NATR

Business Context and Reporting Period

Company: Nature's Sunshine Products, Inc.
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: September 30, 2009
Business Overview: The Company manufactures and markets herbal products, vitamins, minerals, and personal care products through a direct sales force of independent Distributors and Managers. Operations are divided into three segments: Nature's Sunshine Products (United States), Nature's Sunshine Products (International), and Synergy Worldwide.

Key Financial Metrics

Amounts in thousands, except per share data.

Margins (Nine Months 2009):
- Gross Margin (Net Sales less COGS): 80.0%
- Operating Margin: 2.1%
- Net Profit Margin: 0.8%

Material Changes vs. Prior Period

• Revenue Decline: Net sales decreased 7.4% for the quarter and 11.2% for the nine months compared to 2008. This was primarily driven by a strengthening U.S. dollar against foreign currencies (notably the Russian ruble and Ukrainian hryvnia) and weakening demand in foreign markets due to economic conditions.
• Profitability Improvement: Despite revenue declines, Net Income turned positive ($2.1M) compared to a Net Loss of $1.3M in the prior nine-month period. Operating income for the quarter increased 199.7% year-over-year.
• Expense Reduction: Selling, General, and Administrative (SG&A) expenses decreased 19.7% for the quarter and 12.0% for the nine months. This was due to reduced spending in Russia/Ukraine and lower professional fees related to regulatory compliance efforts compared to the prior year.
• Segment Performance:
  • NSP International: Sales declined 22.3% (nine months) due to currency fluctuations.
  • NSP United States: Sales declined 1.6% (nine months) due to economic conditions.
  • Synergy Worldwide: Sales declined 4.4% (nine months); however, operating losses narrowed significantly in the quarter to break-even.
• Dividend Suspension: The Company suspended quarterly cash dividends effective in the second quarter of 2009 to conserve cash.

Guidance, Outlook, Risks, and Contingencies

Management Commentary & Outlook: Management attributes the revenue decline to foreign exchange headwinds and global economic conditions. They believe working capital requirements can be met through existing cash and operating cash flows but noted that a prolonged economic downturn or unfavorable tax settlements could adversely affect long-term liquidity. The Company does not currently maintain a long-term credit facility but is exploring options.

Material Risks and Contingencies:

• Legal Proceedings (Class Action): A shareholder class-action lawsuit regarding alleged misrepresentations has reached a settlement stipulation for $6 million, to be funded by the Company's insurer. Preliminary court approval was granted; final approval is pending a hearing in February 2010. If not approved, the case returns to litigation.
• IRS Examination: The IRS issued a report proposing adjustments for tax years 2003-2005 regarding transfer pricing. The Company plans to appeal. An audit for 2006-2007 is expected to commence in Q4 2009. The Company has accrued $20.4 million for unrecognized tax positions.
• Foreign Currency Risk: Approximately 54.5% of net sales are realized outside the U.S. A strengthening U.S. dollar negatively impacts reported revenue and operating income. The Company does not use derivative instruments for hedging.
• Venezuela Currency Restrictions: The Company holds cash in Venezuelan bolivars. Government restrictions on converting to U.S. dollars at the official rate create liquidity risks. The Company recently incurred a $1.15 million exchange loss using the parallel market rate.
• Internal Controls: Material weaknesses in Accounting for Taxes and Information Technology (Access Control, Change Management, Spreadsheets) remain as of September 30, 2009, though remediation is in process. The Financial Reporting Process weakness has been remediated.

Investor Verification Checklist

• Settlement Finality: Verify the status of the $6 million class-action settlement and whether the court grants final approval in February 2010.
• Tax Liability Exposure: Monitor the outcome of the IRS appeals process for 2003-2005 and the upcoming 2006-2007 audit, given the $20.4 million accrual for unrecognized tax positions.
• Currency Sensitivity: Assess the impact of continued U.S. dollar strength on the International segment, which accounts for over half of sales.
• Liquidity in Venezuela: Track the Company's ability to repatriate funds or convert Venezuelan bolivars at the official exchange rate.
• Internal Control Remediation: Confirm the timeline for fully remediating the remaining material weaknesses in tax accounting and IT controls.