Nature’s Sunshine Products, Inc. — Q3 2016 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2016. Unaudited consolidated results; dollar figures below are in millions unless stated otherwise. The company manufactures and directly sells nutritional and personal care products through independent distributors, across four segments.
Financial performance
| Metric | Q3 2016 | Q3 2015 | Nine months 2016 | Nine months 2015 |
|---|---|---|---|---|
| Net sales | $85.4 | $79.6 | $257.2 | $244.7 |
| Gross profit | $63.9 | $58.9 | $190.6 | $181.1 |
| Gross margin | 74.8% | 74.1% | 74.1% | 74.0% |
| Operating income | $5.1 | $3.1 | $11.4 | $11.7 |
| Operating margin | 5.9% | 3.9% | 4.4% | 4.8% |
| Income from continuing operations | $3.9 | $1.6 | $8.1 | $8.2 |
| Net income attributable to common shareholders | $4.2 | $2.8 | $8.8 | $11.0 |
| Diluted EPS attributable to common shareholders | $0.22 | $0.15 | $0.46 | $0.57 |
- Q3 sales rose 7.4% year over year (6.1% excluding currency); nine-month sales rose 5.1% (6.2% excluding currency).
- Q3 operating income increased 61% as gross margin improved and volume incentives fell as a percentage of sales. Nine-month operating income declined 1.9%, as higher SG&A more than offset gross-profit growth.
- Q3 SG&A was $29.2 million, up $2.1 million; nine-month SG&A was $88.8 million, up $8.0 million. The nine-month effective tax rate was 34.6%, versus 26.0% in 2015; Q3 rates were 22.4% and 44.4%, respectively.
- Nine-month operating cash flow was $5.1 million, versus $8.2 million. Investing used $7.9 million, chiefly capital expenditures; financing provided $0.6 million. Cash decreased $1.0 million to $40.4 million.
- At September 30, cash was $40.4 million, current assets $110.2 million, current liabilities $62.6 million, and working capital $47.6 million. Inventory rose to $48.9 million from $38.5 million at year-end 2015.
- Revolver borrowings were $9.0 million, up from $2.7 million at year-end; $16.0 million of the $25.0 million facility remained available. The facility matures September 1, 2017; the company reported compliance with its covenants. Cash paid for interest for the first nine months was $0.2 million.
Material changes and segment trends
- Synergy Worldwide: Q3 sales rose 12.7% to $31.3 million; nine-month sales rose 10.8% to $94.2 million. Asia Pacific growth, including South Korea and Japan, was partly offset by North American declines.
- China and New Markets: Q3 sales were $4.4 million versus $1.0 million; nine-month sales were $10.8 million versus $3.0 million. Growth reflected pre-opening product sales through Hong Kong, not yet a broad launch of the planned China direct-selling/e-commerce business.
- NSP Americas: Q3 sales declined 2.7% to $43.3 million and nine-month sales declined 2.1% to $133.2 million. Latin America remained weak; U.S. sales were broadly stable.
- NSP Russia, Central and Eastern Europe: Q3 sales increased 1.6% to $6.4 million, while nine-month sales fell 7.5% to $19.0 million.
- Active distributors and customers worldwide declined to approximately 244,500 from 256,800 a year earlier; active Managers were approximately 13,200 versus 13,000.
Management outlook, risks and unusual items
- Management said cash, operating cash flow and available borrowing capacity should fund normal operating needs, dividends, repurchases, capital expenditures, potential business development and obligations for the next 12 months and foreseeable future. No specific revenue or earnings guidance was provided.
- Management expects Russia and nearby markets to remain affected by political unrest, sanctions and currency devaluation. Latin American sales face changing product-registration rules. Foreign exchange remains material: international operations generated 56.3% of nine-month sales, and the company does not hedge currency exposure with derivatives.
- The planned China business depends on product registrations, permits and licenses. China expansion, inventory build-up, pre-opening Hong Kong sales and Oracle ERP implementation contributed to higher expenses; management anticipated ERP completion by early 2017.
- Q3 and nine-month SG&A included $1.5 million and $3.4 million, respectively, of service fees for Hong Kong pre-opening sales; $0.5 million and $2.7 million of increased China investment; and $0.5 million and $2.2 million of non-capitalizable Oracle project labor costs. Prior-year restructuring charges partially offset these increases.
- Nine-month 2015 results included $2.1 million of income from discontinued operations, mainly related to Venezuela asset-sale proceeds and a release of Brazil-related accrued liabilities. There was no discontinued-operations income in 2016.
- Accrued unrecognized income-tax positions were $6.1 million, down from $7.8 million at year-end 2015. Accrued non-income-tax contingencies were $0.4 million; possible future payments were estimated at $0 to $4.2 million. Other foreign litigation could involve $0 to approximately $0.2 million; outcomes remain uncertain.
- Cash held in foreign markets was $36.9 million and may be subject to withholding taxes or other repatriation restrictions. The filing also cites distributor dependence, regulatory scrutiny, product liability, cyber and IT risks, and international political and economic uncertainty. Management reported effective disclosure controls and no material changes to internal control during the quarter.
Key facts for investors to verify
- Whether reported growth is sustainable without Hong Kong pre-opening sales, and whether China product approvals and launch milestones progress as planned.
- Whether distributor counts and sales recover in NSP Americas and Russia/Central and Eastern Europe, and whether Synergy’s growth offsets declines elsewhere.
- Inventory growth, working-capital needs and operating cash conversion, alongside the increased revolver usage and its 2017 maturity.
- The continuing cost and expected completion of the Oracle ERP program, and the effect of China investment and service fees on margins.
- Potential outcomes and cash effects of tax positions, non-income-tax contingencies and legal proceedings, as well as restrictions on foreign-held cash.