Herbalife Ltd. sales jumped 20% in the fourth quarter and 18% for 2013, even as the multilevel marketer of sports and weight-loss supplements defended itself against an activist investor’s complaint. Since then, the firm has faced further scrutiny in the form of a lawmaker’s questions on its business model.

The firm on Feb. 18 reported net sales of $1.3 billion and net income of $123.5 million, or $1.15 per diluted share, for the quarter. For 2013 Herbalife said its net sales reached a record $4.8 billion and its net income $571.5 million, or $4.91 per diluted share.

CEO Michael Johnson noted that increased attention worldwide to obesity is helping drive the Los Angeles-based firm’s sales growth. "The global obesity epidemic continues to expand around the world, having an adverse impact on community health,” Johnson said in a same-day release.

Herbalife’s independent distributors “are uniquely positioned, with education, coaching, and nutritious, industry-leading products to help their customers live healthier lives," he added.

During a Feb. 19 conference call with analysts to discuss Herbalife’s earnings, Johnson pointed out the firm had “another record performance of double-digit growth while under the constant and unrelenting attack” by activist investor William Ackman.

In December 2012 Ackman, of Pershing Square Capital Management, alleged that Herbalife inflates reported retail sales made through its network of independent distributors. He announced he was short-selling the firm’s stock, betting it eventually would fall to zero, and made a detailed argument for why he believed the company is running a pyramid scheme Also see "Herbalife Pushes To Counter Pyramid Scheme Narrative" - Pink Sheet, 3 July, 2013..

Herbalife CEO Michael Johnson

Johnson said “proven facts supported by independent research … undermine Ackman’s baseless and reckless argument.”

He said three Herbalife-commissioned studies “confirm” millions of consumers are Herbalife customers and “the overwhelming majority are outside the network,” findings that “directly disprove” Ackman’s allegation.

While Ackman contends most Herbalife distributors get into the business only to sell to other distributors, Johnson said the firm’s products are the draw. He said 71% of the firm’s U.S. distributors have not provided products to another distributor.

“The vast majority of members do not join Herbalife for the business opportunity, rather they join to take advantage of the discounts offered on” Herbalife products, Johnson said.

Responding To Markey

Nevertheless, Herbalife remains under scrutiny from Sen. Edward Markey, D-Mass., and federal regulatory agencies.

Markey in January asked Herbalife for information about its compensation system and sales to non-distributors, and urged the Securities and Exchange Commission and Federal Trade Commission to look at the number of compensation levels employed by multi-level marketing companies such as Herbalife and by pyramid schemes and to inform him of the turnover rate in the lowest tier needed to trigger an investigation ([A#05140127007]).

According to Johnson’s Feb. 18 letter to Markey, the firm commissioned studies by Lieberman Research Worldwide and Nielsen to analyze its business model. He noted multilevel marketers [Amway Corp.], which provides household and personal care products and owns the Nutralite dietary supplement brand, and cosmetic and personal care products firm [Avon Products Inc.] are “household” names.

He said Herbalife directly employs around 7,400 people and has more than 3.5 million distributors globally. “We offer a business opportunity to members who, in addition to purchasing Herbalife products at a discount, seek also to supplement their income,” the CEO said.

During the conference call, Johnson said around 4% of Herbalife distributors make sales of the products their full-time job. He acknowledged that some distributors might have coerced larger and more frequent purchases by other distributors or consumers or could be unsatisfied with their relationship to the firm.

“Any company as large as Herbalife and with as many members will have a few bad actors,” he said.

To curb potential abuses by distributors and encourage stronger ties to the firm, Herbalife this year will begin requiring sales leaders to complete a company training program – “the key dos and don’ts of direct selling – to be eligible for royalty compensation, Johnson said.

Distributors interested in opening a nutrition club – the daily sales model most use – must complete a training program in addition to the 90-day waiting period previously implemented. The firm also this year will begin requiring annual recertification training for sales leaders, he said.

Further, in his letter to Markey, Johnson outlined Herbalife’s distributor compensation and refund policies. Each starter kit costs less than $90 and includes “sample products” with a greater retail value and Herbalife’s “generous refund policy” provides new members with 100% refunds on starter kits within 90 days of purchase. “We do not require the individual to even return the kit,” he said.

Additionally, distributors are entitled to 100% refund on returned, unopened products purchased within the prior 12 months, with shipping costs covered by the firm.

“Equally important, these gold standard policies are not only in the member rulebook as they have always been for many years, but now all new members are required to acknowledge that they are aware of these consumer protections, before they even join us,” Johnson told analysts.

Herbalife Chief Financial Officer John DeSimone said during the conference call that he and other representatives of the firm met with Markey’s staff on Jan. 31. “We’ve been in frequent communication with Sen. Markey’s office,” he said, adding, “I thought we were completely responsive to their questions, and subsequent to that meeting we’ve sent a letter to his office.”

Markey acknowledged the firm’s cooperation. “I appreciate the promptness of the company’s response to my inquiry. I am currently reviewing it and look forward to receiving replies from the FTC and SEC,” he said in an email.

China Leads Sales Growth

The firm’s Central and South America region led in sales for the October-December period with $290.3 million, a 42.8% increase from the year-ago quarter, while the Asia-Pacific region – not including China – slumped by 5.3% to $279.6 million. Central and South America sales were up 41.4% for the year to $973.5 million and Asia-Pacific sales grew 3.1% to $1.17 million.

U.S and Canada sales grew 6.6% to $210.3 million for the quarter and 7.8% for the year to $908 million. The firm’s sales in Mexico increased 8.3% in the quarter to $142.6 million and 13.3% for the year to $562.4 million. In Europe, the Middle East and Africa, Herbalife sales jumped 20.1% to $197.6 million and 17% for the year to $735.3 million.

Sales in China soared 121.2% to $148.4 million despite trade regulators’ questions about multi-level marketing businesses.

DeSimone said Chinese authorities’ investigation of Nu Skin Enterprises Inc., a marketer of anti-aging skin-care and nutritional products, should help stabilize multilevel marketing in the country.

“China is an ever-changing, evolving marketplace. I think we’re comfortable that we’re in compliance with today’s regulations and we’re also comfortable that if the regulations mature that we can be in compliance wherever they go and I think that our business is based on people taking our product every day and that model will work and we can certainly adjust it accordingly as needed in the marketplace,” DeSimone said.

Nu Skin suspended business promotional meetings in China and recruitment of sales representatives to beef up its training and education programs, following media reports of a state investigation into allegations of an illegal pyramid scheme by the Provo, Utah-based firm ([A#05140127005]).

Herbalife President Desmond Walsh attributed the firm’s growth in China to the spread of the daily consumption sales model, which has been the primary driver across all of the firm’s markets since it was pioneered in Mexico in the early 2000s, and to a preferred customer pilot program for identifying repeat customers and encouraging their continued purchases. Average sales by Herbalife’s leading distributors in China increased 27% for the year.

“Our focus in China has been and will continue to be building a sustainable business foundation of long-term customers, and we remain committed to moving slowly and thoughtfully, when necessary, to achieve these desired results,” Walsh said during the call.

The firm reported earnings guidance of 8% to 10% net sales growth for its fiscal 2014 first quarter, ending March 31, and 7.5% to 9.5% growth for the year.

Herbalife Sales Soar, But Firm Confronts Renewed Scrutiny

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