Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message| ()  

Executives

Michael O. Johnson – Chairman & Chief Executive Officer

Richard Goudis – Chief Financial Officer

Dr. Steve Henig – Chief Scientific Officer

Des Walsh – Executive Vice President

Brett Chapman – General Counsel & Secretary

Analysts

Chris Ferrara – Merrill Lynch

Simeon Gutman - Goldman Sachs

Tim Ramey – D.A. Davidson & Co.

Scott VanWinkle – Canaccord Adams

Karen Howland – Lehman Brothers

Rommel T. Dionisio - Wedbush Morgan Securities

Douglas M. Lane – Jeffries & Company, Inc.

Herbalife Ltd. (HLF) Q1 2008 Earnings Call May 2, 2008 11:00 AM ET

Operator

Good day ladies and gentlemen and welcome to the first quarter 2008 earning conference call for Herbalife. On the call today is Michael Johnson, the company’s Chairman and CEO; Rich Goudis, the company’s CFO; Dr. Steve Henig, the company’s Chief Scientific Officer; Des Walsh, Executive Vice President; 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

Before we begin and as a reminder during this conference call comments may be made that include some forward-looking statements. These statements involve risks 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 forward-looking statements and our business.

In addition, during this call certain financial performance measures may be discussed that differ from comparable measures contained in our financial statements prepared in accordance with U.S. Generally Accepted Accounting Principles referred to by the SEC 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 www. Herbalife.com to find our fourth-quarter press release containing a reconciliation of these measures.

I’ll now to turn the call over to Michael.

Michael O. Johnson

Good morning and welcome everyone. This has been an interesting week as you all know but I am incredibly pleased to report another record quarter of results. In our first quarter we achieved net sales of $604 million reflecting an increase of 19% over the first quarter last year. With this top line performance we’ve now had 17 consecutive quarters of double digit sales growth. I think you know this but 80% of our sales are international. Excluding a currency benefit of 710 basis points we had double digit sales in the quarter of 12%. Our net income was a record $62.4 million in the quarter an increase of 36% driven by strong sales growth, expansion in operating margins and a lower effective tax rate. We generated $63 million in cash from operating activities an increase of 36%. We reported diluted EPS of $0.93 reflecting an EPS growth rate of 52%.

Our operating margins expanded 53 basis points. Our balance sheet improved as we paid down $30 million on our credit facility. Our leverage is now less than one times anticipated 2008 EBITDA. Financially our company is frankly, it’s just never been stronger. The fuel behind this tremendous performance is the hard work and the teamwork of our Distributors and employees. Our Distributors’ adoption of DMOs that promote daily consumption of our products continues to transform the company creating a much stronger foundation for our future. The evolution of the Nutrition Club model in the Commercial and Central Clubs expansion of this DMO from Mexico into the US, Taiwan, Russia and Brazil just to name a few continues to demonstrate the strength of this wonderful business opportunity.

Our recruiting is up. New sales leaders in the first quarter increased 10% compared to last year. Without China new Supervisors grew 6%. And we see double digit growth at all levels of the marketing plan. All of this demonstrates continued momentum in our wonderful business. Our relationship with the Distributor leadership has never been stronger, it’s never been better. During the quarter our management team had numerous opportunities to work and interact with our Distributors. Let me provide you with some of these highlights.

As we mentioned in our last call in February we hosted two extravaganza events in South America in Buenos Aires, Argentina and Caracas, Venezuela. We touched and interacted with over 20,000 Distributors. In March we connected with 20,000 more Distributors as part of our Asia tour through several cities including Hong Kong, Taipei, Tokyo, Shanghai and Seoul both to meet our Distributors and to participate in the Los Angeles galaxy exhibition games. Our Asia travels culminated in Singapore where we held our annual Herbalife Honors and Mark Hughes Bonus Event Award. We had a full day session with our Founders Circle and Chairman’s Club where we discussed ways to take Herbalife to the next level and to reach our goal of $5 billion in retail sales.

On Sunday evening in Singapore we had the pleasure of awarding a record $34 million in the Mark Hughes bonus the largest check was a record breaking $2 million. The top seven checks exceeded $1 million each. Some investors attended this event. For those who were not there let me say this was one incredible evening. As part of the curriculum we asked Distributors to share their big ideas. These are ideas that are helping fuel growth in the Distributor business in many parts of the world. By showcasing our Distributors’ success and showcasing their financial rewards we can cross-pollinate their ideas globally. Let me give you a sense of some of these wonderful ideas.

Commercial and Central Clubs Club owners from South America, Taiwan and the United States shared their stores of how they’ve accumulated and acculturated Mexican nutritional club model to best meet the needs of their community the secrets of success in South America. The Distributor leadership for this fast growing region shared insights on how their unified approach to the business has been a catalyst for sales success. The weight loss challenge this emerging DMO where Distributors recruit people looking to lose weight and organize a challenge where the whole group works with our Herbalife Distributor on customized programs to meet their weight loss goals.

The Internet, this section included ideas how to use the Internet for training to develop an online community and to build more cohesion with an organization and to improve Distributor productivity with our product called Bizworks. Brand activation, this was a presentation on how to leverage Herbalife’s brand building investment in each Distributor’s local community and local business. Examples included the AYSO activation, Distributor led sponsorships including triathlons in the Philippines and soccer club sponsorships in Portugal and there were many, many other examples. We have seen ideas like this drive our business, create growth in the future. And we know that sharing these ideas works. For example and as many of you well know we started the first Nutrition Club concept at a Distributor leadership event like this in 2004. We now have an estimated 40,000 clubs across 40 countries.

We are proud of our first quarter. Not only did we set records again we carried positive momentum from 2007 and we have enhanced it further through the many efforts I’ve just mentioned. Our business, it’s never been stronger. More Distributors than ever, more sales leaders than ever and our financial performance has never been stronger. As you read our financial guidance contained in Wednesday’s press release you can see that I look forward to another record setting year in 2008. Before we go into our business highlights there are two items I’d like to address.

Last week Spain’s Ministry of Health issued an alert about consumption of our products. No specific product or ingredient is named in that alert. In Spain the company sells 48 products including products for skin and hair care such as facial creams, shampoo and soap. The company is in an ongoing discussion with the Ministry and we provided the final section of our dossier on April 23rd the agreed upon date. As we have noted in previous filings from time to time we receive inquiries like this one and we fully cooperate with authorities around the world. No products have ever been pulled, no ingredients have ever been cited that have been of any danger to anyone. We are currently working with the Spanish Ministry of Health and we will continue to work with them to clear this matter.

My second item is much more personal. It was announced this week in our earnings release on April 30th that I accepted Greg Probert’s resignation. Given the company’s unwavering commitment to the highest standards of business ethics the company had no other choice but to accept Greg’s resignation. Today however is a new chapter in Herbalife and I am very pleased to introduce Des Walsh in his new capacity as Executive Vice President of Herbalife. Des and I began his career and my career together at Disney in the successful expansion of the video business and since he joined the company four years ago he’s been crucial and central in developing our unique relationship with our Distributors as well as spreading ideas for growth around the world.

Des and I travel globally together, he is on almost every trip I have ever taken in this company. Our Distributors are the key to our success and Des is known and respected worldwide for his Distributor relationships and his leadership. Des has served as Senior Vice President of the Worldwide Sales since he joined the company. In addition to his current responsibilities for sales strategy, business development, corporate events, call center and Distributor services in worldwide promotions the company’s five regional managers will now report to Des as will additional key functions in support of Herbalife’s independent Distributors such as Corporate Marketing services and alliances. That’s a big plate but this man’s up to the challenge.

Des has extensive international business experience gained during his 20 year career in sales, marketing and executive management. You’ll hear it in his accent, his worldliness is unprecedented. He carries two passports and he’s a tremendous executive.

Now I’d like to turn the call over to my new partner, Des, who will give you insights into our business highlights and update you on our regional markets.

Des Walsh

Before I start with my prepared remarks I’d just like to congratulate our Distributors and employees for the records they set during the quarter and most importantly for their unity and teamwork which have created tremendous excitement and positive momentum in our business. Let me share some insights now on business trends in key markets including the US, Mexico, Brazil and China.

The US market remains our largest market and grew 14% versus first quarter 2007 and grew 8% sequentially from fourth quarter 2007. This was in line with our expectations. The Latino portion of our Distributor base continues to be the catalyst for growth. In the first quarter 2008 Latino volume points represented 62% of the total for the market up 24% from first quarter 2007. Looking forward we see continued penetration opportunities for this market as the top 25 metro areas in the US are up 33% growing at a faster rate than the total Latino market. As expected, sales were down 6% in our non-Latino group. The decline in this part of the business reflects a slowdown in the Internet sampling DMO as well as Distributors making a transition to a daily consumption model via Central and Commercial Clubs which as we know is a strong retail method that leads to enduring growth and like the Latino market we see continued penetration opportunities as the top 25 metro areas are up 6% demonstrating continued growth despite the softness across the full US non-Latino market. In fact among the top 25 markets in the US volume is up 26% growing at a higher pace than the total market which is up 11%.

Focusing on deeper penetration across the US market continues to be a priority. If the US market could attain the penetration of Los Angeles our US business would exceed $1 billion. In the quarter there were over 9,000 new Supervisors across the region and for the US new Supervisor growth was 1% and as we mentioned in our call in February the retention rate for the US gained 30 basis points which is a very healthy indicator as we had through 2008. For the rest of the year key initiatives for the US include activation of the AYSO sponsorship and opening of sales centers in Chicago, New York and Northern California and as part of the bifurcation of the US business we’re developing plans to support the separate needs of our Latino and non-Latino Distributor audiences.

We have recently named [Eddie Heinrich] to head the non-Latino business in the US. Eddie is an 18 year Herbalife veteran who has a track record of growth as the region head for the Southeast Asia markets and with the South America markets prior to that. Key initiatives for the non-Latino segment include the college sampling initiative which launched in April and an African-American initiative that will start in second quarter 2008. Across the whole US there has been a lot of Distributor energy behind a series of 12 leadership development weekends that took place in April. More than 8,000 Distributors received inspiration and training on many topics including Central and Commercial Club DMO as well as the emerging weight loss challenge DMO. Looking forward we believe that the US market will continue to grow in the double digit range but at a slightly decelerated pace as they comp against the 20+% growth they’ve had over the previous fixed quarters.

Now on to Mexico, Mexico’s net sales were essentially flat versus first quarter 2007 with sequential improvement from fourth quarter 2007. Looking at volume month-by-month Mexico showed volume gains in both January and February with softness in March. One reason for the softness was the Easter holiday falling in March in 2008 versus April in 2007. Without this change we would have had positive year-over-year comps for the quarter. More importantly I’d like to highlight the new Supervisor trend. Mexico posted a 6% increase in new Supervisors this quarter. This is the first growth in the new Supervisor metric since fourth quarter 2006 and this is an important metric to demonstrate that the market can be headed back towards growth. In the second and third quarters we’ll be working against tougher comps in the new Supervisor metric. The Club of Clubs Challenge is slated to begin in the second quarter and we see this as an important promotion to accelerate growth in both the new Supervisor metric and net sales in the back half of 2008.

Now on to Brazil, Brazil had net sales growth of 7% for the quarter. Looking at volume points the market was down 2%. This is a strong improvement compared to trends through 2007 and in 2008 monthly trends showed continued improvement in February and March versus prior year as this market continues to convert to a daily consumption model. Among those Distributors who have been using the Nutrition Club DMO for more than a year sales were up 21%. This growth is very encouraging and leads us to believe that the concept has been acculturated and Distributors have figured out how to replicate the model. More importantly volume from Distributors who’ve adopted the Nutrition Club DMO now represent 23% of total volume in the Brazil market. We remain encouraged that our Distributors are having success with Nutrition Clubs and we are optimistic that this market will return to volume growth in the back half of 2008 behind this strong model.

China, the China market had net sales growth of 112% in the quarter. The market continues on the run rate we projected during the fourth quarter conference call of $100+ million in net sales for 2008 which would indicate a 33% growth rate. We do not yet have updates on the five direct selling licenses in review with the Chinese government but let me reiterate that we are optimistic that we will receive those licenses. We continue to work with the central government for their approval. Once received, the addition of these five licenses will expand the reach of our direct selling audience from 85 million to 350 million people. We have continued to develop our retail based operations with 88 stores across 29 provinces in China. Since the end of 2007 we have closed two stores as part of our real estate strategy and plan to be back to 90 stores by second quarter 2008. The objective behind our real estate strategy in China is to operate in the best locations for our sales representatives and sales employees, optimize retail investments and meet government needs regarding retail visibility and representation from product return.

Now I’ll turn over to Rich for an update on the financials.

Richard Goudis

Let me briefly walk you through the first quarter financial results that were contained in yesterday’s press release. I’ll also provide financial guidance for the second quarter of 08 and revised guidance for the full year of 2008. Then we’ll open up the call for your questions.

Net sales of $604.4 million in the first quarter were up 19% versus the first quarter of 2007 reflecting strong volume across many of our markets coupled with 10.4% growth in new sales leaders. FX had a 710 basis point favorable impact during the quarter reflecting the global nature of our business. On a reported basis gross profit in the first quarter was $486.8 million or 80.5% of net sales. This is an increase of 165 basis points compared to the first quarter of 07. The difference was primarily the result of foreign currency fluctuations coupled with country mix.

We’ve been receiving several questions regarding the impact of hard commodity costs on our business so I’d like to address this point proactively. While we are seeing cost increases on many commodities on items such as soy, dairy products, resin and transportation our hope is to continue to mitigate those costs going forward by implementing price increases in select markets, couple with the pursuit of cost savings initiatives. We do anticipate a 60 basis point degradation in cost of goods over the balance of the year from where we performed in the first quarter again primarily due to commodity cost pressures.

Royalty expense in the first quarter was $212.7 million or 35.2% of sales reflecting an improvement of 28 basis points compared to last year. Normalized for China sales employee expense which as you know is recorded in SG&A the royalty rate was essentially flat at 38.5% of sales. On a reported basis first quarter SG&A was $184.4 million or 30.5% of sales. Again normalizing for the China sales expense SG&A expense would have been $173.5 million or 28.7% an increase of about 12 basis points versus last year. The increase primarily reflects investments in Distributor events and promotions coupled with a higher cost as a result of the weaker US dollar.

First quarter operating income was $89.7 million or 14.8% of sales on a reported basis. When adjusting for certain items in the first quarter of 07 the increase was 53 basis points. First quarter interest expense was $3.8 million versus $2.2 million in the first quarter of 07. The increase primarily reflects higher average net debt balance as we utilize our revolver to repurchase stock and invest in the business. The weighted average interest rate on our debt was 4.07% as we exited the first quarter versus 6.82% in the first quarter of 07. On a reported basis our first quarter effective tax rate was 27.4% primarily due to country mix reflecting the global entity structuring and planning of Herbalife. Net income on a reported basis was $62.4 million in the quarter an increase of 36.4% compared to the adjusted first quarter 2007 adjusted net income. First quarter diluted earnings per share was $0.93 compared to $0.61 on an adjusted basis in the first quarter of 07 reflecting an increase of 52.1%.

Now let’s turn to the balance sheet. We ended the first quarter with $191 million in cash and $337 million in outstanding debt. We were successful in reducing inventory by about $2 million since December and in terms of efficiency our days on hand improved 12 days to 108 from December and our inventory turnover was 3.36% versus 2.91% in the first quarter a year ago. In the quarter we invested $25 million in capital expenditures primarily in support to improve customer service and significant investment of our Oracle ERP system. As a brief update on our Oracle rollout the team completed a successful first quarter milestone as planned and to us the plan was on time and on budget.

We are providing second quarter guidance for the first time and we are raising our full year 2008 net sales growth and EPS projections. For the first quarter we expect top line growth rate to be in the range of 15% to 17% and diluted EPS to be in the range of $.089 to $0.92 which reflects an effective tax rate in the range of 29.5% to 30.5%. Based on current business trends we are also raising our outlook for 2008 as Michael suggested. We now expect top line growth to be in the range of 13% to 15% up from 9% to 11% which we initially guided in February and full year diluted EPS to be in the range of $3.52 to $3.57 an increase from the $3.25 to $3.30 which we also guided in February which reflects an effective tax rate of 30.5% to 31.5% for the full year.

Please note that these estimates that we just provided exclude costs that we expect to incur throughout 2008 associated with our realignment for growth initiative and also accretion resulting from any future share repurchases.

This concludes our prepared remarks. We’ll now open up the call for your questions.

Question-And-Answer Session

Operator

(Operator Instructions) Our first question comes from Chris Ferrara – Merrill Lynch.

Chris Ferrara – Merrill Lynch

Can you talk about the gross margin expansion in the quarter, Rich? I know you’re saying its FX drive, country mix but that doesn’t seem to be new this quarter unless I’m missing something. What was the incremental factor that happened in the quarter relative to the last couple that we’ve seen?

Richard Goudis

Chris, I think the material part again was FX because the dollar continued to weaken throughout the course of the quarter and obviously you saw in the net sales a 710 basis point improvement or contribution from that year-over-year. So I think it’s become a little bit more meaningful but additionally we’ve been taking price increases in select markets. I’ll give you the extreme, Venezuela which is one of our top 10 markets we increased prices 20% in January. We believe our pricing is very elastic but we’re very sensitive to price increases and we work with our Distributor leadership to implement those when at the appropriate times so that’s also been a little bit of a tailwind to us here.

Chris Ferrara – Merrill Lynch

Can you just give a little bit more color on the new Distributor growth rate especially in Mexico? I think you said you’re facing tougher new Distributor rate comps as the next couple of quarters move in. I guess the nature of the new Distributors, are these people that have been in the business before and are coming back into it now that have left the business? Do you have color into that and to help us get a better idea of what it’s going to mean for sales growth going forward?

Richard Goudis

Let me just reiterate the new Supervisor growth rate in Mexico in the first quarter was up 6% and we had not seen an increase in that market given the transition that market went through and the stabilizing initiatives that went in last year, we hadn’t seen an increase since the fourth quarter of 06. I think what Des was articulating was that as Mexico stabilized throughout the course of 07, right, as we progress now through 08 the new Supervisor growth rate becomes a more difficult comp but I think most importantly for us and I think the positive of this, is that new Supervisor growth is a leading indicator for us and again without the Easter holiday having flipped between April and March, we think we probably would have been positive in the first quarter and I think the leading indicator and the signaling I guess in the investment continues we’re looking for very positive things in Mexico as we progress throughout the course of the year from a true volume and obviously net sales growth. So these are the new Supervisors we don’t know necessarily that they were in the business or not before, but these are new people who have come into the business. Primarily these people are Club operators and you know the stickiness and the retention rate of these Clubs which is a very healthy thing for our business with a real focus and balance on retailing, retention and recruiting.

Operator

Our next question comes from Simeon Gutman - Goldman Sachs.

Simeon Gutman - Goldman Sachs

First, Michael how do you weight the reputational benefits from the whole resignation versus the effects that I think Greg had on the business and then related to that, will all of his responsibilities be accounted for by Des? Is he assuming all of it and are you considering at all looking at any internal or other external people to enhance the bench strength from here?

Michael O. Johnson

Greg had a far flung role in this company as you know and the one area that is not going to be in Des’ responsibility is the supply chain management and Rich and I are sitting to work with that. We’ve hired an excellent new head of supply chain management recently and that group is working very hard along with the IT group to implement a new program and a new place there. We’re looking at a lot of options there and Rich and the gentleman he has brought named John Desimone and I and [Shayne] Carr who is the head of supply chain are going to sit early next week and discuss exactly how we’re going to handle that. Right now it’s status quo, it’s working fine, there is no issues but that’s just one area that would be too much to put on Des’ plate with all of the other responsibilities that he has.

On the reputation side, you all know that Greg and I worked a long time together. There’s no way to express the disappointment that both he and I feel about all this. I wish things were different but they weren’t. None of us knew about this issue and it’s terribly unfortunate for everyone in here but I have to run this company on the high road. We set a vision mission in values statement for this company five years ago and many of the people who are sitting with me here helped author that. It’s something we believe in very strongly. I don’t know what the reputational benefits are. I only know how to operate the way I operate and what we have put in place, Simeon, is a philosophy and a practice that integrity rules the day in this company. We have constituencies here, employees, Distributors and investors who are all equally important to us and it’s impossible to make a decision in an ethics or integrity situation with anyone if you don’t make it with everyone.

So you have to be consistent and you have to play the game with the rules the way that you’ve set them out and Greg understood that. Greg and I had a long talk about this last week and he made a mistake and he feels terrible about it, but we have to take the actions and deal with the consequences but we are very, very fortunate to have bench strength in this company and that is a huge accolade to both Greg’s team building and what has taken place inside the company because Des, whether you know it or not and whether anyone on this call knows it, Des has been with us a long time. I purchased a company when I worked at Disney that Des came along with the deal and what we found in there was this incredible executive and he’s been with us ever since and I think, Simeon, you have relationships with Distributors in this company and I invite all of you to go on an inquiry about that because when you query Des’ credentials and his relationship with our Distributors, you’re going to find a gold platinum rating all across the board. There’ll be exceptions because we’re not universally loved but what you’ll find is great performance, great acceptance and the amount of emails that I’ve had in the last couple of days in support of Des have been tremendous. They’ve been heartwarming and tremendous.

We’ll get beyond this. This company’s bigger than an individual. It’s bigger than anyone. So we have a great opportunity to help people change their lives, a great business opportunity. We’re getting bashed around a little bit by some outsiders right now. I’m not worried about that. We have a record quarter. We have great momentum in this company. Our financial fundamentals have never been stronger. Our reputation is going to take us to a higher level. Frankly as sad as the events were last week, and we’re in a new situation and new situations give me energy so I’ve got a lot of energy coming out of this and I’m incredibly excited for Des. Not the circumstances in which it came, but we’ve always had our eye on Des as someone who is going to move up in this organization. He just moved up a little quicker than we expected but he’s ready and I’m excited.

Simeon Gutman - Goldman Sachs

On the topic of Distributors, has the entire Chairman’s Club come together via conference call given some of the short notice? I’m just curious what the reaction is and I imagine given the emotional nature of this business, the energy level is high but any observations you can offer?

Michael O. Johnson

Tremendous support from the Chairman’s Club. We’ve heard from almost every single one of them on email. We’ll be doing a conference call with them next week. We were going to do a call today that we usually do if there’s a situation that we believe that needs dealing with and stuff but the response is so overwhelming that we’re staying with our regularly scheduled call which is next Tuesday. Just so you know we have a monthly conference call with our Chairman’s Club that is at minimum three hours. They can go on. So there’s a lot of ideas that transfer but Des runs those calls and he has for four years. He runs the Chairman’s Club calls. He always has. I work with him very closely on those calls but he runs our Chairman’s Club meetings, he runs our Chairman’s Club calls, he sets the agendas, he does the promotions, he works with the Chairman’s Club, he works every event management with them. He’s got that underneath him so his contact with the Chairman’s Club is more consistent and more frequent than any executive in this company.

Simeon Gutman - Goldman Sachs

Operationally, can you give us an update on the direct to consumer platform that was being pioneered in the South America region? Second of all, on the Internet sampling DMO is that a controlled slow down is that something you just had expected and what’s happening in that arena?

Michael O. Johnson

Let’s start with the Internet, we will be rolling that out in Argentina in late this fall, probably October is what we’re shooting at right now. We have overwhelming support from the Argentinean President’s Team Distributors there to roll this out. We will test it and what we do, Simeon, is when new ideas come across we’re testing something in Russia right now that I don’t want to say too much about, but it’s kind of exciting for us. We’re testing different things in different marketplaces and we pick markets where we think we can isolate the opportunity to have a fair test and then come back to the Distributors and explain our results to them and see if they endorse or do not endorse the strategy forward. As you know two years ago or three years ago we implemented a 12 month re-qualification for non-royalty enjoying Distributors and this has been a tremendous opportunity for us to keep customers into our company, not Distributors building business but customers. So we’ve seen a retention rate of our Supervisors go up quite a bit by this.

We’re testing another idea and it’s based off that in Russia. Again, I’m not going to say too much about it because first of all I don’t want to tip my hat to any of my competitors and secondly, until this test finds its way through we won’t be conclusive in what we’re going to do. So we’re doing the same thing in Argentina with a direct to customer program. We’ve had a lot of different ideas in how this should work and how to make sure there’s no channel conflict with Distributors and it has Distributors’ support. So once we test that and see then we’ll come back to the leaders of the company and say, here, here is what it looks like and that’s the way we operate.

Simeon, I’m sorry. I forgot the other side of your question.

Simeon Gutman - Goldman Sachs

The Internet sampling and the slow down there, whether it’s controlled or expected and what’s going on in there?

Des Walsh

Effectively what we’re doing there is that we’re sitting down with our Internet people and we’re looking at ways whereby we can enhance that growth. In any situation where you’ve got sustained continued growth in an area eventually sometimes you literally level off and we see it as a leveling off but our goal is to [inaudible] these people that have been coming in with this in the next week or so and we’re going to be sitting down with them to work out solutions for restoring growth there again.

Simeon Gutman - Goldman Sachs

Last for Rich, priorities as far as debt paid on share repurchase and I think heading into the year maybe there was a balance or maybe even a thought that debt was probably the right way to go but as much as you can update us on with the shares down here? What are your thoughts?

Richard Goudis

First the facts are we have $65 million remaining in our current $450 million authorization. We had a Board meeting yesterday and I will tell it’s a topic of discussion that Michael keeps alive with the Board as we look forward and especially with the free cash that we anticipate kicking off this year even after a significant investment in the year. We were in a blackout period over the last month or so and as you know in February and March I think we shared this with investors, it’s kind of a peak cash outflow month is that we pay employee bonus, Distributor bonus, quarterly dividend, quarterly tax payments. So I think we’ve gotten through that liquidity issue for those couple months and you saw that where we paid down $30 million in debt even on top of all those payouts so our open period opens on Monday morning and I think we’ll update you accordingly on the second quarter conference call in August.

Operator

Our next question comes from Tim Ramey – D.A. Davidson & Co.

Tim Ramey – D.A. Davidson & Co.

We were talking about the margin leverage from FX and is that related to the fact that a lot of your cost of goods is dollar denominated, that you’re seeing around the world? Can you just expand a little bit on how that works to be margin as well as translation benefit?

Richard Goudis

Tim, nearly 70% of our volume worldwide is actually manufactured in the US. Europe is pretty self-contained with the majority of their volume is actually locally produced so producing in Euro, selling for the most part in Euro. The rest of the world is primarily and without China where we have local production, the rest of the world we produce in dollars and sell in local currencies and over the last couple months obviously the dollar has weakened against most of those currencies. So we saw a significant benefit in our gross profit in the first quarter.

Tim Ramey – D.A. Davidson & Co.

Rich, could you update us on what your currency hedge position is?

Richard Goudis

Let’s start with our philosophy of hedging, is we typically look out a year and we try to protect at least 50% to 70% of our anticipated net income exposure. We use different tools or vehicles and it would probably be safe to assume that those hedges and those forwards what have when it’s in place during March. So effectively any weakness from the dollar from that point on you probably are not going to see.

Tim Ramey – D.A. Davidson & Co.

And Michael, not to beat a dead horse on the share repurchase but the Board has been remarkably prescient on the stock, rejecting a $40 bid last year for the stock and buying the stock very well in the fourth quarter of last year for the company. If it was a topic of discussion was it not a topic of action just because you have the $65 million or can you give us some more detail on that?

Michael O. Johnson

What we did is we discussed it in the Audit Committee very carefully and when we got the general Board discussion we decided to pick it up after the $60 million. We’re going to continue the discussion with them and just as one note, it was $38 that the bid was put in at, not $40. And I agree with you, they have handled themselves very well, our Board has, through all of this.

Operator

Our next question comes from Scott VanWinkle – Canaccord Adams

Scott VanWinkle – Canaccord Adams

Michael, you mentioned how Probert’s responsibilities are being assigned. What about the responsibilities or I should give this directly to Des, what about Des’ responsibilities prior to taking on the incremental role?

Michael O. Johnson

As I said, Des has got a full plate right now. I’m going to let him address that. We foresaw this issue very early, not early but just over the weekend, Des and I have spent a lot of time together and discussed this through the beginning of the week and we are reorganizing. He’s reorganizing his group and taking some responsibilities and moving it around. Fortunately he inherits, and I should let Des speak this, a very capable group of executives who in Greg’s style was to put very high quality people in and let them run. So there wasn’t a lot of day to day oversight on these people so there wasn’t hours and hours spent every single day dealing with Wynne Roberts or dealing with Bill Rahn or Anita in Mexico. The styles are a little bit different. I actually think Des will probably be a little more consistent with the communication. I don’t mean that in a negative way in any way, but he’ll probably be a little more up close and personal with them. So Des I’m going to drop that in your lap.

Des Walsh

Here’s the situation, Scott, we’ve actually had initiatives in the company for quite some time whereby individuals identify their successors. So we actually have a succession plan in place for all key positions and in this instance, although obviously the change was unexpected and sudden, rest assured that I’m already having discussions with people who I had identified as potential successors and we’re going to have a very smooth transition.

Scott VanWinkle – Canaccord Adams

On the Easter shift, talking about certainly the Hispanic side of the business and I certainly understand that Nutrition Clubs will be negatively impacted by Easter falling into the month of March but I wonder about the rest of the business that’s not a daily consumption type of model where you have a repeat, monthly reorder type of business. I wonder is there any impact on that side of the business from an Easter shift and what do we see coming into April when we have a favorable comparison?

Richard Goudis

Scott, if you’re specifically talking about Mexico, as you know the majority of the Mexican business has converted over the last few years to the Club model. So we would probably say somewhere near 70% to 75% of the business is Club oriented at this point in time. We’re looking at April trends and I would say that obviously our guidance and the move up in guidance reflects the positive trends we’re seeing.

Scott VanWinkle – Canaccord Adams

I was speaking more specifically to the US where I guess almost 40% is non-Hispanic. Did you see the same type of impact in March on that business?

Richard Goudis

No, I think Des had a good comment when he talked about the penetration opportunity. We’re going through a major conversion in that non-Latino business and I think the indicator that it’s starting to work is by looking at the top Metro markets I think Des indicated that that market for the non-Latino was actually up 6% where the rest of the market or the overall non-Latino was down. We’re still seeing the beginning of success much like we are seeing in Brazil that as these folks convert their business model they’re able to post very strong numbers.

Scott VanWinkle – Canaccord Adams

Rich, on your tax rate guidance is that a cash tax rate or just an accrual just from the standpoint of getting an idea of free cash flows?

Richard Goudis

No, use it as a cash tax rate, Scott.

Operator

Our next question comes from Karen Howland – Lehman Brothers.

Karen Howland – Lehman Brothers

I was wondering if you could give an update. I know you now have the direct selling license in the Jiangsu province. I was wondering if you could talk at all about how trends in that market of China have compared to the rest of the Chinese market where you just have the retailing?

Richard Goudis

Karen, for obvious competitive reasons we have not articulated any particular region’s velocity or growth rates. It might be something we consider as we get more broadly distributed with direct selling licenses across many of the markets but it’s something that for competitive reasons we choose not to share.

Karen Howland – Lehman Brothers

Is it reasonable to think that it’s accelerating faster or you just don’t want to comment at all?

Richard Goudis

I think it’s reasonable to assume it’s growing at a very strong clip. Obviously the direct selling licenses allow the employees to sell away from a fixed location which you could imagine gives them potentially more upside.

Karen Howland – Lehman Brothers

Also I was wondering if you could talk a little bit about the growth that you saw in South America? I know there are several markets, Peru, Bolivia that are relatively new markets and presumably sitting it a significant ramp up, I was wondering if you could talk at all how much of that growth was in fact new markets compared to existing markets seeing continual growth?

Richard Goudis

Let me start with the first, there was no new markets opened in South America so it’s all organic in that regard. I think obviously we’ve had some very strong growth in Venezuela, Bolivia, both triple digits but I think the underlying which really helped us is that Brazil continues to improve probably a little bit faster than we had articulated over the last six months and I’ll give you just one fact point. If you look at the growth rate and I think Des spoke to this but in volume point terms we were down 2% in the first quarter. But that’s a significant improvement where in the fourth quarter we were down 16% and in the third quarter last year we were down 18%. So we’ve gone in just the last three reporting periods from down 18%, down 16% and down 2%. So clearly there is a strong momentum building in Brazil and I think it’s really reflecting the conversion to Clubs where I think that group was up 21% in the quarter. I think it’s a really well balanced story throughout South America.

Karen Howland – Lehman Brothers

And then the SG&A growth that you saw this quarter, I know a lot of that was based on extravaganzas that you’ve had in place. Do you expect it to continue to grow at a similar rate throughout the year or do you think the first quarter was a little bit higher than your normal run rate?

Richard Goudis

I think the FX impact which is about a third of let’s say the dollar growth rate will continue. The lumpy part is event related and we did invest significantly in the first quarter in events so that was a little bit lumpy. You can check with [Erin] if you’d like to better dial in your model as far as the lumpiness and timing of events and then the last third was some of it was timing but some of it was also increases as it relates to overall inflation, etc.

Operator

Our next question comes from Rommel T. Dionisio - Wedbush Morgan Securities.

Rommel T. Dionisio - Wedbush Morgan Securities

A couple months ago you guys had talked about the plan to maybe move some of the production from Europe to the US given some of the [crunchy] moves now I guess that’s offset by increased freight costs given the way oil prices are but could you just talk about where you are with that plan and if you’re still thinking about going forward with that the second half of this year.

Richard Goudis

As Michael indicated earlier we have a new Senior Vice President of Global Operations and he is leading a team right now that is looking at a global strategy for our not only product sourcing but also distribution transportation warehousing looks like all the way to landed cost. So that project is anticipated to conclude in June. Concurrent with that we are looking at different initiatives that will help us accelerate reducing our landed costs. I think more to follow but I think directionally we’re looking to get potentially more vertical in our supply chain, control costs better and also control quality in our intellectual property and I think we haven’t changed from that message in the last year or so.

Rommel T. Dionisio - Wedbush Morgan Securities

On top of that, Rich, assuming you come to some decision in June would that be an 08 event or 09?

Richard Goudis

Potentially. We’re very opportunistic. We have a very strong balance sheet with cash available to invest so we’ll look at very opportunistically, Rommel.

Operator

Our next question comes from Douglas M. Lane – Jeffries & Company, Inc.

Douglas M. Lane – Jeffries & Company, Inc.

Rich, to follow up on the previous question from where you sit today, do you expect SG&A to be higher or lower as a percent of sales this year?

Richard Goudis

Probably as a percentage of sales at about last year, maybe a little bit of improvement. Over the last couple of years the majority of our leverage and improved leverage in the business has come out of SG&A. I think that we’re on that trend with the exclusion that the strong FX benefit we’re seeing at the top line is mitigating some of that leverage in the SG&A line at this point in time. That coupled with continued strong growth, triple digit growth, in China.

Michael O. Johnson

I’m as you know the big pusher on the margin door. Both top line and bottom line are sacrosanct with me, volume and margin. I think our SG&A still needs some work, we will continue to push very, very hard on that door.

Douglas M. Lane – Jeffries & Company, Inc.

I understand that those are pressure points.

Michael O. Johnson

Rich is good, he’s always cautious. I’m going to be a little more bullish on that.

Douglas M. Lane – Jeffries & Company, Inc.

What do you look for for interest expense this year, Rich?

Richard Goudis

Doug, I think you can use the 4% to 4.5% and then assume some kind of, as far as an effective rate, given where LIBOR is, etc. and I think you can, depending on how your models work and if you assuming that we’re paying down debt obviously you can take down our net debt balance accordingly or you assume, I don’t know what your model is assuming as far as buy back and what have you. Use 410 to 425 as en effective rate and I think you’re going to be close.

Douglas M. Lane – Jeffries & Company, Inc.

Michael, on previous calls you had talked about formulating a more detailed strategy for Eastern Europe and Russia and I wondered A) where does that stand and B) does Greg’s departure impact the timetable?

Michael O. Johnson

Greg’s departure does not impact that. It’s firmly in Wynne Roberts’ camp there and we have as you may have heard earlier we are testing something in Russia right now and again I’m not going to say what that is, I’ll just tell you we’re running a test on something. Our Eastern European numbers are picking up where Russia is up 64% right now. Poland is up 55% so we’re seeing some aggressive growth in those areas. We’ve got an excellent new General Manager that we put into the, she’s based out of Poland for Eastern Europe. Very, very excited about having her on board and so, Doug, nothing has changed there other than the growth.

Douglas M. Lane – Jeffries & Company, Inc.

And then lastly, Rich, can you update us on the Oracle conversion and in that context what you look for for capital expenditures in 2009?

Richard Goudis

Let’s just walk through, it’s our major cap ex investment this year, let’s say maybe even half of our capital expense that’s in our guidance is Oracle. We have major milestones coming up. Right now the US, Peru, Canada are all on Oracle. Mexico and Central rolls out at the end of June. So by the end of June 50% of the business is on Oracle. In September Oracle rolls out into South America, in November it rolls out into Asia with the exception of China and then we take a hiatus, get through year end, get through our Distributor recall and then in March of 09 we roll out the Oracle platform into our EMEA market. So I think where the acuteness of spending really from here is over the next 12 months and I would think it tapers off significantly after March, April of 09.

Douglas M. Lane – Jeffries & Company, Inc.

So full year 09 should be meaningfully less than full year 08?

Richard Goudis

Exactly.

Operator

Our next question comes from Chris Ferrara – Merrill Lynch.

Chris Ferrara – Merrill Lynch

Can you guys talk a little bit about what kind of penetration assumptions that you’re using for the US to get to continued double digit growth? I understand if you use LA’s penetration level that it’s going to be a pretty big number but how are you thinking about both the Latino and the traditional demographic?

Richard Goudis

Chris, we look as you know, we talk volume points per capita and that’s kind of our benchmark and we talk it internally and we actually talk it with our Distributors so I don’t want to disclose to you what we believe what the opportunity is. Suffice it to say that the data that we did share with you where we look at our top 25 metro markets, I think that’s indicative that in both cases, both the Latino and the non-Latino respectively, the growth in our 25 top metro markets is stronger than the growth nationwide. So suffice it to say that we think not only is there ongoing penetration opportunity in those top 25, but more importantly, probably even more penetration opportunity outside of the top 25 and that’s why issues like AYSO are significantly important to us because they’re such broad reaching and gets us into so many small markets. From that I’ll pass it over to Des if there’s any other color on that matter.

Des Walsh

Chris, as you know this is a business based on confidence and excitement so within our non-Latino group our key focus now is on the metro markets that are up 6% and what we do essentially is that we highlight the activities, the DMOs, the things that our Distributors are doing in those markets so that those Distributors in those parts of the countries which are down at the moment, that they can look at those markets and say, wow, you know something? It’s not an overall US situation. It’s not an overall non-Latino situation. There are areas and markets within the non-Latino community where there’s growth and as we get them, then we encourage them to adopt then that same philosophy and derive their confidence from that. So that’s why that’s essentially what we do around the world, it’s been a consistent formula and obviously we’re supplementing that with some of these new emerging ideas that are creating such excitement and specifically the adoption of Commercial and Nutrition Clubs with why our non-Latino Distributors and then this other new emerging idea that we’re very excited about called the Weight Loss Challenge.

Chris Ferrara – Merrill Lynch

Can I just ask again about the South American region? Given that for the quarter I guess it contributed about 55% of your local currency top line growth and obviously three big standout markets you called out in the release Venezuela, Bolivia and Peru. Can you give a little context around how big those markets are and how much of the growth of the region those three contributed?

Richard Goudis

Of those markets the only market of those that’s in our overall company top 10 is Venezuela. I think from that standpoint I think Venezuela’s net sales were just about $25 million. Actually then Brazil, Brazil was about $36 million. So those are the two driving markets from a volume standpoint. But again Bolivia, Bolivia was up triple digits obviously from small base but up triple digits and Peru, which we opened a year ago, was up also triple digits. Again less than half the size of let’s say a Venezuela market but still very good balance if I look at Argentina, Bolivia, Chile, Colombia and Peru, let’s say they’re all less than $12 million but it’s a horse race and I think our leadership does a great job of distributing a lot of the great DMOs down there so there’s tremendous balance and it’s a very strong unified leadership. I think that’s what’s really the success story in South America.

Chris Ferrara – Merrill Lynch

I’m sorry if you said this before, but what’s the DMO that’s prevalent in those high growth markets?

Des Walsh

The wonderful thing about what’s happening in South America is that it’s based on all DMOs, there is no one single DMO that’s driving the growth. In fact for those of you who are in Singapore, we actually have a training session which we refer to as the Secret of South America and we had four of our Distributor leaders all from different markets represent the pillars upon which the growth in South America has based and one of those pillars was that with respect for all DMOs and what they trained on was the fact that everything works as long as the Distributors are working. So that’s the key message of South America, that message is that everything works and secondly is that unity is the key to success and it was really interesting because we actually have a very successful Herbalife Family Foundation auction where we raised about I think about.

Michael O. Johnson

I’m going to steal this one from Des because actually Doug and I were standing next to each other when we conjured this idea up and at the Herbalife Family Foundation we decided to auction off it’s what we call the Four Tenors, there’s four President’s Team members in Latin America and now they’re Chairman’s Club members, two of them are Chairman’s Club members or three? Two or three? Two are Chairman’s Club members and they got together and basically said we have to unify the Latin American team. So we set up a calendar, we set up a program and we look at actual results and embrace all business methods. There was an auction of these four people going around the world, that they would come to your market and work with your leadership. These are four Distributors and what did we get for that?

Barb

Specifically for that?

Michael O. Johnson

You don’t want to say what they got for that? Barb won’t say what they got, but we got a lot of money for that. It was the largest auction item of the night, I think it surpassed actually something with me so that was an egotistical downfall for me, but I was very proud to see our Distributors get so excited about that, generate the charity but also generate to building our business. It’s very exciting what’s taking place there.

Chris Ferrara – Merrill Lynch

Just a quick follow up to those comments, what’s the direct selling market like in those high growth countries? Is this a live vibrant large market and are you just relatively new entrance to it and how much did your marketing activity play a role in that enormous growth that you saw near term?

Des Walsh

Chris, there’s no one single factor. It’s all the building blocks. I think you start obviously with a tremendous Distributor leadership that we have in that region which is just extraordinary, then you add the unity that they have, you add the broad based DMOs and then you throw in things like the addition of the galaxy because as you know soccer is a huge issue in that part of the world so the visibility, the confidence in the name Herbalife. All of those things played a factor. Those markets are strong markets for direct selling but I think in the vast majority of them with the exception of Brazil we probably are top of the group in that. Overall I think it’s just a combination of all of those factors that have led to the extraordinary growth.

Richard Goudis

Kevin, why don’t we take just one more question as we’re approaching an hour on this call.

Operator

Our next question comes from Karen Howland – Lehman Brothers.

Karen Howland – Lehman Brothers

Just one more follow up question just so we wouldn’t be surprised in the second quarter. I know the second quarter of last year North America was exceptionally strong as far as growth, up 30% or so. Second quarter growth in North America, is it reasonable to assume that it’ll be lower than that 13.5% growth that we’re seeing in the first quarter?

Richard Goudis

I don’t know if I would say it’s reasonable to assume that. I think our guidance reflects a double digit, mid-teensish type of year for North America and specifically the US. We don’t want to get into one quarter at a time.

Michael O. Johnson

Are we through with questions?

Operator

Yes, we have no further questions.

Michael O. Johnson

I want to just thank everybody for being on this call. Obviously this has been an emotional week for the leadership of this company and for this company itself. But there’s an old Mark Hughes saying that the more interesting the situation, the bigger the problem, the bigger the opportunity for a bigger a check in this company and our Distributors are incredibly resilient to change. They are opportunistic, they are unbelievably positive. They have already come together. Just on this call, I’ve got my email in front of me. I’ve gotten four more Chairman’s Club members, incredible support emails towards Des, towards the company, the confidence that they have in what’s going on. We have incredible top line growth. You know my two fanatasisms in this company are volume and margin. Our top line growth is unprecedented. Our profitability is unprecedented. Our financial strength by accelerating new leader sales trends, global business with a currency tailwind that’s happening in our company, this is a tremendously good business model in spite of any outside skepticism. We continue to drive margin expansion. It’s a model that generates tremendous free cash flow which allows us to optimize our capital allocation. This company will continue with strength, we will continue with momentum, we will continue with courage. We’re helping people lose weight, live healthier, more active lives and the world is an opportunistic market for us right now.

I’m confident about our future, I’m excited about the prospects of Herbalife today, tomorrow and deeply into the future. We have a dedicated team here of great bench strength and I just want to thank you guys for your support. I think our value right now in the marketplace is unprecedented. Thank you all very much. We continue to work for you for your shareholders, for our Distributors and employees with great enthusiasm. Thank you.

Operator

Ladies and gentlemen, this does conclude today’s presentation. You may now disconnect.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: Herbalife, Inc. Q1 2008 Earnings Call Transcript
This Transcript
All Transcripts