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Whitney Tilson: Herbalife Ltd. (HLF)’s Shocking Confession

Herbalife Ltd. (HLF)’s Shocking Confession by Whitney Tilson – Seeking Alpha

Whitney Tilson in his email says, “I converted my email this morning into a more in-depth article that I just published on Seeking Alpha (see below). The stock has under-reacted I think – it’s only down ~7%.”

Summary

Herbalife just confessed that the numbers it reported in the last two quarters for one of its most critical metrics, Active New Members, were hugely overstated.

This is terrible news for three reasons: the numbers are much worse, it calls into question the company’s internal systems (and perhaps integrity).

And it highlights that Herbalife is so complicated that not even the company itself can get its arms around it.

Shareholders, analysts and regulators should demand that management immediately answer a number of important questions.

The Herbalife (NYSE:HLF) saga has had so many twists and turns over the years that I thought I’d seen it all — but I was wrong…

Herbalife just confessed in an 8-K filed early this morning that the numbers it reported in the last two quarters for one of its most critical metrics investors and analysts use to evaluate the company, Active New Members, were hugely overstated due to “database scripting errors” and “quarterly aggregation issues.”

I’ll give you three guesses which direction almost all of the errors are… And the adjustments aren’t small — they’re huge. Here are the highlights (lowlights):

In Q4 ’15

  • The company reported that “Worldwide, active new members’ excluding China was up 16.7 percent in the quarter”. The actual number: +3.2%.
  • In the U.S., the company reported a 71.0% increase. The actual number: +30.7%.
  • In Europe, the Middle East and Africa, the company reported a 44.0% increase. The actual number: +17.7%.

In Q3 ’15

  • The company reported “On a worldwide basis excluding China total number of new active members was up 21.0% compared to the prior-year period.” The actual number: +8.7%.
  • In North America, the company reported a 33.0% increase. The actual number: +1.8%.
  • In Europe, the Middle East and Africa, the company reported a 34.0% increase. The actual number: +10.2%.

For the entire year (2015)

  • The company reported that “[Worldwide active new members, excluding China] up 8.3% for the full year.” The actual number: +3.4%.

Why This Is Terrible News

I’m sure Herbalife bulls will say that: 1) This doesn’t affect reported financials (or so the company claims); 2) Active New Members are still growing (albeit at a slower rate); and 3) In two countries (Mexico and Brazil), correcting the errors slightly increased growth.

But anyone who views this new disclosure as anything but terrible news for the company is kidding themselves for three reasons:

  1. The much-worse number undermine management’s claims that the business is getting better;
  2. It calls into question the company’s internal controls and systems (and perhaps integrity); and
  3. It highlights that Herbalife is so complicated that not even the company itself can get its arms around it.

Herbalife’s Active New Members Is a New, Made-Up Metric

It’s ironic that this metric is causing trouble for Herbalife because Active New Members isn’t a GAAP number – rather, it’s something the company just made-up a few months ago and first started using on its Q3 conference call in November, supposedly as evidence that things were getting better (kudos to Quoth the Raven, who noticed this and asked shortly thereafter, “Why is the company using a term called “active members” on its latest conference call that does not appear in any filings or any previous conference calls and has not been defined?”) It really says something when you can’t even get your made-up metrics right!

Questions Management Needs to Answer Immediately

Shareholders, analysts and regulators should demand that management immediately answer the following questions:

  • Management first used this metric on the Q3 ’15 conference call on November 3, 2015 and again used it many times on the Q4 call, yet has never fully defined or explained it. Does management plan to continue using this metric and, if so, does it plan to better explain it?
  • Management trumped the strong Active New Member growth as evidence that the business was getting better. Now that they know that Active New Member growth was, in fact, far lower, is this evidence that the business is doing poorly?
  • Now that management is aware that Active New Member growth was so much lower than they thought, does this affect guidance going forward?
  • When did the company learn of this error and how much time elapsed before it was disclosed?
  • Why did it take so long to discover the error?
  • Who discovered it? Was it someone internal or external?
  • Should shareholders be worried that this mistake is indicative of larger problems with the company’s internal controls and systems?
  • How does the company propose to compensate shareholders who bought the stock at inflated prices based on incorrect information?
  • Given that the company trumpets Active New Member growth as a critical driver of the revenues and profits of business, how is it possible that slashing Active New Members has no impact on the company’s reported financials? Is there any chance that at restatement will be necessary?

Disclosure: I am/we are short HLF.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

Whitney Tilson Herbalife Ltd. (HLF)

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