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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549 
_________________________________________________________________
 
FORM 10-Q 
(Mark One)
 
ý      QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 
For the quarterly period ended September 30, 2017
 
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: 001-34483
logoa03.jpg 
 
NATURE’S SUNSHINE PRODUCTS, INC.
(Exact name of Registrant as specified in its charter) 
Utah
 
87-0327982
(State or other jurisdiction of
 
(IRS Employer
incorporation or organization)
 
Identification No.)
 
2500 West Executive Parkway, Suite 100
Lehi, Utah 84043
(Address of principal executive offices and zip code)
 
(801) 341-7900
(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  ý  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  ý  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).
Large accelerated filer  o
 
Accelerated filer  x
 
 
 
Non-accelerated filer  o
 
Smaller reporting company  o
(Do not check if a smaller reporting company)
 
 
 
 
Emerging growth company  o
 
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).  Yes  o  No  ý.
 
The number of shares of Common Stock, no par value, outstanding on November 2, 2017, was 18,901,898 shares.
 

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NATURE’S SUNSHINE PRODUCTS, INC.
FORM 10-Q
 
For the Quarter Ended September 30, 2017
 
Table of Contents
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

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CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS
 
Certain information included or incorporated herein by reference in this report may be deemed to be “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements may include, but are not limited to, statements relating to the Company's objectives, plans and strategies. All statements (other than statements of historical fact) that address activities, events or developments that the Company intends, expects, projects, believes or anticipates will or may occur in the future are forward-looking statements. These statements are often characterized by terminology such as “believe,” “hope,” “may,” “anticipate,” “should,” “intend,” “plan,” “will,” “expect,” “estimate,” “project,” “positioned,” “strategy” and similar expressions, and are based on assumptions and assessments made by management in light of their experience and their perception of historical trends, current conditions, expected future developments and other factors they believe to be appropriate. For example, information appearing under “Management’s Discussion and Analysis of Financial Condition and Results of Operations” includes forward-looking statements. Forward-looking statements are not guarantees of future performance and are subject to risks and uncertainties that could cause actual results to vary materially. Important factors that could cause actual results, developments and business decisions to differ materially from forward-looking statements are more fully described in this report, including the risks set forth under “Risk Factors” in Item 1A, and in the Company's Annual Report on Form 10-K for the year ended December 31, 2016, but include the following:

•
changes in laws and regulations, or their interpretation, applicable to direct selling or the nutritional supplement industry may prohibit or restrict the Company's ability to sell its products in some markets or require the Company to make changes to its business model in some markets;
•
legal challenges to its direct selling program or to the classification of its independent distributors;
•
complex legal and regulatory requirements in China, including the failure to obtain the necessary approvals and licenses to expand its direct sales activities in China;
•
extensive government regulations to which its products, business practices and manufacturing activities are subject;
•
the impact of anti-bribery laws, including the U.S. Foreign Corrupt Practices Act;
•
the full implementation of its joint venture for operations in China with Fosun Industrial Co., Ltd.;
•
registration of products for sale in China, or difficulty or increased cost of importing products into China;
•
its business practices in some of the jurisdictions in which it operates, including China and South Korea, where the business practices may be legal and compliant with local and foreign law, but still draw unnecessary media or regulatory attention;
•
its ability to attract and retain independent distributors;
•
the effect of fluctuating foreign exchange rates;
•
negative consequences resulting from difficult economic conditions, including the availability of liquidity or the willingness of its customers to purchase products;
•
geopolitical issues and conflicts;
•
restrictions on the repatriation of money;
•
uncertainties relating to the application of transfer pricing, duties, value-added taxes, and other tax regulations, and changes thereto;
•
changes in tax laws, treaties or regulations, or their interpretation;
•
taxation relating to its independent distributors;
•
high levels of inflation in one or more of the countries in which the Company operates;
•
cyber security threats and exposure to data loss;
•
reliance on information technology infrastructure;
•
liabilities and obligations arising from improper activity by its agents, employees or independent distributors;
•
its relationship with, and its inability to influence the actions of, its independent distributors, and other third parties with whom it does business;
•
its reliance upon, or the loss or departure of any member of, its senior management team;
•
challenges in managing rapid growth in China;
•
the slowing of the Chinese economy;
•
negative effects from its independent distributor promotions or compensation plans;
•
risks associated with the manufacturing of the Company's products;
•
availability and integrity of raw materials;
•
obsolescence of product inventory;
•
changing consumer preferences and demands;
•
the competitive nature of its business and the nutritional supplement industry;
•
negative publicity related to its products, ingredients, or direct selling organization and the nutritional supplement industry;
•
product liability claims;

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•
the sufficiency of trademarks and other intellectual property rights; and
•
reliance on third-parties to distribute its products and provide support services to independent distributors.
 
It is not possible to predict or identify all potential risks and uncertainties and the above list is not a complete list of all potential risks and uncertainties. All forward-looking statements speak only as of the date of this report and are expressly qualified in their entirety by the cautionary statements included in or incorporated by reference into this report. Except as is required by law, the Company expressly disclaims any obligation to publicly release any revisions to forward-looking statements to reflect events after the date of this report.  Throughout this report, Nature’s Sunshine Products, Inc., together with its subsidiaries, are referred to as “the Company.”

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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,
2017
 
December 31,
2016
Assets
 

 
 

Current assets:
 

 
 

Cash and cash equivalents
$
47,692

 
$
32,284

Accounts receivable, net of allowance for doubtful accounts of $187 and $205, respectively
10,927

 
7,738

Investments available for sale
—

 
1,776

Assets held for sale
998

 
521

Inventories
49,442

 
47,597

Prepaid expenses and other
5,253

 
4,585

Total current assets
114,312

 
94,501

 
 
 
 
Property, plant and equipment, net
70,175

 
73,272

Investment securities - trading
1,907

 
1,391

Intangible assets, net
984

 
976

Deferred income tax assets
21,395

 
21,590

Other assets
13,436

 
13,840

Total assets
$
222,209

 
$
205,570

 
 
 
 
Liabilities and Shareholders’ Equity
 

 
 

Current liabilities:
 

 
 

Accounts payable
$
4,850

 
$
5,305

Accrued volume incentives and service fees
20,930

 
16,264

Accrued liabilities
25,040

 
24,400

Deferred revenue
4,790

 
3,672

Current portion of revolving credit facility
—

 
9,919

Income taxes payable
2,552

 
3,475

Related party note payable
500

 
—

Total current liabilities
58,662

 
63,035

 
 
 
 
Liability related to unrecognized tax benefits
4,944

 
6,755

Deferred compensation payable
1,907

 
1,391

Revolving credit facility
19,184

 
—

Other liabilities
1,196

 
1,991

Total liabilities
85,893

 
73,172

 
 
 
 
Commitments and contingencies


 


 
 
 
 
Shareholders’ equity:
 

 
 

Common stock, no par value, 50,000 shares authorized, 18,902 and 18,757 shares issued and outstanding, respectively
131,141

 
129,654

Retained earnings
15,286

 
12,718

Noncontrolling interests
661

 
1,286

Accumulated other comprehensive loss
(10,772
)
 
(11,260
)
Total shareholders’ equity
136,316

 
132,398

Total liabilities and shareholders' equity
$
222,209

 
$
205,570

 

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See accompanying notes to condensed consolidated financial statements.

NATURE’S SUNSHINE PRODUCTS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(Amounts in thousands, except per share information)
(Unaudited) 
 
Three Months Ended
September 30,
 
2017
 
2016
Net sales
$
89,301

 
$
85,441

Cost of sales
23,505

 
21,512

Gross profit
65,796

 
63,929

 
 
 
 
Operating expenses:
 

 
 

Volume incentives
30,716

 
29,684

Selling, general and administrative
32,926

 
29,187

Operating income
2,154

 
5,058

Other income, net
193

 
20

Income before provision for income taxes
2,347

 
5,078

Provision for income taxes
(1
)
 
1,136

Net income
2,348

 
3,942

Net loss attributable to noncontrolling interests
(95
)
 
(213
)
Net income attributable to common shareholders
$
2,443

 
$
4,155

 
 
 
 
Basic and diluted net income per common share:
 

 
 

 
 
 
 
Basic earnings per share attributable to common shareholders
$
0.13

 
$
0.22

 
 
 
 
Diluted earnings per share attributable to common shareholders
$
0.13

 
$
0.22

 
 
 
 
Weighted average basic common shares outstanding
18,897

 
18,751

Weighted average diluted common shares outstanding
19,286

 
19,255

 
 
 
 
Dividends declared per common share
$
—

 
$
0.10

 
See accompanying notes to condensed consolidated financial statements.


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NATURE’S SUNSHINE PRODUCTS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(Amounts in thousands, except per share information)
(Unaudited) 
 
Nine Months Ended
September 30,
 
2017
 
2016
Net sales
$
253,743

 
$
257,209

Cost of sales
66,430

 
66,610

Gross profit
187,313

 
190,599

 
 
 
 
Operating expenses:
 

 
 

Volume incentives
87,987

 
90,352

Selling, general and administrative
95,098

 
88,821

Operating income
4,228

 
11,426

Other income, net
1,909

 
957

Income before provision for income taxes
6,137

 
12,383

Provision for income taxes
2,346

 
4,286

Net income
3,791

 
8,097

Net loss attributable to noncontrolling interests
(625
)
 
(695
)
Net income attributable to common shareholders
$
4,416

 
$
8,792

 
 
 
 
Basic and diluted net income per common share:
 

 
 

 
 
 
 
Basic earnings per share attributable to common shareholders
$
0.23

 
$
0.47

 
 
 
 
Diluted earnings per share attributable to common shareholders
$
0.23

 
$
0.46

 
 
 
 
Weighted average basic common shares outstanding
18,873

 
18,723

Weighted average diluted common shares outstanding
19,265

 
18,995

 
 
 
 
Dividends declared per common share
$
0.10

 
$
0.30


See accompanying notes to condensed consolidated financial statements.

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NATURE’S SUNSHINE PRODUCTS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Amounts in thousands)
(Unaudited) 
 
Three Months Ended
September 30,
 
2017
 
2016
Net income
$
2,348

 
$
3,942

Foreign currency translation gain, net of tax
113

 
833

Net unrealized losses on investment securities (net of tax)
—

 
(3
)
Total comprehensive income
$
2,461

 
$
4,772

 
 
Nine Months Ended
September 30,
 
2017
 
2016
Net income
$
3,791

 
$
8,097

Foreign currency translation gain (net of tax)
473

 
1,296

Net unrealized gains on investment securities (net of tax)
15

 
12

Total comprehensive income
$
4,279

 
$
9,405

 
See accompanying notes to condensed consolidated financial statements.

 
NATURE’S SUNSHINE PRODUCTS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS’ EQUITY
(Amounts in thousands)
(Unaudited) 
 
Common Stock
 
Retained
Earnings
 
Noncontrolling
Interests
 
Accumulated
Other
Comprehensive
Income (Loss)
 
Total
 
Shares
 
Amount
 
 
 
 
Balance at January 1, 2017
18,757

 
$
129,654

 
$
12,718

 
$
1,286

 
$
(11,260
)
 
$
132,398

Share-based compensation expense
—

 
1,904

 
—

 
—

 
—

 
1,904

Shares issued from the exercise of stock options and vesting of restricted stock units, net of shares exchanged for withholding tax
145

 
(417
)
 
—

 
—

 
—

 
(417
)
Cash dividends ($0.10 per share)
—

 
—

 
(1,848
)
 
—

 
—

 
(1,848
)
Net income
—

 
—

 
4,416

 
(625
)
 
—

 
3,791

Other comprehensive income
—

 
—

 
—

 
—

 
488

 
488

Balance at September 30, 2017
18,902

 
$
131,141

 
$
15,286

 
$
661

 
$
(10,772
)
 
$
136,316

 
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,
 
2017
 
2016
CASH FLOWS FROM OPERATING ACTIVITIES:
 

 
 

Net income
$
3,791

 
$
8,097

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

 
 

Provision for doubtful accounts
(22
)
 
270

Depreciation and amortization
6,036

 
3,610

Share-based compensation expense
1,904

 
2,412

Loss on sale of property and equipment
—

 
145

Deferred income taxes
245

 
311

Purchase of trading investment securities
(450
)
 
(340
)
Proceeds from sale of trading investment securities
102

 
84

Realized and unrealized gains on investments
(145
)
 
(96
)
Foreign exchange gains
(2,089
)
 
(501
)
Changes in assets and liabilities:
 

 
 

Accounts receivable
(3,115
)
 
409

Inventories
(616
)
 
(9,875
)
Prepaid expenses and other current assets
(573
)
 
102

Other assets
799

 
(771
)
Accounts payable
(422
)
 
328

Accrued volume incentives and service fees
4,240

 
2,721

Accrued liabilities
(621
)
 
301

Deferred revenue
1,118

 
(847
)
Income taxes payable
(847
)
 
111

Liability related to unrecognized tax benefits
(1,815
)
 
(1,744
)
Deferred compensation payable
516

 
335

Net cash provided by operating activities
8,036

 
5,062

CASH FLOWS FROM INVESTING ACTIVITIES:
 

 
 

Purchases of property, plant and equipment
(3,889
)
 
(7,929
)
Proceeds from sale of property, plant and equipment
522

 
—

Proceeds from sale/maturities of investments available for sale
1,776

 
—

Net cash used in investing activities
(1,591
)
 
(7,929
)
CASH FLOWS FROM FINANCING ACTIVITIES:
 

 
 

Payments of cash dividends
(1,848
)
 
(5,632
)
Proceeds from new revolving credit facility
19,184

 
—

Net borrowings on original revolving credit facility
(9,996
)
 
6,311

Proceeds from related party borrowing
500

 
—

Net proceeds from the exercise of stock options
104

 
128

Payment of withholding taxes related to the vesting of restricted stock units
(521
)
 
(169
)
Net cash provided by financing activities
7,423

 
638

Effect of exchange rates on cash and cash equivalents
1,540

 
1,252

Net increase (decrease) in cash and cash equivalents
15,408

 
(977
)
Cash and cash equivalents at the beginning of the period
32,284

 
41,420

Cash and cash equivalents at the end of the period
$
47,692

 
$
40,443

SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
 

 
 

Cash paid for income taxes
$
3,874

 
$
4,704

Cash paid for interest
215

 
187

 
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
(Unaudited)
 
(1)    Basis of Presentation
 
Nature’s Sunshine Products, Inc., together with its subsidiaries (hereinafter referred to collectively as the “Company”), is a natural health and wellness company primarily engaged in the manufacturing and direct selling of nutritional and personal care products. The Company sells its products to a sales force of independent distributors who use the products themselves or resell them to consumers.
 
Principles of Consolidation
 
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 intercompany accounts and transactions are eliminated in consolidation. The Company consolidates the joint ventures in Hong Kong and China in its consolidated financial statements, with another party's interest presented as noncontrolling interest. 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, 2017, and for the three and nine-month periods ended September 30, 2017 and 2016.  The results of operations of any interim period are not necessarily indicative of the results of operations to be expected for the year ending December 31, 2017.
 
It is suggested that these condensed consolidated financial statements be read in conjunction with the consolidated financial statements and the notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2016.

Noncontrolling Interests

Noncontrolling interests decreased as a result of the net loss attributable to the noncontrolling interests by $0.6 million and $0.7 million during the nine months ended September 30, 2017 and 2016, respectively. As of September 30, 2017, and December 31, 2016, noncontrolling interests were $0.7 million and $1.3 million, respectively.

Classification of Ukraine as a Highly Inflationary Economy and Devaluation of Its Currency

As of June 2017, Ukraine has been designated as a highly inflationary economy, which, in accordance with U.S. Generally Accepted Accounting Principles ("U.S. GAAP"), requires that the Company's functional currency for this market be the U.S. dollar. However, because the Company's operations in Ukraine are served by a U.S. subsidiary through third-party entities, for which all business is conducted in U.S. dollars, the U.S. dollar has historically been the functional currency for the Company in this market. As a result, there were no resulting gains or losses from a re-measurement of the financial statements using official rates of the Company’s Ukrainian subsidiary.  However, as a result of the weakening of the Ukraine Hryvnia, the purchasing power of the Company’s independent Distributors in this market has diminished. During the three months ended September 30, 2017 and 2016, the Company’s Ukrainian subsidiary’s net sales represented approximately 2.3 percent and 2.3 percent of consolidated net sales, respectively. During the nine months ended September 30, 2017 and 2016, the Company’s Ukrainian subsidiary’s net sales represented approximately 2.3 percent and 2.2 percent of consolidated net sales, respectively.

Recent Accounting Pronouncements
 
In May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2014-09 - Revenue from Contracts with Customers (Topic 606), and has subsequently issued ASUs 2015-14 - Revenue from Contracts with Customers (Topic 606): Deferral of the Effective Date, 2016-08 - Revenue from Contracts with Customers (Topic 606): Principal versus Agent Considerations (Reporting Revenue Gross Versus Net), 2016-10 - Revenue from Contracts with Customers (Topic 606): Identifying Performance Obligations and Licensing, 2016-12 - Revenue from Contracts with Customers (Topic 606): Narrow-Scope Improvements and Practical Expedients, and 2016-20 - Revenue from Contracts with Customers (Topic 606): Technical Corrections and Improvements to Topic 606 (collectively, Topic 606).


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Topic 606 outlines a single comprehensive model for entities to use in accounting for revenue arising from contracts with customers and supersedes most current revenue recognition guidance, including industry-specific guidance. The guidance is based on the principle that an entity should recognize revenue to depict the transfer of goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The guidance also requires additional disclosure about the nature, amount, timing and uncertainty of revenue and cash flows arising from customer contracts, including significant judgments and changes in judgments and assets recognized from costs incurred to fulfill a contract. This guidance is effective for the Company beginning on January 1, 2018, and provides the Company with the option of using either a full retrospective or a modified retrospective approach for the adoption of the new standard. The Company expects to adopt Topic 606 using the modified retrospective approach, under which the cumulative effect of initially applying Topic 606 is recognized as an adjustment to the opening balance of retained earnings in the first quarter of 2018.

The Company is concluding the assessment phase of implementing Topic 606. The Company has evaluated each of the five steps in Topic 606, which are as follows: 1) Identify the contract with the customer; 2) Identify the performance obligations in the contract; 3) Determine the transaction price; 4) Allocate the transaction price to the performance obligations; and 5) Recognize revenue when (or as) performance obligations are satisfied. The Company expects to identify similar performance obligations under Topic 606, as compared with deliverables and separate units of account previously identified. As a result, the adoption of Topic 606 is not expected to have a material impact on the Company’s results of operations and consolidated financial statements. However, disclosure requirements under the new guidance in Topic 606 have been significantly expanded in comparison to the disclosure requirements under the current guidance.

There are also certain considerations related to internal control over financial reporting that are associated with implementing Topic 606. The Company is currently evaluating its control framework for revenue recognition and identifying any changes that may need to be made in response to the new guidance. Designing and implementing the appropriate controls over gathering and reporting the information required under Topic 606 is currently in process.

In November 2015, the FASB issued ASU 2015-17, Income Taxes (Topic 740): Balance Sheet Classification of Deferred Taxes. This guidance requires that entities with a classified statement of financial position present all deferred tax assets and liabilities as non-current. This update was adopted during the first quarter of 2017 and applied on the retrospective basis. Other than the netting of current deferred tax assets of $5.6 million, which increased long-term deferred tax assets from $16.0 million to $21.6 million as of December 31, 2016, the adoption of this ASU did not have a material impact on the Company’s results of operations and consolidated financial statements.

In January 2016, the FASB issued ASU No. 2016-01, Financial Instruments - Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities. This update amends the guidance in U.S. GAAP on the classification and measurement of financial instruments. Although the ASU retains many current requirements, it significantly revises an entity’s accounting related to (1) the classification and measurement of investments in equity securities and (2) the presentation of certain fair value changes for financial liabilities measured at fair value. The ASU also amends certain disclosure requirements associated with the fair value of financial instruments. This update is effective for interim and annual periods beginning after December 15, 2017. The adoption of this ASU is not expected to have a material impact on the Company’s results of operations, consolidated financial statements and footnote disclosures.

In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842): Accounting for Leases. This update specifies that lessees should recognize assets and liabilities arising from all leases, except for leases with a lease term of 12 months or less. The recognition, measurement, and presentation of expenses and cash flows arising from a lease by a lessee will largely remain unchanged and shall continue to depend on its classification as a finance or operating lease. The ASU will be effective for annual periods beginning after December 15, 2018 with early adoption permitted. The adoption of this ASU is not expected to have a material impact on the Company’s results of operations; however, it is expected to gross-up the consolidated balance sheet as a result of recognizing a lease asset along with a similar lease liability.

In May 2017, the FASB issued ASU 2017-09, Compensation - Stock Compensation (Topic 718): Scope of Modification Accounting. This update amends the scope of modification accounting surrounding share-based payment arrangements as issued in ASU 2016-09 by providing guidance on the various types of changes which would trigger modification accounting for share-based payment awards. ASU 2017-09 is effective for annual periods beginning after December 15, 2017, and interim periods within those annual periods. Early adoption is permitted, including adoption in any interim period, for public business entities for reporting periods for which financial statements have not yet been issued. While the Company does not expect the adoption of ASU 2017-09 to have a material effect on its business, the Company is still evaluating any potential impact that adoption of ASU 2017-09 may have on its results of operations, consolidated financial statements and footnote disclosures.
 

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(2)    Inventories
 
The composition of inventories is as follows (dollar amounts in thousands):
 
 
September 30,
2017
 
December 31,
2016
Raw materials
$
10,994

 
$
14,995

Work in progress
758

 
694

Finished goods
37,690

 
31,908

Total inventory
$
49,442

 
$
47,597


(3)    Property, Plant and Equipment

As of September 30, 2017, the Company reclassified an eight-acre property in Provo, Utah, as an asset held for sale. The Company originally acquired the property with the intent to erect a building for the corporate headquarters. As there is no intention to move the corporate headquarters to this location, Company management decided to sell the property. The property is currently under contract to sell. The Company anticipates the sale of the property to be completed by December 31, 2017, with a possible three-month extension at the option of the buyer. As the fair value of the property exceeds the carrying value, no loss was recognized during the three months ended September 30, 2017.

(4)    Investments
 
As of September 30, 2017, the Company had no investments available for sale. Proceeds from the sale of available-for-sale investments were $1.8 million during the nine-month period ended September 30, 2017.

The amortized cost and estimated fair values of available-for-sale securities by balance sheet classification are as follows (dollar amounts in thousands):
 
As of December 31, 2016
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Fair
Value
U.S. government securities funds
$
1,799

 
$
—

 
$
(23
)
 
$
1,776

Total short-term investment securities
$
1,799

 
$
—

 
$
(23
)
 
$
1,776

 
There were no proceeds from the sale of investments during the nine-months ended September 30, 2016.
 
The Company’s trading securities portfolio totaled $1.9 million at September 30, 2017, and $1.4 million at December 31, 2016, and generated gains of $66,000 and $43,000 for the three months ended September 30, 2017 and 2016, respectively, and $168,000 and $78,000 for the nine months ended September 30, 2017 and 2016, respectively.
 
As of September 30, 2017, and December 31, 2016, the Company had an unrealized loss of $0 and $23,000, respectively, in its U.S. government securities funds. There were no securities that were in a loss position for more than 12 months.
 
(5)    Revolving Credit Facility

On July 11, 2017, the Company entered into a revolving credit agreement with Bank of America, N.A., with a borrowing limit of $25.0 million, that matures on July 11, 2020 (the “Bank of America Credit Agreement”). In connection with the closing of the Bank of America Credit Agreement, the Company terminated its revolving credit agreement with Wells Fargo Bank, N.A. (the "Wells Fargo Credit Agreement") and satisfied in full the outstanding balance thereof through borrowings on the Bank of America Credit Agreement. The Company pays interest on any borrowings under the Bank of America Credit Agreement at LIBOR plus 1.25 percent (2.49 percent as of September 30, 2017), and an annual commitment fee of 0.2 percent on the unused portion of the commitment. The Company is required to settle its net borrowings under the Bank of America Credit Agreement only upon maturity, and as a result, has classified its outstanding borrowings as non-current on its condensed consolidated balance sheet as of September 30, 2017. At September 30, 2017, the outstanding balance under the Bank of America Credit Agreement was $19.2 million.

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The Bank of America Credit Agreement contains customary financial covenants, including financial covenants relating to the Company’s solvency, leverage, and minimum EBITDA. In addition, the Bank of America Credit Agreement restricts certain capital expenditures, lease expenditures, other indebtedness, liens on assets, guarantees, loans and advances, dividends, and merger, consolidation and the transfer of assets except as permitted in the Bank of America Credit Agreement. The Bank of America Credit Agreement is collateralized by the Company's manufacturing facility, accounts receivable balance, inventory balance and other assets. The Company was in compliance with the debt covenants set forth in the Bank of America Credit Agreement as of September 30, 2017.

Prior to the termination of the Wells Fargo Credit Agreement, the Company paid interest at LIBOR plus 1.25 percent (2.13 percent at December 31, 2016), and an annual commitment fee of 0.25 percent on the unused portion of the commitment. At December 31, 2016, the outstanding balance under the Wells Fargo Credit Agreement was $9.9 million.

The Company's joint venture in China borrowed $0.5 million during the three months ended September 30, 2017, from the Company's joint venture partner. This note is payable in one year and bears interest of 3.0 percent.

(6)    Net Income Per Share
 
Basic net income per common share (“Basic EPS”), is computed by dividing net income by the weighted average number of common shares outstanding during the period. 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.

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, 2017 and 2016 (dollar and share amounts in thousands, except for per share information): 
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
2017
 
2016
 
2017
 
2016
Net income attributable to common shareholders
$
2,443

 
$
4,155

 
$
4,416

 
$
8,792

 
 
 
 
 
 
 
 
Basic weighted average shares outstanding
18,897

 
18,751

 
18,873

 
18,723

 
 
 
 
 
 
 
 
Basic earnings loss per share attributable to common shareholders
$
0.13

 
$
0.22

 
$
0.23

 
$
0.47

 
 
 
 
 
 
 
 
Diluted shares outstanding
 

 
 

 
 

 
 

Basic weighted-average shares outstanding
18,897

 
18,751

 
18,873

 
18,723

Stock-based awards
389

 
504

 
392

 
272

Diluted weighted-average shares outstanding
19,286

 
19,255

 
19,265

 
18,995

 
 
 
 
 
 
 
 
Diluted earnings per share attributable to common shareholders
$
0.13

 
$
0.22

 
$
0.23

 
$
0.46

 
 
 
 
 
 
 
 
Dilutive shares excluded from diluted-per-share amounts:
 

 
 

 
 

 
 

Stock options
294

 
240

 
294

 
240

 
 
 
 
 
 
 
 
Anti-dilutive shares excluded from diluted-per-share amounts:
 

 
 

 
 

 
 

Stock options
1,309

 
663

 
1,309

 
1,440


Potentially dilutive shares excluded from diluted-per-share amounts include performance-based options to purchase shares of common stock for which certain earnings metrics have not been achieved. Potentially anti-dilutive shares excluded from diluted-per-share amounts include non-qualified stock options and unearned performance-based options to purchase shares of common stock with exercise prices greater than the weighted-average share price during the period.
 

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(7)    Capital Transactions
 
Dividends
 
On March 7, 2017, the Company announced a cash dividend of $0.10 per common share in the aggregate of $1.8 million, which was paid on April 3, 2017, to shareholders of record as of March 22, 2017.

On May 10, 2017, the Company announced that its Board of Directors elected to suspend the payment of quarterly dividends. The Company's Board of Directors will periodically evaluate the Company’s dividend policy in the future. The declaration of future dividends is subject to the discretion of the Company’s Board of Directors and will depend upon various factors, including the Company’s earnings, financial condition, restrictions imposed by any indebtedness that may be outstanding, cash requirements, future prospects and other factors deemed relevant by the Company's Board of Directors.

Share Repurchase Program
 
In November 2014, the Board of Directors authorized a $20.0 million share repurchase program beginning January 1, 2015. Such purchases may be made in the open market, through block trades, in privately negotiated transactions or otherwise. The timing and amount of any shares repurchased will be determined based on the Company’s evaluation of market conditions and other factors and the program may be discontinued or suspended at any time. At September 30, 2017, the remaining balance available for repurchases under the program was $13.4 million. There were no repurchases of common shares under the share repurchase program by the Company during the three and nine month periods ended September 30, 2017 and 2016.
 
Share-Based Compensation
 
During the year ended December 31, 2012, the Company’s shareholders adopted and approved the Nature’s Sunshine Products, Inc. 2012 Stock Incentive Plan (the “2012 Incentive Plan”).  The 2012 Incentive Plan provides for the grant of incentive stock options, non-statutory stock options, stock appreciation rights, restricted stock, restricted stock units, dividend equivalent rights, performance awards, stock awards and other stock-based awards.  The Compensation Committee of the Board of Directors has authority and discretion to determine the type of award, as well as the amount, terms and conditions of each award under the 2012 Incentive Plan, subject to the limitations of the 2012 Incentive Plan. A total of 1,500,000 shares of the Company’s common stock were originally authorized for the granting of awards under the 2012 Incentive Plan. In 2015, the Company’s shareholders approved an amendment to the 2012 Incentive Plan, to increase the number of shares of Common Stock reserved for issuance by 1,500,000 shares. The number of shares available for awards, as well as the terms of outstanding awards, are subject to adjustment as provided in the 2012 Incentive Plan for stock splits, stock dividends, recapitalizations and other similar events.
 
The Company also maintains a stock incentive plan, which was approved by shareholders in 2009 (the “2009 Incentive Plan”). The 2009 Incentive Plan also provided for the grant of incentive stock options, non-statutory stock options, stock appreciation rights, restricted stock, restricted stock units, dividend equivalent rights, performance awards, stock awards and other stock-based awards.  Under the 2012 Incentive Plan, any shares subject to award, or awards forfeited or reacquired by the Company issued under the 2009 Incentive Plan are available for award up to a maximum of 400,000 shares.
 
Stock Options
 
The Company’s outstanding stock options include time-based stock options, which vest over differing periods of time ranging from the date of issuance to up to 48 months from the option grant date, and performance-based stock options, which have already vested upon achieving operating income margins of six, eight and ten percent as reported in four of five consecutive quarters over the term of the options.
 

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Stock option activity for the nine-month period ended September 30, 2017, is as follows (amounts in thousands, except per share information):
 
Number of
Shares
 
Weighted Average
Exercise
Price Per Share
Options outstanding at December 31, 2016
1,524

 
$
12.41

Granted
25

 
13.50

Forfeited or canceled
(54
)
 
14.27

Exercised
(9
)
 
11.98

Options outstanding at September 30, 2017
1,486

 
12.27

 
During the nine months ended September 30, 2017, the Company issued options to purchase 25,000 shares of common stock under the 2012 Stock Incentive Plan to a new member of the Company's Board of Directors. These options were issued with an exercise price of $13.50 per share and a grant date fair value of $4.94 per share, with expected life of five years, risk-free interest rate of 1.8 percent, and expected volatility of 39.8 percent.

During the nine months ended September 30, 2017, the Company modified vested options to purchase 131,000 shares of common stock for one individual (included in options outstanding above) to extend the expiration date for approximately one year. It is expected the options will terminate by June 30, 2018. This was a modification of the terms of an equity award, and accordingly, the Company treated this as an exchange of the original award for a new award. The Company recorded incremental compensation expense of approximately $0.1 million for the nine months ended September 30, 2017, which was included in selling, general and administrative expense on the accompanying statements of income.

Share-based compensation expense from time-based stock options for the three-month periods ended September 30, 2017 and 2016, was approximately $(0.2) million as a result of cancellations and $0.2 million, respectively. Share-based compensation expense from time-based stock options for the nine-month periods ended September 30, 2017 and 2016, was approximately $0.2 million and $0.6 million, respectively. As of September 30, 2017 and December 31, 2016, the unrecognized share-based compensation expense related to the grants described above was $0.1 million and $0.3 million, respectively. As of September 30, 2017, the remaining compensation cost is expected to be recognized over the weighted-average period of approximately 0.4 years.
 
At September 30, 2017, the aggregate intrinsic value of outstanding stock options to purchase 1,486,000 shares of common stock, exercisable stock options to purchase 1,385,000 shares of common stock and stock options to purchase 102,000 shares of common stock that are expected to vest was $0.9 million, $0.9 million and $0, respectively. At December 31, 2016, the aggregate intrinsic value of outstanding options to purchase 1,524,000 shares of common stock, the exercisable options to purchase 1,201,000 shares of common stock, and options to purchase 306,000 shares of common stock expected to vest was $4.2 million, $3.7 million and $0.4 million, respectively.

For the nine-month periods ended September 30, 2017 and 2016, the Company issued 9,000 and 32,000 shares of common stock upon the exercise of stock options at an average exercise price of $11.98 and $3.99 per share, respectively. The aggregate intrinsic values of options exercised during the nine-month periods ended September 30, 2017 and 2016, was $7,000 and $0.2 million, respectively. For the nine-month period ended September 30, 2017 and 2016, the Company recognized $0 and $0.1 million of tax benefits from the exercise of stock options during the period, respectively.
 
Restricted Stock Units
 
The Company’s outstanding restricted stock units ("RSUs"), include time-based RSUs, which vest over differing periods of time ranging from 12 months to up to 48 months from the RSU grant date, as well as performance-based RSUs, which vest either upon achieving cumulative annual net sales growth targets over a rolling one-year period or upon achieving earnings-per-share targets over a rolling one-year period. RSUs granted to members of the Company's Board of Directors are not issued until the expiration of a two-year restriction period following vesting. There were 78,000 and 69,000 vested RSUs as of September 30, 2017, and December 31, 2016, respectively, that have been granted to members of the Company's Board of Directors but remain subject to the two-year restriction period.
 

15
Table of Contents

RSU activity for the nine-month period ended September 30, 2017, is as follows (amounts in thousands, except per share information):
 
Number of
Shares
 
Weighted Average
Grant Date
Fair Value
Restricted Stock Units outstanding at December 31, 2016
838

 
$
11.39

Granted
263

 
12.62

Forfeited
(142
)
 
12.07

Issued
(175
)
 
12.24

Restricted Stock Units outstanding at September 30, 2017
784

 
11.60

 
During the nine-month period ended September 30, 2017, the Company granted 263,000 RSUs under the 2012 Incentive Plan to the Company’s Board of Directors, executive officers and other employees, which were comprised of both time-based RSUs and net sales and operating income and earnings-per-share performance-based RSUs. The time-based RSUs were issued with a weighted-average grant date fair value of $12.22 per share and vest in annual installments over a three-year period from the grant date or according to the restrictions for the Board of Directors noted above. The net sales and operating income and earnings-per-share performance-based RSUs were issued with a weighted-average grant date fair value of $13.35 per share and vest upon achieving both (i) net sales and operating income targets over a three-year period from the grant date and (ii) earnings-per-share targets over a six-year period from the grant date.
 
RSUs are valued at market value on the date of grant, which is the grant date share price discounted for expected dividend payments during the vesting period. 
 
Share-based compensation expense for RSUs for the three-month periods ended September 30, 2017 and 2016, was approximately $0.3 million and $0.6 million, respectively. Share-based compensation expense from RSUs for the nine-month periods ended September 30, 2017 and 2016, was approximately $1.7 million and $1.8 million, respectively. As of September 30, 2017, and December 31, 2016, the unrecognized share-based compensation expense related to the grants described above, excluding incentive awards discussed below, was $2.2 million and $2.0 million, respectively. The remaining compensation expense is expected to be recognized over the weighted average period of approximately 1.1 years.
 
The Company has not recognized any share-based compensation expense related to the net sales and earnings-per-share performance-based RSUs for the nine-month periods ended September 30, 2017 and 2016.  Should the Company attain all of the net sales metrics related to the net sales performance-based stock option grants, the Company would recognize up to $3.3 million of potential share-based compensation expense.
 
The number of shares issued upon vesting of RSUs granted pursuant to the Company's share-based compensation plans is net of the minimum statutory withholding requirements that the Company pays on behalf of its employees, which was 39,000 shares for the nine-month period ended September 30, 2017. Although shares withheld are not issued, they are treated as common share repurchases for accounting purposes, as they reduce the number of shares that would have been issued upon vesting. These shares do not count against the authorized capacity under the repurchase program described above. 

(8)    Segment Information
 
The Company has four business segments. These business segments are components of the Company for which separate information is available and evaluated regularly by the chief executive officer in deciding how to allocate resources and in assessing relative performance.
 
The Company's four business segments are divided based on the different characteristics of their distributor and customer bases, distributor compensation plans and product formulations, as well as the internal organization of its officers and their responsibilities and business operations. Three business segments operate under the Nature’s Sunshine Products brand (NSP Americas; NSP Russia, Central and Eastern Europe; and China and New Markets), and one business segment operates under the Synergy® WorldWide brand.


16
Table of Contents

Reportable business segment information is as follows (dollar amounts in thousands):
 
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
2017
 
2016
 
2017
 
2016
Net sales:
 

 
 

 
 

 
 

NSP Americas
$
41,301

 
$
43,260

 
$
125,367

 
$
133,168

NSP Russia, Central and Eastern Europe
7,129

 
6,421

 
21,398

 
19,042

Synergy WorldWide
34,470

 
31,331

 
92,146

 
94,192

China and New Markets
6,401

 
4,429

 
14,832

 
10,807

Total net sales
89,301

 
85,441

 
253,743

 
257,209

 
 
 
 
 
 
 
 
Contribution margin (1):
 

 
 

 
 

 
 

NSP Americas
17,764

 
19,057

 
53,454

 
57,077

NSP Russia, Central and Eastern Europe
2,335

 
2,231

 
7,090

 
6,477

Synergy WorldWide
10,160

 
9,556

 
27,769

 
28,740

China and New Markets
4,821

 
3,401

 
11,013

 
7,953

Total contribution margin
35,080

 
34,245

 
99,326

 
100,247

 
 
 
 
 
 
 
 
Selling, general and administrative expenses (2)
32,926

 
29,187

 
95,098

 
88,821

Operating income
2,154

 
5,058

 
4,228

 
11,426

 
 
 
 
 
 
 
 
Other income, net
193

 
20

 
1,909

 
957

Income before provision for income taxes
$
2,347

 
$
5,078

 
$
6,137

 
$
12,383

_________________________________________

(1)   Contribution margin consists of net sales less cost of sales and volume incentives expense.

(2)  Service fees in the China and New Markets segment related to sales in China, occurring after the Company's receipt of its direct selling license and pre-opening product sales through Hong Kong, totaled $2.1 million and $4.7 million for the three and nine-month periods ended September 30, 2017, respectively, compared to $1.5 million and $3.4 million for the three and nine-month periods ended September 30, 2016. These service fees are included in the Company's selling, general and administrative expenses.

From an individual country perspective, only the United States and South Korea comprise 10 percent or more of consolidated net sales for the three and nine-month periods ended September 30, 2017 and 2016, as follows (dollar amounts in thousands):
 
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
2017
 
2016
 
2017
 
2016
Net sales:
 

 
 

 
 

 
 

United States
$
35,124

 
$
36,473

 
$
106,664

 
$
112,366

South Korea
14,371

 
14,083

 
38,203

 
42,754

Other
39,806

 
34,885

 
108,876

 
102,089

 
$
89,301

 
$
85,441

 
$
253,743

 
$
257,209



17
Table of Contents

Net Sales generated by each of the Company’s product lines is set forth below (dollar amounts in thousands):
 
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
2017
 
2016
 
2017
 
2016
NSP Americas:
 

 
 

 
 

 
 

General health
$
18,211

 
$
19,063

 
$
56,258

 
$
58,914

Immune
4,938

 
4,599

 
13,180

 
13,913

Cardiovascular
3,434

 
3,193

 
9,570

 
9,723

Digestive
11,084

 
11,684

 
34,892

 
36,608

Personal care
2,114

 
1,925

 
5,487

 
5,708

Weight management
1,520

 
2,796

 
5,980

 
8,302

 
41,301

 
43,260

 
125,367

 
133,168

NSP Russia, Eastern and Central Europe:
 

 
 

 
 

 
 

General health
$
3,192

 
$
2,732

 
$
9,691

 
$
7,956

Immune
789

 
650

 
2,190

 
2,047

Cardiovascular
542

 
538

 
1,553

 
1,508

Digestive
1,983

 
1,741

 
5,890

 
5,269

Personal care
443

 
517

 
1,475

 
1,619

Weight management
180

 
243

 
599

 
643

 
7,129

 
6,421

 
21,398

 
19,042

Synergy WorldWide:
 

 
 

 
 

 
 

General health
$
9,268

 
$
8,711

 
$
23,579

 
$
27,045

Immune
119

 
205

 
357

 
455

Cardiovascular
14,369

 
13,188

 
38,075

 
39,386

Digestive
4,428

 
3,383

 
12,047

 
9,312

Personal care
1,891

 
1,838

 
5,884

 
5,725

Weight management
4,395

 
4,006

 
12,204

 
12,269

 
34,470

 
31,331

 
92,146

 
94,192

China and New Markets:
 

 
 

 
 

 
 

General health
$
1,409

 
$
575

 
$
3,374

 
$
2,583

Immune
251

 
206

 
517

 
553

Cardiovascular
961

 
948

 
2,514

 
2,471

Digestive
2,559

 
2,118

 
6,014

 
3,640

Personal care
144

 
189

 
265

 
650

Weight management
1,077

 
393

 
2,148

 
910

 
6,401

 
4,429

 
14,832

 
10,807

 
$
89,301

 
$
85,441

 
$
253,743

 
$
257,209


From an individual country perspective, only the United States comprised 10 percent or more of consolidated property, plant and equipment as follows (dollar amounts in thousands):
 
 
September 30,
2017
 
December 31,
2016
Property, plant and equipment:
 

 
 

United States
$
67,454

 
$
70,770

Other
2,721

 
2,502

Total property, plant and equipment
$
70,175

 
$
73,272

 

18
Table of Contents

(9)    Income Taxes
 
For the three months ended September 30, 2017 and 2016, the Company’s provision for income taxes, as a percentage of income before income taxes was 0.0 percent and 22.4 percent, respectively, compared with a U.S. federal statutory rate of 35.0 percent. For the nine months ended September 30, 2017 and 2016, the Company’s provision for income taxes, as a percentage of income before income taxes was 38.2 percent and 34.6 percent, respectively, compared with a U.S. federal statutory rate of 35.0 percent.
 
The difference between the effective tax rate and the U.S. federal statutory tax rate for the three months ended September 30, 2017, was primarily attributed to decrease in the tax liability associated with uncertain tax positions, partially offset by current year losses, primarily related to China, that presently do not provide future tax benefit.

The difference between the effective tax rate and the U.S. federal statutory tax rate for the nine months ended September 30, 2017, was primarily attributed to current year foreign losses, primarily related to China, that presently do not provide a future tax benefit, partially offset by foreign tax credit benefits as well as a decrease in tax liabilities associated with uncertain tax positions.

The difference between the effective tax rate and the U.S. federal statutory tax rate for the three and nine months ended September 30, 2016, was attributed to foreign tax credit benefits and a decrease in tax liabilities associated with uncertain tax positions, partially offset by the impact of losses during the period that will not provide a tax benefit.

Changes to the effective rate due to dividends received from foreign subsidiaries and the impact of foreign tax credits are expected to be recurring. Depending on various factors, changes from the foregoing items may be favorable or unfavorable in a particular period.
 
The Company’s U.S. federal income tax returns for 2014 through 2016 are open to examination for federal tax purposes. The Company has several foreign tax jurisdictions that have open tax years from 2010 through 2016.
 
As of September 30, 2017, the Company had accrued $4.9 million related to unrecognized tax positions, compared with $6.8 million as of December 31, 2016. This net decrease was primarily attributed to changes in contingencies related to international tax.
 
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. Although the Company believes its tax estimates are reasonable, the Company can make no assurance that the final tax outcome of these matters will not be different from that which it has reflected in its historical income tax provisions and accruals.  Such differences 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. 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 and/or future periods. The Company maintains 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.
 
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, including value-added taxes and sales tax. The Company provides provisions for U.S. state sales taxes in each of the states where the Company has nexus. September 30, 2017 and December 31, 2016, accrued liabilities were $0.3 million 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 believes future payments related to these matters could range from $0 to approximately $4.0 million.
 
Other Litigation
 
The Company is a party to various other legal proceedings in several foreign jurisdictions related to value-added tax assessments and other civil litigation.  As of each of September 30, 2017, and December 31, 2016, accrued liabilities were $1.0 million and $0.8 million, respectively, related to the estimated outcome of these proceedings. In addition, the Company is a party to other litigation where there is a reasonable possibility that a loss may be incurred, either the losses are not considered to be probable or 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 $0.5 million.
 
(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 assets, measured at fair value on a recurring basis, as of September 30, 2017 (dollar amounts in thousands):
 
 
Level 1
 
Level 2
 
Level 3
 
 
 
Quoted Prices
in Active
Markets for
Identical Assets
 
Significant
Other
Observable
Inputs
 
Significant
Unobservable
Inputs
 
Total
Trading Investment securities
$
1,907

 
$
—

 
$
—

 
$
1,907

Total assets measured at fair value on a recurring basis
$
1,907

 
$
—

 
$
—

 
$
1,907

 

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The following table presents the Company’s hierarchy for its assets, measured at fair value on a recurring basis, as of December 31, 2016 (dollar amounts in thousands):
 
 
Level 1
 
Level 2
 
Level 3
 
 
 
Quoted Prices
in Active
Markets for
Identical Assets
 
Significant
Other
Observable
Inputs
 
Significant
Unobservable
Inputs
 
Total
Investments available-for-sale
 

 
 

 
 

 
 

U.S. government security funds
$
1,776

 
$
—

 
$
—

 
$
1,776

Trading Investment securities
1,391

 
—

 
—

 
1,391

Total assets measured at fair value on a recurring basis
$
3,167

 
$
—

 
$
—

 
$
3,167

 
Investments available-for-sale — The majority of the Company’s investment portfolio consists of U.S. government security funds. The Level 1 securities are valued using quoted prices for identical assets in active markets including equity securities and U.S. government treasuries. 
 
Trading Investment securities — The Company’s trading portfolio consists of various marketable securities that are valued using quoted prices in active markets.
 
For the nine months ended September 30, 2017, and for the year ended December 31, 2016, there were no fair value measurements using significant other observable inputs (Level 2) or significant unobservable inputs (Level 3).
 
The carrying amounts reflected on the condensed consolidated balance sheet for cash and cash equivalents, accounts receivable, and accounts payable approximate fair value due to their short-term nature. The carrying amount reflected on the condensed consolidated balance sheet for the revolving credit facility approximates fair value due to it being variable-rate debt. During the nine months ended September 30, 2017 and 2016, the Company did not have any re-measurements of non-financial assets at fair value on a nonrecurring basis subsequent to their initial recognition.

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Item 2.                            MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 
The following Management’s Discussion and Analysis should be read in conjunction with the unaudited condensed consolidated financial statements and notes thereto included in this report, as well as the consolidated financial statements, the notes thereto, and management’s discussion and analysis included in the Company's Annual Report on Form 10-K for the year ended December 31, 2016, and its other reports filed since the date of such Form 10-K.
 
OVERVIEW
 
The Company is a natural health and wellness company primarily engaged in the manufacturing and direct selling of nutritional and personal care products. The Company has four business segments that are divided based on the different characteristics of their distributor and customer bases, distributor compensation plans and product formulations, as well as the internal organization of its officers and their responsibilities and business operations.  Three business segments operate under the Nature’s Sunshine Products brand (NSP Americas; NSP Russia, Central and Eastern Europe; and China and New Markets), and one business segment operates under the Synergy® WorldWide brand.

The Company’s independent distributors market and sell the Company's products to customers and sponsor other independent distributors who also market the Company's products to customers. The Company's revenue is highly dependent upon the number and productivity of its independent distributors. Growth in sales volume requires an increase in the productivity of the Company's independent distributors and/or growth in the total number of its independent distributors. The Company seeks to motivate and provide incentives to its independent distributors by offering high quality products and providing its independent distributors with product support, training seminars, sales conventions, travel programs and financial incentives.

In the third quarter of 2017, the Company experienced an increase in its consolidated net sales of 4.5 percent (or 4.3 percent in local currencies) compared to the same period in 2016. NSP China and New Markets net sales increased approximately 44.5 percent compared to the same period in 2016. NSP Russia, Central and Eastern Europe net sales increased approximately 11.0 percent compared to the same period in 2016. Synergy WorldWide net sales increased approximately 10.0 percent compared to the same period in 2016 (or 10.7 percent in local currencies). NSP Americas net sales decreased approximately 4.5 percent compared to the same period in 2016 (or 5.2 percent in local currencies). The strengthening of the U.S. dollar versus the local currencies, primarily in the Company's Asian markets, resulted in an approximate 0.2 percent, or $0.2 million, decrease of its net sales during the quarter.

The Company made a significant investment in its information systems of approximately $48.0 million as of September 30, 2017, and began the initial implementation of the Oracle ERP system on April 2, 2017, for the Company’s NSP Americas segment as well as other corporate operations. The implementation of the Oracle ERP system negatively impacted net sales and profitability during the second and third quarters of 2017, primarily by causing wait times for calls into the Company's call center to be longer than usual and by causing difficulties within the Company's on-line product ordering system, which led to customer attrition. The Company continues to address these and other issues. The Company anticipates the implementation of the Oracle ERP system may continue to negatively impact net sales and profitability going forward.


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RESULTS OF OPERATIONS
 
The following table summarizes the Company's unaudited consolidated operating results from continuing operations in U.S. dollars and as a percentage of net sales for the three months ended September 30, 2017 and 2016 (dollar amounts in thousands):
 
 
Three Months Ended
September 30, 2017
 
Three Months Ended
September 30, 2016
 
Change
 
Total
dollars
 
Percent of
net sales
 
Total
dollars
 
Percent of
net sales
 
Total
dollars
 
Percentage 
Net sales
$
89,301

 
100.0
 %
 
$
85,441

 
100.0
%
 
$
3,860

 
4.5
 %
Cost of sales
23,505

 
26.3

 
21,512

 
25.2

 
1,993

 
9.3

 
65,796

 
73.7

 
63,929

 
74.8

 
1,867

 
2.9

Volume incentives
30,716

 
34.4

 
29,684

 
34.7

 
1,032

 
3.5

SG&A expenses
32,926

 
36.9

 
29,187

 
34.2

 
3,739

 
12.8

Operating income
2,154

 
2.4

 
5,058

 
5.9

 
(2,904
)
 
(57.4
)
Other income, net
193

 
0.2

 
20

 
—

 
173

 
865.0

Income before income taxes
2,347

 
2.6

 
5,078

 
5.9

 
(2,731
)
 
(53.8
)
Provision for (benefit from) income taxes
(1
)
 
—

 
1,136

 
1.3

 
(1,137
)
 
(100.1
)
Net income
$
2,348

 
2.6
 %
 
$
3,942

 
4.6
%
 
$
(1,594
)
 
(40.4
)%

The following table summarizes the Company's unaudited consolidated operating results from continuing operations in U.S. dollars and as a percentage of net sales for the nine months ended September 30, 2017 and 2016 (dollar amounts in thousands):
 
 
Nine Months Ended
September 30, 2017
 
Nine Months Ended
September 30, 2016
 
Change
 
Total
dollars
 
Percent of
net sales
 
Total
dollars
 
Percent of
net sales
 
Total
dollars
 
Percentage 
Net sales
$
253,743

 
100.0
%
 
$
257,209

 
100.0
%
 
$
(3,466
)
 
(1.3
)%
Cost of sales
66,430

 
26.2

 
66,610

 
25.9

 
(180
)
 
(0.3
)
 
187,313

 
73.8

 
190,599

 
74.1

 
(3,286
)
 
(1.7
)
Volume incentives
87,987

 
34.7

 
90,352

 
35.1

 
(2,365
)
 
(2.6
)
SG&A expenses
95,098

 
37.5

 
88,821

 
34.5

 
6,277

 
7.1

Operating income
4,228

 
1.7

 
11,426

 
4.4

 
(7,198
)
 
(63.0
)
Other income, net
1,909

 
0.8

 
957

 
0.4

 
952

 
99.5

Income before income taxes
6,137

 
2.4

 
12,383

 
4.8

 
(6,246
)
 
(50.4
)
Provision for income taxes
2,346

 
0.9

 
4,286

 
1.7

 
(1,940
)
 
(45.3
)
Net income
$
3,791

 
1.5
%
 
$
8,097

 
3.1
%
 
$
(4,306
)
 
(53.2
)%

 Net Sales
 
The Company’s international operations have provided, and are expected to continue to provide, a significant portion of its total net sales. As a result, total net sales will continue to be affected by fluctuations in the U.S. dollar against foreign currencies. In order to provide a framework for assessing how its underlying businesses performed excluding the effect of foreign currency fluctuations, in addition to comparing the percent change in net sales from one period to another in U.S. dollars, the Company compares the percentage change in net sales from one period to another period by excluding the effects of foreign currency exchange as shown below. Net sales excluding the impact of foreign exchange fluctuations is not a U.S. GAAP financial measure. Net sales in local currency removes from net sales in U.S. dollars the impact of changes in exchange rates between the U.S. dollar and the functional currencies of its foreign subsidiaries, by translating the current period net sales into U.S. dollars using the same foreign currency exchange rates that were used to translate the net sales for the previous comparable period. The Company believes presenting the impact of foreign currency fluctuations is useful to investors because it allows a more meaningful comparison of net sales of its foreign operations from period to period. However, net sales

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excluding the impact of foreign currency fluctuations should not be considered in isolation or as an alternative to net sales in U.S. dollar measures that reflect current period exchange rates, or to other financial measures calculated and presented in accordance with U.S. GAAP. Throughout the last five years, foreign currency exchange rates have fluctuated significantly. See Item 3. Quantitative and Qualitative Disclosures about Market Risk.

The following table summarizes the changes in net sales by operating segment with a reconciliation to net sales excluding the impact of currency fluctuations for the three months ended September 30, 2017 and 2016 (dollar amounts in thousands):
 
 
Net Sales by Operating Segment
 
Three Months Ended
September 30, 2017
 
Three Months Ended
September 30, 2016
 
Percent
Change
 
Impact of
Currency
Exchange
 
Percent
Change
Excluding
Impact of
Currency
NSP Americas:
 

 
 

 
 

 
 

 
 

NSP North America
$
34,896

 
$
36,479

 
(4.3
)%
 
$
105

 
(4.6
)%
NSP Latin America
6,405

 
6,781

 
(5.5
)
 
176

 
(8.1
)
 
41,301

 
43,260

 
(4.5
)
 
281

 
(5.2
)
NSP Russia, Central and Eastern Europe
7,129

 
6,421

 
11.0

 
79

 
9.8

Synergy WorldWide:
 

 
 

 
 

 
 

 
 

Synergy Asia Pacific
25,829

 
22,637

 
14.1

 
(538
)
 
16.5

Synergy Europe
5,924

 
6,107

 
(3.0
)
 
328

 
(8.4
)
Synergy North America
2,717

 
2,587

 
5.0

 
—

 
5.0

 
34,470

 
31,331

 
10.0

 
(210
)
 
10.7

China and New Markets
6,401

 
4,429

 
44.5

 
—

 
44.5

 
$
89,301

 
$
85,441

 
4.5
 %
 
$
150

 
4.3
 %

The following table summarizes the changes in net sales by operating segment with a reconciliation to net sales excluding the impact of currency fluctuations for the nine months ended September 30, 2017 and 2016 (dollar amounts in thousands):
 
 
Net Sales by Operating Segment
 
Nine Months Ended
September 30, 2017
 
Nine Months Ended
September 30, 2016
 
Percent
Change
 
Impact of
Currency
Exchange
 
Percent
Change
Excluding
Impact of
Currency
NSP Americas:
 

 
 

 
 

 
 

 
 

NSP North America
$
106,132

 
$
112,224

 
(5.4
)%
 
$
83

 
(5.5
)%
NSP Latin America
19,235

 
20,944

 
(8.2
)
 
54

 
(8.4
)
 
125,367

 
133,168

 
(5.9
)
 
137

 
(6.0
)
NSP Russia, Central and Eastern Europe
21,398

 
19,042

 
12.4

 
61

 
12.1

Synergy WorldWide:
 

 
 

 
 

 
 

 
 

Synergy Asia Pacific
65,881

 
66,850

 
(1.4
)
 
272

 
(1.9
)
Synergy Europe
17,946

 
19,101

 
(6.0
)
 
(52
)
 
(5.8
)
Synergy North America
8,319

 
8,241

 
0.9

 
—

 
0.9

 
92,146

 
94,192

 
(2.2
)
 
220

 
(2.4
)
China and New Markets
14,832

 
10,807

 
37.2

 
—

 
37.2

 
$
253,743

 
$
257,209

 
(1.3
)%
 
$
418

 
(1.5
)%
 
Consolidated net sales for the three and nine months ended September 30, 2017, were $89.3 million and $253.7 million, respectively, compared to $85.4 million and $257.2 million for the same periods in 2016, which represents an increase of 4.5

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percent and a decrease of 1.3 percent, respectively. The decrease in net sales for the nine months ended September 30, 2017 was principally related to decreases in the Company's NSP Americas and Synergy WorldWide segments. Net sales in the Company's NSP Americas segment decreased $2.0 million and $7.8 million for the three and nine months ended September 30, 2017, respectively, compared to the same periods in 2016. Net sales in the Company's Synergy WorldWide segment increased $3.1 million and decreased $2.0 million for the three and nine months ended September 30, 2017, respectively, compared to the same periods in 2016. Net sales in the Company's China and New Markets segment increased $2.0 million and $4.0 million for the three and nine months ended September 30, 2017, respectively, compared to the same periods in 2016. The Company's NSP Russia, Central and Eastern Europe segment net sales increased $0.7 million and $2.4 million for the three and nine months ended September 30, 2017, respectively. Net sales for the three and nine months ended September 30, 2017, were favorably impacted by $0.2 million and $0.4 million of foreign currency exchange rate fluctuations, respectively. Excluding the impacts of foreign currency exchange rate fluctuations, consolidated net sales increased by 4.3 percent and decreased 1.5 percent, respectively, from the same periods in 2016.

The Company made a significant investment in its information systems of approximately $48.0 million as of September 30, 2017, and began the initial implementation of the Oracle ERP system on April 2, 2017, for the Company’s NSP Americas segment as well as other corporate operations. The implementation of the Oracle ERP system negatively impacted net sales and profitability during the second and third quarters of 2017, primarily by causing wait times for calls into the Company's call center to be longer than usual and by causing difficulties within the Company's on-line product ordering system during the second quarter of 2017. The Company continues to address these and other issues. It anticipates the implementation of the Oracle ERP system may continue to negatively impact net sales and profitability going forward.
 
NSP Americas
 
Net sales from the Company's NSP Americas segment for the three and nine months ended September 30, 2017, were $41.3 million and $125.4 million, respectively, compared to $43.3 million and $133.2 million for the same periods in 2016, or decreases of 4.5 percent and 5.9 percent, respectively. Net sales declined primarily due to interruptions in customer service associated with the implementation of the Oracle ERP system, which began in the Company's NSP America's segment at the beginning of the second quarter of 2017. The implementation of the Oracle ERP system caused wait times for calls into the Company's call center to be longer than usual and caused difficulties within the Company's on-line product ordering system. The Company continues to address these and other issues relating to the implementation of the Oracle ERP system. The Company anticipates that the implementation of the Oracle ERP system may continue to negatively impact net sales and profitability going forward. In local currency, net sales decreased 5.2 percent and 6.0 percent, compared to the same three and nine month periods in 2016, respectively. Fluctuations in foreign exchange rates had $0.3 million and $0.1 million favorable impacts on net sales for the three and nine months ended September 30, 2017, respectively. Active Managers within NSP Americas totaled approximately 5,900 and 6,500 at September 30, 2017 and 2016, respectively. Active Distributors and customers within NSP Americas totaled approximately 107,300 and 125,900 at September 30, 2017 and 2016, respectively. The issues associated with the implementation of the Oracle ERP system continued to negatively impact the Company's ability to attract new Distributors and customers, and retain existing Distributors and customers, which was a significant cause for the decrease in the number of independent Managers, Distributors and customers. Independent Managers and active independent Distributors and customers were down 14.5 percent, compared to the same period in 2016. The active independent Managers category includes independent Managers under the Company's various compensation plans that have achieved and maintained certain product sales levels. As such, all independent Managers are considered to be active independent Managers. The active Distributors and customers category includes independent Distributors and customers who have purchased products directly from the Company for resale and/or personal consumption during the previous three months.
 
Notable activity in the following markets contributed to the results of NSP Americas:
 
In the United States, net sales decreased approximately $1.5 million and $5.8 million, or 4.3 percent and 5.6 percent, for the three and nine months ended September 30, 2017, respectively, compared to the same periods in 2016. The decrease was primarily due to the issues associated with the implementation of the Oracle ERP system in the Company's NSP Americas segment at the beginning the second quarter of 2017, which continued to have a negative impact on the Company's net sales during the third quarter of 2017.

In Latin America, net sales decreased approximately $0.4 million and $1.7 million, or 5.5 percent and 8.2 percent, for the three and nine months ended September 30, 2017, respectively, compared to the same periods in 2016. In local currency, net sales for the three and nine months ended September 30, 2017, decreased 8.1 percent and 8.4 percent, respectively, compared to the same periods in 2016. Currency devaluation had a $0.2 million and $0.1 million favorable impact on net sales for the three and nine months ended September 30, 2017, respectively. The decrease in net sales was primarily due to the issues associated with the implementation of the Oracle ERP system in the Company's NSP Americas segment at the beginning of the second

24
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quarter of 2017, which impacted net sales in the second and third quarters of 2017. Net sales in Latin America continues to be negatively impacted by changing regulations for product registration that affect the Company's ability to sell some of its products in certain countries in Latin America. To address this, the Company continues to emphasize the IN.FORM business model, which includes products the Company anticipates will be acceptable for registration under the changing product registration requirements in Latin America, and, at the same time, ensuring its resources are aligned with this initiative.

 NSP Russia, Central and Eastern Europe
 
Net sales in the Company's NSP Russia, Central and Eastern Europe segment for the three and nine months ended September 30, 2017, were $7.1 million and $21.4 million, respectively, compared to $6.4 million and $19.0 million for the same periods in 2016, or an increase of 11.0 percent and 12.4 percent, respectively. Active independent Managers within the Company's NSP Russia, Central and Eastern Europe segment totaled approximately 2,900 and 2,600 at September 30, 2017 and 2016, respectively. Active independent Distributors and customers within NSP Russia, Central and Eastern Europe totaled approximately 61,000 and 60,600 at September 30, 2017 and 2016, respectively. Net sales increased primarily as a result of the relative stabilization of Russian ruble against the U.S. dollar and product promotions that have improved distributor engagement.
 
Synergy WorldWide
 
The Company's Synergy WorldWide segment reported net sales for the three and nine months ended September 30, 2017, of $34.5 million and $92.1 million, respectively, compared to $31.3 million and $94.2 million for the same periods in 2016, or an increase of 10.0 percent and a decrease of 2.2 percent, respectively. The increase in net sales for the three months ended September 30, 2017, was primary due to the increases in Synergy Japan and Synergy Korea which have refocused on building up their manager ranks and emphasizing core products. The decrease in net sales for the nine months ended September 30, 2017, was primarily due to decline in sales in the segment's Asia Pacific and Europe region, offset by growth in North America. The three and nine months ended September 30, 2017, were impacted by an unfavorable $0.2 million and a favorable $0.2 million in foreign currency exchange rate fluctuations, respectively. In local currency, net sales increased 10.7 percent and decreased 2.4 percent for the three and nine months ended September 30, 2017, respectively, compared to the same periods in 2016. Active independent Managers within the Company's Synergy WorldWide segment totaled approximately 4,600 and 4,100 at September 30, 2017 and 2016, respectively. Active independent Distributors and customers within the Company's Synergy WorldWide segment totaled approximately 45,100 and 55,600 at September 30, 2017 and 2016, respectively. The Company's Synergy WorldWide segment operates under a traditional direct selling method.
 
Notable activity in the following markets contributed to the results of Synergy WorldWide:
 
In South Korea, net sales increased $0.3 million and decreased $4.6 million, or an increase of 2.0 percent and a decrease of 10.6 percent, for the three and nine months ended September 30, 2017, respectively, compared to the same periods in 2016. In local currency, net sales for the three and nine months ended September 30, 2017, increased 2.5 percent and decreased 12.5 percent, respectively, compared to the same periods in 2016. The increase in local currency net sales for the three months ending September 30, 2017, was primarily the result of an increased focus on core products for the market. The decrease in local currency net sales for the nine months ended September 30, 2017 was primarily due to a reduction in distributor engagement as well as recent geopolitical tension and economic conditions in the region. These conditions may continue for the foreseeable future and may, therefore, continue to negatively impact the Company's future financial results.
 
In Japan, net sales increased $3.8 million and $5.4 million, or 100.7 percent and 47.8 percent, for the three and nine months ended September 30, 2017, respectively, compared to the same periods in 2016. In local currency, net sales for the three and nine months ended September 30, 2017, increased 113.4 percent and 52.7 percent, respectively, compared to the same periods in 2016. The increase in local currency net sales is primarily tied to strong traction of the new sales program launched in 2016, which has been successful in encouraging distributor engagement.
 
In Europe, net sales decreased $0.2 million and $1.2 million, or 3.0 percent and 6.0 percent, for the three and nine months ended September 30, 2017, respectively, compared to the same periods in 2016. In local currency, net sales for the three and nine months ended September 30, 2017, decreased 8.4 percent and 5.8 percent, respectively, compared to the same periods in 2016. The decrease in local currency net sales is primarily due to market saturation and a reduction in sales activity in the market's Scandinavian countries.

In North America, net sales increased approximately $0.1 million and $0.1 million, or an increase of 5.0 percent and 0.9 percent, for the three and nine months ended September 30, 2017, respectively, compared to the same periods in 2016.
 

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China and New Markets
 
China and New Markets had net sales for the three and nine months ended September 30, 2017, of $6.4 million and $14.8 million, respectively, compared to $4.4 million and $10.8 million for the same periods in 2016, or increases of 44.5 percent and 37.2 percent, respectively. The increase in net sales is largely the result of the Company receiving its direct selling license in China during the three months ended June 30, 2017, which allows the Company to expand its business scope to include direct selling activities within China.
   
Further information related to NSP Americas, NSP Russia, Central and Eastern Europe, Synergy WorldWide, and China and New Markets business segments is set forth in Note 8 to the Unaudited Condensed Consolidated Financial Statements in Part 1, Item 1 of this report.
 
Cost of Sales
 
Cost of sales as a percent of net sales was 26.3 percent and 26.2 percent for the three- and nine-month periods ended September 30, 2017, compared 25.2 percent and 25.9 percent for the same periods in 2016. The change in the cost of sale percentage for the three month period is primarily due to the change in segment market mix resulting from net sales increases in markets with lower margins.
 
Volume Incentives
 
Volume incentives are a significant part of the Company's direct sales marketing program, and represent commission payments to independent distributors. These payments are designed to provide incentives for reaching higher sales levels. Volume incentives vary slightly, on a percentage basis, by product due to pricing policies and commission plans in place in the various operations. The Company does not pay volume incentives in China, instead the Company pays independent service fees, which are included in selling, general and administrative expenses.

Volume incentives as a percent of net sales was 34.4 percent and 34.7 percent for the three and nine months ended September 30, 2017, respectively, compared to 34.7 percent and 35.1 percent for the same periods in 2016. The change in volume incentives as a percent of net sales for the nine month period is primarily due to change in segment market mix such as the sales growth in China and New Markets related to sales in China, occurring after the Company's receipt of its direct selling license, and pre-opening product sales through Hong Kong, for which no volume incentives are paid.
 
Selling, General and Administrative
 
Selling, general and administrative expenses represent operating expenses, components of which include labor and benefits, sales events, professional fees, travel and entertainment, marketing, occupancy costs, communications costs, bank fees, depreciation and amortization, independent services fees paid in China, and other miscellaneous operating expenses.

Selling, general and administrative expenses increased by approximately $3.7 million and $6.3 million, respectively, to $32.9 million and $95.1 million for the three and nine months ended September 30, 2017, respectively, compared to the same periods in 2016. Selling, general and administrative expenses were 36.9 percent and 37.5 percent of net sales for the three and nine months ended September 30, 2017, respectively, compared to 34.2 percent and 34.5 percent for the same periods in 2016. The increase in selling, general and administrative expenses for the three and nine months ended September 30, 2017, as compared to the same periods in 2016, was primarily related to:


•
$1.2 million and $2.4 million of increased depreciation related to the Oracle ERP implementation project incurred for the three and nine months ended September 30, 2017, respectively;
•
$0.6 million and $2.3 million of increased investment in China during the three and nine months ended September 30, 2017, respectively; and
•
$0.6 million and $1.3 million of increased independent service fees in China for the three and nine months ended September 30, 2017, respectively.

Offset by:
•
$0.1 million and $0.8 million reduction of reserves for product liability for the three and nine months ended September 30, 2017, respectively.
 

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Other Income (Expense), Net
 
Other income (expense) net, for the three and nine months ended September 30, 2017, increased $0.2 million and $1.0 million, respectively, to $0.2 million and $1.9 million, compared to the same periods in 2016. Other income for the three and nine months ended September 30, 2017 primarily consisted of foreign exchange gains. The change in other income was primarily due to increases in foreign exchange gains as a result of changes in foreign currencies.
 
Income Taxes

For the three months ended September 30, 2017 and 2016, the Company’s provision for income taxes, as a percentage of income before income taxes was 0.0 percent and 22.4 percent, respectively, compared with a U.S. federal statutory rate of 35.0 percent. For the nine months ended September 30, 2017 and 2016, the Company’s provision for income taxes, as a percentage of income before income taxes was 38.2 percent and 34.6 percent, respectively, compared with a U.S. federal statutory rate of 35.0 percent.
 
The difference between the effective tax rate and the U.S. federal statutory tax rate for the three months ended September 30, 2017, was primarily attributed to decrease in the tax liability associated with uncertain tax positions, partially offset by current year losses, primarily related to China, that presently do not provide future tax benefit.

The difference between the effective tax rate and the U.S. federal statutory tax rate for the nine months ended September 30, 2017, was primarily attributed to current year foreign losses, primarily related to China, that presently do not provide a future tax benefit, partially offset by foreign tax credit benefits as well as a decrease in tax liabilities associated with uncertain tax positions.

The difference between the effective tax rate and the U.S. federal statutory tax rate for the three and nine months ended September 30, 2016, was attributed to foreign tax credit benefits and a decrease in tax liabilities associated with uncertain tax positions, partially offset by the impact of losses during the period that will not provide a tax benefit.

Changes to the effective rate due to dividends received from foreign subsidiaries and the impact of foreign tax credits are expected to be recurring. Depending on various factors, changes from the foregoing items may be favorable or unfavorable in a particular period.
 
The Company’s U.S. federal income tax returns for 2014 through 2016 are open to examination for federal tax purposes. The Company has several foreign tax jurisdictions that have open tax years from 2010 through 2016.
 
As of September 30, 2017, the Company had accrued $4.9 million related to unrecognized tax positions, compared with $6.8 million as of December 31, 2016. This net decrease was primarily attributed to changes in contingencies related to international tax.

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. Although the Company believes its tax estimates are reasonable, the Company can make no assurance that the final tax outcome of these matters will not be different from that which it has reflected in its historical income tax provisions and accruals.  Such differences 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.
 
Product Categories
 
The Company’s line of over 700 products includes several different product classifications, such as immune, cardiovascular, digestive, personal care, weight management and other general health products. The Company purchases herbs and other raw materials in bulk and, after rigorous quality control testing, it formulates, encapsulates, tablets or concentrates them, labels and packages them for shipment. Most products are manufactured at the Company's facility in Spanish Fork, Utah. Contract manufacturers produce some of its products in accordance with its exacting specifications and standards. The Company has implemented stringent quality control procedures to verify that its contract manufacturers have complied with its specifications and standards.

Presented below are the U.S. dollar amounts and associated revenue percentages from the sale of general health, immune, cardiovascular, digestive, personal care and weight management products for the three and nine months ended September 30, 2017 and 2016, by business segment.
 

27
Table of Contents

Three Months Ended September 30,
2017
 
2016
NSP Americas:
 

 
 

 
 

 
 

General health
$
18,211

 
44.1
%
 
$
19,063

 
44.1
%
Immune
4,938

 
12.0

 
4,599

 
10.6

Cardiovascular
3,434

 
8.3

 
3,193

 
7.4

Digestive
11,084

 
26.8

 
11,684

 
27.0

Personal care
2,114

 
5.1

 
1,925

 
4.4

Weight management
1,520

 
3.7

 
2,796

 
6.5

Total NSP Americas
41,301

 
100.0

 
43,260

 
100.0

 
 
 
 
 
 
 
 
NSP Russia, Central and Eastern Europe:
 

 
 

 
 

 
 

General health
$
3,192

 
44.8
%
 
$
2,732

 
42.5
%
Immune
789

 
11.1

 
650

 
10.1

Cardiovascular
542

 
7.6

 
538

 
8.4

Digestive
1,983

 
27.8

 
1,741

 
27.1

Personal care
443

 
6.2

 
517

 
8.1

Weight management
180

 
2.5

 
243

 
3.8

Total NSP Russia, Central and Eastern Europe
7,129

 
100.0

 
6,421

 
100.0

 
 
 
 
 
 
 
 
Synergy WorldWide:
 

 
 

 
 

 
 

General health
$
9,268