Nu Skin Enterprises, Inc. — Q3 2011 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2011. Amounts are U.S. dollars; financial statement figures are in millions unless stated otherwise.
Business context
Nu Skin is a global direct-selling company selling personal care products and nutritional supplements under the Nu Skin and Pharmanex brands. It reported revenue across North Asia, Greater China, South Asia/Pacific, the Americas and Europe. Management cited emerging-market growth and distributor expansion, offset by softness in the United States and Japan.
Financial performance and liquidity
| Metric | Q3 2011 | Q3 2010 | Nine months 2011 | Nine months 2010 |
|---|---|---|---|---|
| Revenue | $428.4 | $383.6 | $1,248.7 | $1,136.0 |
| Gross profit | $357.8 | $314.8 | $1,006.2 | $934.5 |
| Operating income | $67.2 | $52.9 | $158.2 | $158.2 |
| Net income | $46.8 | $35.3 | $103.8 | $98.7 |
| Diluted EPS | $0.72 | $0.55 | $1.61 | $1.53 |
| Operating cash flow | — | — | $127.4 | $138.3 |
- Revenue rose 12% in Q3 and 10% year to date; foreign exchange added approximately 7% to reported revenue in both periods.
- Gross margin was 83.5% in Q3 versus 82.1%. Year-to-date reported gross margin was 80.6% versus 82.3%; excluding the $32.8 million Japan customs charge, 2011 margin was 83.2% (non-GAAP).
- Q3 net income increased 33%. Nine-month net income increased 5%; excluding the customs charge, management reported net income of $124.3 million and diluted EPS of $1.93 (both non-GAAP).
- Q3 selling expense was 43.0% of revenue, up from 42.3%, reflecting distributor incentives and trips. General and administrative expense fell to 24.8% from 25.9% as a share of revenue.
- Q3 other expense was $6.9 million, including a primarily unrealized $6.2 million foreign-currency loss on intercompany balances. The nine-month effective tax rate was 31.1%, down from 34.6%; Q3 included a $7.7 million discrete tax benefit related to settlement of an IRS audit.
- Cash and cash equivalents were $242.0 million at September 30, 2011, versus $230.3 million at December 31, 2010. Working capital was $261.3 million, versus $206.1 million.
- Total debt was approximately $137.9 million ($28.6 million current and $109.4 million long-term), down from approximately $160.9 million at year-end 2010. The company had no outstanding balance on its $25 million revolving facility.
- Nine-month capital expenditures were $28.0 million. Financing included $51.0 million of share repurchases, $26.7 million of dividends and $26.5 million of debt payments. Cash increased $11.7 million over the nine-month period.
Material changes versus prior periods
- Growth was strongest in Mainland China (Q3 revenue +79%), South Korea (+33%), South Asia/Pacific (+23%) and Europe (+11%). The Americas declined 7%; Japan declined 2% in Q3, while local-currency Japan revenue fell 11%.
- Pharmanex revenue increased to $190.1 million in Q3 from $156.0 million; Nu Skin revenue increased to $236.0 million from $224.5 million. For the nine months, Pharmanex grew while Nu Skin revenue declined slightly.
- Operating income was essentially unchanged for the first nine months despite revenue growth, partly reflecting higher operating expenses and the $32.8 million customs charge. The charge was recorded in Q1, was non-cash in 2011 because the assessments had previously been paid, and is under appeal.
- Global active distributors were 833,000 versus 783,000 a year earlier; executive distributors were 39,751 versus 34,805.
Outlook, risks and unusual items
- At an October distributor convention, the company received approximately $100 million in orders for new ageLOC products; it expected 80%–90% to be recognized as Q4 2011 revenue and planned a broader global launch during 2012. Management cited delivery timing, returns and possible cannibalization as uncertainties.
- Management expected Thailand flooding to negatively affect that market in Q4. It anticipated foreign exchange to have a slightly positive effect on 2011 reported revenue based on then-current rates.
- Management forecast $20–$25 million of additional capital expenditures for the rest of 2011 and expected to fund obligations with cash, operating cash flow and available credit. A $11.7 million LifeGen Technologies asset acquisition was subject to definitive agreement, diligence and other closing conditions; the company anticipated closing before year-end.
- A separate Japan customs dispute covered assessments and disputed import duties totaling approximately $51.3 million at September 30, 2011, increasing about $2.0 million per quarter. The company was pursuing the case in Tokyo District Court and recorded disputed deposits/payments as a long-term receivable; an adverse outcome could require a non-cash expense. Additional customs disputes existed in Thailand and Taiwan.
- Other disclosed risks include regulatory limits on direct selling and product claims, especially in China; distributor retention and activity; currency volatility; and product-device classification. A U.S. shipment of Galvanic Spa Systems was detained pending FDA review, and some markets required medical-device registration.
- Craig and Harper sued the company and subsidiaries, seeking more than approximately $42 million in damages and $200 million in punitive damages; the company said it believed the claims were without merit and would defend them. A related counterclaim sought more than $2 million and $20 million in punitive damages; the company likewise disputed it.
Most important facts for investors to verify
- Progress and potential financial exposure in the $51.3 million Japan customs dispute, distinct from the $32.8 million charge already recorded.
- Whether Q4 revenue from the ageLOC launch met management’s order-recognition expectations, and the effects of returns, fulfillment and product cannibalization.
- Whether growth in China, South Korea and South Asia/Pacific can offset continued weakness in Japan and the Americas, including distributor trends.
- Resolution of the FDA classification review and other market-specific regulatory requirements for Galvanic Spa products.
- Closing and final terms of the proposed LifeGen acquisition, and the company’s cash-flow capacity alongside planned investment, dividends and share repurchases.