Natural Health Trends Corp. — Q3 2014 Form 10-Q
Business and period. Unaudited results for the quarter and nine months ended September 30, 2014. The company sells NHT Global personal care, wellness and quality-of-life products through direct selling and e-commerce. It reported 48,500 active distributors. Hong Kong generated 88.9% of Q3 sales; the company says most Hong Kong sales are delivered to members in China.
Financial performance
| Metric | Q3 2014 | Q3 2013 | Nine months 2014 | Nine months 2013 |
|---|---|---|---|---|
| Net sales | $31.8m | $14.2m | $89.2m | $33.4m |
| Gross profit | $25.1m | $10.8m | $69.7m | $25.3m |
| Gross margin | 78.8% | 76.3% | 78.1% | 75.6% |
| Operating income | $5.5m | $1.3m | $14.8m | $2.6m |
| Net income | $5.4m | $1.3m | $14.6m | $2.5m |
| Diluted EPS | $0.42 | $0.12 | $1.16 | $0.22 |
Cash flow and liquidity. Nine-month operating cash flow was $20.9m, versus $5.1m a year earlier. Investing used $0.2m; financing provided $4.5m, including $4.9m from warrant exercises, partly offset by $0.35m of dividends and $0.10m of share repurchases. Cash rose to $39.7m from $14.6m at year-end 2013. Current assets were $45.0m and current liabilities $22.6m; reported working capital was $22.4m and the current ratio 1.99. No borrowing or debt balance is reported on the presented balance sheet.
Other balance-sheet figures. Inventory increased to $4.3m from $1.8m at December 31, 2013. Total liabilities were $22.6m, all classified as current; stockholders’ equity was $25.2m.
Changes and management commentary
- Q3 sales rose 125% year over year, led by a $17.1m increase in Hong Kong sales. Nine-month sales rose 167%, with Hong Kong accounting for $80.3m, or 90.1%, of revenue.
- Management attributed sales gains to leadership development, promotions, incentives, events, new products, training, commissions and services. Active distributors increased from 22,500 to 48,500 year over year.
- Gross margin improved, which management attributed to lower Russian service-provider fees and import costs, a more favorable Hong Kong product mix, and a lower proportion of sales from Russia. Distributor commissions rose to 45.6% of quarterly sales and 45.3% for the nine-month period, partly reflecting Hong Kong commissions and incentive programs.
- SG&A increased 58% in Q3 and 75% for the nine-month period, primarily due to employee-related costs, incentive-program accruals, and higher credit-card fees and assessments.
Outlook, risks and notable items
- No quantified revenue or earnings guidance is provided. Management believes cash on hand and operating cash flow should fund normal operations and commitments for at least 12 months, assuming no significant unforeseen expense or revenue decline.
- The company may invest up to $10m in its Mainland China entity over the next 18 months for manufacturing capabilities, centers or offices, and potentially a deposit connected to a direct-selling license application. It does not hold a China direct-selling license and cannot predict whether or when one will be granted.
- Revenue is highly concentrated in Hong Kong and China-related activity. Management warns that Chinese legal interpretation or enforcement could restrict its e-commerce activity or member conduct. It also cited continued political unrest as a factor in CIS-market sales declines: down 28% in Q3 and 27% for the nine-month period.
- On November 4, 2014, the board declared approximately $0.13m in cash dividends and authorized a one-time repurchase of up to $5m, expected to begin in November and finish by January 2015. The program is discretionary and funded from working capital. Largest shareholder and director George K. Broady expressed interest in selling shares into the program; terms were still under discussion.
- The board also authorized management to pursue a Nasdaq Capital Market listing; timing and completion are not assured. Separately, the company has a royalty agreement with a director’s affiliate for ReStor and was discussing a proposed royalty arrangement for Soothe.
- The filing reports no legal proceedings and says disclosure controls were effective at September 30, 2014. Management identifies risks including distributor retention and compensation, regulation, product and supplier concentration, foreign exchange, and China/Hong Kong exposure.
Important facts for investors to verify
- Whether Hong Kong-led growth and the increase in active distributors continue, and how much sales depend on China-related demand.
- China regulatory developments, including any effect on the Hong Kong e-commerce model or the direct-selling license process.
- Whether gross-margin gains persist as commission rates, incentives, logistics costs and geographic mix change.
- Inventory growth, cash conversion and the company’s intended use of cash, including the proposed China investment and $5m repurchase.
- Completion and terms of the repurchase, including any participation by the director and largest shareholder; progress toward Nasdaq listing; and resolution of the proposed Soothe royalty.