New Horizon Health launches probe into disputed sales figures

The provider of cancer-screening products issued a positive profit alert in January, but the full earnings report has yet to appear after auditors raised questions about the company’s revenues

Key Takeaways:

• New Horizon Health has brought in experienced accountants as independent directors and set up a special committee to investigate the allegations
• The controversy revolves around the company’s revenue accounting method, in which over-shipments of goods to distributors could inflate sales figures

By Molly Wen

It was a Chinese success story in the health technology sector, feted by the stock market. New Horizon Health Ltd. (6606.HK) was the country’s first cancer-screening company to go public and enjoyed fast revenue growth, before doubts began to surface last year about its sales figures.

The controversy roared back into the headlines in recent weeks when New Horizon Health failed to release its annual earnings report and its auditor, Deloitte, expressed reservations about the company’s sales record.

The biotech, which went public on the Hong Kong stock market in 2021, supplies tests for gastric, colorectal and cervical cancer through hospitals, healthcare websites and other sales outlets. New Horizon’s business performance was once the envy of the industry, with revenue surging more than 20 times in the three years through 2023 and gross margin jumping from 52% to 90%.

However, in the second half of last year an investigation by the U.S. financial website CapitalWatch cast doubt on the stellar numbers, arousing suspicions among stock investors.

In January this year the company issued positive earnings guidance to the market, predicting revenue for 2023 would range between 1.98 billion yuan ($273 million) and 2.05 billion yuan, a rise of 158.9% to 168.2% from the previous year. The bowel cancer screening product ColoClear was estimated to have racked up sales of more than 1 billion yuan as the firm’s blockbuster product.

However, the March earnings season came and went without any sign of the full results. On the day of the expected release, the company announced that investors would have to wait until March 28 to see the full report, towards the end of Hong Kong’s annual reporting period.

However, the earnings release did not materialize on that day. Instead, investors heard the bombshell news that Deloitte, the auditing firm that had served New Horizon since its IPO, had questioned the validity of some sales transactions for key products such as ColoClear, Pupu Tube and UU Tube. Deloitte also raised concerns about the firm’s sales and marketing model, concluding that an independent investigation was needed. In short, the auditors had serious doubts about the accounts and could not sign off the results, hence the publication delay.

Investors could sense trouble in the days leading up to the Deloitte news. New Horizon’s share price suddenly plunged 19.8% before the market closed on March 28. Including a drop the day before, the company’s stock shed 25% of its value to sink to a 17-month low in the two sessions before trading was suspended.

Then on April 8 New Horizon announced that two independent non-executive directors had joined its board, both with extensive experience in accounting, audit investigations and internal corporate controls. The two new directors had also both worked at Deloitte, one of them as a partner there for 17 years.

In a further response to the concerns raised by Deloitte, the company said it had set up a special committee of board members, including non-executive directors, to oversee an independent investigation by third-party experts into the allegations.

Such committees are usually convened when listed companies are suspected of having corporate governance problems or are facing regulatory investigations. They are typically staffed by independent directors with legal or accounting expertise who have no vested interest in the matters under investigation.

What is the controversy about?

The details of Deloitte’s concerns have not been made public, but potential clues can be gleaned from the CapitalWatch investigation published last August.

The short-seller website said a 16-month investigation had concluded that New Horizon Health was over-supplying to distributors who then struggled to sell the products, resulting in inflated sales figures.  Taking the core product as an example, the report said the company sold 6,000 ColoClear products to public hospitals in 2022 for 500 yuan per unit, generating verified revenue of only 3 million yuan.  However, the company said it made 260 million yuan by selling about 172,000 units to hospitals for about 1,483 yuan each, far above the 500 yuan cited in the investigative report and higher than the product’s retail price in some hospitals.

At the time, the company disputed the investigation’s findings as a distortion of the facts. But there is something unusual about the way it calculates revenue. Some expired products are counted in the revenue figures, including samples sent back to the lab for testing and ones sold to consumers after the 12-month cut-off date. In 2022, ColoClear reported shipments of 806,000 units, and 361,000 were recognized in revenue. In the first half of 2023, 539,000 units were shipped, with 429,000 units included in revenue. This suggests shipments could be overstated in financial statements or revenues otherwise inflated.

Moreover, accounts receivable as a share of total revenue have also been rising, from 31% in 2019 to 117% in the first half of 2023. CapitalWatch suspected the high receivables resulted from excessive shipments of goods to distributors, while the company cited its revenue recognition method whereby most revenue from one accounting period lands in the corporate coffers in the next period.

The independent probe is likely to take some time.  But in the long run, New Horizon Health could still enjoy a promising future because of rising demand for cancer testing kits. Its three key screening products, ColoClear, Pupu Tube and UU Tube, target colorectal and stomach cancer, the two most common types of gastrointestinal cancer in China.

As home testing takes off, New Horizon’s market could expand further. Right now, investors are waiting to see if the investigation commissioned by the company can reassure the market.

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