Richard M. Nixon And Nu Skin's 5th Amendment

Sep. 2.14 | About: Nu Skin (NUS)

Summary

Nu Skin breached debt covenants of the Prudential Agreement not just once.

Hedge fund manager John Hempton's article sheds new light on Nu Skin's breach of debt covenants.

Richard M. Nixon, the signatory on behalf of JP Morgan on Nu Skin's SEC filings, draws scrutiny.

[Author's update, Sept. 2, 2014, 2:20 PM: See note at the end of this article regarding the signatory on behalf of JPMorgan.]

New developments related to Nu Skin (NYSE: NUS) since the publication of the article titled, "Is Nu Skin Insolvent?" necessitated this follow-up article in just four short days.

Many observations made in "Is Nu Skin Insolvent?" were based on the most recent SEC filings by Nu Skin. In retrospect, it's an oversight on my part not to look deep enough into the previous SEC filings, which paint an even bleaker picture of Nu Skin's financial situation. A professional investor and a hedge fund manager, Mr. John Hempton of Bronte Capital also looked into Nu Skin's SEC filings. In his blog-post titled, "Nixon pardons Nu Skin" Mr. Hempton presented a much closer look at Nu Skin's violation of debt covenants.

Violations and Amendments to Debt Covenants

The following is Nu Skin's disclosure related to credit agreement (italicized emphasis mine), filed with first-quarter 10-Q (Source: The Fifth Amendment, dated May 6, 2014)

As of March 31, 2014, the Company was in violation of its restricted payments covenant under its amended and restated credit agreement, dated as of May 25, 2012, among the Company, various financial institutions, and JPMorgan Chase Bank, N.A. as administrative agent, as amended (the "JPMC Agreement") and its amended and restated note purchase and private shelf agreement (multi-currency), dated as of May 25, 2012, among the Company, Prudential Investment Management, Inc. and certain other purchasers, as amended (the "Prudential Agreement"), which restricts the Company from making dividend payments or stock repurchases to the extent the aggregate amount of such payments exceed $100 million plus the cumulative cash flow from operations less capital investments since June 30, 2012. Effective May 6, 2014, the Company entered into amendments of the JPMC Agreement and the Prudential Agreement that allow the aggregate amount of restricted payments to exceed the allowed threshold by no more than $50 million for the quarter ending March 31, 2014, $100 million for the quarter ending June 30, 2014 and $50 million for the quarter ending September 30, 2014, to avoid default or acceleration provisions of these agreements. The amendment of the JPMC Agreement also fixed the applicable interest rate at LIBOR plus 0.75%, increased the commitment fee to 0.25% and extended the term of the agreement from May 9, 2014 to August 8, 2014, with $15 million reductions in the commitment amount on June 30, 2014 and July 31, 2014.

The following is Nu Skin's disclosure related to credit agreement, filed with second-quarter 10-Q (Source: The Fifth Amendment, dated Aug. 8, 2014). Compare italicized emphasis with the emphasis in first-quarter 10-Q.

As of June 30, 2014, the Company was in violation of its restricted payments covenant under its amended and restated note purchase and private shelf agreement (multi-currency), dated as of May 25, 2012, among the Company, Prudential Investment Management, Inc. and certain other purchasers, as amended (the "Prudential Agreement") and the amended and restated credit agreement, dated as of May 25, 2012, among the Company, various financial institutions, and JPMorgan Chase Bank, N.A. as administrative agent (the "JPMC Agreement"), which restricts the Company from making dividend payments or stock repurchases to the extent the aggregate amount of such payments exceed $100 million plus the cumulative cash flow from operations less capital investments since June 30, 2012. Effective August 8, 2014, the Company entered into an amendment of the Prudential Agreement that allows the aggregate amount of restricted payments to exceed the allowed threshold by no more than $110 million for the quarter ending June 30, 2014 and $50 million for the quarter ending September 30, 2014, to avoid default or acceleration provisions of the Prudential Agreement. The JPMC Agreement expired pursuant to its terms on August 8, 2014, prior to which all amounts outstanding thereunder were repaid in full.

These two disclosures indicate that the company was in violation of debt covenant for two quarters in a row and still managed to amend the credit agreements after the quarter ended and just a few days prior to filing the 10-Q.

Did Nu Skin Also Breach Covenants Amended for the Second Time?

Mr. Hempton conducted a detailed analysis of the above-mentioned covenants vis-a-vis the company financials dating back to June 2012. The following is the relevant section of Mr. Hempton's worksheet.

Click to enlarge

(Spreadsheet source: Bronte Capital)

As shown in the figure, Mr. Hempton looked at the covenant terms filed with the first-quarter 10-Q in two different ways and concluded:

It doesn't matter which way you look at it. They breached the covenant in the first quarter. This is disclosed in the first-quarter 10-Q.

...

They amended this breach after quarter end (which it seems required the signature of Richard M. Nixon).

You will note however the wording of the amended covenant changed between the first quarter filing and the second quarter filing. This is pursuant to more modifications of covenants dated 8 August as described above (and repeated here):

Effective August 8, 2014, the Company entered into an amendment of the Prudential Agreement that allows the aggregate amount of restricted payments to exceed the allowed threshold by no more than $110 million for the quarter ending June 30, 2014 and $50 million for the quarter ending September 30, 2014.

Strangely they breached that covenant too (as demonstrated in the attached Google sheet).

This restricted them from paying dividends (and presumably also led to default debt acceleration).

While referring to Nu Skin's admitted violation of debt covenants as filed with Form 10-Q for quarter ending June 2014, I stated:

The essence of this convoluted write up is that the cumulative payments as dividends or share repurchases or other qualified items from June 30, 2012 should not exceed $100 million (or $110 million - as amended on June 30, 2014). However, a closer look at dividend payments, stock repurchases and other relevant items indicate that the company may still be under violation of even the revised debt covenants under the Prudential Agreement.

Mr. Hempton's analysis also backs these observations. How often do the bankers graciously agree to amend credit terms whenever somebody breaches the credit terms and repeatedly so? As somebody who is investing for a long time, I've learned to run away from investing in companies that mention the likelihood of 'default' in their debt agreement disclosures. To further drive my point home, I would like to reiterate that Nu Skin's actions and disclosures related to short-term cash maneuvers do not reconcile with the company's claim of having $219 million in cash and equivalents on their balance sheet. Such actions are only indicative of a company that is teetering on the edge of insolvency.

Will the Real Richard M. Nixon Stand Up, Please?

Mr. Hempton didn't stop at poring over SEC filings and other financial disclosures by Nu Skin. The name Richard M. Nixon, the signatory on behalf of JP Morgan on the said Nu Skin's Fifth Amendment to the Prudential Agreement, piqued Hempton's curiosity. He did an extensive search for this banker named Nixon in SEC databases, on LinkedIn and even called JP Morgan to confirm Nixon's identity and authority. He states:

There may - despite my concerted and failed efforts to find them - be a person called Richard M. Nixon who is authorized to sign for and did sign for JPMorgan - but much effort has got me nowhere.

One alternative however is unthinkable. It is that Nu-Skin has been hawking fake documents which modify their debt covenants - possibly so they can make undisclosed borrowings contrary to their debt covenants.

Either "Richard M. Nixon" is a real person who has signed a single SEC document for Nu Skin or Nu Skin's CFO (the other signature on the document) has some explaining to do.

Whoa! What we do know for fact are the following. By Nu Skin's own admittance, there were two consecutive breaches to the debt covenants on a credit agreement and its amendment. Each breach is followed by a gracious amendment by one Mr. Richard M. Nixon, on behalf of JP Morgan, the banker. With regard to this scoop by Mr. Hempton, I agree with an anonymous commenter on Bronte Capital bolg who said the following:

Click to enlarge

Forget about the identity of Mr. Nixon. Given the repeated nature of the breach and magnanimous nature of the amendments, it is a very appropriate question to ask: are these amendments to the agreement legitimate?

I do not want to come-across as abusing my First Amendment right by joining Mr. Hempton in questioning the legitimacy of Nu Skin's "Fifth Amendment" filed with their 10-Qs. However, I believe that this is a legitimate concern that should be addressed by Nu Skin to dispel any misconceptions.

Short Interest in Nu Skin

The public prognostications by Mr. Truman Hunt, CEO of Nu Skin and some bitter investors who are long stock, would have you believe that Nu Skin is heavily shorted. Reality is different. The short interest in Nu SKin is miniscule (short ratio of 2.7). For the past several weeks, I've been monitoring options trading in Nu Skin. I noticed something different on Aug. 29 trading.

Take a look at the following screen-shot taken from my Fidelity Brokerage account.

Option Action in NUS on Friday, Aug. 29Click to enlarge

Though Seeking Alpha is an influential platform, I was not expecting the article, "Is Nu Skin Insolvent" to have any measurable impact on NUS options trading. However, most big blocks of puts were traded after the article was published. The put-to-call ratio on Nu Skin options on Aug. 29th stood at a very high 7.8 to 1. Even more dramatic than the ratio is the jump in implied volatility (IV) for near-term options. When compared to put call ratio and IVs of recent weeks, these numbers are out of whack. It could be a mere coincidence that heavy put-buying and rise in volatility occurred on the same day a negative article was published in Seeking Alpha.

Smart money is always several steps ahead of ordinary investors like me. Judging purely based on the options activity, I can say that serious traders are expecting a major drop in Nu Skin stock price - very soon.

Bonus Chart

The following chart was posted over the long weekend in my InstaBlog post in which I provide periodic updates on Nu Skin.

Conclusions

The company is in repeated breach of debt covenants and appears to be desperate for cash. Increasing scrutiny of Nu Skin's regulatory filings are raising more and more red flags as can be seen here, here, here and here. Implied volatility (IV) on near-term options (four weeks or less) are on steep rise indicating further downside to the stock price in the short term. Extreme caution is urged if you are long the stock.

UPDATE: A few hours after posting this article on SA, on September 2, Nu Skin filed an 8-K with SEC. The filing addressed the controversy related to the name of the signatory as follows:

2-Sep-2014

Other Events

Item 8.01. Other Events.

In response to questions regarding the Fifth Amendment (the "Amendment") to the Amended and Restated Credit Agreement (the "JPMC Agreement"), among Nu Skin Enterprises, Inc. (the "Company"), various financial institutions, and JPMorgan Chase Bank, N.A. as administrative agent, filed as Exhibit 10.3 to the Company's quarterly report on Form 10-Q on August 12, 2014, the Company notes that the Amendment, as filed, contained an inadvertent typographical error on the signature page. The Amendment was signed by Richard M. Hixson, Senior Underwriter, JPMorgan Chase Bank, N.A., not Richard M. Nixon. As previously disclosed, the JPMC Agreement expired pursuant to its terms on August 8, 2014, prior to which all amounts outstanding thereunder were repaid.

The controversy over the name Richard M. Nixon is, therefore, a non-issue. However, the remainder of the thesis presented in this article is still valid. If anything, I believe that the typographical error helped investors focus on one of the most troubling parts of the company financials.

Disclosure: The author is short NUS.

The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.