Unveiling Herbalife’s Earnings Disaster Shows the Pyramid in Collapse

For my friends at various regulatory agencies, this is what it looks like when a pyramid scheme begins to collapse:


In true Madoff fashion, the jig at Herbalife is almost up. Ironically, it’s coming at the hands of Uncle Sam in a different way than first thought. While the regulators likely work dutifully to mount the evidence necessary to prove that Herbalife is a pyramid scheme, the strong U.S. dollar has done them a favor and catalyzed the destruction of the company by limiting its cash inflows. Look at Mexico – find it interesting that there’s a direct correlation between sales and new members? Find it interesting that all of these metrics move in “lock step” with each other?


When do schemes collapse? As Zero Hedge says, “Ask Madoff.” They collapse when not enough cash comes in. That’s Herbalife’s problem – cash from operations is declining – and they no longer have a balance sheet to fall back on.

God help the bankers that have been approached by this company to refinance their debt, or potentially take on an LBO.


Here’s some thoughts to get us started on Herbalife’s horrendous fourth quarter report that came out yesterday. If you’re looking for more short, simple analysis about why this past quarter telegraphs complete destruction of the company, you can read Zero Hedge’s fantastic piece on earnings here.

Incidentally, I think I found Herbalife CFO John DeSimone’s favorite movie. Herbalife hid a horrendously bad quarter and misses on absolutely everything behind one number: an “adjusted” EPS number which excluded everything from currency headwinds (which are very real parts of the business) and costs related to the FTC inquiry and Ackman, which totaled about $25 million last year (also a very real part of the business).

Jeez, instead of spending all of this money, why not just answer some of those key questions Ackman keeps asking? You know, pesky questions like “Why does a global nutrition company need it’s own ATM’s in Mexico?”

That’s weird. And it reminds me – it’s laundry day.

I give you John DeSimone, starring in:


If you were looking for obfuscation, look no further. As I write this, I’m watching more and more smoke and mirrors being unveiled from Herbalife’s 10-K. Take a look yourself and see if there isn’t something absurd that you can’t point out – play along at home! For instance, here’s one example that alert 10-K reader @Mattintoronto eloquently pointed out:


Ah, it seems that behind the “adjustments,” there’s even more “adjustments”. Could it be that if you so much as scratch the surface under the $1.41 “adjusted” EPS number, you’re likely to find a treasure trove of expectations being missed, combined with even more obfuscation? But, wait. Maybe it’s just me, Matt, and other “knuckleheads in bathrobes” that think the numbers are a veil over the poor operating results. Surely no one else on Twitter thought Herbalife could be pulling a fast one on us, right?

ob1 ob5 ob7 ob8 ob9 ob11 ob13 ob15 ob16 ob18 ob20 ob21 ob23 ob24 ob40 ob587

Look, the facts are – if you take away the $1.41 “adjusted” EPS, this earnings report was a full-scale, four alarm emergency. You can stare at that adjusted $1.41 EPS number until your eyes bleed, it doesn’t change the fact that Herbalife is in deep, deep, trouble.

Here’s some lighter points I’d like to lead with, before digging into the ugly stuff:

  • The lack of color on potential buybacks in the future denotes to me and others that the company may not have gotten friendly responses from bankers with regard to refinancing their debt. (h/t Matt Stewart)
  • Feel like you were rushed off the conference call? The first words out of the company’s mouth were that they were going to try and keep it short. Why? Because for this quarter, the less detail, the better – who wants to discuss a train-wreck of a quarter?
  • Michael O. Johnson valiantly claimed on the call that the company left 2014 with a “healthy” balance sheet. Is that what we’re calling negative $400M+ in shareholder equity nowadays? The company has no balance sheet, and hundreds of millions in assets that they do have are intangible (read: worthless).
  • Des Walsh, President of the company, who is normally the one who lends his cheery Irish brogue to lay out the volume point specifics in each region, didn’t even make an appearance but for some quick words at the end. Again, no point in opining on the horrible regional recruiting numbers.
  • Absolutely nothing was said about the regulatory inquires. So much for those e-mails I got today suggesting the company was going to “announce they were in negotiations”.
  • Conspicuously absent from the call was perma-bull Meredith Adler, of Barclay’s
  • The company mentioned their product (Formula 1) on the call only once (I believe, from memory). The company spent the rest of the call speaking about recruiting and meeting qualification standards for recruiting. If this is a nutrition company, why was the entire (abbreviated) conference call about ways to recruit sales leaders? This is a recruiting company, not a product company.


Now, onto Venezuela. First, a bit more “creative” chart making – here’s Herbalife showing volume point declines in five out of seven regions. Yet, conveniently Venezuela just “doesn’t count,” so they break that off into its own row and offer an “adjusted” number. It’s a great way to run a business, right? Focus on your successes and completely ignore where things have gone horribly wrong. I can’t believe their securities lawyers let them get away with this and I hope the SEC is paying very close attention to all of these “adjustments”.

Declines: North America, Asia Pacific, Mexico, South & Central America, and Venezula

Increases: EMEA, China

qtr4As you recall, the company is a bit slow on the uptake when it comes to their Venezuelan accounting. With recent news that the Bolivar has been devalued and now trades regularly around 170:1 with the U.S. dollar, you’d think Herbalife would update their 50:1 SICAD II rate which they’re using. This would result in a write off of about $30-$35M and affect future guidance by about $0.15-$0.20 per share, if my back of the envelope math serves me right. Maybe I’m just the only one that noticed this and thinks it’s ridiculous. No, wait, nevermind:

venez venez2 venez3


And while we’re on the topic of Venezuela, what’s the point of the company holding an extravaganza event there, as they did this past month, when the currency is worthless and the business there has basically been written off?

“Bueller? Bueller? Bueller?”


Now, let’s talk about how we know this pyramid scheme is in collapse.

When the cash flows start to wane and slow down, in any business, people generally turn to the balance sheet. The balance sheet is the “castle” of sorts, can be used for leverage to raise capital necessary to turn businesses around, and it’s what gives the company a book value. Herbalife’s balance sheet, as show in the below tweets from @FearandGreedSA and @Zerohedge, has become increasingly, horrifically leveraged. If you’re not an accounting buff, use the color codes. Green means “pyramid scheme” and red means “pyramid scheme that’s way over leveraged with tons of debt”.

fear and greed 4

zero headge 2

The same alert reader points out that the company’s free cash flow is heading in the wrong direction. In Madoff’s case, this is comparable to when investors all of a sudden wanted to take out more money than they were depositing. Not good.

fear and greed

And Zerohedge shows us cash from operations overlaid with stock buybacks. Again, the buybacks have dried up – most of them were undertaken while shares were above $50.


zerohedge 2

While the business is collapsing on itself, there’s also that pesky question of regulator intervention. @ProbesReporter pointed out the other day that the SEC investigation of the company is ongoing. They posted this response to a FOIA request, which indicates that an “on-going enforcement proceeding” continues.


Then, we have this in the company’s 10-K. Wouldn’t it be something if other attorneys general, like Kamala Harris in California, turned out to also be investigating?


And in other regulatory news, it was announced during the afternoon on February 27 that the SEC had shut down an international pyramid scheme that targeted Latino communities. I don’t want to say that’s a bad omen for Herbalife, but Herbalife does happen to be an international pyramid scheme targeting Latino communities. So, call that what you will. The release can be read here, and it looks like this:



As Mr. Ackman said on his last appearance on Bloomberg, this has now become a “race to the bottom”. You can also watch his last appearance on CNBC here, where Joe Kernen interrupts him after asking him questions (Herbalife discussion starts at 7:29). At least he didn’t hiss at him, I guess.

If you’re a regulator and you’re reading this, all you need to do is take a quick glance behind the EPS to see Herbalife is in trouble. The facts of this report were:

  • The company “interestingly” beat the top end of their Q4 guide by $0.01.
  • Gross margin, “mysteriously” still hasn’t fluctuated, despite the major global volatility
  • The company missed on revenue
  • The company guided down, again, for FY2015 by nearly 20% less that previous expectations
  • The company guided down net sales for 2015
  • The recruiting numbers have fallen, despite retention increasing
  • Volume point numbers (congruent with purchasing) are down in 5 of 7 regions
  • The low end of the company’s cash flow guidance for next year is, I believe, extremely optimistic
  • The company is, I believe, on their last growth legs in China, as they’ve now reached all 32 provinces


But, I’ll let @Amabonovella simply sum this one up:


The sooner regulators shut it down, the better.

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