UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
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QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended March 31, 2007
OR
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TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from to
Commission File Number: 0-26272
NATURAL HEALTH TRENDS CORP.
(Exact name of registrant as specified in its charter)
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Delaware
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59-2705336 |
(State or other jurisdiction of
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(I.R.S. Employer |
incorporation or organization)
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Identification No.) |
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2050 Diplomat Drive |
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Dallas, Texas
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75234 |
(Address of principal executive offices)
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(Zip Code) |
Registrants telephone number, including area code: (972) 241-4080
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by
Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for
such shorter period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days. Yes þ No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer or
a non-accelerated filer. See definition of accelerated filer and large accelerated filer in Rule
12b-2 of the Exchange Act. (Check one):
Large accelerated filer o Accelerated filer o Non-Accelerated filer þ
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the
Act). Yes o No þ
At May 8, 2007, the number of shares outstanding of the registrants common stock was 8,809,873
shares.
NATURAL HEALTH TRENDS CORP.
Quarterly Report on Form 10-Q
March 31, 2007
INDEX
FORWARD-LOOKING STATEMENTS
Certain statements contained in this report constitute forward-looking statements within the
meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities
Exchange Act of 1934, as amended. All statements included in this report, other than statements of
historical facts, regarding our strategy, future operations, financial position, estimated
revenues, projected costs, prospects, plans and objectives are forward-looking statements. When
used in this report, the words believe, anticipate, intend, estimate, expect, project,
could, would, may, plan, predict, pursue, continue, feel and similar expressions
are intended to identify forward-looking statements, although not all forward-looking statements
contain these identifying words.
We cannot guarantee future results, levels of activity, performance or achievements, and you
should not place reliance on our forward-looking statements. Our actual results could differ
materially from those anticipated in these forward-looking statements as a result of various
factors, including the risk described in Risk Factors, and elsewhere in this report. Our
forward-looking statements do not reflect the potential impact of any future acquisitions, mergers,
dispositions, joint ventures or strategic investments. In addition, any forward-looking statements
represent our expectation only as of the date of this report and should not be relied on as
representing our expectations as of any subsequent date. While we may elect to update
forward-looking statements at some point in the future, we specifically disclaim any obligation to
do so, even if our expectations change.
Although we believe that the expectations reflected in any of our forward-looking statements
are reasonable, actual results could differ materially from those projected or assumed in any of
our forward-looking statements. Our future financial condition and results of operations, as well
as any forward-looking statements, are subject to change and to inherent risks and uncertainties,
such as those disclosed in this report. Important factors that could cause our actual results,
performance and achievements, or industry results to differ materially from estimates or
projections contained in forward-looking statements include, among others, the following:
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our relationship with our distributors; |
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our need to continually recruit new distributors; |
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our internal controls and accounting methods may require further modification; |
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our need to raise additional capital if revenues continue to decline; |
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risks related to an SEC investigation and securities litigation; |
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adverse consequences from audit committee investigations or management changes; |
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our dependence on our Hong Kong and China market for most of our revenues; |
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regulatory matters governing our products and network marketing system; |
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regulatory matters pertaining to direct-selling laws, particularly in China; |
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our ability to recruit and maintain key management and consultants; |
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adverse publicity associated with our products or direct selling organizations; |
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product liability claims; |
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our reliance on outside manufacturers; |
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risks associated with operating internationally, including foreign exchange risks; |
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product concentration; |
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dependence on increased penetration of existing markets; |
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the competitive nature of our business; and |
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our ability to generate sufficient cash to operate and expand our business. |
Additional factors that could cause actual results to differ materially from our
forward-looking statements are set forth in this report, including under the heading Risk
Factors, Managements Discussion and Analysis of Financial Condition and Results of Operations
and in our financial statements and the related notes.
Forward-looking statements in this report speak only as of the date hereof, and forward
looking statements in documents incorporated by reference speak only as of the date of those
documents. The Company does not undertake any obligation to update or release any revisions to any
forward-looking statement or to report any events or circumstances after the date hereof or to
reflect the occurrence of unanticipated events, except as required by law. Unless otherwise noted,
the terms we, our, us, Company, refer to Natural Health Trends Corp. and its subsidiaries.
PART I FINANCIAL INFORMATION
Item 1. FINANCIAL STATEMENTS
NATURAL HEALTH TRENDS CORP.
CONSOLIDATED BALANCE SHEETS
(In Thousands, Except Share Data)
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December |
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March |
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31, 2006 |
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31, 2007 |
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(Unaudited) |
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ASSETS |
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Current assets: |
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Cash and cash equivalents |
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$ |
11,936 |
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$ |
8,535 |
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Restricted cash |
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455 |
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403 |
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Certificates of deposit |
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1,277 |
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525 |
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Accounts receivable |
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462 |
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272 |
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Inventories, net |
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5,857 |
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4,361 |
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Other current assets |
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2,639 |
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2,331 |
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Total current assets |
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22,626 |
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16,427 |
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Property and equipment, net |
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2,944 |
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2,132 |
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Goodwill |
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14,145 |
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14,145 |
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Intangible assets, net |
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3,400 |
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3,200 |
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Restricted cash |
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4,142 |
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4,785 |
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Deferred tax assets |
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208 |
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205 |
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Other assets |
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1,120 |
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819 |
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Total assets |
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$ |
48,585 |
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$ |
41,713 |
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LIABILITIES AND STOCKHOLDERS EQUITY |
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Current liabilities: |
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Accounts payable |
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$ |
3,424 |
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$ |
3,010 |
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Income taxes payable |
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281 |
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469 |
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Accrued distributor commissions |
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3,852 |
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2,792 |
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Other accrued expenses |
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5,255 |
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5,995 |
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Deferred revenue |
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5,641 |
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4,317 |
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Other current liabilities |
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3,135 |
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3,112 |
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Total current liabilities |
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21,588 |
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19,695 |
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Commitments and contingencies |
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Minority interest |
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22 |
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23 |
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Stockholders equity: |
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Preferred stock, $0.001 par value; 5,000,000 shares authorized; none issued and outstanding |
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Common stock, $0.001 par value; 50,000,000 shares authorized, 8,199,933 shares issued and
outstanding at December 31, 2006 and March 31, 2007 |
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8 |
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8 |
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Additional paid-in capital |
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70,042 |
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70,121 |
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Accumulated deficit |
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(44,128 |
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(49,166 |
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Accumulated other comprehensive income: |
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Foreign currency translation adjustment |
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1,053 |
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1,032 |
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Total stockholders equity |
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26,975 |
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21,995 |
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Total liabilities and stockholders equity |
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$ |
48,585 |
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$ |
41,713 |
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See accompanying notes to consolidated financial statements.
1
NATURAL HEALTH TRENDS CORP.
CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
(In Thousands, Except Per Share Data)
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Three Months Ended |
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March 31, |
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2006 |
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2007 |
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Net sales |
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$ |
39,474 |
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$ |
21,515 |
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Cost of sales |
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8,242 |
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5,697 |
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Gross profit |
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31,232 |
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15,818 |
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Operating expenses: |
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Distributor commissions |
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20,685 |
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10,424 |
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Selling, general and administrative expenses |
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11,555 |
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10,410 |
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Total operating expenses |
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32,240 |
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20,834 |
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Loss from operations |
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(1,008 |
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(5,016 |
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Other income, net |
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159 |
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189 |
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Loss before income taxes and minority interest |
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(849 |
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(4,827 |
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Income tax provision |
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(255 |
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(210 |
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Minority interest |
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(30 |
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(1 |
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Net loss |
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$ |
(1,134 |
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$ |
(5,038 |
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Loss per share: |
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Basic |
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$ |
(0.15 |
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$ |
(0.61 |
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Diluted |
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$ |
(0.15 |
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$ |
(0.61 |
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Weighted-average number of shares outstanding: |
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Basic |
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7,711 |
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8,200 |
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Diluted |
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7,711 |
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8,200 |
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See accompanying notes to consolidated financial statements.
2
NATURAL HEALTH TRENDS CORP.
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(In Thousands)
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Three Months Ended |
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March 31, |
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2006 |
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2007 |
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CASH FLOWS FROM OPERATING ACTIVITIES: |
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Net loss |
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$ |
(1,134 |
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$ |
(5,038 |
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Adjustments to reconcile net loss to net cash provided by (used in) operating activities: |
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Depreciation and amortization of property and equipment |
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232 |
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289 |
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Amortization of intangibles |
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240 |
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200 |
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Minority interest |
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30 |
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1 |
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Stock-based compensation |
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177 |
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79 |
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Imputed interest on KGC installment payable |
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(165 |
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(117 |
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Impairment of long-lived assets |
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532 |
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Deferred income taxes |
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(6 |
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Changes in assets and liabilities: |
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Accounts receivable |
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(30 |
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184 |
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Inventories, net |
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4,276 |
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1,471 |
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Other current assets |
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(1,853 |
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(86 |
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Other assets |
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(52 |
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295 |
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Accounts payable |
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(126 |
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(411 |
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Income taxes payable |
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72 |
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188 |
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Accrued distributor commissions |
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692 |
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(1,043 |
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Other accrued expenses |
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(739 |
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758 |
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Deferred revenue |
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846 |
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(1,301 |
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Other current liabilities |
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308 |
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(9 |
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Net cash provided by (used in) operating activities |
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2,774 |
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(4,014 |
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CASH FLOWS FROM INVESTING ACTIVITIES: |
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Purchases of property and equipment |
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(444 |
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(13 |
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Decrease (increase) in restricted cash |
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129 |
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(587 |
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Decrease in certificate of deposit |
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103 |
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734 |
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Proceeds from KGC receivable |
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507 |
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507 |
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Net cash provided by investing activities |
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295 |
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641 |
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CASH FLOWS FROM FINANCING ACTIVITIES: |
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Payments on debt |
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(20 |
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Proceeds from issuance of common stock |
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18 |
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Net cash used in financing activities |
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(2 |
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Effect of exchange rates on cash and cash equivalents |
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13 |
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(28 |
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Net increase (decrease) in cash and cash equivalents |
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3,080 |
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(3,401 |
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CASH AND CASH EQUIVALENTS, beginning of period |
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18,470 |
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11,936 |
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CASH AND CASH EQUIVALENTS, end of period |
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$ |
21,550 |
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$ |
8,535 |
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See accompanying notes to consolidated financial statements.
3
NATURAL HEALTH TRENDS CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
1. NATURE OF OPERATIONS AND BASIS OF PRESENTATION
Nature of Operations
Natural Health Trends Corp., a Delaware corporation, is an international direct-selling and
e-commerce company headquartered in Dallas, Texas. Subsidiaries controlled by the Company sell
personal care, wellness, and quality of life products under the NHT Global brand to an
independent distributor network that either uses the products themselves or resells them to
consumers.
The Companys majority-owned subsidiaries have an active physical presence in the following
markets: North America, which consists of the United States and Canada; Greater China, which
consists of Hong Kong, Macau, Taiwan and China; Southeast Asia, which consists of Singapore, the
Philippines and Indonesia; Australia and New Zealand; South Korea; Japan; Latin America, which
primarily consists of Mexico; and Slovenia.
Basis of Presentation
The unaudited interim consolidated financial statements have been prepared in accordance with
accounting principles generally accepted in the United States of America for interim financial
information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. As a result,
certain information and footnote disclosures normally included in financial statements prepared in
accordance with accounting principles generally accepted in the United States have been condensed
or omitted. In the opinion of management, the accompanying unaudited interim consolidated
financial statements contain all adjustments, consisting of normal recurring adjustments,
considered necessary for a fair statement of the Companys financial information for the interim
periods presented. The results of operations of any interim period are not necessarily indicative
of the results of operations to be expected for the fiscal year. These consolidated financial
statements should be read in conjunction with the consolidated financial statements and related
notes included in our 2006 Annual Report on Form 10-K filed with the United States Securities and
Exchange Commission (SEC) on March 28, 2007.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation
The consolidated financial statements include the accounts of the Company and all of its
majority-owned subsidiaries. All significant intercompany balances and transactions have been
eliminated in consolidation.
Effective July 1, 2006, the Company sold its equity interests in eKaire.com, Inc. and other
subsidiaries that distribute products under the Kaire brand (collectively, the Kaire Entities).
As a result, the results of operations of the Kaire Entities are not included in the Companys
consolidated statement of operations for the three months ended March 31, 2007.
Use of Estimates
The preparation of financial statements in accordance with accounting principles generally
accepted in the United States of America requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and the disclosure of contingent assets and
liabilities at the date of the consolidated financial statements and the reported amounts of
revenues and expenses during the reported period.
The most significant accounting estimates inherent in the preparation of the Companys
financial statements include estimates associated with note and installment receivables, obsolete
inventory and the fair value of acquired intangible assets, including goodwill, and other
long-lived assets, as well as those used in the determination of liabilities related to sales
returns, distributor commissions, and income taxes. Various assumptions and other factors prompt
the determination of these significant estimates. The process of determining significant estimates
is fact specific and takes into account historical experience and current and expected economic
conditions. The actual results may differ materially and adversely from the Companys estimates.
To the extent that there are material differences between the estimates and actual results, future
results of operations will be affected.
4
Reclassification
Certain balances have been reclassified in the prior year consolidated financial statements to
conform to current year presentation.
Income Taxes
Effective January 1, 2007, the Company adopted the provisions of FASB Interpretation No. 48,
Accounting for Uncertainty in Income Taxes an Interpretation of FASB Statement No. 109 (FIN
48). FIN 48 requires the Company to recognize in its financial statements the impact of a tax
position if that position is more likely than not of being sustained on audit, based on the
technical merits of the position. The adoption of FIN 48 did not materially affect the
consolidated financial statements and, as a result, the Company did not record any cumulative
effect adjustment upon adoption.
As of the date of adoption, the Company does not have any unrecognized tax benefits for
uncertain tax positions. Interest and penalties on tax uncertainties are classified as a component
of income tax expense. The total amount of interest and penalties accrued as of the date of
adoption were not significant. In addition, the total amount of interest and penalties recorded in
the consolidated statements of operations during the three months ended March 31, 2006 and 2007
were not significant.
The Company and its subsidiaries file income tax returns in the United States, various states,
and foreign jurisdictions. The Company is no longer subject to U.S. federal income tax
examinations for years prior to 2003, and is no longer subject to state income tax examinations for
years prior to 2001. No jurisdictions are currently examining any income tax returns of the
Company or its subsidiaries.
Revenue Recognition
Product sales are recorded when the products are shipped and title passes to independent
distributors. Product sales to distributors are made pursuant to a distributor agreement that
provides for transfer of both title and risk of loss upon our delivery to the carrier that
completes delivery to the distributors, which is commonly referred to as F.O.B. Shipping Point.
The Company primarily receives payment by credit card at the time distributors place orders.
Amounts received for unshipped product are recorded as deferred revenue. The Companys sales
arrangements do not contain right of inspection or customer acceptance provisions other than
general rights of return.
Actual product returns are recorded as a reduction to net sales. The Company estimates and
accrues a reserve for product returns based on its return policies and historical experience.
Enrollment package revenue, including any nonrefundable set-up fees, is deferred and
recognized over the term of the arrangement, generally twelve months. Enrollment packages provide
distributors access to both a personalized marketing website and a business management system. No
upfront costs are deferred as the amount is nominal.
Shipping charges billed to distributors are included in net sales. Costs associated with
shipments are included in cost of sales.
Various taxes on the sale of products and enrollment packages to distributors are
collected by the Company as an agent and remitted to the respective taxing authority. These taxes
are presented on a net basis and recorded as a liability until remitted to the respective taxing
authority.
Income Per Share
Basic income per share is computed by dividing net income applicable to common stockholders by
the weighted-average number of common shares outstanding during the period. Diluted income per
share is determined using the weighted-average number of common shares outstanding during the
period, adjusted for the dilutive effect of common stock equivalents, consisting of shares that
might be issued upon the exercise of outstanding stock options and warrants. In periods where
losses are reported, the weighted-average number of common shares outstanding excludes common stock
equivalents because their inclusion would be anti-dilutive.
The dilutive effect of stock options and warrants is reflected by application of the treasury
stock method. Under the treasury stock method, the amount the employee must pay for exercising
stock options, the amount of compensation cost for future service that the Company has not yet
recognized, and the amount of tax benefit that would be recorded in additional paid-in capital when
the award becomes deductible are assumed to be used to repurchase shares. The potential tax
benefit derived from exercise of non-qualified stock options has been excluded from the treasury
stock calculation as the Company is uncertain that the benefit will be realized.
5
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|
|
|
|
Three Months Ended March 31, |
|
|
|
2006 |
|
|
2007 |
|
|
|
(In Thousands, Except Per Share Data) |
|
Net loss |
|
$ |
(1,134 |
) |
|
$ |
(5,038 |
) |
|
|
|
|
|
|
|
|
|
Basic weighted-average number of shares outstanding |
|
|
7,711 |
|
|
|
8,200 |
|
Effect of dilutive stock options and warrants |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Diluted weighted-average number of shares outstanding |
|
|
7,711 |
|
|
|
8,200 |
|
|
|
|
|
|
|
|
Loss per share: |
|
|
|
|
|
|
|
|
Basic |
|
$ |
(0.15 |
) |
|
$ |
(0.61 |
) |
Diluted |
|
$ |
(0.15 |
) |
|
$ |
(0.61 |
) |
Options and warrants to purchase 1,942,124 and 1,080,504 shares of common stock, respectively,
were outstanding during the three months ended March 31, 2006, but were not included in the
computation of diluted income per share because of the net loss reported for the period.
Options and warrants to purchase 1,041,458 and 1,080,504 shares of common stock, respectively,
were outstanding during the three months ended March 31, 2007, but were not included in the
computation of diluted income per share because of the net loss reported for the period. Options
for 821,791 shares of common stock, with expirations through June 23, 2014, were still outstanding
at March 31, 2007. Such warrants expire on October 6, 2009.
Recent Accounting Pronouncements
In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements, which defines fair
value, establishes a framework for measuring fair value in generally accepted accounting principles
(GAAP), and expands disclosures about fair value measurements. SFAS No. 157 is effective for
financial statements issued for fiscal years beginning after November 15, 2007. The Company is
currently evaluating the impact, if any, the adoption of SFAS No. 157 will have on its consolidated
financial statements.
3. SHARE-BASED COMPENSATION
Share-based compensation expense totaled of approximately $177,000 and $79,000 for the three
months ended March 31, 2006 and 2007, respectively. No tax benefits were attributed to the
share-based compensation because a valuation allowance was maintained for substantially all net
deferred tax assets.
During the three months ended March 31, 2006, the Company granted 20,000 stock options with a
weighted-average fair value of $5.67 per share. The fair value of each option grant was estimated
on the date of grant with the following weighted-average assumptions: expected life of 3.1 years,
risk-free interest rate of 4.6%, expected volatility of 92%, and dividend yield of zero. No stock
options were granted during the three months ended March 31, 2007.
A summary of the status and activity of the Companys stock option awards is as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Wtd. Avg. |
|
|
|
|
|
|
|
|
|
|
Wtd. Avg. |
|
|
Remaining |
|
|
Aggregate |
|
|
|
|
|
|
|
Exercise |
|
|
Contractual |
|
|
Intrinsic |
|
|
|
Shares |
|
|
Price |
|
|
Life |
|
|
Value1 |
|
Outstanding at December 31, 2006 |
|
|
1,041,458 |
|
|
$ |
8.88 |
|
|
|
|
|
|
|
|
|
Granted |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Exercised |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Forfeited or expired |
|
|
(219,667 |
) |
|
|
3.56 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding at March 31, 2007 |
|
|
821,791 |
|
|
|
10.30 |
|
|
|
3.6 |
|
|
|
56,000 |
|
Vested and expected to vest at March 31, 2007 |
|
|
804,160 |
|
|
|
10.38 |
|
|
|
3.6 |
|
|
|
56,000 |
|
Exercisable at March 31, 2007 |
|
|
547,458 |
|
|
|
12.83 |
|
|
|
3.3 |
|
|
|
48,000 |
|
|
|
|
1 |
|
Aggregate intrinsic value represents the
total pretax intrinsic value (the difference between the closing price of the
Companys common stock on the last trading day for the date indicated and
the exercise price, multiplied by the number of in-the-money options) that
would have been received by our option holders had all option holders exercised
their options on the date indicated. |
6
The total intrinsic value of stock options exercised during the three months ended March 31,
2006 was $9,701,000. As of March 31, 2007, total unrecognized share-based compensation expense
related to non-vested stock options was approximately $747,000, which is expected to be recognized
over a weighted-average period of 2.1 years.
4. COMPREHENSIVE INCOME (LOSS) (In Thousands)
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended March 31, |
|
|
|
2006 |
|
|
2007 |
|
Net loss |
|
$ |
(1,134 |
) |
|
$ |
(5,038 |
) |
Other comprehensive income (loss), net of tax: |
|
|
|
|
|
|
|
|
Foreign currency translation adjustment |
|
|
138 |
|
|
|
(21 |
) |
|
|
|
|
|
|
|
Total comprehensive loss |
|
$ |
(996 |
) |
|
$ |
(5,059 |
) |
|
|
|
|
|
|
|
5. CONTINGENCIES
Legal Matters
During the fall of 2003, the customs agency of the government of South Korea brought a charge
against NHTK Ltd. (NHTK), formerly LXK, Ltd., the Companys wholly-owned subsidiary operating in
South Korea, with respect to the importation of the Companys Alura product. The customs agency
alleged that Alura is not a cosmetic product, but rather should be categorized and imported as a
pharmaceutical product. On February 18, 2005, the Seoul Central District Court ruled against NHTK
and fined it a total of 206.7 million Korean won (approximately $217,000 at March 31, 2007). NHTK
also incurred related costs of 40.0 million Korean won (approximately $42,000 at March 31, 2007) as
a result of the judgment. The Company recorded a reserve for the entire 246.7 million Korean won
at December 31, 2004 and appealed the ruling. On May 10, 2006, an intermediate court of appeals
issued a ruling that the Company believes reversed that part of the judgment that had imposed 186.7
million Korean won of the fine, but upheld the fine of 20.0 million Korean won (which has already
been paid) and the ruling that Alura cannot be imported as a cosmetic product. NHTK has filed an
appeal of this ruling with the Korean Supreme Court. The Company has been unable to determine with
certainty that it will not be subject to the fine of 186.7 million Korean won if the appeal is
unsuccessful, and will therefore continue to reserve 226.7 million Korean won (approximately
$238,000 at March 31, 2007). The inability to sell Alura in South Korea if the appeal is
unsuccessful is not anticipated to have a material adverse effect on the financial condition,
results of operations, and cash flow or business prospects of NHTK.
On or around March 31, 2004, the Companys U.S. subsidiary, NHT Global, Inc. (NHT Global
U.S.), received a letter from John Loghry, a former NHT Global distributor, alleging that NHT
Global U.S. had breached its distributorship agreement with Mr. Loghry and that the Company had
breached an agreement to issue shares of the Companys common stock to Mr. Loghry. On May 13,
2004, NHT Global U.S. and the Company filed an action against Mr. Loghry in the United States
District Court for the Northern District of Texas (the Loghry Case) for disparagement and to
declare that they were not liable to Mr. Loghry on his alleged claims. Mr. Loghry filed
counterclaims against the Company and NHT Global U.S. for fraud and breach of contract, as well as
related claims of fraud, tortuous interference and conspiracy against Mark Woodburn, former
President and director of the Company, and Terry LaCore, former Chief Executive Officer of NHT
Global U.S. and former director of the Company, and an NHT Global distributor. In February 2005,
the court dismissed all of Mr. Loghrys claims against the individual defendants, except the claims
for fraud and conspiracy to commit fraud. Mr. Loghry then filed amended counterclaims and, on June
2, 2005, the Company and the other counterclaim defendants moved to dismiss the counterclaims on
the grounds that the claims were barred by Mr. Loghrys failure to disclose their existence when he
filed for personal bankruptcy in September 2002. On June 30, 2005, the U.S. Bankruptcy Court for
the District of Nebraska granted Mr. Loghrys request to reopen his bankruptcy case. On September
6, 2005, the United States Trustee filed an action in the U.S. District Court for the District of
Nebraska (the Trustees Case) asserting Mr. Loghrys claims against the same defendants. On
February 21, 2006, the Trustees Case was transferred to the United States District Court for the
Northern District of Texas. On December 27, 2006, the Loghry Case and the Trustee Case were
consolidated. On April 23, 2007, the District Court granted motions for summary judgment that
Loghrys claims be dismissed for lack of standing. The Company continues to deny the allegations
by the United States Trustee and intends to vigorously contest his claims. An unfavorable judgment
could have a material adverse effect on the financial condition, results of operations, or cash
flows of the Company.
On September 11, 2006, a putative class action lawsuit was filed by The Rosen Law Firm P.A.
purportedly on behalf of certain purchasers of the Companys common stock to recover damages caused
by alleged violations of federal securities laws. The lawsuit
7
names the Company and certain current and former officers and directors as defendants. On
December 20, 2006, the court granted an unopposed motion to designate The Rosen Law Firm P.A. as
lead counsel. On February 18, 2007, the plaintiffs filed an amended complaint. On April 23, 2007,
the Company filed a Motion to Dismiss. The Company intends to vigorously defend this lawsuit.
On February 9, 2007, the Company and NHT Global U.S. received a demand letter for $229,750
from a former distributor who claims to have wire transferred this amount to NHT Global U.S. in
2004 for products that were not delivered and for exclusive sales rights in England and Japan that
were not honored. The Company is investigating this claim.
In August 2006, the Company was advised by the Staff of the SEC that it was conducting an
informal inquiry into matters that are the subject of previously disclosed investigations by the
Companys Audit Committee, including the payments received by Messrs. Mark Woodburn and Terry
LaCore from an independent distributor. In connection with the inquiry, the Staff of the SEC
requested that the Company voluntarily provide it with certain information and documents, including
information gathered by the independent investigator engaged by the Companys Audit Committee. The
Company voluntarily cooperated with this inquiry. On October 20, 2006, the Company received a
formal order of investigation issued by the SEC regarding possible securities laws violations by
the Company and/or other persons. At this time, it is not possible to predict the outcome of the
investigation nor is it possible to assess its impact on the Company. The Company has been
cooperating fully with the SEC with respect to its investigation.
Currently, there is no other significant litigation pending against the Company other than as
disclosed in the paragraphs above. From time to time, the Company may become a party to litigation
and subject to claims incident to the ordinary course of the Companys business. Although the
results of such litigation and claims in the ordinary course of business cannot be predicted with
certainty, the Company believes that the final outcome of such matters will not have a material
adverse effect on the Companys business, results of operations or financial condition. Regardless
of outcome, litigation can have an adverse impact on the Company because of defense costs,
diversion of management resources and other factors.
6. RELATED PARTY TRANSACTIONS
In August 2001, the Company entered into a written lease agreement and an oral management
agreement with S&B Business Services, an affiliate of Brad LaCore, the brother of Terry LaCore,
former Chief Executive Officer of NHT Global U.S. and director of the Company, and Sherry LaCore,
Brad LaCores spouse. Under the terms of the two agreements, S&B Business Services provided
warehouse facilities and certain equipment, managed and shipped inventory, provided independent
distributor support services and disbursed payments to independent distributors. In exchange for
these services, the Company paid $18,000 annually for leasing the warehouse, $3,600 annually for
the lease of warehouse equipment and $120,000 annually for the management services provided, plus
an annual average of approximately $12,000 for business related services. The Company paid S&B
Business Services approximately $15,000 during the three month period ended March 31, 2006. No
amounts were paid during the three months ended March 31, 2007.
The payment disbursement function was transferred to the Companys Dallas head office during
the third quarter of 2005. In January 2006, the Company hired Sherry LaCore as an employee and
simultaneously terminated the oral management agreement with S&B Business Services. Additionally,
the Company closed the warehouse facility by the end of March 2006 and terminated the related lease
agreement.
In connection with its acquisition of MarketVision Communications Corporation (MarketVision)
in 2004, the Company entered into a software license agreement (the Software License Agreement),
with MarketVision Consulting Group, LLC, a limited liability company owned by John Cavanaugh, the
President of MarketVision, and Jason Landry, a Vice President of MarketVision (the Licensee).
Upon an Event of Default (as defined), the Software License Agreement grants, among other things,
the Licensee with an irrevocable, exclusive, perpetual, royalty free, fully-paid, worldwide,
transferable, sublicensable right and license to use, copy, modify, distribute, rent, lease,
enhance, transfer, market, and create derivative works to the MarketVision software. An Event of
Default under the Software License Agreement includes a Share Default, which is defined as the
market value per share of the Company failing to equal or exceed $10.00 per share for any one
rolling period of six months for a certain period following the acquisition of MarketVision. The
last time that the Companys stock closed at or above $10.00 per share was February 16, 2006, and a
Share Default would otherwise have occurred on August 17, 2006. The parties to the Software
License Agreement amended that agreement to provide that no Share Default will occur prior to
December 31, 2006. No further amendments have been entered into, and as a result, the Company is
currently in default.
Although an Event of Default has occurred, the Company believes that it continues to have the
right to continue using the MarketVision software for its internal use only and not as an
application service provider or service bureau, but may not rent, lease, license, transfer or
distribute the software without the Licensees prior written consent. Moreover, the Company
believes that it has the right to receive certain application service provider services from
Licensee, if it chooses to do so. The Company does not believe that the occurrence of the Event of
Default has had or will have a material adverse effect on the Company.
8
A former director of the Companys China subsidiary is the sole director of Access Intl
(Zhuhai Ftz) Warehousing & Trading Co. Ltd. and its group (collectively, Access), a
transportation and logistics company, and the owner of Info Development Ltd. (Info), an import
services company, both of which provided services to the Companys Hong Kong subsidiary. Payments
totaling approximately $185,000 and $64,000 were paid to Access and Info during the first three
months of 2006, respectively. Payments totaling approximately $90,000 were paid to Info during the
first three months of 2007. At March 31, 2007, approximately $20,000 was due to Info.
On March 23, 2006, an independent investigator retained by the Audit Committee of the Board of
Directors confirmed that affiliates of immediate family members of Mark Woodburn, former President
and director of the Company, have owned since 1998, and continued to own on March 23, 2006, equity
interests in Aloe Commodities (Aloe), the largest manufacturer of the Company and the supplier of
the Skindulgence® Line and LaVie products, representing approximately 5% of the outstanding shares
of Aloe. The Company paid Aloe and certain of its affiliates approximately $51,000 during the
first three months of 2007. No amounts were paid during the first three months of 2006. At March
31, 2007, approximately $432,000 was due to Aloe and certain of its affiliates.
On February 10, 2006, the Company entered into an escrow agreement (the Escrow Agreement)
with Messrs. Woodburn and LaCore, the LaCore and Woodburn Partnership, an affiliate of Messrs.
Woodburn and LaCore, and Krage and Janvey LLP, as escrow agent (the Agent). Pursuant to the
Escrow Agreement, (i) the Company issued and deposited with the Agent stock certificates in the
name of the Agent representing an aggregate of 1,081,066 shares of the Companys common stock (the
Escrowed Shares) and (ii) Messrs. Woodburn and LaCore deposited with the Agent $1,206,000 in cash
(the Cash Deposit). The Escrowed Shares are the shares of common stock issuable upon the
cashless exercise of stock options issued in 2001 and 2002 to Mr. LaCore and the LaCore and
Woodburn Partnership for 1,200,000 shares of common stock exercisable at $1.00 and $1.10 per share.
The number of Escrow Shares is based upon the closing price of the Companys common stock on
February 9, 2006 of $10.14 and the surrender of 118,934 option shares as payment of the aggregate
exercise price of $1,206,000.
The Escrowed Shares were issued to the Agent upon receipt from the Agent of an irrevocable
proxy to the Company to vote the Escrowed Shares on matters presented at meetings of stockholders
or written consents executed in lieu thereof. The parties also agreed that the Agent will hold the
Escrowed Shares and the Cash Deposit until it receives (i) joint written instructions from the
Company, Messrs. Woodburn and LaCore, or (ii) a final non-appealable order from a court of
competent jurisdiction.
On October 31, 2006, the Company, Messrs. Woodburn and LaCore entered into several agreements
(collectively, the Settlement Agreements), pursuant to which they resolved certain pending
disputes among the parties relating to, among other things, payments to Messrs. Woodburn and LaCore
from certain positions in the Companys distribution tree, as follows:
|
(a) |
|
Under the main Settlement Agreement, (i) Messrs. Woodburn and LaCore made a
non-recourse promise to repay the Company $2.5 million (the Payment Amount) no later than
October 31, 2008, (ii) the Company agreed to release the Cash Deposit to Mr. LaCore and the
Escrowed Shares to Messrs. Woodburn and LaCore (subject to the pledge described below),
(iii) Mr. LaCore agreed to provide the Company with assistance for up to 10 hours per month
with respect to network marketing, compensation plan adjustments and strategic planning
assistance during the one-year period ending October 31, 2007, (iv) Messrs. Woodburn and
LaCore agreed to certain restrictions on their activities, and (v) the parties agreed to
enter into the other Settlement Agreements described below. |
|
|
(b) |
|
Messrs. Woodburn and Mr. LaCore signed a Non-Recourse Promissory Note to pay the
Payment Amount plus interest at the rate of 6% per annum, secured by a pledge of the
released Escrow Shares. At any time, Messrs. LaCore and Woodburn may elect to repay all or
part of the Note by delivering a number of Pledged Shares based upon the Fair Market Value
(as defined in the Note) of such shares. The Company may also elect at any time to have
all or part of the Note repaid by requiring the surrender of a number of Pledged Shares
having a Fair Market Value equal to the repayment amount. In no event shall Messrs. LaCore
and/or Woodburn be obligated to repay an amount due under the Note in excess of the Fair
Market Value of the Pledged Shares. Given the uncertainty of the Payment Amount that will
ultimately be realized, the Company will not recognize any Payment Amount in its financial
statements until it is received or until the Pledged Shares are surrendered. |
|
|
(c) |
|
The Company and Mr. Woodburn entered into a Consulting Agreement, pursuant to which Mr.
Woodburn agreed for a one-year period to assist the Company as a consultant with general
administration, accounting, finance and strategic planning. Mr. Woodburn will be paid
$17,000 per month plus reimbursement of bona fide business expenses approved in advance in
writing by the Company. If Mr. Woodburn is terminated without Cause (as defined in the
Consulting Agreement), he will be entitled to continue to receive his monthly retainer fee
for the remainder of the term, unless he breaches the terms of his Restricted Activity
Agreement (described below) or otherwise engages in a Competitive Activity (as defined in
the Restricted Activity Agreement). Mr. Woodburn is permitted to engage in certain
consulting activities for third parties that will not constitute Cause under the Consulting
Agreement. |
9
|
(d) |
|
The Company and Messrs. LaCore and Woodburn entered into a Voting Agreement covering
all shares of Company capital stock beneficially owned by them or shares acquired by them
during the three year period ending October 31, 2009. All of such shares shall be voted by
the Companys Board of Directors, or such third party that is reasonably acceptable to each
of the Company, Messrs. LaCore and Woodburn. |
|
|
(e) |
|
Each of Messrs. LaCore and Woodburn signed a Restricted Activity and Proprietary Rights
Assignment Agreements, pursuant to which they each agreed to keep confidential or
competitively sensitive information confidential and to disclose and assign to the Company
any Work Product (as defined in the agreements). During the one year period ending October
31, 2007, Mr. LaCore agreed not to directly or indirectly (i) recruit or solicit any
company personnel or independent distributors, or (ii) perform any services for any
independent distributor of the Company (the Covenant Not to Interfere). During the term
of his Consulting Agreement with the Company and continuing through the one year period
following the receipt of his last monthly consulting fee or severance payment, Mr. Woodburn
has also agreed to the Covenant Not to Interfere. In addition, except for Permitted
Consulting Arrangements (as hereinafter defined), during the one year period ending on
October 31, 2007, Mr. Woodburn has agreed not engage in any activity which competes with
any substantial aspect or part of the Companys business (or any affiliate thereof).
Permitted Consulting Arrangements means any consulting or similar arrangement or
agreement between Woodburn and any third party so long as Woodburn delivers to the Company
not less than 10 business days prior to the commencement of service a written notice that
describes the terms and conditions of the proposed consulting arrangement. |
|
|
(f) |
|
The Company, Messrs. LaCore and Woodburn entered into an Indemnification Agreement,
pursuant to which each of Messrs. LaCore and Woodburn agreed as to his individual conduct
to indemnify and hold harmless the Company and its affiliates for his conduct except for
(i) Specified Conduct (as defined), and (ii) conduct for which Messrs. LaCore or Woodburn,
as the case may be, is entitled to indemnification from the Company under the Companys
certificate of incorporation, by-laws and Delaware law. |
|
|
(g) |
|
The Company executed a limited release in favor of Messrs. LaCore and Woodburn with
respect to all charges, claims, causes of action and demands related to their (i)
directing, accepting, or permitting payments to or from certain positions in the Companys
distributor tree from January 1, 2001 through the date of the release, (ii) any related
party transactions relating or pertaining to Messrs. LaCore or Woodburn that were
previously disclosed in the Companys public filings, and (iii) any disclosures made or
omitted, if any, relating or pertaining to any of the foregoing conduct (collectively, the
Specified Conduct). |
|
|
(h) |
|
Messrs. LaCore and Woodburn executed a general release in favor of the Company and its
affiliates, including present and former stockholders, officers, directors, shareholders,
employees, and representatives with respect to all charges, claims, causes of action and
demands of any nature, known or unknown, which Messrs. LaCore or Woodburn had or may have
in the future, except with respect to the Companys obligations under the Settlement
Agreements. |
In connection with the execution of the Settlement Agreements, the Company, Mr. LaCore, Mr.
Woodburn, and the Escrow Agent terminated the Escrow Agreement.
On March 21, 2007, the Company entered into a temporary week-to-week agreement with Mr. LaCore
to administer certain distributor positions at the top of the Companys distribution network tree
and commissions accrued and payable to those positions for periods beginning on and after February
12, 2007. These are the same positions held by the distributor that indirectly made the payments
to Messrs. Woodburn and LaCore that were discovered by the Audit Committees independent
investigator on November 10, 2005 (as previously disclosed). Under the temporary agreement, Mr.
LaCore is expected to provide certain master distributor services and provide leadership and
support to the Companys other distributors, all of whom are down-lines of the positions being
temporarily administered by Mr. LaCore. In return, the Company pays the commissions generated by
these positions under the Companys distributor compensation plan to Mr. LaCore, who in turn must
pay some or all of the commissions to other distributors downline. The total amount of gross
commissions that the Company will pay to Mr. LaCore for administration of these positions under
this temporary arrangement is uncertain, as the amount of commissions varies from week to week.
The amount of gross commissions paid to Mr. LaCore for temporary administration of these positions
for the period beginning Feb. 12, 2007 and ending March 31, 2007 was approximately $107,000. The
Company is currently considering various longer term arrangements with Mr. LaCore.
10
7. SUBSEQUENT EVENTS
Executive Officer Employment Agreements
Following recommendation by the Compensation Committee and approval by the Board of Directors
of the Company, on April 23, 2007 the Company entered into employment agreements (the Executive
Employment Agreements) with each of the following executive officers of the Company (each an
Executive Officer): Chris T. Sharng, President; Timothy S. Davidson, Chief Financial Officer and
Senior Vice President; Gary C. Wallace, General Counsel, Chief Ethics and Compliance Officer and
Secretary; and Curtis Broome, Worldwide President of NHT Global.
Under the Executive Employment Agreements, each Executive Officer remains an at will
employee of the Company, and either the Executive Officer or the Company can terminate the
employment relationship at any time upon four weeks notice to the other party. The applicable
Executive Employment Agreement for each of Messrs. Sharng, Davidson, Wallace and Broome provides
for an annual base salary of $250,000, $180,000, $190,000 and $250,000, respectively. The base
salary for each Executive Officer is subject to a minimum 3% annual increase each January 1st.
Each Executive Officer is also entitled to participate in the Companys annual incentive plan,
equity incentive plan and other standard U.S. employee benefit programs.
Under the Executive Employment Agreements, each Executive Officer will be entitled to
severance benefits in the event that the Executive Officers employment is terminated by the
Company without Cause (as defined in the Executive Employment Agreements) or in connection with a
Change of Control (as defined in the Executive Employment Agreements). Each Executive Officer is
also entitled to severance benefits in the event that the Executive Officer terminates his
employment for Good Reason (as defined in the Executive Employment Agreements). Each Executive
Officer shall, following an event triggering severance benefits, receive as severance the
continuation of his base salary, as well as the continuation of certain health and medical
benefits, for a period of one year for a termination without Cause or for Good Reason, and for a
period of two years for a termination in connection with a Change of Control.
The Executive Employment Agreements for Messrs. Sharng and Broome provide the following
provisions in addition to those set forth above:
|
|
|
The Company has agreed to appoint Mr. Sharng to the Companys board of directors by no
later than October 2007; provided, however, that if Mr. Sharng is, at any time, no longer
an employee of the Company he agrees to resign from the Companys board of directors. |
|
|
|
|
Mr. Broome is entitled to a housing and living allowance of $80,000 per annum (subject
to periodic adjustment) for the period of time during which he resides in Hong Kong. |
In connection with the Executive Employment Agreements, each of the Executive Officers has
entered into a Non-Competition and Proprietary Rights Assignment Agreement, pursuant to which each
Executive Officer has agreed (i) to keep certain Company information confidential, (ii) to assign
the rights to certain work product to the Company and (iii) not to compete with the Company or
solicit Company customers or distributors during the term of his employment and for six months
thereafter.
Restricted Stock Grants
Following approval by the Compensation Committee, on April 21, 2007 the Company granted
609,940 shares of restricted stock under the Companys 2007 Equity Incentive Plan to the Companys
Executive Officers, directors and other key employees. Those grants of restricted stock to the
Companys Executive Officers and key employees vest quarterly on a pro rata basis over a three-year
period. The restricted stock granted to the Companys directors vest immediately. The following
numbers of shares of restricted stock were granted to the Companys Executive Officers: Mr.
Sharng, 111,900 shares; Mr. Davidson, 25,000 shares; Mr. Wallace, 25,000 shares; Mr. John
Cavanaugh, President of MarketVision, 99,400 shares; and Mr. Broome, 84,400 shares.
Sale of Preferred Stock
On May 4, 2007, the Company consummated a private equity placement generating gross proceeds
of approximately $3.0 million. The financing consisted of the sale of 1,759,307 shares of the
Companys Series A convertible preferred stock at a price of $1.70 per share. The preferred stock
is convertible at the election of the holder into an equivalent number of shares of common stock.
The financing also included the sale of warrants evidencing the right to purchase 1,759,307 shares
of the Companys common stock at a purchase price of $0.00001 per underlying share of common stock.
The warrants are exercisable at any time during the period beginning six months after their
issuance and ending six years following their issuance. The exercise price of the warrants varies
from $3.80 to $5.00 per share, depending on the time of exercise. In connection with the
financing, the Company agreed, subject to certain terms and conditions, to exercise its reasonable
best efforts to register for resale under the Securities Act of 1933 the shares of
common stock issuable upon conversion of the preferred stock and exercise of the warrants.
The Company plans to use the net proceeds from the financing to provide additional working capital.
11
Item 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Business Overview
We are an international direct-selling and e-commerce company. Subsidiaries controlled by us
sell personal care, wellness, and quality of life products under the NHT Global brand to an
independent distributor network that either uses the products themselves or resells them to
consumers.
As of March 31, 2007, we are conducting business in at least 15 countries through
approximately 82,000 active distributors. We consider a distributor active if they have placed
at least one product order with us during the preceding year. Although we have experienced
significant revenue growth in prior years due in part to our efforts to expand into new markets, we
do not intend to devote material resources to opening any additional foreign markets in 2007. Our
priority for the remainder of 2007 is to focus our resources in our most promising markets, namely
Greater China, South Korea and Europe. Sales into the European market are currently fulfilled by
our North American subsidiaries.
During the year 2006 and the first three months of 2007, we generated approximately 89% of our
revenue from subsidiaries located outside North America, with sales in Hong Kong representing
approximately 67% and 62% of revenue, respectively. Because of the size of our foreign operations,
operating results can be impacted negatively or positively by factors such as foreign currency
fluctuations, and economic, political and business conditions around the world. In addition, our
business is subject to various laws and regulations, in particular regulations related to direct
selling activities that create certain risks for our business, including improper claims or
activities by our distributors and potential inability to obtain necessary product registrations.
China is currently the Companys most important business development project. While
multi-level marketing was previously banned in China, new direct selling legislation was adopted in
December 2005. Before the formal adoption of direct selling laws, certain approved domestic and
international direct selling companies operated in China in a retail format. In June 2004, NHT
Global obtained a general business license in China. The license stipulates a capital requirement
of $12.0 million over a three-year period, including a $1.8 million initial payment that the
Company made in January 2005. In December 2005, the Company submitted a preliminary application
for a direct selling license and fully capitalized its Chinese entity with the remaining capital
necessary to fulfill the $12.0 million required cash infusion. In June 2006, the Company submitted
a final application package. By the end of the second quarter of 2007, we plan to launch a new
e-commerce retail platform in China that does not require a direct selling license and is separate
and distinct from our current worldwide platform. We believe this model, which offers discounts
based on volume purchases, will encourage repeat purchases of our products for personal consumption
in the Chinese market. The platform is designed to be in compliance with our understanding of
current laws and regulations in China. We believe a direct selling license would enhance the
business conducted in China under the proposed e-commerce retail platform. The Company is unable
to predict whether it will be successful in obtaining a direct selling license to operate in China,
and if it is successful, when it will be permitted to enhance its e-commerce retail platform with
direct selling operations.
Most of the Companys Hong Kong revenues are derived from the sale of products that are
delivered to members in China. After consulting with outside professionals, the Company believes
that our Hong Kong e-commerce business does not violate any applicable laws in China even though it
is used for the internet purchases of our products by buyers in China. But the government in China
could, in the future, officially interpret its laws and regulations or adopt new laws and
regulations to prohibit some or all of our e-commerce activities with China and, if our members
engage in illegal activities in China, those actions could be attributable to us.
12
Income Statement Presentation
The Company derives its revenue from sales of its products, sales of its enrollment packages,
and from shipping charges. Substantially all of its product sales are to independent distributors
at published wholesale prices. We translate revenue from each markets local currency into U.S.
dollars using average rates of exchange during the period. The following table sets forth revenue
by market and product line for the time periods indicated (in thousands).
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended March 31, |
|
|
|
|
2006 |
|
|
|
2007 |
|
|
|
|
North America |
|
$ |
3,006 |
|
|
|
7.6 |
% |
|
$ |
2,275 |
|
|
|
10.6 |
% |
Hong Kong |
|
|
29,120 |
|
|
|
73.8 |
|
|
|
13,346 |
|
|
|
62.0 |
|
Taiwan |
|
|
766 |
|
|
|
1.9 |
|
|
|
1,244 |
|
|
|
5.8 |
|
Southeast Asia |
|
|
263 |
|
|
|
0.7 |
|
|
|
241 |
|
|
|
1.1 |
|
South Korea |
|
|
2,687 |
|
|
|
6.8 |
|
|
|
2,723 |
|
|
|
12.7 |
|
Australia/New Zealand |
|
|
309 |
|
|
|
0.8 |
|
|
|
235 |
|
|
|
1.1 |
|
Japan |
|
|
1,812 |
|
|
|
4.6 |
|
|
|
741 |
|
|
|
3.4 |
|
Latin America |
|
|
1,148 |
|
|
|
2.9 |
|
|
|
365 |
|
|
|
1.7 |
|
Other |
|
|
|
|
|
|
|
|
|
|
345 |
|
|
|
1.6 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total NHT Global |
|
|
39,111 |
|
|
|
99.1 |
|
|
|
21,515 |
|
|
|
100.0 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
North America |
|
|
265 |
|
|
|
0.7 |
|
|
|
|
|
|
|
|
|
Australia/New Zealand |
|
|
98 |
|
|
|
0.2 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total eKaire2 |
|
|
363 |
|
|
|
0.9 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
39,474 |
|
|
|
100 |
% |
|
$ |
21,515 |
|
|
|
100 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2 |
|
The Company no longer consolidates the
operating results of the eKaire.com and other subsidiaries that distribute
Kaire branded products (the Kaire Entities) for
periods beginning after June 30, 2006 as it sold its interests in the Kaire
Entities to Kaire International (Canada) Ltd. effective July 1, 2006. |
13
Cost of sales consist primarily of products purchased from third-party manufacturers, freight
cost for shipping products to distributors, import duties, costs of promotional materials sold to
the Companys distributors at or near cost, and provisions for slow moving or obsolete inventories.
Cost of sales also includes purchasing costs, receiving costs, inspection costs and warehousing
costs.
Distributor commissions are our most significant expense and are classified as an operating
expense. Under our compensation plan, distributors are paid weekly commissions in the
distributors home country, in their local currency, for product sold by that distributors
down-line distributor network across all geographic markets. Distributors are not paid commissions
on purchases or sales of our products made directly by them. This seamless compensation plan
enables a distributor located in one country to sponsor other distributors located in other
countries where we are authorized to do business. Currently, there are two fundamental ways in
which our distributors can earn income:
|
|
|
Through retail markups on sales of products purchased by distributors at wholesale prices; and |
|
|
|
|
Through a series of commissions paid on product purchases made by their down-line distributors. |
Each of our products carries a specified number of sales volume points. Commissions are based
on total personal and group sales volume points per sales period. Sales volume points are
essentially based upon a percentage of a products wholesale cost. To be eligible to receive
commissions, a distributor may be required to make nominal monthly purchases of our products.
Certain of our subsidiaries do not require these nominal purchases for a distributor to be eligible
to receive commissions. In determining commissions, the number of levels of down-line distributors
included within the distributors commissionable group increases as the number of distributorships
directly below the distributor increases. Distributor commissions are dependent on the sales mix
and, for fiscal 2006 and the first three months of 2007, represented 51% and 48% of net sales,
respectively. From time to time we make modifications and enhancements to our compensation plan to
help motivate distributors, which can have an impact on distributor commissions. From time to time
we also enter into agreements for business or market development, which may result in additional
compensation to specific distributors.
Selling, general and administrative expenses consist of administrative compensation and
benefits (including stock-based compensation), travel, credit card fees and assessments,
professional fees, certain occupancy costs, depreciation and amortization, and other corporate
administrative expenses. In addition, this category includes selling, marketing, and promotion
expenses including costs of distributor conventions which are designed to increase both product
awareness and distributor recruitment. Because our various distributor conventions are not always
held at the same time each year, interim period comparisons will be impacted accordingly.
Provision for income taxes depends on the statutory tax rates in each of the jurisdictions in
which we operate. We implemented a foreign holding and operating company structure for our
non-United States businesses effective December 1, 2005. This structure re-organized our
non-United States subsidiaries into the Cayman Islands. Though our goal is to improve the overall
tax rate, there is no assurance that the new tax structure will be successful. If the United
States Internal Revenue Service or the taxing authorities of any other jurisdiction were to
successfully challenge these agreements, plans, or arrangements, or require changes in our transfer
pricing practices, we could be required to pay higher taxes, interest and penalties, and our
earnings would be adversely affected.
Critical Accounting Policies and Estimates
In response to SEC Release No. 33-8040, Cautionary Advice Regarding Disclosure about Critical
Accounting Policies and SEC Release Number 33-8056, Commission Statement about Managements
Discussion and Analysis of Financial Condition and Results of Operations, the Company has
identified certain policies and estimates that are important to the portrayal of its financial
condition and results of operations. Critical accounting policies and estimates are defined as
both those that are material to the portrayal of our financial condition and results of operations
and as those that require managements most subjective judgments. These policies and estimates
require the application of significant judgment by the Companys management.
The most significant accounting estimates inherent in the preparation of the Companys
financial statements include estimates associated with obsolete inventory and the fair value of
acquired intangible assets, including goodwill, and other long-lived assets, as well as those used
in the determination of liabilities related to sales returns, distributor commissions, and income
taxes. Various assumptions and other factors prompt the determination of these significant
estimates. The process of determining significant estimates is fact specific and takes into
account historical experience and current and expected economic conditions. The actual results may
differ materially and adversely from the Companys estimates. To the extent that there are
material differences between the estimates and actual results, future results of operations will be
affected. The Companys critical accounting policies at March 31, 2007 include the following:
Inventory Valuation. The Company reviews its inventory carrying value and compares it to the
net realizable value of its inventory and any inventory value in excess of net realizable value is
written down. In addition, the Company reviews its inventory
14
for obsolescence and any inventory identified as obsolete is reserved or written off. The
Companys determination of obsolescence is based on assumptions about the demand for its products,
product expiration dates, estimated future sales, and managements future plans. Also, if actual
sales or management plans are less favorable than those originally projected by management,
additional inventory reserves or write-downs may be required. The Companys inventory value at
March 31, 2007 was approximately $4.4 million, net of reserve of $3.6 million. Reserve of $2.6
million was recorded in 2006 to write down inventory to its net realizable value due to declining
sales, particularly in Mexico and Japan, and the discontinuation of the Gourmet Coffee Café
TM product line. Additional reserve was recorded during the first three months of 2007 of
$0.3 million related to discontinued products.
Valuation of Intangible Assets and Other Long-Lived Assets. The Company has adopted Statement
of Financial Accounting Standards (SFAS) No. 142, Goodwill and Other Intangible Assets. SFAS No.
142 requires that goodwill and intangible assets with indefinite useful lives no longer be
amortized, but instead be tested for impairment at least annually or sooner whenever events or
changes in circumstances indicate that they may be impaired. At March 31, 2007, goodwill of
approximately $14.1 million was reflected on the Companys balance sheet. No impairment of
goodwill has been identified in any of the periods presented.
The Company reviews the book value of its property and equipment and intangible assets with
definite lives whenever an event or change in circumstances indicates that the carrying amount of
an asset or group of assets may not be recoverable. Recoverability of these assets is measured by
comparison of its carrying amounts to future undiscounted cash flows the assets are expected to
generate. If property and equipment and intangible assets with definite lives are considered to be
impaired, the impairment to be recognized equals the amount by which the carrying value of the
asset exceeds its fair value. During the first three months of 2007, the Company decided to
terminate its existing office lease in Mexico City and relocate to a less costly location. As a
result, an impairment charge of $0.3 million was recorded for certain office equipment and
leasehold improvements. Additionally, the Company determined that it was in its best interest to
discontinue the use of certain computer software in the Japan office, which resulted in additional
impairment totaling $0.2 million. These charges are included as a component of selling, general
and administrative expenses. At March 31, 2007, the net book value of the Companys property and
equipment and intangible assets were approximately $2.1 million and $3.2 million, respectively.
Allowance for Sales Returns. An allowance for sales returns is provided during the period the
product is shipped. The allowance is based upon the return policy of each country, which varies
from 14 days to one year, and their historical return rates, which range from approximately 1% to
approximately 13% of sales. Sales returns are approximately 4% and 5% of sales for the three
months ended March 31, 2006 and 2007, respectively. The allowance for sales returns was
approximately $1.8 million and $1.7 million at December 31, 2006 and March 31, 2007, respectively.
No material changes in estimates have been recognized for the three months ended March 31, 2007.
Revenue Recognition. Product sales are recorded when the products are shipped and title passes
to independent distributors. Product sales to distributors are made pursuant to a distributor
agreement that provides for transfer of both title and risk of loss upon our delivery to the
carrier that completes delivery to the distributors, which is commonly referred to as F.O.B.
Shipping Point. The Company primarily receives payment by credit card at the time distributors
place orders. The Companys sales arrangements do not contain right of inspection or customer
acceptance provisions other than general rights of return. Amounts received for unshipped product
are recorded as deferred revenue. Such amounts totaled approximately $1.0 million and $0.6 million
at December 31, 2006 and March 31, 2007, respectively. Shipping charges billed to distributors are
included in net sales. Costs associated with shipments are included in cost of sales.
Enrollment package revenue, including any nonrefundable set-up fees, is deferred and
recognized over the term of the arrangement, generally twelve months. Enrollment packages provide
distributors access to both a personalized marketing website and a business management system. No
upfront costs are deferred as the amount is nominal. Costs associated with shipments are included
in cost of sales. At March 31, 2007, enrollment package revenue totaling $3.7 million was
deferred. Although the Company has no immediate plans to significantly change the terms or
conditions of enrollment packages, any changes in the future could result in additional revenue
deferrals or could cause us to recognize the deferred revenue over a longer period of time.
Tax Valuation Allowance. The Company evaluates the probability of realizing the future
benefits of any of its deferred tax assets and records a valuation allowance when it believes a
portion or all of its deferred tax assets may not be realized. At December 31, 2005, the Company
increased the valuation allowance to equal its net deferred tax assets due to the uncertainty of
future operating results. During 2006, the Company recorded deferred tax assets in foreign
jurisdictions that are expected to be realized and therefore no valuation allowance is necessary.
The valuation allowance will be reduced at such time as management believes it is more likely than
not that the deferred tax assets will be realized. Any reductions in the valuation allowance will
reduce future income tax provisions.
15
Results of Operations
The following table sets forth our operating results as a percentage of net sales for the periods
indicated.
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended March 31, |
|
|
|
2006 |
|
|
2007 |
|
Net sales |
|
|
100 |
% |
|
|
100 |
% |
Cost of sales |
|
|
20.9 |
|
|
|
26.5 |
|
|
|
|
|
|
|
|
Gross profit |
|
|
79.1 |
|
|
|
73.5 |
|
Operating expenses: |
|
|
|
|
|
|
|
|
Distributor commissions |
|
|
52.4 |
|
|
|
48.4 |
|
Selling, general and administrative expenses |
|
|
29.3 |
|
|
|
48.4 |
|
|
|
|
|
|
|
|
Total operating expenses |
|
|
81.7 |
|
|
|
96.8 |
|
|
|
|
|
|
|
|
Loss from operations |
|
|
(2.6 |
) |
|
|
(23.3 |
) |
Other income, net |
|
|
0.4 |
|
|
|
0.9 |
|
|
|
|
|
|
|
|
Loss before income taxes and minority interest |
|
|
(2.2 |
) |
|
|
(22.4 |
) |
Income tax provision |
|
|
(0.6 |
) |
|
|
(1.0 |
) |
Minority interest |
|
|
(0.1 |
) |
|
|
|
|
|
|
|
|
|
|
|
Net loss |
|
|
(2.9 |
)% |
|
|
(23.4 |
)% |
|
|
|
|
|
|
|
Net Sales. Net sales were $21.5 million for the three months ended March 31, 2007 compared to
$39.5 million for the three months ended March 31, 2006, a decrease of $18.0 million, or 45%. This
decrease was primarily due to continued distractions and disruptions caused by management changes
in the last 18 months, a shareholders demand for action involving some of the Companys Chinese
members, as well as the members reaction to the uncertain regulatory environment in China that is
currently impacting the Companys Hong Kong-based business. Hong Kong net sales decreased $15.8
million, or 54%, over the comparable period a year ago. Additionally, net sales for Japan and
Latin America were down $1.1 million and $0.8 million, respectively. Partly offsetting the
decrease, Taiwan net sales increased $0.5 million, or 62%, compared to the same period in 2006.
As of March 31, 2007, the operating subsidiaries of the Company had approximately 82,000
active distributors, compared to 96,000 and 121,000 active distributors at December 31, 2006 and
March 31, 2006, respectively, excluding the Kaire subsidiaries, which were sold effective July 1,
2006. This decrease is primarily due to the uncertain regulatory environment in China that is
currently impacting the Companys Hong Kong-based business. Hong Kong experienced a decrease of
39,000 active distributors from March 31, 2006 to March 31, 2007.
As of March 31, 2007, the Company had deferred revenue of approximately $4.3 million, of which
approximately $0.6 million pertained to product sales and approximately $3.7 million pertained to
unamortized enrollment package revenue.
Cost of Sales. Cost of sales was $5.7 million, or 26.5% of net sales, for the three months
ended March 31, 2007 compared with $8.2 million, or 20.9% of net sales, for the three months ended
March 31, 2006. Cost of sales decreased $2.5 million, or 30%, for the three months ended March 31,
2007 over the comparable period in the prior year, due primarily to the decrease in net sales.
Cost of sales as a percentage of net sales increased primarily due to Chinese importation costs
incurred in Hong Kong, as these costs have not declined at the same rate as net sales. Also, the
Company recorded an additional inventory provision of $0.3 million related to discontinued
products.
Gross Profit. Gross profit was $15.8 million, or 73.5% of net sales, for the three months
ended March 31, 2007 compared with $31.2 million, or 79.1% of net sales, for the three months ended
March 31, 2006. This decrease of $15.4 million was mainly due to decreased sales, and as discussed
above, Chinese importation costs incurred in Hong Kong that did not decrease relative to sales and
the additional inventory provision.
Distributor Commissions. Distributor commissions were $10.4 million, or 48.4% of net sales,
for the three months ended March 31, 2007 compared with $20.7 million, or 52.4% of net sales, for
the three months ended March 31, 2006. Distributor commissions decreased by $10.3 million, or 50%,
mainly due to the decrease in net sales. The decrease in our commission rate results from less
supplemental commissions paid in North America, and fewer commissions earned in the newer markets
of Japan and Latin America, as well as our efforts to align the overall commission payout in South
Korea with our other markets. We are planning to phase in a distributor commission
enhancement program in the second quarter of 2007, which we believe, when fully in effect, will
lower our commission rate as a percentage of net sales.
16
Selling, General and Administrative Expenses. Selling, general and administrative
expenses were $10.4 million, or 48.4% of net sales, for the three months ended March 31, 2007
compared with $11.6 million, or 29.3% of net sales, for the three months ended March 31, 2006.
Selling, general and administrative expenses decreased by $1.1 million, or 10%, in the three months
ended March 31, 2007, mainly due to the following:
|
|
|
lower credit card charges and assessments in Hong Kong ($0.4 million); |
|
|
|
|
lower legal and accounting fees in North America ($0.6 million); |
|
|
|
|
lower convention cost in North America as the North American Convention was held in
first quarter of 2006 ($0.7 million); |
|
|
|
|
decreased personnel ($0.4 million) and distributor-related ($0.3 million) costs in Japan; partly offset by |
|
|
|
|
costs to terminate the existing lease facility in Mexico City due to relocation to a less costly site ($0.4 million); |
|
|
|
|
costs to discontinue the use of certain computer software in the Japan office ($0.2 million); |
|
|
|
|
severance cost for two former executive officers ($0.6 million) and distributor
settlement costs ($0.1 million) in North America; and |
|
|
|
|
higher professional fees in Hong Kong ($0.2 million). |
Other Income (Expense). Other income was $0.2 million for the three months ended March 31,
2006 and 2007. This income was derived primarily from interest income, including imputed interest
of $0.2 million and $0.1 million on the KGC receivable for the three months ended March 31, 2006
and 2007, respectively.
Income Taxes. The Company recorded a provision of $0.3 million and $0.2 million during the
three months ended March 31, 2006 and 2007, respectively, related to its international operations.
The Company did not recognize a tax benefit for U.S. tax purposes due to uncertainty that the
benefit will be realized.
Effective January 1, 2007, the Company adopted the provisions of FASB Interpretation No. 48,
Accounting for Uncertainty in Income Taxes an Interpretation of FASB Statement No. 109 (FIN
48). FIN 48 requires the Company to recognize in its financial statements the impact of a tax
position if that position is more likely than not of being sustained on audit, based on the
technical merits of the position. The adoption of FIN 48 did not materially affect the
consolidated financial statements and, as a result, the Company did not record any cumulative
effect adjustment upon adoption. As of the date of adoption, the Company does not have any
unrecognized tax benefits for uncertain tax positions.
Net Loss. Net loss was $5.0 million, or 23.4% of net sales, for the three months ended March
31, 2007 compared to net loss of $1.1 million, or 2.9% of net sales, for the three months ended
March 31, 2006. The increased losses were primarily due to lower sales in Hong Kong and Chinese
importation costs incurred in Hong Kong that did not decline at an equivalent rate, partly offset
by a reduction in selling, general and administrative expenses as compared to the comparable period
in the prior year.
Liquidity and Capital Resources
Cash generated from operations has been the main historical funding source for the Companys
working capital and capital expenditures. Additionally, the Company raised approximately $16.0
million, net of transaction fees, through a private equity placement in October 2004. Most
recently, on May 4, 2007 the Company consummated a private equity placement generating gross
proceeds of approximately $3.0 million. The financing consisted of the sale of 1,759,307 shares of
the Companys Series A convertible preferred stock at a price of $1.70 per share. The financing
also included the sale of warrants evidencing the right to purchase 1,759,307 shares of the
Companys common stock at a purchase price of $0.00001 per underlying share of common stock. The
warrants are exercisable at any time during the period beginning six months after their issuance
and ending six years following their issuance. The exercise price of the warrants varies from
$3.80 to $5.00 per share, depending on the time of exercise. The Company plans to use the net
proceeds from this private equity placement to provide additional working capital.
At March 31, 2007, the Companys cash and cash equivalents totaled approximately $8.5 million,
including $3.4 million in China that may not be freely transferable to other countries because the
Companys Chinese subsidiary is subject to a business license capitalization requirement. At
December 31, 2006, the Companys cash and cash equivalents totaled approximately $11.9 million,
including $4.1 million in China.
At March 31, 2007, the ratio of current assets to current liabilities was 0.83 to 1.00 and the
Company had a working capital deficit of approximately $3.3 million. Working capital as of March
31, 2007 decreased $4.3 million compared to that as of December 31, 2006 mainly due to cash used in
operations and additional investment of $0.6 million into a consumer protection fund in South
Korea.
17
Cash used in operations for the three months ended March 31, 2007 was approximately $4.0
million. Cash was mainly utilized due to the incurrence of net losses and decreases in current
liabilities; including accounts payable, accrued distributor commissions and deferred revenue;
partly offset by a reduction in existing inventories.
Cash provided by investing activities during the period was approximately $0.6 million, which
primarily results from $0.7 million received from a certificate of deposit and proceeds received on
the KGC receivable of $0.5 million, offset by an increase in restricted cash of approximately $0.6
million. This increase in restricted cash reflects additional investment of $0.6 million into a
consumer protection fund in South Korea. Total cash and cash equivalents decreased by
approximately $3.4 million during the period.
The Company believes that its existing liquidity, anticipated improvement in cash flows from
operations, and the proceeds received from the private equity placement consummated in May 2007
should be adequate to fund normal business operations expected in the near future, assuming no
significant unforeseen expense or further revenue decline.
We do not intend to devote material resources to opening any additional foreign markets in
2007. Our priority for the remainder of 2007 is to focus our resources in our most promising
markets, namely Greater China, South Korea and Europe.
Related Party Transactions
In August 2001, the Company entered into a written lease agreement and an oral management
agreement with S&B Business Services, an affiliate of Brad LaCore, the brother of Terry LaCore,
former Chief Executive Officer of NHT Global U.S. and director of the Company, and Sherry LaCore,
Brad LaCores spouse. Under the terms of the two agreements, S&B Business Services provided
warehouse facilities and certain equipment, managed and shipped inventory, provided independent
distributor support services and disbursed payments to independent distributors. In exchange for
these services, the Company paid $18,000 annually for leasing the warehouse, $3,600 annually for
the lease of warehouse equipment and $120,000 annually for the management services provided, plus
an annual average of approximately $12,000 for business related services. The Company paid S&B
Business Services approximately $15,000 during the three month period ended March 31, 2006. No
amounts were paid during the three months ended March 31, 2007.
The payment disbursement function was transferred to the Companys Dallas head office during
the third quarter of 2005. In January 2006, the Company hired Sherry LaCore as an employee and
simultaneously terminated the oral management agreement with S&B Business Services. Additionally,
the Company closed the warehouse facility by the end of March 2006 and terminated the related lease
agreement.
In connection with its acquisition of MarketVision Communications Corporation (MarketVision)
in 2004, the Company entered into a software license agreement (the Software License Agreement),
with MarketVision Consulting Group, LLC, a limited liability company owned by John Cavanaugh, the
President of MarketVision, and Jason Landry, a Vice President of MarketVision (the Licensee).
Upon an Event of Default (as defined), the Software License Agreement grants, among other things,
the Licensee with an irrevocable, exclusive, perpetual, royalty free, fully-paid, worldwide,
transferable, sublicensable right and license to use, copy, modify, distribute, rent, lease,
enhance, transfer, market, and create derivative works to the MarketVision software. An Event of
Default under the Software License Agreement includes a Share Default, which is defined as the
market value per share of the Company failing to equal or exceed $10.00 per share for any one
rolling period of six months for a certain period following the acquisition of MarketVision. The
last time that the Companys stock closed at or above $10.00 per share was February 16, 2006, and a
Share Default would otherwise have occurred on August 17, 2006. The parties to the Software
License Agreement amended that agreement to provide that no Share Default will occur prior to
December 31, 2006. No further amendments have been entered into, and as a result, the Company is
currently in default.
Although an Event of Default has occurred, the Company believes that it continues to have the
right to continue using the MarketVision software for its internal use only and not as an
application service provider or service bureau, but may not rent, lease, license, transfer or
distribute the software without the Licensees prior written consent. Moreover, the Company
believes that it has the right to receive certain application service provider services from
Licensee, if it chooses to do so. The Company does not believe that the occurrence of the Event of
Default has had or will have a material adverse effect on the Company.
A former director of the Companys China subsidiary is the sole director of Access Intl
(Zhuhai Ftz) Warehousing & Trading Co. Ltd. and its group (collectively, Access), a
transportation and logistics company, and the owner of Info Development Ltd. (Info), an import
services company, both of which provided services to the Companys Hong Kong subsidiary. Payments
totaling approximately $185,000 and $64,000 were paid to Access and Info during the first three
months of 2006, respectively. Payments totaling approximately $90,000 were paid to Info during the
first three months of 2007. At March 31, 2007, approximately $20,000 was due to Info.
18
On March 23, 2006, an independent investigator retained by the Audit Committee of the Board of
Directors confirmed that affiliates of immediate family members of Mark Woodburn, former President
and director of the Company, have owned since 1998, and continued to own on March 23, 2006, equity
interests in Aloe Commodities (Aloe), the largest manufacturer of the Company and the supplier of
the Skindulgence® Line and LaVie products, representing approximately 5% of the outstanding shares
of Aloe. The Company paid Aloe and certain of its affiliates approximately $51,000 during the
first three months of 2007. No amounts were paid during the first three months of 2006. At March
31, 2007, approximately $432,000 was due to Aloe and certain of its affiliates.
On February 10, 2006, the Company entered into an escrow agreement (the Escrow Agreement)
with Messrs. Woodburn and LaCore, the LaCore and Woodburn Partnership, an affiliate of Messrs.
Woodburn and LaCore, and Krage and Janvey LLP, as escrow agent (the Agent). Pursuant to the
Escrow Agreement, (i) the Company issued and deposited with the Agent stock certificates in the
name of the Agent representing an aggregate of 1,081,066 shares of the Companys common stock (the
Escrowed Shares) and (ii) Messrs. Woodburn and LaCore deposited with the Agent $1,206,000 in cash
(the Cash Deposit). The Escrowed Shares are the shares of common stock issuable upon the
cashless exercise of stock options issued in 2001 and 2002 to Mr. LaCore and the LaCore and
Woodburn Partnership for 1,200,000 shares of common stock exercisable at $1.00 and $1.10 per share.
The number of Escrow Shares is based upon the closing price of the Companys common stock on
February 9, 2006 of $10.14 and the surrender of 118,934 option shares as payment of the aggregate
exercise price of $1,206,000.
The Escrowed Shares were issued to the Agent upon receipt from the Agent of an irrevocable
proxy to the Company to vote the Escrowed Shares on matters presented at meetings of stockholders
or written consents executed in lieu thereof. The parties also agreed that the Agent will hold the
Escrowed Shares and the Cash Deposit until it receives (i) joint written instructions from the
Company, Messrs. Woodburn and LaCore, or (ii) a final non-appealable order from a court of
competent jurisdiction.
On October 31, 2006, the Company, Messrs. Woodburn and LaCore entered into several agreements
(collectively, the Settlement Agreements), pursuant to which they resolved certain pending
disputes among the parties relating to, among other things, payments to Messrs. Woodburn and LaCore
from certain positions in the Companys distribution tree, as follows:
|
(a) |
|
Under the main Settlement Agreement, (i) Messrs. Woodburn and LaCore made a
non-recourse promise to repay the Company $2.5 million (the Payment Amount) no later than
October 31, 2008, (ii) the Company agreed to release the Cash Deposit to Mr. LaCore and the
Escrowed Shares to Messrs. Woodburn and LaCore (subject to the pledge described below),
(iii) Mr. LaCore agreed to provide the Company with assistance for up to 10 hours per month
with respect to network marketing, compensation plan adjustments and strategic planning
assistance during the one-year period ending October 31, 2007, (iv) Messrs. Woodburn and
LaCore agreed to certain restrictions on their activities, and (v) the parties agreed to
enter into the other Settlement Agreements described below. |
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|
(b) |
|
Messrs. Woodburn and Mr. LaCore signed a Non-Recourse Promissory Note to pay the
Payment Amount plus interest at the rate of 6% per annum, secured by a pledge of the
released Escrow Shares. At any time, Messrs. LaCore and Woodburn may elect to repay all or
part of the Note by delivering a number of Pledged Shares based upon the Fair Market Value
(as defined in the Note) of such shares. The Company may also elect at any time to have
all or part of the Note repaid by requiring the surrender of a number of Pledged Shares
having a Fair Market Value equal to the repayment amount. In no event shall Messrs. LaCore
and/or Woodburn be obligated to repay an amount due under the Note in excess of the Fair
Market Value of the Pledged Shares. Given the uncertainty of the Payment Amount that will
ultimately be realized, the Company will not recognize any Payment Amount in its financial
statements until it is received or until the Pledged Shares are surrendered. |
|
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(c) |
|
The Company and Mr. Woodburn entered into a Consulting Agreement, pursuant to which Mr.
Woodburn agreed for a one-year period to assist the Company as a consultant with general
administration, accounting, finance and strategic planning. Mr. Woodburn will be paid
$17,000 per month plus reimbursement of bona fide business expenses approved in advance in
writing by the Company. If Mr. Woodburn is terminated without Cause (as defined in the
Consulting Agreement), he will be entitled to continue to receive his monthly retainer fee
for the remainder of the term, unless he breaches the terms of his Restricted Activity
Agreement (described below) or otherwise engages in a Competitive Activity (as defined in
the Restricted Activity Agreement). Mr. Woodburn is permitted to engage in certain
consulting activities for third parties that will not constitute Cause under the Consulting
Agreement. |
|
|
(d) |
|
The Company and Messrs. LaCore and Woodburn entered into a Voting Agreement covering
all shares of Company capital stock beneficially owned by them or shares acquired by them
during the three year period ending October 31, 2009. All of such shares shall be voted by
the Companys Board of Directors, or such third party that is reasonably acceptable to each
of the Company, Messrs. LaCore and Woodburn. |
19
|
(e) |
|
Each of Messrs. LaCore and Woodburn signed a Restricted Activity and Proprietary Rights
Assignment Agreements, pursuant to which they each agreed to keep confidential or
competitively sensitive information confidential and to disclose and assign to the Company
any Work Product (as defined in the agreements). During the one year period ending October
31, 2007, Mr. LaCore agreed not to directly or indirectly (i) recruit or solicit any
company personnel or independent distributors, or (ii) perform any services for any
independent distributor of the Company (the Covenant Not to Interfere). During the term
of his Consulting Agreement with the Company and continuing through the one year period
following the receipt of his last monthly consulting fee or severance payment, Mr. Woodburn
has also agreed to the Covenant Not to Interfere. In addition, except for Permitted
Consulting Arrangements (as hereinafter defined), during the one year period ending on
October 31, 2007, Mr. Woodburn has agreed not engage in any activity which competes with
any substantial aspect or part of the Companys business (or any affiliate thereof).
Permitted Consulting Arrangements means any consulting or similar arrangement or
agreement between Woodburn and any third party so long as Woodburn delivers to the Company
not less than 10 business days prior to the commencement of service a written notice that
describes the terms and conditions of the proposed consulting arrangement. |
|
|
(f) |
|
The Company, Messrs. LaCore and Woodburn entered into an Indemnification Agreement,
pursuant to which each of Messrs. LaCore and Woodburn agreed as to his individual conduct
to indemnify and hold harmless the Company and its affiliates for his conduct except for
(i) Specified Conduct (as defined), and (ii) conduct for which Messrs. LaCore or Woodburn,
as the case may be, is entitled to indemnification from the Company under the Companys
certificate of incorporation, by-laws and Delaware law. |
|
|
(g) |
|
The Company executed a limited release in favor of Messrs. LaCore and Woodburn with
respect to all charges, claims, causes of action and demands related to their (i)
directing, accepting, or permitting payments to or from certain positions in the Companys
distributor tree from January 1, 2001 through the date of the release, (ii) any related
party transactions relating or pertaining to Messrs. LaCore or Woodburn that were
previously disclosed in the Companys public filings, and (iii) any disclosures made or
omitted, if any, relating or pertaining to any of the foregoing conduct (collectively, the
Specified Conduct). |
|
|
(h) |
|
Messrs. LaCore and Woodburn executed a general release in favor of the Company and its
affiliates, including present and former stockholders, officers, directors, shareholders,
employees, and representatives with respect to all charges, claims, causes of action and
demands of any nature, known or unknown, which Messrs. LaCore or Woodburn had or may have
in the future, except with respect to the Companys obligations under the Settlement
Agreements. |
In connection with the execution of the Settlement Agreements, the Company, Mr. LaCore, Mr.
Woodburn, and the Escrow Agent terminated the Escrow Agreement.
On March 21, 2007, the Company entered into a temporary week-to-week agreement with Mr. LaCore
to administer certain distributor positions at the top of the Companys distribution network tree
and commissions accrued and payable to those positions for periods beginning on and after February
12, 2007. These are the same positions held by the distributor that indirectly made the payments
to Messrs. Woodburn and LaCore that were discovered by the Audit Committees independent
investigator on November 10, 2005 (discussed above). Under the temporary agreement, Mr. LaCore is
expected to provide certain master distributor services and provide leadership and support to the
Companys other distributors, all of whom are down-lines of the positions being temporarily
administered by Mr. LaCore. In return, the Company pays the commissions generated by these
positions under the Companys distributor compensation plan to Mr. LaCore, who in turn must pay
some or all of the commissions to other distributors downline. The total amount of gross
commissions that the Company will pay to Mr. LaCore for administration of these positions under
this temporary arrangement is uncertain, as the amount of commissions varies from week to week.
The amount of gross commissions paid to Mr. LaCore for temporary administration of these positions
for the period beginning Feb. 12, 2007 and ending March 31, 2007 was approximately $107,000. The
Company is currently considering various longer term arrangements with Mr. LaCore.
Recent Accounting Pronouncements
In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements, which defines fair
value, establishes a framework for measuring fair value in generally accepted accounting principles
(GAAP), and expands disclosures about fair value measurements. SFAS No. 157 is effective for
financial statements issued for fiscal years beginning after November 15, 2007. The Company is
currently evaluating the impact, if any, the adoption of SFAS No. 157 will have on its consolidated
financial statements.
20
Off Balance Sheet Arrangements
The Company does not utilize off-balance sheet financing arrangements other than in the normal
course of business. The Company finances the use of certain facilities, office and computer
equipment, and automobiles under various operating lease agreements.
Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
In the normal course of business, we are exposed to market risks from changes in foreign
currency exchange rates. We do not use derivative financial instruments to manage market risks.
In the first three months of 2007, approximately 89% of our revenue was recorded by
subsidiaries located outside of North America. Revenue transactions and related commission
payments, as well as other incurred expenses, are typically denominated in the local currency.
Accordingly, our international subsidiaries use the local currency as their functional currency.
The results of operations of our international subsidiaries are exposed to foreign currency
exchange rate fluctuations during consolidation since we translate into U.S. dollars using the
average exchanges rates for the period. As exchange rates vary, revenue and other operating
results may differ materially from our expectations. Additionally, we may record significant gains
or losses related to foreign-denominated cash and cash equivalents and the re-measurement of
inter-company balances.
We believe that our foreign currency exchange rate exposure is somewhat limited since the Hong
Kong dollar is pegged to the U.S. dollar. We also purchase all inventories in U.S. dollars. Our
foreign currency exchange rate exposure, mainly to Korean won, Singapore dollar, New Taiwan dollar,
Japanese yen, Mexican peso, Chinese yuan, and Australia dollar, represented approximately 26% of
our revenue in the first three months of 2007. The Company recorded a nominal foreign currency
gain during the first three months of 2007. Our foreign currency exchange rate exposure may
increase in the near future as our China subsidiary commences operations. Additionally, our
foreign currency exchange rate exposure would significantly increase if the Hong Kong dollar were
no longer pegged to the U.S. dollar.
We currently do not have plans to hedge translation risks. Changes in the currency exchange
rates that would have the largest impact on translating our international net assets include Korean
won, Chinese yuan, Japanese yen, Mexican peso, New Taiwan dollar, and Australian dollar.
Item 4. CONTROLS AND PROCEDURES
Our management is responsible for establishing and maintaining an adequate level of internal
controls over financial reporting. Internal control over financial reporting is a process designed
to provide reasonable assurance regarding the reliability of financial reporting and the
preparation of financial statements for external purposes in accordance with generally accepted
accounting principles (GAAP). Internal control over financial reporting includes policies and
procedures that:
|
|
|
pertain to the maintenance of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the assets of the Company; |
|
|
|
|
provide reasonable assurance that transactions are recorded as necessary to permit
preparation of financial statements in accordance with GAAP, and that receipts and
expenditures of the Company are being made only in accordance with authorizations of
management and directors of the Company; and |
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|
|
|
provide reasonable assurance regarding prevention or timely detection of unauthorized
acquisition, use, or disposition of the Companys assets that could have a material effect
on the consolidated financial statements. |
Because of its inherent limitations, internal control over financial reporting may not prevent
or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are
subject to the risk that controls may become inadequate because of changes in conditions, or that
the degree of compliance with existing policies or procedures may deteriorate.
The following material weaknesses in our internal control over financial reporting were
reported in our 2006 Annual Report on Form 10-K filed with the United States Securities and
Exchange Commission on March 28, 2007:
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|
|
We did not maintain an effective control environment because (1) we lack an effective
anti-fraud program to detect and prevent fraud, for example, relating to the former top two
executive officers of the Company, Mark Woodburn and Terry LaCore, in terms of (i)
conflicts of interests related to executive officers, especially their financial dealings
with independent distributors and other vendors, and (ii) proper supervision of the
executives conduct separating their executive duties from |
21
|
|
|
personal financial interests outside the Company, and (2) an adequate tone was not set from
the top as control measures in place were ignored by the previous top two executives and the
importance of controls was not properly emphasized and communicated throughout the Company; |
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|
|
We did not maintain effective monitoring controls over financial reporting because we do
not have an internal audit function; |
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|
|
|
We lacked documentation with respect to certain related party transactions, subsidiary
operations and expense reimbursement procedures. In addition, policies related to
independent distributor relationships were inadequate. |
Each of the control deficiencies described above could result in a misstatement of the
aforementioned accounts or disclosures that would result in a material misstatement to the annual
or interim consolidated financial statements that would not be prevented or detected. Management
has determined that each of the control deficiencies constitutes a material weakness.
Based on this evaluation, the Companys President and Chief Financial Officer have concluded
that our disclosure controls and procedures at March 31, 2007 were not effective to provide
reasonable assurance that information required to be disclosed in the reports we file and submit
under the Exchange Act is recorded, processed, summarized and reported as and when required.
In light of this conclusion and as part of the preparation of this report, we have applied
compensating procedures and processes as necessary to ensure the reliability of our financial
reporting. Accordingly, management believes, based on its knowledge, that (1) this report does not
contain any untrue statement of a material fact or omit to state a material fact necessary to make
the statements made not misleading with respect to the periods covered by this report, and (2) the
financial statements, and other financial information included in this report, fairly present in
all material respects our financial condition, results of operations and cash flows for the periods
then ended.
Changes in Internal Control Over Financial Reporting
The following changes in our internal control over financial reporting occurred during the
first three months of 2007:
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|
|
Effective February 21, 2007, Stephanie Hayano resigned as the Companys President and
Chief Executive Officer, and the Board of Directors appointed (i) Chris Sharng, previously
Executive Vice President and Senior Financial Officer, to the position of President of the
Company and (ii) Timothy S. Davidson, previously Chief Accounting Officer, to the position
of Senior Vice President and Chief Financial Officer. |
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|
In March 2007, our subsidiary in Japan discontinued the use of its existing financial
software system and migrated to a package more suitable for its current operating
environment. |
In light of the noted material weaknesses, we will continue to institute control improvements
that we believe will reduce the likelihood of similar errors:
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|
|
We are devoting more resources to develop an anti-fraud program to detect and prevent
fraud. We have subscribed to compliance training programs provided by WeComply, Inc.
concerning fraud awareness, insider trading, and the Foreign Corrupt Practices Act, and
required substantially all employees to complete such programs. We may engage outside
counsel in each market to review our distributor-related policies, procedures and business
practices. Additionally, the program may include the hiring of outside or in-house counsel
to be dedicated to the development and enforcement of compliance programs. The compliance
program also will include a communication project to set the right tone from the top; |
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We will evaluate whether to engage outside resources to perform internal audit projects;
and |
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|
We are developing policies for proper documentation, review and approval related to
related party transactions, subsidiary operations, expense reimbursements, and distributor
relationships. |
Certain of these remediation efforts will require significant ongoing effort and investment.
Our management, with the oversight of our audit committee, will continue to identify and take steps
to remedy known material weaknesses as expeditiously as possible and enhance the overall design and
capability of our control environment. We believe that the foregoing actions will continue to
improve our internal control over financial reporting, as well as our disclosure controls and
procedures.
If the remedial policies and procedures we continue to implement are insufficient to address
the material weakness or if additional significant deficiencies or other conditions relating to our
internal controls are discovered in the future, we may fail to meet our future
22
reporting obligations, our financial statements may contain material misstatements and our
operating results may be adversely affected. Any such failure could also adversely affect the
results of the periodic management evaluations and annual auditor attestation reports regarding the
effectiveness of our internal controls over financial reporting, which will be required when the
SECs rules under Section 404 of the Sarbanes-Oxley Act of 2002 become applicable to us beginning
with the filing of our Annual Report on Form 10-K for the year ended December 31, 2007. Internal
control deficiencies could also cause investors to lose confidence in our reported financial
information. Although we believe that we will address in the near future our material weakness in
internal controls, we cannot guarantee that any measures we take will remediate the material
weakness identified or that any additional material weakness or significant deficiencies will not
arise in the future due to a failure to implement and maintain adequate internal controls over
financial reporting.
PART II OTHER INFORMATION
Item 1. LEGAL PROCEEDINGS
The Company is subject to certain legal proceedings which could have an adverse effect on its
business, results of operations, or financial condition. For information relating to such legal
proceedings, see Note 5 in the Notes to Consolidated Financial Statements contained in Part I, Item
1 of this Quarterly Report on Form 10-Q.
Item 1A. RISK FACTORS
The Company is exposed to certain risks factors that may affect operations. The significant
risk factors known to the Company are described in Item 1A in the Companys Annual Report on Form
10-K for the year ended December 31, 2006, which was filed with the Securities and Exchange
Commission on March 28, 2007. There have been no material changes from the risk factors as
previously disclosed in that Form 10-K.
Item 6. EXHIBITS
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|
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Exhibit |
|
|
Number |
|
Exhibit Description |
10.1
|
|
Employment Letter Agreement dated January 3, 2007 between the Company and Gernot Senke
(incorporated by reference to Exhibit 10.1 to Current Report on Form 8-K filed January 9,
2007) |
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10.2
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|
Non-Competition and Proprietary Rights Assignment Agreement dated January 3, 2007 between
the Company and Gernot Senke (incorporated by reference to Exhibit 10.2 to Current Report
on Form 8-K filed January 9, 2007) |
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10.3
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Severance Agreement between Natural Health Trends Corp. and Stephanie Hayano dated as of
February 21, 2007 (incorporated by reference to Exhibit 10.1 to Current Report on Form 8-K
filed February 26, 2007) |
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10.4
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Severance Agreement between Natural Health Trends Corp. and Gernot Senke dated as of
February 21, 2007 (incorporated by reference to Exhibit 10.2 to Current Report on Form 8-K
filed February 26, 2007) |
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10.5
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Form of Notice of Restricted Stock Grant and Restricted Stock Agreement
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31.1
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Certification of the President pursuant to Rule 13a-14(a) of the Securities Exchange Act
of 1934, as amended (the Exchange Act) |
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31.2
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Certification of the Chief Financial Officer pursuant to Rule 13a-14(a) of the Exchange Act |
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32.1
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|
Certification of the President pursuant to Rule 13a-14(b) of the Exchange Act and 18
U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 |
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32.2
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Certification of the Chief Financial Officer pursuant to Rule 13a-14(b) of the Exchange
Act and 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002 |
23
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly
caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
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NATURAL HEALTH TRENDS CORP.
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Date: May 11, 2007 |
/s/ Chris T. Sharng
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Chris T. Sharng |
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President (Principal Executive Officer) |
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24
EXHIBIT INDEX
|
|
|
Exhibit |
|
|
Number |
|
Exhibit Description |
10.1
|
|
Employment Letter Agreement dated January 3, 2007 between the Company and Gernot Senke
(incorporated by reference to Exhibit 10.1 to Current Report on Form 8-K filed January 9,
2007) |
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10.2
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|
Non-Competition and Proprietary Rights Assignment Agreement dated January 3, 2007 between
the Company and Gernot Senke (incorporated by reference to Exhibit 10.2 to Current Report
on Form 8-K filed January 9, 2007) |
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|
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10.3
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|
Severance Agreement between Natural Health Trends Corp. and Stephanie Hayano dated as of
February 21, 2007 (incorporated by reference to Exhibit 10.1 to Current Report on Form 8-K
filed February 26, 2007) |
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10.4
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Severance Agreement between Natural Health Trends Corp. and Gernot Senke dated as of
February 21, 2007 (incorporated by reference to Exhibit 10.2 to Current Report on Form 8-K
filed February 26, 2007) |
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10.5
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Form of Notice of Restricted Stock Grant and Restricted Stock Agreement
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31.1
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|
Certification of the President pursuant to Rule 13a-14(a) of the Securities Exchange Act
of 1934, as amended (the Exchange Act) |
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31.2
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|
Certification of the Chief Financial Officer pursuant to Rule 13a-14(a) of the Exchange Act |
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32.1
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|
Certification of the President pursuant to Rule 13a-14(b) of the Exchange Act and 18
U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 |
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32.2
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|
Certification of the Chief Financial Officer pursuant to Rule 13a-14(b) of the Exchange
Act and 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002 |