Earnings Call Transcript - NATR Q1 2020

Nate Brower, General Counsel

Good afternoon. Thanks to all of you for joining our conference call to discuss our first quarter 2020 financial results. This call is available for replay in a live webcast that will be posted on our website at www.naturessunshine.com in our Investors section. The information on this call may contain certain forward-looking statements. These statements are often characterized by terminology 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 annual 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.

Terrence Moorehead, CEO

Thank you, Nate. Good afternoon, everyone, and thank you for joining today's call. I hope you are all well and staying safe and healthy as we adjust to the unique conditions under which we are currently living. It's been an extraordinary start to 2020 as the effects of the COVID-19 pandemic continue to impact communities around the world and present business leaders with historic challenges and unprecedented change. As such, I want to take this opportunity to thank you for your continued support of our company in our efforts to transform the business for the future. I would also like to take a moment to recognize our health care workers, our first responders, state and local officials, and the countless number of people who work to keep our communities safe and functioning, and to thank them for their dedication and support. Their collective efforts provide strength and hope when we need it most. I would also like to recognize and thank my team at Nature's Sunshine. Amidst the stress and uncertainty, the team continues to stay focused and has remained in good spirits despite the crisis, quickly adapting to our new reality, cognizant of the fact that people are counting on them to provide the products they need, want, and trust. As we work from home and practice social distancing, we've worked tirelessly to ensure our transformation initiatives continue to move forward without disruption. Our people are dealing with the rapidly evolving situation and working together to overcome each of the near-term obstacles as they arise. Importantly, everyone in the company is dedicated to keeping our people safe while combining forces to keep our company strong. The COVID-19 pandemic has clearly been disruptive to our people's lives, but I'm incredibly proud of our team for their resilience, determination, flexibility, and compassion for the people in our community. I'm especially grateful to our shipping and manufacturing teams that have been coming to work every single day throughout the crisis to keep our facilities fully operational and on top of the increasing demand for our products. Their courage, dedication, and love for our company is an inspiration to us all. With that in mind, when the crisis began, our first and primary goal was and continues to be the health and safety of our employees, distributors, partners, and customers. We immediately implemented a series of protective measures to safeguard our people, including deep cleaning at all of our facilities, daily temperature scans at the beginning of each shift, training on proper hand washing and good hygiene, isolating work groups, and either restricting or closing certain common areas, providing hand sanitizing stations throughout our buildings, and requiring the use of masks for all associates and protective gloves for associates dealing with products. We also made sure to educate our team and strictly follow all CDC guidelines related to social distancing and personal hygiene to ensure our teams can effectively and safely continue working.

Joseph Baty, CFO

Thanks, Terrence, and good afternoon, everyone. Net sales in the first quarter of 2020 were $95.9 million compared to $91.3 million in the same quarter last year. On a local currency basis, net sales increased 6.6% year-over-year. Unfavorable foreign currency exchange rate fluctuations impacted net sales by approximately $1.4 million compared to the prior year. Net sales in Asia declined 7.9% year-over-year to $31 million during the first quarter, but decreased 4.6% in local currencies. As Terrence mentioned and discussed on our fourth quarter call, we anticipated the first quarter decline in Asia, primarily as a result of the COVID-19 pandemic. On a local currency basis, net sales in China declined 8.5%, declined 2.9% in Japan, and declined 6.5% in South Korea. Future results may continue to be negatively impacted by the pandemic and fluctuating foreign currency rates. Net sales in Europe increased 32.2% year-over-year to $20.6 million or 33.5% growth in local currencies. The increase in net sales reflects growth in Central and Eastern Europe, including strong performance in Russia. While first quarter results were not significantly impacted by the pandemic or oil pricing volatility, future quarters could be. North America net sales increased 6.1% on a reported basis, and 6.2% in local currency to $38.8 million. The growth in North America reversed quarterly declines over the last couple of years, reflecting strong sales trends in March, primarily related to immunity support product demand resulting from the COVID-19 pandemic and improving underlying trends resulting from strategic initiatives enacted over the last year. As Terrence referenced, we experienced some softening of demand in April. Net sales for Latin America and Other increased 0.5% year-over-year to $5.6 million, or a 2.4% increase on a local currency basis. Due to the substantial shutdown of certain Latin America markets, future results could be impacted. Gross margin was 74.3%, flat when compared to the prior year. Volume incentives as a percentage of net sales were 34.4% compared to 34% in the same period last year. The increase was driven by changes in market mix, including a lower mix of China revenue. Selling, general, and administrative expenses were $31.1 million, down from $33.9 million in the prior year. The decrease in SG&A is primarily due to savings from restructuring activities over the last year. As a percentage of net sales, SG&A expenses were 32.4% compared to 37.1% in the same period in 2019. Excluding the impact of $1.6 million of restructuring expenses in the prior year and $0.5 million VAT-related income this year, SG&A expenses declined to 32.9% of net sales from 35.4% in the prior year period. We reported operating income of $7.2 million or 7.5% of net sales compared to operating income of $3 million or 3.3% of net sales in the prior year period. Excluding the previously mentioned unusual items relating to restructuring and VAT-related income, among others, we generated $6.7 million of operating income or 6.9% of net sales for the current quarter compared to $4.6 million or 5% of sales in the prior year period. Adjusted EBITDA, as 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, was $9.7 million in the first quarter of 2020 as compared to $7.3 million in the first quarter of 2019. Net income attributable to common shareholders for the quarter was $2.9 million or $0.15 per diluted share as compared to $1.8 million or $0.09 per diluted share in the year-ago period. Adjusted net income attributable to common shareholders was $2.5 million or $0.12 per common share compared to $2.7 million or $0.14 per common share in the prior year period. A reconciliation of adjusted net income to GAAP net income is provided in today's press release. Turning to liquidity. We had cash and cash equivalents on March 31 of $64.1 million with no long-term debt. During the first quarter, we generated $13.5 million of cash from operations as compared to using cash of $3.9 million in the comparable prior year period. The change in cash from operating activities on a year-over-year basis primarily reflected growth in net sales and profit dollars, changes in working capital, specifically a reduction in accounts receivable and inventories, assisted by an increase in accrued volume incentives, primarily due to the timing of cash receipts and payments, and the timing of cash payments for income taxes. We are pleased with our overall strength and liquidity. We also recognize that the COVID-19 pandemic and related impact on future financial results is uncertain but could be significant over the course of 2020 and beyond. Accordingly, at this time, our goal is to maintain and, hopefully, continue to improve our overall cash and liquidity position. I would now like to turn the call back to the operator to facilitate questions and answers.

Steve Martin, Analyst

Great quarter in the face of all the challenges we all know we're discussing. Can you provide more specifics around April, May, and the future? How is the changing status in China, Asia, the U.S., and Europe impacting revenues and your sales functions?

Terrence Moorehead, CEO

It's a tough one to answer because, again, as I tried to allude, things are moving around. We've had to cancel events, cancel some incentive programs, and introduce new ones. As a result, things that were planned and that we had a good sense for what we thought they'd deliver are now something different with a different time frame. So there's just so much uncertainty right now, Steve. It's hard to answer your question directly. But what we do know is we're seeing an impact from it. The closures and not being able to have meetings are having an impact. Of course, the team is fighting back with new products and new promotional concepts simultaneously. We are also, as you can see, redoubling our efforts to support our distributors, focusing on the healing power of herbs and sharing those with everyone around the world. We are really playing to our strengths and our heritage, but again, doing that in a very new manner. It’s tough to answer your question given all the uncertainties out there.

Steve Martin, Analyst

Let me ask it slightly differently. Asia went into the soup earlier than we did here in the U.S. and Europe, and has come out of the worst of the impact. How did your business in Asia trend as it started to reopen?

Terrence Moorehead, CEO

It's interesting. The trends are, and I'll let Joe follow up on this. The trends are good with our current people. We're not losing people; we're not losing customers. The issue we're seeing right now is a slowdown in new customer acquisition, again, in the face of not being able to have meetings and canceling field events. I'll let Joe follow up on this with maybe a little additional color.

Joseph Baty, CFO

Steve, as Terrence noted earlier, it's very difficult to quantify. Trend-wise, overall, what I would tell you is that if you look at the three key markets we have over there. In China, we can look at China and say, well, they appear to be back, fully engaged, in the sense that our office is fully open and our people are back on-site in the office, but there are still some limits to the level of activity that our leaders can engage in. While we see hope that things will get better, it's still very difficult to predict how it's going to play out. When we look into Korea and Japan, the other two key markets within our Asia business unit, I'd say they were impacted in Q1, but it's impacted more in the latter part of the quarter versus the early part. So, trend-wise, that suggests that it may carry over into Q2 and potentially beyond. They are not back to full mode like China in some areas due to the pandemic. There's a little more uncertainty. Our leaders are doing everything they can to maintain, support, and grow their businesses. They are still facing struggles in being able to open new markets and onboard new customers. It’s just very fluid and difficult to quantify, but the overall business could be negatively impacted by the COVID-19 situation as we look into Q2.

Steve Martin, Analyst

You guys have done a great job on cost controls and reducing expenditures. Where are you in that process? Are you in the third, the sixth, or the ninth inning?

Terrence Moorehead, CEO

We're probably still not in the seventh inning stretch yet, so we're in the fourth or fifth inning.

Joseph Baty, CFO

Yes, we have completed half of the process, Steve. However, in my view, and I believe in Terrence's view as well, we will never truly be done. We will always seek additional opportunities to improve our margins and enhance cost efficiencies. Regarding our overall strategy to reduce costs and undergo restructuring, we are clearly at the midpoint of that effort. The current situation may pose certain challenges, but we remain fully committed to long-term margin improvement.

Steve Martin, Analyst

On the manufacturing side as opposed to the expense side, where do you stand on improving your manufacturing cost structure?

Terrence Moorehead, CEO

Can you address that?

Joseph Baty, CFO

Well, again, you will see that on a quarter-over-quarter basis. Our gross profit margin was relatively flat. We can look at that and consider the overall mix. The level of promotions we are doing is impacting that margin. That being said, we are not where we expect to be long-term on our gross profit margin or for any of the margins, operating margin, or EBITDA margin. However, we still believe there's room for improvement, and we anticipate some improvement depending on how this year plays out. There's all the uncertainty, so we'll have to see. But looking ahead into 2021 and 2022, we expect to see further manufacturing efficiencies and some improvement in our gross profit margin.

Terrence Moorehead, CEO

There are a couple of things we're working on, Steve. Everything from really reviewing our formulations to looking at our supplier lists and consolidating them, negotiating better prices, and exploring local manufacturing, which can have significant benefits. We see opportunities in areas where we are shipping products over long distances. We're pursuing all of these options, some closer in than others, but we are actively pursuing them.

Steve Martin, Analyst

Can I ask one last question? CapEx and investment spending for the remainder of the year, what had you expected? Have you adjusted it to reflect what's going on?

Joseph Baty, CFO

Well, in the first quarter, we spent a little over $1 million. We have several initiatives that Terrence has referenced today and in prior comments that our plan, as it stands, is to continue with those initiatives. However, we may look to scale back some over the course of the year depending on how Q2 plays out, especially as we look to preserve cash. It may make sense to delay some less critical capital expenditures into 2021. From an overall standpoint, aside from the key initiatives, we don't anticipate any substantial increase in our CapEx beyond what you've seen the last couple of years.

Terrence Moorehead, CEO

What we're trying to do, Steve, is ensure that we are strategic in our focus here. As Joe mentioned, we want to be conservative with our cash to protect our cash position while funding strategic initiatives that will help us during these times. We need to focus on digital capabilities to stay relevant and competitive in the marketplace. Okay. Well, thanks again, everybody, for all of your support, for participating in today's call, and for everything you do for our company. We look forward to updating you on our next call. Please stay safe and healthy during these uncertain times. Have a great day. Thanks very much. Bye now.

Joseph Baty, CFO

Thank you.

Operator, Operator

This concludes today's conference call. You may disconnect your lines. Thank you for participating, and have a pleasant day.