Item 7. Management’s Discussion and Analysis
Item 7. 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. See Note 13 of the Notes to Consolidated Financial Statements in “Item 8. Financial Statements and Supplementary Data” of this report for further information about our net sales by geographic area.
As of December 31, 2023, we were conducting business through 32,410 active members, compared to 38,660 at the end of 2022. 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. For further information regarding some of the risks associated with our loss of members, see “Item 1A. Risk Factors - Our recent loss of a significant number of members is adversely affecting our business…”.
We generate approximately 92% of our net sales from subsidiaries located outside the Americas, with sales of our Hong Kong subsidiary representing 79% of net sales in the latest fiscal year. Because of the size of our foreign operations, operating results can be impacted negatively or positively by factors such as foreign currency fluctuations, inflation rates, 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,” and more specifically under the captions “Risk Factors - Because our Hong Kong operations account for a substantial portion of our overall business...”, “Risk Factors - Our Hong Kong operations are being adversely affected by recent political and social developments in Hong Kong….”, and “Risk Factors - 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, 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, but in 2019 a Chinese governmental authority recommended that we withdraw 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.
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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 were 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 was specifically focused on the business practices of direct selling companies. The campaign and associated negative media coverage resulted in a significant adverse impact on our business, as consumers 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 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 in April 2019, we are not aware of any information indicating that the campaign has formally concluded. However, the Chinese government subsequently 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 2023 generated approximately 79% of our revenue in Hong Kong, substantially all of which was derived from the sale of products to members in China. The Chinese and Hong Kong governments, like the governments of the other countries in which we operate, continue to adjust the restrictive measures that they impose to control COVID-19 based on then-current local circumstances; however, it should be noted that the Chinese and Hong Kong governments imposed some of the most restrictive COVID-19 control measures of any country in the world.
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 2022. During the first half of the year, our third-party logistics providers also 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. Over the course of the pandemic, we also took 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. Finally, 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-person event at the end of the third quarter of 2022 in China. Notwithstanding this modestly improved state of affairs, through late 2022 the Chinese and Hong Kong governments continued to impose strong control measures that were negatively impacting our ability to interact with our members and the ability of our members to interact with each other and their customers.
In late 2022, the Chinese and Hong Kong governments took comprehensive steps to relax many of their COVID-19 control measures, although the cumulative effect of these disruptions materially negatively impacted our financial results from 2020 through 2022. This less restrictive business environment in China and Hong Kong continued throughout 2023, and we were able to sponsor a number of in-person member events in China during 2023, as well as a large in-person event in Macau during the second quarter of 2023 and a large in-person event in Hong Kong during the fourth quarter of 2023. We are planning more such events and are hopeful that we will continue to normalize operations in China and Hong Kong. Nevertheless, it is still too early to accurately predict the impact on us and our third-party providers of this relaxation of control measures and whether it will prove enduring. Ultimately, the 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 the related control measures, which we are unable to accurately predict. See “Item 1A. Risk Factors - Epidemics, such as the COVID-19 pandemic, or natural disasters, terrorist attacks or acts of war…”.
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 these developments have negatively affected our operations and financial performance. Although we were able to sponsor a large in-person member event in Hong Kong in the fourth quarter of 2023, it is too early to predict whether these developments will continue to adversely affect our overall business, results of operations and financial condition. See “Item 1A. Risk Factors - Our Hong Kong operations are being adversely affected by recent political and social developments in Hong Kong...”.
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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.
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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 each of fiscal 2023 and 2022 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:
Year Ended December 31,
2023
2022
Net sales
100.0
%
100.0
%
Cost of sales
25.4
25.8
Gross profit
74.6
74.2
Operating expenses:
Commissions expense
41.9
42.2
Selling, general and administrative expenses
36.5
32.6
Total operating expenses
78.4
74.8
Loss from operations
(3.8
)
(0.6
)
Other income, net
5.5
1.8
Income before income taxes
1.7
1.2
Income tax provision
0.4
0.6
Net income
1.3
%
0.6
%
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Net Sales
The following table sets forth revenue by market for the periods indicated (in thousands):
Year Ended December 31,
2023
2022
Americas 1
$
3,364
7.7
%
$
3,256
6.6
%
Hong Kong 2
34,898
79.4
38,436
78.2
China
1,235
2.8
2,017
4.1
Taiwan
2,181
5.0
2,493
5.1
South Korea
164
0.4
172
0.4
Japan
450
1.0
676
1.4
Malaysia and Singapore
275
0.6
393
0.8
Russia and Kazakhstan
480
1.1
559
1.1
Europe
733
1.7
891
1.8
India
144
0.3
241
0.5
Total
$
43,924
100.0
%
$
49,134
100.0
%
1 United States, Canada, Mexico and Peru.
2 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.”
Net sales were $43.9 million for the year ended December 31, 2023 compared with $49.1 million a year ago, a decrease of $5.2 million, or 11%. Hong Kong net sales, substantially all of which were derived from the sale of products shipped to members residing in China, decreased $3.5 million, or 9%, over the prior year. The decrease in Hong Kong net sales was primarily due to the changes in deferred revenue in the two years. Deferred revenue increased $569,000 during 2023, but decreased $2.9 million during the prior year as promotional orders from December 2021 were fulfilled and recognized, resulting in a $3.5 million variance. As a result of tepid consumer sentiment in China during 2023, our order volume was down 3% compared with the prior year. The decrease in Hong Kong net sales was also due to the recognition of lower administrative fees in 2023 as compared to the prior year, as increased activity within member electronic wallet (eWallet) accounts resulted in less fees assessed during the current year. Outside of our Hong Kong business, net sales decreased $1.7 million, or 16%, over the prior year, with decreased year-over-year net sales in each other geographic market except the Americas. The decrease in net sales during 2023 resulted in a loss from operations for the year, as well as negative cash flows from operations. As of December 31, 2023, deferred revenue was $6.2 million, which primarily consisted of $4.4 million pertaining to unshipped product orders and unredeemed product vouchers, as well as $1.8 million in auto ship advances.
Gross Profit
Gross profit was 74.6% of net sales for the year ended December 31, 2023 compared with 74.2% of net sales for the year ended December 31, 2022. Excluding the impact of decreased administrative fee revenue referred to above, the gross profit margin percentage in 2023 slightly improved over the prior year primarily due to lower logistics costs.
Commissions Expense
Commissions were 41.9% of net sales for the year ended December 31, 2023 compared with 42.2% of net sales for the year ended December 31, 2022. Excluding the impact of decreased administrative fee revenue referred to above, commissions as a percentage of net sales decreased slightly in 2023 as compared to the prior year.
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Selling, General and Administrative Expenses
Selling, general and administrative expenses were $16.0 million for each of the years ended December 31, 2023 and 2022. Selling, general and administrative expenses as a percentage of net sales increased in the current year as compared to the prior year due to the decrease in net sales in the current year and the relatively inelastic nature of these expenses.
Other Income, Net
Other income increased to $2.4 million for the year ended December 31, 2023 as compared with $872,000 in the prior year. The increase in other income is primarily due to greater interest earned on our cash equivalents as compared to the prior year.
Income Taxes
An income tax provision of $177,000 was recognized for the year ended December 31, 2023 compared with $289,000 for the year ended Decemb er 31, 2022 . The tax provision for 2022 primarily resulted from the impact of the global intangible low-taxed income (“GILTI”) inclusion offset by foreign tax credit attributes generated as a result of GILTI, as well as income tax expense from various foreign jurisdictions. Our effective tax rate for the year ended December 31, 2023 was lower than in the year ended December 31, 2022 primarily because our reduced income in foreign operations during the year ended December 31, 2023.
Liquidity and Capital Resources
At December 31, 2023, our cash and cash equivalents totaled $56.2 million. Total cash and cash equivalents decreased by $13.5 million from December 31, 2022 to December 31, 2023, primarily due to cash used in operating activities and dividends paid during 2023. We consider all highly liquid investments with original maturities of three months or less, when purchased, to be cash equivalents. As of December 31, 2023, we had $47.2 million in available-for-sale investments classified as cash equivalents. In addition, cash and cash equivalents included $3.7 million held in banks located in China subject to foreign currency controls.
As of December 31, 2023, the ratio of current assets to current liabilities was 3.21 to 1.00 and we had $ 44.2 million of working capital. Working capital as of December 31, 2023 decreased $ 12.9 million compared to our working capital as of December 31, 2022.
Cash used in operations was $4.3 million and $4.9 million during 2023 and 2022, respectively. Income tax paid during April 2023 and 2022 for the repatriation tax on the deemed repatriation of deferred foreign income was $3.0 million and $1.6 million, respectively. Disregarding these payments, cash used in operations improved $2.0 million in 2023 primarily due to an increase in interest earned on our cash equivalents, as well as less employee-related payouts compared to the prior year.
Cash used in investing activities totaled $46,000 and $143,000 during 2023 and 2022, respectively.
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Cash used in financing activities during 2023 and 2022 consisted solely of quarterly dividend payments of $0.20 per common share, totaling an aggregate of $9.2 million and $9.1 million during 2023 and 2022, respectively. Subsequent to December 31, 2023, on February 5, 2024, the Board of Directors declared another quarterly cash dividend of $0.20 on each share of common stock outstanding. The dividend will be payable on March 1, 2024 to stockholders of record on February 20, 2024. W e expect to continue paying a quarterly cash dividend of $0.20 on each share of common stock outstanding for the foreseeable future . However, any future cash dividends will be at the sole discretion of the Board of Directors, and will depend on our financial condition, results of operations, capital requirements and other factors considered relevant by the Board of Directors.
On January 12, 2016, the Board of Directors authorized an increase to our 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, we 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 that we acquire a specific number of shares, and may be suspended from time to time or discontinued. As of December 31, 2023, $21.9 million of the $70.0 million stock repurchase program remained available for future purchases, inclusive of related estimated income tax.
We believe that our existing internal liquidity, supported by cash and cash equivalents, as well as cash flows from operations should be adequate to fund normal business operations and address our financial commitments for the foreseeable future.
We do not have any significant unused sources of liquid assets. If necessary, we may attempt to generate more funding from the capital markets, but currently do not believe that will be necessary.
Our priority is to focus our resources on investing in our most important markets, which we consider to be Greater China and countries where our existing members may have the connections to recruit prospects and sell our products, such as Southeast Asia, India, South America and Europe. We will continue to invest in our Mainland China entity for such purposes as establishing China-based manufacturing capabilities, increasing public awareness of our brand and our products, sourcing more Chinese-made products, building a chain of service stations, opening additional Healthy Lifestyle Centers or branch offices, adding local staffing and other requirements for a prospective China direct selling license application.
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Critical Accounting Estimates
We prepare our consolidated financial statements in accordance with U.S. generally accepted accounting principles, which require our management to make estimates that affect the reported amounts of assets, liabilities and disclosures of contingent assets and liabilities at the balance sheet dates, as well as the reported amounts of revenues and expenses during the reporting periods. To the extent that there are material differences between these estimates and actual results, our financial condition or results of operations would be affected. We base our estimates on our own historical experience and other assumptions that we believe are reasonable after taking account of our circumstances and expectations for the future based on available information. We evaluate these estimates on an ongoing basis.
We consider an accounting estimate to be critical if: (i) the accounting estimate requires us to make assumptions about matters that were highly uncertain at the time the accounting estimate was made, and (ii) changes in the estimate that are reasonably likely to occur from period to period or use of different estimates that we reasonably could have used in the current period, would have a material impact on our financial condition or results of operations. There are items within our financial statements that require estimation but are not deemed critical, as defined above.
For a detailed discussion of our significant accounting policies and related judgments, see Note 1 of the Notes to Consolidated Financial Statements in “Item 8. Financial Statements and Supplementary Data” of this report.
Item 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Not applicable under smaller reporting company disclosure rules.
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