Natural Health Trends Corp. — Form 10-Q Summary
Reporting period: Quarter and nine months ended September 30, 2013. Unaudited results; dollar amounts below are in millions unless otherwise stated.
Business context
The company sells NHT Global personal care, wellness and “quality of life” products through direct selling and e-commerce. It reported one operating segment and 22,500 active distributors, up from 20,600 a year earlier. About 95% of sales came from outside North America; Hong Kong generated 79% of third-quarter sales and 74.8% of nine-month sales. The company opened a Kazakhstan marketing center in June 2013 and began sales and distribution there in September.
Financial results
| Metric | Q3 2013 | Q3 2012 | Nine months 2013 | Nine months 2012 |
|---|---|---|---|---|
| Net sales | $14.18 | $9.33 | $33.43 | $29.40 |
| Gross profit | $10.82 | $6.95 | $25.27 | $21.74 |
| Gross margin | 76.3% | 74.5% | 75.6% | 73.9% |
| Operating income | $1.33 | $0.79 | $2.57 | $2.23 |
| Net income | $1.32 | $0.75 | $2.51 | $2.10 |
| Diluted EPS | $0.12 | $0.07 | $0.22 | $0.19 |
| Operating cash flow | Not separately stated | Not separately stated | $5.10 | $1.60 |
Third-quarter sales increased 52%; nine-month sales increased 14%. Hong Kong sales rose 67% in Q3 and 19% year to date. The company attributed growth mainly to its 12-month Supreme Bonus member incentive program; a Hong Kong, Russia and North America price increase on Alura may also have brought orders forward. Outside Hong Kong, Q3 sales rose 14%, while nine-month sales were flat.
Gross margin improved, which management attributed to lower Russian service-provider and import costs as a share of sales, higher-margin products in Hong Kong, and prior price increases. Distributor commissions rose to 44.1% of Q3 sales from 41.7%, reflecting the incentive program; the nine-month rate was 43.0%, versus 42.4%. SG&A increased 43% in Q3 to $3.22 million and 18% year to date to $8.27 million, primarily due to employee-related costs, travel and credit-card fees.
Financial position and liquidity
- Cash and cash equivalents were $9.13 million at September 30, 2013, versus $4.21 million at December 31, 2012. Operating cash flow of $5.10 million was partly offset by $0.14 million of investing outflows and $0.03 million of financing outflows.
- Current assets were $11.18 million and current liabilities $9.22 million; working capital was $2.0 million and the current ratio 1.21. Excluding $1.54 million of deferred revenue from current liabilities, the ratio was 1.46.
- Total liabilities were $9.22 million, all classified as current. The balance sheet does not list borrowings or other debt.
- Total assets were $13.69 million and stockholders’ equity was $4.47 million. Inventory was $1.20 million, compared with $0.87 million at year-end; goodwill remained $1.76 million.
Management said existing cash and operating cash flows should fund normal operations and commitments for at least 12 months, assuming no significant unforeseen expense or revenue decline. It said it did not expect to need capital-market funding. No quantified revenue or earnings guidance was provided.
Outlook, risks and notable items
- China and Hong Kong exposure: Most Hong Kong revenue comes from products delivered to members in China. The company lacked a Chinese direct-selling license; its application had not materially progressed, and it used a separate e-commerce model. Chinese authorities could change or interpret rules in ways that restrict this activity. Management also described member attrition and reduced activity amid uncertainty and enforcement actions.
- Concentration and execution: Sales are highly concentrated in Hong Kong and Greater China. The business depends on distributor relationships, incentive programs, product acceptance and third-party manufacturers. Direct-selling, product, advertising and other regulatory requirements may constrain operations.
- Foreign exchange: International sales and earnings are exposed to currency movements. The nine-month 2013 foreign-exchange loss was $6,000, compared with $92,000 in 2012.
- Contingencies: In South Korea, a consumer-indemnity arrangement could require payments of up to three months of rolling sales; $132,000 was held under the contract, and management considered use of the funds remote. No contingent liability was recorded for registration-payment arrangements related to outstanding warrants.
- Related-party royalty: The company entered into a Restor license agreement with an entity owned by a director and significant shareholder, with royalties of 2.5% of sales. It accrued $28,000 for the first nine months of 2013. A proposed Soothe royalty arrangement was still under discussion.
- Potential dilution: Warrants to purchase 1,495,952 shares remained outstanding at September 30, 2013, expiring April 21, 2015. The company said it intended to file a registration statement covering the shares. The warrants were excluded from diluted EPS as anti-dilutive.
- The company reported no legal proceedings and no material changes in internal control over financial reporting; management concluded disclosure controls were effective.
Important facts for investors to verify
- Whether sales growth and distributor activity persist after the Supreme Bonus program and whether the Alura price increase shifted purchases between quarters.
- Hong Kong’s share of revenue and the legal, regulatory and enforcement risks associated with sales to members in China.
- Whether elevated distributor commissions and employee, travel and incentive costs weigh on margins as sales mix or promotional programs change.
- The quality and sustainability of operating cash flow, including the contribution from timing changes in commissions, accrued expenses and deferred revenue.
- Terms and governance of the related-party Restor royalty, any final Soothe agreement, and the status and potential dilution from outstanding warrants.