Herbalife Ltd. (HLF) Earnings Call Transcript & Summary

Good afternoon. My name is Bill Reuter. I'm the high-yield food analyst here at Bank of America. Very pleased that you could all join us today to hear the Herbalife story. Very pleased to have Alex Amezquita, who's the Chief Financial Officer; and Eric Monroe, Senior Director of Investor Relations, with us here today. With that, I'm going to turn it over to Alex to make a few remarks, and then we're going to kind of just go back and forth. Alex?

Thanks, Bill. Thanks for that introduction. And I've gotten to know Bill a couple of years now. Was about 1.5 years since we first started talking. So really, really happy to be here in this fireside chat and getting to talk to all of you. I think when we started this journey, we were talking to Bill about how we had all this growth in front of us and then COVID-19 hit and then we had our 2020. Our 2020 wound up being a record-breaking year. We had 14% net sales growth in 2020 over '19. Our guidance is that we're anticipating now between 6% and 14% net sales growth as we continue into 2021. We're doing the, I think, an acceleration of really the opportunity that has always been in front of us before sort of the pandemic conditions sort of accelerated some of that growth. We were on a nice growth trajectory, growing our substantial cash flow. And I think as consumer trends shifted during this pandemic, as more consumers are becoming more interested in what they're putting in their body, making that connection between what I eat is representative of my health and how I might be able to respond in the new world that we're living in, we saw an acceleration of all of the -- of that addressable market we felt like with those in front of us coming to fruition. So we're continuing on that journey in 2021. Again, a very solid base built in 2020. And we continue to be on that trajectory as we move into the next year. So really excited. I think the other thing that's meaningfully changed over the past couple of months is a big upscale on our Board of Directors. We had a recent announcement of 3 new additions to our Board. Again, really elevating the guidance that Board is providing to us as we continue to navigate our future. And we had a large transaction in the beginning of January in which Icahn Enterprises made -- repurchased $600 million of Icahn Enterprises stock, which then also precipitated the exit of those members from our Board. So we started a new chapter now where, from a company composition standpoint, Board standpoint, shareholder standpoint, but it doesn't take away from the growth opportunity that's in front of us, the cash flow generation, which is probably most important to the constituents on this call here, will continue and just the resiliency of this business despite what economic cycle we might be in. So I'll just pause there. That's probably a little bit longer than we anticipated. But I just kind of wanted to set up where I think we are today.

Sometimes it's hard to hold back the enthusiasm, I guess. So I think your point about being well positioned in the pandemic makes sense why you are successful. But your growth was still above what I think most in the market would have anticipated, particularly in things like Nutrition Clubs in the U.S., which you saw growth there, which I don't think people would have expected. So can you talk a little bit about where in the country you're seeing Nutrition Club growth? What those are looking like? And I guess, how it was such a tailwind last year?

Yes. I think, first, I'm going to start in the channel and then I'm going to directly answer that question. I think we are a nutrition company. We have -- our channel is a direct selling channel. We really actually think that is a core competitive advantage for this category. And so what we saw in many markets, like, for example, I'm guessing, we're largely U.S.-centric, so I'm going to use some U.S. analogies. When we saw the pandemic largely hit at the end of March, it took about 3 to 4 weeks for our distributors, that's our channel, to really get a sense of, okay, what's changing? How do I adjust? What do I do? These are tens of thousands of small businesses effectively, right, independent small businesses around the world. And so I think one of the advantages of this channel is you have all these entrepreneurs that are very nimble, that are incredibly well positioned to react to changes in their local communities. And so I agree with you. On the face of it, if you said, hey, here are effectively sets of retail locations in these Nutrition Clubs, brick-and-mortar locations more often than not, and rely on an interesting interaction to make a transaction. How could you possibly grow in the U.S. -- we'll take U.S., but this phenomenon really applies globally, how can you grow when this in-person connection is potentially compromised because of the pandemic condition? Well, our Nutrition Clubs and our distributors, they quickly figured out, okay, I still have leverage of asset. I still have a location where I can make consumption-ready services, where I have my connection with my customers still in my local community. How do I put this into -- adversity into opportunity? And they started doing things like delivering. Those same customers that would have gone in, they're saying, hey, where are you, I'm going to drop off your shake or whatever program they may be on. Starting to do things where just similar to how we're doing probably a lot of food even still today, where it's just -- you just pick up, right? You don't go inside, you just pick up. So same thing. So they were able to leverage those assets. Again, I think you largely could see lots of third-party commentary where consumer trends are really much more interested in what they're putting in their body. And here you have in each local community a nutrition club that can deliver nutrition, deliver a nutri-dense, nutritious calorie and then also have it available for pickup. So they actually just leverage those assets that they had in a different model and they did it quickly, and we're able to actually grow similar to other models. So that's really -- it's really the entrepreneurship and ingenuity of our channel, really taking advantage of opportunities. They were doing things like, for example, at hospitals, for example, and they were setting up a stand outside of, say, a nurse clinic or a hospital where our health care workers are in there grinding out the good fight that they're fighting, out there where the community could donate to the Nutrition Club, hey, I'm going to donate a shake, and then they would show up at the health care location with those donated shakes for the health care workers. So again, it just shows the way that they can be so nimble to react to the situation.

Right. The actual club count that we had in the U.S. was a pretty dramatic increase during the year 2020. So we had -- at the end of 2019, about 7,700 Nutrition Clubs in the U.S., and by the end of 2020, we had around 9,000. So yes, a pretty strong growth. A lot of these were popping up in the more rural parts of the U.S. where our Nutrition Clubs have really embedded in local communities and we're really pleased to see that progression throughout the course of the year.

Yes. You mentioned the entrepreneurial element of this, which I think makes sense. Some may think that the environment having been so uncertain about jobs may have led to more people taking opportunities like this as opposed to more traditional employment and ways of making money. Do you have fears? And how do you make sure that you can continue to grow your number of distributors coming out of the pandemic?

Sure. I think that's a common question or thought, particularly on -- when you're having an economic cycle where you're seeing higher unemployment, where you're seeing challenges in the economic conditions in a particular market, where now you have a business opportunity. We're a nutrition company, but the other element of what we offer is a business opportunity for those that want to pursue that particular path. And so when you have a very flexible business opportunity, which you could scale from something from very part-time and very small time commitment, maybe making a few extra dollars to supplement whatever else I'm doing to a full-time, full business opportunities, some of these businesses spanning multiple continents and hundreds -- and thousands of people in our organization, when you have that range of economic opportunity, it does tend to attract those when you're having that down economic cycle. So that is an attractive point for us in sort of these types of cycles. But to me, I would point it back to, at the end of the day, you still need the consumer demand. Whether you have more or less distributors coming in for the business opportunity, you need to just make sure that underlying consumer demand is always present: that need for nutrition, that need for advice, consulting, accountability, all those things that actually come with. And we still think in our existing markets, we're in 95 markets around the world with tremendous opportunity for us to continue to penetrate those markets, and as that opportunity exists, distributors coming into our organization for the business opportunity, whether that's in a down economic cycle or up economic cycle, you're going to need that influx to placate that demand. There is a business opportunity that can go satisfy that demand. The rates may change, depending on where you are in an economic cycle perhaps, perhaps there's some correlation to that. But fundamentally, the underlying demand that's in the consumer is what gives me confidence that despite the economic cycle we're in, there are people that are going to be interested in the business opportunity there to placate that demand.

Yes. One of the things, which I first found attractive about your business, and I found it was a competitive advantage than other forms of nutrition, is that you have the personal relationships with your distributors. Who knows how the world is going to change, but -- whether it's lots more working from home, less people out and about, who knows how it's going to evolve. But I know that you've also been giving new tools to your distributors to try and help them evolve for a dynamic environment. Can you talk about -- a little bit about some of those things that you're giving them, which may help them be successful.

Sure. I think to answer that question, the first thing, what -- from the company's perspective in supporting our distributors, what's the most valuable asset that we think our distributors have, and it's their time, right? They're incredible in developing that personal relationship with their customers. And so what we want to do as a company is put them where they -- what they do best. So let's not then have spending a ton of time on inventory and ordering product on all of the logistics that are involved with running a business. Let's provide them tools to improve their productivity so they can spend the time in building those customer relationships and nurturing those relationships to have that stickier customer to just provide all those things that we've talked about, right? And so in different markets, we're rolling out different suites. But I would say, generally speaking, thematically, it's tools to help manage their nutrition or distributors that have Nutrition Clubs, how do I more effectively manage my Nutrition Club. For distributors that are managing a large network of customers, what's a CRM tool that can help me with managing my customers? What have they ordered? When have they last ordered? Hey, do I need go check in with somebody, if it's not in my normal ordinary [ moat ], right? So helping them with what I would call is a suite of business productivity tools. And then also on our side, making it easier to order, making it easier to sign up, making all of these friction points less time-consuming and easier to understand, particularly as technology continues to evolve. This is important for us to kind of keep pace to what consumers expect and what you would expect if you're operating a business.

Yes. Some of my questions have been a little bit centric around the U.S. market. One of the areas, which I think people have found to be the most compelling growth opportunity, but also recently has had some tougher trends, is China. Some of that, some operational restrictions; some of it, some changes you guys are doing with regards to your relationships. So can you talk about a couple of the impediments to recent growth? And then what the outlook is there? Are we going to revert to this being one of the key growth regions?

Right. So first, China is an important element of our overall value proposition. We still see the long-term opportunity in China. That hasn't changed despite our Q4 performance or despite what happened in 2019 with 100-day campaign or whatever challenges have been thrown at China, we still see this long-term opportunity. I think what we learned, clearly, Q4's performance was under our expectation. And I think that underperformance is attributed to a handful of things. It's a macroeconomic situation. It's consumer trends in China have different business models that may be competing for business opportunity folks in China. There is a technology solution that we stood up called our e-store Personal Store. And what we learned in that process was very helpful. In fact, it accounted for approximately 1/3 of our volume in China in Q4. While a great addition, what we're really recognizing is the technology solutions that consumers, particularly in China, expect. We really have to still take another leap forward in really -- China, from a technology standpoint and particularly from the way consumers engage with the brands that they purchase and engage with, the technology platforms are still head and shoulders above the rest of the world and certainly where we need to be. So we're going to continue to make investments in building out that suite of technologies to match those consumer expectations. So it's a lot of little things. You also mentioned the marketing plan change, which probably did create a little bit of a headwind in Q4 for new, effectively, business builders in China. However, those changes were made for long-term sustainability. And so ultimately, we think that's going to be for the benefit of China even if it had a short-term impact. So bigger picture, we still believe in the long-term growth opportunity in China. We do believe there's a bunch of work that we need to do on a technology standpoint, really just being very mindful of the macroeconomic conditions and just the different forces that are going on in that market to make sure we take advantage of it. We've always known China is this big prize, but there is volatility inherent with that market for a bunch of reasons, right? And so right now, we're having probably a little bit more of a challenge that we anticipated. But we're on top of it. And I do think that at some point, we will be returning to growth in that market. It may just -- it may take a quarter or two to start to change that inflection.

Yes. Shifting gears a little bit with regard to your products. So you've always had a heavy penetration in weight management. I know that there's other areas such as sports nutrition that have lots of opportunity, but these are very competitive categories. Can you talk about what you're doing to try and grow those categories? And how you think the mix is going to evolve?

Sure. And so it's a good question because that's been part of our sort of strategy for a number of years now, product, and particularly growing. We you sort of have 3 addressable markets that we're going after. As you mentioned, our weight management market, which is a little bit more of our legacy market. We're the #1 meal replacement. We have the largest market share and that continues to grow at a nice clip. There is the sports nutrition market, which has been a focus for us over the past handful of years as a category, higher growth -- or subcategory, I should say, higher growth potential that we, Herbalife Nutrition, having a small market share. And this targeted nutrition, which has a bunch of subcategories, anything from vitamins to brain health to all sorts of targeted specialty health, oftentimes supplements, that help with a particular objective. So -- and again, really large market opportunity there with an attractive overall growth rate. What you've seen over the past couple of years is despite all the growth in the company, our share of weight management products continue to go down modestly, not by much, because the growth in our sports nutrition and the growth in our targeted nutrition products are outpacing the weight management growth. So the strategies that we're employing are working as evidenced by that shift. I would say I'll take your one question where you mentioned that sports nutrition highly competitive, absolutely agree. And so one of the pieces of that growth strategy really become making sure that we have a broad enough product portfolio. We continue to add products to that portfolio. You need a certain critical mass. This is a much more discerning consumer given the performance that they're seeking. Whether you are a professional athlete or you're just an amateur athlete, you still train the same way. If you're still trying to achieve that 1% better performance, 2% better performance, you're incredibly discerning in what you put in your body. And so those products and having that portfolio of products that can address different combination of needs for these performance athletes is really important. And so we continue to build out that line as we get feedback and as we start to navigate that market. Again, I think over the past couple of years, if you look at the growth of that category for us, the strategy is working.

Right. Maybe I'll just add just a few numbers there to put some context around it. Alex kicked off the call by mentioning, in 2020, we had about 14% net sales growth. If you dig into the product categories, that sports and fitness category, our Herbalife24 sports line, the products that come along in that suite, we actually had growth of about 24% in that product category. And then the targeted nutrition, which is primarily the health and wellness suite, a 19.5% growth. So you see the outpace growth coming from those 2 product categories where we do feel we have a great opportunity to continue to grow that suite and penetrate deeper within those 2 opportunities.

Yes. That all makes sense. In terms of specifically around new product introduction, I know 1/3 of your sales are your meal replacement. So that's a big part of your sales. What percent are usually new products? And I guess, you talked about the discerning nature of the sports nutrition customer, is there any ability to partner with someone such that it would add some legitimacy, not that you need it, but just some way to somehow through sponsorships. How do you try and mix that in your business?

Yes. That's actually a great question. There's a couple of things that we're doing to enhance our credibility in the space. Clearly, you mentioned sponsorships. We actually have a lot of sponsorships around the world, whether that be Cristiano Ronaldo, who authentically uses the product, actually that relationship was built when we found out that he was a user of our products and then we wound up co-designing a product for him, to really we try to focus on the athletes in the market that resonates best for that market. So it might be a rowing team in an Asia Pacific company -- country. It might be a soccer team in a European country. So it really just depends on that so sports sponsorships really done at sort of a market-by-market level that's most relevant for that market. The other big initiative that we have been doing, we partnered with -- and actually, we took a minority equity position in Proactive Sports Performance. It is a company that trains the high -- the athletes of the highest caliber. We're talking about these are the athletes going to the NFL combine, going to the NBA combine, going to Major League Baseball. They train at this complex and Herbalife Nutrition, particularly our H24 line is the protein and sports nutrition products that are used in this program. It's a highly competitive, highly successful program. We partnered with them. We are in the process of launching our first Herbalife Nutrition sports performance center. Think of this as state-of-the-art, world-class performance facility where training for these athletes will be conducted with nutrition programs correlated to performance so that we can really see how body movement and nutrition come together and being on the forefront of this science. We're really excited about that. This is a -- this year, we're really kicking off that facility. There's going to be more news to come on this, but this is really -- these are the types of things that we're doing to really enhance our credibility in the line. We really want to be, and we think we have a product portfolio and I think it's really on us to get that recognition of being best-in-class in sports nutrition. Bill, I think [indiscernible].

Yes. I was -- you can't read my lips? So shifting gears a little bit to operations. I think that's been particularly on investors' minds, given all of the port congestion, given raw material inflation, given lack of availability of labor. You manufacture about 2/3 of your products. I guess how do you think that, that evolves? And can you talk about any -- whether there are any current logistical challenges in terms of product shortages, inputs, et cetera, right?

First, I think I'm going to toot the horn of the management team that sort of put forth the plan, the Seed to Feed plan that we started probably 10-so years ago, to actually have that capability of being vertically integrated where we self manufacture about 2/3 of our products. It has paid off in spades, particularly this past year, where there was tremendous disruption in the supply chain. With that much self-manufacturing, we're still able to keep -- sure, we had some out of stocks. But on a relative basis, we were able to keep up with the demand in many of our markets. And so that has been a tremendous advantage that has really shown the value of having 2/3 of that being self-manufactured. The other 1/3 are the manufacturers -- strategic manufacturers that we've had for [indiscernible] Fine Foods in Europe, Liotecnica in Brazil. These are strategic partners. Of that 1/3, probably 2 or 3 make up the lion's share of the remainder of that 1/3. So these are long-time partners that we've had. So I think we feel really good about our manufacturing capability. Some of the supply chain, we have to keep an eye on that. But we have long-dated contracts, not really subject to the up and down volatility that may -- that some companies may be subjected to, I'm not sure. But we have -- when we put, say, for example, our soy isolate, when we put a contract, that's long dated, a year, potentially longer in advance. So we don't -- we're not subject to the volatility. We feel good about the supply chain. We've done inventory builds ahead of many of the issues that we've seen so that we don't get subject to some of the higher cost emergency pricing that you might have to -- if you have to airfreight something because you have an out-of-stock. We've been -- we've had the foresight to really think about where might we have -- where might we need inventory builds to really placate that demand. So it's been a challenge. Our ops team is really working hard. There's been a lot of fires that they've put out. But there's been a lot of proactive work that they've done here to really minimize that. So really kudos to them. I think if you look at margins through 2020, aside from the freight and home delivery matter that I talked about at some length, which is really that last-mile delivery, we've done quite well, I think, through these turbulent times.

Last year, you took, I think, about 2.5% or 3% pricing. Do you have an expectation for what amount of price you're going to take this year? And do you think, based on your current outlook that the pricing you have in place will be enough to offset any of these inflationary pressures?

Yes. So the answer is yes. The answer is yes, but let me give you more detail to that. So the way that we think about pricing more generally is we try to keep pace with local inflation. Again, we're in 95 markets. So whatever the inflation is of that market, we try to keep pace with that inflation. That preserves not only margin and making sure that we don't get margin pressure in that particular market, but it also preserves the earning opportunity for the distributors in that particular market so that they're making -- their purchasing power from their level of effort continues to keep pace with the goods and services in that market, and it's done in a way typically in an annual way. Sometimes it's more than annual, depending on the rate of inflation. If it's a higher inflationary market, we might make a couple of changes. But by and large, we try to keep those markets stable. We want stability in the market. We want predictability in the market. And we want everyone to kind of know what's the overall plan. What does that translate if you just combine all those 95 markets? Historically, it's kind of hit that 2% to 3% price increase as a company. So I would anticipate, as we look to 2021, that's likely where we'll land. We'll continue to keep with that policy and that's likely what the outcome will be.

One question that I frequently get from investors is, look at this company's gross margins, how is something like that sustainable? How does it not create the desire for lots of competitive entrants? So if you can describe a little bit about what makes your gross margins the way that they are? And whether you do believe that this potentially leads to increased competition?

Well, so let's go to some -- a lot of our core products are powders. Powder manufacturing is not a commodity type manufacturing. It's another reason why we went to self-manufacturing. We couldn't find the product quality in third-parties that we need and require and making sure that, again, our channel has the confidence that they have a best-in-class high-quality product. So there is a barrier to entry in the manufacturing of the product in the first place. And then, secondly, I would say, we're not competing on simply the product. This isn't simply take one of our best-selling products and then go compare it to something that you get on Amazon, best price wins, right? I'll go back to some of my earlier comments that I made around our channel and our core competitive advantage, that value that those distributors have in each of those hyper-localized markets, there's a value to that service. And so when you take the product and you take our core competitive advantage and the value that the distributors bring to those consumers, that's very something -- that's very difficult to compete with on a price point. And I think that gives us, while we are very mindful of the Amazons and retail and all these other low-cost ways, we have to always be mindful of competitive threats. We do feel like our channel gives us that different point of differentiation where we can maintain our margin structure, where we can maintain an opportunity and we can maintain -- continue to actually attract more and more customers.

I think with regard to capital allocation, so you guys do a phenomenal amount of free cash flow. And I guess, at a big picture level, I'm going to start, how are you thinking about your allocation of that? You mentioned the $600 million share repurchase from Icahn earlier this year. I guess outlook for share repurchases? And what you're going to do with your cash?

Yes. I think we are now officially in our, what I would call, fundamentally driven capital allocation policy. We're operating in that. What I mean by that is, as you mentioned, our business does throw off a ton of cash. If you look over the last 10 years, on average, we throw off about $600 million of adjusted operating cash flow every year. It's largely been between $550 million and $650 million a year, fairly consistent. And so we envision that to be what we see as we move forward. With that said, as cash comes in, you don't have a tremendous amount of need. We use it for the CapEx that we need to make the investments that we've talked about. We look at all of our internal investments. We look at external opportunities. We're not a company where we're going to likely do large scale M&A. That doesn't really -- there are certain challenges for that type of activity, particularly with the channel that we have, it creates some challenges. So that excess cash that we generate, that consistent excess cash that we're generating we will likely give that back to our shareholders. I think, again, if you look at years past, we see a lot of tender offers, there's an ASR in there, there's sort of lumpy share repurchases, which were a little bit more of a product of the circumstances rather than any sort of desire in and of itself. As we move forward, I could see that capital allocation policy looking more like sort of a steady repurchase, more open market, more 10b buys, more things that aren't these big, lumpy situations. Our capital structure is right where, more or less, we want it to be. There's always going to be some refinement. I think we're -- based on the EBITDA growth we had last year, we're probably a little bit under our target leverage. And so would we look for opportunity potentially to kind of top up maybe. But to me, that's sort of refinement on the cash flow structure. There's no anticipation that our a 3x gross target leverage that we've espoused for some time now, that 3x becomes 4x or anything like that. We're quite happy where we are, and we'll do some refining as opportunities come in and out. Obviously, bond market is really attractive right now so should we take advantage of that more aggressively.

You mentioned that you traditionally haven't been particularly active in M&A. I guess I wonder, are there opportunities that come across your guys' desks at some times that you look at and say, this might be able to accelerate our growth, particularly in sports nutrition where it is, I think, so hard to really kind of build that kind of beachhead where you can continue to build upon. Is that anything that would make sense?

Well, so let's break that down a little bit. So there are opportunities that could this potentially make sense as an acquisition to accelerate -- I mentioned earlier, one of the big strategies we have is to continue to add products to our sports nutrition line to build that critical mass to attract that concerning consumer, right? So could there be an M&A opportunity that can accelerate that path? Clearly. But the challenge has become we're never going to go around our distributors. I think I probably mentioned it half a dozen times where we see that core competitive advantage in that channel in our distributors. So would we do an M&A opportunity in sports nutrition that may have a nice product portfolio, but it's strictly retail distribution, which effectively with go-around issues, that creates a challenge because you're going to have to pay for retail distribution. But you wouldn't necessarily do if you owned that business. You're not -- again, you're not going to go around your channel, that would be sort of our high amount of dis-synergies. So the opportunity set for those acquisitions really become more product portfolios that may not necessarily have large retail distribution. That narrows the set of potential opportunities pretty significantly right off the bat, right? And so again, I can imagine tuck-ins or smaller acquisitions. But in terms of anything of scale, anything of scale would likely involve either another direct seller or someone that has a large retail presence. And either of those types of M&A opportunities have their own challenges to actually execute.

Yes. You mentioned not wanting to go around your distributors, I know that relationship is obviously incredibly important. Have you seen or heard of other opportunities for them to transition to other products, which is a competitor for you in a way as these are entrepreneurial individuals?

Yes. I mean, I think you have to look at -- if they're investing in Herbalife Nutrition, the way that they're successful in that business really is around our product -- around this product portfolio. So having this product portfolio and then having another nutrition product, that's probably just using, I would imagine. I don't really see that as being a threat from that perspective. Now clearly, 4 individuals that are strictly looking at a business opportunity and it's -- they're a little bit agnostic of, hey I kind of don't care if I go into beauty. I kind of don't care if I go into health and nutrition or maybe some other category. Making sure that we have an attractive business opportunity for those agnostic folks and then bring them in, get them educated on who we are, I mean that has to be attractive for that type of person. So there is some element of competition you have. But candidly, I kind of -- I feel like our distributors are really good at that. Typically, the people that tend to grow and become leaders in their respective businesses are really people that believe in the product, people that use the product, people that can really connect with customers because of their own authenticity in the product. So that tends to be really what we like. So to me, continue to be world-class, high-quality nutrition company, provide a business opportunity framework for people to be successful. And I think the competitive threat will take care of themselves.

Alex, Eric, thank you very much for being with us today. I've been a big believer in your story and continue to be. And I'm glad that you've been able to share it with some additional investors here. So thanks.

Thanks, Bill. Thanks, everybody.

Thank you, Bill.