Herbalife Ltd. (HLF) Earnings Call Transcript & Summary

Welcome, everyone, to the Small-Cap Spotlight podcast. I'm here with Shawn Severson, CEO and Founding Partner of Water Tower Research. In today's podcast episode, I'm being joined by John DeSimone, CFO of Herbalife that trades on the NYSE, ticker symbol HLF. Herbalife was founded 45 years ago in Southern California as a weight loss management company, and since, it has then transformed itself into the #1 active and lifestyle nutrition brand in the world. And that's according to Euromonitor and is well on its way to becoming the world's premier health and wellness company, community and platform. Also joining us today is my colleague, Doug Lane, Head of Consumer Products Equity Research at Water Tower Research. Before we dive into today's conversation, I'd like to hand it over to Erin Banyas, Herbalife's Head of Investor Relations, for a quick note on forward-looking statements. Erin?

Thank you, Shawn. Before we begin today's podcast, I would like to direct you to Herbalife's cautionary statements regarding forward-looking statements included in our most recent Form 10-Q filing and earnings release, which are both available under the Investor Relations section of Herbalife's website. The Form 10-Q and earnings release include a discussion of some of the more important factors that could cause results to differ from those expressed in any forward-looking statement within the meaning of the Private Securities Litigation Reform Act of 1995. As is customary, the content of today's podcast will be governed by this language. In addition, during today's podcast, we may discuss certain non-GAAP financial measures. These non-GAAP financial measures include certain unusual or nonrecurring items that management believes impact the comparability of the periods referenced. Please refer to our historical earnings release and presentation materials available under the Investor Relations section of Herbalife's website for additional information regarding these non-GAAP financial measures and the reconciliations to the most directly comparable GAAP measure. And with that, I will now turn it back to Shawn to kick off today's discussion.

Great. Thank you, Erin, and good morning, folks. And good morning, John and Doug, for joining us in today's podcast.

Thanks, Shawn.

Thanks, Shawn.

So let me just start out. John, you're nearly 1.5 years into your second stint as Herbalife's CFO. It seems there's been a lot of changes in leadership there recently. And I think it makes sense to talk a little bit about those changes and touch on what brought you back to the CFO role.

Sure. Thanks, Shawn. There have been some recent changes. I think, importantly, they're all internal movements within our core team. And that team has deep Herbalife and direct selling expertise. The changes really started with Michael Johnson. Michael Johnson has been our CEO and Chairman for much of the past 22 years, and he is moving into the Executive Chairman role, which opened up the CEO role. Stephan Gratziani, he moved from the President of the company to the CEO role. And I want to come back on Stephan's unique experience. But as a consequence of Stephan moving out of the President's role, Rob Levy has stepped into the President's position. And Rob's been at Herbalife over 30 years. So lots of experience within the group that moved around. Now I'll talk specifically about Stephan, who is our new CEO. He has 34 years of Herbalife experience, which includes more than 32 years as a distributor, which is pretty unique. And he just wasn't any distributor. He became our second largest distributor worldwide. And I believe his success came from his strategic mindset and his ability to navigate change effectively. And I've seen that since I started working with him in the C suite. And I think what separates Stephan from the rest of the C suite, my peers, is that he has this street-level business building experience that none of us has. He knows how to take a team and grow it and maintain success over decades and thrive in an ever-changing commercial landscape. So that's very unique, and we're excited to work with him, and he's got a great mind. And I think beyond his great mind and his experience, he has a deep passion for the company, for our vision, the ability of Herbalife to make a positive impact around the world. So that's exciting. I think for the second part of your question is why did I return as CFO. There's really 4 reasons that all work together. So one is margin improvement. We came out of the pandemic, got hit with some challenging times, and our adjusted EBITDA margins were down into the 11.3% range in 2023. And I just believed there was an opportunity to enhance our margins, and I could help with that. And we've made a lot of strides in the last 1.5 years. Last year, margin -- adjusted EBITDA margins got up to 12.7%. And this year, they're going to be above that. So that's heading in the right direction, but that was one of the reasons I came back. Number two is what I believe was a game-changing strategy that was backed by Stephan's vision and his ability to drive distributor activity and ultimately deliver strong sales growth, and I believe in that. So that was the second reason. The third was I believe the company is tremendously undervalued. Our enterprise multiple is around 4x, and I just see a huge opportunity. We're a low capital business. We're a high cash generating business. We should not be trading at 4 in my opinion. And I think by delivering the margin expansion that I talked about as point one and sales growth, that we believe will come, which is the second point I talked about as to why I came back. I think we have a real chance to improve our valuation. And so that was the third reason. And then the fourth reason is I share Stephan's passion for the company. I believe in the vision of the company and the ability to positively impact the world. So that's what brought me back.

Great. Appreciate that, John. Thanks for the overview. Now I'll turn it over to -- the podcast over to Doug Lane, and he has a few additional questions.

Yes. Thanks, Shawn. And John, I'll also point out that a very large part of your compensation is in equity, right? So we align with shareholders. I've been monitoring Herbalife for a long time, and it does appear that the underlying business is improving. Metrics we track like organic sales growth and average active sales leader numbers have shown several quarters of improvement after a noticeable deceleration in the business coming out of the pandemic. Can you elaborate on what's driving this improvement?

Sure. You mentioned the pandemic. I'll start by saying our business was actually positively impacted during the pandemic for many reasons that we've discussed before. However, the cohort of distributors that joined during the pandemic proved less sustainable than what we had seen historically, also for reasons we've discussed in the past. So I don't need to get into the reasons. But I think the key point is we've stabilized sales, for the last 6 quarters have shown constant currency net sales growth. And while currency translation has worked against us during that time, that headwind is now starting to shift, which is an interesting point. But just as importantly, alongside stabilizing sales, we've rolled out a series of initiatives that have boosted distributor engagement and activity. And we believe that these improved distributor metrics will translate to organic sales growth. And in fact, our Q3 guidance reflects this optimism. We're projecting reported net sales growth for both Q3 and Q4 of this year.

John, looking at new distributor trends for the past 5 quarters, you posted 4 consecutive quarters of double-digit year-over-year growth through the first quarter of 2025. Then in the second quarter that you just reported, the trend was flat year-over-year. Can you provide some insight into what has driven the slowdown and whether this is indicative of a broader trend? And how should we think about the growth trajectory going forward?

Yes. Thanks, Doug. Big picture, our second quarter distributor metrics were actually strong. The challenge from a comparison standpoint was a tough comp to last April when we launched the Premier League promotion. That launch created a sharp 1-month spike of new distributors before settling into a more stable but still strong growth rate. One way to see past that spike is to look at the 2-year stack growth rate. So if we compare Q2 of this year to Q2 of 2023, new distributors grew 13%, which is actually stronger than the 10% 2-year stack growth rate we saw in Q1.

So actually, on a 2-year basis, it's accelerating. So that's indicative of the underlying strength of the business. And I do like to look at 2-year stacks as well, John, because in this business, any given quarter can bounce around a little bit. So I think it's a better way to capture the underlying trends. Now I'm just back from your North American Extravaganza. It was down in Texas in late July, and there was a lot of energy around the beta reveal of your new Pro2col app. Can you provide an overview of what is Pro2col and how important is Pro2col to Herbalife going forward?

Yes, that's a big question. That will take a moment. But Pro2col is a cornerstone of our vision to become the premier health and wellness company, community and platform. And when we say platform in this context, we mean the complete set of tools that are designed to track, enhance and personalize the connection between customers, their distributors and the company. So Pro2col is our next-generation personalized wellness platform that deepens and amplifies that connection, and it delivers the value in 4 key ways. So first is data and biomarkers. Pro2col is a health and wellness app that captures vital data and biomarkers. So that's number one. Number two, it tracks product. And based on that data and each customer's personal goals, the app can suggest targeted product solutions, which will drive engagement, boost sales. We believe it will improve retention and ultimately increase lifetime value of the customer. So again, first is data tracking. Second is product tracking. Third point is the lifestyle guidance that the app offers. So beyond product, Pro2col offers personalized lifestyle plans, helping users build healthier habits and achieving their overall wellness goals. And then the fourth point that is the fourth pillar of Pro2col's, it strengthens the bond between customers, their distributors and Herbalife as a whole, which I mentioned before. Now if I zoom out, that's zooming in a little bit. If I zoom out, why does all this matter? One of the biggest challenges most health and wellness apps face is customer acquisition. But we already have one of the most powerful distribution networks in the world. We have over 2 million distributors worldwide deeply embedded in their local communities. We have over 60,000 Nutrition Clubs globally. For example, in the U.S. alone, which represents about 20% of our sales, we have over 4 million customers visiting Nutrition Clubs each year. So in other words, we already have the customer. And Pro2col will not only enhance these existing relationships, but it will give us invaluable data that can increase the customer value and also accelerate new product launches. And just by way of example, in just a few weeks, with just the 7,000 participants in the beta program, we've collected a ton of data, hundreds of thousands of data points from basic data points like age and gender and nutritional goals to something more complex like sleep quality and anxiety levels. We've had 31,000 products that have been scheduled into the app to track usage. There's been 146,000 usage incidences showing how and when the products were consumed. There are thousands of recorded wellness activities in the app from cold plunges to meditation and breath work. So the data is just incredibly powerful, and we're literally just getting started. We just launched a couple of weeks ago and just to a very small beta group. So you can envision the power of this data when it becomes operational, commercialized, both not just the U.S. but ultimately over time globally.

You've come a long way with Pro2col since you just acquired it in really early this year in April. And here you are with a beta test in July in North America and then still a planned rollout in the fourth quarter in North America, right? What is the schedule for rolling out Pro2col from here?

Well, like you said, we did the beta launch in North America a couple of weeks ago. We will launch it commercially in North America in the fourth quarter. And then we have a rollout plan we're working on for next year that we have not yet announced for beyond North America, for different regions around the globe.

And then if I remember right, at the event, you talked about additional beta tests coming down the pike as well. Can you talk a little bit about them?

Yes, there's going to be beta tests on different types of biomarkers that we can capture through blood samples or stool samples. So the beta group that we started with now will become a beta group for enhancements that we decide to do along the journey. Even after we commercialize the app itself, we'll have the 7,000 participants that we can now test other opportunities for.

So you really are -- I mean, we are really digitizing the whole health and wellness space, it sounds like, and that this has a lot of potential beyond what even we can imagine here in the early days. What is -- one thing I -- that you mentioned in -- when you made the acquisitions is the capabilities for personalization. Can you talk a little bit about the personalization capabilities of Pro2col?

Yes. So far, on this call, we have not yet discussed the product side of Pro2col. We really have discussed the app. And the app has personalized Pro2col opportunities, which is your personalized lifestyle program. But we also, at the event a couple of weeks ago, launched a product. It's our first product to launch under this umbrella and the product was a healthy lifestyle umbrella. And so what we believe is that the Pro2col, the app with product launches us into a new category, similar to the way Herbalife24 launched us into sports nutrition a decade ago. And we've just launched the first product. There will be other products that we plan on launching that culminates in this highly personalized product opportunity we expect to launch next year. And by highly personalized, I mean a product with a unique formulation tailored to an individual informed directly by the data collected from that person. So Doug, you could have your own personalized nutrition formula that you can get through the use of the Pro2col app and ordering through the second acquisition that we purchased, at least we purchased a majority ownership in, Link BioSciences that can manufacture that highly personalized product. So it's a very exciting umbrella of products coming that starts on the left side, if you kind of drew a spectrum, which is one product for a lot of people all the way to the right where it's a very individualized, personalized product, one product, one formula for an individual and a whole spectrum of opportunities in between.

Yes, it sounds exciting. One thing you mentioned on your earnings call was the year-over-year volume growth that you delivered on a worldwide basis in July, albeit just 1 month in the third quarter. But more notably, I think that July was the first month North America posted year-over-year volume growth since April of 2021. So talk a little bit about July. What was driving the strong growth in July? And can we expect these trends to continue for the rest of the third quarter and the full year?

Well, thanks, Doug. That's a good question. So let me start by repeating what we said on the earnings call, which is in the month of July, so after Q2 ended, we had volume growth in the U.S. for the first time, as you said, in over 4 years, but we also had volume growth globally in the month. Also on the call -- on the earnings call, we said we issued guidance, and we expect net sales growth in the third quarter. What drove the volume in Q3? There's a lot of things that impacted volume -- actually not Q3 but in July. It starts with all the activities that's happened in the last 1.5 years that's created momentum. So the U.S. has been slowly improving, has not reached growth, but the decline has been shrinking with all the activities. That's one of the things that helped contribute to the July success. The other is we launched Pro2col, and we launched another product called Multiburn. Multiburn was hugely successful in July. Importantly, while the U.S. had volume growth in July. That doesn't mean it's going to have volume growth for the quarter because it did benefit from some product launches. However, what we did say is that the U.S. will have meaningful improvement in Q3 over the trend we saw in Q2. So by way of trend, volume was down 8% in Q1 in the U.S. It was down 6% in Q2. It possibly grows, but if it's down in Q3, it will be down meaningfully less than it was in Q2 and still has a chance to have sales growth. So I want to put that in perspective.

No, that's very useful. It does sound like things are building below the surface, and there's a lot on the horizon as far as the digitization of the company. So it all seems very exciting. So let's talk about the free cash flow that you mentioned earlier in the call here. You generate a lot of free cash flow, and you've been buying a lot of debt. Since you came back in 2024, I think, in the second quarter, you set a target of paying down $1 billion of debt by the end of 2028. And so far, you've repurchased around $215 million. And you achieved your targeted leverage ratio of 3.0x, which you targeted for the fourth quarter of 2025, but you actually achieved it in the first quarter. So the free cash flow story sounds good. You're achieving your goals. Just talk about the capital allocation going forward. Is it more of the same? Or what should we look for from uses of free cash flow?

Well, it's important to note that we generate more free cash than we need to invest in our business. So we're positive cash flow. We have negative working capital. This business generates cash and always has. We have set -- we set a couple goals with investors. You mentioned them both in your question. One was we wanted to have our leverage ratio be below 3x by the end of this year. We've achieved that already. We achieved that actually in Q1. So we're 3 quarters ahead of schedule. Secondly, we had told investors a year ago that we would pay $1 billion of debt down between that point in time and the end of 2028. Another way to say that is, at that point in time, our gross debt was $2.4 billion. We said it would be at $1.4 billion by the end of 2028. We will live up to that commitment. That is a priority. Having said that, I expect that we can generate more cash than we need to achieve that goal. So that gives us an extra bucket of money to do something with. Whatever that may be, we haven't necessarily decided. We did a small acquisition this year. We're not a big M&A company, but it's possible we do something small in the future. That generates -- we generate enough cash to be able to do that and achieve our 2028 debt paydown target. Share buyback is not a priority, but if we're generating more cash than we need to be able to hit our debt goals, that's a possibility. But again, it's not a priority as is dividend. I mean the reality is if you generate more cash than you need to fund the business, which we do, that cash has to be used for something. M&A is a possibility, but it's small, and then it really comes back to debt paydown or returning money back to shareholders. And we've been pretty clear that at least from now until 2028, debt paydown is the priority. But having said that, we may generate more cash than we need to do that, and that will free up money to do some of these other things that I just mentioned.

Well, you mentioned your low EV to EBITDA multiple. If you can move $1 billion out of debt into equity, you'll be doing shareholders a big service. That's for sure. So...

Yes. If I can build on that, Doug, sorry to interrupt, but I mean, that's part of the investment thesis, too. I mean to me, it's an insurance policy. But look, our valuation is incredibly low, right? It's 4x. If nothing changes, and I'm not saying it won't because I believe it will and should, but if nothing changes and we pay $1 billion of debt off in the next 3.5 years, that's $1 billion of value that switches from the debt holders to the equity holders at the same 4x if nothing else changes in performance. That more than doubles the stock from where it is today, right? So that in itself could be part of the investment thesis.

No,, that's an important part. I mean, so you've got -- you mentioned the multiple, and we'll let investors do their own work on what the multiple had been in the past. Plus, you've got the underlying metrics of the business that we've talked about showing some improvement and all this technology-related stuff associated with Pro2col. So it's a very good story. So I appreciate you coming on and talking to us about it. I think we're coming up on time here. So thanks again, John, and I'll turn it back over to Shawn.

Thank you, Doug.

Thanks, Doug. Thanks, John. That was a great update today. Really appreciate you joining us, so thank you for being on our podcast today. And I'd also like to thank my equity research colleague, Doug Lane. Great overview, Doug and John. Finally, a special thanks to the producer and editor of the podcast, my WTR colleague, Joe Brunetto. Thank you, everyone, for listening, and don't forget to subscribe as well as visiting us at www.watertowerresearch.com, where you can stay up to speed on the company's written research, reports, podcasts, fireside chats and conference schedules. As a reminder, of course, that is always open access and available for all investors to access our website, events and research. We will see you next time for another edition of the WTR Small-Cap Spotlight, and thank you, everyone, for joining us today. Appreciate it.