Natural Health Trends Corp. — Q2 2013 Form 10-Q
Business and period: Unaudited results for the quarter and six months ended June 30, 2013, compared with the corresponding 2012 periods. The company sells personal care, wellness and quality-of-life products through its NHT Global direct-selling and e-commerce business. It reported 20,100 active distributors, down from 21,200 a year earlier. Hong Kong generated 73.3% of Q2 sales; the company says most Hong Kong revenue relates to products delivered to members in China.
Financial performance
| Metric | Q2 2013 | Q2 2012 | Six months 2013 | Six months 2012 |
|---|---|---|---|---|
| Net sales | $10.598 million | $10.980 million | $19.249 million | $20.070 million |
| Gross profit / margin | $8.028 million / 75.8% | $8.096 million / 73.7% | $14.451 million / 75.1% | $14.787 million / 73.7% |
| Operating income / margin | $948,000 / 9.0% | $889,000 / 8.1% | $1.240 million / 6.4% | $1.440 million / 7.2% |
| Net income | $904,000 | $846,000 | $1.191 million | $1.353 million |
| Net income available to common / diluted EPS | $900,000 / $0.08 | $842,000 / $0.08 | $1.183 million / $0.11 | $1.345 million / $0.12 |
| Operating cash flow | Not separately reported | Not separately reported | $2.578 million | $2.586 million |
For the six months, distributor commissions were 42.2% of sales (42.7% in 2012); SG&A was 26.3% (23.7%). The company reported a $21,000 foreign-exchange loss for the 2013 half-year, versus a $61,000 net other expense in 2012, including a $64,000 foreign-exchange loss.
Liquidity, balance sheet and cash flow
At June 30, 2013, cash and cash equivalents were $6.695 million, up from $4.207 million at December 31, 2012. Current assets were $8.413 million and current liabilities $7.679 million, yielding working capital of $734,000 and a current ratio of 1.10:1 (1.28:1 excluding $1.120 million of deferred revenue). Total assets were $10.785 million; stockholders’ equity was $3.106 million. The balance sheet presents no debt balance.
Six-month operating cash flow was $2.578 million. Investing activities used $57,000, financing activities used $21,000 for common-stock repurchases, and cash increased by $2.488 million. Management believes 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. The company said it has no significant unused liquid-asset sources.
Changes and management commentary
- Q2 sales fell 3% year over year; six-month sales fell 4%. Hong Kong sales declined 5% in Q2 and 3% for the half-year. Management attributed the comparisons partly to 2012 incentive timing and a June 2012 price increase that may have pulled orders forward.
- Q2 gross margin improved to 75.8%, attributed to lower Russian service-provider and import costs, the Hong Kong product price increase, and newer higher-margin products.
- Q2 SG&A increased 13% to $2.609 million, mainly from employee-related and travel costs; six-month SG&A increased 6% to $5.054 million.
- Active distributors declined by 1,100 year over year. Management is prioritizing Greater China and CIS markets, including Russia, Ukraine and Kazakhstan, and opened a marketing center in Kazakhstan in June 2013.
Outlook, risks and contingencies
No specific revenue or earnings guidance was provided. Management’s liquidity outlook is conditional on no significant unforeseen expense or revenue decline. The business is highly concentrated in Hong Kong/China and exposed to Chinese legal and regulatory uncertainty: the company lacks a China direct-selling license, and it says its Hong Kong e-commerce model could face adverse interpretation or regulatory change. Other stated risks include distributor retention, competition, product acceptance and regulation, foreign exchange, and reliance on third-party manufacturers.
Contingencies include a South Korean consumer-indemnity arrangement with potential claims capped at three months of rolling sales; management considered use of the $88,000 underlying asset remote. No contingent liability was recognized under registration-payment arrangements. A 2.5% royalty agreement for Restor with an entity owned by a director and significant shareholder was entered into in February 2013; $15,000 of royalties was accrued but unpaid for the first half. A proposed similar Soothe royalty agreement remained under discussion.
Outstanding seven-year warrants cover 1,495,952 shares, have a $3.52 exercise price and expire April 21, 2015; exercise could provide funding but dilute shareholders. Management reported disclosure controls effective at June 30, 2013, with no material quarterly change in internal controls. No legal proceedings were reported.
Important facts for investors to verify
- Whether the Hong Kong/China concentration and Chinese regulatory environment affect sales, member activity or the ability to operate.
- Whether lower sales and the decline in active distributors persist, and how incentive programs influence order timing and commission costs.
- Whether the stated 12-month liquidity expectation remains supportable given the $734,000 working-capital balance and management’s assumptions.
- The terms, approvals and ongoing costs of related-party product royalty arrangements, including the proposed Soothe agreement.
- Potential dilution from outstanding warrants and employee stock awards, and the timing and effect of any warrant exercise.