NATURAL HEALTH TRENDS CORP quarterly report, Q2 FY2011

Natural Health Trends Corp. — Form 10-Q Summary

Reporting period: Quarter and six months ended June 30, 2011. The company sells personal care, wellness and “quality of life” products through the NHT Global brand, primarily using independent distributors and e-commerce. Figures below are in U.S. dollars; financial statement amounts are in thousands unless noted.

Financial performance

Metric	Q2 2011	Q2 2010	Six months 2011	Six months 2010
Net sales	$7.208 million	$5.935 million	$12.383 million	$12.168 million
Gross profit / margin	$5.231 million / 72.6%	$4.256 million / 71.7%	$8.877 million / 71.7%	$8.658 million / 71.2%
Operating income (loss)	$655,000	$(846,000)	$277,000	$(1.684) million
Net income (loss) attributable to common stockholders	$665,000	$(509,000)	$189,000	$(1.346) million
Basic and diluted EPS	$0.06	$(0.05)	$0.02	$(0.13)

Q2 sales rose 21% year over year. Hong Kong sales increased 32% to $4.688 million and Russia sales increased 56% to $1.236 million; China sales declined to $232,000 from $414,000.
First-half sales increased slightly. Management notes that first-half 2010 included $708,000 of Hong Kong revenue from orders placed in 2009 after logistics issues were resolved.
Distributor commissions were 37.6% of Q2 sales versus 33.4% a year earlier, and 36.2% for the first half versus 34.8%. The company attributed the increase mainly to compensation-plan enhancements in Hong Kong and Russia and, to a lesser extent, healthy lifestyle center sales goals.
SG&A fell $880,000 in Q2 and $1.5 million in the first half. Management cited lower personnel, occupancy and professional costs, reduced stock compensation, and vendor settlements that generated credits to expense.

Cash, liquidity and balance sheet

Cash and cash equivalents were $1.437 million at June 30, 2011, up $789,000 from year-end. First-half operating cash flow was positive $583,000, compared with cash used of $275,000 in the prior-year period. Investing activities used $81,000; financing provided $233,000, including related-party advances.
Current assets were $4.498 million and current liabilities $9.548 million, implying a 0.47 current ratio and a $5.1 million working-capital deficit. Excluding $2.696 million of deferred revenue, the stated current ratio was 0.66.
Total liabilities were current; the balance sheet reports no long-term debt. Stockholders’ deficit was $2.555 million. Inventory rose to $1.193 million from $751,000, while goodwill remained $1.764 million and no impairment was recorded.
A director advanced $200,000 in February and March 2011 at 9% interest, in addition to smaller advances. The company reported partial repayment later in 2011 and expected to repay the remaining principal and interest by year-end.
Management believed available liquidity should fund normal operations and commitments for at least 12 months, assuming no significant unforeseen expense or further revenue decline. It cautioned that the assumptions could prove incorrect and said there were no significant unused liquid-asset sources.

Outlook, risks and notable items

No specific revenue or earnings guidance was provided. Management said it would focus resources on Greater China and Russia and did not intend to devote material resources to opening additional foreign markets in the near term.
Hong Kong generated about 65% of Q2 sales, and approximately 95% of sales came from outside North America. The company’s dependence on Hong Kong/China exposes results to regulatory, political, economic and currency risks.
The company lacked a direct-selling license in China; its applications had not materially progressed. Management said the Hong Kong e-commerce business was believed to comply with applicable Chinese law, but warned that regulatory interpretations or enforcement could restrict activity. It also described member departures or reduced activity amid uncertainty and enforcement actions.
Management cited a network-marketing model dependent on independent distributors, competition, product acceptance, foreign exchange, supplier reliance, and direct-selling and product regulations among key business risks.
Vendor agreements settled prior balances for $209,000 less than carrying value in Q2, recognized as an SG&A credit; the first-half credit was $262,000. A further $220,000 settlement credit was recognized in Q3 as a subsequent event.
A landlord lawsuit was settled for $125,000, paid by June and September 2011, and dismissed with prejudice. A separate distributor-related lawsuit was settled confidentially in March 2011. The company disclosed no other pending litigation.
Disclosure controls were deemed ineffective because internal control over financial reporting was not effective; management cited insufficient documentary evidence and targeted completing its documentation by year-end 2011, without assurance it could do so. Management nevertheless stated it believed the financial statements fairly presented the company’s financial condition and results.
The filing’s cover page marks “No” for having filed all required reports during the preceding 12 months; investors should verify the reporting-compliance status. The company also reported 600,000 restricted shares granted in May 2011 and 3,704,854 warrants outstanding at quarter-end.

Important facts for investors to verify

Whether the filing’s “No” response on timely required reports reflects reporting delinquencies and what the status was as of the filing date.
Whether the reported operating cash generation and management’s 12-month liquidity assessment remain supportable given the working-capital deficit and reliance on continued revenue and cost control.
How China-related legal and regulatory developments, Hong Kong sales concentration, and distributor activity affect revenue and the company’s ability to operate.
The status and terms of the director advances and repayments, and the effects of outstanding warrants and restricted stock on potential dilution.
Whether internal-control documentation was completed and whether any material weaknesses were identified.