Natural Health Trends Corp. (NHTC) Q3 2015 Earnings Report, Transcript and Summary

Greetings and welcome to the Natural Health Trends Corporation Third Quarter 2015 Earnings Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Ms. Whitney Steininger. Thank you, you may begin.

Thank you. And welcome to Natural Health Trends third quarter 2015 earnings conference call. During today’s call, there may be statements made relating to the future results of the company that are forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. Actual results, performance, or achievements could differ materially from those anticipated in forward-looking statements as a result of certain factors including those set forth in the company’s filings with the Securities and Exchange Commission. It should also be noted that today’s call will be webcast live and can be found on the Investors section of the company’s corporate website at www.naturalhealthtrendscorp.com. Additionally in today’s financial results press release which was issued at approximately 4 pm Eastern Time, instructions can be found for accessing the archived version of the conference call via the internet. At this time, I’d like to turn the call over to Chris Sharng, President of Natural Health Trends.

Thank you, Whitney. And thanks to everyone for joining us. With me today is Scott Davidson, our Chief Financial Officer. We had a record quarter. Our third quarter revenue of $80.8 million and net income of $14.5 million, both posted significant sequential increases and more than doubled that of the third quarter of last year. In addition, year-to-date as of September 30th, we generated $65.2 million in operating cash flow and $61.5 million in free cash flow. We continue to see strong consumer demand for our products in China. In addition, we achieved growth in our active member base to more than 94,700 versus 76,400 three months ago and 48,500 12 months ago. We define Active Members as those who have placed at least one product order with us during the preceding 12 months. We also have an upcoming incentive trip to New Zealand, planned for our Chinese members in the spring of 2016. The qualification period runs through the end of this year. If our current sales trends hold up, we anticipate 1,500 Chinese members in attendance, making it our largest incentive trip ever. On the product front, we held our International Success Forum in Hong Kong in August which was attended by over 7,200 participants. As the forum, we launched new and refreshed packaging designs for our entire product line for a cohesive look. Our new home goods product line which was introduced in China last quarter and more efficiently at the forum, has surpassed $900,000 in sales for our indoor and car air purifiers. Our top selling products in the quarter, Premium Noni Juice, Essential Probiotics and Triotein comprised about half of our total revenue. We have initiated a process for submitting our direct-selling license application in the Chinese province of Guangdong. We are hopeful that a license will enable us to drive incremental growth by leveraging our growing brand recognition in China as well as our Hong Kong distribution infrastructure. The timing for obtaining our direct-selling license or whether we can get one is uncertain. In the interim, we will remain highly focused on managing all aspects of our core business. That said, we anticipate devoting substantial resources to our mainland China entity. Uses for investments may include establishing China-based manufacturing capabilities; increasing public awareness of the NHT Global brand and our products; sourcing additional Chinese made products; building a chain of service stations; opening additional healthy lifestyle centers or branch offices and adding local staff. In support of our brand awareness initiatives, we started an online media campaign as well as in print in China. We also recently signed on as sponsor for our Guangzhou-based charitable event in December called Walking Proud. Many of our members will participate in various activities in the week, leading us to the walk itself. Moving on to North America, in late November, we plan to open our first healthy lifestyle center in the U.S. in Southern California. Similar to our 14 existing healthy lifestyle centers already up and running in China, this brick and mortar presence will allow members to experience our products in person as well as submit orders and take on the new products. We are committed to enhancing value for our shareholders. Our strong liquidity position affords us, the flexibility and the resources to continue investing in the growth of our business while at the same time, providing returns to our shareholders through quarterly cash dividend and repurchasing shares of our common stock. As such on October 21st, our Board of Directors declared a $0.05 per share cash dividend. Also we will continue to execute against the $15 million stock repurchase announced three months ago with another $5 million buyback expected in the next few days. Now, I’d like to turn the call over to Scott Davidson, our CFO to discuss our third quarter financials in greater detail. Scott?

Thank you, Chris and thank you to everyone for joining us today. Total revenue for the third quarter was $80.8 million, an increase of 154% compared to $31.8 million in the third quarter of 2014. Sales in Hong Kong which accounted for 94% of our third quarter revenue, increased 168% over the prior year quarter. Third quarter revenue outside of Hong Kong was up 38% over the prior year quarter. Excluding the Commonwealth of Independent States, revenue increased 67% over the prior year quarter. Our ecommerce sales in China were up 172% year-over-year, as a result of strong air purifier sales. Now turning to cost and our operating expenses. Gross profit margin for the third quarter increased to 80.2% compared to 78.8% in the third quarter of 2014. Commission expense was 49.6% of net sales for the third quarter compared to 45.6% in the same quarter of last year due to increased cost estimates for the current year incentive program. Selling, general and administrative expenses were $9.9 million, an increase of 94% from the third quarter of 2014, primarily due to credit card fees and employee related expenses. Now turning property measures for the quarter. Operating income totaled $14.8 million, an increase of 171% compared to $5.5 million in the third quarter of 2014. As a percent of total revenue, operating income increased to 18.3% as compared to 17.2% of revenue in the third quarter of 2014. Net income was $14.5 million or $1.18 per diluted share as compared to net income of $5.4 million or $0.42 per diluted share in the third quarter of 2014. Turning to the balance sheet and cash flows. As of September 30th, cash and cash equivalents totaled $94.6 million, an increase of $20.2 million compared to June 30, 2015 due to strong cash provided by operations. Our cash balances net of $5 million which was used to repurchase just over 162,000 shares of our common stock during the quarter at average price of $30.76 per share as well as $489,000 used to pay cash dividend. And as Chris mentioned, on October 21st, our Board of Directors approved the cash dividend of $0.05 per share payable on November 20th to shareholders of record on November 10th. We also plan to buyback another $5 million of our common stock within the previously announced stock repurchase program. That concludes our prepared remarks. I will now turn the call back over to the operator to begin the question-and-answer session. Operator?

At this time, we will be conducting a question-and-answer session. [Operator Instructions] Our first question is from Leo Abbe with Iroquois Capital Management. Please state your question.

Great numbers, great quarter, all good stuff. Just wanted to know real quick; it seems that in the cash buyback, if I understand correctly, something like 30% to 40% of the stock buyback rather is going towards buying back stock from a former director. Wouldn’t it be more beneficial to have like special dividend to declare some sort of a special dividend like $1 or $2 a share? That would really I think add some juice to the stock, add some juice to the story and that would create the buying necessary to increase the stock price and also be able to sort of take this director out of his remaining shares?

Hi, Leo. Thank you for calling in. [Inaudible] and the total scope of our capital return is on a regular basis evaluated and we think that has the right amount. Not to take the chance to explain that this particular director that participates in one-third of the capital return is Mr. Broady, he currently is still on the board and he is a reluctant seller of the shares. It’s the board imposing upon him, so that our capital return program will not in inappropriately [ph] increase his percentage of ownership. But I appreciate your comment and we will take that into account.

Can I follow up with that or no?

Please go ahead.

Okay, great. I just wasn’t sure how this works. So, it seems to me though that -- okay, so he’s still on the board and he’s reluctant to sell it. But either way, I guess my question is, to address the first part of your answer, it seems like the company has so much cash on the balance sheet. And even with all of the programs that you announced, looking -- that you are seeking to make investment in, I just don’t see how this company could even dream of touching most of its war chest without -- even with this kind of the special dividend that I was suggesting, I just -- it would seem to me, would just be a win-win for everybody.

I think the size of our capital return is carefully analyzed. We’re very straight forward in our public filings about the fact that we do operate in a country that has a lot of operational risks and that we do have a concentration risk as well. And we don’t have any bank account or any big assets to call bank account. So, we like to have healthy level of cushion. We do fund our overall working capital and we purchase inventories at front and then there is a lot of commitment on our part. And some of the cash increase is a way ahead of our earnings increase. And we’re setting on eWallet cash that’s not really ours; it’s our distributor’s cash. And we do have commitment that needs to be made on short-term basis as well. I note your comment; I appreciate it, and we’ll incorporate that.

Could you elaborate on when you say you’re setting on the cash but it’s not your cash, it’s the distributor’s cash. What do you mean by that?

I like your point, your attention to our balance sheet for instance that we have aligned for eWallet. The eWallet is one of the ways that which we pay commission payment. And then there is a rapid increase over the last few quarters in the balance of eWallet. The commission is already earned and we keep the cash until they cash it up; they transfer or they use it on the other part. It was not intended on our part that the somehow cash will be accumulated in that way. We have a lot of incentive programs, a lot of them coming into deal at the end of the year. So we have a lot of full commissions, for example on the balance sheet. I like to see that where we evaluate our capital return program, so we’re looking at our earnings, not just the cash balance.

Right, but if you -- even if you -- okay, even if you were to go to take your accrued commissions out of the cash balance that’s there, it would still -- I’m not sure exactly what that number would be, maybe you can lighten us. But I imagine, it would still be a very, very sizable number, much more than the company could ever dream of having a need or in the next, I can’t even -- 24 to 48 months?

I think you’re entitled to opinion, Leo. And I appreciate your opinion but we also have done our careful analysis and we feel comfortable with what we had done. Thank you.

Our next question is from Martin Svanda with Western International Securities. Please state your question.

If I can just ask couples please. The first I guess kind of piggybacks on the last one. What portion of your cash is held onshore versus which portion of is held in foreign accounts?

In the U.S., currently we have less than $500,000 held here; the rest is held offshore.

So, I imagine that influences your decisions for dividend repayments and stock repurchases and things like that as well.

Yes, you are right, Martin and that is one of the factors.

Okay. If I can also, you mentioned that the Noni Juice, the Essentials, and the Triotein are somewhere north of 15% of your overall revenues, is that correct?

Yes, that’s correct.

Okay. If I go back to your filings, all three of these products have pretty much been around for last half dozen or dozen years. I think the Noni Juice has been around since your first start making filing. What would you account or what products would you account for the huge increase in revenues that you’ve seen over the last course of the year or two; is it just the old products were kind of new again or are there a newer products that are on the tail end of that as well?

Martin, that’s a very important question. I look at the progression of our product revenue, five or six years ago to top five products accounted for more than 80% of our total. And that number has now gone down to maybe 70%, 65%. We had in the last few years launched many products, and many of them are successful. So now, we have really more of a diversified portfolio of products that we offer to our member base.

Okay. If I could just ask one more question. If I go back to filings, you in the past have had upwards of 100,000 distributors Hong Kong, China based. Is there any way for you guys to track, are the distributors that you’re adding back now simply distributors that have one point in time fell off your roles and now are coming back into the system or are they completely new distributors that you folks are attracting?

I can’t tell you the specific numbers but I’ve personally come across many people that have come back and become more active with us. But a lot of the people, they have been using our product over years and maybe they have purchased more of the new products as opposed to the older products, as you alluded to.

[Operator Instructions] Our next question is from Lily Sanchez, [ph]a private investor. Please state your question.

Thank you for taking my question. I had a question for Chris. You guys have done spectacularly in the last few years since the I guess the regulatory environment changed in early -- in 2010 or so. And my question is this, what would you attribute your success to? You’ve done -- you’ve grown and it seems like your growth rate accelerated recently. How would you attribute your success to? And follow-up to that question is that, if you would see changes in your growth rates and the environment might change in the future, how would you address that in terms of your strategy going forward?

I would like to consider our recent success attributable to the fact that we have an overall successful program in the market. And I will call them as a combination of our leadership development, our product development, our training, our marketing program, our incentive program and the services that we offer. I felt that we have done a good job over the last few years in planning and implementing effective programs in all those assets. And I think that these programs are going to continue. And then I feel very comfortable with that what we’re doing right now and they will carry out into the future.

You do see this kind of -- I mean obviously China market is huge and the growth rate of China is kind of 50% at this point. Do you see that growth rate going -- I know it’s hard to foresee, in the long future but a next few quarters, do you see that going, the rate it’s been going?

As a matter of policy, I can’t give guidance and all I can offer is that we do very good. It’s about what we are doing right now, how we are doing right now, and I feel confident about our future.

You’d mentioned earlier in the call that you’re investing your money in manufacturing and also China-based production for this. I am curious about this because I saw you guys were advertising your product as sort of U.S. made to the quality concepts and consumers -- health conscious consumers. If you source products from China, will that receive that sort of brand positioning and maybe I misunderstood it. But can you elaborate that?

Yes, as I understand, as we get closer to completing our direct-selling license applications in China, having manufacturing facility, or capability in China is a required ingredient in our business planning. And so I don’t forget [ph] that we have manufacturing expertise in-house but the Chinese authority would like to see us owning some process in manufacturing. And so we will take that on as our application move forward. So, I anticipate at some point we’ll make some investments.

Do you foresee that as a significant amount of investment or is it symbolic investment required by the government?

I wouldn’t call it symbolic, it will be a sustentative investment; it will be meaningful that we meet the Chinese government’s requirement. But I can’t really tell you right now how sizeable that might be, I don’t know.

But you don’t foresee this to be a drain in capital in terms of investment required?

Whatever the investment we make, will have to be measured with our profitability or we’ll have to invest in the responsible way. No, I don’t see that.

Our next question is from Andrew Hanson with Redwood Investment Management. Please state your question.

First, congratulations on your great execution of a well-thought out plan. Appreciate it. My first question has to do with the license in Guangdong; is that provincial only and will that extend to other provinces?

The process is for us to submit a license application with the province first. And then if the province approves, then the application will go to the central government, to sate council. And if we begin a license, then the license will be granted by the central government. But then the province will give us a permit. And…

So, the Central government issues the license which is country-wide than I take it, but you need to have the permit from each individual province once that’s issued, correct?

We assume, in theory yes, it’s country-wide but we still need to go through the province-by-province process of obtaining permit. But the initial permit is only applicable to Guangdong.

Second, your eWallet program, how favorable is the response to that and how often do you top off the wallet?

The feedback that we’ve received to-date has been very well-received by our members. In terms of topping all, we fund the wallet every week electronically of course. And our members have the option of cashing out whenever they like; it’s just the matter of preference on their part.

And then the last question, prospective member, they probably considering other companies with similar sales programs to yours, do you get any feedback on why they choose natural health trends over say another direct selling company or something similar?

Andrew, my experience in the field is that usually our members develop a passion for our product. And that’s the first handshake we have with our members. And we like to retain them for a multiyear time and then they can also be the best advocates for other potential members. I like to think that the reason that we could be differentiated is because of our product. And I think we have great products and the high quality and high impact products. For the most part, manufactured and developed in the U.S. and that’s a great marketing strategy for our Chinese consumers. I think that is the main factor.

Our next question is from Simon Werok, [ph] a private investor. Please state your question.

Following up on the last caller’s question, it sounded like it’s a three-step process to get the approval. First, you’ve submitted application to the province; then once that is approved, you get an approval from the central government; and then you request a permit from that province. Am I right so far?

Yes. That’s consistent with how I understand it. Yes.

So, if you wanted to go into another province, would you have to do all three steps again or is step one already done because of Guangdong and step two already done because the central government has approved it and you would only have to do step three, or would you have to do all three steps for province?

Yes, when we over found the three steps you mentioned, the next step to another province as I understand is less onerous. [Ph] There are a lot of the technical requirements permanent to that province that we need to meet. For example that we need to have and net worth of service stations that supposed to be already in place in the first province, so we would have to make some investments and then we need to build out the service stations where a member could take a product, they can exchange orders and stuff like that. But it takes a little bit time but it’s not an onerous as the first three steps.

Is there any field that you have for what might be the bare minimum amount upon to get all three steps done within Guangdong? Is it going to be at least two years let’s say in the best case or at least one year, is there any feel for that?

My personal feel it would take years. I can’t say if two years or more, but I think that this will be a interactive process. We will have to have a lot of consultations with various levels of government and we need to find ways to do fulfill what they need be. So it would take some time.

There are no further questions at this time. This concludes today’s conference. Thank you for your participation. You may disconnect your lines at this time.