There is one word in Herbalife Ltd.'s big announcement this afternoon that deserves more attention than any other. That would be the word "material" and just what it means.
Herbalife shares rose 9 percent today to $74.83 after the company issued a news release declaring that its new accounting firm had finished auditing its books and that "there were no material changes" to its financial reports since 2010. In fact, Herbalife did make revisions to its previously reported numbers, and its shareholder equity and its earnings in some periods did decline. However, this seems like an instance where materiality is in the eye of the beholder.
Herbalife used to be audited by KPMG LLP. The nutritional-supplements distributor had to get its books re-audited because the KPMG partner who used to be responsible for its audit, Scott London, gotcaught feeding insider tips about Herbalife and other KPMG clients to a friend of his in exchange for cash and gifts. (He pleaded guilty to one count of securities fraud in July.) The company's new auditor is PricewaterhouseCoopers LLP.
One of the most significant revisions was to the company's shareholder equity as of the end of 2012, which fell 6 percent to $395.5 million from $420.8 million. I would have thought an adjustment of that size would be deemed material, thus requiring a formal restatement. Herbalife and PricewaterhouseCoopers obviously didn't see things this way. Similarly, shareholder equity as of March 31, 2013, fell 7 percent to $317.7 from $342.9 million. Other revisions included a 3 percent decline in net income for 2012 to $464 million from $477.2 million. There is room for debate about whether any of the company's adjustments were material. What was unnecessary (and annoying) was for Herbalife to describe the results incompletely in its news release. Rather than saying there were "no material changes," it would have been better to say what the changes were and that the company considered them to be minor. Instead, the company included a footnote in its news release that mentioned in passing that its amended filings included some changes, without saying what those changes were.
There was a 23-minute lag between the time Herbalife issued its news release and the time when the first of its amended reports showed up in the Securities and Exchange Commission's filing system, during which time the share price rose. There was no need for Herbalife to spin its numbers when the details were going to emerge anyway in a matter of minutes.
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