Nu Skin Enterprises, Inc. — Q1 2018 Form 10-Q
Reporting period: Three months ended March 31, 2018. Nu Skin is a global direct-selling company focused on personal care and nutritional products. Figures are in U.S. dollars; financial statement amounts are in millions unless otherwise noted.
Financial performance
| Metric | Q1 2018 | Q1 2017 | Change / context |
|---|---|---|---|
| Revenue | $616.2 | $499.1 | Up 24% reported; up 17% at constant currency. Currency contributed approximately 7 percentage points. |
| Gross profit / margin | $469.9 / 76.3% | $387.8 / 77.7% | Margin declined 1.4 percentage points, mainly due to acquired businesses’ lower margins. |
| Operating income / margin | $59.0 / 9.6% | $46.3 / 9.3% | Operating income increased 28%. |
| Net income | $35.5 | $27.5 | Up 29%. |
| Diluted EPS | $0.64 | $0.51 | Up 25%. |
| Operating cash flow | $(1.1) | $21.3 | Decline attributed mainly to payment of year-end accruals, particularly commissions following Q4 LumiSpa offerings. |
| Cash and current investments | $430.1 | $438.2 at Dec. 31, 2017 | Cash and equivalents alone were $421.5 at March 31. |
| Working capital | $99.4 | $330.4 at Dec. 31, 2017 | Decrease primarily reflected a $284.8 increase in short-term debt. |
| Debt | $469.9 carrying value | $388.6 at Dec. 31, 2017 | Reported current debt was $362.7 and long-term debt $107.3. The convertible notes and existing credit facilities were repaid after quarter-end. |
Selling expenses were 41.8% of revenue versus 41.9%; general and administrative expenses were 24.9% versus 26.6%. Cash dividends paid were $19.8 million ($0.365 per share); share repurchases were $17.4 million.
Material changes and business drivers
- Customers increased 11% to 1.086 million and Sales Leaders increased 16% to 63,500. Management cited social-selling initiatives and demand for the ageLOC LumiSpa device.
- Mainland China revenue grew 32% reported (22% constant currency); Americas/Pacific grew 29% (32% constant currency); EMEA grew 32% (15% constant currency). South Korea revenue rose 8% reported but only 1% constant currency, while Japan rose 3% reported and declined 2% constant currency.
- South Korea segment contribution fell 17% and Americas/Pacific fell 17%; other reported segments increased contribution. South Korea’s customer acquisition remained challenged by online competition and political and economic conditions. Japan remained a soft direct-selling market amid regulatory and demographic challenges.
- Three acquisitions brought manufacturing and packaging operations in-house. Acquired businesses contributed $16.0 million of Q1 revenue and $1.7 million of acquired-intangible amortization expense. Goodwill rose from $115.0 million to $187.4 million.
- Revenue adoption of ASC 606 reduced Q1 revenue by $0.6 million and reduced opening retained earnings by $11.2 million, principally due to deferral of loyalty-point revenue.
Outlook, liquidity, and risks
- Management said existing cash, expected operating cash flows, and credit facilities should be adequate for short- and long-term needs. It anticipated continuing quarterly dividends, subject to board discretion and business conditions.
- Management estimated approximately $55 million of capital expenditures for the remainder of 2018, plus approximately $15–20 million for a planned Mainland China manufacturing plant, subject to approvals.
- On April 18, 2018, the company entered a five-year $400 million term loan and $350 million revolving facility, initially priced at LIBOR plus 2.25%. It drew the full term loan and $78.5 million on the revolver, then repaid the old credit-agreement debt and the $210 million convertible-note principal. The notes’ cash settlement, including accrued interest, was $213.4 million. The new facilities include leverage and interest-coverage covenants.
- Q1 earnings included a $13.6 million non-cash gain on step acquisitions, a $7.2 million non-cash loss on extinguishment of convertible debt, and a $5.8 million increase in tax reserves following an Indonesia tax assessment. The effective tax rate rose to 41.0% from 34.1%; a $2.0 million Japan-related tax benefit partly offset the reserve increase.
- Foreign exchange was a significant revenue tailwind; management cautioned that a stronger U.S. dollar could reduce reported revenue and profits. Cash outside the U.S. was $397.2 million, including $201.7 million denominated in Chinese RMB; repatriation from some markets is subject to procedural restrictions and withholding taxes.
- The company disclosed ongoing tax examinations and litigation, investigations, and regulatory exposure involving products, advertising, direct selling, and foreign tax and customs matters. Management did not expect current proceedings to have a material consolidated effect, but outcomes are uncertain. The Japan customs assessment remains under appeal to the Supreme Court; the disputed $31.4 million charge was recorded in 2016.
- Management warned that product launch promotions can create unusually high purchasing and distort comparisons. Q1 results may also reflect seasonal effects. Acquired businesses were expected to continue weighing on gross margin, with the impact expected to lessen later in 2018 as their products flow through cost of goods sold. Acquired-intangible amortization was expected to be approximately $2–3 million per quarter during 2018.
Investor verification priorities
- Track whether customer, Sales Leader, and LumiSpa momentum persists after introductory promotions, and distinguish organic growth from acquired revenue and favorable currency effects.
- Monitor cash conversion and working capital, especially inventory, receivables, commission payments, and the reduced working-capital balance.
- Review the post-quarter refinancing, debt balances, interest costs, and compliance with the new credit agreement’s covenants.
- Assess the acquired manufacturers’ contribution to revenue, margins, integration, goodwill, and expected amortization.
- Follow the Indonesia tax assessment and other tax examinations, the Japan customs appeal, and any developments in regulatory or legal matters.