Natural Health Trends Corp. — Q3 2016 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2016. The company sells NHT Global personal care, wellness and quality-of-life products through direct selling and e-commerce. It reported one operating segment. Approximately 93% of Q3 sales came from Hong Kong, substantially all shipped to members in China; about 98% of sales were generated outside North America.
Financial performance
| Metric | Q3 2016 | Q3 2015 | Nine months 2016 | Nine months 2015 |
|---|---|---|---|---|
| Net sales | $70.7 million | $80.8 million | $225.4 million | $191.2 million |
| Gross margin | 80.7% | 80.2% | 80.9% | 79.6% |
| Operating income | $15.2 million | $14.8 million | $44.1 million | $34.0 million |
| Operating margin | 21.5% | 18.3% | 19.6% | 17.8% |
| Net income | $12.6 million | $14.5 million | $36.0 million | $33.5 million |
| Diluted EPS | $1.12 | $1.18 | $3.14 | $2.70 |
| Operating cash flow | Not provided for quarter | Not provided for quarter | $36.3 million | $65.2 million |
Q3 sales fell 13% year over year, while operating income rose 3%; net income declined about 14%, principally amid a substantially higher income tax provision ($2.7 million versus $137,000). For the first nine months, sales increased 18%, operating income 30% and net income 7%. Nine-month commissions declined to 45.9% of sales from 48.9%, while SG&A increased 40% to $34.5 million. Management attributed improved gross margins to event and training revenue, product margins and lower logistics costs.
Balance sheet, liquidity and capital returns
- At September 30, cash and cash equivalents were $114.5 million, including $57.4 million of available-for-sale investments classified as cash equivalents; $5.8 million was held in Chinese banks subject to foreign-currency controls.
- Current assets were $133.0 million and current liabilities $66.2 million; working capital was $66.8 million and the current ratio 2.01:1. Restricted cash was $3.1 million.
- The balance sheet presents no borrowings or other debt line; total liabilities were $71.1 million, including $19.5 million of eWallet balances and $18.6 million of accrued commissions.
- Nine-month operating cash flow was $36.3 million, down from $65.2 million. The company cited timing of commission payments, member use of eWallets and U.S. income-tax payments. Cash increased $9.6 million to $114.5 million.
- Investing cash outflow was $0.7 million, including $0.5 million in software development costs. Financing cash outflow was $25.8 million, including $23.7 million of share repurchases and $2.0 million of dividends.
- The company repurchased 903,031 shares during the first nine months. The $70 million repurchase authorization had $32 million remaining at September 30, inclusive of estimated related tax. It declared subsequent quarterly and special dividends totaling $0.43 per share, payable November 25, 2016.
Changes, outlook and risks
- Q3 Hong Kong sales fell 13% year over year. Management cited Chinese government restrictions and disruption around the G20 Summit in Hangzhou, and the absence in 2016 of a supplemental incentive trip promotion offered in 2015.
- Nine-month Hong Kong sales rose 17%; the company cited 27,000 more active members year over year and about $5.8 million of growth from new Wellness products. Active members totaled 122,900, down from 126,440 three months earlier and up from 94,700 a year earlier.
- The Chinese yuan had depreciated 6% against the Hong Kong dollar, reducing Chinese members’ purchasing power. Management also identified weakness in South Korea and CIS markets, partly offset by growth in China e-commerce and Europe.
- The company had no direct-selling license in China and said it could not predict whether or when it would obtain one or whether licensed operations would be profitable. Management planned continued investment in China and potential expansion in Southeast Asia and Central and South America. It stated existing liquidity and operating cash flow should fund foreseeable needs; no specific financial guidance was provided.
- Two securities class actions allege misleading statements about the legality of China operations; the company’s motion to dismiss remained unresolved. Two related derivative actions were stayed pending that ruling. Potential damages are indeterminate, and the filing says these matters could materially affect results or financial condition. The company disputes the claims and intends to defend them.
- Other notable exposures include concentration in Hong Kong/China, Chinese regulatory and direct-selling uncertainty, foreign-exchange movements, product and member conduct regulation, and possible additional tax expense if more foreign earnings are no longer considered permanently reinvested. Management reported disclosure controls were effective and no material change in internal control during the quarter.
Key facts for investors to verify
- Whether Hong Kong/China sales and active-member trends recover, and how any further yuan weakness affects demand.
- Progress and regulatory requirements for a China direct-selling license, and the potential operating costs and economics if obtained.
- Developments in the securities and derivative litigation, including any ruling on the motion to dismiss and possible financial exposure.
- Whether operating cash flow rebounds as commission, eWallet and tax-payment timing effects normalize, while the company continues repurchases and dividends.
- Potential further tax expense from repatriation decisions and the accessibility of cash held in China under currency controls.