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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q

 

(Mark One)

 

x      QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended September 30, 2009

 

OR

 

o         TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from                          to                         ..

 

Commission File Number:  0-8707

 

 

NATURE’S SUNSHINE PRODUCTS, INC.

(Exact name of Registrant as specified in its charter)

 

 

75 East 1700 South

Provo, Utah  84606

(Address of principal executive offices and zip code)

 

(801) 342-4300

(Registrant’s telephone number including area code)

 

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 x No o

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every

Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).     Yes o No o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act (Check one).

 

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).     Yes o No x

 

The number of shares of Common Stock, no par value, outstanding on October 31, 2009 was 15,510,159 shares.

 

 

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NATURE’S SUNSHINE PRODUCTS, INC.

FORM 10-Q

 

For the Quarter Ended September 30, 2009

 

Table of Contents

 

Part I. Financial Information
	Item 1. Financial Statements (Unaudited)
		Condensed Consolidated Balance Sheets	3
		Condensed Consolidated Statements of Operations	4
		Condensed Consolidated Statements of Cash Flows	6
		Notes to Condensed Consolidated Financial Statements	7
	Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	21
	Item 3.	Quantitative and Qualitative Disclosures about Market Risk	29
	Item 4.	Controls and Procedures	32
Part II. Other Information
	Item 1.	Legal Proceedings	35
	Item 1A.	Risk Factors	35
	Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	36
	Item 3.	Default Upon Senior Securities	36
	Item 4.	Submission of Matters to a Vote of Security Holders	36
	Item 5.	Other Information	38
	Item 6.	Exhibits	38

 

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PART I FINANCIAL INFORMATION

 

Item 1.  FINANCIAL STATEMENTS

 

NATURE’S SUNSHINE PRODUCTS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(Amounts in thousands)

(Unaudited)

 

		September 30, 2009			December 31, 2008
Assets
Current Assets:
Cash and cash equivalents		$	36,263		$	34,853
Accounts receivable, net of allowance for doubtful accounts of $1,779 and $1,472, respectively		11,921			10,786
Investments available for sale		3,370			3,858
Restricted investments		—			2,050
Inventories, net		40,640			39,558
Deferred income tax assets		9,568			9,080
Prepaid expenses and other current assets		8,205			7,935
Total current assets		109,967			108,120
Property, plant and equipment, net		28,945			30,224
Investment securities		1,646			1,394
Intangible assets		1,450			1,538
Deferred income tax assets		6,558			6,412
Other assets		16,431			16,588
		$	164,997		$	164,276
Liabilities and Shareholders’ Equity
Current Liabilities:
Accounts payable		$	7,498		$	8,777
Accrued volume incentives		18,272			15,753
Accrued liabilities		41,690			45,475
Deferred revenue		4,249			5,167
Income taxes payable		3,999			2,748
Total current liabilities		75,708			77,920
Liability related to unrecognized tax benefits		31,676			30,952
Deferred compensation payable		1,646			1,394
Other liabilities		3,219			333
Total long-term liabilities		36,541			32,679
Commitments and Contingencies (Note 10)
Shareholders’ Equity:
Common Stock, no par value; 20,000 shares authorized, 15,510 shares issued and outstanding as of September 30, 2009 and December 31, 2008		66,705			66,705
Retained earnings		5,548			4,172
Accumulated other comprehensive loss		(19,505		)	(17,200		)
Total shareholders’ equity		52,748			53,677
		$	164,997		$	164,276

 

See accompanying notes to condensed consolidated financial statements.

 

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NATURE’S SUNSHINE PRODUCTS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

 (Amounts in thousands, except per share information)

(Unaudited)

 

		Three Months Ended September 30,
		2009			2008
Net Sales Revenue (net of the rebate portion of volume incentives of $11,466 and $12,267, respectively)		$	85,777		$	92,661
Cost and Expenses:
Cost of goods sold		17,299			17,146
Volume incentives		31,068			34,580
Selling, general and administrative		31,203			38,864
		79,570			90,590
Operating Income		6,207			2,071
Other Income (Expense), Net		1,300			(448		)
Income Before Provision for Income Taxes		7,507			1,623
Provision for Income Taxes		5,427			1,789
Net Income (Loss)		$	2,080		$	(166	)
Basic Net Income (Loss) Per Common Share		$	0.13		$	(0.01	)
Diluted Net Income (Loss) Per Common Share		$	0.13		$	(0.01	)
Weighted Average Basic Common Shares Outstanding		15,510			15,510
Weighted Average Diluted Common Shares Outstanding		15,510			15,510

 

See accompanying notes to condensed consolidated financial statements.

 

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NATURE’S SUNSHINE PRODUCTS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

 (Amounts in thousands, except per share information)

(Unaudited)

 

		Nine Months Ended September 30,
		2009			2008
Net Sales Revenue (net of the rebate portion of volume incentives of $34,920 and $38,799, respectively)		$	253,102		$	285,023
Cost and Expenses:
Cost of goods sold		50,633			53,159
Volume incentives		93,281			107,634
Selling, general and administrative		103,769			117,882
		247,683			278,675
Operating Income		5,419			6,348
Other Income (Expense), Net		3,048			(495		)
Income Before Provision for Income Taxes		8,467			5,853
Provision for Income Taxes		6,315			7,163
Net Income (Loss)		$	2,152		$	(1,310	)
Basic Net Income (Loss) Per Common Share		$	0.14		$	(0.08	)
Diluted Net Income (Loss) Per Common Share		$	0.14		$	(0.08	)
Weighted Average Basic Common Shares Outstanding		15,510			15,510
Weighted Average Diluted Common Shares Outstanding		15,510			15,510

 

See accompanying notes to condensed consolidated financial statements.

 

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NATURE’S SUNSHINE PRODUCTS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

 (Amounts in thousands)

(Unaudited)

 

		Nine Months Ended September 30,
		2009			2008
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss)		$	2,152		$	(1,310	)
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
Provision for doubtful accounts		129			1,027
Depreciation and amortization		3,425			4,381
Share-based compensation expense		—			86
Loss on sale of property and equipment		140			62
Deferred income taxes		(361		)	(531		)
Amortization of bond discount		21			29
Purchase of trading investment securities		(169		)	(119		)
Proceeds from sale of trading investment securities		65			78
Realized and unrealized (gains) losses on investments		(194		)	261
Amortization of prepaid taxes related to gain on intercompany sales		911			942
Foreign exchange gains		(2,268		)	(100		)
Changes in assets and liabilities:
Accounts receivable		(1,043		)	(1,207		)
Inventories		(696		)	(3,523		)
Prepaid expenses and other current assets		(196		)	(1,843		)
Other assets		(283		)	(942		)
Accounts payable		(946		)	1,299
Accrued volume incentives		2,226			1,591
Accrued liabilities		(3,239		)	2,614
Deferred revenue		(918		)	(1,773		)
Income taxes payable		1,235			2,745
Liability related to unrecognized tax positions		724			187
Deferred compensation payable		252			(137		)
Net cash provided by operating activities		967			3,817
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property, plant and equipment		(2,452		)	(6,767		)
Proceeds from sale of investments available for sale		600			640
Purchases of investments available for sale		(5		)	—
Proceeds from sale of restricted investments		2,050			25
Proceeds from sale of property, plant and equipment		53			79
Net cash provided by (used in) investing activities		246			(6,023		)
CASH FLOWS FROM FINANCING ACTIVITIES:
Payment of cash dividends		(776		)	(2,327		)
Proceeds from short-term borrowings		7,900			—
Payments on short-term borrowings		(7,900		)	—
Net cash used in financing activities		(776		)	(2,327		)
Effect of exchange rates on cash and cash equivalents		973			(880		)
Net increase (decrease) in cash and cash equivalents		1,410			(5,413		)
Cash and cash equivalents at the beginning of the period		34,853			45,299
Cash and cash equivalents at end of the period		$	36,263		$	39,886
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid for income taxes		$	6,632		$	2,169
Cash paid for interest		$	69		$	59

 

See accompanying notes to condensed consolidated financial statements.

 

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NATURE’S SUNSHINE PRODUCTS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Amounts in thousands, except per-share information)

(Unaudited)

 

(1)                     Basis of Presentation

 

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 products, and miscellaneous products. Nature’s Sunshine Products, Inc. is a Utah corporation with its principal place of business 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, China, Hong Kong, Poland, South Korea, Mexico, Venezuela, Japan, Brazil, Canada, Central America, Colombia, the Dominican Republic, Ecuador, Peru, the United Kingdom, Austria, Germany, the Netherlands, Norway, Sweden, the Czech Republic, Israel, Taiwan, Thailand, Singapore, Indonesia, Malaysia, the Philippines, Australia, Russia, Ukraine, Latvia, Lithuania, Kazakhstan, Mongolia, and Belarus. The Company also exports its products to several other countries, including Argentina, Australia, Chile, New Zealand, and Norway.

 

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. The unaudited condensed consolidated financial statements include the accounts of the Company and its subsidiaries.  All significant intercompany accounts and transactions are eliminated in consolidation. In the opinion of management, the accompanying unaudited condensed consolidated financial statements contain all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation of the Company’s financial information as of September 30, 2009, and for the three and nine-month periods ended September 30, 2009 and 2008.  The results of operations of any interim period are not necessarily indicative of the results of operations to be expected for the fiscal year ending December 31, 2009.

 

These condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and the notes thereto included in the Company’s Annual Report on Form 10-K/A for the year ended December 31, 2008.

 

During 2008, the Company determined that it had a variable interest and was the primary beneficiary in a development stage entity. As a result, the Company has consolidated the entity in accordance with authoritative guidance issued by the Financial Accounting Standards Board (“FASB”) related to the consolidation of variable interest entities.   This variable interest is the result of loans provided by the Company to the entity during 2008 and early 2009, which are secured by the entity’s assets. The Company provided loans to the entity in order to provide them with some of the capital necessary to market its products, and to provide the Company with access to new product formulations. The Company has provided no guarantees on behalf of the entity and has no future obligations to the entity.  Its creditors do not have any recourse against the Company.  The Company has provided additional loans of $0 and $439 during the three and nine months ended September 30, 2009, respectively. The effect of consolidating the variable interest entity was a decrease of the Company’s net income of $141 and $570 for the three and nine month periods ended September 30, 2009. During the three months ended September 30, 2009, the entity had no significant operations.

 

The Company records Volume Incentives that represent purchase rebates as a reduction of sales revenue.  As part of the Company’s review of the quarterly results for the three months ended March 31, 2009, it identified that the volume rebates for the branches in Russia and Ukraine had been recorded as an expense rather than as a reduction of sales revenue.  There was no impact on beginning or ending retained earnings, operating income, net loss, loss per share, or cash flows for any periods. As a result, the Company is correcting its condensed consolidated statements of operations for the three month and nine-month periods ending September 30, 2008 as follows:

 

		Three Months Ended September 30, 2008						Nine Months Ended September 30, 2008
		As Previously Presented			As Corrected			As Previously Presented			As Corrected
Net sales revenue		$	94,669		$	92,661		$	291,105		$	285,023
Volume incentives		36,588			34,580			113,716			107,634

 

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Recent Accounting Pronouncements

 

Recently Adopted Accounting Guidance

 

In December 2007, the FASB issued new guidance on business combinations that changes how business combinations are accounted for and will impact financial statements both on the acquisition date and in subsequent periods. In addition, the guidance expands required disclosures surrounding the nature and financial affects of business combinations. The Company adopted this guidance on January 1, 2009, and will apply it to future business combinations.

 

In December 2007, the FASB issued new guidance on noncontrolling interests in a subsidiary that changes the accounting and reporting standards for the noncontrolling interests in a subsidiary in consolidated financial statements.  The guidance recharacterizes minority interest as noncontrolling interests and requires noncontrolling interests to be classified as a component of shareholders’ equity. The guidance requires retroactive adoption of the presentation and disclosure requirements for existing minority interest. The Company’s adoption of this guidance, effective January 1, 2009, did not have a material impact on the Company’s financial condition, results of operations, or cash flows.

 

In April 2008, the FASB issued authoritative guidance related to the determination of the useful life of intangible assets. The guidance states that in developing assumptions about renewal or extension options used to determine the useful life of an intangible asset, an entity needs to consider its own historical experience adjusted for entity-specific factors. In the absence of that experience, an entity shall consider the assumptions that market participants would use about renewal or extension options. This guidance is to be applied to intangible assets acquired after January 1, 2009. The adoption of this guidance did not have an impact on the Company’s financial condition, results of operations, or cash flows.

 

In April 2009, the FASB issued new guidance requiring disclosures about the fair value of financial instruments for interim reporting periods of publicly-traded companies, as well as in annual financial statements. The disclosure requirements of this guidance are effective for interim reporting periods ending after June 15, 2009. The Company has included the additional disclosures in the accompanying Notes to the Unaudited Condensed Consolidated Financial Statements.

 

In April 2009, the FASB issued new guidance that amends the other-than-temporary impairment guidance in GAAP for debt securities to make the guidance more operational and to improve the presentation and disclosure of other-than-temporary impairments of debt and equity securities in the financial statements. This guidance does not amend existing recognition and measurement guidance related to other-than-temporary impairments of equity securities. The guidance is effective for interim and annual reporting periods ending after June 15, 2009. The adoption of this guidance did not have an impact on the Company’s financial condition, results of operations, or cash flows.

 

In April 2009, the FASB issued new guidance providing additional guidance on factors to consider in estimating fair values when there has been a significant decrease in the market activity for a financial asset or liability. It also includes guidance on identifying circumstances that indicate a transaction is not orderly. This guidance is effective for interim and annual reporting periods ending after June 15, 2009, and shall be applied prospectively. The adoption of this guidance did not have an impact on the Company’s financial condition, results of operations, or cash flows.

 

In May 2009, the FASB issued new authoritative guidance on events that occur after the balance sheet date but prior to the issuance of the financial statements. The guidance distinguishes events requiring recognition in the financial statements and those that may require disclosure in the financial statements. Furthermore, it requires disclosure of the date through which subsequent events were evaluated. This guidance is effective for interim and annual periods after June 15, 2009. The Company has adopted this guidance during the quarter ended June 30, 2009, and has evaluated subsequent events through November 9, 2009, the date of this filing.

 

In June 2009, the FASB Accounting Standards CodificationTM and the Hierarchy of Generally Accepted Accounting Principles,” (“Codification”) was issued. The Codification supersedes all existing accounting standard documents and is the single source of authoritative non-governmental U.S. GAAP. All other accounting literature not included in the Codification will be considered non-authoritative. The Codification was implemented on July 1, 2009 and is effective for interim and annual periods ending after September 15, 2009. The Company’s notes to the condensed consolidated financial statements reflect the adoption of the Codification.

 

 

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Recent Accounting Guidance Not Yet Adopted

 

In June 2009, the FASB issued an amendment to the accounting and disclosure requirements for the consolidation of variable interest entities (“VIEs”). The amendment requires an enterprise to determine whether its variable interest or interests give it a controlling financial interest in a VIE.  The primary beneficiary of a VIE is the enterprise that has both the power to direct the activities of the VIE that most significantly impact the entity’s economic performance and has the obligation to absorb losses or the right to receive benefits from the entity that could potentially be significant to the VIE. The amendment requires ongoing reassessments of whether an enterprise is the primary beneficiary of a VIE as well expanded disclosure requirements for enterprises with an interest in a VIE. The guidance is effective for fiscal years beginning after November 15, 2009, with early adoption prohibited.  The Company does not expect the adoption of this amendment to have a material impact on its financial condition, results of operations, or cash flows.

 

In October 2009, the FASB issued amendments to the accounting and disclosure for revenue recognition.  These amendments, effective for fiscal years beginning on or after June 15, 2010 (early adoption is permitted), modify the criteria for recognizing revenue in multiple element arrangements and the scope of what constitutes a non-software deliverable.  Although applicable to the Company, the Company does not expect the adoption of these amendments to have a material impact on its financial condition, results of operations, or cash flows.

 

(2)                     Inventories

 

Inventories consist of the following:

 

		September 30, 2009			December 31, 2008
Raw Materials		$	9,567		$	9,515
Work in Progress		854			766
Finished Goods		30,219			29,277
		$	40,640		$	39,558

 

(3)                     Intangible Assets

 

At September 30, 2009 and December 31, 2008, product formulations had a gross carrying amount of $1,763 and $1,763, accumulated amortization of $313 and $225, and a net amount of $1,450 and $1,538, respectively. The useful lives of the product formulations are estimated to be 15 years.

 

Amortization expense for intangible assets for the three months ended September 30, 2009 and 2008 was $29 and $40, respectively. Amortization expense for intangible assets for the nine months ended September 30, 2009 and 2008 was $88 and $99, respectively. Estimated amortization expense for each of the five succeeding fiscal years is $118.

 

(4)                     Investment Securities

 

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

 

As of September 30, 2009		Amortized Cost			Gross Unrealized Gains			Gross Unrealized Losses			Fair Value
Municipal obligations		$	2,237		$	119		$	—		$	2,356
U.S. government securities funds		697			15			—			712
Equity securities		234			73			(5		)	302
Total short-term investment securities		$	3,168		$	207		$	(5	)	$	3,370

 

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As of December 31, 2008		Amortized Cost			Gross Unrealized Gains			Gross Unrealized Losses			Fair Value
Municipal obligations		$	2,858		$	66		$	(1	)	$	2,923
U.S. government securities funds		691			19			—			710
Equity securities		233			—			(8		)	225
Total short-term investment securities		$	3,782		$	85		$	(9	)	$	3,858

 

Contractual maturities of municipal obligations fair value at September 30, 2009, are as follows:

 

Mature less than one year		$	378
Mature after one year through five years		1,760
Mature after five years		218
Total		$	2,356

 

During the nine months ended September 30, 2009 and 2008, the proceeds from the sales of available-for-sale securities were $600 and $640, respectively. The gross realized gains on sales of available-for-sale securities (net of tax) were $0 for each of the three and nine months ended September 30, 2009 and 2008. The gross realized losses on the sales of available-for-sale securities (net of tax) were $0 for each of the three and nine month ended September 30, 2009 and 2008.

 

The Company’s trading securities portfolio totaled $1,646 at September 30, 2009 and $1,394 at December 31, 2008, and generated gains of $96 and losses of $9 for the three months ended September 30, 2009 and 2008, respectively, and generated gains of $142 and losses of $41 for the nine months ended September 30, 2009 and 2008, respectively.

 

As of September 30, 2009 and December 31, 2008, the Company had unrealized losses of $5 and $9, respectively, in its municipal obligations and equity securities investments. These losses are due to the interest rate sensitivity of the municipal obligations and the performance of the overall stock market for the equity securities.

 

As of September 30, 2009 and December 31, 2008, none of the Company’s investments included unrealized losses that were considered to be other-than-temporary impairments.

 

(5)                     Net Income (Loss) Per Share

 

Basic net income (loss) per common share (“Basic EPS”) is computed by dividing net income (loss) by the weighted-average number of common shares outstanding during the period.  Diluted net income (loss) 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 common stock equivalents that would have an anti-dilutive effect on net income (loss) per common share.

 

The following is a reconciliation of the numerator and denominator of Basic EPS to the numerator and denominator of Diluted EPS for the three and nine months ended September 30, 2009 and 2008.

 

		Net Income (Loss) (Numerator)			Shares (Denominator)		Net Income (Loss) Per Share Amount
Three Months Ended September 30, 2009
Basic EPS		$	2,080		15,510		$	0.13
Effect of options		—			—		—
Diluted EPS		$	2,080		15,510		$	0.13
Three Months Ended September 30, 2008
Basic EPS		$	(166	)	15,510		$	(0.01	)
Effect of options		—			—		—
Diluted EPS		$	(166	)	15,510		$	(0.01	)

 

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		Net Income (Loss) (Numerator)			Shares (Denominator)		Net Income (Loss) Per Share Amount
Nine Months Ended September 30, 2009
Basic EPS		$	2,152		15,510		$	0.14
Effect of options		—			—		—
Diluted EPS		$	2,152		15,510		$	0.14
Nine Months Ended September 30, 2008
Basic EPS		$	(1,310	)	15,510		$	(0.08	)
Effect of options		—			—		—
Diluted EPS		$	(1,310	)	15,510		$	(0.08	)

 

For the three and nine months ended September 30, 2009, a total of 205 exercisable options to purchase shares of common stock were not included in the computation of diluted earnings per share because their exercise price was greater than the average market price of the common shares and, therefore, the effect would be anti-dilutive. Because of net losses in the three and nine-month periods ended September 30, 2008, outstanding common stock options of 282 were not included in the computation of diluted earnings per share because the effect on net loss per share would be anti-dilutive.

 

(6)                     Comprehensive Income (Loss)

 

The components of comprehensive income (loss), net of tax, for the three and nine-month periods ended September 30, 2009 and 2008, respectively, are as follows:

 

		Three Months Ended September 30,
		2009			2008
Net income (loss)		$	2,080		$	(166	)
Foreign currency translation gain (loss)		118			(408		)
Net unrealized gains (losses) on investment securities		50			(24		)
Total comprehensive income (loss)		$	2,248		$	(598	)

 

		Nine Months Ended September 30,
		2009			2008
Net income (loss)		$	2,152		$	(1,310	)
Foreign currency translation (loss) gain		(2,367		)	87
Net unrealized gains (losses) on investment securities		62			(101		)
Total comprehensive loss		$	(153	)	$	(1,324	)

 

(7)                     Capital Transactions

 

Dividends

 

The Company paid cash dividends of $776 and $2,327 during the nine months ended September 30, 2009 and 2008, respectively. During the second quarter of 2009, the Company suspended payment of its quarterly cash dividend.

 

Share-based Compensation

 

Share-based compensation expense from nonqualified stock options for the three-month periods ended September 30, 2009 and 2008 was approximately $0; the related tax benefit was approximately $0.  Share-based compensation expense from nonqualified stock options for the nine-month periods ended September 30, 2009 and 2008 was approximately $0 and $86, respectively; the related tax benefit was approximately $0 and $33, respectively. As of September 30, 2009, there was no unrecognized share based compensation related to issued qualified or non-qualified employee stock options.

 

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Stock option activity for the nine-months ended September 30, 2009 is as follows:

 

		Number of Shares		Weighted Average  Exercise Price Per Share
Options outstanding at December 31, 2008		263		$	11.77
Granted		—		—
Forfeited or canceled		(58	)	11.79
Exercised		—		—
Options outstanding at September 30, 2009		205		11.76
Exercisable at September 30, 2009		205		$	11.76

 

No options were granted or exercised during the three and nine-month periods ended September 30, 2009 and 2008. The aggregate intrinsic value of options outstanding and exercisable at September 30, 2009 and 2008 was $0 and $0, respectively.

 

On September 24, 2009, the Company granted options to purchase approximately 250 shares under its 2009 Stock Incentive Plan (the “Plan”) subject to the Plan’s approval by the Company’s shareholders.  On November 6, 2009, the Plan was approved by a vote of the Company’s shareholders.  Under the Plan, 750 shares have been reserved for the issuance of awards under the Plan.  All employees, officers, consultants, independent contractors and non-employee members of the Board of Directors of the Company are eligible to participate in the Plan.  The Compensation Committee of the Board of Directors have exclusive authority and complete discretion to determine which individuals are to receive awards, the type of award, the number of shares, and the terms and condition of the award.

 

(8)                     Segment Information

 

The Company has three business segments. These reportable segments are components of the Company for which separate information is available and evaluated regularly by the chief operating decision maker in deciding how to allocate resources and in assessing performance.

 

The Company has two reportable 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 reportable business segment is Synergy Worldwide, which offers products with formulations different from those of the Nature’s Sunshine Products offerings as well as marketing and Distributor compensation plans sufficiently different from those of Nature’s Sunshine Products to warrant its treatment as a separate reportable segment. Net sales revenues for each segment have been reduced by any intercompany sales as they are not included in the measure of segment profit or loss reviewed by the chief operating decision maker. The Company evaluates performance based on operating income (loss) by segment before consideration of certain inter-segment transfers and expenses.

 

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Reportable segment information is as follows:

 

		Three Months Ended September 30,						Nine Months Ended September 30,
		2009			2008			2009			2008
Net Sales Revenue:
Nature’s Sunshine Products:
United States		$	37,596		$	37,288		$	113,571		$	115,380
International		33,226			41,416			98,391			126,676
		70,822			78,704			211,962			242,056
Synergy Worldwide		14,955			13,957			41,140			42,967
		85,777			92,661			253,102			285,023
Operating Expenses:
Nature’s Sunshine Products:
United States		35,181			37,108			108,572			113,925
International		29,476			38,415			93,536			117,349
		64,657			75,523			202,108			231,274
Synergy Worldwide		14,913			15,067			45,575			47,401
		79,570			90,590			247,683			278,675
Operating Income (Loss):
Nature’s Sunshine Products:
United States		2,415			180			4,999			1,455
International		3,750			3,001			4,855			9,327
		6,165			3,181			9,854			10,782
Synergy Worldwide		42			(1,110		)	(4,435		)	(4,434		)
		6,207			2,071			5,419			6,348
Other Income (Expense), Net		1,300			(448		)	3,048			(495		)
Income Before Provision for Income Taxes		$	7,507		$	1,623		$	8,467		$	5,853

 

From an individual country perspective, only the United States, Japan, Russia and Ukraine comprise approximately 10 percent or more of consolidated net sales revenue for any of the three and nine-month periods ended September 30, 2009 and 2008 as follows:

 

		Three Months Ended September 30,								Nine Months Ended September 30,
		2009				2008				2009			2008
Sales Revenue:
United States		$	38,392			$	38,412			$	115,147		$		116,147
Russia		6,370				8,669				21,679			29,164
Japan		6,635				9,295				20,571			29,672
Other		34,380				36,285				95,705			110,040
Total Sales Revenue		$		85,777		$		92,661		$	253,102		$	285,023

 

Net sales revenue by product group has not been disclosed as management has determined that it is impracticable to accumulate such information.

 

Long-lived assets by geographical area as of September 30, 2009 and December 31, 2008 are as follows:

 

		September 30, 2009			December 31, 2008
Long-Lived Assets:
United States		$	22,832		$	23,723
Venezuela		4,657			4,646
Other		2,906			3,393
Total Long-Lived Assets		$	30,395		$	31,762

 

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(9)                     Income Taxes

 

Interim income taxes are based on an estimated annualized effective tax rate applied to the respective quarterly periods, adjusted for discrete tax items in the period in which they occur.  For the three months ended September 30, 2009 and 2008, the Company’s provision for income taxes, as a percentage of income before income taxes, was approximately 72.3 percent and 110.2 percent, respectively, compared with a U.S. federal statutory rate of 35.0 percent. For the nine months ended September 30, 2009 and 2008, the Company’s provision for income taxes, as a percentage of income before income taxes, was approximately 74.6 percent and 122.4 percent, respectively, compared with a U.S. federal statutory rate of 35.0 percent.

 

The differences between the effective rate and the U.S. federal statutory rate for the three and nine months ended September 30, 2009 and 2008, are primarily attributed to increases in tax liabilities associated with uncertain tax positions, the U.S. tax impact of foreign operations, and increases in foreign valuation allowances primarily related to foreign subsidiary net losses for which no tax benefit is being recognized.  Tax amounts recorded related to the uncertain tax positions, valuation allowances, and other permanent tax items have a significant impact on the effective tax rate. The effective rate declined in the three and nine-month periods ended September 30, 2009 compared to the same periods in the prior year primarily as a result of the permanent tax items having less impact on the higher pre-tax income.

 

As of September 30, 2009, the Company had accrued $20,399 (net of $11,277 of other assets related to competent authority and royalty benefits) related to unrecognized tax positions compared with $19,675 (net of $11,277 of other assets related to competent authority and royalty benefits) as of December 31, 2008.  This net increase is primarily attributed to increases in liabilities recorded related to transfer pricing.

 

In October 2009, the Internal Revenue Service (“IRS”) issued an examination report formally proposing adjustments with respect to the 2003 through 2005 taxable years, which primarily relate to the prices that were charged in intragroup transfers of property and the disallowance of related deductions. The Company expects to commence administrative proceedings with the Office of Appeals of the Internal Revenue Service challenging the proposed adjustments. Management believes that the Company has appropriately reserved for these matters at an amount which it believes will ultimately be due upon resolution of the administrative proceedings. The Company is currently unable to determine the outcome of these discussions and their related impact, if any, on the Company’s financial condition, results of operations, or cash flows.

 

The Company has also been advised by the IRS that it will begin to examine the Company’s tax returns for the 2006 and 2007 taxable years. The Company anticipates this audit will commence during the quarter ending December 31, 2009. The Company’s U.S. federal income tax returns are open from 2003 to 2008, and the Company has several foreign jurisdictions that have open years between 2003 and 2008.

 

Although the Company believes its estimates for unrecognized tax positions are reasonable, the Company can make no assurance that the final outcome of these matters will not be different from that which it has reflected in its historical income tax provisions and accruals. Such difference could have a material impact on the Company’s income tax provision and operating results in the period in which the Company makes such determination.

 

(10)              Commitments and Contingencies

 

Legal Proceedings

 

The Company is party to various legal proceedings, including those noted below. Management cannot predict the ultimate outcome of these proceedings, individually or in the aggregate, or their resulting effect on the Company’s business, financial position, results of operations or cash flows as litigation and related matters are subject to inherent uncertainties, and unfavorable rulings could occur. Were an unfavorable outcome to occur, there exists the possibility of a material adverse impact on the business, financial position, results of operations, or cash flows for the period in which the ruling occurs or future periods. The Company maintains directors’ and officers’ liability, product liability, general liability and excess liability insurance coverage. However, no assurances can be given that such insurance will continue to be available at an acceptable cost to the Company, that such coverage will be sufficient to cover one or more large claims, or that the insurers will not successfully disclaim coverage as to a pending or future claim.

 

Class-Action Litigation

 

Between April 3, 2006 and June 2, 2006, five separate shareholder class-action lawsuits were filed against the Company and certain of its present and former officers and directors in the United States District Court for the District of Utah. These matters were consolidated and on November 3, 2006, the plaintiffs filed a consolidated complaint (the “Consolidated Complaint”) against the Company, the Company’s Chief Executive Officer and a director, Douglas Faggioli, the Company’s former Chief Financial Officer, Craig D. Huff, and a former director and former Chair of the Company’s Audit Committee, Franz L. Cristiani. The Consolidated Complaint asserts three separate claims on behalf of purchasers of the Company’s common stock: (1) a claim against Mr. Faggioli and the Company for violation of Section 10(b) of the Securities Exchange Act of 1934, as amended (“the Exchange Act”) and Rule 10b-5 promulgated thereunder, alleging that Mr. Faggioli made a series of alleged material misrepresentations to the investing public; (2) a

 

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claim against Mr. Faggioli and the Company for violation of Section 10(b) and Rule 10b-5, alleging that Mr. Faggioli made a series of misrepresentations to the Company’s then independent auditor, KPMG, LLP (“KPMG”), for the purpose of obtaining unqualified or “clean” audit opinions and review opinions from KPMG concerning certain of the Company’s annual and quarterly financial statements; and (3) a claim against Messrs. Faggioli, Huff and Cristiani for violation of Section 20(a) of the Exchange Act, alleging that the individual defendants have “control person” liability for the previously-alleged violations by the Company. The Consolidated Complaint seeks an unspecified amount of compensatory damages, together with interest thereon, litigation costs and expenses, including attorneys’ fees and expert fees, and any such other and further relief as may be allowed by law.

 

On January 5, 2007, the Company and Messrs. Faggioli, Huff and Cristiani moved to dismiss the Consolidated Complaint in its entirety. On May 21, 2007, the Court issued its decision denying the motion in large part, but shortening the proposed class period on one of the plaintiffs’ claims. On June 6, 2007, the Company and the other defendants answered the Consolidated Complaint, wherein they denied all allegations of wrongdoing and raised a number of affirmative defenses. On November 1, 2007, the plaintiffs filed their motion for class certification, which the Company opposed. On September 25, 2008, the Court granted the plaintiffs’ motion for class certification in part, establishing the class as all persons who purchased or otherwise acquired the Company’s common stock, and were damaged thereby, from March 16, 2005 to March 20, 2006. On May 9, 2008, at the invitation of the Court based upon recent case law developments, the Company filed a motion to dismiss the plaintiffs’ second cause of action (a 10b-5 claim based on non-public representations to KPMG).  The plaintiffs opposed this motion.  On September 23, 2008, the Court granted the Company’s motion and dismissed the plaintiffs’ second cause of action.

 

On September 14, 2009, the parties and the Company’s directors’ and officers’ liability insurer signed a Stipulation of Settlement (“Stipulation”), which was filed with the Court on September 14, 2009.  The Stipulation sets forth the complete terms of parties’ proposed settlement.  The basic terms of the settlement are that the Company’s insurer will pay the settlement class, which is defined as all persons (except for defendants and specified related persons and entities) who purchased the Company’s common stock during the period from April 23, 2002 through April 5, 2006, $6 million in exchange for a dismissal with prejudice of the lawsuit and a release of all claims held by members of a settlement class.  As set forth in the Stipulation, the proposed settlement will not become final until a number of conditions are satisfied, including the Stipulation receiving both preliminary and final approval from the Court.  On October 8, 2009, the Court entered an order (i) granting preliminary approval of the Stipulation, (ii) requiring that notice of the proposed settlement and the proposed plan of allocation of the settlement proceeds be mailed to members of the settlement class by October 26, 2009, and (iii) setting a February 9, 2010 hearing.  At this hearing the Court will consider, among other issues, (i) whether the Stipulation should receive final approval, (ii) whether the proposed plan of allocation for the settlement proceeds should be approved, (iii) whether the settlement class counsel’s application for an award of attorneys’ fees and reimbursement of costs and expenses should be approved, and (iv) whether the settlement class counsel’s application for incentive awards to the settlement class representatives should be approved.  The Court’s October 8, 2009 order also sets January 19, 2010 as the deadline by which settlement class members must submit a valid proof of claim, if they want to share in the settlement proceeds, or a proper opt-out request, if they want to be excluded from the settlement class and thereby not be bound by the terms of the Stipulation.

 

If the Stipulation does not receive final approval from the Court, the case will be returned to the litigation track and would most likely be subject to a new scheduling order.  As of the date of the Stipulation, the case was in the early stages of discovery and trial was not scheduled to commence until January 24, 2011.  If the case is returned to the litigation track, the Company and the other defendants will continue to vigorously defend themselves against the allegations in the lawsuit.  Notwithstanding this intent, the Company is not able at this time to predict the outcome of this litigation or whether the Company will incur any liability associated with the litigation, or to estimate the effect such outcome would have on the financial condition, results of operations, or cash flows of the Company.

 

The Company maintains insurance that may provide coverage for the potential consequences of a negative outcome of the litigation described above. The Company has given notice to its insurers of the claims and the insurers have responded by requesting additional information and by reserving their rights under the policies, including the rights to deny coverage under various policy exclusions or to rescind the policies in question.  As stated above, the Company’s directors’ and officers’ liability insurer has agreed, as part of the Stipulation, to fully fund the proposed $6 million settlement.  If, however, the Court refuses to give final approval to the Stipulation, the case will return to the litigation track.  If this were to occur, there can be no assurance that the insurers will then not seek to deny coverage or rescind the policies; that some or all of the claims will not be covered by such policies; or that, even if covered, the Company’s ultimate liability will not exceed the available insurance.  Moreover, there can be no assurance as to the Company’s ability to obtain insurance coverage in the future, or as to the cost of such insurance.

 

Threatened Derivative Lawsuits

 

By letter dated October 4, 2007, a shareholder of the Company alleged that a number of the current and former officers and directors of the Company breached their fiduciary duties to the Company by supposedly engaging in the same alleged wrongdoing that is the subject of the class-action lawsuit. The shareholder demanded that the Company take action to recover from the specified

 

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officers and directors all damages sustained by the Company as a result of the alleged misconduct, and threatened to commence a derivative action if the Company failed to act on the shareholder’s demand within a reasonable period of time.

 

On December 26, 2007, before the expiration of the Company’s allotted 90-day period for responding to the demand, the shareholder presented a second but substantively identical demand on the Company, thereby triggering a new 90-day response period. The Company’s Board of Directors responded to this demand on March 20, 2008, rejecting the shareholder’s demands.

 

On May 21, 2008, the same shareholder filed a summons and complaint in the Fourth Judicial District Court for the State of Utah seeking an order compelling the Company to produce certain books and records to the shareholder. The Company filed its answer to the complaint on June 12, 2008.

 

Although the Company and the other defendants are vigorously defending against the allegations in the threatened derivative lawsuit above, management believes that it is not possible at this time to predict the outcome of this litigation or whether the Company will incur any liability associated with the litigation, or to estimate the effect such outcome would have on the financial condition, results of operations, or cash flows of the Company.

 

SEC and DOJ Investigations

 

On July 31, 2009, the Securities and Exchange Commission (“SEC”) filed a settled enforcement action against the Company, Douglas Faggioli, and Craig Huff, the Company’s former chief financial officer, relating to alleged violations of the Foreign Corrupt Practices Act (“FCPA”) by one of the Company’s foreign subsidiaries in 2000 and 2001.  This settlement resolved an SEC investigation previously disclosed by the Company related to an independent investigation by the Company’s Audit Committee.

 

Under the terms of the settlement with the SEC, the Company agreed to pay a civil penalty of $600 and to consent to the entry of injunctions against future violations of the FCPA as well as the antifraud, books and records, and internal controls provisions of the federal securities laws.  No additional undertakings are required of the Company under the terms of the settlement.

 

In addition, Messrs. Faggioli and Huff each agreed to pay a civil penalty of $25 and to consent to the entry of injunctions against future violations relating only to the books and records and internal control provisions of the federal securities laws.

 

The SEC’s complaint alleged that, in 2000 and 2001, former employees in the Company’s Brazilian subsidiary made undocumented cash payments to customs brokers, some of which were later paid to Brazilian customs officials in order to allow unregistered products to be imported and sold in Brazil.  No current officers, directors, or employees of the Company are alleged to have participated in or had knowledge of these actions.

 

The complaint further alleged that, in 2000 and 2001, Mr. Faggioli, the Company’s then chief operating officer (and current chief executive officer), and Mr. Huff, the Company’s then chief financial officer, as control persons, failed to adequately supervise the Company’s management and other personnel who were directly responsible for the Company’s books and records and internal controls related to the registration of product in one foreign subsidiary.  As part of the settlement, the Company and the individual parties agreed to neither admit nor deny the allegations in the complaint.

 

The Company believes that all government investigations relating to potential FCPA violations by the Company or related persons have been resolved.   The Company anticipates no action by the Department of Justice (“DOJ”) in a previously disclosed investigation relating to these events.

 

As previously disclosed, in March 2006, the Company voluntarily provided to the SEC and the DOJ information related to an independent investigation by the Company’s Audit Committee.  The Company fully cooperated in these government investigations.

 

16

 

SEC Section 12(j) Proceeding

 

On July 12, 2007, the Company announced that the SEC had instituted administrative proceedings pursuant to Section 12 (j) of the Exchange Act to suspend or revoke the registration of its common stock under Section 12 of the Exchange Act.  On November 8, 2007, an administrative law judge in the administrative proceeding issued an Initial Decision to revoke the registration of the Company’s common stock because of its failure to file required periodic reports.  Shortly thereafter, the Company filed a petition for review with the SEC.  On December 5, 2007, the SEC granted the Company’s petition for review. The SEC heard oral argument from both the Company and the SEC staff on January 7, 2009.  On January 21, 2009, the SEC issued a final order revoking the registration of the Company’s common stock.  On February 12, 2009, the Company filed a registration statement on Form 10 to re-register its common stock under the Exchange Act. The Company’s registration statement became effective as a result of the passage of time on April 13, 2009. On May 26, 2009, the Company cleared all comments from the SEC related to its registration statement on Form 10.   On October 12, 2009 the Company began trading its common stock on the NASDAQ Capital Market under the symbol “NATR.”

 

Prescott Matter

 

In April 2009, Prescott Group Aggressive Small Cap Master Fund, G.P. (“Prescott”) filed, but did not serve, a complaint in the Fourth Judicial District Court for Utah County, Utah, (Prescott Group Aggressive Small Cap Master Fund, G.P. v. Nature’s Sunshine Products, Inc, Civil No. 090401518). Prescott’s filed complaint requested that the court compel the Company to hold an annual meeting of the Company’s shareholders.  The complaint did not request that the court award monetary damages other than the payment of attorneys’ fees.  On May 22, 2009, the Company and Kristine F. Hughes, Eugene L. Hughes and Pauline Hughes Francis in their capacity as shareholders of the Company (collectively, the “Hughes Parties”) entered into a settlement and voting agreement (the “Prescott Agreement”) with Prescott.  Contemporaneously with the Prescott Agreement, the Company and the Hughes Parties entered into voting agreements (collectively with the Prescott Agreement, the “Voting Agreements”) with each of the following shareholders of the Company:  Red Mountain Capital Partners II, L.P., Red Mountain Capital Partners III, L.P. and Paradigm Capital Management, Inc. (collectively with Prescott, the “Shareholder Parties”).

 

Pursuant to the Voting Agreements, effective as of June 7, 2009 , (i) the authorized number of directors of the Board was increased from six to eight directors in accordance with Section 3.2 of the Bylaws of the Company, creating two additional vacancies in addition to one previously unfilled vacancy on the Board, (ii) with the exception of Kristine F. Hughes, all of the current members of our Board of Directors (the “Board”) resigned as members of the Board, resulting in a total of seven vacancies on the Board and (iii) Michael D. Dean, Albert R. Dowden, Douglas Faggioli, Pauline Hughes Francis, Willem Mesdag, Jeffrey D. Watkins and Candace K. Weir were appointed, without any specific Board class designation, to fill such vacancies on the Board to serve as directors until the next annual meeting of shareholders at which directors are elected and until their respective successors are duly elected and qualified, unless they resign, are removed or are otherwise disqualified from serving as a director of the Company.

 

The Voting Agreements also provide that, at the next annual meeting of shareholders, which was held on November 6, 2009, the Company would nominate, and the Shareholder Parties and the Hughes Parties would vote all of the shares of Common Stock beneficially owned by them in favor of, each of the following individuals, with such nominees serving in the Board class set forth opposite his or her name:

 

Name		Class
Jeffrey D. Watkins		Class I
Willem Mesdag		Class I
Michael D. Dean		Class II
Douglas Faggioli		Class II
Candace K. Weir		Class II
Kristine F. Hughes		Class III
Pauline Hughes Francis		Class III
Albert R. Dowden		Class III

 

The voting arrangement set forth in the Voting Agreements terminated on November 6, 2009, immediately following the annual meeting of shareholders of the Company.

 

17

 

Other Litigation

 

The Company is party to various other legal proceedings in several foreign jurisdictions related to VAT assessments and other civil litigation.  While there is a reasonable possibility that a material loss may be incurred, the Company cannot at this time estimate the loss, if any, therefore, no provision for losses has been provided.  The Company believes future payments related to these matters could range from $0 to approximately $1.4 million.

 

Non-Income Tax Contingencies

 

The Company has reserved for certain state sales and use tax and foreign non-income tax contingencies based on the likelihood of an obligation in accordance with accounting guidance for probable loss contingencies. Loss contingency provisions are recorded for probable losses at management’s best estimate of a loss, or when a best estimate cannot be made, a minimum loss contingency amount is recorded.  The Company provides provisions for potential payments of tax to various tax authorities for contingencies related to non-income tax matters.  The Company also provides provisions for state sales taxes in each of the states where the Company has potential nexus. As of September 30, 2009 and December 31, 2008, accrued liabilities include $17,332 and $17,359, respectively, related to non-income tax contingencies. While management believes that the assumptions and estimates used to determine this liability are reasonable, the ultimate outcome of those matters cannot presently be determined. The Company is not able at this time to predict the ultimate outcomes of those matters or to estimate the effect the ultimate outcomes, if greater than the amounts accrued, would have on the financial condition, results of operations, or cash flows of the Company.

 

Self-Insurance Liabilities

 

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. 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 cash flows.

 

The Company self-insures for certain employee medical benefits. 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.

 

The Company reviews its self-insurance accruals on a quarterly basis and determines, based upon a review of its recent claims history and other factors, that portions of its self-insurance accruals be considered short-term and long-term.

 

The Company has accrued $2,865 and $2,873 for product liability and employee medical claims at September 30, 2009 and December 31, 2008, respectively, of which $358 and $2,873 was classified as short-term.  Such amounts are included in accrued liabilities and other long-term liabilities on the Company’s unaudited condensed consolidated balance sheets.

 

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Government Regulations

 

The Company is subject to governmental regulations pertaining to product formulation, labeling and packaging, product claims and advertising, and to the Company’s direct selling system. The Company is also subject to the jurisdiction of numerous foreign tax and customs authorities. Any assertions or determinations that either the Company or the Company’s Distributors are not in compliance with existing statutes, laws, rules or regulations could potentially have a material adverse effect on the Company’s operations. In addition, in any country or jurisdiction, the adoption of new statutes, laws, rules or regulations, or changes in the interpretation of existing statutes, laws, rules or regulations could have a material adverse effect on the Company and its operations. Although management believes that the Company is in compliance, in all material respects, with the statutes, laws, rules and regulations of every jurisdiction in which it operates, no assurance can be given that the Company’s compliance with applicable statutes, laws, rules and regulations will not be challenged by foreign authorities or that such challenges will not have a material adverse effect on the Company’s financial position or results of operations or cash flows.

 

(11)              Fair Value Measurements

 

The fair value of a financial instrument is the amount that could be received upon the sale of an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.  Financial assets are marked to bid prices and financial liabilities are marked to offer prices.  Fair value measurements do not include transaction costs. A fair value hierarchy is used to prioritize the quality and reliability of the information used to determine fair values of each financial instrument.  Categorization within the fair value hierarchy is based on the lowest level of input that is significant to the fair value measurement.  The fair value hierarchy is defined into the following three categories:

 

Level 1: Quoted market prices in active markets for identical assets or liabilities.

Level 2: Observable market based inputs or unobservable inputs that are corroborated by market data.

Level 3: Unobservable inputs that are not corroborated by market data

 

The following table presents the Company’s hierarchy for its asset and liabilities measured at fair value on a recurring basis as of September 30, 2009:

 

		Level 1			Level 2			Level 3
		Quoted Prices in Active Markets for Identical Assets or Liabilities			Significant Other Observable Inputs			Significant Unobservable Inputs			Total
Investments available for sale		$	1,014		$	2,356		$	—		$	3,370
Investment securities		1,646			—			—			1,646
Total assets measured at fair value on a recurring basis		$	2,660		$	2,356		$	—		$	5,016

 

The following table presents the Company’s hierarchy for its asset measured at fair value on a recurring basis as of December 31, 2008:

 

		Level 1			Level 2			Level 3
		Quoted Prices in Active Markets for Identical Assets or Liabilities			Significant Other Observable Inputs			Significant Unobservable Inputs			Total
Investments available for sale		$	933		$	2,925		$	—		$	3,858
Investment securities		1,394			—			—			1,394
Restricted investments		—			—			2,050			2,050
Total assets measured at fair value on a recurring basis		$	2,327		$	2,925		$	2,050		$	7,302

 

Investments available for sale — The majority of the Company’s investment portfolio consists of mutual funds, equity securities and various fixed income securities, such as U.S government funds and state and municipal bonds.  The Level 1 securities are valued using quoted prices for identical assets in active markets including equity securities, U.S. government treasuries, and various mutual funds.  The Level 2 securities include investments in state and municipal bonds, as well as various mutual funds whereby all significant inputs are observable or can be derived from or corroborated by observable market data for substantially the full term of the asset.

 

Investment securities — The majority of the Company’s trading portfolio consists of various mutual funds that are using quoted prices in active markets.

 

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Restricted investments  —  The Company’s restricted investments include auction rate preferred investments that failed at auction during 2008.  Despite the underlying long-term contractual maturity of auction-rate securities (“ARS”), there was historically a ready liquid market for these securities based on the interest reset mechanism.  However, as a result of negative liquidity and uncertainty in financial credit markets, the Company experienced “failed” auctions associated with its ARS.  In the case of a failed auction, the ARS become illiquid investments (until a future auction is successful or the security is called prior to the contractual maturity date by the issuer) and the rates are reset in accordance with terms in the prospectus/offering circular

 

The ARS consisted primarily of AAA securities.  In determining the fair value of the Company’s restricted investments at December 31, 2008, the Company has taken into consideration fair values determined by the financial institutions, current credit rating of the underlying securities, insurance provisions, discounted cash flow analysis, as deemed appropriate, and its current liquidity position.

 

The following table shows a reconciliation of the beginning and ending Level 3 fair value measurements using significant unobservable inputs for the three months ended September 30, 2009 and 2008:

 

		Three Months Ended September 30,
		2009			2008
Balance at July 1,		$	—		$	2,050
Net unrealized gains included in earnings		—			—
Sales of restricted investments		—			—
Purchases		—			—
Balance at September 30,		$	—		$	2,050

 

The following table shows a reconciliation of the beginning and ending Level 3 fair value measurements using significant unobservable inputs for the nine months ended September 30, 2009 and 2008:

 

		Nine Months Ended September 30,
		2009			2008
Balance at January 1,		$	2,050		$	2,075
Net unrealized gains included in earnings		—			—
Sales of restricted investments		(2,050		)	(25		)
Purchases		—			—
Balance at September 30,		$	—		$	2,050

 

During the nine month periods ended September 30, 2009 and 2008, the Company sold restricted investments of $2,050 and $25, respectively, that included ARS that had failed at auction during 2008.  These securities were sold at par value, which was the carrying value of these securities.  As a result, there was no realized gain or loss as a result of the sale of the ARS.

 

The carrying amounts reflected on the consolidated balance sheet for cash and cash equivalents, accounts and notes receivable, accounts payable, and short-term borrowings approximate fair value due to their short-term nature. During the three and nine months ended September 30, 2009, the Company did not have any write-offs related to the remeasurement of non-financial assets at fair value on a nonrecurring basis subsequent to their initial recognition.

 

(12)     Subsequent Event

 

Currency restrictions enacted by the government of Venezuela require approval from the government’s currency control organization for the Company’s subsidiary in Venezuela to obtain U.S. dollars at the official exchange rate to pay for imported products or to repatriate dividends back to the Company. The parallel market rate, which is substantially lower than the official rate, may be used to obtain U.S. dollars or other currencies without approval of the government’s currency control organization.

 

As of September 30, 2009, the Company had 9,322 bolivars, or the equivalent of $4,346 U.S. dollars at the official exchange rate. In October 2009, the Company elected to settle 4,000 bolivars, the equivalent of $1,865 U.S. dollars at the official rate, for $712 U.S. dollars of its intercompany payable balances using the legal parallel market exchange process to mitigate the Company’s currency exchange risk in Venezuela. The Company recorded an exchange loss of $1,153 as a result of using the parallel market rate versus the official rate for the transaction. The Company periodically assesses its ability to obtain U.S. dollars at the official exchange rate.  However, the Company continues to apply for and expects to receive approval from the government of Venezuela to convert is bolivars at the official exchange rate to pay for imported products and other remittances. However, the timing and ability to obtain U.S. dollars in the future at the official exchange rate could adversely affect the Company’s financial condition and results of operations.

 

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