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Executives

Michael O. Johnson – Chairman & CEO

John DeSimone – CFO

Desmond Walsh – President

Brett Chapman – General Counsel

Analysts

Mike Schwartz – SunTrust

John San Marco – Janney Montgomery Scott LLC

Pierre Ostlund – Jefferies & Company

Tim Ramey with DA Davidson.

Scott Vanwinkle – Canaccord Genuity

Christopher Ferrara – Bank of America, Merrill Lynch

Anand Vankawala – Avondale Partners

Herbalife Ltd. (HLF) Q2 2011 Earnings Call August 2, 2011 11:00 AM ET

Operator

Good morning, and thank you for joining the Second Quarter 2011 Earning Conference Call for Herbalife Ltd. On the call today is Michael Johnson, the company's Chairman and CEO; the company's President, Des Walsh; John DeSimone, the company's CFO and Brett Chapman, the company's General Counsel.

I would now like to turn the call over to Brett Chapman to read the company's Safe Harbor language.

Brett Chapman

Before we begin, as a reminder, during this conference call, comments maybe made that include some forward-looking statements. These statements involve risk and uncertainty and as you know actual results may differ materially from those discussed or anticipated.

We encourage you to refer to yesterday's earnings release and our SEC filings for a complete discussion of the risks associated with these forward-looking statements and our business. In addition, during this call certain financial performance measures maybe discussed that differ from comparable measures contained in our financial statements that prepared in accordance with the U.S. Generally Accepted Accounting Principles, referred to by the Securities and Exchange Commission as non-GAAP financial measures. We believe these non-GAAP financial measures assist management and investors in evaluating and comparing period-to-period results of operations in a more meaningful and consistent manner.

Please refer to the Investor Relations section of our website, herbalife.com to find our press release for this quarter which contains a reconciliation of these measures. Additionally when management makes reference to volume during this conference call we are referring to volume points.

I'll now turn the call over to Michael.

Michael Johnson

Thanks Brett. Good morning everyone and welcome to our second quarter earnings call. This has been a very strong quarter. The strong top and bottom line results that we reported yesterday are the results of the hard work of 2.3 million distributors and all of team Herbalife. We'd like to start off by saying thank you to everyone for their commitment to our vision and our mission for nutrition.

While we are beginning to see the hard work bear fruit, we believe there is still so much more opportunity ahead of us. Frankly, we're just getting started. Let me start this call by recapping some of the financial results included in our earnings release.

Record volume points of 980 million, up 17% over 2010. Record net sales of almost 880 million, a 28% increase over the very strong results of the prior year. Record earnings per share of $0.88, a 35% increase over our earnings of the prior year. Notable, in our record performance is 21% increase in average active sales leaders over the prior year. And finally, our cash from operations was $143 million, an increase of 74% compared to the prior year and a record for us.

The drivers of our growth continue to be distributor engagement and expansion of daily consumption. Through daily consumption, more distributors are interacting with more consumers on a regular basis and these consumers are experiencing product results. This creates a sticky customer. In response to a survey of U.S. Nutrition Club members, nearly 60% said they attended a nutrition club everyday, almost 80% attended more than 3 days a week, and more than 40% have been attending the club for longer than one year.

In a similar survey, Mexico, more than 50% of members responded that they attend everyday. And 90% attending at least three times a week. Korean clubs have reported similar statistics with 35% attending everyday and more than 80% visiting at least 3 days a week.

The organic nature of distributor growth coming from with interim member base is as exciting as it speaks to our longer term growth opportunity. The exciting thing we're seeing is that the newest distributors are coming from our constantly growing base of Nutrition Club members.

We're seeing the development and training the new distributors from the member base of Nutrition Clubs or lifestyle centers. The successful implementation of daily consumption continues to drive both distributor engagement and retention. For the second quarter, average active sales leaders increased 21% over the prior year and new distributors increased 20%, both increased in all six of our regions.

You may remember from last quarter, our 2010 sales leader retention rate was 48.9%, which we believe is an industry-leading number. These metrics of activity and retention tells a story of the strength we're seeing underlying our growth story.

Our distributors are also inspired by the seed to feed strategy, represented by our state-of-the-art manufacturing facility in Lake Forest, California. We believe we're continuing to raise the bar in the supplements industry. We have toured thousands of distributors through the facility and their confidence was echoed by Wall Street analysts in a recent report, “Herbalife's innovation and manufacturing facility is essentially a branding and packaging facility, but undoubtedly one of the most impressive nutritional supplement facilities we have ever toured. And we have toured dozens of facilities over the last 15 years”.

If the facility is impressive to a seasoned analyst, imagine the impact on an Herbalife distributor of a tour through their very own manufacturing facility and then returning home to tell their customers in down line how proud they are to be associated with Herbalife and that confidence they have in the products that they are selling.

During last quarters conference call, we mentioned two new initiatives for the company. The soft launch of our sports nutrition line, Herbalife 24 in the U.S. and the acquisition of the new Internet-based tool for our distributors called iChange. iChange accelerates our presence within social media and is designed to make it easy for our distributors to offer nutrition information to large numbers of customers, both within the site and to other social media channels such as Facebook and Twitter.

Customers get access to free coaching from distributors and access to nutritional tracking tools to help them achieve their goals. It's available anytime and anywhere through their mobile device or a computer. It's a powerful set of tools to help our distributors develop relationships online and leverage their own social networks.

During the second quarter, we had a beta group of 500 distributors using the iChange system and next week we'll begin a controlled rollout of the tool to a larger groups and distributors in eight English-speaking markets by the end of the third quarter.

In the latter half of May, we had the soft launch of the Herbalife 24 product line with five of the seven products. Herbalife 24 is our revolutionary new sports product line designed to meet the high-end nutritional needs of the 24-hour athlete, such as those on our Herbalife sponsored teams around the world.

A 100% of the product launch are tested by the Banned Substance Control Group in independent testing lab and every canister will carry the BSCG symbol. So all athletes can be confident there are no banned substances.

The product packaging has QR codes, which enable our distributors and their customers to quickly link to a video explanation of the product science and its benefits. This new line of seven products is truly revolutionary. And we believe, Herbalife 24 will redefine sports nutrition. Athlete or athletes, 24x7 and whether you're a professional athlete, a weekend warrior or someone who enjoys an energetic walk with friends, there is an Herbalife 24 product or combination of products designed for your unique needs.

In addition to the long-term business opportunity that we believe exists from the launch of Herbalife 24, also helps our goal to have the Herbalife brand become synonymous with a healthy active lifestyle.

As many of you have seen recently, Herbalife is the title sponsor of World Football Challenge featured on ESPN, Univision and other networks throughout the world. Top football teams such as Real Madrid, Manchester United, Man City, CD Guadalajara, Club America and our Herbalife sponsored teams, the LA Galaxy and FC Barcelona are competing in cities throughout the U.S. and Canada.

The Herbalife 24 products are prominently displayed and available to the players on the sidelines of every game. The amount of press coverage Herbalife has received over the past few weeks both domestically and internationally has been significant. Our nutrition scientists are spending time with each of the team's trainers and coaches introducing them to the benefits of Herbalife 24 and the response has been tremendous.

Before passing the call over to Des, let me conclude my prepared remarks by repeating my earlier comments. We believe, we're just getting started. Our aspirational goal is to achieve 10 billion volume points by 2020. Our products and our business opportunity are more relevant for today's marketplace at anytime in our 31-year history.

Our highly entrepreneurial distributors continue the globalization of daily consumption business methods that are enabling more distributors to be successful than ever before in our history. Our brand and image are gaining strength and the strategic initiatives being launched, all lead us to believe that the momentum will continue and that we truly are just getting started.

Now let me turn it over to Des for some specific market updates.

Desmond Walsh

Thank you, Michael. As Michael mentioned, we truly do believe that we are just getting started and I think you would feel the same as I walk you through some of our regional and country-level metrics. The momentum we're seeing in our business continues to be driven by two key forces. Our distributor's commitment to expanding daily consumption business methods around the world, which helps create a long-term stable customer base, and the continuing commitment of our distributors to Herbalife's mission for nutrition.

We continue to see the expansion in daily consumption business methods as a primary driver of our distributors business and Herbalife's growth. We believe the momentum behind this evolution will continue to accelerate as more distributors in more markets have success acculturating daily consumption business methods to their markets.

We were often asked about how far along we are in the evolution of the business? And as we evaluate penetration metrics by key markets, we believe we are still in the early stages of this transformation in our business.

Now, let me provide regional highlights, some color on key countries and by way of background, a little history on the utilization of daily consumption in various regions.

This quarter, I'm going to begin my discussion with Mexico, the country where we first see our daily consumption begin to transform a market, in 2003 with the proliferation of home-based Nutrition clubs. So, to those that ask long a market can continue to grow through daily consumption? We believe that Mexico represents a very good indicator of the potential for long-term growth.

Mexico, a market where daily consumption has been in place for 8 years just experienced the biggest volume quarter in their history, June 2008 was a record volume month driven by the rapid duplication of Nutrition Clubs in the market. In June 2011, Mexico topped that record, posting the highest volume in their 26-year history.

We believe that the market is the testament to the long-term growth opportunities available through their creation of long-term customers. When we look at the opportunities within a market, we measure per capita penetration by dividing volume points by population. And in Mexico, in 2010, our per capita penetration was 5 volume points per person compared to 1.2 in 2003. And while we're very pleased with the deeper penetration, we believe that there is still a lot of room for growth in the market.

In Mexico, local currency net sales to the quarter increased 31% and volume points increased 26% compared to the prior year period. New distributors in the second quarter increased 28% compared to the prior year. We are very pleased to see average active sales leaders increased 26% for the quarter compared to second quarter 2010.

The revitalization and continued growth in Mexico has been driven by improvements in product access, enhanced training and distributor engagement. With these elements in place, coupled with the stickiness of customers verified in the Nutrition Club customer surveys referenced by Michael, we believe that the 5 volume points per person is sustainable and indicates the future which lies ahead for many other markets still in the early stages of adopting daily consumption.

North America, the second region to utilize daily consumption business methods, starting in 2005, had another strong quarter. Posting growth of 7% volume and 11% local currency net sales compared to the prior year period. New distributors increased 4% in the quarter. One of the measurements that we used to gauge distributor engagement, average active sales leaders increased almost 14% in the North American region compared to last years' second quarter results.

For the quarter, net sales in the U.S. grew 11% and volume points increased 7% versus the same quarter last year. Compared to the prior year period, new distributors in the U.S. increased 4% and average active sales leaders increased 14%. The growth in the U.S. continues to be driven by the expansion of daily consumption business methods. Although the U.S. are our oldest and largest market, per capita penetration is only 2.8 volume points per person compared to less than 1 in 2003.

We see tremendous opportunity for future growth in the U.S. and are very excited by the expansion of daily consumption that we are seeing take hold in cities around the country. Based on weight loss challenges, Nutrition Clubs, and other traditional activities focused on creating long-term customers, generation H our younger distributors typically under 35 years old are really beginning to take daily consumption to heart and are opening very exciting iterations of Nutrition Clubs that integrate the idea of a healthy active lifestyle, sports, and Herbalife products.

The momentum and distributor engagement in the U.S. has also resulted in much higher attendance at our distributor training events. During the quarter, we saw a 27% increase in attendance at our Leadership Development Weekend and that is continued into the third quarter. Attendance at July LDWs increased 50% compared to the events of the prior year.

In 2007 and 2008 distributors in the Asia Pacific region, specifically South Korea and Taiwan began to increase their focus on daily consumption and specifically Nutrition Clubs. By the end of 2010, per capita consumption within those two countries was approximately 4.5 and about 9 volume points per person respectively, which represents an almost four-fold increase over 2003 levels, all driven by the expansion of daily consumption in those markets. And while those markets have driven great growth for our Asia Pacific region over the past few years, we are excited by the seeds of expansion that we are seeing begin to bear fruit in several other markets throughout the region.

During the second quarter, local currency net sales for our Asia Pacific region increased 29% and volumes points grew 27% compared to the prior year period. In the second quarter, new distributors increased 42% versus the prior year. We believe the growth within the region continues to be driven by the expansion of daily consumption business methods and the high degree of distributor engagement. Average active sales leaders increased 31% in the quarter.

For the past several quarters, we have been discussing our excitement about the growth we're beginning to see in India. Well, India was again a highlight in the second quarter, posting volume point growth of approximately 121% compared to the prior year. The Herbalife business is taking route in multiple states throughout India and we are working diligently to ensure that our infrastructure continues to be capable of supporting this level of growth.

When we look at per capita consumption in India, it is a much more difficult measure, frankly because the denominator is just so large. But suffice to say that we are comfortable that we are just beginning to scratch the surface of our opportunity in India. Similar to our Waldo's program in Mexico we are currently testing a program to increase access points in Southern India with the company that is over 125 locations. We'll keep you posted on this test.

Our South and Central American region posted very solid growth in the second quarter. Local currency net sales increased 44% and volume points in the region were up 34% in the quarter. Average active sales leaders in the region increased 22% over last year's second quarter. New distributors increased 23% for the quarter compared to the prior year period.

Regionally, we believe that our distributor leadership is seeing the benefits that daily consumption business methods can bring to their markets and that there is a long runway of opportunity ahead in this region. Bolivia, Colombia and Peru, while smaller markets for us today, are all beginning to experience solid growth from the expansion of daily consumption and Nutrition Clubs.

Within the South and Central America region, we need to mention the momentum that we are seeing in Brazil. Brazil experienced volume point growth of approximately 39% in the second quarter as Nutrition Clubs as well as our traditional business methods experienced growth. Yet, per capita penetration in Brazil is still only 0.9 volume points per person. This is two times what it was in 2003, but compared to the 5 volume points per person we're achieving in Mexico, we believe that there is significant growth ahead in Brazil and our distributors in this market are just beginning to scratch the surface of the real market opportunity.

Turning to EMEA, this is a region where we are seeing the early stages of growth of daily consumption business models in several different countries. During the second quarter local currency net sales increased 8% and volume points in the region grew 7% compared to the prior year. Both average active sales leaders and new distributors in the region improved 14% in the quarter as compared to the second quarter 2010.

Russia continues to be a market which exemplifies the impact of daily consumption coupled with the enhancements to our marketing plan, first introduced there in 2009. Russia has had another very strong quarter that deserves to be highlighted. Compared to the second quarter 2010, this quarter's volume points were up approximately 46% with an almost 45% increase in new distributors and an approximately 45% increase in average active sales leaders.

We are seeing healthy expansion of Nutrition Clubs throughout Russia. And as we saw in Mexico, increasing product access for distributors can be a catalyst for growth and we are continuing to add to our base of product pickup centers throughout key areas of Russia.

Distributor engagement is also growing as evidenced by the 28% increase in attendance at the Russian speaking extravaganza in Minsk during July. While we are very pleased with the volume point growth there, volume points per capita as of 2010 was only 0.4. And therefore, we believe there remains an enormous opportunity for further growth as daily consumption continues to make its way into this huge market.

Now, let's turn to China. While local currency net sales declined almost 5% and volume points decreased approximately 9% in the second quarter compared to the prior year period. This is in line with our expectations. As we are working hard to transition China to a daily consumption model and we are pleased to see positive indicators out of the market that tell us that this transition is taking route.

Specifically we are seeing changes in distributor ordering pattern. As we have seen in other markets, including Brazil and Korea, the transition to daily consumption can be identified by a pattern of smaller orders with increasing frequency, which is exactly what we experienced in China during the second quarter. So, while we saw volume in China turn negative in the second quarter, average active sales leaders in the country increased more than 25%.

Over the past month, we have seen more than 20,000 people at training meetings throughout China. The focus of the meetings has been on growing through daily consumption and the newly implemented 5K qualification in their market. While we are very pleased with the progress of the business in China, we remain cautious about expecting too much too soon from this market. We are focused there on building a sustainable business on a solid foundation of long-term customers.

As we have been discussing with you for the past several quarters, we believe that there is an ongoing transformation within our business. The daily consumption model has taken hold in some of our largest markets and it continues to expand into more of our existing markets everyday. But in the vast majority of our 76 countries, daily consumption is in its infancy.

On a global basis, our per capita penetration is only 0.8 volume points per person. And with the beginnings of daily consumption taking route in so many of our markets around the world, we believe that our penetration rates can go much higher. As Michael said at the outset, we are indeed just getting started.

Let me take this opportunity to thank our distributor leadership for their continued engagement and for what we believe is going to continue to be an excellent year.

Now, let me pass the call over to John, to review the financials.

John DeSimone

Thank you, Des. First, comparing this quarter to last year's second quarter, our volume of $980.5 million increased by 17.1% over the very strong 19.9% increase reported for the second quarter of last year.

Our net sales of $879.7 million represents an increase of 27.7% comprised of our local currency net sales increase of 19.9%, plus a 780 basis point benefit from foreign currency. Like the last year's second quarter and the first quarter of this year, the top line strength were consistently throughout the quarter.

As Michael noted in his opening comments, the sixth single largest volume months in the company's history are each of the months from this year. Our business momentum is very strong. Compared to our guidance, we exceeded the high end of the range by 43 million volume points or 4.6% and the high-end of our net sales range by $46 million or 5.5%. This improvement versus guidance was consistently spread across the quarter.

As Des, has already provided detail commentary on volume, I will turn to gross margin, which for the quarter was approximately 40 basis points better than the second quarter of last year. This was due mostly to cost savings from our seed to feed strategy, including benefits from our new HIM facility in Lake Forest. This facility produced approximately 23% of all worldwide in the nutrition production volume during the quarter, which was in line with our expectations.

Sequentially, the manufacturing facility added 58 basis points to gross margin. And we believe that further expansion is possible as we begin to bring manufacturing for other countries, such as several of our South American markets into the facility next year. Additionally, our investment in seed to feed, will continue in the second half of this year when we expect our botanical extraction facility will be completed.

Moving on to SG&A as a percent of sales, this quarter improved by approximately 40 basis points versus last year, this includes overcoming a $13.7 million year-over-year swing from gains and losses on foreign currency and hedging transactions. Last year, we recognized $8.2 million in foreign currency gains during the second quarter, which this year was a $5.5 million loss. Excluding the impact of these realized foreign currency related items and also the impact of China sales employee expense, SG&A as a percent of sales improved 182 basis points on a year-over-year basis.

The second quarter operating margin of 17.4% was 50 basis points ahead of last year and is an all time high for the company. The operating margin improvements come from both the short and long-term leverage in the business.

We expect to maintain a long-term contribution margin in the 20% range by being disciplined in our strategic investments and by investing in leveragable platforms such as our global Oracle System in manufacturing.

Second, in addition to the long term leverage inherent in the model, the incremental short-term contribution margin temporarily benefits operating margins when sales significantly exceeds our expectations. This happened in this year's second quarter and last year's. Accordingly the sequentially operating margin profile for the back half of this year should track along a similar pattern as last year's as we look to invest behind this quarter's growth and activities that support and drive distributor engagements.

The effective tax rate for the quarter, up 27% was approximately 100 basis points better than last year's and 130 basis points better than the low point of guidance. A portion of the improved effective tax rate carries forward as we have lowered the full year guidance range on both the high and low ends by 50 basis points.

Also in the quarter, we adopted an accounting method change that positively impacts the effective tax rate and negatively impacts fully diluted share count. This changed increased of fully diluted share comp by 1.7 million shares in the quarter. From an EPS standpoint, these items effectively offset each other in the quarter and had a negative $0.01 impact for the second quarter of last year. The adjustments for the last six quarters from this accounting change is posted on our website.

Turning to earnings per share, the company reported EPS of $0.88 which was $0.23 higher than the second quarter of last year and $0.14 better than the high-end of our guidance range. The majority of the upside compared to the high-end of our guidance was due to the almost $50 million increase in net sales.

During the quarter, the company generated cash flow from operations of a $143 million, an increase of 72% versus the comparable quarter in 2010. Free cash generated during the quarter of a $127 million represents a 114% of net income. Free cash for the year-to-date period also exceeded net income at a 103%. During the quarter, we repurchased 1.8 million shares for a total of $98.9 million, which leaves $678 million remaining on our $1 billion share repurchase program.

Now, let me discuss our guidance for 2011, both Q3 and full year. Guidance figures are based on exchange rates as of the end of Q2 consistent with our prior practice. For the third quarter, we expect volume point growth of 13% to 15%, while our net sales are expected to increase by 21% to 23%. The increase in net sales reflects volume growth, as well as the favorable effects of a generally weaker U.S. dollar compared to prior year. EPS is expected to be between $0.71 and $0.76.

For the full year, we expect volume growth of 15% to 17% compared to our previous guidance of 12% to 14% and net sales are expected to grow 22% to 24% compared to our previous guidance of 18% to 20%.

In terms of EPS, we are raising both the low and high-end of our guidance range by $0.20 and $0.18 respectively. We now expect, full year EPS to be in the range of $2.97 to $3.07 per share.

That ends our prepared comments. We will now open up the call for your questions. Thank you very much.

Question-and-Answer Session

Operator

(Operator Instructions). Your first question comes from the line of Mike Schwartz with SunTrust.

Mike Schwartz – SunTrust

Good morning, everyone.

Michael Johnson

Good morning, Mike.

Mike Schwartz – SunTrust

Hey, with regards to China, could you give us some context around what's going on there with regards to Nutrition Clubs and compare that maybe to what you've seen in some of your other successful markets?

Desmond Walsh

Sure Mike. Hi, this is Des, I'll take that one. So, what we're seeing in China, Mike is essentially transition to daily consumption which is very similar to what we saw taking place in Brazil about three years ago. And whenever that happens, we see a number of things taking place. The first is that we see an increase in the number of our people who are placing orders each month and then we see a reduction in terms of the average order size. And that's really the real indication to us that we're moving more to a market based on daily consumption. So that's why we're, you know, very optimistic about what we're seeing in China based on these trends and what it portends for the future.

Mike Schwartz – SunTrust

Okay, great. And this is, is this is first quarter where you've really seen that kick in, because I don't recall you pointing that out specifically in quarters past?

Desmond Walsh

So, we have been talking about these transition to daily consumption in the past, what we're seeing now is the acceleration of that based on the success of our leaders there who've already introduced the concept. So, we now have approximately 1,000 clubs in China, we see that developing. And we're seeing success comes from those leaders who have already adopted them and that tends to accelerate the adoption by other leaders.

Mike Schwartz – SunTrust

Okay, great. Thanks a lot.

Operator

Your next question comes from the line of John San Marco with Janney.

John San Marco – Janney Montgomery Scott LLC

Thanks. Hey guys, and congratulations.

Michael Johnson

Thank you, John.

John San Marco – Janney Montgomery Scott LLC

Can you give me an update on what percentage of your total volume you sell through daily consumption business methods? And then, maybe if you also have an estimate how that breaks out versus, you know, in terms of clubs versus weight loss challenges or any other major methods I might be missing?

John DeSimone

So, as you know, John, it's not an exact science or it's an estimate and it's around 35% and accelerating because, you know, Nutrition Clubs and daily consumptions methods of all types are driving our growth. We don't breakout the difference between the various daily consumption methods as it is not an exact science, but it is...

John San Marco – Janney Montgomery Scott LLC

Okay. If you don't mind using that same in exact science maybe and just telling me, you know, whether when you breakout that 17% total company volume growth. Do you think the growth metric was substantially higher than in daily consumption? Or how is daily consumption trending versus, you know, the more traditional methods of multilevel marketing?

Desmond Walsh

So, John, this is Des. As John said, it's very difficult to break it out because the reality is that our distributors operate a blend of different business methods in doing their business everyday. So, even though we talk about the clubs, the reality is that in the club you've got a whole variety of different methods being operated simply from a location. So, you have club operators doing weight loss challenges, doing traditional methods, you know, and so on. So that's why it's difficult. Having said that, you know, we do know that we've got more customers consuming the products everyday and that we have more of those customers transitioning to become successful distributors. And obviously for us that's the key import of daily consumption. It's as we refer to the circle of success. So, in terms of volume point with 17%, I think you could safely say that, you've got daily consumption within that accelerating at a higher level, but actually breaking it out specifically is impossible to do.

John DeSimone

You know, I guess, another measurement that we can point you to, to get your comfortable that daily consumption is driving the growth, as look at the countries where growth is occurring at the fastest rate, Mexico, Korea, Brazil, Russia, those are all daily consumption models.

John San Marco – Janney Montgomery Scott LLC

Great. That all makes sense and checks out. Just one last one, on the subject of daily consumption. In the past you've articulated a strategy of expanding product offerings, you know, were the right fit for daily consumption clubs and so forth. Can you update me and what you've already changed on this front and then maybe what your plans are?

Michael Johnson

Well, so this is Michael. I think, we're constantly looking at sizing. You know, some of the club models around the world are asking for some larger sizes from us and we are experimenting with that, we're looking at it, we're looking at flavorings. We've come out with a couple of new flavorings and some marketplaces that have been by request in these markets. We're looking at ways obviously to create a lot of excitement in these clubs through new product offerings and we're looking at ways frankly in the future to expand product lines in the clubs that could offer more service to some of our club members who are coming in possibly even in the other nutrition area.

John San Marco – Janney Montgomery Scott LLC

Okay. It sounds like that's still something that's mostly still in the planning and experimenting stages, you haven't had any major shifts, it sounds like is that fair?

Michael Johnson

Well, our core products in the club are the shakes and the tea in the allo product and we are definitely looking at local market driven ideas in there. Yes, we've experimented all over – all around the world with different things, but we are not at liberty to go into some of those yet.

John San Marco – Janney Montgomery Scott LLC

Great. Well, that's helpful. Thanks again guys and congratulations.

Michael Johnson

Thanks John.

Operator

Your next question comes from the line of Per Ostlund with Jefferies & Company.

Pierre Ostlund with Jefferies & Company.

Thanks. Good morning everybody. Congratulations. Just to maybe a follow-up quickly on Mike's question I think from earlier on China, Des, I know you alluded to a lot of this in your prepared remarks and that answer and it does sound like that transition is very much playing out as you would have expected. I guess maybe my question is realizing that it's something that you guys have sort of looked at institutionalize globally, was there a specific catalyst that sort of, you know, maybe just turned it on a little extra this quarter, like how much might that 5K qualification, had maybe been a little bit of a trigger point for that?

Desmond Walsh

Yeah. So, Per, it's a good question. So anytime we see a transition, it's always obviously a number of factor that contributes that and we do believe that the 5K has helped, because again what it focuses is that is on gradual movement on, you know, up our compensation plan and certainly, you know, that coupled with the club model, it's a very effective combination. So, I think you've got a combination of factors, but I actually believe also Per it's partially acculturation. We know from experience around the world that this probably the single biggest factor because local leaders have to take the concept of the club and then they could work locally and I think that's what we're seeing in terms of the early stages in China today.

Pierre Ostlund – Jefferies & Company

Okay, that makes sense. Maybe just and not to dwell on the China issue but and it might be a little bit of a slippery number. But is there a way at all to broadly quantify the impact to the vacation promotions that you had last year, just to maybe frame the discussion a little bit about around the retrenchment volumes this quarter?

Desmond Walsh

You know, obviously promotions have an impact on our business because they create excitement, they support distributor engagement. But actually in a way Per, it's a healthy sign, that the promotions did not have a comparable impact in terms of, you know, driving volumes, because what it means is that our distributors in China focused on daily consumption business methods and not so driven by promotions. So, again, it's another indication to us that China is proceeding in a very healthy way and building a strong long-term sustainable business.

Pierre Ostlund – Jefferies & Company

Make sense. Turning quickly to the Lake Forest facility if I may, so you, I think you indicated 23% of the volumes here in this quarter. Is the next phase bringing in the international volumes, some of the South American volumes and perhaps Mexico down the line, is it really just a regulatory thing at this point that keeps it from happening sooner than, you know, early 2012?

John DeSimone

Yes, it's licensing the regulatory, right. There are long lead times on licensing for and putting our products into these countries and when you change manufacturing locations, you have relicense the product.

Pierre Ostlund – Jefferies & Company

Okay. Is there anything that we should look for in terms of, is there going to be an inventory build kind of ahead of that transition, is there any one-time kind of cost that we might want to be aware or be need to be aware of it as you'd love to migrate the volumes?

John DeSimone

No, nothing material, I mean, there might be a little build in Mexico but nothing material.

Pierre Ostlund – Jefferies & Company

Okay. Then maybe just one last one on 24, it's obviously early days there, but the energy, sports and nutrition was up 44% in the quarter, is 24 some of that impact. And then maybe on that point is the expectation, is the prevailing expectation that 24 might be a type of cannibalistic in the immediate term as the distributor maybe substitutes that for a products they might normally purchase while there are kind of ramping up on learing the selling proposition there?

Michael Johnson

Lot of questions there. So, 24 is moving on nicely in soft launch right now. We've got five of the seven products out. We'll be rolling out both Europe and US much more aggressively through the fall. We're using a promotional platform, obviously this summer of Indianapolis, we've got this Mountain Bike Race in Leadville, Colorado, where one of the presenting sponsors. We also have the World Football Challenge that has given us access to all of the team trainers, we're working with our doctors to go in and spend time them, to educate them about this product. We've a tremendous reception to what this product is all about. It's a brand lifter, it's an image lifter.

On the business side, well it might be cannibalistic to a couple of small products in our line, but the real opportunity is to attract new distributors with new business methods, Des mentioned this in his prepared remarks about we are seeing a younger group come in here and apply new business methods in the daily consumption load, but far away from just a Nutrition Clubs or weight loss challenge, they into a fitness challenge on this and they are using many, many different methods for a healthy active lifestyle and are recruiting and retailing based on this and it's really exciting to see these new folks in our business. So, there's a kind of – it's kind of a what Des calls a virtual circle here between the product, the opportunity and the business build.

Pierre Ostlund – Jefferies & Company

Maybe just – and I appreciate you are tackling what was obviously a one question there Michael.

Michael Johnson

But a long answer.

Pierre Ostlund – Jefferies & Company

How much is the new generation, I guess, if you will coming in behind the 24 product, are they coming in based on some of the brand-building efforts, you've seen around the football challenge and what not, or is it, you know, maybe a regular Nutrition Club attendee that's learning about and going about it that route.

Michael Johnson

I think it's a blend of a lot of things. You got to remember this is a push business and where our distributors push out into the marketplace and attract people to the opportunity, they can certainly take advantage of some of the brand awareness that's been built out there, whether it is through, you know, the use of T-shirts or through the use of big posters or it's the use of the media exposure that we're getting on some of these products, it's truly a blend, it's taking place there and these new distributors coming in, some of them, you know, are attracted to the company by weight loss and then find the opportunity in healthy active lifestyle and fitness. So, it's a lot of doors that they come through.

Pierre Ostlund – Jefferies & Company

That makes sense. Thanks for all your answers. Congratulations.

Michael Johnson

Thank you.

Operator

Your next question comes from the line of Tim Ramey with DA Davidson.

Timothy Ramey – DA Davidson & Co

Good morning. The great performance out of the plant in Southern California, you know, we're hearing new skin talk about maybe saving on some duties and so on by exciting plants in Southeast Asia and I know you have your extraction facility and China coming online, are there opportunities to, you know, perhaps lower gross margin or impact duties through further diversification of the manufacturing into other countries?

Michael Johnson

You know, long term, we recognize as an opportunity to lower duties by producing product closer to consumption and we've a long term strategy to introduce a new facilities, whether there are facilities or lines that we control in with the partner and it maybe 2 to 4 years projects in this point in time, whether that increases gross margin or actually lower selling price in the market is yet to be determined, but there is economic benefit by taking advantage of trade agreements and producing for example sell South American product in Brazil or Asian product in Southeast Asia, Russian products in Russia and so forth. So when we're looking is Brazil somewhere in Southeast Asia, probably India and Eastern Europe.

Timothy Ramey – D. A. Davidson & Co.

Great. And then just back to the seed to feed, you know, I didn't write that great piece Michael, but I sure echo the sentiment and it really seems to me that this message resonates with consumers, but I'm not sure that you're in a position to really tell that story as big and as aggressively as you'd might want to. Can you give us a sense of, kind of when you think that can be sort of a strong headline to the sales force to go out and talk about quality assurance and efficacy and traceability of ingredients, when we be able to kind of really advance that?

Desmond Walsh

Yeah Tim. Tim this is Des. We actually have already started aggressively promoting that message. So for example, you saw Michael talk about it, you saw Rich talk about it. Rich now (inaudible) is probably our – one of our most requested corporate speakers around the world and we give him a hard time about it everyday. But it's a testament to how that message really is resonating with our distributors.

In addition, we've actually produced a whole set of marketing materials, so that our distributors can help pass that message on. And so, out in our website we've included just a smaller version Richard's presentation because we really do believe this is a point of difference for Herbalife. We believe that it's a huge point of confidence and pride for distributors and it's absolutely a message we want our distributors to push out to consumer throughout the world.

Timothy Ramey – D. A. Davidson & Co.

Perfect. Thank you.

Operator

Your next question comes from the line of Scott Vanwinkle with Canaccord.

Scott Vanwinkle – Canaccord Genuity

Thank you. And congrats on the quarter. A couple of quick follow-ups, that 23% of manufacturing percentage of your sales, so that stays relatively constant until the beginning of 2012 or does it inch up a little bit, trying to think of what that 58 basis points of gross margin improvement do over the next couple of quarters?

John DeSimone

It can inch up but really the next wave is getting international product into that facility and that could be late fourth quarter, early next year.

Scott Vanwinkle – Canaccord Genuity

Okay. And John, did you say something about a 20% operating margin target in your prepared comments?

John DeSimone

No, I said a 20%...

Michael Johnson

Well, I sure like that though.

John DeSimone

Okay.

Scott Vanwinkle – Canaccord Genuity

I heard that before, so I'm just making sure.

John DeSimone

No, no. So what I've distinguished – what I was trying to distinguish was the short-term contribution from the long-term contribution, right. So in the short-term we have a pretty high contribution margin around, maybe 35%, 40% but we have to reinvest a good portion of that back into support the growth and support our distributor. So long-term contribution margin is looked – we try to manage to 20% and we think that's very achievable. So that's the contribution model from incremental sales from where we were back in keeping 2009 as a base.

Scott Vanwinkle – Canaccord Genuity

Okay. And then if we look last year second quarter where you were surprised by volume had the big margin, this year you were very adamant about the margin being down or not repeating last year. And then the big volume comes through. You couldn't have been surprised as much this year as you were last year. And the nature of my question is I would assume the step down sequentially into the back half of the year isn't as steep as it was last year on the margin.

John DeSimone

Well, you have our guidance right, and then we have EPS guidance, you have our tax rate guidance, so you can easily back into your operating profit. You've got a top line guidance. So you can see what our, really range of what the step down or what the margin profile is expected to be for the back half of the year.

Scott Vanwinkle – Canaccord Genuity

I guess I was trying to get to the comment of how conservative it was. And then, this quarter you just did 17% volume growth against 20% last year, if I have my numbers correct. You're guiding as you always do prudently in the back half of the year, but with good new distributor and active distributor trends this momentum shouldn't end here. I just – I wonder if there is anything we should think about in the back half other than challenging comparisons when we think of volume growth.

John DeSimone

So we're projecting our guidance volume growth of 13% to 15% in the third quarter, I don't think that's the indication of any lost momentum. I think it's an indication of continued momentum and that is still off a very strong double-digit growth number for last year. So I would characterize it differently then I think you just did so.

Scott Vanwinkle – Canaccord Genuity

Okay. And then the last question is a little more bigger picture. You've got a lot of things going. You've got some brand-building efforts, on the advertising, you've got a product story that's new and better than – I think it has been in quite sometime. You got good tools, you got selling methods, what are the distributors telling you right now is making their job easier to drive this acceleration we see in the last two years?

Desmond Walsh

So Scott, I think it's a whole variety of different factors. First of all, you've obviously got a tremendous excitement around Herbalife 24, you've got the increased confidence from seed to feed, you've got the changes in the marketing plan which obviously have made it easier than ever to do the business, grow up the marketing plan and earn a substantial income. You've got the increasing adoption of daily consumption business methods, which is focused on creating permanent customers and obviously from our distributors at permanent customers that obviously drives customer retention, which drives distribution retention which in turn drives recruiting and then when we bring new distributors we've focus again on completing the circle and creating more long-term customers.

Also we have improved product access significantly in many countries around the world. And obviously through the clubs, we've actually managed to lower the effective price point and that's opened up the products to a much larger segment of the population. So, and then wrapping around all of those you've got distributor confidence because obviously when you put all those things together what it means that our distributors have lots to talk about, lots of things happening, and then obviously we've supported this confidence with a whole variety of tools from biz works, to online application and so on. So, really, you know, every corner that you look at there is positive things out there, I think, all of that is contributing to the momentum that we're seeing and that we believe we'll continue to see, you know, in the future.

Scott Vanwinkle – Canaccord Genuity

Thanks. And Des, you compared China, the transition in China to Brazil, does this play out probably in the same way as far as duration of when you see the volume really starts to pick up?

Desmond Walsh

You know, that's really not possible to tell Scott frankly, because no two markets are identical. Certainly, it's indicative and obviously we're confident about that happening in China because we've been through it before. But as to when it will happen, the curve, that's really impossible to say. But we're particularly excited frankly about what's happening in Mexico. Because if you think about Mexico, here we are, you know, 8 years since the introduction of daily consumption in the clubs there and we have the highest volume a quarter in Mexico's history. So, for us as we look to the future, you know, that's very exciting because it gives us, if Mexico is the leading indicator at 5 volume point and record growth 8 years in and then obviously that tells us, we've got a lot of runway ahead of us.

Scott Vanwinkle – Canaccord Genuity

Thank you.

Michael Johnson

Okay. We have time for two more questions.

Operator

Your next question comes from the line of Chris Ferrara with Bank of America.

Christopher Ferrara – Bank of America, Merrill Lynch

Hey guys, thanks. I know, I guess we've all taken a swing at this question in the past. But I want to try to get knew from a different angle, right I mean. The same store sales concept. So if you take Mexico in particular and obviously the momentum has been really good to your point. And it's the place you've been longest with the concept and that's great. I guess, is there any chance of you know, even roughly disaggregating what the growth looks like right now between new geographies, I mean, are you expanding in different directions versus filling in between geographies versus driving more club visits per club g-er. How do we think about that stuff in Mexico right now?

Desmond Walsh

Yeah. So, Chris, part of our strategy for the Herblife decade and getting to the you know, Michael's, goal or Herblife decade of 10 billion volume points is lighter and deeper. And obviously wider represents more countries, deeper represents increasing volume points in every market. So, in Mexico as in all our major markets we've adopted this concept of regionalization and regionalization means that we are focused with our distributor leaders and the company working together in increasing volume points on a city-by-city basis. So, if you look at many of our market historically, we've been focused on the larger cities, now we've broken Mexico into numerous regions, we have assigned an internal person responsible for working closely with our distributor leaders in that sub region they are now based not out of our head offices, but they are based in the field. So, everyday, they are working with distributor leaders, they're planning local promotions, they're visiting clubs, and they're all contributing to the sense of working together with our distributor leaders to growth the business.

So, I think that's one of the things that we are seeing and, you know, we're seeing that obviously not just in Mexico, but many other countries. Along with that obviously, we're expanding our access points in support of that visualization strategy. And lastly, you know, as always we're working with the distributor leaders to expand and promote great ideas. So, and that really is what continues to drive the business, it's that unique relationship that we have with our distributors working locally city-by-city.

Christopher Ferrara – Bank of America, Merrill Lynch

But and I guess, if you think about your volume growth in the quarter, I mean, can you give a rough idea of how much of that was the increase volume point in the same areas where you already, currently have clubs versus getting new clubs out there?

John DeSimone

Chris, we don't break it out that way, it's, there is a lot of activity, I mean, Des just spoke for two minutes and all the good things that are going on in just one country and it all works together.

Christopher Ferrara – Bank of America, Merrill Lynch

And is it just because you don't want to, I mean, you don't want to talk that granularity of it, get to that level of granularity or –

John DeSimone

I've already started –

Christopher Ferrara – Bank of America, Merrill Lynch

And I just start to figure out too, right, I mean –

John DeSimone

Well, so the one thing we have access to that we don't disclose is, our volume point activity by city and by state within each region, so we do know our penetration rates by sub region, we know, we have a going up, but that's not information that is something we want to share, it's very competitive intelligence.

Christopher Ferrara – Bank of America, Merrill Lynch

No, understood, understood that make sense. And I guess –

John DeSimone

We can break it out geographically internally; it's really difficult to break out one initiative because there is not just one initiative going on in any marketplace.

Christopher Ferrara – Bank of America, Merrill Lynch

That make sense, I appreciate that. And I guess your, the penetration levels you're seeing, if you're going to small geographical areas right, I mean, just broadly speaking, it's Mexico the place where you have the most penetrated areas for Nutritional Clubs? Like in other words the city in Mexico, or town in Mexico or is that, is that where the best Nutritional Clubs are, the highest volume clubs are?

John DeSimone

Yeah, so in answer to your question. Again, not an exact signs, but directionally, now we believe that there are even cities there in United States where we have actually a deeper penetration in specific cities. For example, we know one community in the northern part of United States where we believe that as many as 20% of the people in the community are regular Nutrition Club members. So, you know, so we have similar situations in Russia, Brazil and India and Korea also where we've got very high concentration of clubs with very, very deep penetration. And again, by the way, even historically, you know, that in Iceland, we've had you know, penetration rates up, 18, 19 volume points per person and that in a country of whatever 400,000 to 500,000 people. So, in terms of where the – if you're looking to see where is the ceiling, I'm not sure there is a ceiling. But, you know, we have markets out there where we've got close on 20 volume points per person. And that's why we say, even in Mexico with 5 volume points per person, you know, there is a lot of opportunity for growth still ahead.

Christopher Ferrara – Bank of America, Merrill Lynch

No, no, I appreciate that. I guess, what I'm trying – what I'm trying to get, I know it's not the easiest thing. That path from 5 to 20, I mean, does that necessitate going to places. It's a big part of that going to places where you're not, biggest penetration maybe at 20 in the good part of that country and I'm not sure it's not in a large part of the country. But you know, what I'm saying.

Desmond Walsh

And that's why the opportunity exists throughout Mexico. And you know, we share information of local base of the distributor leaders to help them identify areas. But the reality is even in the areas frankly, where we have the deepest penetration, we believe that we're no where close to what that connects out us.

Christopher Ferrara – Bank of America, Merrill Lynch

Great, thanks a lot guys.

Michael Johnson

Thank you. One more question please.

Operator

Your next question comes from the line of Anand Vankawala with Avondale Partners.

Anand Vankawala – Avondale Partners

Hi, thanks for taking my question, just had two quick questions. The first one, just on repurchase activity and where do you see that going forward. You know, we had a pretty big jump in the second quarter after no activity in the first quarter. Are we going to be reverting back to the typical $50 million per quarter or you know, what type of run rate do we expect?

John DeSimone

I can tell you, $50 million per quarter is what's assumed in our guidance. If we decide to accelerate beyond that, then you'll know after the fact.

Anand Vankawala – Avondale Partners

All right. And then, just one quick follow up on China. I think it was Des that said that there is currently roughly 1,000 clubs in China. I'm just wondering what that was last year, so I can get some type of growth?

Desmond Walsh

It was you know, directionally, you know, our club numbers are still you know, in exact science and on because obviously we are introducing a notification project so that we can get a better handle on this. Probably, I would say about 10% less than that. But again, you know, we hesitate to give exact numbers because – it's not an exact science today.

Anand Vankawala – Avondale Partners

Perfect, thanks guys, great quarter.

Michael Johnson

Yeah, I'd just like to close with a couple of comments. One thing we don't talk about much is our bench strength in this company. And we're really proud, not only of new distributors that are coming into the company but some of the great new young and talented employees in science areas and areas of manufacturing, finance are coming from really the best of class companies. We're seeing an unbelievable migration of strength into our company right now. We're very excited about that. Obviously the developing of new generation of leaders within the company and the distributor base makes us very exciting. So, we've got a great future ahead of us. And I know this is a redundant statement from us, but truly the best is yet to come. And we just want to thank you all for your support and your continued interest in Herbalife. Now we get back to work. Thanks.

Operator

Thank you for participating in today's conference call. You may now disconnect.

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