Herbalife (HLF) Sees Volatility As SEC Questions Discussed

Herbalife Ltd. (NYSE: HLF) is seeing some whipsaw trading mid-day following a report from CNBC's Herb Greenberg highlighting the recent questions asked by the SEC asked about financial reports.

The letter shows the SEC has concerns about the discussion of the "70% rule" in the company's 8-K on May 2nd. The SEC effectively asked the same questions asked by David Einhorn on the May 1 conference call - "why do you no longer view the percentage of distributors who are considered 'discount buyers, small retailers and potential supervisors' as relevant."

The company answered this question in a letter dated June 18th.

"We divided non-sales leader distributors into the three general categories…based on historical sales order size. We originally disclosed these percentages because at one time we believed that sales orders placed within a given category was an indication of the business intention of the non-sales leader distributor that placed the associated order. However, with changes in the business over time we determined that sales order size was no longer a reliable indicator of the business intention of the non-sales leader distributors and therefore not as useful as we initially believed. While we have not historically placed great significance on this information in our periodic filings and, in the absence of any established use for the data and for the reasons discussed below we do not view the disclosure as valuable to investors.

We do not believe the percentage of annual sales orders placed by the three categories of distributors who were not sales leaders at the time of the order is valuable to investors for several reasons. First and foremost, our management does not rely on or otherwise utilize the information in managing the Company’s business. As disclosed in our periodic filings, the key metrics in this area on which our management focuses its attention are average active sales leaders, the number of sales leaders and the sales leader retention rates. In addition, a new method of sales leader qualification introduced globally in October 2009 allows a distributor to achieve sales leader status based on smaller, more frequent orders placed within a twelvemonth period as opposed to our previous qualification methods which are based upon larger orders over a shorter period of time. With this change, because sales leader status can now be achieved through either a limited number of large orders or a greater number of small orders, sales order size is no longer a reliable indication of which particular group a non-sales leader distributor should belong to or of an individual non-sales leader distributor’s intentions generally. Finally, because the information reflects only the number of sales orders but does not account for either the size or total value of a particular sales order, it has not been proven useful to indicate trends with respect to sales volume or other measures on which we focus."

On June 27th the SEC asked for further clarification and on July 5th the company provided it. On July 11th the SEC closed the matter and it has now been resolved.

Commenting on the matter, D.A. Davidson & Co. noted: "Painful as this constant second-guessing may be to shareholders and to the company, our belief is that this ultimately will be a healthy thing for HLF's valuation – we suspect that six months from now the "Asked and Answered" view of the model will prevail. That will be a good thing." The firm maintained their Buy rating and $72 price target.