10-Q 1 a11-14070_110q.htm 10-Q

Table of Contents

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 


 

FORM 10-Q

 

(Mark One)

 

x      QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended June 30, 2011

 

OR

 

o         TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from                          to                         .

 

Commission File Number:  0-8707

 

 

NATURE’S SUNSHINE PRODUCTS, INC.

(Exact name of Registrant as specified in its charter)

 

Utah

 

87-0327982

(State or other jurisdiction of

 

(IRS Employer

incorporation or organization)

 

Identification No.)

 

75 East 1700 South

Provo, Utah 84606

(Address of principal executive offices and zip code)

 

(801) 342-4300

(Registrant’s telephone number including area code)

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes x No o

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes x No o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act (Check one).

 

Large accelerated filer o

 

Accelerated filer x

 

 

 

Non-accelerated filer o

 

Smaller reporting company o

(Do not check if a smaller reporting company)

 

 

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).  Yes o No x.

 

The number of shares of Common Stock, no par value, outstanding on July 29, 2011 was 15,559,402 shares.

 

 

 



Table of Contents

 

NATURE’S SUNSHINE PRODUCTS, INC.

FORM 10-Q

 

For the Quarter Ended June 30, 2011

 

Table of Contents

 

Part I. Financial Information

 

 

 

 

 

 

Item 1. Financial Statements (Unaudited)

 

 

 

 

 

 

 

Condensed Consolidated Balance Sheets

3

 

 

Condensed Consolidated Statements of Operations

4

 

 

Condensed Consolidated Statements of Cash Flows

6

 

 

Notes to Condensed Consolidated Financial Statements

7

 

 

 

 

 

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

17

 

 

 

 

 

Item 3.

Quantitative and Qualitative Disclosures about Market Risk

27

 

 

 

 

 

Item 4.

Controls and Procedures

31

 

 

 

 

Part II. Other Information

 

 

 

 

 

 

Item 1.

Legal Proceedings

31

 

 

 

 

 

Item 1A.

Risk Factors

31

 

 

 

 

 

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

31

 

 

 

 

 

Item 3.

Default Upon Senior Securities

31

 

 

 

 

 

Item 4.

Removed and Reserved

31

 

 

 

 

 

Item 5.

Other Information

32

 

 

 

 

 

Item 6.

Exhibits

32

 

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PART I FINANCIAL INFORMATION

 

Item 1.  FINANCIAL STATEMENTS

 

NATURE’S SUNSHINE PRODUCTS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(Amounts in thousands)

(Unaudited)

 

 

 

June 30,
2011

 

December 31,
2010

 

Assets

 

 

 

 

 

Current Assets:

 

 

 

 

 

Cash and cash equivalents

 

$

62,998

 

$

47,604

 

Accounts receivable, net of allowance for doubtful accounts of $730 and $918, respectively

 

8,955

 

5,947

 

Investments available for sale

 

6,969

 

6,470

 

Inventories

 

38,047

 

36,235

 

Deferred income tax assets

 

4,697

 

4,582

 

Prepaid expenses and other

 

5,704

 

5,700

 

Total current assets

 

127,370

 

106,538

 

 

 

 

 

 

 

Property, plant and equipment, net

 

26,072

 

27,391

 

Investment securities

 

1,636

 

1,778

 

Intangible assets, net

 

1,229

 

1,303

 

Deferred income tax assets

 

13,229

 

12,916

 

Other assets

 

10,338

 

9,489

 

 

 

$

179,874

 

$

159,415

 

 

 

 

 

 

 

Liabilities and Shareholders’ Equity

 

 

 

 

 

Current Liabilities:

 

 

 

 

 

Accounts payable

 

$

5,082

 

$

4,855

 

Accrued volume incentives

 

19,913

 

18,619

 

Accrued liabilities

 

38,127

 

34,601

 

Deferred revenue

 

2,817

 

3,385

 

Income taxes payable

 

5,095

 

3,708

 

Total current liabilities

 

71,034

 

65,168

 

 

 

 

 

 

 

Liability related to unrecognized tax benefits

 

20,862

 

21,366

 

Deferred compensation payable

 

1,636

 

1,778

 

Other liabilities

 

2,778

 

2,721

 

Total long-term liabilities

 

25,276

 

25,865

 

 

 

 

 

 

 

Commitments and Contingencies (Note 11)

 

 

 

 

 

 

 

 

 

 

 

Shareholders’ Equity:

 

 

 

 

 

Common stock, no par value; 50,000 shares authorized, 15,559 and 15,533 shares issued and outstanding as of June 30, 2011 and December 31, 2010

 

69,191

 

67,752

 

Retained earnings

 

20,514

 

8,278

 

Accumulated other comprehensive loss

 

(6,141

)

(7,648

)

Total shareholders’ equity

 

83,564

 

68,382

 

 

 

$

179,874

 

$

159,415

 

 

See accompanying notes to condensed consolidated financial statements.

 

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NATURE’S SUNSHINE PRODUCTS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

 (Amounts in thousands, except per share information)

(Unaudited)

 

 

 

Three Months Ended
June 30,

 

 

 

2011

 

2010

 

 

 

 

 

 

 

Net sales revenue (net of the rebate portion of volume incentives of $11,356 and $10,976, respectively)

 

$

91,811

 

$

87,143

 

Cost and expenses:

 

 

 

 

 

Cost of goods sold

 

17,129

 

16,759

 

Volume incentives

 

33,390

 

32,546

 

Selling, general and administrative

 

33,240

 

34,565

 

 

 

83,759

 

83,870

 

Operating income

 

8,052

 

3,273

 

Other expense, net

 

(420

)

(902

)

 

 

 

 

 

 

Income before provision for income taxes

 

7,632

 

2,371

 

Provision for income taxes

 

2,018

 

965

 

Net income from continuing operations

 

5,614

 

1,406

 

Loss from discontinued operations

 

 

(352

)

Net income

 

$

5,614

 

$

1,054

 

 

 

 

 

 

 

Basic and diluted net income per common share

 

 

 

 

 

 

 

 

 

 

 

Basic:

 

 

 

 

 

Net income from continuing operations

 

$

0.36

 

$

0.09

 

Loss from discontinued operations

 

$

 

$

(0.02

)

Net income

 

$

0.36

 

$

0.07

 

 

 

 

 

 

 

Diluted:

 

 

 

 

 

Net income from continuing operations

 

$

0.36

 

$

0.09

 

Loss from discontinued operations

 

$

 

$

(0.02

)

Net income

 

$

0.36

 

$

0.07

 

 

 

 

 

 

 

Weighted average basic common shares outstanding

 

15,536

 

15,512

 

Weighted average diluted common shares outstanding

 

15,659

 

15,602

 

 

See accompanying notes to condensed consolidated financial statements.

 

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NATURE’S SUNSHINE PRODUCTS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

 (Amounts in thousands, except per share information)

(Unaudited)

 

 

 

 

Six Months Ended
June 30,

 

 

 

2011

 

2010

 

 

 

 

 

 

 

Net sales revenue (net of the rebate portion of volume incentives of $22,938 and $22,216, respectively)

 

$

184,655

 

$

173,933

 

Cost and expenses:

 

 

 

 

 

Cost of goods sold

 

35,681

 

34,676

 

Volume incentives

 

67,688

 

65,097

 

Selling, general and administrative

 

65,613

 

70,317

 

 

 

168,982

 

170,090

 

Operating income

 

15,673

 

3,843

 

Other income (expense), net

 

(155

)

1,999

 

 

 

 

 

 

 

Income before provision (benefit) for income taxes

 

15,518

 

5,842

 

Provision (benefit) for income taxes

 

3,282

 

(335

)

Net income from continuing operations

 

12,236

 

6,177

 

Loss from discontinued operations

 

 

(970

)

Net income

 

$

12,236

 

$

5,207

 

 

 

 

 

 

 

Basic and diluted net income per common share

 

 

 

 

 

 

 

 

 

 

 

Basic:

 

 

 

 

 

Net income from continuing operations

 

$

0.79

 

$

0.40

 

Loss from discontinued operations

 

$

 

$

(0.06

)

Net income

 

$

0.79

 

$

0.34

 

 

 

 

 

 

 

Diluted:

 

 

 

 

 

Net income from continuing operations

 

$

0.78

 

$

0.40

 

Loss from discontinued operations

 

$

 

$

(0.06

)

Net income

 

$

0.78

 

$

0.33

 

 

 

 

 

 

 

Weighted average basic common shares outstanding

 

15,535

 

15,511

 

Weighted average diluted common shares outstanding

 

15,591

 

15,597

 

 

See accompanying notes to condensed consolidated financial statements.

 

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NATURE’S SUNSHINE PRODUCTS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Amounts in thousands)

(Unaudited)

 

 

 

Six Months Ended
June 30,

 

 

 

2011

 

2010

 

CASH FLOWS FROM OPERATING ACTIVITIES:

 

 

 

 

 

Net income

 

$

12,236

 

$

5,207

 

Adjustments to reconcile net income to net cash provided by operating activities:

 

 

 

 

 

Provision for doubtful accounts

 

(69

)

(54

)

Depreciation and amortization

 

2,117

 

2,152

 

Share-based compensation expense

 

1,144

 

218

 

Loss on sale of property and equipment

 

13

 

2

 

Deferred income taxes

 

(419

)

(62

)

Loss on restricted cash

 

 

497

 

Amortization of bond discount

 

10

 

11

 

Purchase of trading investment securities

 

(38

)

(116

)

Proceeds from sale of trading investment securities

 

226

 

60

 

Realized and unrealized (gains) losses on investments

 

(56

)

59

 

Amortization of prepaid taxes related to gain on intercompany sales

 

 

542

 

Foreign exchange losses (gains)

 

1,237

 

(2,280

)

Changes in assets and liabilities:

 

 

 

 

 

Accounts receivable

 

(2,860

)

(4

)

Inventories

 

(1,577

)

2,010

 

Prepaid expenses and other current assets

 

49

 

(345

)

Other assets

 

(691

)

(76

)

Accounts payable

 

326

 

710

 

Accrued volume incentives

 

1,101

 

1,369

 

Accrued liabilities

 

2,907

 

647

 

Deferred revenue

 

(568

)

(834

)

Income taxes payable

 

1,405

 

(2,429

)

Liability related to unrecognized tax benefits

 

(510

)

(1,986

)

Deferred compensation payable

 

(142

)

83

 

Net cash provided by operating activities

 

15,841

 

5,381

 

CASH FLOWS FROM INVESTING ACTIVITIES:

 

 

 

 

 

Purchases of property, plant and equipment

 

(694

)

(1,286

)

Proceeds from sale of investments available for sale

 

2,382

 

 

Purchase of investments available for sale

 

(2,849

)

 

Net cash used in investing activities

 

(1,161

)

(1,286

)

CASH FLOWS FROM FINANCING ACTIVITIES:

 

 

 

 

 

Proceeds from the exercise of stock options

 

295

 

27

 

Net cash provided by financing activities

 

295

 

27

 

Effect of exchange rates on cash and cash equivalents

 

419

 

350

 

Net increase in cash and cash equivalents

 

15,394

 

4,472

 

Cash and cash equivalents at the beginning of the period

 

47,604

 

35,538

 

Cash and cash equivalents at end of the period

 

$

62,998

 

$

40,010

 

SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:

 

 

 

 

 

Cash paid for income taxes

 

$

2,688

 

$

3,506

 

 

See accompanying notes to condensed consolidated financial statements.

 

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NATURE’S SUNSHINE PRODUCTS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Amounts in thousands, except per-share information)

(Unaudited)

 

(1)                     Basis of Presentation

 

Nature’s Sunshine Products, Inc. and its subsidiaries (hereinafter referred to collectively as the “Company”) are primarily engaged in the manufacturing and marketing of nutritional, herbal, weight management, energy and other complementary products. Nature’s Sunshine Products, Inc. is a Utah corporation with its principal place of business in Provo, Utah. The Company sells its products to a sales force of independent Distributors and Managers who use the products themselves or resell them to other Distributors or consumers.

 

The Company markets its products in Australia, Austria, Belarus, Canada, the Czech Republic, Colombia, Costa Rica, Denmark, the Dominican Republic, Ecuador, El Salvador, Germany, Guatemala, Honduras, Hong Kong, Indonesia, Ireland, Japan, Kazakhstan, Latvia, Lithuania, Malaysia, Mexico, Mongolia, the Netherlands, Nicaragua, Norway, Panama, Peru, the Philippines, Poland, Russia, Singapore, South Korea, Sweden, Taiwan, Thailand, Ukraine, the United Kingdom, the United States, Venezuela and Vietnam. The Company also exports its products to several other countries, including Argentina, Australia, Chile, Israel, New Zealand and Norway.

 

Principles of Consolidation

 

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. The unaudited condensed consolidated financial statements include the accounts of the Company and its subsidiaries.  All significant intercompany accounts and transactions are eliminated in consolidation. In the opinion of management, the accompanying unaudited condensed consolidated financial statements contain all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation of the Company’s financial information as of June 30, 2011, and for the three and six-month periods ended June 30, 2011 and 2010.  The results of operations of any interim period are not necessarily indicative of the results of operations to be expected for the fiscal year ending December 31, 2011.

 

These condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and the notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2010.

 

Discontinued Operations

 

As more fully described in Note 2, “Discontinued Operations,” the Company ceased the operations of its Brazilian subsidiary in the third quarter of 2010, and the results of its operations are classified as discontinued operations in the Company’s statements of operations and accompanying notes for all periods presented.

 

Classification of Venezuela as a Highly Inflationary Economy and Devaluation of Its Currency

 

As of January 1, 2010, Venezuela was designated as a highly inflationary economy. Accordingly, the U.S. dollar became the functional currency for the Company’s subsidiary in Venezuela. All gains and losses resulting from the re-measurement of its financial statements are determined using official rates. On January 8, 2010, the Venezuelan government announced the devaluation of the bolivar against the U.S. dollar.

 

Currency restrictions enacted by the government of Venezuela require approval from the government’s currency control agency organization in order for the Company’s subsidiary in Venezuela to obtain U.S. dollars at the official exchange rate to pay for imported products or to repatriate dividends back to the Company. Prior to January 1, 2010, the market rate, which is substantially lower than the official rate, was available to obtain U.S. dollars or other currencies without approval of the government’s currency control organization. In 2010, the government of Venezuela enacted additional currency restrictions, which effectively replaced the market rate with the System for Foreign Currency Denominated Securities (“SITME”), which is administered by the Venezuela Central Bank. Under SITME, entities domiciled in Venezuela can obtain U.S. dollar denominated securities in limited quantities each month through banking institutions approved by the government.

 

At this time, the Company is not able to estimate reasonably the future state of exchange controls in Venezuela and its availability of U.S. dollars at the official exchange rate or at the SITME rate. However, the Company has been successful repatriating

 

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funds from Venezuela for imported products using the SITME rate. The Company re-measures its results in Venezuela at the SITME rate, which was approximately 5.30 bolivars per U.S. dollar as of June 30, 2011.

 

As a result of the events described in the preceding paragraphs, the Company recorded a gain of $3,668 in the first quarter of 2010 in connection with the re-measurement of its balance sheet to reflect the highly inflationary designation and the devaluation due to the negative position of the Company’s Venezuelan subsidiary’s net monetary assets, which is recorded in foreign exchange gains or losses, a part of other income. The success of future operations will be affected by several factors, including the Company’s ability to take actions to mitigate the effect of devaluation, further actions of the Venezuelan government and economic conditions in Venezuela, such as inflation and consumer spending.

 

During the three months ended June 30, 2011 and 2010, the Company’s Venezuelan subsidiary’s net sales revenue represented approximately 1.4 percent and 1.8 percent of consolidated net sales revenue, respectively. During the six months ended June 30, 2011 and 2010, its net sales revenue represented approximately 1.4 percent and 1.7 percent of consolidated net sales revenue, respectively. The Company’s Venezuelan subsidiary held total assets of $8,402 and $8,024 (which includes an intercompany receivable denominated in U.S. dollars of $2,043 and $1,978) and net assets of $5,220 and $4,185 at June 30, 2011 and December 31, 2010, respectively.

 

Recent Accounting Pronouncements

 

In May 2011, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update No. 2011-04 Fair Value Measurement (Topic 820): “Amendments to Achieve Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs”. This Update addresses how to measure fair value and requires new disclosures about fair value measurements. The amendments in this update are effective for interim and annual periods beginning after December 15, 2011.

 

In June 2011, the FASB issued Accounting Standards Update No. 2011-05 for Comprehensive Income (Topic 220): “Presentation of Comprehensive Income”. This Update improves the comparability, consistency and transparency of financial reporting and increases the prominence of items reported in other comprehensive income. This update is effective for interim and annual periods beginning after December 15, 2011.

 

 (2)                  Discontinued Operations

 

During 2010, the Company ceased its operations in Brazil as a result of declining sales and increased regulatory restrictions, which made it difficult for the Company to register and sell key products in that market. This market was part of the Company’s NSP International segment.

 

The following table summarizes the operating results of the Company’s discontinued operations for the periods indicated:

 

 

 

Three Months Ended
June 30,

 

Six Months Ended
June 30,

 

 

 

2011

 

2010

 

2011

 

2010

 

Net Sales Revenue

 

$

 

$

215

 

$

 

$

471

 

 

 

 

 

 

 

 

 

 

 

Loss before income tax provision

 

$

 

$

(352

)

$

 

$

(970

)

Income tax provision

 

 

 

 

 

Loss from discontinued operations, net of tax

 

$

 

$

(352

)

$

 

$

(970

)

 

The cash flows from our discontinued operations are included in the Company’s operating cash flows, but were insignificant.

 

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(3)                     Inventories

 

Inventories consist of the following:

 

 

 

June 30,

 

December 31,

 

 

 

2011

 

2010

 

Raw Materials

 

$

10,695

 

$

9,177

 

Work in Progress

 

827

 

956

 

Finished Goods

 

26,525

 

26,102

 

 

 

$

38,047

 

$

36,235

 

 

(4)                     Intangible Assets

 

At June 30, 2011 and December 31, 2010, intangibles for product formulations had a gross carrying amount of $1,763 and $1,763, accumulated amortization of $534 and $460, and a net amount of $1,229 and $1,303, respectively. The estimated useful lives of the product formulations range from 9 to 15 years.

 

Amortization expense for intangible assets for the three months ended June 30, 2011 and 2010 was $37 and $29, respectively. Amortization expense for intangible assets for the six months ended June 30, 2011 and 2010 was $74 and $59, respectively.  Estimated amortization expense for each of the five succeeding fiscal years is $149.

 

(5)                     Investments

 

The amortized cost and estimated fair values of available-for-sale securities by balance sheet classification are as follows:

 

As of June 30, 2011

 

Amortized
Cost

 

Gross
Unrealized
Gains

 

Gross
Unrealized
Losses

 

Fair
Value

 

Municipal obligations

 

$

1,569

 

$

68

 

$

 

$

1,637

 

U.S. government securities funds

 

984

 

 

(7

)

977

 

Short-term deposits

 

3,931

 

 

 

3,931

 

Equity securities

 

228

 

196

 

 

424

 

Total short-term investment securities

 

$

6,712

 

$

264

 

$

(7

)

$

6,969

 

 

As of December 31, 2010

 

Amortized
Cost

 

Gross
Unrealized
Gains

 

Gross
Unrealized
Losses

 

Fair
Value

 

Municipal obligations

 

$

1,883

 

$

77

 

$

 

$

1,960

 

U.S. government securities funds

 

989

 

 

(15

)

974

 

Short-term deposits

 

3,148

 

 

 

3,148

 

Equity securities

 

228

 

160

 

 

388

 

Total short-term investment securities

 

$

6,248

 

$

237

 

$

(15

)

$

6,470

 

 

The municipal obligations held at a fair value of $1,637 at June 30, 2011 all mature in less than five years.

 

During the six-month periods ended June 30, 2011 and 2010, the proceeds from the sales of available-for-sale securities were $1,582 and $0, respectively. There were no gross realized gains (losses) on sales of available-for-sale securities (net of tax) for the six-month periods ended June 30, 2011 and 2010, respectively.

 

The Company’s trading securities portfolio totaled $1,636 at June 30, 2011 and $1,778 at December 31, 2010, and generated losses of $6 and $70 for the three months ended June 30, 2011 and 2010, respectively and generated gains of $75 and losses of $26 for the six months ended June 30, 2011 and 2010, respectively.

 

As of June 30, 2011 and December 31, 2010, the Company had unrealized losses of $7 and $15, respectively, in its U.S. government securities funds. These losses are due to the interest rate sensitivity of the U.S. government securities funds.

 

(6)                     Net Income Per Share

 

Basic net income per common share (“Basic EPS”) is computed by dividing net income by the weighted average number of common shares outstanding during the period. Diluted net income per common share (“Diluted EPS”) reflects the potential dilution that could occur if stock options or other contracts to issue common stock were exercised or converted into common stock. The computation of Diluted EPS does not assume exercise or conversion of securities that would have an anti-dilutive effect on net income per common share.

 

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The following is a reconciliation of the numerator and denominator of Basic EPS to the numerator and denominator of Diluted EPS for the three and six months ended June 30, 2011 and 2010:

 

 

 

Three Months Ended June 30,

 

Six Months Ended June 30,

 

 

 

2011

 

2010

 

2011

 

2010

 

Net income available to common stockholders

 

 

 

 

 

 

 

 

 

Net income from continuing operations

 

$

5,614

 

$

1,406

 

$

12,236

 

$

6,177

 

Loss from discontinued operations

 

 

(352

)

 

(970

)

Net income

 

$

5,614

 

$

1,054

 

$

12,236

 

$

5,207

 

 

 

 

 

 

 

 

 

 

 

Basic weighted average shares outstanding

 

15,536

 

15,512

 

15,535

 

15,511

 

 

 

 

 

 

 

 

 

 

 

Basic net income per common share:

 

 

 

 

 

 

 

 

 

Net income from continuing operations

 

$

0.36

 

$

0.09

 

$

0.79

 

$

0.40

 

Loss from discontinued operations

 

$

 

$

(0.02

)

$

 

$

(0.06

)

Net income

 

$

0.36

 

$

0.07

 

$

0.79

 

$

0.34

 

 

 

 

 

 

 

 

 

 

 

Diluted Shares Outstanding

 

 

 

 

 

 

 

 

 

Basic weighted average shares outstanding

 

15,536

 

15,512

 

15,535

 

15,511

 

Stock options

 

123

 

90

 

56

 

86

 

Diluted weighted average shares outstanding

 

15,659

 

15,602

 

15,591

 

15,597

 

 

 

 

 

 

 

 

 

 

 

Diluted net income per common share:

 

 

 

 

 

 

 

 

 

Net income from continuing operations

 

$

0.36

 

$

0.09

 

$

0.78

 

$

0.40

 

Loss from discontinued operations

 

$

 

$

(0.02

)

$

 

$

(0.06

)

Net income

 

$

0.36

 

$

0.07

 

$

0.78

 

$

0.33

 

 

 

 

 

 

 

 

 

 

 

Potentially dilutive shares excluded from diluted per share amounts:

 

 

 

 

 

 

 

 

 

Stock options

 

661

 

50

 

455

 

50

 

 

 

 

 

 

 

 

 

 

 

Potentially anti-dilutive shares excluded from diluted per share amounts:

 

 

 

 

 

 

 

 

 

Stock options

 

202

 

416

 

534

 

430

 

 

Potentially dilutive shares excluded from diluted per share amounts include performance based options to purchase shares of common stock for which certain earnings metrics have not been achieved. Potentially anti-dilutive shares excluded from diluted per share amounts include both non-qualified stock options and unearned performance based options to purchase shares of common stock with exercise prices greater than the weighted-average share price during the period.

 

(7)                     Comprehensive Income

 

The components of comprehensive income, net of tax, for the three and six months ended June 30, 2011 and 2010, respectively, are as follows:

 

 

 

Three Months Ended
June 30,

 

 

 

2011

 

2010

 

Net income

 

$

5,614

 

$

1,054

 

Foreign currency translation gain

 

986

 

296

 

Net unrealized gains (losses) on investment securities

 

12

 

(31

)

Total comprehensive income

 

$

6,612

 

$

1,319

 

 

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Six Months Ended
June 30,

 

 

 

2011

 

2010

 

Net income

 

$

12,236

 

$

5,207

 

Foreign currency translation gain

 

1,485

 

1,573

 

Net unrealized gains (losses) on investment securities

 

22

 

(33

)

Total comprehensive income

 

$

13,743

 

$

6,747

 

 

(8)                     Share-based Compensation

 

Stock option activity for the six months ended June 30, 2011 is as follows:

 

 

 

Number of
Shares

 

Weighted Average
Exercise
Price Per Share

 

Options outstanding at December 31, 2010

 

859

 

$

9.20

 

Granted

 

630

 

10.84

 

Expired

 

(76

)

9.67

 

Exercised

 

(26

)

11.14

 

Options outstanding at June 30, 2011

 

1,387

 

9.88

 

 

During the six-month period ended June 30, 2011, the Company issued options to purchase 630 shares of common stock under the 2009 Incentive Plan to the Company’s executive officers, other employees and to new members of its Board of Directors, of which 505 were subject to achieving certain earnings metrics. These options were issued with a weighted-average exercise price of $10.84 per share, and a weighted-average grant date fair value of $5.13 per share. All of the options issued have an option termination date of ten years from the option grant date.

 

The fair value of each option grant was estimated on the date of the grant using the Black-Scholes option-pricing model with the following weighted-average assumptions for the six-month period ended June 30, 2011:

 

 

 

2011

 

Expected life (in years)

 

3.0 to 4.0

 

Risk-free interest rate

 

0.7 to 1.2

 

Expected volatility

 

49.0 to 67.7

 

Dividend yield

 

0.0

 

 

Expected option lives and volatilities are based on historical data of the Company. The risk free interest rate is calculated as the average U.S. Treasury obligation rate that corresponds with the option life.

 

The Company’s outstanding stock options include both non-qualified stock options, which vest over the expected life of the option grant, and performance-based stock options, which vest upon achieving operating income margins of six, eight and ten percent as reported in four of five consecutive quarters over the term of the options.

 

Share-based compensation expense from non-qualified stock options for the three-month periods ended June 30, 2011 and 2010, was approximately $136 and $149, respectively; the related tax benefit was approximately $54 and $58, respectively. Share-based compensation expense from non-qualified stock options for the six-month periods ended June 30, 2011 and 2010, was approximately $224 and $218, respectively; the related tax benefit was approximately $88 and $85, respectively. As of June 30, 2011 and December 31, 2010, the unrecognized share-based compensation cost related to the grants described above was $1,045 and $451, respectively.

 

The Company recorded shared-based compensation expense of $920 and a related tax benefit of approximately $370 for the three and six months ended June 30, 2011 for the six and eight percent operating margin performance-based stock options. No share-based compensation costs for performance-based stock options were recorded for the same periods in 2010. Unrecognized share-based compensation related to these options was approximately $1,468. Should the Company attain a 10 percent margin, the Company could recognize up to $1,200 of additional stock compensation expense.

 

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At June 30, 2011, the aggregate intrinsic value of outstanding options to purchase 1,387 shares of common stock, the exercisable options to purchase 316 shares of common stock and options to purchase 288 shares of common stock expected to vest was $13,307, $3,358 and $2,473, respectively. At December 31, 2010, the aggregate intrinsic value of options outstanding to purchase 859 shares of common stock was $855.

 

(9)                     Segment Information

 

The Company has three business segments. These business segments are components of the Company for which separate information is available that is evaluated regularly by the chief executive officer in deciding how to allocate resources and in assessing relative performance.

 

The Company has two reportable business segments that operate under the Nature’s Sunshine Products brand and are divided based on their geographic operations in the United States and in countries outside the United States. The Company’s third reportable business segment operates under the Synergy Worldwide brand, which offers products with formulations that are sufficiently different from those of Nature’s Sunshine Products and has marketing and Distributor compensation plans that are sufficiently different from those of Nature’s Sunshine Products to warrant accounting for these operations as a separate business segment. Net sales revenues for each segment have been reduced by intercompany sales as they are not included in the measure of segment profit or loss reviewed by the chief executive officer. The Company evaluates performance based on operating income (loss) by segment before consideration of certain inter-segment transfers and expenses.

 

Reportable business segment information is as follows:

 

 

 

Three Months Ended
June 30,

 

Six Months Ended
June 30,

 

 

 

2011

 

2010

 

2011

 

2010

 

Net sales revenue:

 

 

 

 

 

 

 

 

 

Nature’s Sunshine Products:

 

 

 

 

 

 

 

 

 

United States

 

$

35,897

 

$

36,219

 

$

71,542

 

$

72,881

 

International

 

33,055

 

34,318

 

69,602

 

70,498

 

 

 

68,952

 

70,537

 

141,144

 

143,379

 

Synergy Worldwide

 

22,859

 

16,606

 

43,511

 

30,554

 

Total net sales revenue

 

91,811

 

87,143

 

184,655

 

173,933

 

 

 

 

 

 

 

 

 

 

 

Operating expenses:

 

 

 

 

 

 

 

 

 

Nature’s Sunshine Products:

 

 

 

 

 

 

 

 

 

United States

 

32,194

 

34,020

 

64,081

 

70,222

 

International

 

31,208

 

33,266

 

65,701

 

68,621

 

 

 

63,402

 

67,286

 

129,782

 

138,843

 

Synergy Worldwide

 

20,357

 

16,584

 

39,200

 

31,247

 

Total operating expenses

 

83,759

 

83,870

 

168,982

 

170,090

 

 

 

 

 

 

 

 

 

 

 

Operating income (loss):

 

 

 

 

 

 

 

 

 

Nature’s Sunshine Products:

 

 

 

 

 

 

 

 

 

United States

 

3,703

 

2,199

 

7,461

 

2,659

 

International

 

1,847

 

1,052

 

3,901

 

1,877

 

 

 

5,550

 

3,251

 

11,362

 

4,536

 

Synergy Worldwide

 

2,502

 

22

 

4,311

 

(693

)

Total operating income (loss)

 

8,052

 

3,273

 

15,673

 

3,843

 

 

 

 

 

 

 

 

 

 

 

Other income (expense), net

 

(420

)

(902

)

(155

)

1,999

 

Income before provision for income taxes

 

$

7,632

 

$

2,371

 

$

15,518

 

$

5,842

 

 

The Company moved its Dominican Republic market from the NSP United States segment to the NSP International segment during the quarter ended March 31, 2011, and has made conforming changes to the results presented above for the prior year periods. The net sales revenue and operating loss of this market for the three months ended June 30, 2010 were $1,247 and ($148), respectively. The net sales revenue and operating loss of this market for the six months ended June 30, 2010 were $2, 415 and ($237), respectively.

 

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From an individual country perspective, only the United States comprises approximately 10 percent or more of consolidated net sales revenue for either of the three and six-month periods ended June 30, 2011 and 2010 as follows:

 

 

 

Three Months Ended
June 30,

 

Six Months Ended
June 30,

 

 

 

2011

 

2010

 

2011

 

2010

 

Net sales revenue:

 

 

 

 

 

 

 

 

 

United States

 

$

41,196

 

$

40,092

 

$

81,983

 

$

79,323

 

Other

 

50,615

 

47,051

 

102,672

 

94,610

 

 

 

$

91,811

 

$

87,143

 

$

184,655

 

$

173,933

 

 

Net sales revenue by product group has not been reported as management has determined that it is impracticable to accumulate such information.

 

From an individual country perspective, only the United States and Venezuela comprise 10 percent or more of consolidated property, plant and equipment as follows:

 

 

 

June 30,
2011

 

December 31,
2010

 

Property, plant and equipment:

 

 

 

 

 

United States

 

$

19,283

 

$

20,350

 

Venezuela

 

4,146

 

4,353

 

Other

 

2,643

 

2,688

 

Total property, plant and equipment

 

$

26,072

 

$

27,391

 

 

(10)              Income Taxes

 

Interim income taxes are based on an estimated annualized effective tax rate applied to the respective quarterly periods, adjusted for discrete tax items in the period in which they occur. For the three months ended June 30, 2011 and 2010, the Company’s provision for income taxes, as a percentage of income before income taxes was 26.4 percent and 40.7 percent, respectively, compared with a U.S. federal statutory rate of 35.0 percent. For the six months ended June 30, 2011 and 2010, the Company’s provision for income taxes, as a percentage of income before income taxes was 21.1 percent and a benefit of 5.7 percent, respectively, compared with a U.S. federal statutory rate of 35.0 percent.

 

The differences between the effective tax rates and the U.S. federal statutory tax rate for the three months ended June 30, 2011 was primarily attributed to a decrease in deferred tax liabilities related to taxes on foreign earnings.

 

The differences between the effective rate and the U.S. federal statutory rate for the three months ended June 30, 2010 were primarily attributed to increases due to foreign subsidiary net losses for which no tax benefit is currently being recognized, offset by decreases in tax liabilities associated with uncertain tax positions and the utilization of foreign tax credits.

 

The difference between the effective tax rate and the U.S. federal statutory tax rate for the six months ended June 30, 2011 was primarily attributed to net decreases in tax liabilities associated with uncertain tax positions due to the expiration of the statute of limitations on certain liabilities in various foreign jurisdictions, which resulted in a tax benefit of approximately $1,000.

 

The differences between the effective tax rate and the federal statutory tax rate for the six months ended June 30, 2010 were primarily attributed to:

 

·     decreases in tax liabilities associated with uncertain tax positions due to the expiration of the statue of limitations on certain liabilities in various foreign jurisdictions, which resulted in a tax benefit of $1,361;

·     foreign subsidiary net losses for which no tax benefit was being recognized; and

·     the foreign exchange gain related to the implementation of highly-inflationary accounting for Venezuela recognized for financial reporting purposes, but not for income tax purposes.

 

As of June 30, 2011, the Company had accrued $15,175 (net of $5,687 of other assets related to competent authority and royalty benefits) related to unrecognized tax positions compared with $15,679 (net of $5,687 of other assets related to competent authority and royalty benefits) as of December 31, 2010. This net decrease was primarily attributed to the expiration of the statute of limitations on certain liabilities in various foreign jurisdictions.

 

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Table of Contents

 

The Company’s U.S. federal income tax returns for 2003 through 2009 are open to examination for federal tax purposes. The Company has several foreign tax jurisdictions which have open tax years from 2000 through 2009. The Internal Revenue Service (“IRS”) is currently conducting an audit of the Company’s U.S. federal income tax returns for the 2009 through 2008 tax years.

 

In October 2009, the IRS issued an examination report formally proposing adjustments with respect to the 2003 through 2005 taxable years, which primarily relate to the prices that were charged in intra-group transfers of property and the disallowance of related deductions. The Company has commenced administrative proceedings with the Office of Appeals of the Internal Revenue Service challenging the proposed adjustments.   Management believes that the Company has appropriately reserved for these matters, relating to all open periods, at an amount which it believes will ultimately be due upon resolution of the administrative proceedings, and such amounts reflect management’s estimates based upon available evidence resulting from discussions with the IRS Office of Appeals. These estimates are based upon a more-likely-than-not recognition threshold. The Company is currently unable to determine the outcome of these discussions and their related impact, if any, on the Company’s financial condition, results of operations, or cash flows.

 

Although the Company believes its estimates are reasonable, the Company can make no assurance that the final tax outcome of these matters will not be different from that which it has reflected in its historical income tax provisions and accruals. Such difference could have a material impact on the Company’s income tax provision and operating results in the period in which the Company makes such determination.

 

(11)              Commitments and Contingencies

 

Legal Proceedings

 

The Company is party to various legal proceedings, including those noted below. Management cannot predict the ultimate outcome of these proceedings, individually or in the aggregate, or their resulting effect on the Company’s business, financial position, results of operations or cash flows as litigation and related matters are subject to inherent uncertainties, and unfavorable rulings could occur. Were an unfavorable outcome to occur, there exists the possibility of a material adverse impact on the business, financial position, results of operations, or cash flows for the period in which the ruling occurs and/or future periods. The Company maintains directors’ and officers’ liability, product liability, general liability and excess liability insurance coverage. However, no assurances can be given that such insurance will continue to be available at an acceptable cost to the Company, that such coverage will be sufficient to cover one or more large claims, or that the insurers will not successfully disclaim coverage as to a pending or future claim.

 

NutriPlus Arbitration

 

In 1999 and 2000, the Company and Nutriplus LLC (“NutriPlus”) entered into an Asset Purchase Agreement and subsequent Settlement Agreement (together the “Purchase Agreement”) under which the Company acquired certain assets in order to establish its Russian business, and Nutriplus acquired rights to receive certain royalty payments from the Company expressed as a percentage of the Company’s net sales in its Russian business.

 

On July 12, 2010, the Company submitted a demand for arbitration to the American Arbitration Association (the “AAA”) naming NutriPlus as respondent. The Company sought a declaration of its rights and obligations, including with respect to royalty payments, and the calculation thereof, arising out of the Purchase Agreement.

 

On July 20, 2010, NutriPlus submitted its own demand for arbitration to the AAA naming the Company as respondent. NutriPlus alleged that the Company underpaid NutriPlus for royalties arising out of the Purchase Agreement. In arbitration, NutriPlus sought damages related to the alleged underpayment and a declaratory judgment with respect to the method the Company must use in determining the amount of royalties to pay NutriPlus in the future.

 

The arbitration demands were consolidated into a single proceeding, and the hearing was scheduled for July 2011.

 

On July 8, 2011, the Company and NutriPlus entered into a Settlement Agreement, wherein both parties settled all claims in the arbitration and bore their own costs associated with the arbitration. As a result of the settlement, the Company will pay NutriPlus $21,700 and all of the Company’s ongoing obligations under the Purchase Agreement were extinguished, including all obligations with respect to accrued unpaid royalties and all obligations to pay future royalties to NutriPlus in perpetuity. In 2010, the Company recorded total royalty costs for the year of approximately $5,553. The Company recorded royalty costs of approximately $1,290 and $1,259 for the three months ended June 30, 2011 and 2010, respectively, and $2,894 and $2,762for the six months ended June 30, 2011 and 2010, respectively.  As of June 30, 2011, the Company had accrued $6,950 related to the liability for unpaid royalties to NutriPlus for the period from April 1, 2010 through June 30, 2011. The Company will apply such accrual to the settlement payment.

 

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Table of Contents

 

Other Litigation

 

The Company is party to various other legal proceedings in several foreign jurisdictions related to VAT assessments and other civil litigation. Although there is a reasonable possibility that a material loss may be incurred, the Company cannot at this time estimate the loss, if any. Therefore, no provision for losses has been provided. The Company believes future payments related to these matters could range from $0 to approximately $1,700.

 

Non-income Tax Contingencies

 

The Company has reserved for certain state sales and use tax and foreign non-income tax contingencies based on the likelihood of an obligation in accordance with accounting guidance for probable loss contingencies. Loss contingency provisions are recorded for probable losses at management’s best estimate of a loss, or when a best estimate cannot be made, a minimum loss contingency amount is recorded. The Company provides provisions for potential payments of tax to various tax authorities for contingencies related to non-income tax matters, including value added taxes and sales tax. The Company provides provisions for U.S. state sales taxes in each of the states where the Company has nexus. As of June 30, 2011 and December 31, 2010, accrued liabilities include $9,262 and $10,235, respectively, related to non-income tax contingencies. While management believes that the assumptions and estimates used to determine this liability are reasonable, the ultimate outcome of those matters cannot presently be determined. The Company is not able at this time to predict the ultimate outcomes of those matters or to estimate the effect the ultimate outcomes, if greater than the amounts accrued, would have on the financial condition, results of operations or cash flows of the Company.

 

Government Regulations

 

The Company is subject to governmental regulations pertaining to product formulation, labeling and packaging, product claims and advertising, and to the Company’s direct selling system. The Company is also subject to the jurisdiction of numerous foreign tax and customs authorities. Any assertions or determinations that either the Company or the Company’s Distributors are not in compliance with existing statutes, laws, rules or regulations could potentially have a material adverse effect on the Company’s operations. In addition, in any country or jurisdiction, the adoption of new statutes, laws, rules or regulations, or changes in the interpretation of existing statutes, laws, rules or regulations could have a material adverse effect on the Company and its operations. Although management believes that the Company is in compliance, in all material respects, with the statutes, laws, rules and regulations of every jurisdiction in which it operates, no assurance can be given that the Company’s compliance with applicable statutes, laws, rules and regulations will not be challenged by foreign authorities or that such challenges will not have a material adverse effect on the Company’s financial position, results of operations or cash flows.

 

(12)              Fair Value Measurements

 

The fair value of a financial instrument is the amount that could be received upon the sale of an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Financial assets are marked to bid prices and financial liabilities are marked to offer prices. Fair value measurements do not include transaction costs. A fair value hierarchy is used to prioritize the quality and reliability of the information used to determine fair values of each financial instrument. Categorization within the fair value hierarchy is based on the lowest level of input that is significant to the fair value measurement. The fair value hierarchy is defined into the following three categories:

 

Level 1: Quoted market prices in active markets for identical assets or liabilities.

Level 2: Observable market based inputs or unobservable inputs that are corroborated by market data.

Level 3: Unobservable inputs that are not corroborated by market data.

 

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Table of Contents

 

The following table presents the Company’s hierarchy for its assets measured at fair value on a recurring basis as of June 30, 2011:

 

 

 

Level 1

 

Level 2

 

Level 3

 

 

 

 

 

Quoted Prices
in Active
Markets for
Identical Assets

 

Significant
Other
Observable
Inputs

 

Significant
Unobservable
Inputs

 

Total

 

Investments available for sale

 

 

 

 

 

 

 

 

 

Municipal obligations

 

$

 

$

1,637

 

$

 

$

1,637

 

U.S. government security funds

 

977

 

 

 

977

 

Short-term deposits

 

 

3,931

 

 

3,931

 

Equity securities

 

424

 

 

 

424

 

Investment securities

 

1,636

 

 

 

1,636

 

Total assets measured at fair value on a recurring basis

 

$

3,037

 

$

5,568

 

$

 

$

8,605

 

 

The following table presents the Company’s hierarchy for its assets measured at fair value on a recurring basis as of December 31, 2010:

 

 

 

Level 1

 

Level 2

 

Level 3

 

 

 

 

 

Quoted Prices
in Active
Markets for
Identical Assets

 

Significant
Other
Observable
Inputs

 

Significant
Unobservable
Inputs

 

Total

 

Investments available for sale

 

 

 

 

 

 

 

 

 

Municipal obligations

 

$

 

$

1,960

 

$

 

$

1,960

 

U.S. government security funds

 

974

 

 

 

974

 

Short-term deposits

 

 

3,148

 

 

3,148

 

Equity securities

 

388

 

 

 

388

 

Investment securities

 

1,778

 

 

 

1,778

 

Total assets measured at fair value on a recurring basis

 

$

3,140

 

$

5,108

 

$

 

$

8,248

 

 

Investments available for sale — The majority of the Company’s investment portfolio consists of various fixed income securities such as U.S government funds, state and municipal bonds, mutual funds, short-term deposits and equity securities.  The Level 1 securities are valued using quoted prices for identical assets in active markets including equity securities, U.S. government treasuries, and various mutual funds.  The Level 2 securities include investments in state and municipal bonds whereby all significant inputs are observable or can be derived from or corroborated by observable market data for substantially the full term of the asset.

 

Investment securities — The majority of the Company’s trading portfolio consists of various marketable securities that are using quoted prices in active markets.

 

For the six months ended June 30, 2011 and for the year ended December 31, 2010, there were no fair value measurements using the significant unobservable inputs (Level 3).

 

The carrying amounts reflected on the consolidated balance sheet for cash and cash equivalents, accounts and notes receivable, and accounts payable approximate fair value due to their short-term nature. During the six months ended June 30, 2011 and 2010, the Company did not have any write-offs related to the re-measurement of non-financial assets at fair value on a nonrecurring basis subsequent to their initial recognition.

 

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Table of Contents

 

Item 2.                              MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

The following Management’s Discussion and Analysis should be read in conjunction with the unaudited consolidated financial statements and notes thereto included in this report, as well as the consolidated financial statements, the notes thereto, and management’s discussion and analysis included in our Annual Report on Form 10-K for the year ended December 31, 2010, and our Reports on Form 8-K, that have been filed with the SEC since then through the date of this report.

 

Throughout this report, we refer to Nature’s Sunshine Products, Inc., together with its subsidiaries, as “we,” “us,” “our,” “Company” or “the Company.”

 

OVERVIEW

 

Nature’s Sunshine Products, Inc. and its subsidiaries are primarily engaged in the manufacturing and marketing of nutritional, herbal, weight management, energy and other complementary products. Nature’s Sunshine Products, Inc. is a Utah corporation with its principal place of business in Provo, Utah. We sell our products to a sales force of independent Distributors and Managers who use the products themselves or resell them to other Distributors or consumers. The formulation, manufacturing, packaging, labeling, advertising, distribution and sale of each of our major product groups are subject to regulation by one or more governmental agencies. We also sell our products through a separate division and operating business segment, Synergy Worldwide. Synergy Worldwide offers different marketing plans, Distributor compensation plans and products with formulations sufficiently different from those of the Nature’s Sunshine Products offerings to warrant its treatment as a separately reportable business segment.

 

We market our products in Australia, Austria, Belarus, Canada, the Czech Republic, Colombia, Costa Rica, Denmark, the Dominican Republic, Ecuador, El Salvador, Germany, Guatemala, Honduras, Hong Kong, Indonesia, Ireland, Japan, Kazakhstan, Latvia, Lithuania, Malaysia, Mexico, Mongolia, the Netherlands, Nicaragua, Norway, Panama, Peru, the Philippines, Poland, Russia, Singapore, South Korea, Sweden, Taiwan, Thailand, Ukraine, the United Kingdom, the United States, Venezuela and Vietnam. We export our products to several other countries, including Argentina, Australia, Chile, Israel, New Zealand and Norway.

 

During the second quarter of 2011, we experienced an increase in our consolidated net sales of 5.4 percent. Our Synergy Worldwide business segment (“Synergy Worldwide”) experienced an increase in net sales revenue of approximately 37.7 percent (or 29.5 percent in local currencies excluding the positive impact of foreign currency fluctuations). Our Nature’s Sunshine Products International business segment (“NSP International”) experienced a decrease in net sales of approximately 3.7 percent compared to the same period in 2010, and a decrease in local currency net sales of 5.2 percent (excluding the positive impact of foreign currency fluctuations), while our domestic business segment (“NSP United States”) net sales decreased approximately 0.9 percent. The significant sales revenue growth was from our Synergy European, Korean, United States markets and our NSP Russian market during the second quarter of 2011. Gains in these markets were partially offset by decreases in our NSP Dominican Republic, NSP and Synergy Japan and NSP Mexico markets.

 

Over the same period, selling, general and administrative costs as a percentage of net sales revenue for the quarter decreased from 39.7 percent in the prior year to 36.2 percent in the current year as a result of revenue growth (primarily in Synergy), and successful efforts to reduce operating costs in all of our operating segments. We continue to implement cost reduction measures within all of our operating segments.

 

As a result of our overall growth in net sales revenue and reductions in operating expenses, our operating income for the quarter increased from 3.8 percent in the prior year to 8.8 percent of net sales revenue in the current year.

 

We distribute our products to consumers through an independent sales force comprised of Managers and Distributors. A person who joins our independent sales force begins as a “Distributor.” A Distributor interested in earning additional income by committing more time and effort to selling our products may earn “Manager” status. Manager status is contingent upon attaining certain purchase volume levels, recruiting additional Distributors, and demonstrating leadership abilities. Active Managers worldwide totaled approximately 29,600 and 30,600 at June 30, 2011 and 2010, respectively. Active Distributors and customers worldwide totaled approximately 675,100 and 687,500 at June 30, 2011 and 2010, respectively.

 

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RESULTS OF OPERATIONS

 

The following table summarizes our unaudited consolidated operating results in U.S. dollars and as a percentage of net sales revenue for the three months ended June 30, 2011 and 2010 (dollar amounts in thousands).

 

 

 

 

 

 

 

 

 

 

 

Change from

 

 

 

2011

 

2010

 

2011 to 2010

 

 

 

Total

 

Percent of

 

Total

 

Percent of

 

 

 

 

 

 

 

dollars

 

net sales

 

dollars

 

net sales

 

Dollar

 

Percentage

 

Net sales revenue

 

$

91,811

 

100.0

%

$

87,143

 

100.0

%

$

4,668

 

5.4

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Costs and expenses:

 

 

 

 

 

 

 

 

 

 

 

 

 

Cost of goods sold

 

17,129

 

18.6

 

16,759

 

19.2

 

370

 

2.2

 

Volume incentives

 

33,390

 

36.4

 

32,546

 

37.3

 

844

 

2.6

 

SG&A expenses

 

33,240

 

36.2

 

34,565

 

39.7

 

(1,325

)

(3.8

)

Total operating expenses

 

83,759

 

91.2

 

83,870

 

96.2

 

(111

)

(0.1

)

Operating income

 

8,052

 

8.8

 

3,273

 

3.8

 

4,779

 

146.0

 

Other income, net

 

(420

)

(0.5

)

(902

)

(1.1

)

482

 

53.4

 

Income before provision for income taxes

 

7,632

 

8.3

 

2,371

 

2.7

 

5,261

 

221.9

 

Provision for income taxes

 

2,018

 

2.2

 

965

 

1.1

 

1,053

 

109.1

 

Net income from continuing operations

 

5,614

 

6.1

 

1,406

 

1.6

 

4,208

 

299.3

 

Loss from discontinued operations

 

 

 

(352

)

(0.4

)

352

 

100.0

 

Net income

 

$

5,614

 

6.1

%

$

1,054

 

1.2

%

$

4,560

 

432.6

%

 

The following table summarizes our unaudited consolidated operating results in U.S. dollars and as a percentage of net sales revenue for the six months ended June 30, 2011 and 2010 (dollar amounts in thousands).

 

 

 

 

 

 

 

 

 

 

 

Change from

 

 

 

2011

 

2010

 

2011 to 2010

 

 

 

Total

 

Percent of

 

Total

 

Percent of

 

 

 

 

 

 

 

dollars

 

net sales

 

dollars

 

net sales

 

Dollar

 

Percentage

 

Net sales revenue

 

$

184,655

 

100.0

%

$

173,933

 

100.0

%

$

10,722

 

6.2

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Costs and expenses:

 

 

 

 

 

 

 

 

 

 

 

 

 

Cost of goods sold

 

35,681

 

19.3

 

34,676

 

20.0

 

1,005

 

2.9

 

Volume incentives

 

67,688

 

36.7

 

65,097

 

37.4

 

2,591

 

4.0

 

SG&A expenses

 

65,613

 

35.5

 

70,317

 

40.4

 

(4,704

)

(6.7

)

Total operating expenses

 

168,982

 

91.5

 

170,090

 

97.8

 

(1,108

)

(0.7

)

Operating income

 

15,673

 

8.5

 

3,843

 

2.2

 

11,830

 

307.8

 

Other income, net

 

(155

)

(0.1

)

1,999

 

1.1

 

(2,154

)

(107.8

)

Income before provision (benefit) for income taxes

 

15,518

 

8.4

 

5,842

 

3.3

 

9,676

 

165.6

 

Provision (benefit) for income taxes

 

3,282

 

1.8

 

(335

)

(0.2

)

3,617

 

1,079.7

 

Net income from continuing operations

 

12,236

 

6.6

 

6,177

 

3.5

 

6,059

 

98.1

 

Loss from discontinued operations

 

 

 

(970

)

(0.5

)

970

 

100.0

 

Net income

 

$

12,236

 

6.6

%

$

5,207

 

3.0

%

$

7,029

 

135.0

%

 

Net Sales Revenue

 

Consolidated net sales revenue for the three and six months ended June 30, 2011 was $91.8 million and $184.7 million compared to $87.1 million and $173.9 million for the same periods in 2010, increases of approximately 5.4 percent and 6.2 percent, respectively. The increases in net sales revenue for the three and six months ended June 30, 2011 compared to the same periods in 2010, are primarily due to improvements in our Synergy Worldwide segment, partially offset by a declines in our NSP United States and NSP International segments.

 

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NSP United States Segment

 

Net sales revenue for our NSP United States segment for the three and six months ended June 30, 2011 was $35.9 million and $71.5 million compared to $36.2 million and $72.9 million for the same periods in 2010, or decreases of 0.9 percent and 1.8 percent, respectively, in 2011 compared to 2010. Shifting the timing of our national convention from the fall of 2010 to the spring of 2011 negatively affected Manager retention and Distributor and customer recruiting efforts during the prior year, and has continued to adversely affect our sales during the current year. Net sales revenue also decreased compared to the same period in the prior year due to changes to some of our less profitable promotional programs.

 

The NSP United States segment includes both English and Spanish language sales divisions, of which the English language division is approximately 80 percent of segment net sales revenue. English language division net sales revenue decreased $0.1 million and $0.7 million for the three and six months ended June 30, 2011, or 0.2 percent and 1.2 percent, respectively, compared to the same periods in 2010. Our Spanish language division net sales revenue decreased $0.3 million and $0.7 million, or 3.3 percent and 4.2 percent, respectively, for the three and six months ended June 30, 2011, compared to the same periods in 2010. While both the English and Spanish language divisions were significantly affected by shifting the timing of the national convention from 2010 to 2011 and the corresponding effect on Manager, Distributor and customer retention, the change to some of our promotional programs had a more significant impact on our Spanish language division.

 

During our National Convention held in March 2011, we launched the Brilliant Body, Brilliant Business. This significant initiative aims to expand our Manager and Distributor base by emphasizing daily consumption of our products and providing an easier and more standardized approach for recruiting and retaining new members. This program is in its early development stage and it is our intention to build the program over the next few years.

 

Active Managers within NSP United States totaled approximately 6,200 and 7,300 at June 30, 2011 and 2010, respectively. The decrease in the number of active Managers was caused by the discontinuance of a program that allowed Distributors to attain Manager status by meeting low performance criteria and the lingering effect of shifting the timing of our national convention. Active Distributors and customers within NSP United States totaled approximately 194,200 and 231,400 at June 30, 2011 and 2010, respectively. The number of active Distributors and customers decreased due to changes to some of our less profitable recruiting and retention programs and the negative effects of shifting the timing of our national convention from the fall of 2010 to the spring of 2011.

 

NSP International Segment

 

Our NSP International segment reported net sales revenue for the three and six months ended June 30, 2011 of $33.1 million and $69.6, compared to $34.3 million and $70.5 million for the same periods in 2010, decreases of approximately 3.7 percent and 1.3 percent, respectively. In local currencies, net sales decreased 5.2 percent and 2.7 percent, respectively, compared to the same periods in 2010. Fluctuation in foreign exchange rates had a $0.5 million and $1.0 million favorable impact on net sales for the three and six months ended June 30, 2011, respectively. The decrease in sales is due to lower local currency sales in our Dominican Republic, Japan and Mexico markets, offset by higher sales in our Russian markets and positive currency fluctuations.

 

Notable activity in the following markets contributed to the results of our NSP International segment:

 

In our Russian markets (Russia, Ukraine and several other Eastern European nations), net sales revenues increased approximately $0.3 million and $1.3 million, or 2.4 percent and 4.7 percent, for the three and six months ended June 30, 2011, respectively, compared to the same periods in 2010. Our Russian markets continue to build on the momentum gained in the prior year as a result of improved Manager and Distributor recruiting efforts and strengthening economies in the region. However, this growth has been slowed by a growing debt crisis in Belarus, which has affected our Belarusian Distributors’ ability to obtain foreign currency to purchase our products and may impact our growth in this country going forward. Our sales in Belarus were $0.8 million lower for the three and six months ended June 30, 2011, compared to the same periods in 2010.

 

In Japan, our net sales revenues decreased approximately $0.1 million and $0.3 million, or 5.8 percent and 7.7 percent, for the three and six months ended June 30, 2011, respectively, compared to the same periods in 2010. In local currency, net sales decreased 15.8 percent and 17.9 percent, respectively, compared to the same periods in 2010. Fluctuations in foreign exchange rates had a $0.2 million and $0.4 million favorable impact on net sales for the three and six months ended June 30, 2011. The decrease in local

 

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currency sales is partially due to the recent earthquake, tsunami and subsequent nuclear disasters, which has suppressed consumer confidence and spending and has made it difficult to ship ordered products, as well as retain active Distributors.  Our future sales may be negatively affected while Japan rebuilds and recovers from these recent disasters.

 

In Mexico, our net sales revenues decreased approximately $0.8 million and $1.1 million, or 20.0 percent and 14.7 percent, for the three and six months ended June 30, 2011, respectively, compared to the same periods in 2010. In local currency, net sales decreased 25.0 percent and 20.0 percent, respectively, compared to the same periods in 2010. Fluctuations in foreign exchange rates had a $0.2 million and $0.4 million favorable impact on net sales for the three and six months ended June 30, 2011. We believe the decrease in local currency net sales is principally due the continuing effects of a tax law interpretation by the Mexican taxing authority requiring the collection of value-added tax on all of our products sold in Mexico and our compliance with this interpretation.

 

In the Dominican Republic, our net sales revenues decreased approximately $0.6 million and $1.0 million, or 50.0 percent and 41.7 percent, for the three and six months ended June 30, 2011, respectively, compared to the same periods in 2010. The decrease in sales is due to the elimination of promotional programs and events which historically had promoted sales growth, but did not produce profitable results.

 

Active Managers within NSP International totaled approximately 20,900 and 21,300 at June 30, 2011 and 2010, respectively. Active Distributors and customers within NSP International totaled approximately 398,000 and 377,000 at June 30, 2011 and 2010 respectively.

 

Synergy Worldwide Segment

 

Synergy Worldwide reported net sales revenue for the three and six months ended June 30, 2011 of $22.9 million and $43.5 million, compared to $16.6 million and $30.6 million in 2010, increases of approximately 37.7 percent and 42.4 percent, respectively. In local currencies, net sales increased 29.5 percent and 35.5 percent for the three and six months ended June 30, 2011, respectively, compared to the same periods in 2010. Fluctuations in foreign exchange rates had a $1.4 million and $2.1 million favorable impact on net sales for the three and six months ended June 30, 2011, respectively, compared to the same periods in 2010. The increase in net sales was primarily due to growth in our United States, Korean and European markets, and the opening of our Vietnam market, offset by sales declines in our Japan market.

 

Notable activity in the following markets contributed to the results of our Synergy Worldwide segment:

 

In the United States, our net sales revenues increased approximately $1.4 million and $4.0 million, or 35.9 percent and 62.5 percent, for the three and six months ended June 30, 2011, respectively, compared to the same periods in 2010.  Our growth within the Unites States is due to effective Company and Manager sales and marketing efforts of a well-accepted product offering, which has resulted in the growth of our U.S. Distributor base.

 

In Europe, our net sales revenues increased approximately $2.6 million and $4.8 million, or 92.9 percent and 90.6 percent, for the three and six months ended June 30, 2011, respectively, compared to the same periods in 2010. In local currency, our net sales increased 75.0 percent and 81.1 percent, respectively, compared to the same periods in 2010.  Fluctuations in foreign exchange rates had a $0.4 million and $0.5 million favorable impact on net sales for the three and six months ended June 30, 2011 compared to the same periods in 2010. Our growth in Europe is due to strong Distributor marketing and development, causing increased market penetration primarily within Austria, Norway and Sweden.

 

In Korea, our net sales revenues increased approximately $2.5 million and $3.8 million, or 104.2 percent and 84.4 percent, for the three and six months ended June 30, 2011, respectively, compared to the same periods in 2010. In local currency, our net sales increased 91.7 percent and 75.6 percent, compared to the same periods in 2010.  Fluctuations in foreign exchange rates had a $0.3 million and $0.4 million favorable impact on net sales for the three and six months ended June 30, 2011, compared to the same periods in 2010. Our growth in Korea is due to strong and productive Company and Manager development of sales groups and a broader product line that is well accepted in the market.

 

In Japan, our net sales revenues decreased approximately $0.4 million and $0.8 million, or 10.8 percent and 7.7 percent, for the three and six months ended June 30, 2011, respectively, compared to the same periods in 2010.  In local currency, net sales decreased 21.6 percent and 16.7 percent compared to the same periods in 2010. Fluctuations in foreign exchange rates had a $0.4 million and $0.7 million favorable impact on net sales for the three and six months ended June 30, 2011, compared to the same periods in 2010. The strengthening of the business in Japan was stalled by the recent earthquake, tsunami and subsequent nuclear disaster.  Our future sales may be negatively affected while Japan rebuilds and recovers from these recent disasters.

 

Active Managers within Synergy Worldwide totaled approximately 2,500 and 2,000 at June 30, 2011 and 2010, respectively. Active Distributors and customers within Synergy Worldwide totaled approximately 82,900 and 79,100 at June 30, 2011 and 2010, respectively.

 

Further information related to NSP United States, NSP International and Synergy Worldwide business segments is set forth in Note 9 to the Unaudited Condensed Consolidated Financial Statements in Part 1, Item 1 of this report.

 

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Cost of Goods Sold

 

Cost of goods sold as a percent of net sales revenue decreased to 18.6 percent and 19.3 percent for the three and six months ended June 30, 2011, compared to 19.2 percent and 20.0 percent for the same periods in 2010. These decreases are primarily due to the reductions in product and material write-offs, changes in product mix between markets and lower raw material costs, primarily offset by increased importation fees related to higher transfer prices within some of our foreign markets.

 

Volume Incentives

 

Volume incentives are a significant part of our direct sales marketing program and represent commission payments made to our independent Distributors and Managers. These payments are designed to provide incentives for reaching higher sales levels and for recruiting additional Distributors. Volume incentives vary slightly, on a percentage basis, by product due to our pricing policies and commission plans in place in our various operations.  Volume incentives as a percent of net sales revenue decreased to 36.4 percent and 36.7 percent for the three and six months in 2011, compared to 37.3 percent and 37.4 percent for the same periods in 2010. The decreases are primarily due to reductions in volume incentive payment rates due to our lower Manager and Distributor base within the NSP United States segment and an increase in product purchases with a lower volume incentive in Synergy Worldwide.

 

Selling, General and Administrative

 

Selling, general and administrative expenses decreased to 36.2 percent and 35.5 percent of net sales revenue for the three and six months ended June 30, 2011, compared to 39.7 percent and 40.4 percent in 2010, or by approximately $1.3 million and $4.7 million to $33.2 million and $65.6 million for the three and six months ended June 30, 2011, respectively.

 

Significant increases to selling, general and administrative expenses during the three and six months ended June 30, 2011, compared to the same period in 2010 included:

 

·                  increased variable costs of $1.1 million and $2.0 million, respectively, related to the sales growth of Synergy Worldwide in Europe, Korea, the United States and Vietnam as well as NSP International in the Russian markets;

·                  approximately $0.5 million and $1.0 million, respectively, of unfavorable currency fluctuations;

·                  approximately $0.9 million and $0.9 million, respectively, due to the recognition of performance-based stock compensation costs based upon the Company’s determination that it is probable the related performance metrics will be achieved; and

·                  approximately $1.1 million and $1.5 million, respectively, in professional fees related to litigation costs.

 

Significant decreases to selling, general and administrative expenses during the three and six months ended June 30, 2011, compared to the same period in 2010 included:

 

·                  decreased administrative costs of $0.9 million and $2.4 million, respectively, in U.S. convention and promotion related costs due to the differences in event qualification periods between years;

·                  decreased U.S. compensation and other benefit related costs of $0.6 million and $1.6 million, respectively;

·                  cost reductions in many of our foreign markets totaling approximately $1.7 million and $2.6 million, respectively;

·                  a $0.7 million and $1.1 million decrease in foreign value-added tax reserves between periods; and

·                  a decrease of $0.4 million and $0.8 million, respectively, related to our U.S. healthcare costs during 2011.

 

We continue to implement cost reduction measures within all of our operating segments.

 

Operating Income

 

Consolidated operating income increased approximately $4.8 million during the three months ended June 30, 2011, compared to the same period in 2010, from $3.3 million to $8.1 million. For the six months ended June 30, 2011, operating income increased approximately $11.8 million, compared to the same period in 2010, from $3.8 million to $15.7 million. Operating income increased to 8.8 percent and 8.5 percent of net sales from the three and six months ended June 30, 2011, compared to 3.8 percent and 2.2 percent for the same periods in 2010, respectively.

 

Operating income for NSP United States increased $1.5 and $4.8 million for the three and six months ended June 30, 2011, compared to the same period in 2010, from $2.2 million and $2.7 million to $3.7 million and $7.5 million, respectively. The increase in operating income is primarily the result of significant cost reductions in our selling, general and administrative expenses described above.

 

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Operating income for NSP International increased approximately $0.8 million and $2.0 for the three and six months ended June 30, 2011, compared to the same periods in 2010, from $1.1 million and $1.9 million to $1.8 million and $3.9 million, respectively, primarily as the result of revenue growth in our Russian markets, and cost reductions within our foreign markets and positive changes in foreign VAT reserves.

 

Operating income for Synergy Worldwide increased $2.5 million and $5.0 million for the three and six months ended June 30, 2011, respectively, compared to the same periods in 2010, from break-even and an operating loss of $0.7 million to operating income of $2.5 million and $4.3 million, respectively. This was primarily due to improvements in sales within its European, U.S, and Korean subsidiaries.

 

Other Income (Expense), Net

 

Other income (expense), net for the three and six months ended June 30, 2011 increased $0.5 million and decreased $2.2 million, respectively, compared to the same periods in 2010. The year-to-date decrease is primarily due to prior year foreign exchange gains of $3.7 million in Venezuela as a result of the devaluation of the bolivar and the change to a highly inflationary economy that were non-recurring, offset by net foreign exchange gains and losses in certain of our other markets based on changes in exchange rates.

 

Income Taxes

 

Interim income taxes are based on an estimated annualized effective tax rate applied to the respective quarterly periods, adjusted for discrete tax items in the period in which they occur. For the three months ended June 30, 2011 and 2010, the Company’s provision for income taxes, as a percentage of income before income taxes was 26.4 percent and 40.7 percent, respectively, compared with a U.S. federal statutory rate of 35.0 percent. For the six months ended June 30, 2011 and 2010, the Company’s provision for income taxes, as a percentage of income before income taxes was 21.1 percent and a benefit of 5.7 percent, respectively, compared with a U.S. federal statutory rate of 35.0 percent.

 

The differences between the effective tax rates and the U.S. federal statutory tax rate for the three months ended June 30, 2011 was primarily attributed to a decrease in deferred tax liabilities related to taxes on foreign earnings.

 

The differences between the effective rate and the U.S. federal statutory rate for the three months ended June 30, 2010 were primarily attributed to increases due to foreign subsidiary net losses for which no tax benefit is currently being recognized, offset by decreases in tax liabilities associated with uncertain tax positions and the utilization of foreign tax credits.

 

The difference between the effective tax rate and the U.S. federal statutory tax rate for the six months ended June 30, 2011 was primarily attributed to net decreases in tax liabilities associated with uncertain tax positions due to the expiration of the statute of limitations on certain liabilities in various foreign jurisdictions, which resulted in a tax benefit of approximately $1.0 million.

 

The differences between the effective tax rate and the federal statutory tax rate for the six months ended June 30, 2010 were primarily attributed to:

 

·     decreases in tax liabilities associated with uncertain tax positions due to the expiration of the statue of limitations on certain liabilities in various foreign jurisdictions, which resulted in a tax benefit of $1.4 million;

·     foreign subsidiary net losses for which no tax benefit was being recognized; and

·     the foreign exchange gain related to the implementation of highly-inflationary accounting for Venezuela recognized for financial reporting purposes, but not for income tax purposes.

 

The Company’s U.S. federal income tax returns for 2003 through 2009 are open to examination for federal tax purposes. The Company has several foreign tax jurisdictions which have open tax years from 2000 through 2009. The Internal Revenue Service (“IRS”) is currently conducting an audit of the Company’s U.S. federal income tax returns for the 2006 through 2009 tax years.

 

In October 2009, the IRS issued an examination report formally proposing adjustments with respect to the 2003 through 2005 taxable years, which primarily relate to the prices that were charged in intra-group transfers of property and the disallowance of related deductions. The Company has commenced administrative proceedings with the Office of Appeals of the Internal Revenue Service challenging the proposed adjustments.  Management believes that the Company has appropriately reserved for these matters, relating to all open periods, at an amount which it believes will ultimately be due upon resolution of the administrative proceedings, and such amounts reflect management’s estimates based upon available evidence resulting from discussions with the IRS Office of Appeals. These estimates are based upon a more-likely-than-not recognition threshold. The Company is currently unable to determine

 

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the outcome of these discussions and their related impact, if any, on the Company’s financial condition, results of operations, or cash flows.

 

Although the Company believes its estimates are reasonable, the Company can make no assurance that the final tax outcome of these matters will not be different from that which it has reflected in its historical income tax provisions and accruals. Such difference could have a material impact on the Company’s income tax provision and operating results in the period in which the Company makes such determination.

 

Discontinued Operations

 

During 2010, we ceased our operations in Brazil as a result of increased import regulations and declining sales. As a result, we reclassified the Brazil subsidiary’s operations to discontinued operations. During 2011, there were no significant costs related to this market. This market represented less than 0.3 percent of our consolidated net sales for 2010.

 

LIQUIDITY AND CAPITAL RESOURCES

 

Our principal use of cash is to pay for operating expenses, including volume incentives, inventory and raw material purchases, capital assets and funding of international expansion. As of June 30, 2011, working capital was $56.3 million, compared to $41.4 million as of December 31, 2010.  At June 30, 2011, we had $63.0 million in cash and cash equivalents, of which $40.3 million was held in our foreign markets and may be subject to various withholding taxes and other restrictions related to repatriation, and $7.0 million in unrestricted short-term investments, which were available to be used along with our normal cash flows from operations to fund any unanticipated shortfalls in future cash flows.

 

Our net consolidated cash inflows (outflows) are as follows (in thousands):

 

 

 

Six Months Ended June 30,

 

 

 

2011

 

2010

 

Operating activities

 

$

15,841

 

$

5,381

 

Investing activities

 

(1,161

)

(1,286

)

Financing activities

 

295

 

27

 

 

For the six months ended June 30, 2011, we generated cash from operating activities of $15.8 million compared to $5.4 million for the same period in 2010. Operating cash flow improved due to growth in our operating income and the timing of payments for accrued liabilities and income taxes payable, and was offset by the timing of payments and receipts for accounts receivable and inventory.

 

Capital expenditures related to the purchase of equipment, computer systems and software for the six months ended June 30, 2011 and 2010 were $0.7 million and $1.3 million, respectively.

 

During the six months ended June 30, 2011, we had cash proceeds of $2.4 million from the sale of available-for-sale investments. During the same period we used cash of $2.8 million to purchase available-for-sale investments.

 

The Company is in the process of completing the negotiation of a long-term revolving credit facility that will allow us to borrow up to $15.0 million. We believe that, with this credit facility in place, our working capital requirements can be met for the foreseeable future with cash generated from our operating activities, our available cash and cash equivalents, and draws on the credit facility. However, among other things, a prolonged economic downturn, a decrease in demand for our products, an unfavorable settlement of our unrecognized tax positions or non-income tax contingencies could adversely affect our long-term liquidity.

 

In addition, the Company is also in the process of completing the negotiation of a $10.0 million term credit facility repayable over three years  and secured by the Company’s manufacturing facility in Spanish Fork, Utah.

 

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

 

Our unaudited consolidated financial statements have been prepared in accordance with U.S. GAAP and form the basis for the following discussion and analysis on critical accounting policies and estimates. The preparation of these financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On a regular basis we evaluate our estimates and assumptions. We base our estimates on

 

23



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historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results could differ from these estimates and those differences could have a material effect on our financial position and results of operations. Management has discussed the development, selection and disclosure of these estimates with the Board of Directors and its Audit Committee.

 

A summary of our significant accounting policies is provided in Note 1 of the Notes to Consolidated Financial Statements in Item 8 of our Annual Report on Form 10-K for the year ended December 31, 2010. We believe the critical accounting policies and estimates described below reflect our more significant estimates and assumptions used in the preparation of our consolidated financial statements. The impact and any associated risks on our business that are related to these policies are also discussed throughout this “Management’s Discussion and Analysis of Financial Condition and Results of Operations” where such policies affect reported and expected financial results.

 

Revenue Recognition

 

Net sales revenue and related volume incentive expenses are recorded when persuasive evidence of an arrangement exists, collectability is reasonably assured, the amount is fixed and determinable, and title and risk of loss have passed, generally when the merchandise has been delivered. The amount of the volume incentive is determined based upon the amount of qualifying purchases in a given month. It is necessary for us to make estimates about the timing of when merchandise has been delivered. These estimates are based upon our historical experience related to time in transit, and timing of when shipments occurred and shipping volumes. Amounts received for undelivered merchandise are recorded as deferred revenue. From time to time, our U.S. operations extend short-term credit associated with product promotions. In addition for certain of our international operations, we offer credit terms consistent with industry standards within the country of operation. Payments to Distributors and Managers for sales incentives or rebates are recorded as a reduction of revenue. Payments for sales incentives and rebates are calculated monthly based upon qualifying sales. Membership fees are deferred and amortized as revenue over the life of the membership, primarily one year. Prepaid event registration fees are deferred and recognized as revenues when the related event is held.

 

A reserve for product returns is recorded based upon historical experience.  We allow Distributors or Managers to return the unused portion of products within ninety days of purchase if they are not satisfied with the product.  In some of our markets, the requirements to return product are more restrictive.

 

Investments

 

Our available-for-sale investment portfolio is recorded at fair value and consists of various fixed income securities such as U.S. government and state and municipal bonds, mutual funds, depository certificates and equity securities. These investments are valued using (a) quoted prices for identical assets in active markets or (b) from significant inputs that are observable or can be derived from or corroborated by observable market data for substantially the full term of the asset. Our trading portfolio is recorded at fair value and consists of various marketable securities that are valued using quoted prices in active markets.

 

For available-for-sale debt securities with unrealized losses, we perform an analysis to assess whether it intends to sell or whether it would be more likely than not required to sell the security before the expected recovery of the amortized cost basis. Where we intend to sell a security, or may be required to do so, the security’s decline in fair value is deemed to be other-than-temporary and the full amount of the unrealized loss is recorded within earnings as an impairment loss.

 

For all other debt securities that experience a decline in fair value that is determined to be other-than-temporary and not related to credit loss, we record a loss, net of any tax, in accumulated other comprehensive income (loss). The credit loss is recorded within earnings as an impairment loss when sold. Management judgment is involved in evaluating whether a decline in an investment’s fair value is other-than-temporary.

 

Regardless of our intent to sell a security, we perform additional analysis on all securities with unrealized losses to evaluate losses associated with the creditworthiness of the security. Credit losses are identified where we do not expect to receive cash flows sufficient to recover the amortized cost basis of a security.

 

For equity securities, when assessing whether a decline in fair value below our cost basis is other-than-temporary, we consider the fair market value of the security, the length of time and extent to which market value has been less than cost, the financial condition and near-term prospects of the issuer as well as specific events or circumstances that may influence the operations of the issuer, and our intent and ability to hold the investment for a sufficient time in order to enable recovery of our cost. New information and the passage of time can change these judgments. Where we have determined that we lack the intent and ability to hold an equity

 

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security to its expected recovery, the security’s decline in fair value is deemed to be other-than-temporary and is recorded within earnings as an impairment loss.

 

Inventories

 

Inventories are stated at the lower-of-cost-or-market, using the first-in, first-out method. The components of inventory cost include raw materials, labor and overhead. To estimate any necessary lower-of-cost-or-market adjustments, various assumptions are made in regard to excess or slow-moving inventories, non-conforming inventories, expiration dates, current and future product demand, production planning and market conditions.

 

Self-Insurance Liabilities

 

Similar to other manufacturers and distributors of products that are ingested, we face an inherent risk of exposure to product liability claims in the event that, among other things, the use of our products results in injury to consumers due to tampering by unauthorized third parties or product contamination. We have historically had a very limited number of product claims or reports from individuals who have asserted that they have suffered adverse consequences as a result of using our products. These matters have historically been settled to our satisfaction and have not resulted in material payments. We have established a wholly owned captive insurance company to provide us with product liability insurance coverage and have accrued a reserve that we believe is sufficient to cover probable and reasonable estimable liabilities related to product liability claims based upon our history. However, there can be no assurance that these estimates will prove to be sufficient, nor can there be any assurance that the ultimate outcome of any litigation for product liability will not have a material negative impact on our business prospects, financial position, results of operations or cash flows.

 

We self-insure for certain employee medical benefits. The recorded liabilities for self-insured risks are calculated using actuarial methods and are not discounted. The liabilities include amounts for actual claims and claims incurred but not reported. Actual experience, including claim frequency and severity as well as health care inflation, could result in actual liabilities being more or less than the amounts currently recorded.

 

Incentive Trip Accrual

 

We accrue expenses for incentive trips associated with our direct sales marketing program, which rewards independent Distributors and Managers with paid attendance at our conventions and meetings. Expenses associated with incentive trips are accrued over qualification periods as they are earned. We specifically analyze incentive trip accruals based on historical and current sales trends as well as contractual obligations when evaluating the adequacy of the incentive trip accrual. Actual results could generate liabilities more or less than the amounts recorded.

 

Impairment of Long-Lived Assets

 

We review our long-lived assets, such as property, plant and equipment and intangible assets for impairment when events or changes in circumstances indicate that the carrying value of an asset may not be recoverable. We use an estimate of future undiscounted net cash flows of the related assets or groups of assets over their remaining lives in measuring whether the assets are recoverable. An impairment loss is calculated by determining the difference between the carrying values and the fair values of these assets. As of June 30, 2011 and December 31, 2010, we did not consider any of our long-lived assets to be impaired.

 

Contingencies

 

We are involved in certain legal proceedings. When a loss is considered probable in connection with litigation or non-income tax contingencies and when such loss can be reasonably estimated with a range, we record our best estimate within the range related to the contingency. If there is no best estimate, we record the minimum of the range. As additional information becomes available, we assess the potential liability related to the contingency and revise the estimates. Revision in estimates of the potential liabilities could materially affect our results of operations in the period of adjustment. Our contingencies are discussed in further detail in Note 11, “Commitments and Contingencies”, to the Notes of our Condensed Consolidated Financial Statements, of Item 1, Part 1 of this report.

 

Income Taxes

 

Our income tax expense, deferred tax assets and liabilities and contingent reserves reflect management’s best assessment of estimated future taxes to be paid. We are subject to income taxes in both the United States and numerous foreign jurisdictions. Significant judgments and estimates are required in determining the Company’s consolidated income tax expense.

 

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Deferred income taxes arise from temporary differences between the tax and financial statement recognition of revenue and expense. In evaluating our ability to recover our deferred tax assets, we consider all available positive and negative evidence, including scheduled reversals of deferred tax liabilities, projected future taxable income, tax planning strategies and recent financial operations. In projecting future taxable income, we develop assumptions including the amount of future state, federal and foreign pretax operating income, the reversal of temporary differences, and the implementation of feasible and prudent tax planning strategies. These assumptions require significant judgment about the forecasts of future taxable income and are consistent with the plans and estimates that we are using to manage the underlying businesses. Valuation allowances are recorded as reserves against net deferred tax assets by the Company when it is determined that net deferred tax assets are not likely to be realized in the foreseeable future.

 

Changes in tax laws and rates could also affect recorded deferred tax assets and liabilities in the future. Management is not aware of any such changes that would have a material effect on the Company’s results of operations, cash flows or financial position.

 

The calculation of our tax liabilities involves dealing with uncertainties in the application of complex tax laws and regulations in a multitude of jurisdictions across our global operations. Income tax positions must meet a more-likely-than-not recognition threshold to be recognized.

 

Share-Based Compensation

 

Our outstanding stock options include both non-qualified stock options, which vest over the expected life of the option grant and performance based stock options that vest upon achieving  operating income margins of six, eight and ten percent as reported in four of five consecutive quarters over the term of the options.

 

We recognize all share-based payments to employees, including grants of employee stock options, in the statement of operations based on their grant-date fair values. We record compensation expense, net of an estimated forfeiture rate, over the vesting period of the stock options based on the fair value of the stock options on the date of grant. We estimate the forfeiture rate based upon historical experience.

 

For performance-based stock options, we perform a review each reporting period to determine if the associated earnings metrics for each option have been achieved and consider other pertinent information available to the Company.

 

RECENT ACCOUNTING PRONOUNCEMENTS

 

Please refer to Note 1 to the Unaudited Condensed Consolidated Financial Statements in Part 1, Item 1 of this report for information regarding recently issued accounting pronouncements.

 

SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

 

The Management’s Discussion and Analysis of Financial Condition and Results of Operations and other sections of this report may contain “forward-looking statements.”  Such forward-looking statements are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995 and Section 21E of the Securities and Exchange Act.  All statements other than statements of historical fact are forward-looking statements.  Forward-looking statements may include, but are not limited to, statements relating to our objectives, plans and strategies. All statements (other than statements of historical fact) that address activities, events or developments that we intend, expect, project, believe or anticipate will or may occur in the future are forward-looking statements. These statements are often characterized by terminology such as “believe,” “hope,” “may,” “anticipate,” “should,” “intend,” “plan,” “will,” “expect,” “estimate,” “project,” “positioned,” “strategy” and similar expressions, and are based on assumptions and assessments made by management in light of their experience and their perception of historical trends, current conditions, expected future developments and other factors they believe to be appropriate. Forward-looking statements are not guarantees of future performance and are inherently subject to risks and uncertainties, some of which cannot be predicted or quantified. Future events and actual results could differ materially from those set forth in, contemplated by, or underlying the forward-looking statements.

 

Important factors that could cause our actual results, performance and achievements, or industry results to differ materially from estimates or projections contained in our forward-looking statements includes, among others, the following:

 

·                  our relationship with and our ability to influence the actions of our independent Distributors and Managers;

 

·                  our ability to attract and retain a sufficient number of independent Distributors and Managers;

 

·                  changes in laws and regulations regarding network marketing that may prohibit or restrict our ability to sell our products in new or existing markets;

 

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·                  determinations regarding tax liabilities and required tax obligations in U.S. and foreign jurisdictions;

 

·                  our products and manufacturing activities are subject to extensive government regulations and restrictions;

 

·                  general economic conditions;

 

·                  an economic slowdown in the markets in which we do business could reduce consumer demand for our products;

 

·                  currency and exchange rate fluctuations could lower our revenue and net income;

 

·                  some of the markets in which we operate may become highly inflationary;

 

·                  some of the markets in which we operate have currency controls in place which restrict our ability to repatriate funds to the United States;

 

·                  the availability and integrity of raw materials could be compromised;

 

·                  significant legal disputes and adverse settlements;

 

·                  geopolitical issues and conflicts could adversely affect our business;

 

·                  our business is subject to the effects of adverse publicity and negative public perception;

 

·                  changes in taxation and transfer pricing could affect our operations;

 

·                  our business is subject to intellectual property risks;

 

·                  product and liability claims;

 

·                  changing consumer preferences and demands;

 

·                  inventory obsolescence due to finite shelf lives and changing product demand;

 

·                  product concentration;

 

·                  system failures;

 

·                  changes in key management personnel; and

 

·                  the competitive nature of our business.

 

Additional factors that could cause actual results to differ materially from our forward-looking statements are set forth in this report and our Annual Report on Form 10-K for the fiscal year ended December 31, 2010 under the heading “Risk Factors.”

 

Forward-looking statements in this report speak only as of the date hereof, and forward-looking statements in documents attached that are incorporated by reference speak only as of the date of those documents.  We do not undertake any obligation to update or release any revisions to any forward-looking statement or to report any events or circumstances after the date hereof or to reflect the occurrence of unanticipated events, except as required by law.

 

Item 3.    QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

We conduct business in several countries and intend to continue to grow our international operations. Net sales revenue, operating income and net income are affected by fluctuations in currency exchange rates, interest rates and other uncertainties inherent in doing business and selling product in more than one currency. In addition, our operations are exposed to risks associated with changes in social, political and economic conditions inherent in international operations, including changes in the laws and policies that govern international investment in countries where we have operations, as well as, to a lesser extent, changes in U.S. laws and regulations relating to international trade and investment.

 

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Foreign Currency Risk

 

During the six months ended June 30, 2011, approximately 55.6 percent of our net sales revenue and approximately 55.3 percent of our operating expenses were realized outside of the United States. Inventory purchases are transacted primarily in U.S. dollars from vendors located in the United States. The local currency of each international subsidiary is generally the functional currency, while certain regions, including Russia and the Ukraine, are served by a U.S. subsidiary through third party entities, for which all business is conducted in U.S. dollars. We conduct business in twenty-three different currencies with exchange rates that are not on a one-to-one relationship with the U.S. dollar. All revenues and expenses are translated at average exchange rates for the periods reported. Therefore, our operating results will be positively or negatively affected by a weakening or strengthening of the U.S. dollar in relation to another fluctuating currency. Given the uncertainty and diversity of exchange rate fluctuations, we cannot estimate the effect of these fluctuations on our future business, product pricing, results of operations, or financial condition, but we have provided consolidated sensitivity analyses below of functional currency/reporting currency exchange rate risks. Changes in various currency exchange rates affect the relative prices at which we sell our products. We regularly monitor our foreign currency risks and periodically take measures to reduce the risk of foreign exchange rate fluctuations on our operating results. We do not use derivative instruments for hedging, trading or speculating on foreign exchange rate fluctuations.  Additional discussion of the impact on the effect of currency fluctuations has been included in our management’s discussion and analysis included in Part I, Item 2 of this report.

 

The following table sets forth a composite sensitivity analysis of our net sales revenue, costs and expenses and operating income in connection with strengthening of the U.S. dollar (our reporting currency) by 10%, 15% and 25% against every other fluctuating functional currency in which we conduct business.  We note that our individual net sales revenue, cost and expense components and our operating income were equally sensitive to increases in the strength of the U.S. dollar against every other fluctuating currency in which we conduct business.

 

Exchange rate sensitivity for the three months ended June 30, 2011 (dollar amounts in thousands)

 

 

 

 

 

With Strengthening of U.S. Dollar by:

 

 

 

 

 

10%

 

15%

 

25%

 

 

 

 

 

($)

 

(%)

 

($)

 

(%)

 

($)

 

%)

 

Net sales revenue

 

$

91,811

 

$

(3,077

)

(3.4

)%

$

(4,416

)

(4.8.

)%

$

(6,770

)

(7.4

)%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cost and expenses

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cost of goods sold

 

17,129

 

(534

)

(3.1

)%

(766

)

(4.5

)%

(1,175

)

(6.9

)%

Volume incentives

 

33,390

 

(1,164

)

(3.5

)%

(1,671

)

(5.0

)%

(2,562

)

(7.7

)%

Selling, general and administrative

 

33,240

 

(1,013

)

(3.0

)%

(1,454

)

(4.4

)%

$

(2,229

)

(6.7

)%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Operating income

 

$

8,052

 

$

(366

)

(4.5

)%

$

(525

)

(6.5

)%

$

(804

)

(10.0

)%

 

Exchange rate sensitivity for the six months ended June 30, 2011 (dollar amounts in thousands)

 

 

 

 

 

With Strengthening of U.S. Dollar by:

 

 

 

 

 

10%

 

15%

 

25%

 

 

 

 

 

($)

 

(%)

 

($)

 

(%)

 

($)

 

%)

 

Net sales revenue

 

$

184,655

 

$

(6,016

)

(3.3

)%

$

(8,632

)

(4.7

)%

$

(13,235

)

(7.2

)%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cost and expenses

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cost of goods sold

 

35,681

 

(1,079

)

(3.0

)%

(1,548

)

(4.3

)%

(2,373

)

(6.7

)%

Volume incentives

 

67,668

 

(2,271

)

(3.4

)%

(3,259

)

(4.8

)%

(4,997

)

(7.4

)%

Selling, general and administrative

 

65,613

 

(2,052

)

(3.1

)%

(2,944

)

(4.5

)%

$

(4,514

)

(6.9

)%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Operating income

 

$

15,673

 

$

(614

)

(3.9

)%

$

(881

)

(5.6

)%

$

(1,351

)

(8.6

)%

 

As noted above, certain of our operations, including Russia and the Ukraine, are served by a U.S. subsidiary through third-party entities, for which all business is conducted in U.S. dollars. Although changes in exchange rates between the U.S. dollar and the Russian ruble or the Ukrainian hryvnia do not result in currency fluctuations within our financial statements, a weakening or strengthening of the U.S. dollar in relation to these other currencies can significantly affect the prices of our products and the purchasing power of our independent Managers and Distributors within these markets.

 

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The following table sets forth a composite sensitivity analysis of our financial instruments by those balance sheet line items that are subject to exchange rate risk, together with the total gain or loss from the strengthening of the U.S. dollar in relation to our various fluctuating functional currencies.  The sensitivity of our assets and liabilities, taken by balance sheet line items, is somewhat less than the sensitivity of our operating income to increases in the strength of the U.S. dollar in relation to other fluctuating currencies in which we conduct business.

 

Exchange rate sensitivity of Balance Sheet as of June 30, 2011 (dollar amounts in thousands)

 

 

 

 

 

With Strengthening of U.S. Dollar by:

 

 

 

 

 

10%

 

15%

 

25%

 

 

 

 

 

($)

 

(%)

 

($)

 

(%)

 

($)

 

(%)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Financial Instruments Included in Current Assets Subject to Exchange Rate Risk