Natural Health Trends Corp. — Q3 2015 Form 10-Q
Reporting period: Three and nine months ended September 30, 2015. The company sells personal care, wellness and “quality of life” products through the NHT Global brand, primarily via an independent member network. Its business is heavily concentrated in Greater China, especially Hong Kong.
Key financial results
| Metric | Q3 2015 | Q3 2014 | Nine months 2015 | Nine months 2014 |
|---|---|---|---|---|
| Net sales | $80.8 million | $31.8 million | $191.2 million | $89.2 million |
| Gross profit / margin | $64.8 million / 80.2% | $25.1 million / 78.8% | $152.2 million / 79.6% | $69.7 million / 78.1% |
| Operating income / margin | $14.8 million / 18.3% | $5.5 million / 17.2% | $34.0 million / 17.8% | $14.8 million / 16.5% |
| Net income | $14.5 million | $5.4 million | $33.5 million | $14.6 million |
| Diluted EPS | $1.18 | $0.42 | $2.70 | $1.16 |
Q3 sales rose 154% year over year; nine-month sales rose 114%. Hong Kong accounted for 94.0% of Q3 sales and 93.2% of nine-month sales. Q3 net income increased to $14.5 million from $5.4 million. Gross margin improved, while commissions rose to 49.6% of Q3 sales from 45.6%, mainly reflecting higher estimated costs for ongoing cash and other incentive programs. SG&A increased 94% in Q3, primarily due to employee and incentive costs, professional fees, director and facility costs, and sales-related credit card fees.
Cash, liquidity and capital
- Cash and cash equivalents were $94.6 million at September 30, 2015, up $49.7 million from year-end 2014. The company reported no debt on the balance sheet.
- Current assets were $103.2 million and current liabilities $59.5 million; working capital was $43.7 million and the current ratio was 1.73.
- Nine-month operating cash flow was $65.2 million, compared with $20.9 million in 2014. The increase included higher product orders and deferred revenue, as well as commission balances retained in member eWallets rather than paid immediately.
- Investing cash use was $3.7 million, including a $3.1 million restricted deposit for a potential China direct-selling license. Financing cash use was $11.9 million, including $11.1 million of share repurchases and $1.1 million of dividends.
- Cash and cash equivalents included $3.5 million held in Chinese banks subject to foreign-currency controls. Restricted cash totaled $3.2 million. The company said existing liquidity and operating cash flows should fund normal operations and commitments for the foreseeable future.
Material changes, outlook and risks
- Active members reached 94,700, compared with 48,500 a year earlier. Management attributed growth to leadership development, promotions, incentives, events, new products, training, commission plans and services.
- Management identified Greater China and markets where existing members can recruit as priority areas. It began a preliminary application process for a China direct-selling license in August 2015, but gave no assurance whether or when a license would be obtained or whether licensed operations would be profitable. The filing says China e-commerce sales were less than 2% of net sales; Hong Kong sales were the dominant source of revenue.
- The company warned that Chinese authorities could disagree with its interpretation of applicable laws, and that regulatory enforcement or member conduct could adversely affect its business. Hong Kong and China concentration, direct-selling regulation, member retention, competition, product acceptance, currency movements and reliance on third-party manufacturers are additional disclosed risks. CIS sales were affected by regional political unrest and ruble devaluation.
- Management recorded a $9.3 million deferred tax liability on some undistributed foreign earnings after changing its indefinite-reinvestment assertion. A similar valuation allowance was released, so management reported no significant effect on the quarter’s tax provision. Further changes in the assertion could result in additional tax expense.
- The company repurchased $11.1 million of common stock during the first nine months. A director and greater-than-5% shareholder participated in private repurchases alongside company programs. The company declared a subsequent $0.05-per-share dividend on October 21, payable November 20, 2015.
- Other commitments include $3.8 million of future operating lease payments through September 2025. The filing reports no legal proceedings and says disclosure controls were effective, with no material change in internal control during the quarter. No formal revenue or earnings guidance was provided.
Important facts for investors to verify
- Whether the exceptional sales growth and member gains are durable, given the 94% Q3 revenue concentration in Hong Kong.
- How much operating cash flow is repeatable versus attributable to deferred customer orders and eWallet commission balances.
- Progress, regulatory requirements and potential costs of a China direct-selling license, including the use and restrictions on the consumer-protection deposit.
- The effect of rising commission and incentive costs on margins, and the potential tax consequences of future changes to the foreign-earnings reinvestment assertion.
- Capital allocation and related-party transactions: remaining repurchase authorization, future dividends, and terms of royalty and share-repurchase arrangements involving the director’s company or holdings.