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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 September 30, 2022

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 October 28, 2022, 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

September 30, 2022

 

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:

 

 

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;

 

Epidemics, such as the COVID-19 pandemic, or natural disasters, terrorist attacks or acts of war may seriously harm our 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;

  We experienced negative operating cash flows during the year ended December 31, 2019, and only modest positive operating cash flows during the years ended December 31, 2021 and 2020. Unless our operating cash flows improve, this negative financial performance could have a material adverse effect on our business and our stock price;
  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;
 

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

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

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

 

Growth may be impeded by the political and economic risks of entering and operating in foreign markets;
  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 common stock;
  We could be adversely affected by management changes or an inability to attract and retain key management, directors and consultants;
  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;
  Although virtually all of our members are independent contractors, improper member actions that violate laws or regulations could harm our business;
  An increase in the amount of compensation paid to members would reduce profitability;
 

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;
  Our business in China is 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;
  Changes in government trade and economic policies, including the imposition or threatened imposition of tariffs and other restrictive trade policies, and ongoing political and economic 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;
 

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;

  Our business is subject to a variety of laws, regulations and other obligations regarding privacy, data protection and information security. Any actual or perceived failure by us or our third-party vendors to comply with such laws, regulations or other obligations could materially adversely affect our business;
 

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

 

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

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;

 

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;
 

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

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

 

 

 

 

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

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, or the failure to comply with related laws and regulations, 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;
 

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

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.

 

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) 

 

  

September 30, 2022

  

December 31, 2021

 
  

(Unaudited)

     

ASSETS

        

Current assets:

        

Cash and cash equivalents

 $70,663  $83,843 

Inventories

  4,989   5,257 

Other current assets

  3,360   4,369 

Total current assets

  79,012   93,469 

Property and equipment, net

  425   463 

Operating lease right-of-use assets

  4,243   3,021 

Restricted cash

  69   522 

Deferred tax asset

  293   309 

Other assets

  553   571 

Total assets

 $84,595  $98,355 

LIABILITIES AND STOCKHOLDERS’ EQUITY

        

Current liabilities:

        

Accounts payable

 $983  $761 

Income taxes payable

  2,995   1,345 

Accrued commissions

  2,524   3,636 

Other accrued expenses

  1,321   1,933 

Deferred revenue

  5,254   8,536 

Amounts held in eWallets

  5,151   6,341 

Operating lease liabilities

  1,165   1,239 

Other current liabilities

  846   865 

Total current liabilities

  20,239   24,656 

Income taxes payable

  9,098   12,130 

Deferred tax liability

  152   153 

Operating lease liabilities

  3,197   1,928 

Total liabilities

  32,686   38,867 

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 September 30, 2022 and December 31, 2021

  13   13 

Additional paid-in capital

  86,102   86,102 

Accumulated deficit

  (6,961)  (231)

Accumulated other comprehensive loss

  (1,341)  (492)

Treasury stock, at cost; 1,556,875 shares at September 30, 2022 and December 31, 2021

  (25,904)  (25,904)

Total stockholders’ equity

  51,909   59,488 

Total liabilities and stockholders’ equity

 $84,595  $98,355 

 

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 September 30,

  

Nine Months Ended September 30,

 
  

2022

  

2021

  

2022

  

2021

 

Net sales

 $11,716  $14,276  $36,622  $43,897 

Cost of sales

  3,098   3,668   9,398   10,857 

Gross profit

  8,618   10,608   27,224   33,040 

Operating expenses:

                

Commissions expense

  4,863   6,027   15,370   18,468 

Selling, general and administrative expenses

  3,900   4,102   12,167   13,488 

Total operating expenses

  8,763   10,129   27,537   31,956 

Income (loss) from operations

  (145)  479   (313)  1,084 

Other income (expense), net

  187   (53)  472   (92)

Income before income taxes

  42   426   159   992 

Income tax provision (benefit)

  (5)  (45)  34   139 

Net income

 $47  $471  $125  $853 

Net income per common share:

                

Basic

 $0.00  $0.04  $0.01  $0.08 

Diluted

 $0.00  $0.04  $0.01  $0.07 

Weighted average common shares outstanding:

                

Basic

  11,423   11,063   11,341   10,969 

Diluted

  11,423   11,423   11,423   11,423 

 

See accompanying notes to consolidated financial statements.

 

2

 

 

NATURAL HEALTH TRENDS CORP.

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS) (UNAUDITED)

(In Thousands)

 

  

Three Months Ended September 30,

  

Nine Months Ended September 30,

 
  

2022

  

2021

  

2022

  

2021

 

Net income

 $47  $471  $125  $853 

Other comprehensive income (loss), net of tax:

                

Foreign currency translation adjustment

  (367)  (72)  (828)  (158)

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

  (34)  9   (21)  18 

Comprehensive income (loss)

 $(354) $408  $(724) $713 

 

See accompanying notes to consolidated financial statements.

 

3

 

 

NATURAL HEALTH TRENDS CORP.

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY (UNAUDITED)

(In Thousands, Except Share Data)

 

Nine months ended September 30, 2022

 

                          

Accumulated

             
                  

Additional

      

Other

             
  

Preferred Stock

  

Common Stock

  

Paid-In

  

Accumulated

  

Comprehensive

  

Treasury Stock

     
  

Shares

  

Amount

  

Shares

  

Amount

  

Capital

  

Deficit

  

Loss

  

Shares

  

Amount

  

Total

 
                                         

BALANCE, December 31, 2021

    $   12,979,414  $13  $86,102  $(231) $(492)  (1,556,875) $(25,904) $59,488 

Net loss

                 (105)           (105)

Dividends declared, $0.20/share

                 (2,285)           (2,285)

Foreign currency translation adjustments

                    (205)        (205)

Unrealized losses on available-for-sale securities

                    (23)        (23)

BALANCE, March 31, 2022

        12,979,414   13   86,102   (2,621)  (720)  (1,556,875)  (25,904)  56,870 

Net income

                 183            183 

Dividends declared, $0.20/share

                 (2,285)           (2,285)

Foreign currency translation adjustments

                    (256)        (256)

Unrealized gains on available-for-sale securities

                    36         36 

BALANCE, June 30, 2022

        12,979,414   13   86,102   (4,723)  (940)  (1,556,875)  (25,904)  54,548 

Net income

                 47            47 

Dividends declared, $0.20/share

                 (2,285)           (2,285)

Foreign currency translation adjustments

                    (367)        (367)

Unrealized losses on available-for-sale securities

                    (34)        (34)

BALANCE, September 30, 2022

    $   12,979,414  $13  $86,102  $(6,961) $(1,341)  (1,556,875) $(25,904) $51,909 

 

 

Nine months ended September 30, 2021

 

                          

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, 2020

    $   12,979,414  $13  $86,102  $7,822  $(336)  (1,556,875) $(25,904) $67,697 

Net income

                 153            153 

Dividends declared, $0.20/share

                 (2,285)           (2,285)

Foreign currency translation adjustments

                    (182)        (182)

Unrealized losses on available-for-sale securities

                    (7)        (7)

BALANCE, March 31, 2021

        12,979,414   13   86,102   5,690   (525)  (1,556,875)  (25,904)  65,376 

Net income

                 229            229 

Dividends declared, $0.20/share

                 (2,285)            (2,285)

Foreign currency translation adjustments

                    96         96 

Unrealized gains on available-for-sale securities

                    16         16 

BALANCE, June 30, 2021

        12,979,414   13   86,102   3,634   (413)  (1,556,875)  (25,904)  63,432 

Net income

                 471            471 

Dividends declared, $0.20/share

                 (2,285)            (2,285)

Foreign currency translation adjustments

                    (72)        (72)

Unrealized gains on available-for-sale securities

                    9         9 

BALANCE, September 30, 2021

    $   12,979,414  $13  $86,102  $1,820  $(476)  (1,556,875) $(25,904) $61,555 

 

See accompanying notes to consolidated financial statements.

 

4

 

 

NATURAL HEALTH TRENDS CORP.

CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

(In Thousands)

 

  

Nine Months Ended September 30,

 
  

2022

  

2021

 

CASH FLOWS FROM OPERATING ACTIVITIES:

        

Net income

 $125  $853 

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

        

Depreciation and amortization

  156   237 

Noncash lease expense

  889   895 

Deferred income taxes

  (2)  66 

Changes in assets and liabilities:

        

Inventories

  140   (675)

Other current assets

  1,000   (823)

Other assets

  (44)  65 

Accounts payable

  228   300 

Income taxes payable

  (1,382)  (1,253)

Accrued commissions

  (1,055)  29 

Other accrued expenses

  (540)  (157)

Deferred revenue

  (3,209)  2,973 

Amounts held in eWallets

  (1,150)  (1,716)

Operating lease liabilities

  (950)  (935)

Other current liabilities

  4   (416)

Net cash used in operating activities

  (5,790)  (557)

CASH FLOWS FROM INVESTING ACTIVITIES:

        

Purchases of property and equipment

  (130)  (165)

Net cash used in investing activities

  (130)  (165)

CASH FLOWS FROM FINANCING ACTIVITIES:

        

Dividends paid

  (6,855)  (6,855)

Net cash used in financing activities

  (6,855)  (6,855)

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

  (858)  (151)

Net decrease in cash, cash equivalents and restricted cash

  (13,633)  (7,728)

CASH, CASH EQUIVALENTS AND RESTRICTED CASH, beginning of period

  84,365   92,892 

CASH, CASH EQUIVALENTS AND RESTRICTED CASH, end of period

 $70,732  $85,164 

SUPPLEMENTAL DISCLOSURES OF OTHER CASH FLOW INFORMATION:

        

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

 $2,218  $516 

 

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 Malaysia, Singapore and Thailand; 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 2021 Annual Report on Form 10-K filed with the United States Securities and Exchange Commission (SEC) on February 25, 2022.

 

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.

 

Net Income Per Common Share

 

Diluted net income 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 table illustrates the computation of basic and diluted net income per common share for the periods indicated (in thousands, except per share data):

 

  

Three Months Ended September 30,

 
  

2022

  

2021

 
  

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

 $47   11,423  $0.00  $471   11,063  $0.04 

Effect of dilutive securities:

                        

Non-vested restricted stock

               360     

Diluted net income per common share:

                        

Net income available to common stockholders plus assumed conversions

 $47   11,423  $0.00  $471   11,423  $0.04 

 

  

Nine Months Ended September 30,

 
  

2022

  

2021

 
  

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

 $125   11,341  $0.01  $853   10,969  $0.08 

Effect of dilutive securities:

                        

Non-vested restricted stock

     82          454     

Diluted net income per common share:

                        

Net income available to common stockholders plus assumed conversions

 $125   11,423  $0.01  $853   11,423  $0.07 

 

 

6

 

Recent Accounting Pronouncements

 

In June 2016, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“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 Accounting Standards Codification (“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.

 

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, including any product vouchers sold on a stand-alone basis in Hong Kong, 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 5% of sales.  Sales returns were 1% of sales for each of the nine months ended September 30, 2022 and 2021No 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 orders and unredeemed product vouchers are considered a contract liability and are recorded as deferred revenue. The decrease in deferred revenue from December 31, 2021 to September 30, 2022 is primarily due to $6.5 million of revenue recognized during the nine months ended September 30, 2022 that was included in deferred revenue as of December 31, 2021 offset by $3.4 million of cash received for unshipped product orders and unredeemed vouchers during the nine months ended September 30, 2022. 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 11 for revenue by market information.

 

7

 

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

 

  

Three Months Ended September 30,

  

Nine Months Ended September 30,

 
  

2022

  

2021

  

2022

  

2021

 

Product sales

 $10,534  $12,809  $32,889  $39,405 

Administrative fees, freight and other

  1,235   1,524   3,865   4,777 

Less: sales returns

  (53)  (57)  (132)  (285)

Total net sales

 $11,716  $14,276  $36,622  $43,897 

 

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 nine months ended September 30, 2022 and 2021. 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):

 

  

September 30, 2022

  

December 31, 2021

 

Cash, cash equivalents and restricted cash:

        

Cash

 $12,080  $17,281 

Cash equivalents

  58,583   66,562 
   70,663   83,843 

Restricted cash

  69   522 
  $70,732  $84,365 

Inventories:

        

Finished goods

 $4,304  $4,476 

Raw materials

  769   873 

Reserve for obsolescence

  (84)  (92)
  $4,989  $5,257 

Other accrued expenses:

        

Sales returns

 $89  $137 

Employee-related expense

  728   988 

Warehousing, inventory-related and other

  504   808 
  $1,321  $1,933 

Deferred revenue:

        

Unshipped product and unredeemed product vouchers

 $3,400  $6,525 

Auto ship advances

  1,771   1,901 

Other

  83   110 
  $5,254  $8,536 

 

 

4. FAIR VALUE MEASUREMENTS

 

As of September 30, 2022, cash and cash equivalents include the Company’s investments in money market funds, government and municipal debt securities, and corporate debt securities. 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 ASC 320, Investments - Debt and Equity Securities. As such, the Company determined its investments in debt securities held at September 30, 2022 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 (expense). Realized gains and losses, as well as interest income, are also included in other income (expense). 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):

 

   

September 30, 2022

  

December 31, 2021

 
 

Fair Value Level1

 

Adjusted Cost

  

Gross Unrealized Losses

  

Fair Value

  

Adjusted Cost

  

Gross Unrealized Losses

  

Fair Value

 

Money market funds

Level 1

 $10,956  $  $10,956  $20,711  $  $20,711 

Government and municipal debt securities

Level 2

  10,658   (2)  10,656   14,006   (2)  14,004 

Corporate debt securities

Level 2

  37,008   (37)  36,971   31,863   (16)  31,847 

Total investments

 $58,622  $(39) $58,583  $66,580  $(18) $66,562 

 


 

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 7,300 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.  In September 2022, the Company renewed its Hong Kong office lease resulting in a lease extension through June 2026.  To help further develop the market for its products in North America, the Company leases 1,600 square feet of retail space in each of Rowland Heights, California and Richmond, British Columbia and 2,000 square feet of retail space in Metuchen, New Jersey. The Rowland Heights, Richmond and Metuchen locations have terms expiring in November 2025, February 2024 and December 2028, respectively.

 

The Company leases seven branch offices throughout China, and additional office space in Peru, Japan, Taiwan, South Korea, Malaysia, Singapore, Thailand, India and the Cayman Islands. The Company also leases a 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 were as follows (in thousands):

 

  

Three Months Ended September 30,

  

Nine Months Ended September 30,

 
  

2022

  

2021

  

2022

  

2021

 

Operating leases

 $292  $338  $954  $996 

Short-term leases

  36   44   124   133 

Total lease cost

 $328  $382  $1,078  $1,129 

 

Cash paid for amounts included in the measurement of operating leases liabilities was $309,000 and $327,000 for the three months ended  September 30, 2022 and 2021, respectively, and $946,000 and $1.0 million for the nine months ended  September 30, 2022 and 2021, respectively.

 

The weighted-average remaining lease term and discount rate related to operating leases as of September 30, 2022 were as follows:

 

Weighted-average remaining lease term (in years)

  5.2 

Weighted-average discount rate

  4.1%

 

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 September 30, 2022 were as follows (in thousands):

 

Remainder of 2022

 $344 

2023

  1,104 

2024

  941 

2025

  913 

2026

  574 

Thereafter

  978 

Total lease payments

  4,854 

Less: imputed interest

  (492)

Present value of lease liabilities

 $4,362 

 

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 nine months ended September 30, 2022 includes an estimate for the Global Intangible Low-Taxed Income (“GILTI”) inclusion. As of September 30, 2022, 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 September 30, 2022, 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 September 30, 2022, the Company no longer has U.S. federal net operating losses due to its filing in December 2021 to carry back $603,000 of losses generated in the tax year ended December 31, 2020 to offset taxable income from the tax year ended December 31, 2016. The Company has post-apportioned U.S. state net operating loss carryforwards of $427,000 that begin expiring in 2039. At September 30, 2022, the Company has foreign net operating loss carryforwards of approximately $1.9 million in various jurisdictions with various expirations.

 

As of September 30, 2022, income taxes payable for the repatriation tax on the deemed repatriation of deferred foreign income required by the U.S. Tax Cuts and Jobs Act (the “Tax Act”), enacted on December 22, 2017 by the U.S. government, totaled $12.1 million, of which $9.1 million is reflected as a noncurrent liability.

 

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 September 30, 2022, 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 September 30, 2022 have already been repatriated. Due to the Tax Act, 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 September 30, 2022.

 

11

 

The Company and its subsidiaries file tax returns in the United States, California, New Jersey, 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 “IRS”). The audit was subsequently expanded to also include the 2017, 2018 and 2019 tax years. On October 12, 2021, the Company received notification from the IRS that it had completed the audit process for all tax years with no changes made to the Company's previously reported tax. The Company is no longer subject to state income tax examinations for years prior to 2017. The Company is not aware of any other jurisdictions that are currently examining any income tax returns of the Company.

 

 

7. COMMITMENTS AND CONTINGENCIES

 

The Company has employment agreements with certain members of its management team that can be terminated by either the employee or the Company upon four weeks’ notice.  The employment agreements entered into with the management team contain provisions that guarantee the payment of specified amounts in the event of a change in control (together with a termination without cause), as defined, or if the employee is otherwise terminated without cause, as defined, or terminates employment for good reason, as defined.

 

 

8. STOCK-BASED INCENTIVE PLANS

 

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 September 30, 2022, 1,219,583 shares remained available for issuance under the 2016 Plan.

 

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, 2021

  186,245  $7.08 

Vested

  (186,245) $7.08 

Nonvested at September 30, 2022

    $ 

 

Phantom Equity

 

On March 15, 2021, the Company’s Board of Directors approved and adopted a Phantom Equity Plan (the “Phantom Plan”). Under the terms of the Phantom Plan, the Compensation Committee may grant to the Company’s employees, officers, directors, contractors, consultants, or advisors awards of phantom shares entitling grantees the right to receive a cash payment equal to the fair market value of an equal number of shares of the Company’s common stock upon the close of a vesting period, subject to any maximum payment value that the Compensation Committee may set. The vesting of phantom shares is subject to such vesting conditions as the Compensation Committee may specify in a grantee’s award agreement. Grantees of phantom shares shall not by virtue of their receipt of phantom shares have any ownership rights in shares of the Company’s common stock. The Phantom Plan shall continue for a period of ten years, after which no further phantom shares may be awarded (although any phantom shares awarded prior to the expiration of such 10-year period shall be unaffected by the termination of the Phantom Plan).

 

Also on March 15, 2021, awards for 223,307 phantom shares were granted to the Company’s employees and its non-employee directors.  The phantom shares vest in eight equal three-month vesting increments, subject to the satisfaction of both a time-based vesting condition and a performance vesting condition. These vesting conditions were deemed satisfied on the grant date for the initial vesting increment. In order for the time-based vesting condition to be satisfied for each vesting period, the grantee must remain continuously employed by, or be otherwise continuously providing services to, the Company through the end of the vesting period, and in order for the performance vesting condition to be satisfied for each vesting period, the performance criteria designated by the Compensation Committee must be satisfied. The initial performance vesting condition to be applied to measure performance for the period between March 15, 2021 and June 15, 2021 was designated by the Compensation Committee on or before April 14, 2021, and will apply to all future performance periods unless the Compensation Committee elects to change the performance vesting condition on a prospective basis. Future changes to the performance vesting condition shall be made on or before the fifteenth day of any future performance period. If either vesting condition is not satisfied for a vesting date, then the phantom shares scheduled to vest on such date will be forfeited. These phantom shares are subject to a maximum payment value of $12.00 per phantom share. An additional award with similar vesting conditions for 9,074 phantom shares was granted on May 14, 2021 to the Company's new non-employee director, while unvested 9,074 phantom shares granted to the Company's departing non-employee director were forfeited on or about the same date. On May 23, 2022 and again on August 31, 2022, the Compensation Committee determined to amend the outstanding awards to provide that the performance criteria shall be deemed satisfied for the three-month performance periods relating to the June 15, 2022 and September 15, 2022 vesting dates, respectively. In making its determination, the Compensation Committee noted that the fact that the performance criteria were not achieved for the relevant performance periods was due to extraordinary business circumstances in China that were clearly beyond the Company’s control.

 

The phantom share awards are accounted for as liabilities in accordance with FASB ASC Topic 718, Compensation Stock Compensation since they require cash settlement. The grant date of each vesting increment will be established when the Company and the grantees reach a mutual understanding of the key terms and conditions of an award, which is the date upon which each performance vesting condition is communicated to the grantees. Compensation expense is recognized over the requisite service period if it is probable that the performance vesting condition will be achieved. The fair value of the liability incurred is remeasured at the end of each reporting period with any changes in fair value recognized as compensation expense over the requisite service period.

 

Awards totaling 27,913 phantom shares vested during each of the three months ended September 30, 2022 and 2021, resulting in compensation expense of $126,000 and $195,000 during the three months ended September 30, 2022 and 2021, respectively, related to their cash settlement. Awards totaling 83,739 phantom shares vested during each of the nine months ended September 30, 2022 and 2021, resulting in compensation expense of $475,000 and $588,000 during the nine months ended September 30, 2022 and 2021, respectively, related to their cash settlement.

 

12

 
 

9. STOCKHOLDERS’ EQUITY

 

Dividends

 

The Company declared and paid cash dividends of $0.20 per common share during each of the first three quarters of 2022 and 2021, totaling $6.9 million in each nine month period. 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. Any repurchases 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. As of September 30, 2022, $21.9 million of the $70.0 million stock repurchase program remained available for future purchases, inclusive of related estimated income tax.

 

Accumulated Other Comprehensive Loss

 

The changes in accumulated other comprehensive loss by component for the first nine months of 2022 were as follows (in thousands):

 

  Foreign Currency Translation Adjustments  Unrealized Losses on Available-For-Sale Investments  

Total

 

Balance, December 31, 2021

 $(474) $(18) $(492)

Other comprehensive loss

  (828)  (21)  (849)

Balance, September 30, 2022

 $(1,302) $(39) $(1,341)

 

 

10. 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 former director of the Company and beneficial owner of more than 5% of its outstanding common stock, is an indirect owner of BHS. Brunde E. Broady, a director of the Company and daughter of Mr. Broady, is the President and Chief Executive Officer 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. The Company recognized royalties of $13,000 and $25,000 during the three months ended September 30, 2022 and 2021, respectively, and $39,000 and $44,000 during the nine months ended  September 30, 2022 and 2021, respectively, under this agreement. The Company is not required to purchase any product under the agreement, and the agreement may be terminated under certain circumstances with no notice. The agreement terminates 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.

 

13

 
 

11. 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 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 September 30,

  

Nine Months Ended September 30,

 
  

2022

  

2021

  

2022

  

2021

 

Net sales:

                

Primary Reporting Segment

 $11,241  $13,576  $34,888  $41,679 

China

  346   501   1,313   1,596 

Russia and Kazakhstan

  129   199   421   622 

Total net sales

 $11,716  $14,276  $36,622  $43,897 
                 

Income (loss) from operations:

                

Primary Reporting Segment

 $1,967  $2,558  $6,124  $7,803 

China

  (71)  5   (86)  51 

Russia and Kazakhstan

  (36)  5   (132)  (101)

Income from operations for reportable segments, net

  1,860   2,568   5,906   7,753 

Unallocated corporate expenses

  (2,005)  (2,089)  (6,219)  (6,669)

Other income (expense), net

  187   (53)  472   (92)

Income before income taxes

 $42  $426  $159  $992 

 

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

 

  

Three Months Ended September 30,

  

Nine Months Ended September 30,

 
  

2022

  

2021

  

2022

  

2021

 

Net sales from external customers:

                

United States

 $332  $279  $860  $918 

Canada

  149   140   450   481 

Peru

  290   608   1,099   1,752 

Hong Kong1

  9,424   11,201   28,916   34,227 

China

  346   501   1,313   1,596 

Taiwan

  482   584   1,675   1,990 

Japan

  157   204   528   540 

Malaysia and Singapore

  96   120   316   326 

Russia and Kazakhstan

  129   199   421   622 

Europe

  188   258   693   869 

Other foreign countries

  123   182   351   576 

Total net sales

 $11,716  $14,276  $36,622  $43,897 

 


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.

 

14

 
 

12. SUBSEQUENT EVENT

 

On October 31, 2022, 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 November 25, 2022 to stockholders of record on November 15, 2022. 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 Malaysia, Singapore and Thailand; South Korea; Japan; India; and Europe. We also operate in Russia and Kazakhstan through our engagement with a local service provider.

 

As of September 30, 2022, we were conducting business through 41,170 active members, compared to 45,760 at December 31, 2021 and 45,950 at September 30, 2021. 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 93% of our net sales from subsidiaries located outside the Americas, with sales of our Hong Kong subsidiary representing 80% 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 our potential inability to obtain necessary product registrations. We continually evaluate our business for compliance with applicable laws and regulations, and this process can and has resulted in the identification of certain matters of potential noncompliance, which we work to satisfactorily address. For further information regarding some of the risks associated with the conduct of our business in China and Hong Kong, see “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2021, and more specifically under the captions “Epidemics, such as the COVID-19 pandemic, or natural disasters, terrorist attacks or acts of war...”, “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 business in China is 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 platform in Hong Kong that generates revenue derived from the sale of products to members in Hong Kong and elsewhere, with substantially all of our Hong Kong revenues derived from the sale of products that are delivered to members in China. Through a separate Chinese entity, we also 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

 

 

In January 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, and is reviewing its regulatory oversight of the industry. 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 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 we have recently been able to relax some restrictions on member activities in certain markets, it may again in the future be necessary or advisable to suspend member activities or take similar actions from time to time, and such periods of reduced activity may have a material adverse effect on our business.

 

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 in China for health product companies continues to be challenging, which has been exacerbated by negative social media sentiment expressed for these types of companies. 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 COVID-19 was first identified in China and subsequently spread around the world. On March 11, 2020 the World Health Organization declared the COVID-19 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 have significant business in China and in 2021 generated approximately 78% of our revenue in Hong Kong, substantially all of which was derived from the sale of products to members in China. The Chinese government continues to adjust the restrictive measures that it imposes to control COVID-19 based on then-current local circumstances, as have the governments of the other countries in which we operate. The scope and impact of the pandemic and related control measures are uncertain, but we have taken 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 pandemic. We have also canceled or rescheduled a number of in-person member events over the course of the pandemic. The ultimate severity of the impact on us of the COVID-19 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.

 

The business disruptions wrought by the COVID-19 pandemic have materially negatively impacted our financial results throughout 2020, 2021, and the first nine months of 2022, and we expect that our financial results for the near-term may be adversely affected. Of particular note, the spread of the Omicron variant in Hong Kong and China, along with the imposition of strong government control measures, significantly disrupted our operations and negatively affected our results of operations in the first nine months of 2022. During the first half of the year, our third-party logistics providers experienced substantial difficulties importing and distributing our products in China. However, by early June 2022 the Chinese government began relaxing some of its more stringent policies and we found that the difficulties encountered by our third-party logistics providers were largely resolved by the end of the month. Further, after four consecutive quarters during which we were unable to sponsor any in-person member events in China, Macau or Hong Kong, we sponsored an in-personevent at the end of the third quarter of 2022 in China and are now contemplating more such events. Additionally, we were able to conduct a series of roadshows throughout September, though the size of the gatherings were limited.Notwithstanding this modestly improved state of affairs, the Chinese government continues to impose strong control measures that are negatively impacting our ability to interact with our members and the ability of our members to interact with each other and their customers. We will continue to assess the financial and operational impact of the COVID-19 pandemic, including its impact on the operations of our third-party providers. See “Item 1A. Risk Factors - Epidemics, such as the COVID-19 pandemic, or natural disasters, terrorist attacks or acts of war…” in our most recent Annual Report on Form 10-K.

 

Recent political and social developments in Hong Kong, along with the impact of the COVID-19 pandemic and related government control measures, are also adversely affecting our Hong Kong operations and led us in 2020 to cease sponsoring member meetings and events in Hong Kong. Inasmuch as member meetings and events located in Hong Kong have in the past served as an important component of our product marketing and distribution efforts, we believe that this action has negatively affected our operations and financial performance. If current conditions continue or further deteriorate, we anticipate that our business, financial condition and results of operations will be adversely affected. See “Item 1A. Risk Factors - Our Hong Kong operations are being adversely affected by recent political and social developments in Hong Kong...” in our most recent Annual Report on Form 10-K.

 

17

 

 

Our Hong Kong net sales (substantially all of which were derived from products shipped to members residing in China) for the first nine months of 2022 were lower than the comparable period in 2021. The decline in net sales during the first nine months of 2022 resulted in a loss from operations for the period, as well as negative cash flows from operations. We anticipate that our financial performance for the near-term will continue to be adversely impacted.

 

 

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 nine months of 2022 and 2021, represented 42% 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 September 30,

   

Nine Months Ended September 30,

 
   

2022

   

2021

   

2022

   

2021

 

Net sales

    100.0 %     100.0 %     100.0 %     100.0 %

Cost of sales

    26.4       25.7       25.7       24.7  

Gross profit

    73.6       74.3       74.3       75.3  

Operating expenses:

                               

Commissions expense

    41.5       42.2       42.0       42.1  

Selling, general and administrative expenses

    33.3       28.7