Natural Health Trends Corp. — Q1 2018 Form 10-Q
Reporting period: Three months ended March 31, 2018; comparisons are with Q1 2017 unless stated otherwise. The company sells NHT Global personal care, wellness, and lifestyle products through direct selling and e-commerce.
Financial results and liquidity
| Metric | Q1 2018 | Q1 2017 / comparison |
|---|---|---|
| Net sales | $52.4 million | $59.9 million; down 13% |
| Gross profit / margin | $42.1 million / 80.5% | $48.6 million / 81.2% |
| Operating income / margin | $10.0 million / 19.2% | $13.0 million / 21.7% |
| Net income | $8.8 million | $10.4 million |
| Diluted EPS | $0.78 | $0.93 |
| Operating cash flow | $11.1 million | $13.8 million |
| Cash and cash equivalents at quarter-end | $145.1 million | $135.3 million at Dec. 31, 2017 |
| Working capital / current ratio | $117.3 million / 3.81 | Working capital up $8.0 million from year-end |
| Debt | No borrowings are presented on the balance sheet |
Cash, cash equivalents, and restricted cash totaled $148.4 million at March 31. The company reported $74.8 million of available-for-sale investments classified as cash equivalents; $144.1 million of cash and cash equivalents was held overseas, including $9.0 million in China subject to currency controls. Investing activities used $17,000; dividends paid used $1.5 million. The quarterly dividend was $0.13 per share.
Material changes and operating drivers
- Hong Kong sales fell 13% to $47.6 million and represented 91% of total sales. Substantially all Hong Kong revenue comes from products delivered to members in China.
- Management attributed weaker sales to a prolonged slowdown in Asian markets, which affected members’ ability to conduct business and logistics partners’ operations. Hong Kong active membership fell by 21,600, or 21%, year over year. Company-wide active members were 95,040, versus 113,710 a year earlier.
- Outside Hong Kong, sales declined 11%; China e-commerce sales fell 28%, mainly due to lower Home product sales, partly offset by Wellness growth.
- Gross margin declined 0.7 percentage point, primarily because of lower event revenue. Commissions rose to 43.9% of sales from 43.4%, reflecting higher estimated incentive-program costs. SG&A declined 6% to $9.1 million, mainly from lower professional fees, event costs, and payment fees.
- The effective tax rate was lower than in Q1 2017, partly reflecting the Tax Cuts and Jobs Act. GILTI added approximately $1.0 million, or about 10 percentage points, to the quarter’s effective tax rate. Management projected a 13.6% effective tax rate for full-year 2018.
Outlook, risks, and unusual items
- No specific revenue or earnings guidance was provided. Management said existing liquidity and operating cash flows should fund normal operations and commitments for the foreseeable future. It plans to continue investing in Greater China and selected markets, including China-based capabilities and infrastructure associated with its direct-selling-license application; timing and success of obtaining a Chinese license remain uncertain.
- Business concentration is a significant risk: Hong Kong generated 91% of quarterly sales, with substantial exposure to deliveries to China. The company cited regulatory uncertainty, direct-selling rules, member retention, competition, product and supply concentration, and foreign-exchange exposure. It does not hedge short-term currency movements.
- Disclosure controls were not effective at March 31 because of a previously identified material weakness in internal control over financial reporting relating to the proprietary web-based system. Remediation was ongoing; management expected it to be completed during 2018.
- The securities class action settlement of $1.75 million was approved April 2, 2018 and is to be fully funded by insurers. A proposed settlement of derivative lawsuits received preliminary court approval in April; final approval was scheduled for July 16, 2018. If finalized, it would require governance reforms and allow up to $250,000 in plaintiffs’ attorneys’ fees, also insurer-funded. The filing warns unresolved claims could materially affect results or financial condition.
- On April 17, 2018, the board declared a $0.14 quarterly dividend and a $1.76 special dividend per share, payable May 25, 2018. Future dividends remain at the board’s discretion.
- The company adopted ASC 606 on January 1, 2018 using the modified retrospective method and reported no material impact.
Important facts for investors to verify
- Whether Hong Kong/China sales and member trends stabilize, given the pronounced geographic concentration.
- Progress and final court approval of the derivative settlement, and any uninsured legal exposure.
- Completion and effectiveness of the internal-control remediation plan.
- Cash availability and repatriation constraints, including funds subject to China foreign-currency controls, and the effect of the special dividend on liquidity.
- Final accounting and tax effects of the Tax Act, including GILTI and the projected 2018 tax rate.