Nature’s Sunshine Products, Inc. — Q3 2011 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2011. Unaudited consolidated results. The company manufactures and markets nutritional and complementary products through independent distributors and managers across multiple countries, under Nature’s Sunshine Products and Synergy Worldwide brands.
Financial performance
| Metric | Q3 2011 | Q3 2010 | Nine months 2011 | Nine months 2010 |
|---|---|---|---|---|
| Net sales | $91.1 million | $86.1 million | $275.8 million | $260.0 million |
| Operating income (loss) | $(5.1) million | $3.9 million | $10.6 million | $7.7 million |
| Net income (loss) | $(2.3) million | $(5.7) million | $10.0 million | $(0.5) million |
| Diluted EPS | $(0.14) | $(0.37) | $0.64 | $(0.03) |
| Operating cash flow | Not provided for quarter | Not provided for quarter | $(4.1) million | $10.2 million |
- Q3 sales rose 5.8%; nine-month sales rose 6.0%. Synergy Worldwide drove growth, while both NSP U.S. and NSP International had lower sales.
- Reported Q3 operating margin was negative 5.6%, including $14.75 million of NutriPlus contract termination expense. Excluding that item, management reported pro forma operating income of $9.6 million, or 10.6% of sales, versus $3.9 million, or 4.5%, a year earlier.
- Nine-month reported operating margin was 3.8%. Excluding the termination charge, management reported pro forma operating income of $25.3 million, or 9.2% of sales, versus $7.7 million, or 3.0%, in 2010.
- Cost of goods sold was 18.5% of sales in Q3 and 19.1% year to date, down from 19.3% and 19.7%. Volume incentives were 35.9% and 36.4% of sales, down from 37.2% and 37.4%. SG&A was 35.0% and 35.3%, down from 39.0% and 39.9%.
- Cash and equivalents were $54.1 million at September 30; working capital was $53.4 million. Of cash, $41.3 million was held in foreign markets and may face withholding taxes or repatriation restrictions. Short-term available-for-sale investments totaled $4.6 million.
- Operating cash outflow of $4.1 million reflected the $21.7 million NutriPlus settlement payment and working-capital timing, partly offset by improved operating income. Management stated pro forma operating cash flow, excluding the settlement payment, was $17.6 million.
- The company borrowed $10.0 million under a three-year term loan, secured by its Spanish Fork, Utah manufacturing facility. It had $15.0 million available and undrawn under a revolving facility through August 2013. Debt was $10.0 million, of which $3.3 million was current. The company reported compliance with debt covenants.
Material changes and segment trends
- Synergy Worldwide sales grew 34.3% in Q3 and 39.4% year to date; segment operating income was $2.6 million and $7.0 million, respectively. Growth was led by the U.S., Europe and Korea.
- NSP U.S. sales declined 2.9% in Q3 and 2.2% year to date. Management cited economic weakness and changes to less-profitable promotions; active U.S. distributors and customers fell to about 210,300 from 241,900.
- NSP International sales declined 0.8% in Q3 and 1.1% year to date. Its reported operating losses included the $14.75 million termination charge; excluding it, management reported improved segment operating income. Weakness in Belarus, Japan, Mexico and the Dominican Republic offset Russian-market growth.
- Brazil operations were discontinued in 2010; there were no significant related costs in 2011. The 2010 comparisons include Brazil discontinued-operation losses of $8.4 million for Q3 and $9.4 million for the nine-month period.
Outlook, unusual items and risks
- The July 2011 NutriPlus settlement cost $21.7 million: $6.95 million was applied to previously accrued royalties and $14.75 million was expensed for contract termination and extinguishment of future royalties. Management estimated annual operating-cost savings of $5.6–$6.0 million versus continued royalties, dependent on Russian sales; Q3 costs were reduced by $1.3 million.
- Management said available cash, operating cash flows and the undrawn revolver should meet working-capital needs for the foreseeable future. This is not earnings guidance.
- Risks cited include distributor recruitment and retention, economic weakness, foreign exchange and currency controls, product and direct-selling regulation, raw-material costs, litigation and tax exposures. Japan sales faced disruption following the earthquake, tsunami and nuclear disasters; Belarus’s debt crisis constrained distributors’ ability to obtain foreign currency; Mexican sales were affected by VAT enforcement.
- Foreign markets generated 56.2% of nine-month sales. The company does not hedge foreign exchange with derivatives. Its sensitivity analysis estimated that a 10% strengthening of the U.S. dollar would reduce nine-month operating income by about $1.0 million, excluding the fixed termination charge.
- The IRS was auditing 2006–2010 returns; administrative proceedings continued over proposed 2003–2005 adjustments. Management said the ultimate outcome and impact could not be determined. Accrued liabilities included $7.46 million for non-income-tax contingencies; other litigation could result in payments estimated at $0–$1.5 million, with no provision recorded.
- Management stated disclosure controls were effective at September 30, 2011, and there were no material changes in internal control over financial reporting during the quarter.
Investor verification priorities
- Verify the cash amount and accounting treatment of the NutriPlus settlement, and assess whether anticipated royalty savings materialize with Russian sales.
- Reconcile the reported operating cash outflow with the settlement payment, working-capital movements and management’s $17.6 million pro forma cash-flow figure.
- Monitor segment-level sales and profitability, especially Synergy growth and NSP U.S. distributor trends, as well as weakness in Belarus, Japan, Mexico and the Dominican Republic.
- Review the availability and repatriability of foreign-held cash, debt repayments and covenant requirements.
- Track IRS proceedings, other tax and legal contingencies, and the potential effects of currency controls, exchange rates and regulatory changes.