Natural Health Trends Corp. — Q2 2016 Form 10-Q
Business context and reporting period. International direct-selling and e-commerce company selling NHT Global personal care, wellness and quality-of-life products. This filing covers the quarter and six months ended June 30, 2016; financial amounts below are U.S. dollars. The company reported one operating segment and had 126,440 active members, up from 76,400 a year earlier. Hong Kong accounted for 91% of Q2 net sales; approximately 98% of net sales came from subsidiaries outside North America.
Financial performance and liquidity
| Metric | Q2 2016 | Q2 2015 | Six months 2016 | Six months 2015 |
|---|---|---|---|---|
| Net sales | $80.4m | $69.7m | $154.7m | $110.4m |
| Gross profit | $65.3m | $55.6m | $125.4m | $87.4m |
| Operating income | $14.9m | $12.3m | $28.9m | $19.2m |
| Net income | $12.2m | $12.3m | $23.5m | $19.0m |
| Diluted EPS | $1.07 | $0.98 | $2.03 | $1.52 |
Q2 gross margin was 81.3% versus 79.8%; operating margin was 18.6% versus 17.6%; net margin was 15.2% versus 17.6%. For the six months, gross margin was 81.0% versus 79.2%, operating margin 18.7% versus 17.4%, and net margin 15.2% versus 17.2%. Management attributed higher gross margins to improved product margins and lower logistics costs.
- Cash flow: Six-month operating cash flow was $30.4m, down from $39.5m. Investing used $0.5m, including $0.426m for software development. Financing used $25.0m, mainly $23.7m for share repurchases and $1.3m for dividends. Cash and cash equivalents increased $4.7m to $109.6m.
- Liquidity and debt: Current assets were $124.9m and current liabilities $69.4m; working capital was $55.6m and the current ratio 1.80. The balance sheet reports no borrowings. Restricted cash was $3.1m, and $6.5m of cash was held in China subject to foreign-currency controls.
- Capital returns: The company repurchased 903,031 shares for $23.7m in the first half. At June 30, $32.0m remained under the $70.0m authorization after estimated related tax. First-half dividends declared were $0.11 per share; a further $0.07-per-share dividend was declared July 19, payable August 26.
Changes versus prior period
- Q2 sales rose 15%; six-month sales rose 40%. Hong Kong sales increased 13% in Q2 and 39% for the first half. China e-commerce sales also increased, although Hong Kong remained highly dominant.
- Q2 operating income rose 22%, but net income slipped 1% as the income-tax provision increased to $2.7m from $0.1m. Six-month net income increased 24%, while the tax provision rose to $5.4m from $0.2m.
- Q2 SG&A increased 50% to $12.4m; first-half SG&A increased 59% to $23.3m, reflecting employee costs, training and event costs, professional fees, facilities, and higher card fees and assessments. Commissions declined as a share of sales, to 47.1% from 50.2% in Q2, largely due to lower estimated ongoing incentive-program costs.
- Basic weighted-average shares fell to 11.3m in Q2 from 12.4m, supporting EPS growth despite slightly lower Q2 net income.
Outlook, risks and unusual items
- Management said existing cash and operating cash flows should fund normal operations and commitments for the foreseeable future; it did not provide quantitative earnings or revenue guidance. The company plans to focus investment on Greater China and markets where its member network can expand, including Southeast Asia.
- The company did not hold a direct-selling license in China and said it could not predict whether or when one might be obtained, or whether licensed operations would be profitable. A license could bring additional fixed costs, including service centers, branch offices and manufacturing capabilities.
- China and Hong Kong concentration, direct-selling and product regulation, foreign exchange, and member retention are material business risks. The Russian and CIS markets were affected by regional political unrest and ruble devaluation. The company does not hedge short-term currency exposure.
- Two securities class actions and two shareholder derivative complaints allege, among other things, misleading statements about the legality of the company’s China operations; the class-action complaint also alleges an illegal multilevel-marketing operation. The company denies the claims and intends to defend them. The class action seeks an indeterminate amount; the derivative actions also seek equitable remedies. The filing says the cases could materially affect results or financial condition.
- The first-half tax provision included a $4.8m tax liability associated with changing the indefinite-reinvestment assertion for some foreign earnings in connection with capital returns. The company expects possible additional tax provision if further foreign earnings are no longer considered permanently reinvested.
- Management stated disclosure controls were effective at June 30, 2016, with no material change in internal control over financial reporting during the quarter. It reported no material changes to the risk factors in its 2015 Form 10-K.
Investor verification priorities
- Track Hong Kong sales and member growth, and the company’s continuing dependence on Hong Kong and Greater China.
- Review developments in the China direct-selling license process, regulatory compliance and the related litigation.
- Assess whether sales growth converts to operating cash flow, particularly given the first-half decline in cash from operations and changes in commissions, eWallets and deferred revenue.
- Monitor the effective tax burden and any further repatriation or changes to foreign-earnings reinvestment assumptions.
- Check the pace and price of share repurchases, dividends and remaining authorization against liquidity and investment needs.