Nu Skin Enterprises, Inc. — Q3 2014 Form 10-Q
Business context and reporting period. The filing covers the quarter and nine months ended September 30, 2014. Nu Skin is a global direct-selling company selling personal-care products and nutritional supplements, including Nu Skin, Pharmanex and ageLOC products. Its business was affected by difficult comparisons with 2013 ageLOC TR90 limited-time offers and by disruption in Mainland China following media and regulatory scrutiny.
Financial results
| Metric | Three months ended September 30 | Nine months ended September 30 |
|---|---|---|
| Revenue | $638.8 million, down 30% year over year | $1.960 billion, down 8% |
| Gross margin | 82.9%, versus 84.6% | 81.0%, versus 83.9% |
| Operating income | $105.0 million, versus $168.3 million | $260.9 million, versus $365.5 million |
| Net income | $68.3 million, versus $110.9 million | $142.7 million, versus $239.6 million |
| Diluted EPS | $1.12, versus $1.80 | $2.34, versus $3.91 |
| Operating cash flow | Not stated separately for the quarter | $(151.3) million, versus $484.1 million provided |
Quarterly revenue fell 2% sequentially from Q2 2014. Gross margin was pressured by currency movements, lower utilization of Mainland China manufacturing, a lower Mainland China share of revenue, promotions and the $50 million second-quarter inventory write-down. Selling expense was 41.2% of quarterly revenue and 43.9% for the nine months; management expected it to return to about 44% in Q4. General and administrative expense was 25.3% of quarterly revenue and 23.8% for the nine months.
Regional performance. Greater China revenue declined 50% for the quarter and 17% for the nine months; Mainland China fell 54% and 19%, respectively. North Asia grew 2% in both periods, with South Korea up 14% for the quarter and Japan down 14%. South Asia/Pacific declined 30% in the quarter and the Americas 10%; EMEA declined 8% in the quarter. Total Actives were 1.056 million and Sales Leaders 61,204, down from 1.273 million and 96,890 a year earlier.
Cash, liquidity and debt
At September 30, 2014, cash and cash equivalents were $194.9 million, down from $525.2 million at year-end 2013; working capital was $355.2 million. Nine-month operating cash use was attributed principally to paying selling and incentive expenses accrued in 2013, settling year-end payables after inventory builds, and lower earnings. The company generated $33.6 million of operating cash in Q3. Nine-month capital expenditures were $80.6 million, with about $20 million more anticipated for the rest of 2014.
Reported debt at September 30 totaled approximately $188.7 million ($92.9 million current and $95.8 million long-term). After quarter-end, the company entered a five-year credit agreement with $127.5 million of U.S.-dollar term loans, a 6.6 billion yen term loan facility and a $187.5 million revolving facility. It drew the term facilities in full and $112.5 million on the revolver, then repaid specified legacy debt and paid a $7.4 million prepayment fee. The new agreement includes leverage and interest-coverage covenants. Quarterly dividends were $0.345 per share; the board declared the same amount for payment in December.
Material changes, outlook and unusual items
- The 2013 second-half TR90 global limited-time offer generated $550 million of sales, including $203 million in Q3 2013, creating a difficult comparison. 2014 limited-time offers generated $81.4 million in Q3 and $190.6 million in the first nine months. Management estimated Q4 2014 limited-time-offer sales of about $20 million.
- Mainland China business meetings and acceptance of new sales representative applications, suspended voluntarily early in 2014, resumed in May. Management said the business showed signs of stabilization in Q3 but cautioned that rebuilding the sales force remained uncertain.
- Venezuela currency remeasurement and devaluation produced a $46.3 million non-cash charge in the first half, including $14.7 million and $25.3 million currency losses. The nine-month results also included a $6.3 million out-of-period adjustment to correct prior-period accounting classification. Venezuela’s exchange restrictions have limited currency conversion, repatriation and settlement of intercompany balances.
- A $50 million inventory write-down was recorded in Q2, primarily for Mainland China surplus inventory after reduced expectations for a TR90 offer. The filing reports inventory valuation adjustments totaling $60.7 million at September 30, 2014.
- Management reported a material weakness in controls over hyperinflationary accounting for Venezuela; disclosure controls were therefore ineffective at September 30. Remediation controls had been implemented and tested for design, but had not operated long enough to establish full remediation.
- The company revised the presentation of 2013 results for selling rebates, reducing revenue and selling expense by $19.3 million for Q3 and $39.7 million for the nine months, with no effect on operating income, net income or cash flows.
Management cited ongoing promotional activity and anticipated Q4 year-over-year comparisons would remain difficult. It believed cash balances, operating cash flows and credit lines would meet cash needs, but noted it could reduce capital spending, repurchases or dividends or seek additional financing if needed. The filing gives no formal earnings or revenue guidance.
Risks and contingencies
Risks include regulatory and reputational exposure in Mainland China, uncertainty rebuilding the Chinese sales force, foreign-exchange volatility, Venezuelan currency controls and possible further devaluation, and potential further inventory write-downs. Nu Skin is disputing approximately 4.4 billion yen ($39.7 million) in Japanese customs assessments and duties; an adverse outcome could require a non-cash expense. Securities class-action and shareholder derivative cases related to China-related disclosures and stock-price declines were pending; the company said it intended to defend them. Tax examinations are ongoing in the U.S. and certain foreign jurisdictions, and unrecognized tax benefits could increase by approximately $1–$3 million over the next 12 months.
Important facts for investors to verify
- Whether Mainland China sales leadership and revenue stabilized after the Q3 resumption of meetings and recruiting.
- Whether revenue, gross margins and cash generation recover after the TR90 comparison effects and inventory write-down.
- The realized financial and liquidity impact of Venezuela currency restrictions and the $46.3 million charge.
- Progress in remediating the material weakness and any effect on future reporting.
- Outcomes of the Japan customs dispute and China-related securities and derivative litigation.
- Post-quarter debt balances, covenant compliance, and the sustainability of dividends and repurchases.