Herbalife (HLF) Shares Rocked as Einhorn Questions Distribution Model

May 1, 2012 1:24 PM EDT
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Shares of Herbalife (NYSE: HLF) were smashed Tuesday morning as traders responded to questions from Greenlight Capital's David Einhorn on the company's first-quarter earnings conference call.

Prior to Einhorn's "grilling," as one trader described the hedge fund manager's questioning, Herbalife shares were down under 3 percent. Now into the afternoon session, although off session lows, the stock is still down nearly 20 percent.

Below is a summary of the exchange between Einhorn and several Herbalife execs:

Einhorn: "I got a couple of questions for you... First is, how much of the sales that you'd make in terms of final sales are sold outside the network and how much are consumed within the distributor base?"

President Desmond Walsh: "...we have a 70% custom rule which is basically says that 70% of all products sold to consumers or actually consume my distributors for their own personal use..."

Einhorn: "So, what is the percentage that actually sold to consumers that are not distributors?"

Walsh: "...we don't have an exact percentage David because we don't have visibility to that level of detail."

Einhorn: "Do you have an approximation?"

Walsh: "...well again going back to our 70%, where we believe is that it is that 70% or potentially in excess of that."

Einhorn: "Okay. What is the incentive for supervisor to sign somebody up to become a distributor as opposed to -- if they're just going to consume for themselves as opposed to just selling them the product for the markup. How does the distributor -- how does the supervisor come out better?"

Walsh: Two reasons: "...we know from our business today that many of our future supervisors and business builders come in as customers and then they become distributors. So, the benefit from a supervisor is the ability for greater retention of that customer/distributor because they are now earning a 25% discount. The second issue is that it preserves linage..."

Einhorn: "Right. But just trying to understand this clearly, if I sell to a customer, I bought it - I'm a supervisor, I buy at a 50% discount, I sell to a customer, I make 50 points, if he pays the full price. If he signs up with a distributor and buys it himself, he gets a 25% discount and I get seven points as a royalty. Is that how it works?"

Walsh: "No, you would get the other 25%."

Einhorn: "...One last question, when you had your previous 10-K, you disclosed three groups of distributors at the low-end. You called 29% self consumers, 57% small retailers, and 14% potential sales leaders and then that disclosure did not repeat in the subsequent 10-K. So, I got two questions, first of all how do you track that and how do you characterize and know which ones are which? And second, why did you stop disclosing that in the last 10-K? Is that something that you stopped tracking or just stopped disclosing?"

CFO John DeSimone: "The criteria for grouping distributors into different classes was based off of their volume purchases and we are making assumptions that people below of certain volume. While doing the business, they were buying soft consumption and I don't remember the exact amounts, but I can get it to you after the call, as how we delineated between the three classes. And one the reason that we took out of the 10k is a change in CFO from which to me I didn't view it is valuable information to the business or to the investors. However, we can easily provide the exact same breakout going forward if you would like that sent to you and our investors. Again, I don't remember the exact delineation between the three classes, but I can certainly get it to you. Our objective is to be completely transparent."

While investors certainly can't be happy about the lack of visibility on the "percentage to customers not distributors" question, traders may already be assuming and getting set up for Einhorn to announce Herbalife as his next short position...

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