Item 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Business Overview
We are an international direct-selling and e-commerce company. Subsidiaries controlled by us sell personal care, wellness, and “quality of life” products under the “NHT Global” brand. Our wholly-owned subsidiaries have an active physical presence in the following markets: North America; Greater China, which consists of Hong Kong, Taiwan and China; Commonwealth of Independent States (“CIS”), which consists of Russia and Kazakhstan; South Korea; Japan; Singapore; and Europe. In most markets, we sell our products to a network of members referred to us by other members.
Our member network operates in a seamless manner from market to market, except for the Chinese market, where we sell to consumers through an e-commerce platform, and the CIS market, where we operate through our engagement of a third-party service provider. Our engagement of a third-party service provider in the CIS market results in a different economic structure than our other markets. Otherwise, we believe that all of our other operating segments are similar in the nature of the products sold, the product acquisition process, the types of customers products are sold to, the methods used to distribute the products, and the nature of the regulatory environment. There is no separate segment manager who is held accountable by our chief operating decision-makers, or anyone else, for operations, operating results and planning for neither the Chinese market or CIS market on a stand-alone basis, and neither market is material for the periods presented. As such, we consider ourselves to be in a single reporting segment and operating unit structure.
As of
September 30, 2016
, we were conducting business through
122,900
active members, compared to
126,440
three months ago and
94,700
a year ago. We consider a member “active” if they have placed at least one product order with us during the preceding year. Our priority is to focus our resources in our most promising markets, which we consider to be Greater China and countries where our existing members have the connections to recruit prospects and sell our products, such as Southeast Asia. We also plan to invest resources in Central and South America.
We generate approximately
98%
of our net sales from subsidiaries located outside North America, with sales of our Hong Kong subsidiary representing
93%
of net sales in the latest fiscal quarter. Because of the size of our foreign operations, operating results can be impacted negatively or positively by factors such as foreign currency fluctuations, and economic, political and business conditions around the world. In addition, our business is subject to various laws and regulations, in particular regulations related to direct selling activities that create uncertain risks for our business, including improper claims or activities by our members and potential inability to obtain necessary product registrations. For further information regarding some of the risks associated with the conduct of our business in China, see generally in Part I, Item 1A, “Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2015, and more specifically under the captions “Risk Factors - Because our Hong Kong operations account for a substantial portion of our overall business...” and “Risk Factors - Our operations in China are subject to compliance with a myriad of applicable laws and regulations...”.
China has been and continues to be our most important business development project. We operate an e-commerce direct selling model in Hong Kong that generates revenue derived from the sale of products to members in Hong Kong and elsewhere, including China. Substantially all of our Hong Kong revenues are derived from the sale of products that are delivered to members in China. Through a separate Chinese entity, we operate an e-commerce retail platform in China. We believe that neither of these activities requires a direct selling license in China, which we do not currently hold. We have previously sought to obtain a direct selling license, and in August 2015 initiated the process for submitting a new preliminary application for a direct selling license in China. If we are able to obtain a direct selling license in China, we believe that the incentives inherent in the direct selling model in China would incrementally benefit our existing business. Increased sales in China that could be derived from obtaining a direct selling license may be partially offset by the higher fixed costs associated with the establishment and maintenance of required service centers, branch offices, manufacturing facilities, certification programs and other legal requirements. We are unable to predict whether and when we will be successful in obtaining a direct selling license to operate in China, and if we are successful, when we will be permitted to conduct direct selling operations and whether such operations would be profitable.
Income Statement Presentation
We mainly derive revenue from sales of products. Substantially all of our product sales are to independent members at published prices. Product sales are recorded when the products are shipped and title passes to independent members, which generally is upon our delivery to the carrier that completes delivery to the members. We estimate and accrue a reserve for product returns based on our return policies and historical experience. Enrollment package revenue, including any nonrefundable set-up fees, is deferred and recognized over the term of the arrangement, generally twelve months. We bill members for shipping charges and recognize the freight revenue in net sales. Event and training revenue is deferred and recognized as the event or training occurs.
Cost of sales consists primarily of products purchased from third-party manufacturers, freight cost for transporting products to our foreign subsidiaries and shipping products to members, import duties, packing materials, product royalties, costs of promotional materials sold to our members at or near cost, and provisions for slow moving or obsolete inventories. Cost of sales also includes purchasing costs, receiving costs, inspection costs and warehousing costs.
Member commissions
are typically our most significant expense and are classified as an operating expense. Under our compensation plan, members are paid weekly commissions, generally in the currency for the country they were registered, for product purchases by their down-line member network across all geographic markets, except China, where our subsidiary maintains an e-commerce retail platform and does not pay any commissions. This “seamless” compensation plan enables a member located in one country to enroll other members located in other countries where we are authorized to conduct our business. Currently, there are basically two ways in which our members can earn income:
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•
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through commissions paid on product purchases made by their down-line members; and
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•
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through retail markups on sales of products purchased by members at wholesale prices (in the majority of our markets, sales are for personal consumption only and income may not be earned through retail mark-ups on sales in that market).
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Each of our products is designated a specified number of bonus volume points. Commissions are based on total personal and group bonus volume points per weekly sales period. Bonus volume points are essentially a percentage of a product’s wholesale price. As the member’s business expands from successfully enrolling other members who in turn expand their own businesses by selling product to other members, the member receives higher commissions from purchases made by an expanding down-line network. In some of our markets, to be eligible to receive commissions, a member may be required to make nominal monthly or other periodic purchases of our products. Certain of our subsidiaries do not require these nominal purchases for a member to be eligible to receive commissions. In determining commissions, the number of levels of down-line members included within the member’s commissionable group increases as the number of memberships directly below the member increases. Under our current compensation plan, certain of our commission payouts may be limited to a hard cap dollar amount per week or a specific percentage of total product sales. In some markets, commissions may be further limited. In some markets, we also pay certain bonuses on purchases by up to three generations of personally enrolled members, as well as bonuses on commissions earned by up to three generations of personally enrolled members. Members can also earn income, trips and other prizes in specific time-limited promotions and contests we hold from time to time. Member commissions are dependent on the sales mix and, for the first
nine
months of 2016 and 2015, represented
46%
and
49%
of net sales, respectively. From time to time we make modifications and enhancements to our compensation plan to help motivate members, which can have an impact on member commissions. From time to time we also enter into agreements for business or market development, which may result in additional compensation to specific members.
Selling, general and administrative expenses consist of administrative compensation and benefits (including stock-based compensation), travel, credit card fees and assessments, professional fees, certain occupancy costs, and other corporate administrative expenses. In addition, this category includes selling, marketing, and promotion expenses (including the costs of member training events and conventions). Because our various member conventions are not always held at the same time each year, interim period comparisons will be impacted accordingly.
The functional currency of our international subsidiaries is generally their local currency. Local currency assets and liabilities are translated at the rates of exchange on the balance sheet date, and local currency revenues and expenses are translated at average rates of exchange during the period. Equity accounts are translated at historical rates. The resulting translation adjustments are recorded directly into accumulated other comprehensive income.
Sales by our foreign subsidiaries are generally transacted in the respective local currencies and are translated into U.S. dollars using average rates of exchange for each monthly accounting period to which they relate. Most of our product purchases from third-party manufacturers are transacted in U.S. dollars. Consequently, our sales and net earnings are affected by changes in currency exchange rates, with sales and earnings generally increasing with a weakening U.S. dollar and decreasing with a strengthening U.S. dollar.
Results of Operations
The following table sets forth our operating results as a percentage of net sales for the periods indicated.
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Three Months Ended September 30,
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Nine Months Ended September 30,
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2016
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2015
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2016
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2015
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Net sales
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100.0
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%
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|
100.0
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%
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100.0
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%
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100.0
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%
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Cost of sales
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19.3
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19.8
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19.1
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20.4
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Gross profit
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80.7
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80.2
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80.9
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79.6
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Operating expenses:
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Commissions expense
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43.3
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49.6
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45.9
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48.9
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Selling, general and administrative expenses
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15.8
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12.2
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15.3
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12.8
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Depreciation and amortization
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0.1
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0.1
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0.1
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0.1
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Total operating expenses
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59.2
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61.9
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61.3
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61.8
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Income from operations
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21.5
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18.3
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19.6
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17.8
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Other income (expense), net
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0.1
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(0.1
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)
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—
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(0.1
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)
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Income before income taxes
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21.6
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18.2
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19.6
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17.7
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Income tax provision
|
3.8
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|
0.2
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3.6
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|
0.2
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Net income
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17.8
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%
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|
18.0
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%
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|
16.0
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%
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|
17.5
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%
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Net
Sales
The following table sets forth revenue by market for the periods indicated (in thousands):
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Three Months Ended September 30,
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Nine Months Ended September 30,
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2016
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2015
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2016
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2015
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North America
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$
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1,345
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1.9
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%
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$
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1,136
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1.4
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%
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$
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4,403
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2.0
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%
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$
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4,247
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2.2
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%
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Hong Kong
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65,904
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93.3
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75,900
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|
94.0
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207,410
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|
92.0
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178,017
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93.2
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China
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1,354
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1.9
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1,544
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1.9
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7,169
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3.2
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2,855
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1.5
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Taiwan
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1,329
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1.9
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1,685
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2.1
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4,453
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2.0
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4,049
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2.1
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South Korea
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152
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0.2
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178
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0.2
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544
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0.2
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906
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0.5
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Japan
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24
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—
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22
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—
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60
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—
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64
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—
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Singapore
|
57
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0.1
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—
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—
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99
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—
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—
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—
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Russia, Kazakhstan and Ukraine
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203
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0.3
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225
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0.3
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630
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0.3
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806
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0.4
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Europe
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311
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0.4
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89
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0.1
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648
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0.3
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260
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0.1
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Total
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$
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70,679
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100.0
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%
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$
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80,779
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100.0
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%
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$
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225,416
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100.0
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%
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$
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191,204
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100.0
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%
|
Net sales were
$70.7 million
for the
three months ended September 30, 2016
compared with
$80.8 million
for the comparable period a year ago, a decrease of
$10.1 million
, or
13%
. Hong Kong net sales, substantially all of which were shipped to members residing in China, decreased
$10.0 million
, or
13%
, over the comparable period a year ago. The sales decrease was partly attributable to the special measures the Chinese government implemented in preparation of the G20 Summit in Hangzhou, one of our top markets, in which they relocated city residents, emptied entire districts, blocked urban traffic and shut down businesses in July, August and early September. In addition, the second and third quarter of 2015 included a supplemental incentive trip promotion to the U.S., which proved to be appealing to our members and contributed to increased sales. A similar supplemental incentive trip was not offered during 2016.
Net sales were
$225.4 million
for the
nine months ended September 30, 2016
compared with
$191.2 million
for the comparable period a year ago, an increase of
$34.2 million
, or
18%
. Hong Kong net sales, substantially all of which were shipped to members residing in China, increased
$29.4 million
, or
17%
, over the comparable period a year ago. Hong Kong experienced an increase of
27,000
active members, or
31%
, from
September 30, 2015
to
September 30, 2016
, which contributed to the increase in product sales volume. We also launched new
Wellness
products in the first nine months of 2016, which contributed approximately $5.8 million to our top-line growth. However, we believe our net sales increase was adversely impacted by the factors identified above that impacted our quarterly results, as well as the devaluation of the Chinese yuan, which has depreciated by 6% against the Hong Kong dollar and has indirectly affected our financial results by increasing the product pricing in the currency of our Chinese members.
Outside of our Hong Kong business, net sales increased
$4.8 million
, or
37%
, over the comparable
nine
month period a year ago, driven by a 151% increase in our China e-commerce business, a 149% increase in Europe and a 10% increase in Taiwan, offset by the performance of South Korea, which decreased
40%
and our CIS market, which decreased 22%. The $4.3 million net sales increase in our China e-commerce business was primarily driven by our
Home
product line.
As of
September 30, 2016
, deferred revenue was
$4.2 million
, which primarily consisted of
$1.6 million
pertaining to unshipped product orders,
$2.2 million
pertaining to auto ship advances and
$423,000
pertaining to unamortized enrollment package revenue.
Gross Profit
Gross profit was
80.7%
of net sales for the three months ended
September 30, 2016
compared with
80.2%
of net sales for the three months ended
September 30, 2015
. The gross profit margin percentage increase is due to higher event and training revenue.
Gross profit increased to
80.9%
of net sales for the
nine months ended September 30, 2016
compared with
79.6%
of net sales for the
nine months ended September 30, 2015
primarily due to higher event and training revenue, higher product margins and lower logistics costs.
Commissions
Commissions were
43.3%
of net sales for the three months ended
September 30, 2016
, compared with
49.6%
of net sales for the three months ended
September 30, 2015
, and
45.9%
of net sales for the
nine months ended September 30, 2016
, compared with
48.9%
for the comparable period a year ago. The decrease as a percentage of net sales for both the
three and nine
months periods ended
September 30, 2016
primarily resulted from lower estimated costs for on-going cash and other incentive programs.
Selling, General and Administrative Expenses
Selling, general and administrative expenses were
$11.2 million
for the
three months ended September 30, 2016
compared with
$9.9 million
in the same period a year ago. Selling, general and administrative expenses increased by
13%
during the three month period mainly due to an increase in the cost of member training events, professional fees and event costs as compared to the same period in the prior year.
For the
nine months ended September 30, 2016
, selling, general and administrative expenses were
$34.5 million
compared with
$24.6 million
for the comparable period a year ago. Selling, general and administrative expenses increased by
40%
during the nine month period mainly due to an increase in employee-related costs, the cost of member training events, professional fees, event costs, as well as an increase in credit card fees and assessments due to higher net sales as compared to the same period in the prior year.
Income Taxes
An income tax provision of
$2.7 million
and
$137,000
was recognized during the three month periods ended
September 30, 2016
and 2015, respectively. An income tax provision of
$8.1 million
and
$330,000
was recognized during the
nine
month periods ended
September 30, 2016
and 2015, respectively. As a result of capital return activities approved by the Board of Directors during the first quarter of 2016 and anticipated future capital return activities, we determined that a portion of our current undistributed foreign earnings are no longer deemed reinvested indefinitely by our non-U.S. subsidiaries. We repatriated
$19.8 million
to the U.S. during the three months ended March 31, 2016, part of which was offset by U.S. net operating losses. Accordingly, the deferred tax liability previously established for undistributed foreign earnings up to its existing U.S. net operating losses was reduced. The excess amount repatriated during the nine months ended September 30, 2016 was generated from current foreign earnings. We will continue to periodically reassess the needs of our foreign subsidiaries and update our indefinite reinvestment assertion as necessary. To the extent that additional foreign earnings are not deemed permanently reinvested, we expect to recognize additional income tax provision at the applicable U.S. corporate tax rate.
Liquidity and Capital Resources
At
September 30, 2016
, our cash and cash equivalents totaled
$114.5 million
. Total cash and cash equivalents increased by
$9.6 million
from
December 31, 2015
to
September 30, 2016
. We consider all highly liquid investments with original maturities of three months or less, when purchased, to be cash equivalents. As of
September 30, 2016
, we had
$57.4 million
in available-for-sale investments classified as cash equivalents. In addition, cash and cash equivalents included
$5.8 million
held in banks located within China subject to foreign currency controls.
As of
September 30, 2016
, the ratio of current assets to current liabilities was
2.01
to 1.00 and we had
$66.8 million
of working capital. Working capital as of
September 30, 2016
increased
$10.7 million
compared to our working capital as of
December 31, 2015
, due primarily to increases in cash from operations and inventory, offset by an increase to our eWallet liability during the
nine months ended September 30, 2016
.
Cash provided by operations for the first
nine
months of 2016 was
$36.3 million
compared with
$65.2 million
in the comparable period of 2015. The decrease in operating cash flows resulted primarily from the timing of increased commission-related payments, the impact of our members’ utilization of our eWallet functionality and U.S. income tax payments of $7.4 million, offset by our increased net income during the first
nine
months of 2016.
Cash flows used in investing activities totaled
$679,000
during the first
nine
months of 2016. Software development costs of
$518,000
were incurred during the first
nine
months of 2016 for our Oracle ERP upgrade and enhancement of our back office software platform. Cash flows used in investing activities totaled
$3.7 million
during the first
nine
months of 2015 and consisted primarily of our June 2015 funding of a bank deposit amount in the amount of CNY 20 million (USD $3.3 million) for our direct selling license application.
Cash flows used in financing activities during the first
nine
months of 2016 totaled
$25.8 million
. We used
$23.7 million
to repurchase shares of our common stock. On January 12, 2016, the Board of Directors authorized an increase to our stock repurchase program first approved on July 28, 2015 from
$15.0 million
to
$70.0 million
. Repurchases are expected to be executed to the extent that our earnings and cash-on-hand allow, and will be made in accordance with all applicable securities laws and regulations, including Rule 10b-18 of the Exchange Act. For all or a portion of the authorized repurchase amount, we may enter into one or more plans that are compliant with Rule 10b5-1 of the Exchange Act that are designed to facilitate these purchases. The stock repurchase program does not require us to acquire a specific number of shares, and may be suspended from time to time or discontinued. During February 2016, pursuant to the stock repurchase program, we authorized our broker to proceed with the purchase of shares of our common stock in the open market. During the first
nine
months of 2016, the stock repurchase program resulted in our purchasing a total of
903,031
shares of our common stock for an aggregate purchase price of
$23.7 million
, plus transaction costs. As of
September 30, 2016
,
$32.0 million
of the
$70.0 million
stock repurchase program approved on July 28, 2015 and increased on January 12, 2016 remained available for future purchases, inclusive of related estimated income tax. Cash flows used in financing activities during the first
nine
months of 2015 totaled
$11.9 million
, and consisted primarily of $11.1 million in stock repurchases.
Other financing cash flows during the first
nine
months of 2016 included the following cash dividend payments (in thousands, except per share amounts):
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|
Declaration Date
|
|
Per Share
|
|
Amount
|
|
Record Date
|
|
Payment Date
|
July 19, 2016
|
|
$
|
0.07
|
|
|
$
|
787
|
|
|
August 16, 2016
|
|
August 26, 2016
|
April 21, 2016
|
|
$
|
0.06
|
|
|
$
|
686
|
|
|
May 10, 2016
|
|
May 20, 2016
|
March 1, 2016
|
|
$
|
0.05
|
|
|
$
|
576
|
|
|
March 16, 2016
|
|
March 24, 2016
|
|
|
$
|
0.18
|
|
|
$
|
2,049
|
|
|
|
|
|
On
October 23, 2016
, the Board of Directors declared a cash dividend of
$0.08
and a special cash dividend of
$0.35
on each share of common stock outstanding. Such dividends are payable on
November 25, 2016
to stockholders on record on
November 15, 2016
. Payment of any future dividends on shares of common stock will be at the discretion of our Board of Directors.
We believe that our existing internal liquidity, supported by cash on hand and cash flows from operations should be adequate to fund normal business operations and address our financial commitments for the foreseeable future.
We do not have any significant unused sources of liquid assets. If necessary, we may attempt to generate more funding from the capital markets, but currently we do not believe that will be necessary.
Our priority is to focus our resources on investing in our most important markets, which we consider to be Greater China and countries where our existing members may have the connections to recruit prospects and sell our products, such as Southeast Asia. We will continue to invest in our Mainland China entity for such purposes as establishing China-based manufacturing capabilities, increasing public awareness of our brand and our products, sourcing more Chinese-made products, building a chain of service stations, opening additional Healthy Lifestyle Centers or branch offices, adding local staffing and other requirements for a China direct selling license application. We also plan to invest resources in Central and South America.
Critical Accounting Policies and Estimates
A summary of our significant accounting policies is provided in Note 1 of the Notes to Consolidated Financial Statements in Item 1 of our Annual Report on Form 10-K filed with the United States Securities and Exchange Commission (SEC) on March 4, 2016. The preparation of financial statements in accordance with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reported period. The process of determining significant estimates is fact specific and takes into account historical experience and current and expected economic conditions. To the extent that there are material differences between the estimates and actual results, future results of operations will be affected.
Critical accounting policies and estimates are defined as both those that are material to the portrayal of our financial condition and results of operations and as those that require management’s most subjective judgments. Management believes our critical accounting policies and estimates are those related to obsolete inventory and the fair value of goodwill, revenue recognition, as well as those used in the determination of liabilities related to sales returns, member commissions and income taxes.
Inventory Valuation.
We review our inventory carrying value and compare it to the net realizable value of our inventory and any inventory value in excess of net realizable value is written down. In addition, we review our inventory for obsolescence and any inventory identified as obsolete is reserved or written off. Our determination of obsolescence is based on assumptions about the demand for our products, product expiration dates, estimated future sales, and management’s future plans. Also, if actual sales or management plans are less favorable than those originally projected by management, additional inventory reserves or write-downs may be required. At
September 30, 2016
and
December 31, 2015
, our inventory value was
$14.8 million
and
$10.5 million
, respectively, net of reserves of
$21,000
and
$29,000
at
September 30, 2016
and
December 31, 2015
, respectively. No significant provision was recorded during the periods presented.
Valuation of Goodwill.
We assess qualitative factors in order to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If, through this qualitative assessment, the conclusion is made that it is more likely than not that a reporting unit’s fair value is less than its carrying amount, a two-step impairment test is performed. Our policy is to test for impairment annually during the fourth quarter. At
September 30, 2016
and
December 31, 2015
, goodwill of
$1.8 million
was reflected on our balance sheet. No impairment of goodwill was recognized during the periods presented.
Allowance for Sales Returns.
An allowance for sales returns is provided during the period the product is shipped. The allowance is based upon the return policy of each country, which varies from 14 days to one year, and their historical return rates, which range from 1% to 7% of sales. Sales returns were 2% and 1% of sales for the nine-month periods ended
September 30, 2016
and 2015, respectively. The allowance for sales returns was
$1.2 million
and
$1.6 million
at
September 30, 2016
and
December 31, 2015
, respectively. No material changes in estimates have been recognized during the periods presented.
Revenue Recognition.
Product sales are recorded when the products are shipped and title passes to independent members. Product sales to members are made pursuant to a member agreement that provides for transfer of both title and risk of loss upon our delivery to the carrier that completes delivery to the members, which is commonly referred to as “F.O.B. Shipping Point.” We primarily receive payment by credit card at the time members place orders. Our sales arrangements do not contain right of inspection or customer acceptance provisions other than general rights of return. Amounts received for unshipped product are recorded as deferred revenue. Such amounts totaled
$1.6 million
and
$1.8 million
at
September 30, 2016
and
December 31, 2015
, respectively. Shipping charges billed to members are included in net sales. Costs associated with shipments are included in cost of sales. Event and training revenue is deferred and recognized as the event or training occurs.
Enrollment package revenue, including any nonrefundable set-up fees, is deferred and recognized over the term of the arrangement, generally twelve months. Enrollment packages provide members access to both a personalized marketing website and a business management system. No upfront costs are deferred as the amount is nominal. At
September 30, 2016
and
December 31, 2015
, enrollment package revenue totaling
$423,000
and
$331,000
was deferred, respectively. Although we have no immediate plans to significantly change the terms or conditions of enrollment packages, any changes in the future could result in additional revenue deferrals or could cause us to recognize the deferred revenue over a longer period of time. Additionally, deferred revenue includes advances for auto ship orders. In certain markets, when a member’s cumulative commission income reaches a certain threshold, a percentage of the member’s weekly commission is held back as an advance and applied to an auto ship order once the accumulated amount of the advances is sufficient to pay for the pre-selected auto ship package of the member. Such advances were
$2.2 million
and
$1.6 million
at
September 30, 2016
and
December 31, 2015
, respectively.
Member Commissions.
Independent members earn commissions based on total personal and group bonus volume points per weekly sales period. Each of our products are designated a specified number of bonus volume points, which is essentially a percentage of the product’s wholesale price. We accrue member commissions when earned and pay commissions on product sales generally two weeks following the end of the weekly sales period.
In some markets, we also pay certain bonuses on purchases by up to three generations of personally enrolled members, as well as bonuses on member commissions earned by up to three generations of personally enrolled members. Independent members may also earn incentives based on meeting certain qualifications during a designated incentive period, which may range from several weeks to up to a year. These incentives may be both monetary and non-monetary in nature. We estimate and accrue the costs associated with incentives over the duration of the qualification period based on member achievement of the qualification requirements. Accrued commissions, including the estimated cost of our international recognition incentive program and other supplemental programs, totaled
$18.6 million
and
$19.6 million
at
September 30, 2016
and
December 31, 2015
, respectively.
Income Taxes.
We evaluate the probability of realizing the future benefits of any of our deferred tax assets and record a valuation allowance when we believe a portion or all of our deferred tax assets may not be realized. During the third quarter of 2015, the valuation allowance against U.S. net operating losses was removed, and a corresponding deferred tax liability was recognized as we determined that a portion of our undistributed foreign earnings were no longer deemed reinvested indefinitely. During the first quarter of 2016, these net operating losses were fully utilized to offset the repatriation of foreign earnings. As of
September 30, 2016
, a valuation allowance remained against the existing U.S. deferred tax assets and certain deferred tax assets of non-U.S. subsidiaries. The valuation allowance will be reduced at such time as management believes it is more likely than not that the deferred tax assets will be realized.
Provision for income taxes depends on the statutory tax rates in each of the jurisdictions in which we operate. An income tax provision of
$2.7 million
and
$137,000
was recognized during the three-month periods ended
September 30, 2016
and 2015, respectively, and
$8.1 million
and
$330,000
was recognized during the nine-month periods ended
September 30, 2016
and 2015, respectively. As a result of capital return activities approved by the Board of Directors during the first quarter of 2016 and anticipated future capital return activities, we determined that a portion of our current undistributed foreign earnings are no longer deemed reinvested indefinitely by our non-U.S. subsidiaries. We will continue to periodically reassess the needs of our foreign subsidiaries and update our indefinite reinvestment assertion as necessary. To the extent that additional foreign earnings are not deemed permanently reinvested, we expect to recognize additional income tax provision at the applicable U.S. corporate tax rate.
We believe that we operate in compliance with all applicable transfer pricing laws and we intend to continue to operate in compliance with such laws. However, there can be no assurance that we will continue to be found to be operating in compliance with transfer pricing laws, or that those laws would not be modified, which, as a result, may require changes in our operating procedures. If the United States Internal Revenue Service or the taxing authorities of any other jurisdiction were to successfully challenge these agreements, plans, or arrangements, or require changes in our transfer pricing practices, we could be required to pay higher taxes, interest and penalties, and our earnings would be adversely affected.