Herbalife has been making many changes to its business model since activist investor Bill Ackman started alleging that the company is a pyramid scheme. It’s clear that those changes have had an impact on sales, but just how much of an impact has been up for debate.
Now Herbalife management has come clean with more details on just how those changes are impacting the business.
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Herbalife changes volume point structures
In a report dated March 24, Barclays analysts Meredith Adler, Eric Cohen and Sean Kras provided the details of a meeting they held with Herbalife CFO John DiSimone and Investor Relations Vice President Alan Quan. They explained in detail the four big changes the multi-level marketing company made. Three of the changes were implemented after a majority of distributors voted in favor of them, while the third did not require distributors to vote.
The first change was a limit to distributors’ first orders. In the first ten days after they sign up to be a member, they can only order 1,100 volume points of product. Herbalife said this change was made to ensure new members have an understanding of the business model and believe they can make money selling the products before spending too much money on purchasing them.
Second, Herbalife now allows members to qualify as sale leaders with 4,000 volume points in 12 months. Previously, the company had required members to sell either 4,000 volume points in a single month or 5,000 points in two months.
The point of this change was to encourage distributors to grow their business gradually. Herbalife management said retention and productivity are higher. The company said Europe’s retention rate is 68% and that most members there qualified over a longer period of time. In Asia, however, most members qualify quickly, but the retention rate is only 41%.
Other changes at Herbalife
The company also eliminated the field sales concept. These sales are those made from one distributor to another, thus bypassing Herbalife entirely. Now all distributors must purchase their products through Herbalife. The biggest impact from this change is felt in Mexico.
Management said it enables the company to more closely connect with all of its distributors to make sure they have been properly trained and are following the rules. Herbalife said in order to help with this change, it has found retail partners to deliver products to members who live in smaller communities.
The change that did not require a vote from distributors was the decision to keep distributors who have been members for less than three months from opening Nutrition Clubs.
Herbalife sees sales slow
The biggest and most obvious impact from the changes is the slowdown in sales. Members who otherwise would have qualified to be sales leaders in just a month or two are now buying products more slowly.
Herbalife management estimates that this impact will last about 12 months after the changes are fully implemented in all of their markets. Some markets started implementing the change immediately, so the company expects to start seeing part of this slowdown cycle through this fall.
Additionally, the company said it loses members entirely now because some try it out but find they can’t do it. Herbalife said previously members would often purchase 4,000 volume points’ worth of product to qualify as sales leaders before quitting, but now they usually only buy 1,100 points’ worth.
Inventory and distraction issues
Management also said since they did away with field sales, some distributors have excess inventory they are still working through, which will take some time. In the meantime, they’re making fewer purchases.
And finally, they said the productivity of its members has been negatively impacted by the distraction of the changes themselves. For example, they saw big disruption in Mexico where distributors were against the elimination of field changes. However, they think productivity is beginning to recover.
Herbalife has reportedly planned a seven-figure advertising budget in order to assist in the recovery efforts. Among the marketing initiatives is a partnership with the American Red Cross, with the company providing nutritional bars to people after they give blood. The company is also sponsoring the Special Olympics and broke a world record for having the most people participating in a high intensity workout in 24 hours.
Settling concerns about currencies
Another issue that has plagued Herbalife and all U.S.-based companies is the strengthening of the U.S. dollar. Herbalife management told the Barclays team that in the upcoming quarter, they’re hedging all currencies. Some currencies, including the euro, they can hedge for longer periods of time. The purpose of hedging is to cut down on earnings volatility.
One of their hedging practices is manufacturing their products outside the U.S. For example, they manufacture all of the products they sell in China in China. The same is true for Europe and India. In Brazil, they manufacture 60% of the products they sell there. Herbalife is also building a new facility in the U.S.
Additionally, the company is trying to pay more of its operating expenses in local currencies. This initiative is not yet fully implemented. Also Herbalife raises prices only for local inflation rather than due to currency exchange rates.
Herbalife’s other initiatives
Management also addressed the question of share repurchases, rejecting the suggestion of some shareholders that they use some of their cash to buy back shares now. They are more focused on paying back debt because they don’t want to use the cash to buy back shares and force debtors to refinance next year.
And finally, the Barclays team noted that Herbalife has begun a new e-commerce initiative by allowing distributors to customize their own internet platform directly through the Herbalife website rather than by setting up their own websites. Interested buyers can locate distributors through Herbalife’s website to order products, and the distributors can contact them to see if they want to become members. The Barclays analysts believe buyers locate distributors through their zip codes, but they’re unsure.
As has typically been the case, Herbalife management had nothing to say about the ongoing investigations, particularly the undisclosed one the Securities and Exchange Commission (which Probes Reporter uncovered) appears to be involved in somehow.
As of this writing, shares of Herbalife were up 0.51% to $41.60 per share.