Nu Skin Enterprises, Inc. — Q2 2012 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2012. Nu Skin is a global direct-selling company of personal-care products and nutritional supplements, operating through the Nu Skin and Pharmanex brands. Financial amounts below are in U.S. dollars.
Financial performance and key metrics
| Metric | Q2 2012 | Q2 2011 | Six months 2012 | Six months 2011 |
|---|---|---|---|---|
| Revenue | $593.2M | $424.4M | $1,055.2M | $820.3M |
| Gross profit | $497.7M | $353.3M | $883.9M | $648.4M |
| Gross margin | 83.9% | 83.2% | 83.8% | 79.1% |
| Operating income | $97.9M | $66.0M | $169.6M | $91.0M |
| Net income | $60.4M | $41.7M | $108.2M | $57.0M |
| Diluted EPS | $0.94 | $0.65 | $1.67 | $0.89 |
- Q2 revenue increased 40% year over year; first-half revenue rose 29%. Foreign exchange reduced reported revenue by approximately 2% in Q2 and 1% for the first half.
- Operating expenses were $399.7M in Q2 and $714.3M for the first half. Selling expense rose to 45.1% of Q2 revenue, primarily due to limited-time-offer incentives; G&A declined to 22.3% of revenue as sales grew faster than overhead.
- First-half operating cash flow was $168.4M, versus $80.8M a year earlier. Investing used $26.1M, including $30.1M of capital expenditures; financing used $45.2M. The company repurchased $113.3M of shares, paid $24.7M of dividends, repaid $15.4M of debt, and issued $100.0M of long-term debt.
- At June 30, cash and cash equivalents were $371.8M, current investments $13.6M, working capital $345.8M, and total assets $1,135.0M. Total debt was approximately $218.8M, including $28.1M current and $190.7M long-term debt. Cash plus current investments was $385.4M.
- The board declared a $0.20-per-share quarterly dividend in July, payable September 12, 2012. The company had $219.9M remaining under its repurchase program at June 30.
Material changes and business drivers
- Greater China revenue grew 152% in Q2, led by Hong Kong, where revenue rose to $101.9M from $12.3M. South Asia/Pacific grew 66%; Americas grew 20%; Europe grew 7%. North Asia declined 3% in reported dollars.
- AgeLOC R2 and Galvanic Body Spa limited-time offers generated approximately $165M in orders, of which $140M was recognized as Q2 revenue. Management cautioned that these offers typically cause unusually high distributor activity and purchasing during the offer quarter.
- Management attributed gross-margin improvement to supply-chain improvements. First-half 2011 results included a $32.8M non-cash Japan customs charge; excluding it, the 2011 first-half gross margin was 83.0% and diluted EPS was $1.21, compared with reported EPS of $0.89.
- Executive distributors increased 41% globally and active counts increased 8% year over year. The filing reports 895,000 actives and 54,028 executives at June 30, 2012.
Outlook, risks, and unusual items
- No specific full-year revenue or EPS guidance is provided. Management expected foreign exchange to have a modest negative effect on 2012 reported revenue and anticipated approximately $70M of additional capital expenditures during the second half of 2012.
- Planned initiatives include fourth-quarter limited-time product offers in Japan, South Korea, the Americas, and Europe, and opening Vietnam for authorized business in Q3. Management stated these plans may positively affect results; outcomes are uncertain.
- Japan customs matters remain significant. A separate dispute covers approximately 4.2 billion yen, or $53.5M, of assessments and disputed duties; the company is challenging the assessments in Tokyo District Court and records disputed amounts paid or bonded as a long-term receivable. An adverse outcome could result in a non-cash expense. Separately, the company appealed a prior $32.8M customs assessment recorded in Q1 2011.
- The FDA refused admission of U.S. shipments of Galvanic Spa facial units, stating the product may require medical-device clearance. The company disagrees and is exploring resolution options; further imports may be restricted pending resolution or clearance. U.S. facial-unit sales represented about 1% of global Q2 revenue.
- Other risks include regulatory scrutiny of direct selling in Japan and China, distributor compliance and retention, product and medical-device regulation, foreign-exchange exposure, customs duties, supplier/quality issues, and tax examinations. Foreign tax examination outcomes were undetermined; gross unrecognized tax benefits could change by approximately $1–$2M within 12 months.
- Management reported effective disclosure controls and no material change in internal control over financial reporting during the quarter. The filing identifies no update to previously disclosed legal proceedings.
Important facts for investors to verify
- Whether limited-time-offer sales represent repeatable underlying demand, and how much revenue, deferred revenue, accrued commissions, and inventory effects relate to those offers.
- Progress and potential financial exposure in both Japan customs disputes, including the recoverability of the $53.5M disputed amount and outcome of the appeal of the prior assessment.
- Resolution of the FDA import issue and any related impact on U.S. sales, product availability, or clearance requirements in other markets.
- Whether revenue growth and distributor activity persist across regions, particularly given weakness and regulatory scrutiny in Japan and the unusually strong Greater China quarter.
- Use of cash for planned capital spending, share repurchases, dividends, and debt service, and the company’s ability to sustain liquidity if operating cash flow moderates.