UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 


 

FORM 10-K

 

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE

SECURITIES EXCHANGE ACT OF 1934

 

For the Fiscal Year Ended

 

Commission File Number

December 31, 2004

 

0-8707

 

 

NATURE’S SUNSHINE PRODUCTS, INC.

(Exact name of Registrant as specified in its charter)

 

Utah

 

87-0327982

(State or other jurisdiction of
incorporation or organization)

 

(IRS Employer
Identification No.)

 

75 East 1700 South

Provo, Utah  84606

(Address of principal executive offices and zip code)

 

(801) 342-4300

(Registrant’s telephone number)

 

Securities registered pursuant to Section 12(b) of the Act:

None

 

Securities registered pursuant to Section 12(g) of the Act:

Common Stock, without par value

 


 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes ý   No o

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ý

 

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act.) Yes ý   No o

 

The aggregate market value of the voting stock held by non-affiliates of the registrant on June 30, 2004 was approximately $146,317,737 based on the closing price of $14.24 as reported on the NASDAQ Market on such date and using the definition of beneficial ownership contained in Rule 16a-1(a)(2) promulgated to the Securities Exchange Act of 1934.

 

The number of shares of Common Stock, no par value, outstanding on March 11, 2005 was 15,052,961 shares.

 

Documents Incorporated by Reference:

 

Proxy Statement for the May 27, 2005 Annual Meeting of Shareholders (Part III of this Report).

 

 



 

PART I

 

Item 1. Business

 

The Company

 

Nature’s Sunshine Products, Inc., founded in 1972 and incorporated in Utah in 1976, and its subsidiaries (sometimes hereinafter referred to collectively as “we”, “our” or the “Company”), are primarily engaged in the manufacturing and marketing of nutritional and personal care products.  The Company sells its products worldwide to a sales force of independent Distributors who use the products themselves or resell them to other Distributors or consumers.

 

Our operations are conducted in the United States as well as in certain other countries.  The Company’s subsidiaries are located in Mexico, Central America, Canada, Venezuela, Dominican Republic, Japan, Ecuador, the United Kingdom, Colombia, Peru, Israel, and Brazil. We export our products to several other countries, including Argentina, Australia, Chile, New Zealand, Norway and the Russian Federation.

 

We also sell our products through a separate division, Synergy Worldwide.  Synergy Worldwide sells products in Japan, the United States, South Korea, Singapore, Thailand, Taiwan, and Australia.

 

We maintain an Internet website at http://www.natr.com.  We make available free of charge on our website our annual report on Form 10-K, our quarterly reports on Form 10-Q, our current reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) of the Securities Exchange Act of 1934 as soon as practicable after we electronically file these documents with, or furnish them to, the Securities and Exchange Commission.

 

Financial Information by Business Segment

 

We are principally engaged in one line of business; namely, the manufacturing and marketing of nutritional and personal care products.  The Company has two operating business segments that operate under the Nature’s Sunshine Products name and are based on geographic operations: a United States segment and an international segment.  The Company’s third operating business segment operates under the Synergy Worldwide name.  The segments have similar business characteristics and each offers similar products through similar methods of distribution. Information by business segment for each of our last three fiscal years for sales revenue and operating income, and information by business segment as of the end of our last two fiscal years for identifiable assets, are set forth in Note 14 of the Notes to Consolidated Financial Statements appearing in Item 8 of this Report.

 

Products and Manufacturing

 

Our line of over 700 products includes herbal products, vitamins and mineral supplements, personal care, nutritional drinks, and miscellaneous other products.  We purchase herbs and other raw materials in bulk and, after quality control testing, formulate, encapsulate, tablet or concentrate, and package them for shipment.  Most of our products are manufactured at our facility in Spanish Fork, Utah.  Contract manufacturers produce some of the personal care and miscellaneous other products for us in accordance with our specifications and standards.  We have implemented stringent quality control procedures to verify that the contract manufacturers have complied with our specifications and standards.  Our product lines are described below.

 

Herbal Products

 

We manufacture a wide selection of herbal products, which are sold in the form of capsules or tablets.  These capsules or tablets contain herb powder or a combination of two or more herb powders.  We also produce both single herbs and herb combinations in the form of liquid herbs and extracts.  Liquid herbs are manufactured by concentrating herb constituents in a vegetable glycerin base.  Extracts are created by dissolving powdered herbs into liquid solvents that separate the key elements of the herbs from the fibrous plant material.

 

2



 

Vitamins and Mineral Supplements

 

We manufacture a wide variety of single vitamins, which are sold in the form of chewable or non-chewable tablets.  We also manufacture several multiple vitamins and mineral supplements, including a line containing natural antioxidants.  Generally, mineral supplements are sold in the form of tablets; however, certain minerals are offered only in liquid form.

 

Personal Care Products

 

We manufacture or contract with independent manufacturers to supply a variety of personal care products for external use, including oils and lotions, aloe vera gel, herbal shampoo, herbal skin treatment, toothpaste, and skin cleanser.

 

Other Products

 

We manufacture or contract with independent manufacturers to supply a variety of other products, including a variety of different nutritional drinks, homeopathic products, and powders.

 

Distribution and Marketing

 

Our independent distributors market our products to consumers through direct-selling techniques as well as sponsor other distributors.  We seek to motivate and provide incentives to our independent distributors through a combination of high quality products, product support, financial benefits, sales conventions, travel programs, and a variety of training seminars.

 

Our products sold in the United States are shipped directly from our manufacturing and warehouse facilities located in Spanish Fork, Utah, as well as from our regional warehouses located in Columbus, Ohio; Dallas, Texas; and Atlanta, Georgia.  Each international operation maintains warehouse facilities with inventory to supply its customers.

 

Demand for our products is created from approximately 665,000 active distributors at December 31, 2004, which include approximately 223,000 in the United States.  A person who wishes to join our independent sales force begins as a “Distributor”.  An individual can become a Distributor by signing up under the sponsorship of someone who is already a Distributor.  Each Distributor is required to renew his/her distributorship on a yearly basis; approximately 20 percent renew annually.  Many Distributors sell our products on a part-time basis to friends or associates or consume the products themselves.  A Distributor interested in earning additional income by committing more time and effort to selling our products may earn “Manager” status.  Manager status is contingent upon attaining certain purchase volume levels, recruiting additional Distributors, and demonstrating leadership abilities.  Managers numbered approximately 18,400 at December 31, 2004, including approximately 6,000 in the United States.  Managers resell the products they purchase from the Company to Distributors within their sales group, to consumers, or use the products themselves. Historically, approximately 60 percent of Distributors appointed as Managers have continued to maintain that status.

 

In the United States, we generally sell our products on a cash or credit card basis.  From time to time, our United States operation extends short-term credit associated with product promotions.  For certain of our international operations, we use independent distribution centers and offer credit terms consistent with industry standards within each respective country.

 

We pay sales commissions (“Volume Incentives”) to our Managers and Distributors based upon the amount of sales group product purchases.  A portion of these volume incentives are paid as rebates for purchases made by Managers and Distributors of products for their own use or for resale and a portion of these volume incentives are commissions for purchases made by their down-line Distributors. Reference is made to Item 8 herein for “Volume Incentives” paid by us for the years ended December 31, 2004, 2003, and 2002.  In addition, Managers who qualify by attaining certain levels of monthly product purchases are eligible for additional incentive programs including automobile allowances, sales conventions, and travel.

 

3



 

Source and Availability of Raw Materials

 

Raw materials used in the manufacture of our products are available from a number of suppliers.  To date, we have not experienced any major difficulty in obtaining adequate sources of supply.  We attempt to assure the availability of many of our raw materials by contracting, in advance, for our annual requirements.  In the past, we have found alternative sources of raw materials when needed.  Although there can be no assurance we will be successful in locating such sources in the future, we believe we will be able to do so.

 

Trademarks and Trade Names

 

We have obtained trademark registrations of our basic trademark, “Nature’s Sunshine”, and the landscape logo for all of our product lines.  We own numerous trademark registrations in the United States and in many other countries.

 

Seasonality

 

Our business does not reflect significant seasonality.

 

Inventories

 

We maintain a considerable inventory of raw materials and finished goods in order to provide a high level of product availability to our independent Distributors and Managers.

 

Dependence Upon Customers

 

We are not dependent upon a single customer or a few customers, the loss of which would have a material adverse effect on our business.

 

Backlog

 

We typically ship orders for our products within 24 hours after receipt. As a result, we have no significant backlog at any time.

 

Competition

 

Our products are sold in competition with other companies, some of which have greater sales volumes and financial resources than we do, and which sell brands that are, through advertising and promotions, better known to consumers.  We compete in the nutritional and personal care industry against companies which sell through retail stores as well as against other direct selling companies.  For example, we compete against manufacturers and retailers of nutritional and personal care products, which are distributed through supermarkets, drug stores, health food stores, discount stores, etc.  In addition to competition with these manufacturers and retailers, we compete for product sales and independent Distributors with many other direct sales companies, including Shaklee, NuSkin, Usana, and Amway.  The principal competitors in the encapsulated and tableted herbal products market include Nature’s Way, Nutraceuticals, and NBTY.  We believe that the principal components of competition in the direct sales marketing of nutritional and personal care products are quality, price, and brand recognition.  In addition, the recruitment, training, travel, and financial incentives for the independent sales force are important factors.

 

Research and Development

 

We conduct research and development activities at our manufacturing facility located in Spanish Fork, Utah.  Our principal emphasis in our research and development activities is the development of new products and the enhancement of existing products.  The amount, excluding capital expenditures, spent on research and development activities was approximately $1.7 million, $2.1 million, and $2.2 million in 2004, 2003, and 2002, respectively.  During the three years in the period ended December 31, 2004, we did not contract for any third-party research and development.

 

4



 

Compliance with Environmental Laws and Regulations

 

The nature of our business has not required any material capital expenditures to comply with federal, state, or local provisions enacted or adopted regulating the discharge of materials into the environment.  No material expenditures to meet such provisions are anticipated.  Such regulatory provisions have not had any material effect upon our results of operations or competitive position.

 

Regulation

 

The formulation, manufacturing, packaging, labeling, advertising, distribution and sale of each of our major product groups are subject to regulation by one or more governmental agencies.  The most active of these is the Food and Drug Administration (“FDA”), which regulates our products under the Federal Food, Drug and Cosmetic Act (“FDCA”) and regulations promulgated thereunder.  The FDCA defines the terms “food” and “dietary supplement” and sets forth various conditions that unless complied with may constitute adulteration or misbranding of such products.  The FDCA has been amended several times with respect to dietary supplements, most recently by the Nutrition Labeling and Education Act of 1990 (the “NLEA”) and the Dietary Supplement Health and Education Act of 1994 (the “DSHEA”).

 

FDA regulations relating specifically to foods for human use are set forth in Title 21 of the Code of Federal Regulations.  These regulations include basic food labeling requirements and Good Manufacturing Practices (“GMPs”) for foods.  Detailed dietary supplement GMPs have been proposed; however, no regulations establishing such GMPs have been adopted.  Additional regulations to implement the specific DSHEA requirements for dietary supplement labeling have also been proposed, and final regulations should be implemented over a period of time upon final publication.

 

Our products are also regulated by the Federal Trade Commission (“FTC”), the Consumer Product Safety Commission (“CPSC”), the United States Department of Agriculture (“USDA”), and the Environmental Protection Agency (“EPA”).  Our activities, including our multi-level distribution activities, are also regulated by various agencies of the states, localities, and foreign countries in which our products are sold.

 

In the future, we may be subject to additional laws or regulations administered by the FDA or other federal, state, local, or foreign regulatory authorities, the repeal or amendment of laws or regulations which we consider favorable and/or more stringent interpretations of current laws or regulations.  We can neither predict the nature of such future laws, regulations, interpretations, or applications, nor what effect additional governmental regulations or administrative orders, when and if promulgated, would have on our business.  They could, however, require reformulation of certain products to meet new standards, recall or discontinuance of certain products not able to be reformulated, imposition of additional record-keeping requirements, expanded documentation of the properties of certain products, expanded or altered labeling and/or scientific substantiation.  Any or all such requirements could have a material adverse effect on our business prospects, results of operations, liquidity, and financial position.

 

Employees

 

The number of individuals employed by us as of December 31, 2004, was 1,069.  We believe that our relations with our employees are satisfactory.

 

International Operations

 

Our sales of nutritional and personal care products are established internationally in Japan, Mexico, Central America, Canada, Venezuela, South Korea, Dominican Republic, Ecuador, the United Kingdom, Colombia, Thailand, Peru, Singapore, Israel, Brazil, Taiwan, and Australia. We also export our products to numerous other countries, including Argentina, Australia, Chile,
New Zealand, Norway, and the Russian Federation.  Information by business segment for each of our last three fiscal years for sales revenue and operating income, and information by business segment as of our last two fiscal years for identifiable assets attributable to the Nature’s Sunshine United States, Nature’s Sunshine International, and Synergy Worldwide business segments are set forth in Note 14 of the Notes to Consolidated Financial Statements appearing in Item 8 of this Report.

 

5



 

Our international operations are conducted in a manner comparable with those conducted in the United States; however, in order to conform to local variations, economic realities, market customs, consumer habits, and regulatory environments, differences may exist in the products and in the distribution and marketing programs.

 

Our international operations are subject to many of the same risks faced by the United States operations, including competition and the strength of the local economy.  In addition, international operations are subject to certain risks inherent in carrying on business abroad, including foreign regulatory restrictions, fluctuations in monetary exchange rates, import-export controls and the economic and political policies of foreign governments.  The importance of these risks increases as our international operations continue to expand.

 

Item 2. Properties

 

Our corporate offices are located in two adjacent office buildings in Provo, Utah.  The facilities consist of approximately 63,000 square feet and are leased from an unaffiliated third party through lease agreements, which expire in as early as two years but are renewable upon expiration.

 

Our principal warehousing and manufacturing facilities are housed in a building consisting of approximately 265,000 square feet owned by us and located on approximately ten acres in Spanish Fork, Utah.  During 2002, we completed an expansion of our manufacturing facility at a total cost of approximately $14 million.

 

We own approximately 60,000 square feet of office and warehouse space in Mexico and approximately 10,800 square feet of office space in Venezuela.

 

We lease properties used primarily as distribution warehouses located in Columbus, Ohio; Dallas, Texas and Atlanta, Georgia, as well as offices and distribution warehouses in Japan, Mexico, Central America, Canada, Venezuela, South Korea, Dominican Republic, Ecuador, the United Kingdom, Colombia, Thailand, Peru, Singapore, Israel, Brazil, Taiwan, and Australia.  We believe these facilities are suitable for their respective uses and are, in general, adequate for our present and near-term future needs.  During 2004, 2003, and 2002, we spent approximately $4.6 million, $3.6 million, and $4.0 million, respectively, for all of our leased facilities.

 

Item 3.  Legal Proceedings

 

We are a defendant in various lawsuits that are incidental to our business.  We believe, after consultation with legal counsel, that any liability resulting from these matters will not have a material effect upon our business prospects, results of operations, liquidity, or financial position.

 

Item 4.  Submission of Matters to a Vote of Security Holders

 

None.

 

6



 

PART II

 

Item 5.  Market for Registrant’s Common Equity and Related Shareholder Matters

 

Our common stock is traded on the NASDAQ National Market System (symbol NATR).  The information in the table below reflects the actual high and low sales prices of our stock in 2004 and 2003.

 

 

 

Market Prices

 

 

 

Market Prices

 

2004

 

High

 

Low

 

2003

 

High

 

Low

 

First Quarter

 

$

14.99

 

$

8.25

 

First Quarter

 

$

9.99

 

$

6.65

 

Second Quarter

 

15.69

 

12.45

 

Second Quarter

 

10.89

 

7.50

 

Third Quarter

 

16.00

 

13.00

 

Third Quarter

 

9.19

 

7.10

 

Fourth Quarter

 

21.36

 

13.76

 

Fourth Quarter

 

9.03

 

7.61

 

 

There were approximately 1,266 shareholders of record as of March 14, 2005.  During 2004 and 2003, the Company paid quarterly cash dividends of $0.05 cents and $0.033 cents per common share, respectively.  On February 24, 2005, the Company declared a cash dividend of $0.05 cents per common share to shareholders of record on March 9, 2005. The Company expects to continue to pay cash dividends in the future.

 

Purchases of Equity Securities

 

Period

 

(a) Total Number of
Shares Purchased

 

(b) Average Price
Paid Per Share

 

(c) Total Number of
Shares Purchased as
Part of Publicly
Announced Plans or
Programs

 

(d) Maximum
Number (or
Approximate Dollar
Value) of Shares that
May Yet Be
Purchased Under the
Plans or Programs

 

October 1 to

October 31, 2004

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

November 1 to

November 30, 2004

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

December 1 to

December 31, 2004

 

1,000,000

(1)

$

16.50

 

1,000,000

 

 

 

 

 

 

 

 

 

 

 

 

 

Total

 

1,000,000

 

$

16.50

 

1,000,000

 

 

 


(1)       On October 26, 2004, our Board of Directors authorized the repurchase of up to 1,000,000 shares of our common stock through a Dutch Auction tender offer, which commenced on October 27, 2004 and expired on November 24, 2004.  Pursuant to the Dutch Auction tender offer, we repurchased 1,000,000 shares at a price of $16.50 per share on December 3, 2004.

 

7



 

Item 6. Selected Financial Data

(Dollar and Share Amounts in Thousands, Except for Per Share Information)

 

Income Statement Data

 

 

 

Net Sales
Revenue

 

Cost of
Goods Sold

 

Volume
Incentives

 

Selling, General
and Administrative

 

Operating
Income

 

Income Before
Income Taxes

 

Net Income

 

2004

 

$

331,063

 

$

62,693

 

$

127,985

 

$

118,731

 

$

21,654

 

$

22,961

 

$

17,078

 

2003

 

260,151

 

51,927

 

93,910

 

106,608

 

7,706

 

7,232

 

5,099

 

2002

 

261,574

 

53,317

 

92,926

 

103,663

 

11,668

 

10,696

 

7,064

 

2001

 

279,075

 

57,659

 

98,665

 

98,853

 

23,898

 

25,333

 

16,659

 

2000

 

275,578

 

55,448

 

98,078

 

95,424

 

26,628

 

27,920

 

17,131

 

 

Balance Sheet Data

 

 

 

Working
Capital

 

Current
Ratio

 

Inventories

 

Property, Plant and
Equipment, Net

 

Total
Assets

 

Long-Term
Debt

 

Shareholders’
Equity

 

2004

 

$

40,694

 

1.79:1

 

$

36,713

 

$

34,731

 

$

145,076

 

$

 

$

91,219

 

2003

 

30,052

 

1.65:1

 

26,528

 

32,318

 

125,558

 

 

77,342

 

2002

 

34,105

 

1.92:1

 

26,460

 

34,621

 

123,834

 

 

83,900

 

2001

 

40,561

 

2.24:1

 

26,834

 

35,294

 

131,428

 

 

95,798

 

2000

 

43,570

 

2.48:1

 

26,043

 

25,293

 

118,447

 

 

84,884

 

 

Common Share Summary

 

 

 

Cash Dividend
Per Share

 

Basic Net Income
Per Share

 

Diluted Net Income
Per Share

 

Basic Weighted
Average Shares

 

Diluted Weighted
Average Shares

 

2004

 

$

0.20

 

$

1.14

 

$

1.10

 

14,917

 

15,478

 

2003

 

0.133

 

0.36

 

0.36

 

14,181

 

14,336

 

2002

 

0.133

 

0.45

 

0.43

 

15,844

 

16,496

 

2001

 

0.133

 

1.02

 

0.99

 

16,283

 

16,851

 

2000

 

0.133

 

1.02

 

1.02

 

16,830

 

16,875

 

 

Other Information

 

 

 

Number of
Managers

 

Square Footage of
Property in Use

 

Number of Employees

 

2004

 

18,374

 

921,677

 

1,069

 

2003

 

15,151

 

806,343

 

1,037

 

2002

 

14,000

 

863,688

 

1,037

 

2001

 

16,190

 

866,219

 

1,109

 

2000

 

16,081

 

719,884

 

1,080

 

 

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

RESULTS OF OPERATIONS

 

Forward-Looking Information

 

Statements included in Management’s Discussion and Analysis of Financial Condition and Results of Operations and other items in this Form 10-K may contain forward-looking statements.  Such forward-looking statements are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995.  Such statements may relate but not be limited to projections of revenues, costs and expenses, income or loss, capital expenditures, plans for growth and future operations, financing needs, as well as assumptions relating to the foregoing.  Forward-looking statements are inherently subject to risks and uncertainties, some of which cannot be predicted or quantified.  When used in “Management’s Discussion and Analysis of Financial Condition and Results of Operations”, and elsewhere in this Form 10-K, the words “estimates”, “expects”, “anticipates”, “forecasts”, “plans”, “intends” and variations of such words and similar expressions are intended to identify forward-looking statements that involve risks and uncertainties.  Future events and actual results could differ materially from that set forth in, contemplated by, or underlying the forward-looking statements.

 

8



 

Net Sales Revenue

 

Consolidated net sales revenue for the year ended December 31, 2004, was $331.1 million compared to $260.2 million in 2003, an increase of approximately 27.3 percent. Net sales revenue decreased approximately 0.5 percent in 2003 compared to $261.6 million in 2002.  During 2004, the increase in net sales revenue is primarily due to continued growth in the Company’s international business segment as well as expansion of the Company’s Synergy Worldwide business segment, which operates primarily in Asia.

 

We distribute our products to consumers through an independent sales force comprised of Managers and Distributors. Active Managers totaled approximately 18,400, 15,200, and 14,000 at December 31, 2004, 2003, and 2002, respectively. Active Distributors totaled approximately 665,000, 562,000, and 509,000 at December 31, 2004, 2003, and 2002, respectively.  We anticipate the number of active Distributors to increase as we expand our existing operations, enter new international markets, and as current Distributors grow their businesses.

 

Net sales revenue related to the United States business segment operations decreased approximately 0.5 percent in 2004 to $142.8 million compared to $143.6 million in 2003.  Net sales revenue decreased 3.1 percent, compared to $148.1 million in 2002.  Price increases of 2.0 percent in our United States market went into effect in 2004 and 1.0 percent in 2003.  A price increase of approximately 1.0 percent, primarily associated with increased raw material costs, is scheduled to become effective on April 1, 2005.  Management believes this price increase in the Company’s United States market will be acceptable to its sales force and will result in increased net sales revenue.

 

International net sales revenue increased to $104.6 million in 2004 compared to $89.6 million in 2003, an increase of approximately 16.7 percent.  Net sales revenue increased approximately 4.7 percent in 2003 compared to $85.6 million in 2002.  The increase in international net sales revenue in 2004 and 2003 is primarily the result of continued growth in our operations in the Russian Federation, Venezuela, Canada, and Mexico. Price increases are planned in various international markets to compensate for foreign currency devaluations and increases in the cost of finished products.  Management believes the price increases will be acceptable to its sales force and will result in increased net sales revenue.

 

Synergy Worldwide net sales revenue increased to $83.6 million in 2004 compared to $26.9 million in 2003, an increase of approximately 210.5 percent. During the fourth quarter 2004, the Company changed its distribution method to its distributors in the Japanese market.  Prior to the fourth quarter 2004, the Synergy Worldwide segment shipped its products directly from the United States to its Japanese Distributors through a personal import program.  During the fourth quarter 2004, the Synergy Worldwide segment established a subsidiary in Japan and began shipping the majority of its products to its Japanese distributors directly from its warehouse in Japan. The result of this conversion was a decrease in the amount of revenue recognized by the Company due to the decrease in shipping and handling fees charged by the Company to its Japanese distributors under its personal import program. Net sales revenue decreased approximately 3.5 percent in 2003 compared to $27.9 million in 2002.  The increase in net sales revenue in 2004 is primarily the result of growth in Synergy Worldwide’s Japanese operations. The decrease in net sales revenue in 2003 as compared to 2002 is primarily the result of decreases in Synergy Worldwide’s operations in South Korea as a result of increased competition.  Further information related to the United States, International and Synergy Worldwide business segments is set forth in the Note 14 of Notes to Consolidated Financial Statements appearing in Item 8 of this Report.

 

Costs and Expenses

 

Our costs and expenses, which include cost of goods sold, the commission portion of volume incentives, and selling, general and administrative, are identified as a percent of net sales revenue in the table below:

 

Year ended December 31

 

2004

 

2003

 

2002

 

Cost of goods sold

 

18.9

%

20.0

%

20.4

%

Volume incentives

 

38.7

 

36.1

 

35.5

 

Selling, general and administrative

 

35.9

 

41.0

 

39.6

 

 

 

93.5

%

97.0

%

95.5

%

 

9



 

Cost of Goods Sold

 

Cost of goods sold as a percent of net sales revenue decreased in 2004 and 2003 compared to 2002 primarily as a result of (1) decreased importation costs in several of our international operations, (2) increased efficiency gained from our expanded manufacturing facility, and (3) increased net sales revenue in our Synergy Worldwide operations where costs of goods sold are lower as a percent of net sales revenue.  Management believes that cost of goods sold as a percent of net sales revenue will remain relatively constant during 2005 as compared to 2004.

 

Volume Incentives

 

Volume incentives are a significant part of our direct sales marketing program and represent commission payments made to our independent Distributors and Managers. These payments are designed to provide incentives for reaching higher sales levels and for recruiting additional Distributors.  Volume incentives as a percent of net sales revenue increased slightly during 2004 as compared to 2003 and 2002, primarily as a result of the increased sales revenue in our Synergy Worldwide business segment where volume incentives are slightly higher than in the United States and our other international operations.

 

As required by EITF 01-9, we have presented $37.1 million, $39.1 million, and $39.2 million in volume incentive rebates as a reduction in revenue for 2004, 2003, and 2002, respectively. As a result, volume incentive expense is lower by those same amounts in each respective year. This presentation has no impact on operating income, net income, or earnings per basic or diluted common share.

 

Management expects volume incentives as a percent of net sales revenue to increase slightly during 2005 as compared to 2004 due to increased sales levels in our Synergy Worldwide business segment where volume incentives are slightly higher.

 

Selling, General and Administrative

 

Selling, general and administrative expenses increased $12.1 million in 2004 compared to 2003 as a result of expenses related to the Synergy Worldwide business segment expansion. In 2003, selling, general and administrative expenses increased $2.9 million as compared to 2002, primarily as a result of expenses incurred to restructure several of our operations and consolidate various employee functions.  Approximately $2.2 million of the increase in 2003 was related to (1) cost cutting programs designed to eliminate and consolidate various management and employee functions and realign programs and market strategies, and (2) increased expenses in our Synergy Worldwide business segment.  Selling, general and administrative expenses as a percent of net sales revenue decreased to 35.9 percent in 2004 compared to 41.0 percent in 2003 and 39.6 percent in 2002.  This category includes costs for research and development, distribution, and incentive programs such as our conventions.

 

We believe that selling, general and administrative expenses as a percent of net sales revenue will decrease during 2005 as compared to 2004 due to continued cost containment measures and increased net sales revenue.  In our international and Synergy Worldwide business segments, reductions in selling, general and administrative expenses are planned in our South Korea, Japan, and Brazil operations.

 

Income Taxes

 

The effective income tax rate was 25.6 percent for 2004, compared to 29.5 percent for 2003, and 34.0 percent for 2002.  The decrease in the effective income tax rate was primarily due to a detailed income tax study of its foreign tax assets which resulted in a benefit of approximately $2.2 million.  The income tax rate in 2004 is not indicative of the effective tax rate for 2005.

 

10



 

Product Liability

 

Similar to other manufacturers and distributors of products that are ingested, we face an inherent risk of exposure to product liability claims in the event that, among other things, the use of our products results in injury.  As a result of increased regulatory scrutiny of products that contain ephedrine alkaloids and kava, we have not been able to obtain product liability insurance covering such products.  As of April 12, 2004, we complied with the U.S. Food and Drug Administration’s ban on the ingredient ephedra. When we discontinued the use of ephedrine alkaloids, less than 2 percent of our products contained some amount of ephedrine alkaloids.  We carry insurance in the types and amounts we consider reasonably adequate to cover the risks associated with our business. On June 1, 2003, we established a wholly owned captive insurance company to provide us with product liability insurance coverage.  We have accrued an amount using the assistance of a third-party actuary that we believe is sufficient to cover probable and reasonably estimable liabilities related to product liability claims based on our history of such claims.  However, there can be no assurance that these estimates will prove to be sufficient nor can there be any assurance that the ultimate outcome of any litigation for product liability will not have a material negative impact on our business prospects, financial position, results of operations, or liquidity.

 

LIQUIDITY AND CAPITAL RESOURCES

 

For the year ended December 31, 2004, we generated cash from operating activities of $18.1 million compared to $17.3 million in 2003.  The increase in cash generated from operating activities was primarily due to an increase in net income and accrued liabilities offset, in part, by an increase in inventory.

 

Capital expenditures were $8.1 million, $3.7 million, and $6.1 million for the years ended December 31, 2004, 2003, and 2002, respectively.  The high level of capital expenditures in 2004 was primarily due to the expansion of our Synergy Worldwide business segment.  Capital expenditures were primarily for equipment, computer systems and software, office furniture, and leasehold improvements made to enhance existing operations as well as the expansion of international markets.

 

On October 27, 2004, we commenced a Dutch Auction tender offer for up to 1,000,000 shares of our common stock, at a price not greater than $16.50 nor less than $14.20 per share.  The tender offer expired at midnight on November 24, 2004. A total of approximately 1,482,617 shares of common stock were properly tendered and not withdrawn at or below $16.50 per share.  We purchased an aggregate of 1,000,000 shares of common stock at a purchase price of $16.50 per share.  The resulting proration factor for the tender offer was approximately 67.42%. The tender offer was funded with available cash and borrowings under our $15 million unsecured line of credit.

 

During 2002, we entered into an operating line of credit agreement providing for borrowings of up to $15.0 million.  The proceeds from this line of credit may be used to repurchase common shares of our outstanding stock under Board-authorized repurchase programs as well as to fund working capital, capital expenditures, and related costs.  As of December 31, 2004, we had an outstanding balance of $7.5 million on this line of credit.  Proceeds from the line of credit were used to purchase approximately 1,000,000 shares of our stock under a Board-authorized Dutch Auction tender offer. We amended the terms of the line of credit during the second quarter of 2004 to extend the maturity date to July 1, 2006.  The line of credit had an original maturity of July 1, 2004.  As of December 31, 2004, we are in compliance with all financial covenants.  We intend to pay off the line of credit during 2005 using cash generated from operating activities. Additional information with respect to this line of credit is set forth in Note 7 of the Notes to Consolidated Financial Statements appearing in Item 8 of this Report.

 

We have certain commitments related to operating leases as set forth in Note 13 of the Notes to Consolidated Financial Statements appearing in Item 8 of this Report.

 

We believe that our working capital requirements can be met through our available cash and cash equivalents and cash generated from operating activities for the foreseeable future; however, a prolonged economic downturn or a decrease in the demand for our products could adversely affect our long-term liquidity.  In the event of a significant decrease in cash provided by our operating activities, we might need to obtain additional external sources of funding.  We currently maintain an operating line of credit allowing for borrowings of up to $15.0 million of which $7.5 million has been borrowed as of December 31, 2004.  The proceeds from this line of credit may be used to repurchase common shares, as well as to fund working capital requirements. The line of credit contains other terms and conditions as well as affirmative and negative financial covenants. As of December 31, 2004 we were in compliance with these covenants.

 

11



 

We do not currently maintain a long-term credit facility or any other external sources of long-term funding; however, we believe that such funding could be obtained on competitive terms in the event additional sources of funds become necessary.

 

The following table summarizes information about contractual obligations as of December 31, 2004:

 

 

 

Total

 

Less than 1 year

 

1-3 years

 

4-5 years

 

After 5 years

 

Line of credit

 

$

7,500

 

$

7,500

 

$

 

$

 

$

 

Operating leases

 

11,791

 

4,116

 

4,825

 

2,454

 

396

 

Total contractual obligations

 

$

19,291

 

$

11,616

 

$

4,830

 

$

2,454

 

$

396

 

 

Key Accounting Policies

 

Our accounting policies are more fully described in the Note 1 of the Notes to Consolidated Financial Statements appearing in Item 8 of this Report. As disclosed in Note 1 of Notes to Consolidated Financial Statements, the preparation of financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions about future events that affect the amounts reported in the financial statements and accompanying notes. Future events and their effects cannot be determined with absolute certainty. Therefore, the determination of estimates requires the exercise of judgment. Actual results inevitably will differ from those estimates, and such differences may be material to the financial statements.

 

Revenue Recognition

 

We recognize sales revenue when products are shipped and title passes to our independent Distributors.  For most product sales, the sales price is received in the form of cash or credit card payment, which accompanies or precedes the shipment of the product.  Sales revenue is recorded net of the rebate portion of volume incentives. Further information related to volume incentives is set forth in Note 1 of the Notes to Consolidated Financial Statements appearing in Item 8 of the report. As products are shipped, persuasive evidence of an arrangement exists, delivery has occurred, the price to the buyer is fixed, and collectibility is reasonably assured. A reserve for product returns, which reduces revenue, is accrued based on historical experience.  From time to time, our United States business segment extends short-term credit associated with product promotions.  For certain of our international operations, we offer credit terms consistent with industry standards within the country of operation.  Amounts received for unshipped merchandise are not recognized as revenue but rather they are recorded as customer deposits and are included in accrued liabilities.

 

Volume Incentives Accrual

 

We accrue for expenses for volume incentives associated with our net sales revenue. Volume incentives are a significant part of our direct sales marketing program and represent payments made to our independent Distributors and Managers.  As required by EITF 01-9, we record rebates as a reduction in revenue.  As a result, volume incentive expense is reduced by the corresponding amounts each year. We specifically analyze volume incentives based on historical and current sales trends when evaluating the adequacy of the accrued volume incentives.

 

Self-insurance liabilities

 

We self-insure for certain employee medical and product liabilities. The recorded liabilities for self-insured risks are calculated using actuarial methods and are not discounted. The liabilities include amounts for actual claims and claims incurred but not reported. Actual experience, including claim frequency and severity as well as health care inflation, could result in actual liabilities being more or less than the amounts currently recorded.

 

12



 

Incentive Trip Accrual

 

We accrue for expenses for incentive trips associated with our direct sales marketing program, which rewards independent Distributors and Managers with paid attendance at our conventions and meetings. Expenses associated with incentive trips are accrued over qualification periods as they are earned. We specifically analyze incentive trip accruals based on historical and current sales trends as well as contractual obligations when evaluating the adequacy of the incentive trip accrual. Actual results could result in liabilities being more or less than the amounts recorded. We have accrued convention and meeting costs of approximately $4.3 million and $4.0 million at December 31, 2004 and 2003, respectively.

 

Recent Accounting Pronouncements

 

The Financial Accounting Standards Board (FASB) issued SFAS No. 123R, Share-Based Payment, which is effective for reporting periods beginning after June 15, 2005 (third quarter 2005 for us). SFAS No. 123R requires us to recognize the cost of employee services received in exchange for our equity instruments. Currently, in accordance with APB Opinion 25, we record the intrinsic value of stock-based compensation as expense. Accordingly, no compensation expense is currently recognized for fixed stock option plans as the exercise price equals the stock price on the date of grant. Under SFAS No. 123R, we will be required to measure compensation expense over the stock options’ vesting period based on the stock options’ fair value at the date the options are granted. SFAS No. 123R allows for the use of the Black-Scholes or a lattice option-pricing model to value such options. We have determined that we will use the Black-Scholes option-pricing model to calculate the fair value of our options. As allowed by SFAS No. 123R, we can elect either Modified Prospective Application, which applies SFAS No. 123R to new awards and modified awards after the effective date, and to any unvested awards as service is rendered on or after the effective date, or Modified Retrospective Application which can apply SFAS No. 123R to either all prior years for which SFAS No. 123 was effective or only to prior interim periods in the year of adoption. We are currently evaluating which method of application will be used. Note 1 of the Notes to Consolidated Financial Statements illustrates the effects on net income and earnings per share if we had adopted SFAS No. 123, Accounting for Stock-Based Compensation, using the Black-Scholes option-pricing model. Management does not believe the adoption will have a material effect on the Company’s results of operations, financial condition or liquidity.

 

In December 2004, the FASB issued SFAS No. 151, “Inventory Costs, an amendment of ARB No. 43, Chapter 4,” which requires that abnormal amounts of idle facility expense, freight, handling costs and wasted material (spoilage) be recognized as current-period charges. In addition, the statement requires that allocation of fixed production overheads to the costs of conversion be based on the normal capacity of the production facilities. SFAS No. 151 is effective for fiscal years beginning after June 15, 2005. The Company will adopt this statement as required, and management does not believe the adoption will have a material effect on the Company’s results of operations, financial condition or liquidity.

 

Item 7A. Quantitative and Qualitative Disclosures about Market Risk

 

We conduct business in several countries and intend to continue to expand our international operations.  Net sales revenue, operating income, and net income are affected by fluctuations in currency exchange rates, interest rates and other uncertainties inherent in doing business and selling product in more than one currency.  In addition, our operations are exposed to risks associated with changes in social, political, and economic conditions inherent in international operations, including changes in the laws and policies that govern international investment in countries where we have operations as well as, to a lesser extent, changes in United States laws and regulations relating to international trade and investment.

 

13



 

Foreign Currency Risk

 

During the year ended December 31, 2004, approximately 56.9 percent of our net sales revenue and approximately 56.5 percent of our expenses were realized outside of the United States.  Inventory purchases are transacted primarily in U.S. dollars from vendors located in the United States.  The local currency of each international subsidiary is considered the functional currency, and all revenues and expenses are translated at average exchange rates for the periods reported.  Therefore, reported sales and expenses 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 uncertainty of exchange rate fluctuations, we cannot estimate the effect of these fluctuations on our future business, product pricing, results of operations, or financial condition.  Changes in currency exchange rates affect the relative prices at which we sell our products.  We regularly monitor our foreign currency risks and periodically take measures to reduce the impact of foreign exchange rate fluctuations on our operating results.  We do not use derivative instruments for hedging, trading, or speculating on foreign exchange rate fluctuations.

 

The following table sets forth average currency exchange rates of one U.S. dollar into local currency for each of the currencies in which sales revenue exceeded $10.0 million during any of the years presented.

 

Year ended December 31

 

2004

 

2003

 

2002

 

Canada

 

1.3

 

1.4

 

1.6

 

Japan

 

108.1

 

115.8

 

125.5

 

Mexico

 

11.3

 

10.8

 

9.6

 

South Korea

 

1,144.2

 

1,190.5

 

1,245.3

 

Venezuela

 

1,880.9

 

1,615.5

 

1,106.2

 

 

During 2004 and 2003 Venezuela experienced a significant devaluation in the Bolivar, which adversely affected the results of operations.  Continued devaluation could adversely affect the results of operations in future periods.

 

During the first quarter of 2004, management determined based on the three year cumulative inflation rate that the Dominican Republic is highly inflationary and will be accounted for in accordance with FAS 52.  We believe that this change in functional currency will not have a material effect upon our results of operations, liquidity or financial position.

 

Interest Rate Risk

 

The primary objectives of our investment activities are to preserve principal while maximizing yields without significantly increasing risk.  This is accomplished by purchasing investment grade securities; substantially all of which either mature within the next 12 months or have characteristics of marketable securities.  At December 31, 2004, we had investments of $8.3 million of which $4.7 million were municipal obligations, which carry an average fixed interest rate of 5.07 percent and mature over a 5-year period. A hypothetical 1 percent change in interest rates would not have had a material effect on our liquidity, financial position, or results of operations.

 

14



 

Item 8. Financial Statements and Supplementary Data

 

MANAGEMENT’S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING

 

To the Shareholders of Nature’s Sunshine Products, Inc.:

 

The management of Nature’s Sunshine Products, Inc. (the “Company”) is responsible for establishing and maintaining adequate internal control over financial reporting as such term is defined in the Securities Exchange Act, rules 13a-15(f). The Company’s internal control over financial reporting was designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of the Company’s financial statements for external reporting purposes in accordance with U.S. generally accepted accounting principles.

 

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

 

Management assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2004. In making this assessment, it used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control – Integrated Framework. Based on our assessment, we concluded that, as of December 31, 2004, the Company’s internal control over financial reporting is effective to provide reasonable assurance regarding the reliability of financial reporting and the preparation of the Company’s financial statements for external reporting purposes in accordance with U.S. generally accepted accounting principles.

 

Our management’s assessment of the effectiveness of our internal controls over financial reporting as of December 31, 2004 has been audited by KPMG LLP, an independent registered public accounting firm, as stated in their report which appears on the following pages.

 

15



 

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

 

The Board of Directors and Shareholders of Nature’s Sunshine Products, Inc.:

 

We have audited management’s assessment, included in the accompanying Management’s Report on Internal Control over Financial Reporting that Nature’s Sunshine Products, Inc. and subsidiaries maintained effective internal control over financial reporting as of December 31, 2004, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Nature’s Sunshine Products, Inc. and subsidiaries’ management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on management’s assessment and an opinion on the effectiveness of the Company’s internal control over financial reporting based on our audit.

 

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

 

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

 

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

 

In our opinion, management’s assessment that Nature’s Sunshine Products, Inc. and subsidiaries maintained effective internal control over financial reporting as of December 31, 2004, is fairly stated, in all material respects, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Also, in our opinion, Nature’s Sunshine Products, Inc. and subsidiaries maintained, in all material respects, effective internal control over financial reporting as of December 31, 2004, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).

 

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Nature’s Sunshine Products, Inc. and subsidiaries as of December 31, 2004 and 2003, and the related consolidated statements of income and comprehensive income, shareholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2004, and our report dated March 14, 2005 expressed an unqualified opinion on those consolidated financial statements.

 

 

KMPG LLP

 

Salt Lake City, Utah
March 14, 2005

 

16



 

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

 

The Board of Directors and Shareholders of Nature’s Sunshine Products, Inc.:

 

We have audited the accompanying consolidated balance sheets of Nature’s Sunshine Products, Inc. (a Utah corporation) and subsidiaries as of December 31, 2004 and 2003, and the related consolidated statements of income and comprehensive income, shareholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2004. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.  We did not audit the financial statements of Nature’s Sunshine Korea, Ltd., a wholly owned subsidiary, for the year ended December 31, 2002, which financial statements reflect net sales revenues constituting 8 percent of the related 2002 consolidated totals.  Those statements were audited by other auditors whose report has been furnished to us, and our opinion, insofar as it relates to the amounts included for Nature’s Sunshine Korea, Ltd. for the year then ended, is based solely on the report of other auditors.

 

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits and the report of other auditors provide a reasonable basis for our opinion.

 

In our opinion, based on our audits and the report of other auditors, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Nature’s Sunshine Products, Inc. and subsidiaries as of December 31, 2004 and 2003, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2004, in conformity with U.S. generally accepted accounting principles.

 

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of Nature’s Sunshine Products, Inc. and subsidiaries internal control over financial reporting as of December 31, 2004, based on criteria established in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated March 15, 2005 expressed an unqualified opinion on management’s assessment of, and the effective operation of, internal control over financial reporting.

 

 

KMPG LLP

 

Salt Lake City, Utah
March 14, 2005

 

17



 

NATURE’S SUNSHINE PRODUCTS, INC. AND SUBSIDIARIES

 

CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME

 

(Amounts In Thousands, Except Per Share Information)

 

Year Ended December 31

 

2004

 

2003

 

2002

 

Net Sales Revenue (net of the rebate portion of volume incentives of $37,103, $39,056, and $39,249, respectively)

 

$

331,063

 

$

260,151

 

$

261,574

 

Costs and Expenses:

 

 

 

 

 

 

 

Cost of goods sold

 

62,693

 

51,927

 

53,317

 

Volume incentives

 

127,985

 

93,910

 

92,926

 

Selling, general and administrative

 

118,731

 

106,608

 

103,663

 

 

 

309,409

 

252,445

 

249,906

 

Operating Income

 

21,654

 

7,706

 

11,668

 

Other Income (Expense):

 

 

 

 

 

 

 

Interest and other income

 

568

 

1,518

 

1,090

 

Impairment of investments

 

 

(1,768

)

(3,000

)

Interest expense

 

(104

)

(268

)

(39

)

Foreign exchange gains

 

843

 

44

 

977

 

 

 

1,307

 

(474

)

(972

)

Income Before Provision for Income Taxes

 

22,961

 

7,232

 

10,696

 

Provision for Income Taxes

 

(5,883

)

(2,133

)

(3,632

)

Net Income

 

17,078

 

5,099

 

7,064

 

Other Comprehensive Income (Loss), net of tax:

 

 

 

 

 

 

 

Foreign currency translation adjustments

 

81

 

(1,150

)

(4,120

)

Net unrealized losses on marketable securities

 

(18

)

(58

)

(861

)

Reclassification adjustment for net realized (gains) losses on marketable securities included in net income

 

(27

)

279

 

1,459

 

 

 

36

 

(929

)

(3,522

)

Comprehensive Income

 

$

17,114

 

$

4,170

 

$

3,542

 

 

 

 

 

 

 

 

 

Basic Net Income Per Common Share

 

$

1.14

 

$

0.36

 

$

0.45

 

Diluted Net Income Per Common Share

 

$

1.10

 

$

0.36

 

$

0.43

 

 

See accompanying notes to consolidated financial statements.

 

18



 

NATURE’S SUNSHINE PRODUCTS, INC. AND SUBSIDIARIES

 

CONSOLIDATED BALANCE SHEETS

 

(Amounts In Thousands)

 

As of December 31

 

2004

 

2003

 

Assets

 

 

 

 

 

Current Assets:

 

 

 

 

 

Cash and cash equivalents

 

$

36,206

 

$

30,665

 

Accounts receivable, net of allowance for doubtful accounts of $1,862 and $2,138, respectively

 

6,540

 

5,567

 

Inventories, net

 

36,713

 

26,528

 

Deferred income tax assets

 

4,525

 

3,553

 

Prepaid expenses and other

 

8,522

 

9,723

 

Total current assets

 

92,506

 

76,036

 

Property, plant and equipment, net

 

34,731

 

32,318

 

Long-term investments

 

7,746

 

6,416

 

Definite-lived intangible assets, net

 

1,757

 

2,094

 

Deferred income tax asset, net

 

5,734

 

5,359

 

Other assets

 

2,602

 

3,335

 

 

 

$

145,076

 

$

125,558

 

Liabilities and Shareholders’ Equity

 

 

 

 

 

Current Liabilities:

 

 

 

 

 

Line of credit

 

$

7,500

 

$

5,000

 

Accounts payable

 

4,509

 

4,003

 

Accrued volume incentives

 

14,662

 

12,093

 

Accrued liabilities

 

20,665

 

18,009

 

Income taxes payable

 

4,476

 

6,879

 

Total current liabilities

 

51,812

 

45,984

 

Deferred compensation

 

2,045

 

2,232

 

Commitments and Contingencies (Note 13)

 

 

 

 

 

Shareholders’ Equity:

 

 

 

 

 

Common stock, no par value; 20,000 shares authorized, 19,446 shares issued

 

21,692

 

25,437

 

Retained earnings

 

139,074

 

124,997

 

Treasury stock, at cost, 4,571 and 5,267 shares, respectively

 

(51,324

)

(54,833

)

Accumulated other comprehensive loss

 

(18,223

)

(18,259

)

Total shareholders’ equity

 

91,219

 

77,342

 

 

 

$

145,076

 

$

125,558

 

 

See accompanying notes to consolidated financial statements.

 

19



 

NATURE’S SUNSHINE PRODUCTS, INC. AND SUBSIDIARIES

 

CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY

 

(Amounts In Thousands)

 

Year Ended December 31

 

2004

 

2003

 

2002

 

Common Stock:

 

 

 

 

 

 

 

Balance at beginning of year

 

$

25,437

 

$

31,332

 

$

36,308

 

Tax benefit related to exercise of stock options

 

3,337

 

189

 

628

 

Issuance of 1,698, 373, and 397 shares of treasury stock, respectively

 

(7,082

)

(6,084

)

(5,604

)

Balance at end of year

 

21,692

 

25,437

 

31,332

 

Retained Earnings:

 

 

 

 

 

 

 

Balance at beginning of year

 

124,997

 

121,789

 

116,836

 

Net income

 

17,078

 

5,099

 

7,064

 

Cash dividends

 

(3,001

)

(1,891

)

(2,111

)

Balance at end of year

 

139,074

 

124,997

 

121,789

 

Treasury Stock:

 

 

 

 

 

 

 

Balance at beginning of year

 

(54,833

)

(51,891

)

(43,538

)

Purchase of 1,002, 1,326, and 1,532 shares of common stock, respectively

 

(16,999

)

(11,796

)

(16,877

)

Issuance of 1,698, 373, and 397 shares of treasury stock, respectively

 

20,508

 

8,854

 

8,524

 

Balance at end of year

 

(51,324

)

(54,833

)

(51,891

)

Accumulated Other Comprehensive Loss:

 

 

 

 

 

 

 

Balance at beginning of year

 

(18,259

)

(17,330

)

(13,808

)

Other comprehensive income(loss)

 

36

 

(929

)

(3,522

)

Balance at end of year

 

(18,223

)

(18,259

)

(17,330

)

Total Shareholders’ Equity

 

$

91,219

 

$

77,342

 

$

83,900

 

 

See accompanying notes to consolidated financial statements.

 

20



 

NATURE’S SUNSHINE PRODUCTS, INC. AND SUBSIDIARIES

 

CONSOLIDATED STATEMENTS OF CASH FLOWS

 

(Amounts In Thousands)

 

Increase (Decrease) in Cash and Cash Equivalents

 

Year Ended December 31

 

2004

 

2003

 

2002

 

CASH FLOWS FROM OPERATING ACTIVITIES:

 

 

 

 

 

 

 

Net income

 

$

17,078

 

$

5,099

 

$

7,064

 

Adjustments to reconcile net income to net cash provided by operating activities:

 

 

 

 

 

 

 

Increase (decrease) in allowance for doubtful accounts

 

(276

)

415

 

1,682

 

Depreciation and amortization

 

5,728

 

6,388

 

8,298

 

Tax benefit from stock option exercise

 

3,337

 

189

 

628

 

Loss on sale of property and equipment

 

311

 

203

 

117

 

Deferred income taxes

 

(1,252

)

(3,265

)

(4,953

)

Deferred compensation

 

(187

)

747

 

(140

)

Loss on impaired investment

 

 

1,808

 

3,000

 

Changes in assets and liabilities:

 

 

 

 

 

 

 

Accounts receivable

 

(599

)

(549

)

(602

)

Inventories

 

(9,798

)

165

 

374

 

Prepaid expenses and other

 

1,541

 

(3,189

)

2,233

 

Accounts payable

 

457

 

956

 

(1,835

)

Accrued volume incentives

 

2,312

 

2,133

 

(2,163

)

Accrued liabilities

 

2,405

 

4,235

 

1,835

 

Income taxes payable

 

(2,978

)

1,959

 

913

 

Net cash provided by operating activities

 

18,079

 

17,294

 

16,451

 

CASH FLOWS FROM INVESTING ACTIVITIES:

 

 

 

 

 

 

 

Capital expenditures

 

(8,124

)

(3,702

)

(6,076

)

Proceeds from sale of investments

 

4,753

 

5,084

 

780

 

Purchase of investments

 

(6,128

)

(2,699

)

(598

)

(Purchase) sale of other assets

 

829

 

(351

)

(113

)

Payments received on long-term receivables, net

 

624

 

1,663

 

526

 

Proceeds from sale of property and equipment

 

126

 

161

 

127

 

Net cash provided by (used in) investing activities

 

(7,920

)

156

 

(5,354

)

CASH FLOWS FROM FINANCING ACTIVITIES:

 

 

 

 

 

 

 

Net proceeds from line of credit

 

2,500

 

(500

)

5,500

 

Purchase of treasury stock

 

(16,999

)

(11,796

)

(16,877

)

Payments of cash dividends

 

(3,001

)

(1,891

)

(2,111

)

Proceeds from exercise of stock options

 

13,422

 

2,743

 

2,894

 

Net cash used in financing activities

 

(4,078

)

(11,444

)

(10,594

)

Effect of Exchange Rates on Cash and Cash Equivalents

 

(540

)

(1,516

)

(4,116

)

Net Increase (Decrease) in Cash and Cash Equivalents

 

5,541

 

4,490

 

(3,613

)

Cash and Cash Equivalents at Beginning of the Year

 

30,665

 

26,175

 

29,788

 

Cash and Cash Equivalents at End of the Year

 

$

36,206

 

$

30,665

 

$

26,175

 

 

Year Ended December 31

 

2004

 

2003

 

2002

 

Supplemental disclosure of cash flow information:

 

 

 

 

 

 

 

Cash paid for income taxes

 

$

4,706

 

$

4,519

 

$

4,659

 

Cash paid for interest

 

75

 

262

 

39

 

Supplemental disclosure of non-cash investing and financing activities:

 

 

 

 

 

 

 

Disposition of assets in exchange for note receivable

 

$

 

$

 

$

83

 

 

See accompanying notes to consolidated financial statements.

 

21



 

NATURE’S SUNSHINE PRODUCTS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Amounts in thousands, except per share information)

 

NOTE 1: NATURE OF OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES

 

Nature of Operations

 

Nature’s Sunshine Products, Inc. and its subsidiaries (hereinafter referred to collectively as the “Company”) are primarily engaged in the manufacturing and marketing of herbal products, vitamin and mineral supplements, personal care, and miscellaneous other products.  Nature’s Sunshine Products, Inc. is a Utah corporation headquartered in Provo, Utah. The Company sells its products to a sales force of independent Distributors and Managers who use the products themselves or resell them to other Distributors or consumers. The formulation, manufacturing, packaging, labeling, advertising, distribution and sale of each of the Company’s major product groups are subject to regulation by one or more governmental agencies.

 

The Company markets its products in the United States, South Korea, Mexico, Venezuela, Japan, Brazil, Canada, Central America, Colombia, Dominican Republic, Ecuador, Peru, the United Kingdom, Israel, Taiwan, Thailand, Singapore and Australia. The Company also exports its products to several other countries, including Argentina, Australia, Chile, New Zealand, Norway, and the Russian Federation.

 

Principles of Consolidation

 

The accompanying consolidated financial statements include the accounts and transactions of Nature’s Sunshine Products, Inc. and its subsidiaries.  At December 31, 2004 and 2003, all of the Company’s subsidiaries were wholly owned. Intercompany balances and transactions have been eliminated in consolidation.

 

Use of Estimates

 

The preparation of financial statements in conformity with U. S. generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts in these financial statements and accompanying notes.  Due to inherent uncertainty, actual results could differ from these estimates and those differences could have a material affect on the Company’s financial position and results of operations.

 

The most significant accounting estimates inherent in the preparation of the Company’s financial statements include estimates associated with its evaluation of impairment of long-lived assets as well as those used in the determination of liabilities related to Distributor and Manager incentives and in the determination of income tax assets and liabilities.  In addition, significant estimates form the basis for allowances with respect to the collection of accounts receivable, inventory valuations and certain benefits provided to employees. Various assumptions and other factors enter in to the determination of these significant estimates. The process of determining significant estimates is fact specific and takes into account historical experience and current and expected economic conditions. Historically, actual results have not significantly deviated from those determined using the estimates described above.

 

22



 

Cash and Cash Equivalents

 

The Company considers all highly liquid short-term investments with original maturities of three months or less to be cash equivalents.  The amount of short-term investments classified as cash equivalents total $488 and $3,845 at December 31, 2004 and 2003, respectively.  The majority of the Company’s cash deposits exceed the United States federally insured limit and a significant portion of the cash balances are located in countries that do not have government insured accounts.

 

Allowance for Doubtful Accounts Receivable

 

Accounts receivable have been reduced by an allowance for amounts that may be uncollectible in the future.  This estimated allowance is based primarily on the aging category, historical trends and management’s evaluation of the financial condition of the customer.  This reserve is adjusted periodically as information about specific accounts becomes available.

 

Investments

 

The Company’s investments, which are categorized as available-for-sale securities, are reported at fair value, with unrealized gains and losses, net of tax, recorded in accumulated other comprehensive income (loss) in shareholders’ equity.  Unrealized losses on available-for-sale securities that are determined to be other than temporary are included in the determination of net income in the period that determination is made.  The cost of the securities sold is based on the specific identification method.  Realized gains and losses on sales of available-for-sale securities are included in interest and other income.

 

The Company has certain investments classified as trading securities.  The Company maintains its trading securities portfolio to generate returns that offset changes in certain liabilities related to the Company’s deferred compensation arrangements (see Note 11).  The trading securities portfolio consists of marketable securities, which are recorded at fair value.  Both realized and unrealized gains and losses on trading securities are included in interest and other income.

 

Fair Value of Financial Instruments

 

The Company’s financial instruments consist primarily of cash, cash equivalents, trade and notes receivable, long-term investments, trade payables, and debt instruments. The carrying values of these financial instruments approximate their fair values.  The estimated fair values have been determined using appropriate market information and valuation methodologies.

 

Inventories

 

Inventories are stated at the lower of cost (using the first-in, first-out method) or market value.

 

Property, Plant and Equipment

 

Property, plant and equipment are recorded at cost less accumulated depreciation and amortization.  Depreciation is computed using the straight-line method over the estimated useful lives of the related assets.  Estimated useful lives for buildings and improvements range from 20 to 30 years, and equipment, furniture and fixtures range from 3 to 10 years.  Leasehold improvements are amortized over the shorter of the lease term or the estimated useful lives of the related assets.  Maintenance and repairs are expensed as incurred, and major improvements are capitalized.  Gains or losses on sales or retirements are included in interest and other income in the consolidated statement of income.

 

23



 

Intangible Assets

 

Intangible assets consist of acquired distributor networks associated with the acquisition of Synergy Worldwide, Inc. (“Synergy”).  Definite-lived intangible assets are being amortized using the straight-line method over a period of ten years. Intangible assets, net of accumulated amortization, totaled $1,757 and $2,094 at December 31, 2004 and 2003, respectively.  Accumulated amortization totaled $1,456 and $1,119 at December 31, 2004 and 2003, respectively (see Note 5).

 

Impairment of Long-Lived Assets

 

The Company reviews its long-lived assets for impairment when events or changes in circumstances indicate that the carrying value of an asset may not be recoverable. The Company uses an estimate of future undiscounted net cash flows of the related assets or groups of assets over their remaining lives in measuring whether the assets are recoverable.  An impairment loss is calculated by determining the difference between the carrying values and the fair values of these assets. At December 31, 2004, the Company did not consider any of its long-lived assets to be impaired.

 

Translation of Foreign Currencies

 

The local currency of the international subsidiaries is used as the functional currency, except for subsidiaries operating in highly inflationary economies.  The financial statements of international subsidiaries, where the local currency is the functional currency, are translated into U.S. dollars using exchange rates in effect at year end for assets and liabilities and average exchange rates during each year for the results of operations. Adjustments resulting from translation of financial statements are reflected in accumulated other comprehensive loss.

 

There were no countries considered to have a highly inflationary economy during 2004, 2003, and 2002.  However, the Company has determined that during the first quarter of 2005 the Dominican Republic will become highly inflationary.  The functional currency in highly inflationary economies is the U.S. dollar and transactions denominated in the local currency are re-measured as if the functional currency were the U.S. dollar.  The re-measurement of local currencies into U.S. dollars creates translation adjustments, which are included in the consolidated statements of income and comprehensive income.

 

Revenue Recognition

 

For sales transactions in the United States, the Company generally receives its product sales price in the form of cash or credit card accompanying the orders from independent Distributors and Managers. From time to time, the Company’s United States operation extends short-term credit associated with product promotions.  For certain of the Company’s international operations, the Company offers credit terms consistent with industry standards within each respective country.  Net sales revenue and related volume incentive expenses are recorded when persuasive evidence of an arrangement exists, collectibility is reasonably assured, the amount is fixed and determinable, title and risk of loss have passed, and the merchandise has been shipped. Amounts received for unshipped merchandise are recorded as deferred revenue and are included in accrued liabilities. Cash payments of volume incentives related to product orders are made in the month following the sale.

 

The Company accounts for payments made to its Distributors and Managers in accordance with Emerging Issues Task Force Issue (“EITF”) No. 01-9, “Accounting for Consideration Given by a Vendor to a Customer (Including a Reseller of the Vendor’s Products)”.  In accordance with EITF 01-9, payments to Distributors and Managers for sales incentives or rebates are recorded as a reduction of revenue.

 

24



 

The Company accounts for shipping and handling fees in accordance with EITF No. 00-10, “Accounting for Shipping and Handling Fees and Costs.”  Under EITF 00-10 guidelines, amounts billed to a customer for shipping and handling are classified as revenue.  Shipping and handling revenues of approximately $14,877, $8,309, and $6,883 were classified as net sales revenue for the years ended December 31, 2004, 2003, and 2002, respectively.  The corresponding shipping and handling expenses are classified in selling, general and administrative expenses and approximated the amounts classified as net sales revenue.

 

Selling Expenses

 

Independent Distributors and Managers may earn Company-paid attendance at conventions as well as other travel awards by achieving the required levels of product purchases within a specified qualification period.  Convention costs and other travel expenses are accrued over the qualification period as they are earned.  Accordingly, the Company has accrued convention costs of approximately $4,346, $3,992, and $3,753 at December 31, 2004, 2003, and 2002, respectively.

 

Research and Development

 

All research and development costs are expensed as incurred and classified in selling, general and administrative expense. Total research and development expenses were approximately $1,700, $2,100, and $2,192 in 2004, 2003, and 2002, respectively.

 

Income Taxes

 

The Company recognizes a liability or asset for the deferred income tax consequences of temporary differences between the tax basis of assets or liabilities and their reported amounts in the financial statements.  These temporary differences will result in taxable or deductible amounts in future years when the reported amounts of the assets or liabilities are recovered or settled. The deferred income tax assets are reviewed for recoverability and valuation allowances are provided as necessary (see Note 9).

 

Net Income Per Common Share

 

Basic net income per common share (Basic EPS) excludes dilution and is computed by dividing net income by the weighted-average number of common shares outstanding during the year.  Diluted net income per common share (Diluted EPS) reflects the potential dilution that could occur if stock options or other contracts to issue common stock were exercised or converted into common stock.  The computation of Diluted EPS does not assume exercise or conversion of securities that would have an anti-dilutive effect on net income per common share.

 

25



 

Following is a reconciliation of the numerator and denominator of Basic EPS to the numerator and denominator of Diluted EPS for all years:

 

 

 

Net Income
(Numerator)

 

Shares
(Denominator)

 

Per Share
Amount

 

December 31, 2004

 

 

 

 

 

 

 

Basic EPS

 

$

17,078

 

14,917

 

$

1.14

 

Effect of options

 

 

561

 

 

 

Diluted EPS

 

$

17,078

 

15,478

 

$

1.10

 

December 31, 2003

 

 

 

 

 

 

 

Basic EPS

 

$

5,099

 

14,181

 

$

0.36

 

Effect of options

 

 

155

 

 

 

Diluted EPS

 

$

5,099

 

14,336

 

$

0.36

 

December 31, 2002

 

 

 

 

 

 

 

Basic EPS

 

$

7,064

 

15,844

 

$

0.45

 

Effect of options

 

 

652

 

 

 

Diluted EPS

 

$

7,064

 

16,496

 

$

0.43

 

 

At December 31, 2004, 2003, and 2002, there were outstanding options to purchase 34, 494, and 250 shares of common stock, respectively, that were not included in the computation of Diluted EPS because the options’ exercise prices were greater than the average market price of the common shares during the year.

 

Stock Options

 

The Company accounts for employee stock-based compensation plans under Accounting Principles Board Opinion No. 25, under which no compensation cost has been recognized in the accompanying consolidated statements of income for the years ended December 31, 2004, 2003, and 2002.  Had compensation costs been determined consistent with SFAS No. 123, “Accounting for Stock-Based Compensation”, the Company’s net income and earnings per common share would have been reduced to the following pro forma amounts:

 

Year ended December 31

 

2004

 

2003

 

2002

 

Net Income

 

As reported

 

$

17,078

 

$

5,099

 

$

7,064

 

 

 

Stock option expense

 

(445

)

(249

)

(870

)

 

 

Pro forma

 

16,633

 

4,850

 

6,194

 

 

 

 

 

 

 

 

 

 

 

Basic Earnings Per Share

 

As reported

 

$

1.14

 

$

0.36

 

$

0.45

 

 

 

Stock option expense

 

(0.02

)

(0.02

)

(0.06

)

 

 

Pro forma

 

1.12

 

0.34

 

0.39

 

 

 

 

 

 

 

 

 

 

 

Diluted Earnings Per Share

 

As reported

 

$

1.10

 

$

0.36

 

$

0.43

 

 

 

Stock option expense

 

(0.03

)

(0.02

)

(0.05

)

 

 

Pro forma

 

1.07

 

0.34

 

0.38

 

 

26



 

The weighted average fair value of options granted was $12.29, $8.57, and $11.89 for 2004, 2003, and 2002, respectively.  The fair value of each option granted is estimated on the date of grant using the Black-Scholes option- pricing model with the following weighted-average assumptions used for grants: risk-free interest rate of 3.3 percent in 2004, 2003, and 2002 with an expected life of 5 years. The expected dividend yield was approximately 1.6 percent in 2004 and 1.4 percent in 2003 and 2002, respectively.  The expected volatility was 52 percent, 61 percent, and 61 percent in 2004, 2003, and 2002, respectively.  The estimated fair value of options granted is subject to the assumptions made, and if the assumptions were to change, the estimated fair value amounts could be significantly different.

 

Reclassifications

 

Certain reclassifications have been made in the prior years’ consolidated financial statements to conform to the current year presentation.  During the years ended December 31, 2003 and 2002, we reclassified to Sales Revenue $1,943 and $2,089, respectively, of membership fees that were previously recorded as a decrease to selling, general and administrative expenses.

 

Recent Accounting Pronouncements

 

The Financial Accounting Standards Board (FASB) issued SFAS No. 123R, Share-Based Payment, which is effective for reporting periods beginning after June 15, 2005 (third quarter 2005 for the Company). SFAS No. 123R requires the Company to recognize the cost of employee services received in exchange for the Company’s equity instruments. Currently, in accordance with APB Opinion 25, the Company records the intrinsic value of stock based compensation as expense. Accordingly, no compensation expense is currently recognized for fixed stock option plans as the exercise price equals the stock price on the date of grant. Under SFAS No.123R, the Company will be required to measure compensation expense over the stock options’ vesting period based on the stock options’ fair value at the date the options are granted. SFAS No. 123R allows for the use of the Black-Scholes or a lattice option-pricing model to value such options. The Company has determined that it will use the Black-Scholes option-pricing model to calculate the fair value of its options. As allowed by SFAS No. 123R, the Company can elect either Modified Prospective Application, which applies SFAS No. 123R to new awards and modified awards after the effective date, and to any unvested awards as service is rendered on or after the effective date, or Modified Retrospective Application which can apply SFAS No. 123R to either all prior years for which SFAS No. 123 was effective or only to prior interim periods in the year of adoption. The Company is currently evaluating which method of application will be used.   Management does not believe the adoption will have a material effect on the Company’s results of operations, financial condition or liquidity.

 

In December 2004, the FASB issued SFAS No. 151, “Inventory Costs, an amendment of ARB No. 43, Chapter 4,” which requires that abnormal amounts of idle facility expense, freight, handling costs and wasted material (spoilage) be recognized as current-period charges. In addition, the statement requires that allocation of fixed production overheads to the costs of conversion be based on the normal capacity of the production facilities. SFAS No. 151 is effective for fiscal years beginning after June 15, 2005. The Company will adopt this statement as required, and management does not believe the adoption will have a material effect on the Company’s results of operations, financial condition or liquidity.

 

NOTE 2: DISPOSITIONS

 

On August 1, 2002, the Company sold the assets of Comercializadora Nature’s Sunshine Chile LTDA., a wholly owned subsidiary of Nature’s Sunshine Products, Inc. with operations in Chile, for an $83 note receivable.  The $83 note receivable for the assets sold under the terms of the agreement is due over a two-year period and bears interest at a rate of 5.0 percent, which represented a market rate of interest at the origination date of the note. The assets sold are collateral for the note receivable.

 

27



 

NOTE 3: INVENTORIES

 

The composition of inventories is as follows:

 

As of December 31

 

2004

 

2003

 

Raw materials

 

$

8,705

 

$

6,940

 

Work in process

 

694

 

914

 

Finished goods

 

27,314

 

18,674

 

 

 

$

36,713

 

$

26,528

 

 

NOTE 4: PROPERTY, PLANT AND EQUIPMENT

 

The composition of property, plant and equipment is as follows:

 

As of December 31

 

2004

 

2003

 

Buildings and improvements

 

$

28,092

 

$

27,101

 

Machinery and equipment

 

20,975

 

19,156

 

Furniture and fixtures

 

22,451

 

18,752

 

 

 

71,518

 

65,009

 

Accumulated depreciation and amortization

 

(38,019

)

(33,921

)

Land

 

1,232

 

1,230

 

 

 

$

34,731

 

$

32,318

 

 

NOTE 5: INTANGIBLE ASSETS

 

In connection with the adoption of SFAS No. 142 in 2002, the Company reassessed the useful lives and classification of its intangible assets.  The Company determined that $3,213 of previously identified goodwill should be classified as an acquired distributor network and should continue to be amortized over a 10-year period using the straight-line method.  The Company has determined that none of its intangible assets are impaired.

 

The Company’s acquired distributor networks consist of the following:

 

 

 

As of December 31, 2004

 

As of December 31, 2003

 

 

 

Carrying
Amount

 

Accumulated
Amortization

 

Net

 

Carrying
Amount

 

Accumulated
Amortization

 

Net

 

Acquired Distributor Networks

 

$

3,213

 

$

1,456

 

$

1,757

 

$

3,213

 

$

1,119

 

$

2,094

 

 

Amortization expense for intangible assets for the years ended December 31, 2004, 2003, and 2002 was $337, $953, and $1,759, respectively.  Estimated amortization expense for the five succeeding fiscal years and thereafter is as follows:

 

 

 

Estimated
Amortization
Expense

 

2005

 

$

299

 

2006

 

299

 

2007

 

299

 

2008

 

299

 

2009

 

299

 

Thereafter

 

262

 

 

 

$

1,757

 

 

28



 

NOTE 6: INVESTMENTS

 

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

 

As of December 31, 2004

 

Amortized
Cost

 

Gross
Unrealized
Gains

 

Gross
Unrealized
Losses

 

Fair
Value

 

Cash equivalents:

 

 

 

 

 

 

 

 

 

Municipal obligations

 

$

487

 

$

1

 

$

 

$

488

 

Total cash equivalents

 

487

 

1

 

 

488

 

Long-term investments:

 

 

 

 

 

 

 

 

 

Municipal obligations

 

4,667

 

90

 

(16

)

4,741

 

U.S. Government Securities Fund

 

606

 

 

 

606

 

Equity securities

 

211

 

140

 

 

351

 

Total long-term investments

 

5,484

 

230

 

(16

)

5,698

 

 

As of December 31, 2003

 

Amortized
Cost

 

Gross
Unrealized
Gains

 

Gross
Unrealized
Losses

 

Fair
Value

 

Cash equivalents:

 

 

 

 

 

 

 

 

 

Municipal obligations

 

$

3,844

 

$

1

 

$

 

$

3,845

 

Total cash equivalents

 

3,844

 

1

 

 

3,845

 

Long-term investments:

 

 

 

 

 

 

 

 

 

Municipal obligations

 

3,697

 

158

 

 

3,855

 

Equity securities

 

212

 

116

 

 

328

 

Total long-term investments

 

3,909

 

274

 

 

4,183

 

 

Contractual maturities of municipal obligations fair value at December 31, 2004, are as follows:

 

Mature after one year through five years

 

$

3,461

 

Mature after five years

 

1,280

 

Total long-term investments

 

$

4,741

 

 

During 2004, 2003, and 2002, the proceeds from the sales of available-for-sale securities were $485, $198, and $780, respectively.  The gross realized gains on sales of available-for-sale securities were $28, $152, and $69 for the years ended December 31, 2004, 2003, and 2002, respectively.  The gross realized losses on the sales of available-for-sale securities were $0, $98, and $71 for the years ended December 31, 2004, 2003, and 2002, respectively.

 

The Company’s long-term and short-term trading securities portfolio totaled $2,113 and $2,424 at December 31, 2004 and 2003, respectively, and generated income of $23 and losses of $1,378, respectively.

 

As of December 31, 2004, the Company had unrealized losses of $16 in its municipal obligations investments.  These losses are due to the interest rate sensitivity of these investments.

 

For the purposes of determining realized gains or losses on the sale of available-for-sale securities, the Company determines the cost of the securities sold using the specific identification method.

 

29



 

NOTE 7: LINE OF CREDIT

 

The Company has an operating line of credit with an interest rate equal to LIBOR (2.75 percent as of December 31, 2004) plus 1.5 percent, which provides for borrowings of up to $15.0 million.  Borrowings under this line of credit may be used for working capital, capital expenditures, and other related costs.  The line of credit is unsecured and matures July 1, 2006. However, the Company intends to pay off the line of credit during 2005 and therefore it has been classified as current.  The outstanding borrowings under this line of credit at December 31, 2004 totaled $7,500.  The weighted average amount of borrowings outstanding on this line of credit during 2004 and 2003 was $1,170 and $8,250, respectively.  The weighted average interest rate for 2004 and 2003 was 3.64 percent and 3.18 percent, respectively.  The line of credit contains other terms and conditions as well as affirmative and negative financial covenants. As of December 31, 2004, the Company was in compliance with these covenants.

 

NOTE 8: ACCUMULATED OTHER COMPREHENSIVE LOSS

 

The composition of accumulated other comprehensive loss, net of tax, is as follows:

 

 

 

Foreign Currency
Translation
Adjustments

 

Net Unrealized
Gains (Losses) On
Available-For-Sale
Securities

 

Total
Accumulated Other
Comprehensive Loss

 

Balance as of December 31, 2001

 

$

(13,158

)

$

(650

)

$

(13,808

)

Period Change

 

(4,120

)

598

 

(3,522

)

Balance as of December 31, 2002

 

(17,278

)

(52

)

(17,330

)

Period Change

 

(1,150

)

221

 

(929

)

Balance as of December 31, 2003

 

(18,428

)

169

 

(18,259

)

Period Change

 

81

 

(45

)

36

 

Balance as of December 31, 2004

 

$

(18,347

)

$

124

 

$

(18,223

)

 

NOTE 9: INCOME TAXES

 

The domestic and foreign components of income (loss) before provision for income taxes are as follows:

 

Year Ended December 31

 

2004

 

2003

 

2002

 

Domestic

 

$

11,022

 

$

(5,026

)

$

(2,263

)

Foreign

 

11,939

 

12,258

 

12,959

 

Total

 

22,961

 

$

7,232

 

$

10,696

 

 

The provision for income taxes consists of the following:

 

Year Ended December 31

 

2004

 

2003

 

2002

 

Current:

 

 

 

 

 

 

 

Federal

 

$

2,811

 

$

2,500

 

$

799

 

State

 

252

 

249

 

472

 

Foreign

 

4,169

 

3,374

 

5,402

 

 

 

7,232

 

6,123

 

6,673

 

Deferred:

 

 

 

 

 

 

 

Federal

 

$

(346

)

(4,098

)

(1,954

)

State

 

(50

)

(50

)

12

 

Foreign

 

(953

)

158

 

(1,099

)

 

 

(1,349

)

(3,990

)

(3,041

)

Total provision for income taxes

 

$

5,883

 

$

2,133

 

$

3,632

 

 

30



 

The income tax benefits associated with employee exercises of options under the nonqualified stock option plan decreased the income taxes payable by $3,337, $189, and $628 in 2004, 2003, and 2002, respectively.  These benefits were recorded as a direct increase to common stock.

 

The provision for income taxes, as a percentage of income before provision for income taxes, differs from the statutory U.S. federal income tax rate due to the following:

 

Year Ended December 31

 

2004

 

2003

 

2002

 

Statutory U.S. federal income tax rate

 

35.0

%

35.0

%

35.0

%

State income taxes, net of U.S. federal income tax benefit

 

2.5

 

(2.5

)

(0.8

)

Net effect of foreign taxes

 

(11.4

)

1.2

 

4.3

 

Valuation allowance change related to operations

 

 

(3.3

)

1.4

 

Write-off of subsidiary investments

 

 

 

(5.3

)

Other

 

(0.5

)

(0.9

)

(0.6

)

Effective income tax rate

 

25.6

%

29.5

%

34.0

%

 

The significant components of the deferred income tax assets and liabilities are as follows:

 

Year Ended December 31

 

2004

 

2003

 

Deferred income tax assets:

 

 

 

 

 

Inventory

 

$

1,092

 

$

1,064

 

Accrued liabilities

 

2,393

 

1,841

 

Impaired investments

 

1,517

 

1,454

 

State income taxes

 

65

 

87

 

Foreign taxes

 

5,724

 

4,888

 

AMT carry forward

 

106

 

201

 

Deferred compensation

 

773

 

918

 

Amortization of intangibles

 

678

 

629

 

Bad debts

 

899

 

1,230

 

Net operating losses

 

2,843

 

2,442

 

Valuation allowance

 

(3,607

)

(3,350

)

Other

 

720

 

(155

)

Total deferred income tax assets

 

13,203

 

11,249

 

Deferred income tax liabilities:

 

 

 

 

 

Accelerated depreciation

 

(2,109

)

(1,515

)

Other

 

(835

)

(823

)

Total deferred income tax liabilities

 

(2,944

)

(2,338

)

Net deferred income tax assets

 

$

10,259

 

$

8,911

 

 

Management has provided a valuation allowance of $3,607 and $3,350 for 2004 and 2003, respectively, for certain international subsidiaries deferred income tax assets for which management does not believe it is more likely than not that they will be realized in accordance with SFAS No. 109.  During 2004, the Company reviewed its foreign tax positions and increased its valuation allowances by approximately $257.

 

At December 31, 2004, the Company had available net operating losses for foreign income tax purposes of $7,428.  Generally, the tax net operating losses will expire at various dates from 2005 through 2011.  The Company has approximately $5,724 of foreign tax credits, which begin to expire in 2012.

 

31



 

NOTE 10: CAPITAL TRANSACTIONS

 

Treasury Stock

 

During 2004, the Company recorded a $17.0 million increase to treasury stock upon the completion of a Dutch Auction tender offer by repurchasing 1,000 shares of outstanding stock.  The Dutch Auction tender was open to all shareholders of the Company including employees.  Employees were required to tender outstanding shares and be at risk consistent with all shareholders; therefore, no compensation cost was recorded for shares repurchased from employees.

 

During 2004, 2003, and 2002, the Company repurchased 1,002, 1,326, and 1,532 shares of common stock for a total of $16,999, $11,796, and $16,877, respectively. As of December 31, 2004, the Company has no current Board authorization to purchase additional common shares on the open market.

 

Stock Options

 

The Company maintains a stock option plan, which provides for the granting or awarding of certain nonqualified stock options to officers, directors and other employees.  The term, not to exceed 10 years, and the vesting and exercise period of each stock option awarded under the plan are determined by the Company’s Board of Directors.  All grants were made at the quoted fair market value of the stock at the date of grant.  At December 31, 2004, the Company had approximately 106 shares available to be granted under the plan.  At December 31, 2004, the Company had reserved 1,463 treasury shares to accommodate the exercise of outstanding options.

 

Stock option activity for 2004, 2003, and 2002 consisted of the following:

 

 

 

Number of
Shares

 

Weighted Average Exercise
Price Per Share

 

Options outstanding at December 31, 2001

 

3,823

 

$

8.04

 

Issued

 

130

 

11.89

 

Forfeited or canceled

 

(30

)

8.89

 

Exercised

 

(395

)

7.33

 

Options outstanding at December 31, 2002

 

3,528

 

8.26

 

Issued

 

66

 

8.57

 

Forfeited or canceled

 

(113

)

10.72

 

Exercised

 

(370

)

7.41

 

Options outstanding at December 31, 2003

 

3,111

 

8.28

 

Issued

 

95

 

12.29

 

Forfeited or canceled

 

(45

)

8.96

 

Exercised

 

(1,698

)

7.91

 

Options outstanding at December 31, 2004

 

1,463

 

$

8.94

 

 

Shares related to the exercise of stock options were issued from treasury stock during 2004, 2003, and 2002.  Options for 1,281, 2,915, and 2,952 shares of common stock with weighted average exercise prices of $8.85, $8.19, and $8.12, were exercisable on December 31, 2004, 2003, and 2002, respectively.

 

The following table summarizes information about options outstanding and options exercisable at December 31, 2004.

 

 

 

Options Outstanding

 

Options Exercisable

 

Range of Option
Prices Per Share

 

Shares
Outstanding

 

Weighted-Avg.
Remaining
Contractual Life

 

Weighted-Avg.
Exercise Price
Per Share

 

Shares
Exercisable

 

Weight-Avg.
Exercise Price
Per Share

 

$6.50 to $9.95

 

1,183

 

1.9 years

 

$

7.96

 

1,023

 

$

7.88

 

$10.00 to $16.88

 

280

 

4.1 years

 

13.08

 

258

 

12.71

 

$6.50 to $16.88

 

1,463

 

2.3 years

 

8.94

 

1,281

 

8.85

 

 

32



 

NOTE 11: EMPLOYEE BENEFIT PLANS

 

Deferred Compensation Plans

 

The Company sponsors a qualified deferred compensation plan, which qualifies under Section 401(k) of the Internal Revenue Code.  The Company makes matching contributions of 100 percent of employee contributions up to a maximum of five percent of the employee’s compensation.  The Company’s contributions to the plan vest after a period of three years.  During 2004, 2003, and 2002, the Company contributed to the plan approximately $863, $902, and $894, respectively.

 

The Company provides a nonqualified deferred compensation plan for its officers and certain key employees.  Under this plan, participants may defer up to 100 percent of their annual salary and bonus (less the participant’s share of employment taxes).  The deferrals become an obligation owed to the participant by the Company under the plan.  At the end of each year and at other times provided under the plan, the Company adjusts its obligation to a participant by the investment return or loss on the funds selected by the participant under rules established in the plan.  The plan is not qualified under Section 401 of the Internal Revenue Code.  Upon separation of the participant from the service of the Company, the obligation owed to the participant under the plan will be paid over a period of either three or five years (and will continue to be adjusted by the applicable investment return or loss during the period of pay-out).  At December 31, 2004 and 2003, the amounts payable under the plan are valued at the fair market value of the related assets and total $2,045 and $2,232, respectively.

 

Management and Employee Bonus Plan

 

The Company has a bonus plan that provides for participants to receive payments based upon the achievement of specified annual increases in net sales revenue and operating income as set by the Board of Directors as well as individual objectives. The expense related to the bonus plan was approximately $6,076, $2,364, and $2,277 for 2004, 2003, and 2002, respectively, these amounts were accrued as liabilities in the respective year-end consolidated balance sheets. All United States employees as well as key international employees participate in the bonus plan.

 

NOTE 12: IMPAIRMENT OF INVESTMENTS

 

During 2001, the Company’s wholly owned subsidiary, Innovative Botanical Solutions, Inc., entered into an exclusive agreement with Cetalon Corporation to manufacture a proprietary line of Cetalon-branded herbs and vitamins.  Additionally, Innovative Botanical Solutions, Inc., purchased approximately $2,000 in Cetalon common stock.  This investment was recorded using the cost method, carried at the lower of cost or fair market value and classified as available for sale.  A loan of $1,000 with a market rate of interest was also provided to Cetalon Corporation, and in connection therewith, Innovative Botanical Solutions, Inc., obtained an option to purchase additional shares of Cetalon common stock.  Two officers of the Company were members of the Board of Directors of Cetalon for a period of time between May 2001 and January 2002.  These officers were not compensated for serving in this capacity and resigned in January 2002, one having served for seven months and the other having served for three months.  During the three months ended March 31, 2002, it was determined that the investment and loan to Cetalon Corporation were impaired.  Accordingly, the Company wrote off its entire investment of $3,000 in Cetalon.

 

During 2003, the Company recorded an impairment on in its equity investment in HealtheTech, Inc., a publicly traded company.  Management determined that the impairment was an other-than-temporary decline in value and wrote down the investment to its quoted market value.  As a result, the Company recorded an impairment loss of $1,768 in other expense during 2003.

 

33



 

NOTE 13: COMMITMENTS AND CONTINGENCIES

 

The Company leases certain facilities and equipment used in its operations and accounts for leases with escalatory payments using the straight-line method. The Company incurred expenses of approximately $4,766, $3,754, and $4,044 in connection with operating leases during 2004, 2003, and 2002, respectively. The approximate aggregate commitments under non-cancelable operating leases in effect at December 31, 2004, were as follows:

 

Year Ending December 31

 

 

 

2005

 

$

4,116

 

2006

 

2,784

 

2007

 

2,041

 

2008

 

1,411

 

2009

 

1,043

 

Thereafter

 

396

 

 

 

$

11,791

 

 

The Company is a defendant in various lawsuits which are incidental to the Company’s business. Management, after consultation with legal counsel, believes that any liability as a result of these matters will not have a material adverse effect upon the Company’s business prospects, results of operations, liquidity, or financial position.

 

Similar to other manufacturers and distributors of products that are ingested, the Company faces an inherent risk of exposure to product liability claims in the event that, among other things, the use of its products results in injury.  As a result of increased regulatory scrutiny of products that contain ephedrine alkaloids and kava, the Company has not been able to obtain product liability insurance covering such products.  Effective April 12, 2004, the Company complied with the U.S. Food and Drug Administration’s ban on the ingredient ephedra. The Company carries insurance in the types and amounts it considers reasonably adequate to cover the risks associated with its business. On June 1, 2003, the Company established a wholly owned captive insurance company to provide it with product liability insurance coverage.  The Company has accrued an amount that it believes is sufficient to cover probable and reasonably estimable liabilities related to product liability claims based on the Company’s history of such claims.  However, there can be no assurance that these estimates will prove to be sufficient nor can there be any assurance that the ultimate outcome of any litigation for product liability will not have a material negative impact on the Company’s business prospects, financial position, results of operations, or liquidity.

 

The Company self-insures for certain employee medical and product liabilities. The recorded liabilities for self-insured risks are calculated using actuarial methods and are not discounted. The liabilities include amounts for actual claims and claims incurred but not reported.  Actual experience, including claim frequency and severity as well as health care inflation, could result in actual liabilities being more or less than the amounts currently recorded.

 

34



 

NOTE 14: OPERATING BUSINESS SEGMENT AND INTERNATIONAL OPERATION INFORMATION

 

The Company has three operating business segments.  These operating segments are components of the Company for which separate information is available that is evaluated regularly by management in deciding how to allocate resources and in assessing performance. The Company evaluates performance based on operating income (loss).

 

The Company has two operating business segments based on geographic operations that include a United States segment and an international segment that operate under the Nature’s Sunshine Products name.  The Company’s third operating segment operates under the Synergy Worldwide name.  The segments have similar business characteristics and each offers similar products through similar methods of distribution as described in Note 1.  The accounting policies of the segments are the same as those described in the summary of significant accounting policies in Note 1.  Inter-segment sales, eliminated in consolidation, are not material. The Company evaluates performance based on operating income (loss) by segment before consideration of certain inter-segment transfers and expenses.

 

During the year ended December 31, 2004, the Company changed the composition of its operating segments as a result of converting certain locations from Nature’s Sunshine to Synergy Worldwide operations and has restated the corresponding items of segment information from prior periods.

 

Operating business segment information for the years ended December 31, 2004, 2003, and 2002 is as follows:

 

Year Ended December 31

 

2004

 

2003

 

2002

 

Sales Revenue:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Nature’s Sunshine Products:

 

 

 

 

 

 

 

United States

 

$

142,780

 

$

143,567

 

$

148,084

 

International

 

104,633

 

89,641

 

85,579

 

 

 

247,413

 

233,208

 

233,663

 

Synergy Worldwide

 

83,650

 

26,943

 

27,911

 

 

 

331,063

 

260,151

 

261,574

 

Operating Expenses:

 

 

 

 

 

 

 

Nature’s Sunshine Products:

 

 

 

 

 

 

 

United States

 

134,683

 

136,177

 

138,681

 

International

 

94,254

 

86,496

 

82,364

 

 

 

228,937

 

222,673

 

221,045

 

Synergy Worldwide

 

80,472