康寶萊 (HLF) 2011 Q2 法說會逐字稿

Good morning, and thank you for joining the second quarter 2011 earnings conference call for Herbalife Ltd. On the call today is Michael Johnson, the Company's Chairman and CEO; the Company's President, Des Walsh; John DeSimone, the Company's CFO; and Brett Chapman, the Company's General Counsel.

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

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 different materially from those discussed or anticipated. We encourage you to refer to yesterday's earnings release and our SEC filings for a complete discussion of risks associated with these forward-looking statements and our business. In addition, during this call, certain financial performance measures may be discussed that differ from comparable measures contained in our financial statements prepared in accordance with US generally accepted accounting principles, referred to by the Securities and Exchange Commission as non-GAAP financial measures. We believe these non-GAAP financial measures assist management and investors in evaluating comparing period to period results of operations in a more meaningful and consistent manner. Please refer prefer to the Investor Relations section of our website, www.Herbalife.com, to find our press release for this quarter which contains a reconciliation of these measures. Additionally, when management makes reference to volume during this conference call, they're referring to volume points.

I'll now turn the call over to Michael.

Thanks, Brett. Good morning everyone, and welcome to our second quarter earnings call. This has been a very strong quarter. The strong top and bottom line results that we reported yesterday are the results of the hard work of 2.3 million distributors and all of Team Herbalife. We'd like to start off by saying thank you to everyone for their commitment to our vision, and our mission for nutrition. While we are beginning to see the hard work bear fruit, we believe there's still so much more opportunity ahead of us. Frankly, we're just getting started. Let me start this call by recapping some of the financial results included in our earnings release. Record volume points of $980 million, up 17% over 2010. Record net sales of almost $880 million, a 28% increase over the very strong results of the prior year. Record earnings per share of $0.88, a 35% increase over our earnings of the prior year. Notable in our record performance is a 21% increase in average active sales leaders over the prior year. And finally, our cash from operations was $143 million, an increase of 74% compared to the prior year, and a record for us.

The drivers of our growth continue to be distributor engagement and expansion of daily consumption. Through daily consumption more distributors are interacting with more consumers on a regular basis. And these consumers are experiencing product results. This creates a sticky customer. In response to a survey of US nutrition club members, nearly 60% said they attended a nutrition club every day, almost 80% attended more than three days a week, and more than 40% have been attending a club for longer than one year. In a similar survey in Mexico, more than 50% of members responded that they attend every day, and 90% attending at least three times a week. Korean clubs have reported similar statistics with 35% attending every day and more than 80% visiting at least three days a week.

The organic nature of distributor growth coming from within our member base is exciting as it speaks to our longer term growth opportunity. The exciting thing we are seeing is that the newest distributors are coming from our constantly growing base of nutrition club members. We are seeing the development in training of new distributors from the membered base of nutrition clubs or life-style centers. The successful implementation of daily consumption continues to drive both distributor engagement and retention. For the second quarter, average active sales leaders increased 21% over the prior year, and new distributors increased 20%. Both increased in all six of our regions. You may remember from last quarter, our 2010 sales leader retention rate was 48.9%, which we believe is an industry leading number. These metrics of activity and retention tell the story of the strength we are seeing underlying our growth story.

Our distributors are also inspired by the Seed to Feed strategy, represented by our state of the art manufacturing facility in Lake Forest, California. We believe we're continuing to raise the bar in the supplements industry. We have toured thousands of distributors through the facility and our confidence was echoed by Wall Street analyst in a recent report, and I quote, Herbalife's innovation and manufacturing facility is essentially a blending and packaging facility, but undoubtedly one of the most impressive nutritional supplement facilities we have ever toured, and we have toured dozens of facilities over the last 15 years. That ends the quote. If the facility is impressive to a seasoned analyst, imagine the impact on an Herbalife distributor of a tour through their very own manufacturing facility and then returning home to tell their customers and down line how proud they are to be associated with Herbalife and the confidences they have to be in the products that they are selling.

During last quarter's conference call, we mentioned two new initiatives for the Company. The soft launch of our sports nutrition line, Herbalife 24, in the US, and the acquisition of a new Internet based tool for our distributors called iChange. iChange accelerates our presence within social media and is designed to make it easy for our distributors to offer nutrition information to large numbers of customers both within the site and other social media channels such as Facebook and Twitter. Customers get access to free coaching from distributors and access to nutritional tracking tools to help them achieve their goals. It's available anytime and anywhere through their mobile device or a computer. It's a powerful set of tools to help our distributors develop relationships online and leverage their own social networks. During the second quarter, we had a beta group of 500 distributors using the iChange system and next week we'll begin a controlled roll out of the tool to large groups distributors in eight English speaking markets by the end of the third quarter.

In the latter half of May, we had a soft launch of the Herbalife 24 product line, with five of the seven products. Herbalife 24 is our revolutionary new sports product line designed to meet the high end nutritional needs of the 24 hour athlete, such as those on our Herbalife sponsored teams around would world. 100% of the product lots are tested by the Banned Substance Control Group, and independent testing lab, and every canister will carry the BSCG symbol so all athletes can be confident there are no banned substances. The product packaging has QR codes which enable our distributors and their customers to quickly link to a video explanation of the product's science and its benefits. This new line of seven products is truly revolutionary. We believe Herbalife 24 will redefine sports nutrition. Athletes are athletes 24/7, and whether you're a professional athlete, a weekend warrior, or someone who enjoys an energetic walk with friends, there is an Herbalife 24 product, or combination of products designed for your unique needs.

In addition to the long term business opportunity that we believe exists from the launch of Herbalife 24 it also helps our goal to have the Herbalife brand become synonymous with a healthy active lifestyle. As many of you have seen recently, Herbalife is the title sponsor of the World Football Challenge featured on ESPN, Univision, and other networks throughout the world Top football teams such as Real, Madrid, Manchester United, Nan City, CD Guadalajara, Club America, and our Herbalife sponsored teams, the LA Galaxy and FC Barcelona, are competing in cities throughout the US and Canada. The Herbalife 24 products are prominently displayed and available to the players on the sidelines of every game. The amount of press coverage Herbalife has received over the past few weeks both domestically and internationally has been significant. Our nutrition scientists are spending time with each of the team's trainers and coaches introducing them to the benefits of Herbalife 24, and the response has been tremendous.

Before passing the call over to Des, let me conclude my prepared remarks by repeating my earlier comment. We believe we are just getting started. Our aspirational goal is to achieve 10 billion volume points by 2020. Our products and our business opportunities are more relevant for today's marketplace than at any time in our 31 year history. Our highly entrepreneurial distributors continue the globalization of daily consumption business methods that are enabling more distributors to be successful than ever before in our history. Our brand and image are gaining strength and the strategic initiatives being launched all lead us to believe that the momentum will continue and that we truly are just getting started.

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

Thank you, Michael. As Michael mentioned we truly do believe that we are just getting started, and I think you will feel the same as I walk you through some of our regional and country level metrics.

The momentum we are seeing in our business continues to be driven by two key forces. Our distributors commitment to expanding daily consumption business methods around the world, which helps create a long-term, stable customer base, and the continuing commitment of our distributors to Herbalife's mission for nutrition. We continue to see the expansion and daily consumption business methods as a primary driver of our distributor's businesses and Herbalife's growth. We believe the momentum behind this evolution will continue to accelerate as more distributors in more markets have success acculturating daily consumption business methods to their markets. We are often asked about how far along we are in the evolution of the business, and as we evaluate penetration metrics by key markets, we believe we are still in the early stages of this transformation in our business.

Now, let me provide regional highlights, some color on key countries, and by way of background, a little history on the utilization of daily consumption in various regions. This quarter, I'm going to begin my discussion with Mexico, the country where we first saw daily consumption begin to transform the market in 2003 with the proliferation of home based nutrition clubs. So, to those that ask how long a market can continue to grow through daily consumption, we believe that Mexico represents a very good indicator of the potential for long-term growth. Mexico a market where daily consumption has been in place for eight years, just experienced the biggest volume quarter in their history. June 2008 was a record volume month driven by the rapid duplication of nutrition clubs in the market. In June 2011, Mexico topped that record, posting the highest volume in their 26 year history. We believe that the market is a testament to the long-term growth opportunities available through the creation of long-term customers. When we look at the opportunities within a market, we measure per capita penetration, by dividing volume points by population, and in Mexico, in 2010, our per capita penetration was 5-volume points per person, compared to 1.2 in 2003. And while we are very pleased with the deeper penetration, we believe that there is still a lot of room for growth in the market.

In Mexico, local currency net sales for the quarter increased 31%, and volume points increased 26% compared to the prior year period. New distributors in the second quarter increased 28% compared to the prior year. We are very pleased to see average active sales leaders increase 26% for the quarter, compared to second quarter 2010. The revitalization and continued growth in Mexico has been driven by improvements in product access, enhanced training and distributor engagement. With these elements in place, coupled with the stickiness of customers verified and the nutrition club customer surveys referenced by Michael, we believe that the 5-volume points per person is sustainable and indicates the future which lies ahead for many other markets still in the early stages of adopting daily consumption.

North America, the second region to utilize daily consumption business methods starting in 2005, had another strong quarter, posting growth of 7% volume and 11% local currency net sales compared to the prior year period. New distributors increased 4% in the quarter. One of the measurements that we use to gauge distributor engagement, average active sales leaders, increased almost 14% in the North American region, compared to last year's second quarter results. For the quarter, net sales in the US grew 11%. And volume points increased 7% versus the same quarter last year. Compared to the prior year period, new distributors in the US increased 4%, and average active sales leaders increased 14%.

The growth in the US continues to be driven by the expansion of daily consumption business methods. Although the US is our oldest and largest market, per capita penetration is only 2.8 volume points per person, compared to less than 1 in 2003. We see tremendous opportunity for future growth in the US, and are very excited by the expansion of daily consumption that we are seeing take hold in cities around the country. Based on weight loss challenges, nutrition clubs, and other traditional activities focused on creating long-term customers, generation H, our younger distributors, typically under 35 years old, are really beginning to take daily consumption to heart, and are opening very exciting iterations of nutrition clubs that integrate the idea of a healthy active lifestyle, sports, and Herbalife products.

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

In 2007 and 2008, distributors in the Asia Pacific region, specifically South Korea and Taiwan, began to increase their focus on daily consumption and specifically nutrition clubs. By the end of 2010, per capita consumption within those two countries was approximately 4.5 and about 9 volume points per person respectively, which represents an almost fourfold increase over 2003 levels, all driven by the expansion of daily consumption in those markets. And while those markets have driven great growth for our Asia Pacific region over the past few years, we are excited by the seeds of expansion that we are seeing begin to bear fruit in several other markets throughout the region. During the second quarter, local currency net sales for our Asia Pacific region increased 29%, and volume points grew 27% compared to the prior year period. In the second quarter, new distributors increased 42% versus the prior year. We believe the growth within the region continues to be driven by the expansion of daily consumption business methods, and the high degree of distributor engagement. Average active sales leaders increased 31% in the quarter.

For the past several quarters, we've been discussing our excitement about the growth we are beginning to see in India. Well, India was again a highlight in the second quarter, posting volume point growth of approximately 121% compared to the prior year. The Herbalife business is taking root in multiple states throughout India, and we are working diligently to ensure that our infrastructure continues to be capable of supporting this level of growth. When we look at per capita consumption in India, it is a much more difficult measure, frankly because the denominator is just so large. But suffice it to say that we are comfortable that we are just beginning to scratch the surface of our opportunity in India. Similar to our Waldo's program in Mexico, we are currently testing a program to increase access points in southern India with a company that has over 125 locations. We'll keep you posted on this test.

Our South and Central American region posted very solid growth in the second quarter. Local currency net sales increased 44%, and volume points in the region were up 34% in the quarter. Average active sales leaders in the region increased 22%, over last year's second quarter. New distributors increased 23% for the quarter compared to the prior year period. Regionally, we believe that our distributor leadership is seeing the benefits that daily consumption business methods can bring to their markets, and that there is a long runway of opportunity ahead in this region. Bolivia, Columbia, and Peru, while smaller markets for us today, are all beginning to experience solid growth from the expansion of daily consumption and nutrition clubs.

Within the South and Central American region, we need to mention the momentum that we are seeing in Brazil. Brazil experienced volume point growth of approximately 39% in the second quarter, as nutrition clubs as well as our traditional business methods experienced growth. Yet, per capita penetration in Brazil is still only 0.9 volume points per person. This is 2 times what it was in 2003, but compared to the 5 volume points per person we are achieving in Mexico, we believe that there is significant growth ahead in Brazil, and our distributors in this market are just beginning to scratch the surface of the real market opportunity.

Turning to EMEA, this is a region where we are seeing the early stages of growth of daily consumption business models in several different countries. During the second quarter, local currency net sales increased 8%, and volume points in the region grew 7% compared to the prior year. Both average active sales leaders and new distributors in the region improved 14% in the quarter, as compared to the second quarter 2010. Russia continues to be a market which exemplifies the impact of daily consumption, coupled with the enhancements to our marketing plan, first introduced there in 2009. Russia has had another very strong quarter that deserves to be highlighted. Compared to the second quarter 2010, this quarter's volume points were up approximately 46%, with an almost 45% increase in new distributors, and an approximately 45% increase in average active sales leaders. We are seeing healthy expansion of nutrition clubs throughout Russia. And as we saw in Mexico, increasing product access for distributors can be a catalyst for growth, and we are continuing to add to our base of product pickup centers throughout key areas of Russia. Distributor engagement is also growing as evidenced by the 28% increase in attendance at the Russian speaking extravaganza in Minsk during July. While we are very pleased with the volume point growth there, volume points per capita as of 2010 was only 0.4, and therefore we believe there remains an enormous opportunity for further growth as daily consumption continues to make its way into this huge market.

Now, let's turn to China, where local currency net sales declined almost 5% and volume points decreased approximately 9% in the second quarter compared to the prior year period. This is in line with our expectations as we are working hard to transition China to a daily consumption model and we are pleased to see positive indicators out of the market that tell us that this transition is taking root. Specifically, we are seeing changes in distributor ordering patterns. As we have seen in other markets, including Brazil and Korea, the transition to daily consumption can be identified by a pattern of smaller orders, with increasing frequency which is exactly what we experienced in China during the second quarter. So, while we saw volume in China turn negative in the second quarter, average active sales leaders in the country increased more than 25%. Over the past month, we have seen more than 20,000 people at training meetings throughout China. The focus of the meetings has been on growing through daily consumption, and the newly implemented 5K qualification in their market. While we are very pleased with the progress of the business in China, we remain cautious about expecting too much too soon from this market. We are focused there on building a sustainable business on a solid foundation of long-term customers.

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

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

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

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

Thank you, Des. First, comparing this quarter to last year's second quarter, our volume of $980.5 million increased by 17.1% over the very strong 19.9% increase reported for the second quarter last year. Our net sales of $879.7 million represents an increase of 27.7% comprised of a local currency net sales increase of 19.9% plus a 780 basis point benefit from foreign currency. Like last year's second quarter and the first quarter of this year, the top line strength was spread consistently throughout the quarter. As Michael noted in his opening comments, the sixth single largest volume months in the Company's history are each of the months from this year. Our business momentum is very strong. Compared to our guidance we exceeded the high end of the range by 43 million volume points, or 4.6%, and the high end of our net sales range by $46 million, or 5.5%. This improvement versus guidance was consistently spread across the quarter.

As Des has already provided detail commentary on volume, I will turn to gross margin, which for the quarter was approximately 40 basis points better than the second quarter of last year. This was due mostly to cost savings from our Seed to Feed strategy, including benefits from our new HIM facility in Lake Forest. This facility produced approximately 23% of all worldwide inner nutrition production volume during the quarter which was in line with our expectations. Sequentially, the manufacturing facility added 58 basis points to gross margin and we believe that further expansion is possible as we begin to bring manufacturing for other countries such as several of our South American markets into the facility next year. Additionally, our investment in Seed to Feed will continue in the second half of this year when we expect our Botanical Extraction facility will be completed.

Moving onto SG&A as a percent of sales. This quarter improved by approximately 40 basis points versus last year. This includes overcoming a $13.7 million year-over-year swing from gains and losses on foreign currency and hedging transactions. Last year, we recognized $8.2 million in foreign currency gains during the second quarter, which this year was a $5.5 million loss. Excluding the impact of these realized foreign currency related items, and also the impact of China sales employee expense, SG&A as a percent of sales improved 182 basis points on a year-over-year basis. The second quarter operating margin up 17.4%, was 50 basis points ahead of last year, and is an all time high for the Company. The operating margin improvements come from both the short and long-term leverage in the business. We expect to maintain a long-term contribution margin in the 20% range by being disciplined in our strategic investments and by investing in leverageable platforms such as our global Oracle system in manufacturing.

Second, in addition to the long-term leverage inherent in the model, the incremental short-term contribution margin temporarily benefits operating margins when sales significantly exceeds our expectations. This happened in this year's second quarter and last year's. Accordingly, the sequential operating margin profile for the back half of this year should track along a similar pattern as last years, as we look to invest behind this quarter's growth in activities that support and drive distributor engagement. The effective tax rate for the quarter of 27% was approximately 100 basis points better than last year's and 130 basis points better than the low point of guidance. A portion of the improved effective tax rate carries forward as we have lowered the full year guidance range on both the high and low ends by 50 basis points. Also in the quarter, we adopted an accounting method change that positively impacts the effective tax rate and negatively impacts fully diluted share count. This change increased the fully diluted share count by 1.7 million shares in the quarter. From an EPS standpoint, these items effectively offset each other in the quarter and had a negative $0.01 impact from the second quarter of last year. The adjustments for the last six quarters from this accounting change is posted on our website.

Turning to earnings per share. The Company reported EPS of $0.88 which was $0.23 higher than the second quarter of last year, and $0.14 better than the high end of our guidance range. The majority of the upside compared to the high end of our guidance was due to the almost $50 million increase in net sales. During the quarter, the Company generated cash flow from operations of $143 million. An increase of 72% versus the comparable quarter in 2010. Free cash generated during the quarter of $127 million represents 114% of net income. Free cash for the year-to-date period also exceeded net income at 103%. During the quarter we re-purchased 1.8 million shares for a total of $98.9 million. Which leaves $678 million remaining on our $1 billion share re-purchase program.

Now let me discuss our guidance for 2011 both Q3 and full year. Guidance figures are based on exchange rates as of the end of Q2 consistent with our prior practice. For the third quarter, we expect volume point growth of 13% to 15%, while net sales are expected to increase by 21% to 23%. The increase in net sales reflects volume growth as well as the favorable effects of a generally weaker US dollar compared to prior year. EPS is expected to be between $0.71 and $0.76. For the full year, we expect volume growth of 15% to 17% compared to our previous guidance of 12% to 14%, and net sales are expected to be grow 22% to 24% compared to our previous guidance of 18% to 20%. In terms of EPS, we are raising both the low and high end of our guidance range by $0.20 and $0.18 respectively. We now expect full year EPS to be in the range of $2.97 to $3.07 per share.

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

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

Good morning, everyone.

Morning Mike.

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

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

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

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

Okay. Great. Thanks a lot.

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

Thanks, hi guys and congratulations.

Thank you, John.

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

So as you know, John, it's not an exact science, already it's an estimate and it's around 35% and accelerate, because you know, nutrition clubs and daily consumption methods of all types are driving our growth. We don't break out the difference between the various daily consumption methods. As it is, it's not an exact science. But it is a driver.

Okay. You -- if you don't mind using that same inexact science maybe and just telling me, you know, whether, when you break out that 17% total company volume growth, do you think that growth metric was, was substantially higher than that in daily consumption? Or how is daily consumption trending versus, you know, the more traditional methods of multi-level marketing?

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

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

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

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

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

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

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

Thanks, John.

Your next question comes from the line of [Per Offland] with Jefferies & Company.

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

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

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

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

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

Yes it licensing and regulatory. There's long lead times on licensing for importing our products into these countries, and when you change manufacturing locations you have to re-license the product.

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

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

Okay. Then maybe just one last one on 24. It's obviously early days there, but the energy sorts nutrition was up 44% in the quarter. Is 24 some of that impact? And then maybe on that point, is the expectation, you know, is the prevailing expectation that 24 might be a tad cannibalistic in, in the immediate term as a distributor maybe substitutes that for a product they might normally purchase while they're kind of ramping up on learning the selling proposition there?

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

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

Maybe just, and I appreciate you tackling what was obviously a long question there, Michael.

With a long answer. (laughter)

How, how much of the, how much of the new, the new generation, I guess if you will, coming in behind the 24 product? Are they, are they coming in based on, on some of the brand building efforts you've seen around the football challenge and whatnot? Or is it, is it, you know, maybe a regular nutrition club attendee that's learning about it, and, and going about it that route?

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

That makes sense, thanks for all the answers. Congratulations.

Thank you.

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

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

So you know, long-term we recognize there's an opportunity to lower duties by producing product closer to consumption, and we have a long-term strategy to introduce some new facilities whether they're our facilities or, or lines that we control with the partner, it's, you know, maybe 2 year to 4 year project from this point in time. Whether that increases gross margin or actually lowers selling price in the market is yet to be determined, but there is economic benefit by taking advantage of trade agreements and producing, for example, some South American product in Brazil, or Asian product in Southeast Asia. Russian product in Russia. And so forth. So where we're looking is Brazil, somewhere in Southeast Asia probably India, and Eastern Europe.

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

Yes. Tim, Tim this is Des. We actually have already started aggressively promoting that message. So for example, you saw Michael talk about it at Honors. You saw Rich talk about it. Rich now, oddly enough, is probably our, one of our most requested corporate speakers around the world. And we give him a hard time about it every day, but it's a testament to how that message really is resonating with our distributors. In addition we've actually produced a whole set of marketing materials so that our distributors can help pass that message on. And so out on our website we've included just a smaller version of Richard's presentation because we really do believe this is a point of difference for Herbalife. We believe that it is a huge point of confidence and pride for distributors and it's absolutely a message we want our distributors to push out to consumers throughout the world.

Perfect. Thank you.

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

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

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

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

No, I said a 20% --.

Boy, I sure like that, though. (laughter)

Okay. I hadn't heard that before, so I was just making sure.

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

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

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

I guess I was trying to get you to comment on how conservative it was. (laughter).

It's within our guidance.

You know this quarter, you just did 17% volume growth against 20% last year, if I have my numbers correct. You know you're guiding as you always do, prudently in the back half of the year. But with good new distributor and active distributor trends, this momentum shouldn't, shouldn't end here. I just, I wonder if there's anything we should think about in the back half, you know, other than challenging comparisons when we think of volume growth?

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

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

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

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

Thanks. Oh, and Des, you compared China, the transition in China to Brazil. Does it play out probably in the same way as far as duration of when you see the volume really start to pick up?

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

Thank you.

We have time to for two more questions.

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

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

Yes, so, so Chris part of our strategy for Herbalife decade in getting to the, to the, you know, Michael's goal for Herbalife decade of 10 billion volume points is wider and deeper. And obviously wider represents more countries, deeper represents increasing volume points in every market. So in Mexico, as in all our major markets we've adopted this concept of regionalization. And regionalization means that we're focussed with our distributor leaders and the Company working together in increasing volume points on a city by city basis. So if you look at many of our markets historically, we've been focused on the larger cities. Now, we've broken Mexico into numerous regions. We have assigned an internal person responsible for working closely with our distributor leaders in that sub region. They are now based not out of our head offices but they are based in the field.

So every day they're working with distributor leaders, they're planning local promotions, they're visiting clubs, and they're all contributing to the sense of working together with our distributor leaders to grow the business. So I think that's one of the things that we are seeing, and you know, we're seeing that obviously not just in Mexico but many other countries. Along with that obviously, we're expanding our access points in support of that regionalization strategy. And lastly, you know, as always we're working with our distributor leaders to expand and promote great ideas. So and that really is what continues to drive the business. It's, it's that unique relationship that we have with our distributors working locally, city, by city.

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

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

And, and, is it because you just don't, you don't want to talk that granularity of it, get to that level of granularity? Or (multiple speakers) it's a bear to figure out too. Right? I mean is that --?

So, so the one thing we have access to that we don't disclose is our volume point activity by city and by state within each region. So we do know our penetration by sub region, we know where they're going up, but that's not information that is something we want to share.

Right.

It's very competitive intelligence.

No. Understood, understood. That makes sense. And I guess -- I, I imagine --.

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

Yes, yes. No, that -- no, that makes sense, I appreciate that. And I guess your -- the penetration levels you're seeing, if you go in smaller geographic areas, right, I mean, just broadly speaking, is Mexico the place where you have the most penetrated areas for a nutrition clubs. Like, in other words, a city in Mexico or a town in Mexico, is that is that where the best nutritional clubs are, or the highest volume clubs are?

Yes. So, so in answer to your question, again, not an exact science. But directionally, no, we believe that there are even cities in the United States where we have actually a deeper penetration in specific cities. For example, we know one community in the north, in the northern part of the United States where we believe that as many as 20% of the, of the people in a particular communicatory are regular nutrition club members. So, so you know, so we have similar situations in Russia, Brazil and India, Korea also where we have very high concentration of clubs with very, very deep penetration.

And again, by the way, even historically, you know that in Iceland we've had, you know, penetration rates up 18 volume points, 19 volume points per person, and that is in a country of, whatever, 400,000 or 500,000 people. So in terms of where the -- if you're looking to see where's the ceiling? I'm not sure there is a ceiling, but you know, we have markets out there where we've got close on 20 volume points per person. And that's why we say, even in Mexico, with five volume points per person, you know, there's a lot of, a lot of opportunity for growth still ahead.

No, no I appreciate that. I guess what I'm trying to get to, and I know it's not the easiest thing, but you know that path from 5 volume points to 20 volume points, I mean, does that necessitate going to places -- like, is a big part of that going to places where you're not, because penetration may be at 20 volume points in a good part of that country and I'm sure it's not in a large part of the country. But, you know what I'm saying?

(Inaudible) for sure. And that's why the opportunity exists throughout Mexico, and you know, we, we share information on a local basis with distributor leaders to help them identify areas. But the reality is, even in the areas, frankly, where we have the deepest penetration, we believe that we're nowhere close to what that can max out at.

Great. Thanks a lot guys.

Thank you. One, one more question please.

Your next question comes from the line of [Annan Bankuala] with Avondale Partners.

Hi, guys. Thanks for taking my question. Just had two quick questions. The first one, just on re-purchase activity, and where you see that going forward? You know, we had a pretty big jump in the second quarter after almost no activity in the first quarter, are we going to be reverting back to the typical $50 million per quarter? Or what type of run rate should we expect?

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

Okay. And then just one quick follow-up on China. I think it was Des that said that a, there's currently roughly 1,000 clubs in China. Just wondering what that was last year so I can gauge some type of growth?

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

Perfect. Thanks. Guys. Great quarter.

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

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