FINAL TRANSCRIPT
Thomson StreetEvents
HLF- Herbalife Ltd. at Jefferies Consumer Conference
Event Date/Time: Jun. 22. 2010/ 3:15PM GMT
CORPORATE PARTICIPANTS
John DeSimone
Herbalife Ltd. – CFO
CONFERENCE CALL PARTICIPANTS
Doug Lane
Jefferies – Analyst
PRESENTATION
Doug Lane- Jefferies-Analyst
Okay. Good morning, everybody. Welcome to the Jefferies Global Consumer Conference. My name is Doug Lane. I’m on the Jefferies consumer team. I am a consumer products analyst. It is my pleasure to introduce John DeSimone, the CFO of Herbalife. Amy Greene from IR is also here as well for follow-up questions, and let me turn it over to John.
John DeSimone – Herbalife Ltd. – CFO
Thank you, Doug. Good morning, everyone. I will start with the Safe Harbor language. There is a copy for those that are working on the Internet or on the webcast. There is a copy of the Safe Harbor language on our website.
We can start the presentation with four overview slides, general overview slides. This is a big picture of the story. It is a growth story. The Company has doubled in the last five years, and we expect to triple in the next 10. That is our goal. So we expect the growth rate that we have been experiencing to continue and all the drivers of the growth.
First and foremost, it starts with product. Our products, our nutrition-based products address two key megatrends, obesity and antiaging. It is funny this morning I read an article on FIFA, the World Cup. Great big world stage and catching grief for having sponsorships from McDonald’s, Coke and Budweiser. Because in South Africa 29% of the men are obese and 56% of the women. So it’s just amazing how what you will (inaudible) today of how important nutrition is and how unhealthy obesity is, and that awareness is accelerating. So our products fit those megatrends. That is key.
The second driver of growth is a change in the model. Our model had evolved or transformed from – or it is in the process of transforming I should say from traditional direct selling, which will go over the characteristics of that in a few slides, to daily consumption, and daily consumption in every market that is adopted, daily consumption in the nutrition core model has had a significant growth. It has been an accelerator of growth. And there are a lot of markets that are just now getting to that stage and a lot that has not even gotten to the beginning yet. And daily consumption, which is offering our products to consumers at a daily price point and we will talk about that in a few slides, has been driving growth both in emerging markets and in established markets, which is different than most direct sellers. We will have a slide on giving you a little bit of history on that, too.
From a business model standpoint, we’re a very low capital business. So our capital expenditures this year are estimated to be around 3% of net sales. That is a good run-rate going forward, and we are looking to go vertical. That 3% covers the capital requirements to go vertical. In addition, we generate strong free cash flow. Our cash flow for the last three years – three and a half years with one exception has exceeded net income. The only exception is when we put Oracle in, and we have some details on that coming. And we have very low debt.
Our debt is 0.7 times EBITDA, and our net debt when we back out cash is 0.2 times EBITDA. So we’re very conservatively levered. And then we have a disciplined return of capital, so we are not – meaningful M&A is probably not in our future. So with cash flow equally or exceeding net income and capital expenditures equal to about 3% of net sales, we look to return cash to shareholders through a dividend and a buyback program. We have authorized a $1 billion buyback program a couple of months ago. That extends for the next four plus years. We will talk about that in a little bit. But up until the end of the first quarter, we had returned over $600 million to shareholders in share buyback over the last three years and $150 million in dividends, and that is an approach that we will continue for the next four plus years for sure.
Just a slide that details our portfolio of products or how it breaks down into categories. 63% of our products – just under 63% of our products is in daily nutrition or weight management. It’s not a diet product line. That is important. It is more of a lifestyle change. We don’t have the seasonality that traditional diet products have. And you will see on the next slide, we are more of a functional food company. 22% of our sales come from we call it targeting nutrition. That’s condition specific products like heart health or digestive health and things like that. And then energy and sports is a relatively new product line for us. It represents a small percentage of our business, a little over 4%, and skin care we call it outer nutrition or personal care represents 5% of our sales.
This is an important slide for anybody new to the story. I think there is a perception and I had the perception before I came to the Company a few years back that we are a diet company with the typical contentious diet products ,right, the ones that are, you know, take a pill, don’t eat for 30 days and lose weight. It’s not who we are. Herbalife doesn’t – we don’t chase that.
Our top five products are mostly functional food category products. Formula 1 represents almost 30% of our sales. It is a 30-year-old product. We had Formula 1 shakes that we passed around at the last break. I hope everybody had a chance to try some. We have more coming in now that you can try, but it is a meal replacement shake. It is not a contentious product. It is very well established.
Our second largest product line are teas. Right? You know, caffeine-oriented teas, morning drinks, again not a contentious product. Aloe represents 9% of our sales. That is the third biggest. And those three products you will see in a few slides represent what we call that Corporate Nutrition Club line, that daily consumption line. And then augmenting those three products are protein powders – again, not a contentious product line – and then our fifth largest product is a product called Niteworks that is developed by a Nobel Laureate scientist. So it’s not traditional supplements, and I want to get potential investors off that mindset.
This slide depicts our geographical diversity. We are in 73 countries, grouped into six regions. We don’t need to go into all the numbers. It is available on our website. The important takeaway is we are not overly rated in any one region. North America is our largest region, representing just under 25% of our revenue. Asia-Pacific is second with a little over 20, EMEA for those who are not familiar with the Company is Europe, Middle East and Africa. That represents a little over 20%. And then it works down from there to Central America, Mexico and China. To diversify geographically is the takeaway.
This slide might take a minute to set up. This speaks about the transition from traditional direct selling to daily consumption. And this may be a five-minute slide.
Traditional direct selling – and it is all direct selling. It was Herbalife, but it’s everybody who sells direct is traditionally getting a few people to buy a lot. It is a medium to high-priced monthly purchase or every two weeks in some cases. So a distributor of model skims the surface of people that can participate in the product offering because it’s an expensive price point. It’s a high acquisition cost, and it is a very inefficient model for distributors because distributors have to go to their customer. And in 2003 that is exclusively what Herbalife was. And then last year you can see that the Company over the six years from 2000 through to 2009 has almost doubled with profit up to 120%.
The characteristics of the new model, daily consumption model, is that it is looking for a lot of people to buy a little, instead of a little people to buy a lot and has a daily price point. And that means the consumer comes in and buys the product they need just for that day. It is a one day serving. And that is a much more effective model that reaches much deeper into every market that has been introduced, and it makes a lot of sense, and we have a slide that I really like on the next page that talks about the power of that model.
It penetrates deeper. It has a much lower customer acquisition cost, much higher retention rate. It is a stickier model for a lot of reasons. Not only (inaudible) get consumers when they only have to spend what they need that day, but it’s a forced discipline that does not exist in traditional direct selling, and traditional direct selling when a distributor comes into a business, they need to be self-motivated. So they come in that day, they are probably quite motivated. But 30 days later, what do they do? How are they successful?
When you have a club, you have a job. You have to get up every day. You have that forced discipline so the distributor knows what they have to do to be successful. Our retention rates and success rates for people doing club is much greater than people doing traditional business models, and it is a more predictable, more consistent model. And right now we estimate on 30% of our business falls into that category and it is growing.
And an additional benefit that I did forget is that in that daily consumption model, customers come to distributors instead of distributors having to go to customers. So once you have got a customer, it’s much more efficient to keep it running than traditional direct selling.
I like this slide. This slide analogizes the daily consumption model to coffee. Starbucks is on here. It’s a great example, I think, at $2 a day, which is what you pay for a cup of coffee at Starbucks. Very expensive. If you had to pay $60 at the beginning of each month for that month’s supply of coffee, far fewer people could participate. But when you pay $2 a day, it is such a low price point, people can afford it. People living hand to mouth or whatever it may be, so far more people can afford that. And that is what we have seen with our core products that are offered at a daily price point is far more people can come in and pay $3 a day than would have paid $100 for that month’s supply. And that $3 is sold primarily as a meal replacement. So the distributor is looking for consumers to replace what they are spending for a meal and come to Herbalife as opposed to an incremental spend. So we have it is a strategy we call “replace one meal a day from fast food.” So that is what you are going after. Somebody who is eating poorly, who will benefit from good nutrition, who only has to replace the money they are already spending in terms of incremental dollars, and that has been driving the growth.
This slide depicts the opportunity, and what we have seen in markets that have adopted daily consumption.
Let me set this slide up. It will take a minute, too. The blue bars are the penetration rates in 2003 in our top markets, and the green bars are the penetration rates in 2009. And we measure penetration rates as volume points per capita. Our volume points, to keep it simple because it is an Herbalife measurement, is the equivalent of retail sales reinstated to 2003 in US dollars. So it takes out price increases, and it takes out currency or anything else. It is just volume.