Business context and reporting period
Nu Skin Enterprises, Inc. is a global direct-selling company focused on personal-care products and nutritional supplements. This unaudited Form 10-Q covers the quarter and nine months ended September 30, 2016. Amounts below are in U.S. dollars; financial statement amounts are generally shown in millions.
Financial performance and liquidity
| Metric | Q3 2016 | Q3 2015 | Nine months 2016 | Nine months 2015 |
|---|---|---|---|---|
| Revenue | $604.2 | $571.3 | $1,676.5 | $1,674.8 |
| Gross profit | $478.3 | $418.6 | $1,284.5 | $1,306.8 |
| Operating income | $82.4 | $42.5 | $170.3 | $183.0 |
| Net income | $56.9 | $16.3 | $104.9 | $97.2 |
| Diluted EPS | $0.98 | $0.28 | $1.85 | $1.63 |
Q3 revenue rose 6% year over year; nine-month revenue was essentially flat. Gross margin was 79.2% in Q3 versus 73.3% a year earlier, and 76.6% for the nine months versus 78.0%. Operating margin was approximately 13.6% in Q3 versus 7.4%, and 10.2% for the nine months versus 10.9%. The filing attributes the strong Q3 comparisons in part to the prior-year $37.9 million Greater China inventory write-down. Nine-month gross profit also reflects a $31.4 million Japan customs charge recorded in Q1 2016.
Cash from operating activities was $185.4 million for the first nine months, down from $242.0 million. Management cited payments of prior-year accruals, including commissions, and inventory build for planned launches. Q3 operating cash flow was $49.6 million. Capital expenditures were $35.0 million for the nine months; the company anticipated approximately $20 million more for the remainder of 2016.
At September 30, cash and cash equivalents were $517.0 million and current investments were $15.6 million, or $532.6 million combined. Working capital was $531.1 million. Balance-sheet debt was $429.6 million, comprising $73.3 million current and $356.3 million long-term; cash and current investments exceeded this carrying amount by approximately $103 million. The company reported compliance with its credit-agreement covenants.
In June, Nu Skin issued $210 million of 4.75% convertible senior notes due 2020. Their effective interest rate is approximately 7.1% after discount and issuance-cost amortization. The notes are convertible beginning December 16, 2016 at an initial conversion price of approximately $46.50 per share, subject to adjustment. The company said proceeds were being used primarily for share repurchases. Nine-month dividends paid were $59.6 million and share repurchases were $41.7 million. A $0.355-per-share quarterly dividend was declared in November.
Material changes and operating trends
- Regional mix: Q3 Greater China revenue increased 15% to $216.5 million, and North Asia rose 24% to $208.7 million. South Asia/Pacific fell 35% to $70.9 million, largely against a prior-year limited-time offer that generated about $47 million. Americas revenue increased 1% to $71.3 million; EMEA rose 5% to $36.9 million.
- Promotions and currencies: A South Korea limited-time offer generated about $49 million of Q3 revenue. Foreign exchange increased reported Q3 revenue by 1% overall; it reduced nine-month revenue by 2%. Management cautioned that limited-time offers can distort period comparisons.
- Profit and taxes: Q3 earnings benefited from higher revenue, lower foreign-currency translation expense than in Q3 2015, and a tax benefit associated with the substantial liquidation of Venezuelan operations. The effective tax rate was 25.8% in Q3 and 30.4% for the nine months, versus 42.1% and 36.7% in the comparable 2015 periods.
- Other expense: Q3 other expense was $5.7 million, versus $14.4 million a year earlier; nine-month other expense was $19.6 million versus $29.5 million. Lower Q3 currency translation expense was partly offset by higher interest expense following the convertible-note issuance.
Outlook, risks, contingencies, and unusual items
The filing provides no formal revenue or earnings guidance. Management expected difficult Q4 comparisons in North Asia and the Americas because Q4 2015 limited-time offers generated approximately $27 million and $21 million, respectively; it did not plan a North Asia limited-time offer for Q4 2016. Planned product developments included ageLOC Youth availability in South Korea and Japan in Q4 2016, ageLOC Me availability in Mainland China in Q1 2017, and an air purifier launched in Mainland China in October 2016.
Nu Skin ceased Venezuelan business operations in Q3. The Japan customs assessment appeal remained pending after a Tokyo District Court ruling; the related $31.4 million Q1 charge was non-cash because the assessments had previously been paid. The $47 million securities class-action settlement was finally approved in October 2016 and was funded by insurers; the company recorded an offsetting receivable and liability, with no net income impact. A related derivative-action settlement requires governance measures and $1.3 million in plaintiffs’ legal fees and expenses, of which insurers had paid $1.0 million. The company also paid $765,688 to resolve an SEC investigation concerning books and records and internal controls for a 2013 charitable contribution in China; it neither admitted nor denied the SEC’s findings.
Key exposures include foreign exchange movements, direct-selling and product regulation, tax and customs audits, and the ability to sustain distributor activity and promotional demand. Management said it believed cash, operating cash flow, and credit facilities would be adequate for short- and long-term needs, while noting that weaker cash generation could lead it to reduce capital spending, repurchases, or dividends. It also noted that repatriation of some overseas cash is subject to procedural or other requirements.
Most important facts for investors to verify
- Whether Q3 growth, particularly in China and South Korea, persists after the limited-time offers and against tougher comparisons.
- Progress in South Asia/Pacific, the Americas, Taiwan and Hong Kong, and distributor indicators: total Actives were 999,000 versus 993,000 a year earlier; Sales Leaders were 67,282 versus 65,089.
- Cash conversion and working-capital trends, including the effect of inventory, accrued commissions, and prepaid expenses on operating cash flow.
- Debt service, convertible-note conversion or repurchase terms, covenant headroom, and the use of note proceeds for repurchases.
- Outcome of the Japan customs appeal and any tax, regulatory, or compliance developments; management stated that other ordinary-course litigation was not expected to have a material adverse effect.