Herbalife reported second quarter net earnings of $1.2 billion, which represented a 3% year-over-year increase. The company reported a loss of $22.9 million in the quarter, though, caused mostly by the $203 million paid out in regulatory settlements.
CEO Michael Johnson and CFO John DeSimone spoke with analysts on an earnings call this week. The call was posted in transcript form on the site seekingalpha.com. The pair spent much of the call discussing the specifics of the company's settlement with the Federal Trade Commission (the company also settled a case brought by the Illinois Attorney General). FTC had begun investigating Herbalife in 2014, and while the agency does not make details of its investigations public, the nature of the settlement makes clear that the primary purpose of the probe was to determine if Herbalife represented a legitimate multilevel sales organization or was an illegal pyramid scheme.
New structure mandated by FTC
To settle these concerns, Herbalife agreed to change the way sales are accounted within the organization. In the past, when a shipment went out the door with a distributor’s shipping address on it, that transaction was counted as a sale, more or less. FTC was demanding more granularity and specificity on where those products were going and who was consuming them (or if they were languishing in a distributor’s garage). The key point for the agency was putting into place a structure that could demonstrate that sales were occurring because consumers wanted to use the products, not because distributors wanted to qualify for higher bonuses based on the volume of products shipped to them, and that the ultimate purpose of the organization was sales, not the recruitment of new distributors.
Herbalife agreed to implement a new accounting tool that will record sales receipts to consumers. Included in that system is a limit to the amount of product distributors can buy and account for as being intended for their own personal use. But Johnson said that the new system will not change how much distributors can potentially earn. Johnson did not discuss on the call changes FTC mandated to the way that Herbalife presents the business opportunity to new distributors to more accurately reflect what they could reasonably expect to earn. Despite the promise held out that distributors could earn career-type income surpassing six figures annually that would allow them to quit their regular jobs, FTC said the reality is that very few distributors earn significant commissions.
Johnson said Herbalife had a deadline of May of 2017 to implement the changes. But he said the company plans to have them up and running by early next year. Getting out from under the FTC cloud will help the company focus on renewed growth, he said.
“Distinguishing customers from business-building distributors simply makes sense. It is something our management and our member leaders have been contemplating for a while because we know that it will allow us to better tailor our products, training and services to meet the distinct needs of each of these groups,” Johnson said.
“I'm confident that once implemented, the changes currently being introduced will once again be a catalyst for growth,” DeSimone said.
Herbalife’s strong Q2 showing is all the more impressive given some of the markets the company operates in. Turbulence in the currency markets and regional economic concerns are issues that have affected all companies doing business globally. China’s economy, while still growing strongly, has retreated from the 10% or better returns of a number of years ago, and analysts are starting to come around to the idea that the country’s economy is starting to mature and growth rates of 7% or less will be the new norm. Venezuela’s economy is in a state of collapse and its currency has become next to worthless. And Brazil’s economy, while still functioning (unlike Venezuela’s), is in a state of deep recession as the national political crisis continues. China has devalued its currency over the past couple of years and the Brazilian real was worth about 60 US cents four years ago but is worth only about 30 cents today. Herbalife has had significant operations in all three countries.
“Like many multinational companies with a majority of their sales outside the US, currency exchange rates have really worked against us over the last few years. The combined effect of currency headwinds over the past three years has negatively impacted our full-year 2016 adjusted earnings projections by almost $3 per share, including Venezuela, and $2 per share, excluding Venezuela,” DeSimone said.
Herbalife’s volume of product sold declined in China and sank more steeply in South America. Those setbacks were more than made up with strong results in North America and in the company’s EMEA (Europe, Middle East and Africa) region. The North American results in particular where surprising, given that Herbalife, along with some other network marketing companies focusing on nutritional products (Usana for example), had shown flat to declining sales in the region for a number of quarters.