Natural Health Trends Corp. — Q1 2019 Form 10-Q
Reporting period: Three months ended March 31, 2019; unaudited. Natural Health Trends is an international direct-selling and e-commerce company selling NHT Global personal care, wellness and quality-of-life products.
Financial performance and liquidity
- Revenue: $19.3 million, down 63% from $52.4 million in Q1 2018. Hong Kong sales fell 68% to $15.4 million and represented 79.5% of revenue; substantially all were from products shipped to members in China.
- Profitability: Gross profit was $14.1 million, with gross margin declining to 73.0% from 80.5%. The company reported an operating loss of $2.7 million versus operating income of $10.0 million, and a net loss of $1.9 million versus net income of $8.8 million. Diluted loss per share was $0.17.
- Expenses: Commissions were $9.5 million, or 49.1% of sales, versus 43.9% a year earlier; a March incentive accounted for 5.9% of quarterly revenue. SG&A declined 20% to $7.3 million.
- Cash flow: Operating activities used $11.4 million, compared with $11.1 million provided in Q1 2018. Investing activities used $46,000; financing activities used $2.7 million for dividends. Cash, cash equivalents and restricted cash declined $13.9 million during the quarter.
- Liquidity: Cash and cash equivalents were $118.7 million at quarter-end, including $86.0 million of available-for-sale investments classified as cash equivalents; an additional $3.1 million was restricted cash. Working capital was $101.2 million and the current ratio was 3.79. The company reported no borrowings in the presented balance sheet; the filing does not provide a separate debt metric.
- Balance sheet: Total assets were $149.3 million and total liabilities were $63.5 million. Lease liabilities of $4.1 million were recognized following adoption of the new lease accounting standard.
Changes and management commentary
- Management attributed the steep revenue decline primarily to China’s 100-day regulatory campaign and the company’s voluntary suspension, beginning in January, of member roadshows, training and larger company-sponsored events in China. Active members fell to 87,340 from 97,840 three months earlier and 95,040 a year earlier.
- Management said Hong Kong sales, substantially all tied to deliveries to members in China, were expected to be substantially lower in the first half of 2019 than in the comparable 2018 period, possibly beyond. It warned that revenue declines could exceed the company’s ability to reduce expenses, potentially leading to negative cash flow and a declining cash balance.
- Management believed existing liquidity should fund normal operations and commitments for the foreseeable future, while continuing to invest in Greater China and selected growth markets. It noted that the China campaign’s short-term impact was significant and that its duration and enforcement remained uncertain.
- The company declared and paid dividends of $0.24 per share, totaling $2.7 million. Future dividends are at the board’s discretion.
Risks, contingencies and unusual items
- China exposure and regulation: Revenue is highly concentrated in Hong Kong, with substantially all Hong Kong revenue derived from products delivered to members in China. The company does not hold a Chinese direct-selling license and cannot predict whether or when it may obtain one. Management cited regulatory uncertainty and identified potential compliance matters it was working to address.
- Legal matters: A securities class action filed in January 2019 alleges misleading statements about the legality of the company’s China operations. Defendants said they consider the claims without merit and intend to defend them. The SEC has conducted a non-public investigation into securities trading since 2016; its outcome is uncertain, and the company said the investigation is not an indication that a violation occurred.
- Controls: Management concluded disclosure controls were not effective at March 31 because of a material weakness involving review of third-party logistics shipment documentation. Remediation began in Q1, with completion expected in Q2 2019.
- Other exposures: The company cited foreign-exchange, direct-selling regulation, product and member concentration, and U.S.-China trade-dispute risks. An IRS audit covers tax year 2016, with earlier years open due to tax attribute carryovers; no adjustments had been proposed.
- Tax and accounting: Q1 included a $354,000 income tax benefit. The company adopted lease accounting Topic 842 on January 1, recognizing approximately $4.5 million of lease liabilities and corresponding right-of-use assets.
Most important facts for investors to verify
- Whether China’s regulatory campaign and suspended member activities continue, and how they affect Hong Kong and China sales.
- Whether the company can stabilize revenue and reduce costs enough to improve operating cash flow.
- Progress and effectiveness of the shipment-documentation control remediation, including whether the material weakness is resolved.
- Developments in the securities class action and SEC investigation, including any changes to potential exposure.
- Cash availability, including funds subject to Chinese foreign-currency controls, and the sustainability of dividends amid operating cash use.