of Herbalife’s Q2’13 10-Q notes that Herbalife’s effective tax rate decreased from 28.1% in Q2’12 to 23.4% in Q2’13 “primarily due to an increase of net benefits from discrete events, principally related to favorable tax audit settlements, and the impact of changes in the geographic mix of the Company’s income. (emphasis added)”
- Why does the Company add-back non-recurring expense items when calculating Adjusted EPS, but fail to deduct benefits such as the favorable settlement of tax audits that the Company itself describes as “discrete events?”
- Given that the Company has been sued numerous times for being a pyramid scheme, and given that, in the past, other investors have raised allegations about Herbalife’s business model similar to those issues raised by Pershing Square, why does Herbalife consider “expenses incurred responding to attacks on the Company’s business model” a non-recurring expense?
- Has PwC reviewed the Company’s Non-GAAP adjustments and provided the Company with an opinion as to whether or not they are appropriate?
Page 22 of Herbalife’s Q2’13 10-Q notes that “the Company recorded $8.1 million and $17.6 million, respectively, of professional fees and other expenses related to [expenses incurred responding to attacks on the Company’s business model].” The 10-Q further notes that: included in these amounts are expenses related to “a cash settlement liability award, or the Liability Award, outstanding as of June 30, 2013, which is tied to the Company’s stock price and which only vests if certain conditions are met relating to the above matter.”
- Please provide a detailed breakdown of the $17.6 million of expenses relating to this matter.
- Who is the beneficiary of this Liability Award and how is it determined?
Senior Distributor Departure Disclosure
Herbalife’s SEC filings contain vague statements that Herbalife’s “sales leaders, together with their downline sales organizations, account for substantially all of our revenues” and that “the loss of a group of leading sales leaders, together with their downline sales organizations, or the loss of a significant number of distributors for any reason, could negatively impact sales of our products, impair our ability to attract new distributors and harm our financial condition and operating results.” (HLF Q2 FY 2013 Report on Form 10-Q, page 45)
- Given that two very senior distributors, Anthony Powell and Shawn Dahl (one of 39 Chairman’s Club members), have left Herbalife (Powell in Q1 ’13 and Dahl late in Q2 ’13), why isn’t the current and future impact of the loss of these two senior distributors quantified in any way, and disclosed in Herbalife’s MD&A? Have other senior distributors departed, and what is the likelihood of more senior distributor departures in the future?
- When do you plan on reinstituting the Chairman’s Club website (http://www.herbalife.com/chairmansclub), which Des Walsh said on the last conference call is down for “scheduled maintenance”? Why does the scheduled maintenance of the website take months to complete?
The Impact of Pricing Increases
Page 30 of Herbalife’s Q2’13 10-Q notes that net sales in Brazil increased 32.7% in Q2’13, partially due to “a price increase of approximately 4.0% in March 2013 which contributed to the increase in sales.” Similarly, net sales growth in Venezuelaincreased 73.1%, fueled, in part, by “price increases of 15% in December 2012 and 17% in April 2013.”
However, page 31 of Herbalife’s Q2’13 10-Q explains the decrease of net sales in Malaysia by 20.1% in Q2’13 by saying: “the decrease in net sales for the three months ended June 30, 2013 was primarily due to a price increase that took effect at the end of March 2013. As generally occurs, distributors reacted to the announcement of the upcoming price increase by accelerating their purchases in advance of the price increase, which increased sales for the first quarter of 2013 but led to lower sales for the second quarter of 2013.”
- Why do price increases lead to increased net sales in certain countries (i.e. Brazil and Venezuela) but cause decreased net sales in other countries (i.e. Malaysia)?
Amendment To The Agreements Of Distributorship
On July 18, 2002, the Company published a Notice To Distributors regarding Amendment To The Agreements Of Distributorship between Herbalife International, Inc. and Each Herbalife Distributor. As part of this agreement, “the Company may not, in countries where the Company is currently operating, materially change the relative relationship between the volume points, the adjusted retail price and/or the retail price of all products sold by the Company in the markets in which such products are being sold, unless such changes are made to convert adjusted retail prices up to a full retail price basis (i.e., one volume point per US $1.00 in the United States) or unless such changes are required by applicable law or are necessary in the Company’s reasonable business judgment to account for specific local market conditions or local currency conditions to achieve a reasonable profit on operations in such respective market or markets.”
We note that, since 2004, the ratio of “Retail Sales” to volume points in North America has increased from a ratio of 1.04x to 1.20x (as of Q2’13). This has the effect of increasing the price a distributor must pay to “buy” a volume point.
- Given that the ratio of retail sales to volume points has increased ~15% since 2004, why is the Company not in violation of the terms of the agreement it signed with its distributors in 2002?
Distributor Churn
Page 8 of Herbalife’s Q1’13 10-Q stated that as of March 31, 2013, the Company had 3.6 million independent distributors, which included 0.2 million in China. Page 8 of Herbalife’s Q2’13 10-Q states that as of June 30, 2013, the Company had 3.4 million independent distributors, which includes 0.2 million in China. This implies non-China distributors decreased a net 0.2 million from Q1’13 to Q2’13. We further note that Herbalife’s Regional Key Metrics supplement shows that Herbalife gained 517,701 new distributors in Q2’13 (excluding China).
- Is it correct to assume that 717,701 distributors exited the business in Q2’13 (3.4mm + 0.518mm – 3.2mm = 0.718mm)?
- Given that the Company had 2.9mm non-sales leaders (excluding China) as of Q1’13, this implies a ~98% annual churn rate in the Company’s non-sales leader distributor base (0.7mm / 2.9mm = 24.4% * 4 = 98%)? Do you agree with this calculation? If not, what is the annual churn rate for non-sales leader distributors?
- What is the reason for the wide variance in the implied non-sales leader distributor churn metric from Q1’13 to Q2’13?
- Why doesn’t the Company provide new distributor numbers and non-sales leader churn metrics in its audited public filings, along with explanations for the change in the underlying churn rate?
Visit www.factsaboutherbalife.com to view Pershing Square’s presentation and to learn more about the company.
About Pershing Square Capital Management, L.P.
Pershing Square Capital Management, L.P. (“Pershing Square”), based in New York City, is a SEC-registered investment advisor to private investment funds. Pershing Square manages funds that are in the business of trading — buying and selling — securities and other financial instruments. Funds managed by Pershing Square are short the stock of Herbalife Ltd. Pershing Square may increase, decrease, dispose of, or change the form of its investment in Herbalife for any or no reason, at any time. Pershing Square may change its views about or its investment positions in Herbalife at any time, for any reason or no reason. Pershing Square may buy, sell, cover or otherwise change the form or substance of its Herbalife investment. Pershing Square disclaims any obligation to notify the market of any such changes. Please see the full Disclaimer appearing on
