Natural Health Trends Corp. — Q2 2014 Form 10-Q
Reporting period: Three and six months ended June 30, 2014; comparisons are to the corresponding 2013 periods. Unaudited consolidated financial statements. The company sells NHT Global personal care, wellness and quality-of-life products through direct selling and e-commerce. It reported 42,400 active distributors at quarter-end.
Financial performance and liquidity
Amounts below are in U.S. dollars; financial statement amounts are in millions except per-share data.
| Metric | Q2 2014 | Q2 2013 | First half 2014 | First half 2013 |
|---|---|---|---|---|
| Net sales | $34.2 | $10.6 | $57.4 | $19.2 |
| Gross profit | $26.7 | $8.0 | $44.6 | $14.5 |
| Gross margin | 78.0% | 75.8% | 77.7% | 75.1% |
| Operating income | $6.2 | $0.9 | $9.3 | $1.2 |
| Net income | $6.1 | $0.9 | $9.2 | $1.2 |
| Diluted EPS | $0.49 | $0.08 | $0.76 | $0.11 |
- Q2 sales increased 223%; first-half sales increased 198%. Hong Kong sales rose 307% in Q2 and 277% for the first half. Hong Kong accounted for 92.5% of Q2 sales and 90.7% of first-half sales.
- Distributor commissions rose to 45.2% of sales in Q2 and 45.1% in the first half, from 41.9% and 42.2%, respectively, primarily due to the Supreme Bonus incentive program. SG&A increased 93% in Q2 and 86% in the first half, driven by employee costs, incentive accruals and sales-related card fees.
- Management attributed higher gross margins mainly to lower Russian service-provider and import costs as Russian sales formed a smaller share of sales, and more favorable Hong Kong product mix; Hong Kong logistics cost increases partly offset these benefits.
- First-half operating cash flow was $12.8 million, versus $2.6 million a year earlier. Investing cash outflow was $0.1 million; financing cash inflow was $2.4 million, including $2.6 million from warrant exercises and offset by dividends and share repurchases. Cash increased $15.1 million to $29.6 million.
- At June 30, current assets were $34.8 million and current liabilities $19.9 million; working capital was $14.9 million and the current ratio 1.75:1 (2.08:1 excluding deferred revenue). Inventory increased to $4.3 million from $1.8 million at year-end 2013. The balance sheet lists no debt.
- Total assets were $37.5 million and stockholders’ equity $17.7 million at quarter-end. Common shares outstanding were 12.1 million; 748,000 warrants were exercised during the first half for $2.6 million, and 748,069 warrants remained outstanding at June 30, expiring by April 2015.
Outlook, risks and other notable items
- No numerical revenue or earnings guidance was provided. Management said cash on hand and operating cash flow should fund normal operations and commitments for at least 12 months, assuming no significant unforeseen expense or revenue decline.
- The company may invest up to $10.0 million in its Mainland China entity over the next 18 months for manufacturing capabilities, locations and potentially a deposit for a direct-selling license application. It has no China direct-selling license; applications have not materially progressed. Hong Kong represented most sales, with many products delivered to members in China, creating significant regulatory and geographic concentration exposure.
- Management reported political unrest reduced first-half sales in Russia, Kazakhstan and Ukraine by 26% year over year; Q2 CIS-region sales declined 35%. Other key risks include changes in Chinese interpretation or enforcement of laws, foreign-exchange movements, distributor retention and regulatory restrictions on direct selling and product marketing.
- The board declared approximately $124,000 of dividends on July 29, 2014, payable in August. In July, additional warrants for 110,000 shares were exercised for $387,000.
- A director’s related-party company received royalties of $65,000 in the first half under a product license. The company was also considering a proposed royalty arrangement for another product; terms were not finalized.
- Management concluded disclosure controls were effective at June 30, 2014, with no material quarter changes to internal control over financial reporting. The filing reports no legal proceedings.
Important facts for investors to verify
- Whether the exceptional Hong Kong-driven sales growth and distributor expansion are sustainable, and how much sales depend on China-linked activity.
- The effect of higher commission and incentive costs on margins, and whether inventory growth is aligned with demand.
- Progress and potential cost of China investment and licensing plans, including regulatory exposure to cross-border e-commerce and distributor conduct.
- Remaining warrant exercises, related dilution, and the company’s capacity to fund dividends and planned investment while maintaining liquidity.
- Potential terms and governance of the proposed related-party product royalty agreement.