Q. Who was known as the "Mob's Accountant"?
If you said Meyer Lansky you win a can of Formula 1.
Q. Who was Worldcom's CFO?
If you said Jeff Skilling you are incorrect. Worldcom's CFO was Scott Sullivan.
Q. Do you remember this scene from The Untouchables? Do you remember the witness they were trying to protect?
If you said Al Capone's bookkeeper you win a Herbalife Aloe.
Here's part of the transcript:
"The opportunity for Herbalife has never been better."
In response to a question on Club 100:
"It's not systematic sales practices it's systematic training."
In response to a question on Venezuela:
"Most companies have not moved to SICAD II"
Note the ease with which Mr. DeSimone paints a rosy picture for Ms. Ruhle. Evidently he and Mr. Walsh took the same PR training course.
Nobody knows the numbers at Herbalife better than Mr. DeSimone. Remember that when you consider which one of Herbalife's executive's might turn state's evidence down the line if they haven't done so already.
In the interim, here are 10 crafty accounting decisions Mr. DeSimone makes to deceive investors, regulators and distributors.
#1 Venezuelan Accounting. Herbalife (HLF) generates 4% of revenues in Venezuela. These revenues are booked at an Exchange rate that is roughly 5x more benevolent than the actual practical exchange rate currently available to companies looking to convert Bolivars to $U. Put another way, these revenues are overstated by a factor of 5. In addition, much of Herbalife's historical earnings in Venezuela show-up in the firm's cash balances. This account is also grossly inflated. Herbalife's adjusted eps accounting for an exchange rate closer to 50:1 for current sales plus a charge to cash for historical earnings would have had a material impact on Herbalife's reported earnings last quarter. Instead, Mr. DeSimone made the aggressive accounting decision to mark these accounts to myth.
#2 Distributor Failure Rates/Recruiting Statistics. The quickest place to spot the harm caused by a Pyramid Scheme is by looking at the company's failure rates for its distributors. Deliberately and intentionally, Herbalife does not include this data in its 10Ks and 10Qs. Nor do "business opportunity" seekers receive any information about the percentage of salespeople who drop out of the sales force in this critically important document. Herbalife discloses the results of its recruiting activities in a separate schedule entirely too which can be found here. Herbalife is always keen to tell investors who is coming in the front door of the pyramid. As to who is leaving the back door? We'll let you figure that one out on your own.
#3 Administration Fees - Herbalife generates a number of fee streams from its distributors. Specifically, the company sells IBPs in two flavors, charges an annual $80 admin fee for Supervisors and a $15 admin fee for non-Supervisors. In all likelihood these fees are both material and probably have extraordinary contribution margins.
- 500,000 Supervisors x $80 = $40 million
- 2,000,000 IBPs at $80 = $160 million
- 1,000,000 non-Supervisors x $15 = $15 million
Upwards of $200 million worth of Herbalife revenues may come from fee streams. Assuming 50% contribution as much as $100 million in Operating Income may come from fees. Herbalife hides this idea from its salespeople. IBPs could be as much as $1 per share in eps...who knows?
#4 Shipping and Handling - if you thought Admin Fees and IBPs were a juicy profit center, they hardly compare to Shipping and Handling. Shipping and Handling is a huge profit center for Herbalife. Distributors are up-charged a massive amount. Unfortunately for them, Mr. DeSimone doesn't exactly tell them that in the company's financial disclosures. For more information on just how much profit Herbalife makes from Shipping please read this article. Not only do distributors get scammed by the endless chain but they get fee-scammed on the ride too. Awesome! Now, don't forget too about all the money people pay to attend Extravaganzas and Training workshops, etc.
#5 Retail Sales and Distributor Allowances - Herbalife's 10ks and 10Qs include non-GAAP accounts for Retail Sales and Distributor Allowances. If you can't find them in their SEC filings you might be able to find them in the Fiction section of your local bookstore. All market based evidence reveals that Supervisors use the monopolistic advantage granted to them by the company's price discrimination against its own salespeople (50% off v. 25% off) to discount the sale of product well below SRP. That means that the company's representations to those who seek the "business opportunity" that they payout up to 73% in comp is pure fiction too.
#6 "Consumos" - Mr. Desimone readily admits to Ms. Ruhle, it would seem, that real live people are paying for training in Nutrition Clubs all over the world. As I pointed out in my article yesterday, the FTC would view all commissions generated on these transactions as recruiting rewards. Still, the party line is that revenues from NCs are retail in nature. Hmmmm?
#7 Segment reporting - When Mr. DeSimone took over from Rich Goudis one of the first changes he made was to eliminate the company's historical segment reporting. Herbalife used to classify its non Sales Leaders as either :discount customers, small retailers or future Sales Leaders. Seemingly, if somebody had purchased just shy of $3,000 worth of product then they were considered a future Sales Leader. Historically, at least 50% of non Sales Leaders were "pursuing the business". Now, according to Mr. DeSimone all of these "Members" are mostly just discount customers. Note, too, how Herbalife fails to disclose how much Revenue is generated by each one of its distributor segments. Instead of reporting revenues based on actual orders by segment like this:
- Sales Leaders - X
- Qualified Producers - Y
- Success Builders - Z
- Distributors - T
Investors and regulators get an opaque, mosh-pit type view of the company's business activities. Hiding business opportunity seekers form plain sight seems to be the new M.O. in accounting.
#8 Retail Sales - the shortest distance between two points for Herbalife to demonstrate some degree of legitimacy is to track and report Retail Sales to non-Participants. Evidently this is an impossibility. This impossibility strikes me as evasive when you consider just how crafty Mr. DeSimone is with the rest of HLF's accounts. Certainly if the results of this kind of data collection effort favored Herbalife one would think that the data would have been disclosed by now. Instead, the company is paying millions in fees to investment banks, PR advisors, regulators and "consultants".
#9 Guidance - Herbalife seems to classify litigation expenses, currency write downs, advisory fees, etc. as "one-time expenses" for the purpose of providing guidance to investors. Practically, these expenses seem like an ongoing cost of doing business for Herbalife who is constantly being sued. Of course any rational view of the Bolivar reveals that Herbalife's earnings guidance is pure fiction anyway. Still, as long as sell-side analysts are willing to eat it up who cares?
#10 Herbalife is a pyramid scheme - turns out that if you sponsor a Marketing Plan that promotes the recruitment of an endless chain of salespeople in 91 countries around the world without placing any speed limits nor restrictions on its proliferation that's fraud. Signing off on the financial statements as if the Marketing Plan is legitimate is fraud too. Investors like John Hempton who are obviously relying upon the legitimacy of Herbalife's accounts may be in for a rude awakening. It's not that the books are cooked, per se, as much as the accounting tracks the activities of an illicit enterprise. Be careful John, I don't think Herbalife's Gold Standard, Money Back Guarantee applies to you and your investors.
To summarize, a legitimate MLM would have nothing to hide from investors, regulators, and salespeople alike. Financial results would be presented in a transparent manner. Profit centers would be easy to spot. The success or failure of salespeople would be easy to track. Pride would be taken in how robust the "business opportunity" actually is.
Herbalife's CFO does exactly the opposite. He hides the truth in the numbers and obfuscates the revenues and drivers of this business. Most notably, he hides just how many people fail around the world every year and how much "juice" is taken from its salespeople on the way by.
For those who are actually counting, since the end of 2007 over 8 million people have been torched by Herbalife in some way, shape or form.
You didn't know that?
Probably because Mr. DeSimone wants to keep it that way.
Disclosure: The author is short HLF.
The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.