Nature’s Sunshine Products, Inc. — Q3 2017 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2017. The company manufactures and sells nutritional and personal-care products through independent distributors. Amounts below are in U.S. dollars; financial-statement amounts are in millions unless stated otherwise.
Financial results
- Q3 revenue: $89.3 million, up 4.5% year over year (4.3% in local currencies). Gross profit was $65.8 million; gross margin was 73.7%, versus 74.8%. Operating income fell to $2.2 million from $5.1 million; operating margin was 2.4%, versus 5.9%. Net income was $2.3 million and net income attributable to common shareholders was $2.4 million ($0.13 per diluted share), compared with $3.9 million, $4.2 million and $0.22, respectively, in Q3 2016.
- Nine-month revenue: $253.7 million, down 1.3% (down 1.5% in local currencies). Gross profit was $187.3 million and gross margin 73.8%, versus 74.1%. Operating income was $4.2 million, down 63%; operating margin was 1.7%, versus 4.4%. Net income was $3.8 million; net income attributable to common shareholders was $4.4 million ($0.23 per diluted share), versus $8.1 million, $8.8 million and $0.47 in the prior-year period.
- Expense and tax trends: Q3 SG&A rose 12.8% to $32.9 million and was 36.9% of revenue, versus 34.2%. Nine-month SG&A increased 7.1% to $95.1 million and was 37.5% of revenue, versus 34.5%. The nine-month effective tax rate was 38.2%, compared with 34.6%; Q3 tax provision was approximately zero, primarily reflecting a reduction in liabilities for uncertain tax positions.
- Cash flow: Nine-month operating cash flow was $8.0 million, versus $5.1 million; investing cash outflow was $1.6 million, versus $7.9 million; financing cash inflow was $7.4 million, versus $0.6 million. Ending cash was $47.7 million, up from $32.3 million at year-end 2016.
- Liquidity and debt: Working capital was $55.7 million, versus $31.5 million at December 31, 2016. Cash included $38.4 million held by foreign subsidiaries, potentially subject to repatriation restrictions or taxes. Revolver borrowings were $19.2 million under a $25 million Bank of America facility maturing July 2020; interest was LIBOR plus 1.25% (2.49% at quarter-end). The company reported compliance with covenants. China joint venture borrowings included a $0.5 million related-party note due within one year at 3% interest.
Material changes and business developments
- Q3 growth was led by China and New Markets (+44.5%), NSP Russia, Central and Eastern Europe (+11.0%), and Synergy WorldWide (+10.0%). NSP Americas declined 4.5%. For the nine months, China and New Markets grew 37.2% and Russia/CEE 12.4%, while NSP Americas fell 5.9% and Synergy declined 2.2%.
- The company received a direct-selling license in China in Q2 2017, enabling expansion of direct-selling activity there. China growth also includes pre-opening sales through Hong Kong; China segment service fees were $2.1 million in Q3 and $4.7 million for the nine months.
- The Oracle ERP system went live for NSP Americas and corporate operations on April 2, 2017. Implementation problems increased call-center wait times and disrupted online ordering, contributing to customer and distributor attrition, lower NSP Americas sales and weaker profitability. Management said the disruption may continue to negatively affect sales and profitability.
- Active distributors and customers worldwide were 213,400, down from 242,100 a year earlier; active managers were 13,400, versus 13,200. NSP Americas active distributors and customers fell to 107,300 from 125,900.
- The board suspended quarterly dividends in May 2017 after a $0.10-per-share dividend paid in April. No shares were repurchased during the quarter or nine-month period; $13.4 million remained under the repurchase authorization.
Outlook, risks and contingencies
- No quantitative earnings or revenue guidance is provided. Management expects cash from operations and available cash to fund normal operating needs, including capital expenditures, but cautions that prolonged economic weakness, lower demand, tax settlements or contingencies could impair long-term liquidity.
- Key disclosed risks include continued ERP implementation disruption; dependence on distributor numbers and productivity; direct-selling and product regulation, including China licensing and Latin American product-registration changes; foreign-exchange movements; geopolitical and economic conditions in Russia, Ukraine and South Korea; and product, cyber-security and supply-chain risks.
- Ukraine was classified as highly inflationary in June 2017. Management said the change did not cause remeasurement gains or losses because the U.S. dollar was already the functional currency for the relevant operations; weaker local purchasing power may still affect sales.
- Accrued non-income-tax contingencies were $0.3 million, with possible future payments estimated at $0 to approximately $4.0 million. Accruals for other foreign tax assessments and civil proceedings were $1.0 million; possible payments were estimated at $0 to approximately $0.5 million. Management warns that litigation outcomes are uncertain and could be material. Unrecognized income-tax benefits were $4.9 million at quarter-end.
- Topic 606 was expected to be adopted using the modified retrospective method on January 1, 2018; management did not expect a material financial-statement impact, but was still developing related controls and disclosures.
Important facts for investors to verify
- Whether Oracle ERP service and ordering issues are resolved, and whether distributor/customer attrition and NSP Americas sales stabilize.
- Whether China’s license-led growth can continue and translate into sustainable segment economics after service fees and expansion costs.
- Whether SG&A growth and reduced operating margins improve as ERP-related depreciation and China investment evolve.
- Availability of foreign-held cash, covenant headroom and the effect of debt restrictions on dividends or other capital returns.
- Outcomes of tax positions, legal matters and non-income-tax contingencies, including the range of possible payments disclosed.