Nu Skin Enterprises, Inc. — Q3 2010 Form 10-Q
Business and period: Global direct seller of personal-care products and nutritional supplements under the Nu Skin and Pharmanex brands. This unaudited filing covers the three and nine months ended September 30, 2010; comparisons are with the corresponding 2009 periods. Amounts below are U.S. dollars; financial statement amounts are in millions unless otherwise noted.
Financial performance
| Metric | Q3 2010 | Q3 2009 | Nine months 2010 | Nine months 2009 |
|---|---|---|---|---|
| Revenue | $383.6 | $334.2 | $1,136.0 | $953.0 |
| Gross profit | $314.8 | $272.1 | $934.5 | $776.5 |
| Gross margin | 82.1% | 81.4% | 82.3% | 81.5% |
| Operating income | $52.9 | $40.9 | $158.2 | $95.5 |
| Net income | $35.3 | $25.6 | $98.7 | $59.5 |
| Diluted EPS | $0.55 | $0.40 | $1.53 | $0.93 |
- Revenue increased 15% in Q3 and 19% for the first nine months. Foreign exchange added approximately 4% and 6%, respectively, to reported revenue growth.
- Management attributed growth principally to ageLOC products, including the ageLOC Transformation skincare system, which generated approximately $200 million in sales in its first year. Q3 also included a limited-time ageLOC Vitality offering in Japan and the U.S. and a 9% year-over-year increase in global executive distributors.
- Gross margin improved, supported by higher-margin ageLOC sales and, for the nine-month period, favorable currency effects. General and administrative expense declined as a share of revenue to 25.9% in Q3 and 26.3% year to date. Selling expense was 42.3% and 42.0% of revenue, respectively.
- Other expense was $0.7 million in Q3 and $7.3 million year to date, versus $2.8 million and $3.2 million in 2009; management said currency movements were the main source of fluctuation. Effective tax rates were 32.4% for Q3 and 34.6% year to date.
Cash, liquidity and debt
- Nine-month operating cash flow was $138.3 million, versus $102.7 million in 2009. Capital expenditures were $28.7 million; cash increased by $39.6 million to $197.6 million.
- Working capital was $189.6 million at September 30, compared with $152.7 million at December 31, 2009. Current assets were $403.4 million and current liabilities $213.8 million.
- Total debt was approximately $145.4 million, including $38.1 million current and $107.3 million long-term, versus approximately $156.5 million at year-end 2009. The $25 million revolving facility and $100 million uncommitted shelf facility had no borrowings. The company paid its $16.6 million yen-denominated note in October 2010.
- Financing cash outflows included $50.0 million of share repurchases, $23.4 million of dividends and $20.5 million of debt payments. The board had authorized $162.6 million remaining under the repurchase program at quarter-end. Quarterly dividends were $0.125 per share; a further $0.125 dividend was declared for payment in December.
Material changes and outlook
- Growth was broad but uneven: Q3 regional revenue rose 55% in South Asia/Pacific, 17% in Greater China, 12% in North Asia, 6% in Europe and 4% in the Americas. South Korea, Mainland China and South Asia/Pacific were notable growth markets; Japan revenue increased in reported dollars but declined 2% in local currency, with active and executive distributor counts down 7% and 3% in Japan.
- The U.S. ageLOC Vitality limited-time offering contributed approximately $15 million in sales during the first nine months. Latin America remained weak, with local-currency revenue down 23% in Q3, which management linked to reduced distributor activity and Venezuela’s difficult political and business environment.
- Restructuring charges were zero in 2010 periods, compared with $0.8 million in Q3 2009 and $11.8 million for the first nine months of 2009, primarily from Japan restructuring. Management said improved earnings also reflected revenue growth, stronger margins and expense control.
- Management expected a Q4 effective tax rate of 35.5%–37.0% and approximately $10–$12 million of additional 2010 capital expenditures, excluding a possible related-party property purchase. A potential purchase of Provo corporate facilities was being evaluated at an estimated $33–$35 million; a special committee of independent directors was assessing the transaction. Management expected 2010 currency movements to benefit reported revenue and believed existing cash, operating cash flows and credit lines would meet liquidity needs.
Risks, contingencies and unusual items
- Japan customs disputes: The company was contesting assessments of 2.7 billion yen ($32.3 million) for 2002–2005 and 1.7 billion yen ($20.7 million) for 2006–2008. It recorded $7.2 million of disputed excess import-duty payments as a receivable and expected another customs audit could lead to further assessments. Unsuccessful challenges could require charges to earnings and higher expense on future imports.
- Tax matters: The IRS was examining tax years 2005–2008, with completion anticipated in 2011; foreign examinations were also ongoing. Gross unrecognized tax benefits could change by approximately $7–$10 million over the next 12 months. The company reported a $16.0 million decrease in such benefits during the first nine months, mainly from statute expirations.
- Key disclosed risks include currency volatility, challenges and regulatory scrutiny in Japan, restrictions and regulatory uncertainty in China, distributor retention and conduct, product and supply quality, and changing rules affecting direct selling, supplements and import duties. Management cautioned that forward-looking statements are subject to these and other uncertainties.
- The filing also notes an expected U.S. property transaction involving partnerships principally owned by company directors and family members; the independent-director committee was evaluating whether to proceed.
Important facts for investors to verify
- Whether ageLOC-led growth and distributor recruitment persist, particularly in South Korea, China and South Asia/Pacific, and whether Japan stabilizes in local currency.
- Developments and potential earnings exposure from the Japanese customs disputes, new audit and recorded $7.2 million receivable.
- Cash conversion and working-capital needs, including rising inventory, planned capital spending, debt repayments, dividends and share repurchases.
- Actual Q4 tax rate versus the 35.5%–37.0% outlook and outcomes of IRS and foreign tax examinations.
- Whether the related-party Provo property purchase proceeds, its final terms and funding, and whether currency movements continue to support reported results.