Natural Health Trends Corp. — Q3 2019 Form 10-Q
Business and period: International direct-selling and e-commerce company selling NHT Global personal care, wellness and “quality of life” products. This report covers the quarter and nine months ended September 30, 2019. Hong Kong generated 79.7% of Q3 sales; substantially all Hong Kong sales were products shipped to members in China. Active members fell to 68,150 from 78,280 three months earlier and 97,160 a year earlier.
Financial performance
| Metric | Q3 2019 | Q3 2018 | Nine months 2019 | Nine months 2018 |
|---|---|---|---|---|
| Net sales | $17.0 million | $47.0 million | $59.8 million | $150.3 million |
| Gross profit / margin | $12.7 million / 74.3% | $37.1 million / 78.9% | $44.8 million / 74.9% | $119.8 million / 79.7% |
| Operating income (loss) | ($1.1 million) | $7.8 million | ($3.8 million) | $28.0 million |
| Net income (loss) | ($1.2 million) | $7.6 million | ($2.8 million) | $25.5 million |
| Diluted EPS | ($0.12) | $0.67 | ($0.25) | $2.25 |
Cash flow and liquidity: For the first nine months, operating cash flow was negative $18.7 million, versus positive $25.3 million in 2018. Investing cash outflow was $0.2 million; financing cash outflow was $12.3 million, including $9.6 million of share repurchases and $2.7 million of dividends. Cash and cash equivalents were $101.1 million at September 30, down from $132.7 million at year-end 2018; restricted cash was $2.9 million. Working capital was $89.0 million and the current ratio was 4.29:1. Management said existing liquidity should fund normal operations and commitments for the foreseeable future. No borrowings are disclosed; liabilities include income taxes payable and operating lease obligations.
Balance sheet: Total assets were $127.1 million and total liabilities $44.5 million at September 30, 2019. Operating lease liabilities totaled approximately $3.6 million. Stockholders’ equity was $82.6 million.
Changes and management commentary
- Sales declined 64% year over year in Q3 and 60% for the nine-month period. Hong Kong sales fell 67% and 64%, respectively. The China 100-day campaign, suspended member activities in China, and unrest in Hong Kong curtailed sales, meetings and events; management expected continued lower sales and adverse financial performance for the foreseeable future.
- Gross margin fell 4.6 percentage points in Q3 and 4.8 points year to date, mainly due to higher logistics costs; Q3 was also affected by a higher inventory-obsolescence reserve, while year-to-date margin reflected promotions.
- SG&A fell to $6.4 million in Q3 and $20.3 million year to date, primarily reflecting lower event and employee-related costs. Commissions were 43.2% of Q3 sales versus 46.8% a year earlier, but 47.3% year to date versus 44.8%.
- Management identified Greater China and selected markets in Southeast Asia, India, South America and Europe as priorities, including continued investment in China operations and infrastructure. The company does not have a China direct-selling license and cannot predict whether or when it may obtain one.
- No quantified financial guidance was provided. The board declared a subsequent special dividend of $0.40 per share on October 29, payable November 29, 2019.
Risks, contingencies and unusual items
- Geographic concentration is significant: Hong Kong accounted for about 80% of Q3 sales, and its business is substantially dependent on deliveries to members in China. Chinese regulatory action, the continuing campaign and Hong Kong political and social unrest pose material risks; currency movements and U.S.-China trade tensions may also affect results.
- A securities class action alleges misleading statements regarding the legality of the company’s China operations. Defendants moved to dismiss; the company said it would vigorously defend the claims. The SEC has conducted a non-public investigation since 2016 into possible securities-law violations; the outcome is uncertain.
- Disclosure controls and procedures were deemed ineffective because of a material weakness related to review of third-party logistics shipment documentation. Management was testing remediation and expected completion in Q4 2019.
- In August, the company issued 1.12 million restricted shares to settle $7.9 million of unpaid long-term incentive awards for earlier performance periods. It repurchased approximately 996,000 shares for $9.6 million during the nine months, including a related-party purchase from a director’s trust. A $0.24-per-share dividend was paid during the period.
- Gross margin and inventory were affected by an increased obsolescence reserve. The filing also notes an IRS audit of tax year 2016, with no adjustments proposed at the time.
Investor verification priorities
- Track China and Hong Kong sales, member counts, regulatory developments and the resumption or further curtailment of member activities.
- Assess the cash burn, cash balance, working capital and whether operating cash flows improve as sales conditions evolve.
- Verify the resolution and potential financial consequences of the securities litigation and SEC investigation.
- Confirm whether the shipment-documentation material weakness was remediated and controls were judged effective after Q3.
- Review the effect of restricted-stock awards, repurchases and dividends on share count, compensation expense and cash resources.