Nu Skin Enterprises, Inc. — Q2 2011 Form 10-Q
Business context and period. Global direct seller of personal-care products and nutritional supplements under the Nu Skin and Pharmanex brands. This unaudited report covers the quarter and six months ended June 30, 2011; comparisons are with the corresponding 2010 periods. The company reports five geographic regions and one operating segment.
Financial performance
| Metric | Q2 2011 | Q2 2010 | Six months 2011 | Six months 2010 |
|---|---|---|---|---|
| Revenue | $424.4 million | $388.4 million | $820.3 million | $752.5 million |
| Gross profit | $353.3 million | $320.4 million | $648.4 million | $619.7 million |
| Operating income | $66.0 million | $59.2 million | $91.0 million | $105.3 million |
| Net income | $41.7 million | $32.4 million | $57.0 million | $63.4 million |
| Diluted EPS | $0.65 | $0.50 | $0.89 | $0.98 |
- Q2 revenue increased 9%; management said currency movements added about 8 percentage points. First-half revenue also increased 9%, with about 7 percentage points from currency.
- Q2 gross margin was 83.2%, versus 82.5%; first-half reported gross margin was 79.1%, versus 82.4%. Excluding the first-quarter Japan customs charge, first-half gross margin was 83.0%.
- The first half included a $32.8 million non-cash customs expense, reducing net income by $20.7 million after tax. Management reported adjusted first-half net income of $77.7 million and diluted EPS of $1.21; these are non-GAAP measures.
- Q2 selling expenses were 43.2% of revenue, up from 41.4%, reflecting distributor incentives and temporary Japan commission support. General and administrative expenses fell to 24.4% of revenue from 25.9%.
- Cash from operations was $80.8 million for the first half, compared with $87.2 million. Capital expenditures were $16.4 million; cash and equivalents were $233.4 million at June 30.
- Working capital was $251.5 million. Total debt was approximately $146.3 million, down from approximately $160.9 million at year-end 2010; $28.0 million was current. The company had no borrowings under its listed revolving or 2009 shelf facilities.
- First-half cash uses included $33.8 million of share repurchases, $16.7 million of dividends and $32.1 million of debt and related-party debt repayments. The board declared a subsequent quarterly dividend of $0.16 per share, up from $0.135.
Changes and operating trends
- Q2 regional revenue rose in South Asia/Pacific (29%), North Asia (12%) and Europe (22%), but fell in Greater China (2%) and the Americas (4%). Mainland China grew 85% in reported Q2 revenue, while Hong Kong declined 61%, largely reflecting prior-year convention sales and comparisons with a product launch.
- North Asia growth was led by South Korea; Japan revenue rose 2% in reported dollars but declined 10% in local currency. Management estimated Japan disasters reduced Q2 revenue by about $10 million.
- Pharmanex revenue increased to $194.1 million in Q2 from $145.8 million; Nu Skin revenue declined to $227.9 million from $239.9 million. Management cited product interest and distributor growth overall, with global active distributors up 5% and executive distributors up 8% year over year.
- Other expense declined sharply year over year, primarily because Q2 2010 had significant foreign-currency translation losses. The Q2 2011 effective tax rate was 36.7%; the first-half rate was 36.9%.
Outlook, risks and unusual items
- Management expected continued U.S. softness in Q3, with growth in Q4 potentially supported by the October global convention and planned ageLOC product introductions. It anticipated a slightly positive currency impact on 2011 reported revenue, based on then-current exchange rates.
- Management forecast an additional $40–$45 million of capital expenditures for the remainder of 2011, including projects in Provo and Shanghai, market facilities and technology.
- A separate Japan customs dispute involved approximately 3.8 billion yen, or $46.8 million, as of June 30, for assessments and disputed current import duties; the amount was increasing by about $3.5 million per quarter. Japan’s Ministry of Finance rejected the administrative appeal, and the company was preparing to pursue court proceedings. Additional payments were recorded as a long-term receivable; failure to recover them could result in a significant non-cash expense.
- The company had appealed the separate $32.8 million assessment upheld by the Tokyo District Court in March 2011, which was charged in Q1. This charge is distinct from the $46.8 million dispute.
- Key risks include foreign exchange volatility; distributor recruitment and retention, particularly in Japan and the U.S.; Japan regulatory scrutiny and consumer complaints; Chinese direct-selling regulation and licensing; product and supplement regulation; customs duties; and tax audits. The IRS was examining 2005–2008, and gross unrecognized tax benefits could change by approximately $8–$11 million within 12 months.
- Management stated it believed liquidity was sufficient for short- and long-term needs. Disclosure controls were judged effective as of June 30, 2011, with no material quarterly change in internal control over financial reporting.
Investor verification priorities
- Track the separate Japan customs matters: the appealed $32.8 million charge and the $46.8 million disputed assessment/deposit balance, including court progress, quarterly growth and recoverability.
- Assess whether reported revenue growth persists after currency effects, especially in Japan, the U.S., Mainland China and South Asia/Pacific, and monitor distributor counts and productivity.
- Reconcile GAAP first-half earnings with management’s non-GAAP adjustments and monitor gross margin, selling costs and cash conversion.
- Review the planned capital spending, debt repayment, repurchases and dividend commitments against operating cash flow and liquidity.
- Monitor regulatory developments in Japan and China, nutritional-supplement rules, and the outcomes of tax examinations and uncertain tax positions.