Nu Skin Enterprises, Inc. — Q2 2015 Form 10-Q
Business context and reporting period. Nu Skin is a global direct-selling company of personal care products and nutritional supplements, including Nu Skin, Pharmanex and ageLOC brands. This unaudited quarterly report covers the three and six months ended June 30, 2015; comparisons are to the corresponding 2014 periods. The company reports one operating segment and revenue across five geographic regions.
Financial performance and liquidity
| Metric | Q2 2015 | Q2 2014 | First half 2015 | First half 2014 |
|---|---|---|---|---|
| Revenue | $560.2 million | $650.0 million | $1,103.5 million | $1,321.1 million |
| Gross profit | $449.9 million | $494.0 million | $888.2 million | $1,058.4 million |
| Gross margin | 80.3% | 76.0% | 80.5% | 80.1% |
| Operating income | $71.8 million | $54.7 million | $140.4 million | $155.9 million |
| Net income | $44.7 million | $19.5 million | $80.9 million | $74.4 million |
| Diluted EPS | $0.75 | $0.32 | $1.35 | $1.22 |
- Q2 and first-half revenue declined 14% and 16%, respectively. Currency movements reduced revenue by 7% in both periods. Prior-year limited-time-offer sales also weighed on comparisons: approximately $76 million in Q2 and $109 million in the first half, with no significant limited-time offers in the first half of 2015.
- Q2 operating income rose despite lower sales, while first-half operating income fell. The reported improvement in net income and EPS versus 2014 was substantially affected by prior-year Venezuela currency losses and an inventory write-down, rather than revenue growth.
- First-half cash from operations was $159.6 million, versus cash used of $184.9 million in 2014. Investing activities used $34.8 million, primarily for property and equipment; financing activities used $109.4 million, including $75.9 million of share repurchases and $41.2 million of dividends. Cash increased $4.0 million to $292.4 million.
- At June 30, cash and current investments were $303.9 million; working capital was $387.0 million, down from $416.3 million at year-end 2014. Total debt on the balance sheet was approximately $252.1 million, including the Korean subsidiary loan and net of debt financing costs. Credit Agreement borrowings were reported at $232.1 million net of the debt discount. The company reported compliance with leverage and interest-coverage covenants in its discussion but did not provide the period-end ratios in the supplied text.
- Cash dividends of $0.35 per share were paid in March and June. In August, the board declared another $0.35 quarterly dividend. The company repurchased 1.4 million shares for $75.9 million in the first half; $271.5 million remained authorized for repurchases.
Material changes and operating trends
- Revenue declined in all five regions in Q2: Greater China $200.1 million, down 13%; North Asia $172.9 million, down 12%; Americas $83.5 million, down 7%; South Asia/Pacific $68.0 million, down 17%; and EMEA $35.6 million, down 32%. Currency and prior-year limited-time offers were material factors; Mainland China operations also remained affected by prior business disruption.
- Sales Leaders were down 1% and Actives down 6% company-wide year over year. At June 30, the reported totals were 62,160 Sales Leaders and 1,015,000 Actives, compared with 62,923 and 1,079,000 a year earlier.
- Gross margin benefited from the absence of the $50.0 million Q2 2014 inventory write-down, primarily in Mainland China. This was partly offset by reclassifying warehousing and shipping overhead from general and administrative expense to cost of sales: $7.6 million in Q2 and $8.3 million in Q1 2015.
- Inventory declined $33.5 million from December 2014 to $305.0 million. The company’s carrying value still reflected prior inventory adjustments of $40.3 million at June 30, 2015.
Outlook, risks and unusual items
- The filing gives no numerical revenue or earnings guidance. Management expected the stronger U.S. dollar to continue to pressure 2015 results and anticipated new products would support revenue in the remainder of 2015 and 2016. Planned introductions included ageLOC Youth, ageLOC Me, ageLOC cosmetic oils and Epoch essential oils across selected markets and quarters.
- Management expected approximately $35 million of additional capital expenditures in the second half of 2015 and believed cash, operating cash flows and credit lines would meet short- and long-term needs. It noted it could reduce capital spending, repurchases or dividends, or seek additional financing, if needed.
- Venezuela remained subject to foreign-exchange controls that restrict conversion and repatriation. Adoption of the SIMADI rate in Q1 2015 generated a $10.2 million foreign-exchange loss. Venezuela cash was $2.6 million at June 30; management said risks there had largely been mitigated, while acknowledging continued currency and operating uncertainty.
- A Japanese customs dispute involved approximately 4.4 billion yen, or $35.9 million, in assessments and disputed duties. The Tokyo District Court closed proceedings in June 2015, and the company anticipated a decision later in 2015. If recovery fails, the company could record a non-cash expense for the disputed amount.
- The company faced a securities class action alleging misleading statements about Mainland China operations and results; its motion to dismiss was denied. A related derivative action was stayed pending resolution of the securities case. The company disputed the allegations and intended to defend itself; adverse outcomes could materially affect results or financial condition.
- Other disclosed exposures include tax examinations and regulatory requirements covering products, claims, advertising and direct selling. Management reported disclosure controls were effective as of June 30, 2015, with no material quarter changes to internal control over financial reporting.
Important facts for investors to verify
- Whether revenue and distributor activity stabilize, particularly in Greater China, and whether planned product launches meet management’s expectations.
- How much of the earnings comparison reflects recurring operations versus the 2014 Venezuela and inventory charges, and how the 2015 overhead reclassification affects margin comparisons.
- Cash conversion and working-capital trends, debt balances and covenant headroom, and the capacity to sustain dividends and repurchases alongside planned capital spending.
- Developments and potential financial exposure in the Japanese customs case and securities litigation, plus the effects of foreign-exchange restrictions and currency movements.