Natural Health Trends Corp. — FY 2018 Form 10-K
Reporting period: Fiscal year ended December 31, 2018; filed April 26, 2019. The company sells NHT Global wellness, personal care, beauty and lifestyle products through direct-selling members and e-commerce. Results below are in U.S. dollars.
Financial performance
| Metric | FY 2018 | FY 2017 | Change |
|---|---|---|---|
| Net sales | $191.9 million | $197.6 million | Down 2.9% |
| Gross profit / margin | $152.5 million / 79.5% | $158.9 million / 80.4% | Margin down 0.9 percentage points |
| Operating income / margin | $33.7 million / 17.6% | $43.1 million / 21.8% | Operating income down 21.7% |
| Net income | $31.0 million | $23.6 million | Up 31.6% |
| Diluted earnings per share | $2.74 | $2.09 | Up 31.1% |
| Cash from operations | $29.7 million | $26.6 million | Up $3.1 million |
Net income increased mainly because the 2017 tax provision included a one-time Tax Act transition-tax charge. The 2018 provision was $3.5 million versus $19.8 million in 2017; 2018 included a $4.0 million GILTI tax expense before related offsets. Operating performance weakened despite higher reported net income.
Fourth-quarter 2018 sales were $41.6 million, versus $46.1 million in fourth-quarter 2017, a decline of about 9.8%. Fourth-quarter 2018 net income was $5.6 million; the prior-year quarter reported a $4.5 million loss, reflecting the Tax Act impact.
Liquidity, cash flow and capital
- Year-end cash and cash equivalents were $132.7 million, including $85.3 million of available-for-sale investments classified as cash equivalents; $11.1 million was held in China and subject to currency controls.
- Working capital was $107.1 million and the current ratio was 3.49 to 1. The company said existing cash and operating cash flows should fund normal operations and commitments for the foreseeable future.
- Cash used in investing was $0.2 million. Cash used in financing was $31.5 million, entirely dividends. Dividends declared during 2018 totaled $2.77 per share; the board’s future dividend decisions are discretionary.
- The balance sheet reports no borrowings or debt balance. Total liabilities were $68.1 million. Contractual obligations totaled $32.5 million, including $18.6 million of Tax Act repatriation-tax payments, $9.0 million of long-term incentive compensation, and $4.5 million of operating leases.
Material changes and business trends
- Hong Kong generated $169.5 million, or 88.3% of sales; substantially all Hong Kong revenue came from products delivered to members in China. Hong Kong sales fell 3%. The Americas grew 21%, while Taiwan sales fell 29%.
- Gross margin declined due to lower event revenue, China e-commerce promotions, Noni Juice promotions and higher freight costs. Commissions rose to 45.6% of sales from 42.3%, mainly from supplemental cash and other incentives.
- Active members increased to 97,840 from 95,670. Inventory rose to $12.2 million from $8.4 million as the company built Greater China inventory amid trade uncertainty.
- The company paid $31.5 million in dividends in 2018, compared with $17.2 million in 2017.
Outlook, risks and unusual items
- China outlook: Following a January 2019 government campaign focused on health-product companies and direct selling, the company voluntarily suspended member activities in China, including roadshows, training and larger events. Management expected Hong Kong sales—substantially tied to China deliveries—to be substantially lower in the first half of 2019, potentially beyond. It warned that revenue could fall faster than expenses, creating negative cash flow and reducing cash balances.
- Regulatory exposure: The company does not hold a China direct-selling license and says it cannot predict whether or when it will obtain one. It faces evolving Chinese rules and enforcement, including scrutiny of direct selling and multilevel marketing. The filing also cites a January 2019 CCTV segment alleging an illegal pyramid scheme; the company’s January 2019 securities complaint alleges misleading statements about China operations, which the company says it will vigorously defend.
- Legal and regulatory matters: A putative securities class action was filed January 8, 2019 against the company and two executives concerning alleged statements about the legality of China operations. The SEC has conducted a non-public investigation since August 2016 into possible federal securities-law violations relating to trading in company securities; the company says it is cooperating and the outcome is uncertain. The SEC stated its document requests do not indicate that a violation occurred.
- Financial reporting controls: Management identified a material weakness in controls over revenue cut-off and deferred revenue, involving review and testing of shipping documentation from third-party logistics providers. No material financial-statement misstatement was identified, but management found controls ineffective and the auditor issued an adverse opinion on internal control over financial reporting. Remediation began in the first quarter of 2019; management expected completion in the second quarter.
- Concentration and execution risks: The company depends heavily on the Hong Kong/China business and on independent members. Premium Noni Juice and Enhanced Essential Probiotics each exceeded 10% of revenue and each came from a single supplier. Other stated risks include product regulation and claims, currency changes, trade tensions, member attrition, and a limited number of manufacturers.
Important facts for investors to verify
- Whether China’s campaign and suspension of member activities continued, and the resulting sales, cash-flow and cash-balance effects after year-end.
- Developments in the China direct-selling license process, regulatory scrutiny, the 2019 securities class action and the SEC investigation.
- Progress and independent testing of remediation for the revenue-recognition control weakness, including whether the weakness was fully remediated as expected.
- Whether margins and commission rates stabilize, and whether the company can reduce its dependence on China/Hong Kong and its two major products and single-source suppliers.
- Future dividend policy and capacity to meet tax, incentive-compensation and lease commitments if sales decline materially.