Nature’s Sunshine Products, Inc. — Q2 2016 Form 10-Q
Reporting period: Three and six months ended June 30, 2016. The company manufactures and directly sells nutritional and personal-care products through independent distributors and operates four segments: NSP Americas, NSP Russia/Central and Eastern Europe, Synergy WorldWide, and China and New Markets. Amounts below are in U.S. dollars; financial statements are unaudited.
Financial performance
| Metric | Q2 2016 | Q2 2015 | Six months 2016 | Six months 2015 |
|---|---|---|---|---|
| Net sales | $89.4 million | $81.2 million | $171.8 million | $165.1 million |
| Gross profit / margin | $66.3 million / 74.2% | $60.2 million / 74.1% | $126.7 million / 73.7% | $122.2 million / 74.0% |
| Operating income / margin | $4.2 million / 4.8% | $3.2 million / 3.9% | $6.4 million / 3.7% | $8.5 million / 5.2% |
| Net income from continuing operations | $2.4 million | $2.4 million | $4.2 million | $6.6 million |
| Net income attributable to common shareholders | $2.6 million | $2.6 million | $4.6 million | $8.2 million |
| Diluted EPS attributable to common shareholders | $0.14 | $0.13 | $0.24 | $0.43 |
| Operating cash flow | Not reported by quarter | Not reported by quarter | $6.5 million | $3.1 million |
| Capital expenditures | Not reported by quarter | Not reported by quarter | $4.6 million | $13.1 million |
- Q2 revenue rose 10.0% year over year, or 11.5% excluding currency effects; six-month revenue rose 4.0%, or 6.3% excluding currency effects. Foreign exchange reduced revenue by about $1.2 million in Q2 and $3.8 million year to date.
- Q2 operating income increased 33.4%, while continuing-operations net income was nearly flat. For the first half, operating income declined 25.2% and continuing-operations net income declined 37.0%.
- Q2 SG&A increased $3.9 million to $31.2 million and rose to 35.0% of sales from 33.7%. Drivers included $2.0 million of Hong Kong pre-opening service fees, higher China investment, and Oracle ERP training costs; lower prior-year restructuring charges partly offset the increase.
- Six-month effective tax rate was approximately 43.1%, versus 19.5% in 2015. The filing attributes the increase mainly to foreign losses, particularly in China, that do not currently yield tax benefits, and an adjustment to prior-year deferred tax assets.
Balance sheet, cash flow and liquidity
- At June 30, cash and cash equivalents were $41.4 million, current assets $109.0 million, current liabilities $61.0 million, and working capital $48.1 million. Working capital was $48.4 million at year-end 2015.
- Cash was essentially unchanged from year-end. Inventories rose to $45.0 million from $38.5 million.
- Six-month cash flows: $6.5 million provided by operations, $4.6 million used in investing, and $2.6 million used in financing. Dividends paid were $3.8 million. Net cash increased by only $8,000, including a favorable $779,000 currency effect.
- Of cash held by foreign subsidiaries, $37.8 million may be subject to withholding taxes or other restrictions before repatriation.
- The revolving credit facility allows borrowings up to $25 million and matures September 1, 2017. Outstanding borrowings were $3.9 million, up from $2.7 million at December 31, 2015; the company reported compliance with covenants. Interest was LIBOR plus 1.25% (1.75% at June 30).
- Management stated cash, operating cash generation, and available borrowing capacity should cover normal operating needs, dividends, repurchases, capital expenditures, and obligations for the next 12 months and foreseeable future. The share-repurchase program had $13.4 million remaining; no shares were repurchased in the first half.
Material changes and management commentary
- Segment sales in Q2: Synergy WorldWide rose 15.9% to $33.0 million; China and New Markets increased to $5.4 million from $0.9 million, largely from Hong Kong pre-opening product sales. NSP Americas declined 0.7% to $44.7 million, and NSP Russia/Central and Eastern Europe declined 8.0% to $6.3 million.
- For the first half, Synergy sales increased 9.8% and China and New Markets increased 209.8%; Americas declined 1.8% and Russia/Central and Eastern Europe declined 11.5%. China and New Markets sales included $2.0 million of Hong Kong service fees recorded in SG&A, not revenue.
- South Korea and Japan supported Synergy growth. Management cited distributor recruitment and program changes in those markets. NSP Americas’ U.S. business had continued year-over-year growth, while Latin America faced sales declines and product-registration challenges.
- Active distributors and customers worldwide declined to approximately 248,900 from 262,300 a year earlier; active Managers declined to approximately 13,200 from 13,400. The filing links weakness particularly to Russia/Central and Eastern Europe and lower recruitment in some markets.
- Venezuela had ceased operations in 2014. The first half of 2015 included $1.3 million of discontinued-operations income from asset-sale proceeds; there was no comparable income in 2016. This makes reported year-over-year common-shareholder earnings comparisons less like-for-like.
- The Oracle ERP implementation was expected to be completed by early 2017. No numerical full-year revenue or earnings guidance is provided.
Risks, contingencies and unusual items
- Management expects Russia/Central and Eastern Europe sales to remain affected by political unrest, sanctions, and currency devaluation. Foreign-exchange sensitivity analysis estimated a 10% strengthening of the U.S. dollar would reduce six-month operating income by about $385,000, holding other factors constant.
- The FTC announced a settlement with another multilevel marketing company on July 15, 2016. The filing warns that the settlement could signal regulatory views on distributor compensation and marketing; changes required for this company could adversely affect results. The company notes its model differs from that competitor’s.
- The company was party to various legal proceedings and could not predict their outcomes. Accrued non-income-tax contingencies were $0.3 million; estimated possible future payments ranged from zero to approximately $4.0 million. Other foreign tax and civil matters had possible payments estimated at zero to approximately $0.2 million, with no provision recorded.
- Accrued unrecognized income-tax positions were $7.8 million. U.S. federal returns for 2012–2014 and foreign tax years 2009–2015 were open to examination. Final tax outcomes could materially affect results.
- Other disclosed risks include nutritional-product and direct-selling regulation, product liability, distributor relationships, international operations, China regulatory approvals and execution, and foreign currency exposure. Management reported disclosure controls were effective and no material change in internal control during the quarter.
Most important facts for investors to verify
- Whether revenue growth in China and New Markets persists beyond pre-opening Hong Kong sales, and how associated service fees and China investment affect profitability.
- Whether Synergy’s Asia-Pacific growth offsets weaker Americas, Latin America, and Russia/Central and Eastern Europe markets, including distributor-base trends.
- Whether higher SG&A, elevated first-half tax expense, and foreign-exchange headwinds continue to pressure margins and earnings.
- Cash accessibility: a large share of subsidiary cash is held outside the United States and may face repatriation restrictions or taxes; also monitor inventory growth and working-capital needs.
- Developments in FTC/direct-selling regulation, outstanding legal and tax contingencies, and compliance with the credit-facility covenants.