Natural Health Trends Corp. — Q1 2016 Form 10-Q
Reporting period: Three months ended March 31, 2016; balance-sheet comparisons are with December 31, 2015. Amounts below are in U.S. dollars unless noted.
Business context
Natural Health Trends sells personal care, wellness and quality-of-life products under the NHT Global brand through direct-selling and e-commerce channels. It reported 119,800 active members, up from 62,010 a year earlier. Approximately 99% of net sales came from outside North America, and Hong Kong represented 91.7% of quarterly sales. The company does not hold a China direct-selling license; its China activities include an e-commerce retail platform and Hong Kong operations selling to members, including those in China.
Financial performance
| Metric | Q1 2016 | Q1 2015 |
|---|---|---|
| Net sales | $74.3 million | $40.7 million |
| Gross profit / margin | $60.1 million / 80.8% | $31.8 million / 78.1% |
| Operating income / margin | $14.0 million / 18.8% | $6.9 million / 17.0% |
| Net income / net margin | $11.3 million / 15.2% | $6.7 million / 16.5% |
| Diluted earnings per share | $0.95 | $0.54 |
| Cash provided by operations | $13.8 million | $16.6 million |
Gross margin improved primarily because of higher product margins and lower logistics costs. Commissions rose to 47.2% of sales from 45.2%, reflecting higher estimated costs for ongoing cash and other incentive programs. SG&A increased 70% to $10.9 million, driven by employee and incentive costs, professional fees, events, facilities and higher sales-related fees.
The income tax provision was $2.7 million versus $71,000 a year earlier. A $2.4 million tax liability was recorded after the company determined that half of current undistributed foreign earnings were no longer considered indefinitely reinvested, in connection with capital-return activities. Net income growth therefore lagged operating-income growth.
Liquidity, cash flow and capital returns
At March 31, 2016, cash and cash equivalents were $99.6 million, including $58.5 million of available-for-sale investments classified as cash equivalents and $7.0 million held in China subject to foreign-currency controls. Restricted cash was $3.2 million. Working capital was $48.4 million, and the current ratio was 1.76:1. The filing presents no borrowings or debt balance.
Operating cash flow was $13.8 million. Investing cash outflow was $0.24 million, including $0.19 million for a Canadian center buildout. Financing cash outflow was $18.9 million, including $18.3 million for repurchases of 720,361 shares and $0.6 million of dividends. Cash decreased $5.3 million during the quarter. The board increased the repurchase authorization to $70 million; $41.7 million remained available at quarter-end. The company paid a $0.05-per-share dividend and declared a subsequent $0.06-per-share dividend, payable in May.
Management said existing cash and operating cash flows should fund normal operations and commitments for the foreseeable future. The filing gives no quantitative earnings or revenue guidance.
Material changes, outlook and risks
- Sales rose 83% year over year. Hong Kong sales increased 83% to $68.2 million; China e-commerce sales were $3.3 million versus $0.5 million. Sales outside Hong Kong increased 84% overall, while CIS sales fell 36%, attributed to regional political unrest and ruble devaluation.
- Management attributes growth primarily to higher product volumes and member activity, supported by leadership development, promotions, incentives, events, new products, training, commission plans and services. Active members increased 105% in Hong Kong year over year.
- The company is pursuing a China direct-selling license but cannot predict whether or when it will obtain one or whether licensed operations would be profitable. A license could bring additional fixed costs, including service centers, branch offices, manufacturing facilities and certification programs.
- Two securities class actions and two shareholder derivative complaints allege, among other things, misleading statements about the legality of the company’s China operations; derivative claims also allege fiduciary breaches involving insider sales and repurchases. The company says it will vigorously defend the claims. Potential damages or other penalties could materially affect results or financial condition; amounts are indeterminate.
- Foreign exchange, China and Hong Kong regulatory and business conditions, direct-selling rules, member retention, competition, product regulation, and litigation are material risks. The company reported no material changes to the risk factors in its 2015 Form 10-K.
- Other notable items: $19.8 million was repatriated to the U.S. during the quarter. A director-award modification added $64,000 of stock-compensation expense. A $0.06 dividend was declared after quarter-end, and 51,015 restricted shares were granted in April.
Important facts for investors to verify
- Whether Hong Kong’s unusually high sales concentration and rapid member growth are sustainable, and how much growth depends on promotions and incentives.
- Progress and regulatory status of the China direct-selling license application, and the legal basis for existing China-related activities.
- Developments in the securities and derivative litigation, including any consolidated complaint, potential exposure and related disclosures.
- The effect of further repatriations or changes in the indefinite-reinvestment assertion on taxes and cash available to foreign subsidiaries.
- Cash generation after repurchases and dividends, the remaining repurchase authorization, and whether capital returns affect operating investment needs.
- Foreign-exchange exposure and the availability of cash subject to China currency controls; management says it has not used foreign-exchange contracts to reduce short-term exposure.