Nu Skin Enterprises, Inc. — Q2 2014 Form 10-Q
Reporting period: Three and six months ended June 30, 2014. Unaudited consolidated results. Nu Skin is a global direct-selling company offering personal-care products and nutritional supplements.
Financial performance
Amounts below are in millions of U.S. dollars except per-share data. Comparisons are with the corresponding 2013 period.
| Metric | Q2 2014 | Q2 2013 | First half 2014 | First half 2013 |
|---|---|---|---|---|
| Revenue | $650.0 | $671.3 | $1,321.1 | $1,212.6 |
| Gross profit | $494.0 | $560.1 | $1,058.4 | $1,011.3 |
| Gross margin | 76.0% | 83.4% | 80.1% | 83.4% |
| Operating income | $54.7 | $114.6 | $155.9 | $197.2 |
| Other expense, net | $(21.1) | $(1.2) | $(38.6) | $(1.1) |
| Net income | $19.5 | $74.4 | $74.4 | $128.7 |
| Diluted EPS | $0.32 | $1.22 | $1.22 | $2.11 |
| Operating cash flow | Not presented by quarter | $(184.9) | $188.9 |
Q2 revenue declined 3%; first-half revenue rose 9%, with foreign exchange reducing revenue by 2% and 3%, respectively. Q2 net income fell about 74% and first-half net income fell about 42%. First-half operating cash use reflected payment of prior-year accrued selling and incentive expenses, inventory build, and lower Mainland China sales.
At June 30, cash and cash equivalents were $219.5 million, down from $525.2 million at year-end; working capital was $327.4 million. Current assets were $846.0 million and current liabilities $518.7 million. Debt totaled approximately $211.4 million ($99.8 million current and $111.6 million long-term). First-half capital expenditures were $57.1 million; management expected about $40 million more in the remainder of 2014. Cash dividends paid in the first half totaled $40.5 million.
Material changes and operating trends
- Mainland China revenue fell 19% in Q2 to $153.8 million, although it rose 18% for the first half. Adverse media and regulatory scrutiny, and the company’s temporary suspension of promotional meetings and new-representative applications, disrupted operations. Mainland China Sales Leaders and Actives were down 18% and 44% year over year at quarter-end.
- Greater China revenue declined 12% in Q2. North Asia revenue was nearly flat: South Korea rose 22%, while Japan fell 21%. Americas rose 8%, EMEA 14%, and South Asia/Pacific declined 5% in Q2.
- The $50 million Mainland China inventory write-down, lower manufacturing utilization, and a smaller Mainland China share of sales reduced gross margin. Selling expenses were 43.6% of Q2 revenue versus 44.3% a year earlier; first-half selling expenses were 45.2% versus 43.7%.
- TR90 limited-time offers generated $560 million in the second half of 2013; management said the unusually large launch and three-month kit configuration weighed on subsequent demand. Some consumers were dissatisfied with weight-loss results.
Outlook, risks and unusual items
- Management planned to expand Mainland China activity in the second half of 2014 after resuming corporate-hosted meetings and accepting new-representative applications in May. It cited uncertainty about rebuilding the sales force and warned that second-half 2014 comparisons would be difficult after 2013 TR90 sales.
- Management planned a U.S. facial-spa launch in Q4 2014 and an EMEA ageLOC Tru Face Essence Ultra limited-time offer in Q4. No quantitative revenue or earnings guidance is provided in the filing.
- Venezuela currency changes produced $46 million of first-half foreign-exchange charges ($25 million in Q2). Currency controls hindered conversion and repatriation of funds. The company also recorded a $6 million out-of-period adjustment to correct prior accounting for Venezuela currency translation; it did not restate prior periods.
- The company disclosed a material weakness in controls over hyperinflationary accounting for Venezuela; disclosure controls were deemed ineffective as of June 30. The issue led to a restatement of Q1 2014 financial statements. Management described remediation efforts.
- At June 30, the company was in violation of restricted-payments covenants under its Prudential and JPMC agreements. An August 8 amendment to the Prudential agreement permitted specified excess restricted payments to avoid default or acceleration; the JPMC facility expired that day after outstanding amounts were repaid. A separate $50 million Bank of America line was undrawn. Subsequent July borrowings included about $30 million due September 30 and $20 million due in December; the filing also flags approximately $80 million of debt due in September and refinancing risk.
- A Japan customs dispute involved about 4.3 billion yen ($42.1 million) of assessments and disputed duties. The company said it believed the assessments were improper; unsuccessful recovery could result in a non-cash expense. Securities class-action and shareholder derivative suits related to Mainland China disclosures and scrutiny were pending; the company intended to defend itself.
- Other risks include regulatory compliance, foreign-exchange volatility, recruiting and sales-force retention, and potential further inventory surplus. Management stated interim results may not indicate full-year results.
Investor verification points
- Track Mainland China sales, recruiting and sales-force recovery, regulatory developments, and the results of resumed business activities.
- Reconcile the major Q2 earnings impacts: $50 million inventory write-down, $25 million Venezuela currency loss in Q2, and the higher effective tax rate.
- Review operating cash conversion, inventory levels, cash availability, upcoming debt maturities, refinancing progress, and compliance with amended debt covenants.
- Monitor the Venezuela exchange rates, currency restrictions, and related accounting controls and remediation.
- Follow the Japan customs litigation and the securities and derivative lawsuits for changes in exposure or potential financial impact.