Nu Skin Enterprises, Inc. — Q3 2018 Form 10-Q
Reporting period: Three and nine months ended September 30, 2018. Nu Skin is a global direct-selling company selling personal-care products and nutritional supplements through the Nu Skin and Pharmanex brands. Unless noted, amounts below are U.S. dollars.
Financial performance
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Revenue | $675.3m | $563.7m | $1,995.7m | $1,612.9m |
| Gross margin | 76.7% | 78.6% | 76.3% | 78.1% |
| Operating income | $80.7m | $64.4m | $222.4m | $175.4m |
| Net income | $53.1m | $41.7m | $139.6m | $111.2m |
| Diluted EPS | $0.94 | $0.76 | $2.47 | $2.04 |
| Operating cash flow | Not separately presented | Not separately presented | $113.9m | $155.8m |
Q3 revenue rose 20% and nine-month revenue rose 24%; diluted EPS increased 24% and 21%, respectively. Revenue growth included a 5% acquisition contribution in Q3 and 4% year to date. Foreign exchange reduced Q3 revenue by 3%, but increased nine-month revenue by 2%. Operating income grew as revenue increased, while gross margin declined, primarily because acquired manufacturing businesses have lower margins and LumiSpa carries a somewhat lower margin than other products.
Q3 selling and general and administrative expenses were $271.5m and $165.7m, respectively. For the nine months, they were $802.0m and $499.0m. Q3 and nine-month effective tax rates were 27.9% and 32.0%, versus 34.1% and 33.4% a year earlier.
Liquidity, debt and capital allocation
At September 30, cash and cash equivalents were $390.1m and current investments were $11.4m, totaling $401.5m. Working capital was $398.1m. Balance-sheet debt was $448.2m, including $82.5m current and $365.8m long-term, compared with $388.6m at December 31, 2017. The company reported compliance with its new credit agreement covenants: leverage no greater than 2.25 to 1.00 and interest coverage no less than 3.00 to 1.00.
Nine-month operating cash flow was $113.9m, down from $155.8m, reflecting payment of prior-year accruals and increased inventory investment. Capital expenditures were $42.3m. The company paid $60.4m in dividends and repurchased $48.2m of shares during the period. Cash and cash equivalents declined $36.3m from year-end.
Material changes and unusual items
- Mainland China revenue increased 31% in Q3 and 35% year to date; reported growth was 34% and 30% at constant currency. South Korea revenue was nearly flat in Q3, and management cited ongoing online competition and declining customer and sales-leader counts.
- Sales Leaders increased 14% and Customers increased 9% year over year overall. Management attributed growth to LumiSpa, social-selling initiatives and rollout of the Velocity compensation program.
- 2018 acquisitions brought Innuvate, Treviso and L&W Holdings under company ownership. Acquired businesses contributed $26.0m of external revenue in Q3 and $65.9m year to date. Acquisition-related amortization was $2.4m in Q3 and $7.1m year to date.
- The conversion and repayment of $210.0m of convertible notes produced a $7.2m debt-extinguishment charge; step acquisitions generated a $13.6m gain. Foreign-currency losses were $4.2m in Q3 and $13.8m year to date, according to management.
- The company adopted Topic 606 on January 1, 2018, recording an $11.2m net reduction to opening retained earnings, primarily for loyalty-point deferrals. The adoption affected 2018 revenue by an increase of $0.1m in Q3 and a decrease of $1.2m year to date.
Outlook, risks and contingencies
Management said existing cash, expected operating cash flows and credit lines should be adequate for short- and long-term needs. It estimated remaining 2018 capital expenditures of $15–20m and expects approximately $55m for a planned Mainland China manufacturing plant over the next two to three years, including $9–10m in Q4 2018. Management anticipates continued quarterly dividends, subject to board discretion; the October-declared dividend was $0.365 per share. The filing provides no explicit revenue or EPS guidance.
Key risks include foreign-exchange volatility, inflation and currency devaluation, U.S.–China trade tensions and tariffs, regulatory and direct-selling compliance, and technology-system outages or capacity constraints. Argentina began highly inflationary accounting in Q3 2018; its sales were less than 2% of consolidated sales for the nine-month period. A newly hired chief transformation officer was reviewing IT, social-selling and digital initiatives; the review could lead to strategic changes, impairment charges or additional spending. Management did not expect disclosed litigation or proceedings to have a material effect, but tax audits could result in additional liabilities. The Japan customs dispute was closed after the Supreme Court declined to hear the company’s appeal; the related $31.4m charge had been recorded in 2016.
Investor verification points
- Assess whether reported growth is sustainable apart from acquisitions, product-launch activity and foreign-exchange effects, particularly in Mainland China and South Korea.
- Monitor gross-margin pressure from acquired businesses and product mix, and whether Velocity-related selling costs support durable customer and Sales Leader growth.
- Review cash conversion, inventory and receivables growth, debt levels, covenant headroom and the funding demands of dividends, repurchases and the planned China plant.
- Track currency exposure, trade-policy developments, Argentina’s inflation effects, tax-audit outcomes and potential costs or impairments from the technology and digital-strategy review.