Nu Skin Enterprises, Inc. — Q1 2014 Form 10-Q
Reporting period: Three months ended March 31, 2014; comparisons are with Q1 2013 unless noted. Nu Skin sells personal care products and nutritional supplements through a global direct-selling network. Financial amounts below are in U.S. dollars.
Key financial results
| Metric | Q1 2014 | Q1 2013 | Change |
|---|---|---|---|
| Revenue | $671.1 million | $541.3 million | +24% |
| Gross profit / gross margin | $564.4 million / 84.1% | $451.3 million / 83.4% | Margin +0.7 percentage points |
| Operating income | $101.2 million | $82.7 million | +22% |
| Net income | $64.3 million | $54.3 million | +18% |
| Diluted EPS | $1.05 | $0.90 | +17% |
| Operating cash flow | $(160.6) million | $70.4 million | Decreased $231.0 million |
| Capital expenditures | $30.5 million | $41.2 million | — |
Operating expenses rose 26% to $463.2 million. Selling expense increased to 46.7% of revenue from 43.1%, while general and administrative expense fell to 22.4% from 25.0%. Other expense was $3.6 million, versus $0.1 million of other income a year earlier; the increase was primarily attributed to currency movements. The effective tax rate was 34.2%, compared with 34.4%.
Balance sheet, debt and liquidity
At March 31, 2014, cash and cash equivalents were $284.6 million, down from $525.2 million at year-end 2013. Working capital was $331.4 million, compared with $341.5 million. Inventory increased by approximately $71.0 million from year-end to $410.7 million. Total debt was approximately $197.9 million, comprising $88.0 million current and $109.9 million long-term debt.
Operating cash use reflected payment of prior-year accrued selling and incentive-trip expenses, inventory built for planned product launches, and the China business disruption. The company paid $20.1 million in dividends and repurchased $25.0 million of stock during the quarter. Management expected approximately $70 million of additional capital expenditures for the rest of 2014.
Performance changes and business drivers
- Greater China revenue increased 63% to $278.9 million; Mainland China revenue rose 77% to $212.2 million. South Korea revenue rose 41% to $114.0 million.
- North Asia revenue grew 5% to $195.5 million, as South Korea growth was partly offset by a 22% decline in Japan. Japan’s reported revenue was affected by yen weakness and lower sales compared with the prior-year product launch.
- Americas revenue increased 6% to $79.9 million; South Asia/Pacific increased 6% to $71.2 million; and EMEA increased 9% to $45.6 million. Foreign exchange reduced reported revenue growth overall by 4%.
- Management reported year-over-year increases of 24% in Sales Leaders and 12% in Actives. Sequentially from Q4 2013, revenue fell 36%, Sales Leaders 34%, and Actives 16%; management cited seasonality and the unusually strong prior quarter’s limited-time offer activity.
Outlook, risks and unusual items
- Mainland China: In response to media scrutiny and government investigations, Nu Skin temporarily suspended promotional meetings and applications for new sales representatives. These activities resumed in April and May 2014, respectively. The company reported fines of approximately $524,000 and $16,000 against Nu Skin China, and approximately $241,000 in aggregate against six sales employees. Management said the effect of restarting normal business activity remained uncertain.
- Products and inventory: AgeLOC TR90 generated approximately $550 million in sales during the second half of 2013. Management said subsequent limited-time offer sales were lower, including amid consumer dissatisfaction with weight-loss results. Changes to launch plans raised the risk of inventory write-offs; no amount was specified. Planned launches included products in China and other markets, and U.S. facial spa availability was expected in the second half of 2014.
- Credit covenant and financing: At March 31, the company was in violation of restricted-payment covenants limiting dividends and share repurchases. Amendments effective May 6, 2014 provided temporary additional capacity through September 2014 to avoid default or acceleration. The JPMC credit agreement was extended to August 8, 2014, with scheduled commitment reductions; the company said it was seeking an extension or replacement. It warned that further waivers, debt restructuring, or reduced dividends, buybacks, or capital spending might be needed if cash flow proved insufficient.
- Contingencies: The company disputed Japanese customs assessments and duties totaling approximately 4.2 billion yen, or $40.3 million, and was pursuing the matter in Tokyo District Court. If unsuccessful, it could record a non-cash expense. Securities class actions and shareholder derivative claims related to China media and regulatory scrutiny were at an early stage; outcomes and potential exposure were not clear from the filing.
- Other risks: The filing highlights regulatory and licensing uncertainty in China, direct-selling compliance, foreign-exchange exposure, and tax examinations. Approximately $24.3 million of Venezuelan cash was subject to currency restrictions. Management stated that cash, operating cash flows, and credit facilities were expected to meet needs, subject to planned credit extensions or replacements.
No formal numeric earnings or revenue guidance was provided in the filing. Management described plans and expectations for product launches, capital spending, dividends, and financing, while noting that future dividend declarations remained subject to board discretion.
The 2013 comparative income statement was revised to reduce revenue and selling expense by $8.8 million for a selling-rebate classification error; the revision did not affect operating income, net income, comprehensive income, balance sheet, or cash flows and was deemed immaterial. Management reported disclosure controls were effective as of March 31, 2014.
Investor verification checklist
- Track China sales-force recruitment and activity after resumption, regulatory developments, and any further fines, license restrictions, or operating interruptions.
- Review operating cash flow, inventory levels and sell-through, and any inventory write-offs after the revised product-launch plans.
- Confirm covenant compliance, replacement or extension of credit facilities, upcoming debt commitments, and the implications for dividends and repurchases.
- Monitor the Japan customs dispute and related deposits or receivables, along with the China-related securities and derivative litigation.
- Assess regional growth against currency effects and the continued contribution of product launches, particularly TR90 and planned China launches.