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 headquartered in Rolling Hills Estates, California. Subsidiaries controlled by the Company sell personal care, wellness, and “quality of life” products under the “NHT Global” brand.
The Company’s wholly-owned subsidiaries have an active physical presence in the following markets: the Americas, which consists of the United States, Canada, Cayman Islands, Mexico and Peru; Greater China, which consists of Hong Kong, Taiwan and China; Southeast Asia, which consists of Singapore, Malaysia and Vietnam; South Korea; Japan; 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 2017 Annual Report on Form 10-K filed with the United States Securities and Exchange Commission (SEC) on March 27, 2018.
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.
Reclassification
In accordance with the adoption of Accounting Standards Update (“ASU”) No. 2016-18,
Statement of Cash Flows - Restricted Cash
, the Company has included amounts classified as restricted cash or restricted cash equivalents when reconciling beginning-of-period and end-of-period total cash, cash equivalents and restricted cash amounts, as presented in its consolidated statements of cash flows.
2. ACCOUNTING PRONOUNCEMENTS
In November 2016, the Financial Accounting Standards Board (“FASB”) issued ASU No. 2016-18 that requires amounts generally described as restricted cash or restricted cash equivalents be included with cash and cash equivalents when reconciling the beginning-of-period and end-of-period total amounts shown on the statement of cash flows. The new standard is effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. The adoption of this guidance did not have a material effect on the Company’s consolidated financial statements.
In February 2016, the FASB issued ASU No. 2016-02,
Leases
, that requires organizations that lease assets, referred to as “lessees”, to recognize on the balance sheet the assets and liabilities for the rights and obligations created by those leases with lease terms of more than 12 months. ASU 2016-02 will also require disclosures to help investors and other financial statement users better understand the amount, timing, and uncertainty of cash flows arising from leases and will include qualitative and quantitative requirements. The new standard will be effective for fiscal years beginning after December 15, 2018, including interim periods within those annual years, and early application is permitted. The Company is currently assessing the impact that this standard will have on its consolidated financial statements.
In May 2014, the FASB issued ASU No. 2014-09,
Revenue From Contracts With Customers
, that outlines a single comprehensive model for entities to use in accounting for revenue arising from contracts with customers. ASU 2014-09 is based on the principle that an entity should recognize revenue to depict the transfer of goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. It also requires additional disclosure about the nature, amount, timing and uncertainty of revenue and cash flows arising from customer contracts, including significant judgments and changes in judgments and assets recognized from costs incurred to fulfill a contract. Entities had the option of using either a full retrospective or a modified retrospective approach for the adoption of the new standard. In July 2015, the FASB approved the deferral of the effective date for annual reporting periods that began after December 15, 2017, including interim reporting periods. The adoption of this guidance did not have a material impact on the Company’s consolidated financial statements. See Note 3 for additional information.
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.
3. REVENUE
Revenue Recognition
The Company recognizes revenue in accordance with ASC Topic 606,
Revenue From Contracts With Customers
, which was adopted on January 1, 2018 using the modified retrospective method. All revenue is recognized when the performance obligations under a contract are satisfied. Product sales are recognized when the products are shipped and title passes to independent members. Product sales to members are made pursuant to a member agreement that provides for transfer of both title and risk of loss upon the Company’s delivery to the carrier that completes delivery to the members, which is commonly referred to as “F.O.B. Shipping Point.” The Company’s sales arrangements do not contain right of inspection or customer acceptance provisions other than general rights of return. These contracts are generally short-term in nature.
Actual product returns are recorded as a reduction to net sales. The Company estimates and accrues a reserve for product returns based on its return policies and historical experience. The reserve is based upon the return policy of each country, which varies from 14 days to one year, and their historical return rates, which range from 1% to 7% of sales. Sales returns were
2%
and
3%
of sales for the
six months ended
June 30, 2018
and
2017
, respectively. No material changes in estimates have been recognized during the periods presented. See Note 5 for additional information.
The Company has elected to account for shipping and handling activities performed after title has passed to members as a fulfillment cost, and accrues for the costs of shipping and handling if revenue is recognized before the contractually obligated shipping and handling activities occurs. Shipping charges billed to members are included in net sales. Costs associated with shipments are included in cost of sales. Event and training revenue is deferred and recognized as the event or training occurs. Costs of events and member training are included within selling, general and administrative expenses.
Various taxes on the sale of products to members are collected by the Company as an agent and remitted to the respective taxing authority. These taxes are presented on a net basis and recorded as a liability until remitted to the respective taxing authority.
Deferred Revenue
The Company primarily receives payment by credit card at the time members place orders. Amounts received for unshipped product are considered a contract liability and are recorded as deferred revenue. The decrease in deferred revenue for the three months ended
June 30, 2018
is primarily due to
$2.8 million
of revenue recognized which was included in deferred revenue as of March 31, 2018, offset by cash payments received or due in advance of satisfying the Company’s performance obligations. See Note 5 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.
The following table sets forth revenue by market for the periods indicated (in thousands):
|
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|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended June 30,
|
|
Six Months Ended June 30,
|
|
2018
|
|
2017
|
|
2018
|
|
2017
|
Americas
1
|
$
|
1,855
|
|
|
3.6
|
%
|
|
$
|
1,641
|
|
|
3.2
|
%
|
|
$
|
3,391
|
|
|
3.3
|
%
|
|
$
|
3,101
|
|
|
2.8
|
%
|
Hong Kong
2
|
44,615
|
|
|
87.7
|
|
|
45,688
|
|
|
88.8
|
|
|
92,234
|
|
|
89.3
|
|
|
100,255
|
|
|
90.0
|
|
China
|
2,553
|
|
|
5.0
|
|
|
1,247
|
|
|
2.4
|
|
|
3,812
|
|
|
3.7
|
|
|
3,001
|
|
|
2.7
|
|
Taiwan
|
937
|
|
|
1.8
|
|
|
1,729
|
|
|
3.4
|
|
|
1,998
|
|
|
1.9
|
|
|
2,887
|
|
|
2.6
|
|
South Korea
|
140
|
|
|
0.3
|
|
|
129
|
|
|
0.2
|
|
|
259
|
|
|
0.3
|
|
|
251
|
|
|
0.2
|
|
Japan
|
44
|
|
|
0.1
|
|
|
33
|
|
|
0.1
|
|
|
109
|
|
|
0.1
|
|
|
60
|
|
|
0.1
|
|
Singapore
|
51
|
|
|
0.1
|
|
|
39
|
|
|
0.1
|
|
|
82
|
|
|
0.1
|
|
|
84
|
|
|
0.1
|
|
Malaysia
|
57
|
|
|
0.1
|
|
|
—
|
|
|
—
|
|
|
100
|
|
|
0.1
|
|
|
—
|
|
|
—
|
|
Russia and Kazakhstan
|
239
|
|
|
0.5
|
|
|
229
|
|
|
0.4
|
|
|
442
|
|
|
0.4
|
|
|
446
|
|
|
0.4
|
|
Europe
|
419
|
|
|
0.8
|
|
|
730
|
|
|
1.4
|
|
|
850
|
|
|
0.8
|
|
|
1,254
|
|
|
1.1
|
|
Total
|
$
|
50,910
|
|
|
100.0
|
%
|
|
$
|
51,465
|
|
|
100.0
|
%
|
|
$
|
103,277
|
|
|
100.0
|
%
|
|
$
|
111,339
|
|
|
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” in our most recent Annual Report on Form 10-K.
The Company’s net sales by product and service are as follows (in thousands):
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|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended June 30,
|
|
Six Months Ended June 30,
|
|
2018
|
|
2017
|
|
2018
|
|
2017
|
Product sales
|
$
|
48,458
|
|
|
$
|
49,528
|
|
|
$
|
97,823
|
|
|
$
|
106,105
|
|
Freight and other
|
3,434
|
|
|
3,179
|
|
|
7,186
|
|
|
7,815
|
|
Less: sales returns
|
(982
|
)
|
|
(1,242
|
)
|
|
(1,732
|
)
|
|
(2,581
|
)
|
Total net sales
|
$
|
50,910
|
|
|
$
|
51,465
|
|
|
$
|
103,277
|
|
|
$
|
111,339
|
|
Concentration
No single market other than Hong Kong had net sales greater than 10% of total net sales and no single customer accounted for 10% or more of net sales for the three and
six months ended
June 30, 2018
and
2017
. 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.
4. 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 and the amount of tax benefit that would be recorded in additional paid-in capital when the award becomes deductible are assumed to be used to repurchase shares.
The following tables illustrate the computation of basic and diluted net income per common share for the periods indicated (in thousands, except per share data):
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|
|
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|
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|
|
|
|
|
|
Three Months Ended June 30,
|
|
2018
|
|
2017
|
|
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
|
$
|
9,023
|
|
|
11,298
|
|
|
$
|
0.80
|
|
|
$
|
10,303
|
|
|
11,243
|
|
|
$
|
0.92
|
|
Effect of dilutive securities:
|
|
|
|
|
|
|
|
|
|
|
|
Non-vested restricted stock
|
—
|
|
|
7
|
|
|
|
|
|
—
|
|
|
31
|
|
|
|
|
Diluted net income per common share:
|
|
|
|
|
|
|
|
|
|
|
|
Net income available to common stockholders plus assumed conversions
|
$
|
9,023
|
|
|
11,305
|
|
|
$
|
0.80
|
|
|
$
|
10,303
|
|
|
11,274
|
|
|
$
|
0.91
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Six Months Ended June 30,
|
|
2018
|
|
2017
|
|
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
|
$
|
17,847
|
|
|
11,292
|
|
|
$
|
1.58
|
|
|
$
|
20,728
|
|
|
11,236
|
|
|
$
|
1.84
|
|
Effect of dilutive securities:
|
|
|
|
|
|
|
|
|
|
|
|
Non-vested restricted stock
|
—
|
|
|
5
|
|
|
|
|
|
—
|
|
|
28
|
|
|
|
|
Diluted net income per common share:
|
|
|
|
|
|
|
|
|
|
|
|
Net income available to common stockholders plus assumed conversions
|
$
|
17,847
|
|
|
11,297
|
|
|
$
|
1.58
|
|
|
$
|
20,728
|
|
|
11,264
|
|
|
$
|
1.84
|
|
Certain
non-vested restricted stock is anti-dilutive upon applying the treasury stock method since the amount of compensation cost for future service results in the hypothetical repurchase of shares exceeding the actual number of shares to be vested.
Non-vested restricted stock totaling
11,030
and
13,331
shares were not included for the three and six months ended June 30, 2018, respectively.
5. BALANCE SHEET COMPONENTS
The components of certain balance sheet amounts are as follows (in thousands):
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|
|
|
|
|
|
|
|
|
June 30, 2018
|
|
December 31, 2017
|
Cash, cash equivalents and restricted cash:
|
|
|
|
Cash
|
$
|
51,124
|
|
|
$
|
61,703
|
|
Cash equivalents
|
77,146
|
|
|
73,608
|
|
|
128,270
|
|
|
135,311
|
|
Restricted cash
|
3,111
|
|
|
3,167
|
|
|
$
|
131,381
|
|
|
$
|
138,478
|
|
Inventories:
|
|
|
|
Finished goods
|
$
|
9,852
|
|
|
$
|
7,779
|
|
Raw materials
|
574
|
|
|
799
|
|
Inventory reserve for obsolescence
|
(68
|
)
|
|
(180
|
)
|
|
$
|
10,358
|
|
|
$
|
8,398
|
|
Other accrued expenses:
|
|
|
|
Sales returns
|
$
|
455
|
|
|
$
|
614
|
|
Employee-related expense
|
6,069
|
|
|
5,568
|
|
Warehousing, inventory-related and other
|
1,633
|
|
|
1,423
|
|
|
$
|
8,157
|
|
|
$
|
7,605
|
|
Deferred revenue:
|
|
|
|
Unshipped product
|
$
|
1,703
|
|
|
$
|
2,411
|
|
Auto ship advances
|
1,752
|
|
|
1,665
|
|
Other
|
376
|
|
|
379
|
|
|
$
|
3,831
|
|
|
$
|
4,455
|
|
6. FAIR VALUE MEASUREMENTS
As of
June 30, 2018
, cash and cash equivalents include the Company’s investments in debt securities, comprising municipal notes and bonds and corporate debt, commercial paper, money market funds and time deposits. The Company considers all highly liquid investments with original maturities of three months or less when purchased and have insignificant interest rate risk to be cash equivalents. Debt securities classified as cash equivalents are required to be accounted for in accordance with ASC 320,
Investments - Debt and Equity Securities
. As such, the Company determined its investments in debt securities held at
June 30, 2018
should be classified as available-for-sale and are carried at fair value with unrealized gains and losses reported in accumulated other comprehensive income in stockholders’ equity. The cost of debt securities is adjusted for amortization of premiums and discounts to maturity. This amortization is included in other income. Realized gains and losses, as well as interest income, are also included in other income. The fair values of securities are based on quoted market prices.
The carrying amounts of the Company’s financial instruments, including cash and cash equivalents 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. The Company’s cash equivalents are valued based on level 1 inputs which consist of quoted prices in active markets.
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.
Available-for-sale investments included in cash equivalents at the end of each period were as follows (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
June 30, 2018
|
|
December 31, 2017
|
|
Adjusted Cost
|
|
Gross Unrealized Losses
|
|
Fair Value
|
|
Adjusted Cost
|
|
Gross Unrealized Losses
|
|
Fair Value
|
Municipal bonds and notes
|
$
|
7,176
|
|
|
$
|
(1
|
)
|
|
$
|
7,175
|
|
|
$
|
13,320
|
|
|
$
|
(1
|
)
|
|
$
|
13,319
|
|
Corporate debt securities
|
49,900
|
|
|
(22
|
)
|
|
49,878
|
|
|
49,432
|
|
|
(24
|
)
|
|
49,408
|
|
Financial institution instruments
|
20,093
|
|
|
—
|
|
|
20,093
|
|
|
10,881
|
|
|
—
|
|
|
10,881
|
|
Total available-for-sale investments
|
$
|
77,169
|
|
|
$
|
(23
|
)
|
|
$
|
77,146
|
|
|
$
|
73,633
|
|
|
$
|
(25
|
)
|
|
$
|
73,608
|
|
Financial institution instruments include instruments issued or managed by financial institutions such as money market fund deposits and time deposits.
7. STOCKHOLDERS’ EQUITY
Dividends
The following table summarizes the Company’s cash dividend activity for the
six months ended
June 30, 2018
(in thousands, except per share data):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Declaration Date
|
|
Per Share
|
|
Amount
|
|
Record Date
|
|
Payment Date
|
April 17, 2018 (special)
|
|
$
|
1.76
|
|
|
$
|
20,022
|
|
|
May 15, 2018
|
|
May 25, 2018
|
April 17, 2018
|
|
0.14
|
|
|
1,592
|
|
|
May 15, 2018
|
|
May 25, 2018
|
February 6, 2018
|
|
0.13
|
|
|
1,479
|
|
|
February 27, 2018
|
|
March 9, 2018
|
|
|
$
|
2.03
|
|
|
$
|
23,093
|
|
|
|
|
|
Declaration and payment of any future dividends on shares of common stock will be at the discretion of the Company’s Board of Directors.
Stock Repurchases
On January 12, 2016, the Board of Directors authorized an increase to the Company’s stock repurchase program first approved on July 28, 2015 from
$15.0 million
to
$70.0 million
. Repurchases are expected to be executed to the extent that the Company’s earnings and cash-on-hand allow, and will be made in accordance with all applicable securities laws and regulations, including Rule 10b-18 of the Exchange Act. For all or a portion of the authorized repurchase amount, the Company may enter into one or more plans that are compliant with Rule 10b5-1 of the Exchange Act that are designed to facilitate these purchases. The stock repurchase program does not require the Company to acquire a specific number of shares, and may be suspended from time to time or discontinued. As of
June 30, 2018
,
$32.0 million
of the
$70.0 million
stock repurchase program approved on July 28, 2015 and increased on January 12, 2016 remained available for future purchases, inclusive of related estimated income tax.
Restricted Stock
No stock-based compensation was recognized for the three or
six months ended
June 30, 2018
. Stock-based compensation expense totaled
$8,600
and
$17,300
for the three and
six months ended
June 30, 2017
, respectively.
At the Company’s annual meeting of stockholders held on April 7, 2016, the Company’s stockholders approved the Natural Health Trends Corp. 2016 Equity Incentive Plan (the “2016 Plan”) to replace its 2007 Equity Incentive Plan. The 2016 Plan allows for the grant of various equity awards including incentive stock options, non-statutory options, stock, stock units, stock appreciation rights and other similar equity-based awards to the Company’s employees, officers, non-employee directors, contractors, consultants and advisors of the Company. Up to
2,500,000
shares of the Company’s common stock (subject to adjustment under certain circumstances) may be issued pursuant to awards granted. At
June 30, 2018
,
2,359,671
shares remained available for issuance under the 2016 Plan.
On February 1, 2018, the Company granted
34,202
shares of restricted common stock under the 2016 Plan to certain employees for the purpose of further aligning their interest with those of its stockholders and settling fiscal 2017 performance incentives totaling
$554,000
. The shares vest on a quarterly basis over the next three years and are subject to forfeiture in the event of their termination of service to the Company under specified circumstances.
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, 2017
|
58,032
|
|
|
$
|
28.59
|
|
Granted
|
34,202
|
|
|
16.19
|
|
Vested
|
(23,374
|
)
|
|
26.31
|
|
Nonvested at June 30, 2018
|
68,860
|
|
|
23.20
|
|
Accumulated Other Comprehensive Loss
The changes in accumulated other comprehensive loss by component for the first
six
months of 2018 were as follows (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Foreign Currency Translation Adjustment
|
|
Unrealized Gains/(Losses) on Available-For-Sale Investments
|
|
Total
|
Balance, December 31, 2017
|
$
|
(386
|
)
|
|
$
|
(27
|
)
|
|
$
|
(413
|
)
|
Other comprehensive income (loss)
|
(365
|
)
|
|
4
|
|
|
(361
|
)
|
Balance, June 30, 2018
|
$
|
(751
|
)
|
|
$
|
(23
|
)
|
|
$
|
(774
|
)
|
8. INCOME TAXES
The effective income tax rate for the three and
six months ended
June 30, 2018
was significantly impacted by recording the effect of the Tax Cuts and Jobs Act (the “Tax Act”), enacted on December 22, 2017 by the U.S. government. The Tax Act makes broad and complex changes to the Internal Revenue Code of 1986, as amended, which affected the Company’s year ended December 31, 2017, including, but not limited to, reducing the maximum U.S. federal corporate tax rate from 35% to 21% effective January 1, 2018, and requiring a one-time repatriation tax on certain un-repatriated earnings of foreign subsidiaries at a rate of 15.5% tax on post-1986 foreign earnings held in cash and an 8% rate on all other post-1986 earnings, which is payable over eight years beginning with 8% of the liability due with the filing of the year ended December 31, 2017 federal tax return that will be due in 2018.
On December 22, 2017, the Securities and Exchange Commission staff issued Staff Accounting Bulletin No. 118 (“SAB 118”), which provides guidance on accounting for tax effects of the Tax Act. SAB 118 provides a measurement period that should not extend beyond one year from the Tax Act enactment date for companies to complete the accounting under ASC 740,
Income Taxes
. In accordance with SAB 118, a company must reflect the income tax effects of those aspects of the Tax Act for which the accounting under ASC 740 is complete. To the extent that a company’s accounting for certain income tax effects of the Tax Act is incomplete but it is able to determine a reasonable estimate, it must record a provisional estimate to be included in the financial statements. If a company cannot determine a provisional estimate to be included in the financial statements, it should continue to apply ASC 740 on the basis of the provision of the tax laws that were in effect immediately before the enactment of the Tax Act. While the Company is able to make reasonable estimates of the impact of the reduction in the corporate income tax rate and the deemed repatriation transition tax, the final impact of the Tax Act may differ from these estimates, due to, among other things, changes in the Company’s interpretations and assumptions, additional guidance that may be issued by the Internal Revenue Service, and actions it may take. The Company is continuing to gather additional information to determine the final impact. Any adjustments recorded to the provisional amounts through the fourth quarter of 2018 will be included as an adjustment to income tax expense.
Effective January 1, 2018, the Company is subject to the new Global Intangible Low-Taxed Income (“GILTI”) tax rules. GILTI is the excess income of foreign subsidiaries over a 10% routine return on tangible assets. After a 50% deduction, GILTI is subject to the 21% corporate tax rate. Due to the complexity of the GILTI tax rules, the Company continues to evaluate this provision of the Tax Act and the application of ASC 740. Under U.S. GAAP, the Company is allowed to make an accounting policy choice of either treating taxes due on future U.S. inclusions in taxable income related to GILTI as a current period expense when incurred (the “period cost method”) or factoring such amounts into the Company’s measurement of its deferred taxes (the “deferred method”). Although the Company has not elected an accounting policy, it has recorded a provisional amount of the GILTI tax as a current period expense for 2018. The impact of GILTI as a component of the effective tax rate for the six months ended
June 30, 2018
was approximately 8%, or
$1.6 million
, net of foreign tax credits attributed to GILTI. The provisional amount of the GILTI tax during the second quarter of 2018 resulted in a decrease as a component of the effective tax rate from 10% in the first quarter of 2018. The Company will determine the appropriate accounting policy for its structure and record any necessary adjustments within the measurement period.
As a result of capital return activities, the Company determined that a portion of its current undistributed foreign earnings are 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. Due to the adoption of a territorial tax regime upon the enactment of the Tax Act, any foreign source portion of a qualified dividend received by a 10% U.S. corporate shareholder is exempt from U.S. federal tax, therefore resulting in any future repatriation having a minimal effect on the Company’s effective tax rate. To the extent that additional foreign earnings are not deemed permanently reinvested, the Company expects to recognize additional income tax provision at the applicable U.S. state corporate tax rate(s). As of
June 30, 2018
, the Company has accrued tax liabilities for earnings that it plans to repatriate out of accumulated earnings in future periods for state tax purposes only. All undistributed earnings in excess of 50% of current earnings on an annual basis are intended to be reinvested indefinitely as of
June 30, 2018
.
The Company and its subsidiaries file tax returns in the United States, California, New Jersey and Texas and various foreign jurisdictions. For federal income tax purposes, fiscal years 2007 through 2016 remain open for examination by tax authorities as a result of net operating loss carryovers from older years being used to offset income in recent tax years. The Company is no longer subject to state income tax examinations for years prior to 2012. No jurisdictions are currently examining any income tax returns of the Company or its subsidiaries.
9. COMMITMENTS AND CONTINGENCIES
Securities Class Action
In January 2016, two putative securities class action complaints were filed against the Company and its top executives in the United States District Court for the Central District of California. On March 29, 2016, the court consolidated these actions under the caption Ford v. Natural Health Trends Corp., Case No. 2:16-cv-00255-TJH-AFMx, appointed two Lead Plaintiffs, Mahn Dao and Juan Wang, and appointed the Rosen Law Firm and Levi & Korsinsky LLP as co-Lead Counsel for the purported class. On April 2, 2018, the court approved a class-wide settlement of the action in the amount of
$1.75 million
, which was fully funded by the Company’s insurers. On April 6, 2018, the court entered a Final Judgment and Order of Dismissal With Prejudice.
Shareholder Derivative Claims
In February 2016, a purported shareholder derivative complaint was filed in the Superior Court of the State of California, County of Los Angeles:
Zhou v. Sharng
. In March 2016, a purported shareholder derivative complaint was filed in the United States District Court for the Central District of California:
Kleinfeldt v. Sharng
(collectively the “Derivative Complaints”). The Derivative Complaints purport to assert claims for breach of fiduciary duties, unjust enrichment, abuse of control, gross mismanagement and corporate waste against certain of the Company’s officers and directors. The Derivative Complaints also purport to assert fiduciary duty claims based on alleged insider selling and conspiring to enter into several stock repurchase agreements, which allegedly harmed the Company and its assets. The Derivative Complaints allege, among other things, that the Company has been running an allegedly illegal multilevel marketing business in China, and it has made materially false and misleading statements regarding the legality of its business operations in China, and that certain officers and directors sold common stock on the basis of this allegedly material, adverse non-public information. The Derivative Complaints seek an indeterminate amount of damages, plus interest and costs, as well as various equitable remedies.
On February 1, 2017, pursuant to a stipulation among the parties, the Los Angeles Superior Court entered a stay of the
Zhou
action pending conclusion of the related federal class action in the United States District Court for the Central District of California:
Ford v. Natural Health Trends Corp.
A nearly identical stipulated stay was entered in the
Kleinfeldt
case on February 28, 2017. On November 10, 2017, the parties to both the
Zhou
and
Kleinfeldt
actions entered into a Memorandum of Understanding (“MOU”) to resolve both actions, subject to the negotiation of a written settlement agreement and approval by the federal court in the
Kleinfeldt
matter. On November 15, 2017, the parties filed a joint status report and stipulation in the
Zhou
matter, alerting the court to the MOU and seeking to maintain the stay pending finalization and court approval of the parties’ tentative settlement. The
Zhou
court entered an order continuing the stay on November 17, 2017. On March 9, 2018, the parties filed a Stipulation of Settlement and supporting papers in the
Kleinfeldt
action. On March 22, 2018, plaintiffs filed a motion for preliminary approval of the tentative settlement. On April 4, 2018, the court entered an order preliminarily approving the proposed settlement and setting a final hearing for July 16, 2018. On July 16, 2018, the court granted final approval of the settlement and entered judgment in the
Kleinfeldt
matter. In exchange for full releases, the settlement requires the Company to implement certain corporate governance reforms and includes an award of
$250,000
in attorneys’ fees to plaintiffs’ counsel, all of which will be fully funded by the Company’s insurers. The settlement and judgment also requires that plaintiff take the necessary steps to voluntarily dismiss the
Zhou
action with prejudice promptly after the judgment becomes final and non-appealable.
Other Claims
The Company is currently involved in a legal matter with one of its vendors and an outside party. Per the royalty agreement with the vendor, the Company believes that it is fully indemnified in the event of an unfavorable outcome and any potential settlement costs related to the matter would be fully covered by the Company’s vendor.
10. RELATED PARTY TRANSACTIONS
In February 2013, the Company entered into a Royalty Agreement and License with Broady Health Sciences, L.L.C., a Texas limited liability company, (“BHS”) regarding the manufacture and sale of a product called
ReStor™
. George K. Broady, a director of the Company and beneficial owner of more than 5% of its outstanding common stock, is owner of BHS. Under the agreement, the Company agreed to pay BHS a royalty of
2.5%
of sales revenue in return for the right to manufacture (or have manufactured), market, import, export and sell this product worldwide, with certain rights being exclusive outside the United States. On April 29, 2015, the Company and BHS amended the Royalty Agreement and License to change the royalty to a price per unit instead of 2.5% of sales revenue. Such provision was effective retroactively to January 1, 2015. Such royalties were
$93,000
and
$86,000
for the three months ended
June 30, 2018
and
2017
, respectively, and
$176,000
and
$177,000
for the
six months ended
June 30, 2018
and
2017
, respectively. The Company is not required to purchase any product under the agreement, and the agreement may be terminated at any time on
120 days
’ notice or, under certain circumstances, with
no
notice. Otherwise, the agreement terminates March 31, 2020.
11. SUBSEQUENT EVENT
On
July 18, 2018
, the Board of Directors declared a quarterly cash dividend of
$0.15
and a special cash dividend of
$0.25
on each share of common stock outstanding. Such dividends are payable on
August 24, 2018
to stockholders of record on
August 14, 2018
. Declaration and payment of any future dividends on shares of common stock will be at the discretion of the Company’s Board of Directors.