Earnings Call Transcript - HLF Q1 2022

Operator, Operator

Good afternoon, and thank you for joining the First Quarter 2022 Earnings Conference Call for Herbalife Nutrition Ltd. On the call today is Dr. John Agwunobi, the company's Chairman and CEO; John DeSimone, the company's President; Alex Amezquita, the company's Chief Financial Officer; and Eric Monroe, the company's Senior Director of Investor Relations. I would now like to turn the call over to Eric Monroe to read the company's safe harbor language.

Eric Monroe, Senior Director, Investor Relations

Before we begin, as a reminder, during this conference call, we may make forward-looking statements within the meaning of the federal securities laws. These statements involve assumptions and are subject to known and unknown risks and uncertainties that could cause actual results to differ materially from those discussed or anticipated. For a complete discussion of risks associated with these forward-looking statements in our business, we encourage you to refer to today's earnings release and our SEC filings, including our most recent quarterly report on Form 10-Q. Our forward-looking statements are based upon information currently available to us. 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. 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. A reconciliation of these non-GAAP measures to the most comparable GAAP financial measures is included in our earnings press release submitted to the SEC. These reconciliations, together with additional supplemental information, are available at the Investor Relations section of our website, herbalife.com. Additionally, when management makes reference to volumes during this conference call, they are referring to volume points. I will now turn the call over to our Chairman and CEO, John Agwunobi.

Dr. John Agwunobi, Chairman and CEO

Good afternoon. Thank you for joining us on the call today. I'll jump right into our Q1 performance, where volume points for the quarter declined 7% compared to the prior year. This result was within our Q1 guidance range of down 9.5% to down 3.5%. Reported net sales for the first quarter declined 11% compared to the prior year, which was below our guidance range. The bridge between volume point and net sales results was driven by the unfavorable impact of foreign exchange rates during the quarter as well as a shift in the geographic mix of revenue compared to our projections. We were able to deliver bottom-line results at the high end of our guidance range. Reported earnings per share for the first quarter was $0.96 and adjusted earnings per diluted share was $0.99, near the top of our adjusted earnings per share guidance range of $0.80 to $1. Net income during the quarter was $98.2 million, resulting in adjusted EBITDA of $185.6 million, just above our adjusted EBITDA guidance range of $165 million to $185 million. Overall, top line results fell short of our expectations. From a macro perspective, we believe economic pressures from the inflationary environment and widespread geopolitical uncertainty have had an impact on our channel. Additionally, the current wave of the COVID-19 crisis in Asia-Pacific and South and Central America negatively impacted the business during the quarter. And in China, the latest lockdowns have added to ongoing challenges in that market. Despite the adaptability and ingenuity of our distributor base, we've begun to see an emerging shift in behavior. Specifically, we've begun to see that as a group, the behavior of distributors that joined the business during the pandemic has diverged from historic trends. The number of distributors from this cohort that are ordering and recruiting is below last year and below expectations. However, on the positive side, this slowdown is primarily isolated to the collective performance of this pandemic-era group. Those that joined the business pre-pandemic continue to order at historical levels. Also on the positive side, we've not seen a material change in the behavior in our preferred customer segment as a whole. We believe this data, which shows consistent behavior within the pre-pandemic distributor cohort and our total preferred customer segment demonstrates the continued strength of the foundation of our business. It also makes us believe that the return of in-person events and the numerous sales initiatives that we've implemented at a local level will act as a catalyst to improve results. Most of the distributors that joined Herbalife during the pandemic have never been to an in-person event, and there is no substitute for gathering in person for learning, collaborating, and motivating. As a result of the top line trends observed during the first quarter and year-to-date, we are updating our guidance for the year. For the full year, we are lowering our net sales guidance to a range of down 10% to down 4%. The volume point guidance is being reduced to a range of down 12.5% to down 6.5%. Our updated guidance implies year-over-year net sales will be flat in the second half of the year, and we will show growth for the fourth quarter. Our teams here at corporate and around the world are laser-focused on achieving this growth. We are also focused on improving margins and controlling costs. As we discussed in detail last quarter, input cost inflation continues to be at historic levels, driving a significant rise in costs for ingredients, production, and transportation of product. We are actively engaged on multiple fronts to support margin accretion. Today, we're announcing that incremental pricing actions will be implemented globally in the second quarter. These price increases will partially offset the ongoing increases in input and freight costs. In addition to price, we are implementing cost control measures. We're being surgical in our approach to avoid any negative impact on sales or service to our distributors. These actions are in addition to the transformation program we announced last quarter. As such, we expect to see an improving EBITDA margin trend in the back half of 2022 compared to the first half of the year, and an accretive full year margin in 2023 compared to full year 2022. Before I turn it over to Alex, I want to say that we have an unwavering confidence in the resilience and strength of our business, and we're keenly focused on creating shareholder value through driving performance and returning to growth. I will now turn the call over to Alex.

Alex Amezquita, Chief Financial Officer

First quarter net sales of $1.3 billion represent a decline of 11% on a reported basis compared to the first quarter in 2021. As John mentioned, although volume points landed near the midpoint of our guidance range, net sales were negatively impacted by currency movement and country mix. The unfavorable country mix impact was largely driven by India outperforming our expectation, while China, Western Europe, and the U.S. underperformed. Currency was a headwind to net sales in the quarter, representing a drag of approximately 320 basis points, which was 80 basis points unfavorable than what was assumed in Q1 guidance. As you are aware, the Q1 year-over-year trend was impacted by a challenging comparison period. When comparing to the last quarter that was largely unimpacted by the pandemic, our two-year stack grew approximately 6%. Reported gross margin for the first quarter of 77% decreased by approximately 210 basis points compared to the prior year period. The decrease was largely driven by increased costs in our supply chain, lower production volume at our facilities, and the unfavorable impact of country mix. The decreases were partially offset by the impact of our price increases, which were taken in line with our historical strategy to increase prices in line with local CPI. First quarter 2022 reported and adjusted SG&A as a percentage of net sales were 34% and 33.8%, respectively. Excluding China member payments, adjusted SG&A as a percentage of net sales was 29.8%, approximately 250 basis points unfavorable compared to the first quarter 2021. This was primarily driven by the reduction in net sales as nominal spend was down year-over-year, partially due to the timing of distributor events that took place in Q1 last year and will take place in Q2 this year. For the first quarter, we reported net income of approximately $98.2 million or $0.96 per diluted share. This resulted in adjusted earnings per share of $0.99 and adjusted EBITDA of $185.6 million. Both adjusted EPS and adjusted EBITDA results finished at the high end of our guidance range for the quarter. Note that Q1 benefited from approximately $0.10 of China grant income that we had previously projected to occur in the second quarter. We are issuing guidance for the second quarter 2022 as well as revising our full year '22 guidance. For the second quarter, we estimate net sales to be in the range down 17.5% to down 11.5%, which includes an approximately 270 basis point currency headwind versus the prior year. For context, the midpoint of this guidance range is an increase of approximately 7% over the second quarter of 2019, which was the last second quarter prior to the pandemic. Second quarter adjusted diluted EPS is estimated to be in the range of $0.60 to $0.80. Adjusted EBITDA is expected to be in the range of $135 million to $155 million. Adjusted EPS and EBITDA include a projected currency headwind of $0.07 and $9 million, respectively, compared to the second quarter of 2021. For the full year, we are reducing our net sales estimates to be in a range of down 10% to down 4% on a reported basis. The revised guidance implied an approximately flat second half of '22. And as John stated, we expect to return to year-over-year net sales growth in the fourth quarter. The strengthening of the dollar has resulted in an expected full year currency headwind to net sales of 230 basis points compared to the expected 160 basis points headwind from a quarter ago. As a reminder, the projected currency headwind is reflective of the average U.S. dollar to foreign currency exchange rates for the first two weeks of April. We are reducing full year '22 guidance for adjusted diluted EPS to a range of $3.50 to $4. This $0.75 reduction to the midpoint of our prior adjusted EPS guidance is primarily driven by reduced sales expectations for the remainder of the year, partially offset by the incremental pricing actions and cost control measures. FX now represents an approximately $0.23 headwind for the year, $0.06 unfavorable from the $0.17 headwind assumed a quarter ago. For the year, we now expect adjusted EBITDA to be in a range of $680 million to $740 million. While organic sales growth remains our top priority, we are taking meaningful steps to improve margins. We implemented price increases in the majority of our markets in the first quarter that were consistent with our practice of keeping in line with local CPI. Given the unprecedented increase in our input and freight costs that are substantially in excess of current CPI levels, we will be taking incremental pricing actions during the second quarter. We are also implementing short-term and long-term cost control measures. These actions are in addition to the previously announced transformation program to optimize global processes for future growth while improving margins through productivity and efficiency enhancements within our business. As I discussed last quarter, the company expects the first phase of the program to result in annual incremental savings in the range of $10 million to $15 million with some savings beginning in 2022. We are actively looking to accelerate the second phase of the program to begin in late 2022 with expected ongoing annualized savings in the same magnitude as Phase 1. Turning to our cash position and our share repurchase activity. We began '22 by generating $130.5 million in operating cash flow in the first quarter. This was above our cash flow generation in the first quarter of '21. However, the first quarter benefited from the timing of our annual distributor bonus, which will be paid in the second quarter of '22, where it was paid during the first quarter last year. We currently have $570 million of cash on hand. This cash balance is after our execution of approximately $102 million in share repurchases during the first quarter. We continue to believe the repurchase of common shares is consistent with the company's long-term goal of maximizing shareholder value. We remain committed to returning our excess cash flow to shareholders through share repurchases. This concludes our prepared remarks. Operator, please open up the line for questions.

Operator, Operator

Our first question will come from Steph Wissink with Jefferies. Please go ahead.

Steph Wissink, Analyst

I'm wondering if we can talk about that pandemic recruited cohort. And if you can give us some sense of how much more burden on the model you expect to see before you digest through kind of a baselining of that cohort engagement?

Alex Amezquita, Chief Financial Officer

Yes, that's a great question, Steph. I'll build up to the answer to ensure it's clear. First, we believe our business foundation is strong. One reason for this belief is that the cohorts who have been with us for a while are performing very well, and we can mainly isolate the performance issues to the cohorts that joined during the pandemic in most countries. We also notice from our historical performance in different markets that as they have rapidly grown in the past, it’s common for newer cohorts to underperform compared to older ones. We have shown resilience and the ability to recover from this in the past. Additionally, the pandemic cohorts have had limited exposure to the full Herbalife Nutrition experience. They have only interacted via Zoom and have not felt the energy that comes from in-person events or the exchange of ideas that happens with both speakers and fellow distributors. This lack of exposure partly explains what we are witnessing. When we view this as a layered business, with the strong foundation and some weaker layers above it, we believe that in-person events can help reengage those who joined during the pandemic. However, we also need to introduce new layers, which is crucial. Live events are starting up again, and based on our long-term experience with these events, we anticipate being able to quickly reengage these individuals. It won't happen overnight, as this will be a gradual improvement, but we hope to see this progress soon, particularly in the second half of this year.

Steph Wissink, Analyst

That actually leads into my second question, which is the stabilization in the back half with the fourth quarter returning to growth. If you could just give us some degree of what's underlying that assumption base. What are you seeing that gives you confidence in the ability to kind of return to growth in the fourth quarter? Or what would you be watching for that might change the trajectory, either higher or lower as we progress over the course of the next several months?

Alex Amezquita, Chief Financial Officer

Yes, that makes sense, Steph. I'll take that question. And I'll answer it as it relates to our guidance. Our guidance for the rest of this year reflects what we saw in this emerging trend that John A. articulated and that John B. just explained with the new cohort. It reflects the run rate that we saw largely in March, but even more so in April. The rest of the guidance reflects the behavior of that month taken forward. So if we just assume that the channel and our distributors and the business markets behave the same way we're currently seeing because of the comps, the first half of this year compared to what was still a lot of demand in the first half of 2021 versus how it compares against the second half of 2021 with the same run rate that we're seeing over the past two months, we will see flat net sales in the back half, and that should imply some growth in the fourth quarter. I was going to mention one of the aspects we consider, which relates to your question, and these aspects can be divided into two categories. There are many metrics within these categories, and we construct our evaluation based on all these metrics collectively. Think of it in terms of activity and productivity. Activity refers to our internal measure of engagement, which encompasses both collective and individual distributor metrics. It includes how often they place orders, how often their organization places orders, the number of new recruits coming from the distributor level, how those new distributors are advancing in the marketing plan to become sales leaders, and the profile of their customers, including whether they are acquiring new preferred customers if that program is available in their market. We analyze various metrics and will monitor changes in those metrics to assess whether we are aligned with our latest guidance.

Dr. John Agwunobi, Chairman and CEO

I want to emphasize that we are taking an active and even aggressive approach to promoting sales globally. Every market has a strategy to boost sales for the remainder of the year. We are very confident that, when we assess the upcoming events and sales activities happening in each of our global markets, these efforts will help us meet our guidance.

Steph Wissink, Analyst

Last really quick one is just the risk parameters around could the business actually progressively get a bit worse before it gets a bit better. What are the conditions of the backdrop that you're seeing that give you confidence that the March/April trend line is suitable to just kind of straight-line go forward from here?

John DeSimone, President

Yes, Steph, this is John D. I'll take that one. I believe that our return to live events is really the key, unless there's another global event. Since February, we've experienced the Russia-Ukraine situation, which extends beyond just those countries. The sentiment at the consumer and distributor levels may have influenced our activity levels in many countries. So, barring any new developments or escalation of that conflict, we think that in-person events will serve as a catalyst, almost an inflection point for our improving activity levels.

Operator, Operator

Our next question will come from Doug Lane with Lane Research. Please go ahead.

Douglas Lane, Analyst

Just looking at our forecast in the first quarter, which, as you pointed out, was a little miss on the top line. It wasn't a huge miss. But the biggest divergence from what I was looking for, I think, really was in North America. Can you talk then in a little more detail on what's going on in North America with regards to the volume points and the distributor trends?

John DeSimone, President

Doug, this is John D. again. I'll take that one. You're correct in stating that this may have been the market that underperformed the most compared to our expectations. As previously mentioned, this is what's happening in the U.S. When we analyze our performance by cohort, those distributors and sales leaders who have been with the business for two years or more are performing very well. However, the newer cohort, often referred to as the pandemic cohort, is underperforming. This issue isn't limited to the U.S.; it's particularly evident in the markets that experienced the most growth during the pandemic. Consequently, the U.S. is seeing the greatest impact, as it had 50% to 60% growth for several quarters during that time, and now we’re experiencing some of that decline because the newcomers from that period are the ones who are struggling. This is why the impact is more significant in the U.S., reflecting the positive skew we saw initially when the pandemic began.

Douglas Lane, Analyst

Yes. I mean we're not seeing the same thing in Europe. Europe also had some good quarters there, maybe not 50%, but certainly 20%, 30%. And their declines from volume points anyway is pretty consistent the last three quarters in that high single-digit area. So why is the U.S. and North America acting so much more differently than Europe, for instance?

John DeSimone, President

Well, it's not as much as it looks, right? So Europe is made up of 50-something countries, and it's a pool of countries, and it's got a basket effect that the U.S. doesn't have, right? The U.S. is a country, and even North America is in itself almost entirely just the U.S. for our business. So you're really looking at one country versus a basket of countries. If you look in Europe, the countries that grew the most during the pandemic, the U.K., South Africa, Spain, and Italy, they're also having pretty steep declines. So you're getting a basket effect. Plus, you're offsetting a little bit of some of the decline in Europe with some pull forward in Russia-Ukraine business that happened.

Douglas Lane, Analyst

You mentioned that you are exiting Russia. Could you explain the logistics and timing involved in this decision and how it affects your forecast? Are we to consider Russia in your projections or not? What should we take away from this situation?

Alex Amezquita, Chief Financial Officer

Yes. As we said in our press release just after the onset of the war, we have stopped shipping products into Russia. The inventory that was in market is expected to run off. There's still a handful of months left of inventory there as that inventory runs off. With respect to our full year as compared to the February guidance that we provided, about 120 million volume points are isolated to Russia and then also to Ukraine, which obviously that market is not operating for all the obvious reasons. There's about $120 million of volume points that are no longer in our forecast attributed to those two specific markets. Obviously, the impact of Russia and Ukraine is beyond the borders of those two markets, but I think your question was specific to those markets. So about 120 million volume points are attributed to those.

Douglas Lane, Analyst

And I assume there's some EPS impact to those volume points. I mean, obviously, a $0.75 reduction; could we say $0.10 of that is Russia?

Alex Amezquita, Chief Financial Officer

I mean you could just follow down the P&L and take our average and kind of back into the EPS impact.

Douglas Lane, Analyst

Okay, fair enough. And just lastly, on stock buyback here. We talked about the $50 million a quarter run rate as kind of a baseline that you have in your forecast. And you did $100 million, which makes sense given where the stock price is. Any other kind of guidelines we should think about? Should we still be using a $50 million a quarter baseline and then expect that there's opportunity for opportunistic upside depending upon how the quarter goes with regards to your stock?

Alex Amezquita, Chief Financial Officer

Yes. We've indicated in our guidance package that the guidance package does still include the same assumptions, the $50 million guide per quarter. So that's still in place. Nothing changes with respect to that.

Operator, Operator

Our next question will come from Hale Holden with Barclays. Please go ahead.

Hale Holden, Analyst

I had a couple of questions. I guess, John, what gives you confidence that you're going to be able to add new layers on top of the base that are stronger as we go forward given the churn off from the pandemic cohort? I would just think it's sort of difficult to go out and recruit when you've got sort of a turn off of one tier coming.

John DeSimone, President

I believe that the underperforming tier is the one that had the least exposure to effective recruitment methods. The foundation, which consists of individuals who have been with us since before the pandemic, is showing an increase in the number of orders. This group has faced many challenges and demonstrated resilience through difficult times, such as the implementation of the FTC order and other unique global situations specific to Herbalife. Each time, they have successfully re-engaged and re-recruited people. I am confident in this group's potential, especially if we can bring them together in person at events; I think that will be critical.

Dr. John Agwunobi, Chairman and CEO

I'll just add that over the past 42 years in this business, operating in 95 different countries, we've experienced various events. There have been times when certain groups in the pipeline performed weaker than others, as John mentioned. Our system is designed to thrive as long as our sponsor leaders are strong, which they are. They provide additional support and attention, and that's the essence of these live events. It's one of the reasons we are confident about turning things around. While we've never faced a pandemic before, we've seen similar dynamics in the past on a smaller scale in different countries and markets, and we've always managed to overcome them. We believe we can do the same with this group.

John DeSimone, President

Actually, what you're looking at is really a bunch of synchronized events, right? Normally, the events that can drive inflections in growth or switch it to a decline unique to a country or a handful of countries, and we've always had the basket effect because we're in so many countries, where it doesn't have an overweighting impact on the overperformance. But with the pandemic, there were so many countries that grew at the same time and grew tremendously, and those are the ones that are suffering now that you're seeing a more collective impact on the overall performance of the company than you would normally see when these kinds of behavior shifts happened in the past.

Hale Holden, Analyst

Okay. My second question was, I guess, the opposite of what Doug just asked you, which is on your EBITDA guide. It looks like you'll be over your leverage target for the first time in some time on a gross basis. I was wondering how that sort of played into your thinking on buybacks and capital allocation and what should we be doing with your cash.

Alex Amezquita, Chief Financial Officer

Yes. The business is still going to generate cash and still has a profitability level that we feel comfortable with. So we feel very comfortable with keeping the $50 million guide. Obviously, there's an opportunistic piece of our share repurchase program. So we're just going to have to monitor that as the year progresses to see how opportunistic we can be. But certainly, even with the revised level of EBITDA, we feel comfortable with the guide we've put out.

Operator, Operator

Our next question will come from Jeff Van Sinderen from B. Riley. Please go ahead.

Jeff Van Sinderen, Analyst

Let me say this is a multipart question, if you can just bear with me a little bit. As you look at your major regions and contemplate a return to growth year-over-year in Q4, which regions do you see driving that growth? Is that really just a big bounce back in the U.S.? And then maybe if you could touch on your thinking about perhaps a little bit longer term when each major region might return to growth that isn't growing now, even if that's beyond Q4. And then also maybe if you could remind us how the company has performed in a macroeconomic recession in the past.

John DeSimone, President

This is John D. I'll take that. We don't give specific guidance by region. When you go back for the last couple of years and look at the regions that had very meaningful growth caused by new cohorts coming in during the pandemic, those are the ones that are suffering the most now, and those are the ones that have benefited most from live events. There's some uniqueness in those live events being allowed in most places. There are still some places where it's not; there are still some countries that are dealing with shutdowns and some countries are dealing with pandemic effects right now. In those countries, it may take a little longer. Again, I don't want to go against our historical practice in not guiding by region, but I'm giving you some of the variables to look at. Through that lens, you'll be able to determine when we think different regions will grow. And what was the last part of your question?

Jeff Van Sinderen, Analyst

Sure. I just wonder about the performance of the company in a macroeconomic recession in the past.

John DeSimone, President

Look, you only have to look at Herbalife Nutrition. You can look at direct selling in general. It's been very countercyclical. That's been a positive element to direct sales during a recession and people looking to generally supplement their income, more than just look for a new income. In the U.S., we'll see where that goes. Obviously, that's been a little different lately. But globally, based on the last 100 years of direct selling, it's been very countercyclical. Herbalife has been able to perform well in both up and down cycles because we also offer nutrition products, which is a macro trend that really favors our product line. We've been able to perform well during both.

Jeff Van Sinderen, Analyst

Is it possible that in the event of a global economic recession, some of the new cohorts that emerge seeking to supplement their income may be more resilient compared to those that came about during the pandemic?

John DeSimone, President

They may be more sticky, right? Now I want to be clear. The distributors that came in and the ones that came in seeing sales leaders that came into the pandemic probably would have still been sticky had we returned to live events much sooner when they were active. I don't know that it was a mindset. I think the people that came in during the pandemic are probably also looking for incremental income during the time that was very challenging. But there wasn't this infrastructure built in a way that could cross-train them and cross-pollinate them with our distributor base in general. I think the current cohort that comes in that will have access to our historical way of doing business with the added benefit of some virtual training by not having that be the primary way to learn will likely be more sticky than the group that came in over the last two years.

Alex Amezquita, Chief Financial Officer

I think it's a real issue that we're looking at. It's really hard to give any specific attribution to that fact. But clearly, the job market is as tight as it ever has been. The jobs report that came out this morning is showing that it's not going to abate anytime soon. So that is an issue when you think of all of the opportunity costs that an individual has where our business opportunity has to compete with all those opportunities; clearly, that's going to be a bit of a headwind. But how much of that is contributing to the activity rates that we have seen in the past 1.5 months versus other factors like the lack of training that has largely been present is really hard to pinpoint the why to one or the other with any specificity. What we do know is that we see the KPIs. We see the activity KPIs. So we know what the problem is, and we've been through these issues before historically, and we know how to address those. The local sales initiatives in addition to all of the live event catalysts that John D. and John A. have mentioned, we think that's going to address those types of issues as we move forward here.

Operator, Operator

I'm showing no further questions in the queue at this time. I will now turn the call back over to Chairman and CEO, John Agwunobi, for any closing remarks.

Dr. John Agwunobi, Chairman and CEO

Thank you. I understand that many of our shareholders are disappointed with these results, and we are too. I want to make that very clear. We, along with many other companies worldwide, are facing what can be described as an unprecedented time in the macroeconomic landscape. There’s a lot happening simultaneously. However, we will not allow these challenges to hinder our aggressive pursuit of our goals. I have communicated with our distributor leaders globally, and we are convening in person in Los Angeles next week to reinforce our strategy for the remainder of the year. We remain as confident about our future as we have ever been. We have concrete plans and actions in place, both in terms of revenue generation and financial management, to navigate through these challenging times. I encourage everyone listening to acknowledge that our team understands this is a moment for us to step up and move forward, and we are committed to doing just that. Thank you for being with us.

Operator, Operator

Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.