Natural Health Trends Corp. — FY2013 Form 10-K
Reporting period: Fiscal year ended December 31, 2013. This is an annual report; standalone fourth-quarter results are not clearly provided. Comparisons below are with FY2012.
Business context
Natural Health Trends sells NHT Global wellness, skincare and lifestyle products through direct selling and e-commerce. It reported one operating segment. Its business is highly international: Hong Kong generated 77.3% of FY2013 net sales, and approximately 95% of sales came from subsidiaries outside North America. Most Hong Kong sales were products delivered to members in China. Active distributors increased to 27,520 from 20,680.
Financial results and liquidity
| Metric | FY2013 | FY2012 |
|---|---|---|
| Net sales | $52.527 million | $37.514 million |
| Gross profit / margin | $39.976 million / 76.1% | $27.829 million / 74.2% |
| Operating income / margin | $4.223 million / 8.0% | $2.645 million / 7.1% |
| Net income | $4.089 million | $2.630 million |
| Net income available to common stockholders | $4.074 million; $0.36 diluted EPS | $2.613 million; $0.23 diluted EPS |
| Cash provided by operating activities | $10.686 million | $2.214 million |
Sales rose 40%, with Hong Kong sales up 55% to $40.585 million. Management attributed much of the increase to a year-long international recognition and incentive campaign. Outside Hong Kong, sales increased 6% overall; growth in Taiwan and South Korea partly offset declines in Russia and other markets.
Gross margin improved, which management attributed to lower Russia-related service and import costs as a share of sales, higher-margin products in Hong Kong, and a prior price increase on Premium Noni Juice. Distributor commissions rose to 45.8% of sales from 41.9%, largely reflecting the year-long incentive program. SG&A increased 24% to $11.634 million, including higher employee costs, travel, credit-card fees, professional fees and $320,000 of increased severance costs.
At year-end, cash and cash equivalents were $14.550 million, current assets $17.170 million and current liabilities $13.750 million. Working capital was $3.4 million; the current ratio was 1.25, or 1.54 excluding deferred revenue. The balance sheet presents no debt balance. The company reported $10.686 million of operating cash flow, used $292,000 in investing activities and used $52,000 in financing activities. Cash increased $10.343 million during the year.
Outlook, risks and notable items
- Management said existing cash and operating cash flows should fund normal operations and financial commitments for at least 12 months, assuming no significant unforeseen expense or revenue decline. No quantified revenue or earnings guidance was provided.
- The company plans to focus resources on Greater China and CIS markets, especially Russia, Ukraine and Kazakhstan, and said it did not expect to devote material resources to opening additional foreign markets in the near term. Kazakhstan sales operations began in 2013; Ukraine operations began in February 2014.
- China-related regulatory exposure is material. The company lacks a Chinese direct-selling license and relies on e-commerce, including Hong Kong-based sales to members in China. It warned that regulatory interpretations, investigations, fines or changes to the business model could disrupt operations. The 2013 filing reports prior investigations and fines but no material change to the model as a result.
- Product and supplier concentration is significant: Premium Noni Juice and Alura together accounted for a majority of revenue, and each was sourced from a single supplier. The company also relies on a limited number of third-party manufacturers and disclosed that it does not carry product-liability insurance.
- Distributor compensation is a key cost and rose as a percentage of sales. Other risks include distributor retention, competition, foreign-exchange movements, product and direct-selling regulation, and dependence on information systems and third-party cloud servers.
- Commitments include operating leases with $960,000 of future minimum payments and a supplier exclusivity agreement requiring at least $40,000 of monthly purchases through July 2016. Accrued severance obligations of $296,000 were expected to be paid in 2014.
- After year-end, the board declared cash dividends payable April 8, 2014: $0.005 per common share and $0.81507 per outstanding Series A preferred share. The filing reports $98,000 of accrued unpaid preferred dividends at December 31, 2013.
- As of February 28, 2014, 1,375,952 warrants remained outstanding at an exercise price of $3.52 and were due to expire April 21, 2015. The filing describes anti-dilution provisions and potential dilution.
Key facts for investors to verify
- Whether Hong Kong/China sales concentration and the incentive-driven growth can be sustained, and what portion of Hong Kong revenue depends on Chinese members.
- The status of Chinese regulatory scrutiny, any subsequent enforcement actions, and the company’s ability to continue its e-commerce and cross-border sales model.
- Revenue contribution, supplier continuity and alternative sourcing for Premium Noni Juice and Alura.
- How much of 2013 operating cash flow reflects sustainable earnings versus working-capital movements, including higher accrued commissions, payables and deferred revenue.
- Potential dilution from outstanding warrants and preferred shares, and the cash impact of declared dividends and other commitments.
- The independent auditor gave an unqualified opinion on the financial statements. Management concluded internal control over financial reporting was effective; the auditor did not provide an internal-controls attestation.