Nature’s Sunshine Products, Inc. (NASDAQ:NATR) Q3 2022 Earnings Conference Call November 3, 2022 5:00 PM ET
Company Participants
Terrence Moorehead – Chief Executive Officer
Martin Gonzalez – Executive Vice President, Global Supply Chain
Jon Lanoy – Interim CFO
Nate Brower – General Counsel
Conference Call Participants
Steven Martin – Slater
Operator
Please standby. Good afternoon, everyone. And thank you for participating in today’s Conference Call to discuss Nature’s Sunshine’s Financial Results for the Third Quarter ended September 30, 2022.
Joining us today are Nature’s Sunshine CEO, Terrence Moorehead, Executive Vice President of Global Supply Chain, Martin Gonzalez, Interim CFO, Jon Lanoy; and General Counsel, Nate Brower. Following their remarks, we will 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.
Nate, please go ahead.
Nate Brower
Yeah. Thank you, Sarah. Good afternoon. And thanks for joining our conference call to discuss our third quarter 2022 financial results. I’d like to remind everyone that this call is available for replay via telephonic dial-in through November 17th and via a live webcast that will be posted in the Investor Relations portion of our website at ir.naturessunshine.com.
The information on this call contains forward-looking statements. Those are statements often characterized by terminologies such as believe, hope, may, anticipate, expect 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, but — 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.
Now I would like to turn the call over to the CEO of Nature’s Sunshine, Terrence Moorehead. Terrence?
Terrence Moorehead
Thank you, Nate, and good afternoon, everyone. I want to thank you for joining today’s call to review our third quarter results. The resilience of our portfolio was on display in the third quarter, where despite unprecedented external headwinds, we delivered third quarter sales of $105 million on a reported basis or $112 million when removing the impact of foreign exchange.
To put these results in perspective, our third quarter sales were only down 2% versus prior year on a constant dollar basis, and year-to-date, sales were actually up 3% in local currency. Both measures reflect the underlying strength of our business, especially given the current environment, where it has become more difficult to drive customer engagement.
What’s more, due to inflationary pressures and volatile foreign exchange rates, everything has become more expensive. As a result, third quarter gross margins contracted as inflation and foreign exchange negatively impacted cost of goods by approximately $3 million or roughly 300 basis points versus Q3 of the prior year.
Sales declines driven by foreign exchange also negatively impacted profitability by an additional $3 million, which contributed to adjusted EBITDA of $6.8 million for the third quarter versus $12.9 million in Q3 of the prior year. As I shared last quarter, we are committed to meeting these challenges head on and now have a detailed plan to deliver $10 million to $12 million of gross savings to help improve profitability.
I have invited our new supply chain lead, Martin Gonzalez to join us today so he can briefly walk you through our plans. But first, I want to share a few more comments about the quarter to help provide some perspective.
Despite the challenges from the external headwinds, we continue to gain traction from three key strategic investments. First, our investment in field activation continues to gain traction in markets like Taiwan, Japan and South Korea, where sales increased 97%, 22% and 8%, respectively, on a local currency basis.
While believe — while we believe the underlying fundamentals of our business in China remain strong, sales struggled in the third quarter, down 31%, driven by deteriorating macroeconomic conditions and the hangover effects from China’s zero COVID policy. Once external headwinds abate, we hope to see a return to growth.
Overall, Asia-Pacific led the company’s third quarter results, delivering 12% sales growth in local currency and 21% sales growth year-to-date.
Second, our investment in digital activation continues to gain traction in North America as digital sales increased 22% in the third quarter. We have continued to invest in digital, and as a result, we have been able to attract new customers, double the effectiveness of our CRM campaigns and our Subscribe and Thrive auto ship program now represents about 27% of sales.
Solid gains from digital were more than offset by average order declines from existing customers who continue to order Nature’s Sunshine products, but are purchasing about one less unit per order on average. This is consistent with the broader market trend where we see consumers offsetting inflationary pressures by purchasing smaller quantities, delaying purchases or trading down to cheaper brands. Overall, North America sales were down 16% in the third quarter.
Finally, our investment in customer growth has helped us gain some early traction in both Central and Eastern Europe and Latin America. In Central and Eastern Europe, initiatives in Poland, Turkey and several Baltic states helped partially offset the gap created by the war in Ukraine.
We are still preparing for the re-launch of the business in Western Europe, where economic challenges have customers buying and spending less, negatively impacting orders and average order size.
Overall, Europe’s third quarter sales were better than expected as we grew 13% on a sequential basis versus the second quarter and were only down 6% versus prior year in constant dollars. This is a tremendous result and speaks to the skill, determination and resilience of our regional leadership teams.
In Latin America, customer growth initiatives helped attract more new customers in the last two months of the third quarter than in the first and second quarters combined. The positive momentum was offset by a decrease in orders from existing customers impacted by the depressed economy. So LatAm’s third quarter sales were down 14% in local currency.
We are still on the front end of our transformation and are pleased with the progress our new leadership team has made recruiting new talent and creating a roadmap for the future. Importantly, we are not sitting idly waiting for the effects of the global headwinds to pass.
We are fighting back by continuing to invest in our growth strategies and by launching a comprehensive initiative to optimize gross margins and reduce SG&A. As I mentioned earlier, we have identified a series of initiatives to drive out costs and improve productivity over the next 18 months.
With that in mind, I’d like to invite our new Head of Supply Chain, Martin Gonzalez, to update you on our plans related to gross margin. Martin?
Martin Gonzalez
Good afternoon, everyone. It’s good to be here with all of you. As you may know, I joined Nature’s Sunshine a little over five months ago as the Executive Vice President for Global Supply Chain. And since joining the company, I have been working in partnership with our finance, sales, marketing, R&D and supply chain team to identify opportunities to optimize our gross margins and offset increased costs driven by inflation.
Working together over the past few months, the team has identified three key initiatives that will deliver significant savings and will allow us to make meaningful progress against our gross margin targets.
The initiatives will be launched over the next 12 months to 18 months and will deliver approximately $10 million of gross savings. I would like to briefly give you a sense of — for the initiatives we are working on.
Our first initiative involves a deep dive review of our ingredients, packaging and formulations. Raw materials represent a significant portion of our cost of goods, so they are an important area to explore. We believe there are significant savings from optimizing the materials using our products and we are aggressively looking for opportunities to drive out cost, while maintaining quality and performance.
Using one of our top products, as an example, we found that by optimizing the ingredients, we could improve the flavor, produce sugar, improve the fiber content and increase the gross margin profile by $0.5 million per year. That’s just one example, but there are many products in our portfolio that will help us to deliver the efficiencies we are looking to achieve.
Our second initiative focuses on improving efficiencies and driving waste out of our manufacturing processes. Our small batch manufacturing capabilities give us real advantage when it comes to product quality and performance, but they can also add complexity to the process when run times are negatively impacted by unnecessary changeovers.
For the past few months, we have been analyzing how we can more effectively optimize our production schedules by prioritizing production rounds, improving preventive maintenance and reducing change over time. This initiative will allow us to increase uptime, improve yield and deliver significant savings.
Our third initiative focuses on logistics and transportation, where we are working to improve truck utilization, increased pallet density in the warehouse and reduce the amount of air freight. We believe this offers significant potential to drive savings. Again, we expect these initiatives to improve our gross profit by approximately $10 million or 200 basis points to 250 basis points of gross margin.
Now I will turn the call back over to Terrence. Terrence?
Terrence Moorehead
Thank you, Martin. While we expect these savings to start impacting results in late 2023 to 2024, the project teams are already up and running and making progress. This initiative is an important part of a comprehensive approach to improve gross margin and we are committed to delivering the initiatives that Martin outlined.
I want to reiterate our steadfast commitment to successfully navigating this unique period of market volatility and uncertainty, and I want to leave you with three key takeaways. First, the persistent challenges posed by inflation, foreign exchange and COVID-related disruptions were the primary factors negatively impacting our performance.
Second, despite the challenging environment, Nature’s Sunshine continues to be healthy and the underlying fundamentals of the business are sound. We have a strong balance sheet, customer orders are still largely holding and when we adjust for currency, performance is still near historical highs.
Third, we continue to see positive results from our targeted investments that we have made. So, we are going to lean into the investments we believe will drive growth going forward.
And finally, we are fighting back against the challenges of the current macroeconomic landscape by introducing a comprehensive initiative that will deliver gross savings of $10 million to $12 million from the gross margin initiatives Martin reviewed and SG&A reductions from across the business.
In challenging times like these, it’s more important than ever to stay focused and drive our strategies forward and that’s exactly what we are going to do. Backed by our strong balance sheet and our team of experts around the globe, we remain confident in our ability to provide long-term value to our stakeholders.
Before passing the call over to Jon, I’d like to recognize our outgoing CFO, Joe Baty. On behalf of the Board and all of our employees here at Nature’s Sunshine, I want to thank Joe for his valuable contributions.
Joe played a key role in developing a strong finance team and driving improvements that have put Nature’s Sunshine in a position to win. I am deeply appreciative of Joe’s service and leadership and wish him all the best.
With that, I’d like to turn the call over to Jon Lanoy, our Interim CFO, who will walk you through our financials in more detail. Jon?
Jon Lanoy
Thank you, Terrence, and good afternoon, everyone. Net sales in the third quarter were $104.5 million, compared to $114.7 million a year ago. This 9% decline was largely driven by declines in North America and Europe. As Terrence mentioned, excluding the impact from foreign exchange rates, consolidated constant currency net sales decreased only 2% in the third quarter.
Gross margin in the third quarter was 71.6%, compared to 74.4% a year ago. The decline was primarily driven by inflationary pressures on our cost of goods sold related to increases in materials, production and transportation costs, as well as the adverse movements in foreign exchange rates.
Third quarter volume incentives as a percentage of net sales were 31.6% compared to 31.2% in the prior year quarter. The slight increase was due to changes in market mix.
Selling, general and administrative expenses during the third quarter were reduced to $36.8 million, compared to $39.5 million a year ago. The reduction was from lower service fees in China and lower overall compensation cost, partially offset by increases from a return to in-person events, promotion related activities and investments in our digital initiatives.
As a percentage of net sales, SG&A expenses were 35.2% for the third quarter of 2022, compared to 34.4% a year ago. Reflective of gross margin pressures, operating income was $5 million or 4.8% of net sales compared to $10 million or 8.7% of net sales in the prior year.
GAAP net income attributable to common shareholders for the third quarter was $0.1 million or breakeven per diluted share, as compared to $4.9 million or $0.24 per diluted share a year ago. In addition to reduced operating margins, the decline also reflects increases of $1.1 million in valuation allowances against deferred tax assets for which we do not expect to receive a benefit. Excluding these allowances, our tax rate would have been 52.7% for the third quarter.
Adjusted EBITDA, as defined in our press release was $6.8 million, compared to $12.9 million in the third quarter of 2021.
Moving on to liquidity and our capital allocation plan. Our balance sheet remains clean with cash and cash equivalents of $57 million and only $1.5 million of debt. During the quarter, inventory decreased approximately $3 million versus the second quarter and we believe aggregate inventories will continue to decline in the fourth quarter as we work to right-size the amount of inventory within our supply chain.
As part of our capital allocation plan, we continue to utilize our share repurchase authorization, buying 93,000 shares in the third quarter for $1 million or an average of $10.48 per share. At September 30th of this year, $24.6 million remains of our $30 million share repurchase program. Looking beyond share repurchases, our healthy capital allocation structure positions us well to continue our digital transformation, supply chain and other strategic investments.
Now turning to our outlook, which includes the assumption that the ongoing market headwinds will persist, we continue to expect topline sales for 2022 to reflect a low-to-mid single-digit decline versus 2021. As previously communicated, we expect overall European sales for 2022 to decline approximately 15% to 25% as compared to 2021 and continued declines in North America given the current inflationary environment.
Lastly, we expect Asia to increase in the mid-single digits as compared to 2021, with the current growth in Japan, Korea and Taiwan, offset by declines in China due to the current COVID restrictions. The challenges presented by inflation and foreign currency volatility are expected to persist, and as a result, we expect to continued — to have continued pressures on our gross margins.
While Martine has shared several initiatives, we are actively pursuing to improve gross margins. I would remind you that the impact of these actions will not be reflected in our results until late 2023 and into 2024 as these changes cycle through our inventory.
Due to our strong belief in the long-term potential and success of Nature’s Sunshine, our investment in growth directed initiatives will continue. As a result, while we work to optimize our SG&A spend to support our investments, we expect SG&A as a percentage of net sales to continue to increase.
We currently expect our adjusted EBITDA margin, including the add back for certain war related working capital charges may decline 3 full percentage points to 5 full percentage points from the 11% we reported last year.
Despite market headwinds, most of which remain out of our control, we are very excited about and remain committed to the long-term growth opportunities for the business and we are committed to pursuing opportunities to maximize value for our shareholders.
Now, with that, I will turn the time back over to the Operator. Sarah?
Question-and-Answer Session
Operator
Thank you. [Operator Instructions] And we will take our first question from Steven Martin with Slater.
Steven Martin
Hi, guys.
Terrence Moorehead
Hi, Steve.
Steven Martin
I have asked you for the last two quarters, why you weren’t looking to save some costs and reduce some expenses? Now you announced you are going to do it, but it’s not going to be effective until the end of 2023. I am not quite sure I understand?
Terrence Moorehead
Sure.
Steven Martin
And second of all…
Terrence Moorehead
Yeah.
Steven Martin
… I don’t understand with sales declining, your inventory went down a little, but why are you sitting on so much inventory and why not generate some cash and buy back more shares, buying back 90,000 shares as a joke?
Terrence Moorehead
Yeah. So, with respect to your first question on SG&A savings and the gross margin savings, we actually do have — again this is — it’s a comprehensive plan. It’s a — I think it’s a pretty striking plan. We have been working on this for, as Martin pointed out, several months. There’s a lot of complexity involved.
We will have some savings rolling off the assembly line, Steve, in advance of kind of the timing that we told you. But it’s just that the bulk of it needs to go through cost of goods. So there’s an inventory turn kind of issue there that we need to — there’s some complexity involved and Martin talks, for example, about having to reformulate a product.
That’s formulation, that’s labels, that’s approvals, then you get it into inventory and it goes through. So these are meaningful savings, I think they are quite impactful and they are sustainable as well, so and we feel really good about them.
We do have a range of SG&A savings as well that will be coming through. But again, the lion’s share of the opportunity is from driving out gross margin and we are just getting started here, right? So, this is an ongoing project. I feel very good about it. I think it’s a strong effort.
And I want you to remember, we have already taken out some $26 million of savings over the past couple of years. So we are adding on top of that with our SG&A and then the gross margin savings on top of that, I think, are quite substantial. As it relates to second question, Jon, do you want to take a stab at that?
Jon Lanoy
Yeah. Steve, yeah, we do have quite a bit of inventory on hand and we are aware of that. Going into the beginning of last year, I mean, we were in a different place where we had higher expectations of growth before the war and everything else there and we were buying inventory ahead of inflation, trying to make sure we had enough to support our growth and when that growth didn’t come at the levels we expected, we already had commitments there. And so, we are working through those commitments, we have canceled orders, we are buying raw materials were needed, targeted buys and we are continuing to just work down the inventory.
Terrence Moorehead
I hope that answers question.
Steven Martin
Yeah. Well, then the corollary to that is with your stock at $8, why did you only buy back 90,000 shares?
Terrence Moorehead
We do have volume constraints. So we did buy with volume. We are also — we have prioritized the investments that we talked about. There are some investments that are required in order to drive out some of the costs from gross margin.
So we think those are actually very good, very strong priorities for us right now, given where we are. It’s a lot more — it’s a lot harder and more expensive for us to reacquire — acquire new customers than it is to try and keep our existing customers.
So that’s really where our kind of our focus is right now and then on driving out some of these costs and we do have pretty sizable needs in terms of some of the things to upgrade equipment and upgrade facilities, and that’s just kind of coming online right now in terms of the investments.
Steven Martin
Well, speaking as one of your shareholders, I have heard those words before. I just assume you spend some money buying back some stock instead of sitting with $60 million on your balance sheet?
Terrence Moorehead
Yeah. We appreciate the sentiment.
Steven Martin
All right. I will talk to you offline next week.
Terrence Moorehead
Thanks, Steve.
Operator
And at this time, that does conclude our question-and-answer session. I would like to turn the conference back over to Mr. Moorehead for closing remarks.
Terrence Moorehead
Okay. Thank you. Well, we would like to thank everyone for listening to today’s call and we look forward to speaking with you when we report our fourth quarter and full year 2022 results in March of 2023. Thanks again for joining us. Take care.
Operator
Ladies and gentlemen, this does conclude today’s teleconference. You may disconnect your lines at this time. Thank you for your participation.
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