In December 2017, the FASB issued ASU No. 2017-12,
Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities
.
The
new standard makes more financial and non-financial hedging strategies eligible for hedge accounting. It also amends the presentation and disclosure requirements and changes how companies assess effectiveness. For public companies, the amendments in this ASU are effective for fiscal years beginning after December 15, 2018, and interim periods within those fiscal years. Early adoption is permitted in any interim period. The adoption of this guidance is not expected to have a material impact on the Company's financial statements.
In April 2017, the Tokyo High Court issued a ruling on a dispute between the Company and the customs authorities in Japan. The High Court affirmed the Tokyo District Court's February 2016 decision upholding previous customs assessments related to the importation of several of the Company's products into Japan during 2010. The Company filed an appeal with the Japan Supreme Court in May 2017. The High Court's April 2017 ruling applied only to imports that occurred during 2010, but in September 2017, the Tokyo High Court issued its ruling regarding imports that occurred in 2006-2009 and 2011, which are the other time periods in the dispute. For both of these time periods, the High Court affirmed the Tokyo District Court's decisions upholding previous customs assessments. In October 2017, the Company filed an appeal with the Japan Supreme Court regarding the Tokyo High Court's September 2017 ruling.
As previously disclosed, the Company already recorded a charge of $31.4 million to cost of sales in the first quarter of 2016, when the District Court issued its decision. This charge represents the full amount being disputed. It was a non-cash item because the Company was previously required to pay the assessments.
In the first quarter of 2016, the Company purchased 70% of Vertical Eden, LLC, an early-stage company in the warehouse growing market, based in Alpine, Utah, for $3.3 million in cash and contingent consideration valued at $1.5 million which resulted in $2.5 million of goodwill. In the second quarter of 2017, the Company purchased the remaining 30% of Vertical Eden for $12.5 million in cash. The purchase of Vertical Eden includes specialized technology in remote programming and management of the entire crop growing cycle. As a result of this acquisition, the Company recorded approximately $4.4 million of intangible assets which are being amortized over the useful lives of 3 to 7 years.
On February 28, 2017, the Company purchased a 35% membership interest in Treviso, LLC, which owns a manufacturing company, for a purchase price of $21.0 million and a possible earnout of $1.0 million. The purchase price included $12.6 million in cash and $8.4 million in the Company's stock (169,560 shares based on the closing stock price of $49.54 per share on February 28, 2017).
ITEM 2.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
This quarterly report on Form 10-Q (this "Quarterly Report") contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, that represent our current expectations and beliefs. All statements other than statements of historical fact are "forward-looking statements" for purposes of federal and state securities laws and include, but are not limited to, statements of management's expectations regarding our performance, initiatives, strategies, product introductions and offerings, growth, opportunities and risks; statements of projections regarding future sales, expenses, operating results, taxes and duties, capital expenditures, sources and uses of cash, foreign currency fluctuations or devaluations, and other financial items; statements of management's expectations and beliefs regarding our markets; statements regarding the payment of future dividends and stock repurchases; statements regarding the outcome of litigation, audits or investigations; accounting estimates and assumptions; statements of belief; and statements of assumptions underlying any of the foregoing. In some cases, you can identify these statements by forward-looking words such as "believe," "expect," "project," "anticipate," "estimate," "intend," "plan," "targets," "likely," "will," "would," "could," "may," "might," the negative of these words and other similar words. We undertake no obligation to publicly update or revise any forward-looking statement, whether as a result of new information, future events or otherwise, except as required by law. We caution and advise readers that these statements are based on assumptions that may not be realized and involve risks and uncertainties that could cause actual results to differ materially from the expectations and beliefs contained herein. For a summary of these risks, see the risk factors included in our Annual Report on Form 10-K for the year ended December 31, 2016 and in our subsequent reports on Form 10-Q.
The following Management's Discussion and Analysis should be read in conjunction with our consolidated financial statements and related notes and Management's Discussion and Analysis included in our Annual Report on Form 10-K for the year ended December 31, 2016, and our other reports filed with the Securities and Exchange Commission through the date of this report.
Overview
Revenue for the three-month period ended September 30, 2017 was $563.7 million, a 7% decrease from the prior-year period, and revenue for the nine-month period ended September 30, 2017 was $1.6 billion, a 4% decrease from the prior-year period. The three- and nine-month periods of the prior year included approximately $56 million and $163 million, respectively, in revenue from limited-time offers of
ageLOC Me
and
ageLOC Youth
in connection with the launch of these products, with no similar limited-time offers occurring during the first nine months of 2017. The limited-time offers in the prior year also drove Sales Leader growth in the prior year, impacting the year-over-year comparison. Sales Leaders decreased 5% and Customers increased 7% compared to the third quarter of 2016. In addition, foreign currency fluctuations negatively impacted revenue 1% in both the three- and nine-month periods ended September 30, 2017 compared to the prior-year periods.
Earnings per share for the third quarter of 2017 were $0.76 compared to $0.98 in the prior-year period. Earnings per share for the first nine months of 2017 were $2.04 compared to $1.85 in the prior-year period, or $2.21 in the prior-year period excluding a non-cash expense of $31.4 million in the first quarter of 2016 associated with the Japan customs ruling that is discussed in Note 15 to the consolidated financial statements contained in this report. Earnings per share excluding Japan customs expense is a non-GAAP financial measure. See "Non-GAAP Financial Measures," below. The earnings per share comparisons in both the three- and nine-month periods reflect the decline in revenue and the fixed nature of certain expenses as revenue declined. The negative impact of these items was partially offset by our having fewer shares outstanding in 2017 due to stock repurchases.
In the fourth quarter of 2017, we began the launch process for our
ageLOC LumiSpa
skin treatment and cleansing device by selling a limited quantity at our global Nu Skin LIVE! event in October 2017. We are continuing the launch process for this product across our markets during the fourth quarter of 2017 and into 2018. During November and December 2017, we are doing Sales Leader previews of this product in our markets. These previews are expected to generate lower revenue than the limited-time offers that we have done with certain product launches in the past; we currently anticipate
LumiSpa
sales will generate approximately $100 million of revenue in the fourth quarter of 2017. Throughout the first half of 2018, we plan to make the product generally available for purchase in our markets.
Segment Results
We report our business in seven segments. The following table sets forth revenue for the three- and nine-month periods ended September 30, 2017 and 2016 for each of our reportable segments (U.S. dollars in thousands):
|
|
Three Months Ended
September 30,
|
|
|
|
|
|
Constant
Currency
Change
(1)
|
|
Nine Months Ended
September 30,
|
|
|
|
|
|
Constant
Currency
Change
(1)
|
|
|
2017
|
|
|
2016
|
|
|
Change
|
|
|
2017
|
|
|
2016
|
|
|
Change
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Mainland China
|
|
$
|
172,556
|
|
|
$
|
168,320
|
|
|
|
3
|
%
|
|
|
3
|
%
|
|
$
|
494,658
|
|
|
$
|
471,319
|
|
|
|
5
|
%
|
|
|
8
|
%
|
South Korea
|
|
|
89,238
|
|
|
|
136,188
|
|
|
|
(34
|
%)
|
|
|
(34
|
%)
|
|
|
258,626
|
|
|
|
315,342
|
|
|
|
(18
|
%)
|
|
|
(20
|
%)
|
Americas
|
|
|
79,214
|
|
|
|
71,250
|
|
|
|
11
|
%
|
|
|
12
|
%
|
|
|
221,968
|
|
|
|
204,882
|
|
|
|
8
|
%
|
|
|
9
|
%
|
South Asia/ Pacific
|
|
|
78,994
|
|
|
|
70,867
|
|
|
|
11
|
%
|
|
|
13
|
%
|
|
|
216,727
|
|
|
|
226,742
|
|
|
|
(4
|
%)
|
|
|
(3
|
%)
|
Japan
|
|
|
62,513
|
|
|
|
72,489
|
|
|
|
(14
|
%)
|
|
|
(7
|
%)
|
|
|
188,465
|
|
|
|
210,429
|
|
|
|
(10
|
%)
|
|
|
(7
|
%)
|
Hong Kong/ Taiwan
|
|
|
41,050
|
|
|
|
48,140
|
|
|
|
(15
|
%)
|
|
|
(16
|
%)
|
|
|
120,069
|
|
|
|
140,568
|
|
|
|
(15
|
%)
|
|
|
(17
|
%)
|
EMEA
|
|
|
40,133
|
|
|
|
36,908
|
|
|
|
9
|
%
|
|
|
3
|
%
|
|
|
112,385
|
|
|
|
107,186
|
|
|
|
5
|
%
|
|
|
4
|
%
|
Total
|
|
$
|
563,698
|
|
|
$
|
604,162
|
|
|
|
(7
|
%)
|
|
|
(6
|
%)
|
|
$
|
1,612,898
|
|
|
$
|
1,676,468
|
|
|
|
(4
|
%)
|
|
|
(3
|
%)
|
|
(1)
|
Constant-currency revenue change is a non-GAAP financial measure. See "Non-GAAP Financial Measures," below.
|
The table below sets forth segment contribution for the three- and nine-month periods ended September 30, 2017 and 2016 for each of our reportable segments (U.S. dollars in thousands). Segment contribution excludes certain intercompany charges, specifically royalties, license fees, transfer pricing and other miscellaneous items. We use segment contribution to measure the portion of profitability that the segment managers have the ability to control for their respective segments. For additional information regarding our segments and the calculation of segment contribution, see Note 6 to the consolidated financial statements contained in this report.
|
|
Three Months Ended
September 30,
|
|
|
Nine Months Ended
September 30,
|
|
|
|
2017
|
|
|
2016
|
|
|
2017
|
|
|
2016
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Mainland China
|
|
$
|
42,375
|
|
|
$
|
38,240
|
|
|
$
|
130,085
|
|
|
$
|
113,250
|
|
South Korea
|
|
|
23,713
|
|
|
|
41,739
|
|
|
|
70,503
|
|
|
|
89,991
|
|
Americas
|
|
|
12,822
|
|
|
|
11,637
|
|
|
|
34,564
|
|
|
|
34,286
|
|
South Asia/Pacific
|
|
|
18,664
|
|
|
|
16,371
|
|
|
|
47,083
|
|
|
|
53,172
|
|
Japan
|
|
|
12,786
|
|
|
|
15,510
|
|
|
|
36,134
|
|
|
|
43,490
|
|
Hong Kong/Taiwan
|
|
|
8,096
|
|
|
|
10,401
|
|
|
|
20,945
|
|
|
|
25,829
|
|
EMEA
|
|
|
2,896
|
|
|
|
3,258
|
|
|
|
8,304
|
|
|
|
6,438
|
|
The following table provides information concerning the number of Customers and Sales Leaders as of September 30, 2017 and 2016. "Customers" are persons who have purchased products directly from the Company during the three months ended as of the date indicated. "Sales Leaders" are independent distributors, and sales employees and independent marketers in China, who achieve certain qualification requirements.
|
|
As of
September 30, 2017
|
|
|
As of
September 30, 2016
|
|
|
% Increase
(Decrease)
|
|
|
Customers
|
|
|
Sales Leaders
|
|
|
Customers
|
|
|
Sales Leaders
|
|
|
Customers
|
|
Sales Leaders
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Mainland China
|
|
|
190,000
|
|
|
|
25,600
|
|
|
|
182,000
|
|
|
|
25,300
|
|
|
|
4
|
%
|
|
|
1
|
%
|
South Korea
|
|
|
185,000
|
|
|
|
8,400
|
|
|
|
198,000
|
|
|
|
11,700
|
|
|
|
(7
|
%)
|
|
|
(28
|
%)
|
Americas
|
|
|
215,000
|
|
|
|
7,200
|
|
|
|
171,000
|
|
|
|
6,700
|
|
|
|
26
|
%
|
|
|
7
|
%
|
South Asia/Pacific
|
|
|
149,000
|
|
|
|
7,900
|
|
|
|
116,000
|
|
|
|
7,200
|
|
|
|
28
|
%
|
|
|
10
|
%
|
Japan
|
|
|
131,000
|
|
|
|
6,500
|
|
|
|
136,000
|
|
|
|
7,000
|
|
|
|
(4
|
%)
|
|
|
(7
|
%)
|
Hong Kong/Taiwan
|
|
|
71,000
|
|
|
|
4,300
|
|
|
|
75,000
|
|
|
|
5,300
|
|
|
|
(5
|
%)
|
|
|
(19
|
%)
|
EMEA
|
|
|
128,000
|
|
|
|
4,300
|
|
|
|
121,000
|
|
|
|
4,100
|
|
|
|
6
|
%
|
|
|
5
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
|
1,069,000
|
|
|
|
64,200
|
|
|
|
999,000
|
|
|
|
67,300
|
|
|
|
7
|
%
|
|
|
(5
|
%)
|
Following is a narrative discussion of our results in each segment, which supplements the tables above.
Mainland China
. Our business's performance in Mainland China continues to be steady, with revenue, Sales Leaders and Customers each increasing on a year-over-year basis. The momentum in this segment reflects favorable responses to our product and sales compensation initiatives and the launch of
ageLOC Me
, which we sold on a limited basis in the segment during March 2017 and made generally available beginning in April 2017. The year-over-year revenue comparisons also reflect approximately $58 million generated by a limited-time offer of
ageLOC Me
during the second quarter of 2016 and an additional $7 million in the third quarter of 2016.
The year-over-year increase in segment contribution for the third quarter of 2017 reflects increased revenue and a 1.7% decrease in selling expenses as a percentage of revenue. The year-over-year increase in segment contribution for the nine-month period ended September 30, 2017 reflects increased revenue and a $6.9 million decrease in general and administrative expenses driven primarily by reductions in labor and depreciation expenses.
South Korea
. The year-over-year decline in revenue in our South Korea segment for the three- and nine-month periods ended September 30, 2017 primarily reflects approximately $49 million of revenue generated by a limited-time offer of a local variation of our
ageLOC Youth
nutritional supplement during the third quarter of 2016. The limited-time offer also drove an increase in Sales Leaders during that quarter. Although our Sales Leaders number in this segment increased slightly from the second quarter to the third quarter of 2017 due to a product promotion, our business in this segment continues to experience difficulties. We believe that Customer acquisition has been strained due to online competitive pressures. We also believe the political and economic environment in South Korea has negatively impacted our performance in this market.
The year-over-year decline in segment contribution for the three- and nine-month periods ended September 30, 2017 primarily reflects decreased revenue, as well as the fixed nature of certain of our general and administrative expenses as revenue decreased. The comparisons additionally reflect the 2016 limited-time offer, which increased gross margin in 2016 and also increased selling expenses in 2016, as more Sales Leaders qualified for higher sales compensation and promotional incentives in connection with the limited-time offer.
Americas
. Our business in this segment continued to improve for both the three- and nine-month periods ended September 30, 2017, largely due to Sales Leader social media sales initiatives. These initiatives drove large year-over-year increases in our revenue, Sales Leaders and Customers in some of our Latin America markets during the third quarter of 2017. These initiatives also drove a large third-quarter year-over-year increase in our Customers in the United States, our largest market in this segment, though this trend may be softening, as our Customer numbers in the United States have begun to flatten on a sequential basis. In addition, revenue in the United States for the third quarter of 2017 grew 3% on a year-over-year basis, compared to 9% year-over-year growth during the second quarter of 2017.
Segment contribution for the third quarter of 2017 increased proportionately with revenue; as a percentage of revenue, segment contribution was 16.3% in the third quarter of 2017 compared to 16.4% in the third quarter of 2016. The dollar amount of segment contribution in the nine-month period ended September 30, 2017 remained even with the prior-year period despite the increase in revenue because general and administrative expenses as a percentage of revenue increased 1.6%. The increase in general and administrative expenses reflects increased labor expenses in the United States, as well as labor, rent and depreciation expenses associated with new facilities that we opened in Argentina and Chile during 2017.
South Asia/Pacific
. The increases in revenue, Sales Leaders and Customers in this segment for the third quarter of 2017 were primarily driven by successful Sales Leader social media sales initiatives. The year-over-year decline in revenue for the first nine months of 2017 reflects a limited-time offer of
ageLOC Youth
during the second quarter of 2016, which generated approximately $35 million in revenue.
The year-over-year increase in segment contribution for the third quarter of 2017 primarily reflects increased revenue, as well as a $2.4 million decrease in general and administrative expenses due to a 2016 sales force convention in the segment. These improvements were partially offset by a 1.9% decline in gross margin due to product mix and a product promotion in 2017, and increased selling expenses related to incentive trips and other promotional incentives. The year-over-year decrease in segment contribution for the nine-month period ended September 30, 2017 reflects decreased revenue and a 2.6% decline in gross margin due to changes in product mix.
As discussed further in Item 1A. Risk Factors—"Challenges to the form of our network marketing system could harm our business," we are currently in discussions with Vietnam authorities regarding an account transfer fee that may be found to violate Vietnam's anti-pyramid laws. Consequences for violating these laws may include monetary penalties and revocation of our license to do business in Vietnam. Our Vietnam subsidiary's revenue represented 0.5% of our 2016 consolidated revenue and 1.0% of our consolidated revenue in the third quarter of 2017.
Japan
. The declines in revenue, Sales Leaders and Customers continued to reflect a soft direct selling market and challenging regulatory environment in Japan. Foreign-currency fluctuations also negatively impacted revenue 7% and 3% for the three- and nine-month periods ended September 30, 2017, respectively, compared to the prior-year periods.
The year-over-year decline in segment contribution for both the three- and nine-month periods ended September 30, 2017 reflects decreased revenue and decreased gross margin.
Hong Kong/Taiwan
. The declines in revenue and Customers in this segment were driven by continued year-over-year declines in Sales Leaders as fewer people were selling our products. Our initiatives have not generated the increases in Sales Leaders that we have targeted in this segment. The year-over-year revenue comparison for the nine-month periods also reflects approximately $14 million generated by a limited-time offer of
ageLOC Me
in the second quarter of 2016 in this segment. On a sequential basis, our business in Hong Kong slightly improved due to a promotion, with revenue, Sales Leaders and Customers each increasing over the second quarter of 2017.
The year-over-year decrease in segment contribution for the third quarter of 2017 primarily reflects decreased revenue. The year-over-year decrease in segment contribution for the nine-month period ended September 30, 2017 reflects decreased revenue and a 2.1% increase in general and administrative expenses as a percentage of revenue due to the fixed nature of certain of our general and administrative expenses as revenue decreased.
EMEA
. The year-over-year growth in revenue, Sales Leaders and Customers in this segment reflects continued success of Sales Leader social media sales initiatives in certain markets of the region. Foreign-currency fluctuations also positively impacted revenue 6% in the third quarter of 2017 compared to the prior-year period.
The year-over-year decrease in segment contribution for the third quarter of 2017 primarily reflects increased general and administrative expenses. The year-over-year increase in segment contribution for the nine-month period ended September 30, 2017 reflects increased revenue and a 1.7% improvement in gross margin due to various factors, including foreign currency fluctuations and decreased duties and customs.
Consolidated Results
Revenue
Revenue for the three-month period ended September 30, 2017 decreased 7% to $563.7 million compared to $604.2 million in the prior-year period. Revenue for the nine-month period ended September 30, 2017 decreased 4% to $1.6 billion compared to $1.7 billion in the prior-year period. For a discussion and analysis of these decreases in revenue, see "Overview" and "Segment Results," above.
Gross profit
Gross profit as a percentage of revenue decreased to 78.6% for the three-month period ended September 30, 2017 compared to 79.2% for the prior-year period. This decrease primarily reflects the decline in revenue and the fixed nature of certain components of cost of sales. Gross profit as a percentage of revenue increased to 78.1% for the nine-month period ended September 30, 2017 compared to 76.6% for prior-year period. This year-over-year increase was primarily driven by the non-cash Japan customs expense of $31.4 million in the first quarter of 2016 that is discussed in Note 15 to the consolidated financial statements contained in this report. Excluding this expense, gross profit as a percentage of revenue for the first nine months of 2016 was 78.5%, consistent with the current year. Gross profit excluding Japan customs expense is a non-GAAP financial measure. See "Non-GAAP Financial Measures," below.
Selling expenses
Selling expenses as a percentage of revenue decreased to 41.7% for the three-month period ended September 30,
2017
compared to
42.3% for the same period in 2016. Selling expenses as a percentage of revenue remained level at 41.7% for the nine-month period ended September 30,
2017
compared to
the same period in 2016.
General and administrative expenses
General and administrative expenses increased to $143.2 million in the third quarter of 2017 compared to $140.7 million in the prior-year period. As a percentage of revenue, general and administrative expenses increased to 25.4% for the third quarter of 2017 compared to 23.3% for the prior-year period, as certain of our general and administrative expenses, such as labor, rent and depreciation, remained relatively fixed while revenue decreased. For the nine-month period ended September 30, 2017, general and administrative expenses decreased to $411.3 compared to $415.0 million in the prior-year period. As a percentage of revenue, this represents a small increase to 25.5% compared to 24.8% for the prior-year period.
In the fourth quarter of 2017, we anticipate that general and administrative expenses will be approximately $10 million higher than in the third quarter of 2017 due to our global Nu Skin LIVE! event, which took place in October 2017.
Other income (expense), net
Other income (expense), net for the third quarter of 2017 was $(1.2 million) of expense compared to $(5.7 million) of expense for the prior-year period. The lower expense primarily reflected a foreign currency gain associated with our foreign operations that offset a portion of our other expenses.
Other income (expense), net for the first nine months of 2017 was $(8.5 million) of expense compared to $(19.6 million) of expense for the prior-year period. The decrease in expense for the nine-month periods reflects a $17.1 million decrease in foreign currency translation expenses, primarily due to an expense of $11.1 million in the second quarter of 2016 that resulted primarily from the strengthening of the Japanese yen against the U.S. dollar and its impact on our Japanese yen-denominated debt and liabilities. The decrease in foreign currency translation expenses was partially offset by a $7.5 million increase in interest expense in 2017 due to the convertible notes that we issued in June 2016.
Provision for income taxes
Provision for income taxes for the three- and nine-month periods ended September 30, 2017 was $21.5 million and $55.7 million, compared to $19.8 million and $45.8 million for the same periods in 2016. The effective tax rate was 34.1% and 33.4%, of pre-tax income during the three- and nine-month periods ended September 30, 2017, respectively, compared to 25.8% and 30.4%, respectively, in the prior-year periods. The increase in effective tax rate for both the three- and nine-month periods primarily reflects a decreased tax rate in the third quarter of 2016 due to the substantial liquidation of our business operations in Venezuela during that quarter, which resulted in the recognition of a previously unrecognized deferred tax asset. The favorable impact of this matter on our effective tax rate for the first nine months of 2016 was partially offset by the impact of the Japan customs expense that was recognized in the first quarter of 2016, which reduced our income before taxes in that quarter, thereby increasing our effective tax rate for that quarter. The year-over-year comparisons for both the three- and nine-month periods also reflect a benefit in 2017 due to the new accounting standard for stock-based compensation, which was not reflected in our 2016 results.
Net income
As a result of the foregoing factors, net income for the third quarter of 2017 was $41.7 million compared to $56.9 million in the prior-year period. Net income for the first nine months of 2017 was $111.2 million, compared to $104.9 million for the first nine months of 2016, or $125.0 million in the first nine months of 2016 excluding Japan customs expense of $31.4 million ($20.1 million, net of tax). Net income excluding Japan customs expense is a non-GAAP financial measure. See "Non-GAAP Financial Measures," below.
Liquidity and Capital Resources
Historically, our principal uses of cash have included operating expenses (particularly selling expenses) and working capital (principally inventory purchases), as well as capital expenditures, stock repurchases, dividends, debt repayment and the development of operations in new markets. We have at times incurred long-term debt to fund strategic transactions and stock repurchases. We typically generate positive cash flow from operations due to favorable margins and have generally relied on cash from operations to fund operating activities. In the first nine months of 2017, we generated $155.8 million in cash from operations compared to generating $185.4 million in cash from operations during the prior-year period. This decrease in cash flow from operations primarily reflects the year-over-year decline in sales, partially offset by the payment in 2016 of a significant amount of items that were accrued as of the end of 2015, particularly commissions based on limited-time offers during December 2015. The Consolidated Statement of Cash Flows for the nine months ended September 30, 2016 contained in this report also includes an adjustment of $31.4 million because the Japan customs expense that is discussed in Note 15 to the financial statements contained in this report was a non-cash item.
Two line items in the Consolidated Statement of Cash Flows for the nine months ended September 30, 2016 contained in this report include amounts that offset each other. As a result of the previously disclosed February 2016 settlement of our putative securities class action consolidated lawsuit, the Prepaid expenses and other line item includes a negative adjustment of $47 million due to the recording of a short-term receivable from our insurers, and the Accrued expenses line item includes a positive adjustment of $47 million due to the recording of a short-term liability representing the agreed-upon settlement amount. For further information, see Note 16 to the consolidated financial statements contained in our Quarterly Report on Form 10-Q for the third quarter of 2016.
As of September 30, 2017, working capital was $329.4 million, compared to $315.3 million as of December 31, 2016. Cash and cash equivalents, including current investments, as of September 30, 2017 and December 31, 2016 were $371.8 million and $368.1 million, respectively.
Capital expenditures in the first nine months of 2017 were $39.0 million, and we anticipate additional capital expenditures of approximately $20 million for the remainder of 2017. Our 2017 capital expenditures are primarily related to:
•
the expansion and upgrade of facilities in our various markets; and
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•
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purchases and expenditures for computer systems and equipment, software, and application development.
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In June 2016, we issued $210.0 million principal amount of convertible 4.75% senior notes, due 2020 (the "Convertible Notes") to Ping An ZQ China Growth Opportunity Limited ("Ping An ZQ") at face value. Net proceeds on the issuance of the Convertible Notes were $203 million. We used the proceeds for repurchasing common stock throughout the remainder of 2016. The Convertible Notes are senior unsecured obligations of the Company and rank equal in right of payment to all senior unsecured indebtedness of the Company. Interest on the Convertible Notes is payable semiannually in cash on June 15 and December 15, and the Convertible Notes mature on June 15, 2020, subject to earlier conversion. Although the stated interest rate on the Convertible Notes is 4.75%, interest on this debt is expensed on our income statement at a rate of approximately 7.1%, reflecting the amortization of a debt discount resulting from approximately $6.3 million in issuance costs and approximately $10.9 million of the principal amount that is allocated to equity due to the conversion option. As of December 2016, the Convertible Notes became convertible at the holder's discretion at a conversion rate of 21.5054 per $1,000 principal amount of Convertible Notes (which represents an initial conversion price of $46.50 per share), in each case subject to customary anti-dilution adjustments. Throughout the term of the Convertible Notes, the conversion rate may be adjusted upon the occurrence of certain specified events. Upon conversion, we intend to settle the Convertible Notes in cash with respect to the principal amount of Convertible Notes converted and any accrued and unpaid interest to such date, and in shares of our common stock with respect to any additional amounts.
Upon a change in control of the Company (as defined in the indenture governing the Convertible Notes) or the failure of our common stock to be listed on certain stock exchanges, the holders of the Convertible Notes may require that we repurchase all or part of the principal amount of the Convertible Notes at a purchase price equal to 108% of the principal amount plus accrued and unpaid interest. In addition, we may redeem all or part of the principal amount of the Convertible Notes, at our option, at a purchase price equal to the principal amount plus accrued and unpaid interest, provided that the closing trading price of our common stock exceeds 180% of the then-current conversion price for 20 or more trading days in the 30 consecutive trading day period preceding our exercise of this redemption right (including the last three such trading days). The Convertible Notes are subject to customary events of default, which may result in the acceleration of the maturity of the Convertible Notes.
Our Credit Agreement (the "Credit Agreement") with various financial institutions, and Bank of America, N.A. as administrative agent, provides for a $127.5 million term loan facility, a 6.6 billion Japanese yen term loan facility and a $187.5 million revolving credit facility, each with a term of five years ending in October 2019. The Credit Agreement requires that we maintain a consolidated leverage ratio not exceeding 2.25 to 1.00 and a consolidated interest coverage ratio of no less than 3.00 to 1.00. As of September 30, 2017, we had debt pursuant to the Credit Agreement of $216.7 million. See Note 12 to the consolidated financial statements contained in this report for further information regarding the Credit Agreement and other debt.
Our board of directors has approved a stock repurchase plan authorizing us to repurchase up to $500 million of our outstanding shares of Class A common stock on the open market or in private transactions. The repurchases are used primarily for strategic initiatives and to offset dilution from our equity incentive plans and from conversion of the Convertible Notes. During the first nine months of 2017, we repurchased approximately 0.8 million shares of Class A common stock under this plan for $47.8 million. At September 30, 2017, $151.9 million was available for repurchases under the stock repurchase plan.
In February, May and August 2017, our board of directors declared a quarterly cash dividend of $0.36 per share. These quarterly cash dividends of $19.0 million, $19.1 and $19.0 million were paid March 15, 2017, June 14, 2017 and September 13, 2017 to stockholders of record on February 27, 2017, May 26, 2017 and August 25, 2017. In October 2017, our board of directors declared a quarterly cash dividend of $0.36 per share to be paid on December 6, 2017 to stockholders of record on November 17, 2017.
Currently, we anticipate that our board of directors will continue to declare quarterly cash dividends and that the cash flows from operations will be sufficient to fund our future dividend payments. However, the continued declaration of dividends is subject to the discretion of our board of directors and will depend upon various factors, including our net earnings, financial condition, cash requirements, future prospects and other relevant factors.
As of September 30, 2017 and December 31, 2016, we held $371.8 million and $368.1 million, respectively, in cash and cash equivalents, including current investments. These amounts include $311.2 million and $283.5 million as of September 30, 2017 and December 31, 2016, respectively, held in our operations outside of the U.S. Substantially all of our non-U.S. cash and cash equivalents are readily convertible into U.S. dollars or other currencies, subject to procedural or other requirements in certain countries as described below.
We typically fund the cash requirements of our operations in the U.S. through intercompany dividends and intercompany charges for products, use of intangible property, and corporate services. Some markets impose government-approval or other requirements for the repatriation of dividends. For example, in Mainland China, we are unable to repatriate cash from current operations in the form of dividends until we file the necessary statutory financial statements for the relevant period. As of September 30, 2017, we had $110.8 million in cash denominated in Chinese RMB. We also have intercompany loan arrangements with some of our markets, including Mainland China, that allow us to access available cash. However, in recent months, the Chinese government has placed limits on the permitted amount of intercompany lending, which has slowed our ability to access cash in that market. We currently plan to repatriate undistributed earnings from our non-U.S. operations as necessary, considering the cash needs of our non-U.S. operations and the cash needs of our U.S. operations for dividends, stock repurchases, capital investments, debt repayment and strategic transactions. Except for partial indefinite reinvestment in two jurisdictions, we have not designated our investments as indefinitely reinvested, but rather have these funds available for our operations in the U.S. as needed. Any repatriation of non-U.S. earnings requires payment of U.S. taxes in accordance with applicable U.S. tax rules and regulations. Accordingly, we have accrued the necessary U.S. taxes related to the funds that are not indefinitely reinvested.
We currently believe that existing cash balances, future cash flows from operations and existing lines of credit will be adequate to fund our cash needs on both a short- and long-term basis. The majority of our historical expenses have been variable in nature, and as such, a potential reduction in the level of revenue would reduce our cash flow needs. In the event that our current cash balances, future cash flow from operations and current lines of credit are not sufficient to meet our obligations or strategic needs, we would consider raising additional funds in the debt or equity markets or restructuring our current debt obligations. Additionally, we would consider realigning our strategic plans, including a reduction in capital spending, stock repurchases or dividend payments.
Contingent Liabilities
Please refer to Note 11 to the consolidated financial statements contained in this report for information regarding our contingent liabilities.
Critical Accounting Policies
There were no significant changes in our critical accounting policies during the quarter ended September 30, 2017.
Seasonality and Cyclicality
In addition to general economic factors, we are impacted by seasonal factors and trends such as major cultural events and vacation patterns. For example, most Asian markets celebrate their respective local New Year in the first quarter, which generally has a negative impact on that quarter. We believe that direct selling is also generally negatively impacted during the third quarter, when many individuals, including our sales force, traditionally take vacations.
Prior to making a product generally available for purchase in a market, we typically do a promotional offering of the product, such as a preview of the product to our key Sales Leaders in the market, a limited-time offer, or other type of promotion. Sales Leader previews, limited-time offers and other promotions may generate significant activity and a high level of purchasing, which can result in a higher-than-normal increase in revenue during the quarter and can skew year-over-year and sequential comparisons.
Currency Risk and Exchange Rate Information
A majority of our revenue and many of our expenses are recognized outside of the United States, except for inventory purchases, a significant portion of which are primarily transacted in U.S. dollars from vendors in the United States. The local currency of each of our Subsidiaries' primary markets is considered the functional currency with the exception of our Asia product-distribution subsidiary in Singapore. All revenue and expenses are translated at weighted-average exchange rates for the periods reported. Therefore, our reported revenue and earnings will be positively impacted by a weakening of the U.S. dollar and will be negatively impacted by a strengthening of the U.S. dollar. Given the large portion of our business derived from outside of the United States, any strengthening of the U.S. dollar negatively impacts reported revenue and profits, whereas a weakening of the U.S. dollar positively impacts our reported revenue and profits. Given the uncertainty of exchange rate fluctuations, it is difficult to predict the effect of these fluctuations on our future business, product pricing and results of operations or financial condition. During 2015 and 2016, the strengthening of the U.S. dollar against other currencies significantly impacted our financial results.
Additionally, we may seek to reduce our exposure to fluctuations in foreign currency exchange rates through the use of foreign currency exchange contracts and through intercompany loans of foreign currency. We do not use derivative financial instruments for trading or speculative purposes. We regularly monitor our foreign currency risks and periodically take measures to reduce the impact of foreign exchange fluctuations on our operating results. As of September 30, 2017, we did not hold any non-designated mark-to-market forward derivative contracts to hedge foreign-currency-denominated intercompany positions or third-party foreign debt. As of September 30, 2016 we held non-designated mark-to-market forward derivative contracts to hedge foreign-currency-denominated intercompany positions or third-party foreign debt with notional amounts of 11.5 billion South Korean won ($10.4 million), 300 million Japanese yen ($3.0 million). Gains and losses related to non-designated derivative contracts are recorded as part of Other Income (Expense). In addition, as of September 30, 2017, we held forward contracts designated as foreign currency cash flow hedges with notional amounts totaling approximately 1.4 billion Japanese yen ($12.4 million) to hedge forecasted foreign-currency-denominated intercompany transactions, compared to 2.3 billion Japanese yen and 6.0 million euros ($22.7 million and $6.7 million, respectively) as of September 30, 2016. Because of our foreign exchange contracts at September 30, 2017, the impact of a 10% appreciation or 10% depreciation of the U.S. dollar against the Japanese yen would not represent a material potential loss in fair value, earnings or cash flows against these contracts. This potential loss does not consider the underlying foreign currency transaction or translation exposures to which we are subject.
Non-GAAP Financial Measures
Regulation G, Conditions for Use of Non-GAAP Financial Measures, and other SEC regulations define and prescribe the conditions for use of certain non-GAAP financial information. Earnings per share, gross margin and net income, each excluding the Japan customs expense, and constant-currency revenue change are non-GAAP financial measures. Management believes that the non-GAAP financial measures assist management and investors in evaluating, and comparing from period to period, results from ongoing operations in a more meaningful and consistent manner while also highlighting more meaningful trends in the results of operations. These measures are used in addition to and in conjunction with results presented in accordance with GAAP and should not be relied upon to the exclusion of GAAP financial measures.
Constant-currency revenue change is calculated by translating the current period's revenue at the same average exchange rates in effect during the applicable prior-year period and then comparing this amount to the prior-year period's revenue.
The following is a reconciliation of gross profit, as reported, to gross profit excluding Japan customs expense for the nine months ended September 30, 2017 and 2016 (U.S. dollars in thousands):
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Nine Months Ended
September 30,
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|
|
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2017
|
|
|
2016
|
|
|
|
|
|
|
|
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Revenue
|
|
$
|
1,612,898
|
|
|
$
|
1,676,468
|
|
|
|
|
|
|
|
|
|
|
Gross profit
|
|
$
|
1,259,279
|
|
|
$
|
1,284,531
|
|
Japan customs expense
|
|
|
—
|
|
|
|
31,355
|
|
Gross profit, excluding Japan customs expense
|
|
$
|
1,259,279
|
|
|
$
|
1,315,886
|
|
|
|
|
|
|
|
|
|
|
Gross profit as a % of revenue
|
|
|
78.1
|
%
|
|
|
76.6
|
%
|
|
|
|
|
|
|
|
|
|
Gross profit, excluding Japan customs expense, as a % of revenue
|
|
|
78.1
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%
|
|
|
78.5
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%
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The following is a reconciliation of net income and diluted earnings per share, as reported, to net income and diluted earnings per share excluding Japan customs expense for the nine months ended September 30, 2017 and 2016 (U.S. dollars in thousands, except per share amounts):
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|
Nine Months Ended
September 30,
|
|
|
|
2017
|
|
|
2016
|
|
|
|
|
|
|
|
|
Net income
|
|
$
|
111,202
|
|
|
$
|
104,901
|
|
Japan customs expense
|
|
|
—
|
|
|
|
31,355
|
|
Tax effect of Japan customs expense
|
|
|
—
|
|
|
|
(11,257
|
)
|
Net income, excluding Japan customs expense
|
|
$
|
111,202
|
|
|
$
|
124,999
|
|
|
|
|
|
|
|
|
|
|
Diluted earnings per share
|
|
$
|
2.04
|
|
|
$
|
1.85
|
|
|
|
|
|
|
|
|
|
|
Diluted earnings per share, excluding Japan customs expense
|
|
$
|
2.04
|
|
|
$
|
2.21
|
|
|
|
|
|
|
|
|
|
|
Diluted weighted-average common shares outstanding (000s)
|
|
|
54,519
|
|
|
|
56,586
|
|
Available Information
Our website address is www.nuskinenterprises.com. We make available free of charge on the Investor Relations portion of our website, ir.nuskin.com, our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 as soon as reasonably practicable after we electronically file such material with, or furnish it to, the Securities and Exchange Commission.
We also use the Investor Relations portion of our website, ir.nuskin.com, as a channel of distribution of additional Company information that may be deemed material. Accordingly, investors should monitor this channel, in addition to following our press releases, Securities and Exchange Commission filings and public conference calls and webcasts. The contents of our website shall not be deemed to be incorporated herein by reference.