0000912061 Natural Health Trends Corp. false --12-31 Q2 2020 0.001 0.001 0.001 0.001 5,000,000 5,000,000 0 0 0 0 0.001 0.001 50,000,000 50,000,000 12,979,414 12,979,414 1,556,875 1,556,875 0.20 0.20 0.24 14 1 2 0 0 0 0 0 0 5 0 5 1 Substantially all of our Hong Kong revenues are derived from the sale of products that are delivered to members in China. See "Item 1A. Risk Factors" in this report and in our most recent Annual Report on Form 10-K. FASB Topic 820, Fair Value Measurements, establishes a fair value hierarchy that requires the use of observable market data, when available, and prioritizes the inputs to valuation techniques used to measure fair value in the following categories: Level 1: Quoted market prices in active markets for identical assets or liabilities. Level 2: Observable market-based inputs or unobservable inputs that are corroborated by market data. 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Table of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

FORM 10-Q

(Mark One)

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended June 30, 2020

 

OR

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from ______ to _______

 

Commission File Number: 001-36849

 

NATURAL HEALTH TRENDS CORP.

(Exact name of registrant as specified in its charter)

Delaware

59-2705336

(State or other jurisdiction of

(I.R.S. Employer

incorporation or organization)

Identification No.)

 

Units 1205-07, 12F

Mira Place Tower A

132 Nathan Road, Tsimshatsui

Kowloon, Hong Kong

(Address of principal executive offices, including zip code)

 

Registrant’s telephone number, including area code: +852-3107-0800

 

Securities registered pursuant to Section 12(b) of the Exchange Act:

Title of each class

Trading Symbol(s)

Name of each exchange on which registered

Common Stock, par value $0.001 per share

NHTC

The NASDAQ Stock Market LLC

 

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☑ No ☐

 

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for shorter period that the registrant was required to submit such files). Yes ☑ No ☐

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer

 

Accelerated filer

Non-accelerated filer

 

Smaller reporting company

   

Emerging growth company

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes No ☑

 

At July 31, 2020, the number of shares outstanding of the registrant’s common stock was 11,422,539 shares.

 

 

 

 

NATURAL HEALTH TRENDS CORP.

Quarterly Report on Form 10-Q

June 30, 2020

 

INDEX 

 

 

 

Page

PART I - FINANCIAL INFORMATION

 

Item 1.

Financial Statements

1

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

16

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

23

Item 4.

Controls and Procedures

23

 

 

 

PART II - OTHER INFORMATION

 

Item 1.

Legal Proceedings

24

Item 1A.

Risk Factors

24

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

24

Item 3.

Defaults Upon Senior Securities

24

Item 4.

Mine Safety Disclosures

24

Item 5.

Other Information

24

Item 6.

Exhibits

24

 

 

 

Signatures

25

 

 

 

 

 

FORWARD-LOOKING STATEMENTS

 

This Quarterly Report on Form 10-Q, in particular “Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations,” includes “forward-looking statements” within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). When used in this report, the words or phrases “will likely result,” “expect,” “intend,” “will continue,” “anticipate,” “estimate,” “project,” “believe” and similar expressions are intended to identify “forward-looking statements” within the meaning of the Exchange Act. These statements represent our expectations or beliefs concerning, among other things, future revenue, earnings, growth strategies, new products and initiatives, future operations and operating results, and future business and market opportunities.

 

Forward-looking statements in this report speak only as of the date hereof, and forward-looking statements in documents incorporated by reference speak only as of the date of those documents. We undertake no obligation to publicly update or revise any forward-looking statement, whether as a result of new information, future events or otherwise, except as required by law. We caution and advise readers that these statements are based on certain assumptions that may not be realized and involve risks and uncertainties that could cause actual results to differ materially from the expectations and beliefs contained herein.

 

For a summary of certain risks related to our business, see “Part I, Item 1A. Risk Factors” in our most recent Annual Report on Form 10-K, which includes the following:

 

 

We could be adversely affected by management changes or an inability to attract and retain key management, directors and consultants;

 

Because our Hong Kong operations account for a substantial portion of our overall business, and substantially all of our Hong Kong business is derived from the sale of products to members in China, any material adverse change in our business relating to either Hong Kong or China would likely have a material adverse impact on our overall business;

 

Our Hong Kong operations are being adversely affected by recent political and social developments in Hong Kong, and the negative impact on our operations and financial performance could continue or intensify;

 

Our operations in China are subject to compliance with a myriad of applicable laws and regulations, and any actual or alleged violations of those laws or government actions otherwise directed at us could have a material adverse impact on our business and the value of our company;

 

Our recent loss of a significant number of members is adversely affecting our business, and if we cannot stabilize or increase the number of members our business could be further negatively impacted;

 

Epidemics, such as the 2020 coronavirus outbreak, or natural disasters, terrorist attacks or acts of war may seriously harm our business;

 

We experienced negative operating cash flows during the year ended December 31, 2019, and if this trend continues it could have a material adverse effect on our business and our stock price;

 

We are currently involved in, and may in the future face, lawsuits, claims, and governmental proceedings and inquiries that could harm our business;

 

Although virtually all of our members are independent contractors, improper member actions that violate laws or regulations could harm our business;

 

Direct-selling laws and regulations may prohibit or severely restrict our direct sales efforts and cause our revenue and profitability to decline, and regulators could adopt new regulations that harm our business;

 

The high level of competition in our industry could adversely affect our business;

 

Challenges by third parties to the legality of our business operations could harm our business;

 

An increase in the amount of compensation paid to members would reduce profitability;

 

Currency exchange rate fluctuations could lower our revenue and net income;

 

Changes in tax or duty laws, and unanticipated tax or duty liabilities, could adversely affect our net income;

 

Transfer pricing regulations affect our business and results of operations;

 

Our products and related activities are subject to extensive government regulation, which could delay, limit or prevent the sale of some of our products in some markets;

 

Failure of new products to gain member and market acceptance could harm our business;

 

New regulations governing the marketing and sale of nutritional supplements could harm our business;

 

Regulations governing the production and marketing of our personal care products could harm our business;

 

If we are found not to be in compliance with good manufacturing practices our operations could be harmed;

 

Failure to comply with domestic and foreign laws and regulations governing product claims and advertising could harm our business;

 

Adverse publicity associated with our products, ingredients or network marketing program, or those of similar companies, could harm our financial condition and operating results;

 

 

 

 

We are subject to risks relating to product concentration and lack of revenue diversification;

 

We rely on a limited number of independent third parties to manufacture and supply our products;

 

Growth may be impeded by the political and economic risks of entering and operating in foreign markets;

 

We are subject to anti-bribery laws, including the U.S. Foreign Corrupt Practices Act;

 

Recently enacted tariffs, other potential changes to tariff and import/export regulations, and ongoing trade disputes between the United States and other jurisdictions, particularly China, may have a negative effect on global economic conditions and our business, financial results and financial condition;

 

We may be held responsible for certain taxes or assessments relating to the activities of our members and service providers, which could harm our financial condition and operating results;

 

We may be unable to protect or use our intellectual property rights;

 

We do not have a comprehensive product liability insurance program and product liability claims could hurt our business;

 

Failure to maintain effective internal controls in accordance with the Sarbanes-Oxley Act of 2002 could negatively impact our business and the market price of our stock;

 

We rely on and are subject to risks associated with our reliance upon information technology systems;

 

System disruptions or failures, cybersecurity risks, and compromises of data could harm our business;

 

Our systems, software and data reside on third-party servers, exposing us to risks that disruption or intrusion of those servers could temporarily or permanently interrupt our access and damage our business;

 

Disappointing quarterly revenue or operating results could cause the price of our common stock to fall;

 

Our common stock is particularly subject to volatility because of the industry and markets in which we operate;

 

Our common stock continues to experience wide fluctuations in trading volumes and prices. This may make it more difficult for holders of our common stock to sell shares when they want and at prices they find attractive; and

 

Future sales by us or our existing stockholders could depress the market price of our common stock.

 

Additional factors that could cause actual results to differ materially from our forward-looking statements are set forth in this report, including under the headings “Risk Factors” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and in our financial statements and the related notes.

 

 

 
 

 

PART I - FINANCIAL INFORMATION

 

Item 1. FINANCIAL STATEMENTS

  

NATURAL HEALTH TRENDS CORP.

CONSOLIDATED BALANCE SHEETS

(In thousands, except share data) 

 

  

June 30, 2020

  

December 31, 2019

 
  

(Unaudited)

     

ASSETS

        

Current assets:

        

Cash and cash equivalents

 $93,206  $96,035 

Inventories

  4,114   6,404 

Other current assets

  5,057   5,936 

Total current assets

  102,377   108,375 

Property and equipment, net

  599   735 

Operating lease right-of-use assets

  3,096   3,135 

Restricted cash

  513   3,390 

Deferred tax asset

  1,163   2,039 

Other assets

  729   823 

Total assets

 $108,477  $118,497 

LIABILITIES AND STOCKHOLDERS’ EQUITY

        

Current liabilities:

        

Accounts payable

 $1,084  $680 

Accrued commissions

  3,113   2,931 

Other accrued expenses

  1,763   2,387 

Deferred revenue

  2,645   4,506 

Amounts held in eWallets

  11,438   12,938 

Operating lease liabilities

  1,247   1,655 

Other current liabilities

  1,438   1,205 

Total current liabilities

  22,728   26,302 

Income taxes payable

  13,748   15,365 

Deferred tax liability

  203   202 

Operating lease liabilities

  1,963   1,564 

Total liabilities

  38,642   43,433 

Commitments and contingencies (Note 7)

        

Stockholders’ equity:

        

Preferred stock, $0.001 par value; 5,000,000 shares authorized; no shares issued and outstanding

      

Common stock, $0.001 par value; 50,000,000 shares authorized; 12,979,414 shares issued at June 30, 2020 and December 31, 2019

  13   13 

Additional paid-in capital

  86,102   86,102 

Retained earnings

  11,008   16,117 

Accumulated other comprehensive loss

  (1,384)  (1,264)

Treasury stock, at cost; 1,556,875 shares at June 30, 2020 and December 31, 2019

  (25,904)  (25,904)

Total stockholders’ equity

  69,835   75,064 

Total liabilities and stockholders’ equity

 $108,477  $118,497 

 

 

See accompanying notes to consolidated financial statements.

 

1

 

 

NATURAL HEALTH TRENDS CORP. 

CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)

(In thousands, except per share data)

 

   

Three Months Ended June 30,

   

Six Months Ended June 30,

 
   

2020

   

2019

   

2020

   

2019

 

Net sales

  $ 16,404     $ 23,428     $ 31,352     $ 42,756  

Cost of sales

    4,817       5,407       9,331       10,631  

Gross profit

    11,587       18,021       22,021       32,125  

Operating expenses:

                               

Commissions expense

    7,113       11,398       13,716       20,896  

Selling, general and administrative expenses

    4,291       6,627       9,570       13,942  

Total operating expenses

    11,404       18,025       23,286       34,838  

Income (loss) from operations

    183       (4 )     (1,265 )     (2,713 )
Other income, net     125       373       218       805  

Income (loss) before income taxes

    308       369       (1,047 )     (1,908 )

Income tax provision (benefit)

    274       (28 )     (508 )     (382 )

Net income (loss)

  $ 34     $ 397     $ (539 )   $ (1,526 )
Net income (loss) per common share:                                

Basic

  $ 0.00     $ 0.04     $ (0.05 )   $ (0.14 )

Diluted

  $ 0.00     $ 0.04     $ (0.05 )   $ (0.14 )
Weighted-average common shares outstanding:                                
Basic     10,580       11,082       10,532       11,207  

Diluted

    11,424       11,135       10,532       11,207  

 

 

See accompanying notes to consolidated financial statements.

 

2

 

 

NATURAL HEALTH TRENDS CORP.

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS) (UNAUDITED)

(In thousands)

 

   

Three Months Ended June 30,

   

Six Months Ended June 30,

 
   

2020

   

2019

   

2020

   

2019

 

Net income (loss)

  $ 34     $ 397     $ (539 )   $ (1,526 )

Other comprehensive income (loss), net of tax:

                               

Foreign currency translation adjustment

    84       (212 )     (138 )     47  

Unrealized gains (losses) on available-for-sale securities

    105       (6 )     18       11  

Comprehensive income (loss)

  $ 223     $ 179     $ (659 )   $ (1,468 )

 

 

See accompanying notes to consolidated financial statements.

 

3

 

 

NATURAL HEALTH TRENDS CORP.

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY (UNAUDITED)

(In Thousands, Except Share Data)

 

Six months ended June 30, 2020

 

                          

Accumulated

             
                  

Additional

      

Other

             
  

Preferred Stock

  

Common Stock

  

Paid-In

  

Retained

  

Comprehensive

  

Treasury Stock

     
  

Shares

  

Amount

  

Shares

  

Amount

  

Capital

  

Earnings

  

Loss

  

Shares

  

Amount

  

Total

 
                                         

BALANCE, December 31, 2019

    $   12,979,414  $13  $86,102  $16,117  $(1,264)  (1,556,875) $(25,904) $75,064 

Net loss

                 (573)           (573)

Dividends declared, $0.20/share

                 (2,285)           (2,285)

Foreign currency translation adjustments

                    (222)        (222)

Unrealized losses on available-for-sale securities

                    (87)        (87)

BALANCE, March 31, 2020

        12,979,414   13   86,102   13,259   (1,573)  (1,556,875)  (25,904)  71,897 

Net income

                 34            34 

Dividends declared, $0.20/share

                 (2,285)           (2,285)

Foreign currency translation adjustments

                    84         84 

Unrealized gains on available-for-sale securities

                    105         105 

BALANCE, June 30, 2020

    $   12,979,414  $13  $86,102  $11,008  $(1,384)  (1,556,875) $(25,904) $69,835 

 

 

Six months ended June 30, 2019

 

                          

Accumulated

             
                  

Additional

      

Other

             
  

Preferred Stock

  

Common Stock

  

Paid-In

  

Retained

  

Comprehensive

  

Treasury Stock

     
  

Shares

  

Amount

  

Shares

  

Amount

  

Capital

  

Earnings

  

Loss

  

Shares

  

Amount

  

Total

 

BALANCE, December 31, 2018

    $   12,979,414  $13  $86,415  $44,431  $(1,250)  (1,603,322) $(39,748) $89,861 

Net loss

                 (1,923)           (1,923)

Common stock issued

              (166)        22,603   543   377 

Dividends declared, $0.24/share

                 (2,736)           (2,736)

Foreign currency translation adjustments

                    259         259 

Unrealized gains on available-for-sale securities

                    17         17 

BALANCE, March 31, 2019

        12,979,414   13   86,249   39,772   (974)  (1,580,719)  (39,205)  85,855 

Net income

                 397            397 

Repurchase of common stock

                       (612,729)  (6,682)  (6,682)

Foreign currency translation adjustments

                    (212)        (212)

Unrealized losses on available-for-sale securities

                    (6)        (6)

BALANCE, June 30, 2019

    $   12,979,414  $13  $86,249  $40,169  $(1,192)  (2,193,448) $(45,887) $79,352 

 

See accompanying notes to consolidated financial statements.

 

4

 

 

NATURAL HEALTH TRENDS CORP.

CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

(In thousands)

 

   

Six Months Ended June 30,

 
   

2020

   

2019

 

CASH FLOWS FROM OPERATING ACTIVITIES:

               

Net loss

  $ (539 )   $ (1,526 )

Adjustments to reconcile net loss to net cash used in operating activities:

               

Depreciation and amortization

    202       189  

Noncash lease expense

    834       914  

Deferred income taxes

    870       (3 )

Changes in assets and liabilities:

               

Inventories

    2,314       1,881  

Other current assets

    845       (752 )

Other assets

    82       (35 )

Accounts payable

    402       (956 )

Accrued commissions

    212       (5,475 )

Other accrued expenses

    (617 )     (1,946 )

Deferred revenue

    (1,872 )     (3,409 )

Amounts held in eWallets

    (1,560 )     (765 )

Operating lease liabilities

    (811 )     (964 )
Income taxes payable     (1,617 )     (1,617 )

Other current liabilities

    237       (318 )

Long-term incentive

          (277 )

Net cash used in operating activities

    (1,018 )     (15,059 )

CASH FLOWS FROM INVESTING ACTIVITIES:

               

Purchases of property and equipment

    (68 )     (141 )

Net cash used in investing activities

    (68 )     (141 )

CASH FLOWS FROM FINANCING ACTIVITIES:

               
Repurchase of common stock           (6,682 )

Dividends paid

    (4,570 )     (2,736 )

Net cash used in financing activities

    (4,570 )     (9,418 )

Effect of exchange rates on cash, cash equivalents and restricted cash

    (50 )     73  

Net decrease in cash, cash equivalents and restricted cash

    (5,706 )     (24,545 )

CASH, CASH EQUIVALENTS AND RESTRICTED CASH, beginning of period

    99,425       135,651  

CASH, CASH EQUIVALENTS AND RESTRICTED CASH, end of period

  $ 93,719     $ 111,106  

SUPPLEMENTAL DISCLOSURES OF OTHER CASH FLOW INFORMATION:

               

Issuance of treasury stock for employee awards, net

  $     $ 377  

Right-of-use assets obtained in exchange for operating lease liabilities

  $ 1,081     $ 4,697  

 

 

See accompanying notes to consolidated financial statements.

 

5

 

NATURAL HEALTH TRENDS CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

 

 

1. NATURE OF OPERATIONS, BASIS OF PRESENTATION AND CONSOLIDATION

 

Nature of Operations 

 

Natural Health Trends Corp., a Delaware corporation (whether or not including its subsidiaries, the “Company”), is an international direct-selling and e-commerce company. Subsidiaries controlled by the Company sell personal care, wellness, and “quality of life” products under the “NHT Global” brand.

 

The Company’s wholly-owned subsidiaries have an active physical presence in the following markets: the Americas, which consists of the United States, Canada, Cayman Islands, Mexico and Peru; Greater China, which consists of Hong Kong, Taiwan and China; Southeast Asia, which consists of Singapore, Malaysia, Thailand and Vietnam; South Korea; Japan; India; and Europe. The Company also operates in Russia and Kazakhstan through an engagement with a local service provider.

 

Basis of Presentation 

 

The unaudited interim consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. As a result, certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted. In the opinion of management, the accompanying unaudited interim consolidated financial statements contain all adjustments, consisting of normal recurring adjustments, considered necessary for a fair statement of the Company’s financial information for the interim periods presented. The results of operations of any interim period are not necessarily indicative of the results of operations to be expected for the fiscal year. These consolidated financial statements should be read in conjunction with the consolidated financial statements and related notes included in the Company’s 2019 Annual Report on Form 10-K filed with the United States Securities and Exchange Commission (SEC) on March 9, 2020.

 

Principles of Consolidation

 

The consolidated financial statements include the accounts of the Company and all of its wholly-owned subsidiaries. All significant inter-company balances and transactions have been eliminated in consolidation.

 

Restricted Cash

 

In June 2015, the Company funded a bank deposit account in the amount of CNY 20 million ($2.9 million at December 31, 2019) in anticipation of submitting a direct selling license application in China. Such deposit is required by Chinese laws to establish a consumer protection fund. The Company received a refund of this deposit in March 2020 in connection with the withdrawal of its application.

 

Net Income (Loss) Per Common Share

 

Diluted net income (loss) per common share is determined using the weighted-average number of common shares outstanding during the period, adjusted for the dilutive effect of common stock equivalents. The dilutive effect of non-vested restricted stock is reflected by application of the treasury stock method. Under the treasury stock method, the amount of compensation cost for future service that the Company has not yet recognized, if any, is assumed to be used to repurchase shares.

 

The following tables illustrate the computation of basic and diluted net income (loss) per common share for the periods indicated (in thousands, except per share data):

 

  

Three Months Ended June 30,

 
  

2020

  

2019

 
  

Income (Numerator)

  

Shares (Denominator)

  

Per Share Amount

  

Income (Numerator)

  

Shares (Denominator)

  

Per Share Amount

 

Basic net income per common share:

                        

Net income available to common stockholders

 $34   10,580  $0.00  $397   11,082  $0.04 

Effect of dilutive securities:

                        

Non-vested restricted stock

     844          53     

Diluted net income per common share:

                        

Net income available to common stockholders plus assumed conversions

 $34   11,424  $0.00  $397   11,135  $0.04 

 

  

Six Months Ended June 30,

 
  

2020

  

2019

 
  

Loss (Numerator)

  

Shares (Denominator)

  

Per Share Amount

  

Loss (Numerator)

  

Shares (Denominator)

  

Per Share Amount

 

Basic net loss per common share:

                        

Net loss available to common stockholders

 $(539)  10,532  $(0.05) $(1,526)  11,207  $(0.14)

Effect of dilutive securities:

                        

Non-vested restricted stock

                    

Diluted net loss per common share:

                        

Net loss available to common stockholders plus assumed conversions

 $(539)  10,532  $(0.05) $(1,526)  11,207  $(0.14)

 

In periods when losses are reported, the weighted-average number of common shares outstanding excludes common stock equivalents because their inclusion would be anti-dilutive. As such, non-vested restricted stock totaling 892,083 and 55,430 shares were not included for the six-month periods ended June 30, 2020 and 2019, respectively.

 

Recent Accounting Pronouncements

 

In June 2016, the FASB issued ASU 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, which introduced an expected credit loss model for the impairment of financial assets measured at amortized cost basis and added Topic 326 to the FASB ASC. In November 2019, the FASB issued ASU 2019-11, Codification Improvements to Topic 326, Financial Instruments - Credit Losses. The amendments to ASU 2019-11 clarify, correct and make improvements to Topic 326. ASU 2016-13 as well as the updates in ASU 2019-11 are effective for interim and annual periods beginning after December 15, 2022, and early adoption is permitted. The Company is currently evaluating the impact of this standard on its consolidated financial statements.

 

6

 

In August 2018, the FASB issued ASU 2018-13, Fair Value Measurement (Topic 820): Disclosure Framework - Changes to the Disclosure Requirements for Fair Value Measurement. This guidance modifies, removes, and adds certain disclosure requirements on fair value measurements. This ASU is effective for interim and annual periods beginning after December 15, 2019, and early adoption is permitted. The adoption of this standard did not have a material impact on the Company’s consolidated financial statements.

 

In December 2019, the FASB issued ASU 2019-12, Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes. This guidance removes certain exceptions for recognizing deferred taxes for investments, performing intraperiod allocation and calculating income taxes in interim periods. It also adds guidance to reduce complexity in certain areas, including recognizing deferred taxes for tax goodwill and allocating taxes to members of a consolidated group. This ASU is effective for interim and annual periods beginning after December 15, 2020, and early adoption is permitted. The Company elected to early adopt the new standard during the first quarter of 2020. Such adoption did not have a material impact on the Company’s consolidated financial statement.

 

Other recently issued accounting pronouncements did not or are not believed by management to have a material impact on the Company’s present or future financial statements.

 

 

2. REVENUE

 

Revenue Recognition

 

All revenue is recognized when the performance obligations under a contract are satisfied. Product sales are recognized when the products are shipped and title passes to independent members. Product sales to members are made pursuant to a member agreement that provides for transfer of both title and risk of loss upon the Company’s delivery to the carrier that completes delivery to the members, which is commonly referred to as “F.O.B. Shipping Point.” The Company’s sales arrangements do not contain right of inspection or customer acceptance provisions other than general rights of return. These contracts are generally short-term in nature.

 

Actual product returns are recorded as a reduction to net sales. The Company estimates and accrues a reserve for product returns based on its return policies and historical experience. The reserve is based upon the return policy of each country, which varies from 14 days to one year, and their historical return rates, which range from 1% to 10% of sales.  Sales returns were 2% of sales for each of the six-month periods ended June 30, 2020 and 2019, respectively.  No material changes in estimates have been recognized during the periods presented. See Note 3 for additional information.

 

The Company has elected to account for shipping and handling activities performed after title has passed to members as a fulfillment cost, and accrues for the costs of shipping and handling if revenue is recognized before the contractually obligated shipping and handling activities occurs. Shipping charges billed to members are included in net sales. Costs associated with shipments are included in cost of sales. Event and training revenue is deferred and recognized as the event or training occurs. Costs of events and member training are included within selling, general and administrative expenses.

 

Various taxes on the sale of products to members are collected by the Company as an agent and remitted to the respective taxing authority. These taxes are presented on a net basis and recorded as a liability until remitted to the respective taxing authority.

 

Deferred Revenue

 

The Company primarily receives payment by credit card at the time members place orders. Amounts received for unshipped product are considered a contract liability and are recorded as deferred revenue. The decrease in deferred revenue for the three months ended June 30, 2020 is primarily due to $1.9 million of revenue recognized during the quarter that was included in deferred revenue as of March 31, 2020 offset by $565,000 of cash payments received for unshipped product during the quarter. See Note 3 for additional information.

 

Disaggregation of Revenue

 

The Company sells products to a member network that operates in a seamless manner from market to market, except for the Chinese market where it sells to consumers through an e-commerce retail platform and the Russia and Kazakhstan market where the Company operates through an engagement of a third-party service provider. See Note 10 for revenue by market information.

 

7

 

The Company’s net sales by product and service are as follows (in thousands):

 

  

Three Months Ended June 30,

  

Six Months Ended June 30,

 
  

2020

  

2019

  

2020

  

2019

 

Product sales

 $15,200  $22,100  $29,211  $40,623 

Freight and other

  1,454   1,745   2,538   3,245 

Less: sales returns

  (250)  (417)  (397)  (1,112)

Total net sales

 $16,404  $23,428  $31,352  $42,756 

 

Concentration

 

No single market other than Hong Kong had net sales greater than 10% of total net sales. Sales are made to the Company’s members and no single customer accounted for 10% or more of net sales for the three and six months ended June 30, 2020 and 2019. However, the Company’s business model can result in a concentration of sales to several different members and their network of members. Although no single member accounted for 10% or more of net sales, the loss of a key member or that member’s network could have an adverse effect on the Company’s net sales and financial results.

 

Arrangements with Multiple Performance Obligations

 

The Company’s contracts with customers may include multiple performance obligations. For such arrangements, the Company allocates revenues to each performance obligation based on its relative standalone selling price. The Company generally determines standalone selling prices based on the prices charged for individual products to similar customers.

 

Practical Expedients

 

The Company generally expenses sales commissions when incurred because the amortization period would have been one year or less. These costs are recorded in commissions expense.

 

The Company does not provide certain disclosures about unsatisfied performance obligations for contracts with an original expected length of one year or less.

 

8

 

 

 

3. BALANCE SHEET COMPONENTS

 

The components of certain balance sheet amounts are as follows (in thousands):

 

   

June 30, 2020

   

December 31, 2019

 

Cash, cash equivalents and restricted cash:

               

Cash

  $ 14,020     $ 13,720  

Cash equivalents

    79,186       82,315  
      93,206       96,035  

Restricted cash

    513       3,390  
    $ 93,719     $ 99,425  

Inventories:

               

Finished goods

  $ 3,368     $ 6,142  

Raw materials

    1,253       1,249  

Reserve for obsolescence

    (507 )     (987 )
    $ 4,114     $ 6,404  

Other accrued expenses:

               

Sales returns

  $ 195     $ 373  

Employee-related expense

    994       1,258  

Warehousing, inventory-related and other

    574       756  
    $ 1,763     $ 2,387  

Deferred revenue:

               

Unshipped product

  $ 584     $ 2,390  

Auto ship advances

    1,955       1,985  

Other

    106       131  
    $ 2,645     $ 4,506  

 

 

4. FAIR VALUE MEASUREMENTS

 

As of June 30, 2020, cash and cash equivalents include the Company’s investments in municipal and corporate debt securities, money market funds, and time deposits. The Company considers all highly liquid investments with original maturities of three months or less when purchased and have insignificant interest rate risk to be cash equivalents.  Debt securities classified as cash equivalents are required to be accounted for in accordance with the FASB Accounting Standards Codification (“ASC”) 320, Investments - Debt and Equity Securities. As such, the Company determined its investments in debt securities held at June 30, 2020 should be classified as available-for-sale and are carried at fair value with unrealized gains and losses reported in stockholders’ equity. The cost of debt securities is adjusted for amortization of premiums and discounts to maturity. This amortization is included in other income. Realized gains and losses, as well as interest income, are also included in other income. The fair values of securities are based on quoted market prices to the extent available or alternative pricing sources and models utilizing market observable inputs.

 

The carrying amounts of the Company’s financial instruments, including cash and accounts payable, approximate fair value because of their short maturities. The carrying amount of the noncurrent restricted cash approximates fair value since, absent the restrictions, the underlying assets would be included in cash and cash equivalents.

 

Accounting standards permit companies, at their option, to choose to measure many financial instruments and certain other items at fair value.  The Company has elected to not fair value existing eligible items.

 

9

 

Investments by significant category included in cash equivalents at the end of each period were as follows (in thousands):

 

       

June 30, 2020

   

December 31, 2019

 
    Fair Value Level1  

Adjusted Cost

    Gross Unrealized Losses    

Fair Value

   

Adjusted Cost

    Gross Unrealized Losses    

Fair Value

 

Money market funds

 

Level 1

  $ 35,607     $     $ 35,607     $ 11,659     $     $ 11,659  

Time deposits

 

Level 2

    12,077             12,077       13,544             13,544  

Municipal debt securities

 

Level 2

    31,198             31,198       347             347  

Corporate debt securities

 

Level 2

    305       (1 )     304       56,784       (19 )     56,765  

Total investments

      $ 79,187     $ (1 )   $ 79,186     $ 82,334     $ (19 )   $ 82,315  

 


 

1 FASB Topic 820, Fair Value Measurements, establishes a fair value hierarchy that requires the use of observable market data, when available, and prioritizes the inputs to valuation techniques used to measure fair value in the following categories:

Level 1: Quoted market prices in active markets for identical assets or liabilities.

Level 2: Observable market-based inputs or unobservable inputs that are corroborated by market data.

Level 3: Unobservable inputs that are not corroborated by market data.

 

 

5. LEASES

 

The Company leases 9,600 square feet of office space in Hong Kong and 4,900 square feet of office space in Rolling Hills Estates, California for its corporate staff.  In June 2020, the Company extended the Rolling Hills Estates office lease for an additional five years with a term now expiring in September 2030.  Effective July 1, 2020, the Company modified the terms of its largest Hong Kong office lease resulting in 10% monthly lease cost savings and a lease extension through June 2023. The modification will also result in an $831,000 increase in operating lease liability. To help further develop the market for its products in North America, the Company leases 2,400, 1,600 and 2,000 square feet of retail space in Monterey Park, California; Richmond, British Columbia; and Metuchen, New Jersey, respectively. The Monterey Park, Richmond and Metuchen locations have terms expiring in August 2020, February 2021, and November 2022, respectively.

 

The Company leases eight branch offices throughout China, and additional office space in Peru, Japan, Taiwan, South Korea, Singapore, Malaysia, Vietnam, Indonesia, Thailand, India, and the Cayman Islands. The Company also leases a multi-purpose facility and factory in Zhongshan, China. The Company contracts with third parties for fulfillment and distribution operations in all of its international markets. None of the Company’s third party logistics contracts contain a lease as the Company does not have the right to access the warehouses or move its inventories at will.

 

The components of lease cost for the three and six months ended June 30, 2020 and 2019 were as follows (in thousands):

 

   

Three Months Ended June 30,

   

Six Months Ended June 30,

 
   

2020

   

2019

   

2020

   

2019

 

Operating leases

  $ 446     $ 523     $ 915     $ 1,032  

Short-term leases

    82       62       165       128  

Total lease cost

  $ 528     $ 585     $ 1,080     $ 1,160  

 

Cash paid for amounts included in the measurement of operating leases liabilities was $421,000 and $577,000 for the three months ended  June 30, 2020 and 2019, respectively, and $900,000 and $1.1 million for the six months ended  June 30, 2020 and 2019, respectively.

 

The weighted-average remaining lease term and discount rate related to operating leases as of June 30, 2020 were as follows:

 

Weighted-average remaining lease term (in years)

    6.1  

Weighted-average discount rate

    4.5 %

 

10

 

As most of our leases do not provide an implicit rate, the Company used its incremental borrowing rate, or the rate of each of its subsidiaries if available, based on the information available at the lease commencement date to determine the present value of lease payments.

 

The annual scheduled lease payments of our operating lease liabilities as of June 30, 2020 were as follows (in thousands):

 

Remainder of 2020

  $ 816  

2021

    743  

2022

    477  

2023

    224  

2024

    193  

Thereafter

    1,186  

Total lease payments

  $ 3,639  

Less: imputed interest

    (429 )

Present value of lease liabilities

  $ 3,210  

 

For all asset classes, the Company elected not to recognize assets or liabilities at the acquisition date for leases that, at the acquisition date, have a remaining lease term of 12 months or less. Additionally, for all asset classes, the Company choose not to separate nonlease components from lease components and instead account for the combined lease and nonlease components associated with that lease component as a single lease component.

 

 

6. INCOME TAXES

 

The effective income tax rate for the three and six months ended June 30, 2020 includes an estimate for the Global Intangible Low-Taxed Income (“GILTI”) inclusion along with recording the effect of the U.S. Coronavirus Aid, Relief, and Economic Security (“CARES”) Act enacted on March 27, 2020. The CARES Act makes broad changes to the Internal Revenue Code of 1986, as amended, including, but not limited to, the ability to carry net operating losses generated in tax years 2018, 2019 or 2020 back to the each of the five tax years preceding the tax year of such loss.

 

As of June 30, 2020, the Company does not have a valuation allowance against its U.S. deferred tax assets. The Company analyzed all sources of available income and determined that they are more likely than not to realize the tax benefits of their deferred assets. As of June 30, 2020, the Company has a valuation allowance against deferred tax assets in certain foreign jurisdictions with an overall net operating loss. The valuation allowance will be reduced at such time as management believes it is more likely than not that the deferred tax assets will be realized. Any reductions in the valuation allowance will reduce future income tax provision.

 

As of June 30, 2020, the Company has U.S. federal net operating losses of $3.6 million which are expected to be fully utilized to offset taxable income from the tax year ended December 31, 2016. The Company has U.S. state net operating loss carryforwards of $2.4 million that begin expiring in 2040. At June 30, 2020, the Company has foreign net operating loss carryforwards of approximately $3.3 million in various jurisdictions with various expirations.

 

As a result of capital return activities, the Company determined that a portion of its current undistributed foreign earnings is no longer deemed reinvested indefinitely by its non-U.S. subsidiaries. For state income tax purposes, the Company will continue to periodically reassess the needs of its foreign subsidiaries and update its indefinite reinvestment assertion as necessary. To the extent that additional foreign earnings are not deemed permanently reinvested, the Company expects to recognize additional income tax provision at the applicable state corporate income tax rate(s). As of June 30, 2020, the Company has not recorded a state deferred tax liability for earnings that the Company plans to repatriate out of accumulated earnings in future periods because all earnings as of June 30, 2020 have already been repatriated. Due to the U.S. Tax Cuts and Jobs Act in 2017, repatriation from foreign subsidiaries will be offset with a dividends received deduction, resulting in little to no impact on federal tax expense. All undistributed earnings in excess of 50% of current earnings on an annual basis are intended to be reinvested indefinitely as of June 30, 2020.

 

11

 

The Company and its subsidiaries file tax returns in the United States, California, New Jersey and Texas and various foreign jurisdictions. During the fourth quarter of 2018, the Company was notified that it was selected for audit of the 2016 tax year by the U.S. Internal Revenue Service. The audit was expanded to also include the 2017 and 2018 tax years. For purposes of this audit, fiscal years since 2007 are open for examination by tax authorities as a result of net operating loss carryovers from older years being used to offset income in recent tax years. No adjustments have been proposed at this time. The Company is no longer subject to state income tax examinations for years prior to 2015.

 

 

7. COMMITMENTS AND CONTINGENCIES

 

On January 8, 2019, the Company and its two executive officers were named in a putative securities class action filed in the United States District Court for the Central District of California, captioned Kauffman v. Natural Health Trends Corp., Case No. 2:19-cv-00163. On May 3, 2019, the court issued an order appointing Xia Yang as lead plaintiff and appointing The Rosen Law Firm, P.A. as lead counsel. On June 3, 2019, lead plaintiff filed an amended complaint. On January 17, 2020, after briefing and oral argument on the Company’s motion to dismiss, the court issued an order dismissing the entire action with prejudice and ordering that judgment be entered for defendants. On February 14, 2020, plaintiff filed a notice of appeal to the Ninth Circuit Court of Appeals. On April 9, 2020, plaintiff filed a stipulated motion for voluntary dismissal of her appeal, concluding this matter.

 

The SEC is conducting a non-public investigation to determine whether there have been violations of the federal securities laws relating to the trading of the Company’s securities and/or its public disclosures. The Company has fully cooperated with the SEC and continues to do so. The amount of time needed to resolve this matter is uncertain, and the Company cannot predict the outcome or whether it will face additional governmental inquiries or other actions.

 

 

8. STOCKHOLDERS’ EQUITY

 

Dividends

 

The following table summarizes the Company’s cash dividend activity for the six months ended June 30, 2020 (in thousands, except per share data):

 

Declaration Date

 

Per Share

   

Amount

 

Record Date

 

Payment Date

February 10, 2020

  $ 0.20     $ 2,285  

February 25, 2020

 

March 6, 2020

May 4, 2020

    0.20       2,285  

May 19, 2020

 

May 29, 2020

    $ 0.40     $ 4,570        

 

The declaration and payment of any future dividends on shares of common stock will be at the sole discretion of the Company’s Board of Directors.

 

Stock Repurchases

 

On January 12, 2016, the Board of Directors authorized an increase to the Company’s stock repurchase program first approved on July 28, 2015 from $15.0 million to $70.0 million. Repurchases are expected to be executed to the extent that the Company’s earnings and cash-on-hand allow, and will be made in accordance with all applicable securities laws and regulations, including Rule 10b-18 of the Exchange Act. For all or a portion of the authorized repurchase amount, the Company may enter into one or more plans that are compliant with Rule 10b5-1 of the Exchange Act that are designed to facilitate these purchases. The stock repurchase program does not require the Company to acquire a specific number of shares, and may be suspended from time to time or discontinued.

 

On May 16, 2019, the Company’s Board of Directors authorized the Company to proceed with the purchase of up to $8.0 million in shares of common stock under the foregoing stock repurchase program. In connection therewith, the Company was advised that George K. Broady, a director of the Company and beneficial owner of more than 5% of its outstanding shares of common stock, would participate in the stock repurchase program through The George K. Broady 2012 Irrevocable Trust (the "Broady Trust") on a basis roughly proportional to his family’s ownership interest (see Note 9). During May 2019, the Company authorized its broker to proceed with the purchase of shares of the Company’s common stock in the open market for a total purchase price of $4.7 million in accordance with all applicable securities laws and regulations, including Rule 10b-18 of the Exchange Act. The open market repurchases were completed on May 31, 2019. The stock repurchases, which included both open market purchases and the purchase of shares from the Broady Trust, resulted in the Company purchasing a total of 612,729 shares of its common stock for an aggregate purchase price of $6.7 million, plus transaction costs.

 

As of June 30, 2020, $21.9 million of the $70.0 million stock repurchase program approved on July 28, 2015 and increased on January 12, 2016 remained available for future purchases, inclusive of related estimated income tax.

 

Restricted Stock

 

At the Company’s annual meeting of stockholders held on April 7, 2016, the Company’s stockholders approved the Natural Health Trends Corp. 2016 Equity Incentive Plan (the “2016 Plan”) to replace its 2007 Equity Incentive Plan. The 2016 Plan allows for the grant of various equity awards including incentive stock options, non-statutory options, stock, stock units, stock appreciation rights and other similar equity-based awards to the Company’s employees, officers, non-employee directors, contractors, consultants and advisors of the Company. Up to 2,500,000 shares of the Company’s common stock (subject to adjustment under certain circumstances) may be issued pursuant to awards granted. At June 30, 2020, 1,219,583 shares remained available for issuance under the 2016 Plan.

 

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The following table summarizes the Company’s restricted stock activity under the 2016 Plan:

 

   

Shares

    Wtd. Avg. Price at Date of Issuance  

Nonvested at December 31, 2019

    957,682     $ 7.34  

Vested

    (195,722 )   $ 7.53  

Nonvested at June 30, 2020

    761,960     $ 7.29  

 

Accumulated Other Comprehensive Loss

 

The changes in accumulated other comprehensive loss by component for the six months of 2020 were as follows (in thousands):

 

    Foreign Currency Translation Adjustment     Unrealized Gains (Losses) on Available-For-Sale Investments    

Total

 

Balance, December 31, 2019

  $ (1,245 )   $ (19 )   $ (1,264 )

Other comprehensive income (loss)

    (138 )     18       (120 )

Balance, June 30, 2020

  $ (1,383 )   $ (1 )   $ (1,384 )

 

 

9. RELATED PARTY TRANSACTIONS

 

The Company is a party to a Royalty Agreement and License with Broady Health Sciences, L.L.C., a Texas limited liability company, (“BHS”) regarding the manufacture and sale of a product called ReStor™. George K. Broady, a director of the Company and beneficial owner of more than 5% of its outstanding common stock, is owner of BHS. Under this agreement (as amended), the Company agreed to pay BHS a royalty based on a price per unit in return for the right to manufacture (or have manufactured), market, import, export and sell this product worldwide by or through multi-level marketing or network marketing. Such royalties were $35,000 and $29,000 for the three months ended June 30, 2020 and 2019, respectively, and $50,000 and $56,000 for the six months ended June 30, 2020 and 2019, respectively. The Company is not required to purchase any product under the agreement, and the agreement may be terminated under certain circumstances with no notice. An amendment to the agreement effective March 20, 2020 extends the term of the agreement for an additional five years to March 31, 2025, after which it shall be automatically renewed for successive one-year terms unless notice is given by either party at least 90 days in advance of the expiration of the then-current term.

 

The Company procured in China and arranged for shipment to The Aberdeen Group, LLC (“Aberdeen”) one order of apparel products in the amount of $7,100 during the three months ended March 31, 2019. Aberdeen is owned 40% by Sharng Holdings, which is wholly-owned by the Company’s president, Chris T. Sharng, and his wife, 40% by Mr. Broady, and 20% by an unrelated third party.  Aberdeen promptly paid the Company for the product and shipping cost incurred. Given the Company’s provision of such product sourcing service to Aberdeen, Aberdeen also paid the Company a market-based fee consistent with the provision of such service of $420. The Company analyzed the nature of the transaction with Aberdeen to determine whether it could be construed a violation under the guidelines of Section 402 of the Sarbanes-Oxley Act of 2002. The Company, through advice from its legal counsel, concluded that there is not a reasonable possibility that the transaction with Aberdeen would be deemed a violation of Section 402. This relationship between the Company and Aberdeen ceased following the completion of this transaction.

 

On May 17, 2019, the Company entered into a Stock Repurchase Agreement with The George K. Broady 2012 Irrevocable Trust (“Broady Trust”). Mr. Broady is the trustee and a beneficiary of the Broady Trust. The Stock Repurchase Agreement, which the Company and the Broady Trust entered into in accordance with Rule 10b5-1 under the Securities Exchange Act of 1934, provided for the Company’s purchase of common stock from the Broady Trust in off-the-market, private transactions at a rate of 0.4105 times the number of shares purchased by the Company’s broker in conjunction with the stock repurchase program authorized by the Company’s Board of Directors on May 16, 2019. The Company’s purchases from the Broady Trust concluded on May 31, 2019, were completed at a per share purchase price equal to the weighted average price per share paid by the Company’s broker in its open-market purchases, and resulted in the purchase of 178,324 shares of common stock for an aggregate purchase price of $1.9 million. See Note 8.

 

 

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10.    SEGMENT INFORMATION

 

The Company sells products to a member network that operates in a seamless manner from market to market, except for the China market where it sells to some consumers through an e-commerce platform, and the Russia and Kazakhstan market where the Company’s engagement of a third-party service provider results in a different economic structure than its other markets. Otherwise, the Company believes that all of its other operating segments have similar economic characteristics and are similar in the nature of the products sold, the product acquisition process, the types of customers products are sold to, the methods used to distribute the products, and the nature of the regulatory environment. Therefore, the Company aggregates its other operating segments (including its Hong Kong operating segment) into a single reporting segment (the “Primary Reporting Segment”).

 

The Company reviews its net sales and operating income (loss) by operating segment, and reviews its assets and capital expenditures on a consolidated basis and not by operating segment. As such, net sales and operating income (loss) are presented by reportable segment and assets and capital expenditures by operating segment are not presented. Segment operating income (loss) is adjusted for certain direct costs and commission allocation.

 

The Company’s operating information by geographic area are as follows (in thousands):

 

   

Three Months Ended June 30,

   

Six Months Ended June 30,

 
   

2020

   

2019

   

2020

   

2019

 

Net sales:

                               

Primary Reporting Segment

  $ 15,416     $ 22,671     $ 29,424     $ 40,725  
China     818       557       1,516       1,613  

Russia and Kazakhstan

    170       200       412       418  

Total net sales

  $ 16,404     $ 23,428     $ 31,352     $ 42,756  
                                 

Income (loss) from operations:

                               

Primary Reporting Segment

  $ 2,008     $ 3,710     $ 3,323     $ 4,532  

China

    13       (424 )     (70 )     (735 )

Russia and Kazakhstan

    104       (31 )     22       (56 )

Total income from operations for reportable segments

    2,125       3,255       3,275       3,741  

Unallocated corporate expenses

    (1,942 )     (3,259 )     (4,540 )     (6,454 )

Other income, net

    125       373       218       805  

Income (loss) before income taxes

  $ 308     $ 369     $ (1,047 )   $ (1,908 )

 

The Company’s net sales by geographic area are as follows (in thousands):

 

   

Three Months Ended June 30,

   

Six Months Ended June 30,

 
   

2020

   

2019

   

2020

   

2019

 

Net sales from external customers:

                               

United States

  $ 372     $ 514     $ 863     $ 1,055  

Canada

    143       210       404       496  

Peru

    238       669       598       1,357  

Hong Kong1

    13,693       19,524       25,106       34,890  

China

    818       557       1,516       1,613  
Taiwan     550       1,057       1,490       1,691  

South Korea

    41       84       168       190  

Russia and Kazakhstan

    170       200       412       418  

Europe

    255       331       488       674  

Other foreign countries

    124       282       307       372  

Total net sales

  $ 16,404     $ 23,428     $ 31,352     $ 42,756  

 


1 Substantially all of our Hong Kong revenues are derived from the sale of products that are delivered to members in China. See “Item 1A. Risk Factors” in this report and in our most recent Annual Report on Form 10-K.

 

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11. SUBSEQUENT EVENTS

 

Effective July 1, 2020, the Company modified the terms of one of its Hong Kong office leases.  See Note 5.

 

On August 3, 2020, the Board of Directors declared a quarterly cash dividend of $0.20 on each share of common stock outstanding. The dividend will be payable on August 28, 2020 to stockholders of record on August 18, 2020. The declaration and payment of any future dividends on shares of common stock will be at the sole discretion of the Company’s Board of Directors.

 

15

 
 

 

Item 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

Business Overview

 

We are an international direct-selling and e-commerce company. Subsidiaries controlled by us sell personal care, wellness, and “quality of life” products under the “NHT Global” brand. Our wholly-owned subsidiaries have an active physical presence in the following markets: the Americas, which consists of the United States, Canada, Cayman Islands, Mexico and Peru; Greater China, which consists of Hong Kong, Taiwan and China; Southeast Asia, which consists of Singapore, Malaysia, Thailand and Vietnam; South Korea; Japan; India; and Europe. We also operate in Russia and Kazakhstan through our engagement with a local service provider.

 

As of June 30, 2020, we were conducting business through 54,370 active members, compared to 56,490 three months ago and 78,280 a year ago. We consider a member “active” if they have placed at least one product order with us during the preceding year. Our priority is to focus our resources in our most promising markets, which we consider to be Greater China and countries where our existing members have the connections to recruit prospects and sell our products, such as Southeast Asia, India, South America and Europe.

 

We generate approximately 95% of our net sales from subsidiaries located outside the Americas, with sales of our Hong Kong subsidiary representing 84% of net sales in the latest fiscal quarter. Because of the size of our foreign operations, operating results can be impacted negatively or positively by factors such as foreign currency fluctuations, and economic, political and business conditions around the world. In addition, our business is subject to various laws and regulations, in particular, regulations related to direct selling activities that create uncertain risks for our business, including improper claims or activities by our members and potential inability to obtain necessary product registrations. We have identified certain matters of potential noncompliance and are working on a continuing basis to satisfactorily address such matters. For further information regarding some of the risks associated with the conduct of our business in China and Hong Kong, see generally in “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2019, and more specifically under the captions “Because our Hong Kong operations account for a substantial portion of our overall business...”, “Our Hong Kong operations are being adversely affected by recent political and social developments in Hong Kong...”, and “Our operations in China are subject to compliance with a myriad of applicable laws and regulations...”.

 

China has been and continues to be our most important business development project. We operate an e-commerce direct selling model in Hong Kong that generates revenue derived from the sale of products to members in Hong Kong and elsewhere, including China. Substantially all of our Hong Kong revenues are derived from the sale of products that are delivered to members in China. Through a separate Chinese entity, we operate an e-commerce retail platform in China. We believe that neither of these activities require a direct selling license in China, which we do not currently hold. We previously submitted a preliminary application for a direct selling license in China in August 2015, but in 2019 a Chinese governmental authority recommended that we withdraw our application. We understand that the governmental authorities recommended that other companies with pending direct selling license applications also withdraw their applications. We applied to withdraw our application in November 2019, and the governmental authorities approved the withdrawal of our application shortly thereafter. In connection with the withdrawal of our application, we received a refund in March 2020 of a consumer protection fund deposit of CNY 20 million ($2.9 million) that we made upon the submission of our application. We expect to reapply for a direct selling license in China when we believe that circumstances are again ripe for doing so. If we are ultimately able to obtain a direct selling license in China, we believe that the incentives inherent in the direct selling model in China would incrementally benefit our existing business. We do not expect that any increased sales in China derived from obtaining a direct selling license would initially be material and, in any event may be partially offset by the higher fixed costs associated with the establishment and maintenance of required service centers, branch offices, manufacturing facilities, certification programs and other legal requirements. We are unable to predict whether and when we will be successful in obtaining a direct selling license to operate in China, and if we are successful, when we will be permitted to conduct direct selling operations and whether such operations would be profitable.

 

16

 

On January 8, 2019, the Chinese government announced a 100-day campaign focused on companies involved in the sale of food, equipment, daily necessities, small home electrical appliances and services that are claimed to promote health. The Chinese government ministries in charge of this campaign indicated that they are targeting illegal practices in the industry, particularly the manufacture and sale of counterfeit and substandard products, and false advertising and misleading claims as to the health benefits of products and services. It is understood that the campaign is specifically focused on the business practices of direct selling companies. During the campaign, we understand that the government is not issuing any additional direct selling licenses, is not issuing certifications of quality or other approvals of various healthcare products, is reviewing its regulatory oversight of the industry, and is prohibiting companies from conducting large distributor meetings. Since it was implemented, the campaign and associated negative media coverage have had a significant adverse impact on our business, as consumers have widely curtailed their purchases within the affected industries. We, like some of our peers, voluntarily decided in January 2019 to temporarily suspend our member activities, such as product roadshows, product trainings and larger company-sponsored events, in China. We did this because we have learned that the 100-day campaign was announced in broad outlines by the central government, and the interpretation and enforcement of the campaign was delegated to the provincial and local governments. We consider it a top priority for our business to develop an understanding of and cooperate with all levels and jurisdictions of the government agencies, and did not want to run the risk of being inadvertently entangled in government enforcement actions as the provincial and local governments formulate and implement their interpretive guidance and rule-making. Although the 100-day campaign was due to expire on or about April 18, 2019, we are not aware of any information indicating that the campaign has formally concluded. However, on August 27, 2019, the Chinese government announced that it would conduct a “look-back review” to evaluate the 100-day campaign. As part of this review, we understand that various Chinese governmental agencies formed a working group to assess the 100-day campaign, particularly focusing on the health market and its supervision in certain provinces. We understand that during September 2019 the working group evaluated the performance and results of a number of organizations and governmental departments in these provinces and made recommendations for various improvements. It was noted that each province had opened a number of investigative cases, had successfully closed numerous cases, and had imposed various fines and penalties. We understand that the look-back review continued after September 2019, and we are not aware that this review has been completed. As a result, the business environment for health product companies operating in China continues to be challenging, which has recently been exacerbated by negative social media sentiment expressed for these types of companies. Our suspension of member activities currently remains in effect, and it may be necessary or advisable to repeat this or similar actions from time to time in the future. We believe that the campaign, as well as its extension and aftermath (including the look-back review), will continue to negatively impact our business in China in the near-term, but will ultimately benefit us and Chinese consumers in the long-term as purveyors of substandard products are driven from the market.

 

In late 2019 or early 2020 an outbreak of the coronavirus (COVID-19) was first identified in Wuhan, China. The coronavirus has since spread within China and in many countries around the world, and on March 11, 2020 the World Health Organization declared the coronavirus outbreak a global pandemic. The outbreak caused the Chinese government to implement powerful measures to control the virus, such as requiring businesses to close throughout various areas of China and restricting public gatherings and certain travel within the country. We conduct significant business in or near Wuhan and in 2019 generated approximately 81% of our revenue in Hong Kong, substantially all of which was derived from the sale of products to members in China. The Chinese government has recently taken steps to reduce some of the restrictive measures that it imposed to control the coronavirus, while the governments of other countries in which we operate are working at various stages in their efforts to control the virus. The scope and impact of the pandemic and related control measures are uncertain, but we are taking steps to adapt some of our marketing programs, such as relying on certain product promotions and webcast training, to overcome the physical restrictions imposed in response to the outbreak. We also determined to cancel both of our major member events planned for 2020, as protecting the health and safety of our members, employees, and customers remains paramount. The severity of the impact on us of the pandemic will depend on future developments, including the duration and spread of the virus, and related control measures, which we are unable to accurately predict. Regardless, these disruptions have materially negatively impacted our financial results for the first two fiscal quarters of 2020, and we expect that our financial results for the remaining fiscal quarters of 2020 may be adversely affected. These disruptions have also adversely affected the operations of some of our third party logistics providers, and we expect that the future operations of these logistics providers and other third parties with whom we work may be adversely affected by these disruptions. We will continue to assess the operational and financial impact of the coronavirus pandemic for the remainder of the year. See “Item 1A. Risk Factors - Epidemics, such as the 2020 coronavirus outbreak, or natural disasters, terrorists attacks or acts of war…” in our most recent Annual Report on Form 10-K.

 

Recent political and social developments in Hong Kong are also adversely affecting our Hong Kong operations. Hong Kong has historically served as a key location for meetings and events for our members, but these developments recently led us to curtail the number and scope of such meetings and events. These recent developments in Hong Kong, along with our currently effective suspension of member activities in China, are negatively impacting our business.

 

17

 

To date, the recently enacted tariffs and the trade disputes between the United States and China have not materially impacted our business, although they may have negatively impacted the value of the Chinese yuan, which has in turn negatively affected our Hong Kong revenues because the prices at which our Chinese members can purchase our products have effectively increased. In the event that political and trade tensions involving the United States, China and Hong Kong continue or intensify, our business could be negatively impacted in the future. For more information, see “Item 1A. Risk Factors - The China legislature's recent passage of a national security law in Hong Kong...” in this Quarterly Report on Form 10-Q, and “Item 1A. Risk Factors - Recently enacted tariffs, other potential changes to tariff and import/export regulations, and ongoing trade disputes between the United States and other jurisdictions, particularly China…” in our most recent Annual Report on Form 10-K.

 

Our Hong Kong net sales (substantially all of which were derived from products shipped to members residing in China) for the first six months of 2020 were substantially lower than the comparable period in 2019, and it’s likely that we will experience continued lower net sales on a year-over-year basis for the foreseeable future. The substantial decline in net sales during the first six months of 2020 resulted in a net loss for the six-month period ended June 30, 2020, as well as negative cash flows and a decreasing cash balance. We anticipate that our financial performance will be adversely impacted for the foreseeable future.

 

 

Statement of Operations Presentation

 

We mainly derive revenue from sales of products. Substantially all of our product sales are to independent members at published wholesale prices. Product sales are recognized when the products are shipped and title passes to independent members, which generally is upon our delivery to the carrier that completes delivery to the members. We estimate and accrue a reserve for product returns based on our return policies and historical experience. We bill members for shipping charges and recognize the freight revenue in net sales. We have elected to account for shipping and handling activities performed after title has passed to members as a fulfillment cost, and accrue for the costs of shipping and handling if revenue is recognized before the contractually obligated shipping and handling activities occurs. Event and training revenue is deferred and recognized as the event or training occurs.

 

Cost of sales consists primarily of products purchased from third-party manufacturers, freight cost for transporting products to our foreign subsidiaries and shipping products to members, import duties, packing materials, product royalties, costs of promotional materials sold to our members at or near cost, and provisions for slow moving or obsolete inventories. Cost of sales also includes purchasing costs, receiving costs, inspection costs and warehousing costs.

 

Member commissions are our most significant expense and are classified as an operating expense. Under our compensation plan, members are paid weekly commissions by our subsidiary in which they are enrolled, generally in their home country currency, for product purchases by their down-line member network across all geographic markets. Our China subsidiary maintains an e-commerce retail platform and does not pay commissions, although our Chinese members may participate in our compensation plan through our other subsidiaries. This “seamless” compensation plan enables a member located in one country to enroll other members located in other countries where we are authorized to conduct our business. Currently, there are basically two ways in which our members can earn income:

 

 

through commissions paid on the accumulated bonus volume from product purchases made by their down-line members and customers; and

 

 

through retail profits on sales of products purchased by members at wholesale prices and resold at retail prices (for purchasers in some of our smaller markets and purchasers from our China subsidiary, sales are for personal consumption only and income may not be earned through retail profits).

 

Each of our products is designated a specified number of bonus volume points. Commissions are based on total personal and group bonus volume points per weekly sales period. Bonus volume points are essentially a percentage of a product’s wholesale price. As the member’s business expands from successfully enrolling other members who in turn expand their own businesses by selling product to other members, the member receives higher commissions from purchases made by an expanding down-line network. In some of our markets, to be eligible to receive commissions, a member may be required to make nominal monthly or other periodic purchases of our products. Certain of our subsidiaries do not require these nominal purchases for a member to be eligible to receive commissions. In determining commissions, the number of levels of down-line members included within the member’s commissionable group increases as the number of memberships directly below the member increases.

 

18

 

Under our current compensation plan, certain of our commission payouts may be limited to a hard cap dollar amount per week or a specific percentage of total product sales. In some markets, commissions may be further limited. In some markets, we also pay certain bonuses on purchases by up to three generations of personally sponsored members, as well as bonuses on commissions earned by up to seven generations of personally sponsored members. Members can also earn additional income, trips and other prizes in specific time-limited promotions and contests we hold from time to time. Member commissions are dependent on the sales mix and, for the first six months of 2020 and 2019, represented 44% and 49%, respectively, of net sales. Occasionally, we make modifications and enhancements to our compensation plan to help motivate members, which can have an impact on member commissions. We may also enter into performance-based agreements for business or market development, which can result in additional compensation to specific members.

 

Selling, general and administrative expenses consist of administrative compensation and benefits, travel, credit card fees and assessments, professional fees, certain occupancy costs, and other corporate administrative expenses (including stock-based compensation). In addition, this category includes selling, marketing, and promotion expenses (including the costs of member training events and conventions that are designed to increase both product awareness and member recruitment). Because our various member conventions are not always held at the same time each year, interim period comparisons will be impacted accordingly.

 

The functional currency of our international subsidiaries is generally their local currency. Local currency assets and liabilities are translated at the rates of exchange on the balance sheet date, and local currency revenues and expenses are translated at average rates of exchange during the period. Equity accounts are translated at historical rates. The resulting translation adjustments are recorded directly into stockholders’ equity.

 

Sales by our foreign subsidiaries are generally transacted in the respective local currencies and are translated into U.S. dollars using average rates of exchange for each monthly accounting period to which they relate. Most of our product purchases from third-party manufacturers are transacted in U.S. dollars. Consequently, our sales and net earnings are affected by changes in currency exchange rates, with sales and earnings generally increasing with a weakening U.S. dollar and decreasing with a strengthening U.S. dollar.

 

 

Results of Operations 

 

The following table sets forth our operating results as a percentage of net sales for the periods indicated.

 

   

Three Months Ended June 30,

   

Six Months Ended June 30,

 
   

2020

   

2019

   

2020

   

2019

 

Net sales

    100.0 %     100.0 %     100.0 %     100.0 %

Cost of sales

    29.4       23.1       29.8       24.9  

Gross profit

    70.6       76.9       70.2       75.1  

Operating expenses:

                               

Commissions expense

    43.4       48.7       43.7       48.9  

Selling, general and administrative expenses

    26.1       28.3       30.5       32.6  

Total operating expenses

    69.5       77.0       74.2       81.5  

Income (loss) from operations

    1.1       (0.1 )     (4.0 )     (6.4 )