In its second quarter earnings release yesterday, the company reported $1.1 billion in net sales, which was a decline of 5% over the same period a year previous. But profits came in stronger than expected. Reported net income for the second quarter was $137.6 million or $1.61 per diluted share.
FTC rollout nears completion
On an earnings call with analysts yesterday, new CEO Rich Goudis attributed some of the top line revenue disappointment to drops in the markets in China, the US and Mexico. He characterized most of these shortfalls to issues surrounding the implementation of the agreement the company came to with FTC more than a year ago. In that settlement, in which Herbalife agreed to pay a $200 million fine, the company also pledged to put in place a series of practices that would help draw the bright line between a pyramid scheme and a legitimate network marketing business.
The line that separates a legitimate network marketing company from a pyramid scheme is determined by whether the business exists as a way to sell a product or a service for which there is demand in the marketplace, or if it is simply a vehicle to sign up new members who would inject cash into the system by paying initiation fees, paying to participate in training events, buying large amounts of products, etc.
Drawing the line
FTC said that among the specific changes Herbalife has agreed to make that will bring them into compliance on this point are:
• The company will now differentiate between participants who join simply to buy products at a discount and those who join the business opportunity. “Discount buyers” will not be eligible to sell product or earn rewards.
• Multi-level compensation that business opportunity participants earn will be driven by retail sales. At least two-thirds of rewards paid by Herbalife to distributors must be based on retail sales of Herbalife products that are tracked and verified. No more than one-third of rewards can be based on other distributors’ limited personal consumption.
• Companywide, in order to pay compensation to distributors at current levels, at least 80% of Herbalife’s product sales must be comprised of sales to legitimate end-users. Otherwise, rewards to distributors must be reduced.
• Herbalife is prohibited from allowing participants to incur the expenses associated with leasing or purchasing premises for “Nutrition Clubs” or other business locations before completing their first year as a distributor and completing a business training program.
The company is now collecting receipts on end sales to consumers, and the tools are now in place across the company’s markets to do that. The transition period had an inevitable impact on the business, Goudis said. But president Des Walsh said the transition period is now over:
“What our distributors have shown us is that they are in a position to comply with the order, they’ve got the tools, they’ve got people engaged and now it's time to get back and refocus on the business. And I think that’s what we’re seeing,” he said. The transcript of the earnings call was posted on the site seekingalpa.com.