Herbalife International is a global multi-level marketing corporation that develops, markets and sells nutrition supplements, weight management, sports nutrition and personal-care products. The company was founded by Mark Hughes in 1980, and it employs an estimated 8,000 people worldwide. Herbalife reported net sales of US$4.488 billion in 2016, flat with 2015, and net income of $260.0 million, down 23% from the year prior. The business is incorporated in the Cayman Islands, where its corporate headquarters are also located.
The company operates internationally and distributes its nutrition products in 95 countries (as of July 2015) through a network of approximately 3.2Â million independent distributors, some of whom earn profit on product sales and additional commission from a network marketing compensation structure. The company has been criticized by, among others, hedge fund manager Bill Ackman of Pershing Square Capital, who claimed that Herbalife operates a "sophisticated pyramid scheme" after taking a $1 billion short position in Herbalife stock. Following Ackman's allegations, the company was investigated by the U.S. Federal Trade Commission (FTC) in 2014. The organization reached a settlement with the company in 2016, in which the company paid $200 million and changed aspects of its business. As a result of investigation, the accusation the company was a pyramid scheme was dismissed by the FTC. In November 2017, Ackman's hedge fund closed out its short position in Herbalife.
History
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In February 1980, Mark Hughes began selling the original Herbalife weight management product from the trunk of his car. Hughes often stated that the genesis of his product and program stemmed from the weight loss concerns of his mother Joanne, whose premature death he attributed to an eating disorder and an unhealthy approach to weight loss. His stated goal was to change the nutritional habits of the world.
His first product was a protein shake designed to help people manage their weight. He structured his company using a direct-selling, multilevel marketing model.
In 1985, the California Attorney General sued the company for making inflated claims about the efficacy of its products. The company settled the suit for $850,000 without admitting wrongdoing. In 1986, Herbalife became a publicly traded company on the NASDAQ, and in 1996 Herbalife reached US$1Â billion in annual sales.
Mark Hughes died at age 44 on May 20, 2000. The Los Angeles County Coroner autopsy results ruled that the entrepreneur had died of an accidental overdose of alcohol and doxepin, an anti-depressant. The company continued to grow after his death and in 2002 was acquired for US$685Â million by J.H. Whitney & Company and Golden Gate Capital, which took the company private again.
Plant sources of ephedrine were removed from Herbalife products in 2002 after several U.S. states banned supplements containing such herbs. The U.S. Food and Drug Administration banned supplements containing ephedrine in 2004.
In April 2003, Michael O. Johnson joined Herbalife as CEO following a 17-year career with The Walt Disney Company. On December 16, 2004, the company had an initial public offering on the NYSE of 14,500,000 common shares at $14 per share. 2004 net sales were reported as $1.3Â billion.
On April 9, 2013, the company's long-time auditor, KPMG, resigned after the KPMG executive who oversaw Herbalife audits admitted to providing insider information to a golfing friend about at least five companies, including Herbalife and Skechers. The company hired PricewaterhouseCoopers as its auditor on May 21, 2013.
In March 2014, Herbalife came under investigation by the U.S. Federal Trade Commission and the state of Illinois. On May 7, 2014, the company announced that it entered into a deal with Bank of America Merrill Lynch to repurchase $266 million of its stock.
In July 2016, Herbalife agreed to change its business model and pay $200 million to its distributors in a settlement with the FTC. The company announced in November 2016 that Chief Operating Officer Richard Goudis would take over the position of CEO in June 2017 and Johnson would transition to executive chairman. In August 2017, the company announced that it would repurchase up to $600 million of its stock.
Products
Herbalife's "nutrition" products including weight-loss and protein shakes. The company's products also include protein bars, teas, aloes, vitamins, and sports hydration, energy and personal care products. The company's original product is the Formula 1 protein shake, a soy-based meal-replacement shake. The product debuted in 1980 and as of 2015 was the company's best selling product accounting for nearly 30% of total sales.
Other products include products for heart health, digestive health, skin care, and the 24 sports line. Some products are vegetarian, kosher, allergen free, or halal.
Unsubstantiated claims of health benefits from products
Herbalife's claims of health benefits from their products have met scrutiny from the medical community, consumers, and government agencies. No evidence was found to support Herbalife's claim of an of their weight-loss products to burn calories. The Department of Justice of Canada filed criminal charges against the company in November 1984 for misleading medical claims in advertisements.
The specialists of the German Society for Nutrition concluded that the use of Herbalife products without exercise or other dieting does not solve weight problems.
Manufacturing sites
Herbalife's products are produced at the company's five manufacturing facilities in the U.S. and China as well as third-party manufacturing partners. The company's production process is based on a 'seed to feed' strategy which the company initiated in the 2010s and allows it trace where the ingredients in its nutritional products originated. Since 2013, the company has operated a botanical extraction facility in Changsha, Hunan Province. The facility produces botanical extracts, including teas, guarana, chamomile, broccoli, and bilberry, for use in many of the company's products. Before extracts are processed they undergo a botanical identification program and are tested several times throughout the production process. The processed raw materials from the extraction facility are used at all of the company's branded manufacturing facilities as well as its partners. As of 2015, 58 percent of the companies nutrition products were manufactured at Herbalife owned facilities.
In China, the company's manufacturing sites are located in Suzhou, Nanjing. In the U.S., the company has manufacturing facilities in Lake Forest, California and Winston-Salem, North Carolina.
Adverse effects
Allegations of lead contamination
In May 2009, an organization known as the Fraud Discovery Institute reported that laboratory test results of Herbalife products showed lead levels in excess of limits established by law in California under Proposition 65. The Fraud Discovery Institute was founded by Barry Minkow; it dissolved in 2011 after Minkow pleaded guilty to an insider trading charge not related to Herbalife.
Multiple independent labs reported finding lead in Herbalife products. Herbalife responded by stating its products met federal FDA requirements and claimed that they had commissioned independent laboratory tests showing that the products did not exceed Proposition 65 limits. According to court documents, Herbalife settled with Minkow and paid him US$300,000. In August 2008, Minkow retracted all accusations against Herbalife and removed any mention of the company from his web site.
On May 10, 2008, a civil lawsuit was filed on behalf of a woman who developed lead-related liver complaints that she claimed were a reaction to a combination of Herbalife products. The suit was filed by lawyer Christopher Grell, cofounder of the Dietary Supplement Safety Committee and an ally of Barry Minkow. On June 17, 2008, the suit was expanded to add distributors who had supplied the woman with the Herbalife products, with Grell launching a website to offer persons who believe they were harmed by Herbalife products the chance of redress.
Herbalife and liver disease inquiries
In 2004, Israel's Health Minister began an investigation into Herbalife's products after four persons using Herbalife's products were found to have liver problems.
Herbalife was accused of selling products containing toxic ingredients such as Qua-qua, Kompri, and Kraska. The products were sent to Bio-Medical Research Design LTD (B.R.D), to a private U.S. laboratory, and to Israel's Forensic research laboratory. A study of the cases funded by the Israeli Ministry of Health concluded that a causative relationship is suggested by the evidence, which included the temporal association between exposure to Herbalife products and the development of liver injury, the negative evaluation of other potential causes of liver injury, the normalization of liver function when Herbalife products were discontinued, and the return of liver injury symptoms in three patients who resumed using Herbalife products after recovery. Herbalife withdrew one product, which was only marketed in Israel, but not all of the Israeli patients had consumed this specific Herbalife product. Herbalife's SEC 10-Q filings state that the Israeli Ministry of Health did not establish a causal relationship between the product and liver ailments. The Israeli Ministry of Health advises individuals with compromised liver function to avoid dietary supplements. In 2009, an Israeli woman sued Herbalife International and Herbalife Israel, claiming that her liver damage resulted from the use of Herbalife products.
Scientific studies in 2007 by doctors at the University Hospital of Bern in Switzerland and the Liver Unit of the Hadassah-Hebrew University Medical Center in Israel found an association between consumption of Herbalife products and hepatitis. In response, the Spanish Ministry of Health issued an alert asking for caution in consuming Herbalife products. Herbalife stated they were cooperating fully with Spanish authorities, and after investigation, the agency determined no action was required and removed the alert.
Hospitals in Israel, Spain, Switzerland, Iceland, Argentina, and the United States had reported liver damage in a number of patients, some of whom had used Herbalife products. Some patients recovered after they had stopped taking the products, while in others the disease continued, and two patients died. Several authors considered it “certain†that Herbalife products were the cause of the observed liver disease because of a positive re-challenge, while most of the remaining cases were scored as “probable.†Herbalife employees claim there is no definitive proof that Herbalife products cause hepatotoxicity or other liver problems.
In January 2009, the Scientific Committee of the Spanish Agency for Food Safety and Nutrition (AESAN) reached the same conclusion. After reviewing cases implicating Herbalife products in Spain, Switzerland, Israel, Finland, France, Italy, Iceland and Portugal, the 12-member scientific panel issued a report concluding: "The analyses of these cases and information regarding their circumstances have not allowed us to establish a causal relationship" between liver anomalies and Herbalife's dietary supplements. The panel attributed the cases to metabolic changes from overzealous and unsupervised dieting. However, neither a 2005 American Association for the Study of the Liver position paper on the management of acute liver failure nor a 2013 review in the New England Journal of Medicine lists "overzealous dieting" among the recognized causes of acute liver failure.
A July 2013 peer-reviewed study published in the World Journal of Hepatology reexamined known cases of hepatoxicity that had previously been linked to consumption of Herbalife products and concluded that using "the liver specific Council for International Organizations of Medical Sciences scale, causality was probable in 1 case, unlikely and excluded in the other cases. Thus, causality levels were much lower than hitherto proposed." In a separate review published less than a year earlier, the same author described the relationship between Herbalife products and reported hepatoxicity cases as "highly probable".
Business model
Herbalife is a pyramid (sometimes called pyramid scheme or network marketing) company. In addition to profits from product sales, Herbalife distributors can earn additional commissions from sales by other distributors they recruited, called their downline distributors. Supporters of MLM contend this is a fair compensation system, while critics contend that it is a pyramid scheme. The MLM compensation structure consists of commissions, royalties and bonuses on sales done by a distributor's downline (the people they have sponsored as new recruits). Out of about 526,000 total members in the US at the beginning of 2014, about 62,000 received bonuses of some kind from Herbalife: 7,385 (1.4%) received over $5,000 in bonuses per year (this translates to an average of $417 per month) and 1,304 (0.25%) received over $50,000 ($4,167 per month average). These figures do not include income from product sales nor do they include any costs incurred by distributors. Critics also argue that the company does not make enough effort to curb abuses by individual distributors, though Herbalife has consistently denied such allegations. Herbalife is a member of the Direct Selling Association in most countries in which it operates. In its filings with the U.S. Securities and Exchange Commission (SEC), company management note problems with inappropriate business practices in the past, their subsequent long-lasting effects and the need to avoid any repetition.
A 2004 settlement resolved a class action suit on behalf of 8,700 former and current distributors who accused the company and distributors of "essentially running a pyramid scheme." A total of $6Â million was to be paid out, with defendants not admitting guilt.
In a California class action suit (Minton v. Herbalife International, et al.) filed on February 17, 2005, the plaintiff challenged "the marketing practices of certain Herbalife International independent distributors and Herbalife International under various state laws prohibiting "endless chain schemes", insufficient disclosure in assisted marketing plans, unfair and deceptive business practices, and fraud and deceit".
In a West Virginia class action suit (Mey v. Herbalife International, Inc., et al.) filed on July 16, 2003, the plaintiffs allege that some
telemarketing practices of certain Herbalife International distributors violate the Telephone Consumer Protection Act, or TCPA, and seeks to hold Herbalife International vicariously liable for the practices of these distributors. More specifically, the plaintiffs' complaint alleges that several of Herbalife International's distributors used pre-recorded telephone messages and autodialers to contact prospective customers in violation of the TCPA's prohibition of such practices
Herbalife management insisted they have meritorious defenses in both cases and that, in the West Virginia case, any such distributor actions also went against Herbalife's own policies. Management also contends that any adverse legal outcomes Herbalife might suffer would not significantly affect their financial condition, particularly since they have already set aside an amount that they "believe represents the likely outcome of the resolution of these disputes". The case was resolved with Herbalife and its distributors paying $7Â million into a fund for class members part of the suit. Herbalife International did not acknowledge wrongdoing or admit culpability for the actions of its distributors.
As of April 2008, a series of commercials featuring a large red animated fox advertising home-based business opportunities has been running on American television. The advertisements typically feature testimonials from actors playing individuals who have made sums of money between US$5,000 and US$15,000 per month as a result of participating in an undescribed business program. The advertisements direct viewers to a website that allows them to purchase a "success kit". The kit also provides no information about how the business opportunity works. These advertisements have been found to be run by independent Herbalife distributors, as a method of recruiting new downline distributors. While it is not illegal, critics of this type of advertising prefer advertisers to be up-front about their company associations.
Company management considers the number and retention of distributors a key parameter and tracks it closely in financial reports. By January of each year, sales leaders are required to requalify. In February of each year, individuals who did not satisfy the sales leader qualification requirements during the preceding 12 months are removed from that rank. For the latest 12-month requalification period ending January 2011, approximately 48.9 percent of the eligible sales leaders requalified, an improvement from 43 percent in 2009. The company was cited as one of the most profitable companies in Los Angeles County.
Herbalife Nutrition Clubs
While there are many ways to do the Herbalife business, earlier methods have fallen out of favor over time (i.e. direct mail and internet “lead generation"). One of the most popular current ways of doing the business is through what is called a "Nutrition Club." These clubs are usually storefront shops in densely populated areas, often predominantly Latino.
Some Herbalife distributors complain they have no way of knowing if other clubs are already open in the area. One of the reasons for this is that Herbalife Nutrition Clubs can be hard to find, since the company doesn’t allow the shop owner/manager to advertise, to have awnings, to have any visible interior, to have an open / closed sign, to have a public facing website, or indicate in any other way that they are a business. They also cannot use the word “Herbalife†or "shop" on the club's exterior.
Furthermore, distributors are disallowed from selling the products directly at the club; instead they are to sell a daily "membership" that entitles the customer to a shake, a cup of aloe water, and a tea in a styrofoam cup. A daily "member" typically pays $5 to $7 in cash for the membership. Herbalife rules also dictate that no one can leave the club with these products; they must be consumed in the club.
Pyramid scheme allegations
On December 3, 2013, a Belgian appeals court overturned a November 2011 ruling by the Commercial Court in Brussels, Belgium that Herbalife was an illegal pyramid scheme. The company filed an appeal on March 8, 2012.
Short sales
On May 1, 2012, a well-known short seller David Einhorn asked pointed questions about the company’s business and sales models during the Q1 earnings call, setting off suspicions that Einhorn had a short position. These suspicions were proved correct in January 2013 when at an investor meeting Einhorn revealed that he had profited through a short position against the company. Einhorn said the short had been closed before the end of 2012.
Allegations of running a 'pyramid scheme'
On December 20, 2012, Bill Ackman (of Pershing Square Capital) presented a series of arguments outlining why his firm believed that Herbalife operates a "sophisticated pyramid scheme". Ackman has alleged after a year-long investigation that the majority of distributors lose money, that the chance of making the testimonial-implied headline income is approximately one in five thousand, and that the company materially overstates its distributors' retail sales and understates their recruiting rewards, to the point that he concludes it is a pyramid scheme.
According to Reuters:
- "The sales method, under which some people get more money for recruiting new distributors than selling products, has attracted criticism."
Ackman claimed that Herbalife distributors "primarily obtain their monetary benefits from recruitment rather than the sale of goods and services to consumers." His firm estimates that, since 1980, the scheme has led to more than $3.5 billion of total net losses suffered by those at the bottom of the Herbalife chain. He said on CNBC that millions of low income people around the world, hoping to become millionaires, are being duped with this scheme, and if they knew that the probability is less than 1% of making a hundred thousand dollars, what Herbalife calls the "millionaires team", no one would sign up for it.
Herbalife responded to Ackman's 2012 presentation saying:
"[It] was a malicious attack on Herbalife's business model based largely on outdated, distorted and inaccurate information. Herbalife operates with the highest ethical and quality standards, and our management and our board are constantly reviewing our business practices and products. Herbalife also hires independent, outside experts to ensure our operations are in full compliance with laws and regulations. Herbalife is not an illegal pyramid scheme."
Herbalife also countered that Ackman based his accusations on a misunderstanding of the company's distributor base. At an investor conference in January 2013, the company released results of a Nielsen Research International survey showing 73 percent of Herbalife distributors never intended to make money by reselling the product. Instead, they wanted to buy products at a discount for personal use. To make the distinction clearer, the company announced on its June 2013 earnings call that it would begin referring to these discount buyers as "members" rather than "distributors."
According to a number of financial commentators, Ackman bet roughly $1 billion against the company; soon after remarks to the press, the price of the stock decreased such that Ackman would have made $300 million if he had closed his short position then. Ackman stated that he will donate all of his profits from the trade to charity, taking the financial incentive out of the equation. A few months after Ackman's initial comments, billionaire investor Carl Icahn refuted Ackman's comment in a very public spat on national TV. Shortly thereafter, Icahn bought shares of Herbalife Intl. As Icahn continued to buy up HLF shares, the stock price continued to show strength. By May 2013, Icahn owned 16.5% of the company. That number had declined to 6.4 by November 2013. Investor George Soros and Post Foods CEO William Stiritz also bought large shares of Herbalife. Ackman acknowledged losing $400â€"500 million on his short position in November 2013. By November 2014, Soros had sold 2.8 million shares, 60% of his stake, while Perry Capital had purchased 1.6 million shares.
By December 2, 2014 stock prices had fallen nearly 50% to $42.08 from their January 8 high of $83.48. On 17 December 2014 Pershing Square Capital released a 2005 video of a Herbalife training conference in which Stephan Gratziani, a member of Herbalife's Chairman's Club sales team, was recorded telling an audience of high-level distributors "We sell people on a dream business that they can make it, yet deep down inside we know that most of them aren't going to," along with other statements that Pershing described as implying that the business model was not sustainable. According to an unnamed source speaking to the New York Post, the video had previously been subpoenaed by federal investigators. In an interview with Bloomberg, Ackman predicted that the company would experience an "implosion" in 2015 or early 2016, citing federal scrutiny and debt.
FTC investigation
Based on information from a Freedom of Information Act (FOIA) request, the New York Post reported on February 4, 2013, that HerbaLife was subject to a pending probe from the Federal Trade Commission (FTC). The FTC released 729 pages containing 192 complaints received over a 7-year period in regards to the New York Post's FOIA request. After reviewing the now-public complaints, which the FTC put on its website, Ackman told the New York Post: “I have a lot more confidence in our government’s regulators than those who own the stock.†The FTC stated that the wording it used in its response to the FOIA request was incorrect; the FTC could not confirm or deny an investigation into Herbalife.
In March 2014, the FTC opened an investigation into Herbalife in response to calls from consumer groups and members in both houses of Congress. Herbalife responded to the probe by saying it “welcomes the inquiry given the tremendous amount of misinformation in the marketplace, and will co-operate fully with the FTC. We are confident that Herbalife is in compliance with all applicable laws and regulations.†The investigation process that is required for alleged pyramid schemes takes 12 to 18 months. In cases like the Herbalife investigation, the FTC often seeks to impose changes to a company’s practicesâ€"known as injunctive reliefâ€"in order to stop misconduct that it sees as harming consumers. In May 2016 a spokesperson from the FTC told Bloomberg that “Injunctive relief can be just as significant as the money obtained for consumers and even more influential on a company’s future operationsâ€, in response to speculation that Herbalife was close to a resolution with the FTC.
In July 2016, Herbalife agreed to change its business model and pay $200 million in a settlement with the FTC. Partial refund checks were mailed to roughly 350,000 Herbalife distributors in January 2017.
The lawsuit alleged that Herbalife deceived consumers into believing they could earn substantial income from the business opportunity or big money from the retail sale of the company’s products. In addition, the complaint charged that one of the fundamental principles of Herbalife’s business modelâ€"incentivizing distributors to buy products and to recruit others to join and buy products so they could advance in the company’s marketing program, rather than in response to actual consumer demandâ€"is an unfair practice in violation of the FTC Act.
As part of the settlement, Herbalife agreed to pay distributors based only on actual retail sales of products, rather than for recruiting other distributors. The FTC had noted that the overwhelming majority of Herbalife's distributors earn very little or nothing.
In popular culture
The 2016 documentary Betting on Zero is about Herbalife, exploring the allegation from Bill Ackman that the company is a pyramid scheme and personal stories of Herbalife distributors who have lost their life savings due to the company. Filmmaker Ted Braun says that he "was making a film that looked at all sides," but believes that "the company instructed them [current Herbalife distributors] not to talk." A reviewer writes that, "one would be hard-pressed to come away with a favorable view of Herbalife." In 2016, a Last Week Tonight with John Oliver segment on multi-level marketing focuses on Herbalife, strongly condemning the company for its structure resembling a pyramid scheme and cited the FTC report which implied the company has been operating illegitimately. Oliver criticises Herbalife for its exploitation of Latino communities, and overstatement of their product's health benefits. One reviewer writes that it appears to be largely based on Betting on Zero, and caused no immediate change in Herbalife's stock prices.
Sports sponsorship
Herbalife shirt-sponsors Major League Soccer club LA Galaxy since 2007 and sponsors Cristiano Ronaldo since 2013. They sponsored FC Barcelona and Lionel Messi between 2010 and 2013.
See also
- Direct selling
References
External links
- Company profile by MarketWatch
- Herbalife Ltd.'s financial reports - Corporate disclosure and financial reports filed with the U.S. Securities and Exchange Commission
- Herbalife Ltd. (HLF) company's profile - Yahoo Finance
- Herbalife agrees to $200M settlement with FTC, will stop 'deceptive' practices