to club – we call it a club inflection point. So daily consumption works differently in each market. Okay?
In Mexico, it was a home club. Very social culture. Very comfortable people coming over to their house. It started in 2001. All right. In direct selling, in a given market or subsegment of a market, once a model works, that’s when you start to see it replicate. So it started in 2001. It started to really work in 2003, and that’s where it started to replicate.
In 2003, this is nine months year to date figures, the volume points –volume points for those who don’t know, it’s a proxy for unit volume – were 75,000 for the 9-month period ending September 2002. In 2009, it was up five times that. Okay. That’s the magic of daily consumption, right? It goes much deeper into a marketplace, and we’ll talk about penetration rates in a little while. And that happened in 2003.
So the next question is, well, what took so long for that model to spread? Most of the other countries with an Herbalife saw that model as a model that can only work in Mexico. Very social culture. You bring people into your house. I wouldn’t do that in the US, I wouldn’t do it in Taiwan. I would do it in Korea.
But over time as Mexico became more successful, our distributors paid more attention to daily consumption. As they paid more attention to daily consumption, they tried to duplicate it. And we find that when a market really tries to duplicate it, there is still a 24-month period, maybe a little less, little more, but they figure out how to make it work in their market. All right?