Earnings Call Transcript - HLF Q1 2020

Eric Monroe, 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 annual report on Form 10-K and 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 revision 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.

John Agwunobi, CEO

Good afternoon everyone. First and foremost, I hope you and your families are all safe and healthy. This is an extremely challenging time for us all and our thoughts are with those most affected by this global pandemic especially those on the front lines of the crisis. As you saw from our press release, the first quarter was an all-time high in terms of volume points. We and our distributors are working hard to overcome the various challenges we've encountered to ensure our nutrition products are accessible to customers. Our factories as well as our third-party manufacturing facilities are operating at close to normal capacity. As many of you know, the majority of our products are foods, yet there have been last-mile delivery disruptions and Nutrition Club restrictions in various markets. We believe the strength of our direct selling model and our culture of collaboration with our distributors have helped us minimize the impact of those disruptions to date by sharing best practices and developing localized solutions. Our distributors have been utilizing consumer-facing technology to interact with their customers, particularly in cases where face-to-face interactions are unable to take place. Attendance at virtual product training and business opportunity meetings have been extraordinarily strong. For example, a recent virtual meeting in North America had over 40,000 participants. Additionally, we've been utilizing our training teams in new and exciting ways. For example, our doctors have offered virtual trainings on our products and on how to stay safe and healthy. And our sponsored athletes and fitness experts are leading at-home virtual workouts around the world. The learnings and enhancements that we have had from this time will only benefit us in the future. While we focus on the immediate priorities related to the pandemic, we continue our work to successfully deliver against our strategic initiatives. Our strategy is working, yet we're constantly learning new ways to build it better and to innovate, so that we come through each challenge stronger than before. We will continue to evolve our strategy to best support our distributors as they grow their businesses and drive the company forward. Turning now to updates on our top four markets. Let's start with China where volume points grew 29% compared to the first quarter of 2019. While this growth was extraordinary and due to the team's ability to quickly adjust to changing marketplace dynamics. I want everyone to remember that last year's performance was impacted by the Chinese government's 100-day review of the health products industry. We learned from last year's review that we needed to be less reliant on large in-person meetings. And therefore, we created a very robust e-commerce platform, and we moved many of our sales meetings online. These moves have proven to be extremely helpful during the pandemic. As the economy in China reopens so have approximately 90% of our Nutrition Clubs with social distancing measures in place. Now, in the U.S. the first quarter and the month of March were all-time record highs. We did see an initial decline in sales in mid-March especially in Nutrition Clubs as states and localities placed restrictions on commerce. However, this decline has been partially offset by the ingenuity and the creativity of our distributors who pivoted and focused their energies on increasing home deliveries and carryout services. India volume increased by 15% during the quarter, but the pandemic had an adverse impact on sales late in the quarter and on into April. Finally, in Mexico volume points were down 7% in the quarter. We are seeing some softening of sales attributable to the pandemic in addition to the already difficult economic conditions in that market. Due to the uncertainty surrounding COVID-19's evolving impact on our business and on the global economy we are unable to provide guidance at this time. However, for transparency, we are providing you with April volume performance. Given the magnitude of the restrictions put in place by local government in response to the pandemic, we are encouraged that volume points for the month of April were down by only 1% compared to April 2019. Again, we believe this strong performance speaks to the strength of our direct selling model and our distributor culture. We are confident our business can continue to manage through this pandemic and that we will come out stronger at the end. Here are a few reasons why: Well, first, this is a global event, but it's very local in the way that it impacts each country each city and each community. We have an innovative infrastructure and our distributors know how to operate effectively in their local communities almost at the block-by-block level. We're encouraged by the ways our distributors are connecting with and servicing their customers in this environment. Second, good nutrition and healthy active lifestyles have always been important and people are realizing that that is true now more than ever before. And finally, the need for supplemental income has always existed and our business model may help provide an opportunity for some at this time. It's remarkable how our distributors and our employees have stepped up together to keep our businesses moving forward and I couldn't be more proud to be part of this company at this time. So at this point, let me hand this over to Alex to review the financials.

Alex Amezquita, Senior Vice President of Finance Strategy and Investor Relations

Thank you, John. Our record-selling volume in the quarter converted to first quarter net sales of $1.3 billion, representing an increase of 7.7% on a reported basis compared to the first quarter in 2019 and included double-digit net sales growth in six of our top 10 countries. Adjusting for the headwind in foreign exchange rates, net sales for the quarter increased 10.4% year-over-year. We reported net income of approximately $45.6 million or $0.32 per diluted share, which includes an additional legal accrual of $83 million related to the SEC and DOJ investigations on the FCPA matter in China. Adjusted earnings per diluted share were $0.83, an increase of 27% compared to adjusted earnings per adjusted diluted share of $0.66 for the first quarter last year. Note that our reported and adjusted results this quarter included expenses related to the China growth program of approximately $2.2 million. Additionally, our adjusted EPS figures continue to exclude items we consider to be outside of normal company operations or we believe will be useful to investors when analyzing period-over-period comparisons of our results. As such, we have excluded net expenses related to the response to COVID-19 of $5.8 million during the first quarter. The impact of currency fluctuations represented a year-over-year headwind of only approximately $0.02 on results for the first quarter, despite the approximate 270 basis point headwind to net sales. This is due to headwinds and other short-term offsets within the quarter. COVID-19 sentiment drove a significant strengthening of the U.S. dollar in late March and is expected to have a more material impact on EPS results for the remainder of the year, should currency rates stay at current levels. Reported gross margin for the first quarter of 80.5% increased by approximately 115 basis points compared to the prior year period. The increase was primarily driven by the impact of retail price increases and lower inventory write-downs as well as the roll-off of the Mexican retaliatory tariffs that impacted the first quarter of 2019. First quarter 2020 reported SG&A as a percentage of net sales of 43.5% was primarily driven by the previously mentioned legal accrual of $83 million. Adjusted SG&A as a percentage of net sales was 36.4%. And adjusted SG&A excluding China member payments was 28%, approximately 140 basis points lower than the first quarter 2019, primarily driven by the cancellation of a major distributor event and the cancellation or delay of a number of other events and activities, all due to the impact of COVID-19. As John mentioned, given COVID-19's impact on our ability to provide guidance, we are disclosing preliminary April volume point results. April preliminary volume point results provide some insight as to the severity different markets have been impacted by COVID-19 restrictions as well as the phase of the impact. For example, China and the U.S. are up 20% and 14% respectively, while India and Brazil are down 30% and 31%, respectively. We will periodically reassess our ability to set 2020 guidance as and when we can reasonably estimate the impact of COVID-19. Related to the balance sheet, we currently have $944 million of cash on hand and $1.5 billion in our share repurchase program. Our financial profile remains strong with ample liquidity and a favorable debt maturity schedule. During mid-March, we announced an amendment to our existing credit facility that modestly increased borrowing capacity, extended the maturity and reduced the interest rate applicable to the Term Loan A facility and revolver by 50 basis points. Being able to execute this amendment during these uncertain macroeconomic times demonstrates the confidence and support our lenders have in Herbalife Nutrition. This concludes our prepared remarks. Operator, please open up the line for questions.

Wendy Nicholson, Analyst, Citigroup

Hi. A couple of questions for you if I can. The first one, the major distributor event I know that had been obviously, something you were looking forward to. It was a big deal and so I understand why there were such big cost savings. But what's your thinking on – in terms of rescheduling that? And I'm wondering for two reasons. Number one, the impact to the P&L to the extent there are costs that we should build in maybe in the back half sometime. But also in terms of keeping the momentum alive, do you think that's necessary for the momentum and the goodwill among the distributors?

John DeSimone, President

Yes. This is John. I'll take that. So the event was done virtually. There will not be a live Honors this year. I can tell you I think it was done in a way and in collaboration with distributors that was actually motivating. It does keep the momentum going. In terms of savings look we spend a certain amount of our percent of sales on distributor events and promotions and we hope to get back to that same level by the end of the year. It may be redirected into something else, but I think it will be somewhere included in the model.

Wendy Nicholson, Analyst, Citigroup

Got it. And then my second question is with regard to China. Can you give us a sense – the volume points of up 29% in the quarter are stunning. That's fantastic. And I know it was an incredibly easy comp. But is there any way you can break that down kind of January, February, March, so that we can get a sense for how much COVID impacted you maybe in February or March versus how much growth you saw in January? I don't even know, if that would be helpful or meaningful but just curious to try to get a sense of whether COVID was in fact a big deal or not in China in the first quarter. Thanks.

John DeSimone, President

Yes. I will provide some numbers, but first, I need to clarify that analyzing them is challenging due to the timing of the Chinese New Year this year compared to last year, along with the effects of the 100-day campaign last year. What I can share is that the growth rate in China for March was roughly the same as in Q1, with a 29% growth rate for March compared to 29.4% for the quarter. However, providing numbers for January and February would be difficult to interpret due to the timing of the Chinese New Year. This year, it began in January, while last year it was in February, leading to significant variations in the data.

Wendy Nicholson, Analyst, Citigroup

Got it. Okay. That's helpful. Thank you, very much.

Karru Martinson, Analyst, Jefferies

Good afternoon. When we examine the regional volume points in April, it's clear that in North America and China, progress has been made with the e-commerce platform. How significant was that improvement in these markets due to e-commerce? And does this influence your plans for rolling it out globally?

John DeSimone, President

Yes. I think it's more than just e-commerce. So first I think big picture in countries and regions that have sophisticated infrastructures the ability for distributors to find alternative methods to do the business or enhance. Those with maybe some weaker infrastructure is a little more difficult. Also China and the U.S. have preferred members and that helps in preferred members. In April actually in the U.S. was a record number of new preferred members. So, I think there are some benefits that we can learn from China's performance and from the U.S. performance that will enhance other regions over time as we accelerate the rollout of some of these tools. Of course when you start looking at India in Brazil in South Central and South America the lockdowns were a little more challenging in general than they were in the U.S. So they...

John Agwunobi, CEO

And they're ongoing.

Karru Martinson, Analyst, Jefferies

Okay. And then when we look at the Nutrition Clubs, certainly encouraging to hear them pivoting and doing more carryout and delivery. But how are they performing? Are they getting rent relief for the times that they're required to be closed? What's the health of your distributors here in the U.S. in particular?

John DeSimone, President

Yes, Nutrition Club volume is down, but the U.S. is experiencing record performance. Many Nutrition Club operators engage in activities beyond just running the clubs. They also have preferred members and can offer customer-direct shipments, which saw a 40% increase in April. I believe they are exploring alternative methods to adapt. Regarding rent abatement, that varies for each individual distributor, so I'm not aware of specific details. However, April was a record month for the U.S., and overall, distributors are performing very well here.

Karru Martinson, Analyst, Jefferies

In terms of the states that are reopening, where do Nutrition Clubs stand regarding the state-by-state guidelines that need to be met? How quickly can distributors open that channel for you?

John DeSimone, President

That's a very localized question, and I don't know the specifics. However, when considering clubs, they primarily sell food and have been providing curbside deliveries in many states. What you're really asking is how quickly they will be able to return to normal operations once things reopen. I'm not yet ready to provide an answer to that. Nevertheless, in the U.S., March was the highest volume month in history, and April surpassed that record.

Karru Martinson, Analyst, Jefferies

Thanks very much guys. Appreciate it.

Hale Holden, Analyst, Barclays

I had two questions. The first one is I heard your comments on Latin America and Brazil. Is it just really the lockdown and the economy there? Or is there something else going in that market? Because it is an outsized decline for volume points versus your other trends.

John DeSimone, President

Yes. The lockdown is having a significant impact for several reasons. For instance, in Brazil, clubs are completely closed and there is no delivery service available. We rely heavily on third-party logistics providers in these regions, and many have shut down. Consequently, consumer access to products, particularly in the South and Central America markets, has been restricted much more than in other parts of the world. I want to add that South and Central America, including Brazil, experienced 7% growth in February and combined growth in January and February. It was in March that they saw a decline. Prior to the impact of COVID in March, we were observing positive trends in South and Central America.

Hale Holden, Analyst, Barclays

That's helpful. Thank you. I was wondering if your representatives had adjusted their marketing or value approach to account for lockdown restrictions, focusing more on the vitamins you've been highlighting or on meal replacements to maintain health while staying at home and managing weight, along with some of the dynamic shifts they have been making.

Alex Amezquita, Senior Vice President of Finance Strategy and Investor Relations

I am not sure if the distributors are changing in response to the demand from their customers. In many countries, we have seen an increase in the immunity segment of our portfolio as people become more focused on staying healthy to avoid any potential health issues. Therefore, we have observed a shift in demand towards different parts of our portfolio. However, I do not believe this significantly alters the distributors' business model. We have noticed some modest changes in purchasing behavior.

Hale Holden, Analyst, Barclays

Okay. Thank you very much. I appreciate it.

Stephanie Wissink, Analyst, Jefferies

Thank you. Good afternoon, everyone. Just a few questions for us. The first one we wanted to unpack a little bit more on the digital sales. Can you just remind us what percentage of the business is dot-com? And just share a little bit more on some of the tools that you might have put into the market during this period to help your distributors bolster some of the sales opportunity.

Alex Amezquita, Senior Vice President of Finance Strategy and Investor Relations

Yes. I believe the most notable change in digital behavior has been in China. In response to the 100-day campaign in 2019, we focused on reducing reliance on meetings by introducing alternative methods for distributors to conduct business. This strategy has proven effective during the COVID-19 situation, with approximately 30% of transactions in China now occurring through the digital platform, up from virtually 0%. This represents a significant shift. There has also been an increase in the U.S., although I don't have the precise figures, but it is evident that it has grown.

John DeSimone, President

Yes, I got them. If you consider customer direct, which involves going on the GoHerbalife site, it's around 21% to 22% of our business, as it was in April. This discussion is in the context of the post-COVID impact. In the U.S., there are many digital platforms, and preferred members order directly from the company. We have Nutrition Clubs utilizing different digital tools, and I'm specifically referring to the dot-com site.

Stephanie Wissink, Analyst, Jefferies

Okay. That's great. And then I'd like to ask you to extrapolate a little bit on the disclosure around the FCPA both on the call and in your filing today. I think that the language you used is you've reached an understanding in principle and you'll enter into administrative resolution. Can you just talk a little bit about that where you are in that process and then what that may permit you to do with respect to some of the cash and the buyback?

John Agwunobi, CEO

Thank you, Stephanie, for your participation and your questions. I hope you're staying safe. As you saw from our update in the 10-Q regarding the SEC and DOJ investigation, all the details we can share are in that document. We believe that it has relieved us of any material non-public information that would impact our ability to repurchase shares. However, we are also aware of the need to exercise caution and good judgment in light of COVID-19 and its unavoidable effects on the economy. We are navigating the situation as we monitor developments with the DOJ, SEC, COVID-19, and the economy while trying to find a balance as we look ahead.

Stephanie Wissink, Analyst, Jefferies

Okay. That's very helpful. Last one for us is just your enthusiasm around the U.S. on reaching the highest number in April. It's certainly palpable. Can you talk a little bit about new customers how you think about retaining those customers? Just life cycle value of some of those new customers that you're bringing in. Thank you.

John DeSimone, President

Yes. The number of new customers and their lifecycle are two key metrics for us. I won't provide the exact number of new customers from the past few months, but I can say that the average order size in the U.S. is decreasing. The growth in the U.S. has been driven by an increase in the number of people placing orders. We will track the lifetime value of these customers and their reorder rates moving forward. It's encouraging to see that growth is stemming from more people ordering.

Ivan Feinseth, Analyst, Tigress Financial

Thank you for answering my questions and congratulations on the record results, especially during such a challenging time. In driving these record results, what do you believe were the key factors and products that surprised you the most? What future opportunities do you see? Many people emphasize that a key to staying healthy is to be proactive about health, which presents significant potential for a company like yours.

John Agwunobi, CEO

Thank you, Ivan. First, it's important to recognize that no one wants to see situations like this occur. This is a crisis in every sense of the word, affecting many families, including our customers, employees, and distributors, who may have lost loved ones or faced illness themselves. It's crucial to acknowledge that during such times, individuals often reassess their personal circumstances. They evaluate their health, income, family security, and consider how to improve their situations for the future. We entered this crisis with strong ties to our communities through our distributors, who are deeply embedded at the local level. Our business model is designed around what we call the circle of influence, allowing us to connect with families and friends within the community. This approach has proven effective during lockdowns, as distributors and customers have been able to maintain connections, demonstrating the value of our business model. The need for our products and services has significantly increased worldwide, and I'm thankful to our entire team for meeting this demand. Looking ahead, as you mentioned in your question, the future is vital for us. A key aspect of our strategy involves integrating technology into our operations and the transactions of our distributors, which has now become even more critical. Tools like Zoom, social media, and other technology-driven platforms are essential to our business and will be a focus as we implement these strategies globally based on what we're learning today.

Ivan Feinseth, Analyst, Tigress Financial

Any specific products that you saw a surge in demand, for example, like the immunity products, or even stress management products that surprised you?

John Agwunobi, CEO

I'll turn it over to Alex, just a second, to give you the details if you require. But I will say this; all of our product categories have seen increased sales. It's true that those products that are most associated with immune support, perhaps more than others. But, Alex, do you want to add any detail to that?

Alex Amezquita, Senior Vice President of Finance Strategy and Investor Relations

Yes. Ivan, there has been broad-based growth across the portfolio, as John just mentioned. I did mention immunity in my response earlier, because we have seen that a little bit more disproportionately grow than other elements of our portfolio. But, really, if you look at targeted nutrition, our sports line is up double digits. Targeted nutrition is up double digits. Outer nutrition is up double digits. It's really across the whole portfolio. So we're just grateful for that.

Ivan Feinseth, Analyst, Tigress Financial

That's great to hear and congratulations again. Thank you.

John Agwunobi, CEO

Yes, this is John Agwunobi. I want to begin by expressing how fortunate we are at Herbalife Nutrition for our distributors and their innovation, resilience, and hard work during this crisis. Their connections with customers and preferred members, as well as their community relationships, have greatly impacted their independent businesses and our company as a whole. Looking ahead, our focus is on navigating through this situation while continuing to grow, adhering to our strategy and long-term vision. It is important that we take a moment to ensure that all of you—our partners—stay as safe as possible. We will overcome this pandemic, and our business will thrive and expand in the future, as we have indicated. We believe our model is effective, and it is proving to be successful during these times. Thank you, stay safe, and we look forward to connecting next quarter.

Operator, Operator

Ladies and gentlemen, we thank you for joining us for the first quarter 2020 earnings conference call for Herbalife Nutrition Limited. You may now disconnect.