Natural Health Trends Corp. — Q1 2014 Form 10-Q
Reporting period: Three months ended March 31, 2014; balance-sheet figures compared with December 31, 2013. The company sells NHT Global personal-care, wellness and “quality of life” products through direct-selling and e-commerce channels. It reported 35,100 active distributors at quarter-end.
Financial performance
Amounts below are in millions of U.S. dollars, except per-share data and percentages.
| Metric | Q1 2013 | Q1 2014 | Change |
|---|---|---|---|
| Net sales | $8.651 | $23.162 | +168% |
| Gross profit / margin | $6.423 / 74.2% | $17.910 / 77.3% | Margin +3.1 percentage points |
| Distributor commissions | $3.674 / 42.5% of sales | $10.423 / 45.0% | Expense grew faster than sales |
| SG&A | $2.445 | $4.347 | +78% |
| Operating income / margin | $0.292 / 3.3% | $3.119 / 13.4% | Improved |
| Net income | $0.287 | $3.071 | Up substantially |
| Diluted EPS | $0.03 | $0.26 | Improved |
| Operating cash flow | $1.018 | $8.283 | Increased |
Hong Kong sales were $20.411 million, or 88.1% of total sales, versus $6.048 million, or 69.9%, a year earlier. Sales outside Hong Kong increased 6% overall; Russia, Kazakhstan and Ukraine sales fell 16%, which management attributed to regional political unrest. Gross-margin improvement reflected lower Russian service-provider fees and import costs as a share of sales, and a more favorable Hong Kong product mix; higher Hong Kong logistics costs partly offset the gains.
Financial position and liquidity
- Cash and cash equivalents rose to $23.334 million from $14.550 million. Net cash increased $8.784 million during the quarter.
- Current assets were $28.567 million and current liabilities $21.681 million; working capital was $6.9 million and the current ratio was 1.32. Excluding deferred revenue, the current ratio was 2.07.
- Deferred revenue totaled $7.881 million, including $7.1 million for unshipped product orders. The increase contributed to operating cash flow, along with higher sales; inventory and other current assets also increased.
- Inventory rose to $3.323 million from $1.828 million. Total liabilities were $21.681 million, all classified as current in the balance sheet. The filing does not report borrowings or a separate debt balance.
- Investing cash outflow was $0.063 million. Financing cash inflow was $0.574 million, including $0.598 million from warrant exercises, partly offset by $0.024 million of stock repurchases.
Outlook, risks and notable items
- Management said existing liquidity and operating cash flows should fund normal operations and commitments for at least 12 months, assuming no significant unforeseen expense or revenue decline. It did not provide financial guidance and said it did not currently expect to need capital-market funding.
- The Supreme Bonus incentive campaign helped sustain sales momentum, particularly in Hong Kong. Commissions increased to 45% of sales, in part because of this program. Management plans to focus resources on Greater China and promising existing markets, including potentially Southeast Asia, rather than materially expanding into new foreign markets.
- China is a major regulatory and concentration risk. Direct selling requires a license that the company does not have; its China business uses an e-commerce model. Hong Kong generated 88% of Q1 sales, and most Hong Kong revenue came from products delivered to members in China. The company cautioned that changes in Chinese rules or enforcement could restrict these activities.
- Other material risks include foreign-exchange movements, reliance on distributors and third-party manufacturers, product and direct-selling regulation, and political and economic conditions in foreign markets. Management cited CIS political unrest as a factor in lower regional sales.
- The board declared Q1 cash dividends of $0.005 per common share and $0.81507 per Series A preferred share, payable April 8, 2014. On May 6 it declared additional dividends totaling $60,000, payable June 4. Warrants for 170,000 shares were exercised in Q1 for $0.598 million; further exercises for 202,465 shares and $0.712 million occurred in April and May. Warrants for 1,165,952 shares remained outstanding as of May 5 and expire April 21, 2015 if unexercised.
- A related-party royalty agreement covers ReStor; Q1 royalties were $29,000. The company was also considering a proposed royalty arrangement for Soothe, with approximately $6,800 calculated as accrued through Q1 if a 2.5% rate applied. No definitive Soothe agreement was reported.
- Management concluded disclosure controls were effective as of March 31, 2014 and reported no material change in internal control over financial reporting. The filing reported no legal proceedings.
Important facts for investors to verify
- Whether the exceptional sales growth and Hong Kong concentration are sustainable, and the extent to which reported sales reflect unshipped orders and deferred revenue.
- Developments in Chinese regulation and enforcement affecting Hong Kong-to-China sales, the e-commerce platform and the pending direct-selling license process.
- Whether distributor incentives and commissions remain elevated, and how they affect margins and profitability.
- Cash conversion and working-capital trends, particularly deferred revenue, inventory growth and subsequent dividend payments.
- Remaining warrant exercises, potential share dilution and the impact of dividends on warrant exercise terms.
- The status and terms of the proposed Soothe related-party royalty arrangement.