Natures Sunshine Products Inc Q3 FY2020 Earnings Call

Good afternoon everyone and thank you for participating in today's conference call to discuss Nature's Sunshine Financial Results for the Third Quarter Ended September 30th, 2020. Joining us today are Nature's Sunshine CEO, Terrence Moorehead; CFO, Joseph Baty; and Executive Vice President and General Counsel, Nathan Brower. Following their remarks, we'll open the call for your questions. Before we go further, I would like to turn the call over to Mr. Brower as he reads the company's Safe Harbor statement within the meaning of the Private Securities Litigation Reform Act of 1995 that provides important cautions regarding forward-looking statements.

Thank you. Good afternoon and thanks to all of you for joining our conference call to discuss our third quarter 2020 financial results. I'd like to remind everyone that this call is available for replay via telephonic dial-in through November 24th and via our live webcast that will be posted in the Investor Relations portion of our website at naturessunshine.com. The information on this call may contain certain forward-looking statements. These statements are often characterized by terminologies such as believe, hope, may, anticipate, expect, will, and other similar expressions. Forward-looking statements are not guarantees of future performance. And the actual results may be materially different from the results implied by forward-looking statements. Factors that could cause results to differ materially from those implied herein include but are not limited to, those factors disclosed in the company's interim report on Form 10-K under the caption, Risk Factors, and other reports filed with the Securities and Exchange Commission. The information on this call speaks only as of today's date, and the company disclaims any duty to update the information provided herein. Now, I'd like to turn the call over to the CEO of Nature's Sunshine, Terrence Moorehead.

Thank you, Nate, and good afternoon, everyone, and thank you for joining today's call. I hope you're all well and staying safe as we continue to deal with the ongoing challenges of COVID-19. I'm very pleased to be here with you today to discuss our record-breaking third quarter results and the excellent progress we've made transforming our business. That's an exciting initiative that we'll be launching in the coming days and months. With me today is our Chief Financial Officer, Joe Baty, who will walk you through our financials in greater detail, but I'm going to kick things off with a brief overview of the business. Before I begin my formal remarks, I want to take a moment to put our historical third quarter results in perspective since 2020 has been such an extraordinary year. While the effects of COVID-19 have forced people to adapt and rethink their priorities, our team has continued to successfully transform the business, keeping spirits high while staying focused on implementing our strategies, achieving our objectives, and delivering improved results. At a time when you hear so many people talking about COVID, our team has worked tirelessly to ensure our transformation initiatives continue to move forward without disruption. Of course, our incredible practitioners and retailers have really made a difference as they continue to partner with us on transforming the business.

Thanks, Terrence, and good afternoon, everyone. Net sales in the third quarter increased 13% to a company record of $100.3 million, compared to $88.5 million in the same quarter last year. This increase was primarily driven by new product development, the easing of COVID restrictions across our several key markets, and continued execution on our business transformation plans. Net sales in Asia increased 12% on a currency basis to $38.1 million, compared to $33.7 million in the year-ago quarter. The increase was primarily attributable to new brand and product launches as well as the reopening of our Korean market. On a local currency basis, net sales in China increased 27%. Japan sales increased 22%, and in South Korea sales increased 9%, as these markets continue to benefit from lifted lockdown restrictions and recalibrated incentive structures. Net sales in Europe increased 21% year-over-year in local currency to $18 million, compared to $14.6 million in the year-ago quarter. The increase reflects strong growth in Central and Eastern Europe, including the continued strong performance in Russia and Poland. North American net sales increased 10% on a local currency basis to $37.6 million compared to $34.2 million in the year-ago quarter. The various strategic and e-commerce enhancements we have implemented have positioned us well, as we continue to capitalize on the strong demand resurgence within the U.S. market. Our growth in this region is also supported by increased new customer acquisition. Net sales in Latin America and other regions increased 14% in local currency to $6.6 million compared to $6 million in the year-ago quarter, with the increase primarily due to new product launches and the easing of COVID-related restrictions. Gross margin was 72.7%, compared to 74.3% in the prior year. The decline was primarily due to certain isolated inventory charges, higher material costs, and a delay in the planning of price increases in North America. Volume incentives as a percentage of net sales increased 50 basis points to 34.2%, compared to 33.7% in the same period last year. Selling, general, and administrative expenses were $33.3 million, compared to $31.2 million in the prior year. The increase was primarily attributable to higher expenses related to our business model relaunch. As a percentage of net sales, SG&A expenses were 33.2%, compared to 35.2% in the same period in 2019. Excluding the impact of $23 million of restructuring expenses in the prior year and $21 million this year, SG&A expenses were 33.1% of net sales, compared to 34.8% in the prior year period. Operating income was $5.5 million or 5.5% of net sales, compared to operating income of $4.7 million or 5.3% of net sales in the prior year period. Excluding restructuring-related expenses, we generated $5.6 million of operating income or 5.6% of net sales for the current quarter, compared to $5.1 million or 5.8% of sales in the prior year period. Adjusted EBITDA is defined in our press release as net income from continuing operations before income taxes, depreciation, amortization, and other income or loss adjusted to exclude share-based compensation and certain noted adjustments increased 13% to $9.4 million in the third quarter of 2020 as compared to $8.3 million in the third quarter of 2019. Overall, the increase in EBITDA is driven by the aforementioned record net sales this quarter flowing through to the bottom line. Net income attributable to common shareholders for the quarter was $6.9 million, or $0.34 per diluted share, as compared to $1.3 million or $0.07 per diluted share in the year-ago period. Turning to liquidity, we had cash and cash equivalents on September 30 of $82.3 million and $5.4 million of debt. For the first nine months of 2020, we generated $26.8 million of cash from operations, as compared to using $5.5 million in the comparable prior year period. The increase is primarily due to the significant improvement in net income and the tightening of both working capital-related adjustments and certain capital expenditures. While we expect to continue our strength into the fourth quarter, our investments in the next stages of our business transformation may increase your costs and profitability relative to this quarter. Further, we are closely monitoring any resurgence of COVID-19 cases across our geographies that may affect operations, especially in certain international markets where reopening statuses have fluctuated. Despite these uncertainties, we are confident in our ability to continue executing on five global growth strategies and believe we will continue to drive solid results through the remainder of 2020 and into the beginning of 2021. Before opening questions, I wanted to reiterate our pride in our team's strong performance and in the momentum built throughout the year. Now, I will turn it back over to the operator for Q&A.

Thank you. We’ll take our first question from Steven Martin with Slater. Please go ahead.

Hi, guys.

Hi, Steve, how are you doing?

Good, good guys. Hope everyone's safe out there.

Yeah, absolutely. You too. Good to hear from you.

You've been great over the last couple of years on the margins and the costs. This was the first quarter where the gross margin and the volume incentive slipped a little. Should we expect that these are new levels of gross margin and volume incentives? Or what should we expect them to be in the future?

Yeah. We saw some pressure on gross margins from cost increases as a result of sourcing within the COVID environment. But, Joe, do you want to talk about some additional factors as well, and what to expect going forward?

Yeah. I mean, I would look at it more as a near-term situation, Steve. While we can certainly see a little sensitivity or fluctuation on both gross margin and volume incentive basis in an individual quarter, from a longer-term perspective, I would say that the nine-month year-to-date margins are more in line with what we expect. In fact, even from a longer-term standpoint, we expect our gross margin to improve.

Yeah.

I would have expected with volume increases, with having the first double-digit up quarter that you might see some of that reflected in the gross margin.

Go ahead.

No, I think you said it well, Joe. This is just a temporary flex short-term. But we do have pretty aggressive long-term plans and expectations to improve those margins. Okay. And the question I ask you guys every quarter, what about any turnaround at the top line and cost containment?

I'll take the top line. It's still listed up. As I mentioned, in September, we just launched the bulk of our business model components. We'll continue to refine and fine-tune those in an effort to ensure that they work for all the various constituents out there. We still have a number of things that we haven't even really launched yet that are up on deck to stick with our baseball analogy here. So, we're still early innings with respect to revenue growth. And then on operating growth, Joe, you want to add some comments?

Yes. As we noted last time, Steve, I appreciate the question, and please continue to ask it, because it's something that we monitor. I believe we're very much on top of it, and we do believe we're in the back half of the ballgame. I'm not going to say we're in the necessarily synthetic stretch yet at least long-term. But as far as the similar near-term initiatives and what we're looking to accomplish, some of the organizational restructuring, I would say we're doing well.

So, does that translate to a lot of the SG&A costs we see going forward will imply the function of the leverage, if the top line grows double-digit?

Yes, it'll certainly come into play there. One of the things internally we need to evaluate especially given this pandemic situation, in which I'm not sure anyone has a clear line of sight on when it's going to end. One of the things we'll have to take a pretty hard look at is post-pandemic, whenever that may be, to what extent do we make certain investments in the business, whether it's an expansion of events, conventions, travel-related costs, and so forth. Because for the time being, or in 2020, we can't deny that we've benefited to some degree from the reduction of some of those types of activities on the SG&A side. Overall, a 13% top-line growth with a reduction in events and conventions is pretty impressive.

All right. What about your hemp CBD product line? What can you tell us?

Yes, so for hemp, we have just launched a couple of new products and we will be marketing the product line much more aggressively in the months to come. There are some things that I probably can't talk about yet because we haven't implemented them. But if you've gone online, you'll see that we've completely re-engineered and redesigned the website. We're going to continue to aggressively promote the line. There's some work still to be done, to make sure that our pricing is competitive and to ensure that the awareness and all the marketing programs are as powerful as necessary. But again, we've got the best CBD in the marketplace. Our products offer better performance, better quality, and better transparency, which is a very powerful sales message. So now I think that we've got the website in a better position, we'll tighten up our pricing and promotional activity. Soon, we'll follow up with a much more aggressive digital activation to help increase awareness and build traction. We're still really in the early days of hemp, I will say this, the increased focus on immune products in the marketplace overall has shifted people's short-term focus away from CBD, you might have seen that, and we're seeing that in kind of an overall market result. So we're still talking about 30%, 40%, 50% growth. The opportunity is there, and we're still very, very bullish on hemp.

All right? Now, I'm going to – this is also a comment we go through every quarter, and I'm going to address this to your Board of Directors.

Very good.

It's time to do your job. Okay, you've got $80 million of cash, you have 20 million shares. Your stock has gone nowhere for a couple of years, despite the good work of the current management. If your Board's not prepared to do the right thing, then maybe somebody has to come in from the outside.

So as I mentioned, the Board is looking at the full range of opportunities. Right now, we are really focused on investing in the business and protecting our position. As you know, we've got one manufacturing location that services 80% of our production around the world. So having cash on hand is really important to us right now because the Board is very focused on the issue.

So that's all I can say is, given the improvement in EBITDA with the cash on hand, you're trading at about three and a half times EBITDA. There's probably no investment you can make that has that kind of rate of return. And I am really going to be disappointed, and I'm not going to be quite as peaceful if we go through another quarter and I hear the same language about the Board exploring everything all the time.

Sure, sure. Also, right now, we're just about keeping the business moving forward and continuing to make tremendous strides on the top and bottom line.

Well, I understand, but that's why I address these comments to the Board of Directors who may or may not be on this call because I think you guys have done the job you were brought in to do, and they have not done the job of a Board that understands its fiduciary responsibility to its shareholders.

Sure. Okay.

Thank you. Yeah. Appreciate the call. Take care. Stay safe.

And we’ll take our next question from Durian Hofmann with Global Corp.

Hi, good day. Thanks for taking the questions and congratulations on the very good quarter, of course. Maybe, yeah, first just expanding on the condition question, especially if you just thinking about potential like expansions or refurbishments, and is like, in addition – well mechanization of the factory in China, one of the considerations there?

We actually do have a relatively small facility in China right now that’s providing some good production and making good progress. We will be making some adjustments to expand that, as well as expanding some of our R&D capabilities out in the region.

Okay. And are inorganic investments playing into your considerations at all as well?

I'm sorry, could you repeat your question? I couldn't hear you.

Inorganic investments, are they part of the considerations too?

I would say that the Board is considering the full range of options. We don't talk about anything that's outside of the normal scope of our business right now. Most of our focus is on building our internal capabilities, particularly our digital capabilities, as well as helping to migrate our business from being solely channel-focused to being much more consumer-focused and lifecycle-focused. This really means we need to get much better and much stronger at things like personalization. So there's a fair amount of investments we want to make that we believe will dramatically improve our competitiveness and also transform the complexion of our business, distancing ourselves from the competition, creating new competitive advantages. Those are a couple of areas that we're looking at internally. Anything the Board of Directors might be considering would be out of balance for me to talk about in this form and at this juncture.

Can you share your experience with the recent in-person sales events in Asia? Specifically, I'm interested in insights on the global customer experience, including attendance levels and preferences.

Yeah, they actually split the event up. They focused on one particular group in the Shanghai area. I think attendance was a little bit higher than in the past. We also had people beaming in remotely, so you got this mix of folks who were there on the ground and people connecting in, but there was a lot of tremendous energy, and people felt great being together. They managed to do it safely, and everyone is okay, which is equally as important.

Okay. Great. Thanks very much.

Absolutely. Thank you. Thank you, Durian.

We’ll take our next question from Nick Monroe with PRSPCTV Capital.

Hi. Congrats on the quarter. Just a quick question. You mentioned new customers in North America with digital media advertising. Do you have any comments on the cost of acquisition of those customers and if they're coming back and buying more products?

Hey, Nick. Could you speak up just a little bit? We're having a little problem hearing you from our end.

Yeah, sorry. So you mentioned new customers in North America. Can you talk about the cost of acquisition for those customers? Is that increasing or decreasing on a percentage basis? And then the retention, are they coming back and buying more than one order?

Yeah, absolutely. So right now, the customer growth that we're seeing is really through organic on-the-ground activity. It was not through any of our digital activation or digital investments; that has not started yet. It really is simply through repositioning the business, talking about things differently, and changing our messaging and our website. From that standpoint, obviously customers are free. But we were not making incremental investments at this point in time to drive those customers. They're being driven by our practitioners and retailers partnering with us, along with whatever work we were doing on the rebranding and product launches, etc. So, I think that answers your question. In the future, we will have more specific investments that we're looking to do as we build out our digital campaigns, but for now, it’s designed to acquire new customers. With respect to retention, we're still just in the first month or so of the process. Obviously, as we build out our subscribe-and-drive capabilities, our expectation is we'll be building more people who are staying with us on an ongoing basis. And by the way, it's the only way they're going to get the therapeutic results from our products or any products, if they continue to take them. It's like signing up for a gym membership; you can't just do that for the first week in January, you have to keep going. So subscribe-and-drive is the way to go, and we've tried to make it as easy and as attractive as possible. I'd say give us some time on that, as it's going to take time for people to understand it and engage with it so we can get enough critical mass, because it’s not necessarily something we expect everybody to click on the first time through.

Great. Thanks, guys.

Thanks, Nick.

At this time, it concludes our question-and-answer session. I would now like to turn the call back over to Mr. Moorehead for closing remarks.

Okay. Thank you. Again, I want to thank everybody for listening to today's call. We have a lot going on, and we look forward to speaking to you again next quarter and to continue on the path to transform our business and build momentum. So again, thank you for your participation. Thanks for your support, and we look forward to talking to you soon. Take care.

Thank you.

Ladies and gentlemen, this does conclude today's teleconference. You may disconnect your lines at this time. Thank you for your participation.