Nature’s Sunshine Products, Inc. — Q2 2014 Form 10-Q
Reporting period: Three and six months ended June 30, 2014. Unaudited financial statements; amounts below are in millions of dollars unless noted. The company manufactures and directly sells nutritional and personal-care products through independent distributors in international markets.
Financial performance
| Metric | Q2 2014 | Q2 2013 | Six months 2014 | Six months 2013 |
|---|---|---|---|---|
| Net sales | $94.3 | $93.7 | $190.1 | $190.2 |
| Gross profit / margin | $71.0 / 75.2% | $71.0 / 75.8% | $143.6 / 75.5% | $143.1 / 75.2% |
| Operating income / margin | $5.8 / 6.2% | $7.8 / 8.3% | $13.0 / 6.8% | $14.8 / 7.8% |
| Income before taxes | $5.4 | $9.3 | $11.5 | $16.6 |
| Income tax provision (benefit) | $2.2 | $3.2 | $(1.4) | $5.6 |
| Net income / margin | $3.2 / 3.4% | $6.1 / 6.5% | $12.9 / 6.8% | $10.9 / 5.7% |
| Diluted EPS | $0.20 | $0.38 | $0.79 | $0.68 |
| Dividends declared per share | $0.10 | $0.10 | $0.20 | $0.20 |
Q2 sales increased 0.7% reported and 1.1% in local currencies. Six-month sales were essentially flat reported, or up 0.7% in local currencies. Q2 net income fell 46.6%, reflecting lower operating income and a swing in other income/expense to a loss. Six-month net income rose 18.2% despite lower pretax income, principally because a $6.7 million discrete tax benefit arose from foreign tax credits related to $21.5 million of intercompany dividends. Management said it was unlikely that tax items would again have as large an effect.
Q2 gross margin edged down as product promotions increased discounting. Six-month gross margin improved with product mix, lower raw-material costs and lower in-market distribution costs. SG&A rose to 32.1% of Q2 sales from 30.6%; management cited $0.8 million of Fosun-related professional fees and $1.1 million spent evaluating an alternative distribution-channel opportunity that the company did not pursue. Other income/expense worsened by $1.9 million in Q2 and $3.3 million year to date, largely due to foreign-exchange losses, including Venezuela.
Segments and operating trends
| Segment | Q2 2014 sales | Q2 year-over-year | Six-month 2014 sales | Six-month year-over-year |
|---|---|---|---|---|
| NSP Americas, Asia Pacific and Europe | $49.0 | −8.3% (−5.4% local currency) | $99.7 | −6.5% (−4.3% local currency) |
| NSP Russia, Central and Eastern Europe | $12.8 | −14.3% | $27.9 | −10.4% |
| Synergy WorldWide | $32.5 | +28.5% (+23.9% local currency) | $62.5 | +19.1% (+17.3% local currency) |
Synergy growth was led by South Korea, where Q2 sales more than doubled, and by Japan. Declines in the NSP segments reflected weaker North American sales, lower distributor activity, and political and currency pressures in Russia and Ukraine. The company reported about 302,500 active distributors and customers and 15,700 active managers, down from 331,000 and 17,100, respectively, a year earlier. The U.S. national convention shifted from Q2 to Q1, affecting Q2 promotional sales.
Cash flow, liquidity and debt
- Cash and cash equivalents were $68.6 million at June 30, down from $77.2 million at year-end; working capital was $79.3 million versus $80.0 million. Of cash, $45.4 million was held in foreign markets and may face repatriation restrictions or taxes. Short-term investments were $2.0 million.
- Six-month operating cash flow was $8.1 million, compared with $15.3 million. Investing used $11.5 million, including $11.6 million in capital expenditures; financing used $4.7 million, including $3.2 million of dividends and $1.7 million of debt repayments. Cash declined by $8.7 million.
- Capital spending included $9.0 million for an Oracle ERP implementation, which management expected to complete by mid-2016. Operating cash flow less capital expenditures was approximately negative $3.4 million for the half-year.
- Debt totaled approximately $10.6 million: $10.0 million drawn on a $25.0 million revolving facility and $0.6 million remaining on a term loan. The term loan matured August 9, 2014; the revolving agreement was stated to mature September 1, 2015. The company reported compliance with covenants. It said cash, operating cash flow and available resources should fund normal operations and planned investment.
Outlook, transactions and risks
- No specific financial guidance was provided. Management cited continuing growth potential in Synergy, while cautioning that near-term NSP Russia and Eastern Europe performance may be affected by unrest in Ukraine and Russia, weaker currencies and reduced distributor purchasing power. Management said the effect of any escalation could not be estimated.
- The company and Fosun Pharma signed agreements for an 80%-owned China joint venture and a concurrent private placement. Subject to customary conditions and regulatory approvals, closing was anticipated in Q3 2014. Fosun was to invest about $46.3 million for approximately 2.9 million shares at $16.19 per share, or about 15% ownership, and receive a board designee. The joint venture was to be initially funded with $16 million from Nature’s Sunshine and $4 million from Fosun. The company intended to use part of its proceeds for the venture and a contingent $1.50-per-share special dividend, expected to total about $29 million. China market launch timing depends on product registrations, permits and licenses.
- A new three-year reseller agreement for certain Eastern European territories took effect April 1, 2014, after the general dealer returned about $3.0 million of previously withheld discounts. The agreement adds a variable management fee estimated at $1.5–$2.0 million annually at current sales trends.
- Venezuela was remeasured at the SICAD 1 rate of 11.3 bolivars per U.S. dollar effective March 31, producing an $0.845 million foreign-exchange loss. The company had not obtained dollars at the official 6.3 rate and said it was uncertain how it could collect for previously shipped products. Venezuela generated about 1.6% of Q2 sales. Belarus was also identified as highly inflationary.
- Unrecognized income-tax-benefit liabilities were $13.2 million, up from $12.4 million; the IRS was auditing 2009–2011 federal returns. Accrued non-income-tax contingencies were $4.8 million. Other litigation was reasonably possible but not probable or estimable; potential payments were described as ranging from zero to approximately $0.8 million. Management warned that unfavorable legal, tax or contingency outcomes could materially affect results.
- Risks also include foreign exchange, regulatory requirements for products and direct selling, distributor retention and productivity, product-liability claims, competition, and dependence on international markets. The company reported effective disclosure controls and no material change in internal controls during the quarter.
Important facts for investors to verify
- Whether the Fosun placement and China joint venture closed, and the resulting share dilution, dividend payment, funding commitments and regulatory timetable.
- Whether cash generation improves as ERP capital spending continues, and how much reported cash is practically available given foreign holdings and repatriation costs.
- Whether Synergy’s South Korean-led growth can offset continued distributor and sales declines in NSP Americas and NSP Russia/Eastern Europe.
- Developments in Venezuela’s currency and collection mechanisms, and the impact of Russia–Ukraine conditions on sales and distributor purchasing power.
- Outcomes of the IRS audit, transfer-pricing exposures, non-income-tax matters and other litigation, including any effects beyond amounts accrued.