Herbalife Ltd. (HLF) Earnings Call Transcript & Summary

Good day, everyone. I'm Steph Wissink, Senior Research Analyst and Managing Director on the consumer platform at Jefferies. Thank you for joining us for this chat with the team from Herbalife. On the screen, you should see Alex Amezquita, the company's CFO; and Eric Monroe, the company's Head of Investor Relations. Thank you, guys, for joining me today.

Thanks, Steph.

So we're coming off a really important day, yesterday, company's first Analyst Day in several years, and I want to spend the time today just level setting and cleaning up some of the misconceptions out there. And so, Alex, maybe I'll put you on the spot, but just to start with some facts.

So we were on a spot for 24 hours straight, so this doesn't change anything.

Okay. So you're in the hot seat. The first thing I want to do is just talk about the third quarter guidance. So the guidance that you gave does imply that the September month has gotten somewhat better. So I wanted to just have you contextualize what you saw in July and August, what is implied in the guidance, which would -- again, would assume a slight step-up in September. And then let's take that one step further, how August provides the baseline for your back half guidance, again, if it's the low point that that's providing the framework that you're using for Q3 and Q4.

Right. Yes. So I guess, the way to think about it, first, I guess, it's important to think about what was 2020. And I think 2020, right, Q3 was an exceptionally high demand quarter. And really, if you break down Q3 even further, it really was -- we really peaked in terms of that in July, and we started to kind of flatten and come off that in August and then September of last year, right? And then we had a Q4 that was below Q3, which is normal seasonality for us. Normal seasonality -- again, as a reminder for folks, normal seasonality for us as a Q2, which is typically our largest quarter, a Q3, a little bit lower than that, and then a Q1 and a Q4 of that same calendar year, a step below that. And so another sort of example of how unusual Q3 last year, we had a Q3 that was larger than Q2 that -- if you go look in our history, that almost never happens. If you break that down then in a quarter by August, September, and that's what we're [indiscernible]. So in July, then August then September, you're seeing in our guidance, because we gave July and August, we're seeing a little bit of [indiscernible] in terms of year-over-year comp. You're already seeing some improvement. It's still down, no doubt, if you do the math, but you're seeing a little bit from a comp perspective improvement in less down as you move through the quarter. And then, clearly, as -- if you see what the implied Q4 means in that full year rate, that trend continuing. We were asked a question yesterday, when does it turn around and go positive, right? So clearly, that's not in our Q4 guidance. I mean, it's in the range of our Q4 guidance, but the midpoint of our Q4 guidance still has us down, but obviously, significantly less down than where we -- where our Q3 guidance suggests. I'll talk net sales midpoint, down 5%. If you look at what that implied, growth is on a net sales basis through Q4, it's significantly less than minus 5%, meaning closer to flat than minus 5%. So the comps get easier in 2022. I don't want to talk about '22 guidance because we haven't done that work. We haven't -- really, my next data point is going to be actually how September comes in. There is a lot of discussion out there as to the whys. We've talked about the what's, meaning less new distributors, less preferred customers this year versus last year Q3. By the way, completely expected. We knew that was going to happen. That was in our prior guidance. It's simply August -- really August, a little bit in July is when we started seeing, hey, is this something that we need to monitor? It was sort of confirmed as we saw the end of August come in, and we started to think about what does that mean going forward. So August was really kind of the delta there. But still, what I take away, and I think the confidence that you saw from John and myself yesterday is because, still, the underlying metrics from what -- are we benefiting from COVID, the pandemic, the past 15 months, are we benefiting in a way that we believe will create foundational improvement that we can take into 2022 and beyond, absolutely. Why do I think that? We still have stack rate. If we look at net sales, we still have 2-year stacks in the mid-teens. If I look at leading indicators, even though the number of news, new distributors, new preferred customer, is lower than we expected, it's still 30% up from where we were in 2019, same period. If we look at a concept like our storefronts concept, right, that we -- our storefronts concept is really represented in the KPI, we call it active sales leaders. The number -- the nominal number of active sales leaders selling in July and August is up 10% from Q3 2020, right? That's typically the leading indicator of the foundation of growth. So yes, that means productivity is a little bit down for those folks, but the number of them are larger. But the productivity is down again from that new constituency being less prevalent today than it was yesterday, I think -- or last year. And again, I don't think any of us ever thought last year was run rate. So this was expected. It was expected on our prior guidance. It was just a little bit more of a delta than we anticipated. And so I'll go back to -- I said that next data point that I'm looking for is now September to give some context of was August the result of pent-up demand for vacations and 15 months of hitting it hard. There is a human element of our channel. And after a sustained period of success, particularly in this COVID environment, where there was no opportunity to kind of take vacation, a lot of markets opened up, particularly in the U.S. and Europe, could that be the case? That is a plausible theory. Obviously, I can't evidence and say that is it today. But as I see September rolls in and I can see some of the differences in that behavior, we can have a view on that and understand perhaps what is the duration or where are we going forward for the rest of the year. The guidance we have is based on August behavior and the first 10 days of September behavior. So what I would say is there's no return to prior activity levels baked into our rest of year guidance. So hopefully, that's conservative guidance. And again, we'll see as September comes in and, obviously, as the months come in, what does that mean for 2022. I guess, I'll just pause there.

So if I could -- yes, Alex, if I could paraphrase because I think this is so important that you have 2 critical metrics in your business, which is your actives and your revenue per actives essentially. And last year's Q3 had an unrealistic revenue per active comparison, but you are still seeing active counts advance, which is essentially the predictor of future revenue per active opportunity.

Correct.

So if we think about it...

The analogy of storefronts, right? We have more storefronts.

Yes. So I want to just connect that then to -- and unfortunately, I think a lot of these great takeaways from yesterday got overshadowed. So I want to give you the ability to talk about with more actives, better technology to drive more productivity per active, what's kind of feature cast over the next several years around digitization, product innovation, speed to market, Gen Z, all of the big themes from yesterday and how that gives you conviction in this multiyear long-term algorithm that you've laid out.

Yes. No, absolutely. I would even take one further step back and just what's the demand equation, right? You have to -- I think, first, you have to start there. What are we delivering? 100%, there has to be a better solution for nutrition globally. I think if you start there and you have to set and you look at obesity trends, you look at overweight trends, you look at younger demographics and their fit and active trends, if you look at all that demand, how is that demand being placated? We feel like we are ideally positioned to placate that demand. So first, I feel like you have to start with, is there real demand. And I think unequivocally, the answer is yes. So then if that's the answer, and by the way, we tried to evidence that in Investor Day multiple ways. We tried to evidence it with our strategies, which some of you alluded to a moment ago, with our digital strategy, with our product strategy with our generation strategy. You look at the categories we play in, I think you go -- you pick it, you pick the third party, we happen to show Euromonitor, significant category growth over the next few years. And you look at sort of the peer group, are we really unique in this growth? We kind of put up our peer groups, although it's arising in this health and wellness trend, which we are squarely right in the center of. So I think any way you sort of triangulate, there is certainly support for our top line to be growing and to continue to grow. We've had some ups and downs. By the way, we pulled guidance last year in 2020 because we weren't sure how COVID was going to affect us. We actually -- we know there was demand for nutrition, but we couldn't have predicted the acceleration of folks coming to Herbalife Nutrition for our channel to actually be beneficiaries of that shift in consumer demand connecting nutrition and health. We benefited from all of that. That doesn't just go away, though. That doesn't just go away as COVID. Now clearly, from a Q3 2020, if you comp that in a period, you have a difficult comp. But long term, we see a tremendous opportunity for us. We were growing before COVID, we grew during COVID, and we're confident to grow after COVID or whenever the world becomes -- whenever the world post COVID or with COVID or whatever we turn into, we see a future in that growth.

And Alex, just or Eric, if you'd like to jump in here, just for the sake of having it in the transcript, the long-term growth algorithm. And I want to give you a specific mention, if you could just talk about that operating margin because that was one of the newer points of illustration is that the model over many years has delivered consistent margin expansion, but it's been masked a lot by currency. So talk a little bit about the key elements of the long-term algorithm.

Yes. So good point. So I'll just hit the key points. I think we just talked about top line a little bit. Over the long term, mid-single digits in our top line. I think that is certainly achievable. Again...

Mid- to high single digits.

Yes. I don't believe these short-term fluctuations, particularly how we're reacting to COVID, particularly the underpinnings of how Delta variant may have affected our July and August disproportionately, I mean, some of this stuff we cannot predict. What I do know is there is a demand equation that I just mentioned, that certainly supports a top line growth, the mid- to high single digits. Moving to operating margin, again, we have to be constant currency neutral because as -- if you look at that constant currency impact, and by the way, look at it on an EPS basis, if we were constant currency, we would be up in the -- near the $10 range, if we were, which is remarkable. But in -- from an operating margin perspective, there is some level of operating levels in the business. We've demonstrated it over the past 10 years. We know it's in front of us in terms of investment, and we still see that opportunity going forward. As we continue to scale our global shared services, there's many opportunities for us as we manage -- we can manage that operating margin to the benefit. And then lastly, the third component being that incremental leverage on earnings per share through -- we generate a lot of cash. By the way, nothing about the past couple of months changes that. We're still going to generate a lot of cash this year. We're still going to generate a lot of cash in the future, way more cash than we need for our internal investments, all the things that we talked about for Herbalife Nutrition specific strategies around our digital strategy, our product strategy, those types of things. And so we really only have 2 options. It's a dividend or a share repurchase. At these share price levels, it's just -- the share repurchase strategy just makes so much sense at these share price levels.

So Alex, let's run the math together because we've been doing this with investors throughout the course of the day yesterday and today. If we were just to essentially pause your model and say the business does not grow anymore from the 2021 level, it just flat lines from here forward, no incremental revenue growth, no incremental earnings growth on a core basis, $4.75 in earnings is your midpoint. Your buyback as authorized and based on current trading levels would power more than 10% EPS growth a year.

Yes. That's the math, yes.

So if there's any growth in the underlying business, the business should generate collectively with buyback and organic EPS growth north of 10% EPS.

Yes.

So help us think through, as you're thinking out again, not 2022, but just really the next 3 to 5 years, the cash flow engine that you have and like well north of $800 million on your balance sheet, the shareholder base is very different today than it was even 18 months ago, 24 months ago. How do you think from the CFO seat about the power of that buyback contributing to potentially enhanced earnings growth?

I mean, it's part of the algorithm. It's core to the algorithm. We've historically -- I mean, I gave some stats. It's -- our share repurchase -- our commitment to the share repurchase program has always been there. Now it looked different because we were dealing with a bunch of circumstances that caused more lumpy purchases in those shares. And there were times when we had to be -- we couldn't be in the market with an open market share repurchase program with 10b-5s consistently through that time period, but we were committed to it. I think there could be differences in opinions on how we implemented it, but I think we have demonstrated our commitment to it in the past, and that commitment doesn't change. We'll continue to be committed to that going forward to really have that gearing in our EPS. Going forward, it's going to be more in consistent ways. We're going to be out there with 10b-5s in open markets. It's going to be on a quarter-by-quarter basis. It is going to be a little bit consistent with how the cash moves through our global model. And to the extent it's excess, we'll be out repurchasing. So the way we'll do it is probably going to look a little different, but our commitment to it is unwavering.

All right. That's very definitive. All right. I want to talk on a couple more things I didn't get a ton of attention yesterday, but were really intriguing to me, this idea of innovation, both speed to market and localization. And we get asked a lot of questions in direct selling models that it would be wonderful if all markets move together. But the irony is that you actually are very comfortable operating in a market-by-market dynamic environment. But talk a little bit about how speed to market and localization, how that influences your direct market strategy and how you think that might play out at the enterprise level in terms of the volatility in the business relative to the consistency.

Right. So it's a little bit hard to say this at this very moment, obviously, because we just had the revise. But generally speaking, we have all of these markets. Portfolio theory would suggest, while all these markets may be going in different directions, you get some stability from the diversification of all of it sort of happening in different ways. And so it should gravitate to the mean of that sort of long-term growth algorithm over time. Now again, we're going to have quarter-to-quarter fluctuations as one market or the other disproportionately moves that around. But generally speaking, 95 markets should give some level of stability from a diversification standpoint. The localization and, really, we're in an effort where we're continuing to push some of that autonomy out to the markets. That speed to market on a localized way, we've seen a lot of benefits over the past number of years, whether that's India in their Ayurvedic line and some of the flavors that are unique to that market. Same with China, in the U.S., we just made a small tuck-in vegan acquisition so to help with some of the consumer demand in that market that the channel has been asking for. So all these different markets sort of have different trends that they're playing on, and our ability to be able to react to that from a company helps our channel be able to do that from what they're seeing in the field. So really, this is really enabling us the company to really placate that -- those observations that our channel is saying, "Hey, we need to move in this direction. We need to move in that direction." And we as a company are just trying to become more nimble to react to that element of our competitive advantage.

Just following through to some of the efficiencies that we've had around new product launches, we gave a stat yesterday that we've been able to improve the speed to market in our product launches by 22%. Using this more localized strategy, being efficient with what's going on in the ground and implementing quickly, it really improved our ability to launch products in a more quick manner.

And Eric and Alex, would you say that the localization strategy is also a bit about precision, meaning instead of offering a worldwide catalog, you start to curate to what that local market need state is and it might ultimately result in some improvement in the working capital turns at the local level?

Let me think about that for a moment. How does that translate? It's interesting. I don't know -- I don't have something that materially says that, that's really impacting our working capital to the benefit or to our detriment. It's sort of -- I think that element of product development is sort of neutral probably to working capital. With that said, working capital is generally pretty favorable for this business model. So I don't see it taking us away from that. But let me -- I'll think about that a little bit more for the next time we get together.

But it does allow to be more specialized in what we're doing for the market to appeal to the consumers within that specific geographies. So Alex mentioned things around the Ayurvedic line in India, but we can do unique flavor profiles to match what consumer demand is. If there are specialized ingredients that we want to apply in certain geographies around the world, that more localized effort really does allow us to be more nimble in the way that we can address that local consumer demand from both the product flavor and a product ingredient perspective to make sure that we're appealing to those local consumers.

Yes.

I also want to circle back just on -- we're getting asked a lot of questions among investors in consumer goods companies around inflation, cost inflation, input costs, packaging, transport. So just remind us what the guidance embeds in terms of the cost of goods line for the back half of the year.

Yes. So on our raws, we're not seeing that. There was at a point that one of our biggest ingredients is soy protein isolate not -- it's somewhat correlated to soy, but pretty sufficiently because there's a processing element of it and the way that we were one of the largest purchasers of that particular raw. So we have long-dated purchasing agreements with some of the biggest suppliers in the world on that type of stuff. So we typically have 6 months, 9 months, 12 months plus type contracts. So any sort of short-term increase in raws is something that we can weather for a period of time until market prices get back to a level that makes more sense. At present, there's nothing in our forecast that has, in our cost of goods line, higher raws. We're just not seeing that certainly for the rest of 2021. I know we've already started making purchases for a good part of 2022 at levels prior to sort of this discussion that the broader world has been having over the past couple of months with inflation. Now we have seen a little bit of wage inflation. We have seen a little bit on the packaging and logistics side. We have seen some of those increases. Again, not materially impacting 2021, but it is something that we're going to have to look out for 2022 as we start pulling that together.

And just to finalize that thought, Alex. Is there a pattern over the course of the last decade or so of taking price when you have volatility and inflation in your inputs?

Not necessarily volatility, but certainly inflation. So we have a pricing strategy around the world. It is really our best antidote. We don't have a ton of natural hedges, so the best antidote to the strengthening of the U.S. dollar, which I explained at Investor Day, and so we could see how dramatic that impact is. The best antidote for us right now is to make sure that we're taking pricing with local inflation in every market around the world. Finance theory would suggest if you have a strengthening dollar, you should see elevated rates of inflation in non-U.S. markets sort of catch up to that dollar imbalance. And we've seen that over the past, I think, 3 or 4 years, we've taken pricing on average 2.7% up. So we have that pricing power. Again, going back to our model, we're not fighting online retailers on a price point basis. Our products tend to be a little bit more expensive actually than other products that you could find on a shelf in Walmart or et cetera, because of that value that comes with our channel. It's more than the product, right? So we do have pricing power where we compete. It's not on a -- we're not competing on a cost basis. So we will look to take pricing in all those markets to kind of counteract some of the strengthening of the dollar that we've seen over the past decade.

Okay. Very helpful. Eric, I just want to make sure we didn't miss anything from the conversations you've been having over the last 24 hours or so.

Yes. It's been relatively in line with investor discussions. So I'm glad we're able to clarify a few things here and stress that, look, we still see this long-term opportunity in a business that is incredibly attractive. Clearly, we're dealing with a challenging Q3 comp, but kind of taken a zoomed out view of the business performance over the last year. Over the last 6 quarters, we've seen a strong performance. We've seen the 2-year stack numbers continue to be strong even through this challenging year-over-year Q3 comp. And yes, we did a lot at Investor Day into these long-term strategies that give us that confidence.

And Eric, there's one party thought that I want to give folks because it has come up a lot. I touched on it briefly, but I really want to emphasize it. There's seasonality in our P&L, quarter-to-quarter seasonality. If one were to simply take our implied Q4 guidance and just multiply it by 4 and just say that's our run rate, there would be a lot of dollars you're leaving on the table. So certainly not the methodology that I would encourage anyone to use as you think about our go-forward financials. If you -- again, I kind of highlighted what that looks like. And so really, as you start thinking and you're trying to model that out, annualizing any one quarter definitely going to give you probably an incorrect view of the business.

Thank you, Alex. That's really important. I think we're going to leave it there. If you do have any follow-up questions for Herbalife, please reach out to your Jefferies representative. We are happy to get you in touch with the management team. Alex, Eric. I know it's been a really long 24-hour period, so I thank you so much for this time today. And I think these were really important clarification comments that you've made. And again, we'll send people your way if we have any follow-up. But thank you, everyone, in the audience for listening in, for joining in today, and please have a wonderful afternoon. Take care.

Thank you.