Natural Health Trends Corp. — Q3 2018 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2018. The company is an international direct-selling and e-commerce business selling NHT Global personal care, wellness and quality-of-life products.
Financial performance
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Net sales | $47.0m | $40.1m | $150.3m | $151.5m |
| Gross profit | $37.1m | $31.9m | $119.8m | $122.3m |
| Operating income | $7.8m | $8.5m | $28.0m | $34.4m |
| Net income | $7.6m | $7.3m | $25.5m | $28.1m |
| Diluted EPS | $0.67 | $0.65 | $2.25 | $2.49 |
| Gross margin | 78.9% | 79.6% | 79.7% | 80.7% |
| Operating margin | 16.7% | 21.2% | 18.6% | 22.7% |
Q3 sales rose 17% year over year, but operating income fell 8%; net income increased 4%, aided in part by a $496,000 discrete tax benefit. For the nine-month period, sales declined 1%, operating income declined 19% and net income declined 9%. Commissions rose to 46.8% of Q3 sales from 39.4%, and to 44.8% for the nine-month period from 42.1%, primarily because of higher estimated incentive-program costs. Q3 gross margin declined due to Hong Kong promotions and higher freight costs; nine-month margin also reflected lower event revenue and China e-commerce promotions.
Cash, liquidity and capital allocation
- At September 30, cash and cash equivalents were $132.2m, with an additional $3.0m of restricted cash; $10.0m was held in banks in China subject to foreign-currency controls. Cash and cash equivalents were $135.3m at December 31, 2017.
- Current assets were $148.2m and current liabilities $43.9m; working capital was $104.3m and the current ratio was 3.38:1. Total liabilities were $68.1m and equity $88.2m. The balance sheet presents no borrowings.
- Nine-month operating cash flow was $25.3m, versus $15.3m a year earlier. Investing cash outflow was $0.2m, primarily for office buildouts and software; financing cash outflow was $27.6m in dividends. Cash, cash equivalents and restricted cash decreased $3.3m.
- The company paid $2.43 per share in dividends during the first nine months, including a $20.0m special dividend. After quarter-end, the board declared a further $0.34 per share, payable November 23, 2018.
Business changes, outlook and risks
- Hong Kong generated 88.1% of Q3 sales; substantially all Hong Kong revenue comes from products delivered to members in China. Q3 Hong Kong sales increased 18% year over year, while nine-month Hong Kong sales declined 1%. Active members were 97,160, versus 99,690 a year earlier and 93,000 three months earlier.
- Management attributed Q3 growth to marketing programs, including the Hong Kong Ambassador Academy; Americas sales also benefited from the Airelle skincare launch and growth in Peru. Nine-month Americas sales rose 24%, while Taiwan sales declined 29%.
- No specific revenue or earnings guidance is provided. Management said existing liquidity and operating cash flows should fund normal operations and commitments for the foreseeable future, and plans continued investment in Greater China and selected growth markets.
- The company does not hold a China direct-selling license and cannot predict whether or when it may obtain one. U.S.-China trade tensions had not materially affected operations as of the filing, but management cited possible future effects, including yuan weakness that can raise effective purchase prices for Chinese members.
- The company recorded a provisional $2.3m GILTI tax impact for the first nine months; its projected 2018 effective tax rate was 12.2% excluding discrete items. An IRS audit of the 2016 tax year was disclosed.
- Management said disclosure controls were ineffective because of a previously identified material weakness involving the proprietary web-based system. Remediation steps were underway, with full remediation expected during 2018; completion was not yet stated.
- A shareholder derivative settlement was approved and the related state case dismissed; the $250,000 attorneys’ fee was funded by insurers. In a separate vendor-related matter, the company believes it is indemnified. A related-party product royalty agreement generated $248,000 of royalties in the first nine months.
Investor verification priorities
- Track Hong Kong/China concentration, active-member trends and any changes in China licensing or regulatory conditions.
- Assess whether higher commissions, promotions and freight costs continue to pressure margins and operating income.
- Verify progress in remediating the material weakness and whether disclosure controls are subsequently judged effective.
- Monitor cash generation against dividends, China-related spending, foreign-currency restrictions and trade risks.
- Review final GILTI and other tax outcomes, the 2016 IRS audit, and developments in the vendor-related legal matter.