LifeVantage Corporation — Form 10-Q Summary
Reporting period: Fiscal second quarter and six months ended December 31, 2016. The unaudited filing covers a direct-selling business offering nutraceutical, skin-care, energy and weight-management products through independent distributors and customers in the Americas and Asia/Pacific & Europe.
Financial performance
| Metric | Three months ended Dec. 31, 2016 | Prior year | Six months ended Dec. 31, 2016 | Prior year |
|---|---|---|---|---|
| Revenue | $48.9 million | $52.0 million | $103.8 million | $97.3 million |
| Gross profit | $41.4 million | $44.2 million | $87.5 million | $82.5 million |
| Gross margin | 84.7% | 84.9% | 84.3% | 84.8% |
| Operating income | $0.7 million | $3.0 million | $2.7 million | $5.7 million |
| Net income | $0.3 million | $1.6 million | $1.5 million | $2.7 million |
| Diluted EPS | $0.02 | $0.11 | $0.10 | $0.19 |
| Operating cash flow | Not presented separately for the quarter | $5.1 million | $8.5 million |
Second-quarter revenue declined 5.9% year over year, while six-month revenue increased 6.7%. Six-month net income fell about 45%. Revenue was helped by foreign exchange by $1.3 million in the quarter and $3.4 million for the six months. The quarter’s operating income was pressured by lower sales and higher selling, general and administrative expenses.
At December 31, cash and cash equivalents were $11.7 million, versus $7.9 million at June 30; working capital was $13.2 million, versus $13.9 million. Total debt principal was $8.5 million, including $2.0 million current and $6.5 million long-term. The term loan bears fixed interest of 4.93%, matures March 30, 2019, and is secured by substantially all company assets. The company reported compliance with applicable financial and other covenants. Six-month capital expenditures were $0.2 million; financing cash outflow included $1.0 million of loan principal payments.
Material changes and management outlook
- Second-quarter Americas revenue fell 6.1%; Asia/Pacific & Europe revenue fell 5.1%. Hong Kong revenue declined 64% in the quarter. Japan revenue increased in reported dollars, but management attributed this to yen strength; local-currency sales and distributor numbers declined.
- For the six months, Americas revenue rose 4.0% and Asia/Pacific & Europe revenue rose 15.6%, with foreign exchange contributing materially to international growth. The active customer base contracted year over year: preferred customers declined 5.1% and independent distributors declined 6.0%.
- Six-month SG&A rose to $35.0 million from $27.5 million, primarily due to legal and accounting costs related to the Audit Committee review, increased staffing and compensation, and event costs. Management expected SG&A as a percentage of revenue to decrease slightly in the remainder of fiscal 2017, following completion of the review. It expected commission and incentive expense to remain consistent and projected increased Americas revenue and moderate Asia/Pacific & Europe growth; no quantified earnings or revenue guidance was provided.
- Management said it was restricting distribution into countries where products are unregistered or direct selling is restricted, and expected future revenue from products carried or shipped into those countries to be significantly lower than in fiscal 2016.
Risks, contingencies and unusual items
- Material weakness in internal controls: The company identified inadequate controls over international policies, distributor enrollment, payments, shipping, monitoring and training. Management concluded disclosure controls were ineffective as of December 31, 2016. Remediation was underway, but management could not estimate when it would be complete. The Audit Committee review found sales into four countries with registration or direct-selling restrictions; management said related revenue was properly recognized and no tax or other accruals were required.
- Litigation: A securities class action alleges misleading statements about internal controls and financial results for fiscal 2016; an amended complaint was filed in January 2017. A consolidated shareholder derivative case was stayed pending proceedings in the class action. A former distributor’s counterclaim for defamation remains unresolved; defendants had sought at least $20 million in damages. The company recorded no loss accrual for these matters, stating losses were not considered probable or estimable, but warned an adverse outcome could be material.
- Leadership change: CFO Mark Jaggi’s employment was terminated January 18, 2017; Gary Koos was appointed interim CFO and principal financial officer.
- Other exposures: International operations and foreign-exchange movements, distributor compliance, product acceptance and inventory obsolescence, debt covenants, and reliance on a limited product range remain risks. A 10% strengthening of the U.S. dollar against relevant foreign currencies would have reduced six-month revenue by an estimated $2.7 million, or 2.6%.
- Management believed available cash and operating cash flow would meet requirements for at least 12 months. The filing reports no off-balance-sheet arrangements. A lender waiver had extended the deadline for delivery of fiscal 2016 audited statements; the company reported satisfying the requirement after filing its Form 10-K.
Important facts for investors to verify
- Whether the international-control remediation is completed, tested and deemed effective, and whether further regulatory or compliance actions affect sales.
- Whether distributor and preferred-customer trends stabilize, and whether reported international growth persists after excluding foreign-exchange effects.
- Progress, potential costs and outcomes of the securities, derivative and former-distributor litigation; no accrual was recorded for the disclosed matters.
- Quarterly operating cash generation, inventory valuation and obsolescence, and ability to remain within loan covenants while servicing debt.
- Whether management’s stated regional growth expectations and anticipated SG&A ratio improvement are achieved; the filing provides no numerical forward guidance.