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As all who follow Herbalife (NYSE:HLF) know, Herbalife is under the gun to prove that it generates legitimate retail sales. So, Herbalife disclosed in its conference call today plans to adjust the company's nomenclature for distributors beginning in April.

Specifically, President Des Walsh made the following statement:

"The next area that we're focused on is our nomenclature. There is a misperception in the market that frankly people have thought to capitalize on. Because when a person hears the term distributor, then they naturally assume that that is somebody that is distributing Herbalife products.

What we, of course, know from our research (see Lieberman)is that a very significant percentage of people who become distributors do so in order to receive a wholesale price on Herbalife products because they are avid Herbalife users. (Author's note - these "avid" users typically churn out in less than a year) So what we want to do is that we want to simplify matters by breaking out that group and identifying them separately so that it's clear that this is a group that are not distributing product, but rather are engaged as wholesale customers."

Q. How does Nuskin (NYSE:NUS) deal with "wholesale customers"? Here is a link to Nuskin's Distributor Agreement in the U.K. Nuskin allows individuals to sign-up as Preferred Customers as part of their consumer network. However, when a consumer does this they agree to a very specific set of terms and conditions.

Specifically, the agreement states:

1. I wish to purchase products from NSE Products Inc. at the wholesale price, with the option of becoming an Independent Distributor at a later date.

2. As a Preferred Customer, I am entitled to purchase products for personal consumption only.

3. I understand that I am not entitled to sponsor other persons in order to become an Independent Distributor. I am not allowed to resell or promote the sale of NSE Products Inc. products so I am not entitled to receive commission payments.

4. Products returned within 90 days from delivery will be fully refunded, provided the packaging of the returned products is unbroken. For these purposes, I understand that the following conditions apply:

• I must inform my local Nu Skin office within 90 days of the retail purchase date, and

• I must obtain an RMA number from my local Nu Skin office and provide them with the receipt, and

• I must return the products to my local office at my own cost.

5. I understand that the Company reserves the right to adjust and amend the terms of this contract. Notice of such adjustments and amendments will be published at least 30 days before being made effective.

6. I understand that this Agreement will be automatically terminated if I have not made any purchases for a period of 12 months. I may change Sponsor at any time, unless I have an ongoing Automatic Delivery Rewards (ADR) order, in which case I will be required to terminate that and wait for six (6) months before signing up with a new Sponsor.

7. I understand that this Agreement will last for an indefinite period, unless cancelled in writing by myself. The Company will discontinue the Agreement within 30 days of receiving the written notice.

8. I understand that if I wish to become an Independent Distributor, I am required to apply by completing the relevant details regarding Independent Distributors on the Independent Distributor Agreement form. To sign up as an Independent Distributor under a different Sponsor, I will be required to terminate my Preferred Customer Agreement and observe a six (6) month waiting period, during which no purchases or other distributor-related activities can be made by me.

9. I agree and consent that the personal data specified in this Agreement as well as personal data collected in the performance of this Agreement is necessary for the Company to operate and co-ordinate the Nu Skin distribution network and carry out its obligations under this Agreement. The data collected is used by the Company's internal and external departments taking part in the operation of the management of the distribution network. It will be transferred outside the European Economic Area for the purpose of processing by the Company. I understand that I may have access to the personal data relating to myself and have it corrected if it is incorrect.

Nuskin's Distributor Agreement for "wholesale customers" clearly establishes a bright line between who is a customer and who is a distributor. In practice, the first line of the application requires the applicant to check a box and select one definition or the other.

Herbalife has recently argued to investors that most of its distributors with no downline are not distributors at all, but are just "wholesale customers". To date all we have as evidence to support this claim is their word. Pershing Square argues these individuals are failing at the business opportunity and churning out every year. Pershing Square argues that these individuals are victims of the Herbalife pyramid scheme.

This begs the question, will Herbalife require its Junior distributors to agree to similar terms and conditions as Nuskin distributors in order to, in like manner, establish a similar bright line?

The implications of this kind of change are material for Herbalife for a number of reasons.

1. If a wholesale customer is not allowed to pursue the business opportunity then potentially Herbalife's recruiting apparatus may be curtailed and its growth prospects may diminish.

2. If it is clearly revealed that hundreds of thousands of Herbalife distributors are simply customers who are buying product strictly for "personal consumption" then what does that say about the business opportunity? How do "distributors" compete as retailers if "wholesale customers" can buy directly for 25% off? Why would anyone pay SRP for the product?

3. Will Herbalife require "wholesale customers" to buy inventory directly from the company like Nuskin so they can clearly track this retail activity? Today, purchases can be made from upline distributors.

4. How will investors respond when it is confirmed that many if not most of Herbalife's distributors are not distributors at all?

5. What if any breakage/resignation might Herbalife encounter if it requires Junior distributors to clearly select "I am a distributor" or "I am a wholesale customer"?

6. If Herbalife doesn't require distributors to make a bright line selection, how can regulators and investors be sure that the company's pending nomenclature will be credible? How can it ask the market to accept a process that lacks the integrity of Nuskin's process?

7. What are the implications of this change on Herbalife's Sales Tax collection policies? Today Herbalife collects Sales Tax as if all product is sold at SRP. Now we are told that a significant volume of product may actually be sold at retail prices 25% to 50% below SRP. Does this not mean that Herbalife has over-collected all historical Sales Tax? Does this become a future liability for the company?

8. Will Herbalife adjust wholesale prices to charge all distributors a level wholesale price in the future? Nuskin does not discriminate on price between its Preferred customers and distributors.

Historically, Herbalife has used different nomenclature to describe Jr. distributors including "small retailer", "discount buyer", and "future Sales Leader" - except each of these labels was based upon the assumption that a certain level of Volume Points mapped to a certain type of behavior without specific evidence.

Nuskin makes no such assumptions. On the contrary, Nuskin hard codes its Preferred Customers and backs-up its policy with strict rules and guidelines so that they can prove to regulators and investors alike the difference between a legitimate "end user" and an individual who might be "personally consuming" while also dabbling in the business opportunity too.

To date, Herbalife wants investors and regulators to give the company the benefit that personal consumption should be counted as retail activity. However, they have not put any teeth behind their policies and procedures to clearly separate "wholesale customers" from "biz opportunity seekers".

We are told the company will pursue changes to its nomenclature in April. Ostensibly, this doesn't seem like a big deal. In practice, the implications of this kind of change may be material for Herbalife investors in a negative way.

The key question is: Will Herbalife copy Nuskin or not? Will distributors have to choose to be either a "wholesale customer" or a "distributor" without the nonsensical and muddy idea that they can be both for regulatory purposes?

Nuskin has attacked this regulatory issue with vigor. Will Herbalife be equally courageous? Time will Tell.

In the interim, Herbalife still has not disclosed any material evidence that it produces legitimate outside retail sales at all.

Source: Nomenclature: Will Herbalife Copy Nuskin?