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NEW YORK, July 30, 2013 //- In advance of Herbalifes earnings call for the second quarter of 2013, Pershing Square Capital Management, L.P. (Pershing Square) has compiled a list of questions arising from Herbalifes recently published earnings release and second quarter 10-Q that we think any reasonable investor, analyst, and regulator would like answered.
Herbalifes Continued Use of Exchange Rates that are Unavailable in the Venezuelan Market
According to the 10-Q on page 10, in the second quarter of 2013 Herbalife used the official CADIVI rate of 6.3 Bolivars to 1 U.S. dollar for the purpose of consolidating its Venezuelan operations and balance sheet . Herbalife has been unable to convert Bolivars to U.S. dollars at this rate and has resorted to alternative legal exchanges in which the Company has only been able to convert a nominal amount of Bolivars at a rate 75% less favorable than the new CADIVI rate (10-Q p. 10). As highlighted in the 10Q on page 37, if the company used an exchange rate commensurate with the rates available in alternative legal exchanges, the companys reported cash and cash equivalents as of June 30, 2013 would decline by $93.2 million and it would incur a corresponding amount of foreign exchange loss to operating profit. Furthermore, Herbalife Venezuela would operate at a loss and this could have a significant negative impact to our consolidated financial statements. Why does the Company continue to use an exchange rate in Venezuela that is substantially better than what can be achieved in the market? Why does managements guidance for the balance of 2013 assume a Venezeulan exchange rate of 10 to 1 if the Company is marking its Venezuelan assets and liabilities on its June 30, 2013 balance sheet at the CADIVI rate of 6.3 Bolivars per U.S. dollar?
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Q3 2013 operating income calculated by using (i) the midpoint of the Companys guidance for Diluted EPS of $1.11; multiplied by (ii) 107mm diluted shares outstanding; divided by (iii) 1 23.5% (midpoint of the effective tax rate guidance); plus $5.6mm of interest expense.
Page 10 of the 10-Q further discloses that, of the $13.2mm tax expense adjustment in year 2012, $1.6mm was misstated in the first six months. Assuming the remainder of the restatement is split across the third and fourth quarters, this implies that Herbalifes Q412 diluted EPS results were overstated by five cents per share. We note that Herbalifes Q412 results were the first period reported after Pershing Square s presentation entitled Who wants to be a Millionaire? on December 20, 2012. This was an important quarter for the Company to demonstrate EPS growth. During that quarter, the Company reported $1.05 of diluted EPS, which exceeded consensus EPS estimates by four cents per share. Had Herbalife correctly accounted for its income tax expense in Q412, would the Companys reported diluted EPS have been less than the consensus figure of $1.01? If so, does the Company still believe that the restatement is not material?
Page 16 of Herbalifes Q213 10-Q notes that Herbalifes effective tax rate decreased from 28.1% in Q212 to 23.4% in Q213 primarily due to an increase of net benefits from discrete events, principally related to favorable tax audit settlements, and the impact of changes in the geographic mix of the Companys income. (emphasis added) Why does the Company add-back non-recurring expense items when calculating Adjusted EPS, but fail to deduct benefits such as the favorable settlement of tax audits that the Company itself describes as discrete events? Given that the Company has been sued numerous times for being a pyramid scheme, and given that, in the past, other investors have raised allegations about Herbalifes business model similar to those issues raised by Pershing Square, why does Herbalife consider expenses incurred responding to attacks on the Companys business model a non-recurring expense? Has PwC reviewed the Companys Non-GAAP adjustments and provided the Company with an opinion as to whether or not they are appropriate?
Page 22 of Herbalifes Q213 10-Q notes that the Company recorded $8.1 million and $17.6 million, respectively, of professional fees and other expenses related to [expenses incurred responding to attacks on the Companys business model]. The 10-Q further notes that: included in these amounts are expenses related to a cash settlement liability award, or the Liability Award, outstanding as of June 30, 2013, which is tied to the Companys stock price and which only vests if certain conditions are met relating to the above matter. Please provide a detailed breakdown of the $17.6 million of expenses relating to this matter. Who is the beneficiary of this Liability Award and how is it determined?
upcoming price increase by accelerating their purchases in advance of the price increase, which increased sales for the first quarter of 2013 but led to lower sales for the second quarter of 2013.
Why do price increases lead to increased net sales in certain countries (i.e. Brazil and Venezuela) but cause decreased net sales in other countries (i.e. Malaysia)?
Distributor Churn
Page 8 of Herbalifes Q113 10-Q stated that as of March 31, 2013, the Company had 3.6 million independent distributors, which included 0.2 million in China. Page 8 of Herbalifes Q213 10 -Q states that as of June 30, 2013, the Company had 3.4 million independent distributors, which includes 0.2 million in China. This implies non-China distributors decreased a net 0.2 million from Q113 to Q213. We further note that Herbalifes Regional Key Metrics supplement shows that Herbalife gained 517,701 new distributors in Q213 (excluding China). Is it correct to assume that 717,701 distributors exited the business in Q213 (3.4mm + 0.518mm 3.2mm = 0.718mm)? Given that the Company had 2.9mm non-sales leaders (excluding China) as of Q113, this implies a ~98% annual churn rate in the Companys non-sales leader distributor base (0.7mm / 2.9mm = 24.4% * 4 = 98%)? Do you agree with this calculation? If not, what is the annual churn rate for non-sales leader distributors? What is the reason for the wide variance in the implied non-sales leader distributor churn metric from Q113 to Q213? Why doesnt the Company provide new distributor numbers and non -sales leader churn metrics in its audited public filings, along with explanations for the change in the underlying churn rate?
Visit www.factsaboutherbalife.com to view Pershing Squares presentation and to learn more about the company. About Pershing Square Capital Management, L.P. Pershing Square Capital Management, L.P. (Pershing Square), based in New York City, is a SECregistered investment advisor to private investment funds. Pershing Square manages funds that are in
the business of trading buying and selling securities and other financial instruments. Funds managed by Pershing Square are short the stock of Herbalife Ltd. Pershing Square may increase, decrease, dispose of, or change the form of its investment in Herbalife for any or no reason, at any time. Pershing Square may change its views about or its investment positions in Herbalife at any time, for any reason or no reason. Pershing Square may buy, sell, cover or otherwise change the form or substance of its Herbalife investment. Pershing Square disclaims any obligation to notify the market of any such changes. Please see the full Disclaimer appearing on website www.factsaboutherbalife.com.
Media Contacts: Pershing Square Capital Management, L.P. Jennifer Burner D: 212-235-6203 M: 352-281-5357 jburner@globalstrategygroup.com Mike Geller D: 212-729-2163 M: 646-567-3596 mike.geller@edelman.com