NATURES SUNSHINE PRODUCTS INC - Quarter Report: 2014 June (Form 10-Q)

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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, 2014

 

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: 001-34483

 

 

NATURE’S SUNSHINE PRODUCTS, INC.

(Exact name of Registrant as specified in its charter)

 

 

2500 West Executive Parkway, Suite 100

Lehi, Utah 84043

(Address of principal executive offices and zip code)

 

(801) 341-7900

(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 25, 2014, was 16,202,840 shares.

 

 

 

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NATURE’S SUNSHINE PRODUCTS, INC.

FORM 10-Q

 

For the Quarter Ended June 30, 2014

 

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Part I. Financial Information
	Item 1.	Financial Statements (Unaudited)	4
		Condensed Consolidated Balance Sheets	4
		Condensed Consolidated Statements of Operations	5
		Condensed Consolidated Statements of Comprehensive Income	5
		Condensed Consolidated Statements of Cash Flows	7
		Notes to Condensed Consolidated Financial Statements	8
	Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	19
	Item 3.	Quantitative and Qualitative Disclosures about Market Risk	35
	Item 4.	Controls and Procedures	38
Part II. Other Information
	Item 1.	Legal Proceedings	38
	Item 1A.	Risk Factors	38
	Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	39
	Item 3.	Default Upon Senior Securities	39
	Item 4.	Mine Safety Disclosures	39
	Item 5.	Other Information	39
	Item 6.	Exhibits	39

 

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CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS

 

Certain information included or incorporated herein by reference in this report may be deemed to be “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. 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. For example, information appearing under “Management’s Discussion and Analysis of Financial Condition and Results of Operations” includes forward-looking statements. Forward-looking statements are not guarantees of future performance and are subject to risks and uncertainties. Important factors that could cause actual results, developments and business decisions to differ materially from forward-looking statements are more fully described in this report, including the risks set forth under “Risk Factors” in Item 1A, is included from time to time in our reports filed with the Securities and Exchange Commission (“SEC”), including our Annual Report on Form 10-K for the year ended December 31, 2013, as well as our quarterly reports on Form 10-Q, particularly under the captions “Forward-Looking Statements” and “Risk Factors.” but include the following:

 

·             any negative consequences resulting from the economy, including the availability of liquidity to us, our Distributors and our suppliers or the willingness of our customers to purchase products;

·             our relationship with, and our ability to influence the actions of, our Distributors, and other third parties with whom we do business;

·             improper action by our employees or Distributors;

·             negative publicity related to our products or direct selling organization;

·             changing consumer preferences and demands;

·             our reliance upon, or the loss or departure of any member of, our senior management team which could negatively impact our Distributor relations and operating results;

·             the competitive nature of our business;

·             regulatory matters governing our products, our direct selling program, or the direct selling market in which we operate;

·             legal challenges to our direct selling program;

·             risks associated with operating internationally and the effect of economic factors, including foreign exchange, inflation, disruptions or conflicts with our third party importers, pricing and currency devaluation risks, especially in countries such as Venezuela, Ukraine, Russia and Belarus;

·             uncertainties relating to the application of transfer pricing, duties, value-added taxes, and other tax regulations, and changes thereto;

·             our dependence on increased penetration of existing markets;

·             our reliance on our information technology infrastructure;

·             the sufficiency of trademarks and other intellectual property rights;

·             changes in tax laws, treaties or regulations, or their interpretation;

·             taxation relating to our Distributors;

·             product liability claims; and

·             share price volatility related to, among other things, speculative trading.

 

All forward-looking statements speak only as of the date of this report and are expressly qualified in their entirety by the cautionary statements included in or incorporated by reference into this report. Except as is required by law, we expressly disclaim any obligation to publicly release any revisions to forward-looking statements to reflect events after 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.”

 

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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, 2014			December 31, 2013
Assets
Current assets:
Cash and cash equivalents		$	68,555		$	77,247
Accounts receivable, net of allowance for doubtful accounts of $663 and $1,087, respectively		9,010			10,206
Investments available for sale		2,024			2,006
Inventories		40,477			41,910
Deferred income tax assets		5,596			5,711
Income tax receivable		8,447			6,665
Prepaid expenses and other		5,330			4,849
Total current assets		139,439			148,594
Property, plant and equipment, net		41,066			32,022
Investment securities		1,022			971
Intangible assets, net		779			853
Deferred income tax assets		13,930			9,928
Other assets		8,943			7,244
		$	205,179		$	199,612
Liabilities and Shareholders’ Equity
Current liabilities:
Accounts payable		$	5,800		$	5,664
Accrued volume incentives		19,322			19,206
Accrued liabilities		29,087			34,893
Deferred revenue		3,745			4,173
Current installments of long-term debt and revolving credit facility		572			2,267
Income taxes payable		1,575			2,366
Total current liabilities		60,101			68,569
Liability related to unrecognized tax benefits		13,223			12,402
Long-term debt and revolving credit facility		10,000			10,000
Deferred compensation payable		1,022			971
Other liabilities		2,638			2,411
		86,984			94,353
Commitments and contingencies
Shareholders’ equity:
Common stock, no par value, 50,000 shares authorized, 16,203 and 16,179 shares issued and outstanding as of June 30, 2014, and December 31, 2013, respectively		85,414			83,122
Retained earnings		45,762			36,100
Accumulated other comprehensive loss		(12,981		)	(13,963		)
Total shareholders’ equity		118,195			105,259
		$	205,179		$	199,612

 

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,
		2014			2013
Net sales revenue		$	94,325		$	93,675
Cost of sales		(23,372		)	(22,630		)
Gross profit		70,953			71,045
Operating expenses:
Volume incentives		34,834			34,525
Selling, general and administrative		30,305			28,709
Operating income		5,814			7,811
Other income (loss), net		(378		)	1,482
Income before provision for income taxes		5,436			9,293
Provision for income taxes		2,202			3,241
Net income		$	3,234		$	6,052
Basic and diluted net income per common share
Basic:
Net income		$	0.20		$	0.38
Diluted:
Net income		$	0.20		$	0.38
Weighted average basic common shares outstanding		16,187			15,896
Weighted average diluted common shares outstanding		16,224			16,112
Dividends declared per common share		$	0.10		$	0.10

 

See accompanying notes to condensed consolidated financial statements.

 

NATURE’S SUNSHINE PRODUCTS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(Amounts in thousands)

(Unaudited)

 

		Three Months Ended June 30,
		2014			2013
Net income		$	3,234		$	6,052
Foreign currency translation gain (loss) (net of tax)		793			(2,040		)
Net unrealized gains on investment securities (net of tax)		8			6
Total comprehensive income		$	4,035		$	4,018

 

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,
		2014			2013
Net sales revenue		$	190,078		$	190,154
Cost of sales		(46,478		)	(47,075		)
Gross profit		143,600			143,079
Operating expenses:
Volume incentives		70,551			69,500
Selling, general and administrative		60,063			58,826
Operating income		12,986			14,753
Other income (loss), net		(1,493		)	1,812
Income before provision for income taxes		11,493			16,565
Provision (benefit) for income taxes		(1,406		)	5,649
Net income		$	12,899		$	10,916
Basic and diluted net income per common share
Basic:
Net income		$	0.80		$	0.69
Diluted:
Net income		$	0.79		$	0.68
Weighted average basic common shares outstanding		16,183			15,860
Weighted average diluted common shares outstanding		16,392			16,079
Dividends declared per common share		$	0.20		$	0.20

 

See accompanying notes to condensed consolidated financial statements.

 

NATURE’S SUNSHINE PRODUCTS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(Amounts in thousands)

(Unaudited)

 

		Six Months Ended June 30,
		2014			2013
Net income		$	12,899		$	10,916
Foreign currency translation gain (loss) (net of tax)		971			(3,926		)
Net unrealized gains on investment securities (net of tax)		11			30
Total comprehensive income		$	13,881		$	7,020

 

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,
		2014			2013
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income		$	12,899		$	10,916
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for doubtful accounts		110			19
Depreciation and amortization		2,375			2,181
Share-based compensation expense		2,082			1,930
Loss on sale of property and equipment		19			25
Deferred income taxes		(3,887		)	183
Amortization of bond discount		1			1
Purchase of trading investment securities		(98		)	(36		)
Proceeds from sale of trading investment securities		93			193
Realized and unrealized gains on investments		(44		)	(33		)
Foreign exchange losses (gains)		1,390			(1,583		)
Changes in assets and liabilities:
Accounts receivable		1,165			229
Inventories		1,384			1,163
Prepaid expenses and other current assets		(2,331		)	(642		)
Other assets		(1,467		)	103
Accounts payable		410			(1,296		)
Accrued volume incentives		19			1,643
Accrued liabilities		(5,568		)	699
Deferred revenue		(428		)	(901		)
Income taxes payable		(858		)	401
Liability related to unrecognized tax benefits		821			216
Deferred compensation payable		51			(125		)
Net cash provided by operating activities		8,138			15,286
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property, plant and equipment		(11,568		)	(2,332		)
Proceeds from sale of property, plant and equipment		3			46
Purchase of investments available for sale		(18		)	(75		)
Proceeds from investments available for sale		51			—
Net cash used in investing activities		(11,532		)	(2,361		)
CASH FLOWS FROM FINANCING ACTIVITIES:
Payments of cash dividends		(3,237		)	(3,170		)
Principal payments of long-term debt and revolving credit facility		(1,695		)	(1,391		)
Proceeds from the exercise of stock options		210			1,356
Net cash used in financing activities		(4,722		)	(3,205		)
Effect of exchange rates on cash and cash equivalents		(576		)	(1,666		)
Net increase (decrease) in cash and cash equivalents		(8,692		)	8,054
Cash and cash equivalents at the beginning of the period		77,247			79,241
Cash and cash equivalents at the end of the period		$	68,555		$	87,295
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid for income taxes		$	4,062		$	5,407
Cash paid for interest		106			32

 

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., together with its subsidiaries (hereinafter referred to collectively as the “Company”), is a natural health and wellness company primarily engaged in the manufacturing and direct selling of nutritional and personal care products. The Company is a Utah corporation with its principal place of business in Lehi, Utah and sells its products to a sales force of Managers and Distributors 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 the Company’s major product groups are subject to regulation by one or more governmental agencies.

 

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

 

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, 2014, and for the three- and six-month periods ended June 30, 2014 and 2013.  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, 2014.

 

It is suggested that these condensed consolidated financial statements 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, 2013.

 

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

 

Since January 1, 2010, Venezuela has been designated as a highly inflationary economy. Accordingly, the U.S. dollar became the functional currency for the Company’s subsidiary in Venezuela. On February 11, 2013, the Venezuelan government’s currency control agency (“CADIVI”), announced the further devaluation of the bolivar to 6.3 bolivars per U.S. dollar. In addition, the CADIVI enacted a new currency exchange mechanism, the First Complementary System for Foreign Currency Administration (“SICAD 1”), and mandated foreign entities domiciled in Venezuela to formally apply and be approved by the CADIVI to obtain U.S. dollars through banking institutions approved by the Venezuelan government at the official CADIVI exchange rate of 6.3 bolivars per U.S. dollar or at the official SICAD 1 exchange rate of 11.3 bolivars per U.S. dollar. On a weekly basis, the CADIVI determined how many U.S. dollars would be sold and which previously approved companies would be authorized to obtain them. Companies were approved to obtain U.S. dollars based on the individual products that they imported and sold in Venezuela. Products that are considered to be more beneficial to consumers in Venezuela, such as medicinal products, were approved for payment at the official CADIVI exchange rate of 6.3, while other beneficial products, such as dietary supplements, were approved for payment at the official SICAD 1 exchange rate of 11.3.   Foreign entities domiciled in Venezuela pay bolivars to the Venezuela Central Bank, which then pays U.S. dollars directly to the foreign entities to limit the amount of U.S. dollars available within Venezuela. The Company is currently in the process of registering its products in order to obtain U.S. dollars at the official CADAVI exchange rate of 6.3 or the official SICAD 1 exchange rate of 11.3. The Company has not successfully obtained U.S. dollars at the CADIVI exchange rate since the establishment of the SICAD 1 currency exchange mechanism.

 

Effective January 24, 2014, additional changes to the country’s foreign exchange system were enacted by the Venezuelan government that expanded the types of products that could be subject to the weekly SICAD 1 auction process. In addition, a new currency control agency (“CENCOEX”) was established to replace the CADIVI. The CENCOEX official exchange rate was

 

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maintained at the CADIVI official exchange rate 6.3 bolivars per U.S. dollar. The CENCOEX also enacted a new currency exchange mechanism, the Second Complementary System for Foreign Currency Administration (“SICAD 2”) that will supplement and coexist with the SICAD 1 currency exchange mechanism. The SICAD 2 is expected to provide a greater supply of U.S. dollars from sources other than the Venezuelan government and to allow all sectors and companies to participate. The SICAD 2 is intended to more closely resemble a market-driven exchange rate than the official CENCOEX and SICAD 1 exchange rates of 6.3 and 11.3, respectively. As of June 30, 2014, the SICAD 2 exchange rate was approximately 50.0 bolivars per U.S. dollar.

 

The Company does not intend to apply for exchange or register any products at the SICAD 2 exchange rate. The Company is currently monitoring the currency exchange mechanisms in place and the potential for currency exchange transactions should the Company’s applications for currency exchange be unsuccessful. At this time, the Company is uncertain of the process or exchange rate for obtaining U.S. dollars for previously shipped products dating back to the establishment of the SICAD 1 currency exchange mechanism in February 2013.

 

Due to these circumstances, the Company has re-measured its assets and liabilities in Venezuela at the official SICAD 1 exchange rate of 11.3, effective March 31, 2014. This re-measurement resulted in a foreign exchange loss of $845. Going forward the Company will report its results at the higher official exchange rate of 11.3 bolivars to the U.S. dollar.

 

During the three months ended June 30, 2014 and 2013, the Company’s Venezuelan subsidiary’s net sales revenue represented approximately 1.6 percent and 2.0 percent of consolidated net sales revenue, respectively.  During the six months ended June 30, 2014 and 2013, the Company’s Venezuelan subsidiary’s net sales revenue represented approximately 2.0 percent and 2.1 percent of consolidated net sales revenue, respectively.  As of June 30, 2014 and December 31, 2013, the Company’s Venezuelan subsidiary held cash and cash equivalents of $2,906 and $3,922, respectively. As of June 30, 2014 and December 31, 2013, the Company’s Venezuelan subsidiary held net assets of $4,884 and $5,721, respectively, of which was property, plant and equipment of $3,016 and $3,207, respectively.

 

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

 

Since June 30, 2012, Belarus has been designated as a highly inflationary economy. The U.S. dollar is the Company’s functional currency for this market. As a result, there were no resulting gains or losses from a re-measurement of the financial statements using official rates of the Company’s Belarusian subsidiary.  However, as a result of the weakening of the Belarusian ruble, the purchasing power of the Company’s Distributors in this market has diminished. During the three months ended June 30, 2014 and 2013, the Company’s Belarusian subsidiary’s net sales revenue represented approximately 2.3 percent and 1.9 percent of consolidated net sales revenue, respectively. During the six months ended June 30, 2014 and 2013, the Company’s Belarusian subsidiary’s net sales revenue represented approximately 2.4 percent and 2.1 percent of consolidated net sales revenue, respectively.

 

Strategic Alliance with Fosun Pharma

 

On June 26, 2014, the Company and Shanghai Fosun Pharmaceutical (Group) Co., Ltd. (“Fosun Pharma”), a leading healthcare company in the People’s Republic of China (“China”), announced the signing of definitive agreements with respect to the formation of a China joint venture to market and distribute Nature’s Sunshine and Synergy products in China and a concurrent investment by Fosun Pharma of approximately $46,300 in Nature’s Sunshine common stock to be issued pursuant to a private placement transaction. Nature’s Sunshine intends to use the net proceeds of the private placement transaction to fund its share of the China joint venture and pay a cash dividend of $1.50 per share contingent upon transaction closing.  The amount of the cash dividend paid to shareholders is expected to be approximately $29,000. The parties anticipate closing the joint venture and private placement transaction in the third quarter of 2014, subject to customary closing conditions including the receipt of required regulatory approvals.

 

Nature’s Sunshine and Fosun Pharma have agreed to enter into a joint venture in China which will be owned 80 percent by Nature’s Sunshine and 20 percent by a wholly-owned subsidiary of Fosun Pharma. The joint venture will be capitalized initially with $16,000 from Nature’s Sunshine and $4,000 from Fosun Pharma.  The launch of the joint venture is subject to customary conditions, including regulatory approvals by the Chinese government. The Company will consolidate the joint venture in its consolidated financial statements, with the 20 percent Fosun Pharma interest presented as a noncontrolling interest.

 

The joint venture, known as Nature’s Sunshine Hong Kong Limited, expects to market and distribute Nature’s Sunshine products in China.  Nature’s Sunshine Hong Kong Limited currently anticipates deploying a multi-brand, multi-channel go-to-market strategy that offers select Nature’s Sunshine-branded products through certain of Fosun Pharma’s existing retail locations across China, and select Synergy-branded products through a direct selling model.  The time to market will be dependent upon regulatory processes, including product registration, permit and license approvals.

 

Pursuant to a concurrent private placement transaction, Nature’s Sunshine has agreed to issue approximately 2,860 shares of unregistered common stock to Fosun Pharma at a price of $16.19 per share, representing aggregate proceeds to Nature’s Sunshine of

 

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approximately $46,300. The purchase price represents a 10 percent premium to Nature’s Sunshine’s average stock price over the trailing 30 business day period as of June 26, 2014.  Upon the closing of the sale, Fosun Pharma will own approximately 15% of Nature’s Sunshine outstanding common shares. Nature’s Sunshine has granted Fosun Pharma certain registration rights with respect to the private placement shares.  In addition, Nature’s Sunshine has agreed to initially appoint one director designated by Fosun Pharma to its board of directors.  The issuance and sale of the shares is subject to customary closing conditions, including the consummation of the joint venture transaction and is expected to close concurrently with the joint venture transaction.

 

Recent Accounting Pronouncements

 

In April 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2014-08 Presentation of Financial Statements (Topic 740) and Property, Plant, and Equipment (Topic 360): “Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity”. This update changes the criteria for reporting discontinued operations while enhancing disclosures in this area. Under the new guidance, only disposals representing a strategic shift in operations should be presented as discontinued operations. Those strategic shifts should have a major effect on the organization’s operations and financial results. In addition, the new guidance requires expanded disclosures about discontinued operations that will provide financial statement users with more information about the assets, liabilities, income, and expenses of discontinued operations. The amendments in this update are effective for interim and annual periods beginning after December 15, 2014.  The adoption of this ASU is not expected to have a material impact on the Company’s consolidated financial statements.

 

In May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2014-09 Revenue from Contracts with Customers (Topic 606). This update requires an entity to recognize revenue to depict the transfer of promised goods and services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods and services. As such, this update affects an entity that either enters into contracts with customers or transfers goods and services or enters into contracts for the transfer of nonfinancial assets unless those contracts are within the scope of other standards. This update will supersede the revenue recognition requirements in Topic 605, Revenue Recognition, and most industry-specific guidance, and creates a Topic 606. The amendments in this update are effective for interim and annual periods beginning after December 15, 2015.  The adoption of this ASU is not expected to have a material impact on the Company’s consolidated financial statements.

 

In June 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2014-12 Compensation — Stock Compensation (Topic 718): “Accounting for Share-Based Payments When the Terms of an Award Provide That a Performance Target Could Be Achieved after the Requisite Service Period”. This update requires that a performance target that affects vesting and that could be achieved after the requisite service period be treated as a performance condition. The performance target should not be reflected in estimating the grant-date fair value of the award. Compensation costs should be recognized in the period in which it becomes probable that the performance target will be achieved and should represent the compensation cost attributable to the period for which the requisite service has already been rendered. If the performance target becomes probable of being achieved before the end of the requisite service period, the remaining unrecognized compensation cost should be recognized prospectively over the remaining requisite service period. The requisite service period ends when the employee can cease rendering service and still be eligible to vest in the award if the performance target is achieved. The amendments in this update are effective for interim and annual periods beginning after December 15, 2015.  The adoption of this ASU is not expected to have a material impact on the Company’s consolidated financial statements.

 

(2)                     Inventories

 

The composition of inventories is as follows:

 

		June 30,			December 31,
		2014			2013
Raw materials		$	11,887		$	10,848
Work in progress		800			740
Finished goods		27,790			30,322
Total inventory		$	40,477		$	41,910

 

(3)                     Intangible Assets

 

At June 30, 2014, and December 31, 2013, intangibles for product formulations had a gross carrying amount of $1,763 and $1,763, accumulated amortization of $984 and $910, and a net amount of $779 and $853, respectively. The estimated useful lives of the product formulations range from 9 to 15 years.

 

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Amortization expense for intangible assets for the three months ended June 30, 2014 and 2013, was $37 and $37, respectively. Amortization expense for intangible assets for the six months ended June 30, 2014 and 2013 was $74 and $74, respectively.  Estimated amortization expense for the next succeeding fiscal year thereafter is $149 followed by four fiscal years with estimated amortization expense of $91.

 

(4)                     Investments

 

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

 

As of June 30, 2014		Amortized Cost			Gross Unrealized Gains			Gross Unrealized Losses			Fair Value
Municipal obligations		$	401		$	5		$	—		$	406
U.S. government securities funds		998			—			(11		)	987
Equity securities		227			412			(8		)	631
Total short-term investment securities		$	1,626		$	417		$	(19	)	$	2,024

 

As of December 31, 2013		Amortized Cost			Gross Unrealized Gains			Gross Unrealized Losses			Fair Value
Municipal obligations		$	403		$	12		$	—		$	415
U.S. government securities funds		997			—			(14		)	983
Equity securities		227			386			(5		)	608
Total short-term investment securities		$	1,627		$	398		$	(19	)	$	2,006

 

The municipal obligations held at a fair value of $406 at June 30, 2014, all mature in less than two years.

 

During the six-month periods ended June 30, 2014 and 2013, the proceeds from the sales of available-for-sale securities were $51 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, 2014 and 2013, respectively.

 

The Company’s trading securities portfolio totaled $1,022 at June 30, 2014, and $971 at December 31, 2013, and generated gains of $44 and $33 for the six months ended June 30, 2014 and 2013.

 

As of June 30, 2014 and December 31, 2013, the Company had unrealized losses of $11 and $14, respectively, in its U.S. government securities funds. These losses are due to the interest rate sensitivity of the municipal obligations and the performance of the overall stock market for the equity securities.

 

(5)                     Long-Term Debt

 

The Company’s revolving credit agreement with Wells Fargo Bank, N.A., permits the Company to borrow up to $25,000 through August 9, 2014, bearing interest at LIBOR plus 1.25 percent (1.50 percent as of June 30, 2014 and December 31, 2013). The Company must pay an annual commitment fee of 0.25 percent on the unused portion of the commitment. Currently, the revolving credit agreement matures on September 1, 2015.  At June 30, 2014 and December 31, 2013, the outstanding balance under the revolving credit agreement was $10,000.

 

A term loan of $10,000 was obtained in conjunction with the revolving credit agreement with Wells Fargo Bank, N.A. and has a maturity date of August 9, 2014, and a variable interest rate of LIBOR plus 1.25 percent (1.50 percent as of each of June 30, 2014 and December 31, 2013). The outstanding balance under the term loan was $572 and $2,267 as of June 30, 2014 and December 31, 2013, respectively. The term loan is collateralized by the Company’s manufacturing facility in Spanish Fork, Utah.

 

The various debt agreements contain restrictions on liquidity, leverage, minimum net income and consecutive quarterly net losses. In addition, the agreements restrict capital expenditures, lease expenditures, other indebtedness, liens on assets, guaranties, loans and advances, and the merger, consolidation and the transfer of assets except in the ordinary course of business. The Company is in compliance with these debt covenants as of June 30, 2014.

 

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(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.

 

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, 2014 and 2013:

 

		Three Months Ended June 30,						Six Months Ended June 30,
		2014			2013			2014			2013
Net income		$	3,234		$	6,052		$	12,899		$	10,916
Basic weighted average shares outstanding		16,187			15,896			16,183			15,860
Basic net income per common share		$	0.20		$	0.38		$	0.80		$	0.69
Diluted weighted average shares outstanding
Basic weighted average shares outstanding		16,187			15,896			16,183			15,860
Weighted average stock options outstanding		37			216			209			219
Diluted weighted average shares outstanding		16,224			16,112			16,392			16,079
Diluted net income per common share		$	0.20		$	0.38		$	0.79		$	0.68
Potentially dilutive shares excluded from diluted per share amounts:
Stock options		133			146			133			163
Potentially anti-dilutive shares excluded from diluted per share amounts:
Stock options		653			306			468			428

 

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 and shares that would be anti-dilutive to the computation of diluted net income per share for each of the years presented.

 

(7)                    Capital Transactions

 

Dividends

 

The declaration of future dividends is subject to the discretion of the Company’s Board of Directors and will depend upon various factors, including the Company’s earnings, financial condition, restrictions imposed by any indebtedness that may be outstanding, cash requirements, future prospects and other factors deemed relevant by its Board of Directors.

 

On March 17, 2014, the Company announced a cash dividend of $0.10 per common share in an aggregate amount of $1,618 that was paid on April 7, 2014, to shareholders of record on March 28, 2014. On May 7, 2014, the Company announced a cash dividend of $0.10 per common share in an aggregate amount of $1,619 that was paid on June 2, 2014, to shareholders of record on May 21, 2014.

 

Share Repurchase Program

 

On August 8, 2013, the Board of Directors authorized a $10,000 share repurchase program to be implemented over two years. Such purchases may be made in the open market, through block trades, in privately negotiated transactions or otherwise. The timing and amount of any shares repurchased will be determined based on the Company’s evaluation of market conditions and other factors and the program may be discontinued or suspended at any time. Due to a blackout period beginning in mid-December 2013 and the

 

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subsequent negotiations with Fosun Pharma for a strategic alliance, the Company has not repurchased any shares of its common stock under the share repurchase program in 2014. At June 30, 2014, the remaining balance available for repurchases under the program was $7,454.

 

Share-Based Compensation

 

Stock option activity for the six months ended June 30, 2014, is as follows:

 

		Number of Shares		Weighted Average Exercise Price Per Share
Options outstanding at December 31, 2013		1,926		$	12.54
Granted		258		15.38
Expired		(16	)	13.55
Exercised		(24	)	8.84
Options outstanding at June 30, 2014		2,144		12.92

 

The Company’s outstanding stock options include time-based stock options, which vest over differing periods ranging from the date of issuance up to 48 months from the option grant date; performance-based stock options, which have already vested 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; performance-based stock options, which vest upon achieving cumulative annual net sales revenue growth targets over a rolling two-year period, subject to the Company maintaining at least an eight percent operating income margin during the applicable period; and performance-based stock options, which vest upon achieving annual net sales targets over a rolling one-year period.

 

During the six-month period ended June 30, 2014, the Company issued options to purchase 258 shares of common stock under the 2012 Stock Incentive Plan to the Company’s executive officers and other employees, which are composed of time-based stock options. These options were issued with a weighted-average exercise price of $15.38 per share and a weighted-average grant date fair value of $6.53 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, 2014:

 

		2014
Expected life (in years)		6.0
Risk-free interest rate		1.5
Expected volatility		56.7
Dividend yield		2.6

 

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 bill rate that corresponds with the option life.  The dividend yield is based on the Company’s historical and expected amount of dividend payouts, at the time of grant. On August 29, 2013, the Company paid a special one-time cash dividend of $1.50 per common share. The Company has excluded this special one-time cash dividend from the dividend yield used in the Black-Scholes option-pricing model calculations as it is not representative of future dividends to be declared by the Company.

 

Share-based compensation expense from time-based stock options for the three-month periods ended June 30, 2014 and 2013, was approximately $719 and $729, respectively; the related tax benefit was approximately $284 and $288, respectively. Share-based compensation expense from time-based stock options for the six-month periods ended June 30, 2014 and 2013, was approximately $1,616 and $1,803, respectively; the related tax benefit was approximately $638 and $712, respectively. As of June 30, 2014 and December 31, 2013, the unrecognized share-based compensation expense related to the grants described above was $3,293 and $3,294, respectively. As of June 30, 2014, the remaining compensation cost is expected to be recognized over the weighted-average period of approximately 1.9 years.

 

The Company has not recognized any share-based compensation expense related to the net sales revenue performance-based stock options for the six-month period ended June 30, 2014.  Should the Company attain all of the net sales revenue metrics related to the net sales revenue performance-based stock option grants, the Company would recognize up to $800 of potential share-based compensation expense.

 

At June 30, 2014, the aggregate intrinsic value of outstanding stock options to purchase 2,144 shares of common stock, exercisable stock options to purchase 1,096 shares of common stock and stock options to purchase 869 shares of common stock that

 

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are expected to vest was $8,975, $6,498 and $2,353, respectively. At December 31, 2013, the aggregate intrinsic value of outstanding options to purchase 1,926 shares of common stock, the exercisable options to purchase 838 shares of common stock, and options to purchase 905 shares of common stock expected to vest was $9,415, $6,069 and $3,179, respectively.

 

Restricted stock unit activity for the period ended June 30, 2014 is as follows:

 

		Number of Shares		Weighted Average Grant Date Fair Value
Units outstanding at December 31, 2013		32		$	12.47
Granted		140		13.85
Issued		—		—
Forfeited		(3	)	14.38
Units outstanding at June 30, 2014		169		13.39

 

During the six-month period ended June 30, 2014, the Company issued 140 restricted stock units (RSUs) of common stock under the 2012 Incentive Plan to the Company’s Board, executive officers and other employees. The RSUs were issued with a weighted average grant date fair value of $13.85 per share and vest in annual installments over a four year period from the grant date.

 

RSUs are valued at the market value on the date of grant, which is the grant date share price discounted for expected dividend payments during the vesting period.  For RSUs with post-vesting restrictions, a Finnerty Model was utilized to calculate a valuation discount from the market value of common shares reflecting the restriction embedded in the RSUs preventing the sale of the underlying shares over a certain period of time. The Finnerty Model proposes to estimate a discount for lack of marketability such as transfer restrictions by using an option pricing theory. This model has gained recognition through its ability to address the magnitude of the discount by considering the volatility of a company’s stock price and the length of restriction. The concept underpinning the Finnerty Model is that restricted stock cannot be sold over a certain period of time. Using assumptions previously determined for the application of the option pricing model at the valuation date, the Finnerty Model discount for lack of marketability is approximately 17.5 percent for a common share.

 

Share-based compensation expense from RSUs for the three-month periods ended June 30, 2014 and 2013, was approximately $269 and $52, respectively; the related tax benefit was approximately $106 and $18, respectively. Share-based compensation expense from RSUs for the six-month periods ended June 30, 2014 and 2013, was approximately $466 and $127, respectively; the related tax benefit was approximately $184 and $44, respectively. As of June 30, 2014 and December 31, 2013, the unrecognized share-based compensation expense related to the grants described above was $1,533 and $62, respectively. As of June 30, 2014, the remaining compensation expense is expected to be recognized over the weighted average period of approximately 2.1 years.

 

(8)                     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 business segments that operate under the Nature’s Sunshine Products brand and are divided based on the characteristics of their Distributor base, similarities in compensation plans, as well as the internal organization of NSP’s officers and their responsibilities (NSP Americas, Asia Pacific and Europe and NSP Russia, Central and Eastern Europe). The Company’s third business segment operates under the Synergy WorldWide brand, which distributes its products through different selling and Distributor compensation plans and has products with formulations that are sufficiently different from those of the NSP Americas, Asia Pacific and Europe and NSP Russia, Central and Eastern Europe 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 contribution margin (loss) by segment before consideration of certain inter-segment transfers and expenses.

 

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Reportable business segment information is as follows:

 

		Three Months Ended June 30,						Six Months Ended June 30,
		2014			2013			2014			2013
Net sales revenue:
NSP Americas, Asia Pacific and Europe		$	49,000		$	53,416		$	99,673		$	106,553
NSP Russia, Central and Eastern Europe		12,838			14,978			27,875			31,118
Synergy WorldWide		32,487			25,281			62,530			52,483
Total net sales revenue		94,325			93,675			190,078			190,154
Contribution margin (1):
NSP Americas, Asia Pacific and Europe		19,725			22,305			40,646			44,261
NSP Russia, Central and Eastern Europe		4,563			5,523			9,959			11,506
Synergy WorldWide		11,831			8,692			22,444			17,812
Total contribution margin		36,119			36,520			73,049			73,579
Selling, general and administrative		30,305			28,709			60,063			58,826
Total operating income		5,814			7,811			12,986			14,753
Other income (expense), net		(378		)	1,482			(1,493		)	1,812
Income before provision for income taxes		$	5,436		$	9,293		$	11,493		$	16,565

 

(1)              Contribution margin consists of net sales revenue less cost of sales and volume incentives expense.

 

From an individual country perspective, only the United States and South Korea comprise 10 percent or more of consolidated net sales revenue for the three and six-month periods ended June 30, 2014 and 2013, as follows:

 

		Three Months Ended June 30,						Six Months Ended June 30,
		2014			2013			2014			2013
Net sales revenue:
United States		$	37,932		$	40,195		$	75,547		$	79,343
South Korea		14,336			6,894			26,707			13,615
Other		42,057			46,586			87,824			97,196
		$	94,325		$	93,675		$	190,078		$	190,154

 

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Revenue generated by each of the Company’s product lines is set forth below:

 

		Three Months Ended June 30,						Six Months Ended June 30,
		2014			2013			2014			2013
NSP Americas, Asia Pacific and Europe:
General health		$	22,091		$	22,312		$	43,402		$	44,784
Immune		5,388			5,934			11,970			12,920
Cardiovascular		3,272			3,812			6,763			7,247
Digestive		14,156			15,572			29,067			31,018
Personal care		1,058			1,381			2,110			2,862
Weight management		3,035			4,405			6,361			7,722
		49,000			53,416			99,673			106,553
NSP Russia, Central and Eastern Europe:
General health		$	4,831		$	5,499		$	10,376		$	11,259
Immune		1,500			1,734			3,468			3,835
Cardiovascular		789			1,102			1,727			2,240
Digestive		3,451			4,020			7,398			8,066
Personal care		1,468			1,754			3,336			4,113
Weight management		799			869			1,570			1,605
		12,838			14,978			27,875			31,118
Synergy WorldWide:
General health		$	11,689		$	9,108		$	22,442		$	17,776
Immune		256			416			467			808
Cardiovascular		11,652			9,580			22,096			20,669
Digestive		4,953			3,958			9,970			8,822
Personal care		1,734			1,531			3,470			3,273
Weight management		2,203			688			4,085			1,135
		32,487			25,281			62,530			52,483
		$	94,325		$	93,675		$	190,078		$	190,154

 

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, 2014			December 31, 2013
Property, plant and equipment:
United States		$	35,271		$	25,713
Venezuela		3,016			3,207
Other		2,779			3,102
Total property, plant and equipment		$	41,066		$	32,022

 

(9)                     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, 2014 and 2013, the Company’s provision (benefit) for income taxes, as a percentage of income before income taxes was 40.5 percent and 34.9 percent, respectively, compared with a U.S. federal statutory rate of 35.0 percent. For the six months ended June 30, 2014 and 2013, the Company’s provision (benefit) for income taxes, as a percentage of income before income taxes was (12.2) percent and 34.1 percent, respectively, compared with a U.S. federal statutory rate of 35.0 percent.

 

The difference between the effective tax rate and the U.S. federal statutory tax rate for the three months ended June 30, 2014, was primarily attributed to state taxes and an increase in tax liabilities associated with uncertain tax positions, offset by a favorable domestic manufacturing deduction and net favorable foreign items related to tax rate differences and adjustments to foreign valuation allowances.

 

The difference between the effective tax rate and the U.S. federal statutory tax rate for the three months ended June 30, 2013, was primarily attributed to an increase in tax liabilities associated with uncertain tax positions, in addition to net favorable foreign items related to foreign tax rate differences, the impact of unremitted earnings, and adjustments to foreign valuation allowances.

 

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