FINAL TRANSCRIPT
Thomson Street Events
HLF- Herbalife Ltd. at Bank of America Merrill Lynch Consumer Conference
Event Date/Time: Mar. 11. 2010/ 6:40PM GMT
CORPORATE PARTICIPANTS
John DeSimone
Herbalife, Ltd. – CFO
PRESENTATION
Unidentified Speaker
Next up we are pleased to have Herbalife. Here for the Company is newly appointed CFO, John DeSimone. John was appointed just this past December ahead of their Analyst Day. Now, John takes the role as a number of key markets are improving and there’s a number of key initiatives for the Company. And John’s going to walk us through it.
John DeSimone –Herbalife, Ltd. – CFO
Okay. Thank you, Chris. With me, next to Chris, is Amy Greene, our Vice President of Investor Relations.
I’ll start by pointing to the safe harbor language in the presentation, which is also available on our website for those listening online. Our website is www.herbalife.com under the Investor Relations icon.
I’m going to start with an overview. We’ll talk a little bit about who we are. Then we’ll get into what’s driven growth over the last five years and what’s going to drive growth for the next five. And then we’ll end with the financial review.
Herbalife is in – we’re a $2.5 billion revenue company located in 73 countries that we’ve grouped into six regions. No one region is overly weighted. We have three regions – North America which, for our purposes, excludes Mexico – North America; EMEA, which is Europe, Middle East and Africa; and then Asia Pacific. Each range between 21 and 23% of sales. South America is around 16% of sales. And then two what we call regions, but they’re really countries, Mexico and China, represent around – Mexico’s 12% of sales and China’s around 6.6 or 7% of sales. It’s the most – it’s the newest region for us and it’s under development right now.
For the year, you can see in the boxes we have our – this is local currency net sales growth, so it takes out translation. And for 2009 we had actually a record volume year in what was a really difficult economic challenging environment. Four of our six regions grew in terms of local currency in 2009. Specifically in the fourth quarter that growth accelerated. We had growth in five of our six regions. It was a record quarter for us, so it was the highest volume quarter in our history. So we ended in 2009 with a lot of momentum.
And then, from another perspective, from an emerging market perspective, which is not how it’s presented here, but more than half of our business is in countries that are classified as emerging market countries from the World Bank. So it’s an important data point for some investors.
From a product standpoint we consider ourselves one of the world leaders in nutrition. We’re $2.5 billion. 62% of our business is done in what’s called weight management. I think it’s an important distinction between what we call weight management and what maybe people think of when they think of weight management. We are not a magic pill company. We’re not about take the pill and don’t eat for 30 days. Half of our weight management product is a meal replacement shake. It’s our oldest product. It’s what the Company was founded on in 1980. It’s been around for 30 years, tried and tested, and it represents 30% of our sales.
We have another category called targeted nutrition, which is condition-specific product, such as brain health, heart health, immune health, things like that. That makes up 22% of our business. Then we have two smaller categories. One is more of a branding category for us, which is sports nutrition, which is how we build our brand around the world. And then personal care is really an opportunity for us. It’s a relatively small percent of our sales, like 6% of sales. We haven’t done a great job at growing that, but it is a strategic initiative for us, because it is an opportunity.
Little bit about the story of Herbalife, where we are. Our model has really evolved a lot from where it was 10 years ago. As I said earlier, we’ve doubled the Company, size of the company, in the last six years. That growth has been driven by a couple of concepts. One is our products are relevant. Our products address two megatrends. So first is obesity and our products are used as a meal replacement product that helps people maintain their weight. And second, the jobs. So, right, healthcare and jobs are two of the things you hear the most about today in the news. And we have an element of our business plan that supports jobs, kind of a countercyclical element, if you would. I don’t think that we were perfectly positioned for that, but we made some changes that will help us be more countercyclical when we need to be.
The real driver of growth, for those who are unfamiliar with the story, is a transition from what was a, really a monthly purchased – monthly purchase model, where consumers had to purchase our product at a monthly fee, a monthly base, a monthly price point to a new model where consumers can produce – purchase the product at a daily price point. And what you’ll see in a few slides is how that has dramatically increased penetration into our marketplace. Because the traditional direct-selling model can only skim the surface of consumers that can participate in the business, whereas a daily price point really digs deeper into a market as to who can participate in the business.
From a financial modeling standpoint, we’re very low capital requirements. We don’t have much capital needs, even to grow the business. Most of our cost structure is variable in nature, so we don’t have a high fixed cost base. And we generate a lot of free cash. All right? So we’ve generated in excess of $200 million in free cash the last few years each year. And it’s far more cash than we can effectively spend. And we have a trend of returning that money to shareholders through – we have a dividend.
And we have a share repurchase program. That share repurchase program started at $300 million, went to $600 million. Then we added another $300 million. So our board tends to do $300 million tranches of buyback. We’ll talk a little bit about that in a few pages, but I think for analysts that – I mean for investors that are familiar with Herbalife, they appreciate the cash flow. For those who are unfamiliar with Herbalife, that may be the most underappreciated aspect of our business model, is the amount of free cash flow we have and the cash flow yield of the Company.
Back to the evolution of the business from traditional direct selling to daily consumption. Again, traditional direct selling, distributors have to sell to their consumers – and this is all direct selling, not just Herbalife –at a monthly price point. And they do that through in frequent purchases. So a distributor will call up their customer once a month, once every two weeks, whatever the cycle is for that company, and they would try to get the months’ order from that customer. So not very efficient for the distributor, because they have to call the customers up. And the people who could afford to buy that product are a lot smaller population than those who could afford to buy it if it was a daily price point. It’s also a very low penetrating model and it’s a high turnover and high acquisition cost of customers.
The shift that our distributors have done over the last five years is offered – they’ve come up with a model that offers a good portion of our product at a daily price point, so just that daily use of products. For example, a program for a month of three products in Herbalife, three core products, which are the shake, the tea, and the aloe drink, would have been about $100. So people, if they wanted to participate in the product offering, had to pay $100 at a time, whereas now they can pay $3.00 just for that day’s supply. And that’s been a big driver of growth. And we’ll talk about that in a few slides.
This slide tries to analogize what our distributors have done, and what this new model has done, through coffee. And I think it’s a good analogy. Coffee at $2 a day doesn’t seem expensive, because it’s a low daily price point. But the reality is if you had to pay $60 at the beginning of reach month for your month’s supply of coffee, you’d go buy a pound of coffee and make it at home. But a few dollars a day just doesn’t seem expensive, and far more people can participate in that coffee offering under a daily price point.
And that’s what happened with three of our core products. And these three products you’ll see in the next slide make up more than half of our company’s volume. These three products can now be offered through what’s called clubs – and I’ll spend a moment on clubs – at a daily fee.
The genesis of clubs happened in Mexico. And it really happened from a distributor who is a professor at a university who loved the product, saw the need for the product with the Mexican population, but realized most people in Mexico couldn’t afford to buy the product at $100 for the month’s supply. He came up with a home club concept that has now evolved to a commercial club concept, where consumers come to a fixed location. In some market’s that’s a home; in some market’s that’s a commercial club. And they pay $3 and they get three products every day. In other words, every day they come they get a meal replacement shake – and it’s a meal replacement shake and I’ll talk about what that’s an important concept – a drink of tea for caffeine and they get an aloe drink, which is digestion.
The meal replacement shake is an important component of the program in general, because if you replace a meal with a shake, first of all it’s the same – it’s cheaper money, so you’re trading down economically and buying a meal. But more importantly, you’re trading up nutritionally. And if you trade a bagel and a muffin for a 220-calorie shake, you’ll also lose weight and that creates stickiness to the product line. It’s been an important element of our growth.
And we compare on this page – this compares some of the key peer groups in our business and their model for this new model. Our product model fits well with a daily serving size, whereas a lot of our competitors do not. And we think that’s a huge competitive advantage.
So the two concepts to walk away with is, we have a daily price point and now we have daily touch points, where our consumers are coming to distributors instead of distributors going to consumers. So it’s a far more efficient model for distributors than traditional direct selling.
These are the three products that are sold on a daily basis in clubs. And it’s really just these three products. And that’s another opportunity, right, for us to offer more of our product at this daily price point. And that’s a strategy for us going forward. But these three products – you can see on the far right our volume points – which is, call it a proxy for unit volume – have grown 84% in the last six years, where these three products have grown 152%, so 2X. And they total a little over 50% of our business.
So the message is, our growth has been about going deeper. And we’ve only gone deeper in a handful of markets. And the opportunity is to deeper in additional markets, which you’ll see on the next slide.
This slide attempts to put some perspective around the opportunity. So on the bottom you can see the year in which clubs in these various markets took hold. And these are our top five markets. The blue bar is the penetration rate back in 2003 for each of these countries. And the green bar is the penetration rate last year for each of these countries. So in Mexico, for example, on volume points, they had 1.2 volume points per capita per year, meaning, if there were 100 million in Mexico, we’d get 120 million volume points in the year.
Through—to growth from clubs. We’ve been able to grow Mexico four times as big as it was before clubs started, because of that penetration. Instead of attacking just the top of each market with consumers, we’ve been able to go deeper in each market. In the US Latino market, where penetration rate was 2.3 volume points per capita in 2003, that jumped up to over 10 last year. Right? It’s a huge, huge, success story for us. And even within that 10, there are cities where we’re 20 and cities where we’re still 1. So there’s a lot of opportunity, even within the Latino community, to grow the business.
Taiwan – Taiwan – so Mexico and even the US Latino business started with home clubs. Taiwan evolved it to commercial clubs, as did Korea and Brazil. And we’ve had tremendous growth, similar growth to what we had in Mexico. They’re just earlier in that cycle, just from clubs and the ability to sell as a daily price point instead of a monthly price point.
It’s also a very sticky model for distributors, right? There’s a forced discipline with the club model that you don’t get in traditional direct selling where a distributor has to get up every day and determine what they’re going to do that day. And if they’re not motivated they may fall out of the business. But when you have a club you have a reason to get up; you have something to do. It helps drive success with distributors that traditional selling doesn’t necessarily do.
So we talked a little bit about daily consumption, the evolution of where it’s been, where it’s going. There is one country I didn’t mention that’s an interesting country for us. So India is not – it’s teetering on the top 10 market for us. We went into India 10 years ago. And we went in and it was a big – it’s called pop and drop. You go in. A lot of distributors come in. They recruit and you get a lot of volume. Those distributors leave the country and you get a big drop. And for 10 years we’ve been flat.
But for each of the four quarters we’ve had high-double to low-triple digit growth in India, from the introduction of clubs. Because in India there’s a large percentage of the population that cannot afford to buy product at $100 price point, that can afford to buy it at a much cheaper price point. And it’s all driven from clubs right now. So that’s a new – a market that’s really exciting for us. It’s a huge opportunity. There’s 200 to 300 million people in India that can afford to participate in this product offering at the daily price point. So we’re watching that closely.
And that may translate at some point in time to china, where they haven’t figured out clubs yet. So China is not in that accelerated growth mode. It actually declined slightly in the fourth quarter, but we’ll grow it this year. But generally when a country tries to launch clubs it’s a learning curve. There an [enculturalization] period where they’ve got to figure out how to make it work with their culture, their community. And China is in that phase right now, whereas India’s gone through that phase and we’re starting to see those clubs duplicate. So it’s an exciting opportunity.
We’re in 73 markets, as I said in the opening. We don’t want to stop there. Those 73 markets represent about 75% of the world’s population. There’s still 25% of the world’s population we do not address yet. Some of those are real bid opportunities for us. And really, we haven’t had the ability to go into markets too easily over the couple of years, because we were putting in a worldwide Oracle system. That system is now in in every country but China. It was completed in the middle of ’09. And in the back half we opened two countries, Vietnam and Paraguay.
And we look to open five or six this year, and five or six every year. Some of those will be meaningful. Some will be small, but the point is it’s not a lot of capital for us to open up markets anymore. So if we’ve got a small market and we can do it easily, we’ll do it. And we’re going after some of the bigger markets that we’re still not in, like the Middle East, Egypt, countries like that.
Manufacturing—we have a strategy, we call it seed to feed. This is our strategy to elevate our company above the rest in this industry. We as a company only manufacture our product in China, for China. The rest of the world is made by third-party manufacturers. As a part of a strategy, we decided that we want to control supply chain from the fields to the consumer it goes to. So traditionally have crops. Those ingredients would then go to an extraction company and they extract the ingredients from the crop, to a broke, who sells it to ta raw material suppler, who sells it to a manufacturer, who sold it to us. And there’s a lot of profit layers. But more importantly, it was really difficult to have the traceability you need in this industry to figure out what field your product came from.
So we’re working backwards. We bought a manufacturing facility in the middle of 2009. And we’ve hired a guy, a gentleman named Gerry Holly. Gerry Holly’s the foremost manufacturing expert the US in this category. We segmented that with a new hire, a gentleman called Dr. – named Dr. Francos. He is the head of dietary supplements for the FDA. He is retiring from the FDA this month and coming to work for us next month. That’s a critical hire for us too.
And then we pushed it back. We started a sourcing company. We hired a gentleman name Jim Barton from Pfizer. He ran worldwide strategic sourcing for Pfizer’s nonpatented business. And he now works for us in a sourcing company. So all—and we’ll work our way back and we’ll get into the extraction business. So we will know where our extraction company purchased the product from, so we’ll know the fields. Our company will extract the ingredients the proper way, sell it to our ingredient company, who will either sell it to us if we manufacture it, or sell it to our co-packers if they manufacture it for us. So we will be in control of the product form the beginning to the end.