Natural Health Trends Corp. — Q2 2019 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2019. The company sells NHT Global personal care, wellness and quality-of-life products through direct selling and e-commerce. Figures are in U.S. dollars; financial statement amounts are in millions unless noted.
Financial performance
| Metric | Q2 2019 | Q2 2018 | First half 2019 | First half 2018 |
|---|---|---|---|---|
| Net sales | $23.4 | $50.9 | $42.8 | $103.3 |
| Gross profit margin | 76.9% | 79.6% | 75.1% | 80.0% |
| Operating income (loss) | $(0.0) | $10.1 | $(2.7) | $20.2 |
| Net income (loss) | $0.4 | $9.0 | $(1.5) | $17.8 |
| Diluted EPS | $0.04 | $0.80 | $(0.14) | $1.58 |
| Operating cash flow | Not separately provided for Q2 | $(15.1) | $16.5 |
Q2 commission expense was $11.4 million (48.7% of sales); SG&A was $6.6 million. First-half commission expense was $20.9 million (48.9% of sales), and SG&A was $13.9 million. Management attributed the higher commission ratio in part to special incentives.
At June 30, cash and cash equivalents were $108.1 million, with another $3.0 million in restricted cash. Current assets were $124.6 million and current liabilities $31.5 million; working capital was $93.0 million and the current ratio was 3.95. Cash and cash equivalents declined $24.5 million from year-end 2018. The company reported no borrowings; operating lease liabilities totaled $3.9 million, including $1.7 million current. First-half financing cash outflows were $9.4 million, including $6.7 million of share repurchases and $2.7 million of dividends.
Changes and operating context
- Q2 sales declined 54% year over year; first-half sales declined 59%. Hong Kong sales fell 56% in Q2 and 62% in the first half. Hong Kong represented 83% of Q2 sales, and substantially all of those sales were products delivered to members in China.
- Active members fell to 78,280 at June 30, from 87,340 three months earlier and 93,000 a year earlier.
- Gross margin declined year over year, reflecting promotions—particularly an AquaPur water purifier promotion in Q1—and higher logistics costs. First-half commissions rose to 48.9% of sales from 43.8%, while SG&A declined year over year.
- The company reported a first-half net loss and negative operating cash flow, compared with substantial profit and positive operating cash flow in the prior-year period.
Outlook, risks and unusual matters
- Management said China’s 100-day government campaign and related negative publicity materially curtailed consumer purchases and led the company to suspend certain member activities, including roadshows, training and larger events. Despite the campaign’s expected April expiration, management said it was not aware that it had concluded and that the operating environment remained restrictive.
- Management expects lower sales and negative financial effects to continue for the foreseeable future. It said existing liquidity should fund normal operations and commitments; no quantified revenue or earnings guidance was provided.
- The business is highly exposed to China-related demand and regulation: substantially all Hong Kong revenue derives from products delivered to members in China. The company does not hold a Chinese direct-selling license and cannot predict whether or when it will obtain one. Management said trade disputes had not materially affected operations to date but could do so in the future.
- A securities class action alleges misleading statements concerning the legality of the company’s China operations. The company disputes the claims and intends to defend itself; the filing does not quantify potential damages. The SEC has also conducted a non-public securities-trading investigation since 2016; outcome and timing are uncertain.
- Disclosure controls were deemed ineffective at June 30 because of a previously identified material weakness involving review of third-party logistics shipment documentation. Management expected to complete testing of remediation controls in Q3 2019.
- In May, the company repurchased 612,729 shares for $6.7 million, including $1.9 million from a trust associated with director and significant shareholder George K. Broady. The filing gives different remaining-program amounts: $25.3 million in MD&A, described as inclusive of estimated income tax, versus $29.6 million in the issuer-purchase table.
Important facts for investors to verify
- Whether China’s regulatory environment and suspended member activities continue to suppress sales, especially through Hong Kong shipments to China.
- The pace of cash use and the ability to sustain operations if negative operating cash flow and declining sales persist.
- Developments and potential financial effects of the securities litigation, SEC investigation and China licensing/compliance matters.
- Remediation and independent testing of the material weakness, and whether disclosure controls become effective.
- The reconciliation of the two reported remaining stock-repurchase authorization balances ($25.3 million and $29.6 million).