Herbalife's (HLF) CEO Rich Goudis on Q2 2017 Results - Earnings Call Transcript

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About: Herbalife Ltd. (HLF)
by: SA Transcripts

Herbalife Limited (NYSE:HLF) Q2 2017 Earnings Conference Call August 1, 2017 5:30 PM ET

Executives

Rich Goudis - Chief Executive Officer

Des Walsh - President

John DeSimone - Chief Financial Officer

Alan Quan - Vice President, Investor Relations

Analysts

Tim Ramey - Pivotal Research Group

Mike Swartz - SunTrust Robinson Humphrey

Doug Lane - Lane Research

Beth Kite - Citi

Ivan Feinseth - Tigress Financial

Tim Ramey - Pivotal Research Group

Operator

Good afternoon. And thank you, for joining the Second Quarter 2017 Earnings Conference Call for Herbalife Limited. On the call today is Rich Goudis, the Company's CEO; Des Walsh, the Company’s President; John DeSimone, the Company's CFO; and Alan Quan, the Company's Vice President, Investor Relations.

I would now like to turn the call over to Alan Quan to read the Company's Safe Harbor language.

Alan Quan

Before we begin, as a reminder, during this conference call, comments may be 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 today's earnings release, and our SEC filings for a complete discussion of risks associated with these forward-looking statements in our business. We do not undertake any obligation to update or release any revisions to any forward-looking statement, or to report any future events or circumstances, or to reflect the occurrence of unanticipated events, except as required by law.

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 Securities and Exchange Commission as non-GAAP financial measures. We believe that these non-GAAP financial measures assist management and investors in evaluating our performance and preparing period-to-period results of operations in a more meaningful and consistent manner, as discussed in greater detail in the supplemental schedules to our earnings release.

Please refer to the Investor Relations section of our Web site, herbalife.com, for additional supplemental information and to find our press release for this quarter, which contains a reconciliation of these measures. Additionally, when management makes reference to volumes during this conference call, they are referring to volume points.

I'll now turn the call over to our CEO, Rich Goudis.

Rich Goudis

Good afternoon, everyone. In my first few months as CEO, I couldn’t be more encouraged and confident about our future as a premier global nutrition company. I’ve had the opportunity to travel to some of our key markets recently to meet with our distributors, almost 55,000 in total, in Thailand, India, Hong Kong and the U.S., as well as employees from around the world to share our purpose and vision for the future. Listening to the success stories of our distributors, seeing their enthusiasm and witnessing their passion and dedication for improving their communities and making the world healthier and happier, motivates us and provides us with confidence in our future.

Before I share with you initiatives that are underway and we are really excited about, let's first review our second quarter results. While our bottom line performance was better than expected, our top line performance was lower than we’re accustomed to delivering. Specifically, Q2 volume declined 8% as compared to the same period last year, largely due to our results in the U.S., Mexico and China. While we anticipated the results in the U.S. and China, Mexico's volume finished lower than expected. John will give greater detail about this and other financial information later on the call.

While our volume trends are softer than expected, we have and we’ll continue to have a keen focus on delivering the bottom line. As a result, reported and adjusted diluted EPS was $1.61 and $1.51 respectively. Net sales of $1.1 billion represented 5% decline on a reported basis and 3% decline on a constant currency basis compared to this quarter last year. While we’ve had year-over-year currency headwinds versus prior quarter and years for quite some time, the impact is becoming less material to our business. And if the current rates hold, we could see a year-over-year currency benefit as early as the fourth quarter this year.

As we said for the past few quarters, 2017 is a year of transformation for our Company. As those of you who have followed us for a while know, we have gone through similar transitions in recent years and the short-term volume softness we experienced this past quarter is typical when our distributors shift their attention from building their businesses to a temporary acute focus on learning new tools and procedures, and business techniques. We saw a similar situation in many markets as recently as late 2014 and early 2015 when we implemented enhancements to our worldwide marketing program.

During that implementation time period, we experienced a temporary decline in volume, which was then followed by accelerating growth rates and led to record volume in 2016. In fact, last year’s second quarter was a record high volume, both worldwide and in the U.S., reflecting what is possible and what is expected when our distributors focus on growing their businesses.

We want investors to know that during periods of transformation the behavior and order patterns of our distributors are less predictable similar to what happened in late 2014. During this current transformation period, we will continue to hold back or defer expenses not directly tied to driving revenue growth. With that said, we are confident in our plans to return to growth and expect sequential improvement in trends later this year. As you know for the past 12 months, our North American distributors and many of us inside the Company, have focused on implementing changes in the U.S. required by the FDC order. Making sure we could perform under the order was our most important priority. Since going live with the order in May, we’ve successfully demonstrated our ability to operate under newly established rules and that success provides our distributors and management with the confidence to get back to what we do best, running the business and increasing sales.

As we enter the second half of 2017, we are entering into a new chapter for the Company. Internally, we’re calling it the pivot. We’re leading a conscious effort to shift the mindset of our distributors and our organization, building on the successful implementation of the SEC agreement in second quarter, implementing new technologies to leverage the vast amounts of new customer information that we’ve never had before and putting all these distractions behind us to focus on growth.

Having several months of success under our belts gives us confidence from a metrics perspective, including exceeding the 80% threshold. And what's even more exciting is that distributor attitudes and engagement in the U.S. are extremely high. We witnessed this renewed level of activity first hand at our North American extravaganza last month in St. Louis, which was attended by approximately 21,000 distributors, as well as many of our top investors. When support and take away from this figure is that all the attendees were business builders. We know this because we segmented distributors and preferred members earlier this year, and we now have over 440,000 preferred members in the U.S. and only distributors were allowed to attend this event. And at this one event, we welcome additional 7,000 new distributors to our Company.

History tells us this type of contiguous enthusiasm emanating from our North America distributors has a positive effect on our leaders around the world and we anticipate that their leadership will be an important catalyst for growth in the coming months. I'm highly confident that we remain strategically well positioned in a global marketplace. We've talked about global megatrends on previous calls, so I won't repeat all of them again today, except to bring your attention to a new study in a New England Journal of Medicine. And our recently published study had indicated one-third of the world's population is overweight or obese. They represent almost 604 million adults worldwide. And in the area of extra income, our recent study by Bankrate.com shows over 44 million American adults have a side gig, a way to earn extra money other than their main source of income. Our products, our distributors and our business opportunity, working together, should flourish because of these trends.

As we assess our most recent performance, we recognize a real need for more distributors to help us to take advantage of these megatrends and accelerate our top line growth rate. We recently implemented new programs and promotions to further drive customer and distributor sponsorship and retention. These include new and improved versions of our business opportunity presentation materials and new promotions that encourage consistent and duplicable activity. For example, our data shows that distributor who qualify under our member activation program outperform non-qualifiers in the areas of activity and marketing plan performance throughout their carriers. The same data shows their organizations also performed better than those that don’t participate in that program. We’re also adding a new sponsoring and mentoring reward program to our existing member activation program to stimulate the recruitment of new business builders, focused on attracting and mentoring long-term customers.

Just as nutrition clubs, fit camps, weight loss challenges and wellness evaluations, have become core business building strategies around the world, focus on daily consumption of our products, will continue to globalize best practices and the great ideas that come from our distributors. We recently placed a key executive in China with the intent that he will help to accelerate some of these successful practices that could help stimulate growth in this key market.

Our commitment to education and training will further strengthen what we call our distributor difference. Our distributors have an enviable one-o-one connectivity with their customers, and they also have the last mile into millions of homes around the world. We plan to invest more into that point of sale to further enrich the customer experience. It seems each week we’re reminded a bit downward trend of traditional brick-and-mortar retail. We have a strategic competitive advantage, our distributors, who provide an experience dramatically different than what is found at traditional retail. And we want to invest more behind this unique go-to-market distribution model.

We will soon begin to incorporate the benefit of the robust customer data that we've collected through our new tools and technology. For example, over the past three months, we’ve captured approximately 9 million receipts in the U.S., which has provided us inside into customer behavior that we've never had before. In addition, we're excited to announce a new partnership with Salesforce, the world's number one customer relationship management platform. Salesforce will help our distributors leverage this information to create a more effective distributor experience and a powerful more personalized customer experience. Now, we can enrich the customer experience using proven technologies, and in the process, accelerate growth and better address the ever present and known mega trends.

Using this new technology, we will soon initiate a pilot test in the U.S. before we roll this capability out more broadly next year. But rest assured, the transformation of a digital customer experience is well on its way and it’s greatly enhanced from the data we’re not capturing due to the segmentation of our members, combined with our new receipting tools. Importantly, we will strengthen our distributor difference by putting relevant information into the hands of our passionate distributors, which we believe will further unleash their entrepreneurial spirit. Just imagine, our distributors will be armed with scientifically substantiated products, more prepared education and training content, and innovative proprietary new tools, driven by robust customer data. Combined, this is a powerful competitive advantage for our distributors and our Company, and its only getting stronger every day.

Furthermore, we are accelerating innovation and introducing exciting new products to the marketplace. Products we envisioned, as recently as March, are already coming to market because of our more streamlined new product process and improved development and commercialization efficiencies. In July, we launched the first of its kind Formula 1 evening shake in Russia that will provide consumers with an extra day part consumption opportunity. The evening meal shake is designed as a balanced dinner or late night snack when people often overeat. It was named innovative product of the year 2017 in the dietary nutrition category by the National Trade Organization in that country.

The Formula 1 evening shake will launch in Kazakhstan later this month and in Ukraine in September. Offering more consumption occasions throughout the day is a key product strategy for us, and this evening shake further expands our efforts that began last year with the introduction of our Formula One Nutri Soup in Brazil, and this year in Mexico.

In the area of microbiome health, we also introduced our Simply Probiotic in the U.S. last month. This unique product promotes the growth of beneficial bacteria in the intestines for those who want to maintain a healthy digestive system. This product is especially formulated with GanedenBC30, a patented shelf stable probiotic stream that can survive the acidic gastric passage to germinate any intestine, not in the stomach like so many other probiotics on the market. To offer more choice and appeal to a broader customer base, we plan to launch a variety pack of smaller Formula 1 canisters in the U.S. this fall. The offering will feature three different flavored 10 serving size canisters, instead of the typical single flavored 30 serving size, providing our distributors additional opportunities to drive trial with their customers.

And lastly, in October in the U.S., we’ll introduce a bitesize format of one of our top 10 selling items, our Deluxe Protein Bars. These new formats and sizes of our top selling products, in addition to new flavors of our most popular products, are a few examples of how we plan to create excitement, drive trial and repeat purchases, provide more variety and offer our distributors new opportunities to build incremental sales with their customers. All-in-all, products introduced in last three years have contributed to almost 25% of our volume. Our goal, through ongoing innovation efforts and improvements in our speed to market process, is to increase this to one-third of our total volume.

Finally, we are realigning our organizational structure to enhance our focus on the worldwide distributor and customer experience, including the key areas of innovation and education and training. As such, I'm extremely pleased to announce the promotion of Dave Pezzullo to Chief Operating Officer. Dave has been a team member since 2004, initially serving as our Company Senior Vice President and Chief Accounting Officer and most recently, as Executive Vice President of Worldwide Operations. Dave has been instrumental in creating worldclass organizations in accounting, tax and treasury, and global operations. His successful implementation of our C2B program has created competitive advantage for our Company. Dave and I have a long history working together since 1998, and we share the same vision and passion for innovation. I couldn’t be more pleased to have him on our leadership team in his new role as COO.

We also announced the creation of a new position reporting to Dave, our Chief Innovation and Needs officer, that'll be filled by Senior Vice President, Chris Morris who previously led so much success with our Member Technology and Strategy Group. The entire executive team is actively engaged in on a road meeting with distributors to accelerate growth. Next week, many of us will be meeting with all of our top leaders from around the world at our annual retreat to discuss and develop plans for growth with the goal to expand our distributor base and reach more customers than ever before. And before we speak again in November, I'll have the opportunity to meet almost 60,000 more distributors in Fortaleza, and Rio de Janeiro, Brazil, Minsk in Belarus, Madrid, Spain, Mexico City and Guadalajara and a large tainted delegation at Bangkok. And in his new role as Executive Chairman, this week Michael Johnson is attending key distributor leadership events in four cities across Mexico to meet with, inspire and motivate, almost 12,000 distributors.

We continue to believe that there's never been a better time to be part of Herbalife Nutrition. We understand the challenges that have slowed our top line and we are committed to improving our growth rate, while we make the necessary investments in our future. This quarter, we are pivoting the entire organization to once again be laser-focused on growth, attracting new customers and distributors to our business, and providing with the products, tools and resources they need to be successful. It truly is a new chapter of our Company and it’s an exciting time to be involved with Herbalife Nutrition. And we believe the future, with all of our new products and exciting education and training programs in place, will be even more rewarding. Our distributors, employees and management all share in this enthusiasm and bring that spirit to everything they do. And for those of you who have been with us recently, you can see the engagement, you can feel the enthusiasm and it's infectious and compelling. And I'm grateful to be leading this effort.

Before we turn to some collections, John will give some additional details about the quarter, as well as the rest of the year.

John DeSimone

Thank you, Rich. Today, I will start by discussing the Company's second quarter 2017 reported and adjusted results, which will include key market highlights. I will then review our third quarter and full year 2017 guidance, and conclude by providing an update on our share repurchase program. Net sales for the second quarter were $1.1 billion, which represented a decrease of 5% on a reported basis and a decrease of 3% on a constant currency basis, respectively, compared to the second quarter in 2016. Volume points for the second quarter of 2017 were $1.4 billion, which represented a decrease of 8% compared to the second quarter of 2016.

As we anticipated, this was a challenging period from a volume point comparison perspective. As Rich stated earlier, Q2 last year was the largest volume point quarter in the Company's history. In addition, this year's second quarter was negatively affected by the transitionary impact of the FTC implementation, as well as the previously disclosed April 1st price increase in China that pulled volume into Q1 and Q2. Reported net income for the second quarter was $137.6 million or $1.61 per diluted share compared to a reported net loss of $22.9 million or $0.28 per diluted share for the second quarter 2016.

Adjusted diluted EPS for the second quarter was $1.51 per diluted share compared to $1.29 per adjusted diluted share for the second quarter 2016. Reported EPS exceeded the high end of our updated guidance by $0.66 and adjusted EPS exceeded the high end of our updated guidance by $0.36 per share. Reported EPS included the benefit of $0.33 from certain government grants received in China, which are excluded from our adjusted EPS. The purpose of these China government grant programs is to encourage local investment in operations. However, there is no assurance that the Company will continue to receive these grants in future periods.

With our reported and adjusted results benefited by $0.25 from excess tax benefits related to second quarter exercise of employees stock based compensation, excluding this ETB benefit, adjusted EPS exceeded our updated guidance by $0.11. The lower than expected sales were more than offset by expense controls, as well as $0.13 of the late expenses which were originally expected to occur in Q2. These expenses are now expected to occur in the back half of the year and reduced our forecast for the balance of the year. Most of the late expenses are related to marketing and promotion spending.

The adjusted EPS figures continue to exclude items we consider to be outside of no company operations, and we believe we will be useful to investors when annualizing period-over-period comparisons of our results. Please refer to our second quarter 2017 earnings press release for additional details on these adjustments.

Currency continues to be a headwind in the year-over-year comparisons. Second quarter 2017 reported and adjusted net income were negatively impacted by $6.9 million or $0.08 per reported and adjusted EPS. Reported gross margin for the second quarter of 80.9% increased by approximately 60 basis points compared to prior year period. This increase was driven primarily by the impact of cost savings through strategic sourcing and self manufacturing, as well as retail price increases, partially offset by the unfavorable impact of foreign currency fluctuations.

Second quarter 2017 reported and adjusted SG&A, as a percentage of net sales, were 38.6% and 37.8%, respectively. Excluding China member payments, adjusted SG&A, as a percentage of net sales, was 28.6%, approximately 40 basis points lower than the second quarter 2016 and driven by the timing of marketing and promotion spending previously noted.

Our second quarter reported effective tax rate was 17.6%, while our adjusted effective tax rate was 13.7%. Included in the reported and adjusted tax rate for the quarter, it's approximately $21.4 million from excess tax benefit on share-based compensation. Similar to last quarter, this benefit relates to the impact of the updated stock compensation standard, ASU number 2016-09, adopted in Q1. As previously stated, any tax benefit the Company receives from the exercise of equity grants that is different than the fair value at the date of the grant will now hit the P&L. Excluding this direct ETB benefit, our tax rate would have been approximately 28%.

Shifting now to our regional and market highlights. Second quarter volume points for the U.S. were down 18.5% compared to the second quarter of 2016, which was a record high quarter for the U.S. This decline in volume is the result of short-term trends from behavior, pattern adjustments due to the FTC implementation, which we believe is transitionary in nature. Throughout this transition, our distributors have continued to adapt and educate their organizations, our new tools and procedures and continued to demonstrate high engagement levels. Mexico volume points decrease 6% year-over-year. However, local currency net sales decreased only 1%. As Rich previously mentioned, this was below our expectations for the quarter. Along with the U.S., Mexico was also comparing to a record high volume quarter in 2016. To put the difficult comparison in perspective, Mexico volume on a two-year stack basis grew 4% compared to Q2 2015. We believe the fundamentals of our business in Mexico remained strong as Q2 2017 have the second largest number of average active sales leaders in Mexico history.

As previously disclosed, China’s volume in the second quarter was impacted by the timing of a price increase announcement, which we believe resulted in the pull forward of approximately $40 million to $45 million volume points into the first quarter. Otherwise, we believe much of this volume likely would have been recorded in the second quarter. The result was a volume point decline of 14% compared to the previous year's second quarter, and in line with our expectations for the quarter. The net sales impact of this volume point decrease was less significant as many of the transactions related to the pull forward of volume points at the end of the first quarter were recorded as net sales in the second quarter.

The EMEA region set new volume point record for the quarter, increased 2% compared to the previously record high in the second quarter of 2016. EMEA continues to show strong performance with the two years stacked volume point growth of 24% compared to Q2 2015. Volume points for the Asia-Pacific region show a slight decline of 1% compared to the second quarter in 2016. Volume points to Asia Pacific, excluding South Korea, increased by 6% compared to the prior year period reflecting strong performances in Indonesia and Malaysia, which were up on year-over-year basis 19% and 13% respectively.

Looking ahead to guidance. For the third quarter 2017, we estimate volume points to be in a range of a decline of 7% to a decline of 2%. For the full year 2017, recognizing the transitionary period we were in, we’re reducing our volume point range to a decline of 5% to flat. Net sales guidance ranges for the third quarter and full year 2017 are estimated to be between a decline of 5% and flat for the third quarter, and between of a decline of 3% in growth of 2% for the full year. As Rich stated, while we remained disciplined in our cost management, we are confident in our plans to return to growth, and expect meaningful and sequential improvement in trends later this year. For EPS, excluding the potential impact of any future share repurchase, third quarter reported diluted EPS is estimated to be in the range of $0.48 to $0.68, and adjusted diluted EPS guidance to be in a range of $0.65 to $0.85.

Third quarter adjusted EPS guidance includes a substantial portion of the $0.13 per share of Q2 delayed expenses previously discussed, as well as a projected currency headwind of approximately $0.05 per diluted share versus the third quarter of 2016.

Despite the reduction in sales expectations, the Company has raised its full year reported diluted and adjusted diluted EPS guidance to a range of $3.80 to $4.20, and $4.30 to $4.70 respectively. This reflects the beat in Q2, partially offset by the net impact of the volumes reductions previously discussed and cost savings identified to mitigate the impact of lower top line. Additionally, the impact of shares already repurchased, which I will discuss in more detail, will raise 2017 reported and adjusted EPS by $0.06. Full year 2017 currency headwinds are projected to be approximately $0.20 compared to 2016 and in line with the impact included in our previous guidance.

Capital expenditures for the third quarter and full year are expected to be within a range of $40 million to $50 million, and $115 million to $135 million respectively. Third quarter effective tax rate guidance is 30% to 32% on a reported basis and 27.5% to 29.5% on an adjusted basis. Our full year 2017 effective and adjusted tax rate guidance have been reduced to ranges of 23.5% to 25.5%, and 21.5% to 23.5% respectively.

Lastly, in regards to cash and our share repurchase activity. At the end of the second quarter, we had approximately $1.6 billion in cash on hand. Since the inception of our new Board approved repurchase program, the Company has purchased total 4.6 million shares or Herbal Life’s common stock at an aggregate cost of approximately $299.2 million or an average cost of $65.41 per share. Of this amount, the Company purchased 1.1 million shares in the first quarter, 2.7 million in the second quarter and 800,000 shares in July. Since the end of first quarter, shares were purchased in the open market, utilizing a 10B5-1 plan. While we do not buy back as many shares as anticipated when the most recent 10B5 plan was implemented a few months ago, we remain committed to buying back a significant amount of our stock during the second half of 2017. As we have confidence in our future growth outlook, now that the implementation of FTC order is behind us, the remaining authorized capacity under the Company’s $1.5 billion share repurchase program is $1.2 billion.

This concludes our prepared remarks. Operator, please open the line for questions.

Question-and-Answer Session

Operator

[Operator Instructions] And our first question comes from the line of Tim Ramey with Pivotal Research Group.

Tim Ramey

So I guess the key questions revolve around your 3Q guidance. And one would be, given or taken that guidance for the grant itself, given how far you were off on the 2Q, your guidance was or minus 12 or 34% you referred about 17%.So trying not to second guess it too much. But why should we assume that the 3Q will be as soft as it is? You mentioned something about delayed expenditures and perhaps anything over that a little bit done.

Rich Goudis

I think you're talking on bottom line is the nature of your question, I think. And couple of things to keep in mind for Q3. One is there is a meaningful amount of expenses that were projected in Q2 that have been moved mostly into Q3, and that’s around marketing and promotions. That’s just the movement from Q2 to Q3. Additionally, one of our larger events, which is our Founder's Circle and Chairman's Club event, which is not insignificant in the amount of money, it cost within Q4 last year and this year is actually in August. So it’s in Q3, and that’s another about $0.05 that’s timing. So there’re some timing issues in our guidance for Q3 that is a bit unusual.

Tim Ramey

And then relative to share repurchase, you’ve mentioned being somewhat disappointed with the pace in the 2Q, and you were disappointed in the pace in the 1Q. Why are we not hitting this closer to expectations?

Rich Goudis

Yes, I don’t think I used the word disappointed as much as just do as less than we expected. As you know, I think, we’ve been transparent that we’ve been using mostly 10b(5), actually this quarter was exclusively a 10b(5) plan. Those 10b(5) plans set up certain parameters for repurchasing stock. At the moment, you enter those plans and you live by those parameters and the parameters that we put into what ultimately was less of a amount of shares repurchased than we would have thought, given reference we started at with some of that is that stock moved a lot after the 10b(5) plan was put in place, both in Q1 and it did again in Q2. So those are the driving factor, it was in our commenting to share buyback. In fact, what it really leaves us with is our plan for the amount of -- money we want to spend on repurchase this year hasn’t changed. So the fact that we purchased less than expected, both in Q1 and Q2, means that we’re going to purchase more than expected in Q3 an Q4 versus what our original plan was when we put the authorization together.

Tim Ramey

And presumably, your instructions on your 10b(5) or whatever, is the vehicle would allow for that?

Rich Goudis

That’s correct. Again, no guarantee to 10b(5) this time around. But whatever we do, our intention would be repurchase more quantities in Q3 and Q4 than we did in Q1 and Q2.

Tim Ramey

And then just Rich your commentary on the state of the business was pretty effusive pretty upbeat, and didn’t really square well in my mind with the call down in sales expectations for the 3Q and for the full year. Can you speak to that?

Rich Goudis

I’ll start with the excitement part and hand off the guidance to John. But we came out of July extravaganza with 21,000 people, and we were all extremely moved by the enthusiasm and excitement in the business. It was apparent. It was visible. You could hear it. And listen there is a lot of reasons for that. The success of the FTC order gives our distributors amazing amount of conference that they can live on to these new rules. And they are seeing in their checks every month. And layered on top of that now and given that their business and the only way to get paid is based on receipts. Now, we have the confidence to layer on some more promotions that we have been shy to have for the last few years as it relates to bringing a new distributor into the business.

So we see, in this business, the metrics really start first by being close to distributors and listening to what they’re saying and how they are talking about the business. And that was very loud for us in July. And then we seen that contagious enthusiasm picked up around the world just over the last two or three weeks. So as John said and I agree, we’re still going through a transformation period. We still have people learning new tools, learning how to be more productive with those tools. And I think that our expectation is we have this year that you can see the momentum of the business pick up.

Operator

Your next question comes from the line of Mike Swartz with SunTrust. And Mike your line is open.

Mike Swartz

Just wanted to touch on the U.S. business, down 18% in the quarter, I know you said that was in line with the updated expectations you gave in June. But just wondering how you’re thinking about that business in the back half of the year. It sounds like you think you’re going to get through this soft period. But I guess what are you building into your outlook for that?

John DeSimone

Mike, this is John, I'll take that. So a couple of things in U.S.; one is I think distributors are getting used to the tools and that’s been a lot of focus for our distributors is really, I think of it as almost the validation of what they’ve already know and now they get to be more back to normal business routine. And I think one of the weaker points was distributor sponsorship, because they were so much focused on documenting consumer sales that that effort took time away from finding other business builders. And our distributors are in fact our customer acquisition vehicle. And so we’re starting to see that momentum change a little bit -- I don’t know if you were in St. Louis. But as Rich said, the additives are very positive. And we’re able to now design promotions around consumer transactions but that combined now with sponsoring a business builder. So there is a little bit of increased level of engagement, going forward, in our forecast and that combines with what is going to be an easier comp, given that we announced the settlement with the FTC last July and things softened after that.

Mike Swartz

And just to clarify. Are you seeing things improve in July?

John DeSimone

So I think what Rich was referring to is since St. Louis where we’ve launched some new promotions that we hadn’t in a while that we are seeing sponsoring pick up, small sample size so putting in perspective. Let me pass it to Des to maybe add comment.

Des Walsh

Mike, I think the key message at extravaganza in St. Louis was obviously in relation to the FTC settlement just the line that we got this. So what our distributors have shown us is that they are in a position to comply, they’ve embraced the tools. As Rich mentioned, approximately 9 million receipts that have come to us, but now it's time to pivot and that was a clear message given throughout the event in extravaganza and we are seeing that in terms of levels of excitement, levels of enthusiasm, levels of engagement. And listen, our distributors are never happier than they’re talking to more prospects, whether it’d be customers, whether it’d be future distributors. And now they feel they’re in a position to do that. They’re in a position to comply with the order, they’ve got the tools, they’ve got people engaged and now it's time to get back and refocus on the business. And I think that’s what we’re seeing.

Mike Swartz

Rich, you had mentioned a number of investment areas that you’re looking at going forward and some of that was on sponsorship, I think some of your talking about POS or just the retail side of the business. Can you talk about maybe a little more color on that, and how to think about maybe the dollar investment you’re thinking about and timing of that investment?

Rich Goudis

So listen, I think, we’re very much off to the race. So from a standpoint of building blocks, let me pick-up from what Des said. So with this transformation and working under the new order in U.S. we've collected 9 million customer transaction receipts in the last three months. And to be quite honest with you, we've just been absorbing them, our systems have absorbed them, we're [indiscernible] all of them et cetera, et cetera. And we’re now with this announcement with Salesforce who we've been talking to them and others over the last several months to pick the right vendor, the right partner. We’re going to start to role from our heels just absorbing those receipts to getting upon a tippy toes and use those receipts, work with sample group of about 2,000 distributors during this beta test, reaching little over 10,000 customers and start to really use and leverage the CRM technology, coupled with what we already have is this enviable one-on-one relationship between our distributors and their customers.

So we think that those together is going to be very exciting for our distributors engaging, I think it's going to win last -- extend the customer relationship, the customer in ordering and the life cycle of the customer, because we’re going to provide those customers with better experience. On top of that, if you think about that last mile that we talked about, content is very important. So what we hear from our distributor is by providing them very rich content; whether it's a product content; whether it's how to make the product or how the products are made or the nutrition behind our products and sign; whether it's training on different methods of operation that kind of content; whether it's fitness content; whether it's third meal of preparation content; all this content that helps consumers achieve their goals, achieve their results. And if our distributors could be the conduit for that in a prepackaged manner, it will enrich their experience and drive better results again leading hopefully to longer lasting customers and then innovations. So the last one is really innovation and it's really across the board. We’ve had a lot of success recently on innovation and product. We’re taking some of our top-selling products and as you heard in the calls we’re going to have some sample sizes of our products if you will to create more trail and engagement, and create more excitement for our customers.

And we've taken out and leveraging anything, let's have this innovation culture really be spread throughout and across the entire Company. So there is lot of reasons for excitement, but the foundation and the building blocks are now behind us. And there is an emotional, as Des said, there is an emotional feeling of success that we've done it now let's build from here. And then you balance all of this internal step-up with the megatrends and obesity, ageing population, skyrocketing public healthcare cost, the rise of people seeking entrepreneurial activity, the decay of traditional retail and we’re pinching ourselves that we’re just such in a unique and exclusive spot.

Mike Swartz

And then just maybe final question for John, if I -- looking at the math correctly here, it looks like pricing added about 5% to top-line during the quarter. But look back at first quarter, pricing was slightly negative and then with your guidance that implies something like 2% or maybe 3% at pricing in the back half of the year. So can you talk about what's driving the pricing and maybe the discrepancy between the quarters?

John DeSimone

I think it's not just pricing, it's pricing and mix. And we've had a swing in mix. So as you know, the way China sales are booked there wasn’t a discount, so that discount doesn’t exit that exit in other markets. So it ends up being a higher gross margin country, not a higher operating margin for a volume point country, but when you think in terms of net sales, China plays a big swing as does Korea, because they both have different marketing plans. And so as -- and different countries have different profitability levels. So there is a mix issue in there that also has an impact, and that’s really more than price.

Operator

Your next question comes from the line of Doug Lane with Lane Research.

Doug Lane

Just want to stay on the investment that you're making in the technology here. Obviously, it's been a big cost in a short period of time over that last year, and now we're starting to talk about the returns on that cost and that’s fairly intriguing. So what do you have now in place, what kind of information do you have now that you didn’t have before? And maybe to put it in prospective, a lot of direct selling companies direct ship to customers already. What kind of information may be you’re getting as a company that your competitors are not getting?

Rich Goudis

So Doug, first as you said over the last year, we built these amazing point of sales tools and operate for all the different methods of our business, whether you come into a nutrition club, whether you’re transacting over you cell phone or iPad or just over a traditional desktop computer. So those tools are now foundational. And I think once we through this year, given the desire of people distributors around the world to have similar tools, I think we're now starting to develop how to enroll that functionality and capability out. And again, these are built on an Oracle platform. So the ability to roll this out I think is a lot more efficient now that we have the foundation built.

I think if you, specific to your question, even in the past our distributors had customer. And even though we may have dropped ship to their customers, we didn’t know what they paid for the order. And so now we have that visibility. And now hopefully with Salesforce, we’re going to be also work with our distributors to get permission on how we increase and improve that customer experience of even just what they get in the box. And also now with segmentation of our business, we can now put different messages in boxes that we know are going to preferred member versus going to a distributor. Before this year, Doug as you know, we treated everybody like a distributor. Hey Doug, congratulations on the 100 volume point order, you’re 200 volume points away from going to an SDS this week and then Doug like, what’s an SDS. I am just a preferred number.

Now we're able to segment those messages and we're seeing like click-through rates on emails more than double what they used to be just because we’re more of a exact targeting the message to the right audience. And then I think you layer on top of all this foundation what we think is this real excitement of what Salesforce can bring us given some of the test and the modeling that we've seen so far. And now we're putting it in our hands to manage, but putting it more importantly into the hands of entrepreneurial people that potentially becomes explosive, and that’s what's really exciting. And as you said, leverageable and really drives an ROI on this technology investment we put in. And just on that note, Doug, in two or three weeks we're upgrading our Oracle platform here to Oracle R12. Again, to give us a longer lasting competitive advantage that I think is pretty enviable in this industry.

Doug Lane

And along those ends, Rich, can you talk about the dynamic between the Company and the distributor leadership. There’s always been a bit of a natural tension there as they’re very protective of their businesses and their customers. And now all the sudden, you’ve got this huge pipeline, if you will, into the end user. How has that worked out between you and your distributors and your ability to work together?

Rich Goudis

Listen, I think it’s a partner relationship, right. And I think that honestly with the FTC that hold or deal brought to us was a stronger partnership, really a behavior like family as we’ll work on and get internally. The trust is high, the engagement is high because they see that working together. We’ve created a competitive advantage for our distributors. I think as you specifically think about how Salesforce will roll out, I think that’s going to be something that through this beta test and we’re going to work through with our distributors to find out what should they do, what should we do. There may be cases where people would rather spend their time bringing new distributors into the business, and may offload the relationship, the customer relation management, if you will, to the Company, right.

There may be others that want to be highly engaged. There may be some that say, hey listen, I am a sports enthusiasts so if I have a weight loss customer, I may dump and push that customer into Herbalife to manage, because that’s not my forte or my strength. So I think that we’re still eager to find out the capabilities, complete capabilities of Salesforce. As you know with our distributors, they got feet on the ground and they’re going to bring things to our attention that we can’t even think about here. And then working together make that really the best installation we can have.

Doug Lane

Just finally, John, on volume points. The third quarter volume points, I mean taken into consideration use your comparison. It looks like more the same versus the June quarter. And you brought down the full year by 3 point to the midpoint. Was most of that in the third quarter, is it the flip between the third quarter than fourth quarter? I mean I guess what I am getting to is, are we still looking for positive volume point growth in the fourth quarter?

John DeSimone

So most of the impact from our guidance reduction is Q3, but there is some impact into Q4. And Q4 could be -- that’s in the range that’s implied in the guidance but so is slightly negative. So it’s around that flat. It’s a big improvement in Q4 versus Q3. But if you look at the range and just do the math, you see it startles flat. And the reason of course is, if we look at where the volume softness has been, it’s really been in lower volume from new distributors being sponsored, and that’s all the change that we’ve talked about with the promotions going on. But that activity is already taken place on the sponsorship side in Q2 that will impact Q3. So now with the efforts in Q3 around these promotions that will drive the benefits in Q4.

Operator

Your next question comes from the line of Beth Kite with Citi.

Beth Kite

If I could just touch on local currency sales growth a bit more. So your range for that for 2017 and also for volume point growth is obviously wider now. So if you could help us, which markets drove you to expand that range when you think about the second half of the year? And as you came in at the low end of the range, where do you expect the pressure points might continue to be? And conversely, if you do better and are at the higher end of the range, which markets do you expect could outperform the midpoint of your guidance?

Rich Goudis

There is three markets really to discuss; Mexico, as Rich mentioned earlier I think in his opening comments that was a little bit of a surprise, I’ll expand on Mexico in a second; the U.S. and its China. Mexico is somewhat near a little bit of Mexico. It was a really difficult comp I know we’ve talked about that. The two year stack actually and volume points is growth of 4%, some of the challenge is really relate to what happened in Q2 of last year, which is in incredibly strong quarter. New members last year in Mexico in the second quarter were up 31%. So two year stack on new members, we’re still up close to double digit. So it's really tough comp, but we did miss.

And anytime we’re going through a transformational change that’s behavioral driven where our distributors are driving some behavioral shift from what's normal, our models are little less predictable. And when our models are less predictable, we widen the range. And that’s the purpose for widening the range is to indicate that during this transitions it's a little bit more variance to what we’re predicting. But the upside and the down are all going to be in those three markets, I believe.

Beth Kite

And actually that leads me to couple of my other questions. On China specifically, the description of the business in the 10-Q for the second quarter has a number of drivers, I would say handful positive and handful negative; the positives being the number of duration program that cited; the new couple of new products through the online platform. I would say nutrition clubs coming down; the social media impact. So can you just help us to understand what matters the most to you, where are you still really isolated labor focused in trying to solve for in China? And then related to that, there is one of the negatives cited as being the impact of the national congress this fall and the lack of approvals I guess you should say for some commercial mediums. So if you could adjust that as well. Thanks.

Des Walsh

So directionally, Beth, probably see in China is that obviously we’ve got some regions of China that are positive and some regions that are negative. And so as always what we’re doing is we’re working with our local leadership to actually identify the factors of driving growth and identify the factors into those regions that are negatively impacting us. And obviously for us the key factor always is the engagement of our distributor leadership. I'm just happy to say as that’s obviously very strong in China. In addition to that, obviously, we’re putting a huge amount of focus on China. As you know, we’ve recently had somebody relocate there, somebody with a huge experience in the business who has run some of our top performing regions over the years, so 15 year veteran. In addition, other vets are actually in China pretty well on a monthly basis.

So working very closely with our distributor our leadership to identify the key success factors and then mitigate those factors that have been working against us. In relation to the second part of your question, every five years, there is a national congress takes place in China. That taking place is fall and coming up and in the months leading up to that, there is overall restriction in relation to meeting distributors. This by the way doesn’t apply just to us, apply to all of them. It's just the nature of how things operate there. And so we obviously see this is having a short-term impact on the business, but we’re engaged with our distributors and how to address that. And then obviously what we’re planning is at the back end of the year just a very substantial series of meetings across all of China to close out the year and prepare us for 2018.

Beth Kite

And then if I may please move to the United States. Are you able to share with us the percentage of sales in the U.S. that were document purchases by consumers for now the three month period of May, June and July?

John DeSimone

I'll take that. Look, it's not inconsistent with our results for the last two months and for the quarter in total is consistent actually with our announcement in May. We’re not going to get in the habit of announcing what those are every month. But I think we cited for this quarter and it was consistent with our announcement results.

Beth Kite

And then not to run on, on extravagant too much, but it sounds positive for sure from the commentary you said so for in the call. But were there new promotions offered or announced at that and also the new products that Rich cited at the start of the call. Were those debuted, what was the consumer or the distributor response to some of those new product pack sizes, and things like that?

Rich Goudis

So why don’t I take the product first and I'll hand off the promotion Beth and to your point. So a few things, so one, we launched our Simply Probiotic product as the extravagant. But more importantly, we show them what's coming in just the next few months. For example, bitesize of our -- top 10 selling Deluxe Protein Bar, 10 serving size canisters of Formula 1 in a three pack for the holiday season, live stage boosters for our Formula 1 so that we can segment Formula 1 better by different life stages and we pretty view that a new mom booster, because we want to be on the right side of mom and breast feeding during that really important time in their lives together.

So I think that those are all hit with enthusiasm. And especially if you think of a lot of the new people coming to our business with 25 to 35 year old female who want to lose weight, this is a community of a lot of women who have just had a child. So I think that there was tremendous enthusiasm that the products that we’re looking launch here in the next several months are hitting a really strong sweet spot with our distributors. And then the promotion, I’ll hand off to Des.

Des Walsh

Beth, so you know that one of the things that we've been focused on almost for 18 months now is the whole question of member activation. They are encouraging they’re new members since the end of the business that they focus on creating a strong stable base of five to seven happy customers. And that's been a program that we've pretty well launched around the world. What we introduced at extravaganza here in July was an additional element of that, whereby we reward the up line for actually creating qualifiers in the member activation program. And so because obviously what we want what we found is that your up line has a huge impact on training and mentoring and guiding you to success. And so we wanted to reward that. So that was extremely well received by our distributor dealership and we think that's going to be one of those things that you’re going to see have an impact in the latter half of this year.

Beth Kite

And if I may ask just one final question, on the SEC investigation, it looks to me like the language in the 10-Q for the second quarter is similar if not the exact same as the first quarter. So is there anything else that you can add any context regarding that. This is the investigation regarding China. And then even if you cut that at context run what you’re seeing internally. Just are there dollars being set forth? Are you incurring legal fees or otherwise associated to that investigation? Thank you so much.

John DeSimone

You’re right. Our disclosure did not change substantially and maybe I think it's actually identical to what it was in Q1. With that, there is no other comment that we can say, the investigation is ongoing. Regarding cost, if you look at our adjustments that we've made to our earnings on the back page of our press release, you'll see an amount therefore regulatory increase and that's what this investigations, the back offs. So you can see it. It's pretty transparent.

Operator

Your next question comes from the line of Ivan Feinseth with Tigress Financial.

Ivan Feinseth

My question is about product development. In addition to the probiotic that you launched last month, what is going to be your R&D development process for new products and what products could we expect going forward?

Rich Goudis

We could spend a couple of hours on that one. But just to hit some highlights to tease out a little bit is. Listen, we want to find more consumption opportunities for our number one selling products. So let's just take Formula 1. Most people take a meal replacement shake in the morning. So as we said on the call, we’ve launched a dinner shake in Russia to now have the opportunity and be given the permission from distributors and their customers to have Herballife at night. We're looking at things like soups rolling out around the world we introduced a soup in Brazil last year. Early this year, in Mexico, we did and we’re going to have additional soup lines going in Brazil. So at least get the permission from consumers to may be participate at lunch or at dinner.

We're looking at different transformational type of boosters that will take our Formula 1 as a mix today and you have this transformational booster to it and it becomes a pan cake or it becomes a waffle or it become a muffin or a cookie, all with the same protein, all with the same as a prescriptive side panel of nutrients micro or macro nutrients. Again, that’s just extending what we know and what we’re good at, very vertical in the sourcing, strategic sourcing of our Formula 1 and the manufacturing and the quality. And if we can extend that brand across multiple day parts with things like smoothies in the afternoon; we're also looking at thinks like protein dips; we're looking at things like salad dressings with Formula 1.

So again, I think our customers give our distributors permission to talk to them about their nutrition, specifically about healthy weight management. So if we can extend that throughout the course of the day, I think that will help us grow our sales with just that one category. We’re also looking at teas, may be more functional teas. We're looking at aloe and may be more functional aloe. Again, leveraging our supply chain leveraging our vertical manufacturing capabilities and providing more segmentation of those top selling brands, if you will, and again lengthening the customer experience of our products.

Ivan Feinseth

And are you planning on making let's say certain market specific, country specific products. Or how would you come up with those types of products?

Rich Goudis

So listen, definitely flavors, I think that’s one thing we’ve been venturing on over the little last five years is making country specific flavors. If they are country specific products, we have to do the ROI and then see what the return is given the investment; in big countries, quite possibly like Brazil, like Mexico, China, Russia, India and a few others. But I think the other countries we just get the benefit of some of these big products and then we roll them out and localize them.

Operator

And our final question comes from the line of Tim Ramey with Pivotal Research Group.

Tim Ramey

I just was unclear about how the Oracle platform works with or is planted by the Salesforce platform. Will there be any one time cost related to either Oracle or Salesforce? And back to John's comment on shifting costs from the 2Q to the 3Q. Could you be more specific on that, and whether those fall in SG&A or royalty and overrides?

John DeSimone

Yes, I would actually take both. So Salesforce is a tool that will leverage the data that we capture in Oracle and any other system that we have. What Salesforce will do is use our data, present it in a way for the Company and its distributors to benefit their consumers. That technology is technology we don't have. We have the data we don't have the technology to use the data in an optimal format that the Salesforce brings. Will there be some costs? Yes, Salesforce is not free. We'll find a way to fund it. It's probably 50% of the cost to be CapEx, the other 50% will be OpEx. But it's not significant cost to put in perspective, it’s very manageable. And then regarding the timing, the timing of spending is mostly SG&A.

Tim Ramey

So that should increase as a percentage of sales. I would think fairly meaningfully, and that's in 2Q, is that correct?

John DeSimone

It's a beta test right now, Tim. So I think that's something once we get through the beta test, we'll have to see how this scales next year with Salesforce.

Rich Goudis

Salesforce isn't going to meaningfully impact Q3. But the timing of the expenses that move from Q2 will and yes you'll see a spike in SG&A as a percentage of sales in Q3.

Operator

And we have reached our allotted time for questions. And I would like to turn the call back over to Rich Goudis.

Rich Goudis

Okay thank you. And thanks everybody. So listen, we wanted to end the call today and reiterate that our top line growth rate is not what we should be delivering. But as you've heard in the call and some of you’ve actually called out on the Q&A, we're very excited about the future. We have strong initiatives in place to address the opportunity to return to more normal top line growth rates. We're extremely optimistic about our future as we focus on accelerating innovation through our business, strengthening our distributor difference and enhancing the customer experience. I'm thrilled to be leading this great company and ushering in this new chapter of our history. Thanks everybody.

Operator

Thank you for your participation. This does conclude today's conference call, and you may now disconnect.